Covid-19: Director’s liability for insolvent trading

Covid-19: Director’s liability for insolvent trading

It is without a doubt that the period of Covid-19 lockdown will have a devastating effect on the financial viability of many many companies.  The directors of those companies will need to be very aware of their duties under the Companies Act 1993 not to allow their company to engage in insolvent/ reckless trading. 

The relevant section is section 135 of the Companies Act 1993 which provides that a director of a company must not:

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

There is also section 136 of the Companies Act which provides that a director must not agree to the company incurring an obligation unless the director believes at that time on reasonable grounds that the company will be able to perform the obligation when it is required to do so.

Under section 301 of the Companies Act 1993, a court can hold a director personally liable to any creditors of the company who have suffered a loss as a result of a director breaching its duties under the Act. 

Directors must therefore act with care when incurring additional financial obligations during the lockdown period and must ensure that they are satisfied that the company will be able to perform these obligations (i.e. via intercompany support or shareholders loans).  An example would be if the directors of a company authorised the company to obtain financial accommodation to get them through this tough period.  The directors must, prior to entering into any loan documentation, have grounds to believe that the company will be able to meet its existing and new obligations. 

Directors must also reasonably believe that the company continuing to trade would mean that the company would not be at risk of being unable to meet its existing commitments to creditors.

In exercising any decisions regarding the company incurring further obligations or meeting its existing obligations, directors should be very conscious of any personal guarantees and the effect that incurring these additional obligations may have on their personal liability under those guarantees.  Increasing the Company’s liability may only serve to increase the Director’s personal liability if the company is in fact unable to meet its obligations.

The Australian Government is ahead of New Zealand in relation to a director’s liability for insolvent trading during this difficult time.  On 24 March 2020 the Australian government announced changes to the Corporations Act 2001 (Cth) and the Bankruptcy Act 1996 (Cth) which will remain in place for the next 6 months (but this period can be extended if necessary).  These changes have the effect of allowing a director to make decisions about their company without fear of any personal liability for allowing the company to trade while insolvent.  In summary, the changes are that for a period of 6 months from 24 March 2020: 

  1. Directors will not have any personal liability for trading while insolvent provided the debt is incurred in the “ordinary course of business’, was incurred during the six month period and was incurred before the appointment of any administrator or liquidator over the company.
  2. The minimum amount for issuing a statutory demand has been increased from $2,000 to $20,000 and the time frame for compliance is now 6 months. In New Zealand the threshold for a statutory demand is $1,000 and the time frame is 15 working days.
  3. The threshold for bankruptcy notices has increased from $5,000 to $20,000 and the period for compliance was increased from 21 days to 6 months. There is no threshold in New Zealand for bankruptcy notices, but the time frame is 15 working days.

Let’s hope that our government can take the lead from Australia and provide directors with the freedom to enter into the transactions they need to ensure the survival of their company without fear of personal liability.

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