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COVID-19: Relief for company directors, business debt hibernation and associated changes to insolvency laws

by Stephen on April 14th, 2020

On 3 April, the Government announced that it will be introducing legislation to make (temporary) changes to the Companies Act 1993 to help companies facing insolvency due to COVID-19 to remain viable and keep New Zealanders in jobs.

The temporary changes announced include:

  • giving directors of companies facing significant liquidity problems because of COVID-19 a ‘safe harbour’ from insolvency duties under the Companies Act;
  • enabling businesses affected by COVID-19 to place existing debts into hibernation until they are able to start trading normally again;
  • allowing the use of electronic signatures where necessary due to COVID-19 restrictions;
  • giving the Registrar of Companies the power to temporarily extend deadlines imposed on companies, incorporated societies, charitable trusts and other entities under legislation; and
  • giving temporary relief for entities that are unable to comply with requirements in their constitutions or rules because of COVID-19.

The changes announced will require legislation to be passed by Parliament.  To date, it is unclear when those legislative changes will be made – other than that they are urgent.  However, the announcement by the Minister of Finance did state that the Government will be asking Parliament to agree that the safe harbour (for company directors – from insolvent trading) be backdated to the date of the announcement (i.e. 3 April).

The Cabinet paper relating to the proposed law changes also states that the changes to (filing and other) deadlines will be backdated to have effect from 21 March 2020 (i.e. the date of announcement that New Zealand had entered Alert Level 2).

Subsequently, when the relevant Cabinet papers were made available, it became clear that:

  • business debt hibernation will not be available for sole traders – because there is no practical means for including them given the lack of separation between the trader’s business finances and their personal finances; and
  • neither business debt hibernation nor the directors’ safe harbour will be available for licensed insurers, registered banks and non-bank deposit takers – because this would be incompatible with the prudential supervision to which they are subject by the Reserve Bank.

Directors’ safe harbour – insolvent trading

Subject to the required legislative changes being enacted by Parliament, the 3 April announcement will provide a temporary safe harbour from sections 135 and 136 of the Companies Act, subject to the terms that the directors’ decisions to keep on trading, as well as decisions to take on new obligations, over the next 6 months will not result in a breach of duties if:

  1. 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;
  2. the company was able to pay its debts as they fell due on 31 December 2019; and
  3. 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 (e.g. because trading conditions are likely to improve or they are likely to able to reach an accommodation with their creditors).

Note:  By providing a finite list of requirements it is expected that this temporary safe harbour will enable directors to act with certainty and not get tied up in fine distinctions about the ordinary/normal course of business, when debts incurred in good faith with the aim of keeping the business going may not be said to have been otherwise ordinary/normal.

Without this temporary relief, company directors would be in a difficult position – because continuing to trade and taking on new obligations in circumstances where the company’s business has been clobbered by the impact of COVID-19 would raise serious questions about the application of the following duties:

  • Reckless trading (section 135):  A director must not agree to (or cause or allow) the business being carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors; or

If a company’s business is impacted by COVID-19 in such a way that it is (temporarily) unable to pay its debts – then, by trading on, the directors risk breaching these duties (if the effort to trade out of difficulty is ultimately unsuccessful).  

As a result, it is clear that Cabinet has accepted that the risk of exposure to personal liability could cause directors to act conservatively – with the result that otherwise sound businesses (temporarily) impacted by COVID-19 could face liquidation unnecessarily.

Business debt hibernation (COVID-19 Business Standstill (CBS))

The proposed CBS regime is intended to:

  • encourage directors to talk to their creditors with a view to putting together a simple proposal for putting the business into hibernation;
  • allow for the directors to retain control of the company, rather than passing control to an insolvency practitioner;
  • provide certainty to new creditors that they won’t have to repay any money they receive, so as to encourage businesses to continue transacting with businesses in CBS; and
  • be simple and flexible so that it can be enacted quickly, and businesses can readily apply it to their circumstances without having to obtain legal advice.

Key features of the proposal are that:

  • directors will have to meet a threshold before being able to access the CBS regime and putting a proposal to their creditors;
  • creditors will have one month from the date of notification of the proposal to vote on it, with the CBS proposal going ahead if 50% (by number and value) agree; and
  • there will be a one month moratorium on the enforcement of debts from the date the CBS proposal is notified, and a further 6 month moratorium if the CBS proposal is passed.

CBS would be binding on all creditors (other than employees) and would be subject to any conditions agreed with creditors.  If the creditors reject the CBS proposal, the directors would still have the range of existing options available including trading on, entering voluntary administration and appointing a liquidator.

While a business is in CBS it would be able to continue to trade, subject to any restrictions agreed with creditors as a condition of entering into it.

In order to encourage businesses to continue to transact with a company that has entered CBS, it is proposed that any further payments, or dispositions of property, made by the company to third party creditors would be exempt from the voidable transactions regime.  This exemption would not extend to related parties.

This means anyone continuing to trade with the company will not have to worry about a liquidator seeking to unwind transactions if the company is later placed into liquidation.  This exemption would be subject to a condition that the transaction was 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.

CBS will be available to all forms of ‘legal person’ (not just companies) and entities that do not have legal personality (i.e. trusts and partnerships).

The purpose of CBS is to give companies an opportunity to talk to their creditors to reach a temporary arrangement – that might provide further scope for the business to trade its way out of (COVID-19 related) difficulties.

What is not yet clear from the Government’s announcement is whether the CBS regime will include protection against so-called ‘ipso facto’ clauses.  An ipso facto clause is a term of a contract that allows one party to terminate or modify the operation of the contract (or provides for this to occur automatically) upon the occurrence of a specified insolvency related event.  It would be something of a pyrrhic victory to enable (say) a franchisee to enter CBS only to find that, by doing so, it enabled the franchisor to terminate the franchise agreement because it was (ipso facto) insolvent.

Voidable transactions – clawback period reduced

The 3 April measures included a decision to bring forward a change decided last year (for an Insolvency Law Reform Bill to be released later this year) to reduce the voidable transaction clawback period from 2 years to 6 months (where the debtor company and the creditor are not related).  The Cabinet paper refers to this fast-tracking as having the potential to provide significant benefits, given the large number of liquidations that are likely to result due to the COVID-19 epidemic.

Insolvency practitioner licencing regime to be deferred for up to 12 months

The Government also proposes to defer the new insolvency practitioner licencing regime for up to 12 months.  The new regime was meant to start in June 2020 – and it is known that industry bodies such as RITANZ still believe that the original timeline is achievable.

Changes to compliance periods

The Government has also announced a proposal to allow the Registrar of Companies to (temporarily) extend deadlines for statutory obligations in relation to meetings and reporting for companies, limited partnerships, incorporated societies and charitable trusts.  This is seen as a matching response to that already being provided by the FMA – under the FMC Act. 

Electronic signatures

The Contract and Commercial Law Act 2017 allows for a legal requirement for a signature to be met by means of an electronic signature subject to certain conditions.  However, this does not apply to powers of attorney.  This is understood to be preventing businesses from entering into security agreements with their banks because those agreements routinely contain powers of attorney.  As a result, a temporary change was announced to extend to the entry into security agreements containing powers of attorney (subject to the existing provisions relating to the reliability of electronic signatures – as a guard against potential abuse).

No changes for statutory demands

The Cabinet paper notes the decision not to follow Australia by making changes to statutory demands (by changing thresholds and increasing the timeline for a response).

Instead, the Cabinet paper notes that increasing the threshold both raises questions about how to transition back down from the higher minimum amount to the current minimum (because it would be unusual for a company that has been trading while insolvent to be immediately solvent again once the temporary changes are lifted) and extending the timeline for a response to a statutory demand would effectively place the statutory demand system in hiatus because there would be no point in issuing them.

Further information

Whilst further detail is expected in the form of draft legislation – it is anticipated that the legislative process will be short (with only limited scope for consultation and/or submissions).

Please contact me should you have any queries concerning the information to be provided.

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