Debtors, creditors and business risk

Bob Dylan’s famous line “The times they are a-changin’” has hardly been truer for small business in New Zealand than now.

For the first time since the Pandemic started businesses are operating in an environment where there is a reduction of easily accessible cash for their customers.  Interest rates are rising, inflation is high and not only does this affect profitability of the business it affects the customers of our businesses.

In this environment businesses need to pay careful attention to their debtors and creditors and the risk that they pose.

Due to increase in costs in the economy and interest rates, customers of most businesses are not paying their accounts as quickly as they were a year ago.  For cash flow purposes this is extremely important for every business.  As well as the usual focus on communicating with debtors to ensure payment is made, businesses should in this current time, review their contracts with their customers.

It is recommended that Terms of Trade be updated to ensure they allow for effective recovery of debt and security if appropriate.  Receiving a personal guarantee from your customers or taking a charge over goods sold as part of their Terms of Trade may be critical to whether or not your business receives payment.

Be conscious under the Fair Trading Act that contracts with non-business customers must not include any unfair contract terms as defined in the Fair Trading Act.  From August 2022 these obligations also apply to business to business contracts worth less than $250,000 (ie. not just consumers). Unfair terms include limiting your liability entirely or having the unilateral ability to terminate the contract, vary prices or impose penalties. The Commerce Commission have helpful information about other terms which may be deemed unfair at https://comcom.govt.nz/business/your-obligations-as-a-business/unfair-contract-terms

On the other side of the ledger, our own suppliers also need to be paid.  If our debtors are slow paying can we pay our creditors?

The Companies Act sets out a range of duties of directors.  A primary obligation of company directors is to not carry on your business in a manner likely to create a substantial serious loss to the company’s creditors.

Continuing to trade when you are unable to pay your creditors could pose a serious risk to your company and to you as a director.  Directors will be personally liable for losses in circumstances where they trade recklessly.

Directors can also be personally liable for misrepresentations under the Fair Trading Act in circumstances of insolvency.  A recent case called Dempsey Wood Civil Limited v Gapes [2021] NZHC2362 came to court because Mr Gapes as a director of Panama Road Development Limited (PRD) assured one of its suppliers, Dempsey Wood Civil Limited (Dempsey Wood) that PRD could pay for ongoing work.

When they went into liquidation and Dempsey Wood wasn’t paid, Mr Gapes was required by the court to pay $100,000 for the breach of his director’s duties under the Companies Act and a further $280,000 to Dempsey Wood for breaching the Fair Trading Act because he represented that PRD could pay for ongoing work.

If you have any concerns about whether or not your business can meet its obligations under the Companies Act, you should seek advice from either your lawyer or your accountant.

At no time since the global financial crisis has it been more important for directors to be conscious of their obligations and to consider asset protection mechanisms for themselves.  As the Dempsey case shows, directors have significant personal liability and we can advise you on appropriate measures to protect not only your business but your personal assets in the current environment.

As Dylan said the Times they are a changin’.  Now cash is harder to come by and costs are rising we highly recommend that businesses:

• Review their debtors and customer contracts to make sure they are relevant for the current times and in particular:
  • Ensure terms of trade are incorporating appropriate security.
  • Ensure terms of trade do not contain any unfair contractual terms.
• Review obligations to their own creditors to ensure they are meeting their own payment obligations; and
• Take steps to protect not only their business but their personal assets.