Containing the COVID-19 contagion: temporary relief for financially distressed companies

The Coronavirus Economic Response Package Omnibus Bill 2020 (Coronavirus Response Bill) was passed on 23 March 2020 and received Royal Assent on 24 March 2020 following the Federal Government’s announcements made between 12 and 22 March 2020 of its economic response to the spread of the coronavirus pandemic.

The Coronavirus Response Bill provides, amongst other legislative amendments, for temporary changes of 6 months’ duration to Australian insolvency and corporations laws to assist in managing the sudden economic shock resulting from COVID-19.

Key Takeaway

The new safe harbour law only applies to section 588G(2) of the Corporations Act 2001 (Cth) (Act) (being the civil penalty provision relating to insolvent trading). It does not apply to section 588G(3) of the Act, which is the criminal offence for insolvent trading conducted with a dishonest purpose.

Debts incurred by a company when the director suspects that the company is insolvent or may become insolvent by incurring the debt will not be afforded protection by the temporary new safe harbour law where that the director’s failure to prevent the company incurring the debt was dishonest. However, there is some doubt as to whether “dishonesty” in section 588G(3) would cover incurring a debt when the company was known to be insolvent (rather than merely suspected).  We hope that the courts and regulators will take a sympathetic approach to this issue where directors are making good faith efforts to ride out the temporary impacts of the Coronavirus.

The Coronavirus Response Bill does not require a nexus between insolvency and the current Coronavirus pandemic.

Therefore, the Coronavirus Response Bill achieves its stated aims of assisting directors of companies that are likely to become insolvent as a result of the current Coronavirus pandemic who despite having a suspicion that their company may be or about to become insolvent, are nonetheless motivated by an honest and genuine belief that the company or its business can be saved.

Summary of new insolvent trading laws

A new section 588GAAA will be inserted into the Act with the effect of directors being provided a new “safe harbour” of 6 months relief from personal liability for insolvent trading under section 588G(2) of the Act in relation to debts incurred in the ordinary course of business.

Specifically, a director may rely on the new temporary safe harbour 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 6 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.

For example, a director may be taken to incur a debt in the ordinary course of business if it is needed to keep the business going during the 6 months after the legislation commences operation. This could include a director taking out a loan to move some business operations online. It could also include debts incurred through continuing to pay employees during the coronavirus pandemic.

However, the regulations may prescribe circumstances in which the temporary new safe harbour is taken never to have applied in relation to a person and a debt. The Regulations have not yet been issued.

The relief from personal liability for trading whilst insolvent will not alleviate the company’s requirements to pay its debts during the next 6 months. The company will still be liable for the debts incurred.

Similarly, under a new section 588WA(1) of the Act, a holding company may rely on the temporary safe harbour for insolvent trading by its subsidiary if it takes reasonable steps to ensure the temporary safe harbour applies to each of the directors of the subsidiary and to the debt, provided that the temporary safe harbour does so apply. The holding company will however bear an evidential burden in relation to these matters.

In addition, by reason of an amendment to section 588GB(7) of the Act, information or company books will not be admissible to support a claim for coverage by the temporary new safe harbour in a proceeding in which unlawful insolvent trading is alleged if the person fails to produce the books of the company in accordance with a relevant notice.

The inapplicability of the new section 588GAAA to s 588G(3) of the Act means that cases of dishonesty will remain, as always, subject to criminal liability and penalties. Depending on the approach to be adopted by the Courts to what “dishonesty” means in section 588G(3) – there is very little judicial guidance on this point -  it is possible that incurring a debt when a director knows that the company is insolvent (as opposed to suspects) could trigger the application of section 588G(3) and personal liability despite the new (or old) safe harbour.  However, we hope that Courts and regulators will, in all of the circumstances, take a sympathetic approach to the residual application of section 588G(3). That said, we consider that consideration may need to be given to further law reform.

Consequently, the new provision’s temporary enlargement of the potential safe harbour from insolvent trading liability does not give unlimited relief from section 588G of the Act. In addition, nothing in the new provisions affects a director’s other existing statutory and general law duties, such as the duties to act with due care and skill in good faith in the company’s best interests and for a proper purpose and to otherwise not engage in misleading and deceptive conduct. In this respect, the rigorousness of any restructuring plan, its underlying assumptions and the acuity of the advice of the “appropriately qualified” advisor to whom the director will invariably turn for assistance in developing and implementing that plan will remain critically important in determining upon whom liability ultimately falls.

The Coronavirus Response Bill can be found here and the Bill’s Explanatory Memorandum can be found here.

If you have any questions or would like advice, please contact any of the JWS Finance and Restructuring team below.