Safe harbour reform

This article appeared in The Australian Financial Review on 14 June 2017 (subscription may be required).

The Government has introduced legislation to reform Australia’s insolvency laws to provide better outcomes for companies in financial distress, and their employees.

Our insolvency laws are widely recognised as being among the harshest in the world. Unlike comparable countries, such as the UK and Singapore, where the law focuses on what directors are doing to try and turn a company around, Australia’s laws focus solely on the tipping point where a company cannot pay its debts at the point in time when they fall due. Due to the personal liability implications for directors, the perverse result of this is that the Australian system pushes directors down the route of administration, irrespective of the longer term viability of the company. This stifles innovation and potentially causes businesses to prematurely close their doors.

This focus on pushing companies towards administration does untold economic damage. How much value and how many jobs could be saved if the law allowed conscientious directors to undertake reasonable measures to save a business, rather than going into administration or liquidation? What major corporate collapses could have been prevented, avoiding devastating job losses and value diminution if directors had the option of pursuing a restructure or workout?

Australia’s insolvency regime contributes also towards a wider social problem of risk aversion in Australian businesses. In a rapidly evolving world, companies need to be able to take rational risks in order to create jobs and value, but in order to do so the law needs to support them in their efforts to protect a company’s value when these risks don’t pan out.

The Government’s proposed safe harbour laws would go some way to helping change things. These much-needed reforms are not a blank cheque or exemption for directors of failing companies. They are aimed at giving directors who take reasonable actions to save businesses or achieve a better outcome for the company a legal defence against the substantial personal, professional and legal penalties that come with trading while insolvent. Importantly, the defence would not be available to directors where obligations around employee entitlements, including superannuation, and taxation reporting are not being met. Nor would there be a safe harbour for directors who fail to meet their obligations to assist liquidators in the event that a company does subsequently close its doors.

In an increasingly global world, these reforms are needed not just for the businesses that already exist, but for the ones that are yet to be thought of. In start-up and scale-up businesses, the number one thing on the mind of directors is often the ‘runway’, that is to say, how long will the cash last. Thanks to Australia’s tough insolvency laws, the length of the runway is the difference between taking off, or bailing out. Ask almost any director of one of these businesses and they’ll tell you that even if a growing company has good prospects and good revenue, if it’s skating close to the wind on cash the administrators will be called in as the personal liability risks are just too great.

How many potentially good businesses, that had the opportunity to employ Australians and create value, have failed because directors and officers don’t have the opportunity to trade through a brief period of cash flow issues, or to implement reasonable business strategies to turn things around? In a rapidly evolving world where the jobs of tomorrow likely don’t even exist yet, a framework that punishes risk taking and innovation will hamstring our economy.

Furthermore, the best thing start-up and scale-up businesses could have is a team of experienced and knowledgeable directors sitting around the board table who can offer advice, guidance and good governance. Yet the risks of failure and insolvency for these businesses is high, and as such many good directors shy away from serving on these boards due to the high professional and legal risks associated with insolvent trading.

Australians punish failure harshly, and so does our legal system. However, if we want to see innovation grow on our shores then we need to change that. Creating an appropriate safe harbour for directors who try and save jobs and value in good faith, rather than throw in the towel, is essential if we want to encourage the businesses of the future.