13 June, 2016
What you need to know
- A Treasury Proposals Paper seeks views on two alternative models for providing directors with a safe harbour from insolvent trading liability.
- The first model proposes the appointment of a restructuring adviser to advise directors. The restructuring adviser must meet certain experience and qualification criteria. The director who is relying on the defence must take reasonable steps to ensure that the company returns to solvency within a reasonable period of time.
- The alternative model places greater responsibility for corporate rehabilitation on the directors themselves, requiring them to be satisfied that reasonable steps are being taken to maintain the company's solvency or return it to solvency. The directors must honestly and reasonably believe that any debts incurred are in the best interests of the company and its creditors. Also, the debts must not in fact materially increase the risk of serious loss to creditors.
- Submissions to Treasury on the proposals are due by 27 May 2016.
Current law on insolvent trading
Under the current law, directors of a company who allow the company to trade while it is insolvent can be liable to pay for the loss or damage caused by the company's insolvent trading. If the directors act dishonestly, they commit an offence.
There is currently no safe harbour defence to this potential liability that would protect directors while they seek to develop and implement a restructuring for the company.
A director of a company is civilly liable for insolvent trading if, when the company incurs a debt:
- The company is insolvent or becomes insolvent by incurring that debt and any other contemporaneous debts
- the director is aware at that time of reasonable grounds for suspecting that the company is already insolvent, or would by incurring the debt become insolvent, or a reasonable person in a like position in a company in the company's circumstances would be so aware (Corporations Act 2001 (Cth) (Corporations Act) s 588G(2)).
There are the following defences to this civil liability (Corporations Act s 588H):
- reasonable grounds to expect that the company was solvent when the debt was incurred and would remain solvent even if it incurred that debt and any other contemporaneous debts
- reasonable reliance on a competent and reliable person who is responsible for providing adequate information about the company's solvency
- non-participation in the management of the company because of illness or for some other good reason
- taking all reasonable steps to prevent the company from incurring the debt, including by the appointment of an administrator.
A director can also seek whole or partial relief from this civil liability if the director has acted honestly and, having regard to all the circumstances, ought fairly to be excused (Corporations Act ss 1317S, 1318), though the grant of this relief is at the court's discretion.
A director is criminally liable for insolvent trading if, when the company incurs a debt:
- the company is insolvent or becomes insolvent by incurring that debt and any other contemporaneous debts (this element is identical to the equivalent civil liability element)
- the director suspected the company's insolvency
- the director's failure to prevent the company incurring the debt was dishonest (Corporations Act s 588G(3)).
The court can order a person found guilty of this offence to pay compensation.
Treasury Paper safe harbour proposals
At the end of April 2016, Treasury released for public comment a Proposals Paper Improving bankruptcy and insolvency laws. The proposals in the Paper form part of the Government's National Innovation and Science Agenda (the Innovation Agenda), announced on 7 December last year.
The Treasury Paper puts forward for discussion two alternative models for a safe harbour from insolvent trading liability.
Model A provides a defence based on obtaining advice from a restructuring adviser. This model is based on a recommendation of the Productivity Commission Report Business Set-up, Transfer and Closure (September 2015) (the Productivity Commission Report), released the same day as the announcement of the Innovation Agenda.
Model B limits the insolvent trading prohibition itself (rather than providing a defence) so that it encourages appropriate director behaviour, without requiring the appointment of an adviser.
Model A Elements of the defence
The proposed defence would be available if the following elements were satisfied:
- a reasonable director would have an expectation, based on advice provided by a restructuring adviser, that the company can be returned to solvency within a reasonable period of time
- the director who is relying on the defence is taking reasonable steps to ensure that the company returns to solvency within a reasonable period of time
- the restructuring adviser:
- is appropriately experienced, qualified and informed (the onus would be on the company's directors to ensure that the adviser's qualifications and experience were appropriate for the nature and circumstances of the company)
- is provided with appropriate books and records within a reasonable period of his or her appointment to enable him or her to form a view about the viability of the business
- is and remains of the opinion that the company can avoid insolvent liquidation and is likely to be able to be returned to solvency within a reasonable period of time (that is, that the company is "viable").
- The Government's intention is that an adviser's qualifications would include accredited membership of an organisation that has its own disciplinary framework, educational framework and ethical standards. The paper mentions the Law Society, CPA Australia, Chartered Accountants Australia and New Zealand, the Australian Restructuring Insolvency & Turnaround Association and the Turnaround Management Association as examples of such organisations.
Other factors that directors should consider when appointing a restructuring adviser would be set out in ASIC guidance (or possibly in the regulations: the Government seeks views on this question).
Safe harbour defence applicable only to insolvent trading liability
The defence would apply only to liability for insolvent trading. It would not apply to other director duties and obligations.
Furthermore, the Paper proposes that the period during which the safe harbour defence applies would be disregarded for the purpose of calculating any "reach- back" period for unreasonable director-related transactions.
Non-availability of the defence
The intention is that "safe harbour is extended to directors of companies with good corporate governance who are acting in accordance with their directors' duties". Accordingly, safe harbour would not be available:
- to a person who was:
- disqualified from managing a corporation when
- the debt was accrued
- determined by ASIC or the Court to be ineligible to rely on the defence because of prior conduct (for instance, where there has been a breach of directors' duties and, as a result of the breach, property is no longer available to meet the claims of a creditor and the creditor has consequently suffered loss)
- when a company has failed to lodge multiple Business Activity Statements
- when there has been a significant failure to pay employee claims, PAYG, employee superannuation or employee claims that accrue during the safe harbour period.
Governance matters relating to restructuring advisers
The Paper proposes that restructuring advisers be:
- "appointed by the company, not the directors, and thus owe any duties to the company". This is presumably meant to clarify that the adviser is engaged by the company and not by the directors personally, although the appointment of the adviser would need to be made by the directors on behalf of the company
- required to exercise their powers and discharge their duties in good faith in the best interests of the
company and to inform ASIC of any misconduct that they identify
- not civilly liable to third parties for an erroneous opinion, provided that it was honestly and reasonably held
- unable to be appointed in any subsequent insolvency without the leave of the Court
- specifically carved out of the expanded definition of "director" contained in the Corporations Act (that is, a restructuring adviser would not be a shadow or de facto director).
Continuous disclosure and safe harbour appointments
The Proposals Paper points to privacy as an important factor in the success of informal workouts. Accordingly, the Government does not propose to require that companies disclose whether they are operating in safe harbour. Equally, however, the Government does not propose any relaxation of a company's continuous disclosure obligations where they currently apply.
This approach to disclosure reflects that taken in the Productivity Commission Report. However, we note that, if the relevant company is a disclosing entity, it will need to continue to monitor whether the fact of an appointment of a restructuring adviser or the circumstances that gave rise to the appointment constitute information that a reasonable person would expect to have a material effect on the price or value of the company's securities and that therefore requires disclosure.
Model B
Under this model, the insolvent trading prohibition would not apply if:
- the debt was incurred as part of reasonable steps to maintain solvency or return the company to solvency within a reasonable period of time
- the person held the honest and reasonable belief that incurring the debt was in the best interests of the company and its creditors as a whole, and
- incurring the debt does not materially increase the risk of serious loss to creditors.
The safe harbour would be carved out of the liability provision, rather than provided as a defence, so that a liquidator would have the burden of proving that none of these elements applied to a director.1
The formal appointment of an appropriately qualified and experienced restructuring adviser would be included in the Court's consideration of whether a director had taken "reasonable steps to maintain or return the company to solvency within a reasonable period of time".
Ashurst comment on safe harbour proposals
The approach in Model B appears to be closer to that in the United Kingdom. There, the equivalent of insolvent trading is known as wrongful trading. A person can be liable for wrongful trading where, amongst other things:
- at some time before the commencement of the winding up, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation; and
- that person failed to take every step with a view to minimising the potential loss to the company’s creditors.
The Model B and UK wrongful trading approaches allow a director in appropriate circumstances to explore options that could rescue the company's business even if the company is insolvent. Both allow directors to pursue a rescue or restructure plan.
However, Model B, unlike the UK wrongful trading provision, contains an additional, apparently objective, element, that incurring the relevant debt does not materially increase the risk of serious loss to creditors. Where liquidators can prove that the incurring of a debt has in fact increased the risk of serious loss to creditors, directors will still be exposed to the effect of potential insolvent trading liability. It is also unclear how this additional element fits in with a director having an honest and reasonable belief that incurring a debt is in the best interests of the company and its creditors as a whole.
A key difference between the UK approach and Model B, on the one hand, and Model A, on the other hand, is that the UK provision and Model B focus on the director taking reasonable steps and making a judgment, while Model A overlays that with an express requirement for directors to act on advice from an appropriately qualified and briefed adviser.
1 Curiously, even though the Paper says that the safe harbour under Model B would be "a carve out, rather than a defence", the discussion of Model B subsequently refers twice to the contents of Model B as "the defence". The meaning of these references is unclear.
For further information please contact:
Emanuel Poulos, Partner, Ashurst
emanuel.poulos@ashurst.com