It is tough for businesses at the moment. Employees are hard to find and keep. Interest rates are rising. As are fuel prices. Record setting weather events are moving across large parts of the country. A war halfway across the world is pushing out costs at home. Global and local market fluctuations. Isolation requirements have lifted, but business is not what it was before the COVID-19 pandemic. A perfect storm. Certainly, there is currently no shortage of challenges for businesses – whether these affect your business directly or indirectly by impacting your upstream or downstream markets.
As companies face challenging times, their directors will be planning their next steps and in doing so it is important to keep some simple principles in mind.
Remember – no insolvent trading
One such noteworthy principle is that directors have a strict statutory duty to prevent a company from trading while insolvent. This means that directors are obliged to ensure that a company does not:
- incur a debt while insolvent, or
- incur a debt that would result in its insolvency, or
- incur a debt while there are reasonable grounds for suspecting that the company is insolvent or would become insolvent as a result.
How do we understand insolvency?
Simply, insolvency can be understood as the inability of a company to meet to its debts as and when they become due and payable.
Accordingly, companies that may be experiencing financial pressure and considering debt restructuring, bridging finance or new or extended overdraft facilities should take note and take advice before implementing any next steps.
Risk to directors
Directors who fail to meet this duty, to prevent insolvent trading, can be held personally liable for those debts.
Now what?
It was recognised some time ago (with the introduction of s588GA to the Corporations Act 2001 (Cth)) that there is a need for an insolvent trading safe harbour for directors to allow them “breathing space” to explore opportunities which may improve the company’s financial prospects.
As a result, the risk of personal liability for such debts can be limited if the directors, on becoming aware that the company is or may become insolvent, start developing one or more courses of action that are reasonably likely to lead to a better outcome for the company.
How?
The risk of personal liability for debts in relation to insolvent trading is not automatically excluded.
To benefit from the protection of the insolvent trading safe harbour provisions, the directors must:
- maintain adequate books and records,
- have paid and continue to pay all employee entitlements (including superannuation) as and when due, and
- have met and continue to timeously meet all tax reporting requirements.
Directors should also:
- take steps to prevent misconduct by officers and employees of the company,
- ensure that the company keeps appropriate financial records,
- obtain advice from an appropriately qualified entity,
- keep themselves informed and up to date regarding the company’s financial position, and
- develop and implement a clear and reasoned plan to improve the financial prospects of the company, and document the plans and decisions taken in this regard.
It is not a public process. It is a confidential board decision. The safe harbour resolution would only become public, to a limited extent, if the company entered a formal insolvency process.
The protection
If found to apply, the protection from personal liability afforded directors under the insolvent trading safe harbour provisions will apply to debts incurred directly, or indirectly, in connection with that course of action. For example, where directors acting appropriately under the insolvent trading safe harbour provisions arrange bridging finance, enter into borrowing arrangements, restructure debt or establish new or extended lines of credit, or new or extended overdraft facilities.
The insolvent trading safe harbour provisions do not absolve directors of their duties to the company generally. These duties to continue to apply and directors must continue to act in good faith and in the best interests of the company.
Review
An independent review of the insolvent trading safe harbour provisions was conducted in November 2021 to investigate whether these provisions were fit for purpose and the extent of benefit to business. A final report was released in March 2022.
Interesting observations noted in the report include that:
- there is no industry or best practice guide as to how the provisions will operate,
- there has been little judicial guidance on the insolvent trading safe harbour provisions, and
- there is insufficient awareness or knowledge of these provisions and how they operate, particularly among SME directors.
All of which points to the importance of seeking early advice and the important role advisers play in such instances.
Remember
The risk of directors’ personal liability for debts incurred whilst a company trades in insolvent circumstances has not been removed. The decisions and actions taken by directors in these circumstances should be carefully managed. If you think these circumstances may apply, it is important to take early advice to ensure best outcomes for both the company and its directors.
If you have any questions about this article or would like to take steps to investigate whether it may apply to your circumstances, please feel free to contact Frank Law on (02) 9688 6023.
This is not legal advice
