Dr Nitin Gupta,
Creating a culture of innovation means striking a balance between promoting productive and discouraging reckless risk-taking. Insolvency laws help to strike this balance.
Australia’s insolvency laws are increasingly out of sync with trends across much of the OECD, and risk undermining the innovation outcomes of the Australian economy.
The importance of innovation as a means to promote
growth has been an important part of the Government’s policy agenda.
This is because the mining boom—the mainstay of the economy for the last two
decades—is coming to an end, and there is a broad consensus that the boom has obscured
a general decline in national productivity.
The ways in which an economy encourages and
regulates risk are critical to its innovation outcomes. The rules have to
strike a balance between promoting risk-taking on one hand, and minimising the
possibility that risk protections lead to abuse and reckless behaviour by
companies (the moral hazard problem) on the other. Insolvency laws are an
important marketplace mechanism by which countries try to strike this balance.
Insolvency laws fall broadly into two groups. In
the first are those that prioritise liquidation of a company over its
restructuring. These assume that insolvency is the result of deliberate
malpractice by companies, and accordingly, place greater emphasis on the
protection of creditors. In the second are laws that reflect a ‘rescue culture’
that allows for financially constrained companies to reorganise themselves
rather than be forced into liquidation. These assume that insolvency may not
reflect deliberate malpractice and that a second chance for the company will be
in the longer-term interest of creditors.
Insolvency in Australia—the key issues
Under the Corporations Act
2001, ‘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’. Thus ‘a
person who is not solvent is insolvent.’
Australian insolvency law does not take account of an
insolvent company’s longer-term prospects, its competitiveness, assets, or
brand value, and is geared towards its premature closure and liquidation. It
does not allow for the possibility that, through some restructuring or
assistance, the company could return to profitability and preserve the
interests of creditors.
laws in other advanced countries
Globally, insolvency laws have tended towards
restructuring rather than liquidation. The ‘Chapter 11’ (Ch. 11) provisions of
Bankruptcy Code are considered the most liberal, and place great
emphasis on corporate rescuing. These provisions have been
used as a model for insolvency law reforms in several other countries.
Some of the key advantages of the Ch. 11 approach are
that they provide:
- higher planning reliability, avoiding short-term thinking in
- continued employment and wages for workers and
- preservation of skills and experience, brand name and relationships.
These intangible assets are highly valued and can take years to build.
In the last few decades the UK, Germany and Canada have
all recognised the value of an effective insolvency regime for driving innovation,
and have implemented reforms—based on Ch. 11—with the explicit aim of creating
a ‘rescue culture’ rather than one based on liquidating an insolvent company.
In the UK, insolvency laws are based on the
recommendations of the 1982
Cork Report which reasoned that restoring the profitability of
companies would be in the longer-term interests of creditors. Until about 2008,
German law was geared towards liquidation of a debtor’s assets. Since then, laws
have been progressively reformed to improve the possibility of corporate
restructuring, and also to raise the profile of German insolvency law versus
foreign jurisdictions. Canada has implemented several reforms since 1992,
and also has special provisions for large companies owing more than $5 million.
Laws in these countries broadly
follow Ch. 11 by preventing creditors from liquidating a company’s assets
while the latter is underdoing restructuring. However, unlike Ch.11 which allows an insolvent company’s directors to retain control over
its operations, these countries typically have greater scrutiny
and involvement by the courts, including passing of operational control to a
reforms in Australia
Both Labor and Coalition Governments have proposed changes
to the Australian insolvency laws in order to modernise them.
The Ch. 11 provisions have provided a useful
reference point for Australia’s thinking on insolvency law reforms. Over
several years, multiple reviews have yielded a general view—illustrated by the 2004
Joint Committee inquiry into insolvency, and the 2015 Productivity
Commission inquiry into Business
Set-up, Transfer and Closure—that a Ch. 11-style framework would
be inappropriate for Australia. The specific objection was that an insolvent
company’s directors should not be in control of operations once insolvency is
In this vein the National Innovation and Science
Agenda (NISA), announced by the Government in December 2015, proposed
several changes to the insolvency laws, including:
- reducing the current default bankruptcy period from three years to one
- introducing a ‘safe harbour’ provision to protect directors from
personal liability for insolvent trading if the company is undertaking a
- making the ‘Ipso Facto’ clause, which allow contracts to be
terminated solely due to an insolvency event, unenforceable if the company is
undertaking a restructure.
No legislation to give effect to these changes had
been introduced prior to the prorogation of the 44th Parliament. However, the Government
demonstrated its interest in insolvency reform with the passage of the Insolvency
Law Reform Act 2016, which aligned standards for corporate insolvency
practitioners with those of personal bankruptcy practitioners.
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