5 top tips for In-house Counsel dealing with financial distress caused by COVID-19

INTRODUCTION

The COVID-19 pandemic is causing unprecedented disruption to Australian businesses.  

Cash flow forecasting is increasingly more difficult, supply chains are strained and consumer demand in many sectors is weakening. 

In the coming months, many companies face the potential prospect of increasing financial pressure and may be dealing with counterparties in financial distress. 

As In-house Counsel, these are some of the issues to be aware of to help your business navigate the challenges of COVID-19. 

1. FAMILIARISE YOURSELF WITH THE TEST FOR INSOLVENCY

A company is considered insolvent if it is unable to pay its debts as and when they become due and payable. 

The Government has announced a temporary relief from directors' insolvent trading laws which can impose personal liability on directors who allow a business to trade in insolvent circumstances. The temporary relief is aimed at allowing a company to incur debt in the ordinary course of business for a period of 6 months even if insolvent, without personal liability for directors for insolvent trading. It is important to note that all other ordinary director duties continue to apply. Further, the Government's announcement stated that egregious cases of dishonesty and fraud will still be subject to criminal penalties. 

Further, the amount for which a creditor can issue a statutory demand to a company for a debt owing by the company has been increased from $2,000 to $20,000; and the time by which a company must respond to a statutory demand to avoid liquidation proceedings against it has been extended from 21 days to 6 months.

The above initiatives are to apply for a period of 6 months only. Accordingly, companies faced with solvency issues still need to implement a long term plan. This is important in order to continue to communicate effectively with lenders and contracting parties.

Therefore, as an initial step, a review of existing financing arrangements to identify any potential pressure points is recommended. While the reforms will be effective to defer the ability of a trade creditor to bring a statutory demand, they do not affect the rights of lenders to declare an event of default or for secured financiers to enforce security.

Potential options to deal with any issues which may affect your existing financing arrangements include:

• seeking a temporary (or permanent) waiver, suspension or amendment from anticipated or actual breach
• requesting a payment deferral (e.g. capitalising upcoming interest obligations)
• extending maturity dates or instalment repayment dates
• raising new debt and/or equity capital to boost liquidity
• exploring sale and leaseback arrangements
• if a default waiver is not available, seeking an enforcement standstill arrangement.

Carefully consider any request made to the company for a solvency certificate as part of any discussions or arrangements with financiers.

2. FAMILIARISE YOURSELF WITH THE SAFE HARBOUR REGIME 

Directors who suspect that the company is insolvent or nearing insolvency may seek protection under the Corporations Act Safe Harbour regime – ideally before taking on further debts.  

This is relevant even in light of the Government's relief from insolvent trading, which is to be in place for a period of 6 months (discussed above). Therefore, the financial position of the company at the end of that 6 month period is still relevant and measures to address it should be implemented throughout the temporary suspension on insolvent trading. 

The Safe Harbour regime involves steps to assist a company to make it through a period of financial distress. It is designed to encourage directors to implement a workout plan that will provide a better outcome for the company and its creditors than going into insolvency.  

To enter the Safe Harbour, directors must develop a course of action that is reasonably likely to lead to a better outcome for the company, when compared with immediate liquidation or administration.  

Companies should consider the following steps:

• regular board meetings to monitor the development and implementation of a workout plan and to assess the company's solvency
• review each phase of any workout plan to assess whether it continues to be reasonably likely to result in a better outcome
• determine a materiality threshold for new debts, having regard to the size and nature of the company's business and ensure it is consistent with any workout plan
• thoroughly document the information that the board is obtaining to stay informed of the company's financial position and pursue a work out plan.

Our previous series on the Safe Harbour regime and how it works is available at the following link: https://www.ashurst.com/en/news-and-insights/legal-updates/navigating-safe-harbour/ 

The tip sheet below was also produced for the 2019 ARITA National Conference for best practice in providing Safe Harbour advice: see download link below. 

3. FAMILIARISE YOURSELF WITH THE IPSO FACTO STAY REGIME 

Consider whether the Corporations Act ipso facto stay regime will affect your contractual rights and obligations if your business or a contractual counterparty enters into a formal restructuring or insolvency procedure.

An ipso facto clause allows one party to terminate a contract, or exercise other specified contractual rights (e.g. to suspend performance) if a certain insolvency-related event occurs – for example, the appointment of an administrator or receiver.

The stay regime restricts this ability and may enable a distressed company to continue trading during the restructuring process.  

The key thing to note is that this only applies to contracts entered into on or after 1 July 2018 – so check the dates of your contracts. Preventing termination on the basis of ipso facto could keep valuable contracts alive for you. Conversely, be aware that your ability to terminate certain contracts could be curtailed, so this can operate both in and against your favour.

4. CONSIDER WHETHER ANY FORCE MAJEURE CLAUSES IN YOUR CONTRACTS COULD BE ENLIVENED BY COVID-19

You should review your high-risk contracts (e.g. those that have a direct impact on your cash flow) to determine whether they contain a force majeure clause that could be enlivened by COVID-19. 

A force majeure clause may relieve a party from the consequences of non-performance of contractual obligations, if such performance was impaired by events outside of the party's control (e.g. COVID-19).  

We are already seeing an increased number of companies claiming force majeure against contractual counterparties. As at 3 March 2020, the China Council for the Promotion of International Trade has issued 4,811 "force majeure certificates" due to COVID-19, for contracts worth USD $53.79B. While these certificates alone will not automatically enliven a force majeure clause, they foreshadow that a significant number of force majeure claims may be made over the coming months. 

5. REVIEW YOUR KEY CONTRACTS TO UNDERSTAND PERFORMANCE RIGHTS AND OBLIGATIONS, INCLUDING SET-OFF CLAUSES 

You should review your contracts to determine whether they contain relevant termination and suspension of performance clauses and understand your rights and obligations under these clauses.

Set-off clauses may also be relevant if performance is affected. In its most basic form, a set-off clause gives you the right to set off the debts you owe to a counterparty against the debts the counterparty owes to you, and vice versa.  

As things progress, there may be damages claims for non-performance which could be set off against receivables. This would clearly compound any existing pressures on cash flow. 

Therefore, in light of potential set off claims, it is worth knowing where you stand in relation to mutual debts and assessing performance when evaluating your level of debtors.

Authors: Emanuel Poulos, Partner; Ross McClymont, Partner; Jason Salman, Partner and Meredith Bennett, Partner.