The Federal Government has passed safe harbour laws which allow directors of struggling companies to pursue restructuring efforts without fear of liability for insolvent trading.
Prior to 18 September 2017, Australia’s insolvency laws resulted in directors incurring personal liability for debts incurred when their company traded while insolvent. Section 588G of the Corporations Act 2001 (Cth) imposed a duty upon a director to prevent a company from engaging in insolvent trading where:
- He or she was a director of the company at the time the company incurred the debt;
- The company was insolvent at the time (or became insolvent by incurring that debt, or by incurring at that time debts including that debt); and
- At the time there were reasonable grounds for suspecting that the company was insolvent or would become insolvent.
Section 588G was intended to discourage directors from allowing companies to incur debts which the company would be unable to repay. However, it has also had the effect of encouraging directors to prematurely engage their company in the formal insolvency process, even in circumstances where the company could have been viable in the long term.
The Current Position
On 18 September 2017, new sections 588GA and 588GB were incorporated in the Corporations Act 2001 (“Safe Harbour Provisions”). Under the Safe Harbour Provisions, a director will not be personally liable for debts incurred by the company while the company was insolvent, where it can be shown that:
- The director started developing one or more Courses of Action (“Course of Action”) that were reasonably likely to lead to a “better outcome” for the company; and
- The debts were incurred directly or indirectly in connection with the Course of Action.
The Safe Harbour Provisions
- Defines a “better outcome” for the company as an outcome that is better than the immediate appointment of an administrator or liquidator of the company; and
- Provides a non-exhaustive guide as to what may be taken into account in determining whether a Course of Action is reasonably likely to lead to a better outcome for a company.
The guidelines include the following:
- Whether a director properly informs him or herself of the company’s financial position;
- Whether a director take appropriate steps to prevent any misconduct by officers or employees that could adversely affect the company’s ability to pay all its debts;
- Whether a director take appropriate steps to ensure that the company is keeping appropriate financial records consistent with the size and nature of the company;
- Whether a director obtains advice from an appropriately qualified entity (e.g. an insolvency practitioner) who has sufficient information to give such advice; or
- Whether a director develops or implements a plan for restructuring the company to improve its financial position.
A failure to do any of the above things will run the risk of the Safe Harbour Provisions becoming unavailable. However, the likely practical outcome of any proposed actions will still need to be assessed, and whether that assessment is likely to paramount.
The Safe Harbour Provisions will apply from the time the director starts developing a Course of Action until the earlier of the following:
- If the director fails to implement a Course of Action within a reasonable period;
- The director ceases to take a Course of Action;
- The Course of Action ceases to be reasonably likely to lead to a better outcome for the company; or
- The company appoints an administrator or liquidator.
The Safe harbour Provisions do not define “reasonable period”. It is likely to be assessed on a case by case basis having regard to the nature, size, complexity and financial position of the company and the Course of Action developed.
For more information, contact Rockliffs.