Insolvency law reform

THE PAST DECADE or so has seen significant insolvency law reform in many jurisdictions. This column has previously examined related issues, including the difference between corporate insolvency and personal bankruptcy (see China Business Law Journal, volume 4, issue 10: Bankrupt or insolvent?) and cross-border insolvency law (see China Business Law Journal, volume 8, issue 8: Cross-border insolvency).

In 2016, India enacted the Insolvency and Bankruptcy Code, intended to support corporate debt restructuring and create greater efficiencies.

In 2020, the UK introduced significant legal reforms, including the availability of a moratorium to enable directors to stay in control of the business while exploring debt restructuring options.

In 2020, Singapore introduced legislation to consolidate personal and corporate insolvency and debt restructuring laws, to simplify and modernise the insolvency framework. This was part of a set of reforms intended to make Singapore an international hub for debt restructuring and included adoption of the UNCITRAL Model Law on Cross-Border Insolvency in 2017.

Meanwhile, the Hong Kong Special Administrative Region is still considering the introduction of a statutory corporate law rescue framework, a potential insolvency law reform that has been debated for decades.

This article provides a brief overview of the main corporate insolvency regimes in Australia and reforms in recent years, and discusses the challenges of insolvency law reform.

AUSTRALIA REGIMES

Australia has four main corporate insolvency regimes: voluntary administration; creditors’ scheme of arrangement; receivership; and winding up (also known as liquidation).

Voluntary administration is not a debtor-in-possession model, but instead a practitioner-in-possession model that involves the appointment of an external administrator. The process is designed to be quick – it can be implemented by a simple resolution of the company’s board of directors, and in some cases can be completed within a few weeks.

It can take place without any court involvement, although this is common when there are applications to extend time limits. It also provides for a general moratorium enabling the administrator to continue to trade the company’s business during the administration period.

The voluntary administration process involves a proposal being put to creditors which, if approved, is implemented via what is called a deed of company arrangement (DOCA). This is binding on the company, its shareholders and the company’s creditors, with the exception of secured creditors who do not vote in favour of the DOCA.

One of the benefits of voluntary administration is that after the appointment of an administrator, directors can avoid liability for insolvent trading (the incurring of new debt by the company after the directors become aware that the company is insolvent).

Australia has onerous insolvent trading laws, which are actively enforced by liquidators and also by the corporate regulator, the Australian Securities and Investments Commission (ASIC). Indeed, it is often the threat of personal liability for insolvency trading that prompts directors to act early and initiate voluntary administration. The risk of insolvent trading liability is a key reason why directors resolve to put the company into voluntary administration. This has often been premature, which is partly why reforms were adopted in 2017.

A creditors’ scheme of arrangement operates along similar lines to schemes of arrangement in other common law jurisdictions. Unlike the situation in voluntary administration, however, both the court and the ASIC have critical roles to play. Terms of the proposed scheme and the draft explanatory statement must be lodged with the ASIC, which may make submissions to the court in relation to the scheme.

In addition, the court cannot approve a scheme of arrangement unless it is satisfied that the scheme has not been proposed to avoid compliance with the takeover requirements, or unless the ASIC issues a statement that it has no objection to the scheme.

One of the benefits of a scheme compared with voluntary administration is that it binds all creditors in the affected creditor classes, which can include secured creditors. Another benefit is that a third party contributing finance for the benefit of creditors can be released from claims by those creditors.

In Australia, receivership operates in much the same way as in other common law jurisdictions. Under receivership, a receiver (often appointed as a receiver and manager) is generally privately appointed by a secured creditor over some or all of the company property subject to the security interest. The receiver has no direct role in relation to unsecured creditors, which is why it is common for a receivership to take place concurrently with an administration or liquidation.

Another reason why these procedures take place concurrently is that there is no moratorium or stay on the enforcement of claims against the company in receivership, as there is in administration, and the receiver therefore benefits from any statutory moratorium applicable in administration.

A winding up can take the form of either a court-ordered winding up or a creditors’ voluntary winding up.

A court-ordered winding up can only be effected by an order of the Federal Court or Supreme Courts of the States and Territories of Australia. A creditors’ voluntary winding up, on the other hand, may commence without any court involvement.

RECENT REFORMS

Australia has had a number of insolvency law reforms in recent years. In 2017, the harshness of its insolvent trading laws was reduced by adopting a safe harbour, which protects directors from liability for insolvent trading and gives them time to restructure the company if certain conditions are satisfied.

In 2018, an ipso facto stay regime was introduced – applicable to administrations, certain receiverships and schemes of arrangement – prohibiting counterparties to a company from relying on insolvency-related termination clauses to terminate contracts entered into by the company. The regime has been criticised, partly because many transactions are excluded from the scope of the ipso facto regime.

In 2019, unlawful phoenixing reforms were introduced. Unlawful phoenixing occurs where directors intentionally shift company assets for little or no payment to new companies, to avoid paying parties such as employees, creditors or the tax office.

The reforms introduced the concept of a “creditor-defeating disposition”, which allows the ASIC or court to void any transaction with the effect of preventing, hindering or significantly delaying the property becoming available to meet claims of the company’s creditors in the winding up.

In 2021, the small business restructuring process was adopted. This enables the directors of eligible companies – small businesses with total liabilities of less than AUD1 million (USD685,000) – to manage their debt restructuring, rather than restructuring being entirely externally managed.

However, it is a hybrid model insofar as it involves the appointment and support of a Small Business Restructuring Practitioner, whose role is to assist the directors implement the debt restructuring plan. But the Small Business Restructuring Practitioner also has the power to terminate the process if it’s reasonably believed the company is not eligible, the process is not in creditor interests, or it would be in creditor interests to end the restructure or wind up the company.

An inquiry is also currently underway by the Parliamentary Joint Committee on Corporations and Financial Services into corporate insolvency. This inquiry is examining the effectiveness of Australia’s corporate insolvency laws in protecting and maximising value for the benefit of all interested parties and the economy.

Its scope includes a review of the above-mentioned reforms and also potential areas of reform.

The inquiry has been described as the most extensive and broad ranging insolvency review in the more than three decades, since the Australian Law Reform Commission issued a General Insolvency Inquiry Report in 1988. Known as the Harmer Report, this laid the groundwork for the introduction of Australia’s current insolvency law system.

Law reform has been a key focus of the author’s work over the past two-and-a-half years as he has supported the Australian Law Reform Commission with an inquiry into how the legislative framework for corporations and financial services regulation might be simplified and made more coherent, easier to navigate, and ultimately easier to comply with. For further details, see HERE.