COVID-19: What directors need to know about the lifting of director liability for insolvent trading

As part of a range of economic measures in response to COVID-19, the government has announced six-month temporary relief for directors from personal liability for trading while insolvent. Here’s what directors need to know.

Temporary relief from director’s duty not to trade while insolvent

Under insolvent trading laws in s 588G of the Corporations Act 2001 (Cth), a director of a company can be personally liable for debts incurred by the company if, at the time the debts were incurred, there were “reasonable grounds” to suspect that the company was either insolvent or would become insolvent by incurring the debt.

In the context of the current COVID-19 crisis, directors will need to make urgent decisions regarding incurring debt. The temporary safe harbour is designed to give directors the confidence to continue to trade, pay their bills and retain staff through the COVID-19 crisis without pressure to enter their organisation into administration if there is a chance it might be insolvent.

Directors will be able rely on the temporary relief in relation to a debt incurred by the company if:

• the debt is incurred in the ‘ordinary course of the company’s business’;
• the debt is incurred during the six month period (starting on the day the new law commences), or a longer period as prescribed by the regulations; and
• the debt is incurred before any appointment of an administrator or liquidator of the company during the temporary safe harbour application period.

Because each company’s circumstances are different, the new law is not prescriptive in terms of what debt incurred in the ‘ordinary course of the company’s business’ may be considered eligible for the relief. Rather, a director will be taken to incur a debt in the ‘ordinary course of the company’s business’ if it is necessary to facilitate the continuation of the business during the six-month period that begins on commencement of the new law. This could include, for example, debts incurred through continuing to pay employees during the Coronavirus pandemic. It could also include a director taking out a loan to move some business operations online.

It is unclear however from the government’s proposal whether a company incurring debt as part of recapitalising during the applicable six-month period would qualify for relief. Accordingly, It will be a matter of degree for directors, and care should be taken, to assess whether the debt incurred is necessary for the business to survive in the current climate, which will inevitably vary on a case-by-case basis.

Ordinarily, the insolvency provisions under the Corporations Act provide that the onus of proof is on the person trying to make a director liable for insolvent trading.

Under the new temporary safe harbour, a director wishing to rely on the relief in a proceeding in which unlawful insolvent trading is alleged will bear an evidential burden in relation to that matter (e.g. point to evidence that suggests a reasonable possibility that the matter exists or does not exist).

What duties will continue to apply?

Importantly, this reform is not a “free pass” for directors, who must continue to carefully oversee the solvency of their organisation. All existing Corporations Act duties will continue to apply, including that of directors to act with care and diligence, in good faith in the best interests of the company and to not improperly use their position or information received for personal gain.

Any debts incurred by the company will still be payable by the company and egregious cases of dishonesty, illegal phoenix activity and fraud will still be subject to criminal penalties.

Notwithstanding the proposed relief from personal liability for insolvent trading, if the company is approaching insolvency, case law states directors must begin to also take the interests of creditors into account.. Accordingly, directors will need to exercise careful judgment in deciding whether their organisation should accrue additional liabilities at a time when the ongoing solvency of the organisation is questionable.

Notably if the company does fall into formal insolvency, the temporary relief will be taken not to have been available if a person substantially fails to comply with their obligations to assist an administrator, liquidator or controller. That is, directors must provide all the books and information that they are ordinarily required to provide to an administrator or liquidator. If they fail to do this, they will not be entitled to rely on these books or information as evidence when relying on the safe harbour to defend insolvent trading claims made by a liquidator in a later proceeding.

AICD perspective

The economic impacts of the Coronavirus and health measures to prevent its spread could see many otherwise profitable and viable businesses temporarily undergoing financial distress. Accordingly, the AICD has strongly welcomed the government’s measures to provide businesses a safety net and reduce the risk of personal liability for company debts, at a time when otherwise many directors may feel compelled to place their company into voluntary administration

Nonetheless, directors should not see this temporary reform as offering them carte blanche with respect to their general director’s duties . It is critical that directors continue to mitigate the risks of falling into insolvency by taking reasonable steps to inform themselves about the company’s current and ongoing financial viability as well as assessing the impact of incurring any further debts. In particular, directors must think carefully about their ongoing duty to act in the best interests of the corporation (including the interests of creditors when approaching insolvency), and whether incurring additional liabilities would be a prudent course of action, and consistent with their obligation of care and diligence.

Amendments to the Corporations Act to implement the new temporary safe harbour from personal liability for insolvent trading became effective on 24 March 2020 via the Coronavirus Economic Response Package Omnibus Act 2020 (Cth), and will remain in place for 6 months unless otherwise extended.

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