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help for startups in financial difficulty during covid-19

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Update as at 24 July 2020: 

Since this blog first went up in April 2020, legislation has been passed putting into effect the safe harbour measure described in the original blog.  A safe harbour is available to directors who may otherwise be at risk of being found personally liable for keeping a company trading between 3 April 2020 and 30 September 2020, and incurring further obligations (debt) while doing so.  The safe harbour only applies if:

  • as at 31 December 2019, the company was able to pay its debts as they fell due (or the company was incorporated between 1 January 2020 and 3 April 2020);
  • the directors believe in good faith that the company is facing, or is likely to face, significant liquidity problems in the next 6 months due to the impact of covid-19 on the business itself or the business’ creditors; and
  • the directors believe 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.  In making this call, directors may take into account any matters they consider relevant, including the likelihood of trading conditions improving, and the likelihood of the company reaching a compromise or other arrangement with its creditors.

The legislation allows for that initial safe harbour period of 3 April 2020 to 30 September 2020 to be extended to 31 March 2021 under further regulations, if necessary.

The points below, from our original April blog, continue to be relevant.  In particular:

  • the safe harbour is not intended to enable a company to continue trading where it has no realistic prospect of continuing to trade or operate in the medium or long term; and
  • these changes aren’t carte blanche to disregard directors’ duties under NZ law during the safe harbour period.  Directors’ overriding duty to act in good faith and in the best interests of the company will continue to apply, as will other protections in the Companies Act punishing directors who dishonestly incur company debts.

One final point – the legislation places the burden of proof on directors to show, if necessary, that the safe harbour applies to shield them from liability if a claim is brought against them.  With that in mind, we recommend directors check in regularly, and in detail, with their companies and keep records of their decision-making throughout the safe harbour period.

…….

The NZ Government will be introducing legislation to Parliament shortly to make it easier for companies who have been hit with the effects of covid-19 to keep trading long enough to outlast the disruption. Whilst these measures apply to all NZ businesses, these changes are particularly welcome for startups who will face significant cashflow issues over the coming months as investment activity slows down.

The two headline changes are:

  • a safe harbour from insolvency duties for directors of companies facing significant liquidity problems because of covid-19, and
  • an existing debts hibernation option.

In this blog we focus on the first change – the safe harbour from directors’ insolvency duties.  A short, practical summary of what the safe harbor means for you as a director follows below.

(Click here to go to all our covid-19 related content on our blog.)

what’s the risk being addressed here?

Any director of a startup will be familiar with the question – is this company viable?  The answer lies in the balance between the company’s trading prospects and ability to raise further capital if/when needed, and the expenses and other liabilities involved in continuing to trade.

Under the Companies Act, directors are subject to two specific duties that speak directly to that balancing act:

  • directors must not allow the company’s business to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors, and
  • directors must not agree to the company incurring an obligation unless, at the time the transaction is entered into, the director believes on reasonable grounds that the company will be able to perform the obligation when required to do so.

If directors are found to have breached either of those two duties, they can be held personally liable for some or all of the company’s debts.

what do we mean by “safe harbour”?

Briefly – protection for directors against the risk of being held personally liable for the company’s debts, in specific circumstances.

Under the proposed safe harbour, directors will not be held personally liable for keeping a company trading, and incurring further debt while doing so, over the next 6 months as long as all 3 of the following apply:

  • the directors believe in good faith that the company is facing, or is likely to face, significant liquidity problems in the next 6 months due to the impact of covid-19 on the business itself or the business’ creditors
  • the company was able to pay its debts as they fell due on 31 December 2019, and
  • the directors believe 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 the next 18 months.

why is the safe harbour important?

The prospect of being held personally liable for debts incurred by a company is scary.  Particularly for directors who may already be facing uncertainty in their own personal finances due to covid-19.  Also, the rules apply to all directors, including investor directors often appointed to the boards of startups.

Faced with the question of whether or not to continue to running a business whose liquidity has become significantly jeopardised due to the impact of covid-19, it’s reasonable to assume that many directors will make the choice to put the business into liquidation if the alternative exposes them to being held personally liable for the company’s debts. 

The Government’s proposed change will remove directors’ personal liability as a deciding factor.  If directors make the call to continue trading, they won’t personally be responsible for the company’s debts as long as they believe in good faith that their company has a chance to survive covid-19.  Directors will be more inclined to continue trading for a while longer, retaining staff and looking for opportunities to pivot or otherwise weather the storm.

am I ok to start taking this approach before the amendments have been formally adopted by Parliament?

We recommend taking a cautiously optimistic approach.  The new rules will apply retrospectively from the date of announcement (Friday 3 April) but there is always the risk that the final detail won’t reflect the big picture announcements made.

If you’re a director, give some thought to whether the safe harbour criteria would apply to your company if you were making the call today.  If you think the safe harbour would apply, and if your other directors agree (if you have any), then we hope the Government’s announcement gives you some confidence to continue trading, even for the short term until the final detail of these proposed changes becomes clear.

I’m a director of a company and this sounds great – what do I need to remain wary of?

Two things:

  1. directors’ duties and obligations that continue to apply, and
  2. the fact that the safe harbour is only available if your business was otherwise viable before covid-19 came along.

These changes aren’t carte blanche to disregard directors’ duties under NZ law over the next 6 months.  Directors’ overriding duty to act in good faith and in the best interests of the company will continue to apply, as will other protections in the Companies Act punishing directors who dishonestly incur company debts.

These changes are also designed to specifically target companies that have suffered as a direct result of covid-19.  If your business was facing liquidity issues before covid-19, the proposed safe harbour won’t help you.

To paraphrase Finance Minister Grant Robertson – if your business was a good, functioning, solvent business going into covid-19, it should be able to be a good, functioning solvent business coming out of it.  We hope that turns out to be true, and we welcome the proposed changes as a small step to help protect NZ’s startup ecosystem.

Get in touch if you would like further information on this topic.

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