Directors' duties and insolvency: Impact of COVID-19 for development and construction companies

Construction organisations are generally capital intensive businesses. They also invariably operate on the basis of negative cash flow under their contracting arrangements, with payments typically made in arrears.

As a result of New Zealand’s COVID-19 Alert Level 4 lockdown, it is likely that construction organisations involved in ‘non-essential’ construction activities will have limited cash flow through May and into June – this will affect not only head contractors but potentially the entire supply chain. These circumstances present a real risk to the Construction sector of insolvent trading over the coming months, endangering employee job security and exposing directors to breaches of their duties under the Companies Act 1993.

As the Construction sector prepares for remobilisation on Tuesday 28 April 2020 when Alert Level 3 takes effect, partners Silvana Schenone, Michael Langdon and Travis Tomlinson discuss the outlook post-COVID-19 and the measures that the Government intends to put in place to provide relief for directors who are facing challenging decisions in order to keep their companies afloat.

The Government intends to introduce legislation to provide company directors with a ‘safe harbour' from their obligations under sections 135 (reckless trading) and 136 (duty in relation to obligations) of the Companies Act 1993, if directors can meet the following test:

  • directors must believe in good faith that the company is facing or is likely to face significant liquidity issues in the next 6 months as a result of the impact of COVID-19 on them or their creditors; and
  • the company must have been able to pay its debts as they fell due on 31 December 2019; and
  • the directors must consider in good faith that it is more likely than not that the company will be able to pay its debts as they fall due within the next 18 months (for example, because trading conditions are likely to improve or they are likely to be able reach an accommodation with their creditors).

In considering whether they qualify for the ‘safe harbour’ relief, directors must make their assessment in good faith and should keep accurate records of any decisions reached, including outlining what was taken into account in reaching its decisions.

Directors who qualify for the ‘safe harbour' relief must ensure that they continue to comply with their other duties as directors under the Companies Act 1993, including their paramount duty to act in the best interests of the company.

In addition, the Government intends to legislate (we anticipate that it is likely to be in late April or May) for a ‘business debt hibernation regime' (BDH) which will enable businesses that are facing liquidity issues as a result of COVID-19 to vary debt payment obligations for a period of up to 7 months and prevent secured parties, landlords and owners of leased personal property from taking enforcement action.

Once an entity is placed in BDH its creditors must, within the first month of the moratorium, approve (50% in number and value of those creditors who vote) the BDH proposal to ensure the entity continues to have the benefit of such moratorium for a further six months.

Construction organisations should be looking at how to deal with some of the challenges, including cash flow, that are being created by the COVID-19 pandemic. If they are in a position to do so, this may involve agreeing to different payment terms under their current contracting arrangements enabling the acceleration of cash flow.

When considering future contracts, it is essential that parties continue to take steps to understand the financial circumstances of a party that they contract with and what arrangements can be put in place to deal with solvency concerns.

Click here to read our article on Remobilising the construction sector

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