Update to insolvency laws – insolvency review working group

For businesses, creditors, and debtors it is now more important than ever to have clarity in the area of insolvency.  Those businesses who anticipate difficulties in the months ahead will appreciate commercial certainty when navigating financial difficulty, or securing payment of debts from businesses in financial distress.

In 2015 the Insolvency Review Working Group (Working Group) was set up to examine the landscape of corporate insolvency law and recommended a range of changes in two reports.  Following the first report changes were made to existing law which came into force on 17 June 2019 including additional regulatory requirements for Insolvency Practitioners.  On 15 May 2017 the second report was published, and Cabinet has indicated a Bill will be tabled this year introducing further changes to the Companies Act 1993, Insolvency Act 2006 and Receiverships Act 1993.  The changes proposed will affect the reckless trading provisions, the voidable transactions regime, and introduce minor changes to existing insolvency provisions.

Voidable transactions

Under the current system the pari passu principle of insolvency law states that creditors of the same class are treated equally.  The Companies Act sets out distribution rules which ensure that those who have greater security are the first to receive funds in a liquidation and those without security are the last to receive funds.

The ‘voidable transactions’ regime allows liquidators to enforce this structure and is based on the idea that companies are typically insolvent for months, sometimes years, before a liquidator is appointed.

During this time it is common that transactions will have occurred which have led to an individual or individuals receiving more than they would have obtained per the distribution rules in the Companies Act.  The Companies Act allows liquidators to “void” any transactions made while a company was functionally insolvent but before the court ordered liquidation (or the company entered liquidation voluntarily).  These orders, referred to as “claw backs” require the individual to repay these funds, which are applied by the liquidator per the distribution rules.

An individual creditor may have a defence to a claw back attempt by a liquidator where:

  • They acted in good faith; and
  • A reasonable person in their position would not have suspected, and they did not expect, that the company was or would become insolvent; and
  • They gave value for the property or altered their position reasonably believing that the transfer of property to them was valid and would not be set aside.

There is also a two to three year limit as to how far back a liquidator may look to claw back a transaction.

The Working Group has proposed increasing this claw back period for those closest to the company by introducing separate claw back periods for different parties, bringing New Zealand in line with Australia, the United Kingdom, Canada and the United States.  The current changes proposed are:

  • For unrelated parties the claw back period be decreased from two years to six months;
  • For related parties the voidable transaction period be increased from two to four years;
  • For transaction with related parties that are akin to a fraud on creditors the period be increased to four years.

A related party is one who would be more likely than other creditors to have information that puts them on notice of the company’s financial situation such as a director, spouse or relative of a director, or related company (a comprehensive list may be found at s245A of the Companies Act).  The same periods of vulnerability are also intended to apply to voidable charges.

In addition to the claw back powers related to transactions detailed above, liquidators also have the ability to claw back amounts relating to transactions at undervalue and for inadequate or excessive consideration.  In respect of these transactions it is proposed:

  • Unrelated party transactions at undervalue will have an unchanged two year claw back period (ostensibly as these transactions always harm creditors);
  • Related party transactions at undervalue will have an increased clawback period from two to four years; and
  • Related party transactions for inadequate or excessive consideration will have an increased clawback period from three to four years.

It is hoped that the changes will promote greater commercial certainty for unrelated creditors who now face a shorter period of vulnerability, and encourage prudence from those related to companies in financial strife.

Reckless trading

The Working Group also identified issues with the pursuit of reckless trading claims by liquidators, which the upcoming bill will also address.  These are claims made by a liquidator against former directors of a company when they have carried on business in a manner likely to create a substantial risk of serious loss to the company’s creditors.  The damages awarded to the liquidator are then used settle creditor debts.

A problem identified with the existing law is that liquidators often do not have incentives to make reckless trading claims.

When a liquidator brings a claim, the costs are met by the assets of the company and are therefore paid for (indirectly) by unsecured creditors first.  An issue for liquidators is that directors may have security over all assets of the business in the form of a GSA (General Security Agreement).

In such a case if a liquidator brought a claim successfully against a director they would be required to distribute some or all of the proceeds back to the secured creditors first, meaning the very director who was prosecuted would be paid before unsecured creditors.

As a result it is proposed that damages won by reckless trading actions be limited to distribution among unsecured creditors.  This is already the case in the United Kingdom and Australia.

Other changes

Some minor changes have also been recommended by the Working Group and approved by Cabinet for the new Bill may also be of interest:

  • Inclusion of Employees’ long service leave and payments in lieu of notice as priority sums in liquidation; and
  • The additional requirement for Companies which issue gift cards or vouchers and enter liquidation to continue to honor at least 50% of their value should they continue to trade through the insolvency.

MBIE, Inland Revenue and Customs have also been invited to undertake policy development aimed at better supporting unsecured creditors.  A discussion document outlining potential policy options will be released later this year, but does not involve any proposed law changes.

The Insolvency Law Reform Cabinet paper indicates that an exposure draft of the Bill introducing all the reforms will be circulated this year.

In these unprecedented times having up to date advice is key, and staying abreast of new developments is essential.  Foresight in the coming months will be the difference between winners and losers in business and in the technical area of insolvency.  Talk to our team for up to date insolvency advice with an eye to the future.

18 May 2020

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