Australia: Proposed insolvent trading safe harbour – a new life raft for companies struggling to stay afloat?

HG Corporate Advisory Alert: 1 July 2015
Last Updated: 7 July 2015
Article by Nicole Radice

The Productivity Commission has recommended that the insolvent trading provisions in the Corporations Act 2001 (Cth) be amended to include a 'safe harbour' for directors in certain circumstances.

The proposal aims to encourage directors to explore restructuring options and to avoid prematurely plunging companies into voluntary administration.

If adopted, the amendments could prove to be a useful measure in assisting companies to stay afloat in what is a less than buoyant market.

In this alert, Partner Nicole Radice and Solicitor Shilpa Dougall briefly explain the proposed changes set out in the Productivity Commission's draft report and examine the potential utility of the safe harbour by directors should the recommendations become law.

Current state of the law and the proposed 'safe harbour'

Section 588G of the Corporations Act imposes upon directors a duty to prevent insolvent trading by a company. The section exposes directors to potential civil penalties, compensation orders and criminal charges if they incur any further debt, if the entity is insolvent at the time of incurring debt or becomes insolvent as a consequence of incurring the debt.

In its Draft Report on Business Set-up, Transfer and Closure, released on 22 May 2015, the Productivity Commission acknowledges that this threat of directors' personal liability, together with uncertainty as to when a company actually becomes insolvent, is encouraging a culture of risk aversion amongst directors with the consequence that directors are forcing entities into voluntary administration when that entity may, in fact, only be experiencing temporary financial difficulties.

The Productivity Commission has recommended an amendment to section 588G to militate against this. The proposal is to allow companies and their directors to explore restructuring options without liability for insolvent trading. During such a period, the directors would retain control of the company, but receive independent advice from registered advisers. The key aspects of the proposal are as follows:

  • Advisers appointed in 'safe harbour' would be disqualified to act as administrators, receivers or liquidators in any subsequent insolvency process for the company;
  • The company would be required to inform ASIC and the ASX (if applicable), of the appointment of an adviser;
  • In informing themselves and the adviser, and determining whether to act on any restructuring advice, directors would be under a duty to exercise their business judgment in the best interests of the company's creditors as a whole, as well as the company's members; and
  • If the positive thresholds above are met (and evidenced), a director's duty not to trade while insolvent would be considered to be satisfied during the period of advice and for actions directly related to implementing the restructuring advice (which itself may limit the benefit of the 'safe harbour').

According to the Productivity Commission, such a model would allow directors the opportunity to undertake a rational decision making process free from fear of liability, without fundamentally altering the balance within the law, and still protecting the company and creditors from reckless action when a company is already in financial difficulty.

What could the amendment mean for struggling companies?

Legislators and regulators are increasingly recognising the challenges faced by companies, small and large, arising from current market conditions.

The proposed safe harbour to the insolvent trading provisions, when considered with other key regulatory changes, may mean that directors have more tools at their disposal in order to keep their companies afloat in testing times.

For example, late last year the ASX made critical changes to the '20 cent rule.' Broadly speaking, those changes (which are of particular significance to companies undertaking a backdoor listing) enable an issue or sale price to be as low as 2 cents on the basis that certain conditions are met, including obtaining shareholder and ASX approval. For further details in this regard, please see our previous alert.

Backdoor listings are an increasingly attractive option for companies in the present market. The proposed safe harbour when, for example, used in conjunction with the changes to the '20 cent rule' could potentially enable directors to pursue such opportunities with more freedom and fewer reservations. These entities may also become more attractive if there is a 'work-out' solution available.

The Productivity Commission is recommending that legislators throw struggling companies a life raft to weather the storm. However, don't jump just yet - the report is in draft form and the Productivity Commission is calling for comment.

© HopgoodGanim Lawyers

Award-winning law firm HopgoodGanim offers commercially-focused advice, coupled with reliable and responsive service, to clients throughout Australia and across international borders.

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.

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Nicole Radice
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