This legal update expands on and should be read in conjunction with the basic insolvency principles outlined in Part 2 (Insolvency fact sheet) of this series of legal updates. This update focusses on assisting company directors to understand their obligations under the new temporary relief measures in place during the COVID-19 crisis.
REMEMBER: A director is a person who is appointed to the position of a director or is appointed to the position of an alternate director and is acting in that capacity. A director can also be a person who is not validly appointed as a director, if they act in the position of a director or the directors of the company or body are accustomed to act in accordance with the person’s instructions or wishes.
What temporary relief measures are available to directors?
The Australian Government has responded to the COVID-19 crisis with a number of financial assistance measures and adjustments to insolvency laws. Of particular importance to directors is the legislative enactment of the Coronavirus Economic Response Package Omnibus Act 2020 (Cth) (CERP Act), which commenced on 25 March 2020.
Among other measures, the CERP Act inserts temporary relief measures for directors for insolvent trading and personal liability for transactions taking place in the ordinary course of business.1
REMEMBER: This temporary measure does not replace the existing safe harbour provisions but adds to them. Ordinarily, a director of a company is under an obligation to prevent the company trading while it is insolvent. A director may also be personally liable for debts incurred by the company if it trades while insolvent.
Do the temporary relief measures apply to all directors?
A director may only rely on the new temporary safe harbour provisions in relation to a debt incurred by the company, if:
- the debt is incurred in the ordinary course of the company’s business;
- the debt is incurred during the six month period starting 25 March 2020; and
- the debt is incurred before any appointment of an administrator or liquidator of the company during the temporary safe harbour period.
Debts may be incurred while a company is insolvent if it “is necessary to facilitate the continuation of the business”. This may include:
- a director taking out a loan to move some business operations online; or
- debts incurred through continuing to pay employees during the coronavirus pandemic.
While this is a welcome development for directors trying to deal with the current crisis, directors should be aware that any transactions outside the ordinary course of business will also be outside this particular safe harbour protection and will be subject to the stricter safe harbour provisions, which existed pre-COVID-19.
REMEMBER: Whether or not certain debts are incurred “in the ordinary course of business” will be a question of fact in your particular circumstances, which relates to the nature of the company’s business and the kinds of debts it would ordinarily incur as part of its usual trading operations. There may be some ‘grey’ areas if the debts incurred are new or different to those previously incurred.
Is there any temporary relief from creditors pursuing debts?
The CERP Act increases the minimum threshold at which creditors can issue a statutory demand from $2,000 to $20,000 for a period of six months, and companies will have six months to respond to a statutory demand rather than the usual 21 days.
These changes apply from 25 March 2020 and apply to statutory demands that are served on or after this date. The statutory demands can relate to debts already incurred, due and payable.
However, the changes to the statutory demand regime do not affect the ability of creditors to pursue a company through the courts system, in order to obtain a court order or judgment for a debt owing.
What other duties, liabilities and obligations will continue to apply to directors?
The amendments to the safe harbour provisions in the CERP Act only prevent the operation of the insolvent trading provisions for the temporary six-month period. The other provisions of the Corporations Act and directors’ other duties under the common law continue to apply. This means that directors must comply with all their other legal obligations and in particular, they must:
- exercise the due degree of care and diligence2;
- act in good faith in the best interests of the company and for a proper purpose3;
- avoid improper use of their position or information to gain an advantage for themselves or someone else or to cause detriment4;
- provide a declaration as to solvency and that the company’s financial statements comply with accounting standards and give a true and fair view of the company’s financial position and performance5;
- prevent the company entering into “creditor-defeating dispositions”6; and
- prevent the company entering into transactions likely to lead to employees being worse off in a liquidation scenario7.
Directors can also still be held personally liable in circumstances involving fraud or dishonesty and their company will still be liable to pay any debts incurred.
What is the pre-COVID-19 safe harbour protection and does it continue to apply?
Before COVID-19, a mechanism already existed to protect directors from personal liability under the insolvent trading provisions.8 That mechanism, commonly referred to as a safe harbour, continues to exist and is particularly relevant to a business attempting to conduct transactions outside the ordinary course of its business as an attempt to restructure a business in financial distress.
The pre-COVID-19 safe harbour protection will operate where a director “at a particular time after he or she starts to suspect the company may become or be insolvent, starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the company.”
What courses of action are reasonably likely to lead to a better outcome?
The existing safe harbour provisions give some guidance on what matters a director should consider when determining whether a course of action is reasonably likely to lead to a better outcome for the company, namely taking steps to:
- properly inform themselves of the company’s financial position;
- prevent any misconduct by the officers and employees of the company that could adversely affect the company’s ability to pay all its debts;
- ensure that the company is keeping appropriate financial records consistent with the size and nature of the company;
- obtain advice from an appropriately qualified entity, which was provided sufficient information to give appropriate advice; and
- develop and implement a plan for restructuring the company to improve its financial position.
REMEMBER: to obtain the benefit of the safe harbour protection, directors are required to continually monitor the course of action proposed to be taken by the company to lead to a better outcome and continually assess and reassess whether the steps taken are reasonably likely to lead to a better outcome.
For the pre-COVID-19 safe harbour provisions to provide protection to a director of a company, the director must ensure that the company:
- pays all employee entitlements on or before the date when they are due to be paid; and
- gives all returns, notices, statements, applications or other documents as required by taxation laws.
A director will be disqualified from protection under the pre-COVID-19 safe harbour provisions if compliance with these obligations is less than substantial or if the company has failed two or more times to meet the obligations within the 12-month period prior to the date when the debt is incurred.
What practical steps can directors take during COVID-19?
In light of COVID-19, directors and company boards should seek to assess the economic impacts of the crisis on their business and, where relevant, develop and implement contingency plans.
Other practical steps that directors may undertake include (as relevant):
- review and monitor supply chain disruption and consider alternative sources;
- review contractual obligations to customers and employees and seek legal advice regarding ongoing obligations if required;
- engage in early dialogue with relevant business partners and/or stakeholders, where there is potential for any issues to arise;
- consider whether pre-emptive capital raising is required for business sustainability;
- to the extent not already in place, establish weekly reporting channels with management to obtain an update on the financial positon of the company;
- to the extent not already in place, establish reporting channels whereby management are required to report on any failure to pay employee entitlements as they fall due;
- management continue to hold weekly meetings to discuss and review the company’s cash flow position;
- continue to work with advisers and management to develop and critically test various courses of action to provide a better outcome for the company; and
- continue to review and revise a restructuring plan on a weekly basis.
How have the courts demonstrated flexibility during COVID-19?
As mentioned in Part 2 of this series, the voluntary administration process is a flexible restructuring tool. One of the key elements of this gives the court a very broad power to make orders about the operation of the Corporations Act in respect of a particular company.9
The recent and notable administration of Virgin Australia Holdings Ltd (Virgin) demonstrates that the courts are prepared, as a matter of discretion and flexibility, to try to assist administrators who sensibly seek amended regimes pursuant to section 447A of the Corporations Act.10
As a result of the COVID-19 economic downturn, Virgin recently applied to the Federal Court of Australia for the following orders (in summary):11
- to provide notices of meetings to creditors electronically;
- to conduct meetings of creditors and committee of inspection electronically by video-link or telephone;
- to form a single committee of inspection for Virgin, with the members of that committee to be selected by the Administrators and, then approved by the creditors;
- to permit the Administrators to have 10 business days to respond to requests for information from creditors (increased from the statutory period of five business days); and
- to allow a four-week extension of the time, to allow the Administrators to give notice to landlords of property leased by Virgin whether Virgin will continue with that lease or not – this also included asking for a corresponding extension of the period in which the Administrators do not have personal liability for obligations under those leases.
On 24 April 2020, Justice Middleton granted the orders sought by the Administrators. The Court also made orders relieving the administrators of Virgin from any personal liability with respect to any of the property leased, used or occupied from any landlords for the period of 28 April 2020 to 26 May 2020.
The COVID-19 measures announced by the Australian Government to relieve directors of insolvent trading liability when the company is undertaking transactions in the ordinary course is a welcome development.
However, where directors seek to turnaround or restructure their businesses to respond to circumstances of financial distress, careful consideration will be required as to the best strategies bearing in mind the directors’ various legal duties.
This update is applicable to Australian law only and are generic in nature. If you have any specific legal concerns relating to the impact of COVID-19 on your people or your business, please reach out to our pro bono team (firstname.lastname@example.org) and we will consider your pro bono legal request. If we aren’t able to help you, we will try to find someone else who can. This update is current as at 20 May 2020.