Insolvent Trading: A safe harbour for reorganisation outside of external administration

On 19 January 2010 the Federal Government released a discussion paper entitled Insolvent Trading: A safe harbour for reorganisation attempts outside of external administration. The paper provides an overview of Australia's insolvent trading laws, and a discussion on some options to address stakeholder concerns that the laws negatively impact on genuine work-out attempts, particularly in the present global economic conditions.

The first option involves maintaining the status quo. As things stand, directors are required to ensure that their company remains solvent while attempting to reorganise (outside of external administration), and may be liable under the Act for debts incurred by the company. The paper notes that although these standards (correctly) require a high degree of compliance, stakeholders consider that the criteria used by courts in determining whether directors should be held liable are too uncertain.  

The second option would address this uncertainty, by way of the introduction of a modified business judgment rule. Presently the business judgment rule operates as a defence to breaches of directors’ duties of care and diligence.  If the business judgment rule was extended, directors may have a complete defence to insolvent trading in circumstances where:

  1. financial accounts and records of the company present a true and fair picture of the company's financial circumstances;

  2. directors have obtained appropriate advice on the state of these accounts and records, from an appropriately qualified person;

  3. the director could show that the interests of shareholders and creditors were best served by pursuing restructuring; and

  4. the director has diligently pursued the restructuring.

This option would potentially provide a high degree of protection for directors who are genuinely attempting to keep the company outside of external administration.  On the other hand it is said that this option provides no incentive to directors to consider strategies to maintain solvency and may be subject to abuse.

The third option is a moratorium from the insolvent trading prohibition during a work-out period.  This option would require a company to advise the market (including creditors and potential creditors) that the company is insolvent and that it intended to pursue a work-out outside external administration.  It is proposed that such a mechanism would be designed in such a way that creditors would have the final say over when the moratorium period would finish. It is argued that this approach would also allow the market (including creditors) to be better informed as to the potential pitfalls of investing in a company in difficult circumstances. On the other hand, such an approach could damage the reputation of a company by forcing it to disclose its insolvency, instead of trying to resolve company difficulties ‘beneath the radar’.

The discussion paper provides an important milestone in Australian corporations law and we will keep you informed of any developments.

For further information please contact Tim Coyle on 9288 6761 or Daniel Butler on 9288 6714.

Disclaimer – the information contained in this publication does not constitute legal advice and should not be relied upon as such. You should seek legal advice in relation to any particular matter you may have before relying or acting on this information. The Lavan team are here to assist.