COVID-19: Insolvency Law Changes Passed By Stephen Layburn*

The package of measures announced by the Government on 3 April has now been passed: COVID-19 Response (Further Management Measures) Legislation Act 2020.

There were a small number of changes made during the pathway through Parliament – for measures that are intended to be temporary and provide much needed support for businesses (and their directors) that need some breathing room in order to be able to form a realistic view of whether they will survive the rigours that have, or will, flow from the COVID-19 outbreak.

Most of these temporary measures have immediate effect - noting that the safe harbours (for directors) from insolvent trading are retrospective.

Directors’ duties – safe harbour

The safe harbour for directors from the insolvent trading regime in the Companies Act take effect from the date of announcement (3 April) and provide some relief for a period of 6 months.

During that period, a director’s actions will not breach the duties in sections 135 and 136 of the Companies Act (reckless trading / incurring obligations) if:

• the company was able to pay its debts as they fell due on 31 December 2019 1 ;

• in the good faith opinion of the director:

- the company has, or in the next 6 months 2 is likely to have, significant liquidity problems, which are a result of COVID-19; and

- it is more likely than not that the company will be able to pay its due debts in 18 months’ time (30 September 2021). In order to assess this, the directors may take into account the likelihood of trading conditions improving, the likelihood of the company reaching a compromise or other arrangement with its creditors, or any other relevant matters.

It is important to note that, despite this temporary relief, directors continue to be subject to the balance of their duties under the Companies Act (including the ‘primary duty’ - to act in good faith and in best interests of company). As a result, care needs to be taken to ensure that decision making is soundly based and adequately documented – and independent / professional advice is obtained where required.

As a result of submissions during the legislative process a ‘purposes’ clause was added:

However, it is not a purpose of this schedule [the safe harbour] to facilitate the ability of a company that has no realistic prospect of continuing to trade or operate in the medium or long term to defer a decision to enter into liquidation to the detriment of its creditors.

This serves to underline the point that the temporary safe harbour is aimed at providing directors with the necessary confidence to work on saving / trading out of difficulties a business that is otherwise viable and has suffered a temporary setback as a result of COVID-19.

Business Debt Hibernation (BDH)

The BDH regime provides companies (and a range of other trading entities – but not sole traders) with some much-needed breathing room to work with their creditors – to come up with a longer term ‘work-out plan’.

There are two steps to the hibernation under the BDH regime:

entry: which triggers an automatic one-month moratorium; and

approval (by creditors): which triggers an extension of up to 6 months,

in both cases preventing the enforcement of debts – other than certain secured debts.

Entry into BDH is achieved if the directors agree that:

the entity was able to pay its debts as they fell due on 31 December 2019;

at least 80% of the directors (acting in good faith) vote in favour of the entry resolution; and

those directors who voted in favour certifies 3 that, as at 31 December 2019, the entity was paying its debts as they fell due, and in the director’s good faith opinion:

- the company has, or in the next 6 months is likely to have, significant liquidity problems, which are a result of COVID-19; and

- it is more likely than not that the company will be able to pay its due debts on and after 30 September 2021.

Entry into BDH is achieved by delivery of a notice to the Registrar of Companies. That notice must be sent to creditors as soon as reasonably practicable after delivery to the Registrar.

The one-month stay is to be used to put a proposal to creditors to address its liquidity issues. A creditor vote must take place before the end of that one-month stay.

Any such proposal must contain sufficient detail to enable creditors to make a reasoned judgment about it.

To be implemented, the proposal must be approved by 50% of creditors.

Once approved, the moratorium is extended by a maximum of a further 6 months – and is binding on all creditors (except for GSA holders and certain excluded debts – see below).

It is important to note some exceptions to the moratorium, for:

GSA holders: A General Security Agreement holder may still enforce their security at any time – both during the automatic one-month moratorium and through the extension approved by creditors. In practical terms, this means that entry into the BDH is likely to need the support of the GSA holder – particularly in the context of the proposal submitted to creditors for approval.

Excluded debts: As previously noted, certain excluded debts are not subject to the moratorium – including debts incurred after the entry into BDH, salary and wages payable to employees and PAYE and similar deductions payable to the IRD.

One of the important protections of the BDH regime is that payments made by an entity that is subject to BDH are exempt from the voidable transactions regime (under the Companies Act and provisions relating to transactions that prejudice creditors in the Property Law Act 2007) – so long as they are entered into (by all the parties) in good faith and on arm’s-length terms. There is an important qualification here – namely that the voidable charges protection in section 292 of the Companies Act continues to apply.

The Companies Office has prepared a guide that is aimed at professional users. The guide summarises the process and provides links to the forms that will need to be completed for any business wishing to enter BDH.

Other changes

Amongst the changes is a reduction in clawback period for voidable transactions (other than for related party transactions) from 2 years to 6 months. This is a much-needed change to the risk exposure, which will be permanent.

*Stephen Layburn is a commercial barrister based in Auckland and is a member of the NZBA Commercial Bar Committee. He advises on a wide range of corporate/ commercial matters. He maintains an active involvement in law reform issues, including as a member of (and former convenor) of the Commercial & Business Law Committee of the New Zealand Law Society and is one of the external counsel to the NZX Markets Disciplinary Tribunal. Contact Stephen at stephen@stephenlayburn.co.nz

Stephen would like to thank Michael Webb and Callum Reid for their encouragement during lockdown to pen a number of guides on the changes to commercial legislation made in response to the COVID-19 outbreak.