‘Safe Harbour’ legislation was passed in September, offering protection to directors from insolvent trading exposure. Is this the big reform that will encourage entrepreneurship and provide a platform to protect (or “harbour”) business value in Australia?

So What’s Changed?

Existing insolvent trading laws will remain in place, however the new laws will protect directors when continuing to trade companies of questionable viability, provided:

  • They take a course of action that is “reasonably likely to lead to a better outcome for the company and the company’s creditors as a whole”
  • The debts incurred during this period are either directly or indirectly in connection with this course of action 
  • The course of action that is developed must be implemented within a reasonable timeframe
  • The company complies with its obligations to pay its employees (including superannuation)
  • The company continues to meet its tax reporting obligations

The director will have the burden of proving on the balance of probabilities whether a course of action is ‘reasonably likely to lead to a better outcome’ (at the time of the decision). The Bill provided a list of indicative factors to be considered including whether the director has:

  • Kept themselves informed about the company’s financial position
  • Taken steps to prevent misconduct by officers and employees of the company
  • Taken appropriate steps to ensure the company maintained appropriate financial records
  • Obtained appropriate advice from ‘an appropriately qualified adviser’ (one would expect a restructuring professional), and
  • Been taking appropriate steps to develop or implement a plan to restructure the company to improve its financial position

An added layer of protection against abuse of the system is that where the restructuring plan fails and the company enters liquidation, the Safe Harbour would only be open to compliant directors who assist the liquidator. One would suspect that these provisions were focused more on encouraging compliance by SME directors than the boards of publically listed companies.

Are Australia’s ‘tough' insolvent trading laws really a barrier to a business turnaround culture?

It has been argued that Australia’s insolvent trading laws are driving directors to limit personal liability by prematurely seeking the appointment of voluntary administrators. However the long term trend in Voluntary Administration (VA) appointments over the last decade suggests that this may not necessarily be correct:

  • VA’s represented 17% of total insolvency appointments in 2007 vs 11% in 2017; and
  • Only 103 cases of insolvent trading were prosecuted between 1961 (being the year in which insolvent trading provisions were first introduced) and 2004, of which 77 were found liable for insolvent trading.  In FY16 alone a total of 5,736 reports were lodged with ASIC alleging insolvent trading. Arguably the current law is not overly onerous or ASIC is reluctant to enforce it.   

So why have VA’s declined in relevance? Whilst VA’s are still in vogue for larger enterprises (Network Ten, Top Shop, etc.), the decline in VA’s for SMEs (which represents the vast majority of insolvency appointments) is arguably attributable to the erosion of value that often follows a formal insolvency appointment (termination of critical contracts combined with substantial professional fees).

Who are the real beneficiaries of the reforms? 

Directors of publicly listed companies are generally provided with professional advice to ensure the corporate veil is preserved.   By contrast, directors of small businesses are generally poorly funded and already personally exposed to the company’s liabilities by way of personal guarantees provided to banks, suppliers and landlords.   Somewhere between these two extremes sit directors of midmarket businesses (MMB’s), who may be the major beneficiaries of the reforms.

What are the challenges to rescuing a distressed business?

According to ASIC, in 2016 the top three nominated causes of failure for companies were:

(a) inadequate cash flow or high cash use (45.6% of reports);

(b) poor strategic management of business (45.6% of reports); and

(c) poor financial control including lack of records (33.6% of reports).

A transfer of business ownership can provide a quick fix to each of the above and may prove the dominant strategy pursued by SME’s under the Safe Harbour regime.

Whilst the legislation ensures employee entitlements will be paid during the Safe Harbour period, unsecured trade creditors are left to carry the risk. If the Safe Harbour regime is to be embraced by industry, it is critical that creditors that support the business during the Safe Harbour period are not disadvantaged as a consequence of this action. Put simply, Safe Harbour strategies should ensure that:

  • The distressed business has the capacity to pay for supplies made during the Safe Harbour period (e.g. a dedicated funding line); and
  • A portion of any business sale proceeds conducted during the Safe Harbour period is made available for unsecured creditors.

Will the Safe Harbour reforms develop a business rescue culture?

The ‘light’ of Safe Harbour reforms will shine brightly in the media over the coming months and should improve the efficiency of Australia’s insolvency regime and stakeholder outcomes. Whether the light endures in in the minds of SME / MMB directors will ultimately depend on whether professionals advising in this space can offer robust and achievable strategies to repair, re-stock and re-crew a distressed ship.

Original article: www.linkedin.com/pulse/safe-harbour-who-cameron-crichton/]

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