FAF Holdings Ltd (in liq) v Bethune

[2017] NZHC 2796

IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY

I TE KŌTI MATUA O AOTEAROA TĀMAKI MAKAURAU ROHE

CIV-2015-412-080 [2017] NZHC 2796

UNDER

the Companies Act 1993

IN THE MATTER

of the liquidation of FAF Holdings
Limited (In Liquidation)

BETWEEN

FAF HOLDINGS LIMITED (IN LIQUIDATION)

First Plaintiff

VIVIEN JUDITH MADSEN-RIES and HENRY DAVID LEVIN as liquidators of FAF HOLDINGS LIMITED (IN LIQUIDATION)

Second Plaintiffs

AND

RICHARD JOHN BETHUNE Defendant

Hearing:	3-6 April 2017
Appearances:	K H Morrison and J OʼConnell for the Plaintiffs P R Cogswell for the Defendant
Judgment:	15 November 2017

JUDGMENT OF WOODHOUSE J

This judgment was delivered by me on 15 November 2017 at 11:30 a.m. pursuant to r 11.5 of the High Court Rules 1985.

Registrar/Deputy Registrar

……………………………………

Solicitors:

Ms K H Morrison, Meredith Connell, Solicitors, Auckland

Mr P R Cogswell, Cogswell Law, Auckland

FAF HOLDINGS LIMITED (IN LIQ) v BETHUNE [2017] NZHC 2796 [15 November 2017]

INTRODUCTION

[1]      This is a claim by FAF Holdings Ltd (in liquidation) (FAF) and its liquidators against  Richard  Bethune  as  a  director  of  FAF.    The  plaintiffs  contend  that  Mr Bethune  breached  his  director’s  duties  and  failed  to  keep  adequate  accounting records and, in consequence, FAF suffered losses recoverable from Mr Bethune.

OUTLINE OF CLAIMS AND DEFENCES

[2]      There are two causes of action.1

[3]      The first involves claims pursuant to s 301 of the Companies Act 1993 (the Act).2    The plaintiffs allege that Mr Bethune breached four of his director’s duties under the Act: (1) the duty to act in good faith and in the best interests of the company (s 131); (2) the duty to avoid reckless trading (s 135); (3) the duty in relation to obligations (s 136); and (4) the duty of care (s 137).   Particulars of the alleged breaches are summarised below, after setting out the factual background.

[4]      The plaintiffs’ claims under s 301 are for alleged losses under four main headings:

(a)       The sole creditor of FAF, apart from the liquidators, is Inland Revenue in respect of unpaid taxes for periods ending 31 March 2013 and 31

October 2014.   Inland Revenue’s claim in the liquidation has been admitted  in  a  sum  of  $538,213.28.    In  respect  of  that  debt,  the plaintiffs seek an order that Mr Bethune contribute such sum to the assets of FAF by way of compensation as the Court considers just. This claim is made pursuant to s 301(1)(b)(ii) of the Act.  I will refer

to this as “the tax claim”.

1      There was another cause of action in which the plaintiffs sought to recover the director’s salary

paid to Mr Bethune on the grounds that it was paid in breach of s 161 of the Companies Act

1993.   Before the hearing commenced, the plaintiffs advised Mr Bethune that they were not pursuing this claim.  It does not require consideration as an independent cause of action, but the fact of receipt of the salary is relevant to the cause of action pursuant to s 301 of the Act.

2 The relevant provisions of s 301 are below at [104].

(b)In the period between 1 April 2013 and 31 August 2014 Mr Bethune was  paid  a  salary  by  FAF  totalling  $136,399.90.    The  plaintiffs contend that that sum was received by Mr Bethune in breach of his duties  as  a  director  to  FAF  and  seek  to  recover  it  pursuant  to s 301(1)(b)(i) of the Act.  I will refer to this as “the salary claim”.

(c)      There  is  a  claim  for  $648,428  alleged  to  be  the  total  of  losses sustained  by  FAF  in  respect  of  what  the  plaintiffs  contend  were related party loans by FAF to Westside 2000 Ltd (Westside) and Hard Rock New Zealand Ltd (Hard Rock).   The plaintiffs allege that Mr Bethune breached his duties as a director of FAF in permitting or authorising these loans to be made at all, or to be made without proper documentation,  security  and  provision  for  interest.    This  claim  is made pursuant to s 301(1)(b)(i) of the Act.  I will refer to this as “the related parties claim”.

(d)There is a further claim for appropriate compensation pursuant to s 301(1)(b)(ii) for the costs of liquidation, including the liquidators’ fees and disbursements as actually incurred.

[5]      Mr Bethune denies that he breached any of his duties as a director and further disputes the quantum of the sums claimed.   He also advances three affirmative defences.  The first, in reliance on s 138 of the Act, is a contention that he properly and reasonably relied on information provided to him by an employee of FAF, Alan Campbell, who was the in-house accountant.   The second is that he cannot have liability for the related party loans because they were not loans.  Mr Bethune argues that the claim is founded on an error by FAF’s external accountants in recording the relevant transactions as loans from FAF, rather than repayment by FAF of loans from Westside and Hard Rock.   The third affirmative defence is that the related parties claim is in any event time-barred under the Limitation Act 1950.

[6]       The second cause of action is under ss 194 and 300 of the Act.  The plaintiffs allege that Mr Bethune, as a director, breached the duty under s 194 to ensure that accounting records were kept for FAF at all times which correctly recorded the

transactions of the company.   It is further alleged that this breach caused losses which are to be assessed under s 300(1) of the Act.  The sum claimed is the total of the debt to Inland Revenue, also claimed under the first cause of action.

[7]      Mr Bethune denies the accounting records claim.  He further contends that he took all proper steps in respect of accounting records through FAF’s employment of, and his reliance on, Mr Campbell, the in-house accountant.

FACTUAL BACKGROUND

Incorporation of FAF and the “related party loans”

[8]      FAF was incorporated in 2001.  Mr Bethune was a director of FAF from 1

April 2005, together with his wife.  Mr Bethune was also a director and shareholder of Westside and Hard Rock.

[9]      In  June  2004  FAF  purchased  a  property  at  Turakina  Road  in  Dunedin (Turakina Road).  Turakina Road was recorded as an asset of FAF in its financial statements for the years ended 31 March 2005 and 2006.   The 2006 financial statements also recorded that FAF was owed $44,685 by Westside.

[10]     In February 2007 FAF sold Turakina Road.   A substantial part of the net proceeds of sale was transferred by FAF to Westside.  FAF’s financial statements for the year ended 31 March 2007 recorded a loan to Westside of $643,428 and a loan to Hard Rock of $5,000.   The annual financial statements for FAF for the following years through  to  31  March  2010  recorded  the  same  sums,  although  these were recorded as “investments” by FAF.   No further financial statements for FAF were produced beyond those for 31 March 2010.

[11]     Mr Bethune’s contentions that the transactions were erroneously recorded as loans by FAF’s accountants, and that the transactions were in fact repayments by FAF of loans from the other two companies, are considered later.

Boogie Nights, Shooters and the Christchurch earthquakes

[12]     In 2009 or 2010 Mr Bethune acquired rights to set up cafés in Auckland and Christchurch under the Hard Rock name.   The premises he found for a café in Christchurch had been used to operate two bars called Boogie Nights and Shooters Bar. The company that had been operating the bars was in receivership.  Mr Bethune purchased the bar operations, land, buildings and chattels.  He intended to operate the bars while the Hard Rock Café was being established on the same site.   Mr Bethune incorporated different companies to operate each bar – Boogie Nights Ltd and Shooters Christchurch Ltd.  Mr Bethune was the sole director and shareholder of both companies.

[13]     On acquisition  of the bar businesses, Alan Campbell  was  retained  as  an employee.  Mr Campbell had been employed by the previous owner as an in-house account.   On a number of central issues, Mr Bethune gave evidence of what Mr Bethune says he was told by Mr Campbell and, on more peripheral issues, what Mr Bethune had been told by the receiver about Mr Campbell.  Neither Mr Campbell nor the receiver was called as a witness.  The plaintiffs objected to this evidence as hearsay.  These objections are upheld, although Mr Bethune’s stated reasons for his own actions, apparently founded on advice from others, can be noted.

[14]     Mr Bethune decided to use FAF as a payroll company to employ staff who worked at the two bars.  This was because staff worked between both bars, but each business was owned by a separate company.   If staff were paid by one of the companies, each employee would pay secondary tax when employed by the other company.  Having FAF as the single employer of all staff avoided the difficulty.  Mr Bethune said that he made this decision as a consequence of a discussion he had with Mr  Campbell  and  following  further  advice  from  FAF’s  external  accountants, G S McLauchlan & Co.

[15]     Mr Bethune said that FAF had “sat dormant” since January 2007.   FAF

entered into a heads of agreement with Boogie Nights and Shooters on 20 August

2010.  FAF employed the staff and invoiced the appropriate company for the hours worked by its staff.  FAF also charged GST to Boogie Nights and Shooters for the

service of providing staff.  The payments required to be made by Boogie Nights and Shooters to FAF for wages included PAYE on those wages.   The payments by Boogie Nights and Shooters for the PAYE component were paid on by FAF to Inland Revenue.    The  GST was  required  to  be  paid  separately by  Boogie  Nights  and Shooters to FAF and FAF in turn accounted for this to Inland Revenue.  FAF did not carry on any other business.  It was not intended to generate any profit.  Nor was it anticipated that there would be any loss, provided all sums required to be paid by FAF, for all taxes and net wages, were met by Boogie Nights and Shooters.

[16]     Mr Bethune’s interests took possession of the businesses on 1 December

2010.   The businesses traded from acquisition until 22 February 2011, when the second Christchurch earthquake occurred.  The businesses were then forced to close. In the end they did not reopen.

Town Ball

[17]     On 1 January 2012 Mr Bethune incorporated a new company, The Town Ball Ltd (Town Ball).  It was incorporated to operate a new bar and functions business pending final decisions in relation to Boogie Nights and Shooters and the hoped for establishment of the Hard Rock Café business.  The original directors of Town Ball were Mr Bethune and his wife, Mrs Tania Bethune.  The original shareholders were Mr and Mrs Bethune.   At the date of incorporation of Town Ball, Mr and Mrs Bethune were also the directors of FAF.

[18]     On 1 August 2012 Town Ball and FAF entered into a heads of agreement for FAF to provide the same services to Town Ball that it had provided to Boogie Nights and Shooters (the Town Ball agreement). The agreement relevantly provided:

2FAF shall, in addition to management and administration roles for the Town Ball, be responsible for the employment agreements and all employment responsibilities, obligations, liabilities and rights in respect of the staff to be employed in the businesses operated by the Town Ball and in the event of trading recommencing, Boogie Nights and Shooters.

3FAF shall invoice the Town Ball on a weekly basis for an amount equivalent to the staff hourly rates actually paid to the staff used by the Town Ball to the intent that FAF shall pay each of the staff from

the income derived from the Town Ball pursuant to the invoices referred to herein.

4FAF  shall  be  responsible  for  any  liabilities  arising  from  any employment  disputes  and  resolutions  required  in  respect  of  the above but shall be reimbursed and indemnified by the Town Ball in respect of any such liabilities arising.

5The  Town   Ball   shall   also   reimburse   FAF   in  respect   of   all administration, salaries and management fees incurred in the employment and management role referred to herein.

[19]     Town  Ball  commenced  operations  in  October  2012.    Mr  Campbell  was retained as in-house accountant for the new business, initially full-time and then on a part-time basis from July 2013.   Mr Bethune’s evidence was that Mr Campbell moved to a part-time role as it became apparent that there was insufficient work for Mr Campbell with only one business in operation.  Mr Bethune’s evidence was that Mr Campbell, after changing to a part-time role, on average worked for eight hours a week.

Tax payment defaults

[20]     On 7 May 2013 FAF defaulted in a payment of GST that should have been made to Inland Revenue no later than 7 May.   This was GST for the two month period ending 31 March 2013. This debt, and almost all GST payments subsequently due, were not met.  From July 2013 FAF also began to default in payments to Inland Revenue of PAYE, and in respect of KiwiSaver, student loan and superannuation contribution obligations.

[21]     Companies Office records show that Mrs Bethune ceased to be a director of FAF and of Town Ball on 1 August 2013.  Mr Bethune continued as the sole director of both companies through to liquidation.

[22]     Inland Revenue notified FAF of its outstanding tax obligations by letters dated 22 September and 22 October 2013.   The notices were sent to FAF’s post office box.   Inland Revenue file notes record that an officer contacted FAF by telephone on 23 October 2013 and spoke to an “admin officer” about FAF’s outstanding obligations.

[23]     Mr Bethune’s evidence was that he only became aware of these outstanding debts towards the end of November 2013.    The date on which Mr Bethune first had direct knowledge of defaults is an issue discussed later.

[24]     Mr Bethune said that he then contacted FAF’s external accountants.  On 19

November 2013 G S McLauchlan & Co. sent a letter to Inland Revenue which stated:

[FAF] employs a person to do the Payroll and GST filing for the company. As part of this role, this person is supposed to report to the Directors if there are any problems in this regards.

Unfortunately, this person has not reported to the Director that PAYE and GST has not been paid. This fact has only recently been discovered by the Director. To complicate matters further, the Director is currently overseas and not due back for about three weeks.

The Director wants to address this problem, so this letter is a request to the Inland Revenue Department to hold any action in regards to this account until his return. The Director intents to contact the Department to work out a way to alleviate the problems the company now faces.

[25]     Mr Bethune and G S McLauchlan & Co. engaged in communications with Inland Revenue over the next year or so.   In respect of this period, Mr Bethune contends that he took all reasonable steps he responsibly could to address matters. This is another matter to be considered in due course.

[26]     Town Ball’s lease was due to expire at the end of July 2014.  Mr Bethune said that, in April 2014, he decided that Town Ball would cease trading at the end of the lease.   Mr Bethune said that Town Ball had taken deposits for functions over the June  rugby  test  weekends  and  that  personal  guarantees  “precluded  an  earlier departure from the lease”.  Town Ball ceased trading on 28 June 2014.  During July and August the site was cleared.  FAF continued to pay some wages and a salary to Mr Bethune for some time.

[27]     On 11 December 2014 FAF was placed in liquidation by Court order on an application of Inland Revenue. The second plaintiffs were appointed liquidators.

[28]     The liquidators have admitted a claim by Inland Revenue in the liquidation for a total of $538,213.28, made up of the following:

(a)       A preferential claim for court liquidation costs of $3,635.39;

(b)A preferential claim for $326,917.06 which is the core debt for the various unpaid taxes.

(c)      A non-preferential claim for $207,660.83 which is the portion for interest and penalties, on the unpaid taxes.

PARTICULARS OF ALLEGED BREACHES OF DIRECTOR’S DUTIES

[29]     The plaintiffs’ pleaded particulars of alleged breaches of duty by Mr Bethune are relied on in respect of the alleged breaches of all four duties earlier itemised.3   In summary, the plaintiffs allege that Mr Bethune breached his duties as follows:

(a)      Permitting FAF to make the related party loans in a manner and in circumstances which meant that the money was unavailable to FAF and that Mr Bethune’s personal interests, and those of Westside and Hard Rock, were preferred over FAF’s interests.

(b)Failing to ensure that FAF was able to meet its obligations arising from the Town Ball agreement as they arose.

(c)      Failing to ensure that FAF did meet its obligations from the Town Ball agreement as they arose and, in particular, payment of tax.

(d)      Failing to require Town Ball to pay to FAF the sums required for FAF

to meet all of its tax liabilities as they fell due and thereby causing

FAF to incur tax debts it could not meet.

3 Amended statement of claim dated 20 October 2016, at [55]. Paragraph 55 is expressly directed to the alleged breach of duty to act in good faith (s 131). The pleadings in respect of the other duties allegedly breached simply record that “the plaintiffs repeat paragraph 8 above”. Mr Cogswell submitted that the cross-reference to paragraph 8 means that no particulars were provided in respect of the other duties because paragraph 8 has nothing to do with director’s duties. There is no merit in the submission. The reference to paragraph 8 is plainly a clerical error. It is clear that the reference should be to paragraph 55.

(e)      Failing to terminate the Town Ball agreement, and to stop providing services to Town Ball, thereby enabling Town Ball to benefit at FAF’s expense.

(f)       Causing FAF to incur debts with Inland Revenue and not to pay them.

(g)      Failing to ensure sufficient funds were retained by FAF to enable FAF

to pay its creditors.

(h)Causing FAF to incur Inland Revenue debts without knowing on reasonable grounds that FAF could meet those debts when they fell due.

(i)       Permitting and causing FAF to pay a salary to him when:

(i)there were no reasonable grounds to believe that such was fair to FAF;

(ii)      when FAF was insolvent; and

(iii)in circumstances which preferred his own interests over the interests and obligations of FAF.

(j)Failing to cause adequate accounting records to be kept for FAF for the period 1 April 2010 to the date of the liquidation order on 11

December 2014.

CENTRAL ISSUES

[30]     Ms Morrison, in her closing submissions for the plaintiffs, identified five issues which she described as “overarching factual issues for determination”.  I am satisfied that the issues she identified are central to the issues between the parties, including some of Mr Bethune’s affirmative defences.  Four of those are discussed in this section.  The fifth is discussed in the assessment of liabilities under s 131.  That

issue is whether Mr Bethune preferred Town Ball’s and his own interests over those

of FAF.

[31]     The four central issues for consideration at this point are:

(a)       Did Mr Campbell conceal the Inland Revenue debt and is the s 138 defence available?

(b)      When did Mr Bethune become aware of the unpaid tax debts?

(c)       The  related  party  loans  by  FAF:  were  they  loans  and  is  there  a limitation defence?

(d)      Was FAF insolvent when in contract with Town Ball?

Did Mr Campbell conceal the Inland Revenue debt and is the s 138 defence available?

[32]     Mr Bethune said that he had no knowledge that FAF had not made payments to Inland Revenue until November 2013 when he, for “the first time ever”, went to FAF’s post office box to clear the mail and found a letter from Inland Revenue recording the liability.  Mr Bethune said the only reason he cleared the mail on this occasion was because Mr Campbell, whose responsibility it was, was on holiday.  Mr Bethune said that he discovered letters from Inland Revenue replying to letters from Mr Campbell about tax returns, that he had never seen these letters, and that Mr Campbell had not raised any issue about Inland Revenue debt in any meetings or reports.

[33]     Mr Bethune said Mr Campbell had a wide range of accounting and clerical responsibilities which, Mr Bethune suggested, made Mr Bethune dependent on Mr Campbell   to   know   if   FAF   debts   were   not   being   paid.      These   included: responsibilities for all outward payments; completion of Inland Revenue reporting for and payment of GST, PAYE and other tax liabilities; preparation and presentation of aged trial balances of debtors and creditors of Town Ball on a fortnightly basis; and clearing the post office box.  Mr Bethune said, in particular:

Alan Campbell had sole access rights to the IRD’s online services account for FAF Holdings and the related companies, Shooters Bar, Boogie Nights and the Town Ball.  I did not have access until later, around January 2014. This was in accordance with his role in the businesses.

[34]     Mr Bethune said that Town Ball’s debtor and creditor reports are what he relied on to know whether there was an overdue debt of Town Ball to FAF.  Arising from this, and central to Mr Bethune’s contention that he was unaware of the Inland Revenue debt until November 2013, was the following allegation against Mr Campbell:

What I now know Alan Campbell was doing – unknown by me until the end of November 2013 when he was away on leave – was that he was deleting the outstanding FAF liabilities from the Town Ball’s records when they went beyond the 60 day outstanding column.

[35]     It may be noted at this point, for subsequent discussion, that an essential premise of this contention, in relation to Mr Bethune’s knowledge, is that there was no other accounting record of Town Ball which would have alerted Mr Bethune to the increasing liability to Inland Revenue, and that there was no accounting record at all of FAF which would perform that function.

[36]     The allegation against Mr Campbell is an essential part of Mr Bethune’s affirmative defence under s 138 of the Act.  Section 138(1) relevantly provides that, when a director is exercising powers or performing duties as a director of a company, the director may rely on reports and other information from an employee of the company whom the director believes on reasonable grounds to be reliable and competent  in  relation  to  the  matters  concerned.    This  provision  is  qualified  by s 138(2), but the defence under s 138(1) will not have been made out in this case unless Mr Bethune has established that Mr Campbell falsified Town Ball’s reports as alleged.  I have concluded, for reasons that follow, that that is not established.

[37]     There  was  no  plausible  explanation  for  what  Mr  Bethune  alleged  Mr Campbell had done.  Mr Campbell was only ever an employee of FAF. There was no suggestion that Mr Campbell sought to benefit financially by falsifying accounting records.  Mr Campbell would have faced risks of serious personal and professional repercussions for no apparent purpose.

[38]     There was inadmissible hearsay evidence from Mr Bethune that Mr Campbell said he falsified the records because he did not want to disappoint Mr Bethune.  It was hearsay evidence because it was plainly offered as evidence by Mr Bethune to prove the truth of what Mr Campbell allegedly said.  If the evidence was admissible because Mr Bethune was not offering it to seek to prove the truth of its contents, it does not provide any support for a conclusion that Mr Campbell did falsify the reports.

[39]     The admissible evidence indicates that Town Ball was in financial difficulty at least by March 2013.  In those circumstances, and in the absence of evidence from Mr Campbell, or documentary evidence justifying an inference of manipulation of accounting records by Mr Campbell – and there was neither – the reasonable inference as to the likely course of action by Mr Campbell is that he would have told Mr Bethune that Town Ball could not pay all of its creditors and sought instructions.4

There is evidence that Mr Campbell did exactly that at other times.  Matters of this

nature are considered further in the next section, when assessing the related question

as to when Mr Bethune did become aware of FAF’s default in paying tax liabilities.

[40]     Mr Campbell was in a formal sense employed by FAF, like all other staff, but was also responsible for maintaining accounting records of Town Ball.  Mr Bethune said that he discovered in November 2013 that Mr Campbell had falsified the Town Ball debtor reports.  In spite of this, Mr Campbell continued as an employee of FAF until September 2014.  There was no adequate explanation from Mr Bethune for Mr Campbell’s continued employment notwithstanding his alleged deception.  What is more,  there  was  no  indication  that  the  wide  range  of  responsibilities  that  Mr Campbell had before November 2013 changed in any material way after that date. Also, in the letter of 19 November 2013 to Inland Revenue from G S McLauchlan & Co. on behalf of FAF, there was no suggestion that Mr Campbell had been falsifying

records.

4      The relevant records were in evidence and did show that the debts to FAF were absent from the “aged creditors” sections of the reports.  But this does not show who made those changes, how, or on what instructions, or even that there were changes.

[41]     It is also not reasonably possible to reconcile Mr Bethune’s allegation against Mr Campbell with what happened in relation to  payment of tax liabilities after November 2013.  Nothing changed.  Tax was not paid.  Mr Bethune, understandably given his own evidence, did not seek to argue that Mr Campbell continued to be at fault for the non-payment of tax.   In respect of the period from November 2013, through to around August 2014, the essence of Mr Bethune’s evidence was that he was then endeavouring to trade Town Ball out of financial difficulties and, from time to time, was in communication with Inland Revenue about FAF’s liability to Inland Revenue, which was steadily increasing.

[42]     In addition to the fact that defaults in payment of tax continued, there was no material change to the aged debtor reports of Town Ball after 2013.  The increasing indebtedness of Town Ball to FAF remained absent from Town Ball’s reports.

[43]     There was no adequate explanation from Mr Bethune as to how Mr Campbell managed to falsify Town Ball’s relevant reports without that becoming apparent from other financial records of Town Ball.   In fact, except in relation to the allegation about the aged debtor report for the liability of Town Ball to FAF, Mr Bethune firmly argued  that  Town  Ball’s  accounting  records  were  reliable.    He  advanced  that argument in response to the plaintiffs’ claim that Mr Bethune failed to ensure that adequate accounting records were kept for FAF, on the basis that Town Ball’s records could also serve as records for FAF.

[44]     For these reasons, directed to an assessment of admissible evidence, I reject

Mr Bethune’s allegation that Mr Campbell falsified relevant reports.

[45]     There is a further consideration arising from the fact that Mr Campbell was not called as a witness.  On this issue, Ms Morrison submitted that, given the fact that Mr Bethune did not call Mr Campbell to give evidence, the Court is entitled to infer that any evidence that Mr Campbell would have given would have been unhelpful to Mr Bethune’s case.  Mr Cogswell’s response for Mr Bethune was that it was open to the plaintiffs to call Mr Campbell and, since they chose not to, there is no good reason not to accept Mr Bethune’s evidence.

[46]     I do not accept Mr Cogswell’s submission.  For the reasons already recorded, Mr Bethune’s allegation is unpersuasive when weighed against the other matters referred to.  This conclusion is also reinforced by conclusions in the next section, dealing with the question as to when Mr Bethune knew that the tax was not being paid.  The only evidence that Mr Campbell falsified Town Ball’s debtor reports and that, if he had not done so, Mr Bethune would have been aware at the outset that FAF was not being paid, were Mr Bethune’s bare allegations to that effect.

[47]     On the other hand, the fact that Mr Bethune presented an argument based on what he asserted he was told by Mr Campbell, but Mr Bethune then chose not to call Mr Campbell, supports the conclusion against Mr Bethune.  The principle was discussed by the Court of Appeal in Ithaca (Custodians) Ltd v Perry Corporation as

follows:5

In Jones v Dunkel,6 Windeyer J at 320 approved of the following passage from Wigmore on Evidence (3rd  ed), 1940 at 142, which he said was “plain commonsense”, as follows:

“The failure to bring before the tribunal some circumstance, document, or witness, when either the party himself or his opponent claims that the facts would thereby be elucidated, serves to indicate, as the most natural inference, that the party fears to do so, and this fear is some evidence that the circumstance or document or witness, if  brought,  would  have  exposed  facts  unfavourable  to  the  party. These inferences, to be sure, cannot fairly be made except upon certain conditions; and they are also open always to explanation by circumstances which made some other hypothesis a more natural one than the party's fear of exposure. But the propriety of such an inference in general is not doubted.”

…

Where an explanation or elucidation is required to be given, an inference that the evidence would not have helped a party’s case is inevitably an inference that the evidence would have harmed it. The result of such an inference, however, is not to prove the opposite party’s case but to strengthen the weight of evidence of the opposite party or reduce the weight of evidence of the party who failed to call the witness.

[48]     Mr Bethune sought to give evidence, which I have ruled inadmissible, of things  he contends  he  was  told  by Mr Campbell,  and  he has  made the central

5      Ithaca (Custodians) Ltd v Perry Corporation [2004] 1 NZLR 731 (CA) at [151] and [154] (footnote added).

6      Jones v Dunkel (1959) 101 CLR 298.

allegation against Mr Campbell of falsification of the reports.  I am satisfied that the Court can infer that, if Mr Campbell had been called, his evidence would not have assisted Mr Bethune.

When did Mr Bethune become aware of the tax debts?

[49]     I am satisfied that Mr Bethune knew from the outset that FAF was failing to make payments to Inland Revenue when they fell due.  I am also satisfied that he was the person responsible for this.  My reasons, in summary, are as follows:

(a)      From early 2013 Town Ball was operating at a loss.  Mr Bethune will have been well aware of this.  The operating deficit of Town Ball was reduced, at least in part, by withholding from FAF the sums required to be paid to FAF so it could meet its tax liabilities.

(b)Mr Bethune said that he did not have access at the time to relevant FAF records.   This would not relieve Mr Bethune from liability for breach of duties he had as a director of FAF, but in any event I do not accept his evidence.

(c)       I do not accept Mr Bethune’s evidence that he only discovered the tax

liability on clearing the post office box in November 2013.

(d)What occurred  from 2013,  both in relation to  FAF’s tax payment defaults and Town Ball’s record keeping and performance, is not only inconsistent with Mr Bethune’s contention of discovering the defaults in November, but is also consistent with a positive conclusion that he had directed what had occurred before November 2013.

(e)      The fact that the serious allegation was made by Mr Bethune against Mr Campbell,  and  my rejection  of that  allegation  for the reasons already discussed, further supports the overall conclusion.

[50]     I will expand on that summary.

[51]     Town Ball commenced operations in October 2012.  The monthly statements of income and expenses, for a 12 month period from January 2013, record losses for the five months from January to May 2013 ranging from $30,224 in January to a high of $49,028 in March.7     In June and July 2013 the losses were, respectively,

$11,515 and $12,337, with a small profit in August of $1,378.  This change in Town Ball’s position coincided with the commencement of FAF’s failure to pay GST, with defaults soon after in payment of PAYE.  The GST payable for the period ending March  2013  was  $22,150.73.    The  liability  for  that  tax  was  the  first  default, occurring on 7 May 2013.   By the end of May 2013 the total of GST payable by FAF, that was not paid because FAF did not receive payments from Town Ball and did not have any other means to pay (as I will come to), was over $44,000.  By the end of July the deficit was $86,000.

[52]     Town Ball’s debts to FAF that were not paid represented additional funds available for use by Town Ball.  Mr Bethune did not dispute the arithmetic in relation to the additional funds, but said he did not know whether he would have noticed the extra cash available to Town Ball.  He said:

$20,000 is a lot of money, you don’t want to have to go and find it tomorrow afternoon at 2 o’clock, but when we were sort of selling 180 to $200,000 a month it’s pretty easily washed out in some of the expenses we were having.

[53]     This answer was somewhat equivocal on the question whether Mr Bethune was aware of the surplus available to Town Ball.  In any event, I am satisfied it was a disingenuous answer; he would have been aware of the improved cash position.  It is clear from the evidence that Mr Bethune paid a lot of attention to Town Ball’s financial   performance   and   that   he   had   a   good   understanding   of   business management.   A saving in excess of $20,000 was substantial in relation to Town Ball’s sales.  These fluctuated but never got close to $200,000 a month.  The round figures for sales in March and April 2013 were $115,000 and $110,000.  The gross margins for those months, in round figures, were only $83,500 and $78,000.  The surplus, arising by not paying GST to FAF, would not have been directly reflected in

the monthly accounts I have been referring to, but I am satisfied, from Mr Bethune’s

7      The losses for February, April and May were, respectively, $40,451, $47,267 and $38,555.

evidence of the attention he gave Town Ball’s overall position on a regular basis, that

he would have been aware of the surplus.

[54]     Mr Bethune’s evidence was that he did not have access to, or at least did not review, FAF records which would have disclosed non-payment of tax. At [33] above I quoted Mr Bethune’s statement in his brief of evidence that Mr Campbell “had sole access rights to the IRD’s online services account for FAF” and that Mr Bethune did not have access until “around January 2014”.  With that evidence Mr Bethune was plainly asking the Court to accept that Mr Bethune had no means of checking the position online until around January 2014.  I do not accept this evidence.  The online account for FAF with Inland Revenue was in fact set up by Mr Bethune, as he acknowledged.  Also, in cross-examination Mr Bethune was asked whether, prior to January 2014, only Mr Campbell had access to the online system.  The answer was equivocal, to the point of being inconsistent with the categorical assertion in the brief of evidence, when he said:

Well, Alan was the one processing and doing it in fact even after the balloon

[went up] Alan was still the one processing it …

[55]     Mr Campbell was recorded as the authorised user of the electronic system, but Mr Bethune was able to access the system using Mr Campbell’s username and password, as he expressly acknowledged he did from around January 2014.  I have given some emphasis to this point because, although it is in one respect simply a small part of the picture, it is telling because Mr Bethune, in his brief of evidence, clearly sought to distance himself from anything to do with FAF’s dealings with Inland Revenue.  And he did so by giving evidence that he intended should be given weight, but which was misleading.

[56]     The Inland Revenue online system was, in any event, not the only way in which Mr Bethune was able to know whether payments were being made by FAF to Inland Revenue.   FAF’s bank statements were put in evidence.   Because FAF’s operations were very limited, the bank statements record a limited number of transactions – in large measure, payment of wages, payment of GST and PAYE to Inland Revenue, and receipts from Town Ball.   When the payments of GST and PAYE were being made regularly to Inland Revenue, the fact of those payments is

readily seen in the bank statements.  So too are the receipts from Town Ball.  The only regular deposits to FAF’s account were receipts from Town Ball with the nature of these also readily seen.

[57]     Mr Bethune, in cross-examination, effectively acknowledged that he was able to, and did, monitor FAF’s position by reference to FAF’s bank statements.  This was in the course of cross-examination on the adequacy of his supervision of Mr Campbell, rather than the specific issue I am now dealing with, and Mr Bethune’s response was directed to a different proposition.   But it was somewhat telling in relation to the issue I am now dealing with.  He said:

… with FAF being a net sum company it’s not like it ever earned or had

$50,000 in it one week because whatever went in immediately went out.  So, you know, the criticism of the lack of records, every time you went in the bank account you could see how much was there.  The only thing we didn’t know was what wasn’t being paid because that was being withheld.

[58]     I do not accept the final proposition because it was plain from the bank statements  that  the  regular  pattern  of  payments  from  Town  Ball  for  GST  had stopped.  The final sentence also ignores the fact that it was also plain from the bank statements when FAF began to default on payments to Inland Revenue.   The first part of the answer was inadvertent support from Mr Bethune of these conclusions.

[59]     Later in his evidence Mr Bethune said that he did not review FAF’s bank account.   I do not accept this.   In addition, and as Mr Bethune acknowledged, he handled the payroll system for staff.  This required him to log into Town Ball’s bank account to undertake a manual transfer of funds to FAF to pay wages.

[60]     Events in and after November 2013 are not consistent with Mr Bethune’s evidence of his knowledge.   There is inconsistency beginning with Mr Bethune’s evidence that he had no knowledge until finding the letter from Inland Revenue in November when he cleared the post office box.  Following the order for liquidation Mr Bethune, at the liquidators’ request, completed what is called a “business profile” of FAF.  The document is dated 23 December 2014 and was signed by Mr Bethune. One question was what caused the company to become insolvent.   Mr Bethune wrote:

The employed accountant (Alan Campbell) was to report weekly the position to the director.  He did not at any stage notify that the IRD was going unpaid. I became aware when I was called by IRD.

[61]     Two points arise from that statement.  The first is that, as with the letter to Inland Revenue from G S McLauchlan & Co., there was no suggestion that Mr Campbell had been deliberately falsifying weekly reports.  Even if there had been a decision not to report the allegation to Inland Revenue in 2013, or if the information had not been known at that time, it is a surprising omission, if the allegation was true, from a statement as to the cause of insolvency from the sole director to the liquidators.  The second point is that Mr Bethune’s explanation in the report to the liquidators,  as  to  how  he  became  aware  of  the  default  in  payments  to  Inland Revenue,  is  materially  different  from  his  explanation  in  his  brief  of  evidence, referring to his clearing the mail when Mr Campbell was on holiday.

[62]     In the preceding section I referred to the fact that what had occurred before November 2013 continued after that date.  Mr Bethune argued that he was doing his best for Town Ball in difficult trading circumstances, and in fact putting his own money into Town Ball.  This does not bear in a material way on the inference to be drawn from the fact that there was no change, at all, from December 2013, apart from increasing debt to Inland Revenue.  I agree with a succinct submission of Ms Morrison as follows:

The fact that nothing materially changed as regards FAF’s manner of operation following November 2013 suggests precisely that: that nothing actually changed as at that date.   The reaction that ought to have been evident following such a significant discovery is noticeably absent.

[63]     Mr Cogswell’s closing submission for Mr Bethune, on the question as to when Mr Bethune became aware of the tax arrears, also was succinct.  He referred to evidence from Mr Levin, in cross-examination, that Mr Levin did not have any record of contact between Inland Revenue and Mr Bethune before November 2013. Mr Cogswell then submitted:

That is Mr Bethune’s case. He knew nothing of the arrears before November

2013 when he cleared the PO box for the first time and discovered the IRD

correspondence. There is no documentary evidence to challenge that and Mr

Bethune’s evidence is conclusive on that.

[64]     I accept that there is no direct evidence that Mr Bethune was aware of any letter from Inland Revenue before November 2013, but that fact is a long way short of making Mr Bethune’s assertion conclusive.  Mr Bethune is fully entitled to have his admissible evidence assessed, as it has been.  But it must be weighed against all other admissible and reliable evidence.  The evidence against which I have weighed Mr Bethune’s evidence, including his serious allegation against Mr Campbell, is a substantial body of evidence, and a lot of which was not contested in any material way.  Having considered the relevant evidence, I do not accept this central part of Mr Bethune’s defence, for the reasons discussed in this section and in the preceding section dealing with the allegation against Mr Campbell.

[65]     There are two further considerations relating to Mr Bethune’s affirmative defence under s 138.   Section 138(2) provides that a director may rely on reports from an employee only if the director acts in good faith, makes proper enquiry where the need for enquiry is indicated by the circumstances, and has no knowledge that such reliance is unwarranted.   In light of my conclusions in this section, and the preceding section dealing with the allegation against Mr Campbell, even if there was some basis for concluding that Mr Campbell may have failed adequately to maintain Town  Ball’s  records,  I  could  not  conclude  that  Mr  Bethune  had  made  proper enquiries on behalf of FAF when they were required.  They were required because of Mr Bethune’s knowledge of the financial difficulties of Town Ball.

The related  party loans  by FAF: were they  loans  and is  there a limitation defence?

[66]     As earlier recorded, in February 2007 FAF sold Turakina Road and FAF’s annual financial statements for the year ended 31 March 2007 recorded a loan from FAF to Westside of $643,428 and a loan to Hard Rock of $5,000.   Mr Bethune contended that these entries in the financial statements arose from error by FAF’s accountants G S McLauchlan & Co.   He said that transfers of money by FAF to Westside and Hard Rock, following sale of Turakina Road, were repayments by FAF of loans from those companies.

[67]     The question whether these sums were loans is central to the plaintiffs’ claim

to recover the total of $648,428 from Mr Bethune on the grounds that he breached

his duties in authorising the loans to be made at all, or in authorising them to be made without proper documentation, security and provision for interest.  For reasons I will come to, I accept Mr Bethune’s defence that the plaintiffs’ claim is time barred under the Limitation Act 1950.  It is nevertheless relevant to consider the evidence for the plaintiffs, and from Mr Bethune, on the question whether the transaction with Westside was a loan, because this bears on other claims made by the plaintiffs.  For example, it impacts on claims based in part on a question whether FAF was solvent when it entered into the Town Ball agreement and over the following two years or so of its dealings with Town Ball.  The evidence on this issue also has a bearing on my assessment of the reliability of Mr Bethune’s evidence generally. As with some other central issues, I was unable to accept Mr Bethune’s evidence on this issue.

[68]     I will refer only to the evidence relating to the transaction between FAF and Westside.  The $5,000 relating to Hard Rock does not require consideration because a claim in relation to it is time barred and the sum involved is, in context, inconsequential.

[69]     Mr Bethune’s evidence in his brief was as follows:

… The debt was in fact the repayment of loans.  When FAF, [Westside] and [Hard Rock] sold off the building [at Turakina Road], [Westside’s] assets, trading business and stock, the loans taken by the 3 entities required repayment.  Westside 2000 needed to be recompensed for all of its assets, goodwill and stock.   These items were recorded in error by our external accountants.   Records lost in the Earthquake [sic] would have accurately determined the matter and bank records have proven impossible to obtain given the passage of time.

… The funds received repaid loans.

… The related party loan was not an asset of FAF Holdings.

[70]     I  am  unable  to  accept  Mr  Bethune’s  contentions.     Contemporaneous documents were obtained by the liquidators and produced in evidence.  All of these support a positive conclusion that the transactions were properly recorded in FAF’s annual financial statements as loans by FAF to the two other companies.   These include  documents  obtained  by  the  liquidators  to  respond  to  Mr  Bethune’s contentions in his brief of evidence which had not been apparent in any way from his

statement  of  defence.8      The  most  relevant  evidence  in  relation  to  Westside  is recorded in the following paragraphs.

[71]     FAF’s solicitors’ trust account ledger for the sale of Turakina Road records that FAF received net sale proceeds of $1,401,506.22.  Of this sum, $824,406.67 was paid to National Bank to repay a mortgage debt.  Rates, legal fees, and GST totalling

$4,320.43 were paid. The entire balance of $572,779.14 was transferred to Westside.

This  was  recorded  in  the  trust  account  ledger  as  ‘TRANSFER  TO  13211

WESTSIDE 200 ADVANCE”.   The solicitors’ statement to FAF records the same particulars, with the payment to Westside expressly recorded as “Advance to Company”.

[72]     FAF’s signed financial statements for the year ended 31 March 2007 recorded two items as non-current “liabilities”, although they are in fact assets.  These were recorded as follows:

$ Loan – Westside 2000 Limited [Westside]  (643,428) Advance – Westside Autos Limited [Hard Rock]9  (5,000)

[73]     The accounting work papers  for the  year to  31  March  2007  record that Westside’s debt at the beginning of the financial year was $44,685.  This increased by $611,243.43 on account of “Transfer on sale of 4 Turakina Rd”, being the sum of

$572,779.14  plus  $38,464.29  for  “Sale  of  Assets  as  per  sale  agreement  via Westside”.   As will be seen, the first of those figures corresponds with the sum recorded in the solicitors’ trust account ledger, and in the solicitors’ statement to FAF, as an advance to Westside.  The total debt was reduced by $12,500 on account of a $10,000 transfer and “FAF share of Accounting fee” to arrive at the figure of

$643,428 recorded in the 31 March balance sheet, after allowing for the debt carried forward of $44,685.

[74]     The advance to Westside continued to be recorded in that sum in FAF’s

financial statements for the years ended 31 March 2008, 2009 and 2010.  There were

8      Relevant detail in relation to the further documents obtained from FAF’s solicitors are recorded

in a minute dated 3 April 2017. The detail does not need to be reproduced in this judgment.

9      The name was changed in July 2009 from Westside Autos Ltd to Hard Rock.

no annual financial statements after 2010 through to liquidation.  The only changes from the 2007 financial statements are that the sum was recorded as a credit sum in FAF’s balance sheet as a non-current asset and it was described as an “investment”.

[75]     The financial statements for each of the years ending 31 March 2008, 2009 and 2010 were completed in  or about January 2012.   On 23 January 2010 Mr Bethune signed the financial statements or, on the same date, certified tax returns for FAF based on those financial statements.

[76] Mr Bethune’s bare assertion (at [69] above) that, on sale of Turakina Road, FAF was required to recompense Westside for assets, goodwill and stock of Westside, cannot be reconciled with the terms of the agreement for sale and purchase, quite apart from what is established on the face of the solicitors’ trust account records. The agreement for sale and purchase is one of the documents obtained by the liquidators in response to new allegations by Mr Bethune in his brief of evidence, and which documents Mr Bethune sought to have excluded from

evidence.10    The  agreement  for  sale  and  purchase  contradicts  Mr  Bethune’s

allegation.   It records that the sale price of $1,400,000 was for land and buildings owned by FAF.

[77]     In addition to the plain words of the agreement for sale and purchase there is the elementary fact that Turakina Road was registered in FAF’s name.  No document was produced to suggest that FAF held it in trust for Westside, or for any other entity. On  the  face  of  it,  following  sale,  FAF’s  entire  equity  in  Turakina  Road  was transferred to Westside, apart from the small sum in payment of rates, legal fees and GST.

[78]     Mr Bethune acknowledged that he gave instructions to FAF’s solicitors on the transfer.  I am satisfied that Mr Bethune, at the time, would have been alert to the need to give clear instructions to his solicitors as to the nature of the transfer to Westside.  The inference is that the solicitors acted correctly in accordance with the

instructions they received.

10     See above at [70] and n 8.

[79]     The only evidence that the accountants made an error is Mr Bethune’s bare assertion to that effect.  The accountants’ records were obtained by the plaintiffs.  It was not necessary for the plaintiffs to call a witness from G S McLauchlan & Co. As with the allegation against Mr Campbell, an inference may be drawn that if a witness from G S McLauchlan & Co. had been called, the evidence would not have assisted Mr Bethune.  And the actual accounting records, including the detailed accounting work papers, are consistent with the contemporaneous records of the solicitors.

[80]     Mr Bethune suggested in his evidence that there had been loans to Westside (and Hard Rock) which, the implication appears to be, were required to be repaid from the proceeds of sale of Turakina Road, in addition to repayment of the National Bank loan to FAF.  That contention cannot readily be reconciled with other parts of Mr Bethune’s evidence in his brief, with the reference to recompense to Westside for assets, goodwill and stock.   In cross-examination Mr Bethune then said that the advance by FAF to Westside was to enable Westside to repay its own loans, which Westside had in relation to the business and the building, and therefore FAF was not reimbursing Westside for assets, goodwill and stock.

[81]     Mr  Bethune  suggested  that  there  were  bank  records  which  would  have supported his contention, but these had been “impossible to obtain given the passage of time”.  I am unable to accept that, if bank records would have assisted, it would not have been possible to obtain them.   I do accept that it is possible that some records may have been lost in one of the Christchurch earthquakes.   But I am not persuaded, by that possibility, that Mr Bethune’s contentions should be accepted in the face of clear evidence from a range of primary documents, with some of these in fact verified by Mr Bethune himself, or confirmed as having been produced on his instructions.

The limitation argument

[82]     Mr Bethune pleaded that the related party claim is time barred under the Limitation Act 1950 because the acts in question occurred more than six years before this proceeding was commenced.

[83]     The plaintiffs’ claim was explicit in contending that Mr Bethune breached duties he had to FAF when the loans were made immediately following the sale of Turakina Road in February 2007.  A six year limitation period, if it applies, therefore expired in or about February 2013. This proceeding was not commenced until 2015.

[84]     The limitation period is six years on a claim for breach of director’s duties

brought pursuant to s 301 of the Act.11

[85]     Ms Morrison sought to argue that there was an ongoing breach of duty by Mr Bethune; that the breach alleged by the plaintiffs was not confined to a single point in time.  It was submitted that Mr Bethune had “multiple opportunities to take steps and act in FAF’s best interests”.

[86]     I am not persuaded that those arguments are open to the plaintiffs for three reasons.  First, they amount to a positive contention that there was ongoing breach of duty in respect of the related party loans, but that was not the plaintiffs’ pleading. Second, in a formal reply to Mr Bethune’s defence (being an amended statement of defence dated 2 December 2016) the plaintiffs simply denied the limitation defence. Third, at a pre-trial conference, five days before the hearing commenced, Mr Cogswell objected to an allegation of fraud against Mr Bethune made in written opening submissions for the plaintiffs, the objection grounded on the fact that fraud had not been pleaded.  Ms Morrison argued that the pleadings raised an argument of equitable fraud, and that equitable fraud would, pursuant to s 28 of the Limitation Act,  preclude  Mr  Bethune’s  limitation  argument.    After  hearing  from  counsel, Wylie J advised Ms Morrison that he did not consider that fraud had been raised in the pleadings.  Ms Morrison sought an adjournment to take instructions.  Following the adjournment she advised that the plaintiffs did not wish to amend their pleadings and that they abandoned any allegation of fraud and any reliance on s 28 of the

Limitation Act.

11     Arataki Properties Ltd v Craig [1986] 2 NZLR 294 (CA).

[87]     There were pleadings by the plaintiffs, and evidence in support from Mr Levin, relating to the fact that Mr Bethune, as a director of FAF, took no steps to put FAF in funds to meet its liabilities by means independent of the obligation of Town Ball to FAF.  Those contentions are relevant to the plaintiffs’ allegations of breach of duties in respect of the tax claim and the salary claim.  But they are not contentions which mean that the six year limitation for action for breach in making the loans does not apply.

[88]     The related party claim is out of time and it is accordingly dismissed.

Was FAF insolvent when in contract with Town Ball?

[89]     The plaintiffs submitted that FAF was balance sheet insolvent from 31 March

2013 at the latest, and at least by 7 May 2013 had also become unable to pay its debts as they fell due.  The 7 May date relates to the first default in payment of GST. The liability accrued on 31 March, with 7 May being the last date for payment.  FAF did not have money to pay the debt on either date.

[90]     The solvency test for a company is prescribed by s 4(1) of the Act.  There are two limbs to the test and both must be satisfied.   A company, putting it in the negative, is not solvent unless it is both able to pay its debts as they become due in the normal course of business and the value of the company’s assets is greater than the value of its liabilities, including contingent liabilities.

[91]    There was no substantial evidence from Mr Bethune, or submissions of consequence from Mr Cogswell, directed to the question of FAF’s solvency.   The reason is perhaps contained in a concise submission of Mr Cogswell as follows:

This is not one of those cases where it transpires that the company was never profitable.  FAF Holdings traded well until 2013.

[92]     That submission, although inaccurate in relation to profit, reflected one of the arguments given emphasis by and for Mr Bethune relating to the way in which FAF was meant to have operated – as a zero-sum company.   If FAF had operated as originally intended, and if Town Ball had complied with its contractual obligations, FAF would not have made any profit or any loss.

[93]     It may be accepted that that, when FAF entered into the Town Ball agreement in August 2012, Mr Bethune’s intention was that FAF would operate without incurring debt that it could not pay, on the basis that each FAF debt was to be met by a payment from Town Ball for that very debt.   But that intention, or expectation, does not bear on the question whether FAF met both limbs of the solvency test from and  following  March  2013.     The  question  of  solvency  is  to  be  determined objectively, not on the basis of what Mr Bethune may have intended or anticipated would happen.

Balance sheet solvency

[94]     I am satisfied that, at least by 31 March 2013, FAF was insolvent on a balance sheet basis – its liabilities exceeded its assets.   That never changed; there was in fact a rapid deterioration.

[95]     The last financial statements produced for FAF, for the year ended 31 March

2010, recorded a working capital deficit of $12,828 (largely due to unpaid GST of

$13,480), but a net asset surplus of $635,600.  The net asset surplus resulted, almost entirely,  from  the  fact  that  the  related  party  loans  to  Westside  and  Hard  Rock remained recorded as assets of FAF.  In real terms, these nominal assets were of no value to FAF.  This is for the reasons recorded in the preceding section.  So long as Mr Bethune was the director of FAF, and this was the position at all relevant times, Mr Bethune was not going to call up the sums recorded as owed by Westside and Hard Rock because Mr Bethune was adamant that no sums were owed by those companies.  In addition, if an independent director of FAF had sought to recover the loans to Westside and Hard Rock, it is clear that Mr Bethune, as a director of Westside and Hard Rock, would have disputed liability, and any claim made after February 2013 would have been time barred.

[96]     There is no evidence of any material change from the position recorded in FAF’s balance sheet for the year ended 31 March 2010 through to 31 March 2013. At 31 March 2013 FAF had a working capital deficit and more liabilities than assets.

Ability to pay debts

[97]     I am also satisfied that, from 31 March 2013, FAF was not able to meet its debts as they fell due.  This arises from the GST debt for the period ending 31 March

2013 which accrued on that date.

[98]     Although FAF was not required to account to Inland Revenue for GST until

7 May 2013, at 31 March 2013 FAF had no means of paying the GST debt unless and until it received the necessary sum from Town Ball. At 31 March 2013 FAF had a nominal asset in the form of a debt payable by Town Ball to enable FAF to pay the GST but, as with the “investments” in Westside and Hard Rock, FAF’s asset represented by Town Ball’s liability was of no real value.  The evidence establishes that, at least from April 2013, Town Ball was consistently running at a loss.   It stopped paying FAF.   FAF, through Mr Bethune, took no steps to enforce Town Ball’s liability to FAF.  Nor did Mr Bethune cause FAF to cancel the contract it had with Town Ball.  Some aspects of this were touched on in earlier sections and are developed further when considering the claims for breaches of ss 131 and 135.

MR LEVIN’S EVIDENCE

[99]     The evidence for the plaintiffs was given by Mr Levin, one of the liquidators. Mr Cogswell, in his opening submissions, submitted that Mr Levin, as an accountant and one of the liquidators, was in no position to give expert evidence about directors’ conduct.   He submitted that independent expert evidence on the conduct required should  have been  brought,  but  had  not  been.    In  closing there was  a  vigorous challenge to Mr Levin’s expertise, and a submission that his opinions in any event should be given little weight because of a lack of independence.

[100]   I do not accept these submissions.  Most of Mr Levin’s evidence was factual evidence coupled with Mr Levin’s interpretation of financial records.  There was no foundation for a challenge to Mr Levin’s expertise to comment, to the extent necessary, on financial records, and to interpret them.  Mr Levin is an expert in the fields of insolvency and, at least from that perspective, the conduct of directors of companies.  Mr Levin has been appointed liquidator or receiver of more than 1,000

companies, including liquidations out of Christchurch following the earthquakes.  He has had experience advising directors and as a banker.

[101]   In terms of the admissibility of his opinion evidence, and given the expertise I have noted in bare outline, I obtained substantial assistance from his interpretation of the financial information.  Mr Cogswell elicited the fact that Mr Levin is not a chartered  accountant.    That  is  irrelevant.    Mr  Levin  is  undoubtedly  expert  in assessing the financial position of companies from his experience as an insolvency practitioner and a banker.   He was well qualified to comment on FAF’s financial position.

[102]   Mr Cogswell submission about a lack of independence was based on Mr Levin’s  evidence  that  Mr  Levin’s  firm,  Deloitte,  is  funding  this  litigation,  and Deloitte will not recover the costs unless there is a recovery from Mr Bethune. Those facts do not bear on the admissibility of Mr Levin’s opinion evidence, to the limited extent that there was true opinion evidence rather than expert interpretation of financial records.   At most it might bear on the weight to be given to some opinions.  I am satisfied that Mr Levin’s opinion evidence was not affected by the matters referred to by Mr Cogswell.   Had there been opinion evidence from Mr Levin of the nature I have described – essentially interpretation of unchallenged financial information – which was skewed because of a lack of independence, that would quickly have become apparent. There was no such evidence.

[103]   This part of Mr Bethune’s challenge to Mr Levin’s evidence was rolled up with a criticism of the liquidators for pursuing this proceeding when Mr Bethune, he said, was making good progress in endeavouring to reach settlement with Inland Revenue.  That argument, to the extent that it has any evidential foundation, does not bear on the admissibility of Mr Levin’s evidence or the weight to be put on it.

THE FIRST CAUSE OF ACTION: BREACH OF DUTY? Introduction: the application of s 301

[104]   The plaintiffs’ claims for alleged breaches by Mr Bethune of his duties as a director of FAF are brought under s 301 of the Act.   Section 301(1) relevantly provides as follows:

If, in the course of the liquidation of a company, it appears to the Court that

… a past or present director … of the company, has misapplied, or retained, or become liable or accountable for, money or property of the company, or been guilty of negligence, default, or breach of duty or trust in relation to the company, the Court may, on the application of the liquidator …,—

(a)       Inquire into the conduct of the … director …; and

(b)       Order that person—

(i)       To repay or restore the money or property or any part of it with interest at a rate the Court thinks just; or

(ii)      To contribute such sum to the assets of the company by way of compensation as the Court thinks just; or

…

[105]   As will be seen, there are two essential steps in the enquiry: has Mr Bethune breached duties, as alleged; if so, what is the sum, if any, Mr Bethune should be ordered to repay to the company, or to pay by way of compensation?  The present section of this judgment is directed to the first step.

Section 131: duty to act in good faith

Section 131: relevant legal principles

[106]   Under s 131(1) of the Act, a director of a company, when exercising powers or performing duties, must act in good faith and in what the director believes to be the best interests of the company.   This primary duty is subject to qualifications contained in subs (2) to (4) of s 131.  Mr Cogswell did not argue that they have any application and I am satisfied that they do not.

[107]   In  some  cases,  application  of  s 131(1)  will  require  careful  weighing  of evidence on the related elements of good faith and the director’s subjective belief as

to what was in the best interests of the plaintiff company.   That exercise is not necessary in this case because there are two well established specific obligations which are part of the duty under s 131(1) and which apply on the facts of this case.

[108]   The first obligation is that a director must not put his or her own interests, or the interests of a third party, ahead of the company’s interests.12      A director will not necessarily breach the duty under s 131 by causing the plaintiff company to act, or refrain from acting, in order to provide a benefit to the director, or to a third party, provided the act is one which the director believes in good faith will also be in the interests of the plaintiff company.  The word “ahead” is given emphasis in the first sentence of this paragraph to distinguish such cases.

[109]   Because the wording of s 131(1) requires that a director must act in good faith, a question may arise whether a failure to act can be a breach of the duty under s 131.13     Some of Mr Bethune’s conduct discussed below can be described as a failure to act (for example a failure by Mr Bethune to cause FAF to cancel its contract with Town Ball).  I am satisfied that s 131 should not be read so literally. Section 131 cannot exclude the possibility of breach through failure to act, particularly if the evidence establishes a failure to act combined with positive acts which, taken overall, indicate that the director has not acted in good faith in the best

interests of the company.

[110]   A leading authority is the decision of the High Court of Australia in Walker v Wimborne.14     In that case, directors of a company that was in financial difficulty caused it to lend money to two related companies which also were in financial difficulty. The directors were held to be in breach.

[111]   There are two matters of particular relevance arising from the judgment of

Mason J, with which Barwick CJ concurred.15    The first is that one of the matters taken  into  account  amounted  to  an  omission,  rather  than  a  positive  act.    That

12     Morgenstern v Jeffreys [2014] NZCA 449, (2014) 11 NZCLC 98-024 at [55]. The Court cited Peter Watts “Duty to act in the best interests of the company” in Peter Watts, Neil Campbell and Christopher Hare (eds) Company Law in New Zealand (LexisNexis, Wellington, 2011) at [13.4]. See now the 2nd edition, 2016, also at [13.4].

13     See Peter Watts in Company Law in New Zealand, above n 12, at 407–408.

14     Walker v Wimborne (1976) 137 CLR 1.

15     Jacobs J dissented.

omission  was  a failure  to  have regard  to  the needs  or interests  of the  plaintiff company.  That omission caused loss.  The second matter is that the directors were also directors of, or had some interests in, the two related companies (although the three companies were not members of a “group” as that expression is used in companies’ legislation).  In the leading judgment of Mason J there are the following

statements which have reasonably direct application on the facts of this case:16

It was not suggested that Asiatic [the company in liquidation] received any benefit   or   advantage   from   the   making   of   the   payment.   The   only consideration which it received was the implied promise to repay the money on demand. No security and no promise to pay interest was exacted from [one of the related companies]. No attention was given to these aspects of the matter, no doubt because the respondents failed to appreciate that each company was a separate legal entity and that entry into each transaction required to be examined in the light of the interests of each company participating in it.

…

Indeed, the emphasis given by the primary judge to the circumstance that the group derived a benefit from the transaction tended to obscure the fundamental principles that each of the companies was a separate and independent legal entity, and that it was the duty of the directors of Asiatic to consult its interests and its interests alone in deciding whether payments should be made to other companies. In this respect it should be emphasised that the directors of a company in discharging their duty to the company must take account of the interest of its shareholders and its creditors. Any failure by the directors to take into account the interests of creditors will have  adverse  consequences  for  the  company  as  well  as  for  them.  The creditor of a company, whether it be a member of a “group” of companies in the  accepted  sense  of  that  term or  not,  must  look  to  that  company  for payment. His interests may be prejudiced by the movement of funds between companies in the event that the companies become insolvent.

[112]   The second well established specific obligation under s 135 was adverted to in those observations of Mason J.  When a company is insolvent, near insolvency, or of  doubtful  insolvency,  or  if  solvency  would  be  jeopardised  by  a  proposed transaction, the directors have a positive duty to consider the interests of creditors.17

Section 131: assessment

[113]   The evidence establishes that Mr Bethune, as a director of FAF, did give preference to Town Ball’s interests, his own interests as a shareholder of Town Ball,

16     At 5 and 6–7.

17     Nicolson v Permakraft (NZ) Ltd [1985] 1 NZLR 242 (CA) at 250. See also Robb v Sojourner

[2007] NZCA 493, [2008] 1 NZLR 751 at [25]; Morgenstern v Jeffreys, above n 12, at [55].

and his own interests in respect of his salary, over the interests of FAF in relation to FAF’s  indebtedness.    The  evidence  also  establishes  that  Mr  Bethune  failed  to consider the interests of FAF’s creditors when FAF was insolvent.  The evidence I have relied on to come to that conclusion, as opposed to the conclusion itself, was not put in issue by Mr Bethune in any material way.  Some of the evidence came directly from Mr Bethune.

[114]   As earlier noted, the evidence establishes that Town Ball was running at a loss at least by March 2013.  I am satisfied that, by then, Mr Bethune was focused entirely on Town Ball’s operations and financial position, without any regard for what was best for FAF.  There is no evidence that Mr Bethune had given any thought to his responsibilities to FAF up to that point.  In an interview of Mr Bethune by one of the liquidators’ staff, Mr Bethune said the following:

FAF ever only existed for other [companies] – Boogie Nights and Shooters

… It was only there to pay payroll to the other companies. … this is going to

sound awful, but FAF was a front.   I never sat down and concentrated on FAF – wasn’t trading component of business.  We were getting management reports from Alan [Campbell] – didn’t show the increasing obligation to [Inland Revenue].18

[115]   Mr Bethune’s reference to the management reports from Mr Campbell do not alter  the  conclusion  that  Mr  Bethune’s  focus  was  entirely on Town  Ball.    The management reports were management reports for Town Ball.  And although there are the references to Boogie Nights and Shooters, the full context is applicable also to the whole of the period during which FAF was contracted to Town Ball.

[116]   Mr Bethune’s focus on Town Ball, and corresponding disregard of his duties as a director of FAF, did not diminish.  For the period from November 2013, when Mr Bethune claimed he first became aware of the increasing debt to Inland Revenue, Mr Bethune’s own evidence made clear that his focus was entirely on Town Ball’s difficulties.  Further evidence in this regard, and my conclusions, are recorded in the earlier sections addressing Mr Bethune’s allegation against Mr Campbell, and the related question as to when Mr Bethune was first aware that Town Ball was not

paying FAF in full.

18     Mr Bethune denied saying FAF was “a front”.   He may have used a different word, but this

makes no difference to the substance.

[117]   Mr Bethune did not cause FAF to make a demand on Town Ball for payments due when Town Ball began to default in making the required payments to enable FAF to meet its tax liabilities.  Mr Bethune in fact appeared to consider formal action by FAF against Town Ball to be absurd.  In cross-examination he said:

I don’t get how one company can require another company to do anything … I don’t think many directors would write a letter to themselves.

[118]  In the same way, notwithstanding Town Ball’s breach of its contractual obligations to FAF, Mr Bethune did not cause FAF to terminate its contract with Town Ball.  It is clear that there would not have been any adverse consequences to FAF from termination of the contract.   Mr Bethune must have known by March

2013, and possibly earlier, that Town Ball’s financial difficulties meant that it would not be able to meet all of the payments due to FAF, at least without significantly increasing Town Ball’s financial difficulties.   That knowledge of Mr Bethune was available to him as a director of FAF, and he probably should have terminated FAF’s contract with Town Ball before the first default occurred.   In any event, had FAF terminated the contract when Town Ball first defaulted, the tax liability would have been capped at a small sum.

[119]   Against this, there were obvious benefits to Town Ball in continuation of the arrangement with FAF.  Town Ball was able to continue to operate, and employ staff, but without incurring any tax liability.  The only liability it was incurring was the increasing liability to FAF, but which Town Ball knew, through Mr Bethune, was a liability which would not be enforced by FAF.

[120]   The extent to which Mr Bethune improperly preferred the interests of Town Ball over those of FAF became apparent from Mr Bethune’s own evidence of events from November 2013.  Mr Bethune acknowledged that he then knew that FAF had not paid Inland Revenue since May but, as earlier recorded, from that point nothing changed, other than an increasing liability of FAF to Inland Revenue with a corresponding benefit to Town Ball.

[121]    FAF’s only creditors were the Town Ball staff (employed in a contractual sense by FAF), Inland Revenue, and a company which provided the payroll software

to FAF.  The staff were paid.  That provided a benefit to Town Ball, but no benefit to FAF.  At the same time, FAF was incurring an increasing liability to Inland Revenue for PAYE on staff wages which FAF could not pay.  The software company also was not paid.

[122]   In addition, Mr Bethune, throughout the entire period of FAF’s operation until late 2014, caused FAF to make salary payments to himself and thereby caused FAF to incur further unpaid debt to Inland Revenue for PAYE.  In the period from 1

April  2013  to 31 August  2014,  cash  funds totalling $136,399  were paid  to  Mr

Bethune.

[123]   Mr Bethune said Town Ball could not have ceased trading before July 2014 because “personal guarantees were in place which precluded an earlier departure from the lease”.19   That was a reference to Town Ball’s lease and to guarantees given by Mr Bethune.  Neither matter was of concern to FAF from a legal perspective, or in respect of obligations of FAF.  In this regard, Mr Bethune was preferring his own interests over those of FAF.

[124]   Mr Bethune said that once Town Ball stopped operating it sold off all of its assets and the proceeds were used to pay outstanding creditors.   No part of these proceeds was used to pay, or reduce, the debt owed by Town Ball to FAF.   The creditors of Town Ball who were paid included National Bank.  The bank also had a personal guarantee from Mr Bethune.

[125]    Although Town Ball ceased operating as a bar at the end of June 2014, FAF continued to make payments for staff directly employed by Town Ball, and salary to Mr Bethune, until 25 November 2014.   Mr Bethune explained in evidence that, during this period, the site was cleared.   Again, there was no benefit to FAF, but increasing debt, in continuing to provide services during this time.

[126]   There  was  evidence  from  Mr  Bethune  about  the  consequences  of  the

Christchurch earthquakes.   The Christchurch earthquakes plainly had an adverse

19     Mr Bethune said this in his brief of evidence. He sought to resile from it in cross-examination. I

am satisfied that what he said in his brief is what he took into account at the time.

effect on the businesses of Boogie Nights and Shooters and, in consequence, on Mr Bethune’s investments in those companies.  But those matters are not relevant to the matters I need to consider in respect of Mr Bethune’s duties as a director of FAF in the period it was contracted to Town Ball.

[127]   Mr  Bethune  also  gave  evidence  of  communications  he  had  with  Inland Revenue in an endeavour to reach an agreement in relation to FAF’s liability to Inland Revenue.  That evidence is not relevant to the questions bearing on the claims against Mr Bethune for breaches of duty.   In any event, although there were negotiations, no agreement was reached with Inland Revenue.

[128]   I agree with the following summary by Ms Morrison of material benefits Mr

Bethune secured for Town Ball, and himself, at FAF’s expense:

Mr Bethune prioritised his attempts to preserve Town Ball for as long as he could.  By using FAF in the manner he did, Mr Bethune was able to “wash off” the tax liabilities associated with the staff working for Town Ball’s businesses, and thereby artificially reduce Town Ball’s operating costs.  This in turn reduced the cash burden on Mr Bethune to meet the costs of the personally guaranteed lease of Town Ball’s premises, and avoid early termination.

Town Ball was able to claim a GST refund due to its arrangement with FAF, thereby further creating extra cash for Town Ball.  FAF failed to account to Inland  Revenue  for  any  GST  from  the  period  ended  31  March  2013. However Town  Ball  would  have  claimed  a  credit  for  the  GST  liability arising from its receipt of FAF’s services.  As Mr Bethune acknowledged, this is generally how GST works.   This was a further benefit Mr Bethune obtained for himself and Town Ball at FAF’s expense.

Further, when FAF sought to recover these sums from Town Ball (after FAF was placed into liquidation), Mr Bethune denied Town Ball had to pay FAF the outstanding amounts claimed on the basis no invoice had been issued. This is notwithstanding Mr Bethune acknowledging in this proceeding that Town  Ball  owed  a  debt  to  FAF,  and  it  being  clear  from Mr  Bethune’s evidence that the transfer of funds from Town Ball was made from the figures obtained from the IMS Payroll rather than any invoice being issued. Mr Bethune’s opposition of the town Ball liquidation proceeding is either evidence of his deliberate use of FAF to avoid Town Ball having to meet the costs of the tax liabilities associated with the staff, or his obstruction of the realisation of assets by FAF’s liquidators.

[129]   For these reasons I am satisfied Mr Bethune breached his duty under s 131.

Section 135: duty not to trade recklessly

Section 135: legal principles

[130]   Section 135 of the Act provides as follows:

135     Reckless trading

A director of a company must not—

(a)       Agree to the business of the company being carried on in a manner likely to create a substantial risk of serious loss to the company's creditors; or

(b)       Cause or allow the business of the company to be carried on in a manner likely to create a substantial risk of serious loss to the company's creditors.

[131]   In Mason v Lewis the Court of Appeal said that the “essential pillars” of s 135 are as follows:20

•the duty which is imposed by s 135 is one owed by directors to the company (rather than to any particular creditors);

•         the test is an objective one;

•it focuses not on a director's belief but rather on the manner in which a company's business is carried on, and whether that modus operandi creates a substantial risk of serious loss;

•what is required when the company enters troubled financial waters is … a “sober assessment” by the directors, we would add of an ongoing character, as to the company's likely future income and prospects.

[132]   The evidence in some cases may require consideration of questions as to whether s 135 imposes a strict obligation on directors to avoid substantial risk, or whether there is some leeway for the taking of risks and, if there is some leeway, how it should be measured.21   Mr Cogswell advanced an argument that Mr Bethune was entitled, as a matter of principle, to a reasonable period of time to review the position  and  to  endeavour  to  trade  out  of  the  financial  difficulties  and,  if

unsuccessful, then to cease operations.   This argument was advanced on the basis

that  Mr  Bethune  did  not  become  aware  of  the  debt  to  Inland  Revenue  until

20     Mason v Lewis [2006] 3 NZLR 225, (2006) 9 NZCLC 264,024 (CA) at [51].

21     See Peter Watts in Company Law in New Zealand, above n 12, at [17.2.2(a)].

November 2015.   For reasons I will come to, that argument is not tenable on the facts.   No other argument was advanced which might require consideration of the principles for measuring the obligation under s 135, and I am satisfied that the facts do not give rise to any other argument.

Section 135: assessment

[133]   The reason why this case does not require consideration of points of principle of the sort just referred to is because, as Ms Morrison submitted, FAF’s simple operating structure makes the assessment a lot simpler than what has been required in many other cases that have considered s 135.

[134]   As the Court of Appeal said in Mason v Lewis, the focus is on the manner in which a company’s business is carried on.  There was no dispute in this case that FAF was intended to operate without making any profit or any loss.  Section 135 is, of course, directed to the duty to avoid a substantial risk of serious loss.   FAF, because of its modus operandi, coupled with the fact that it always had a working capital deficit, was entirely dependent on Town Ball’s meeting its contractual obligations to FAF to avoid any additional loss.

[135]   For Mr Bethune, as the sole director of FAF, an assessment, in or about March or April 2013, as to whether continuation of FAF’s business was likely to create a substantial risk of serious loss to creditors of FAF, was equally straightforward.  The “sober assessment” required at that point was not undertaken. It had to be an independent sober assessment.   An independent sober assessment required  action  on  behalf  of  FAF  against Town  Ball,  but  there  was  none.    By continuing FAF’s operations, rather than cancelling the contract with Town Ball, Mr Bethune  actually  carried  on  FAF’s  business  knowing  that  this  was  not  simply creating a substantial risk of serious loss to Inland Revenue, but in fact rapidly increasing an existing loss.

[136]   The extent of Mr Bethune’s dereliction of his duty under s 135, assessed as it must be by reference to his duty to FAF and not his assessment of what was best for Town Ball, is readily seen by recording the increasing debt to Inland Revenue:22

$

30.04.13	22,345
30.06.13	45,545
31.08.13	91,219
31.10.13	137,960
30.11.13	160,619
31.01.14	233,730
31.03.14	293,170
30.06.14	394,478
30.11.14	454,578

[137]   The debt at 30 November 2013 has been highlighted because that is the month in which Mr Bethune claimed he only first became aware of the debt.  Even if I  had  accepted  his  evidence,  that  would  not  have  assisted  Mr  Bethune  on  the question of liability under s 135 (or under s 131). At 30 November 2013 the position had gone well beyond questions of substantial risk of serious loss.   There was no remotely realistic prospect of avoiding serious loss to Inland Revenue in respect of the existing debt.  There was high probability of a rapid increase in the amount of the debt through FAF’s continuing to incur the tax liabilities for wages it was paying to staff actually working for Town Ball, and in paying a salary to Mr Bethune.

[138]   Those  considerations  are  sufficient  to  make  Mr  Bethune’s  liability clear, subject  to  consideration  of  the  argument  that  Mr  Bethune  was  entitled  to  a reasonable period of time to review the position and to endeavour to trade out of the financial difficulties.

[139]   Mr Cogswell submitted (in his opening):

If the Court accepts that Mr Bethune’s governance of FAF Holdings was appropriate and that his first actual knowledge of the insolvency of the company was November 2013, then it must follow that a reasonable period be allowed to turn the company around.

22     Schedule B to Mr Levin’s brief of evidence in reply. The figures are rounded.

[140]   He further submitted that a period of six months was a reasonable period and (in broad measure) that was the period through to Town Ball’s ceasing business operations in June 2014.

[141]   Given my conclusion that Mr Bethune was aware of the default by Town Ball in or about April 2013, the factual premise on which the argument is based is absent. It is nevertheless appropriate to consider the argument on an assumption that Mr Bethune did not have actual knowledge of the defaults until November 2013 (which leaves aside the question as to whether he should have known before then).   It is appropriate to do so given the emphasis Mr Bethune placed on this part of his defence through his evidence.

[142]   Mr Cogswell’s submission that “it must follow that a reasonable period of time be allowed” to turn a company around, appears to be based on an assumption that there is a rule to that effect.  In assessing whether directors have breached their duty under s 135, courts in some cases have concluded that it was reasonable for directors to continue trading for a period.  But that conclusion, and an assessment as to an appropriate period of continued trading, depends on application of s 135 to the particular circumstances of the case.  It is not a rule.

[143]   A strong statement pointing towards Mr Cogswell’s base position is that of

William Young J in Re South Pacific Shipping Ltd (in liq):23

No-one suggests that a company must cease trading the moment it becomes insolvent (in a balance sheet sense). Such a cessation of business may inflict serious loss on creditors and, where there is a probability of salvage, such loss can fairly be regarded as unnecessary. The cases, however, make it perfectly clear that there are limits to the extent to which directors can trade companies while they are insolvent (in the balance sheet sense to which I referred) in the hope that things will improve. In most of the cases, the time allowance has been limited, a matter of months.

[144]   On the other hand, in Fatupaito v Bates O’Regan J said:24

The important  point is that  when  a company has  negative  shareholders' funds, the decision to keep trading is a decision which necessarily involves risk for creditors (both existing creditors and those which will arise from the

23     Re South Pacific Shipping Ltd (in liq) (2004) 9 NZCLC 263,570 (HC) at [125(3)].

24     Fatupaito v Bates [2001] 3 NZLR 386 (HC) at [77].

future trading). While there may be circumstances where continued trading is justified by the prospect of collecting pre-existing debts or generating significant income from a reasonably minor expenditure (as in situations where projects are nearly completed and a small amount of work to complete them will justify payment of a full contract price), directors must be very cautious before embarking on that course.

[145]   The discussions in those two cases, as well as indicating a possible difference of approach, highlight the importance of the facts of the particular case.

[146]   In relation to matters referred to in South Pacific Shipping and Fatupaito, the facts are quite different from those in the present case.   FAF, for reasons earlier discussed, was always insolvent in a balance sheet sense.  The comments in South Pacific Shipping and Fatupaito were only directed to circumstances where the company had become insolvent on a balance sheet basis.  In FAF’s case it was also insolvent, at least by May 2013, because it could not pay its debts as they became due.

[147]   One matter that underpins consideration of  whether it was reasonable to continue trading, is an assessment whether continuation of trading might have been seen to be realistically likely to produce profit.  This is the point at which there is no proper basis to compare the facts of this case with the facts of other cases where the courts have concluded that it was reasonable for the directors to continue trading for a period.  In this case, continued trading by FAF was not capable of producing any funds to pay any debt and, given that fact, continued trading by FAF, on any realistic assessment of FAF’s circumstances, could only increase the debt.  This does not, in my judgment, involve impermissible use of hindsight.  It is directed to the way in which FAF operated.

[148]   The argument for Mr Bethune is in substance not directed to whether it was reasonable for FAF to continue trading, but whether it was reasonable for Town Ball to continue trading.  That, for reasons explained by Mason J in Walker v Wimborne, is of no avail to Mr Bethune in respect of his duties to FAF.

[149]   For these reasons I do not accept that, when Town Ball stopped paying FAF, it was reasonable for Mr Bethune, as a director of FAF, to allow FAF to continue trading.   More detailed reasons in that regard are contained in the discussion of

liability under s 131.   The conclusions there apply with greater force under s 135 given the nature of the duty under s 135.

Sections 136 and 137

[150]   Given my conclusions that Mr Bethune breached his duties under ss 131 and

135 it is not strictly necessary to consider the plaintiffs’ further claims of breach of ss 136 and 137.  I will nevertheless set out the statutory provisions and briefly record my conclusions.

[151]   Section 136 is as follows:

136      Duty in relation to obligations

A director  of  a  company  must  not  agree  to  the  company  incurring  an obligation unless the director believes at that time on reasonable grounds that the company will be able to perform the obligation when it is required to do so.

[152]   When FAF incurred each of the debts to Inland Revenue which were not paid, that obligation was incurred by FAF with Mr Bethune’s agreement as FAF’s director. Agreement on Mr Bethune’s part arose from his causing FAF to continue, month by month, to provide the service to Town Ball with the obligation of FAF to pay the taxes then arising.  For reasons now recorded at length, Mr Bethune could not have believed on reasonable grounds, at least by April 2013, that FAF would be able to pay or account for the tax to Inland Revenue when it was required to do so.

[153]   Section 137 is as follows:

137      Director’s duty of care

A director of a company, when exercising powers or performing duties as a director, must exercise the care, diligence, and skill that a reasonable director would exercise in the same circumstances taking into account, but without limitation,—

(a)       The nature of the company; and

(b)       The nature of the decision; and

(c)       The position of the director and the nature of the responsibilities undertaken by him or her.

[154]   The assessment is an objective one, based on what a reasonable director would do.   Notwithstanding Mr Cogswell’s submissions that there was no independent expert evidence for the plaintiffs as to what a reasonable director would do, in the circumstances of this case I am satisfied that Mr Bethune breached the duty under s 137.  On the facts as I have found them, Mr Bethune simply failed to give any, or any proper, attention to the interests of FAF; he did not exercise care, diligence and skill even to a low level.  He simply failed to turn his attention to FAF beyond deciding, by default, that it would continue to provide the service to Town Ball.

SECTION 301: ASSESSMENT OF QUANTUM Introduction

[155]   The quantum of two claims requires assessment: (a)    The tax claim for a sum of $538,213.

(b)      The  salary  claim,  in  respect  of  the  payments  to  Mr  Bethune,  of

$136,399.90.    That  is  the total  of the salary paid  to  Mr Bethune between 1 April 2013 and 31 August 2014.

[156] Although both claims were advanced for breach of all four of the statutory duties, the quantum of relief sought was based on different statutory provisions in s 301, as briefly noted in outlining the claims at [4] above.

[157]   The relief sought on the tax claim is expressly directed to compensation for loss, pursuant to s 301(1)(b)(ii).  The relief sought on the salary claim is for an order under s 301(1)(b)(i) that Mr Bethune restore to FAF the amount of the salary he received.

[158]   I will deal separately with the two claims, with the different measures of

“damages”.

Quantum for loss on the tax claim

Principles

[159]   In Mason v Lewis the Court of Appeal summarised the approach to a claim under s 301 for compensation for a loss as follows:25

[109]  The standard approach has been to begin by looking to the deterioration in the company's financial position between the date inadequate corporate governance became evident (really the “breach” date), and the date of liquidation.

[110]    Once that figure has been ascertained, New Zealand courts have seen three factors - causation, culpability, and the duration of the trading - as being distinctly relevant to the exercise of the Court's discretion (see Re Bennett, Keane & White Limited (in liquidation) (No 2) (1988) 4 NZCLC

64,317per Eichelbaum J; and Löwer v Traveller [2005] 3 NZLR 479, which endorsed those principles).

[160]   In Löwer v Traveller the Court of Appeal explained the elements of causation and culpability as follows:26

[79]     The element of causation is concerned with the link between the carrying on of the company's business recklessly, to the knowledge of the impugned director, and the indebtedness of the company for which it is sought  to  impose  personal  liability.  In  a  case  such  as  the  present  that involves an assessment of how much the liabilities of the company were increased because of the illegitimate delay in its ceasing to trade and the identification of a point in time when the director knew that continuing to trade would be reckless. The resulting figure however is no more than a relevant consideration for the Court although the amount of the director's liability  would  not  exceed  the  sum  identified  as  caused  by  the  known reckless trading.

…

[83]      The relevance of culpability is linked to the deterrent purpose of the provision. This factor calls for an assessment of the blameworthiness of Mr Löwer's conduct, bearing in mind that at one end of the range the nature of a director's involvement will be blind faith or muddleheadedness, while at the other end there will be actions or instances of inaction which are plainly dishonest:  Thompson  v  Innes  (1985)  2  NZCLC  99,463.  The  deterrent purpose  of  the  section  is  served  in  cases  involving  a  high  degree  of culpability by orders which are punitive as well as compensatory: Re Cyona Distributors Ltd (Supra) at p902.

25     Mason v Lewis, above n 20.

26     Löwer v Traveller [2005] 3 NZLR 479 (CA).

Quantum of loss on the tax claim: assessment

[161]   I  consider  that  a  proper  assessment  of  compensation  may  be  made  by reference to the three factors identified in Mason v Lewis, although considering them in a different order.   Assessment of those factors takes account of Mr Bethune’s evidence and the submissions advanced for him by Mr Cogswell, both in opening and in closing, to the extent that relevant submissions have not already been addressed when assessing liability.

The duration of the wrongful trading

[162]   I have concluded that FAF was insolvent from March 2013.  It continued to trade in an insolvent state, in a substantial way, for approximately 18 months through to August 2014.  Further liabilities were incurred through to November 2014. That is a long period to continue trading while insolvent.  But the measure of time is not the only consideration under this heading, and also not the most important consideration. The most important consideration, relating to duration of trading, is that all of the debt to Inland Revenue, which is now sought through the tax claim, was incurred during this period.

Causation

[163]   In my judgment there is a direct link between the breaches of the duty owed by Mr Bethune to FAF and the debt FAF now has to Inland Revenue.   This is demonstrated most clearly by Mr Bethune’s failure to terminate FAF’s contract with Town Ball.  It may be noted that Mr Bethune did not seek to argue that FAF did not have any legal right to terminate the contract.  The arguments were all directed to the question whether it was reasonable for Town Ball to continue trading.

Culpability

[164]   I consider that Mr Bethune’s culpability is high.  Although I have held that his breaches of duty occurred in and following March 2013, it is relevant when considering culpability to note that Mr Bethune chose to engage FAF in providing the services to Town Ball four months earlier.  He chose to do so when, as far as Mr

Bethune was concerned, if Town Ball failed to make payments, FAF had no separate assets available to meet the debts which would accrue.

[165]   If Mr Bethune had caused FAF to contract with a company with which Mr Bethune had no connection, that act, when FAF’s liabilities exceeded its assets, and it had no means of meeting liabilities other than the contract with the third party, would in itself have involved breaches of reasonably serious culpability.  For the reasons explained by Mason J in Walker v Wimborne, Mr Bethune’s actions as a director of FAF in contracting with Town Ball are to be assessed in the same way.

[166]   Mr Bethune sought to mitigate his culpability by referring to the steps he took, as a director of Town Ball, to try to ameliorate Town Ball’s financial predicament.  For the reasons earlier considered, that does not reduce Mr Bethune’s culpability as a director of FAF.  However, the fact that Mr Bethune had available, as a director of FAF, the knowledge that he acquired as a director of Town Ball, adds materially to his culpability as a director of FAF when assessing the continuing breaches of his duties over the period of approximately 21 months through to the order for liquidation.

[167]  The analysis of culpability at various stages tends to come back to the fundamental point that Mr Bethune’s focus was entirely on Town Ball.  He was, at best in terms of culpability, indifferent to the consequences for FAF.  This extended even to the question of termination of the contractual relationship.  I have recorded Mr Bethune’s attitude to the suggestion that, as a director of FAF, he should have made demand on Town Ball, and the fact that he did not terminate FAF’s contract with Town Ball.  The exclusive focus on Town Ball, in respect of continuation of the contract, is illustrated by Mr Bethune’s contention that he was entitled to a period of time to try to trade Town Ball out of difficulty.  That contention carried with it the necessary corollary that,  if those efforts were unsuccessful, FAF’s contract with Town Ball would be brought to an end by Town Ball’s collapse.  And that is what happened.

[168]   There are other considerations.  These are contained in the findings of fact throughout this judgment.  In terms of culpability, there was egregious conduct by

Mr Bethune in insulating Town Ball from any liability to Inland Revenue by continuing, throughout the whole of the period discussed, to have FAF incur that legal liability, while Town Ball was enjoying the benefits.   And at the end, when Town Ball ceased trading, it realised its assets and paid off almost all of its creditors, other than FAF, and relieved Mr Bethune of liabilities as a guarantor.

Overall assessment

[169]   This is not a case where the conduct of the director gives rise to reasonable arguments on both sides as to the extent to which the director’s defaults contributed to the loss.  For all of the reasons recorded in this judgment, on a range of issues, responsibility rested solely with Mr Bethune.  In my judgment it is a responsibility which requires him to compensate FAF for the total loss sustained by FAF.  Under this heading it is a loss of $538,213.28.

Quantum for loss on the salary claim

Principles

[170]   In Morgenstern v Jeffreys the Court of Appeal said:27

[99]     As this Court held in Sojourner v Robb,28    relief under s 301(1)(b) will, bearing in mind the Court's ultimate discretion,29 be calculated by examining the nature of the breach of duty and by judging the appropriate amount of compensation to be awarded based on common law and equitable principles. A breach of s 131 involves the breach of a fiduciary obligation, requiring a strict standard of causation and imposition of the fiduciary measure of damages, including on a “restitutionary” or notional account of profits  basis.30    A  company's  loss,  where  “loss”  is  in  any  event  the appropriate   measure   of   compensation,   is   calculated   based   on   the deterioration of its financial position between the date of the breach and the date of liquidation.31   The onus is on the delinquent director to prove that the loss, or part of it, would have been caused regardless of the breach.32

27     Morgenstern v Jeffreys, above n 12.

28     Sojourner v Robb, above n 17, at [53] and [58]–[59].

29     Mason v Lewis, above n 20, at [55].

30     FXHT Fund Managers Ltd (in liq) v Oberholster [2010] NZCA 197 at [28]–[30]: contrast the s 135 and s 137 duties (at [30]) and Robb v Sojourner, above n 17, at [31] and [60]. Lynne Taylor “Liquidation” in John Farrar and Susan Watson (eds) Company and Securities Law in New Zealand (2nd ed, Brookers, Wellington, 2013) 837 at [31.7.2(2)(a)].

31     Mason v Lewis, above n 20, at [109].

32     FXHT Fund Managers, above n 30, at [28].

[100]    Adopting this approach, the appropriate amount of compensation will be the company's actual loss, that is the amount required to put it back into the position it would have been in but for the transaction.

[171]   An application for leave to appeal against the Court of Appeal’s decision in Morgenstern v Jeffreys was dismissed by the Supreme Court, with the passage just cited expressly approved.33

Assessment

[172]   The substance of the plaintiffs’ claim is that Mr Bethune misapplied funds of FAF equivalent to the salary paid to him whilst FAF was insolvent.  In my opinion this part of the claim, seeking an order in respect of the salary, in addition to the order in respect of the loss represented by the total debt to Inland Revenue, is misconceived.

[173]   The  salary  actually  received  by  Mr  Bethune  was  the  net  amount  after deduction of tax.  The net amount paid to Mr Bethune by FAF was repaid to FAF by Town Ball.  FAF is not entitled to an order which would result in FAF being paid twice for the same sum.

[174]   Payment by FAF of the salary to Mr Bethune did result in FAF’s incurring liability to Inland Revenue for the tax on that salary.  But that part of the salary also cannot be the subject of an order in addition to the order already made to compensate FAF for the total of the tax debt.

[175]   This claim, as a separate item for relief, is accordingly dismissed.

The costs of liquidation

[176]   There is a claim for the costs of liquidation, including the liquidators’ fees and disbursements as actually incurred.   This claim was formally advanced as a claim for compensation under s 301(1)(b)(ii), but pleaded in terms of quantum as “a

sum yet to be determined”.

33     Morgenstern v Jeffreys [2014] NZSC 176 at [11].

[177]   The plaintiffs did not in the end provide any evidence of the sum sought for the costs of liquidation.  It appears, from submissions made on quantification, that the plaintiffs were anticipating that there would be orders for payment of the sum sought on the salary claim, or on the related party claim, or both, and that, because the totals were well in excess of the amount owing to FAF’s only external creditor, Inland Revenue, sufficient funds would be available to meet the liquidators’ costs. However, it was for the plaintiffs to provide evidence of the quantum sought on this quite separate claim.  As there was no evidence, there are no grounds for making a distinct order for payment of the costs of liquidation, assuming  an order might

otherwise have been justified.34

[178]   This claim is accordingly dismissed.

Interest

[179]   There  is  a  claim  for  interest  on  the  tax  claim;  that  is,  on  the  sum  of

$538,213.28 admitted in the liquidation.  No particulars of the claim were provided in the statement of claim and there was no evidence on this.  The plaintiffs’ closing submissions simply stated that it was a claim for the “loss to Inland Revenue”, with interest to be calculated from the date of liquidation.

[180]   The basis on which either of the plaintiffs could advance a claim on behalf of Inland Revenue was not articulated and is unclear.  The primary claim for the tax debt was not a claim on behalf of Inland Revenue but a claim against Mr Bethune, pursuant to s 301(1)(b)(ii) to contribute a sum to “the assets of the company” as the Court thinks just.   The wording of that provision is broad enough to allow for interest, but having regard to the nature of the claim in this case, being a claim by the company, an order that an additional sum by way of interest be paid for the benefit of a third party does not readily fit with other provisions of the Act.   In particular, s 301(1)(c) makes express provision for an order for interest where the claim is made by a creditor.   There is also the express provision for interest where the claim is

made under s 301(1)(b)(i) for an order that the director (or other liable person) repay

34     See the recent decision of the Court of Appeal in Shaw v Owens [2017] NZCA 315, allowing an appeal against an order for payment of all of the costs of liquidation, and expressing the need for caution in making such orders.

or restore money or property to the company.  In any event, I do not consider that in this case there should be an order that the amount of Mr Bethune’s compensation to the assets of FAF should exceed the total of the debt admitted in the liquidation. That  debt,  in  itself,  includes  a  substantial  sum  for  interest  up  to  the  date  of liquidation, together with the core debt and penalties.

[181]   The interest claim is accordingly dismissed.

THE SECOND CAUSE OF ACTION: ACCOUNTING RECORDS

[182] As recorded at [6] above, in the second cause of action the plaintiffs alleged that Mr Bethune, as FAF’s director, breached the duty under s 194 of the Act to ensure that at all times accounting records were kept for FAF which correctly recorded the transactions of the company. The mechanism for bringing a claim for breach of s194 is provided in s 300 of the Act. The compensation sought was the

amount sought for the tax claim under the first cause of action.35

[183]   At some points in this judgment I have directly or implicitly referred to the fact that FAF did not have accounting records as required by s 194.  The plaintiffs’ claim was well founded.  However, it is unnecessary to consider the claim.  It was, in substance, an alternative to the claim advanced under the first cause of action on which the plaintiffs have succeeded.

RESULT

[184]   There is judgment for the plaintiffs against the defendant on the tax claim in a sum of $538,213.28.

[185]   There is judgment for the defendant on the following claims of the plaintiffs: (a)     The related parties claim.

(b)      The salary claim.

35     There was also a pleaded claim under this cause of action for compensation for the costs of the liquidation.  Ms Morrison, in her opening submissions, recorded that that claim, as part of the second cause of action, was not pursued.

(c)       The claim for the costs of liquidation, other than the costs of and incidental to this proceeding.

(d)      The claim for interest.

[186]   Notwithstanding the defendant’s success on some of the claims, the plaintiffs are entitled to costs of and incidental to this proceeding.  In respect of those costs I make the following directions:

(a)       A memorandum for the plaintiffs in support of the claim is to be filed and served by 15 December 2017.

(b)To allow for the Christmas vacation, any memorandum in reply for the defendant is to be filed and served by 26 January 2018.

(c)       Any reply for the plaintiffs is to be filed and served by 9 February

2018.

(d)      A decision will be made on the papers.

Woodhouse J