Spotlight on Safe Harbour - Leap of faith

LEAP OF FAITH: THE PSYCHOLOGICAL BARRIER

The concept of Safe Harbour represents a significant psychological challenge for directors. It requires a leap of faith – acknowledging potential financial distress while simultaneously developing a strategic rescue plan. This mental hurdle can be as challenging as the legal complexities themselves.

Explanatory Memorandum – Not So Helpful

The Explanatory Memorandum 633305.pdf;fileType=application/pdf issued with the Release of the Treasury Laws Amendment (2017 Enterprise Incentives No.2) Bill 2017, provided general guidance and context in relation to the proposed laws, and worked examples of Safe Harbour processes.

Whilst a helpful document (notwithstanding the SME focus of most of the worked examples!!) there is no reflection on the subjective nature of the suspicion of insolvency – in fact the 'Comparison of key features of the new law' on page 9 specifically referred to an 'insolvent company' rather than a person developing a suspicion of insolvency, the worked example on page 10 refers to 'concerns about cashflow' and on page 18 the 'deteriorating financial position'. Essentially, there was no clear guidance on when it might be reasonable for that suspicion to begin, or indeed what constitutes insolvency for that purpose.

The AICD – A Bit More Helpful

In January 2020 the AICD released their Director Tool relating to Safe Harbour insolvency-safe-harbour-director-tool.pdf which contains "suggested steps the AICD considers likely to be relevant when pursuing a restructuring plan and attempting to trigger the safe harbour protection from civil liability for insolvent trading provided in s588GA(1) of the Corporations Act 2001 (Cth) (Corporations Act)." The AICD did not specifically consider the terms 'start' and 'suspicion' but concluded:

• The time taken between considering what should be done and actually going ahead … it is not limitless, and the Safe Harbour will only protect directors during a reasonable period between the consideration of the various courses of action and their implementation;
• The Explanatory Memorandum notes that the duration of the reasonable period will vary on a case-by-case basis;
• This suggests that directors can be protected by the Safe Harbour even if their course of action has not been put into action but is still in a planning or development phase; and
• Directors should move promptly and decisively towards implementing a suitable course of action (or entering the company into formal insolvency) as is responsible in the circumstances.

The Review Panel – Even More Helpful

In our article on 28 October 2024 SAFE HARBOUR – IS IT FIT FOR PURPOSE? | News & Insights we covered the work of the Review Panel in assessing whether the Safe Harbour Law is fit for purpose.

Section 8.1 of the Panel Review Report the issue of "Subjectivity of Awareness" was considered by the Review Panel. We note:

• There were concerns that formally linking Safe Harbour to a subjective suspicion of insolvency, directors are making it easier for a future liquidator to prove the suspicion requirement under section 588G(2);
• This concern led to feedback during roundtable discussions that some directors have been reluctant to engage the Safe Harbour provisions for fear of admitting the company is insolvent;
• That reluctance can be juxtaposed with the objective that directors should engage early and accept the prospect of insolvency in order to restructure;

• Some suggested more certainty about when Safe Harbour began, and used the subjective element of 588GA(1) as a reason to minute their concerns (and, therefore, create the records to support their evidentiary burden).

   

The Panel concluded, inter alia:

• Enlivening the Safe Harbour provisions did not, of itself, amount to an admission of a breach of section 588G;
  The prohibition on insolvent trading set out in section 588G refers to a company being insolvent or becoming insolvent as a consequence of the debt incurred. That is, a liquidator needs to prove actual insolvency;
• The reference to subjectivity in the provisions may increase or create a negative view of Safe Harbour or support a finding that in order to obtain protection, directors must somehow formally resolve to do so; but
• The Safe Harbour provisions work flexibly and don't require formal resolutions or 'start dates' to apply - the words 'start to suspect' and 'may' allow for directors to realise that they don't need to wait to engage the Safe Harbour provisions;
• There was benefit in directors seeking early access to appropriately qualified advisers, and developing alternative courses of actions. The Panel also recognised that directors should be encouraged to document their Safe Harbour deliberations.

The Review Panel also suggested there was a lack of awareness and understanding of a director's duty to prevent insolvent trading (and the related safe harbour provisions), and suggested a plain English 'best practice guide' to Safe Harbour be developed with industry groups. This is the basis of recommendation 4 of the Panel Review.

The Wexted View – Most Helpful!

When undertaking Safe Harbour work, Wexted generally adopt the view of the Review Panel:

• An exhaustive consideration of start dates and nature of the suspicion of insolvency is not required;
• Our Engagement Letters generally acknowledge and set out the reasons for the enlivenment of Safe Harbour – what are the circumstances leading to the suspicion and are they reasonable;
• Documenting the suspicion from at least a certain date, and minuting the appointment of an AQE (but not the potential start date) is recommended.

INSOLVENCY – NOT EASY

Establishing the actual existence of Insolvency in disputed circumstances (as opposed to a suspicion to commence Safe Harbour) is a rigorous test, that incorporates, cashflow, balance sheet and common law (ASIC/Plymin) testing. 

Still, it is helpful for Directors to have a good understanding of issues contributing to that suspicion as early as possible. 

In our Wexted Diversions Article I’ve had it for ages doctor but its started changing colour!  We assess the symptoms and causes of failure for a typical business.   The symptoms should be identifiable, and the causes (generally) controllable.  Forming a view on solvency requires an assessment of (a) the presence of symptoms that cannot be treated and (b) an inability to control the root causes. 

ASIC GUIDANCE:  REMAIN INFORMED!!

ASIC have issued:

• A Consultation Paper CP372 Consultation Paper CP 372 Guidance on insolvent trading safe harbour provisions: Update to RG 217 and draft update to Regulatory Guide 217 Consultation Paper CP 372 
• Guidance on insolvent trading safe harbour provisions: Update to RG 217 on the duty to prevent insolvent trading.

We will assess the proposed changes to RG217 (issued in August 2020) in a later Spotlight Article.