SHELTER FROM THE STORM: PHOENIX ACTIVITY AND THE SAFE HARBOUR.

• Date: 01 April 2018
• Author: Anderson, Helen

I Introduction II Deliberative Challenges of Conflict Society Referendums A Five Characteristics of Conflict Societies 1 Social Division and Polarisation 2 Group-Targeting 3 Low Information and Misinformation 4 Uneven Deliberative Commitments 5 Violence and Reaction B Referendums in Conflict Societies III Value-Deliberation A Referendums and Value-Deliberation 1 Value-Deliberation and Public Reason 2 Value-Deliberation by Non-Elites B Limitations 1 Inclination to Applied-Deliberation 2 Incompatible Values 3 Low Information and Misinformation 4 Axiomatic and Identitarian Values 4 Axiomatic and Identitarian Values C Shotgun Referendum Conditions 1 Value Focus 2 Deliberative Referendum Design 3 Generalisation 4 Deliberative Minimalism IV Popular Legitimacy A Referendums and Popular Legitimacy B Limitations 1 Uneven Deliberative Commitments 2 Elite Roles 3 Popular Unity C Shotgun Referendum Conditions 1 Deliberative and Democratic Referendum Conditions 2 Non-Elite Priority V Conclusion I Introduction

This article is concerned with insolvent trading legislation, which imposes liability on directors for allowing a company to incur new debts when it is no longer able to pay existing debts. (1) Choosing the 'right' course of action when insolvency looms has always been difficult for directors. On the one hand, a prompt liquidation ensures that further creditors are not exposed to losses from the company's collapse, and that available assets are distributed in the liquidation only to those creditors whose losses have become unavoidable. On the other hand, continuing to trade in appropriate circumstances might see a turnaround in the company's fortunes, so that all creditors are paid or at least receive more than they would have if the company were quickly liquidated. Ensuring that 'bad' behaviour is deterred and 'good' behaviour is permitted when creditors are facing significant additional risk requires careful drafting of both the insolvent trading liability provision and its defences. (2)

Company directors benefit from the fact that the company is a separate legal entity and that debts incurred in the company's name by them as its controllers are payable by the company. Like companies themselves, liability imposed on directors for insolvent trading is a creation of statute, if a 'somewhat convoluted' one. (3) This article comes in the wake of the federal government's introduction in 2017 of a 'safe harbour' carve out from insolvent trading liability for directors, (4) primarily aimed at encouraging directors of large companies not to liquidate the company prematurely. (5) The aim of the carve out is to allow directors in appropriate circumstances to engage in an informal work-out, rather than placing the company into liquidation or voluntary administration ('VA'), but nonetheless not face liability where debts that the company cannot pay are incurred during the work-out period. Significant safeguards against abuse of the safe harbour have been included in the legislation.

On 28 March 2017, the government released draft legislation and called for public submissions. (6) The current interest in a safe harbour follows a Treasury discussion paper on the same topic in 2010 ('2010 Safe Harbour Paper') that dealt with the concept of a safe harbour and proposed a business judgment rule as a means to implement it. (7) The fact that the 2017 safe harbour legislation was passed through federal Parliament is not central to this article. Instead, it makes two arguments: first, that some of the policy justifications for a safe harbour for the directors of large companies are questionable, which leads to the second, that the safe harbour runs the risk of increasing the prevalence of phoenix activity, particularly among small companies, (8) without achieving a compensating benefit in 'the big end of town'. For policy perspectives, this article relies on Treasury's 2010 Safe Harbour Paper and subsequent submissions. These are used in preference to the explanatory memorandum to the 2017 draft legislation and subsequent submissions, which largely concentrate on the operation of the legislation as proposed rather than whether a safe harbour itself is a good idea. This article also includes the views of the Senate Economics Legislation Committee ('Senate ELC') which were released in August 2017. (9) It recommended that the Bill be passed without amendment, (10) and it was duly passed with some minor amendments on 12 September 2017. (11)

Part II sets the scene by briefly outlining our current insolvent trading provision and defences, the relevance of liquidation and VA, and the justifications for, and elements of, the safe harbour. Part III examines the distinguishing features of phoenix activity relevant to insolvent trading, principally insofar as they occur among small companies. Part IV provides the analysis, asking first whether the safe harbour justifications stand up for companies of any size, and second, what difficulties a safe harbour could produce in the deterrence and prosecution of directors of mainly small companies choosing to engage in phoenix activity. Part V concludes that the safe harbour carve out enacted in 2017 is unlikely to be effective for directors of large companies and may well encourage directors of small companies towards phoenix activity.

II Background

A Current Insolvent Trading Liability

The current insolvent trading provision is contained in s 588G of the Corporations Act 2001 (Cth) and it owes much to the recommendations of the Harmer Report. (12) The Harmer Report justified imposing personal liability on directors for the insolvent trading of their companies thus:

The concept of limited liability as a privilege available to the commercial community was introduced into English law by the Limited Liability Act 1855 (UK). The limited liability company was seen then, and is seen now, as a device for encouraging entrepreneurial activity and promoting economic growth. However, despite these desirable and widely accepted goals, the corporate form was abused. In particular, its use by persons who took advantage of being able to conduct business through a company with a minimum paid up capital was in marked contrast to the original conception of a company as a means of attracting substantial capital to undertake significant projects. There followed attempts to curb the abuses without derogating from the advantages of limited liability. In strict legal theory, the measures taken to curb abuses involve invasion of the principle of the separate entity of the company, although they are sometimes loosely characterised as disturbing the principle of limited liability. Initially, the development of the law of the limited liability company centred upon the protection of investors (shareholders and debenture holders). It was not until some 70 years after the introduction of the concept of limited liability that legislators turned to consider the protection of creditors. (13) The main elements of s 588G are that the liable person is a director of the company, the company is insolvent at the time the debt is incurred or becomes insolvent by incurring that debt, and 'there are reasonable grounds for suspecting that the company is insolvent, or would so become insolvent, as the case may be'. (14) Certain actions which diminish the company's assets are deemed to be debts, including paying a dividend or entering an uncommercial transaction. (15) Liability for the director is imposed by s 588G(2) where the director is aware of the reasonable grounds for suspecting insolvency or a reasonable person in their position would be so aware. According to s 95A, '[a] person is solvent if, and only if, the person is able to pay all the person's debts, as and when they become due and payable.' (16) The person in question here is, of course, the company.

Contravention of s 588G(2) allows the liquidator to recover from directors by means of civil proceedings. (17) The money recovered is payable to the company and is available for distribution to all unsecured creditors, not just those whose debts were incurred during the period when the director had reasonable suspicions of the company's insolvency. (18) However, in creditor-initiated actions, which are permitted with consent, (19) the amount recovered is payable to the unsecured creditor. (20)

Liquidator recovery for contravention of s 588G(2) requires the company to be wound up. (21) This may have been intended to encourage directors to find alternatives to liquidation, such as VA, not only to benefit themselves but also creditors. (22) Placing an insolvent company into VA under pt 5.3A of the Corporations Act gives an administrator time to explore possibilities for saving the company or its business, failing which the assets are disposed of in a way that 'results in a better return for the company's creditors and members than would result from an immediate winding up of the company'. (23) The Harmer Report said, upon recommending the introduction of VA, that

the aim is to encourage early positive action to deal with insolvency. It will be worthwhile and a considerable advantage over present procedures if it saves or provides better opportunities to salvage even a small percentage of the companies which, under the present procedures, have no alternative but to be wound up. (24) The submission of the Insolvency Practitioners Association of Australia ('IPAA') to Treasury in 2010 recognised the role of the insolvent trading laws in achieving this aim:

[T]he Harmer Report saw the insolvent trading laws as supplementing and supporting the then new voluntary administration regime ... The strictness of the insolvent trading laws were meant to give a serious incentive to directors to focus on their company's financial position, something that the law at that time did not do. (25) Choosing to place the company into VA can mean that directors avoid the personal consequences of...