As part of its COVID-19 economic response package, the Federal Government recently introduced a temporary ‘safe harbour’ for directors from personal liability for a company’s insolvent trading, which will apply for a period of six months from 25 March 2020.
The intent of the relief is to give companies the confidence to continue trading during the COVID-19 pandemic, by reducing liability for directors if the company is not necessarily able to pay its debts when they become due and payable. However, for Boards navigating the impacts of COVID-19, it is important to note that this measure does not absolve directors of their core duties to the company, such as the duty to act with due care and diligence and in the best interests of the company as a whole. Directors must be careful to uphold those duties in their decision-making, including decisions which affect the solvency of the company.
New temporary ‘safe harbour’ from personal liability
Under s 588G(1) of the Corporations Act 2001 (Cth) (Corporations Act), a director has a duty to prevent a company from incurring a debt:
- if the company is insolvent or becomes insolvent by incurring the debt; and
- there are reasonable grounds for suspecting that the company is already insolvent or would become insolvent by incurring the debt.
A breach of the duty provided for in s 588G(1) can attract criminal and civil penalties and the director can be required to pay compensation to the company. For that reason, directors may understandably move quickly to enter some form of external administration where there is a risk that the company is trading while insolvent.
The temporary relief is established by the Coronavirus Economic Response Package Omnibus Act 2020 (Cth) (COVID-19 Act), which amends the Corporations Act to include new section 588GAAA. Pursuant to this section, s 588G will not apply to a person and a debt incurred:
- in the ordinary course of the company’s business;
- for the six month period commencing on 25 March 2020; and
- before any appointment during that period of an administrator or liquidator of the company.
Paragraph 12.18 of the Explanatory Memorandum for the COVID-19 Act states that a company director “is taken to incur a debt in the ordinary course of business if it is necessary to facilitate the continuation of the business during the six month period … of the [temporary legislation]”.
This could include debts incurred by continuing to pay employees during the COVID-19 pandemic or new loans for working capital purposes.
It is noted that a director who wishes to rely on s 588GAAA bears the evidential burden in establishing the requirements of s 588G i.e. that the debt was incurred in the ordinary course of the company’s business during the relevant period.
Section 588GAAA does not extend to a failure to prevent insolvent trading which is dishonest, which is a criminal offence under the Corporations Act.
Existing ‘safe harbour’ provisions still relevant
In addition to the temporary relief from s 588G, directors may be able to rely on existing ‘safe harbour’ from s 588G introduced in 2017.
Under s 588GA of the Corporations Act, a director will not be liable under s 588G if, after the director suspects the company may become or is insolvent, the director starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the company. Our original article on the safe harbour provisions can be found here and recent consideration of their applicability amidst COVID-19 can be found here.
This existing safe harbour may have greater application after the expiry of the temporary relief (if it is not extended beyond six months) as the long-term impacts of the pandemic come into focus.
Directors’ duties continue to apply
Notwithstanding the temporary ‘safe harbour’ from liability where a company is trading insolvent, the duties which directors owe to the company under the Corporations Act (and the equivalent duties at common law) continue to apply.
A director can still be liable for breach of one or more of these core duties even where they are able to rely on the temporary safe harbour from a breach of s 588G. A breach of duty can attract a civil penalty of up to $200,000 under the Corporations Act or where the company has suffered loss, a court may make a compensation order.
The duties of a director include (amongst other duties) a duty to:
- act with due care and diligence (s 180(1) of the Corporations Act); and
- act in good faith in the best interests of the company and for a proper purpose (s 181(1)(a) Corporations Act).
Whether a director has complied with their duty to act with care and diligence is determined by reference to the “business judgement rule” under s 180(2) of the Corporations Act. A director who makes a business judgement complies with the duty if they:
- make the judgement in good faith and for a proper purpose;
- do not have a material personal interest in the subject matter of the judgement; and
- inform themselves about the subject matter of the judgement to the extent they reasonably believe to be appropriate; and
- rationally believe the judgement is in the best interests of the company.
It will be important for directors to keep these duties “front of mind” as they confront the unprecedented challenges of the COVID-19 pandemic and measure their decisions against the business judgement rule.
ASIC’s recent article Directors duties in the context of COVID-19 reinforces the need for reflection on directors’ duties at this time. ASIC notes the following:
- The relief does not extend to relief from statutory and common law directors’ duties (as discussed above).
- Certain duties (including those in s 180 and 181 of the Corporations Act, referred to above) also apply to officers of the company, which includes persons who have the capacity to significantly affect the financial standing of the company. For more detail on who is considered an officer, refer to our recent article here.
- Directors should seek advice early from a suitably qualified and independent advisor about the company’s financial affairs to manage the disruption caused by COVID-19.
- ASIC will continue to investigate and act on matters affecting the public interest. Whether action is taken depends on an assessment of all relevant circumstances, including what a director or officer could reasonably have foreseen at the time of taking relevant decisions or incurring debts.
Key takeaways
- The temporary relief from personal liability for insolvent trading will alleviate some pressure on Boards facing difficult decisions about whether to keep a company trading where it may not be able to meet its liabilities when they fall due. However, the relief does not extend to the other duties which directors owe to the company, which continue to apply.
- It will be important for Boards to regularly assess the financial position of the company as the impacts of COVID-19 are felt and seek advice on any steps that must be taken to provide liquidity.
- Boards should carefully monitor the incurring of further liabilities which cannot be met and ensure they are appropriate, have purpose and are in the best interests of the company. Notably, the caselaw indicates that where a company is insolvent or nearing insolvency, the duty to act in the best interests of the company as a whole can involve an obligation to take into account the interests of creditors.
If you would like further advice on the matters discussed in this article, please contact our Corporate and Mergers & Acquisitions team.