A port in the storm – What directors need to know about the new safe harbour provisions

(c) discourage directors from taking proactive and diligent steps to save a company on the brink of insolvency which will often lead to negative outcomes for creditors, employees and shareholders of the company.

New exception to directors’ personal liability 

The new safe harbour provisions essentially provide breathing space for directors to take control over the financial restructuring of a company when it is reasonably likely that it will result in a better outcome for creditors, employees and shareholders than if the company entered into a formal insolvency process.

The Treasury Laws Amendments (2017 Enterprise Incentives No. 2) Bill 2017 (the Bill) provide an exception under the new section 588GA of the Corporations Act to a director’s personal liability for insolvent trading if certain actions by the director can be demonstrated after insolvency is suspected. 

Essentially, the director must prove that they took a course of action reasonably likely to lead to a better outcome for both the company and its creditors as a whole in order for the safe harbour provisions to apply.

The Bill provides a non-exhaustive list to aid in this determination which includes whether the director:

(a) took steps to prevent any form of misconduct within the company that could impact the company’s ability to pay its debts;

(b) took steps to keep financial records;

(c) obtained appropriate advice;

(d) informed themself of the company’s overall financial position; and

(e) implemented, or began to develop, a plan to restructure the company to improve its financial position.

If a director can produce evidence to the Court that their course of action would reasonably likely lead to a better outcome, the onus of proof shifts to the individual alleging insolvent trading (in most cases, the liquidator) to prove that safe harbour does not apply.  Importantly, the above factors are not definitive and the Bill, together with the accompanying Explanatory Memorandum, indicate that each course of action will turn on the facts.  The protections afforded under safe harbour will also apply even if the company is ultimately placed into a formal insolvency process.

Practical considerations & key takeaways

• Directors in companies experiencing financial difficulty should take action immediately to benefit from the safe harbour protections – a passive approach will not reward you.

• It is important to practice good corporate housekeeping – the safe harbour provisions will only apply if the company is meeting all of its employee entitlements (including superannuation payments) and tax reporting obligations consistent with a company that is solvent and has followed the proper maintenance of the company’s books and records. 

• Beware of new financing – only debts incurred in connection with the course of action reasonably likely to lead to a better outcome will be covered by the safe harbour provisions.  A director may still be personally liable for insolvent trading if it cannot be demonstrated that they believed the company could repay the debt. 

• Directors must continually satisfy safe harbour conditions during the entire restructuring process – the protection will only be afforded to directors who monitor their course of action at every stage of the restructuring process to ensure compliance with the new requirements.  In circumstances where restructuring may take months, directors should be mindful of staying on top of their obligations under the new provisions.

• The new legislation is not yet in force – directors should be aware that the commencement date of the Bill is the day after the Bill’s assent by the governor general (which has not yet been proclaimed).

Note on ipso facto clauses

In many commercial contracts, it is a common clause that one party can exit or terminate the agreement in circumstances where the other party experiences an insolvency event (e.g. the winding up of a company or its entry into voluntary administration).  For a company in financial distress, the termination of a major commercial contract usually will spell its financial demise as well as damage its goodwill and ability to pay a return to outstanding creditors.  Under the amendments introduced by the Bill, two kinds of stay provisions will enliven in such circumstances (subject to certain excluded contracts):