The outbreak of COVID-19 has delivered a shock to the global economy and disrupted, if not devastated, countless Australian businesses. As we navigate these uncertain and unprecedented economic times, company directors must ensure they remain diligent and proactive in the steps taken to keep their businesses afloat. The COVID-19 pandemic puts many Australian businesses in financial distress and at risk of insolvency.
The Commonwealth Government has relaxed insolvency laws, including around insolvent trading, in an effort to encourage businesses to continue trading. Directors should be aware of these changes and also the availability of “safe harbour” protections under the Corporations Act.
Duty to prevent insolvent trading
Directors have a duty under the Corporations Act to ensure their company does not trade whilst insolvent. Directors who breach this duty may be liable for the debts incurred when the company is insolvent, and in certain circumstances can face criminal prosecution.
A safe harbour from insolvent trading – recent updates to legislation
On 23 March 2020, both Houses of Parliament passed the Coronavirus Economic Response Package Omnibus Bill 2020 (Coronavirus Bill). This legislation creates a temporary “safe harbour” for directors of companies which may be at risk of becoming insolvent, and trading whilst insolvent, over the next six months.
It is relevant to note that in 2017, the Corporations Act was amended so as to create a “safe harbour” to protect company directors from personal liability for insolvent trading. This regime continues to operate alongside the new safe harbour provisions.
Ordinarily (and as stated above), a director who incurs a debt while the company is insolvent can be liable for civil and criminal penalties. However, under the new expanded safe harbour provisions, directors will not be liable for insolvent trading if the debt is incurred in the “ordinary course of the company’s business” and before an administrator or liquidator is appointed. These provisions came into effect on 26 March 2020. These changes will apply for six months.
A debt incurred in the “ordinary course of business” includes a debt which is necessary to ensure the business can trade. This could include, for example, a loan taken out in order to facilitate the move to operations online, or debts incurred through continuing to pay employees undertaking critical activities.
In short, this legislation essentially relieves directors of their duty to prevent insolvent trading, as it enables companies to continue trading during a period in which there is a lack of liquidity without exposing directors to liability.
It is relevant to note, however, that if insolvent trading is later alleged and a director seeks to rely on the new temporary safe harbour provisions, the director has the burden of proving the debt was incurred in the ordinary course of the company’s business.
The existing safe harbour regime
Whilst the new (but temporary) provisions introduced by the Coronavirus Bill operate alongside the existing safe harbour regime, in practice, these provisions effectively supersede the existing regime.
Notwithstanding the new provisions, however, it would be prudent for directors to do everything they can to ensure they are otherwise in the “safe harbour.” That is, directors should develop a planned course of action for the company to trade out of financial difficulty.
The existing safe harbour regime provides that a director will not be held personally liable for insolvent trading if the following conditions are met:
Eligibility for safe harbor protection requires the company to pay employee entitlements (including superannuation) and to maintain compliance with tax reporting and payment obligations.
Directors should take the following minimum steps:
Directors of companies in distress should:
It is evident that directors can expect some latitude in the present climate. That is not to be interpreted as a licence for directors to act in dereliction of their duties or otherwise than in accordance with principles of good corporate governance or sound commercial judgment.
Directors who take proactive and decisive steps aimed at improving the financial position and viability of their businesses will put themselves in the best position to both reduce the risk of personal liability for insolvent trading and improve the likelihood of their business emerging from the COVID-19 pandemic intact.
If you would like to discuss how these legislative updates will affect your business, please contact Justin Sharman.
This article provides general comments only. It does not purport to be legal advice. Before acting on the basis of any material contained in this article, we recommend that you seek professional advice.
Justin Sharman, Princpal in our Disputes Team
Phone: +61 8 8210 2279
Annika Beaty, Lawyer in our Disputes Team
Phone: +61 8 8210 2225