As we navigate the choppy waters of economic downturns, the prospect of insolvency looms larger for many businesses. In these challenging times, it is imperative for directors to be acutely aware of insolvency risks and to implement robust risk management strategies to safeguard their companies. The recent economic climate has accentuated the need for prudent financial oversight and strategic decision-making, making it more important than ever to ensure that directors are fulfilling their duties diligently.

Understanding Insolvency Risk

Insolvency occurs when a company is unable to meet its financial obligations as they fall due or when its liabilities exceed its assets. The Companies Act 1993 provides a solvency test that directors must adhere to, which includes both a liquidity test and a balance sheet test. Directors are required to ensure that:
The company is able to pay its debts as they become due in the normal course of business.
The value of the company’s assets is greater than the value of its liabilities, including contingent liabilities.

Heightened Risk in Economic Downturns

Economic downturns exacerbate the risk of insolvency due to reduced consumer spending, supply chain disruptions, and increased cost pressures. During such times, businesses often face declining revenues and tighter credit conditions, making it more difficult to maintain solvency. Directors must, therefore, be proactive in:

• Regularly Reviewing Profitability: Ensure that the company’s operations are generating sufficient profit margins to sustain business activities.
• Monitoring Debt Levels: Maintain a manageable level of debt and avoid over-leveraging the company.
• Assessing Capitalisation: Ensure that the company has adequate capital reserves to weather financial difficulties.

Director Responsibilities and Duties

Under the Companies Act 1993, directors owe duties to the company, its shareholders, and creditors. These duties include acting in good faith, exercising care and diligence, and avoiding conflicts of interest. Directors must ensure compliance with the solvency test before making any distributions to shareholders and must be prepared to demonstrate this compliance.

Potential Claims Against Directors

Directors can face severe consequences for dishonest, fraudulent, or wrongful actions, including:

• Fraudulent Trading: Continuing to trade while knowing the company is insolvent can lead to personal liability.
• Reckless Trading: Engaging in business activities that create substantial risk of serious loss to creditors.
• Breach of Director Duties: Failing to act in the best interests of the company or exercising required care and diligence.

Director Disqualification

The Registrar of Companies has the authority to disqualify directors who fail to meet their obligations. Disqualification can occur due to persistent breaches of the Companies Act, involvement in multiple insolvencies, or conviction of offences related to company management. Disqualified directors are prohibited from being involved in the management of a company for a specified period.

Compensation Under Section 301

Section 301 of the Companies Act 1993 allows for compensation claims against directors for losses incurred due to their breach of duties. This provision empowers liquidators or creditors to seek redress for damages, holding directors personally accountable for their misconduct.

Case Study:

A typical case in 2023 involved the liquidation of a mid-sized manufacturing company in Auckland. The directors were found to have continued trading despite clear signs of insolvency, including mounting debts and an inability to pay suppliers. The court ruled that the directors had breached their duties under the Companies Act, leading to significant personal liability and disqualification. This case underscores the critical importance of directors adhering to their legal obligations and making prudent business decisions.

Conclusion

In the current economic climate, directors must be vigilant in managing insolvency risks. Regular financial reviews, prudent decision-making, and strict adherence to the solvency test are essential strategies to prevent insolvency or mitigate its consequences. By understanding their duties and the severe repercussions of failing to meet them, directors can navigate these challenging times more effectively, ensuring the longevity and stability of their businesses.

For more information and guidance on managing insolvency risk, please This email address is being protected from spambots. You need JavaScript enabled to view it. at McDonald Vague Ltd. We are here to support you in safeguarding your business against potential financial pitfalls.

In the current economic climate, businesses are being advised to keep a close eye on costs.  Certain sectors are experiencing heightened financial distress, posing significant risks to lenders, customers, and suppliers. Understanding these risks and taking appropriate precautions can mitigate potential losses and ensure more stable business relationships. Below, we outline the top 10 sectors in critical financial distress and provide strategies to protect your interests.

Top 10 Sectors Facing Financial Distress

Retail: The retail sector is grappling with reduced consumer spending, a big drop in consumer confidence, people working from home affecting foot traffic, the rise in crime / safety issues and high operational costs. E-commerce has also intensified competition, putting additional strain on traditional retailers.  The recent announcement of Smith & Caughey department stores to close after facing 144 years in business but now facing unsustainable trading losses is one example.

Hospitality and Tourism: Changing consumer behaviour arising from less disposable income has severely impacted this sector. Hotels, restaurants, and tour operators face ongoing financial challenges.  Staff shortages, staff retention, cost of living crisis are all hurting this industry.  

Construction: Delays in projects, a squeeze on margins, instability in demand, and labour shortages are affecting the financial stability of construction firms.  Key concerns in this industry are inflation and interest rates.

Automotive: The automotive industry is dealing with reduced demand led by higher cost of funding, customers tightening their belts and increased labour costs. Those that have invested heavily in EV technology have had a dramatic reduction in demand since the government change in the clean car scheme and the introduction of road user charges for EV vehicles.

Manufacturing: The hangover from the Covid Global supply chain disruptions and rising raw material costs have continued to squeeze profit margins for manufacturers.

Transport and Logistics: Fuel price volatility and regulatory changes continue to impact the profitability of transport and logistics companies.

Healthcare: Despite high demand, healthcare providers are facing financial stress due to increased operational costs, challenges with sourcing staff and regulatory pressures.  Larger supersized businesses are hurting the smaller community providers.

Real Estate: Market volatility, interest rates, and fluctuating property values are creating financial uncertainties for real estate firms.

Education: Private educational institutions are struggling with fluctuating enrolment numbers and rising operational costs.

Energy: The shift towards renewable energy sources requires significant capital investment, putting traditional energy companies under financial pressure.

What to Watch Out For

As a lender, customer, or supplier, it is crucial to be vigilant about the financial health of the businesses you interact with. Here are some red flags and precautionary measures to consider:

Late Payments: Delayed payments from a company can indicate cash flow problems.

Frequent Financial Revisions: Companies that frequently revise their financial forecasts may be experiencing instability.

Negative Media Coverage: Watch for news about legal troubles, layoffs, or other distress signals.

Reduced Orders: A sudden drop in orders from a company can signal declining demand or financial trouble.

Leadership Changes: Frequent changes in top management might indicate underlying issues within the company.

Precautions to Protect Your Interests

PPSR Registration: Registering your interest for stock/equipment supplies on the Personal Property Securities Register (PPSR) can secure your position as a creditor and ensure you have priority over unregistered claims in the event of insolvency.

Good Trade Terms: Negotiate favourable trade terms that include shorter payment cycles and clear penalties for late payments to protect your cash flow.

Guarantees: Obtain personal or corporate guarantees from directors or parent companies to secure your credit.

Trust Accounts for Deposits: Use trust accounts to hold deposits for goods or services. This ensures that the funds are secure and can be returned if the transaction falls through.

Trade Limits: Establish credit limits based on the financial health of your business partners. Regularly review and adjust these limits to minimize risk.

Credit Insurance: Consider purchasing credit insurance to protect against the risk of non-payment due to insolvency.

Regular Financial Reviews: Conduct periodic financial reviews of your major clients and suppliers to stay informed about their financial health.

Diversification: Avoid over-reliance on a single client or supplier. Diversifying your business relationships can reduce your exposure to any one company's financial troubles.

Detailed Contracts: Ensure that contracts are comprehensive and include clauses that protect your interests in case of non-payment or delivery failures.

Stay Informed: Keep abreast of industry trends and economic forecasts to anticipate potential issues in the sectors you are involved with.

Conclusion

In these uncertain times, vigilance and proactive measures are essential for protecting your business interests. By understanding the sectors most at risk and implementing robust risk management strategies, lenders, customers, and suppliers can safeguard themselves against the ripple effects of financial distress.

For more detailed advice on managing financial risk and ensuring the stability of your business relationships, This email address is being protected from spambots. You need JavaScript enabled to view it.. We are here to provide you with expert guidance and support.

Many construction companies are facing tough times in the current economic climate. The cost of living and interest rates are creating concern.  Managing cashflow and profitability during the uncertainties of long term projects can be an ongoing challenge for many companies. An equally important challenge is knowing when it’s time to get advice on whether your company can survive or not.

In April 2024 Centrix reported the highest number of liquidations in nine years with construction companies leading the way.  March 2024 liquidations included 56 construction companies.  Centrix reported 486 construction company liquidations during the financial year ended 31 March 2024, compared to 415 in March 2023 and 262 in March 2022.

Construction companies often fail more than those in other industries during economic downturns or recessions due to several inherent vulnerabilities. Firstly, construction projects are typically capital-intensive and highly dependent on financing, which becomes scarce and more expensive during economic downturns. Secondly, construction companies face long project timelines with fixed costs but variable revenues, making them susceptible to cash flow issues when demand decreases. Thirdly, the industry is highly cyclical, closely tied to economic conditions and consumer confidence; when a recession hits, both residential and commercial construction projects are among the first to be postponed or cancelled.

Additionally, construction firms often operate on thin margins, leaving little buffer to absorb financial shocks. The combination of these factors—high fixed costs, dependency on external financing, project delays, and narrow profit margins—exposes construction companies to greater financial risk, leading to a higher rate of failure during economic downturns compared to companies in more stable industries.

If you are concerned about the state of your company then early action is critical. Taking steps to ensure your company remains financially sound will minimise the risk of an insolvent trading action. It may also improve your company’s performance.

The Inland Revenue have issued a warning on non compliance in the sector and advised of the consequences.  They have advised that tax debt is high in the construction sector and 40,000 companies have overdue debt, returns or both and can expect to be followed up.  A particular focus is on cash jobs.

Many people are unaware that there are serious penalties and consequences of insolvent trading including civil penalties and criminal charges. Insolvency can be established by either of the Cashflow or Balance Sheet tests. The company only needs to fail one of these tests to be insolvent.

The Cashflow test is simply whether the company can pay its debts when they fall due. The Balance Sheet test is whether the company's assets exceed its liabilities (including contingent liabilities).

As a director, you need to be aware of your options so that you can make informed decisions about your company’s future. If your company is insolvent you must not incur further debt in the name of the company or you could be made personally liable for that debt.

Options can include refinancing or capital injection, sale of assets, and restructuring or changing company activities. A further option is to enter into a company compromise with creditors whereby debt (in part or full) will be repaid over an agreed period of time. We regularly arrange such Compromises.

Sadly, the matter is often left too late and the only options left are to appoint a voluntary administrator, receiver or liquidator.

The best scenario is to avoid a crisis in the first place by seeking independent expert advice in respect of your duties and the options available.

If you are concerned that your construction company may be insolvent please contact one of our team at McDonald Vague to discuss your options.

In our 41st Insolvency by the Numbers, we look at our data set for April 2024. We review how the month has tracked compared to prior months and years.

In the last month we have seen the latest release of unemployment data showing a rise to 4.3% for the March 2024 quarter, with expectation that it may continue to increase. We have seen a decrease in inflation driven largely by tradeable inflation, meanwhile the non-tradeable inflation continues to remain high, showing we still have some work to do to get over inflation in NZ.

The Reserve Bank has continued with no change to the OCR during the month with the next announcement due in May 2024 hoping to shed some light on when there will be a reduction, economists have revised their estimates to late 2024 or early 2025.

Anecdotally the uptake seen in media enquiries into new appointments has continued, leading to with steady coverage in local and regional news media of the variety of appointments being taken by insolvency practitioners with special emphasis on the number and quantum of creditors left out of pocket.

Company Insolvencies – Liquidations, Receiverships, and Voluntary Administrations

While April 2024 insolvency appointments saw a drop in March hights we have continued the trend seen so far this year being up on past years. Total appointments for the month were 193. April 2024 is 25% up on the long-term average of 148 monthly appointments.

2024 continues showing strong appointment figures well exceeding the last 7 years for the cumulative total of the 4 months to date. As predicted April figures were up again. It definitely highlights the steady drop seen up to 2022 and the quick resurgence in insolvency work that has taken place this year to date and in 2023.

As a percentage spread compared to the average, we have seen solvent liquidations take a drop down 7% in April to 8% while insolvent shareholder appointments and receiverships have increased comparatively.

We expect increases across all types of appointments to continue throughout 2024 and into 2025.

Winding Up Applications

April 2024, the trend continued with 88 applications, marking a slight increase from the previous year but still reflecting a robust level of activity compared to pandemic times which saw 10 applications during that first lockdown. Among these, 38 were attributed to company winding-ups, while 50 were linked to proceedings initiated by the Inland Revenue Department (IRD).

It has now been 13 months since the IRD advertised less winding up applications than every other non-creditor combined. The IRD continues its drive to collect the current level of arrears from delinquent debtors. This will likely be ongoing for several years as they work through a steady backlog.

Personal Insolvencies – Bankruptcy, No Asset Procedure and Debt Repayment Orders.

In February 2024, there were 38 bankruptcy filings, 34 no asset procedures, and 6 debt repayment orders, totalling 78. Personal insolvency figures remain stagnant as seen over the past few years. We expect that we will not see a significant rise in personal insolvency till into the 2nd half of 2024. Notably you can see in the above graph how they have historically tracked corporate insolvency appointments, this trend has changed in the last 6 months with a large difference in the last 2.

Where to from here?

The signs continue to point to the NZ economy being in for continued pain for the foreseeable future with it likely to get worse before it gets better, we foresee continued rising appointments when compared to prior years months as the year progresses. The OCR is unlikely to be dropped in the next 6 months potentially 1 year and inflation continues to be above the target of 2% and may be for some years with non-tradable inflation refusing to come under control.

If you want to have a chat about any points raised or an issue you may have you can call on 0800 30 30 34 or email This email address is being protected from spambots. You need JavaScript enabled to view it..