6 months on from the introduction of insolvency law reform, it is time to check in with the provisions and to ensure that directors remain aware of their obligations.
The amendments to the Corporations Act 2001 (Cth) (Act) received royal assent on 18 September 2017 and came into effect on 19 September 2017. The amendments provide a ‘safe harbour’ for directors involved in legitimate business rescue strategies.
The aim of the provisions is to encourage directors to maintain control of their company, to engage early with possible insolvency, and to take reasonable risks and steps to turn around a company’s business, instead of placing the company into voluntary administration or liquidation. The government sees a need to promote a culture of entrepreneurship and innovation, and to shift the focus of insolvency legislation from penalising failures to rewarding successes. Prior to the introduction of the amendments, the legislation discouraged directors from taking reasonable risks to facilitate their company’s recovery, as directors were too concerned about being held personally liable for failing to prevent insolvent trading.
The provisions act as a carve-out from the civil insolvent provisions of the Corporations Act (s588G(2)). Those provisions hold that a director is personally liable for failing to prevent insolvent trading if they were aware at the time (or a reasonable person in a similar position would be aware) that there were grounds for suspecting the company is insolvent or would become insolvent by incurring a debt.
The new safe harbour provision (s588GA) provides protection to a director who, at the time when the debt is incurred, suspects the company may become or may be insolvent, and starts developing one or more courses of action which are reasonably likely to lead to a better outcome for the company than an immediate appointment of administrator or liquidator. The safe harbour also applies to holding company liability for the insolvent trading of a subsidiary, provided that the holding company takes reasonable steps to ensure that the safe harbour is available to the directors of the subsidiary.
The legislation provides guidance on working out whether a course of action is reasonably likely to lead to a better outcome. The Act states that consideration should be given to whether the director:
- is properly informing himself or herself of the company’s financial position; or
- is taking appropriate steps to prevent any misconduct by officers or employees of the company that could adversely affect the company’s ability to pay all its debts; or
- is taking appropriate steps to ensure that the company is keeping appropriate financial records; or
- is obtaining appropriate advice; or
- is developing or implementing a plan for restructuring the company to improve its financial position.
This is not an exhaustive list, and there will likely be other relevant considerations depending on the circumstances.
A ‘better outcome’ could take into consideration:
- the effect on the company’s creditors;
- the ongoing employment of staff;
- the flow-on effect to suppliers and customers;
- the public interest; and
- the effect on other related entities and stakeholders.
What qualifies as ‘appropriate advice’ has yet to be tested in the courts. It is highly likely that unqualified pre-insolvency advisers who promote illegal phoenix activity will continue to position themselves as appropriately qualified advisers for the purposes of the safe harbour provisions, taking advantage of companies in difficulty. Caution needs to be exercised by directors to ensure that legitimate advice is being obtained in order to rely on the safe harbour provisions and to avoid personal liability. When choosing an adviser, directors should give consideration to the following factors:
- the nature, size, complexity, and financial position of the company (smaller companies may be able to rely on a team of 1 accountant and 1 lawyer, while larger companies will likely need larger teams made up of more specialist advisers);
- the adviser’s independence, professional qualifications, good standing, and membership of appropriate professional bodies (such as ARITA, CPA, TMA, CAANZ, etc);
- the adviser’s experience;
- whether the adviser adheres to a code of conduct;
- the adviser’s reputation and trustworthiness; and
- whether the adviser has an appropriate level of professional indemnity insurance.
In order for the safe harbour to apply, directors must continually assess whether the course of action taken is still reasonably likely to lead to a better outcome, and adjust the course of action appropriately. If no course of action is reasonably likely to lead to a better outcome, directors must place the company into voluntary administration, or take steps to wind up the company. Directors must also continually assess their own and the company’s compliance with all other obligations in order for the safe harbour protections to continue to apply. The safe harbour is not available where a company is not meeting its employee entitlement or tax reporting obligations.
Safe harbour will only apply to debts incurred:
- directly or indirectly in connection with developing or taking the course of action,
- during the period commencing when the course of action is first taken and ending the earliest of:
- the end of a reasonable period after a director starts to suspect company’s insolvency if director fails to take required course of action within that period; or
- when the course of action ends; or
- when the course of action ceases to be reasonably likely to lead to a better outcome; or
- when the company enters into administration/liquidation.
Directors wanting to rely on the safe harbour need to point to evidence suggesting the reasonable possibility that they took a course of action that was reasonably likely to lead to a better outcome for the company.
In satisfying the evidential burden, directors will be prevented from using the company books and information as evidence of a reasonable course of action if they previously failed to provide those items to the administrator/liquidator on request.
In conclusion, directors need to ensure they can identify the early warning signs of insolvency, engage early with an appropriately qualified adviser to develop and implement a restructuring plan, continually monitor effectiveness of the implementation of the plan and compliance with their and the company’s obligations, and take action immediately to protect themselves if the plan fails.
The safe harbour provisions are set to be independently reviewed in September 2019 to determine their effectiveness.
Please contact Steven Morris or Jennifer Ingrey of our office if you need any advice in relation to anything set out in this article.