Covid-19 - Insolvency relief for businesses
Covid-19 has resulted in businesses facing unprecedented and unforeseen pressures, regardless of their size, industry or location. Many businesses are having to consider for the first time the insolvency provisions and duties imposed on directors in the Companies Act 1993.
Following Australia’s example, the New Zealand Government announced on 3 April 2020 that it will be introducing legislation to assist companies facing insolvency due to Covid-19.
- Directors of companies who are facing serious liquidity problems are being given a “Safe Harbour” from certain insolvency duties under the Companies Act 1993.
- Companies may place existing debts into hibernation until they are able to start trading normally again.
- Electronic signatures can be used if necessary because of Covid-19 restrictions.
- Deadlines can be extended for companies, limited partnerships, incorporated societies and charitable trusts under legislation for obligations such as filing annual returns and holding annual general meetings etc.
- Temporary relief can be given to companies, limited partnerships, incorporated societies and charitable trusts that cannot comply with their constitutions or rules because of COVID-19 until they are reasonably able to comply. These entities can use electronic communications or hold electronic meetings even if their constitutions or rules do not allow them to.
- The period of vulnerability for voidable transactions will be reduced from 2 years to 6 months, where the debtor company and the creditor are unrelated parties.
Some aspects of the legislation will be retrospective.
BUSINESS DEBT HIBERNATION
What is the aim of “Business Debt Hibernation”?
The aim of the “Business Debt Hibernation” measures are to:
- get businesses to engage with their creditors, giving them a proposal to put the business debt into hibernation for a 6 month period;
- allow directors to continue to run their businesses, instead of appointing an insolvency practitioner to run them;
- give new creditors certainty to transact with businesses when they may be concerned payments they receive will be clawed back by an insolvency practitioner; and
- allow businesses and creditors to agree to specific conditions as part of any proposal.
How does a business qualify?
Subject to certain exceptions, any business which is a legal entity (with or without legal personality) can qualify including a business or entity which is a company, trust or partnership. The most notable exception is that sole traders do not qualify.
In order to qualify, directors will have to meet a threshold and the proposal put to creditors must be approved by 50% of creditors by number and value. Creditors are given one month from the date of notification of a proposal to vote on it.
What happens after a Business Debt Hibernation Proposal is Approved?
For one month from the date a proposal is notified, debts cannot be enforced against the business. For six months from the date a proposal is approved by creditors, debts cannot be enforced against the business. If a Business Debt Hibernation proposal is approved, then it binds all creditors except the businesses employees
While a business is in Business Debt Hibernation, it can continue to trade subject to any conditions agreed with creditors as part of the approval process.
Any payments, or dispositions of property made by the company to creditors (except related party creditors) while it is in Business Debt Hibernation will be exempt from being voided by an insolvency practitioner. This exemption will be subject to the transaction being entered into in good faith, on arm’s length terms and without the intent to deprive the existing creditors of the company. This allows businesses to keep trading because they can give creditors certainty that if a liquidator is subsequently appointed, they cannot try to unwind transactions.
SAFE HARBOUR PROTECTIONS
What do the “Safe Harbour” provisions mean for directors?
Under the Companies Act directors have the following duties (in addition to other duties):
- Reckless trading (s135): a director must not allow the business of a company to be carried on in a way which could create a substantial risk of serious loss to creditors.
- Incurring Obligations (s136): a director cannot agree to a company incurring an obligation unless the director reasonably believes the company will be able to perform the obligation when required.
These duties are owed by the directors to the company, not to the shareholders. The penalties are harsh and include personal liability of directors for debts of the company andprosecution by IRD for failure to pay PAYE deductions or GST.
The Safe Harbour Protections will mean that directors can decide to continue trading and/or take on new obligations over the next 6 months (dates to be confirmed in due course) without breaching their duties under sections 135 and 136 but only if:
- in the good faith opinion of the directors, the company is facing or is likely to face significant liquidity problems in the next 6 months as a result of the impact of the COVID-19 pandemic on them or their creditors;
- 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 18 months (for example, because trading conditions are likely to improve or they are likely to be able to reach an accommodation with their creditors).
We anticipate that, following the Australian example, these “new obligations” will be those incurred in the ordinary course of business but this is yet to be confirmed. This detail will be important for the Government to work through to give directors and creditors certainty.
The Government will be asking Parliament to agree that the safe harbour be backdated to the date of this announcement.
OTHER IMPORTANT INFORMATION
Other Directors Duties Remain Unchanged
These measures do not excuse directors from meeting their other duties under the Companies Act 1993 such as acting in good faith and in the best interests of the company; exercising powers for a proper purpose; exercising the care, diligence and skill that a reasonable director would exercise in the same circumstances taking into account, without limitation, the nature of the company, the decision and the position and responsibilities of the director.
Business Continuity and Turnaround Plans
The Covid-19 Safe Harbour and Business Debt Hibernation measures will allow businesses some time to assess the position of their business before they decide whether what they need is a plan to turnaround their business or whether they need to proceed with insolvency measures. The measures are not intended to help businesses that already had insolvency issues prior to Covid-19. Directors need to be satisfied that they can return to trading solvently at the end of the 6 month period.
For many business the impact of Covid-19 will be felt well beyond 6 months and they may well find themselves facing the same issues regarding reckless trading and/or incurring obligations. The Business Debt Hibernation measures alone will not be enough to turn businesses around, further steps will be required. Steps such as applying for the Covid-19 Wage Subsidy, drafting, implementing and measuring a business continuity and turnaround plan which extends beyond the 6 month period, refinancing, capital raising, cost reductions and business restructures.
It will by crucial for directors to document their business continuity and turnaround plans and their implementation for their own protection. They should include the following:
- The current financial situation of the business.
- What actions are proposed and how the success of those measures will be assessed.
- Compare what the outcome is if the plan is implemented versus an insolvency outcome; will creditors be better or worse off?
- Obtain legal and accounting advice.
A useful guide to base your Business Continuity Planning on can be found here.
Protect yourself by obtaining professional advice
Directors may rely on information or advice from professional advisers and experts for a particular matter. Directors however cannot substitute that advice for their own consideration of key matters and they must make their own decisions and form their own opinions.
During these difficult times we encourage you to seek information and advice from us about your duties as a director and what the Safe Harbour and the Business Debt Hibernation measures mean for you and your business.
The above information is of a general nature only. The information contained in this document does in no way constitute legal advice and all readers should contact a law firm for advice relating to your specific circumstances.
About Anna Fox
Anna is the Managing Partner of SRB, and former head of our Commercial Team. She assists clients with major commercial transactions, including structuring business entities and advising on large scale property transactions. Anna also advises on securities law compliance.
About Nick Strettell
Nick is a Partner in Saunders Robinson Brown’s Commercial Team. He specialises in company law, commercial property matters and business sale and purchases.