Reckless trading

A company is by far and away the most popular choice of trading structure in New Zealand. One of the reasons for its popularity is that generally speaking the liability of the company (and therefore the human individuals that own the company) is limited to the assets of the company.

There are circumstances where a director can be personally liable to a company’s creditors. This includes where a director allows the company to trade in a reckless manner. Section 135 of the Companies Act 1993 prohibits a director from allowing the business to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors.

Reckless trading refers to a director taking illegitimate business risks. Material factors to assess that a business risk is legitimate include whether:

• The risk was fully understood by those whose funds were at risk
• The company was insolvent and continued to trade over an extended period
• The director’s conduct was normal, in its ordinary course of business
• The interests of creditors were considered when the company was near to or insolvent.

The courts have stipulated that a director’s “sober” assessment of the company’s likely future income prospects is required when a company hits troubled waters. The test of recklessness is an objective one. It focuses on the manner in which the company’s business is conducted, rather than on the director’s belief.

Liability for reckless trading can relate to an isolated transaction. The company does not need to be in liquidation and no knowledge of the reckless trading is required.

If your company’s business starts to show signs of insolvency, such as difficulty obtaining working capital, increasing arrears in accounts payable or your creditor days ballooning, take a moment to make a “sober” assessment of your company’s trading prospects.  While during difficult times when you’re trying to turn the company around deciding whether to stop trading is the elephant in the room, this conversation may save you from incurring personal liability in the event of your company’s insolvency.