This essay deals with directors’ duties, focusing on the duties that specially arise in the context of a company becoming insolvent. The relevant duties are those under sections 131, 135 and 136 of the Companies Act 1993. The drafting of these insolvent trading provisions in New Zealand has been criticised in the legal literature. This research paper considers not only this criticism but also deals with the more general debate about the value of insolvent trading provisions in general. Although the current drafting of the relevant provisions in New Zealand is not without minor flaws, the need for creditor protection requires the maintenance of insolvent trading provisions in general. Besides that, this essay looks at the remedies for breaches of directors’ duties. The most important provision in this context is s 301 Companies Act 1993. Pursuant to this provision both the liquidator and individual creditors can enforce directors’ civil liability. However, the possibilities of individual creditors to obtain payment directly to themselves are restricted. The final part of this essay considers the question whether a separate duty directly owed to individual creditors should be introduced. Although such a duty seems to have some benefits, it would not be commensurate with leading principles and ideas of Insolvency Law and should therefore not be introduced.
It is the concern of this research paper to point out the many issues that arise in context of directors’ duties and insolvency law and to show that it is important to strike an appropriate balance between the intended creditor protection and the entrepreneurial freedom of company directors.
Table of Contents
I INTRODUCTION
II DEFINITION OF “DIRECTOR”?
III THE CONTENTS OF DIRECTORS’ DUTIES
A Directors’ Duties in General
1 The Duty to Act in Good Faith and in the Company’s Best Interest (s 131 CA)
2 The Duty to Exercise Powers for a Proper Purpose (s 133 CA)
3 The Duty to Comply with the Act and the Constitution (s 134 CA)
4 The Duty of Care, Diligence and Skill (s 137 CA)
5 Ratification of Breach of Duty
B Change of Directors’ Duties In or Near Insolvency
1 Reckless Trading (s 135 CA)
(a) Contents and Objectives of s 135 CA
(b) Substantial Risk of Serious Loss
(c) Standard of s 135 CA
(d) Non-executive Directors
(e) Summary
2 The Duty in Relation to Obligations (s 136 CA)
(a) Contents and Objectives of s 136 CA
(b) Standard of s 136 CA
(c) Main Points of Criticism Against s 136 CA
(i) Lack of Exception for Risk-Conscious Creditors
(ii) Uncertainty of s 136 CA
(d) Summary
3 The Duty to Act in the Company’s Best Interest (s 131 CA)
(a) Contents and Background
(b) When Is This Duty Triggered?
(c) Summary
4 Solvency Test
5 Tort of “Deepening Insolvency”
6 Ratification of Breach of Duty
7 Evaluation of Insolvent Trading Provisions in General
(a) Concern That Directors Get Too Cautious
(b) Balance Between Entrepreneurial Freedom and Creditor Protection
(c) Concern of Lack of Business Experience and Fairness among Judges
(d) Ways of Protection: Deterring Effect and Compensation
(e) Concerns about the Deterrent Effect of Insolvent Trading Provisions
(f) A Director’s Conflict of Interest in the (Pre-) Insolvency Situation
(g) Summary
IV THE DIRECTOR’S CIVIL LIABILITY – ENFORCEMENT OF DIRECTORS’ DUTIES
A Enforcement of Directors’ Duties in General
1 Overview of the Available Remedies
2 Who Can Generally Enforce Directors’ Duties?
B Enforcement of Directors’ Duties in Course of Liquidation
1 Additional Possibilities of Enforcement in Course of Liquidation – s 301 CA
2 Enforcement by Individual Creditors
3 Possibility of Enforcement for Creditors Outside of s 301 CA
4 Summary
V SEPARATE DUTIES DIRECTLY OWED TO CREDITORS?
A Alleged Benefit of Solving System Inconsistencies
B Alleged Benefit of Discrimination of Creditors
C Policy Considerations Against Separate Duties to Creditors
VI CONCLUSION
Objectives and Core Themes
This research paper examines the legal obligations of company directors during insolvency, specifically focusing on sections 131, 135, and 136 of the New Zealand Companies Act 1993. The primary objective is to evaluate how these duties serve to protect creditors and to determine whether a shift toward separate, direct duties owed to individual creditors is justified, while balancing the need for creditor protection against the importance of maintaining entrepreneurial freedom for directors.
- Analysis of core directors' duties in the context of insolvency.
- Evaluation of the insolvent trading provisions and their effectiveness.
- Investigation of the civil liability and enforcement mechanisms under the Companies Act 1993.
- Critical review of the proposal to introduce separate duties owed directly to individual creditors.
- Balancing creditor protection with the entrepreneurial environment and corporate governance principles.
Excerpt from the Book
Reckless Trading (s 135 CA)
According to s 135 CA a director must not agree to a company’s business being carried on in a manner likely to create a substantial risk of serious loss to creditors, nor cause or allow for this to happen.
This duty is derived from Common Law and based on s 320(1)(b) Companies Act 1955. Therefore, the decisions under s 320(1)(b) CA 1955 will remain relevant for the interpretation of s 135 CA.
According to s 169 CA the duty imposed by s 135 CA is expressly owed to the company, not to the company’s shareholders or to its individual creditors. Having said this, the question remains - and is important to be answered - who actually is “the company”. The term requires interpretation. The question can only be answered by having a closer look at the duty’s contents, its purpose and the concept of a company as a separate legal entity. As having outlined above, a company can be equated with the shareholders as a whole as long as it is a running concern. This is because it is the shareholders’ investment that constitutes the company’s assets and with that the directors run the company’s business. Once these funds are exhausted and the company enters or nears insolvency, the company’s creditors as a whole have the priority interest in the company’s economic performance, because this performance is crucial for what they can get out of the liquidation process. Therefore, the creditors as a whole can be regarded as the ones whose funds constitute the assets of the company.
Summary of Chapters
I INTRODUCTION: This chapter outlines the scope of the paper, detailing the significance of directors' powers and the necessity for controls, particularly when a company faces insolvency.
II DEFINITION OF “DIRECTOR”?: This section provides an expansive definition of directors, covering de jure, de facto, and shadow directors, as well as delegates and non-executive directors.
III THE CONTENTS OF DIRECTORS’ DUTIES: This major section covers both general duties (care, fiduciary) and those specific to the (pre-) insolvency phase, including reckless trading and obligations to creditors.
IV THE DIRECTOR’S CIVIL LIABILITY – ENFORCEMENT OF DIRECTORS’ DUTIES: This chapter analyzes the mechanisms for enforcing liability, focusing on the role of liquidators and individual creditors under section 301 of the Companies Act.
V SEPARATE DUTIES DIRECTLY OWED TO CREDITORS?: This chapter critically assesses arguments for establishing direct duties to creditors and ultimately rejects the proposal based on principles of collective insolvency law.
VI CONCLUSION: The final chapter summarizes the findings, reiterating the necessity of maintaining current directors' duties to protect the collective interests of creditors.
Keywords
Directors' Duties, Insolvency Law, Companies Act 1993, Reckless Trading, Creditor Protection, Civil Liability, Liquidation, Shadow Directors, Corporate Governance, Fiduciary Duties, Insolvent Trading, Business Judgment Rule, Enforcement, Company Assets, Entrepreneurial Freedom
Frequently Asked Questions
What is the central focus of this research paper?
The paper focuses on the legal duties imposed on company directors, particularly when a company becomes insolvent or faces financial distress, and investigates the efficacy of these duties in protecting creditors.
What are the primary duties discussed in relation to insolvency?
The paper primarily discusses sections 131, 135, and 136 of the New Zealand Companies Act 1993, which cover good faith, reckless trading, and duties regarding company obligations.
What is the main goal of the research?
The goal is to determine if current directors' duties are sufficient to protect creditors and whether the introduction of separate, direct duties to individual creditors would be beneficial or contrary to existing insolvency law principles.
Which legal mechanisms are examined for enforcement?
The paper examines civil liability, particularly under section 301 of the Companies Act, and the roles of liquidators and individual creditors in enforcing these liabilities.
What does the main body address regarding directors' behavior?
The main body addresses the standard of conduct expected of directors, the "objective" versus "subjective" nature of these duties, and the tension between allowing entrepreneurial risk-taking and ensuring creditor safety.
What characterizes the key themes of this work?
The key themes include the "insolvent trading" debate, the balancing of interests between shareholders and creditors, and the enforcement of personal liability for company directors.
Is the "Deepening Insolvency" theory supported by this research?
No, the paper argues that "deepening insolvency" should be viewed merely as a damage theory rather than a distinct cause of action, noting it is too vague and unnecessary given existing duties.
How does the paper view the role of non-executive directors?
The paper acknowledges that while their role differs from executive directors, they are still subject to high standards of monitoring and cannot adopt a passive "hands-off" approach to company affairs.
Why does the author reject the introduction of separate duties to individual creditors?
The author rejects this because it would lead to a "race to the courts," undermine the collective nature of insolvency proceedings (the pari passu principle), and create legal inconsistencies.
- Quote paper
- Julia Honds (Author), 2006, Directors' duties in the context of insolvency, Munich, GRIN Verlag, https://www.grin.com/document/80625
