Covid-19 is testing the new safe harbour rules. The rules, amended in 2017, intend to protect directors from personal liability while making decisions for the company, especially when the company is on the brink of insolvency. At the onset of the pandemic, the Australian government provided temporary safe harbour rules exempting directors from personal liabilities for decisions made during six months from March 25 to September 25, 2020.
Act now, rather than later, Hamilton Locke suggests. “We would recommend the directors consider the safe harbour and take appropriate advice now given the global uncertainty. If there are any concerns or doubts about future financial performance the directors should look to avail themselves of the potential protection sooner rather than later.”
The Insolvency Service recommends seeking the advice of professionals to help directors make sound financial decisions for the company because even though safe harbour provisions are in place, they do not provide absolute protection.
Pre-COVID-19 Safe Harbour
Safe harbour provisions prior to COVID-19 provide directors who were trying to save a business with protection from future insolvent trading claims. These provisions also protect creditors who have a substantial stake in the outcome of the management of the business.
To avoid personal liability, the director must show that the debts were incurred at the time the business was pursuing a course of action that was “reasonably likely” to lead a better outcome for the company than liquidation. Such that even if the company was insolvent or on the way to being insolvent, there is no personal liability for the director.
Determining whether the course of action is “reasonably likely” to lead to a better outcome involves looking into different actions or inactions by the director. For one, the court may look into whether the director properly informed himself of the company’s financial position.
The court will also explore whether the director, knowing the company’s financial position, took the right steps to make sure that the company is preventing misconduct by the officers and employees of the company. Any misconduct committed by an officer or employee could adversely affect the company’s financial capabilities.
In many instances, these requirements simply constitute good financial management during financial distress. The government rolled out business stimulus and rent relief packages, most of which requires companies to file Business Activity Statements and comply with tax reporting obligations.
Temporary safe harbour
In response to the Covid-19 pandemic, temporary safe harbour regime commenced in March. This regime applies until 31 December 2020. As with the existing safe harbour provisions, the temporary rules protect directors from personal liability for decisions made only during the temporary period. Specifically, the rules exempt directors from the risks of personal liability for insolvent trading if the company incurred the debts in following conditions:
- in the ordinary course of business
- within the temporary period, and
- before the appointment of an administrator or liquidator during the temporary period.
The government explained that “ordinary course of business” means the debt was necessary for the business to continue to operate during the six months. As an example, the government said this condition could include taking out a loan for a business to shift to online operations.
Directors should note an important thing: the temporary safe harbour rules are restricted between March 25 and 31 December 2020. If the company incurred the debts before or after this period, those debts may not pass the conditions exempting the director from personal liability for insolvent trading.
Hamilton Locke notes that the temporary safe harbour provisions will provide comfort if the company:
- Will be able to recover quickly and be in a position to pay its debts in the next six months; and
- Only needs to incur debts in the next six months which are clearly within the scope of the company’s ordinary course of business.
However, the law firm points out that businesses incurred unexpected and unprecedented expenses during this Covid-19 pandemic and may continue to incur expenses beyond the six months. Hamilton Locke advises businesses to be “honest about the scope of the issues facing the company and the breadth of the protections required.” The law firm reminds businesses that pre-existing safe harbour provisions are still in place during the six months and can be utilized if necessary.
Director’s Duties Not Exempted
Both pre-existing and temporary safe harbour provisions do not exempt the director’s duties. The rules also require directors to perform specific duties that should prevent insolvent trading. One of these duties is to exercise their powers and discharge their duties with the degree of skill and diligence that a reasonable person would exercise if they were director of a corporation in the company’s circumstances.
The rules prohibit directors from improperly using their positions to gain advantage for themselves or someone else or cause harm to the company. Moreover, the rules prohibit directors from improperly using information they obtained as director to gain advantage for themselves or someone else or cause harm to the company. Lastly, the rules require directors to prevent conflicts of interest arising between their private interest and the company’s interest.
The last duty is important because the director should always take into consideration creditors’ interest while looking after the financial interest of the company. Case law tells us that if a company is insolvent or approaching insolvency, a director is duty-bound to also weigh in the interests of creditors. Courts interpreted this to mean that if the directors allowed the company to incur debts knowing that it cannot pay creditors, this would constitute a breach of duty to creditors.
Given insolvency is defined as when a company is unable to meet its payments as and when they fall due, many Australian businesses currently risk insolvency. Directors should, therefore, ensure they act on the basis that they have a duty to the company’s creditors.
Although safe harbour can apply, a future liquidator could argue that incurring debts when a director was reasonably aware, or ought to be aware, that those debts could not be paid by the company is a breach of these duties. Whether directors have satisfied their duties depends on the specific facts of each situation, and may depend on the scope, quantum and type of debts incurred, and the company’s circumstances and prospects at the time those debts were incurred.
When navigating through this uncertainty, directors should always act in the best interests of the company. When approaching insolvency, this should include the company’s creditors. Obtaining advice as to the company’s options will be essential to meeting these duties.
Directors are business leaders whose duties are most important at this time of crisis. Advice from an appropriately qualified professional is crucial for businesses struggling at these times. Businesses need to implement a plan exploring different options, whether voluntary administration or insolvency, to continue operating the business or maximize recoveries for creditors.