With the number of companies entering external administration expected to reach a level not seen for a decade, directors need to understand their options and liabilities.
A company is insolvent when it cannot pay its debts when they are due. As a director, there are serious penalties for allowing your company to trade while insolvent. The Australian Securities and Investments Commission (ASIC) provides guidelines for directors to understand the actions available to directors and the penalties that might be incurred (bit.ly/4e3sFOW).
In Australia, the number of companies entering administration has been increasing. ASIC predicted more than 10,000 companies were expected to have failed in the financial year ended 30 June 2024, a level not seen since 2012–13.
The safe harbour regime was introduced in 2017 to give directors a framework to pursue the restructuring or turnaround of a financially distressed company without fear of personal liability — providing certain conditions are met.
McGrathNicol partner Kathy Sozou says as a company begins to show signs of financial distress, directors need to become more acutely aware of their obligations to avoid insolvent trading. Sozou is also vice president and a current board member at the Australian Restructuring Insolvency and Turnaround Association (ARITA). In a troubled environment, making informed decisions on the best way forward can be complex. The earlier advice is sought, the more likely a range of options can be considered, she says.
What to look for
Appropriate financial reporting
To accurately assess the financial position of the company and recognise the early warning signs of distress, you need to be aware of the real financial position of the company, according to Sozou. “This requires appropriate reporting to be provided on a regular basis,” she says. “Directors need to ensure these financial reports not only capture the historic trading performance, but also contain forecast data that is capable of being challenged and sensitised for changing underlying assumptions.”
Sozou adds that the frequency of this reporting should increase in line with the level of distress, and should also include information on earnings and cash flow — both of which are necessary to monitor current and future solvency.
Cover the basics
Ensure you are meeting the eligibility criteria of the safe harbour provisions, such as timely tax lodgements, meeting all employee entitlements as they fall due and resolving any disputes in a timely and professional manner. Late payments of superannuation, for instance, are a common indicator of distress and can disqualify a director from safe harbour protection, says Sozou.
“Review the company’s policies to confirm there are appropriate controls in place to protect against actions occurring outside of your reasonable knowledge. As a director, you cannot know everything that is happening every day, but you can be diligent in your decisions around oversight and delegation.”
What not to do
Don’t be complacent, says Sozou. In times of distress, self-preservation instincts can leave many leaders and staff reluctant to “share the bad news”. As a director, you should actively seek to understand the company’s position and challenge the fact base, not just rely on information presented.
Safe harbour planning
Michael Fingland MAICD is a director of the Australian Restructuring Insolvency and Turnaround Association (ARITA), and the founder and CEO of Vantage Performance.
“The commencement of the safe harbour legislation in 2017 was the single biggest change to insolvency law in the past 20 years in terms of being able to have a meaningful impact on the rate of corporate failure,” he says.
Fingland suggests three simple and impactful policies could make a difference in its uptake and impact on corporate failure:
When the ATO is considering a payment plan for a business, it could ask the business and its directors to develop a safe harbour plan When considering providing financial support to a client in default, financiers could encourage that client to develop a safe harbour plan
ASIC could undertake a safe harbour awareness campaign.
“These three measures would make a big difference as companies wouldn’t be prematurely placed into voluntary administration or liquidation, leading to billions of dollars annually in economic loss, let alone the devastating social impacts,” says Fingland. “If directors are in safe harbour, it means that they and their advisers have developed a robust turnaround plan and the business is more likely to succeed.”
This article first appeared under the headline 'Fight or Fail’ in the July 2024 issue of Company Director magazine.
Practice resources — supporting good governance
Examples of the AICD’s contemporary governance practice resources for members:
Insolvency
- Joint AICD-BCA submission: Review of the Insolvent Trading Safe Harbour
- How insolvency safe harbour can offer protection
- The insolvency safe harbour
- Webinar: Turnaround Fundamentals: Board resilience during tough times
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