Discuss About The Exposure Draft Differs Current Insolvency?
The current law on insolvent trading imposes a positive duty on directors of preventing insolvent trading.[1] By virtue of that law, a director is required to prevent a company from incurring debts if it is already insolvent or if by incurring those debts, it runs into insolvency. Section 588G (1) provides that there are reasonable grounds upon which a director may assume that the company is running into debt. A director is deemed to have engaged in insolvency trading if that company incurs debt and; becomes insolvent as a result of the incurred debt; there are reasonable grounds to suspect that the company would become insolvent; the director has knowledge of those grounds or a reasonable person in the same scenario would be aware; and the director did not prevent the incurring of debt by the company.[2] Section 95A defines insolvency as the inability to pay all the debts as and when they become due.
The Australian Government’s Exposure Draft titled Treasury Laws Amendment (2017 Enterprise Inventive No. 2) Bill 2017 makes proposals for amending the Corporations Act. The amendments in the draft Bill under Part 1, will exclude company directors from personal liability for insolvent trading by creating a ‘safe habour’ in cases where a company undertakes restructure in particular circumstances. The intention of the Exposure Draft, particularly Part I of the same, is operating as a carve-out from the duties of a director to prevent insolvent trading.[3] Its objective is to save businesses and nurture a turnaround culture.[4] The major difference between the current insolvency laws and the Exposure Draft is that the current law is focused on the creditor and prefers the creditor to the rehabilitation of companies.[5] To fully capture the differences between the Exposure Draft and the current insolvency laws, the following section critically analyses the effectiveness of Part I of the Exposure Draft.
The Exposure Draft has introduced a safe harbour from personal liability to insolvent trading. This it has done by introducing section 588GA just below section 588G, which contains the safe harbour provisions. The safe harbour is expected to operate as a carve-out to directors from the section 588G (2) provisions of civil insolvent trading. This paper notes that the Exposure Draft limits how the carve-out operates. For instance, directors must demonstrate that they were taking reasonable steps likely to achieve a better outcome for the entirety of the creditors and company. Directors are precluded from taking passive roles or from allowing a company to trade normally during financially difficult times or undertaking recovery plans. Furthermore, directors can only rely on the safe harbour if they were taking appropriate courses of action to ensure compliance with the company’s duty of maintaining proper records and books, provision for entitlements to employees and tax reporting requirements. Where a liquidator has already been appointed, directors who withhold books and records do not fall under the protection of the safe harbour.
The Exposure Draft also outlines a list of factors that a court may consider to establish that a reasonable course of action was undertaken to lead to a likely better outcome for the company and creditors thereof. It is important to note that the limits set in the Exposure Draft are not intended at making provision for a company to trade past its viability. Accordingly, it is notable that discretion is left to the courts to determine if the circumstances of each case are meritorious for qualifying for the safe harbour. Also, it is noteworthy that the scope of mounting a defence based on a company’s circumstances is considerable. The burden of proof is on a liquidator who alleges that section 588G was contravened to argue and prove that the safe harbour is not applicable since a director failed to take reasonable steps;
The Exposure Draft proposes the evidential burden mechanism. The Explanatory Memorandum explains that directors bear the burden of proof. The onus is on a director to furnish the relevant information, books and not to withhold any.[6] Such evidences are examined by the liquidator who then makes a determination of whether more material is required. For a director who seeks to place reliance on the safe harbour provisions, the initial evidentiary burden is lowered.[7] This evidential burden is reasonable since it gives room for identifying issues that are relevant. In addition, it is in line with the principle that a plaintiff establishes the wrong that a defendant is alleged to have committed.
The safe harbour provision addresses numerous issues such as timing of insolvency. This gives ample opportunity to directors for undertaking rational decision making processes devoid of fear of liability. It also assists directors to make sure that the balance within the law is not fundamentally altered while offering protections to the company and creditors from recklessness where a company has already entered into debt.[8] According to ARITA, the safe habour provisions must not be deemed as relaxing the responsibilities of directors but one that heightens them. Beneficial and positive governance thresholds must be met before invoking the business judgement rule.[9]
The Exposure Draft proposes the mandatory appointment of a restructuring advisor by a company that is in insolvency. Such appointment should be a recommendation and not mandatory to enable good corporate governance, which a company adopts voluntarily. This mandatory requirement is flawed and may give rise to unnecessary problems since it disempowers directors.[10] A myriad of issues affect business performance, for example, business cycles, international relations, demographic changes and the general economy, among other factors. A company may have adopted an appropriate strategy and all that is needed to manifest positive changes may be some more time or a few tactical changes. Engaging the services of an external advisor too early may not be favorable to a company or creditors and only serves the purpose of undermining the directors and not demonstrating confidence and trust in them. Hence, the reputation and morale of a company is likely to be affected adversely. If the appointment is mandated, it may only be a short while before it becomes mandatory to disclose the appointment.
Even if the restructuring adviser is to be appointed by the company, the requirement for accreditation should be removed at the very least. The Australian Institute of Company Directors in their submission of 2016, at page 5, recommend an approach that is principle based rather than the prescriptive approach proposed by the Exposure Draft. Very business differs and under the ever changing circumstances, there is a plethora of needs. No accreditation can ever suffice to cater for the ever changing nature of business.[11] Accordingly, the decision for appointment of a restructuring adviser should be left at the discretion of the company if is so elects.
It is important that the Australian Securities and Investment Commission keep a register containing the names and education, qualifications and codes of professional conduct of restructuring advisors.
The policy objective underpinning the Exposure Draft proposals in introducing a safe habour is provision of a moratorium where directors are able to turn around the business. The consequence is better returns for creditors and the continual use of assets in a productive manner as opposed to a “fire sale”. In this regard, this paper agrees that the restructuring adviser’s role would be formulating an idea as to the viability of a company. However, although it is agreeable that the test for viability should be avoiding insolvent liquidation, this paper does not agree that the appropriate method of determining viability is “return to solvency”. This is more so in light of the stringent test for solvency in the current law of the Corporations Act. In numerous instances where corporate groups have been successfully restructured, there are companies that were wound up when their business assets were sold, and this exemplifies a rescue of a business that is viable by selling it to a new owner.
This paper considers that any reforms made to the personal liability for directors for insolvent trading must not be at the expense of suppliers, customers, employees and innocent creditors who are bona fide in their dealings with the company assuming that it is solvent. In other words law reform on duties of directors as relates to insolvent trading should not be at the sacrifice of protection of creditors. Informed markets should necessarily be the cornerstone of approaches to laws on insolvency trading.[12] Under the Exposure Draft, directors are not required to reveal whether they are carrying on business in a safe harbour. Under the current law as constituted, confidentiality applies to situations where there are work-outs and restructurings. With regard, therefore to disclosure, there is no change between the proposals and the current law as creditors are still uninformed. It is noteworthy that trade supplier creditors are required to be secured by virtue of the provisions of the Personal Properties Securities Act 2009 (Cth). Hence even though the safe harbour provisions to directors in insolvency are introduced creditors who fail to protect themselves will lose their goods. With respect to public listed companies, the Exposure Draft is neutral, since it leaves the decision to disclose that the company is in a workout under the continuous disclosure rules to the public to the directors. This position is arguably reasonable since it would not be reasonable for a company to disclose such information at a time it is undertaking a business rescue.
Based on the above discourse, the question is how effective is Part I of the Exposure Draft. The answer to this question is not as straight forward as it may seem. It is a matter that is subject to much ongoing deliberation and analysis. The Australian Institute of Company Directors (2017, p.1) has noted that if the proposed reforms are effectively designed, they will foster innovation and entrepreneurship by encouraging directors and companies to take responsible risks. Accordingly, whether Part I of the Exposure Draft is effective or not is dependent on how effectively they will be designed. The design of the proposals will be achieved through incorporating the various views expressed by the respective stakeholders as above-discussed and thus making necessary adjustments to the law. However, overall, this paper strongly supports the reforms to Australia’s insolvency laws which are considered to be among the world’s strictest insolvency laws.
Conclusion
To answer the question as to: whether the amendments should proceed as drafted; or if the current law should remain; or if other amendments should be made, this paper answers as follows. There is no doubt, need for the proposed amendments as the current insolvency law is draconian, especially when benchmarked against global insolvency laws. The changes are needed to implement a cultural shift and minimize the impact of the stigma that attends to business failure.[13] Indeed, changes are necessary to strike a balance between creditor protection and encouraging entrepreneurship.[14] However, further amendments should be made to the Exposure Draft proposed amendments to fine tune the law and make it more economically viable. The following are the recommendations this essay makes.
References
ARITA (Australian Restructuring Insolvency and Turnaround Association) 2014, A Platform for Recovery 2014, Discussion Paper, October, p.13.
Australian Institute of Company Directors (AICD), ‘Improving bankruptcy and insolvency laws’, Treasury.gov.au, 2016, https://www.governanceinstitute.com.au/media/881308/final_submission_insolvency_law_reform.pdf (accessed 18 September 2017), p.5.
Australian Institute of Company Directors (AICD), ‘National Innovation and Science Agenda – Improving corporate insolvency law’, Treasury.gov.au, 2017 https://static.treasury.gov.au/uploads/sites/1/2017/06/C2017-010_Australian-Institute-of-Company-Directors-UPDATED.pdf (accessed 20 September 2017).
Australian Shareholders Association, ‘Treasury Laws Amendment (2017 Enterprise Incentives No. 2 Bill)’, https://static.treasury.gov.au/uploads/sites/1/2017/06/C2017-010_Australian-Shareholders-Association.pdf, 2017 (accessed 17 September 2017).
Corporations Act 2001 (Cth).
Davis, H, ‘Insolvency Law Reform – Submissions of Henry Davis York’, https://static.treasury.gov.au/uploads/sites/1/2017/06/C2017-010_Henry-Davis-York.pdf, 2017 (accessed 17 September 2017).
Dong, L, ‘Submission Regarding Insolvency Law Change’, 2017, https://static.treasury.gov.au/uploads/sites/1/2017/06/C2017-010_Dong-Lin.pdf, 2017 (accessed 17 September 2017).
Governance Institute of Australia, ‘Insolvent Trading: A safe Harbour for Reorganisation Attempts Outside of External Administration’, Treasury.gov.au, https://www.governanceinstitute.com.au/media/37076/Final_submission_revised_business_judgment_rule_insolvency.pdf, 2010, p.2.
KordaMentha Restructuring, ‘Improving Corporate Insolvency Law – Exposure Draft 2017’, https://static.treasury.gov.au/uploads/sites/1/2017/06/C2017-010_KordaMentha.pdf, 2017 (accessed 17 September 2017).
Law Council of Australia, ‘Submission in response to the Treasury National Innovation
and Science Agenda – Improving bankruptcy and insolvency laws’, Treasury.gov.au,
https://www.lawsociety.com.au/cs/groups/public/documents/internetpolicysubmissions/1176437.pdf, 2016 (accessed 18 September 2017), p.1.
Productivity Commission 2015, Business Set-up, Transfer and Closure, Draft Report, Canberra, p.353.
The Treasury, 2017. Explanatory Memorandum – National Innovation and Science Agenda – Improving corporate insolvency law. Canberra: The Treasury, pp.5-18.
The Treasury, Improving bankruptcy and insolvency laws Proposals Paper, 2016, Canberra:
The Treasury, pp.10-15.
Westpac Banking Corp v Bell Group Ltd [2012] WASCA 157 CACV 52 of 2009 pp. 517-18.
Winter, J, ‘Improving bankruptcy and insolvency laws – Proposals Paper April 2016’, p.1
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