Good Business: Director Duties and the Risk of Personal Liability for Directors

Whether you are a first-time director of a newly formed start-up, or a seasoned director sitting on multiple boards, it can be useful to regularly remind yourself of your director duties. Why is fulfilling your director duties so important? If you breach your duties and the company is placed into liquidation, you risk being held personally liable to repay funds, or to contribute an amount of money to the assets of the company.

By way of summary, as a director you have a range of specific legal duties, including to:
• act in good faith and what you believe to be the best interests of the Company (which includes an obligation to consider the interests of all creditors);
• use your powers for a proper purpose;
• follow the Companies Act and your constitution;
• be able to meet your commitments;
• trade in a manner that protects your creditors; and
• use company information appropriately.

Because these duties are active, rather than passive, it is impossible to be a ‘silent’ or ‘sleeping’ director. All directors are responsible for fulfilling these duties, which means that you cannot simply delegate duties to your co-directors.

In a 2020 decision (Debut Homes Limited v Cooper) , the Supreme Court clearly spelt out that that in insolvency, or near-insolvency situations, it is not acceptable to simply try to “trade through” in the belief that this will improve the Company’s financial position. Instead, directors must ensure they use the formal (or informal) mechanisms provided for in the Companies Act 1993 (“Act”) to address their financial predicament. If directors fail to meet their duties, they face a very real risk of incurring personal liability. Where there are no prospects of a company returning to solvency, it makes no difference that a director honestly thinks some of the creditors will be better off by continuing trading. Directors need to be careful not to enter into a course of action that results in some creditors receiving a higher return at the expense of incurring new liabilities which will not be paid. As the Supreme Court put it, it is not legitimate to “rob Peter to pay Paul”.

Options for directors
As a director, there are various mechanisms that are available to you if you are facing insolvency or near-insolvency. The key mechanisms are:
• Liquidation – winding up the company.
• Creditor’s compromise – this usually involves part of a company’s debts being forgiven. It must be approved by a majority of creditors, representing at least 75% of the debt owed to each class of creditors.
• Court-approved creditor’s compromise – where the court agrees that a compromise is fair and reasonable to creditors.
• Voluntary administration – an administrator is appointed to increase the prospects of a company surviving. This must be approved by a majority of creditors, representing at least 75% of the debt owed to each class of creditors.

Summary
If a company reaches the point where continued trading will result in a shortfall to creditors and the company is not salvageable, then continued trading will be deemed reckless and a breach of director duties. If as a director you allow an insolvent company to continue trading without using one of the available formal or informal mechanisms, then you will breach your director duties and likely incur personal liability. Whether or not to continue trading is therefore a critical decision for directors. If you are a director of a company in financial distress, it is essential that you promptly deal with the situation and seek both legal and accounting advice as to your options. This should include considering the mechanisms available through the Act, such as liquidation, voluntary administration or a creditors’ compromise.

If you have any questions, please contact us for an appointment T:06 349 0090 or email timo@horlseychristie.co.nz.

Tim Oliver
ASSOCIATE
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Disclaimer: This publication should not be construed or acted on as legal advice. It is brief and general in nature. Specific advice should be sought.