Safe Harbour: Getting past the Harbour Master?

Tuesday, 18 April 2017

The Federal Government's recent Exposure Draft of legislation designed to provide a safe harbour from insolvent trading laws has generated significant commentary regarding the practical and legal challenges of staying within the safe harbour.  

However, there has been less commentary on the proposed gatekeeper subsection, Section 588GA(4), which excludes a person from access to the safe harbour provisions. This subsection provides that the safe harbour protection provided by:

Subsection (1) does not apply if the company is failing to do any of the following to a standard that would reasonably be expected of a company that is not at risk of being wound up in insolvency:

(a)  providing for the entitlements of its employees

(b)  giving returns, notices, statements, applications or other documents as required by taxation laws (within the meaning of the Income Tax Assessment Act 1997).

Complexity and ambiguity undermine new draft Safe Harbour legislation

As currently drafted, there are numerous difficulties in determining whether a person is eligible for safe harbour arising from this subsection. Rather than providing directors and their advisers with clear guidance, the Exposure Draft has used concepts and language that will make it harder for directors and their advisers to determine whether they will fall inside the bounds of the safe harbour.

The subsection creates a new standard or benchmark being the reasonable standard applied by a “company that is not at risk of being wound up in insolvency”. What this means is unclear given the breadth of companies that may not be at risk of winding up and the wide variance in compliance standards across corporate Australia. Is the reference set to be those companies that have never been subject to winding up proceedings or is there a higher financial standard to be met to be a reference company? Even amongst wholly solvent companies, compliance standards for employee entitlements and taxation compliance vary widely. By applying a subjective test of whether a company has reasonably met its compliance obligations, the Exposure Draft creates uncertainty around whether directors may rely on the safe harbour provisions.

The uncertainty created by this subsection is further amplified by the language used when identifying the matters than “must be being done to a reasonable standard” by that company.

Firstly, the company must be providing for the entitlements of its employees. The Exposure Draft indicates that entitlements will be defined by reference to subsection 596AA(2) and so the entitlements to be provided for include retrenchment and termination payments. However, the Exposure Draft does not define what is meant by ‘providing’ for these entitlements. The Explanatory Memorandum provides no more clarity on the meaning of ‘providing’ with various references to providing or having met employee entitlement obligations. Is it sufficient that any employee entitlements that have fallen due are paid when due? Is an accounting provision for entitlements sufficient even though accounting provisions do not usually extend to retrenchment and termination payments? Does it mean that the company needs to provide for the entitlements by fully cash backing or otherwise segregating sufficient value to protect all employee entitlements in the event of formal insolvency proceedings? If so, how are issues such as security interests over circulating assets or employees in corporate service companies to be considered?

An accounting provision for entitlements provides no real comfort for protection of employee entitlements. Compliance by a company in paying all employee entitlements that have fallen due is a good start for access to the safe harbour but it does little to protect unpaid employee entitlements from risk. Given the inclusion of retrenchment and termination entitlements in the definition of entitlements, it seems that the intent is that more is required than payment of entitlements falling due. Further, in respect to providing for entitlements, if providing means a requirement to fully secure all employee entitlements, that will be a liquidity hurdle that will further challenge a company facing solvency concerns as well as cause concern for companies that are not in financial distress. The legislation then starts to impact on existing and well established accounting standards and the very definition of solvency.

Secondly, the company must comply with the taxation reporting obligations of the Income Tax Assessment Act 1997. It would seem a simple test to determine whether a company is compliant or non-compliant with its taxation reporting obligations. However, the subsection sets the compliance standard by reference to the hypothetical “company that is not at risk of being wound up in insolvency”. Is there a level of non-compliance with taxation law that is now to be legislatively acceptable? If not, the subsection should be amended to reflect clearly that all taxation reporting obligations must be up to date to obtain access to the safe harbour provisions.

Proposed changes to the draft Safe Harbour legislation

The exercise of judgement required for directors and their advisers in implementing effective safe harbour protection will be challenging. The capacity to access the safe harbour is not helped by drafting which makes the availability of safe harbour protection uncertain for directors and their advisers. If the safe harbour legislation is to be readily accessible, the Harbour Master entry requirements need to be amended to:

• Exclude the new subjective test of the standards applied by a company that is not at risk of being wound up in insolvency.
• Make clear what the test is regarding ‘providing’ for employee entitlements. If the test is payment of all employee entitlements that have fallen due, that is a simple test that can be applied. If it is to fully secure payment of all employee entitlements if the company is subject to either voluntary administration or winding up, the legislation should set that test, even though it is likely that this will substantially limit the number of companies that can access safe harbour.
• Exclude any reference test in relation to compliance with taxation reporting obligations. A company is either compliant or non-compliant by reference to the Income Tax Assessment Act 1997.