Insolvency: Out of safe harbour and into dry dock

Mar 2020


Crisis Management ‘How To’: Don’t Throw Your Hands In The Air!

In our latest post, we turn to crises – and, more importantly, how to manage them. Crises can take a number of forms and by their nature they happen unexpectedly without warning.  Inhouse counsel have an important role in identifying risks in order to prepare for a crisis.  While a crisis is unfolding, inhouse counsel are critical in protecting privilege and providing legal advice in the moment.

The temporary suspension of the ‘insolvent trading’ regime is a unique opportunity to see if general directors’ duties can do the job instead.

Australia has one of the harshest regimes for insolvent trading in the world. But its laser focus on the interests of creditors, and harsh penalties, has served to distract directors in times of distress – and arguably stood in the way of better outcomes for everyone (creditors included). Refocusing directors’ attention to the interests of the company as a whole could change that.

At the regime’s inflexible core is section 588G of the Corporations Act, which requires every company director to prevent their company from trading while insolvent. This duty indiscriminately applies to directors of companies large and small, regardless of whether they’re on the high street or in a high tower.

A breach has the harshest consequences – criminal and civil penalties, and personal liability for any debts incurred while the company is insolvent.

Preventing a company from getting deeper into debt is just one consideration in navigating rough times. The unfortunate side-effect of the insolvent trading regime is it effectively becomes the only consideration.

“Preventing a company from getting deeper into debt is just one consideration in navigating rough times.”

Amalgam of stakeholders

Instead of creditors first second and third, a company ought to be viewed as an amalgam of its stakeholders – shareholders, directors, employees, suppliers, lenders, customers, even the community at large. Recognising directors’ obligations to these people makes the case for governing them through flexible, yet comprehensive, general statutory and common law duties.

The government’s recent legislation suspending section 588G’s operation is welcome, but doesn’t go far enough. What is needed is to wipe the slate clean and abolish section 588G.

Isn’t this tipping the scales too far in favour of directors?

No. Directors already owe strict statutory duties under the Corporations Act, and general law – to act with reasonable care and diligence, and in good faith in the best interests of the company.

Abolishing section 588G would not give carte blanche for boards to behave as they wish, or to fail to act where action is clearly required.

Rather, it would focus directors on what really matters – taking reasonable and prudent steps to keep the company alive and successful, having regard to its best interests as a whole. An insolvent trading overlay is not required.

Financial distress

Compliance with these duties requires they give greater attention to creditors’ interests in times of financial distress – as creditors become the stakeholders most impacted by directors’ decisions but noting that creditors and shareholders alike will benefit if the business can be saved and returned to profitability.

The need for flexibility has already been recognised. The safe harbour rules of 2017 provided distressed company directors with some breathing space to consider the best course of action without the risk of personal liability.

But it cannot deal with unprecedented widespread distress; it is difficult for directors to rationally form a view that restructuring or other “course of action” (as the legislation requires) would likely lead to a better outcome for the company than immediately appointing administrators or liquidators.

The temporary suspension of the “insolvent trading” regime provides a unique opportunity to see whether the general directors’ duties are robust enough to regulate directors conduct.

Will directors start acting more recklessly? The fact remains that directors who recklessly exercise their powers otherwise than in good faith and in the interests of the corporation (for example, by allowing the company to incur debts which it is unlikely to be able to repay and in the absence of an overall plan for a better outcome than formal insolvency proceedings), risk committing criminal offences (section 184, Corporations Act).

We believe that the current crisis will force directors to properly understand all of their general duties in navigating their companies through challenging times. We may (hopefully) emerge without need for return of a distracting insolvent trading overlay.


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