Insurance & Reinsurance
In response to the COVID-19 pandemic, the Australian Federal Government introduced reforms to better protect businesses from financial distress. As the economy recovers, some of those reforms will be made permanent while others discarded.
It is uncontentious that Australia has some of the toughest insolvent trading laws in the world. Section 588G of the Corporations Act places a positive obligation on directors to prevent their company from incurring debts when the company is insolvent and the mere suspicion of insolvency (either objectively or subjectively) is sufficient to trigger potential liability.
Insolvent trading offences in Australia are effectively strict or absolute liability offences which have often been blamed for premature corporate collapse, which was no doubt the reason for the moratorium.
On 23 March 2020, the Coronavirus Economic Response Package Omnibus Bill 2020 was introduced which temporarily suspended a director's duty to prevent insolvent trading along with any associated personal liability for directors if the relevant debt was incurred '"in the ordinary course of business" (section 588GAAA).
The Bill was designed to allow directors to continue to run companies through the most uncertain of times during the Covid crisis and provide them with protection from being personally liable for debts of the company, thereby allowing directors to focus on making critical decisions for the continued existence of the company.
The moratorium came to an end on 31 December 2020 and consequently the old strict liability rules apply in a business environment which is still very uncertain, particularly for small and medium businesses which are also impacted by the uncertainty surrounding the continued jobkeeper government assistance.
Economists have warned of a real risk of an increase in company failures which have previously survived only by reason of the protections of the insolvent trading moratorium. Post 31 December 2020 and beyond, we expect to see an increase in insolvencies and resultant claims against directors for personal liability for insolvent trading and related regulatory action.
How then do directors, companies (and their insurers) navigate this?
Firstly, it is important that directors are fully aware of the solvency of their company, in particular the indicia of insolvency on which a court relies, which were set out in ASIC v Plymin  VSC 123 .
If a company is in financial difficulty, it is important that directors do everything they can to protect themselves going forward and avail themselves of the statutory defences to insolvent trading provided by section 588H. Namely, that at the time the debt was incurred the director relevantly had reasonable grounds:
We see so many directors try to rely on these defences years after the event, with little or no contemporaneous documentation and scratching around for supporting evidence. Directors should ensure that there is a good evidentiary record of the "reasonable grounds" for their expectation or belief of solvency. This should include a record of all the documentation and evidence relied on, together with their inquiries of management (including the CFO) about solvency which evidences them bringing an 'independent and inquiring mind' to the information provided to them. Too many times we see board minutes make no mention of solvency inquiries or answers purportedly given at board meetings, or the minutes merely referring to the fact that solvency was discussed and the CFO's confirmation that the company was solvent – the latter does little to establish the required "reasonable grounds" sufficient to enable the statutory defence. It is difficult for a director to try to recreate these grounds years after the event.
Further, a company can also seek to avail itself of the safe harbor provisions, including the 'safe harbour' defence in s 588GA of the Corporations Act. The Corporations Amendment (Corporate Insolvency Reforms) Act 2020 (Cth) (Insolvency Reforms Act) permits a restructuring (under conditions) of the business for eligible small companies where the relevant debt is less than $1m.
For Underwriters, the expiring moratorium will likely see an increase in insolvency related claims and investigations for which indemnity is sought under Directors & Officers or Management Liability policies.
The key protection for Underwriters will, of course, be their policy wordings and, in particular, the wording of any insolvency exclusion. The wording of these type of exclusions vary, with some extending to all claims (including the inevitable section 596 examinations) by liquidators, receivers or administrators, while most just exclude cover for claims and/or loss that "arises from, is based upon or attributable to" the insolvency event.
The recent decision of the Full Federal Court in AIG Australia Limited v Kaboko Mining Limited  FCAFC 96 provides good guidance on how insurers should word these exclusions.
The Federal Court found that the insolvency exclusion did not operate (with minor exceptions) on a claim/loss for breach of directors duties, as that did "arise out of, was not based upon or attributable to the actual insolvency of the Company", even if that was the reason or trigger for the proceedings being commenced against Kaboko (i.e. to recover debts the company had not paid).
The practical take away is that Underwriters should ensure any causal requirements of an insolvency exclusion are broad, such that it can be triggered by any connection to the insolvency event (for example, "in any way howsoever connected with or related to the insolvency event"). However, if underwriters do not want to cover claims by any insolvency practitioner or creditors, then the best way to exclude such claims is to expressly and clearly specifically exclude them.
Further, the categories of excluded loss should be comprehensive, limited not only to Loss and Claims but "any liability under this policy" and the description of the insolvency event wide enough to capture all insolvency related events.
Pre-covid, Section 674 of the Corporations Act and Rules 3.1-3.1A of the ASX Listing Rules required listed companies to immediately disclose all information to the market if a ‘reasonable person’ would expect it to have a material effect on the price or value of the entity’s securities. The intent of the corporation/director, and whether the failure to disclose was 'innocent', was irrelevant. Again, it was effectively a strict liability offence as to whether or not relevant information was disclosed immediately, although there are some exemptions to the rule provided by s 674(2) and Listing Rule 3.1A.
Claims for breaches of section 674 are also usually coupled with claims for misleading and deceptive conduct pursuant to section 1041H of the Corporations Act, where again the only question is whether the conduct was incorrect (i.e. misleading and deceptive or, in respect of future matters, whether there was a reasonable basis for the representations made). The issue of whether there was any intent to mislead or deceive is irrelevant. Breaches of s 674 and s1041H of the Corporations Act are the basis of each and every shareholder class action in Australia.
Compliance with section 674 during COVID-19 was no easy task – in accurately forecasting earnings and future operations in an ever changing and unknown environment. Accordingly, on 25 May 2020, the continuous disclosure obligations were amended to introduce an element of 'intention' – whereby there was only a breach if the failure to disclose was with actual knowledge, reckless or negligent.
These amendments were criticised by both sides to the debate – either on the basis that it was too soft on errant companies and directors, or it failed to include the misleading and deceptive provisions thereby nullifying its intended effect.
On 17 February 2021, the Government announced that the previous temporary amendment would be made permanent and also expanded to include the misleading and deceptive provisions, the stated purpose being to "prevent opportunistic class actions" and bring Australia closer in alignment to the disclosure regimes in the US and the UK – which it will now do, requiring the company/director to have done something wrong, rather than merely not having done everything right.
The initial changes were a positive development for corporate entities and directors impacted by COVID-19, and their insurers, in what were most uncertain times – although the effect was limited by the failure to include misleading and deceptive conduct provisions. The emphasis has now shifted 'post-covid' to the deceleration of securities class actions which is a major important development in the Australian class action landscape.
Class actions are stated to be one of the top three risks faced by Australian listed companies, and a primary cause of the current reduced Australian D&O capacity and the significantly increased D&O premiums which have increased by 299% for ASX listed companies over the year to quarter three in 2020. Reducing speculative class actions – which the proposed legislation should achieve – can only be of benefit to all.
The extension of the reform to misleading and deceptive allegations was required in order to avoid that loop hole and give effect to the proposed reform. While the changes will not be retrospective, they will inevitably have significant impact in the class action environment in Australia from enactment.
There are 5 key takeaways from the discussion above:
 Insolvency is defined as not being solvent – which is defined as the ability to pay debts as and when due.
 Only requiring2 findings – the insolvency of the company when the debt was incurred and the objective or subjective suspicion of insolvency by a director.
 this includes: continuing losses, liquidity ratios below 1; overdue taxes; creditors paid outside trading terms; poor relationship with the primary bank (including inability to borrow further funds); no access to alternative finance; suppliers placing the company on cash on demand terms; special arrangements with selected creditors; letters of demand or summonses issued against the company; and an inability to produce timely and accurate financial information to display the company's trading performance and financial position and make reliable forecasts
 Introduced and effective from 1 January 2020
 Liquidators now invariably utilise their powers of examination under section 596 of the Corporations Act to examine officers of failed companies.
 Due to expire on 22 March 2021.
 Both types of allegations could enliven the conduct exclusion.