Changes to the Corporations Act now provides protection to company directors from personal liability for insolvent trading in certain circumstances.
On 19 September 2017, Australian insolvent trading laws went through a significant shake up with the introduction of safe harbour reforms in a new section under the Corporations Act 2001 (Cth).
What was the law?
Prior to the introduction of these reforms, the Corporations Act 2001 (Cth) held company directors personally liable for any debts incurred during the restructuring of an insolvent company.
If at the time the debts were incurred, the director had reasonable grounds to believe the company was facing liquidation, they would assume complete and personal liability for those debts. This left little room for directors to problem solve, when any attempt at turning the company around may be at personal cost to them.
This personal risk discouraged legitimate business rescue and deterred directors from taking steps to rescue the company. As a result, recoverable, and even solvent, companies were frequently rushed into liquidation by directors to protect themselves from liability.
What is the law now?
The reforms protect company directors that are attempting to preserve or rescue a business through insolvent trading.Directors will be free from liability if, it can be demonstrated they were developing a course of action which was reasonably likely to lead to a better outcome for the company. There is a focus on the intention and behaviour of a director rather than just the time the debts were incurred.
The new provisions encourage directors to take reasonable risks to turn the company around rather than leaping into liquidation in fear of liability. Whilst the reforms are designed to be accessible, there are still eligibility requirements for directors looking to enter the ‘safe harbour’.
The primary rule being that the harbour is only open to directors acting honestly and diligently. The prime example of this is a proactive and documented turn around plan for the company.
The harbour is closed to directors relying on strategies of hope or attempting to evade paying debts. Other considerations include whether the director took steps to prevent misconduct, kept adequate financial records, obtained advice from qualified parties, provided employee entitlements and kept tax reporting up to date.
Key Takeaways
– Directors are no longer personally liable for debts incurred by a company when approaching insolvency.
– Safe harbour laws allow for creative and consequence-free insolvent trading that may save a company from liquidation.
– To qualify for Safer Harbour a director must demonstrate they have acted honestly and diligently in their efforts to rescue the business.