Essential tips to avoid personal liability – Part 1
The safe harbour is designed to support company directors to pursue an active turnaround or recovery strategy with protection from civil insolvent trading liability.
The recently introduced Section 588GA of the Corporations Act 2001 (‘the Act’), acts as carve out to the insolvent trading penalties under Section 588G of the Act. This could prove to be a valuable tool for directors of all sized businesses who have the business nous and resources to steer their company away from a formal insolvency administration.
Existing legislation attempts to deter insolvent trading by focusing on the solvency of the company and the time at which debts are incurred. Personal exposure to directors can arise when there are reasonable grounds for suspecting the company might become insolvent. As a result of these deterrent provisions, directors can experience concern as to their personal exposure, leading to the premature appointment of an external administrator. Furthermore, experienced directors may be deterred from being involved in new enterprises in order to avoid further risks to personal exposure. The Government’s National Innovation and Science Agenda argued that these factors lead to a depressed culture of innovation and entrepreneurship in Australia, hence the introduction of counter measures like Safe Harbour which attempt to reward success.
Meeting the Safe Harbour Criteria
A company director will only be liable for debts incurred while the company was insolvent where they were not developing or taking a course of action reasonably likely to lead to a better outcome than external administration or liquidation (s588GA of the Act). Safe Harbour also limits the liability of a holding company under s588V of the Act where the holding company was helping the directors meet the qualification criteria. To qualify:
- The company must comply with obligations to pay employees including superannuation;
- The company must comply with tax reporting obligations;
- The director must continue to comply with formal obligations during a subsequent formal insolvency;
- The director must provide a subsequent administrator or liquidator with access to a company’s books and records. This includes immediately complying with a request for these records (cannot delay the production of records or retrospectively prepare them); and
- The director must not prevent a subsequent administrator or liquidator from investigating the company’s activities.
Safe Harbour does not affect:
- Continuous disclosure obligations per the Act (such as s674 of the Act) or those imposed by a market operator (although the ASX does not stipulate an automatic disclosure requirement);
- Criminal liability;
- Ability of a creditor to take action to wind up a company or enforce debts; and
- Actions brought against a director for other breaches of the law such as a breach of directors’ duties (such as under sections 180, 181, 286 of the Act).
Directors can enjoy protection from when they begin developing one or more courses of action. This allows time for directors to consider their options, but there must continue to be forward progress. ‘Reasonable’ periods to plan, consider and implement options will vary between companies. For example, if a small company is considering courses of action, it would reasonably be expected to have considered its options within a few days of formulating them.
Safe Harbour ends when:
- The course of action stops being reasonably likely to lead to a better outcome;
- The company goes into administration or liquidation; or
- The directors fail to take a course of action within a reasonable period of time.
Developing a Plan
When a plan is developed, it needs to be ‘reasonably likely’ to lead to a ‘better outcome’ than administration or liquidation. ‘Reasonably likely’ is canvassed in the explanatory memorandum to the legislation as being a fair chance of achieving a better outcome than administration or liquidation; it can be ‘fair’, ‘sufficient’ or ‘worth noting’. Importantly, hope is not a strategy and plans cannot be fanciful.
The likelihood of success needs to be assessed at the time the decision is made to take a course of action and must be continually reassessed during the implementation of the plan. Whilst directors are not required to contemplate all possible variables or outcomes in detail, documentary evidence should be prepared at the time a decision is made to support the determination there is a fair chance the action might lead to a better outcome.
To maintain Safe Harbour protection, directors should have regard to the following factors as set out in s588GA(2) of the Act:
- Directors are continually informed about the company’s financial position;
- Steps are taken to prevent misconduct by officers and employees;
- Appropriate financial records are maintained
- Advice is obtained from appropriate qualified adviser; and
- Directors are actively developing or implementing a plan to restructure to improve the company’s financial position.
Adjustments to the course of action set out by the plan might be necessary during implementation so these should be documented as well. Depending on the size of the business, documentation might consist of directors’ meeting minutes all the way through to detailed, externally prepared reports.
In the next edition of The Real CFO, we will delve deeper into Safe Harbour including why it is critical to get appropriate advice when implementing your organisations plan.
Read part-two of Entering a Safe Harbour here.
To find out more on Safe Harbour and explore the eight signs of a business heading towards insolvency click here.
This article covers legal and technical issues relating to safe harbour legislation in a general manner and is intended for information purposes only. This information should not be taken as constituting professional advice and William Buck is not liable for any loss caused, whether due to negligence or otherwise arising from the use of, or reliance on, the information provided directly or indirectly in this article. It is recommended that further advice be sought prior to taking action on any specific issues dealt with in this article.