In December 2015, as part of its National Innovation and Science Agenda, the Federal Government announced a proposal to introduce a ‘safe harbour’ for directors from personal liability for insolvent trading.
The proposal seeks to address Australia’s insolvent trading laws, which are significantly stricter than comparable laws in the United Kingdom, Canada and New Zealand. The United States has no insolvent trading laws. The consequences of breaching Australia’s insolvent trading laws range from directors being personally liable to pay the debts incurred by the company while it was insolvent, to imprisonment.
These laws are widely accepted in the business community as stifling entrepreneurship and innovation.
At one end of the spectrum, directors are often seen as being too quick to appoint an administrator or liquidator to protect themselves from personal liability, in circumstances where a restructure or turnaround strategy could result in the company returning to profit within a reasonably short period. This has the potential consequence of destroying value in what could otherwise be a successful venture.
At the other end of the spectrum, the laws are often regarded as not having their intended effect of preventing insolvent trading. Directors with their personal wealth tied to the company are often seen as continuing to trade to try to save their investment on an ‘all or nothing’ basis. This activity is undertaken at the expense of creditors.
Proposals for ‘safe harbour’ reforms have been discussed at length by the Government and industry groups such as TMA AUSTRALIA since 2007. In this regard, the reforms are long overdue.
The proposal announced in December 2015 will protect directors from personal liability for insolvent trading if they appoint a restructuring adviser to develop a turnaround plan for the company.
Although the detail remains to be seen, a possible mechanism to give effect to the ‘safe harbour’ is a ‘business judgment rule’ similar to the rule that already exists in relation to directors’ duties. Directors are deemed not to be in breach of their duties to the company if they discharge their duties in good faith and for a proper purpose, inform themselves about the subject matter of the judgment to the extent they believe is appropriate and rationally believe the judgment is in the best interests of the company.
In the insolvent trading context, the Australian Restructuring Insolvency & Turnaround Association would also add the following key criteria:
- That the director has taken all proper steps to ensure that the financial information of the company for the provision of the restructuring advice is accurate;
- That the director was informed with restructuring advice from an appropriately qualified and experienced professional;
- That it was the director’s business judgment that the interests of the company’s creditors and members were best served by the restructuring; and
- That the director took all reasonable steps to ensure that the company pursued the restructuring.
Squire Patton Boggs welcomes the proposed reforms to the insolvent trading laws. We consider that the laws will balance the need to encourage responsible risk taking in business ventures against the interests of creditors, and will thereby meet the Government’s stated objective of encouraging innovation.