Corporations Law: Insolvent Trading and Safe Harbour Provision

This article discusses the legislation related to insolvent trading of a company and the liabilities of directors. It also explores the introduction of the safe harbour provision in 2017 and its justifications. The article highlights the elements of the safe harbour carve out and examines its applicability and drawbacks.

Running head: CORPORATIONS LAW
CORPORATIONS LAW
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Introduction:
The present article deals with the legislation related to the insolvent trading of a
company and it puts liabilities on the company directors when they allow the company to
incur new debts when it is already not in a position to pay its existing current debts as per sub
section (1)(b) of the section 588G of the Corporations Act 2001 (Cth). Selecting an
appropriate course of action when the company is under insolvency looms is always being a
difficult task for the directors as held by Horne (Horne 2017). From one point of view, an
immediate liquidation helps to secure the interest of the creditors such that they are no more
exposed to losses due to the insolvency of the company and the remaining company assets
are to be realised by the liquidators to distribute among the creditors whose losses cannot be
avoided. Again, if the company continues to deal, it may be able to turn around the
insolvency of the company such the creditors are paid at least more than what they could get
if the company was put to liquidation. In this scenario, the directors play the most crucial
part.
These directors have an advantage that a company being a separate legal entity, the
debts incurred by the company will be payable by the company itself as held by Omari
Simmons (Simmons 2019). Similar to companies liability, the liabilities of the directors for
insolvent trading is a product of statute and is somewhat convoluted as stated in the case of
Fryer v Powell (2001) 159 FLR 433, 442 [56] by Olsson Justice. In this regard, light must
be thrown on the introduction of the concept of ‘safe harbour’ in 2017 that carves out from
the liability of insolvent trading of the directors. This provision of the safe harbour is mainly
aimed at motivating the directors of companies not to allow liquidation of the company
prematurely as put forwarded by James Dunn (Dunn 2017).
Background:

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One 11th of September, 2017, one of the major and significant reforms was made to
the insolvency law of Australia in the form of the in the form of the introduction of the safe
harbour provision. The aim of the legislators is to allow the directors and to motivate them to
engage in some acts instead of placing the company into voluntary administration (VA) or
liquidation. Some important safeguards in this regard against the safe harbour are also
included in the legislation as argued by Sam Marsh and Roberts Shane (Marsh and Roberts
2017)
Section 588 G provision contained in CA 2001 owes much to the Harmer Report’s
recommendations as given in the Southern Cross Interiors Pty Ltd v Deputy
Commissioner of Taxation (2001) 188 ALR 114, 132 [98]. This Report gave justifications
for imposing liability personally on the directors for causing insolvent trading of their
company. The main components under s 588G are that the director is a liable, the company is
insolvent when the debt accrued to the company or the company becomes insolvent by
incurring such debts and there lie reasonable ground of suspicion that the company is
approaching towards insolvency as given in section 588 (1) of the Act. The director’s liability
is imposed by section 588 G(2) where the director knows that reasonable grounds of
insolvency are present. Infringement of section 588G (2) empowers the liquidators to recover
the debts from the directors by means of civil proceedings as given in section 588M of the
Act. However, ASIC (Australian Securities and Investments Commission) has the power to
check the right to begin proceedings of insolvent trading instead of liquidation according to
the decision of ASIC v Plymin, Elliott & Harrison [2003] VSC 123 (5 May 2003),
popularly known as Water Wheel Mills Pty Ltd and Water Wheel Holdings Ltd.
Section 588G (2) provides a positive duty to prohibit insolvent trading for the
directors subject to section 588H providing many defences. Directors who did not take art to
prevent the insolvency have no defence and as per old legislation, the family members are too

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held liable if they had merely signed any documents related to the company as seen in
Morley v Statewide Tobacco Services Ltd [1993] 1 VR 423. Defences can be actual
expectation of company’s insolvency on the bass of reasonable grounds, illness or any other
strong reasons and also taking all the necessary steps to prevent the debt incurring as
provided in section 588H. To summarise everything discussed above, it is seen the duty of
insolvent trading with its defences were not made to allow the directors to involve in actions
before liquidation. The justification of the change will now be taken into consideration.
Justification for introducing Safe Harbour provision:
As discussed above, the rationale behind liability of insolvent trading and its defences
is to prevent the directors from playing with money of the creditors together with giving
protection to the honest directors who did their best before the insolvency of the company.
The principle is that a threat or fear of liability can curb improper behaviour of the directors
in order to benefit the ability of the creditors to recover the debts from the company. Though
the newly enacted provision of safe harbour is not restricted to company of any particular size
but it appears to be aimed mainly at the large companies’ directors (Low and Low 2018).
Elements of Safe Harbour 2017 Carve Out:
As per the Minister for Revenue and Financial Services, the March 2017 draft
legislation was aimed mainly to promote an entrepreneurship culture and its innovation
together with decrease of the stigma linked with any business failure. A crucial element is
that section 588 GA(1) acts like a ‘carve out’ from, instead of a defence to liability of section
588 G (Anderson 2017). While the directors have the burden to produce evidence that they
have taken some course of action to lead a better result for the company, it is still required for
the regulator or the liquidator to prove the elements of breach of section 588G(2) and in
addition to overcome the entitlement evidences for claiming safe harbour. However, the

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burden is on the director to prove the entitlement to defences as per section 588H of the Act.
This is an important difference.
Under section 588GA(2), the court will consider the steps taken to prohibit the
misconduct, to receive advice, to ensure perfect record keeping, to be informed about the
financial position of the company and finally to create a restructuring plan to improve the
financial position of the company. However as per section 588GA(1), the directors will not
be able to use the safe harbour due to the failure of the company to give employee
entitlements and to keep documentation of taxation up to date in such a manner that would be
expected from a solvent company as given in the section 588GA(4)(a) of Treasury Laws
Amendment Act (n4).
Due to the safeguards built into safe harbour. It may appear that it is a simple
harmless sign of encouraging the directors of a company not to call for premature liquidation
and not to incur risk of losing enterprise value.
Does the Justifications of Safe Harbour stand up?
For premature liquidation, though both 2010 Safe Harbour Paper and the 2017
legislation explanatory memorandum provide that liability of insolvent trading may cause
liquidation prematurely, it is not clear whether it is true or not.
In this regard, a director is needed to make the company to comply with all its
liabilities to pay for the withholding tax responsibilities as per section s 269-15 of the
Taxation Administration Act 1953 (Cth). This responsibility remains as long the company
does not pay the tax or is under liquidation or is paced in voluntary administration. Directors
are responsible for penalty equal to the sum of money owed by the company by issuing a
director penalty notice or DPN if they failed to their duties within a period of 21 days.

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Moreover, inhibition of inappropriate act during the insolvency of the company is a reason of
both liability as well as defence and the extent up to which they can be enforced.
The liquidators are also in problematic position for instituting insolvent trading suits
against the directors. The submission made by Insolvency Practitioners Association of
Australia (IPAA) to 2010 Safe Harbour Paper held that there is a misapprehension that
company can be either solvent or insolvent. It is difficult to demarcate between this stages as
there can be some transition phase. The IPAA stated that this difficulty is enhanced by the
claims made under section 588G are litigation intensive as held in Hall v Poolman (2009) 75
NSWLR 99.
Inapplicability of the Safe Harbour Justifications:
It was discussed above that the safe harbour was introduced with a justification of
overcoming the fears of the directors in relation to liability incurred from insolvent trading
leading to risk opposed behaviour mainly by premature liquidation of the company. The 2010
Safe Harbour Paper admitted that the company directors during financial difficulties are
instigated to involve in insolvent trading to incur benefits for them as shareholders at the cost
of the creditors (Harris 2016).
Apart from the difficulties faced by the liquidators enumerated above, the absence of
transparency and accountability about the internal affairs of a company which may lead to
formal liquidation, are reasons of serious concerns (Cook and Cowden 2017). It can be
possible that even if the directors breached their duties, the liquidators can institute suits
against them in company’s name. When the company has money left, the liquidators have to
make a difficult decision about how to spend it; whether to repay the creditors or to use to
bring an action against the directors to strengthen what is to be distributed.

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The situation for the advisors belonging to small companies is in contrast to that for
restructuring the large companies’ advisors. Advisors of pre-insolvency are an alarming cause
of concern mainly for ASIC as stated by Brown (Brown 2016). This issue was first brought in
to notice in the submissions made to the Senate ELC on the draft 2017 that points out taking
advice and suggestion from proper qualified entity who is provided with adequate
information to advice properly. The ASIC, the Australian Restructuring Insolvency and
Turnaround Association (‘ARITA’) and the Law Council of Australia all declared similar
cautions regarding the pre insolvency advisors (Arnold, Ferrier and McHattan 2019.).
Conclusion:
The objective of the 2017 ‘safe harbour carve out legislation’ is motivating the
directors of a company not to allow the liquidation of that company immediately in a pre
mature manner which results in loss to the share holders, investors as well as to the creditors.
Apart from this, this premature liquidation also results into economic loss to the society. It is
absolutely clear that the present insolvent trading responsibility and the defences it offers are
not made to allow provision for informal working out. Again, formal workout via the
Voluntary Administration system is very unpopular in present days. This article is not
intended to point out the loopholes of a legislation or any amendment instead it points out the
drawbacks that are present in the safe harbour provision. This safe harbour defence system
has shown a number of drawbacks. It creates a burden on the liquidators to prove their case
before the court when a safe harbour provision is claimed. It also gives the directors to
misuse their powers and involve into transactions with third parties like investors, creditors or
stake holders of a company for incurring personal benefits. This may result in to voluntary
insolvency of the concerned company. All these must be noted by the legislature for
providing suitable amendment to the relevant section of the Act. Moreover, changes need to
be made the directors more responsible to their works. More defences are to be made

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available to the directors for breach of their duties because in that case, they will be
encouraged to take more reasonable attempts to prevent voluntary administration and
liquidation, however, some control must be there to prevent them from incurring any further
personal gains at the cost of the investors.

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References:
Anderson, H., 2017. Shelter from the storm: Phoenix activity and the safe harbour. Melb. UL
Rev., 41, p.999.
Arnold, K., Ferrier, N. and McHattan, N., 2019. A quarterly round-up of the ARITA
specialist team's work on law and practice issues. Australian Restructuring Insolvency &
Turnaround Association Journal, 31(1), p.49.
Brown, A., 2016. ASIC: Releasing liquidator reports under FOI, action against pre-
insolvency advisor. Australian Restructuring Insolvency & Turnaround Association
Journal, 28(2), p.42.
Cook, D. and Cowden, M., 2017. Liquidator's remuneration: Good news for insolvency
professionals. LSJ: Law Society of NSW Journal, (33), p.78.
Dunn, J., 2017. Safe harbour. Company Director, 33(6), p.28.
Fryer v Powell (2001) 159 FLR 433, 442 [56].
Hall v Poolman (2009) 75 NSWLR 99.
Harris, J., 2016. Reforming insolvent trading to encourage restructuring: safe harbour or
sleepy hollows?. Journal of Banking and Finance: Law and Practice.
Horne, A., 2017. Call for review of Corporations Act. Governance Directions, 69(8), p.450.
Low, C.K. and Low, T.H., 2018. The Business Judgment Rule: A Safe Harbour for
Directors?.
Marsh, S. and Roberts, S., 2017. Personal liability for insolvent trading: Company directors
find berth in safe harbour. Governance Directions, 69(10), p.611.
Morley v Statewide Tobacco Services Ltd [1993] 1 VR 423.

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Simmons, O., 2019. Responsibility for Flawed Corporate Cultures. Jotwell: J. Things We
Like, p.1.
Southern Cross Interiors Pty Ltd v Deputy Commissioner of Taxation (2001) 188 ALR 114,
132 [98].
The Corporations Act 2001 (Cth).
The Taxation Administration Act 1953 (Cth).
The Treasury Laws Amendment Act (n4) 2019.