Proposed safe harbour reforms for directors

June 2017

In an attempt to create a 'safe harbour' for directors from personal liability for insolvent trading, Federal Treasury has released draft legislation reforming our insolvency laws.

The Government hopes to promote a culture of entrepreneurship and innovation and reduce the current focus on penalising directors personally for failure. Here partner Brit Ibanez reports on what this latest development means for directors.

The current position

The law currently provides that a director is personally liable for debts incurred by a company that is insolvent, or you might reasonably suspect will become insolvent.

In the real world, this line is incredibly difficult to navigate. Despite there being many options available to a director faced with a struggling company, the risks involved in pursuing those strategies mean the company is often wound-up instead.

Special counsel Selina Nutley explains the background to these changes in our February 2016 edition of Fundamental.

The proposed reforms

These reforms aim to provide a 'safe harbour' for a director if the company is undertaking a restructure and the director can prove they took a course of action reasonably likely to lead to a better outcome for the company and the company's creditors. A better outcome is where the company and its creditors are better off than if the company had entered into external administration.

The types of actions taken by a director that could satisfy this test are:

  • taking steps to prevent misconduct by officers and employees of the company
  • taking appropriate steps to ensure the company maintains appropriate financial records
  • obtaining appropriate advice
  • keeping themselves informed about the company's financial position
  • developing or implementing a plan to restructure the company to improve its financial position.

However, a director will not be able to rely on the proposed safe harbour provisions if the company has not provided for the entitlements (including superannuation) of its employees; maintained its books and records (so they are available to a liquidator or administrator, if required); or met all taxation reporting obligations.

Prohibition of 'ipso facto' clauses

The legislation also seeks to prevent termination of commercial contracts by relying upon an 'ipso facto' clause which allows for termination of a contract solely because the company has committed an act of insolvency or appointed an insolvency practitioner. The pressure on businesses during periods of financial hardship is often exacerbated by the actions of their suppliers during this critical period. Also, termination of key commercial contracts can prevent the company restructuring its affairs or achieving a sale of its business as a going concern. The proposed legislation attempts to swing the balance back towards the distressed business.

We will keep you up to date with any developments and can help explain what these changes mean for you.