Safe harbour – A shelter from the storm

Safe Harbour – A shelter from the storm

Dr. Stephen van der Mye
Honorary Adjunct Professor, Faculty of Law, Bond University

Corporate Insolvency Overview

The Australian Securities and Investments Commission (ASIC) has reported a significant rise in corporate insolvencies. Data from July 2023 to March 2024 shows a 36.2% increase, with 7,742 companies entering external administration. This surge is most pronounced in the construction and accommodation/food services industries, which together account for over 40% of these insolvencies. ASIC projects that by June 30, 2024, the number of companies entering external administration will exceed 10,000—a level not seen since 2012-2013.

The repercussions of these insolvencies are wide-reaching:

• Customers face the risk of not receiving goods or services they've paid for.
• Employees might not receive their salaries, wages, and superannuation entitlements.
• Suppliers are likely to suffer from unpaid invoices.
• Governments will lose out on taxes, including corporate, payroll, and goods and services taxes.
• Shareholders will see a loss of invested capital.

So what are the consequences for directors as regards a company that has become insolvent or is about to become insolvent in the not too distant future and can the “safe harbour” provisions of the Corporation Acts 2001 (Cth) (the Act) provide them some level of protection from the law?

Director Responsibilities and Risks

Under Section 588G of the Corporations Act 2001 (Cth) (the Act), directors must prevent their companies from trading while insolvent. This law applies not only to formally appointed directors but also to de facto and shadow directors. Breaching this duty can lead to severe civil and criminal penalties, including personal bankruptcy and loss of personal assets.

Section 588G Overview:

1. A director must prevent the company from incurring debt when insolvent.
2. The director should be aware, or a reasonable person in their position should be aware, of the company's insolvency.

The penalties on directors for breaching section 588G of the Act are both civil and criminal. Consequently, insolvent trading claims can expose directors to bankruptcy and cause the loss of personal assets in certain circumstances.

Introduction of Safe Harbour

As a result of the “draconian” nature of Australia’s insolvency trading laws, as compared to say the Chapter 11 regime of the United States of America, combined with the uncertainty over the precise moment a company becomes insolvent have long been criticised as driving directors to seek voluntary administration of a company even in circumstances where a company may be viable in the longer term.

To counter this often-observed factor, the Parliament of Australia passed the Treasury Laws Amendment Act (2017 Enterprise Incentives (No 2) Bill on Tuesday, 12 September 2017, which took effect after receiving Royal Assent on Tuesday, 19 September 2017. This is often referred to as the “safe harbour” legislation, the term of which originated from maritime law, where a “safe harbour” is a place where a ship can take refuge from a storm.

Safe Harbour Provisions:

• Established under Section 588GA, these provisions protect directors from personal liability for insolvent trading if they take action likely to lead to a better outcome for the company and its creditors.
• The protection begins when the director starts a course of action to address the company's financial issues and ends when the action is no longer viable or the company enters administration.

To benefit from the "safe harbour" provisions, directors must ensure:

• Debts are incurred in connection with efforts to improve the company's situation.
• Employee entitlements, including superannuation, are paid on time.
• Tax reporting obligations are met.

The “safe harbour” was not intended to be a mechanism for a company to continue trading past the point where it is viable. A key aspect of the protection was that it only applies where a director is taking a course of action that is reasonably likely to lead to a “better outcome for the company” and its creditors. Once it becomes clear that the company cannot be viable in the long term, the course of action will no longer meet the description and the protection of the “safe harbour” will cease.

Ongoing Obligations and Good Practice

Even under "safe harbour" protections, directors must continue to act in good faith and in the company's best interests, adhering to all other legal obligations under the Act. The court will consider several factors to determine if the director's actions were likely to lead to a better outcome, such as seeking appropriate advice, taking steps to prevent misconduct, and maintaining proper financial records.

Key Takeaways

1. Rising Insolvencies: ASIC predicts over 10,000 companies will enter external administration by June 2024, marking the highest level since 2012-2013.
2. Director Duties: Directors have a duty to prevent insolvent trading and can face severe penalties for failing to do so.
3. Safe Harbour: Section 588GA provides a "safe harbour" to protect directors from personal liability if they take reasonable steps to improve the company's financial situation.

To navigate potential insolvency effectively, directors should act decisively at the first signs of trouble, seek specialist advice, and comply with all legal obligations to leverage "safe harbour" protections for themselves and the company.

Further Learning

Bond University offers a Master of Laws in Enterprise Governance and an Advanced Credential in Enterprise Governance. for those interested in deepening their understanding of corporate governance and director responsibilities.

For more information on these educational opportunities, please visit Bond University's website.