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BY BLAIR PLEASH PARTNER OF HALL CHADWICK

Hall Chadwick Recent developments in Insolvency Law and Practice Safe Harbour, IPSO Facto Clauses & Phoenix Companies. BY BLAIR PLEASH PARTNER OF HALL CHADWICK. Understanding Insolvency, Safe Harbour, Phoenix Companies. Definition & Legal Test of Insolvency

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BY BLAIR PLEASH PARTNER OF HALL CHADWICK

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  1. Hall ChadwickRecent developments in Insolvency Law and PracticeSafe Harbour, IPSO Facto Clauses & Phoenix Companies BY BLAIR PLEASH PARTNER OF HALL CHADWICK

  2. Understanding Insolvency, Safe Harbour, Phoenix Companies • Definition & Legal Test of Insolvency • Indicators of Financial Distress • Safe Harbour • Ipso Facto • Phoenix Activity

  3. Why do you need to know what insolvency is? • When seeking the appointment of an external administrator, the company needs to have formed the opinion that the company is insolvent or is likely to become insolvent; • Issuing a Statutory demand to initiate a court liquidation; • Pursuing preferences and other voidable transaction under the Corporations Act; • Pursuing an Insolvent Trading claim; • Pursuing individuals for Insolvent Trading or otherwise as shadow/de facto directors; and • To determine whether the safe habour can be triggered.

  4. Definition & Legal Test of Insolvency Pursuant to Section 95A of the Corporations Act • A person is solvent, if and only if, the person is able to pay all the person’s debts, as and when they become due and payable. • A person who is not solvent is insolvent.

  5. Proving Insolvency • The ability to pay debts as and when they fall due is not a balance sheet test • The legal test of insolvency doesn’t require cash to be on hand • The legal test of insolvency includes monies raised through both/either the selling and mortgaging of assets • The proximity of the due date and the availability of funds • Third party support • Variations of payment terms • The legal test of insolvency excludes asset realisation programs • Temporary illiquidity doesn’t mean insolvency • Money obtainable from unsecured borrowings is not to be included when determining insolvency • Expert reports do not establish insolvency

  6. Indicators of Financial Distress Top Ten Warning Signs of Insolvency • Non-payment of Tax Liabilities • Continuing Losses • No access to credit • Outside trading terms with creditors and supply on Cash on Delivery (“COD”) • Receiving demands and/or other legal notices • Sales are decreasing • Unfunded superannuation • Excessive reliance on related parties • Low stock turnover • High Accounts Receivable

  7. Safe Harbour Reform Introducing a ‘safe harbour’ for directors from personal liability for insolvent trading if they appoint a restructuring advisor to develop a turnaround plan for the company.

  8. 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 person is a director of a company at the time when the company incurs a debt; and • 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 • at that time, there are reasonable grounds for suspecting that the company is insolvency, or would become so, as the case may be.

  9. Safe Harbour Carve out • 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 • 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 • Incurring the debt does not materially increase the risk of serious loss to creditors.

  10. Safe Harbour Factors to be considered • 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.

  11. Safe Harbour End of Protection • 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.

  12. ‘Safe harbour’ would not be available to a person: • Who is disqualified from managing a corporation at the time the debt was incurred; • ASIC determined the person ineligible as a result of poor conduct; • The company failed to lodge multiple business activity statements; and • There has been a significant failure to pay employee entitlements including PAYG.

  13. Points to note • No restriction on enforcement action • Documenting safe harbour strategy / turnaround plan • Privileged Communications • Duty of Care

  14. Ipso Facto Clauses • Any term of a contract or agreement which terminates or amend any contract or agreement (or any item of any contract or agreement), by reason only that ‘insolvency event’ has occurred would be void; • Nothing in the proposal would extend the operation of the provision beyond ipso facto clauses; counterparties would maintain a right to terminate, amend, accelerate or vary an agreement with the debtor company for any other reason, such as for a breach involving non-payment or non-performance; • Nothing in the operation of the provision would require any creditor to provide a further advance of money or credit; • Affected Counterparties may apply to the Court to vary contract terms if they can show they have suffered hardship; • Comes into force on 1 July 2018 – will not apply retrospectively.

  15. Phoenix Activity What is a phoenix company? In a report commissioned by the Fair Work Ombudsman in June 2012 titled “Phoenix Activity – Sizing the problem and matching solutions”, the following definition of phoenix activity was developed in consultation with stakeholders: “Phoenix activity is the deliberate and systematic liquidation of a corporate trading entity which occurs with the fraudulent or illegal intention to: • Avoid tax and other liabilities, such as employee entitlements • Continue the operation and profit taking of the business through another trading entity.”

  16. There are three phoenix offender types: - • Innocent offender Involves a business which gets into financial distress because its principals do not realise the business is performing poorly due to inadequate managerial control and monitoring systems. • Occupational Hazard This segment are at risk of engaging in potential phoenix behavior simply by dint of their occupation. • Careerist Involves those who are aware of the law and make a conscious decision to behave in a way that will defeat their creditors.

  17. Indicators a company is participating in, or about to participate in, fraudulent phoenix activity. • The company is able to seriously undercut other contractors • Workers are pressured to take leave • Workers have their employment status changed from permanent to casual • Workers are underpaid or paid irregularly • Superannuation payments are not made • Equipment, machinery and uniforms are not replaced as needed • Company owners or directors enjoy an extravagant lifestyle that doesn’t appear to match their income.

  18. Signs a new business is the result of phoenix activity, such as: • The directors of the new entity are family members of the director of the former company or are close associates, such as managers, of the former business. • A similar trading name is used by the new entity. • The same business premises and telephone number (particularly mobile number) are used by the new entity.

  19. Anti-phoenixing reforms • The introduction of a Director Identification Number (DIN) which will interface with other government agencies and databases so that regulators can map the relationships between individuals, entities and other people; • Specific phoenixing offences; • Prohibiting related entities to the phoenix operator from appointing a liquidator; • Restricting the ability of related creditors to vote on the removal or replacement of an external administrator; • A dedicated phoenix hotline for reporting illegal phoenix activity; • The penalties that apply to those who promote tax avoidance schemes to be extended to capture advisers who assist phoenix operators; • Stronger powers for the ATO to recover a security deposit from suspected phoenix operators to cover any outstanding tax liabilities; • Making directors personally liable for GST liabilities as part of extended director penalty provisions; • Preventing directors from backdating their resignations to avoid personal liability or from resigning and leaving a company with no directors; and • Expanding the tax offices powers to retain refunds were there are outstanding tax lodgements. No date of effect of any measure is specified in the budget papers.

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