View/Open - Research Commons - The University of Waikato

contributed by the shareholders and does not reflect the current value of the company. 46
So, when the company is in difficulty, the creditors could not rely on the amount
represented to be used to pay them because it did not represent the company‟s current
position.
Hence, the solvency test has begun to replace the doctrine as a tool to protect creditors.
This test can give more adequate protection to creditors because it reflects the company
current status. Creditors too are concerned with the company‟s flow of funds instead of
the amount of shares capital. 47 This is because creditors will be able to gauge their
position more accurately from the cash flow of the company.
New Zealand has taken the initial step of replacing the doctrine with that of the solvency
test. The Act allows directors to take advantage of the limited liability, provided the
company is solvent, although the duty to maintain company‟s solvency is not absolute. 48
Directors lose the protection if they expose the company‟s assets and capital to risks
deemed as illegitimate risks. 49 Other jurisdictions have slowly followed suit and provided
that directors should first satisfy the solvency test before any assets are returned to
shareholders in relation to rules of capital maintenance. 50 The purpose of prohibiting a
company from making distributions to shareholders prior to satisfying a solvency test is
to prevent misallocation of wealth. 51
46 Mike Ross Corporate Reconstructions Strategies for Directors (CCH, Auckland, 1999).
47 Ibid.
48 Mountfort v Tasman Pacific Airlines of NZ Ltd [2006] 1 NZLR 104.
49 Ibid.
50 See the UK Companies Act 2006, the Malaysian Corporate Law Reform Committee “ A Consultative
Document on Capital Maintenance and Share Capital: Simplifying and Streamlining Provisions
Applicable to the Reduction of Capital, Share Buy Back and Financial Assistance (2006) and section 67A
of the Malaysian Companies Act 1965.
51 Ross above n46.
19