How to understand the Safe Harbour Laws to avoid insolvency
You can listen to the full show here
Alternatively read below for my preparation notes for the show
Preparation notes for the Interview on Safe Harbour
Introduction
Before we start talking about the Safe Harbour Laws, I first want to put some context around this.
One of the reasons many people set their business up in a company structure is that this separates their business assets and liabilities from their personal assets.
In theory, the creditors of your business can not seek to get repaid out of your personal assets. For example, if your business went broke owing your landlord, suppliers and staff their leave entitlements, they generally could not force you to sell your house to pay these debts.
You have a wall between your business liabilities and your personal assets.
But in Australian law, they have put a gate in that wall for what the lawyers call insolvent trading.
Insolvent trading is when a business continues to trade when there are reasonable grounds for suspecting your business was unable to pays its bills when they were due. For example, you owe supplier a $10,000 and they put you on a trading halt because you can’t pay them, and you then buy from Supplier B, knowing you may struggle to pay them as well.
In this situation, you as the director, could be personally liable for any debts that the business ran up in this period.
Statutory Demands
And the threshold for a creditor to open the gate is very low.
A creditor owed just $2,000 could seek recovery of their debt by issuing a statutory demand against the company. And unless within 21 days you:
- paid the debt;
- came to a suitable arrangement with the creditor; or,
- made an application to set the demand aside within that time period,
then the company is presumed to be insolvent.
Now this statutory demand does not need to be completed by a lawyer and is relatively straight forward to complete and lodge at your registered office. By the way, this is a very good reason to ensure your registered office address with ASIC is up to date. It is no excuse if they sent this to an out of date address and you did not get this.
A simple piece of paper from a creditor owed as little as $2,000, can open the gate, and depending on your actions as a business owner, can open that gate for all business creditors to walk straight through and force you to sell your house to pay them back.
What did business owners do?
And because it was so easy for creditors to open this gate, many business owners when they were suffering financial difficulties were very concerned that they could lose their personal assets. This was even more evident if the business had independent directors.
They felt they had no choice but to put the business in administration.
But the problem with this is that very few businesses ever recover from being placed into voluntary administration. At least 9 in 10 businesses in voluntary administration end up being shut down with the administrator on average getting paid thousands of dollars. The creditors get cents in the dollar and the business owner left with nothing from the business and may end up losing their house and other assets.
A business that could possibly trade out, may close because they could not survive the stigma of being in administration. For example, customers got scared and stopped ordering, so revenue fell even more, reducing the risk of recovery.
Safe Harbour Laws
A really drastic outcome from what could just be a potential short term down period. A bit like what is happening now with COVID-19.
To stop this, the government gave the business owner the ability to put a lock on the gate when they enacted a couple of years ago, what is called the “Safe Harbour” laws.
If you are eligible to use these Safe Harbour laws, these laws can allow you as the business owner, to avoid being personally liable for certain debts that the business runs up in the period you are trying to improve the financial position of the business.
In other words, if you are eligible for these Safe Harbour laws, you, as the business owner can have some time to fix the financial problems of your business without putting your personal assets such as your house at risk.
Temporary Safe Harbour Laws
Because of the business impacts of COVID-19 shutdowns, the federal government put some temporary safe harbour laws, or barricades on the gate in the wall between your business liabilities and personal assets.
Firstly, a creditor had to be owed more than $20,000 to lodge a statutory demand (up from $2,000) and you had 6 months to respond (up from 21 days).
Secondly, they temporarily suspended the normal insolvent trading rules we spoke about previously in relation to any debts incurred in the ordinary course of business.
Effectively this allows the business to trade, without putting the business owner’s personal assets such as their house at risk. It is important to note that the debt still has to be paid by the business at some stage in the future.
To qualify for this, the debt must be incurred in the ordinary course of business in a specific period (currently 25 March to 31 December 2020). A debt can be a debt to a supplier, your landlord, your staff, etc. But, if the debt was incurred to fund a personal expense of the owner, it is unlikely to be considered in the ordinary course of business and these short term laws do not apply.
And the burden of proof on being in the ordinary course of business and in the time period, is on you as the business owner.
What happens on 1 January 2021?
On 1 January 2021, the temporary safe harbour barricades the government put up on the gate in the wall between your business liabilities and personal assets comes down.
A creditor owed just $2,000 could lodge a simple piece of paper, a statutory demand for repayment of their debt and unless you deal with this in 21 days, you could be presumed to be insolvent. Now there is agitation to change this from Kate Carnell, the Australian Small Business and Family Enterprise Ombudsman to $5,000 and 30 days.
This means that there is an increased risk of your business being placed into administration from 1 January 2021.
This can be devasting on your business as very few businesses actually survive being placed into administration. The winner is the administrator who gets paid in full. The creditors get cents in the dollar and you as the business owner left with nothing from the business.
I even heard a story the other day of an administrator refusing to take the appointment unless the business owner gave a charge over their house to pay the administrator.
As part of this, you get the mental health toll on you, your family and your staff, customers and suppliers.
Once your business is placed in administration, unless you have properly locked the gate in the wall between your business liabilities and personal assets, your personal assets such as your house may also at risk.
What should the business owner do?
If you want to buy yourself some time to trade through your financial difficulties, and lock the gate in the wall between your business liabilities and personal assets, you need to take steps to make sure you are eligible for the “Safe Harbour” laws that will be in effect from 1 January 2021.
To be eligible to use the Safe Harbour laws there are two key areas that the business and business owner need to comply.
The first part is very factual. Is your business:
- Paying all entitlements to your staff by the time they fall due. For example, paying superannuation on time.
- Meeting all your tax reporting obligations to the Australian Taxation Office.
- Taking appropriate steps to ensure you have appropriate financial records.
- Taking appropriate steps to prevent any fraud or misconduct by officers or employees of the company.
- Obtaining advice from an appropriately qualified entity.
- Developing or implementing a plan for restructuring the company to improve its financial position.
And are you, as a business owner, properly informing yourself of the company’s financial position.
These are all factual questions and you as the business owner need to support these statements with some form of reasonable evidence.
The other area is less factual and more subjective.
You, as the business owner, must be developing one or more courses of action that are reasonably likely to lead to a better outcome for the company within a reasonable time frame. In other words, a business rehabilitation plan.
What is a Better Outcome?
The Safe Harbour law defines a better outcome as one that is better for the company than the immediate appointment of an administrator, or liquidator.
Some of the things that you as the business owner need to consider to determine if you can achieve a better outcome include:
- Are the financial difficulties facing the business from short term issues or a longer term irreversible decline? If it is a long term decline, then will a rehabilitation plan be reasonably able to improve the business outcome in an appropriate time frame? Maybe in this situation you have no choice but to appoint an administrator.
- Are the financial difficulties facing the business a result of factors outside your control? If the factors are outside you control, will you be able to implement changes for the better? If not, maybe you have no choice but to appoint an administrator.
- Can any rehabilitation plan be implemented in a reasonable time frame?
A better outcome may be even selling all or part of the business as a going concern. This is exactly what one of my clients did.
This takes time
The steps to ensure you are eligible for the Safe Harbours laws to buy yourself some time to trade through your financial difficulties, and lock the gate in the wall between your business liabilities and personal assets take time.
Don’t think on New Year’s Eve you will be able to tick all these boxes.
If you are currently under financial difficulties, or expect to be under financial difficulties on lower JobKeeper and possibly higher rents, you need to do something now to start to put that lock on. It is less than 15 weeks to 1 January 2021.
Engaging a resource?
The law requires you to obtain advice from an appropriately qualified entity. Appropriately qualified is viewed more with a sense of “fit for purpose” and is not limited merely to the possession of particular qualifications.
This includes whether the adviser is appropriate considering:
- the nature, size, complexity and financial position of the business;
- the adviser’s independence, professional qualifications, good standing and membership of appropriate professional bodies. This could be a lawyer, insolvency practitioner, accountant;
- the adviser’s experience; and
- whether the adviser has adequate levels of professional indemnity insurance to cover the advice being given.
It is up to the business to determine this.
Other duties and potential liabilities of business owners
Just one last thing I want to mention to business owners. You may have the temporary barricades up and the gate locked, but the government through ASIC and / or the ATO can bring a big pair of bolt cutters to the wall and cut straight through any locks if you are not complying with your other duties and potential liabilities of business owners such as:
- Acting in good faith in the best interest of the company and for a proper purpose.
- Acting with due care, skill and diligence.
- Not using their position as director, officer or employee to gain an advantage for themselves or someone else, or cause detriment to the company.
Summary
In summary, right now the government has put some temporary barricades on the gate in the wall between your business liabilities and personal assets.
These barricades will be taken down in less than 15 weeks on 1 January 2021.
If you are having financial difficulties, you have a choice once these barricades come down.
You can either buy yourself some time and lock the gate between your business liabilities and your personal assets and ensure you are eligible for safe harbour.
Or do nothing and leave the gate unlocked, ready for your creditors to close your business and claim your house to pay off your business debts.
I know which option I would take. And I would start doing something about it now.