Business Debt Hibernation
The Business Debt Hibernation Scheme is a new Government initiative introduced to soften the COVID-19 impact on business. It allows for businesses which are facing serious cashflow problems due to COVID-19 to get relief from payments owing to creditors until they can start trading again.
The protection provides for a standstill period in which all creditors, other than general security agreement (GSA) holders, are prevented from taking individual debt enforcement actions. The scheme provides two different stages of statutory protection.
Firstly, the scheme grants an initial one-month period of protection from creditors' claims, to allow for the arrangement to be set up. This is automatically triggered when the company delivers the required notice to the Companies Office informing it that it wishes to put this scheme in place (which must be approved by 80% of directors in the case of a company).
During this time, the applicant is required to present a payment plan for the business going forward to its creditors. While the payment plan should outline deferring payments, it does not allow for debts to be cancelled either partly or fully.
If 50% of the creditors (by number and value) approve the approve the arrangement, it will bind most of the business’s creditors and the statutory protection period will be extended for an additional six months.
To be eligible, the board (or equivalent) must approve the company’s entry into the scheme and ensure:
- The business was solvent as at 31 December 2019;
- 80% of directors vote in favour of the process;
- The board in good faith resolves that:
- the business has or is going to have liquidity problems;
- the liquidity problems are the result of COVID-19’s effects on the business; and
- the business will be able to pay its due debts on and after 30 September 2021.
It is important to note that wages, salaries, and relevant deductions (Kiwisaver, student loans, and child support) cannot be hibernated in under this scheme.
How does the relief work?
As a rule, creditors must not during the protection period:
- enforce any mortgage or other securities over the entity’s property;
- take possession of the business’s property or recover property used by it;
- start or continue court proceedings against the business;
- start any debt enforcement processes can be commenced by creditors; or
- enforce any personal guarantee given by company directors, shareholders or related parties.
However, if a creditor has a GSA over all (or most of) a business’s assets (often this is a bank), the scheme does not restrict them from taking steps to enforce their security against the business. As such, for this scheme to be an option in practice, it needs to be clear that the GSA holder does not intend to take enforcement action within the protection period.
To put the scheme in place, we recommend a business works with us to develop a business plan, including a plan for the repayment of the debt it owes to its creditors. This plan must then be put forward to the creditors who are entitled to five working days to consider it before voting on it.
Further, several formal declarations and legal documents are required, and statutory processes need to be followed to put this debt hibernation scheme in place. If you think utilising this scheme may be a good option for your business or would like to know how to get started, please get in touch with one of our Insolvency Team members (contact details below).
Other Insolvency Options
Below we summarise other corporate insolvency options.
This formal process is used by companies that have the potential to be returned to a solvent state. It is used by companies which are insolvent (or near insolvent) but still have a business or assets of value. The affairs of the company are frozen to allow for an administrator to look to restructure the company’s affairs, sell assets or compromise with creditors.
To appoint an administrator the board of directors or equivalent must pass a resolution appointing the relevant insolvency practitioner. In some cases, a business may be placed into voluntary administration by a liquidator, secured creditor, or by application to the Court.
Voluntary administration provides breathing space to allow an administrator to formulate and execute a substantial restructuring plan. Typically, a binding compromise is reached with creditors and control of the company is given back to the directors or the company is placed in liquidation.
This process is almost always initiated by through a GSA (by the “GSA holder”), which is most often a bank. This allows the bank (or GSA holder) to appoint a receiver.
A receiver is able to either continue to trade or sell the company. The receiver’s primary duty is to the GSA holder and while it has a general duty to ensure that any sale of company assets is for reasonable value, its job is primarily to make sure the GSA holder gets repaid.
Receivership is usually terminal to a company and is likely there will be no business assets at the end of the process.
A liquidation is a formal process used where a company has no prospect of being rehabilitated. A company may be placed into liquidation by the passing of a special resolution (75% or a higher majority if the company constitution requires it) of its shareholders or by the court after a creditor’s application.
An insolvent liquidation is the most destructive process to a business’ value and is unlikely to return any value to shareholders.
While the appointed liquidator’s primary duty is to take possession of and sell assets for the benefit of the company’s creditors, a liquidator will also call a creditors meeting (if it considers it useful), investigate the affairs of the company and the governance of the directors and report any criminal activity.
The purpose of a creditor’s compromise is to give creditors more than what they would if the company was put into liquidation.
A creditor’s compromise often occurs when a company is not necessarily insolvent, but it can foresee liquidity issues arising. It is usually proposed by directors to keep the company operating. The goal here is for a company to reach an agreement with its creditors to pay them less than the full amount owing or to pay the debt over an extended period.
The compromise is submitted to a meeting of creditors and will take effect if it is approved by creditors holding 75% of the monetary value of the company’s debt. In contrast, we note the creditor approval threshold in Government’s new debt hibernation scheme is lower at only requiring 50% of creditor (in number and value) approval.
The compromise is binding on all creditors and prevents them from applying to the High Court for the company to be liquidated.
Trading a company whilst it is insolvent places the company’s creditors at serious risk (as if their debts are not paid, they may become insolvent). Although directors may want to be optimistic about a company’s future there is a risk that if they continue to let their company trade while insolvent, they will be held personally liable.
While the Government has also introduced a temporary amendment called the “Safe Harbour Regime” to the Companies Act to allow directors to keep trading and not breach the Act if they do so, it is important to note that this regime does not provide a blanket exception to insolvent trading. This amendment is not designed to support an entity that has no realistic prospect of continuing to trade.
Where this regime may be useful is, if the directors can in good faith, resolve that the impact on their business is:
1. as a result of the COVID-19 pandemic;
2. the company was able to pay its debts as they fell due on 31 December 2019;
3. it is more likely than not that the company will be able to pay its debts as they fall due within 18 months.
It is also important that directors further understand that the Companies Act prescribes the order of which creditors and shareholders are paid from the company’s assets. This can be a complicated area of law and failing to consider the relevant priorities may lead to a liquidator later having recourse against the recipient of the funds, or directors.
Get In Touch
If you are a director of a business which is facing potential insolvency, please contact us if you wish to discuss your options. Business owners should obtain advice early to increase the chance of a positive outcome. In insolvency situations it is important to be aware that there are statutory timeframes and processes that need to be followed and we recommend that being proactive is the best approach.
Please get in touch with one of our Insolvency Team lawyers if you would like to discuss the matters set out in this article.