Question

What was the reason behind the recent introduction of CA s 588GA? Explain your answer with reference to CA s 588G.

Answer 1

On 19 September 2017, the safe harbour provisions came into force, which were introduced to the Corporations Act 2001 (Cth) (the Act) by amendment. These amendments:

• created a defence for directors against insolvent trading known as the 'safe harbour defence', which was designed to encourage company directors to attempt to restructure companies that are at risk of insolvent trading, rather than simply placing the company into voluntary administration at the first sign of trouble; and
• were part of a broader set of legislative changes that were designed to encourage a 'turnaround culture' in Australian companies by removing some of the barriers to restructuring faced by struggling companies and their directors.

he prohibition on insolvent trading: section 588G of the Act

Section 588G of the Act imposes a positive duty on company directors to avoid insolvent trading. Essentially, clauses 588G(1) and 588G(2) of the Act provide that a director will be in breach of the Act if they fail to prevent the company from incurring a debt where:

1. the company is insolvent, or, as a result of incurring that debt, becomes insolvent;
2. at the time when the debt is incurred, there are reasonable grounds for suspecting that the company is or will become insolvent; and
3. either:
   • the director is aware that there are grounds for suspecting that the company is or will become insolvent; or
   • a reasonable person in a like position in a company in the company's circumstances would be so aware.

Pursuant to section 588GA(3) of the Act, the director bears the onus of proving the existence of the safe harbour defence.

One year on from these changes, it remains unclear whether the safe harbour provisions will lead to a significant change in the turnaround culture in Australia, for the following reasons:

1. the onus of proving that the elements of the defence are established falls on the director. Depending on the circumstances, this could be difficult for the director to prove;
2. whether or not a course of action is reasonably likely to result in a better outcome for the company than the immediate appointment of an administrator or liquidator and, accordingly, whether the defence is available, can change over time. The defence can be lost if a director does not immediately develop and implement a new course of action in response to changing circumstances;
3. a director will never be in breach of section 588G if they appoint an administrator or liquidator where the company is at risk of insolvent trading, but a director continues to be at risk of breaching section 588G if they attempt to rely on the safe harbour defence; and
4. a director will only know for certain whether the safe harbour defence applies if this is tested in a court.