Heightened Risks for Directors: The End of Temporary Relief - JHK Legal Commercial Lawyers

29 April 2021

Heightened Risks for Directors: The End of Temporary Relief

As the challenges of the COVID-19 pandemic continue, many businesses have innovated and adjusted their business models to stay afloat. With the changes came temporary measures and stimulus packages to ease the pressure and burden businesses would face. Many of those measures have now come to an end.

The outlook for 2021 has normality in sight, but it’s not over yet. It is important that now, more than ever, directors and business owners consider their next play and their potential exposure.

Here are a few important changes that directors should take note of:

  1. Insolvent trading protections ended

Under Section 588G of the Corporations Act 2001 (Cth), directors have a duty to prevent their business from trading whilst insolvent.

In March 2020, the federal government introduced the Coronavirus Economic Response Package Omnibus Act 2020 (Cth) (Omnibus Act) to provide temporary relief and protection to directors of financially distressed businesses. The temporary measures ultimately provided a moratorium to directors from being pursued for any insolvent trading claim. As such, directors could not be held personally liability for their business trading insolvent during the pandemic if the debt was:

  • incurred in the ordinary course of the business; and
  • incurred between 25 March 2020 to 31 December 2020.

This protection and safe harbour for directors has inevitably come to an end as of 31 December 2020. Directors are only protected from insolvent trading if the company was placed into liquidation before 31 December 2020. Directors of companies that are liquidated after this cut off will not be protected by the safe harbour. Any debt incurred from 1 January 2021, whilst the company is insolvent, will mean that the director can be held personally liable for those debts.

If a director suspects that their company may be trading insolvent, it is important to seek legal advice to avoid being held personally liable and to take steps to protect themselves and the future of the company. The traditional safe harbour regime may still offer some protection to directors in certain circumstances, or alternatively, a restructure or deed of company arrangement may be considered.

  1. Illegal phoenixing

With the increase in restructuring and directors in survival mode, there is no doubt an increase in directors turning to illegal phoenixing to attempt to recover their businesses and avoid paying debts.

Illegal phoenix activity is where a company deliberately liquidates its assets and transfers them to a new company for no value or below market value to avoid paying debts, including taxes, creditors and employee entitlements.[1]

In an effort to tackle illegal phoenixing, ASIC has introduced new “director identification numbers” for all directors (“DIN Regime”). The DIN Regime, is expected to be implemented by about 22 June 2022 (or earlier, if a date is set).

Previously, a director could have multiple records with ASIC due to minor variations with their details such as a middle name not being included on one record, or a different address. Now, directors will be required to keep the same director identification number and it cannot be issued to anyone else. It will mean that directors will need to apply for a director identification number prior to being appointed as a director or will be required to apply for one within the timeframe directed to do so. The implementation of the DIN Regime has inevitably been delayed due to the uncertain challenges of COVID-19, but when it does come into effect, it will have a significant impact in combatting illegal phoenixing by ensuring directors can be tracked across multiple companies. It will also allow directors and their corporate history to be tracked more efficiently.

Directors should be aware of their duties and obligations not to engage in illegal phoenixing in order to avoid exposure and being personally sued for such action. Feel free to reach out if you need advice about your obligations or the new director identification number requirements. It is important directors stay up to date with these changes to ensure compliance.

  1. The end of JobKeeper

Since COVID-19, the federal government supported a number of businesses and employees with the introduction of the JobKeeper package.

JobKeeper ended on 28 March 2021. What does this mean for businesses? This has meant that many businesses have needed to re-adapt and stand on their own without the government’s support. It is predicted that small-medium sized businesses will be the most impacted, particularly those with minimal funding options. Businesses may look to solutions such as the inevitable reduction of staff, negotiating rental payments, restructuring or closing down permanently.

It is important for directors to identify whether the business is just experiencing a short term cashflow problem or whether there are indicators that the business is facing a bigger insolvency issue. Upon looking at the business more broadly, if there are underlying insolvency issues, it is important to reach out for advice, particularly if the business is struggling to meet overheads without JobKeeper. Dealing with these issues early and formulating a plan might help the business to recover and come out stronger on the other end.

  1. The end of the Rental Moratorium

From 28 March 2021, a landlord can now take action against a lessee for any failure to pay rent under the Retail and Other Commercial Leases (COVID-19) Regulation (No 3) 2020 (NSW).

This relief gave lessee’s financial ease for some time, but it has unfortunately come to an end. As with the end of JobKeeper, it is important for directors to identify whether the business is able to continue to maintain rental payments and if these payments are causing short term cashflow problems or potentially an underlying insolvency issue.

The solution? Negotiate with your landlord – although there is no longer an obligation for your Landlord to engage in negotiations, there is nothing to lose. Your landlord is likely to offer something if you can show your business has been affected, rather than lose their current lessee. This will allow the business to cut its fixed costs. With the phasing out of JobKeeper, this may be an avenue to look at if your business has been impacted. We have been able to assist many businesses re-negotiate their lease in the current climate.

  1. Improper use of stimulus

Directors further have a duty to avoid transactions that are not in the best interests of the company. Such transactions are voidable and a liquidator may have a right to make a claim against the director under Section 588FE of the Corporations Act 2001 (Cth) to ensure that assets are distributed fairly amongst creditors. The transactions must also be insolvent transactions, i.e. must have occurred at a time when the company was insolvent.

Whilst the stimulus packages have helped businesses deal with short term cashflow issues, these measures have not relieved directors from the voidable transaction provisions. Directors need to ensure they are not tempted to deal with the stimulus packages received inappropriately, for example, drawing the funds for personal loans and expenses. Although these payments may boost business agility, ironically, if not used appropriately, these payments can cause even more financial distress and are at risk of being clawed back by a liquidator if the company unexpectedly goes into insolvency.

It is the liquidators’ job to ensure that the assets of the company are maximised and available for fair distribution to unsecured creditors. Directors need to ensure company debts are paid first prior to spending the funds on personal use or otherwise, to avoid a personal claim being made against the director for their use of the funds if the company becomes insolvent.

  1. ATO Debt

The ATO has confirmed that it will officially be resuming its compliance activities from April 2021 to pursue and enforce debt recovery action. The resumption will be on a case by case basis, where taxpayers have failed to comply with their obligations. They will be collecting unpaid tax debt, including issuing Director Penalty Notices (“DPN”). This means that if the business has an unpaid tax debt, the director can be held personally liable for the debt under certain circumstances by way of a DPN.

It understood that firm action will not be taken if attempts are made to reach out to the ATO and do the right thing. It is important to get on the front foot and deal with any demand letters received from the ATO immediately. Further, all lodgements must be up to date and lodged within the required timeframes to avoid becoming personally liable under a DPN.

There are avenues available for businesses to deal with their overdue tax debts, with the most common being to negotiate a payment plan. This will ease the pressure and allow you to pay back the debt within a longer timeframe of a year or so.

Key takeaways: So what next?

The next few months will be pivotal for medium and small businesses. Directors should keep a close eye on cashflow and the general financial position of their businesses in order to mitigate their losses as much as possible.

There are a number of avenues available for directors and businesses facing difficulties and it is important to seek advice to discuss your options.

How we can help you

JHK Legal can provide advice or general assistance in safeguarding the future of your business and avoiding personal exposure. Please reach out to the JHK Legal team to see how we can help you and your company.

Written by Kristina Ghobar, Associate

[1] Australian Taxation Office, Illegal phoenix activity; Australian National Audit Office, Addressing illegal phoenix activity