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investor directors’ duties and managing conflicts during covid-19

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(This is one of a series of blogs on Covid-19. See the others here.)

Many of New Zealand’s startups have an investor director on their boards. As the economic effects of the Covid-19 pandemic play out, investors’ portfolio companies may quickly become financially distressed.  

We’ve looked at areas for investor directors to think about in respect of portfolio companies experiencing financial difficulties.

directors’ duties

reckless trading and incurring obligations

Under the New Zealand Companies Act 1993 (Act) directors must not allow the company to engage in reckless trading or agree to the company incurring an obligation unless they reasonably believe the company will be able to perform it, when required. 

  • on reckless trading: directors must not allow the business to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors, and
  • on incurring an obligation: a director must not agree to the company incurring an obligation unless, at the time the transaction is entered into, the director believes on reasonable grounds that the company will be able to perform the obligation. 

    (An example: entering into a loan agreement with no reasonable basis for believing the company will be able to repay the loan when required.)

On 3 April, the Government announced that they were making changes to legislation to help businesses facing insolvency due to Covid-19. Subject to the proposals being agreed to by Parliament, the announced chances will provide a safe harbour from these above provisions of the Act. Directors’ decisions to keep on trading, as well as decisions to take on new obligations, over the next 6 months will not result in a breach of duties if certain circumstances apply. Check out our blog on these safe harbour provisions to learn more.

Investor directors will still need to be mindful of their duties to exercise care, diligence, and skill, and also to act in good faith and in the best interests of company. These duties will continue to apply when the announced changes come into effect.

practical tips for an investor director

Where a company is in financial distress, directors should:

  • meet weekly, or even daily, to assess the financial position of the company, and
  • obtain and review up-to-date financial information, including cashflow projections.

If a company projects that it cannot meet payroll, that is likely to be a very good indicator that the company cannot continue to trade. The new safe harbour provisions will of course come into play on any analysis of this.

Directors should keep a paper trail of decisions made, including in all directors’ resolutions and certifications. They should also state clearly any reports, financial statements or projections upon which directors are relying in making these decisions.

managing investor director conflicts

This is an issue specific to investor directors. In normal times, the interests of the company and investor are closely aligned. However, during a period of financial distress, this may change with founders and the investor having different views on strategy. The investor director will still need to meet the same obligations as all other directors and can face the same liabilities and possible claims for breaches of the Act. At the same time, they need to balance this with their obligations to their investor.

To help manage the conflict issue and minimise potential investigation of an investor director’s conduct, consider the following:

  • ensure a clear separation between shareholder matters and board matters. At this time, the investor director may need to support the board in a transparent way, and cease to be directly involved in decision making amongst investors 
  • consider arranging for an investor director to remove themselves from a meeting or board discussion on topics in which the investor has an interest, to allow for free and frank discussions between the other directors
  • ensure any communications from investors are made to the board at the same time as the investor director is made aware of the matter – this will help to avoid suggestions of a conflict from the company side
  • if the financial situation escalates toward insolvency, investors and the board should seek separate legal advice, with someone stepping in to lead this on behalf of the investor group, instead of the investor director
  • if the investor is a creditor, be mindful of situations that would require the directors to use their powers to prefer the investors’ position over the company’s other creditors
  • maintain at all times accurate records of all decision making by the board

Are you an investor director and have issues relating to one of your portfolio companies? Get in touch with us. View our other Covid-19 resources on our blog.

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