Skip to main content

Australian Insolvency Laws Finally Almost Ready for Their Major Leap Forward

Posted on: April 18, 2017

Last year, we reported that Australia had proposed significant insolvency reforms that, in our view, are long overdue ("A Major Leap Forward for Australian Insolvency Laws"). Now, the Australian government has released a revised draft of its insolvency legislation (text available here) providing a safe harbor from director insolvent trading liability and limitations on the enforceability of ipso facto clauses upon the occurrence of certain insolvency-related events.

Safe Harbor
The directors of an insolvency Australian company can be held personally liable by a liquidator for debts incurred while the company is insolvent if the company is unable to repay such debts. The risk of personal liability naturally has a chilling effect on a board’s willingness to take even reasonably calculated risks, sometimes creating roadblocks to an otherwise clear path to restructuring outside of an administration. The draft legislation would not remove the risk of liability entirely, but it would shield directors of insolvent companies from civil liability for debts incurred in connection with a course of action that is reasonably likely to lead to a better outcome for the company and its creditors as a whole. To rely on the safe harbor provision, a director must initially offer some evidence that the course of action was reasonable before the burden is shifted to the liquidator. The legislation includes a list of factors that may be considered in determining reasonableness, including proper information gathering, taking appropriate steps to prevent employee/officer misconduct, keeping appropriate financial records, obtaining qualified and informed advice, and developing or implementing a restructuring to improve the company’s financial position. And regardless of reasonableness, the proposed safe harbor is unavailable in certain circumstances (e.g., where the company fails to provide for employee entitlements or satisfy tax reporting obligations).

Ipso Facto Clauses
Ipso facto clauses are essentially contractual provisions that provide for termination of a contract (and/or payments due) upon the occurrence of a bankruptcy filing or other insolvency event. Such clauses are generally unenforceable in bankruptcy in the United States, but Australian law has long upheld the right of parties to agree to part ways upon the insolvency of either party. The draft legislation would prevent parties from enforcing ipso facto clauses when a counterparty is in administration or has proposed a scheme of arrangement to avoid being wound up in insolvency. Without providing this relief, Australian restructurings have sometimes been hampered by the threat that vendors, suppliers, lessors and other counterparties will walk before a restructuring can be consummated. Preventing the enforcement of ipso facto clauses should reduce the likelihood of liquidation and provide breathing room to successfully restructure debt.

Why These Changes Are Good for US Investors
Adding a safe harbor provision and restricting ipso facto clause enforcement would benefit US investors by reducing barriers to successful restructurings and thereby preserving the going concern value of distressed Australian borrowers. In any jurisdiction, restructuring in- and out-of-court can be challenging in terms of building consensus and binding minority hold-outs. In Australia, the process has additional challenges; directors face not only personal liability for trading whilst insolvent but also face severe reputational damage for being associated with a failed company in Australia’s close-knit business and financial community. Such high personal stakes tend to suppress a director’s appetite  to take measured risk to preserve a struggling business once it enters the zone of insolvency. A similar attitude is prevalent among third party suppliers seeking to avoid unnecessary credit exposure. While incentives to avoid business failure may promote a greater degree of care and prudence among directors, those same incentives can hinder proactive financial solutions and discussions with stakeholders. We expect the proposed legislative changes, once implemented, to give directors greater leeway in considering and implementing restructurings. Directors of an insolvent company may consider rescue financing or lender concessions where appropriate to bridge a temporary downturn or catastrophic event that might otherwise result in liquidation. And if a consensual restructuring can be negotiated—and even if an administrator is appointed—the ipso facto restriction will enable debtors to maintain the status quo with vendors and other counterparties for a period to allow the borrower and its creditors to implement a scheme of arrangement. We believe these proposed changes create a better framework for implementing value-preserving solutions and should make Australian companies more attractive borrowers (with a lower cost of capital) by reducing downside credit risk.

Next Steps in the Process
The Australian government is accepting written responses to the draft legislation until later this month, and further changes may be warranted. For example, the safe harbor provision appears to terminate upon the appointment of a receiver over any of the company’s assets—and ipso facto clauses would still be enforceable in receivership. If all goes according to schedule, the final version of the legislation should be enacted before year end, with an anticipated effective date  of January 1, 2018. We will provide another update when that happens.