Insolvent trading and innovation reforms in Australia

Risk aversion among company directors in Australia is significantly higher than other OECD countries. This is due to a corporate environment in which insolvent trading is easily triggered and difficult to overcome.

Under existing provisions stipulated in the Corporations Act, insolvent trading is not only defined as trading while the company meets the tests of insolvency, but includes trading, or conducting business, in a manner which will lead to its insolvency.

Directors who lead their company into potentially profitable but unknown territory, are flirting with insolvency. In this pursuit of innovation, directors are opening themselves up to the risk of personal liability.

As a consequence of the personal liability provisions, directors are unwilling to take the necessary risks required to truly innovate.

The Senate Economics References Committee recently released its long awaited Innovation Report which identified the insolvency framework as one of several barriers to innovation in Australia. The Government has responded by issuing an Innovation Statement outlining 28 significant initiatives. One of which was the long awaited Insolvency Reform.

The Insolvency Reform intends to make three significant changes:

Reduce the current default bankruptcy period from three years to one year;
Introduce a ‘safe harbour’ for directors from personal liability for insolvent trading if they appoint a restructuring adviser; and
Make ‘ipso facto’ clauses, unenforceable if a company is undertaking a restructure. This will allow companies to continue to trade and derive the benefit of the contract while they innovate.

The proposal paper will be released early this year and will attempt to strike a balance between protecting creditors and encouraging entrepreneurship.

The new laws, which would apply to all companies, could unleash innovation by established businesses whose directors may currently feel constrained by Australia's existing insolvent trading laws.