Kelstworural Limited (in liquidation) v Mounsey-Ross
[2021] NZHC 1632
•2 July 2021
IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY
I TE KŌTI MATUA O AOTEAROA TĀMAKI MAKAURAU ROHE
CIV-2018-404-2541
[2021] NZHC 1632
UNDER the Companies Act 1993 IN THE MATTER
of the liquidation of Kelstworural Limited (In Liquidation)
BETWEEN
KELSTWORURAL LIMITED (IN LIQUIDATION)
First plaintiff
MALCOLM GRANT HOLLIS and CRAIG ALEXANDER SANSON
Second plaintiffsAND
KELLY MICHELLE MOUNSEY-ROSS
First defendant
KELLY WILLIAM ROSS
Second defendant
Hearing: 1 July 2021 Appearances:
GAD Neil and S P Farnell for the plaintiffs
Date of judgment:
2 July 2021
JUDGMENT OF JAGOSE J
This judgment was delivered by me on 2 July 2021 at 4.00pm.
Pursuant to Rule 11.5 of the High Court Rules.
…………………………
Registrar/Deputy Registrar
Solicitors:
Meredith Connell, Auckland
KELSTWORURAL LTD (IN LIQUIDATION) v MOUNSEY-ROSS [2021] NZHC 1632 [2 July 2021]
[1] Having obtained summary judgment on their first cause of action to recover the defendants’ current account debt to the plaintiff company,1 the plaintiffs now pursue their second cause of action claiming compensation for the defendants’ alleged breach of their directors’ duties under ss 131, 135, 136 and 137 of the Companies Act 1993. By reason of the defendants’ default in filing their affidavit evidence in opposition, their defence was struck out.2 The matter proceeds by way of formal proof.
Background
[2] Since its incorporation in 2011, the first plaintiff traded as the Red Fox Tavern on leased land in Waikato’s Maramarua. The land was owned by the second defendant, Mr Ross, together with another person. The defendants each have a 50 per cent shareholding in the company, and are (and were) the plaintiff company’s only directors. The company accrued substantial tax liabilities, very predominantly in unremitted PAYE deductions, over the years of its operation until ceasing trading on 15 December 2017 on sale of its business. The sale of both the business and the land was conducted through an associated company, Red Fox Tavern 2006 Ltd (owned by Mr Ross’ mother), which retained the $216,000 proceeds of the business’ sale.
[3] The plaintiff company persistently failed to return to the Commissioner deductions to be made from amounts paid as remuneration to employees or received in payment for goods and services supplied, even after the Commissioner’s intervention and provision of education and training. The former PAYE failure only came to light on the Commissioner’s investigation of discrepancies in the latter GST payments. At the same time, the defendants accumulated net drawings of almost
$360,000 over the time of the company’s operation. As said,3 summary judgment was
entered against them for repayment of that debt in the sum of $326,219.86.
[4] On 13 July 2018, the company was put into liquidation on application of the Commissioner of Inland Revenue. The liquidators have admitted the Commissioner’s
1 Kelstworural Ltd v Mounsey-Ross [2019] NZHC 752.
2 Kelstworural Ltd v Mounsey-Ross HC Auckland CIV-2018-404-2541, 20 May 2021 (Minute of Duffy J).
3 See [1] above.
claim for some $610,000 (comprising core preferential debts of nearly $292,000, plus interest and penalties) as the company’s debt to its sole creditor in the liquidation. From their investigation of the company’s affairs (an investigation impeded by the directors’ lack of co-operation), the liquidators conclude the company was unable to meet its tax liabilities “from very much the outset of its trading”. That is consistent with the company’s reported position of liabilities significantly exceeding its assets through its operation. On either and both limbs of the solvency test,4 the company was insolvent at the latest from the end of its March 2012 financial year.
The law
[5] It is trite law directors have duties to the company to act in good faith and in its best interests. These duties are recited, and with greater specificity, in the Companies Act.5 In particular, a director must: act in what s/he believes to be “the best interests of the company”;6 not agree to, 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”;7 and 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”.8 The “best interests of the company” include taking account of its obligations to creditors, which have greater weight in circumstances of at least pending insolvency.9 Directors “must exercise the care, diligence, and skill that a reasonable director would exercise in the same circumstances”.10
[6] On liquidation, as is the present case, a director may be required to compensate the company for such breach, or pay such sum to an applicant creditor.11 The amount of that contribution is to be determined by reference to the cause of, (lack of)
4 Companies Act 1993, s 4.
5 Sections 131–138.
6 Section 131, and see Madsen-Ries v Cooper [2020] NZSC 100 at [109].
7 Section 135.
8 Section 136.
9 Nicholson v Permakraft (NZ) Ltd [1985] 1 NZLR 242 (CA) at 250.
10 Companies Act, s 137.
11 Section 301.
culpability for, and duration of trading under “inadequate corporate governance” leading to deterioration of the company’s financial position.12
Discussion
[7] I have no hesitation in concluding the directors’ persistent insolvent trading of the company, while permitting shareholders’ derivation of substantial benefit, could not honestly have been believed by the directors to be in the company’s best interests. There is no evidence of the directors’ actual consideration of the company’s best interests; despite being insolvent almost from the outset, there is no evidence of any consideration of creditors’ interests; and the directors’ obligations to the company, while being shareholders obtaining drawings, put them in a position of significant conflict, of which there is no evidence they sought to address.13
[8] The directors’ apparent reliance on an accounting assistant from 2011 to 2014 “to make and record all tax related payments to Inland Revenue” is no answer, particularly as payments and receipts were made through the company’s bank account, to which there is no evidence the accounting assistant had transactional access. Thus retentions from payments and receipts, and their onward return to the Commissioner, inferentially remained matters for exercise of the directors’ governance of the company.
[9] Similarly, the directors plainly permitted the company’s business to be carried on in a manner at least likely to create a substantial risk of serious loss to its only outstanding creditor, the Commissioner. Permitting drawings in sum remarkably close to (and exceeding) the company’s core debt to the Commissioner is illustrative. So too is the absence of trade creditors. This goes well beyond the not-uncommon circumstance of using the company’s unmet tax liability as a source of involuntary financing of an insolvent business. It was, in the circumstances of this company, the directors using that liability to reward themselves as shareholders. It is exacerbated by the directors’ bad faith conduct in expropriating proceeds of the business’ sale.
12 Madsen-Ries v Cooper, above n 6, at [158], approving Mason v Lewis [2006] 3 NZLR 225 (CA) at [108]–[110].
13 See Madsen-Ries v Cooper, above n 6, at [113]–[114].
No reasonable director, even of a modest corporate entity similar to the plaintiff, would have conducted itself in such a way.
[10]The above establish breaches of the defendants’ duties under ss 131, 135 and
137. However, I doubt s 136’s prohibition on incurring obligations can be said to bite on the present facts. Prospective liability to pay or return taxes “is not relevant to the issue of whether or not there was a breach of duty”.14 The obligation to return PAYE or GST only arises at the time of payment or receipt respectively; alternatively, perhaps, in setting up for trade through employees for revenues in sum requiring GST- registration. At those times, (expectations of) gross payments or receipts may provide a foundation for a belief on reasonable grounds the company will be able to perform the obligation when required to do so. On testing the proposition with the plaintiff’s counsel, Sarah Farnell, she did not press s 136’s breach here.
[11] I also conclude the company’s unmet liability exclusively is caused by the directors failing to ensure the company remitted its tax payments to the Commissioner, for which only they were responsible throughout the entire period of the company’s trading. The company’s deleterious financial position entirely is due to the directors’ inadequate corporate governance. That conduct renders the directors liable to the company by way of restitution or other compensation.
[12] Restitutionary remedies generally are “to correct normatively defective transfers of value, usually by restoring the parties to their pre-transfer positions”.15 That is not entirely apposite here, on the plaintiffs’ second cause of action, which seeks compensation (as may include restitutionary relief)16 for the company’s liability to the Commissioner. I am to fashion s 301 redress “tailored towards the combination of breaches found”.17
[13] Correction of normatively defective transfers of value, as may be thought achieved on the first cause of action, is not responsive to the directors’ failure to ensure
14 At [93].
15 Investment Trust Companies v Revenue and Customs Commissioners [2017] UKSC 29, [2018] AC 275 at [42]; and see similarly Madsen-Ries v Cooper, above n 6, at [156]–[157].
16 Madsen-Ries v Cooper, above n 6, at [161].
17 At [162].
the company met its tax liabilities. Neither is the usual measure of s 135 breach in the “net deficiency approach”, because here that would involve an artificial reconstruction of the deterioration of the company’s financial position from the date of insolvency to the date of liquidation.18 From those perspectives, on the second cause of action, contribution of the company’s unmet liability to the Commissioner is the just remedy. But the plaintiffs cannot recover in sum exceeding the company’s loss caused by the directors’ breach of duty. That is inherent in s 301(1)(b)(ii)’s “compensation”; it is not a penalty.19
Result
[14] Under s 301(1)(b)(ii) of the Companies Act, I order the defendants jointly and severally to contribute $609,738.74 to the assets of the company, plus interest under the Interest on Money Claims Act 2016.
Costs
[15] As the successful parties, the plaintiffs are entitled to an award of costs. I reserve their quantum for determination on short memoranda of no more than five pages — annexing a single-page table setting out any contended allowable steps, time allocation, and daily recovery rate — to be filed and served by the plaintiffs within ten working days of the date of this judgment, with any response or reply to be filed within five working day intervals after service.
—Jagose J
18 At [164].
19 Yan v Mainzeal Property and Construction Ltd (in liq) [2021] NZCA 99 at [302]; and see Peter Watts Directors’ Powers and Duties (2nd ed, LexisNexis, Wellington, 2015) at [10.2.5].