Ian Walker of Minter Ellison discusses the developments in insolvency and restructuring law over the past year in Australia.
Australia’s economic performance did not suffer as much as other countries from the downturn initiated by the global financial crisis in 2008. This has been largely due to the growth and performance of Australia’s mining and resources sector which has continued to grow driven heavily by Chinese demand, prompting talk of a “two-speed” economy. However, Australia has not been totally impervious to worldwide trends with a strong Australian dollar affecting tourism, manufacturing and other export industries. Retailing has been particularly hard hit over the last three years and domestic properties have been dropping in value, particularly over the last 12 months. Current confidence levels in both business and consumer areas are low.
The Australian Securities and Investments Commission (ASIC) releases statistics on a monthly basis showing the number of companies that have gone into external insolvent administration. These statistics show that at present the Australian economy is in a worse position than it was in June 2011, judged by the number of external insolvent administrations that have occurred. In the period 1 July 2010 to 30 June 2011, 9,829 companies entered external insolvent administration for the first time. In the 11 months to 31 May 2012, 9,958 companies went into insolvent administration. Accordingly, in the financial year ending 30 June 2012 Australia will see more companies enter into insolvent administration than last year.
The impact of insolvency on creditors and shareholders is still significant. Statistics were released by ASIC in November 2011 relating to insolvencies in a number of specific industry sectors – these being business and personal services, construction, retail, accommodation and food services and manufacturing. Of the 5,698 companies in those industries that went into external insolvent administration in the period July 2010 to June 2011, 5,332 (or over 93 per cent) of them paid creditors no dividends at all. The shareholders in those 5,332 companies would have received nothing either. Of the remaining companies that went into insolvent administration in these five industries, less than 5 per cent paid a dividend in the range of zero to 10 cents in the dollar, with only 24 companies paying creditors a dividend of between 50 and 100 cents in the dollar (or about 0.4 per cent of the insolvent companies). These statistics probably reflect the broader experience of unsecured creditors of insolvency in the economy. Despite the significant impact of insolvency on unsecured creditors and shareholders, there does not appear to be anything in the Australian law, or in the current legislative programme of reforming insolvency law, that will improve these outcomes.
Australia’s insolvency regime, short of liquidation, is dominated by administration under Part 5.3A of the Corporations Act, which permits the company to appoint an administrator on the basis that the company is insolvent or likely to become insolvent. An automatic stay operates under section 440D of the Corporations Act once an administrator is appointed, but there is no restriction on creditors or third parties exercising rights of termination under executory contracts, such as exists under §365(e)(1) of the US Bankruptcy Code, which makes it illegal for a party to terminate an executory contract on the basis of insolvency of the counterparty alone. One consequence of that in Australia is that severe damage is done to insolvent businesses that go into Part 5.3 administration, because although actions for recovery of property in the possession of the insolvent company are stayed, together with other litigation, the fact remains that notices of termination can be given under the company’s contracts with third parties. Termination of contracts due to insolvency will generally make it more difficult for the company to be reconstructed and returned to solvency, given that creditors will often take the approach of exercising their right to terminate contracts that permit termination to occur in the event of insolvency. This is an area of Australia’s insolvency law that requires reform.
Australian law, as it applies to directors, imposes a duty on directors to prevent the company from incurring debts while the company is insolvent. A breach of this duty can lead to a director being held personally liable for the losses suffered by creditors as a result of the liquidation, whose debts were incurred when the company was insolvent. The lifting of the corporate veil in this regard presents a significant personal risk for directors if their company happens to be insolvent or approaching insolvency. The existence of the duty can contribute to a high level of uncertainty and potential risk for the directors, with the result that, unless they are confident they have a defence based on solvency, they will often choose to place the company into administration to mitigate their personal exposure.
One of the proposed amendments suggested by the government to the Corporations Act was to change the law on directors’ duties, so as to protect directors of companies that were being financially restructured, during the period of that restructuring, so that those directors could allow the company to continue to trade without being exposed to the risk of a breach of their duty to prevent insolvent trading under section 588G of the Corporations Act.
The foreshadowed changes would have provided directors with a modified business judgement rule to assist them in restructuring the business while protecting them from the risk of breach of duty to prevent insolvent trading. The proposed rule required that the company’s financial accounts and records be true and fair when the business judgement rule was invoked. The directors also had to be informed by, and follow the advice of, an appropriately experienced turnaround professional who had access to those books and records, and who gave advice as to the feasibility of the means of ensuring that the company remained solvent or that it would be returned to solvency within a reasonable period of time. The business judgement of the director required that it was in the interests of the company’s creditors as a whole, as well as its members, that it pursue restructuring, and that the restructuring must be diligently pursued by the director. The government’s proposal also provided an option for a moratorium and would have required the company to inform the market – including existing and potential creditors – that the company was insolvent and intended to pursue a workout outside of external administration.
These proposed amendments were first floated at the start of 2010 and were viewed positively by the market, particularly in the context of restructuring and turnarounds, on the basis that they would increase the scope for directors to put a company into a turnaround or restructuring, without risking personal liability for the debts that the company incurred during that period. However, despite asking for and receiving submissions in favour of them, the government has not implemented these proposed changes and shows no sign of doing so.
In July 2010 the prime minister committed the government to what was described as the Protecting Workers’ Entitlements package. One of the aims of the government’s measure was to assist employees of companies that had been abandoned by their directors. To do this ASIC was empowered on an administrative basis to wind up a company that had been abandoned by its directors. Winding up would then entitle those employees to receive payments from the General Employee Entitlements and Redundancy Scheme (GEERS). GEERS is funded by the Australian government for employees who have lost their employment due to winding up or bankruptcy of an individual employer, and whose employee entitlements have not been paid in full.
To give effect to this reform the government introduced what is known as the Corporations Amendment (Phoenixing and Other Measures) Act 2012. In summary, the new law gives ASIC the power to place abandoned companies into liquidation. The new provision, section 489EA, provides ASIC with the power to order the winding up of a company where the company has not lodged any documents with ASIC in the last 18 months, or where ASIC has reason to believe the company is not carrying on business, or ASIC considers that a winding-up order is in the public interest. Following ASIC’s order for the winding-up it can appoint a liquidator for the purpose of winding up the affairs of the company and distributing its property. Before ordering the company into liquidation ASIC must notify the company and each director that it proposes to make such an order. Directors have the option of objecting in writing to ASIC winding up the company. Provided they do so during a 10-business-day period after receiving the notice, then ASIC cannot use its power to wind up the company.
Part of the government’s rationale for giving ASIC these powers to was to enable a liquidator to be appointed to perform the duties that liquidators normally perform in terms of investigation of the company’s affairs in relation to these abandoned companies. Apart from the use of the word “phoenix” in the Act’s title there is no specific mention of phoenix activity in the Act. Despite that, the government is hoping that liquidators, when appointed, will deal with phoenix activity by investigating and taking action against delinquent directors. If there are to be any investigations of substance undertaken by a liquidator that will require funding if the investigation is to continue beyond a fairly limited examination of the company’s affairs. While there is an assetless companies fund to assist liquidators in this regard it is difficult to see the true connection between ASIC’s power to wind up companies with the prevention of phoenix activity.
The Corporations Amendment (Phoenixing and Other Measures) Act 2012 also introduces new measures designed to provide for the publication on a single corporate insolvency notices website of all public notices relating to the insolvency of a company for the benefit of creditors and stakeholders to inform them of events during the insolvency administration such as creditors’ meetings. The insolvency notices website will be administered by ASIC.
There are other government efforts to stop phoenix activity. Draft legislation has been released which will also further amend the Corporations Act under which a director of a failed company (that has not paid all its debts) can be rendered liable for the debts of a phoenix company that operates under a similar name to the pre-liquidation name of the failed company. This legislation, the Corporations Amendment (Similar Names) Bill 2012, is intended as a direct attack on phoenix activity, which occurs when the corporate form is misused with the intention of denying unsecured creditors payment by using some or all the assets of the failed company in a new business. The provisions will apply to make a person who was a director of both the failed company and the phoenix company liable individually and jointly with the phoenix company for the latter’s debts (proposed s596AJ). The phoenix company has to be operating under a name that was similar to a pre-liquidation name of the failed company. It is possible to gain exemption from these provisions by obtaining an order from the court to that effect or having the liquidator of the failed company grant an exemption. Exemptions will only be granted if the court or liquidator is satisfied that the director has acted honestly and, having regard to all the circumstances, ought fairly be excused from the operation of the new provision (proposed s596AL).
These proposed amendments are substantially similar in effect to sections 216 and 217 of the Insolvency Act 1986 (UK), although the UK statute covers not just debts, but also liabilities and other obligations such as damages. These are not currently within the scope of the Australian legislation.
Attempts to pierce the corporate veil to make directors personally liable for debts of the company are becoming more common in Australia. It is not just in the case of a breach of duty to prevent insolvent trading that a director is exposed to personal liability, or in respect of phoenix activity, where the concept of limited liability has been compromised. A major form of personal liability imposed on directors is for the company’s obligations in respect of tax and other money that has been withheld from employees in respect of pay-as-you-go tax (PAYG) not paid to the Tax Office. This is already the subject of legislation that sees directors having a personal liability for unpaid tax in certain circumstances.
Australia has had a director penalty notice regime since about 1993. The current regime enables directors to avoid personal liability for the unpaid tax subject of a director penalty notice served on them, by paying the tax or by placing the company into voluntary administration or liquidation, provided that it is done within 21 days of receiving the director penalty notice. The Tax Office’s experience under the current regime is such that they were often left in a situation where the full amount of unpaid tax was commonly not recovered because directors would take the step of putting the company into insolvent administration, thereby avoiding the personal liability. Changes are to be made to the penalty notice regime which would make it impossible for directors to avoid personal liability by putting the company into administration or liquidation where the tax has been unpaid for three months after the due date. The amendments proposed also expand the penalty notice regime to cover the company’s unpaid superannuation guarantee charge obligations (see the Tax Laws Amendment (2012 Measures No. 2) Bill 2012). These amendments will see directors made personally liable under the director penalty notice regime for unpaid superannuation guarantee charges in addition to any unpaid PAYG tax amounts that remain unpaid. If they don’t pay in three months after the due date they cannot avoid personal liability. Additional amendments introduced by the Pay As You Go Withholding Non-compliance Tax Bill 2012 make directors and their associates liable to pay what is described as PAYG withholding non-compliance tax where the company concerned has failed to pay amounts withheld to the tax office, and the directors or associates are entitled to a PAYG withholding credit that is attributable to an extent to an amount withheld by the company from payments made by the company to the director. Once again the government considers it is endeavouring to discourage phoenix activity by introducing these amendments, because they see phoenix operators as commonly withholding amounts from payments made to workers but never paying those withheld amounts to the Commissioner.
This is another area where Australian insolvency law is changing to increase the focus on directors by rendering them personally liable for what would otherwise be a liability of the company. Given the potential personal exposures directors face on these various fronts, when insolvency looms, Australia’s insolvency laws don’t readily provide the opportunity or the climate for a business to be restructured to avoid insolvency. It seems that Australia’s insolvency laws are focused on the consequences and responsibility for insolvency, without much in the way of options to protect creditors or increase returns to them by avoiding insolvency, through workouts or restructuring.