03/04/2020

Insolvency relief announced

On 3 April the government announced insolvency relief measures intended to assist well-governed viable business suffering significant but short-term illiquidity as a result of the COVID-19 pandemic.  The primary initiatives are the Safe Harbour and Business Debt Hibernation rules.  Legislation and definitive rules are still to come; based on the detail announced to date we provide some guidance below as to how these rules may affect you.  Please contact us with any queries either conceptually or in completing preparatory work.
https://www.companiesoffice.govt.nz/news-and-notices/insolvency-relief-for-businesses-impacted-by-covid-19/

Safe Harbour

What’s the point?

The proposal for a Safe Harbour is aimed at the obligations imposed on directors under sections 135 (reckless trading) and 136 (duty in relation to obligations) of the Companies Act 1993.

Section 135 provides a director must not allow or cause the business of the company to be carried on in such a way as creates a substantial risk of serious loss to the company’s creditors.

Section 136 imposes a duty on each director not to allow the company to undertake an obligation unless the director believes at that time the company will be able to perform the obligation when it is required to do so on reasonable grounds.

Generally, if a director fails in his duty under section 135 and allows the company to trade recklessly, an impacted creditor may sue; resulting in the director being personally liability for the loss.  Alternatively, where a liquidation subsequently occurs, the liquidator may require the director to provide compensation personally where a breach under either section has occurred.

The proposal…

Where the company faces liquidity problems due to COVID-19, the proposal is there will be a 6-month grace period for directors who allow the company to continue trading in contravention of a straight-forward reading of the above sections.

That said, to receive the protection under the proposals, the company must have been able to pay its debts as at 31 December 2019, the directors must act in good faith and be able to show they have reasonable grounds for believing:

• COVID-19 is the reason for the liquidity problems faced in the next six-months (i.e., from 3 April 2020); and

• It is more likely than not the company will be able to pay its debts as they fall due within 18-months.

Good faith remains the key.  This is not a ‘get-out-of-jail’ card for directors and serious assessment of the company’s likely position over the next 18-months will be necessary, both in claiming the proposed relief and in not triggering existing creditor protections that continue to apply in the Companies Act, (e.g., those addressing serious breaches of the duty to act in good faith and dishonestly incurred debts).

What do you need to demonstrate?

Details are light in the announcement and legislation is expected within the next few weeks.

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 under sections 135 and 136, if:

1. In the good faith opinion of the directors, the company is facing or 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, it is more likely than not 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 able to reach an accommodation with their creditors).

When will the Safe Harbour apply?

The government has stated they will seek to have the provisions apply to trading in the period starting on the date of announcement (3 April 2020) for six-months (3 October 2020).

Is creditor approval or notification required?

No creditor approval or notification protocol is indicated in the announcement.

Does the proposed Safe Harbour provision merely delay the inevitable?

Key requirements of the proposals are for it to apply to viable businesses suffering short-term liquidity issues as a result of the COVID-19 pandemic and for companies to act in good faith.  This should mean the Safe Harbour rules do not apply to businesses that were not viable as at 31 December 2019 and do not encourage insolvent or reckless trading as a matter of course.

In considering the next 18-months of trading, companies should be thinking about how the ongoing challenges of COVID-19 will impact their business.  We recommend you consider the following at a minimum.

• Talk to your suppliers and customers; everyone is facing similar challenges and everyone is seeking the same outcome – to trade out profitably at the end of the recession.

• Maintaining regular communication with suppliers and customers should enable you to promptly identify risks and will allow you to be more agile.

• Understand your short-term liquidity position: monitoring short-term cash flow in such a way as to allow you to predict pressure points in a timely manner will be key.

• Consider your working capital cycle, maximising inventory stocks and managing receivables will be top priorities.

• Consider your supply chain; stress test and consider alternatives.

• Monitor cost escalations and impact on any margins.

• Look at any funding covenants; do you have personal obligation under existing contracts (e.g., guarantees); manage communications with your providers.

• Are your debt investments in the business covered by a general security agreement giving you preferential status in a liquidation scenario?  If not, this should be considered (referencing your bank or other existing security arrangements).

• Revisit your budgets and business plans; consider what working capital requirements you now have, and how these should be funded.  Is the government’s finance guarantee scheme for working capital an option for you (please see our communications on this topic)?

• Consider whether a restructure, reorganisation or divestment will put your business in a stronger position going forward.  Should you be considering a creditor compromise agreement?  A debt factoring arrangement?

• A liquidation may also be a sensible approach, limiting losses and putting you in a strong position to restart in the future.

Whatever you’re considering we can help.  Involvement with your advisers as early as possible will help you find the strongest platform for the continuation of your business and future endeavours.

When are further details and /or legislation expected?

The announcement states further guidance including the documentation templates for applying the scheme will be available in the coming weeks.  We anticipate this will be provided soon to provide the maximum utility during the lockdown period.

Business Debt Hibernation

What’s the point?

The proposal is intended to offer a binding creditor agreement alternative to the existing regime providing a moratorium on existing creditors taking enforcement action for 6-months (7-months if you count the discussion period).
The government’s published intention for this scheme is 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 Business Debt Hibernation;

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.”

The proposal…

Directors will need to meet an unspecified threshold before being able to utilise the Business Debt Hibernation regime.

The proposal must be put to the business’ creditors.  One-month from receiving notification the creditors will vote and must agree at 50% or more (by value and number).  The creditors may require conditions to be imposed.

During the month from the delivery of the proposal to creditors and the vote, there is a moratorium on the enforcement of debt.  If the creditors vote to pass the proposal, a further six-month moratorium applies.  The moratorium is binding on all creditors other than employees.

The business will be able to continue trading (subject to any creditor restrictions imposed).  Further payments or property dispositions resulting from good faith, arm’s length transactions will occur outside the voidable transactions regime (not if the transaction is with a related party or there is an intent to defraud the existing creditors).

It seems likely creditors will only approve a Business Debt Hibernation if the company is able to satisfy them that the company’s prospects will likely result in full repayment (albeit in 6-months), or there are sufficient assets or future investment commitments to allow for an additional 6-months of trading and full repayment (again albeit in 6-months) on a subsequent wind-up.  Open and frank communication with creditors will be imperative should any proposal hope to succeed.

In the period leading up to the finalisation of the scheme terms, we recommend business revisit their short, medium and long-term forecast to facilitate a speedy consultation with creditors should utilisation of this option be necessary.
Contact us if you are considering this option and we can assist in the drafting of a proposal.
If creditors reject the proposal, directors still have the range of existing options available including trading on, entering voluntary administration or appointing a liquidator.

What entities can apply the rules?

Business Debt Hibernation will be available to all entities with legal personality (not just companies) and entities without legal personality (i.e. trusts and partnerships).

Is anyone excluded?

The Business Debt Hibernation rules are not available to licensed insurers, registered banks and non-bank deposit takers, and sole traders.
(Sole traders who become insolvent are instead subject to the Insolvency Act 2006 (which covers personal insolvency) because there is no separation between the trader’s business finances and their personal finances.)

The announcement refers to a threshold to be demonstrated, what’s this?

Details are light in the announcement and legislation is expected within the next few weeks.   It seems likely proof of prior COVID-19 solvency and/or viability will be required as with the Safe Harbour rules above (where an ability to meet debts as they fall due as at 31 December 2019 is required).

Is creditor approval required?

Yes, 50% approval across creditors by value and number is required to apply the regime.

Are overall debt levels reduced under the scheme?

No, debt repayment is merely deferred.

How long does it last?

One-month from notification to the creditors plus six-months if the creditors agree.

How are secured creditors impacted?

Secured creditors are not specifically covered in the announcement.  We anticipate specific considerations will be included in the legislation still to be drafted.

What notification would need to be provided to new creditors?

New creditor notification is not considered in the announcement.  We anticipate this will be covered in the draft legislation still to be provided.

When are further details and/or legislation expected?

The announcement states further guidance including the documentation templates for applying the scheme will be available in the coming weeks.  We anticipate this will be provided soon to provide the maximum utility during the lockdown period.

Does the proposed Business Debt Hibernation scheme merely delay the inevitable?

A key requirement of the proposal is for businesses meeting the criteria to act in good faith with respect to their creditors.  This should mean the Business Debt Hibernation rules do not apply to businesses that were not viable and do not encourage insolvent or reckless trading as a matter of course.   The process should mean the basis for applying the Business Debt Hibernation rules will be well documented but any perceived gaps in evidencing intention should be separately considered in the business’ records.
In considering the next 18-months of trading, businesses should be thinking about how the ongoing challenges COVID-19 brings will impact their business.  We recommend you consider the following at a minimum.

• Talk to your suppliers and customers; everyone is facing similar challenges and everyone is seeking the same outcome – to trade out profitably at the end of the recession.

• Maintaining regular communication with suppliers and customers should enable you to promptly identify risks and will allow you to be more agile.

• Understand your short-term liquidity position: monitoring short-term cash flow in such a way as to allow you to predict pressure points in a timely manner will be key.

• Consider your working capital cycle, maximising inventory stocks and managing receivables will be top priorities.

• Consider your supply chain; stress test and consider alternatives.

• Monitor cost escalations and impact on any margins.

• Look at any funding covenants; do you have personal obligation under existing contracts (e.g., guarantees); manage communications with your providers.

• Are your debt investments in the business covered by a general security agreement giving you preferential status in a liquidation scenario?  If not, this should be considered (referencing your bank or other existing security arrangements).

• Revisit your budgets and business plans; consider what working capital requirements you now have, and how these should be funded.  Is the government’s finance guarantee scheme for working capital an option for you (please see our communications on this topic)?

• Consider whether a restructure, reorganisation or divestment will put your business in a stronger position going forward.  Should you be considering a creditor compromise agreement?  A debt factoring arrangement?

• A liquidation may also be a sensible approach, limiting losses and putting you in a strong position to restart in the future.

Whatever you’re considering we can help.  Involvement with your advisers as early as possible will help you find the strongest platform for the continuation of your business and future endeavours.

Other Regulatory Relief

1. Bring forward the reform of the application of the voidable transactions regime to reduce the period of vulnerability from 2 years to 6-months where the creditor is an unrelated party.

2. The Insolvency Practitioners Regulation Act 2019 and the Insolvency Practitioners Regulation (Amendments) Act 2019 are scheduled to come into force on 17 June 2020; to allow for unexpected COVID-19 the implementation date may be delayed by up to 12-months.

3. Amend the Contract and Commercial Law Act 2017 to allow electronic signatures for security agreements containing powers of attorney.

4. Extending statutory deadlines

        Registrars will have temporary exemption powers to:

• Relax the statutory deadlines in some corporate governance legislation (e.g. for holding AGMs, and filing annual returns for example) for companies, limited partnerships, incorporated societies, charitable trusts and other entities

• Relax deadlines for Registrars under various Acts to carry out certain functions, such as processing applications to reserve company names.

5. Non-compliance with entity constitutions

• Temporary relief absolving entities (including incorporated societies, charitable trusts, unincorporated associations and other entities) unable to comply with any obligations in their constitutions or rules because of the impacts of COVID-19 until such time when it is reasonably able to perform it.

• These entities may also use electronic communications (including electronic meetings) even if this is not permitted in their current constitutions or rules.