Practical considerations for the small business industry.
On 18 September 2017, Treasury Law Amendments (2017 Enterprise Incentives No.2 Bill) received Royal Assent, which deals with the safe harbour and ipso facto reforms. The safe harbour law is now in effect while the law around ipso facto clauses is likely to commence on 1 July 2018. The safe harbour laws’ intention at a broad economic level are to provide an environment that encourages entrepreneurialism and innovation. More specifically, the laws seek to provide directors an opportunity to explore restructuring opportunities where previously, stringent insolvent trading laws may have made directors hesitant to do so.
Directors will be able to seek protection from insolvent trading if, when they suspect the company is insolvent or likely to be insolvent, they develop one or more courses of action that are 'reasonably likely' to lead to a 'better outcome’. A better outcome for a company is defined as ‘better’ than the immediate appointment of an administrator, or liquidator, to the company.
The Act does not define ‘reasonably likely’, but the Bill’s Explanatory Memorandum details that a better than 50 percent chance is not required, rather that the chance of achieving the better outcome is not ‘fanciful’ or ‘remote’, but is ‘fair’, ‘sufficient’ or ‘worth noting’.
Several factors must be considered to assess whether the course of action reasonably likely leads to a better outcome, which are whether the person:
- keeps themselves informed about the company’s financial position
- takes steps to prevent company officers’ and employees’ misconduct
- takes appropriate steps to ensure the company maintained appropriate financial records
- obtains advice from an appropriately qualified adviser
- develops or implements a plan for restructuring the company to improve its financial position.
Not all factors above are necessary for directors to seek safe harbour protection. However, obtaining advice from an appropriately qualified advisor is recognised may, often, form a key part in developing the course of action itself. The Explanatory Memorandum explains that ‘appropriately qualified’ doesn’t merely mean certain qualifications are possessed, and the director must determine who an appropriate advisor would be, under the circumstances. The Explanatory Memorandum goes on to state that for small business, a simple restructure may only need an accountant or a lawyer’s advice, perhaps with insolvency experience.
Critically, directors are only protected from personal liability for those debts incurred directly or indirectly regarding any such course of action. The protection ends if the director fails to act within a ‘reasonable period’, ceases course of action, or an administrator or liquidator is appointed. The Explanatory Memorandum notes that ‘reasonable period’ will vary case-by-case and that for a small business: it may only be days.
Directors cannot take advantage of safe harbour if the debt is incurred when:
- Employee entitlements are not paid when due.
- Breach their ongoing lodgement requirements with the Australian Taxation Office (ATO).
- They fail to provide the Report as to Affairs and books and records to a voluntary administrator or liquidator.
In addition, in any subsequent court proceedings for insolvent trading, the evidentiary burden is on the director claiming safe harbour protection.
So, what are some practical considerations in small business? (The list is extensive!).
- Several key terms within the new legislation is subject to interpretation and it’s inevitable that the judicial system will play its role in providing guidance as directors seek to rely on safe harbour for insolvent trading claims. Small businesses directors may be hesitant to use untested legislation while in its infancy without gaining assurance around what is considered acceptable safe harbour processes.
- We often find that when small businesses are in financial distress, the directors are concerned about existing personal exposures such as personal guarantees, personal real property used as security for bank finance, director loan accounts and ATO Director Penalty Notices (DPN). A safe harbour could enable a successful turnaround, avoiding some of these personal exposures (e.g. an unremitted lock-down DPN is excluded). However, with small businesses already cash-strapped, directors are unlikely to fund or risk treading through what may be considered onerous obligations in having to continuously document details of the action being taken. The result may be that the directors fall short of the requirements and exposed to a larger insolvent trading claim.
- In the Worrells submission to the Treasury in 2016, we advocated that the ‘appropriately qualified adviser’ should have the skills akin to a registered liquidator. The Australian Restructuring and Insolvency Turnaround Association’s (ARITA) took a comparable view. During the Bill vote the opposition proposed that the advisor should be a registered liquidator but the proposal failed. Providing appropriate advice in distressed situations requires a specialised skill set that is developed through years of education, training and experience, and subject to high professional standards and accountability in a regulated sector. Unfortunately, ‘pre-insolvency advisors’ that are likely to advise directors on accessing safe harbour—are currently unregulated. As explained earlier, the onus is on directors to determine who an appropriate advisor should be based on their circumstances. Unqualified advisors may take advantage of vulnerable directors with restructuring advice that may at face value look to provide safe harbour protection, but fail to address all the complex insolvency issues.
We welcome the changes in its efforts to give directors a chance to accomplish a genuine business restructure. The safe harbour laws’ effectiveness will largely be left in the hands of those advising to develop best practice policies and guidelines, and ensuring that appropriate restructuring plans are offered to directors. Personally, I’m interested to see how these laws will impact and reshape director culture and attitude.