Private, tightly held companies are particularly vulnerable to unforeseen internal crises.  The precipitating event may be the unexpected death or incapacity of a director/ shareholder, personal or financial pressures on a director/shareholder leading to the need for immediate access to their equity in the business or a falling out between directors/shareholders which may itself have been triggered by an earlier crisis such as the sudden loss of critical staff, components or  materials supplier or of a major customer or major damage to plant or equipment or an IT catastrophe.

Some shareholder agreements contain robust dispute resolution and buy-out mechanisms that can be brought into play but many are primitive or non-existent. It is argued here that in such cases the Safe Harbour provisions of the Corporations Act, designed to provide defences to directors against insolvent trading, can provide access to the skills and experience of an independent third party, a safe harbour advisor and thus be a useful framework within which to preserve the company, while solutions are identified and implemented.

‘Safe harbour’ provisions – what are they and how do they operate?

The ‘safe harbour’ provisions were introduced to give directors a safe harbour within to develop a course of action to save the company. They operate to protect directors from insolvent trading claims where directors have engaged in a course of action that is found to have been reasonably likely to have led to a better outcome for the company than immediate administration or liquidation (better outcome test). That is, they are a defence rather than a sword although given the way they operate, Safe Harbour does provide a framework for directors wishing to turn around distressed companies and it is this framework that I argue can be applied more generally to companies in crisis.

The defence has three themes. The first two are mandatory while the third is not but is a matter that will be taken into account by a Court in deciding whether to apply the defence. Those themes are:

  • the company must remain up-to-date with its tax affairs and payment of employee entitlements;
  • the better outcome test must be satisfied and in considering that test, the Court may have regard to the criteria set out in s 588GA; and
  • directors may obtain advice from “an appropriately qualified entity” who was given sufficient information to give appropriate advice.

The s 588GA criteria are that a director has:

  • properly informed himself or herself of the company’s financial position;
  • taken 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;
  • taken appropriate steps to ensure that the company is keeping appropriate financial records consistent with the size and nature of the company; and
  • developed or implemented a plan for restructuring the company to improve its financial position.

To a significant extent, these requirements simply mirror good governance and are no more than good corporate hygiene. Further the s 588GA criteria provide a structure within which a plan can be tailored to each company and then amended or adjusted as events unfold but it is the idea of advice from an appropriately qualified entity that adds the extra dimension and may give the Court comfort that the workout plan was reasonable and satisfied the better outcome test bearing in mind that despite everyone’s best efforts the company did go into liquidation (as otherwise the defence would not arise) so the Court has to take a view about decisions made while the company was insolvent.

So who could give that advice?

The concept of ‘appropriately qualified entity’ is not defined in the legislation, so potentially, it could cover not only registered liquidators but also accountants, lawyers or even bankers with restructuring and turnaround expertise. However, the word ‘appropriately’ suggests proportionality between the size and complexity of the company and the appointee’s background, resources and experience.

It is also possible that the safe harbour advisor could be a joint appointment involving a company’s trusted advisors (its accountant and/or business lawyer) and an appropriately qualified entity (which could be a company or individual).

How could Safe Harbour operate for companies in crisis?

Safe Harbour offers a framework within which outcomes can be developed and may be especially useful where there is no, or only an inadequate, shareholder or joint venture agreement. It may be light touch or become a major exercise depending upon the nature of the crisis, current circumstances of the company and availability of feasible solutions. Safe Harbour is a dynamic process within a structure that is outcome focussed (achieving an outcome that is better than liquidation) designed to be tailored as required.

Where a safe harbour advisor is appointed, they do not take over the company although they may recommend the appointment of an interim chief executive to ensure that there is an experienced hand at the helm if that is absent

But why Safe Harbour where insolvency is not an immediate concern? Faced with a crisis, many directors are ill-equipped to develop and agree a workout framework and indeed may be reluctant to agree to anything with co-directors who are becoming opponents so the opportunity to utilize a structure and role created by legislation expressly to protect directors may be very beneficial.

Further directors embroiled in  internecine conflict often resist the idea that  even directors in one or two director companies owe duties to the company that are separate to their own interests (Australasian Annuities Pty Ltd (in liq’n) v Rowley Super Fund Pty Ltd [2015] VSCA 9 – 12 February 3015) but that resistance may diminish where the legislation articulating this duty also provides a mechanism for discharging that duty while potentially giving directors protection from insolvent trading claims.

Seeking a Safe Harbour may also of itself act as a circuit breaker by refocusing attention away from the immediate demands of the crisis to the needs of the company!

Using a Safe Harbouradvisor also introduces a skilled, independent third party into the mix which may give reassurance, calm fears, re-establish day-to-day equilibrium, ensure adequate information flow and preserve staff morale all assisting to maintain the value of the directors’ investment and the longevity of the company. The presence of a respected stranger may also moderate or temper behaviours therefore facilitating an environment where solutions may be found.

Where the crisis was triggered by the sudden death or incapacity of a director/shareholder, going into safe harbour may place the company into a holding pattern preserving value while the stakeholders trigger buyout mechanisms or otherwise craft a solution. This may be especially useful where due to the unforeseen nature of the crisis, the surviving director/shareholder may be unable to respond to a tight contractual buyout timeline but is the obvious purchaser of the other shareholder’s interest. If stakeholders have the comfort that the company is ticking along, creative solutions can be crafted possibly with the help of a Safe Harbour advisor.

Where there is disagreement between stakeholders, a Safe Harbour advisor may facilitate dispute resolution by providing avenues of communication between the parties or if necessary, acting as a go-between or engaging a mediator or an expert adjudicator if appropriate.

It is also possible that the Safe Harbour exercise could enhance shareholder value if in consequence, fat is trimmed, administrative and management practices are updated and business strategies are revised and refreshed.

Where directors act quickly and the issue is confined, they may only require a temporary or light touch Safe Harbour but sometimes, a crisis brings on other issues and the problem escalates so more dramatic intervention is required.

How would Safe Harbours operate for a company in crisis?

The defence requires the directors to implement a restructuring plan.

Where a Safe Harbour advisor is appointed, that advisor may:

  • review financial records for regulatory and ‘safe harbour’ compliance and if necessary, recommend steps to improve compliance;
  • assess current and future liabilities, available cash flow and advise whether any liabilities can be renegotiated, deferred or avoided;
  • assess staff requirements, advise regarding any skills shortages and assist in developing company re-organization proposals;
  • advise about prospects and threats to the business;
  • give insolvency advice if required;
  • identify areas where specialist advice may be required and if necessary, assist the company to procure that advice;
  • facilitate the appointment of an interim chief executive, if required;
  • assist in negotiations with bankers and financiers;
  • obtain legal advice regarding the legal exposures of the business including employment, supply contracts, IP, leases, financing and directors’ guarantees among others;
  • assist in identifying director and shareholder objectives then develop restructuring options to meet those objectives which may include enabling parts of the business to be disaggregated or shut down or sold with a view to satisfying the better outcome test;
  • enable financial modelling to facilitate identification of buyout options for the parties if they are on the table or assist a party to find another investor/business partner;
  • assist in the development of a restructuring plan that satisfies the better outcome test and includes agreed criteria against which success will be measured;
  • if requested, assist in a sale process; and
  • monitor implementation and then recommend variation and amendment as required, as events unfold.

In some cases, only a few of these may be necessary and only light touch at that however this list illustrates the potential benefits of appointing a safe harbour advisor.

Through Safe Harbour, a skilled third party or parties can be introduced to a company in crisis, enhancing the prospects of finding a solution at the same time preserving the company and protecting directors from insolvent trading.

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This article is for general information purposes only and does not constitute legal or professional advice.  It should not be used as a substitute for legal advice relating to your particular circumstances.  Please also note that the law may have changed since the date of this article.