Australia: The prospect of a safe harbour for company directors
From Red to Black 2016

Australia has been criticised as placing too much emphasis on penalising and stigmatising corporate failure and not enough on celebrating success.

As part of its program to "innovate" business, following the recommendations of the Productivity Commission, the Federal Government announced in December 2015 it would legislate to protect directors from insolvent trading claims when engaged in undertaking a corporate restructuring: that is, to create a safe harbour in the event the corporate restructure fails. Taking away penalty risk while encouraging a turnaround culture allows businesses the freedom to fail and get back up on their feet. In April 2016 the Government circulated two possible "safe harbour" models, terming these Model A and Model B. Around 70 submissions were received by Treasury in response to its consultation and we expect to see further progress on this issue in FY17. Model A provides a defence to insolvent trading where directors formally appoint a restructuring adviser to develop a plan to rescue the company "within a reasonable period of time". The onus would be on the directors of the company to ensure that the experience and qualifications of the restructuring adviser were appropriate for the nature and circumstances of the company. Model B removes the risk of liability in specific circumstances, including where directors take reasonable steps to maintain or return the company to solvency while acting in the best interests of the company and its creditors as a whole, and operates more as a carve-out than a defence. In an environment where insolvencies are on the rise, many commentators would prefer either model over the status quo, but in the context of a reform agenda which is striving to promote innovation and entrepreneurship, it seems clear that neither model will sufficiently support the policy objectives of safe harbour. More effort is clearly needed to reduce the unreasonable burden of liability on directors and create a true business rescue culture in Australia.

• Industry views

Model A

Clayton Utz partners are heavily represented on the TMAA, which supports Model A, as does the Australian Chamber of Commerce and Industry, ARITA and the Australian Shareholders' Association. That support comes from the need for a board, often made up of directors with little to no experience in dealing with the distressed side of capital markets, to engage with an accredited restructuring adviser (or "safe harbour master"). The restructuring adviser will have deep experience in the usual sudden shifts in counterparty priorities according to the value breaks in the capital structure and burning platform organisational, cultural, communications, planning and restructuring needs of an ailing company. That person, or more accurately, the team behind the adviser, becomes the trusted communicator with various internal and external stakeholders, the developer of a turnaround plan and then the party responsible for measuring and reporting on the effectiveness of the plan in implementation.

There are varying views as to what qualifications, experience and accreditations the directors need to consider when appointing a formal restructuring adviser and whether those factors should be set out in regulatory guidance by ASIC. Bodies such as the TMAA and ARITA (who both provide education) as well as professional advisers could provide such assistance. Most importantly, a restructuring adviser must have the skills and expertise which will be key to a successful turnaround/restructure.

Model A could provide an effective safe harbour for the directors of large companies, but may not be accessible to the directors of small- and medium-sized enterprises or start-ups due to the costs and additional red tape. Further, it does not address the complicated issue of forming a view on the prospective insolvency of the company because the proposed defence would only be activated if restructuring advice is obtained while the company remains solvent.

Model B

Model B is seen by some (including the Australian Institute of Company Directors) as being more flexible in allowing directors to retain control of the company, with or without a restructuring adviser, and to focus their attention on working towards a rehabilitation of the business. It also, much like the American model, gives the fox charge of the chicken coop and does not deal with either the cultural or experience inadequacies of many directors when dealing with distressed situations.

While this model is likely to be more user friendly to SME and start-ups, it has the capacity to increase risk to creditors who continue to supply/trade with the company undergoing the restructure.

• Clayton Utz's view

Our preference is to see Model A as the default position, with Model B to be an option to be exercised by directors on an exceptions-based reporting basis. As with other exceptions-based reporting systems, the risk of disclosure, justification and measuring success or failure very much makes the model a riskier proposition for directors (who may not retain the safe harbours benefits of the model) engaged in large or complex restructuring situations.

• Other alternatives

One suggestion is that the UK insolvency laws be considered as a guide, in particular the "wrongful trading" provision contained in the UK Insolvency Act. Under that regime, the court can absolve a director from making a contribution to the company's assets if the director took every step with a view to minimising the potential loss to the company's creditors that ought to have been taken in the circumstances. In practice, this has allowed directors a greater degree of flexibility to pursue a restructure.

Other ideas range from a two-tiered approach (separating the regime for SMEs and start-ups from that for larger corporates), to limiting the prohibition to the incurring of specific debts, to the abolition of exposure to civil penalty provisions to the complete abolition of the prohibition. Given that most insolvent trading activity occurs in the SME sector where pursuing the directors is often not worthwhile financially, the entire basis upon which the prohibition exists should be looked at more closely, including whether creditors are already sufficiently protected by the duties imposed on directors under sections 180-183 of the Corporations Act.

• Timing

There is no certainty as to the timing of the introduction of the safe harbour reform. It falls into the Government's second tranche of insolvency law reforms, which is being progressed as part of the Government's National Innovation and Science Agenda.

• The bigger picture

Fundamentally, legislative reform (and it is yet to be determined how the concept of safe harbour is to be addressed in any legislation), only provides a process for change. For restructurings to succeed, directors and management must also accept the cultural challenge of restructuring, involving as it does different communication and stakeholder engagement than exist in non-distressed situations. Transparency, broader stakeholder interaction (outside shareholders and not always beholden to an immediate reporting cycle), engagement with experienced outsiders and a willingness to sacrifice the sacred cows of the business to restore long-term value are each matters for a board and management to deal with in order to make a restructuring plan work. Only then, together with a change in the law, will innovation and entrepreneurship thrive.

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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. Persons listed may not be admitted in all states and territories.