New Safe Harbour, Early Detection of Insolvency and PPSR for Trading Trusts

Safe Harbour … what does it mean?

In our newsletter last quarter, we introduced the concept of safe harbour and what it was aimed to achieve. The legislation giving effect to safe harbour has now been introduced as Section 588GA of the Corporations Act 2001 (“Act”).

From discussions we have had with accountants and other advisors following the introduction of the legislation, it appears that many do not understand what the legislation is intended to achieve. This article seeks to address that.

Firstly, safe harbour is not a new insolvency procedure; it is a new defence to an insolvent trading claim. It is intended that this defence support honest, diligent and hard-working directors for having the courage to avoid insolvency by embarking on a restructure of their businesses when times are tough.

Secondly, it will only ever be an issue for a director if, despite their honest, diligent and hard-working efforts to restructure, their company ends up in liquidation.

The Act provides various thresholds (relating to employee entitlements and the lodgement of documents required by taxation laws) for directors to comply with to avail themselves of the defence, and they are consistent with what one would expect of an honest, diligent and hard-working director complying with their director duties.

In practice, we envisage the process directors would follow if they wished to maximise the opportunities to avail themselves of a safe harbour defence, would be as follows:

  1. Early signs of solvency concerns are detected by the directors.
  2. A critical assessment of the causes of the problems and the financial position of the company is undertaken.
  3. Advice is sought from appropriately qualified professionals concerning turnaround risks, options and director duties more generally.
  4. A restructuring or turnaround plan is then created, financially modelled and tested, for the directors to then be satisfied that the course of action being contemplated is likely to lead to a better outcome for creditors.
  5. Key stakeholders are engaged to confirm the achievability of the turnaround plan and its assumptions.
  6. The turnaround plan is implemented, any needed steps to prevent any misconduct with officers /employees are taken.
  7. The progress of the turnaround plan is monitored, stakeholders remain engaged and it continues until final success is achieved.

We believe it is beneficial for directors that the turnaround plan and strategy be clearly documented, and the decisions to enter and exit the safe harbour be recorded in the minutes in the company’s statutory records.

Having regard to the process and the focus on reducing director risk, we see that it is likely to be larger companies or organisations with advisory boards that are most likely to implement the protections of safe harbour. However, there is a role for safe harbour in SME matters as well, given the overarching objective of safe harbour is to support directors and assist companies avoiding external administration.

Early detection of solvency concerns

Having provided clarification of the aims and outcomes of safe harbour, we thought it worthwhile to revisit a suite of early detection indicators of insolvency given they are key to the awareness of directors to initiate restructurings.

As we have often written, early detection of insolvency concerns maximises the chances of a company avoiding an external administration, and now also of availing directors of the opportunities of safe harbour.

In the often referred to decision of ASIC v Plymin (2003) 46 ACSR 126, there were a dozen indicators of insolvency highlighted by the Court. They include:

  1. Continuing trading losses.
  2. Liquidity ratio below 1.0.
  3. Overdue Commonwealth & State taxes and Statutory obligations.
  4. Poor relationship with present bank including inability to borrow additional funds.
  5. No access to alternative finance.
  6. Inability to raise further equity capital.
  7. Supplier placing the debtor on ‘cash-on-delivery’ (COD) terms, or otherwise demanding special payments / arrangements before resuming supply.
  8. Creditors being paid outside of trading terms.
  9. Issuing of post-dated cheques / dishonoured cheques.
  10. Payments to creditors of rounded figures, which are irreconcilable to specific invoices.
  11. Solicitors’ letters, summons(es), judgments or warrants issued against the company.
  12. Inability to produce timely and accurate financial information to display the company’s trading performance and financial position, and make reliable forecasts.

As a further tool, we have created a website called www.askinsolvency.com.au that you can also use to identify when indicators of insolvency are becoming so prevalent as to indicate a high risk to the long-term viability of a business.

It is our recommendation that at the earliest stage, when more than just a few indicators of insolvency appear in a business, expert advice be sought on the risks that those indicators pose to the business and its directors.

PPSR - Security interests and trading trusts

In recent months we have seen several defective PPSR security registrations involving trustee companies and trusts.

This form of trading structure is very common, and these examples have highlighted a weakness in the understanding of the rules when registering a security interest on the PPSR.

When registering a security interest on the PPSR, you need to identify the grantor. The grantor is the individual or organisation who owns or has an interest in the personal property to which the security interest is attached. If the registration is incorrect, there is a risk that the registration will not be effective.

Different rules apply depending on whether the grantor is a body corporate, partnership, trustee of a trust etc.

For trusts, if the trustee is a body corporate without an ARSN and the trust has an ABN, registration must be against the trust ABN. If the trustee is a body corporate without an ARSN and the trust does not have an ABN, registration must be against the body corporate’s ACN.

In the event of external administration, if the financing statements registered on the PPSR included the ACN of the corporate trustee rather than the ABN of the trust, the security interests are likely to be found defective and vested in the trust to became part of the property of the trust for the benefit of the trust’s creditors.

The above highlights a risk to both borrowers and lenders, and a review of security interests registered on the PPSR of companies and trusts (when the trustee structure is used) may highlight errors that could be corrected to avoid later embarrassment.