Safe Harbour laws effectively provide protection to directors from insolvent trading liability if they pursue a plan that is reasonably likely to achieve a better outcome than an immediate appointment of an Administrator or Liquidator.
As set out in the Explanatory Memorandum, it's been suggested that “reasonably likely” does not mean “a more than 50% chance” of achieving a better outcome - rather that there is a chance that a better outcome is fair, sufficient or worth noting and not fanciful or remote.
Whether a course of action is likely to lead to a better outcome for a company will vary on a case-by-case basis. The test takes into account the fact that the directors must operate in a rapidly changing and uncertain environment, often without the benefit of complete information.
To get Safe Harbour protection from insolvent trading, prudence dictates that the plan embodying the course of action should:
- Clearly identify the assumptions made. Document the decision on safe harbour suitability and information relied upon to conclude the outcome would be better.
- Explain why the strategic plan is objectively likely to result in a better outcome supported by 13 week cash flow, integrated forecasts, and evidence of support from stakeholders.
- Provide a clear set of steps required to implement the plan- regular minuted meetings, management pack, updated financials, updated forecasts, updated 100 day work plan, stakeholder updates.
Does a better outcome mean restoring to Solvency?
It is important to note that a better outcome does not necessarily mean restoring a Company to solvency. A better insolvency outcome may be achieved when unsecured creditors receive a better return on their claims then would otherwise be the case as objectively assessed in Liquidation/Administration scenarios.
By way of example, assume Company A, a financially distressed subcontractor to a head contractor has:
- Employee entitlements of $3m
- Trade creditors of $3m
- Warranty claims of $2m.
- Cash and debtors of $3m. and
- If Company A were to proceed into Liquidation/Administration immediately, it could not continue performing under the contract giving rise to a damages claim by the head contractor of $50m.
In an immediate Liquidation/Administration, after the administration costs and priority creditor claims the estimated return to unsecured creditors would be nil.
In this example, if the Company, while in Safe Harbour, can negotiate a transaction with the head contractor under which the head contractor:
- Takes on liability under the employment contracts, transferring employees and their entitlements of $3m to enable the completion of the main contract; and
- Assumed certain trade creditor claims of say $3m associated with the main contract.
Then the Head contractor would avoid lodging a damages claim of $50m being in the Liquidation/Administration of Company A. This would leave the company’s cash and debtors available for payment of other unsecured creditors and warranty claimants.
In this outcome, the return for unsecured creditors has significantly improved where they will now receive a meaningful dividend, even though they won’t be paid in full.
We await further development on this issue.