A company entering into safe harbour will want comfort that it has the support of its financiers and will continue to have access to funding under its loan facilities throughout any potential restructure process. To this end, before entering safe harbour, a company should ensure that appropriate due diligence is undertaken on any finance documentation which the company has in place, and any appropriate disclosures are made to, or waivers or consents are obtained from, its financiers.
The Safe Harbour provisions
The purpose of the safe harbour provisions of the Corporations Act 2001 (Cth) is to encourage directors in distressed companies to pursue restructuring opportunities without fear of incurring liability for insolvent trading, rather than prematurely commencing a formal external insolvency process.
The safe harbour provisions operate as a protection for directors personally and not the company. A director who successfully relies on the safe harbour defence, will not be personally liable for any debts incurred by the company directly or indirectly in the course of implementing a recovery plan formulated whilst in safe harbour. Safe harbour is not a formal insolvency process and does not need to be disclosed publicly.
Each of the directors seeking to rely on safe harbour needs to satisfy various criteria, including that the director has:
- properly informed themselves of the company’s financial position (for example, accessing the company’s latest financial information to assess the feasibility of a given course of action);
- taken appropriate steps to prevent any misconduct by other officers or employees that could adversely affect the company’s ability to pay all its debts;
- ensured that all employee entitlements have been paid and tax filings are up to date;
- taken appropriate steps to ensure the company maintains appropriate financial records consistent with the size and nature of the company;
- obtained advice from an appropriately qualified entity (commonly known as the safe harbour advisor) who has been given sufficient information. The role of the safe harbour advisor is to advise and assist the board in formulating the course of action which the company proposes to take; and
- assisted in developing and implementing a plan or course of action for the company to improve its financial position and which is reasonably likely to lead to a better outcome for the company than the appointment of an administrator or liquidator to the company.
More commentary on safe harbour can be found here.
The provisions in the finance documents which are most relevant to a company proposing to enter safe harbour fall within the following categories:
- specific “safe harbour” provisions;
- insolvency events; and
- material adverse effect or “MAE” clauses.
Specific “Safe Harbour” Provisions
The market has generally been resistant to the inclusion of specific safe harbour provisions in finance documentation which would be triggered upon an obligor company entering safe harbour. From a policy perspective, this seems the right outcome. However, specific safe harbour provisions have been seen in lending documentation from some credit funds and non-bank lenders, and so the finance documentation needs to be carefully reviewed to ensure that any such provisions are identified, and any requisite consents or waivers are obtained, or disclosures made.
All finance documents will contain an insolvency based event of default of some description. Given that a company cannot enter safe harbour unless the board has “started to suspect that the company may be or become insolvent”, careful consideration will need to be given as to whether an insolvency event under the company’s finance documentation has occurred or will occur.
The drafting of the insolvency event of default will differ from transaction to transaction. As a general comment, provided that the relevant company is solvent, then the entering into safe harbour by a company should not of itself trigger an insolvency event under the usual market wording as it is not a formal insolvency process, provided that the relevant company:
- has not suspended payments or rescheduled its debts; or
- has not entered into an arrangement with creditors.
However, the specific wording of the insolvency event definition in the finance documentation needs to be carefully reviewed to ensure that appropriate disclosures are made to, or waivers or consents are obtained from, the company’s financiers. Also, as the company progresses through any restructuring process (especially if that involves compromises with creditors), the insolvency event definition needs to be re-visited to ensure that any additional consents or waivers are obtained prior to the implementation of any restructuring plan.
Material Adverse Effect
Most finance documents will contain a “material adverse effect” or “material adverse change” (“MAE”) concept or provision of some kind. The MAE will generally be defined as a material adverse effect on the:
- ability of any obligor (or the obligors or the group as a whole) to perform its (or their) obligations under the finance documents; or
- business, assets or financial condition of any obligor (or of the obligors or the group taken as a whole).
The MAE provision can be woven into the finance documentation in various ways, and most commonly appears as:
- a qualifier to certain representations and warranties, undertakings and events of default; and
- more relevantly for our purposes, a stand-alone event of default which is triggered upon the occurrence of any event or series of events (whether related or not) which has (or may or could have, depending on how the clause is drafted) a MAE.
The representations and warranties will also usually include a representation and warranty that no event of default (and sometimes no potential event of default) has occurred or is subsisting (or words to that effect). On each drawdown date, the representations and warranties will be repeated, and if the representations and warranties are not correct in any material respect, that can:
- operate as a draw stop (on the basis that the financier is not obliged to comply with a drawdown request unless the representations are true and correct in all material respects); and
- in turn, lead to an event of default if the relevant event is not cured within any specified cure period.
Whether or not a MAE has been triggered by:
- the company entering safe harbour; or
- the facts or circumstances which have prompted the company to enter safe harbour in the first place,
would be a factual matter to be ascertained at the relevant time.
Historically, financiers have been reluctant to rely on the occurrence of a MAE of itself to trigger an event of default. However, a financier may be less reluctant to rely on a MAE as a draw stop, meaning further funding requests under any available limits from a company who has entered safe harbour may be denied.
Before entering safe harbour, a company should ensure that appropriate due diligence is undertaken on any finance documentation which the company has in place, and any appropriate disclosures are made to, or waivers or consents are obtained from, its financiers. This will give comfort to the company that it has the support of its financiers and access to working capital throughout the process. From a financier’s perspective, the fact of a company entering safe harbour should not necessarily be cause for concern, as it demonstrates that the company is proactively looking to address underlying issues by taking expert advice with the aim of ultimately preserving value in the business and indirectly protecting the financiers’ position.
As the company progresses through any restructuring process, the documentation (and, in particular, the insolvency event definition) needs to be re-visited to ensure that any additional consents or waivers are obtained, or disclosures are made, prior to the implementation of any restructuring plan and to ensure ongoing support.