Story Richard Gordon and Ashley Kirk

Temporary “safe harbour” measures are offering company directors in NZ a reprieve from insolvent and reckless trading restrictions. The move aims to give directors the necessary confidence to ride out the COVID-19 storm, thereby supporting the New Zealand economy, without personal liability hanging over them.

What has changed for directors’ duties in New Zealand?

Under sections 135 and 136 of the Companies Act 1993 (the Act), a director of a company must not engage in reckless trading or incur any obligation unless they believe the company will be able to perform the obligation when required to do so. If directors are found to be in breach of either of these provisions, the usual protection afforded by limited liability can be seriously compromised.

In particular, in the course of a company’s liquidation, a liquidator, creditor or a shareholder of the company can bring an action seeking compensation against directors personally for breaches of these (and other) directors’ duties.

The COVID-19 Response (Further Management Measures) Legislation Act 2020 amends the Act to establish a “safe harbour” that protects directors from liability.

When do the safe harbour provisions apply?

The safe harbour provides that, in certain circumstances, decisions by a director to keep a company trading, as well as any decisions to take on new obligations, for an initial period from 3 April 2020 until 30 September 2020, will not result in a breach of sections 135 and 136 of the Companies Act 1993.

The safe harbour will apply if:

• in the good faith opinion of the directors, the company is facing (or is likely to face in the next six months) significant liquidity problems as a result of the impact of the COVID-19 pandemic; and
• the company was able to pay its debts as they fell due in the normal course of business 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 on and after 30 September 2021 (for example, because trading conditions are likely to improve, or they are likely to be able reach an accommodation with their creditors).

Why has the safe harbour been put in place?

The COVID-19 pandemic has brought with it a period of great uncertainty. The safe harbour provisions are designed to provide increased flexibility to directors in dealing with this uncertainty and support businesses to trade through the effects of COVID-19.

This gives directors comfort that if the company takes business risks but is unable to weather the storm, they will not be exposed to personal liability that they might ordinarily be exposed to.

Looking at the broader picture, without this type of intervention many more businesses may be shut down as a result of the COVID-19 pandemic.

For the New Zealand economy to recover in the best possible shape, it is important that as many businesses as possible survive. The safe harbour will be an important part of ensuring economic recovery is given the best possible chance of success.

Picture: Richard Gordon.

“For the New Zealand economy to recover in the best possible shape, it is important that as many businesses as possible survive.”

What does the safe harbour mean in practice?

While the safe harbour provides some relief, it is not a free pass for directors. Directors still need to be mindful of their other directors’ duties, including the duty to act in good faith and in the best interests of the company, and their other obligations under the Act.

The safe harbour is only a temporary measure intended to respond to the immediate impacts of the COVID-19 crisis. The pre-conditions ought to mitigate against misuse.

The safe harbour only applies to directors of companies who were able to pay their debts as they fell due on 31 December 2019, differentiating between businesses that were struggling before COVID-19 and businesses who are suffering because of the pandemic.

It would be extremely risky indeed for a company that was sailing close to the wind in 2019 to use the safe harbour provisions as a way to continue with what may later be considered reckless trading.

Additionally, directors still need to believe, in good faith, that the company will be able to pay its debts as they fall due within the next 18 months. That will not necessarily be a straightforward calculation. Therefore, despite the uncertainty created by COVID-19, directors need to have confidence that the company will be able to trade out of any liquidity problems in the near future

What’s happening in other countries

Governments across the world have been faced with providing timely assistance to businesses to help them survive the effects of the COVID-19 lockdowns.

In enacting a safe harbour for directors, New Zealand has aligned itself with the likes of Australia, which enacted a temporary six-month COVID-19 safe harbour providing protection for directors from the duty to prevent insolvent trading, and the United Kingdom, where a three-month suspension on the rules relating to ‘wrongful trading’ was put in place.

Picture: Ashley Kirk.

New provisions strike a good balance

Introducing the safe harbour is a positive step towards helping directors of viable businesses navigate the uncertainty of COVID-19. Many businesses will face difficult decisions in their response to the current crisis and, while directors need to remain mindful of their wider obligations, the safe harbour provisions should provide confidence for directors seeking to trade through its effects.

The new measures aim to, and should, provide a balance between allowing necessary business risks to be taken, while the pre-conditions afford protection to creditors, particularly from any misuse of the new provisions.

Richard Gordon is a RITANZ (Restructuring, Insolvency and Turnaround Association of New Zealand) board member and partner in dispute resolution and litigation at MinterEllisonRuddWatts.

Ashley Kirk is a senior lawyer in dispute resolution at MinterEllisonRuddWatts in Wellington.

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