KickStartup Series: What Are The Upcoming Changes to Insolvency Laws?

In December 2015, the Federal Government unveiled a science and innovation package of 24 measures to rejuvenate innovation in Australia. As part of this $1.1 billion package over four years, there will be a number of changes to insolvency laws. These changes aim to help those in financial failure. The promised legislation will include:

• Reducing the default bankruptcy period from three years to one year.
• Introducing a personal liability safe harbour for directors for insolvent trading if they appoint a professional restructuring adviser.
• Removing the ipso facto clauses that terminate contracts upon insolvency if the company is undertaking a restructure.

The primary legislation in insolvency law is the Corporations Act 2001 (Cth). Australia’s current insolvency laws have fallen behind world’s best practice by focusing too much on penalising and stigmatising businesses and financial failure. For companies that become insolvent, there are both formal insolvency processes as well as insolvency regimes to help companies restructure their affairs. These processes and regimes include voluntary administration and schemes of arrangement.

Proposed Insolvency Laws

The Federal Government’s proposed changes aim to strike a better balance between protecting creditors and encouraging entrepreneurship and minimising harsh penalties on businesses that fail. The first paper outlining the proposals will be introduced in the first half of 2016 and the legislation to enter Federal Parliament in mid-2017.

Default Bankruptcy Periods

The current personal bankruptcy period is three years. The reform will reduce the stigma attached to personal bankruptcy and encourage entrepreneurs to re-enter by facilitating a positive ethos to re-enter. The government recognises that business failure can often be a result of fraud, misconduct or poor planning. Reducing the personal bankruptcy period to one year will facilitate rescue and rehabilitation for businesspeople.

Personal Liability Safe Harbour for Directors

Under the current insolvency laws, company directors who continue to trade when under financial distress in hopes of reviving the business may be sued for insolvent trading. The new regime will introduce a defence where directors would be protected from insolvent trading liability if they engage a qualified restructuring adviser. Directors would then be required to act in accordance with the adviser’s advice.

Ipso Facto Clauses

“Ipso facto” clauses will also be changed. These clauses enable one party in a contractual arrangement to terminate an agreement upon the insolvency of the other party. The exercise of this clause will often end a company’s business and result in liquidation. Under the new changes, a company facing financial issues will appoint an adviser to arrange new credit facilities to address any short-term cash flow problems. Ipso facto clauses will no longer be enforceable and will achieve a more beneficial outcome.

These three changes will be a welcome move in encouraging investment and risk-taking. By facilitating an entrepreneurial environment that embraces risk, entrepreneurs will strive to innovate and learn from their mistakes, as well as the mistakes of others. The insolvency law changes in the National Science and Innovation Plan is a positive step in changing the stigma behind a business’ failure.

Questions on insolvency law or the upcoming changes to startups and small businesses under the Federal Government’s Innovation Plan? Get in touch.