Preserving companies and protecting directors in times of pandemic

Breaking news: On Sunday 22 March 2020, the Australian Government foreshadowed significant changes to Australia’s insolvency and bankruptcy laws, in response to the Covid-19 crisis.

A summary of the proposed changes, provided by the Australian Government, states as follows:

“The elements of the package are:

• A temporary increase in the threshold at which creditors can issue a statutory demand on a company and the time companies have to respond to statutory demands they receive;
• A temporary increase in the threshold for a creditor to initiate bankruptcy proceedings, an increase in the time period for debtors to respond to a bankruptcy notice, and extending the period of protection a debtor receives after making a declaration of intention to present a debtor’s petition;
• Temporary relief for directors from any personal liability for trading while insolvent; and
• Providing temporary flexibility in the Corporations Act 2001 to provide targeted relief for companies from provisions of the Act to deal with unforeseen events that arise as a result of the Coronavirus health crisis.”

We will be reviewing the proposed changes, and updating our guidance.  Stay tuned.

Original article: With events cancelled, schools, businesses and potentially cities in lock down and many industry sectors already under financial pressure, how can directors focus on preserving their companies for the benefit of all stakeholders while at the same time protect themselves from the risks of insolvent trading? 

The Safe Harbour provisions of the Corporations Act provide the answer!

These provisions were introduced into the Corporations Act on 19 September 2017 to protect directors from insolvent trading claims where they have engaged in a course of action that is found to have been reasonably likely to have led to a better outcome for the company than immediate administration or liquidation (better outcome test). They provide a framework for directors wishing to turn around distressed companies and were designed to give them comfort regarding the risks of insolvent trading claims.

As a defence, Safe Harbour is a shield not a sword but as such, provides signposts regarding good practices in times of crisis.

The defence has three limbs. Two are mandatory while the third is not but is a matter that will be taken into account by a Court in deciding whether to apply the defence. So, first, the company must remain up-to-date with its tax affairs and payment of employee entitlements – and most companies impacted by the current crisis would comply here.

Next the better outcome test must be satisfied and in considering this, the Court may have regard to the s 588GA criteria which require a director to have:

• properly informed himself or herself of the company’s financial position;
• taken appropriate steps to prevent any misconduct by officers or employees of the company that could adversely affect the company’s ability to pay all its debts;
• taken appropriate steps to ensure that the company is keeping appropriate financial records consistent with the size and nature of the company; and
• developed or implemented a plan for restructuring the company to improve its financial position.

It could be said that these requirements simply restate good governance practice. However, they were designed to give directors comfort and the freedom to try and rescue distressed companies so are well suited to current circumstances.

Finally, the third limb, also within s 588GA, a discretionary step, but worthy of separate mention, is whether the director has obtained advice from an appropriately qualified entity who was given sufficient information to give appropriate advice. That entity may be a restructuring and insolvency firm or practitioner, banker or other turnaround expert with the experience and expertise commensurate with the circumstances of the company.

Safe Harbour leads to one point:  a restructuring plan which in the case of a pandemic may include first keeping the company in a holding pattern and then pursuing a recovery strategy as events unfold and the crisis passes.

It provides an environment within which a preservation and recovery plan can be tailored to each company and then amended or adjusted as events unfold. Further where the risks of insolvency become very real,  advice from an appropriately qualified entity although not mandatory for the defence,  may both facilitate the development of a realistic plan given their expertise  and give the Court comfort that the workout plan was reasonable and met the better outcome test at the time bearing in mind that considering the test will only ever arise should the company actually go into liquidation; that is, despite best endeavours, the company cannot be saved. Further the advisor would be well placed to monitor the financial health of the company and so be able to advise quickly should the company reach a point of no return such that some form of insolvency administration was the only alternative.

Safe Harbour offers a framework within which outcomes can be developed. It is a dynamic process within a structure that is outcome focused (achieving an outcome that is better than liquidation) designed to be tailored as required. For companies approaching the danger zone, it not only provides protection for directors while they try to devise a solution but encourages access to expert turnaround advice, potentially freeing up management to focus on frontline activities while maintaining stakeholder confidence.