Safe Harbour – Risking Personal Liability to Rescue a Company

Twilight ZoneTwilight Moon

When a company is under performing financially, directors might:
  1. do nothing or procrastinate;
  2. decide to resign or jump ship;
  3. risk attempting a restructuring or turnaround; or
  4. place the company into the hands of a registered liquidator for administration or liquidation.

Directors of financially distressed companies may expose themselves to personal liability if their company is found to have incurred debts whilst insolvent.

Prior to the Safe Harbour reform, directors (and advisors) would normally determine the risk too great and either resign or place the company into administration or liquidation to avoid personal liability for company debts (later proven by a registered liquidator to have been incurred whilst it was insolvent).

Directors found to have been trading insolvent also face additional fines which often cause significant detriment to personal financial welfare and may ultimately result in bankruptcy (directors found guilty of trading insolvent can face civil penalties of up to $200,000 or criminal penalties of a maximum $220,000 fine or up to five years in jail).

Why Risk Personal Liability?

  • It is understandable why directors might think of self-preservation whilst in this ‘so called’ Twilight Zone. Clearly, prior to the Safe Harbour reform there was little incentive for directors to take the drastic action that is often so crucial to effectively achieving a successful turnaround.Value vs Liability Diagram
  • This is far from ideal as such action could potentially rescue the business or, even in the worst case scenario, may help preserve the value of the business’s goodwill and assets.
  • Expertly crafted turnaround strategies are likely to result in a better outcome for creditors and the employees (taking a long term view) – irrespective of whether the company is ultimately forced through an administration or liquidation.

Safe Harbour Quick Overview (again…)

At TurnAbout, we are persistent in our efforts to promote the potential of the Safe Harbour reform to the Australian business community (Safe Harbour became effective 19/9/17).Darling Harbour - Safe Harbour Not only does it have immediate practical application for companies that meet the thresholds, it is a powerful initiative to innovate business cultures to begin corporate rescue as soon as warning signals emerge.
The purpose of Safe Harbour is to remove or mitigate insolvent trading exposure for directors where:
  • upon suspecting insolvency, they start developing one or more courses of action that are reasonably likely to lead to a better outcome; and
  • any debts incurred directly or indirectly are in connection with such courses of action.
Safe Harbour ends at the earliest of any of the following times:
  • if directors fail to take any such course of action within a reasonable period after that time
  • if directors cease taking any such courses of action or where any such courses of action are no longer reasonably likely to lead to a better outcome for the company
  • the appointment of an administrator or liquidator.

Better Outcome

‘Better outcome’, with regards to the company and ‘courses of action’, means an outcome that  is better than the immediate appointment of an administrator or liquidator.Increase in Value
Section 588GA(2) provides that in determining whether a course of action is reasonably likely to lead to a “better outcome” for the company, regard may be had as to whether directors:
  • where properly informed about the company’s financial position,
  • took appropriate steps to prevent any misconduct by officers or employees that could adversely affect the ability of the company to pay all its debts,
  • took appropriate steps to ensure that the company is maintaining appropriate financial records in accordance with the size and nature of the company,
  • obtained advice from an appropriately qualified entity who was sufficiently informed, qualified, experienced & insured to give appropriate advice,
  • developed and implemented a strategic plan for restructuring the company to improve its financial position or future prospects.

Burden of ProofWork Attire

  • The burden on directors is described as ‘evidential’ – meaning that supporting documentation, records and financial performance information must be retained throughout directors reliance on the Safe Harbour provisions. These must be delivered up to the registered liquidator, if ultimately appointed.
  • However, the term ‘burden’ could be misleading for directors as Safe Harbour was deliberately legislated as a ‘carve out’ rather than a ‘defence’. This effectively means the real ‘burden’ is that of actual proof – and this rests with the registered liquidator (should one end up being be appointed).
  • In reality, there would need to be substantial grounds for taking insolvent trading action against diligent and honest directors who have relied upon a timely Safe Harbour, delivered up accurate records and cooperated fully with any registered liquidator.

Appropriately Qualified Advisor – Divided Opinions 

  • The ‘appropriately qualified entity’ that is required to give directors advice on Safe Harbour has not been defined. However, the advisor should hold specialist professional indemnity insurance and have suitable turnaround qualifications, relevant turnaround experience and possess membership of a professional body that is adequate given the company’s circumstances.Suit
  • It is our opinion that all of these criteria should be met by the ‘appropriately qualified entity’ or advisor. For example, membership of any one single professional body does not automatically qualify that individual to give advice.
    • A registered liquidator or professional ARITA member may be an expert on insolvency law but may not have undertaken ARITA’s ‘restructuring and turnaround’ certification (ARITA only introduced their advanced ‘restructuring and turnaround’ certification late 2016).
    • More critically, an ARITA professional member or registered liquidator may lack actual business rescue expertise (specifically, actual experience of transformation, restructuring or turnaround outside of any formal insolvency regimes).
  • Similarly, a turnaround practitioner may lack industry expertise, technical insolvency knowledge or general experience that is required to advise the company adequately (given the inevitable unique set of circumstances which always apply in each individual matter).

Voluntary administration is the formal corporate rescue mechanism in the Corporations Act and was meant to provide a way to save businesses. However, the numbers of voluntary administration are declining and the returns on deeds of company arrangement are less than 10c in the dollar….

If we are to make significant changes to our insolvency and restructuring laws we must be mindful not to simply deal with whatever interest group speaks the loudest.

Jason Harris, 5 September 2015, “The effect of voluntary administration on business restructuring”, Senior lecturer, UTS Faculty of Law, PhD candidate Adelaide Law School.

Disruption of the Insolvency Profession? Time for Collaboration…

Interestingly, when Safe Harbour was introduced in the Netherlands, the insolvency industry shrank by 60%!

Michael Fingland, Turnaround Specialist & Safe Harbour Expert, CEO of Vantage Performance, “Continued Disruption of the Insolvency Industry”, Published October 23, 2017 on Linkedin. 

However, overall the reform has been welcomed and, quite rightly, celebrated. It has brought about collaboration of the key professional bodies that are critical to the successful implementation of a rescue culture in Australia. Whilst it is acknowledged that Safe Harbour (and unenforceable ipso facto clauses in 2018) may not be the ultimate solution for an Australian rescue culture, it is a huge step in the right direction.

It has been the view of the TMAA Board – along with the Australian Institute of Company Directors and the Australian Shareholders Association – that the safe harbour qualified entity must possess appropriate experience to deal with the situation under engagement. 
This recognises that every situation is different and that the combination of experienced professionals will derive a better solution, whereby the qualified entity may be positively influenced by practitioners with operating, management, financial advisory, legal, investment banking and possibly funds experience.
What is just as important as the skillset is that the experience is relevant, that the person(s) operate according to a set of ethical standards and there is a common set of guidelines to address the engagement.

Determining the ‘Appropriately Qualified Entity’ and Combination of ProfessionalsBusiness Meeting

  • As directors must continually strive towards a better outcome and remain vigilant throughout Safe Harbour, it is plausible that they may decide to adjust their turnaround strategies whilst utilising Safe Harbour and, logically, this could also mean switching or changing advisors depending on how the story unravels.
  • An example of this could be where the likelihood of a formal insolvency appointment is extremely high. In this instance, from the outset the ideal advisor would possess a detailed working knowledge of the intricacies of Australia’s harsh and complex insolvency laws. However, following this preliminary advice the next step might be to engage an advisor who specialises purely in business transformation, restructuring and turnaround strategies.
  • It should be noted that if you choose a registered liquidator to advise on safe harbour and the business rescue attempt fails, that advisor will not be permitted to accept appointment as the administrator or liquidator. A registered liquidator’s requirement to be independent prevents them from consenting to act.

Turnaround Practitioners – Flexibility & Commitment

  • An interesting point about Safe Harbour is that, once in place, it protects any incoming directors and executive officers that are appointed.One in All In
  • This gives the company an opportunity to engage an ‘interim manager’ or ‘chief transformation officer’ to oversee implementation of the Safe Harbour turnaround strategies. As a director designate, the turnaround practitioner in this scenario is a fiduciary and bound by all the usual duties and responsibilities that are bestowed upon the other directors.
  • This has huge potential and is where a company stands to gain a valuable long term industry and inter-company savvy advisor – by engaging a turnaround practitioner, a company has gained an additional security measure that can be called upon in times of crisis.

Implementing Safe Harbour

  • Once engaged, advisors will independently review the business and financials. A strategic plan will then be formulated with the input of the directors and/or management. The strategic turnaround plan is then performance checked to ensure the company’s financial position is improving (or continuing to provide a ‘better outcome’ for creditors).Lighthouse
  • Where a turnaround practitioner doesn’t take on an interim position at the company, they will normally be appointed to take the lead. Depending on the circumstances, the turnaround practitioner will then make a recommendation for the directors to call upon accountants, lawyers and/or industry experts who are ideally suited or have worked with the company previously (this may include non-executive directors). If the circumstances are terminal, the turnaround practitioner should make the recommendation that directors immediately approach a registered liquidator (and maybe even a personal insolvency specialist – such as a lawyer or trustee in bankruptcy).
  • However, where the position isn’t deemed terminal the turnaround practitioner will then collaborate with the accountants, lawyers, industry experts and potentially a registered liquidator to draw together any additional financial, tax, legal and industry expertise that are critical for directors to review. We consider this thorough and structured approach will strongly support the argument that directors have taken ‘reasonable courses of action’ and will be afforded the maximum possible ‘safe harbour’ protection.

Caution – the Safe Harbour ‘thresholds’ pose the greatest barrier 

If the company has failed to do one or more of the following then Safe Harbour protection will not be available:
  • pay the employee entitlements as and when they fall due;
  • submit returns, give notices, applications or other documents as required by taxation laws; and
  • keep accurate financial records (in basic terms, the company must keep the employees paid up-to-date and ensure the ATO remains informed of its tax position).

Phoenixing, Prepack Sales & Management Buy Outs (MBO)

Stigma attaches to formal insolvency proceedings (even voluntary administration) and the longer a company remains under the control of a registered liquidator, the less likelihood there is of salvaging anything from the wreckage.

Insolvency proceedings, such as receivership, liquidation and even voluntary administration (which has a stated purpose of trying to save businesses) carry a stigma of failure, which makes trading on as a business more difficult and reduces creditor confidence in the potential to save the business through a formal restructuring.Phoenix

Jason Harris. Class warfare in debt restructuring: Does Australia need cross-class cram down for creditors’ schemes of arrangement? [online]. University of Queensland Law Journal, The, Vol. 36, No. 1, 2017: 73-97.

Pre-positioned sales, pre-packs or simply obtaining the best outcome…

Presenting at a meeting of the Association of Independent Insolvency Practitioners (AIIP) on 15 August 2017, Richard Fisher AM and Nick Crouch argued that pre-packs provide a way for government to regulate the pre-insolvency market, discourage illegal phoenix activity and provide for the legitimate restructuring of small insolvent enterprises, which constitute the vast majority of external administrations (‘Moves Afoot To Propel Pre-Packs Onto Political Agenda’, SiN, 16 August 2017).

There’s strong evidence to support the view that if nothing else, pre-packs save jobs…This could reduce the budgetary burden on the FEG scheme

Richard Fisher AM, Adjunct Professor of Law at the University of Sydney quoting evidence from the UK where pre-packs have been legal for 15 years.

Ability to demonstrate achievement of market value for the sale of business and assets and liaising with key stakeholders is critical. Such matters are dealt with in the ever-evolving UK guidance for practitioners – ‘Statement of Insolvency Practice 16‘. Indeed, such a sale can often maximises the value of the business’s goodwill and assets – often resulting in a higher return to creditors and/or shareholders (and minimising employees priority claims in insolvency proceedings – refer to the statistics in Nick Crouch’s May 2017 submission).

“Good phoenixing is what you’d properly call restructuring and turnaround. It’s taking a business in some element of distress and getting it back in shape. Sometimes that requires debt compromises.”
John Winter, ARITA CEO, “It’s not that hard to stop illegal phoenixing”, AICM Magazine December 2017. 

Irrespective of whether insolvency proceedings are necessary, business continuity and rescue should be paramount. Maximising business and asset value and reducing creditors claims (especially by preserving employees jobs) is beneficial to the economy. After all, failure begets failure and the majority of suppliers would prefer to keep their customers rather than risk insolvency themselves. The ultimate challenge for both directors and professionals alike is to embrace Australia’s new rescue culture and join forces in encouraging the business community to seek advice as early as possible.

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