On Sunday, 22 March, 2020, the Australian Federal Treasurer announced changes to the Corporations Act in order to provide temporary relief for financially distressed businesses due to the COVID-19 pandemic and its economic and social effects.
It means changes to Australia’s laws on insolvency, but it doesn’t mean it’s open slather on debts. Honorary Adjunct Professor Stephen Van Der Mye explains why.
Written by Co Program Director of the Master of Laws in Enterprise Governance and Honorary Adjunct Professor Stephen Van Der Mye
Section 588G of the Corporations Act 2001 (Cth) (hereinafter after referred to as the Corporations Act) imposes a positive duty on directors to prevent insolvent trading by the company. It should be noted that the extended definition of director under section 9 of the Corporations Act which includes de facto and shadow directors also come under this section.
The penalties on directors for breaching section 588G of the Corporations Act are both civil and criminal. Consequently, insolvent trading claims can expose directors to bankruptcy and loss of personal assets in certain circumstances.
The Safe Harbour Provisions
As a result of the “draconian” nature of Australia’s insolvency trading laws, as compared to say the Chapter 11 regime of the United States of America, combined with the uncertainty over the precise moment a company becomes insolvent have long been criticised as driving directors to seek voluntary administration of a company even in circumstances where the company may be viable in the longer term.
In an effort to counter this often observed factor the Parliament of the Commonwealth of Australia passed the Treasury Laws Amendment (2017 Enterprise Incentives No 2) Bill on Tuesday 12 September 2017 which took effect after receiving Royal Assent on Tuesday 19 September 2017.
Under the legislation section 588GA of the Corporations Act established a safe harbour for directors of an insolvent company against personal liability for contraventions of the insolvent trading provisions under subsection 588G (2) of the Corporations Act. The safe harbour protection was aimed at facilitating more successful company restructures that is, those reasonably likely to lead to a “better outcome for the company” and the company’s creditors, outside of formal insolvency processes.
The protection applies from the time the director starts to take a course of action after beginning to suspect that the company may become insolvent and applies until either the course of action ends, the course of action stops being reasonably likely to lead to a “better outcome for the company” and its creditors or the company goes into administration.
The viability of the course of action needs to be monitored carefully and if it becomes apparent that it will not reasonably lead to a better outcome then the director’s need to place the company into voluntary liquidation.
COVID-19 Reforms to the Insolvency Laws
On Sunday, 22 March 2020 the Federal Treasurer announced a series of amendments to the Corporations Act in order to provide temporary relief for financially distressed businesses due to the spread of COVID-19 and the various restrictions being placed on the movement of persons in the community.
The Coronavirus Economic Response Package Omnibus Act 2020 (Cth) (hereafter referred to as the CERPO Act) passed both Houses of Parliament on Monday, 23 March 2020 and received Royal Assent on Tuesday, 24 March 2020 and will operate for a six month period starting on Wednesday, 25 March 2020 being the day after Royal Assent was granted.
The changes made, contained in schedule 12 to the CERPO Act, are intended to avoid unnecessary insolvencies and bankruptcies by providing a safety net for:
- directors and businesses to help them operate during a temporary period of illiquidity rather than enter into voluntary administration or liquidation; and
- Individuals to assist them with managing debt and avoiding bankruptcy.
Insofar as director’s liabilities for insolvent trading are concerned the COVID-19 Act inserts a new section 588GAAA into the Corporations Act titled “Safe harbour – temporary relief in response to the coronavirus”. The period of temporary relief is for a period of six months and a director may rely on the new temporary safe harbour in relation to a debt incurred by the company if:
- The debt is incurred in the ordinary course of the company’s business;
- The debt is incurred during the six month period starting on the day the new law commences, or a longer period as prescribed by the regulations; and
- The debt is incurred before any appointment of an administrator or liquidator of the company during the temporary safe harbour application period.
At this stage it is not clear which debts will be regarded as being incurred in the ordinary course of business although the Explanatory Memorandum to the CERPO Act states the following:
“A director is taken to incur a debt in the ordinary course of business if it is necessary to facilitate the continuation of business during the six month period that beings on commencement of the subparagraph. This could include, for example, a director taking out a loan to move some business operations online. It could also include debts incurred through continuing to pay employees during the Coronavirus pandemic”.
Nevertheless, there will be limits on what transactions meet this test and the Explanatory Memorandum indicates that a person wishing to rely on the temporary safe harbour in a proceeding in which unlawful insolvent trading is alleged bears an evidential burden in relation to the temporary safe harbour. A definition of Evidential Burden is provided in the Explanatory Memorandum.
As with the original safe harbour provisions directors should remain aware that the temporary safe harbour measures do not change a director’s duties:
- owed to the company to take into account the interests of creditors of the company continuing to incur debts thereby potentially worsening the financial position of the company:
- owed to the company on either a fiduciary basis or a statutory basis as to acting in good faith , with care and diligence and for a proper purpose and;
- owed in relation to unpaid taxes and superannuation guarantee contributions.
While the amendments to the Corporations Act flowing from its recent amendments are welcome, directors should still follow the requirements of the safe harbour 2017 provisions including:
- knowing the financial position of the company;
- preparing a course of action in regards to a “better outcome for the company” and its creditors;
- having the course of action signed-off by an appropriate “qualified” person; and
- keeping on top of the continued trading position of the company.
The COVID-19 amendments are not “open slather” on debt.
Master of Laws in Enterprise Governance
The Master of Laws in Enterprise Governance is delivered as a combination of intensive two-day workshops and online modules. The program available to both law and non-law graduates and has been designed for those who aspire to a governance role.