Alert – A ‘Safe Harbour’ for the COVID-19 Storm - What Directors Should Consider
This article has been updated following the publication of the COVID-19 Response (Further Management Measures) Legislation Bill introduced to Parliament on 5 May 2020. This is an omnibus Bill which introduces changes to legislation to enable businesses to more effectively manage the impacts of COVID-19. It endeavours to address the concern that the uncertainty created by the COVID-19 pandemic could lead to numerous companies being placed into liquidation.
The Bill includes temporary amendments to the Companies Act 1993, including provisions.
- adding a safe-harbour for insolvency-related directors’ duties; and
- adding a “business debt hibernation” (BDH) regime to allow companies and other trading entities to enter into agreements with their creditors in relation to existing debt.
These amendments will remain in place until 31 May 2022.
The economic circumstances are evolving rapidly. In anticipation that the legislation will be passed, businesses and their directors should take prompt and appropriate action to deal with any financial difficulties to increase the prospects of turning the company around and avoid administration or liquidation. More importantly, as the ‘safe harbour’ is directed at protecting directors from personal liability for insolvent trading, it is in the directors’ interest to begin considering measures which need to be put in place to trigger safe harbour protection, should that be necessary.
This note highlights a few key factors for directors to consider in this respect. The note also records the key elements of the BDH regime.
Under current legislation, if a company fails its directors may be personally liable for permitting the company to trade recklessly (section 135) and for agreeing to the company entering into obligations that it could not reasonably have been expected to perform (section 136).
Protection from insolvent trading
The Bill introduces a safe harbour protecting directors from personal liability if they decide to continue trading an insolvent company or decide to take on new obligations. The safe harbour provisions apply to a director if, at the time of making the decision, the director, in good faith, is of the opinion that:
- the company has, or in the next 6 months is likely to have, significant liquidity problems;
- the liquidity problems are a result of the effects of COVID-19, and
- it is more likely than not that the company will be able to pay its due debts on and after 30 September 2021.
The Bill sets out factors the director may have regard to when coming to an opinion on the company’s liquidity, which include:
- the likelihood of trading conditions improving; and
- the likelihood of the company reaching a compromise or other arrangement with its creditors.
Companies to which safe harbour protections apply
The safe harbour protections will apply to a company if:
- as at 31 December 2019, the company was able to pay its debts as they became due in the normal course of business; or
- the company was incorporated on or after 1 January 2020 but before 25 March 2020.
The protections do not apply to certain companies, including registered banks and licensed insurers.
Safe harbour period
The initial safe harbour period starts on 3 April 2020 and ends on 30 September 2020, however regulations could be made to extend this period.
PRACTICAL CONSIDERATIONS FOR DIRECTORS
If a company is in financial distress, directors should seek to delay or defer the taking on of any further obligations until they are satisfied that they have considered the need for safe harbour protection. Issues that directors should consider include:
- Was the company able to pay its debts due as at 31 December 2019? The intended protection for insolvent trading over the next six months is only available if the company was solvent on a cashflow basis on 31 December 2019.
- The company’s current financial position and the cash-flow forecasts for the short to medium term - to the extent possible, cashflow forecasts should be prepared for the relevant statutory timeframes (six months and 18 months).
- Does the company qualify/has it applied for any assistance programmes, e.g. the wage subsidy scheme, offered by the Government?
- Is equity support available from current shareholders or new investors?
- What are the company’s financing arrangements, including maturity, covenants and key terms? The directors should consider various scenarios for short and medium-term liquidity and alternative funding arrangements. They should also consider whether the company qualifies/should apply for the Business Finance Guarantee Scheme.
- At this stage of the assessment, directors should obtain professional accounting and legal advice regarding the company’s trading prospects and personal liability risk.
- If the initial assessment and advice points to the likelihood that the company will be able to pay its debts as they fall due within 18 months the directors should consider developing a restructuring plan.
- When implementing the restructuring plan, directors should continually assess whether their chosen course of action is on track. Where necessary, directors should obtain updated professional advice.
- If, having actively engaged with the above issues, directors genuinely feel the situation is hopeless or the plan is no longer capable of being implemented to achieve the desired outcome, then formal insolvency proceedings should be considered.
- The directors should ensure that all the above steps are recorded carefully, and the related information and advice are preserved.
- The existing insurance and indemnity policies, including D&O insurance. Are these up-to-date and adequate?
Notably, the protection provided by the intended safe harbour provisions does not extend beyond protecting a director from civil liability for insolvent trading. Directors must continue to comply with their other duties, for example the duties to act in good faith and the best interests of the company.
The proposed BDH regime is intended to facilitate discussions between directors and creditors with a view to reach agreement on putting the business’ debt into hibernation. This would allow directors to retain control of the company and continue to trade rather than passing control to an insolvency practitioner.
Entering into BDH
The board of an entity may agree to the entity entering into BDH if:
- as at 31 December 2019, the entity was able to pay its debts as they became due;
- at least 80% of the entity’s directors vote in favour of entering BDH;
- each of the directors who votes in favour of entering BDH makes a statutory declaration; and
- each of the directors who vote in favour of entering BDH are acting in good faith.
In making a statutory declaration, the directors must declare they are of the opinion that:
- the entity has, or in the next 6 months is likely to have, significant liquidity problems;
- the liquidity problems are a result of the effects of COVID-19; and
- it is more likely than not that the entity will be able to pay its due debts on 30 September 2021.
Once the board of an entity has agreed to do so, the entity can enter into BDH by:
- delivering a notice to the Registrar; and
- delivering a notice to each known creditor, along with a high-level description of a proposed arrangement to address the entity’s liquidity problems, to be approved by the creditors.
The Bill provides entities in BDH with the following protections:
- a mortgage or other charge over the entity’s property is unenforceable;
- an owner or lessor must not recover property used by the entity;
- a proceeding against the entity in a court or tribunal cannot be begun or continued;
- enforcement processes against the entity in relation to its property are halted;
- a court officer must not take actions under an execution process in relation to the entity’s property, and must deliver to the entity any of the entity’s property in the court officer’s possession under an execution process;
- a guarantee of liability of the entity given by a director, member, or a relative of a director or member, must not be enforced.
To encourage trading with entities in BHD, payments or dispositions of property made by the entity to non-related creditors are exempt from the voidable transactions regime in the Companies Act and Part 6 of the Property Law Act. This protection is subject to the transactions having been entered into in good faith and on arm’s length.
When the BDH protections apply
The BDH protections start to apply when the entity has delivered the notice to the Registrar. These protections will cease to apply after 1 month. However, if the creditors approve the proposed arrangement, the protections will last for a further 6 months.
During this period the directors will be able to:
- assess whether the entity can resume normal trading;
- propose a formal compromise to creditors;
- place the entity into voluntary administration; or
- place the entity into liquidation.
The protections may cease to apply in certain other circumstances, including if the entity fails to comply with the conditions of the creditors’ approval, fails to send new declarations about its situation on request from a creditor, or enters into voluntary administration.
After the initial 1 month period, the BDH protections will not apply in relation to a secured creditor that has a charge over the whole property of the entity. The BDH protections also do not apply in relation to salary or wages owed to employees or to a debt incurred after the entity has delivered notice to the Registrar.
We will carefully follow the intended legislative changes and keep you updated. We trust that our alerts will help companies and creditors alike to navigate the financial distress caused by COVID-19.
Anderson Creagh Lai would be pleased to assist you with any queries you may have about your business’ contractual obligations and help you through this challenging time.
ANDERSON CREAGH LAI LIMITED
Article written by Jeffrey Lai and Mihai Pascariu
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