The attraction of operating a business via a corporate entity for most comes down to the protection of limited liability for stakeholders should the trading operations of the business sour. Against this protection, and in order to protect the creditors of the business, the Corporations Act 2001 contains insolvent trading laws that prevent directors of a company continuing to incur debts of the business once they become aware, or should reasonably have been aware, that the business was unable to pay its debts as and when they fall due. These laws encourage directors to act quickly in appointing an insolvency practitioner should the company become insolvent or risk being held personally liable for those liabilities of the business incurred after that point. To balance these two competing requirements, and prevent directors from putting companies that could be restructured and saved into liquidation, a new “safe harbour” regime was introduced in September 2017. The Federal Government has foreshadowed changes to the Corporations Act 2001 to assist with impacts of COVID-19 on director’s liabilities. The details of those changes are unknown at this stage. Our comments below reflect the law as it currently functions and represents a prudent approach for directors to follow right now.
The Safe Harbour Rules
As a result of the safe harbour rules, a director will not be subject to the insolvent trading laws under the Corporations Act 2001 (and therefore not held personally liable for the debts of the business incurred past a point of potential insolvency) where they are implementing a plan of action to restructure the affairs of the company that complies with the safe harbour rules. Generally, a plan that is effective under the safe harbour rules will include one or more courses of action that are reasonably likely to lead to a better outcome for the company than liquidation. Additionally, the directors are required to ensure that all employee entitlements are met as and when they fall due and that the company is meeting its tax reporting obligations.
The Uncertainty of COVD-19 for Businesses
With the rate at which government restrictions on the operation of businesses are currently occurring, and as the government acts with haste to introduce business support measures, directors find themselves scrambling to come to terms with the impacts of changes on their business and how to take advantage of relief measures to offset these impacts. It is not so difficult to assume that directors currently dealing with these challenges may be falling foul of the insolvent trading rules. Having spoken recently to insolvency practitioner colleagues, it would seem that the safe harbour rules once implemented have experienced a fairly sleepy existence. Until now.
The Pathway Forward
All company directors should be preparing a plan of attack to ensure the future survival of their businesses. With this in mind, it is important that they include sufficient documentation to support that their actions are being carried out in accordance with a plan of action compliant with the safe harbour rules.
A potential planning process given the current environment might include:
- Obtaining sufficient and reliable financial information in respect of the business (this would include at least a forward cash flow covering a period sufficient to see the company through this difficult period).
- Adjust the cash flow for an expectation of trading impacts that may occur through the period of uncertainty (yes, this is uncertain for most).
- Adjust for any internal actions that might reasonably be implemented to soften the impact of the down-turn (this may include rent abatement, legally enforceable adjustments to staffing arrangements, etc.).
- Adjust for the various economic stimulus impacts being outlined by Federal and State Governments as they are announced (including PAYG instalment and withholding refunds, payment deferment options and payroll tax measures).
- Adjust for various repayment deferral arrangements announced by the Australian Bankers Association.
- Ensure that the company can meet its employee entitlements as and when they fall due.
- Ensure that the company meets its taxation reporting responsibilities.
- Ensure that all debts of the company are incurred directly or indirectly in connection with the plan of action.
- Ensure that the outcomes of the plan could reasonably be expected to put the company in a better position than immediate professional administration/liquidation.
- Implement a program of constant monitoring to ensure that the above conditions are maintained and updated.
This is not an exhaustive list and the process should be undertaken by a suitably skilled person after seeking appropriate professional advice.
The Importance of Documentation
The appropriateness, or otherwise, of directors actions in this time of increased stress will be measured far into the future. Whilst the Government and even banks are currently bending over backwards to provide assistance that will keep businesses operating, potential director insolvent trading actions will be assessed well into the future, in the somewhat less forgiving environment of the court system and with the benefit of hindsight. In that situation, directors seeking to rely on safe harbour protection now would be well advised to have sufficient documentation of the plan implemented and activities undertaken in executing that plan. As always in the legal process contemporaneously written evidence will carry far more weight and verbal evidence.
How can Nexia Edwards Marshall NT help you?
If you would like to find out more about safe harbour rules or believe you need help navigating the planning process, please contact your Nexia Edwards Marshall NT Advisor.