Covington Railways Ltd v Uni-Accommodation Ltd

IN THE COURT OF APPEAL OF NEW ZEALAND

CA186/00

BETWEEN	COVINGTON RAILWAYS LIMITED
Appellant

AND	UNI-ACCOMMODATION LIMITED
Respondent

Hearing:	3 October 2000
Coram:	Gault J Keith J Blanchard J
Appearances:	B O’Callahan and J Heimsath for Appellant D J Neutze for Respondent
Judgment:	11 October 2000

JUDGMENT OF THE COURT DELIVERED BY BLANCHARD J

The appellant, Covington Railways Ltd (Covington), and the respondent, Uni-Accommodation Ltd (UAL), a company owned by the University of Auckland, are in dispute about their contractual obligations relating to the development by Covington of 227 residential units in the former railway station building, now known as the Railway Campus. UAL agreed to take long-term leases of certain accommodation units from Covington and arrange for them to be occupied by students, staff and other persons approved by the University. It was envisaged that Covington would then sell its interest in the units to individual investors guaranteeing them a 9% return for a period after the sale. Covington covenanted with UAL that during a two year guarantee period it would meet any shortfall in the revenues received by UAL from occupiers of the units which it had taken on lease and would also meet certain outgoings in respect of those units. It is clear that however these obligations are to be calculated, which has been a matter of contention, Covington is substantially behind in making these payments. It says, though, that it has its own claim against UAL giving rise to an equitable set-off because of an alleged misrepresentation by UAL and because UAL has failed to operate its accommodation business in accordance with a covenant to do so to “good industry standards”. The take-up of occupancy has fallen well short of expectations. UAL blames changes in market conditions since the project began in 1998 and defaults by Covington in the performance of its construction obligations.
It seems that the parties have not found it possible to resolve their differences except by this litigation. This is most unfortunate in view of their continuing relationship. Members of the Court gained the impression that more might have been achieved by the devotion of energy to dispute resolution than by the present proceedings.
Covington stopped paying UAL’s monthly invoices for revenue shortfalls and outgoings in October 1999. In February of this year UAL served two statutory demands on Covington in reliance on ss287 to 289 of the Companies Act 1993. They were for sums totalling $421,536.92. Covington did not comply with them. UAL then made an application to the High Court for the liquidation of Covington.
In May a third statutory demand was made by UAL for a further sum of $289,086.08. Again, there was no compliance by Covington.
Covington then applied for orders restraining the advertising of the liquidation proceeding and staying any further steps in that proceeding. It also made an originating application for an order that the third statutory demand be set aside.
Both of Covington’s applications were heard together by Master Gambrill, who delivered a reserved judgment on 31 August 2000. The Master concluded that $250,170 of the amounts claimed in the first and second demands and the whole of the $289,086.08 in the third demand could not be disputed by Covington. She refused Covington’s applications but ordered that it should have seven days to pay the total indisputable sum of $539,256.08. In default, UAL was to be permitted to list the application for liquidation on 10 October. From that judgment Covington appeals.
It is convenient to leave to one side for the moment a question relating to the significance of a $500,000 banker’s performance guarantee in favour of UAL from the Hong Kong and Shanghai Banking Corporation Ltd in relation to Covington’s obligations, and to deal first with the quantum of the sums held by the Master to be indisputable and with Covington’s argument that its claims against UAL should be set-off against the amounts which it owes Covington for rent and outgoings. We do this because we are satisfied that the Master cannot be said to have erred in her conclusions on these two matters.

Deduction from third demand

Mr O’Callahan accepted for present purposes the figure of $250,170 but said that it reflected the argument he had made to the Master that Covington was entitled to certain deductions in respect of outgoings related to units not taken over by UAL. His argument on appeal was that the Master had failed to make a corresponding allowance in respect of the third demand. Counsel submitted that a sum of $46,626 should have been deducted from the figure of $289,086.08. That would reduce the total indebtedness (subject to the question set-off) to $492.630.08, which is less than the amount of the performance guarantee.
The difficulty for Covington in this argument is that there was no evidence provided before the Master to support the claim for deductions from the third demand figure, as had been done by Covington in respect of the earlier demands. The Master cannot be said to have erred in refusing to make an assumption that the position remained the same so far as UAL’s occupancy and Covington’s obligations were concerned during the period covered by the third demand.

Set-off claim

We turn next to the breaches by UAL said to give rise to a set-off, noting as we do that the claim has not been quantified by Covington.
Where a company which is the subject of a liquidation application is indisputably in debt to the applicant creditor, it may nonetheless be able to show that it has a claim against the applicant which reduces the net balance owing to the creditor or even off-sets it altogether. Where there are liquidated sums due each way, that is simply an arithmetical exercise. It is more difficult if, on the applicant’s side, there is an indisputable liquidated sum, but the other party’s claim is for an unliquidated sum with liability and/or quantum in dispute. Then, in order to impeach the statutory demand and overcome the presumption in s287(a) that the company is unable to pay its debts when it has failed to comply with the demand, it must be able to do more than merely assert that there is an available set-off. It must be able to point to evidence before the Court showing that it has a real basis for the claimed set-off and that accordingly the applicant’s claim to be a creditor is, to the extent of the set-off, seriously in doubt. In the words of Buckley LJ in Bryanston Finance Ltd v De Vries (No.2) [1976] Ch 63, 78, it must show that there are “clear and persuasive grounds” for the set-off claim. Where this can be done, the party who has issued the statutory demand against the company will be shown to be using the statutory demand and liquidation procedures improperly because there is a “genuine and substantial dispute” about the net amount of the company’s indebtedness (Taxi Trucks Ltd v Nicholson [1989] 2 NZLR 297, 299). The dispute should then be resolved in the ordinary way – except as to any undisputed balance – rather than upon the hearing of a liquidation application.
In this case we consider that the Master correctly decided that Covington had not sufficiently demonstrated the existence of its claimed equitable set-off. Covington’s first allegation was misrepresentation. Mr Speedy of Covington pointed to the contrast between, on the one hand, figures supplied by UAL before the development contracts were entered into, showing that over the last five years the university had had on average between 2,200 – 2,500 annual applications for the 962 rooms which it had available and, on the other hand, the relatively poor take-up of occupancy by students and others on the Railway Campus. This was said to suggest that UAL must have misstated the figures for annual applications for rooms. It is apparent however that this suggestion is no more than speculation on Covington’s behalf. UAL denies any misstatement and all Mr Speedy has felt able to depose to is that
…it is difficult for me at this stage to know whether the representations were actually correct. However, I have observed the very poor performance of the facility and that leads me to believe that the representations may have been wrong.
The other breach alleged by Covington is that UAL has failed to adhere to “good industry standards” in operating its accommodation business. The Master summarised this as Covington “trying to say marketing has been poor, the facility has been run in a bureaucratic fashion and there is poor performance on the campus”. As the Master said, there is no evidence independently given of any of the matters related to the allegations made. Nor did Covington provide any support for its suggestion that students have been put off applying for accommodation on the Railway Campus by the allegedly invasive nature of UAL’s standard application form. The Court has seen the form and it is not obvious from it that students would react in that way. None has so deposed.
We agree with the Master than neither of these allegations provides a proper foundation for any claimed set-off by reason of which the respondent’s proceeding should be stayed.

The performance guarantee

The remaining point concerns the Hong Kong and Shanghai Banking Corporation Ltd’s performance guarantee. Covington covenanted with UAL in the principal deed that as security for its obligations under its covenants relating to outgoings and revenue shortfalls and default interest it would (a) execute a bond for $1 million (which it has done) and (b) procure three guarantees in an agreed form. The first of the guarantees was to be in the sum of $500,000, to be given by Hong Kong and Shanghai Banking Corporation Ltd (“the Bank”) and was to be effective until the expiry of the guarantee period. It is accepted that this guarantee has been duly provided by Covington. The other two guarantees were to be given at a later time by a New Zealand registered bank approved by UAL. They have not been provided.
The performance guarantee given by the Bank is dated 10 November 1998 and provides as follows:
IN CONSIDERATION of UAL accepting the Bond of CRL and entering into the Principal Deed with CRL THE HONGKONG AND SHANGHAI BANKING CORPORATION LIMITED (hereinafter together with its successors liquidators and assigns called “the Guarantor”) GUARANTEES to UAL payment of the sum of $500,000 neither more nor less, as is bound to be paid to UAL under the Bond, which payment is to be made without condition or proof forthwith upon first written request signed by, or on behalf of UAL and given on or before the specified date referred to in paragraph (f) below.

It is also agreed by the Bank that (inter alia) the guarantee is not to be abrogated, prejudiced or affected by the liquidation or insolvency of Covington and that it is a continuing and irrevocable guarantee. There are also the following provisions:

(e)Payment will only be made upon receipt of a written demand purporting to be signed by UAL and will then be made without reference to and notwithstanding any instruction from CRL to the Guarantor to the contrary.
(f)The “Specified Date” on or before which request for payment under this Guarantee must be made is 31 March 2001. This Guarantee expires on the Specified Date and, without in any way limiting the liability of the Guarantor in respect of any claim made prior to the Specified Date, the Guarantor thereafter has no further liability under it.

In Edward Owen Engineering Ltd v Barclays Bank International Ltd [1978] 1 All ER 976 Lord Denning MR described performance guarantees of this kind as “virtually promissory notes payable on demand”. He said that so long as an honest demand is made the banks are bound to pay, and that this led to the conclusion that a performance guarantee stands on a similar footing to a letter of credit:
A bank which gives a performance guarantee must honour that guarantee according to its terms. It is not concerned in the least with the relations between the supplier and the customer; nor with the question whether the supplier has performed his contracted obligation or not; nor with the question whether the supplier is in default or not. The bank must pay according to its guarantee, on demand if so stipulated, without proof or conditions. The only exception is when there is a clear fraud of which the bank has notice. (p983)

Browne LJ agreed. Geoffrey Lane LJ commented that although the agreement in that case was expressed to be a guarantee, it was not in truth such a contract. “It has much more of the characteristics of a promissory note than the characteristics of a guarantee”. (p986)

The guarantee in the present case was given by the Bank at the request of Covington which had executed a general debenture charge to the Bank over all its assets. Covington deposited $500,000 into a cash collateral account with the Bank. The debenture contained an express fixed charge over that bank account. Covington also executed a counter-indemnity in favour of the Bank authorising it to meet UAL’s demand under the performance guarantee and entitling the Bank in that event to debit the cash collateral account. Thus if UAL makes demand on the Bank, it will effectively be Covington’s funds which are used to satisfy the demand.
UAL accepts that as Covington is in default in paying as covenanted more than $500,000 it could at any time until expiry of the performance guarantee make demand on the Bank. It also accepts that in this way it could receive immediate payment of $500,000. Yet it says that it does not want to do this. It prefers instead to apply to have Covington put into liquidation, saying that Covington is insolvent and that there is a risk that recovery of Covington’s assets may be difficult if liquidation is delayed. These allegations are based upon Covington’s slowness in paying UAL’s monthly invoices and its refusal to pay anything at all since the end of last year. UAL points to passages in an affidavit from a chartered accountant instructed by Covington who refers to a very substantial loan made by Covington to its parent company, Covington Corporation Ltd. The Covington group of companies is engaged through other subsidiary companies in other substantial property developments. Notwithstanding the accountant’s expression of a view that Covington and the group are solvent, UAL says that it is at some risk as a creditor of Covington and that the independent control and investigation of a liquidator is immediately desirable. It also says that since the third demand there has been further default by Covington in paying amounts falling due in subsequent months, though apparently these defaults have not yet been the subject of any statutory demand. UAL also says that there are likely to be further moneys falling due over the balance of the guarantee period.
The present question is, however, whether it is to be presumed from Covington’s failure to pay the $539,256.08 found by the Master to be indisputable that it is unable to pay its debts. The presumption is rebuttable under the 1993 Act but in considering what will be sufficient to do so it is worth remembering that there is authority for the view that despite a company otherwise appearing financially sound, the inference can be drawn that it is unable to do so when it is under an undisputed obligation to pay a particular sum and has failed to do so (Mann v Goldstein [1968] 1 WLR 1091; Cornhill Insurance plc. v Improvement Services Ltd [1986] 1 WLR 114). Hence even strong evidence from a debtor company as to its solvency may not carry the day if a statutory demand is not complied with in accordance with s289(2)(d).
That provision stipulates that the demand must
[r]equire the company to pay the debt, or enter into a compromise under Part XIV 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.
There is compliance with the demand and consequently no presumption of inability of the company to pay its debts if any of these things is done within the 15 working days, or a longer period ordered by the Court (as the Master ordered in this case) “to the reasonable satisfaction of the creditor”.
Mr O’Callahan submitted that as to $500,000 there has been a payment, a compounding or the provision of a charge to secure payment; and that, as the provision of the performance guarantee was pursuant to agreed arrangements between the parties, UAL must be taken to be reasonably satisfied to that extent.
We do not agree that the existence of the performance guarantee can amount to a payment, although it is certainly a means by which payment can immediately be obtained if UAL chooses to do so. A promissory note and a letter of credit are means of accessing payment but they are not in themselves payment. So it is with a performance guarantee.
Nor has there been any compounding between debtor and creditor. The guarantee exists as originally stipulated for. It does not amount to a compromise or agreed variation of the terms binding on the parties.
But Mr O’Callahan sensibly concentrated his argument in this Court, which differed in some respects from that made in front of the Master, on whether the guarantee and the arrangements between Covington, UAL and the Bank which led to its execution by the Bank, amount to the giving by Covington of a charge over its property to secure payment of its debt (to the extent of $500,000).
We think it does. There is no reason to read s289(2)(d) as referable only to an event occurring after the demand is made. If in the circumstances it is reasonable to expect a creditor to be satisfied by a charge over the property of the company, why should it matter whether that was given before or after the making of the statutory demand? In assessing what is reasonable in the circumstances it is very relevant to take into account what has earlier been agreed to and done by the parties. And when the Court is considering only whether there has been reasonable satisfaction as to a particular amount immediately recoverable under an existing performance guarantee, it would seem to be of little relevance that there may have been a failure to provide other guarantees of further amounts.
The definition of “charge” in s2 of the Companies Act includes a right or interest “in relation to property owned by a company, by virtue of which a creditor of the company is entitled to claim payment in priority to creditors entitled to be paid under s313” (the pari passu rule), but there is no need to read into the use of that defined word in s289(2)(d) any requirement that the charge over the company’s property (its chose in action in respect of the cash collateral account) must be given in favour of the creditor who has made the statutory demand. In this case, the charge to the Bank was a charge over Covington’s property in terms of s289(2)(d).
The critical question is whether the charge to the Bank can be said in this context to secure payment of the debt. There is no doubt that the performance guarantee was given to afford UAL a means of recourse for recovering moneys owing to it in the event Covington defaulted on its covenanted obligations. As such, it was intended to operate as a security, in the sense of giving UAL a priority over Covington’s other creditors. The Bank itself gave no charge over its own assets; UAL is not a secured creditor of the Bank. But we consider that it is sufficient for the purposes of s289(2)(d) that, overall, the arrangement between the three parties does provide a charge over Covington’s asset and thereby gives UAL priority in relation to the party whose solvency is in issue. (If there were any question about the solvency of a performance guarantor under such an arrangement, which there is not in this case, that would be a matter going to “reasonable satisfaction.”)

We conclude that to the extent of $500,000 the statutory demands have been complied with.
The appeal must therefore be allowed and the Master’s order varied by staying the liquidation proceeding based on the first two statutory demands (since the indisputable sum under them is less than $500,000). Covington is to have seven days from delivery of this judgment to comply with the third statutory demand as to the balance in excess of $500,000, namely $39.256.08. If it does not do so then, as matters now stand, and if UAL thinks fit to do so, an application for liquidation of Covington could be brought based upon the third demand and may be advertised. We put the matter in this way because we are conscious of the reference from the Bar towards the end of the oral argument to another fund said to be held by UAL from which it may be accountable to one of the members of the Covington group of companies. Depending upon the ownership of the rights to that fund, and of course any set-off available to UAL, some further allowance may have to be made against the balance of the demanded indebtedness.
The respondent is to pay Covington’s costs on the appeal of $5,000 together with its reasonable disbursements, including travel and accommodation costs of counsel, as fixed by the Registrar if they are not agreed upon.

Solicitors:

Carter & Partners, Auckland for Appellant

Brookfields, Auckland for Respondent

[2000] NZCA 230

11 October 2000