In February this year the directors of Mainzeal were ordered to pay $36m for breaching their duties under section 135 of the Companies Act because Mainzeal was trading while balance sheet insolvent before it collapsed in 2013.
Do you know if your company is solvent? If it’s insolvent and you continue to trade you could be in breach of the Companies Act. If the company can’t pay its bills, creditors could seek recovery from you personally.
The building industry is chocka with small businesses, as well as individual tradesmen operating as contractors through a limited company. Regardless of the size of your operation, as a director you have a responsibility to act in the best interests of the company.
There are two sections of the Companies Act 1993 that are particularly relevant and all company directors should be well aware of them:
135 Reckless trading
A director of a company must not—
- agree to the business of the company being carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors; or
- cause or allow the business of the company to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors.
136 Duty in relation to obligations
A director of a company must not agree to the company incurring an obligation unless the director believes at that time on reasonable grounds that the company will be able to perform the obligation when it is required to do so.
It may only take one client defaulting on payment, or one adverse adjudication as happened with Arrow International, and the company could be in trouble. If your company is forced into liquidation it is a good bet the liquidator will want to know if the business had been trading while insolvent. If so, they are very likely to take a close look at the directors, with a view to recovering any debts the company owes from the directors personally.
Do you know if your business is solvent?
Solvency means the company is able to pay its debts as they come due.
- If the value of its assets is less than the value of its liabilities your company is insolvent.
- If your business is not able to pay its creditors when the debts fall due your company is insolvent.
In either case you should not be taking on any new obligations (such as new customers or creditors) and should seek professional advice immediately. We know from experience that many building companies do operate while technically insolvent. And while this may not be a problem for the day to day running of the business, it does place liability upon the directors personally if the company gets into trouble.
Top 10 reasons construction firms fail
An assessment of the causes of failure in the Australian construction industry in 2013-2014 highlighted the following:
- Inadequate cash flow or high use of cash
- Poor management of business
- Poor financial control or poor financial skills
- Trading losses
- Poor economic conditions
- Under capitalization
- Poor management of accounts receivable
- Payments withheld or not received
- Low margins
This shows there are many reasons that could cause your company to fail, some within your control (such as having a good financial understanding and management) and some outside of it (such as poor economic conditions and payments being withheld). Either way, the old Kiwi attitude of “she’ll be right” won’t cut it if you have creditors owed money and a liquidator with the legal authority to pursue you personally.
As a company director or officer you could also be personally responsible for health & safety failures
The Health & Safety at Work Act puts responsibility on company directors and managers to that the company has, and implements, appropriate health and safety processes. Failure to do so could see the director, or any officer of the company found responsible, face prison time and/or a substantial fine.
How can you protect yourself?
This is a topic in itself and deserves more than a few bullet points. However, recognising that you don’t know it all and can’t do it all is a good start.
- Ensure you have experienced professionals (who know the building industry) supporting your business, providing you with the right legal, financial, health & safety and insurance structures and advice. Set up a meeting to review your business with each of these advisers.
- Make sure you have a good handle on the financial aspects of your business, so that you can see any potential issues coming. Do some financial literacy training (there are many free courses), make sure you’re using a system that provides up to date visibility of the company’s financial health and get frequent updates from your accountant.
- Don’t put your head in the sand when it comes to your health & safety obligations. Get help from an expert to do an audit of your company’s policies and procedures.
Insurance to protect company directors in these situations
It appears from media reports that a substantial portion of the $36m ordered to be paid personally by the Mainzeal directors will be covered by insurance. Known as directors & officers (D&O) liability insurance it pays both the legal defense costs and any payment that may be ordered by the court if you are accused of failing in your duties as a director.
D&O is a type of liability insurance for losses suffered as a result of the actions of a company’s board of directors and executives. Directors and officers owe a duty of care to the company’s shareholders, customers, employees and creditors. When they breach that duty of care, usually by failing to exercise reasonable care when making decisions, a D&O policy will cover the resulting damages.
D&O policies are payable to either the directors and officers themselves, or directly to the company, to indemnify the insured for the losses. This type of insurance has the potential to cover a wide variety of claims brought against a business for the actions of its directors and officers.
Who should have it
Any one who is a director of a company is subject to the obligations imposed under the Companies Act and the Health & Safety at Work Act.
If your company does not have its own constitution the default provisions of the Companies Act 1993 will apply, and these default provisions prohibit the company from arranging insurance for a director or employee of the company. So, make sure your company has a constitution that expressly allows it to arrange this cover.
In a nutshell
Whether you’re a self-employed contractor or a multi-million dollar construction business, if you operate a limited liability company you could be held personally liable for the losses suffered by creditors and for health & safety breaches. Make sure you understand what your liability is and put in place measures to protect yourself, including taking out directors & officers liability insurance.