One of the fundamental duties of directors is to ensure a company does not trade while insolvent. During this COVID-19 period, directors may find themselves at risk of breaching this duty while at the helm of financially stressed businesses. The Corporations Act provides two ‘safe harbour’ mechanisms to protect directors from this liability.
COVID-19 Safe Harbour Provisions – March 2020
On 23 March 2020, Parliament passed amendments to the Corporations Act comprising a six-month moratorium on insolvent trading liability of directors where a debt is incurred by a company:
- in the ordinary course of the company’s business;
- during the 6-month period from 24 March 2020; and
- before the appointment of an administrator or liquidator of the company.
The Explanatory Memorandum for the amending Act says that a director “is taken to incur a debt in the ordinary course of business if it is necessary to facilitate the continuation of the business during the six month period … this could include, for example, a director taking out a loan to move some business operations online. It could also include debts incurred through continuing to pay employees during the Coronavirus pandemic”. This would appear to expand the usual meaning of ‘the ordinary course of business.’
These measures will provide temporary reprieve for directors, particularly where businesses can recover quickly and move back to solvency. However, where recovery of the business is slow, or the impacts of COVID-19 continue beyond six months, this safe harbour will not provide enough protection for directors at risk of liability for future insolvent trading. In this event, businesses should begin to prepare a detailed plan for recovery in line with the 2017 safe harbour requirements below rather than simply ‘hibernating’ for the six-month period and hoping to then return to solvent trading.
Safe Harbour Provisions – September 2017
In September 2017, new ‘safe harbour’ provisions were introduced which were intended to provide directors with protection from insolvent trading liability while they are pursuing a turnaround plan. To obtain such protection, the following requirements must be met:
- the directors must suspect the company may become or is insolvent;
- the directors must develop one or more ‘courses of action’ that are reasonably likely to lead to a better outcome for the company than could be achieved by putting the company in administration or liquidation; and
- the debt incurred must be directly or indirectly in connection with one or more of the above courses of action.
Note that the safe harbour will not be available unless employee entitlements have been paid when due and tax reporting obligations have been complied with by the business.
The turnaround ‘courses of action’ must be implemented within a reasonable time of identifying severe financial difficulty. The court may consider a number of factors when determining whether a course of action is reasonably likely to lead to a better outcome for the company, including whether the directors:
- properly informed themselves of the company’s financial position;
- are obtaining advice from appropriately qualified and properly briefed experts;
- are developing or implementing a plan for restructuring the company to improve its financial position; and
- are taking appropriate steps to ensure the company is keeping suitable financial records and to prevent any misconduct by officers or employees that could adversely affect the company’s ability to pay all its debts.
The ‘better outcome’ test will likely be satisfied if the turnaround plan will provide the company’s creditors with a greater return than that which they would receive upon the winding up of the company.
This safe harbour will only provide protection while the business is actively implementing the turnaround plan. Therefore, with the assistance of appropriate experts, directors should instigate planning and implementation of a detailed turnaround plan as early as possible and assess the success of the plan regularly.
No protection for other breaches
It is important to note that directors will still be liable for breaches of other statutory and common law duties, including failing to act in the best interest of the company and failure to act with care, diligence and good faith.
Regardless of the safe harbours provided by the Corporations Act, directors must continue to deal with COVID-19 issues confronted by the business and consider the effects of these issues on creditors. When a company nears insolvency, directors owe a duty to consider the interests of creditors in discharging their duties with care, diligence and for a proper purpose.
Documenting and implementing stabilisation and survival plans to address all relevant issues will be critical. Where those plans become unrealistic or unworkable, consideration must be given to external administration options and the protection which might be afforded through those regimes.
Follow Expert Advice
Advice from appropriately qualified experts throughout the process is the fundamental pre-requisite to ensuring that directors take the correct options to ensure that they are not exposed to personal liability for insolvent trading.