Encouraging corporate turnarounds
Following the release of the Financial System Inquiry’s Final Report, Finsia and DibbsBarker brought together leading experts from banking and professional services to discuss corporate turnaround in Australia at a roundtable event.
The focus of the roundtable was on the potential for reform. In particular, participants agreed that future reform is needed and should focus on the introduction of safe harbour laws, the appointment of restructuring specialists to assist management teams and the suspension of ipso facto clauses during restructuring efforts.
DibbsBarker Partner Macaire Bromley discusses for INFINANCE how banks can participate in the reform, to help struggling businesses get back on track.
Below, Finsia CEO Russell Thomas takes you through the roundtable highlights:
Help for directors and struggling companies
Australia’s insolvent trading laws are among the harshest in the world and put a struggling company’s directors in a position of conflict. The laws force directors to choose between continuing their efforts to turn a struggling company around (to the benefit of the company, its shareholders and creditors), and putting the company into voluntary administration to prevent their own homes from being at risk if those efforts fail.
This conflict, sometimes referred to as the ‘fear factor’, could be removed if directors were provided with a safe harbour defence to insolvent trading, triggered when a corporate turnaround is pursued.
However, the roundtable participants broadly agreed that directors often lack the expertise to deliver a corporate turnaround, because the skills required to rescue a struggling business are different to the skills required to build and maintain growth.
Acknowledging that shareholders and creditors are at risk of suffering increased losses during restructuring efforts, participants generally agreed that a well-balanced safe harbour defence should be predicated on a requirement that directors must either have themselves, or otherwise engage, the necessary expertise to produce a viable turnaround plan. The availability of accurate financial information and realistic forecasts is also an essential element of the restructuring process.
The roundtable participants also considered corporate turnaround regimes utilised elsewhere, with some participants bringing to the forum decades of experience in international banking and restructuring markets. Both the Chapter 11 style regime in the US and the ‘London Approach’ followed in the UK were discussed.
The Chapter 11 style regime in the US was generally dismissed as too costly and complex for Australia. Chapter 11 is a court driven process, during which a company remains in control of its own affairs and proposes a reorganisation plan to its creditors. While a company is subject to a Chapter 11 proceeding, creditors cannot take enforcement action against the company and they cannot terminate contracts by reason of the company’s insolvency. The Chapter 11 proceeding ends once the reorganisation plan is approved by the court and all the payments under it are made.
Drawing on UK experiences, the benefit in embracing aspects of the London Approach was discussed. This is an informal framework which evolved in the UK in the 1990s with the support of the British Banking Association and the Bank of England. It provides a set of guiding principles for banks and other financial creditors in dealing with customers in financial difficulty. They are principles which codify an approach, and do not form a rule of law. Nevertheless, the principles have been very effective in prescribing behaviours, so much so that the principles are now applied in UK restructurings as market standard practice and have assisted in entrenching what is now a strong business rescue culture.
The tenets of the London Approach are:
- constructive cooperation
- creditors remaining supportive when they receive bad news
- making decisions based on accurate information that is shared with other creditors
- working together to a collective view
- equal treatment for equal ranking
- the importance of proper coordination
- priority for new money.
An Australian protocol?
It was suggested by some roundtable participants that an informal restructuring protocol, and one that adopts principles proven to facilitate corporate turnarounds elsewhere, could be introduced in Australia. Such a protocol would have the potential to deliver certainty and consistency around debt restructuring practices in Australia to the benefit of financial creditors and their customers alike.
Additionally, if market participants increasingly worked within such a protocol, we would see a number of other benefits in Australia. First, there would be a cultural shift towards parties working together collectively to support corporate turnarounds more often. Second, positive turnaround experiences in Australia would increase, with the resulting increased awareness and pool of expertise meaning that more often, turnaround would be tabled as a viable alternative to insolvency options.
Ipso facto clauses
The roundtable participants discussed the potential benefit in Australia of one particular principle enshrined in US bankruptcy laws. This is the principle that ipso facto clauses are not enforceable in bankruptcy. An ipso facto clause is a provision in an agreement that provides a party with rights against the other party if that other party becomes insolvent (for example, to terminate the agreement upon insolvency).
In Australia, the proposal under consultation is that, while a company is attempting to turn itself around, parties are suspended from enforcing rights which are triggered upon insolvency. This suspension broadly equates to the concept of standing still under the London Approach. The roundtable participants noted that such reform would assist to retain going concern value in a company during the restructuring efforts.
Finsia are supportive of encouraging corporate turnarounds in Australia and pursuing reform, particularly in the areas discussed at the roundtable.