Australian directors receive new protections against insolvent trading laws

By Andrew Lacey and Emilia Lukeman, McCabes

In September 2017, the Australian Parliament passed laws introducing new protections for directors of companies experiencing financial difficulty, through the concept of a “Safe Harbour”.

The Safe Harbour reforms introduced in the Treasury Law Amendment (2017 Enterprise Incentives No. 2) Act 2017 create a safe harbour for company directors from personal liability for insolvent trading if the company is undertaking a restructure outside formal insolvency processes.

The purpose of the reforms is to amend the Corporations Act 2001 (Corporations Act) to promote a culture of entrepreneurship and innovation and reduce the stigma associated with business failure, to drive business growth and encourage risk. The reforms are also designed to enable viable businesses to continue to trade on to recover from an insolvency event. The reforms encourage company directors to engage early with financial hardship, keep control of their companies and take reasonable steps to pursue a corporate restructure.

The reforms came into effect on 19 September 2017.

Background to the reforms

The Safe Harbour reforms were introduced following recommendations made by the Australian Productivity Commission in its 2015 Inquiry Report: Business Set-Up, Transfer and Closure. As a result of the recommendations in that report the safe harbour initiative was included in the Australian Federal Government’s national innovation and science agenda in 2015.

According to the Productivity Commission, concerns over inadvertent breaches of insolvent trading laws are frequently cited as the reason why early stage investors (also called angel investors) and professional directors are reluctant to become involved in start-ups.

Personal liability for insolvent trading

Section 588G(2) of the Corporations Act imposes personal liability on directors of companies for all debts incurred while a company is insolvent, unless that director is able to prove one of the defences set out in section 588FGA of the Corporations Act, which include a belief that the company was solvent based on reasonable reliance on another person, or taking active steps to avoid the company incurring the relevant debt (including seeking to appoint an administrator to the company).

The Safe Harbour

The new safe harbour reforms create a legislative carve-out from the personal liability of directors for debts incurred while a company is insolvent pursuant to section 588G(2) of the Corporations Act. Under the new section 588GA of the Corporations Act, the insolvent trading liability provisions do not apply to a director in respect of a debt if:

  1. At a particular time after the person starts to suspect the company may become or be insolvent, the person starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the company; and
  2. The debt is incurred directly or indirectly in connection with such a course of action.

A “better outcome” is defined in section 588GA(7) of the Corporations Act as “an outcome that is better for the company than the immediate appointment of an administrator, or liquidator, of the company”.

For the purposes of working out whether a course of action is reasonably likely to lead to a better outcome for the company, section 588GA(2) provides that regard may be had to a number of factors including whether the person is properly informing themselves of the company’s financial position, whether they have taken steps to prevent misconduct by officers or employees of the company, whether they have taken steps to ensure the company is keeping appropriate records, whether they are obtaining advice from an appropriately qualified and informed entity, or whether the person is developing a plan for restructure which is designed to improve the company’s financial position.

While the safe harbour reforms do not provide any specification on who may be an “appropriately qualified entity” to provide advice in relation to a restructure, the parliament considered and rejected a proposal that this be limited to registered liquidators, providing directors with increased flexibility in their options for obtaining advice. However, since the onus of proving that the safe harbour should apply lies with the person who seeks to rely on the safe harbour, it would be prudent for directors to take qualified advice from reputable organisations or individuals.

The practical effect of the Safe Harbour is that it provides directors of companies the opportunity to seek to rescue the company, without risking personal liability for all debts during that period if the attempts are unsuccessful, provided they take reasonable steps to improve the company’s financial position.

When the Safe Harbour does not apply

It ought to be noted that a director is unable to rely on the safe harbour provisions in respect of a debt incurred by a company if the company is failing to pay employee entitlements, failing to comply with taxation law requirements, or if the director does comply with the reporting requirements to an external administrator. In addition, a director may not rely on books and records of the company to support a safe harbour position if they fail to permit the inspection of or deliver up the books of the company to an external administrator.

Andrew Lacey

Andrew Lacey

McCabes, Sydney, Australia
T: +61 2 9265 3214
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Andrew Lacey is the Managing Principal of McCabes. He also heads McCabes’ Litigation and Dispute Resolution Group. He acts for numerous medium to large Australian and International businesses across a variety of industries including manufacturing, property, insurance and finance.

McCabes is a multi-disciplinary law firm. With a focus on technical excellence, McCabes provides astute and commercial legal solutions for its clients. By emphasising technical excellence and commitment to quality, McCabes offers commercially relevant legal solutions tailored to the current and future business objectives of its clients. McCabes distinguishes itself from other legal service providers by offering legal services that focus on the client’s needs. McCabes was awarded the GGI XLNC award for 2014 as member firm of the year.
Emilia Lukeman

Emilia Lukeman

McCabes, Sydney, Australia
T: +61 2 9265 3259
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Emilia Lukeman is an Associate in McCabes’ Litigation and Dispute Resolution Group. Her experience covers corporate and personal insolvency matters for trustees and administrators, acting in a wide range of commercial matters and civil litigation disputes for individual and corporate clients.

Published: February 2018 l Photo: esmehelit -

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