Government Issues Relief For Directors & Companies From Insolvency Provisions In The Companies Act

This Article has been updated following the commencement of the COVID-19 Response (Further Management Measures) Legislation Act (the Act), on 16 May 2020.

MinterEllisonRuddWatts welcomed the Government’s announcement on 3 April of several measures to support businesses during the period of unprecedented uncertainty created by COVID-19.

The reforms will provide flexibility in the application of certain directors' duties in the Companies Act 1993 (Companies Act) and implement a temporary new regime through which a company (and other entities) may benefit from a moratorium on the payment of debts for a period of time.

MinterEllisonRuddWatts participated in the process of developing these changes through different channels, including working with the Ministry of Business, Innovation and Employment (MBIE), as the legal partner of the Institute of Directors assisting with its submissions, and through our involvement with the Restructuring Insolvency & Turnaround Association New Zealand Incorporated.

The changes come as a result of concerns that the uncertainty created by the COVID-19 pandemic could lead to numerous companies being placed into liquidation, mainly due to the inability to predict the pandemic’s outcome. The relief provided under the Act grants a fixed term easing of the rules that would otherwise apply to directors and companies regarding their dealings with creditors.

Directors' duties relief

The relief provides a ‘safe harbour’ to the directors' duties contained in sections 135 and 136 of the Companies Act.

Under sections 135 and 136 of the Companies Act, a director of a company:

• must not agree to the business of the company, or cause or allow the business of the company, to be carried on in a manner likely to create substantial risk of serious loss to the company’s creditors; and
• must not agree to the company incurring an obligation unless the director believes at the time on reasonable grounds that the company will be able to perform the obligation when it is required to do so.

The newly created safe harbour provides that decisions by a director to keep trading, as well as any decisions to take on new obligations, for an initial period from 3 April 2020 until 30 September 2020, will not result in a breach of sections 135 and 136 of the Companies Act if:

• in the good faith opinion of the directors, the company is facing (or is likely to face in the next 6-months) significant liquidity problems as a result of the impact of the COVID-19 pandemic; and
• the company was able to pay its debts as they fell due in the normal course of business on 31 December 2019; and
• 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 on and after 30 September 2021 (eg, because trading conditions are likely to improve, or they are likely to be able reach an accommodation with their creditors).

This safe harbour will not apply to directors of some companies including licensed insurers and registered banks (because those classes of entities are prudentially regulated by the Reserve Bank of New Zealand) and to companies incorporated after 3 April 2020.

The Act permits regulations to extend the safe harbour period (to end no later than 31 March 2021) or provide for a further safe harbour period (for no longer than six months, that ends no later than 30 September 2021).

Business Debt Hibernation or COVID Business Standstill

The second major change is the introduction of a temporary “Business Debt Hibernation” regime (or “BDH” as it is now referred to in the Companies Act). BDH will be provided for in Schedule 13 of the Companies Act and will be available until 24 December 2020 (or any later date prescribed by the regulations).

The BDH regime will be available to most entities with legal personality (e.g. companies, limited partnerships, unincorporated bodies of persons and certain other body corporates) and other entities such as partnerships but will not extend to (among other things) licensed insurers, registered banks and non-bank deposit takers, sole-traders and entities that were formed or established on or after 3 April 2020.

The purpose of the BDH regime is to provide a process for entities facing current and future liquidity issues due to COVID-19 to operate in a way that:

1. maximises the chances of the entity, or as much as possible of its business, continuing in existence; or
2. (if is not possible for the entity or its business to continue in existence) results in a better return for the entity’s creditors and members than would result from the immediate liquidation of the entity.

When an entity is in BDH, it will have the benefit of a moratorium on certain enforcement actions for a defined period (initially up-to one month with the potential for a further period of six-months, subject to creditor approval). During this period the entity can continue to trade, subject to the payment variation terms agreed with creditors.

During this period the directors will be able to (among other things):

1. further assess whether the entity can resume trading as normal;
2. propose a further formal compromise to creditors;
3. enter into administration; or
4. decide to liquidate the entity.

The changes to the obligations of the entity in BDH are temporary, and if the entity will not be in a position to perform such obligations at the end of the BDH period, it will need to settle or renegotiate terms prior to the expiry of the period. Payments, or dispositions of property, made by an entity in BDH to third party creditors (but not related parties) are exempt from the voidable transactions regime in the Companies Act and Part 6 of the Property Law Act, subject to the transaction having been entered into in good faith by both parties and on arm’s length terms. The purpose of this exemption is to give comfort to anyone trading with the entity that a liquidator will not be able to unwind transactions made while an entity is in BDH and that have been specifically authorised under an arrangement with that entity’s creditors, if that entity is later placed into liquidation.

If the creditors vote against any proposed BDH arrangement then they will be able to enforce debts as usual, and the existing options under the Companies Act will be available (e.g. creditor’s compromise, administration or liquidation).

Commencing the Business Debt Hibernation process

The board of an entity may agree to the entity entering BDH if:

1. as at 31 December 2019, the entity was able to pay its debts as they became due in the normal course of business; and
2. at least 80% of its directors’ vote in favour of a resolution for the entity to enter into BDH; and
3. each director who votes in favour of the resolution has signed a certificate that:

i. states that, as at 31 December 2019, the entity was able to pay its debts as they became due in the normal course of business;

ii. includes a statement that the director is of the opinion that:

a. the entity has, or in the next 6 months is likely to have, significant liquidity problems; and

b. the liquidity problems are, or will be, a result of the effects of COVID-19 on the entity, its debtors, or its creditors; and

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

iii. sets out the grounds for the opinions in (ii) above; and

d. each of the directors who vote in favour of the resolution are acting in good faith.

If an entity was formed after 1 January 2020 then there is no need for an entity to have been able to pay its debts on 31 December 2019 or make any such declaration. When an entity is in BDH, any creditor may request that at least 80% of the directors of the relevant entity sign new certificates in the form set out above. If the entity does not send these new certificates to the relevant creditor within five-working-days, then its protection under the BDH regime will cease. This requirement will not apply if the directors have provided new certificates to that (or any other) creditor within the preceding two-months of receiving that request.

If the threshold test is met, the directors must then deliver a notice to the Registrar of Companies (with a copy sent to all known creditors of the entity) that the entity is to be placed into BDH. The notice to creditors should indicate that the entity has agreed to enter into BDH and must contain (among other things):

• a high-level summary of the proposed arrangement that will be put to creditors to deal with liquidity issues;
• a copy of each director’s certificate and the date on which the notice was delivered to the Registrar.

After the notice is given, an initial protection period of up to one month will begin. During this period there will be a moratorium on taking enforcement action against the entity (subject to the secured lending exceptions noted below). This initial period will end if a proposal for continued BDH does not pass.

At least five working days before the voting date (which must take place before the expiry of the one-month moratorium period) the entity must prepare and give creditors a final proposed arrangement and request that each of the creditors vote on a resolution to approve the arrangement. This notice will contain details of voting and set out how the proposal will bind all creditors who were given the notice provided that the proposal is approved by a majority in number and value of the creditors who are entitled to vote (and actually do vote) on it. This means that a creditor who receives notice of the proposal and either does not vote or votes against the proposal, will still be bound by the outcome of the vote.

The proposal will not be able to cancel any part of the debt owing to the creditor or otherwise vary the terms of the debt except to;

1. reduce the amount of any payment made during the protection period (without a consequential change being made to an annual interest rate);
2. postponing, during the protection period the dates on which payments are to be made by the entity to a creditor (without a consequential change being made to an annual interest rate); and
3. prevent the exercise by a creditor of any rights, or restricting any of the creditor’s rights, to enforce payment of the due debt during the protection period;

A provision of the arrangement that contravenes the points above is of no effect to the extent of the contravention.

Related creditors cannot vote on the proposal unless the Court orders otherwise.

A further six-month moratorium period will begin from the date a majority in number and value of the creditors who are entitled to vote approve the proposal. There is also an option for the entity to hold a creditors’ meeting for the purpose of this vote. In our view it seems unlikely that this option will be used in normal circumstances. Regardless of the outcome of any vote, the relevant entity must submit a decision notice to the Registrar. Where an entity’s creditors impose any conditions on that entity entering into BDH, and that entity materially fails to comply with those conditions, then its protection under BDH will cease.

The new regime includes specific provisions on the rights of secured creditors, owners, and lessors of property.

For the period that an entity is in BDH (and subject to the exceptions set out below):

1. No person may enforce a charge over any property of that entity (except for a charge over perishable goods) without the written consent of that entity or the permission of the court;
2. The owner, or lessor of any property that is used by, in the possession of or occupied by the relevant entity must not take possession without the written consent of that entity, or the permission of the High Court;
3. No legal proceedings shall begin against an entity in relation to any debt, or its property, without the written consent of that entity or the permission of the High Court;
4. An entity will not be liable for damages if it refuses to grant consent to a creditor to take enforcement action (see a, b and c above);
5. A court officer (including a registrar) who receives written notice that an entity is in BDH must not sell that entity’s property or deal with the proceeds of any sale of that entity’s property; and
6. Except with the court’s permission, a guarantee of a liability must not be enforced against:
   1. a director of that entity; or
   2. a shareholder or other member of the entity; or
   3. the spouse or relative of a director, shareholder, or any other member of the entity.

The protections available to an entity under the BDH provisions do not apply to a secured creditor with a charge (or charges) over the whole (or substantially the whole) of any relevant entity’s property and will also not apply to any debt that was incurred after that entity entered into BDH, or any wages, or salary that an entity owes to its employees. If a secured creditor enters into an agreement to sell any property of an entity (or exercises any other power in relation to that property) before that entity goes into BDH, it will not be prevented from enforcing its charge in relation to that property. An entity’s protection under BDH provisions will cease if it enters into a formal compromise with its creditors, voluntary administration, receivership or liquidation.

If an entity is in BDH, third parties are not permitted to use that fact as evidence that the entity is:

1. in breach of (or in default under) any agreement; or
2. unable to pay its debts or has become otherwise insolvent.

In addition, no third-party may:

1. require the payment or performance of any liability from that entity, which would not otherwise have been exercisable; or
2. release a surety from any liability.

Third-parties can, however, use the fact that an entity is in BDH as a drawstop of money or credit event as long as they would be entitled to take such action against that entity if it were not in BDH. An entity may decide to come out of BDH early if a majority of the directors of that entity vote in favour of a resolution to leave BDH. Where an entity’s directors vote in favour of a resolution to leave BDH, they must provide notice of this resolution to the Registrar. This notice must set out the date on which the entity will leave BDH, which must be at least five working days after the notice is delivered to the Registrar.

Other changes

In addition to the above, the following corporate governance changes are included in the Act:

• Other insolvency law changes reducing the period of vulnerability under the voidable transactions regime from two-years to six-months where the debtor company and the creditor are unrelated and deferring the commencement of insolvency practitioner licensing potentially until 1 June 2021.
• Granting of temporary exemptions including providing certain Registrars with a temporary power to issue exemption notices relating to compliance with statutory obligations under the Companies Act, Limited Partnerships Act 2007, Incorporated Societies Act 1908, Charitable Trusts Act 1957 and various other statutes.
• Relief for non-compliance with entity constitutions including the ability for entities to make temporary modifications of requirements and restrictions in their constitutions where they are unable to comply with their constitutions or rules because of the impacts of COVID-19 and providing that entities can use electronic communications even if their constitution or rules do not allow them to do so.

Many of the proposals are scheduled to remain in force until 30 September 2020 on the assumption that the current scale of disruption caused by the COVID-19 pandemic will last for a relatively short amount of time. The Government has noted that, if this assumption is incorrect, deadlines may need to be extended. As such, the Act provides in many cases that such time periods can be extended up to 31 March 2021.

What should directors and companies keep in mind?

While the safe harbour for directors’ duties in sections 135 and 136 provides a level of relief that should give directors greater comfort when continuing to trade in challenging circumstances, it does not change the need to comply with other directors’ duties, including the paramount duty to always act in the best interests of the company. The offence for serious breach of the directors' duty to act in good faith and in the best interests of the company (s138A of the Companies Act), and the offence for using false pretences or fraudulent behaviour to induce a person to give credit to the company or that causes material loss to a creditor (s380 of the Companies Act), amongst others, remain unchanged.

Companies should not use the BDH regime as an opportunity to hoard cash and stop making payments when it would otherwise be in a position make payments as normal. Additionally, the regime may not be used if solvency issues have arisen for reasons unrelated to COVID-19. If the likely outcome is that the company will be placed into liquidation, even with a six-month moratorium on the payment of debts, the BDH regime should not be used to delay liquidation to the disadvantage of creditors.

Some might view the secured party exceptions in the BDH regime as adding unnecessary complexity to the process. Another view is that it provides an independent process for the assessment of any proposal. A bank will require information from each relevant entity to assess whether it should take enforcement action. As a bank’s interests are aligned with the entity’s successful exit from the BDH process they will provide an independent and objective set of eyes to any proposal.

Our view

The proposed changes are helpful in supporting New Zealand’s economy and responsible businesses to continue to trade in the difficult and uncertain times that the COVID-19 pandemic has brought. However, directors will still need to carefully consider and assess decisions made with respect to the operation of their business and the relationships with creditors.

Keeping good records of any decisions made and the grounds for making them will be important. Likewise, the grounds that allow directors and businesses to avail themselves of the new safe harbour and moratorium provided will need to be regularly reassessed by directors, and if a view is formed that a company has passed the point of potential recovery, then the directors are likely to be in a position where they can no longer rely on the relief.

The above is a high-level summary of new legislation. For legal advice on any of the issues discussed above please contact one of our specialists.

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