Think HBR

Safe harbour and directors’ liability for insolvent trading

Sam Roberts
Roberts Legal
On 19 September 2017 amendments, to the Corporations Act 2001 commenced which create a “safe harbour” for Directors to protect them from personal liability for debts incurred by an insolvent company in certain circumstances.
Why the need for safe harbour
Prior to the amendments, the provisions of the Corporations Act governing corporate insolvency focused on the need for Directors to appoint Voluntary Administrators of a company if they suspected that the company was insolvent in order to avoid the risk of the Director being found personally liable for debts that the company incurred whilst it was trading insolvently. The appointment of a Voluntary Administrator is frequently followed by the appointment of a Liquidator and results in the total loss of any goodwill of the business of a company and the fire sale of assets and little or no recovery of debts for unsecured creditors.
The purpose of the safe harbour provisions is to encourage a culture of restructuring in Australia by offering protection to Directors who are proactively taking steps to achieve a better outcome for the company than the outcome likely to flow from the immediate appointment of an Administrator or Liquidator.
Insolvent trading & directors’ personal liability
Under Sections 588G(2) and 588M of the Corporations Act, a Director of a company to whom the safe harbour provisions do not apply is personally liable for loss or damage that a creditor suffers in relation to a debt where:
1. The company was insolvent at that time the debt was incurred, or became insolvent by incurring the debt
2. There were reasonable grounds for suspecting that the company was insolvent or would so become insolvent
3. The Director was aware at that time that there were such grounds for so suspecting, or a reasonable person in a like position would be so aware
When is a company insolvent
Generally, the test for determining whether a company is insolvent is whether the company is able to meet its debts as and when they fall due.
What is “Safe Harbour”?
A Director will be safe harboured from the provisions of Section 588G(2) of the Corporations Act if:
1. At a particular time after the Director starts to suspect the company may become or be insolvent, the Director starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the company, and
2. The debt is incurred directly or indirectly in connection with any such course of action during the safe harbour period.
As safe harbour may, however, apply from the time that a Director suspects that a company is or may become insolvent, it is recommended that Directors act promptly to ensure the safe harbour applies as soon as they have any concerns about the company’s ability to pay its debts as and when they fall due.
What is a better outcome?
“Better outcome” for the company, means an outcome that is better for the company than the immediate appointment of an Administrator, or Liquidator, of the company.
The early evaluation of the company’s financial position and an assessment of the likely outcome of the Administration or Liquidation of the company are essential for maintaining safe harbour protection and assessing whether proposed courses of action are reasonably likely to lead to a better outcome.
What is restructuring?
Restructuring is a corporate management term for action taken to reorganise or change operations, structures or financial accommodation of a company for the purpose of making it more profitable, better organised for its present needs or the elimination of financial harm.
Conditions for Safe Harbour Protection
A Director will not be eligible for safe harbour protection in relation to a debt if, when the debt is incurred, the company is failing to:
1. Pay the entitlements of its employees (including superannuation), by the time they fall due, or
2. Meet its taxation law reporting requirements, and such failure amounts to less than substantial compliance with the relevant matter or is one of two or more such failures by the company during the 12 month period prior to the debt being incurred
Period of safe harbour protection
The safe harbour protections will, subject to the above conditions, commence when a Director who has begun to suspect that the company may become or be insolvent starts developing a course of action that is reasonably likely to lead to a better outcome for the company and will continue thereafter until the earlier of the following times:
1. If the Director fails to take any such course of action within a reasonable period after that time – the end of that reasonable period,
2. When the Director ceases to take any such course of action,
3. When any such course of action ceases to be reasonably likely to lead to a better outcome for the company, and
4. The date of appointment of an Administrator, or Liquidator, of the company.
Appropriately qualified advisors
The obtaining of advice from an appropriately qualified entity is one of the circumstances that the courts may consider in working out whether a course of action is reasonably likely to lead to a better outcome for the company. There is, however, no definition of ‘appropriately qualified entity’ in the Corporations Act.
An appropriately qualified entity would conceivably include:
• A business accountant
• An insolvency lawyer
• An insolvency practitioner
• A turnaround management specialist
• Other business advisors.
Implications for accountants, lawyers and other advisors
Accountants, lawyers and other advisors who have an ongoing retainer or relationship with a company and its Directors need to be wary that their common law duty of care owed to Directors now extends to advising Directors in relation to:
• the available safe harbour laws, and
• the need to promptly develop and implement a Restructuring Plan if the Director suspects insolvency. Where insolvency is suspected, advisors would also be expected to act promptly to assist Directors to invoke the safe harbour protections and to develop and implement a Restructuring Plan within a reasonable time.
From a litigator’s perspective, advisors who are not familiar with safe harbour protections, and/or who fail to provide Directors of companies with appropriate advice at the earliest possible time face the risk of actions for professional negligence by Directors against whom a claim for insolvent trading might subsequently be brought by a Liquidator of the company. Significantly, as the requirements for invoking safe harbour are relatively low, it is likely that in most cases Directors might have been easily able to invoke safe harbour protections had appropriate advices been given and that, therefore, the risk for advisors who fail to give appropriate advice is significant.
In order to assist accountants, general practitioners and other business advisors to provide appropriate early advice to Directors, Roberts Legal have developed a short Information Sheet: ‘Safe Harbour, What Directors who suspect Insolvency should do’ and sample Safe Harbour Resolution available on request, which we recommend be provided to Director clients promptly if there is any reason to suspect that the company is or may become insolvent.
IMPORTANT DISCLAIMER: This article is intended to provide comment and information of a general nature only and is not legal advice. Whilst the information was accurate on the day of publication the law may have changed since that date.
Roberts Legal is not responsible for any actions taken or not taken on the basis of this information. You should obtain specific legal advice on any matters of interest or concern arising from this content.
Sam Roberts Sam Roberts
is the founder and Managing Director of Roberts Legal. He is 1 of only 4 Accredited Specialists in Commercial Litigation in the Newcastle, Hunter Valley and Central Coast regions having acquired his accreditation in the area of Building & Construction Law. He is the author of Roberts Legal’s popular Security of Payment Guide and a member of the HIA.