Up Again New Zealand: Governance

Corporate

1. What are the key topics that boards should focus on to ensure proper discharge of their duties as directors, as their businesses return to work following a lockdown?

The key issues boards need to be aware of are solvency and the health and safety of their employees. Revenue is likely to be materially reduced for a significant period of time and debts may not be paid through supplier failures. There is a real risk that directors could be held personally liable for these risks if they do not take sufficient steps to properly discharge their duties during this return-to-business period.

The New Zealand government and other regulatory agencies have introduced a range of measures to help businesses to respond to COVID-19. For any business seeking to rely on these measures their boards need to be vigilant that their business is complying with the strict requirements of the measures, including being aware of time limits on temporary measures in place and other legal and regulatory obligations, for example regarding statutory filings and relaxation of certain aspects of the listed company regime.

On 5 May 2020, the New Zealand government introduced the COVID-19 Response (Further Management Measures) Legislation Bill to Parliament, which is now being considered urgently. The most significant measure is changes to insolvency and corporate law to increase the prospects of businesses surviving the COVID-19 response.

These include:

  • Adding a “business debt hibernation” regime to allow companies and other entities to enter into agreements with their creditors regarding existing debt.
  • Adding a safe harbour for insolvency-related directors' duties.
  • Extending statutory deadlines.
  • Enabling Registrars to issue exemption notices regarding compliance with statutory obligations.
  • Providing relief for entities that cannot comply with rules in their constitutions because of COVID-19.

The threshold to enter the business debt hibernation regime is not simple. Debts incurred on or after the date on which notice is given to the Registrar to rely on the regime (and all interest accrued thereon), employee wages/salaries, Kiwisaver and any other amounts withheld from an employee’s wages/salary are all excluded from the scope of the regime, and remain payable as they fall due. The business debt hibernation regime does not extend to a creditor with security over the whole, or substantially the whole, of the entity’s property. Nothing in the Bill extends to a restriction on enforcement of a personal guarantee. It should be noted that any failure by a board of directors to comply with the requirements of the business debt hibernation regime is liable on conviction to a fine of no more than NZD10,000.

The NZX has issued extra guidance for listed companies during the COVID-19 crisis. The obligation to disclose material information promptly and without delay is always in the forefront of directors’ minds, to ensure that there is no information asymmetry in the market. The NZX notes that many issuers have revised or withdrawn previous financial forecasts or projections in light of COVID-19 developments, but the market should be able to assume that remaining or new forecasts remain valid. Continuous disclosure is of vital importance as directors can be personally liable for losses that result from breaches of the listing rules. These may be substantial, and reputational damage severe. Information not made available to the market concerning prospects, profit and earnings can have major consequences.

Given Recommendation 6.1 of the NZX Corporate Governance Code, most issuers should already have a robust risk management framework in place. But the COVID-19 outbreak may prove a timely reminder to ensure it remains fit for purpose and covers matters such as business continuity and contingency planning, exploration of alternative suppliers and emergency communications procedures.

The Financial Markets Authority has issued a range of exemptions and “no action” notices regarding compliance by financial service providers and FMC Reporting Entities with a range of obligations, including financial reporting where extensions of time have been given.

2. Should boards adopt particular governance practices in this context?

Because no one knows how long the epidemic will last, businesses need forecasts that look out three months, six months, nine months and a year. Boards should ideally prepare a low-case, medium-case and high-case forecast for each time period, and prepare a business plan based on each forecast. Boards should carefully monitor the trading performance against each forecast. This will allow a board to determine if and when a company will run out of money in each scenario and how significantly operating cost reductions will affect that liquidity analysis.

Typically, boards think on a consolidated basis and groups of companies operate on a cash-pooling basis. But in times of distress, and in determining whether directors have complied with their directors’ duties, the law views company groups on an entity-by-entity basis. Directors will need to think about:

  • whether a subsidiary should pay money to a parent to be used in another part of a group if it is at risk of not having sufficient cash available to meet its own liabilities; and
  • whether the board wishes to continue to fund speculative subsidiaries or joint ventures.
  • In the event that liquidity issues arise, the board should work through the spectrum of options and carefully consider each of them. This will include:
  • whether shareholder support will be available;
  • whether operational cost reductions can be implemented;
  • whether government or industry support may be available; and
  • whether your key stakeholders may be able to provide any other form of assistance/relief.

The board should consider whether the company is dependent on any key supplier, customer, joint venture partner or business partner and whether there are alternative options available should that supplier, customer, joint venture or business partner fail. The board should ensure that the company engages with those key parties so that it can understand and respond to any risk of failure.

Operating cost reductions can be traumatic, time consuming and slow to impact on cashflow (redundancy processes/winding down unprofitable operations). The reductions may also mean that the business is poorly positioned to take advantage of the inevitable economic improvement. 

Restructuring financial obligations may prove to be more efficient and flexible. The company should consider its financial position with lenders, landlords, financiers and Inland Revenue. Financial creditors may be prepared to amend repayment terms, defer payments or switch to interest only. Implementation of these sorts of steps will have an immediate positive impact on liquidity.

Ultimately directors need to be honest and forthright with employees, customers, suppliers, financiers and the government. Once trust is lost, support for a distressed business evaporates.

3. To what extent are boards being encouraged to take into account corporate purpose and values in the context of COVID-19 and a return to work?

The indication is the move to return to business will be sequential, with a continuing emphasis on working from home where possible. There continues to be a strong emphasis for businesses on physical distancing, hygiene, and tracking.

Any business planning a return to the workplace for at least some positions must think about how it will deal with employees who are concerned about the possible health risk – even when it has changed the way it does things – and don’t want to return. And prepare for the reverse. If a business wants to continue in working-from-home mode, it must consider how it will respond to staff who are finding it difficult at home and want to move back to the workplace.

Boards should consider what it will mean for individual staff members if school children are unable to return to school. Businesses may need to find work arrangements which can accommodate their employees' childcare needs.

Boards need to think ahead to any interaction with the changes they have implemented to pay, hours or duties, and the wage subsidy scheme when making changes to activity levels. Any alterations to terms of employment will require consultation, and in some cases, agreement, so this should be factored into planning.

Businesses who have reached an accommodation on their lease arrangements while out of their premises should “front-foot” a discussion about any changes which see them making some (but potentially not full) use of the premises on a return to business.

The level of service a business was able to provide before lockdown likely won’t be what it was. It will potentially be slower and more costly to do. Boards should think about what that means for the company's key supply contracts, any statements in the market about service levels, and their brand.

Businesses coming out of lockdown will be discovering what their customers want (it may be different) and whether they are surviving at all. Early communication is recommended for a business that is looking to ramp back its level of activity.  The same goes for suppliers – don’t assume they can provide the same service, or are surviving well. Changes to a way a business does things will require drawing on new resources and services, for example making greater use of couriers or other delivery services and IT platforms. Attempt to identify those suppliers that are key to success in the new world and beyond and find ways to secure that critical supply.

Where a business decides to go with regional variations in how it operates it will require clear communications with employees, customers, the market generally, suppliers. It is recommended to have those stress-tested.

This will be the beginning of the beginning. Once a business has stabilised its return to business, the shape of a medium-term plan might be easier to envisage. This can include engaging lenders and shareholders on how the structure of debt and capital that supports the business' medium-term plan.

Finally, a return to some form of lockdown cannot be ruled out, depending on how the epidemic progresses from here. Boards should accordingly review how their business plans for the lockdown performed and whether there are any lessons for the future.

Restructuring

4. Your company is facing liquidity issues as a result of COVID-19:

a. What are the repercussions for continuing to operate your company?

You may be in breach of director's duties under the Companies Act 1993 (CA93). In particular, there are duties in sections 131 (re, good faith and best interests of the company), 133 (re, proper purpose), 134 (re, compliance with CA93 and constitution), 135 (re, reckless trading) and 136 (re, incurring obligations).

Note that:

  • directors can be liable for an offence (punishable by imprisonment or fines) under (among other provisions) section 138A (re. acting in bad faith and knowing it will cause loss to the company) and section 380 (re. carrying on business fraudulently or dishonestly incurring debt);
  • a director who has breached duties may be liable to contribute to the liquidation under section 301 – this has real teeth; and
  • for various types of non-compliance, a director may be disqualified from being a director or otherwise managing a company for a specified period or indefinitely in accordance with the provisions set out section 383.

Please note that there is currently a bill before parliament to create safe harbour for directors as part of the New Zealand Government's COVID-19 relief measures.

If a company is placed into liquidation, the liquidators will have the power to take action in respect of any transactions in the previous two years that are considered to be “insolvent transactions” under s292 of the CA93.  This risk of a transaction being found to be an insolvent transaction and therefore unwound by the liquidators should be considered. Note that as part of the New Zealand Government's COVID-19 relief measures, this vulnerability period is being shortened from two years to six months.

b. Do you have to file for insolvency if your company cannot pay all its debts as they fall due?

Continuing to trade when the company cannot pay all its debts as they fall due runs the risk of breaching director's duties listed above, and a risk that transactions that are entered into during the time the company is unable to pay its debts are voidable. 

A liquidator may be appointed by a special resolution of shareholder(s), the board of the company (if the constitution so permits) or by the court on application by the company, a director, a shareholder, a creditor or certain others. See section 241 of CA93.

Please note that there is currently a bill for a debt hibernation scheme that is part of COVID-19 relief measures.

c. Are there any steps that should be taken to minimise the risk of your actions as director being challenged?

Good record-keeping is essential. You should record reasons for any decisions you make. You should also keep any evidence which you base your decisions on, such as forecasts and minutes of your discussion with your creditors. You should obtain legal advice on director's duties and financial and accounting advice as required.

d. Will your company be wound up if you fail to make payments when due?

When you default on payment, a creditor can serve statutory demand on the company. The service of and non-compliance with a statutory demand allows the creditor to apply to the court for the appointment of liquidator.

A secured creditor may appoint a receiver regarding property of a company over which it holds security if there is a default under its security agreement.