28 April 2020
Demystifying safe harbour in the era of COVID-19
This article was published in FS Advice, The Australian Journal of Financial Planning, Financial Standard, Volume 15, Issue 2
COVID-19 is and will continue to have severe financial impacts on individuals and on small to medium businesses alike for some time yet. Employees, customers and clients of many small businesses across the country have retreated into their homes for both work and self isolation. Businesses have been the subject of Government directions.
On 23 March 2020, the NSW State Government issued a Public Health Order under the Public Health Act 2010 directing that businesses such as pubs, food and drink premises, entertainment facilities, amusement centres and indoor recreation facilities must not be open to members of the public. These directions were expanded to confining people to their place of residence and limiting gatherings to 2 people only on 30 March 2020. Other businesses such as retailers, have since closed their doors.
How long COVID-19 and its effects on our lives and businesses go on for is anyone’s guess at this stage.
With little or no revenue, but with rent and other fixed costs still needing to be paid (if not now, some time in the future), together with businesses desperate to retain staff so that experience and expertise is not lost, company directors are no doubt conscious of trading whilst insolvent and personal liability that may be attached.
The Federal Government has introduced temporary measures to reduce some of these financial pressures on businesses and the risk of personal liability for company directors for insolvent trading. These temporary changes to the insolvency regime will cease on 31 December 2020. After then, a new regime will come into place that differentiates ‘small businesses’ from other businesses for the purposes of insolvency related options. Our article Demystifying Small Business Insolvency deals with these aspects.
These temporary measures may not be enough to support businesses and protect directors from personal liability beyond COVID-19. Whilst there may be short term relief from the Government and some financiers, landlords and suppliers, the debts continue to accrue.
It is vital that directors turn their attention to and develop plans that will not only see their company through the current COVID-19 period, but will also put their company on a reasonable footing to allow it to continue trading successfully post COVID-19 once normal trading conditions are resumed and businesses open their doors again.
The Government’s response to Covid-19
The Federal Government has introduced a package of reforms through the Coronavirus Economic Response Package Omnibus Bill 2020 (Coronavirus Bill), designed to assist businesses in financial distress as a result of the economic impacts of COVID-19.
Some of these reforms include changes to the Corporations Act 2001 (Cth) (Corporations Act), to provide temporary relief for directors from their duty to prevent insolvent trading and temporary relief for businesses at risk of insolvency, including through increasing the statutory minimum amount and time period for creditor's statutory demands.
The reforms also provide for a temporary safe harbour for directors from liability for insolvent trading with respect to debts incurred during the COVID-19 pandemic. Section 588GAAA of the Corporations Act provides that a director will not be liable for insolvent trading if the debt is incurred in the following circumstances:
in the ordinary course of the company’s business; and
during the six-month period starting on the day the section commences, being 24 March 2020 (or any longer period prescribed by the regulations).
The onus of proof lies with the director to document and be able to produce evidence of the above circumstances (s588GAAA(2)).
The Government has also provided a number of stimulus packages to support eligible small to medium sized businesses, including access to funding to continue paying employees, cash flow support to continue business operations, and assistance from the ATO with temporary reduction of payments or deferrals, or withholding enforcement actions including Director Penalty Notices and wind-ups.
A company is insolvent if it cannot pay its debts as and when they fall due. This is principally a test of a company’s cashflow and whilst funding and debt moratoriums provide immediate relief by the deferral of a requirement to pay, debts continue to accrue on the company’s balance sheets and will become due and payable at some point in time.
While the Government has provided significant temporary relief to assist businesses and directors through the COVID-19 pandemic, it is our view that these measures alone will not be enough for many businesses, particularly those struggling prior to COVID-19, to return to solvent trading at the end of the pandemic.
For these companies, directors should consider whether they qualify for the 2017 safe harbour provisions under section 588GA of the Corporations Act and if so, develop and implement a recovery plan from the impacts of COVID-19.
What is Safe Harbour
We explained the safe harbour provisions in detail in our April 2018 bulletin, which can be accessed here.
To briefly recap, on 19 September 2017, new legislation came into force providing “safe harbour” protection for company directors against insolvent trading claims while they develop and implement plans to restructure the company.
In particular, s588GA of the Corporations Act provides protection for company directors from personal liability for insolvent trading if, at a particular time after the director starts to suspect that the company may be insolvent, he or she develops and implements a course of action that is reasonably likely to lead to a better outcome for the company, and the relevant debt is incurred in connection with that course of action.
A director will not qualify for “safe harbour” protection if the company has not:
paid its employee entitlements, including superannuation by the time they fall due; or
provided its returns, notices, statements, applications or other documents to the ATO more than once during the 12 month period prior to a debt being incurred from which the director seeks the protection of the safe harbour.
Why is Safe Harbour still important?
It is almost certain that the financial impact on businesses as a result of COVID-19 will continue beyond the six-months currently allowed for by the Government’s reforms.
The Government’s temporary relief measures and the six month protection from insolvent trading for directors may prove sufficient for a healthy business with a viable cash flow to enable it to return to solvent trading at the end of the six-month period.
But for many businesses facing working capital difficulties arising prior to and as a result of COVID-19, sole reliance on these Government measures without a turnaround strategy for when the pandemic ends will not be enough.
For these businesses, steps should be taken so that directors can take advantage of the “safe harbour” protections in the Corporations Act. The company should pursue a course of action that:
will allow it to continue to trade once normal trading conditions are resumed in a manner that affords directors protection from insolvent trading liability; and
is assessed with the input of an appropriately qualified adviser to be reasonably likely to lead to a better outcome for the company than administration or liquidation once the pandemic ends.
We suggest that directors take this opportunity to:
stay informed about the company’s financial position, and what government support is available to support businesses through the COVID-19 period;
revisit credit and debt arrangements for the company, and ensure cashflow is maximised by focussed debt recovery;
liaise with company financiers to obtain deferrals and other support as appropriate and determine whether any form of financial restructure is possible;
ensure costs are contained and reduced where appropriate, bearing in mind the ability of the company to rebound once the COVID-19 period is over will depend largely on its workforce;
ensure the company is keeping appropriate financial records;
prevent misconduct by company officers and employees that could adversely affect the company’s ability to pay its debts;
obtain advice from an appropriately qualified adviser on whether the threshold matters for entering the “safe harbour” are complied with and the development of a restructure plan, ensuring it is reasonably likely to lead to a better outcome for the company than administration or liquidation; and
implement the plan for restructuring the company to improve its financial position for when the pandemic ends.
Bartier Perry has extensive experience and a wide range of networks to assist directors seeking safe harbour protection. Please contact us for a no obligation discussion.