In today’s uncertain economic climate created by COVID - 19, many otherwise successful businesses become at risk due to their inability to pay their debts as and when they fall due, thereby rendering them insolvent.

If a company reaches the point where it is unable to pay its debts ("insolvency") and continues to trade beyond such point, the directors of the company may be personally liable for the debts incurred by the company during the period of the insolvent trading of the company. Section 588G of the Corporations Act imposes a positive duty on company directors to avoid insolvent trading.

However, all is not lost. In 2017, directors were offered a life line when the Federal Government passed s 588GA of the Corporations Act. This section protects directors who are trying to save their business from insolvent trading claims. Known as the “safe harbour” defence, it is an important section that all company directors need to be aware of.

Insolvent trading

During liquidation, a liquidator can make a claim against a director personally for any debts which the company incurred during the period of insolvent trading by the company, regardless of whether that director has resigned prior to the appointment of the liquidator. Insolvency provisions are designed to ensure that directors act quickly when a company is in financial difficulty to minimise the risk to creditors.

Section 588GA – safe harbour provision

The safe harbour regime is intended to achieve a balance between protecting creditors and enabling directors to try to save the company rather than simply placing the company into voluntary administration. It provides an exception from liability under the insolvent trading provisions in s 588G, provided certain criteria are met under s 588GA of the Corporations Act.

To rely on a safe harbour defence and avoid personal liability for any debts incurred by the company during a period of insolvent trading, the requirements of s 588GA(1) must be satisfied. S 588GA(1) states that the requirement under s 588G(2) to prevent the company from trading insolvently does not apply:[1]

if a director starts to suspect that the company may become or be insolvent and they can establish that they were pursuing a course of action that was reasonably likely to lead to a better outcome for the company than the immediate appointment of a liquidator or administrator. This is the case even if the company was insolvent (or was likely to become so) at the time the debt was incurred; and
the debt was incurred directly or indirectly in connection with that course of action and during a specified time period.

When should a director consider thinking about safe harbour?

A question for a director to consider is when should they start thinking about the safe harbour? Preferably, this should occur as soon as the director has reason to suspect the company is approaching insolvency, i.e. when the company is approaching a position where it might not be able to pay its debts as they fall due.

The safe harbour provision only protects directors during a “reasonable period” between the consideration of the various options available to them and their implementation. Once a liquidator is appointed, it is too late to consider the safe harbour.

When does safe harbour apply?

The protection of safe harbour revolves around the directors implementing a course of action that is 'reasonably likely to lead to a better outcome for the company'. This is one that is better for the company than the appointment of an administrator or liquidator. If the course of action is no longer reasonably likely to produce a better outcome for the company, safe harbour protection will no longer apply.

If you feel that the "safe harbour" provisions may be relevant to your company, our experienced and qualified team at Rae & Partners can provide you with sound legal advice and ongoing monitoring. This is essential to the success of safe harbour in protecting directors.

[1] It is important to note that a director may still be liable under s 588G (3).

Insolvent Trading Safe Harbour Provision Can Help Companies Survive the Economic Impact of COVID-19