A curious thing happens when a director believes their company is about to be insolvent.
Whereas the legal obligation of the director up to this point has been to promote the best interests of the company, (Companies Act 1993 Section 131) a director’s priority must then change to considering the best interests of creditors.
This can be a very difficult decision for a director make. The company might be experiencing severe cash flow difficulties but the director may think there is perhaps a way to trade out of the problems. A balance sheet deficit might only be a temporary issue and there may be an expectation that assets will soon exceed liabilities. On that basis it may well be in the best interests of creditors that the company continues to trade. Or, it may not. There lies the rub.
In coming to its decision to trade on the director must show that their belief was reasonable, prudent and justifiable.
The following is a snap shot of a checklist for a director in the unhappy position of drawing the conclusion that their company is about to become insolvent –
- Make sure your financial data is accurate and up to date
- The Board must meet regularly and minute everything
- Obtain and follow professional advice
- Consider whether it is appropriate to cease trading, and obtain insolvency advice
- Explore and record funding options
- Obtain the support of key creditors
- Manage cash flow and fully record decisions
These are just the headline key points to consider. There will inevitably be more.
The important takeaway is to be aware of the financial position, don’t stick your head in the sand and take appropriate professional advice early rather than later.
Quite often liquidators are considered the last resort to ride in and stab the wounded. Brent and I are members of Restructuring and Insolvency Turnaround Association of New Zealand (RITANZ). We have a better chance to generate greater returns and results if approached for advice at an earlier stage. The options can include a restructure, re-negotiated terms, sale and/or break up into parts. Recently we were involved in an advisory role that our mere presence forced the major creditor to take the situation seriously and come to agreed terms that resulted in a better result for both parties avoiding a formal liquidation.