Holistic vs piecemeal: the state of review of Australian corporate insolvency laws

With the mass of reports, reviews and consultations that have already occurred, there is no lack of critiques, complaints and proposed solutions. The risk is that these will (once again) be cherrypicked for fixes, rather than form the basis for a comprehensive review.

It has been 33 years since the "recession we had to have" in 1991. Fears that Australia would enter a technical recession during 2023 didn’t eventuate.

At the time of writing, our economy continues to still be resilient (relying on massive population growth through migration) despite ongoing decreasing consumer sentiment but another year of slow growth around the world in 2024 is predicted. Two G7 economies having dipped into recession at the end of 2023, along with New Zealand slipping into a second technical recession within 18 months.

Whether we enter a recession or not, more insolvency pain will come as insolvency numbers are tracking at pre-COVID levels year-on-year across all industries. High interest rates (which will probably stay high until at least February 2025), increased costs of living and reduced credit availability all contribute to ongoing tough operating conditions for Australian businesses in 2024, particularly those with excess leverage and unsustainable legacy debt.

That means a serious test of our corporate insolvency laws is around the corner. Despite recent piecemeal reforms, there is a general agreement that more is needed, and there are calls for a Harmer-style holistic review: what are the laws trying to achieve, how do they work together, and how do we fix them?

That requires a commitment from the Federal Government, which so far has not been actioned. Into that vacuum has rushed a variety of reviews, suggestions and submissions, tackling the issues from subtly different perspectives and policy positions.

Below, we trace the recent history of reviews and reforms pre-2023, including the introduction of safe harbour regime and the small business restructuring regime, and look at what impact they've had on the insolvency landscape in 2023, before setting out the post-2023 attempts to amend Australia's corporate insolvency laws, and where we might be in the future.

2022: Assessing the insolvent trading safe harbour laws

Post the COVID-19 pandemic and associated lock downs in Australia, the Australian Government announced in its 2021 Budget that it would undertake an independent review of the insolvent trading safe harbour laws which were enacted in 2017.

On 24 March 2022, an independent panel of experts panel handed its Review of the insolvent trading safe harbour – Final report (Safe Harbour Report) to the Government. It identified a number of matters, particularly a lack of awareness and understanding of a director's duties and the related safe harbour provisions.

2022: Parliamentary Joint Committee's comprehensive review of insolvency laws

In response to calls for a more comprehensive and coherent review of Australia’s insolvency regime made by various industry bodies and commentators, in October 2022, the Federal Parliamentary Joint Committee on Corporations and Financial Services (PJC) began the first thorough review of Australia's restructuring and insolvency framework since the Harmer review in 1988. Inquiring into the "effectiveness of Australia's corporate insolvency laws in protecting and maximising value for the benefit of all interested parties and the economy", it outlined seven key areas of interest:

  1. recent and emerging trends in the use of corporate insolvency and related practices in Australia, such as temporary COVID-19 pandemic insolvency measures(which included the suspension of directors’ personal liability for insolvent trading)and changes in economic conditions that have affected businesses more broadly;
  2. current legal and regulatory arrangements, such as the operation of the Personal Properties Securities Act and recent reforms to small business restructuring, liquidation, and unlawful phoenixing;
  3. potential areas for reform, including the unfair preference claims regime, the morass which is the insolvency of corporate trustees, safe harbour from insolvent trading claims, and international approaches and developments;
  4. supporting businesses in managing financial distress by improving access to corporate turnaround capabilities;
  5. insolvency practitioners and their role, remuneration, financial viability and overall conduct, including receivers, liquidators, administrators, and small business restructuring practitioners;
  6. government agencies and their role in the corporate insolvency system, including the corporate regulator ASIC, the Australian Taxation Office and other relevant bodies; and
  7. any other related corporate insolvency matters.

Speaking in her capacity as a Board member of the Turnaround Management Association of Australia (TMA), one of the authors (Jennifer Ball) attended the public hearing and argued the complexity of the insolvency law:

"has been compounded by ad hoc reforms which have resulted in inconsistencies which make the processes unnecessarily time consuming and costly. The TMA's view, as previously raised with government, was that there were significant advantages in undertaking a holistic and thorough review of Australia's restructuring and insolvency framework by a suitably qualified and diverse panel of experts, with appropriate time and breadth taken to consider views of all stakeholders, using position papers, hearings and fuller submissions. We do not see much utility in ongoing bandaid solutions, which otherwise could be referred to as lazy regulation."

It was also suggested that Australia might learn from other jurisdictions that are viewed as international leaders in restructuring and turnaround such as the United State and the United Kingdom who:

"have designed and continue to develop and reform systems to promote corporate turnaround. TMA considers that it is important that reforms of this nature are considered as a part of a broader roots and branch review (discussed in more detail below) to ensure that Australia remains a leading jurisdiction for investment on an international stage."

Those industry views were reflected in the PJC's lengthy final report, issued on 12 July 2023. The PJC concluded that Australia's corporate insolvency is "overly complex, difficult to access, and creates unnecessary cost and confusion for both debtors and creditors" with inefficiencies and low returns for creditors and lacking in restructuring opportunities for restructuring.

Crucially, it commented that Australia's approach to date to any corporate law reform has been applying a band aid solution or been piecemeal in nature, with reforms attending to just parts of the insolvency process without any regard to the whole system.

It therefore included in its 28 Recommendations for reform one that the Government conduct a "comprehensive review" to be led by the Australian Law Reform Commission or the Productivity Commission, set a clear timetable for its comprehensive review and explore substantive law reform on a number of topics.

The PJC commented that also recognised some key Recommendations or "low hanging fruit" which could be progressed independently of, and sooner than the completion of, the comprehensive review some of which are in the process of being addressed. One Recommendation that was seen as a priority was for the Government to implement the recommendations of the Safe Harbour Report.

2023: more insolvency pain to come, and more testing of Australia's insolvency laws

 

All appointments over a company including the first, subsequent and transitional appointments–Appointment type, FINANCIAL YEAR TO DATE AS OF 3 JUNE

 

The top five reasons for failures were:

  • inadequate cash flow or high cash use (51.9%),
  • other (50.2%),
  • trading losses (49.1%),
  • poor strategic management of business (42.3%), and
  • poor economic conditions (36.4%).

For the period 1 July 2022 to 30 June 2023, small- to medium-sized corporate insolvencies continued to dominate external administrators’ reports. Of the reports lodged, 83% had assets of $100,000 or less, 82% had fewer than 20 employees, 32% had liabilities of less than $250,000 and 68% had liabilities of less than $1 million. In this group of creditors, 96% received between 0–11 cents in the dollar, reflecting the asset/liability profile of small- to medium-sized corporate insolvencies.

 

 

 

KPMG 2024 Market Perspectives & Economic Distress Indicators Turnaround and Restructuring – February 2024

There were:

  • 476 winding up proceedings in the first seven months of 2023, compared with 14 in the same period of 2022.
  • 17,901 director penalty notices issued to companies in FY 22/23 and more than 23,000 director penalty notices issued to directors of these companies.

The ATO has stated that it is taking firmer and stronger action, to help mitigate the growth in collectable debt. It has a collectable debt as at 30 June 2023 of $50.2 billion, which is an increase from $26.5 billion (at 30 June 2019) – up $23.7 billion or 89%.

2023 Post the PJC Report: ASIC review of insolvent trading safe harbour provisions RG 217

In September 2023, in response to Recommendation 7 of the PJC Report, ASIC released a consultation paper seeking feedback on its proposed updates from directors, professional advisers and registered liquidators, turnaround and restructuring professionals and other interested parties to ASIC's Guidance on insolvent trading safe harbour provisions, Regulatory Guide RG 217 (first published in 2010), with a view to releasing the updated RG 217 in the first quarter of 2024.

The paper sought feedback on several aspects including:

  • updating existing guidance to include information about when a holding company may be liable for debts incurred by a subsidiary when the subsidiary has continued to trade while insolvent,
  • providing information and general guidance about the operation of the safe harbour provisions and the factors that ASIC will consider when assessing whether safe harbour protection is available to a director, and
  • providing guidance for directors about the key principles they should consider in carrying out their duty to prevent insolvent trading.

The current RG217 provides little guidance on the operation of the safe harbour provisions and sections 588GA and 588GAAB. Rather, it simply expands on the application of section 588G such as director duties, the consequences of duty, the consequences of breaching this duty, the defences available facing a civil claim from solvent trading, the criteria for determining insolvency, and the actions directors must undertake to fulfil their duties.

Stakeholders welcomed ASIC's intentions to update RG217 to reflect the recommendations to be made to the safe harbour provisions and strongly supported changes to be made to improve directors and advisors' understanding of the safe harbour regime. The ASIC consultation on the amendments to RG217 closed on 26 October 2023.

Some suggested stakeholder comments included:

  • more guidance on ASIC's website on restructuring options that are available to directors so that those restructuring options would then be consistent with Government policy to encourage directors to consider how to turn around financial struggling businesses rather than prematurely placing them into voluntary administration or liquidation.
  • better explanation by ASIC as to creditors' interests in any safe harbour process to better reflect the state of law in Australia;
  • the following changes be made to ASIC's RG217:
    • focus on obligations and expectations on directors and responsible persons of charities and not for profits as it relates to insolvency;
    • enhanced use of visual aids, diagrams and additional examples to improve accessibility and understanding (particularly for directors of family-owned SMEs);
    • targeted additions to the proposed safe harbour guidance, including expanding the guidance on "reasonably likely" consistent with the explanatory memorandum;
    • amend RG217.61(f) which deals with steps a director may take to establish safe harbour protection.
  • amend RG217.61(f) which deals with steps a director may take to establish safe harbour protection.

The proposed amendments are yet to be implemented.

2023: PPSA changes and the Whittaker Review

The Government has responded to Recommendation 26, which states "The committee recommends that the government provide a formal response to the Whittaker Review which was completed in 2015."

On 22 September 2023, the Government released the Personal Property Securities Amendment Bill 2023 (PPSA Bill) for public consultation, in which it accepted 345 of the 394 Whittaker recommendations. The consultation period closed on 17 November 2023, and there have been no further comments on the progress of this PPSA Bill.

2024: Exposure draft Treasury Laws Amendment Bill 2024: Miscellaneous and technical amendments

On 30 January 2024, the Government released an exposure draft "Treasury Laws Amendment Bill 2024: Miscellaneous and technical amendments – Autumn 2024" together with accompanying regulations and an explanatory memorandum. The proposed minor amendments are said to be aimed at simplifying the legislation as it relates to the safe harbour provisions in section 588GA. For example:

Of the 28 recommendations referred to in the PJC Report, the above miscellaneous and technical amendments are perhaps only a fraction of the low hanging fruit that can be progressed with respect to the to the safe harbour provisions independently of any comprehensive and independent review.

2024: ASIC Consultation on Regulatory Guide 258 Registered Liquidators: Registration, Disciplinary Action and Insurance Requirements

There was a shared view at the PJC hearings and in submissions that more needs to be done to "ensure that the profession is more reflective of the community that it serves."

At the public inquiry, the TMA explained that the current requirement to demonstrate 4,000 hours or relevant experience within the five years prior to applying for registration is problematic, particularly for applicants that have caring responsibilities or take parental leave.

This is especially where:

  • many family units actively plan to have children in close succession in order to minimise the impact on their career;
  • primary caregivers often return to work on a part time basis (the criteria call for applicants to have completed 800 hours per year in the preceding five years, which is not possible if a practitioner has returned to work part-time after taking one year's parental leave); and
  • we know that women's elevation to senior levels of partnership merely perpetuates the lack of women achieving key leadership roles. These of course are separate issues to any perhaps degrees of unconscious biasness in the path to becoming a liquidator for women. The statistics do evidence that there's a lack of female registered liquidators nationally.

Recommendation 12 of the PJC Report stated:

  • section 588GA(1)(b) has been amended to clarify the terms "directly or indirectly in connection with such course of action" to extend to debts incurred in the ordinary course of business (PJC Report, Recommendation 3).
  • the definition of "restructuring" in section 9 to specify that the definition does not apply to in section 588GA(2)(e) and will only apply for certain small business companies under Part 5.3B (PJC Report, Recommendation 6).
  • section 588GA(2) is amended so to cover circumstances where advice is being sought from an appropriately qualified adviser by the company itself rather than the company's director (PJC Report, Recommendation 8).
  • section 588GA(4)(a)(i) has been amended to delete the words "by the time they fall due" and replace with the words "that are payable" to align the payment of employee entitlements with that safeguard in Regulation 5.3B.24 of the Corporations Regulations. This was in response to the views that a course of action being pursued will involve the business continuing to operate as a going concern. In those circumstances, it is only appropriate that debts incurred in the ordinary course of business will be considered as bring incurred in connection with the course(s) of action that the company continue as a going concern (PJC Report, Recommendation 9).

"The Committee recommends that the government reform the experience eligibility requirements for registered liquidators, to address the inequity of the requirements and the gender imbalance in the population of registered liquidators. Reforms could potentially include:

  • increasing the period over which experience is demonstrated; or
  • replacing part of the required hours with competency-based exam."

RG258 guide is dated March 2017 and still requires updating due to law changes since then in particular that the interview committee has a discretion to grant registration to an applicant even though by way of example that applicant may not have met the 4,000 hours of experience. ASIC is currently consulting on proposed changes to the existing Regulatory Guide 258.

The future of insolvency law reform and the need for Harmer 2.0

While the PJC report and its 28 recommendations were warmly welcomed as an addition to the body of work on Australia's corporate insolvency regime, the key recommendation is the need for an independent and comprehensive review of Australia's corporate and personal insolvency laws, to be done in two stages. Based on what stakeholders have been saying, it's critical for the long-term future of the insolvency sector and the Australia’s insolvency regime.

Beyond calling for a holistic review, what do they stakeholders actually need in the review? The PJC's recommendations are a sound place to start, along with various industry proposals:

The investment by Government in a comprehensive review was firmly considered by the PJC as "worth it" given the importance of a "robust, fit-for-purpose insolvency framework". It noted that the work of a comprehensive review could be progressed in stages over three years. This would allow reforms to be recommended to Government and Parliament agree to those reforms while the review continues.

With the mass of reports, reviews and consultations that have already occurred, there is no lack of critiques, complaints and proposed solutions. The risk is that these will (once again) be cherrypicked for fixes, rather than form the basis for a comprehensive review as called for by the PJC and the insolvency industry. We could then be confronted with a wave of insolvencies, armed only with a patchwork of laws which lack a coherent underlying policy position – a recipe for expensive litigation.

The ball is clearly in the Government's court.

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