‘Safe harbour’ laws to protect directors
June 28, 2018
On 19 September 2017, the Corporations Act 2001 (Cth) was amended to introduce ‘safe harbour’ protections for company directors from personal liability for insolvent trading. These amendments are part of a series of amendments to existing laws aimed at reducing insolvencies and increasing innovation and entrepreneurship, including restrictions on ‘ipso facto’ termination rights (which we reported on in our March 2018 edition of Commercial Directions).
This is welcome news for some, but troubling for others. If a director suspects the company to which he / she has been appointed is or is nearly insolvent, the director may attempt to assist the company to trade out of trouble without the fear of being held personally liable for insolvent trading. If a company can trade out of its troubles, this can be great news for:
- Creditors (particularly unsecured creditors) who would have likely lost out in any insolvency
- Employees, who can maintain their employment, and
- The economy in general.
However, the changes have also been greeted with some apprehension. If the director ultimately fails to assist the company to trade out of trouble, including if the company incurs greater debts, its creditors could be left exposed to more substantial losses than if the company had been immediately wound up when the suspicion of insolvency first arose.
Previously, if a director permitted a company to incur a debt while the company was insolvent, and there were reasonable grounds for the director to suspect the company’s insolvency, the director could be personally liable for those debts incurred while the company was trading while insolvent. This meant that as soon as a director became concerned about the solvency of the company to which the director was appointed, he / she could become concerned about their personal liability and elect to commence action to wind up the company in circumstances in which the company may have otherwise been capable of trading out of its temporary financial difficulty.
The new amendments create a ‘carve out’ to the previous position. That is, a director will now not be exposed to personal liability for insolvent trading if the director correctly takes advantage of the ‘safe harbour’ provisions. These provisions will provide protection to a director:
- Who starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the company as soon as the director starts to suspect that the company may become or may be insolvent
- If the debt is incurred directly or indirectly in connection with any such course of action.
One or more courses of action
The amendments allow a director to explore and develop a range of turnaround strategies, without a need to immediately select and pursue a particular strategy.
Reasonably likely to lead to a better outcome for the company
In determining whether a course of action is reasonably likely to lead to a better outcome for the company, regard is to be had to a number of factors such as whether the director is:
- Properly informing him / herself of the company’s financial position
- Taking appropriate steps to prevent misconduct by officers or employees of the company that could adversely affect the company’s ability to pay its debts
- Taking appropriate steps to ensure that the company kept appropriate financial records
- Obtaining advice from an appropriately qualified entity, or
- Developing and implementing a plan for restructuring the company to improve its financial position.
A ‘better outcome’ means an outcome that is better for the company than the immediate appointment of an administrator or liquidator of the company. This means that a director is still likely to be protected if he / she is pursuing an ultimate, later winding up of the company which would provide a better return to creditors than an immediate winding up.
Bars to reliance
A director cannot rely on ‘safe harbour’ if the company is failing to ‘substantially comply’ with its obligations to:
- Pay employee entitlements such as wages, superannuation, injury compensation, leave of absence entitlements and retrenchment payments, when they fall due, or
- Give returns, notices, statements applications or other documents required by taxation laws, such as Business Activity Statements, company tax returns and fringe benefits tax returns.
This does not mean that the company has to pay all of its tax payments; however, the company must be submitting all of its relevant notices and returns.
It’s still too early to tell how effective the changes will be, however the amendments will be reviewed in two years’ time.
Further information / assistance regarding the issues raised in this article is available from the author, Sarah Hammond, Associate or your usual contact at Moray & Agnew.
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