The Government has announced temporary relief for directors from the two insolvency-related directors’ duties in the NZ Companies Act to encourage COVID-19 impacted companies to continue trading and not prematurely liquidate. While legislation enacting this relief is not expected to be introduced until the end of April, the Government has provided extensive details of the relief and advised that it will apply retrospectively from 4 April 2020.
This document has been prepared to alert directors of this relief and provide guidance as to how it may apply to a company they direct.
Feel free to share this with other directors who you think might benefit from having this guidance too. We suggest they contact a legal adviser if they need specific advice.
Disclaimer: This guidance is general in nature and based on the details provided by the Government as at 15 April 2020. It is not intended to be legal advice for your specific circumstances. Each situation will turn upon its own unique facts. Please seek legal advice if necessary.
The COVID-19 lockdown has caused significant cash-flow problems for many NZ businesses. This brings into sharp focus the following Companies Act directors’ duties:
- Section 135 (reckless trading): A director must not allow the business of the company to be operated in a manner likely to create a substantial risk of serious loss to the company’s creditors.
- Section 136 (new obligations): A director must not allow the business to incur 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 can be personally liable for breaching these duties. In particular, a director’s compliance with these duties may be scrutinised by liquidators exploring all avenues to recover cash for unpaid creditors of a company in liquidation.
Due to this liability risk, the Government is aware that these duties may lead to companies being voluntarily liquidated prematurely by directors who understandably wish to limit their liability exposure during these uncertain times. Such early liquidations would likely exacerbate the inevitable economic downturn and further delay NZ’s economic recovery.
“Safe harbour” relief from 4 April 2020 to 4 October 2020
To address this concern, the Government will implement a temporary “safe harbour” for directors from their duties under sections 135 and 136. This means that board decisions to keep on trading, or take on new obligations, over the 6 month period (4 April 2020 to 4 October 2020) will be deemed reasonable if the following conditions are met:
- 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, its creditors or its debtors.
- The company was able to pay its debts as they fell due on 31 December 2019.
- 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, they are able to restructure the business, or they are likely to able to reach an accommodation with their creditors).
In practice, the safe harbour is providing directors of otherwise viable businesses comfort that they may allow the company to trade through a 6-month cash flow negative period (even if the business may struggle to pay its debts) provided those directors have reasonable grounds to believe that the business will, within 18 months, return to a position where it is able to pay its debts as they fall due.
Even with the safe harbour, directors should remain conscious that this does not provide them with a free pass to disregard their other duties to the company and its shareholders for the next 6 months. Other 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, remain in place.
Directors must also continue to assess the applicability of condition 3 on a regular basis. If, as more clarity around future scenarios develops, there is uncertainty as to whether Condition 3 can continue to be met, Directors should seek advice.
The Government has also indicated that the 6-month period may be extended if the economic disruption caused by COVID-19 continues to subsist.
Does the Safe Harbour apply?
We encourage boards seeking to rely on the safe harbour to consider and record the reasons why the safe harbour applies. This can help protect the directors in the event that the decision to continue to trade, or take on a new obligation, is later scrutinised.
In the table below, we’ve set out our comments on what considerations may be relevant for a board seeking to rely on the safe harbour when managing a business with negative cash-flow.
|Condition 1: the cause of the cash-flow problem||
|Condition 2: the position as at 31 December 2019||
|Condition 3: the 18 month recovery||
Considering your ‘levers’
Being able to pay debts as they fall due does not necessarily require a company to be profitable. However, such companies must be realistic about their cash burn and understand the point on the cash runway where it must cease trading, or wind back operating costs, so not to put creditors at undue risk of not being paid.
When considering whether it will be likely that the company will be able to pay its debts as they fall due within 18 months, directors can consider all the “levers” which may be pulled to manage the company’s cash flow. These include:
- Cash in bank: what cash will the company have available?
- Capital raising: are there realistic prospects that the company could successfully raise capital if broader economic conditions improve? Does the company have a track record of successful capital raises to support this assessment? Is there any existing shareholder loans which may be deferred or converted into equity?
- Other shareholder support: is there other shareholder support the company is relying on (including parent company support)? If such support exists, how is this documented? Will the shareholder be bound to provide funding if called upon?
- Compromise with creditors: can the company reach a compromise with its creditors to help spread debt servicing obligations over a broader range of time? In addition to the new safe harbour, the Government is also introducing a new “Business Debt Hibernation” regime by which companies can enter into a six-month moratorium on enforcement of debts. The Government has indicated that the Companies Office will make available comprehensive guidance and a simple “fill-in-the-box” form that entities will be able to complete in order to make a standstill proposal to their creditors.
- Lease relief: is the company able to get relief from its rent obligations under its lease? We have circulated guidance regarding rent abatement provisions which are commonly found in some standard form ADLS leases (see here). Even if you do not have a rent abatement provision in your lease, we have found that landlords are willing to defer a portion of the short-term rent over a longer period.
- Government assistance: can the company take advantage of the Government’s support packages? This includes the employer wage subsidiary scheme and the business finance guarantee scheme. More information on those schemes is available here.
- Restructuring: can the company restructure its workforce and operations to enable it to operate profitable in more constrained market conditions?
Throughout this period we would suggest that companies prepare forecasts that look out three months, six months, nine months and a year. Prepare a low case, medium case and high case forecast for each time period, and consider what “levers” could be pulled for each forecast.
The board should regularly monitor the trading performance against each forecast. This will allow a board to determine if and when a company will run out of cash in each scenario and how possible operating cost reductions will impact the board’s liquidity analysis.
Any questions, get in touch.