Jordan v O'Sullivan HC WN CIV 2004-485-002611
[2008] NZHC 2322
•13 May 2008
IN THE HIGH COURT OF NEW ZEALAND WELLINGTON REGISTRY
CIV 2004-485-002611
IN THE MATTER OF CONDRENS PARKING LIMITED (IN RECEIVERSHIP AND LIQUIDATION)
BETWEEN BARRY PHILLIP JORDAN AND DAVID STUART VANCE
Plaintiffs
ANDAENEAS EDWARD O'SULLIVAN First Defendant
ANDMARK GERARD MCKINLEY Second Defendant
ANDJOHN GEORGE SWAN Third Defendant
ANDCLIFFORD JOSEPH CONDREN Fourth Defendant
ANDPARKING NEW ZEALAND LIMITED Fifth Defendant
Hearing: 13-14, 16-17, 20-21, 23-24, 27-31 August 2007
Appearances: R J Latton & C N Wilson for Plaintiffs
G Dewar, D Vincent and N Davis for First, Second, Fourth (for part of trial only) and Fifth Defendants
R Laurenson for Third and Fourth (for part of trial only) Defendants
Judgment: 13 May 2008 at 2.15pm
RESERVED JUDGMENT OF CLIFFORD J
Solicitors: Lee Salmon Long, Auckland for Plaintiffs
Thomas Dewar Sziranyi Letts, Lower Hutt, for Defendants
JORDAN AND VANCE V O'SULLIVAN AND ORS HC WN CIV 2004-485-002611 13 May 2008
Contents
Paragraph
Introduction....................................................................................................... [1] The parties and their claims ............................................................................ [6] Directors’ duties – the law.............................................................................. [33] An overview of the evidence........................................................................... [72] The facts
Background matters.................................................................................. [85] Problems with Ballance St car park......................................................... [92] Trading at Ballance St .............................................................................. [98] Condrens’ trading ................................................................................... [103] Business expansion – the Specified Leases ........................................... [104] Financial difficulties – receivership and liquidation ............................ [117] Key elements of factual narrative........................................................... [133]
Condrens’ business records and corporate governance............................ [141] Was Condrens insolvent as asserted by the plaintiffs? ............................. [160] Were the defendants responsible for reckless trading? ............................ [202] Causation ...................................................................................................... [255] Culpability ..................................................................................................... [266] Issues as regards Tington’s status as a creditor......................................... [274] Result and costs ............................................................................................. [286]
Introduction
[1] Condrens Parking Limited (“Condrens”), by then already in receivership, was placed in liquidation on 26 April 2002.
[2] The principal creditor in Condrens’ liquidation is Tington Investments
Limited (“Tington”).
[3] Tington is the developer and owner of the Reading cinema complex in central Wellington. Tington had agreed to lease a car parking building in Wakefield St, forming part of that complex, to Condrens. That lease, which was to replace an earlier lease to Condrens, was to come into force when the cinema complex opened. Condrens’ anticipated inability to meet its rental obligations to Tington under that new lease when it came into force – Condrens up until then having paid its debts as they fell due, including rent under the prior lease – was the cause of Condrens being placed in receivership.
[4] The plaintiffs bring these proceedings against the defendants under s 301 of the Companies Act 1993. As particularised during the trial, they seek orders from this Court requiring the defendants to contribute up to $2,310,812.60 to Condrens’ assets, the amount they say is owed to Condrens’ creditors in its liquidation.
[5] These proceedings have been funded by Tington, and Tington has also agreed to indemnify the liquidators against any award of costs in these proceedings. Tington is by far the largest unsecured creditor in Condrens’ liquidation. Any contribution that this Court might order the defendants to make to Condrens’ assets would, subject to the fact that the first defendant is, directly and through associated interests, also a secured creditor of Condrens, be for the principal benefit of Tington.
The parties and their claims
[6] The plaintiffs, Messrs Jordan and Vance, are the liquidators of Condrens.
[7] The first to fourth defendants, Messrs O’Sullivan, McKinley, Swan and Condren, were – at various times – the directors of Condrens. Messrs O’Sullivan, McKinley, and Condren are or were (directly or indirectly) all the shareholders of Condrens. The fifth defendant, Parking New Zealand Limited, is a company in which Mr O’Sullivan, the first defendant, is, or was at all material times, the sole shareholder and director.
[8] The plaintiffs’ statement of claim, as at the start of the trial, contained ten causes of action.
[9] The plaintiffs’ first six causes of action were against the first to fourth defendants. The plaintiffs alleged that the first to fourth defendants, in their capacity as directors of Condrens, breached duties they owed to Condrens to have regard for the interests of Condrens’ creditors.
[10] During the trial the plaintiffs reached a settlement with Mr Swan, the third defendant. The plaintiffs discontinued their claim against Mr Swan, with no issues as to costs. Mr Laurenson, who until that point had represented Mr Swan and Mr Condren, continued to represent Mr Condren. Mr Laurenson, on instructions from Mr Condren, subsequently applied for leave to withdraw. Mr Condren’s intention was to retain Mr Dewar. I granted that application on Mr Dewar’s indication he would advise Mr Condren to re-engage Mr Laurenson if he subsequently determined he was not in a position to continue to represent Mr Condren as well as Messrs O’Sullivan and McKinley.
[11] The plaintiffs’ seventh to tenth causes of action were against the fifth and the first defendants, and alleged a transfer of assets of Condrens, procured by Mr O’Sullivan, to the fifth defendant Parking New Zealand at an undervalue. In opening the case for the plaintiffs, Mr Latton advised that the plaintiffs were not proceeding with those claims. Those claims were therefore effectively discontinued, questions of costs being reserved. Notwithstanding that discontinuance, at several points I understood Mr Latton to suggest, albeit somewhat indirectly, that Mr O’Sullivan may have benefited improperly from that transaction, or may have acted improperly in that he supported Condrens’ payment of rent to one of its lessors, who
may have owed money to another entity with which Mr O’Sullivan was associated, but not to Tington. I later understood Mr Latton explicitly to disown any such suggestions, and I have proceeded accordingly.
[12] As a result of those matters, therefore, the trial concerned the plaintiffs’ first to sixth causes of action (together “the causes of action “) against the first, second and fourth defendants (together “the defendants”).
[13] The plaintiffs brought their case under s 301 of the Companies Act 1993. Section 301, as relevant, provides as follows:
If, in the course of the liquidation of a company, it appears to the Court that
… a past or present director … has … 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 ⎯
…
(ii) To contribute such sum to the assets of the company by way of compensation as the Court thinks just; …
[14] Section 301 provides a procedure for a liquidator, in effect on behalf of the creditors of a company, to pursue directors for breaches of their duties to the company. The section does not, of itself, create or impose any such duties.
[15] In bringing this action, the basic legal proposition on which the plaintiffs rely is that where a company is, or is near to being, insolvent, the duties that the directors owe to that company require them to consider the interests of the company’s creditors.
[16] The liquidators claim that the defendants breached duties they owed to consider the interests of Condrens creditors as regards two aspects of Condrens’ business.
[17] The first relates to certain advances made by Condrens to a related company, Carparks International Ltd (“CPI”), to fund CPI’s losses (“the CPI Advances”). Messrs O’Sullivan, McKinley and Condren are or were (directly or indirectly) all the
shareholders of CPI also. The liquidators say the CPI Advances, which were shown in Condrens’ accounts as assets at face value, were in fact irrecoverable. Without those assets Condrens had negative shareholders funds. It was balance sheet insolvent.
[18] The second relates to the defendants causing or allowing Condrens to enter into, or assume liability under, long-term leases of three car parking buildings, in Albert St, Auckland, Wakefield St, Wellington (the Reading Cinema complex) and Tory St, Wellington (separately “the Albert St, Wakefield St and Tory St Leases” and, together, “the Specified Leases”). The defendants, it is claimed, having regard to Condrens’ financial position, were at the time of those actions required to act with particular regard to the interest of creditors, and with heightened caution. In breach of those requirements, the directors failed to assess properly, or provide for, the risks associated with Condrens entering into the Specified Leases – those risks essentially relating to Condrens obtaining sufficient car parking revenue to meet lease outgoings and associated overheads.
[19] In asserting a legal duty to consider creditors’ interests, on which the defendants’ liability was founded, Mr Latton relied particularly on Condrens’ failure to satisfy the second limb of the solvency test found in s 4 of the Companies Act. In his closing, he did so in the following terms:
a) On the plain words of s 4(1), a company cannot pass the solvency test if it fails one or other of the two limbs. That makes it clear that failure to pass either limb means that the company is in a state of doubtful solvency. In other words, if either of these limbs is not satisfied or is near to not being satisfied, the obligation to consider the interests of creditors is triggered.
b)It is clear that until shortly before it went into liquidation, Condrens Parking was paying its debts as and when they fell due. Therefore, Condrens passed the first limb of the solvency test.
c) What is relevant, then, is whether Condrens Parking also satisfied the second limb of the solvency test: whether its assets exceeded its liabilities during that period.
d)As Condrens, by reference to balance sheet considerations and the true value of the CPI Advances, was either insolvent or nearly insolvent at all material times, the defendants’ duties to Condrens required a consideration of the interests of its creditors, which duties the defendants had failed to discharge.
[20] As regards the CPI Advances, the plaintiffs’ allegations were that the defendants engaged in reckless trading (s 135), acted in breach of their general duty of good faith and fidelity (s 131) and breached their duty of care (s 137).
[21] As regards the Specified Leases the plaintiffs’ allegations were that the defendants (again) engaged in reckless trading (s 135), breached their duty in respect of incurring obligations (s 136) and (again) breached their general duty of care (s
137).
[22] Although the plaintiffs allege breach of duties under each of ss 131, 135, 136 and 137, Mr Latton suggested that as regards the claim with respect to the Specified Leases, the case was perhaps best considered in terms of s 136. Section 136, as relevant, provides:
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.
[23] The essential thrust of the plaintiffs’ allegations as regards the Specified Leases was that the defendants agreed to Condrens assuming the obligations constituted by the Specified Leases when they did not believe on reasonable grounds that Condrens would be able to meet the outgoings on those leases when required. I do not think it was suggested that the defendants did not have a belief, and an honest one, as to that matter. The challenge was as to the reasonableness of the grounds on
which they based that belief, by reference to Condrens’ alleged balance sheet insolvency.
[24] In a similar vein, I consider that the decision as regards the CPI Advances is best understood in terms of s 135. That section provides:
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.
[25] The plaintiffs’ allegation, as regards the CPI Advances, was essentially that, by reference to the directors having made, continued and not recovered the CPI Advances, Condrens’ business was carried on in a manner likely to create a substantial risk of serious loss to its creditors. Funds were diverted from Condrens itself, and – when paid to CPI – were not likely ever to be recovered. Condrens’ creditors were put at substantial risk of serious loss accordingly .
[26] By way of relief, the liquidators sought declarations that the defendants had breached their duties to Condrens and that:
a) In respect of the first to third causes of action, the defendants – or any of them – contribute $588,681.00 (the amount of the CPI Advances at the date of Condrens’ liquidation) to Condrens assets.
b)In respect of the fourth to sixth causes of action, the defendants – or any of them – contribute $2,310,812.60 (the total sum owing to creditors in liquidation, including $515,000.00 owing to the first defendant and/or interests associated with him as secured creditors but in respect of which no proof has been filed).
[27] As is apparent, the claim for contribution as regards the first to third causes of action is, in terms of the overall amount claimed, duplicated by the claim as regards the fourth to sixth causes of action.
[28] When the amount owed to the secured creditors is excluded, the total owing in the liquidation was said to be $1,795,812.60, comprising:
a) Inland Revenue $43,430.00;
b)Tington $1,694,702.60 (as recalculated during the trial); and
c) Other unsecured claims $57,680.00.
[29] As is obvious, the great bulk of the amount claimed is said to be owed to
Tington.
[30] Interest and costs were also sought.
[31] The defendants’ response to the liquidators’ claims was, very much in summary, that:
a) Condrens was not insolvent, or of sufficiently doubtful solvency, at any relevant time so as to give rise to circumstances in which, in performing their duties to Condrens, the defendants were required to have regard to the interests of its creditors. Accordingly duties to creditors did not arise.
b)Furthermore, the defendants at all times discharged their duties as directors of Condrens. They did not, to use the general phrase, cause Condrens to trade recklessly, or breach any other of the duties they owed to the company. Rather, they made reasoned and balanced business decisions supported by proper decision making processes. The defendants had been mindful of the need at relevant times to provide further funding to Condrens, whether as capital or debt, and had provided such funding. In that way they had positively assured Condrens’ on-going solvency. Condrens had, in fact, paid all its trade creditors in full prior to being placed in liquidation.
c) These proceedings were, therefore, fundamentally misconceived.
[32] The defendants made a number of other assertions as regards flaws in the plaintiffs’ case, including:
a) That the liquidators had acted improperly in the conduct of these proceedings by reference to:
i) The discrepant amounts claimed by the liquidators over time:
initially, in excess of $11,000,000.00; at the start of the trial
$4,031,011.67; reduced to $2,384,388.00 as finally pleaded;
and further reduced to $2,310,812.60 by the close of the trial.
ii)The failure of the liquidators to properly satisfy themselves, and therefore be in a position to prove in these proceedings, the amounts actually owed to certain of Condrens’ claimed unsecured creditors.
b)That the losses claimed by Tington were not, in law, debts provable in a liquidation or able to be recovered pursuant to s 301.
c) That the Wakefield St Lease was not in force or able to be sued on, as a pre-existing lease the termination of which was a condition precedent, of necessity, to that lease coming into existence had not at the point of the receivership been terminated.
Directors’ duties – the law
[33] In this case, I think it is helpful to record my general understanding of the relevant legal principles at the outset.
[34] The basic legal principle articulated by the plaintiffs, that is, where a company is, or is near to being, insolvent, the duties that directors owe to the company require them to consider the interests of the company’s creditors, has a
well-known pedigree. It was first articulated in obiter dicta by Cooke J, as he then was, in Nicholson v Permakraft (NZ) Ltd [1985] 1 NZLR 242.
[35] More recently, this principle was referred to in the following terms by the Court of Appeal in its decision in Robb v Sojourner [2008] 1 NZLR 751, in a decision released after I had heard this case, at [25]:
Whatever the commercial prospects of Aeromarine 1 prior to restructuring, it was certainly insolvent immediately afterwards. It was common ground before us that the obligations of Mr and Mrs Robb to the company extended to a requirement to take into account the interests of the creditors (compare Nicholson v Permakraft (NZ) Ltd [1985] 1 NZLR 242 (CA)). Further, and importantly, their assent to the restructuring as shareholders (which is at least implicit in what happened) does not justify their actions as directors. On this point we refer to the views expressed by Cumming-Bruce and Templeman LJJ in Re Horsley & Weight Ltd [1982] Ch 442 (CA) at pp 454 and 455 and adopted by Cooke J in Permakraft at p 250. As Gummow J put it in Re New World Alliance Pty Ltd (1994) 51 FCR 425 at 444-445:
“It is clear that the duty to take into account the interests of creditors is merely a restriction on the right of shareholders to ratify breaches of the duty owed to the company. The restriction is similar to that found in cases involving fraud on the minority. Where a company is insolvent or nearing insolvency, the creditors are to be seen as having a direct interest in the company and that interest cannot be overridden by the shareholders. This restriction does not, in the absence of any conferral of such a right by statute, confer upon creditors any general law right against former directors of the company to recover losses suffered by those creditors … the result is that there is a duty of imperfect obligation owed to creditors, one which the creditors cannot enforce save to the extent that the company acts on its own motion or through a liquidator.”
To the same effect is the judgment of the New South Wales Court of Appeal in Kinsela v Russell Kinsela Pty Ltd (in liq) (1986) 4 NSWLR 722 at p 730, which in turn has been followed and applied by the English Court of Appeal in West Mercia Safetywear Ltd (in liq) v Dodd [1988] BCLC 250 at p 252.
[36] What is less clear, in my judgment, is the relationship between that general principle, the specific duties of directors now provided by ss 131, 135, 136 and 137 of the Companies Act as relied on in this case, and the recognition that one purpose of the limited liability company is to allow for the taking of business risks.
[37] These issues have been commented on, particularly as they relate to ss 135 and 136, in a number of cases, and by a range of commentators.
[38] Turning first to the relevant legal principles in respect of s 135, William Young J, as he then was, provides a useful summary of the state of the debate as it stood in 2004 and following in his High Court decision Re South Pacific Shipping Limited (in liq); Traveller v Löwer (2004) 9 NZCLC 263,570 at [113].
[39] Referring to a number of earlier decisions, William Young J built on and developed a distinction between the taking of legitimate and illegitimate business risks. Pursuant to that distinction, behaviour in respect of which a director would be held personally liable, pursuant to an inquiry conducted under s 301 as regards s 135, could be characterised as behaviour that involved the taking of illegitimate business risks.
[40] In reaching that conclusion, which he expressed (at [130]) as a provisional view, William Young J was mindful that in using the words “substantial risk of serious loss” in s 135 the legislature might be thought to have adopted the approach taken by Bisson J in Thompson v Innes (1985) 2 NZCLC 99,463 to the concept of reckless trading, namely:
Was there something in the financial position of this company which would have drawn the attention of an ordinary prudent director to the real possibility not so slight as to be a negligible risk, that his continuing to carry on the business of the business of the company would cause the kind of serious loss to creditors of the company that s 320(1)(b) was intended to prevent?
[41] Reflecting on that issue, he first expressed the following view at [120]:
Despite the judicial and legislative approval of the language in question, it is perfectly clear that the italicised passage cannot sensibly be regarded as expressing the whole test for determining whether trading is reckless for the purposes of s 320(1)(b) of the Companies Act 1955. Risk is implicit in business and the chance of business failure is seldom “so slight as to be a negligible risk”. Business failure is likely to cause serious loss to the creditors. It is unlikely therefore that Bisson J was intending to suggest that directors would necessarily be liable under s 320(1)(b) in any case where there had been more than a negligible risk of business failure which, if it crystallised, would cause serious loss to creditors.
[42] He then referred to a number of commentators who had developed a distinction between the taking of legitimate and illegitimate business risks, before concluding (at [123]) that he was of the view that it was only the taking of
illegitimate business risks that warranted a finding of reckless trading. He found support for that conclusion in several s 320 cases, including Thompson v Innes itself and the decision of Eichelbaum J in Re Bennett, Keane and White Ltd (in liq) (No 2) (1988) 4 NZCLC 64,317 at 64,333.
[43] At [127] and [128] of his judgment, he considered the relevance of this distinction to s 135. Concluding on the point, he noted at [129] and [130]:
Something of a divide has now opened up between those who believe that the section can be construed so as to make a distinction between legitimate and illegitimate risk taking activity and those who feel compelled to construe it in a literal manner. In the former camp is Tomkins J in the article to which I have referred. In the latter camp is O’Regan J, see Fatupaito v Bates (2001) 9 NZCLC 262,583; [2001] 3 NZLR 386.
… I am provisionally of the view that the approach of Tomkins J should be adopted as it otherwise is impossible to apply the section in a sensible way. It is fair to say, however, that it is clear that liability under s 135 must be at least as broad as liability under s 320(1)(b).
[44] I respectfully support that conclusion.
[45] Speaking in general terms, but in my view ones which fairly capture the type of behaviour to which s 135 is, as was s 320(1)(b), aimed, William Young J characterised the conduct of the liable director in Re South Pacific in the following terms at [151]:
His behaviour departed so markedly from orthodox business practice and involved such extensive and unusual risks to the creditors that it can fairly be stigmatised as reckless.
[46] At an earlier point, he had commented as follows at [126]:
In all of this it is important to remember that s 320(1)(b) penalises trading which is “reckless”. Reference as to what reasonable directors would have done or foreseen can easily lead to a process of thinking in which liability is imposed for negligence and not recklessness. At the end of any enquiry in relation to s 320(1)(b) the Judge must still square up to the issue whether the conduct complained of can fairly be regarded as reckless.
[47] In that case, William Young J had found that the company had been insolvent for some time, and that the director was motivated in his decisions by various collateral benefits accruing to him. He had an incentive to cause the company to
keep trading, despite the risks to trade creditors in doing so. In holding the director liable, William Young J also referred to what he described as the “lamentable” governance of the company in question for which that director had been responsible. The director ought to have been prepared to put his own money up by capitalising the company to an extent that was appropriate, given the risks he was taking with creditors’ money.
[48] This distinction between the taking of illegitimate and legitimate risk was adopted on appeal in Löwer v Traveller [2005] 3 NZLR 479. That the Court of Appeal did so is, in my view, reflected in the following passage at [22]:
The Judge concluded that Mr Löwer’s situation was covered by s 320 of the Companies Act 1955 which was aimed at those who took illegitimate business risks which warranted a finding of reckless trading.
[49] This approach has been developed further by the Court of Appeal in Mason v Lewis [2006] 3 NZLR 225. In discussing s 135, the Court first noted the criticisms which the provision had attracted. The Court referred in particular to comments that s 135 may give rise to a virtual warranty of solvency, and that it had the potential to operate particularly harshly due to its application before insolvency. Furthermore, the Court of Appeal referred to the view expressed by several commentators that the test more closely resembled one of negligence rather than recklessness.
[50] The Court of Appeal indicated however that the Courts had been alive to those concerns. In that regard, the Court of Appeal (at [47]) referred first to Nippon Express (NZ) v Woodward (1998) 8 NZCLC 261,765 where Anderson J drew a distinction between “mere risk” and “substantial risk of serious loss” (at 261,773).
[51] The Court then (at [49]) referred to the distinction it and other Courts had drawn between the taking of legitimate and illegitimate risks, noting that leave had been given to appeal its decision in Löwer v Traveller to the Supreme Court in [2005] NZSC 79. That appeal has now, I understand, been formally abandoned.
[52] Finally (at [50]) the Court noted that “in addition to the risk being a substantial and illegitimate one, the weight of authority is that in deciding whether particular conduct is inappropriate under s 135, New Zealand Courts will take an
objective approach”, referring in that context to the decision of O’Regan J in
Fatupaito v Bates [2001] 3 NZLR 386.
[53] The Court of Appeal concluded (at [51]) that the “essential pillars” of s 135 were as follows:
• 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, … of an ongoing character, as to the company’s likely future income and prospects.
[54] Turning to s 136, I note that there directors have a duty not to agree to the company incurring an obligation unless they believe on reasonable grounds that the company will be able to meet that obligation.
[55] Section 136 therefore entails a mixed, objective-subjective approach. The director will breach the duty unless he or she subjectively believes, at the time the obligation was entered into, that the company will be able to meet the obligation incurred when it is required to do so. That subjective belief must, however, be based on objectively reasonable grounds (see, for example, PC Company Ltd v Sanderson HC HAM CP18/00 1 November 2001).
[56] The need for the director’s belief to be based on objectively reasonable grounds means the director must have sufficient knowledge of the company’s position and ability to meet the obligation so as to give rise to reasonable grounds. It is implicit that the director must take sufficient steps to obtain this knowledge – claiming ignorance will not be a defence.
[57] In Re Hilltop Group Limited (in liq); Lawrence v Jacobson (2001) 9 NZCLC
262,477, a case under s 190 of the Companies Act 1955 (inserted by the Companies
Amendment Act 1993 and having the same effect as s 136), Potter J said that the test
is that of the “reasonable prudent director” faced with the circumstances of the company.
[58] Where the ability to meet the obligation is dependent on anticipated income, the reasonableness of expecting this income to eventuate is highly relevant. In Re Wait Investments Ltd (in Liquidation) [1997] 3 NZLR 96 for example, Barker J concluded (at 103) that the directors were in breach of s 320(1)(a) in circumstances where their expectation that the company would be able to raise finance and thus pay the debt in question was “unduly optimistic and without proper foundation”.
[59] Section 136 does not appear to require that the company’s ability to meet the obligation arises from the company’s separate resources, as long as the director believes on reasonable grounds that the company will be able to do so. Therefore, it would appear that a director who believes, on reasonable grounds, that the obligation will be met by means of shareholder or director contributions will not breach the duty. That s 136 will not be breached if director contributions are reasonably anticipated is implicit in the judgment of Paterson J in Ocean Boulevard Properties Ltd v Everest (2000) 8 NZCLC 262,289. In concluding that s 136 had been breached, Paterson J noted at [10] that “[i]t must be inferred that the directors did not have the intention or the capacity to contribute funds for the conduct of a business”.
[60] Under s 136, the required belief is that at the time the obligation is incurred
(Ocean Boulevard Properties (at [11]); Fatupaito v Bates (at 404)).
[61] In terms of the relationship between s 135 and s 136, it has been noted (see, for example, Goatlands Ltd (in liq) & Ors v Borrell & Anor (2007) 23 NZTC 21,107 at [113]), that s 136 may be the more apposite section where the challenged conduct relates to the incurring of specific liabilities, rather than a course of conduct over an extended period of time.
[62] On the basis of this authority, and on the basis that the plaintiffs allege reckless trading (i.e. a breach of s 135) as regards the CPI Advances, and reckless trading and improper incurring of obligations (i.e. breaches of both ss 135 and 136) as regards the Specified Leases, in my view the common enquiry is whether, as
regards those two aspects of Condrens’ business, the directors engaged in illegitimate trading, that is, in the taking of illegitimate risks.
[63] It would, in my view, be surprising in these circumstances if a director’s behaviour was to be assessed against a materially different standard depending on whether a particular obligation was incurred as part of a continuing series of transactions, or whether it was incurred as part of a stand-alone transaction. Both situations can properly, in my judgment, be assessed according to whether the decisions taken by the defendants evidenced the taking of a “legitimate” or “illegitimate” risk, with that question being assessed on the basis of the type of consideration outlined by the Court of Appeal in Mason v Lewis.
[64] That approach is not to disregard the distinct tests provided by ss 135 and
136, nor that in cases where a breach of both s 135 and s 136 have occurred the Courts have outlined the different requirements under each section and have conducted a separate inquiry into whether each of the sections has ultimately been breached.
[65] In Re BM & CB Jackson Ltd (in liq); Benchmark Building Supplies Ltd v Jackson (2001) 9 NZCLC 262,612, Wild J began his discussion of whether the directors were in breach of their duties by outlining the requirements under the then relevant sections (s 189 and s 190). He noted at [262] and [621]:
[a] Under s 189 the test is: was there something in the Company’s financial position which would have alerted an ordinarily prudent director to the real possibility that continuing to carry on the Company’s business would cause
… serious loss to the Company’s creditors…
…[b] In terms of s 190 … [t]he inquiry will be: would a reasonable director(s) of this Company in these circumstances have believed the Company could pay the debts it was incurring…
[66] What is to be acknowledged, however, is that there have been numbers of cases, involving significant transactions, where the conduct challenged was found to breach both of the sections, or their s 320 or ss 189 and 190 predecessors. In the case of Re Wait Investments Ltd (in liquidation), for example, a closely held company entered into a substantial sale and purchase agreement. The company had no assets or capital and even the deposit was borrowed. The agreement was
unconditional and was not subject to finance. Barker J first considered s 320(1)(a) (at 103) and held that “[t]here was just no objective ground for their believing that the finance would be obtained”, and that “no reasonable director … would have entered into such a large transaction unconditionally without having finance organised”. The Judge then went on to conclude that the directors’ actions also met the requirements of s 320(1)(b). Applying Bisson J’s test from Thompson v Innes the Judge held that (at 103):
the ordinary prudent director of a company with virtually no capital, managed by a person operating under an insolvency proposal, a company with no assets and with no firm financing arrangements to buy a building for
$1.635m, would have foreseen it as a real possibility that entering into the unconditional agreement could cause a serious loss to at least one of the
creditors of the company, namely the vendor.
[67] In Goatlands Ltd v Borrell the directors were also found to be in breach of both s 135 and s 136. In that case, Lang J stated at [46] the test for determining whether a director’s decision to enter a specific transaction was in breach of s 135 as follows:
If, as in the present case, the directors are considering whether the company should enter into a single transaction that has the potential to cause its complete demise, they must reach their decision after a “sober assessment” of the level of risk that the transaction entailed for the company and its creditors.
In my view, this is essentially a re-statement of the illegitimate risk test, and is equally applicable to the s 136 enquiry.
[68] I consider that the asserted breaches of s 131 and s 137 are also to be considered in a similar light, given the way the plaintiffs argued this case. That is, the actions which were said to evidence a breach of duty under ss 135 and 136 were, at the same time and for the same reasons, seen as breaching s 131 or, as the case may be, s 137. There was, furthermore, no allegation – such as there was in Sojourner v Robb [2006] 3 NZLR 808 – of self-dealing by the directors so as to provide a distinct basis for an action under s 137, as opposed to ss 135 and 136. On that basis, I consider the essential inquiry in this case to be whether the defendants were responsible for reckless trading.
[69] Taken overall, perhaps what can now be said is that, particularly in terms of the statutory expression of directors’ duties found in ss 135 and 136, directors owe duties to a company, that would appear to be designed, in the overall scheme of the Companies Act, to protect, at least to a certain extent, the position of the creditors of the company at all times. Whether or not, at a particular point in time, the directors are likely to breach those duties will, fairly obviously, depend on the financial position of the company. Where a company is in a strong financial position, adequately capitalised and making sustainable profits, it is most unlikely the directors will be engaging in a course of action (s 135), or incurring specific obligations (s 136), that involve the taking of illegitimate risks. They will, therefore, in all likelihood be meeting the duties they owe to the company which are designed to protect the interests of its creditors. If, however, the financial position of the company deteriorates significantly so that the position of the creditors becomes significantly more risky, the directors may, again by reason of the duties the Act provides they owe to the company, need to pay more attention to the position of the creditors. That need becomes most pressing where a company is insolvent, or near to insolvency, and the directors have the difficult decision to make as to whether to cease trading or, on a rational and reasoned basis having appropriate regard to the interests of creditors, continue trading with a view to returning the company to a sound financial position.
[70] Where a breach of duty is established, in a case brought under s 301, the question then becomes whether, and to what extent, the directors should be required to contribute to the assets of the company. In Mason v Lewis at [109] and [120], the Court of Appeal described the approach to be taken in the following terms:
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.
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 Ltd (in liq) (No 2) (1988) 4 NZCLC 64,317 per Eichelbaum J; and Löwer v Traveller, which endorsed those principles).
[71] I note that the Court in Mason v Lewis at [55] counselled against a conflation of the two inquiries called for (i.e. whether there is a breach of duty and the s 301 determination).
[72] I approach this case on the basis of the general principles I have set out above.
Overview of evidence
[73] Mr Jordan, one of the plaintiff liquidators, gave evidence as to what he considered to be the unsatisfactory state of Condrens’ financial and management record keeping systems, and of his view of the status of the CPI Advances as being essentially irrecoverable. He was of the view, therefore, that Condrens had negative working capital throughout the entire period from 1998 to 2002. He also gave evidence of the circumstances in which the Specified Leases were entered into and his view of the risk analysis (which was in his opinion inadequate) undertaken by the defendants prior to making the decisions to enter into those leases.
[74] Mr Jameson was appointed General Manager of Condrens in February 2001. He continued to be associated with the company until the time it was put into receivership and liquidation. Mr Jameson provided evidence as to Condrens’ financial and management systems. Mr Jameson was – in his evidence-in-chief – generally critical of those systems, and of the financial records they generated. He modified that view significantly in cross-examination.
[75] Mr Abel Pattinson, a commercial leasing agent, gave evidence of the circumstances relating to the entry of the Wakefield St Lease, and the subsequent re- leasing of those premises by Tington after Condrens was put into receivership.
[76] Mr Marsh, a vice president of Reading International, and the representative of
Tington who dealt with Condrens, gave evidence relating to the Wakefield St Lease.
[77] Mr Owen Gibson, an auditor who had investigated circumstances relating to the Wakefield St Lease in January 2002, also gave evidence as to the accounting and operational systems of Condrens.
[78] Expert evidence was given for the plaintiffs by Mr Basil Logan, a professional director, with respect to the adequacy of the defendants’ decision- making processes, and by Mr Graham, a receiver and a liquidator, as to Condrens’ solvency at relevant times. Mr Logan was critical of the defendants’ decision- making processes, and of the substantive content of their analysis. Mr Graham’s evidence was that Condrens was balance-sheet insolvent at relevant times, by reference to the impaired character of the CPI Advances.
[79] Reply evidence was provided by Mr Beltecky, the managing director of Care Parking New Zealand Ltd (“Care Parking”). Care Parking leased the Wakefield St premises from Tington at the time that, or very soon after, Condrens was put into receivership. Care Parking subsequently acquired Condrens’ Wellington business from its receivers. Mr Beltecky commented on aspects of the car parking business, as opposed to a property development business. He outlined what he considered to be the analysis appropriate to assess the viability of a particular car parking property and the type of financial controls Care Parking undertook, relative to those said to have been undertaken by Condrens. On the basis that Mr Beltecky was not an expert witness, Mr Dewar objected to that opinion evidence. Mr Beltecky also confirmed the rental payments made by Care Parking to Tington.
[80] Mr Swan, the third defendant, provided evidence for the plaintiffs following their discontinuance against him.
[81] For the defendants, Messrs McKinley and O’Sullivan were the principal witnesses as to the affairs of Condrens and the defendants’ decision making processes. Their evidence covered events relating both to the CPI Advances and the Specified Leases, and more generally to the conduct of Condrens’ business throughout the relevant period.
[82] Mr Boyer and Mr Berry, respectively Condrens’ legal adviser and accountant, both provided evidence. Mr Boyer’s evidence principally related to the financial difficulties Condrens faced in 2001, and the steps the directors took, in response to these difficulties, with a view to restructuring Condrens. Mr Berry, Mr O’Sullivan’s brother-in-law, gave more general evidence as regards the company’s financial and management systems, the advice he had provided to the defendants over time and his perspective of relevant events.
[83] Mr Sheppard, appointed as receiver of Condrens in March 2002, gave evidence as regards attempts by Condrens, and particularly Mr O’Sullivan, to renegotiate the Wakefield St Lease.
[84] Mr Baxter, an Auckland property investor, described his dealings with Mr McKinley with respect to the Albert St Lease, and events in Auckland that affected the car park located at Albert St.
[85] For the defendants, expert evidence was provided by Mr Downey on accounting and corporate governance matters. Mr Wheeler also provided evidence on corporate governance matters. Mr Downey’s evidence addressed both the question of Condrens’ solvency, and the defendants’ decision making as regards the CPI Advances and the Specified Leases. Mr Downey did not assess Condrens as being balance sheet insolvent. The CPI Advances were, at least, a long term investment and, as such, had a positive value. Both Mr Downey and Mr Wheeler considered that the defendants had made appropriate business decisions at all times, and had paid appropriate attention to corporate governance matters.
The facts
Background matters
[86] Condrens’ car parking business was established by the fourth defendant, Mr Condren. Up until December 1996 he ran that business through two companies he owned and controlled, Condrens and CPI. That business was essentially a simple
one. Car parking sites – often vacant development sites but also a small number of car parking buildings – were occupied under management or leasing arrangements. These arrangements were generally short term. As a manager, the business collected car parking revenues as agent for property owners, and deducted its costs and a commission. As a tenant, the business paid rent to the property owners, and derived revenue from short or long term car park use agreements.
[87] CPI was the principal operating company, and entered into most of the lease and management arrangements. Condrens would appear to have been a management company, with few – if any – assets of its own. Condrens had been incorporated with a capital of $100.00, comprising 100 shares of $1.00 each. CPI’s capital comprised 40,000 $1.00 shares. Condrens and CPI were effectively run by Mr Condren as one business.
[88] By 1996 CPI had interests in approximately twenty eight car parking sites in
Wellington. One site, Ballance St, was occupied pursuant to a ten-year lease.
[89] In late 1996 the first and second defendants, Messrs O’Sullivan and McKinley, who already knew Mr Condren, were told by him that he was looking for other investors in his business. Messrs O’Sullivan and McKinley were property valuers who had been friends and work colleagues since 1972.
[90] Mr Condren provided information about his business to Messrs O’Sullivan and McKinley. He gave them a schedule of parking sites and accounts to the end of March 1996, and a valuation of his business. Messrs O’Sullivan and McKinley reviewed the information provided by Mr Condren, and assessed various aspects of the business, including:
a) The location of the car parking sites, and those of the business’
principal competitor Wilsons Carparking Limited (“Wilsons”).
b)The terms upon which Condrens occupied its sites, estimated car park occupancy levels and associated revenues.
c) The potential for Condrens to improve its profitability over time.
[91] They reasoned that the number of car parking spaces available in central Wellington would decrease. The City Council had a policy of restricting the construction of new parking buildings. At the same time, vacant sites used for car parking were being redeveloped. Their plan was to bring the property skills, knowledge and contacts they had acquired as valuers to the management and development of the Condrens’ business.
[92] They concluded the business was trading profitably, that there was potential to add value, but that the business was not worth the $500,000 to $700,000 that Mr Condren had spoken of. On 20 December 1996 they each purchased a 25% shareholding in Condrens and CPI for a combined total of $100,000. They also became directors of both companies at that time. The purchase price reflected their view that, at that time, the combined Condrens’ business was worth around
$200,000.
Problems with Ballance Street carpark
[93] Shortly after he and Mr O’Sullivan completed their investment in Condrens and CPI, difficulties with the ten-year lease of the car parking building in Ballance St were drawn to Mr McKinley’s attention. These difficulties involved the rent review provisions of that lease. Those provisions enabled Wilsons to, in effect, dictate the Ballance St rent reviews. At the same time Mr McKinley became aware that Ballance St was not trading profitably, contrary to what Mr Condren would have appeared to have told Mr O’Sullivan and him.
[94] In response to this unwelcome information, Mr O’Sullivan and Mr McKinley sought various ways out of their investment. They discussed the possibility of a sale to Wilsons. This caused a level of conflict with Mr Condren. No such transaction, however, eventuated. In Mr McKinley’s words:
We decided to make the best of a bad bargain. Selling out was not an option and until Ballance St was turned around, it was unlikely that the company could be sold to other investors [brief, para 35].
[95] As a first step, sometime later in 1997 the business was restructured. All of the lease and management arrangements comprising the car parking business were, with the exception of the Ballance St Lease, transferred, on what were described as arms’ length terms, from CPI to Condrens for no consideration.
[96] Isolating that lease in CPI would – at least in theory – allow Condrens to leave the Ballance St site to fail on its own, without affecting the rest of the business. More significantly, however, given the defendants’ and Mr Berry’s view of the adverse effect that allowing CPI to default on the Ballance St lease would have had on the goodwill of the Condrens’ name, and therefore its business, the separation was seen by the defendants as giving the defendants some leverage in their negotiations with Guardian Trust, the Ballance St lessor.
[97] Following that transaction Condrens embarked on a process, including the making of the CPI Advances, designed to restore the Ballance St site to profitability. At the same time, Messrs O’Sullivan and McKinley went about reorganising and, over time, expanding Condrens’ business, including – eventually – by entering into the Specified Leases.
[98] Each of Mr McKinley and Mr O’Sullivan gave evidence that, based on Mr Berry’s advice, they had been aware from a very early stage, and I took this to mean from the time Condrens and CPI were restructured in late 1997, that the losses being funded by the CPI Advances (as discussed below) would require further shareholder support. Mr Berry confirmed that that had been his advice. These matters were not disputed by the plaintiffs.
Trading at Ballance St
[99] From early 1998, until Condrens was ultimately placed in receivership in March 2002, CPI incurred very significant losses under the Ballance St Lease. Condrens advanced a total of $588,000.00 to CPI by way of the CPI Advances, to cover those losses. It would appear those advances were made by way of the operation of some form of joint bank account, into which CPI paid its revenues and from which its debts were met.
[100] CPI’s financial performance did, however, improve over this period. Its annual losses were greatest (-$259,749.00) in the year immediately following the initial restructuring of the business, that is in the financial year ending (“FYE”)
31.3.98. It returned to profitability (+$14,681.55) in FYE 31.3.02, having shown steady improvement in the intervening years.
[101] The defendants would appear to have put considerable time and energy into addressing CPI’s financial difficulties, particularly by successfully resisting various efforts by the landlord to increase the rent, including at one point by making demand on CPI for the repayment of the CPI Advances. By April 2000, negotiations with a new landlord largely stabilised the rent through to April 2010.
[102] In addition to addressing the difficulties associated with the terms of the Ballance St Lease, the defendants increased the amount of carparking revenue derived from the building. They did this in a variety of ways, including maximising the number of car parks able to be offered, and concluding agreements with a number of corporate customers for permanent carparking arrangements.
[103] In October 1999 $200,000.00 of additional capital was provided to Condrens by the defendants increasing its authorised and issued capital to $200,100.00. Of the additional $200,000.00, $50,000.00 was provided by each of Messrs O’Sullivan and McKinley, and $100,000.00 by Mr Condren. That capital was provided to support Condrens given the impact on Condrens, by that time, of the making of the CPI Advances.
Condrens’ trading
[104] Prior to the business expansion involving the Specified Leases, the Wellington-based business acquired by Condrens traded with a moderate degree of success. It recorded profits totalling $226,000.00 in the FYEs 31.3.98 ($190,000.00), 31.3.99 ($6,400.00) and 31.3.00 ($30,000.00).
Business expansion – the Specified Leases
[105] In June 1998, Condrens occupied the Wakefield St carparking building for the first time. Originally part of a large Chase Corporation development site, by this time the carparking building – now adjacent to an empty site – was owned by an investment company.
[106] From August/September of 1998 onwards Messrs O’Sullivan and McKinley, operating through their company Condrens Management Ltd (“CML”), began to establish a car parking business in Hamilton and Auckland. Mr Condren was not involved in CML. It would appear Messrs O’Sullivan and McKinley initially used the Condrens name without Mr Condrens’ approval. That was a source of some tension. Messrs O’Sullivan and McKinley had dealings with Mr Baxter. They would subsequently enter into the Albert St Lease with a company associated with Mr Baxter.
[107] Condrens first leased vacant land for use as a car park in Tory St from a Mr Serapisos in 1998. Discussions on a possible longer term lease began with Mr Serapisos in late 1998, after he proposed developing the site into a hotel and apartment block, together with a parking building. Initial discussions went nowhere due to Mr Serapisos’ high rent expectations.
[108] Tington acquired the Wakefield St property, and the adjoining vacant
“Chase” land, in late 1999.
[109] In early January 2000 Tington sought proposals for an interim lease of the Wakefield St car park to cover the construction period for its adjoining Reading Cinema complex. On 18 January 2000, Condrens, who were competing with Wilsons for the opportunity to stay in the building, offered Tington a three-year lease, terminable by either party on six months’ notice. Following discussions, that offer was accepted. The notice period was reduced to four months. Tington was to notify Condrens five months out from the completion of its development to enable negotiation, on a non-exclusive basis, of ongoing lease arrangements.
[110] By November 1999 Messrs O’Sullivan and McKinley, operating through CML, had entered into detailed negotiations for the lease of the Auckland property that became known as the Albert St car park. Mr McKinley undertook a range of investigations, and in late November 1999 – on behalf of CML – offered to enter into a 5 year lease, commencing on practical completion of the property which was estimated at that time for 1 December 2000. After some negotiations, CML signed up to the lease of Albert St on 14 March 2000.
[111] In December 1999 agreement was reached to merge the Auckland and Hamilton operations of CML with the Condrens’ business. Mr Condren took valuation advice from a chartered accountant. Messrs McKinley, O’Sullivan and Condrens’ shareholdings in Condrens were equalised at 33% each, reflecting an assessment of the positive value of the CML business. Mr Swan became a director. Minutes of a board meeting of both Condrens and CML of 20 February 2000 record Mr Condren being appointed as chairman of both boards.
[112] In April 2000 – far earlier than anticipated when the interim lease had been signed – Tington, through its agent Landplan Pacific limited (“Landplan”), sought tenders for a permanent lease of the Wakefield St car park on completion of the Reading cinema complex. It was a condition of Tington’s development funding that a permanent lease be arranged at that point in time. Mr McKinley took principal responsibility for preparing Condrens’ response. In May 2000 Condrens submitted its offer. Condrens’ competitor was, again, Wilsons.
[113] Condrens’ tender was, ultimately, successful.
[114] Agreement in principle with Tington was reached in late August/early September. On 29 November 2000 Condrens signed an agreement to lease with Tington. The agreed lease, that is the Wakefield St Lease, was not to commence until “the day on which the cinema in the Centre commenced trading as determined by the Landlord”. That event was not expected to occur for quite some time – in May 2000, the cinema was expected to open by 31 March 2002, that is, over 18 months away.
[115] On 3 August 2000 Condrens formally assumed liability for the Albert St Lease, together with a number of other leases of premises in Auckland and Hamilton, effective as at 30 March 2000. The Albert St Lease was not, however, to come into effect until March/April 2001, when practical completion was in fact achieved.
[116] By December 2000 Condrens was in a position to reach agreement with Mr Serapisos for a long-term lease of the car parking property to be developed by him in Tory St. That lease was for a term of 6 years at an annual rental of $1.18 million, and was to come into effect on the “occupation date”, which was not scheduled to occur for some time. The arrangements provided for a three-month initial rent holiday. The Tory St building was not, in fact, completed until November 2001. The three month rent holiday had not expired when receivers were appointed to Condrens. Condrens, in fact, never paid rent under the Tory St Lease.
[117] In March 2001, and to take account of disruption that would be caused by a further development of the Albert St building, the Albert St Lease was renegotiated. A revised lease was signed on 20 April 2001. Contrary to the plaintiffs’ assertion, that does not appear to have involved an increase in the rent payable. That Condrens made a loss of $90,000.00 in FYE 31.3.01 appears to have reflected trading difficulties at the Wakefield St site in Wellington, and at a number of sites in Auckland.
Financial difficulties – receivership and liquidation
[118] In March 2001 the Albert St building opened. Condrens had a rent holiday until May 2001, and so paid no rent on Albert St in FYE 30.3.01. As soon as Albert St opened, however, Wilsons cut the prices in its nearby carparking buildings dramatically. Condrens was forced to respond to Wilsons’ lower prices. Wilsons also complained to the Auckland City Council that Condrens was breaching the terms of the building’s consent in the way it was operating the permanent and casual car parking. That dispute certainly engaged Condrens in negotiations and a legal dispute with the Council, but the evidence overall appeared to be that Condrens
[288] If the parties cannot agree on costs they will, no doubt, file submissions.
“Clifford J”
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