On 28 March 2017, the Federal Government released draft reform legislation to Australia’s insolvency laws to promote a culture of entrepreneurship and help reduce the stigma associated with business failure.

The reforms, known as ‘safe-harbour’ provisions propose changes to directors’ personal liability for insolvent trading under the Corporations Act 2001 (Cth) (Act).

Background

Currently, under section 588G of the Act, directors can be held personally liable for a debt incurred by a company that is insolvent, or becomes insolvent by incurring the debt, where there are reasonable grounds for suspecting that the company is or will become insolvent.

The ‘safe-harbour’ provisions

The proposed amendments to the Act will create a ‘safe harbour’ for company directors from this personal liability if the company is undertaking a financial restructure. They are intended to encourage honest company directors to remain in control of a financially distressed company and take reasonable steps to restructure and allow the company to trade out of its difficulties.

The proposed ‘safe-harbour’ provisions will provide a carve-out from personal liability where directors can prove that, at the time the company was insolvent, they took a course of action which was reasonably likely to lead to a better outcome for the company and the company’s creditors. A better outcome is one where the company and its creditors are better off than if the company had entered into external administration.

The amendments also provide an indicative and non-exhaustive list of factors to determine if the directors’ actions were reasonable and likely to lead to a better outcome, including whether the directors have:

  • taken steps to prevent misconduct by officers and employees of the company;
  • taken appropriate steps to ensure the company maintains appropriate financial records;
  • obtained appropriate advice;
  • kept themselves informed about the company’s financial position; and
  • been developing or implementing a plan to restructure the company to improve its financial position.

The amendments to the Act are intended only to apply to directors acting honestly to pursue a reasonable course of action. There are certain circumstances in which directors will not be able to rely on the ‘safe harbour’ provisions, including where the company has not:

  • provided for the entitlements (including superannuation) of its employees;
  • maintained its books and records (so they are available to a liquidator or administrator, if required); or
  • met all taxation reporting obligations.

Next steps

The provisions aim to strike a balance between protecting creditors and encouraging directors to actively engage and take reasonable risks to restructure a financially distressed company. To address the stigma often associated with corporate failures, the provisions seek to shift the cultural focus from the existence of insolvency to the behaviour of the directors in seeking restructure the company.

The proposed ‘safe harbour’ provisions are not intended to be a mechanism for a company to continue to trade past the point where it is viable. At that time, it is appropriate for the directors of the company to either make adjustments to their course of action or place the company into voluntary administration. Failure to do so may expose the directors to personal liability under the Act.

The proposed amendments are open for public submission until 24 April 2017 by email or post.