Insolvent Trading Risks for SMEs

This is the second in a series of articles aimed at informing directors of their duties and options for small to medium enterprises (SME) if faced with insolvency. Following on from our previous article, we will now look at one of the more prominent duties, being insolvent trading and one of the options available to manage that risk.

What are my duties as a Director?

As most people are aware, taking on the role of company director means that you assume certain personal legal duties. In general, these duties cannot be delegated, and the law is designed to limit the excuses for breach committed, which can result in director banning or having to pay compensation. In an insolvency scenario, a liquidator may look to enforce these claims (on behalf of the company and creditors) against the former directors. The majority of the duties are outlined in Chapter 2D of the Corporations Act 2001 (Cth) (the Act).

What will a liquidator look for?

WCT Advisory managing partner Andrew Weatherley says “a liquidator will investigate whether a director has breached any of the several duties outlined in the Corporations Act” and “if a breach has been committed, a liquidator may pursue that director for loss caused to the company, and is also required to report that breach to the Australian Securities & Investments Commission for potential action”.

One of the most discussed duties, is the duty to prevent insolvent trading under Section 588G of the Act. In our previous article (Insolvency Issues for SMEs) we touched on some the major warning signs of a potentially insolvent business. Fortunately, if a director is proactive enough in identifying potential signs of financial distress there are protections available. One the most significant protections, is what is referred to as ‘Safe Harbour’. In 2017, new legislation was introduced aimed at encouraging directors to seek advice early if there were any concerns about the viability and solvency of a business. By providing protective mechanism for directors who are willing to be proactive, it allows breathing space for directors to focus their efforts on saving the business rather than worry about personal liability. 

The still relatively new safe harbour from insolvent trading is one of the most significant reforms in corporate insolvency since the introduction of voluntary administration in 1993. The new reforms can be used in conjunction with, or implemented separately to, other strategies or restructure steps. 

 Requirements for safe harbour protection

Entry into the safe harbour does not occur automatically. Directors must comply with the requirements of the Act and will only have protection from personal liability for insolvent trading if:

• At the time they suspected or knew the company was insolvent they start developing a course of action that at the time of development was reasonably likely to lead to a better outcome for the company than proceeding to immediate administration or liquidation; and 

• The debt was incurred directly or indirectly in connection with a course of action.

Companies are also required to pay all staff entitlements (wages and superannuation) during this period and comply with tax reporting obligations, or they will lose the protection of the safe harbour for all debts that were incurred.

Crucially, each stage of the process should be carefully documented so that directors can prove they have met their threshold obligations.

It is this evidentiary burden that may provide a challenge for SMEs who may not have sufficient professional support to document their claim for safe harbour protection.

Who should Directors seek advice from?

An appropriately qualified adviser should be engaged to assist with reviewing the situation, developing and assessing the plan or course of action. Early advice and action are the key.

In assessing the ability to rely on safe harbour, regard will be had to whether advice was sought from a suitably qualified entity.  As there is no strict definition of who fits the bill of an appropriately qualified advisor, this has of course been the subject of some debate. That being said, common sense suggests this would be someone that holds verifiable qualifications, such as a registered liquidator who will also generally be a qualified accountant.  It is important not to simply accept someone telling you they are qualified to assist.  Do your homework on who you are engaging, particularly due to the potential consequences of getting bad advice.

Andrew Weatherley is a ARITA professional member and Registered Liquidator, who is fully qualified in intricacies of Australia’s complex insolvency laws. He has the added benefit of actual experience in acting as a suitably qualified advisor for directors seeking advice and assistance with navigating the requirements of the Safe Harbour legislation.