Insolvency laws were temporarily changed in Australia at the end of March 2020 with the introduction of the COVID19 Safe Harbour. This provides directors with protection from insolvent trading personal liability.
At first, this might make you relax a little if your company was facing financial distress, because you can temporarily continue to trade a business despite potentially being insolvent and becoming personally liable.
The threshold for statutory demands was increased to $20,000 and the timeframe for responding extended from 21 days to six months (the factsheet can be found here).
While all this sounds to be good news for some business owners, it is not entirely without risk. The changes may only serve to postpone the inevitable or provide businesses with false hope. At worst, they could lead directors down a dangerous path.
This article steps you through what’s changed, what you need to know, and what I personally recommend you do.
What you need to know about the change to insolvency laws
When Australia’s governments closed sectors down to prevent the spread of coronavirus, a large number of businesses would inevitably face the risk of liquidation or voluntary administration.
The law was changed and the COVID19 Safe Harbour introduced to prevent a surge of business closures (or at least to flatten the insolvency curve).
Here are the key facts about the change to the insolvency laws:
- Directors are temporarily relieved from the risk of personal liability for insolvent trading (COVID19 Safe Harbour)
- The change is valid from 25 March until 25 September 2020
- The change exists alongside existing 2017 Safe Harbour provisions
- The change has no retrospective provisions.
Directors need to be careful as this only applies to insolvency that occurs after 25 March 2020. If a company was trading insolvent prior to that time, the directors may still be held personally liable for the debts incurred.
The change seeds greater risk for suppliers and creditors
At first glance, the changes to insolvency laws appear to be positive. But what happens to suppliers and creditors? Right now, if you’re a creditor or supplier to an insolvent business, you face an increased risk of overdue payments. Think landlords and tenants.
Directors must be vigilant about recovering company funds, just in case the business falls foul of a discreetly insolvent enterprise. You must also be aware that your own suppliers may move to up-front payments in order to mitigate their own financial risks.
Take care that these changes among creditors and suppliers will not push your business into an undesirable position. Keep an eye on your cashflow, and keep conversations open.
Be careful that new debts do not act as life rafts
The changes to insolvency laws will only protect you if you accrue debts through your business-as-usual practices. This might mean that you’ve sought a loan to support a shift to remote working, or that you’ve had to acquire debt in order to pay your employees.
But I’d like to give you a warning:
The legislative change is very new. Some of its definitions are broad, and there’s no real clarity about what is considered ‘appropriate’ in terms of debt acquisition.
For example, imagine that you get a loan in order to save your business. Is that considered to be ‘in the ordinary course‘ of business?
Nobody yet knows.
Therefore, you must be very careful that any new debts form part of your business-as-usual operations, rather than a life raft.
Limits to the COVID19 Safe Harbour
Any debts incurred by the company will still be payable by the company despite the postponement. Dishonesty, illegal phoenix activity and fraud will still be subject to criminal penalties.
Both directors and advisors must be aware of the Treasury Laws Amendment (Combating Illegal Phoenixing), Bill passed in February 2020.
It is important to bear in mind that directors can still be made personally liable for tax debt through the ATO issuing a Directors Penalty Notice. Since 1 April 2020, directors can be held personally liable for GST in addition to PAYG and superannuation. Businesses should now be using single touch payroll, and directors should remember the superannuation amnesty comes to an end in August 2020 (the month prior to the COVID19 Safe Harbour expiry).
Directors duties under the Corporations Act continue to apply, including that of directors to act with care and diligence, in good faith in the best interests of the company and to not improperly use their position or information received for personal gain. With regards to care and diligence, advice on the business judgement rule should be sought.
Seek shelter from the 2017 Safe Harbour provisions
To be blunt, as a director it is in your best interests to seek shelter from the 2017 Safe Harbour provisions if you believe there is a risk of financial distress or insolvency. This should be done prior to September 2020 to minimise the risk of personal liability for insolvent trading.
Doing so means that you have a greater level of protection and a broader range of options. The 2017 Safe Harbour ‘better outcome test’, in conjunction proving fair market value, is a defense to a creditor defeating disposition in phoenix activity.
Utilising the 2017 Safe Harbour requires you to gain expert advice, to keep appropriate financial records, pay employee & super entitlements and develop business restructuring and turnaround strategies.
Proactive and forward thinking directors who make use of professional advisors stand the best possible chance of having their business emerge from the COVID19 crisis.
At ReGroup Solutions, we’re offering a free one hour virtual video consultation.