Storm warning for directors as virus crisis threatens to send their companies bust

GLENDA KORPORAAL

MARCH 17, 2020

The Australian

The coronavirus crisis is set to provide the first big test of Australia’s reasonably new “safe harbour” ­insolvency laws.

Directors of companies that are fundamentally sound, but are facing short-term financial hardship as a result of the crisis, should make themselves aware of the process that was introduced a few years ago.

Accounting firms are getting an increase in inquiries from nervous directors wanting to learn more about the process as they try to work through a crisis that is increasingly looking as though it will have a much more severe impact than anyone imagined.

According to the Australian Restructuring Insolvency and Turnaround Association, the laws are designed to “allow directors of financially distressed businesses a new ‘safe harbour’ to turn around their businesses free of the worry of being personally pursued for insolvent trading actions”.

The provisions have been used by companies already but they have not received much publicity, as it is a process basically done in private between a distressed company and its advisers.

There is no public reporting system for the process, as there is for insolvencies or bankruptcies.

It is only if a company that has used or is using a “safe harbour” process fails and legal action is taken against the directors that the public will learn how ­effective the process is as a legal defence.

Under the laws, directors of companies that are in trouble and who have a plan for working through their issues can approach a qualified adviser — an accountant or insolvency practitioner — and request professional advice on their situation, specifically requesting to use the “safe harbour” provisions.

Companies have to have their taxes paid up, their employee entitlements paid up, including superannuation, and have their books and financial records in good order.

The company and their advisers have to develop a restructuring plan that is “reasonably likely to lead to a better outcome for the company” than if the directors had put it into insolvency or voluntary liquidation.

These provisions will exclude many small and medium-sized firms whose problems are too serious to be fixed by a restructuring and which may not be able to ­afford the high price of advisers over a long period.

One of the problems is that Australian laws are some of the strictest in the world on directors who allow their company to trade while insolvent or commit other “offences”. Combine that with the regime in Australia of well-funded class actions, and many independent directors of SMEs that are facing a sharp downturn in cash flows and no immediate prospect of a turnaround must now be wondering if they would be safer just to hand in their resignation and walk out the door.

What SME can guarantee they won’t be insolvent in three to six months’ time in the current economic environment?

At what point do thousands of company directors, particularly of listed companies, decide that the crisis is too serious, with no end in sight, that they can’t risk their own personal assets by being hit with a lawsuit if the company fails?

Directors need to check their professional indemnity insurance clauses, as some now become invalidated once a company goes into administration or insolvency.

The “safe harbour” does provide some protection if directors have engaged professional advisers and are working on a sensible plan. But as PricewaterhouseCoopers head of restructuring Stephen Longley says, the provisions will mainly be of help to ­directors of larger companies.

And he points out the “safe harbour” provisions are not a protection for directors even if they have tried their best to save their company from going broke. They are merely a defence a director can use if he or she gets sued.

“If the company eventually fails, the director is still at risk,” Longley says. “I don’t like the fact that it is just a defence. Safe harbour helps them navigate through a process, but it has its limits.”

So if the company does go bust and the directors are sued, how much real protection will they get if they can show they have gone through the proper steps under “safe harbour”?

The answer is no one knows until the law gets tested in court, which has not yet happened.

Will judges decide directors have done their best having followed all the “safe harbour” processes? Or will a smart lawyer find fault with how they have gone about the process?

Longley believes this is an issue the government urgently needs to consider — potentially providing some short-term protection.

Shifting the laws from “defence” to “protection” would help at least for a temporary period during the COVID-19 crisis.

Australia has rightly opted not to have a Chapter 11 bankruptcy process, which is used in the US and has been the fate of many American airlines.

The process is very expensive — a lawyers’ picnic — and is run by special bankruptcy courts, which control a company’s future.

ARITA’s chief executive, John Winter, says his members are already getting calls from worried companies and he is expecting a big spike in corporate insolvencies in the next few months.

Winter admits there are “significant hurdles” for companies wanting to use the “safe harbour” provisions. A company that is in such bad shape that it can’t pay its staff is not going to comply with the provisions.

Winter says the important thing is for the company in trouble or facing trouble to get good financial and legal advice early.

He says too many businesses try valiantly to trade their way out of problems, until it is too late and insolvency is the only option.

From conversations with several accounting specialists, it is clear companies are already beginning to access the “safe harbour” processes.

Every company director in Australia now has some hard decisions to make — decisions that could well exacerbate the crisis unless they can feel they have some protection for staying on and “doing the right thing”.