It's unclear that safe harbours by themselves will
provide genuine opportunities for restructuring distressed
The Productivity Commission's upcoming report on corporate
insolvency will address two burning issues: ipso facto clauses and
how to encourage directors to save financially-stressed
Ipso facto clauses allow creditors to break a contract if the
other side suffers an insolvency event. If that results in a
company being starved of supplies or customers, the chances of
successfully restructuring its debts are greatly reduced.
There is much support for abolishing or restricting the use of
ipso facto clauses. Conversely, there are two reasons why such a
change might not be enacted or, if enacted, might be ineffective:
the principle that the law should be slow to interfere with
freely-negotiated contracts, and the possibility that clever
drafters might write contracts that achieve the same effect as ipso
facto clauses, without breaching the prohibition.
The debate about ipso facto clauses pales into insignificance
compared to the discussion about how to encourage directors to try
to save their companies.
We already have a statutory regime ? voluntary administration ?
which allows directors to appoint an external expert to explore
ways of saving their company. This also shields the directors from
personal liability for corporate debts.
Unfortunately, voluntary administration is often just the scenic
route to insolvency. Broadly speaking, there are two schools of
thought on why this is so.
There are those who believe that voluntary administration is
part of the problem, rather than the solution: directors, it's
claimed, appoint voluntary administrators more to avoid personal
liability than to find a way to save their company.
The opposing view is there's not much wrong with voluntary
administration: corporate failures are just the free market at
work, and it's not surprising that, by the time an
administrator is appointed, many struggling companies are beyond
hope of rescue. Part of the problem, it is suggested, is that
directors are too slow ? not too quick ? to appoint an
The Productivity Commission's draft report suggested a new
form of corporate rescue: a personal liability "safe
harbour" period for directors during which they could seek
professional advice on how to restructure their company and its
But would this increase the number of successful restructures?
As the Queensland University of Technology Centre for Commercial
and Property Law pointed out in its submission to the Commission,
much of this debate takes place in an information vacuum.
Statistics about the effectiveness of voluntary administration
are hard to come by. Equally importantly, there is next-to-no
accurate (as opposed to anecdotal) information on how directors
actually think and behave in a financial crisis. Without that
information, the idea that a safe harbour will save more companies
is largely based on hope.
But why not just give the safe harbour proposal a run, to see if
it works? The problem is that, every time another protection is
extended to directors, someone else (in this case, creditors)
suffers a corresponding detriment. Before further crimping their
legal rights, we owe it to creditors to ensure that its adverse
impact on them will be minimal.
One objective of the Australian corporate insolvency regime is
to provide genuine opportunities for restructuring distressed
businesses. The available evidence demonstrates that, the earlier
in the distress cycle the turnaround professionals (including
lawyers) are retained by directors, the more likely the
rehabilitation of the struggling enterprise. It may be that
acceptance by directors of this simple fact will do more to enhance
a restructuring culture than any legislative change.
Clayton Utz communications are intended to provide
commentary and general information. They should not be relied upon
as legal advice. Formal legal advice should be sought in particular
transactions or on matters of interest arising from this bulletin.
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A recent NSW decision has implications for liquidators of trustee companies dealing with trust funds and priority debts.
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