Despite an expanded COVID-19 safe harbour regime from insolvent trading, directors need to be aware of traps and pitfalls that could lead to personal liability
Businesses have already suffered disruption from the COVID-19 pandemic, whether in supply chain disruptions, employee health or contracts. As the pandemic continues to evolve, it is likely these disruptions will continue to be felt in the medium-term, with restrictive measures expected to remain in place for at least six months.
The expanded safe harbour regime
Australian companies face the prospect of solvency issues over this time. In the face of this, the Australian Parliament has passed the Coronavirus Economic Response Package Omnibus Act 2020, which provides temporary measures aimed at assisting companies to trade through a temporary period of illiquidity rather than enter external administration.
One of the measures is to relieve directors from the risk of personal liability for insolvent trading for a six-month period from 25 March 2020 (although the period can be extended by regulation).
To fall within the extended safe harbour provisions, the debt must have been incurred in the ordinary course of the company’s business, during the 6-month period (or longer period if extended by regulation) and before any appointment during that period of an administrator or liquidator.
Holding companies can also rely on the extended provisions in relation to insolvent trading by a subsidiary. The holding company must take reasonable steps to ensure the temporary safe harbour applies to each of the directors of the subsidiary and to the debt(s). The temporary safe harbour must also actually apply in relation to each of the directors and the debt(s).
It is crucial for directors (and holding companies) to bear in mind that they will need to evidence each of the above factors. While the unusual circumstances of the pandemic may lead to a risk that some debts incurred are not “in the ordinary course of business”, the explanatory memorandum is clear that any debt “necessary to facilitate the continuation of the business” is taken to be in the ordinary course. Directors should ensure that decisions made and debts incurred over this period are documented to assist in making out this defence if necessary.
The existing safe harbour regime
The temporary period for the extended provisions is set to end on 25 September 2020, but the financial impacts such as delayed recovery from debtors, changes to supply terms or heightened voidable transaction risks are likely to continue much longer. Directors can seek to utilise the existing safe harbour regime to protect against debts incurred outside the ordinary course of business or once the temporary period for extended safe harbour ends.
To fall within the existing regime requires directors to be actively developing or taking a course of action that at the time was reasonably likely to lead to a better outcome for the company than immediately entering external administration. Relevant factors include obtaining external advice from a properly qualified advisor and developing or implementing a restructuring plan. The existing safe harbour provisions will not apply where a company has not complied with its obligations to pay employee entitlements (including superannuation) or not meeting tax reporting obligations.
Neither the existing or new safe harbour regimes protect directors against criminal penalties from insolvent trading where fraud or dishonesty is involved.
Directors must also bear in mind that their usual duties continue to apply over this period, including to act with care and diligence, in good faith in the best interests of the company and for a proper purpose.
It is likely that the disruptive effects of COVID-19 will affect companies’ cash flow and operations for some time. As the extended safe harbour provisions are currently set to expire 25 September 2020, directors should consider taking steps now to fall under the existing regime. Developing or taking a course of action reasonably likely to lead to a better outcome than administration or liquidation not only benefits the company but also works to protect directors’ positions after the new regime expires.
If you would like further information or advice about addressing liquidity or solvency concerns, please contact us.
This publication has been prepared for general guidance on matters of interest only and does not constitute professional legal advice. You should not act upon the information contained in this publication without obtaining specific professional legal advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication and to the extent permitted by law, Cowell Clarke does not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting or refraining to act in relation on the information contained in this publication or for any decision based on it.