As the director of a company, it can be worrying when your company becomes insolvent. You may wish to continue to trade whilst insolvent to repay the company’s debts and return to solvency. However, doing so may constitute reckless trading, which is a breach of your obligations as a company director. This article will outline:

  • what reckless trading is; 
  • what happens when a company engages in reckless trading; and
  • the alternatives to trading whilst insolvent. 

What Is Reckless Trading?

Reckless or wrongful trading is any trading that is likely to create a substantial risk of serious loss to your company’s creditors. As the company’s director, you are under a duty to not engage in any form of reckless trading. You cannot: 

  • agree to business that is likely to create a substantial risk of serious loss to the company’s creditors; or
  • allow your company to conduct business in a manner that is likely to create a significant risk of serious loss to the company’s creditors

Engaging in trade whilst your company is insolvent can be deemed as reckless trading. You may engage in reckless trading if:

  • you know that the company is insolvent
  • despite the insolvency, continue to trade or allow the company to trade; and
  • this trading is likely to create a substantial risk of serious loss to the company’s creditors.  

However, there are rare instances where a company may engage in trade whilst it is insolvent. Trading whilst insolvent is not itself prohibited. Although, conduct that is likely to create a serious loss to your company’s creditors is. 

There are circumstances where you may reasonably expect to generate sufficient funds from a trade that would lift the company out of insolvency, and avoid a loss to your creditors. Similarly, a trade may not wholly recover your company’s losses, but you may still expect an improvement to your creditors’ financial position. It is only in these limited scenarios that you may continue to trade whilst the company is insolvent. 

How to Avoid Reckless Trading

It is best practice to avoid trading whilst insolvent. Before engaging in any transaction, you should ensure that:

  • your company is solvent. A company will be solvent when it can pay debts when they are due, and its total debt is less than the value of all of its assets;
  • this trade is not likely to give rise to substantial risk to your company; and
  • this trade is not likely to cause serious loss to your company’s creditors. 

Doing so ensures that you are not engaging in any reckless trading. 

What Happens When a Company Trades Whilst Insolvent?

If you engage in or allow insolvent or fraudulent trading, which is likely to create a substantial risk of serious to the company’s creditors, you may engage in reckless trading.

In instances of reckless trading, a company director may be found personally liable for the damage caused to the company and its creditors due to the trading. There have been instances in New Zealand where company directors have been held liable for up to $36 million after allowing their company to trade recklessly. To avoid this personal liability, you must review every transaction your company engages in to ensure it does not constitute reckless trading.

Alternatives to Trading Whilst Insolvent

If your company is insolvent, there are methods through which you can deal with your company’s financial position that does not constitute reckless trading. These alternatives include:

Liquidation

You may voluntarily place your company into liquidation, or your shareholders or court order can put your company into liquidation. 

Once the company is in liquidation, an independent liquidator will:

  • investigate your company and its financial affairs; 
  • determine why your company got into debt; and
  • identify any potential offences that were committed.

The liquidator will take control of, freeze and sell your company’s unsecured assets to repay the shareholders and creditors. Throughout this liquidation process, the liquidator must prepare regular reports and provide this to the creditors, shareholders and Companies Office. After the process, the liquidator will prepare and file a final report on the liquidation outcome with the Companies Office.

Receivership

Your company may have to go into receivership if it cannot pay the debts owed to a secured creditor.

A secured creditor is an individual that has loaned your company money, on the basis that some kind of security backs the loan. If your company cannot repay this creditor, you can appoint a receiver to collect or sell-off that security as a form of repayment. This collection and sale is the process of receivership. 

Your company will no longer be in receivership once:

  • you repay your debt; 
  • the receiver notifies the Companies Register that the receivership has ended; and
  • the receiver provides the Companies Register with a report on the outcome of the receivership.

Key Takeaways

It can be stressful to be the director of an insolvent company. However, it is best practice to cease all trade once your company goes insolvent. Doing so ensures that your company does not engage in any reckless trading, and prevents you from being personally liable for any damage caused to the company due to the trading. Instead of engaging in insolvent trading to deal with financial difficulty, you can:

  • place your company into liquidation; or 
  • go into receivership. 

If you are unsure whether your company can trade, contact LegalVision’s New Zealand corporate lawyers on 0800 005 570 or fill out the form on this page.

Frequently Asked Questions

Is trading whilst insolvent illegal?

In New Zealand, it is illegal for company directors to engage in or allow reckless trading. If your insolvent trading qualifies as reckless trading, it will be unlawful.

What is reckless trading?

Reckless trading is any trading that is likely to create a substantial risk of serious loss to your company’s creditors.

What is operating insolvent?

Operating insolvent is when you continue to operate your company whilst it is unable to pay debts when they are due, and the company’s total debt is greater than the value of all of its assets.

What are alternatives to trading whilst insolvent?

Instead of engaging in insolvent trading to deal with financial difficulty, you can place your company into liquidation or go into receivership. 

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