Insolvency safe harbour reforms

In a bid to make Australia more entrepreneurial, draft legislation introduced to Federal Parliament in March has caused a lot of discussion around the proposed insolvent trading safe harbour provisions. The Australian Government’s National Innovation and Science agenda proposals contained two key law reforms relating to insolvent trading and ‘ipso facto’ clauses.

Government minister Kelly O’Dwyer has described the impetus of the proposal to drive cultural change amongst company directors and promote the retention of their company. Hoping to spark more risk taking entrepreneurial tactics, the government’s reforms are targeted at allowing early engagement with possible insolvency measures instead of premature external administration.

Currently, directors commit an offence of insolvent trading when they incur debts at a time of insolvency or become insolvent due to the debts incurred. The changes set out in the most recent legislation create a ‘safe harbour’ whereby, directors would not be held liable for an insolvent company’s debts if they can prove that their behaviour was reasonably likely to lead to a better outcome for the company and its creditors, than liquidation or administration. 

Similarly, the other key reform focusses on was making ‘ipso facto’ clauses, i.e. those clauses that allow termination of a contract when a party has committed an act of insolvency, unenforceable during times of restructure.

If enacted, new section 588GA establishes a safe harbour which will operate as a carve-out to the directors’ duty to prevent insolvent trading, provided the following two elements are satisfied:

  • Their course of action is reasonably likely to lead to a better outcome for the company and creditors; and
  • the debt is incurred after beginning to suspect the company may become insolvent until either the course of action ends, the course of action stops being reasonably likely to lead to a better outcome or the company enters external administration.

Given that this draft legislation is designed to significantly affect the status quo, the proposal has tried to balance the interests of stakeholders by limiting the availability of the provision to ‘honest and diligent’ directors.

A number of relevant factors are taken into account when determining if the course of action was reasonably likely to lead to a better outcome:

  • Whether or not the director is taking appropriate steps to prevent misconduct by officers and employees of the company;
  • taking appropriate steps to ensure the company maintains appropriate financial records congruous with their size;
  • obtaining appropriate advice from a sufficiently qualified practitioner;
  • being properly informed about the company's financial position; and
  • developing or implementing a plan to restructure the company to improve its financial position.

Yet, should the director have not provided for employee entitlements or given notices/documents required by taxation laws to an expected standard, then the option of safe harbour will be unavailable.

The onus is on the director to prove that safe harbour applies. In doing so, they will be prevented from using books and information about a company, as evidence that the action taken was reasonably likely to lead to a better outcome, unless the said documents were provided to a liquidator or administrator following an appropriate request.

Creditors are at the forefront of the change, meaning that when the directors take on the challenge for a ‘better outcome’ this needs to be the most beneficial outcome for the company and its creditors. However, some issues concerning how ‘better’ is assessed either monetarily or non-monetary are likely to arise during the contentious invocation of safe harbor provisions.

In a nation where concerns over inadvertent breaches of insolvent trading laws are frequently cited as a reason early stage investors are reluctant to get involved in startups, these reforms strive to encourage Australians to take a risk, leave behind the fear of failure and be more innovative and ambitious.

Overall, it will be interesting to see how the incoming reforms are going to affect corporate restructuring and voluntary liquidation with the ultimate aim of maintaining the fine balance of entrepreneurship and accountability.