Since 2017, directors have had the benefit of a safe harbour from liability from insolvent trading. Subject to important conditions, they can now pursue plans to restructure a company which is thought to be insolvent to improve its financial condition, without needing to appoint a voluntary administrator. This is provided it is reasonably likely to lead to a better outcome than immediately appointing a voluntary administrator to liquidator.

On 25 March 2020, a new temporary safe harbour from liability for insolvent trading was introduced in the context of the current COVID-19 pandemic. This applies to debts incurred by the company in the ordinary course of its business on or after 25 March 2020 and for a period of at least 6 months.

How will Safe Harbour be implemented during the downturn prompted by COVID 19?

First, there needs to be a clear eyed understanding of the precise nature of the solvency challenges. Solvency goes principally to the company's working capital and cash flow position. Is this a temporary liquidity crisis, triggered by what are temporary and soluble challenges to supply chain, or has this exposed an existing and potentially fatal weakness in the company's financial position and prospects?

To secure the benefit of the temporary COVID-19 safe harbour, the directors must ensure that the debts are incurred in the 'ordinary course' of the company's business, that is, debts that are necessary to facilitate the continuation of the business during the COVID-19 safe harbour period. This would include, for example, a director taking out a loan to move some business operations online, and debts incurred through continuing to pay employees during the COVID-19 pandemic. Directors should follow the usual process of documenting all decisions to incur debts which may not clearly be within the 'ordinary course' to assist in them in being able to establish the COVID-19 safe harbour defence down the track, if necessary.

For debts that do not fall within the COVID-19 safe harbour, the directors will need to secure the benefit of the 2017 safe harbour. In order to do so, the directors must actually be developing courses of action that are reasonably likely to lead to the better outcome. Relevant factors here include obtaining advice from an appropriately qualified advisor, who is given sufficient information to give appropriate advice, and the development or implementation of a restructuring plan.

Key here will be whether these courses of action can be limited to waiting out the current circumstances, without doing more. Is this enough? We think not. It will be necessary and appropriate to take time to gather the facts, and then make a decision, but when doing so, the courses of action identified and taken must be focussed on achieving the better outcome in the relevant sense. Directors cannot make that decision without considering the counterfactual, that the company might be better off being placed into voluntary administration. Third party advice should be focussed on giving directors the facts, and a proper framework to make this critical decision.

Third, there are gateways which need to be satisfied before the 2017 safe harbour can be relied on, including the payment of all employee entitlements, by the time they fall due and the maintenance of appropriate taxation records.

Finally, the jury is still out on whether the course of action can include proceeding with a sale or other transaction for value, which leaves some or all the company's creditors unpaid, on the basis that they will still receive more than if the same transaction was implemented after the company was placed into external administration. Here the directors are exposed to particular risks, noting also the recent introduction of laws intended to defeat so called phoenix company activity, which focus attention clearly on the value that is derived.

For more information during the current situation

During this time of survival it is important to remember we are all in this together. Working with both sides of the supply chain will enable a better outcome for all parties. COVID-19 will pass and there may be an increase of demand to cope with before we get back to a level of stability. If you need advice on what options are available to you, our recovery team is able to assist.