In response to the pandemic, a range of economic measures have been announced. Referred to as the COVID-19 Safe Harbour, a six-month temporary relief period has been granted for directors from personal liability for trading a company while insolvent.
COVID-19 Safe Harbour for Directors
Referred to as the COVID-19 Safe Harbour, for a period of six months the current ‘insolvent trading’ regime has been suspended. Insolvent trading laws under s588G of the Corporations Act state that a director can be held personally liable for the debts incurred by a company if, at the time when the debts were incurred, there were “reasonable grounds” to suspect actual or future insolvency.
As part of its economic response to COVID-19, the Government has announced this ‘temporary COVID-19 safe harbour’ as a measure to prevent companies from having to appoint a liquidator or voluntary administrator. If this measure is used wisely, it may prove an effective way for companies and creditors to navigate financial distress for years to come.
The purpose of the new Bill, effective 24 March 2020 (day after Royal Assent), is intended to help businesses avoid unnecessary insolvencies and bankruptcies. The COVID-19 response has had an immediate impact on business, putting many directors at risk of trading their companies while insolvent or being forced to cease trading operations due to the issues faced with short-term liquidity.
COVID action taken includes granting directors a ‘COVID-19 Safe Harbour’ (under s588GAAA). Directors are temporarily relieved from insolvent trading personal liability where company debts are incurred in the ‘ordinary course of business’. The temporary relief will operate alongside the existing Safe Harbour Regime (under s588GA) and will last six months.
The threshold for which creditors can issue statutory demands has also been increased to $20,000 for a period of six months, and the response time for companies to respond to statutory demands has increased from 21 days to six months.
Many directors will welcome these measures given the uncertainties surrounding the impact of COVID-19 on business operations and cashflow. It is expected that the measures will assist companies in continuing to trade through the COVID-19 period of disruption. The COVID19 action and legislative changes are to help companies continue trading through the current period of disruption without having to appoint a liquidator or voluntary administrator.
The Explanatory Memorandum states that a debt is incurred ‘in the ordinary course of business’ if it is necessary to facilitate the continuation of the business during the 6 months. Two examples were given as to what ‘debts incurred in the ordinary course of business’ might be:
- taking out a loan to move business operations online; and
- debts incurred as a result of continuing to pay employees during COVID-19 disruption.
Temporary relief from insolvent trading personal liability
In the context of the current COVID-19 crisis, directors will need to make urgent decisions regarding incurring debt. The temporary safe harbour is designed to give directors the confidence to continue to trade, pay their bills and retain staff through the COVID-19 crisis without pressure to enter their organisation into administration if there is a chance it might be insolvent.
Directors will be able to rely on the temporary relief about a debt incurred by the company if:
- the debt is incurred in the ‘ordinary course of the company’s business’;
- the debt is incurred during the six months (starting on the day the new law commences), or a longer period as prescribed by the regulations; and
- the debt is incurred before any appointment of an administrator or liquidator of the company during the temporary safe harbour application period.
Each company’s circumstances are different, so the new law is not prescriptive in terms of what debt can be incurred in the ‘ordinary course of the company’s business’. A director will be taken to incur a debt in the ‘ordinary course of the company’s business’ if it is necessary to facilitate the continuation of the business. This could include, for example, debts incurred through continuing to pay employees. It could also include a director taking out a loan to move some business operations online.
It is unclear however from the government’s proposal whether a company incurring debt as part of recapitalising during the applicable six-month period would qualify for relief. Accordingly, It will be a matter of degree for directors, and care should be taken, to assess whether the debt incurred is necessary for the business to survive in the current climate, which will inevitably vary on a case-by-case basis.
Ordinarily, the insolvency provisions under the Corporations Act provide that the onus of proof is on the person trying to make a director liable for insolvent trading.
Under the new temporary safe harbour, a director wishing to rely on the relief in a proceeding in which unlawful insolvent trading is alleged will bear an evidential burden about that matter (e.g. point to evidence that suggests a reasonable possibility that the matter exists or does not exist).
What duties will continue to apply?
The new laws do not alleviate directors completely. They must continue to oversee the solvency and operations of the business. Directors duties under the Corporations Act continue to apply, including that of directors to act with care and diligence, in good faith in the best interests of the company and to not improperly use their position or information received for personal gain. With regards to care and diligence, the business judgement rule should be referred to. Any debts incurred by the company will still be payable by the company and cases of dishonesty, illegal phoenix activity and fraud will still be subject to criminal penalties.
Notwithstanding the proposed relief from personal liability for insolvent trading, if the company is approaching insolvency, case law states directors must begin to also take the interests of creditors into account. Accordingly, directors will need to exercise careful judgment in deciding whether their organisation should accrue additional liabilities at a time when the ongoing solvency of the organisation is questionable.
If the company does fall into formal insolvency, the temporary relief will be taken not to have been available if there is a substantial failure to comply with their obligations to assist an administrator or liquidator. Directors must provide all the books and information that they are ordinarily required to provide to an administrator or liquidator. If they fail to do this, they will not be entitled to rely on these books or information as evidence when relying on the safe harbour to defend insolvent trading claims made by a liquidator in a later proceeding.
COVID-19 could see many otherwise profitable and viable businesses temporarily undergoing financial distress or insolvency. We are supportive of the measures to provide businesses with a safety net and reduce the risk of for directors personally liability. Directors may otherwise have felt compelled to immediately place their company into voluntary administration or liquidation. This would have caused the unnecessary destruction of enterprise value and worsened the economic outlook for decades to come. However, we strongly recommend that all directors consider advice under the 2017 safe harbour (give the additional protections and options that are available).
Directors must continue to mitigate the risks of falling into insolvency by taking reasonable steps to inform themselves about the company’s current and ongoing financial viability as well as assessing the impact of incurring any further debts. In particular, directors must think carefully about their ongoing duty to act in the best interests of the corporation (including the interests of creditors when approaching insolvency), and whether incurring additional liabilities would be a prudent course of action, and consistent with their obligation of care and diligence.