If you’ve read the headlines lately, you’ll have seen that businesses are facing a range of risks in 2022. Here’s a sample from the past few months: “Inflation predicted to reach highest level in 30 years”, “Pre covid supply chains may never return”, “Worker shortage in New Zealand will take its toll” and “Steadily rising interest rates are on the way”.
For company directors, these risks present their own set of challenges. And it’s important that anyone in the role, or about to step into it, understands what’s required. In this article, we cover off some of the basics about directors’ duties in challenging economic times.
Who is a director?
It may be a simple question, but the answer isn’t always obvious. A formal appointment may not be necessary, beware the shadow or de facto director! The Companies Act definition is broad and includes any person acting as a director by whatever name they are called, a person who gives instructions to a named director, or those who give directions to the board.
What’s covered in directors’ duties?
Director’s duties are outlined in Sections 131 – 138 of the Companies Act 1993 including:
• Good faith and best interests of the company – the overarching duty on directors is to act in good faith and in the best interests of the company.
• Duty to exercise powers for a proper purpose – a director must exercise their powers for a proper purpose that do not go beyond their mandate or are for personal gain or advantage.
• Duty of care – a director must exercise care, diligence, and skill.
The following are particularly important in times of economic stress:
• Reckless and insolvent trading – a director must not agree to, or cause, or allow a business to be carried on if there is substantial risk of serious loss to creditors. In short, they must consider the ability of the company to pay its debts.
• Duty in relation to obligations – a director must not agree to the company incurring an obligation unless they believe that it will be able to perform the obligation when it is required. A relevant everyday question to ask, is how safe is it for the company to incur further credit during a period of financial instability?
And don’t forget the liability if proper accounting records are not kept – directors should ensure that up to date financial records are kept and that they understand these records and reports.
Understanding your role as a director is critical to success. As a director of a company are you in control of growth, looking for turnaround or exit strategies or loosing control and facing a growing and ageing accounts payable ledger?
The importance of timely action
The sooner directors identify problems, the more options and time they have. As someone who works in restructuring and turnaround services, I highly recommend seeking advice early in these times of
uncertainty.
It is critically important for those holding an appointment as a director to always keep these duties front of mind particularly when the company is experiencing financial
difficulties.
Good governance is key
There is plenty of case law and media coverage where governance has failed; think Mainzeal, Debut Homes and South Pacific Shipping. As a director, recognise when you are at risk of trading insolvently, document your decision-making process and take (and act on) specific professional advice.
Working in the ‘twilight zone’
If you have recognised weakening performance or strategic and operational issues, ask yourself if you have the right information at the right time and is it still relevant.
• How are you responding to that information – have you put plans in place for closer monitoring and what do contingency plans look like?
• Have you taken any professional advice?
• How are you managing demands from creditors?
• Have you documented your decision-making process and are you following that?
• And, most importantly, have your management team and the board, got the bandwidth, the appetite, and the capability to deal with additional pressures?
Be aware of the warning signs with regards to working capital issues. Are you seeing any of these;
• Stretching of trade creditors.
• Increased IRD arrears.
• Breaches of banking covenants.
• Interest charges and penalties.
• Strains on key relationships.
• Increased staff turnover.
What are the penalties?
There are serious consequences for breaching directors’ duties. On the liquidation of a company, the court could order the director to repay, restore or contribute money or property to the company, by way of compensation (the size of any award is linked to the extent of the company’s indebtedness).
Finally, do your due diligence before accepting an appointment as a director. Ask yourself if you have fulfilled your duty of care and other directors’ duties and what evidence you have of doing this. And remember, if you disagree with the actions being taken by the board, what did you do? Ultimately, you could have resigned, although remember you will still be responsible for the actions taken prior to your resignation.
Being a director in challenging times can be incredibly stressful, rewarding and reputation defining. Having the right information, communication, advice, and the wisdom to know when to stop are key.
