Safe harbour guidance for directors

The COVID-19 Response (Further Management Measures) Legislation Act 2020 introduces temporary safe harbours for insolvency-related director duties in the Companies Act 1993. The safe harbours are to assist directors of companies that were viable before COVID-19, not those already in trouble. They provide relief from potential personal liability.

Existing insolvency-related director duties under the Companies Act

The following director duties in the Companies Act are specifically relevant in the event of insolvency:

Duty not to trade recklessly: Directors must not agree to, cause or allow the business to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors (s 135)
Duty not to agree to a company incurring inappropriate obligations: Directors must not agree to a company incurring an obligation unless they believe at the time on reasonable grounds that the company will be able to perform the obligation when it is required (s 136).

Safe harbour provisions

The safe harbour provisions are set out in a new schedule in the Companies Act 1993. They essentially provide that a director’s actions will not breach the above duties if, at the time of taking them, the director, in good faith, is of the opinion that:

the company has, or in the next 6 months is likely to have, significant liquidity problems;
the liquidity problems are, or will be, a result of the effects of COVID-19 on the company, its debtors, or its creditors; and
it is more likely than not that the company will be able to pay its due debts on and after 30 September 2021. The schedule states that the director may have regard to the likelihood of trading conditions improving, the likelihood of the company reaching a compromise or other arrangement with its creditors and any other matters the director considers to be relevant.

The safe harbour provisions apply from 3 April 2020 until 30 September 2020, although there is scope for the government to extend the timeframe.

Guidance for directors*

Directors seeking to rely on the safe harbour provisions bear the burden of proving they apply. Good records of decisions and the grounds for them will be critical.

A good faith opinion means an honest belief, which is a relatively low threshold and allows some scope for getting things wrong. Meeting the criteria is not a “set and forget” function. Directors need to constantly review whether the criteria continue to be satisfied, particularly before incurring new obligations.

To be a good faith opinion, directors will need to demonstrate a basis for the view formed including:

Preparing detailed weekly or daily cashflow forecasts (over a 13 – 17 week period) to form a robust view of cash availability, liquidity constraints and ability to manage solvency;
Preparing robust 12 – 18 month projections which should consider a range of scenarios with some support for the key assumptions;
Re-evaluating the assumptions and forecasts regularly as a clearer picture of the economic impact emerges; and
Challenging the forecasts and assumptions to understand the level of rigour in their preparation.

The forecasts will need to factor in the prospect of meeting new commitments in addition to existing commitments in a constrained economic environment.

Directors will still need to carry out their other duties under the Companies Act such as exercising reasonable care, diligence and skill and acting in good faith and in the best interests of the company.

*This is based on guidance in the article Directors’ duties during COVID-19 by KPMG and MinterEllisonRuddWatts.