Temporary relief from directors’ duty to prevent insolvent trading due to Covid-19

Temporary relief from directors’ duty to prevent insolvent trading due to Covid-19

Covid-19 has presented new challenges for directors as they navigate unchartered territory. Due to the pressure placed on businesses by Covid-19, the government introduced the Coronavirus Response Package Omnibus Act 2020 (Cth) which came into effect on 25 March 2020. One of the measures introduced was a safe harbour provision from the directors’ duty to prevent insolvent trading (section 588GAAA).

What is the director’s duty to prevent insolvent trading?

Under the Corporations Act 2001 (Cth), directors have a duty to prevent insolvent trading

  • When the company is insolvent; or
  • When, by incurring the debt, the company becomes insolvent; and 
  • There are reasonable grounds for suspecting, at the time of incurring the debt, that the company is insolvent or will become insolvent (section 588G(1)). 

A company is considered insolvent when it is unable to pay its debts as and when they are due. 

When a director breaches this duty, they may be held personally liable for losses the company incurred while it was insolvent in addition to other civil penalties such as disqualification from managing a corporation for a period of time. 

There is a pre-existing safe harbour defence in section 588GA which prevents directors from being held personally liable for insolvent trading when the director is taking action which is reasonably likely to improve the outcome for the company than the immediate appointment of an administrator/liquidator.  

In that case, what is the effect of this safe harbour provision?

The Covid-19 safe harbour provision provides increased protection from personal liability to directors during the relevant period as the requirements are easier to meet than the pre-existing safe harbour defence. 

It is hoped this safe harbour provision, among other measures, could help companies survive the economic hit of the coronavirus. 

When does the safe harbour provision apply?

The safe harbour provision applies as of 25 March 2020 for a period of 6 months or longer if provided for in the regulations. At the time of writing, this measure has been extended until 31 December 2020

To rely on the safe harbour provision, the debt must be incurred:

  • In the ordinary course of the company’s business; and 
  • During the 6-month period or longer dependent on the regulations; and
  • Before the appointment of an administrator or liquidator is appointed during the safe harbour period

Other duties still apply

Other directors duties continue to apply and so directors should exercise care even in light of this safe harbour provision. For example, a director may still breach their duty to act in the best interests of the company as a whole and/or their duty to act with due diligence, care and in good faith even if they cannot be held liable for insolvent trading. 

Key takeaway

Until 31 December 2020, a safe harbour provision protects directors from personal liability for insolvent trading. However, other directors duties continue to apply, and so decisions to trade insolvent companies should be made in light of those duties and potential liabilities. Court’s may excuse directors for breaching their duties if they have acted honestly and in good faith. In this period of uncertainty, those principles should continue to guide directors.

About Brigid Nelmes

Brigid NelmesBrigid is a legal intern at OpenLegal, working with our legal content team. She is currently completing her Bachelor of Laws and Bachelor of Arts (International Studies) at the University of Technology Sydney. Her interests are in digital/privacy and startup law.