Safe harbour protection and the temporary relief from insolvent trading
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On 23 March 2020, the Parliament passed a relief package to mitigate the economic ramifications arising from the Coronavirus outbreak. Included in the relief package is a temporary relief for directors from personal liability for insolvent trading for the next six-month, except for egregiously fraudulent or dishonest activities.
In light of the temporary relaxation of insolvent trading provisions, it is timely to revisit the protections afforded to directors under the Safe Harbour Regime and see how they may help you to weather the storms ahead.
Safe harbour protection for restructuring
Under the Corporations Act, directors owe to creditors a duty to prevent insolvent trading.[i] This means that if a company incurs debts when it was insolvent (i.e. unable to serve its existing debt obligations as and when they fall due), directors could be held personally liable for the unpaid debt so incurred.[ii] While it protects the interest of creditors, this has the undesirable effect of disincentivising directors from engaging in legitimate corporate restructuring, hence may potentially lead to unnecessary business closure.
Safe harbour was introduced in 2017 to address this problem. Under its regime, directors are shielded from insolvent trading offences when they engage in genuine restructuring activities, even if the company still ends up in liquidation.[iii] This allows directors to seek proper advice and attempt to turnaround of their businesses, without the fear of being pursued for doing so in an insolvent trading claim.
To be eligible for safe harbour protection, directors must make sure of the following:
- Financial records in order and compliance with tax obligations
Safe harbour protection would not be available unless the company’s financial records are in order.[iv] This is pivotal because directors cannot be informed about the company’s financial position and devise a viable restructuring plan without adequate books and records.
Moreover, substantial compliance with tax reporting and employee entitlements obligations is also necessary for the application of safe harbour.[v]
- Seek advice from qualified experts
Directors have to then obtain appropriate advice.[vi] While the law does not explicitly prescribe what is required for an adviser to be considered appropriately qualified, it is critical to ensure the advisor that you engage is fit for purpose with regard to the company’s circumstances.
- Develop and implement a restructuring plan
Once directors are properly informed of the company’s financial position and obtained professional advice, a restructuring plan needs to be developed and implemented. A good restructuring plan should clearly outline the steps to be taken to improve the company’s financial health, and is ‘reasonably likely to lead to a better outcome for the company and the company’s creditors than if it had entered into voluntary administration or liquidation’.[vii]
Throughout the whole process it is critical for directors to properly document each step of the way, so that evidence can be adduced to attest their compliance with the statutory requirements for safe harbour protection should the plan fail.
Temporary relief from insolvent trading
The new temporary relief for directors from insolvent trading can be seen as an ad hoc extension of the safe harbour regime. It seeks to encourage companies to continue to trade through the current outbreak, with the prospect of returning to viability once the crisis is over.
Directors seeking to avail themselves of the temporary relief bear the onus to prove that the debt is necessary to facilitate the business to continue trading, such as to retain employees or to move some operations online, during the six-month period starting from 23 March 2020.[viii] As usual, adequate evidence must be maintained so that directors can demonstrate the steps they took to mitigate the risks of insolvent trading.
Apart from new protection, it is important that consideration be given to the existing defences for insolvent trading which might be available. For instance, under ss 1317S and 1318 or the Corporations Act, the Court may grant relief for insolvent trading where a director has acted honestly and ought fairly be excused for their conduct given the circumstances of the case.
Moreover, a director may also be able to utilise the defence under s 588H(4) that they have not participated in the management of a company on the basis of ‘illness or for some other good reason’ arising from the impact of the Covid-19 pandemic.
In a time of great uncertainty, it is crucial to seek expert advice and assistance to navigate the unfolding coronavirus pandemic. The team at Collins Wentworth are experienced in business financial matters. If you have concerns about the financial position of your business and wish to know more about how we can assist you, contact us today.
For details of the Government’s relief package to support businesses, see here.
[i] Section 588G, Corporations Act 2001 (Commonwealth)
[ii] Section 588M, Corporations Act 2001 (Commonwealth)
[iii] Section 588GA, Corporations Act 2001 (Commonwealth)
[iv] Section 588GA(2)(c), Corporations Act 2001 (Commonwealth)
[v] Section 588GA(4)(a), Corporations Act 2001 (Commonwealth)
[vi] Section 588GA(2)(d), Corporations Act 2001 (Commonwealth)
[vii] Section 588GA(1)(a) Corporations Act 2001 (Commonwealth)
[viii] See Temporary relief for financially distressed businesses
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