Tag Archives: Law Reform

Comments on the Exposure Draft of the Insolvency Reform Legislation – Corporations Amendment (Corporate Insolvency Reforms) Bill 2020

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Actual picture of the parliamentary drafting table

Laws are like sausages, it is better not to see them being made.

Otto von Bismarck

After announcing the introduction of streamlined Debtor in Possession reforms for small corporate business insolvencies just 2 weeks ago (see my thoughts at the time of release here) by 1 January 2021, the Commonwealth has now released an exposure draft of the amending legislation and an explanatory memorandum.   It really is a case of making  sausages.

In summary, the exposure draft leaves a lot of work to be done by the drafters to get the legislation finalised.  A lot of the meat (no pun intended) in terms of substantive changes to the existing law is left to regulation, probably sensibly the only way to get this process done with consultation within the industry in time.  It seems to me that the exposure draft has been rushed out by using this device and that a lot of the hard yards will be done in the process of sifting through submissions to be made,  due on Monday and in further consultation, hopefully with industry bodies and the legal profession.

My thoughts on the exposure draft:

  1. To be completed by regulations:  the draft is the ultimate “fixer upper” opportunity, being only about two thirds finished.  The unfinished parts are to be filled by regulations to be made later.  Presumably the idea is to permit more time for the Commonwealth to consult with the professions, industry and other SME stakeholders, which may be the only practical way to get the changes made so they can commence by 1 January 2021.  This approach, whilst unorthodox for insolvency reform, is welcome given that there was little or no consultation before the package was announced.
  2. A whole new insolvency office:  The term for the appointee used in the part is “restructuring practitioner”.  A new definition in s.9 of the Act is included to define that term.  The term is used for an appointee both during the restructuring period and after the restructuring plan is accepted: there is no term akin to “deed administrator”.
  3. A whole new part:  Rather than adapting the existing processes for voluntary administration, the drafters have inserted an entirely new part, Part 5.3B, dealing with restructuring of a company under the debtor and position model.   Again, this reflects the object of the reforms, which is a revolutionary, rather than an adaptive.
  4. #tag –  (Restructuring Practitioner Appointed):  Section 457B requires a company subject to the restructuring process must add the words “(restructuring practitioner appointed)” after its name.
  5. An act of insolvency:  like a part X proposal for an individual in bankruptcy, a company who proposes a restructuring plan is taken to be insolvent – s455A(2).
  6. Restructuring Practitioner’s power to end it all:   Interestingly, there is provision under subdivision C for the role of the restructuring practitioner to have the power to terminate a restructuring on certain grounds:  see s453J.  The grounds include at least if the company does not meet the eligibility criteria for restructuring,  if it would not be in the interests of creditors to make a restructuring plan, or continue with a plan, or it would be in the interests of creditors for the company to be wound up.  It will be interesting to see on what basis this power to terminate the restructuring of a company will be exercised in practice.  One would imagine the type of situations in which a VA might recommend liquidation would be a basis – where businesses are dead and buried with no potential of saving, so that the appointment is misconceived, or cases involving substantial fraud or criminality.
  7. Recycled nuts and bolts:   A lot of basic mechanics dealt with in the new Part 5.3B are copies of similar provisions from 5.3A.  An example: a person appointed as a restructuring practitioner must make a declaration of relevant relationships.  The DIRRI provision, section 60, has been amended accordingly.  Similarly, there are parallel restrictions on third party property and secured creditor action during the period of the restructuring process.  See generally subdivision D. 
  8. So much to be provided by regulation:  Some notable examples include:
    • The eligibility of a company to participate in a restructuring based on its liabilities, and the degree to which a director can have previously been involved in another restructuring – see 435C.  The whole question of what liabilities count toward the threshold debt ceiling for eligibility, and even what the ceiling is to be, are not yet in the legislation;
    • Surprisingly, nearly all of the functions, duties and powers of the restructuring practitioner.   There is a generic provision for basic functions like providing advice to the company on restructuring matters, assisting and preparing a restructuring plan, making a declaration to creditors “in accordance with the regulations” in relation to the plan and any other functions given to the practitioner under the Act.  Apart from that, the regulations are to provide…;
    • The form, content, making, implementation, varying, lapsing, voiding, contravention and termination of restructuring plans.    Regulations are also to provide for the role of the restructuring practitioner in relation to the plan.  There are all very important issues for the success of the reforms.  Whilst crossing the proverbial fingers, one would think that regulations are being used in order to allow consultation with the industry before the legislation is finalised, or perhaps allowing it to be easily tweaked after 1 January 2021.  It will be interesting to see whether substantive text is used in the final draft of Part 5.3B rather than in regulations. 
  9. The Role of The Court is a work in progress:  
    • There is a balancing act in any insolvency regime.  On one hand it is desirable to allow creditors or other stakeholders to go to court to protect themselves from abuse of process.  On the other hand, too much judicial oversight can make the process to expensive to use.  Cost is a key complaint that has led to the reform package.  The fact that the role of the Court is to be finalised in the Exposure Draft reflects, I think, a lot of thinking going on at government level and probably a desire to further consult on this issue with the profession.
    • The role of the Court is, in many respects, to be provided: there is division 6, which provides for the powers of the court in relation to restructuring plans to be subject to regulation.  Among more mechanical sections of the part copied over from part 5.3A, the role of the Court is defined, for example regarding permitting or penalising dealing with assets or shares during the restructure that would otherwise not be permitted (Part 1 Subdivision D), effects of an appointment on a winding up (which are akin to a VA appointment) and secured creditor assets and leave to proceed.
    • Section 458A does provide that the powers of the Court will include at least a power to vary or terminate a restructuring plan and to declare a restructuring plan void.
  10. Reporting Obligations to and from the Company and the Restructuring Practitioner are still to be finalised:  Division 5 deals with information, reports and documents, in relation to the company.  The draft provides for regulations to deal with these sorts of issues.  Section 457A deals with the things that the regulations can provide for, and they do include matters such as reporting to the restructuring practitioner by the company or others, reporting to ASIC, reporting to creditors, and reporting generally about a restructuring or restructuring plan to the public by publication. 
  11. Secured Creditors Decision Period:  there is an amendment to the dictionary in section 9 of the meaning of “decision period”.  The decision period for restructuring is the same as for voluntary administration – that is 13 days after the day of appointment.
  12. Relation Back Day:  There are amendments to section 91 to accommodate the restructuring process into the relation back day definition for a company that goes into a subsequent liquidation.  Basically, a restructuring appointment that is made after a winding up application starts preserves the relation back date of the application to wind up.  Likewise, for a winding up which commences as a consequence of an application made after the beginning of a restructuring period, the relation back day is the date on which the restructuring appointment is made, called the section 513CA day.
  13. Transition to VA and Liquidation:  There is provision for transition to a voluntary administration or liquidation in the event that a restructuring plan is rejected.  It is not clear to me exactly how this is to occur:  it is to be provided for in regulations (s453A(b)).  Amendments to the small business guide in Part 1.5 of the Act do provide that if creditors do not agree to the restructuring plan the company may be placed in voluntary administration or winding up.  It appears that the rejection of the restructuring plan will amount to a resolution by creditors that the company be wound up unless alternative arrangements are made to transition to a voluntary administration.  Logically it would be similar to the rejection of a DOCA proposal.
  14. Voidable Transactions – Protection for ordinary course transactions in restructuring period:  There is a significant change to voidable transactions for a liquidation which follows a restructuring.  The main change is that there is a carve out for transactions entered into by the company whilst it is in the restructuring phase, in the ordinary course of business or with the consent of the restructuring practitioner.  In voluntary administration there is a similar carve out for transactions entered into by a voluntary administrator or a deed administrator.  Since the new process is a debtor in possession model, it does make sense for transactions entered into by the company in the ordinary course of its business or with consent of the restructuring practitioner to be similarly exempt.  That is provided for in a new subsection 588FE(2C)(d) and (2D)(d).
  15. Another safe harbour:  There are amendments to the safe harbour provisions, and a new safe harbour for companies under restructuring in 588GAA(B).  There is a carve out for insolvent trading in relation to transactions entered into during the restructuring period which are in the ordinary course of the company’s business or with the consent of the restructuring practitioner.
  16. Liquidator Investigation:   In terms of subsequent supervision, there is provision for a liquidator appointed after a restructuring to examine the restructuring practitioner on a mandatory basis under amendments to 596A and further consequential amendments in the examination provisions.
  17. Insolvency Practice Rules A host of changes have been made to the insolvency practice rules, mainly to include restructuring practitioner where appropriate.  However there are carve outs which indicate the limited nature of the simplified liquidation process.  They include exempting completely from the simplified liquidation process any provision for committees of inspection.  They simply do not apply to the simplified liquidation process.
  18. Simplified Liquidation:  Once again, future regulation is to play a large part in defining how the simplified liquidation process is to be implemented.  The regulations are to provide in future for the eligibility criteria for the simplified liquidation process, simplified methods of dealing with proofs of debt and distribution of dividends, ASIC reporting, dealing with contributories, payment of dividends, and more limited basis of circumstances in which unfair preferences can be recovered.  See generally a new subdivision B to be added at the end of Division 3 of Part 5.5 of the Corporations Act.
  19. Virtually Done: As has been commented widely elsewhere, there are welcome changes that basically permit creditors meetings to be held virtually, notification and communication by electronic means and for “e signing” of documents electronically.

Exposure Draft of the Covid Insolvency Reforms released – just five more days (including this weekend) to make submissions….

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I would not ordinarily post a link to something I had not read, but this is a pandemic! The Commonwealth announced its proposed insolvency law reforms just 2 weeks ago and has now released an exposure draft of the amending legislation together with an explanatory memorandum.

Submissions on the draft are due on Monday, 12 October 2020!!! So get cracking! This makes the road runner look slow.

I will make some further comments in the next day or so once i have read it.

Proposed Law on Phoenix Activity Falls Flat

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Proposed legislation to attack directors of companies involved in so called “Phoenix” activity appears to have fallen flat owing to two major bungles in the drafting of the amendments in one of the bills.

The Federal Government has released drafts of two Bills.  The Bills follow pre-election commitments in the Protecting Workers’ Entitlements package announced in July 2010.

Identifying Phoenix Activity

Distinguishing “Phoenix activity” from the legitimate cycle of business failure is sometimes complicated and involves issues of intention.  In the 2009 paper entitled “Phoenix Proposal Paper” (link), the Treasury noted the following:

Defining precisely what constitutes fraudulent phoenix activity is inherently difficult….underlying the distinction between illegitimate, or fraudulent, phoenix activity and a legitimate use of the corporate form, is the intention for which the activity is undertaken. Relevantly, ASIC draws a distinction between businesses that get into a position of doubtful solvency or actual insolvency as a result of poor business practices (for instance, poor record keeping or poor cash management practices) and those operators who deliberately structure their operations in order to engage in phoenix activity to avoid meeting obligations. (emphasis added).

The government’s proposed legislation really does not deal with the difficulty of identifying what is and what isn’t Phoenix activity at all.

Penalising the Directors

The Corporations Amendment (Similar Names) Bill 2012 will expose directors to personal liability for their company’s debts, if:

  • the company’s name is the same as or similar to a company or business name of another company that has been wound up; and
  • the director was also a director of that other company; and
  • the company incurs the debts within five years after the start of the winding up of the other company.

This bill suffers from two major problems.  The first and most obvious problem is that personal liability only applies if the subsequent company has the same or a similar name as the old company.  So a director can escape personal liability simply by choosing a new name that is not similar to the old company or business name.

In my view, the director ought be made liable if the new company is carrying on substantially part or all of the same business as the old company, and the Courts should be given some flexibility in applying that test.  The name alone is a poor indicator.  A list of indicators to be taken into account by the Court could be devised in a similar way as exists in applying other evaluative tests, such as section 425(8).  They might include the assets employed, the customer base, the nature of the business conducted, the name of the business, the premises used and the staff employed among other things.  A defence should be available if the director can show that the old company was given fair value for the business.   Further, the Court should have a discretion to excuse directors who have acted honestly and who in the circumstances ought be excused (as exists in the draft bill) to deal with the issue of intention identified in the 2009 paper I noted above.

The second problem is that the director is liable for the debts of the new company, not the old.  The drafters appear to have copied similar legislation in the UK and in New Zealand.  The idea is to hinder phoenix operators from transferring the name of the business and therefore its goodwill, by restricting the limited liability of the new company.

But in most phoenix cases, the creditors of the new company are not at risk since they are usually trade creditors whom the directors need to keep happy.  It is the old company’s creditors like the ATO and other non essential suppliers who need help.

There are a plethora of articles available on the exposure drafts, including very useful posts by AAR (link), Minters (link) and Carrie Rome-Sievers of the Victorian Bar (link) which goes into some detail about the politics of the bills.

The two problems I have identified have both been drawn to the Federal government’s attention in submissions by various bodies and we can only hope that Canberra will fix them.

Providing Access to the GEERS Scheme

The second bill is the Corporations Amendment (Phoenixing and Other Measures) Bill 2012.  It provides ASIC with administrative power to order that a company be wound up, generally in circumstances where ASIC considers that the company has been ‘abandoned’. This will trigger employees’ entitlements under the Government’s General Employee Entitlements and Redundancy Scheme (GEERS).

The second bill is a welcome development as in the past, employees or other creditors left abandoned in the old company shell had to go to the expense of winding up the shell at their own expense.

Regards

Mark