Don't knock those with the guts to risk failure

A firm's success often hinges on taking calculated risks, says corporate lawyer MARK LOWNDES.

As a country, we applaud entrepreneurship, but we can be strangely ambivalent about entrepreneurs themselves.

We tend to find business failure rather distasteful, and when entrepreneurs fail, we assume that they made silly mistakes and possibly tried to pull a swiftie or two along the way

Yet these views are at odds with what we know, that entrepreneurship is about taking myriad calculated risks - risks that can lead to great rewards, or to business failure.

And, inevitably, with any failure comes the call to make the directors personally liable. It is this reaction, and the sometimes unfairly simplistic laws relating to directors' personal liability, that can act as a disincentive for people to offer their expertise as directors.

This can deprive entrepreneurs of the experienced mentors they need.

The laws are also a disincentive for skilled directors to stay on the board of a company going through bad times and try to rescue it. Yet this is when a company may need its board most, particularly its independent directors.

For example, under section 136, directors must not agree to the company incurring an obligation unless they believe on reasonable grounds that the company will be able to perform the obligation on due date.

How does a director of a rapidly growing company that will need future capital rounds to become viable know that the company will be able to perform its ongoing obligations? The reality is that the company relies on those future capital raisings, or other significant events, that may or may not occur.

The "reckless trading" section of the Companies Act prohibits directors from agreeing to a business "being carried on in a manner likely to create a substantial risk of serious loss to the company's creditors".

With this in mind, when should directors stop trying to save a company? The law can suggest that quite soon after trouble surfaces is the safest. Yet what if the Air New Zealand directors had done that? Those directors were under huge pressure from almost all stakeholders to find a solution to save the airline, which eventually they did (but at considerable personal risk).

If New Zealand wants to promote an entrepreneurial culture, then we should carefully examine the duties of directors to balance the legitimate protection of creditors against the need for directors to take reasonable and calculated risks.

GEM Special Report