Australia: Australia Announces Bankruptcy Changes—Moves Toward US Position

Last Updated: 15 December 2015
Article by Maria Yiasemides

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.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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