30 May Finding a Safe Place to Restructure in a Deep Ocean
We have all seen the newspaper headlines trumpeting the virtues of Safe Harbour and using professional, regulated advisors to navigate the rough waters of insolvency.
However, burning questions have long held my mind – will this really be suitable for Small to Medium Enterprise (SME) sized companies? Can the average sole director really take advantage of this regime? Or really will it only suit medium to large private companies or public companies that have sophisticated boards and proactive accountants? Will the compliance and payment obligations be too onerous for the majority of SMEs to even avail themselves?
The general consensus seems to be that we will not see a large volume of SME safe harbour engagements, but the regime will still be useful for the right companies with highly motivated and compliant directors.
For those who think directors of SME’s will get a benefit, we need to think about what the impediments to implementing a Safe Harbour Strategy might be. Be they cost, compliance or exclusion barriers. While we would all like SMEs to act early and restructure their businesses, the realities of SME insolvency are largely universal – that directors are nearly always too late and usually behind in tax obligations and record keeping – all of which will not provide the Safe Harbour protection as its intended.
At the end of the day, publicly listed companies usually have professional advisors to ensure the directors are protected. So, somewhere sandwiched in the middle are the Midmarket Businesses (MMB) who may ultimately prove to be the most voluminous beneficiaries of the Safe Harbour laws.
Safe Harbour Laws – Commencement
The Safe Harbour laws came into effect on 19 September 2017 after Royal Assent was received.
When the Bill was first released, the Minister said
“This Bill will protect diligent and competent company directors from personal liability for insolvent trading if they are pursuing a restructure outside of a formal insolvency process. Directors will be able to remain in control of the company and take proactive steps to restructure a company when that is reasonably likely to deliver a better outcome for creditors, employees and shareholders.”
On the face of, it gives great hope to directors and the image of a restructuring culture in Australia.
What is Safe Harbour?
The protection afforded by the provisions is to provide a “safe harbour” for directors from personal liability for insolvent trading if the company is undertaking a restructuring outside of formal insolvency. It is aimed to balance the need for directors to have an opportunity to turnaround a business while safeguarding exploitation of creditors and stakeholders.
It is a carve-out (not a defence) of existing insolvent trading legislation allowing directors to continue to trade a company that may be insolvent for the purposes of achieving a better outcome for the company and creditors than a formal appointment (e.g. Voluntary Administration or Liquidation) would achieve.
The Act implements the Safe Harbour for insolvent trading for directors (with some qualifications). Section 588GA(1) of the Corporations Act (the Act) provides for the exclusion for liability under the existing 588G insolvent trading regime.
It is for directors to give them protection while an action plan is developed. But it relates only to a particular time after a person starts to suspect their company may be insolvent or about to become insolvent and they start developing a course of action that is reasonably likely to lead to a better outcome for the Company.
It also provides protection for holding companies where the holding company took appropriate steps.
What it is not – is a formal appointment under the Act.
What has changed?
To answer, in some respects not much, but also a lot. It is a bit like keeping the old bath water and adding in some bubbles to give the baby a bit of spruce up.
The old insolvent trading laws in the Act are still there. They have not changed. What has changed is the carve out and the protections available to directors. These apply provided:-
- The directors take a course of action that is “reasonably likely” to lead to a better outcome for the company and creditors
- The new debts incurred in the safe harbour period are either directly or indirectly connected to the course of action taken by the directors (this should include new trade debtors)
- The course of action must be implemented in a reasonable timeframe
- The company complies with its employee obligations (incl superannuation)
- The company continues to meet its tax obligations
There are a lot of “reasonables” and “better outcomes” in the legislation as are the “substantial compliance” hurdles.
I really question how many directors of SME’s would meet the last two requirements, let alone have the knowledge, funds and advice to instigate the first three.
Burden of Proof on Directors
The director has the burden of proving whether a course of action is “reasonably likely” to lead to a better outcome when the decision is made to enter Safe Harbour.
Indicative factors to be considered are whether the director has
- Kept informed of the financial position
- Taken actual steps to prevent misconduct by officers and employees
- Taken steps to ensure proper financial records are kept
- Obtained advice from an appropriately qualified adviser (e.g. an ARITA member or Registered Liquidator) and
- Taken steps to implement or develop a restructuring plan to improve the Company’s financial position
These factors are aimed at preventing abuse of the safe harbour regime, but one would expect that these factors are not really aimed at boards of listed companies that would have advisors and systems in place, but rather at SME’s or MMBs. But can SME’s really afford to do that?
When does protection end?
The protection only lasts when the debt is directly or indirectly in connection with the course of action taken and ends at the earliest of:
- If the director fails to take any such course of action within a reasonable period after that time – the end of that reasonable period
- When the director ceases to take any such course of action
- When any such course of action ceases to be reasonably likely to lead to a better outcome for the company
- The appointment of an administrator, or liquidator, of the company.
Director Liability before and after Safe Harbour is implemented
A director would only be liable for insolvent trading (during the Safe Harbour period), if it is shown that the director did not take any action that would try and lead to a better outcome for the company and its creditors, rather than entering into a formal insolvency appointment.
But what about before and after entering the safe harbour in the event the restructuring fails? Creditors can still pursue a winding up action during the Safe Harbour period. The new provisions do not give that protection. Insolvent trading may have occurred well before the Safe Harbour was entered and so even though an attempt has been made to restructure, protection is only good for the specified period.
The director may still be liable for any insolvent trading before Safe Harbour protection was engaged. The risk is always there for the old debt if the company fails in the end.
The protection ends when any of the first 3 of the trigger events occurs. So any trading after the end of safe harbour protection could expose the director for insolvent trading again.
Difficulties in the law
There are difficulties in the law and the protection it may or may not offer.
Firstly, the question whether the course of action is “reasonably likely to have a better outcome” for the company seems to be an objective question.
Secondly, the term “better outcome” is defined as a better outcome for the company than the immediate appointment of an administrator or liquidator. The case law will need to determine what is the threshold at which steps taken are “reasonably likely” to lead to a better outcome for the company, and whether that comparison has regard only to the company or also to the interests of its creditors, or classes of creditors.
Thirdly, there will be a question as to the extent of connection that is required to fall within the language “directly or indirectly in connection with the course[s] of action”.
The generality of the legislation can only be made out in the case law. The Courts will no doubt bring down some interesting analyses on what constitutes “reasonableness” or “better outcomes”. Until then, professional advisers will just have to use their own best judgements as to what is “reasonable” or “better”.
Are the Safe Harbour provisions too onerous for small businesses?
There are many barriers to SME business owners in considering using the safe harbour regime. Not including the costs of engaging an adviser and ensuring all of the obligations required are met. Directors would ultimately face a difficult and expensive argument in Court defending insolvent trading proceedings.
They also run the risk in keeping up ATO payments that if the restructuring fails, they may be caught up in an indemnity if a liquidator pursues preference payments against the ATO.
Appropriately Qualified Adviser
An interesting question that also arises, and which is important to all directors, is what constitutes “an appropriately qualified entity” to be the safe harbour adviser.
ARITA raised some serious questions about what constitutes “an appropriately qualified entity” to give the advice. ARITA strongly advocated for professionals with requisite Professional Indemnity insurance. In particular registered liquidators, but at the very least a regulated adviser subject to high professional standards.
All of the Registered Liquidators at SV Partners are suitably qualified to be Safe Harbour advisers.
What does it mean for creditors?
The old laws were all about protection of creditors.
The new regime may mean, in successful restructures, that creditors that would have received little from a formal appointment, may get a better return in the long run.
But what if the restructure is not successful? Creditors will bear the risk and lose even more because they would have incurred more debt.
The law shifts the risk from the director to the creditors to some extent, all in the name of entrepreneurialism. Perhaps it is the directors, not the creditors that need to put their money where their mouth is? More likely as creditors will not often know that a company has sailed into the safe harbour, they will over time tighten their credit policies, thus depriving directors much of the funding they crave for a restructure.
Will vessels be rescued in the small pond?
For SME’s and MMB’s, a move to a business restructuring culture will only be achieved if professionals such as accountants, financial advisers and legitimate (pre) insolvency advisers can offer strategies that are cost effective and compliant with the laws to repair the boat, sometimes put in a new crew and launch it back out to sea.
However, no matter what repairs are done, a rescue will only be successful if creditors, who bear the ongoing risk, agree to support the business through the Safe Harbour period. They will not do that if they will be disadvantaged by it.
Article written by Jason Porter, Executive Director SV Partners Sydney