The insolvent trading law, as seen from the eyes of the Australian business community, was verging on draconian, penalising business failure heavily and stigmatising corporate insolvency beyond salvage. If, despite the best of plans, a business was heading for failure, the director had all the incentives to act conservatively rather than take bold decisions to lead the company back to recovery and risking their own personal wealth in the process.

All that changed with the new legislation that breathed fresh air not just into companies in distress, but also into the Australian business culture.

Background

The Federal Government has amended The Corporations Act (2001) with the express aim of creating safe harbour for company directors. The important change to the law was that rather than focusing on punishing directors for corporate failure, the emphasis was now on rehabilitating companies in trouble.

The law, before the changes were brought in through Treasury Law Amendment (2017 Enterprise Incentives No. 2) Bill 2017, would hold the company director personally liable for the debt incurred by the company if the company went insolvent on account of the debt, or if the company was already insolvent at the time of the debt. Under section 588G of the Corporations Act 2001(Cth), this would also apply to cases where the director may have had prior knowledge of an impending insolvency.

What the law did, effectively, was to make the director responsible for preventing trading by the company in the event of impending insolvency. However, the law also assumed that the director would be able to anticipate insolvency beforehand, when in reality, corporate failure is put together only in hindsight. The director tries to keep the company afloat with the best of intentions rather than try to go through the motions and sail towards an apparently inevitable failure.

What has changed in safe harbour legislation?

One of the primary changes is that the director of an ailing company that seeks to restructure would not be held personally liable for debts incurred in the process of restructuring the company’s operations and setting its finances back on track. While it takes considerable planning and strategising to run a successful company, it is even more painstaking to put a restructuring plan together when the chips are down.

With the changes in legislation, safe harbour ensures that the directors are discharged of their personal liabilities in trading, provided the company undertakes measures that are legitimately directed towards restructuring outside of insolvency. This gives directors the freedom to act, make decisions, and execute turnaround plans without being weighed down by the prospects of personal liabilities attached to their actions.

Apart from such relief from personal liabilities of directors, ipso facto clauses involved in the event of insolvency would effectively be suspended. An ipso facto clause is aimed at terminating certain contracts in the event of insolvency, such as a company entering into voluntary administration or receivership. The stay on ipso facto clause means that, effective 1 July 2018, parties may not be able to rely on the right to terminate their contracts triggered by insolvency.

How to qualify for Safe Harbour

Despite the positivity brought about by safe harbour for directors, it should be clear that it is not a walk in the park to claim safe harbour. There are stringent measures in place to establish a course of action that is intended to steer a company away from its impending downfall. Some of the checks and balances used to establish this include the concept of recovery being ‘reasonably likely’, the hope for a better outcome, and the appointment of appropriate turnaround experts.

What is ‘reasonably likely’?

The idea is that safe harbour should not be a roadmap to disaster. What if the directors were given more time only to make things worse for the creditors? After all, when safe harbour is in place, creditors would not be able to hold anyone specifically responsible for the money lent to the company. Further, if the directors were particularly bad at discharging their responsibilities and were the reasons behind the downfall of the company in the first place, how could they be trusted with additional time and resources that they may not be accountable for? The chance of a recovery should be reasonably likely through the initiatives taken with the new turnaround plans, and this should be clearly demonstrated by the director.

Hope for a better outcome

The idea behind safe harbour is not to help the company trade its way to further misery. Rather, a course of action should be devised that would make it reasonably likely that following the course would lead to better results for stakeholders than the one that goes down the voluntary administration or liquidation paths.

Appoint the right advisors

One of the important requirements for directors to qualify for safe harbour is to appoint appropriately qualified turnaround management professionals. There are two aspects to appointing turnaround management professionals – to satisfy the legal requirements that are associated with safe harbour, and to successfully implement a turnaround that justifies the safe harbour provision.

How to secure safe harbour

Directors of firms entering safe harbour should provide demonstrable evidence to this effect, such as providing documents involved in contracting turnaround professionals, on advises sought, on business plans established etc. Further, any debts incurred should be directly or indirectly related to the turnaround plans. Maintaining transparency and accuracy of financial records, and ensuring fair conduct from employees form integral responsibilities of the director in devising the turnaround plan and securing safe harbour.