Safe Harbour Reform: Will a higher degree of latitude and flexibility be afforded to Directors?

This article was written by Samantha Kinsey and Tony Troiani.

Until very recently, for directors and creditors alike Australia's insolvent trading regime had been failing. 

On the one hand, the risk of personal liability or prosecution for insolvent trading is a significant consideration for directors upon the onset of financial distress. As noted in a previous King & Wood Mallesons Directions Survey Report, 50% of directors agreed with this sentiment and this statistic in itself leads to the inescapable conclusion that personal liability risk is affecting directors' decision making. In a very real sense, it places directors in a position of conflict of interest, when times get tough. 

On the other hand, the early commencement of formal insolvency process, and the value depleting impact of that, does not leave creditors (and other stakeholders) feeling as if their position has been optimised.

The introduction of a "safe harbour" from personal liability for insolvent trading represents a significant step forward in this regard, at least potentially.  That potential will be realised, over time, as directors come to understand the impact of the reform on their duties as officers of their company and thereby gain the confidence to fully explore options outside of formal insolvency proceedings.

The "safe harbour" has been in play since September; so what do directors need to know and how can they best prepare to utilise this new regime? 

Importantly, the insolvent trading laws remain as they were; directors can be made personally liable for debts incurred by their company whilst it is insolvent, and directors also risk criminal prosecution if they dishonestly allow such debts to be incurred.  However, the recent reform overlays a condition (the so-called "safe harbour") whereby directors will, in effect, have immunity from those insolvent trading laws during any period in which they are developing or pursuing a course of action that is reasonably likely to lead to a better outcome for the company than an immediate administration or liquidation. 

There are certain minimum thresholds which must be met in order for that immunity to be engaged, and other factors that will be taken into account by a Court in determining whether a course of action was reasonably likely to lead to a better outcome for the company. (see below table). Directors of listed companies will also need to continue to comply with continuous disclosure obligations.

Significantly, the new legislation does not provide definitive guidance as to when the protection will apply; it does not articulate the actions necessary to import the protection.  It is not a "box ticking" exercise.  However, it is expected, in accordance with the legislative intention, that a higher degree of latitude and flexibility is now to be afforded to Australian directors who actively engage with problems affecting the financial capacity of their company and genuinely survey options for optimising outcomes for the company.  Certainly, as the legislation places the onus of proof on directors who claim the immunity, directors will need to illustrate and justify their entry into the safe harbour. So what will this require of directors? 

First, directors must insist on having access to accurate and up to date information which enables them to properly understand the financial position and what the outcome might look like under a formal insolvency process. This will not only require the existence of sound infrastructure to enable the business to produce the information, but will also depend on the company having a healthy culture that supports the identification and escalation of important issues to the board.  Directors should, in tandem with that first step, survey available options and obtain appropriate advice as to those options.  

Secondly, if an option emerges which is reasonably likely to result in a better outcome, directors must chart a clear plan on how to achieve that better outcome. This plan need not render the company solvent (that is, it need not be a complete turnaround plan) however it will need to be demonstrably capable of delivering a better outcome than an immediate administration or winding up. 

Finally, successful engagement of the safe harbour will rely on the support of multiple key stakeholders across varying units of the business such as financiers, employees, suppliers and customers. Without transparent and consistent consultation it might ultimately be difficult to establish  that any plan was 'reasonably likely' to succeed in the absence of gaining stakeholder buy-in.