Insolvency and corporate law relief becomes law
On 15 May 2020 the COVID-19 Response (Further Management Measures) Legislation Act 2020 (Act) received royal assent. The Act brings into law the announcements made at the start of April, including changes to insolvency and corporate law practices, and is designed to increase the prospects of businesses surviving the COVID-19 Pandemic.
Changes which may be relevant to your business under the Act include the introduction of two new schedules to the Companies Act 1993 (Companies Act) which provides safe harbours for directors, and a business debt hibernation regime. We set out in some detail below how these procedures will operate. If you wish to discuss how any of these changes may apply to you or your business, please get in touch.
Safe Harbours from Director’s Duties
Safe harbours for directors have been introduced to the Companies Act by way of a new Schedule 12 which relates to reckless trading and incurring new obligations. These amendments apply retrospectively from 3 April 2020 and initially only apply until 30 September 2020 (unless extended).
To be eligible, a company must show that as at 31 December 2019 the company was able to pay its debts as they became due in the normal course of business (or the company was incorporated on or after 1 January 2020 but before 3 April 2020). It is important to note that safe harbour provisions do not apply to registered banks, licenced insurers, non-bank deposit takers or companies incorporated after 3 April 2020.
Section 135 of the Companies Act provides that a director must not cause or allow the business of a company to be carried on in a manner likely to create substantial risk of serious loss to its creditors.
Section 136 provides that a director must not agree to the company incurring obligations unless the director believes on reasonable grounds the company will be able to perform those obligations when required to do so.
The new Act provides that during the safe harbour period (3 April 2020 to 30 September 2020, unless extended), a director will not be in breach of these duties if the company was able to pay its debts at 31 December 2019 (as above) and at the time of taking the action, the director, in good faith, is of the opinion that:
- the company has, or in the next six months is likely to have, significant liquidity problems which are the result of the effects of COVID-19 on the company, its debtors, or its creditors; and
- it is more likely than not that the company will be able to pay its debts on and after 30 September 2021 (or a later date if prescribed by regulations). When coming to this opinion, a director may have regard to the likelihood of trading conditions improving or the company reaching a compromise or other arrangement with its creditors, or any other matters the directors consider to be relevant.
Note that Schedule 12 allows regulations to be made which may include prescribing to what companies the safe harbours apply and any further conditions to be met (including for particular classes of companies and transactions), as well as extending the safe harbour period.
Although this provides much needed comfort to directors to enable them the confidence to trade during these difficult times, it is important to remember that these measures do not offer blanket protection. Directors are still subject to their duties to act in the best interests of the company, in good faith, and to exercise reasonable care, diligence and skill. It is clear that the safe harbours are not available to companies that have no realistic prospects of recovering from their current financial distress. It is also important to note the safe harbour will only cover decisions made in the safe harbour period (3 April 2020 to 30 September 2020, unless extended).
It will be critical for directors to properly consider and document the reasons for holding the opinions required by the safe harbours as well as maintain proper records to substantiate those opinions.
Business Debt Hibernation Regime
The new Act has now also brought into force the business debt hibernation (BDH) regime, which provides for entities that are, or may be in the future, facing significant liquidity problems as a result of COVID-19. The Companies Office has released a step by step guide for companies to help them work through the process (here).
The BDH regime allows companies and other entities to enter a one month moratorium upon enforcement of its debts, and then to enter into arrangements with creditors to put existing debts into hibernation for a further six months. This is not available to certain entities such as banks, licensed insurers, non-bank deposit takers and sole traders, nor any entities formed on or after 3 April 2020. The BDH regime is also not available if the entity is already subject to a formal insolvency process such as receivership or liquidation.
It is important to note that the BDH regime cannot vary or reduce the amount of the debt payable or alter a creditors rights after expiry of the hibernation period, rather it can only be used to reduce or alter payments required to be made during the hibernation period.
A BDH may be entered into by an entity if the entity was able to pay its debts as they came due on 31 December 2019, and 80% of directors (or equivalent) vote in favour of a resolution for the entity to enter into a BDH. Each director who votes in favour of the BDH will be required to sign a certificate that as at 31 December 2018, the entity was able to pay its debts, it has, or is likely to have in the next 6 months, significant liquidity problems as a result of COVID-19, and it is more likely than not it will be able to pay its due debts on and after 30 September 2021 (or later if altered by regulations).
When considering the last point, a director may have regard to the likelihood of trading conditions improving, the likelihood of a BDH arrangement being approved by creditors, and any other matters they consider relevant.
To enter into BDH, an entity must submit an entry of notice to the Registrar. The Board (or equivalent) must also send a copy of the Registrar notice to each known creditor as soon as reasonably practicable, along with other required information including a high level description of the proposed hibernation arrangement.
In the first month following notification, the entity is to propose a hibernation arrangement to its creditors. The entity must give the creditors, at least five days before the expiry of the month, a copy of the final proposed arrangement, a request that the creditors vote on a resolution to approve the arrangement, and specified details around voting. It should be noted that it is not necessary for a creditor meeting to be held, and that related creditors cannot vote unless the court orders otherwise.
If a majority of creditors (by number and value) vote to approve the BDH, the BDH will apply for an additional six month period from the date of approval. The BDH is binding on all creditors other than employees and does not prevent a general security interest holder from enforcing its security. Interestingly, the entity may come out of BDH early if a majority of directors vote in favour of such and required notifications are sent. If it is not approved, the BDH will cease at the earlier of the end of the one month period or the close of the voting date, and existing options such as trading on, voluntary administration and appointing a liquidator will be available to the entity.
The entity must submit a decision notice to the Registrar, regardless of the result of the vote. Importantly, an entity can only enter into a BDH once, and the arrangement must be entered into before 24 December 2020 (unless extended).
Effect of BDH
If the debt hibernation is approved, creditors will not be able to enforce their debts or place the entity into liquidation during that period and the business is able to continue to trade, subject to any restrictions that may have been agreed with creditors when entering into hibernation. Any transactions must still be entered into in good faith, on arm’s length, and without the intent to deprive the existing creditors of the company.
A guarantee of the company’s obligations given by a director, shareholder (or their relative) cannot be enforced against them during the hibernation period without court approval. This gives directors some assurance that they will not be targeted for payment under these guarantee arrangements where debtors cannot enforce against the entity directly.
Transactions entered into in good faith, arms’ length terms and authorised by the BDH arrangement during the hibernation period will also not be voidable in the context of a future liquidation – which will give third parties confidence to continue to trade with an entity in BDH. However note that the moratorium only applies to debt incurred prior to entry into BDH, all subsequently incurred debts will need to be paid when due.
Note also that a general security agreement holder will not be restrained from enforcing its security at any time throughout the first month and any hibernation period. This will inevitably assist a company to gain the support of any GSA holder to approve the regime as part of the creditor approval process.
It is important that the BDH regime is complied with correctly. If directors do not correctly comply with specified parts of the regime, then directors can each be liable on conviction to a fine of up to $10,000.
Whilst BDH will be a simple and low cost solution for some businesses, it is important to remember that the business debts are put in hibernation, and will be repayable in the future, along with any other debts the entity has accrued in the meantime. It also does not apply to debts to employees or instalment arrangements with IRD and neither does it apply to fully secured creditors (with a general security interest).
You should consider your other options and decide whether BDH is right for you. For example, there is the small business cashflow loan scheme available until 12 June 2020. If you do not see a light at the end of the tunnel (to be comfortable of the likelihood of solvency by September 2021), then other options remain available to you such as voluntary administration or liquidation.
The new Act also brings forward changes to the voidable transactions regime by reducing the claw back period from two years to six months for transactions between parties that are not related. Currently, the claw back period remains at two years for related party transactions.
The updates discussed above are some of many of the amendments made under the Act.
Should you require advice relating to any of the above, the team at Lane Neave would be happy to assist.