Sojourner v Robb HC Christchurch CIV 2004-476-000568
[2006] NZHC 1676
•4 July 2006
For a Court ready (fee required) version please follow this link
IN THE HIGH COURT OF NEW ZEALAND CHRISTCHURCH REGISTRY
CIV 2004-476-000568
IN THE MATTER OF KUT PRICE YACHTS LIMITED (In
Liquidation)
BETWEEN CLIFF LEE SOJOURNER First Plaintiff
ANDSAILING CAT CRUISES LIMITED Second Plaintiff
ANDTREVOR ALLAN ROBB AND MARGARET CHRISTINE ROBB Defendant
Hearing: 29, 30, 31 May and 1, 2, 6, 7 and 8 June 2006
Appearances: R C Laurenson for Plaintiffs
JCD Guest and N Scott for Defendant
Judgment: 4 July 2006
JUDGMENT OF FOGARTY J
SOJOURNER And Anor V ROBB HC CHCH CIV 2004-476-000568 [4 July 2006]
INDEX
Paragraph
Introduction [1]
Was the sale of Aeromarine a breach of the defendants’ [10]
duties as directors to Aeromarine?
The sale
The statutory duty [12] The rival contentions [13] A preliminary consideration of the legal issues [16]
The character of the “technical insolvency” and the [19]
consequential options
Ability to pay debts as they became due [21]
Disparity of liabilities to assets [24]
Intercompany debits [25] Contingent liabilities [32] Goodwill as an asset [42]
Conclusion on insolvency [55]
Why did the directors sell Aeromarine’s business to the
new company Aeromarine Industries? [57]
Conclusion on purpose of sale [83]
Do these findings of fact constitute a breach of the
directors’ duty to the company as imposed by s 131(1)? [84]
Conclusion [107] Remedy on application of s 301 [108] Guidance from equity [121]
Conclusion on remedy [158]
Other causes of action [162] Final orders [166] Costs [167]
Introduction
[1] Kut Price Yachts Limited (In Liquidation) was originally incorporated in
1978 as Aeromarine (Robb and Co) Limited. Later its name was changed to Aeromarine Limited. Aeromarine built boats and undertook general engineering work, particularly with fabrication and fibreglass. It was only after its business had been sold to a new company, Aeromarine Industries Limited, that the old company was renamed Kut Price Yachts Limited.
[2] Mr and Mrs Robb, the defendants, have for the last ten years or so been the only shareholders and directors of Aeromarine, the old company. They are the only shareholders and directors of the new company, Aeromarine Industries.
[3] Mr and Mrs Robb operated Aeromarine as part of a group of companies and a farming partnership. All of these entities are owned by themselves as shareholders, or in the case of the farming partnership, as partners. The partnership owns the farm land and receives fees for the personal administration by Mr and Mrs Robb of the various business interests of the group. Hadlow Farming Co Limited operates the farm. Lonica Holdings Limited owns commercial property out of which the business of Aeromarine was conducted. Magnum Boats Limited holds various interests relating to the fabrication of small pleasure boats. The group has at all material times had one banking facility with the ASB Bank and filed its tax returns as a group entity.
[4] Aeromarine entered into two loss making contracts to build two large luxury catamarans. Mr Sojourner is the first plaintiff; his contract was made on 16 August
2000. The second plaintiff is a company owned substantially by the Hiscock family and all the dealings of Mr Robb were with Mr Hiscock. That contract was made on
1 October 2001.
[5] There had been one previous contract by Aeromarine for a big boat. That boat was delivered in 1999. Mr Robb worked out Aeromarine did not make any money on it. He treated that as a learning curve and took on these two contracts.
[6] By the last quarter of 2002, when both contracts were due to be completed staff of Aeromarine realised that progress payments had been paid and spent well in advance of actual progress. The projects consumed enormous amounts of labour. The company would have to devote further considerable labour for no return to complete the boats, at a loss in excess of $300,000.
[7] As an outcome of this predicament the directors sold the stock and plant of Aeromarine to the new company, Aeromarine Industries. The new company took over the staff of the old company and continued to deal with its customers. Sundry debtors of the old company were used to pay its trade creditors together with assistance with loans from Hadlow Farming Co Limited. The old company went into liquidation later in 2003. The plaintiffs proved as unsecured creditors in the winding up. They received nothing.
[8] The plaintiffs bring these proceedings seeking an order from the Court which requires the defendants to pay to the liquidator sufficient funds to enable the plaintiffs to receive from the liquidation payment satisfaction of their proofs of debt, which total about $318,000 plus interest and costs.
[9] There are no allegations of fraud. The central contention of the plaintiffs is that the directors breached duties of loyalty imposed by law to the old company and thereby to themselves as contingent creditors of that company. The plaintiffs contend that it is just that the directors now pay compensation. In response the defendants say that the sale to the new company was a “hiving down” action as an alternative to liquidation.
Was the sale of Aeromarine a breach of the defendants’ duties as directors to
Aeromarine?
The sale
[10] On 10 March 2003 Mr Robb executed an agreement for sale and purchase between Aeromarine and the new company. The agreement used the Real Estate Institute and Auckland District Law Society standard form for agreement for sale
and purchase of a business. The business was described as fibreglass product purchasers. The total purchase price was $217,934.63 made up of :
• Vehicles at valuation 37,600.00
• Plant, fitting and fixtures 35,800.00
• Office equipment 5,501.00
• For the goodwill of the business (including where applicable the benefit of the lease of
the premises including use of moulds) 50,000.00
• Stock and trade 89,033.63 (Expressed as “at valuation”)
[11] The purchase price was expressed to have a possession date of 28 February
2003. The existing employees of Aeromarine were taken over by Aeromarine Industries. Aeromarine Industries collected the receivables of Aeromarine. Aeromarine Industries and Hadlow Farming Limited paid out the current creditors of Aeromarine as at the date of sale of the business from the receipts and by way of advances from Hadlow. Aeromarine Industries from 28 February carried on the business of Aeromarine, except that it did not assume liability for the two luxury yacht contracts of the plaintiffs. The receivables of Aeromarine were essentially expended in the process of meeting Aeromarine’s current creditors. The assets of Aeromarine, understood as the receivables plus the consideration received on sale, were exhausted on the process of paying out the current creditors of Aeromarine leaving unpaid Hadlow Farming Company as a creditor in the sum of at least
$117,000 (as at January 2003) and up to approximately $144,000. There were no assets available to meet the contingent liability of the company to the two plaintiffs for the yachts. Proofs of debts were subsequently admitted by the liquidator totalling for the first plaintiff $159,564.49 and for the second plaintiff $131,550.93, and a further $11,326 for other creditors.
The statutory duty
[12] Section 131(1) of the Companies Act 1993 provides:
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.
The rival contentions
[13] The plaintiffs’ principal allegations are:
1.The transfer of the business was for the purpose of avoiding the contingent liability of Aeromarine to each of the first plaintiff and the second plaintiff.
2. The transaction was not at arms length and was at under value.
[14] The defendants say that any liability is joint. Mr Robb acted at all times for both his wife and himself. Their counsel had essentially two responses. First, that it was not necessary for the defendants to prove that they did not breach duties and that the focus must be on the plaintiffs’ case. Second, Mr Guest argued for the defendants, that the transaction had to be understood as the directors’ response to the insolvency of Aeromarine. The transfer was an alternative to liquidation and was a legitimate “hiving down”. Posing the proposition rhetorically: so why hive down to a new company? He responded:
• To “clean up” the business vehicle for a possible sale to a third party.
• To avoid the possible liability of trading whilst insolvent.
•To trade and preserve the viable aspects of the business for building up to its former state.
•To “ring-fence” the issues with the Plaintiffs for attending to outside of the ongoing business.
[15] Mr Guest said that what the defendants were not prepared to do was to put in further funds from either themselves or entities owned by them and they were not required to do this. They could have put the company into liquidation at that time without any liability arising. That would have been a reasonable act. Their actions and the impact on the plaintiff should be judged against what the result of liquidation would have been. It was submitted that, it is at least probable, but more likely certain, that the plaintiffs would have got nothing if the defendants had liquidated the company in February 2003. The transaction was not to favour themselves or any related entity. Indeed, Hadlow Farming Limited was left unpaid as a creditor and stands with the plaintiffs in its loss.
A preliminary consideration of the legal issues
[16] In support of his argument, Mr Guest relied on four cases particularly, Lion Nathan v Lee (1997) 8 NZCLC 261,360; Re Gellert Developments Limited (In Liquidation) (2002) 9 NZCLC 262,942; Gray v Wilson (1998) 8 NZCLC 261,530; Nicholson v Permakraft (NZ) Ltd [1985] 1 NZLR 242. Essentially, he was arguing that if there are sound reasons for restructuring a company, and the major purpose of the restructuring is to preserve the business, the fact that it has a consequence of ring-fencing a liability does not make the action a breach of duty.
[17] Counsel for the plaintiffs sought to distinguish the above cases from this case on the facts. Both counsel agreed that the application of the duty to act in good faith and in what the directors believe to be the best interest of the company is substantially to be decided on the facts. Certainly, before any judgment can be made as to whether the cases relied upon by the defendants offer useful guidance, it is necessary to explore the facts in some considerable detail.
[18] That exploration does, however, have to be in the context of applying s 131(1). It may be noted immediately that that statutory duty is cast at a high level of principle. It is appropriate to keep in mind that the cautionary observations in the
classic text Gower and Davies’ Principles of Modern Company Law, (7th ed. 2003)
at 371:
Before turning to the substance of directors’ duties, we need to ask who are their beneficiaries, i.e. to whom are they owed? At one level the answer in British law is clear: they are owed to the company. However, as we saw in Chapter 2, the personal assets and liabilities of the legal personality of the company is a highly abstract concept. Its main function is to separate the assets and liabilities generated by the business carried on by the company from those who invest in it, manage it, work for it or deal with it. To say, therefore, that directors must exercise their powers in the interests of the company is to give very imprecise guidance to those directors about what the law requires. If the company is not to be equated with any of the groups just mentioned, whose interests, precisely, should the directors have in mind when the [sic] discharge their functions? …
… The traditional answer of the common law has been the classical one that the duties are owed to the members of the company as a whole, the members being the persons who created it or who have subsequently become members, normally by buying shares in it. The usual justification for this way of defining “the company’ is that the shareholders stand last in line to receive the economic benefits of the company’s activities and therefore have the strongest incentive of all the groups involved with the company to monitor the board effectively. The ‘shareholders as residual claimants’ argument relies on the fact that the profits of the company (some part of which are likely to be distributed to the shareholders) are struck only after the claims of creditors on the company have been allowed for and that, on a winding up, the shareholders are the last to receive a distribution from the company.
Creditors
However, even in these terms it might be thought to follow that, as the company nears insolvency, the interests of the members should be replaced by the interests of the creditors. The shareholders are unlikely to receive a distribution on an insolvent winding up and those with the keenest interest in the company’s performance are then its creditors. In fact, the statutory law recognises this fact very clearly, for one of the main objects of the Insolvency Act 1986 is to place the creditors’ interests in the forefront and to replace the directors, appointed by the shareholders, with an insolvency practitioner accountable, in one way or another, to the creditors. In addition, in recent years the common law has come to accept that the creditors’ interests should be formally recognised within the law of directors’ duties, as insolvency approaches but the formal mechanisms of the Insolvency Act have not yet been triggered.
[19] On 12 February 2003 there was a meeting between Mr Trevor Robb, Mr Donald Gray (the ASB bank manager), and Mr R G Hornsey, the company accountant. The minutes of this meeting are as follows:
MINUTES OF THE MEETING OF THE COMPANY HELD IN THE OFFICES OF MCFARLANE HORNSEY SIMPSON LIMITED ON WEDNESDAY 12 FEBRUARY 2003 AT 1.30 PM.
PRESENT
Mr T A Robb, In attendance Mr Donald Gray and Mr R G Hornsey.
The purpose of the meeting was to discuss the funding requirements for
Aeromarine Limited for the twelve months ending 31 May 2004.
Mr Robb gave a brief summation of the trading to 31 January 2003, which was reflected in the draft accounts prepared to that date showing a loss for the ten months of $123,370.
With assets of $411,235 as per draft statement of financial position as at 31
January 2003 and external liabilities of $520,899 would appear that the company was technically insolvent.
It was decided that the company investigates the opportunity to sell the assets of the company in an effort to generate funds to liquidate the debt.
It was noted that the company owed ASB Bank $259,151 as per reconciled balance as at 31 January 2003. Mr Gray indicated that he would consider releasing the assets of Aeromarine Limited to facilitate a sale provided sufficient security was offered under other ventures owned by Mr and Mrs Robb.
Should this release of the security be agreed to by the bank it was agreed that the company enter into an agreement over the assets of Aeromarine Limited with Hadlow Farming Company Limited and would assume responsibility for satisfying the ASB Bank advance.
The meeting concluded at 2.30 pm
[20] The solvency test is set out in the Companies Act 1993 in s 4(1) as follows:
4 Meaning of “solvency test”
(1) For the purposes of this Act, a company satisfies the solvency test if— (a) The company is able to pay its debts as they become due in the normal
course of business; and
(b) The value of the company’s assets is greater than the value of its liabilities, including contingent liabilities.
Ability to pay debts as they became due
[21] It will be noted that there was no reference in the minutes to any inability of the company to be able to pay its debts as they become due. Mr Gray made his own file note of a meeting with Trevor Robb at the factory on the same day as this meeting, of which the minutes are set out above. It includes this paragraph:
The draft accounts for Aeromarine to 31 Jan (9th mths) record a loss of approx $123k. Apart from the costs relating to the boats Trevor is concerned with the productivity during January and has taken steps to improve this. As a result of the loss the companys liabilities exceed assets. No additional funding has been requested as Trevor believes he can work within existing arrangements. I have requested Russell Hornsey prepare an updated cashflow to review the position going forward.
[22] It is appropriate to keep in mind that the ability of Mr Robb to work within existing arrangements is a reference to the ASB’s credit facilities to the Robb family’s group of companies. Aeromarine as a single entity did not own land. Its tangible assets were stock and plant. It would be a hypothetical and speculative exercise to work out whether it would be able to pay its debts as they become due in the normal course of business, if it did not participate in the group facility for it is not possible to predicate the extent of its credit facility. Mr Gray declined to do so. The fact of the matter is that it participated within the group’s credit facility. As the last two paragraphs of the minutes of the company reveal it was understood by everybody that the directors of Aeromarine did not have a simple discretionary power to remove themselves from the group facility. Amendment of the terms of that facility had to be agreed with the bank.
[23] It follows that it was in the group’s wider interests to ensure for the time being that Aeromarine did not default on its obligations to the bank. Only a few months earlier the group had obtained an increase in its credit facility from the bank. This was to accommodate the deterioration in Aeromarine’s financial position.
[24] The cautious reference in the company minutes to an appearance of technical insolvency is therefore a reference to paragraph (b) of the insolvency test. The accounts to 31 January 2003 did not include in the assets ledger any credit for goodwill. Such a sum would have recognised Aeromarine’s customer relationships and skilled workforce which in combination underpinned a reasonable expectation of future net income. Nor did they include any debit for contingent liabilities. I will return to the absence of these items after considering the criticism of the entries in the accounts.
Intercompany debits
[25] An expert witness for the plaintiffs, Mr Lazelle, criticised the accounts of the company to 31 January recording this deficit. He targeted several intercompany transactions which he contended were unnecessary so that if they were removed the balance sheet insolvency would largely be eliminated. Mr Lazelle’s criticisms had some weight but not sufficient to completely eliminate the balance sheet deficit. In the next few paragraphs I briefly summarise each of the challenged debit entries.
[26] There was an administration fee of $42,000, debited in favour of Hadlow Farming. The accountants’ paper work showed that this was for 1400 hours of secretarial assistance charged at $30 per hour. Mr Robb said it also included Hadlow Farming staff working on the grounds of the premises leased by Aeromarine. The accountants thought it was solely for the work of a secretary. The working sheets show that the accountants did not simply debit Aeromarine with the salary of the secretary in proportion to the time spent on Aeromarine. The charge out rate at $30 an hour suggests that the accountants charged a margin in favour of Hadlow Farming, no doubt on instructions from Mr Robb. I infer that the $42,000 figure could have been reduced closer to actual cost of Hadlow Farming Limited consistent with ordinary accounting principles provided the accountants received appropriate instructions from Mr Robb.
[27] There was a management fee entered of $27,688.90. This was for ten months of the financial year through to year end 31 March 2003. The previous financial year the management fees totalled $216,796.68. There was significant management time by Mr and Mrs Robb each week. But equally there is no doubt that the management fee entry was a traditional mechanism for taking drawings as income from the company, as profitability allowed. The debit is clearly justified but was a discretionary entry by Mr Robb.
[28] There was a debit entry described as “Interest – ASB loans (TA and MC)
$43,750”. Mr Hornsey explained that there was a longstanding charge of $4,375 per month as interest on the capital provided by Mr and Mrs Robb when setting up the business of the company. In that sense this was a standing charge and not any change in accounting practice.
[29] There was a debit of $40,465.83 as interest to the Solomon Heritage Trust. This trust is a charitable trust. It had advanced a considerable sum to Aeromarine. However, that sum had been on lent by Aeromarine to its landlord, Lonica. Lonica is another company in the group. Aeromarine paid rent for the premises at commercial rates to Lonica. However, it appears that the on loan of the money from Solomon Heritage Trust to Lonica was interest free. Had Lonica paid interest at the same rate, or even with a margin favourable to Aeromarine, that would largely have offset this debit item. There was not enough detail provided as to the duration of the loan and to make any firm finding in this regard.
[30] Finally, the accounts show a subvention payment made of $52,763. This sum equates to Aeromarine’s assessable taxable income for the year ended 31 March
2002. On 3 December the minute book authorised a subvention payment to Hadlow Farming Co Limited. Presumably that company had a trading loss for the same financial year. Such intergroup payments are allowed by tax legislation and had the effect of eliminating tax liability of Aeromarine of one-third of $52,763 ($17,587.66). But it also had the consequence of transferring the profit after tax of
$35,175.33 to Hadlow Farming Co Limited. Advantage could have been taken within the group of the Hadlow Farming tax losses by offsetting those losses in favour of Aeromarine, eliminating the latter’s tax without involving any concomitant
transfer of wealth from Aeromarine to Hadlow Farming. That said, it appears that there was an ongoing practice for the elimination of taxation liability to be done the other way by way of subvention payment.
[31] Putting to one side the absence of goodwill or contingent liabilities, in round terms the deficit as stated in the company minute can be justified. But it could have been significantly reduced by Mr Robb without any breach of accounting principle, had he wanted to. In this context it becomes material that the minute describes it as a “technical” insolvency.
Disparity of liabilities to assets (Continued)
Contingent liabilities
[32] All that said, in a material sense the company’s books to 31 January understate the financial problems of the company. This is because there was no provision for the contingent liabilities of the company under the two contracts with the plaintiffs. At the date of the insolvency minute of 12 February, Mr Hornsey had not made any provision for these contingency liabilities, so was not applying the s 4(1)(b) test. Mr Robb did take the view that these claims could be negotiated. He hoped to settle Mr Sojourner’s claim within the $109,000 held in the trust account. Yet on 25 October previous Mr Robb had estimated a loss to the company at
$319,903 if the company completed the boats. On 31 October Mr Hornsey had reported to the bank an anticipated loss of $322,182 regarding the boats.
[33] The prospect of losses first came to the directors’ knowledge about 17
October. What management staff found and reported was that the progress payments received from the plaintiffs had significantly exceeded actual progress on the boats. The company also had to recast its accounts to reflect that income booked to the year ended 31 March 2002 overstated the true income as progress payments had been accepted in advance of actual progress. That reduced reported profit from about
$120,000 down to the aforesaid figure of $52,763. A large amount of labour was being consumed on the boats for no productive return. This had two dimensions:
further labour on the boat would effectively be for no return; and, be a lost opportunity for the company to use that skilled labour to earn money on productive work with other customers.
[34] The directors took steps to avoid those possible losses. The first solution had been to finish off Mr Hiscock’s boat and all but stop work on the Sojourner boat. The latter event happened on 18 October. Mr Hiscock’s boat was launched on 9
December and he was not happy. It leaked. There were a number of other deficiencies in quality, he thought. He had the boat surveyed by Dunsford Marine. Dunsford Marine detailed a large number of deficiencies and by 29 January Mr Robb had that report.
[35] Mr Sojourner, seeing the quality of the Hiscock boat, lost confidence in Aeromarine. He retained solicitors who wrote to Aeromarine on 4 December. His solicitors started by seeking a program of work for completion. Mr Sojourner’s boat was moved outside of the shed it was being constructed in, as the lease of that shed had been brought to an end. The latter event occurred as part of the cost cutting program by the company to meet its new financial problems.
[36] It is doubtful that there was any work done on the Sojourner boat from 18
October. Certainly no work was done on it from January. By mid January Mr Sojourner wanted the boat moved to be completed at another boat yard. At this time, in addition to a large number of his progress payments having been received by Aeromarine, there was a sum of $109,000 held in trust by the Solomon Heritage Trust.
[37] So by 12 February there were serious disputes going on between the two plaintiffs and Aeromarine. The Hiscock boat had gone but there was a real risk that there would be a quantified claim based on the Dunsford Marine report. In respect of the Sojourner boat it was still there, but the company knew it would cost a lot of money (which could not be recovered) if they completed it, and it had to be uncertain as to what kind of deal they could do with Mr Sojourner. There was the potential for both disputes to escalate. There was a significant contingent liability.
[38] A conservative measure of that contingent liability would be Aeromarine’s own internal assessments of what it would cost to actually complete the boats to the contract standard, adjusted for events since those costings were done in October. Another conservative approach would be to cost out the Dunsford Marine report using their own expertise in respect of the Hiscock boat and using their own knowledge of the degree of completion of the Sojourner boat measured against the amount of money held in trust. The latter work had in fact already been done since there had been not much work done on the Sojourner boat since October.
[39] An optimistic view would be to treat both claims as likely to settle, and discount them severely.
[40] There remained, however, a significant cashflow problem in the long term. As at 19 February the opening bank balance was overdrawn $259,151 and was forecast to end at $302,449 OD. It may be noted that this was a significant improvement on the forecast back in October. On 30 October the opening bank balance had been forecast at $495,095 OD and the closing balance at $538,251 OD. However, that cashflow envisaged both receipts and payments in respect of the two big yachts and ongoing labour costs.
[41] The 19 February budget forecasted that the overdraft would reduce over 12 months so that at the end of February 2004 it would be $141,075 OD. However, there was no provision in that cashflow for the contingent liabilities in respect of the two boats.
Disparity of liabilities to assets (Continued)
Goodwill as an asset
[42] The s 4(1)(b) insolvency test intends all assets to be taken into account. It is dangerous to treat it as a balance sheet exercise. For balance sheets on a going concern basis may not recognise intangible assets such as work in progress and
goodwill. On 12 February Mr Hornsey and Mr Robb had not made any provision for the value of intangible assets in the balance sheet.
[43] The question is whether it had goodwill, i.e. the ability to generate future income. The company had recognised that its core business had suffered by reason of labour being used unproductively on these boats. Mr Hornsey said in his brief that at
18 February the income of Aeromarine had ceased. There was no business. There were no ongoing contracts.
[44] Aeromarine had a long trading history, dating back to 1977. Mr Robb was a boat builder, as had been his father. The business of Aeromarine had been predominantly to undertake light industrial work through fabricating fibreglass or composites. The making of small boats had been part of this. One of the companies in the group is Magnum Boats Limited, and Aeromarine does work for that company. Magnum Boats produced good revenues. A very good customer was a bus manufacturing company, Designline. Aeromarine supplied prefabricated fibreglass panels for the bodies of buses. It also made shower enclosures for bathrooms. It had made hydroslides used in aquatic centres. It supplied components to other manufacturers. It had had only three big boat contracts. The first had not been profitable. The next two were the plaintiffs.
[45] From the time the difficulties with the two boats had emerged in mid October Mr Robb had been reporting to the ASB Bank. As part of this exercise Mr Hornsey’s office had prepared cashflows forward on instructions from Mr Robb. The first cashflow on 17 October predicted serious net deficits for October through to February 2003, pushing the bank overdraft out to a maximum of $538,251, were such an overdraft available. Mr Robb advised Mr Gray on 17 October that the company could not work within its cashflow. He did not rely directly on the cashflow analysis but did it by reference to the remaining expenditure on the boats, then estimated to be $390,000 and identified a deficit in the cashflow of $190 -
$250,000. The bank responded in early November increasing its credit facilities by a further $350,000. The company itself responded by effectively electing not to do any more work on the Sojourner yacht and cutting other costs including terminating
the lease on the boat shed, making their full time receptionist redundant and being very happy that several unproductive staff resigned.
[46] The company recognised in October the need to take on additional work. The cashflow projection in October had a new line entry for “additional work” from Designline. On 16 October Mr Hornsey had identified the need to take on new work. Obviously, the intention to stop work on the Sojourner boat was to enable the labour force to be put onto productive work. On 31 October Mr Hornsey reported to the ASB proposed solution including to pursue existing work that was available from clients that had not before been able to be taken up.
[47] Between 4 and 7 February Mr Sojourner told Aeromarine to stop work on the boat. Mr Robb’s evidence was that this caused a problem as there was no work for the staff so released. However, at that time there was very little of any work being done on the boat which had been moved out of the shed. The internal documents of the company are all emphasising looking for other work. I am satisfied in substance it was the company that stopped work on the boat as Mr Brown told Mr Sojourner on
18 October 2002. That was at a time when they were focussing on finishing the Hiscock boat. But they were also concerned about the fact that completing Mr Sojourner’s boat was going to be at a loss, as Mr Brown reported to Mr Robb on
23 October. Mr Brown’s evidence was that the labour force were ready to apply resources to the Sojourner boat at this time but did not do so after the stop work. He then said:
At the suspension of work on the Sojourner boat the factory works were refocused on to industrial manufacturing.
That refocusing had began in October. There was no detail proving idle labour.
[48] Mr Robb’s evidence conflicted as to the availability of additional work in February 2003. At one point in cross-examination he places talking to Designline in January. On another occasion, without putting a date on it, he suggests that it was after the sale. Yet, there was no doubt that additional work from Designline had been identified back in October. It was then quantified at the rate of an additional
$20,000 per month. Detailed actual cashflow statements show that most of the work
the company was billing in December, January and February was to Magnum Boats and to Designline. It was suggested, without any detail, that a lot of the billing in this time was of work that had been done rather than new work. But on any view of it Designline was a substantial client, it was a longstanding client at all material times, including on 12 February. The Magnum Boat franchise appeared to be unaffected. There was no evidence to the contrary. Undoubtedly the diversion of unproductive labour had meant that Aeromarine had not pursued other traditional work.
[49] On 8 February there was adverse newspaper publicity about Aeromarine in the local Timaru Herald. The Herald had previously run a positive account of the construction by Aeromarine of Mr Hiscock’s boat. The second article contained Mr Hiscock’s criticisms of the boat.
[50] About 18 February Mr Hornsey prepared another cashflow budget, taking instructions from Mr Robb to use the income for the year ended 31 March 1996 as the assumption of future income. He produced this on 19 February. About the same time he was also preparing an assessment of EBIT (earnings before interest and tax). On 18 February he sent the following fax message to Mr Robb:
Hi Trevor,
Attached lease find the summary of trading for 10 years identifying the yacht sales from other sales. Assuming no profit or loss on the yachts, and including the Magnum boat sales, we have calculated the EBIT to provide a basis for the goodwill valuation.
Your comments today of goodwill equating to approx one years ebit is challenged with the basis we have used by applying the basis of John Issac.
A compromise is necessary, but the low cost of plant and stock levels generating very good profits identifies the skill level of your business.
Perhaps a capitalisation factor of 30% would give a goodwill figure of
$600,000, 40% $400,000. I look forward to your comments. Regards
Russell
[51] There are a number of aspects about this fax which should be noticed. This analysis and these comments were prepared a day before the company gave a listing
for sale to Ms Prier of Ray White Commercial at Christchurch. It was suggested that Mr Hornsey’s assessment of goodwill was an optimistic figure designed to be provided to Ms Prier. That is probable. The fax indicates also that Mr Robb had been of the view that goodwill should equate to approximately one year’s EBIT. That view was rejected by Mr Hornsey. He explained that he did the EBIT as part of a company valuation exercise adopting the method recommended by an author, Mr John Isaac. In the context he is saying to Mr Robb that it was not possible to equate goodwill with one year’s EBIT.
[52] Mr Hornsey also observed that the fact that the low cost plant and stock generated very good profits identified the skill level of “your” business.
[53] It is quite clear that on 12 February, just as on 18 February, there were intangible assets belonging to the business, in addition to plant and stock, representing the skilled workforce and long established customer relationships. This intangible asset could be quantified using standard valuation principles, calculating EBIT and applying a capitalisation factor. Obviously, there would be some doubt as to the resultant figure.
[54] The EBIT analysis that Mr Hornsey did, using trading for the past ten years, was different than the budget cashflow for the bank, using the 1996 turnover as a prudent assumption. The 1996 turnover assumed monthly sales of $130,000. It was
$20,000 below the assumed sales of $150,000 for the cashflow presented to the bank in October 2002. The lower figure is, on the probabilities, a good indication of Mr Robb’s then confidence in sales that could be achieved by the business going forward, with the labour force released from the two big boats.
Conclusion on insolvency
[55] On 12 February the company was able to pay its current creditors’ debts as they fell due. Furthermore, the directors had confidence of the ability to say trade, at least in the medium term. As Mr Gray reported, see [21] above:
Trevor believes he can work within existing arrangements.
[56] Had Mr Hornsey and Mr Robb applied the second limb of the solvency test in s 4 correctly they would have been in considerable doubt as to whether the liabilities of the company did in fact exceed the assets. They erred in law on 12 February by not assessing the contingent liabilities, and the intangible assets.
Why did the directors sell Aeromarine’s business to the new company Aeromarine
Industries?
[57] It will be recalled that the defendants’ counsel, Mr Guest, suggested it was a combination of four reasons (see paragraph [5] above).
[58] At the trial Mr Robb expressed himself with some vehemence as to his concern to avoiding trading whilst insolvent. Mr Hornsey said it was his idea to sell to a new company pending a possible sale to a third party. Neither of these two witnesses embraced expressly Mr Guest’s other two possible reasons being:
1.To trade and preserve the viable assets of the business for building up to its former state.
2.“Ring-fence” the issues with the plaintiff for attending to outside of the ongoing business.
[59] Those reasons were appropriately advanced by Mr Guest. This is because there was at the time no short term prospect of not meeting the liabilities to creditors by continuing to trade. The group, including the company, was able to trade within the current ASB credit facility. These two additional reasons of Mr Guest do not go far enough to accept the pleading of the plaintiffs: that the transfer of the business was for the purpose of avoiding the contingent liability of Aeromarine to the plaintiffs. It is accordingly necessary to examine the evidence further.
[60] On 29 January Mr Hornsey had written to Mr Robb setting out some options based on interim accounts which had been prepared to mid January. Upon analysis the letter proffered two options in paragraphs 5 and 6.
5:
Aeromarine Limited will as at 31 January 2003 become a manufacturing arm of Hadlow Farming /TA & MCR Partnership and will have assets of stock, debtors, plant, investments and fixed assets (motor vehicles and plant) and it will owe:
(1) Liability if any to Hiscock and Sojourner. (2) Creditors for January.
(3) Bank Overdraft.
(4) Solomon Heritage Trust. (5) GST.
(6) General
The difference between assets and liabilities will be the inter-company balance and the net equity currently in negative in the draft accounts to the extent of $123,406.
6:
Options available:
If the dispute with either Hiscock and/or Sojourner escalates to a significant amount:
(1)The shares in Magnum Boats and Rob Marine be sold to T A Robb and/or nominees and the funs deposited into the account of Aeromarine Limited.
(2)Continue to trade with caution. You must be satisfied that you can pay for goods supplied even if continuity is difficult.
(3) Apply debtors and sale of stock to pay creditors.
(4) If dispute continues with either Hiscock or Sojourner:
(a)Company can only go into receivership on a debenture from the bank. It cannot be placed in receivership, but can go into
liquidation on the action of creditors and/or shareholders.
(b) Liquidation can either be:
(1) On petition to the court,
(2) By creditors winding the company up or, (3) By voluntary decision of the shareholders.
It is important to note that a liquidation is final and can only result in the eventual wind up of the business.
[61] Discussions continued between Mr Robb and Mr Hornsey. They met on
29 January and Mr Hornsey’s notes indicated they discussed a potential claim from Mr Hiscock of $200,000 and the prospect that Mr Franklin would be engaged by Mr Sojourner to finish his boat. On 30 January one of Aeromarine’s managers, Mr Brown, advised Mr Robb on a proposed counteroffer to Sojourner which would have ended up with a net loss of $41,000 versus having to complete the Sojourner boat which would have cost the company $172,000. On 30 January Mr Robb had also discussed with Mr Hiscock the prospect of settling the issues on his catamaran.
[62] Somewhere between 31 January and 11 February Mr Robb decided that he was not prepared to meet the Sojourner and Hiscock liabilities, if they escalated, from Hadlow Farming Limited’s resources, i.e. from the farm income. The notion of the company becoming an arm of Hadlow was off the table. The two men began discussing the possibility of transferring the business to the new company. In advance of a planned meeting with Mr Gray, Mr Hornsey prepared a letter which he gave to Mr Robb and which is dated 12 February. It sets out to answer a question which it poses in the first paragraph:
You have asked for clarification as to the options available for Aeromarine Limited in relationship to its current trading position and any possible claims from customers.
[63] In fact, the letter did not consider further options of trading on, with or without becoming an arm of Hadlow Farming. Rather the substance of the letter examines how Aeromarine’s assets could be sold to a third party.
[64] It begins with this premise:
From our discussions it is clearly your intention to pay all creditors for materials supplied, services provided and to staff for their wages for effort, and that these will be honoured in the normal course of business.
[65] It anticipates that at Mr Robb’s request the ASB might accept the repayment of Aeromarine’s overdraft and release that company from their debenture charge over the group companies. If that should occur then Hadlow Farming Limited could take up the security of the debenture charge over the assets of Aeromarine.
[66] It then went on:
There is no reason for Aeromarine Limited not to enter into negotiations for the sale of its assets to a third party provided independent valuations of any assets to be sold are obtained commercial values are obtained prior to disposition [sic].
From the proceeds of the sale all current liabilities identified in the Financial statements to 31 January 2003 of Aeromarine Limited should be settled in the normal course of business.
It is unlikely that there will be sufficient funds to repay the debt to Hadlow Farming Company Limited. Hadlow Farming may exercise its right under the debenture document to make a call on Aeromarine to pay the balance. If
after due time this is not achieved a breach of the debenture deed will have occurred and Hadlow Farming Company Limited may exercise its right to the appointment of a receiver by the debenture holder.
The receiver after assessing the position may elect to continue to trade to ensure collection of debtors etc and settlement of creditors in preferential in order and do all that is necessary to maximise collection of funding to reduce the amount owing to Hadlow Farming Company Limited.
Once this action has occurred the company would move into liquidation. The liquidator would automatically cancel the right of agency of the receiver and would immediately wind up the company as he has no authority to continue to trade.
[67] The letter went on to emphasise that the ASB was unlikely to agree to
Aeromarine avoiding any liability to pay its accounts. It warned:
The Directors of Aeromarine Limited and Hadlow Farming Limited must be prepared to satisfy enquiries of the future that their intentions were honourable in the move to receivership and possibly liquidation.
In fact the letter had started in the second paragraph with a similar warning:
It must be stated at this stage that any intention to defeat the normal course of action and to deprive creditors under general credit trading arrangements could be deemed to be fraudulent.
[68] The letter concluded:
To pursue the matter further after your meeting with ASB Bank Limited we would suggest that a valuation of the assets of Aeromarine be identified, that a contract for sale and purchase of the existing assets be negotiated with a new company or other parties, and from the proceeds of that sale all known creditors be settled.
[69] Parts of this letter are ambiguous. Mr Laurenson cross-examined Mr Hornsey on the proposition that this letter, of 12 February, set out the template for sale of Aeromarine to a new company, also to be owned by Mr and Mrs Robb and to become part of the group of companies. Furthermore, that the reference to providing independent valuations was to independent valuations of the plant to be sold and did not include an independent valuation of the business.
[70] However, another interpretation of the letter is that it was anticipating a sale to a third party which could be either a new company (to be within the group) or other parties.
[71] Mr Hornsey agreed that on 17 February he instructed his staff to prepare a draft sale and purchase agreement to a new company. That his and his staff attendances on that and the ensuing days were to calculate a sale price for stock, plant and the moulds, effectively without any provision for goodwill. An independent valuation was obtained as to the plant.
[72] On 18 February Mr Hornsey prepared calculations for the value of the company for the purpose of providing a price to Ms Prier of Ray White Commercial. In that calculation he calculated goodwill comprising $750,000.
[73] But at no time was an independent valuation commissioned as to the value of goodwill, or more broadly the value of selling the business as a going concern.
[74] There is little doubt that by 19 February, seven days after the advice of 12
February, Mr Robb and Mr Hornsey are preparing to sell Aeromarine Limited to a new company, to be named Aeromarine Industries Limited, and that there was to be no consideration for goodwill. On 19 February Mr Hornsey said to Mr Robb by fax, inter alia:
A sale and purchase agreement needs to be prepared for the sale of stock and plant when valued. I would suggest that the new company does not take over the staff of Aeromarine Limited but employs staff on application. The question of termination costs including pay in lieu of notice, holiday pay etc needs careful handling. Such sale would incur GST but this could be managed. Funding for the new company should be by way of loan from Hadlow Farming Co Limited and I would recommend a separate bank account to be opened once the transactions have been completed. A formal lease agreement needs to be in place with Lonica at a commercial rate which in turn identifies the market value of Lonica. Other issues will be identified as the issue progresses.
I will prepare minutes of Aeromarine Limited to reflect the decisions of last week at the meeting with Donald Gray.
[75] I am satisfied that Mr Laurenson’s submission is fundamentally correct. The primary purpose of the letter of 12 February was to set out a plan for selling Aeromarine Limited to a new company. The possibility of a sale to a third party was there, but it was not at the centre of the plan. The decision to sell to the new company was made incrementally. The agreement was not signed until 10 March but substantively the commitment was made at a meeting between Mr Hornsey and
Mr Robb on 27 February. On that day Mr Hornsey advised the ASB that he had had a meeting with Mr Robb and it had been agreed that the assets of the company would be sold to the new company Aeromarine Industries Limited, that the agreement would include plant and vehicles at valuation, stock and W.I.P. at valuation and goodwill at say $50,000 with change of ownership to be effected 28 February 2003.
[76] It will be recalled at this point in time Ms Prier had obtained an agency to sell the company to a third party. A potential buyer was in the wind. However, no arrangement was made for the new company as vendor to account to the old company for the recovery of any goodwill or other components of sale in addition to the values achieved on the sale of old company to new company. On 27 February Mr Hornsey also reminded Mr Gray of ASB Bank of the request that the bank release the debenture security over Aeromarine Limited to allow it to be transferred to Hadlow Farming Company. It ended:
We will forward a projection of the windup of Aeromarine Limited (which may change its name to avoid confusion) to 31 March 2003 shortly.
[77] Mr Hornsey and Mr Robb disputed that there was any immediate intention to wind up the old company. I am satisfied, however, from the documents already surveyed that there was a recognition that in due course the old company would be wound up. On the most optimistic view of events there was a possibility that the old company could be wound up without defeating the claims of the two plaintiffs. Mr Hiscock might simply go away. Mr Sojourner’s claim might be accommodated within the $109,000 held in the trust account of the Solomon Heritage Trust. But equally plainly there was no prospect of the old company meeting the claims of the plaintiffs should they “escalate”, to use the language of Mr Hornsey.
[78] There is no immediate reason to sell from old company to new company to make the business assets more saleable to a third party. Mr Hornsey said this was one of the purposes. I accept his evidence, but on the totality of the picture, Mr Robb was allowing for the possibility of a sale to a third party provided a good price could be achieved, but in the meantime proceeding to a sale to a new company, by paying for the components as reported to the bank on 27 February. That leaves the irresistible inference that he was not prepared for the business to trade on as the
property of the old company in company with pending claims against the old company by Mr Hiscock and Mr Sojourner, as they might well escalate into reasonably large sums which would then be a charge on the old company’s assets.
[79] In that sense, as part of the same inference, one of the purposes of the sale to the new company was to limit the exposure of the group of companies, including Aeromarine. Limiting the exposure is understating it. The effect of the sale was to remove the value of stock and plant and work in progress, and the benefits of the ongoing cashflow of the business, as assets which could be tapped or even exhausted potentially by an escalated liability to the two plaintiffs. A fence was being put around the Aeromarine core business. The purpose was to protect that business. The necessary corollary was to defeat any future claim by the plaintiffs on those assets. That necessary corollary may not have been the subjective intention of the directors of the old company. But it was the necessary consequence of their decision to sell on those terms as from 28 February.
[80] If they did not sell, there was a risk that by continuing to trade the liabilities to the plaintiffs could not be discharged within the limits of the old company’s overdraft facility.
[81] There is a marked comparison between Mr Hornsey’s requirements of an independent valuation of assets to be sold on 12 February, and his attendances calculating a goodwill valuation for Ms Prier, on the one hand, and on the other the complete absence of any attempt of valuation of the goodwill, whether independent or in-house, on the sale to the new company. The goodwill of $50,000 was in fact for the value of moulds to be transferred. Mr Hornsey agreed that it was inappropriate to use the term goodwill to cover these items.
[82] The inference is that Mr Robb instructed Mr Hornsey not to prepare or obtain an independent valuation of the goodwill of the company. Of course if that had been done by way of independent valuation before the sale, a good faith sale of the business from old company to new company, without providing for goodwill, would simply not have been possible. For to do so with no value for goodwill in the face of an independent valuation would plainly be an action to defeat the contingent
creditors of the old company. It needs to be kept in mind that at all material times
Mr Robb was intending that the trade creditors of the company and staff be paid.
Conclusion on purpose of sale
[83] In a substantial sense the sale of the business from the old company to the new company was in order to avoid the contingent liability of the first two plaintiffs. Second, it was to acquire the intangible assets of the old company for no value. These were on any view of it substantial although difficult to value. In short, there was a goodwill value. It could have been as Mr Hornsey costed it, optimistically, up to $750,000. It could well have been much lower than that in the mind of a third party purchaser buying the company without the benefit of Mr Robb’s continuing association.
Do these findings of fact constitute a breach of the directors’ duty to the company as imposed by s 131(1)?
[84] A significant part of Mr Guest’s argument was that the transfer was a legitimate alternative to liquidation, that had the company been liquidated on 28
February the plaintiffs would have received nothing. This was the benchmark against which the Court should judge whether the directors of the company were discharging their duties to act in good faith and in what the directors believe to be the best interests of the company. He argued that in this context, at that date, hiving down was a legitimate decision.
[85] To assess the merit of Mr Guest’s argument it is appropriate to start by examining the four decisions he referred to: Lion Nathan Ltd v Lee (1997) 8
NZCLC 261,360; McCullagh v Gellert (2002) 9 NZCLC 262,942; Gray v Wilson
(1998) 8 NZCLC 261,350; and Nicholson v Permakraft (NZ) Ltd [1985] 1 NZLR
242.
[86] In Permakraft Cooke J, as he then was, said:
(iii) The duties of directors are owed to the company. On the facts of particular cases this may require the directors to consider inter alia the interests of creditors. For instance creditors are entitled to consideration, in my opinion, if the company is insolvent, or near-insolvent, or of doubtful solvency, or if a contemplated payment or other course of action would jeopardise its solvency.
…
In a situation of marginal commercial solvency such creditors may fairly be seen as beneficially interested in the company or contingently so. (at 249)
[87] It may be noticed immediately that this dictum by a New Zealand Court of Appeal Judge is completely consistent with the passages from Gower and Davies cited under the preliminary consideration of the duty earlier in the judgment, in paragraph [18].
[88] It may also be noted that the advice that Mr Hornsey gave Mr Robb on 12
February referred to “creditors”, “current liabilities” and “known creditors”, but never to contingent creditors.
[89] In Permakraft there were no contingent creditors to consider at the time of sale. After the passages quoted from the judgment Cooke J went on to distinguish the difficulty of making out a duty to future new creditors. By that he intended to refer to:
… those minded to commence trading with and give credit to a limited liability company … (at 250)
[90] In Lion Nathan Ltd v Lee the Court was considering two allegations. The first was of fraud. It was that the old company’s directors had knowingly intended to defraud a creditor through the transfer of the company’s assets to another company in the group. This claim relied on s 320(1)(c) of the 1955 Act. The second allegation was under s 321 that the directors had not acted bona fide in the best interests of the company when completing the sale, leaving the company as a shell destined for liquidation and preferring the body of creditors over one creditor. The second allegation is the comparable here. Chisholm J applied the dictum of Cooke P in Permakraft. He found as a fact that the directors had endeavoured to protect the
company’s business, its employees and its creditors as a whole. In grappling with the problem that they had sold the assets at fair value, probably much higher than that he found they were not seeking to put their own interests first. He found that while an independent valuation report had not been obtained, the directors had the benefit of the independent accountant’s report which provided a fair indication as to value and that they proceeded under legal and accounting guidance. These are not the facts here, quite to the contrary.
[91] Mr Guest sought to explain the decision in Lee as greatly influenced by the finding that the disadvantaged creditor, the landlord, was not made any worse off by restructuring than it would have been in a liquidation of the company. The Judge referred to this point when he went on to consider whether he would have exercised his discretion under ss 320 and 321 had breach of either section been made out.
[92] The Court of Appeal in Mason & Anor v Lewis & Anor (CA267/04, 30
March 2006) has emphasised the importance of separating the application of s 301 of the Companies Act 1993 which provides for consequential remedies upon breach from analysis of breach. The decision of Lion Nathan Ltd v Lee does not assist the defendants in this case on the question of whether or not there is a breach of s 131.
[93] Mr Guest also relies on Gray v Wilson, for the proposition that directors do not have an obligation to continue to trade where in so doing there is a reasonable likelihood that a creditor might benefit. He submitted this was an important proposition in this case. Indeed he went on to say:
It would be introducing a new, and somewhat extraordinary proposition, if directors had to make decisions about the operation of their company for the benefit of creditors; indeed one might say for the benefit of anyone other than the company and its shareholders. A duty to creditors is something different from an obligation to manage the company for their benefit.
It may be noted immediately that that latter submission of counsel is quite inconsistent to the dictum of Cooke J in Permakraft. I will return to the issue of taking into account creditors’ interests after completing this review of the authorities cited by Mr Guest.
[94] Gray v Wilson was another case alleging fraud under s 320(1)(c) of the Companies Act 1955. It failed on a finding of fact, that the price at which the assets of the old company were transferred to the new company were not at an under value from which it could be inferred that the transfers were made by the directors with a fraudulent intent of defeating creditors.
[95] In Gray at the time of transfer of assets from old company to new company the plaintiff was a contingent creditor. There was a real prospect she would become a creditor on the basis of a referee’s report and litigation then on foot. The Judge, Elias J, as she then was, followed Cooke J’s dictum in Permakraft recognising a duty to consider such contingent creditors in the case of insolvency or doubtful insolvency. The Judge noted that there was no claim made pursuant to s 321 of the Companies Act, (thus reinforcing the allegation was one of fraud). Hence, the plaintiff had to show the defendant directors were acting with actual dishonesty.
[96] The analysis thereafter of the Judge in Gray v Wilson is of no assistance in this case, as it is applying a different criterion. In fact the Judge went on to hold the directors defrauded the company’s creditors.
[97] Mr Guest sought to distinguish the decision of Gellert. That is the case of a liquidator’s application to set aside the payment of remuneration to directors. It is of no particular assistance in this case as it is considering different statutory provisions.
[98] Directors of a company who are also the only shareholders of the company do not naturally believe that the best interests of the creditors of the company are the best interests of the company. Plainly that was the case here in respect of Mr Robb’s attitude to the plaintiffs as contingent creditors. The question arises as to whether or not his subjective belief at the time as to what was in the best interests of the company determines whether he is in breach of s 131(1).
[99] A broad submission of Mr Guest is that the directors here were doing their best in very difficult circumstances. In that respect he was inviting the Court to apply s 131 by emphasising the subjective part of the section requiring the director to believe his or her conduct is in the best interests of the company.
[100] New Zealand company law is an amalgam of the common law and statute. Some authors have suggested that the Companies Act 1993 should be interpreted as a comprehensive code of directors’ duties, superseding the common law. See for example Mr Andrew Beck’s Chapter 23 of Morrisons Companies and Securities Law, paragraphs 23.2 and 24.1. A statute such as this does not supplant the common law when it enacts a common law standard which is of its character a principle rather than a rule. As a principle it has to be applied in a wide variety of circumstances and such application is appropriately guided by the common law cases which led to the articulation of the principle in the first place. I prefer the view of Heath J in Benton v Priore [2003] 1 NZLR 564 at [46], that ss 131-138 of the Act:
… should be seen as a restatement of basic duties [developed by the common law] in an endeavour to promote accessibility to the law.
[101] The principle that directors must act in good faith and in what they believe to be the best interests of the company is a formulation taken from the case law worked out in the United Kingdom and now adopted in New Zealand. Gower and Davies places this duty as one of the duties of loyalty. That text explains that these duties were developed by the Courts by analogy with the duties of trustees. Historically this came about because prior to the Joint Stock Companies Act 1844 (UK) most joint stock companies were unincorporated and depended for their validity on a deed of settlement vesting the property of the company in trustees. Often the directors were themselves trustees, and even when a distinction was drawn between the passive trustees and the directors the latter would quite clearly be regarded as trustees in the eyes of equity, insofar as they dealt with the trust property. The authors go on:
Nevertheless, to describe directors as trustees seems today to be neither strictly correct nor invariably helpful. In truth, directors are agents of the company rather than trustees of it or its property. But as agents they stand in a fiduciary relationship to their principal, the company. The duties of good faith which this fiduciary relationship imposes are virtually identical with those imposed on trustees, and to this extent the description “trustee” still has validity. Moreover, when it comes to remedies for breach of duty, the trust analogy can provide a strong remedial structure. Directors who dispose of the company’s assets in breach of duty are regarded as committing a breach of trust, and the persons (including the directors themselves) into whose hands those assets come may find that the company has proprietary as well as personal remedies for their recovery. (at 380)
[102] In this context the standard in s 131 is an amalgam of objective standards as to how people of business might be expected to act, coupled with a subjective criteria as to whether the directors have done what they honestly believe to be right. The standard does not allow a director to discharge the duty by acting with a belief that what he is doing in the best interest of the company, if that belief rests on a wholly inappropriate appreciation as to the interests of the company. If a director believes that the duty to act in the best interests of the company is a duty always to act in the best interests of the shareholders, and never in the interests of the creditors, in a situation of doubt as to the solvency of the company, the director cannot be said to be acting in good faith. Creditors are persons to whom the company has ongoing obligations. The best interests of the company include the obligation to discharge those obligations before rewarding the shareholders.
[103] Mr Hornsey and Mr Robb made a number of mistakes of law which meant that the directors did not recognise the fiduciary obligations of the directors to act in the interests of the company which had significant obligations to the plaintiffs as contingent creditors. In short, to consider the interests of these creditors – to paraphrase Cooke J in Permakraft. As a result, Mr and Mrs Robb were not acting in good faith when selling the old company’s business to the new company. The fact that they personally thought they were acting in the interests of the company is irrelevant in this context.
[104] There were at least three errors of law. First, when considering the solvency of the company the directors did not bring into account the intangible asset of the company – that is its ability to earn a good income from its skilled staff and longstanding relationships with customers; i.e. they did not value its goodwill. Second, they appear to have disregarded the interests of the plaintiffs because the plaintiffs were not current creditors or creditors. Third, and as a direct consequence of these other errors, they did not recognise that their duty to the company, included doing their best to ensure the company met all its obligations, current and contingent.
[105] With this personal state of mind they were no longer correctly understanding their duties as directors and for that reason were not acting in good faith. I reiterate that this is an objective finding. I apprehended during the trial that Mr Robb is a
decent man, not someone who would deliberately break the law. I have not found he did so deliberately. Rather I have found he acted in error of law, in a mistaken belief as to where his duties lay. As with trustees, the law expects that directors of a company will direct their minds properly to the question of whether a transaction was in fact, in the circumstances prevailing at that time, in the interests of the company.
[106] For this reason directors normally need to take professional advice before embarking on the sale of the business of an old company to a new company. This is particularly the case when the sale is not at arms length. If that advice is as here infected with error of law, that is not exculpatory on the part of the directors.
Conclusion
[107] In my mind there is no doubt that the directors of Aeromarine were in breach of s 131 when selling the business of Aeromarine to the new company, Aeromarine Industries, of which they were also the owners. The new company did so taking all the benefit of the valuable intangible assets of the old company for no consideration.
Remedy on application of s 301
[108] The scheme of the Companies Act is to separate out the duties of directors, ss 131-138, from the remedies which a Court may impose as the Court thinks just.
[109] Section 301 of the Act 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, 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, 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 19(d) of the Insolvency Act
1967.
[110] This case, as well as being an examination of whether or not directors were in breach of s 131 has also been at the same time an enquiry into the conduct of the directors. The enquiry has been into whether or not the directors have been in “breach of duty or trust in relation to the company”. See s 301(1). Because the enquiry was in respect of the relationship between the directors and the company it was not a case of an allegation of misapplication or liability for money or property due to a particular creditor or shareholder. I refer to the decision of Master Venning, as he then was, in Mitchell v Hesketh (1998) 8 NZCLC 261,559. In that case the Master identified that s 301(1)(b)(ii) was addressing not an identified or specific sum that ought to be repaid but the sum assessed by the Court by way of compensation where general damage has been caused to the company.
[111] Mr Laurenson and Mr Guest accepted this interpretation of s 301. Mr Laurenson for the plaintiffs was not seeking any award by this Court directly to the plaintiffs. He did not think that was possible under s 301. I agree.
[112] As a consequence Mr Laurenson also recognised that the Court had to consider therefore the position of all the creditors of the old company who were left proving in liquidation, not only the plaintiffs. A significant third contingent creditor was the owner of the first large yacht built by Aeromarine who proved in the sum
believed to be approximately $8,000. The other significant creditor was Hadlow Farming Limited, who did not prove in the liquidation. Hadlow Farming could have proved for about $117,000 – $144,000. Mr Laurenson essentially submitted that the just solution would be to have a two tier order of compensation. He sought as the first tier sufficient compensation to match the proofs of debt of the two plaintiffs and the owner of the first yacht on the assumption that Hadlow Farming continues not to prove in the liquidation. If, however, Hadlow does prove in the liquidation then the order for compensation should be increased by the amount of the Hadlow debt to avoid a dilution of recovery by the owners of the three yachts.
[113] Mr Guest’s argued that when considering the possibility of relief under s 301 the Court should examine first what the plaintiffs would have obtained if the old company had been liquidated. He argued that that sum should place a cap on any recovery by the plaintiffs. In that respect he relied on an analysis by his expert, Mr Jordan, indicating that the dividend was likely to range from nil (pessimistic),
9 cents based on sale values, or 26 cents on an optimistic scenario.
[114] Mr Guest’s approach draws on what the Court of Appeal in Mason v Lewis
describes as the “standard approach”:
[109] The standard approach has been to begin by looking to the deterioration in the company’s financial position between the date inadequate corporate governance became evident (really the “breach” date), and the date of liquidation.
[110] Once that figure has been ascertained, New Zealand courts have seen three factors - causation, culpability, and the duration of the trading - as being distinctly relevant to the exercise of the Court’s discretion (see Re Bennett, Keane & White Limited (in liquidation) (No 2) (1988) 4 NZCLC
64,317 per Eichelbaum J; and Löwer v Traveller [2005] 3 NZLR 479, which endorsed those principles).
[115] This approach is clearly mandated where the directors have recklessly traded on when they should have liquidated. That was the context when the standard was adopted by Eichelbaum J in Re Bennett. This is the standard when the Court is examining whether there is a causal relationship between the debts proved in the liquidation and the act of default of the director in trading on (64,330). Eichelbaum J was himself following Tompkins J in the case of Maloc Construction Ltd (In Liq) v Chadwick (1986) 3 NZCLC 99,794. On the facts of Maloc it was
natural for the Judge when addressing causation to examine the extent of the failure of the officers of the company to keep proper records on the position of the company at liquidation resulting from that failure, (see 99,809). Tompkins J introduced the criteria of culpability because in his view the law was intended to be, at least to some extent, punitive in nature, (see 99,810 and Re Maney and Sons Deluxe Service Station Limited, Maney v Cowan [1969] NZLR 116). That judgment was construing s 320 of the Companies Act 1955, which was a provision addressing fraudulent conduct. That is not the case here. The third criterion of duration is an aspect of causation.
[116] But this is not a case of reckless trading prolonging the due date of liquidation. The Court of Appeal in Mason v Lewis and Löwer v Traveller do not say that these three criterion always have to be used when applying s 301, let alone say that the comparison is always with the consequences of liquidation at the time of breach. The Court could not possibly say that, because that would be to gloss s 301 with a different test.
[117] Given that s 131 is an enactment of the common law it would be strange if Parliament intended to direct the Courts to impose a different consequence than would pertain at common law when empowering the Court to make an order:
To contribute such sum to the assets of the company by way of compensation as the Court thinks just. (s 301(1)(b)(ii))
[118] What the Court thinks just will in turn be a consequence of the wrong identified as creating the breach. As Mr Andrew Beck points out in his discussion of directors’ powers and duties in Morrison at paragraph 24.10 the consequences of breach of fiduciary duty are not the same in every case. As the Court of Appeal in the decision Bank of New Zealand Limited v New Zealand Guardian Trust Co Ltd [1999] 1 NZLR 664 said, the nature of the breach of duty should be carefully examined as at common law (including equity) as the remedy may well differ. To take the simplest example, the breach of duty may be of a duty to take reasonable care, in which case the common law measure of damages in tort is applicable.
[119] For these reasons, taken together, I do not presume that the standard approach of causation, ability and duration of trading identify the appropriate criteria in this case. Indeed, I doubt whether culpability is a relevant factor, though if this case were one of reckless trading I would be bound to apply it. It may be that the toleration of culpability as a factor reflects the majority view albeit obiter in Aquaculture Corporation v New Zealand Green Mussel Co Ltd [1990] 3 NZLR 299 (CA), at 301 – that exemplary damages may be awarded for breach of fiduciary duty. Somers J demurred: “equity and penalty are strangers”, (at 302).
[120] The correct approach is to examine carefully the character of the breach and then to look for guidance from the common law including equity when considering how to judge what contribution should be made to the assets of the company by way of compensation as the Court thinks just.
Guidance from Equity
[121] Mr Guest argued that in February of 2003 the directors would have been entitled to place the company in liquidation, and could not have been criticised for that option. However, there was no immediate insolvency predicament, to pay current creditors. The core business was known to trade profitably. There was time for an orderly sale of the business at arms length, supported by independent valuations to guide the sale. The group was trading within its credit facility. Mr Robb had reassured the bank on 12 February that he did not need any additional credit facility.
[122] Moreover, at that time the directors did not have a simple liquidation option. Aeromarine Limited was part of a group of companies. There was only one group financing facility. The overdraft was in the order of $250,000 to $260,000 OD. As Mr Jordan’s analysis shows the likely range of deficit to the secured creditor, ASB, ranged from a low of $34,000 and a high of $255,000. On the basis of looking at values achieved in the February contract there would have been a deficit of $128,000 to the ASB. The low of $34,000 assumes that somehow in the liquidation there would have been recovery of $175,000 for goodwill. That presumes that the liquidator would have been able to sell the business as a going concern. That is a
very optimistic proposition. Putting the company into liquidation at this time would risk the ASB looking to other assets of the group. At the very least before the company could be put into liquidation Mr and Mrs Robb as directors of the other group of companies would have to renegotiate their relationship with the ASB Bank. There is no evidence that Mr and Mrs Robb or their advisers ever seriously considered that liquidation was an option.
[123] All of this is to a degree academic. As the directors decided to sell to a new company to which they would be the shareholders and which would become another company in their group of companies. This step enabled the Robbs not to lose the benefit of what Mr Hornsey had described to Mr Robb on 12 February as “your business”, which Mr Robb had built up since 1977.
[124] Against these facts there is no merit in deriving as a just sum to compensate the plaintiffs, a sum likely to be equivalent to a dividend from a liquidation of the company in February 2003. Rather, the focus needs to be upon the implications of the directors selling the assets of the company to a new company owned by themselves, and continuing to trade profitably.
[125] The situation of the Robbs having sold the assets of the company in breach of s 131 is more accurately characterised in the passage already quoted from Gower which I repeat:
Moreover, when it comes to remedies for breach of duty, the trust analogy can provide a strong remedial structure. Directors who dispose of the company’s assets in breach of duty are regarded as committing a breach of trust, and the persons (including the directors themselves) into whose hands those assets come may find that the company has proprietary as well as personal remedies for their recovery. (380)
Hereafter I adopt that trust analogy as a strong guide to determining “compensation as the Court thinks just”, s 301(1)(b)(ii).
[126] It was the famous decision of Regal (Hastings) Ltd v Gulliver and Others [1942] 1 All ER 378; [1967] 2 AC 134, which settled that this trust principle applies to directors. The most quoted speech was by Lord Russell of Killowen. But
for present purposes it is sufficient to quote the following passage from the speech of
Lord MacMillan:
The equitable doctrine invoked is one of the most deeply rooted in our law. It is amply illustrated in the authoritative decisions which my noble and learned friend Lord Russell of Killowen has cited. I should like only to add a passage from PRINCIPLES OF EQUITY, by Lord Kames, which puts the whole matter in a sentence (3rd Edn., 1778, vol 2, p.87): “Equity,” he says, “prohibits a trustee from making any profit by his management, directly or indirectly.” (at 391)
Equity’s enquiry is not thwarted by the fact that the directors did not purchase directly. Accordingly, equity does not ignore the fact that the new company, Aeromarine Industries Limited, is owned by Mr and Mrs Robb in equal shares. Similarly, they owned the shares in Hadlow Farming Company Limited. The focus is on whether the persons in breach obtained a benefit or profit, not how. Section 301 itself necessitates an enquiry past the corporate structure when assessing a just award. The enquiry does not depend on fraud or absence of bona fides. See Lord Russell of Killowen in Regal at page 386.
[127] The plaintiffs might have brought proceedings against Aeromarine Industries. This could have been on the basis that that company received the intangible assets/goodwill of the old company with knowledge of the breach of duty so as to be treated as holding it upon trust. See J J Harrison (Properties) Ltd v Harrison [2002]
1 BCLC 162, 173 – cited by Gower for the passage quoted above.
[128] But for the breach, Aeromarine would have traded on or been sold on the open market to a third party after a thorough testing of the market. A significant part of the plaintiffs’ case was that the company was capable of trading on within the limits of the credit facility then in place in February 2003. Alternatively, counsel argued that had the property been sold on the open market from February it would have netted a sufficient sum for goodwill, enough to be capable of clearing all of its indebtedness including the sums proved in the liquidation by the plaintiffs. There is inherently no certainty about either of those two propositions, as neither in fact happened.
[129] In support of both propositions the plaintiffs called an expert witness, Mr Lazelle. In brief Mr Lazelle’s opinion was that Aeromarine could have traded out of its difficulties. The new company did very well in its first full trading year. It performed substantially better than the budget produced to the bank on 27 February. That predicted a total net cashflow from 1 March 2003 to 31 March 2004 (13 months) of $86,944. In its first full year of operations the company made a profit of
$239,000 on sales of $1.35 million. This profit was after the company had paid Mr Robb a management fee of $82,535. Though no interest was charged to the new company by Mr Robb or Hadlow, the new company had been funded during the year by advances from Hadlow. The new company’s profits together with some asset sales enabled it to reduce its indebtedness to Hadlow by $214,000 during the year to March 2004. During the same period the Robb group was able to reduce its external debt by $277,000. Mr Lazelle, the expert for the plaintiffs, was of the opinion that substantially all the funds to make this debt reduction were generated by the new company.
[130] These figures can be contrasted with the sum of $332,501 being Mr Lazelle’s calculations of the sum required to settle the plaintiffs’ claims ($291,080) and other creditors and meet various fees and charges. Some of these costs were occasioned by litigation post breach. Mr Sojourner had obtained judgment of this Court with fees and costs, all of which was proved in the liquidation.
[131] I am satisfied that the old company could have traded as well, utilising the same business, to have a good prospect of meeting its contingent liabilities. I have not overlooked Mr Robb’s and Mr Hornsey’s evidence that the success of the new company was due to Mr Robb’s skills, contacts and energy. I have rejected the proposition that the business was resurrected after the sale. See [47] and [48] above.
[132] Following Gower’s trust analogy, equity does not listen sympathetically to the proposition by a trustee that account should be taken of the added value he added to a trust asset that he had acquired for no consideration, when equity is assessing the remedy to be imposed to compensate for the wrongful acquisition in the first place. Rather, the view equity takes is that normally such a person should account not only for the asset acquired but also for the profits earned on that asset. Equity will allow
an adjustment for work and skill expended to make the profit. See Boardroom v
Phipps [1967] 2 AC 46.
[133] Aeromarine Industries did not trade as well in the two subsequent financial years ending 31 March 2005 and 2006. The reasons for the poor profitability in those years (EBIT - adjusted for management fees at 2003 levels, $62,000, $31,000) are not explained. Mr Robb said that in those latter two years there was negligible use of the moulds. He said he believed that his name and the Aeromarine name had been damaged by the saga of the big boats. That was the extent of the explanation. Yet his name and the Aeromarine name did not seem to have been damaged in the year ended 2005 immediately after the disaster with the two boats. He had the confidence to select the same name essentially for the new company. The moulds were inferentially being utilised frequently in that year.
[134] Alternatively Mr Lazelle was of the opinion if it had been sold for $634,000, it could have paid out all creditors including Hiscock and Sojourner in the sum of
$291,080. A sale price of $634,000 would on his calculations reflect a goodwill of
$390,000 (634,000 minus value of assets sold 194,000 minus goodwill/moulds
50,000).
[135] This goodwill figure of about $400,000 compares with Mr Hornsey’s calculation of goodwill for the purpose of listing the property for sale in the order of
$700,000 - $750,000.
[136] The evidence of Mr Jordan, the expert for the defendants, was that Aeromarine was a profitable company whose core business had suffered because much of its internal activities had been focussed on the two yachts. As a result its trading position became tenuous. Then, critically, he records as a fact:
There was little alternate works accrued to move the workforce onto. Unless new work could be secured quickly, the losses and financial position of the company would have deteriorated quickly.
Mr Jordan assumed a low EBIT in the first year with recovery to past years only at year three.
[137] In this respect Mr Jordan was dependent on the instructions he obtained as to the trading expectations of the company at the time of the sale. In my view he received inappropriately negative instructions, not borne out by the facts, as has been analysed above. In fact the old company had been taking steps from about 17
October 2002 to secure additional business. It had an established clientele. It was able to look forward with confidence to continuing its core business and rebuilding.
[138] It is speculation as to what the business would have sold for if it had been offered on the open market in February 2003, in the immediate aftermath of the yacht debacle. The assumption, of course, is that the viable business would be sold leaving the contingent liability with the vendor. A prudent buyer would do due diligence and explore whether or not the customer relationships associated with the core business had been damaged by the diversion of the internal resources of the company to the yachts during 2002 and by the adverse publicity on 8 February 2003. A buyer would have approached some of the main customers of the business. A buyer would have looked for some kind of protection against the directors and owners of the business seeking to take advantage of its goodwill by setting up a competing business post sale. It is unrealistic to expect expert evidence as to the outcome. It may be noted that the budget that Mr Robb provided the bank on 27
February for the new firm contains an EBIT in excess of $200,000 per annum.
[139] Mr Robb continued to entertain the prospect of sale to a third party down to late March. The bank was told on 24 March of the possibility of a sale to a third party. On 26 March Ms Prier wrote to Mr Robb. Discussing the sale of the business as a going concern she said:
Depending on the value of the plant an asking price from around $850,000 to
$900,000 may be realistic.
As to goodwill she noted this:
… is always the “grey” area, and vigorously negotiated by a purchaser.
[140] It would appear that this letter marked the end of the prospect of sale to a third party. For some reason, never clearly explained, Mr Robb found this letter unsatisfactory.
[141] The only reasonable inference why Mr Robb did not want to negotiate the sale of the business is that he valued it higher than the value he thought sale in the open market would achieve. In his hands the core business was valuable, more valuable than a sum a third party would pay. That judgement was vindicated by the new company’s trading in the first year.
[142] It is no longer possible for Aeromarine, now in liquidation, to have restored to it its intangible assets, quantified as goodwill. However, in deciding what is just compensation for the purposes of s 301 it is appropriate to keep in mind that equity’s goal was restitution rather than compensation and that compensation is a second best result from an equitable point of view.
[143] Originally equity did not award damages as a remedy against delinquent trustees and other fiduciaries. See Ex parte Adamson (1878) Ch D 807 at 819 per James and Baggallay LJJ:
The Court of Chancery never entertained a suit for damages occasioned by fraudulent conduct or for breach of trust. The suit was always for an equitable debt or liability in the nature of a debt. It was a suit for the restitution of the actual money or thing, or value of the thing, of which the cheated party had been cheated.
[144] In Hanbury and Martin’s ‘Modern Equity’ (17th ed 2005) the learned authors state the principal remedy in this way:
A trustee who fails to comply with his duties is liable to make good the loss to the trust estate. Even if there is no loss, the trustee is accountable for any profit made in breach of trust. The object of the rule is not to punish the trustee, but to compensate the beneficiaries. (at 656, 23-001)
Applying the trust analogy, the directors had a continuing obligation to make good the loss to the old company, Aeromarine. And they were accountable for the profit being derived in the new company, Aeromarine Industries.
[145] It may be noted immediately that this formulation of principle is consistent with the compensatory power given to the Court in s 301 of the Companies Act. That section, however, is remedial, in that the Court is not tied to the detailed application of that principle as applying in the law of equity, such as the need for an election between an account of profits or compensation for loss.
[146] From an equity perspective the new company was trading with the intangible assets of the old during 2003 to 31 March 2004 very profitably. During that period it appears to have shrugged off any taint on goodwill, and thereafter would have been marketable.
[147] In that context, the directors in default had a continuous duty to restitute to the old company. Rather than do that, during the year ended 31 March 2004 the directors of the old company were realising the fruits of the sale as the owners of the new company and distributing the benefits within their group of companies and their partnership. After the sale to the new company the core business could still have been sold to the benefit of the old, or the transaction reversed. The sale transaction to the new company was a paper transaction. The staff continued. The trade suppliers continued. The customer relationships remained. The core business and stock and plant and the goodwill could have been sold within, or independently of, the new incorporation.
[148] By mid 2004, if the trading difficulties of the next two years were not apparent, it is likely that had the business been sold it would have achieved a total value exceeding the sum of $634,000. That being the sum estimated by Mr Lazelle as he needed to clear the liabilities to the plaintiffs. That sum would need some adjustment to take it forward. But on any view of it the trading in mid 2004 confirmed an EBIT in excess of $200,000 per annum. On normal valuation principles that translates to a value of $700,000 using a multiplier of 3.5, the lower of Mr Lazelle’s multipliers. That would indicate a total value well in excess of
$634,000 was achievable, as that figure included $390,000, which is the comparable to $700,000.
[149] Mr Guest, for the defendants, submitted that the plaintiffs should have called more specific valuation evidence. I consider these indicators are sufficient. I have already found, that by his conduct, Mr Robb clearly valued the business at a sum higher than what he thought a sale would have achieved. He had no intention of using these assets to fund the contingent liability of the old company to the plaintiffs.
[150] It is not possible to find, as more probable than not, that the old business would have traded on solvent up to the trial date. Similarly, it is not possible to find that the business would have sold in 2004 for a sum sufficient to discharge all the liabilities. As noted, Mr Guest submitted that the focus should be on the plaintiffs’ case. See paragraph [14]. Essentially he was inviting the Court to follow common law principles of onus of proof and causation and remoteness. However, equity does not follow the law, in this respect, when assessing compensation for breach of duties of loyalty.
[151] It does not lie upon the directors as fiduciaries in breach of a duty of loyalty to place an evidential onus continuously on the plaintiffs to prove that either the profit on trading after the sale could accommodate all the liabilities of the old business, and/or that the business could have been sold and netted sufficient funds. The onus shifts in the course of analysis. In Bank of New Zealand v New Zealand Guardian Trust Co Ltd [1999] 1 NZLR 664 at 687 Tipping J said:
In the second kind of case, the trustee or other fiduciary has committed a breach of duty which involves an element of infidelity or disloyalty engaging the fiduciary’s conscience – what might be called a true breach of fiduciary duty. In this situation, the law applies the approach recently outlined by this Court in Gilbert v Shanahan [1998] 3 NZLR 528. In short, in such a case once the plaintiff has shown a loss arising out of a transaction to which the breach was material, the plaintiff is entitled to recover unless the defendant fiduciary, upon whom is the onus, shows that the loss or damage would have occurred in any event, ie without any breach on the fiduciary’s part. Questions of foreseeability and remoteness do not arise in this kind of case either. Policy dictates that fiduciaries be allowed only a narrow escape route from liability based on proof that the loss or damage would have occurred even if there had been no breach.
[152] This formulation by Tipping J recognises that the damages are compensation but for breach. However, the fiduciary in default has an onus of disproving loss. In Gilbert the Court of Appeal emphasised that the recovery of damages has to follow proof of loss caused by the breach (at 535-536). However, the New Zealand Court of Appeal has not read “the retreat from Brickenden” (Brickenden v London Loan and Savings Co [1934] 3 DLR 465) as displacing this reverse onus. The speech of Lord Browne-Wilkinson in Target Holdings Ltd v Redferns [1996] 1 AC 421,
428-441, does not address this point. It focuses upon the need for compensation to be the loss flowing from the breach. There is a doubt as to whether it was addressing
liability arising from a traditional trust analogy, as applying here. See 436E. At equity compensation is not assessed ignoring its restitutionary context, where that is appropriate. In that context the fiduciary in breach has an evidential onus.
[153] Equity proceeds on the basis that where fiduciary is found in breach, in a situation where property has been transferred, there is an immediate and continuing obligation to return the property. If the property cannot be returned then there is an obligation on the fiduciary to make good by way of damages. In a restitutionary context, it would be plainly inconsistent with that principle for the fiduciary in breach to be able to say: “well I cannot restore the asset, now you prove on the probabilities how much you have lost”. Once the plaintiff has scoped the loss, the burden shifts to the defendant beneficiary to reduce the compensation by arguing that the loss, or part of it, would have been suffered anyway notwithstanding the breach.
[154] This concept of a reverse onus is ancient. It is usefully captured in two dicta. In Thomson v Eastwood (1877) 2 App. Cas. 215, Lord Cairns LC said:
Equity will examine into it [the sale], will ascertain the value paid by the trustee, and will throw upon the trustee the onus of proving that he gave full value. (at 236)
Second, by Lord Penzance in Erlinger v New Sombrero Phosphates Co (1878), (1877-1878) LR 3 App. Cas. 1218 (HL). This was a case where a syndicate, of which Erlinger was the head, purchased from an insolvent company an island, said to contain valuable mines of phosphates. Erlinger, who managed the purchase, prepared to get up a company to take over the island and work the mines. The sale of the island to the company was made nominally by a person who had no real interest in the island. It was held that Erlinger was in a fiduciary position to the company and was obliged to faithfully state to the company the facts which applied to the property and which would influence the company in deciding on the reasonableness of acquiring it. The question was whether the contract should be allowed to stand. The House of Lords held that the contract could not be sustained. Lord Penzance said in his speech:
A contract of sale effected under such circumstances is, I conceive, upon principles of equity liable to be set aside.
The principles of equity to which I refer have been illustrated in a variety of relations, none of them perhaps precisely similar to that of the present parties, but all resting on the same basis, and one which is strictly applicable to the present case. The relations of principal and agent, trustee and cestui que trust, parent and child, guardian and ward, priest and penitent, all furnish instances in which the Courts of equity will give protection and relief against the pressure of unfair advantage resulting from the relation and mutual position of the parties, whether in matters of contract or gift; and this relation or position of unfair advantage once made apparent, the Courts have always cast upon him who holds that position, the burden of showing that he has not used it to his own benefit. (at 1229-30) (Emphasis added)
[155] It is sufficient that the plaintiffs have demonstrated that there was a good prospect of the business trading on and meeting its liabilities to them, or being sold for a sum sufficient to discharge its liabilities to them. Second, the plaintiffs have shown that the defendants deliberately rejected the opportunity to try to sell to a third party. Third, the plaintiffs have shown that the defendants acquired the intangible assets (goodwill) of the business for no consideration.
[156] The burden was on directors then to prove that the plaintiffs would not have recovered all or part of their claims, as admitted to proof. The defendants have not done so. The poor trading in the last two years was described as disastrous by Mr Robb, but he did not explain why, and when it was anticipated. As already noted he did not explain why he terminated the agency of Ms Prior. Accordingly, at equity the plaintiffs would be entitled to damages for the full amount of their proofs of debt accepted by the liquidator.
[157] So far I have been applying the trust analogy to the relationship of the directors to the old company for the purpose of deriving the remedy that equity would impose. I now test that outcome against the purpose of s 301 when applying a standard of what the Court thinks just by way of compensation. I see no reason why these equitable principles should not apply. On the contrary, they are of longstanding, and well thought out, and very much applicable to the situation that has arisen here.
Conclusion on remedy
[158] Therefore it is just that the defendants should pay to the liquidator a sum sufficient to enable:
• The plaintiffs to recover their proofs of debt accepted by the liquidators.
• For the other disappointed unsecured creditor/s to recover.
• Interest at the judicature rate less 0.5% calculated from 27 February 2003 on the proofs of debt of all the unsecured creditors, except in the case of Mr Sojourner to be varied by calculating the interest on the judgment debt at the judicature rate.
• The incidental costs of the liquidator in completing the liquidation accounts in order to ensure that a sufficient sum is paid in order to meet the proofs of debt of the unsecured creditors.
[159] Hadlow Farming Limited did not prove in the liquidation. All the group companies and the unincorporated partnership were owned equally by Mr and Mrs Robb. The intended purpose of s 301 would be thwarted if Mr and Mrs Robb or any of their entities could come back in to prove in the liquidation in order to pay a portion of the sum ordered in order to compensate the company.
[160] Mr and Mrs Robb were direct beneficiaries of the profitability of the new company. It became quite apparent through the hearing that there is a veritable cat’s cradle of intercompany and partnership advances and debt and management fee transactions between the Robbs partnership, the farming company and other entries such as Lonica Holdings Limited. One can safely be sure that all the operations were managed for the ultimate benefit of Mr and Mrs Robb, the owners. In terms of the equity analysis they are the ultimate beneficiaries. See paragraph [126]. Any of their entities proving now in the liquidation would be doing so for their benefit, to the detriment of the plaintiffs and any other creditors.
[161] Mr Laurenson’s solution was that if Mr and Mrs Robb or any of their entities took this fresh opportunity to prove in the liquidation that Mr and Mrs Robb as directors be ordered to increase their compensation to the company to the extent of these additional proofs. I think that is a just and appropriate condition.
Other causes of action
[162] The second and third causes of action pleaded respectively breach of s 133 of the Companies Act, exercising a power for an improper purpose and s 134, acting in a manner which contravenes the Companies Act. These causes of action rely on the same facts. They do not need to be considered further, as the finding for the plaintiffs on the first cause renders further analysis redundant.
[163] The fourth cause was one of breach of s 135 of the Companies Act on the proposition that it the continuation of the company after the sale pending its winding up was reckless trading. This action fails because in substance the business did not trade, it was being effectively voluntarily wound up. All that was going on was that its debts were being collected and its trade creditors were being paid from the monies collected and from advances to the old company by Hadlow Farming Co Limited.
[164] The fifth cause of action is another allegation of breach of s 135 of the Act, this time alleging that the yacht contracts were recklessly entered into. Mr Laurenson abandoned that cause of action. It was never going to succeed anyway.
[165] The sixth cause of action alleged breach of s 136 and challenged the various intercompany transactions introduced into the accounts of the plaintiff when stated as at 31 March 2003. That action is now redundant but it fails anyway. As analysed the entries were legitimate, albeit discretionary.
Final orders
[166] I wish to hear counsel before finalising the relief described in paragraphs
[158] – [161] above. This is due principally to doubt as to the number, identity, and
amounts of the other unsecured creditors. It is likely to be necessary for counsel for the plaintiffs to discuss those details with the liquidator. Hopefully, counsel will be able to agree on the terms of the order to meet the outcomes in the aforesaid paragraphs. There may be issues as to calculation of the interest on Mr Sojourner’s debt. To that extent this is an interim judgment reserving such issues as may arise in giving effect to the decisions in this judgment.
Costs
[167] The plaintiffs are entitled to costs against the defendants on a 3C basis. Mr Guest has submitted the trial was unduly long. I will receive submissions on that point.
Fogarty J
Solicitors:
Kiely Thompson Caisley, Wellington, for Plaintiffs (Counsel: R C Laurenson) Norm Scott Layer, Timaru, for Defendants (Counsel: JCD Guest)
0
0