By James Allen (Lawyer) and Venn King (Special Counsel)
On 18 September 2017 the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Cth) (Act) received assent, introducing significant reforms to Australia’s insolvency and restructuring laws.
The reforms introduce two concepts to protect both directors and companies during periods of significant financial distress: “safe harbour” protections and the ipso facto enforceability regime.
What is the ipso facto regime?
Ipso facto means “by that very fact or act”. The new law applies to rights (including a right of termination or a right to damages) exercisable by one party to a contract because of the fact that the other party, being a company, enters administration, receivership or a scheme of arrangement. The law imposes a stay temporarily preventing the enforcement of those rights, in order to allow the affected company time to consider its position, keep trading, and (hopefully) return to solvency.
The new ipso facto regime assists companies by ensuring that they are not penalised for the sole reason that they are in financial distress, provided that they continue to meet their contractual obligations (eg payment obligations). However, where (for example) a right of termination exists if a company suffers such an occurrence, the other party will still be able to terminate the contract.
- Stays preventing enforcement – the ipso facto regime provides for automatic ‘stays’ preventing the enforcement of rights that are triggered when a company enters administration, receivership or a scheme of arrangement, for the purposes of avoiding being wound up in insolvency. The regime covers ipso facto clauses that are self-executing, as well as those that need to be triggered by one of the parties to a contract. The court may also render rights unenforceable indefinitely following formal insolvency, where the rights relate only to the company’s entry into formal insolvency or its financial position before, or during, formal insolvency.
- Exceptions – if a company is protected by the operation of a stay, a contractual counterparty will still be able to take action against it for any other valid reason, including non-payment or non-performance of the contract. Courts will also be able to allow ipso facto rights to be enforced if appropriate in the interests of justice.
- Additional powers – courts may, however, require a party seeking to enforce independent rights (such as a right of termination for convenience) following the issue of a stay, to apply for leave from the Court to exercise those rights, where the Court suspects that they are only being exercised because the other party has entered formal insolvency.
- Exclusions – there are exclusions from the ipso facto regime for certain rights, including:
- agreements made after the commencement of a formal restructure;
- agreements made before the commencement of the Act and not subsequently varied; and
- agreements of a type specified in regulations or declared by the Minister.
Ensure that your rights of termination under a contract are not solely triggered by the other party’s insolvency – rights of termination for breach should generally be included as standard (including clear rights in relation to non-payment if you are a supplier), and consider rights of termination for convenience. If you are looking to terminate in circumstances where the other party is a company subject to an insolvency event, or if you are a trading company dealing a party faced with insolvency, seek legal advice as early as possible.
What are the “safe harbour” protections?
The new safe harbour protections provide directors with certain protections against personal liability arising from the provisions of the Corporations Act prohibiting insolvent trading. These protections are designed to allow directors greater flexibility to trade out of difficult financial positions, provided they are taking reasonable steps in accordance with a planned course of action that is subject to qualified advice.
- Purpose – the safe harbour changes protect directors from the application of section 588G of the Corporations Act – the insolvent trading provisions. The removal of personal liability should assist directors in pursuing opportunities where a company is considered to be solvent in the long term and avoid situations where companies are unnecessarily liquidated. Safe harbour protections only apply to section 588G of the Corporations Act and directors must ensure that they comply with all other legal obligations.
- Effect – a director will be not liable for debts incurred while the company was insolvent, when he or she was developing or taking a course of action that was reasonably likely to lead to a better outcome for the company than proceeding directly to immediate administration or liquidation. Further, the director will not be liable for debts “incurred directly or indirectly in connection with” developing and taking that course of action.
- Appropriately qualified advisor – the director’s course of action must be determined in consultation with an appropriately qualified advisor, where the advice should be “fit for purpose”, and ‘appropriateness’ will depend on the nature, complexity and financial position of the company.
- Period of safe harbour – the safe harbour commences from the time the director, after suspecting or identifying that the company may become insolvent, starts to develop one or more appropriate courses of action. This includes the period required to obtain initial advice and a reasonable decision-making period. Directors must take the decided course of action within a “reasonable period”, which will depend on the circumstances – a few days for a small company to perhaps months for a large complex entity.
While you may be covered by the new safe harbour provisions, that protection is not without conditions. If you are unsure if the safe harbour provisions apply to you, and you are a director of a company that has or may become insolvent, speak to a member of our Corporate & Commercial team for tailored advice.
When will these laws commence?
The safe harbour provisions are in force now, while the ipso facto regime will commence on (and apply to contracts entered into on or after) 01 July 2018.
If you require further information about the new laws, please do not hesitate to contact a member of our Corporate & Commercial team.
See also our earlier post about proposed significant changes to the Bankruptcy Act 1966 (Cth).