Within hours of Kodak's move into Chapter 11 bankruptcy, the internet was alive with bad jokes:
"Kodak's business didn't develop the way they expected."
"Kodak was overexposed to the GFC."
"Kodak's Chapter 11 hearing was held in camera."
Australian businesses and liquidators might be forgiven for thinking that the bigger joke is Australia's lack of a Chapter 11 turnaround culture.
Next year is the 20th anniversary of the "Harmer amendments", the rewrite of corporate insolvency lawswhich had as its centrepiece the new voluntary administration regime. Voluntary administration was going to be the legislative tool that finally gave financially troubled companies the tools they needed to restructure and avoid liquidation.
Unfortunately, voluntary administration never really lived up to the hype. There have been some successes along the way, but the statistics suggest that voluntary administration is, far more often than not, simply the scenic route to winding up and dissolution.
Our tough insolvent trading laws are often blamed for this, but that's not the view commonly taken by insolvency professionals. They are more likely to point the finger at ipso facto clauses – provisions in contracts that allow one party to terminate the contract upon the insolvency of the other.
Interestingly, when the Government recently conducted aninquiry into insolvent trading laws, a number of industry submissions discussed the importance of ipso facto clauses, even though they were not the focus of the inquiry. Some high-profile submissions pointed out that the operation of ipso facto clauses in commercial agreements can destroy businesses overnight.
Despite this advocacy, ipso facto clauses do not appear to be on the law reform agenda.
This situation may be contrasted with that in the US where there is a different emphasis on how to react to an insolvency. This difference is deeply rooted in US culture. Insolvency does not have the same stigma in the US as it has in Australia or the UK. Chapter 11 is still something to be avoided but, if it cannot, there is a concerted effort to salvage the business, because that is what US society expects. That more liberal approach to corporate failure reflects the relationship corporate America has with society generally (evidenced, for example, by the far more director-friendly application of the business judgment rule in the US).
That attitude is fundamentally different to the expectations of Australian society (rightly or wrongly illustrated by our now firmly entrenched insolvent trading provisions). American corporations are less regulated than their Australian cousins, but that comes at a price: in America, there is a greater expectation that corporate America will be the engine of growth and will determine the nation's prosperity. Hand in hand with that expectation is an understanding that it is okay if, every now and then, a company goes bankrupt – because that is the necessary cost of collectively pursuing the free enterprise system, which is intimately linked to the US political system.
This emphasis on doing business also means that, even in bankruptcy, there is an expectation that American corporations will try to survive, In Australia, on the other hand, we too often call for the screens when there's even the merest hint of financial troubles for a company.
In practical terms, these differences are reflected in the two countries' statutory workout provisions.
The focus on obtaining approval for a chapter 11 plan of restructure is largely aided by the ability of the debtor to preserve the value of its goodwill and minimize the disruption to its contractual rights. The immediate imposition of a stay on all enforcement actions (a feature of liquidation and administration in Australia, but not receivership) and the statutory prohibition on creditors' terminating contracts due to the debtor seeking chapter 11 protection, allow the company and its advisers to focus on restructuring its capital needs and maximizing any sale proceeds of its assets.
Often the most valuable asset of a company is its goodwill, reflected by the quality of its work-in-progress. By limiting the ability of trade creditors to terminate these critical contracts, the prospects of a genuine workout or improved sale price for assets are vastly improved.
Unsecured creditors in the US are generally compensated for the loss of their rights to terminate. One of the most common “first day” motions to the US Bankruptcy Court is for the payment of employee wages and benefits, insurance premiums and critical trade suppliers.
The introduction of a similar regime in Part 5.3A of the Corporations Act 2001, applying only to unsecured creditors for the duration of the convening period set out in section 439A(5), would significantly improve the prospects of an administration achieving the objects of section 435A.
Administrators are already personally liable under sections 443A to 443C for certain debts incurred during the course of the administration. Even if unsecured creditors were not directly compensated under Part 5.3A, the usual period they would be prevented from terminating would be some 4 to 5 weeks, short by US standards. I think corporate Australia would be willing to bear this cost, if it significantly improved the chance of businesses preserving value when they were insolvent.
Generally, the insolvency systems of the US and Australia suit the natures of their respective societies. However, that is not to say they cannot be improved from time to time: the Australian system would benefit immensely from a limited prohibition on the operation of ipso facto clauses.
Cameron Cheetham is a senior associate in Clayton Utz’s Sydney office currently on a leave of absence and working with the highly regarded Restructuring group at Kirkland & Ellis in New York.
Contact Cameron on [email protected]
See for instance section 365(e)(1) of the United States Bankruptcy CodeBack to article