Given the impact of COVID-19 on supply chains, the workforce, the operations of Government, and the economy as a whole, the casualties will inevitably include businesses as well as individuals. While the full impact has yet to be felt, there are already reported cases of businesses citing COVID-19 as the cause of, or a significant contributing factor to, their insolvency (eg. Flybe Limited, which entered administration in the UK on 5 March 2020, and Valeritas Holdings Inc. which filed for Chapter 11 in the US on 9 February 2020).
Some of the issues which lenders will need to consider are addressed above in Finance.
For borrowers COVID-19 may have implications in relation to financial and information covenants in loan facility documentation, as well as (as discussed above in Section 5 (Finance)) potential MAC triggers. Early engagement and transparency with lenders and key contractual counterparties will be essential. While the duration of financial distress and interruption may be difficult to gauge, refinance or further funds may be necessary, forbearances and / or standstills on enforcement may need to be negotiated and a conservative but achievable recovery plan established. For directors of Australian companies, the "safe harbour" regime established under recent amendments to the Corporations Act may protect them from exposure to personal liability for insolvent trading by the company. To obtain such protection, the company must be eligible for safe harbour (in the sense of having satisfied the statutory prerequisites) and its directors must develop “one or more courses of action that are reasonably likely to lead to a better outcome for the company" than an immediate insolvency appointment, ideally with the assistance of a qualified restructuring or turnaround adviser.
For contractual counterparties, there is, as identified, the counterparty's inability to perform contractual obligations and the risk of default. Rights and notice periods under existing contracts should be assessed and rights reserved where appropriate. Commercial contracts will generally include "ipso facto" clauses, being clauses which give a party a right to immediately terminate the contract upon the occurrence of an "event of default" or an "insolvency event" of their contractual counterparty. The impact of the Commonwealth Government's 2018 ipso facto reforms also needs to be considered, as, for certain contracts entered into on or after 1 July 2018, a stay may operate on the termination of a contract by reason (only) of a counterparty's external administration or receivership (or scheme proposal) or in substance, the financial condition of the counterparty. Specialist legal advice should be sought before precipitously relying on a force majeure or termination for default clause, or for any alleged contractual frustration in reliance on COVID-19 related default or delay.
Temporary insolvency reforms
The Coronavirus Economic Response Package Omnibus Act 2020 (Cth) is intended to encourage business to continue trading free of risk that insolvent trading laws – which prevent directors of insolvent companies incurring fresh debt – would impose a personal civil and criminal liability on them. There are also changes to changes to statutory demands and debtor's petitions.
The Government has announced that the amendments to the Corporations Act 2001 (Cth) and the Bankruptcy Act 1996 (Cth) will remain in place for six months from the commencement date, although the Act contemplates that they could operate for a longer period if prescribed. There is also power granted to the Treasurer for the changes to be extended for a further period of up to six months.
Temporary safe harbour from insolvent trading
A new section 588GAAA has been inserted in the Corporations Act. This new temporary section provides directors with a new safe harbour "temporary relief due to coronavirus" from personal liability for any debts incurred by a business while insolvent. This relief will only apply to debts incurred in the ordinary course of the company's business and during the six month period.
The relief will apply for six months from the date the commencement date, or longer if prescribed and the onus of establishing the protection of the new "temporary safe harbour" rests on the person seeking to rely upon the protection. The company will remain liable for all debts incurred.
Importantly, the existing provisions of the Corporations Act and the statutory defences already available, remain. Sections 1317S and 1318 provide that the court has power to grant relief from liability for breach of a civil penalty provision, which will include insolvent trading. A court may provide relief where a director may have acted honestly and, having regard to all the circumstances of a particular case, the director ought fairly be excused for their conduct. Cases of fraud and dishonesty will be subject to criminal proceedings.
It is very important to recognise that director's duties (fiduciary, "care and diligence", prohibitions against misleading and associated conduct) are not relieved under the amendments to the Corporations Act.
Accordingly, directors must be able to point to a continuing viable business during or at least by the end of the safe harbour. Continuing to trade a financially distressed company without purpose is not an option and would probably expose directors to personal liability under the relevant statutory provisions of the Corporations Act. It is important that directors and officers make themselves aware of those provisions, assess their financial position in a proactive manner and take advice from an experienced adviser early.
This is particularly so since businesses facing COVID-19-induced illiquidity may need to restructure and employ turnaround techniques and standstills; refinancing; cost outs and operating model redesigns. They will need to identify capital raising programs, debt facility alternatives, cost containment efforts, business operation re-orientation and major strategic changes (including around workforce).
The safe harbour provisions in section 588GA will remain an important consideration, mirroring, if possible, this new and temporary safe harbour. Accordingly, if the business is insolvent, or likely to become insolvent at any point of time, directors should still ensure they satisfy or explain why they are not able to satisfy the preconditions to safe harbour protections, including to record the strategy in a written plan.
Two changes to statutory demands
Two amendments will be made to the Corporations Act in respect of statutory demands. First, the statutory minimum for the issuing of a statutory demand will be increased from $2,000 to $20,000: section 9.
Second, the period for compliance with a statutory demand is temporarily extended from 21 days to six months: section 459F.
These changes will occur by inserting new definitions in section 9 and amending sections 459E, 459F and 459G to refer to the new defined terms. Importantly they will only apply to statutory demands served on or after the commencement of the changes which are designed to be repealed six months after commencement.
Bankruptcy notices: higher thresholds, longer timeframes
Two amendments will be made to Bankruptcy Act 1966 (Cth) in respect of bankruptcy notices. First, the judgment amount at which an Official Receiver can issue a bankruptcy notice against an individual will be increased from $5,000 to $20,000: section 41(1).
Second, the period for compliance with a bankruptcy notice has been temporarily extended from 21 days to six months: section 40(1)(g).
These changes will occur by inserting new definitions in section 5(1) and amending sections 33, 40, 41, 42, 44 and 244 to refer to the new defined terms. These changes, similar to the corporation statutory demand amendments, will apply only to bankruptcy notices issued on or after the commencement date and are designed to be replaced six months after commencement.
What amendments will be made to debtor's petitions?
According to the fact sheet, the period of protection a debtor receives upon presenting a debtor's petition from unsecured creditors taking action to recover debts will increase temporarily from 21 days to six months.
Can a creditor continue to pursue debts?
Creditors will still have the right to enforce debts through the courts.
ASIC, ACCC and FIRB: current position and relief
ASIC is also considering a series of complementary steps designed to grant relief from certain regulatory compliance matters to accommodate COVID-19 scenarios. At this stage, relief (or a "no action" letter) would need to be applied for on an individual, case-by-case basis. Some of the areas where ASIC has indicated that relief would be considered (and we expect this list to expand over the coming months) include:
- hold AGMs online and the ability to delay AGMs by up to two months (ASIC is considering a "no action" position to permit this and further regulation may be considered to address associated legal issues);
- change details/dates/times etc in respect of meetings already concerned;
- send documents by email or weblinks;
- execute documents electronically;
- cancel or defer declared dividends (some noted the possible exposure for cancelling determined dividends on the basis of misleading or deceptive conduct – notwithstanding many felt this sort of claim would be a stretch);
- allow beneficial shareholders and others to lodge proxies directly (rather than having to go through their custodians who are notoriously slow);
- abbreviate notice periods to 21 (or possibly 14 days), in particular for listed companies; and
- defer the date by which audited accounts must be lodged (a class order is being considered which would require companies to submit the unaudited management accounts which were submitted to audit teams).
ACCC is working on guidance around market relief when dealing with distressed market concentrations; we will keep you updated. We anticipate also receiving FIRB updates in relation to foreign capital investments.
Taking advantage of the breathing space
Even with a six-month temporary relief from insolvent trading liability, businesses which trade without a properly considered and formulated recovery plan risk putting themselves in a perilous position and with limited recovery options once the period of temporary relief comes to an end, meaning the risk and inevitability of a formal insolvency process becomes very real.
In other words, this 6 month period should be viewed as a planning period to reassess a company’s financial position, business model, costs and expenses and to model what business conditions look like going forward. If done using traditional safe harbour techniques with specialist expert advisers, any risks of insolvent trading liability can also continue well beyond the six-month relief period.
It is also worth remembering that despite the temporary relief from insolvent trading liability, most businesses will see significant interruptions to their cash flow, in particular to payment of their book debts and receivables. This means that continuing to trade without a plan risks significantly worsening the position, particularly given the temporary changes to the statutory demand process (extending the debt threshold from $2,000 to $20,000 and the time period for compliance from 21 days to six months), which is typically used as a debt collection tool.
How can businesses affected by COVID-19 continue to plan for the future?
A plan would be expected to incorporate, at least, these features:
- articulation of the impact COVID-19 was having on operations, supplies, financing and execution of existing strategic plans and whether that impact was causing, or might cause, the business to become insolvent;
- creation of three-way cashflow reporting models with sensitivity points to measure revenue (cash) impact on the business under various scenario plans, eg. operation shutdown;
- confirmation bias in favour of meeting employee entitlements or planning labour stand-downs or reductions if entitlements cannot be met from other sources, including government or additional bank funding;
- outlining creditor payments or resets;
- costs containment exercises and renegotiations with key counterparties – the economic impact of outcomes from these negotiations will be inputs into revised cashflows;
- regular board meetings to ensure:
- the plan is being followed and adjusted as required to meet changing conditions;
- advisory teams are engaged to provide the legal, financial and capital markets or other special situations feedback needed for directors to believe there is likely to be a bridge from present conditions to a safe landing at some defined point in the future (this point may be adjusted to meet new ex-events) – the bridging steps should be explained;
- ASIC or regulatory/listing relief or approvals required to meet rescue capital needs and/or any control transaction are quickly identified – many of these instruments will be familiar to directors trading in post-GFC days;
- market expectations are met – these are likely to require the maintenance of tax and other filings, keeping of proper records, meeting of employee entitlements (including accessing Government assistance packages);
- various inflection points and reassessment to ensure objectives remain achievable or require adjustment; and
- augmentation of financial, risk and compliance committee sub-reporting to ensure the meeting of financial covenants, licensing and permit obligations (for example, a mining venture would need to meet tenement, expenditure, remediation requirements), workforce awards and industrial instruments, environmental, major contract breach events, market disclosures and other continuous trading responsibilities. This is not intended to be a complete list; the circumstances of each enterprise turning on its own market requirements.