21 December 2020

Extension of insolvency protections - Impact on company directors

Directors must continue to be mindful of the requirement to comply with their director's duties owed to the company.
Australia Insolvency/Bankruptcy/Re-Structuring
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On 24 September 2020 we published an article about the: "Extension of Insolvency Protections" and the impact the Commonwealth Government's "temporary insolvency and bankruptcy protections" extension to 31 December 2020 has on business and the corporate bodies in Australia.

On 29 September 2020 the Australian Restructuring Insolvency & Turnaround Association issued a Practice Note about the impact of the temporary insolvency relief for directors provided by the Commonwealth Government.

However, an important feature of that "reform" (or "band aid") is that there is no retrospective relief for a director's liability for insolvent trading if the relevant company enters external administration after 31 December 2020.

Whether the Commonwealth Parliament remedies the lack of "retrospective approval" or "protections for directors" the risk, like COVID-19, remains to be seen the question in the vernacular, "how far and what will the Commonwealth Government continue to kick down the road" before allowing the market to correct itself and perhaps prevent viable businesses being suffocated by debts owed by unviable or mortally wounded businesses.

Temporary Relief for Directors

Section 588GAAA of the Act states that section 588G(2) of the Act, which provides that a director has a duty to prevent a company from incurring a debt where:

  • the director is aware at the time, or had reasonable grounds for suspecting, that the company is insolvent; or
  • a reasonable person in a like position in the company in the company's circumstances would be so aware that the company is insolvent,

does not apply if the debt is incurred:

  • in the ordinary course of the company's business; and
  • during;
  • the 6 month period starting on the day that section commenced (being 25 March 2020); or
  • any longer period that starts on the day that section commenced and that is prescribed by the regulations for the purposes of section 588GAAA (which has been extended to 31 December 2020); and
  • before any appointment of an administrator, or liquidator, of the company on or before 31 December 2020.

The impact of section 588GAAA means that for a director to be protected under section 588GAAA, the company must:

  • incur the debt after 25 March 2020 and before 31 December 2020 (unless the Commonwealth Government again extends this date by legislation); and
  • an administrator or liquidator must be appointed to the company before 31 December 2020.

Safe Harbour

Section 588GAAA applies in addition to section 588GA of the Act which creates a "safe harbour" for directors of financially distressed businesses to attempt to turn around a business free from personal liability from insolvent trading under section 588G(2) of the Act.

For section 588GA to apply:

  • after a director "starts to suspect" that a company might become or is insolvent, the director(s) must start developing "one or more courses of action" that are reasonably likely to lead to a better outcome for the company; and
  • the debt, as referred to in section 588G(2) of the Act, must be directly or indirectly incurred in connection with the "one or more courses of action" referred to in above paragraph (a) during the period in which the "development of the one or more courses of action" commences and ending on the earliest of:
  • the director failing to develop "one or more courses of action" within a reasonable period;
  • the director ceasing to take action in accordance with the developed "one or more courses of action";
  • the "courses of action" ceasing to be reasonably likely to lead to a better outcome for the company; or
  • an administrator or liquidator being appointed to the company.

For the "safe harbour" regime to apply and to work out whether a "course of action" is reasonably likely to lead to a better outcome for the company, directors must:

  • properly inform themselves of the company's financial position;
  • take appropriate steps to prevent misconduct by the company's officers and employees that could adversely impact on the company's ability to pay its debts;
  • ensure that the company's books, records and accounts are up to date and in order;
  • obtain advice from an appropriately qualified adviser (which include ARITA Professional Members and Registered Liquidators); or
  • develop or implement a plan for restructuring to improve the company's financial position.

The "safe harbour" regime under section 586GA will not apply if at the time the debt is incurred:

  • the company's employee entitlements, including superannuation, are not paid up to date; and
  • the company is not up to date with its tax reporting obligations to the ATO, including lodgement of tax returns and activity statements required under the Income Tax Assessment Act 1997 (Cth); and
  • the company fails to continue to ensure that it complies with the payment of its employee entitlements and its tax reporting obligations during the development and implementation of the "course of action".

Director's Duties

Despite the extension of insolvency protections referred to above, in our article on 24 September 2020 and the "safe harbour" regime, directors must continue to be mindful of the requirement to comply with their director's duties owed to the company:

  • under section 180 of the Act to exercise their powers and discharge their duties with care and diligence;
  • under section 181 of the Act to act in "good faith";
  • under section 182 of the Act not to use their position to gain advantage for themselves or someone else or cause detriment to the company;
  • under section 183 of the Act to not to improperly use information to gain an advantage for themselves or cause detriment to the company;
  • at common law, such as a duty of care; and
  • in equity, such as fiduciary duties.

Protecting Your Interests

When utilising the temporary insolvency relief and the "safe harbour" regime, it is important that directors minimise risk and personal exposure by ensuring that:

  • the company has a clear, thorough, achievable and forward looking restructuring plan;
  • the company properly and fully documents its "development of" and implementation of the restructuring plan;
  • they comply with their director's duties and obligations;
  • they obtain advice from suitably qualified and experienced professionals in or knowledgeable about the insolvency industry; and
  • they remain up-to-date about the rapidly changing corporate insolvency reforms which are expected to transform some corporate insolvency for small to medium enterprises.

Kott Gunning has an experienced and knowledgeable insolvency team and long established and reliable access to many other insolvency professionals.

We can assist you and your business understand the legal and practical requirements and plan for look to the future now.

We recommend that you act now because the various relief and safe harbours are all conditional, including by time, and it could soon be too late.

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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