Legal Insights

Softening the financial blow of COVID-19: Sweeping temporary changes made for directors and debtors

By Sam Kingston & Mathew Gashi

• 07 April 2020 • 5 min read

Yesterday, the Federal Government announced the following temporary measures for financially distressed businesses:

  • increasing the minimum amount for a creditor to issue a statutory demand to a company from $2,000 to $20,000;
  • increasing the threshold at which a creditor can initiate bankruptcy proceedings from $5,000 to $20,000;
  • increasing the time both companies and individual debtors have to respond to statutory demands or bankruptcy notices from 21 days to 6 months; and
  • relieving directors from their duty to prevent insolvent trading with respect to any debts incurred in the ordinary course of the company’s business. In effect, absent some “egregious dishonesty or fraud”, directors may avoid personal liability for insolvent trading regardless of whether they have been taking “safe harbour” steps. Holding companies may also avoid liability for insolvent trading by subsidiaries.

The temporary measures are intended to apply for a period of 6 months from commencement of the enabling legislation[1] and are in addition to the various stimulus packages and other measures that have recently been announced. For example, it is also intended that the ATO will adopt more “tailored” solutions for business that are struggling in the pandemic which relevantly includes withholding taking certain enforcement action such as issuing Director Penalty Notices and winding up proceedings.

The temporary measures were introduced to parliament today and while they are not yet law they have already been welcomed by many. It is clear that decisive action and some flexibility is necessary to support business through the current crisis. The immediate impact of these measures is difficult to predict, particularly until the final form of any law is known.[2] However, at this stage the following observations can be made:

  • Maddocks’ recent articleThe Safe Harbour regime may assist businesses navigating the effects of COVID-19, but directors need to start now” comments on the defence to insolvent trading claims already available to directors where they were taking genuine steps to produce a better financial outcome for the company as opposed to the appointment of a liquidator or administrator. One of the intentions of those reforms was to encourage directors to seek appropriate advice at an earlier time. Notwithstanding any further limitation on personal liability, directors should still seek advice at an early stage;
  • It appears that, absent dishonesty or fraud, directors will have blanket relief from their duty to ensure a company does not trade whilst insolvent. Some commentators have already suggested that relaxing some of the pre-conditions to safe harbour (such as payment of employee entitlements and compliance with tax reporting obligations) may better achieve the objective rather than a blanket exemption;
  • It appears that directors’ other duties remain unchanged and directors will still need to consider whether debts are being incurred in the “ordinary course of business”. In what is universally acknowledged to be unprecedented circumstances, this concept may be significantly broader then previously envisaged;
  • It also appears that the voidable transaction regimes will not be affected. In circumstances where many businesses are forced to close their doors but continue to trade in some capacity it is likely to be difficult for a creditor to argue that they have not received an unfair preference payment and have no grounds to suspect that the debtor was insolvent;
  • The reforms do not consider the position where, for example, a company was insolvent or on the brink of insolvency before these reforms commence. On one view of it, there will be a significant increase in “zombie” companies who will continue to trade (albeit in a limited capacity given the current restrictions);
  • Although the reforms do not excuse debtors from paying their debts, and creditors may pursue debtors “through the courts”, a company that has routinely been unable or unwilling to pay creditors on time now has no incentive to do so. The temporary measures mean suppliers are at risk of carrying outstanding debts for a long period of time, which may affect their own financial position. It seems highly likely that many suppliers will revise terms to, for example, move to cash on delivery, reduce credit limits or supply on retention of title terms. If they were not already, suppliers should consider their terms of trade immediately;
  • The Federal Government has separately referred to reforms to tenancy legislation to restrict landlords’ rights. The scope of those reforms are also unknown, but landlords potentially face a very difficult period if they are prevented from recovering both possession of their properties and debts owing to them; and
  • The Government’s announcement does not comment on any implications for secured creditors and at this stage it appears that only unsecured creditors will be affected. Banks have made it clear that they will support businesses, but the position of non-bank lenders and other financiers such as those in equipment finance are less clear.

It should be noted that the temporary measures also include flexibility for the Treasurer to make further amendments to the Insolvency Law as the pandemic continues. The situation continues to develop, and it will be interesting to see if this power results in any further measures being brought in.

Maddocks has produced guides to a range of legal issues raised by the coronavirus (COVID-19). You can access these guides here.

Need help responding to COVID-19?

Get in touch with the Restructuring & Insolvency team.

By Sam Kingston & Mathew Gashi

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