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A time of change across the Australian insolvency landscape

While legislators ponder new ‘safe harbour’ laws, insolvency practitioners face increased judicial scrutiny of remuneration

Safe Harbour laws

Australian insolvency laws are currently in a state of flux as the Federal Government prepares to implement the most wide-reaching reform agenda in two decades. Prime Minister Malcom Turnbull has placed insolvency law reform at the centre of the 'National Innovation & Science Agenda', which is designed to facilitate a "cultural shift" in Australian business practices to "encourage Australians to take a risk, leave behind the fear of failure and be more innovative and ambitious". Critics say the existing insolvency laws present a barrier to entrepreneurship by putting too much focus on penalising and stigmatising business failures, in particular, because of the personal liability imposed upon directors for debts incurred by a company which is found to have traded whilst insolvent. A key plank in the reform agenda is the proposed introduction of a 'safe harbour' defence for directors, to promote corporate restructure by removing or reducing the personal liability consequences for directors if the restructure is ultimately unsuccessful.

The Government has postulated two possible 'safe harbour' models, terming these 'Model A' and 'Model B'. Model A provides a defence to insolvent trading where directors formally appoint a restructuring adviser to develop a plan to rescue the company "within a reasonable period of time". The onus would fall on the directors of the company to ensure that the experience and qualifications of the restructuring adviser were appropriate for the nature and circumstances of the company. Model B removes the risk of liability in specific circumstances, including where directors take reasonable steps to maintain or return the company to solvency whilst acting in the best interests of the company and its creditors as a whole. Model B contemplates that in such circumstances statutory insolvent trading liability would not arise – effectively operating as a carve out to the existing regime, than a defence.

Model A has had significant support from within the restructuring and insolvency industry, including industry bodies – the Turnaround Management Association of Australia, the Australian Chamber of Commerce and Industry, the Australian Restructuring Insolvency & Turnaround Association and the Australian Shareholders' Association. The rationale underlying the endorsement of Model A is a recognition, from industry experts, that a board of directors, often made up of directors with little to no experience in dealing with, or navigating, corporate distress, will benefit from engaging with an accredited restructuring adviser (or "safe harbour master"). The restructuring adviser will have deep experience in the usual sudden shifts in counterparty priorities according to the value breaks in the capital structure and burning platform organisational, cultural, communication, planning and restructuring needs of an ailing company. That person, or more accurately, the team behind the adviser, becomes the trusted communicator with various internal and external stakeholders, the architect of a turnaround plan and the party responsible for measuring and reporting on the effectiveness of the plan in implementation.

Model A is not without its limitations. While Model A may offer effective safe harbour for the directors of large companies, it may not be accessible to the directors of small and medium-sized enterprises or start-ups due to the costs and complexity associated with such a process. Further, it does not address the complicated issue facing the board – namely the need to form a threshold view on the prospective insolvency of the company (noting that the proposed defence would only be activated if restructuring advice is obtained while the company remains solvent).

Model B is seen by some (including the Australian Institute of Company Directors) as being more flexible in allowing directors to retain control of the company, with or without a restructuring adviser, and to focus their attention on working towards a rehabilitation of the business. However, it also, much like the American Chapter 11 model which it seeks to emulate, leaves the 'fox [in] charge of the chicken coop', and nor does it deal with the fact that many directors simply do not have the requisite "turnaround" skill-set or experience to deal with distressed situations. While this model is likely to be more user friendly to SME and start-ups, it has the capacity to increase risk to creditors who continue to supply/trade with the company undergoing the restructure.

In an environment where insolvencies are on the rise, many commentators would prefer either model over the status quo, but in the context of a reform agenda which is striving to promote innovation and entrepreneurship, it seems clear that neither model will sufficiently support the policy objectives of safe harbour. More effort is clearly needed to create "a true business rescue culture in Australia". For restructurings to succeed, directors and management must be prepared to accept the cultural challenge of restructuring, involving as it does different communication and stakeholder engagement than exists in non-distressed situations. Transparency, broader stakeholder interaction (not always beholden to an immediate market reporting cycle), engagement with experienced outsiders and a willingness to sacrifice the sacred cows of the business to restore long term value are each matters for a board and management to deal with in order to make a restructuring plan succeed. Only then, together with a change in the law, can innovation and entrepreneurship thrive.

Remuneration of Insolvency Practitioners

Meanwhile, another key trend in the restructuring and insolvency space has been emerging at the judicial level. In general, the remuneration an insolvency practitioner is entitled to receive for a formal appointment as administrator or liquidator of a company is subject to Court and/or creditor approval. Like many other professionals, insolvency practitioners typically price their services based upon hourly rates. A series of recent court decisions has cast doubt upon this practice, at least in relation to appointments where the insolvency practitioner's remuneration calculated in this way may be "disproportionate" to the amount of funds realised in the administration.

This trend was exemplified in a recent judgment of the New South Wales Supreme Court, which is the busiest insolvency court in Australia. In Independent Contractor Services, Brereton J was faced with an application by a liquidator for approval of his remuneration in the amount of $49,510. Justice Brereton allowed remuneration of $30,000, only, and expressly criticised the practice of seeking remuneration based solely on time reasonably spent at standard hourly rates.

Instead, he approved and applied an ad valorem approach to assessing a liquidator's remuneration:

"ad valorem remuneration, while not without shortcomings, is inherently proportionate, incentivises the creation of value rather than the disproportionate expenditure of time, was – until the relative recent proliferation of time-based costing – conventional, and is still contemplated by the relevant statutory provisions."

The Court arrived at the $30,000 figure having regard to the size of the funds in the company, the totality of work undertaken and time expended by the liquidator and his staff, the challenges presented, and the extent to which others (including lawyers and debt collectors) were engaged and remunerated for associated work.

The judicial trend has prompted concerns amongst insolvency practitioners and their industry association (ARITA), that judicial application of a strict proportionality test fails to give due regard to the obligations of insolvency practitioners to perform work not just for the benefit of creditors, but also to practitioners' wider responsibilities which include reporting to and conducting investigations on behalf of regulators and reporting any offences to those regulators, as required by law. Speaking on this topic extra judicially in August 2016, Justice Brereton's fellow New South Wales Supreme Court judge, the Honourable Justice Black, reviewed early and recent case law on the issue and concluded that the Courts have long considered different approaches (such as time cost and percentage of realisations) as well as the notion of 'proportionality' in assessing a liquidator's remuneration, in essence underscoring the point that practitioners should not presume that time-based charging is always appropriate. Referring to recent case law, Black J indicated that "… a claim for remuneration based on hourly rates is likely to be, at least, tested by reference to a percentage of realisations and possibly, as an appropriate case, displaced by remuneration on that basis or by a mixed approach."

In this evolving area, some minor legislative amendments to the process for remuneration of insolvency practitioners are also anticipated to take effect upon the commencement of the Insolvency Law Reform Act 2016 (Cth) (currently expected to commence on 1 September 2017).

Never far from controversy, insolvency practitioner remuneration and the manner of calculation of such remuneration will remain topical both at a judicial and legislative level in Australia.

  1. The Australian Productivity Commission, Business Set-up, Transfer and Closure, Draft Report May 2015.