Shannon Agricultural Consulting Ltd (in liq) v Shannon
[2015] NZHC 1133
•26 May 2015
IN THE HIGH COURT OF NEW ZEALAND HAMILTON REGISTRY
CIV-2014-419-000408 [2015] NZHC 1133
BETWEEN SHANNON AGRICULTURAL
CONSULTING LIMITED (IN LIQUIDATION)
First Plaintiff
HENRY DAVID LEVIN and VIVIEN JUDITH MADSEN-RIES as liquidators of Shannon Agricultural Consulting Limited (In liquidation)
Second Plaintiffs
AND
PATRICK WYNTON SHANNON First Defendant
CHRISTINE MERLE MOORHOUSE Second Defendant
Hearing: 19 May 2015 Appearances:
K Morrison and J O'Connell for the Plaintiffs
No appearance by or on behalf of the DefendantsJudgment:
26 May 2015
JUDGMENT OF WOOLFORD J
This judgment is delivered by me on Tuesday, 26 May 2015 at 11.00 am pursuant to r 11.5 of the High Court Rules.
..................................................... Registrar / Deputy Registrar
Solicitors: Meredith Connell, Auckland
And to: P Shannon and C Moorhouse, Te Awamutu
SHANNON AGRICULTURAL CONSULTING LIMITED (In liquidation) & ORS v SHANNON & ANOR [2015] NZHC 1133 [26 May 2015]
Introduction
[1] This is a claim by Shannon Agricultural Consulting Limited (in Liquidation) (the company) and its liquidators, as the first and second plaintiffs, against Patrick Wynton Shannon and Christine Merle Moorhouse, the directors and shareholders of the company, as first and second defendants, to recover amounts owing by the defendants on their overdrawn current accounts. The plaintiffs also claim a proprietary interest in a Te Awamutu property owned by the defendants as a consequence of the the defendants’ use of company funds to repay their personal mortgage.
[2] The plaintiffs also seek compensation for the defendants’ breaches of directors duties under s 301 of the Companies Act 1993 (the Act). In particular, the plaintiffs allege that the defendants failed to act in good faith and in the best interests of the company; failed to ensure the business of the company was not carried on in a manner that created a substantial risk of serious loss to its creditors; and caused the company to continue trading notwithstanding no reasonable grounds existed to believe the company would be able to meet its obligations when required.
[3] The company went into liquidation on 3 March 2014 owing $328,971.42 to two creditors, primarily the Inland Revenue Department. The liquidators attribute the losses suffered by the company and its creditors to the defendants’ persistent drawing of significant funds from the company, their failure to repay these funds and their failure to properly discharge their responsibilities as directors of the company.
[4] The plaintiffs filed this proceeding in the High Court at Auckland on
6 October 2014. It was served on the defendants on 9 and 10 November 2014. They have not filed a statement of defence and have chosen not to defend the proceedings. The plaintiffs are therefore able to proceed by way of formal proof.
[5] In preparation for the formal proof hearing, the plaintiffs filed two affidavits by one of the second plaintiffs, Henry David Levin, as liquidator of the company and affidavits from two employees of Deloitte, Hamish Mervyn Ellis-Jack and Eugene Serguevich Souslov, together with two volumes of documents, a bundle of authorities and a synopsis of submissions. On 19 May 2015, I heard from
Ms K Morrison and Ms J O’Connell, on behalf of the plaintiffs. There was no appearance by or on behalf of the defendants. The plaintiffs’ claim was therefore uncontradicted.
Company history
[6] The company was incorporated on 8 May 2002. Mr Shannon and Ms Moorhouse have been directors and shareholders of the company since incorporation. The company carried on business as an agricultural consultant, operating from Mr Shannon and Ms Moorhouse’s home address of 122 Jackson Street, Te Awamutu. It had a computer and an old car. On 9 October 2013, the Commissioner of Inland Revenue filed an application to liquidate the company. The company ceased trading a week later. Following liquidation on 3 March 2014, Mr Shannon recorded the reasons for the company’s insolvency as follows:
(a) poor financial planning;
(b) failure to adjust charge-out rates over time; (c) uncontrolled personal expenditure;
(d) high levels of medical expenditure; and
(e) chargeable time lost due to the need to attend to Ms Moorhouse’s
health needs.
[7] Two creditors have submitted claims in the liquidation. The Inland Revenue
Department claim totals $328,690.50 and is comprised as follows:
(a) A preferential claim for court liquidation costs of $6,198.55;
(b)A preferential claim totalling $41,878.90 for unpaid GST for various tax periods between 31 January 2009 and 30 November 2013;
(c) An unsecured claim totalling $150,732.27 for unpaid income tax for various tax periods between 31 March 2008 and 31 March 2013; and
(d)An unsecured claim for interest and penalties that have accrued up to the date of liquidation on the above core tax liabilities.
[8] Eurofins NZ Laboratory Services Limited has also submitted an unsecured claim in the liquidation totalling $280.92. The liquidators have admitted the Inland Revenue Department claim in the sum of $317,351.33 and the Eurofins’ claim in full.
[9] On liquidation the company did not have any material realisable assets, except for legal claims. To date no realisations have been made in the liquidation.
Date of insolvency
[10] There were financial statements completed for the company up until the year ending 31 March 2013. The latest financial statements showed a net equity of
$346,718. I am of the view however that these statements were materially incorrect as they assigned a realisable value to Mr Shannon’s and Ms Moorhouse’s current account, which is shown as at 31 March 2013 to total $585,952. Despite the fact that this amount is repayable on demand, it has not been repaid. I am therefore of the view that Mr Shannon’s and Ms Moorhouse’s current account did not have any realisable value to the company at the material times and should be excluded as an asset of value to the company.
[11] Section 4 of the Act sets out the solvency test for companies. The test requires a company to be both balance sheet and cash flow solvent to pass the solvency test. The former requires the value of the company’s assets to be greater than the value of its liabilities, including contingent liabilities; the latter requires a company to be able to pay its debts as they become due in the normal course of business. If a company fails either limb of the solvency test it is insolvent.
[12] If the reported value of the current account debt is reduced to a nil realisable value, the financial statements for the company would record that it was operating with a sizable working capital and net asset deficit since at least 31 March 2008.
[13] The company first defaulted on its income tax obligations in the period ending 31 March 2008. Following this, from the period ending 31 March 2010 up to the period ending 31 March 2013, the company consistently defaulted on its annual income tax obligations. While some payments were made they were not significant and failed to pay the core income tax debt. Interest and penalties consequently accrued on the outstanding debt.
[14] The company also first defaulted on its GST obligations in the period ending
31 January 2009. From then the company repeatedly and regularly defaulted on its GST obligations until the period ending 30 November 2013. Again, while some payments were made, they were insufficient to discharge the core GST debt. Interest and penalties consequently accrued.
[15] Based on the uncontradicted evidence of Mr Levin, I am of the view that the company was insolvent on both the balance sheet and cash flow basis from at least
31 January 2009 and possibly earlier.
Current account debt owing by defendants
[16] Mr Shannon and Ms Moorhouse have had a joint current account with the company since at least 2008. Current accounts are commonly used to record advances made by a company to its shareholders, or vice versa. At all material times the company had one current account, which was in the joint name of the two defendants.
[17] The company’s financial statements for the year ending 31 March 2013 record that, as at 31 March 2013, Mr Shannon and Ms Moorhouse owed $585,952 to the company under their joint current account. It is a well settled principle that
advances made by a company to its shareholders are debts owed by the shareholder to the company. Such advances are repayable on demand.1
[18] In addition, the liquidators have identified further transactions since
31 March 2013, which should be added to the current account debt as recorded at
31 March 2013. The liquidators reviewed the company’s Banklink accounting software package. The ledger report for the period from 1 April 2013 to 31 January
2014 coded each transaction of the company undertaken through its bank account for this period. This ledger report led to the identification of further transactions that were coded against Mr Shannon’s and Ms Moorhouse’s current account with the company. These transactions totalled an additional $65,969. The liquidators are of the opinion that the transactions are drawings by the defendants for their personal benefit and are inconsistent with the business expenditure of the company.
[19] The liquidators have also considered whether or not the transactions could have been salaries paid by the company to either Mr Shannon and/or Ms Moorhouse, but in their opinion, the transactions are not salaries. They were not regular in amount or frequency. The transactions were also characterised under the ledger codes recorded against Mr Shannon and Ms Moorhouse’s current account in the general ledger. In this way, the company itself characterised these payments as drawings by (and therefore a loan to) to Mr Shannon and Ms Moorhouse.
[20] The liquidators have also not been provided with any employment contract between the company and Mr Shannon and/or Ms Moorhouse. In any event, the liquidators have not been provided with copies of the requisite resolutions and authorisations required under ss 161 or 107 of the Act when salaries are paid to a company’s director.
[21] In the circumstances, the plaintiffs consider that the sum of $651,921 is repayable to the company by Mr Shannon and Ms Moorhouse – comprising
$585,952 in respect of the 2013 current account debt and $65,969 in respect of the
further transactions identified since 1 April 2013.
1 Thom Contractors Ltd (in liquidation) v Thom HC Auckland CIV-2008-404-6829, 28 April
[22] On 5 March 2014 the company made demand on Mr Shannon and Ms Moorhouse for payment of the 2013 current account debt. On 25 June 2014 the company made further demand on Mr Shannon and Ms Moorhouse for payment of the amount owing in respect of the further transactions. To date no payment has been received by the company. I am of the view that the company is entitled to recover the total current account debt from the defendants in the sum of $651,922.
Constructive trust
[23] Mr Shannon and Ms Moorhouse are the registered proprietors of a property at
122 Jackson Street, Te Awamutu. The ANZ Bank holds a registered mortgage over the property. At the outset of the liquidation, Mr Shannon met with Deloitte staff. During this meeting he acknowledged that the payments coded as “loan payments” in the ledger report were made to meet his personal loan obligations to the ANZ Bank, which were secured by the mortgage over the property.
[24] In the period 1 April 2010 to 31 January 2014, the liquidators have identified payments totalling $76,534 that were coded against “loan payments” in the ledger report. The mortgage payments were paid to the defendants’ joint personal account with the ANZ Bank and then transferred to their ANZ loan account. Consequently, the mortgage payments reduced the amount of the debt owing to the ANZ Bank by the defendants and secured by the mortgage, thereby increasing the defendants’ equity in the property by $76,534.
[25] It is well established that a company director, in consequence of the fiduciary nature of the duties which he or she owes to the company, is treated as if he or she was a trustee of the company’s property under his or her control.2 Therefore a breach of a director’s fiduciary duty is considered to be the equivalent to a breach of trust. Mr Shannon and Ms Moorhouse, as fiduciaries of the company, had obligations not to profit personally from their position as directors; not to allow a
conflict of interest to arise between their duties as directors and their self interest;
and were required to exercise their powers in good faith for the best interests of the company.
2 John Farrar and Susan Watson (eds) Company and Securities Law in New Zealand (2nd edition,
[26] In so far as the company’s funds were under the control of Mr Shannon and Ms Moorhouse, they had an obligation to ensure that those funds were not misapplied. In causing or allowing the mortgage payments to be paid by the company and applied for their personal benefit when the company was itself insolvent, Mr Shannon and Ms Moorhouse misapplied company funds.
[27] A fiduciary is accountable for any benefit or gain acquired through breach of his or her duty, but also, in most cases, it will be appropriate for the Court to declare that the ill-gotten gains are held subject to an institutional constructive trust for the principal. The institutional constructive trust is recognition by the Court that an event occurred in the past that generated a trust over the property acquired by the constructive trustee. Such a trust comes in to being before any order of the Court, which simply confirms the trust.
[28] Examples of a constructive trust flowing from a breach of fiduciary obligations are found in Dickie v Torbay Pharmacy (1986) Ltd3 and Attorney- General (Hong Kong) v Reid.4
[29] I am of the view that in the present case, Mr Shannon and Ms Moorhouse as constructive trustees, have deposited money subject to a constructive trust into their personal bank account and subsequently used the money to meet their personal obligations, secured by the mortgage over the property. The company’s funds have therefore been used to make an investment in the property, giving the company an interest in that property to the extent of the company’s funds used. I am also of the view that Mr Shannon and Ms Moorhouse, as sole directors of the company, can be taken to have had actual or constructive knowledge that the mortgage payments were subject to constructive trusts in the company’s favour. They therefore had the requisite level of knowledge to sustain the plaintiffs’ constructive trust claim. The company is therefore entitled to follow the mortgage payments into the property and therefore claim an equitable proprietary interest in the defendants’ equity in the
property.
3 Dickie v Torbay Pharmacy (1986) Ltd [1995] 3 NZLR 429 (HC).
4 Attorney-General (Hong Kong) v Reid [1994] 1 NZLR 1; [1994] 1 AC 324 (PC).
Breach of directors duties
[30] The plaintiffs claim under s 301 of the Act for breaches of directors duties by
Mr Shannon and Ms Moorhouse. Section 301 provides:
301 Power of court to require persons to repay money or return property
(1) If, in the course of the liquidation of a company, it appears to the court that a person who has taken part in the formation or promotion of the company, or a past or present director, manager, administrator, liquidator, or receiver of the company, has misapplied, or retained, or become liable or accountable for, money or property of the company, or been guilty of negligence, default, or breach of duty or trust in relation to the company, the court may, on the application of the liquidator or a creditor or shareholder,—
(a) inquire into the conduct of the promoter, director, manager, administrator, liquidator, or receiver; and
(b) order that person—
(i) to repay or restore the money or property or any part of it with interest at a rate the court thinks just; or
(ii) to contribute such sum to the assets of the company by way of compensation as the court thinks just; or
(c) where the application is made by a creditor, order that person to pay or transfer the money or property or any part of it with interest at a rate the court thinks just to the creditor.
(2) This section has effect even though the conduct may constitute an offence.
(3) An order for payment of money under this section is deemed to be a final judgment within the meaning of section 17(1)(a) of the Insolvency Act 2006.
(4) In making an order under subsection (1) against a past or present director, the court must, where relevant, take into account any action that person took for the appointment of an administrator to the company under Part 15A.
[31] Section 301 does not, of itself, create any duties on directors. It is rather a means of enforcement against directors who have misapplied or retained or become liable or accountable for money or property of the company or been guilty of negligence, default or breach of duty or trust in relation to the company. Claims brought under s 301 involve a two-stage evaluation:
(a) Has there been a breach of a duty owed by a director to the company;
and
(b)If so, to what extent should the director contribute to the losses of the company.
[32] The plaintiffs allege that the defendants breached ss 131(1), 135 and 136 of the Act. These are:
131 Duty 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.
…
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.
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.
[33] In the present case, again based on the uncontradicted evidence filed by the liquidators, I am of the view that Mr Shannon and Ms Moorhouse failed to ensure that the company met its tax obligations as they became due. By doing so, they allowed the company to continue trading and incur further debts to creditors, primarily Inland Revenue Department, after it had become insolvent. The company’s inability to meet its tax obligations was largely due to the use by Mr Shannon and Ms Moorhouse of the company’s funds for their personal benefit. These funds, which included amounts received by the company on behalf of the Crown for GST, ought to have been paid to Inland Revenue Department shortly after receipt. Rather, Mr Shannon and Ms Moorhouse took these funds for their personal benefit and applied them to their personal mortgage and other personal expenses at the expense of the company and its creditors. The funds the defendants took from the company would have been more than sufficient to meet its tax obligations.
[34] While Mr Shannon and Ms Moorhouse continued to take drawings in preference to meeting the company’s debts, the company had no prospect of meeting its overdue debts, much less the further debts it would accrue. As a result, the company and its creditors suffered increasing losses until the company was placed in to liquidation. Such loss was suffered as a direct result of Mr Shannon’s and Ms Moorhouse’s failure to act in good faith and the best interests of the company. I am also of the view that they were reckless in operating the company in a very informal manner with scant regard to formal requirements. They therefore breached their statutory duties.
[35] Having determined that Mr Shannon and Ms Moorhouse breached their statutory duties, outlined in ss 131(1), 135 and 136 of the Act, I am now required to identify the appropriate relief to grant to the company. The relief sought by the plaintiffs under s 301 is compensation for the loss suffered by the company with reference to the claims in liquidation. The approach to relief under s 301 was articulated by the Court of Appeal in Mason v Lewis as follows5:
[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 Ltd (in liquidation) (No 2) (1988) 4 NZCLC 64, 317 per Eichelbaum J; and Löwer v Traveller [2005] 3 NZLR 479, which endorsed those principles).
…
[118] Finally, claims of this character necessarily have to be approached in a relatively broad-brush way. The jurisdiction to order recompense is of an “equitable” character.
[36] The breach date for s 301 is, at the latest, 31 January 2009, when the company became unable to pay its debts as they fell due. The debts incurred by the company following 31 January 2009 totalled $302,718.16, being the total admitted claims of $317,632.25 less $14,633.17, which was the portion of the Inland Revenue
Department’s claim for core income tax debt incurred before the date of insolvency.
5 Mason v Lewis [2006] 3 NZLR 225 (CA).
[37] I am of the view that the actions of Ms Shannon and Ms Moorhouse were the cause of the company’s losses as they had sole responsibility for the management of the company as its directors. I am also of the view that, in the present case, their actions were at the upper end of the range of culpability. As Mr Shannon acknowledged, poor financial planning and uncontrolled personal expenditure caused the company to become insolvent. Mr Shannon and Ms Moorhouse knew or ought to have known of the increasing levels of overdue tax liability signified by the large amounts of penalties and interest that the company was accruing. The amount owing to creditors at liquidation was significant. Mr Shannon and Ms Moorhouse chose, however, to pay themselves by taking significant drawings instead of paying the company’s creditors. The sum taken by Mr Shannon and Ms Moorhouse was more than sufficient to meet the company’s debts. They did not however repay those funds to the company, choosing instead to allow the debts to the company’s creditors to continue to increase. As a result, the creditors’ losses cannot be characterised as a result of the impact of the commercial risks of trading. Rather, it was as a result of a decision by Mr Shannon and Ms Moorhouse to deprive the company of money that would otherwise have been available to allow the company to meet its liabilities. As to the duration of the wrongful trading in the present case, the company traded while insolvent for at least four years eight months. This duration is lengthy.
[38] In the circumstances, and in exercising the wide discretion conferred upon the Court, I am of the view that it is appropriate to direct that Mr Shannon and Ms Moorhouse compensate the company in the sum of $302,718.16, being 100% of the creditor’s losses admitted by the liquidators, which were accrued after the date of insolvency.
Result
[39] I am conscious that I have found Mr Shannon and Ms Moorhouse liable to pay considerably more in total than the loss suffered by the creditors. Funds are needed, however, to pay the liquidators. Further, if there is a surplus in the liquidation, it will be returned to Mr Shannon and Ms Moorhouse as the sole shareholders. All of the claims against Mr Shannon and Ms Moorhouse are conceptually different and all have been made out on the uncontradicted evidence.
[40] Judgment is accordingly given in favour of the plaintiffs against Mr Shannon and Ms Moorhouse jointly and severally in the sum of $878,105.16, which comprises their current account debt of $575,387 (being the total current account debt of $651,921 less the mortgage payments of $76,534) and compensation of
$302,718.16, pursuant to s 301 of the Act.
[41] In addition, there is a declaration that the company is entitled to trace the payments into and has an equitable proprietary interest in the property owned by Mr Shannon and Ms Moorhouse at 122 Jackson Street, Te Awamutu (CT SA1042/143 and SA32B/595) to the sum of $76,534 and that Mr Shannon and Ms Moorhouse hold the property on trust for the company to the sum of $76,534.
[42] Interest is payable on the sum of $575,387 from 25 June 2014, being the date demand was made of Mr Shannon and Ms Moorhouse for repayment of the total current account debt. Interest is also payable on the sum of $302,718.16 from the date of liquidation.
[43] Finally, the plaintiffs are entitled to costs on a 2B basis.
……………………………….
Woolford J
8
0
1