Australian laws impose a duty on company directors to prevent the company from trading while insolvent. Pursuant to s 588G of the Corporations Act 2001 (Cth) (‘the Act’) a director can be personally liable for debts incurred by the company if, at any time the debt is incurred, there are reasonable grounds to suspect that the company is insolvent.
However, the focus of the provision on timing rather than on the conduct of the directors came with some devastating consequences including premature appointments of administrators or liquidators by directors hoping to avoid liability rather than trying to find ways to save their company. The provision also deterred people from taking up directorships in riskier or innovative start-up companies.
The Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017 (Cth) has sought to overcome these drawbacks of the regime by, amongst other things, introducing a new defence that sees to strike a balance between protecting creditors and encouraging directors to innovate and take reasonable risks.
The new defence essentially allows for directors who start to suspect that a company may become or be insolvent to start developing “…one or more courses of action that are reasonably likely to lead to a better outcome for the company…” and to incur a reasonable debt in relation to such a course of action.
Having said that, there are certainly a number of qualifying factors which need to be present in order for the director to gain the benefit of the new defence including the following:
- Director involvement in the turnaround strategy;
- A connection between the debt and the turnaround strategy; and
- Importantly, the ‘better outcome’ test.
The courts have not as yet provided guidance on these and many other questions related to the new provisions and it is important for directors who might seek to rely on this defence to get expert legal opinion before attempting to implement them.
At KPL Lawyers we have a dedicated team of corporate lawyers with the experience and foresight necessary to help directors make appropriate decisions for their companies and avoid liability.
