COVID-19: What are the safe harbour laws in Australia?
The Federal Coronavirus Economic Response Package Omnibus Act 2020 (Cth) (“Omnibus Act”) has introduced various measures designed to assist people and businesses in dealing with the consequences of the COVID-19 outbreak and social distancing measures put in place for our protection.
One of the aims of the Omnibus Act is to prevent unnecessary insolvencies and assist businesses with managing debts. To do this, the Omnibus Act introduces temporary amendments to the Corporations Act 2001 (Cth) (“Corporations Act”) and Bankruptcy Act 1966 (Cth) in respect of insolvent trading.
What is insolvency?
For the purposes of the Corporations Act, a person (which covers all manner of structures but particularly the common “private company”) is insolvent if they are unable to pay their debts as and when those debts fall due.
What is insolvent trading?
Section 588G(2) of the Corporations Act imposes a duty on a director of a company to prevent that company from incurring debts whilst insolvent i.e. to stop incurring debts when the company is insolvent or not to incur a debt that would render the company insolvent.
Directors can be held personally liable to repay any debts of the company that were incurred whilst the company was insolvent. Such actions may be pursued by a liquidator or by creditors to whom those debts were incurred and remain unpaid (but is generally done by the liquidator, who is better equipped to investigate such matters).
There are defences to insolvent trading found in section 588H of the Corporations Act, which continue to apply in respect of insolvent trading. Those defences are generally inconsistent with someone actively seeking to rely on ‘the safe harbour’ regime.
What are safe harbour laws?
The legislature was concerned that, commonly, directors were too quick to conclude a company suffering financial distress was a ‘lost cause’ and place it into external administration. Directors would do this to avoid being held personally liable for insolvent trading, rather than try to save the company.
Accordingly, in September 2017, additional provisions were introduced into section 588GA of the Corporations Act. The amendments provided protection from insolvent trading for directors that are making legitimate efforts to turn around a struggling company. That protection is generally referred to as the ‘safe harbour’.
To avail themselves of the safe harbour protection from insolvent trading, directors who come to suspect that their company is or may become insolvent must develop a course of action (a recovery plan) that is reasonably likely to result in a better outcome for the company (and its creditors) than if the company was placed into external administration, and to implement that recovery plan.
In commencing that plan, directors must ensure all employee entitlements are paid up to date and substantial compliance is maintained as to the company’s tax reporting obligations.
Debts incurred by the company directly or indirectly in connection with the recovery plan will not attract personal liability to the director for insolvent trading, even if the company was insolvent, but it is the director who will bear the onus of establishing that he or she is in the safe harbour. We therefore recommend that a director seeking to rely on the safe harbour provisions in section 588GA should seek appropriate expert advice and diligently document the recovery plan, the basis for its feasibility and its implementation on an ongoing basis.
Safe harbour protection can be lost, if:
- the recovery plan is not followed;
- it subsequently becomes apparent that following the recovery plan would not be reasonably likely to lead to a better outcome; or
- during the period in which the director seeks protection, the company fails to continue paying all employee entitlements or fails to adhere to financial reporting obligations to the ATO on time.
What are the enhanced safe harbour provisions arising from COVID-19?
The Omnibus Act introduces a new section 588GAAA into the Corporations Act. This section provides a further and enhanced safe harbour to directors from insolvent trading. This enhanced safe harbour is only temporary and has been put in place to try and keep businesses trading wherever possible (in combination with other measures).
Accordingly, from 26 March 2020 until 25 September 2020, company directors are protected from liability for insolvent trading for debts that the company incurs during this period provided that those debts are incurred in the ordinary course of business.
The phrase in the ordinary course of business takes its plain meaning (i.e. there is no definition in the Corporations Act) and is seemingly wide enough to cover all but extraordinary debt.
The explanatory memorandum provides a little guidance as to what in the ordinary course of business means by suggesting that the phrase includes debts incurred by a company to facilitate the continuation of the business during the six month period, such as a loan to cover the expenses of moving the business operations of the company online.
Unless extended, the safe harbour protection will end on 25 September 2020. If, prior to this date, a director considers that the company will be insolvent when the temporary safe harbour ends, then the director should either:
- put in place a recovery plan under section 588GA to remain in the safe harbour; or
- appoint an external administrator.
How can DSA Law help?
 See our summary of the changes regarding statutory demands, How Coronavirus (COVID-19) affects Defaults and Statutory Demands.