We live in interesting times. 

Uncertainty in global markets, inflationary pressure, the rapid rise in AI and low consumer confidence are just some of the issues Australian businesses are facing. The spate of recent insolvencies in the property and construction sector, most notably the Bathla Group, has placed, and will continue to place, further financial pressure on businesses. The multiplier effect of the Bathla collapse has yet to play out but it may be significant, impacting both small and large businesses across many sectors of the economy. 

It all may seem daunting to business owners, but such conditions are not unprecedented. Our economy is cyclical and rises and falls are normal and to be expected. 

Recognising this puts things into perspective, but it will not solve the immediate problems. Businesses must remain agile, take positive steps and not assume that what worked yesterday will work tomorrow. 

Fortunately, there are legal mechanisms available to Australian businesses that can minimise risk and assist businesses to ride out financial stresses to emerge, if not unscathed, at least still standing. 

The most important message to businesses is: 

• don't panic; 
• don't ignore problems and hope they fix themselves; and 
• seek experienced and qualified assistance promptly.

Many businesses in Australia operate through companies. This seems an obvious statement but it is extremely important to understand the legal structure of each business so as to consider how best to respond to potential or actual financial distress. It is astonishing how often the fundamental legal structure and obligations that structure creates are not understood until it is too late. The directors of a company are responsible for the management of companies and bear some significant legal risks. 

In this article we will discuss some of the options available to directors to navigate financial stress, and to also manage personal risk, so as to allow the business to return to profitability. 

A director of a company may become personally liable for debts incurred by that company if those debts are incurred whilst the company is insolvent or the company becomes insolvent as a consequence of incurring that debt.

This very real risk of personal liability has in the past been seen as a barrier to companies continuing in business whilst taking steps to "fix" the business. Concern as to personal risk has led some directors to appoint administrators or liquidators prematurely with immediate disastrous impact on employees and other stakeholders. 

The Corporations Act provides a mechanism described as "Safe Harbour". The intent was to alleviate the personal risk directors faced and encourage genuine efforts to restructure a company's business to provide a better outcome for the company than would be the case if it were immediately put into liquidation or administration. 

The safe harbour regime has been in place now for nearly a decade and a number of reports and considerable academic and professional discussion of the effectiveness of the safe harbour regime has taken place. There is, however, limited consideration by courts. 

In order to qualify for the safe harbour protection, a company must, at the least, have paid all of its employees all of their entitlements and must have lodged all necessary returns with the Australian Taxation Office (ATO). Ensuring that ATO lodgements are made on time is crucial for other reasons; not least as it reduces the risk of a director receiving a Directors Penalty Notice that may make them personally liable for unpaid tax. 

Safe harbour is not a solution to all problems facing a company; its strictly legal purpose is as a defence to a future claim of insolvent trading. 

It however has significant practical utility if implemented properly. 

Safe harbour does not reduce a director's duty to act in the best interests of the company. This obligation remains. 

The most valuable benefit of safe harbour protection is to require directors to obtain advice from an appropriately qualified person and then to implement a plan that is reasonably likely to lead to a "better outcome" than if that company were to be immediately placed into liquidation. 

This may sound theoretical, but a better outcome plan implemented with the protection of safe harbour can be extremely effective. 

Merely saying one is in safe harbour does not solve anything. What must happen is the implementation of a proper and realistic plan to restructure the business. 

Safe harbour is particularly useful in larger companies where directors may not have significant personal exposure or investment in the company even though they have all of the legal obligations and liability of a director. By removing some of the personal risk, directors may concentrate on the plan to restructure the business. 

In small and medium enterprise businesses, particularly family based businesses, there is usually a greater level of personal investment and personal risk to directors because of personal guarantees given to lenders or suppliers rather than because of directorial liability. Directors may think that adopting safe harbour has no value because they are "on the hook" anyway. 

This is wrong. 

If properly implemented, safe harbour will minimise the risk of insolvent trading but importantly it will focus the minds of the directors on preparing and implementing a viable plan to turn the business around and ensure a better outcome than immediate administration. 

Safe harbour protection is effectively useless if it is nothing more than a screen for the directors to continue to run the company in the same way they always have. If the company is facing financial distress, then something needs to be done that is different to that which has previously been done. Borrowing more money alone (and providing more security) is rarely the answer (Bathla demonstrates this). 

There is no one solution that fits all circumstances. Preparing and adopting a proper safe harbour plan is, in our experience, a very effective way of considering the best solution to preserve value for all stakeholders, whilst protecting directors from additional personal liability. 

It does, however, require fresh eyes to help prepare a plan. 

Directors should not just hand over the business to the external advisor. The advisor's role is to assist and ensure the plan makes sense. Safe harbour allows directors who should have the most knowledge of their business to consider how to turn the business around and focus on how to do this. 

The professional advisor is there to assist, not to run the company. If a business is at the point where someone else has to run it and the directors don't have a viable plan, the appointment of an administrator is appropriate. The business may still then be saved by a Deed of Company Arrangement but with greater cost and commercial risk. 

Smaller businesses, particularly those that are run by a single family or long term business partners, face other risks that safe harbour can't solve. Even though a company structure is in place, the directors and individual shareholders of smaller trading companies are likely to have substantial personal liability through personal guarantees to lenders and suppliers that most suppliers require as a matter of course. They have probably also mortgaged their family home to the primary financier. 

Safe harbour can still assist. 

In those circumstances, the main value of the safe harbour regime is the discipline of imposing a plan with an advisor assisting. It is essential, however, that such businesses do not ignore impending, financial distress. 

The main message we want to emphasise is that the longer a problem festers the worse it is going to get. It is very unlikely that the next deal or the next sale is going to save the situation without some fundamental changes to a business. 

Ask for help! 

We have acted in a large number of effective restructures in which safe harbour has been utilised. 

By its very nature, a safe harbour regime is usually not publicised. It is usually only when the administrator or receivers are appointed that the safe harbour regime becomes public. 

This firm is engaged regularly by the directors of companies to advise upon the proper implementation of a safe harbour plan and consequent business restructure. 

One example of a successful outcome, which is publicly known, relates to the wind down of a small capitalised insurance company, Eric insurance Limited. That company was engaged in a solvent run off approved by the insurance regulator planning to cease to trade in several years, when it became subject to multiple and consistent small claims from prior policyholders. 

As a consequence, the solvent run‑off became problematic and a significant challenge to both the directors and the regulator. Our advice to the directors to implement a safe harbour regime was accepted and a planned administration subsequently entered into. This had the outcome of paying all creditors who proved in the deed of company arrangement 100 cents in the dollar and resulting in a return of capital to shareholders. 

While this is an unusual circumstance, it would not have been possible without the benefit of the safe harbour regime as an immediate liquidation would have been required and this would have inevitably resulted in substantially increased costs and a loss to creditors. 

We have advised in many other circumstances where, by adopting safe harbour, the directors have successfully restructured their business.

If a company is facing financial distress, the directors and management should be the first to know. It is pointless to ignore the signs and hope that things will just get better. It is essential to obtain proper professional advice quickly. 

There are many mechanisms available to assist directors to restructure a viable business. If the business is no longer viable, dealing with that circumstance quickly will minimise loss and pain to the shareholders, directors, employees and creditors. Whilst this might seem counter intuitive, the Australian Taxation Office and most reputable lenders generally react in a positive manner and try and assist a business that is acting honestly and proactively to try and deal with its problems. 

We have significant experience in advising directors and companies facing financial distress.  

Please feel free to contact any of the following if we can assist: Scott Hedge, Glen Williams, Ece Mustafa-Ay and Stuart McKenzie.