Australian Insolvency Law Essay

Question:

Discuss about the Australian Insolvency Law.

Answer:

Introduction:

Australian insolvency law is based on the two characteristics and both the characteristics imposed difficulties in context of protection and restructuring of existing business at the time of financial difficulties. Insolvency law provides the formal mechanism for the purpose of assisting the organization in case of restructuring of the business and this formal mechanism is known as voluntary administration. If organization wants to enter into the voluntary administration then counterparties and suppliers get the authority to rescind the contract. Because of this directors of the company tried to restructure the business in informal manner, but if this option does not work then law imposed personal liability on the directors of the company as per the provisions of the insolvency law. This framework of the Australian insolvency law was mainly introduced for the purpose of boosting the company’s directors to opt for voluntary administration instead of restructuring of the business.

Subsequently, Australian government realize this issue and make efforts to resolve this issue, which leads to introduction of new amendment in the insolvency law on 18th September 2018. [1]It must be noted that, this amendment is mainly deals with the two issues such as it introduce safe harbor protection for the purpose of protecting the directors of the company in the reconstruction process, and secondly it introduce IPSO facto which prevent the counter parties and suppliers of the company from using their termination rights in context of voluntary administration.

This paper mainly highlights the part 1 of the amendment made by Australian government in context of insolvency law on 18th September 2017, and it must be noted that’ structure of this paper includes short details of the amendment, distinct between the old and new insolvency law, and also the critical evaluation of the part 1 effectiveness. Last section of the paper defines recommendation. This paper is concluded with the help the help of brief conclusion.

Short description of amendment:

Legislature mainly assure cultural changes in the director’s position while framing the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017. These cultural changes are incorporated by encouraging the directors of the company, to retain their company’s control in the situation of financial crises and also identifying the signs of insolvency at early stage. Directors of the company must ensure the recovery of their company by taking the reasonable risk in this context instead of opting voluntary administration or liquidation for the company. However, it must be noted that this amendment does not facilitate forgiveness of the past loans of the company which are taken by the directors of the company in context of insolvent trading. It only assures new opportunities to the company’s directors to take such loans or make such financial arrangements which help the company to deal with the situation of insolvency and restructure their business.

In other words, company’s directors will not be held liable for the loans taken by them in relation of developing and taking any step which ensures good outcome for the company.[2]

Difference between new and old law related to insolvent trading:

Section 588G of the corporation Act 2001 defines the provisions related to the prohibition in insolvent trading. This section stated that directors of the company are under obligation to prevent their companies from taking any debt in the period of insolvency of the company. It must be noted that this section is applied on the directors of the company in following situations:

  • Organization is not solvent at that time when loan is taken by the directors of the company, or company become insolvent because directors take that loan.
  • Directors must have reasonable evidences to believe that company is not solvent, or may be become insolvent if directors take that loan.
  • Directors of the organization must be aware at that time of period that such evidences are present which clearly shows that company is insolvent, or any other reasonable individual who stands in similar situation of directors of the company to get aware in context of these situations. [3]

Section 588H of the Corporation Act 2001 defines four types of situations which work as statutory defenses related to the insolvent trading for the directors of the company. Some of these defenses are stated below:

  • At the time when loan was taken by the directors of the company, thy have sufficient signs to believe that company was not insolvent at that time, and remain solvent even after taken that loan by the directors.
  • Directors of the company must have considerable grounds to believe at the time of taken loan that they hire competent and reliable person in context of providing them information related to the solvency of the company.
  • Company’s directors do not make any participation in the management of the company because of some relevant reason such as illness at the time when loan was taken by the directors.
  • Company’s directors take all reasonable steps which are necessary from preventing the company to take loan.[4]

In terms of company’s solvency, law makers introduce different tests, and some of these tests are stated below:

Cash flow test- as per this test, court stated that person is not solvent if such person is unable to pay off all the loans and other liabilities at the time when such loans and liabilities are become due and payable.


Balance test- under this test court consider whether liability side of the balance sheet shows more amount as compared to the asset side of the balance sheet, and if liability side shows more amount then it is consider as the strong evidence of the insolvency.

Subsequently, legislature makes some amendments in the above stated provisions and these amendments are reflected in section 588GA of the Corporation Act 2001. As peer this section, company’s directors are not considered as liable either in direct or indirect manner for any loan taken by the company in lieu of developing and taking any action that will lead the company towards better result instead of immediate appointment of the administrator or liquidator in the company.[5]

Clause 2 of this section stated five characteristics which consider whether action taken by directors for above stated situation have potential to lead the company towards better result or not, and these factors are defined below:

  • Whether company’s director is completely aware about the financial position of the company, and whether they make all efforts to assure the same.
  • Whether company’s directors take all necessary actions fore restricting the misconduct in terms of company’s employees and officers which adversely affect the ability of the company to pay all its loans and liabilities.
  • All the required actions are taken the directors of the company for ensuring that company maintain all the proper financial records in lieu of size, nature, etc.[6]Whether company’s directors take all the necessary advice from the expert and professional entity, and such entity receives complete information in this context.
  • Whether company’s directors develop or implement any plan in lieu of business restructuring.

It is necessary for the company’s directors to understand that protection under safe harbor rule is not available if directors take loan after the insolvency of the company, and for this purpose insolvent company include those organizations which fails to make the payment related to the employee entitlements and tax obligations[7].

On the basis of above stated discussion, it is clear that these new laws ensure various new opportunities for the organizations which are threatening insolvency. Under the protection of safe harbor rule, company’s directors get the protection and directors can avoid their personal liability in lieu of loans taken by directors for ensuring better outcome for the company. situation before making the amendment is completely opposite, as directors of the company face the risk of personal liability.

Critical evaluation of the effectiveness of Part 1 of the Amendment:

In case of medium and small companies, law related to safe harbor rule is not very much effective because directors of these companies provide personal guarantee and their company exercise control over them for longer period of time. Because of all these reasons, directors of these companies prefer to make formal appointments so that they can avoid their disclosure under personal guarantee. There are number of directors who fail to gain benefit of expert advice, which means they does not take advice from professional and qualified entity on the ground that this condition of the above stated sections is not compulsory.

In case of directors of the large organizations take proper advice related to the insolvency from the expert and qualified entity at the beginnings so that they can clear their suspicion in lieu of solvency of the company. Directors of the large organization bear more risk as compared to the small organizations, and their risk depends on the safe harbor requirement. In other words, signs of the insolvency must be transparent at the initial stage of the process. If directors of big corporations fail to comply with the compulsory requirement of the safe harbor in context of entitlement of employees and reporting obligations of tax, then liquidator has power to believe that directors have reasonable grounds to detect insolvency. Directors of the company breach section 588G of the Corporation Act 2001.


Currently, there are number of doubts related to the operations of the provisions introduced by the minister such as introduction and declarations of regulations. It must be noted that success of this amendment mainly depends on the fact whether director and management of the company is willing to spend resources on restructuring methods or not[8].

Recommendations:

Present law:

Directors of the organizations and companies threatening insolvency get new opportunities through this amendment because this law provides necessary protection to the directors of the company if they want to save their company through insolvency. Safe harbor rule provide necessary protection to the directors and also define the grounds on the basis of which Court consider whether actions taken by directors have potential to provide better outcome or not. There is one exception also which state that this new amendment does not ensure directors protection in case of loan taken by the directors after insolvency. This provision does not state any such factors through which Court can check whether directors of the company meet with the necessary conditions of this new amendment or not.

Law maker must provide any such provisions through which Court can check whether directors of the company meet with the necessary conditions of this new amendment or not.

Previous law:

Reenactment of previous law is not required because previous law fails to provide any such protection to the directors of the company who wants to protect their companies from the protection of the creditors. But there is one provision related to the previous law which must be incorporated in the new provisions and that provision is creditors and suppliers protection. Law maker does not provide any such facts which secure the interest of creditors who trust the capabilities of directors in case of insolvency also.

Other amendments:

Law makers fail to provide any such grounds which highlight the situations of those directors who provide personal guarantee to the companies. In other words, those directors who provide personal guarantee to the companies fail to take advantage of this new provision of the insolent law.

Conclusion:

Above stated facts clearly indicate that amendment made by legislature in the insolvency law such as safe harbor protection. This amendment not only provide protection to the directors from the personal liability in terms of loans taken by directors for the company’s reconstruction but also provide new opportunities to those companies who want one more chance to restructure their business. However, currently there are number of doubts related to the operations of the provisions introduced by the minister such as introduction and declarations of regulations. It must be noted that success of these provisions mainly depends on the fact whether director and management of the company is willing to spend resources on restructuring methods or not.

References:

Corporation Act 2001- Section 588G.

Corporation Act 2001- Section 588GA.

Corporation Act 2001- Section 588H.

Cowell Clarke, (2017) Safe Harbor: Protection for directors from insolvent trading laws [Online]. Available at: Accessed on 14th April 2018.

Davies, W. (2017). Solving Insolvency - should company directors be shielded from liability?. Available at: Accessed on 14th April 2018.

Federal Register of legislation, (2017). Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017. Available at: Accessed on 13th April 2018.

McCabes, (2017). Safe Harbour and Ipso Facto reforms pass into law. Available at: Accessed on 14th April 2018.

Walter, D. (2017). Australia: Insolvency and director liability law reforms – National Innovation and Science Agenda. Available at: Accessed on 14th April 2018.

McCabes, (2017). Safe Harbour and Ipso Facto reforms pass into law. Available at: Accessed on 14th April 2018.

Federal Register of legislation, (2017). Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017. Available at: Accessed on 13th April 2018.

Corporation Act 2001- Section 588G.

Corporation Act 2001- Section 588H.

Corporation Act 2001- Section 588GA.

Cowell Clarke, (2017) Safe Harbor: Protection for directors from insolvent trading laws [Online]. Available at: Accessed on 14th April 2018.

Accessed on 14th April 2018.

/solving-insolvency-should-company-directors-be-shielded-from-liability/. Accessed on 14th April 2018.

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