Insolvency Laws Make Welcome Leap into 21st Century

Disruption, innovation and being Amazon-ready are often cited as the keys to business success and employment growth in a rapidly changing world. However sometimes it is the practical changes to our legal framework that have the greatest potential to create lasting and meaningful change.

This article appeared in The Australian Financial Review on 20 September 2017 (subscription may be required).

The Government, with the support of the Greens and most of the Crossbench, this week passed the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017, bringing Australia’s insolvency laws into the 21st century. This vital reform will align our insolvency laws with those of other developed economies. It will provide an opportunity for directors to restructure troubled businesses which have good future prospects, helping save jobs and reinvigorating our business culture.

Such reforms are crucial given that the unemployment rate is too high and growth in Australia’s economy remains below trend, despite record low interest rates. Our productivity growth has been poor for much of the last decade and recent gains are well below the long-term average. If we are going to turn these figures around we need to give Australian businesses every chance to succeed.

The overhaul of Australia’s insolvency regime, which was introduced in the 1990s, is a good way to start. These laws were widely considered among the harshest in the world and caused companies to be prematurely placed into external administration before restructuring options could be properly explored or implemented. Taking this route, rather than restructuring, destroyed untold wealth and thousands of jobs. Indeed, it has been estimated that almost $4 billion could be saved each year through the introduction of a safe harbour.

The reform of these laws, which provide directors with a safe harbour to take action to potentially secure the ongoing viability of the business, can help preserve jobs, boost economic growth, and encourage entrepreneurialism and innovation.

First, allowing affected firms more regulatory leeway means economic activity and jobs are not sacrificed, as they too often have been, merely because of what may prove to be a temporary dip in financial performance. Many of these jobs might have been saved had a safe harbour framework been in place.

Second, if the consequences of corporate failure are not as dire, more firms may be willing to take measured risks in order to innovate and add to the economy’s productive capacity and employment. This will help provide opportunities for innovation in the market.

On another front, these reforms will help remove the stigma around business failure and encourage appropriate entrepreneurial risk-taking, encouraging more senior directors to provide their vital expertise to Australia’s burgeoning start-up and scale-up sector.

Finally, the government’s reforms will give companies a realistic chance to restructure their business and improve performance. What we have seen previously is that once a company enters administration it was swiftly followed by liquidation, helped along by ‘ipso facto clauses’, which allowed contracts to be terminated solely because a company has become insolvent. The reforms passed by parliament this week will introduce a stay on a counterparty’s ability to enforce an ipso facto clause in cases where a formal restructure is underway, allowing a company much-needed breathing room.

While it will take some time for the benefits of this legislation to flow through the economy, in the medium-term it will have an important impact on Australia’s business culture and competitiveness.

Importantly, the safe harbour is conditional on meeting employee entitlements, tax reporting obligations and existing statutory obligations to provide assistance in the event of administration or liquidation. The reforms also incentivise keeping company books in good order. Put simply, these laws will benefit diligent directors who do the right thing, but will offer no respite to those who flout important responsibilities, including to employees.

Achieving reform did not happen overnight. Creating a safe harbour from personal liability for insolvent trading in certain circumstances was recommended by the Productivity Commission in 2015. Getting to the stage where such an idea became law took time, commitment and consistent engagement. The Government and Treasury should be congratulated for the thorough and extensive consultation with all stakeholders on this issue. Success here provides hope that well-reasoned and rational arguments for reform do have the opportunity to see the light of day. Time will tell whether or not insolvency reform is the first of many productivity boosting reforms to make it through the 43rd Parliament.