Current law provides that directors are obliged not to continue trading in a reckless or insolvent manner. For many, the risks associated with these obligations were brought into sharper focus following the Mainzeal decision last year. The directors in that case were found personally liable for NZ$36 million in damages following the company’s collapse. Several countries (including Australia and the UK) have decided that some of the obligations on directors in respect of reckless or insolvent trading should be relaxed in the current circumstances, where even a fundamentally sound business may face serious cashflow problems. Will New Zealand take the same approach?

New Zealand’s reckless and insolvent trading rules

Under section 135 of the Companies Act, a director must not:

a) agree to the business of the company being carried out in a manner likely to create a substantial risk of serious loss to the company’s creditors; or

b) cause or allow the business of the company to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors.

Further, under section 136, a director must not agree to the company incurring an obligation (e.g. a debt) unless the director reasonably believes that the company will be able to perform the obligation.

The case for a change

There are a number of emergency measures in place to support the economy through the COVID-19 crisis. For such measures to work, it is important that directors of companies that are struggling, but may be viable in the long term, do not appoint liquidators prematurely. In particular, the Government’s wage subsidies rely on employers continuing in business, as do the deferment of bank loan repayments etc. However, if directors fear that they may be found personally liable for continuing to trade, the temptation will be to take a safety first, cautious approach at a point where future trading conditions are uncertain.

To reduce this risk, countries such as Australia and the United Kingdom have suspended, or are proposing to suspend, their insolvent trading requirements for a period. Australia already had a ‘safe harbour’ scheme whereby directors would be exempt from liability in certain circumstances where they were pursuing a recovery plan. There have been calls for New Zealand to take similar steps. One option would be to adapt the Companies (Safe Harbour for Insolvent Trading) Amendment Bill which was a private member’s bill published last year for consultation.

What will happen next?

The Government has not yet put forward any proposals to relax the reckless and insolvent trading rules. However, there will be more announcements in the coming week as to further measures to support the economy and we anticipate changes, or at least temporary changes, to directors duties will be on the agenda.

The current New Zealand legislation is sometimes seen as more ‘director friendly’ than in either Australia or the United Kingdom, so it may be that sweeping exemptions (i.e. complete suspension of the reckless and insolvent trading rules) are not seen as necessary here. It is perhaps more likely that a safe harbour scheme applying in limited defined circumstances (e.g. where the directors are exploring financing options or to allow uncertainty in the particular industry to clear) will be implemented. There is a careful balance, as any relaxation of the rules brings with it the risk that more creditors will lose out.

How should directors proceed?

Directors across New Zealand are facing difficult decisions at the moment and will need to assess the particular circumstances that they face.

For now, directors have to continue observing their duties under the existing reckless and insolvent trading rules but, where possible, we advise against taking any hasty decisions on the basis of these rules while the crisis, and the Government response, is still playing out. Every company’s situation will be different and some directors will have little choice but to stop trading. However, where the situation is still as fluid and uncertain as is the case now, we would expect the courts to have some sympathy for a director seeking to do the right thing. As always, the key thing is to take early advice, have a plan, closely monitor your company’s financial position and clearly document your decisions. Directors who can clearly show why they decided to continue to trade and on what basis will be in a much stronger position than directors who bury their head in the sand.

If you are concerned about your obligations as a director, please get in touch with the authors of this article, who would welcome the opportunity to discuss your situation with you.