TEMPORARY INSOLVENCY LAW PILLS FOR COVID-19 AFFECTED FIRMS

New Zealand is soon set to join a few other countries that have introduced temporary insolvency measures for ailing companies. New Zealand’s proposed measures apply to companies and other entities (but exclude banking companies, Non-bank deposit takers, licensed insurers and sole traders).

The measures could largely be categorised under two heads – safe harbours and business debt hibernation (BDH).

Safe harbour

The safe harbour measures provide temporary relief from the operation of section 135 and 136 of the Companies Act, 1993.

Section 135 (reckless trading) sets out that a director must not agree to, cause, or allow 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.

Section 136 (duty in relation to obligations) sets out that a must not agree to the company incurring an obligation unless the director believes at that time on reasonable grounds that the company will be able to perform the obligation when it is required to do so.

Both provisions are concerned with a director’s duties when the company is in troubled financial waters. Covid-19 has indeed put a lot of companies in troubled financial waters and directors have to decide whether to continue trading and risk breaching these duties or to put the company under voluntary administration (or liquidation in extreme cases).

The Covid safe harbour will allow directors to avoid breaching these sections if they meet three conditions:

(i) they have made a good faith assessment that the company is facing or is likely to face significant liquidity problems in the next 6 months as a result of the impact of the COVID-19 pandemic on them or their creditors;

(ii) the company was able to pay its debts as they fell due on 31 December 2019; and

(iii) the directors have made a good faith assessment 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).

So, if the company is able to meet these three criteria, the hope is that the temporary safe harbour will allow companies to continue trading while trying to find innovating ways of dealing with the current circumstances.

It is interesting to note here that Australia, in July 2019, introduced a safe harbour of its insolvent trading provision to similarly encourage directors to continue trading and pursue restructuring options by taking away the fear of personal liability which the relevant provision (s 588 G) provided for. This reform was introduced prior to Covid-19 and I only mention it here to show that there is sense in incentivising directors to pursue restructuring options while continuing to trade, to avoid prematurely putting companies into voluntary arrangement.

The government proposes that the safe harbour’s availability will be backdated to April 3, 2020 when Parliament approves the measures.

Business Debt Hibernation

As the term suggests this regime will provide a moratorium on enforcement of debts.

To enter this regime, the first step is for directors to have to meet a certain threshold. This threshold is yet to be provided but the government has said it will 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.

Step 2 is to notify their creditors that they will seek a six-month moratorium. This notice will immediately trigger a month-long moratorium for pre-existing debts.

Step 3 brings creditors to the table (electronically of course). If at least 50% of the creditors agree, the moratorium will be extended for another six-month period. Creditors are also able to impose some conditions and if they do, the moratorium will be subject to those conditions being met. This moratorium would be binding on all creditors except employees. If the 50% vote cannot be secured, the BDH will not be available to the company. However, other options like creditors’ compromise, voluntary arrangement and liquidation are still open to the company.

Once a company has availed itself of the BDH regime, to further facilitate its business continuity, the government has proposed that any further payments, or dispositions of property, made by the company to third party creditors would be exempt from the voidable transactions regime. This exemption would only be available where the transactions are entered into in good faith by both parties, are conducted at arms length, and without an intent to deprive existing creditors.

While the BDH regime sounds promising, it is missing a stay on ipso facto clauses (contractual clauses allowing counter-parties to terminate contracts on an insolvency event being triggered). As Chapman Tripp notes, it would be inconsistent with the rest of the regime if a company’s entry into BDH can be treated as a ground to terminate contracts.

It should come as no surprise that this was the other significant reform introduced in Australia prior to the Covid-19. The new position in Australia is that ipso facto clauses in contracts will be unenforceable. Even in New Zealand, there have been suggestions to consider reforms regarding ipso facto clauses in a corporate insolvency context. Perhaps introducing it into the BDH regime will give it the necessary push to be adopted into the insolvency regime.

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