10 Jul 2014

Chapter 11 again mooted as an option for Australia's insolvency regime

by Nick Poole, Peter Bowden

A Senate Committee has said amendments to Australia's corporate insolvency laws should be considered to encourage and facilitate corporate turnarounds.

The Senate Economics References Committee called for a review of Australia's corporate insolvency laws to ensure they facilitate corporate turnarounds. One suggestion was for the implementation of certain features of the US' Chapter 11 regime into Australia's insolvency laws.

The arguments for changing the insolvency regime

Despite the focus of the inquiry being on the performance of ASIC, the Committee received submissions throughout the inquiry calling for fundamental changes to how large corporate insolvencies are undertaken in Australia. Amongst the submissions was a suggestion that Australia adopt Chapter 11-like provisions which put "recovery ahead of burial".

The Committee's Report referred to comments by the chairman of the Australian Restructuring Insolvency and Turnaround Association (ARITA) that the previous Government had considered some reforms to the Australia insolvency regime intended to harmonise regulation and empower creditors. However, whether or not Australia should adopt a Chapter 11-like framework (or if, for example, Australia should consider the US approach to ipso facto clauses) was not necessarily dealt with in the previous Government's proposal.

Further, the Report quoted ASIC Chairman Greg Medcraft as describing Chapter 11 as "a very good system". In Mr Medcraft's view this was because, amongst other things, Chapter 11 "retains management with the company, as opposed to handing the management to an insolvency expert."

Quoting ARITA, the Report also outlined some of the arguments commonly made against Chapter 11. These included that it is expensive given the supervisory function performed by the Court, and that different attitudes to corporate failure in Australia compared to the US may make it difficult to leave a company in the hands of existing management. Despite this, certain changes, particularly regarding a common regulator in respect of personal and corporate insolvency and the capping of fees in smaller liquidations, were suggested as being appropriate.

The report recommends features of Chapter 11 be adopted

On the whole, the Committee was concerned that liquidations in Australia were still subject to strident criticism from external parties and were the source of much dissatisfaction in the community.

In its view, previous attempts to modernise the current insolvency regime in Australia should be reinvigorated, and the current laws should be scrutinised to see if they encourage turnarounds and restructuring in large corporate insolvencies. Particular consideration should be given to elements of the Chapter 11 regime that could be adopted in the Australian environment:

"the Government commission a review of Australia's corporate insolvency laws to consider amendments intended to encourage and facilitate corporate turnarounds. The review should consider features of the chapter 11 regime in place in the United States of America that could be adopted in Australia."

How elements of Chapter 11 could help corporate turnarounds in Australia

It will be interesting to see if anything materialises from the comments made by the Committee. However, given the idea of introducing Chapter 11-like provisions into Australian law has previously been considered and deemed unnecessary (see, for example, CAMAC's 2004 Report), it seems unlikely that the comments will gain any real traction.

In any event, it is worth having a discussion regarding the status quo of the Australian insolvency regime, as it has been quite some time since Australia's insolvency laws have been significantly overhauled (for example, the voluntary administration regime in Part 5.3A of the Corporations Act 2001 (Cth) was introduced over 20 years ago). In this respect, the notion of ipso facto clauses is a recurring theme among commentators seeking to amend the Act to make it more aligned with Chapter 11.

By way of background, an ipso facto contractual clause allows a party to terminate the contract upon the insolvency of the other party. Under Australian bankruptcy law (ie. personal rather than corporate insolvency) , such clauses in contracts are rendered void if the relevant obligor becomes insolvent (see section 301(1) of the Bankruptcy Act 1996 (Cth)). There is no such prohibition in relation to corporations under the Corporations Act.

Similar to the position regarding personal bankruptcy in Australia, the provisions of Chapter 11 prevent creditors from terminating contracts of an insolvent party if the relevant debtor seeks protection under Chapter 11.

The justification for these types of provisions is to ensure important contracts are maintained such that goodwill is preserved while the company is under bankruptcy protection. This should, all things being equal, maximise the chances of the company continuing as a going concern or otherwise its value to third parties.

While the relative pros and cons for implementing such a provision have been discussed ad nauseam, it is difficult to argue that such provisions would not assist corporate turnarounds in Australia. The extent to which such clauses may adversely affect third parties, however, is a contentious issue and one which is beyond the scope of this note.

Real discussion around the facilitation of corporate turnarounds in Australia should be welcomed. However, it remains to be seen whether Australia will look to Chapter 11 and a complete overhaul of the current system or will cherry-pick elements of Chapter 11 (such as, for example, a prohibition on ipso facto clauses). We continue to watch this space.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.