Commissioner of Inland Revenue v Chester Trustee Services Ltd
[2002] NZCA 258
•14 October 2002
| IN THE COURT OF APPEAL OF NEW ZEALAND | CA111/02 |
| BETWEEN | THE COMMISSIONER OF INLAND REVENUE |
| Appellant |
| AND | CHESTER TRUSTEE SERVICES LIMITED |
| Respondent |
| Hearing: | 17 September 2002 |
| Coram: | Tipping J Hammond J Baragwanath J |
| Appearances: | A C Beck and K Parkash for Appellant A J Forbes QC for Respondent |
| Judgment: | 14 October 2002 |
| JUDGMENTS OF THE COURT |
Judgments
Paragraph No
Tipping J [1]
Hammond J [7]
Baragwanath J [8]
TIPPING J
I agree with the conclusions reached in the judgment to be delivered by Baragwanath J. There is nothing I wish to add to his discussion of the first two issues. I am writing separately because of the general importance of the third issue, which involves the basis upon which statutory demands may be set aside “on other grounds” under s290(4)(c) of the Companies Act 1993. I agree that if the company upon which the demand is served cannot show a substantial dispute concerning the debt, or that it has a qualifying cross-claim, the creditor is prima facie entitled to have the company put into liquidation. The creditor is not, however, entitled to liquidation as of right (ex debito justitiae as it was put in earlier times). To take that view would not be consistent with Parliament’s direction that there can be other grounds upon which the statutory demand may be set aside. Hence Parliament has contemplated that it may in some circumstances be inappropriate for a company which is undoubtedly insolvent to be placed in liquidation. Furthermore Parliament has not chosen to categorise what those circumstances are. While it is undoubtedly helpful to identify circumstances which have been held to qualify in the past, it is important not to regard those circumstances as comprising an exhaustive or exclusive list.
Baragwanath J has noted that in s291(1), which allows the Court, when declining an application to set aside a statutory demand, to give time to pay or to make an order putting a company immediately into liquidation, there is no reference to the “other grounds” basis for setting aside. That feature does not affect the general thesis set out above. Indeed, it must be implicit in s291(1) that the Court is also satisfied that no other ground exists for setting aside the statutory demand. I have written the foregoing to endorse, in my own words, the statement which Baragwanath J makes in paragraph [47] of his judgment, that the Courts should not seek to fetter the general discretion which Parliament has given them in s290(4)(c).
That said, I agree with Baragwanath J that the general policy of the Act that insolvent companies should be put into liquidation, if a creditor seeks such an order, should not be departed from lightly. To justify such departure there must be some other factor, be it policy, principle or simply the justice of the particular case, which outweighs the prima facie entitlement of the creditor to an order putting the insolvent company into liquidation. If the focus is on the justice of the particular case the discretion must always be exercised on a principled basis and not on some ad hoc perception of what individual justice might require. All cases involving s290(4)(c) must in the end come down to a judgment by the Court as to whether the creditor’s prima facie entitlement is outweighed by some factor or factors making it plainly unjust for liquidation to ensue. The ground advanced by the insolvent company must be sufficiently compelling to overcome the general policy of the Act with regard to insolvent companies.
Turning to the circumstances of the present case, I am content to express my general agreement with the reasons given by Baragwanath J for allowing the appeal. With respect to the Master, before whom the creditor’s argument appears to have been within a much narrower compass, I am satisfied that Chester’s grounds are not sufficient to deprive the creditor of its prima facie entitlement to winding up. I agree that it is generally inappropriate for an insolvent company to continue to act as trustee. The price of Chester’s ability to do so should be payment of its debt. I do not regard it as plainly unjust to place Chester in liquidation if it, or its backers, are unable or unwilling to pay the debt owed to the creditor. Similarly, I do not consider that in circumstances such as the present the Court should relieve an insolvent company of the discipline and potential collateral consequences of a liquidation. The privilege of being able to continue operating with limited liability should not lightly be afforded to an insolvent company if a creditor wishes to put it into liquidation and there is no countervailing wish on the part of other creditors to avoid liquidation.
I do not find it necessary expressly to address the position of solicitors’ nominee companies or the suggested analogies with general trustee law.
The Court being unanimous in the result, the appeal is allowed, the order made by the Master setting aside the statutory demand is itself set aside. The application to set aside is dismissed. We direct, pursuant to s290(3), that the time for compliance with the statutory demand shall start running on the day following delivery of this judgment. Chester is to pay the Commissioner for his costs of the proceedings both in this Court and in the High Court the total sum of $7500.00 plus disbursements to be fixed if necessary by the respective Registrars.
HAMMOND J
I concur with my brothers in the result of this appeal and the general approach taken by Baragwanath J. I would wish however to associate myself with the additional remarks of Tipping J.
BARAGWANATH J
Table of Contents Paragraph No Introduction [8] The first issue: whether Chester became liable to tax [19] The second issue: whether Chester’s resignation as
trustee relieved it of liability[33] The third issue: whether the statutory demand was
correctly stayed[39] Company law [41] Trustee law [61] This case [65]
Introduction
The Commissioner of Inland Revenue appeals against a judgment of Master Venning of 22 May 2002 reported at (2002) 20 NZTC 17,725 setting aside his statutory demand of 15 November 2001 given under s289 of the Companies Act 1993 to the respondent Chester Trustee Services Limited (Chester). The demand claimed payment of $34,546.57 for “goods and services tax and penalties and/or interest thereon under the Goods & Services Tax Act 1985 and/or the Tax Administration Act 1994” from Chester “as trustee of the Brook Family Trust and the G & I Family Trust”.
Chester is an insolvent limited liability company. It is currently the trustee of some 35 trusts established on behalf of clients of Mr Cousins, a solicitor who is Chester’s sole director. In that capacity it appears on numerous certificates of title as the registered proprietor of pieces of land belonging to such trusts.
At the time the GST debt was incurred Chester was the sole trustee of the Brook Family Trust (“BFT”) and of the G & I Family Trust (“GIFT”). The debt resulted from the issue of sales invoices to purchasers of parts of a subdivision of BFT/GIFT land at Cambridge which Chester, by its director Mr Cousins, had caused the trusts to acquire and develop. So Chester was operating the trusts as what in Australia are known as “trading trusts”, although having resigned from both BFT and GIFT trusteeships Chester submits that it is now functioning as a bare trustee of the remaining trusts which do not trade.
Acting under s27 of the GST Act the Commissioner had made against BFT and GIFT, a single joint tax assessment which was never challenged under the available procedures of the Tax Administration Act (TAA). Chester having been a trustee of each trust throughout the period covered by the assessment, the Commissioner claims that it is liable under s57 of the GST Act to pay the assessment. His statutory demand not having been met, the Commissioner submits that winding up procedures against Chester should be permitted to proceed. Chester supports the Master’s decision.
The learned Master rejected Chester’s primary submission that on the true construction of the GST Act Chester had never become liable for the BFT/GIFT tax debt.
But he held that on the proper construction of s57(3) of the GST Act, as it read prior to an amendment effective from 10 October 2000, Chester’s resignations as trustee relieved it from liability for the GST to which until that point it had been liable. Accordingly he relied on s290(4)(a) of the Companies Act 1993 which in part reads:
290 Court may set aside statutory demand
(1) The Court may, on the application of the company, set aside a statutory demand.
…
(4) The Court may grant an application to set aside a statutory demand if it is satisfied that—
(a) There is a substantial dispute whether or not the debt is owing or is due; or
…
(c) The demand ought to be set aside on other grounds.
…
He held further that, even if he were wrong as to subclause (a) of s290(4), the demand ought to be set aside under subclause (c), on the grounds that there would be no point in placing Chester into liquidation; to do so would require it to resign as trustee in relation to all other positions of trust it holds which would entail substantial and unnecessary costs.
Mr Forbes QC challenged the Master’s finding that Chester had incurred initial liability for the BFT/GIFT tax debt and also supported the two grounds relied upon by him to set aside the demand.
Mr Beck and Ms Parkash supported the Master’s conclusion as to Chester’s tax liability and challenged the two grounds on which the statutory demand was stayed.
I would endorse the Master’s decision on the primary question as to Chester’s tax liability but am satisfied that neither ground for setting aside the demand can be supported. Accordingly the Master’s order should be discharged.
I deal with the issues in the following sequence:
[a] whether Chester became liable to tax;
[b] whether its resignation as trustee relieved it of such liability;
[c] whether the statutory demand was correctly stayed.
The first issue: whether Chester became liable to tax
The notice of assessment related to the two month period ending 31 May 1999 during which Chester was a trustee for BFT and for GIFT. Each had a separate GST registration which at their request the Commissioner had directed should be accounted for on a payments basis, signifying that the tax became payable only when a debtor of the trust had paid its invoice. On 11 May 2000 following a tax investigation the Commissioner issued a notice of his intention (1) to register BFT and GIFT as a single entity for GST purposes as from 1 July 1998; and (2) to assess that entity for undisclosed output tax on the sale of three home units with respect to the taxable period ended 31 May 1999. Such notice of proposed adjustment (NOPA) was required by s89C TAA; by s89H, in the absence of notice of response (s89G) by the recipient within two months rejecting the adjustment, it may not challenge the proposed adjustment. No notice of response having been received, the Commissioner assessed BFT/GIFT in terms of the NOPA and by letter of 17 October 2000 gave notice under s111 TAA of such assessment directing that the entity account on an invoice basis, which required payment of tax on invoices issued within the previous two months whether they had been paid or not. Chester had resigned as trustee of each trust, from BFT on 19 April 2000 and from GIFT on 15 May 2000. It did not however give the Commissioner notice of having done so until 30 July (BFT) and 31 August (GIFT) of the following year.
While an assessment can normally be challenged only by the disputes procedures of the TAA, Mr Forbes submitted that the purported assessment was outside the powers conferred on the Court by Parliament and should be declared a nullity: Golden Bay Cement Co Ltd v Commissioner of Inland Revenue [1996] 2 NZLR 665, 670-1; Commissioner of Inland Revenue v Abattis Properties Ltd CA 4/02, 31 July 2002 para [24]. His first contention was that during the period of the trusteeship no GST liability could accrue to either trust because, given their separate registration and payments basis, no GST liability then existed; while by the time the joint registration was effected and an invoice basis imposed by the notice of 17 October 2000 each had resigned; so the Court could and should declare it a nullity. I disagree.
Goods and services tax is imposed by s8(1) of the GST Act which provides:
8 Imposition of goods and services tax on supply
(1) Subject to this Act, a tax, to be known as goods and services tax, shall be charged in accordance with the provisions of this Act at the rate of 12.5 percent on the supply… in New Zealand of goods and services… by a registered person in the course or furtherance of a taxable activity carried on by that person, by reference to the value of that supply…
By s9:
9 Time of supply
(1) Subject to this Act, for the purposes of this Act a supply of goods and services shall be deemed to take place at the earlier of the time an invoice is issued by the supplier or the recipient or the time any payment is received by the supplier, in respect of that supply.
It is therefore the statute that imposes the tax. In the case of income tax, as McCarthy J stated in Reckitt & Colman (New Zealand) Limited v Taxation Board of Review [1966] NZLR 1032, 1045:
Liability for tax is imposed by the charging sections… The Commissioner acts in the quantification of the amount due, but it is the Act itself which imposes, independently, the obligation to pay. The assessment and objection procedures are merely machinery for quantifying; they do not cast liability. If the taxpayer does not object to the Commissioner’s assessment within the time stated in the assessment…the amount assessed by the Commissioner becomes incontestably fixed…
There is no reason for any different analysis in the case of GST. Indeed under the GST Act there is normally no need for any Commissioner’s assessment at all. That Act provides:
20 Calculation of tax payable
(1) In respect of each taxable period every registered person shall calculate the amount of tax payable by that registered person in accordance with the provisions of this section…
It is the duty of the registered person to self-assess in accordance with that provision.
The Commissioner’s power under s27 to assess is a policing provision dealing essentially with cases of default by the registered person. It provides:
27 Assessment of tax
(1) …the Commissioner may from time to time, from returns furnished under this Act and from any other information in the Commissioner's possession, make assessments of the amount that, in the Commissioner's judgment, is the tax payable pursuant to this Act…
As the learned Master observed, the phrase “from time to time” empowers the Commissioner to issue revised assessments relating to earlier periods.
In terms of ss8 and 9 liability for GST accrues (in the absence of earlier payment) at the time of issue of the invoice. The fact that an assessment is not made until later does not affect that result. It follows that liability of a trustee to pay the tax due upon provision of goods and services by the trust must fall on the trustee in office at the time of issue of the invoice.
Mr Forbes argued that such result should not occur in the present case where at the time of the supply BFT and GIFT were both separately registered and had been permitted to defer payment of tax until payment was received. It was only as a result of the October 2000 assessment, of which notice was given on 17 October, that the Commissioner registered them jointly and altered their status to an invoice basis, so rendering them liable to pay GST for the period 31 May 1999 even though payment of the relevant invoice had not been made. By then Chester had resigned as a trustee of each. I am however satisfied that the Act does not contemplate deferral of liability in such circumstances.
By s19(1) GST is normally payable on an invoice basis. The Commissioner may under s19(2) on application by a registered person direct that it account on a payments basis in certain limited circumstances, one of which is that the total value of its taxable supplies in the previous 12 months has not exceeded $1.3m (until 1 October 2000 $1m). But by s19A(2) where the Commissioner is satisfied that a registered person who has been directed to account for tax payable on a payments basis has exceeded the $1.3m ($1m) limit, the Commissioner may direct that the person account for tax on an invoice basis. That is what he did in the notice of assessment.
A key point is from when the changed basis became operative. By s51(1) every person who carries on a taxable activity and is not registered becomes liable to be registered at the end of any month where the total value of supplies made in that and the immediately preceding 11 months has exceeded $30,000. Where such person has not made application for registration that person shall be a registered person for the purposes of the Act with effect from the date on which that person first became liable to be registered: s51(4). The Commissioner determined that taxable activity was being carried on by both BFT and GIFT and that together they constituted an unincorporated body of persons within the meaning of s57, which was making supplies. Accordingly he issued on such basis first the NOPA and then the assessment, of which notice was given on 17 October 2000.
So viewed, in terms of s57 the joint BFT/GIFT entity which had never previously existed came into an existence legally distinct from those of BFT and GIFT individually. On that basis neither BFT nor GIFT should have secured, or continued, their separate individual registrations. So the case is not one of BFT or GIFT changing its accounting basis, but of the business being conducted by what under s57 is a different entity. Registration must relate back to the date on which that entity became liable to registration, which pursuant to s51(4) the Commissioner fixed as 1 July 1998. There having been no application to the Commissioner in respect to the BFT/GIFT entity to depart from an invoice basis of accounting, that basis necessarily applied.
Such result conforms with other provisions of the Act. In cases where on a registered person’s own application the Commissioner changes that person’s accounting basis from invoice to payments, or vice versa, in terms of s19(4) the new basis does not take effect retrospectively but only from the commencement of the following taxable period. Section 19A(2) however, which deals with correction by the Commissioner of an unauthorised use of the payments basis contains no such provision. I consider that none is to be implied.
The starting point is the presumption of s19(1) of an invoice basis. That may be departed from, on application, if certain conditions are satisfied. But if they are not – something that must be known to the registered person – the Commissioner may direct what is in effect a correction. I reproduce the material provision in its present form:
19A Requirements for accounting on payments basis
…
(2) Where the Commissioner is satisfied … that a registered person who has been directed to account for tax payable on a payments basis has ceased to satisfy the condition [that the total value of the person’s taxable supplies in the period of 12 months then ending has not exceeded $1.3m] the Commissioner shall either—
(a) Direct that the registered person account for tax payable on an invoice basis; or
(b) If the registered person so requests in writing, direct that the registered person account for tax payable on a hybrid basis.
…
By contrast with cases under s19(4), where the registered person has sought and secured the Commissioner’s direction for change, under ss19A(2) that person has usurped a privilege to which it is not entitled. In the absence of any procedure for prospective change the only sensible inference is that the Commissioner may retrospectively remove the unlawful advantage the registered person has attempted to secure. That result is consistent with the conclusion in paragraph [31].
The second issue: whether Chester’s resignation as trustee relieved it of liability
Section 57 of the GST Act 1985 in the form material to this case made special provision for the imposition of GST on the taxable activity of supply or acquisition of goods or services by any unincorporated body of persons, including the trustees of a trust. (The section extends also to members of a partnership and of a joint venture, called “members”, which is why BFT/GIFT is a legal entity distinct from each of BFT, GIFT, and the trustee Chester. For the purposes of the present ground it is convenient to confine consideration to the case of trustees and their trust). By subs (2) it relieved the trustees of personal liability to registration; in respect of the taxable activity of the trust the registration must be in the name of the trust. A supply of goods and services made by the trust in the course of the activity was deemed conducted by the trust and not by a trustee. Subject to subs (3) any change of trustee had no effect for the purposes of the Act.
But by subs (3):
Notwithstanding anything in this section, every [trustee] is liable jointly and severally with any other [trustees] for all tax payable by the [trust] while that [trustee] remains a [trustee] of that [trust], and, where that [trustee] is an individual, after that [trustee’s] death, that [trustee’s] estate shall be severally liable in due course of administration for such tax payable as far as it remains unpaid:
Provided that where any such body is… the trustees of a trust, a [trustee] shall not cease to be a [trustee] for the purposes of this section until the date on which any change of membership of that [trust] is notified in writing to the Commissioner.
After the event with which this case is concerned subs (3) was replaced and substituted by new subss (3)-(3B) which provide:
(3) Despite this section, a member is jointly and severally liable with other members for all tax payable by the unincorporated body during the taxable periods, or part of taxable periods as the case may be, the person is a member of the body, even if the person is no longer a member of the body.
(3A) When an individual member dies, the member’s estate is severally liable in due course of administration for tax payable by the unincorporated body to the extent that it remains unpaid, whether or not the individual was a member on the date of their death.
(3B) For the purpose of subsections (3) and (3A), a member does not stop being a member of the unincorporated body until the date on which the Commissioner receives written notice of a change in membership of the body.
That removes the problem for the future. The question is what the statute provided before the amendment.
That turns on the true construction of:
every [trustee] is liable jointly and severally with any other [trustees] for all tax payable by the [trust] while that [trustee] remains a [trustee] of that [trust].
read with the proviso that:
Where any such body is… the trustees of a trust, a [trustee] shall not cease to be a [trustee] for the purposes of this section until the date on which any change of membership of that [trust] is notified in writing to the Commissioner.
There are two logically possible meanings. One is that the trustee’s liability is:
for all tax [that becomes] payable by the trust while that trustee remains a trustee of that trust
The other, adopted by the learned Master, is that the trustee’s liability is:
for all tax [that remains] payable by the trust [during the period] while that trustee remains a trustee of that trust [but not afterwards].
I prefer the former construction for the following reasons:
[a] It is a natural meaning of the provision;
[b] it requires a smaller departure from the literal words of the statute than the alternative;
[c] it conforms with the common law, in my view departed from by s51 only in part, that a trust is not a legal entity distinct from its trustee, who is personally liable to its creditors for all the debts it incurs (Ex p Garland (1804) 10 Ves. Jun. 110), Labouchere v Tupper (1857) 11 Moo. P.C. 198, In re Graham, Pitt & Bennett ex parte Nolan & Skeet (1891) 9 NZLR 617) even where the trustee contracts with the creditors “as trustee” (Muir v City of Glasgow Bank and Liquidators (1879) 4 App Cas 337, Watling v Lewis [1911] 1 Ch 414, Primary Producers Finance v Dixon (1938) 40 W.A.L.R. 34);
and
[d] it avoids the surely unintended result that a trustee could avoid liability simply by resignation at any time prior to judgment.
I do not rely on the point advanced by the Commissioner, that the provisions of the subsequent amendment (paragraph [37] above) are consistent with his argument. The Privy Council rejected a similar submission in Golden Bay Cement Co Ltd v Commissioner of Inland Revenue [1999] 1 NZLR 385, 392-3, at least in the absence of ambiguity. While subsequent legislation may offer a possible interpretative option for consideration when construing its predecessor, to treat the later legislation as indicating a particular legislative policy could be said to beg the essential question of whether the amendment was intended to confirm or to change the earlier policy as deduced on conventional principles. Since the point is not essential to this decision I say no more about it.
The third issue: whether the statutory demand was correctly stayed
The final question is whether there are proper grounds to disturb the exercise of the Master’s discretion under s290(4)(c). He considered that the demand ought to be set aside on “other grounds”, namely that there is no realistic prospect of Chester’s trading in the future; that rights of indemnity of Chester by the family trusts are worthless; and that if Chester were placed in liquidation it would have to resign in relation to all other trusteeships with consequential transfers both of shares in some 31 companies and of the registration as registered proprietor on some 20 titles to land held on behalf of trusts, which would entail some $20,000 in fees, $3000 costs plus GST, for which no funds are available to a liquidator.
The construction of s290(4)(c) is of practical importance in the process of debt collection and has not previously been considered by this Court. It is desirable in considering it in the present context to go back to first principles of company and trustee law.
Company law
The long title to the Companies Act 1993 describes it as:
An Act to reform the law relating to companies, and, in particular,—
(a) To reaffirm the value of the company as a means of achieving economic and social benefits through the aggregation of capital for productive purposes, the spreading of economic risk, and the taking of business risks; and
(b) To provide basic and adaptable requirements for the incorporation, organisation, and operation of companies; and
(c) To define the relationships between companies and their directors, shareholders, and creditors; and
(d) To encourage efficient and responsible management of companies by allowing directors a wide discretion in matters of business judgment while at the same time providing protection for shareholders and creditors against the abuse of management power; and
(e) To provide straightforward and fair procedures for realising and distributing the assets of insolvent companies
The very purpose of the legislation creating a legal entity distinct from its directors and shareholders is to allow it to engage in business activities entailing risk without exposing shareholders to greater liability than the amount of their investment. The condition of the privilege is that the company be able to pay its due debts. Inability to pay debts triggers a series of consequences. These include voidability of transactions having preferential effect (s292(2)(a)(i)), voidability of charges (s293(1)(b)), liability of transactions at undervalue to be set aside (s297(1)(c)(i)), vulnerability of certain securities and charges (s299(1)) and being presumptively deemed to have failed to keep proper accounting records (s300(1)(a)).
“Inability to pay debts” is the watershed: up until that point the company may lawfully expose its capital and assets to the risks of trade; after that the emphasis is on the position of creditors.
Paragraph (e) of the long title is of particular importance. The machinery for its “straightforward and fair procedures for realising and distributing the assets of insolvent companies” is contained in ss287-291 under the heading Company Unable to Pay its Debts. The following provisions are reproduced:
287 Meaning of “inability to pay debts”
Unless the contrary is proved… a company is presumed to be unable to pay its debts if—
(a) The company has failed to comply with a statutory demand; or
…
289 Statutory demand
(1) A statutory demand is a demand by a creditor in respect of a debt owing by a company made in accordance with this section.
(2) A statutory demand must—
(a) Be in respect of a debt that is due and is not less than the prescribed amount; and
(b) Be in writing; and
(c) Be served on the company; and
(d) Require the company to pay the debt, or enter into a compromise under Part 14 of this Act, or otherwise compound with the creditor, or give a charge over its property to secure payment of the debt, to the reasonable satisfaction of the creditor, within 15 working days of the date of service, or such longer period as the Court may order.
290 Court may set aside statutory demand
(1) The Court may, on the application of the company, set aside a statutory demand.
(2) The application must be—
(a) Made within 10 working days of the date of service of the demand; and
(b) Served on the creditor within 10 working days of the date of service of the demand.
(3) No extension of time may be given for making or serving an application to have a statutory demand set aside, but, at the hearing of the application, the Court may extend the time for compliance with the statutory demand.
(4) The Court may grant an application to set aside a statutory demand if it is satisfied that—
(a) There is a substantial dispute whether or not the debt is owing or is due; or
(b) The company appears to have a counterclaim, set-off, or cross-demand and the amount specified in the demand less the amount of the counterclaim, set-off, or cross-demand is less than the prescribed amount; or
(c) The demand ought to be set aside on other grounds.
(5) A demand must not be set aside by reason only of a defect or irregularity unless the Court considers that substantial injustice would be caused if it were not set aside.
(6) In subsection (5) of this section, “defect” includes a material misstatement of the amount due to the creditor and a material misdescription of the debt referred to in the demand.
(7) An order under this section may be made subject to conditions.
291 Additional powers of Court on application to set aside statutory demand
(1) If, on the hearing of an application under section 290 of this Act, the Court is satisfied that there is a debt due by the company to the creditor that is not the subject of a substantial dispute, or is not subject to a counterclaim, set-off, or cross-demand, the Court may—
(a) Order the company to pay the debt within a specified period and that, in default of payment, the creditor may make an application to put the company into liquidation; or
(b) Dismiss the application and forthwith make an order under section 241(4) of this Act putting the company into liquidation,—
on the ground that the company is unable to pay its debts.
(2) For the purposes of the hearing of an application to put the company into liquidation pursuant to an order made under subsection (1)(a) of this section, the company is presumed to be unable to pay its debts if it failed to pay the debt within the specified period.
Section 290(4)(c) aside, the insolvency policy of the companies legislation is clear: (1) insolvency results in winding-up; (2) insolvency is proved by inability to establish a substantial dispute over the debt or by way of cross-claim. Section 290 may be compared with ss291(1) which refers only to the first two limbs of subs (4) – of substantial dispute whether or not the debt is owing or is due and whether the company appears to have a counter claim set off for cross-demand exceeding the amount of the demand.
Turning to the construction of s290(4)(c) I note the observation of Wild J in Applefields Ltd v The Trustees Executors and Agency Co of New Zealand Limited (1999) 13 PRNZ 387 at 392 endorsing a series of Masters’ decisions, saying:
Sensibly, they have not made any attempt to define or limit what might constitute “other grounds”.
Master Venning at 17,730 para [33], citing this passage, stated that:
Each case must turn on its facts.
I agree that it is no function of the Court to create an exclusive list of circumstances in which the discretion may be exercised where Parliament has not done so. But caution is required when considering how the discretion may properly be used. In Macpherson’s Law of Company Liquidation (3rd edition) it is stated, at paragraph 3.51:
Winding up is sometimes described as the remedy which a creditor possesses for the purpose of enforcing his judgment; but, whether or not judgment has in fact been obtained, an unpaid creditor is, as a general rule, entitled to a winding-up order against a company which is insolvent. In Bowes v. Hope Life Insurance Co. [(1851) 11 H.L.C. 389 at 402; 11 E.R. 1383 at 1389], Lord Cranworth stated that it was:
“not a discretionary matter with the court when a debt is established, and not satisfied, to say whether the company shall be wound up or not; that is to say, if there be a valid debt established, valid both at law and equity. One does not like to say positively that no case could occur in which it would be right to refuse it; but, ordinarily speaking, it is the duty of the court to direct a winding up.”
This has led to a rule that an applicant who can prove that his debt is unpaid and that the company is insolvent is entitled to a winding-up order ex debito justitiae – a phrase which in turn has been said to mean no more than that, in accordance with settled practice, the court can exercise its discretion in only one way, namely, by granting the order sought.
…the court is never bound to make an order merely upon proof of a ground for winding up, but has a discretion to decide whether or not it will do so. Its power to refuse an order is, however, fairly strictly regulated and is exercised in accordance with principles which are relatively well defined. There are, in fact, certainly no more than five, and probably only four, reasons which will justify the court in refusing to make an order on the application of an unpaid creditor. These are that (1) the applicant’s debt amounts to less than [the statutory minimum]; (2) the debt is bona fide disputed by the company; (3) the company has paid or tendered payment of applicant’s debt; (4) winding up is opposed by other creditors; and (5) the company is in the process of being wound up voluntarily.
Section 290 serves a valuable purpose, allowing a truly disputed debt to be challenged or a cross-claim to be advanced by a more convenient procedure than that of application for interim injunction required under previous legislation. I accept that subclause (c) provides jurisdiction to the Court to set aside a statutory demand even though a company is unable to pay its debts and is therefore insolvent. But like any statutory discretion, that conferred by s290(4)(c) must be exercised in conformity with the purposes of the measure by which it is conferred. Use of the exceptional power must be confined to cases which clearly justify departure from the fundamental principle that insolvency should bring the end of a company’s existence.
The Master gave heavy weight to a decision of Master Thomson in Lower Hutt City Centre Solicitors Nominee Co Ltd v Hutt City Council (1995) 7 NZCLC 260, 637 where the Court set aside a statutory demand in the exercise of the discretion under the predecessor to s290(4)(c) on the grounds there would be no purpose in liquidating the nominee company. In that case the demand made against the solicitors nominee company was made by the council to enforce payment of a judgment for rates of $6,699.25. Master Thomson accepted the argument on behalf of the solicitors nominee company that the company was a bare trustee and had no assets and the company’s directors had no authority to demand the rates from the beneficial owners of the subject first mortgage.
Counsel for the Hutt City Council had acknowledged that a solicitors nominee company will never be in a position to meet a rate demand from its own resources. To do so it will need to look to the beneficial owners of the particular mortgage to meet it. It was conceded that the Solicitors Nominee Company’s Rules in their then (1988) form (now superseded by the 1996 rules) did not give a company or its directors power to make a call on the beneficial owners to meet demand for rates. It was acknowledged that the only apparent benefit to the city council if the company were put into liquidation would be the ability to obtain the names of the mortgagee contributors to the mortgage who were personally liable to pay the rates.
Master Thomson recognised that the purpose of the winding up procedure as explained by this Court in Taxi Trucks Limited v Nicholson [1989] 2 NZLR 297, 301 is to deal with insolvency: “[t]he issue on [a winding up] hearing is whether or not the company is insolvent.” He considered that given that a solicitors nominee company is a bare trustee and by definition has no assets and cannot incur debt that any question relating to its solvency should never arise. He expressed the view that providing such company has operated in accordance with the Nominee Company Rules it will never be appropriate to use the winding up procedure which would give no tangible benefit to creditors. He considered that the object which the council sought to achieve by issuing a winding up petition, namely the discovery of the names of beneficial owners of the first mortgage, could be satisfied by setting aside the statutory demands on condition (under s264(7) of the Companies Act 1955) that the directors of the nominee company disclose to the council the names of the beneficial owners of the first mortgage. He adjourned the application to allow his order to be complied with.
The very special case of solicitors nominee companies with which Master Thomson was concerned is not comparable. These are established under rules made by the Council of the New Zealand Law Society pursuant to powers under s17(2)(g) of the Law Practitioners Act 1982. Rule 5 of the 1988 rules prohibited a solicitors nominee company from carrying on any business except:
[a] To act as a nominee company holding securities upon a bare trust for the legal or beneficial owners and as such nominee to lend moneys.
[b] On behalf of the beneficial owner or owners to exercise remedies consequent upon the holding of such securities.
[c] On behalf of the beneficial owner buying in at mortgagee sale and reselling.
[d] On behalf of the beneficial owner or owners executing documents or performing other acts as required in respect of any such security or interest.
By Rule 5.4 all costs in connection with the operation and winding up of the nominee company were the responsibility of the practitioner serving as its director.
Nominee companies operating under such stringent rules have little in common with Chester, whose director does not accept liability for its debts. Such companies could never have gone into business operating trading trusts or have run up GST liability as a result.
An exercise of discretion under s290(4)(c) must take account of the wishes of any outstanding creditor. To relieve the company and its officers of liability to close examination of their affairs and conduct is a course not lightly to be taken. Perverse incentives would be created if the Court were too readily prepared to accept an argument that “nothing will come of the liquidation”. Where as here the creditor represents the Crown which funds the Official Assignee – with tax money – an argument of cost saving can have little appeal.
Further, encouragement of arguments for stay where both debt and insolvency are undisputed would run counter to the policy of clause (e) of the long title to the Companies Act. For these reasons, in point of company law such applications are to be kept within narrow bounds.
Some guidance as to how the s290(4)(c) discretion is to be exercised is given by the structure of s290. Section 290(5) provides that a statutory demand is not to be set aside on the grounds of a defect or irregularity unless the court considers substantial injustice would be caused by the failure to set aside the demand. A statutory demand may only be set aside in reliance on the power established in s290(4) when one of the three subsections is triggered. Subsection (4)(a) arises where the debt is subject to dispute. Subsection (4)(b) justifies the setting aside of a statutory demand when by reason of a counter-claim or set-off the amount that is truly owed is less than the statutory minimum. Therefore, defects or irregularities, whether in the statutory demand itself or in the process by which it is served, which mean that the failure to set aside the demand will cause substantial injustice to the company or other persons, may justify the setting aside of a statutory demand only if they come within s290(4)(c). It is a necessary implication from the enactment of s290(5) that such serious defects must come within the broad language of s290(4)(c).
Moreover, as is noted in McPherson at paragraph [47] above, the wishes of the majority of creditors may require a statutory demand to be set aside. Halsbury’s Laws of England 4th edition, 1996, 7(3) states at paragraph 2240:
A creditor who cannot obtain payment is entitled as of right as against the company to a winding-up order, but this is subject to the court’s power on the hearing of the petition to give effect to the wishes of a majority of the creditors on the question whether a winding-up order should be made…
Where the company is not in voluntary liquidation, and the only fact which emerges is that the company is insolvent, opposing creditors must give reasons for their opposition, even if they represent the majority in number and value, for the court to take their opposition seriously…
Where the company is insolvent, the wishes of the creditors only are regarded. In the case of creditors of different classes, the interest of the class particularly affected must be primarily considered. Thus, on the question of winding up a company whose assets are entirely covered by debentures, the wishes of the unsecured creditors must be regarded in preference to those of the secured creditors. The creditors who are only partly secured and share the class interest of unsecured creditors in protecting or increasing the value of the company’s assets are, however, entitled to the same consideration, in respect of the unsecured portion of their debt, as wholly unsecured creditors. The wishes of creditors will be given weight only if they have reasons which relate to their position as creditors, and are not motivated by collateral purposes.
Thus, the well-founded opposition of a majority of creditors to the winding up of the company may justify the court in setting aside the statutory demand notwithstanding the ordinary rule.
It will also be legitimate for the court to use s290(4)(c) to prevent an abuse of the statutory demand process. Where a statutory demand is being used for a purpose that is not contemplated by the Companies Act it will be appropriate for the court to set aside the demand, notwithstanding the company’s insolvency.
Trustee law
In cases such as the present, where despite its insolvency a company proposes to continue to operate as trustee for other continuing trusts, trustee law points in a similar direction. That follows from the nature and responsibilities of a trustee’s role.
While for the purposes of imposition of GST s57 deems taxable activity by trusts to be performed by the trusts and not by their trustee, it is relevant that the tax liability accrued as a result of the trustee’s trading on their behalf. Reference was made in argument to the Law Commission’s discussion in its recent report Some Problems in the Law of Trusts (NZLC R79 April 2002) of the trading of trusts. The report states, at pages 13-14:
27 We use the term “trading trust” in the sense in which it is usually employed in Australia. There is established a trust, of which the sole trustee is a limited liability company. It is that company that trades, but the assets to which the company has title are beneficially owned by the beneficiaries of the trust, so that if the company fails the only assets available to the creditors of the company in liquidation are the trustee’s right to indemnity out of such assets of the trust as may still be available. While it is probable that this right of indemnity may not be lawfully limited or excluded by the trust instrument, the risks to unsecured creditors remain substantial:
This is especially so when persons dealing with the trustee of such a trust do not realise that a trust is involved at all, or that the trustee has no beneficial interest in the assets which he apparently owns. The problems are exacerbated when the trustee is a company of negligible paid-up capital…[Meagher and Gummow Jacob’s Law of Trusts in Australia (6th ed) 69]
There are also risks to beneficiaries whose only recourse in the event of the failure of the business is against an assetless trustee. We were told by some who made submissions that they have yet to encounter trading trusts or problems resulting from their use. This is understandable because use of trading in trusts in New Zealand is not yet widespread, though it has begun. The very purpose of the Law Commission’s recommendations is to prevent the occurrence in New Zealand of difficulties of the type that have been encountered in Australia before they actually happen.
Chester is and was an assetless trustee. Under s51(2)(d) and (e) of the Trustee Act 1956 among the grounds on which application may be made to the High Court to make an order substituting one trustee for another is that the trustee has been adjudged bankrupt or, if it is a corporation, it has ceased to carry on business, has been placed in liquidation or has been dissolved. In a paper Trust Busting and the Impact of Insolvency presented to the Accountants Trust Conference, Auckland May 2001, Paul Heath QC and Michael Whale observed at page 12:
Those provisions reflect the policy judgment by the Legislature that individuals who become bankrupt or companies which are placed in liquidation are generally unfit to act as trustees.
and at page 2:
Trust law has developed on an underlying expectation that any settlor would want a solvent trustee to be appointed for beneficiaries to sue in the event that the interests of the beneficiaries are defeated by breach of trust on the part of a trustee
I agree with the former comment and observe as to the latter that, while the prospect of suit of the trustee might not be at the forefront of a settlor's mind, stability and responsibility are certainly to be expected.
Heath and Whale cite an address delivered in 1979 to the 20th Australian Legal Convention by R P Meagher QC (now Meagher J of the Court of Appeal of New South Wales) Insolvency of Trustees (1979) 53 ALJ 648 at 648:
The first, and most obvious, result of the insolvency of a trustee is that it renders him liable to be removed from office… the cases seem to lay down the rule that a bankrupt trustee will be removed almost as of course.
[Bainbrigge v Blair (1839) 1 Beav. 495, In re Barker’s Trusts (1875) 1 Ch D 43, Re Adams Trusts (1879) 12 Ch D 634, In re Hopkins (1881) 19 Ch D 61, Re Foster’s Trust (1886) 55 LT 479, Chambers v Jones (1902) 2 SR (NSW) Eq 177, Miller v Cameron (1936) 54 CLR 572]
…
As the High Court pointed out in the last-mentioned case, the result is almost dictated by the Court’s duty, in a removal application, to have as its dominant consideration the welfare of the beneficiaries. The reason why the retention of such a trustee is not usually in the beneficiaries’ interest is twofold: (a) the fact of bankruptcy is prima facie evidence that the bankrupt is a person who has been unwise or improvident in the conduct of his own affairs, and is therefore probably unfit to conduct another person’s affairs; and (b) a bankrupt is ex hypothesis a person of small or no means “and a necessitous man is more likely to be tempted to misappropriate trust funds than one who is wealthy”. The cases show that neither of these two presumptions is conclusive, both may be rebutted, and if rebutted one has the exceptional case where the trustee is not removed. However, the cases where both presumptions are rebutted and the trustee is confirmed in office are rare indeed. In particular, the fact that the bankruptcy is not of recent origin will not, of itself, suffice to rebut either presumption. The cases also show that no distinction will be drawn between actual bankruptcy of the trustee, on the one hand, and an assignment by him for the welfare of his creditors, on the other hand. Nor is it easy to conceive of any relevant distinction between actual bankruptcy and insolvency, unless perhaps the insolvency be of a fleeting and exceptional nature.
I agree.
This case
I turn to the present case and the question whether there were proper “other grounds” on which the learned Master was justified in setting aside the statutory demand. Mr Forbes QC conceded that had the activities giving rise to the GST liability been conducted by an individual who was unable to pay the tax debt a bankruptcy order would have been made as of course. For the reasons given by Meagher QC, removal of such individual from office as trustee would have followed almost as inevitably.
In the present case there were no such constraints upon Chester as exist in the case of a solicitor’s nominee company; Chester could and did as trustee engage in the conduct performed on behalf of BFT and GIFT.
It had registered BFT and GIFT separately for GST purposes, BFT from 1 July 1998 when that trust was settled, GIFT on 4 November 1998 for GST purposes; the commencement date was backdated to 26 May 1998, the date on which Chester became its trustee. Each trust sought and was allocated an individual payments basis for its two-monthly GST returns on the footing that their operations were distinct, something that did not survive analysis at audit.
By written agreement dated 11 August 1998 BFT and GIFT each contracted to buy a half share in a section at 13 Pope Terrace, Cambridge. Mr Cousins on behalf of the vendor issued to BFT/GIFT a tax invoice for $192,905 dated 17 August 1998. BFT/GIFT paid for the property by taking over a mortgage for $192,195 to Westpac. BFT and GIFT each claimed in its GST return input tax deduction of its respective half-share ($96,462.50) of the purchase price.
On 26 March 1999 BFT contracted to sell units 1, 2 and 4 to separate purchasers at $226,000 (GST inclusive) each by signed but undated agreement for sale. On the same day GIFT contracted to sell units 5-7 to Pope Properties Limited for $647,000 (GST inclusive). On 26 May 1999 BFT borrowed $641,840 from Southern Cross Building Society to pay for its share of the cost of building the units. The same day a similar loan was taken out by GIFT for $519,886. Personal guarantees were given by Mrs Jackson, settlor of the BFT, and her husband, for the total amount of the loans taken out to complete the development. Mr Jackson was acting as agent for both trusts in respect of the Pope Terrace project. Draw downs commenced on 4 June 1999 in the case of GIFT, and on 27 August 1999 in the case of BFT. For the period from 26 July 1999 Straven Trustee Services Limited was a co‑trustee of BFT with Chester until the resignation of each on 19 April 2000. Thereafter Mr and Mrs Jackson became trustees. They are now both bankrupt. Chester was sole trustee of GIFT during the period from 26 May 1998 until 15 May 2000 when it was replaced by a Ms Spain.
Mr Cousins deposed that to his knowledge none of the purchasers ever settled and no payment on account was made by any of them. Only one of the agreements had been cancelled but he did not expect that the others would be likely to settle because the units had not been completed. The whole of the property has now been sold to BFT for a purchase price of $1,349,646 subject to the mortgage to the Southern Cross Building Society which, as mortgagee, had entered possession of the property. Mr Cousins deposes:
24. The consequence is that, based on my knowledge, both trusts are insolvent. The liabilities of [BFT] substantially exceed the only asset it has, namely the property at Pope Tce Cambridge. To my knowledge [GIFT] has no assets apart from a right of indemnity from [BFT] for the liability as assumed under the agreement dated June 2000… [GIFT] otherwise continues to have the same liabilities as [BFT].
25. I therefore believe and, indeed am quite sure, that any right of indemnity against the trust assets which Chester may have for any GST liability in respect of either trust would not in fact be available.
The Commissioner’s investigator deposed that as at 17 October 2000 there was a net debt of $9,448 owed by BFT/GIFT to the Commissioner after subtracting output debits $71,888 from input credits $62,440. Penalties and interest increased that figure to the amount of the demand.
The learned Master was satisfied that such indemnities as Chester has against trust assets are worthless and that there would be no point in placing Chester into liquidation to enable the Official Assignee or other liquidator to pursue such indemnities. The Master identified a further factor that he considered weighed in favour of the application. He found that if Chester were to be placed into liquidation it would have to resign as trustee in relation to all other positions of trust it holds. The approximately 20 titles of land held in its name would have to be transferred to other entities. Mr Cousins has calculated that the disbursements involved in affecting transfers of interests in land where Chester is registered on the title would be approximately $30,000 plus GST together with other costs associated with obtaining the consents of mortgagees if necessary. In addition, there would be legal costs involved in the preparation and completion of the transfers, in completion of transfer of shares in approximately 31 companies where Chester holds shares. On a normal basis Mr Cousins estimates that approximately $20,000 in fees could be incurred. There are no funds for a liquidator to meet those costs. He concluded that in the circumstances it was appropriate to set aside the statutory demand pursuant to s290(4)(c) and ordered accordingly.
Mr Forbes submitted that it would be purposeless and oppressive to permit the winding up to proceed. He emphasised Mr Cousins’ evidence in his second affidavit:
28. The present situation in which Chester has found itself as being the subject of a claimed GST liability as trustee means that for the future my firm will, in the case of a trust that will or may trade, use a stand-alone trustee company for a client trust, rather than a general trustee company like Chester, where it could be at risk for a GST liability in respect of a particular trust to the detriment of other client trusts of which it is also a trustee. This will involve extra establishment and on-going compliance costs for the client.
and submitted that in view of Mr Cousins’ sworn assertion there is no future risk of Chester’s being used to trade.
It is Mr Forbes’ argument that at the time Chester, in its role as trustee, caused or permitted the trust to be registered for GST purposes on a payments basis and to engage in the property development which proved unsuccessful, Mr Cousins, as its director, had no reason to expect the Inland Revenue Department audit leading to the assessment, of which notice was given on 17 October 2000, combining the businesses of the two trusts and rendering them liable to GST on an invoice basis. He submits that the unhappy history of the development is in the past and for the future Chester should be permitted to continue despite its insolvent position for the kind of reasons that were accepted by Master Thomson and adopted by Master Venning in this case.
I respectfully disagree with Master Venning’s decision and with his approach to the exercise of discretion.
It is necessary to stand back and look at the matter in wider perspective than the arguments before him suggested. The presumption of inability to pay debts that will justify a winding up normally arises where there is no arguable defence and a company is unable to respond to a s289 notice. An application under s290 is appropriate in the cases falling within subclauses (a) and (b), where there has been a defect or irregularity that causes substantial injustice (and thus is not excluded by s290(5)), in the other cases listed by Macpherson (paragraph [47] above), which include a situation where the majority of creditors oppose, for good grounds, the winding-up of the company, and no doubt, where there is reason to believe that there may be abuse of process. The privilege of incorporation being given on the premise of continued insolvency, when the presumption of inability to pay debts is triggered in terms of s287, the “straightforward and fair procedures for realising and distributing the assets of insolvent companies” are those of liquidation or receivership. The statutory demand procedure is balanced by a procedure for the alleged debtor to demonstrate substantial dispute or the existence of a cross-claim. But the area of dispute by reason of the internal affairs of an insolvent debtor should not be a prominent part of insolvency jurisdiction.
The normal expectation of insolvent companies should be of exposure to investigation by a liquidator, which should not readily be averted by an application under subclause (c). The creditor lacks information as to the circumstances of the debtor and the perverse incentive of encouraging an insolvent company to protect itself from investigation is not to be encouraged.
That is the more so where the consequence of an order will be to permit an insolvent company to continue as trustee. In this case Mr Cousins has produced a letter from his firm to the Commissioner stating:
…A company like Chester will never be in a position to meet any liability, as a trustee, from its own resources and neither the company nor its director have the power to make a call on the beneficiaries under the trust to meet the GST claimed by the IRD. Any issue as to whether or not the company is insolvent is accordingly academic. The advice we have is that it would not be appropriate to use the liquidation procedure against such a company which has at all times operated within the terms of its constitution.
Such advice is wrong. For a trustee company to have no substance is generally a reason not to protract but to terminate its operation.
The narrow focus of the argument advanced to the Master led to failure to consider the wider issues of company and trust law discussed in this judgment. While there is an assertion by Mr Cousins that Chester was not careless or at fault, the present proceedings are not a convenient procedure to determine whether that is so. In the ordinary way the failure of a trading company that results in loss to creditors should lead to appointment of a liquidator who will have the means of investigating whether recourse may be available against directors.
Nor will the Courts readily acquiesce in the continuation as trustee of an assetless company, at least in the absence of the kind of safeguards attending solicitors nominees companies. It is an axiom of the law of trusts that a trustee must be fit to discharge its functions or be liable to be discharged from office. I have referred to s51 of the Trustee Act 1956 which empowers the Court to appoint a new trustee “whenever it is expedient” to do so “and it is found expedient, difficult, or impracticable to do so without the assistance of the Court…”. It further provides:
(2) In particular and without prejudice to the generality of the foregoing provision, the Court may make an order appointing a new trustee in substitution for a trustee who—
(a) Has been held by the Court to have misconducted himself in the administration of the trust; or
…
(d) Is a bankrupt; or
(e) Is a corporation which has ceased to carry on business, or is in liquidation, or has been dissolved.
In the exercise of the Court’s discretion under review I pay regard to the fact that the beneficiaries under the present trusts are infants whom it is the Court’s responsibility to protect. Whether there will be further repercussions of the past trading problems of Chester is unknown. But I consider it wholly unsuitable to have Chester remain in office as a trustee, with responsibility to protect the interests of the beneficiaries, when it has no capacity to do so. However “bare” the trustee’s role, there are certain obligations cast upon trustees even simply of land that can arise where there are disputes over rates with zoning or with neighbours while if the properties are developed there may be difficulties with tenants and repairs.
Indeed it may be thought implicit in the professional arrangement between Mr Cousins and his clients that the trustee company employed to hold their assets would have the capacity to perform its trust obligations, no doubt with recourse to trust assets, but without the distraction of insolvency.
The combination of the presumptive desirability of liquidation of a company that has incurred debt through trading and of the position of the beneficiaries under the numerous trusts outweighs in my opinion the cost of the conveyancing necessary to remove the continuing trusts from Chester’s hands. The appeal should be allowed with the consequences stated by Tipping J.
Solicitors
Crown Law Office, Wellington for Appellant
Cousins & Associates, Christchurch for Respondent
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