As reported in our recent Waterstone Newsletter, February 2024 saw a record number of liquidations, some of which got the attention of the media, like Selah Homes. Insolvency is increasingly relevant in the corporate context as not just the insolvent companies themselves, but also those who deal with them, are at risk.
Most directors will be familiar with directors’ duties imposed under New Zealand law, which include:
- Act in good faith and in the best interests of the company.
- Exercise powers for proper purposes.
- Exercise care, diligence, and skill.
- Avoid reckless trading.
- Manage conflicts of interest.
- Avoid insider trading.
- Maintain confidentiality.
- Ensure compliance with the law.
Directors must fulfil these duties to promote the company’s success and protect the interests of stakeholders. These duties are investigated during insolvency, with breaches commonly resulting in personal liability.
Directors should make business decisions with this in mind, noting that certain behaviours, such as company assets sold under value, liabilities undertaken that were too onerous for the business to bear, and whether transactional documents are/were invalid, could have serious implications during liquidation proceedings.
In the event the company becomes insolvent, the company must comply with insolvency proceedings and the insolvency practitioners, as not doing so could result in court orders to enforce them.
Lawyers and others who draft, negotiate, and enter contracts on behalf of the company, should ensure that the company’s interests are protected in the event that either contracting party becomes insolvent.
This could be done using a termination clause in the event of insolvency, and a security such as a registered first ranking security interest or enforceable separate personal or corporate guarantee from an entity who holds registered assets with remaining value to the company if realised.
Professionals should also be informed about the insolvency process beyond the statutory demand or debt collection regime, in the event that their company becomes a creditor to an insolvent company. This includes, but is not limited to, repossession of the debtor’s assets (subject to having a registered security interest under a security agreement), filing a creditor claim, right to be informed about the debtor’s financial status (noting a prescribed frequency of reporting for liquidators and administrators), participation in creditors meetings, and objection to debtors’ discharge.
When an agreement or interest is disclaimed by a liquidator as no longer being effective, such as a lease or statutory demand, a company or its lawyer would benefit from knowing how to recover the company’s debt in the event its debtor is insolvent.
For example, the company’s rights to enforce a security interest, personal guarantee or mitigating further losses to the company and prevent it from accruing any liability by cooperation with the insolvency practitioners by providing timely access to property for collection of an insolvent debtor’s assets.
Financial officers and accountants must be aware of the specific financial reporting requirements and solvency tests. Companies are required to file financial statements annually, which must comply with generally accepted accounting principles (GAAP) or applicable financial reporting standards.
Publicly listed companies, large companies, and certain other entities are subject to additional reporting requirements. The ‘balance sheet test’ determines whether the company’s assets exceed its liabilities, and the ‘cash flow test’ determines whether the company is able to pay its debts when due. These two are the main solvency tests in New Zealand.
Directors have a duty to ensure that the company meets these solvency tests and to monitor the company’s financial position on a regular basis. Therefore, finance and accounting professionals should monitor and advise on the solvency of the company.
If concerns arise, directors must take appropriate actions, such as implementing a restructuring plan or seeking professional advice. If the company is insolvent, directors have a duty to cease trading and take steps to minimise losses to creditors. Again, time will be of the essence, and all such actions (or omissions) may be investigated during the insolvency process.
Additionally, as a matter of professionalism, ethics, and protection against personal liability, finance and accounting professionals must be transparent in the company’s status of solvency. New Zealand legislation allows, as a defence against directors’ duty breach, that the director reasonably relied on reports, statements, and financial data and other information prepared or supplied, and on professional or expert advice given by its employees that it believes to be reliable and competent. This provided the director acted in good faith, made proper inquiry, and without knowledge of an unwarranted reliance.
Need confidential advice?
Get in touch with our team if you are seeking recovery of a debt owed, or need guidance and options tailored to your company’s financial circumstances, as our team offer significant expertise on all matters corporate insolvency.
