Personal liability clock approaching midnight for unprepared company directors

Company directors are currently scheduled to lose the benefit of temporary protection from personal liability for insolvent trading from midnight on 31st December 2020.

The directors of companies still yet to deal with pandemic debt hangovers now have less than six weeks (including Christmas) to either demonstrate solvency or take other steps to insulate themselves from personal liability. There are various options for directors with solvency doubts to better protect themselves ahead of this deadline and provide their business with the best prospects of rehabilitation, including by accessing the ‘safe harbour’ regime or the new small business restructuring process. These processes are subject to specific eligibility criteria and require a level of advance planning. Concerned directors must act now by taking specialist advice and putting plans in place to protect themselves and their businesses beyond year-end.

The insolvent trading provisions of the Corporations Act impose some of the world’s most onerous obligations on company officers. These complex provisions impose a positive obligation on company directors to prevent a company trading whilst insolvent. A breach of this obligation can give rise to a claim against directors in their personal capacity for compensation. The exposure for directors extends to all unpaid debts incurred beyond the date of insolvency.

A company is insolvent if it cannot meet its debts as and when they fall due. The primary statutory defence available to directors requires them to have reasonable grounds to expect that the company was solvent and would remain solvent even if it incurred the relevant debt. Generally speaking this is a point in time test that a mere expectation of future profits will not satisfy.

Temporary pandemic related relief from insolvent trading liability is currently available under section 588GAAA of the Corporations Act, introduced on 25th March this year via the Coronavirus Economic Response Package Omnibus Bill 2020. Relief was originally granted for a six-month period and was extended on 7th September 2020 until the end of the calendar year. It presently remains unclear whether any further extension will be forthcoming.

Unhelpfully, there remains some uncertainty as to whether this temporary relief offers directors the level of ongoing protection initially envisaged. This is because, as currently drafted, the legislative relief could be interpreted as conditional on the appointment of an administrator or liquidator by 31 December 2020. Industry bodies concerned about this ambiguity have sought urgent clarification. In the interim the prevailing uncertainty adds further weight to the case for guidance from a restructuring specialist as year-end approaches.

As a practical matter, many companies are presently insolvent due to rent, tax, bank, employee and/or trade creditor arrears built up during the coronavirus pandemic. Directors of these companies have less than six weeks (including Christmas) to either demonstrate solvency or take other steps to insulate themselves from personal liability beyond 1 January 2021.

The ‘safe harbour’ legislation introduced in September 2017 may offer protection for directors concerned about their ability to demonstrate solvency by 31 December 2020.  

These measures protect directors from personal liability for debts incurred in the ordinary course of business provided they are pursuing a strategy reasonably expected to deliver a better outcome for creditors than could be achieved by placing the company into administration or liquidation.

Certain criteria must be satisfied to qualify for safe harbour protection including the preparation of a ‘turnaround plan’ and the benchmark insolvency counterfactual analysis. The appointment of an appropriately qualified safe harbour advisor can provide directors with a fast track to eligibility and much needed reassurance.

Insolvent companies with liabilities of less than $1M will also have an additional restructuring option from 1 January 2021. The appointment of a small business restructuring practitioner will provide companies with a short debt moratorium while directors, protected from insolvent trading liability, continue to run the business and formulate a compromise offer to creditors. The objective is to provide a quick and inexpensive means of debt restructuring to support viable businesses suffering financially.

The expiration of temporary relief from insolvent trading is fast approaching and, notwithstanding the many other pandemic related challenges facing company directors, now is the time for those with solvency doubts to take the appropriate professional advice and to put the necessary arrangements in place to protect themselves and their businesses beyond year-end.