Under the Companies Act 1993 (Act) directors of a company must act in good faith and in what they believe to be in the best interests of the company.
Directors of a company must not trade a company in a reckless manner likely to create a substantial risk of serious loss to creditors (s135 of the Act) or agree to a debt being incurred unless they believe on reasonable grounds that the company will be able to meet the obligation (s136 of the Act). If directors breach these duties they can be held personally liable for the debts of the company.
While there are many cases where personal liability has been attached to directors who have breached these duties, the most recent and prominent example relates to Mainzeal Property and Construction Limited (In Receivership and In Liquidation), where the Court found that its directors were liable for compensation of $36 million.
This is not a situation anyone wants to find themselves in, especially due to the unprecedented and unexpected nature of COVID-19!
The Government has recognised the impact COVID-19 has had on businesses, with many effectively becoming insolvent overnight and facing uncertainty around when normal trading can resume, and profitability will return to normal.
For this reason, the Government has proposed new temporary ‘Safe Harbour’ provisions into the Act, which will provide directors with protection from these duties (or penalties for not fulfilling them), if directors decide to continue to trade.
Safe Harbour would be available to directors, if:
- The company was able to pay its debts as they fell due on 31 December 2019;
- In the opinion of the directors, in good faith, the company is facing or likely to face significant liquidity problems in the next six months as a result of the Covid-19 pandemic on the company, its debtors or its creditors;
- 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 by 30 September 2021 (or later date by regulation; refer below). For example, if trading conditions are likely to improve or they are likely to be able to reach agreement with their creditors.
Safe Harbour is designed to provide directors with a reasonable period of time to seek professional advice, formulate a credible plan, and monitor how the impacts of COVID-19 are likely to impact on the company.
A director can only rely on Safe Harbour for decisions and obligations incurred during a six month period. This initial period is proposed to be from 3 April 2020 to 30 September 2020. If the COVID-19 circumstances require, this period may be extended up to 31 March 2021. Further regulations may prescribe a new Safe Harbour period, but this would be no later than 30 September 2021.
Safe Harbour is not a ‘get out of jail free’ card for directors, if:
- The company was insolvent as at 31 December 2019 and/or
- There is no reasonable belief or credible prospect that the company can be rescued after a reasonable period of time.
If there is no credible prospect that the company can be rescued after a reasonable period of time, the directors should make the decision to cease trading or they will risk personal liability for breaching their duties as directors. Directors/shareholders should also consider placing the company into liquidation or voluntary administration.
Safe Harbour does not provide any protection to directors who decide to continue trading and who breach other duties, for example:
- Acting in good faith and in the best interests of the company (s131 of the Act); and/or
- Exercising their powers and perform their duties with the care, diligence and skill of a reasonable director (s137 of the Act).
Safe Harbour is not currently available to:
- Companies incorporated on or after 3 April 2020.
- Licensed insurers, registered banks and non-bank deposit-takers, on the basis that those classes of entities are regulated by the Reserve Bank of New Zealand.
What should directors do now?
- Ensure they have accurate financial records, such as management accounts that verify that the company was solvent as at 31 December 2019.
- Prepare a business plan, with a cash flow forecast at least up to 20 September 2021.
- Have a business plan and forecast that shows that the business can return to a position of solvency and normal trading terms by 30 September 2021.
- Given the uncertainty that exists around the timing and duration of Alert Levels 2 and 1, and businesses’ knowledge of their customer and suppliers’ own positions, we recommend that the forecast should include alternative scenarios.
- The business should look to reach agreements with creditors regarding any arrears. This means that, going forward, the business can pay its current obligations as they fall due, thus proving a return to solvency and viability.
- Management and directors should make all reasonable efforts to reduce costs in the business to ensure that any ongoing debt that is not ’necessary’ is not incurred. For example, rented equipment that is now unnecessary.
- Monitor the plan and situation. Unfortunately the situation and the impact on creditors and suppliers will continue to evolve, making forecasting all the more difficult. Directors should be flexible and be prepared to adapt their business plan to the current situation.
- Keep accurate financial records/information that supports their business plan and any necessary or unforeseen deviation from it.
- Keep an eye on the initiatives to limit the application of Safe Harbour for classes of companies, transactions and circumstances, as well as extension and introduction of new Safe Harbour.
- Keeping records is important because the onus of proof, if Safe Harbour is challenged, will be on directors to demonstrate that their opinions were based on good faith and solid financial information. At the present time it may be clear to a director why they have made the decisions they have made, but with time these reasonings can become less clear. Plan and document!
There are multiple ways in which a company can reach an agreement with its creditors. The Government has said it will be introducing a new temporary Business Debt Hibernation Scheme (BDHS) into the Act. Put simply, the BDHS allows a company to come to a short-term moratorium with its creditors. A comprehensive analysis of the BDHS scheme can be found here. This also contains some detail of an existing business rescue mechanism under the Act known as a Creditor Compromise. A Creditor Compromise is significantly more flexible than BDHS and we expect that a Creditor Compromise will be relevant to a number of businesses. An analysis of the various rescue options, including Voluntary Administrations, is available here.
The content of this article is accurate as at 12 May 2020, the time of publication. This article does not constitute professional advice. If you wish to understand the potential implications of current events for your business or organisation, please get in touch. Alternatively, our COVID-19 webpages provide information about our services and provide contacts for relevant experts who can help you navigate this quickly evolving situation.