COVID-19 – CHANGES TO COMPANY & INSOLVENCY LAW TO HELP PRESERVE BUSINESSES

Today the Government announced urgent legislative changes to the Companies Act 1993 (“the Act”) to help companies face the unique challenges presented by COVID-19.

The Government’s aim continues to be helping solvent businesses survive COVID-19 and keeping New Zealanders employed.

What are the changes announced today?

The temporary changes announced today can be split into two groups;

1. insolvency law changes to help profitable businesses remain viable and keep New Zealanders employed; and
   
   
2. administrative changes to ease the burden on companies and other entities during these unprecedented times.

Insolvency law changes

The insolvency law changes announced today are:

1. Giving company directors facing significant liquidity problems because of COVID-19 a ‘safe-harbour’ from insolvency duties under the Act.  The Government has indicated that the ‘safe-harbour’ will be time-limited to 6 months, starting from 3 April 2020.  We expect that these changes will be to section 135 (duty not to engage in reckless trading) and section 136 (duty not to incur obligations unless the director reasonably believes they can be met) of the Act; and
   
   
2. Enabling businesses affected by COVID-19 to place existing debts into hibernation until they are able to start trading normally again (known as Business Debt Hibernation).  A company’s BDH proposal would only occur with the agreement of 50% of creditors, and is to be time-limited for 6 months.

Administrative changes

The administrative changes announced today are:

1. Allowing the use of electronic signatures where necessary, due to COVID-19 restrictions;
   
   
2. Giving the Registrar of Companies the power to temporarily extend deadlines imposed on companies, incorporated societies, charitable trusts and other entities under legislation; and
   
   
3. Giving temporary relief for entities that are unable to comply with requirements in their constitutions or rules because of COVID-19 (for example, the requirement to hold annual meetings).

When will the law changes come into effect?

Finance Minister Grant Robertson announced that the proposed law changes have to pass through Parliament, but when implemented, will have retrospective effect to 3 April 2020.  The Government hopes the announcement today will give businesses certainty and provide practical assistance to directors, in the knowledge that they will be given at least some relief from the risk of personal liability in addressing the challenges presented by COVID-19.

We understand the Institute of Directors lobbied hard for these changes, recently writing to Commerce and Consumer Affairs Minister Kris Faafoi seeking a package to support directors facing trading challenges due to COVID-19.  Under the package of changes proposed by the Institute, it was clear that directors would have an obligation under the temporary arrangements to demonstrate that they were solvent at 31 December 2019.

How will the changes to insolvency law work?

Until the draft legislative changes have been released, it is difficult to know exactly how the changes announced today will work in practice.  However, from the announcement, it is clear that the focus is on:

1. preserving businesses that were solvent in the absence of COVID-19, but are now facing insolvency or liquidity issues as a direct result of COVID-19.  Businesses that were already insolvent or at risk of insolvency prior to COVID-19 are not the intended beneficiaries of these changes, and the directors of those businesses should not expect relief from them;
   
   
2. maintaining directors’ obligations generally (and the risk of personal liability), including their duties to act in good faith and to have regard to the interests of creditors (in some circumstances);
   
   
3. encouraging directors of companies facing insolvency or liquidity issues as a result of COVID-19 to keep trading, and find solutions to these extremely difficult times, rather than prematurely wind up businesses for fear of personal liability for insolvent trading; and
   
   
4. allowing businesses the time and opportunity to talk to their creditors about prioritising or reorganising some debts, and deferring others for six months.  The Government hopes this will help some businesses weather the storm in a way that does limited damage to creditors’ interests.

Our thoughts on the changes

We are pleased the Government has announced changes in this area.  This follows similar steps in other jurisdictions, such as Australia and the United Kingdom, which have suspended parts of equivalent laws and made it more difficult for creditors to enforce debts.

The duties imposed on directors under sections 135 and 136 of the Act require directors to make a realistic assessment of the solvency of a company, and its future prospects.  In discharging their obligations under the Act, directors must do their best to assess the value of a company’s cashflow, the availability (and reliability) of credit, as well as the value of its accounts receivable, inventory and other key assets.  The solvency of suppliers is also relevant.

The intent behind sections 135 and 136 of the Act is to strike a balance between allowing directors to take legitimate business risks necessary to have a thriving and agile economy, against the need to protect creditors from the risk of being unreasonably exposed to risk of failure.

In the context of the unprecedented challenges thrust upon us by COVID-19, directors’ duties in relation to solvency can be extremely challenging.  While prior to today, the law allowed directors considerable scope to take legitimate business risks, directors will have been rightly concerned about the risks of personal liability.  They may have felt the safer course was to limit losses and risk now, by terminating staff, exiting contractual arrangements or winding up the business, rather than persist in trying to weather the storm and trade through COVID-19.  The consequences of such action for the wider economy could be extremely significant.

In our view:

1. the changes to directors’ duties announced today strike the right balance between easing the legitimate concerns of directors and encouraging otherwise sound business to trade through COVID-19, while protecting creditors from unreasonable risk.  With the focus being on preserving otherwise solvent businesses, directors of businesses facing solvency issues prior to COVID-19 need to take particular care to ensure they comply with their obligations.  For some businesses, ceasing trading now will still be the right course of action and difficult choices will remain;
   
   
2. it will be interesting to see how the Business Debt Hibernation scheme works in practice.  While the idea of placing a moratorium on debt enforcement is good in principle, it will require buy-in from creditors in order to be effective.  If the COVID-19 Level 4 lockdown continues beyond the initial 4 week period, or even if repeated or regional lockdowns continue for some time, businesses of all kinds will continue to struggle to maintain cashflow.  In those circumstances, creditors may be reluctant or unable to take part in the scheme;
   
   
3. the Government’s changes to business administration are welcome as businesses struggle to grapple with significant challenges at this time.  Businesses will need to carefully keep an eye on future announcements and review the detail of the Government’s changes when available, to ensure that key obligations are not overlooked.

As COVID-19 and the Government’s response continues to unfold daily, we will continue to update our website with further detail about these and other changes that affect your business.

If you have any questions on the changes announced today, or want to discuss your obligations in considering the impacts of COVID-19, please contact Jono, Dave, Jaesen or Mark.