The ‘safest harbour’ for better outcomes
Company directors can protect themselves against insolvent trading risks by utilising the safe harbour insolvency regime, writes BDO Director Chris Demeyere.
Summer holidays. For many of us, that means family gatherings, beach breaks and test match cricket.
For many businesses, it means the office or worksite closes for potentially up to a month. What results? A cashflow shortfall in the new year due to limited billable income whilst continuing cash outflows, particularly for employees’ annual leave and superannuation. Without sufficient cash reserves, businesses may find themselves unable to pay staff and suppliers.
Appointing external administrators may be appropriate where the business’s situation is terminal. However, where a better outcome is foreseeable, company directors can protect themselves against insolvent trading risks by utilising the safe harbour insolvency regime.
The workings of the safe harbour regime are outlined as follows:
What is insolvent trading?
Directors face significant risks in the current economic environment, especially when it comes to insolvent trading.
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Put simply:
- A company is insolvent when it cannot meet payment of its debts as they fall due
- Insolvent trading occurs when directors allow a company to continue to incur debts while insolvent
- Directors who allow a company to trade while insolvent may be held personally liable for the company’s debts incurred if the company later enters liquidation.
A better outcome
Amendments to the Corporations Act 2001 in September 2017 introduced provisions to protect directors from personal liability for debts incurred by an insolvent company, if they genuinely believe in and take a course of action that is reasonably likely to lead to a better outcome for the company and its creditors, compared to the appointment of an administrator or a liquidator.
This allows directors to incur company debts during a ‘restructure/turnaround period’ without the risk of being held personally liable for those debts if they cannot be repaid.
The regime acts as an “insurance policy” against personal liability for directors and encourages responsible decision-making, aiming to balance protecting creditors while also supporting directors in responsibly working towards turning around a company.
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However, the director’s protection ceases when the course of action stops being likely to lead to a better outcome.
Conditions for Safe Harbour protection
To rely on the safe harbour provisions, directors must:
- Meet their employee entitlements (including superannuation) by the time they fall due
- Meet their tax reporting obligations
- Start developing one or more courses of action that are reasonably likely to lead to a better outcome for the company than the immediate appointment of an administrator or liquidator
- If the company enters external administration, provide the requested assistance and documentation to the external administrator.
However, for the best chance of relying on the safe harbour provisions while a turnaround strategy is implemented, directors should:
- Be proactive and seek advice early
- Engage qualified advisers who specialise in turnaround and restructuring plans to obtain appropriate advice
- Maintain proper financial records
- Keep themselves informed of the company’s financial position, monitoring the plan, and making informed decisions based on up-to-date information
- Document plans and ongoing actions/decisions to provide evidence should safe harbour protection be challenged.
What is involved in the plan?
The plan will vary depending on the industry and size of the business. It typically involves several key steps:
- The current state. Determining the company’s survival chances and formulating an initial action plan. Directors should work with a qualified adviser to develop this.
- Immediate actions. Short-term actions to improve the company’s financial position while outlining a medium-to-long-term path to profitability/viability. Short-term actions may include rationalising staffing, pausing product development, or selling unused liquid assets.
- Long term. The business restructure phase. This step involves creating a long-term plan to enhance business efficiency and sustainability.
For more information on how directors can protect themselves from personal liability and ensure better outcomes for companies and creditors, contact BDO today.
