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Changes to insolvency and restructuring laws

Supporting start ups and entrepreneurs through turmoil - a high level review of the Government's National Innovation and Science Agenda to modernise insolvency and restructuring practices.

Remember the old maxim: “if at first you don’t succeed, try, try, try again” ?. It comes from the poem “Try Try Again” by TH Palmer which provides words of “encouragement” for those who fail but have the will to keep going until they eventually succeed.

One would not usually associate the laws of insolvency with poetry, however this theme of “Try, Try, Try Again” appears to be reflected in the proposed reforms to the Australian insolvency and restructuring regime.

The Federal Government wants to create a culture shift in the economy by modernising insolvency and restructuring practices that support the growth of start-ups and new business, instead of punishing them in their infancy. A reality of entrepreneurialism is that many businesses or individuals will have a series of failures before they are successful. The proposed reforms seek to shift the focus away from penalising and stigmatising failures to promoting growth by encouraging entrepreneurship whilst at the same time protecting creditors.

What are the proposed reforms?

In April 2016, the Government’s National Innovation and Science Agenda (NISA) released a Proposal Paper with an agenda that focusses on three measures to improve bankruptcy and insolvency laws:

  • Reducing the current default bankruptcy period from three years to one year;
  • Introducing a ‘safe harbour’ for directors from personal liability for insolvent trading if they appoint a restructuring adviser to develop a turnaround plan for the company; and
  • Making ‘ipso facto’ clauses, which have the effect of allowing contracts to terminate solely due to an insolvency event, unenforceable if a company is undertaking a restructure.

Further changes to insolvency laws are being implemented under the Insolvency Law Reform Act 2016 which is due to commence in March 2017. The Act seeks to reform aspects of the legislation governing insolvency regimes such as the Corporations Act 2001, the Australian Securities and Investments Commission Act 2001 and the Bankruptcy Act 1966.

Briefly, the purpose of the Insolvency Law Reform Act 2016 is to simplify, streamline and improve the costs and efficiency of insolvency administrations. It will also afford greater protection to creditors during the external administration process by giving them greater powers to request information and also the power to pursue voidable transaction claims by appointment by the liquidator.

What does this mean for me?

If you are thinking of starting a new business or have a start-up that you wish to get off the ground but are discouraged because of the high risk of failure in light of the merciless insolvency laws, then it may be worth thinking about how these new reforms may assist you.

Broadly, the reforms are designed to assist start-ups and promote innovation in, the following ways:

  • Reducing the default bankruptcy period to 1 year: The current default period is three years and is seen as a disincentive to business start-ups. During the bankruptcy period, the bankrupt faces many restrictions such as travel, obtaining finance, incurring further debts and licensing and employment restrictions. Sometimes people fall bankrupt because of misfortune and external factors outside their control and not always misdeed. Reducing the period to one year will reduce the associated stigma and encourage discharged bankrupts to continue to pursue their entrepreneurial endeavours.
  • Director safe harbours: the Government proposes to implement a safe harbour for directors from the insolvent trading provisions under the Corporations Act. The risk of breaching insolvent trading laws are one of the key deterrents for early stage investors and professional directors getting involved with start-ups. Insolvent trading is a serious offence and carries some heavy penalties for directors. It is sometimes hard to pick when a company is technically insolvent and many companies enter voluntary administration as a result. Put generally, a safe harbour allows directors to appoint a professional restructuring adviser over its company that is in financial difficulty and may be insolvent or nearing insolvency. The safe harbour is intended to provide directors with a restructuring option that allows them to retain control of the company and receive formal restructuring advice rather than handing over the company to external administrators. The directors can appoint an adviser without the fear of being pursued under insolvent trading laws. The safe harbour option is only available to directors who have acted in accordance with their directors duties and have not been disqualified from managing the company at the time debts were accrued.
  • Unenforceable ‘ipso facto clauses’: “ipso facto” translates to “because of that fact”. In the context of insolvency, in many contracts because the fact a contracting party becomes insolvent, the agreement is automatically terminated because an act of insolvency or bankruptcy amounts to automatic termination. This is regardless of continued performance. To put this in perspective, if Company A is a trade creditor of Company B and Company B goes into administration but is still paying for goods, if there is a ipso facto clause in the relevant contract between the companies, Company A can terminate the contract.

However, under the reforms, if a company is undertaking a restructure, the “ipso facto” clauses will be unenforceable. As NISA reports, these clauses diminish the value of a business entering insolvency and may reduce the opportunity for a successful restructure or prevent the sale of a business of a going concern. The current voluntary administration regime offers little protection against these clauses and is an area the Government wants to specifically target.

Try, Try, Try….and try some more

NISA, the driving force behind the reforms, has stated that entrepreneurs will fail several times before they make it and will usually learn a lot in the process. The Government also encourages entrepreneurs and start-ups to take a risk, leave behind the fear of failure and be more innovative and ambitious.

Will these reforms achieve this? Only time will tell and there is much debate about their effectiveness and feasibility in practice. But in the meantime, as part of any business strategy or plan, you should be aware of how both the current insolvency laws and reformed insolvency laws will affect your business – before it’s too late.

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