Government reform of insolvency laws to offer greater protection to directors

The Rudd Government has unveiled a plan to reform insolvency laws that will make it easier for beleaguered directors to try and rescue their companies without the threat of being sued for trading while insolvent.

Financial Services Minister Chris Bowen has announced the Government will also legislate to overturn the High Court’s controversial decision in the Sons of Gwalia case, which gave shareholders of collapsed companies the same rights as unsecured creditors.

Bowen is also concerned that the High Court decision has pushed up funding costs for businesses.

“Any direct benefits to aggrieved shareholders arising from non-subordination are outweighed by the negative impacts on shareholders generally as a result of restrictions on access to, and increases in, the cost of debt financing for companies,” Bowen said in a statement.

Bowen has also released a discussion paper which outlines three proposals to reform Australia’s insolvent trading law to make it easier for directors of struggling companies to try and restructure their business before it enters a formal insolvency process such as administration or liquidation.

Insolvency experts have long argued that many directors are forced to place companies that could be saved into liquidation because they fear being sued under insolvent trading laws.

The Treasury discussion paper suggests three reform options.

Under the first, known as the modified business judgement rule, directors would not breach insolvent trading laws if:

• The financial accounts and records of the company presented a true and fair picture of its financial circumstances;
• The director was appropriately informed by restructuring advice based on those accounts and records;
• It was the director’s business judgement that the interests of both the company’s creditors and members were best served by pursuing restructuring; and
• The restructuring was diligently pursued by the director.

Under the second option, known as the expressed moratorium rule, a company would inform the market, including existing creditors and potential new creditors, that it was insolvent and intended to pursue a restructuring outside of the formal insolvency processes.

A moratorium would then start, “during which honest insolvent trading would be permitted”. Creditors could bring the moratorium to an end through a resolution or court order, and there would be restructure on how long the moratorium could run for.

The proposals are now open to public comment.

Jim Downey, founder of insolvency firm JP Downey, agrees insolvent trading laws could be tweaked, particularly to help directors of large companies that might have complex structures that make it difficult to tell if a company is actually trading while insolvent.

“You need to have some latitude to directors who are going to make a pretty landmark decision in relation to their company.”

However, he is not convinced that the latitude needs to be extended to directors of SME companies, who are typically able to tell when a company is insolvent much more easily.

“It’s a rare occasion that we can’t work itself out with an hour or two of interviewing – it’s normally as plain as the nose on your face whether a company is insolvent or not.”

He also points out that the voluntary administration process is designed to allow companies to get professional help in trading their way out of difficulties.

“I don’t think that wagon is broken.”