What Safe Harbour Legislation Means for a Struggling Business
Andrew Birch is the Executive Director of the Vantage Performance Perth office. For the last ten years, he’s been focused predominantly on business turnaround and performance improvement services. Andrew also heads up the Board Advisory Service Line nationally, which helps people navigate Safe Harbour legislation, among many other areas.*
What is Safe Harbour legislation?
Safe Harbour legislation offers some protection from legal liability for insolvent trading. It was introduced by the Turnbull government in September 2017. Part of their innovation and reform agenda, it aims to create a safe harbour for directors whilst their company is in the ‘twilight zone’.
‘Safe harbour’ essentially means that directors of a company can’t be held directly responsible for losses during this period, while they’re trying to ‘right the ship’.
How can a director tell if they are in the insolvency twilight zone?
All companies have their ups and downs and face different challenges from time to time. The twilight zone is the grey area where financial difficulties mean the company is potentially insolvent.
Technically, the definition is that you’re solvent if you’re able to meet your liabilities as and when they become due; and, if you’re not solvent, you’re insolvent. But it can sometimes be unclear when a company becomes insolvent.
Everyone knows when they’re definitely solvent; they’re making lots of money, have plenty of cash in the bank, and can pay all of their liabilities. Everyone knows when they’re desperately insolvent – they can’t even pay the wages this week.
In the middle, there is the twilight zone, which requires some analysis to properly understand whether you’re insolvent or not. For instance, you would need to look at all of the potential sources of cash and when you can reasonably expect to receive them. Then, compare your cash sources to your obligations to pay other parties and when those obligations become due to determine whether you’re making a profit or a loss. The trouble is, if you can’t meet your liabilities, and you continue incurring debt, you’re trading insolvent, which is illegal.
If the directors of a company are concerned about solvency, then the reality is that they probably should be – and probably are – in the twilight zone.
What impact does Safe Harbour legislation have?
Safe Harbour legislation was introduced because the Government felt that too many directors were giving up too easily in turning around company performance – choosing voluntary administration instead – because they had potential liability for insolvent trading.
In this context, the Safe Harbour legislation enables directors to trade on for longer without fear of being personally liable for insolvent trading.
The key benefit, though, is that it encourages directors who are in the twilight zone to engage with external experts to help them with the challenges that they’re facing.
Running a business is difficult enough at the best of times, without the added stress that comes from needing to improve performance on the one hand and tightly manage cash flow on the other.
What needs to happen to ensure directors are covered by Safe Harbour Legislation?
Safe Harbour is new legislation, and we don’t fully know how it will be viewed by courts because we haven’t seen any cases relating to it yet.
We recommend that directors engage an appropriately qualified entity to provide advice as to whether safe harbour is available to the company. This qualified entity will look to see whether the company has paid all employee entitlements and whether it is complying with tax reporting obligations; check that the company has maintained appropriate financial records, and that the directors are aware of the financial position of the company.
Other important areas include checking that any key creditors who could commence an action or enforce security against the company have agreed to a standstill – and making sure that there’s no misconduct by officers or employees. Provided that those things come up positively, then safe harbour is likely available.
The recommendation is usually that the directors should have a board meeting to resolve the above matters, and then to pass a resolution that the company enter safe harbour.
Once in safe harbour, the directors need to develop a course of action to turn the business around and monitor whether the turnaround plan is helping the company become solvent.
How does safe harbour protection differ from indemnity insurance?
Indemnity insurance for directors typically works to indemnify them against something that they couldn’t reasonably be expected to know. The problem with indemnity insurance is that it often has an exclusion when the directors have been negligent.
In layman’s terms, negligent means not doing what you’re supposed to do, and so if you were trading whilst insolvent, then you’re clearly not doing what you’re supposed to have been doing as a director, and your directors’ and office’s insurance may not protect you (depending on the terms of your policy).
“Conversely, if your board agrees to moving into safe harbour, not only do you receive protections from insolvent trading, the company can bring in someone who is appropriately qualified and experienced to provide you with advice relevant to your needs.”
What are the options other than safe harbour for a struggling company?
You have some options, all of which come with their own benefits and risks. In our experience, the choices usually include:
- Continuing with the current strategy for the business, and hoping it will be successful;
- Engaging a business coach, consultant or mentor to get external advice;
- If you believe the company is insolvent, appointing a voluntary administrator or liquidator; and,
- Selling the business or raising more capital; or appointing a liquidator.
Continuing with the current strategy – i.e. “business as usual” – might be successful. Clearly, there are some exceptions, but we typically find that “what got you here, won’t get you there.” To put that another way, without a significant change in leadership, management, thinking or strategy, you’re most likely to continue the current trajectory.
Engaging a business coach, consultant or mentor could result in a change in thinking or strategy that might be successful. We recommend that businesses adopting this option find a coach that is experienced in helping distressed businesses.
Appointing a voluntary administrator or liquidator prevents further debts being incurred, and therefore, it potentially limits your insolvent trading liability. However, the government statistics around companies that successfully emerge from voluntary administration or liquidation are disheartening. Often if a business does successfully navigate the insolvency process, there is a significant change in ownership, direction and management that is introduced via the process.
Finally selling the business or raising capital might be an option for a few businesses, but in our experience, this option usually only becomes properly viable once the turnaround has commenced.
To summarise: if you’re in a twilight situation, your options are to trade on, trade on or turnaround with safe harbour protection, liquidation, voluntary administration, sale of part or all of the business, or raise more capital.
How long does safe harbour last?
Safe harbour lasts until the directors decide that the company no longer needs safe harbour protection and resolves to leave safe harbour. We expect most companies will be in safe harbour for about 18 to 24 months.
How can Safe Harbour legislation be leveraged to sell a business?
An owner may wish to sell the shares in the company, although that is unlikely to happen if the company is insolvent. In that case, a company director may sell the business and assets to a buyer, and use the sale price to pay the company’s liabilities.
Let’s use a bakery as an example. An owner could sell off all of the fixtures and fittings in the bakery: the baking ovens, the ingredients, the intellectual property around the recipes, etc. After selling the business and assets to another party, the amount paid for the business and assets would go into the company’s bank account. The company now has money in the bank which can be used to settle outstanding liabilities to creditors and employees.
Before safe harbour, it was potentially quite difficult to do that. The reason being that during the period after you realise you’ve got a major problem with the company, and all the way up to settlement of the sale of the business, you have to trade whilst the company is insolvent.
Under safe harbour legislation, if the course of action that you’re following – such as selling the business as a going concern – will result in a better return to creditors, then you can continue to trade the business whilst it’s insolvent. After settling the transaction, you would then distribute the cash to creditors, or appoint a liquidator to ensure that is done appropriately.
How can a company like Vantage Performance help directors rely on safe harbour?
Vantage Performance’s directors all have many years’ experience turning around underperforming companies and are appropriately qualified to help companies navigate their business through the twilight zone and into and out of safe harbour.
Our people have literally helped hundreds of businesses; we have seen first hand what works and what has not.
We typically bring:
- Independence, objectivity and a fresh perspective to any situation. We may see options that the existing management team, who are immersed in the problem, have not seen.
- Deep financial analysis skills. We can upskill most accounting teams in cash flow and financial analysis for turnarounds.
- A new level of credibility with all parties, due to our strong relationships with many key stakeholders, such as banks and the ATO.
*This article is general in nature and is not to be taken as financial or governance advice. You should consider seeking independent legal, financial, taxation or other advice to check how the information relates to your unique circumstances. Vantage Performance is not liable for any loss caused, whether due to negligence or otherwise arising from the use of, or reliance on, the information provided directly or indirectly.