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Changes to insolvency laws announced amidst COVID-19

03 April 2020

The Minister of Finance has today announced significant proposals to change insolvency law to help companies and their directors manage the impact of COVID-19.

The changes are:

  • for directors of companies facing significant liquidity problems because of COVID-19, the introduction of a “safe harbour” from directors’ duties under sections 135 (reckless trading) and 136 (duty in relation to obligations) of the Companies Act 1993; and
  • enabling businesses affected by COVID-19 to place existing debts into hibernation until they are able to start trading normally again;
  • reduce the voidable transactions claw-back period from two years to six months (where the parties are not related);
  • the deferral of the new insolvency practitioner licencing regime (due to start in June) for up to 12 months;
  • the allowing of electronic signatures where necessary due to COVID-19 restrictions; and
  • giving the Registrar of Companies the power to temporarily extend deadlines imposed on companies, incorporated societies and charitable trusts.

The changes will be enacted by legislation to be passed by Parliament. The majority of the changes will take effect after legislation is enacted, save that:

  • the safe harbour will be backdated to have effect from 3 April 2020; and
  • the changes to deadlines will be backdated to have effect from 21 March 2020 (when New Zealand entered Alert Level 2).

At this stage, New Zealand has not followed Australian changes to the statutory demand regime.

Update: On 8 April, MBIE published the cabinet paper and minute recording the proposed changes

Directors’ duties

As discussed in a prior Brief Counsel, directors face difficult decisions about trading on and taking on new obligations in circumstances of significantly reduced revenue and cashflow problems. That brings into sharp relief directors’ duties such as:

  • s 135 (Reckless trading) – A director must not agree to the business of the company being carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors
  • s 136 (Duty in relation to obligations) – A director must not allow the business incurring an obligation unless the director believes on reasonable grounds that the company will be able to perform the obligation when it is required to do so.

Directors of companies, temporarily unable to pay their debts due to COVID-19, risk breaching these duties if their attempts to trade on are ultimately unsuccessful. Decisions to trade on can be difficult to make. Directors facing potential personal liability are likely to act in a risk-averse way, potentially leading to unnecessary liquidations of business that were sound but for circumstances caused by COVID-19.

To address that concern, the Government will introduce a “safe harbour” for directors from sections 135 and 136. Directors’ decisions to keep on trading, and decisions to take on new obligations, over the next six months will not result in a breach of those sections if:

  • in the good faith opinion of the directors, the company is facing or is likely to face significant liquidity problems in the next six months as a result of the impact of COVID-19 on the company or its creditors;
  • the company was able to pay its debts as they fell due 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 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).

Other duties and protections in the Companies Act, such as those addressing serious breaches of the duty to act in good faith and punishing those who dishonestly incur debts, will remain in place.

By way of comparison:

  • Australia has taken a similar step by temporarily expanding existing “safe harbours”. For the six months starting on 25 March 2020, debts incurred in the ordinary course of business will not give rise to insolvent trading liability for directors in Australia;
  • the UK government will suspend the prohibition against wrongful trading temporarily, with retrospective effect dating back to 1 March 2020. As with New Zealand’s amendment, it does not suspend other related liabilities (such as misfeasance-based liability and fraudulent trading).

New Zealand’s safe harbour helpfully gives directors clear guidance on the criteria and avoids the problematic and uncertain phrase “ordinary course of business”.

Business Debt Hibernation regime

The Government will introduce a Business Debt Hibernation regime by which companies (as well as trusts and partnerships) can enter into a moratorium on enforcement of debts. We understand that the Companies Office website will have a form that companies will be able to fill out to seek such a standstill proposal to their creditors.

The key features of the Business Debt Hibernation regime will be that:

  • to access the regime, directors will need to decide that their company meets a threshold. The details have yet to be spelled out, but we would expect that to involve solvency prior to COVID-19, prospects of trading returning to normal in the future and the hibernation being in the best interests of the company and creditors;
  • if the directors consider that threshold is met, directors first notify creditors that they will seek a six-month moratorium;
  • that notice triggers an immediate month-long moratorium, for pre-existing debts;
  • the company will go into a further six-month moratorium if 50% of creditors (by number and by value) agree to it. Voting seems likely to be done electronically;
  • if creditors vote against the six-month moratorium, directors would have other options available to them, including a creditors’ compromise, voluntary administration and liquidation;
  • the moratorium would be binding on all creditors other than employees;
  • payments made by the company during the moratorium will be exempt from the voidable transactions regime, as long as they were entered into in good faith, at arm’s length, and not intended to deprive existing creditors. This is intended to give counter-parties confidence to supply further goods and services.

We await to hear to what extent the legislation will include protection against Ipso Facto clauses. It would seem to be inconsistent with the rest of the regime for entry into the moratorium to be a breach of any contract, or grounds to terminate any contract, including a lease.

The purpose of this regime is to give companies an opportunity to talk to their creditors to reach an arrangement. Together with the introduction of the ‘safe harbour’, it should give directors greater comfort that they need not put into liquidation business that were otherwise sound prior to COVID-19.

Voidable transactions – clawback period reduced

The Government will also bring forward a change to reduce the voidable transaction claw-back period from two years to six months (where the parties are not related). This change reflects the proposal made by the Insolvency Working Group in 2017.

Insolvency practitioner licencing regime to be deferred for up to 12 months

The Government will also propose to defer the new insolvency practitioner licencing regime for up to 12 months. The new regime was meant to start in June 2020.

Update: On Monday 6 April 2020, RITANZ advised that MBIE still considers 17 June 2020 still achievable, and being targeted, for the Insolvency Practitioners Regulation Act 2019 and the Insolvency Practitioners Regulation (Amendments) Act 2019 to come into force. But Cabinet would allow for that to be deferred for up to 12 months if needed, given the unpredictability associated with COVID-19.

Changes to compliance periods

The Government has also announced a proposal to allow the Registrar of Companies to extend deadlines for statutory obligations in relation to meetings and reporting.

No changes to statutory demand regime

In response to COVID-19, Australia has recently changed its statutory demand regime so that:

  • statutory demands can only be issued for debts of A$20,000 and above; and
  • the recipient has six months to respond to or comply the response and response period (to six months).

New Zealand has not followed at this stage. Such changes would be contrary to the focus on promoting engagement between a company and its creditors reflected in the other changes.

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