What happens if I’m trading while insolvent?

If your continuing business has insufficient money to pay bills in the normal course of business – employees, suppliers, Inland Revenue – there’s a good chance you’re trading while insolvent. This is never a pleasant way to operate. We explore insolvency and who will ultimately end up being responsible.

What is ‘insolvent’
Who’s responsible?
Penalties for trading while insolvent
Reckless trading – legal cases
Now what?

What is ‘insolvent’?

Being insolvent from a business perspective is where:

  • The business is unable to pay its debts (creditors) as they fall due and/or
  • The business’ total liabilities exceed total assets (called ‘negative equity’ or ‘balance-sheet insolvent’)

It’s usually clear when a business cannot pay its debts – creditors will be chasing payment, Inland Revenue sends threatening letters for overdue taxes, your overdraft increases, employees aren’t sure if they’ll be paid.

Calculating negative equity, on the other hand, is more difficult. Estimates need to be made for the current market value of assets and liabilities. Here’s where it gets tricky – the examples below may impact the balance sheet, which could impact on solvency.

  • The business purchased a warehouse 10 years ago for $750,000 and it’s now worth $1,200,000. The financial statements will usually record the asset at its purchase price, not the current market value.
  • You have a lot of old stock sitting around that you know won’t sell, even at cost. Its value is lower than the value indicated in the financial statements.
  • You’re not sure if some of your debtors will pay the business – they’ve been overdue for months and you’ve been unsuccessful in obtaining payment. Clearly, the original value in the financial statements isn’t recoverable and write-offs are needed.
  • The business owes you (or family or friends) money, and it’s not urgent that they be repaid immediately.
  • You have debt owing to Inland Revenue which has been accruing penalties and interest – these additional liabilities are unlikely to be recorded in your financial statements.
  • After your financial statements are completed, you invest more money in the business.
  • The business is involved in a dispute which, if lost, would require the business to pay the other party. This is a contingent liability and probably won’t be included in the financial statements because the case hasn’t yet been decided and the potential liability is unknown.

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So, you’ve done the math, and concluded that the business is in fact insolvent.

Once insolvent, the business must not incur any additional debt by ‘trading recklessly’. This is the point at which you know that if you incur further costs, your creditors are unlikely to be paid in full. This can include buying an asset on finance, purchasing goods from suppliers, taking out a business loan, entering into a new lease agreement.

In short – it’s fraud, which isn’t a word to be taken lightly. You’re entering into a transaction knowing it cannot be completed due to the business’ lack of cash.

It doesn’t need to be reckless trading in the ‘normal course of business’ either. One-off transactions could also be caught – for example, entering into a lease agreement.

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Who’s responsible?


If the business is conducted under the umbrella of a company, it’s straight-forward. The company directors are responsible. In many small businesses, directors are often also shareholders. But it’s in your capacity as a director that you’re liable – not as a shareholder.

Shareholders own a company and appoint its directors. Directors are responsible for leading and overseeing the company. Over the last few years, the director’s role and responsibilities have expanded and been more formalised. The Companies Office provides great guidance at What it means to be a director.

Sole traders

The sole trader individual will be held liable for debts incurred when trading insolvently.


Businesses aren’t often operated through a trust structure, but if it does and continues trading while insolvent, the trustees are responsible. They have a duty of care to the trust’s beneficiaries – even more so since 30 January 2021.

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Penalties for trading while insolvent

A company is unlikely to be fined for trading while insolvent – if the company’s unable to pay its current debts, it’s not going to pay the fine. Instead, it’s the directors who are penalised. As an individual, the director’s personal assets are at risk and may need to be sold to cover the penalty.

If the business is insolvent, the sole trader is also probably insolvent having exhausted all financial options. As a sole trader cannot be liquidated, the bankruptcy process is probably the next step.

A trust is in a similar situation as a company – with negative equity, the trust can’t pay any fines. The trustees obviously haven’t acted in the best interest of the beneficiaries, so they’ll incur any penalties, rather than the trust itself.

It’s important to understand that directors and trustees have a responsibility to the business creditors, as well as to the shareholders and beneficiaries. So, the director could be sued by creditors and/or shareholders/beneficiaries.

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Reckless trading – legal cases

The cases below are summaries of actions taken against directors for reckless trading.


Nobody goes into business intending to fail or to leave customers and suppliers in the lurch.

If you and your business are struggling to pay bills as they fall due and your loans are increasing, something needs to be done. This could be a change of management, implementing new systems, or closing down.

Trying to trade yourself out of insolvency rarely works without receiving professional advice. It’s also illegal. And yes, that’s meant to frighten you.

In some cases, assets tucked away in companies or trusts aren’t as safe as you may think.

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Now what?

The New Zealand Insolvency and Trustee Service is a good starting point if you’re insolvent/bankrupt, or believe you may be in the future.

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As with many problems, acknowledging and quantifying the issue are the first steps. You may be completely overwhelmed financially and mentally, so the best decision could be leaving it in the hands of a liquidator. You’ll need to provide information and help the liquidator, but at least the problem is in one place, dealt with by one person.

If you’re worried about how your business is tracking please get in touch with your accountant or our Support team. We can help you with a plan and take a non-biased look at the business figures.

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