Effective Fencing Ltd v Chapman

[2007] NZCA 12

IN THE COURT OF APPEAL OF NEW ZEALAND

CA84/05
[2007] NZCA 12

BETWEENEFFECTIVE FENCING LIMITED

Appellant

ANDGILBERT DALE CHAPMAN AND GRANT BRUCE REYNOLDS AS LIQUIDATORS OF UPSTAIRS LIMITED (IN LIQUIDATION)

Respondents

Hearing:21 August 2006

Court:Chambers, Randerson and John Hansen JJ

Counsel:M H Benvie for Appellant

S W Greer and B M K Pamatatau for Respondents

Judgment:16 February 2007 at 4 pm

JUDGMENT OF THE COURT

AThe appeal is dismissed.

BThe appellant must pay to the respondents costs of $5,000 plus usual disbursements.

REASONS OF THE COURT

(Given by Chambers J)

A claim by liquidators for reimbursement following a disposition of property at an undervalue

[1]       Gilbert Chapman and Grant Reynolds, the respondents, are liquidators of Upstairs Ltd (in liquidation).  Upstairs was placed in liquidation on 3 June 2004, pursuant to an application filed on 26 March 2004. 

[2]       There is no dispute Upstairs paid $200,000 to Effective Fencing Ltd, the appellant, on 16 May 2001.  The liquidators contend that payment is caught by s 298 of the Companies Act 1993, being a disposal of Upstairs’ property to an associated company for no consideration within three years before the date of application to liquidate Upstairs.  The liquidators sought to recover from Effective Fencing the whole of the amount paid.

[3]       Because they contended Effective Fencing had no defence to the claim, they utilised the summary judgment procedure.  Associate Judge Faire heard and later granted the application: HC AK CIV 2004-404-5905 21 April 2005.  He ordered Effective Fencing to pay the liquidators $199,999, plus interest and costs. 

[4]       Effective Fencing now appeals against that decision.

Issues on the appeal

[5]       Mr Benvie, for Effective Fencing, raised three issues on the appeal.

[6]       First, he submitted the judge had erred in holding that Upstairs had disposed of the $200,000 for no consideration.  He argued that the transaction had to be looked at in a wider context.  He submitted that the payment to Effective Fencing was part of a tripartite arrangement under which Effective Fencing gained $249,000 from a family trust, the Black and White Trust, $200,000 of which was then promptly forwarded to Upstairs.  This was not a case where a company was stripped of assets it previously owned.  Accordingly, there was either no “disposition” within the meaning of s 298 or consideration for the payment in the context of the tripartite arrangement.

[7]       Secondly, he submitted the judge was wrong to find Upstairs and Effective Fencing had been under the same “control” for the purposes of s 298.

[8]       Thirdly, he submitted that, if the transaction was caught by s 298, summary judgment should nonetheless be refused to enable Effective Fencing to join as third parties its former financial advisers, Ernst & Young, who, Effective Fencing said, had devised the scheme involving the money-go-round among the trust, Effective Fencing, and Upstairs.  Associate Judge Faire had refused to defer summary judgment so that joinder could take place. 

[9]       We shall discuss the issues in turn.  Because of its importance in this case, we set out now the salient parts of s 298:

Transactions for inadequate or excessive consideration with directors and certain other persons

…

(2)Where, within the specified period, a company has disposed of … property … to –

…

(c)another company that was, at the time of the disposition, … controlled by a director of the company … -

the liquidator may recover from the … company … any amount by which the value of the … property … , at the time of disposition, … exceeded the value of any consideration received by the company. 

(3)For the purposes of this section, -

…

(b)the provisions of section 7 apply with such modifications as may be necessary to determine control of a company.

(4)For the purposes of subsections (1) and (2), specified period means –

…

(b)in the case of a company that was put into liquidation by the Court, the period of 3 years before the making of the application to the Court together with the period commencing on the date on which, and at the time at which, the order of the Court was made; …

Was the judge wrong to find Effective Fencing had disposed of $200,000 for no consideration?

[10]     Merilyn and Michael O’Connor were the directors and shareholders of Effective Fencing, a manufacturer and installer of fencing and gates.  Mr O’Connor, in an affidavit he swore in opposition to the application for summary judgment, said that he and his wife had received oral accounting advice from Terry Wilson, at the time a sole practitioner but later part of the international accounting firm, Ernst & Young.  According to Mr O’Connor, that advice was to the effect that the O’Connors should establish a family trust, which would borrow money from ASB Bank, secured by a mortgage over the O’Connors’ family home, which was to be transferred to the trust.  The trust would then on-lend the money borrowed to a new company (Upstairs).  Upstairs was to operate “the management side of the [O’Connors’] business”.  Upstairs was then to contract with Effective Fencing: Upstairs would pay Effective Fencing $200,000 as a “procurement fee” pursuant to which Effective Fencing’s management staff would move to Upstairs.  This, it was said, would result in lower accident compensation premiums in respect of management staff.

[11]     The above description of the proposal is taken from Mr O’Connor’s affidavit.  Unfortunately, Mr Wilson’s advice was never reduced to writing.  One can immediately see difficulties with what was allegedly proposed, but this may simply reflect the fact Mr O’Connor, by his own admission, “did not really understand the technical details of why or how this structure would provide the monetary savings Mr Wilson said it would”.  It may be Mr O’Connor has misunderstood what Mr Wilson intended.

[12]     Agreements to reflect the proposal were never entered into, but the proposal was nonetheless carried out in part – presumably by Mr Wilson.  On 16 May 2001, ASB Bank sent Mr Wilson a fax setting out what money transfers had taken place that day.  These included repayment of the O’Connors’ existing mortgage, the bank loan to the trust, the on-payment by the trust to Upstairs, and the $200,000 payment to Effective Fencing.

[13]     Mr Benvie argued before us, as he had before Associate Judge Faire, that the payment to Effective Fencing was not a “disposition” in terms of s 298(2)(c) because there was no “stripping” of assets.  In reality, all that was transferred was a large portion of the money Upstairs had itself received only moments beforehand from a family trust.  Indeed, it was possible, Mr Benvie said, “Upstairs was no more than a mere conduit for the payment from the Black and White Trust to Effective Fencing”.  Alternatively, he argued there was consideration for the payment if the transaction was looked at as a whole.

[14]     The judge held the payment to Effective Fencing was a disposition of property.  “Property” is defined in s 2 and includes personal property.  “Disposition” is not defined but the transfer of funds was clearly a disposition of property.  When a court is considering whether there was a “disposition”, the length of time for which the disposing company has held the property is irrelevant.  And the suggestion that Upstairs was “a mere conduit” for a payment from the trust to Effective Fencing does not stand up to scrutiny.  The trust was not lending money to Effective Fencing, a fact recognised by the trust’s act of filing a proof of debt in the Upstairs liquidation in respect of its unpaid loan to Upstairs.  Upstairs was a vital cog in the overall scheme Mr Wilson devised. 

[15]     On the question of consideration, the judge held there was none: at [40]. Mr Benvie’s only response to that has been to argue there is effectively “consideration” if one has regard to the “wider context”, a course mandated, he says by this court’s decision in Re Burgess Homes Ltd [1989] 1 NZLR 692. His argument in effect is that Upstairs received $249,000 from the trust because it was prepared to on-pay $200,000 of it to Effective Fencing.

[16]     But that is clearly not right, for the reasons the judge gave.  The consideration for the loan from the trust was Upstairs’ promise to repay.  But Upstairs received no benefit from its $200,000 payment to Effective Fencing.  Indeed, all it potentially got wereas liabilities!  Although nothing in this confused story can be said with certainty, it appears Upstairs may have acquired some of Effective Fencing’s employees; if that is right, then it was bound to meet their salaries.  But it had no means to pay them.  The fencing manufacturing and installation business continued to be operated by Effective Fencing.  In fact, Effective Fencing continued to pay Upstairs’ employees (if they really were its employees).  As Mr Reynolds said in his first affidavit, Upstairs has never received “any income or any other benefit” from its involvement with Effective Fencing.  Upstairs’ contractual inability to call on Effective Fencing to assist with salaries is demonstrated by the event which led to Upstairs’ liquidation.  John Maio obtained from the Employment Relations Authority an order that Upstairs pay him about $10,000 for unjustifiable dismissal.  When Upstairs did not pay – because Effective Fencing did not put it in funds – Mr Maio successfully applied to have Upstairs liquidated. 

[17]     Effective Fencing’s first ground of appeal must fail.  Upstairs received nothing for its $200,000 payment to Effective Fencing.

Was the judge wrong to find Upstairs and Effective Fencing had been under the same “control” for the purposes of s 298?

[18]     In order to be caught by s 298(2)(c), a disposition must not only be for inadequate consideration but must also be to an associated company, i.e. another company that was, at the time of the disposition, controlled by a director of the disposing company.  As we have seen, s 298(3)(b) applies the definition of “control” as set out in s 7, “with such modifications as may be necessary”.  Section 7 reads as follows:

For the purposes of section 5 of this Act, without limiting the circumstances in which the composition of a company's board is to be taken to be controlled by another company, the composition of the board is to be taken to be so controlled if the other company, by exercising a power exercisable (whether with or without the consent or concurrence of any other person) by it, can appoint or remove all the directors of the company, or such number of directors as together hold a majority of the voting rights at meetings of the board of the company, and for this purpose, the other company is to be taken as having power to make such an appointment if—

(a)     A person cannot be appointed as a director of the company without the exercise by the other company of such a power in the person's favour; or

(b)      A person's appointment as a director of the company follows necessarily from the person being a director or other officer of the other company.

[19]     Mr and Mrs O’Connor, as well as being the directors of Effective Fencing, were Upstairs’ directors.  They also jointly owned all the shares in Upstairs with Elizabeth Neill. 

[20]     The judge concluded on this issue:

[39]     I conclude that the requisite control is present for three specific reasons, namely:

a)Section 298(3)(b) provides that the s 7 definition applies “with such modifications as may be necessary”. A modification is necessary here. Further, the definition of “control” in s 7 is expressed to be not exhaustive as to the circumstances when control will exist. From a practical point of view, it is clear that the O’Connors had control of the defendant company. They were instrumental in approving the payment made by the plaintiff to the defendant company;

b)That interpretation is consistent with the rule of interpretation laid down in s 33 of the Interpretation Act 1999 which provides:

33   Numbers

Words in the singular include the plural and words in the plural include the singular

Accordingly, it is possible to read the term “a director” in s 298(2)(c) as meaning directors. When the section is read this way there can be no real question that s 298(2)(c) applies in this case;

c) The purpose of s 298(2)(c) of the Companies Act 1993 is to cover dispositions made (inter alia) to other companies which are essentially controlled by the company. The emphasis is on the fact of control.  The subsection should be read to give effect to this purpose.

For these reasons, then, I conclude that the second requirement is met and that there is the requisite degree of control for the purposes of the section. In reaching this conclusion I do not overlook s 36 and the general power of shareholders to appoint directors. That power could be exercised by Mr and Mrs O’Connor in respect of the defendant. However, it does not provide a basis for excluding the operation of s 298 of the Companies Act 1993 in respect of this payment.

[21]     Mr Benvie challenged this conclusion.  He submitted the judge was not justified in modifying the s 7 definition.  The O’Connors did not control Effective Fencing because, “when viewed as separate persons neither of the directors of Upstairs ‘controlled’ Effective Fencing in terms of having the power to appoint or remove the directors of Effective Fencing”.

[22]     We have no hesitation in upholding the judge’s conclusion, for the three reasons he gave.  We do not find it necessary to consider the application of s 7 in detail.  The definition is not exclusive.  The directors of Upstairs (the O’Connors) undoubtedly controlled Effective Fencing.  The O’Connors were Effective Fencing’s sole directors and the O’Connors, as shareholders, controlled the Effective Fencing board. 

Should summary judgment have been refused so that Effective Fencing could join Ernst & Young as third parties?

[23] Associate Judge Faire ruled there was no basis for refusing summary judgment because of a possible claim by Effective Fencing against Ernst & Young. The liability issues against Ernst & Young were quite different from matters in issue on this claim by the liquidators. As well, the quantum issues that would arise between Effective Fencing and Ernst & Young were different from the quantum claim here. The judge thought there was “no risk” of a court determining the dispute between Effective Fencing and its accountant coming to a different conclusion on any issue arising between the liquidators and Effective Fencing: at [45].

[24]     Mr Benvie challenged that conclusion.  He submitted there was a “real risk of two different conclusions as to a common issue (the circumstances and efficacy of the transaction between Upstairs and Effective Fencing) in two separate proceedings”.  He said it was possible Ernst & Young would be able to satisfy the court that the transaction it conceived and implemented ought not to give rise to a liability on Effective Fencing under s 298.

[25]     Again, we have no doubt the judge was right on this issue.  The “common issue” identified by Mr Benvie is not a “common issue” at all.  At this stage, we do not know exactly what the O’Connors’ instructions to Ernst & Young were and why that firm did not complete documentation for the proposal.  That is likely to be the principal issue between the O’Connors and Ernst & Young.  Indeed, it is by no means clear Effective Fencing even has a claim against Ernst & Young.  The letter of engagement Mr O’Connor says he and his wife signed names them as the clients, not Effective Fencing.

[26]     In addition, there would seem to be real causation difficulties with respect to any claim against Ernst & Young.  The only reason Upstairs went into liquidation was its failure to meet the judgment Mr Maio obtained against it.  Had the O’Connors put Upstairs in funds so that that debt could be paid, Upstairs would not have gone into liquidation and s 298 liability could not have arisen.  It is extremely difficult to see how Ernst & Young can be liable in these circumstances.  A timely payment of the relatively small amount owing to Mr Maio would have avoided all this litigation, with its attended costs and consequences.  At least at this stage, however, responsibility for the O’Connors’ predicament seems to lie with them, not Ernst & Young.

[27]     The judge was right not to refuse summary judgment on this ground.

Result

[28]     We dismiss the appeal.  Effective Fencing has not shown the judge was wrong on any ground.

Solicitors:
Alexander Dorrington, Auckland, for Appellant
Malcolm Whitlock, Auckland, for Respondents