Kaikoura Freight Ltd (in liq) v Collins
[2017] NZHC 1490
•30 June 2017
IN THE HIGH COURT OF NEW ZEALAND CHRISTCHURCH REGISTRY
CIV-2016-409-1130 [2017] NZHC 1490
UNDER the Companies Act 1993 IN THE MATTER
of the liquidation of Kaikoura Freight
LimitedBETWEEN
KAIKOURA FREIGHT LIMITED (IN LIQUIDATION)
First Plaintiff
VIVIEN JUDITH MADSEN-RIES AND HENRY DAVID LEVIN AS LIQUIDATORS OF KAIKOURA FREIGHT LIMIED (IN LIQUIDATION) Second Plaintiffs
AND
GRANT HAROLD COLLINS Defendant
Hearing: 24 May 2017 Appearances:
K Wakelin and E J Egan for First and Second Plaintiffs
No appearance for DefendantJudgment:
30 June 2017
Reissued:
3 July 2017
JUDGMENT OF NICHOLAS DAVIDSON J
Introduction
[1] Kaikoura Freight Ltd (“the Company”) and its liquidators Ms Madsen-Ries
and Mr Levin (“the Liquidators”) sue the defendant, Mr Collins, in his personal
capacity, and in his capacity as a former director of the Company.
KAIKOURA FREIGHT LTD (IN LIQ) & ORS v COLLINS [2017] NZHC 1490 [30 June 2017]
[2] The Company and the Liquidators seek compensation from Mr Collins pursuant to s 301 of the Companies Act 1993 (“the Act”) for breaches of his duties as a director being:
(a) the duty to act in good faith and in the best interests of the Company
(s 131(1));
(b)the duty to ensure the business of the Company was not carried on in a manner that created a substantial risk of serious loss to its creditors (s 135);
(c) the duty not to cause the Company to continue trading after there were no reasonable grounds to believe the Company would be able to meet its obligations to creditors (s 136); and
(d)the duty of exercising the care, diligence, and skill expected of a reasonable director in the circumstances (s 137).
[3] They also seek directions under s 284 of the Act that:
(a) for the purpose of any distribution to creditors of any part or all of the compensation or damages awarded to the plaintiffs under the first cause of action, the Liquidators may value at zero any claim that may be made in the liquidation by the defendant;
(b)the Liquidators do not have to make provision for any claims that may be submitted in the liquidation by the defendant;
(c) the Liquidators do not have to take further steps to notify the defendant of his ability to file claims in the liquidation, and
(d) they seek leave to apply for further directions as required.
[4] The Company went into liquidation owing $340,837.01 to creditors, over a third of which is owed to the Inland Revenue. The plaintiffs say that the
Company’s unpaid debts were incurred due to the defendant’s failure to properly discharge his responsibilities as a director of the Company, and his failure to protect the interests of the Company and its creditors.
Procedural History
[5] This proceeding was commenced by statement of claim dated
17 November 2016 and served on the defendant on 20 December 2016. No statement of defence has been filed. The plaintiffs seek judgment pursuant to r 15.9 of the High Court Rules, and they must prove their claims on the evidence.
[6] The plaintiffs’ submissions and evidence are uncontested and given the immediate and wider implications, the Court must be cautious in reaching judgment.1 It is one thing to establish breach, another to establish the quantum of judgment.
Background
[7] The Company was incorporated on 25 May 2012 and provided general freight services between Kaikoura and Christchurch. It ceased trading at the end of July 2016, and was put into liquidation on 18 August 2016 on the application of the Commissioner of Inland Revenue (“Inland Revenue”). The Company had negligible assets at the time of liquidation.
[8] Creditor claims total $346,758.47, of which the liquidator’s admit
$340,837.01. Inland Revenue initially filed a claim for $114,734.55 plus costs, but amended this to $127,016.36 plus costs. The Liquidators admit the sum of
$126,696.36 plus costs.
[9] The plaintiffs’ case is that the defendant caused or allowed the Company to continue to trade after it became insolvent, resulting in serious loss to creditors, and caused or allowed the Company to incur further obligations through the purchase of a new business without adequate due diligence, resulting in further losses.
Insolvency
[10] A company must be balance sheet solvent, so the value of its assets is greater than the sum of its liabilities. It must be cash flow solvent, able to pay its debts as they become due in the normal course of business.2
Balance Sheet test
[11] The Company’s financial statements show the Company was operating with significant overall net liabilities in excess of its assets in each year from 2013 to 2017. I find that the Company did not meet the balance sheet solvency test since 2013.
The Cash Flow test
[12] The Company’s profit and loss statements and balance sheets show it was
operating with:
(a) significant trade deficits from 2013 until the date of liquidation in
2016;
(b) significant reported working capital deficits from 2016; and
(c) significant and increasing reported net deficit from 2013.
[13] Much the Company’s debt was outstanding for a long time. The company began defaulting on its PAYE obligations in 31 October 2012, and its GST obligations from 31 January 2014. If often operated outside its banking facility, incurring dishonour fees and dishonoured payments from 2014.
[14] Mr Levin deposed that based on his experience, a failure to pay tax obligations on a regular basis is a sign of a company in trouble. Under s 167(1) of the Tax Administration Act 1994, businesses which collect PAYE and GST must hold
it on trust for the Commissioner. Companies collecting PAYE and GST act as intermediaries between the taxpayer and Inland Revenue.
[15] I find that the Company had insufficient cash flow to meet its liabilities from 31 October 2012, evidenced by the Company’s default on its tax obligations from that time, with a net asset deficit from that point.
First cause of action: breaches of directors’ duties
[16] Section 301 of the Act empowers the Court to order relief in a wide variety of circumstances.
301Power of court to require persons to repay money or return property
(1) If, in the course of the liquidation of a company, it appears to the court that a person who has taken part in the formation or promotion of the company, or a past or present director, manager, administrator, liquidator, or receiver 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 or a creditor or shareholder,—
(a) inquire into the conduct of the promoter, director, manager, administrator, liquidator, or receiver; 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
(c) where the application is made by a creditor, order that person to pay or transfer the money or property or any part of it with interest at a rate the court thinks just to the creditor.
…
(3) An order for payment of money under this section is deemed to be a final judgment within the meaning of section 17(1)(a) of the Insolvency Act 2006.
(4) In making an order under subsection (1) against a past or present director, the court must, where relevant, take into account any action
that person took for the appointment of an administrator to the company under Part 15A.
[17] The Court of Appeal in Mason v Lewis held that claims brought under s 301 involve a two-stage evaluation:3
(a) Has there been a breach of a duty owed by a director to the company?
(b)If so, to what extent should the director contribute to the losses of the company?
Breach of s 131
[18] Section 131 of the Act provides:
131Duty of directors to act in good faith and in the best interests of the company
(1) …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.
…
[19] In Sojourner v Robb, Fogarty J made the following observations:4
In this context, the standard in s 131 is an amalgam of objective standards as to how people of business might be expected to act, coupled with a subjective criterion as to whether the directors have done what they honestly believe to be right. The standard does not allow a director to discharge the duty by acting with a belief that what he is doing is the best interest of the company, if that belief rests on a wholly inappropriate appreciation as to the interests of the company… Creditors are persons to whom the company has ongoing obligations. The best interests of the company include the obligations to discharge those obligations before rewarding the shareholders.
[20] Here, the Company’s financial position was not improving, and it was unlikely to recover. However, directed by the defendant, it continued to trade and incur further debts to Inland Revenue. Further, in late 2014, the defendant caused the Company to enter into an agreement for the purchase of a general freight
business from Gill Construction Co Ltd. The defendant has said that one reason for
3 Mason v Lewis [2006] 3 NZLR 225 (CA) at [52].
4 Sojourner v Robb [2006] 3 NZLR 808 (CA) at [102].
the Company’s failure was making this purchase. The Liquidators refer to evidence that the defendant for the Company did not undertake any due diligence before the purchase, and had he done so, he would have realised that the purchase should not have occurred. I find on the uncontested evidence that the loss incurred by the Company and its creditors was as a result of the defendant’s failure to act in good faith and in the best interests of the Company.
Breach of s 135
[21] Section 135 of the Act 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.
[22] In Mason v Lewis, the Court of Appeal set out the “essential pillars” of a
claim under s 135 of the Act. They are:5
(a) The duty imposed by s 135 of the Act is one owed by directors to the company (rather than to any particular creditor);
(b) The test is an objective one;
(c) It focuses not on the directors’ belief, but on the manner in which a company’s business is carried on, and whether the modus operandi creates a substantial risk of serious loss; and
(d)What is required when a company enters troubled waters is a sober assessment by the director of an ongoing character, as to the
company’s likely future income and prospects.
5 Mason v Lewis, above n 2, at [51].
[23] In Boutique Tanneries (in liquidation) v Hadley, the defendant carried on business as a tannery and leather-goods retailer.6 The Court formed the view that the director operated in a very informal and relaxed way, with scant regard to formal requirements. The company had been kept afloat for a number of years by paying all its creditors, with the exception of the Inland Revenue. The Court was of the opinion that it was its forbearance that prolonged the company’s trading. The
director was found to have breached various duties, including that under s 135.
[24] This case has similarities with Boutique Tanneries. The Company was kept afloat for a number of years at Inland Revenue’s expense. Boutique Tanneries began missing GST and PAYE payments some time before it went into liquidation. The Court held:7
Mr Weir’s evidence was that business with cash flow difficulties may be tempted to defer obligations to IRD because the Department does not provide service to materials required to continue trading. However, the reality is that the penalties imposed for late payment mean that deferral of obligations to the IRD for any significant period reflect very poor business judgment and, in Mr Weir’s experience, companies that have unpaid PAYE and GST for six months or more often have a fundamental issue as to whether they are able to pay their debts as the fall due.
[25] Mr Levin’s evidence is that the Company was unable to pay its debts as they fell due, and was insolvent from at least 31 October 2012. The only responsible course was to cease trading when the Company had overdue and increasing tax liabilities which it had no realistic prospect of paying. However, the defendant continued to trade the Company until July 2016.
[26] The Company never reported a surplus from trading. If the defendant hoped to improve the Company’s financial position, there was no evident basis for that. A “sober assessment” of the Company’s prospects at any time during this period would have left no room for doubt that the Company should cease trading.
[27] I am satisfied that for a prolonged period of time, the defendant ought to have been aware of the troubled financial circumstances of the Company, yet proceeded to
incur liabilities that created a real risk of substantial loss to the Company. I hold that the defendant traded recklessly in breach of his duty under s 135.
Breach of s 136
[28] Section 136 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.
[29] The plaintiffs allege that the defendant breached his duty not to incur obligations knowing that the Company is unable to meet them. Section 136 of the Act states that “a director of a company must not agree to the company incurring an obligation unless the director believes at the time on reasonable grounds that the
company will be able to perform the obligation when it is required to do so.”8
[30] Assessing a breach in s 136 requires a subjective and objective test. In Fatupaito v Bates,9 O’Regan J held that to establish a breach of s 136, the plaintiff must show that the defendant agreed to the company incurring an obligation at a time when they did not believe (a subjective test), on reasonable grounds (an objective test), that the company would be able to perform that obligation when required to do so. There are overlaps between the breaches of a director’s duties in
ss 135 and 136.
[31] I find that from the date on which the Company became insolvent, there were no reasonable grounds for the defendant to believe that the Company would be able to meet its tax liabilities. Given the long period of time over which the Company incurred debts to Inland Revenue and other creditors, and the worsening financial position, the defendant could not have honestly or reasonably believed that the Company would be able to satisfy its past debts while incurring new obligations. At best he lived in hope.
[32] For these reasons, I find the defendant breached s 136 of the Act.
Breach of s 137
[33] Section 137 of the Act provides:
Director’s duty of care
A director of a company, when exercising powers of 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.
[34] The test under s 137 is an objective one based on “the requisite skill set required of a reasonable director in the same position as the defendant.”10
A director’s personal knowledge and experience are not relevant.
[35] For the reasons which I hold establish breach under ss 131, 135 and 136, I also find that the defendant breached his obligation under s 137. A reasonable director in the position of the defendant would not have continued to trade the Company when it became insolvent in 31 October 2012.
Quantum
[36] The usual approach to awarding relief under s 301 is to assess the extent of the deterioration in the company’s financial position between the date of breach and the date of liquidation.11 It involves exercise of the Court’s discretion. In Mason v Lewis, it was held that:12
[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 (really the ‘breach’ date) and the date of liquidation.
10 Boutique Tanneries (in liq) v Hadley, above n 5, at [31].
11 Mason v Lewis, above n 3, at [109].
[110] Once the figure has been ascertained, New Zealand Court have seen three factors- causation, culpability and the duration of the trading- as being distinctly relevant to the exercise of the Court’s discretion…
…
[118] Finally, claims of this character necessarily have to be approached in a relatively broad-brush way. The jurisdiction to order recompense is of an equitable character.
[37] In Lower v Traveller, the three factors were explained as follows:13
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.
…
The relevance of culpability is linked to the deterrent purpose of the provision. This factor calls for an assessment of the blameworthiness of Mr Lower’s conduct, bearing in mind that at the end of the range the nature of the director’s involvement will be blind faith or muddledheadedness, while at the other end there will be actions or instances which are plainly dishonest.
As to the duration of the wrongful trading, the company continued to trade continued to trade after April 1995 until February 1998 accumulating an increasing deficit in the shareholders’ funds. The duration of the wrongful trading to which Mr Lower was a party was lengthy.
[38] I consider each element in turn.
Causation
[39] I find a causal link between the defendant’s breaches of his duties and the loss suffered by the Company. Had the defendant, as director ceased to trade shortly after it became insolvent, the outstanding debts to creditors would have been substantially reduced and these debts accrued from a position of apparent solvency
before 31 October 2012. The debts were exacerbated by entering into the
13 Lower v Traveller [2005] 3 NZLR 479 (CA) at [79], [83], [86].
Gill Construction Sale Agreement, and the accumulation of interest and penalties to
Inland Revenue.
Culpability
[40] Taking a holistic approach, the defendant’s actions were at the mid to upper end of the range of culpability. The defendant knew or ought to have known the extended period of time for which the Company had overdue tax liabilities, signified by the large amounts of penalties and interest that the Company was accruing. The amount owing to Inland Revenue and other creditors at liquidation was significant.
[41] The creditors’ losses cannot on the evidence be categorised as a result of legitimate commercial risk taking, nor solely due to poor business decisions. I find that the defendant is to blame for continuing to trade in the face of growing obligations to Inland Revenue and other creditors, despite the Company’s deteriorating financial position. In that time he flouted reality, he took salary and drawings.
Duration
[42] In Lower v Traveller, the Court of Appeal found that duration of the breach of two years and 10 months was “lengthy”.14 Here, the Company was trading for longer, estimated as just less than four years since insolvency. This was a very long time to be trading in breach of his obligations.
Quantum
[43] Without a basis to find otherwise and mindful that the Court has power to make orders it thinks just, I direct the defendant to contribute a sum equivalent to the entire amount owed by the Company to its creditors. The Court of Appeal in Mason v Lewis held that the standard approach is to assess compensation by reference to the deterioration in the Company’s financial position between the date inadequate corporate governance became evident, and the date of the liquidation.
The deterioration is reflected in the amount owed to creditors, being the sum of the company’s financial decline since the “breach date” of 31 October 2012. To repeat, the defendant drew on the Company over several years, at the expense of its creditors, which was, or should have been, obvious to him.
[44] The creditor claims admitted by the Liquidators amount to $340,837.01. However, the Company owes the defendant $83,400, being the debt in his shareholder current account. There is no evidence to indicate it is not owing to him but he has not sought to prove the debt in the liquidation.
[45] The plaintiffs propose two courses to deal with the defendant’s potential claim against the Company. The first is to include apparent but not proven debt in the quantum of relief, resulting in a total of $424,237.01. In the alternative, the plaintiffs submit that the quantum of relief be set at $340,837.01, but grant leave for the plaintiffs to seek amended relief in the event that the defendant files a claim in the liquidation.
[46] The latter approach is I consider fair. In Madsen-Ries v Greenhill, a similar approach was taken,15 where a director and creditor had not filed claims. Rather than ordering compensation by reference to those debts, the Court granted the liquidators leave to apply for amended relief. It thus depends on what steps, following judgment, that the defendant now takes.
[47] The plaintiffs are entitled to judgment in the sum of $340,847.01, being the amount owing to the Company’s creditors excluding the defendant, I need to consider whether an order sought by the second plaintiff under s 284 of the Act is warranted.
Direction under s 284
[48] The second plaintiffs seek directions under s 284 of the Act that:
(a) for the purpose of any distribution to creditors of any part or all of the compensation or damages awarded to the plaintiffs under the first cause of action, the Liquidators may value at zero any claim that may be made in the liquidation by the defendant;
(b)the Liquidators do not have to make provision for any claims that may be submitted in the liquidation by the defendant;
(c) the Liquidators do not have to take further steps to notify the defendant of his ability to file claims in the liquidation; and
(d)for leave for the Liquidators to apply for further directions as required.
[49] I am not presently minded to grant the orders sought by the second plaintiffs other than the last, as the orders are only needed if the Court refused to grant leave to amend relief in the event that the defendant files a claim. Further, I am not prepared to make any orders that may prejudice the defendant’s credit claim against the Company but otherwise the Liquidators are bound to distribute the assets of the Company, or the proceeds of the assets, in accordance with the Act. The authority cited is materially different from the present case. The plaintiffs refer to Re Auckland Maritime Investments Ltd (in liq), where the Court made orders allowing the Liquidators to distribute funds to the shareholders who had been identified, and to
treat them as the only shareholders of the company.16 However, the liquidators were
unable to locate all the shareholders and to do so would deplete the limited fund available for distribution, which is quite different to the circumstances here.
[50] At present I refuse to make the s 284 directions sought. I reserve leave for those applications to be renewed as the defendant’s response to judgment, if any, is known.
Disposition
[51] The plaintiffs are entitled to judgment:
(i) The defendant is ordered to pay the plaintiffs $340,837.01.
(ii)The plaintiffs are entitled to interest, pursuant to s 87 of the Judicature Act 1908, from 18 August 2016 and costs on a category 2 B basis plus reasonable disbursements.
(iii)In case the defendant files a claim against the Company for a debt owed to him within 15 working days of this judgment being served on him, I reserve leave for the plaintiff to apply to amend the relief ordered. The plaintiffs are directed to serve a copy of this judgment on the defendant at his known or last known address.
(iv)I reserve leave for any further directions or orders necessary to effect this Judgment, including further directions under s 284 of the Act.
Addendum
[52] This Judgment was reissued because of amendments made to paragraphs [8]
and [51] under HC Rule 1.9 “slip rule”.
………………………………………….
Nicholas Davidson J
Solicitors:
Meredith Connell, Auckland
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