Help for NZ businesses facing insolvency – with strings

This article was current at the time of publication.

On 15 May 2020 in New Zealand the COVID-19 Response (Further Management Measures) Legislation Act 2020 became law, meaning two key measures aimed at addressing the serious insolvency risks arising from the COVID-19 crisis – the “safe harbour” regime and “debt hibernation scheme” – are now in effect.

The temporary safe harbour provision and business debt hibernation initiative can help businesses struggling with the impact of COVID-19 to continue trading, but they are not a "get out of jail free card", advisers caution.

It is a point Minister of Finance Grant Robertson underscored when he announced the measures.

“While they will help increase certainty and provide practical assistance to business owners and directors, the changes must not be seen as a workaround for obligations to creditors and the responsibility of directors to act in good faith,” Robertson said.

The new provisions aim to ease the pressure on directors who may otherwise feel the need to wind up their business owing to the economic climate, the New Zealand Companies Office notes.

In normal circumstances, directors must abide by sections 135 and 136 of the Companies Act, which states they must not run the business in a way that is “likely to create a substantial risk of serious loss to the company’s creditors” and can only incur debt if the directors believe the company will be able to meet its required [obligations].

A limited window

The newly created safe harbour provides that decisions by a director to keep trading from 3 April 2020 until 30 September 2020 without breaching those sections of the Companies Act, providing they believe the company is facing or will face “significant liquidity problems” as a result of the COVID-19 pandemic and that they believe the company will be able to pay its debts as they fall due after 30 September 2021.

The entity also had to be solvent as of 31 December last year for directors to take advantage of the provision.

The second measure, the business debt hibernation scheme, allows businesses affected by COVID-19 to place their existing debts on hold for up to seven months to help them trade normally again, rather than enter processes such as liquidation.

However, at least half of the business’s creditors must agree to the arrangement. During debt hibernation, it can continue to trade, subject to any restrictions agreed with creditors, the Companies Office notes.

Safe harbour is no free ticket

Sean Gollin, a dispute resolution and litigation partner at Minter Ellison Rudd Watts, warns the safe harbour provision isn’t a “get out of jail free card” for directors until September 2021.

“They do need to turn their mind to whether or not, in good faith, they honestly believe that it’s more likely than not that the company will be able to turn its fortunes around by that stage,” Gollin says.

Notably, the provision does not require the company to keep trading. Directors can still agree on an alternative arrangement with creditors.

“What we’ve said to the director community is you can’t just set and forget this, incur an obligation now, thinking you meet the criteria for safe harbour and you’ll be fine – then not follow through with making sure that you try to turn the company’s fortunes around,” Gollin says.

The onus is on accountability

Directors seeking to invoke the provision need to document the reasoning behind their views as to the applicability of the provisions.

“If they are making a decision in good faith, what’s the basis on which they’re forming that view?” Gollin says.

“[Further] are they [going to ensure] that they properly record that and make sure the information they’re basing that assessment on is as robust as it possibly can be in the circumstances?”

He says bank loans are not subject to the business debt hibernation scheme, so businesses need to engage early with their banks to ensure they are onside.

“In terms of those businesses that are looking to invoke the business debt hibernation regime, again, it’s making sure that they’re properly focused on whether there are reasonable prospects for the business to be able to come right in the end, even if that’s through doing a deal with creditors to achieve a more permanent solution,” he says.

Three key principles for safe harbour and debt hibernation schemes

Colin Gower, national leader of business recovery and insolvency at BDO NZ, says there are three main principles for directors wanting to use the safe harbour and business debt hibernation schemes – transparency, communication, and alignment.

“Basically, you’ve got transparency around your financial position with key stakeholders, communicate your strategy effectively, and ensure that shareholders and other stakeholders are actually aligned,” Gower says.

“It's about understanding cash flow, having a plan, understanding the levers of your business and basically what steps you need to take in making sure you have buy-in with your stakeholders – especially fellow shareholders – so everyone’s on the same [page] and understands what needs to be done.”

He says the uptake of the business debt hibernation scheme has been “very, very limited”.

As mentioned, businesses facing insolvency or liquidity issues wanting to use the scheme would have to convince creditors they will be able to pay back the debts they have already incurred and will incur at a later date before the scheme expires.

They also need to be able to pay back creditors as and when they fall due for debts to run up after the scheme expires.

As Gower explains: “For them to be able to generate enough free cash to pay creditors going forward as and when they fall due, and pay all creditors in six months, is a big ask post-COVID-19.

“We’ve got to be very, very careful that we’re just not kicking the can down the road, and [that] at some point there’s going to be a tsunami of business failures.”

Apart from a few specific sectors, such as tourism, for example, most businesses have been able to continue with the help of the government’s wage subsidy, and so haven’t yet needed the scheme, but as Gower warns, that might change come September when the wage subsidies end.