As a company Director there are a number of legal obligations imposed. It is important that you are aware of what these are, as personal liability can be imposed for failing to comply. This is particularly crucial if the company is, or is likely to become, insolvent.
Insolvency: Directors’ Obligations
The Corporations Act 2001 provides that the director of a company commits an offence if they allow the company to incur debts while the company is insolvent, or incur debts that cause the company to become insolvent. A company director is also liable if they were unaware of their company’s insolvency at the time the debts were incurred but should have reasonably known in the circumstances. This places a high onus on company directors to be responsible for and aware of their company’s trading activities.
However, recent amendments to the Act in September 2017 include the introduction of ‘safe harbour’ provisions – new levels of protection for directors of insolvent companies.
Safe Harbour Provisions
Under the new section 588GA, company directors will be protected from debts incurred by their insolvent company if:
- They develop a course of action at the time of insolvency that is reasonably likely to lead to a ‘better outcome’ for the company (that is, ‘an outcome that is better for the company than the immediate appointment of an administrator or liquidator’); and
- The debts in question are incurred directly or indirectly in connection with that course of action.
The Fine Print for Directors Seeking Safe Harbour Provisions
The Safe Harbour Provisions are an important step in allowing company directors to genuinely pursue solutions to insolvency without strict liability for any debts incurred in the process.
Nevertheless, there are many conditions that directors should be aware of in relying upon the safe harbour provisions. Perhaps the most important is the provision which states that the evidential burden will rest upon the director who seeks protection under the safe harbour to prove that they have acted in a way which merits that protection. Other conditions include:
- Directors must continue to adhere to all of their other legal obligations, including their director’s duties.
- Directors may not rely on safe harbour where they fail to pay employees or meet their taxation report obligations. As a result, directors of small to medium-sized enterprises will not likely be protected.
- Passive approaches to trading during financial difficulty will not merit the protections.
- Directors seeking safe harbour will still need to prove compliance with statutory obligations attached to declaring insolvency.
Determining if Courses of Action Are Likely to Lead to a Better Outcome
The new amendments provide that in determining whether the course of action chosen by a director was likely to lead to a better outcome than standard appointment practices, a court will consider:
- Whether the director properly informed him or herself of the company’s financial position;
- Whether the director took necessary steps to prevent misconduct from company staff that could affect the company’s ability to pay its debts;
- Whether appropriate financial records were kept;
- Whether external advice was sought regarding the company’s position; or
- Whether a plan for restructuring the company to improve its financial position was developed or implemented.
With specific regard to seeking advice and developing plans, appointing a qualified entity (such as a registered insolvency practitioner) would likely satisfy some of the requirements.
Ultimately, directors who reasonably suspect insolvency of their company in the near or distant future should consider seeking external advice and ceasing trading for a period of time in order to prioritise the settlement of their outstanding financial accounts. Although the safe harbour provisions provide new support mechanisms for directors wishing to rectify financial difficulties, directors should still be mindful of the threshold requirements for successfully applying for safe harbour.
If you have any questions about safe harbour provisions please get in touch with our experienced team to discuss your situation.
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