Executive Summary

On 28 September 2022, the Federal Government, through the Parliamentary Joint Committee on Corporations and Financial Services (the Committee), commenced an inquiry into the effectiveness of Australia’s corporate insolvency laws in protecting and maximising value for the benefit of all interested parties and the economy (the Inquiry). See here the link to our earlier article on the key focus areas of the Inquiry.

On 12 July 2023, the Committee released their Report making 28 recommendations. The key recommendation of the Committee is that there is the need for an independent and comprehensive review of Australia’s corporate and personal insolvency laws to address the following concerns:

• Australia’s insolvency system is overly complex, difficult to access and creates unnecessary costs and confusion for both debtors and creditors; and

• the system might not reflect modern business practices (particularly for smaller and medium-sized business), nor has it kept pace with changes in the domestic and global economy; and

• reforms since the 1988 ALRC Report 45 (Harmer Report) have been at times “piecemeal” in nature, without always having regard to the whole corporate insolvency system.

Like many industry participants, the Australian Restructuring Insolvency & Turnaround Association (ARITA) has warmly welcomed the findings of the Committee. ARITA was pleased to see almost all their key recommendations accepted by the Committee including a ‘root and branch’ review of insolvency law and bringing the personal and corporate insolvency regimes and oversight together.

Our team has digested the Committee’s Report – here is a deeper-dive into some of the 28 recommendations.

Recommendation 1 – Near-Term Actions and Comprehensive Review

Overall, the Committee found there to be a strong need for an overhaul of Australia’s insolvency system to address its noted “deficiencies”.

As a first step, the Committee recommends the Government commission a comprehensive, and independent review of both personal and corporate insolvency laws. Although the Committee acknowledges the need for a holistic approach to the review and reform of Australia’s insolvency regime, it has recommended that this be done in two stages: (1) some reform actions should be progressed independently (Near-Term Actions)[1] which would address clear and broadly recognised failings in the current law; and (2) the remaining reform actions should be progressed under a comprehensive review (Comprehensive Review)[2]. This will help realise a balance between the need for a considered, holistic review and reform process, and timely responses to shortcomings in law.

The Near-Term Actions are split between recommendations for the Government’s consideration[3] and recommendations for the Australian Securities and Investment Commissions’ (ASIC) consideration[4].

Recommendation 2 – Principles and objectives of insolvency law

The Committee recommended that an early task for the Comprehensive Review is to consider and report on the appropriate principles and objectives of insolvency law as:

• the Corporations Act 2001 (Cth) (the Act) does not set out the objectives of Australia’s corporate insolvency regime (except in relation to voluntary administration); and
• the Committee recognised that the outcomes of a comprehensive review and any resulting recommendations will be shaped by how the principles and purposes of the insolvency law are defined.

Recommendation 7 – Implement the recommendations of the Safe Harbour Review

The “safe harbour” provisions set out in section 588GA of the Act provide a defence to insolvent trading where a director can demonstrate that they were developing or taking a course of action that at the time was reasonably likely to lead to a “better outcome” for the company than an immediate administration or winding-up.

As was required under section 588HA, in 2021-2022 the Government commissioned the Safe Harbour Review[5], which led to a number of recommendations. The Committee has suggested that the implementation of these recommendations be a Near-Term Action item to enhance the current safe harbour regime.

In addition, the Committee recommended that the safe harbour regime be included as part of the Comprehensive Review to examine issues raised during the Inquiry, including:

• relaxing criteria to access the protection of the safe harbour provision;
• small and medium enterprise access;
• the interaction with unfair preference claims;
• the costs relative to phoenixing; and
• the potential exploitation of creditors.

The Committee did not foresee the above issues would prevent the near-term implementation of the Safe Harbour Review recommendations.

Some participants raised concerns in relation to the transparency of the safe harbour process. However, the Committee erred on recommending the process be made public citing the significant practical difficulties which may arise, including that wide knowledge of the safe harbour process may lead to stakeholders taking actions that quickly render a company insolvent and unable to be restructured.

Recommendation 23 – Relative priority of employees, liquidators and secured creditors

The main role of a liquidator is to identify, preserve and realise an insolvent company’s property and organise the distribution of proceeds between creditors. Section 556 of the Act establishes the priority order in which different classes of unsecured creditors may receive a dividend out of the liquidation (where funds are available).

In addition, section 561 gives priority to employees’ claims over circulating assets. This priority is contingent on there being insufficient unencumbered assets to meet employees’ claims.

These two priority regimes have led to competing views between liquidators and the Federal Entitlements Guarantee as to whether section 561 has the ability to override section 556. From the submissions received by the Committee, insolvency practitioners considered that amendments may be required to clarify that any priority afforded to a liquidator’s expenses, costs and remuneration under section 556 is not encumbered by section 561. Whereas the Department of Employment and Workplace Relations argued that employees should retain a super priority by way of section 561.

The Committee acknowledged that some clarity over the operation of these sections was given in a recent NSW Supreme Court decision (In the matter of BCA National Training Group Pty Ltd (in liq) [2023] NSWSC 366) whereby the Court highlighted the contingent nature of section 561 of the Act.

The Committee has recommended that consideration as to the competing priority interests of employees and liquidators over circulating assets under section 561 should be included as a high priority of the Comprehensive Review given:

• the Government’s review of the Personal Property Securities Act 2009 (Cth) (Whittaker Review) in 2015 did not make a recommendation on the Corporations Act circulating assets provisions; and
• such issues need the kind of detailed consideration and consultation that a comprehensive review can provide in light of recent court decisions.

We support this recommendation and the submissions made by practitioners that any potential reform should ensure that section 561 does not override section 556. If section 561 were to override section 556, it may lead to arbitrary and unfair outcomes in circumstances where a secured creditor has a circulating security interest at the commencement of the winding up and it later transpires that there are insufficient assets to pay preferred creditors, even if the secured creditor’s debt is paid out of non-circulating assets.

Recommendation 28 – Clarifying the treatment of trusts in insolvency

In Australia there is no clear statutory regulation of trusts, particularly in the context of corporate trust insolvency. It is an area that the Committee has recognised has long been identified a need for reform which to date have not occurred, (despite the rising prevalence of corporate trusts across the economy and despite inquiries commissioned by the government). Relevantly:

• the Harmer Report proposed 10 recommendations in respect of insolvent corporate trustees which do not appear to have been implemented -The Committee noted a number of participants endorsed these recommendations; and
• in 2021, the clarification of the treatment of trusts in insolvency law was subject to a consultation process conducted by the Department of Treasury (Treasury). Treasury advised the Committee that the government was currently awaiting the outcome of the Committee’s Inquiry before taking further action.

The Committee found that the lack of legislative clarity around the regulation of trusts, and in particular in the context of insolvency, has raised ongoing issues, and caused time inefficiency, complexity and unnecessary expenses. In particular:

• there is no statutory regime to protect stakeholders’ rights (particularly those who do business with or invest in corporate trusts) or to inform on the allocation of assets when trusts become insolvent;
• common clauses in trust deeds remove/ displace trustees from their position upon entering liquidation which then denies the trustee in liquidation the authority and ability to manage and sell trust assets to then use the proceeds to satisfy creditor claims. Instead, liquidators must apply to the court to be appointed as a receiver of trust assets which creates unnecessary costs with detrimental impacts on returns to creditors.

The Committee received an overwhelming support for legislative reform for corporate trust insolvency and agreed that timely and substantial reform was necessary to protect stakeholders and that the following should be considered as part of the process:

• as the power to legislate trusts vests in the states, the Commonwealth may need to seek a referral of powers from the state governments to achieve broader reform;
• cohesive legislative reform is required to end the cycle of piecemeal developments;
• revisiting the Harmer Report recommendations to analyse and update them where necessary to ensure they reflect contemporary circumstances; and
• maintaining the inherent benefits of the trust structure while considering proposals for legislative reform.

At this stage, the Committee is in favour of amending the Act to allow liquidators of insolvent corporate trustees to deal with trust assets but only in respect of single trading trusts. The Committee suggested further consultation may be needed before extending the amendments to trustees of multiple trusts.

There was also strong support in the Inquiry for a public registry of trading trusts to increase transparency, particularly as non-sophisticated investors may not realise that the assets of these entities do not, in a beneficial sense, belong to the relevant company. The Committee agreed with these submissions and have included the establishment of a public registry of trading trusts as part of its recommendation.

Next steps

While the Report and recommendations are welcomed, all eyes will be on the Government to see the extent in which it implements these recommendations.

We will provide further updates in respect to the Government’s response and any future developments.

List of Recommendations