On 19 September 2017 amendments to the Corporations Act 2001 commenced which create a safe harbour for directors to protect them from personal liability for debts incurred by an insolvent company in certain circumstances.

Why the need for safe harbour?

Prior to the amendments, the provisions of the Corporations Act governing corporate insolvency focused on the need for directors to appoint voluntary administrators of a company if they suspected that the company was insolvent. This was in order to avoid the risk of the director being found personally liable for debts that the company incurred whilst it was trading insolvently.

The appointment of a voluntary administrator is frequently followed by the appointment of a liquidator and results in the total loss of any goodwill of the business of a company and the fire sale of assets and little or no recovery of debts for unsecured creditors.

The purpose of the safe harbour provisions is to encourage a culture of restructuring in Australia by offering protection to directors who are proactively taking steps to achieve a better outcome for the company than the outcome likely to flow from the immediate appointment of an administrator or liquidator.

Insolvent trading and directors’ personal liability

Under Sections 588G(2) and 588M of the Corporations Act, a director of a company to whom the safe harbour provisions do not apply is personally liable for loss or damage that a creditor suffers in relation to a debt where:

1. The company was insolvent at the time the debt was incurred, or became insolvent by incurring the debt;
2. There were reasonable grounds for suspecting that the company was insolvent or would become insolvent; and
3. The director was aware at that time that there were such grounds for so suspecting, or a reasonable person in a like position would be so aware.

Under the general insolvent trading provisions, the director is effectively liable for the unpaid debt owed to the creditor where the director fails to prevent the company from incurring the debt in the above circumstances.

When is a company insolvent?

Generally, the test for determining whether a company is insolvent is whether the company is able to meet its debts as and when they fall due.

What is safe harbour?

A director will be safe harboured from the provisions of Section 588G(2) of the Corporations Act if:

1. At a particular time after the Director starts to suspect the company may become or be insolvent, the director starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the company; and
2. The debt is incurred directly or indirectly in connection with any such course of action during the safe harbour period.

For the purposes of working out whether a course of action is reasonably likely to lead to a better outcome for the company, the courts may, among other things, have regard to whether the director is:

1. Properly informing themselves of the company’s financial position;
2. Taking appropriate steps to ensure that the company is keeping appropriate financial records consistent with the size and nature of the company;
3. Obtaining advice from an appropriately qualified entity who was given sufficient information to give appropriate advice; or
4. Developing or implementing a plan for restructuring the company to improve its financial position.

What is restructuring?

Restructuring is a corporate management term for action taken to reorganise or change operations, structures or financial accommodation of a company for the purpose of making it more profitable, better organised for its present needs or the elimination of financial harm.

Restructuring activities can range from small projects aimed at improving efficiency and profitability, to more detailed transformational processes, such as asset or business divestments and/or managed wind downs.

Appropriately qualified advisors

The obtaining of advice from an appropriately qualified entity is one of the circumstances that the courts may consider in working out whether a course of action is reasonably likely to lead to a better outcome for the company. There is, however, no definition of appropriately qualified entity in the Corporations Act.

An appropriately qualified entity would conceivably include:

• An accountant;
• A lawyer;
• An insolvency practitioner;
• A turnaround management specialist, and
• Other business advisors.

As the categories of advisors that may be considered an appropriately qualified entity are potentially very broad, the class of advisors who might, therefore, be expected to be able to advise a company director of the need to invoke the safe harbour protections, and who consequently might be found to owe a common law duty of care to provide such advice, is equally broad.

Implications for accountants, lawyers and other advisors

Accountants, lawyers and other advisors who have an ongoing retainer or relationship with a company and its directors need to be wary that their common law duty of care owed to directors now extends to advising directors in relation to:

• The available safe harbour laws; and
• The need to promptly develop and implement a restructuring plan if the director suspects insolvency.

Where insolvency is suspected, advisors would also be expected to act promptly to assist directors to invoke the safe harbour protections and to develop and implement a restructuring plan within a reasonable time.

From a litigator’s perspective, advisors who are not familiar with safe harbour protections, and/or who fail to provide directors of companies with appropriate advice at the earliest possible time face the risk of actions for professional negligence by directors against whom a claim for insolvent trading might subsequently be brought by a liquidator of the company. Significantly, as the requirements for invoking safe harbour are relatively low, it is likely that in most cases directors might have been easily able to invoke safe harbour protections had appropriate advices been given and that, therefore, the risk for advisors who fail to give appropriate advice is significant.

Advisors who are not experienced or comfortable advising directors in relation to these matters should promptly refer the director to a lawyer and/or accountant experienced with insolvency and restructuring.

Important disclaimer: this article is intended to provide comment and information of a general nature only and is not legal advice. This article does not deal with the pre-conditions for safe harbour protections or the period of protection. Roberts Legal is not responsible for any actions taken or not taken on the basis of this information. You should obtain specific legal advice on any matters of interest or concern arising from this content.