Looking Over The Cliff: The Better Outcome in Safe Harbour

A director can avoid civil liability for insolvent trading of a company where:

1. They begin suspecting insolvency or financial distress;
2. They start developing one or more courses of action;
3. Those courses are reasonably likely to lead to a “better outcome” than immediate administration or liquidation;
4. Debts are incurred directly or indirectly in implementing that course
    

1. What does better outcome “for the company” mean?
2. What stakeholders should be included in that assessment?
3. How should the Board analyse and measure a “better outcome” against the immediate appointment of a voluntary administrator or liquidator (referred to as the counterfactual)?

• Undertaking a restructure
• Undertaking the sale of assets
• Ceasing the incurrence of debts
• Restructuring of debt facilities
• Negotiating key creditor claims
• Reducing expenses
  Appointing an experienced director or directors
• Undertaking a business review

• Ignoring expert advice
• Significantly and unsustainably discounting stock
• Continuing to trade as usual
• Drawing down on bank facilities, knowing that the funds drawn cannot be repaid in full
• Ordering more stock from creditors, knowing that the debt cannot be repaid in full

Directors should measure their plan against the realistic counterfactual—not theoretical possibilities—i.e. compare ongoing trading vs. immediate external administration or winding-up, or other realistic outcomes like a deed of company arrangement (as opposed to remote theoretical scenarios).
The counterfactual assessment may in appropriate circumstances include voluntary administration outcomes and / or liquidation outcomes, and that it considered it appropriate for a better outcome plan to have regard to the continued viability of the business.  
 

“We consider that the appropriate counterfactual will depend on the circumstances the company is facing and, accordingly, the definition of better outcome needs to be flexible enough to accommodate a range of scenarios. The inclusion of both administration and liquidation scenarios provides such flexibility.”

In relation to key stakeholders, and whether the “better outcome” related to outcomes for all stakeholders, the review noted: 

“the interests of creditors are already covered by the reference to ‘company’. A director seeking to rely on the safe harbour provisions is doing so because the company is in financial distress and is seeking protection, ultimately, from the duty not to trade the company while it is insolvent. In those circumstances, the case law is clear: directors are under a duty to consider the interests of creditors…. We are also wary of any suggestion that the better outcome needs to be better for creditors as a whole.”

“Panel considers it unnecessary for any amendment to be made to the wording of section 588GA(1)(a) to expressly recognise the interests of creditors in the better outcome. We are comfortable that the provision, as currently drafted, requires consideration of the interests of key stakeholders, including creditors and employees.”
 

A quantitative analysis focuses on the return to creditors under the better outcome and counterfactual scenario, whereas a qualitative analysis also takes into account other factors such as the ability of the company to continue to trade. The review agreed that:

"the concept of a better outcome involves consideration of both quantitative and qualitative factors. To focus solely on quantitative factors would unduly narrow directors’ assessment of the courses of action available to a company ,"

However it went on to say:

“However, those quantitative and qualitative assessments need to be considered in the circumstance of each company and weighed accordingly. The weight that is given to each will differ depending on the circumstances, but while the overall return to creditors is a significant factor, it is not the only factor and would also not appear to reflect how directors are engaging in this assessment in practice.”

Reflecting on the application of part 5.3A of the Act, the review noted:

“the Panel is also concerned with linking a better outcome too expressly to the objects of Part 5.3A… Caution must be applied in allowing directors (who usually and naturally wish to retain control of the company) to determine a better outcome by reference solely to the business continuing and without regard to what creditors may achieve via an administration.”
 

Directors should:

• Properly inform themselves of the company’s financial situation.
• Prevent misconduct that could jeopardise employee entitlements.
• Keep appropriate and accurate financial records.
• Seek advice from qualified professionals, based on solid information.
• Develop and/or implement a well-considered restructuring plan.