Insolvent trading, safe harbour and directors’ duties

The federal Government recently announced temporary changes to existing insolvency laws in order to provide relief for businesses in financial distress during the COVID-19 crisis, including;

  • an additional ‘safe harbour’ from insolvent trading liability; and 

  • an increase to the minimum threshold at which creditors can issue a statutory demand from $2,000 to $20,000, and an extension of the time companies have to respond to a statutory demand (six months, rather than the usual 21 days).

Whilst these measures will be welcomed by companies whose viability has been threatened by the ongoing pandemic, they are not a free pass to trade while insolvent. The measures  should be viewed as immediate relief for companies who need time to assess how COVID-19 will affect their business, take advice, and either develop a turnaround plan or consider appointing administrators.
 
Additionally, these measures may result in a shifting of credit and liquidity risk to suppliers, and other creditors, who are dealing with struggling companies. This represents an additional reason to be more vigilant with trading counterparties and consider (amongst other measures) adjusting trading terms to reduce this risk. 

Additional insolvent trading safe harbour

The temporary safe harbour measures (COVID-19 Safe Harbour) will provide additional protection to directors from personal liability, for debts incurred while trading insolvent, provided that the company incurs the debt: 

  • in the ordinary course of its business; and

  • during the six-month period of the COVID-19 Safe Harbour.

There is some uncertainty around what constitutes the ‘ordinary course of business’,  the explanatory memorandum that introduced these changes defines it as “a debt necessary to facilitate the continuation of the business” during the six-month period of the COVID-19 Safe Harbour. This potentially narrow definition should provide directors some pause when seeking to only rely on the additional safe harbour measures.

Don’t forget the existing safe harbour

The original safe harbour provisions were introduced in 2017 to protect directors from liability for insolvent trading while they are pursuing a turnaround plan.

This regime applies where a director starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the company than the immediate appointment of an administrator or liquidator.
 
The 2017 safe harbour provisions operate as a carve-out from the insolvent trading provisions of the Corporations Act (which otherwise remain unchanged), providing the directors protection from any personal liability for debts incurred by the company, directly or indirectly in connection with any such course of action. The protection, however, only applies to directors acting honestly and diligently and who have ensured that the company has:

  • complied with its obligations to maintain adequate books and records

  • paid employee entitlements when due (including superannuation)

  • kept up to date with its tax reporting obligations (being no more than three months in arrears)

Directors’ duties still apply

Even if directors are relieved of liability from insolvent trading, they must still consider their duties (fiduciary, care and diligence, prohibitions of misleading and deceptive conduct). All directors should be aware that if their company is (or near) insolvent, they have a duty to consider the interests of creditors.
 
A failure to act with due care and diligence in a manner that prejudices creditors may leave directors personally exposed to claims, by the company (either directly or by external administrators). As such, directors must continue to identify and deal with the issues confronting their businesses, and mitigate the impact those issues may have on their creditors, particularly if they envisage the issues extending beyond the next six months.
 
The documentation and implementation of plans to address business issues will be critical for directors. Where plans become impractical or unrealistic, consideration should be given to external administration options.

What does this mean for creditors?

The changes to the statutory demand provisions will impact creditors who would otherwise rely on the statutory demand process as a reasonably cheap and simple way to pressure debtors to pay outstanding debts.
 
More broadly,  the temporary changes to insolvency laws in relation to the COVID-19 crisis will increase risks for companies who are creditors to companies in distress themselves, or have counterparties and customers experiencing financial difficulty. Now is the time to think about ways in which you can reduce your own risk and minimise the impact if one of these parties were to become insolvent. For instance, you may consider:

  • staying on top of your terms of trade. If possible, more frequently require payment upfront rather than extending credit. This will reduce your risk of voidable transactions;

  • reviewing your contracts and terms of trade to ensure that they are enforceable;

  • asking for personal guarantees from directors;

  • understanding your PPSR position – Are you able to register an interest? If you have existing registrations, have these been registered correctly?

  • if necessary, take legal proceedings to enforce your debts.

How can Moore Stephens help?

Moore Stephens can assist companies and directors to navigate the web of rights and obligations that have become more relevant than ever during the current COVID-19 crisis. Our network of legal and financial professionals can help you recognise where you stand in relation to your own business and those you transact with.