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The current state of Australia’s insolvency regime

As you know, Section 588G of the Corporations Act imposes a duty on directors to stop companies trading while insolvent. It’s part of Australia’s insolvency regime, which focuses on making sure companies trade only while they are solvent.

The section exposes a director to potential civil penalties and criminal charges if their company:

  • incurs any further debt while insolvent
  • is insolvent at the time of incurring debt
  • becomes insolvent as a result of incurring the debt.

It’s designed to give creditors a direct pathway against directors whose actions result in their companies trading while insolvent.

Unfortunately, directors may be putting their companies into voluntary administration or liquidation prematurely simply to avoid breaching the regulations. The fear of personal liability may be stopping them from restructuring their company and achieving a better outcome for current creditors and other stakeholders, which could in turn be having a negative impact on the wider economy.

Changes the government is proposing for Section 588G

The government’s proposed ‘safe harbour’ mechanism would give directors the flexibility to restructure their company without having to worry about an insolvent trading claim being made against them. The directors would retain control of the company while receiving independent advice from registered advisers.

Here are the four key aspects of the proposal:

  1.  Advisers appointed in ‘safe harbour’ would be disqualified to act as administrators, receivers or liquidators in any subsequent insolvency process for the company.
  2.  The company would need to inform the Australian Securities and Investments Commission (and the Australian Stock Exchange if applicable) that it has appointed an adviser.
  3.  Directors would be under a duty to exercise their business judgment in the best interests of both the company’s members and the company’s creditors as a whole.
  4.  If evidence shows that these requirements are met, the director will have satisfied their duty of not trading while insolvent:
    • during the period of advice
    • for actions directly related to implementing the restructuring advice.
How effective will it be?

The effectiveness of this safe harbour mechanism will depend heavily on:

  • the quality of the adviser
  • the ability of the company to restructure.

The directors would need to ensure the adviser’s experience and qualifications were appropriate for the nature and circumstances of their company. And as they play such a crucial role in the safe harbour mechanism, restructurings advisers should all be members of organisations approved by a governed body (CPA, CA, ARITA and/or Law Society) and governed by the framework of that body.

Looking to the future

For a struggling business, Australia’s insolvent trading regime currently focuses on termination rather than resurrection. And the directors of that business have little choice but to either appoint external administrators or shut it down through liquidation.

Unfortunately, a large portion of a company’s value is lost the moment it enters external administration. And history shows that its success in turning around insolvent companies is limited at best.

The proposed ‘safe harbour’ regime will hopefully give directors an incentive to ask for restructuring advice and find a workable solution before it’s too late. It will give struggling businesses a chance to stay alive and, with the help of advisers, turn around, which could have a positive effect on the economy and future budgets.

Any reform that encourages a boost to the economy comes with risks. The proposed safe harbour regime should be reviewed carefully to make sure it still protects creditors in the event of insolvency.

After all, the protection of creditors is fundamental to our current insolvency regime.