Out of the Den into the Harbour; safe harbours for companies during and after hibernation

Out of the Den into the Harbour; safe harbours for companies during and after hibernation

The Coronavirus Economic Response Package Omnibus Act 2020 provides relief for companies and directors that trade while insolvent from
25 March 2020. Nicola Nygh, Ekaterina Zotova and Jack Halim discuss the operation of the new safe harbour on directors’ duties during and after the “hibernation” and the increased threshold and statutory period for issuing statutory demands.

To protect public health during the COVID-19 pandemic, the Australian Government has implemented drastic restrictions on the daily life of all Australians, including quarantines, travel bans, restrictions on gatherings and closure of non-essentials premises. There are more to come.

These restrictions combined with feelings of threat and uncertainty have created an immense and unprecedented impact on the Australian economy. Many companies have already ceased or significantly reduced their operations. This will inevitably cause a ripple effect with more collapses, more issues with liquidity and more unemployed.

In response, the Federal Government has amended existing legislation to provide relief for financially distressed business whose cash flows are restrained. The new legislation was fast-tracked through Parliament and passed both houses on 23 March 2020 as the “Coronavirus Economic Response Package Omnibus Act 2020” (COVID-19 Act). The COVID-19 Act received the Royal Assent on 24 March 2020.

Amendments for Statutory Demands

The amendments were made to the Corporations Act 2001 (Cth) (the Act) and Corporations Regulations 2001 to temporarily increase:

  1. the statutory minimum so that a statutory demand may now only be issued on a company for a debt of $20,000 or more, whereas previously the threshold was $2,000; and
  2. the statutory period, within which the debtor should either pay the amount demanded or make an application to set aside the statutory demand, from 21 days to 6 months.

Those amendments are not retrospective and will apply for 6 months from the day when the amendments commenced, being 25 March 2020, unless that period is extended.

Amendments to Insolvent Trading

The COVID-19 Act also relaxes the insolvent trading provisions in the Act. A new section 588GAAA of the Act (the Safe Harbour 2020) provides that a company director will not be personally liable for insolvent trading if:

  1. the debt is incurred during the six-month period from the day when the section commenced, being 25 March 2020, or a longer period if prescribed; and
  2. in the ordinary course of the company’s business.

A director who wishes to rely on the Safe Harbour 2020 bears the evidential burden to prove that the debt was incurred “in the ordinary course of the company’s business”.  This may cause particular difficulties given the extraordinary issues which many businesses are facing as a result of COVID-19.

The term “ordinary course of the company’s business” has never been clearly defined. The High Court has explained the concept in the following terms “…according to the ordinary and common flow of transactions in affairs of business there is a course, an ordinary course. It means that the transaction must fall into place as part of the undistinguished common flow of business done, that it should form part of the ordinary course of business as carried on, calling for no remark and arising out of no special or particular situation[1].

However, the Explanatory Memorandum to the COVID-19 Bill states that a director is taken to incur a debt in the ordinary course of business if the debt is necessary to facilitate the continuation of the business during the six-month period that begins on commencement of the amendments. 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. This suggests that the legislature intended to give the phrase “the ordinary course of business” in the Safe Harbour 2020 a different meaning from the meaning usually applied by the courts.

When you make it to the other side

The Safe Harbour 2020 is currently limited to six months. Assuming that it will not be extended, businesses will need to shift from survival mode to the “normal” course of running. This will not happen overnight, especially, for those businesses that were shut down or put into “deep” hibernation.

Although it is foreseeable that the Government will extend the immunity for insolvent trading to protect businesses through the emergent stage, it would be wise for businesses to enter a new “safe harbour” before the end of the six months period. This could potentially be achieved through section 588GA of the Act (Safe Harbour 2017). The Safe Harbour 2017 creates a “safe harbour” for a director to protect themself from personal liability if the director “starts to suspect” that the company may become or is insolvent and starts developing a course of action that is “reasonably likely to lead to a better outcome” for the company than the immediate appointment of an administrator or liquidator. For the Safe Harbour 2017 to apply, the debt incurred by the company must be ‘directly or indirectly’ in connection with the course of action taken by the director. However, a director may not be able to rely on the Safe Harbour 2017 if, at the time the debt is incurred, the company is not meeting its usual obligations, including payment of entitlements to its employees, and taxation reporting obligations.

Ongoing Commitment

Section 1362A introduced by the COVID-19 Act gives the Minister power to make regulations during the six-month period after the commencement of the new section.  The regulations may be in force for a maximum of six months. As such, the Minister could extent the operation of the Safe Harbour 2020 until 25 March 2021 for certain industries. The enactment of section 1362A reflects the Australian Government’s commitment to protect vulnerable sectors of the economy and to protect ongoing employment for Australians. It is likely that the Government will only extend the operation of the COVID-19 Act to support Australian small businesses which form a significant part of the Australian economy and provide employment for many Australians.

Despite the changes made by the COVID-19 Act, the vast majority of legal obligations will continue to apply to companies and their directors. In case of doubt, a company director should seek legal advice to avoid potential legal consequences such as incurring debt outside the ordinary course of business, failure to meet contractual obligations during company restructuring and potential unfair dismissal claims.

Resolve Litigation Lawyers has extensive experience in advising directors of distressed companies, as well as former directors of companies in liquidation, including in relation to insolvent trading. Please contact Nicola Nygh on 02 8298 6004 to discuss assisting you in meeting your obligations.


Disclaimer: Please note that this note is a summary only and therefore is general in nature. Specific advice should be obtained in relation to specific problems and issues.

[1] Downs Distributing Co Pty Ltd v Associated Blue Star Stores Pty Ltd (in Liq) (1948) 76 CLR 463 at 477 per Latham CJ.

Photo by Masaaki Komori on Unsplash.

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