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21st January, 2021

In 2017 new laws were passed to allow directors of companies in financial distress to access Safe Harbour protection from personal liability for insolvent trading while implementing a turnaround strategy for their business.

Attempting to salvage a company on the brink of collapse through restructuring efforts is something that is cautiously approached by directors or those acting as shadow directors due to the risk and threat of an insolvent trading liability. This risk is particularly concerning because the ability to determine a company’s solvency at a specific point in time can be difficult, and the uncertainty can cause directors to be overly cautious and may even lead some of them to either resign or place the company into formal insolvency earlier than necessary, thus foregoing the opportunity to potentially salvage a company that could otherwise be saved through the efforts of restructuring.

Ordinarily, pursuant to the insolvent trading provisions in Section 588G(2) of the Corporations Act 2001 (Cth) (“the Act”), company directors will be personally liable for certain debts which are incurred if:

  • They are a director at the time when the company incurs the debt;
  • The company is insolvent at that time, or becomes insolvent by incurring that debt; and
  • At that time, there are reasonable grounds for suspecting that the company is insolvent or would become insolvent.

In an effort to address this issue and potentially mitigate the directors exposure to a personal liability arising from insolvent trading, the Commonwealth Government introduced Section 588GA of the Act in September 2017. The Safe Harbour provisions of Section 588GA of the Act are intended to offer directors a form of “defense” or exception to the insolvent trading provisions of the Act.

To obtain the benefits of the Safe Harbour provisions, directors must be able to demonstrate that the course of action adopted by the company is reasonably likely to lead to a better outcome than the immediate appointment of an administrator or liquidator. Debts incurred ‘directly or indirectly in connection with that course of action’ are excluded from the directors liability for insolvent trading under the Act.

Factors to be considered when relying on Safe Harbour provisions should include the following:

  • That the director has properly informed himself or herself of the company’s current financial situation;
  • The proposed restructuring plan should contain a sufficient level of detail, including measures for the ongoing assessment of the proposed course of action;
  • That the director is developing or implementing a plan of restructuring that will improve the company’s financial situation;
  • That appropriate steps are being taken to ensure that the company is keeping appropriate financial records;
  • Steps should be taken to prevent misconduct by officers and employees of the company;
  • Advice has been sought from a qualified legal / accounting professional.

The protections afforded to directors under Safe Harbour provisions apply until:

  • The directors or the company stop taking the course of action;
  • The course of action stops being reasonably likely to lead to a better outcome; or
  • The company appoints an administrator or liquidator.

Directors should be mindful that they may lose the protection of Safe Harbour should they fail to meet their employee entitlement obligations, fail to meet reporting obligations under Sections 429(2), 475(1), 497(4) or 530(1) of the Act, or fail to provide returns or notices required in relation to the Income Tax Assessment Act 1997 where the failure forms part of two or more in the preceding twelve (12) month period when the debt is incurred.

Directors should be mindful that the protections afforded pursuant to Safe Harbour provisions is only for insolvent trading and does not extend to other duties a director may have to the company, such as those captured under Sections 180 – 184 of the Act.

Safe Harbour and COVID-19

In response to the current global pandemic that is COVID-19 and the devastation and upheaval it is causing to the business sector, the Commonwealth Government made amendments to existing Safe Harbour provisions within the Act in March 2020. The amendments are intended to provide further relief for financially distressed businesses by providing additional Safe Harbour relief from insolvent trading in respect to debts incurred during the six (6) months from March 2020 ‘in the ordinary course of the company’s business’.  This additional temporary relief was due to expire on 25 September 2020, however, it was extended to 31 December 2020. From January 2021 a new simplified insolvency regime for small businesses meeting certain criteria is being introduced.

Should you have any queries regarding the above information or any related matters, please do not hesitate to contact our team via our website Hamilton Murphy or send us an email at [email protected].

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