Safe Harbor: Protecting Directors from Insolvent Trading

This article discusses the concept of Safe Harbor and how it protects directors from being held legally liable for incurring debts during the insolvency period of a company. It explains the fiduciary duty of directors, the Australian Corporations Laws, and the responsibilities and requirements of the Safe Harbor Defense. It also explores the restrictions and limitations of the Safe Harbor Defense and provides real-life examples of directors breaching their duties. The article concludes with the importance of preventing insolvent trading and the impact of voluntary declaration of insolvency on organizations.

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Safe Harbor
Name
Institution

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Part A
Question: 1
The responsibility to prevent insolvent trading is a fiduciary act. The fiduciary duty is
demonstrated by directors who are charged with the responsibility of protecting the interests of
the investors. According to the Australian Law fiduciary duty is recognized in the law
prohibiting directors and managers from engaging in actions that may cause a negative effect to
organizations. While protecting corporations from engaging in insolvent trading refers to
corporations taking debts or making business decisions which they are unable to honor (Barker,
2016). The relation between insolvent trading and fiduciary can be linked to the process that
protects both the business and the directors for obligations which they are unable to fulfill.
The Australian Corporations Laws introduced in the Treasury Discussions Papers of 2010
section 588G prohibited companies from engaging in trading activities involving obtaining of
debts while insolvent (Gevurtz, 2010). This act states that directors who engage in insolvent
trading are to be held legally responsible and liable. It’s the responsibility of the directors to
practice prudent corporate governance acts that will not make them liable.
To ensure fiduciary acts are upheld directors need to take due diligence in dealing with
different elements of insolvency trading laws under Sections 588G (Cox, 2015). The directors of
companies need to ensure that they don't incur debts while the company is under liquidation.
Insolvency trading, while a company is facing liquidation, exposes the directors to legal
liabilities. This is because the directors under fiduciary duty are responsible for ensuring the
company is able to meet all its financial obligations. It’s unethical and unprofessional for a

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company to take debts while it’s being liquidated because the process of liquidation involves
winding up the business and paying those who are owned.
To prevent trading while a business is insolvent shows an act of good faith and can be
demonstrated by the directors having business forecast and projection. Fiduciary in dealing with
financial institutions and equity demands directors not engage in interests that may conflict with
the corporations they manage.
Answer to Question: 2
The Corporations Acts of 2001 were amended in 2017 and the Safe Harbor Defense for
directors introduced to the act under the Treasury Discussions Papers of 2010 relating to
insolvency Tradings. The Safe Harbor Defense operates by discouraging directors of
corporations from engaging in insolvency trading and seeking alternative ways of operations that
do not present legal challenges. As the name suggests ‘safe harbor defense’ presents an
environment that does not conflict with either the business or the law.
The Safe Harbor Defense gives the directors an alternative business restructuring option
of not acquiring debts while the business is facing insolvency challenges (Gleeson, 2012). The
main reason for the enactment of Sections s588G was based on the business report by the
Commissions for Productivity of Australia that was released in 2015.
Safe Harbor Defense operates on the basis of creating a business sustainability culture. Based
on prudent business judgment, the act operates on the basis of the directors developing strategies
within the organization to rescue the business from within. The act is contained in Section
588GA Subsection CA. This act provides the directors with the following responsibilities that
shield them against prosecution.

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 There should be evidence on the side of the directors that due diligence was followed to
prevent the business from being insolvent. Among this provision is evidence of proper
record keeping detailing the financial position of the company before and after the
company becomes insolvent.
 Evidence of the directors obtaining advice from qualified and approved consultants in
their line of business (Tucker, 2016). This advice needs to be quantified with detailed
steps and strategies enacted from the professional advice received in restructuring the
business to profitability.
 The 588GA Act demands that the directors have to provide evidence that shows the debts
were undertaken to better the business. This provides a safe harbor that does not hold the
directors liable because the debts are not obtained towards any other function apart from
business restructuring.
The Safe Harbor Defense does not apply to directors in situations where debts are not
according to the provisions of 588GA which includes financial reporting. The directors are
required by the act to ensure that financial statements that include, notices, tax reports and profit
warnings are issued on time. Failure by the directors in providing the financial position of the
business will make them not qualify for the safe harbor defense. This is because the lack of
transparency may depict conflict of interest on the part of the directors which makes them liable.
Answer to Question: 3
The provision of s588GA protects directors from being held legally liable for incurring
debts during the insolvency period of a company. The Act shields directors acting in accordance

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with the law in ensuring taking measures for business continuity. Some of these measures
include capital injection to the business which may involve getting into debts.
The Businesses Judgments Rules s180 (2) of the 2001 Corporations Act advises directors
of corporations to practice due diligence in strategic efforts to prevent businesses from going
insolvent. Business judgment according to s180 (2) dictates that the directors of companies will
be held responsible for the actions they undertake in meeting the organization's obligations
(Hopt, 2015). These actions are always based on the nature of the business and experience of the
directors as provided in the preceding act s180 (3).
The main difference between the provisions of s588GA and Businesses Judgments Rules
s180 (2) of the 2001 Corporations Act is in relation to how the directors operate in taking due
diligence. The provisions of s180 (2) prevents directors from having any personal interest with
the business they are managing. This is aimed at guarding the directors against having any
unbiased or subjective prejudices towards making sound decisions.
ASIC v Casimantis 2015
The case of The Commissions for Investment and Securities in Australia against
Stompers Financial Services provide a distinction and application of both s588GA and The
Businesses Judgments Rules s180 (2). The financial services provider was sued by the
commission for relying on advice that leads to massive losses of the financial institution and its
ultimate liquidation.
The commission found Stompers Financial Services breached s180 (2) of the business
judgment law by relying on the professional advice of one its directors Mr. Casimantis
misadvised investors who were approaching retirement to take mortgages which they were

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unable to service to completion because of age and retirement. This action made most of the
investors and the financial institution to become insolvent (Hanrahan, 2018). While the actions
were done in good faith, according to s588GA, the court found out that due diligence was not
taken in the process and ruled as follows in convicting Mr. Casimantis who was one of the
financial institution director’s.
Answer to Question: 4
There are several restrictions to the operation of s588GA protection.The Corporations Act
will not provide protection and shield directors who breach the following provisions of the law.
 According to s588GA (6), the court of law can order the withdrawal of the defense
provision if there is sufficient evidence that due diligence was not carried out by the
directors and also in upholding the rule of law which includes the laws of tort and
common law.
 This provision will also not prove a protection to debts that may have been gotten before
the start of the safe defense period.
 The safe harbor will not apply if, during the restructuring period, the directors fail to
provide proper financial reporting statements showing the true financial position of the
company (Lozano, 2015). This helps the regulating agencies to monitor the financial
recovery process of the company in a transparent way.
Answer to Question: 5
Corporation Laws are in constant change to conform to changes in the economy and
society. Changes made to Division 3 of the Corporations Act s588GA have improved the way
corporations declare insolvency. Voluntary closing down of a company can be due to various

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reasons. Businesses closing due to liquidity challenges are referred to have taken a special
resolve to wind up the business. The law provides in Section 491 of the Corporations Act the
circumstances under which voluntary winding up is permissible.
The changes in Division 3 will provide a further safe haven for business to restructure.
Despite the law being a vigil in ensuring that enterprises thrive, The Enterprise Law has allowed
businesses to have an extra capital injection (Jacobs, 2015). This practice will drastically reduce
the number of companies that will be declared insolvent.
The main cause of insolvency is liquidity challenges and with the changes in Division 3,
and the advancement in the Corporations Act, it’s unlikely for businesses to be insolvent. A case
in point of challenges that businesses face that the Capital Incentive has addressed include the
ones in the Menhard v. Salmons.
The 1920 case of Menhard v. Salmons that was presided in the US Court of Appeal found
the defendant Menhard failed to act with utmost good faith towards his business partner
Salmons. The plaintiff claimed that Menhard gained an undue advantage and profited from their
business partnership without informing him as a co-director of the company. This case
demonstrates a breach of the principle of fiduciary. The court in its ruling delivered by Judge
Benjamin held that;
"The level of operation by fiduciaries needs to be beyond reproach and higher than the
common law and law of torts. Fiduciaries have to act in utmost good faith with honesty to
their business partners and honesty."
The judgment was praised to have set precedence on future breach of fiduciary cases.
Preventing insolvency trading according to Section 588a ensures that both the law and trust is

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maintained in the business. This also prevents the directors from being held liable for incurring
debts that the business cannot honor.
The challenges that organizations face after the voluntary declaration of insolvency may
directly or indirectly hinder many organizations and limit future business ventures (Kraakman,
2017). This is due to the nature of what the business environment may perceive to have caused
the insolvency in which most of the times is due to poor management.
The action of a voluntary declaration of insolvency can also be attributed to the
admittance of guilt and liability. The safe harbor provision may not apply in these cases because
instead of admittance, the directors have been given the responsibility of restructuring the
business. Despite very adverse cases beyond the economic capabilities of the directors it's when
voluntary declaration for insolvency is allowed.
Part B
Answer to Question: 1
Mr. Daly’s actions and three other directors of Investors Incomes Opportunity Fund were
found guilty and legally liable by Judge Rogers of The Federal Court for breaching several
Corporations Acts and Laws. Mr. Daily and the co-accused directors were charged with the
responsibility to invest and protect their clients’ money in the IIOF financial services fund they
managed. Among the unethical actions by the directors included advancing to themselves
personal loans using their clients’ money. This is both morally and legally wrong. The following
director’s duties were breached by Mr. Daly.

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 Mr. Daly breached fiduciary duty that was his responsibility to ensure that he acts in the
best interest of the clients (Chen, 2018). Instead of acting in good faith to protect the
investors’ money he advanced himself loans. Some of the loans were not in the best
interest of the business and the investors like funding the daughter’s expensive wedding.
 Due diligence was not followed by the directors of IIOF in policy making and decision
making. It was the responsibility of Mr. Daly to ensure the investors got 8% in
investments of their funds.
 Mr. Daily failed in his duties as the managing director for IIOF by not following the
Corporations Acts 2001 and its subsequent provisions that would have provided a safe
harbor for IIOF.
Answer to Question: 2
The other three directors of IIOF also breached several duties that they were responsible to
oversee. Despite Mr. Daly is the managing director, it was the responsibility of the other
directors to advise and support the rule of law and Corporations Acts (Hanrahan, 2018). Among
the duties that the directors breached included the following.
 One of the directors was accused of taking a personal loan from the investors’ fund to
finance his divorce proceedings. This is in contravention of fiduciary law and the
common law. The divorce was a private matter and did not warrant to be given the loan.
 The other directors are also accused of failing to adhere to transparency and openness to
their clients. The directors were running two funds simultaneously and failing to invest

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clients’ money in government bonds and mortgage schemes as agreed. Alternatively, they
were using the unregistered fund's schemes to expand their private business operations.
 The directors were accused of running IIOF like a Ponzi scheme. Records proved that the
money that was being collected for investment was being used to pay taxes and
employees. This is very wrong because investment funds are only meant for investment
and not for expenditure.
Answer to Question: 3
IIOF Company was trading while it was insolvent. This was proved by the investigations
and financial statements that were presented before the High Court as evidence (Horrigan, 2010).
The expenditure records presented before the court showed that the company was paying for
utility bills and other financial obligations like taxes using investors' money.
Another evidence of the company operating while insolvent was presented by the failure
of the directors complying with s588G which could have provided a safe haven for the directors
(Hobbs, 2014). The directors could have declared to the authorities about their true financial
position. This could have helped them trade in relation to the safe harbor provision.
Failure to honor financial obligations to their investors and shareholders also proved that
the company was operating while it was facing liquidity challenges (Hill, 2012). Due to improper
financial decisions, the financial institution was bound to face financial challenges.
Answer to Question: 4
There are some safe harbor defenses that Mr. Daly and the other directors can use to
explain their conduct of trading while facing insolvency challenges (Page, 2010). The first

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defense is that the company had consulted the services of a financial consultant to advise them
on how to restructure as provided in the Corporations Acts. Unfortunately, this defense may not
hold because the financial consultant advisory was not followed by the directors.
There is no other visible defense because IIOF had good policies on paper which were
never put into action (Mann, 2012). Lack of transparency and poor reporting also may weaken
any defense applied. The fact that the money misappropriated was used for unnecessary things
and not for the betterment of customers portfolio also shows lack of any due diligence followed.
Answer to Question: 5
The new safe harbor defense can assist the financial institution if proper measures and due
diligence is followed to incorporate the s588 provisions of the Corporations Acts (Arnold-
Moore, 2018). IIOF will be required to address the following measure for the safe harbor
provision to apply.
 Declare to the AISC about their financial position. This will be based on transparency
and how the client's funds are to be invested.
 Procure and adhere to the services of a financial consultant to aid IIOF in corporate
restructuring.
 Develop a strategy for business continuity that will ensure all the investors are paid.
The safe harbor provision for defense will apply to IIOF after the above conditions have been
followed according to s588 provisions of the Corporations Acts 2001.

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