A safe harbour from our harsh insolvency laws?!

The “safe harbour” reform bill has been introduced into federal parliament to address directors’ “medium risk” of liability for insolvent trading.  The reform represents a significant shift in favour of directors and their companies. This is a “carve out” not a defence; to the extent that a defence is required it is to the level of an evidential burden only and the director is allowed and encouraged to “remain in possession”.  All this, with director groups offering little or anything in return. 

The safe harbour bill [1]provides protection for directors from liability for insolvent trading under s 588G of the Corporations Act if they operate within the parameters set by new section 588GA. The aim is to have directors more willing to engage in valid efforts to resolve their company’s difficulties outside the formal constraints of insolvency law, with the formal administration and liquidation regimes remaining available if needed. At the same time, directors must act properly within set parameters if they are to successfully claim the defence against any later action by a liquidator.

Readers will have the benefit of much black letter analysis of this new law.  These several points are made, for the moment… 

  1. The reform seeks to balance the interests of creditors with those of business enterprise.  But that balance remains weighted against creditors. Claims by director groups that our insolvent trading laws are among the harshest internationally are refuted by INSOL International’s recent publication Directors in the Twilight Zone, which refers to our laws as being of “medium risk” to directors.
  2. While the safe harbour protection has long been sought by those director groups and their advisers, there has been little concession made by directors in offering some quid pro quo that would serve to raise the level of business transparency needed for proper business conduct. Assurance of a director’s identity (by way of the “director identity number”, or DIN) and disclosure of corporate beneficial ownership, and more ready access to corporate databases are the sort of necessary landscape measures that director groups might well have promoted over the years in order to allow potential creditors better information to assess those with whom they trade. These new safe harbour laws would have been better justified if those preventive processes were in place beforehand.
  3. At the same time, creditors need to understand the new “entrepreneurial” focus of the law and themselves reassess their own protection. PPS registration, access to new credit information on tax defaults, and stricter terms of trade are available options. If a safe harbour outcome requires creditors to compromise their claims, they should understand that the insolvency alternative will generally offer a worse result. Nevertheless, at any time, a creditor has the ready option of a statutory demand and winding up action against a debtor company, whether in safe harbour or not. 
  4. While non-disclosure of safe harbour protection will generally be possible, save for large disclosing entities, any defence raised in court against a winding up or debt recovery action will require disclosure to the court, and the business community.   
  5. The new law needs to be explained and “sold”. ASIC, the ATO and the banks will need to support that message and the courts will need to read the law according to its purpose. Co-operation and concession is often the best option. That may require a cultural change that will take time, and behavioural and related disciplines may be needed to more quickly embed the message. The ability of the director to remain “in possession”, in fact to be a central part of the restructuring, even without an adviser, addresses many behavioural disincentives of the current law.
  6. As to that, the Explanatory Memorandum to the Bill is an elaborate account of the purpose of safe harbour and how the law should operate. In particular, the simply termed “appropriately qualified entity” to advise the director is described in depth, seemingly trying to meet the demands of the competing stakeholder groups interested in becoming that “entity”. How much that description will find its way into real law awaits the courts reading of the plain words of section 588GA. The adviser remains a discretionary though no doubt important criterion in meeting the requirements of section 588GA.
  7. While accountants may be appropriate advisers, the forthcoming changes to their international Code of Ethics (APES 110) that impose responsibility to refer client breaches of the law to the authorities, may present issues in advising failing businesses, given what are reported by liquidators to be a high level of illegality in insolvent companies.[2] As the American Society of CPAs cautions, the new Code requirements may have a “chilling effect” on potential clients in regulatory difficulties. In any event, the legal requirements of running a business, let alone one in distress and in safe harbour, may result in lawyers being central to any restructure.
  8. State laws may contradict the government’s intentions under this new law.  Just as section 588GA is being introduced to prompt proactive obligations of directors, Queensland has repealed similar criteria in its building licensing laws, as an “anti-phoenix measure”, which now serve to withhold licence renewals for 3 years of those who are responsible for a construction company failure, with a lifetime ban for two or more failures.[3] The federal government’s Innovation Statement acceptance and support for the reality that “entrepreneurs will fail several times before they make it” may hold no sway elsewhere. A director may survive save harbour but crash on the rocks of state law.
  9. Corporate laws on the duties of directors also still apply, those of care and diligence (s 180), good faith (s 181) and more. A question will be whether a director meeting the standards of s 588GA will also meet the general standards expected of a director, in all cases. The director, and their adviser, will need to be aware of the legal frameworks that still remain despite s 588GA, and not only in corporate law, but also in tax, employment, fair trading and more.    
  10. The new law follows a long period of analysis and debate, with opinion often divided. Reform was at one stage rejected because no “evidence” of the need for the reform was offered. That being the case, it is up to those who have so actively sought this safe harbour law to now put in place mechanisms to assess its worth, however and through whatever discipline might assist.  A sunset clause or review period in the law would have been useful, or inclusion of relevant s 588GA criteria in rules rather that in the law itself. 
  11. Some comfort might be taken that this reform is worthwhile given the international government and academic focus on the need for beneficial arrangements for attending to financially distressed companies. See Turnaround Management and Bankruptcy, Adriaanse & van der Rest (eds), Routledge, 2017. 

The real concern is that while safe harbour is an apparently worthwhile law, it is yet another piecemeal reform in the complex interactions of how insolvency operates, tax law for one, and increasing financial, health and safety and environmental regulation as well.  Unintended consequences could be a result.  Without the preventive environmental landscape measures that would make business dealings made more transparent, the acceptance and development of safe harbour restructurings will be more limited.   

But if we waited for the government to implement a major review of insolvency law, taking into account that broader economic, legal and societal landscape, no insolvency reforms would be enacted for quite some years. 

[1] Treasury Laws Amendment (2017 Enterprise Incentives No 2) Bill 2017

[2] See www.apesb.org.au

[3] The current and former laws in the Queensland Building and Construction Commission Act 1991 (Qld) are discussed in D’Arro v Queensland Building and Construction Commission [2017] QCA 90

 

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