Smartpay Ltd v Kumar
[2022] NZHC 997
•13 May 2022
IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY
I TE KŌTI MATUA O AOTEAROA TĀMAKI MAKAURAU ROHE
CIV-2020-404-001775 [2022] NZHC 997
IN THE MATTER OF the liquidation of 4468440 Limited (previously known as Optimizer Corporation Ltd) BETWEEN
SMARTPAY LIMITED
Plaintiff
AND
MANAS DHARMENDRA KUMAR
Defendant
Hearing: 2 – 5 May 2022 Counsel:
DJ Chisholm QC and J Ryan for Plaintiff
MA Corlett QC and M Taylor-Cyphers for Defendant
Judgment:
13 May 2022
INTERIM JUDGMENT OF DOWNS J
This judgment was delivered by me on Friday, 13 May 2022 at 12 pm pursuant to r 11.5 of the High Court Rules.
Registrar/Deputy Registrar
Solicitors/Counsel:
Claymore Partners Ltd, Auckland. Haigh Lyon, Auckland.
DJ Chisholm QC, Auckland. MA Corlett QC, Auckland.
M Taylor-Cyphers, Auckland.
SMARTPAY LTD v KUMAR [2022] NZHC 997 [13 May 2022]
The case
[1] Optimizer Corporation Ltd1 was placed in liquidation 10 December 2015. Smartpay Ltd2 is one of OCL’s creditors. Smartpay contends Manas Kumar, OCL’s director, breached his duties to OCL causing it (and Smartpay) loss. The essence of Smartpay’s case is that Mr Kumar allowed OCL to assume obligations it could never meet because OCL had neither assets nor income, and no legally enforceable means of securing financial help from related companies.
[2] Mr Kumar denies breaching his duties to OCL. He says a viable business existed across OCL and two related companies: Odev Ltd3 and Optimizer HQ Ltd.4 Together, the three companies formed this group:5
Background
[3]Little contest attaches to the background.
[4] Odev developed software products for small businesses. A key product was Swipe HQ. Swipe HQ was an online debit and credit card programme that allowed merchants to process related transactions. Swipe HQ could be allied with a
1 OCL.
2 Smartpay.
3 Odev.
4 HQ.
5 The group.
mobile EFTPOS terminal. If so, small businesses could process EFTPOS transactions wirelessly, without the need to do anything more. Therein lay Swipe HQ’s potential.
[5]Mr Kumar became a director of Odev 21 September 2011.
[6]Odev’s parent, HQ, was incorporated 11 April 2013.
[7]Odev’s sibling, OCL, was incorporated 5 June 2013.
[8]Mr Kumar was a director or sole director of each.
[9] On incorporation, OCL issued 1,000 shares, each for $1. HQ owned all. OCL had no assets beyond the $1,000 presumably paid for its shares.6
[10] Once the group existed, Odev’s business was carried out by HQ, or perhaps HQ and Odev together. No contemporaneous documentation explains why.
[11]On 28 May 2014, OCL and Spark entered an agreement.7 The agreement:
(a)Gave Spark the right to market and sell Swipe HQ.
(b)Required OCL to supply Spark mobile EFTPOS terminals with Swipe HQ.
(c)Presupposed OCL would gain revenue from Spark’s clients by OCL charging them directly for the technology. No fee was payable by Spark to OCL for the technology.
(d)Was for one year.
[12]Mr Kumar signed the Spark agreement on behalf of OCL.
6 Mr Kumar said OCL owned a licence to “commercialise the technology and the intellectual property … being developed” by the group. No contemporaneous documentation was adduced to support this proposition, and Mr Kumar accepted in cross-examination OCL had no assets (beyond the $1,000).
7 The Spark agreement or occasionally, the agreement.
[13] OCL did not have any mobile EFTPOS terminals to provide Spark. Neither did Odev nor HQ.
[14] This explains Smartpay’s involvement in the case: it makes and supplies EFTPOS terminals. OCL, through Mr Kumar, approached Smartpay with a view to it supplying OCL terminals. Smartpay began doing so absent a written agreement.
[15] On 18 September 2014, OCL and Smartpay entered a distribution agreement backdated to 1 August 2014.8 Again, Mr Kumar signed this agreement on behalf of OCL. The Smartpay agreement:
(a)Gave OCL the right to rent EFTPOS terminals made by Smartpay.
(b)Required OCL to pay Smartpay fees of:
(i)$48 per terminal (plus GST).
(ii)$18 per terminal (plus GST) every month.
(iii)0.35 percent (plus GST) of the merchant fee received by OCL.
(c)Retained ownership of the terminals in Smartpay and created a security interest in them.
(d)Was for two years.
[16] As observed, the Spark agreement presupposed OCL would gain revenue from Spark’s clients by OCL charging them directly for the technology. However, the revenue flowing from the Spark agreement went not to OCL, but HQ. Indeed, OCL had no revenue. So, OCL was reliant on HQ, Odev or both to meet its obligations to Spark, Smartpay and others.
8 The Smartpay agreement.
[17] From November 2014, OCL defaulted on its monthly obligations to Smartpay. The pattern was this. Smartpay would issue OCL an invoice in accordance with the Smartpay agreement. OCL would not pay as required. Smartpay would repeatedly chase OCL for payment. OCL would offer an excuse. Belatedly, and sometimes after only more chasing, OCL would pay Smartpay.
[18] OCL did not keep its own financial statements. Those ending 31 March 2015 in relation to the group reveal a loss of $3,428,012 and cash deficit of $3,641,841.
[19]On 22 May 2015, Spark terminated the Spark agreement.
[20] On 3 June 2015, Smartpay issued OCL a statutory demand for $163,050.69. On 24 June 2015, Odev met OCL’s overdue commitments to Smartpay.
[21]On 13 October 2015, OCL’s landlord issued OCL a statutory demand for
$54,042.72. Two days later, Smartpay issued OCL a statutory demand for $39,280.02.
[22] Between 20 October and 26 November 2015, Global Paradigm Ltd, who owned shares in the group, advanced $175,000 to the group.
[23]On 12 November 2015, Smartpay issued OCL another statutory demand for
$39,744.79.
[24]On 10 December 2015, HQ placed OCL (and Odev) in liquidation.
[25] The liquidators consider OCL’s records “inadequate”. Mr Kumar says these were stored on the cloud and he could not access them once OCL was placed in liquidation.
[26]HQ was placed in liquidation 27 November 2020.
The law
[27]The rival contentions are best understood with the law in mind.
[28] Section 15 of the Companies Act 1993 enshrines the elementary principle a company is a legal entity in its own right. Directors of a company have fiduciary duties to it.
[29] Section 131 of the Companies Act requires a director to act in good faith in what the director believes to be the best interests of the company. As the section implies, the test is subjective.9 But—and to foreshadow a point to come—a director cannot believe they are acting in the best interests of the company if they fail to consider the company’s interests.10
[30] Related obligations arise by virtue of ss 135 and 136 of the Companies Act. The former prohibits a director from carrying on the business of a company in a manner likely to create a substantial risk of serious loss to the company’s creditors. The latter precludes a director from permitting a company to incur an obligation unless he or she believes, at that time and on reasonable grounds, the company will be able to perform the obligation when required to do so.
[31] Case law in relation to s 135 draws a distinction between legitimate and illegitimate risk-taking (recognising business entails risk).11 This test is objective, hence what a director considers appropriate is not decisive.12
[32] The leading case in relation to ss 131, 135 and 136 is Debut Homes.13 Therein, Glazebrook J observed for the Supreme Court:14
If a company reaches the point where continued trading will result in a shortfall to creditors and the company is not salvageable, then continued trading will be in breach of s 135 of the Act. ...
If directors agree to debts being incurred where they do not believe on reasonable grounds that the company will be able to perform the obligations when they fall due, then there will be a breach of s 136 of the Act. Such obligations do not need to arise from direct contractual arrangements between the company and the creditor.
9 Madsen-Ries (as liquidators of Debut Homes Ltd (in liq)) v Cooper [2020] NZSC 100, [2021] 1 NZLR 43 at [109]–[112].
10 At [114].
11 Mason v Lewis [2006] 3 NZLR 225 (CA) at [53]–[55].
12 At [49].
13 Madsen-Ries (as liquidators of Debut Homes Ltd (in liq)) v Cooper, above n 9.
14 At [174]–[177] (footnotes omitted).
That there will be breaches of ss 135 and 136 in the above circumstances is clear from the wording of those sections but also from the scheme of the Act with its emphasis on solvency, the carefully prescribed statutory priorities on liquidation, as well as the all-important pari passu principle, and the features of the formal mechanisms for dealing with insolvency or near-insolvency situations.
There will be no breach of s 131 if a director honestly believed they were acting in the best interests of the company. There will, however, be a breach of s 131 if directors, in an insolvency or near-insolvency situation, fail to consider the interests of all creditors. Such a breach may be exacerbated by a conflict of interest.
[33] Section 301 of the Companies Act creates a “procedural short cut” by which a liquidator, creditor or shareholder of a company in liquidation may bring claims against a director for breaches of duty in relation to that company.15 The same section empowers the Court (once a breach is established) to require the director to “contribute such sum to the assets of the company by way of compensation as the Court thinks just”.16
The rival contentions in relation to Mr Kumar’s duties
[34] Smartpay brings the case under s 301. It contends Mr Kumar breached his duties to Smartpay, in contravention of ss 131 and 135, by allowing OCL to enter the Smartpay agreement,17 and thereafter until being placed in liquidation, by trading recklessly in contravention of s 136.18
[35] The essence of Smartpay’s case is that Mr Kumar allowed OCL to assume obligations it could never meet because OCL had neither assets nor income, and no legally enforceable means of securing financial help from HQ or Odev.
[36] Mr Kumar acknowledges the group’s structure was “untidy” in so far as OCL had obligations but no material assets or income.19 However, Mr Kumar says he did not breach his obligations, as a director, to OCL. Mr Kumar says he believed the group had a viable—indeed, potentially lucrative—business centred on Swipe HQ.
15 Yan v Mainzeal [2012] 3 NZLR 598, [2021] NZCA 99 at [298].
16 Companies Act 1993, s 301(1)(b)(ii).
17 The first and third causes of action.
18 The second cause of action.
19 Mr Kumar said this in evidence.
[37] Mr Kumar says when OCL entered the Spark agreement, he believed HQ, Odev, or both, would support OCL. Moreover, Mr Kumar says this belief was reasonably grounded because he was a director of every company in the group, and it was in the interests of each company to support the others because the business was spread across the group. Mr Kumar likened each company to a limb of the human body—he considered the three companies comprised a single entity.
[38] Mr Kumar says events beyond the Spark agreement demonstrate the reasonableness of this approach. HQ, Odev or both did support OCL in meeting its obligations, and the group enjoyed capital injections.20
[39] Finally, Mr Kumar says technology companies invariably struggle in their early years, and he had no intention of defeating creditors by agreeing to OCL’s affairs (or the group’s affairs) being structured as they were.
Analysis
[40] This aspect of the case is blessedly simple because of an unusual, perhaps unique, constellation comprising eight points.
[41] First, OCL had no assets beyond the $1,000 it presumably received for its shares. So, as soon as OCL incurred liabilities of more than $1,000, it became balance sheet insolvent.21 Second, OCL had no revenue. So, as soon as OCL incurred liabilities, it became cashflow insolvent.22 Third, OCL was, therefore, balance sheet and cashflow insolvent from near inception.23 OCL cannot have been other than insolvent in both respects when it entered the Spark agreement 28 May 2014. Fourth, the revenue anticipated to OCL by the Spark agreement went not to OCL, but HQ. Fifth, OCL was therefore reliant on others—HQ, Odev or both—to meet its obligations under the Spark agreement. Indeed, OCL was reliant on others to meet every obligation it had, including those to Smartpay under the Smartpay agreement. Sixth, OCL had no legally enforceable means of securing financial help from HQ or Odev.
20 See [22].
21 Companies Act, s 4(1)(b).
22 Section 4(1)(a).
23 The solvency test in s 4 of the Companies Act does not apply directly to ss 135 and 136 of the Act. However, case law emphasises solvent trading underlies a director’s duties to his or her company.
So, at all material times, OCL was (a) insolvent; and (b) absent legally enforceable aid. Seventh, in testimony, Mr Kumar acknowledged he did not consider OCL’s interests, only the interests of the group. Mr Kumar also acknowledged, again in testimony, OCL gained nothing by entering the Spark agreement. Eighth, Mr Kumar’s interests conflicted in these circumstances: he was a director of every company in the group; the majority shareholder of HQ; and HQ wholly owned OCL.24
[42] The constellation means no separate analysis of the allegations is necessary; Mr Kumar unquestionably breached ss 131, 135 and 136 of the Companies Act.25 By his own evidence, Mr Kumar misapprehended his duties to OCL as director. Mr Kumar believed it sufficient to consider the interests of the group rather than those of OCL independently.26 Mr Kumar failed to recognise, let alone act upon, the elementary principle mentioned earlier: a company is a legal entity in its own right.
[43]This point was emphasised by the High Court of Australia in
Walker v Wimborne:27
To speak of the companies as being members of a group is something of a misnomer .... The word “group” is generally applied to a number of companies which are associated by common or interlocking shareholdings, allied to unified control or capacity to control. In such a case the payment of money by company A to company B to enable company B to carry on its business may have derivative benefits for company A as a shareholder in company B if that company is enabled to trade profitably or realise its assets to advantage. Even so, the transaction is one which must be viewed from the standpoint of company A and judged according to the criterion of the interests of that company.
...
Indeed, the emphasis given by the primary judge to the circumstance that the group derived a benefit from the transaction tended to obscure the
24 And Odev.
25 For completeness, paragraph 19(iii) of the statement of claim is not established. It concerns one particular for the second cause of action; and alleges Mr Kumar breached s 135 by selling OCL just prior to liquidation. The point fails because it received no attention at trial.
26 OCL did not have a constitution. So, Mr Kumar could not rely on s 131(2) of the Companies Act, which provides:
(2) A director of a company that is a wholly-owned subsidiary may, when exercising powers or performing duties as a director, if expressly permitted to do so by the constitution of the company, act in a manner which he or she believes is in the best interests of that company’s holding company even though it may not be in the best interests of the company.
27 Walker v Wimborne (1976) 137 CLR 1 (HCA) at 6.
fundamental principles that each of the companies was a separate and independent legal entity, and that it was the duty of the directors of Asiatic to consult its interests and its interests alone in deciding whether payments should be made to other companies. In this respect it should be emphasised that the directors of a company in discharging their duty to the company must take account of the interest of its shareholders and its creditors. Any failure by the directors to take into account the interests of creditors will have adverse consequences for the company as well as for them. The creditor of a company, whether it be a member of a “group” of companies in the accepted sense of that term or not, must look to that company for payment. His interests may be prejudiced by the movement of funds between companies in the event that the companies become insolvent.
[44] That Mr Kumar believed HQ, Odev or both would help OCL is no defence. The other companies in the group were not obliged to do so. Herein lay part of the problem.28 As will be apparent, that Mr Kumar considered the interests of the group is no defence either. Rather, herein lay another part of the problem. That Mr Kumar might not have intended to defeat creditors is beside the point; no such intention is required.29 The other matters Mr Kumar raises add nothing.30
[45] Grant Graham is an experienced chartered accountant and seasoned expert witness.31 Mr Graham testified for Smartpay. He said:
By causing OCL to enter the Services Agreement and the Distribution Agreement, Mr Kumar (as a direct of OCL) allowed HQ to take all the benefits of OCL’s leased equipment (for which it had obligations to Smartpay), for no consideration. This left OCL without any legally enforceable means to meet its obligations. Simply, Mr Kumar caused OCL’s resources to be inappropriately siphoned off to HQ to the complete detriment of OCL. This is, in my opinion, an action that no director with any understanding of his duties could reasonably have taken. It also highlights Mr Kumar’s conflict of interest in favouring the interests of HQ and its creditors and shareholders (of which Mr Kumar as the majority shareholder) to the detriment of OCL and its creditors.
28 This aspect has some similarity with Yan v Mainzeal, above n 16, at [445].
29 On behalf of Smartpay, Mr Chisholm QC suggested OCL was engineered with this in mind. I make no finding on this aspect for two reasons. First, Mr Chisholm did not put the proposition to Mr Kumar despite s 92 of the Evidence Act 2006. Second, the point is not part of Smartpay’s pleaded case.
30 Mr Kumar said in evidence many of the EFTPOS terminals provided by Smartpay were faulty, and this, with other factors, caused OCL to fail. This evidence was unsupported by a pleading. Ms Taylor-Cyphers disavowed reliance on this testimony during her closing address on behalf of Mr Kumar.
31 Mr Graham gave expert evidence in the Bridgecorp, Nathans, Belgrave, Lombard, South Canterbury and Mainzeal trials.
[46] On behalf of Mr Kumar, Mr Corlett QC skilfully cross-examined Mr Graham. However, Mr Corlett did not challenge this evidence. Realistically, he could not. Mr Kumar allowed OCL to become a supplicant.
A causation argument
[47] Mr Kumar contends even if he breached his duties, that should not result in an order he contribute to the assets of OCL by way of compensation, for, the breaches did not cause Smartpay loss. Ms Taylor-Cyphers observes:
(a)Odev could have entered the Smartpay agreement, not OCL. Mr Kumar said as much.
(b)Had Odev done so, its income could have met what would have been its obligations under the Smartpay agreement.
(c)Mr Graham agreed in cross-examination this would have solved the problem “by having the revenue and … expenses all within one company”.
(d)Mr Graham appeared to agree in cross-examination OCL failed because Spark cancelled the Spark agreement and HQ and Odev could no longer meet OCL’s obligations.
(e)OCL and Odev went into liquidation at the same time. None of Odev’s unsecured creditors was paid in its liquidation.
(f)It therefore follows “it would have made no difference to Smartpay’s recovery if the [Smartpay] agreement was with OCL or … Odev”.
[48] In short, Ms Taylor-Cyphers contends Mr Kumar’s breaches of duty to OCL did not cause Smartpay loss because had Odev been the contracting party to the Smartpay agreement, there would have been no breach of duty by Mr Kumar, yet Smartpay would still have gone unpaid by virtue of Odev’s collapse.
[49] The argument is ingenious. And wrong. As Mr Chisholm QC observes for Smartpay, while the claim under s 301 of the Companies Act is brought by Smartpay as OCL’s creditor, the claim is about OCL’s loss in consequence of Mr Kumar’s breaches. Smartpay is a proxy for OCL, and the relief sought of Mr Kumar is a contribution by him to the assets of OCL by way of compensation.
[50] Relatedly, Ms Taylor-Cyphers’ submission employs the wrong inquiry. The question is not what would have happened if Odev had contracted with Smartpay in relation to the Smartpay agreement. Rather, it is whether Mr Kumar’s breaches of his duties to OCL caused OCL loss.
[51] Plainly, they did. Mr Kumar allowed OCL to incur obligations it could never meet absent assets, income and a legally enforceable means of securing aid within the group.
Admissibility and adjournment determinations
[52] Damian Grant is the principal of Waterstone Insolvency Ltd, an insolvency practice. Mr Grant has been involved with the insolvency profession for more than 15 years and is licensed under the Insolvency Practitioners Regulation Act 2019. Mr Kumar filed a brief of evidence from Mr Grant, then an amended brief.
[53] On 17 March 2022, Smartpay objected to the admissibility of Mr Grant’s evidence.32 As duty Judge, I held the admissibility of the evidence be determined by the Judge at trial.33
[54] I heard argument at the beginning of the trial. Mr Chisholm argued Mr Grant lacked expertise to provide any opinion evidence. He also argued the evidence was not substantially helpful, the test for admissibility of expert opinion evidence.34 Mr Corlett acknowledged some shortcomings in the amended brief. However, he
32 Smartpay also objected to the admissibility of evidence of two other defence witnesses. This objection was abandoned at trial. It is unnecessary to say anything about this other evidence beyond that it had marginal relevance.
33 Minute of 25 March 2022.
34 Evidence Act, s 25(1).
contended much of the brief was admissible and those aspects that fell short could be readily edited.
[55]I upheld Smartpay’s objection and excluded Mr Grant’s evidence.
[56] Mr Grant may be expert in managing or liquidating an insolvent company, but he is not expert in relation to determining if a company is insolvent. Such expertise is typically the preserve of a chartered accountant. Unlike Mr Graham, Mr Grant is not a chartered accountant.
[57] Mr Grant’s evidence in relation to solvency was not substantially helpful either, even if one assumes expertise. Mr Grant criticised Mr Graham’s expert opinion evidence on this topic. He said Mr Graham did not consider director confidence of possible capital injection and employed “technical analysis” only. However, accountancy entails technical analysis. Therein lies the point.
[58] The balance of Mr Grant’s evidence was problematical. Mr Grant appeared to see his role as akin to mine, as will be apparent from these aspects of the amended brief:
Methodology
14. In dealing with the matters raised against the defendant, I will deal with each of the alleged breaches separately. The factual background of this case has been extensively covered by other parties and it seems there is no utility in repeating them.
15. I will analyse the evidence that has been presented against Mr Kumar, compare that with other material that is currently in evidence, and then assess if, in my opinion, there is sufficient evidence exists for a breach.
16. Where there is not sufficient evidence, in my view, to establish a breach, I offer my view of what other material would usually be present in cases where a breach is made out – I do this by way of comment, based on my past experience of dealing with companies that are insolvent, and where I have acted on the basis of such breaches in my insolvency practice
17. Finally, I offer my view on what has caused loss, how Mr Kumar may have contributed to such loss, and what was the duration of such issues.
[59] Mr Grant did not identify the evidence he relied on in formulating his opinions. He also relied on material not in evidence. Mr Grant met Mr Kumar and “put to him
several questions and sought a number of explanations”. That interview was not in evidence; neither Mr Grant nor Mr Kumar offered a record of it.
[60] Some of Mr Grant’s evidence was directed at establishing Mr Kumar did not act with an intention to defeat creditors. Quite apart from the point inference is for the factfinder, not expert; this contention was not part of Smartpay’s pleaded case.
[61] Mr Grant’s evidence included inadmissible character evidence and submission. For example, Mr Grant considered Mr Kumar “an impressive individual” whose efforts ala Swipe HQ and Spark constituted “a remarkable achievement”.
[62] Mr Grant’s evidence also encompassed causation and case law even though both are legal matters, and typically the preserve of the Judge.
[63] Taken together—and contrary to Mr Corlett’s submission—the various difficulties left no room for editing. Mr Grant’s evidence was not substantially helpful.
[64] Mr Corlett sought an adjournment of the trial when I excluded Mr Grant’s evidence. He contended Mr Kumar should have time to find an alternative expert. He said if Mr Kumar did not have the benefit of expert testimony, there was a risk of injustice.
[65] I declined the adjournment application. Smartpay signalled in advance of trial the admissibility of Mr Grant’s evidence was contested.35 Mr Kumar should, therefore, have foreseen the possibility that evidence might not be available in his defence. An adjournment would entail delay absent any fault on the part of Smartpay. In summary, an adjournment was not commensurate with the interests of justice.
35 The trial was originally scheduled to begin 21 March 2022. But, it was adjourned to 2 May 2022 because of Covid-19 related difficulties. As observed, Smartpay signalled its objection 17 March 2022.
Quantum of compensation
[66] In his closing address, Mr Chisholm suggested it may be better if there were a separate hearing on this issue. Because Mr Chisholm closed last, I omitted to ask Mr Corlett for his position on behalf of Mr Kumar.
[67] I invite Mr Corlett to address [66] by memorandum, with argument if Mr Kumar opposes a separate hearing. The memorandum must not exceed five pages and must be filed within seven days of this judgment’s release.
[68]This judgment is accordingly interim.
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Downs J
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