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The New Safe Harbour Provisions – A Potential Lifeline For Company Directors
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In 2015, Prime Minister, Malcolm Turnbull declared that he was seeking to make a cultural shift, where risk taking was embraced and failure would no longer be feared.   Part of this so-called “cultural shift” occurred in 2017, when a number of significant changes were made to Australia’s Insolvency Law following the Productivity Commission report in December 2015. These changes were aimed towards promoting entrepreneurship and risk taking, and setting up more favourable economic regulations for small businesses, and towards reducing the stigma surrounding business failure. 

The major changes that were made to Australian insolvency law were the introduction of “Safe Harbour” provisions and making “ipso facto” contractual clauses unenforceable in certain circumstances.  An “ipso facto” clause is one which operates to immediately terminate a contract, for example an equipment hire agreement, when a particular fact occurs, such as a company entering into a restructure.

The Government has also proposed changes to the length of the bankruptcy period from 3 years down to 1 year. This changes has not yet to come into effect. 

This article will focus on the introduction of the Safe Harbour provisions in the Corporations Act 2001 (Cth).

The “Safe Harbour” provisions, which are now found in sections 588GA and 588GB of the Corporations Act 2001 (Cth), are arguably the most significant reforms made to Australian Insolvency Law over the past decade.  These provisions seem to provide directors with a “get out of jail free” card for insolvent trading and seek to promote entrepreneurial behaviour in directors by lowering the risk of personal liability for debts incurred while a company is insolvent.  While one intention of the amendments is to promote sensible risk taking by directors, it will be interesting to see how it ultimately unfolds.

Pre safe harbour

Australia is viewed as having one of the strictest insolvent trading provisions in the world.  It is the only country in the world in which companies are not permitted to trade whilst insolvent, leaving aside questions of fraud.

Under s588G of the Corporations Act, if a director is found to have engaged in insolvent trading, he/she is held personally liable for the debts incurred by the company whilst the company was insolvent.   There are serious consequences for a director who is found to have allowed a company to trade insolvent, including civil penalties of up to $200,000 (for proceedings commenced by ASIC), orders to compensate the company (or relevant creditor) for the amount of the debt(s) incurred as a result of the breach (see s588M) and potential criminal prosecutions.

Insolvent trading claims are mostly settled between liquidators and directors.  To illustrate this point further, by 2004, there was a total of only 103 insolvent trading cases that had been run in Australia since the introduction of insolvent trading provisions.

Prior to Safe Harbour, the pressure of being exposed to personal liability for company debts has arguably caused directors to be less likely to take risks and attempt to save their company.  The fear of personal liability outweighed the need to save a company and saw many directors moving to external administration as soon as the company came close to insolvency.  It was a significant disincentive to any potential restructure of the failing company.

Safe harbour

The Productivity Commissions report in 2015 identified that Australia’s insolvent trading laws were a driver behind companies prematurely entering into voluntary administration.   As such, the report made a number of recommendations, including the introduction of a safe harbour defence for directors of struggling companies.  

The government took the Productivity Commissions’ recommendation on board and the “Safe Harbour” provisions were ultimately introduced into the Act.  The amendments to the Act attempt to provide some rescue measures and now include provisions which provide that a duty to prevent insolvent trading will not apply if:

  • at a particular time after the director starts to suspect 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; and
  • the debt is incurred directly or indirectly in connection with any such course of action. 

Interestingly, the director only needs to “start” to develop a plan and does not actually have to develop or implement a final plan.  Such a provision may very well encourage directors to drag their feet and potentially cause creditors to suffer even further.  

It is also important to note that the course of action must be reasonably likely to lead to a better outcome for the company.  When assessing whether the course of action is likely to lead to a better outcome, the Court can have regard to the matters set out in s588GA(2).  One interesting matter to consider is whether the director has obtained advice from an “appropriately qualified entity”.  What exactly constitutes an “appropriately qualified entity” is not defined in the Act and could include an accountant, a solicitor, an insolvency practitioner or someone who considers themselves an advisor. 

The protection afforded to directors by the Safe Harbour provisions will end at the earlier of the following:

  • if the director fails to take any such course of action within a reasonable period after that time;
  • when the director ceases to take any such course of action;
  • when any such course of action ceases to be reasonably likely to lead to a better outcome for the company; or
  • the appointment of an administrator, or liquidator of the company; or
  • if the director does not co-operate with a subsequently appointed liquidator.

What this means

The Safe Harbour provisions are not a defence but rather a carve-out, meaning liquidators must consider these provisions before they pursue any insolvent trading claims.  This increases the difficulty for liquidators in running an insolvent trading claim. 

Ultimately, the Safe Harbour provisions are linked to promoting a better outcome for the company which could possibly lead to a better outcome for creditors.  However, one must question whether such provisions are actually in the best interests of creditors. 

In any event, one should remember that not all failure is bad and as said by Malcolm Turnbull, “you may have lost some money, your investors may have lost some money, but the overall economy massively benefits because you are wiser, your employees are wiser, your investors are wiser, everyone’s learnt something and the ecosystem benefits”.

 


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