Insolvency law changes: an overview

Implementation of the Insolvency Law Reform Act 2016 came into effect on September 1 this year, ushering in a raft of major changes that will impact directors, bankrupts, suppliers and creditors.

While these long-awaited reforms have been designed to improve the integrity and efficiency of Australia’s insolvency laws while also enhancing business rescue capabilities and entrepreneurial support, some experts believe they may also initiate in a whole new range of complications.

Safe Harbour and Ipso Facto

Twelve-years in the making, the long-awaited safe harbour and ipso facto reforms are viewed by regulators as necessary for helping create a genuine restructuring culture.

“Ipso Facto”

Presently, a company facing financial issues have the ability to appoint an external administrator to negotiate a compromise position with its creditors to address any short-term cash flow problems. The new rules are an attempt to extend the effectiveness of this regime by nullifying an ipso facto clause in a contract that allows one party to terminate the contract due to an insolvency event, even if the company is continuing to perform under the contract. A common example is the termination of a “sub-contract for works” by the principal, upon the appointment of an external administrator, thereby leaving the subcontractor with no opportunity to trade-out of their difficulties, even with creditor support.

Safe Harbour

The new law also introduces a safe harbour for directors, who are now protected from personal liability for insolvent trading if they meet the Safe Harbour test – “taking a course of action reasonably likely to lead to a better outcome for the company”.

“The safe harbour changes give directors breathing space, providing them time to consider the position of the company early in the piece, without the potential threat of insolvent trading,” explains Amanda Young. “In turn, this may improve the position for creditors, enabling them to explore the possibility of restructure or sale, which may subsequently lead to more of the company’s value being preserved. The ipso facto legislation, meanwhile, eliminates the immediacy of insolvency clauses in certain contracts, such as within the construction industry. However, at times it may not be the ideal situation if the contract is still in place.”

 User-pays funding model

In a bid to recoup the estimated $8-million a year it spends on monitoring Australia’s insolvency industry, ASIC’s new user-pays system requires Australia’s estimated 700 registered liquidators comply with a number of key changes.

These include the introduction of an annual fixed levy of $2,500 per-year in addition to the $3,500 registration fee and $1,700 renewal fee due every three-years. It also requires liquidators to pay a graduated levy based on the number of ‘entity metric events’ charged according to the number of appointments on hand at the start of the financial year, the number of new appointments accepted by the liquidator during the year, and the number of Published Notices Website (PNW) advertisements placed.

Recently John Winter, CEO of the Australian Restructuring, Insolvency & Turnaround Association commented on the regulatory oversight of the insolvency industry by stating ‘Overseen by ASIC and the Australian Financial Security Authority – which are armed with thousands of pages of law, rules and regulations; funded with over $10 million for enforcement; and resourced with around 20 regulation staff between them to cover just 700 practitioners – there is no more closely scrutinised group of professionals.”

Jirsch Sutherland Partner Andrew Spring believes the complexity of the changes, in addition to the already cumbersome statutory process, may create further challenges when dealing with the creditor community.  “The ILRA does provide creditors with more powers in an external administration and increased compliance and regulation for liquidators and trustees,” says Andrew. “However, our discussions with creditors have highlighted a need for better engagement between the external administrators and the creditor group, through efficient investigation, early reporting and greater transparency on the likelihood of return.”

Phoenixing

With the cost of illegal phoenixing to the Australian economy believed to be anywhere between $1.9 and $3.2 billion annually, the significance of this new legislation can’t be overstated.

Put simply illegal phoenixing is where companies are stripped of assets and liquidated, then restarted under a different name, leaving creditors without recourse to the asset pool. In accordance with the new laws, each Australian company director will be assigned a unique identification number to track those with a history of deliberately scuttling their companies to avoid paying creditors before starting up businesses without those debts. The Directors Identity Number will enable directors to be tracked through other government agencies and databases in order to map their relationships to other companies and other people.

“This is a step in the right direction,” says Jirsch Sutherland Partner Andrew Spring. “By making people more aware that they can be easily tracked, it may act as a deterrent to engaging in illegal phoenix activity. And with mandatory DINs, which will require proof of identity, it may stifle the incidence of straw or ‘dummy’ directors.”

Bankruptcy Bill

The new Bankruptcy Bill reduces the default period of bankruptcy from three-years to one.

Re-introduced after being repealed in 2003, the one-year period is designed to lessen the stigma associated with bankruptcy. Under the new bill, bankrupts will be discharged at the end of the period of one-year from the date on which they filed their statement of affairs. It will also reduce the period during which a person must declare themselves bankrupt when applying for credit, as well as the seeking of permission to travel overseas and enter into certain professions or positions.

However, despite the best intentions of the new regulations, Andrew Spring believes significant challenges will still arise. Indeed, while the need to encourage entrepreneurs to re-engage in business has been given as a key reason behind the new legislation, Spring says that discharged bankrupts will still find it difficult to borrow money after one-year.

“When the bankrupt period was spread over three-years, bankrupts were able to establish a new credit rating through their savings, income, or paying their bills on time,” he says. “The reduction to one-year will make this more difficult.”