Saunders and Co v Fagerlund HC Christchurch M 486/00
[2001] NZHC 548
•22 June 2001
IN THE HIGH COURT OF NEW ZEALAND
CHRISTCHURCH REGISTRY
M 486/00
BETWEEN SAUNDERS & CO
Applicant
AND N P FAGERLUND
Respondent
M 10/01
BETWEEN MALLEY & CO
Applicant
AND N P FAGERLUND
Respondent
M 11/01
BETWEEN PRICEWATERHOUSE COOPERS
Applicant
AND N P FAGERLUND
Respondent
Date of Hearing: 28 March 2001
Judgment Released: 22 June 2001
Counsel: D M Lester for Applicant M 486/00
E D Wylie for Applicants M 10/01 and M 11/01
P F Whiteside for Respondent
JUDGMENT OF MASTER VENNING
On Applications For Orders That Transactions Not Be Set Aside
Solicitors: Saunders & Co, Christchurch for Applicant M 486/00
Richard Burtt & Andrew Logan, Christchurch for Applicant M 10/01 and M 11/01 (Counsel - E Wylie, Christchurch)
Wynn Williams & Co, Christchurch for Respondent
INTRODUCTION
[1] The Applicants in M 486/00 and M 10/01 are firms of solicitors practising in Christchurch. The Applicant in M 11/01 is a firm of chartered accountants who also practice in the city. The Defendant accountant is the liquidator of Carlton Corner Holdings Ltd (in liquidation) (Carlton).
[2] Carlton was incorporated on 1 April 1993. It was placed into liquidation by order of this Court on 6 December 1999.
[3] Prior to its liquidation the Applicants had acted for Carlton, its managing director and principal shareholder, Mr Hempseed, and a related company, Merivale Service Station (1984) Ltd (Merivale) for a number of years.
[4] The principal assets owned by Carlton and Merivale were a hotel at the corner of Papanui Road and Carlton Mill, Christchurch owned by Carlton, and an adjoining motel owned by Merivale. Merivale was placed into liquidation on 10 September 1999. The Defendant is also liquidator of Merivale.
[5] The motel owned by Merivale was sold in December 1996. The hotel owned by Carlton was sold and settled on 25 June 1999.
[6] The Applicants in M 10/01, Malley & Co, were acting as solicitors for Carlton, Merivale and Mr Hempseed on the settlement of the hotel sale in June 1999, and on the protracted negotiations leading up to it. In accordance with Mr Hempseed’s instructions they made, inter alia, the following payments from the proceeds of sale:
Saunders & Co $66,196.90
Malley & Co $87,187.50
Pricewaterhouse Coopers $45,457.54
[7] At Mr Hempseed’s direction the $66,196.90 paid to Saunders & Co was paid into his personal trust account with that firm. Most of that sum was applied to repay or reduce existing mortgage commitments. A balance of $25,595.93 was applied on or about 28 June 1999 to pay accounts that Mr Hempseed had agreed to pay to Saunders & Co for legal services.
[8] On 30 November 2000 the Defendant liquidator issued and served notices setting aside the payments in issue, namely the payment of the $25,595.93 to Saunders & Co on 28 June 1999, the $87,187.50 to Malley & Co on 25 June 1999 and the $45,457.54 to Pricewaterhouse Coopers on 28 June 1999. In addition the liquidator issued a separate notice in relation to a payment of $6,923.38 to Pricewaterhouse Coopers made on 5 October 1999. It appears that Pricewaterhouse Coopers overlooked applying to set aside that notice. It is conceded they are now out of time to do so.
[9] The applications variously seek orders “that the payments are not voidable” and “that the notice issued by the liquidator be set aside”. However, as the applications are made under s294(2)(b) the orders sought ought to be that the transactions (ie the payments) not be set aside. The applications are opposed by the liquidator.
[10] With the co-operation of counsel all three applications were able to be considered at the one hearing. There is a degree of overlap and common interest between the Applicants’ respective positions. All payments were made within the restricted period. There are, however, some features that are particular to individual creditors, especially in relation to the payment to Saunders & Co.
[11] Although a number of issues were raised by counsel, at the end of the day for the reasons that follow in my view these applications fall to be determined on the principal issues of whether Carlton could pay its debts when the payments were made, whether the payments can be said to have been made in the ordinary course of business, and whether the payments preferred the Applicants over other creditors. In the case of Saunders & Co there is another issue, namely whether the firm was a creditor at the time.
GENERAL PRINCIPLES
[12] As the payments were made within the restricted period (s292(6)) the onus is upon the Applicants to satisfy the Court that:
• The company was able to pay its debts when the payment was made: or
• The payment was in the ordinary course of business: (s292(3)).
[13] However, apart from these issues preference is also of particular importance. Transactions such as the payments in this case can be set aside if there has been a preference. As noted by Tipping J, delivering the decision of the Court in Re Excel Freight Ltd (in liq); Waikato Freight & Storage (1988) Ltd v Meltzer (2001) 9 NZCLC 262,504:
“[16] In 1993 New Zealand company law underwent a fundamental shift of emphasis in this area. The focus moved from intent to effect. Under the earlier law the focus was on whether the dominant intention of the insolvent company was to prefer the creditor concerned. Under the new law the initial focus is on whether the transaction has a preferential effect.” (emphasis added)
[14] The statutory provision is clear. The transaction may be set aside only if the Court is satisfied that it enabled the Applicant to receive more than they would have been likely to receive in the liquidation (s292(2)).
[15] An example of the practical application of the principle is the decision of Panckhurst J in the case of National Bank of NZ v Coyle (1999) 8 NZCLC 262,100. In that case His Honour said:
“The voidable transaction regime is based on the premise that the general body of creditors has been disadvantaged as a result of the treatment afforded one of their number. In the absence of detriment I do not think there is a basis for the Liquidator to intervene and set aside a transaction:” 262,104
[l6] 1 have found it convenient to consider first whether Carlton was able to pay its debts, next whether the payment was made in the ordinary course of business, and then whether there was a preference. The evidence relating to the first two issues is relevant to consideration of the last issue.
WAS THE COMPANY UNABLE TO PAY ITS DEBTS?
[17] The time for assessing whether a company is unable to pay its debts for the purposes of s292 is at the date of the payments in issue: Re Pasadena Holdings Ltd (in liq); Reece v Montgomerie (Randerson J, HC Auckland, M 1039/98, 30/4/ 99). The payments in the present case were all made in late June 1999, in the case of Malley & Co, on 25 June 1999 and Pricewaterhouse Coopers on 28 June 1999. The payment of the sum of $66,196.90 was made on 25 June with the transfer within Mr Hempseed’s trust account with Saunders & Co of the $25,595.93 on 28 June 1999.
[18] I note that s292(2)(a)(i) requires consideration of whether “the company was unable to pay its due debts” while s292(3)(a) refers only to “debts”. Potentially there is some significance in the difference. For instance, s288(4) provides that when considering whether a company is unable to pay its “debts” (as a ground for liquidation) the Court may take into account its contingent or prospective liabilities. The concept of “due debts” is more restricted. “Due debts” suggests debts that are immediately enforceable, or payable. The phrase “due debts” would not include contingent or prospective liabilities. I consider the reference in s292(3)(a) ought to read as a reference to “due debts” as:
• It would be consistent with the general scheme of the statutory provisions dealing with preference.
• It would be consistent with the use of “due debts” throughout the related section, s297.
• Section 292(2) is the primary subsection that provides the circumstances under which a liquidator may set aside a transaction as voidable. It requires the transaction to have been made inter alia when the company was unable to pay its due debts. A creditor must be able to avoid the effect of s292(2) by proving that the company was able to pay its due debts when the transaction occurred.
[19] Apart from the presumption he is entitled to rely upon, the liquidator’s evidence about Carlton’s inability to pay its due debts is as follows:
“6. That from 25 June 1999 the said company ceased trading. On the sale of the hotel property and the hotel business the said company no longer had any assets. It however had residual debts of approximately $1,116,882.00 in addition to the debts in respect of which voidable payments are alleged to have been made, and was thus unable to pay its due debts as at 25 June 1999.”
Later in his affidavit the liquidator clarifies that the residual debts he referred to were:
“8. That in the liquidation of the said company the following debts appear in the accounts of the company:
a. Merivale Service Station Limited (in liquidation) $806,792.00
b. Princess Margaret Hospital $360,000.00
[sic Robert MacDonald Hempseed]
These debts have not yet been accepted as proven but I have no reason not to accept those amounts as set out in the account s of the company prepared by Price Waterhouse Coopers.”
[20] There is a difference between the two figures referred to by the liquidator, but it was common ground between counsel that the only residual debts owing by Carlton itself are the intercompany loan advance from Merivale and the shareholder advances from Mr Hempseed.
[21] A number of issues arise concerning the company’s inability to pay its debts as at June 1999.
[22] Mr Wylie submitted that it was not correct to say, as the liquidator had, that the company had ceased trading in June 1999. He referred to the money still held in the company’s trust account with Malley & Co as at 25 June 1999 and subsequently. For instance a substantial GST credit was received by the company on 13 September 1999. Funds were subsequently placed on deposit, later withdrawn from deposit, and various other minor creditors were paid up to and including October 1999. In addition, he submitted the company still had another asset, a right of action against the purchaser of the hotel, Mr Archibald, in relation to matters arising from the purchase.
[23] With respect to Mr Wylie’s submission, I consider there is a difference between trading and operating. “Trading” carries with it the connotation that the company is carrying out a main business activity, in the nature of buying and selling/supplying products or services. In the present case the main business of Carlton was initially the ownership and running of the hotel, and more latterly the leasing of the hotel. It did not carry on either of those activities after 25 June 1999 when the sale of the hotel property was settled. Carlton continued in existence after that date, but the transactions that it entered thereafter were financial transactions, largely in the nature of “tidy up” transactions. They were not transactions in the nature of trade as such.
[24] In any event I do not consider the point addresses the main issue which is whether Carlton was able to pay its due debts as at late June 1999. It does not matter whether Carlton was trading or not if it was able to pay its due debts as at late June 1999 when the payments were made. For present purposes there is no practical difference in the position between the dates the payments were made of 25 June and 28 June.
[25] The question is what were the “due debts” of Carlton in late June 1999. Clearly Carlton owed money to a number of creditors. In addition to the payments to the creditors in these proceedings, payments from the proceeds of sale of the hotel were made to the following:
• The National Bank of New Zealand Ltd $1,212,444
• Solicitors Nominee company $161,657
• White Fox & Jones (settlement figure -judgment sum) $91,005
[26] In addition, payments were made to cover inter alia:
• Valuation fees;
• An insurance premium;
• Tax due to the Internal Revenue Department; and
• Christchurch City Council rates.
[27] All those creditors had debts that were due as at late June 1999. Those debts were all paid. It is apparent from the evidence that after payment to the last of the Applicants, Pricewaterhouse Coopers on 28 June 1999, the company still had $12,623 in its trust account with its solicitors. That account was subsequently overdrawn when the payment was made to the Christchurch City Council for rates arrears of $16,547, but that overdraft was more than addressed by a GST credit of $215,625 received in September. There is evidence from the trust account of a number of payments being made thereafter. The trust account had a credit balance, albeit modest, when Carlton was placed into liquidation.
[28] Subject then to the Merivale and Hempseed advances it appears that Carlton was able to pay its due debts as at late June 1999. The best evidence about that is that it was able to, and did make, the payments of the debts that were due to its general creditors. While the trust account was overdrawn briefly, the later GST refund more than offset that. There is no evidence of any other outside debts that were due at the time.
[29] The question is the status of the Merivale intercompany advance and Mr Hempseed’s current account advance. Were they debts that were due for payment as at the end of June 1999?
[30] There is little direct evidence to assist the Court on this point. The effect of the liquidator’s evidence is that for whatever reason, which he does not explain, he has not yet accepted Merivale’s and Mr Hempseed’s debts as proven in the liquidation of Carlton. The procedure for a liquidator to accept debts is set out in the Companies Act: ss302, 303 and 304. The liquidator is directed to either accept or reject a claim as soon as practicable: s304(3). Mr Whiteside was unable to assist the Court as to why the debts had not yet been admitted by the liquidator. The position the liquidator has adopted is not helpful. He seeks to set aside these payments on the basis Carlton was unable to pay its due debts when the payments were made. However, the only debts that were not paid as at June 1999 are the Merivale and Hempseed debts. By inference, and by the issue of these proceedings, it must be taken that the liquidator considers that those debts were due as at June 1999. However, he has not, even yet, admitted those debts in the liquidation. He refers to them as “residual debts”.
[31] The debts are in the nature of intercompany loans and shareholder advances. Typically such loans/advances are made “upon demand” or, more rarely, for a fixed period of time. There is no direct evidence of the basis of the advances in this case. However, in his affidavit in reply Mr Lynskey attaches copies of Carlton’s accounts to 31 March 1996. The notes to those accounts show that Mr Hempseed’s advance at that time was “upon demand”. No reference is made to the intercompany advance.
[32] The advances to Merivale and Hempseed would have been due at June 1999 if demand had been made or, if made for a specific term, if the term had elapsed. There is no evidence whether demand had been made by that time. I note that Carlton was liquidated on Merivale’s application. The basis of the liquidator’s proceeding was a statutory demand issued by Merivale. That statutory demand was dated 28 September 1999. Thus as at 28 September 1999 Merivale made demand of Carlton for repayment. The statutory demand does not, however, suggest that any earlier demand was made.
[33] The evidence on this issue is unsatisfactory. I should record that Mr Whiteside pointed out that none of the Applicants specifically referred to this issue as a ground in support of their applications. He suggested that if they had, the liquidator could have addressed the issue in his evidence.
[34] Mr Lynskey of Pricewaterhouse Coopers deals with the matter indirectly in his affidavit in reply:
“He [Mr Fagerlund] also states that the company was unable to pay its due debts as at 25 June 1999, and further that it was insolvent and unable to pay its debts in December 1997. If Mr Fagerlund is correct that there were debts outstanding and owing in the sum of $1,166,792, then those statements are correct. If the amounts said to be owing to Mr Hempseed and Merivale are not taken into account, then the assertions are incorrect.”
[35] In summary, there is no direct evidence that the debts said to be owing to Merivale and Hempseed were due as at June 1999. On the other hand, there is evidence that the debts existed. In this situation, where the Applicants have not raised the issue in their applications and have not led direct evidence on the point to satisfy the Court the debts were not due, they fail to discharge the onus on them. The presumption is that Carlton was unable to pay its debts: s292(3). The Applicants have not, on the balance of probabilities, proved the contrary. I must find that the presumption Carlton was unable to pay its debts when the payments were made in late June 1999 has not been displaced by the Applicants.
ORDINARY COURSE OF BUSINESS
[36] The crucial question for all Applicants in this case is whether the payments were made in the ordinary course of business. What amounts to “in the ordinary course of business” has been considered by the Privy Council in Countrywide Banking Corp Ltd v Dean [1998] 1 NZLR 385 case and by the Court of Appeal in Waikato Freight (supra).
[37] In Countrywide Banking Corp Ltd Gault J, delivering the opinion of the Privy Council stated:
“Plainly the transaction must be examined in the actual setting in which it took place. That defines the circumstances in which it is to be determined whether it was in the ordinary course of business. The determination then is to be made objectively by reference to the standard of what amounts to the ordinary course of business. As was said by Fisher J in the Modern Terrazzo Ltd case, the transaction must be such that it would be viewed by an objective observer as having taken place in the ordinary course of business. While there is to be reference to business practices in the commercial world in general, the focus must still be the ordinary operational activities of businesses as going concerns, not responses to abnormal financial difficulties.” P394
[38] In the Waikato Freight case Tipping J, delivering the decision of the Court of Appeal, stated:
“[31] In our view the judicial approach has become overcomplicated and over-refined. The question is whether, at the time it was made, the relevant transaction was made in the ordinary course of business. That is a question of objective fact. General business practices are relevant to that question, as are any particular customs or practices within the field of commerce concerned. So too is the previous commercial relationship between the parties. The observer spoken of in the Privy Council is in reality the Court which must look at the circumstances, as objectively apparent at the time of the transaction. The ultimate question is whether on the evidence before the Court the transaction or payment can be said to have been made in the ordinary course of business. Was it in its objective commercial setting an ordinary or an out of the ordinary transaction for the parties to have entered into?
[32] The mental approach of the parties to the transaction, as objectively apparent, may sometimes be relevant as an aspect of the circumstances in which the ultimate factual assessment must be made. That of course is subject to s292(4) which, in itself, demonstrates the legislative purpose to keep subjective intent to prefer on the part of a debtor company out of the arena, unless known to the creditor. It should be noted here that Parliament has made the debtor company’s intent or purpose to prefer relevant only if it is actually known to the creditor. The statutory words are “unless the other person [the creditor] knew that that was the intent or purpose of the company”. Parliament has thereby eschewed constructive knowledge in this context. It has not said “knew or ought to have known”. That being the legislative approach to knowledge in relation to intent to prefer, it is unlikely Parliament intended constructive knowledge to be relevant to other aspects of the transaction, save in the unlikely event that such knowledge is capable of influencing whether the transaction, in its actual setting, was objectively in the ordinary course of business. Intent to prefer is irrelevant unless such intent was known to the creditor. If known, such fact must be regarded as relevant but even then, although pointing towards the payment or other transaction being outside the ordinary course of business, such does not automatically follow. This is consistent with the objective assessment which the Court must make.”
[39] An issue arose during the course of submissions as to whether the Court was to approach the matter from the point of view of the creditors’ business or the company’s business. Mr Whiteside submitted one had to look at it from the point of view of the company’s (ie Carlton’s) trading. Counsel for the Applicants suggested it had to be looked at from the point of view of the usual practice of the creditors.
[40] As noted by Tipping J in the Waikato Freight case, neither approach is entirely correct:
“[23] The fundamental issue to be considered is how much the “objective observer” is to be taken as knowing about the circumstances in which the payment was made. Differences have arisen in the High Court as to whether that observer is to be taken as looking at the matter on the basis of the creditor’s perception of the transaction, the debtor company’s perception or some amalgam of the two. As will be seen, none of these approaches exactly captures the correct position.”
[41] In the present case all Applicants knew of Carlton’s financial position. Carlton’s financial position was intimately related to Mr Hempseed’s personal position and, at least earlier, Merivale’s position. The matter is set out in Mr Robinson’s affidavit for Malley & Co in the following way:
“20. At the time that [Carlton] was running into financial difficulties, it became clear that neither [Carlton] nor Mr Hempseed were able to meet ongoing legal expenses. Both Malley & Co and Coopers & Lybrand (myself and Paul Lynskey) discussed with Mr Hempseed and outlined to him that we believed he was acting into extreme financial difficulties. We indicated to him that were prepared to help but we needed security for our costs. We were happy to act for him on the basis that the fees were paid to us at the end of the day and that was the basis on which we continued to act for [Carlton], [Merivale] and Mr Hempseed throughout. The fees were to be paid by [Carlton], [Merivale] or Mr Hempseed personally once it was ascertained which entity was in a position to pay. In the event that payment was not able to be made during the course of the transactions then it was clearly understood that fees would be deducted from the sale proceeds of the assets of [Carlton], [Merivale] or Mr Hempseed. In point of fact, when the motel land owned by [Merivale] was sold in December 1996 our fees were deducted from the sale proceeds. No issue at all was raised by Mr Hempseed in respect of those fees paid by deduction, nor, as I will attest to later in this affidavit, was there any issue raised by Mr Hempseed after our fees were taken by deduction on the sale of the hotel by [Carlton] in June 1999 until July 2000.
. . .
49. Clearly, neither Mr Hempseed nor [Carlton] nor [Merivale] had earlier been in a position to meet payment of any of the costs and it was clearly understood by Mr Hempseed from as far back as late 1994 that any fees and other professional charges incurred would have to be met from the sale proceeds of assets. This was never in question. In late 1994, Malley & Co arranged a further advance from the National Bank at the request of Mr Hemspeed and this advance was paid to [Carlton] on 23 December 19994. The advance amounted to approximately to $110,000.00. All of those funds were required by Mr Hempseed, [Carlton]/[Merivale] to meet trade creditors and other commitments relating to the hotel. Malley & Co took no fees from this advance and I specifically spoke to Mr Hempseed about the need to meet payment of our fees at a later time ‘when funds were available. This was the basis on which we were acting at that time and continued to act for Mr Hempseed, [Carlton] and [Merivale].
. . .
50. In summary, the main objective of the firm acting for [Carlton], [Merivale] and Mr Hempseed from mid-1995 until settlement with Mr Archibald in June 1999 was to ensure the continuing viability of [Carlton]for the benefit of all - its creditors, [Carlton] and Mr Hempseed. This was successful but not without extreme difficulty.
. . .
g) Mr Hempseed had borrowed money in his own name and under the name of CCLS and MSS. The affairs of all three entities were intermingled and somewhat confusing. In essence, there were two sources of income (the farm through [Merivale] and the hotel through [Carlton]) and three sources of assets ([Carlton] owned the hotel, Mr Hempseed owned the farm and his Hinau Street property and [Merivale] owned the stock and plant on the farm). Mr Hempseed’s handling of his own personal affairs was far from clear and he treated both [Carlton] and [Merivale] as himself and failed to draw or to maintain any clear distinction.”
[42] The picture painted is one of Mr Hempseed using the company structures of Carlton and Merivale to hold assets, but otherwise treating the assets as all entirely within his personal control, and as part of his overall personal interests. He made little distinction between the legal entities and applied funds to pay debts from whichever source had funds available at the time they were needed.
[43] Mr Lynskey put it this way in his affidavit in reply:
“. . . I should state that the affairs of Mr Hempseed and his associated companies were very muddled. Inter company advances and loans were frequently not discussed with me. There was often very real confusion as to where monies had or had not come from, and where and to whom income received should be receipted. Mr Hempseed ran all his companies and his personal affairs effectively as one, and was not really concerned to separate out the individual assets and liabilities of individual companies, or his personal assets and liabilities.”
[44] Mr Lynskey’s evidence confirms the rather confused way that Mr Hempseed carried on his commercial activities.
[45] Against that background it is important to consider what Mr Hempseed and his professional advisers were seeking to achieve by the sale of Carlton’s property and the clearing away of debts from the proceeds of sale. The net result of the exercise, the sale of Carlton’s property, was, as Mr Robinson said:
“41.4 it enabled payment of all the arrears of interest of the nominee company mortgages/contributory mortgage and left Mr Hempseed with a home in Fendalton with a value of $240,000 with a mortgage of $133,000 and his farm in Hawarden now worth about $550,000 with a Saunders & Co contributory mortgage of $350,000.
42. For all intents and purposes, the settlement of the sale with Mr Archibald provided [Carlton] with a more or less nil asset/nil debt situation and, of course, provided solvency to Mr Hempseed. Mr Hempseed knew and accepted from the outset that the realisation of the sale of the hotel to Mr Archibald for $1.725 million was the only thing that stood between [Carlton] and liquidation and indeed Mr Hempseed and insolvency.
. . .
45. The result of the settlement was that all arrears of interest under the nominee company mortgage and contributory mortgage to Saunders & Co were paid thereby allowing Mr Hempseed to refinance these loans and reorganise his affairs.”
[46] Thus from Carlton’s and Mr Hempseed’s point of view the result of the sale of the property and the repayment of creditors was to preserve Mr Hempseed’s personal position, and to clear away all independent creditors of Carlton. From the Applicant creditors’ point of view, they agreed to carry on working for Mr Hempseed and Carlton on the basis they would be paid on settlement.
[47] There is unchallenged evidence from experienced practising accountants and solicitors that it is a common practice for accounting and legal professionals to obtain authorities or undertakings to have legal or accounting costs paid from the proceeds of sale from a business when a client may be unable to meet costs on a regular basis.
[48] Mr Lynskey says:
“12. It was the practice of (then) Coopers & Lybrand to issue accounts for work undertaken even though I was aware that neither Mr Hempseed nor [Carlton] nor [Merivale] could meet payment at that time. There were various discussions with Mr Hempseed concerning outstanding fees and fees that were continuing to be incurred. These discussions were often held in the presence of Mr Robinson. It was quite clear to me that Mr Hempseed understood and agreed that because of the difficult position of [Carlton], [Merivale] and himself that the fees would be met from the sale of the assets or from whichever entity was in a position to meet those fees. This was accepted by Mr Hempseed without question and was not subject to any question or debate by him whatsoever. The practice of deferred payment was not a practice that my partners nor I preferred but Mr Hempseed had been a client of our firm since the early 1980s and it was agreed that we would continue to act for Mr Hempseed and his associated companies on the basis that our fees would be met by him personally or by [Carlton] or [Merivale], whichever entity had the ability to pay. It was agreed that if there was no ability to pay in the interim, these fees would be paid from the sale proceeds of the assets. This was in the ordinary course of business and has been common practice in other commercial transactions that our firm has been involved in.”
[49] Mr Marks, a solicitor over 20 years of experience in commercial law who has dealt with a large number of commercial property transactions, both acquisitions and deposals, says:
“4. I have also read the affidavit of Paul Francis Lynskey dated 5 January 2001. I note in paragraph 12 of Mr Lynskey’s affidavit, that there was a clear arrangement with Mr Hempseed, the director of [Carlton], that where the company was unable to pay for services rendered pending the sale of an asset, fees for services rendered would be paid from the sale proceeds of the asset when a sale was completed.
5. I agree with Mr Lynskey’s view that while this is not a preferred alternative, it is commonly a necessary expedient and can indeed be said to be an arrangement in the ordinary course of business.
6. Quite apart from the situation where a client has not had the funds to pay accounts as they fall due and creditor and client have agreed to defer payment until the availability of proceeds from the sale of an asset, it is common practice, and in my view a usual practice, that the solicitor acting for the client in the disposal of an asset will be instructed or authorised by the client to deduct not only the solicitor’s fees from the sale proceeds before accounting to the client, but also other sums owed to third parties including real estate agent commission, consultants (e.g. valuer) and other professional fees including accountants, and to make those third party payments on the client’s behalf, in order to discharge these liabilities. I have myself been involved in such arrangements frequently and in my view they are transactions in the ordinary course of business.”
Mr Ian Pringle, a solicitor with nearly 50 years of experience in property and commercial law says:
“2. I have been asked by the Plaintiff in this matter to give my opinion as to the way in which a firm of Solicitors would respond to a request by a client when a firm continued to act in circumstances where the client had no immediate prospects of meeting costs that had been incurred and were going to be incurred but have the ability to give some security for the debt perhaps over property or in relation to an ongoing project.
. . .
6. A common form of protection, particularly with developers and property owning clients, is to obtain from the client an undertaking or irrevocable instruction that the firm will act on a property sale and be entitled to deduct fees. Often this involves work done for a separate entity related to the owner of the property being sold. I believe that in the legal profession this would be considered a normal and practical form of security.
. . .
9. It is also a normal situation for the Solicitor to obtain a form of undertaking or irrevocable instruction as a protection for fee payment for work to be done.
10. I have been shown a copy of the document dated lst October 1996 given to Saunders & Co by Mr Hempseed. While the document is brief, I do not consider the terms of this to be out of the ordinary in terms of fee payment arrangements between Solicitors and clients.
. . .
14. It is a normal arrangement to obtain an authority or undertaking to pay legal costs from the proceeds of sale of a property or business. This can arise regularly when the fees may have been incurred for other entities related to the party giving the authority or undertaking, and frequently for quite separate work from the development or asset which will produce payment. In such circumstances the formal undertaking is considered to be normal practice to clarify the understanding between the parties and, in my view, such a document would not be considered out of the normal course of business for a legal practice.”
Mr Benjamin Frampton a solicitor with Saunders & Co who has over 20 years experience says:
“4. From time to time situations arise where the firm is requested to work in situations where it is not clear that the client will be able to pay the fees. Whenever a significant amount of work is anticipated in a situation where it is not known whether the client will be able to pay, it is customary to make arrangements to attempt to ensure the fees will be paid.
5. The situation with Mr Hempseed and his companies was just [sic] a case. The firm was asked to act for him in substantial matters where it was not anticipated that payment would be made directly, but it was known that there was another source of funds available, under the control of Mr Hempseed, from which payment would ultimately be made. In such a case, the agreement to continue to work on the instructions of Mr Hempseed with an undertaking from another firm to pay funds from another source under his control was, in my experience, a normal business arrangement.
6. Frequently, and particularly with commercial clients, the source of funds may be a different legal entity from the party instructing the work. This will frequently happen with private companies under the effective control of the same individual, as in the present case.
7. From the point of view of my firm, the receipt of the payment for the work done for Mr Hempseed and his companies was not in any way considered outside the ordinary course of our business.”
Mr Derek Marshall, a solicitor with over 30 years experience says:
“14. The obtaining of instructions or undertakings to pay costs from the proceeds of sale of property or a business or the like is not uncommon. They are regularly used and are often necessary because bills of costs may have been incurred for other entities related to the party giving the undertaking or for quite separate work from the development expected to yield payment. In those circumstances the value of a lien can be problematic and it is generally considered best practice to clarify the situation in a formal undertaking and the obtaining of such a document would not be considered out of the normal run of legal practice.”
[50] In his written submissions Mr Whiteside suggested that the evidence from the independent solicitors and accountants as to whether costs might be paid on the sale of an asset was totally irrelevant and not helpful. During the course of his submissions he conceded that might be overstating the position and suggested that the evidence was “largely irrelevant” and not “all that” helpful. His original written submissions clearly overstated the position given the comments of the Court of Appeal in the Waikato Freight (supra) case that general business practices are relevant to the question, as are any particular customs or practices within the field of commerce concerned. It may be his suggested concession did not go far enough. In my view, the evidence is relevant and helpful, but not determinative of the issue of whether the payments were in the ordinary course of business.
[51] Mr Whiteside submitted that the transactions were not in the ordinary course of business for a number of reasons. First he relied upon the statutory presumption. There is, however, extensive evidence about the course of business and dealings between these parties for the purposes of these transactions. The presumption is only the starting point.
[52] Next Mr Whiteside referred to and adopted the approach to “the ordinary course of business” as set out in Anderson’s Company and Securities Law at paragraph 292.15. However, with respect, that commentary must now be read in light of the recent decision of the Court of Appeal in Waikato Freight (supra). The question is whether, in their objective commercial setting, were the transactions ordinary or out of the ordinary transactions for the parties to have entered.
[53] Finally Mr Whiteside identified a number of particular matters which he submitted were compelling and took the payments outside the ordinary course of business.
[54] He noted that at the time of the transactions Carlton was no longer operating as a going concern. Its operation as a hotel business had ceased in February 1997. It had ceased its leasing of the premises on settlement and at the time of the payment it was, as Mr Whiteside put it, “in its death throes”.
[55] The fact a payment is made when a company is realising its assets is a factor to be taken into account but again it is not determinative. There may be situations where a company will cease trading in whole or in part, or sell all or part of its asset base. The company may be left as a shell. It may be left that way for the purposes of repositioning itself for other business opportunities. It may be left with tax losses that are of some benefit to its principal shareholder(s). It may be left with interests in related companies. It may be left with a cause of action. Payments by companies in those situations may still, in appropriate cases, be payments made within the ordinary course of business. As noted earlier, Carlton carried on in existence for some months after June 1999, and received a substantial GST credit in September 1999. It was not “in its death throes” in June 1999.
[56] Next Mr Whiteside submitted that Mr Robinson was effectively acting as a liquidator in distributing the entire proceeds of sale. He submitted “. . . the nature and timing of the payments can be explained only on the basis that there must have been an intention to prefer” and referred to a passage from Fisher J’s judgment in Re Modern Terazzo Ltd (in liq) [1998] 1 NZLR 160. In that judgment Fisher J noted that there will be many situations in which the creditor would be privy to the relevant intent or purpose of the paying company, and in particular noted that creditors such as the company’s banker, major financier or professional advisers could fall into that situation. Certainly both Mr Robinson and Mr Lynskey were aware that Carlton had to proceed with and complete the sale to Mr Archibald. They were generally aware of the unsecured creditors. However, their evidence is that they understood that if the sale to Mr Archibald was able to be effected then all the creditors known to them would be met. Mr Robinson says:
“51. . . .
f) Malley & Co took fees from the sale proceeds of [Carlton’s] assets after all other secured and unsecured creditors had been paid except for an indeterminant potential small tax liability that may have been payable as a result of a Default Notice issued by the Inland Revenue Department. As [Carlton] had made no profits and had sustained losses and was therefore not liable for any income tax we understood that this tax liability related to PAYE, GST and ACC. As [Carlton] and Mr Hempseed’s staff attended to these returns for [Carlton], this was unable to be quantified or confirmed at that time. The staff had ceased working for Mr Hempseed or [Carlton] and Mr Hempseed was unfamiliar with these procedural matters that were handled by his staff.
. . .
k) The time the transaction was settled Malley & Co was not aware that there were any other creditors (apart from the Default Notice referred to in (f) above) and consequently we were not aware that any creditors were being preferred.”
[57] Mr Lynskey’s evidence is:
“14. . . . At the time that settlement took place in June 1999 I believe that all creditors, apart from an unascertained IRD Default Notice, were and had been met. I understand that the Default Notice referred to default in PAYE, GST and ACC returns. I was unable to clarify this matter as these returns were attended to by Mr Hempseed’s staff. These staff members were no longer employed by Mr Hempseed and Mr Hempseed, himself, had no real input into these procedural accounting matters. As far as I was aware, there were no other outstanding matters. There was certainly no intention to prefer any creditor least of all Price WaterhouseCoopers over anyone else.”
[58] In light of that evidence it cannot be said that the Applicants knew or that Carlton had the intent or purpose of preferring certain creditors as required by s292(4), or as contemplated by Fisher J in the passage referred to. It can be noted that a payment was made to the Inland Revenue Department on settlement, and later a substantial GST refund was paid to Carlton. It is apparent that the Inland Revenue Department has not proven as a creditor in Carlton’s liquidation.
[59] Next Mr Whiteside submitted that the payment did not assist or foster the preservation of the business of Carlton. He distinguished the present situation from cases where the payments were made to ensure ongoing supply. However, the entire transaction must be considered. The parties had agreed some time previously how the solicitors and accountants were to be paid from the proceeds of sale. That agreement ensured their continued assistance and services for Carlton and Mr Hempseed.
[60] The agreement for the sale of the Carlton property was made initially in 1995. At that time the agreement was for the sale of both Merivale’s and Carlton’s properties. The contract for the sale of Carlton’s property was not confirmed until June 1997. Settlement was initially due March 1998. It was considerably delayed. By continuing to act for Carlton during this period Malley & Co and Pricewaterhouse Coopers ensured that Carlton was able to hold on to the contract and ultimately settle it. That was to the benefit of Carlton, Mr Hempseed and all creditors. The sale price was considerably greater than a more recent valuation. The professional advisers, Malley & Co and Pricewaterhouse Coopers, spent a considerable amount of time to ensure that Carlton continued in operation and was able to pay its creditors. They also had to ensure the agreement for sale and purchase was kept on foot. The settlement and payments to all outstanding creditors must be considered against that background. The net effect was to preserve Mr Hempseed’s personal position.
[61] Finally Mr Whiteside submitted that the position of the solicitors and accountants in this case was no different to the position of the landlord creditor in Countrywide Banking Corp Ltd v Dean (supra). In that case the landlord creditor had argued that not to treat the payment to the landlord as being in the ordinary course of business would disrupt the ordinary conduct of the business affairs of lessors. However, the Privy Council rejected the submission and noted that landlords are not secured creditors. Mr Whiteside submitted that the solicitors and accountants in the present case were in no different position and should not be regarded as secured creditors.
[62] It is important in the present case to note that the accountants and solicitors were treated no differently to the other general creditors of Carlton. As noted, quite apart from the payments made to the Applicants a number of other payments were made on settlement of the sale in June 1999. Apart from the payments made to mortgagees as secured creditors, a payment of $91,005 was made to Messrs White Fox & Jones, solicitors, to settle an outstanding judgment; and other substantial payments were made for the payment of valuations, insurance premiums, tax owing to the Inland Revenue Department and rates due to the Christchurch City Council. Payments were made to all the general creditors that were not related to Carlton. There has been no attempt by the liquidator to set those payments aside, yet there seems to be no basis to treat those payments differently to the payments received by the Applicants in this case. The other payments also related to services that had been provided to Carlton some time previously.
[63] A significant feature of this case is that save for the issue of the “residual debts” to Mr Hempseed and Merivale, all unsecured creditors were paid from the proceeds of the sale from Carlton’s business and land.
[64] Another significant feature of the present case is that, certainly in relation to the payments to Malley & Co and Pricewaterhouse Coopers, all participants involved in the process (Mr Hempseed, Carlton, Malley & Co through Mr Robinson, and Pricewaterhouse Coopers through Mr Lynskey) knew of Mr Hempseed’s financial difficulties. The solicitors and accountants agreed to help and continue to provide financial services to give Mr Hempseed and Carlton the chance to work through those difficulties, but on the basis that fees would be paid at the end of the day either by Carlton or Mr Hempseed once it was ascertained which entity was in a position to pay. As noted by Mr Robinson in his affidavit at paragraph 20, it was a risk he preferred not to take but:
“21. . . . In my experience, it is in the ordinary course of business and it is the norm to accept payment at the end of a transaction particularly when the client is not in a strong position to meet costs during the process of a transaction . . . .”
Mr Lynskey has confirmed the position was similar from his firm’s point of view. Reference can again be made to the evidence of the other solicitors as to general commercial practice in this sort of situation.
[65] Before leaving the issue of the ordinary course of business, there is one other feature of this case that is relevant. When Merivale settled the sale of its land in December 1996 a number of outstanding invoices for professional services were paid from the sale proceeds. The parties accepted that accrued professional fees would be deducted from the proceeds of sale. The situation was the same in relation to the sale of Carlton’s property.
[66] When the above factors are all considered, then although the payments were made from the sale of Carlton’s assets at a time when Carlton had disposed of its principal business, there is sufficient evidence to support the Applicants’ submission that the payments should be seen as normal and usual transactions for the parties to have entered. It is not a question of elevating solicitors and accountants to the status of secured creditors. They will often be in a better position than other creditors to know whether or not there is a likelihood of preference. If there is such a preference and they are aware of it, then they may be caught by the provisions of s292(4). In most cases it will be readily apparent whether there will be a shortfall on sale for general creditors or not. In the present circumstances, however, the evidence before the Court is that neither Mr Robinson for Malley & Co nor Mr Lynskey for Pricewaterhouse Coopers had any reason to consider that all creditors would not be paid. The position of Saunders & Co is a fortiori. The payments were made from the proceeds of sale as had been agreed to by all parties, and were made with the intention that all independent creditors would be repaid leaving Mr Hempseed in the best possible financial position.
[67] On balance, when considered in their objective commercial setting, I find the payments in this case were ordinary transactions for the parties to have entered into.
HAS THERE BEEN A PREFERENCE?
[68] The next, but equally important, issue is whether there has been a preference. It is also affected by the interrelationship between Mr Hempseed, Merivale and Carlton. The evidence referred to above is also relevant to consideration of this issue. As noted, the focus of the statutory provisions is to ensure that the payment does not have a preferential effect: s292(2); Waikato Freight (supra) and National Bank of NZ v Coyle (supra). There can only be a preferential effect if the party receiving the payment receives more than they would have received in the liquidation: National Bank of NZ v Coyle (supra); and Lewis v Hyde [1998] 1 NZLR 12:
“This result conforms with the common sense of the matter. There is no reason to set aside a transaction so as to bring assets into the pool of assets available for distribution amongst creditors in the insolvency unless the transaction so set aside has in fact diminished the pool which would otherwise have been available.” Per Lord Browne-Wilkinson P18
[69] If the payments were made at a time when Carlton was unable to pay its debts and I am wrong in finding that they were in the ordinary course of business, the liquidator can only set aside the payments if they enabled the Applicants to receive more than they would have received in Carlton’s liquidation, or if the effect of the payment was to prefer the Applicants.
[70] Subject to the issue of the joint liquidation of Merivale, unless and until the liquidator accepts the “residual” debts of Mr Hempseed and Merivale as proven it cannot be said that there has been a preference to the Applicants in the present case. If those intercompany debts and shareholder advances are not accepted as debts Carlton itself has no other creditors. The Applicants would be entitled to prove in Carlton’s liquidation.
[71] As matters stand, as the liquidator has not accepted Merivale’s and Mr Hempseed’s debts, and as there are no other creditors of Carlton, if the payments were set aside they would fall into the liquidation to be distributed back to the Applicants.
[72] Mr Whiteside suggested it was likely that the liquidator would accept the Merivale and Mr Hempseed debts. However, he has not yet done so. I have to deal with the matter on the basis of the information before the Court. As noted, The liquidator is directed to accept or reject the debts as soon as practicable. The liquidator has had since shortly after December 1999 to approve or reject the Merivale and Mr Hempseed debts (over 15 months at least). Despite the fact he had not formally accepted the claims by Mr Hempseed and Merivale the liquidator chose to issue the notices to set aside the transactions.
[73] There is no presumption that the transactions have preferred the Applicants. There are no other independent creditors of Carlton. As the liquidator has not accepted Merivale’s and Mr Hempseed’s debts in the liquidation it cannot be said that the payments enabled the Applicants to receive more than they would receive in Carlton’s liquidation.
OTHER FEATURES
The liquidation of Merivale
[74] Mr Whiteside suggested that there were other creditors to consider, the creditors in Merivale’s liquidation.
[75] When Carlton was placed into liquidation an order was made that the liquidation of the Carlton and Merivale should proceed together as though they were one (s271(1)(b)). The order was made on Mr Fagerlund’s application as liquidator of Merivale.
[76] Merivale has other creditors. It has preferential creditors of $113,208.07 and other unsecured creditors of $871,734. Even allowing for the sale of its residual assets there will be a shortfall to preferential creditors.
[77] The fact the companies are to be liquidated as though they are one can not affect consideration of whether the payments by Carlton were made in the ordinary course of business. Nor in my view can it affect consideration of whether the payments enabled the Applicant creditors to receive more in the liquidation of Carlton than they would otherwise have received. Consideration of that issue must be restricted to the creditors of Carlton as at the date of its liquidation. The order under s271(1)(b) was made to assist the administration of the companies in liquidation. It was made in general terms. It would require an order in rather more explicit terms if it is to be suggested that Merivale’s creditors are to be regarded as Carlton’s creditors for the purposes of the application under s292.
Saunders & Co payment
[78] In addition to addressing on the issues of ordinary course of business, Mr Lester submitted the internal transfer within Mr Hempseed’s trust account with Saunders & Co could not be regarded as a transaction in relation to the company, and that it was not possible to “carve up” the payment to try and identify payments which may or may not be voidable. He also submitted that the company did not pay the $25,595.93 to the Applicant, but rather Mr Hempseed did.
[79] Mr Whiteside submitted that in the National Bank of NZ v Coyle (supra) case Panckhurst J had made it clear that it is the substance of the transaction which must be examined to determine whether there was preferential payment by a company. In that case the bank received a payment of $22,000 from shareholders of the company in reduction of the company’s overdraft. The bank argued the payment received was not a payment by the company. His Honour acknowledged that literally that might be correct but stated:
“However, there is abundant evidence to the effect that, regardless of the form of the payment, in substance it was an advance by and on behalf of the three new shareholders .
. . . Whilst it was made by Mr Norton from his personal resources and direct to the Bank, there can be no question that it was in substance an advance to the Company by legal and beneficial shareholders to bring the overdraft facility under control. I have no doubt but that for the intervention of the liquidation, the advance would have been recorded as such in the books of the Company with a corresponding increase to the current accounts of Messrs Goosman and Purser . . .” P262,102 - 262,103
[80] With respect I accept and agree that the substance of the transaction must be looked at. The effect of s292 cannot be avoided by the device of inserting another step into the transaction so that the company would make a payment to a bank account of one of its officers who would then in turn pay the creditor from that account. In the present case it is clear that Carlton was the source of the payment of the $66,196.90.
[81] The situation would be different if it was clear that Mr Hempseed had taken the money personally as a shareholder advance. There may be situations where a company could genuinely make a payment to a shareholder as an advance to that shareholder to enable that shareholder to pay personal accounts. In those circumstances one would regard that payment as an advance by the company to the shareholder’s current account. Payment thereafter by the shareholder would not be a payment by the company. However, there is no evidence about that in this case and given Mr Hempseed’s previous confused dealings, it cannot be inferred that that was how the transaction was to be treated.
[82] Nor do I see a difficulty with that sum of $66,196.90 being split and applied to the payment of different accounts. A payment to a creditor may involve payment of both secured and also unsecured indebtedness, or payment of priority and non-priority amounts. In this case some of the payment was applied to pay mortgage arrears and other payments were made to pay legal bills. The source of the payment can still be identified as Carlton.
[83] The real issue is whether properly considered this particular transaction was a payment to a creditor of the company. In the present case the evidence regarding the payment of the $25,595.93 is that it was made to pay three accounts:
Re Eastwood Construction $6,284.93
Phil Cooper trading as Mobil Victoria Street $11,456.25
Van der Klei $7,854.75
[84] The Eastwood Construction account was for costs incurred in litigation. Mr Hempseed was personally liable as a party to the proceedings for those costs. Carlton was not prima facie liable to Saunders & Co for those costs. The suggestion in Mr James’s letter of 24 July 2000 otherwise can not alter the legal position.
[85] The other costs were incurred by and on behalf of Merivale, not Carlton. Mr Hempseed signed an acknowledgement on behalf of himself and Merivale confirming that in relation to the Van der Klei and Cooper accounts payment could made by deduction from the sale proceeds of the Merivale settlement. That did not occur as there was a shortfall. Mr Hempseed remained personally liable to pay the accounts.
[86] Mr Frampton’s evidence regarding the matter is:
“8. When that land was sold [Saunders & Co] agreed not to enforce its right to payment from those funds as [Carlton] wish [sic] to utilise the funds in the meantime. This was done at the request of Mr Hempseed. On that basis [Saunders & Co] agreed to defer the security had by way of lien over the proceeds of sale of motel land which would have been paid to us by [Merivale].”
[87] While it may be correct, as Mr Whiteside submitted, that Carlton practically received the benefit of the use of those funds in the meantime, that does not of itself make Carlton liable to pay the accounts or make it a debtor for those accounts. There is no direct evidence that Carlton was a debtor and liable to Saunders & Co for the accounts in question. The evidence is that the accounts were Mr Hempseed’s and Merivale’s accounts and that Mr Hempseed had personally bound himself to pay them.
[88] There is no distinction between the balance of the $66,196.90 that was applied towards reduction of personal mortgage borrowings by Mr Hempseed, and the payment to the solicitors for legal fees that Mr Hempseed was personally liable for. The accounts paid were not Carlton’s accounts. Saunders & Co were not creditors of Carlton for those accounts.
[89] The $25,595.93 was not a payment that comes within s292 as it was not a payment to a creditor of Carlton. The situation is the same as that in Chilton Saint James School v Gray (1996) 9 PRNZ 349 (unaffected on appeal in Gray v Chilton Saint James School (1997) 8 NZCLC 261,306).
SUMMARY
[90] This is an unusual case. It has features which have not been directly considered by the Court on applications such as these before. The recent decision of the Court of Appeal in Waikato Freight (supra) has been of assistance on the issue of whether it can be said the payments were made in the ordinary course of business. In principle I accept that a payment made when a company is winding down its business affairs must be considered carefully, but it is not as a matter of course, to be regarded as a payment other than in the ordinary course of business. A particularly unusual feature in this case is the interrelationship between Mr Hempseed and Carlton.
[91] Another feature of this case is that the liquidator has chosen not to challenge a number of other payments that were made from exactly the same source and at the same time that the payments in issue were made. While that is a matter for the liquidator, it is a factor that can be taken into account.
[92] For the reasons set out above I find that the Applicants satisfy the Court the payments were made in the ordinary course of business, and as matters stand it cannot be said the payments had a preferential effect.
[93] In the case of Saunders & Co there is the additional point that Saunders & Co were not a creditor of Carlton in relation to the accounts that make up the payment of $25,595.93 to that firm.
[94] There will be orders on each application that the transactions referred to in the application not be set aside.
COSTS
[95] The Applicants are entitled to costs. Costs to Saunders & Co on a 2B basis together with disbursements. Costs to each of Malley & Co and Pricewaterhouse Coopers on a 2B basis together with disbursements for all steps up to the hearing, but only one award of costs on a 2B basis is allowed for the hearing, given they were represented by the same counsel and a number of the issues overlapped.
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