Safe Harbour Insolvency Reform – Has the Time Come for South Africa?

Safe harbour insolvency reforms should provide directors relief from insolvent trading provisions

By Christopher Rey, Director for BDO Business Restructuring

As an avid South African rugby union supporter, I don't often concede that our Australian counterparts do anything better than we do in South Africa. But in an economic climate as precarious and volatile as the current South African landscape, perhaps there's something to be learnt from Australia's Safe Harbour insolvency reform.

Currently, South African boards are required to take a forward-looking approach when considering the solvency test required by the country's company law and regulations. The solvency test is a demanding assessment for any board, as it involves considering various factors and outcomes to determine whether the company can meet its obligations in the next six months. This determination of whether a company is financially distressed or not is crucial for directors to avoid potential personal liability under our company legislation.

In an economic climate like South Africa's, where entrepreneurship in business must be encouraged, such obligations are more relevant than ever for directors. Shouldn't directors then have a safe place to turn when they see trouble on the horizon and are concerned about potential personal liability?

Director’s duty to prevent insolvent trading

In Australia, a director's duty to prevent insolvent trading resembles South Africa's company law framework, where directors have a similar obligation. This is vital not only for the company itself but also for other companies that interact with an insolvent entity, protecting them from the negative effects of doing business with such a company.

Australia’s Corporations Act 2001 (section 588G) imposes onerous obligations on directors to prevent the company from trading while insolvent. Failure to comply could result in personal liability for those debts if they cannot be repaid. In South Africa, similar director obligations are addressed under section 75 to 77 of the Companies Act, read with certain provisions of the Old South African Companies Act.

Prior to 2017, Australian directors who found themselves in such a situation had only one option: appointing a voluntary administrator, much like entering business rescue in South Africa, or a liquidator. However, amendments to the Corporations Act 2001 introduced a new section, s588GA, offering protection from personal liability for debts incurred by an insolvent company if directors embark on a course of action likely to lead to a better outcome compared to appointing an administrator or a liquidator.

Essentially, s588GA allows directors to incur company debts during a restructure or turnaround period without risking personal liability for those debts if they can't be repaid.

The Safe Harbour legislation in Australia provides directors with relief from personal liability and the opportunity to continue trading the company under distressed circumstances, provided they are taking a course of action reasonably likely to lead to a better outcome. This protection only extends to debts incurred in connection with the defined course of action or its development, ceasing when it no longer promises a better outcome.

While these safe harbour provisions can't replace formal business rescue proceedings in South Africa, they could encourage more boards to seek assistance when financial distress looms. The promise of preventing potential personal liability would likely lead to greater transparency among directors facing financial distress.

What could Safe Harbour mean for South Africa?

In a South African context, adopting a Safe Harbour legislation could yield positive outcomes for businesses, especially considering the increasing number of liquidations and insolvencies. Although such legislation doesn't currently exist in our jurisdiction, seeking advice on financial distress well in advance could prevent catastrophic events resulting from a lack of proactive measures by boards.

Boards in South Africa often face criticism for not identifying financial distress proactively, leading to various reported judgments in our jurisdiction. Adopting Safe Harbour provisions might enable early detection of underlying issues in a business and ensure timely remedial actions, including potential business rescue proceedings.

Whether or not South Africa ever considers implementing safe harbour provisions, partnering with the right restructuring professionals during perceived financial distress will undoubtedly prevent directors from being personally liable and give boards the best opportunity to restructure the affairs of a financially distressed company, ultimately benefiting the South African economy.