In New Zealand, and many other countries, the limited liability company is the preferred business structure for commercial activities.

It provides protection for the directors, shareholders and management staff employed by the company from claims by the company's creditors.

Companies have separate legal personality from those who may hold shares in it, or who are responsible for its management and governance.

The "veil of incorporation" is the legal construct giving effect to the limited liability of a company's directors and shareholders.

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However, there are limited circumstances where New Zealand's laws impose personal liability on directors.

If a company is raising capital via public offers of company shares, the directors can be jailed for up to 10 years if they knew any statements made in the offer documents were false or misleading.

There are also lengthy custodial sentences for directors breaching health and safety obligations.

The operation of New Zealand companies is generally governed by the Companies Act 1993.

Former Black Cap cricketer Andrew Penn is principal at law firm Treadwell Gordon.
Former Black Cap cricketer Andrew Penn is principal at law firm Treadwell Gordon.

Under that statute, directors owe duties to the company, including a duty to act in good faith and in the best interests of the company. If a company runs into trouble approaching insolvency, two creditor-specific duties kick in.

Under section 135 (Reckless Trading), a director must not allow a company to continue to trade if there is a substantial risk of serious loss to the company's creditors.

Section 136 (Incurring Obligations) prohibits directors from entering into contracts unless the directors reasonably believe the company will be able to perform the contractual obligations. Directors cannot hide behind the veil.

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These duties are personal and owed by the directors to the company creditors.

A recent case highlighting these duties was the 2019 High Court judgment against the directors of construction company Mainzeal, including former prime minister Dame Jenny Shipley. Mainzeal's liquidators successfully pursued the directors for breaching of section 135 (Reckless Trading) and were ordered to pay $36 million.

The court found that the directors had allowed Mainzeal to continue to trade throughout 2010 and 2011, despite being balance sheet insolvent and subject to a number of large leaky building claims.

The directors had relied on assurances from Mainzeal's shareholder that capital would be injected into the business as and when required. That reliance was not based on reasonable grounds and not sufficient to discharge the directors from their duty.

What does this mean for businesses navigating their way through the Covid-19 environment?

The Government has recently announced its intention to make significant changes to section 135 and 136 of the Companies Act to assist directors of companies facing liquidity problems.

A bill is currently being progressed through the House which introduces "safe harbours" from the creditor-focused duties for companies affected by Covid-19.

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This means that directors of solvent companies (as at December 31, 2019) with reasonable prospects of success post-Covid cannot be liable for breaches of section 135 (Reckless Trading) and 136 (Incurring Obligations) for a period of six months from April 3, 2020.

Treadwell Gordon
Treadwell Gordon

In other words, directors can continue to trade in circumstances creating substantial risk for creditors without the threat of personal liability hanging over them.

This is risky for creditors, suppliers and consultants, who in turn are likely to be facing their own cashflow challenges.

We recommend that creditors ensure they have sufficient security interests and that those interests are perfected on the PPSR register.

The bill introduces a mechanism to address creditors' invoices outstanding at the time Covid trading restrictions were put in place.

The bill contains a Business Debt Hibernation Scheme (BDH) whereby most businesses can propose to their creditors that business debts be put into a form of "hibernation" for up to six months. Eighty per cent of the company's directors and 50 per cent of the company's creditors must vote in favour of a BDH.

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Directors must ensure that their company keeps comprehensive records of board decisions in case those decisions are called into questions later down the track.

There is no doubt Covid-19 creates unprecedented corporate governance challenges for directors as they seek to assess the future viability of the businesses they supervise.

More than ever, it will be important for businesses to engage early and meaningfully with their creditors. It is also crucial that directors are aware of the extent of their personal liability and take measures to ensure that they comply with the director duties.

• Former Black Cap cricketer Andrew Penn is principal at law firm Treadwell Gordon.