Leicester Gouwland: Impact of limited liability on vulnerable can be reduced

Often small businesses in difficulty cannot afford advice and a fund would be a way of providing help, to reduce the likelihood of insolvency. Photo / Getty Images

• Leicester Gouwland is a director at accountancy and finance specialist William Buck Christmas Gouwland.

With New Zealand business made up of predominantly small family-owned companies which suffer significantly when other businesses fail (such as with Dick Smith), is it time to consider if limited liability has gone too far?

Limited liability has been an essential aspect of business for centuries and is one of the reasons private enterprise has flourished. Limited liability is a way of diversifying risk away from the business owner to the suppliers, employees and customers of that business.

In the year to June 30, 2015 over 2400 New Zealand companies went into liquidation or receivership. Not all have been due to insolvency.

So, do we need to make directors and shareholders more accountable?

And is it not time to decide how to spread the risk of business failure to a range of stakeholders so those owed monies at the time of collapse don't suffer an unfair portion of the loss?

An easy first step would be to set a minimum level of capital on the incorporation of a company - perhaps $1000 is a good start. It would demonstrate a commitment to the business by the owners.

This amount could be reduced in the case of a company set up to act as a trustee, and not trading.

As the level of business activity grows, the amount of capital a company must hold should increase based on the level of creditors at the previous year end.

There are a significant number of companies which are "one-man bands", and consideration should be given as to whether they should be entitled to limited liability. This would make owners more accountable.

However, it is arguably unfair and counterproductive to target a sector of business that is most vulnerable anyway.

As public companies have adequate levels of capital, they would not be subject to these rules.

The next question is how to provide further information to businesses engaging with a company.

One possible solution is, each year when a company's annual return is lodged with the Companies Office, the level of creditors should be disclosed.

And if the company is insolvent then the level of negative equity should also be disclosed. Further, a director statement should be provided advising whether the company is paying its creditors as they fall due.

An easy first step would be to set a minimum level of capital on the incorporation of a company - perhaps $1000 is a good start.

This would give the public a better understanding of the company's solvency and place the obligation on the company's directors to manage the business appropriately.

Should any company advise it can't pay its debts as they fall due, the Registrar of Companies should investigate the reasons. If necessary, the Registrar should require the company to rectify its financial position or be placed in administration.

At the point when directors advise on the annual return that the company can't pay its debts as they fall due, each director should be issued a notice stating they are personally liable as they are trading while insolvent.

This should be a straightforward way of recovering money from directors without a complicated legal process.

It would make the directors more accountable with the hope that insolvent businesses cease trading earlier to minimise the loss to creditors, employees and customers.

To improve the governance of a company, consideration should be given to the appointment of an independent director who is a member of an appropriate professional body.

For instance, a company with a turnover of $30 million is likely to have significant creditors and a reasonable number of employees. The right independent director would add significant value to a business.

In an ideal world, a company should have a reasonable level of liquid assets to meet creditor payments. However, this is an inefficient use of these assets.

Also in an ideal world, companies should have debtors' insurance should any debtor become insolvent due to an inability to pay its debts, and creditors insurance - usually a life or disability policy.

However, these policies are expensive, and may not always be available.

One alternative is for companies to insure themselves through a Government-controlled and managed creditors' fund so those who have suffered losses through insolvency can make a claim, and provide a resource to struggling businesses.

Often small businesses in difficulty cannot afford advice and a fund would be a way of providing help, to reduce the likelihood of insolvency.

As part of the annual return fee there should be a mandatory contribution to the fund - perhaps a minimum of $100. This would rise in line with the company's level of capital. It would be funded by companies and directors. However, the Government could contribute.

When a small business owner is not paid, this could be the lifeline to continue trading, stopping the chain effect of not being able to pay creditors.