Safe harbour protection from insolvent trading

The Australian Government introduced “safe harbour” provisions in to the insolvency regime in September 2017, to protect directors from insolvent-trading liability to allow the chance for a better outcome than formal insolvency. This followed considerable lobbying to adopt a similar approach to the system in the US known as the Chapter 11 bankruptcy regime, to allow directors to remain in control of the company to sell or restructure the business.

1. Protection from insolvent trading

The safe harbour regime is a carve out available to directors for personal liability arising from continuing to trade the company while the company is insolvent. It essentially operates like a defence to that liability. Directors are personally liable for the debts that the company incurs after the point at which the company becomes insolvent.

Up until the introduction of safe harbour, the only way that directors could avoid personal liability for insolvent trading was to the put the company into liquidation or voluntary administration. Go to this link to read about voluntary administration and liquidation.

The problem with this course of action is that the chance of a company being successfully rehabilitated out of either of those insolvency regimes, without spending a significant amount of funds, is relatively small. Safe harbour was introduced as a means of introducing a system that allowed the company to take steps to reorganise that did not require the company to be put into insolvency.

2. What does safe harbour protect?

The safe harbour provisions provide that the insolvent trading prohibition does not apply to debts incurred by a company directly or indirectly in connection with any part of the plan.

Directors seeking to rely on the safe harbour provisions must be able to identify the particular course of action and also identify that the debts were incurred during the period:

(a) commencing when the directors start developing one or more courses of action; and

(b) ending either:

(i) when, among other things, the course of action ceases to be “reasonably likely to lead to a better outcome for the company”; or

(ii) if the directors “cease to take” the relevant course of action outlined in the plan.

Directors should note that the safe harbour is limited to the liability for insolvent trading. During this period, directors must continue to comply with all of their other duties. Go to this link to read about directors duties.

3. Eligibility for safe harbour protection

To be eligible for safe harbour protection, the company must satisfy the eligibility criteria including:

· that all employee wages and entitlements are paid up to date;

· reporting obligations to the ATO are up to date (BAS and tax returns);

· the directors must have adequately maintained books and records, which are up to date; and

· the directors must reasonably suspect that the company is, or is likely to be, insolvent.

If all of these criteria are met, the directors must also be able to satisfy that they have developed or are developing a plan for restructuring. Essentially, the plan must achieve the dual goals of cost cutting and stabilizing the business in a relatively short period of time.

Finally, the plan must be implemented by the directors in conjunction with an “appropriately qualified adviser”. There is no definition of who is an appropriately qualified adviser. Whilst insolvency experts seem to be obviously caught by this, it does not rule out lawyers, accountants or other business advisers with experience in insolvency and restructuring.

4. What is required in a safe harbour plan?

In order for directors to rely on a safe harbour plan as a carve out from insolvent trading, it is necessary for a company to adopt a course of action that is “reasonably likely” to lead to a better outcome than immediately placing the company into administration or liquidation. However, as the safe harbour provisions are relatively new, they have not yet been tested in the courts.

Until the courts give guidance on what the phrase “reasonably likely” means in this context, it is not known what is required in the plan to meet the safe harbour provisions. Until that happens, it is prudent for the company and its directors to determine if the prospects of the parts of the plan are more or less likely to occur.

The plan must be:

· is comprehensive, based on milestones and with a set (short) time to achieve its objectives; and

· is likely to lead to a better outcome than immediately putting the company into external administration.

This requires:

· an assessment of the prospects of the particular transaction in question being agreed, documented and implemented in a way so that the Company receives the prospective benefit of the transaction such as new sources of money or an agreement with creditors for repayment of debt; and

· implementation in sufficient time to enable the Company to satisfy its debts and other financial obligations to return the Company to solvency in a relatively short period of time.

5. Is Safe Harbour appropriate for all companies?

The Small Business Minister said at the time of introducing the safe harbour regime:

“the safe harbour …measures [were designed to] encourage Australians to take a risk, leave behind the fear of failure and be more innovative and ambitious”.

But, does it apply to all businesses? There are many who take the view that safe harbour was not designed with small business in mind. But, that is not to say that small businesses should not go through the process of considering if they should be taking action, including a safe harbour plan, in the face of financial difficulty.

The earlier that business recognises the prospect of financial difficulty and seeks advice, the more likely it is that steps can be taken, including a safe harbour plan, to save the business and the personal liability of the directors.

A safe harbour plan could be appropriate for small businesses to buy more time to allow the company to be turned around without the need to enter formal insolvency, depending on individual circumstances.

It is vitally important that you get advice to determine if safe harbour is appropriate in your circumstances and that a proper plan can be put in place that is likely to deliver a better outcome for creditors than liquidation. If this is not done properly, it can cost directors their personal assets.