By Andrew Hack, Solicitor, and Stephen Mullette, Principal, of Matthews Folbigg Lawyers, in our Insolvency, Restructuring and Debt Recovery Group.
During the COVID-19 outbreak, insolvent trading laws have been relaxed. But this does not mean there is no risk to directors. In reality the breathing space has simply been extended to allow directors to work out a solution. In our previous blog in this series, we discussed the obligations on directors when their companies are or might become insolvent. This blog explores what directors should do about it.
Voluntary Administration
Company directors who fear that a company is or may become insolvent and who might not be protected by the amendments should give consideration to appointing a voluntary administrator (“VA”). Appointing a VA puts in place a moratorium on enforcement action by creditors while the VA investigates the affairs of the company and reports to creditors, including even certain enforcement action by lenders and landlords. Further, director exposure to liability for insolvent trading ceases from that day forward, while the possibility of the company continuing to exist is kept alive.
If directors are aware that they may already be liable for trading whilst insolvent for a period, the VA can be a very useful process by which they can put forward a Deed of Company Arrangement (“DOCA”) proposal to creditors. If directors can convince creditors that the outcome of a DOCA proposal is more beneficial than liquidation, directors will avoid a liquidator chasing them for insolvent trading.
On the other hand, there can be downsides that make directors resistant to appointing a VA. It places the future of the company in the hands of the company’s creditors. Further, even where the company may be returned to the control of the directors following the period of administration, some creditors may take a view that continuing to trade with the company is too risky, either ceasing to do business or imposing strict terms on future credit. Finally, appointing a VA will usually be expensive as the VA must comply with statutory requirements to report, conduct meetings and even adjudicate on claims.
Safe Harbour
Last year the Australian Government enacted the ‘Safe Harbour’ provisions in the Corporations Act, providing a safety net for directors who prudently identify that the company is or may become insolvent, and then seek advice from an appropriately qualified entity. Provided a proper course of action is put place which is reasonably likely to achieve a better outcome for the company, the director is will not be personally liable for debts incurred during that period (at least not under insolvent trading laws).
A Coronavirus Safe Harbour
On 23 March 2019, the Australian Government passed legislation that introduces a further temporary safe harbour regime to provide temporary relief in response to the coronavirus. Directors can avoid liability for insolvent trading if:
- The debt is incurred in the ordinary course of the company’s business;
- It is incurred within the 6 month period or later as prescribed; and
- An administrator or liquidator is appointed during the period.
Bearing in mind point 3, directors should pay attention to when the temporary safe harbour period may end and review their company’s solvency as an appointment of an administrator made outside this period will limit the use of the coronavirus safe harbour.
Conclusion
Directors contemplating the financial future of the company in the wake of COVID-19, particularly given the immediate adverse effects it is having on the economy, should consider seeking advice from properly qualified insolvency practitioners on the solvency of their company, and on how to mitigate the risk of personal liaiblity. If a real risk that the company is or will become insolvent arises, they should consider either a safe harbour course of action or alternatively the appointment of a VA. This will be particularly important if the company relies on credit to finance its operations. By taking the risk in continuing to trade and thus incurring debts, directors may open themselves up to potentially severe liability.
In our next blog in this series, we will look at the new tax legislation company directors should be aware of.
If you would like more information or advice in relation to insolvency, restructuring or debt recovery law, contact Andrew Hack at andrewh@matthewsfolbigg.com.au or a Principal of the Matthews Folbigg Insolvency, Restructuring & Debt Recovery Group:
Jeffrey Brown on (02) 9806 7446 or jeffreyb@matthewsfolbigg.com.au
Stephen Mullette on (02) 9806 7459 or stephenm@matthewsfolbigg.com.au
