Safe Harbour – Act Early or Be Lost at Sea?

The Senate has just passed Safe Harbour Law Reform in relation to insolvent trading which will come into operation after the Bill receives Royal Assent.

The intention of the new legislation is to “reduce the stigma of failure associated with insolvency” and to strike a better balance between the protection of creditors and encourage honest, diligent and competent directors to innovate and take reasonable risks.

The change is intended to encourage directors to remain in control of a business in financial difficulties and take reasonable steps to restructure, allowing the company to trade out of its difficulties.

The new law provides that directors will not be personally liable for certain debts incurred whilst insolvent if after suspecting insolvency, the director starts taking a course of action reasonably likely to lead to a better outcome for both the company and its creditors as a whole.

To determine whether the course of action is reasonable (assessed at the time the decision is made and not with the benefit of hindsight) the following factors are considered:

• Have directors kept themselves informed about the company’s financial position?
• Have directors taken steps to prevent misconduct by officers and employees of the company that could adversely affect the company’s ability to pay its debts?
• Have directors taken appropriate steps to ensure the company maintained appropriate financial records consistent with the size and nature of the company?
• Have directors appointed an appropriately qualified advisor to obtain appropriate advice from?
• Have appropriate steps been taken to develop or implement a plan to restructure the company to improve its financial position?

In the event that the restructure failed and the company was wound up, safe harbour protection would only be provided to directors where they comply with their statutory obligations to the liquidator i.e. provide books & records, complete a report as to affairs and assist the liquidator as required.

Whilst it is the responsibility of the director to provide the evidence to claim the benefit of the safe harbour provisions, it will be up to the liquidator to show that on the balance of probability, the course was not one that was reasonably likely to lead to a better outcome.

The safe harbour protection is only available where:

• A course of action is developed, which at the time, was reasonably likely to lead to a better outcome than an immediate external administration. This course of action should be capable of compliance within a reasonable time frame.
• Employee entitlements, including superannuation, have been paid when due.
• The company is up to date with its tax reporting obligations.

In reality, when a small business enters a period of financial distress, it is not uncommon for them to fall into arrears in respect of superannuation obligations, notwithstanding the personal liability that may attach to directors in this regard. Additionally in these circumstances, tax reporting obligations are often also not up to date.

As a result, the new laws may provide an incentive for company directors to ensure compliance with these obligations so that they can avail themselves of potential safe harbour protection. Surely not an unintended consequence!

However the evidence garnered over our years of experience demonstrates that the vast majority of directors of SME’s and mum & dad companies suffering a cashflow crisis will be delinquent in their employee and tax reporting obligations, and therefore would not be able to consider a safe harbour option, rendering the law changes irrelevant to most SME’s and mum & dad companies. The law changes may encourage such directors to seek assistance and advice earlier, rather than leaving it until it’s too late to enable a meaningful restructure to occur.

Time will tell, and as a two year review period has been inserted into the legislation, the effectiveness of the legislation can be revisited if required.