What is
SAFE HARBOUR?

What is insolvent trading?

Section 588G of the Corporations Act 2001 imposes civil and criminal liability on company directors who incur debts after a company is insolvent. A director can be made personally liable for those company debts.

Why is Safe Harbour needed?

The Safe Harbour reform addresses a concern that the risk of potential insolvent trading claims was forcing directors to place their companies into administration prematurely, rather than try to restructure them. The Government has struck a better balance between the protection of creditors and encouraging honest directors to innovate and take reasonable risks. The Safe Harbour amendments focus on the behaviour of directors in trying to turn their company around, rather than merely on the solvency of the company and the precise timing of debts being incurred as has previously been the case. Safe Harbour is intended to encourage honest company directors to remain in control of a financially distressed company and take reasonable steps to restructure and allow it to trade out of its difficulties.

What factors may be “reasonably likely to lead to a better outcome”?

The legislation sets out some indicators of appropriate steps:

• Taking steps to prevent misconduct by officers and employees;
• Ensure that the company keeps appropriate financial records;
• Obtaining advice from an appropriately Qualified Adviser or entity;
• Keeping properly informed about the company’s financial position;
• Developing a Restructuring Plan.

What would be in a Restructuring Plan?

A Director should create and document a ‘Restructuring Plan,’ setting out:

• An objective, which is probably a return to solvency, but if not, a ‘better outcome’;
• The steps taken to receive advice from an appropriately qualified adviser;
• Future steps to ensure there will be no misconduct that could adversely affect the company’s ability to pay all its debts;
• How the directors conclude that the company is keeping appropriate financial records;
• The strategy and a set of actions to deliver the objective;
• Measures to review the effectiveness of the plan including milestones;
• Probably regular reviews involving the Restructuring Adviser.

What does “better outcome” mean?

Better Outcome is defined to mean where the company and its creditors as a whole are better off than if the company were to go into liquidation or Voluntary Administration.

How good does the Restructuring Plan have to be?

Whether a strategy was appropriate and reasonable will vary on a case by case basis. However, a vague or fanciful plan will not do. Also, Directors who take a passive approach or simply continue trading as usual will fall outside the bounds of the Safe Harbour.

What debts would a director be protected from by Safe Harbour?

The Safe Harbour rule does not cover all debts. It only covers debts that are incurred in connection with the course of action and during the period commencing when the course of action is first taken and ending when the course of action is no longer reasonably likely to lead to a better outcome.

Does Safe Harbour only refer to Debts incurred regarding the restructuring, like professional fees?

No. The legislation make it clear that it refers to debts “incurred directly or indirectly” in connection with the course of action taken. The reference to “indirectly” incurred debts extends to debts incurred in the ordinary course of trading, as well as debts related to the restructuring efforts such as paying for professional advice. This change alleviated a concern that ordinary course debts may not be captured by the safe harbour.

Will a director need to approve every debt to ensure it is covered by Safe Harbour?

No. Again, the explanatory memorandum says that directors will not need to scrutinise every debt incurred. They will need to make an ongoing assessment of whether there is still a reasonable likelihood of a better outcome if the company continues trading and incurring debt.

Will Safe Harbour cover a director for large asset purchases?

Possibly. Significant debts incurred as a result of non-ordinary course asset purchases are potentially covered. However, a director should ensure such purchases are well scrutinised and probably specifically covered in the Restructuring Plan.

What is an “Appropriately Qualified Advisor”?

The legislation does not provide any guidance as to what is an “appropriately Qualified Adviser”. The explanatory memorandum references: independence; professional qualifications; membership of an appropriate professional body; professional indemnity insurance to cover the advice being given.

What if the Restructuring Plan doesn’t work?

While the change is intended to allow companies to be restructured outside of a formal insolvency process, some companies may not be able to recover and will still proceed to voluntary administration or liquidation despite the directors’ best efforts. Provided that the director was pursuing a reasonable course of action then they will still have the benefit of Safe Harbour in these circumstances.

What are the traps that may exclude a director from Safe Harbour protection?

If the Restructuring Plan does not work and the company ends up in liquidation then that is the time when a director will want to claim the benefits of a Safe Harbour for debts incurred. To do so a Director will need to produce to the liquidator all books and records relayed upon to supporting the Safe Harbour defence. So that defence will fail if a Director has concealed, destroyed or removed books of the company or fails to provide a liquidator with access to books or other material. Also, Safe Harbour will not be available to directors who fail to provide for employee entitlements or fail to keep up to date with tax lodgements.

Is Safe Harbour of benefit to small business?

Yes. Safe Harbour provisions provide scope for directors to manage company affairs, enabling all struggling companies to explore restructuring as an avenue to company stability. Crucially for small companies, it will be much cheaper and less disruptive than a Voluntary Administration process.

Is Safe Harbour good for start-ups?

Yes. Safe Harbour will alleviate some problems for new start-up business investors who would previously be reluctant to take on roles as directors because of the risks associated with unintentional breaches of insolvency law.

Who has to prove what to ensure Safe Harbour protection?

Under the legislation, the directors will have the onus of demonstrating that the Safe Harbour exception is available. However, if a director provides some evidence to the liquidator that the Safe Harbour requirements have been met, such as a written Restructuring Plan, then the Director has met the initial burden of proof. It would then be up to the liquidator, or other party who is seeking to make directors personally liable for insolvent trading, to establish that the director’s course of action was not reasonable in the circumstances.

Could the Restructuring Advisor be personally liable if the Plan doesn’t work?

The legislation states that the Restructuring Adviser is carved out of the definition of director, and the restructuring adviser will not be civilly liable to third parties for an erroneous opinion provided that it was honestly and reasonable held. This avoids a situation where restructuring advisers may be reluctant to take an appointment if faced with the possibility of certain personal liabilities.

Can Holding Companies use a Safe Harbour defence for a subsidiary?

Yes. A significant addition in the most recent draft legislation was the extension to now also provide Safe Harbour protection to a holding company of an insolvent subsidiary.

Will the company have to disclose that it intends Safe Harbour protection?

No. companies will not have to disclose whether they are operating in Safe Harbour, but a listed company will still have to abide by continuous disclosure obligations.

What are the different categories of companies in financial distress?

Companies in financial distress can be classified into several broad categories.  We have coined the phrase “Restructuring Spectrum” to describe the broad range of situations a company may be facing. We use four broad categories being:

• Underperforming;
• Financial Distress;
• Insolvent – Restructurable;
• Insolvent – Liquidation

What sort of solutions are available to companies in financial distress?

For each situation there is an appropriate solution for a company in financial distress. The overriding philosophy is to find the “Least Drastic Solution”. That is, the solution as far to the left hand side of the Restructuring Spectrum as possible. The more to the left hand side of the spectrum your assessment is, the less drastic is the situation. The more to the right, the more drastic. Similarly, the solutions available are less drastic on the left than they are on the right.