Although most western legal systems have recognised for some
decades the public benefit in rehabilitating failed enterprises,
some countries do it better than others. To some extent, this is
because of differences in local legislation (sometimes small, but
with far-reaching effects), which either shapes, or is shaped by,
popular or political attitudes to business failure.
The Australian government has just announced a number of important
changes to its insolvency (bankruptcy) legislation, avowedly
designed to make the country more innovative, competitive and
entrepreneurial. Both because of the difference these changes will
make in practice and, one hopes, because of the shift in thinking
they represent, this announcement may herald the beginning of a
period in which Australian management can run their companies more
boldly, the stigma of business failure is reduced, and turnarounds
that preserve enterprise value are more easily achieved.
A Safe Harbour
One of the most troublesome aspects of Australian corporate
insolvency law has been the potential personal liability for a
company's debts that directors face (referred to as liability
for insolvent trading) if the company goes into liquidation. This
personal liability—which is stricter than in most other
countries in the world—reflects an underlying popular need to
apportion blame when a company fails. Its practical effect has been
to stifle the growth of a turnaround or rescue mindset in
Australia. Instead, faced with a sharp, and often sudden, conflict
between their duties to the company and their potential personal
exposure, directors choose to appoint an administrator or
liquidator. In Australia, neither liquidation nor administration
has provided an effective tool for restructuring a company and
saving the relevant enterprise.
Now, the government has announced, directors will be provided with
a safe harbour—i.e., exception from the risk of the personal
liability that has haunted boards to date—if they appoint a
restructuring advisor to assist in attempting to rescue the
company. The details of the exception are yet to be worked
out—e.g., for how long the exception will last, what sort of
role the restructuring advisor will play, and whether there will be
any protections afforded to the company or its creditors during the
period that such an advisor is acting—but this nevertheless
represents a substantial shift away from a culture of rushing
toward a formal insolvency appointment.
This may also see the development of a Chief Restructuring Officer
("CRO") culture in Australia. At the moment, CRO
appointments are almost unheard of because anyone undertaking such
a role would likely face the same insolvent trading risks as do
directors.
Ipso Facto Clauses
The second major change is that contractual provisions which
cause a contract to terminate on one of the parties'
insolvency, or allow the other party to terminate upon the
occurrence of that event (commonly referred to as "ipso facto
clauses") are no longer enforceable.
That has long been the position under the US Bankruptcy Code
(see 11 U.S.C. §365(e)), and it has represented a
marked difference between US bankruptcy practice and insolvency
practice in Australia. Because ipso facto clauses in Australia can
still be used to terminate contracts (until these newly announced
changes are enacted), contractual counterparties have been able to
exert undue influence on any restructuring process, known as
"greenmailing", or the proponents of a restructuring have
found that important contracts underpinning the business have not
been able to be preserved.
Again, precise details have yet to be announced, and they will
become known only when draft legislation is introduced in 2016, but
for those keen to encourage a restructuring and turnaround culture
in place of the more traditional formal insolvency processes that
have been the norm in Australia to date, this is excellent
news.
Reducing the Length of Bankruptcy
Finally, for individuals (as distinguished from corporations)who
go bankrupt, the usual length of time before the debtor receives a
discharge is to be reduced from three years to 12 months. Many
bankruptcies are commenced after directors personally guarantee the
debts of their companies—especially in a start-up context. In
addition, an undischarged debtor is normally ineligible to serve as
a director of a company.
This change will mean that entrepreneurs will be less likely to be
deterred from guaranteeing company debts because of the prospect of
a three-year bankruptcy during which they cannot make a fresh
business start. It will also mean that entrepreneurs, who are often
among the most productive in an economy, are not kept out of
circulation for three years. If an individual debtor is deemed to
be unsuitable for a discharge after 12 months, the trustee will
still be able to seek a deferral of the discharge for up to eight
years—but for the most part, this reduction represents a
recognition that society no longer needs to punish business
failure, and that the greater public good lies in ensuring that
potentially productive members of society are able to fulfil their
potential.
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