The Government has announced several urgent insolvency and corporate law changes in response to the COVID-19 Pandemic, in an attempt to keep solvent businesses afloat during this turbulent economic period. These include:
- permitting electronic signatures where necessary;
- giving entities unable to comply with their constitutional obligations because of the pandemic temporary relief;
- giving the Registrar of Companies authority to extend deadlines imposed by legislation
- amending sections 135 (“reckless trading”) & 136 (“duty to relation to incurring obligations”) of the Companies Act 1993 to afford directors greater comfort when making difficult decisions regarding their ability to continue to trade;
- bringing forward changes to the voidable transactions regime; and
- introducing the business debt hibernation scheme.
Once enacted, the Government has confirmed their application will be given retrospective effect from 3 April 2020.
Changes to Directors’ Duties
In light of concerns directors may prematurely place companies into liquidation for fear of personal liability incurred should they continue to trade or to take on new obligations, two significant amendments have been made to sections 135 & 136 of the Companies Act 1993.
- Section 135 places an obligation on directors to abstain from agreeing, causing or allowing for a company to be operated in a manner likely to create a substantial risk of serious loss to the company’s creditors.
- Section 136 places an obligation on directors to abstain from taking on a new obligation if they do not believe, on reasonable grounds, that the company will be able to fulfil its obligations under the arrangement.
Under the announcement, directors who continue to trade (including the taking on of new obligations), will be afforded a “safe harbour” period from potential claims providing these criteria are met:
- the directors consider, in good faith, that the company is or will likely face significant liquidity problems in the next six months due to the pandemic;
- the company was able to pay its debts as they fell due on 31 December 2019; and
- the directors consider in good faith that it is more likely than not the company will be able to pay its debts as they fall due within 18 months (for example, utilising the business debt hibernation scheme to get the business back on track).
This “safe harbour” is to be enacted for (initially) a six month period. Notably, directors must continue to act prudently and in good faith in their dealings with creditors, as all other directors’ duties continue to apply including the duty to act in good faith and in the best interests of the company under s 131.
How the change to section 136 will be drafted will be of great interest to directors of companies currently under pressure as a result of the lockdown. The requirement that director(s) be satisfied that “…the company will be able to pay its debts as they fall due within 18 months” may be challenging for directors, who will have to show they has maintained appropriate financial records consistent with the size and nature of the company, that their assumptions are reasonable and (where appropriate)the directors have acted on advice. Contracts with longer-term obligations such as leases may not fall within the safe harbour period so directors need to be prudent when accessing longer-term obligations, whether existing or new.
With this in mind, it is important to keep accurate and up-to-date financial information. This includes reasonable budgets and forecasts for the next 18 months. This will allow directors to reach an informed decision on the company’s likelihood of being able to meet its debts as they would fall due in 18 months.
Changes to sections 135 & 136 come at a time when directors are increasingly concerned about their civil liability when dealing with third parties while their business is struggling. Often this results in directors prematurely resigning and appointing an external administrator. This is in part due to the recent High Court decision in Mainzeal Property and Construction Limited v Yan discussed here under which the directors of Mainzeal Property Limited were collectively ordered to pay NZ$36 million for a breach of section 135.
In December 2019, the Companies (Safe Harbour for Insolvent Trading) Amendment Bill was proposed with a view to alleviating directors’ concerns regarding their liability when deciding to continue trading, notwithstanding the company being insolvent. This Bill reduces directors’ civil liability when a company is (or will become) insolvent and its directors undertake new debts in an attempt to improve the company’s position. It remains unclear what extent the amendments mentioned hereinabove will reflect contents of this Bill.
Changes to the Voidable Transaction Regime
According to the current voidable transaction regime, a liquidator can “claw-back” payments made from the debtor company to its creditors two years before its liquidation. It has been proposed to shorten the two year vulnerability period to six months when the debtor company and the creditor are unrelated parties. Originally, this change was contained in the Insolvency Law Reform Bill, however the Government has included it amongst the recent changes because of the increase of liquidations predicted.
Business Debt Hibernation
The Business Debt Hibernation Scheme (“the Scheme”) is to be introduced to the Companies Act 1993 to supplement the relief measures that already exist between creditors and businesses. Debt hibernation effectively allows businesses to place their existing debts into “hibernation” until they are able to start trading again.
With the rationale of enhancing a company’s ability to stay afloat in the face of the pandemic, the scheme aims to:
- increase discussions between creditors and directors;
- enable directors to keep control of their companies rather than appointing an external administrator;
- encourage continued trading between the company and its creditors by providing certainty to both parties; and
- be simple and flexible.
Companies wanting to participate in the Scheme will have to meet certain criteria. This has not been announced in full, but it is expected to include:
- the business would have been solvent had the Pandemic not occurred;
- it would be in the best interests of the business (including its ability to pay creditors) for the business to enter debt hibernation;
- the creditors of the business will need to be notified of the company’s intention to enter into the Scheme;
- once the company notifies its creditors of their intention to enter into the Scheme a one-month moratorium will take effect immediately while creditors cast their votes;
- consent must be obtained by at least 50% of creditors;
- if the business obtains the consent of 50% of creditors, the Scheme becomes binding on all creditors, except employees, and there will be a moratorium on the enforcement of debts for a six month period once the proposal is passed; and
- further payments made by the company to third party creditors during the Scheme will be excluded from the voidable transactions regime – this affords third party creditors with greater protection that, in the event of the company’s insolvency, the advance will not be clawed back.
This article is not a substitute for legal advice and you should talk to a lawyer about your specific situation. Should you need any assistance with this, or with any other commercial matter, please contact Peter van Rij at petervanrij@parryfield.com or Tim Rankin at timrankin@parryfield.com
