Alala International Limited (in liquidation) v Chen

[2020] NZHC 2214

IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY

I TE KŌTI MATUA O AOTEAROA TĀMAKI MAKAURAU ROHE

CIV-2020-404-212

[2020] NZHC 2214

UNDER

the Companies Act 1993

IN THE MATTER

of the liquidation of Alala International Limited (in liquidation)

BETWEEN

ALALA INTERNATIONAL LIMITED (in

liquidation) First Plaintiff

VIVIEN JUDITH MADSEN-RIES and DAVID SEAN WEBB

Second Plaintiffs

AND

PENG CHIH CHEN

Defendant

Hearing:	2 July 2020
Counsel:	PV Shackleton and HL Hui for plaintiffs No appearance for the defendant
Judgment:	28 August 2020
Reissued:	17 September 2020

JUDGMENT OF FITZGERALD J

[As to formal proof]

This judgment was delivered by me on 28 August 2020 at 3pm, pursuant to Rule 11.5 of the High Court Rules.

Registrar/Deputy Registrar

Date……………

Solicitors:           Meredith Connell, Auckland To:           P Chen, Auckland

Alala International Limited (in liquidation) v Chen [2020] NZHC 2212 [28 August 2020]

Introduction

[1]    Alala International Ltd (in liquidation) (the Company) and the second plaintiffs (the liquidators) proceed by way of formal proof against Mr Peng Chih Chen, the sole director and shareholder of the Company. The plaintiffs say Mr Chen breached a number of duties owed by him to the Company and/or its creditors, and also failed to keep adequate accounting records as required by s 194 of the Companies Act 1993 (the Act).

[2]    Given the alleged breaches, the plaintiffs seek orders pursuant to s 301 of the Act that Mr Chen pay compensation to the Company, such orders having the overall effect that Mr Chen would be liable for the Company’s losses.

[3]    At the heart of the plaintiffs’ claim is the Company’s purchase of a property in Queenstown (the Property) in November 2016 and its subsequent sale a little under a year later. After paying back a loan which had been taken out to part-finance the Property’s original purchase, the Company received net proceeds of sale of approximately $1.8 million. The sale gave rise to a GST obligation on the part of the Company of around $330,000.

[4]    Despite the purchase and then sale of the Property being profitable, the GST arising on the sale was not paid by the Company. Instead, over the period 19 October 2017 to April 2018, the net proceeds of sale (together with existing funds in the Company’s bank account) were almost entirely disbursed to a range of parties, including to Mr Chen himself. Given the lack of accounting records, there is no clarity as to what these payments related to. Mr Chen was unable to tell the liquidators what most of the payments were for, aside from that at least some of them were paying back friends or associates who had loaned him money (which he had presumably on-loaned to the Company).

[5]    It is the dispersal of the net proceeds of sale while the Company was incurring significant tax liabilities (which could not then be met) which gives rise to the plaintiffs’ claims.

Procedural background

[6]    These proceedings were commenced in February 2020. They were served on Mr Chen on 9 March 2020. An affidavit of service has been filed. Despite service, Mr Chen has not filed a statement of defence or taken any other steps in the proceedings. He did not seek to appear at the formal proof hearing.

Factual background

[7]    The Company was incorporated on 21 October 2011. Mr Chen has been the sole director since that time. Until 7 April 2015 when it changed its name to “Alala International Ltd”, the Company was known as “BlueSky Golf Management Ltd”.

[8]    Consistent with that original name, the Company initially operated a golf course at Bucklands Beach. In or around April 2015, it ceased managing the golf course and the financial accounts for the years ending 31 March 2016 and 2017 describe the Company’s business as “souvenir sales”.

[9]    On 10 November 2016, Mr Chen entered into an agreement for sale and purchase of the Property. The purchase price was $2 million (including GST, if any). Mr Chen subsequently nominated the Company as the purchaser. I interpolate to note that there was nothing in the evidence explaining why the Company purchased the Property (it not appearing to fall within the Company’s ordinary scope of business).

[10]   The Company funded the purchase of the Property with an initial deposit payment in the sum of $200,000. Ms Madsen-Ries, one of the liquidators, deposes in her affidavit in support of the plaintiffs’ claims that the liquidators have not been provided with any records documenting the source of the deposit payment. The balance of the purchase price of the Property was funded by:

(a)a bank cheque in the sum of $980,000.   In a later interview of    Mr Chen by the liquidators, Mr Chen said the cheque represented a loan to him from a Mr Zhang, a friend of his in China; and

(b)a loan from Southern Cross Finance Ltd (Southern Cross) in the sum of $850,611, secured by a first ranking mortgage over the Property.

[11]   There was no evidence of any documentation, such as a loan agreement, in relation to the suggested loan from Mr Zhang. Mr Chen said that he borrowed the money from Mr Zhang and that he then “put” the money into the Company. He said Mr Zhang did not take any security for the loan. The Company’s financial accounts for the year ended 31 March 2017 do not appear to reflect any loan to the Company of

$980,000, from either Mr Zhang or Mr Chen himself.

[12]   The Company sold the Property on 29 September 2017 for $2.8 million (inclusive of GST, if any). Settlement occurred on 13 November 2017.

[13]   On settlement, the Company received net proceeds of sale of $1,810,246.01 made up of:

(a)$190,300 from payment of the deposit; and

(b)$1,619,946.01, being the balance of funds received on settlement after repayment of the Southern Cross loan.

[14]   I will refer to the sum of $1,810,246.01 in the balance of this judgment as the “Net Proceeds”.

[15]   The Net Proceeds were deposited into the Company’s bank account with Westpac Bank. Immediately prior to the deposit of those funds, the Company’s bank account with Westpac was in credit to the sum of $174,793.32. I will refer to this as the “Opening Balance”.

[16]   The sale of the Property gave rise to a GST obligation on the Company’s part of approximately $330,000.

[17]   Over the period 19 October 2017 to April 2018, the Opening Balance and Net Proceeds were gradually withdrawn from the Company’s bank account. Amounts totalling approximately $915,000 (net) were withdrawn by Mr Chen and paid to

himself. A number of other large and/or round figure withdrawals were also made in favour of other parties. These included:

(a)a payment of $525,000 narrated “Z Chen”;

(b)a payment of $117,000 narrated “Zhou”;

(c)a number of payments (for example, for $5000, $15,000 and

$30,000) narrated “Mirus International”;

(d)a payment of approximately $261,000 narrated “Qiao Investment”;

(e)a payment of $100,000 to a bank account belonging to a Mr Wang (with “loan back” recorded in the narration);

(f)three payments totalling approximately $215,000 narrated “Lyu Rui”;

(g)a payment of $200,000 narrated “Ye” and “loan repayme (sic)”; and

(h)$108,000 to “Cai Yun Ma”.

[18]As at the end of March 2018, the Company’s bank balance was $262.

[19]   In his later interview with the liquidators, Mr Chen could not provide any clear reason or basis for these and other similar payments out of the Company’s bank account. More often than not, he stated he did not know what the payments related to, could not remember who the recipients of the funds were, or believed they might be friends who had lent him money and he was paying them back. For example:

(a)In relation to the payments to Mirus International, Mr Chen confirmed that was a company “we do some business with”, but that he would need to check what the various payments related to (though stated that the dealings sometimes involved the Company lending money to Mirus International).

(b)In relation to the $260,000 payment to Qiao Investment, Mr Chen said he had “no idea” who or what Qiao Investment was, and that he would have to check, though there were two possibilities, one being “a supplier”, the other being “we pay back the money to people, to the lender”.

(c)Mr Wang was “a friend” and the payments were Mr Chen paying money back to him. When asked whether he personally borrowed the money from Mr Wang, Mr Chen stated:

The answer to this question is when we need the money from the company and I borrow from the friend and I put in the company [indistinct] have the money I will pay them back. That’s how he works.

(d)Mr Chen did not recognise the name Lyu Rui and said he would “see if [he could] find out” who it was.

(e)In relation to the $108,000 payment to Cai Yun Ma, Mr Chen stated that “I’m not sure it’s the money paid back or what. I have to check this one” (though he said it was definitely not a supplier).

(f)The payment to a Mr “Ye” related to a shareholder (or intended shareholder) in the Company, Mr Le’s wife Zhao Yi Nuo, but “we didn’t make the deal so I give the money back to them”.

(g)“Z Chen” was one of Mr Chen’s friends, and the payment of

$525,000 could have been an investment in a project that did not go ahead, and Mr Chen would “have to find out” more details about this.

[20]   Given Mr Chen was the sole director of the Company, and given the sheer size of some of the payments, Mr Chen’s vagueness as to what they related to is somewhat surprising.

[21]   In relation to the Company’s tax liabilities, Mr Chen said the following when asked about why the GST on the sale of the Property had not been paid when there ought to have been sufficient funds to do so:

Yeah, cos we paid part of the GST and we applied to IRD to pay by instalments cos we have lots of debits [sic] we need to pay out. Before we purchase this land, you can see from our statements, we don’t make money for the company so we have some debits [sic] we need to pay out first. I think at that time we applied to the IRD we pay back instalments and after we pay few [indistinct] I can’t remember, then we have difficulty cos my cash flow… because the people lending money in, I pay them but it’s very hard to continue to get the money in, especially when they know how a big project in China is not going to work. There’s no future for how we plan to do.

[22]   After discussing the potential “project” for the Company in 2016, the following questions were put to Mr Chen and answers given:

Q:So the money that should’ve gone to the Inland Revenue for the GST was diverted to pay the costs for this project in China?

A:       No, pretty much it’s pay the loan first. Q:  Being Southern Cross?

A:       Not Southern Cross, some private lender.

Q:The GST money was used to pay the private lenders of the company and possibly yourself, as well?

A:       Part of.

[23]   Compounding Mr Chen’s lack of clarity, there were no proper accounting records in relation to the payments. Ms Madsen-Ries notes in her affidavit that despite stating he would provide more details about the various withdrawals discussed above (and other similar withdrawals discussed in her evidence), Mr Chen failed to do so.

[24]   The liquidators also wrote to the relevant third parties (where they had or could ascertain their contact details) to inquire about the payments. No responses were received. Ms Hui, counsel for the plaintiffs, submits that it is proper to infer from these matters that the payments have not been made in the ordinary course of the Company’s business.

The liquidation

[25]   The Company ceased trading in August 2018. The Company was placed into liquidation by the High Court at Auckland on 3 May 2019 (on the application of Inland Revenue). The second plaintiffs were appointed as liquidators. The Company had negligible assets at liquidation.

[26]In terms of the claims in the liquidation, Inland Revenue filed a claim for

$503,398.99 plus petitioning creditor’s costs. Inland Revenue’s claim comprises the following:1

(a)The sum of $531,892.54 for GST, together with interest and penalties of $49,615.97, with repayments and transfers totalling $85,620.26, leaving a net balance of $495,888.25 owing  for  the  period  ended  30 November 2017 and for subsequent periods. This includes a GST assessment of $330,816 for the period ended November 2017 arising from the sale of the Property.

(b)The sum of $7,023.22 for PAYE, plus interest and penalties of

$7,568.13, with repayments and transfers totalling $7,167.21 leaving a net balance of $7,424.14 owing for the periods ended 30 April 2018 and 31 May 2018.

(c)The sum of $86.60 for Employer Superannuation Contribution Tax for the periods ended 30 April 2018 and 31 May 2018.

[27]The liquidators have also received the following claims:

(a)preferential claims from former employees of the Company totalling approximately $39,000; and

(b)other unsecured claims totalling approximately $35,250 (one claim making up approximately $30,000 of that sum).

1      $446,272.28 being preferential claims, $57,126.71 being non-preferential claims.

[28]   All of the claims in the liquidation were incurred after October 2017. Given the Net Proceeds, there ought to have been sufficient funds to pay back both the loan to Mr Zhang (proceeding for present purpose on the basis it was loan to the Company) and to meet the various claims which now feature in the liquidation.

[29]A company will only meet the test for solvency if:2

(a)it is able to pay its debts as they become due in the normal course of business; and

(b)the value of the company’s assets is greater than the value of its liabilities (including contingent liabilities).

[30]   Ms Madsen-Ries has conducted an analysis of the financial position of the Company, including reviewing the available records of the Company and taking into account the information provided by Mr Chen. Ms Madsen-Ries notes that the financial statements for the years ending 31 March 2012 to 2017 show that the Company reported deficits from trading from incorporation and in each of the six successive years. Ms Madsen-Ries deposes that the financial statements show that the Company reported significant and generally worsening net liabilities in each of the financial years ending 2013 to 2017, with net assets/(liabilities) creeping upwards from negative $164 in 2013 to negative $814,391 in 2017. She explains that in her professional opinion, the Company was insolvent from, at the latest, 31 March 2012.

[31]   I also note that at least in conjunction with the accounts for the year ending 31 March 2013, the accountants preparing those accounts wrote to the directors of the Company (that is, Mr Chen) advising him that, on the basis of the 31 March 2013 financial accounts, “your company was, at that date, insolvent”. The letter warned of the consequences of continuing to trade while insolvent, including under the relevant provisions of the Act.

[32]   Given all of the above, the plaintiffs say the Company was insolvent from   31 March 2012 and that there is “no question” the Company was insolvent at the time

2      Companies Act 1993, s 4(1).

the Opening Balance and Net Proceeds were dispersed. On the evidence before me, I agree with those conclusions, though I have formed the view that it is only necessary for me to reach a conclusion as to insolvency from the point at which the GST obligation was incurred (and the commencement of the dispersal of the Opening Balance and Net Proceeds). There is little information about the Company prior to this time, and given the claims in liquidation were all incurred after October 2017, it seems the Company was able to meet its debts up to that point (noting, however, that its asset/liability position was negative at all times from 2012 onwards). It also appears that, probably from inception, the Company’s business was unsustainable without the seemingly “merry go round” of loans from Mr Chen’s friends and/or associates. But what is clear is that from October 2017, the Company had taken on additional significant debt (namely the GST obligation on the sale of the Property), yet at the same time was put in a position where it was impossible to meet that and its other debts.

[33]Against that factual background, I turn now to the plaintiffs’ pleaded claims.

First cause of action – breach of director’s duties

Introduction

[34]   The plaintiffs say this is a case where there was clearly no proper corporate governance applied to the Company for some time, and that Mr Chen fell well short of appropriate compliance with the Act. The plaintiffs point to longstanding authority that the limitations of liability provided by incorporation of a company are conditional upon proper compliance with the Act.3 Relying on the Court of Appeal’s observations in Sojourner v Robb, the plaintiffs further submit that a director’s duty to the Company under the Act extends to taking into account the interests of creditors when the Company approaches insolvency.4 It is in the context of these overarching principles that the plaintiffs say Mr Chen breached his duties contained in ss 131(1), 135 and 137 of the Act, and seek consequent relief under s 301 of the Act.

3      Mason v Lewis [2006] 3 NZLR 225 (CA) at [83].

4      Sojourner v Robb [2007] NZCA 493, [2008] 1 NZLR 751 (CA) at [25].

Section 301 of the Act

[35]   The plaintiffs’ claims for the alleged breaches are brought under the procedural mechanism provided by s 301 of the Act, which provides as follows:

301 Power of court to require persons to repay money or return property

(1)If, in the course of the liquidation of a company, it appears to the court that a person who has taken part in the formation or promotion of the company, or a past or present director, manager, administrator, liquidator, or receiver of the company, has misapplied, or retained, or become liable or accountable for, money or property of the company, or been guilty of negligence, default, or breach of duty or trust in relation to the company, the court may, on the application of the liquidator or a creditor or shareholder,—

(a)inquire into the conduct of the promoter, director, manager, administrator, liquidator, or receiver; and

(b)order that person—

(i)to repay or restore the money or property or any part of it with interest at a rate the court thinks just; or

(ii)to contribute such sum to the assets of the company by way of compensation as the court thinks just; or

(c)where the application is made by a creditor, order that person to pay or transfer the money or property or any part of it with interest at a rate the court thinks just to the creditor.

[36]   The principle purpose of s 301 is to compensate those who have suffered loss as a result of illegitimate trading.5 In Sojourner v Robb, the Court of Appeal described s 301 as “a procedural shortcut by which a liquidator, creditor or shareholder may pursue the claims which a company in liquidation may have against, inter alia, its … directors”.6 In Mason v Lewis, the Court of Appeal explained that claims brought pursuant to s 301 involve a two-stage evaluation:7

(a)First, has there been a breach of a duty owed by a director to the company?

5      Löwer v Traveller [2005] 3 NZLR 479 (CA) at [78]; Insolvency Law & Practice (online ed, Thomson Reuters) at [CA301.01].

6      Sojourner v Robb, above n 4, at [53].

7      Mason v Lewis, above n 3, at [52].

(b)Second, and if so, what is the appropriate relief and should the director should contribute to the losses of the company?

[37]I turn first to the alleged breaches.

Breach of s 131

[38]Section 131 of the Act provides as follows:

131 Duty of directors to act in good faith and in best interests of company

(1)Subject to this section, a director of a company, when exercising   powers or performing duties, must act in good faith and in what the director believes to be the best interests of the company.

…

[39]Once a company is of doubtful solvency, the duty is also owed to its creditors.8

[40]   The plaintiffs submit that it is apparent from Mr Chen’s actions that he preferred his own interests over those of the Company. This submission is based on the following matters:

(a)The Company was insolvent at the time of both the purchase and the sale of the Property.

(b)In agreeing to sell the Property, Mr Chen agreed to the Company incurring an obligation to pay GST on the sale.

(c)Given the difference between the purchase price and sale price for the Property, there should have been sufficient net sale proceeds for the Company to meet its tax obligations on the sale as well as repaying the other creditors who have filed claims in the Company’s liquidation.

8      Nicholson v Permakraft (NZ) Ltd (in liq) [1985] 1 NZLR 242 (CA) at 249 per Cooke J.

(d)Mr Chen failed, however, to ensure the Company retained sufficient funds to enable it to account to Inland Revenue for the GST incurred on the sale and for the Company’s other tax obligations, and to repay its other creditors.

(e)Mr Chen caused the Opening Balance and the Net Proceeds to be used for his own benefit (or dissipated for reasons seemingly unconnected with the Company’s business) and at a time when the Company was insolvent. This conduct was to the detriment of the Company and its creditors, including Inland Revenue.

(f)In the absence of a proper explanation, the disbursement of almost the entirety of the Opening Balance and Net Proceeds is inconsistent with the Company’s business and its best interests. Mr Chen failed to keep proper records explaining these transactions and was unable to explain these transactions to the liquidators. The plaintiffs say the natural inference to be drawn from this is that these transactions were for his personal benefit.

(g)There is no evidence Mr Chen made a proper assessment as to the Company’s likely future income stream and its ability to pay its debts as they fell due, including at the time the Opening Balance and Net Proceeds were being disbursed.

(h)By continuing to trade the Company in the manner he did, Mr Chen caused the Company’s debt to Inland Revenue to continue to increase, with further core debt and accrued penalties and interest, while simultaneously failing to ensure the Company had sufficient funds to pay that debt and its other creditors.

(i)By permitting the Company to continue to trade and failing to appoint a liquidator when the Company became insolvent, Mr Chen caused further loss to the Company and its creditors.

(j)Overall, Mr Chen did not act in the best interests of the Company and its creditors.

[41] I am satisfied that on the basis of those matters summarised at [40] above there has been a breach by Mr Chen of s 131. The inescapable inference is that during the latter part of the Company’s life in particular, Mr Chen effectively used Company monies as his own monies, including in the context of borrowing and repaying money from friends and other associates (who he professed not to recall or to be aware of), and otherwise making significant payments to himself (all of which were effected without any proper accounting records).

[42]   In addition, at a time when Mr Chen clearly knew of the Company’s obligations to Inland Revenue (given his efforts to put in place payment by instalment), Mr Chen diverted very significant Company resources to what appears to be “projects” unconnected with the Company’s business (in particular, the $525,000 payment to “Z Chen”). There is no evidence Mr Chen conducted a proper (or indeed any) analysis of whether such a significant proportion of the Company’s funds should be diverted in this way, or at the very least, utilised in a manner that did not include any security, particularly when Mr Chen was aware of the Company’s precarious financial position. It is difficult to see how such a transaction could ever be in the Company’s best interests. Similar observations apply to the range of other large payments made out of the Company’s bank account for which there is no clear or rational explanation.

[43]   I do not consider such actions to be consistent with a director being cognisant of his obligations to the Company and acting in its best interests. Indeed, it does not appear that Mr Chen was cognisant of his duties as a director, one of the first of his duties being “to actually come to grips with those duties”.9 At the very least, there seems to have been a blurring of the line between the Company’s business and      Mr Chen’s own activities.

[44]   I accordingly accept the plaintiffs’ submission that Mr Chen breached s 131 by failing to act in good faith and in the best interests of the Company.

9      Mason v Lewis, above n 3, at [58].

Breach of s 135

[45]Section 135 of the Act concerns reckless trading and provides as follows:

135     Reckless trading

A director of a company must not—

(a)agree to the business of the company being carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors; or

(b)cause or allow the business of the company to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors.

[46]   The duty is owed by directors to the company and is an objective test. The duty focuses not only a director’s belief, but also on the manner in which a company’s business is carried on and whether that creates a substantial risk of serious loss. In a well-known statement of the applicable principles, the Court of Appeal in  Mason     v Lewis reinforced the test as requiring a “sober assessment” by directors once a company enters troubled financial waters as to the company’s likely future income and prospects.10

[47]   In this context, the plaintiffs submit that Mr Chen dissipated the Opening Balance and the Net Proceeds at a time when the Company was insolvent and for his own personal benefit, and failed to cause the Company to be in a position to meet its tax obligations (thereby incurring interest and penalties).

[48]   I am satisfied these conclusions can be properly reached on the evidence before the Court. The sheer inability of Mr Chen to explain or account for quite significant payments out of the Company’s bank account (to himself and other third parties) gives rise to an inference that the funds were being used ultimately for his own personal benefit or for purposes unconnected with the Company’s business. Further, I agree that dissipating the Opening Balance and the Net Proceeds in a relatively short time period meant Mr Chen caused the Company to be in a position where it was unable to meet its tax obligations, and thereby exposed it to further and ongoing liabilities by way of interest and penalties. In light of the fact the large majority of the Company’s

10 At [51].

resulting liabilities are to Inland Revenue, the plaintiffs’ submission that “[t]he tax paying public of New Zealand was made to bear the risk of the imprudent manner in which Mr Chen chose to direct the Company” has merit.

[49]   I therefore conclude that Mr Chen breached s 135 in that, from October 2017 at the latest, he caused or allowed the business of the Company to be carried on in a manner likely to create a substantial risk of serious loss to the Company’s creditors (and to Inland Revenue in particular).

Breach of s 137

[50]Section 137 of the Act provides as follows:

137     Director’s duty of care

A director of a company, when exercising powers or performing duties as a director, must exercise the care, diligence, and skill that a reasonable director would exercise in the same circumstances taking into account, but without limitation,—

(a)the nature of the company; and

(b)the nature of the decision; and

(c)the position of the director and the nature of the responsibilities undertaken by him or her.

[51]   The test under s 137 is an objective test based on the standard of a reasonable director.11 However, while the test is ultimately an objective one, the position of the particular director must be taken into account, for example whether they are a director of a large publicly listed company, or someone assuming responsibilities as a director of a relatively small trading business without the opportunity for detached guidance from a board.12

[52]   The plaintiffs submit a reasonable director in the position of Mr Chen would not have:

11     Morgenstern v Jeffreys [2014] NZCA 449, (2014) 11 NZCLC 98–024 at [89].

12     Boutique Tanneries Ltd (in liq) v Handley HC Auckland CIV-2006-404-2713, 24 July 2008 at [31].

(a)Caused or allowed the Company to trade in the manner that it did, incurring debts to creditors including Inland Revenue for unpaid PAYE and GST without retaining sufficient (if any) funds to pay those debts, which then increased through penalties and interest.

(b)Caused or allowed the withdrawal of the Opening Balance and Net Proceeds from the Company’s bank account to or for the benefit of Mr Chen personally, when the Company was insolvent, without requiring security or any agreement to be signed.

(c)Caused or allowed the dissipation of the Opening Balance and the Net Proceeds to unknown parties when the Company was insolvent.

(d)Failed to have regard to the Company’s financial statements which showed that it was insolvent. There is no evidence that any forecasts were prepared or appropriate checks put in place to ensure that the Company’s creditors were protected from Mr Chen’s decision to disburse the Opening Balance and Net Proceeds.

[53]   Again, I am satisfied these claims are made out. In short, it seems clear that Mr Chen, particularly in more recent years, has not recognised, or if recognised, failed to implement, the basic standards that would be expected of a company director. This includes being “on top of” the quite significant payments out of the Company’s accounts; being able to account for and explain very substantial sums paid to himself; and ensuring the Company was in a position to meet its tax and other liabilities as and when they fell due.

[54]   I also note that Mr Chen’s ongoing management of the Company into a position that became more precarious as the years went by was against the backdrop of being warned by the Company’s accountants in February 2014 that the Company was insolvent, and being made aware of the legal consequences of continuing to trade.

[55]   I turn now to what relief ought to be granted as a result of Mr Chen’s breach of his statutory duties.

Relief under s 301

Approach

[56]   In Mason v Lewis, the Court of Appeal articulated a three-pronged approach to considering whether to grant relief under s 301:13

[109]     The standard approach has been to begin by looking to the deterioration in the company’s financial position between the date inadequate corporate governance became evident (really the “breach” date), and the date of liquidation.

[110]     Once that figure has been ascertained, New Zealand courts have seen three factors – causation, culpability, and the duration of the trading – as being distinctly relevant to the exercise of the Court’s discretion (see Re Bennett, Keane & White Limited (in liquidation) (No 2) (1988) 4 NZCLC 64,317 per Eichelbaum J; and Löwer v Traveller [2005] 3 NZLR 479, which endorsed those principles).

…

[118]   Finally, claims of this character necessarily have to be approached in a relatively broad-brush way. The jurisdiction to order recompense is of an “equitable” character.

[57]   The first element, causation, is concerned with the link between the carrying on of the company’s business recklessly, to the knowledge of the impugned director, and the indebtedness of the company for which it is sought to impose personal liability.14 The second element of culpability reflects the deterrent purpose of the provision.15 Culpability can range on a spectrum from blind faith or muddle- headedness to plain dishonesty. In cases involving a high degree of culpability, punitive as well as compensatory orders can be accommodated. As to duration, in Löwer v Traveller, the Court of Appeal found wrongful trading over a duration of two years and ten months to be “lengthy”.16 In that case, the Court of Appeal upheld the trial Judge’s finding of 100 per cent liability for loss during the relevant period.

13     Mason v Lewis, above n 3.

14     Löwer v Traveller, above n 5, at [79].

15 At [83].

16 At [86].

Application in this case

[58]   The plaintiffs focus on the period from 2017 onwards, when the Property was bought and then on-sold, coupled with the ongoing dissipation of the Net Proceeds and Opening Balance. I will adopt October 2017 as the “breach date”, being one month after the sale of the Property (at which point the Company’s GST obligation had crystallised) and when the dispersal of the Net Proceeds and Opening Balance began. I adopt April 2018 as the “end date”, being the point at which the Company’s funds had been (almost) fully disbursed.

[59]   Ms Hui submits that the causation analysis in this case is straightforward, given Mr Chen’s wholesale failure to take appropriate steps to ensure the Company met its GST obligations on the sale of the Property, which in turn has caused the large majority of the Company’s losses. I accept that submission. There has been no satisfactory explanation from Mr Chen as to why steps were not taken to ensure the Company could meet its debts, or any suggestion that even had Mr Chen fulfilled his statutory duties, the loss would have been incurred in any event – particularly given there ought to have been plenty of funds available to meet the claims now being made against the Company in the liquidation.

[60]   Turning to culpability, Ms Hui says there is not much “wriggle room” for   Mr Chen, because he has simply failed to give any explanation for the various payments and transactions from the Company’s funds. A theme of Ms Hui’s submissions was that the plaintiffs simply “don’t know why” the various payments were made. She submits Mr Chen’s explanations, as evidenced by the transcript of his interview with the liquidators, are wholly unacceptable.

[61]   At least on the materials before the Court, I am not prepared to infer bad faith on Mr Chen’s part. Rather, I consider the situation has more likely arisen through  Mr Chen failing to understand and implement his duties as a director of a company, and failing to recognise the separate corporate identity of the Company. I do not consider, however, his culpability is at the level of “muddle-headedness” only. In my view, the degree of culpability is at the moderately serious end of the spectrum given:

(a)no steps were taken by Mr Chen to seek to rectify the position into which the Company got itself;

(b)he was on notice from at least early 2014 of the Company’s precarious position (through the advice from the accountants);

(c)the situation deteriorated significantly (and obviously) from 2017 onwards;

(d)what appears to have been a conscious choice to cause the Company to make the various large (and largely unexplained) payments discussed earlier in this judgment, while at the same time being aware of the Company’s increasing obligations to at least Inland Revenue; and

(e)the failure to keep proper accounting records of the suggested loan transactions and payments.

[62]   Given the above, I accept the plaintiffs’ submission that there is a reasonably high degree of culpability.

[63]   Turning to duration, the period in question extends from October 2017 to April 2018. It is not a particularly lengthy period, especially when measured against the time periods in question in some of the authorities to which I have been referred. But I do not consider the relatively short time period involved in this case improves     Mr Chen’s position. In effect, the time period is only short given it only took a short period of time for Mr Chen to direct the dissipation of all of the Company’s funds.

[64]   Drawing these threads together, I am satisfied that a compensatory award of damages pursuant to s 301 is appropriate. The next question is the quantum of that award.

[65]   Ms Hui submits that full compensation orders under s 301 are not unusual in New Zealand. Counsel referred me to a number of cases in which 100 per cent recovery has been ordered.

[66]   In a sense, it is difficult to justify something less than 100 per cent of recovery in circumstances where, as here, I have concluded there is a clear causative link between Mr Chen’s mismanagement of the Company and the incurring of its losses, and a reasonably high degree of culpability. I am therefore satisfied this is an appropriate case for an award of full compensation of the losses incurred by the Company, at least in relation to the claims in the liquidation and summarised at [26] and [27] above. As the plaintiffs submit, the overall effect of such an order is to shift the financial consequences of Mr Chen’s breaches of duty from the Company (and its creditors) to Mr Chen. I agree that consequence is just in the present circumstances.

[67]   Ms Hui confirmed that, unlike in some of the cases to which I was referred, the costs associated with the liquidation are not sought to be recovered through the s 301 claim. As discussed further below, a portion only of those costs are sought under the second cause of action, namely a failure to keep adequate accounting records.

[68] There will accordingly be an order pursuant to s 301(1)(b)(ii) of the Act that Mr Chen pay compensation to the Company in the sum $580,248.24. There will also be orders as to interest (as set out at [82] below).

Second cause of action – failure to keep adequate accounting records

[69]   Directors are obliged under s 194(1) of the Act to ensure a company’s records correctly record and explain the company’s transactions. Directors are also obliged to enable the company’s financial position to be determined with reasonable accuracy at any time and its financial statements to be readily and properly audited.

[70]In Thom Contractors Ltd (in liquidation) v Thom, this Court said:17

As to the financial statements, to which Mr Thom has not subscribed, the liquidators are also able to say that insofar as they, or the company’s records from which they derive, are deficient Mr Thom must accept responsibility. As sole director he was obliged under s 194(1) of the Companies Act 1993 to ensure that the company’s records, amongst other things, correctly recorded and explained the company’s transactions … and enabled its financial position to be determined with reasonable accuracy at any time … and its financial statements to be readily and properly audited … . He is accountable for any

17     Thom Contractors Ltd (in liquidation) v Thom HC Auckland CIV-2008-404-6829, 28 April 2009 at [17].

failure in the accounting records to record entries of money received and spent each day and the matters to which they relate… . These instances are not exhaustive.

[71]   As will be evident from the earlier sections of this judgment, there is no doubt Mr Chen failed in his obligations to keep proper records of the Company. In particular, he failed to:

(a)record and explain the funding of the purchase of the Property, and in particular the terms of payment of the deposit and the $980,000 bank cheque; and

(b)correctly record and explain the dissipation of almost the entirety of the Opening Balance and Net Proceeds.

[72]   The plaintiffs seek orders requiring Mr Chen to pay the sum of $10,000 to the plaintiffs pursuant to s 300(1) of the Act. That amount is the liquidators’ best estimate of the additional costs of the liquidation caused by Mr Chen’s failure to keep proper accounting records; that is, the costs of the liquidators having to reconstruct the accounts as much as could possibly be done.

[73]The elements required for a successful claim under s 300 are as follows:

(a)that the company is in liquidation;

(b)that the company is unable to pay all its debts;

(c)there must have been a failure to comply with s 194 of the Act; and

(d)that the failure to comply has resulted in substantial uncertainty as to the company’s assets or liabilities, or has resulted in the liquidation being substantially impeded, or is causally linked to the company’s insolvency.

[74]   That an award may be made when the costs associated with the liquidation are more than would otherwise have been incurred had the director had complied with his

or her financial accounting obligations was recognised by Gilbert J in Madsen-Ries  v Twine.18

[75] I am satisfied the elements summarised at [73] above have been made out. In particular, I accept the plaintiffs’ submission that Mr Chen’s failure to comply with his duty to keep adequate accounting records has resulted in substantial uncertainty as to the financial position of the Company. The liquidation has also been substantially impeded, given the sheer lack of information about the Company’s business and the transactions from October 2017 onwards. Given the costs of the liquidation are higher than they would have been had proper accounting records been kept, it is appropriate that the person who has caused that state of affairs to come about, namely Mr Chen, meet that cost (rather than the Company).

[76]   The liquidators’ (uncontested) evidence is that approximately $10,000 (plus GST) of the total costs of liquidation can be directly attributable to Mr Chen’s failure to keep adequate records. These costs relate to investigating the disbursement of the Opening Balance and Net Proceeds, dealing with the various banks to chase the identities of the recipients of funds, and attempting to contact the recipients to ascertain the true nature of the transactions.

[77]   In circumstances such as the present, only a relatively high level and broad- brush approach can be taken. There is no reason to doubt Ms Madsen-Ries’ evidence of the additional costs incurred as a result of the almost complete absence of financial records. Indeed, the claim for a contribution of $10,000 appears to me to be relatively modest. I will accordingly make a declaration against Mr Chen pursuant to s 300 of the Act that he is personally liable for that sum.

[78]   Section 300(3) of the Act provides that the Court may give any direction it thinks fit to give effect to the declaration. In this case, the plaintiffs seek a direction that Mr Chen pay the $10,000 to “the plaintiffs”. I do not consider that appropriate or necessarily clear; for example, would  payment  to  the  Company  only  discharge Mr Chen’s obligation under such a direction?

18     Madsen-Ries v Twine [2015] NZHC 227 at [10].

[79]   In the circumstances, and reflecting that the liquidators’ costs are to be met from the assets of the Company,19 I consider the appropriate course is to direct that Mr Chen pay the $10,000 to the Company for the purpose of it being made available to meet a part of the liquidators’ costs.

[80]   I decline to make an order that interest accrue on the sum of $10,000. There is no evidence before me that interest will “accrue” on that sum pending its payment by Mr Chen, or that there is otherwise a loss to either the Company or the liquidators from any time difference between the order being made and the date of payment. In other words, irrespective of the date of payment, so long as the $10,000 is paid by Mr Chen and utilised to meet, in part, the liquidators’ costs, the  full  “loss”  resulting from  Mr Chen’s failure to keep accounting records will have been met.

Result

[81]The plaintiffs have succeeded on the first and second causes of action.

[82]   I make the following declarations and orders pursuant to the first cause of action:

(a)declarations pursuant to s 301(1)(a) of the Act that Mr Chen breached his duties under ss 131, 135 and 137 of the Act;

(b)an order pursuant to s 301(1)(b)(ii) of the Act that Mr Chen pay compensation in the sum of $580,248.24 to the Company;

(c)an order that Mr Chen pay interest on the sum of $580,248.24 from 3 May 2019 (being the date of liquidation) to the date of judgment pursuant to s 10 of the Interest on Money Claims Act 2016; and

(d)an order that Mr Chen pay interest on the sum of $580,248.24 plus the accrued interest calculated under (c) above from the date of judgment

19     Companies Act 1993, s 278.

to the date of payment pursuant to s 10 of the Interest on Money Claims Act 2016.

[83]I make the following orders on the second cause of action:

(a)a declaration under s 300(1) of the Act that Mr Chen is personally liable for the sum of $10,000; and

(b)a direction under s 300(3) of the Act that Mr Chen pays such sum to the Company, and that such sum is to be used in part payment of the liquidators’ costs.

Costs

[84]   The plaintiffs are entitled to scale costs. I agree that category 2B basis is appropriate. There is an award of costs totalling $19,748.00 as detailed in the Schedule of Costs and Disbursements attached to the plaintiffs’ Memorandum of Quantum and Judgment dated 2 July 2020.

Fitzgerald J

Post-script:

This judgment was reissued on 17 September 2020 to correct an accidental slip at [82](d) above. No other changes or alterations have been made.