Safe Harbour Law Will Save More Aussie Businesses
16 June 2017
New safe harbour provisions are set to offer protection for directors who keep a struggling company trading, provided they demonstrate appropriate steps are being taken to restructure the business. Vantage Performance Executive Director Michael Fingland describes it as a game changer, that will save many businesses that might otherwise have been wound up. He says a 5-10 percent reduction in the rate of business failure could inject an extra $13 billion into the Australian economy. In this edition of the Vantage Performance Podcast he explains to Phil Dobbie how the new legislation will work, who will be involved and the impacts it will have. It’s worth spending 18 minutes to get across the detail.
Safe Harbour Provisions
Phil Dobbie: Welcome to the Vantage Performance Podcast, I’m Phil Dobbie. Michael Fingland is with me too, as we look at the new safe harbor legislation that protects directors who try to rescue businesses, but previously might have been worried about their personal liability for doing so.
Now I’m sure you’ve read it by now, the Treasury Laws Amendment (2017 Enterprise Incentives No.2) bill. You know, who doesn’t while away the hours working through government bills? But this is…it’s an important change to how company directors are treated if they are actively trying to save a business that is running into trouble. To talk through the changes and why it’s being introduced, Michael Fingland is with me again, CEO and the Executive Director of Vantage Performance.
Q: The issue it is trying to correct, as I understand it, Michael is people winding up a business because they fear that if they don’t they could be responsible for potentially trading insolvent. So they’re ruining what could have been the chance to save the business. Is that basically it in a nutshell?
Michael Fingland: Yeah. Good morning, Phil. Yeah, it’s a real game changer for the Australian business landscape, and it’s something that as a firm we’ve been advocating for, for a number of years. Because, you know, many, many years ago when we set up Vantage, when I came back from London, there were two big changes that needed to happen in the Australian landscape for a genuine business rescue and turnaround culture to firmly establish itself. And the first was going to be, you know, the financiers taking a really proactive and a lot more productive stance on early intervention and helping their clients restructure and get back on track. And we’ve seen that happen for a number of years, and then legislate a change. And it’s now upon us. It’s due to go live 1 January.
And as you alluded to, the big issue here is that, for the SME to mid-markets base, if the directors are aware of insolvent trading. Which means you can be personally liable for the debts you incur once the business becomes insolvent, if they are aware of it, they’re too scared to put their hand up and get help because they’re worried that draws a line in the sand. And that’s obviously when they were insolvent, so they don’t seek help as early as they should. And at the big end of town large corporate enlisted a lot of directors in that space. Particularly non-executive directors are too concerned about personal liability and they’re not gonna risk their personal net wealth over a $30 to $50 grand NED fee that they get every year. So they prematurely put their hand up and go into voluntary administration, which causes lots of destruction of wealth and jobs and a huge plethora of issues, which, you know, is everything that we are about at Vantage is to try and improve the rate of business success. So this is a really big game changer for the industry, for the economy. It’s going to foster much greater early-intervention culture, which can only lead to more businesses being saved, and that’s a good thing.
Q: So it does that by basically making them immune to that liability. Does it?
A: That’s right. It’s designed as a carve-out. In a nutshell, around the world, America is very debtor-friendly, very company-friendly in terms of their laws. Australia has a very harsh sort of more of a stick approach, where if you are insolvent or trading as insolvent, you then have some defenses that you can deploy. But you still have to spend a lot of money with lawyers, etc. trying to defend, you know, any action from a liquidator or ASIC. In the UK and Europe, it’s more a balanced approach. And our laws coming into place now, it’ll act as a carve-out from insolvent trading. So you know, our laws are gonna be more aligned to Europe than they ever had been, which is a good thing.
So it’s really coming down to a business judgment-type rule which the industry has been advocating along with AICD and all the other professional bodies to provide a framework where as long as the directors have engaged a considerably qualified restructuring turnaround practitioner. They’ve come up with a plan, they genuinely believe that plan is likely, It doesn’t have to 100% guaranteed, but as long as everyone around that table, the boardroom table along with the advisors believes that this plan, the turnaround plan, the restructure plan is likely to lead to a better result, then immediately going into a voluntary administration or liquidation, then they’re covered. They’ve got the safe harbour, as they’re calling it, so it’s a protective bubble if you like. So the directors, you know, cannot be sued for insolvent trading,
And then, you know, there’s a few things you need to tick the box to qualify. One, there’s no outstanding employee entitlements like Super, etc. You’re lodging all of your tax forms on time, BAS and tax returns and whatever, and you can actually be insolvent. So if you think you might be sailing close to the wind or you might actually be insolvent, you can still get protection for the safe harbour. As long as you do those steps. Engage a qualified practitioner, come up with a plan, have a genuinely reasonable belief that this plan is gonna result in a better outcome than a VA or liquidation immediately. If all those boxes are ticked, the board then signs a minute and then the protection mechanism actually kicks in when you start developing the plan, not when you have the minutes in.
Q: But it doesn’t matter how you got into that situation, because obviously, some companies fall into trouble because of external circumstances which are beyond the control of the directors. But other times it’s entirely down to the directors or the mismanagement of the company. It doesn’t matter so long as you’re sharing…
A: Correct. As long as you’re taking good steps, commercial steps, you’re doing it for the right reasons, you’re getting a…you’ve got the advice, you’ve got a robust plan. And then you’ve gotta execute on the plan. There’s no good, if you come up with a plan and then it sits on the shelf. And you’ve just done this, you know, for optics reasons, you will drop out of safe harbour. So you need to be executing that plan and regularly assessing that question, “Are we comfortable that this is still going to result in a better outcome than if we go into VA or liquidation straight away?” So that’s your ongoing test that the board or the director needs to be comfortable with their advisors. And as long as you’re comfortable with that question, you can keep pushing on with that plan for as long as it takes. It could be 3 months, 6 months, 12 months, 18 months. As long as you’re comfortable that that test is meddling the way then you are protected.
Q: Is the divide as clear as you’re describing it? Because obviously, you’d wanna make sure it is. If you wanna carry on knowing that you are being granted this safe harbour, you know, you’re gonna make sure that that is the case so you’re not under the illusion that you are and then discover down the track that you’re not and you’re still liable.
A: Yeah. The whole intent behind this is to encourage a more turnaround and workout culture in Australia. So the legislation has been drafted suitably wide enough. So yeah, there’s some wiggle room there. You know, it’s not, “Hey. If you’ve made losses for three months in a row then you’re no longer protected.” It’s not descriptive as that. It’s as long as the directors still believe that the plan they’ve got in place, and your plan often changes in turnarounds as you know, as we talked about. So it doesn’t have to be the same plan that you started with, but as long the plan that you’re currently working on is still in the belief of the directors that it’s likely to result in a better outcome then you’re still protected.
And obviously, the real protection here comes with having the turnaround advisor working with you. And the board, your legal advisor working with you. Your accountant as well at certain times. So you know, the board is going to derive some comfort from those qualified advisors to help them assess that test on the way through. And you know, there will be some of these that still collapse, of course. But, you know, when a liquidator looks back in time, there’s going to be a lot of weight of evidence where the board, the advisors have all been saying along the way, “This plan, here’s it is, and here’s the 100-day plan, and here’s all the initiatives. And, you know, we’ve got the support of our financiers and creditors and customers.” And you know, all of those things are going to, you know, go in the favour of the directors as long as you are demonstrating that you are executing on that plan.
If the plan doesn’t work for some reason, then there are some things that happened and turnarounds that are outside of your control. The economy could tank, you know, you might lose your major customer. Competitor comes in, anything can happen. But you’re not gonna be punished for that. What you will be punished for is if you’re not executing on that plan and you’ve just done it for optics reasons and it sits on the shelf. And had no intention of it going through that process, that’s gonna be reckless and you won’t be covered. But as long as you’re continuing to work on that plan and you think it passes the test. So there’s gonna be some sort of compliance processes that any advisor and board needs to build into this process. So you’ve got those regular catch-up meetings with the board where you can demonstrate that this is still in the best interests of creditors.
Q: So who makes the call as to whether you qualify for the safe harbour or not? Is that something that’s applied down the track? If something goes wrong and then it looks like there’s legal proceedings then it falls to lawyers to fight it out or is there an overseeing body?
A: The board does. Yeah. The way that the government has drafted the legislation, which is clever. Well, not too much clever, but it’s suitable, it’s practical. Is that it’s the board’s decision. The board has to be comfortable upon taking appropriate advice. So this is where, you know, it’s gonna encourage and essentially mandate that boards have to get qualified. And we’re not talking about people in their mid-20s. You wanna be getting a seasoned professional to help the board demonstrate that this is…we’ve ticked all the boxes. And it’s not going to be hard to do as long as you’ve got the plan and you can, you know, calculate what the business would look like if it goes into VA and liquidation now. And you can do that now with every business. You can work out what the downside risk is and what the likely return to creditors in liquidation receivership, VA scenario.
So that will be part of the process to say, “Here’s our plan. If it works. And we all believe…you know, we’ve all signed up to this and we all believe all the initiatives are sound, reasonable and will work, and we’ve got the support of our stakeholder group,” you weigh that up against, “Well, if we go into VA, it’s likely to shut down and creditor is gonna get 5 cents or 10 cents, or 0.” You know, it’s gonna be pretty easy, as long as you’ve got a good robust plan, to be able to tick those boxes. And for the board and the advisor group to say, “The overwhelming weight of evidence supports that we tick all the boxes, and…” You know, if a business does collapse down the track, the liquidators will still have an obligation to look at, “Did the board and the advisor group have, you know, reasonable grounds to make that call?” And that’s why it’s going be very evidentiary-based. So you can say to the liquidator down that track, or ASIC for that matter, “Look, here’s the turnaround plan, here’s the cash flows, the three ways, here’s letters of support. Here’s the agreement we’ve reached with our financiers.” All of those things will then just make it very, very clear that you had every right to enact the safe harbour protection.
Q: So I can see how it changes the rules for directors, what does it do for financiers? I guess in a way, it sort of reduces the risk for them, does it?
A: It does. It’s gonna be huge in that it’s gonna change the way, and we’ve started talking to financiers about this. It’s gonna change the way they bring on deals, in the first place. Because if they’re refinancing a business that, you know, has had some losses and things like that, they may wish to ask the question in their due diligence process. “Have you ever enacted safe harbour? Are currently in a safe harbour?” Particularly those financiers that do specialise in investing of financing businesses in a turnaround. They’re going to want to, in our view, ensure that the directors have enacted safe harbour, because it also protects the banks as well, or the financiers from any potential insolvency issue or…It’s always ever present the whole issue of shadow directorship for some financiers who overstep the mark and really take an active role in the management of the business. It’s rare, but it’s a theoretical risk that they’re all very mindful of. Well, this will also protect the banks as well, or any financiers for that matter.
So they’re gonna be willing to ask that question on the way, you know ensure that they’ve enacted safe harbour. Because it also means that, you know, if a board has enacted safe harbour or a director, then that means they’ve got the plan, they’ve got everything in place, which increases the credit risk. Or sorry. Reduces the credit risk and increases the credit quality of that file. Conversely, if a file has dropped into the workout division of the financier, in our view, again, and this is where we think this is gonna head, is a condition of ongoing support by your financier group will be a condition that the board has enacted safe harbour. Again, it means they’ve got the plan, they’ve got all of the evidence in place to support, you know, a robust and successful turnaround. And it also protects the financiers as well. So it is gonna change internal processes for financiers.
And the other thing which, you know, we’ve identified that no one else seems to have yet is the…it’s gonna have an impact on accountants and lawyers as well. Because there’s gonna be an expectation, because this is new, there’s gonna be an expectation on accountants and lawyers to advise their client base of this. Because if a client, if a…I mean, the directors are still responsible to be aware of what’s happening in their business industry and to be on top of compliance issues. But there is a risk here that, you know, if an accountant or a lawyer has a client that gets into strife, you know, they’re aware of it and they don’t do anything about it per se, will the directors be able to go back to the accountant and lawyer and say, “Hey, why didn’t you tell me about this safe harbour protection? If we had enacted this, we wouldn’t be getting sued now.”
So there’s gonna be a huge education process that’s gonna be required. It’s gonna happen anyway, but every accountant, lawyer, financier is going to have to look at ways or look and understand how this is going to change their process, the way they interact with clients, the way they communicate this issue to their database via their newsletters, etc. So it’s gonna be a huge media campaign by the government but also by industry to ensure that every director is aware of this. And the end result is gonna be a lot more directors seeking help earlier, which means more businesses will be saved, and that’s just a fantastic thing.
Q. So it’s good news all round unless you’re an administrator. Perhaps this is not such good news if you’re an administrator. You might expect a downturn next year as this comes into law. And I mean, just finally then, I mean, how…. you said it’s a big thing, I mean, just how big is it? What sort of quantum change is it gonna have to the Australian business landscape?
A: Look, it’s a game changer. I mean, we did some…we did a study a number of years ago and worked out that, you know, looking at average rates of recovery and VAs and things like that, just a 5% to 10% improvement in the rate of success or reduction in the rate of failure could have a $13 billion annual impact on the economy. $13 billion. So it’s huge, it’s really huge. It’s not gonna happen straight away, this will take time to filter out, you know, into business land and for every director to become aware of, but that’s where every accountant, lawyer, banker has an obligation, you know, in the media to get this message out there because it’s gonna help the economy, it’s gonna save jobs. And it’s a real game changer. It’s that on top of the banks acting a lot more proactively, which, as I said has been happening for a number of years now, is going to have a huge impact on the rate of business success, which means less redundancies. Less, you know, people living on the government schemes, and less disruption. Because for every company that collapses, there’s another 100 that are impacted.
Q: And more innovation. I mean, the Prime Minister has been making a big thing about innovation. I guess this is a big point towards that, isn’t it?
A: Yeah. I mean, the argument, you know, from some corners of the professional community say, “Well, you know, a business has collapsed, there’s an efficient process in place, being receivership and liquidation, where you recycle those assets and another business picks them up and, you know, it’s efficient.” Well, it’s not because, you know, huge disruption happens. Because, yeah, those assets you might think are sold to another business that picks them up cheaply, but you’ve got 100, 200, 500 people out of a job. They take three months to get another job or longer, so you’ve got impact on government wages, you’ve got impacts on families. It’s huge. It’s a very inefficient recycling process. So if that business, you know, survives, there’s no disruption. And they continue investing in innovation and R&D and growing the business. So, you know, it’s…that’s the best way to recycle assets is to keep them in there and recycle them and invest in them. And sell them when you don’t need anymore because you’re buying new ones.
Learn more about the safe harbour provisions here.