Safe Harbour Provisions in Company Law

This report discusses the recent issue of safe harbour provisions in company law and its impact on directors and companies in Australia. It provides an overview of the background, analysis of the issue, and recommendations for improvement. The report highlights the need for clear guidelines and criteria to determine valid actions for directors during company insolvency.

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Company Law
Safe Harbor

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Table of Contents
Introduction...............................................................................................................................2
Background................................................................................................................................3
Issue............................................................................................................................................4
Analysis.......................................................................................................................................4
Recommendations.....................................................................................................................6
Conclusion..................................................................................................................................7
References..................................................................................................................................8

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Introduction
A corporate entity has a separate legal existence from its members; however, its
operations are managed by directors. Various duties are imposed by the Corporations Act
2001 (Cth) on directors to make sure that they discharge their duties while prioritising the
interest of the company. However, there are various issues faced by the directors and
companies in relation to the imposition of these duties (Marshall & Ramsay, 2012). Effective
compliance with these duties is important for directors to make sure that they avoid legal
consequences. The objective of this report is to evaluate a recent issue that affects
corporations in Australia. The issue of recent changes brought by the government in the
duties of directors will be evaluated in this report to understand its impact on companies in
Australia. Particularly, this report will focus on the issue of ‘safe harbour’ provisions
implemented by the government under section 588GA. This report will evaluate the
background of this issue and evaluate how these provisions changed the duties of directors
and the remedies available for them under the Corporations Act. Lastly, recommendations
will be made, and a conclusion will be drawn based on the analysis of the issue.

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Background
Section 588G recognises a major duty of directors relating to insolvent trading as
given under the Corporations Act 2001 (Cth). As per this section, the director of a company
must not incur a debt when the company is insolvent. The directors are also prohibited from
incurring any debt in case the company is on the verge of being insolvent, and it is likely to
become insolvent if the debt is incurred (Austlii, 2019). In the case of Woodgate v Davis
(2002) 55 NSWLR 222 case, the court provided that this duty is implemented to protect the
welfare of stakeholders of the company. The court provided this duty ensures that directors
discharge their duties while maintaining a high standard of care and diligence which is
expected from them to make sure that they prioritise the interest of the company and its
stakeholders above their personal. They should not misuse their position to engage in
practices that could affect the market position of the enterprise. Violation of this section
leads to the imposition of civil as well as a criminal liability on the directors of a company.
The court can personally hold directors liable under section 588G (2) for engaging in
insolvent trading practices. Furthermore, the judgement given in ASIC v Somerville & Ors
[2009] NSWSC 934 case also highlight an issue in the application of this provision. In this
case, the attorney of the company was held liable by the court for shutting down the
previous company and starting a new corporation to defraud its creditors.
The court held the defendant liable for the violation of section 588G for engaging in
insolvent trading (Sewell, 2018). Previously, the defence against the violation of this duty
was given under section 588H of the Corporations Act. As per section 588H (2), if the
directors have reasonable grounds to believe that the company was solvent, then it can
incur debt in the company (Legislation, 2019). The director relied on reasonable grounds or
information given by reliance subordinates that the company is solvent (Section 588H (3)).
The director was not a part of the decision making the process in which other directors
decided to incur debt in the company when it was insolvent (Section 588H (4)). The director
took all the reasonable steps in order to prevent the incurring of the debt in the company
(Section 588H (5)) (Legislation, 2019). These were the primary defences available for the
directors in case they engage in insolvent trading.

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Issue
The key issue has raised due to the implementation of ‘safe harbour’ policies by the
government. The government made amendments in the Corporations Act on 12 September
2017 after which provisions regarding safe harbour were included under section 588GA. The
intention of this act is to drive cultural change in company directors to make sure that they
take reasonable risks rather than simply placing the company prematurely in voluntary
administration or liquidation (Marcar & Renfrey, 2017). Through this provision, the
government has made changes in the act to protect the right of directors to take calculated
business risks to make sure that they are able to protect the organisations in case it faces
insolvency issues.
This is an issue because it made it difficult for the court to determine which actions
come within the scope of insolvent trading. This act did not provide any provisions or
guidelines within which directors have to act to make sure that they did not violate the
provision of insolvent trading. Under this provision, directors can no longer be held directly
or indirectly liable for the debts which are incurred while the company is insolvent or on the
verge of insolvency (Bryks & Rihak, 2018). This provision only applies if the directors prove
that the debt was incurred in connection with the development of the company. Since there
is lack of information regarding which actions constitute as valid and which actions are
considered as unfair, it becomes difficult for the courts to implement the provisions given
pursuant to section 588G expect in the case when there is clear evidence available that the
directors have acted in an unfair or fraudulent manner.
Analysis
As established by the court in the judgement of Commonwealth Bank of Australia v
Friedrich & Ors (1991) 5 ACSR 115, personal liability can be imposed on a director if they
engage in insolvent trading. It was established in this case that the director could be held
personally liable for the debt which is incurred when the company was insolvent. The court
held in this case that the director must not engage in fraudulent practices when they are
aware that the company is likely to become insolvent from the debts. However, this issue
can no longer be established by the court since directors can prove that the decision taken
during the insolvency of the company was taken to protect the company from liquidation as

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per the provision of the safe harbour. It becomes difficult for the court to determine which
actions constitute as illegal or unethical and which actions come within the scope of
implementation of policies that are taken to protect the company from insolvency.
This could lead to a violation of duties for the directors since they can avoid their
legal obligations by using the defence given under safe harbour (Bryks & Rihak, 2018). The
directors could claim that the debt which the incurred was to make sure that the company
did not go into liquidation since it is difficult to characterise a debt. Due to these policies,
the deficiencies in the current safe harbour policies are highlighted. This provision also
increases the changes of loss suffered by unsecured creditors who gives the loan to the
organisation in order to protect it from insolvency. These creditors are not able to hold the
directors personally liable to receive the loss suffered by them to make sure that they did
not suffer a loss due to the failure of the directors of the company. Thus, this issue shows
that the rights of unsecured creditors are not protected under the safe harbour and it also
becomes difficult for them to receive their money back from the company after its
insolvency.
Currently, there are no provisions implemented by the government to make sure
that the actions which come within the scope of “reasonable practices” are justified (Marsh
& Roberts, 2017). Under section 588GA (3), the court provided that the onus to prove the
existence of safe harbour defence is on the director. This provision resulted in imposing the
burden on the director that is effective when it comes to delivering justice. The director is
obligated to provide evidence to support the arguments that the incurring of the debt was a
result of acting in ‘good faith’ (Bryks & Rihak, 2018). The director had to prove that the debt
was incurred to make sure that the company did not go into liquidation and it was in the
benefit of its stakeholders. In this regards, the element of ‘calculated risk’ plays a major role
since the director has to prove in the court that the pros of taking the decision outweigh its
cons.
Due to this provision, it becomes difficult for directors to rely on the provisions given
under the safe harbour act in order to hide their illegal or fraudulent practices. Since
directors have to provide justification for their actions, it becomes easier for the court to
determine whether the directors prioritised the interest of the company or not. However, in

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many circumstances, it becomes difficult for the court to establish which decisions
constitute as ‘reasonable’. This is a result of lack of availability of any guidelines which
provide necessary provisions that are necessary to be followed by directors in case they
wanted to rely on the defence under the safe harbour. Since there are no such provisions
exist, the delivery of justice becomes difficult for the company. Thus, it shows a major gap in
the current policies which makes it difficult for the court to hold the directors liable under
the breach of section 588G (Marcar & Renfrey, 2017).
Recommendations
In order to address the issue relating to safe harbour provisions, new policies should
be implemented by the government that are targeted towards improving the provision of
the safe harbour. While deciding the actions of the directors, the court should rely on an
objective test to determine whether the actions of directors to incur debts during insolvency
of the company are considered as “reasonable”. While applying this test, the court can also
rely on the expertise of the Australian Securities and Investments Commission (ASIC) to
evaluate whether the actions of the directors were in good faith (Anderson, 2017). Under
this test, the court evaluates whether the arguments made by directors to determine that
his/her actions constitute as valid and whether they provide enough evidence to make sure
that the directors did not violate the provisions given under section 588G.
However, this test is not enough, and the government should make amendments in
section 588GA to increase its effectiveness. Guidelines should be added under this section
which should provide criteria for directors to follow to make sure that they did not misuse
this defence. Under these criteria, provisions should be implemented to make sure that the
directors are not able to misuse their position to incur any debts which are considered
unreasonable. Until specific criteria or guidelines are not fulfilled, the directors should not
have the authority to take action on behalf of the company during its insolvency (Marcar &
Renfrey, 2017). This will resolve the issue involved with safe harbour provision, and it will
increase the effectiveness of this provision.

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Conclusion
To conclude, the implementation of safe harbour policies is a recent corporate law
issue relating to the imposition of director duties which is analysed in this report. As per the
new amendments, further defences are recognised for directors to make sure that they
cannot be held liable if they take the decision to incur the debt during insolvency of the
company if they wanted to protect it from liquidation. This is an issue because adequate
tests or provisions are not included in the act to determine which actions constitute as
reasonably valid by the directors. The onus to prove this defence is on the directors due to
which it becomes difficult for directors to avoid their legal liabilities; however, further
elements should be incorporated in this provision to make sure that directors are not able
to discharge their obligations. It is recommended in this report that along with an objective
test, specific guidelines should be issued by the government to clearly define actions that
constitute as valid for directors during the insolvency of the company. Implementation of
these policies will improve the effectiveness of the safe harbour policies that will protect the
interest of directors, organisations and unsecured creditors.

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References
Anderson, H. (2017). Shelter from the storm: Phoenix activity and the safe harbour. Melb.
UL Rev., 41, 999.
ASIC v Somerville & Ors [2009] NSWSC 934
Austlii. (2019). Corporations Act 2001 - SECT 588G Director's duty to prevent insolvent
trading by company. Retrieved from
http://www.austlii.edu.au/cgi-bin/viewdoc/au/legis/cth/consol_act/ca2001172/
s588g.html
Bryks, D. & Rihak, A. (2018). Australia: s588GA Corporations Act: a safe space for directors -
the safe harbour defence to insolvent trading. Retrieved from
http://www.mondaq.com/australia/x/763042/Insolvency+Bankruptcy/A+safe+space
+for+directors+the+safe+harbour+defence+to+insolvent+trading
Commonwealth Bank of Australia v Friedrich & Ors (1991) 5 ACSR 115
Corporations Act 2001 (Cth)
Legislation. (2019). Corporations Act 2001. Retrieved from
https://www.legislation.gov.au/Details/C2018C00031
Marcar, K. & Renfrey, B. (2017). The new safe harbour insolvency laws – basics for directors
and commercial contracting. Retrieved from
https://www.jws.com.au/en/insights/articles/2017-articles/the-new-safe-harbour-
insolvency-laws-%E2%80%93-basics-for
Marsh, S., & Roberts, S. (2017). Personal liability for insolvent trading: Company directors
find berth in safe harbour. Governance Directions, 69(10), 611.
Marshall, S., & Ramsay, I. (2012). Stakeholders and directors' duties: Law, theory and
evidence. UNSWLJ, 35, 291.
Sewell, B. (2018). Corporate law: Navigating the safe harbour for small-to medium-sized
enterprises. LSJ: Law Society of NSW Journal, (43), 82.

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Woodgate v Davis (2002) 55 NSWLR 222