Introduced for greater protection for personal liability in the event of insolvent trading, we discuss how the safe harbour reforms are tracking two years on.
Pauline Vamos MAICD was a director of Decimal, an ASX-listed software company, when it became clear that sales weren’t coming quickly enough to offset its costs and that the business was in trouble.
Calling in an adviser to run through the options, the board decided on a course of action not previously available, hoping the new “safe harbour” provisions would help buy time so it could work through the issues.
Australian directors of companies with solvency difficulties, such as those faced by Vamos, have been utilising safe harbour protections against insolvent trading, either to save the company or to provide a better outcome for creditors and shareholders.
Two years after the safe harbour legislation took effect, boards of about half of all large and listed businesses that have a “liquidity event” have taken steps to ensure they can meet the safe harbour eligibility criteria, according to figures collected by advisory and restructuring firm McGrathNicol. However, that drops down to about five per cent for SMEs.
From 18 September 2017, directors gained access to a safe harbour from personal civil liability for insolvent trading in certain circumstances. The safe harbour amendment to the Corporations Act 2001 (Cth) states that personal liability does not apply “if at a particular time after the person starts to suspect the company may become or be insolvent, the person starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the company; and the debt is incurred directly or indirectly in connection with any such course of action during the period starting at that time”.
Directors are excluded from the safe harbour if their organisation hasn’t paid all of its employee entitlements, has outstanding tax lodgements or hasn’t kept up-to-date records 588GA(4)(b)(ii).
The safe harbour provision is being used by directors to buy time and allow the company to keep trading instead of immediately tipping it into voluntary administration. The legislation calls for a “better outcome” for the company.
Directors can buy time while they negotiate a sale of the business at better terms than if it was to be sold from voluntary administration. Alternatively, the board can stay in place to effect a restructure.
“If you speak to anybody in a listed company, very rarely is voluntary administration a good option for stakeholders because it’s so expensive,” says Pauline Vamos, former CEO of superannuation industry body ASFA.
“The administrator hasn’t got the relationship with the staff, clients and other stakeholders,” says Vamos. “With a corporate restructure, there is a lot of work around stakeholder management. Your directors, particularly the chair, are the best people to do that.”
The protection safe harbour provides is also crucial in attracting new directors to the board of a struggling company, where previously they might not have considered it, according to Vamos.
Rob Brauer GAICD, a partner at McGrathNicol, says that of the companies his firm has helped to seek safe harbour, about half end up in insolvency and half are turned around, a statistic he describes as unsurprising.
“It needs to be to a sufficient point of distress that you suspect insolvency — and only then are you safe harbour-relevant,” he says.
“It’s not surprising half of those companies end up in insolvency anyway.”
Brauer says it’s not possible to quantify how many of those companies that emerged from safe harbour to continue trading were able to do so thanks to the legislation or would have continued anyway. But he believes it makes a difference. An asset-rich, but cash-poor, business might not be able to pay its creditors when they fall due and technically that would mean the business is insolvent. Some directors would not be prepared to take the risk of insolvent trading so would call in the administrators. “How do directors get comfortable with that?” asks Brauer. “They use the safe harbour protections to continue to trade so they can continue to have discussions with creditors and manage them, and negotiate with them various payment terms, knowing creditors aren’t necessarily worse off because they’re doing that.”
The legislation calls for “a course of action reasonably likely to lead to a better outcome for the company”. There was some concern when it was introduced that the phrase “reasonably likely” wouldn’t give enough certainty to directors that they were in the safe harbour, particularly before it had been tested in court.
But Brauer says the test should be clear to directors because it is action-oriented and involves assessing the company’s position, devising a plan and engaging with appropriate advisers. “They are reasonable steps as opposed to putting up some sort of not-thought-through plan which really exists on paper only and no-one follows,” he says. “The act is designed to see through that.”
Matthew Donnelly, a Perth-based partner at financial advisory firm Deloitte Australia, agrees that directors can be “quite confident” about being in the safe harbour because the legislation is prescriptive, with the three pillars of conscientiousness, reasonableness and honesty. Directors have to continually test that what they are doing is better than immediate administration or liquidation.
Donnelly says safe harbour invocations typically run for three to six months because restructuring, raising capital or negotiating with creditors usually takes time. As a general rule, companies don’t make it public that directors have sought safe harbour protections. Even for listed companies, it is not required because seeking protection is something directors do, not the company. However, Donnelly adds that some events, which might cause directors to seek safe harbour or could have arisen as a result — such as declining revenue, a court judgement against it, or a restructure — might need to be required to be disclosed to the market.
The former Minister for Small Business, Michael McCormack, told federal parliament in 2017 the provision would boost innovation and entrepreneurship.
“Concerns over inadvertent breaches of insolvent trading laws are frequently cited as a reason that early stage or ‘angel’ investors and professional directors are reluctant to become involved in a startup,” he said.
However, accountants who specialise in working with startups say they have not advised their clients in using the safe harbour law and admit they know very little about it.
A likely reason is that directors of smaller companies don’t want to incur the cost of professional advice. Statistics collected by McGrathNicol show that when a company fails, it has, on average, been trading insolvent for a period of six months regardless of whether it is large or small, listed or unlisted. Brauer says that shows it is still very difficult for directors to know when they are in the grey zone, even with well-advised boards.
“To me, that says there is a place for safe harbour,” says Brauer. “It means that when you are running the business or governing the business, it is difficult to be objective and know when insolvency may have commenced. It makes sense. Why wouldn’t you do the few extra steps necessary to enliven the safe harbour protections?”
Navigating safe harbour
While each company situation differs, the AICD suggests these nine steps can help directors when accessing safe harbour protection from civil liability for insolvent trading provided in s 588GA(1) of the Corporations Act 2001 (Cth). Check that:
- Outstanding employee entitlements are paid, and the company will be able to continue to pay employee entitlements by the time they fall due.
- The company is meeting all its tax reporting obligations and systems are in place to continue meeting those obligations.
- There are no outstanding issues relating to misconduct of employees and officers which need to be resolved. Directors should focus on ensuring employees are complying with company policies and misconduct should be identified and dealt with appropriately.
- Insurance/indemnity policies, including D&O insurance, are up-to-date and adequate (see p62).
- Before incurring further company debt, consider making an initial assessment whether immediately appointing an administrator or liquidator will lead to a better outcome for the company. At this stage, directors should consider obtaining advice from an appropriately qualified entity and ensure it is given all the information required to provide advice regarding the company’s prospects.
- If the initial assessment and advice points to the likelihood of a better outcome for the company than the immediate appointment of an administrator or liquidator, directors should consider developing a restructuring plan in earnest — and making arrangements to ensure relevant documents are recorded and archived.
- Consider placing these “standing” items on the agenda of the board for consideration:
- the adequacy of financial records and how they might be improved.
- The financial position of the company and whether it has deteriorated/improved, and how this might impact the availability of the safe harbour.
- Whether further advice needs to be obtained from an appropriately qualified entity.
- Whether the restructuring plan is being implemented, and whether adjustments will be required to ensure the desired outcome.
- Whether it would be better for the company to immediately appoint an administrator or liquidator.
- When implementing a restructuring plan, directors should continually assess whether their chosen course of action will still lead to a better outcome for the company to pursue the restructure when compared with the immediate appointment of an administrator or liquidator. Where necessary, directors should obtain updated advice from an appropriately qualified professional.
- If the company is placed into formal insolvency, directors should ensure compliance with any obligations relating to the provision of books and information to a liquidator, administrator or controller. In addition, directors should ensure they are compliant with obligations to assist a liquidator, administrator or controller.
Please note: These steps are intended to be a helpful guide only, and should not be read as an exhaustive list or as a supplement for legal advice. More information here.
Case files: When safe harbour protection made all the difference
Pauline Vamos MAICD, Chair Freedom Insurance
Pauline Vamos MAICD was a director of ASX-listed software company Decimal when it became clear sales were not offsetting high operational costs. “We underestimated how much time it would cost,” she says. “We had all of this revenue booked... but new clients didn’t come in. We could project the month we were going to be out of money.”
The board called in an adviser to run through the options, including raising capital, getting clients to pay early or potential clients to sign up more quickly.
“It all came down to timing. Some options were viable, but they weren’t going to be soon enough,” she says.
The board considered the safe harbour protections. First, it confirmed the company met the three basic eligibility criteria: its books were in order, its taxes up-to-date and it could pay employees. The next hurdle was whether the options under consideration were a real possibility and a better result for the company than going into voluntary administration.
“As a board, we agreed we could find a buyer — other options such as partnership and capital raising were not as viable.”
The company was eventually sold, a better result for shareholders, says Vamos. They lost money, but didn’t lose everything, which would have been likely under voluntary administration.
Matthew Donnelly MAICD, Deloitte Australia
Matthew Donnelly MAICD has helped several companies (including Decimal) turn around after directors invoked safe harbour protections.
Decimal had a large debt payment due, but forward projections showed it would not have the cash to pay. “There was a technical argument that the directors, if they continued to incur debt, may have been trading while insolvent,” he says.
At the same time, directors believed the facility could be renegotiated or it could undertake a capital raising, both of which would allow the business to trade on or to arrange the sale of the business.
“The better outcome was to assist the director to obtain safe harbour protections so they could be confident they wouldn’t be ultimately liable for insolvent trading,” he says.
“The directors then simultaneously pursued debt restructuring negotiations, sale of business negotiations and a capital raising to see which one would mature the fastest. In that case, there was a successful capital raising, which was used to readjust the debt facility. The company’s trading normalised after that and it continues to trade today. Yet it’s a company that may have otherwise sought the relief of administration.”
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