RISKY BUSINESS – DIRECTORS’ RECKLESS TRADING
Posted by Jesvin Boparoy on January 20 2021 in News
In September last year, the Supreme Court reviewed the law relating to breaches of directors’ duties in a pivotal decision - Madsen-Ries and Levin as Liquidators of Debut Homes Limited (in liquidation) v Cooper  NZSC 100. The decision delivered important guidelines for company directors who continue to trade a company when it is insolvent or near insolvent. As a result, the Supreme Court also raised the stakes for directors and their duties.
Previously, under the Covid-19 safe harbour provisions (which expired on 30 September 2020) the Government gave directors a safety net to be able to trade their companies (for six months) including taking on new obligations while having ‘safe harbour’ for potential claims under the reckless trading section (s135 Companies Act 1993 (Act)) and director duties in relation to obligations (s136) on certain provisos. The ‘safe harbour’ provisions have now expired, and the Supreme Court seemed to show no sympathy for reckless directors who do not have regard to their duties.
Importantly, the case highlights that when a company is insolvent or near insolvent, it will not be acceptable for directors to continue to trade without making an assessment of ‘all of their creditors’ interest, rather than only some of their creditors interest.
Throughout the decision, the Supreme Court emphasised that companies in insolvency or near-insolvency situations should use the various formal mechanisms provided for in the Companies Act 1993 rather than trying to trade through. These are for example, entering into a creditors compromise, voluntary administration, receivership or liquidation.
The case highlights some of the key challenges for directors in having to find a balance between continuing to trade in an environment where the company wants to grow the business and pay off creditors (in spite of its negative balance sheets) while also acting responsibly to ensure that the prospect of trading is prudent. Ultimately, a company director is faced with a difficult decision in ensuring that his/her company does not reach a point of insolvency which is simply not salvageable and which will point to him/her trading recklessly for the purposes of section 135 of the Act.
What is clear from the Supreme Court decision is that it will have no tolerance for any actions by directors who continue to trade while insolvent or near insolvent where there is no hope of turning back. In these circumstances, those directors will be found personally liable for ‘new debts’ the company incurs from the point of insolvency onwards.
Unfortunately, more directors may find themselves having to make difficult decisions about whether to continue trading, and the wrong decision could leave them potentially personally liable.
If you are a company director in this position, then you should consider the following:
- You will need to be extra careful not to trade while insolvent and especially before taking on any “new debt” to repay old debt.
- You must consider all creditors before deciding what is the best action to take (not just some creditors and definitely not just ‘related party creditors’);
- If your company is nearing insolvency, consider entering into either an informal or formal compromise with your creditors or speaking with a receiver/liquidator or voluntary administrator about some of the other options.
Seeking professional advice early and proactively consulting with creditors can help reduce any personal risk for a breach of director duties.
If you want to discuss these implications on your directorship, or have any questions, please contact us.
Kalev Crossland | Partner | Kalev.Crossland@shieffangland.co.nz
Shan Langston | Senior Associate | Shan.Langston@shieffangland.co.nz
Jesvin Boparoy | Senior Associate | Jesvin.Boparoy@shieffangland.co.nz
This paper gives a general overview of the topics covered and is not intended to be relied upon as legal advice.