On 3 April 2020, the Government announced that it would be making changes to the Companies Act 1993 to provide insolvency relief for businesses affected by COVID-19.

Yesterday, 5 May 2020, the first reading of the COVID-19 Response (Further Management Measures) Legislation Bill) took place. That bill introduces, amongst other measures:

• Reducing the voidable transaction and voidable charge period for non-related parties to six months (Schedule 2)
• The safe harbour provisions for directors (Schedule 3)
• The COVID-19 business debt hibernation (Schedule 4)
• Extensions to the periods mortgages and rent can be in arrears before default notices can be issued and enforcement action can be taken under the Property Law Act 2007 (Schedule 14)

Both the Safe Harbour provisions and the Business Debt Hibernation scheme are intended to be used by companies who, but for COVID-19 would not be facing cash flow issues.

Safe Harbour Provisions

The safe harbour provisions allow directors to trade during the safe harbour period (initially 3 April 2020 to 30 September 2020) without breaching section 135 (reckless trading) and/or section 136 of the Companies Act 1993 if:

• The company “was able to pay its debts as they became due in the normal course of business” as at 31 December 2019 (Pre-COVID-19 Solvent); and
• In good faith, the directors are of the opinion that the company:
  
  • has or will have short term, COVID-19 related liquidity problems over the next six months; and
  • will (more likely than not) be able to pay its due debts on and after 30 September 2021.

                (Post-COVID-19 Solvency Opinion)

The bill puts the onus on the directors to show that they are entitled to the protection afforded safe harbour provisions. The bill also contemplates that the safe harbour period could be extended beyond 30 September 2020.

Business Debt Hibernation

The Business Debt Hibernation(BDH)  scheme will allow entities (including companies, partnerships, body corporates, and unincorporated bodies) to delay payment of their debts, whether in full or in part, for a period of up to seven months.

Entities will be able to enter into BDH if:

• The entity was Pre-COVID-19 Solvent;
• At least 80% of the entity’s directors vote in favour of a resolution to enter into BDH; and
• Each director who votes in favour of the BDH:
  
  • Makes a statutory declaration that:
    
    • The entity was Pre-COVID-19 Solvent
    • The director holds a Post-COVID-19 Solvency Opinion
    • Sets out the grounds for his or her Post-COVID-19 Solvency Opinion

                     (Post-COVID-19 Solvency Declaration)

• • Is acting in good faith

The entity will enter into the BDH when it delivers notice of the BDH to the Registrar (as drafted, all entities will deliver the BDH notice to the Registrar of Companies, not just companies registered on the Companies Register). Entities entering into BDH will have an initial one-month protection period during which creditors will be prevented from starting or continuing enforcement action against the entity and its assets while the entity puts forward its proposed arrangement with its creditors. If the proposed arrangement is supported by 50% of the entity’s creditors (in number and value) who vote on the proposed arrangement, the protection period will be extended for a further six months and all creditors who were sent notice of the proposed arrangement will be bound by the proposed arrangement.

During the protection period (including the extended protection period), unless the approved arrangement provides otherwise or only with the court’s permission:

• Creditors will not be able to enforce their charges over the entity’s property;
• Lessors will not be entitled to take possession of the property used or occupied by the entity;
• Creditors will not be able to begin or continue proceedings for a debt or the recovery of property from the entity;
• Creditors cannot start or continue enforcement action against the entity;
• Creditors cannot call on guarantors of BDH debts, if the guarantor is related party of the entity.

The extended protection period will come to an end if at least 80% of the entity’s directors are not prepared to make new Post-COVID-19 Solvency Declarations, if requested to do so by a creditor. Once given, each Solvency Declaration can be supplied to creditors requesting a new Solvency Declaration for a period of up to two months from the date it is given.

The following debts are excluded from BDHs:

• Employees’ remuneration (including PAYE and other deductions)
• Amounts owed to secured creditors with security over all or substantially all of the entity’s assets (after the initial one-month protection period)
• Debts incurred after the company enters BDH
• Excluded debts (the term “excluded debts” is not defined in the bill)

A BDH does not compromise any of the entity’s debts but an entity in BDH can advance a creditor compromise or be placed into voluntary administration during the protection period.

Progressing the Bill

The bill has been referred to the Epidemic Response Committee, who are due to report back to the house on 12 May 2020.

A date for the second reading of the bill has not yet been announced.

You can find a copy of the bill here: 

How We Can Help

Directors wanting to take advantage of the Safe Harbour provisions or entities considering the BDH will need to satisfy themselves that the entity was Pre-COVID-19 Solvent and that they have a good faith basis for their Post-COVID-19 Solvency Opinion. Because of these requirements, if you have any hesitation about your entity’s financial position, we strongly recommend that you take advice.

For entities that cannot meet the solvency requirements of the Safe Harbour provisions or the BDH scheme, there are a number of business restructuring options available that could help directors and shareholders navigate their way through the financial challenges brought about by COVID-19.

If you want to discuss the issues your business is facing, email us on This email address is being protected from spambots. You need JavaScript enabled to view it. to request a phone call from or Zoom meeting with one of our insolvency practitioners.

Are you likely to be forced to repay to a liquidator money previously received from a customer?

It has become relatively common for suppliers and others to be challenged by liquidators to repay funds that they have previously been paid.

Prior to the change of rules in late 2007, the contentious issue was determining what "the ordinary course of business" meant. The decisions surrounding liquidators' challenges did not discourage conventional or usual debt collection measures.

Since the McEntee Hire decision in August 2010 we have observed an increase in liquidators sending out letters seeking to challenge transactions.

It is disappointing that some liquidators seem to take an approach of challenging all payments made, rather than first considering whether there has been an actual preference to the creditor, any continuing business relationship (ie whether the contract was ongoing at the time of payment), industry practice (which may tolerate delays of payments), evidence and knowledge of credit concern, the nature of payments and trading history.

Consequently, we are sometimes asked to assist in reviewing Insolvent Transaction challenges taken by other liquidators.

As a result of such challenges, the Insolvent Transactions regime can be seen by suppliers in particular, to be at odds with prudent credit management. This is a conclusion that could be reached in light of the McEntee decision, but is that conclusion right?

We have also observed that suppliers are belatedly endeavouring to patch up holes in their procedures, in particular by late PPSR registrations of additional security rights to secure past indebtedness.

In our opinion, in some circumstances knowledge of a debtor's insolvency may be hard to avoid. It follows that the longer a debt goes unpaid the more likely it is that the supplier will be considered to be aware of the customer's inability to convert non-cash assets into cash, ie insolvency.

We consider that the consistent use of proper terms of trade, normal timely debt collection procedures, and asset protection mechanisms may protect a supplier from successful Insolvent Transaction challenges.

The regime therefore can be seen to encourage stricter credit terms and management, well defined trading terms and better security management. The mere fact of applying pressure to get payment does not in itself compel the conclusion that the payment is an Insolvent Transaction.

Insolvent Transactions regime

In an insolvent liquidation, unsecured creditors are treated equally and the company's assets are shared on a pro rata (or 'pari passu') basis. The term that is often used is to stop a creditor from 'stealing a march' on others. Where payments give individual creditors a preference, the regime enables a liquidator to set aside and claw back payments made within the two years before liquidation.

One feature of the current regime is the running account concept. This allows for the net effect of a series of invoices and payments in a "continuing business relationship" to be considered as one transaction. This is designed to stop liquidators challenging a series of payments to the same supplier, instead putting the focus on what the overall effect of the transactions was.

A continuing business relationship is established through a background of trading between the supplier and the customer. Factors such as the basis for the relationship, the business purpose and the character of the relationship, length of the relationship and frequency of transactions will usually be taken into account.

In McEntee Hire, it was agreed that a continuing business relationship existed, as McEntee had traded with its customer for over three years, with many sales and payments regularly in that period. However, the Court found that the continuing business relationship ended when McEntee issued a stop credit notice and referred the debt to a collection agency. It was noted that this was done four months after the last invoice for supply had been issued, and in circumstances where its policy in cases of suspected insolvency was to refer the debt to a collection agency.

McEntee argued that the stop credit notice was not the end of the continuing business relationship but more to "rebalance" and "preserve" the trading relationship, and did not reflect any concerns about the company's solvency. The liquidators successfully argued that payments were not being made to induce further supplies, and the relationship had shifted to one of pure debt collection.

We speculate that had the right to stop credit been with regard to a credit limit or other credit terms, and the referral to a debt collection agency been earlier and as a routine referral, the continuing business relationship may have endured.

Running account

An Insolvent Transaction claim is calculated in a number of ways; firstly where there is no running account, as a sum of payments, secondly when there is a running account, the net difference between the opening and closing balances and lastly, at the point of peak indebtedness - being the difference between the peak and the closing balance. This is illustrated as follows:-

Possible scenarios:-

1. No running account - sum of all payments $120,000
2. Simple running account (opening - closing) $10,000
3. Peak indebtedness (point of peak indebtedness - closing balance) $50,000

In this example, a supplier commenced trading with a customer in 2010. By November 2011, the customer owed the supplier $30,000. Six months later the customer owed $40,000. In June 2012, the company is placed into liquidation owing the supplier $20,000. Using this example, a liquidator could argue peak indebtedness and say the supplier was preferred by $50,000. The liquidator cannot cherry- pick a transaction (eg the April 2012 $60,000 payment) when there is a running account, and ignore that the creditor continued to trade with the company as a result of the payments made. Australian authorities have said, however, that liquidators ought to cherry-pick a date of peak indebtedness that best suits the general body of creditors. Section 292(4B) of the Companies Act 1993 does not limit a liquidator's ability to do so.

Summary

Insolvent Transactions will be a contentious but necessary feature of insolvency law for the foreseeable future. Creditors should review trade terms, and ensure that they have policies and debt collection processes and procedures that minimise the ability for liquidators to claw back valuable funds.

DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.