COVID-19 — Temporary Relief for Directors from Duty to Prevent Insolvent Trading

The Coronavirus Economic Response Package Omnibus Act 2020 (Cth) inserted section 588GAAA into the Corporations Act 2001 (Cth) (Corporations Act) with effect from 25 March 2020.

As part of a suite of measures designed to provide temporary relief for financially distressed individuals and businesses, section 588GAAA provides a temporary safe harbour for directors from personal liability where a company trades while insolvent in circumstances where a debt is incurred:

• in the ordinary course of the company’s business
• during the six-month period commencing from 25 March 2020 (or a longer period as prescribed by the regulations)
• before any appointment of an administrator or liquidator during the temporary safe harbour application period.

A director who wishes to rely on this temporary safe harbour will bear the evidentiary burden of demonstrating that these elements have been met.

Decisions Boards are Facing During this Pandemic

In a recent article about directors’ duties in the context of COVID-19, ASIC Commissioner John Price said:

“In a short space of time, companies will be required to focus on and, most likely, recalibrate aspects of their corporate strategy, risk-management framework, and funding and capital management strategy –among other things.

“Given the possible impact of decisions taken during this time on the long-term sustainability of the companies, directors and officers will need to carefully reflect on their fundamental duties to act with due care, skill and diligence and to act in the best interests of the company. This will include reflection on which stakeholders’ interests need to be factored into decisions –including employees, investors and creditors.”

The Commissioner noted that the temporary relief does not extend to the other duties at common law and under statute, such as the duty to act in the best interests of the company as a whole, the duties to act with care and diligence and in good faith, and the duty not to use a director’s position or information obtained as a director to gain an advantage or cause detriment to the company.

Regarding the duty to act in the interests of the company as a whole, several commentators have noted that the extent to which directors are obliged to consider the interests of stakeholders other than shareholders —such as employees, customers and clients, suppliers and communities —is not entirely clear.

ASIC has subsequently provided guidance on the implications of the temporary relief for directors’ statements about the solvency of the company. ASIC states that:

• The requirements to provide a solvency statement in the directors’ declaration and assess whether an entity is a going concern remain in place.
• Directors are encouraged to seek advice early from a suitably qualified and independent adviser about the company’s financial affairs and the options available to manage the disruption caused by the COVID-19 pandemic.
• The uncertainty created by the COVID-19 pandemic may make it more difficult to make assessments on solvency and going concern. Assessments of solvency and going concern are distinct tests that have regard to their own specific criteria:
  
  • any entity is solvent if it will be able to pay its debts as and when they become due and payable.
  • an entity is a going concern unless management either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so.
    
• There may be cases where some entities are insolvent but a going concern. For example, an entity may be facing short-term liquidity issues due to the impact of the COVID-19 pandemic on short-term cash inflows and may be unable to pay suppliers within normal credit terms. The business may be fundamentally sound, has forbearance from its lenders, and is expected to meet its debts in coming months. However, directors should exercise caution in relying on the temporary relief, be mindful of its limitations, and may need to seek appropriate professional legal and financial advice.

On the last point, regarding the prospect of an entity being insolvent but a going concern, the Australian Institute of Company Directors has noted that “This is an entirely novel prospect that preparers of financial statements, directors, auditors, and users will need to adjust to.”

In a climate of great uncertainty, some things are clear:

• The requirement for directors to balance the company’s short-term needs with the long-term implications of their decisions on the company and its stakeholders is especially challenging, and directors will need to be more vigilant than ever in fulfilling their common law and statutory duties.
• It is critical that decisions, the information and reasons on which they are based, and the alternative options that were considered, are documented thoroughly and proper records are kept.
• Robust risk frameworks —encompassing financial and non-financial risks —must be in place and reviewed and tested regularly.
• Frequent consideration should be given to the prudence of obtaining professional advice.