In brief - Directors may be protected from liability for insolvent trading under certain circumstances
It is a truth universally acknowledged, that directors of a company in financial distress, must promptly appoint administrators rather than risk personal liability by trading on (with apologies to Ms Austen).
Does it have to be this way? Recent reforms to the Corporations Act 2001
have introduced a regime to protect directors of companies from liability for insolvent trading where the directors have a plan to rescue the business.
Insolvent trading - directors' duties and defences
A director has a duty to prevent a company from trading whilst insolvent, and a breach of that duty has significant consequences, from personal liability for any debts incurred to criminal liability for blatant breaches.
There are limited defences available to a director who:
- had reasonable grounds to expect that the company was solvent
- played no part in management due to illness or some other good reason, or
- took all reasonable steps to prevent the company from incurring the debt
Given the potential for personal liability, it is no surprise that directors choose to appoint administrators as soon as they form the view that the company is insolvent or likely to become insolvent.
How does the new section 588G(2) work?
The new section 588G(2) acts as a carve out from the duty to prevent insolvent trading, rather than a defence to a claim, in quite particular circumstances. Essentially, directors will not be personally liable for a debt incurred whilst the company is insolvent:
- if at a particular time after the director starts to suspect the company may be insolvent
- the director 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 with any such course of action
There are a number of factors identified in the legislation that are important in considering whether a plan is reasonably likely to lead to a better outcome for the company, including:
- obtaining advice from an appropriately qualified entity, and
- developing or implementing a plan for restructuring the company
Practically, this means that taking advantage of safe harbour requires directors to take positive steps to develop and implement a plan to positively restructure the company, with the assistance of a qualified professional, after a time that the directors of the company have identified that the company may be insolvent.
When may directors not take advantage of safe harbour?
The most important circumstances in which directors will not be able to take advantage of safe harbour is if the company has failed to substantially comply with:
- obligations to pay employee entitlements, and
- taxation reporting requirements
within the previous 12 months.
What should directors of companies in financial distress do?
These provisions potentially allow directors time to take steps to preserve or rescue a business in circumstances where a feasible restructure is possible, without the risk of personal liability for debts incurred while implementing the restructure.
It will be important, however, to ensure that the steps taken by the directors are consistent with the terms of the legislation.
This is commentary published by Colin Biggers & Paisley for general information purposes only. This should not be relied on as specific advice. You should seek your own legal and other advice for any question, or for any specific situation or proposal, before making any final decision. The content also is subject to change. A person listed may not be admitted as a lawyer in all States and Territories. © Colin Biggers & Paisley, Australia 2020.