The duty of directors to not allow a company to trade whilst it is insolvent is a specific duty under section 588G of the Corporations Act 2001 (the Act). Allowing a company to incur a debt at a time when there are reasonable grounds to suspect that it is, or would become unable to pay its debts as and when they fall due, may result in a liquidator (if appointed) claiming against the director personally an amount equal to the debt incurred. It may also be a criminal offence.
In the current environment, directors have two levels of protection against such claims:
Six month suspension of insolvent trading laws
On 23 March 2020 the Prime Minister declared that the insolvent trading laws would not apply against a director for a debt incurred in the ordinary course of business in the six month period following the suspension of insolvent trading laws. Hence, for the expected duration of the COVID-19 disruption, directors can incur certain liabilities without the spectre of personal liability should the debt not be repaid and the company go into liquidation. We anticipate this will drive behaviours such as payment for debts incurred in this period being de-prioritised in favour of payment of debts incurred before and after the protection period and of debts incurred not in the ordinary course in the six month period being prioritised over other debts.
The existing “safe harbour regime” provided in s 588GA(1) of the Act provides directors with a means of resisting insolvent trading claims where they have engaged in a process of developing and implementing a restructuring plan. The directors must reasonably believe the plan will result in a better outcome for the company and its creditors. Safe harbour protection requires that financial records are maintained, the directors are fully informed of the company’s position, and the advice of an independent expert is sought. Notwithstanding the COVID-19 protection outlined above, we recommend that directors who have concerns as to the solvency of their company take steps which would enable them to access the safe harbour protection. This is because the safe harbour regime is current law, which has no six month sunset clause and it demands discipline and rigour around forecasting and reporting which may involve independent review and which, in our view, are fundamental to successful restructure and turnaround.
Notwithstanding the current challenging and rapidly evolving landscape, directors’ duties remain including, when solvency is an issue, the duty to act in the interests of creditors. The interim relaxation of insolvent trading laws and the safe harbour regime provide directors with avenues for relief from potential personal liability. However, both of these avenues have some qualification and neither have been tested in the courts. Directors of companies facing potential solvency risk should maintain contemporaneous evidence of the care and diligence with which they have made decisions and seek independent restructuring and legal advice to ensure that, if required down the track, they can demonstrate that the relief applies.
Disclaimer: This article provides general advice only. Readers are encouraged to seek professional advice specific to their own circumstances. McGrathNicol accepts no liability for reliance on this article by any party.