Reckless Trading

What do we mean by Reckless Trading?

Directors of a company in distress, often ask about trading whilst insolvent and the implications of doing so. Simply put, should the Director/s continue to trade whilst insolvent, the Director/s can become personally liable for any new debt incurred.

There are options around this; however, the most important thing is to take steps to address the issue, should you think you are involved in ‘reckless trading’.

What are the consequences of reckless trading?

The main concept behind ‘reckless trading’ and its prevention is that, should a company Director know that their company is insolvent and continue to trade, creditors who provided credit to the company would have been misinformed and suffered a loss.

Your obligations as a Director.

All Directors need to be aware of the statutory duty they owe to their company not to trade whilst insolvent.

The relevant provision is section 135 of the Companies Act 1993:

A Director of a Company must:

  1. 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
  2. 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.

There are some other points to consider also:

  • The company does not need to be in Liquidation for a Director to be liable for reckless trading
  • Reckless trading can relate to any business of the company – even an isolated transaction unrelated to the usual business of the company
  • A ‘sleeping Director’ (one who has no hands on role in the business)can be held liable for reckless trading

The solvency test

The solvency test has two parts – liquidity and balance sheet.

  1. The liquidity part requires the company to be able to pay its debts as and when they arise in the normal course of business.
  2. The balance sheet part relates to the value of the company’s assets being able to exceed the value of its liabilities – including contingent liabilities. In determining whether the balance sheet aspect will be met, Directors must pay regard to:
    • The most recent financial statements of the company that comply with s10, Financial Reporting Act 1993; and
    • All other circumstances that the Directors know, or should know, affect, or may affect, the company’s liabilities – including contingent liabilities

Directors’ obligations

Directors must ensure that the solvency test will be met by the company immediately following the transaction.

For practical purposes, Directors should state clearly on all Resolutions, the grounds upon which the Directors rely to determine the solvency test will be met. Directors should also state clearly any reports, financial statements, valuations or estimates upon which they rely in meeting the solvency test.

Contact Liquidation Management to find out more about Reckless Trading and how we might help you retrieve your situation best.