The Federal Government’s Bankruptcy and Insolvency Laws Proposals Paper proposes three changes to Australia’s bankruptcy and insolvency laws, with a view to encouraging entrepreneurship in Australia while simultaneously protecting the rights of creditors. Will these changes be beneficial?
The proposals are:
1.Reduction of the current default bankruptcy period from three years to one year.
2.‘Safe Harbour’ provisions for directors from personal liability for insolvent trading, providing they appoint a restructuring adviser.
3.Making ‘ipso facto’ clauses (where contracts can be terminated early due solely to insolvency) unenforceable in cases where the company is undergoing a restructure.
In the sections below we provide some commentary on the proposals, and also outline five steps towards business recovery.
Reduction of the default bankruptcy period
Proposals made in the paper include:
- Retention of the trustee’s ability to object to discharge, and extend the period of bankruptcy up to eight years in cases of
misconduct. - That even after discharge, the obligations on a bankrupt to assist in the administration of their bankruptcy remain in place.
- Separation of the obligation to pay income contributions from the default bankruptcy period. This means income contributions will be payable by a bankrupt for a minimum period
of three years, even with the reduction of the bankruptcy period in place. - Reduction of credit restrictions on a bankrupt to one year, subject to any extension or misconduct.
- Reduction of the overseas travel restriction by the bankrupt to one year, subject to any extension or misconduct.
- Consultation with industry and licencing associations with a view to aligning industry and licencing restrictions with the reduced period of bankruptcy.
We would question whether one of the stated objectives of this proposal, namely, to encourage entrepreneurial activity, is likely to
be accomplished on implementation.
Conclusion
In our overall view the above proposals get the balance right, and should be supported.
Safe harbour provisions and ipso facto clauses
The government has indicated it intends to pursue the innovative approach of providing directors with a safe harbour option. This allows directors to retain control of the company, while receiving restructuring advice from professional advisers within a framework that provides for the interests of creditors.
Background on Australia’s insolvency laws
Prior to 1993, there was no statutory definition of insolvency. The insolvent trading provisions were amended in 1993 to implement the recommendations of the Harmer Inquiry. The amendments sought to address the identified criticisms of the then existing provisions.
The criticisms included:
- Failure to encourage directors to deal with solvency issues in a timely manner.
- A failure to maintain records.
- Directors were provided with a defence in cases where they failed to perform their duties with proper diligence, by omitting to take a sufficient role in management.
- Creditors were given the right to prosecute the claim, in effect excluding the liquidator.
Under the amendments ‘Voluntary Administration’ (VA) was introduced – which allows companies to continue trading even while at risk of insolvency, under the provison that they appoint administrators.
The implementation of the current insolvent trading provisions was accompanied by a great trade off by the ATO. In this case the ATO surrendered its statutory priority for unremitted withholding taxes, and in return gained the director penalty notice regime to recover these taxes from directors in certain circumstances. The director penalty notice regime has been strengthened in recent years, but has failed to incorporate the GST.
Insolvency professionals acting as company administrators are personally liable for debts incurred from the time of their appointment to a company, as well as any amount of GST involved. If directors are not prepared to try to turnaround a failing business with the defences available to them to avoid personal liability, it is little wonder that company administrators have little appetite to seek to implement creative and risky restructuring options with no defences available to them.
Our insolvent trading provisions are often subject to strong criticism by various interest groups. It is claimed they discourage directors
from attempting to implement restructuring proposals to turn their businesses around, and that they bring about the destruction of value and job losses as a consequence of formal insolvency administrations. However, the prohibition on insolvent trading was introduced to protect creditors from directors disregarding the capacity of the company to repay when incurring debt.
Is the safe harbour necessary?
Australia’s insolvent trading regime is tougher than the UK’s wrongful trading regime. In addition, neither the United States nor Canada have a statutory insolvent trading regime.
The Australian regime was implemented in conjunction with the director penalty regime and the VA process, to encourage directors to act in a timely manner to appoint an administrator. The object of the administration is the management of the business, property and affairs of the company. This is done with a view to maximising the chance of the company – or as much as possible of its business – continuing its
existence. In cases where this is not possible, the aim is to at least provide a better return to creditors than would occur in the case of
an immediate winding up.
We consider that the VA process has not provided the opportunities for business restructuring that was hoped for by its creators. Reasons for this include the capacity of a secured creditor to appoint a receiver in certain circumstances, as well as the enforcement of ipso facto clauses and the personal liability of administrators.
It is uncertain whether the safe harbour will meet the high expectations that its promoters promise either. An informal restructuring without statutory imposition of its terms on recalcitrant creditors can be very hard to negotiate, implement and administer.
Conclusion
Efforts by the legislature to encourage timely action by company directors to appoint an administrator, in order to maximise the prospects of a successful restructuring of the business and save jobs, have been frustrated by the practical impacts of ipso facto clauses, secured creditors retaining the right to appoint receivers, and the personal liability of the administrator for debts including GST. Change is certainly required, but the safe harbour provision may not be the answer.
How businesses can regain their financial stability
Often when a business runs into trouble it can be a slippery slope. Without the cash reserves to invest in new staff or processes, the business could find it difficult to recover. However, it may be possible to do so as long as the business owner can take a logical,
stepwise approach.
RSM has identified five steps towards business recovery:
1. Attack the crisis early and head on
Businesses that admit they are in trouble and commit to turning the situation around are more likely to be successful than otherwise. Business owners should assess their current situation, and make immediate changes that will have the biggest positive impact on cash flow and revenue first. It is vital to set objectives and develop a plan for achieving them – the key is to act decisively and quickly.
2. Get information immediately
It may be possible to restructure or extend existing financial credit to ease financial stress in the short term. In light of this it is important for business owners to communicate with financiers and suppliers to get as much breathing room as they possibly can.
3. Communicate with customers
If the business needs to make changes to invoicing schedules and payment terms, it is crucial that they communicate directly with customers to maximise the value of any goodwill and encourage earlier payments. Business owners should consider offering aggressive discounts or
deals to get cash flowing into the business as quickly as possible.
4. Hit the pause button on spending
Businesses in trouble should only buy the minimum amount of inputs needed for the enterprise to operate. Inventory should be kept in line with revenue, while an intense focus on customer service can also help to build revenue.
5. Get help
Organisations should seek professional advice to help them make the changes they need to make. Business and financial advisors can show companies how to restructure both their operations and their financial commitments effectively, in order to maximise their chances of getting back on their feet.
By following the steps listed above, it may be easier for businesses experiencing a difficult patch to recover from their current situation and avoid insolvency and its consequences. However, it’s important to face the situation head on, to seek professional advice as early as possible, and to formulate a comprehensive recovery plan.
For further information, please contact:
Frank Lo Pilato
Partner, RSM Australia
(02) 6217 0348
[email protected]
Jon Colbran
Partner, RSM Australia
(02) 6217 0341
[email protected]
