Safe harbour from insolvent seas
Laws to protect stakeholders in the event of insolvent trading are vital. However, the current law can work against the best outcomes for the company, shareholders and creditors. Directors should have the option of attempting to trade the company out of financial difficulty when it is in the best interests of stakeholders. The Australian Institute of Company Directors has a long-held view that a broad business judgement rule (BJR) defence for directors based on section 180 of Corporations Act 2001 is an important part of addressing the issue.
Background
Minister for Corporate Law Chris Bowen released the Treasury discussion paper, Insolvent trading: A safe harbour for reorganisation attempts outside of external administration, in January 2010 for comment. He notes in the paper that concerns have been raised that the laws regarding insolvent trading may negatively affect genuine work-out attempts. The paper canvasses three options for reform – maintaining the status quo, adopting a modified BJR for a director’s duty to avoid insolvent trading or adopting a moratorium for insolvent trading for work-outs.
Section 588G of the Corporations Act provides that a director will be personally liable if the company incurs a debt when it is insolvent or becomes insolvent by incurring debt. Breaches of the section expose a director to civil penalties of up to $200,000, liability to compensation and in cases warranting criminal prosecution, a fine of up to $200,000, imprisonment for five years or both.
There are a number of defences in section 588H but they are based on a director being able to prove that he or she reasonably believed that the company was solvent when a debt was incurred or was unable to prevent the debt being incurred. Even if a director is not found personally liable, he or she will suffer the reputational damage and incur significant legal costs in defending the claim. It is unlikely that such a director will remain or secure future directorships, which are not a good economic outcome for Australia.
An issue to be addressed
The effect of the law is clear from the results of the December 2008 Australian Institute of Company Directors/Federal Treasury survey of directors of top 200 listed companies (details can be found on our website at www.companydirectors.com.au). The survey highlighted the dampening effect of personal liability on board decision-making, retention and recruitment.
Indeed, 45 per cent of survey respondents said the duty to prevent insolvent trading was responsible, to a medium to high degree, for an overly cautious approach to decision-making. This result was measured only second to the contribution that derivative liability laws and continuous disclosure obligations had. Some 46 per cent of respondents thought there were not reasonable defences and “safe harbours” for directors for insolvent trading.
Adopt a broad BJR
Our preferred position is that a broad BJR defence should be available to a director for breaches of section 588G and other Corporations Act provisions where the director made a business decision in good faith, was informed about the subject matter of that decision to a reasonable extent and had a reasonable belief that the decision was in the best interests of the company. The defence reflects the BJR in section 180(2) of the Corporations Act with two important differences: the director is not precluded from using it if he or she has a material interest in the judgement and the plaintiff bears the onus of proof that the defence is not made out.
Other approaches
We have concerns about the modified BJR defence proposed in the paper. For example, a director would need to prove the financial accounts and records of the company presented a “true and fair picture” of its financial circumstance each time the defence was invoked. However, the term “true and fair view” is unclear and proving it each time could be onerous. Even if a director obtained an opinion from a reputable accounting firm (itself an expensive and time-consuming process unlikely to be undertaken by small to medium-sized enterprises), a court could disagree with that opinion or decide it was correct but did not relate to the precise time in question.
The concerns regarding the insolvent trading laws can be substantially addressed through our broad BJR defence based on section 180 of Corporations Act without the additional elements proposed through the modified BJR defence. Without a broad BJR, other approaches will not be effective. Alternative approaches should not be discounted but we recommend that a Treasury stakeholder working group be established to examine the development of these.
Gabrielle Upton FAICD is Legal Counsel at the Australian Institute of Company Directors. She is a member of the Corporations and Markets Advisory Committee (CAMAC) and a visiting Fellow at the UNSW Law Faculty