No quarantine for new ideas on handling company collapses

Jun 2020

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Australia should look to British law changes for ways to improve our insolvency and restructuring procedures.

Airliners may be grounded and national borders closed but there’s no stopping the cross-border transmission of creative responses to business insolvency problems, including those caused by coronavirus.

The latest example is new legislation introduced in Britain. As a world leader in creative solutions to coronavirus, the Australian government might find even more inspiration in what the Brits are proposing.

The British bill contains three reforms of particular interest to Australia: a modified restriction of “ipso facto” clauses, a “cram-down” procedure for corporate debt reconstructions and a free-floating moratorium on debt collection for financially strapped companies.

Ipso facto clauses are contractual provisions allowing a supplier to stop supplying goods or services to a financially troubled company. Corporate rescue plans may come to nothing if the company’s suppliers can starve it of the goods and services it needs to carry on business.

The Australian government recognised this problem two years ago. It restricted the use of ipso facto clauses where a company is looking at a rescue or restructuring plan under voluntary administration.

Restricting de facto clauses is not universally feasible – or popular.

Accordingly, both Australia and the new British rules allow suppliers to apply to court for permission to use an ipso facto clause. This is not a realistic option for cash-strapped small suppliers. One new British rule is therefore worth urgent consideration in this country: small-scale suppliers of goods and services will be able to use ipso facto clauses (without court approval) until at least June 30 this year. This balances the long-term benefits of restricting ipso facto clauses against the need to keep small-scale suppliers in business during the present crisis. A similar moratorium could be quickly and simply implemented in Australia.

“Restricting de facto clauses is not universally feasible – or popular.”

Rebalance of power

Longer term, another new British provision would be widely welcomed in Australia: cram-downs in schemes of arrangement.

Schemes of arrangement are potentially good tools for corporate debt reconstruction. However, they are not widely used, because they have a major flaw. The law insists on breaking a company’s creditors into “classes” and requires that each class must agree to the restructuring. A scheme can be kyboshed by just one small group of creditors, even if the overwhelming majority support it.

This is a good balance, which protects the financial interests of creditors while discouraging creditor greenmailing.

The new British legislation addresses this problem by allowing courts to approve schemes despite the opposition of one or more classes of creditor. The court must be satisfied that those creditors will be no worse off under the restructuring scheme than they would be if the plan did not proceed. This is a good balance, which protects the financial interests of creditors while discouraging creditor greenmailing. (And a sidenote to corporate lawyers and investment bankers: the new British provisions do not apply to takeover schemes.)

The third interesting new British provision is a “free-floating” moratorium on debt enforcement against a company while its directors investigate a debt restructuring plan. The moratorium may last for up to 40 days (or longer, with court approval) and will be overseen by an insolvency professional.

This appears to combine elements of the US Chapter 11 bankruptcy process and the Australian “safe harbour” provisions (which were introduced by the Australian government a couple of years ago). It goes a lot further than the short-term coronavirus relief available in Australia (which gives companies and their directors a temporary debt holiday). Interestingly, this particular reform has not been universally welcomed in Britain, so it’s probably best left on the Australian government’s backburner at this point.

Overall, however, the new British legislation provides plenty for the Australian government to consider, both in its ongoing response to coronavirus and as part of its program of continuous improvement of our insolvency and restructuring procedures.

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