The Government has recently passed temporary legislation to help companies facing cashflow difficulties due to COVID-19. There are new protections for directors from normal solvency related duties and businesses can place certain debts into ‘hibernation’ while continuing to trade. These supplement the more traditional options available to businesses facing solvency issues.
Directors are usually subject to the following duties under the Companies Act 1993:
Reckless Trading: A director must not agree to 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.
Duty in relation to obligations: A director must not allow the business incurring 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.
In the normal course of events, directors who are found to have breached those duties can face personal liability. To protect directors from such claims between 3 April 2020 and 30 September 2020 (this may be extended), directors may rely on “safe harbour” provisions where:
1. 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 debtors or its creditors;
2. the company was able to pay its debts as they fell due on 31 December 2019 (or was first incorporated between 1 January 2020 and 25 March 2020); and
3. 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.
These provisions may assist directors to carry more risk than they may otherwise be comfortable with – thereby preventing them putting an otherwise viable company into liquidation. However, it is more important than ever that directors have accurate and current financial information, both for past performance and future projections. We note that there are no changes to director’s duties to act in good faith and to exercise the care, diligence and skill that a reasonable director would exercise in the same circumstances.
The temporary Business Debt Hibernation (BDH) regime creates another option to help businesses keep trading, despite cashflow pressures. The BDH scheme puts a one month freeze on the enforcement of debts during the proposal process. A further six months ‘hibernation’ will be available if the proposal is passed.
A process will need to be followed to put a BDH scheme in place; it is not automatic. The business will need to meet a certain threshold, put a proposal to their creditors and obtain agreement from 50% (by number and value) of those creditors within a month.
While an entity is in BDH, it will be able to continue to trade, subject to any restrictions agreed with creditors. Certain debts cannot be hibernated, including debts to the IRD and employment related debts and (for the six months) certain secured creditors. Otherwise, BDH will apply to all creditors regardless of whether they voted for the proposal or not.
To encourage businesses to continue to transact, new payments or dispositions of property are exempt from the voidable transactions regime (unless it is to a related party) while a business is in BDH. However, transactions will still need to be entered into in good faith by both parties, on arm’s length terms and without intent to deprive existing creditors of the company.
Many businesses will be eligible for BDH, including companies, trusts and partnerships. However, sole traders, licensed insurers, registered banks and non-bank deposit takers are exempt.
Due to the complexity in the legislation, and their novelty, obtaining legal advice before relying on these announcements is crucial. This is not a situation where DIY is appropriate; failure to comply can have a significant impact (e.g. there are a number of areas where a director placing a business in BDH can inadvertently commit an offence by not following the specific steps required).
Additionally, while this legislation is new, solvency issues aren’t. There are other options available, which may provide a better long term solution for you and your creditors. Tailored advice will identify the best option for your situation.
Pitt & Moore Lawyers can provide tailored advice and assist businesses worried about solvency issues.
Disclaimer: The information contained in this publication is of a general nature and is not intended as legal advice. It is important that you seek legal advice that is specific to your circumstances.