Attractum Ltd (in liquidation) v Chapman

[2020] NZHC 318

IN THE HIGH COURT OF NEW ZEALAND TAURANGA REGISTRY

I TE KŌTI MATUA O AOTEAROA TAURANGA MOANA ROHE

CIV-2017-470-176

[2020] NZHC 318

UNDER

the Companies Act 1993

IN THE MATTER

of the liquidation of Attractum Ltd (In Liquidation)

BETWEEN

ATTRACTUM LTD (IN LIQUIDATION)

First Plaintiff

HENRY DAVID LEVIN AND VIVIEN JUDITH MADSEN-RIES AS

LIQUIDATORS OF ATTRACTUM LTD (IN LIQUIDATION)
Second Plaintiffs

AND

MARK JOHN CHAPMAN

First Defendant

PAULINE LESLEY CHAPMAN

Second Defendant

Hearing:	29 and 30 October 2019
Appearances:	P V Shackleton and L M Deane for Plaintiffs Defendants in person
Judgment:	28 February 2020

JUDGMENT OF BREWER J

This judgment was delivered by me on 28 February 2020 at 12 noon pursuant to Rule 11.5 High Court Rules.

Registrar/Deputy Registrar

Solicitors:

Meredith Connell (Auckland) for Plaintiffs

ATTRACTUM LTD (IN LIQUIDATION) v CHAPMAN [2020] NZHC 318 [28 February 2020]

Introduction

[1]                 Mr and Mrs Chapman  incorporated  Attractum  Ltd  (“the  Company”)  on  11 February 2008. They were, and remained, its only directors and shareholders. The Company traded as an internet website developer.

[2]                 The Company was put into liquidation on 13 February 2017 on the application of the Commissioner of Inland Revenue. Mr Levin and Ms Madsen-Ries were appointed liquidators (“the liquidators”).

[3]                 Two claims have been filed in the liquidation. The Commissioner of Inland Revenue’s claim is for $64,867.79 being $42,296.88 for unpaid GST plus interest and penalties, plus $4,406.80 for petitioning creditor court costs. The second claim is by the Accident Compensation Corporation and is for $4,821.30. Therefore, the total of the creditors’ claims in the liquidation is $69,689.09.

[4]                 The Company and the liquidators sue the Chapmans under seven causes of action (a number are alternatives). Broadly, the plaintiffs claim $131,380 for recovery of the Chapmans’ current account, $333,605 for recovery of distributions and dispositions made to the Chapmans, and contributions of such sums as is just for breaches of pre and post liquidation directors’ duties.

[5]                 In his closing submissions for the liquidators, Mr Shackleton said the liquidators do not seek awards totalling more than the creditors’ claims plus the costs of the litigation. He put the total figure as $255,590.

[6]                 The Chapmans represented themselves. They did not provide the liquidators with any briefs of evidence prior to the hearing. The sole witness for the liquidators was Mr Levin. After his evidence concluded the Chapmans said they wanted to call Ms Mortlock, the Company’s accountant. They provided a one-and-a-half page brief for her. I adjourned overnight to enable Mr Shackleton to read the brief and take instructions on whether the liquidators would oppose Ms Mortlock giving evidence. In the event, the liquidators did not oppose and Ms Mortlock gave her evidence. Neither Mr Chapman nor Mrs Chapman sought to give evidence.

[7]                 The onus of proof is on the liquidators. The Chapmans’ amended statement of defence is largely a pleading of denial. Ms Mortlock’s evidence goes largely to a dispute over ownership of a motor vehicle which is relevant to the quantum of the Chapmans’ current account. With that exception, the case is close to one requiring formal proof.

Why the Company went into liquidation

[8]                 The Company was a vehicle for Mr and Mrs Chapman’s website development business. Like so many small family-owned companies it was operated with scant regard to the requirements of company law.

[9]                 The Chapmans were not employees of the Company. They were its directors and shareholders. Nevertheless, it was the source of their livelihood. During each year they drew as much income from it as they could and after the end of each financial year the Company’s accountant regularised this by preparing resolutions characterising the totals taken as shareholders’ or directors’ remuneration.

[10]              The Company had no fixed assets other than a Toyota Landcruiser (“the vehicle”). The Chapmans’ method of operating the Company worked only so long as they did not take for themselves too much of its cashflow. But they began to do just that.

[11]              Mr Levin’s evidence, which I accept, is that the Company did not meet the balance sheet limb of the solvency test from FYE 2011.1

[12]              I accept also Mr Levin’s evidence that the Company did not meet the cashflow limb of the solvency test from September 2012.2 From as early as 30 September 2012 the Company began to default on its GST obligations.

[13]              The Company’s accountant knew the Company was insolvent. In each of the FYE 2012 to FYE 2016 the accountant produced resolutions for the Chapmans to sign as shareholders of which the following is the example for FYE 2016:

1      Companies Act 1993, s 4(1)(b).

2      Companies Act 1993, s 4(1)(a).

1.Background

At 31 March 2016, based on the financial statements, the Company appears to be insolvent meaning that the liabilities of the Company exceed its assets.

If the Company did trade while insolvent, both the Company and the directors would be in breach of the Companies Act 1993. If the Company were to go into liquidation without paying its creditors in full, the directors could be held personally liable for all or part of that shortfall to the unpaid creditors and could be prosecuted.

It is important to note the following provisions of the Companies Act 1993:

1.          Under section 135 of the Act, a director must not 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;

2.          Section 136 of the Act provides that a director must not agree to the Company incurring an obligation unless the director believes that at that time, on reasonable grounds, the Company will be able to perform their obligations.

In addition, the Company cannot (while it remains insolvent), issue a “solvency certificate” which is a necessary pre-requisite to a number of matters such as paying a dividend, reducing its capital, and (in some circumstances) paying salaries or drawings to working shareholders.

It is a requirement to note that the Company can continue trading only with the support of its shareholders as stated in this resolution.

2. Resolved that:

We will continue to provide financial support to the Company during the ordinary course of business for the period of fifteen months from the date of this resolution.

[14]              The Company continued to default on GST payments. A payment arrangement was agreed with Inland Revenue in 2013. The Company failed to make the arranged payments. Another arrangement was agreed in 2015. Again, the Company failed to make the arranged payments.

[15]              The Chapmans did not provide financial support to the Company. Instead, they continued to divert the Company’s revenue to themselves. They pleaded in defence that they provided fair value for the revenue through their work for the Company. This was recorded in the annual remuneration resolutions prepared by the Company’s accountant. But the Company was insolvent throughout the relevant period and the insolvency resolutions demonstrate the Chapmans knew that.

[16]              Ms Mortlock, under cross-examination by Mr Shackleton, accepted that each year the Chapmans took the profit of the Company and their current account was credited accordingly.

Liability

[17]              It follows that the liquidators are entitled to recover from the Chapmans whatever amounts they owe to the Company under their current account and whatever distributions and dispositions were made to them while the Company was insolvent. There are alternative causes of action going to grounds of recoverability, but the real issue is with the quantum.

[18]              It also follows that the Chapmans breached duties they owed to the Company as directors. I find, on the balance of probabilities, the liquidators have proved the breaches of directors’ duties pleaded in the fifth cause of action, namely:

(a)To act in good faith and in what they believe to be the best interests of the Company (s 131 of the Companies Act 1993 (“the Act”));

(b)Not to cause or allow the business of the Company to be carried on in a manner likely to cause serious loss to the Company’s creditors     (s 135 of the Act):

(c)Not to allow the Company to incur an obligation unless they believe at the time on reasonable grounds that the Company would be able to perform the obligation when it was required to do so (s 136 of the Act); and

(d)When exercising powers or performing duties as a director, to exercise the care, diligence and skill that a reasonable director would exercise in the same circumstances (s 137 of the Act).

[19]              The basis of those findings is that the Chapmans knew the Company was insolvent, they continued to trade it, they continued to divert to themselves all its revenue save immediate operating expenses, permitted the Company to default on payments of GST and permitted it to default on its ACC payments. The Chapmans did not provide financial support as they annually resolved to do, either through introducing funds or providing security. The Chapmans did not take money as employees receiving properly negotiated salaries. They took the Company’s money in their capacities as controllers and owners.

[20]              The remaining issue under the fifth cause of action will be what the consequences should be for the Chapmans of their breaches of duties.

Current account quantum

[21]              As I have noted, the only fixed asset listed in the Company’s financial statements was the vehicle. It was first entered in the financial statements in FYE 2011 at a book value of $69,787 (plus GST of $10,468). It was purchased partly through a loan from Toyota Finance of $24,905 and the balance was credited to the Chapmans’ current account.

[22]              However, the Chapmans told the liquidators, including during a formal examination under oath, that the vehicle did not belong to the Company. They said it had been purchased by another of their companies, Stratagem International Ltd3 (“Stratagem”) before the Company had been incorporated.

[23]              The liquidators inquired and found the vehicle had been registered to Stratagem in the  New Zealand  Transport  Agency  Motor  Vehicle  Register  since 1 February 2008. They found also that Stratagem was removed from the Companies Office Register on 14 September 2013.

[24]              The liquidators accepted the Chapmans’ averments that the vehicle was not an asset of the Company. They reversed all the financial entries related to it. The effect was to increase the Chapmans’ current account debt by $86,464 from $44,915 to

$131,380.

[25]              Later, the Chapmans changed their minds. In their amended statement of defence they plead the vehicle was an asset of the Company after all. They called the Company’s accountant, Ms Mortlock, primarily to confirm that.

[26]              Ms Mortlock’s evidence was to the effect that she began preparing financial statements and income tax returns for the Chapmans and their associated entities in 2010. As part of her standard inquiry of new clients she asked them whether they used

3      It seems the Chapmans confused “stratagem” with “strategy”.

a vehicle for their business and they identified the vehicle. Ms Mortlock was aware that the vehicle had been purchased originally by Stratagem. Her assumption was that the vehicle was now the Chapmans’ and on the basis of what they told her it was agreed the vehicle should be bought by the Company. The Chapmans’ current account would be credited with the portion of the price not paid by the Company through the loan it took out with Toyota Finance.

[27]              Mr Shackleton submits that on the balance of probabilities the Chapmans were telling the truth when they assured the liquidators the vehicle never belonged to the Company. The vehicle was purchased originally by Stratagem, it continues to be registered in Stratagem’s name and there is no evidence Stratagem ever transferred it to the Chapmans.

[28]              I find the liquidators have not proven the vehicle was not the Company’s. The Chapmans were the directors and shareholders of Stratagem. They controlled its assets. Stratagem was removed from the Register of Companies in 2013. It is unlikely it retained assets at that time. The Chapmans discussed with Ms Mortlock whether they should sell the vehicle to the Company. They were using it for the Company’s business. It was agreed the Chapmans would sell the vehicle to the Company and the price paid partly in cash and partly by crediting their current account. In the succeeding years the Chapmans, as the controlling minds of the Company, kept the vehicle as a Company asset. The Chapmans had the power to take ownership of the vehicle from Stratagem and to sell it to the Company.

[29]              The fact that Stratagem remained as owner on the Motor Vehicle Register is neutral in this context. The Company took no steps to change the registration and, given the Chapmans owned and controlled both Stratagem and the Company, the registration could have been changed easily.

[30]              In my view, when the Company went into liquidation the Chapmans did not want to hand over the vehicle (and they still have not). So, they denied it was the Company’s. When they found out the adverse consequence of that they disavowed their statements.

[31]              I find that the Chapmans’ current account debt to the Company is $44,915 being:

FYE 2016 financial statements balance  4,507.00

Further net drawings from 1 April 2016  40,408.00

Total  $44,915.00

[32]              On the first cause of action I  enter  judgment  against  Mr Chapman  and  Mrs Chapman for the sum of $44,915.

Distributions and dispositions

[33]              The liquidators claim $333,605 as clawback of the monies taken by Mr and Mrs Chapman during the period it traded while insolvent. The claim is in alternative forms in the second, third and fourth causes of action:

(a)The second cause of action pleads the monies taken were distributions by the Company to Mr and Mrs Chapman as shareholders of the Company. Section 56(1) of the Act is relied upon.4

(b)The third cause of action pleads that the Chapmans did not have reasonable grounds for believing that the Company would satisfy the solvency test (as defined in the Act) immediately after payment of the monies in each year. They breached s 56(2) of the Act.5

4      “A distribution made to a shareholder at a time when the company did not, immediately after the distribution, satisfy the solvency test may be recovered by the company from the shareholder unless — (a) The shareholder received the distribution in good faith and without knowledge of the company’s failure to satisfy the solvency test; and (b) The shareholder has altered the shareholder's position in reliance on the validity of the distribution; and (c) It would be unfair to require repayment in full or at all.”

5      “If, in relation to a distribution made to shareholders, — (a) The procedure set out in section 52 or section 70 or section 77 of this Act, as the case may be, has not been followed; or (b) Reasonable grounds for believing that the company would satisfy the solvency test in accordance with section 52 or section 70 or section 77 of this Act, as the case may be, did not exist at the time the certificate was signed, — a director who — (c) Failed to take reasonable steps to ensure the procedure was followed; or (d) Signed the certificate, as the case may be, — is personally liable to the company to repay to the company so much of the distribution as is not able to be recovered from shareholders.”

(c)The fourth cause of action seeks clawback under s 348 of the Property Law Act 2007.6 The pleading is that the monies were taken with the intent to prejudice creditors of the Company, by way of gift and/or without receiving reasonably equivalent value in exchange.

[34]              The findings I have made above mean the liquidators succeed on the second and third causes of action. The fourth cause of action is more complex and since I do not need to decide it, I will not.

[35]              On the second and third causes of action (which are alternatives) I enter judgment against Mr Chapman and Mrs Chapman for the sum of $333,605.

Breaches of directors’ duties – consequences

[36]              I have found the Chapmans breached their duties as directors as pleaded in the fifth cause of action. I make declarations accordingly.

[37]              The issue would normally be whether I should, as claimed, now make an order the Chapmans contribute such sum to the assets of the Company by way of compensation as would be just.

[38]              I have already made orders against the Chapmans totalling $378,520. The liquidators do not seek awards greater than $255,590. Accordingly, I do not find it just to make any further monetary award under the fifth cause of action.

6      “(1) A court may make an order under this section — (a) on an application for the purpose (made and served in accordance with section 347); and (b) if satisfied that the applicant for the order has been prejudiced by a disposition of property to which this subpart applies.

(2)  The order must do 1, but not both, of the following: (a) vest the property that is the subject of the disposition in the person (for any applicable purpose) specified in section 350: (b) require a person who acquired or received property through the disposition to pay, in respect of that property, reasonable compensation to the person (for any applicable purpose) specified in section 350.

(3)   If the order does what is specified in subsection (2)(a), it may also require a person who acquired or received property through the disposition to physically restore some or all of that property that is tangible personal property to 1 or more persons specified in the order.

(4)  Person who acquired or received property through the disposition means a person who acquired or received property — (a) under the disposition; or (b) through a person who acquired or received property under the disposition.

(5)  The order must not have effect so as to increase the value of a security held by a creditor over the debtor’s property.

(6)Subsection (5) overrides subsection (2) and section 350.

(7)This section is subject to section 349.”

Remaining causes of action

[39]              The sixth cause of action is by the liquidators and alleges Mr and Mrs Chapman failed to keep adequate accounting records in breach of s 194 of the Act.7 The claim is predicated on the vehicle being wrongly recorded as an asset of the Company. The resulting costs to the liquidators are sought.

[40]              I have found the vehicle was properly recorded as an asset of the Company. The sixth cause of action is dismissed.

[41]              The seventh cause of action is brought as an alternative to the sixth in case (as has happened) the vehicle was held to be an asset of the Company. The liquidators (in essence) claim the costs in the liquidation incurred as a result of the Chapmans claiming the vehicle did not belong to the Company, including the loss of opportunity to recover the vehicle, a depreciating asset, promptly.

[42]              I find for the liquidators on the seventh cause of action and make a declaration accordingly. In reliance on Mr Shackleton’s advice that no further monetary awards are sought, I do not think it just to make an order by way of compensation.

Decisions

[43]In summary, my decisions are:

(a)Judgment for the first plaintiff on the first cause of action in the sum of

$44,915, plus interest.

7      “(1) The board of a company must ensure that there are kept at all times accounting records that

— (a) correctly record the transactions of the company; and (b) will enable the company to ensure that the financial statements or group financial statements of the company comply with generally accepted accounting practice (if the company is required to prepare such statements under this Act or any other enactment); and (c) will enable the financial statements or group financial statements of the company to be readily and properly audited (if those statements are required to be audited). [[(1A) For the purpose of subsection (1), the transactions of the company include any transaction that constitutes an act of the type described in section 105C(3) of the Crimes Act 1961.]]

(2)   The board of a company must establish and maintain a satisfactory system of control of its accounting records.

(3)   The accounting records must be kept — (a) in written form in English; or (b) in a form or manner in which they are easily accessible and convertible into written form in English.

(4)  If the board of a company fails to comply with the requirements of this section, every director of the company commits an offence and is liable on conviction to the penalty set out in section 374(3).”

(b)Judgment for the first plaintiff on the second and third causes of action (as alternatives) in the sum of $333,605, plus interest.

(c)The fourth cause of action is alternative to the second and third causes of action and there is no need for me to decide it.

(d)Judgment for the plaintiffs on the fifth cause of action:

(i)I make declarations under s 301(1)(a) of the Act that the first and second defendants breached their duties under ss 131, 135, 136 and 137 of the Act;

(ii)I decline to make an order for the payment of money.

(e)Judgment for the defendants on the sixth cause of action.

(f)Judgment for the plaintiffs on the seventh cause of action:

(i)I make a declaration under s 301(1)(a) of the Act that the first and second defendants breached their post-liquidation duties under ss 261(3)(d) and 274 of the Act;

(ii)I decline to make an order for the payment of money.

Costs

[44]              The plaintiffs seek costs on a 2B basis. That is appropriate. Mr Chapman and Mrs Chapman must pay the plaintiffs’ costs on a 2B basis.

Brewer J