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COVID-19 Companies Act and insolvency

16 April 2020

Potential changes to the Companies Act and Insolvency law under the Covid-19 pandemic.

On 3 April 2020 the government announced that it is introducing changes to the Companies Act 1993 (the “Act”) and to law around insolvency practices to provide some assistance to companies so that they could hopefully weather the storm and come out on the other side of the financial distress caused by COVID-19 re-emerging as the viable companies that they were prior to the pandemic. These measures, likely to be temporary, aim to support responsible businesses to trade through this volatile time so that they do not have to make rash and premature decisions to fold and liquidate out of fear of the unknown which in turn will have complications on the labour market and the macro-economy. At this stage we note that the proposed changes as outlined in this article are still to be agreed and passed by the Parliament. 

Safe Harbour for Directors 

Understandably directors of companies will need to make difficult decisions about trading on and taking new business risks under the current circumstances whereby business revenues and cashflow are both affected. These difficulties bring into focus the directors’ duties not to trade recklessly and not to cause the company to incur further obligations while potentially insolvent as spelt out under sections 135 and 136 of the Act as summarised below: 

A director of a company:
  • must not agree to the business of the company, or cause or allow the business of the company, to be carried on in a manner likely to create substantial risk of serious loss to the company’s creditors; and

  • must not agree to the company incurring an obligation unless the director believes at the time on reasonable grounds that the company will be able to perform the obligation when it is required to do so.”

The government is proposing that decisions by a director to keep trading, as well as any decisions to take on new obligations, over the next six months starting from 3 April 2020, will not result in a breach of abovementioned director duties if:

  • in the good faith opinion of the directors, the company is facing or is likely to face significant liquidity problems in the next six months as a result of the impact of the COVID-19 pandemic on them or their creditors; and

  • 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 that the company will be able to pay its debts as they fall due within the next 18 months 

Looking at the criteria, you will see that the one of the hurdles is that your business will need to be financially sound as at 31 December 2019. This may well require the directors to take a retrospective look at their companies’ financial position as at the end of 2019 before progressing to make decisions. There is also a very subjective element in the criteria being the director’s consideration of whether a business is ‘more likely than not’ to be solvent over the next 18 months. 

The purpose of the proposed safe harbour is to effectively reduce the number of unnecessary liquidations of companies which, but for the COVID-19 pandemic, are otherwise viable. Directors should be aware that other directors’ duties and obligations in the Act continue to apply.  These include the duty to act in good faith and in the best interests of the company and to exercise due diligence and care. The curious case of whether the directors have acted reasonably in determining if the safe harbour criteria (so as to avail themselves of breaches in the two duties that the proposed changes aim to circumvent) are satisfied will only be determined retrospectively in the future in each circumstance if challenged. Hence we suggest that the directors keep comprehensive records of meetings, discussions and resolutions during this special time as proof of reasonable and fair decision-making process. 

Business Debt Hibernation 

Another major change introduced is a temporary “Business Debt Hibernation” regime (“BDH”) allowing a moratorium on the payment of debts. The BDH regime will be available to all forms of entity with legal personality, and other entities such as trusts and partnerships, but will not extend to licensed insurers, registered banks and non-bank deposit takers and sole-traders. For the sake of simplicity, we continue the article with references to company structure only. 

The key features of the BDH include: 

  • The company will have to meet a threshold test before being able to use the regime (this threshold is yet to be announced);

  • A company proposing to enter into the BDH scheme can notify its creditors of a proposal seeking a six-month moratorium on existing debts. This notification will trigger a moratorium of one month for existing debts during which the creditors can vote on whether to accept the proposal; 

  • A majority of creditors (50% in number and in value) must vote in support of the company’s entry into the BDH scheme;

  • If creditors approve the company’s entry into the scheme, there will be a moratorium on the enforcement of debts for six months once the proposal is passed. The scheme will be binding on all creditors except employees; 

  • While company is operating in the BDH scheme, further payments or dispositions made by the company to third party creditors (other than related parties) will be exempt from the voidable transactions regime, subject to the transaction having been entered into in good faith by both parties, on arm’s length terms and without the intent to deprive the existing creditors of the company. This exemption will likely incentivise and provide some confidence to creditors to continue supplying goods on credit to a company subject to the scheme. (For more information on what a voidable transaction is, click here  (www.harristate.co.nz/COVID-19-voidable-transactions); and 

  • The Government will also bring forward a change to reduce the voidable transaction claw-back period from two years to six months (where the parties are not related). 

Other than the need to meet a threshold test yet to be announced, it will be important for directors to put forward a well thought out proposal to creditors if the company wants to utilise the BDH scheme. A proposal that goes ahead will be binding on all creditors other than employees, and will be subject to any conditions agreed during the proposal. If the proposal is not accepted by creditors, existing options such as trading on, voluntary administration and appointing a liquidator are still available to companies; similarly, we would imagine that the creditors would have the usual recourse to debt recovery against the company.  Therefore, it is fundamental to be upfront with creditors about the company’s position and to take steps to mitigate the impacts of the pandemic such as negotiating rent abatement of leased premises, and making use of the wage subsidy scheme. 

It also remains uncertain as to how the BDH scheme will interact with the 'ipso facto' clauses under some agreements (or leases) that allow agreements to be terminated because of an act of insolvency or financial distress such as compromising with the creditors, although it would seem counter-intuitive if the draft legislation produces an result such that entry into the BDM scheme could mean a breach of a contract, or raise grounds to terminate any contract. 

The silver lining of the BDH scheme is that, during the hibernation period, the directors will have some time to assess whether the company can resume trading as normal, propose a formal compromise to creditors, or to enter voluntary administration or eventually liquidation without having to face the burning needs to repay creditors. 

Just as the Finance Minister Grant Roberson suggest, if you have a good, functioning, solvent business going into Covid-19, it should be able to be a good, functioning solvent business coming out of it. And the team at Harris Tate is happy to assist you with keeping your businesses viable during this unprecedented time and answer your questions on director duties and BDH.

Our team at Harris Tate can assist.

Talk to us if you need to discuss any matters regarding changes to the Companies Act or issues surrounding Insolvency as a result of the Covid-19 pandemic. 

We are working remotely and our direct dial phone numbers are being diverted to our cell phones. Please contact Yuwen An on 07 571 3668, or email yuwen@harristate.co.nz