SafeHarbour – Director Protection From Insolvent Trading

SafeHarbour for directors from insolvent trading – effective 19 September after royal assent the day prior.

On 11 September 2017, the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017 passed through the Senate. On 18 September 2017 the Bill received royal assent and SafeHarbour came into effect the next day (on the 19 September 2017 – the accompanying ipso facto reforms are not yet to commence until 2018). SafeHarbour is a powerful tool for protecting your business during the COVID-19 Crisis.

Purpose of the legislative reform

The Government has been seeking to strike a more reasonable balance between the protection of creditors and encouraging directors to be innovative and take greater risks. The current regimes (for examples the Part 5.3A Voluntary Administration procedure and Schemes of Arrangement) were deemed to be costly and inaccessible to the SME market. Safe Harbour is intended to encourage entrepreneurs and honest directors; permitting them to retain control of the financially distressed company by taking reasonable steps to trade out of difficulties.

Safe to fail 

Safe harbour from insolvent trading is applicable where directors initiate one or more courses of action that are reasonably likely to provide a better outcome for the company than liquidation or administration. Safe harbour provides protection for directors from insolvent trading liability arising out of debts that are incurred directly or indirectly in connection with the implementation of restructuring or turnaround strategies.

Directors take the helm & develop strategies

The Bill states that a director enters safe harbour upon the development of one or more courses of action that is reasonably likely to lead to a better outcome for the company (the draft legislation had previously included the company and creditors).

What is better outcome? 

In determining ‘better outcome’, the following factors are considered:

– directors were properly informed about the company’s financial position
– steps were taken by directors to prevent misconduct by the company’s officers and employees
– steps are taken to ensure appropriate financial records are maintained
– the restructuring and turnaround strategies were designed to improve the company’s financial position
– the directors obtained advice from an appropriately qualified adviser (who was given sufficient information to give the appropriate advice)

There were two key amendments rejected by the Senate at the eleventh hour. Safe Harbour will be a ‘carve out’ rather than a ‘defence’. Also, the appropriately qualified adviser does not need be a registered liquidator. This is a critical factor in that the burden of proof lies with a liquidator (or any other party claiming Safe Harbour isn’t applicable). Furthermore, it is clear that the Government is in agreement that directors are far more likely to be adequately advised by a Safe Harbour Consultant that is ideally suited to that company’s unique set of circumstances (for example, financial and operational issues may not always require the intervention of a liquidator, insolvency practitioner, practising accountant or lawyer – industry expertise may be the determining factor for developing appropriate turnaround strategies).

Thresholds for entering the SafeHarbour (Criteria)

There are important parameters for directors in entering safe harbour:

1. employee entitlements must have been paid as and when due;

2. tax returns or other documents required by taxation laws have all been lodged or submitted (not necessarily paid); and

3. the books and records of the company must be adequately maintained and current.

Are these thresholds going to prevent a barrier for directors of companies entering Safe Harbour? 

The critical question is whether SafeHarbour is going to be accessible to the directors of small companies. The following criteria require drilling down into in further detail:

1. Employee entitlements under Section 596AA of CA 2001 (Cth) must be paid “as and when due”
2. Tax reporting obligations

1. Employee Entitlements 

The entitlements that are to be paid as and when due are:

• wages & super (practically speaking, superannuation can’t be more than 3 months overdue);
• compensation for injury;
• any leave of absence entitlements as regards an industrial instrument; and
• retrenchment payments (those amounts that become payable upon termination – including redundancy pay) as regards an industrial instrument.

An industrial instrument extends to include an employee contract (written or implied), the relevant industry awards or any enterprise bargaining agreements (that may or may not have expired – bearing in mind EBAs may still remain valid after expiry and may further include more favourable entitlements by reference to older state awards rather than the modern federal awards).

As with external administration, the priority creditors are treated differently under the rules applicable to excluded employees under Section 566 CA 2001 (Cth). Any director or employee related by blood or law to a director will only require payment of entitlements under Safe Harbour to the priority caps of $2,000 for wages and $1,500 in respect of leave entitlements.

2. Tax Reporting Obligations 

Tax obligations requires the submission of returns, notices, applications and any other documentation as required by taxation laws.

Rather than having to ensure these are fully paid, directors simply need to ensure that the company has complied with submission of BAS (Business Activity Statements), tax returns, fringe benefits etc. Once again, practically speaking lodgements shouldn’t be more than 3 months overdue. 

Indeed, had payment of tax obligations been a requirement, it may effectively result in a preference having been given to the ATO (should the company end up in external administration).

Looking closer at turnaround for SMEs…

With regards to SMEs, Safe Harbour turnaround has huge practical potential:

· There is no obligation for a director to make safe harbour disclosures (whereas this will remain in place for listed companies under their continuous disclosure obligations).

· The provisions provide scope for directors to manage their own company affairs; enabling all struggling companies to explore restructuring options in a bid to regain sustainability.

· With regards to start ups, safe harbour should alleviate the reluctance of investors who may now take on roles as directors as the risks associated with unintentional breaches of insolvency law are mitigated.

· Similarly, charities and NFP board members (or NGOs, where often a fiduciary NED role is taken on a pro bono or minimal fee basis) may continue to act in their roles without fear of personal liability of insolvent trading.

· Where a board resolves to restructure a company’s executive team, the incoming executive officers can implement safe harbour to ensure protection against actions taken by previous management.

· There is an extension that provides safe harbour to the holding company of an insolvent subsidiary.

In essence, safe harbour permits directors of an insolvent company to incur credit or make asset purchases provided they are acting in manner ‘in so far as’ is beneficial to the company’s restructuring and turnaround strategies. This is provided it is reasonably expected to lead to a better outcome.

Directors of SMEs must be made aware by their professional advisors…

For SMEs, an enormous benefit is the significant cost saving, lack of disruption and stigma that would otherwise occur through the voluntary administration process. Directors can gain comfort knowing that the new law provides a level of insurance against insolvent trading when they are under Safe Harbour protection.

Caution! Beware the unqualified or unscrupulous pre-insolvency advisor…

Turnaround AU professionals are highly qualified and experienced to provide expert Safe Harbour Business Advisory. Our advisory services are free from the perils so often involved with unscrupulous, under qualified and inexperienced “pre-insolvency” advisers (who frequently encourage phoenix activity – which can often result in dire consequences for directors).

The real questions to ask your proposed advisor is which professional body they are qualified and a member of and whether they hold the requisite professional indemnity insurance.

Qualified, experienced and collaborative….

Most importantly, a SafeHarbour advisor must be adequately skilled to provide forecasted financial outcome statements and supporting advice. This ensures that in entering SafeHarbour, you are exploring strategies that are intended to result in a better outcome for the company than immediate voluntary administration or liquidation.

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