Safe Harbour For Directors For Insolvent Trading
By Georgie Cape, Law Clerk, MST Lawyers and Alicia Hill, Principal, MST Lawyers
Recent amendments to the Corporations Act 2001 (Cth) (the Act) have resulted in extra protection for company directors for trading while insolvent. This ‘safe harbour’ for directors from personal liability ultimately enables company restructures outside of a formal insolvency process. This article will set out the situation before this amendment, the relevant changes, the conditions of this change and the benefits it presents. This article deals with civil liability as opposed to the criminal liability of directors.
Director’s Duty To Prevent Insolvent Trading
Division 3 of the Act specifies the director’s duty to prevent insolvent trading.
Subsection 588G(1) of the Act applies when:
- a person who is a director of a company at the time when the company incurs a debt; and
- the company is insolvent or becomes insolvent by incurring that debt; and
- at that time, there are reasonable grounds for suspecting the company is insolvent or would become insolvent from incurring that debt.
Under subsection 588G(2) of the Act, by failing to prevent the company from incurring the debt, the person contravenes subsection 588G(1) if:
- the person is aware at that time that there are such grounds for so suspecting; or
- a reasonable person in a like position in a company in the company’s circumstances would be so aware.
Current defences for civil liability available for directors are found in section 588H of the Act. These include that the director had:
- reasonable grounds to believe, and did believe, the company was solvent at the time the debt was incurred and would remain solvent after incurring that debt; or
- reasonable reliance on a competent and reliable person responsible for providing adequate information about the company’s solvency and believed this person was achieving that responsibility and expected on this information that the company would remain solvent despite the incurrence of the debt; or
- an illness (or some other good reason) which caused them to not take part in the management of the company; or
- taken all reasonable steps to prevent the company from incurring the debt.
Section 1317S also provides a defence to civil liability, namely if the director acted honestly and having regard to surrounding circumstances, they ought to be excused.
The Treasury Laws Amendment (2017 Enterprise Incentives No.2) Bill 2017 (the Amendment) amends the Act to provide a safe harbour for company directors from personal civil liability for insolvent trading if the company is restructuring outside formal insolvency. The Amendment also makes ipso facto clauses unenforceable during the restructuring of a company in specific formal insolvency processes. This article focuses on the creation of a safe harbour for directors as opposed to ipso facto clauses. The Amendment achieves the creation of the safe harbour by inserting section 588GA into the Act.
Conditions of Safe Harbour
Safe Harbour Elements
Section 588GA of the Act specifies elements for the safe harbour for directors to apply. The onus rests upon the director to demonstrate that they satisfy each of the elements. If the criteria are found to be satisfied, the director will not have contravened the duty to prevent insolvent trading.
The criteria that must be satisfied include:
- The director ‘starts to suspect’ through monitoring the company’s financial affairs that the company is or may become insolvent; and
- The director begins to actively take steps in developing courses of action that are ‘reasonably likely to lead to a better outcome for the company’; and
- The debt was incurred directly or indirectly as a result of that course of action; and
- The course of action is stopped at the earliest of the timeframes provided by the legislation.
Exceptions to the Safe harbour
It is important to note that the safe harbour will not be available to directors where the debt was incurred, and the company failed to pay entitlements to its employees (as they fell due) and/or give tax returns or other documents to comply with taxation laws. This failure must be classified as ‘less than substantial compliance’ or must be one of at least two failures during the last 12 months.
The safe harbour will also not be available to directors where after the debt was incurred there was a failure to provide information and books of the company to controllers of company property or liquidators, under section 588GA(5).
Benefits of Safe Harbour
The protection offered by the safe harbour provides directors with the opportunity to improve the company’s situation through restructure without fear of personal liability. It encourages innovation, entrepreneurship and active solution seeking. This will ultimately mean that companies, stakeholders, employees and creditors will have a higher chance of achieving better outcomes without turning to formal insolvency. Previously, directors may have hastily sent its company into voluntary administration or liquidation for fear of personal liability. Safe harbour removes the emphasis of punishing insolvency and moves the focus to solution seeking.
If you would like to discuss any aspect of this article further, please do not hesitate to email Alicia Hill or phone +61 3 8540 0200.