COVID-19 Insights | Navigating toward the brave new world

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Manage.
Mitigate.
Move Forward.

By Tony Lane

Tony Lane

Unlike many, I’ve not leapt to print during the last couple of weeks; instead choosing to observe, consider and take time to understand what is happening around me, the business I run and the clients I have.  There is absolutely no doubt that businesses now face a challenge greater than any other of recent memory, regardless of the length of time forced shut-down remain in effect. Words like ‘unprecedented’ and ‘apocalyptic’ now regularly supplant the usual lexicon of ‘growth’ and ‘opportunity’.

But, for all the rhetoric of the doomsayers, there are opportunities out there to preserve and protect what you have built as your business – to sure up the foundations in order to rebuild – in what will be a required period of unparalleled perseverance and pride.

Those opportunities come partly by way of a package of measures passed into law by the Australian Parliament.  In this brief article I wanted to unpack those a bit, provide some perspective and suggest that precautions be taken whilst availing yourselves of these measures.

The addition of a defence for directors in respect of their duty to prevent insolvent trading, by the introduction of a temporary safe harbour, with respect to debts incurred in the ordinary course of the company’s business during the crisis, has been hailed by many as an opportunity to loosen what are some of the world’s most draconian insolvency laws.  However, it may not prove as beneficial as many of the pundits would have you believe.

Insolvent trading arises in broad circumstances where a director of a company fails to prevent that company from incurring additional debts at a time when it cannot, or when the director ought to suspect that it cannot, pay its current debts as and when they fall due.  It is certainly true that the reality of insolvent trading may be upon directors of companies across the country right now, or very very soon.

Much has been made of the significance of this measure and its impact on business longevity during this tumultuous period.  However, it is important to distinguish between what is in effect an alleviating measure (a defence) to a legal cause of action against directors personally, and measures to enhance business cashflow.

It is not, as has been widely misreported, a broadly based relief from the insolvent trading laws – it provides a mechanism by which directors, who may at some date in the future become exposed to such a claim, access an additional defence to that claim.  Also note it only applies only for 6 months from 25 March 2020 at this stage.

Directors should be careful when going to the market now incurring new debt, under the assumption that in so doing they may be immune from any consequences.  What has received remarkably little attention is that whilst the application of the insolvent trading provisions have been temporarily mitigated, there are conditions.  For example:

  • The temporary safe harbour does not apply to companies that were already technically insolvent prior to the enactment of the legislation. The measure applies only to new debts.  This presents the obvious problem for directors who currently have little to no understanding of the financial position of their company, for whatever reason – something that is observed far too often in the context of insolvency work;
  • The temporary safe harbour applies only to new debts incurred in the ordinary course of business. This means that any pre-existing debts that are deferred or revised after the day the new law commences will not be included in the temporary safe harbour arrangement.  Also, it is important that directors consider the meaning of ordinary course of business, which attracts a specific definition under the new provisions – specifically it is: “necessary to facilitate the continuation of the business during the six month period that begins on commencement of the subparagraph. This could include, for example, 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” (s12.18 Explanatory Memorandum to the Bill). What is necessary to facilitate continuation of business?  This is clearly a subjective assessment that will be taken in hindsight by a liquidator should it come to that.  In order to be best protected, a director should, in my opinion, be making detailed records of the need to incur a debt and why/how it is connected to the continuation of business.  An example of what may be excluded is taking out new borrowings to finance the purchase of a new ‘private use’ car to take advantage of the increased instant asset write-off threshold.
  • If you plan on relying on the temporary safe harbour, you bear the onus of proof. As the measure is technically a defence, if you intend to rely on that defence it is up to you to prove the matters you seek to rely on.  So, in practical terms, whereas a liquidator is still required to prove that a company incurred new debt when it could not pay old debts so as to establish insolvency, and then prove that the director had reasonable grounds to suspect that insolvency, the defence (and access to the temporary safe harbour) is for the director to prove.  To access the temporary safe harbour and successfully plead it in defence of a claim, a director must prove that there is a reasonable possibility that the incurring of the debt was necessary for the continuation of business.  This then means that a director must keep relevant records that support that position and that those records can be produced as evidence.
  • And further still (and this one is the kicker), those records will be inadmissible in defence of any claim for insolvent trading if the books and records of the relevant company have not been made available for inspection or otherwise delivered to the liquidator. Traditionally, access to records of insolvent companies is not always straightforward.  In many instances, even where records do exist, the state of those records is generally poor.

Consequently, the attractiveness of new short-term debt may not prove as beneficial as many may have you believe.  Weathering the storm, only later to crash into the rocks, seems like poor strategy to me.  Careful analysis and planning is required here as there may be more productive measures that are available to preserve business (and therefore value).

The most overlooked aspect in this conversation is that many of the other mechanisms by which directors could be held liable to compensate a company for its losses remain alive and well – principally the statutory duties that apply to directors under section 180 to 183 of the Corporations Act 2001.  Foremost amongst these will no doubt be section 181, under which a director’s conduct will be assessed in respect of good faith, whether that conduct was in the best interests of the company and if it was for a proper purpose.  The broad umbrella of this section has spawned a long line of authority that supports the proposition that a director’s conduct may well be assessed under these tests in the context of creditor interests.

It remains to be seen what Courts may make of directorial conduct as against circumstances where existing creditor positions are exacerbated by additional debts incurred under a temporary safe harbour.

The reality is that there will be many types of business immediately impacted by forced closures that will not benefit from this payment, particularly those who are no longer employing staff.  For those businesses, the reality of circumstances will become apparent almost immediately and well before access to these cash sums is possible.

The Corporations Regulations previously provided that a statutory demand may only be issued against a company for the repayment of a debt exceeding $2,000.  Under the recently-enacted provisions, that minimum limit has been increased temporarily (for 6 months) to $20,000.  This means that a creditor cannot issue a statutory demand for an amount due (including associated charges and interest) for less than $20,000.

A similar increase (from $5,000 to $20,000) has been applied in the personal insolvency space under the Bankruptcy Act 1966.

The amendments are self-reversing in 6 months (subject to any further additional review) and it does not apply to demands/notices issued before the commencement date of the amendment.

In reality, we may expect this to lead to less creditor driven winding up activity off the back of statutory demands in the corporate space as many businesses move to tighten credit sales, more closely manage debtors and carefully administer cash reserves.  A greater focus on tight management of accounts receivable may be unlikely to result in the generation of debtors greater than $20,000.  Notably there has been no amendment to section 459C and 459D of the Corporations Act.

The same may not be able to be said in the personal insolvency space as, in circumstances where no debt moratorium is in place (think here delayed repayment options etc), it may not be long before individually incurred credit creeps beyond the revised limit.

Given the creditor-driven insolvency market even pre CV-19 accounts a minor proportion of the total insolvency matters (across both corporate and individual markets), the measure may be unlikely to have far-reaching impacts.  It seems principally designed at sending a message for the creditor market to ‘hold their horses’ as it were.

Again the messaging here is perhaps more relevant than the practical effect of the measure.  Any creditor-driven recovery activity that meets the revised threshold tests above will then meet with up to 6 months in delay before an insolvency based application can be brought before the Court.

In practical terms, we would think that this will probably drive more creditors and debtors to negotiate payment plans or debt compromises rather than engage in processes that, without these extended measures, are already in many instances protracted.

However, this does present heightened risk to creditors in the unfair preference space – in particular when entering arrangements for which there is no certainty of completion.

ATO measures

Perhaps some of the most misunderstood and misreported measures are those being deployed via the Australian Taxation Office.

Without addressing any of those measures in particular, it is important to understand that a reprieve or moratorium on the payment of taxation amounts, or the acceptance of a payment arrangement, does NOT, on our assessment of the measures and the relevant case law, change the due date for payments – it merely defers the collection of those amounts to a later date.  The principal amounts remain due.

Why is this important?  Simply because any assessment of insolvency reverts to the predominant test of cash flow – can the business pay its debts as and when they fall due.

That assessment has turned in many case on ‘when does a debt fall due’?  Of crucial importance for directors is that line of authority that has prevailed in the past five years, arising from cases like Smith v Bone and approved in later cases, that has established the clear position that the entering into a payment arrangement with the ATO does NOT vary the due date of payment to align with the payments thereafter made.  The original due date remains the due date.

This leads neatly into discussions around when a company may have become insolvent and what transactions occurred whilst it was insolvent … in particular unfair preferences.

Crucially, directors generally ought alert to a ‘sleeper’ element that may contribute to their personal liability – unfair preference recoveries made against the ATO.

In circumstances where directors are actively considering engaging in a payment arrangement with the ATO, regard must be had for section 588FGA of the Corporations Act under which, should an order be made against the ATO to regurgitate an unfair preference payment to a liquidator, then each person who was a director of the company when the payment was made is liable to indemnify the ATO in respect of the amount of the loss of damage resulting from the order.

This rarely considered but often used provision is the one that most regularly causes directors surprise and anxiety in equal measure.  The effect of the provision is that, where the Company has paid amounts thereafter recovered from the ATO by a liquidator (those amounts often originating from the directors’ personal assets), the director is required to pay the amount again – effectively paying it twice!

No commitment has been made by the ATO during the current crisis to withhold from issuing DPN’s.

The ATO has announced that it may  “tailor solutions for …directors of businesses that are currently struggling due to coronavirus, including…withholding enforcement actions including Director Penalty Notices and wind ups.

Whether this announcement by the ATO actually translates into action to suspend or otherwise relax the issue of these notices is impossible to predict and certainly should not be relied upon.  Clearly there will be pressure on the government’s revenue base the longer the current situation persists and the collection of unpaid taxes has always been the ‘go-to’ when the time comes to prop up a Commonwealth budget or two.

This uncertainty also comes (inconveniently for directors) at a time when the recent passage of the anti-phoenixing measures legislation now equips the ATO with the ability to attach unpaid GST, to unpaid amounts of SGC and PAYG(W), in such DPN’s.

The clear message here is:

1st:          Keep ALL ATO lodgements up to date, even if you can’t pay right away.  This will eliminate the possibility of the ‘lock-down” or Type 2 DPN;  and

2nd:         Do all that you can to continue paying amounts due to the ATO on time to reduce or eliminate the ability of the ATO to consider issuing DPN’s.

Navigating this space is challenging enough in the best of times.  Adding an overlay of a global pandemic without a predictable end date makes it nigh on impossible to predict outcomes.

What is predictable is the value of early, quality advice.  Make contact today.  Gain insight.  Take control.  Manage.  Mitigate.  Move forwardTOGETHER.

Want to know more?

If you would like to find out more about the issues raised in this article, please contact Tony Lane, our Insolvency & Reconstruction Director, for assistance.

An Important Message

While every effort has been made to provide valuable, useful information in this publication, this firm and any related suppliers or associated companies accept no responsibility or any form of liability from reliance upon or use of its contents.  Any suggestions should be considered carefully within your own particular circumstances, as they are intended as general information only.

 

 

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