Insolvency law changes are not a silver bullet (Hamilton Locke)

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As part of the stimulus package to support and protect Australian businesses, the Federal Government has today announced a number of temporary changes to the Australian insolvency laws.

Summary of proposed changes

Outlined below is a summary of the proposed changes based on the limited details provided by the Department of Treasury to date:

• relief from personal liability for directors trading while insolvent for a six month period;
• increased threshold for statutory demands from $2,000 to $20,000 and increased timeframe for compliance from 21 days to six months for companies to respond to statutory demands; and
• discretion for the Federal Treasurer to amend the Corporations Act 2001 (the Act) to relieve companies from certain obligations contained in the Act.

Each temporary change or relief will apply (at this stage) for six months.

How will this practically play out?

Although the changes are well intentioned (i.e. encourage directors to continue trading), they are not the silver bullet needed by companies facing distress.

Based on the release from Treasury and subject to legislation when enacted, we note that:

• The proposed relief from insolvent trading does not extend to the company. As such, the company remains liable for any debts incurred.
• There is no accompanying moratorium on a counterparty’s ability to stop supply or terminate a contract for non-payment by the company.
• The higher threshold and longer timeframe for compliance proposed in relation to statutory demands will provide some breathing room for companies, however it does not address continuity of supply issues. It also remains open to suppliers to simply sue to recover a debt, which means it is likely to be more useful for smaller liabilities. Directors will therefore need to engage with suppliers proactively to ensure there is a broader plan in place to provide comfort around future payment.
• Similarly, a longer timeframe for dealing with demands may not assist a company that is party to facility agreements or other contractual arrangements that require any such demand to be remedied within a much shorter timeframe.
• Our firm view is that directors of companies in distress should still consider the safe harbour provisions and if appropriate, work with a safe harbour advisor to formulate a plan of action to address the broader issues facing the business. Further details of the safe harbour can be found here.
• Questions will inevitably arise as to what constitutes debts incurred in the ‘ordinary course of business’ in such volatile times. However, directors should not allow companies to unnecessarily incur debts in a free-for-all as general directors’ duties under the Act and at common law still apply.

Details of the proposed statutory changes

i. Directors’ relief from personal liability

Under the Act, directors may be held personally liable for debts incurred by a company if it trades while insolvent.

In response to the impact of the COVID-19 crisis, the proposed changes provide that directors are temporarily relieved of their duty to prevent insolvent trading with respect to any debts incurred in the ordinary course of the company’s business. Debts incurred as a result of dishonesty and fraud remain subject to criminal penalties.

We note that whilst any debts incurred by the company will still be payable by the company, directors are relieved of personal liability that would otherwise attach to debts they incur while the company is insolvent.

While this temporary relief may be welcome in the current environment, particularly for companies that do not otherwise meet the threshold requirements to enter the “safe harbour” under the Act (i.e. ability to pay employee entitlement obligations and up to date tax reporting), it does not offer a holistic solution. Nor does it relieve directors of their other statutory and common law duties, including the duty to act in the best interests of the company and its stakeholders (including creditors in times of distress).

It remains prudent at this time for directors to consider the requirements of the safe habour provisions as instructive. These difficult and uncertain times require directors to keep themselves properly informed of a company’s financial position, to take advice from appropriately qualified entities and, most critically, to formulate a plan to ensure that a company can continue to trade once the temporary relief is over.

ii. Higher thresholds for statutory demands

Creditors may enforce debts owed to them by issuing a statutory demand to a debtor company. A failure to comply with a demand is an indicator of insolvency and often relied upon by creditors to place a company into liquidation. Under the proposed changes the minimum threshold for creditors to issue statutory demands to a company will be temporarily increased from $2,000 to $20,000.

The applicable time period for a company to respond to such a demand will be temporarily increased from 21 days to six months. This effectively removes the threat usually associated with a statutory demand as an enforcement tool. The ability to sue on the debt remains available as a remedy noting however the Courts’ availability may impact on the effectiveness of this remedy. We also note that absent a moratorium in place, the issuance of a statutory demand may still trigger consequences in facility agreements and other contractual arrangements that a company may be party to, notwithstanding the extension of the time to respond.

iii. Flexibility around compliance with the Act

The Treasurer will be given powers to amend provisions of the Act to provide relief from certain obligations or to modify obligations to enable compliance with legal requirements during this time. Any regulation made by this power will apply for up to six months from the date it is made.

ASIC continues to have power to offer relief from provisions in the Act.

As further details are released we will continue to provide updates.

If you have any questions about current events and how they may impact your business, please contact Nick Edwards (nicholas.edwards@hamiltonlocke.com.au), Zina Edwards (zina.edwards@hamiltonlocke.com.au) or Brit Ibanez (brit.ibanez@hamiltonlocke.com.au).

Our Finance and Restructuring team has considerable restructuring and turnaround experience across all relevant areas including finance, debt trading, loan to own transactions, distressed M&A, safe harbour, enforcement and insolvency.