How Directors can use Safe Harbour to Avoid Personal Liability During Corporate Distress

This article provides an overview of the safe harbour regime set out in section 588GA of the Corporations Act 2001 (Cth) and explain how the provisions operate as a critical governance tool to encourage directors of companies in financial distress to attempt to restructure or turnaround the business, rather than prematurely appointing an external administrator to avoid risk of personal liability.

Key takeaways

• The safe harbour provisions were introduced with the aim of alleviating fears held by directors as to insolvent trading liability.
• The regime affords directors sufficient latitude to develop a course of action that is appropriate in the context of the relevant company, having regarding to factors including the size, nature, complexity and financial position of the company.
• The Federal Government recently undertook an independent review of the impact of the availability of safe harbour, aimed at determining the effectiveness of the reforms and ensuring they remain fit for purpose.
• The safe harbour regime protects against personal liability under insolvent trading laws, and does not afford protection to directors from DPNs.

Elements of the safe harbour provisions

The safe harbour framework seeks to eradicate the risks faced by directors attempting to rescue a company facing financial decline, the risk of breaching director duties, and risk of an insolvent trading claim should the corporate turnaround be unsuccessful. 

Intended for companies that are genuinely trying to implement a solvent restructure, the regime encourages a move towards recovery rather than insolvency.

The "better outcome" test

Under the Act, safe harbour is available where a director, after beginning to suspect that a company may become or be insolvent, starts developing and is taking a course of action reasonably likely to lead to a better outcome for the company.

A company board that adopts a suitable safe harbour strategy will be eligible to rely on the strategy as an exception to any insolvent trading claim should the company enter liquidation.

A "better outcome" is broadly defined to mean "an outcome that is better for the company than the immediate appointment of an administrator or liquidator of the company".

The legislation specifies factors that a court may consider in working out whether a course of action is reasonably likely to lead to a better outcome for the company. These include whether the director is:

• properly informing himself or herself of the company's financial position; or
• taking appropriate steps to prevent any misconduct by officers or employees of the company that could adversely affect the company's ability to pay all its debts; or
• taking appropriate steps to ensure that the company is keeping appropriate financial records consistent with the size and nature of the company; or
• obtaining advice from an appropriately qualified entity who was given sufficient information to give appropriate advice; or
• developing or implementing a plan for restructuring the company to improve its financial position. 

Evidentiary burden on directors

A director who wishes to rely on safe harbour bears an evidential burden to bring evidence showing a reasonable possibility they were acting pursuant to the safe harbour. Importantly, the course of action taken by the director does not need to succeed.

The safe harbour protection will still apply to debts incurred during the course of action so long as it was still likely to lead to a better outcome at the time the decision was taken. Accordingly, directors are advised to document any course of action taken in response to suspected insolvency as soon as practicable.

Time limits

Safe harbour applies from the time the director develops the course of action until: 

• the director fails to take such course of action within a reasonable period of development;
• the director ceases to take any such course of action;
• the course of action ceases to be reasonably likely to lead to a better outcome; or
• an administrator or liquidator is appointed to the company.

When is the safe harbour protection not available?

To maintain the integrity of the regime and prevent its misuse, there are several preconditions to accessing safe harbour. Whilst safe harbour is a much-preferred outcome to insolvency, the safe harbour protection is not available to a director if:

• the debt is not incurred in connection with the proposed course of action; or
• the company is failing to pay employee entitlements; or
• the company is failing to meet its taxation reporting obligations.

Do the safe harbour provisions provide protection from DPN's?

Notwithstanding that a company may be in safe harbour, the ATO retains all rights, including the right to issue a DPN, to a director whose company has failed to pay GST, PAYG and SGC obligations when due and payable.

What is a Director Penalty Notice?

A director penalty notice (DPN) operates as a debt collection tool utilised by the ATO to recover unpaid tax debts. There are two types of DPNs: non-lockdown and lockdown DPNs. Ordinarily, once a non-lockdown DPN is issued, a director will have 21 days to either:

• appoint an administrator;
• commence winding up the company; or
• pay the company's debts stipulated in the DPN.

Once 21 days has elapsed, the ATO is entitled to commence legal proceedings against a director to recoup the penalty if the director has failed to successfully complete one of the above mentioned actions.

Personal liability may only be avoided by a director who has received a lockdown DPN if the debt is paid by the company within 21 days of receipt.

Whilst there are limited defences available to a director in receipt of a DPN, it is practically difficult to establish a defence likely to be accepted by the ATO.

Personal liability of directors in safe harbour

In the event that a director's turnaround plan is unsuccessful, the director remains personally liable for any liabilities owed under DPNs, meaning that directors face the possibility of the loss of personal assets. In view of this, many consider there to be little incentive for directors to substantively engage with the safe harbour regime, as approaching an appropriately qualified adviser for assistance may not eliminate their personal liability.

However, the appointment of a Safe Harbour adviser may be taken into consideration for existing DPN defences, as such appointment may indicate that a director has taken 'all reasonable steps' to ensure that the company paid the amount outstanding.

The future of safe harbour

On 24 March 2022, the Federal Government released its highly anticipated report following an independent review of the effectiveness of the safe harbour provisions.

Acknowledging the complexity of the existing safe harbour framework, the Government agreed to implement nine key changes, including the following:

1. The introduction of a concept of financial distress, relieving directors of the difficulty in establishing solvency and insolvency.
2. The creation of a plain English 'best practice guide', developed in consultation with key industry bodies.
3. The requirement for a director to deliver all books and records in their possession relating to the company; and
4. Changes to the requirements for mandatory tax and employee compliance, with 'substantial compliance' now only needed.

Whilst these changes are highly welcomed by companies and other stakeholders, it is presently unclear when the proposed changes will come into effect. As such, directors must continue to comply with its tax and employee obligations and seek immediate advice on safe harbour in circumstances of financial distress.