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Review of the Insolvent Trading Safe Harbour

5 minutes read time

The safe harbour provisions introduced into the Corporations Act 2001 (Cth) (Act) in September 2017 are designed to provide company directors with protection from insolvent trading provisions when implementing and carrying out a ‘course of action’ which is ‘reasonably likely to lead to a better outcome for the company’.

The overarching aim of the safe harbour is to encourage directors to seek early advice on how to restructure and save financially distressed but viable companies, rather than closing down prematurely to avoid personal liability. This supports a culture of entrepreneurship and innovation, by providing breathing space for distressed businesses.

Four years on, the independent Review of the Insolvent Trading Safe Harbour (Review) which assesses whether the safe harbour provisions are achieving its aims, including whether the provisions have afforded financially distressed but otherwise viable companies with ‘breathing space’ to restructure their affairs, has been tabled in Parliament.

 

What does the Review say?

The upshot is that directors of large and larger-medium sized companies have been utilising the safe harbour provisions to successfully guide them through restructuring processes such that a ‘better outcome’ for the company has been achieved.

This is seen in the statistics. A survey of the Australian Restructuring Insolvency & Turnaround Association’s (ARITA) professional members, found that 53 per cent of respondents had been engaged by a client to develop a ‘safe harbour plan’ or ‘better outcome analysis’, 62 per cent of respondents had recommended using safe harbour protection since its inception, 76 per cent of respondents said that, when they were engaged as a safe harbour adviser, they had achieved a successful restructure without any form of external administration, 40 per cent of respondents reported a successful turnaround following external administration when they had been engaged to advise of the safe harbour provisions, and 27 per cent of respondents advised that the company had been placed into liquidation despite the development of a safe harbour plan.

The availability of the safe harbour has changed the mentality of company boards who are, anecdotally, in times of financial distress, focussing on ‘turnaround’ rather than avoidance of their own potential personal liability. To that extent the safe harbour is providing a useful shield to directors from personal liability in times of financial stress, to allow better outcomes for companies and creditors to be explored.

That said, the review also identified insufficient awareness and understanding of the safe harbour provisions among directors of SMEs and their advisors, where the general consensus revealed by the review panel’s consultations is that ‘there is little interest, awareness, knowledge or update of safe harbour in the SME market’.

This stems from findings that (1) advice is costly, (2) SMEs are not aware of or do not focus on the legal consequences of trading while insolvent, and (3) as a consequence, their decision making in periods of financial distress are not focused on avoiding contraventions of the insolvent trading prohibitions, rendering the safe harbour of little utility.

 

What will happen as a consequence?

In March 2022, the Government published its ‘Government Response to the Review of the Insolvent Trading Safe Harbour’.

To combat perceived shortcomings and increase the safe harbour’s overall use and benefit, the Government has made a number of recommendations, to provide additional protections and certainty to directors. These are not yet implemented but have been agreed by the Government and likely to be implemented. They include:

·        The expansion of the ambit of the safe harbour protections to ‘courses of action’ developed at a time after a person starts to suspect that the company is in ‘financial distress’ – the rationale being to permit the protection to exist where ‘financial distress’ is suspected – irrespective of whether the notion of insolvency is appreciated. A ‘course of action’ could therefore be developed at a time when a director suspects a company to be in ‘financial distress’.

·        The extension of the protection against transactions likely to avoid, prevent, or significantly reduce the entitlements of employees of the company.

·        Additional incentives for directors to produce company books and records to administrators or liquidators at the time of their appointment, in that a failure to do so will preclude reliance on the safe harbour protections.

·        Removal of prescriptive references to failures in complying with the relevant obligations to pay employees and meet tax lodgements as precluding the application of the safe harbour. This will allow a wholly principles based approach to ensuring compliance under subsection 588GA(4) given the retained requirement for ‘substantial compliance’ with those obligations.

·        The development by Treasury of a plain English ‘best practice guide’ to the safe harbour.

·        That ASIC’s guide on a director’s duty to prevent insolvent trading (namely, Regulatory Guide 217) is updated to refer to the insolvent trading prohibition and the safe harbour provisions, with general guidance as to the operation of same.

 

Conclusion / Key Takeaways

The Report paints a clear picture that, when used correctly, the safe harbour provisions are useful and powerful, and are a potent weapon that may be employed to save distressed, but otherwise fundamentally sound, businesses.

The concept of ‘conduct’ which may achieve a ‘better outcome’ for companies is broad and flexible.  Directors of companies experiencing financial distress should continue to be alive to the benefits of the safe harbour and seek and have regard to appropriate advice from their professional advisers regarding the application of the provisions.

The safe harbour provisions have the potential to save businesses and avoid very costly personal liability if directors get it wrong.

 

For more information, please refer to our earlier articles: ‘Safe Harbour Laws – How can Directors’ Steer the Ship During Uncertain Financial Times?’, which provides an overview of how the safe harbour operates, specifically in the context of the financial distress companies were (and are) facing due to the COVID-19 pandemic.  We discussed directors’ broader duties when faced with uncertain financial times in ‘What are Directors’ Duties during Uncertain Financial Times?’.

This Alert is intended as general information only. It does not purport to be comprehensive advice or legal advice. Readers must seek professional advice before acting in relation to these matters.