A common fear for directors of Australian companies is being held personally liable for debts incurred by the company when insolvency is apparent or suspected.
The recently enacted safe harbour provisions give company directors the opportunity to proactively recover the company’s financial position without being liable for insolvent trading.
The risk of insolvent trading often frightens company directors into prematurely appointing a liquidator or administrator without taking any action to revive a company to its true potential. Thankfully, the enactment of safe harbour defence s 588GA of the Corporations Act 2001 combats this issue by encouraging knowledgeable directors to take reasonable risks to improve the company’s performance.
The defence will apply when, at the time the director suspects the company of being insolvent:
- the director begins developing courses of action that are reasonably likely to lead to a better outcome for the Company; and
- the debt incurred during that time is directly or indirectly incurred to effect the courses of action developed.
The defence will cease to apply when:
- the director fails to take the proposed courses of action within a reasonable time; or
- the director ceases to take the proposed courses of action; or
- the courses of action will no longer lead to a better outcome; or
- an administrator or liquidator is appointed.
- Should the company or director be sued for insolvent trading, the director has the evidential burden of proving the safe harbour provisions apply. Therefore, it is critical to maintain written documentation evidencing what was occurring at the time including any meeting minutes, decision making correspondence and legal advice.
- For the defence to apply, the director must be personally involved in the turn around strategy and cannot just take a passive approach.
- The debts incurred during the safe harbour must be somehow related to the proposed courses of action and all debts should be monitored with this in mind. Operating expenses in the usual course of business would presumably relate indirectly to the proposed courses of action.
- A ‘better outcome’ means a better outcome than the company entering administration or liquidation. In determining whether the proposed strategies will lead to a better outcome, some factors the Court will consider include what the director did to properly inform themselves of the situation, steps taken to avoid misconduct and steps taken to maintain accurate records.
- The company must continue to pay employee entitlements and taxes during the safe harbour period to maintain the benefit of this defence.
Relevance in Franchising
If the directors of a franchisor entity are seeking to rely on safe harbour provisions, they must have determined the Company to be insolvent, or likely to be. Although the safe harbour period does not require any formal changes to the company’s status, this decision will constitute a material change in the franchisor position from the date of the disclosure document. To avoid breaching the Franchising Code of Conduct, the franchisor entity will be required to update their disclosure document within 14 days of forming a view regarding the apparent or suspected insolvency.
Similarly, if a franchisee entity wishes to keep trading its business throughout a safe harbour period, this information will not be readily available to the franchisor. Therefore, it would be diligent for franchisors to include a term in their franchise agreements compelling the franchisee to provide notice should they intend to rely on the safe harbour provisions.
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