Many business owners choose to operate as a limited liability company on the understanding that this offers protection from creditors in the event of business failure. But is this completely correct? The answer is both yes and no. While limited liability companies do theoretically offer some protection, the fact is nobody would would want to do business or offer finance or credit to a company if this were completely true.
There are two mechanisms in place to protect banks, finance companies and suppliers offering goods or services on credit in the event of business failure:
- Sections 135 and 136 of the Companies Act 1993
- Directors guarantees
Section 135 of the Companies Act states that a director of a company must not 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.
Section 136 states that a director must not agree to the company incurring an obligation unless the director believes at that time, on reasonable grounds, that the company will be able to perform the obligation.
Continuing to trade while insolvent can result in director(s) being prosecuted. It is also possible for any dividends and some shareholder salaries or drawings paid while insolvent to be effectively clawed back on the grounds that they were awarded unlawfully.
To provide further protection, banks, finance companies and some suppliers only offer finance or credit to a limited liability company, if they receive a signed and witnessed director’s guarantee. This means that the director(s) is(are) personally liable for the balance owing.
At the end of the day, we are all responsible for paying our debts – there is no guarantee of a free pass. And I believe this is a good thing.
But then, why choose to operate as a company? I will cover the pros and cons of limited liability companies briefly in a subsequent post.
The above information is current at the time of writing and is provided in general terms only, relevant to owner-operated businesses in New Zealand. We do not accept responsibility or liability for its accuracy or for the outcomes that may result from placing reliance on this information. If you have any queries about the topic, please feel free to contact me so I can take any subsequent legislative changes and your particular circumstances into account.
Amanda Imms CA
Principal
AJ Accounting Limited
ph. 021 771 557
amanda@ajaccounting.co.nz
