As the impact of the COVID-19 outbreak continues to play out, companies and their directors are faced with difficult choices about how to respond in an uncertain trading environment.
The Minister of Finance has announced certain temporary changes to the Companies Act 1993 (the Act) to assist companies that are facing insolvency due to COVID-19.
Some key takeaways of the proposed changes are that:
- Some directors duties under the Act will cease to apply if a company trades while insolvent for the next 6 months provided that certain criteria are met including that the company can pay its debts within the next 18 months.
- If half of a company’s creditors agree to an across the board payment proposal, a six month moratorium can be placed on the enforcement of payment of debt by any of the company’s creditors.
The current position under the Act is that directors can be personally liable if they:
- agree to, cause or allow the business of the company to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors (Section 135 (Reckless trading)); or
- agree to the 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 to do so (Section 136 (Duty in relation to obligations)).
These provisions are designed to ensure that directors take steps to reduce the potential losses to creditors once they become aware that there is no longer a reasonable prospect of the company avoiding insolvency. In the uncertain trading environment resulting from COVID-19, these provisions would place a number of directors under pressure to liquidate businesses that were otherwise operating smoothly.
Directors’ decisions to continue trading, as well as decisions to take on new obligations over the next six months will not result in a breach of the duties in section 135 and 136 of the Act, if:
- in the good faith opinion of the directors, the company faces or is likely to face significant liquidity problems in the next six months as a result 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).
The proposed changes aim to give directors facing significant liquidity problems due to COVID-19, a “safe harbour” from the insolvency duties under sections 135 and section 136 of the Act.
The Minister of Finance has emphasised that the “other protections in the Companies Act, such as those addressing serious breaches of the duty to act in good faith and punishing those who dishonestly incur debts, will remain in place”. The suspension of the duties contained in section 135 and 136 should not be viewed as a “get out of jail free” card for any and all actions taken to keep companies operating during the COVID-19 outbreak.
The safe harbour is subject to agreement by Parliament. The Government will ask Parliament that the proposed changes are backdated to 4 April 2020.
Business debt hibernation regime
The Government also proposes to introduce a COVID-19 business debt hibernation regime (BDH regime) to the Act which would allow a company to place a moratorium on debt payments.
The stated intention of the BDH regime is to:
- encourage directors to engage with creditors to arrive at simple arrangements for the management of debt;
- allow the directors to stay in control of their companies;
- provide certainty to creditors that payments will not be clawed back; and
- be simple and flexible so that it can be easily applied to individual circumstances.
The key features of the BDH regime as outlined to date are set out below:
- Directors will be required to meet a threshold test before gaining access to the BDH regime. The details of the threshold test have not yet been provided.
- If the threshold test is met, the directors must notify the creditors of the proposal to place a moratorium on debt payments.
- The creditors will have 1 month from the date they are notified of the proposal (Notification Date) to vote on the proposal. The proposal will proceed if 50% or more of the creditors (by number and value) agree to it.
- A 1 month moratorium on the enforcement of debt will come into effect from the Notification Date and a further 6 month moratorium will apply if the proposal is agreed to by the creditors.
- If the proposal is rejected by the creditors, the directors will still have the range of existing options available to manage debt including continuing to trade or entering into voluntary administration.
- If the proposal is passed, the BDH regime will bind all creditors of the business, other than its employees.
- Crucially, during the moratorium the company is allowed to continue to trade, subject to any restrictions agreed with creditors.
- Any further payments made by the company to creditors will be exempt from the voidable transaction regime. This means that creditors who continue to trade with the company after the entry into the BDH regime will be protected from payments being clawed back if the company is at a later date placed into liquidation (unless those transactions occurred in bad faith).
- The BDH regime will be available to all forms of entities with legal personality as well as other entities such as trusts and partnerships, but will not be available to licensed insurers, registered banks and non-bank deposit takers and sole-traders.
For more information on the safe harbour and the BDH regime and how these changes may apply to your particular circumstances, please feel free to contact our Commercial Team.