Reckless Trading and Insolvency
The recent decision in the Mainzeal court case is a timely reminder of what a Company Directors Statutory duties are.
Mainzeal Directors breached their duties under Section 135 of the Companies Act for “reckless trading”. Directors have been requested to compensate $36 million dollars, which is a third of the total loss to creditors.
Interestingly, $36 million is a figure similar to the balance of funds that the Directors had allowed the shareholder group to extract from Mainzeal.
Not too long ago, Hanover Finance Directors settled out of court in July 2015 for $18 million, half of the $35 million being sought by the FMA.
Reckless trading refers to a Director/s taking illegitimate business risks. The material factors to assess that a business risk is legitimate include whether the risk was fully understood by those whose funds were at risk and whether the company was solvent and continued to trade over an extended period. Mainzeal had traded insolvent continuously for 8 years before going into liquidation.
There are two solvency tests and they have to be continuous and satisfied at all times – Pay debts as they fall due and assets must be greater than liabilities.
The rules around reckless trading and insolvency have been codified in less public court cases. Mason vs. Lewis in 2006 set out the essential elements:
- the duty which is imposed by s 135 is one owed by directors to the company (rather than to any particular creditors);
- the test is an objective one;
- it focuses not on a director’s belief, but rather on the manner in which a company’s business is carried on, and whether that modus operandi creates a substantial risk of serious loss; and
- what is required when the company enters troubled financial waters is described as a “sober assessment” by the directors, we would add of an ongoing character, as to the company’s likely future income and prospects.
The Mainzeal Directors obligations breached, were the same obligations that Mr and Mrs Smith with the local dairy could breach.
And the prudent thing that the Mainzeal Directors, just like Mr and Mrs Smith, should have done, was to have sought independent advice from their professional advisors, their Lawyers and Accountants.
If you need advice from a trusted business advisor, contact the PKF Kerikeri team today.
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