Insolvency & Restructuring Law Reform: "Safe Harbour" commences, and impact on contractual Termination Clauses

23 November 2017

Insolvency law and practice is undergoing significant reform. This reflects the Government’s Innovation and Science Agenda, namely the approach to business restructure, with an increasing emphasis on turnaround and early intervention.

There are two statutory reforms, passed in September 2017 (both by way of amendment to the Corporations Act 2001 (Cth)), of particular significance, and which have broad application. They are:

  1. The directors’ “Safe Harbour” regime, which has already come into force; and
  2. The “Ipso Factor” reform, which has yet to come into force, but which will significantly affect the ability to terminate contracts following an insolvency appointment.
Safe Harbour now in effect

The Safe Harbour reforms came into force on 19 September 2017, and have attracted considerable publicity.

The reforms provide protection for directors from personal liability for insolvent trading, and aim to encourage directors to consider and implement alternatives to a formal insolvency. The protection is provided where directors “develop or take a course of action” that is “reasonably likely” to lead to a better outcome for the company than immediate administration or liquidation.

There are various other requirements to be met to obtain the benefit of the provisions.

To some extent, the reforms codify the pre-existing law, but the amendments are significant. It is important that directors properly understand the impact of the amendments on their duties; the emphasis is on early and decisive action.

The amendments may also affect how creditors deal with companies in financial distress; in particular if directors wish to invoke the safe harbour provisions, they must face up to the commercial realities of continuing to trade and have in place a viable plan.

Ipso Facto reforms: the need for immediate review of contractual provisions

The right to terminate a contract upon an insolvency event is a conventional provision in commercial contracts. It potentially provides various strategic advantages including to immediately sever any ongoing obligations and redeploy resources, or to allow unpaid creditors and suppliers to refuse further supply, absent payment. However, the inability to complete contracts or to obtain ongoing supply has long been a major inhibitor to the restructuring of an insolvent entity.

The new provisions of the Act will render these termination clauses, known as ipso facto (by the fact) clauses, unenforceable. It is expected that the new law will commence on 1 July 2018, and the amendments will apply only to contracts entered into after the new law commences.

This is an entirely new law and it has no parallel under the pre-existing regime. It has the potential to significantly affect the rights of the counter-party to a contract.

The provisions apply to the appointment of an administrator, managing controller (including a receiver and manager), and a scheme administrator.

The law provides exclusions for certain financial products, and a right of appeal for affected counterparties who may suffer hardship. The contract may still be terminated for other reasons, such as non-payment and the stay does not extend to the rights of secured parties.

Although the law will not come into force until 1 July 2018, it is prudent to now make preparations, including to review contractual arrangements (although the laws include anti-avoidance mechanisms to capture contracts drafted to circumvent the provisions), and to consider the potential impact of the new laws on current and future commercial arrangements.

Insolvency and restructuring reforms a source of new complexities

In addition to the above mentioned changes, there is wide ranging legislative and regulatory reform underway that impacts on creditor, insolvency procedures, and on the conduct of directors of distressed entities. The emphasis is increasingly on promoting viable restructures, but the key remains early and realistic action.

This article was written by David O’Farrell, Partner. 

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