Company Law Report: Safe Harbour Provisions and Director Duties

This report delves into the legal complexities of safe harbour provisions within company law, specifically focusing on the duties and responsibilities of company directors. It examines the evolution of these provisions, particularly the amendments introduced under section 588GA of the Corporations Act 2001 (Cth), and their impact on insolvent trading. The report provides a detailed analysis of the background, including relevant case law such as Woodgate v Davis and ASIC v Somerville & Ors, and explores the issues that have arisen with the implementation of the safe harbour policies. It highlights the challenges in determining the scope of insolvent trading and the potential for directors to misuse the defence provided by safe harbour. The report also discusses the existing gaps in the current policies, particularly in defining 'reasonable practices,' and the burden placed on directors to prove they acted in good faith. The report concludes with recommendations for addressing these issues, including the implementation of an objective test and specific guidelines to ensure that directors do not misuse the safe harbour defence during company insolvency. The report is designed to provide a comprehensive understanding of this important area of corporate law.

Company
Law
SAFE HARBOUR

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 imposition of
these duties (Marshall & Ramsay, 2012).
 Effective compliance with these duties is important
for directors to make sure that they avoid legal
consequences.

Introduction
 The issue of recent changes brought by the
government in the duties of directors will be the
focus on this presentation.
 Particularly, this presentation will focus on the
issue of ‘safe harbour’ provisions implemented
by the government under section 588GA.
 This presentation will evaluate how these
provisions changed the duties of directors and
the remedies available for them.

Background
 Section 588G recognise a major duty of
directors relating to insolvent trading.
 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).

Background
 In 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.
 Violation of this section leads to imposition of
civil as well as criminal liability on the directors
of a company.
 The court can personally held directors liable
under section 588G (2) for engaging in
insolvent trading practices.

Background
 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 hold the defendant liable for violation
of section 588G for engaging in insolvent
trading (Sewell, 2018).

Background
 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)).

Background
 The director was not a part of the decision
making 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.

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 was
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).

Issue
 This is an issue because it made it difficult for
the court to determine which actions come
within the scope 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
development of the company.

Analysis
 As established by the court in the judgement of
Commonwealth Bank of Australia v Friedrich &
Ors (1991) 5 ACSR 115, a personal liability can
be imposed on a director if they engage in
insolvent trading.
 It was established in this case that the director
can be held personally liable for the debt which
is incurred when the company was insolvent.
 It was established that the director must not
engage in fraudulent practices when they are
aware that the company is likely to become
insolvent from the debts.

Analysis
 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.
 This could lead to 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.

Analysis
 Due to these policies, the deficiency in the
current safe harbour policies are highlighted.
 Currently, there are no provisions implemented
by the government to make sure that the
actions which comes 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.

Analysis
 This provision resulted in imposing the burden
on the director which is effective when it comes
to delivering of justice.
 The director is obligated to provide evidences 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
goes into liquidation and it was in the benefit of
its stakeholders.

Analysis
 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.
 However in many circumstances, it becomes
difficult for the court to establish which
decisions constitute as ‘reasonable’.
 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 with safe
harbour provisions, new policies should be
implemented by the government.
 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).

Recommendations
 However, this test is not enough and the
government should made 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.
 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 effectiveness
of this provision.

Conclusion
 To conclude, the implementation of safe harbour
policies is a recent corporate law issue relating to
the imposition of director duties.
 As per the new amendments, further defences
are recognised for directors to make sure that
they cannot be held liable if they take 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.

Conclusion
 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 that along with an objective
test, specific guidelines should be issued by the
government to clearly defines actions that
constitute as valid for directors during
insolvency of the company.

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+sa
fe+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.
 Woodgate v Davis (2002) 55 NSWLR 222