The changes are aimed at protecting directors of corporations where they might be treading a close line to insolvency. Section 588G of the Corporations Act 2001 (Cth) sets out the manner in which a director must prevent the corporation taking a step that results in the corporation trading whilst insolvent. It’s fairly specific and makes any prudent director avoid most situations that will result in insolvency. This has resulted in a situation where some corporations, with some fine tuning and a little good management, might have been saved from insolvency if they were allowed to continue to trade insolvent, if that trading resulted in them trading out of their financial difficulties.
In order to do that though, the changes would mean that some insolvency clauses in contracts would be void. Clauses that are triggered by insolvency events such as entering administration, or a scheme arrangement, a receiver or controller appointed, or entering into a deed of company arrangement, could not be used to terminate a contract.
The most important part of this is that the act would not prevent contracts being voided for other reasons, for instance if there was a failure to make payments or other contractual issues. The changes are intended to prevent termination of contracts that are vital to the survival of a company for technical reasons – as long as the corporation maintains its other obligations.
The corollary for this is of course, how do you determine who is genuinely taking this step, and who is avoiding creditors? The consultation with government is to determine, among other things, which of two possible models should be used for implementation of the changes.
One is an external advisor, the other is reliance on the directors own judgment.
The first model needs an external adviser, someone who independently can make a determination that the corporation can trade out of its difficulties. Or to put it simply, can verify that the directions actions may result in the corporation trading out of its position.
The second model is the director making this determination himself, and the only way to ‘check’ that the action is genuine is that any subsequent liquidator would have to prove the director was not genuine.
Bankruptcy is usually for three years, but under the changes a bankrupt could be discharged in one year, and most of the constraints such as being a director, or travelling overseas etc are also limited to one year. Interestingly, the obligations to contribute to the estate or assist generally will remain in place, and a trustee would still have the power to extend the bankruptcy to up to 8 years.
This will not be law till after the election, so if labour is elected they may not go through. On the presumption that it might though, the government is looking for submissions on the above changes.
The above changes are in place to protect corporations from having vital contracts terminated because of insolvency events. This does not mean that the obligations under the contract are avoided, it simply means that the contract can not be terminated simply because the corporation has been placed in receivership. It is unclear as to how that would translate for payments to be made – for instance if there were a Deed of Company Arrangement, would that allow the corporation to make only a percentage of the payments it owes? In my view it will not. It seems counter intuitive for any entity dealing with a corporation to be forced to continue to contract with the corporation where it is not making payments. If that is correct, then the ramifications for creditors may not be necessarily negative.