«SUBMITTED BY: Law Council of Australia Insolvency Practitioners Association of Australia Turnaround Management Association Australia DATED: 2 March ...»
JOINT SUBMISSION IN RELATION TO
INSOLVENT TRADING SAFE HARBOUR
Law Council of Australia
Insolvency Practitioners Association of Australia
Turnaround Management Association Australia
DATED: 2 March 2010
SUBMISSION IN RESPECT OF SAFE HARBOUR OPTIONS PAPER
1 SECTION 1 – INTRODUCTION
1.1 This submission is made jointly by the Law Council of Australia, the Insolvency Practitioners Association of Australia, and the Turnaround Management Association Australia, representing the legal, accounting and business advisers whose principal area of practice is insolvency. It is intended to provide the Government with the views and experience of those professionals whose day-to- day practice and business over many years has been in addressing and dealing with the very matters canvassed in the Discussion Paper.
1.2 As major participants in insolvency and turnaround matters, the bodies represented in this joint submission wish to confirm their collective view that limited reform to insolvent trading laws to provide a restructuring safe harbour would be beneficial, and that the adoption of a modified business judgement rule defence would be the appropriate means for achieving this reform. Such a change should be seen as an improvement to, rather than a replacement of, the status quo, as it provides a framework for directors and stakeholders to lawfully pursue proper restructuring opportunities, and encourages early attention to be given to insolvency concerns.
1.3 The parties to this joint submission are as follows:
(a) Law Council of Australia (LCA).The LCA's Insolvency and Reconstruction Law Committee of its Business Law Section, which has participated in the preparation of this submission, is comprised of legal practitioners across Australia who specialise in the insolvency and restructuring field, and includes many of Australia's leading practitioners in this area.
(b) Insolvency Practitioners Association of Australia (IPA). The IPA is the peak professional body representing company liquidators, trustees in bankruptcy, other insolvency professionals, financiers and academics. The IPA and its members necessarily have extensive knowledge of and expertise in insolvency law, policy and practice and in the particular issues of insolvent trading which are the subject of this submission; and (c) The Turnaround Management Association Australia (TMA). The TMA is a not-for-profit organisation comprising professionals practising in the field of "Turnaround Management", aimed at restoring value to struggling enterprises and avoiding terminal insolvency. The TMA's membership is made up of professionals practising in turnaround management, law, insolvency, accounting, management consulting, banking, finance and private equity.
1.4 The parties to this joint submission may wish individually to provide a supplementary written submission addressing additional matters of interest.
2 SECTION 2 – PRELIMINARY MATTERS Importance of restructurings and informal workouts 2.1 Generally speaking, a successful restructuring or informal work-out will resolve the financial position of a company through the private agreement of key stakeholders outside of any formal insolvency process. More common among large enterprises and public companies, a restructuring will involve negotiations between the company and its bankers, bondholders and/or major investors, and can involve the injection of fresh capital from an external source. Alternatively, those negotiations may produce a moratorium on repayment of bank or bond debt pending asset sales, injection of fresh capital, or both. Successful negotiations can produce a restructured balance sheet that returns the company to a state of solvency, or otherwise eliminates the question mark over the company's solvency and may thereby preserve enterprise value, employment and the business as a going concern.
2.2 The significance of this for addressing doubtful solvency is twofold:
Significance of preserving enterprise value 2.3 In a circumstance of financial distress, "enterprise value" may be defined as the value of the company's assets and businesses. Preservation of enterprise value is
important for at least two reasons:
1 By way of amplification, in an informal work-out of a major corporation, it is usually the case that the claims of its financiers are so significant as a percentage of its total liabilities, that it is in their commercial interests to permit the company to continue to trade under agreed funding arrangements while a restructuring is pursued. In such cases, the business continues to operate and trade creditors are paid in the ordinary course of business during the period of restructuring.
2.4 Similarly, where the financial difficulties of the company can be addressed by a reconstruction of the entity's banking facilities or bondholder debt (or by a combination of that and fresh capital), preservation of enterprise value is critical.
Again, the smaller the differential between assets and liabilities, the smaller the gap that the reconstruction needs to address.
2.5 For the above reasons, preservation of enterprise value must be an important public policy goal in dealing with financial distress.
2.6 It is the experience of the practitioners and industry participants represented by this joint submission that formal insolvency appointments can, and often do, cause a destruction of, or diminution in, enterprise value. This can occur (as noted in the
Discussion Paper) in a number of ways, including:
2 The Corporations Act imposes certain time restrictions on the conduct of an external administration. The voluntary administration regime in Part 5.3A of the Corporations Act provides short timeframes for the transition of the company out of administration. Section 477(1)(a) empowers a liquidator to carry on the business of the company, but only insofar as it is necessary for the beneficial disposal or winding up of that business. Also, section 478(1) requires a liquidator to cause the company's property to be applied against its liabilities as soon as practicable after the Court order that it be wound up.
2.7 In circumstances where it is feasible to overcome a company's solvency difficulties by an informal work-out or a restructuring of its balance sheet, it will in most cases be important for this to occur outside of a formal insolvency process.
2.8 The Discussion Paper contains the suggestion in a number of places that a company is either "solvent" or "insolvent". It is acknowledged that chronic or "obvious" insolvency can be readily identified in some companies that have continued to trade. However, in the experience of the practitioners and participants in the insolvency process represented by this submission, the company's state of solvency is frequently not black and white. The following illustrations provide a few
examples of complexities that occur in practice:
2.9 The above represent a few examples in practice of circumstances facing honest, diligent directors. If the directors appoint administrators they risk destroying or substantially diminishing the value of the business. If they do not call in administrators, they risk incurring personal liability for the company's debts incurred in the future, which would usually mean personal bankruptcy for the directors, if found to be liable.
2.10 The laws of other countries do not impede proper restructuring attempts by directors in the way that our insolvent trading laws do. A full comparative analysis of laws is contained in the INSOL publication "Directors in the Twilight Zone", but generally speaking, in a circumstance of doubtful solvency the laws of other countries impose an obligation on the directors to have primary regard to the interests of creditors in actions they take in consequence of the financial distress.
This contrasts with Australian law where the overriding insolvent trading prohibition compels directors to place the company into administration where they cannot form the requisite view as to an expectation of solvency, even in circumstances where the interests of creditors might be better served by an informal work-out. There is no flexibility at all in the law as it presently exists.
3 SECTION 3 - INSOLVENT TRADING LAW - MAINTAIN THE STATUS QUO OR
INTRODUCE A RESTRUCTURING SAFE HARBOUR?
3.1 The issues of principle raised in the discussion paper can be seen to engage a
number of different public policy considerations, including:
3.2 Questions surrounding the balance to be struck between preventing abuse and curtailing honest behaviour, and between enhancing or diminishing enterprise value, are not new. As far back as the introduction of the first modern insolvency
3.4 The two above passages go to the heart of the policy issues raised in the discussion paper. As observed in 1883, Parliament must endeavour "to diminish the number of wrecks". And as observed in 1925, the policy objective of deterring some instances of wrongdoing must be balanced with the fetters it places on "honest business" and the damage it can do in consequence.
3.5 In this submission, five principal policy reasons are advanced as to why there
should be a safe harbour defence to insolvent trading liability. They are:
3 Westminster Hansard, 19 March 1883, col. 817.
4 Report of the Company Law Amendment Committee appointed by the Board of Trade on 19 February 1925.
3.6 It is also important to bear in mind that to the extent that a refinement to the law in this area will enable some companies to be saved through a restructuring or informal workout, this will result in the protection of employment and reduce job losses.
First policy reason - The existing law, without any safe harbour, can impede or prevent proper attempts at informal workouts 3.7 No other major Western economy has laws that operate in the same manner, and with the same severity, as Australia's insolvent trading laws.5 If there are grounds for suspecting that the company is insolvent and the director is unable to form an expectation that it is in fact solvent, the director faces personal liability for all of the company's debts incurred after that date. In almost all cases, this would mean personal bankruptcy for the director. A dishonest breach of the provision renders the directors liable to imprisonment for up to 5 years.
3.8 Faced with these consequences, honest, diligent directors will ensure that they do not breach the law. For the reasons explained earlier in this submission at paragraphs 2.8 - 2.9, the question of a company's solvency frequently is not black and white, particularly with regard to large enterprises. If the solvency of a financially distressed company is uncertain or incapable of precise determination, it follows that it may be difficult for the director to form the necessary positive expectation that the company actually is able to pay all its debts as and when they fall due. Thus, not only will honest, diligent directors of companies that are actually insolvent place them into administration, but also there will be directors who feel compelled to do the same thing where the solvency is simply brought into question, because of the absence of their ability to form their positive expectation of solvency.
3.9 Moreover, there is a lack of flexibility with the current insolvent trading law. Once the operation of the law is triggered and a director is unable to form a positive expectation that the company is solvent, the director must cease incurring debts, with the likely result that administrators are appointed. This is so even though professional advice suggests it may be in the best interests of creditors that the company explore an informal workout or restructuring. The adverse implications arising from this inflexibility can be illustrated in several ways.
3.10 There are many examples of directors citing the insolvent trading laws as a reason for the appointment of administrators where a restructuring or informal workout was available to be pursued.
3.11 One example is the Henry Walker Eltin group, where the directors, citing concerns regarding insolvent trading liability, placed the company into administration.
5 See paragraph 2.10 of this submission and the INSOL publication, "Directors in the Twilight Zone".
3.12 In many of the recent spate of corporate failures associated with the GFC, insolvent trading concerns have been cited by directors as a significant or determining factor in their decision to appoint administrators.6
3.13 This is not to say that a restructuring would have been feasible in all or, for that matter, most of the matters. That is not to the point. Of significance is the fact that the option of a restructuring or informal work-out is simply not available to be pursued when directors form the view that the insolvent trading law obliges them to make a formal appointment. There are many cases like Henry Walker Eltin where the formal appointment has been considered premature. No doubt in other cases, no attention was given to the issue of a restructuring as this was simply not an option given insolvent trading concerns.
3.14 It is the experience of practitioners and participants represented by this submission that the relevance of the above observations extends to companies of a smaller size as well as large enterprises and public companies.