Will the real zombie please stand up? The opportunity for directors to take control

In our post last week, we flagged the risk of a ‘zombie company’ pandemic, with the potential for entities that faced endemic operational and liquidity issues pre-COVID-19 to use government subsidies to continue to operate despite having no genuine prospect of successful, independent and sustainable trade post-crisis.

This trend is not confined to Australia – it is being seen across the globe. In the United States, for instance, there was an unexpected decline in insolvency filings of 35 per cent in April compared to the same period in 2019. Yet the moment the US Government’s $2 trillion relief package ends, United States Bankruptcy Courts are expected to see their biggest influx of cases in history, well beyond that experienced during the global financial crisis in 2008-2009. The zombies are clinging to life in the United States too, it seems.

However, let’s not forget that of course a company is an artificial entity. Behind it sit the directors who are the real ‘mind and will’ of the company.

Directors in Australia have been given a reprieve from insolvent trading liability until 25 September 2020 following the moratorium introduced by the Commonwealth Parliament in March in its initial COVID-19 response package. It would be a grave misstep for directors to think that continued operations in the absence of a plan (and in many cases, a restructuring plan), or ability, to achieve sustainable trade in the long-term will not have any personal liability implications.

Notably, despite the interim insolvent trading moratorium, directors are still subject to their ordinary general law and statutory duties under the Corporations Act. If directors continue to cause an unviable company to trade in such an uncertain economy, accumulating debts that one day will have to be repaid when the temporary loans and rent deferrals come to an end, there is a risk that they may not be acting reasonably, with due care and diligence, for a proper purpose and in good faith in the best interests of the company. After all, in times of doubtful solvency, it is the interests of creditors that the courts deem to be coextensive with the interests of the company. If creditors are never likely to be repaid as a ‘hopeless’ company continues, then ongoing trade is most likely to be prejudicial and in breach of directors’ core obligations.

For decades, courts have warned that the office of a director carries serious responsibilities – and, necessarily, serious risks. If directors are not willing to accept those risks, then they should not sign up to a directorship, plain and simple.

Directors must take an active interest in the company’s operations and ensure best practice corporate governance at every stage. This involves proactive forward thinking, a forensic approach to risk management and, as ASIC and APRA have keenly emphasised, a culture of compliance. The tone must be set from the top and a failure in an entity’s core values and responsible, ethical decision-making will inevitably filter down and infect every aspect of the operations of a company and those who deal with it.

Now is the opportunity for directors to show their true leadership in a COVID-19 economy. It is crucial to assess whether the hit to a company’s operations is a temporary sniffle or the symptom of a much deeper financial problem for which there is no realistic cure even as the economy scales back up to something remotely normal in the next 12 months. The government support will end sooner rather than later, with the Prime Minister last week warning that ‘the clock is ticking’. He has encouraged Australians and businesses to get out from beneath the metaphorical ‘doona’.

And when the support ends, will the company be able to stand on its own two feet and begin to repay every new debt incurred in this period of slumber?

Directors cannot make that assessment on their own. If you are sick, go to a doctor. If your car is faulty, go to a mechanic. And if your company is broken, call an insolvency practitioner – a restructuring expert who will be able to assess what the operational problems are and work to put in place a restructuring plan or recommend various insolvency alternatives.

Indeed, the insolvent trading safe harbour introduced in September 2017 is designed to provide an incentive for directors to do just that – pursue an informal workout if it has a reasonable prospect of success and is managed by an expert restructuring advisor, or otherwise place the company in voluntary administration or liquidation. This achieves the best outcome for the company and its creditors, while also serving as a ‘carrot’ in the form of protection from personal liability.

Directors should be well-attuned to this landscape, and the move towards more proactive engagement at an early stage with expert insolvency practitioners, and the courts – and the regulators investigating proceedings to begin with – are not going to accept COVID-19 as a blanket excuse for doing nothing.

Only by taking responsibility and control in this manner will directors be able to protect themselves from the risk of personal liability – enhanced in the current class actions landscape in Australia and with regulators continuing to monitor and enforce serious contraventions (even during COVID-19 – and fairly balance the interests of all of the company’s stakeholders in the short and long-term.

If directors do not respond in this manner, the conversation might turn to who the real zombie is in all of this.