Auditors responsibilities going concern in safe harbour
8 July 2021
As auditing teams around Australia gear up for the 30 June 2021 audit season, during what we hope is a brief COVID-19 lockdown period, we consider the overlay of the auditor’s responsibilities in assessing going concern of companies, where directors are seeking reliance on the safe harbour law provisions.
We consider the impact of inflationary headwinds on costs and tightening working capital leading to an increase in directors of ASX Listed Companies and Large Corporates considering and seeking safe harbour as a defence, so they can be afforded protection and time while restructuring and strengthening balance sheets.
We provide an overview of the safe habour law provisions of section 588GA of the Corporations Act 2001 (the Act), the practical interaction between auditors and safe harbour advisors regarding the testing of going concern, and the protection independent safe habour advice provides to auditors.
1. What is Safe Habour
Safe Harbour is a carve out from a director’s liability for insolvent trading provided certain conditions are satisfied, as outlined in section 588GA of the Corporations Act 2001 (the Act).
Safe Harbour will protect directors from insolvent trading liability for debts incurred by a company if, after a director starts to suspect that the company may become or is insolvent, the director starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the entity than the immediate appointment of an external administrator.
Safe Harbour is a defense available to directors, in the event a company is wound up and a liquidator seeks to bring an insolvent trading claim against directors.
2. Benefits of Safe Harbour for Auditors
Auditors obtain an indirect benefit from directors obtaining safe harbour advice from an appropriately qualified entity, as it:
- Improves the prospect of a successful restructure to avoid the company being wound up, avoiding potential causes of action that may arise in a liquidation scenario against auditors; and
- Provides a carve out period of insolvent trading, minimising the potential claims a liquidator can pursue against directors, auditors and insurers (i.e. D&O Policies).
3. Appropriate Qualified Entity
An Appropriately Qualified Entity is an entity with an insolvency practitioner, being a registered liquidator and a member of an industry body (ARITA, TMA, AIIP), and accordingly has the ability and experience to undertake the better outcome assessment of the corporate structuring plan under section 588GA(1)(a) of the Corporations Act 2001.
With listed companies or large complex businesses, insolvency practitioners and legal advisors are generally retained to advise on an appropriate course of action, eligibility, undertake the better outcome assessment and other matters.
Auditors should consider the independence of the Appropriately Qualified Entity, to obtain comfort in the integrity of the process, the corporate structuring plan and supporting cashflow forecasts, and any protection the auditors may derive from the engagement of the Appropriately Qualified Entity.
In the event the restructure is unsuccessful and a liquidator is later appointed to the company, the liquidator will likely seek to challenge the independence of the Appropriately Qualified Entity, and review any relationships with the directors, the audit firm, or other key stakeholders who may derive a benefit from the safe harbour defence. We are of the view that an insolvency practitioner of an audit firm will be conflicted from being the Appropriately Qualified Entity.
4. Eligibility criteria for Safe Harbour
The key requirements for a Director of a company to be eligible for safe harbour protection include:
- Directors must have a suspicion of insolvency;
- Books and records have been adequately maintained;
- Employee entitlements are paid up to date; and
- Taxation reporting obligations are up to date (lodged not necessarily paid).
5. Restructuring Plan in Safe Harbour
The key restructuring requirements for the Corporate Structuring Plan (CSP) include:
- Comprehensive, milestone based and time bound objectives; and
- Likely to lead to a better outcome than the immediate appointment of an external administrator.
In order to assess the better outcome of the CSP to that of an immediate appointment of an external administrator, an independent Registered Liquidator is able to provide this assessment.
6. ASX Listing Rules – Guidance Note 8
ASX has confirmed that the fact an entity’s directors are relying on safe harbour is unlikely to constitute information that, in isolation, requires disclosure to the market, as it is likely to fall within the carve-outs to immediate disclosure under Listing Rule 3.1A. This is on the basis that information about possible alternatives to an insolvent administration being pursued by directors concern an incomplete proposal or is insufficiently definite to warrant disclosure.
Section 588GA is a conditional carve-out from a director’s potential liability for insolvent trading that does not affect an entity’s continuous disclosure obligations or reduce the entity’s obligation to disclose the extent of its financial difficulties.
Most investors would expect directors of an entity in financial difficulty to be considering whether there is a better alternative for the entity and its stakeholders than an insolvent administration. The fact that they are doing so is not likely to require disclosure unless it ceases to be confidential or a definitive course of action has been determined.
A company, where directors are relying on the insolvent trading safe harbour will be subject to a heightened level of continuous disclosure risk as it attempts to implement the CSP in the safe harbour period.
7. Responsibilities of auditors and interaction with safe harbour advisor
When performing risk assessment procedures the auditor considers the entity’s ability to continue as a going concern, and managements representation and assessment of going concern. When reviewing and identifying events or conditions that, individually or collectively, may cast significant doubt on the entity’s ability to continue as a going concern and, if so, management’s plans to address them.
As a requirement of safe harbour is a suspicion of insolvency, the ability of the company to continue to trade as a going concern is identified and flagged early in the audit process by the auditor. This is usually when Management introduce the auditors to the safe harbour advisor, to outline the CSP to address the going concern issues.
Where the audit firm has an insolvency division, the auditor is sometimes accompanied by a member of the audit team’s insolvency division who has knowledge of the safe harbour law provisions. The key issues discussed and addressed at these meetings typically include:
- Understanding the safe harbour advisors’ independence in order to undertake the better outcome assessment, any prior relationships with the Directors, the Company, the audit firm or other beneficiaries of the safe harbour process;
- Understanding the steps taken by the safe harbour advisor to confirm safe harbour eligibility, and the frequency of retesting eligibility by the safe harbour advisor;
- Description of the courses of action that make up the CSP, and the status of the various proposed courses of action the company is embarking upon. This is usually tied into ASX Announcements were market sensitive courses of actions have been defined and approved by the Board of Directors;
- Understanding of the key underlying assumptions made by the safe harbour advisor, generally Registered Liquidators, in their assessment of an immediate external administration; and
- Reviewing and discussing the cashflow forecast adopting the courses of action of the CSP.
Where auditors obtain comfort in the integrity of the safe harbour process and the independence of the safe harbour advisor, this should provide a level of comfort to the auditors, their insurers, and informing any audit opinions in the current audit process.
Further, auditors will also obtain comfort on the structure of the process and discipline around documenting and implementing the CSP for the benefit of stakeholders in the event the CSP is ultimately unable to be implemented and the company is placed into external administration.
8. Key takeaways for auditors
The key takeaways for auditors:
- Keep an open mind to safe harbour when assessing going concern;
- Meet with the safe harbour advisor to obtain their opinions and assessment, comfort in the CSP and the safe harbour process;
- Maintain confidentiality of the safe harbour process to maximise the possibility of a successful restructure; and
- Consider the benefits it provides to auditors.
Wexted Advisors specialise in providing restructuring advice under the safe harbour law provisions. Wexted Advisors are one of the market leaders in safe harbour, having successfully restructured ASX Listed and Large Corporates across Australia. The team includes registered liquidators who are members of the industry bodies (ARITA, TMA and AIIP).
Click here to download the brochure on safe harbour and our recent credentials.