There have been plenty of discussions about the government’s recent changes to the insolvency regime, particularly the safe harbour provision which is supposed to protect directors from insolvent trading claims.
These provisions commenced on 19 September 2017 until the first court cases are handed down there will be a level of uncertainty as to how this act will be applied.
However, at first glance, it appears unlikely that these reforms will be of much use (if at all) for smaller businesses. They may assist larger companies and their directors facing insolvency but the steps required to qualify for this safe harbour appear simply too onerous for smaller businesses. Trying to make use of these provisions may, in fact, lead those directors into other forms of personal liability which they are more likely to be sued for that insolvent trading.
Requirements to establish the defence
There are 4 elements a director must satisfy to be able to make out a defence under the safe harbour provisions to insolvent trading these are:
1. the directors have to be taking a course of action that is reasonably likely to lead to better outcome for the company and its creditors;
2. Any further debts incurred are in connection with the better outcome;
3. The company must have made provision for the employee entitlements (including superannuation) and be compliant with the tax reporting obligations in a manner consistent with a company that’s solvent;
4. All of these factors above must be continually satisfied, if it is not then the defence will no longer apply from that point in time.
As lawyers and commentators consider these provisions further no doubt there will be many more articles and commentaries written in this section. Clearly, this will be an expensive defence to argue in court, it will also be difficult and no doubt costly to comply with to succeed in such a defence.
On an initial review however there are two concerns that should be considered by directors that may not be immediately apparent.
Other potential exposure for directors using this defence
Firstly, if a director was to try and follow the provisions of this safe harbour section they may inadvertently expose themselves personally to other liabilities to the Australian Tax Office (ATO). This arises due to the third element of making sure employee entitlements are being paid and tax reporting requirements are compliant. If the focus is on paying these liabilities and the company eventually goes into liquidation then it is likely that the ATO would be ordered by the court to pay back the amounts it received in the 6 months prior to liquidation as an unfair preference.
The complication for the directors is that if these debts are for superannuation liabilities or PAYG tax then the ATO has a right to seek an order that the directors indemnify the ATO and pay back any amount for those liabilities the ATO has had to pay to the liquidator.
In a small to medium size business, a director is far more likely to be pursued for this sort of indemnity claim by the ATO than they are for insolvent trading by a liquidator. However, insolvent trading is generally the greater fear of directors as this indemnity claim by the ATO is not well understood other than by insolvency lawyers and practitioners.
By focusing on the insolvent trading aspect and attempting to meet the safe harbour provisions of paying the tax and superannuation directors run a serious risk of exposing themselves to a far more likely indemnity claim by the ATO. They are also likely to inadvertently increase the size of this claim by increasing the payments made for superannuation and tax debts when the company is already in financial difficulty.
This is also the sort of risk that may not be explained to a director unless they are getting comprehensive advice from an experienced practitioner.
What is appropriate advice?
Secondly, one of the factors to be considered by the court in determining if the directors have pursued a reasonable course of action is whether they obtained appropriate advice. Presumably lawyers, liquidators, and accountants would qualify as appropriate sources of advice. A number of other restructuring experts no doubt qualify as well. Given however there are many pre-insolvency advisers out there without any formal qualifications it is wholly unclear at this time whether or not a court would consider that to be appropriate advice. It is also unclear whether or not the use of the word appropriate requires directors to consider the content of this advice and whether or not is, in fact, appropriate (most likely the answer to that query is yes).
If these provisions are passed it’s unlikely that they will do much to assist a small business in financial difficulty. However, if a director decides to try and use these provisions they will need to make sure they are obtaining detailed advice from a qualified practitioner, not just being pressured into unnecessarily spending large amounts of money trying to use these safe harbour provisions.
Author and Bennett & Philp Commercial Litigation Director, Andrew Lambros, heads up one of the most experienced Bankruptcy and Insolvency Teams in Queensland. Call Andrew on + 61 7 3001 2999 to find out how he and his team can help protect you and your business.