Restructuring & Insolvency

Understanding Safe Harbour for Company Directors

Safe harbour is a powerful mechanism to provide company directors with protection from insolvent trading whilst they try to achieve a better outcome for the company than putting it into administration immediately.

What is Safe Harbour?
Safe Harbour is legal mechanism that company directors can activate when they believe that the company might be insolvent. It provides the directors with protection whilst they attempt to implement a restructuring plan that may be preferable to a formal insolvency appointment. Prior to the introduction of safe harbor, it was common for company directors to hand control to an administrator as soon as they formed the view that it may be insolvent, even though a realistic restructuring plan existed. This was due to the strength of Australia’s insolvent trading laws that presented directors with considerable personal risk if they attempted to implement a restructuring plan during a period of financial distress. Typically independent directors were unwilling to take this risk and commercial restructuring avenues were prematurely closed.

Using Safe Harbour
There is some ambiguity around the specific actions that directors should take in order to implement safe Harbour. The legislation simply requires that, when a company is in financial distress, directors take a course of action that they believe will lead to a better outcome for the company than immediately appointing an administrator. Having said that there are specific rules around when safe harbor will not be available and there is effectively no guidance from the courts on entering safe harbour.

Broadly speaking directors should inform themselves of the company’s current financial position and get professional advice from an appropriate advisor on the viability of the restructuring plan. Given that this legislative is still in its infancy, our advice to directors is that they should take well documented steps towards implementing safe Harbour including:

  1. Obtaining advice from a professional insolvency practitioner on the company’s financial position and its solvency;

  2. Reviewing the company’s financial accounting procedures to ensure that the company is keeping accurate financial records;

  3. Obtaining advice from the professional insolvency practitioner on the viability of the proposed restructuring plan.

If any these steps are skipped it is very possible that a court may decide in the future that safe harbour protection was not available to the directors of the company because they did not implement the mechanism properly. In our view this risk is simply too high and unquantifiable to take in any situation and can be easily avoided by obtaining the right advice.

Once a company has activated safe Harbour protection, there is no specific time limit for its continuation. This will depend on the restructuring plan being implemented and continuous adjustments that may be made to that plan. Clearly though any restructuring plan that is continuously adjusted because it is not being implemented successfully is likely to be viewed in hindsight as not viable. Again, professional advice from an insolvency practitioner is critical in this situation.

Practical challenges of safe Harbour
Whilst there is no specific requirement to disclose entry into safe harbour, including notifying the Australian Securities Exchange, there is a high degree of ambiguity around the impact of safe harbour on a company’s contractual covenants. If safe harbour is implemented then company directors should review all material contracts that the company has entered into to determine the potential impact and disclosure requirement of safe harbour.

There are also specific rules that a company must comply with in order to qualify for safe Harbour protection such as continued payment of employee obligations on time and lodgement of statutory obligations on time.  Assistance from a professional insolvency practitioner is critical to make sure these requirements are being met during the period of safe harbor.

Safe harbor, if used correctly, is a very powerful mechanism to provide company directors with sufficient protection whilst they try to achieve a better outcome for the company than putting it into administration immediately. Safe harbour is still in its infancy and there are significant risks that it may fail if not implemented correctly. It is critical that companies seeking to use safe harbour get the appropriate advice and not try to cut corners.

Case Study
Facts about ABC PTY LTD (ABC):

  • Secured creditor, a Bank, wishes to end its relationship with ABC.

  • ABC has insufficient funds to repay the Bank and will need to seek alternative finance.

  • ABC is also suffering pressure from other creditors for payment and has fallen behind in meeting other liabilities.

ABC is keen to look at refinancing options with another financial institution to pay out the Bank and provide a needed cash flow injection.

Before the directors embark on this journey, they are concerned that ABC is currently insolvent and they could become personally liable for debts they incur should their refinancing efforts fail.

The directors consider safe harbour to be a tool they can use to informally restructure their business, through a refinance, whilst providing the directors with a defence against insolvent trading should their refinancing plan fail to succeed.

The directors could utilise safe harbour by formalising ABC’s plan which details:

  • Current issues.

  • Amount of funding they require from refinancing.

  • Options for refinancing including mortgage brokers to be approached.

  • Time frame of milestones to achieve.

  • Strategies on professional assistance required to assist during this refinance period.

  • Seeking professional advice to ensure their plan results in a better return for creditors in comparison to external administration.

  • Regular reviews of the plan to ensure it is still viable, milestones are still being met and adjustments can be made.

  • Ongoing professional advice should any adjustments to the plan be needed and to ensure the plan is still achievable.

A registered liquidator reviewed ABC’s plan and determined that their plan was likely to produce a better result to creditors in comparison to external administration. It follows that ABC were in safe harbour whilst executing their plan.

Unfortunately, ABC were unable to procure refinancing due to the large ATO and superannuation debts.1 As a result, the shareholders, who were also the directors, resolved to place ABC into liquidation.

During the safe harbour period, ABC incurred $120,000 in debt that it was subsequently unable to pay. The directors have a defence against an insolvent trading claim, brought by the liquidator, for the $120,000 portion of the claim as those debts were incurred at a time when ABC was in safe harbour.

1 Financial institutions generally shy away from providing finance when part, or all, of the funds are to pay statutory debts.

If you have any questions, contact us to arrange a free, no-obligation discussion to give you clarity on your position and the options available.