As COVID-19 has dramatically changed the business landscape in New Zealand, many directors have been left wondering whether their efforts to save their businesses could expose them to personal liability for trading whilst insolvent. Recognising the pressures businesses are facing, the Government has announced it will seek temporary reforms to insolvency provisions under the Companies Act 1993 by introducing a safe harbour from insolvent trading. If passed, the safe harbour will provide welcome relief to directors who are facing significant liquidity issues.
In this article, we break down what the reforms mean for directors.
What are the insolvent trading provisions?
Under the Companies Act 1993, directors must not agree, cause or allow the business of a company to be carried on in a manner likely to create a substantial risk of serious loss to the company's creditors (section 135). Further, directors must not agree to the company incurring an obligation unless at that time he or she believes on reasonable grounds that the company will be able to perform the obligation when it is required to do so (section 136).
The consequences of breaching these duties are serious for directors, exposing them to personal liability. With the uncertainty surrounding how long the lockdown and Alert Level 4 will continue, directors facing significant liquidity issues are therefore putting themselves at personal risk if they continue to trade.
What is the safe harbour?
Wishing to avoid widespread premature business failure, the Government has proposed a safe harbour for directors from the insolvency provisions. Whilst subject to agreement by Parliament, under the safe harbour provisions, directors will not be in breach of the insolvency provisions for the next six months if they can demonstrate:
- in the good faith opinion of the directors, the company is facing or is likely to face significant liquidity problems in the next 6 months as a result of the impact of COVID-19 on them or their creditors;
- the company was able to pay its debt 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 debt as they fall due within 18 months.
The Government will ask Parliament to apply the changes retrospectively, effective from 3 April 2020.
What does this mean for directors?
If enacted, directors will have some relief from the immediate threat of insolvent trading. However, it is not a get out of jail free card. The Government has made it clear that the purpose of the safe harbour is to protect businesses that were fundamentally sound prior to COVID-19, and not those who may have already been on shaky ground. It does not override general duties of care and obligations of good faith under the Companies Act 1993.
We recommend that directors keep in close contact with their professional financial and legal advisers during this time, particularly if they are concerned about the solvency of their company. Practical steps to improve cashflow include:
- applying for the financial assistance packages from the Government, including the Wage Subsidy Scheme and the Business Finance Guarantee Scheme;
- reducing operational expenses where possible;
- negotiating extended payment terms with creditors;
- restructuring bank debt;
- having clear plans for coming in and out of each alert stage.
The Government is also developing a range of other insolvency reforms to provide temporary relief for businesses, including a debt hibernation scheme. We will publish more details on these as they come available.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.