When the effects of COVID-19 became known, the federal government acted quickly, especially with incentives to help small businesses. But as the realisation grows of what lies ahead when these measures come to an end, will they turn out to be more of a hindrance than a help?
Parliament passed the Coronavirus Economic Response Package Omnibus Act No. 22 of 2020 (the Act), on March 23, 2020, which contains measures to help businesses with financial stress.
How the temporary measures assist directors
Specifically, the Act allows for the temporary increase in the minimum amount of debt required to be owed before a creditor can initiate involuntary bankruptcy proceedings against a debtor from $5000 to $20,000 and extends the period from 21 days to six months for debtors to respond to a bankruptcy notice. The timeframe in which a debtor is protected from enforcement action by a creditor following a declaration of intention to present a debtor’s petition, is also extended from 21 days to six months.
Another measure that’s created much discussion is the six-month temporary relief for directors from personal liability for trading while insolvent. Under the insolvent trading laws of the Corporations Act 2001, directors of a company can be personally liable for debts incurred, if at the time they were incurred there were reasonable grounds to suspect the company was either insolvent or would become insolvent by incurring the debt.
This obligation is now suspended in the ordinary course of the company’s business between March 24-September 23, 2020. In other words, a new “second” Safe Harbour for this period applies. Now directors of a company will be able to rely on this temporary relief measure with regard to a debt 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 commenced), 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.
The current pandemic has meant directors have had to take swift action around debt – including incurring more of it to keep their business operating. Therefore the temporary measures are providing them with the confidence to continue to pay their bills and retain staff without the fear they may have to enter into administration if they are trading while insolvent.
Insolvency should not always be the final option
Peter Hegarty is Principal at Hegarty Legal. He believes there will be an upswing in insolvency appointments once the relief measures come to an end.
“My hope is that people do not see insolvency appointments as something which has to be avoided at all costs, but as being a necessary step where entities are trading insolvently,” he says. “What this then means is that many other businesses with whom they are dealing are able to avoid bad debts and potentially becoming insolvent themselves. This also means that in many cases, restructured entities are able to continue successfully into the future.”
Hegarty says most directors who come to him for advice are acting prudently and want to have a clear understanding of what their obligations are in the context of the companies under their control suffering insolvency headwinds. “They quite properly want to know at what point they may be personally liable under the insolvent trading provisions,” he says. “They also want to know what steps they can legitimately take to preserve the going concern value of their businesses and keep their employees in a job.”
The potential downside: who’s got the creditors’ backs?
While Hegarty says the stimulus measures were well placed and were made for good reasons he has some concerns. “I am concerned about some of the recent amendments made to the Corporations Act and Bankruptcy Act, which I think have approached the problem from the perspective of the insolvent entity or person, without enough regard for other stakeholders,” he says.
He explains that in normal times, there is always a risk that the insolvency of one entity will contribute to the insolvency of many other entities. “That risk is in my view further exacerbated by the recent reforms because they encourage people to take financial risks they would otherwise not take,” he says.
“My concern with the most recent amendments is that they don’t seem to take proper account of the creditors of those insolvent entities who themselves are struggling to navigate through this difficult period. To put this in context, a director of a struggling entity may be more inclined to see his company incur a debt with a supplier, which perhaps shouldn’t be incurred, because of the relaxed insolvent trading provisions.”
Hegarty says, for example, the struggling company could incur a debt for less than $20,000 knowing that it will not be the subject of a statutory demand or if it is greater than $20,000 knowing that the period under any statutory demand is six months.
“What follows is that the supplier entity doesn’t get paid when their invoices are due and potentially themselves are then not in a position to meet their own obligations to their suppliers and employees,” he says. “An unfortunate outcome of this position is that it inevitably leads to a tightening of credit from those supplier entities who quite understandably need to protect their own corner. This is something which the government should be seeking to avoid.”
Adhering to directors’ responsibilities still applies
There is some confusion around when the new measures can be applied: for example, does a company that is recapitalising qualify for the relief. Hence it is important to keep good records and to ensure any debt incurred during this period is actually necessary for business survival.
Jirsch Sutherland Partner Sule Arnautovic agrees while the lifting of certain restrictions can provide much-needed relief, it is incumbent on directors to keep meticulous records in relation to any decisions taken under this new regime. “What is important to note is that the temporary measures do not provide relief from director’s duties owed to the company or third parties under other Corporations Act provisions,” he says.
Arnautovic adds one concern is that the relief measures may support companies that would otherwise be failing no matter what the economic circumstances. “The support should be a help for those businesses that are likely to remain viable over the long term but are facing short-term financial issues as a result of the pandemic,” he says. “If the measures are protecting directors who don’t take their responsibilities seriously, this can have negative consequences for their staff, customers and creditors.”
Seeking professional advice is crucial at this time. “Directors who are considering different options for their struggling business need to make the best decisions for their business and all those affected by it,” Arnautovic says.
“This may include taking advantage of the temporary relief that is being provided by the government or it may involve going down the administration route. What is certain, is that if the temporary relief route is taken but strategies aren’t put in place to deal with the ending of the relief in September, these businesses will be facing the same decisions down the road, but in a worse financial position.”