Owens v Coleman

[2016] NZHC 2644

IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY

CIV-2016-404-138 [2016] NZHC 2644

UNDER

the Companies Act 1993

IN THE MATTER

of the liquidation of Hagfish NZ Ltd (In
Liquidation)

BETWEEN

COLIN DAVID OWENS AND DAVID STUART VANCE AS LIQUIDATORS OF HAGFISH NZ LTD (IN LIQUIDATION) Plaintiffs

AND

PETER COLEMAN First Defendant

PETER COLEMAN and TRUST MANAGEMENT SERVICES LTD as trustees of The Hunua Holdings Trust Second Defendants

Hearing:	8 September 2016
Counsel:	S J F Eglinton for Plaintiffs
Judgment:	4 November 2016

JUDGMENT OF BREWER J

This judgment was delivered by me on 4 November 2016 at 4:00 pm pursuant to Rule 11.5 High Court Rules.

Registrar/Deputy Registrar

Solicitors:           Ford Sumner (Wellington) for Plaintiffs

OWENS AND VANCE v COLEMAN [2016] NZHC 2644 [4 November 2016]

Introduction

[1]      The plaintiffs, as liquidators of Hagfish NZ Ltd (“Hagfish”), seek judgment

by default on the claims set out in their amended statement of claim dated 12 July

2016.

[2]      At the formal proof hearing on 8 September 2016, Ms Eglinton withdrew the claim against the second defendants.

[3]      The  formal  proof  hearing  was  not  completed.    I adjourned  it  part-heard because the one-hour allocated for it was insufficient and because I was unsure of the basis on which the plaintiffs were advancing the causes of action alleging breaches of duties owed by the defendant under the Companies Act 1993 (“the Act”).1   I said I would consider the material filed by the plaintiffs and issue a directions or case management minute if further evidential material would be of assistance.2

[4]      This Judgment determines the first and second causes of action and gives directions as to the determination of the fourth to sixth causes of action.

Background

[5]      Hagfish was incorporated on 24 September 2012 for the purpose of exporting hagfish3  from New Zealand to Japan and Korea.  It was put into liquidation on

20 February 2015.  Mr Coleman was the sole director.

First cause of action

[6]      The first cause of action claims $51,886.59 from Mr Coleman by way of repayment of his overdrawn current account.

[7]      The affidavit of Louise Adrienne Craig sworn on 27 June 2016 sets out the background to the liquidation, the indebtedness of Hagfish at the date of liquidation,4

1      The fourth to sixth causes of action.

2      Owens & Vance v Coleman HC Auckland CIV-2016-404-138, 8 September 2016 (Minute).

3      According to Wikipedia, hagfish are eel-shaped, slime producing marine fish which are unique in that they possess a skull but not a vertebral column.

4      $374,793.91, excluding interest owing on a debt to the Commissioner of Inland Revenue.

and the need to reconstruct Hagfish’s financial transactions by analysis of its bank statements.    The  need  arose  because  Mr Coleman  failed  to  provide  any  books, records or documents despite being served with a notice under s 261 of the Act.

[8]      I  am  satisfied,  having  regard  to  Ms Craig’s  affidavit,  that  Mr Coleman’s current account with Hagfish is $51,886.59, that it is overdrawn, that demand has been made on Mr Coleman and that he has not paid it.

[9]      I find for the plaintiffs on the first cause of action.

Second cause of action

[10]     The  second  cause  of  action  relates  to  the  recovery  of  $86,575  paid  by

Hagfish, ostensibly, to a company called Guyon Holdings Ltd (“GHL”).

[11]     The  point   is  that   GHL  was   struck   off  the   Companies   Register  on

13 September 2005, seven years before Hagfish was incorporated.  Mr Coleman and his wife were the sole directors and shareholders of GHL.

[12]     I  accept  the  evidence  of  Ms Craig  that  there  is  no  consideration,  nor commercial reason, for the payments to the account of this struck-off company.  The payments must be taken to be advances for the personal benefit of Mr Coleman. Demand has been made on Mr Coleman but he has failed to repay the money.

[13]     I find for the plaintiffs on the second cause of action.

Third cause of action

[14]     Although not expressed to be such, this is an alternative cause of action to the second cause of action.  It claims the $86,575 paid to GHL on the basis that GHL was Mr Coleman’s alter ego.   In other words, as sole director of Hagfish, when Mr Coleman made payments to GHL he was really making them to himself.  The payments are therefore advances by Hagfish to Mr Coleman and Mr Coleman is liable to repay them.  Demand has been made and he has not met the demand.

[15]     I find for the plaintiffs on the third cause of action.

Fourth to sixth causes of action

[16]     The fourth  to  sixth  causes  of action  each  claim  against  Mr Coleman  for

$414,949.53.   This is the amount calculated by the plaintiffs, and deposed to by Ms Craig, as being owed by Hagfish to its creditors together with liquidators’ costs and disbursements.

[17]     The legal bases for the claims are:

(a)       Fourth cause of action: breach of s 131 of the Act.   This provides

(relevantly):

131Duty of directors to act in good faith and in best interests of company

(1)       Subject  to  this  section,  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.

(b)      Fifth cause of action: breach of s 135 of the Act. This 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.

(c)       Sixth cause of action: breach of s 137 of the Act. This 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.

[18]     The remedy sought for the pleaded breaches is an order under s 301(1)(b) of the Act for $414,949.53:

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,—

…

(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;

Discussion

Section 301

[19]     The Court should follow a two-stage approach when considering making a s 301 order.5    First, the Court should consider whether there has been a breach of duty (or duties).  Second, the Court should, in its discretion, determine whether and to  what  extent  a  director  should  be  required  to  contribute  to  the  assets  of  the company.  It is important not to conflate the two sections at the outset.6

[20]     The power of the Court to make orders under s 301 is discretionary, but of course cannot be exercised arbitrarily.7    The Court is required to ascertain the conceptual nature of the duty which has been breached because that bears directly on

the principles to be applied when assessing the appropriate compensation to be

5      Peace and Glory Society Ltd (in liq) v Samsa [2009] NZCA 396, [2010] 2 NZLR 57 at [48].

6      Mason v Lewis [2006] 3 NZLR 225 (CA) at [55].

7      FXHT Fund Managers Ltd (in liq) v Oberholster [2010] NZCA 197 at [33].

ordered.  On this point, the Court of Appeal held in FXHT Fund Managers Ltd (in liq) v Oberholster:8

If the duty is of a truly fiduciary nature – that of loyalty or fidelity – then liability is strict and the “but for” test applies, effectively reversing the onus onto the delinquent director to prove that the loss would have been caused regardless of the breach. However, if the breach is of a general duty of care, akin to one arising in common law rather than equity, then the less onerous orthodox or standard principles of causation apply, placing the onus throughout on the plaintiff to prove the necessary causal nexus or link or, in other words, that his loss is attributable to the director's breach.

[21]     An example of the proper approach to a s 301 order is Mason v Lewis.  In it, the Court of Appeal identified the principles to be applied to cases involving reckless trading.9   The Court begins by looking at the deterioration in the company’s financial position between the date inadequate corporate governance became evident and the date of liquidation.   Once that figure has been ascertained there are three factors relevant  to  the exercise  of the Court’s  discretion:  causation,  culpability and  the

duration of the trading.  As Lang J put it in Madsen-Ries and Vance v Petera, the compensation under s 301 must relate to the loss that a company has suffered as a result of the acts or omissions underpinning the relevant breach of duty by the director.10

[22]     Therefore, before making an order under s 301, the Court must be able to identify the precise nature of a director’s breach and be able to fix with requisite specificity the point at which the director was in dereliction of his or her duty.

[23]     I will set out the legal principles relevant to establishing breaches of ss 131,

135 and 137 and then turn to the contentions of the plaintiffs and the evidence in support of them.

Section 131

[24]     Section 131 requires a director to act in good faith and in what the director believes to be the best interests of the company. Although the duty in s 131 is cast in

8 Ibid at [28]. See also the discussion of the Court of Appeal in Morgenstern v Jeffreys [2014] NZCA 449 at [99]-[100].

9      Mason v Lewis at [107]-[118].

10     Madsen-Ries and Vance v Petera [2015] NZHC 538 at [94].

subjective terms, the case law establishes that a director will be unable to discharge the duty by acting with a belief that what he or she is doing is in the best interests of the company if that belief rests on a wholly inappropriate appreciation as to the interests of the company.11

Section 135

[25]     Section 135 prohibits reckless trading of a kind that is “likely to create a substantial risk of serious loss to the company’s 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.  As the Court of Appeal held in Mason v Lewis, what is required when a company enters troubled waters is a sober assessment by the directors of an ongoing character, as to the company’s likely future income and

prospects.12   Critically for present purposes, when determining whether a director is

in breach of s 135, the courts often allow a period of time “for reality to dawn”.13  As William Young J observed in Re South Pacific Shipping Ltd (in liq), there is no suggestion that a company must cease trading the moment it becomes insolvent in a balance sheet sense.14    The approach of the Court is often to fix a point in time at which the Court is satisfied that the company is insolvent and then allow a period of time in which the director is afforded an opportunity to take stock and perform the sober assessment referred to in Mason.  Both Heath J in Syntax Holdings (Auckland) Ltd (in liq) and Brown J in Richard Geewiz Gee Consultants Ltd (in liq) allowed six months for this purpose.15

Section 137

[26]     Section  137  imposes  a  duty  to  exercise  the  care,  diligence  and  skill  a reasonable director would exercise in the same circumstances, taking into account

11     Sojourner v Robb [2006] 3 NZLR 808 (HC) at [102]. See Australian Growth Resources Ltd v

Van Reesema (1988) 13 ACLR 261, 6 ACLC 529.

12     Mason v Lewis, above n 6, at [51].

13     Richard Geewiz Gee Consultants Ltd (in liq) v Gee [2014] NZHC 1483 at [99].

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

15     Richard Geewiz Gee Consultants Ltd (in liq) at [102]; Syntax Holdings (Auckland) Ltd (in liq) v

Bishop [2013] NZHC 2171 at [24].

the nature of the company, the nature of the decision, the position held by the defendant as director and the nature of the responsibilities undertaken by him.16

The plaintiffs’ case

[27]     Ms Eglinton submits that there is evidence that Mr Coleman has breached ss 131, 135 and 137.  There is considerable overlap between the conduct alleged to breach s 131 and that alleged to breach ss 135 and 137.   In effect, Ms Eglinton submits that Mr Coleman breached all his duties because he:

(a)       made  personal  and/or  unauthorised  payments  to  himself  at  the

expense of Hagfish’s creditors;

(b)failed to ensure Hagfish met its obligations to pay its creditors on time;

(c)      allowed Hagfish to continue trading and incur further debts after it did not have access to sufficient funds in its account to meet payment of its indebtedness;

(d)filed  tax  returns  which  zero  rated  a  number  of  transactions  and claimed deductions for input tax which could not be verified on investigation by the IRD.   This resulted in significantly more GST being owed by the company than was actually paid.

[28]     Ms Eglinton submits that, because Mr Coleman was the company’s sole director from its incorporation on 24 September 2012, all losses since this date are directly attributable to Mr Coleman’s acts or omissions.  I find that submission to be overly broad.  The plaintiffs must show a causal nexus between any breach of duty and subsequent loss.

[29]     The first point to make is that, given my findings on the first three causes of action, Mr Coleman will be required to restore the full amount of company money

16     Keshvara v Blanchett [2012] NZCA 553, (2012) 21 PRNZ 475 at [16].

applied to his personal benefit. The company cannot recover twice.17    As a result, Mr Coleman’s personal payments, even if made in breach of s 131, cannot found a further  order   for   compensation   under  s 301   because  they  do   not   establish independent loss.

[30]     Turning to the submission summarised in paragraph [27](b), it is true that a director’s duty to the company includes doing his or her best to ensure the company meets its obligations, current and contingent.18   But context is critical.  The financial position of the company, for example, will inform the nature of the breach and the appropriate order to be made under s 301.   Ms Eglinton submits that Mr Coleman allowed Hagfish to continue trading and incur further debts after it did not have access to sufficient funds in its account to meet payment of its indebtedness.  For that submission to be accepted there must be evidence of when Hagfish was insolvent or

was nearing insolvency.

[31]     The plaintiffs rely on Ms Craig’s affidavit.  But Ms Craig is handicapped by a lack of relevant documentation.   For example, there are no financial statements. Ms Craig’s evidence pertains primarily to Hagfish’s bank account statements and correspondence with the creditors in which they provide their claims against the company.

[32]     In her affidavit, Ms Craig makes a number of conclusory assertions supported only by general references to the evidence:

22.As a result of the investigations referred to above, I formed the view that the first defendant had breached his director’s duties under the Act by:

22.1Advancing sums for his personal benefit when the Company was not in a position to make payments to creditors, which was not in the best interests of the Company (section 135 of the Act).

For   example,   between   24   September   2012   until   22

September 2014, the first defendant, through the Company, had paid for items of a personal nature, made advances to his

bank account and made advances to GHL, which totalled

17     Madsen-Ries and Vance v Petera, above n 10, at [96].

18     Sojourner v Robb, above n 11, at [103].

$138,461.59 at a time (by 22 September 2014) when the

Company owed Blueprint $90,530.46;

22.2Preferring to draw the Company’s funds for personal use over payment of the company’s creditors, which resulted in the debts to creditors increasing while at the same time exposing the creditors to a substantial risk of serious loss (section 135 of the Act);

22.3By preferring himself over the Company’s creditors, the first defendant was not exercising the care, diligence and skill that a reasonable director would exercise in the same circumstances (section 137 of the Act).

23.As  a  result  of  the  first  defendant’s  actions/breach  of  duties,  the Company  and  its  creditors  were  exposed  to  loss  and/or  serious losses.

24.I therefore consider the first defendant is personally liable for the total amount owing by the Company to its creditors, which due to the   Inland   Revenue’s   amended   creditor’s   claim,   is   at   least

$374,793.91 together with the liquidators’ costs and disbursements
totalling $41,686.38 (including GST).

[33]     This  evidence  does  not  make  apparent  the  point  at  which  the  company became insolvent or was nearing insolvency.   It is not the task of the Court to examine the exhibits and draw its own inferences to establish a central foundation of the plaintiffs’ case.

[34]     Given the current state of the evidence before me, I am unable to confidently conclude that Hagfish was insolvent or nearing insolvency throughout the entire duration of its existence.   To the contrary, my initial reading of the bank account statements shows Hagfish receiving significant sums of money at regular intervals throughout the early months of its incorporation.   It may be that a number of the early debts were incurred perfectly legitimately.  What is required is an assessment of the company’s assets and liabilities so that the Court can ascertain with a degree of precision the point at which a sober assessment as to Hagfish’s likely future income and prospects was called for.   To be clear, I need to be in a position to ascertain which of Hagfish’s debts were not incurred legitimately.   Generally, the Court is assisted by expert opinion on these matters.

[35]     Finally, I turn to the submission made under paragraph [27](d), namely that

Mr Coleman filed tax returns which zero rated a number of transactions and claimed

deductions for input tax which could not be verified on investigation by the IRD. My view is that Mr Coleman, in breach of s 137, failed to exercise the care, diligence and skill a reasonable director would exercise in the same circumstances.   I reach this view for two reasons.  First, Mr Coleman delayed filing Hagfish’s tax returns, exposing the company to significant penalties and interest.  Second, when Hagfish was later investigated by the IRD, Mr Coleman was unable to provide any reliable tax invoices or documents to support earlier tax input deductions and certain zero rated transactions.  That meant the company was later assessed to owe substantially more GST than it had initially paid.  It is, therefore, just that Mr Coleman personally compensate the company to the full extent of its liability to the IRD.  I am satisfied, having regard to Ms Craig’s second affidavit sworn on 31 August 2016, that this figure is $243,555.75.

[36]     However, that does not mean that Mr Coleman must be personally liable to the full extent of the other creditors’ claims.  If Mr Coleman had complied with his tax obligations there is no reason to suggest that Hagfish would not have gone on to legitimately  incur  debts  in  the  ordinary  course  of  its  business.   A finding  that Mr Coleman breached his duties in relation to Hagfish’s tax responsibilities does not compel a conclusion that he is to be liable for the full amount of the company’s other debts.

[37]     I find for the plaintiffs on this aspect of the sixth cause of action for the sum of $243,555.75.

Conclusion

[38]     This proceeding is part-heard.  On my analysis, I cannot fully determine the fourth, fifth and sixth causes of action on the evidence before me currently.  I will give  the  plaintiffs  the  opportunity to  provide  further  evidence,  including  expert opinion evidence, on the matters I have discussed.   I bear in mind that this is a formal  proof matter and  that  the plaintiffs have been  put  to  a disadvantage by Mr Coleman’s failure to provide company records.

[39]     Any   further   evidence,   and   submissions   thereon,   are   to   be   filed   by

2 December 2016.  I will then deliver a final judgment on the papers.  If no evidence is to be filed, the plaintiffs are to advise me of their decision forthwith.

[40]     I have not determined whether an order should be made for the liquidators’ full costs and disbursements.  As a general rule, a director of a company which is in liquidation is not liable personally for the costs of the liquidation. A director may be liable personally for some, or possibly all, of the liquidation costs if his or her breach of duty caused the costs to be incurred.  There needs to be a causal link and this has to be identified and the resulting costs quantified.  The plaintiffs have made brief, conclusionary, submissions on this point.  More is required.

Decision

[41]     In this Judgment:

(a)       On the first cause of action I find for the plaintiffs in the sum of

$51,886.59.

(b)On the second and third causes of action I find for the plaintiffs in the sum of $86,575.

(c)       On the sixth cause of action, to this point, I find for the plaintiffs in the sum of $243,555.75.

(d)      I award costs to the plaintiffs on a 2B basis.  These are to be set by the

Registrar.

Brewer J