It’s been just over a year since the “Safe Harbour” reforms became available to directors. Heralded as a major milestone in Australia’s restructuring and turnaround landscape, it’s clear the reforms are yet to reach their full potential.
Safe Harbour was designed to protect directors against an insolvent trading claim in certain circumstances should they choose to allow a suspected insolvent company to continue to operate while a turnaround plan is attempted.
Prior to the reforms, our research indicates companies in external administration (large and small) trade insolvent for an average of six months. For many, this exposes the personal assets of the directors to a liquidator’s claim. Even well-advised, listed businesses have been challenged retrospectively by liquidators for a period of insolvent trading.
The Safe Harbour rules were designed to help mitigate these risks to allow directors to attempt to deliver a ‘better outcome’ than insolvency. While it will take some time to assess the reform’s results, our firm has observed four themes from our experience to date:
1. About half of companies seeking Safe Harbour advice end up in an insolvency process
But that’s ok. As the legislation requires a “suspicion” of insolvency before the Safe Harbour protection becomes relevant, this shouldn’t be surprising. The important point is that Safe Harbour provisions are triggering earlier discussions between directors and turnaround experts, resulting in discernible benefits including:
- a reduction (or complete removal) of the period of time a director is exposed for insolvent trading;
- a higher return to creditors (as assets are not further eroded by trading losses); and
- (where applicable) a smaller deficiency to creditors, and hence lower residual exposure under a director’s personal guarantee.
2. Plenty of questions remain
Apart from ASX guidance regarding continuous disclosure obligations (Guidance Note 8), there is a lack of information or legal precedent to clarify some of the practicalities of the Safe Harbour provisions. Many issues are open to interpretation, including:
- Who is an appropriately qualified entity (i.e. advisor) in which circumstances? When should lawyers engage with accountants and accountants engage with lawyers? When are neither required?
- What is the best engagement structure? Via the lawyers? With the company? With the directors?
- What constitutes a “better outcome for the company”? What if equity interests and creditor interests are in conflict? Can preparation for a ‘better insolvency’ (i.e. a better dividend) be considered a better outcome as directors delay an insolvency appointment? What happens if different creditors are impacted differently during that period of potential insolvent trading?
As yet, there is little industry consensus on these issues with each scenario being tailored to the facts and the preferences of the advisors involved.
3. Safe Harbour has been used in a wide range of scenarios
The reforms can achieve a better outcome for companies of all sizes in a variety of situations. Common scenarios we have observed include:
- Asset-rich, cash-poor businesses – In one example, creditors were estimated to receive full repayment in a liquidation scenario, but trade creditors had not been paid within terms for nearly two years. Safe Harbour provided directors with sufficient comfort to execute a strategy of selling illiquid assets, raising capital, and continuing payment negotiations with a supportive trade creditor base.
- Pre-pack sales – (sales negotiated before an insolvency event and executed once an insolvency practitioner is appointed). Continuing to trade in the knowledge of an impending insolvency event increases a director’s personal liability exposure should the ‘pre-pack’ transaction fail. Safe Harbour advice during this period mitigates this risk.
- ‘White Knight’ transactions – If a company is relying on a last-ditch sale process to generate liquidity to save the business, it is sensible for the directors to form a view that this presents a better outcome for the company in accordance with Safe Harbour provisions. Even if directors believe the sale process is being undertaken whilst the business is solvent, this may differ from the view taken by a liquidator in retrospect if the transaction does not complete.
- Finance negotiations – In distressed scenarios, refinance negotiations can play out ‘against the clock’ before the company’s funds are exhausted. Safe Harbour protection is a valuable overlay for directors if negotiations fail.
4. Uptake appears lower than expected
Whilst the addition of Safe Harbour to a turnaround professional’s toolkit has opened more boardroom doors, the number of directors seeking formal advice appears lower than expected. A significant hurdle for directors (often also owners) appears to be having to admit the suspicion of insolvency.
Of external administrations undertaken by McGrathNicol Restructuring in the last six months, two-thirds of companies appear to have traded whilst insolvent. Of those, none of the directors had sought advice regarding Safe Harbour protections. Further, Safe Harbour advice is only evident in less than 15% of total external administrations – but importantly, no insolvent trading was reported in these instances, hence lower risk for directors and better outcomes for creditors.
Clearly there is some way to go before the anticipated impacts of Safe Harbour reforms are fully realised. Better education and awareness of directors around these issues will be key. Many are seeing the benefits – Chairpersons involved in two of the more recent, high-profile turnaround cases have publicly espoused the virtues of Safe Harbour. At its simplest level, it provides ‘psychological’ comfort to board members to both stay the course in a distressed or crisis scenario (as opposed to resigning and leaving others to carry the burden) and to design a turnaround plan which attempts a solvent restructure.
In passing the Safe Harbour legislation, the Federal Government incorporated a review process after 2 years. In the author’s view, the legislation should achieve a “pass mark” to date. Even though the uptake may be less than expected, nothing has been taken away by the introduction of Safe Harbour – from our observations, evidence of misuse is rare and the pathway to earlier engagement with advisers, improved creditor returns and limiting personal liability is evident.