New Zealand LJ Food Express Taupo Limited (in liquidation) v Zeng

[2024] NZHC 2517

IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY

I TE KŌTI MATUA O AOTEAROA TĀMAKI MAKAURAU ROHE

CIV-2023-404-002436

[2024] NZHC 2517

UNDER

Part 18 of the High Court Rules 2016 and ss 135, 136 and 137 of the Companies Act 1993

BETWEEN

NEW ZEALAND LJ FOOD EXPRESS TAUPO LIMITED (IN LIQUIDATION)

First Plaintiff

KRISTAL LOUISE PIHAMA and LEON FRANCIS BOWKER

Second Plaintiffs

AND

XIAN ZENG

Defendant

Hearing:	27 August 2024
Appearances:	J Caird for the Plaintiffs
Judgment:	4 September 2024

JUDGMENT OF WALKER J

This judgment was delivered by me on 4 September 2024 at 10 am Pursuant to Rule 11.5 High Court Rules

Registrar/Deputy Registrar

Solicitors:

J Caird, Simpson Grierson, Auckland

NEW ZEALAND LJ FOOD EXPRESS TAUPO LIMITED (IN LIQUIDATION) v ZENG [2024] NZHC 2517 [4

September 2024]

[1]    New Zealand LJ Food Express Taupo Limited (In Liquidation) (the Company) owned and operated a Chinese restaurant in Taupo known as “No. 1 China Restaurant”. The defendant is the sole director and shareholder. The second plaintiffs, Kristal Pihama and Leon Bowker, are licensed insolvency practitioners. They are appointed as joint and several liquidators of the company on the application of the Commissioner of Inland Revenue.1

[2]    The company and the liquidators bring this claim alleging that Mr Zeng breached his director’s duties owed to the company under ss 135 and 137 of the Companies Act 1993 (the Act). They seek damages of $342,632.40 plus interest and costs.

[3]    The plaintiffs have been unable to locate and personally serve the defendant. Orders were made by this court for substituted service.2 The proceedings were served in the manner directed by those orders by emailing a copy to the defendant at his known email address. Mr Zeng took no steps. The plaintiffs sought judgment by way of formal proof.

[4]    When the matter was called, Mr Ho appeared on behalf of the defendant. He explained that he had noticed the proceeding in the Court List the evening before and had contacted the defendant. He explained from the Bar that he acts for Mr Zeng in other matters but has not been instructed in this proceeding. He also advised the Court that Mr Zeng contends that he has not received the court documents and was unaware of the hearing. Mr Ho sought an adjournment for one week to take instructions.

[5]Mr Caird, for the plaintiffs, opposed that course.

[6]    I adjourned the hearing to 2.15 pm to enable Mr Ho to speak with his client for more fulsome instructions as to why the hearing should be deferred. I observed that the plaintiffs had done all that was required of them to enable the formal proof to proceed.

1      The court appointed Leon Bowker and Janet Sprosen, of KPMG, as joint and several liquidators of the company on 15 November 2022. On 21 November 2023, Ms Pihama replaced Ms Sprosen as liquidator of the company pursuant to s 283(2) of the Act upon Ms Sprosen’s resignation.

2      Order of Associate Judge Taylor dated 22 May 2024.

[7]    On reconvening in the afternoon, I heard further from Mr Ho. He confirmed that he had taken further instructions from the defendant. The defendant acknowledged receipt of the documents in his “spam” email folder but confirmed he had not seen these before that day. He nonetheless wished to be heard in opposition and reiterated, through Mr Ho, a request for more time to do so.

[8]    I declined that request. The plaintiffs have complied with all steps necessary to proceed with a formal proof, including proof of service. The defendant has other options in the event judgment is entered against him.

[9]This judgment accordingly determines the plaintiffs’ claims.

Background

[10]   Ms Pihama made an affidavit setting out the investigation by liquidators into the financial affairs of the company. She notes that there are no accounting records or financial statements available. The liquidators have instead reconstructed the company’s affairs, relying on the available bank account statements.

[11]The following background is taken from Ms Pihama’s affidavit.

[12]   Ms Pihama deposes that the company leased premises for its restaurant at     in Taupo. The company had minimal assets. The assets used in the restaurant business appeared to be owned by the landlord. The liquidators determined that the only material assets were cash in the restaurant’s till and in the company’s bank account.

[13]   The company was incorporated in April 2017. Ms Pihama says that its financial   position   began   to   deteriorate   shortly   after   incorporation.   From   31 August 2017 onwards, the company’s accumulated liabilities owing to Inland Revenue for unpaid Goods and Services Tax (GST), income tax and PAYE deductions increased each month.  From the end of August  2017 to the date of liquidation on  15 November 2022, the company made only one payment to Inland Revenue, totalling

$594.20.

[14]   By 30 September 2018, the company was cashflow insolvent. There was no apparent means of paying its tax liabilities. By 30 September 2018, the tax liabilities which had accrued were $16,168.14. According to Ms Pihama’s analysis, the company funds available as at that date were only $3,973.60.

[15]   The company was also balance sheet insolvent. Its liabilities (to Inland Revenue  alone)  exceeded  its  assets  at  the  end  of  each  financial  year.    By     31 March 2022, company liabilities exceeded its assets by $178,448.62.

[16]   The company nonetheless continued to trade for a further four years from September 2018, until the date of liquidation.

[17]   By the date of liquidation, the significant arrears included other creditors, including an employee. It was apparent to the liquidators that they could not continue to trade profitably. They terminated the employment of the employees. They were unable to sell the company’s business to Mr Zeng and there was no viable business to sell to any third party.

[18]   Creditors’ claims in the liquidation total $351,443.55. Those claims have been assessed. Along with Inland Revenue, they include liabilities to the landlord, ACC, food suppliers and the employee claim of $41,360.58. Ms Pihama explains:

22.I annex marked “D” copies of the creditors’ claims filed in the liquidation from the creditors listed in the above table. The liquidators have not formally admitted these claims because there are no funds to pay the claims at this stage. However, from the liquidators’ review of these claims and investigations into the Company’s affairs, nothing in the claims appears to be incorrect and the liquidators expect to admit those claims in due course.

23.In October 2023, at the date of plaintiffs’ statement of claim, the Landlord’s creditor’s claim totalled $435,141.55 (including GST), being amounts owing to the Landlord for rent and OPEX through to the end of the lease (31 May 2026). As the Landlord was required to mitigate its losses post-liquidation, the liquidators revised the Landlord’s  claim   to   the   $34,358.07   originally   claimed.   On 19 December 2022, after the appointment of the second plaintiffs as liquidators, the defendant made a payment to the Landlord totalling

$20,323.77 towards the amount owing to the Landlord. Accordingly, the liquidators have further revised the Landlord’s claim to

$14,034.30.

Issues

[19]   I distil the issues to be whether the evidence before the Court establishes to the Court’s satisfaction:

(a)That the company was insolvent from 30 September 2018.

(b)Whether Mr Zeng breached his duties as director.

(c)If so, what is the assessment of damages?

First issue – the solvency test

[20]   The solvency test for companies is set out in s 4 of the Act. Subsection (1) of the Act provides:

4         Meaning of solvency test

(1)For the purposes of this Act, a company satisfies the solvency test if—

(a)the company is able to pay its debts as they become due in the normal course of business; and

(b)the value of the company’s assets is greater than the value of its liabilities, including contingent liabilities.

[21]   Accordingly, a company is “cashflow insolvent” if unable to pay its debts as they become due in the normal course of business. A company is “balance sheet insolvent” if the value of the company’s liabilities is greater than the value of its assets, including contingent liabilities.

[22]   I am satisfied that the evidence before the Court shows the company was unable to pay its debts as they became due in the normal course of business from    30 September 2018. On that date, it had $3,144.64 in its bank accounts, which was insufficient to pay the tax liability owing to Inland Revenue of $16,168.14.

[23]   Despite this, the company continued to accrue further liabilities to Inland Revenue over the next four years as it continued to trade.

[24]   I  conclude  therefore  that  the  company  was   cashflow  insolvent   from   30 September 2018.

[25]   In addition, I am satisfied that the company’s liabilities were also greater than the value of its assets from 30 September 2018 onwards, making it balance sheet insolvent. As at that date, the company’s liabilities to Inland Revenue exceeded its assets by at least $12,194.54. The value of the company’s liabilities continued to exceed the value of its assets thereafter.

[26]   The plaintiffs have established to the Court’s satisfaction that the company was insolvent from 30 September 2018.

Second issue – was there a breach of director’s duties?

[27]   A director of a company owes statutory and fiduciary duties to the company under the Act. Section 135 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.

[28]Section 137 provides:

137     Director’s duty of care

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

(a)the nature of the company; and

(b)the nature of the decision; and

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

[29]   The Supreme Court in Yan v Mainzeal Property and Construction Limited  (In Liq) sets out guidance for assessing liability under s 135.3 There is a two-stage approach. The first stage of the approach is that the court must objectively determine whether the business of the company was carried on in a way that was likely to create a substantial risk of serious loss to the company’s creditors. The second stage is to assess whether the actions of the directors were reasonable. That is, whether they were consistent with the care, skill and diligence expected of directors with the information the directors had, or should have had.

[30]   Directors are entitled to reasonable time to take stock of the situation and obtain professional or expert advice from sources independent of the company.4 They should assess whether there is a path forward for a company so that offers a reasonable basis for concluding that continued trading is not likely to create a substantial risk of serious loss to creditors. But directors must not continue to trade with the company creditors’ money unless they have put in place carefully thought-out strategies, with a good prospect of success, to restore the company’s solvency.5

[31]   The test under s 137 of the Act is objective. The circumstances of the director are relevant to the enquiry. Directors have a continuing obligation to monitor the performance and prospects of the company and, if they do not do so, will breach s 137. Directors should also recognise that a long-term strategy of trading while balance sheet insolvent is generally not acceptable.6

[32]   The plaintiffs contend that Mr Zeng conducted the company’s affairs in a manner  breaching   his   obligations   under   ss   135   and   137   from   at   least   31 December 2018. That is because the company’s bank account statements show that at no time from 30 September 2018 was the company balance sheet solvent. Nor do they show sufficient funds available to pay the amounts owing to Inland Revenue. It follows that as of 30 September 2018, Mr Zeng was under a duty to assess the company’s future and prospects and to act accordingly. The period between end

3      Yan v Mainzeal Property and Construction Limited (In Liq) [2023] NZSC 113, [2023] 1 NZLR 296 at [211].

4      At [271] and [273].

5      At [267]–[268].

6 At [272].

September and end December is said to allow for a reasonable time to make that assessment. There is no evidence he did so. On the contrary, Ms Pihama’s investigation of the company records discloses:

(a)No financial statements or other accounting records were prepared for the company at any time during Mr Zeng’s directorship.

(b)Mr Zeng did not attempt to engage with Inland Revenue in respect of the company’s tax liabilities, to negotiate a settlement or repayment arrangement.

(c)There is nothing to show that Mr Zeng took steps to improve the company’s revenue streams.

(d)There is no evidence that Mr Zeng sought external advice.

(e)Mr Zeng never provided a sufficient injection of funds to allow the company to continue to meet its liabilities.

[33]Thereafter the company’s financial position continued to deteriorate.

[34]   I am satisfied that Mr Zeng breached his duties by causing the company to trade in a manner likely to create a substantial risk of serious loss to the company’s creditors from 31 December 2018. There was an obvious substantial risk because the business was continuing to incur significant liabilities to Inland Revenue and other creditors when there was no apparent way for the company to meet those liabilities.

[35]   I am also satisfied on the basis of the material before the Court that, from at least 31 December 2018, Mr Zeng did not exercise the level of care, diligence, and skill that a reasonable director would have exercised in the same circumstances.

[36]Ms Pihama’s evidence is:

No reasonable director in Mr Zeng’s position would have elected to continue trading in the face of the company’s clear financial difficulties and when there was no way that the company would be able to meet its future obligations

when they fell due. No reasonable director would have elected to stop paying Inland Revenue and continue to trade in the face of the mounting tax obligations (and liabilities to other creditors, including an employee of the company).

[37]   Having regard to the guidance from the Supreme Court in Yan v Mainzeal, the evidence of Ms Pihama and the submissions of Mr Caird, I am satisfied that the plaintiffs    have     made     out     their     claim     for     liability     under     both     ss 135 and 137.7

[38]   The answer to the second issue of whether Mr Zeng breached his duties as director, is “yes”.

Third issue – what is the quantum?

[39]   Quantum falls to be determined by the net deterioration of the company’s position from the date of the breach to the date of liquidation. The total shortfall owing to creditors acts as a cap on recovery.8 Section 301(1)(b)(ii) of the Act reads:

301 Power 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,—

…

(b)      order that person—

…

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

…

7      The plaintiffs do not pursue their claim against the defendant under s 136 of the Act.

8      Yan v Mainzeal Property and Construction Limited (In Liq), above n 3 at [367].

[40]   While the language confers a discretion on the court, the Supreme Court stated in Yan v Mainzeal:9

…compensation for the full extent of such losses is not reserved for cases in which the breach of duty was egregious. Rather it should be regarded as the norm…

[41]   Assessment of loss based on net deterioration is necessarily premised on a counterfactual that assumes cessation of trading, and in practical terms liquidation, at breach date.10 In this case, the liquidators have reconstructed the position of the company which enables an assessment of the company’s affairs as at breach date and liquidation date. I am satisfied therefore that a net deterioration approach is both principled and practical.

[42]   Ms Pihama’s evidence is that the company’s “net deterioration” from the date of breach (31 December 2018) to the date of liquidation is $342,632.40. Mr Caird submits that there are no mitigating factors why Mr Zeng should not be liable for the full losses.

[43]   The net deterioration is calculated by reference to the difference between the company’s financial position at breach date, being ($8,811.15) and the total creditor’s claims at the liquidation date, being $351,443.55.

[44]   I am satisfied on the evidence that this sum is the appropriate quantification of relief for breach of director’s duties.

[45]   Accordingly, I enter judgment of $342,632.40 against Mr Zeng in respect of the breach of his director’s duties owed to the company under ss 135 and 137 of the Act.

[46]   In addition, I award interest on that amount pursuant to s 10 of the Interest on Money Claims Act 2016 from the date of liquidation to the date of payment.

9 At [350].

10 At [282].

[47]The plaintiffs are entitled to costs on a 2B basis plus disbursements.

............................................................

Walker J