Much has been written about the “safe harbour” provisions and business debt hibernation (BDH) regime introduced to address concerns that the COVID-19 pandemic could lead to numerous companies being placed into liquidation.
Little, however, has been written about the impact that these changes (and COVID-19 more generally) may have on companies’ notification obligations under its insurance policies and on the ability of their directors to obtain D&O insurance.
In this article, we explore the implications of COVID-19 and the legislative response to it upon companies and directors’ notification obligations and D&O insurance.
The safe harbour provisions
The COVID-19 Response (Further Management Measures) Legislation Act 2020 introduced a new Schedule 12 to the Companies Act 1993 which, from 3 April 2020, provides company directors with a “safe harbour” from their obligations under section 135 (reckless trading) and 136 (duty in relation to obligations) of the Act, if they can satisfy the following criteria:
- directors must believe in good faith that the company is facing or is likely to face significant liquidity issues in the next 6 months as a result of the impact of COVID-19 on it or its creditors; and
- the company must have been able to pay its debts as they fell due on 31 December 2019; and
- the directors must 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 the next 18 months, for example, because trading conditions are likely to improve or they are likely to be able to reach an accommodation with their creditors.
This safe harbour does not apply to directors of some companies, including licensed insurers and registered banks (which are prudentially regulated by the Reserve Bank of New Zealand) and companies incorporated after 3 April 2020.
Business Debt Hibernation regime
The second major change is the introduction of a temporary “Business Debt Hibernation” regime or “BDH” as it is now referred to in the Companies Act. BDH is provided for in Schedule 13 of the Companies Act and will be available until 24 December 2020 or any later date prescribed by the regulations.
The BDH regime is available to most entities with legal personality (e.g. companies, limited partnerships, unincorporated bodies of persons and certain other body corporates) and other entities such as partnerships but will not extend to (among other things) licensed insurers, registered banks and non-bank deposit takers, sole-traders and entities that were formed or established on or after 3 April 2020.
The purpose of the BDH regime is to provide a process for entities facing current and future liquidity issues due to COVID-19 to operate in a way that:
- maximises the chances of the entity, or as much as possible of its business, continuing in existence; or
- if it is not possible for the entity or its business to continue in existence, results in a better return for the entity’s creditors and members than would result from the immediate liquidation of the entity.
When an entity is in BDH, it will have the benefit of a moratorium on certain enforcement actions for a defined period – initially up to one month with the potential for a further period of six months, subject to creditor approval. During this period, the entity may continue to trade, subject to the payment variation terms agreed with creditors.
During this period the directors will be able to (among other things):
- further assess whether the entity can resume trading as normal;
- propose a further formal compromise to creditors;
- enter into administration; or
- decide to liquidate the entity.
The changes to the obligations of the entity in BDH are temporary and if the entity will not be in a position to perform its obligations at the end of the BDH period, it will need to settle or renegotiate terms prior to the expiry of the period. Payments or dispositions of property made by an entity in BDH to third party creditors (but not related parties) are exempt from the voidable transactions regime in the Companies Act and Part 6 of the Property Law Act, subject to the transaction having been entered into in good faith by both parties and on arm’s length terms. The purpose of this exemption is to give comfort to anyone trading with the entity that a liquidator will not be able to unwind transactions made while an entity is in BDH and that have been specifically authorised under an arrangement with that entity’s creditors, if that entity is later placed into liquidation.
If the creditors vote against any proposed BDH arrangement then they will be able to enforce debts as usual, and the existing options under the Companies Act will be available, e.g. creditor’s compromise, administration or liquidation
Impact of the safe harbour provisions and Business Debt Hibernation regime
While it is difficult to foresee whether these initiatives will prevent liquidations, there is a real risk that they are not the panacea desired by some. They may simply result in a delay in liquidations and a shift in the issues faced by directors of insolvent companies. Liquidators will likely look carefully at whether directors were entitled to take advantage of the “safe harbour” regime and in particular whether a reasonable director could not have formed a good faith view that the company will be able to pay its debts as they fall due within 18 months. If proceedings are issued in any number, we may see a further hardening of the D&O insurance market.
To protect themselves from claims, directors should keep accurate records of any decisions made relating to the “safe harbour” regime, including outlining the matters taken into account in reaching decisions.
The “safe harbour” and BDH regimes also raise interesting questions as to whether companies and their directors are obliged to disclose to their insurers that they are technically insolvent, particularly where they intend to take advantage of the safe harbour regime. If they do not make disclosure at renewal and the directors subsequently face a claim in liquidation, they may face an argument by their insurer that they failed to disclose a material fact that would have influenced a reasonable insurer in determining whether to underwrite the insurance cover or the terms of that cover.
These issues highlight that, while the safe harbour and BDH regimes were intended to assist directors and companies to deal with the present uncertain times, there remain uncertainties with respect to the consequences of insolvency issues for insurance cover. Directors should consider their companies’ insurance positions and their own D&O position in addition to their directors’ duties.
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