Supporting businesses in uncertain times – temporary changes to corporate laws

The Government recently announced further measures to help companies facing financial difficulties as a result of the COVID-19 pandemic and NZ’s current Level 4 status. Temporary changes will be made to the Companies Act 1993 (the Act). The most significant of these changes are to provide company directors with a “safe harbour” from their “insolvency duties” and giving companies the opportunity to place their existing debts into “hibernation” for up to six months.    

Safe harbours

The Act places a number of general duties on directors of companies, and these duties generally apply throughout a company’s life cycle. What are often referred to as “insolvency duties” are the duties that a director must not:

(a) agree to, cause or allow the company’s business to be carried on in a manner likely to create a substantial risk of serious loss to that company’s creditors (section 135); or

(b) agree to the company incurring an obligation unless the director believes on reasonable grounds that the company will be able to perform the obligation (section 136).

Under the proposed “safe harbour” regime, directors of businesses facing insolvency due to COVID-19 may be able to make decisions to keep on trading, and to take on new obligations, without being in breach of their duties mentioned above. The “safe harbour” regime is likely to have conditions that must be met before directors can rely on it.  Early indications from the Government are that the conditions will include the following:

1. in the good faith opinion of the directors, that the company is facing or likely to face significant liquidity problems in the next six months as a result of the impact of COVID-19 on them or their creditors;
2. the company was able to pay its debts as they fall 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 (for example, because trading conditions are likely to improve, or they are likely to able to reach an accommodation with their creditors).

The interim relief to the insolvency related directors’ duties is still to be agreed by Parliament.  However, if agreed, it is likely that the safe harbour protection will be backdated to Friday, 3 April.  

In the meantime, directors should keep in mind:

1. the safe harbour regime will only apply if liquidity issues have arisen due to the COVID-19 pandemic (for example, significantly reduced or no revenue due to no longer being able to trade) – if a company has liquidity issues due to other factors or has doubtful solvency (for example, value of assets is close to the value of liabilities) then the safe harbour may not be available;
2. other director duties will still continue to apply, particularly, obligations to act in good faith and in the best interests of a company (section 131), and exercise reasonable care, diligence and skill (section 137) and directors will need to comply with such duties;
3. there is no difference in the duties of directors who live in New Zealand (or Australia as an enforcement country) compared with directors who live overseas (but are directors of NZ companies), nor is there any difference in the duties of those directors who are considered to be executive, non-executive or independent directors; and
4. “insolvency duties” as they currently stand (i.e. without the proposed amendments) do not prohibit directors from taking reasonable business risks.  So, when a company is in financial difficulty, the duties do not necessarily require directors to stop trading or take steps to liquidate that company.  Directors of companies should always be considering and assessing a matrix of financial factors, including company’s cashflow, outstanding debtors (especially for doubtful or bad debts), reliance on key customers and suppliers’ and their solvency, and the ability to pay employees, creditors and other debts owed.  This may be useful for directors to keep in mind if they are unable to come without the conditions of the safe harbour.

We are pleased that NZ is taking steps to suspend laws relating to directors’ duties, similar to what has already been done in Australia and the UK.  We hope the proposed changes will strike the right balance between the interests of directors and creditors, and provide some certainty for all in these uncertain times.

Business Debt Hibernation regime

Another one of the temporary changes to the Act is the proposed new "business debt hibernation" (BDH) regime which will also be available to businesses with COVID-19 related liquidity issues.  

The Government has only outlined a skeleton of the proposal, but at this stage the BDH regime is looking like this:

1. directors who meet a threshold (yet to be determined) will be able put a proposal to their creditors to put their "business into hibernation".  We anticipate that the threshold will be similar to that for the “safe harbour” regime (for example, that the company is facing or likely to face significant liquidity problems in the next six months as a result of the impact of COVID-19 on them or their creditors);
2. the creditors will be given notice, and will have a month to consider, the BDH proposal.  It seems likely that there will be a minimum amount of information that must be provided to creditors to support any proposal.  However, what information will be required and whether creditors will have the opportunity to meet and/or ask any questions directly to the company is presumably still being worked through;
3. at least 50% of creditors will need to agree to the company being placed into BDH.  The 50% creditor threshold will be based on both the value and the number of creditors.  We assume that employees will not be considered in the 50% threshold (on the basis that any accepted proposal will not be binding on employees so presumably they would also not be able to vote) – again this is still to be confirmed;
4. the creditors may be able to negotiate conditions into the BDH proposal;
5. if agreed to, the proposal will be binding on all creditors (not just those who agreed).  Employees are exempt;
6. while a business is in BDH it would be able to continue to trade, subject to any restrictions agreed with creditors;
7. creditors will not be able to enforce debts during the month-long period they are considering the proposal and if the proposal is agreed to, for another six months as well, so the “BDH” regime may apply to a company for seven months;
8. the voidable transaction regime (where transactions can be unwound by a liquidator if the company ends up in liquidation) will not apply, so unrelated third-party creditors who receive payments from a company in “hibernation” cannot be required to repay monies received (subject to certain conditions being met).  

The Government’s intention for the BDH regime is for it to be a straight-forward, flexible and relatively quick way for companies and creditors to agree about non-payment of debts and hopefully, “buy” directors some time to formulate debt repayment plans.  

We look forward to seeing what the final form of the regime looks like, although we are confident that the assumptions noted above are currently being considered and worked through. Hopefully this new, but temporary, addition to the Act will give COVID-19 affected businesses the opportunity to trade through these unprecedented times, but ultimately still ensure that creditors get paid.  

Additional changes

Additional changes to the Companies Act and other legislation to support businesses:

1. Electronic signatures can be used for security agreements containing powers of attorney (amendments required to Contract and Commercial Law Act 2017);
2. Allowing companies to use electronic communications even if their Constitution does not permit such use;
3. Excusing non-compliance with a company's Constitution due to the impact of COVID-19;
4. Bringing in changes to the voidable transactions regime that reduces the vulnerable period from two years to six months, provided the debtor company and creditor are not related parties;
5. Registrars will have temporary powers to relax deadlines under various legislation, including timing for holding an annual general meeting and filing annual returns by companies; and
6. Registrars will have temporary powers to relax deadlines that they need to work to, for example, processing applications to reserve company names.

End note

These changes still need to be agreed by Parliament, so the likely date that these all changes will become law is not yet known

We will be keeping a close eye on the implementation of the “safe harbour” and “business hibernation” regimes, as well as the other changes mentioned, and will provide updates once further details are made known.  In the interim, please get in touch with us for a chat if you want to discuss these changes or anything else affecting your business.  

Stay home and stay safe – we are all in this together.