29 May 2020
Can directors trade whilst insolvent under safe harbour protection?
Author: by Andrew McCabe
As the impact of COVID-19 becomes clearer, directors assess their company’s financial position and consider whether they are trading whilst insolvent up to 25 September 2020, and beyond, and the ramifications of personal liability for directors.
This article considers the overlay of COVID Safe Harbour protection (s.588GAAA of the Corporations Act) and Safe Harbour (s.588GA), and how directors can utilise these defences against any future insolvent trading claims in a worst-case scenario (liquidation).
Directors remain reliant on CEO’s and CFO’s to navigate the COVID market conditions and produce timely and accurate cash flow forecasts and sensitivity analysis, in order for boards to make informed decisions and declarations on solvency.
We acknowledge the challenges for Management during this uncertain and challenging period and outline the key variables Management consider in an ever-changing market:
- Implications of State Government’s easing restrictions on revenue and margin;
- Available sources of capital and finance facilities limits (i.e. trade and invoice finance limits);
- Government support packages ceasing in late September 2020;
- Rental deferrals and timing of future repayments;
- Tightening working capital, with aging debtors and lower sales during COVID;
- Redundancy costs post JobKeeper and overlay with any notice period;
- Forecast lower consumer discretionary spending in late 2020 (post Government support packages) and how the ‘new normal’ translates into FY21 budgets and profit guidance;
- Tariffs and changing export markets; and
- Impairment of asset values.
When directors ask themselves the question on solvency, consideration should be made on a cash flow test and a balance sheet test, amongst other indicators of insolvency. A recent article published by the Australian Institute of Company Directors, What directors need to know about their financial reporting obligations during COVID-19 on 25 May 2020 provides further guidance for directors and recommends directors to get professional financial and legal advice. Wexted Advisors are the market leaders in providing safe harbour advice for ASX Listed Boards and large corporates across a range of sectors across Australia.
Section 588G of the Act outlines a director’s duty to prevent insolvent trading. Pre and post-COVID a breach of section 588G(3) carried a maximum penalty of up to 2,000 penalty units ($420,000) and five-years imprisonment. Although during the period 25 March 2020 to 25 September 2020, under s.588GAAA there are no penalties.
We provide an overview of the safe harbour insolvent trading defences available to directors pre and post 25 September 2020:
- COVID Safe Harbour (s.588GAAA) – in response to COVID temporary amendments were made to the Act providing temporary relief for directors in relation to personal liability for insolvent trading, absent dishonesty or fraud. The defence applies to all debts incurred in the ordinary course of business for a period of six months to 25 September 2020; and
- Safe Harbour (s.588GA) – at a particular time after a director has a suspicion of insolvency, a director starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the company. In working out whether a course of action is reasonably likely to lead to a better outcome, regard may be had to whether the person is obtaining advice from an appropriately qualified entity. Wexted Advisors are the market leaders in providing safe harbour advice for ASX Listed Boards and large corporates.
There are limited requirements on directors to qualify and obtain the COVID Safe Harbour protection for insolvent trading claims, as detailed below.
COVID Safe Harbour was implemented, accompanying the JobKeeper Program, with minimal entry criteria in order to preserve businesses and importantly retain jobs in the workforce. To date, the government measures implemented are preserving businesses and jobs.
As directors, currently trading whilst insolvent, revisit their statutory duties and obligations beyond 25 September 2020, we consider if there may be an increase in: (a) safe harbour appointments (s.588GA); (b) external administrations; or (c) both. Unfortunately, subject to how quickly the economy can recover between now and September 2020, our view is we are likely to see an increase in activity in both, safe harbour engagements and external administrations post 25 September 2020.
Directors should note these are only defences for insolvent trading, and directors continue to have a requirement to meet their statutory directors’ duties and obligations under the Act.
As directors are educated on the differences between Safe Harbour and COVID Safe Harbour, by the AICD, company secretaries, lawyers and accountants, we expect enquiries levels will continue to increase as we move closer to the 25 September 2020 cut off, or alternatively, as directors are asked to sign companies annual declaration of solvency.
Wexted Advisors are market leaders in providing safe harbour advice for ASX Listed Boards and large corporates in Australia. Wexted Advisors are also registered liquidators. Further information on our credentials and experience as the leaders in safe harbour is on our website www.wexted.com.au
Related articles Some Practical Insights on Safe Harbour
Wexted Advisors communications are intended to provide commentary and general information. They should not be relied upon as financial or legal advice. Formal financial or legal advice should be sought in particular transactions or on matters of interest arising from this communication.
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