Australia: What questions are directors asking about the new safe harbour laws?

The new safe harbour against insolvent trading laws have been in place for about 5 months now. Just over a week ago Scott Butler participated in a panel style presentation to members of the Australian Institute of Company Directors on the new laws with Reece Walker, Richard Hughes and Richard Kennerley. The audience consisted of a mix of company directors, lawyers and other restructuring advisers. The questions from the audience gave a good insight into the issues that directors and their advisers are thinking about and so we thought we would share some of those with you.

For those readers who are unfamiliar with the laws, here is a brief summary. The insolvent trading laws say that if a company is insolvent and there are reasonable grounds to suspect the company is insolvent, a director must prevent the company from incurring debts. Subject to some generally difficult to make out defences, if the director doesn't prevent the company incurring debts and they remain unpaid, the director can be held personally liable for the debts by a liquidator or, less commonly, the Australian Securities and Investments Commission. However, the duty to prevent insolvent trading does not apply to a director during a 'safe harbour' period.

The safe harbour will start to apply from the time a director, after beginning to suspect that the company may become insolvent, starts developing one or more courses of action which are reasonably likely to lead to a better outcome for the company than the immediate appointment of an administrator or liquidator.

The safe harbour ends if:

  • a director stops taking the course of action;
  • the course of action stops being reasonably likely to lead to a better outcome for the company; or
  • after starting to develop a course of action, the director fails to take the course of action within a reasonable period after that time.

Very importantly, to access the safe harbour, the company must pay the entitlements of employees by the time they fall due and lodge all tax related documents (i.e. notices, statements, returns, etc.) when due under the tax laws.

Absolute compliance is not required, but unless a court orders otherwise, at the time a debt is incurred, the company must both:

  • be substantially complying with these obligations; and
  • not have failed two or more times to do these things during the 12 month period ending when the debt is incurred.

The majority of questions which were asked related to the obligations to pay employee entitlements and lodge tax documents. The following are the key points about these obligations:

  1. The entitlements of employees must be being paid by the time they fall due – you can't pay all the obligations up to date later on and then claim safe harbour in relation to debts incurred earlier on when the obligations were outstanding.
  2. Only those entitlements which fall due for payment (generally superannuation and wages), need to be paid on time – you don't have to put aside money for leave or other entitlements which have accrued, but are not yet payable.
  3. Other than paying employee entitlements when they fall due, the company does not have to have paid its other tax obligations, such as GST or income tax; it just has to have reported them to the tax office on time.
  4. In our view:
    • substantial compliance means meeting the obligation within a short period of time after the due date. The longer the delay, the greater the chance of not substantially complying;
    • you could never be substantially compliant with the obligations to pay employees their entitlements by not paying them in full (i.e. paying 95% of what is due would not meet the test).
    • The key is to avoid having to justify that you substantially complied and comply with the obligations in full.
  5. If you enter into a repayment arrangement with the tax office and it includes payments for outstanding PAYG or superannuation, that will (in our opinion) mean that you are (in relation to the liabilities the subject of the repayment arrangement) paying those by the time they fall due (if you comply with the repayment arrangement). However, just paying all the entitlements when they fall due (even under a repayment arrangement with the ATO) and ensuring all lodgments are up to date won't automatically allow to you to enter into the safe harbour if you have failed two or more times to do these things during the previous 12 month period (which is likely if you are in a repayment arrangement). Therefore, at most, you can afford one failure to pay entitlements or lodge tax documents when due in within the preceding 12 months.
  6. For the purposes of the requirement to not have two or more 'failures' to comply with these obligations during the 12 month period ending when the debt is incurred, the company will fail to comply with its obligations if it does not meet them strictly – substantial compliance will still mean a failure for the purposes of this requirement. Therefore, in reality, to get the safe harbour when a debt is incurred, the company can only have a single failure to pay or lodge on time during the 12 months prior to incurring the debt and it must have rectified that before it incurs the debt (or have entered into a repayment arrangement with the Australian Taxation Office and be meeting its obligations under it).

The unfortunate fact of the matter is that a lot of companies that get into financial difficulty will fail to meet these strict tests at the time the directors want to avail themselves of the safe harbour.

One director asked whether a director could be held responsible by creditors or members for loss they say they suffered because the director put a company into voluntary administration instead of trying to trade on and restructure under safe harbour protection. In our view, even if the safe harbour was potentially available to a director, a director could never be held personally liable for appointing administrators if the board had reasonably formed the view that the company was insolvent or likely to become insolvent at some future time (which is what the Corporations Act requires for directors to resolve to appoint an administrator). It is important to keep in mind that getting safe harbour protection is not a fait accompli and a director may have to convince a liquidator or even a court that all the various requirements have been met, which involves a level of risk. If a director is not willing to take that risk, and the company is insolvent or likely to become insolvent at some future time, the director should be able to appoint an administrator with confidence.

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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