COVID-19 Insolvent Trading Relief
Effective 25 March 2020, directors attempting to steer companies through the immense uncertainty created by COVID-19, are relieved of the risk of personal liability associated with insolvent trading, in relation to debts incurred in the ordinary course of a company’s business.
Safe harbour protection continues to provide a framework to guide directors on what they should do, when faced with a financial crisis.
On 25 March 2020, new law* came into effect in Australia making insolvent trading inoperative, in respect of debts incurred ‘in the ordinary course of a company’s business’, for a period of 6 months or such longer period as may be prescribed by the regulations.
This is welcome relief for directors, in what are unprecedented and difficult times. The weight of the insolvent trading provisions has been removed and directors can instead, focus on the question of whether and if so, how, their business can survive.
So, what is the framework that remains intact, to guide directors through the next 6 months?
We highlight below a number of key considerations:
– Nothing feels ordinary about business at all just now – however, practically, for the new law to apply, directors need to be satisfied that new debts being incurred are in the ordinary course for the carve out to apply. The explanatory memorandum gives this helpful guidance: A director is taken to incur a debt in the ordinary course of business if it is necessary to facilitate the continuation of the business during the six-month period. This could include, for example, a director taking out a loan to move some business operations online. It could also include debts incurred through continuing to pay employees during the Coronavirus pandemic.
– Directors bear the evidential burden of pointing to evidence that the debt was incurred in the ordinary course of business. As such, directors should keep a record regarding any new or extraordinary categories of debt being incurred in the next 6 months, and if there is any doubt about whether a debt is necessary to facilitate the continuation of the business, directors should seek advice.
– The pre-existing safe harbour protection under section 588GA of the Corporations Act (Safe Harbour) continues to remain valid and on foot for any debts that are outside of the ordinary course of business.
– It is unclear how long it will take for businesses to recover from this pandemic. As such, at the end of the 6-month period, directors will immediately want to have the benefit of Safe Harbour. In order for this to be the case, directors will need to know that there are no subsisting employee and tax compliance issues, taking into account other failures in the prior 12 months. Practically, this means that directors should continue to pay employee entitlements when due and comply with all tax reporting obligations, subject to any relief granted by government, whilst continuing to maintain good corporate governance. If you are struggling with these commitments, we can help you consider what new arrangements can be negotiated by agreement.
– All other director duties, under general law and the Corporations Act, continue to apply. Under the Corporations Act, a director must act with care and diligence, and exercise good faith in the best interests of the company. Importantly, in the ‘twilight zone’ (as a company nears insolvency) and in insolvency, directors must take into account the interests of creditors under general law. This includes employees, suppliers and financiers. Directors of financially distressed companies cannot discharge their duties by trading the company on, without having regard to the impact of that decision on creditors.
– One way to ensure that you are meeting this general law obligation, is to continue to comply with Safe Harbour.This is the clearest way of getting comfort on whether stakeholders taken as a whole, including creditors, are better off by continuing to trade or not. Safe Harbour protects directors by ensuring:
> you seek advice from an expert in helping businesses in financial crisis
> you develop and implement a plan to survive
> you test that plan against the alternative, of liquidation or voluntary administration
– If you are planning on divesting company property during these difficult times, there is a real risk that that transfer will be scrutinised by any subsequently appointed liquidator if the business fails. If the transfer is effected at an under value, it could be unwound as a creditor defeating disposition and directors can be personally liable. One way to avoid such liability is to ensure that Safe Harbour is in force at the time of the transfer.
– Finally, the carve out does not apply to dishonest insolvent trading, which is a criminal offence.
– directors be comforted by the knowledge that the insolvent trading provisions have been relaxed; and
– directors continue to ensure they meet Safe Harbour requirements: for any debts which might not be ordinary course, to protect any transfers of company property that might be said to be at an undervalue, to easily transition into the period when insolvent trading becomes fully operative again, and to ensure a framework is in place to consider the interests of the company as a whole, including creditors.
Early indication from leading law firms is that they agree; the prudent director ought to continue to meet Safe Harbour requirements, by seeking expert advice in these very difficult times.
* The new law is set out in section 588GAAA of the Corporations Act, the text of which can be found in Schedule 12 of the Coronavirus Economic Response Package Omnibus Bill 2020. This bill addresses a number of measures implemented by Federal Government, in response to the Coronavirus pandemic.
This article is general in nature and is not to be taken as financial, legal or governance advice. You should consider seeking independent financial, legal or other advice to check how the information relates to your unique circumstances. Vantage Performance is not liable for any loss caused, whether due to negligence or otherwise arising from the use of, or reliance on, the information provided directly or indirectly.