1 January 2021 was an important day for Australian company directors. Whilst it symbolised the dawning of a much-needed change in calendar year to spell the end to a very long nine months (at least for those who aren’t presently enjoying the fruits of the dizzying highs of the dual property and resources booms).
It also rather quietly, and to limited fanfare, saw the unwinding of a number of temporary COVID-19 protections provided by March 2020’s Coronavirus Economic Response Package Omnibus Act 2020 (Cth) which had provided an increase to the statutory demand limits and response timelines ($2,000 and 21 days temporarily increased to $20,000 and six months) and temporary protection from personal liability for insolvent trading. Now with Easter 2021 in the rearview, the various other COVID-19 relief measures (JobKeeper, commercial and residential tenancy relief measures, etc.) have also ended.
So whilst we all consider our post-chocolate binge exercise regimen to get our physical health a much needed tune-up, directors of Australian companies whose entities may be sailing close to the winds of insolvency would be well advised to undertake a similar health check on their financial position given the potential personal consequences for trading insolvent.
Consequences of getting it wrong: Personal liability for insolvent trading
Directors of Australian companies have a number of fiduciary duties under the Corporations Act 2001 (Cth) including to act with care and due diligence, in good faith, to not improperly use their position, etc. They also have a duty to prevent their company from trading if it is insolvent.
A company is insolvent if it is unable to pay its debts as and when they fall due. Before directors incur a new debt, they must consider whether they have reasonable grounds to suspect their company is insolvent or will become insolvent as a result of incurring the debt. This doesn’t allow directors to plead ignorance with reckless abandon and there is an overlap between the general fiduciary duties and this more specific insolvent trading duty.
There are various penalties and consequences for directors who are found to have engaged in insolvent trading of their company, including civil penalties (of up to $200,000), compensation proceedings (to repay the detriment caused during the period of insolvent trading) and even criminal charges (which may range from director disqualification to even imprisonment).
In reality, very few insolvent trading actions ever see a courtroom given they are notoriously costly to establish and litigate and there are a series of well-established defences available to directors. Notwithstanding, given the rise of litigation funding in Australia in recent years, it is foreseeable there will be an increase in insolvent trading actions in the near future as funds seek to deploy their capital more freely. Accordingly, good governance should include consideration of preventative measures companies and directors can take to protect themselves.
Safe Harbour protection
Back in September 2017, the Federal Government introduced a regime which aimed to reduce the number of formal insolvency appointments by encouraging directors to continue to trade their financially distressed businesses through difficult periods without fear of personal liability for insolvent trading.
The safe harbour relief provision established by section 588GA of the Corporations Act 2001 (Cth) applies during a period which begins when the directors, having already formed a suspicion that the company is or may become insolvent, engage an appropriately qualified person to assist them with developing one or more courses of action – one at least of which is reasonably likely to lead to a better outcome for the company than going immediately into external administration.
In order for directors to access safe harbour relief there are also some fairly simple eligibility criteria that need to be met, including:
- requirements for the entity to have maintained its books and records to a level which enables its directors to properly understand the company’s financial position;
- the company must have paid all employee entitlements that are due and payable at that time (generally wages and superannuation); and
- the company must also be up to date with its tax reporting obligations, lodging all returns that are due for lodgement (the associated taxes do not need to have been paid).
Once the eligibility criteria have been met and the board of directors have resolved to appoint the appropriately qualified person to confirm their eligibility and assist them through the restructuring process, the board can prepare (or often present, having already largely formulated) its turnaround plan. The safe harbour adviser will then effectively sanction the plan to the effect that it meets the “better outcome” threshold. The plan is then closely monitored during the workout period via a process of regular communication (often via a separate newly formed safe harbour committee), with regular review of continuing eligibility and review of continuing appropriateness of plan in circumstances where certain criteria have been met or become incapable of being met.
Given the confidential nature of safe harbour appointments, it is difficult to assess the full extent of safe harbour uptake in the Australian market since 2017; however, at Pitcher Partners we’ve seen a steady increase of both enquiry and engagement since safe harbour came into force and anecdotally, so have our fellow insolvency practitioners.
The reasons for this increase in uptake seem to be pretty clear: safe harbour can be flexible, relatively low cost, allows the directors to remain in control of their business and can provide the necessary time to work through issues with stakeholders. Further, the introduction of a safe harbour advisor into the negotiation mix can often provide the necessary new voice to break an impasse between the company and its key stakeholders.
For more information about the safe harbour process and other safeguards that can be deployed during periods of financial distress, please do not hesitate to contact the Pitcher Partners team.