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16 May, 2020 | Nathan Tetzlaff
So far, a significant number of New Zealand businesses have applied for the employer wage relief subsidy, indicating that these businesses all predict a revenue drop of 30%. The long-term impact of the pandemic and resulting shutdown will not be known for some time, although a recession is generally considered to be certain. The inevitable outcome is that rates of business failure will increase for the foreseeable future.
Directors and shareholders of struggling businesses may need to make difficult decisions about whether the business has a future, and if not, what to do about this. This article focuses on the various factors that should be considered.
Directors have a variety of duties to the company. Directors must act in good faith and in the best interests of the company. Directors also owe duties to creditors of the company. The Companies Act prohibits “reckless trading”, which is to allow the business to carry on in a manner likely to create a substantial risk of serious loss to the company’s creditors.
If a director of a company which is clearly failing continues to operate the company regardless, and increases the company’s debts, the director risks incurring personal liability for those debts. A claim for reckless trading may be made by the company’s creditors or liquidator in the future.
There is always a certain amount of risk and uncertainty in business. Directors are seldom accused of reckless trading in circumstances where their gamble pays off and the company survives, even if they made decisions that were risky or reckless.
In a recession you can’t just continue with business as usual without carefully considering the future. Do you have a plan to trade through the recession and keep the business afloat? What are the best and worst case outcomes? What is the probable outcome, and is that an outcome which is acceptable to the business’ shareholders given their investment and the business risk?
There may be opportunities for rent relief or obtaining a loan from the government or a financial institution. If there are no other options, costs may be reduced by trimming employee or contractor numbers or remuneration (although this can only be done consistent with ordinary employment law, and the obligations imposed by the wages relief scheme ).
Other considerations will include whether your business’ competitors are better or worse off than you. Even if there is a significant market downturn, if your biggest competitor goes under you may benefit from additional demand as result. Likewise, increasing your marketing may reduce the impact on your business.
The benefit of a registered company is that if the worst happens and the business does fail, the company’s debts are limited to the company’s assets. This may provide some comfort for shareholders who may not be completely wiped out by the company’s failure.
However, especially for small to medium-sized businesses, directors or others may have provided personal guarantees. This becomes a factor to consider when deciding whether the business should be wound up.
If the financial fall-out from closing the business and liquidating the company will extend past the company into personal assets, directors/ shareholders may have an increased appetite for risk and to gamble on the company being able to survive the recension. This can generate personal risk for a director if the desire to continue trading is fuelled by a desire to avoid creditor’s reliance on personal guarantees, and can draw the directors into a situation of reckless trading.
If the company is headed for financial disaster, this does not necessarily mean that it should dive into liquidation as there are alternatives available. If there are a small number of creditors it may be possible to negotiate a settlement with them on the basis that the settlement provides a better outcome for them then liquidation would. This could include elements of debt reduction or a repayment holiday.
Voluntary administration is another option. This is a process where an Administrator is appointed to take over the affairs of the company. The Administrator calls a meeting of creditors who can decide whether to agree to a compromise that allows the business to remain operating, or whether the business should be put into liquidation instead.
If there’s no better alternative and you’ve decided to liquidate, how do you go about this? It’s generally better to be proactive. There is little value in allowing a creditor to liquidate a company. While this will take longer, it does mean that the creditor’s costs will be added to the debt, and more importantly, the creditor will appoint a liquidator of their choosing. This will inevitably be a liquidator who they have confidence will try to squeeze as much money for them out of the company and its shareholders. This is where things like allegations of reckless trading and the potential for voidable transaction come into play.
While every liquidator owes primary obligations to the creditors of the company, some liquidators are known to be easier to deal with than others. A liquidator we already have a good relationship with, and good communications with, may be more willing to negotiate a reasonable outcome with the shareholders than the creditor’s choice of liquidator would.
Economic downturns make hard choices necessary. Make sure that you take appropriate professional advice from a commercial lawyer experienced in this area, your financial advisers and others to know what the future holds for your business. If liquidation or other legal steps do become necessary, we are experts and can help explain the process and select a liquidator who we know and have confidence in.
31 October, 2019 | Nathan Tetzlaff
15 November, 2019 | Nathan Tetzlaff