Insolvency Measures for Covid-19 in New Zealand - A Temporary DIP Model

New Zealand is soon set to join the list of countries that have introduced temporary insolvency measures for ailing companies. New Zealand’s proposed reforms 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 director 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 put a lot of companies in this position and without legislative relief directors would 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 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 on and after 30 September 2021 (or a later date set by regulations)(for example, because trading conditions are likely to improve or they are likely to able to reach an accommodation with their creditors).

The safe harbour’s availability has been backdated to 3 April 2020.

The hope is that the temporary safe harbour will allow companies to continue trading while trying to find innovative ways of dealing with the current circumstances. It is interesting to note that Australia, in July 2019, introduced a safe harbour to 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 588G of the Corporations Act 2001) provided for. This reform was introduced prior to COVID-19 but has more recently been supplemented with a further relaxation for COVID-19 conditions (see here), again with a view to avoiding premature entry into insolvency proceedings.

Business Debt Hibernation

The new BDH procedure will provide a moratorium on enforcement of debts.

To enter this regime, the first step is for the company to satisfy three qualifying conditions. The first condition is that the company was able to pay its debts as they became due as at 31st December 2019. The second is that atleast 80% of the directors agree to enter BDH and those directors make a statutory declaration setting out their opinions about the company’s liquidity problems arising from COVID-19 and their belief that the company is likely to pay its debts on and after 30th September 2021. The third condition is that the directors are acting in good faith.

Step 2 will be to notify the registrar of companies and the creditors of the company that it plans to enter BDH. The notice sent to creditors must include a high-level description of a proposed arrangement to address the company’s liquidity problems. This notice will immediately trigger a month-long moratorium for pre-existing debts.

Step 3 brings creditors to the table (electronically of course). If a majority in number and value of creditors (excluding creditors related to the company) agree, the moratorium will be extended for another six-month period. 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 pre-existing 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 counterparties 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 could be treated as a ground to terminate contracts.

As it happens Australia also enacted a significant reform in this area prior to the Covid-19. The new position in Australia is that ipso facto clauses in contracts are unenforceable. 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 more generally into the insolvency regime.

Threshold to bring insolvency proceedings

The proposals are silent on the ability of creditors to start insolvency proceedings against a company by making a statutory demand. This is significant because when a creditor makes a statutory demand in relation to a debt due and payable to it and the company does not comply with the demand within 15 working days, there a presumption of insolvency against that company.

Australia, as part of its own Covid-19 measures, has temporarily increased the minimum amount of debt that needs to be outstanding for a creditor to be able to make a statutory demand from AUD 2,000 to AUD 20,000. The time available to a company to respond to a statutory demand has also been extended from 21 days to 6 months in Australia. As Aurelio Gurrea-Martínez has argued, in his recent article, these measures may not be enough to give companies the necessary protection at this time.

In New Zealand the thresholds are already lower than in Australia. A creditor can make a statutory demand when a minimum amount of NZD 1,000 is due and payable, and the time available for the company to comply is 15 days. Yet, no change to these rules has been proposed in the COVID-19 context. This seems unlikely to be an oversight on the part of the government since it has had time to consider responses in other countries. What gives?

Perhaps the idea is that the BDH proposal (which has no analogue in Australia) will provide debtors with all the protection they need.

Debtor-in possession model?

Instead of increasing the threshold for creditors to file a statutory demand, the BDH allows New Zealand companies to proactively confer with creditors and seek a moratorium on its debts. Thus, the New Zealand measures (once enacted) have created a debtor-in-possession model via the BDH regime where the management of the debtor company remains in control and works with creditors to steady the ship. This is the better approach because it allows company management and creditors to work collaboratively. As I’ve argued in other work, the debtor-in-possession model has many advantages even in normal times.

Akshaya Kamalnath is Lecturer in Corporate Law at Auckland University of Technology.