Temporary relief for Directors from Insolvent Trading Duties

As part of its response to the national emergency arising from the spread of the Coronavirus, the government announced changes to insolvent trading duties in March 2020.

This will assist organisations under pressure to keep going, pay necessary staff and be positioned to return to normal business.

The relevant legislation (Coronavirus Economic Response Package Omibus Act 2020 (Cth) (the Act)) came into effect on 24 March 2020.  

Critically, the laws have been softened, not repealed, and other directors’ duties remain in place. 

Acting now, boards should:

  1. Ensure you have proper and thorough modelling on the effect of COVID.
  2. Stick to proper processes, including procurement. 
  3. Ensure management has clear view on “ordinary course of business”.
  4. Regularly review what constitutes “ordinary course of business”.  Business may contract and require further cost cutting.
  5. Understand the organisation’s solvency before COVID and note you may still need to place a company into administration.  The laws protect robust businesses which temporarily become insolvent, not those which were already.
  6. Proactively review contracts for services before terminating.  Do not assume you can obtain a refund, noting many fixed term contracts may need to be paid out.  Consider whether there are any “frustration” clauses or clauses which might be penalties, which could assist.  Be pragmatic about preserving relationships with suppliers you will need after the crisis abates.

Changes to Insolvent Trading – How does the coronavirus Safe Haven work?

By providing some relief to insolvency provisions of the Corporations Act, the changes seek to avoid otherwise robust organisations going into financial distress and collapsing due to the COVID-19 pandemic. For the next six months (which may be extended), if a debt is incurred in the ordinary course of a company’s business while that company is insolvent or that causes that company to become insolvent:

  • the civil penalty provisions in 588G(2) will not apply (protecting directors from a potential penalty of up to $200,000); and
  • consequently, directors cannot be required to compensate creditors or the company for any loss or damage suffered through insolvent trading.

Note these protections will not apply if a director dishonestly fails to prevent a debt being incurred. Further, this moratorium is not retrospective and does not apply to debts incurred before 24 March 2020.

For companies that are registered charities, the Australian Charities and Not-for-profits Commission has advised that it will align its interpretation of the Governance Standard duties (which includes a duty “not to allow the charity to operate while it is insolvent”) for all charities with the insolvency safe harbour provisions. This means a charitable company will not be in breach of the ACNC Governance Standards if it trades insolvent between now and 25 September 2020, provided it:

  • ensures that its directors are aware of the issue and have an achievable aim for their charity to return to viability when the COVID-19 crisis has passed, and
  • informs its members and the ACNC if it is trading insolvent.

What does the ordinary course of business mean?

This does not cover dishonesty and fraud but does include debts deemed necessary to facilitate the continuation of the business during the 6 month period commencing on 24 March 2020.  

This emphasises the need to ensure directors still exercise sound judgment and do not breach other directors’ duties. The laws have been relaxed, not repealed entirely.

These would still be problematic: an organisation increasing director pay, entering into agreements which involved a director’s conflict or interest, or entering into an unnecessary agreement involving excessive payments (in the school context, an example would be a prohibited arrangement).

However, entering into a modelled temporary insolvency to pay staff who are still working and who will be needed after the crisis, in the context of considered and suitable cost cutting, would be much less problematic.

In good news for employees, the Explanatory Memorandum specifically notes these would be likely to be in the ordinary course of business:

  • continuing to pay employees during the COVID-19 pandemic, or
  • a director taking out a loan to move some business operations online.

As this legislation was passed swiftly to enable businesses to survive in these extreme conditions, it could be expected that the term “ordinary course of business” will be widely interpreted.

Safe Harbour

In conjunction with this additional relief given by the Act, directors are still able to rely on the existing provisions of the Corporations Act which provide “safe harbour” from insolvent trading where they:

Start developing one more courses of action that are reasonably likely to provide a better outcome for the company than an immediate liquidation or administration. Directors are protected from insolvent trading liability arising from debts incurred directly or indirectly connected to such course of action.

That is, a debt incurred as a result of rescue financing may be provided safe harbour protection, if not by the new provisions of the Act.

Proper financial modelling is therefore key.

Bankruptcy

Further amendments to the Corporations Act include a temporary increase to:

  • the threshold for a creditor to initiate bankruptcy proceedings from $5,000 to $20,000;
  • the time period to respond to a bankruptcy notice from 21 days to 6 months; and
  • the period of protection a debtor receives after making a declaration or intention to present a debtor’s petition.

Statutory Demands

Previously, creditors could issue a statutory demand on a company for a debt of $2,000 or more. This threshold has now increased to $20,000. The time limit to respond to a statutory demand has been extended from 21 days to 6 months. Once again, these amendments only apply to statutory demands issued after 24 March 2020 and will only last for 6 months, unless the provisions are extended.

What does this mean for you?

In summary, the laws allow you to sleep at night, but diligent work is still required. Follow the 6 actions above to ensure you have the protection of the new regime.

How we can help

If in doubt or you require further information and/or guidance, please do not hesitate to contact us.

For more information on how Incorporated Associations are separately regulated in each State and Territory, please read our article here.