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The Safe Harbour regime can help companies deal with the financial effects of COVID-19

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The Safe Harbour regime can help companies deal with the financial effects of COVID-19

In light of the challenges posed by COVID-19 to otherwise profitable Australian businesses, the safe harbour regime is of particular relevance. It is one avenue of assistance available for businesses facing financial difficulties as it provides companies with a better opportunity to restructure and formulate a recovery plan, which may extend beyond the temporary relief announced by the Australian Federal Government on 22 March 2020 and implemented on 25 March 2020.

The safe harbour regime commenced on 19 September 2017. The underlying goal of the legislation is to provide a better opportunity for companies to restructure by encouraging directors take early intervention action to avoid financial deterioration and formulate a recovery plan.

The safe harbour provisions provide directors with a protection from civil insolvent trading liability under s. 588G(2) of the Corporations Act 2001 (Cth) (Act), in certain circumstances.

The Safe Harbour regime

Section 588GA(1) of the excludes liability for insolvent trading under s. 588G(2) of the Act if:

  1. At a particular time after a person starts to suspect a company may become or already be insolvent, he or she 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 that course of action during the period starting at that time and ending at the earliest of any of the following times:
    • if the person fails to take any such course of action within a reasonable period after that time–the end of that reasonable period;
    • when the person ceases to take any such course of action;
    • when any such course of action ceases to be reasonably likely to lead to a better outcome for the company;
    • the appointment of an administrator, or liquidator, of the company.

Directors are not required to actually prove that their course of action was reasonably likely to lead to a better outcome. However, unless a court orders otherwise, at the time a debt is incurred, the company must both:

  1. be substantially complying with these obligations; and
  2. not have failed two or more times to do these things during the 12 month period ending when the debt is incurred.

The safe harbour starts to apply from the time the directors, after beginning to suspect that the company may become insolvent, start developing one or more courses of action. The safe harbour will only protect directors during a “reasonable period” between the consideration of the various courses of action and their implementation. The duration of the reasonable period will vary on a case-by-case basis. This could potentially be available for a significant period of time if, for example, a course of action encompasses a significant debt restructure.

A “better outcome” for the company, means an outcome that is better for the company than the immediate appointment of an administrator, or liquidator, of the company. Directors will likely need to ensure that there are materials and evidence which would indicate a likelihood that their course of action would lead to a “better outcome”. Regard may be had to whether the person[1]:

  1. is properly informing himself or herself of the company’s financial position; or
  2. is taking appropriate steps to prevent any misconduct by officers or employees of the company that could adversely affect the company’s ability to pay all its debts; or
  3. is taking appropriate steps to ensure that the company is keeping appropriate financial records consistent with the size and nature of the company; or
  4. is obtaining advice from an appropriately qualified entity who was given sufficient information to give appropriate advice; or
  5. is developing or implementing a plan for restructuring the company to improve its financial position.

The safe harbour provisions do not apply to all debts. It only applies to debts which are incurred “directly or indirectly in connection with” developing and taking the course of action. Debts to which the protection does apply would include “ordinary trade debts incurred in the usual course of the business”, and “debts taken on for the specific purpose of affecting a restructure as part of that course…”.

Accordingly, any new debts incurred after the commencement of the implementation of a course of action should be assessed to ensure they are connected with the course of action or are necessary for the achievement of the course of action.

Exceptions

Safe harbour is not available if the directors (or the company), amongst other things, do not keep proper books and records, properly provide for employee entitlements (including superannuation), keep tax reporting up-to-date and obtain advice from an ‘appropriately qualified’ restructuring advisor.

The key to any successful restructuring is ensuring financial records and reporting are up-to-date and accurate, early identification of the issues during financial difficulties, obtaining the appropriate advice and formulating and then implementing a restructuring plan.

What is “appropriate” advice?

Whilst “appropriate advice” is not defined in the legislation, directors should:

  • ensure that the adviser is “appropriately qualified”.
  • where possible, obtain an alternative opinion from another adviser to test and compare the views set out in the advice.

In determining whether the entity is “appropriately qualified”, regard should be had to[2]:

  • the nature, size, complexity, and financial position of the business to be restructured;
  • the adviser’s independence, professional qualifications, good standing and membership of appropriate professional bodies (or in the case of an advising entity, those of its people);
  • the adviser’s experience; and
  • whether the adviser has adequate levels of professional indemnity insurance to cover the advice being given.

Any business which is larger or more complex will be required to obtain advice from an appropriate professional with the following attributes[3]:

  • possession of minimum educational qualifications as a condition of eligibility to practise or give that advice (and who is subject to Continuing Professional Development obligations whether by law or by membership of a professional association);
  • possession of appropriate levels of professional indemnity insurance to cover their advice; and
  • being bound by an enforced code of conduct or similar professional standards (whether under the law or by membership of a professional body).

We believe the following persons will constitute an appropriately qualified entity for safe harbour purposes:

  • Lawyers and Liquidators with turnaround and restructuring experience; and
  • ARITA Professional Members. ARITA members are subject to rigorous regulation and oversight by Australia’s peak insolvency body.

MMRB has a specialist team dedicated to insolvency and restructuring. Because we are experts in turning around and restructuring businesses of all sizes, we can help you understand your financial position and your options. Our team has a focus on the best outcomes for all stakeholders of a company in financial difficulty.

What information we need

In order to provide appropriate advice, we will need the following information:

    1. Company accounts. You may wish to properly inform yourself of the company’s position by engaging an auditor to assess solvency;
    2. Management accounts that show the historical performance of the Company;
    3. Tax returns;
    4. Loan and security details;
    5. Any lease and rental details;
    6. Insurance policy details; and
    7. Any other information relevant to the Company’s current and future earnings.

Further, whilst seeking the protection of safe harbour, you should provide your advisor with detailed accurate financial information of the business commensurate with its operations and to track the performance of the operations as compared with the plan being pursued.

Interplay with temporary amendments to insolvency legislation – March 2020

In the face of the threat posed by COVID-19 on Australian businesses, a number of forms of special relief have been announced. Significantly, this includes temporary amendments to insolvency and corporations laws announced on 22 March 2020. The changes set out in Schedule 12 of the Coronavirus Economic Response Package Omnibus Bill 2020 (Cth) are intended to assist directors and businesses to help them operate during a temporary period of illiquidity as opposed to entering into external administration.

The amendments are effective for a period of 6 months, from 25 March 2020.

As part of the changes, directors will be temporarily relieved from the risk of personal liability for insolvent trading, where the debts are incurred in the ordinary course of business and during the 6 month period from the Commencement Date. The temporary relief will operate for a period of 6 months alongside the existing safe harbour regime.

The examples for debts incurred in the “ordinary course of business” set out in the Explanatory Memorandum during the Coronavirus health crisis may include:

  • Debts to pay employees; or
  • Loans to move business operations online.

These provisions supplement the existing safe harbour provisions in the Act. A director will remain liable for insolvent trading that occurred before the amendments became effective.

Accordingly, care will need to be taken by directors to ensure a debt is incurred in the ordinary course of business, if they wish to operate with the protection of the amendments.

It would also appear, based on the examples contained in the Explanatory Memorandum, that “ordinary course of business” may be widely interpreted, however this is uncertain at this stage.

For this reason, the safe harbour regime will continue to be of assistance for directors responding to the unique challenges posed by the Coronavirus health crisis. That is, some debts may not be regarded as incurred within the ordinary course of business but the criteria for safe harbour protection may be satisfied. Further, the temporary provisions only offer protection to directors for debts incurred within the relevant 6 month period.

For more information about the recent temporary amendments, please see our summary here: https://mmrb.com.au/temporary-changes-to-insolvency-laws-announced-to-respond-to-covid-19-effective-from-25-march-2020/.

What steps should a business take to rely on Safe Harbour

If you are seeking to rely on the Safe Harbour provisions, you should, at a minimum:

  • get your books and records in order. Unless you know where your money is coming from or going to, you can’t really have a plan to solve the problems your business is facing.
  • check that the company has complied with all of its tax reporting obligations.
  • check that any outstanding employee entitlements are paid in full.
  • check existing insurance and indemnity policies are adequate.
  • document the proposed course of action including identification of the assumptions behind the plan, provision of an explanation for why the plan is likely to result in a better outcome and specification of a clear set of steps required to implement the proposed course of action, together with a timetable of milestones capable of assessment.
  • obtain expert advice from an appropriately qualified entity, and ensure that the entity was given all the information required to provide advice regarding the company’s prospects.
  • when implementing a restructuring plan, directors should continually assess whether their chosen course of action will still lead to a better outcome for the company to pursue the restructure. Where necessary, directors should obtain updated advice from an appropriately qualified professional regarding these steps.
  • if the company is placed into external administration, directors should ensure compliance with any obligations relating to the provision of books and information to a liquidator, administrator or controller.

Paul Marsh | Managing Partner | paul@mmrb.com.au | 03 9604 9400

Annabel Clarke | Lawyer | annabel@mmrb.com.au | 03 9604 9400

Disclaimer: This article is general commentary on a topical issue and does not constitute legal advice. If you are concerned about any topics covered in this article, we recommend that you seek legal advice.

[1] Section 588GA(2) of the Corporations Act.

[2] Explanatory Memorandum 1.69.

[3] Explanatory Memorandum 1.74.

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