By Hotchkin Hanly Lawyers and Law Central Legal

Is your company unable to pay its debts? Before you commence a formal insolvency process, consider whether there’s a better outcome for the company - the Federal Government has passed safe harbour laws which will allow directors of a struggling company to pursue restructuring efforts without fear of liability for insolvent trading. 

The Past Position

Prior to 18 September 2017, Australia’s insolvency laws resulted in directors incurring personal liability for debts incurred when their company traded while insolvent.  Section 588G of the Corporations Act 2001 imposed a duty upon a director to prevent a company from engaging in insolvent trading where:

• he or she was a director of the company at the time the company incurred the debt;

• the company was insolvent at that time (or became insolvent by incurring that debt, or by incurring at that time debts including that debt); and

• at that time, there were reasonable grounds for suspecting that the company was insolvent or would become insolvent.

Section 588G was intended to discourage directors from allowing companies to incur debts which they would be unable to repay.  However, it also had the effect of encouraging directors to prematurely engage their company in the formal insolvency process, even in circumstances where the company could have been viable in the long term.

The Current Position

On 18 September 2017, new sections 588GA and 588GB were incorporated into the Corporations Act 2001 (“Safe Harbour Provisions”).  Under the Safe Harbour Provisions, a director will not be personally liable for debts incurred by the company while the company was insolvent, where it can be shown that:

• the director started developing one or more courses of action (“Course of Action”) that were reasonably likely to lead to a “better outcome” for the company; and

• the debts were incurred directly or indirectly in connection with the Course of Action.

The Safe Harbour Provisions:

• defines a “better outcome” for the company as an outcome that is better than the immediate appointment of an administrator or liquidator of the company; and

• provides a non-exhaustive guide on what may be taken into account in determining whether a Course of Action is reasonably likely to lead to a better outcome for a company.

The above guide includes the following:

• whether a director properly informs himself or herself of the company’s financial position;

• whether a director takes appropriate steps to prevent any misconduct by officers or employees that could adversely affect the company’s ability to pay all its debts;

• whether a director takes appropriate steps to ensure that the company is keeping appropriate financial records consistent with the size and nature of the company;

• whether a director obtains advice from an appropriately qualified entity (e.g. an insolvency practitioner) who was given sufficient information to give such advice; or

• whether a director develops or implements a plan for restructuring the company to improve its financial position.

In our view, a failure to do any of these things will run the risk of the Safe Harbour becoming unavailable.  However, the likely practical outcome of any proposed actions will still need to be assessed, and that assessment is likely to be paramount.

When does the Safe Harbour Provisions Apply?

The Safe Harbour Provisions will apply from the time the director starts developing a Course of Action until the earlier of the following:

• if the director fails to implement a Course of Action within a reasonable period;

• the director ceases to take a Course of Action;

• the Course of Action ceases to be reasonably likely to lead to a better outcome for the company; or

• the company appoints an administrator or liquidator.

The Safe Harbour Provisions do not define “reasonable period”.  It is likely to be assessed on as case by case basis having regard to the nature, size, complexity and financial position of the company and Course of Action developed.

Gold and Platinum readers should read on for circumstances where the Safe Harbour Provisions do not apply and a discussion about the new law relating to ipso facto clauses which comes into force on 1 July 2018

Conclusion

It will be interesting to see how the Safe Harbour Provisions operate in practice.  It is hoped that they will drive cultural change amongst directors by encouraging them to:

• keep control of their company;

• engage early with possible insolvency; and

• take reasonable risks to facilitate the company’s recovery,

instead of simply placing the company prematurely into voluntary administration or liquidation.

This article is written by Xian-Li Davies, Andrew Throssell and John Wojtowicz.

Xian-Li Davies is a lawyer with the law practice, Hotchkin Hanly Lawyers. Email: xdavies@hotchkinhanly.com.au or telephone 08 9218 7700.

Andrew Throssell is Partner with the law practice, Hotchkin Hanly Lawyers. Email: athrossell@hotchkinhanly.com.au or telephone 08 9218 7700.

John Wojtowicz is the Managing Principal of the law practice, Law Central Legal. Email: john.wojtowicz@lawcentrallegal.com.au or telephone 08 9476 4999.

Disclaimer: The content of this Bulletin is general information only. It is not legal advice. The statements and opinions are the expression of the author, not Law Central, and have not been checked for their accuracy, completeness or changes in the law. Law Central recommends you seek professional advice before taking any action based on the content of this Bulletin.

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