East Coast Aluminium Ltd (in liq) v Perry
[2018] NZHC 317
•5 March 2018
IN THE HIGH COURT OF NEW ZEALAND ROTORUA REGISTRY
I TE KŌTI MATUA O AOTEAROA TE ROTORUA-NUI-Ā-KAHU ROHE
CIV-2016-463-000184
[2018] NZHC 317
BETWEEN EAST COAST ALUMINIUM LIMITED (IN LIQUIDATION)
First PlaintiffVIVIEN JUDITH MADSEN-RIES AND
HENRY DAVID LEVIN as Liquidators of East Coast Aluminium Limited (In
Liquidation) Second Plaintiffs
AND
PATRICIA MERTLE PERRY
First Defendant
DONALD GRAEME PERRY
Second DefendantANTONY DAVID SANDFORD FLEMING
Third Defendant
Hearing: 11-14 September 2017, further submissions on 31 January 2018 Appearances:
N H Malarao and G A Campbell for the Plaintiffs
D M Fraundorfer and T J Conder for the First and Second Defendants
Appearance excused for the Third Defendant
Judgment:
5 March 2018
JUDGMENT OF PALMER J
This judgment is delivered by me on 5 March 2018 at 11.30 am
pursuant to r 11.5 of the High Court Rules.
Solicitors:
Meredith Connell, Auckland
.....................................................
Registrar / Deputy Registrar
EAST COAST ALUMINIUM LTD (IN LIQUIDATION) & ORS v PERRY & ORS [2017] NZHC 317 [5 March 2018]
Holland Beckett, Tauranga
Summary
[1] There can be a great temptation, when running a closely-held company, to mix personal and business expenditure. And when in financial difficulties, it may be tempting to pay creditors with funds that should be used for tax. But a company is legally distinct from its shareholders and directors even when closely held. And PAYE and GST are not a company’s or its directors’ funds to use. East Coast Aluminium Ltd (ECA) got into financial difficulty and was eventually liquidated by Inland Revenue in 2013. Mr Perry, the principal operator and one of its shareholders and directors, was bankrupted by Inland Revenue. The other shareholder and director was his wife Mrs Perry, who did the accounts. Now the liquidators, on behalf of ECA, seek compensation for the Perrys’ use of ECA funds and breaches of director duties.
[2] I accept ECA was insolvent by 31 March 2010. Mrs Perry must repay the joint drawings taken since then, which make up the shareholders’ Current Account debt of
$132,980 plus interest. That includes payments of mortgage instalments on the Westpac 91 and 92 loans for the house owned by the Perrys’ family trust. It does not include payments on the Westpac 93 loan which was for the benefit of ECA. Given that conclusion, I do not need to decide whether the Perrys made prejudicial dispositions which should be restored under s 346 of the Property Law Act 2007.
[3] The remedies of backwards tracing into the house, or an equitable lien arising on it, are not available here. The remedy of equitable subrogation is potentially available but should not be granted here because the recovery of a monetary sum is sufficient to restore the unsecured plaintiff to the position they should have been in. Given the liquidators’ success otherwise, I do not award further compensation under s 301 of the Companies Act 1993 for the Perrys’ breaches of directors’ duties.
What happened?
The Perrys and ECA
[4] Mr Don Perry and Mr Brian Monk incorporated ECA in June 1984. Mr Monk left the company around 1986 and in 1988 Mrs Trish Perry became a director and
equal shareholder. The Company was initially established to supply aluminium joinery in the Eastern Bay of Plenty under a franchise-type arrangement with Carter Holt Harvey Ltd.
[5] ECA operated successfully for a number of years, employing around 12 workers. However, in the late 1990s competition reduced its market share. ECA significantly reduced staffing and sold its premises. Its purchase of stock in advance was limited by its overdraft facility from this point on. But it traded out of its difficulties. From 2000 to 2009, ECA was profitable or operated at a small loss. Mr Perry was the principal person operating the business and Mrs Perry did the day- to-day accounts in an office in her house, on top of her day-job in the healthcare industry. The new leased premises had less storage space so the Perrys’ house was used for some storage.
The house
[6] The Perrys purchased their house in Ōpōtiki in April 1991, with a registered mortgage in favour of BNZ. In December 1998 ownership of the house was transferred to the DG & PM Family Trust, with a registered mortgage in favour of Westpac. In return for the mortgage, Westpac made two loans to the Perrys, of $65,000 (the 91 loan) and $78,000 (the 92 loan). In January 2000, the 91 loan was increased by $20,000 and the funds injected into ECA. On 9 February 2009, the Perrys took out a third loan of $20,000 from Westpac, secured by mortgage over the house (the 93 loan). These funds were also injected into ECA.
Illness and financial difficulties
[7] From around 2009, Mr Perry suffered from significant health problems. Because he was integral to the business, ECA’s revenue dropped significantly and it experienced financial difficulties.1 ECA could not afford to generate annual accounts during this period.2 Mrs Perry continued to keep a ledger, reconciling bank statements with invoices and cheque butts. Where there was no identifiable invoice or cheque- butt notation, Mrs Perry responsibly coded the item as “Perrys”, indicating it was to
1 Notes of Evidence (NOE) at 116/28–30 and 135/24–26.
2 NOE at 95/17–19
be listed as drawings. The annual accounts for this period were subsequently prepared by Ezebiz Accountants Ltd, based on Mrs Perry’s coding in November 2013, just prior to liquidation.3
[8] Under cross-examination, Mr Perry stated ECA was not able to pay its GST, or all its PAYE on time.4 He conceded these were signs ECA was in significant financial difficulty.5 He agreed that, in the first half of 2010, he decided to pay off Westpac and rent, to continue trading and to ignore Inland Revenue.6 The Perrys submit Mr Perry elected to defer paying GST in March 2010, until he was able to return to the business on a full-time basis.7 The Perrys submit this decision was based on: the potential of the business to trade out of its difficulties; the non-urgency of tax obligations compared with other debts which would have immediately have prevented trading; the availability of assets from which the tax obligations could be met; and the chance Inland Revenue would not require ECA to pay the full debt.8 Under cross- examination Mr Perry accepted he decided not to use the equity in the house to pay Inland Revenue.9 He also accepted it would be fair to say that, in managing and directing ECA, he didn’t really distinguish between ECA and himself and Mrs Perry.10
[9] The Perrys say they believed ECA was solvent in terms of the balance book and liquidity, during this period, because they considered ECA was able to call on further shareholder injection of funds, drawing on the equity in the house, if ECA was required to meet repayments.11
Liquidation
[10] In 2013, Inland Revenue took steps to collect its debts from ECA. Payment and compromises was discussed. Annual accounts and tax returns were filed. But ultimately, in late 2013, Inland Revenue decided to put ECA into liquidation. ECA
3 NOE at 129/15-18.
4 NOE at 97/21-25 and 111/4-6 corroborated by Mrs Perry in relation to GST at NOE 133/1-10.
5 NOE at 111/17-19.
6 NOE at 105/2-5 and 109/1-9.
7 Defendants’ closing submissions of 15 September 2017 [Defendants’ Closing] at [3.14].
8 Brief of Evidence of Donald Perry [Donald Perry Brief] at [43].
9 NOE at 114/25-28.
10 NOE at 121/19-24.
11 Donald Perry Brief at [26] and [57]; Brief of Evidence of Patricia Perry [Patricia Perry Brief] at [9].
was liquidated by the High Court on 2 December 2013. ECA’s debt to Inland Revenue had risen from $3,163.29 in GST, interest and penalties at end of the 2010 tax year, to
$41,542.79 on liquidation.12
[11] On liquidation, six claims totalling $81,200 were accepted from Inland Revenue, Chevron NZ Ltd, Ezebiz, McKechnie Aluminium Solutions Ltd (McKechnie), Mainfreight Ltd and Westpac. The Perrys have repaid McKechnie and Westpac in full and Ezebiz in part. ECA now owes $52,008 to Inland Revenue, Chevron, Ezebiz, and Mainfreight.
[12] Mr Perry was bankrupted as a result of failure to pay personal income tax in June 2014.13 He was discharged from bankruptcy in July 2017, after these proceedings commenced.
Proceedings
[13] The liquidators, Ms Vivien Madsen-Ries and Mr David Levin, pursue the following causes of action against the Perrys:
(a)repayment by Mrs Perry of the amounts paid by ECA to the Perrys via the shareholders’ current account (the Current Account debt), totalling
$143,452;
(b)alternatively, repayment by Mrs Perry of the Current Account debt entered into after 31 March 2010 (when the liquidators say ECA became insolvent) as prejudicial dispositions under the Property Law Act 2007, totalling $104,558;
(c)a proprietary interest of $72,032 in the Perrys’ house due to them breaching their fiduciary duties as directors by misapplying ECA funds in using them to repay the Perrys’ own mortgage;
12 Bundle of Documents (BOD) at 565.
13 NOE at 20–25.
(d)compensation from Mrs Perry of $224,652 plus interest and declarations against both of the Perrys, under s 301 of the Companies Act 1993 for breach of directors’ duties.
[14] The trial was conducted in Rotorua over four days. I heard evidence from Mr Levin for the liquidators and from Mr and Mrs Perry for themselves.
[15] At the beginning of the hearing counsel addressed me on objections to Mr Levin’s evidence as opinion evidence, submissions and evidence that requires expertise he does not possess. Mr Conder, for the Perrys, submitted the outcome of the litigation affected whether Mr Levin’s fees would be paid as liquidator and questioned his independence on the basis of potential unconscious bias. Mr Malarao was content for Mr Levin’s lack of independence to bear on the weight I accord his evidence. He pointed out Mr Levin had been appointed liquidator by the Court. I do not consider Mr Levin’s status as a liquidator disqualifies him from giving evidence. I did not take into account evidence that constituted submissions. I have taken Mr Levin’s position into account in assessing the weight to be accorded his evidence.
[16] The third cause of action claiming a proprietary interest in the house is also brought against Mr Fleming, the third trustee in the Perry Family Trust. He abides the Court’s decision on certain conditions recorded in a joint memorandum of counsel dated 9 August 2017, and was excused from the hearing by consent of the other parties.
When did ECA become insolvent?
[17] Mr Malarao, for the liquidators, submits ECA was insolvent by 31 March 2010, relying on the evidence of Mr Levin. Mr Perry conceded in cross-examination ECA was not able to pay GST as it fell due from 2010.14 Mrs Perry also agreed that, around 2010, there was not enough money to pay Inland Revenue.15 ECA’s failure to pay its debts to Inland Revenue as they fell due from that date are a signal indication of serious financial difficulties.
14 NOE at 97/21–25.
15 NOE at 133/26.
[18] Mr Fraundorfer, for the Perrys, submits ECA remained solvent because of the possibility of a cash injection from them as shareholders. He also pointed to goodwill as an asset. The possibility of converting a non-cash asset into a cash asset should only be taken into account for the purpose of assessing solvency if realisation of the asset in that way was in contemplation by the debtor at the time.16 There is no hard evidence of that here. Indeed, the shareholders decided not to make such an injection. Neither the shareholders’ Current Account debt nor goodwill were realisable assets, so the company’s net liabilities exceeded its assets. I accept Mr Levin’s evidence that ECA did not satisfy either the cash flow test or the balance sheet test on 31 March 2010. I accept the liquidators’ submissions that ECA was insolvent from that date.
Issue one: Does Mrs Perry have to repay the Current Account debt?
Law
[19] It is well-established that advances made by a company to its shareholders are debts owed to the company by the shareholders, which are (absent a company resolution to the contrary) repayable on demand.17 The liquidators are entitled to rely on the company’s records.18 Insofar as a company’s records, from which its financial statements are derived, are deficient, the directors must accept responsibility.19
[20] Where parties to a dispute about a transaction between a director and a company rely on company records, the Court of Appeal has found it is appropriate to impose an onus of proof on the director to establish the transaction was for fair value.20 Otherwise, and except in relation to questions of excuse or justification raised by the defendants, the onus of proof is on the plaintiffs. The standard of proof is the balance of probabilities.
16 Re Northridge Properties Ltd (in liq) SC Auckland M46/75, 13 December 1977 at 28.
17 Thom Contractors Ltd (in liq) v Thom HC Auckland, CIV 2008-404-6829, 28 April 2009 at [16].
18 New Zealand Game Meats Exports Ltd (in liq) v Lau HC Whangarei, CP34/98, 19 March 1999 at 13; Chesterton Holdings Ltd (in liq) v Durney HC Napier, CIV-2011-441-007, 19 May 2011 at [27].
19 Thom Contractors Ltd (in liq) v Thom, above n 17, at [17].
20 Morgenstern v Jeffreys [2014] NZCA 449, (2014) 11 NZCLC 98-024 at [58], endorsed by the Supreme Court in Morgenstern v Jeffreys [2014] NZSC 176 at [8].
Submissions
[21] The liquidators seek to recover from Mrs Perry $143,452, the value of the transactions they say comprise the Current Account debt owed by the Perrys to ECA, repayable on demand. They also seek interest from the date demand was made for repayment, which was 6 August 2014. The liquidators do not pursue Mr Perry as he was an undischarged bankrupt at the commencement of the proceeding. The liquidators calculate the amount of the debt by:
(a)adopting the closing balance of the current account as at 31 March 2010;
(b)adding the drawings recorded in the ledgers, subtracting interest charges, adding the Westpac 93 loan repayments; and
(c)adding the personal transactions in the ECA bank statements from 1 April 2013 until liquidation.
[22] Mr Fraundorfer, for the Perrys, submits the Current Account debt to ECA was owed exclusively by Mr Perry. This is the subject of a late application for leave to amend the Amended Statement of Defence, which is opposed by the liquidators. Alternatively, if it were owed by Mrs Perry, Mr Fraundorfer submits the amount is lower than that claimed by the liquidators because a number of items should be recorded as genuine business expenses such as salary and Mrs Perry should only be liable for half of the debt. Mr Fraundorfer submits Mrs Perry has paid that part of the debt that was required to be paid, directly to the creditors concerned. He submits the lack of available evidence favours the Perrys, not the liquidators.
[23] In respect of the payments he submits were salary, Mr Fraundorfer relies on s 161(5) of the Companies Act 1993 which provides that, where payment of remuneration is made to a director without compliance with the requirements in s 161(1) and (4), the director will avoid liability to the extent he or she can prove the payment was fair to the company at the time it was made.
Decision
[24] The claim the Current Account debt was owed by Mr Perry and not Mrs Perry is not sustainable. The references to the nominal “shareholder 1” by Ezebiz in reconstructing drawings on the accounts does not provide sufficient basis for the argument. Both Mr and Mrs Perry admitted the opposite in their Amended Statements of Defence. Mrs Perry accepted, under cross-examination, the current account was a joint responsibility.21 She coded the expenses as “Perrys”. The Current Account was in both of their names, as Mr Perry had to accept.22 They were both equal shareholders and they were both directors. Even if I granted the application for leave for a late change in the Perrys’ pleadings, I would find as a matter of fact the Current Account debt was a joint liability of both of them. And since the liability is joint in law, Mrs Perry is liable for the whole amount.
[25] I consider the liquidators are entitled to adopt the methodology they do, to calculate the Current Account debt, relying on the company’s records consistent with the case law referred to above. I agree the starting balance of $18,989 taken as at 1 April 2009 is appropriate. It reconciles, through the 2008 and 2007 financial statements, with the last timely set of financial statements from 2007.23
[26] I also accept the drawings identified by Ezebiz as shareholder salary in reconstructing the accounts before liquidation from 2010 onwards, are not really salaries. Mr Levin agreed under cross-examination the Perrys had been paid salaries before 2010.24 And he agreed that less well-run companies allocate shareholder salaries by deciding at the end of the year how much of the drawings taken during the year should be kept, retrospectively creating a journal entry.25
[27] But the drawings at issue here were individual transactions coded by Mrs Perry at the time as “Perrys”. They were retrospectively coded by Ezebiz as salary in the accounts formalised in November 2013, just prior to liquidation. Mr Perry’s statement
21 NOE at 137/14.
22 NOE at 117/28–30.
23 Brief of Henry Levin dated 11 September 2017 [Levin Brief] at [6.4] and BoD at 452A and 492.
24 NOE at 42/30–43/7.
25 NOE at 44/23–35.
as director to the liquidators was that he did not take a regular salary.26 In Court, Mr Perry stated the coding practice was “because we weren’t actually drawing a salary per se”, suggested other payments may have been for building materials and said it was “a little bit of a grey area”.27 Mr Perry said he could not explain why Ezebiz had allocated payments as salary as he did not take a regular salary, though he would have liked to be able to pay himself one if the business was able to afford it.28 The evidence of both of the Perrys was some payments may have been groceries bought by Mr Perry.29 No PAYE was paid in relation to these payments, unlike in Madsen-Ries v Petera, relied upon by Mr Fraundorfer.30 Mr Perry confirmed there were no contracts, resolutions, minutes or anything like that in relation to what was coded as salary.31
[28] I conclude the drawings coded as salaries after 1 March 2010, and as personal transactions in the bank accounts from 1 April 2013 until liquidation, should be regarded as drawings, not expenses, in calculating the Current Account debt. For that reason, s 161 is not relevant. Section 56 of the Companies Act 1993 (the Act) entitles a company to recover, from the shareholder or directors, distributions made to shareholders when a company could not satisfy the solvency test.
[29] Even if some of the drawings were remuneration falling under s 161, I would not consider the Perrys proved they were fair to ECA at the time. Mr Levin accepted the small-scale drawings were “not an unreasonable amount for what I believe to be the hours likely to be worked”.32 Mr Perry continued working in the business and Mrs Perry did accounts. But there is little to prove any salary was fair. These payments were not explicitly authorised, in advance or at all, by the directors collectively. The Perrys did not distinguish, in advance, between their own expenditure and ECA’s. There was no control over the amounts or the purposes of the drawings. There is no evidence to suggest any connection between the Perrys’ work and the amount of drawings taken.
26 NOE at 16/15–20, 114/9–10.
27 NOE at 81/2–11.
28 NOE at 114/9–10 and 114/21–22.
29 NOE at 135/15–18 and 81/2–11.
30 Madsen-Ries v Petera [2015] NZHC 538 at [50], upheld on appeal in Madsen-Ries v Petera [2016] NZCA 103.
31 NOE at 114/17–20.
32 NOE at 43/3.
[30] I also do not agree ECA owed money to the Perrys in three respects, offered by Mr Fraundorfer as alternative arguments:
(a)Mr Fraundorfer submits ECA used the Current Account to pay legitimate business expenses totalling $65,000. But there is no evidence to support this proposition. The closest was Mr Perry’s evidence implying a $2,000 cheque for cash was related to ECA’s negotiation with a client over goods ECA purchased on TradeMe.33 But there is no evidence about what was purchased, or from whom, to allow me to assess whether that was a legitimate business expense.
(b)The Perrys pleaded ECA was indebted to the Perrys (or their Family Trust) for use of the house, to the value of $22,000. This is not supported by evidence. At trial, Mr Fraundorfer submitted an allowance should be made for ECA receiving value from the ongoing use of the house. There is no evidence of documentation of such an agreement or its time-period or what the debt related to. Neither is that amount allowed for in the financial statements of ECA.
(c)The Perrys pleaded ECA was indebted to them for loans in 1995 and 2000 for a total of $80,000. The liquidators submit that means they must have been reflected in the 2001 accounts showing the Perrys owed ECA almost $120,000 in 2001. If these loans were made, they should have been reflected in the company’s accounts and therefore in the Current Account debt. They were not.
[31] I do agree with Mrs Perry’s submission the Westpac 93 account was for the purposes of a cash injection of $20,000 by the Perrys made on 9 February 2009. It is classified in the ECA accounts as a term loan. Mr Levin accepted under cross- examination there was a “real question at large” regarding the $20,000 loan.34 But the liquidators maintained their submission this was a loan to the Perrys personally. I
33 NOE at 87/26–35.
34 NOE at 29/24–33.
agree the payments of $10,472 made by ECA to Westpac in respect of the 93 loan should not be added to the Current Account debt.
[32] I conclude the Perrys are jointly liable, and therefore Mrs Perry is liable, to repay the Current Account debt to ECA (other than the payments for the Westpac 93 loan) in the amount of $132,980, plus interest from 6 August 2014. It may be this would lead to a surplus in the liquidation, which would lead to some funds being returned to the Perrys as shareholders. But that repayment to ECA properly reflects what was the Perrys’ money and what was ECA’s.35
Issue two: Are some debts preferential dispositions?
Relevant law
[33] Under s 344, the purpose of subpt 6 of pt 6 of the Property Law Act 2007 is “to enable a court to order that property acquired or received under or through certain prejudicial dispositions made by a debtor (or its value) be restored for the benefit of creditors …”. Sections 345 and 346 clarify the dispositions to which that applies:
(a)dispositions of property (including proceeds of property) made by a debtor;
(b)“with intent to prejudice a creditor, or by way of gift, or without receiving reasonably equivalent value in exchange”;36
(c)which includes where a debtor “must have known that in . . . hindering, delaying or defeating creditors’ recourse to that property” the debtor “was exposing them to a significantly enhanced risk of not recovering the amounts owing to them”;37 and
35 Morgenstern v Jeffreys (CA), above n 20 at [103], Morgenstern v Jeffreys (SC), above n 20, at [11].
36 Property Law Act 2007, s 346(1)(b).
37 Regal Castings Ltd v Lightbody [2008] NZSC 87, [2009] 2 NZLR 433 at [52] (per Blanchard and Wilson JJ), see also Property Law Act 2007 s 345(1)(a).
(d)when the debtor was insolvent or engaging in a transaction for which the remaining assets were unreasonably small, or intended to incur (or believed, or reasonably should have believed) that the debtor would incur debts beyond the debtor’s ability to pay.
[34] Section 348 empowers a Court to vest property or require payment of reasonable compensation, by a person who acquired or received property through the disposition, if satisfied the applicant has been prejudiced by a disposition. Section 349 prohibits a Court from making such an order where a person proves they acquired property for valuable consideration, in good faith and without knowledge it was a prejudicial disposition. It also empowers the Court to decline to make such an order, or may make a more limited order, if there was no valuable consideration but the person’s circumstances have changed so it is unjust to order restoration of the property.
Submissions on preferential dispositions
[35] If the liquidators failed on issue one, Mr Malarao submits Mrs Perry is liable to repay the Current Account debt entered into after 31 March 2010, totalling
$104,558, as prejudicial dispositions under the PLA. He submits all the requirements of s 346 are satisfied by the transactions between ECA and the Perrys between 1 April 2010 and 31 March 2013 and, after 31 March 2013, by the loan repayments by ECA for the Westpac 91, 92 and 93 loans and the $2,000 cash cheque.
[36] Mr Fraundorfer submits ECA was solvent when the relevant payments were made and Mrs Perry did not receive the dispositions. I rejected those submissions above. Alternatively, he submits the amount required to be restored was limited by the amount of creditors’ debt unable to be repaid at the time. He submits they were not unequal exchanges intended to prejudice creditors, so the requirements of s 346 are not met.
Decision on prejudicial dispositions
[37] Given my conclusion on issue one, I do not have to decide this issue. If I did have to, I would decide as follows.
[38] Because the dispositions resulted in increased liabilities of ECA through payments jointly benefitting the Perrys, Mrs Perry “acquired or received property” under s 348(2). They were not personal only to Mr Perry. And s 344 limits the amount required to be restored by the value of the property acquired or received under the prejudicial dispositions, not the amount of the creditor’s debt at the time.
[39] But I do not accept the liquidators have proven the relatively small drawings made by the Perrys between 1 April 2010 and 31 March 2013, or the subsequent cash cheque of $2,000, were made with intent to prejudice a creditor or without receiving reasonably equivalent value. As I noted above, there is evidence the Perrys each contributed time and effort to the business for which they were otherwise unremunerated. And there is no evidence the Perrys intended to prejudice a creditor or “must have known”, in making each of these small drawings, ECA was exposing the creditors to a significantly enhanced risk of not recovering the amounts owing to them. So I consider the liquidators would not have not proved, on the balance of probabilities, their s 344 claim in respect of those transactions.
[40] Neither were the payments in respect of the Westpac 93 loan prejudicial, for the reasons given above. But the payments in respect of the Westpac 91 and 92 loans are different. It seems clear the Perrys consciously accorded other creditors, particularly Inland Revenue, lower priority than Westpac.38 The suggestion they believed repaying Westpac would allow them to make capital injections to ECA is undermined by the fact no such injections were made. In making these payments the Perrys “must have known” ECA was exposing Inland Revenue to a significantly enhanced risk of not recovering the amounts owed. And ECA did not receive equivalent value for its payment. It lost funds that could have been called upon to pay its creditors. Mr Fraundorfer submits ECA gained extinguishment of a debt, but the debt was the Perrys’ not that of ECA.
[41] I would not consider the s 349 defence to be made out in relation to the Westpac 91 and 92 payments. I would consider Mrs Perry established she received the dispositions in good faith. She considered she and her husband were entitled to
38 NOE at 105/2-5 and 109/1-9.
drawings from ECA. She believed ECA would trade out of its difficulties as it had done in the past.39 But I would not accept she has proven the Perrys did not know the payments in respect of the Westpac 91 and 92 loans were prejudicial. That follows from my finding about the Current Account above.
[42] Accordingly, if I had to decide this issue, I would grant the liquidators’ application for prejudicial dispositions in relation to the Westpac 91 and 92 loans but decline it in relation to the other drawings.
Issue three: Does ECA have a proprietary interest in the Perrys’ house?
Law of proprietary interests arising from breach of fiduciary duties
[43] A company director owes fiduciary duties to the company and is trustee of the company’s property that is under his or her control.40 As the Court of Appeal has stated recently, in The Fish Man Ltd (in liquidation) v Hadfield “[t]here is no doubt that it is a breach of fiduciary duty for a director of a company to use its funds to pay personal debts”.41 When that is done, a constructive trust arises regarding the funds.
[44] Such a constructive trust does not necessarily create a traceable interest in the mortgaged property.42 Such “backwards tracing” of funds may be possible when it can be shown a debt was incurred to purchase a specific and identifiable asset.43 Backwards tracing can “transform the unsecured breach of fiduciary duty claim into a propriety interest in property by showing that company funds have, in breach of constructive trust, been put into a property which represents those funds in whole or in part, and from which they can be recovered”.44 But the Court of Appeal in The Fishman Ltd found it was not correct broadly to assume regular mortgage payments after purchase can be traced into secured property.45 The Court of Appeal held “[a] court should look at the substance of a transaction, rather than the strict order in which
39 NOE at 134/21–22.
40 Shannon Agricultural Consulting Ltd (in liq) v Shannon 2015] NZHC 1133 at [25].
41 The Fishman Ltd (in liq) v Hadfield [2017] NZCA 589 at [57], citing Selangor United Rubber Estates Ltd v Cradock [1968] 1 WLR 1555 (Ch) at 1577.
42 At [58].
43 At [59].
44 At [62].
45 At [71].
events occur”, “the focus must be on what the payment of the trust funds actually achieves and in particular whether it leads to the acquisition of ownership of the asset” and “a claimant has to establish a coordination between the depletion of the trust fund and the acquisition of the asset which is the subject of the tracing claim”.46
[45] The Court of Appeal in The Fishman Ltd also considered what it characterised as an alternative way of putting the tracing argument, by way of an equitable lien arising in favour of the company because the repayments improved the property. The Court held the concept of an equitable lien turns on the plaintiff being able to show a specific interest in the property and there was none there.47 In Intext Coatings Ltd (in liq) v Deo, Fitzgerald J considered repayment of a mortgage debt does not amount to an improvement in the defendant’s property so was not available.48
[46] In Intext Coatings Ltd, Fitzgerald J’s approach to backwards tracing and creation of equitable lien was similar in outcome to the Court of Appeal’s subsequent approach in The Fishman Ltd. However, she considered the alternative remedy of equitable subrogation is available for using misappropriated money to discharge a secured debt.49 The Court of Appeal in The Fishman Ltd declined to consider that because the argument arose only on appeal.50 After comprehensive review of the authorities in Intext Coatings Ltd, Fitzgerald J concluded:51
[143] In light of the authorities and commentaries referred to above, I consider subrogation is a sufficiently broad remedy to encompass the concept of using misappropriated money, or money used in breach of a fiduciary duty, to discharge a secured debt. The leading authorities recognise the flexibility of the remedy. They emphasise its breadth and discretionary nature, and the fact there need not be any intention as to how the money is to be used. While there are certainly “classic cases” of subrogation, I do not read any of the authorities as standing for the proposition that the remedy can only be deployed in such cases. What is required, however, is close consideration of whether the defendant has been enriched at the plaintiff’s expenses, and if so, whether that is unjust. And that is not be considered in a moral or overarching “fairness” sense. Rather, a principled approach must be taken.
46 At [69] and [71]. This is generally consistent with the comprehensive review of authorities by Fitzgerald J in Intext Coatings (in liq) v Deo [2016] NZHC 2754, [2017] NZAR 47 at [59]–[102].
47 At [77].
48 Intext Coatings (in liq) v Deo, above n 46, at [109].
49 At [112]–[146].
50 At [81].
51 At [143].
[47] In that case, of judgment by formal proof, where a company director used company funds in breach of a fiduciary duty to discharge a secured debt, Fitzgerald J considered the remedy was available. She ordered an equitable charge over the property in favour of the company as a result of subrogation.
Submissions on proprietary interest
[48] Mr Malarao, for the liquidators, submits the Perrys breached their fiduciary duties as directors, in using $72,032 of ECA funds to repay their family trust’s mortgage when ECA was insolvent, from 31 March 2010 until liquidation on 2 December 2013. He submits:
(a)ECA is entitled to a declaration it has a proprietary interest in the house through a constructive trust being created on the basis of equitable tracing principles, relying on The Fishman Ltd. He submits that claim can be pursued against Mr Perry as well as Mrs Perry, under s 104 of the Insolvency Act 2006.
(b)Alternatively, ECA is entitled to an equitable charge over the property in the amount of the principal and interest, based on subrogation principles, ranking immediately behind the Westpac mortgage.
(c)Alternatively, in supplementary submissions, judgment for the monetary sum plus interest is justified for breach of duty by the Perrys as trustees, leaving the Trust unjustly enriched at ECA’s expense.
[49]Mr Fraundorfer, for the Perrys, submits:
(a)The loan repayments of $72,032 should be adjusted to represent what Mr Fraundorfer submits is the true insolvency period, to take into account that $10,472 relates to ECA refinancing of the Westpac 93 loan and to not include interest.
(b)The duty on company directors to act honestly and with a proper motive is largely subjective and the courts show reasonable deference to
business considerations in presuming directors have complied with the duty. The threshold of actual or constructive bad faith or a decision to act in self-interest and contrary to the interests of the company is a relatively high threshold which is not met here.
(c)The payments to Westpac were legitimate, and there was no breach of duty, because: some of the payments were made while ECA was solvent; the Westpac 93 repayments were part of a plan for cash injections and done in the best interests of ECA; and the house was used for business purposes as an office and overflow storage facility which had real commercial benefits. Mr Fraundorfer also submits the treatment of drawings was based on information provided by Ezebiz and a previous accountant but he accepted there was no evidence advice was provided that would have qualified for the defence under s 138 of the Companies Act 1993.
(d)The Court of Appeal’s judgment in The Fishman Ltd is wholly analogous to the situation here, meaning backward tracing into the property is unavailable and no equitable lien is available because the plaintiffs cannot show a specific interest in the property.
(e)The courts should be slow to allow proprietary remedies, including subrogation, without clear evidence. Subrogation is only available where the secured creditor has been paid in full, which it has not been, and has been heard, which Westpac has not been. An unsecured creditor should not be entitled to gain security through subrogation. It would be inequitable for the Perrys’ home to be in jeopardy when the monies were received in good faith and for proper value. The Perrys have relied on the payments in paying other debts of ECA themselves.
Decision on proprietary interest
[50] The Westpac 91 and 92 accounts were the Perrys’ obligations, secured by guarantee and by mortgage over the property owned by the Perrys’ family trust. The payments made by ECA reduced the Perrys’ debt and increased the trust’s equity in
the property. The $20,000 Westpac 93 loan is in Mr and Mrs Perry’s names and is secured by a mortgage over their family trust’s house.52 But it corresponds with a
$20,000 deposit into ECA’s bank account on 9 February 2009 labelled as “Perry DG Loan/Drawdown”. Both of the Perrys were adamant the 93 loan was only taken out for ECA’s purposes.53 It is classified in the ECA accounts as a term loan. It benefited ECA as a capital injection. It follows that ECA’s payments of the Westpac 93 mortgage instalments were not in breach of the Perrys’ fiduciary duties but payments of the 92 and 92 mortgage instalments were in breach of those duties.
[51] In relation to the payments of the 91 and 92 mortgage instalments, I consider the remedies of backwards tracing into the Perry trust’s property or of an equitable lien arising are not available here for the same reasons as the Court of Appeal considered they were not in The Fishman Ltd. Looking at the substance of the transactions, the mortgage instalment payments from 2010 to 2013 were well removed in time and nature from acquisition of the property, which occurred in 1991. There is insufficient coordination of depletion of ECA’s funds and acquisition of the house to sustain a tracing claim. Neither have the liquidators shown ECA had a specific interest in the property or that the payments improved it, so as to found creation of an equitable lien.
[52] Did the Perrys’ misappropriation of funds to pay the mortgage instalments found equitable subrogation such that ECA should have an equitable charge over the property such as Westpac had? I agree with Fitzgerald J in Intext Coatings Ltd the remedy of equitable subrogation is potentially available where a director used company funds in breach of a fiduciary duty to discharge a secured debt. And it seems clear there was unjust enrichment here.
[53] However, I am not persuaded I should grant the discretionary remedy of equitable subrogation. As Mr Fraundorfer submits, the ability of the Court to grant such a charge is a practical remedy designed to prevent unconscionable trustees defeating a claim. It is not intended to create secured property rights out of unsecured rights unless that is equitable. In the interests of equity, it would have to be fashioned so as to not to exceed the value of the pre-existing obligation and not to change the
52 NOE at 136/13–23.
53 NOE at 136/23 and Donald Perry Brief at [68]–70].
priorities between creditors without reason. Consideration of the Perrys’ intentions in relation to the house and loan would be relevant, about which there is a lack of evidence here. As Professor Jessica Palmer has suggested:54
Subrogation is justified because it protects existing proprietary interests. If it is applied to create proprietary interests within an unjust enrichment framework, then a compelling explanation is required so that the sanctity and security of property rights are not too easily disrupted.
[54] Where judgment for a monetary sum is sufficient to restore an unsecured plaintiff to the position they should have been in, I consider granting a remedy of equitable subrogation will rarely be justified. That is the case here, as Mr Malarao’s third alternative submission suggests. The repayment I have ordered of the Current Account debt in the first cause of action involves repayment of the amounts paid by ECA to Westpac in relation to the principal and interest on the 91 and 92 loans. Accordingly, I make no further award under this cause of action.
Issue four: Should the Perrys repay money for breach of directors’ duties?
Law of repayment
[55] Section 301 of the Companies Act 1993 applies if, in the course of liquidation of a company, it appears to the court that a past or present director “has misapplied, or retained, or become liable or accountable for” money of the company “or been guilty of negligence, default or breach of duty or trust in relation to the company”. It empowers the court, on the application of the liquidator, to inquire into the conduct of the director and order that person to repay or restore the money with interest at a rate the court thinks just.
Submissions
[56] Mr Malarao submits the Perrys breached their duties as directors to act in the best interests of ECA (s 131), not to trade recklessly (s 135) and by causing ECA to incur obligations without reasonably believing it could perform them (s 136). The
54 Jessica Palmer, “Restitution” [2016] 2 NZ L Rev 436 at 454. And see Jessica Palmer, “Unjust Enrichment, Proprietary Subrogation and Unsatisfactory Explanations” (2016) 28 SAcLJ 955 at
[17] (arguing the language of subrogation in these circumstances confuses and conceals what is really taking place) and pt IV.
liquidators seek restitution for breach of s 131, and compensation under ss 135 and 236, from Mrs Perry and a declaration in relation to Mr Perry.
[57] Mr Fraundorfer submits the evidence establishes the Perrys always believed they could trade out of ECA’s financial difficulties. He submits the Perrys’ conduct did not reach the relatively high threshold of bad faith or acting in self-interest required for breach of s 131 and nor did the Perrys trade recklessly or incur obligations without reasonably believing they could be performed, breaching ss 135 and 136. Mr Fraundorfer submits any award should not exceed the total value of claims in the liquidation, $52,008, and that amount must be reduced by any award under the other causes of action.
Decision on repayment
[58] I consider the Perrys did breach their duties in the three respects alleged. This follows from my findings above. They took non-salary drawings from ECA without prior authorisation by the directors collectively, or authorisation at all. Mr Perry did not distinguish between ECA and himself and Mrs Perry. Mrs Perry did distinguish between them, but only afterwards in coding expenses retrospectively. The drawings were taken from ECA after it became insolvent, instead of being used to meet ECA’s obligations to its creditors. During this period, Westpac was repaid, in respect of its loans 91 and 92 to the Perrys personally. Yet a conscious decision was made not to pay Inland Revenue for the GST and PAYE it was owed. I consider these circumstances were sufficient to mean:
(a)The Perrys were not acting in good faith and what they believed to be the best interests of the company (s 131). No director who properly understood his or her duties would take such actions.
(b)The Perrys caused or allowed the business of ECA being carried on in a manner likely to create a substantial risk of serious loss to its creditors (s 135). These actions were not open to a reasonable director in the circumstances.
(c)The Perrys agreed to ECA incurring obligations when they did not believe at the time, on reasonable grounds, ECA would be able to perform the obligation when required to do so (s 136).
[59] If none of the other causes of action against the Perrys had succeeded, I would have considered ordering Mrs Perry to pay restitution or compensation for these breaches. However, the liquidators have already succeeded in relation to the first cause of action. The amount Mrs Perry has to repay broadly restores ECA for the effects of the Perrys’ breaches. I do not consider further payments by the Perrys under s 301 are justified on top of that.55
Result
[60]I order Mrs Perry to repay ECA the shareholders Current Account debt of
$132,980 plus interest from 6 August 2014.
[61] I award costs to the liquidators. If the amount of costs cannot be agreed between the parties I grant leave for the liquidators to file and serve submissions of up to five pages within 10 working days and the Perrys to file and serve submissions in reply of up to five pages within a further 10 working days.
Palmer J
55 Madsen-Ries v Petera [2015] NZHC 538 at [96].
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