Safe Harbour Provisions for Directors of Insolvent Companies

This article discusses the safe harbour provisions introduced for directors of insolvent companies in Australia, highlighting the differences between the present and earlier norms, and analysing the effectiveness of the new law. It also provides recommendations for improving the provisions and concludes that they are effective in providing safeguards for directors to adopt turnaround measures that allow the company to continue its business instead of going into liquidation or voluntary administration.

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TABL5541
Insolvency and Directors
03-Apr-18
(Student Details: )

TABL5541
Introduction
With the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act, 2017 (Cth), a new
safe harbour was introduced for the directors of insolvent companies (Renfrey and Gaertner,
2017). Part 1 of this act is particularly focused on creation of safe harbour, whereby the
Corporations Act, 2001 (Cth) was amended to bring this provision, where the safe harbour
protects the directors from personal liability for such cases where the company indulges in
insolvent trading, particularly when the company undertakes a restructuring in some situations
(Austlii, 2017). The goal of this statute is to drive cultural change in the directors of the
company, where they are encouraged to engage early in cases of financial hardship, where they
keep control of the company and also take the rational risks for facilitating the recovery of
company in place of getting the company in liquidation or voluntary administration prematurely
(Murphy, 2017).
This discussion is aimed at highlighting the provisions which applied earlier on the insolvent
trading and the liability affixed on the directors in comparison to the present provisions. The
discussion would also analyse the effective of part 1 of the amendment and would end with
recommendations in context of the need of continuing the new law.
Difference between present and earlier norms
Before 18th September 2017, the insolvency laws of Australia resulted in the directors bearing the
personal liability for the debts which were incurred when the company in which they were
directors, traded while it was insolvent (Lacey, 2017). Under section 588G of the Corporations
Act, the directors have been imposed with a duty of preventing the company from being engaged
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in insolvent trading (Cassidy, 2006). These were present when the person had been the director
of the company when the company had incurred the debt; at the time, the company had been
insolvent, or became insolvent due to the company undertaking the debt; and there had been
reasonable grounds to suspect that the company was about to become insolvent or was actually
insolvent at that time (Paolini, 2014). The goal of this section was to discourage the directors
from permitting the companies from incurring or undertaking the debts which they would not be
able to repay. Though, the result of this provision was also such that the directors were
encouraged to engage their company in premature formal insolvency process, even in such cases
where the company could have been easily in running or viable for a long duration
(MinterEllison, 2017).
With the 2017 amendment, two new sections were added in the Corporations Act, which is also
referred to as the safe harbour provisions under section 588GA(1) and 588GA(2) of this act
(Rigby Cooke Lawyers, 2017). These provisions present that the director would not the personal
liability for debts which the company incurs at such a situation when it had been insolvent,
provided it can be clearly established that the director had started developing a course of action,
or more than one courses of action, which in a reasonable manner were likely to result in a better
result for the company, and that the debts were being incurred in a direct or indirect manner in
connection with such course of action (EY, 2017).
Part 1 of the Amendment
With the safe harbour provisions, a better outcome for the company has been defined in terms of
being such an outcome which is better than a liquidator or an administrator being immediately
appointed for the company. Further, it also presents a non exhaustive guide on what needs to be
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taken into consideration when the matter of course of action being reasonably likely to result in
better result for the company is determined (Maiden and Papaleo, 2017). The guidance included
under these sections include the director informing them properly regarding the financial position
of the company, the director taking proper steps for restricting misconduct by employees or
officers which could affect the ability of company paying off its debts in an adverse manner, the
directors to take proper steps in making certain that the company keeps proper financial records
which are consistent with the nature and size of company, the directors obtaining advice from
properly qualified entity who had provided proper information in giving this advice, and a
director developing or implementing a plan for the purpose of restructuring the company for
improving the financial position (Federal Register of Legislation, 2017).
In this context, a failure of doing these things would pose a risk of the provisions of safe harbour
being unavailable. Though, the only practical result of proposed actions still requires assessment
and this is paramount. An important point worth noting here is the area where these provisions
would not be applicable. The director would not be able to make use of safe harbour provisions
where they make use of books and information regarding the company as proof that reasonable
course of action had been undertaken where they have not provided such material to the
administrator or liquidator after a request for such materials; and that reliance on safe harbour in
situations where company is not complying with its obligations related to employee entitlements,
taxation reporting obligations and superannuation (Davies, 2017).
The Corporations Act, 2001 has been changed to bring in the safe harbour provisions to save
directors from personal liability which is raised from insolvent trading under section 588 G in
such cases where the company adopts restructuring out of formal insolvency. This is allowed
when the company incurs the debt in course of action in reasonable period of time, and which is
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reasonably likely to result in a better outcome (Narushima, 2017). These provisions have been
deemed as a landmark reform which is expected to energise the economy and business. This is
the view of AICD as in their opinion, the safe harbour provisions would allow the directors to
take common sense steps when it comes to rehabilitation of the distressed businesses (Hughes,
Powers and Sommer, 2017). With this reform, a potential for attracting a greater engagement, as
well as, investments in the new businesses from the experienced directors is noticed. These
provisions bring the possibility of saving the businesses before formal insolvency is initiated and
can get better results for the creditors and employees as well, particularly when they hold interest
in the long terms success of the company. These provisions are conditional on certain
requirements being met by the company and the directors are required to fulfil the present
statutory obligations for providing help in cases of liquidation or administration (McGirr, 2017).
An important point which is to be followed under these sections is that the directors have to
pursue reasonable course of action. The directors would be protected under these provisions only
when they adopt a reasonable course of action resulting in better outcome for the company in
comparison to the winding up or voluntary administration of the company. This protection is
applicable from such time where the director adopts a course of action once they begin to suspect
that there is a possibility of company becoming insolvent and has to apply the course of action to
get better results for the company in place of forcing it towards external administration. Again,
important thing to note here is that this aspect of the new provisions would be assessed on
objective basis. The protection cover through safe harbour is extended to the period where the
preparations and deliberations regarding the course of action take place, and would also depend
upon the particular situation of the case. There is a wide application of safe harbour in context
that the directors have been provided with ample latitude for adopting a course of action which
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can be deemed as proper and appropriate regarding the nature, size and complexity of the
company (Hughes, Powers and Sommer, 2017).
Recommendations
Current law needs to be maintained
There is a dire need to uphold the present provisions for a number of reasons. But of course the
most important reason is to stop the companies being pushed into voluntary administration or
liquidation, but there are a number of other factors as well. There are a number of noteworthy
aspects covered within these provisions which make these sections quite commendable. In this
context is the inclusivity of direct and indirect debts. The provisions of safe harbour relate to the
debts which had been incurred directly or indirectly regarding course of action. This is a major
win-win situation as it clarifies that safe harbour would be available in such cases where the
directors pursue multiple strategies. Further with regards to the debts which were not related in a
direct manner to the turnaround strategy in itself, like the ones which were undertaken in normal
course of ongoing trading, these too would be included (Apáthy, Spencer and Cronk, 2017).
Again, the legislation has been drafted in such a manner that the better outcome has to be
adopted in context of the company alone, instead of it being on creditors as well, as had been
proposed earlier. There is a need to note down that safe harbour does not result in a restriction
being placed on entry into a scheme or receivership. It only stops the company from going into
liquidation or voluntary administration, which is a point from where the directors are no longer
liable or have the control of the company, before it has analysed the possible turnaround
strategies. Where these turnaround strategies are not found or not feasible, the company can go
forward with the scheme of arrangement or receivership (Apáthy, Spencer and Cronk, 2017).
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However, there is scope of improvement
In order to make these provisions more effective, certain suggestions have been covered under
this segment. The first recommendation is for the safe harbour provisions to be reviewed
independently in a span of two years since these provisions came into effect. There is a need for
clarifying before the public that the insolvent trading safe harbour are not a defence, and instead
presents an exception to the regime of insolvent trading. It is also recommended for the directors
taking on these provisions to develop more than one course of action, so as to be able to compare
which one offers the best outcome for the company, in place of only taking that course of action
which is easy or developing a course of action when another course of action has already been
adopted. This would help in clarifying that the directors would gain benefit of these provisions
only when they develop and explore a number of turnaround strategies in place of requiring to
select and pursue the immediately or easily available strategy. In context of better outcome for
the company alone, there is a need to bring clarity on what the company means here. There is
also a need to clarify on what the better outcome would be assessed for different stakeholder
groups, particularly ones other than the creditors (Apáthy, Spencer and Cronk, 2017).
Conclusion
On the basis of the discussion undertaken in the previous parts, a conclusion can be drawn that
the amendments brought through part 1 of the 2017 act are quite effective one. They cancel out
the problems which had been earlier posed in the erstwhile section 588G of the Corporations
Act. With these new provisions, a new life is given to the company as the directors are given
safeguards to adopt turnaround measures which would allow for the company to continue its
business, instead of going in liquidation or for voluntary administration. These are landmark
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provisions which work in a manner which results in the best outcome for the company. Even
though some of the provisions which had been proposed when the act was still in its bill ages
were inadequate, these were given away when the provisions were actually drafted in the 2017
legislation. This is the reason why these provisions have become favourable at least in the
present context. Still, this discussion has highlighted the scope of improvement for these
provisions, which would help in cancelling out some of the problems still present under these
amendments.
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References
Apáthy, P., Spencer, S., and Cronk, L. (2017) Revised And Improved: New Insolvent Trading
Safe Harbour And Ipso Facto Legislation Passes Through The Senate. [online] Available from:
https://www.herbertsmithfreehills.com/latest-thinking/revised-and-improved-new-insolvent-
trading-safe-harbour-and-ipso-facto-legislation [Accessed on: 03/04/18]
Austlii. (2017) Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017. [online]
Available from: http://classic.austlii.edu.au/au/legis/cth/bill_em/tla2017ein2b2017537/
memo_0.html [Accessed on: 03/04/18]
Cassidy, J. (2006) Concise Corporations Law. 5th ed. NSW: The Federation Press.
Davies, X. (2017) Summary Of The Safe Harbour Insolvency Law Reforms. [online] Available
from: https://www.linkedin.com/pulse/summary-safe-harbour-insolvency-law-reforms-xian-
davies [Accessed on: 03/04/18]
EY. (2017) How safe is Safe Harbour? Understanding how to navigate financial stress. [online]
Available from: http://www.ey.com/Publication/vwLUAssets/ey-how-safe-is-safe-harbour-
understanding-how-to-navigate-financial-stress/$FILE/ey-how-safe-is-safe-harbour-
understanding-how-to-navigate-financial-stress.pdf [Accessed on: 03/04/18]
Federal Register of Legislation. (2017) Treasury Laws Amendment (2017 Enterprise Incentives
No. 2) Act 2017. [online] Available from: https://www.legislation.gov.au/Details/C2017A00112
[Accessed on: 03/04/18]
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Hughes, M., Powers, L., and Sommer, A. (2017) Insolvent trading safe harbour and ipso facto
reform exposure draft legislation and explanatory materials released. [online] Available from:
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Lacey, A. (2017) Safe Harbour and Ipso Facto reforms pass into law. [online] Available from:
https://www.mccabes.com.au/safe-harbour-ipso-facto-reforms-pass-law/ [Accessed on:
03/04/18]
Maiden, S.C.S., and Papaleo, N. (2017) Safe Harbour laws commence operation and ipso facto
laws pass into law. [online] Available from:
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ipso-facto-laws-pass-into-law/ [Accessed on: 03/04/18]
McGirr, M. (2017) Landmark ‘safe harbour’ legislation, a reform that could energise businesses
and the economy, has now passed Parliament, and will become law. [online] Available from:
https://aicd.companydirectors.com.au/membership/the-boardroom-report/volume-15-issue-9/
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MinterEllison. (2017) Insolvent trading safe harbour and ipso facto reforms pass the Parliament.
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and-ipso-facto-reforms-pass-the-parliament [Accessed on: 03/04/18]
Murphy, J. (2017) Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017.
[online] Available from: https://www.aph.gov.au/Parliamentary_Business/Bills_Legislation/bd/
bd1718a/18bd033 [Accessed on: 03/04/18]
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Narushima, H. (2017) Director safe harbour and ipso facto insolvency reforms receive Royal
Assent. [online] Available from: https://www.lexology.com/library/detail.aspx?g=a210c2a0-
0858-4077-9e72-8c39e9b39a10 [Accessed on: 03/04/18]
Paolini, A. (2014) Research Handbook on Directors Duties. Northampton, Massachusetts,
United States: Edward Elgar.
Renfre, B., and Gaertner, S. (2017) Insolvency law reform - stay on enforcement of ipso facto
clauses. [online] Available from: https://www.lexology.com/library/detail.aspx?g=b03c7293-
25f8-4a15-b958-30fe05bfe564 [Accessed on: 03/04/18]
Rigby Cooke Lawyers. (2017) ‘Safe Harbour’ and ‘ipso facto’ insolvency reforms - what do they
mean and what will they do? [online] Available from: http://www.rigbycooke.com.au/latest/safe-
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