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21 September, 2017
Navigating Safe Harbour: First Edition
Australia is second only to the United States for rates of shareholder litigation. The introduction of Safe Harbour legislation is to be welcomed as providing a better opportunity for companies to restructure. However, unless carefully navigated Safe Harbour could be the next breeding ground for class actions. The interplay between safeguarding the success of a confidential workout in the listed company space and complying with disclosure obligations will be the most serious issue that any listed company in Safe Harbour faces. If the directors get the balance wrong, class actions may follow.
The underlying aim of the Safe Harbour reforms is to create an environment that encourages informal workouts. The goal is to see more Australian companies return from the twilight zone of insolvency. That is to be encouraged. However, if a financially distressed ASX listed company is required by its continuous disclosure obligation to disclose that directors are relying on Safe Harbour, this could destroy enterprise value and undermine any turnaround plans. There would then be little utility in directors of listed companies having the benefit of Safe Harbour. A run on the company could ensue and the harbour could be worse than the storm sought to be avoided.
Should a company have to disclose that its directors are relying on Safe Harbour for the company to continue trading?
Interaction with continuous disclosure obligations
ASX listed companies have continuous disclosure obligations requiring them to immediately tell the market about any information of which they are or become aware that a reasonable person would expect to have a material effect on the price or value of the company's securities (price sensitive information). A failure to comply can lead to criminal and civil liability for the company and, potentially, its directors and officers. There is also the spectre of shareholder class actions if it becomes apparent that timely disclosure of material information was not made by the company.
As explained in the Explanatory Memorandum relating to the Bill, Safe Harbour does not affect the obligation of a company (or any of its officers) to comply with continuous disclosure. There is no special treatment for companies in financial distress.
However, if an ASX listed company must disclose the fact that its directors are relying on Safe Harbour, this may seriously negatively impact the ability of the company to achieve a turnaround.
Generally, it will be the financial position and performance of the company, and what the company is doing to address these, that is material to investors to know. It should not be a surprise to investors if the directors and management of a financially distressed company are working to bring about a better outcome for the company than the immediate appointment of an administrator or liquidator. Indeed, it may come as a surprise to investors and the market if they were not doing so.
The balance may be that, while a company may (depending on the circumstances) have to disclose the course(s) of action developed and adopted by it for a better outcome, it need not disclose the mere fact that its directors may have the benefit of Safe Harbour, as this is a legal outcome which of itself ought not have a material effect on the price or value of the company's securities. But this stance is not free from doubt. Obviously, disclosure will be fact specific and will depend on the degree of financial distress.
The water is muddied if the directors collectively concluded that they suspect the company may become or be insolvent. For a director to have the benefit of Safe Harbour, they must have started to suspect that the company may become or be insolvent. In practice, directors may be unlikely to resolve this. However, if they do, the fact that the directors have formed this suspicion and/or the information underlying their suspicion could be price sensitive information. If it is price sensitive information, it will need to be disclosed unless a "carve out" from continuous disclosure applies (e.g. on the basis that the information is confidential, comprises a matter of supposition or is insufficiently definite to warrant disclosure, and is information that a reasonable person would not expect to be disclosed). Practically, it may be that the information informing the directors' conclusion, and the fact that they have reached that conclusion, need to be considered separately. It may also make a difference whether the directors suspect that the company may become insolvent, or whether they suspect that the company may be insolvent. The level of and reasons for the suspicion and, in a case where the directors suspect the company may become (but not yet be) insolvent, the directors' assessment of when the company may become insolvent, may all be relevant factors in assessing whether the fact of their suspicion may be price sensitive. The company's previous disclosures, and whether any course of action resolved to be taken in response is disclosable, will also be relevant to the analysis.
Disclosure in financial reports
One should not forget also that a company's financial reports must include a directors' declaration in which the directors must declare whether, in their opinion, there are reasonable grounds to believe that the company will be able to pay its debts as and when they become due and payable. Safe Harbour will not displace reporting obligations.
If the directors of a company start to suspect the company may become or be insolvent, their declaration will need to take this into account and may need to be appropriately qualified.
Guidance from ASX would be helpful
In the absence of ASX guidance on whether reliance by directors on Safe Harbour triggers a continuous disclosure obligation, directors may be concerned about the potential for liability to be incurred by their company and themselves if the company does not disclose the fact that they suspect that the company may become or be insolvent and are relying on Safe Harbour. They may be personally exposed to liability, and their reputations are on the line. It would be helpful if, once the legislation comes into force upon receipt of royal assent, the ASX were to provide guidance on the specific issue to provide comfort to directors and their advisers who are confronted with the situation.
Class Actions
If a listed company is placed into administration then it is certain that both insolvency practitioners and class action firms alike will look closely into continuous disclosure issues that preceded the appointment, particularly if it is revealed that Safe Harbour had been earlier relied on by the directors. The onus will continue to be on companies to get the disclosure balance right. Otherwise, we could see Australia overtake the US in terms of shareholder litigation.
For further information please contact:
Michael Sloan, Partner, Ashurst
michael.sloan@ashurst.com
