Temporary insolvency relief - article

Temporary insolvency relief for directors and organisations

The government has announced a temporary insolvency package to assist directors and organisations in responding to challenges created by COVID-19. We provide an overview of the relief below.

A temporary safe harbour for directors

When a company is insolvent or approaching insolvency, directors need to consider the interests of creditors as part of their duties under the Companies Act 1993. The risk of personal liability for directors is heightened at this time.

Sections 135 and 136 of the Companies Act provide respectively:

Duty not to trade recklessly: Directors must not agree to, cause or allow the business to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors
Duty not to agree to a company incurring inappropriate obligations: Directors must not agree to a company incurring an obligation unless they believe at the time on reasonable grounds that the company will be able to perform the obligation when it is required.

A key issue at present is the significant uncertainty with events surrounding COVID-19. To help provide more certainty for directors in complying with their duties, the government has announced that it will introduce a ‘safe harbour’ for directors.

The essence of the safe harbour will be that that directors’ decisions over the next six months to keep on trading (and decisions to take on new obligations) will not result in a breach of the above duties if:

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 them or their creditors;
the company was able to pay its debts as they fell due on 31 December 2019; and
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 within 18 months (for example, because trading conditions are likely to improve or they are likely to be able to reach an agreement with their creditors).

Subject to Parliament’s approval, the safe harbour will be backdated to the date of the government’s announcement (3 April 2020).

Directors will still be expected to exercise reasonable care, diligence and skill and act in good faith and in the best interests of the company (which includes taking into account creditors’ interests around insolvency). See also Directors’ Duties section 4.2 in The Four Pillars of Governance Best Practice

A business debt hibernation regime

A new temporary regime will be introduced into the Companies Act to enable businesses affected by COVID-19 to place existing debts into hibernation (ie a moratorium on the payment of debts). A key purpose of the regime is to encourage directors to talk with their creditors with a view to concluding an agreement that would enable the business to continue to trade. The regime would also allow for directors to retain control of the company rather than passing control to an insolvency practitioner. The regime is expected to include the following features:

there will be a threshold to access the regime (eg the organisation will need to have been solvent prior to COVID-19 among other things)*
a proposal will need to be put to creditors. Creditors will have a month to vote on it and fifty per cent (by number and value) need to agree
there will be a one month moratorium on the enforcement of debts from the date the proposal is put to creditors, and a further six months if the proposal is passed
this would be binding on all creditors (other than the entity’s employees) and would be subject to any conditions agreed with creditors
if the creditors reject the proposal, the existing insolvency options under the Companies Act are available (eg voluntary administration and liquidation).

It is 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, subject to the following conditions:

this would not extend to a related party transaction
a transaction must have been entered into in good faith by both parties, on arm’s length terms and without the intent to deprive the existing creditors of the company.

The regime is expected to be available to all forms of entities (including incorporated societies and partnerships) but not for licensed insurers, registered banks, non-bank deposit takers, and sole traders (which have other options).

Other relevant changes include:

Voidable transactions: The period of vulnerability under the voidable transactions regime will be reduced from two years to six months (where the debtor company and the creditor are unrelated parties).

Extending statutory deadlines: Some statutory deadlines (eg for holding AGMs, and filing annual returns) will be relaxed, including for companies, limited partnerships, incorporated societies, charitable trusts and other entities.

Non-compliance with entity constitutions: There will also be temporary relief for entities that are unable to comply with obligations in their constitutions or rules because of the impacts of COVID-19. And entities will be able to use electronic communications (including electronic meetings) even if their constitutions or rules do not cover this.

The government will be providing more details on the above package in the next few weeks and we will keep members updated.

*The threshold for the Business Debt Hibernation regime is yet to be finalised.