On 19 September 2017, new legislation came into force providing "safe harbour" protection for company directors against insolvent trading claims while they develop and implement plans to restructure the company.
The Corporations Act 2001 (Cth) prohibits company directors from engaging in insolvent trading.
A director can be liable for debts incurred by the company while it is insolvent, or if incurring the debt makes the company insolvent. The liability arises when the company is placed into liquidation and is brought against the director by the liquidator.
Despite this, the new "safe harbour" legislation allows directors to attempt a restructure of the company without the threat of personal liability for insolvent trading.
The new law seeks to encourage directors, when they know or suspect that the company is insolvent, to take action that is reasonably likely to lead to a better outcome than formal insolvency.
The insolvent trading laws have been criticised as unnecessarily harsh and a disincentive to entrepreneurship and innovation.
Many believe directors have been placing companies into voluntary administration or liquidation in order to avoid personal liability in circumstances where the company may have been viable in the longer term.
The aim of the safe harbour provisions is to give directors space to consider other strategies and to take reasonable risks without the threat of personal liability.
Entering the safe harbour
A director enters the safe harbour when he or she:
- suspects the company may be insolvent
- starts developing, and within a reasonable time puts into effect, a course of action that is reasonably likely to lead to a better outcome for the company (explained further below).
Directors must develop a course of action. Hope is not a course of action.
A director may not enter the safe harbour if the company has not:
- paid its employee entitlements, including superannuation by the time they fell due1
- provided its returns, notices, statements, applications or other documents to the ATO more than once during the 12 month period prior to a debt being incurred from which the director seeks the protection of the safe harbour.
When faced with an insolvent trading claim by a liquidator, directors must be able to demonstrate they have met the legislative requirements for entry into the safe harbour. That means showing:
- employee entitlements were paid when due
- tax reporting obligations have been met
- they have developed a course of action which is reasonably likely to lead to a better outcome for the company
In addition, the director should also keep clear and concise documentation showing:
- the company's financial position at the time the insolvency was suspected
- the likely outcome if the company was placed into formal insolvency (to show that the course of action undertaken was reasonably likely to result in a better outcome)
- advice on the restructure plan from a qualified advisor such as an accountant or lawyer and their opinion as to the prospects of the restructure achieving a better outcome; and
- strategies implemented to measure the turnaround (including the creation of turnaround committees and alternative plans).
What is a reasonably likely better outcome for the company?
A 'better outcome' is defined under the Corporations Act 2001 (Cth) as an outcome better than the immediate appointment of a liquidator or administrator.
The course of action must be reasonably likely to lead to a better outcome. In determining whether this condition has been met, regard will be had as to whether the director:
- stays informed about the company's financial position
- takes appropriate steps to prevent misconduct by company officers and employees that could adversely affect the company's ability to pay its debts
- takes appropriate steps to ensure the company is keeping appropriate financial records
- is obtaining advice from an appropriately qualified adviser
- is developing or implementing a plan for restructuring the company to improve its financial position.
Obviously, any director seeking the protection of the safe harbour should take all these steps.
The course of action must also be reasonably likely to lead to a better outcome for the company.
But a company has many stakeholders whose interests may vary. The interests of a secured creditor, for example, may be different to those of an unsecured creditor. The interests of an employee may be different to those of an unsecured trade creditor.
We will have to wait for guidance from the Court on what constitutes a 'better outcome for the company'. Until then, it is arguable that an outcome is better for the company if it improves the position of any stakeholders of the company, be they shareholders, creditors (unsecured or secured) or employees.
It may also be argued that any course of action that cures or ameliorates a company's insolvency is, almost by definition, better for all stakeholders.
Departing the safe harbour
A director will depart the 'safe harbour' when:
- the course of action is developed but not acted upon in a reasonable time
- the director stops taking the course of action
- the course of action stops being reasonably likely to achieve a better outcome
- a liquidator or administrator is appointed over the company.
Appropriately qualified advisors
In our view, it is essential that a director seeking the protection of the safe harbour obtain advice from an appropriately qualified source.
This may be the company's lawyer or accountant or a specialist restructuring accountant. Their appropriateness will depend on the size, nature and complexity of the company's affairs.
We will need guidance from the Courts before we have more clarity about who qualifies as an 'appropriately qualified person' under the legislation.
The safe harbour laws remove the threat of personal liability for insolvent trading against a director who develops and implements a course of action that is reasonably likely to produce a better outcome for the company than liquidation or voluntary administration.
The onus lies with the director to document and be able to produce evidence of the steps taken.
It is yet to be seen how the Courts will interpret the new legislation. However, it is clear that the aim is to encourage directors to be innovative when facing insolvent trading.
Given the compliance issues involved in entering the safe harbour (that is, paying employee entitlements and lodging ATO compliance documents in the 12 months before the debt was incurred), and the steps required to plan, document and implement the restructure plan, the protections may not be available to smaller, less well-resourced companies.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.