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Insolvency law reforms in Australia – safe harbour and stay on ipso facto clauses

On 18 September 2017, the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Cth) (Treasury Laws Amendment Act) received Royal Assent.  The Treasury Laws Amendment Act creates major changes to Australia’s insolvency law regime by introducing:

  • a “safe harbour” for company directors to avoid contravening the insolvent trading provision in the Corporations Act 2001 (Corporations Act); and

  • provisions making “ipso facto” clauses unenforceable while a company is undergoing specified restructuring or other arrangements aimed at avoiding being wound-up in insolvency.

The new safe harbour provisions came into effect on 19 September 2017 and the changes to the ipso facto laws are expected to come into effect on 30 June 2018.

Background to the Treasury Laws Amendment Act

Australia has had very strict laws aimed at preventing companies from trading while insolvent.  Section 588G of the Corporations Act imposes a statutory duty on company directors to prevent insolvent trading, making the directors personally liable for debts that are incurred and imposing civil and criminal penalties.  In addition, ipso facto clauses (i.e. those that allow one party to terminate or modify a contract on the occurrence of a specified event, such as an insolvency related event) can adversely impact the ability of a company suffering financial difficulties from restructuring, selling assets or trading out of those financial difficulties.

It is hoped that the new provisions will:

  • reduce the number of premature formal insolvency processes;
  • encourage more early stage investors and professional directors to become involved in start-up companies by reducing the stigma associated with being involved with an insolvent company; and
  • give Australian companies facing financial difficulties a better chance of being restructured or turned around (with a view to preserving value for creditors and shareholders). 

Safe Harbour

The Treasury Laws Amendment Act introduces a new section 588GA into the Corporations Act which provides that the civil insolvent trading provisions of section 588G(2) of the Corporations Act do not apply to a person and a debt (i.e. creates a “safe harbour”) if, after the person starts to suspect that the relevant company may become (or already is) insolvent, that person starts developing a course of action that is reasonably likely to lead to a better outcome for the company (Improvement Action) and the debt is incurred in connection with that Improvement Action.  

Key points relating to the operation of the safe harbour are as follows:

  • The safe harbour period starts to apply from the time the person starts developing the Improvement Action (including any decision-making period relating to that Improvement Action and any period required to obtain initial advice). 
  • The Improvement Action must be taken within a reasonable period for the safe harbour to remain in place, and the safe harbour applies until the director or company stops taking the Improvement Action, the Improvement Action stops being reasonably likely to lead to a better outcome for the company or the company goes into administration or liquidation.

  • The Treasury Laws Amendment Act includes a non-exhaustive list of factors that may be considered relevant when determining whether any Improvement Action is reasonably likely to lead to a better outcome for the relevant company.  For example, whether the person/director has:

    • kept him/herself informed about the company’s financial position;

    • taken appropriate steps to prevent misconduct by officers or employees of the company that could adversely affect the company’s ability to pay all its debts

    • taken appropriate steps to ensure the company is maintaining appropriate financial records;

    • obtained advice from appropriately qualified advisers who were sufficiently informed; or

    • developed or implemented a plan to restructure the company to improve its financial position. 

  • During the safe harbour period, directors must continue to comply with their other duties under the Corporations Act and (if applicable) the company and its officers must also continue to comply with the continuous disclosure obligations under the Corporations Act and the ASX Listing Rules.

The safe harbour will be unavailable in certain circumstances, such as where the company has not been paying its employees, complying with its tax reporting obligations, or if a person seeking to rely on the safe harbour fails to substantially comply with obligations to assist an administrator, liquidator or controller that is later appointed under a formal insolvency process.  

Stay on enforcing ipso facto clauses

The amendments in the Treasury Laws Amendment Act provide for a stay against the enforcement of rights that amend or terminate an agreement to which a company is a party in the following circumstances:

  • because of the company entering into a compromise or arrangement under Part 5.1 of the Corporations Act (where the scheme is for the purpose of avoiding insolvent liquidation);
  • where a receiver or managing controller is appointed over all or substantially all of the property of the company under Part 5.2 of the Corporations Act; or
  • where the company is placed into voluntary administration under Part 5.3A of the Corporations Act. 

Key points relating to the operation of the stay are below:

  • The “stay period” (generally) begins and ends at the following times:

    • In the case of a compromise or arrangement under Part 5.1 of the Corporations Act (scheme), the stay period starts when the scheme is publicly announced and ends on the later of:

      • if the company fails to make the scheme application within 3 months after the announcement, at the end of that 3 month period;

      • when the scheme application is withdrawn or dismissed by the court; or

      • when the scheme ends, unless this occurs because the company is to be wound up (in which case the stay period ends when the company’s affairs have been fully wound up). 

    • In the case of receivership or appointment of a managing controller, the stay period starts when the receiver or managing controller is appointed and ends when the receiver’s or managing controller’s control ends.

    • In the case of a voluntary administration, the stay period starts when the company enters into administration and ends when:

      • the administration ends; or

      • the company’s affairs have been fully wound up, 

whichever is the later.

  • The right to amend or terminate an agreement under an ipso facto provision will also continue to be unenforceable indefinitely after the end of the stay period, where the reason for enforcing the relevant amendment or termination right relates to the company having been under one of the specified forms of restructuring arrangements referred to above or because of its financial position before the end of the stay period or in certain other prescribed circumstances (including where the reasons are in substance contrary to the stay provisions).

  • The stay does not apply to agreements made after the commencement of one of the specified forms of external administration referred to above.

  • The provisions do not (generally) impose a stay or prohibit the exercise of a right for any other reason (e.g. termination for a failure by the company to make required payments or perform some other obligation under the relevant contract).

  • While a stay is in force, the relevant contractual counterparty or creditor of the company will not be required to provide additional credit or new advances to the company.

  • The new stay rules will only apply to contracts, agreements or arrangements entered into after the commencement date of the stay provisions.  

Author:  Samantha Khoo

If you have any queries about this article, please contact Samantha Khoo (Senior Associate - skhoo@sierralegal.com.au), Michael Jeffery (Director – mjeffery@sierralegal.com.au) or Craig Sanford (Director – csanford@sierralegal.com.au).