Dealing with insolvency is a stressful process. As a director, you have to worry about risk on multiple fronts: corporate survivability, personal liability and how to satisfy the needs of creditors. But perhaps above all, it is critical to ensure your company does not continue to trade if it becomes insolvent.
RESPONSIBILITIES OF THE DIRECTOR DURING INSOLVENCY
As director, you must ensure that you and your company uphold the provisions and obligations of the Companies Act 1993. The duty imposed by Section 135 of the Act is owed by the directors to the company. The legislation states that minimum requirements for a director to do so adequately include:
- Making decisions in good faith and for the best interests of the company.
- Only using your power as director responsibly.
- Never putting the business at substantial risk of serious loss to the company's creditors.
- Ensuring you take care, diligence and skill that a reasonable director would take in the same circumstances.
- Making sure the company is able to pay its debts and has greater assets than liabilities.
When trading as an insolvent company, there are also important risks to keep in mind as the director.
RISKS WHEN TRADING AS AN INSOLVENT COMPANY
Liability for civil penalties
If your company is entering insolvency, you could be held liable for reckless or negligent trading. Reckless or wrongful trading is any trading that is likely to create a substantial risk of serious loss to your company's creditors. As the company's director, you are under a duty to not engage in any form of reckless trading. The Companies Office may also pursue legal action should this occur.
Insolvent trading can be as simple as assuring creditors that the company is in good shape, while knowing that the opposite is true. This could make you liable under the tort of deceit. To avoid reckless trading you should ensure your company is solvent and able to pay debts when they fall due (and that total debts including contingent liabilities are less than total assets).
If you claim that you did not know about the bad financial situation, however, that could be considered careless and you could be held liable for negligence. A company director can be found personally liable for losses caused to creditors.
Criminal charges
If you fail to disclose that your listed company is unable to pay debts to its investors, you may have a criminal charge brought against you by FMA. A director will be criminally liable if they know that conduct in breach of directors' duties is either seriously detrimental to the interests of the company, or will result in serious loss to the company's creditors.
If directors of a listed company fail to disclose that the company is unable to pay debts to its investors, the directors may have criminal charges brought against them by FMA and/or the Serious Fraud Office under the Crimes Act 1961.
The FMA will monitor and take enforcement action where it sees conduct that could harm investors or damage the reputation of New Zealand's financial markets.
Theft by a person in a special relationship (such as a director) or deception under section 240 of the Crimes Act 1961 or acting dishonestly by taking or using a document under section 228 of the Crimes Act 1961 all carry maximum penalties of seven years imprisonment per charge.
Loss of director role
Remember that when your company enters voluntary administration or liquidation, you will lose control of management of the company. If you have acted proactively and in the interests of the creditors and you have not defrauded the company, you will have a stronger legal defence and creditors with personal guarantees may be more willing to negotiate with you.
You will have statutory obligations, such as providing records and to attend creditor meetings and meetings with the external administrator.
If you act promptly, you may not need a formal insolvency process and may (with the help of a turnaround professional) be able to restructure the business, compromise with creditors and continue as a director.
How to act as a director of an insolvent company
Because of personal risks, directors should take immediate action and gain professional advice on the options for their struggling businesses. There are many options available, such as ceasing to trade (which is best practice) and a sale of business, a hive down action, a company compromise or a voluntary administrator taking control. In more extreme circumstances, you may have to begin an immediate liquidation or a receivership process.
If the company can no longer pay its debts and the likelihood of continuing to trade will increase creditor and personal exposure, take action. In addition, it's important to always be honest, act with integrity and have the best interests of the business in mind.
If you are concerned that your company is close to entering insolvency and want to reduce stress and uncertainty, get in touch with our team at McDonald Vague to discuss our business turnaround solutions. It is important to check you have the appropriate mechanisms in place and are aware of the financial position of the company and the risks it faces.