Australia: Insolvency: Year in review

Last Updated: 3 December 2018
Article by Kim MacKay and Mitchell Waters

Most Read Contributor in Australia, November 2018

Significant insolvency legislative reforms were introduced in 2017. One year on, we assess what changes, if any, these reforms have had on the insolvency market in Australia.

The most significant insolvency law reforms in 20 years were introduced in 2017 to improve efficiency, communication, engagement and competition in external administration processes. The reforms were implemented in two tranches pursuant to the Insolvency Law Reform Act 2016 (Cth) (ILRA).

Tranche 1 commenced on 1 March 2017 and predominantly related to the registration and discipline of insolvency practitioners. It also expanded the external administrator's power to sell the company's legal rights (including voidable transaction claims).

Tranche 2 commenced on 1 September 2017 and increased creditors' powers to request information, give directions and to remove external administrators. It also introduced new rules for funds handling and the review and approval of external administrators' fees.

Significant reforms were also introduced by the Treasury Laws Amendment (2017 Enterprise Incentives) Act 2017 (Cth) namely a safe harbour for insolvent trading and a stay on the enforcement of ipso facto clauses. These reforms were aimed at fostering entrepreneurship by directors to allow more companies to trade out of insolvency and, if external administration cannot be avoided, protecting the company's value for the benefit of shareholders and creditors.

Insolvency Law Reform Act (IRLA)

There has been significant court attention on insolvency practitioner remuneration in recent years. Whilst the decisions have been far from consistent, a number of judges have recurrently incorporated a principle of proportionality in assessing the reasonableness of remuneration. In a series of decisions, Brereton J in the NSW Supreme Court fixed remuneration on an ad valorem basis, allowing recovery of between 5 per cent and 20 per cent of the value of the assets realised. The NSW Court of Appeal, in Sanderson as liquidator of Sakr Nominees Pty Ltd (in liquidation) v Sakr [2017] NSWCA 38 (Sakr), overturned one of these decisions and watered down the significance of the proportionality test articulated by the Supreme Court. Nonetheless, there has been a real push away from the traditional time-based recording and a call upon insolvency practitioners to be able to satisfy creditors that the work they undertake is reasonable and necessary in the circumstances. Under the ILRA the principles enunciated in Sakr will continue to apply. However, creditors now have additional rights to seek a review of an external administrators' remuneration, including through the appointment, by resolution, of a 'reviewing liquidator' who may inquire into an external administrators' remuneration and a cost or expense incurred by the external administrator. The costs of such a review will be an expense in the liquidation. In the absence of a resolution, creditors may apply to the Court for orders appointing a reviewing liquidator.

Creditors who have long felt like silent spectators now have the opportunity to keep appraised of external administrators' actions through broad powers to request documents from external administrators. Creditors may also give directions to external administrators and/or remove and replace external administrators by resolution if they consider it is not in their best interests. It is hoped that the increased powers will allow creditors to keep external administrators accountable for their conduct. At the same time, it is likely that these provisions will create further work for insolvency practitioners appointed as external administrators, thereby increasing remuneration and reducing creditor returns.

A number of drafting anomalies have been identified since the ILRA came into force. Funds handling is one such area where strict time lines have rendered compliance with the statute all but impossible. The risk of hefty financial penalties for non-compliance means that court applications for directions may be necessary to ensure insolvency practitioners remain on the right side of the law. Such an application was made by KordaMentha in relation to the Ten Network's administration.

The ILRA has necessitated amendments to the Corporations rules of each State Supreme Court and the Federal Court. The Supreme Court of Victoria and the Federal Court have enacted updated, ILRA compliant, rules. At the time of writing the Supreme Court of New South Wales had not yet updated their Corporations Rules and references to out of date provisions of the Corporations Act 2001 (Cth) remain. We understand that updated rules are currently being prepared by this court.

Safe harbour and ipso facto

According to ASIC's 2017/18 report, 69.2 per cent of reports to ASIC from external administrators alleged insolvent trading. Of these, only 37.7 per cent advised ASIC that they had commenced or were contemplating taking recovery action against directors. Insolvent trading claims are difficult to prove, expensive to run and there is often little chance of the director being able to satisfy any judgment. External administrators will be further dissuaded from bringing insolvent trading claims with the introduction of the safe harbour defence. It will therefore likely be some time until safe harbour is considered by the courts. Such litigation will likely consider whether a company has successfully entered safe harbour, which will involve a consideration of whether the course of action adopted by the directors would be 'reasonably likely to lead to a better outcome for the company'.

It will also likely be some time before the ipso facto reforms come before the Courts, given they only apply to contracts entered into after 1 July 2018. The raft of exceptions will cause some headaches for insolvency practitioners upon appointment and could lead to disputes around the characterisation of contracts and rights relevant in determining whether an exclusion applied.

Future reforms

There are a number of additional insolvency law reforms in the wings. Most notable, the enactment of a default one year period for bankruptcy, reduced from three years, is likely to be legislated early next year. The consultation process in respect of proposed reforms to combat unlawful phoenix activity has also concluded and we anticipate this legislation to also be placed before the parliament early next year.

This publication does not deal with every important topic or change in law and is not intended to be relied upon as a substitute for legal or other advice that may be relevant to the reader's specific circumstances. If you have found this publication of interest and would like to know more or wish to obtain legal advice relevant to your circumstances please contact one of the named individuals listed.

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