Safe harbour for directors in insolvency

One of the proposals announced in the Federal Government’s Innovation Statement is a safe harbour for directors from personal liability for insolvent trading if they appoint a restructuring adviser to develop a turnaround plan for the company. This was recommended by the Productivity Commission, and is part of a package of insolvency law reforms aimed at encouraging Australians to take risks in business, due to a concern that the fear of failure stifles entrepreneurial activity.

In order to encourage entrepreneurship while ensuring protection of creditors, the proposal in the Innovation Statement also includes:

  • reducing the current default bankruptcy period from three years to one year, and
  • making ‘ipso facto’ clauses, which allow contracts to be terminated solely due to an insolvency event and often lead to a company’s liquidation; unenforceable if a company is undertaking a restructure.

The Innovation Statement notes that concerns over inadvertent breaches of insolvent trading laws are frequently cited as a reason investors are reluctant to get involved in a start-up. However, while there is no proposal paper on the table at present, any reform needs to extend to all companies, given the discussion over many years about the need to create a safe harbour for directors to allow them to bring in advisers early if the company is in financial distress, to assist them to trade out of their difficulties.

Significant concern has been expressed at how the current insolvency laws, which attach personal liability to directors if they trade while insolvent, means that directors tend to call in administrators — or their lenders call in receivers — rather than seeking to work out their difficulties. The unintended consequence of the current law is that directors focus on their own interests rather than those of the company. The business community has been noting for some time that it is not desirable that the corporations law should have this effect.

A proposal paper will be released in 2016, and legislation is expected to pass in mid-2017.

The innovation statement can be found at http://www.innovation.gov.au/.

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