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September 2010 
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Insolvency Law Reform In Australia |
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Pauline Renaud, April 2010 |
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In response to the increase in company failures since the start of the financial crisis, the Australian government announced on 19 January 2010 a Corporate Insolvency Law Reform Package, which promotes informal insolvency procedures to facilitate the restructuring of companies in financial difficulty. It also seeks to reverse the effect of the High Court’s decision in Sons of Gwalia v Margaretic, to encourage lenders to provide unsecured debt finance to Australian companies without pricing in the risk of potential competing shareholder claims. Ultimately, such changes to the framework of Australia’s insolvency laws are designed to help alleviate the effects of the downturn. However, there are some concerns that the proposed reforms fail to address some major issues relating to insolvency, and may actually lead to a rising number of insolvencies.
Recognition of informal procedures
The reform package, outlined in the discussion Paper ‘Insolvent Trading: a safe harbour for reorganisation attempts outside of external administration’, is aimed at improving the balance between discouraging undesirable conduct while promoting responsible risk taking and economic development.
The Paper recognises the benefits of informal workouts in business rescue and the protection of the shareholders, creditors and employees of a distressed business. More specifically, the reforms target three objectives: reducing the costs and complexity of insolvency administrations, improving communications with creditors, and reducing the potential abuse of corporate insolvency law. The Paper presents three options to discuss in insolvency law reform, the first of which is to retain the current regime. “Reasons cited for retaining the law, as it now applies, include the potential consequences of any weakening of the prohibition against insolvent trading and the possibility that any safe harbour from liability for insolvent trading might be the subject of abuse,” says Clint Hinchen, a partner at Allens Arthur Robinson.
The second option is the adoption of a modified ‘business judgement rule’. This new rule would relieve directors of the duty not to trade while insolvent, subject to compliance with the conditions set out in the Paper. Also, this option would provide a safe harbour from the risk of personal liability for insolvent trading for directors making bona fide efforts at an informal workout outside of the bounds of external administration. “The problem is that, currently, Australia’s insolvent trading laws are more severe than those of other jurisdictions, which often require some element of fault or knowledge,” says Mr Hinchen. “They present a strong disincentive for informal workouts of companies which are actually insolvent or close to insolvency, and are an area of considerable concern for directors of companies in financial difficulty.” Under the second option outlined in the reform package, directors and companies would be encouraged to conduct genuine informal workouts. But the issue of legal defences against insolvent trading has become a matter of conjecture following recent federal court cases such as McLellan, in the matter of The Stake Man Pty Ltd v Caroll. According to experts, this was the first time a judge exercised his discretion under the Corporations Act 2001 (Cth) to give a director complete relief from penalty following a finding of insolvent trading.
Finally, the reform package proposes a moratorium. Directors would be permitted to expressly and openly invoke a moratorium from the insolvent trading prohibitions for the purpose of attempting an informal corporate reorganisation outside of external administration. Under this option, businesses would be required to inform the market of their insolvency and intention to pursue a workout outside of external administration. Existing creditors would have the right to bring the moratorium to an end if the company’s insolvent trading was collectively considered to be against the creditors’ interests. This final option would allow directors to continue trading while providing a level of protection and control to existing and potential creditors. Clearly, this option shares some similarities with a US Chapter 11 procedure, which features debtor-in-possession financing and a moratorium.
The proposed reforms would also amend the Corporations Act 2001 to reverse the effect of the High Court’s decision in Sons of Gwalia v Margaretic (2007). Currently, according to that decision, shareholders who have been allegedly induced into purchasing shares in a company just prior to its insolvency by misrepresentations and inadequate market disclosure, are able to lodge claims as creditors in the company’s voluntary administration. The High Court of Australia interpreted the statutory subordination provisions in the Corporations Act 2001 narrowly, with the result that many shareholders have been permitted to stand alongside non-shareholder creditors in corporate insolvencies. “Subordinated debt holders in large corporate failures have, as a result of that decision, found themselves competing with shareholder claims, with a significant increase in the costs of administration further reducing returns to creditors,” explains Michael Lhuede, a partner at Piper Alderman. “The government has announced it will legislate to remove this distinction so as to subordinate shareholder claims to those of ordinary unsecured creditors,” he adds. By reversing the effects of that decision, the Australian government hopes to increase the availability, and lower the cost, of debt funding for Australian companies by encouraging lenders to provide unsecured debt finance without the risk of having potential competing shareholder claims. This reform is also aimed at supporting the growth of the secondary debt market in Australia, and encouraging informal workouts and distressed investment. But, presumably, the insolvency law reform will not impact on the ability of shareholders to pursue companies for damages for misrepresentation, or breaches of continuous disclosure laws in connection with the acquisition of securities issued by the companies, whether those companies are solvent or insolvent.
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