.jpg)
14 November, 2017
The Safe Harbour reforms provide directors with protection from insolvent trading liability where a debt is incurred directly or indirectly in connection with one or more courses of action that are reasonably likely to lead to a better outcome for the company.
What you need to know
The protection of the Safe Harbour effectively gives directors scope to trade while insolvent if it is likely to achieve a better outcome than an immediate insolvency. This is arguably the biggest change effected by the Safe Harbour reforms.
If pursuing a later insolvency is a better outcome than an immediate insolvency, Safe Harbour will protect directors who pursue that course.
The better outcome test will naturally require a comparison of the cents in the dollar return to creditors in an immediate insolvency versus a later insolvency like the s439A assessment a voluntary administrator makes of a DOCA versus liquidation. However, the better outcome test will go furtherand require an assessment of the impact on other stakeholders, such as employees and shareholders.
Inevitably, liquidators will bring the better outcome test before the courts in due course. However, in quantifying loss suffered, it will be difficult for liquidators to prove the counterfactual of an immediate insolvency.
Interestingly, we are already seeing the concept of a "better outcome" being used in the corporate lexicon by companies that are not close to insolvency but may be facing difficult commercial decisions. We may well see the better outcome test being applied more broadly than in relation to Safe Harbour and insolvency.
Please click on the image to enlarge.
Does the legislation allow for the "better outcome" to be a better insolvent outcome?
The Safe Harbour reforms provide directors with protection from insolvent trading liability where a debt is incurred directly or indirectly in connection with one or more courses of action that are reasonably likely to lead to a better outcome for the company.
A better outcome, for the company, means an outcome that is better for the company than an immediate appointment of an administrator, or liquidator, of the company.
Is this 'better outcome test' satisfied where the director(s) develop one or more courses of action that are reasonably likely to lead to a better outcome in insolvency. That is, an outcome which would provide the company's creditors with a greater return upon the winding up of the company? (Broad View). Alternatively, does a director only satisfy the better outcome test when the course of action is one which is aimed at bringing the company out of insolvency? (Narrow View).
The definition of 'better outcome' is broad and could potentially include a course of action that is reasonably likely to increase the return to creditors in a winding up. A better outcome is defined as an outcome which is better than the immediate appointment of an administrator or liquidator, which suggests that the drafters had in mind the operation of the protection even in circumstances where the director incurs a debt relating to a course of action knowing that an administrator or liquidator will be appointed at some point in the future (and thus intending to lead to a better insolvent outcome).
In support of the Narrow View, the final text of the Safe Harbour provisions does not provide for a better outcome for the company or its creditors, as it was originally drafted. Arguably, the creditors are the only group of stakeholders that stand to benefit from a better insolvent outcome. Add to that the fact that the explanatory memorandum to the Bill only refers to courses of action which might save the company (presumably from administration or liquidation).
Despite this, the better view appears to be that the Broad View will prevail, based on a plain reading of the words of the statute.
What are the implications for directors and the market of this test?
The Safe Harbour provisions seek to reduce the number of formal insolvency appointments by providing directors with additional time to formulate a plan for the company's future, where it is reasonably likely that the company can trade and/or restructure its way out of its financial difficulties.
While informal restructurings are common in the market and will be well chartered territory for experienced directors, investors, financiers and advisors, the potential for a company to trade on for a limited time, before entering an inevitable insolvency process, will be much less familiar and the application of the Safe Harbour protections more complex. An informal restructuring will typically be undertaken with the agreement of and participation by all major stakeholders in the company. As a result, appropriate standstill and other arrangements are likely to be in place to allow the company some "breathing space" to complete the restructuring. These arrangements may be a lot more difficult to negotiate where a company is trading its way towards an inevitable insolvency.
It may also pose greater risk to existing creditors of the company or those that become creditors during the Safe Harbour period. For example, if a creditor's exposure to the company increases in the Safe Harbour period, but the company's net liabilities decrease, the directors may be able to avail themselves of the Safe Harbour protections, leaving the creditor to recover its increased debt through the formal insolvency process.
Will Safe Harbour be used as a tool to plan for a "better" insolvency?
For example, can Safe Harbour be used to license insolvent trading with a view to completing a major contract/ completing a sale with a view to producing a better return for creditors?
There may be situations where a company has a pending transaction the effect of which will improve, but not cure, its financial position. In that case, could the directors rely on the Safe Harbour to complete that transaction prior to appointing a voluntary administrator, where there are no other viable plans for the company's future? Directors may well be persuaded to do so, in circumstances where the appointment of a voluntary administrator may risk the counterparty terminating the relevant contractual arrangements. Of course, each situation will have to be assessed with regard to the particular circumstances of the company and the directors will have to carefully consider whether pursuing the transaction in question is reasonably likely to lead to a better outcome.
The better outcome will not only be assessed with regard to a comparison of cents in the dollar recoveries in an immediate insolvency versus an eventual insolvency as trading on may realise other benefits for the company and its stakeholders. For example, employees will remain employed for the period of continued trading. Where a restructuring plan is being pursued, the directors may be satisfied that there is a reasonable chance of preserving shareholder value, which may be another factor to consider when assessing the better outcome being pursued.
What are the risks if the "better insolvent outcome" does not materialise?
The better outcome test does not impose a requirement on the directors to guarantee the better outcome they are pursuing. It merely requires that outcome to be "reasonably likely" to follow. Of course, if the better outcome is not realised, directors may well face claims from creditors and/or shareholders on the basis that the directors should have acted earlier and placed the company into voluntary administration. Equally, advisors to the company and directors during the time they enter the Safe Harbour may also be the subject of claims where the better outcome is not achieved.
When directors are seeking to rely on the Safe Harbour protections, it is important that they:
- take appropriate steps to consider and document their plans;
- resolve to rely on the Safe Harbour provisions; and
- take advice from appropriately qualified professionals, to support any exemption from insolvent trading on the basis that the Safe Harbour provisions apply.
The Australian Chapter of the Turnaround Management Association has released best practice guidelines which set out practical steps companies, directors and their advisors can take when seeking to rely on the Safe Harbour provisions. Taking these steps, and ensuring they are properly documented, will provide directors with the best protection against any claims that might arise where the company emerges from the Safe Harbour in a worse position by making it more difficult for any claimant to prove that the better outcome being pursued was not reasonably likely to be achieved.
Inevitably, liquidators will bring the better outcome test before the courts in due course. However, in quantifying loss suffered, it will be difficult for liquidators to prove the counterfactual of an immediate insolvency.
Finally, we are already seeing the concept of a "better outcome" being used in the corporate lexicon by companies that are not close to insolvency but may be facing difficult commercial decisions. We may well see the better outcome test being applied more broadly than in relation to Safe Harbour and insolvency, as a framework for boards and management to make tough commercial decisions.
For further information, please contact:
Adrian Chai, Partner, Ashurst
adrian.chai@ashurst.com
