Insolvent trading
A director has a duty to prevent a company from trading while insolvent. A director will fail in this duty where they are aware, or a reasonable person in a similar position would be aware, that the company is insolvent and incurs a debt at that time, or incurs a debt that makes the company insolvent (s 588G Corporations Act).
Law changes
Beginning in September 2017, the insolvent trading provisions will not apply where, after the director suspects the company may become or be insolvent, the director starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the company. The aim of this legislation is to give directors more time to formulate a plan for the company’s future where it is reasonably likely that the company can trade and or restructure its way out of difficulties.
The safe harbour
The safe harbour is only available where:
- Directors develop or take a course of action that, at the time the debt was incurred, was reasonably likely to lead to a better outcome for the company than immediate administration or liquidation;
- The company is paying employee entitlements at the time they fall due;
- The company meets its tax reporting obligations;
- The director meets its obligations to assist administrators, liquidators and controllers and provide them with company books and records and a Report as to Affairs.
The director bears the evidential burden of showing that they developed, or took a course of action that was reasonably likely to lead to a better outcome for the company.
Better outcome test
The better outcome test will require a comparison of the cents in the dollar return to creditors in an immediate insolvency versus a later insolvency much like an assessment a voluntary administrator makes of a Deed of Company Arrangement versus liquidation.
The courts will have regard to whether the director was properly informed of the company’s financial position; whether steps were taken by the director to ensure the company kept adequate financial records; what steps they took to prevent misconduct by officers of the company that could affect the solvency of the company; whether advice was obtained; the plan developed by the director to improve the financial position of the company.
How long does the safe harbour last?
It will start when the director develops a course of action that is reasonably likely to improve the outcome for the company, and ends when:
- The director fails to take any such course of action within a reasonable period;
- The director stops that course of action;
- The course of action is no longer reasonably likely to lead to a better outcome for the company; or
- An administrator or liquidator is appointed.
Summary
If you are a company director and you suspect your company is approaching insolvency, you must take action to develop a plan that is likely to lead to a better outcome for the company. This will include seeking the advice of relevant professionals and documenting all steps taken in developing and implementing such a plan. This course of action may protect you from personal liability in the event of insolvent trading.