So far, so good? Considering the success of Australia’s safe harbour reforms

The introduction of a safe harbour protection for company directors was one of a number of generational reforms to the restructuring landscape throughout late 2017 and 2018 aimed at relaxing Australia’s unforgiving insolvency laws.

Now that more than a year has passed, have the safe harbour reforms been a success? And what steps can directors take to ensure they obtain the protections they afford?

The safe harbour reforms provide directors with protection from personal liability for insolvent trading if they have begun developing a course of action that is reasonably likely to lead to a better outcome for the company than the immediate appointment of a voluntary administrator or liquidator.

The idea behind the introduction of the reforms was to give directors breathing space to consider innovative solutions and take reasonable, considered risks to restructure viable companies – without necessarily exposing the company to the stigmatism of a formal, public insolvency process.

It was hoped that this shift[1] in focus to recycling capital through an existing entity would better preserve enterprise value rather than forcing directors to precipitously appoint a voluntary administrator or liquidator to avoid personal liability for insolvent trading.

Considerations for ASX listed companies

Given the safe harbour reforms are still relatively new, a degree of uncertainty remains, including around their impact on listed public companies. This uncertainty exists despite the fact that an updated ASX guidance note on the interaction between safe harbour and the continuous disclosure obligations has been released.

While the guidance note does not require company directors to disclose the invoking of the safe harbour, it has also not been updated to remove the long- standing continuous disclosure obligations in respect of the financial position of the company. The precise interaction between safe harbour and continuous disclosure will be heavily fact dependent.

So far, so good?

In our experience, the safe harbour reforms have been successful in their stated goal of preserving value in distressed companies by providing directors with time to consider, plan and implement restructuring proposals designed to turnaround the company.

We have been involved in a number of examples that have achieved the legislative intention and avoided the often experienced value destruction that formal insolvency regimes usually invoke. One such example is set out below.

Case study

Corrs recently advised an Australian private equity firm regarding its mining services portfolio company that was experiencing solvency issues following the unexpected loss of a critical contract.

Our client was both a majority shareholder and the second ranking secured creditor. We recommended a suitable insolvency professional to work with us and the portfolio company and its board to devise and implement a restructuring plan that involved the realisation of non-core assets to repay the first ranking secured creditor.

Following that, we restructured the remaining secured debt facilities and the insolvency professional worked with management to better understand the cyclical liquidity issues and necessary procedures to significantly reduce the number of ‘lock up days’ for the company’s work-in-progress.

Ultimately, the company emerged from the safe harbour with a renewed focus and refined business plan.

Management had benefited from the opportunity to focus on the most important aspects of the business at probably the most challenging stage of the company’s life, rather than on their own personal liability. This undoubtedly resulted in a better outcome for all stakeholders, including unsecured creditors who can continue to trade with a market leading service provider.

While there is not yet any judicial guidance on the exact steps required to be taken by directors to obtain the protection afforded by safe harbour, we consider that directors should take the following three steps:

1. Ensure that the company’s accounts are up to date, noting that the failure to maintain proper financial books and records leads to a presumption of insolvency in and of itself.
2. Engage specialist accounting and legal advisors to assist in the development of a restructuring proposal and conduct modelling on the likely outcome for the company of that proposal as against a formal insolvency process.
3. Ensure that adequate board minutes and management records are maintained documenting the timeline and steps taken in the development of the restructuring proposal.

_{[1] Together with the imposition of a prohibition on ipso facto clauses in contracts entered into from 1 July 2018. An ipso facto clause generally provides that a party may terminate a contract or take other enforcement action upon the counterparty entering into a formal insolvency process.}