Australian governments have put in place certain measures and recommendations with a view to containing the spread of coronavirus. These measures, which are likely to continue for some time, will affect many small, medium and large sized businesses.
COVID-19 has already resulted in considerable operational disruption and financial difficulty for many companies, which has led to a significant increase in directors considering voluntary administration. These difficulties have been caused by a myriad of primary and follow-on effects, such as employees going into quarantine, supply-chain failures, stock shortages, a drop in high street footfall and a drop in demand for certain products and services.
With today’s indication by the Victorian and New South Wales governments (with others to no doubt follow), of a “comprehensive” shutdown of all non-essential services for the foreseeable future, the financial impact on businesses and individuals will be massive. It is therefore encouraging to see that the Federal Government has offered a significant package of assistance to cushion the financial blow.
This article highlights some features of the Federal Government’s economic response to COVID-19 announced today, and the safe harbour regime under the Corporations Act (2001) (Cth) (Corporations Act) that protects directors from personal liability for insolvent trading.
Temporary Federal Government measures in response to COVID-19
To ease the economic impact of COVID-19, the Federal Government has announced (among others) the following three measures:
- Insolvent trading: to give companies an opportunity to weather the storm and potentially trade out of insolvency, directors will be temporarily relieved for 6 months from personal liability under the Corporations Act for insolvent trading. The Federal Government noted that the proposed measure will not relieve directors for criminal penalties arising from dishonesty and fraud. See our recent note about the directors of Kleenmaid who were jailed for insolvent trading and fraud. Companies will nevertheless remain liable for their debts, and can be sued in the usual way.
This measure, once implemented, may have an impact on the utilisation of the safe harbour regime (addressed further below in this note) which was designed to give directors relief from personal liability to (in effect) trade out of insolvency. Until further detail is available, it is not clear whether under the proposed relaxation of the insolvent trading provisions, directors would have to meet employee entitlements – which is a requirement under the safe harbour regime.
- Statutory demand: ordinarily, where a creditor issues a statutory demand to a company, and that company does not make payment within 21 days or apply to have it set aside, the company is presumed insolvent and the creditor may start winding-up proceedings. The Federal Government has temporarily increased the minimum threshold to issue a statutory demand from $2,000 to $20,000. It has also increased the period to respond to a statutory demand from 21 days to 6 months. This temporary measure is expected to apply for a period of 6 months. This will mean that companies served with a statutory demand will have longer to pay the alleged debt, or apply to Court to have the statutory demand set aside, providing much needed breathing space at this time. This said, we will need to see the exact drafting of the implementation measure to understand its full implication.Notwithstanding this new measure, companies who are owed money should continue to consider their recovery options even if they choose to do nothing for now – they can still start Court claims. Secured creditors may still be able to take enforcement action. Those issued with a statutory demand should take legal advice.
- Bankruptcy proceedings: the Federal Government will make temporary changes to the Bankruptcy Act 1966 (Cth) to increase the threshold amount of debt required for a creditor to start bankruptcy proceedings against a potential bankrupt. This amount will temporarily increase from $5,000 to $20,000. The timeframe to respond to a bankruptcy notice will increase from 21 days to 6 months. This temporary measure will also apply for a period of 6 months. Similarly, we will need to see the exact drafting of the implementation measure to understand the full implication of this.
What is insolvent trading?
Under Section 588G of the Corporations Act, a director (including shadow and de facto directors) may incur civil and or criminal liability:
- if the company of which it is a director incurs a debt at a time the company was insolvent (or the company became insolvent as a result of it incurring the debt); and
- at the time of incurring the debt there are reasonable grounds for suspecting that the company is insolvent or may become insolvent by incurring the debt.
Debts are generally incurred by a company as it trades. Examples include: incurring liability to pay for goods and services, incurring liability to pay employees, or incurring liability for rent under a lease.
There are several defences to insolvent trading, including the ability to come within the statutory safe harbour in the Corporations Act.
What is safe harbour?
‘Safe harbour’ is a statutory protection afforded to directors against personal liability arising from insolvent trading. The safe harbour regime was designed to persuade directors in troubled times to devise a plan of action that is reasonably likely to deliver an outcome that is better for the company than the immediate appointment of an administrator or liquidator.
To dock within the safe harbour, at the time the director starts to suspect the company may become or be insolvent, the director should start to develop courses of action that are likely to lead to an outcome that is better for the company than an immediate appointment of an administrator or liquidator. Further:
- the company must be paying and remain able to pay the entitlements of its employees (wages etc.) by the time they fall due; and
- the company must be complying with disclosures required under tax laws, such as the filing of notices and statements.
How to seek safe harbour protection?
In considering whether a course of action is reasonably likely to lead to a better outcome for the company, the Court may have regard, and therefore the director should have regard to whether he or she:
- is properly informed of the company’s financial position;
- is taking appropriate precautions to prevent any misconduct of the employees or officers of the company that could affect the ability of the company to pay its debts;
- is taking appropriate steps to keep financial records; and
- has obtained advice from a qualified entity or is implementing a plan to restructure the company. A qualified entity could be an ARITA professional member, liquidator or lawyer.
What actions should be considered?
Directors seeking to dock within a safe harbour, should consider (among other things):
- Termination of casual staff
- Redundancies (if affordable)
- Negotiating with suppliers to extend payment terms
- Debt collection
- Negotiating shorter payment terms with buyers
- Negotiating with landlords for extensions of time to pay rent
- Negotiating with financial companies for extension of payment terms
- Closure of sites or venues (if affordable)
- Additional loan facilities
- Secured finance facilities
- Sales of assets
- Capital injection from existing or new shareholders
If a director has successfully docked in safe harbour, he or she will not be held personally liable for insolvent trading. If you do not have a plan which is reasonably likely to lead to a better outcome for the company or you cannot meet the other tests such as payment of employee entitlements, you should consider voluntary administration.
There is clearly some considerable overlap between the safe harbour regime and today’s Federal Government announcement relating to insolvent trading.
Under the Federal Government’s announcement, once the measures are in in force, it has relieved directors from personal liability from insolvent trading for a period of 6 months. This appears to be irrespective of whether employee entitlements are paid. It is however clear that the director is unlikely to be legally required to develop a plan which would meet the threshold test of developing a course of action which would be reasonably likely to lead to a better outcome for the company. In this regard, the Government’s announcement appears to provide, at least temporarily, a safer harbour than the Corporations Act safe harbour regime.
But, should directors ignore the Corporations Act safe harbour regime? No. Currently, the Federal Government’s measure will apply for up to 6 months from the date it comes into force. This time should be used to consider the safe harbour regime and develop courses of action. It would be unwise to wait until the Government’s temporary measure has expired.
Moreover, the aim of the safe harbour regime is to develop a plan which would lead to a better outcome for the company – surely that is a good thing to do in any event. This said, it is fully expected that any plans developed may be tentative, especially as third parties may be unwilling to commit as they experience their own uncertainties.
For more information about the safe harbour regime and the Government’s economic response to the coronavirus, please contact:
Trevor Withane: firstname.lastname@example.org, tel +61 (0)418 717 001