Safe harbour enables company directors to have support and assurance to turnaround the business without the possible threat of insolvent trading looming over their heads during the process.
Introduction
New legislation was introduced to provide some support to and assurance for company directors where a genuine opportunity to turnaround the business exists, but directors are concerned that while assessing the business’s options they are exposed to personal liability for insolvent trading.
The ‘safe harbour’ regime’s aim is to provide company directors with an opportunity to seek proper advice to develop and implement an action plan to achieve a better outcome for the company and its stakeholders compared to simply closing the doors and appointing an administrator or liquidator.
However, safe harbour is not necessarily available to all companies and its directors. A range of criteria must be met to take advantage of the safe harbour regime’s protection.
Why would directors choose to use safe harbour?
The safe harbour regime is aimed at providing directors protection from a potential insolvent trading claim while undertaking a company restructure outside a formal insolvency process.
What is insolvent trading?
Insolvent trading occurs when directors allow their company to incur debts when the company was insolvent. A liquidator can claim as compensation against a director, personally, the total unpaid debts incurred from the time the company became insolvent to the start of the liquidation.
Is safe harbour available to me?
Section 588GA of the Corporations Act 2001 is a new section that establishes a safe harbour for directors of an insolvent company to protect them against personal liability for insolvent trading contraventions under subsection 588G(2) of the Corporations Act.
Section 588GA(4) of the Corporations Act says directors cannot access safe harbour when:
- the company has outstanding employee entitlements (including superannuation)
- the company has not complied with all of its Australian Taxation Office reporting requirements and lodgements (under the Income Tax Assessment Act 1997).
Safe harbour is unavailable when “substantial compliance” with the above two points has not occurred, or there have been two or more instances of non-compliance in the preceding 12 months.
However, if these conditions are met, then directors can qualify for safe harbour protection.
For safe harbour to apply, an action plan must be developed that provides a better outcome for the company as opposed to appointing an external administrator. While individual circumstances are relevant, the following factors are used to determine if a better outcome applies:
- A plan is developed where the likely outcome is better than immediately appointing a liquidator or administrator.
- When decisions are made to restructure, it is recognised that not all attempts will be successful, and that administration or liquidation may still result.
The safe harbour regime aims to:
- promote early engagement with potential insolvency
- reduce the risk of companies not meeting these obligations as they start to experience financial hardship
- ensure that during any course of action to restructure/recover, employee entitlements are properly paid and taxation reporting obligations are met.
What about holding companies?
Section 588WA of the Corporations Act provides for a safe harbour for holding companies. Further to section 588V of the Corporations Act, holding companies will not be liable to compensate creditors of its subsidiary for losses when:
- debts are incurred by the subsidiary when its directors have safe harbour protection
- the holding company took reasonable steps to ensure that the subsidiary directors have safe harbour protection.
How do directors implement safe harbour?
Directors can remain in control of the company and take proactive steps to restructure a company in a way that is likely to deliver a better outcome than immediately appointing an administrator or liquidator, without focusing on their personal liability for debts incurred while the restructure takes place.
Safe harbour protection does not extend beyond the civil liability set out in section 588G(2) of the Corporations Act. During safe harbour, directors must comply their director duties and all other legal obligations.
In view of varying company structures, subsection 588GA(2) provides an indicative (non-exhaustive) list that says that directors in a safe harbour scenario must either:
- inform themselves properly of the company’s financial position
- prevent company officers/employees from adversely affecting the company’s ability to pay its debts
- ensure the company is keeping appropriate financial records (consistent with size and nature of company)
- obtain qualified advice based on sufficient information being given
- develop or implement a restructure plan to improve a company’s financial position.
The above factors in subsection 588GA(2) therefore provide only a guide on the steps a director may consider or take depending on the circumstances, and establishes the factors a court may consider in any subsequent proceedings where the safe harbour is at issue.
Companies with immediate insolvency or long-term insolvency concerns should compel directors to thoroughly consider whether to continue trading and the viability of a well-considered plan being implementable. Directors must exercise ongoing diligence throughout their directorship to avoid circumstances that make them rely on safe harbour provisions.
How long does it apply for?
Safe harbour commences when directors, after first suspecting that the company may become insolvent, starts developing one or more courses of action, and one of those courses of action is reasonably likely to lead to a better outcome for the company than the immediate appointment of an administrator or liquidator.
The safe harbour ceases to apply when:
- Directors do not take the course of action by the end of a reasonable period.
- Directors stop taking the course of action.
- The course of action ceases to reasonably lead to a better outcome for the company.
- A liquidator or administrator is appointed to the company.
Who will know?
Safe harbour does not have any associated registry or database for safe harbour plans to be recorded or searched, nor are there any declaration requirements. Only those who directors trust with this information will know.
Who is an ‘appropriate qualified’ person?
Directors have the evidentiary and legal burden to prove sufficient evidence was given to an appropriately qualified advisor that they appointed.
Directors must be wary of advisers who target company directors whose businesses may be in financial difficulty and suggest actions that could be illegal. For example, transferring assets to another person or company without proper payment (fair market value, or consideration). Such advice, if followed, may compromise safe harbour validity and potentially expose directors to other actions.
Appropriately qualified in this context means “fit for purpose” and is not limited merely to the advisor possessing particular qualifications. Directors who appoint the adviser must determine whether the adviser is appropriate in the context, having regard to issues such as:
- The company’s nature, size, complexity, and financial position.
- The adviser’s independence, professional qualifications, reputation, and membership of appropriate professional bodies (or in the case of an advising entity, those of its people)
- The adviser’s professional experience.
- Whether the adviser has adequate professional indemnity insurance to cover the advice being given.
The advisor qualifications required vary on a case-by-case basis, for example:
- A small business with a simple structure may need only to seek the advice of a qualified accountant, lawyer, or other technical adviser—perhaps with insolvency experience.
- A larger or more complex business, e.g. a construction business, may require the advice of a properly qualified, specialised insolvency or turnaround practitioner who is a member of a professional insolvency or turnaround association (e.g. ARITA), or a specialist lawyer.
What does it include?
Safe harbour protects directors over debts that a company incurs directly or indirectly relating to developing and acting on a restructure plan; and includes ordinary trade debts incurred in the usual course of business.
What does it not include?
Safe harbour protection does not apply to all debts. The debts need to be incurred “directly or indirectly in connection with” developing and taking the course of action. This will include debts incurred in the usual course of business, however if there is a new debt that is not in the ordinary course, and inconsistent with the course of action, that may not be covered by safe harbour.
Safe harbour also does not protect directors from actions brought for any other breach of the law, including a breach of their director’s duties.
Can I come out of safe harbour?
Yes. Ideally the safe harbour action plan must be actionable and measurable by setting dates for certain actions to be implemented or achieved by. The plan’s terms should outline a review date that allows for the strategy to reformulate or amend, or to affirm that the company’s solvency is no longer an issue. To assist with documenting this process, it would be prudent for regular meetings to be held and minutes recorded to reflect the action plan’s progress against its goals. Regular progress reports, forecast financial models, and budgets should also be documented. If appropriate, key stakeholders such as company shareholders or its financiers should be kept up to date on the progress.
The formal definition of insolvency is being unable to pay debts as and when they become due and payable. An assessment should be made on a regular basis to satisfy that the company is solvent and that long-term viability of the company has been achieved. If it has, the company should continue to monitor the changes implemented, and embed the improved strategies into the ongoing management of the company.
What happens if it doesn’t work?
If the safe harbour plan does not achieve its goals, a formal insolvency appointment e.g. voluntary administration or liquidation must be considered to limit a director’s exposure to an insolvent trading claim. If a formal insolvency appointment is necessary, the directors must comply with certain obligations including completing a statutory report and providing company books and records to the administrator or liquidator to rely on safe harbour protection. Any information or documents not provided to the administrator or liquidator cannot be used later for safe harbour protection, unless it was unavailable to the director previously.
Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.
Last Updated: 12.03.2019
