Insolvent Trading During COVID-19

Disputes and Insolvency

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DATE PUBLISHED: April 30, 2020

The coronavirus economic response package has provided directors with temporary relief from personal liability if a company is trading insolvent. These changes encourage businesses to keep trading even if they have been adversely affected by the economic shutdown associated with the coronavirus epidemic.

What changes have been made?

A new ‘safe harbour’ provision providing specific relief in response to coronavirus has been included in the Corporations Act 2001. The new section allows for directors to incur debt without contravening the duty to prevent insolvent trading (even where there are grounds to suspect insolvency) where the debt was incurred:

  • in the ordinary course of the business;
  • during the 6 month period commencing 25 March 2020 (or any period extended by the regulations); and
  • before any appointment of an administrator, or liquidator, of the company during that period. 1

These new changes will apply for 6 months commencing 25 March 2020.

The safe harbour provision also extends to holding companies. A holding company is not liable if the temporary safe harbour provision applies to the subsidiary company, each director of that company and the debt incurred.2 The holding company must take reasonable steps to ensure that the safe harbour provision applies to the subsidiary company.   

What is considered as 'the ordinary course of business'?

The explanatory memorandum to the Coronavirus Economic Response Package Omnibus Act 2020 provides guidance as to when a debt is considered to be incurred in ‘the ordinary course of business’. The memorandum states:

“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 period that begins on commencement of the subparagraph. 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.”

What do these changes mean?

The effect of these changes is to encourage directors, for the time being, to cause companies to continue trading without fear of personal liability for insolvent trading.

Many companies have suffered substantial revenue reduction, which has caused them to become insolvent within the meaning of the corporations legislation. The impact in many cases may have been so severe that the company is unable to rely on the existing ‘safe harbour’ protections, which amongst other things require that the company is paying the entitlements of employees as and when they fall due.

The temporary safe harbour provision introduced as part of the Federal Government’s coronavirus relief package is much broader in application and will allow directors to endeavour to keep the company trading whilst it is temporarily unable to meet its payment obligations.

Directors are not however permitted to cause the company to incur debts outside the ordinary course of business and should not seek to improperly utilise the temporary protection to gain an advantage for themselves or someone else which is not connected with the company’s usual operations. Directors should also avoid incurring debts for the purpose of pursuing speculative business opportunities which are unnecessary to facilitate continuation of the business, as these actions may fall outside the scope of the protection. 

1 Corporations Act 2001 (Cth) s 588GAAA.

Corporations Act 2001 (Cth) s 588WA(1).

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