Running a business and insolvency risk during coronavirus

STUART WILSON, Senior Commercial Lawyer for Nevett Ford Lawyers provides a report on insolvency risk during the current pandemic.

The coronavirus and associated response measures have imposed immense pressure on businesses in many sectors, which in turn places stress on the directors and business operators.

On 22 March 2020, the Australian Government announced that it would temporarily relax insolvency laws and directors’ obligations, with a view to reducing some of the burdens on business operators and leaders, intended to give businesses a better chance to endure the financial distress over the next few months.

Insolvency reforms

The reforms introduced by the Government specifically relating to the insolvency provisions include:

• increasing the minimum debt in respect of which a statutory demand can be issued from $2,000 to $20,000 (and parallel increases in minimum personal bankruptcy notices from $5,000 to $20,000);
• extending the time for repayment of a debt the subject of a statutory demand or bankruptcy notice from 21 days to 6 months;
• relieving directors from personal liability for insolvent trading in relation to debts incurred in the ordinary course of business.

Statutory demands

We think that increasing the threshold and allowing more time to address a statutory demand before a company can be wound up will likely reduce the pressure that can be applied by creditors on their debtors, and it would not be a surprise if statutory demands were not as widely used.

On one hand, this measure may give businesses some breathing space within which to deal with their debts.

Unintended consequences?

However, suppliers and other creditors will now have reduced capacity to use the threat of a statutory demand or insolvent trading liability as a weapon to recover payment (to the extent that it is desirable for statutory demands to be so used).

The changes expose some participants in the market to heightened risks, which may be unintended and undesirable. For example, raw materials suppliers and upstream creditors may be affected by delays or difficulty in recovering overdue payments, and indeed there is already anecdotal evidence of withholding payments on the basis of Coronavirus stress.

This shifts the credit risk to the upstream supplier. Is this a fair outcome? One could argue that it is open to creditors to better secure their position by altering trading terms or seeking money upfront or collateral. However, many suppliers have limited scope to adopt alternative means in a competitive market where capacity to deal with risk is uneven.

The imposition of upfront payment terms may also add to the risk the arrangement might be regarded as a voidable transaction (ie a “preferential” payment made prior to insolvency).

What hasn’t changed

Despite the changes, creditors still have the option to pursue an action against a defaulting debtor through the courts for breach of contract, and seeking a judgment. The effect of the reform measures is merely to impede the use of a cheaper and more efficient system.

Further, for any suppliers and creditors who include a “charging clause” whereby the debtor provides some form of security for performance, there have not been any changes to the ability to rely on such rights. It is recommended that such parties obtain security for performance where possible.

However, the “ipso facto” laws remain in place, which prevent parties from terminating contracts purely as a result of a default arising due to the appointment of a receiver. Creditors under those contracts remain entitled to terminate for other defaults.

Insolvent trading

In normal circumstances, a director of a company can be personally liable for debts incurred by the company if, at the time the debts were incurred, it was likely that the company was either insolvent or would become insolvent by incurring the debt. (Note that “incurring” a debt generally means taking on a fresh debt, rather than a recurring payment under an existing obligation – so rent for a lease that was signed prior to the insolvency is a recurring obligation under an existing contract, however entering into a new lease or finance arrangement would be a new debt.)

The temporary “safe harbour” provisions described above are intended to give directors some comfort to make decisions and keep their businesses trading without fear of personal liability for a misstep. This in turn is intended to keep the cash flowing in the economy.

The conditions under which the exemption will be available to directors are
where the debt is incurred:

• in the ordinary course of business (which includes where it is necessary to facilitate the continuation of the business);
• in the next six months after commencement of the new laws; and
• before any appointment of an administrator or liquidator of the company.

Note that there will be some limits on the availability of the relief, and a director seeking refuge must prove that it should apply (which is contrary to the usual position).

It is also important to remember that this reform is not a licence to act carelessly. Directors remain bound by all of their other duties, including the requirement to act with care and diligence, in good faith in the best interests of the company and to not improperly use their position or information received for personal gain or to cause detriment to the company. A breach of some of these duties may separately expose a director to personal liability.

Previously, a creditor may not have been paid at all if the director feared an insolvent trading liability.

Are the consequences that a director is more willing to incur a liability (which may ultimately be incapable of payment)?

Or is it a benefit to the supply chain that the directors will be prepared to continue to invest? The risk with investment of this nature is that the creditor may find itself the beneficiary of a preferential payment with only a claim against an insolvent entity.

Conclusion

Accordingly, it should be noted that creditors have not been deprived of all of their rights. The measures are directed around relief in connection with insolvency. It will be interesting to see if these measures assist to maintain the supply chain and economic cycle. Like many measures, it probably relies on the participants to use the measures for their intended purpose and not abuse them.

If you would like further information on the reforms, or your rights and obligations under the Corporations Act (whether as a director, business operator or creditor), we would be happy to assist you.

Note that the attached information is intended to be a broad overview of general principles only and does not take into account specific circumstances. This document does not purport to be advice and should not be relied upon as such.

Please call 03 9614 7111 or email us at commercial@nevettford.com.au for a discussion.

Stuart Wilson – swilson@nevettford.com.au
Level 16, South Tower Rialto
525 Collins Street, MELBOURNE VIC 3000
Phone: (03) 9614 7111

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