Directors’ Duties in Tough Economic Times: What You Need to Know

Directors of companies in New Zealand are facing ever more challenging economic conditions characterised by varying interest rates, inflation, and market volatility.  During periods of financial stress, directors must navigate complex legal responsibilities carefully, as failure to comply with statutory duties can lead to severe consequences, including personal liability and regulatory penalties.  

Here’s a quick look at the key directors’ duties under the Companies Act 1993 (the Act) and some practical advice on how directors can mitigate risks during these trying times.

Core Duties of Directors

Under the Act, directors are bound by several fundamental obligations.  Firstly, directors must always act in good faith and in the best interests of the company.  In tough economic conditions, acting in the company’s best interests might involve making difficult but necessary decisions such as restructuring, cost reductions, or pursuing external investment.

Directors also have a duty to exercise the level of care, diligence, and skill that would be expected of a reasonable director in similar circumstances.  Practically, this means staying informed about the company's financial health and being actively involved in its decision making.  The directors' vigilance is particularly key in avoiding reckless trading, as continuing business operations in a manner that risks substantial loss to creditors is prohibited.

Further obligations arise when the company is approaching insolvency.  Directors must avoid incurring new obligations if there is a reasonable belief that the company may not meet these liabilities.  

Key Risks for Directors in Financially Stressed Businesses

Economic downturns introduce heightened risks for directors, particularly around cash flow management and creditor relationships.  Ensuring that the company maintains its ability to meet payment obligations is essential, as failure to do so can expose directors to potential legal actions from creditors.  Additionally, insolvent trading, which is continuing operations while unable to meet financial commitments, can lead to personal liability for directors.

In such conditions, directors are often subject to increased scrutiny from stakeholders, including shareholders, creditors, and regulatory authorities. Creditors may seek to call in debts owing, and shareholders have rights of action under the Act against the company and directors personally, as well as potentially the right to bring actions against directors on behalf of the company. Regulatory authorities can impose fines and, in a worst case scenario, criminal sentences.

Directors' actions must demonstrate transparency, responsible governance, and compliance with all legal obligations to minimise potential claims or regulatory intervention.

Practical Guidance for Directors

To safeguard themselves and their companies, directors should take several proactive measures. Regular financial monitoring is key here, with close attention paid to cash flow, profit margins, and the company’s liabilities.  Financial performance should be reviewed at a Board level regularly and rigorously.

To navigate complex situations and to minimise personal risk, directors should seek professional legal and financial advice early and often.  

Transparent and honest communication with stakeholders is equally important, as proactive dialogue can help quell any uncertainty and avoid disputes or shareholder action.  

Directors should also be open to exploring restructuring options, such as voluntary administration, creditor compromises, or, where necessary, winding up the company.

Recent Case Highlight

A recent and significant case highlighting the importance of directors' duties is Yan v Mainzeal Property and Construction Limited [2023] NZSC 113.  Mainzeal was placed into liquidation in 2013, owing unsecured creditors approximately $110 million.  The Supreme Court found that the directors breached sections 135 (reckless trading) and 136 (duties in relation to obligations) of the Act.  The directors had improperly relied on informal assurances of financial support without enforceable guarantees.  The directors were ordered to personally pay $39.8 million (plus interest).  This decision highlights the necessity for directors to rigorously adhere to statutory obligations, particularly around solvency and creditor protection, at the risk of their own personal liability.

Final Thoughts

Tough economic conditions demand directors demonstrate cautious, informed leadership and strict compliance with the statutory duties outlined in the Act.  By understanding these obligations and proactively managing financial risks, directors can effectively navigate periods of economic uncertainty. Seeking timely professional advice is essential to mitigate potential liabilities and ensure informed decision making that protects both the company and its directors.

If you are a director experiencing financial challenges, consulting with your legal and financial advisers can provide essential guidance on fulfilling your obligations and safeguarding your business.