Changes to the Rule Against Insolvent Trading during Coronavirus

It seems that everything is changing due to the Coronavirus pandemic, and the world of corporation law is no exception. Late last month, federal Parliament enacted legislation which provides temporary relief to directors from their duty to prevent insolvent trading.

The duty ordinarily

In more normal times, directors of companies have a duty under s588G of the Corporations Act 2001 to ensure that their company does not continue to incur debts if it is insolvent. If the director is aware that there are grounds for suspecting their company is insolvent—or if a reasonable person in similar circumstances would be so aware—that director has to prevent the company from incurring any further debts.

The changes due to Coronavirus

Because of the difficult economic climate created by the Coronavirus pandemic and the resulting lockdowns, the government has decided to loosen the normal duty to avoid insolvent trading.

The Coronavirus Economic Response Package Omnibus Act 2020 inserts a new section into the Corporations Act 2001 to provide temporary relief in response to the Coronavirus.

This new section provides that the duty to avoid insolvent training does not apply in relation to debts incurred:

• In the ordinary course of the company’s business;

• During the 6 months starting on the day the section commences, or any longer period prescribed by regulation; and

• Before the appointment of a liquidator.

“Ordinary course of the company’s business”

The new section refers to debts that are incurred in the ‘ordinary course of the company’s business.’

What does this mean?

The Finance Minister has helpfully explained that a debt will be incurred in the ordinary course of the company’s business ‘if it is necessary to facilitate the continuation of the business during the six month period…’[1]

The Minister gave as examples, a director taking out a loan to move some business operations online, or debts incurred through continuing to pay employees during the Coronavirus pandemic.[2]

What these examples seem to indicate is that ‘ordinary course’ is not restricted to things that the business would do in ordinary circumstances. Rather, it would appear to include unusual business moves that are required in the current circumstances for the business to continue ordinary operations.

Word of warning

The new changes to the duty to avoid insolvent trading will undoubtedly provide welcome relief to many company directors who are worries about complying with their directors duties in a difficult time.

However, it is worth noting that at present, the changes only apply to debts incurred during the six-month period ending on 24 September 2020. If a company is in severe financial straits after that date, any debt incurred will once again be insolvent trading, and penalties will apply to directors.

It is also important to note that company directors bear the burden of proof for the new section. That means that if a director wants to rely on the protection of the new section, they have to be able to bring evidence to prove that the debt was incurred in the ordinary course of the company’s business, and that it was incurred within the time period.

As always in matters concerning directors duties, it always pays to be careful and to seek professional legal advice when concerned.

Are you thinking of using the new protections in relation to your company? Why not give us a call to get insolvency legal advice?

[1] Coronavirus Economic Response Package Omnibus Bill 2020, Explanatory Memorandum at 12.18.

[2] Ibid.