Amendment to the Corporations Act and effect
As we introduced in our last update on 23 March 2020 – Disruption – Update to Insolvency Laws, the Coronavirus Economic Response Package Omnibus Act 2020 (CERPO Act) has introduced a new section 588GAAA into the Corporations Act 2001 (Cth) to provide temporary relief to the directors of financially distressed companies in response to the COVID-19 pandemic. Companies are facing unprecedented change to their businesses and the introduction of the new temporary safe harbour provision allows time for companies to develop a survival plan without fear of director liability for insolvent trading.
The insolvent trading rules will not apply to any debts incurred in the ordinary course of business within six months commencing on 25 March 2020, or such other period prescribed by the Regulations. It will have no application or relevance to debt incurred prior to the operation of the CERPO Act.
Whilst the provision effectively places all companies in safe harbour during the six month period, it does provide that any person wishing to rely on the protection in a proceeding relating to a contravention of unlawful insolvent trading, bears an evidential burden in relation to the matters that need to be established for the protection to apply.
The new provision defines ‘evidential burden’ to mean the burden of adducing or pointing to evidence that suggests a reasonable possibility that the matter exists or does not exist. Directors will need to evidence that the debt in question was incurred in the ordinary course of business and within the six months commencing on 25 March 2020, or such other period prescribed by the Regulations.
Similar provisions apply to holding companies and their subsidiaries, save for:
- The holding company will need to show that it has taken reasonable steps to ensure the temporary safe harbour provision applies to each of the directors of the subsidiaries and to the relevant debt that is being incurred; and
- The evidential burden rests with the holding company.
‘Ordinary course of business’ and ‘new’ debt
One of the most contentious aspects of the temporary safe harbour provision will be that relating to the requirement that debts be incurred ‘in the ordinary course of business’. That phrase has not been defined and has been the subject of considerable dispute and litigation in other contexts. It is not clear as to exactly what debts are considered to be incurred in the ‘ordinary course of business’, especially in these unprecedented times.
The temporary safe harbour protection is concerned with the incurring of new debt and not a company’s current creditor position. A director is taken to incur a debt in the ‘ordinary course of business’ if it is necessary to facilitate the continuation of the business during the six month period.
The Explanatory Memorandum for the Bill provides the following examples:
- A director taking out a loan to move some business operations online; or
- Debts incurred through continuing to pay employees during the COVID-19 pandemic.
Directors should therefore:
- Develop an understanding of the debts being incurred to ensure that they are likely to be considered as having been incurred in the ordinary course of business; and
- Document those views and assessments so that the evidential burden referred to above can be discharged.
Other duties to continue
The temporary relief of the new safe harbour provision does not affect the other duties and potential liabilities of directors. These include:
- Act in good faith in the best interest of the company and for a proper purpose;
- Act with due care, skill and diligence;
- Not use their position as director, officer or employee to gain an advantage for themselves or someone else, or cause detriment to the company;
- Not use information gained as a director, officer or employee to gain an advantage for themselves or someone else, or cause detriment to the company.
To manage these risks, directors should consider implementing the same type of measures contemplated by the existing safe harbour regime including:
- Develop a course of action that involves actively taking steps to move towards a definite plan to improve the company’s financial position;
- Seek appropriate advice from an appropriately qualified advisor, and ensure that the advisor is provided with sufficient information to advise on possible courses of action;
- Take appropriate steps to prevent any misconduct by officers or employees of the company that could adversely affect the company’s ability to pay all its debts;
- Ensure that the company is keeping appropriate financial records consistent with the size and nature of the company;
- Review the current level of bank lending facilities and the ability to access additional funding if required; and
- Develop and implement a restructure plan.
It must be understood that the automatic 6 month safe harbour from personal liability for insolvent trading will not save companies from financial distress. The need to carefully consider then implement a restructuring plan for the company, (despite automatic personal protection for the directors), remains.
This article was written by Richard Johnson, Partner, Alison Robertson, Partner, Jonathan Kramersh, Partner and Nikki Ciavatta, Solicitor.