Reforms to Australian corporate insolvency law are in the wind

Various pressures periodically emerge that generate calls for reform of the law of directors’ duties. However, many in the company director fraternity would claim that the century-long creep in raising the liability of directors has extended too far. One argument is that the law erodes legitimate risk-taking, undermining the willingness of motivated and able individuals to take on these important roles.

Another argument has the law at odds with commercial reality where, in the majority of cases, the critical day-to-day running of companies is in the hands of professional managers. As the function of directors is largely one of strategic oversight, to make directors primarily responsible in cases of operational failure misses the point.

Driving corporate law reform in Australia has largely been the bastion of technical bureaucratic elites, such as that built up around the Corporate Law Economic Reform Program, and targeted special-purpose inquiries such as the Australian Law Reform Commission’s Harmer Inquiry into Australia’s corporate insolvency law in 1988, which resulted in the establishment of voluntary administration as the major element in our business recovery arrangements.

We also had standing bodies in place, dealing with complex matters raised by reference from the federal treasury, principal of which has been the now-defunct Corporations and Markets Advisory Committee established under the Australian Securities and Investments Act 2001.

In 2014 the Productivity Commission stepped into the insolvency law-reform fray with its inquiry into business set-up, transfer and closure. The scope of the Productivity Commission’s brief was wide, addressing such vital matters as access to finance (which it concluded not to be a dire problem) and multiple-level government red tape. Importantly, the Commission deliberated on some of the more contentious areas of directors’ duties and liability.

The government has yet to formally respond to the Productivity Commission’s report (submitted on 30 September 2015), but picked up some of its key recommendations within the National Innovation and Science Agenda announced last December – a strong indication that measured bankruptcy and insolvency law reform is on its way.

As expected, Australia’s legal scheme of corporate insolvency and personal bankruptcy is regarded as highly robust and efficient. It’s also noteworthy that most business closures and transfers occurred without the burden and stigma of failure.

“As expected, Australia’s legal scheme of corporate insolvency and personal bankruptcy is regarded as highly robust and efficient.”

The following conclusions and proposals from the Productivity Commission report and the Innovation Statement are relatively incremental in nature but will, in due course, influence the details of advice provided by public practising accountants to their clients.

Proposals for insolvency reforms

  • Some specific reforms to Australia’s corporate insolvency regime are warranted, but a wholesale change to the system – such as adopting the American Chapter 11 “debtor in possession” framework – is neither justified nor likely to be beneficial. For the foreseeable future, this ends agitation for this approach, which typically arises at the time of a high-profile corporate failure such as Ansett Airlines.

    The tendency in Australia to favour creditor over debtor interests is largely preserved. Recognition is also given to the potentially high supervisory cost if specialist bankruptcy courts were established as part of Chapter 11-type oversight.
  • Formal company restructuring through voluntary administration should only be available when a company is capable of being a viable business in the future. This recognises problems that emerged in the “one-size-fits-all” statutory scheme of voluntary arrangements and also promotes a stronger culture of business recovery.
  • A “safe harbour” defence should be introduced to allow directors of a solvent company to explore, within guidelines, restructuring options without them being subject to director personal liability for insolvent trading. This helps business recovery by addressing the tendency to opt for voluntary administration to mitigate financial risk and the professional stigma of trading insolvent.

    While this goes some way to addressing claims by directors that the law makes them unduly risk averse, it remains to be seen if this lessens the push from company directors to extend the current narrow-based business judgement rule protection applicable to the general duty of care and diligence. 
  • A simpler liquidation process should be introduced to reduce the time and expense of winding up businesses with few or no recoverable assets. This is a realistic recognition that many failures at the small corporate end merely survived on a tenuous turnover of working capital.
  • Banning of ipso facto contractual clauses allowing an agreement (typically of supply in nature) to be terminated solely due to an insolvent event if a company is undertaking a restructure. Again, this is intended to promote opportunity for business recovery rather than a quick path to liquidation.

    The default exclusion period and restrictions on bankrupts in relation to access to finance, employment and overseas travel should be reduced from three years to one, with the trustee and courts able to extend this period to prevent abuse. The obligation to repay debts should continue to be required for three years or until bankruptcy discharge.

    While this will bring Australia in line with overseas trends, it is curious that it is tied to an innovation agenda, given that the majority of personal bankruptcies are non-business in nature and often relate to matters such as credit card debt and unemployment arising in economic downturns.
As with any significant law reform, development is likely to be protracted, all the more so as the federal election looms. In terms of drafting itself, the devil will definitely be in the detail. CPA Australia will keep you apprised as the reforms move forward.

Read next: Insolvency - at what cost?


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June 2019
June 2019

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