Safe Harbour Reforms
Section 588G of the Corporations Act 2001 (Cth) (Act) creates obligations for directors of a company to prevent the company trading whilst insolvent. Directors must ensure that their company is not insolvent when it incurs a debt, and that it does not become not insolvent as a result of incurring a debt.
Prior to the change in law, under s588G(2) of the Act, a company director would be held personally liable for insolvent trading if:
- they were a director at the time when their company incurred the debt.
- their company was insolvent at that time, or became insolvent by incurring the debt; or
- at that time, there were reasonable grounds for suspecting that their company was or would become insolvent.
This personal liability became an issue as company directors in financial distress would appoint administrators or liquidators without trying to save their company. The government therefore addressed this issue with the reforms to the Act.
Since the introduction of s588GA to the Act, directors are now safe from being personally liable for a company’s insolvency if (amongst other matters):
- they are developing one or more courses of action that are reasonably likely to lead to a better outcome, that is, a turnaround strategy;
- the debt(s) incurred are connected with the turnaround strategy; and
- the action(s) taken by the director will lead to a better outcome that is better for the company than the immediate appointment of an administrator or liquidator to the company.
The strategies may include (but are not limited to) negotiating with creditors, restructuring the business, refinancing, or selling off part of a business with the assistance of qualified professionals such as lawyers, accountants and turnaround specialists.
‘Ipso Facto’ rights in contracts
An ‘ipso facto’ clause within a contract creates a right that allows one party to terminate or modify a contract upon the occurrence of some specific event, even if the other party is in compliance with all of its obligations under the contract.
When a party to a contract encounters financial difficulty, there are likely to be certain ipso facto rights given to the other party. For example, a typical contract may state that if a party becomes insolvent, then the counterparty may exercise one or more of the following rights to improve or protect their position:
- Suspend the works or take the works out of the insolvent party’s hands .
- Terminate the contract on the grounds of the other party’s insolvency.
- Call upon a bank guarantee or other security.
The operation of ipso facto clauses attracted criticism for reducing the scope for a successful restructure, preventing the sale of businesses as a going concern and reducing or eliminating returns in insolvency due to the destruction of value held in the company’s contractual arrangements. Due to the reform, the ipso facto rights in a contract entered into after 1 July 2018 will be unenforceable against the counterparty if those rights arise as a result of:
- the administration, receivership or proposed scheme of arrangement of the counterparty;
- the credit rating of the counterparty;
- a breach of financial covenants by the counterparty; or
- any other matter which is based on the counterparty’s financial position.
This reform is also aimed at enabling businesses to continue trading and maintaining their existing valuable contractual arrangements in order to recover and restructure from an insolvency event.
If you require further information in relation to the reforms or would like assistance with your contracts or other arrangements please feel free to call the Partners of Marsdens Law Group,
Justin Thornton email@example.com or
Rahul Lachman firstname.lastname@example.org on 4626 5077
both of whom are the only Accredited Specialists in
Business Law in the Macarthur Region.
By Rahul Lachman Partner, Marsdens Law Group
Accredited Specialist in Business Law