Insolvency safe harbour reforms back on the agenda, but more work needed

Back in April 2016, the federal government proposed amendments to bankruptcy and corporate insolvency laws under its National Innovation and Science Agenda.

The government has sat on the proposed amendments for some time now, so it came as a bit of a surprise when a legislation Exposure Draft dealing with safe harbour positions for insolvent trading and ipso facto clauses in insolvency administrations was released last week.

Pitcher Partners has long supported the need for safe harbour provisions. Under the existing legislation, directors commit an offence when they incur debts at a time when the company is insolvent, or becomes insolvent as a result of incurring the debt and there are reasonable grounds for suspecting that the company is insolvent.

The legislation impacts disproportionately on more sophisticated small to medium businesses where directors may have significant wealth outside of the business, and thus they are particularly vulnerable to, and wary of, inadvertently breaching insolvent trading laws.

The impact of personal liability for insolvent trading leads directors of SMEs to be overly cautious when it comes to restructuring activities and results in the liquidation of companies that could become viable businesses.

The government’s new proposed legislation suggests that directors will not be committing an offence if, after becoming concerned about the company’s solvency, a director takes a “course of action that is reasonably likely to lead to a better outcome for the company and the company’s creditors”.

“Reasonableness” in this instance is defined as taking appropriate steps to prevent misconduct by officers or employees; ensuring the company is keeping appropriate financial records; taking advice from an appropriately qualified entity; keeping properly informed of the company’s financial position; and developing or implementing a plan to improve the company’s financial position.

A director must also, during this period, ensure that the company is meeting its payment obligations to its employees and its reporting obligations to the Australian Taxation Office. Holding companies, which may be liable for insolvent trading by a subsidiary will not, under the current exposure draft, be protected by the safe harbour provisions.

The devil here is in the detail, and unfortunately the government has ignored the recommendations of insolvency and business recovery practitioners in formulating its proposed legislation. As a result, the proposed legislation reads more like a solution to a legal issue rather than a practical consideration for directors.

The original proposal paper provided two options for a safe harbour model: Model A, which provided for a restructuring adviser to be appointed to the company, and Model B, which is closer to what’s in the exposure draft legislation and places more onus on directors.

The peak body for insolvency and business recovery practitioners, the Australian Restructuring Insolvency and Turnaround Association (ARITA), supported Model A on the basis it provided a better solution when it came to balancing creditors’ rights with allowing for responsible business risk taking, innovation and entrepreneurialism. A restructuring advisor can act as a provider of accurate, rational assessments of whether a company is capable of being made solvent under a specified time period, and these assessments are crucial to help to engender support from creditors, resulting in greater collaboration and willingness to restore businesses’ value.

In favouring Model B, the government has paid insufficient regard to the disparate challenges facing working capital-challenged entities. The absence of a registered restructuring adviser could further facilitate an environment in which pre-insolvency advisers flourish. Already, there is an unregulated network of ethically challenged pre-insolvency advisors taking advantage of directors during a particularly difficult time.

While a director may not subsequently be able to rely on safe harbour provisions if they engage these advisors, without specifying the need for an appropriately qualified restructuring advisor under the new legislation, the government has left open a situation that could enable unregulated pre-insolvency advisors to sell themselves as experts who can work within the requirements of the new law.

The pre-insolvency advisory industry is already in dire need of regulation. Unfortunately, the safe harbour legislation as it stands is more likely to result in further growth of this sector, compromising the ability of SME directors to effectively pull a company out of a slide into insolvency, and therefore defeating the purpose of the legislation.

The government should revisit the recommendations from ARITA and the industry with respect to the appointment of a restructuring advisor over the course of the legislative review process.

Never miss a story: sign up to SmartCompany’s free daily newsletter and find our best stories on Twitter, Facebook, LinkedIn and Instagram.