Insolvent trading. If you’re a company director you know only too well that those two words are bad news. The good news is that the law that has held directors personally liable for corporate debt in cases of insolvency has recently changed, giving directors a “safe harbour” to encourage them to save their business from liquidation for the benefit of the company and its creditors before it’s too late. But only in limited circumstances.
Protection for directors to help save companies
A new defence or safe harbour has been introduced to protect company directors from being personally liable for insolvent trading, as long as they can meet several criteria.
The idea behind the new law – which took effect in Sept 2017 – is to promote a more positive business culture and an incentive to encourage directors to look for ways to turn around the fortunes of the company before all hope is lost and while there is still value to salvage.
Until this safe harbour was introduced, directors would be held personally liable for the company’s debts if at the time of the debt, there are “reasonable grounds” to suspect the company is insolvent.
Big penalties have deterred directors
The significant civil penalties for insolvent trading of up to $200,000 for an individual and the possibility of being banned as a director for a number of years – and the stigma attached to being caught at the helm of a company trading while insolvent – have more than discouraged directors to stay the course.
Those directors would jump ship early and put the company in the hands of liquidators or administrators – at great financial (and emotional) cost to all involved, including of course creditors and employees. The heavy penalties would also naturally deter directors from taking risks to try to save the business, as well as more broadly, deter investors and professional directors becoming involved in start-ups.
In the past, the only defence available to directors whose company traded while it was insolvent was to show that, at the time the company went into debt, the director had reason to think the company was solvent.
New defence: The test for directors
The new law aims to encourage restructuring and turnaround by providing protection for directors from being personally liable for insolvent trading if, after the director suspects the company may be insolvent, they can take a course of action that’s reasonably likely to lead to a better outcome for the company.
Additionally, the debt incurred needs to be connected with this course of action or the usual course of business.
The director will need to prove that they acted proactively in undertaking a restructure of the company as soon as they suspect insolvency, and will therefore need to keep a clear record of all the actions they took to try to save the company.
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There are several critical issues here, such as how the test – taking a course of action that’s reasonably likely to lead to a better outcome – will be applied and how much the director needs to be connected to this course of action.
We are here to explain it all in detail and help you understand how it could work, and how it could help you in the future.