Innovation statement: Changes to insolvency laws will allow “viable businesses” to be rebuilt

Members of the small business community have welcomed a move by the federal government to alter the current insolvency laws to strike “a better balance between encouraging entrepreneurship and protecting creditors”.

Recognising that many entrepreneurs fail several times before they succeed, the government used its innovation statement to reveal it will reduce the current default bankruptcy period from three years to one year.

The government will also introduce a “safe harbour” provision to protect directors from personal liability for insolvent trading if a restructuring adviser is appointed to help turn the company around.

Legislation will also be introduced to make “ipso facto” clauses that terminate contracts on the basis of insolvency unenforceable if a company is in the process of being restructured.

“Our current insolvency laws put too much focus on penalising and stigmatising the failures,” the innovation statement says.

The recommendations were also contained in the Productivity Commission’s draft report on the barriers of setting up and closing a business, which was released in May.

A proposal paper for the changes will be released in 2016, ahead of plans to introduce legislation in mid-2017.

Peter Strong, executive director of the Council of Small Business of Australia, told SmartCompany the proposed changes show the government is acknowledging that business owners are “people” and sometimes mistakes are made.

“It’s illegal to trade while insolvent but sometimes during the startup phase you can end up doing that just because of the nature of cash flow and marketplaces,” Strong says.

“You’ve got to get someone in and get you back on track and that’s exactly what is being done here. If you business can keep going, everyone is a winner.”

Lack of reform has “held back” Australian insolvency law

John Winter, chief executive of the Australian Restructuring Insolvency and Turnaround Association (ARITA), told SmartCompany this afternoon ARITA has been calling for some of these reforms for “over a decade”.

Winter says the lack of a “safe harbour” provision for directors in particular has “really held insolvency law back in Australia”.

“It will help rebuild viable businesses,” Winter says.

“Some businesses will still be allowed to fail and the capital be re-allocated, but others hit tough times or are subject to a sudden market shift.”

Winter says while the reforms would affect businesses of all sizes that experience insolvency, he says it tends to be directors of larger, listed companies that “rush” towards external administration because of the current director penalty regime.

Winter is particularly pleased to see proposed reforms to the enforceability of “ipso facto” clauses following an insolvency event, which he says have triggered the closure of several high-profile businesses, including One.Tel.

Winter says “ipso facto” clauses are often enacted in supply and rental agreements, with suppliers or landlords currently able to unilaterally cancel contracts if insolvency occurs, even when the business is still paying their bills.

For retailers, this could force the closure of their stores in the event their landlord uses the clause to cancel the contract.

“On its own, we don’t believe an insolvency event is enough to cancel a contract,” Winter says.