7 April 2020
The global COVID-19 pandemic has caused global disruption to life, liberty, and commerce. Along with tragic death and illness, COVID-19 is straining and shutting down borders. businesses, supply chains puts the livelihoods of people at risk.
Closer to home, the NZ Government has taken the unprecedented step of banning the non-essential movement of people and have placed the country into level 4 lockdown. While necessary to stem the spread of COVID-19, the disruption to business and is enormous.
Particularly hard hit are the tourism, aviation, hospitality, accommodation and construction industries. The government has implemented a wage subsidy scheme to support businesses to retain staff through this period and reduce the shedding of jobs. The government has now turned its mind to the next stages and potential tidal wave of insolvencies by announcing on 3 April 2020 a number of changes to the insolvency regime in response to COVID-19.
Duties – Section 135/136
The Companies Act 1993 (the Act) outlines the duties all directors owe when exercising their powers and operating the companies they hold responsibility for.
Section 135 – Reckless trading. The director must not act in a way that is likely to create a substantial risk of serious loss to the company’s creditors.
Section 136 – incurring an obligation. The director must not incur an obligation unless there are reasonable grounds to believe that the obligation can be met when required.
If the company is placed into liquidation, though relatively rare, the liquidators ought to investigate the possibility of breaches pursuant to section 135/136 of the Act. The liquidator can ask the Court to hold the director personally liable for the additional losses to creditors that result from the reckless trading or improper incurring of an obligation.
‘Safe Harbour’
To encourage companies to continue to trade and not voluntarily liquidate too readily, the government has proposed a “Safe Harbour” to liability under section 135/136. To access the safe harbour the following conditions are to be met:
- If the director in good faith has the opinion that the company is facing or likely to face significant liquidity issues as a result of COVID-19; and
- The company was able to pay its due debts on 31 December 2019; and
- The director considers in good faith it is more than likely that than not that the company will be able to pay its debts as they fall due in 18 months.
Importantly, requirements 1&3 are subjective judgments on the part of the director in their specific context. It will be difficult to rebut either as they are projections albeit with a good faith element on the part of a liquidator unless in the most blatant of cases. What may catch out some companies is requirement 2, the ability to pay due debts as at 31 December 2019. This is an objective requirement that will be apparent from the documents and eventual creditor claims.
In addition, it would be prudent for companies to keep records of board/director/management meetings and have contemporaneous documents that back up the decisions to continue to trade despite the potential short-term issues.
Business Debt Hibernation
Businesses in NZ are faced with an unprecedented operating environment with many having forced to close. Businesses that are able to have staff working from home are still faced potentially with reduced demand and productivity.
The government has proposed a business debt hibernation scheme that would freeze the enforcement of debts for a maximum of 7 months. In part this will assist businesses to continue to trade on, however may only push the wall of insolvencies 6 months forward when the debts are enforceable again.
The government has outlined the following:
- Certain threshold to access the scheme (details are yet to be announced);
- Creditors will have 1 month to vote on the proposal and 50% in value and number must agree;
- 1 month moratorium (freeze) on enforcement after the proposal is made and a further 6 months if passed.
The proposal will bind all creditors except for employees and importantly, payments to third parties will be exempt from voidable claw back by a subsequent liquidator (payments to related parties will not be exempt from claw back or payments intended to deprive creditors).
It is unclear what the criteria will be to access the scheme, if secured creditors will be bound by the moratorium and therefore unable to enforce their security and if the votes will be read in classes (i.e. preferential and unsecured).
It will be crucial to ensure that a clear proposal is drafted and that all creditors are notified of the proposal. Waterstone is experienced in running proposals and communicating with creditors and may be able to advise or administer potential debt hibernation arrangements efficiently once enacted.
If you require assistance or have any queries, please get in touch with us or the writer, Adam Botterill – Senior In-House Counsel, adam@waterstone.co.nz.
