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Key points
•Directors in New Zealand owe duties to ensure that their company does not trade recklessly, and does not incur obligations unless the director reasonably believes that they can be paid when due.
•These duties continue to apply during the COVID-19 pandemic and government lockdown.
•Overseas jurisdictions, including Australia and the United Kingdom, have suspended parts of their equivalent laws. They have also made it more difficult for creditors to enforce debts.
•New Zealand has not yet adopted similar reform, although the government has announced that it is under review.
•In our view, the government is right to consider whether we should be amending our laws for the lockdown. However, any such reform will need to balance the need to give directors comfort that they can continue to trade in these extraordinary times, against creditors' interests in not being unduly exposed to insolvency risks.
New Zealand directors' duties
As the COVID-19 lockdown unfolds, businesses in New Zealand and around the world are faced with difficult choices about how to respond to the challenging trading conditions. Directors in particular are dealing with challenges that none would have predicted only a few months before. In many cases, they are facing both uniquely difficult trading conditions outside of their control, and unprecedented uncertainty about how long they will continue. For many, this puts a particular focus on the directors' duties that apply in insolvency contexts. In particular:
•Reckless trading: The duty not to trade recklessly prohibits directors from operating in a way that poses an unreasonable risk to existing creditors. Directors can breach this duty by unreasonably continuing to trade in a way that reduces the money available to creditors, compared to an immediate liquidation (which will usually be the effect of trading while insolvent).
•The duty in respect of obligations: The duty in relation to obligations prohibits directors from allowing the company to incur liabilities without a reasonable basis to believe that they can be paid when due. This duty affects new obligations, including (for example) decisions to obtain overdrafts or to continue to incur operating expenses in circumstances where the future of the business is uncertain.
These duties require directors to make a realistic assessment of the solvency of the company, and of its future prospects. Directors must do their best to assess the value of the company's cashflow and the availability of credit, as well as the value of its accounts receivable, inventory and other key assets, and potentially the solvency of its suppliers. All of this can be difficult in circumstances as challenging as the current lockdown. Bell Gully's summary of the key steps and protections for directors in this period can be accessed here.
These duties are intended to strike a balance between the need to allow directors to take reasonable business risks, and the need to allow creditors to enforce debts and to protect creditors against the risk of being unreasonably exposed to debts that cannot be paid. Although there have been high profile examples of directors falling foul of these duties (see our article on the Mainzeal case), the Court of Appeal has also recently confirmed that the duties must not be assessed with the benefit of hindsight, and that directors should be able to take risks that are sensible in the circumstances. The difficulty for directors is in predicting how much leeway will be allowed in circumstances that are as unpredictable and challenging as the current lockdown.
Overseas relief
Several overseas jurisdictions have responded to these challenges by easing their reckless trading laws. For example:
•In the United Kingdom, the Business Secretary has announced that wrongful trading provisions will be temporarily suspended for three months (and with retrospective effect) so that business can continue without the threat of personal liability to directors.
•Australia has extended safe-harbour provisions, which protect directors from personal liability. This will allow companies to continue to incur debts in the ordinary course of business for the next six months from 25 March 2020, without directors facing personal liability.
Both the United Kingdom and Australia have also made changes restricting the ability of creditors to serve statutory demands and to apply to put defaulting companies in liquidation.
These changes are intended to give directors the space to trade through the COVID-19 crisis, without risking personal liability for reckless trading. They are also intended to prevent a “domino effect" of enforcement actions against companies whose trading is impaired by the crisis. While they are likely to have the intended effect, they are also likely to increase the risk for both existing and future creditors of companies.
New Zealand's response
The law in New Zealand allows directors significant scope to take reasonable business risks. Nevertheless, directors may consider that the potentially severe consequences for breaching their statutory duties mean that it is safer to make cuts quickly, or even cease trading altogether, rather than to incur additional obligations and try to weather the storm. This may lead to a worse outcome overall than a temporary relaxing of directors' duties.
The government should carefully examine these laws and consider following Australia and the United Kingdom's example in order to get us through this crisis. Any such solution will need to balance the interests of both creditors and directors. If we do not get the balance right, we risk worse outcomes overall in the long term.
If you have any questions about the matters raised in this article please get in touch with the contacts listed, or your usual Bell Gully advisor.