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In September 2017 there were several changes to insolvency law in Australia. The reforms have the potential to assist company directors to restructure or improve their company’s financial position while limiting their risk of personal liability. The amendments aim to achieve this through the ‘safe harbour’ and ‘ipso facto’ provisions. This article will explain these amendments and how they may affect your company.

Director’s Liability for Insolvent Trading Before the Reforms

It is a company director’s duty to prevent the company from trading when it is insolvent. A company is insolvent when it is unable to pay its debts when they are due. A company director may be personally responsible for breaching this obligation if:

  • they were the director when the company acquired the debt;
  • the company was insolvent when it acquired the debt or the company became insolvent because it acquired the debt; and
  • there were reasonable grounds for suspecting that the company was, or would become insolvent when the company acquired the debt.

If a director breaches one of these obligations, the court could force them to pay a penalty. Currently, the maximum penalty is $200,000. 

Safe Harbour Reforms

However, in September 2017, a new section was added to the Corporations Act. This section sets out an exception to the duty of company directors to prevent insolvent trading. Specifically, if a director suspects that the company may be insolvent or may become insolvent, they will not breach their duty if:

  • they start to develop a course of action that is reasonably likely to lead to a better outcome for the company (compared to appointing an administrator or liquidator); and
  • the debt that the company acquires is connected to these actions, either directly or indirectly.

However, the exception will not apply if the company is failing to:

  • meet its tax obligations; or
  • pay employees their entitlements.

The safe harbour provisions may seem like a ‘get out of jail free card’ to some creditors of a company. However, the purpose is to encourage directors to take reasonable risks to put their company in a better financial position without fearing a penalty if they are unsuccessful. This will hopefully help companies avoid being placed into administration or liquidation prematurely, which is in a creditor’s long-term interests.

These changes took effect on 19 September 2017.

Ipso Facto Reforms

It is not uncommon for commercial contracts to provide a right to terminate the contract when there is a specific ‘insolvency event’, such as voluntary administration. These clauses are known as ipso facto clauses.

The reforms to the Corporations Act, which apply to contracts entered into on 1 July 2018 or after, have limited parties’ rights to included these clauses in their contracts. Now, a party cannot terminate a contract with a company or use a ‘self-executing’ clause (a clause that takes effect without the need for a party to enforce it), merely because the company:

  • appoints an administrator,
  • appoints a receiver or controller, or
  • proposes a scheme of arrangement.

Under the reform, a party cannot enforce a right to terminate the contract during any of these insolvency procedures. However, these reforms do not remove the right to terminate entirely. Instead, the provisions act as a ‘suspension’ on the right to terminate a contract. It is important to note that the reforms will not apply to a company in liquidation.

Other Contractual Obligations

The company experiencing an insolvency event will still need to perform its other contractual obligations. Otherwise, it may give the other party a different reason to terminate the contract.

Like the safe harbour reforms, the purpose of the ipso facto reforms is to improve a company’s chances of recovering from an insolvency event. It does so by limiting a party’s ability to terminate a contract purely because an insolvency event occurs. To provide some protection to creditors and other parties, the reforms also state that while the suspension is in place, the company cannot require a party to make new advances of money or credit.

Exceptions to the New Ipso Facto Provisions

There are over 30 different types of contracts that are excluded from the new ipso facto provisions. These include:

  • business sale agreements;
  • share sale agreements;
  • government licences; and
  • various contracts for financial arrangements including debt and equity capital agreements.

A government declaration from 20 June 2018 also excludes various contractual rights mainly relating to finance contracts. 

To check whether a contract is exempt, you should review the full list of excluded contracts in the regulations and the excluded rights in the declaration.

Key Takeaways

Recently, the government amended insolvency laws to help companies recover from insolvency and continue to trade. Specifically, the reforms aim to:

  • encourage company directors to take reasonable risks to recover their company, without the added risk of personal liability if these efforts fail; and
  • reduce the financial impact of commercial contracts being terminated by default as a result of an insolvency procedure occurring.

If you have any questions about how the insolvency reforms might affect your company or contractual arrangements, you can contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.

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