Navigating the troubled waters of directors' duties during COVID-19

The increasing pressure directors now face to ensure they don’t allow a company to trade-while-insolvent is high among the many severe impacts on Australian businesses of the COVID-19 crisis.

Directors need to be fully aware of their legal duties and take action to mitigate personal risk, ranging from personal liability for company debts to other civil and even criminal penalties.

There is some relief to be found in the federal government’s new COVID-19 safe harbour from insolvent trading liability, which applies to relieve directors of liability for insolvent trading from 25 March onwards for a period of six months where debts are incurred in “the ordinary course of business”.

But directors should be careful in understanding what exactly this means: any transactions outside the ordinary course will also be outside this particular safe harbour. Almost by definition, major restructuring transactions may well be out of the ordinary course.

This presents a conundrum for directors wanting to do the right thing by attempting to turnaround or restructure their businesses.

To get protection, they will need to ensure that they adhere to the requirements of the more stringent safe harbour provisions which existed before COVID-19 (BC).

To get the BC safe harbour protection, directors must start taking steps to put their companies on a course to achieve a “better outcome” than administration or liquidation.

The company must continue to meet obligations to meet employee entitlements and continue tax reporting obligations, although Government financial assistance measures and ATO administrative concessions might lessen the burden.

The BC safe harbour provisions provide some guide rails as to the kinds of things that would be taken into account – such as obtaining advice and developing a restructuring plan. But ultimately it is a bespoke process which needs to be tailored to the particular circumstances of each business.

Directors should also be aware that they have other ongoing and BC duties, including statutory duties which have been enacted only in the last 12 months.

The first category of these are the duties that are well known to most directors and include things like the duty to exercise care and diligence and the duty to act in good faith in the best interests of the company. In a situation of financial instability or near insolvency, these duties mean that a director is required principally to have in mind the interests of the company’s creditors as a priority.

The second category of these are duties legislated over the last year.

The Government’s phoenixing legislation, passed in February this year, imposes a duty on company directors to avoid transactions where the amount received by the company is less than the market value of the assets or the best price obtainable in the circumstances. Market value is very often an arguable proposition and this duty will generally require embarking on a sales process that can be objectively tested as having achieved the best price.

Last year, the Government legislated to prevent its generous scheme to pay out employee entitlements of insolvent companies from being used as a defacto form of restructuring finance. It imposed duties on directors to avoid any transactions that could lead to employees being worse off if liquidation were to eventuate.

Directors need to take particular care about employee liabilities that might crystallise in a liquidation context but which are not presently due and payable (for example, redundancy or long service leave entitlement).

If all of this sounds complex, it is because it is. In the fast moving and changing circumstances of COVID-19, directors might be more inclined to appoint administrators to avoid liability. That is not necessarily a bad thing.

While company directors often view such a step as a last resort, administration can often provide an opportunity to restructure a business’ liabilities, capital structure and in some cases equity structure for the benefit of the business.

If employed strategically, using the period of the COVID-19 safe harbour to plan and prepare, administration may enable a business to achieve positive outcomes. This is not just good for directors but good for their businesses.

In the COVID-19 business environment, creditors, suppliers, landlords, shareholders, customers and other key stakeholders are likely to show a greater degree of flexibility towards, and acceptance of, an administration process than might usually be the case, providing greater opportunities for successful administration outcomes.

Under the Coronavirus Economic Response Package Omnibus Act 2020 (Cth), the Treasurer has been given power to temporarily amend provisions of the Corporations Act to provide relief from specific obligations or to modify obligations to enable compliance with legal requirements during the crisis. The power will apply for six months from the date it is made. Further details about this are expected to be announced in the near future. These measures are likely to enhance restructuring options for businesses and will need to be considered carefully by directors.

There is already much flexibility in the voluntary administration process with Courts having a quasi-legislative power under section 447A of the Corporations Act to “re-write” the voluntary administration provisions of the Corporations Act as required to better suit the restructuring in question.

In the COVID-19 business environment, it is reasonable to expect the courts to show some appetite for exploring innovative and creative proposals for business preservation and restructuring using this power.

Directors should re-think the overly negative stigma attached to administration. They should recognise this unique chance to take bold action and convert the challenges presented by COVID-19 into an opportunity for a better future for their businesses.

Read our COVID-19 directors' guide to avoiding personal liability in circumstances of a company's financial distress and possible insolvency here.