Section 588G of the Corporations Act 2001(“the Act”) imposes a duty on company directors to prevent a company from trading whilst insolvent. A director can be personally liable for debts incurred by a company if, at the time the debt is incurred, there are reasonable grounds for suspecting that the company is insolvent. Breaching this provision can give rise to both civil and criminal penalties. The focus of the section is on the timing of when the debts are incurred rather than on the conduct of the directors in incurring the debt. The existing statutory defences to an insolvent trading action were very limited.

The Commonwealth Government identified a number of potentially undesirable outcomes of the existing legislation. They were:

• the lower threshold of reasonable grounds for suspecting insolvency, rather than actual insolvency, may motivate directors to cease trading instead of trying to turn around the business. This may be due to the directors’ disproportionate concern about personal exposure. It can lead to the overly cautious step of an external administrator being appointed rather than searching for potential ways to resolve the situation. It can also result in the destruction of enterprise value;
• the directors’ safe bet decision of appointing a voluntary administrator may precipitate, in certain industries, such a loss of confidence in the company that it ultimately ends in a liquidation;
• it is another reason for appropriately qualified people to not take up a directorship;
• the directors’ focus on insolvent trading may result in an imbalance in considering their other duties; and,
• the unnecessary liquidation of companies, which could have been restructured, is not in the interests of stakeholders and the economy as a whole.

From 19 September 2017, Section 588GA now exempts directors from civil liability under Section 588G provided that:

• at a time after the directors start to suspect the company may be, or is, insolvent, the directors start developing a course or courses of action that is reasonably likely to lead to a better outcome for the company; and,
• the debt is incurred, directly or indirectly, in connection with the course of action provided:
  • it is implemented within a reasonable time;
  • the directors cease to take the course of action;
  • if it ceases to be reasonably likely to lead to a better outcome for the company; or,
  • the company enters into external administration.

The directors bear the evidential onus of proving that the course of action is reasonably likely to lead to a better outcome. Factors relevant to this include whether the directors are:

• properly informing themselves of the company’s financial position;
• taking appropriate steps to prevent officer/employee misconduct;
• taking appropriate steps to ensure the company is keeping appropriate financial records;
• obtaining advice from an appropriately qualified entity who was given sufficient information to give appropriate advice; or,
• is developing or implementing a plan for restructuring the company to improve it’s financial position.

There are also vitiating factors which render unavailable the safe harbour of Section 588GA.They are failures to:

• pay employee entitlements when due;
• meet taxation reporting obligations; and,
• substantially comply with reporting obligations and delivery/inspection of/access to documentation to external administrators, if subsequently appointed.

Obviously the safe harbour provisions afford company directors a measure of protection that was not there before. But:

• There is no carve-out from personal guarantee liabilities for debts incurred during the safe harbour period. This may be a serious issue for director guarantees given to suppliers, financiers and landlords (most commonly).

• There is no carve-out for breaches of other directors’ duties during the safe harbour period. Those duties include a general duty of care and diligence and also to act in good faith, in the best interests of the corporation and for a proper purpose.There is authority that directors of an insolvent company owe a duty to that company to consider the interests of its creditors. Thus a company, through its liquidator, may still be able to sue directors for debts incurred during safe harbour. That is a real possibility, particularly if the debt position deteriorated during that time.

• The Australian Stock Exchange (“ASX”) Listing Rule 3.1 requires an entity to immediately disclose to the ASX once it becomes aware of non-confidential information concerning it that a reasonable person would expect to have a material effect on the price or value of the entity’s securities. The ASX considers that entities in financial difficulties are subject to the same Rule 3.1 disclosure standards as other entities. However, the mere fact that a company is in safe harbour is not of itself something the ASX considers generally requires disclosure. It considers a proper course is to approach the ASX for a voluntary suspension. Directors of ASX listed entities thus face a number of conundrums – to disclose that the company is in safe harbour may send its’ shares into free-fall thus defeating the point of safe harbour, to have the company placed into voluntary suspension may have investors reading between the lines and similarly send it’s worth plummeting when re-listed and not to disclose, even if based on the confidentiality carve-out in Rule 3.1A, potentially exposes them to shareholder class actions if a safe harbour course of action is unsuccessful or fails to be implemented.

• Directors seeking director and officer insurance must act with the utmost good faith, and have a duty to disclose to the insurer, before the relevant contract of insurance is entered into, inter alia, every matter known to them which would be relevant to the decision of the insurer to accept the risk and, if so, on what terms. Disclosure of directors’ reliance of safe harbour and hence the basis for it being so, are required, to comply with those duties. That could result in no insurance being procurable, or, if available, at significantly higher premiums or higher excess. The insured will invariably also have continuous disclosure obligations under the contract.

• A breach of Section 588G can incur a criminal sentence of up to five years imprisonment. The Crimes Acts of the States make it a crime to conceal a serious indictable offence, committed by another person, unless the failure to report is because of a reasonable excuse. A serious indictable offence generally applies to an offence punishable by a term of five years or more imprisonment. Thus a non-lawyer appropriately qualified adviser, ought report to a relevant authority (likely ASIC) a director who consults him/her if the director has been or will be trading insolvently, in order to comply with Crimes Act obligations. That is a serious disincentive to a director consulting a professional adviser for safe harbour.

• Most insolvency practitioners, being appropriately qualified persons for Section 588GA purposes, will also be members of professional accountancy bodies in Australia. If so they must comply with the Accounting Professional & Ethical Standards Board Code of Ethics for Professional Accountants (“APES 110”). If they were to find insolvent trading they will need to consider reporting to the company’s auditor and to an appropriate authority. If the accountant believes that intended conduct would constitute an imminent breach of a law that would cause substantial harm to investors, creditors, employees or the general public then he/she may, after discussion with management or those in governance of the company, disclose the matter to an appropriate authority.

• The Australian Taxation Office retains all its rights notwithstanding that a company may be in safe harbour. Those rights include issuing Director Penalty Notices on directors whose companies fail to pay when due, inter alia, PAYG and superannuation obligations, rendering the director personally liable. Further, if the ATO is aware that the directors are availing themselves of the safe harbour and receives PAYG or superannuation guarantee charges payments during that time, it is likely to lead to a Liquidator’s unfair preference claim and the ATO cross-claiming against directors under its statutory indemnity pursuant to Section 588FGA of the Act. If the company had immediately gone into external administration, the directors would not have faced the indemnity obligations arising from Section 588FGA, for unfair preference payments made to it during the safe harbour period.

• Directors who consult insolvency practitioners for safe harbour advice, which is extensive or of long duration, may find that the practitioner is barred from accepting a subsequent external administration. The practitioner is obliged to disclose his/her relationship if it occurred within 24 months of the appointment and may have a conflict of interest or duty barring him/her from taking the fresh appointment. Thus a company runs the risk of incurring substantial fees to a practitioner only to have to re-educate a fresh firm at more expense.

• If safe harbour is not confidential then suppliers may cease to supply or change terms to overcome risk, such as cash on delivery, requiring director guarantees, or increased prices. To financiers and landlords, safe harbour may be regarded as a material adverse change within their contracts and thereby allow them to accelerate payment or take enforcement action under their contract.

• If safe harbour is not disclosed then creditors may assert against the directors a breach of the Australian Consumer Law.

• There also may be difficulties in compliance with the terms of Section 588GA itself. They include:
  • the obligation to pay employee entitlements when due. Debate continues on who is an employee;
  • a better outcome for the company may be open to interpretation;
  • advice needs to be from an appropriately qualified entity. That term certainly would include an experienced insolvency practitioner. However the Act is not limited to them. Other advisors may not be appropriate, or need be added to give appropriate advice. But directors should be astute to ensure that the appointees are of means and have adequate professional indemnity insurance if their advices prove unsuccessful; and,
  • the onus on establishing a reasonable likelihood of a better outcome lies with the director. Thus any plan should be documented as should all discussions as to alternatives and the basis for the reasonableness of belief in the beneficial outcome.