IS IT WORTH SAILING INTO SAFE HARBOUR?
What is Safe Harbour?
The safe harbour reform is a carve-out in the Corporations Act 2001 ("Act"). It was introduced in 2017 to protect directors from insolvent trading claims while planning to turn around a financially distressed but viable company. It aims to encourage directors to engage in greater entrepreneurship and innovation when pursuing turnaround options for their companies and reduce the stigma of failure associated with insolvency.
The Act provides that a director will not be personally liable for insolvent trading where that director incurs debts when carrying out a course of action reasonably likely to lead to a better outcome for the company. "Better outcome" means an outcome better for the company than the immediate appointment of an administrator, or liquidator, to the company.
To be eligible for safe harbour protection, the company must pay employee entitlements and lodge tax documents when due. To demonstrate that the course of action adopted was reasonably likely to lead to a better outcome, the courts consider whether a director.
is well informed about the company's financial position and performance;
took appropriate steps to prevent company officers' and employees' misconduct;
made sure that proper financial records were maintained, consistent with the size and nature of the company;
took advice from an appropriately qualified person; or
was developing or implementing a plan for restructuring the company to improve its financial position.
There are two interesting features of safe harbour.
Many people refer to it as a defence to an insolvent trading claim. However, the safe harbour is a 'carve-out', not a defence. The distinction may have practical consequences.
Why? Because, as a defence, a liquidator could claim against a director and start court proceedings. However, as a carve-out, a liquidator cannot make a claim, let alone commence court proceedings.
2. The Act states that regard is had to whether a director was developing or implementing a restructuring plan.
"developing or implementing" does not mean "completing". A director is not required to complete the plan to claim safe harbour protection. It just needs to be started so the bar is set pretty low.
Therefore, a director doesn't need to worry about being personally liable for insolvent trading if they can formulate a plan that has the prospect of putting the company in a better position than appointing an administrator or liquidator. Of course, you first need to pay employee entitlements and complete tax lodgements when due.
Another interesting feature is that safe harbour is not publicised. It can be implemented in private, which can be a positive. On the contrary, appointing an administrator or liquidator is public, which could negatively impact the company's value and ability to carry on business profitability.
Is Safe Harbour still relevant?
Safe harbour has been in place for 5 years now. Has it been successful? The truth is, it's hard to say.
As previously mentioned, when a company goes into safe harbour it is not publicised. Directors are not required to disclose that their company is in safe harbour. Accordingly, it is difficult to provide a precise figure on how many companies have used safe harbour.
A survey of the Australian Restructuring Insolvency & Turnaround Association's professional members was conducted 4 years after the introduction of safe harbour. The upshot of the survey is that it has mainly been used by the 'big end of town', where directors of large and larger medium size companies used the process to achieve 'better outcomes' with some success. However, in the SME space, the survey revealed a general lack of awareness, interest and understanding of safe harbour protection and, more alarmingly, a director's duty to prevent insolvent trading.
This begs the question, if you are unaware of the duty to prevent insolvent trading, wouldn't you be less likely to be aware of safe harbour? Furthermore, in the SME space, anecdotal evidence suggests that safe harbour:
is rarely used;
advice and compliance is too costly;
is something that many companies do not qualify for;
has the potential to merely increase debt;
The introduction in 2021 of Small Business Restructuring (SBR) reform and the high approval rate of restructuring plans can maybe be seen as a better alternative. An SBR is cheaper and it automatically qualifies for safe harbour protection. It allows for the forgiveness of certain debts, whereas safe harbour does not. At least when it comes to SMEs, the SBR process seems to surpass that of safe harbour.
The best way to make sure that safe harbour or SBR criteria are satisfied is to engage the right advisors. de Jonge Read has the right qualifications and experience to achieve the best turnaround for companies in financial distress.
-------------------------------------------------------------------------------------------------------------------------------Should you have clients or associates that you know are struggling with financial issues or need assistance in reviewing their business affairs in preparation for what’s around the corner, our team of Strategists would be pleased to discuss options that are available on how to best design and implement insolvency strategies.
Contact us now on p. 1300 765 080 | info@djra.com.au