On 3 April 2020, the Government announced further proposed changes to legislation in light of COVID 19, this time in relation to duties under the Companies Act.
While the specific form of the legislation is yet to be introduced, the key changes are:
- A “safe harbour” from insolvency duties for directors of companies that are facing significant liquidity issues because of COVID-19; and
- A debt hibernation provision to allow businesses impacted by COVID-19 to put existing debts into hibernation.
The intent of these changes is to help provide some certainty and practical assistance to business owners, and should not be seen as way to get around obligations to creditors. Other protections will remain in place, including those around serious breaches of good faith.
Safe Harbour Provision
Under the Companies Act, directors have a number of duties that they must comply with. In particular:
- A director must not agree, cause or allow the business of the company to be carried out in a manner likely to create a serious risk of substantial risk to the company’s creditors (section 135, Reckless Trading); and
- A director must not agree to a 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 (section 136).
These duties are likely to cause some real issues for companies and directors of companies that are facing liquidity issues because of COVID-19. Because of the potential for personal liability, directors are likely to act in a risk averse way and companies that would otherwise be solvent may well be liquidated. For this reason, the Government has proposed a “safe harbour”.
The proposed “safe harbour” would provide protection for directors who take on obligations or decide to continue trading over the next six month, providing 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 or its creditors;
- The company was able to pay its debts as they fell due as at 31 December 2019;
- In the good faith opinion of the directors, it is more likely than not that the company will be able to pay its debts as they fall due within 18 months (e.g. because trading conditions are likely to improve or they are likely to be able to reach an accommodation with creditors).
Key protections and duties under the Act in relation to the dishonest incurring of debts and addressing serious breaches of the duty of good faith will remain in place.
These changes are subject to the approval of Parliament. If approved as suggested, they will also have retrospective effect, backdated to 3 April 2020.
Debt hibernation would allow companies to enter into a moratorium on the payment of debts.
In order to place a company into a debt hibernation, the directors will need to consider whether the company reaches a threshold test. The details of this threshold test have yet to be spelled out.
If the directors consider that the threshold is met, they will need to notify creditors that they are seeking a six month moratorium. Creditors will be able to vote, and if 50% of creditors (by number and by value) agree to the moratorium, they company will be placed into debt hibernation. The company will be able to continue to trade and any payments during the moratorium will be exempt from the voidable transactions regime provided that:
- They were entered into in good faith;
- They were arm’s length transactions; and
- The transactions were not intending to deprive existing creditors.
This scheme should provide directors with some confidence going forward to be able to trade through the current environment.
The legislation to formalise these changes has not yet been introduced to Parliament, so it remains to be seen how some of the more specific mechanics will operate. Any changes to legislation are also subject to the approval of Parliament and it is possible that the final form of the legislation may be different to what has been proposed.