Navigating the risk of Company insolvency

5 September, 2025 | Tam Irvine

How Directors can balance competing duties towards their Company and its debtors

Overview

The Companies Act 1993 expects New Zealand company directors to carry out their duties in a manner that balances the interests of company shareholders against those of company creditors.

Maintaining this balance is straightforward when a company can pay off its debts as they fall due. In such circumstance the director’s duties are principally owed towards the company itself.

Even during good times, directors should always remind themselves that their company’s ability to pay its debts can erode over time. Such a change causes a shift in the legal direction of the director’s duties towards company creditors.

It is important for directors to stay alert to such a shift. Should their company end up having liquidators appointed, their adherence will be subject to scrutiny to determine whether they have breached the Companies Act. This is an outcome that can give rise to personal accountability and obligations to pay money towards the company that they previously served.

Identifying When a Director’s Allegiance Shifts

One difficulty that directors face when their duties shift from their company to its creditors is identifying when this switch starts to occur.

Red flags that should put a company director on notice include the obvious, such as when reduced cash availability makes it difficult to pay debts on time (where the company has to ‘scrimp and save’ to stay afloat). Such problems can be forecast when the company’s customers fail to pay their invoices on time and in the amounts expected.

On the other side of the ledger, increased expenses in the form of higher utility costs, lending interest rates or unexpected overheads (for example the costs of defending litigation or a large one-off repair bill), should also serve as a prompt for directors to start looking over their shoulder.

Practical Steps that Can Assist Directors to Balance Competing Duties as Their Allegiance Shifts

There’s no avoiding a potentially uncomfortable level of (hindsight) scrutiny for directors whose companies enter liquidation. Directors are expected to be alert to the fortunes affecting the company and to have judgment that isn’t affected by optimism or unrealistic expectations.

As a broad yardstick, directors should adopt a cautious and conservative approach to business dealings when alerted to problems with their company’s finances.

Review the company’s decision making and record keeping (ensuring that records are complete and up to date). Adopt a more rigorous approach to decision making and record keeping while the company is under financial stress as a means of pre-emptive defence against future (unwelcome) scrutiny. As mentioned above, liquidators are highly likely to scrutinise the decisions of directors. A lack of information surrounding a company’s actions when it’s near insolvency is an opportunity for a company’s creditors’ imaginations to run wild.

Directors who are part of a larger board of directors should always exercise their own independent judgement in respect of company decision making. Recent case law in this area has highlighted the personal risk that individual company directors take if they simply ‘go along with the pack’ when exercising their duties. Any director who is uncomfortable with a board decision should ensure that their dissent is voiced and recorded in the board’s meeting minutes. Where serious concerns exist, seek independent legal advice (for more information, see below).

Where an individual director starts to suspect that company insolvency is more likely than not, they should consider fortifying their decisions from unwelcome criticism by reaching out for professional and independent advice (from consultants, accountants, lawyers etc). While expensive, making business decisions informed by such advice demonstrates a level of responsibility and caution that will improve a director’s odds of escaping personal sanctions in respect of their conduct towards the company. All advice received should be recorded in writing and noted in the records of the company’s decision making.

Contracting practices should be tightened up (the company should only enter contract arrangements that are written, signed and have clear – simple – payment mechanisms; ideally preferring smaller regular payments over larger discretionary ones).

If the company is to be ‘bailed out’ by a stakeholder (a creditor or perhaps a particularly interested shareholder), directors should ensure that such promises of support are legally binding before steering the company on a course of action in reliance of such promises (to do anything else would be to risk engaging in ‘Reckless Trading’ – a potentially serious breach of the Companies Act).

Consider (ahead of time) the benefits to be gained from obtaining directors and officers insurance cover, noting the extent and the adequacy of such policies relative to the size of the company and nature of its trade.

Overall, the guiding approach should be increasing levels of caution and conservatism until the company is either: (a) free of financial problems; or (b) the company is put into liquidation.

Want to know more?

Complete the form below, and we will get back to you promptly, or contact Tam Irvine on 09 837 6837 or tam.irvine@smithpartners.co.nz