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BUSHFIRES, FLOODS, NATURAL DISASTERS, THE CORONA VIRUS AND INSOLVENT TRADING

Newsletter

by Luka Pilipovic21.02.20

Various government and private institutions have put in place measures to help businesses affected by the recent bushfire crises in Australia.

These have included the ATO:

  • Giving extra time to allow taxpayers to defer or pay debts;
  • Remitting penalties for interest charges; and
  • Setting up payment plans for customers.

Further information on the ATO Bushfire assistance measures can be found here.

Following the devastating bushfires, various businesses are now also dealing with the aftermath of the recent floods and ongoing impact of the Corona Virus outbreak. These disasters have particularly impacted the tourism industry and tourism destinations.

If these disasters have not completely put a stop to the business’ trading, they are now continuing to seriously impact the bottom line.

Whilst initiatives by government to assist businesses recover are commendable, business owners must be extremely vigilant and prudent at these times to properly document and record the decisions and courses of action they are taking. Failing to properly record decisions where a Company is insolvent may likely result in the director becoming personally liable for insolvent trading.

The importance of developing a business recovery plan

Where a company is deemed to be insolvent, there is a duty on the Director not to allow the Company to incur further debt. Unless it is possible to promptly restructure of refinance, generally the options available are a voluntary administration or liquidation. 

Where directors are deemed to have failed to properly discharge their duty, they become personally liable for any debts incurred following the Company’s insolvency, ultimately risking the family home and personal assets.

Under section 588H(2) of the Corporations Act, there are defences available to Directors if they can prove that at the time when the debt was incurred, they had reasonable grounds to expect, and indeed did expect, that the company was solvent at the time and would remain solvent. The crucial words in this section are “reasonable grounds” and “solvency”.

It is important to note that the director must prove that he or she had established “reasonable grounds”. Directors have a duty to monitor the Company’s solvency on a regular basis, and where there are reasonable grounds to suspect that a company is insolvent, the director must assess the financial position of the Company carefully. Bushfires, floods, natural disasters and other events should be a warning sign to directors to make and document the assessments of the businesses performance and properly record the impact of the event on their business.

Accordingly, a business assessment or business recovery plan will be important for two reasons:

  1. It will assist in making an assessment of the business’ position both immediately before and after the event or disaster to allow directors to make an assessment of the business’ performance at that time; and
  2. Will document the decision process taken during the ongoing recovery phase to satisfy the reasonableness test.

Business owners may find that if the business had already been struggling prior to the event, a “recovery” of trading in 6 to 12 months time may not resolve underlying issues that already existed in the business before. In those circumstances, the business may already be insolvent and the best option may be to cease trading the current business. 

Conversely, documenting a recovery plan and revisiting it regularly will not only provide some level of protection to directors in demonstrating the reasonable course of action test, but assist in assessing the recovery process and ongoing monitoring of the process.

There are also safe harbour provisions within the Corporations Act available in limited circumstances to assist business recovery. These provisions are complex and expensive and, in our experience, appear to be of limited use in SME space with the cost of implementing safe harbour being somewhat prohibitive. 

There is no reason why the business owner, particularly where the natural disaster was the main reason for the Company’s insolvency, would not be able to incorporate another entity to re-commence trading. 

The issues around insolvent trading, defences to insolvent trading and solvency are complex. In addition, establishing what constitutes “reasonable grounds” for suspecting solvency is also a complex matter. Accordingly, we encourage business owners to actively work with their accountants on coming up with a business recovery plan and speak to our staff at Shaw Gidley to assist in this process.