On 24 March 2020, in response to the evolving COVID-19 pandemic, the Government introduced and passed temporary legislation to provide companies with some form of financial and regulatory relief whilst the crisis continues.
Amongst other changes, the Coronavirus Economic Response Package Omnibus Act 2020 (Cth) (COVID Act) amends the Corporations Act 2001 (Cth), by inserting a new s 588GAAA to temporarily amend the safe harbour provisions for company directors from their duty to prevent insolvent trading. Under this new section, company directors are relieved of any personal liability for insolvent trading if debts are incurred in the ordinary course of business and prior to the appointment of an administrator or liquidator of the company. This relief applies during the six-month period commencing on the day which the section commences, or any longer period as prescribed by the regulations. These provisions are contained in Part 2 of Schedule 12 of the COVID Act. They are in addition to, and do not effect, the existing safe harbour regime.
What is the safe harbour regime?
The safe harbour regime came into effect on 19 September 2017. The regime is aimed at promoting and encouraging entrepreneurship and innovation by providing directors with some protection for handling the trading of a company, whilst balancing the needs of creditors and shareholders.
Pursuant to s 588GA of the Corporations Act, a director is not under a personal duty to prevent insolvent trading if, at the relevant time, the director was engaged in a course of conduct which was reasonably likely to lead to a better outcome for the company.
Gaining a better understanding of the safe harbour provisions, and availing of the regime, could assist companies who are experiencing financial distress, particularly in the current COVID-19 climate.
Entering safe harbour
A director should look to have a company enter safe harbour as soon as they suspect that the company may become insolvent. In the current economic uncertainty surrounding COVID-19, directors are urged to err on the side of caution when it comes to decisions on entering safe harbour.
An independent safe harbour committee should be appointed, with the chair of that committee responsible for complying with the necessary safe harbour provisions. This leaves the chair of the board free to focus on commercial options and strategies for navigating safe harbour, based on what the company and shareholders are seeking to achieve. It also ensures that the process remains impartial, professional and less emotional.
Once in safe harbour, strategies to resolve the situation and save the company need to be both pursued and abandoned quickly if they are not a viable option.
The benefits of safe harbour
The safe harbour regime provides legislative protection which essentially “buys the company some time” to explore other options. Such options may involve capital raising, a merger, acquisition or restructure to achieve a more viable outcome and remove the risk of insolvent trading.
Unlike administration, receivership or liquidation, safe harbour remains a private process, meaning that the company does not have to advertise the fact that it is in safe harbour. This can assist with maintaining the value of the company’s share price, as well as its general reputation.
What the COVID-19 changes mean for corporations
With regards to insolvent trading it is not clear which debts will be regarded as being incurred “in the ordinary course of business”, particularly in the unusual circumstances surrounding COVID-19. Under the new s 588GAAA(2), the evidential burden will fall upon company directors to show that the debt was so incurred.
Paragraph 12.18 of the Explanatory Memorandum for the COVID Act states that a company director “is taken to incur a debt in the ordinary course of business if it is necessary to facilitate the continuation of the business during the six month period … of the [temporary legislation]”. This may include, for example, a company director taking out a loan in order to move some business operations online. It may also include debts incurred by continuing to pay employees during the COVID-19 pandemic.
The amendments appear to apply not only to debts incurred as part of the ordinary day-to-day trading operations of a business but possibly also to debts incurred in order to restructure a business to enable trading through the current COVID-19 crisis. Examples may include taking out a new working capital loan or the costs incurred in transitioning to the online delivery of goods and services, etc.
The safe harbour regime provides a viable option for companies in financial distress and should be considered before the more extreme steps of administration or receivership. The protective regime may be especially pertinent for small businesses who may be struggling in the current COVID-19 economic downturn.
If a director is considering the option to enter safe harbour, they should always seek appropriate and timely legal advice. This will ensure that both the director, and the company, remain compliant with all statutory and regulatory obligations.
Further reading and sources
Safe Harbour Regime – Q&A and a Case Study, Ash Street Legal, 14 April 2020
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