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A company under financial pressure puts its directors personally at risk. Section 588G of the Corporations Act 2001 (Cth) makes a director liable for insolvent trading if the company incurs a debt when it is insolvent, or when there are reasonable grounds to suspect it may become insolvent, and the director allows that debt to be incurred anyway. The consequences can include compensation orders, civil penalties, and, in cases involving dishonesty, criminal liability. It is one of the sharpest personal exposures a director carries, because it attaches to the individual regardless of the protection a company structure usually provides.
The safe harbour provisions in section 588GA of the Corporations Act 2001 (Cth) give directors a defined path through distress. They do not remove the underlying risk of insolvency, and they are not a shield against every kind of liability. What they offer is a defence against personal liability for insolvent trading, available to a director who recognises the warning signs early, takes proper advice, and works a genuine course of action reasonably likely to produce a better outcome than immediate administration or liquidation. For directors of development companies, private lenders and corporate groups carrying debt through a downturn, understanding how safe harbour works, and what it demands in return, is essential before the decision point arrives.
When insolvent trading exposure begins
A director does not need proof that the company is insolvent to be exposed. The duty is triggered at the point there are reasonable grounds to suspect the company may become insolvent, which is a lower threshold than actual insolvency. The test is assessed objectively. It does not turn on what the director subjectively believed at the time.
Insolvency is generally assessed on a cash flow basis: whether the company can pay its debts as and when they fall due. A company can be balance sheet solvent, with assets exceeding liabilities, and still be cash flow insolvent because those assets cannot be converted to cash in time. This is a common trap for development companies holding land or partly completed projects, and for lenders holding security that is illiquid in the short term.
The trigger for liability is incurring a debt, which covers signing new contracts, drawing further finance, accepting deposits, or extending credit terms with suppliers. Liability attaches to the individual director, and can extend to a person acting as a director in substance even without formal appointment. The corporate structure chosen for a project, whether a single purpose vehicle, a trading trust, or part of a wider group, affects how that exposure crystallises and who within the group is exposed. Directors weighing up structure for a new project should settle the business structure for the development with that exposure in mind.
What safe harbour protects, and what it does not
Safe harbour protects a director from personal liability for insolvent trading in respect of debts incurred while the director is developing or implementing a course of action reasonably likely to lead to a better outcome for the company. That is the full scope of the protection. It does not protect a director from breach of other duties, such as the duty to act with care and diligence, the duty to act in good faith, or duties around conflicts of interest. It does not protect against fraud or dishonesty, and it does not reach back to cover debts incurred before the course of action began.
The protection is also personal. Each director on a board must independently satisfy the requirements to rely on safe harbour, and a board resolution alone does not extend the defence to a director who has not met the preconditions or is not genuinely engaged in the plan. Directors managing distress alongside other governance obligations should keep in mind that safe harbour adds to the broader framework of director duties and does not replace it.
The better outcome course of action
The core test is whether the course of action is reasonably likely to lead to a better outcome for the company than immediate appointment of an administrator or liquidator. Better outcome is assessed by reference to the company and its creditors as a whole. It is a different question to what suits a particular director, shareholder or related party.
What counts as a course of action will vary with the business, but commonly includes:
- Restructuring existing debt with financiers, including standstill or forbearance arrangements
- Renegotiating leases, supply contracts or other ongoing obligations
- Selling non-core assets or a business unit to reduce debt and preserve the core operation
- Bringing in new capital or a new investor to recapitalise the company
- Restructuring the corporate group itself where that improves the position of creditors
Bringing in new capital as part of a turnaround plan carries its own disclosure and structuring considerations, particularly where funds come from investors outside ordinary banking channels. Directors need to work through the compliance issues of raising capital without disclosure before pursuing that path.
Timing matters. The course of action needs to start before the point at which a reasonable director would already know that insolvency is unavoidable and no genuine plan remains available. Waiting too long, or relying on a plan that has stopped being credible, takes a director outside the protection even if the paperwork says otherwise.
Preconditions directors must meet
Safe harbour is not available to every director simply because they have engaged an adviser and started a plan. Two preconditions sit ahead of everything else, both concerning obligations owed to people outside the company’s ordinary creditor group.
- Employee entitlements. The company must be substantially up to date with employee entitlements that are due and payable, including superannuation guarantee obligations, at the time the director seeks to rely on safe harbour.
- Tax lodgement obligations. The company must be meeting its lodgement obligations to the Australian Taxation Office, such as business activity statements and related reporting, even where the amounts owing have not yet been paid in full.
The threshold is being substantially compliant rather than perfect, and a director who has fallen behind is not automatically excluded provided reasonable steps are being taken to remedy the position. In practice, one of the first tasks in any distress scenario is a clean reconciliation of payroll, superannuation and lodgement status, because a gap here can undermine the defence entirely, regardless of how strong the underlying turnaround plan is.
Evidence and advisers that support the decision
Safe harbour is not something a director simply declares. If challenged later, most likely by a liquidator examining the period before a formal insolvency appointment, the director carries the burden of establishing that the requirements were met. That makes contemporaneous evidence essential rather than optional.
Directors relying on safe harbour should be able to point to an appropriately qualified adviser engaged early in the process, whether a restructuring specialist, an experienced accountant, or an insolvency practitioner, and to advice received from that adviser that informed the course of action. Board minutes should record the decision to pursue safe harbour, the reasons for it, and how the plan is progressing at each review. Financial records and cash flow forecasts need to stay current and be updated as circumstances change. Directors should also be seen to take active steps to prevent conduct that would materially prejudice creditors, and to keep the company’s books and records in a state that allows its financial position to be readily ascertained.
None of this needs to be elaborate, but it does need to exist and be current. A safe harbour position built on a plan that was never written down, with no advice on file and no board record, is very difficult to defend after the fact.
When safe harbour protection ends
Safe harbour is not a one-off decision that covers a director indefinitely. The protection ends, and ordinary insolvent trading exposure resumes for debts incurred afterwards, when any of the following occurs:
- The course of action stops being reasonably likely to lead to a better outcome for the company
- The director stops taking the course of action, whether by choice or because it has become unworkable
- An administrator, liquidator or receiver is appointed over the whole, or substantially the whole, of the company’s property
- The director fails to maintain the preconditions around employee entitlements and tax lodgements
Because the protection can end without a formal announcement, directors need to reassess the plan on a rolling basis rather than treating the initial decision as sufficient on its own. A plan that was reasonable when it started can stop being reasonable a few months later, and a director who keeps trading on a plan that has quietly failed is exposed for every debt incurred after that point.
Frequently asked questions
Does safe harbour apply automatically once a company is in financial difficulty?
No. Safe harbour only applies once a director has started developing or implementing a genuine course of action reasonably likely to produce a better outcome, and has met the preconditions around employee entitlements and tax lodgements. Financial difficulty alone does not trigger the protection.
Can a company keep trading normally while a director relies on safe harbour?
Yes, and ordinary trading is usually necessary to preserve the value of the business while a turnaround plan is worked through. The protection covers debts incurred through ordinary trading while the plan is genuinely being implemented, as well as debts tied directly to the plan itself.
Does safe harbour protect directors from all forms of liability?
No. It is limited to personal liability for insolvent trading. Directors remain subject to their other duties, including the duty of care and diligence and duties around conflicts of interest, and safe harbour offers no protection against fraud or dishonest conduct.
What happens if the turnaround plan ultimately fails?
A plan failing does not automatically mean a director loses the protection for the period it was genuinely in place. If the director met the preconditions and was properly developing and implementing a course of action reasonably likely to succeed at the time, the protection can still apply to debts incurred during that period, even though the company later enters administration or liquidation. What matters is the reasonableness of the plan and the director’s conduct at the time. The ultimate outcome does not change that assessment.
Every safe harbour position turns on the specific facts of the company and the plan in place, and directors should get advice before relying on it. If you are a director navigating financial distress, contact GRM LAW to discuss your position and the steps available to you.
Disclaimer: This is general information only and is not legal advice. For advice on your circumstances, contact GRM LAW.
Black Shard