NEWSLETTER | November 2017

Safe Harbour for Directors : Murky Waters Ahead

The Corporations Act 2001 (“the Act”) imposes a duty on company directors to prevent a company from trading whilst insolvent and can impose a civil penalty on a director for debts incurred by the company if, at the time the debt is incurred, there are reasonable grounds to suspect the company is insolvent.

Amendments to the Act in relation to the insolvent trading regime received Royal Assent on 18 September 2017 which provide a safe harbour from the civil insolvent trading provisions of section 588G(2) of the Act. These amendments commenced the day after the Amending Act received Royal Assent, i.e. 19 September 2017.

These amendments have been met with much fanfare. However, with reform comes significant detail which can be often overlooked. So what is the ‘Safe Harbour’ and how does it affect directors?

Simply, the safe harbour provisions will protect directors from liability for debts incurred by an insolvent company if they develop and take a course of action that is reasonably likely to lead to a better outcome for the company than the immediate appointment of an administrator or liquidator and the debt was incurred directly or indirectly in connection with the course of action.

The safe harbour provisions are also available to holding companies.

Whilst on the surface the safe harbour provisions appear to achieve the policy objective of avoiding the value destruction of a company through its premature administration or liquidation, when assessing the finer details of the amendments, the reform may not be as appealing as first thought. Directors should be aware that:

  • The safe harbour does not extend beyond the civil liability provisions of section 588G(2) of the Act. During the safe harbour, directors must continue to comply with all their other legal obligations such as their director’s duties.
  • A company must still comply with any continuous disclosure obligations under the law, including section 674 of the Act, or any continuous disclosure rules imposed by a market operator.
  • The safe harbour protection only applies to debts “incurred directly or indirectly in connection with” developing and taking a course of action that is reasonably likely to lead to a better outcome. While this would include ordinary trade debts incurred in the usual course of business and paying a professional turnaround advisor to provide advice on the course of action it would not include debts incurred where they are not for a proper purpose.
  • They will not be able to rely on the safe harbour in circumstances where the company is not meeting its obligation to pay its employees (including superannuation) and its taxation reporting obligations. From our experience this condition will exclude from the safe harbour most small to medium sized enterprises which are facing financial difficulties. Although payment of taxation obligations are not required to rely on the safe harbour, the safe harbour provisions may result in the Australian Taxation Office receiving priority treatment over other ordinary unsecured creditors.
  • Taking merely a passive approach to the business’s position, allowing a company to continue trading as usual during severe financial difficulty, or having a recovery plan which is in hindsight fanciful will fall outside the bounds of the safe harbour.
  • The safe harbour will only apply to a director who complies with certain statutory obligations during a subsequent formal insolvency appointment such as completing a Report as to Affairs and providing books and records.
  • The safe harbour imposes an evidential burden on directors and holding companies to produce evidence that suggests a reasonable possibility they have been acting under the safe harbour.
  • A director failing to provide an administrator or liquidator, following a safe harbour period, with access to the company’s books or secondary evidence following an appropriate request will be prevented from using those materials as evidence that they complied with the requirements of the safe habour provisions.
  • Safe harbour will not prevent the appointment of an administrator, liquidator or receiver by a third party such as a secured creditor.

To work out whether a course of action is reasonably likely to lead to a better outcome, as enshrined in the new subsection 588GA(2), regard may be had to whether the person:

  1. is properly informing himself or herself of the company’s financial position; or
  2. is taking appropriate steps to prevent any misconduct by officers or employees of the company that could adversely affect the company’s ability to pay all its debts; or
  3. is taking appropriate steps to ensure that the company is keeping appropriate financial records consistent with the size and nature of the company; or
  4.  is obtaining advice from an appropriately qualified entity who was given sufficient information to give appropriate advice; or
  5. is developing or implementing a plan for restructuring the company to improve its financial position.

While the above factors provide some guidance to directors, caution needs to be taken as the safe harbour is new legislation and there may not be any judicial guidance for some time, including on:

  1. what is considered appropriate steps;
  2. what is an appropriately qualified entity; and
  3. ultimately, what constitutes a better outcome.

The Explanatory Memorandum on the safe harbour provisions provides some commentary on factors to consider when determining whether the advisor is appropriate in the context and lists the following factors which a director should have regard to:

  1. the nature, size, complexity and financial position of the business to be restructured;
  2. the adviser’s independence, professional qualifications, good standing and membership of appropriate professional bodies;
  3. the adviser’s experience; and
  4. whether the adviser has adequate levels of professional indemnity insurance to cover the advice being given.

In our opinion, appointing a registered insolvency practitioner will give a director certainty that he or she has appointed an appropriately qualified entity to advise on the course of action to be taken and whether it will result in a better outcome for the company.

It is imperative that if a director or his or her advisor is questioning the immediate solvency of the company, the decision to continue trading should not be taken lightly. Where the company’s longer-term solvency is uncertain continued trading should not be done without a well-considered and documented plan in place.

Irrespective of the reform, our advice to directors is to act early and to seek professional advice to maximise the chance of any turnaround and/or mitigate the risk of personal liability.

To find out more about The Safe Harbour amendments in the Act please do not hesitate to contact either Anthony, Ron or Cameron.