Richard Geewiz Gee Consultants Ltd (in Liq) v Gee
[2014] NZHC 1483
•30 June 2014
IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY
CIV-2012-404-2456 [2014] NZHC 1483
BETWEEN RICHARD GEEWIZ GEE
CONSULTANTS LIMITED (IN LIQUIDATION)
First Plaintiff
HENRY DAVID LEVIN AND VIVIEN JUDITH MADSEN-RIES AS LIQUIDATORS OF RICHARD GEEWIZ GEE CONSULTANTS LIMITED (IN LIQUIDATION)
Second Plaintiffs
AND
RICHARD PETER GEE First Defendant
JUDITH GEE Second Defendant
Hearing: 5-8 May 2014 Appearances:
J Sumner for Plaintiffs First Defendant in person Second Defendant in person
Judgment:
30 June 2014
JUDGMENT OF BROWN J
This judgment was delivered by me on 30 June 2014 at 3.30 pm, pursuant to r 11.5 of the High Court Rules
Registrar/Deputy Registrar
Solicitors: Ford Summer, Wellington
Copy To: Defendants
RICHARD GEEWIZ GEE CONSULTANTS LTD (IN LIQ) v GEE [2014] NZHC 1483 [30 June 2014]
Introduction
[1] Until it ceased trading on 30 September 2008 Richard Geewiz Gee Consultants Ltd, now in liquidation, (“the company”) provided consulting and marketing services. Those services were personally undertaken by the first defendant (“Mr Gee”) who was the sole director and an equal shareholder with the second defendant (“Mrs Gee”).
[2] From mid-2005 the company began accumulating debt to the Inland Revenue Department and from July 2006 it ceased to pay GST. On 31 October 2008 on the application of Inland Revenue the company was placed into liquidation and the second plaintiffs were appointed jointly and severally as liquidators of the company.
[3] In this proceeding the company and the liquidators seek recovery of various sums with the objective of paying both the amounts due to the company’s creditors and the costs of the liquidation.
Overview of claim
[4] The statement of claim pleads nine causes of action. The first, third, fourth and fifth causes of action are by the company against Mr Gee comprising:
(a) A claim that Mr Gee pay to the company the amount allegedly
overdrawn from the shareholders’ current account in the sum of
$52,998; and
(b)A claim that Mr Gee return to the company a payment of $34,591 made to him by way of salary in the year ended 31 March 2007. Allegations are made (in the alternative) of a failure of compliance with ss 161, 56 and 52 of the Companies Act 1993 (“the Act”).
[5] The second cause of action by the company against Mrs Gee parallels the first cause of action against Mr Gee and seeks recovery from her of the amount allegedly overdrawn from the shareholders’ current account in the sum of $52,998.
[6] Causes of action six to nine are brought by the liquidators against Mr Gee alleging breaches by him of ss 131, 135, 136 and 137 of the Act. In each case two orders are sought: an order that Mr Gee repay the sum of $54,033.75, being the amount owed to the company’s creditors at the date of liquidation, and an order that Mr Gee pay the sum of $36,308.83 being the liquidators’ costs and disbursements in the liquidation.
[7] The issues which these various causes of action potentially raise were
summarised in the plaintiffs’ opening which I adapt as follows:
(a) Was the shareholders’ current account overdrawn at 31 October 2008
and, if so, are Mr and Mrs Gee liable for repayment of the same?
(b) Was the salary paid to Mr Gee for the years ended 31 March 2007 and
31 March 2008 and the six months ended 30 September 2008 fair to the company?
(c) If not, what is Mr Gee’s liability?
(d) Did Mr Gee breach ss 131, 135, 136 and/or 137 of the Act?
(i)Section 131: Did Mr Gee act in good faith and in what he believed to be the best interest of the company?
(ii)Section 135: Did Mr Gee cause or allow the company’s business to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors?
(iii)Section 136: Did Mr Gee allow obligation(s) to be incurred without the belief on reasonable grounds that the company would be able to perform that/those obligation(s) when required?
(iv)Section 137: Did Mr Gee exercise the care, diligence, and skill that a reasonable director would exercise in the same
circumstances taking into account the nature of the company, the nature of the decision, and the position of the director and the nature of the responsibilities undertaken by him?
(v)If Mr Gee has breached any of the obligations detailed at paragraphs (d)(i)-(iv) above, what compensation is he required to pay pursuant to s 301 of the Act?
[8] It was agreed between Mr Sumner and Mr and Mrs Gee that the documents in the two volumes of the Common Bundle would be evidence in the proceeding and hence it was unnecessary to follow the procedure provided for in r 9.5(4) of the High Court Rules.
[9] Even without the assistance of legal representation, Mr Gee presented his case (and in effect also the case for Mrs Gee) very creditably in what is a moderately complex area of law. However he laboured under the misapprehension that the dismissal of the summary judgment application by Katz J was a substantive determination of various issues in his favour. He also considered that the proceeding against him was frivolous and motivated by extraneous considerations. This belief manifested itself in his complaint about the second plaintiffs to the New Zealand Institute of Chartered Accountants.
Material facts
[10] The company was incorporated on 23 October 2001 with the name PSM Holdings Limited. On 14 June 2005 the company’s name was changed to Richard Geewiz Gee Consultants Limited. Mr Gee has been the company’s sole director since its incorporation.
[11] From July 2005 the company began accumulating debt to Inland Revenue initially in respect of PAYE and subsequently in respect of both GST and KiwiSaver Employer deductions. The company incurred penalties and interest in relation to PAYE from July 2005.
[12] Mr Tim Livingstone, a director of UHY Haines Norton (Auckland) Ltd (formerly Butts Bainbridge & Weir), Chartered Accountants, was Mr Gee’s accountant for some 25 years. He was also the company’s tax agent in respect of PAYE. On 29 November 2006 Inland Revenue wrote to Mr Livingstone (with a copy to Mr Gee) recording disappointment that Mr Gee had again fallen into an arrears situation with regard to his personal tax “and now, the newly formed company tax” (a reference to the company’s tax position). The summary of arrears for the company as at 27 November 2006, attached to that letter, showed an amount outstanding of $2,478.89.
[13] Although Inland Revenue file notes in December 2006 indicated that the company had agreed to clear the amounts then owing by 28 February 2007, arrears continued to accrue. On 1 October 2007 Mr Livingstone sent a letter to Mr Gee advising that he had received from Inland Revenue details of Mr Gee’s and the company’s tax arrears from July 2005 to May 2007, particulars of which were recorded in the letter. The arrears for the company, which concerned PAYE alone, were in excess of $9,000. Mr Gee’s arrears for income tax were approximately
$22,000.
[14] In his letter Mr Livingstone explained that, if it was not possible to pay the outstanding taxes and accrued interest and penalties, which he warned could mount up very quickly if left unaddressed, it was essential that contact be made with the Inland Revenue and a repayment arrangement agreed.
[15] Notwithstanding that advice, from October 2007 (with the exception of two months) the company failed to pay PAYE assessments and also from that date it failed to pay its Kiwisaver Employer deductions. On 24 January 2008 Inland Revenue attempted to contact Mr Gee concerning the company’s failure to account for PAYE and Kiwisaver Employer Deductions from October 2007.
[16] More significant in dollar terms, however, was the company’s failure to
account for GST. It made a substantial short payment for the period ending 31 July
2006 and thereafter it failed to make any GST payments, which resulted in
significant penalties and interest being incurred. As at December 2007 the amount owed for GST, penalties and interest was in excess of $26,000.
[17] In a letter provided on or about 1 February 2008 (erroneously dated
1 February 2007), Mr Livingstone informed Mr Gee that the company was insolvent and drew his attention to the possible consequences of continuing to trade while insolvent.
[18] This letter was generated at the time of Mr Livingstone’s preparation of the company’s financial statements for the year ended 31 March 2007. It appears that a copy of the letter was attached to those statements as an Insolvency Appendix. It said:
In preparing the Financial Statements for your company for the year ended
31 March 2007 we note that the liabilities of the company exceeded its assets at that date.
Technically, your company was, at that date, insolvent. This note is produced automatically when the company books show more liabilities than assets. We would suggest that you discuss this with us. It may be that despite the financial result the company is not insolvent for a variety of reasons.
If a company is insolvent and it continues to trade, the Directors and the company will be in breach of The Companies Act, 1993, and they could be prosecuted; further, if the company were to go into liquidation without paying its creditors in full, the Directors might be held to be personally liable for part or all of the shortfall to the unpaid creditors.
[19] Then, after drawing attention to ss 135 and 136 of the Act, it said:
Additionally, your company cannot (whilst it remains insolvent) issue a
‘Solvency Certificate’ which is a necessary prerequisite to a number of matters such as making a ‘Distribution’ (e.g. paying a dividend), reducing its
capital, and – in some circumstances – paying salaries or drawings to working shareholders.
[20] The letter of 1 February 2008 was not an isolated communication. In a letter dated 9 June 2009 (but likely to have been sent on 9 June 2010), Mr Livingstone informed Mr Gee’s then solicitors that the company was insolvent the entire time it was in operation and that he had written to Mr Gee each year advising him of its insolvent status. In evidence Mr Livingstone elaborated on the statement in that letter in the following way:
… so the only time that I touch the company’s financial position is once a
year and that’s when we do the annual set of accounts, so this company had a
2006 set of accounts and 2007 set of accounts and at both times there was a indication that there was excess liabilities over assets for the year ended
2006 and 2007, so again it was really reiterating, I would have sent a letter to the client in 2006 indicating insolvency and in 2008 indicating technical insolvency.
[21] During January or February 2008 Mr Livingstone prepared the company’s financial statements for the year ended 31 March 2007. Although the compilation report to the directors was dated 1 February 2007, it is plain that the accounts were provided and signed not earlier than 1 February 2008.
[22] Those statements showed that as at 31 March 2007 the company owed Mr and Mrs Gee $16,508.00. Ms Madsen-Ries, one of the liquidators, provided the following analysis of the derivation of that balance in the shareholders’ current account:
On or before 5 February 2008, when the Company’s accountant prepared the financial statements for the year ended 31 March 2007, he/she created a book entry salary expense that increased the level of the Company’s expenses by $46,160.00 and created a liability in favour of Mr Gee (for
$34,591) and Mrs Gee (for $11,569) for unpaid salary.
Prior to this book entry, the Company’s taxable surplus was $46,160.00. Therefore, the salary expense created by the Company’s accountant reduced the taxable surplus to $0.00.
The $46,160.00 liability owed to Mr and Mrs Gee was then set off against and extinguished the amount they would have owed the Company (being
$29,652.00) if not for the book entry, and created the debt owed by the
Company to them (of $16,508.00) as recorded in the financial statements.
[23] In the letter to the company’s solicitor in June 2010 referred to at [20] Mr Livingstone explained what had occurred:
In the first year the company made a loss of $14,302 and was insolvent at year end. In March 2007 the company made a profit of $46,160 and this was paid out as shareholder salaries to Richard and Judith. There were $3649 non-deductible penalties from the IRD for non-payment of GST and PAYE etc. At the end of the 2007 year the company was again insolvent.
[24] The three figures $34,591, $11,569 and $16,508 are shown in the column headed “FYE 2007” in the summary of shareholders’ loan movements table below produced by Ms Madsen-Ries:
30/9/08-
Ceased
Trading
FYE 2008
$
FYE 2007
$
FYE 2006
$
Opening Balance (32,083) 16,508 12,719 - Salary-Richard Gee
-
-
34,591
-
Salary-Judith Gee 9,151 21,360 11,569 - Donations - 300 - - Drawings Richard P Gee 15,549 - - - House Charges 201 1,108 4,757 493 Assets/Liabilities transferred
from Duncansby No 16 Ltd
- - - 29,200 (7,182) 39, 276 63,636 29,693 Less Donations & School Fees - 400 - 40 Earner Premium - - 535 1,070 Drawings 15,305 70,959 46,013 15,132 Motor Vehicle - - 580 732 15,305 71,359 47,128 16,974 Total ($22,487) ($32,083) $16,508 $12,719
[25] On or about 1 February 2008 Mr Gee signed a director’s resolution in respect of Mr Gee’s drawings of $34,591.00 for the year ended 31 March 2007. Mr Gee also signed a certificate of fair value which is recited at [42] below. Both documents had been prepared by Mr Livingstone and both were erroneously dated 1 February 2007. The resolution contained the following acknowledgment:
We acknowledge that Butts, Bainbridge & Weir, Chartered Accountants, have explained and we understand that it is important that the directors of Richard Geewiz Gee Consultants Limited have considered and concluded that the remuneration paid or credited to the person(s), named in Resolution
2 above, for their services to the company are fair to the company for the services supplied. The Directors consider that the said remunerations are not excessive.
We clearly understand that if a liquidator, receiver or shareholder considered that the remunerations were not fair to the company for the services supplied, or that they are excessive, the amount considered unfair or excessive could be demanded to be refunded to the company.
[26] It was something of a puzzle as to how those documents, in fact signed on or after 1 February 2008, came to bear the date 1 February 2007. However, having observed Mr Gee and Mr Livingstone in the witness box, I do not consider that the erroneous date was a deliberate attempt to construct false documentation. Indeed it
would have been an inept attempt given that the purported date was two months prior to the end of the relevant financial year.
[27] I accept the explanation proffered in Mr Livingstone’s affidavit of 15 October
2012 that the 1 February 2007 date was inserted by mistake by someone in Mr Livingstone’s firm when the documents were prepared for Mr Gee. However, the fact that the error was not detected either by the accountants or Mr Gee is in my view an indicator of the perfunctory manner in which the accounts, the director’s resolution and the certificate of value were prepared and completed.
[28] On 1 April 2008 Inland Revenue left another message for Mr Gee. The file note recorded that if no contact was received, the next action would be to issue a statutory demand. In a further file note dated 5 May 2008 Inland Revenue recorded that satisfactory contact had not been made with the company and a statutory demand for $34,963.83 had been prepared. On 9 May 2008, Inland Revenue served a statutory demand on the company for the sum of $34,963.83.
[29] On 18 May 2008 Mr Gee informed Inland Revenue:
(a) That the company had “struggled to overcome the cash flow problems”;
(b) Undertook to make payments of PAYE and GST on time in future;
(c) Indicated that he would request Inland Revenue to “review the penalties” imposed; and
(d)That liquidation would not produce funds to satisfy the company’s debt and that it was better for him to work through it with Inland Revenue.
[30] Mr Gee made two proposals to Inland Revenue to pay over time the arrears due. These proposals were declined for the following reasons:
(a) Mr Gee had proposed to pay all PAYE and GST when it fell due, but had failed to do so;
(b)Mr Gee had a poor personal tax compliance history and had breached the terms of an instalment arrangement in respect of his personal tax arrears;
(c) The cashflow forecast provided by Mr Gee indicated the company would struggle to meet its obligations under the proposed instalment arrangement;
(d) Mr Gee acknowledged the company was insolvent; (e) The company had a poor tax compliance record; and
(f) The integrity of the tax system required that the proposal be declined.
[31] On 9 July 2008 Inland Revenue filed a statement of claim seeking an order placing the company into liquidation.
[32] By a written agreement dated 2 September 2008 the company agreed to sell to a new company, Geewiz Ltd, its fixed assets comprising two motor vehicles, a data projector and a laptop computer. The agreement, which was signed by Mr Gee on behalf of both parties, stated that “due to an impending liquidation of Richard Geewiz Gee Consultants Ltd” the company had agreed to sell its assets at fair market value.
[33] On 30 September 2008 the company ceased trading. On the same day, nearly three months after the Inland Revenue had applied to the Court to place the company into liquidation, a director’s resolution and certificate of fair value in respect of Mr Gee’s drawings of $57,532 for the year ended 31 March 2008 (prepared by Mr Livingstone) were signed by Mr Gee.
[34] On 27 October 2008 (five days prior to the company being placed into
liquidation on 31 October 2008) a director’s resolution and certificate of fair value in
respect of Mr Gee’s drawings of $31,684 for the six month period ending
30 September 2008 (again prepared by Mr Livingstone) were signed by Mr Gee.
[35] Mr Livingstone acknowledged that he prepared the certificates without considering the solvency of the company and without a set of financial accounts. The following cross-examination followed:
Q. So you didn’t turn your mind at the end of 2008 with these certificates, prepared them, but you didn’t actually explore whether the company was insolvent and whether it was appropriate to sign these at that time?
A. I am sure I would have spoken to Richard about the risks of continuing to trade, of continuing to draw funds from the business and if the company is – I mean I would have been aware at that time that there was solvency issues because Richard had already indicated that he was looking to liquidate the company and to liquidate the company you’ve got to be insolvent, so I would have been aware of the insolvency, however, you know, from my perspective I believe, I believed at the time that you could still fairly declare a salary providing it was a fair market salary and not an unfair market salary.
Q. So you don’t, in your practice, take into account the solvency of a company and the expense and issues that creates with creditors at all when you declare these certificates?
A. No.
Q. Do you accept there’s a distinction between a solvent company and an insolvent company when it comes time to declare in these certificates?
A. I believe the answer would be yes.
Q. Do you accept that the impact of executing these certificates just prior to liquidation was to remove one of the key assets of the company out of the hands of the liquidators?
A. Ah yes.
Q. And when that was done with knowledge of liquidation that takes away one of the key assets of the company, an insolvent company?
A. Ah the answer is yes but equally the company has, through the minute, effectively entered into a contract with the shareholder as well to provide a fair market salary.
[36] It was apparent from the cross-examination of Mr Livingstone that it was only on or after 27 October 2008 that he made the following three handwritten entries in the company’s interests register.
Company Name: Richard Geewiz Gee Consultants Ltd DIRECTORS’ REMUNERATION AND OTHER BENEFITS Name of Director Date of Entry in the Register Description of Benefit R Gee R Gee R Gee 1/2/07
30/9/08
27/10/08
Shareholder’s salary $34,591
plus use of company vehicle. Y/e 31/3/07.
Shareholder’s salary of
$57,532 and use of company vehicle. Y/e 31/3/08. Shareholder’s salary of
31,684 and use of company vehicle. P/e 30/9/08.
He acknowledged that at the date he made those entries he understood that the company could go into liquidation.
[37] The claims filed by creditors in the liquidation totalled $54,033.75. The recovery of that sum was one of the orders sought in the four causes of action brought by the liquidators for contravention of various sections of the Act. The amount of the claims admitted is slightly reduced at $53,643.99 and the claim made by the liquidators is adjusted accordingly.
The claim to recover the amount of $34,591
[38] It is convenient to consider the issues in this matter in chronological order. Hence I first address the claim for an order that Mr Gee repay to the company the amount of $34,591 which was the subject of the directors’ resolution and certificate of fair value signed by Mr Gee on or about 1 February 2008. That claim is the subject of three distinct causes of action:
(a) a claim that there was non-compliance with s 161 of the Act;
(b) a claim that the payment was a distribution repayable under s 56; and
(c) a claim that the payment was not in compliance with s 52.
The s 161 claim
[39] Section 161 provides in material part:
161 Remuneration and other benefits
(1) The board of a company may, subject to any restrictions contained in the constitution of the company, authorise—
(a) The payment of remuneration or the provision of other benefits by the company to a director for services as a director or in any other capacity:
…
(2) The board must ensure that forthwith after authorising the making of the payment or the provision of the benefit or the making of the loan or the giving of the guarantee or the entering into of the contract, as the case may be, particulars of the payment or benefit or loan or guarantee or contract are entered in the interests register.
…
(4) Directors who vote in favour of authorising a payment, benefit, loan, guarantee, or contract under subsection (1) of this section must sign a certificate stating that, in their opinion, the making of the payment or the provision of the benefit, or the making of the loan, or the giving of the guarantee, or the entering into of the contract is fair to the company, and the grounds for that opinion.
(5) Where a payment is made or other benefit provided or a guarantee is given to which subsection (1) of this section applies and either—
(a) The provisions of subsections (1) and (4) of this section have not been complied with; or
b)Reasonable grounds did not exist for the opinion set out in the certificate given under subsection (4) of this section,—
the director or former director to whom the payment is made or the benefit is provided, or in respect of whom the guarantee is given, as the case may be, is personally liable to the company for the amount of the payment, or the monetary value of the benefit, or any amount paid by the company under the guarantee, except to the extent to which he or she proves that the payment or benefit or guarantee was fair to the company at the time it was made, provided, or given.
(6) Where a loan is made to which subsection (1) of this section applies and either—
(a) The provisions of subsections (1) and (4) of this section have not been complied with; or
(b) Reasonable grounds did not exist for the opinion set out in the certificate given under subsection (4) of this section,—
the loan becomes immediately repayable to the company by the director, notwithstanding the terms of any agreement relating to the giving of the loan, except to the extent to which he or she proves that the loan was fair to the company at the time it was given
[40] It appears that when the proceeding was first filed, the plaintiffs were under the impression that Mr Gee had not completed a s 161(4) certificate in respect of the salary of $34,591. Indeed a letter dated 23 April 2010 from Ford Sumner, the lawyers for the liquidators, to Mr Gee asserted that a certificate had not been signed and that there had been no entry in the interests register. Hence the allegation in paragraph 21 of the statement of claim that Mr Gee had failed to comply with the s 161 requirement.
[41] However, in the course of the summary judgment application, Mr Gee put in evidence the director’s certificate dated 1 February 2007 (but in fact signed no earlier than 1 February 2008) and an extract from the company’s interests register.1
It was apparent from the narration of Mr Livingstone’s fee note of 31 January 2008 that Mr Livingstone had prepared the certificate of fair value and the shareholder and director resolutions, a fact that he confirmed in the course of his evidence.
[42] Consequently the focus of argument under this head moved to the issue of whether in terms of s 161(5)(b) reasonable grounds existed for Mr Gee’s opinion in the certificate which stated:
Certified:
That the remuneration which is detailed below, and is shown as an expense in the Financial Statements for the year ended 31 March 2007 as paid/or credited to the person(s) named below, for services to the company for the period covered by the said Financial Statements by way of Directors fees, salaries, wages, bonuses, commissions, management fees, or otherwise (howsoever called) pursuant to a resolution of the Directors dated 1 February
2007 are fair to the Company:
Remuneration:
R.P. Gee $34,591
1 Richard Geewiz Gee Consultants Ltd (in liq) v Gee [2013] NZHC 620 at [10].
The grounds for this opinion are that the amount(s) is/are commensurate with the experience, knowledge, time, effort and skills provided to the company by the recipient(s).
[43] The present case raises an issue of interpretation with reference to s 161 which does not appear to have been the subject of previous consideration in the authorities. The issue arises because of the contention by Mr Gee that the payments were fair to the company “at the time of giving” which I understood to mean during the period of the actual drawings. That approach appeared to have the endorsement of Mr Livingstone who made the point that the drawings had been drawn out of the company over a 12 month period spanning 2006-2007. As he said:
… you have to go back and say from the 1st of April 2007, which is the beginning of the 2008 year, okay, you know the shareholder/employee turned up to work that morning and did his job, okay, as an employer and so that is still being fair to – I mean we don’t go everyday and do a shareholder’s resolution to allocate a shareholder’s salary, so it is a retrospective looking back type process and it was, it could very well be argued that it was fair to that employee to receive a salary.
[44] The contention, as I understood it, was that the issue of fairness to the company should be assessed as at the point in time (or more accurately over the period of time) when the drawings were taken. Consequently, while s 161(4) refers to directors stating their opinion that the authorised payment “is fair to the company” (in the present tense), the argument would be that the issue of fairness would be a retrospective analysis relative to the company’s state at the earlier point in time rather than at the date of the signing of the certificate.
[45] To my mind one answer to that question is to be found in the phrase “the payment of remuneration” referred to in s 161(1)(a) and likewise in the subsequent references to “payment” in subsections (2), (4) and (5). In the run of the mill small company, drawings will be taken by a director-employee throughout the period of a financial year (such drawings being reflected as an increasing level of debt in the shareholders’ current account). A resolution (and certificate of fair value) will later
be made authorising the payment of a salary which has the effect of repaying2 the
overdrawn current account. The question is: does the “payment” which is authorised
2 The debit in the shareholders’ current account is balanced by a credit when the profit is determined and salaries are the subject of a resolution: e.g. see Re Gellert Developments Ltd (in liquidation) (2002) 9 NZCLC 262,942 at [44].
and referred to in s 161 comprise the sequence of drawings (progressively debited to the shareholders’ current account) or the salary subsequently approved (and then credited to that account)?
[46] I consider that the payment of remuneration which is authorised is the salary which the board agrees to pay to the director (in whatever capacity) and which is then credited to the shareholders’ current account to balance the drawings which have been progressively taken. I do not consider that the “payment” referred to in s 161(1)(a) is a reference to the individual instances of drawings such that the authorisation is in effect a form of ratification.
[47] The practical effect may be the same, in that the debit in that account is brought into balance by the crediting of the salary. However the true position is that the drawings are in the nature of temporary advances in anticipation of a salary being approved.
[48] The amount of that debt in the shareholders’ current account is (at least in theory) an asset of the company and capable of being recovered by the company from the shareholders. It is only at the point in time when the board approves a salary (and the shareholders’ current account is restored to balance) that the company’s funds are depleted by that amount.
[49] Consistent with that interpretation I note in passing that the “payment” which
was entered in the interests register by Mr Livingstone (albeit not until on or about
27 October 2008 and inaccurately, in that the date entered was 1 February 2007) was the authorised salary, not the sequence of drawings during 2006-2007.
[50] Viewing the authorised payment of remuneration referred to in s 161(1)(a) as the salary subsequently approved by the board seems to me to sit comfortably with the present tense requirement in s 161(4) for the holding of the opinion that the payment “is fair to the company”. I do not consider that s 161(4) is to be read as a retrospective analysis of fairness whereby fairness to the company is to be assessed in the context of the company’s fortunes during the period of the drawings.
[51] Of course the difference in point of time may not be of significance if the financial statements are prepared reasonably promptly after the end of the relevant financial year and the resolutions and certificates of value are made at that time. The problem will only tend to emerge when the resolution and certificate is completed a significant period after the end of the relevant financial year. That is the position in the present case where the resolution and certificate were not signed until at least
1 February 2008, by which time the financial position of the company had deteriorated significantly from that which prevailed when the drawings were taken.
[52] It is for the company to establish, in terms of s 161(5)(b), that reasonable
grounds did not exist for Mr Gee’s opinion in the certificate signed on or about
1 February 2008. If the company discharges that burden, then under s 161(5) the onus moves to Mr Gee to establish that the payment was fair to the company at the time it was made. To the extent that he fails to do so, he will be personally liable to the company for the amount of the payment.
[53] For the company Mr Sumner contended that reasonable grounds did not exist for Mr Gee’s opinion that the salary was fair to the company. He submitted that it was not fair to the company for a director to approve a salary for himself at the expense of the company’s creditors. In support he cited the decision of Judge McElrea in Kiwibilt Engineering Ltd (in liquidation) v Pavlovich which usefully explores the balance between director-employees and creditors from the perspective
of fairness to the company:3
[62] I am not persuaded that an agreement to pay a modest wage to a working director cannot be fair simply because the company is insolvent. Neither of the cases cited by Mr McGill actually says that, or develops the legal basis for the statements relied on by Mr McGill above …
[63] There is a requirement under s 52 of the Act that before a distribution can be made to shareholders the board must be satisfied (on reasonable grounds) that the company will be solvent, but we are not here concerned with that situation. (The defendant claim is not that he was making a distribution to himself as shareholder, but that he was paying himself a salary for work done, in exactly the same way as he would have had to pay someone else to do the same work.) The solvency test is not explicitly part of s 161 concerning the remuneration of directors. The passing comment of Paterson J in Perlanduk assumes that insolvency is a barrier but
3 Kiwibilt Engineering Ltd (in liq) v Pavlovich [2004] DCR 193 at 208-209.
does not state the legal basis for this. Counsel have put nothing stronger in front of me as authority.
[64] I believe that it would be fair to the company, if the work needed to be done, for a director to be paid the going wage to do that work. However, the solvency of the company must be relevant in deciding whether to continue to keep the company going and draw wages. That question of course arises in a different context, where there are allegations of trading while insolvent, but it need not be confined to that context. In the present case the company had never become profitable, because it seems not to have got past the “research and development” stage. Is it fair to the company (including its creditors) to draw wages to keep a company going if the prospects are just greater losses? I would say not, but the precise point at which that stage was reached in this case is hard to say — especially as there are no annual accounts that show the position of the company year by year. Where a new business venture is being set up one can accept that initial losses can be expected. That would be so for a year or two perhaps but hardly for three years and seven months.
[54] Mr Gee argued that the payment to him was by way of salary which he claimed was at a very modest level considering the level of skill which he brought to his work and the satisfaction of the company’s clients with his performance. He contended that it was well below normal market levels.
[55] I accept that the salary was a relatively modest one. Assessed simply in terms of quantum relative to the services which Mr Gee provided on the company’s behalf, it could reasonably be described as a fair salary. However that is only one element of the equation. The issue is whether there were reasonable grounds for the opinion that a payment of a salary even of that order was “fair to the company”.
[56] The grounds which were stated in the certificate were all directed to the quantum of the salary measured against the experience and effort of Mr Gee. The grounds said nothing about the solvency of the company and the liabilities which it faced. Presumably that is because it appeared that Mr Gee did not consider that that was a material consideration in the assessment of whether the proposed salary was “fair to the company”.
[57] The solvency of the company and its liabilities may not have been a significant factor had the certificate been signed (and the requisite opinion formed) on or about 1 February 2007. However the difficulty which Mr Gee faces is that the date of signature of the certificate was not the date shown on the face of the
document, namely 1 February 2007, but rather a date not earlier than 1 February
2008. The date of the signing of the certificate is important because I have concluded that it is at that date that the opinion must be held that the making of the payment is fair to the company.
[58] As at 1 February 2008 the company owed Inland Revenue an amount of not less than $33,000. That liability had steadily accrued over a substantial period. Indeed as Mr Gee was well aware the company had failed to pay GST since July
2006. The failure to meet PAYE obligations extended back to 2005. Furthermore there was no reason to assume that further liabilities would not accrue with the concomitant liability for interest and penalty charges about which Mr Livingstone had warned some months earlier.
[59] In those circumstances it is my view that at the date of the signing of the certificate authorising the payment of a salary of $34,591 there were not reasonable grounds for Mr Gee’s opinion expressed in the certificate that a payment to Mr Gee of that sum was fair to the company as at the date of the certificate, namely
1 February 2008. Consequently in terms of issue (c) in [7] Mr Gee is liable to repay to the company the sum of $34,591.
The s 52 claim
[60] Section 52 provides in material part:
52 Board may authorise distributions
(1) The board of a company that is satisfied on reasonable grounds that the company will, immediately after the distribution, satisfy the solvency test may, subject to section 53 of this Act and the constitution of the company, authorise a distribution by the company at a time, and of an amount, and to any shareholders it thinks fit.
(2) The directors who vote in favour of a distribution must sign a certificate stating that, in their opinion, the company will, immediately after the distribution, satisfy the solvency test and the grounds for that opinion.
…
[61] “Distribution” is defined in s 2(1) of the Act in this way:
Distribution, in relation to a distribution by a company to a shareholder, means—
(a) The direct or indirect transfer of money or property, other than the company's own shares, to or for the benefit of the shareholder; or
(b) The incurring of a debt to or for the benefit of the shareholder—
in relation to shares held by that shareholder, and whether by means of a purchase of property, the redemption or other acquisition of shares, a distribution of indebtedness, or by some other means.
[62] Mr Sumner submitted that the payment of $34,591 the subject of Mr Gee’s certificate, was a distribution, not a salary, and hence the payment was caught by s 52. Mr Gee’s position is that the payment was for his services as an employee- director, not a payment in the nature of a distribution to a shareholder.
[63] It is clear from the requirement that a distribution be made “in relation to shares held by that shareholder” that a distribution does not include the payment of salaries to employees who are also shareholders.4 In Re DML Resources Ltd (in liq)
Heath J observed:5
Similarly, if a shareholder is employed by the company and receives wages, provided the services rendered are genuine any payments made to the shareholder, qua employee, could not be impugned under the distribution provisions …
[64] The certificate which Mr Gee signed refers throughout to the amount being in the nature of “remuneration” which is expressly (and broadly) defined for the purposes of the resolution.6 This context makes it clear that the payment was being authorised as remuneration for services, not by reference to Mr Gee’s shareholding interest.
[65] Accordingly I am not satisfied that the payment was in the nature of a
“distribution” to a shareholder and the claim founded on s 52 does not succeed.
4 J H Farrar and Susan Watson Company and Securities Law in New Zealand (2nd ed, Brookers, Wellington, 2013) at [25.6.1].
5 Re DML Resources Ltd (in liq) [2004] 3 NZLR 490 (HC) at [67].
6 See Kiwibilt, above n 3, at [63] quoted at [53] above.
The s 56 claim
[66] Section 56 provides in material part:
56 Recovery of distributions
(1) A distribution made to a shareholder at a time when the company did not, immediately after the distribution, satisfy the solvency test may be recovered by the company from the shareholder unless—
(a) The shareholder received the distribution in good faith and without knowledge of the company's failure to satisfy the solvency test; and
(b) The shareholder has altered the shareholder's position in reliance on the validity of the distribution; and
(c) It would be unfair to require repayment in full or at all. (2) If, in relation to a distribution made to shareholders,—
(a) The procedure set out in section 52 or section 70 or section
77 of this Act, as the case may be, has not been followed; or
(b) Reasonable grounds for believing that the company would satisfy the solvency test in accordance with section 52 or section 70 or section 77 of this Act, as the case may be, did not exist at the time the certificate was signed,—
a director who—
(c) Failed to take reasonable steps to ensure the procedure was followed; or
(d) Signed the certificate, as the case may be,—
is personally liable to the company to repay to the company so much of the distribution as is not able to be recovered from shareholders.
(3) If, by virtue of section 52(3) or section 70(3) or section 77(3) of this Act, as the case may be, a distribution is deemed not to have been authorised, a director who—
(a) Ceased after authorisation but before the making of the distribution to be satisfied on reasonable grounds for believing that the company would satisfy the solvency test immediately after the distribution is made; and
(b) Failed to take reasonable steps to prevent the distribution being made,—
is personally liable to the company to repay to the company so much of the distribution as is not able to be recovered from shareholders.
(4) If, by virtue of section 55(5) of this Act, a distribution is deemed not to have been authorised, a director who failed to take reasonable steps to prevent the distribution being made is personally liable to the company to repay to the company so much of the distribution as is not able to be recovered from shareholders.
(5) If, in an action brought against a director or shareholder under this section, the Court is satisfied that the company could, by making a distribution of a lesser amount, have satisfied the solvency test, the Court may—
(a) Permit the shareholder to retain; or
(b) Relieve the director from liability in respect of—
an amount equal to the value of any distribution that could properly have been made.
[67] This claim also hinges on the proposition that the payment of remuneration was a “distribution”. For the reasons stated above in the context of my consideration of the claim based on s 52, I do not consider that s 56 applies in the circumstances of this particular case.
Claim for repayment of alleged overdrawn shareholders’ account
[68] An overdrawn shareholders’ current account is a debt repayable upon demand to the company: Re Samarang Developments Ltd (in liq).7 The onus of proving that the shareholders’ account is overdrawn is on the first plaintiff.
[69] In the original statement of claim the sum which the first plaintiff sought to recover from Mr and Mrs Gee was $22,487. That is the figure which appears at the bottom of the column headed “30/9/08–Ceased Trading” in the table at [24]. However an application was made and granted8 to amend the claim to increase to
$52,998 the amount claimed as the overdrawn shareholders’ account.
[70] Ms Madson-Ries provided the following explanation for that adjustment:
The understatement of the Defendants’ shareholders’ current account occurred because I had considered Mrs Gee’s salaries for the year ended 31
March 2008 and the 6 months to 30 September 2008 to be a credit to the
shareholders’ current account. In the course of my review I identified that
7 Re Samarang Developments Ltd (in liq) HC Christchurch CIV-2003-409-2094, 30 September
2004 at [55].
8 Minute of Venning J dated 15 April 2014.
Mrs Gee was in fact paid salaries in cash (crediting the Company’s bank account) therefore the shareholders’ current account asset should not have been reduced by a credit for unpaid salaries.
The impact of these credits has been to reduce the balance of the Defendants’
shareholders’ current account from $52,998.00 to $22,487.00.
[71] The figure of $52,998 is derived by adding to the figure of $22,487 the entries for “Salary – Judith Gee” in the columns headed “30/9/08-Ceased Trading” ($9,151) and “FYE 2008” ($21,360) in the table at [24].
[72] It was Mr Sumner’s submission that the company and the Court are entitled to rely on accounts prepared under the direction of Mr Gee as director of the company, particularly where those accounts have been approved and confirmed as correct by the director, citing NZ Game Meats Exports Ltd (in liq) v Lou.9 He contended that absent any proper explanation for the drawings or a valid resolution classifying the drawings in some other way, such as distributions or salary, the drawings remain as advances repayable upon demand.
[73] Mr Gee’s response is that the amount of the overdrawn current account was
reduced to zero as a consequence of the director’s resolutions which he signed on
30 September and 27 October 2008. In effect he adopts the proposition which was
set out in Mr Livingstone’s letter of 9 June 2010 as follows:
The shareholder current account after paying out shareholders salary of
$57,532 in March 2008 year and $31,684 in September 2008 should be Nil,
not $22,487 as noted by the liquidators. We agree with the liquidators’
current account balance of $16,508 as at 31 March 2007.
Our calculations for shareholder salaries are set out below:
Current Account Balance @ 31/03/2007 $16,508.00 (as per Liquidator) Drawings to 31 March 2008 ($78,797.00) House Charges for 31 March 2008 $4757.00 ($57,532.00) Shareholder Salary for March 2008 $57,532.00 Closing Balance @ 31 March 2008 0.00
Drawings to 31 Sept 2008 ($31,684.00) Shareholder Salary for Sept 2008 $31,684.00
Closing Balance at 30/09/08 0.00 (At Liquidation)
9 NZ Game Meats Exports Ltd (in liq) v Lou HC Christchurch CIV-2003-409-2094, 30 September
2004.
[74] In evidence-in-chief Mr Livingstone was asked to explain how he arrived at the closing balances. He said:
… So, starting from the top the current account balance at 31 March 2007 was 16,508 which came from the accounts. If you look at the balance sheet the current account was in credit under current liabilities at that date, because we had not prepared a set of accounts we received the, a copy of the cashbook prepared by the client for the 12 month period to 31 March 2008 and for the six months 30 September 2008 and from that we identified those items we believed would be drawings as analysed by the client in their cashbook so we calculated, and if you go to page 289 of the evidence that is how we came up with the drawings figure of 78,797, the house charges were an estimate based on the previous year so those three figures were added together just like any current account to come up with a balance, or a projected balance as though we had done a set of accounts to come up with an overdrawn current account of 57,532 and then at that point a shareholder’s salary was declared of 57,532 to offset that current account and that sort of rolls that, that salary mechanism I guess rolls back to the wording in the minutes of the 31st of March 2007, and again for the September there were drawings per the cashbook on pages 291 of 31,684 and again a salary of 31,684 was allocated to cover those.
[75] The response of the company, as I understood it, was that the two sets of director’s resolutions and certificates were not bona fide or were otherwise invalid. Ms Madson-Ries expressed the belief that the signing of those certificates was nothing more than a last ditch attempt to re-characterise a loan that would otherwise be repayable to the company on demand and to escape liability before liquidation.
[76] Mr Gee was pressed on this issue in cross-examination. He maintained that he believed that the certificates were fair even at the dates on 30 September and
27 October. Mr Sumner put to Mr Gee that he had taken the key asset out of the company by a resolution on the basis that it was a fair salary and the lengthy exchange concluded in the following way:
Q. I put it to you Mr Gee, the only basis upon which you could sign those certificates and the only basis was that they were both fair to the company in the circumstances as they stood at 30 September and
27 October?
…
A. Yes, that’s my evidence that they were fair to the company.
Q. Okay. And it doesn’t influence you and it didn’t at the time that you
had liquidation pending, and you have creditors mounting and you
can’t pay because you’ve got no cash flow and you’ve already
admitted you’re insolvent?
A. Of course you take an influence on it, that was not the driving influence for creating those.
Q. Final question, I put it to you that signing those certificates was wholly inappropriate on those dates and that they were not fair to the company at all?
A. You’ve given me a statement and my answer to that is that I believe that they were fair and it was appropriate and it was a requirement to do so.
Q. Okay.
[77] The difficulty the company faces is that the certificates were completed. Mr Gee has given evidence as to his subjective belief that those resolutions and certificates were fair to the company. He submits that they were therefore effective in law with the consequence that the shareholders’ current account was brought into balance and the debt to the company discharged. Unless the resolutions and certificates can somehow be challenged as having no effect in law then the consequence is, as intended by Mr Gee (adopting the construction of Mr Livingstone), that the shareholders’ current account has been repaid to the extent of the sums authorised.
[78] The company did not contend, as I understood it, that the resolutions and certificates could somehow be viewed as a sham10 and hence could be simply brushed aside as being of no effect. Indeed as Mr Sumner put it to Mr Gee in cross- examination:
Yes, as at the day of liquidation as a result of these resolutions, money was moved and we have creditors in the vicinity of 87,000 missed out, who without these resolutions would be able to claw that money back and satisfy some of the creditors in liquidation.
[79] Of course the avenue which is then open to the company is to challenge under s 161(5)(b) the existence of reasonable grounds for Mr Gee’s opinion. Having regard to the proximity of the dates of the resolutions and certificates to the making of the order for liquidation, on the face of it there would be, at the very least, a
reasonable argument that such grounds did not exist whereupon the onus would
10 NZI Bank Ltd v Euro-National Corporation Ltd [1992] 3 NZLR 528 (CA) at 539.
move to Mr Gee to prove that the payments authorised were fair to the company at the date of the resolutions and certificates.
[80] However, unlike its case in relation to the authorised remuneration of
$34,591, the company has not advanced a cause of action in reliance on s 161(5).11
On the contrary the cause of action for recovery of the alleged overdrawn shareholders’ account assumes that no resolutions and certificates were validly made. On the evidence that is not the correct position.
[81] For these reasons the claim in the first cause of action against Mr Gee must fail and, for the same reasons, the only cause of action against Mrs Gee must also fail. Consequently the answer to issue (a) in [7] is in the negative.
The liquidators’ claims against Mr Gee
[82] In each of the four causes of action advanced by the liquidators against Mr Gee the same matters are relied upon as constituting contravention of the statute, namely:
(a) At all material times, Mr Gee had sole responsibility for managing the
company’s business and finances;
(b)As the person who completed the company’s management accounts, Mr Gee had knowledge of the true financial position of the company and would have been aware of the company’s insolvent state;
(c) Mr Gee continued to trade the company from July 2006 to 30
September 2008 when the company was insolvent:
(d) In February 2007, Mr Gee received advice from the company’s
accountants that the company was insolvent;
11 Notwithstanding the fact that issue (b) at [7] above included the question whether the salary paid to Mr Gee for the year ended 31 March 2008 and the six months ended 30 September 2008 was fair to the company.
(e) Following the accountants’ advice Mr Gee continued to trade the
company;
(f) Mr Gee continued to incur debt on behalf of the company when he could not believe, on reasonable grounds, that the company would be able to service that debt;
(g)The payment of the salary of $34,591.00 to Mr Gee was in his personal interest; and
(h)Mr Gee failed to ensure that the company’s board complied with its obligations under sections 52 and 161 of the Act.
As noted above,12 the date in (d) was actually 1 February 2008 which in turn impacts on the allegations in (e) and possibly also in (f).
[83] In each instance the loss alleged to have been suffered comprises the revised amount of the claims admitted in the liquidation ($53,643.99) and the liquidators’ costs and disbursements in the liquidation ($36,308.83). An order for compensation is sought pursuant to s 301.
[84] It is clear that claims brought pursuant to s 301 are to be approached in two stages.13 First, the Court should consider whether there has been a breach of the alleged duties. Secondly 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.
[85] Accordingly as a first step I address each of the four causes of action although in a different sequence from the order in which they are pleaded.
12 At [17].
13 Peace and Glory Society Ltd (in liq) v Samsa [2009] NZCA 396, [2010] 2 NZLR 57 at [48].
[86] As item (c) in [82] reflects, the issue of the insolvency of the company and
Mr Gee’s appreciation of that fact is central to the liquidators’ claims.
[87] The liquidators’ position was that the company was unable to pay its due debts as early as during the four months to 31 March 2006 and throughout the year ended 31 March 2007. They draw attention to the fact that the debt owed by the company to the Inland Revenue accumulated from July 2005 in the following manner:
(a) The company paid PAYE late, incurring penalties and interest for almost every month from July 2005 until September 2007 (a period of just over two years);
(b) With the exception of two months, the company did not pay PAYE
from October 2007 until its liquidation;
(c) The company paid no GST from September 2006 until its liquidation;
and
(d) The company paid no KiwiSaver Employer deductions from October
2007 until its liquidation.
[88] It was the liquidators’ contention that the company’s financial statements painted a picture consistent with a company unable to pay its debts. They pointed to the fact that for the four month period ended 31 March 2006 and for the year ended
31 March 2007 the company:
(a) generated deficits from trading;
(b) operated with working capital deficits; and
(c) had more liabilities than assets.
[89] Ms Madsen-Ries demonstrated that by the following table:
Year ended
31/03/07
$
4 months to
31/03/06
$
Net surplus/(deficit) (3,649) (14,302) Current Assets
19,653
6,731
Current liabilities (55,957) (46,144) Working Capital
(36,304)
(39,413)
NET ASSETS
(17,851)
(14,202)
[90] She noted Mr Gee’s view that the company was balance sheet solvent at both
31 March 2006 and 31 March 2007 by virtue of the fact that the company’s negative net asset position comprised the debt owed by the company to Mr and Mrs Gee (in the form of the positive shareholders’ current account), which debt, in Mr Gee’s view, should not be considered in an assessment of solvency.
[91] However Ms Madsen-Ries made two points in response. First, even after adding back the money that the company owed to Mr and Mrs Gee, the company still had negative net assets as shown below:
2007
$
2006
$
Total Assets 38,106 31,942 Total Liabilities 55,957 46,144 Net asset/(liabilities)
(17,851)
(14,202)
Add back: current account 16,508 12,719 Net asset/liabilities
(1,343)
(1,483)
[92] More significantly, however, after adding back the debt the company was still
operating with a significant working capital deficit as shown below:
2007
$
2006
$
Current Assets 19,653 6,731 Current Liabilities (55,957) (46,144) Working capital
(36,304)
(39,413)
Add back: current account 16,508 12,719 Working capital deficit
(19,796)
(26,694)
[93] The liquidators’ perception of the company’s state as being one of steady deterioration is reflected in the events from April 2007 to September 2008 during which period the company:
(a) was still not paying the vast majority of its PAYE obligations as they fell due and from 31 October 2007 to 31 October 2008 it had only paid two months PAYE;
(b) had not paid its KiwiSaver obligations for at least nine months; and
(c) had not been able to pay its GST obligations for a further seven periods (14 months).
[94] Mr Gee contended that a negative net asset position of $1,343 was hardly a dangerous position in which to continue trading, that in his view the company’s position showed some improvement and that it was only when the Inland Revenue demanded what he described as an “instant solution” to both the company’s and his personal tax arrears that the position became untenable. I consider that Mr Gee’s perception was unduly (indeed hopelessly) optimistic and failed to recognise that the debt to Inland Revenue was steadily accumulating without any coherent strategy for payment.
[95] Mr Sumner argued that the company was not paying its debts from no later than 1 June 2006 (which was the date he nominated as the “breach date” for the
purposes of s 301). In my assessment the company was insolvent at least by
31 March 2007 as recognised a year later by Mr Livingstone in the course of the preparation of the financial statements. Indeed it may well have been insolvent prior to that date. However for the purposes of the consideration of the liquidators’ causes of action I propose to adopt that date as my starting point.
The s 135 claim
[96] Section 135 states:
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.
[97] In Mason v Lewis14 the Court of Appeal identified the essential pillars of s 135 as follows:
The essential pillars of the present section are 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
what Ross (above at [48]) accurately described as a “sober assessment” by the directors, we would add of an ongoing character,
as to the company’s likely future income and prospects.
[98] Mr Sumner argued that it was reckless for Mr Gee to continue to permit the company to trade knowing that it was insolvent and where there was no coherent plan for the payment of amounts due to the Inland Revenue Department. His starting
point was the date of 1 June 2006 referred to at [95]. However, in line with the
14 Mason v Lewis [2006] 3 NZLR 225 (CA) at [51].
approach taken by Heath J in Syntax Holdings (Auckland) Ltd (in liq) v Bishop,15 he submitted that it would be appropriate to allow a period of six months from 1 June
2006 for Mr Gee to take stock of the situation and perform the sober assessment referred to in Mason v Lewis.16
[99] I agree with Mr Sumner’s approach of allowing a period of time for reality to
dawn. As William Young J observed in Re South Pacific Shipping Ltd (in liq):17
No-one suggests that a company must cease trading the moment it becomes insolvent (in a balance sheet sense). Such a cessation of business may inflict serious loss on creditors and, where there is a probability of salvage, such loss can fairly be regarded as unnecessary. The cases, however, make it perfectly clear that there are limits to the extent to which directors can trade companies while they are insolvent (in the balance sheet sense to which I referred) in the hope that things will improve. In most of the cases, the time allowance has been limited, a matter of months.
[100] However the justification for such a hope is comparatively less when the relevant liability is to the Inland Revenue Department for GST and PAYE. As Heath J recognised in Syntax Holdings (Auckland) Ltd (In Liquidation) v Bishop18 the funds payable to the Inland Revenue have a quasi-trust character to them because they are only ever meant to be held by a company for a short period of time prior to payment to the Commissioner of Inland Revenue. His Honour there accepted expert evidence
that a failure to pay GST and PAYE on a regular basis is a sure sign of a company in trouble.
[101] I consider that it was not responsible for Mr Gee to continue to permit the company to trade when a substantial liability had occurred, and was continuing to accrue to the Inland Revenue Department without any coherent plan to address that situation. As O’Regan J observed in Fatupaito v Bates,19 in situations where a company has little or no equity directors will need to consider very carefully whether continuing to trade has realistic prospects of generating cash which will allow for the servicing of pre-existing debt and the meeting of commitments which such trading
will inevitably attract.
15 Syntax Holdings (Auckland) Ltd (in liq) v Bishop [2013] NZHC 2171 at [24].
16 Mason v Lewis, above n 14.
17 South Pacific Shipping Ltd (in liq) (2004) 9 NZCLC 263,570 (HC) at [125].
18 Syntax Holdings, above n 15, at [12].
19 Fatupaito v Bates [2001] 3 NZLR 386 (HC) at [67].
[102] Nevertheless, like Heath J in Syntax Holdings,20 I consider it appropriate to exercise some caution in determining the time at which contraventions of the statute should be treated as having arisen. I proceed from the starting point of 31 March
2007 being a point in time at which I am confident that the company was insolvent.21
From that starting point I allow an equivalent period to that proposed by Mr Sumner, namely six months, for taking stock and performing a sober assessment. That leads me to a point of 31 September 2007 which happens to coincide with the letter from Mr Livingstone to Mr Gee concerning his and the company’s overdue taxation position.
[103] Applying the objective test which s 135 requires, it is my conclusion that from that point on it was irresponsible for Mr Gee to permit the company to continue to trade absent a definite (and not merely hoped for) arrangement with the Inland Revenue Department. As it transpires such an arrangement was never a realistic proposition given Mr Gee’s and the company’s track record. Consequently I find that from 1 October 2007 Mr Gee was in contravention of the prohibition in s 135.
The s 137 claim
[104] Section 137 states:
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.
[105] Section 137 is the statutory expression of the directors’ duty of care and skill.
The standard to be applied is that of the reasonably competent director. The
director’s personal knowledge and experience is no longer relevant. At the same
20 Syntax Holdings, above n 15, at [6].
21 At [95].
time, however the reference in paragraph (c) to the position of the director and the nature of the responsibilities undertaken by him or her introduces an element of subjectivity.22
[106] The degree of overlap between ss 137 and 135 is accentuated in a case such as the present where the same allegations are made in support of both claims.23 For essentially the same reasoning as in the s 135 cause of action, I consider that Mr Gee was negligent and in breach of s 137 in permitting the company to trade after
1 October 2007.
The s 136 claim
[107] Section 136 states:
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.
[108] In Peace and Glory Society Ltd (in liq) v Samsa24 the Court of Appeal noted Professor Farrar’s description25 of the purpose of s 136 as being to deal with obligations on capital account such as major investments. It focuses on a particular transaction rather than on the general conduct of the company’s business whereas
s 135, by contrast, deals with debts on revenue account.
[109] In the circumstances of the present case I do not consider that s 136 appropriately applies. The primary liability incurred in this case was the steadily mounting tax debt which, as Heath J observed in Syntex26 was effectively being used as the company’s bank. This case is more appropriately the subject of s 135 and
s 137.
22 Vercauteren v B-Guided Media Ltd [2011] NZCCLR 9 (HC) at [57].
23 Compare FXHT Fund Managers Ltd (in liq) v Oberholster (2009) 10 NZCLC 264,562 (HC) at
[95].
24 Peace and Glory Society Ltd (in liq) v Samsa, above n 13, at [44].
25 John Farrar Corporate Governance: Theories, Principles and Practice (3rd ed, Oxford
University Press, South Melbourne, 2008).
26 Syntax Holdings, above n 15, at [23].
The s 131 claim
[110] Section 131(1) states:
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.
…
[111] In Sojourner v Robb27 Fogarty J described the standard in s 131 in this way:
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 in the best interest of the company, if that belief rests on a wholly inappropriate appreciation as to the interests of the company. If a director believes that the duty to act in the best interests of the company is a duty always to act in the best interests of the shareholders, and never in the interests of the creditors, in a situation of doubt as to the solvency of the company, the director cannot be said to be acting in good faith. Creditors are persons to whom the company has ongoing obligations. The best interests of the company include the obligation to discharge those obligations before rewarding the shareholders.
[112] A director complies with the duty in s 131 if the director’s primary motivation is to act in a manner that the director genuinely believes to be in the best interests of the company. Negligence, even gross negligence, is not the same as disloyalty and is therefore unlikely to be considered a breach of s 131.
[113] While I have found that Mr Gee was in contravention of both ss 135 and 137, I do not consider that Mr Gee’s conduct amounted to a breach of loyalty to the company such that it could fairly be said that he acted in contravention of s 131. In my view the criticism of Mr Gee for continuing to permit the company to trade despite its insolvency is more properly considered under statutory duties other than
s 131.
27 Sojourner v Robb [2006] 3 NZLR 808 (HC) at [102].
The second stage
[114] Section 301 provides in material part:
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 … 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—
…
(ii) To contribute such sum to the assets of the company by way of compensation as the Court thinks just; or
…
[115] The Court of Appeal in Mason v Lewis28 described the approach to be followed:
[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 became evident (really the “breach” date), and the date of liquidation.
[110] 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 Limited (in liquidation) (No 2) (1988) 4 NZCLC
64,317 per Eichelbaum J; and Löwer v Traveller [2005] 3 NZLR 479, which endorsed those principles).
[116] Very different perspectives were held as to the “breach date”. Mr Sumner contended that time ran from the end of December 2006.29 If, contrary to his resistance to the claim, he was found to have any liability, Mr Gee contended for a
short duration of impermissible trading, at the most from March to September 2008.
28 Mason v Lewis, above n 14, at [109]-[110].
29 See [98].
I concluded that the material date was at the end of September 2007. Consequently I viewed the relevant duration of trading for the assessment of an order for compensation as running from October 2007 to September 2008 (inclusive), a period of one year.
[117] During that period of one year it is my assessment that the extent of deterioration in the company’s financial position was approximately $16,500. In calculating that figure, my starting point was the total of the admitted claims in the
liquidation:
Accident Compensation Corporation 1,200.26 Auckland Regional Chamber of Commerce 281.25 CCH New Zealand 3,741.43 Inland Revenue 43,669.24 Inland Revenue court costs 3,109.71 Vodafone New Zealand Ltd 1,642.10 53,643.99
[118] Of those admitted claims, the Auckland Regional Chamber of Commerce and CCH debts were incurred prior to 1 October 2007 as was most of the ACC debt. By contrast the entirety of the Vodafone debt appeared to have been incurred in the period following 1 October 2007. In my assessment, the following indebtedness was
incurred by the company subsequent to 1 October 2007:
GST 6,485.31 PAYE 4,365.42 KiwiSaver 664.80 Court costs 3,109.71 Vodafone 1,642.10 ACC 184.95 16,452.29
[119] In terms of causation Mr Sumner submitted that Mr Gee was the sole cause of the company’s losses as he had sole responsibility for the company’s business and finances. The level of culpability was said to be clearly at the higher end of the spectrum because there was a failure to seriously consider the company’s ability to trade in the face of professional advice as to the insolvent state of the company. It was contended by the liquidators that there was ample evidence that the company would not be able to trade out of its situation and that Mr Gee had shown disregard for the interests of creditors.
[120] So far as causation is concerned, Mr Gee contended that the company’s demise was a consequence of the economic climate in 2007-2008 and the “failure” of the Inland Revenue to accept a repayment programme. On the issue of culpability he maintained that he had worked frantically to keep the company trading, to reduce debts and to make good decisions from the financial information available to him.
[121] On the issue of causation and culpability I agree with the liquidators’ submissions. The reason why the company continued to trade and continued to incur liabilities to the Inland Revenue Department was because of Mr Gee’s misplaced belief that it was possible to turn the company’s fortunes around despite the ever increasing taxation liabilities about which he was specifically alerted to by his accountant. It is appropriate that he should bear the financial responsibility for the increases in the company’s liabilities during the period from 1 October 2007 to 30
September 2008.
[122] Although the matters relied on by the liquidators30 included the payment to Mr Gee of the salary of $34,591.00, that amount was not sought as a head of claim in the statutory causes of action. However the liquidators included as a head of claim their costs and disbursements in the liquidation up to 7 February 2012 in the sum of
$36,308.83. The figure for costs of $35,405.74 was verified in an affidavit of Mr Levin dated 19 August 2013 and I am satisfied that the amount for disbursements of $903.09 is reasonable.
[123] I explored with Mr Sumner in closing submissions the composition of the liquidators’ costs, in part to be sure that those costs did not incorporate costs related to this litigation.31 I gave leave to Mr Sumner to file a memorandum clarifying the position on the liquidators’ costs.
[124] Mr Sumner filed that memorandum which addressed the law on liquidators’ remuneration on 16 May 2014. He also filed a further affidavit of Mr Levin which detailed the liquidation fees from 8 February 2012 to 11 May 2014. That affidavit
appeared to seek recovery in this proceeding of that further amount. That was not
30 At [82].
31 Peace and Glory, above n 13, at [42].
my intention in seeking clarification of aspects of the liquidators’ costs and I do not
consider it is appropriate to further amend the claim at this stage of the matter.
[125] However I do consider that it is appropriate that Mr Gee should be liable to pay compensation in the amount of the costs and disbursements incurred in the liquidation up to 7 February 2012 with one qualification. In my view those costs should not include work undertaken in connection with the unsuccessful summary judgment application. That application was supported by a substantial affidavit of Ms Madsen-Ries which, although sworn on 2 May 2012, was plainly prepared in material part prior to that time. Although it is a necessarily arbitrary adjustment, in assessing compensation I will made a deduction of $3,000 for the work which I consider would have been undertaken in connection with that application.
[126] Consequently the amount of the order for compensation under s 301 payable by Mr Gee will be $49,761.12 calculated as follows:
Indebtedness from 1 October 2007 16,452.29
Liquidators’ fees and disbursements 36,308.83
Less 3,000.00
49,761.12
Disposition
[127] There is judgment for the company against Mr Gee on the claim under s 161(5) for repayment by Mr Gee of the sum of $34,591.00.
[128] There is judgment for the liquidators against Mr Gee under ss 135 and 137 of the Act and an order under s 301 that Mr Gee pay compensation in the amount of
$49,761.12.
[129] Interest shall run on those sums at the rate of 5 per cent from the date of the filing of proceedings, namely 18 April 2012. I award one set of costs to the plaintiffs
on a 2B basis with reasonable disbursements.
Brown J
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