Insolvent Trading Relief For Directors
With COVID-19 has come unprecedented challenges and financial hardship for many businesses, including the threat of insolvent trading.
A company is insolvent if it is unable to pay all its debts as and when they fall due. There are various early warning signs directors and their advisors may observe, some of which are set out here.
The Federal Government has made temporary legal changes relating to insolvent trading for the period of the COVID-19 pandemic, providing some relief to businesses who may be struggling in the current environment.
What is insolvent trading?
Insolvent trading is when a company is unable to pay all of its debts as and when they fall due and continue to trade, incurring further debts. A director has a duty to prevent their company from trading if it is insolvent. If they fail to do so, they can face a variety of penalties:
- Civil penalties of up to $200,000
- Compensation proceedings
- Criminal charges which can lead to a fine of up to $220,000 or imprisonment for up to 5 years, or both
Given the current impact of the COVID-19 pandemic, it is highly likely that businesses’ liquidity will be significantly affected and some may be on the brink of insolvency. It is therefore important for directors to be aware of the legislation passed by the Federal Government on 23 March 2020, providing them with temporary relief should they choose to continue to trade through the current circumstances.
Temporary safe harbour
The Coronavirus Economic Response Package Omnibus Act 2020 introduced a number of temporary relief measures for financially distressed businesses and individuals, some of which are set out here. One of these measures grants temporary safe harbour for directors from insolvent trading.
Directors have been given six months relief from their duty to prevent insolvent trading, being from 25 March 2020 to 25 September 2020 unless otherwise extended. This relief will only apply to debts incurred in the ordinary course of the company’s business.
What does debts incurred in the ordinary course of business mean?
A director is taken to incur a debt in the ordinary course of business if it is necessary to facilitate the continuation of the business during the six month ‘relief’ period. 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.
The Federal Government has provided information and some examples to illustrate how this may apply to your company and your situation. Further information can be found from the Government’s website here.
What does this temporary change not mean?
Of note is that this does not remove the requirement to repay any outstanding debt – the company will still remain liable for all debts incurred.
Directors and their advisors should also be aware that this temporary reform and relief does not relieve company directors’ from continuing to comply with their general director duties as imposed by the Corporations Act including that of directors to act with care and diligence, in good faith in the best interests of the company and to not improperly use their position or information received for personal gain.
What should I do now?
Now is the time to assess the financial position of your company and consider whether it is appropriate to take steps to:
- restructure your balance sheet;
- ‘right-size’ your business to tackle post-COVID-19 market conditions; or perhaps
- cease operations to conserve owner wealth to enable a new ‘startup’ entity to flourish once market conditions improve
We understand that these are challenging times for all businesses no matter how big or small.
Should you have any queries in relation to the temporary safe harbour or what this may mean for your company after the conclusion of the 6 month relief period, please do not hesitate to contact our office for further assistance.
