For Struggling Businesses Now is the Time to Seek Safe Harbour

The current surge in COVID-19 cases is causing havoc for businesses. Consumers are staying home and not spending, workers are being forced to isolate leaving businesses without enough staff, and supply chains have ground to a halt, so businesses can’t get the products they need to trade.

This confluence of events is hurting business revenue at a time when many businesses already had unhealthy balance sheets as a result of trading through lockdowns, putting Directors at risk of insolvent trading. Which exposes Directors to a significant risk of being made personally responsible for the debts of their business if it later fails.

However, there is an easy and cost-effective way that Directors can mitigate this risk, by taking advantage of the corporate safe harbour.

What is Insolvent Trading?

Insolvent trading occurs when a director allows their company to incur debts while the company is insolvent. If the company later fails, a liquidator can make a claim against the director for those debts, making them personally liable to pay back any amount still owing to those creditors.

A company is insolvent if it can’t pay its debts when they are due. This includes paying its tax and paying superannuation to employees. If a company needs to defer payments to the tax office, landlord, employees, or suppliers as a result of the current trading conditions, it may be trading while insolvent.

What’s the Risk

As noted above, if a director allows their company to trade while insolvent and the company later fails, the director may be help personally liable for the debts of the company. Practically, that means a liquidator will make a demand against the director for payment. If they fail to pay the claim, the Liquidator may bankrupt the director.

What’s the Safe Harbour?

The safe harbour regime exists to provide directors with protection from a potential insolvent trading claim while they implement a plan to turn their business around.

If the director follows the safe harbour process, including getting advice from a qualified professional, the director is protected from the personal liability for insolvent trading.

How do Directors access the Safe Harbour?

To access the safe harbour, a director needs to engage a qualified turnaround professional (like me) to work with them through the process.

When appointed to assist with accessing the safe harbour, I:

1. Help the Director review the financial position of the company.
2. Work with the Director to develop and implement a plan to turn the company around
3. Once the plan is finalised, assist with monitoring the plan to ensure that the company stays in compliance and remains in the safe harbour.

If your business, or a clients, is struggling with the current difficult trading environment, reach out for a no obligation chat about whether the safe harbour might be available. A quick call now could save a lot of trouble and expense in the future.

Looking back at 2021

As we start 2022, it’s a great time to look back at the major events that shaped the insolvency market in 2021. It was an eventful year with new appointment types, continues depressed appointment numbers, and several major court decisions.

Small Business Restructuring and Simplified Liquidation

On 1 January 2021 two new appointment types were introduced, Small Business Restructuring and Simplified Liquidations. Both new reforms were rushed in response to an expected surge in business failures as a result of the pandemic. While a welcome reform, both new appointment types have seen little demand. In particular, the headline reform introducing a debtor in possession insolvency option for small business have had almost no traction. There were only 33 Small Business Restructuring appointments in 2021.

Clarity on the Peak Indebtedness rule

On 10 May 2021, the Full Court of the Federal Court of Australia declared in Badenoch Integrated Logging Pty Ltd v Bryant, in the matter of Gunns Limited (In liq) (receivers and managers appointed) that the ‘peak indebtedness rule’ which has been a long-standing precedent in preference claims, was abolished with the introduction of section 588FA of the Act.

The prevailing position (first articulated in Rees v Bank of New South Wales (1964) 111 CLR 210) had been that the liquidator was entitled to nominate the date from which the ‘running account’ starts when calculating the unfair preference. Practically, this resulted in Liquidator’s choosing the date during the relation back period when the debt owed by the company to the creditor was at its highest, resulting in the largest possible unfair preference claim.

While this decision complicates the calculation of preference claims for liquidations, it does provide a more equitable approach to calculating preference claims.

Introduction of Director Identification Numbers

From 1 November 2021 company directors were able to obtain a Director Identification Number. This reform is designed to bring greater accuracy to the ASIC company register and prevent the use of fictitious director identities.

Clarity on Unfair Preferences and set-off

After several years of back and forth decisions on this issue, the Full Court of the Federal Court of Australia finally provided clarity in Morton as Liquidator of MJ Woodman Electrical Contractors Pty Limited v Metal Manufacturers Pty Limited on 16 December 2021.

The Court ruled that a creditor cannot rely on the statutory set-off under s553C(1) of the Corporations Act 2001 (Cth), to reduce the claim of a liquidator for an unfair preference under section 588FA of the Act.

Government Reviews

Through the year, the government was active with reviews into the insolvency legislative framework. First with a review of the bankruptcy system and the impacts of coronavirus, ending in February 2021.

Second was a review of the insolvent trading safe-harbour, with an independent panel appointed to report to the government on whether the safe harbour provisions remain fit for purpose and how its benefits can be extended to as many businesses as possible

Third, was a review of corporate trusts and insolvency. On 5 October 2021, Treasury opened a consultation seeking stakeholder views on whether the treatment of corporate trusts in Australia’s insolvency law needs to be clarified and input on the benefits this could deliver and how any new framework might operate.

Depressed appointment numbers

The Australian economy held up surprisingly well through the various challenges it faced during 2021. Business failures and personal bankruptcies both remained well below historical trends, with bother seeing approximately 40% less appointments than the historical average.

Given the impact of the lockdowns, other COVID-19 restrictions, and supply chain challenges, it was surprising to see both personal and corporate insolvencies stay so low. However, government support and stimulus did its job and kept business alive during the uncertainty.