Trading While Insolvent in New Zealand

When you’re running a small business, cash flow can feel like a weekly (or even daily) puzzle. You might be waiting on overdue invoices, juggling supplier payments, and hoping the next busy period smooths everything out.

That’s normal. What can become a serious legal issue is continuing to trade when your company can’t actually pay its debts as they fall due - commonly referred to as trading while insolvent - especially if you’re a director.

In New Zealand, directors have specific legal duties under the Companies Act 1993. If the company is insolvent (or heading that way), those duties become very real, very quickly. The consequences can include personal liability, being ordered to repay or contribute money, and being disqualified from acting as a director. (In some situations there can also be offences and fines, but director-duty breaches are most commonly dealt with through civil claims and court orders rather than “automatic” fines.)

Below, we’ll break down what “trading while insolvent” means in practice, the key director duties to know about, common red flags for small businesses, and the practical steps you can take to protect yourself and your business.

What Does Trading While Insolvent Mean In Practice?

In simple terms, trading while insolvent is when a business continues operating and taking on debts even though it can’t pay what it already owes (or can’t pay new debts as they fall due).

In New Zealand, a company’s “solvency” is primarily about whether it can pay its debts as they become due - but the law also looks at whether the value of its liabilities exceeds the value of its assets. In practice, insolvency is commonly assessed using two tests:

Cash flow test: Can the company pay its debts as they fall due?
Balance sheet test: Does the value of the company’s liabilities exceed the value of its assets?

For most small businesses, the cash flow test is where the risk shows up first. If you’re regularly unable to pay suppliers, tax obligations (like GST/PAYE), rent, or loan repayments on time, that’s often where insolvency issues start to bite. (Tax arrears are a common warning sign, but the fact you owe tax doesn’t automatically mean you’re insolvent - it depends on the overall position and timing of debts.)

Why “Just One More Month” Can Be Risky

A common pattern we see is:

you fall behind on one major payment (often tax or a key supplier)
you keep trading to “catch up”
you take on more obligations (new stock, new projects, new staff hours)
the gap grows

Even when your intentions are good, continuing to trade while the company is insolvent can expose directors to personal risk - particularly if the company ultimately fails and ends up in liquidation.

Why Directors Need To Take Trading While Insolvent Seriously

If you operate as a sole trader, insolvency usually affects you personally because the business and you are legally the same “person”.

But if you operate through a company, you might assume the company structure automatically protects you. It often does - but not if you, as a director, breach your duties.

In New Zealand, director duties aren’t optional “best practice”. They’re legal obligations under the Companies Act 1993. When a company is financially stressed, the most relevant duties often include:

Duty To Act In The Best Interests Of The Company

Directors must act in good faith and in what they believe to be the best interests of the company. When insolvency is on the table, “best interests” can become more complicated - because creditors’ interests start to matter much more in practical terms.

Reckless Trading (Section 135)

Under section 135, a director must not agree to, 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.

This is one of the key provisions people mean when they talk about directors “trading while insolvent”. It’s not just about whether the business is insolvent today - it’s about the risk created by continuing to trade in the way you are.

Incurring Obligations The Company Can’t Perform (Section 136)

Under section 136, a director must not agree to the company incurring an obligation unless they believe, on reasonable grounds, that the company will be able to perform that obligation when it’s required.

In small business terms, this could include:

ordering stock on 30-day terms when you already can’t pay existing suppliers
signing a new lease when the business can’t meet current rent
taking customer prepayments when you’re not confident you can deliver

Duty Of Care (Section 137)

Directors must exercise the care, diligence, and skill that a reasonable director would exercise in the same circumstances.

That usually means you need to actually stay on top of the numbers - not “check in when there’s time”. If you don’t understand the financial position, you may need to get help (your accountant, a restructuring adviser, and/or a lawyer) so you can make properly informed decisions.

Personal Liability: How It Can Happen

Even though a company is a separate legal entity, directors can sometimes be ordered to contribute personally if they breach these duties and creditors suffer losses as a result.

Also, many small business owners sign personal guarantees (for leases, loans, trade accounts). So even if there’s no director breach, you may still be personally exposed depending on what you’ve signed.

Warning Signs Your Business Might Be Insolvent (Or Heading There)

If you’re worried about trading while insolvent, you’re not alone. Most directors don’t set out to do the wrong thing - they just stay focused on keeping the doors open.

Here are some common red flags that it’s time to take a closer look.

Cash Flow And Payment Red Flags

Consistently paying suppliers late (or paying only the “loudest” suppliers).
Unable to meet tax obligations (GST, PAYE, provisional tax) on time.
Maxing out overdrafts or credit cards and relying on them for day-to-day bills.
Robbing Peter to pay Paul (using one creditor’s money to pay another).

Creditor Pressure Is Escalating

Receiving formal letters of demand.
Creditors refusing further supply unless you pay upfront.
Threats of statutory demands or legal action.

Your Forecast Depends On “If Everything Goes Right”

Optimism is part of running a business. But if your survival depends on multiple uncertain events happening at once (a big client paying, a new contract landing, a busy season being stronger than usual), that can be a sign you need a more realistic plan.

You Can’t Explain Your Position Clearly

If you can’t confidently answer questions like “What do we owe, and when?” or “How long can we keep trading at this burn rate?”, it’s often a sign the business needs tighter financial reporting and governance.

This is also where having solid internal company processes matters - including your Company Constitution if you’re running a company with multiple shareholders or directors and need clarity on decision-making.

What Should You Do If You’re Worried About Trading While Insolvent?

If you’re concerned your business might be insolvent, the goal is to act early and act deliberately. Waiting until you’ve completely run out of cash usually reduces your options.

Here’s a practical step-by-step approach many small businesses take.

1) Get Clear Financial Information (Fast)

You don’t need perfect information - but you do need current information. At a minimum, try to pull together:

a list of creditors and amounts owing (including IRD)
upcoming payment dates (next 30/60/90 days)
cash in bank and confirmed incoming payments
key contracts that affect cash flow (leases, loans, supply terms)

This helps you assess whether the company can pay its debts as they fall due, and whether continuing to trade is actually realistic.

2) Hold A Proper Directors Meeting And Keep Notes

If you’re a director, decisions around solvency should be documented. That doesn’t mean you need to create mountains of paperwork - but you should be able to show that you:

identified the risk
considered the available information
took advice where needed
made a reasoned decision

Depending on your setup, a formal written resolution may be appropriate - many businesses use a Directors Resolution Template to keep things tidy and consistent.

3) Stop And Think Before Taking On New Obligations

One of the biggest risks under section 136 is continuing to incur obligations when you don’t have reasonable grounds to believe the company can perform them.

That means you should be especially careful with:

new stock orders on credit
new hires or increased hours without secured revenue
long-term commitments (like leases or equipment finance)
taking customer deposits if there’s a risk you can’t deliver

4) Consider Your Options: Restructure, Negotiate, Or Formal Insolvency Processes

Depending on the situation, your options might include:

informal negotiations: revised payment plans with key creditors
refinancing: where viable and responsibly structured
selling part of the business: assets, stock, or a business division
formal processes: such as liquidation, or (in some cases) voluntary administration

Which option is right depends heavily on your specific numbers, business model, and creditor relationships - so it’s worth getting tailored advice early rather than guessing.

If you want a clear view of your risk points and next steps, a Legal Health Check can help identify the most urgent legal issues to address (and what can wait).

How Can You Reduce Your Risk As A Director?

Even if your business isn’t insolvent today, it’s smart to set up your legal and operational foundations so you’re protected if things tighten up later.

Here are some practical risk-reduction strategies that are particularly relevant to small businesses.

Put Clear Agreements In Place With Lenders, Investors, And Suppliers

When cash flow is tight, misunderstandings become expensive. Clear contracts help avoid disputes and can give you more workable options if you need to renegotiate terms.

For example, if your business borrows money or gives security, you may need documents like a General Security Agreement. If someone (including a director) provides a guarantee, you might also need something like a Deed Of Guarantee And Indemnity depending on the arrangement.

These documents shouldn’t be treated as “admin tasks” - they can directly affect who is liable, what property is at risk, and what happens if the business can’t pay.

Check Your Director And Shareholder Settings Early

If you’re running a company with more than one owner, insolvency risk can quickly turn into conflict risk (for example, if one shareholder wants to keep trading and another wants to wind up).

It’s much easier to manage this when everyone is aligned from day one, including through core governance documents like a constitution and shareholder arrangements.

Watch Out For “Accidental” Personal Liability

Even where you’re doing your best as a director, you can still become personally exposed if you’ve signed:

personal guarantees for rent, finance, or supplier accounts
indemnities in customer or supplier contracts
director declarations without properly checking the company’s position

This is one reason legal review is so valuable before signing key commitments - especially during a stressful period when you might feel pressure to sign quickly.

Be Careful With Customer Payments And Marketing Claims

When cash is tight, it can be tempting to run aggressive promotions or take upfront payments to bring money in fast.

Just make sure your advertising and customer promises are accurate and you can actually deliver, because consumer law still applies (and reputational damage during a rough patch can be hard to recover from). If you collect customer information during promotions, make sure you’re handling it properly under the Privacy Act 2020 - many online businesses should have a Privacy Policy in place.

Get Advice Early (Before You’re Forced Into A Corner)

One of the most practical things you can do as a director is get advice early enough that you still have options.

That might involve:

legal advice on director duties and risk exposure
reviewing major contracts and guarantees
guidance on negotiations with creditors
advice on restructuring steps and documentation

If you’re not sure where to start, a Corporate Lawyer Consult can help you map out the right path based on your structure and situation.

Key Takeaways

Trading while insolvent generally means continuing to operate and incur debts when your business can’t pay its debts as they fall due (and/or the value of liabilities exceeds the value of assets).
Directors of New Zealand companies have legal duties under the Companies Act 1993, including duties relating to reckless trading (section 135) and incurring obligations the company can’t perform (section 136).
Common warning signs include ongoing late payments, increasing creditor pressure, reliance on credit for day-to-day operations, and unrealistic “best case” forecasts.
If you suspect insolvency, act early: get clear financial information, document decisions, avoid taking on new obligations you can’t support, and explore restructure or formal options.
Risk reduction is much easier when your business has strong foundations, including clear governance, properly drafted agreements, and careful management of personal guarantees and security documents.
Because insolvency risk is highly fact-specific, getting tailored advice early can help protect both the company and you as a director.

If you’d like help understanding your director duties, assessing insolvency risk, or putting the right documents in place, you can reach us at 0800 002 184 or team@sprintlaw.co.nz for a free, no-obligations chat.

Trading While Insolvent In New Zealand: Director Duties And Risks