The Productivity Commission’s Draft Report in respect of Business Set-Up, Transfer and Closure (‘the Report‘) has recommended amendments to the Corporations Act 2001 (Cth) which would provide a ‘safe harbour’ for directors in certain circumstances.

The Report highlights that, particularly in comparison with overseas jurisdictions, the Australian insolvency system is characterised by a focus on creditors in preference to the  rehabilitation of the company. As has been noted by the Australian Restructuring Insolvency and Turnaround Association (‘ARITA‘):

‘The Australian regime could currently be described as one with a strong bias towards preserving creditors’ rights. Some other jurisdictions have more of a bias towards the preservation of the ongoing nature of organisations in financial distress’ (ARITA 2014b, p. 5)

However, in the Commission’s view, the insolvency system should operate to encourage economic activity through the productive use of assets – either through the continuation of existing, valuable economic activity, or by rapidly deploying employees and capital to other activities in an orderly fashion.

The Report highlights the broad spectrum of stakeholders affected by the insolvency of a company, including owners, employees, customers and suppliers and notes that not all of those interests will necessarily align with those of secured creditors. Accordingly, the Report contends, the current practice in Australia places undue weight on the rights of creditors throughout the insolvency process, and as a result risks diminishing the overall economic value of the process. It calls for ‘a more balanced group-focused process’.

To that end, one of the key recommendations made in the Report is to create a provision for a limited ‘safe harbour’ period prior to voluntary administration, which would allow directors to obtain independent restructuring advice without liability for insolvent trading. The purpose of such a provision would be to improve the genuine opportunities for corporate restructure.

At present, the threat of insolvent trading laws, together with uncertainty as to the precise moment of insolvency effectively mandates directors to move to external administration as soon as a company encounters financial difficulties in order to avoid personal liability and reputational damage. As a consequence, the scheme as it stands discourages directors from taking sensible risks in considering informal corporate restructures or ‘work-outs’ to deal with a company’s financial problems.

The Report makes recommendations for amendments to s 588G of the Corporations Act 2001 (Cth) to the effect that:

• Advisers appointed in safe harbour would be disqualified to act as administrators, receivers or liquidators in any subsequent insolvency process for the company.
• The company would be required to inform the Australian Securities and Investments Commission, and the ASX in the case of listed companies, of the appointment of an adviser.
• In informing themselves and the adviser, and determining whether to act on any restructuring advice, directors would be under a duty to exercise their business judgment in the best interests of the company’s creditors as a whole, as well as the company’s members.
• If the positive thresholds above are met (and evidenced), a director’s duty not to trade while insolvent would be considered to be satisfied during the period of advice and for actions directly related to implementing the restructuring advice.

The Report contends that amendments of this nature afford directors:

‘the opportunity to undertake a rational decision making process free from fear of liability, without fundamentally altering the balance within the law and still protecting the company and creditors from reckless action when a company is already in debt’.

However, the Commission has emphasised that a safe harbour should not be seen as a ‘free pass’ for directors to wash their hands of any liability. Instead, it should be used only as an opportunity to pause when financial difficulty appears imminent and seek external advice to ensure that directors are informed of the options for continuing the company’s existence.