Insolvency Update: Uncertainty about director COVID-19 protections from insolvent trading

There is a looming, although little publicised, risk for companies and specifically their directors, in relation to the expiration of the COVID-19 safe harbour protections.

Subject to any further extension, or amendment, the current protection will apply only if directors make an external appointment (i.e. administrator or liquidator) prior to 31 December 2020.

All companies, and their directors, who have traded during the COVID-19 period in reliance on the protections are encouraged to urgently consider the application of this risk to their circumstances and take advice.

The COVID-19 moratorium and risk for directors

As is well known, the Federal Government made emergency amendments to insolvency laws which include protection from insolvent trading liability (COVID-19 Protection). The COVID-19 Protection presently expires on 31 December 2020.[1]

It appears that many stakeholders have assumed that the COVID-19 Protection would be available absolutely, and in relation to any debts incurred by companies in the period from 25 March 2020 until 31 December 2020.

It has recently become apparent,[2] however, that the COVID-19 Protection will only apply if directors take protective action prior to 31 December 2020. This is explained below.

There is some prospect that this is an unintended consequence of the emergency amendment provisions, and a legislative fix may emerge prior to 31 December 2020.[3]

Absent that fix, directors are in the uneasy position of having to decide whether to appoint an external administrator or liquidator to obtain protection from insolvent trading liability.  That raises countless issues, not the least of which is the difficulty in assessing a company’s solvency position, and prospects, in an uncertain trading environment.

The ‘true’ safe harbour protection gap

The COVID-19 Protection can be described as a form of temporary ‘safe harbour’ protection. It provides ‘safe harbour’ in relation to any debts incurred in the in the period from 25 March 2020 until 31 December 2020 (subject to the above proviso).

This can be contrasted to the ‘true’ safe harbour provisions which provide protection for any debts incurred.

There are strict requirements that a company must adhere to avail this protection and more information about the true safe harbour laws can be found here.

Regardless, there may be a gap period if directors seek to invoke true safe harbour protection (without also making an external appointment for the purposes of the COVID-19 Protection). That is because the true safe harbour provisions only apply to debts incurred during the period in which a company invokes the true safe harbour provisions. For example, if true safe harbour is invoked on, say, 1 November 2020, there will be no protection for debts incurred from 25 March 2020 until 31 October 2020 (absent an appointment of an administrator or liquidator prior to 31 December 2020).

Explanation of COVID-19 Moratorium risk

The COVID-19 Protection was introduced by inserting section 588GAAA into the Corporations Act 2001 (Cth). That section reads:

Subsection 588G(2) does not apply in relation to a person and a debt incurred by a company if the debt is incurred:

• in the ordinary course of the company’s business; and
• during:
  • the 6-month period starting on the day this section commences; or
  • any longer period that starts on the day this section commences and that is prescribed by the regulations for the purposes of this subparagraph; and
• before any appointment during that period of an administrator, or liquidator, of the company.

Section 588GAAA(c) therefore has the effect that directors must make an appointment by 31 December 2020 in order to obtain the protection from insolvent trading liability.

[1] Subject to exceptions for entities with debts under $1million who enter into a restructuring plan, as detailed in our note dated 25 September 2020, available here.

[2] See Stephen Mullete, ‘When your safe harbour leads to a waterfall’ (2020) 20(9) Insolvency Law Bulletin 180.  

[3] ARITA and other industry bodies are making representations to Treasury about a fix.

Special thanks to Jon Patty, Senior Associate and Laura Sclavos, Graduate for their assistance in putting this article together. 

This publication covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. It is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.