New Zealand Grapples with Soaring Company Failures: A Look at Directors’ Duties Under Strain
New Zealand is currently witnessing a significant and concerning surge in company failures, prompting a critical examination of the responsibilities and liabilities placed upon company directors, particularly when businesses find themselves in financial distress. Corporate insolvencies have now reached a 15-year high, with a substantial number of firms entering liquidation or other formal insolvency processes throughout 2025.
This dramatic increase in business collapses has coincided with a timely review by the Law Commission of directors’ duties. This is the first comprehensive assessment of these duties since the foundational Companies Act was enacted three decades ago. The review, slated to deliver its findings in 2027, will delve into the fundamental obligations of directors, their potential liability for any breaches of these duties, and the broader legal framework that imposes personal responsibilities on them.
In light of the alarming number of companies facing collapse, two specific provisions within the Companies Act warrant particular attention during this review: sections 135 and 136. These sections collectively dictate how directors must navigate the challenging period when a company is teetering on the brink of insolvency.
When Protection Becomes a Constraint
At its core, insolvency signifies a business’s inability to meet its financial obligations as they fall due, or when its total liabilities exceed the value of its assets. When a company approaches this critical juncture, directors might be tempted to engage in what is often termed “gambling for resurrection.” By this stage, the company’s equity is frequently depleted, meaning any further risk-taking is essentially being funded by the money owed to creditors. It is precisely this scenario that the insolvent trading duties, enshrined in sections 135 and 136, are designed to address, albeit through slightly different mechanisms.
Section 135 of the Companies Act broadly prohibits directors from allowing a company to continue trading in a manner that creates a substantial risk of serious loss to its creditors. Section 136, on the other hand, mandates that directors must ensure the company is capable of meeting its new obligations as they become due. In essence, both provisions aim to prevent the burden of downside risk from being unfairly shifted onto suppliers, employees, and tax authorities like Inland Revenue once insolvency becomes a looming reality.
The Law’s Imperfections
However, the current legal framework is not without its shortcomings. Section 135, in particular, has long been a subject of criticism due to its vague and open-ended language. Terms such as “substantial risk” and “serious loss” offer directors limited practical guidance when they are forced to make critical business decisions under immense pressure. Unlike judges who have the benefit of hindsight to evaluate decisions in court, directors must act in real-time, often in a highly volatile financial environment.
This lack of clarity can inadvertently lead directors to make overly cautious decisions, potentially stifling necessary risks that could facilitate a company’s recovery. In some instances, it might even discourage sensible risk-taking altogether.
This very issue was brought to the fore in the Supreme Court’s 2020 ruling in the significant Debut Homes Ltd v Cooper case. The court highlighted that directors could be found in breach of section 135 even if their decision to continue trading was a sound business strategy and could have ultimately improved returns for some creditors. This raises questions about the justification of the current rules. If liability hinges primarily on the presence of risk rather than the likelihood of actual outcomes, directors may be incentivised to opt for immediate liquidation over strategies that could potentially benefit creditors. In the long term, this could result in the premature liquidation of viable businesses, leading to a loss of valuable economic activity.
International Approaches to Directors’ Duties
New Zealand’s current approach contrasts with the more flexible frameworks adopted in other jurisdictions.
- Australia: Australian law tends to focus on directors incurring new debts while insolvent, rather than imposing a blanket prohibition on continued trading. Furthermore, Australia has introduced a statutory “safe harbour” provision. This protects directors who pursue a restructuring plan that is reasonably likely to yield a better outcome than immediate administration or liquidation, provided specific conditions are met.
- United Kingdom: In the UK, directors typically become liable only when they knew, or ought to have known, that there was no reasonable prospect of avoiding insolvent liquidation. From that point onwards, they are obligated to take all possible steps to minimise losses to creditors.
- United States: The US approach is generally more permissive. There isn’t a broad statutory duty compelling directors to cease trading upon insolvency. Instead, courts apply a robust business judgment rule, which shields directors who act in good faith, on an informed basis, and without conflicts of interest.
Rebalancing Protection and Recovery
The argument for reform in New Zealand is not about diminishing creditor protection. Instead, it centres on the concern that the current legislation may discourage legitimate rescue attempts in marginal cases. Furthermore, the potential for legal repercussions might deter capable individuals from taking on directorships.
The Law Commission’s review presents a crucial opportunity to reassess the delicate balance the law strikes between safeguarding creditors and fostering sensible risk-taking. New Zealand could consider several avenues for reform:
- Repealing Section 135: The act could be amended to repeal section 135, relying instead on other existing provisions to address demonstrably irresponsible conduct.
- Introducing a Safe Harbour: A statutory safe harbour, similar to the Australian model, could be introduced to provide directors with greater clarity and protection when pursuing legitimate recovery strategies.
- Clarifying Liability Thresholds: The law could be amended to make it clear that liability should only arise when creditors as a whole are likely to be worse off compared to an immediate liquidation scenario, taking into account the information reasonably available at the time of the decision.
Regardless of the Law Commission’s eventual recommendations, it is evident that New Zealand’s current insolvency laws require a thorough and in-depth examination to ensure they effectively support a healthy and dynamic business environment.
