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The District Court of New South Wales in Preiner & Anor v Shin & Anor [2025] NSWDC 341 explored the application of the COVID-19 safe harbour provisions, introduced to shield directors from civil liability for insolvent trading during the pandemic's economic impact.
Key takeaways
- COVID-19 safe harbour provisions do not relieve directors (and
holding companies) of liability for insolvent trading when the
company in question was already insolvent prior to the six-month
relief period (25 March 2020 to 31 December 2020).
- Directors seeking to rely on the COVID-19 safe harbour
provisions must satisfy the evidential burden by demonstrating not
only a reasonable possibility of solvency, but that the debt was
incurred in the ordinary course of the company's business
during the six-month period. A debt will be in the ordinary course
of business if it was necessary to facilitate the continuation of
the business. Simply pointing to the existence of the relevant
dates is insufficient.
- Unaudited financial statements may be admitted into evidence where it is a small company which is not required to have audited accounts. However, unaudited financial statements will not be admitted into evidence if the accounts are unsigned by the directors or the directors have not adopted the accounts, or the accountants have not been prepared to sign or endorse the contents of the financial statements.
Background
Sorenzo Pty Ltd (Sorenzo) owned and operated fine dining Japanese restaurants in Sydney. Between 2018 and 2020, Sorenzo's financial position had slowly disintegrated, culminating in the company having nominal sums left in its bank accounts. It had also received a warning from the Deputy Commissioner of Taxation that collection action would be started for outstanding tax liabilities and a landlord had locked Sorenzo out of one of the restaurant premises due to non-payment of rent. The landlord lock-out meant that Sorenzo was unable to recover its own chattels and fittings in order to trade. Other restaurants owed by Sorenzo were not part of the lock-out.
Claims
Sorenzo and Preiner, in its capacity as a liquidator for Sorenzo, commenced proceedings against the director of Sorenzo, Mrs Yi Jeong Shin and the holding company, Raphael Shin Enterprises Pty Ltd (RSE) claiming:
- Mrs Shin breached her directors' duty under section 588G(1)
of the Corporations Act 2001 (Cth) to prevent
insolvent trading by Sorenzo; and
- as the holding company, RSE breached its duty under section 588V(1) of the Corporations Act to prevent insolvent trading by Sorenzo.
As part of Mrs Shin's defence, she submitted that in the period from 25 March 2020 until 31 December 2020, section 588G(2) of the Act did not apply to her by virtue of the operation of the COVID-19 safe harbour provisions under section 588GAAA of the Act and regulation 5.7B.01 Corporations Regulations 2001 (Cth) (Regulations).
The issues
The foundational issues that the Court considered were:
- Whether a reasonable director, in the place of Mrs Shin, would
have suspected that the company was insolvent, or would become
insolvent, at the time Sorenzo incurred the relevant debts under
section 588G of the Act?
- Whether the COVID-19 safe harbour provisions under section 588GAAA of the Act deferred the date of solvency for the purposes of section 588G(2) of the Act and reduced the quantum of the plaintiff's claims accordingly?
Decision
Liability of Mrs Shin and RSE
The Court held there were grounds for a reasonable director to suspect that Sorenzo was insolvent between 2018 and 2020 when debts were incurred. Further, having regard to the nature and extent of RSE's control over Sorenzo's affairs, it was reasonable to expect one or more of the holding company's directors to be similarly aware. The pivotable time was the lock out by the landlord which rendered Sorenzo unable to trade and so its ability to satisfy the cash flow test was lost. From that time Sorenzowas a mere shell and incapable of carrying out any business yielding a profit.
Safe harbour defence
The defendants claimed that, in the period from 25 March 2020 until 31 December 2020 (safe harbour period), section 588G(2) did not apply to Mrs Shin by virtue of the operation of section 588GAAA of the Act and regulation 5.7B.01 of the Regulations.
The Court rejected the COVID-19 safe harbour defence on several grounds, including:
- The emergency provisions, which suspended the directors'
civil liability during the safe harbour period, did not change the
test for insolvency, nor should they impact on whether a court will
find a company insolvent. The Court was satisfied that Sorenzo was
already insolvent from at least 30 June 2019, nine months prior to
the safe harbour period and so could not rely on the
protection.
- The evidential burden lies on the directors. The Court was
merely asked to infer that the legislative exemption created by the
operation of section 588GAAA of the Act and regulation 5.7B.01 of
the Regulations applies from the existence of the safe harbour
period. However, there was no correlation between those dates and
Sorenzo's insolvency.
- Sorenzo was not even trading during the safe harbour period, having been locked out of one of its restaurant premises for at least nine months prior to the COVID lockdown period.
The Court commented that companies which were already insolvent before the COVID safe harbour protection came into effect would otherwise receive a "free ride", or be "let off" during the safe harbour period. The Court commented that once the company became insolvent, it remained insolvent.
Comment
This decision considered the COVID-19 safe harbour provisions and its application to a company showing indications it was insolvent before, during and after the safe harbour protection period. The Court clearly stated that the COVID-19 safe harbour does not protect directors and holdings companies from liability for insolvent trading where a company was demonstrably insolvent before the safe harbour period commenced.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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