WHAT is Safe Harbour?
The Safe Harbour insolvency regime allows company directors to implement a restructure without the risk of personal liability for debts should the restructure ultimately fail. It is intended to mitigate personal liability for insolvent trading for directors who are undertaking a legitimate restructure supervised by an authorised practitioner, which is likely to result in a better outcome for the company. As such, the regime encourages directors to innovate, take reasonable risks and trade their business out of financial difficulty, rather than resorting immediately to external administration. The protection is outlined in Section 588GA of the Corporations Act 2001 (Cth) (Corporations Act).
Who can do it?
To be eligible for Safe Harbour protection, the director must:
- have paid all employee entitlements by the time they have fallen due;
- have provided all documentation that is required or requested by an external supervising administrator;
- be up to date with all tax obligations of the business; and
- have commenced developing one or more course(s) of action, that is reasonably likely to lead to a better outcome for the company, in comparison to the immediate appointment of an administrator or liquidator.
Actions that may reasonably lead to a better outcome for a company will differ, depending on the industry and size of the business, but generally involves:
- obtaining appropriate advice from an appropriately qualified advisor such as an insolvency practitioner, solicitor and/or accountant;
- maintaining proper financial records;
- being informed of the company’s financial position;
- taking steps to ensure no misconduct occurs by officers and employees; and
- developing and implementing a restructuring plan that improves the company’s financial position.
Additionally, a course of action needs to be completed or actioned within a ‘reasonable time frame’ for the Safe Harbour Protection to still be applicable. The Australian Government Treasury defines a reasonable time as a period that will differ depending on the complexities involved and the specific actions that are required to be completed.
What is involved?
Safe Harbour automatically commences when a director starts developing a plan that is reasonably likely to lead to a better outcome for the company. The development of a plan is simple and its definition changes depending on the industry or size of the business. However, it can be achieved in several ways. The first being to analyse the company’s current situation – determining the company’s chances of survival, along with appropriate strategies that form a preliminary action plan. This should be conducted by a qualified advisor. The second step involves the development of an ‘emergency action plan’ that focuses on short term actions to improve the company’s financial position, while charting a medium-to-long term pathway to profitability. Short term actions may include terminating excess staff, cancelling product development or selling liquid stock. Thirdly, a restructure of the business will need to be actioned after all short-term threats of illiquidity and insolvency have been resolved. This third stage typically involves the development of a long-term plan, focused on business efficiency and sustainability.
Specific Provisions for Small Business Entities
To help small business entities, the Safe Harbour Regime has been amended to focus on the Small Business Restructuring framework. These changes help provide small business entities with a simplified Safe Harbour when undertaking a restructure. While the simplified framework is largely in line with the conventional requirements, the company’s total liabilities must not exceed $1 million (excluding any employee entitlements). Other key differences include:
- a registered liquidator must be appointed as the restructuring practitioner;
- any non-lodgments of taxes and non-payment of employee entitlements do not preclude the appointment of the practitioner; and
- creditors are notified and ipso facto protections apply to impose a moratorium during the planning period.
With the introduction of Safe Harbour, company directors may trade while being ‘insolvent’- allowing directors to perform all normal business actions, under supervision, without the fear of being liable for the debts of the business. The Safe Harbour legislation covers all debts that are incurred in the course of the restructure, including debts incurred from the commencement of the course of action and ending when the course of action ceases to be reasonably likely to lead to a better outcome for the company. Debts incurred during the ordinary course of trading or related to restructuring efforts also fall under Safe Harbour legislation. So long as a reasonable likelihood of a better outcome for the company is maintained, director(s) or restructuring practitioners are not obligated to ensure every debt is approved in order for it to be covered by Safe Harbour protections.
Additionally, the proposed restructuring plan does not ultimately need to be successful for the Safe Harbour provisions to apply, so long as the appropriate records are provided and the initial plan was reasonably likely to lead to a better outcome for the company. Should the criteria be met, the director still falls under the protection of Safe Harbour and is therefore not personally liable for debts incurred during the process with respect to insolvent trading.
In summary, Safe Harbour provides numerous benefits to the directors including but not limited to:
- encouraging directors to innovate, take reasonable risks and trade their business out of financial difficulty;
- no adverse consequences if the process fails;
- no formal insolvency process;
- limited public disclosure that Safe Harbour has been initiated (excluding ASX rules);
- flexibility – allowing adjustments to the current specific needs of the director and business.
Detriments & Costs
Failure to use Safe Harbour or promptly enact it may expose a director to personal liability for all debts the company has incurred as a result of trading while insolvent – even if those debts arose due to efforts to turn the business around. Further, by not engaging Safe Harbour protections, the company will be required to be externally administered if it becomes insolvent; resulting in directors’ loss of control.
Legislation and specific references to law
A relatively new development in Australian law, the nation’s Safe Habour framework was incorporated into the Corporations Act on 12 September 2017. Today, Safe Harbour provisions are found in sections 588GA & 588GAAB of the Corporations Act. No legal action is required to apply for Safe Harbour. A company director must only meet the specified requirements, and have a plan to restructure the business in consultation with the restructuring practitioner.
Despite the Safe Harbour framework, directors maintain statutory and fiduciary duties to companies, including the following provisions of the Corporations Act:
- section 180: to act with care & diligence;
- section 181: to act in good faith;
- section 182: to not misuse their position; and
- section 183: to not misuse information.
Accordingly, directors should be mindful of the above obligations when deciding on continued trading (both with and without the Safe Harbour provisions).
Recent cases, previous experience/precedents
The Australian Restructuring Insolvency & Turnaround Association (ARITA) recently conducted a survey that had 108 responses from professional members. From this survey 53% of professional members had been engaged to develop a Safe Harbour plan for their clients with 76% of respondents then saying that due to being engaged as a Safe Harbour advisor the client was able to successfully restructure and turnaround the company. Because of this survey, ARITA is of the professional opinion that the Safe Harbour regime is achieving the outcomes it has been aiming to deliver with providing breathing space and opportunity for directors.
A successful case of Safe Harbour is exemplified where a company was able to create and implement a suitable restructuring plan providing the opportunity for the directors and management to focus on the most important aspects of the business without having to worry about their own personal liability. This focus undoubtedly led to a better outcome for all stakeholders involved and brought that business out of financial distress and to new heights.
To date, Australian courts have not closely examined the operation of the relatively new Safe Harbour legislation, however greater judicial authority will likely become available as Covid-19 support measures are reduced, and small businesses increasingly rely on expanded Safe Harbour protections.
In the meantime, it is important to seek advice as early as possible if you suspect that your company is under any risk of incurring a debt (or debts) that they will not be able to repay, to mitigate the risks associated with trading whilst insolvent.
If you have any questions, please contact your trusted representative from Hall Chadwick, or legal specialist from KERRS, if you wish to understand the process in greater detail, or are considering creating an appropriate Safe Harbour plan.
Tean Kerr, Solicitor Director at KERRS
Ignatius Campos, Chartered Accountant at Hall Chadwick