Review into Australia’s Corporate Insolvency Laws
On 28 September 2022, it was announced that the federal government, through the Parliamentary Joint Committee on Corporations and Financial Services, had commenced a review into the efficacy of Australia’s corporate insolvency regime in protecting and maximising value for the benefit of all interested parties.
The committee noted that it recognises the need for Australia’s corporate insolvency regime to be “fit for purpose” and to “effectively serve the Australian economy and all participants in it”, announcing a large-scale review of recent and emerging trends in the use of corporate insolvency in Australia. The terms of reference note that the review will canvas temporary COVID-19 insolvency measures and other policy measures introduced in response to the pandemic, as well as recent changes in domestic and international economic conditions, increases in material and input costs for businesses and inflationary pressures more broadly, and supply shortages in certain industries.
The committee has flagged the following areas as potential areas of reform:
The committee is accepting submissions from interested persons and stakeholders up until 30 November 2022, with a view to submitting a report to both Houses of Parliament by 30 May 2023.
Changing Economic Outlook
The review detailed above is considered to have come about because of the federal government’s expectation of a significant uptick in corporate insolvency in the coming years, considering developments in macroeconomic conditions.
The immediate outlook is uncertain for the Australian economy, which has seen a sharp rise in inflation, slowing economic growth and the most rapid interest rates rises in decades, with the Reserve Bank of Australia having increased the cash rate by 250 basis points to 2.60% as of 26 October 2022 (up from just 0.1% in April 2022). Perhaps unsurprisingly, the local M&A market has cooled, corporate lending requirements have tightened significantly, and deal flow has noticeably slowed in the capital markets.
While significant increases in the amount of large-scale corporate collapses have not yet been seen, insolvency appointments are steadily trending upwards and there remains a general sentiment that Australian companies will be experiencing higher-level distress throughout the next period. The authors believe the current conditions could create opportunities for investors operating in the distressed M&A and secondary debt markets.
Changes in Credit Markets
As a result of tightening capital adequacy requirements, prudential standards, the COVID-19 pandemic, more conservative approaches to risk and increased regulatory intervention following the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, banks are increasingly limiting their exposures across all sectors. As in previous years, local banks are also becoming increasingly reluctant to invest in “brown” industries such as coal and mining services. This has the potential to open the Australian debt market to non-traditional lenders such as hedge and special situations funds, investment banks and alternative capital providers.
In Australia, the Corporations Act 2001 (Cth) (Corporations Act) governs corporate insolvency and restructuring. The Bankruptcy Act 1966 (Cth) (Bankruptcy Act) regulates personal insolvency. The aim of both regimes is to balance the interests of creditors and debtors.
Under the Corporations Act, there are various formal insolvency procedures available to Australian companies including:
Solvent liquidations and schemes of arrangement are commonly used as “solvent” restructuring tools.
Although companies are not obliged to initiate a formal insolvency process, directors usually do so to avoid personal liability for insolvent trading. A director may face civil or criminal liability where they knew, or had reasonable grounds for suspecting, that the company was insolvent or would become insolvent when the debts were incurred.
However, Sections 588H(2) and (5) of the Corporations Act provide that directors will not be liable if it is proved that, at the time the relevant debt was incurred, they had reasonable grounds to expect (and did expect) that the company was solvent (and would remain solvent even if it incurred that debt), and took all reasonable steps to prevent incurring the debt.
Directors may also look to rely on the “safe harbour” defence. Under Section 588GA, a director will not be liable for debts incurred by a company while it is insolvent if “at a particular time after the director starts to suspect the company may become or be insolvent, the director starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the company” than the immediate appointment of an administrator or liquidator. The safe harbour, however, will not apply in certain circumstances, including where, at the time the debt is incurred, employee entitlements and tax reporting requirements are not up to date (Section 588GA(4) of the Corporations Act).
A creditor can seek to initiate a winding-up of a company (a compulsory liquidation) by court order. A creditor (or other eligible applicant) must demonstrate that the company is insolvent (for further commentary on the Australian test for insolvency, see 2.5 Requirement for Insolvency).
The court can presume insolvency in certain circumstances, including where a company has not paid a claim exceeding a prescribed amount following a written statutory demand in accordance with the Corporations Act. In response to the COVID-19 pandemic, the Australian government enacted legislation which provided temporary economic and other relief for financially distressed businesses for the period 25 March 2020 to 31 December 2020, which included an increase to the threshold at which creditors can issue a statutory demand from AUD2,000 to AUD20,000 and an increase to the time debtor companies have to respond to the statutory demand from 21 days to six months.
Following the expiry of these temporary measures, the Federal Government announced that, from 1 July 2021, the statutory minimum amount to serve a creditor’s statutory demand would increase from AUD2,000 to AUD4,000 but that the period within which a debtor must respond to a statutory demand would remain 21 days. This increase aims to account for inflation and to serve as a transition following the expiry of the insolvency moratorium on 1 January 2021. Where a debtor does not comply with the statutory demand, or seeks to set it aside, insolvency is presumed for the purpose of the winding-up application.
Other grounds for a court to issue winding-up orders include where it is “just and equitable” to do so or where a deadlock at shareholder or director level affects the ability to manage the company.
Certain other stakeholders (including shareholders, the company and ASIC) may also submit a winding-up application with the court.
Where the court appoints a liquidator, directors will no longer have any management powers and the company will generally cease to be a going concern. The liquidator will assume control of the company and will realise the company’s assets for the benefit of the creditors.
There are no material differences between a compulsory liquidation and a creditors’ voluntary liquidation (being a voluntary process commenced by members where the company is insolvent) once the liquidator is in control of the assets and affairs of the company.
A secured creditor may appoint a receiver and manager pursuant to the relevant security document, where a company has defaulted and the security is enforceable. Far less common is a court-appointed receiver, where the appointment is made to preserve the company’s assets where it may not otherwise be possible to trigger a formal insolvency process.
The appointment of a receiver to the whole, or substantially the whole, of the company’s assets will often lead to, or closely follow, the appointment of an administrator by the directors. Both processes proceed in tandem.
A secured creditor with security over the whole, or substantially the whole, of a company’s assets may appoint an administrator as an alternative, or in addition, to receivership.
In respect of involuntary appointments, insolvency is a requirement for commencing court winding-up proceedings (noting, however, there are other grounds for winding up a company).
Insolvency is not a requirement for a secured creditor to appoint a receiver; or for a secured creditor with security over the whole, or substantially the whole, of a company’s property to appoint an administrator. In these circumstances, all that is required is an entitlement to enforce the security interest.
Directors can only appoint an administrator if, in the opinion of the directors, the company is insolvent or likely to become insolvent.
The solvency test in Australia is the “cash flow” test. A person is solvent if they are able to pay all their debts as and when they become due and payable. A person who is not solvent is insolvent (Section 95A of the Corporations Act).
Courts apply Section 95A of the Corporations Act liberally and will consider the operative commercial circumstances. A “balance sheet” analysis, while not paramount, is often relevant in providing commercial context.
There are no specific restructuring or insolvency regimes applicable to certain companies or institutions. However, the Australian Prudential Regulation Authority has certain powers in respect of authorised deposit-taking institutions (ADIs) and insurance companies under the Insurance Act 1973 (Cth), the Life Insurance Act 1995 (Cth) and the Banking Act 1959 (Cth). These include the ability to appoint a statutory manager to an ADI or to apply to the court for a judicial manager to be appointed to a distressed or insolvent insurer. ADIs and insurance companies can also be wound up under the usual insolvency provisions of the Corporations Act in certain circumstances.
Consensual and out-of-court workouts are common in the Australian restructuring market but are generally only useful in dealing with classes of finance debt (eg, secured debt) because of their inability to bind large groups of general creditors. Despite this, Australian banks are generally reluctant to take enforcement action and this has provided opportunities for distressed borrowers to negotiate with their lenders, contributing to a growing turnaround market. Workouts will often involve the lenders(s) agreeing a compromise to enable the company to trade on.
Section 588GA of the Corporations Act (safe harbour provision) attempts to provide directors with some protection from insolvent trading liability to enable them to trade out of their difficulties (provided a viable plan is in place at the relevant time). While the safe harbour provision was intended to promote informal and consensual workouts, the Australian courts are yet to fully consider its operation or efficacy. Therefore, the extent to which the safe harbour provision has encouraged directors to consensually restructure is unclear.
There is no requirement in Australia for parties to enter mandatory consensual restructuring negotiations before the commencement of a formal statutory process.
Consensual restructuring arrangements are generally implemented between lenders and obligor groups, and include forbearance/standstill and waivers or “amend and extend” arrangements. Lenders may agree to defer or forgo amortisation for a period and agree not to take enforcement action subject to the obligors complying with reporting and other requirements. Consensual restructuring arrangements often include the sale of assets, capitalisation of interest and, sometimes, debt forgiveness. Despite this, these arrangements will usually preserve existing breaches. If successful, consensual restructuring arrangements can give the company, and the directors, breathing space and the ability to trade out of difficulty.
Informal creditors’ committees are sometimes used by lending syndicates to facilitate an effective negotiation process with the debtor but are not commonly used in a restructuring context.
There is no debtor-in-possession financing regime in Australia directly analogous to that seen in the US. Normally, new money is provided by the existing lender group or by a third-party financier with the consent of the existing lenders, such that it receives super senior priority. Both receivers and administrators are personally liable for monies borrowed (although they will be indemnified out of the assets of the company for the new funds) so lenders will often get comfortable lending to these persons, assuming existing lenders consent.
Australia’s restructuring and insolvency laws do not impose general duties on creditors to each other, a company or third parties in the context of informal workouts and restructurings.
In the absence of a formal insolvency administration, a creditors’ scheme of arrangement or the agreement of each party, parties to a consensual arrangement are unable to bind minority creditors or shareholders. However, facility documents or intercreditor arrangements may enable majority lenders to bind minority ones. For example, syndicated facility documents usually allow lenders with a two-thirds majority to amend non-essential terms; however, amendments to essential terms, such as repayment dates, usually require unanimous consent.
In Australia, security can be taken over most assets, such as land, shares, bank accounts, receivables, insurances, goods and equipment.
In respect of land, or fixtures and buildings attached to land, security is most commonly granted by way of a real property mortgage. The mortgagor is free to deal with the land (subject to any restrictions in the mortgage itself) and retains the beneficial and legal interest in the land. The mortgagee holds a legal charge that will confer actionable rights in the event of default.
In respect of all the security provider’s present and after-acquired property, security is most commonly granted by way of a general security deed (conceptually similar to a fixed and floating charge).
In respect of specific assets of the company, security is most commonly granted by way of a specific security deed (conceptually similar to a fixed charge).
Registration and Perfection
Once taken, the security would typically be registered:
While registration is not mandatory, the benefit of registering security is that it gives the secured party priority over other unregistered security or unsecured creditors. In the absence of any intercreditor arrangements, earlier registrations in time will generally prevail over subsequent registrations irrespective of when the underlying security interest was granted (a key exception to this rule is where funds are provided by a financer to a security provider specifically for the purchase of an asset and security is taken over that asset).
The PPS Register is established under the Personal Property Securities Act 2009 (Cth) (the “PPS Act”), which sets out a single national system for the creation, priority and enforcement of security interests in personal property (all property other than land, fixtures and buildings attached to land, water rights and certain statutory licences). The PPS Act also applies to security interests – such as specific lease arrangements, and retention of title arrangements – regardless of whether the relevant arrangement secures payment or performance of an obligation.
Generally, perfection of a security interest occurs when the security provider and the secured party execute a security agreement and the security interest is registered on the PPS Register. However, security interests over certain assets can be perfected other than by way of registration, for example, by control or possession.
There are strict time limits within which a secured party is required to register their security interest on the PPS Register. A failure to register within these time limits may mean that the security interest is void as against a liquidator. In addition, a failure to register a security interest correctly or at all may cause the relevant security interest to be unperfected. An unperfected security interest will “vest” in the security provider upon insolvency, which means that the relevant secured party will lose any interest they have in the relevant collateral that is the subject of the unperfected security interest.
The rights of a secured creditor to enforce a security interest (ie, to appoint a receiver or voluntary administrator if the secured creditor has security over the whole, or substantially the whole, of the company’s property) are subject to:
The Corporations Act provides for an “automatic stay” on the enforceability of contractual ipso facto clauses that allow a contract (entered into on or after 1 July 2018) to be terminated/amended due to:
Ipso facto clauses are clauses that allow one party to enforce a contractual right, or terminate a contract, upon the occurrence of a particular event, usually upon insolvency or a formal insolvency appointment.
A court has the power to lift the automatic stay if doing so is in the interests of justice, or where a relevant scheme of arrangement is found to not be for the purpose of avoiding a winding-up. “Stay orders” may be granted with respect to broader rights not covered by the automatic stay carve-out, but may only be granted upon application by the relevant external administrator.
Secured creditors who have enforced their security interests generally stand outside formal insolvency processes. If a controller (such as a receiver and manager) is appointed to the secured property of a company, the controller’s power will be exercised to the exclusion of another external administrator appointed to the company (such as a liquidator or administrator).
During a voluntary administration, a secured creditor with security over the whole, or substantially the whole, of the company’s property may enforce its security, provided it commences enforcement:
Where a DOCA proposal is put forward for creditor approval and the company executes a DOCA, a secured creditor who did not vote in favour of the proposal will have the ability to enforce its security interests once the DOCA becomes effective.
Secured creditors stand outside the insolvency process and their priority is determined by the Corporations Act, the PPS Act and any contractual intercreditor arrangements. Employees enjoy a priority over ordinary unsecured creditors for certain unpaid amounts and, in the ordinary course, external administrators have priority over all unsecured creditors (including employees) for their approved fees and expenses. Employee claims also have priority over assets subject to a charge over circulating (floating) assets.
While there is no legal basis for this, key suppliers will often be kept whole (or close thereto) in a restructuring (particularly through a DOCA or a scheme of arrangement) if there are commercial drivers for doing so.
In the normal course, a creditor may commence proceedings (and obtain default judgment) through the courts to recover outstanding amounts owed by a debtor. The court has extensive powers to order a range of remedies including seizure of assets, diversion of a debtor company’s income and orders for the winding-up of the company.
However, once a company is placed into administration, a statutory moratorium will apply to any proceedings commenced, including any enforcement proceedings unless administrator consent or leave of the court is obtained (Section 440D of the Corporations Act). Criminal proceedings are an exception.
After the commencement of a winding-up of a company, or after the appointment of a provisional liquidator, legal proceedings are not to be commenced or continued against that company without leave of the court (Section 471B of the Corporations Act).
A court may grant leave for a claimant to proceed against the company if there is a public interest aspect to the claim (eg, claims brought by regulators for statutory breaches).
No moratorium exists during a receivership, and creditors may take action against the company including initiating court proceedings, but any actions are treated as unsecured claims (subordinated to the claims of the secured creditor who appointed the receiver). The receiver is likely to be in control of the company’s material assets and is permitted to realise these assets for the benefit of the secured creditor only (any surplus is provided to the company and would be available for distribution to unsecured creditors).
In certain circumstances, freezing orders (also known as Mareva orders) will be granted by the court to prevent frustration or abuse of the process of the court, including to prevent a company from dealing with, or disposing of, assets; thus ensuring that a company will have assets capable of satisfying any judgment.
Although useful for creditors looking to protect assets, a freezing order does not improve the position of the applicant creditor in the event of insolvency of the judgment debtor.
These orders will only be granted where there is an arguable case, and there exists a real possibility of the company concealing or disposing of – or removing its assets from – the court’s jurisdiction in order to avoid satisfying an adverse judgment against it.
The pari passu principle (Section 555 of the Corporations Act) provides that all debts and claims which are admissible to proof rank equally. However, Section 556 of the Corporations Act provides that, after secured debts are satisfied (except debts secured over circulating assets), certain claims have priority in a liquidation, administration or a DOCA as follows:
Commonwealth government debts (including tax debt) do not receive any special priority.
Employment-Related Liabilities (Including Superannuation)
Employee wages, superannuation, leave entitlements and redundancy payments that are outstanding are given priority over payment of ordinary unsecured creditors in the distribution of assets in a winding-up. Pursuant to the Commonwealth’s Fair Entitlement Guarantee (FEG), when a company is placed into liquidation, the Commonwealth government can make payments to employees of certain levels of unpaid wages, leave and other entitlements, assuming the position of the employee creditors and being afforded the same priority.
Certain employee entitlement claims have priority over secured debts (which are secured by a security interest over circulating assets).
The Corporations Act also affords protection to employee entitlements following the company and its creditors entering into a DOCA; employee claims must receive a priority at least equal to what they would receive if the company were being wound up.
Voluntary Administration/Deed of Company Arrangement (DOCA)
A DOCA is essentially a contract or compromise between the company and its creditors. The rights and obligations of the creditors and company differ under a DOCA and therefore should be viewed as a distinct regime from voluntary administration.
DOCAs are flexible. The terms may provide for a moratorium on debt repayments, a reduction in outstanding debt, and the forgiveness of all or a portion of the outstanding debt. DOCAs may be used to achieve a debt-for-equity swap through the transfer of shares, either with the consent of shareholders or with leave of the court under Section 444GA of the Corporations Act. Court approval will be granted where it is accepted that the shares have no “economic” value.
A DOCA will be entered into if, at the second meeting of creditors in the voluntary administration, a bare majority of creditors in value and number vote in favour of the DOCA. The chairperson (usually, the administrator) may exercise a casting vote. A DOCA will bind the company, its shareholders, directors and unsecured creditors. Secured creditors are not obliged to vote on the DOCA and only those voting in favour are bound by it.
Upon execution of a DOCA, the voluntary administration ends. Once a DOCA has achieved its stated aims it will terminate and the company will be wound up. If a DOCA does not achieve its objectives or is challenged by creditors for being oppressive, unfairly prejudicial or contrary to creditors’ interests, it may be terminated by the court.
In recent years there has been an increase in the use of “holding DOCAs”, which do not provide for a distribution of the company’s property to creditors but rather allow the deed administrators more time to restructure the company or sell its assets.
Creditors’ Scheme of Arrangement
A creditors’ scheme of arrangement is a restructuring tool that may be used regardless of whether the company is insolvent. A scheme is a proposal put forward (with input from management, the company or its creditors) to restructure the company in a manner that includes a compromise of the rights of any or a number of stakeholders. The process is overseen by the courts and requires approval by all classes of financial creditors. Schemes are generally used in large and complex restructurings.
A scheme must be approved by at least 50% in number and 75% in value of creditors in each class of creditors and by the court. Each class should include those persons whose rights are not so dissimilar as to make it impossible for them to consult together with a view to a “common interest”. Despite this long-standing proposition, the decision in Boart Longyear Limited (No 2)  NSWSC 1105 suggests that courts may agree to put creditors in classes even where the creditors within that class appear to have objectively distinct interests.
The outcome of a scheme depends on the terms of the arrangement with the creditors but, most commonly, a company is returned to its normal state upon implementation as a going concern but with the relevant compromises in effect.
The advantages of a scheme are that:
The disadvantages of a scheme include the cost, complexity, uncertainty of implementation, timing issues (it is subject to the court timetable and generally takes between three to six months to complete) and the overriding issue of court approval (a court may exercise its discretion to not approve a scheme of arrangement, despite a successful vote, if it is of the view that the scheme of arrangement is unfair).
Small Businesses Restructuring
On 1 January 2021, the Australian government introduced legislative reforms to the Australian insolvency framework, comprising a new small business restructuring process (the “SBR process”). The reforms are intended to allow small businesses to access a single, streamlined restructuring process whilst allowing directors to remain in control of the business.
The SBR process under the new Part 5.3B of the Corporations Act sets out a framework for eligible companies to engage a restructuring practitioner to develop and propose a debt restructuring plan to creditors that, if accepted, will bind the company and certain of its creditors.
A company is “eligible” for the SBR process where:
Provided a company is eligible, its directors may resolve that they have reasonable grounds for suspecting current or a likelihood of future insolvency and that a small business restructuring practitioner ought to be appointed.
The SBR process follows the structure and key features of the voluntary administration process under Part 5.3A of the Corporations Act. However, a key difference is that, unlike voluntary administration, the SBR process follows a debtor-in-possession model which allows the directors to maintain control of the company.
Voluntary administration, unlike receivership, is entirely a creature of statute (see Part 5.3A of the Corporations Act) and creditors control the outcome of the administration to the exclusion of management and members.
Administrators have wide management powers. They take control of the company’s business, property and affairs, and may carry on the business or terminate or dispose of any part of the business or its property (subject to the rights of secured creditors). Once an administrator is appointed, a statutory moratorium applies, which restricts the enforcement rights of third parties and litigation claims. There is an exception for a secured creditor that has security over the whole, or substantially the whole, of the assets of the company where these rights are exercised within 13 business days of receiving notice of appointment of the voluntary administrator (this being the “decision period”).
There are two creditors’ meetings during the course of an administration. At the first (which must be held within eight business days of the administrators’ appointment), the administrators are confirmed (or replaced) and a committee of creditors may be established. At the second meeting (which is usually be held within 25 business days of the administrators’ appointment), the administrators provide a report on the affairs of the company to the creditors and outline the best option available for the future of the company to maximise returns to creditors. There are three possible outcomes of the second meeting:
The administration will terminate according to the outcome of the second meeting, at which point a secured creditor’s rights will re-enliven unless the termination is due to the implementation of a DOCA approved by that secured creditor. The contractual terms of a DOCA normally mirror many of the elements of an administration (such as a moratorium).
Administrators are personally liable for any new money provided to a company in administration/DOCA. Administrators have a right of indemnity from the company for these funds, which is secured by a statutory lien over circulating assets. However, the lien does not take priority over existing secured creditors without their consent.
Creditors’ Scheme of Arrangement
There is no automatic statutory moratorium when a scheme of arrangement is proposed (other than the ipso facto stay referred to in 4.2 Rights and Remedies). However, the applicant may apply to the court to restrain further legal proceedings against the company.
Unlike voluntary administration, directors and officers of a scheme company maintain their powers during the scheme process.
Any new money provided would be documented under the existing or new credit arrangements between the scheme company and the existing or new lenders and would be given effect to by the scheme terms.
A scheme will give effect to the amendments required/new terms.
Further to the information provided at 6.2 Position of the Company, in an administration, the creditors decide the outcome of the company at the second meeting. In some cases, a committee of creditors will be formed to assist and advise the administrator and monitor their conduct. The committee also has the power to approve the administrators’ remuneration.
Creditors’ Scheme of Arrangement
Creditors are involved in schemes and they must vote according to their class. Creditors have no formal role in the scheme process but will ordinarily remain informed by way of disclosure materials that must be provided to scheme creditors.
Provided that a DOCA is approved by the relevant majorities, the claims of unsecured creditors may be modified without consent. An unsecured creditor could attempt to set a DOCA aside if the cram-down would result in it receiving less than it would receive in a liquidation. In the ordinary course, claims of secured creditors cannot be modified under a DOCA unless they vote in favour of the DOCA or with court approval.
There has, however, been some divergence from the widely held view that secured creditors are not “bound” by a DOCA unless they vote in favour of it. In Australian Gypsum Industries Pty Ltd v Dalesun Holdings Pty Ltd  WASCA 95 and Re Bluenergy Group Limited  NSWSC 977, the courts separately held that a DOCA can (if so expressed) extinguish the debt of a secured creditor that did not vote in favour of the DOCA (under Section 444D(1) of the Corporations Act), but not the secured creditor’s ability (under Section 444D(2)) to realise or deal with its security in the secured property, provided there was a right to enforce the security at the time the DOCA took effect.
Creditors’ Scheme of Arrangement
Claims of creditor classes (including secured and unsecured financial creditors) can be compromised under a creditors’ scheme of arrangement without consent if the requisite majority of each class of creditors is achieved (50% in number and 75% in value). However, a scheme must be approved by each class of creditors so that inter-class cram-down is not possible.
There is no specific prohibition on trading claims during the formal insolvency processes. Often, a creditor group involved in a scheme will enter into a form of “lock-up agreement”, whereby debt trading amongst the group will be prohibited, or require that purchasers agree also to be locked up.
As DOCAs succeed an administration, they are technically only implemented where the company is insolvent or likely to become insolvent and are not necessarily conducive to a reorganisation for administrative efficiency, in the absence of insolvency.
A members’ scheme of arrangement (rather than a creditors’ scheme of arrangement) is a more appropriate vehicle for a solvent restructure or reorganisation.
A corporate group in a liquidation can be “pooled” to achieve winding-up efficiencies in certain circumstances.
Where a company is in administration, that company is unable to use its property and any such transactions are void unless:
The position with a DOCA will be dependent on its terms.
While there are no statutory restrictions on the use of property of a company that has proposed a scheme of arrangement, the documents that give effect to the scheme may impose restrictions.
Section 420A of the Corporations Act imposes a statutory obligation on receivers to obtain market value or, in the absence of a market, the best price obtainable in the circumstances. Upon a sale, the receiver will look to transfer the assets free of the security with the consent of the receivers’ appointor. Often, the terms of any intercreditor arrangements will provide for the automatic release of subordinated security. If not, direct negotiations must occur with the secured subordinated creditors, or the prior ranking security holder could look to sell the assets as mortgagee to overreach the secured subordinated creditors.
Administrators may sell assets but are not permitted to sell assets subject to security without the consent of the secured party or court sanction.
Liquidators can sell or otherwise dispose of unencumbered property of the company without approval from the court or other parties to the liquidation. If assets are encumbered, the consent of the secured party will be required unless a court directs otherwise.
A liquidator owes fiduciary duties to the company and has a duty to obtain the highest possible price when realising the assets of the company.
Traditionally, credit bids have not been a feature of the Australian market. However, there is likely to be an increase in credit bids from credit funds holding security where unsecured creditors are clearly out of the money.
Creditors’ Scheme of Arrangement
The terms of the scheme itself can provide for the disposal of assets and any associated release of security required. These releases will need agreement, either from the creditors or through the scheme itself.
Pre-pack administrations (colloquially known as “pre-packs”) are seen less in Australia than in the UK. A pre-pack is where a restructure is developed by the secured parties prior to the appointment of an administrator or receivers, and is implemented immediately, or very shortly after, the appointment is made. Pre-packs have not been used in their traditional sense because:
However, Australia is likely to see more pre-packs where value can clearly be justified.
Australia’s recently introduced safe harbour provision (see 2.3 Obligation to Commence Formal Insolvency Proceedings), which was intended to encourage directors to pursue restructuring avenues without being held liable for insolvent trading, may not provide sufficient protection for directors (particularly for those with no appetite for risk).
See 6.4 Claims of Dissenting Creditors regarding the rights of secured creditors in the context of a DOCA.
In the context of a scheme, if the requisite majority of secured creditors in the relevant class (50% in number and 75% in value of creditors) vote in favour of the scheme, and the scheme involves a release of property, then the release will be effected.
An administrator can borrow funds on behalf of a company and is personally liable for these debts (and any associated interest and borrowing costs) but will be indemnified from the company’s assets. The administrator has a lien over the company’s assets to secure any liability (see Sections 443D and 443F of the Corporations Act). To the extent that this funding was to be secured, consent of any already existing secured party over the assets would need to be obtained.
Creditors’ Scheme of Arrangement
Subject to the terms of the incumbent financing arrangements, and in the context of the directors maintaining control over the company, there is no prohibition on the company obtaining new money.
DOCAs that involve a distribution to creditors and creditors’ schemes of arrangement must include a process whereby claims the subject of such forums against the company are quantified. Often, these processes will likely mirror the processes in the Corporations Act and Corporations Regulations 2001 (Cth) that apply in a liquidation.
Administrators, receivers and liquidators can, as a general proposition, refrain from performing contracts but do need to recognise equitable and proprietary rights that might exist under such contracts.
A DOCA is approved by the creditors with no court involvement. However, the court may make an order terminating a DOCA if that DOCA is oppressive or unfairly prejudicial to, or unfairly discriminatory against, one or more creditors or contrary to the interests of the creditors as a whole.
Creditors’ Scheme of Arrangement
A court must consider a number of factors in deciding if it is to approve a scheme, including whether that scheme is fair.
The Australian courts have clearly determined that a DOCA cannot release third parties from liabilities without the express agreement of each relevant creditor.
Creditors’ Scheme of Arrangement
A creditors’ scheme of arrangement is more flexible than a DOCA and can extinguish claims that scheme creditors have against third parties provided there is an adequate nexus between the release and the relationship between the creditor and the company, as creditor and debtor.
There is no statutory right of set-off in any external administration (including a scheme), other than liquidation, which includes an automatic statutory set-off (Section 553C of the Corporations Act). It is common for a DOCA to give creditors the right to set off as, otherwise, the potential for challenge on grounds of unfairness increases.
DOCAs and schemes of arrangement are contracts between the relevant company and its creditors. The deed or scheme administrator has the power to enforce the “contract” against a creditor, including by seeking court orders to restrain the creditor from taking further steps.
If a DOCA is not complied with by the company, it could be terminated in accordance with its terms, or the deed administrator may ask the creditors to vote on whether it should be terminated, and the company placed into liquidation.
A DOCA or a scheme could effect a debt for equity swap, in whole or in part (either on a consensual or non-consensual basis), resulting in existing equity holders losing some or all of their equity interests (sometimes without consideration). Alternatively, a DOCA may implement a sale of assets which would mean the equity holder retains shares in a shell company only.
The main role of a receiver is to take control of the assets subject to the relevant security and hold and/or realise those assets for the benefit of the secured creditor(s). Receivers do not have an active obligation to unsecured creditors. A receiver is not necessarily obliged to act on the instructions of the secured creditors but must act in their best interests. This will invariably lead a receiver to seek the views of secured creditors on issues that are material to the receivership. The receiver is not required to report to unsecured creditors regarding the receivership and unsecured creditors are not entitled to obtain a copy of the receiver’s report to the secured creditor.
The security document itself will entitle a secured party to privately appoint a receiver, and will also outline the powers available (supplemented by the statutory powers in Section 420 of the Corporations Act). Generally, a receiver has wide-ranging powers, including the ability to operate the business, and sell or borrow against the secured assets. The receiver has power under Section 419A of the Corporations Act to give notice that they do not propose to exercise rights in relation to premises leased by the company, which protects the receiver against personal liability for rent.
The receiver will, by operation of the security instrument, be the agent of the debtor company, not the appointing secured party (although this changes if a liquidator is appointed to the debtor company, whereby the receiver will become the agent of the secured party). There is no set time frame for receiverships and, once in control of the assets, the receiver may run the business of the company if it is appointed over the whole, or substantially the whole, of the assets of a company.
Voluntary Administration/Deed of Company Arrangement
See sections 4.2, 5.3, 5.5, 6.1 to 6.3, 6.7, 6.11, 6.12, 6.14, 6.15, 7.3 and 9.2 for voluntary administration and DOCAs.
A creditor, a shareholder or the company has standing to apply to the court for the appointment of a provisional liquidator after the filing of a winding-up application and before the making of a winding-up order. A provisional liquidator will normally only be appointed if there is a risk to the assets of a company prior to it entering liquidation and is therefore normally only given very limited powers to preserve the status quo. Provisional liquidators are required to provide creditors with notification of their appointment and prepare a report on company activities and property.
After the appointment of a provisional liquidator, legal proceedings are unable to be commenced or continued against a company without leave of the court (see 5.3 Rights and Remedies for Unsecured Creditors).
A court determines the outcome of a provisional liquidation; either that the company move to a winding-up, or that the appointment of the provisional liquidator is terminated.
Liquidation is the process whereby the affairs of a company are wound up and its business and assets are realised for value. A company may be wound up voluntarily by its members if solvent or, alternatively, if it is insolvent, by its creditors or compulsorily by order of the court.
Voluntary Liquidation (Members and Creditors)
The members of a solvent company may resolve that a company be wound up if the board of directors is able to give a 12-month forecast of solvency. If not, or if the company is later found to be insolvent, the creditors take control of the process.
Compulsory (Involuntary) Liquidation
Further to the information provided at 2.4 Commencing Involuntary Proceedings and 2.5 Requirement for Insolvency, the most common ground for a winding-up application made to the court is insolvency, usually indicated by the company’s failure to comply with a statutory demand for payment of a debt. Other common grounds being:
In both a voluntary and compulsory winding-up, the liquidator will have wide-ranging powers, including challenging voidable transactions and taking control of assets. Generally, a liquidator will not run the business as a going concern and will realise the assets of the company for the benefit of its creditors and, to the extent of any surplus, its members.
After the commencement of a winding-up, legal proceedings are not to be commenced or continued against a company without leave of the court.
The liquidator is required to keep the creditors informed regarding the liquidation, including giving notice to creditors of their appointment and advising creditors of their rights in the liquidation, such as their rights to request information or direct a meeting of creditors to be held. A statutory report is also made available to creditors within three months following the liquidator’s appointment. Liquidators often provide further reports to creditors and creditors may request further reports.
Creditors may lodge a proof of debt in the liquidation and the chairperson of the creditors’ meetings will decide whether to accept the debt for voting purposes. Section 553 of the Corporations Act provides that all debts payable by, and claims against, the company that are present or future, certain or contingent, ascertained or sounding only in damages are provable in a winding-up. A formal proof of debt is required to be submitted in order for creditors to receive a dividend in the liquidation.
Liquidators may disclaim onerous property under Section 568 of the Corporations Act. The types of property that may be disclaimed are broad and include contracts. Third parties are required to attempt to mitigate any loss as a result of the disclaimer however, they may lodge a proof of debt in the liquidation in respect of any loss suffered.
At the end of a winding-up, the company will be deregistered and cease to exist.
Special Purpose Liquidation
The appointment of a special purpose liquidator (SPL) has historically been used where there is an actual or perceived conflict of interest or lack of independence on the part of the liquidator that may jeopardise the liquidator’s ability to carry out a significant function in the liquidation – usually an investigation. However, more recently courts have been open to the appointment of an SPL where a creditor seeks a preferred, alternative liquidator to carry out a legitimate investigation and agrees to fund only that liquidator and no other. In this case, the SPL appointment will co-exist with the existing liquidation.
In addition to the new SBR process (see 6.1 Statutory Process for a Financial Restructuring/Reorganisation), on 1 January 2021 the Corporations Act introduced a new simplified liquidation process for small businesses (“SL process”). The SL process is intended to provide small businesses with a less complex, fast and cheaper winding up.
The SL process may be commenced if:
The eligibility criteria for companies to engage the SL process is largely the same as that for the SBR process, including that:
the company has resolved to be wound up voluntarily, has total liabilities of less than AUD1 million and is up to date with all of its tax lodgements; and
the directors have given the liquidator a report about the company’s affairs and declared that the company is eligible for the SBL process.
As the SL process is aimed at allowing for a simplified liquidation process, a small business liquidator’s obligations and powers differ to those of a liquidator in a creditor’s voluntary liquidation. For example, a liquidator may only seek to challenge a transaction as an unfair preference:
If the liquidator becomes aware that the company or any of its directors have engaged in conduct which they reasonably consider to be fraudulent or dishonest, and has had or is likely to have a material adverse effect on the interests of creditors, the liquidator is required to exit from the SL process.
Any administrator, liquidator or receiver that has been appointed has the power to sell property that is not subject to a security interest. There are limited instances where assets subject to a security interest can be sold (without consent), although this is rare in practice.
While credit bidding is not formally recognised under Australian law, it does occur in practice. A secured creditor may purchase an asset over which it has security sold through a receivership, either directly or through a newly formed company, provided the requirement to obtain market value or, in the absence of a market, the best price reasonably obtainable in the circumstances is satisfied.
See 6.8 Asset Disposition and Related Procedures in relation to pre-pack administrations.
Creditors in voluntary administration may appoint a “committee of inspection” at or after the first meeting of creditors. Members of the committee may be appointed or removed by:
A committee must have at least two members (although five to seven members is common).
The committee has a consultative function; it may advise, assist and give directions to the administrator and monitor the conduct of the administration. If there is a conflict between the direction of the committee and the creditors as a whole, the directions of the creditors will prevail.
The general powers of the committee include to:
The committee exercises its powers by passing a resolution at a committee meeting, which must be attended by a majority of the members.
Membership of the committee is voluntary and unpaid. Except with leave of the court, a committee member cannot derive any income from their position. They also must not purchase the property of the company.
A committee of inspection may be formed to assist and advise the liquidator in both compulsory and creditors’ voluntary liquidations. While the process for appointment and the general powers of the committee are the same as those that apply in a voluntary administration, in a liquidation, the committee has additional powers to:
Recognition of foreign insolvency proceedings in Australia may be effected in two principal ways:
UNCITRAL Model Law
To effect recognition pursuant to the Model Law, Section 10 of the CBIA requires the foreign bankruptcy representative to apply to the Federal Court of Australia or the Supreme Court of a state or territory of Australia for recognition. Recognition as a “foreign main proceeding” will trigger an automatic stay on creditor actions (including a winding-up application) and recognition as a “foreign non-main proceeding” will trigger a court discretion to impose a stay.
The scope of the stay that applies is the same as that which would apply under the analogous Australian procedure in Chapter 5 (other than Parts 5.2 and 5.4A) of the Corporations Act. For example, if the foreign proceeding is a debtor-in-possession corporate rescue or restructuring proceeding, involving a plan requiring creditor approval, the most analogous Australian procedure would be voluntary administration under Part 5.3A of the Corporations Act.
Section 581 of the Corporations Act
As an alternative to recognition under the Model Law, Section 581 of the Corporations Act provides the basis for an Australian court to act in aid of a foreign court in “external administration matters”. The court of a prescribed country can:
The prescribed countries are Canada, Jersey, Malaysia, New Zealand, Papua New Guinea, Singapore, Switzerland, the UK and the USA.
The nature and extent of aid to be given is in the discretion of the court.
While Section 581(2)(a) of the Corporations Act requires the Australian court to aid a foreign court, the Australian court is not expressly permitted or required by the legislation to exercise the statutory powers imposed by the foreign court. The Australian court will deploy its own general jurisdiction so as to assist and support the foreign court by causing its orders to have effect and the objectives of those orders to be achieved (Re Independent Insurance Co Ltd (In liq) (2005) 193 FLR 43).
The recognition of foreign insolvency proceedings in Australia is effected by the methods outlined in 8.1 Recognition or Relief in Connection with Overseas Proceedings.
Under the Model Law, a debtor’s centre of main interest (COMI) will determine whether a foreign proceeding will be recognised as a foreign main proceeding or a foreign non-main proceeding. Where a foreign proceeding is recognised as a foreign main proceeding, creditor actions and enforcement proceedings against the assets of the debtor will be stayed in all non-main jurisdictions. The Model Law is deliberately silent on how to determine COMI. The CBIA provides for a rebuttable presumption that a debtor’s COMI is the location of its registered office.
The courts will apply a general test to determine whether the statutory presumption has been rebutted. The general test is that the COMI should correspond to the place where the debtor conducts the administration of its interests on a regular basis and is therefore ascertainable by third parties. Where a debtor is part of a corporate group, the court will consider a number of factors, including:
Foreign creditors have the same rights as other unsecured creditors in formal insolvency processes.
The Foreign Judgments Act 1991 (Cth) (FJA) creates a general mechanism for the registration of judgments obtained in foreign countries. However, the FJA will only apply to judgments from jurisdictions where, in the opinion of the Governor-General, substantial reciprocity of treatment will be afforded to Australian judgments.
Australian courts may be reluctant to enforce foreign judgments where, for example, the relief sought would adversely affect pre-existing rights of Australian creditors. Notably, due to a lack of reciprocity, judgments of US courts cannot be enforced under this legislation.
Generally, the qualifications and registration requirements to act in the roles of administrator, liquidator, deed administrator or receiver are the same, however, each has a distinct set of powers and obligations.
The liquidator’s role is:
An administrator’s primary duty is to operate consistently with the objects of Part 5.3A of the Corporations Act. In this respect, an administrator must investigate the affairs of a company and provide an opinion on the future of the company. The administrator controls the company’s business, property and affairs, and has broad powers including power to borrow money and to carry on, terminate or dispose of the business or any property of the company.
An administrator’s role is to administer the DOCA to which they have been appointed. Their powers are set out in the DOCA itself (and often mirror administrator powers).
Receivers will usually, as a matter of law, act as agents for a company. Practically, however, a receiver acts in the interests of the secured party that has appointed the receiver, as the receivership is the means by which the secured party is repaid.
Administrators, liquidators, receivers and scheme administrators are each required to be registered liquidators. Individuals may apply for registration with ASIC and will be assessed on their relevant qualifications, conduct and fitness to act.
In a compulsory liquidation, a liquidator will normally be nominated by the creditor bringing the application to the court to wind up a company and appointed by the court. In a creditors’ voluntary liquidation, creditors of the company will resolve to appoint the liquidator.
An administrator will most commonly be appointed by way of written instrument by a company where the company’s board resolves that the company is, or is likely to become, insolvent. Less frequently, a liquidator, provisional liquidator or a secured creditor who has an enforceable security interest in the whole, or substantially the whole, of a company’s property may appoint an administrator.
Almost always, the administrator of a company that enters into a deed of company arrangement will become the administrator of the DOCA.
A security agreement will typically grant the secured party the right to appoint a receiver in respect of the secured property once the security becomes enforceable. The appointment is made by way of a deed of appointment.
Directors owe several general and specific law duties to the company, its shareholders and creditors, including:
In some situations, directors may become personally liable for unremitted amounts of income tax or goods and services tax. The courts maintain a general discretion under the Corporations Act to excuse directors from liability if they can be shown to have acted honestly and reasonably.
A director may face liability for an amount of new debt incurred where they knew, or had reasonable grounds for suspecting, that the company was insolvent or would become insolvent at the time the new debt was incurred.
When a company is insolvent or nearing insolvency, the directors’ duty to act in the company’s best interests includes a duty to consider the interests of creditors. In The Bell Group Ltd (in liq) v Westpac Banking Corporation (No 9)  WASC 239, Owen J held that the directors had breached their duty to have regard to the interests of creditors by entering into refinancing arrangements that improved the secured creditor’s security, to the detriment of other creditors. This was upheld on appeal.
Part 5.7B Division 2 of the Corporations Act contains what are commonly known as the “claw-back” or “avoidance” provisions, for pre-liquidation transactions which may be voidable on application of the liquidator. Transactions may include:
For the first three of these types of transactions, it must also be shown that the company was insolvent at the time of the transaction or became insolvent as a result of that transaction (Section 588FC of the Corporations Act).
Uncommercial transactions and unfair preferences are voidable if the company was insolvent at the time of the transaction or at a time when an act was done to give effect to the transaction. A transaction is “uncommercial” if a reasonable person in the company’s circumstances would not have entered into it. An unfair preference is one where a creditor receives more for an unsecured debt than would have been received if the creditor had to prove the winding-up.
Australian courts have also determined that loans to a company will be “unfair” and thus voidable if the interest or charges in relation to the loan were, or are, not commercially reasonable. This is to be distinguished from the loan simply being a bad bargain. Any “unreasonable” payments made to a director or a close associate of a director are also voidable, regardless of whether the payment occurred when the company was insolvent.
Upon a finding of a voidable transaction, a court may:
Insolvent transactions (which include both unfair preferences and uncommercial transactions) are voidable if entered into, in the case of unfair preferences, during the six-month period ending on the relation-back day, or in the case of uncommercial transactions, during the two-year period ending on the relation-back day. The “relation-back day” is generally the date of the application to wind up the company or the date of the appointment of a liquidator, or if the company had previously been in administration, the date of the appointment of the administrator.
Unfair loans are voidable if entered into at any time before the winding-up began.
Unreasonable director-related transactions are voidable if entered into during the four years ending on the relation-back day.
Transactions entered into for the purpose of defeating, delaying or interfering with creditors’ rights on a company’s winding-up are voidable if entered into during the ten years ending on the relation-back day.
A liquidator has the standing to bring an application to the court on behalf of the company and, in certain circumstances, creditors.
Is Australia’s Safe Harbour Regime Providing Sufficient “Breathing Space” to Distressed but Viable Companies?
Background to the safe harbour regime
Section 588G of the Corporations Act 2001 (Cth) (the “Act”) imposes a duty on directors to prevent a company from incurring debt where they have reasonable grounds to suspect the company is, or may become, insolvent. Under Australian law, a company is taken to be insolvent when it is unable to pay its debts as and when they fall due and payable. If found liable for insolvent trading, directors can face a range of penalties, including civil or criminal penalty orders or orders for compensation to creditors who suffer loss.
In September 2017, Parliament enacted the Treasury Laws Amendment (2017 Enterprise Incentives No 2) Act 2017, introducing a new section 588GA into the Act. This provision gives company directors a “safe harbour” defence to insolvent trading claims under Section 588G(2) of the Act. Section 588GA provides that a director will not be personally liable for debts incurred while the company was insolvent where it can be demonstrated that they were developing or taking a course of action that at the time was reasonably likely to lead to a better outcome for the company than an immediate administration or winding-up.
The reforms were implemented in response to a widespread perception that the threat of insolvent trading claims was leading directors of distressed companies to place companies into voluntary administration and/or liquidation prematurely instead of pursuing other restructuring opportunities, even where more appropriate. The stated aim of the reforms is to promote a culture of entrepreneurship by providing breathing space for distressed businesses to restructure their affairs and continue to do business.
When the safe harbour defence applies, a director will not be personally liable for debts incurred while the company was insolvent where it can be shown that the director was developing or taking a course of action that, at the time the debt was incurred, was reasonably likely to lead to a better outcome for the company than the immediate appointment of an administrator or liquidator. The “better outcome” test involves a comparison of the return to creditors in an immediate insolvency versus a later insolvency and the impact on other stakeholders, such as employees and shareholders.
Section 588GA does not describe what will constitute a course of action likely to lead to a better outcome. Rather, it identifies a number of factors (without limitation) that the court may have regard to when determining whether such a course of action was taken, including whether the director:
The safe harbour defence is only available to directors of a company where the company has complied with its obligation to pay employees (including wages, leave entitlements and superannuation) and its tax reporting obligations during the 12 months before the debt is incurred.
The protections provided as part of this defence do not extend beyond the civil liability set out in Section 588G(2). Directors must continue to comply with their other legal obligations, including their duties to act in good faith and the best interests of the company. The safe harbour does not extend to criminal liability for insolvent trading, which involves dishonest conduct by directors.
Review of the safe harbour reforms
The federal government as part of the 2021–22 Federal Budget announced that it would commission an independent review of the safe harbour provisions pursuant to Section 588HA of the Act to examine and report on the operation and efficacy of the safe harbour provisions (the “Review”). Appointed on 19 August 2021, the independent panel assessed whether the safe harbour provisions are achieving their aims, including giving financially distressed but viable companies more “breathing space” to restructure their affairs.
The Federal Treasury tabled its final review on 24 March 2022, relying on contributions from advisers and industry stakeholders to make several recommendations as to how the safe harbour regime may be improved (the “Report”). The Report notes there was recurring feedback throughout the Review from stakeholders that awareness around insolvent trading and safe harbour ought to be increased, that there was a need for a high-level reconsideration of directors’ duties as they relate to corporate distress generally, and that there is difficulty in adopting a single safe harbour framework to companies of all types and sizes.
The Report sets out several recommendations to enhance the current safe harbour regime, including that:
While these recommendations would be likely to enhance the operation of the current safe harbour regime, there are, in the authors’ view, several threshold issues which make it difficult for the current framework to achieve Parliament’s stated objectives (see below). One further recommendation in the Report, being that that Treasury commission a holistic in-depth review of Australia’s insolvency laws generally, has already been actioned with such review having commenced on 28 September 2022 (see further below).
Limitations of the safe harbour regime
While the introduction of safe harbour generally and the Review especially are welcome steps towards promoting an entrepreneurial approach to restructuring in Australia, there are, in the authors’ view, several threshold issues that will ultimately limit how much can be achieved under the current regime. It is unlikely that these will be resolved by any recommendations contained in the Report.
Safe harbour as a defence to insolvent trading
The first of these is that safe harbour is ultimately a defence to an insolvent trading claim brought against a director. Its protection provides no guarantee to directors whilst trading on during insolvency or likely insolvency that they will not attract liability for insolvent trading. Rather, it is used by directors in the hope that, if and when an insolvent trading claim is brought against them, they will be able to rely on the safe harbour plan that had been in place while the company was attempting to restructure. In the authors’ experience, this in practice derogates from the Parliamentary intention of encouraging entrepreneurial approaches to restructuring in that those directors are provided with no comfort before or during the safe harbour, limiting their risk appetite and ultimately the freedom to trade out of insolvency that comes with a guarantee of no liability.
In short, directors, particularly non-executive directors without any ownership interests, tend to be motivated to not take on any risk. To not take on any risk should a company become insolvent, directors appoint administrators. The alternative of trading on and relying on a safe harbour defence is often not attractive in a relative sense. Further, as a practical matter, it has also proved to be difficult for directors to engage “appropriately qualified advisers” to develop and implement a restructuring plans as, if they do not succeed, advisers expose themselves to the risk of being counterclaimed against if an action is brought against directors.
Compare this to the position of insolvent trading liability in the UK. Section 214(3) of the Insolvency Act 1986 (UK) embeds protection for directors from insolvent trading claims within the liability provision itself, providing that if it becomes clear that there is no reasonable prospect that a liquidation can be avoided, a director will not be liable for insolvent trading if they “took every step with a view to minimising the potential loss to the company’s creditors”. The practical effect is that while a director may not recklessly trade whilst insolvent, it is clear from the outset that they will not risk liability for attempting to turn around a company provided that if it becomes apparent that such turnaround is not possible, they take steps to minimise potential losses to creditors. Unlike Section 588GA of the Act – a defence that may be raised in the face of an insolvent trading claim – the UK framework protects a director from the outset. This enables directors of UK companies to engage in more entrepreneurial approaches to restructuring in contrast to the Australian legislation.
Other limitations of safe harbour protection
Aside from the issues around using safe harbour as a defence (discussed above), there are, in the authors’ view, further limitations which undermine its utility in promoting entrepreneurial approaches to restructuring distressed but viable companies in Australia.
Firstly, safe harbour does not protect directors from breach of duty or other claims which are often brought in tandem with insolvent trading claims. For example, the Arrium litigation involved not only an insolvent trading claim but other duty of care and negligent misstatement claims; a safe harbour defence in these circumstances would be of little comfort. Accordingly, while directors may raise a safe harbour defence to an insolvent trading claim, they will likely remain exposed to a range of different claims based on the same circumstances that had led to the insolvent trading claim in any case.
Secondly, the safe harbour defence does not afford any guarantee for companies looking to enter into new financing arrangements as part of a broader restructuring. Part of many complex restructurings is a new financing package and/or a standstill of existing lender rights in a default scenario. Safe harbour does not confer any benefit on companies required to provide solvency representations and warranties, or comply with financial covenants, under finance documents. A mere reliance on safe harbour could be regarded as an effective admission of insolvency or near-insolvency which makes it difficult for a borrower to comply with covenants or to provide representations or warranties around insolvency. On the other hand, for lenders, safe harbour can be seen as a tool to be leveraged by borrowers in refinancing negotiations. For instance, borrowers have on occasion refused to accept certain terms of a restructure (for example, lender fees) on the basis that such terms are contrary to a safe harbour plan without being under any requirement to disclose the plan to the counterparty. Such instances can be disruptive to a successful restructure.
Finally, where the borrower does end up in liquidation, the safe harbour regime does not protect against a liquidator being able to claw back certain payments made, or set aside transactions entered into, during the safe harbour period. The regime does not make any provision for transactions entered into by a company whilst pursuing a turnaround plan, with the result being that transactions that may have benefitted the company and other stakeholders become vulnerable to attack as antecedent transactions by a liquidator in a winding up scenario (ie, where no turnaround strategy is pursued and the primary objective is to maximise short-term returns for creditors). This may deter directors from pursuing certain opportunities and again limits the available creativity in a turnaround effort. Similarly, directors may be reluctant to enter into transactions or make payments during the safe harbour period for fear of being rendered liable for misfeasance particularly if effected during a period of clear insolvency.
As mentioned above, the Review is a welcome inquiry into how Australia’s insolvency framework can be reformed to encourage a more debtor-friendly environment and foster more creative restructuring solutions for viable businesses. However, the current safe harbour regime is not effective in achieving Parliament’s objectives. A more thorough review of the safe harbour and insolvency regime is necessary to effect a radical change in how the Australian restructuring landscape is viewed.
On 28 September 2022, in a further development, the federal government’s Parliamentary Joint Committee on Corporations and Financial Services (the “Committee”) commenced an inquiry into the effectiveness of Australia’s corporate insolvency laws in protecting and maximising value for the benefit of all interested parties and the economy. The Committee’s objective is to understand the reality of what is happening in the corporate insolvency space, whether the current framework is “fit for purpose” and to consider potential areas of reform.
The Committee flagged safe harbour (as well as unfair preference claims, trusts with corporate trustees, insolvent trading and international approaches) as being a key area of potential reform. The Committee is currently accepting submissions from stakeholders up until 30 November 2022, with a view to tabling a report in both Houses of Parliament by 30 May 2023. We look forward to the outcomes of this report and discerning what it means for the operation of safe harbour and the restructuring landscape in Australia going forward.