06 March 2020
During the second half of 2019, it was generally accepted that the US/China trade war was the most likely macroeconomic event that would precipitate a global slowdown. Even then, given the enormous amount of ‘dry powder’ capital that was available in the market, the downturn, if any, was expected to be mild.
As it turned out, GDP in Australia grew by 0.5 percent for the December quarter, slightly more than forecast by most leading economists, and largely immune from the global trade war fallout. However, along came the devastating bushfire season and now we have the coronavirus (COVID-19).
Even at this relatively early stage, much is being written about the supply and demand side shocks that COVID-19 will cause and businesses with unfulfilled contracts are closely scrutinising force majeure provisions.
The anticipated disruption to business has the potential to cause solvency, not just liquidity, issues for global enterprises. The test for insolvency in Australia is whether a business can pay its debts as and when they fall due, i.e. it is a cash flow, not balance sheet test.
Directors of Australian companies have a clear obligation to ensure a company does not incur debts while insolvent. If they breach this duty, the director can be personally liable to pay the debts the company incurs under section 588G Corporations Act 2001 (Cth) (Act). Insolvent trading liability will arise where:
However, directors can seek sanctuary from personal liability under the Safe Harbour regime, which is a relatively recent addition to the Act. The safe harbour defence is aimed at encouraging directors to keep control of their company during times of financial distress and allow them to focus on the needs of the company rather than their potential personal liability.
For the defence to apply, the following elements must be satisfied:
The defence applies to debts incurred in connection with the ’courses of action’ but not all debts. However, if a course of action includes the business continuing to trade, one could expect the vast majority of debts incurred in the ordinary course of business would fall within the safe harbour.
The safe harbour does not affect any other duties of a director which must continue to be complied with.
Directors may lose the protection of safe harbour if at the time the debt is incurred the company is failing to substantially comply with its obligations to pay employee entitlements, including superannuation contributions when they fall due, or the company is failing to substantially comply with its notice and reporting obligations under the relevant income tax laws.
Whether the safe harbour will be available will be retrospectively assessed. It is therefore critical that directors keep appropriate records of their decisions. The defence will not be available if directors who do not turn their minds to the issue.
This article is part of our insight series COVID-19: Navigating the implications for business in Australia and beyond. To get notified by email when new COVID-19 insights are released, please subscribe for updates here.
The content of this publication is for reference purposes only. It is current at the date of publication. This content does not constitute legal advice and should not be relied upon as such. Legal advice about your specific circumstances should always be obtained before taking any action based on this publication.