Chartered Accountants and Business Advisors THE WINDS OF CHANGE BY BLAIR PLEASH PARTNER OF HALL CHADWICK FINANCIER SEMINAR

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1 Chartered Accountants and Business Advisors THE WINDS OF CHANGE BY BLAIR PLEASH PARTNER OF HALL CHADWICK FINANCIER SEMINAR Thursday, 21 September 2017 Swissôtel Sydney Sydney Level 40 2 Park Street Sydney NSW

2 Contents The Carnell Report... 3 The Khoury Report... 8 Secured Creditor Case Law Update Receivers Priorities v Employee Entitlements Secured Creditors and Stocktakes Preferences and Secured Debts Safe Harbour Reform Appendix Annexure

3 The finance industry has been subject to an unprecedented level of upheaval. Quite aside from the challenges presented by disruption caused by technological change facilitating new entrants to the market such as the so called Fintechs, and changes to traditional distribution channels and a number of consolidations, the finance community has had to contend with a clamour of ever increasing regulation. To date this has culminated with the introduction of the banking levy, although the sceptre of a banking royal commission looms large on the horizon. The purpose of this paper is to provide an introduction to some of the reforms which have been proposed in the last 12 months and some of the more significant court decisions which effect the finance community as well as the safe harbour reform to the Corporations Act. Some of the proposed reforms include those contained in the following reports / reviews: - Australian Small Business and Family Enterprise Ombudsman Inquiry into Small Business Loans (the Carnell Report) - Independent Review of the Code of Banking Practice (Code) (the Khoury Report) Whilst a number of the proposed reforms could be argued as unnecessary or a bridge too far, they are emblematic of an environment wherein the finance community may have little option but to adopt a number of these recommendations or a variant thereof, or face the prospect of further regulation being forced upon them. It is fair to say that the industry faces a sea change and what is perceived as the old way of doing business, particularly as regards to small business will no longer be sufficient. The Carnell Report The Carnell Report was produced by the Australian Small Business and Family Enterprise Ombudsman following her investigation into the adequacy of the law and practices governing financial lending to small business and was released on 6 February The report itself noted since the GFC, 17 inquiries and reviews have been undertaken into practices in the financial services sector. Seven are in progress. An appendix is enclosed listing those inquiries. The report made 15 recommendations: Recommendation 1 The Australian Banker s Association (ABA) six point plan must be strengthened by publishing individual bank implementation plans including key milestones and deliverables. Outcomes against these plans must be published. In April 2016, the ABA announced its six point plan to address problems raised and test the banking industry s commitment to implement reform measures. The plan contains measures designed to protect consumer interests, increase transparency and accountability and build trust and confidence in banking. The six point plan is included as an annexure to this paper. 3

4 Recommendation 2 The revised Code of Banking Practice 2017 be approved and administered by the Australian Securities and Investments Commission under Regulatory Code 183. The Code must be written in plain English and include a dedicated section on small business clarifying how breaches will be enforced. Implementation by December 2017 The ABA developed the Code of Banking Practice. It began in The code was developed in response to consumer dissatisfaction with banking and was in part intended to forestall proposals that the Australian Government introduce statutory consumer protections for the banker consumer relationship. Originally it only applied to the supply of banking services to individuals (with the addition of taking guarantees from individuals). The 2003 revision of the code extended most of its provisions to small business. Protections for guarantors did not extend to small businesses that give guarantees. The ABA successfully lobbied to have the National Consumer Credit Protection Act 2009 (Cwth), restricted to consumer credit for personal and domestic purposes and hence that Act, including its responsible lending obligations do not apply to small business lending. The ABA Code has recently been subject to an independent review by Phil Khoury (the Khoury Report). The findings of that report will be discussed in a later section of the paper. Recommendation 3 For all loans below $5 million where a small business has complied with the loan payments requirements and has acted lawfully the bank must not default a loan for any reason. Any conditions must be removed where banks can unilaterally. - Value existing security assets during the life of a loan; - Invoke financial covenants or catch all material adverse change clauses; The report suggests that asset valuation is appropriate at loan inception and the roll over date. The justification for the recommendation is that 98% of lending to small business customers is under $5 million and it would have the effect of redistributing risk between borrowers and banks. The recommendation does seem to have been made in a vacuum with limited consideration of the prudential requirements banks are subject to by APRA. Recommendation 4 A minimum 30 business days notice period to all changes to general restriction clauses and covenants (except for fraud and criminal actions) be added to give borrowers more time to respond and react to a potential breach of conditions. This would extend to general clauses like not changing a company s ownership structure. The theory behind this proposal is to enable a small business the opportunity to respond to a breach of conditions, reducing the chance of a business in good financial standing being subject to a loan default. There is a reason why loan documents provide flexibility to bankers - circumstances may be such that a security could be in jeopardy and providing a blanket 30 day moratorium could have the effect of damaging the value of a security significantly. 4

5 Recommendation 5 For loans below $5 million, banks must provide borrowers with decisions on roll over at least 90 business days before loans mature, so borrowers can organise alternative financing. A longer period of time should be given for rural properties and complex businesses that would take longer to sell or refinance. The rationale for this recommendation is to provide greater visibility of loan roll over decisions, allowing borrowers to organise alternative financing should roll over be refused. Recommendation 6 For loans below $5 million, banks must provide a one page summary of the clauses and covenants that may trigger default or other detrimental outcomes for borrowers. This recommendation is part of the drive for simplifying terms for borrowers. It is recommended that: - Banks develop a short summary of the clauses and covenants that may trigger a default; and - Included in that summary are what action the bank may take and what action the borrower may take if default is triggered. Recommendation 7 For loans below $5 million, banks must put in place a new small business standard form contract that is short and in plain English. The rationale is to better manage the small business lending relationship and that many of the clauses in existing loan contracts are not relied upon by lenders. Recommendation 8 All banks must provide borrowers with a choice of valuer, a full copy of the instructions given to the valuer and a full copy of the valuation report. The current practice is there is no mandatory disclosure of valuation instructions, valuation results or valuation methodology with borrowers despite borrowers paying for valuations - some banks already do this and some do not. The rationale for the recommendation is to provide borrowers with greater visibility of the valuation process and outcome which they are paying for and is intended to provide the borrower more assurance the process is fair and reasonable. Recommendation 9 Every borrower must receive an identical copy of the instructions given to the investigating accountant by the bank and the final report by the investigating accountant to the bank. Standard loan documentation often includes the mechanism for a secured creditor to appoint an investigating accountant to review a customer s business. This is a mechanism that can be utilised when the customer is non-conforming, a loan is due for roll over or the customers industry sector may be undergoing structural or regulatory change. Whilst it may be a precursor to formal receivership, it can also lead to recommended improvements and/or a revision of the terms upon which the financier would be prepared to continue the finance relationship. 5

6 The nature of the role of the investigating accountant is largely governed by the scope of the assignment and can be utilised as a mechanism to assist a customer s business through a period of intensive care thus avoiding the need for a formal appointment. Recommendation 10 Banks must implement procedures to reduce the perceived conflict of interest of investigating accountants subsequently appointed as receivers. This can be achieved through a competitive process to source potential receivers and by instigating a policy of not appointing a receiver who has been the investigating accountant to the business. At present there is no legislative or industry barrier preventing an investigating accountant from being appointed as Receiver. Indeed the industry guidelines formulated by ARITA, to manage conflicts of interest do not extend to receivership appointments. The rationale is that receiverships are essentially private, contractual relationships between the secured creditor appointor and the appointee, the terms of which are governed by the relevant deed of appointment. Whilst the recommendation has some initial attraction the countervailing argument would be: - It would be an imprudent professional who would jeopardise his/her objectivity not to mention his professional indemnity insurance premiums for the sake of a potential subsequent receivership appointment; - The intellectual capital developed in the course of the investigating accountants assignment would be lost leading to increased costs for the borrower resulting from any subsequent receivership. Whilst not directly on point there have recently been a number of high profile voluntary administrations wherein the formal VA appointment has been preceded by an extensive investigating accountant / informal workout style assignment. The same such considerations have been used to justify what would otherwise appear to be a breach of the existing industry guidelines and there has been some legal gymnastics to justify the retention of the appointments in question. One suspects these tensions will only become reconciled if the turnaround culture' anticipated by the so called safe harbour provisions becomes more prevalent. Recommendation 11 The banking industry must fund an external dispute resolution one stop shop with a dedicated small business unit that has appropriate expertise to resolve disputes relating to a credit facility limit of up to $5 million. Recommendation 12 Banks must establish a customer advocate to consider small business complaints and disputes that may or may not have been subject to internal dispute resolution. If a small business customer is not satisfied at the end of an internal review process they can take their dispute to the Financial Ombudsman Service (FOS), through farm debt mediation (FDM) (if applicable) or to court. Recommendation 13 External dispute resolution schemes must be extended to include disputes with third parties that have been appointed by the bank, such as valuers, investigative accountants and receivers and to borrowers who have previously undertaken farm debt mediation. 6

7 The jurisdiction of the financial ombudsman service does not allow consideration of disputes. - Between a small business and third parties such as valuers, investigative accountants and receivers appointed by the banks; - That have been subject to farm debt mediation, regardless of whether an outcome was achieved. The only recourse for small business in such circumstances is the court system, yet small business often does not have the expertise / resources to challenge banks through the court system. Recommendation 14 A national consistent approach to farm debt mediation must be introduced. Nationally, the average broad acre debt more than doubled from 2000/01 to 2015/16 mainly due to an increase in the average size of Australian farms. Total rural debt increased to $69.5 billion as at September 2016 and bank funding accounted for approximately 95% of total institutional lending. Under FDM schemes, a farmer cannot force a mortgagee to mediate a dispute, although refusal by the mortgagee to attend mediation can lead to a mortgagee being prevented from enforcing its rights under the mortgage for up to six months. The intention behind farm debt mediation was to provide farmers with a chance for mediation before lenders enforce rights under a mortgage. Currently only NSW, QLD and VIC have legislative schemes in place. The Farm Debt Mediation Act 1994 (NSW) states that a secured creditor cannot seize property of the farmer without first giving 21 days written notice of the intentions including the option of mediation. If the farmer requests mediation and the creditor does not comply then an exemption certificate from enforcement may be issued. From 27 April 2017, a regime of compulsory farm debt mediation was introduced in Queensland. Under this regime, when a farmer is in default of a farm mortgage, the credit provider must initially serve the farmer an enforcement notice and a mediation information package. The farmer may ask for mediation of the debt with 15 days of receipt of the notice. If the credit provider fails to mediate, the farmer may apply for an enforcement suspension notice. If a farmer applies for this certificate the Queensland Rural and Industry Development Authority must provide the financier a show cause notice for the failure to mediate. The ASBFEO has recommended a nationally consistent approach to Farm Debt Mediation. Recommendation 15 ASIC must establish a Small Business Commissioner. This recommendation acknowledges the importance of the small business sector to the Australian economy. Regardless the specific needs of small business are often overlooked in the regulatory process and the introduction of a Small Business Commissioner in ASIC is intended to address this oversight. 7

8 Conclusion One of the ABA s submissions to the inquiry noted the following: - For the year ending March 2015, less than 1% of business and agribusiness customers had impaired loans and a tenth of 1% were in recovery action. In only a handful of cases were substantial changes to LVRs (loan to valuation ratios) the major factor that created the impairment of the loan the overwhelming majority of defaults were a result of monetary breaches of the loan covenant or a combination of both monetary and non-monetary breaches. Simply focusing on these raw statistics would indicate that in the vast majority of cases, loan finance operates as intended and leads to beneficial outcomes for both financiers and their customers. That would tend to suggest that some of these recommendations represent a wish list and potentially amount to using a sledge hammer to crack a walnut. However, the review received submissions from extreme examples of poor outcomes and as is often the case in industries which find themselves subject to regulatory oversight it is the minority which influences the ultimate outcome for the majority. On this basis, it would be an optimistic assessment that all of the recommendations or some variant thereof of the ASBFEO could be shelved indefinitely. The Khoury Report On 20 February 2017 Phil Khoury an independent governance expert released his report on the Independent Review of the Code of Banking Practice. The report acknowledges a primary driver of reviews of the code is the level of dissatisfaction with the banking sector in the community and the need to restore trust in the community. That said it is important not to overstate the overall significance of the Code given that banks regulatory obligations include in addition to the code, three major acts of parliament, case law and two other legally binding codes i.e. - National Consumer Credit Protection Act and National Credit Codes; - ASIC Act unfair contract forms provisions; - Corporations Act; - Privacy Act & Credit Reports Code; - Anti-Money laundering legislation; and - E Payments Code. The review made 99 recommendations across a range of areas including: - Small business - Responsible lending - Credit card lending 8

9 - Credit cards and borrower default - Joint account holders - Guarantors - Dealing with customers with financial difficulty - Terms and conditions and charge backs - Fees - Sales practices including insurance cross selling - Customers with special needs - Complaints policy - Code monitoring and compliance Some of the more significant recommendations include the following: - Recommendation 5 broadens the definition of small business to include any business with fewer than 100 employees and where the business has a credit limit of less than $5 million per credit facility. Currently the Code defines a small business as a business having less than 20 full time equivalent employees or 100 employees in the case of a manufacturer. - Recommendation 11 provides that the Code should be amended to require a signatory bank to provide a customer in default under a small business facility below $5 million with 30 days notice before beginning enforcement proceedings. An exception would apply where the bank reasonably believes more urgent action is necessary to recover the debt or avoid loss in value of the security for the credit. Indicative data provided by 8 signatory banks as at the end of March 2015 provides comfort that the vast majority of small businesses are successfully servicing the credit provided by their signatory bank. o o o o Less than 1.5% of loans to small business (farming enterprises and other enterprises) were in work out; Less than 0.5% of loans to small business were subject to loss provision as impaired loans (a loan is typically classified as impaired where the loan is 90 days overdue; Less than 0.02% of loans to small business in recovery action (where loan foreclosure has occurred); and Farming enterprises were up to twice as likely to be in work out, impaired or recovery as compared with non-farming small business loans. - Recommendation 12 provides that the Code should be amended to require a signatory bank to have in place adequate arrangements to address conflicts of interest issues pertaining to proposed appointments of investigating accountants and receivers. 9

10 The Khoury recommendations do not appear quite as prescriptive with respect to this issue as the Carnell Report which would prescribe the practice of appointing investigating accountants as subsequent receivers. - Recommendation 99 recommends that the revised code be submitted to ASIC for approval under Corporations Act Section 1101A and Regulatory Guide 183. The rationale for this recommendation is to enhance community acceptance of the revised code. The report itself acknowledges that an inadequate response to its recommendations would simply engender further cynicism in the general community with respect to the banking industry s commitment to genuine reform. This would also be the case if there was inertia or attempts to water down the recommendations or create extensive carve out from the spirit of the recommendations. On 28 March 2017 the Australian Bankers Association (ABA) released its response to the Khoury Report of the 99 recommendations, the ABA supported 61 in their entirety, 19 in principle, 10 in part and either needs more time to consider the recommendations or disagrees entirely with the 9 remaining recommendations. Secured Creditor Case Law Update Receivers Priorities v Employee Entitlements The Commonwealth Department of Employment (DEWR) has recently been actively scrutinising Receivers treatment of the proceeds of certain classes of assets The Corporations Act provides for employees to take priority to realisations of circulating assets in respect of unpaid entitlements over general security agreement holders. DEWR has been active in this space as it is often subrogated to the rights of employees through its FEG scheme and it is looking to maximise the sum recovered under the scheme by way of its right of subrogation. The decision of the Federal Court in Langdon, the matter of Forge Group Ltd (Receivers and Managers Appointed) (in Liquidation) [2017] FCA 170 provides some useful guidance as to the interpretation of Section 433 of the Corporations Act, the main statutory provision which regulates employee priorities for the purposes of receivership appointments. Facts: Receivers were appointed to Forge on 2 July Administrators were appointed on 11 February 2014 who were subsequently appointed as liquidators on 18 March The Receivers lodged objections to original tax assessments as a result of the termination of long term supplier contracts brought about by the company ceasing to trade. The Commissioner amended 2012 and 2013 assessments which ultimately resulted in a refund of $53.4 million. Issue: The Receivers sought directions as to whether the refund should be characterised as a circulating asset available to employees or whether it should be paid to ANZ who held a general security agreement over the assets of Forge. 10

11 Decision: Section 433 relevantly provides: Receivers pay out the property coming into her or her hands, priority employee entitlements under Section 556(1)(e)(g) or (h) of the Act. The relevant property is that which is comprised in or subject to a circulating security. Section 51(C) provides that circulating security interests are those assets which are secured by a PPSA security interest that has attached to a circulating asset for the purposes of the Personal Property Securities Act 2009 (PPSA) Section 340 of the PPSA defines circulating assets as: a) the personal property covered by subsection 5 or; b) in any other case the secured party has given the grantor express or implied authority for any transfer of the personal property to be made in the ordinary cause of the grantors business, free of the security interest; (5) this subsection covers the following personal property: - an account that arises from granting a right or providing services; - an account that is the proceeds of inventory; - an ADI account (other than a term deposit); - Currency; - Inventory; and - A negotiable instrument. His Honour held: - The date for identifying the distinction between circulating and non-circulating assets is the date the asset passes into the receivers hands i.e. the date of the appointment of the receivers. Assets that come into existence after this date such as the refund are not subject to the priority provided by the provision and thus available to the general security holder. - The right to receive the refund i.e. the chose in action arose only after the amended assessment was issued which was also after the Receivers appointment. - Even if the refund or the right to receive it had arisen prior to the Receivers appointment it was not a circulating asset, as ANZ security documentation did not provide Forge the express or implied authority to utilise the refund in the ordinary course of Forge s business. Accordingly the Receivers were entitled to pay the proceeds of the refund to their appointing bank and it was not available to discharge employee entitlements or FEG S subrogated rights. The case provides useful guidance as does a prior case, re CMI Industrial Pty Ltd (in Liquidation) [2015] 105 ACSA 635, which dealt with entitlement to Receivers post appointment trading profits to both banks / their appointing financiers and to FEG as to the scope of the priority entitlements provided by Section

12 Secured Creditors and Stocktakes A recent decision of the NSW Supreme Court addressed the necessity of a physical stocktake to be conducted during a secured creditors receivership appointment. Bicheno Investments Pty Ltd v David John Winterbottom [2017] NSWSC 536. Facts: The plaintiffs appointed receivers to DSG Holdings Australia Pty ltd (DSG) on 30 June DSG operated a number of discount variety stores across Australia and as at 30 June 2014, its stock on hand numbered in excess of 15 million individual items with an average unit value of less than $2. DSG and the secured creditor were related parties. The terms of the appointment negotiated included an incentive fee for the receivers. The incentive fee was to be calculated in part by reference to the value of DSG s stock as at the appointment date as determined by a stocktake undertaken by the receivers. Issue: The plaintiffs argued that as the receivers had not conducted a physical stocktake their entitlement to the incentive fee had not been triggered. Decision: As a matter of construction of the relevant clauses of the appointment deed, MacDougall J of NSW Supreme Court found the receivers were under no obligation to conduct a physical stocktake of the stock in question, prior to being entitled to withhold the incentive fee prior to accounting to the secured creditor. Implications: One suspects the case cannot be taken as authority that a physical stocktake is unnecessary in all appointments. Section 420A of the Corporations Act provides that a receiver must take reasonable care to secure market value for a company s assets. A necessary antecedent to satisfying this duty of care is a market valuation of the company s assets. The rationale behind the duty is to ensure receivers (and mortgagees) in possession do not ignore the rights of other creditors, in particular guarantors. Quite aside from the construction of the relevant clause the following factors were present in the DSG appointment: - The secured creditor was a related party of DSG who had negotiated the terms of the appointment i.e. it was not a third party appointment as in the case of the appointment of receivers by a financier to its customer. - The internal stock records of DSG were accepted to be accurate, with minimal tolerances for error and a number of internal physical stock takes had been conducted relatively recently prior to the appointment. - The company s stock listing comprised 700 pages with over 15 million individual items of limited unit value rendering a complete physical stocktake an uncommercial proposition. 12

13 One could conceive of circumstances where one or more of these factors were not present, a receiver may be compelled to complete a physical stocktake to satisfy their obligations pursuant to Section 420A of the Act. An initial first step to satisfying the reasonableness standard would be the appointment of an independent expert / valuer to advise on the adequacy / accuracy of the relevant stock system and the most appropriate method of verifying the valuation provided therefrom. If there are difficulties with the accuracy of the stock system further due diligence would most likely be required to satisfy the reasonableness standard. Preferences and Secured Debts A decision of the Federal Court in 2016 Hussain v CSR Building Products Ltd in the matter of FPJ Group Pty Ltd (in Liquidation) [2016] FCA 392 considered amongst other things the relationship between the PPSR Act and the voidable transaction provisions of the Corporations Act relating to unfair preferences. Facts: FPJ Group Pty Ltd was a wholesale supplier of building products. On 26 September 2010, the company entered into a credit agreement with CSR Building Products Ltd wherein CSR retained title to goods supplied until CSR received payment for them. Between January 2014 and June 2014, the company made 18 payments totalling $153, to CSR pursuant to the agreement. The company was wound up in insolvency on 18 July 2014 and the Liquidator sought to establish an insolvency date of 21 November 2013 and sought to impugn the payments made after that date as unfair preferences. Decision: In the result the Liquidator was unsuccessful in demonstrating insolvency which would have been sufficient to dispose of the case. However his Honour Edelman J of the Federal Court proceeded to consider whether it was an unsecured debt for the purposes of Section 558FA of the Act. Section 588FA(1)(b) provides that a transaction is an unfair preference if it results in the creditor receiving from the company, in respect of an unsecured debt that the company owes to the creditor more than the creditor would receive from the company in respect of the debt, if the transaction were set aside and the company were to prove for the debt in a winding up of the company. His Honour found that the definition of security interest in Section 51A includes retention of title arrangements due to the effect of Section 12 of the PPSR Act. Accordingly money paid pursuant to a valid retention of arrangement would be treated as secured for the purposes of Section 588 FA(1)(b) and hence not voidable as against a Liquidator. Implications: Much of the commentary with respect to this case suggest it represents a change to the law and has the effect that a supplier with a valid retention of title clause since the introduction of the PPSR Act will have a defence to a preference. This commentary does ignore to an extent the actual nature of the security interest a retention of title supplier has under the PPSR i.e. a PMSI or purchase money security interest over the relevant items in question. 13

14 That is the PMSI or retention of title clause attaches to the remaining property held by the insolvent customer and to the extent there is a shortfall of property to which the PMSI attaches that shortfall should be treated as an unsecured claim for the purposes of the unfair preference provisions. The judgement itself acknowledges that possibility. It is at least arguable that the case is no more than a restatement of the state of the law prior to the introduction of the PPSR Act. Safe Harbour Reform The insolvency and reconstruction industry has been subject to a significant degree of reform and regulation in the last twelve (12) to eighteen (18) months. It is reasonable to say that these are the most significant reforms to corporate insolvency practice since the introduction of Voluntary Administration in Part 5.3A of the Corporations Act over twenty (20) years ago in Insolvency law reform has been placed at the forefront of the economic policy in a way that probably has not been seen previously. In April 2016 the Federal Government (The Treasury) released the Improving bankruptcy and insolvency laws Proposal Paper as part of the National Science and Innovation Agenda reforms. The proposals were part of the Federal Government s initiative to encourage innovation and risk taking to manage the transition of the Australian economy from resource based to a technology driven economy. Some of the measures proposed were: 1. introducing a 'safe harbour' for directors from personal liability for insolvent trading if they appoint a restructuring adviser to develop a turnaround plan for the company; and 2. making ipso facto clauses, which have the purpose of allowing contracts to be terminated solely due to an insolvency event, unenforceable if a company is undertaking a restructure. Safe Harbour Pursuant to Section 588G(1) of the Corporations Act Director s duty to prevent insolvent trading by company, a director of a company can be held personally liable if: (a) a person is a director of a company at the time when the company incurs a debt; and (b) the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt; and (c) at that time, there are reasonable grounds for suspecting that the company is insolvent, or would become so, as the case may be; and The risk of being held personally liable (and also criminal liability) can be seen as a trigger for directors to place the company into Voluntary Administration prematurely rather than working towards a restructure outside of a formal appointment in a distressed situation. The Government considers that the introduction of a safe harbour to the insolvent trading provisions will facilitate the restructure of businesses, striking a better balance between encouraging entrepreneurship and protecting creditors. On 28 March 2017 the Minister for Revenue and Financial Services released draft legislation, the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017 with respect to these reforms. The draft provides directors with a carve out, against liability for insolvent trading as opposed to a defence to insolvent trading where they start taking a course of action that is reasonably likely to lead to a better outcome for the company and the company s creditors than an external administration. This shifts the evidential burden away from the director, to the party alleging the safe harbour does not apply. 14

15 This is said to be line with the policy objectives of facilitating honest and genuine business turnaround attempts. It should be noted that, as it is presently drafted, such protection only extends to debts incurred in connection with that course of action. This model looks to protect directors against insolvent trading claims where a director has been acting in the best interests of the company and its creditors as a whole with a safe harbour within which they may attempt to return the company to solvency. Carve out from Insolvent Trading The draft legislation proposes the following: Section 588G of the Act does not apply: a) If the debt was incurred as part of reasonable steps to maintain or return the company to solvency within a reasonable period of time; and b) The person held the honest and reasonable belief that incurring the debt was in the best interests of the company and its creditors as a whole; and c) Incurring the debt does not materially increase the risk of serious loss to creditors. It would appear that this is a broader approach and places the onus of proof on any subsequent liquidator to prove that the director had breached any of the three exceptions above. It would be a matter for the Court to consider what is reasonable in relation to steps taken and period of time. The better outcome test is an objective test, dependant on the circumstances of each case. An indicative list of factors to be considered includes: - the steps taken to prevent misconduct by officers and employees of the company; - the steps taken to ensure the company maintains appropriate financial records; - obtaining appropriate advice; - the director keeping themselves informed about the company s financial position; - developing and implementing a restructuring plan to improve the company s financial position. The proposed defence stipulates that obtaining appropriate advice from an appropriately qualified entity is a consideration when determining if a course of action was reasonably likely to lead to a better outcome. The broad wording appropriately qualified entity has received mixed views. Some submissions called for a minimum qualification requirement (such as being a registered liquidator), while others preferred the broad view, recognising that companies face unique circumstances and what is appropriate for one company, may not be necessarily be appropriate for another. It is expected that the pre-insolvency advisory sphere will open to a wider range of advisors. The regulations, when drafted, may provide further guidance in considering whether an entity is appropriately qualified. End of Protection Protection ceases when: (i) (ii) (iii) the action ends; the course of action stops being reasonably likely to result in a better outcome for the company and its creditors; or the company enters external administration. 15

16 Exceptions The safe harbour would not be available to a person: who is disqualified from managing a corporation at the time the debt was accrued; Australian Securities & Investments Commission ( ASIC ) has determined the person was ineligible as a result of prior conduct; the company has failed to lodge multiple business activity statements; and there has been a significant failure to pay employee entitlements, including PAYG. The bill was passed by parliament on Monday, 11 September The safe harbour regime will take effect immediately and the ipso facto reforms will begin later from 1 July 2018, or as otherwise proclaimed. There is an argument that the law already provides for a safe harbour by way of the voluntary administration provisions which also includes formal protections for creditors. Statistics show that a relatively small number of companies are effectively rehabilitated through the voluntary administration/deed of company arrangement process. It is the suspicion that the concept of the safe harbour outside formal administration would in reality apply to a relatively small proportion of distressed companies and that as in the case of informal workouts currently, the blowtorch of scrutiny will apply to failed safe harbour turnarounds. Having said that banks and other financiers will find themselves being asked to effectively endorse / support attempted safe harbour turnarounds. It is axiomatic that the successful implementation of any restructuring plan through the mechanism of the safe harbour in the majority of cases will be dependent on the support of senior debt financiers and financiers of critical plant and equipment. It is unlikely given the turnaround culture being advocated by the government and the customer centric thrust of many of the reforms arising out of the banking review process that a blanket rejection policy of proposed safe harbour turnarounds will be sufficient. Banks and other financiers will have to have documented processes for the reasoning behind any rejection and/or support for a proposed safe harbour turnaround. Having said that if the safe harbour works as its advocates suggest it will, the reform does represent an opportunity for financiers to preserve value as a formal administration can have a detrimental effect on the value of security. 16

17 Appendix 17

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19 Annexure 19

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