Watts & Hughes Construction Limited v Biala
[2020] NZHC 3041
•17 November 2020
IN THE HIGH COURT OF NEW ZEALAND CHRISTCHURCH REGISTRY
I TE KŌTI MATUA O AOTEAROA ŌTAUTAHI ROHE
CIV-2018-409-106
[2020] NZHC 3041
UNDER the Companies Act 1993 BETWEEN
WATTS & HUGHES CONSTRUCTION LIMITED
Plaintiff
AND
VIJAY BIALA
Defendant
Hearing: 3 August – 6 August 2020 Counsel:
D J Jackson for the Plaintiff S Cottrell for the Defendant
Judgment:
17 November 2020
JUDGMENT OF CULL J
[1] A national construction company sues a director of a café and wine company (in liquidation) for $39,629.88 plus interest for reckless trading under s 135 of the Companies Act 1993 (the Act). It is claimed the director carried on the business of the company in a reckless manner and did not make proper provision for the last of the construction costs for a fit-out of the company’s café and wine bar premises.
[2] The construction company, Watts & Hughes Construction Ltd (Watts & Hughes) claims against Vijay Biala, the director of the liquidated company La Di Da Expresso & Wine Bar Ltd (the Company). Watts & Hughes alleges that the Company did not have the funds to meet the fit-out costs, either at the time it engaged Watts & Hughes or throughout the time of its short trading life. Watts & Hughes claims that Mr Biala carried on the business of the Company in a manner likely to create a substantial risk of serious loss to Watts & Hughes, because the Company did not have
WATTS & HUGHES CONSTRUCTION LIMITED v BIALA [2020] NZHC 3041 [17 November 2020]
the funds to pay the construction costs at the time that they were incurred, at the time of the final invoice on 12 November 2014, or in February 2015 when a new agreement between the parties was allegedly reached, and instead paid other creditors in preference to the pre-existing debts of Watts & Hughes.
[3] Mr Biala rejects the allegation that the Company was insolvent at the time it engaged the plaintiff or throughout the construction of the fit-out. By the end of April 2015, however, the financial situation for the Company was untenable and it ceased trading. Mr Biala says that Watts & Hughes breached its construction agreement by failing to complete the fit-out by 20 September 2014 and incurred unauthorised costs over and above the contract price. The unexplained delays by Watts & Hughes, Mr Biala says, prevented the Company from trading and caused loss to the Company.
Background facts
[4] Since 2000, Mr Biala and his family had operated a successful restaurant business known as Maharaja, which was the trading arm of their company Sher-e- punjab Ltd. However, as a result of the Christchurch earthquakes in 2010 and 2011, the Maharaja premises were destroyed. After a period of almost two years of not operating at all, the Biala’s found and moved into a new premises for Maharaja in September 2012.
The Company and fit-out
[5] On the rebuild in Victoria Street, Christchurch, the Bialas decided that their family business could expand and incorporated the Company on 15 July 2014. The defendant, Mr Biala, was the sole director. The Company was operated as a family business, supported by Sher-e-punjab and the Maharaja restaurant business. The Biala family located newly built premises in Victoria Street, which required to be fitted out. They completed budgets based on their experience and expected trading, and they sought professional advice in relation to those budgets.
[6] The Bialas agreed to lease the new premises from 25 August 2014 for an initial term of eight years. Sher-e-punjab signed the deed of lease as the tenant and Mr Biala and his son, Rajiv, guaranteed the lease. They employed Stufkens and Chambers
architects to design a complete fit-out and engaged them to manage the tender process and assist in the construction of the fit-out. Rajiv had worked on the fit-out for the new Maharaja premises with Stufkens and Chambers architects. He emphasised in his evidence that the architects were instructed that the budget and the timeframe had to be tightly controlled so that the project was completed on time and within budget.
[7] Once the designs for the fit-out had been completed, the architects received three quotes from the tender process. Watts & Hughes was the successful tenderer with a tender price of $124,000 plus GST and an expected construction timeframe of four weeks. The completion date was to be 20 September 2014. Rajiv met with Mr Pritchard from Watts & Hughes on 7 August 2014, stressing that they did not want any budget blowout. Although instructions were given by the Bialas to their architect to draw up a contract, the project started without the contract having been signed.
[8] From the initial anticipated completion date of 20 September 2014, the fit-out process was pushed out to 30 September, then to 17 October with a plan to open by Cup Week in November. Cup Week is known as one of the busiest trading times in Christchurch. This did not eventuate. The doors of the café/bar finally opened at the beginning of December. The parties disagree on the actual date of completion of the construction, with Watts & Hughes saying it was completed in November 2014 and Mr Biala saying it was December 2014. The Bialas say the delays prevented the Company from trading and contributed to its financial losses. Watts & Hughes say the delays were caused by the contractors arranged by Rajiv.
[9] The Bialas also dispute the amount claimed by Watts & Hughes. On 5 November 2014, Watts & Hughes sent an estimated final account claim with a trade summary including variations totalling $163,013.89 plus GST to the Biala’s architect and Rajiv. The Company’s architect queried some of the items in relation to the variations, expressing a concern that extra items had been listed but credits had not.
[10] On 12 November 2014, a revised final account estimate for the fit-out construction and installation was sent by Watts & Hughes to both the Biala’s architect and Rajiv in the amount of $147,488.93 plus GST. This totalled $169,612.26. Watts & Hughes pressed for payment of the variations and GST.
[11] On 8 December, Watts & Hughes advised Mr Biala that the latest payment of monies had been received from the third-party financier FlexiGroup and the balance owing was now $48,021.67. In response, Rajiv queried why the project was over budget and asked why he had not been advised of variations before proceeding further. On 9 December, Mr Michel from Watts & Hughes, referring to the architect’s four advice notes, advised the remaining variations were done by emails through the architect or through Rajiv.
The disputed “agreement”
[12] An email exchange between the Bialas and Watts & Hughes on the outstanding payments is at the heart of Watts & Hughes’ claim in this hearing. On 12 February 2015, following a meeting with Rajiv, Mr Gamlen of Watts & Hughes emailed Rajiv seeking confirmation of his agreement on what was owed and how it was to be met. The proposition was:
(a)Silverchef (the financer) is to pay $12,908.19 including GST immediately;
(b)this left a final account balance of $39,629.88 including GST owing;
(c)payments of $4,600 including GST are to be made monthly commencing 20 February 2015;
(d)the balance of the account is to be settled by 20 May 2015;
(e)interest is to be charged at two per cent per month on the balance owing from 20 December 2014;
(f)any collections costs incurred after 20 May 2015 are to be met by the Company; and
(g)Watts & Hughes requires a signed personal guarantee from Rajiv.
[13] On 17 February 2015, Rajiv sent an email which read: “Just confirming this is okay”.
[14] Watts & Hughes relies on Rajiv’s email response as an agreement by the Company to pay $39,629.88 by May 2015 and $12,908.19 immediately. Rajiv strongly refutes that this was such an agreement. At its highest, Rajiv says the email exchange indicated that the Company would pay, but it was not an agreement or an admission of the amount remaining payable. The amount is disputed.
Summary of payments
[15] A summary of the dates of invoices and payments received were agreed between the parties and can be summarised as follows:
Date
Invoice No.
Amount Invoiced
Date Due
Date Paid
Amount Paid
26.09.14 2196 96,563.90 20.10.14 30.10.14 25,000.00 03.11.14 20,000.00 06.11.14 51,000.00 28.10.14 2359 28,979.20 20.11.14 05.12.14 28,979.20 30.10.14 2464 48,021.67 20.11.14 11.02.15 2814 12,908.19 07.12.14 27.02.15 12,908.19
[16] It is agreed between the parties that the payments made by or on behalf of the Company total $137,887.21 inclusive of GST. As the table shows, these payments were made over the period from 30 October 2014 to 27 February 2015. Two of the payments were made on behalf of the Company by third party equipment financers, namely $28,979.20 on 5 December 2014 and $12,908.19 on 27 February 2015.
[17] On 5 May 2015, Watts & Hughes served a statutory demand on the Company in the amount of $39,629.88 plus interest, based on the agreement referred to above. On 20 May, a cheque for $5,000 was given to Watts & Hughes but it was dishonoured when presented.
[18] The Company ceased trading around June 2015 and was placed in liquidation on 1 October 2015 on Watts & Hughes’ application. There were two principal creditors with debts outstanding at the time the Company went into liquidation. Watts & Hughes had around $39,000 outstanding and Sher-e-punjab was owed over
$200,000.
The claim
[19] By a Deed of Assignment dated 16 June 2017, the liquidator of the Company assigned all rights to Watts & Hughes to bring a claim against the director of the Company. Notice of the assignment was given to Mr Biala with the High Court’s approval of the assignment on 8 February 2018.
[20] Watts & Hughes issued proceedings on 21 February 2018 against Mr Biala, alleging that he carried on the business of the Company in a manner likely to create a substantial risk of serious loss to the plaintiff and did not make proper provision to pay for the debt of Watts & Hughes at the time it was incurred. Further, no steps were taken to arrange for payment during the period of the Company’s trading. Watts & Hughes seek compensation under s 301 of the Act for $39,629.88.1
Reckless trading
[21] Section 135 of the Act is the governing legislative provision for a claim in reckless trading. It provides:
135 Reckless trading
A director of a company must not—
1 The plaintiff’s statement of claim dated 21 February 2018 sought payment of $44,382.96. At the hearing, the claim was for $39,629.88 plus interest and costs.
(a)agree to the business of the company being carried on in a manner likely to create a substantial risk of serious loss to the company's creditors; or
(b)cause or allow the business of the company to be carried on in a manner likely to create a substantial risk of serious loss to the company's creditors.
In interpreting and applying this provision, both Counsel relied on the summary of the case law in Mainzeal Property and Construction Ltd (in liq) v Yan, which is under appeal to the Court of Appeal.2
[22] Since the hearing, the Supreme Court issued its judgment in Madsen-Ries and Levin as liquidators of Debut Homes Ltd (in liq) v Cooper (Debut Homes Ltd).3 The Court found that Mr Cooper continued trading in circumstances where he knew that Debut Homes Ltd was unsalvageable and continued trading would lead to serious loss to creditors. In reaching its finding, the Supreme Court applied the test of “substantial risk of serious loss” to its consideration of reckless trading, finding that $300,000 was a “serious loss” and that the loss to creditors “was not merely a “substantial risk”. It was a certainty.”4 The Court also held that s 135 is necessarily forward-looking to loss in the future. As a matter of principle, if a company reaches the point where continued trading will result in a shortfall to creditors and that company is not salvageable, then continued trading will be in breach of s 135 of the Act.5 The Court did not engage with the extent to which s 135 may inhibit taking ordinary and legitimate business risks or continued trading in the hope of salvage.6 The authorities dealing with such factual circumstances were not engaged or overruled.7
2 Mainzeal Property and Construction Ltd (in liq) v Yan [2019] NZHC 255 at [150]-[168].
3 Madsen-Ries and Levin as liquidators of Debut Homes Ltd (in liq) v Cooper [2020] NZSC 100.
4 At [70].
5 At [69] and [174].
6 At [69].
7 Re South Pacific Shipping Ltd (in liq): Traveller v Lӧwer (2004) 9 NZCLC 263,570 (HC); and see footnote 83 in Debut Holmes Ltd, above n 3, at [69] where the Court specifically noted: “We do not need to decide whether William Young J’s approach [in Re South Pacific Shipping, that continued trading in the hope of salvage should last a matter of months only] applies to s 135 as it is common ground that Debut was not salvageable.”
[23] The principles of s 135 have been well canvassed in a number of other leading authorities.8 In Mason v Lewis, the Court of Appeal considered whether s 135 is breached when the company continues to trade when the director knows that it is insolvent.9 The Court emphasised that it is not mere risk that qualifies. There must be a “substantial risk of serious loss.”10 The Court went on to define the essential pillars of s 135 as follows:11
[51]The essential pillars of the present section are as follows:
·the duty which is imposed by s 135 is one owed by directors to the company (rather than to any particular creditors);
·the test is an objective one;
·it focuses not on a director’s belief, but rather on the manner in which a company’s business is carried on, and whether that modus operandi creates a substantial risk of serious loss; and
·what is required when the company enters troubled financial waters is what Ross … accurately described as a “sober assessment” by the directors, we would add of an ongoing character, as to the company’s likely future income and prospects.
[24] The question of what is a substantial and illegitimate risk has exercised the courts, with approval being given to O’Regan J’s articulation in Fatupaito v Bates.12 He said that where a company has little or no equity, directors will need to consider very carefully whether continuing to trade has realistic prospects of generating cash that will service both pre-existing debt and meet the commitments that such trading inevitably attracts.13
[25] In Re South Pacific Shipping Ltd (in liq) William Young J canvassed the type of material considerations that may be taken into account in assessing the legitimate
8 For example, Jordan v O’Sullivan HC Wellington CIV-2004-485-2611, 13 May 2008; Re South Pacific Shipping, above n 7; Fatupaito v Bates [2001] 3 NZLR 386 (HC); and Mason v Lewis [2006] 3 NZLR 225 (CA).
9 Mason v Lewis, above n 8.
10 At [47]-[50].
11 At [51].
12 Fatupaito v Bates, above n 8, at [67], cited with approval in Mason v Lewis, above n 8, at [50].
13 At [67].
and illegitimate business risks.14 He emphasised that a company does not have to cease trading the moment it becomes “balance-sheet” insolvent.15
No-one suggests that a company must cease trading the moment it becomes insolvent (in a balance sheet sense). Such a cessation of business may inflict serious loss on creditors and, where there is a probability of salvage, such loss can fairly be regarded as unnecessary. The cases, however, make it perfectly clear that there are limits to the extent to which directors can trade companies while they are insolvent (in the balance sheet sense to which I referred) in the hope that things will improve. In most of the cases, the time allowance has been limited, a matter of months.
[26] As noted above, the Supreme Court in Debut Homes Ltd did not engage with or disturb the observation which William Young J made, when he suggested that continued trading in the hope of salvage should last a matter of months only, as the Court found that the director knew that Debut Homes Ltd was not salvageable. William Young J’s approach to s 135 remains applicable therefore, where appropriate.
[27]From the authorities, the following can be gleaned:
(a)the threshold of s 135 is high;
(b)the way in which the business of the company is undertaken, particularly when the company is insolvent, must be “likely” to give rise to a “substantial” risk of “serious” loss to the company’s creditors;
(c)the “substantial risk of serious” loss includes a consideration of orthodox commercial practices;16
(d)if a company is not salvageable and continues trading, resulting in a shortfall to creditors, such trading will be in breach of s 135; and
(e)section 135 is forward-looking to future losses.
14 Re South Pacific Shipping, above n 7, at [125].
15 At [125(3)].
16 Re South Pacific Shipping, above n 7, at [125(4)]; and Mainzeal, above n 2, at [165].
[28] Here, the consideration involves the commercial realities of a start-up company. I found the summary of the authorities by Clifford J in Jordan v O’Sullivan to be of assistance when he undertook his assessment of the risks associated with a start-up business.17 He reminded himself of the difference between negligence (what reasonable directors would have done or foreseen) and reckless trading, which is deserving of a penalty.18 The Judge concluded in that case:19
… the directors did undertake a sober assessment of the business decisions involved in the entering into each of the Specified Leases. They did investigate each of the car parking sites involved, they reached a view as to the revenue the sites could generate – based admittedly on their own assessment of likely supply and demand factors – and they negotiated the terms of the leases in each case over some period of time. That in hindsight they under-estimated the risks involved in the start-up phase of each of those lease operations is not, in my judgment, a sufficient basis in this case to conclude that they breached the duties they owed to Condrens. In reaching that conclusion, and as regards the capitalisation of Condrens, it is important here that the directors had, very recently and in their capacity as shareholders, demonstrated a willingness to support the company’s trading by the provision of further capital.
[Emphasis added]
Issues for determination
[29]The parties were agreed that the following are the issues for determination:
(a)Did Mr Biala at any time agree or cause or allow the business of the Company to be carried on in a manner likely to create a substantial risk of serious loss to the Company’s creditors, in breach of s 135 of the Act?
(b)If Mr Biala was in breach of s 135:
(i)did that cause the plaintiff loss?
(ii)if so, was that loss “serious” for the purposes of s 135?
17 Jordan v O’Sullivan, above n 8.
18 At [46].
19 At [254].
(iii)if so, should an order for compensation be made under s 301 of the Act?
[30]Each of the issues are canvassed below.
Was Mr Biala in breach of s 135?
[31] Mr Jackson for Watts & Hughes submits that s 135 applies from the inception of the Company and that both balance sheet and cash flow insolvency is made out on the agreed facts. He submits that solvency, or rather a lack of it, is central to the cause of action in s 135, because a director who takes risks in “troubled waters” is risking the creditor’s money, not the shareholder’s capital.20 The Company, he says, could not pay its debts as they fell due and in this case, Mr Biala made a deliberate decision not to make provision to pay the plaintiff, whilst electing to fund the Company to pay its immediate and trade creditors only. He submits this is the classic “reckless trading” case where the Company, whilst in troubled waters, was managing to pay its immediate and trade creditors but was otherwise ignoring the significant liability already incurred to the plaintiff.
[32] Mr Cottrell for Mr Biala submits that s 135 is only engaged where risk-taking by the Company is causative of serious loss. That risk, he submits, will arise only when potential insolvency is an issue. Here, the critical decision by Mr Biala was the decision to open the new restaurant and engage Watts & Hughes to complete the fit- out of the restaurant, which occurred before the Company started trading. He submits the decision was reasonable in all the circumstances and was made with the benefit of appropriate professional advice and with sufficient financing in place. There is nothing out of the ordinary in these circumstances which takes this case to the high threshold of reckless trading in s 135.
[33] The Court’s assessment involves a start-up company. The starting point therefore is Mr Biala’s decision to open a new restaurant, sign a lease, and undertake the new Company’s operation in new premises. As the authorities emphasise, the test is an objective one, which focuses not on the director’s belief but on the manner in
20 Mainzeal, above n 2, at [164].
which a company’s business is carried out and whether that creates a substantial risk of serious loss.21 The question is whether the director undertook a sober assessment as to the company’s likely future income stream and whether there were reasonable assumptions underpinning the director’s forecast of future liquidity.22 In order to undertake this assessment, it is important to view the facts objectively and in context.
Relevant facts
[34] The Bialas were experienced business people in this area. They had run a successful restaurant business until the premises were destroyed by the earthquakes. They knew what they were doing and had recovered with another successful business, Maharaja, run through their company Sher-e-punjab.
[35] They then saw an opportunity in Victoria Street, Christchurch, an up-and- coming area at the time, and decided that their business could expand. It was a family operation. They decided the new business would be supported by the existing business and would be operated by a family member. They found a brand new premises, which was available for lease, but it needed to be fitted-out. They completed budgets based on their experience and the expected future trading. They sought professional advice on budgets and architectural design.
[36] The Bialas agreed to lease the new premises for an initial term of eight years, with a commencement date at the end of August 2014. They were committing to a long-term operation, and the agreement to lease was entered into by their existing company, Sher-e-punjab. Plainly, if the Company was to trade as a wine bar and café, it needed the commercial lease to conduct its future trading.
[37] Before commencing the Company’s operation, they took professional advice. Although the Bialas were experienced in the restaurant trade, they had no experience as builders and with an empty shell requiring a complete fit-out and kitchen, they sought professional help. They engaged Stufkens and Chamber architects to manage the tender process and to assist in the construction process. As noted, they instructed
21 Mason v Lewis, above n 8, at [51].
22 At [48].
the architects that they wanted the budget and schedule to be tightly controlled so there would not be budget or timeframe blowouts. They accepted Watts & Hughes’ tender price of $124,000 plus GST. Their intention was to have the Company trading in September 2014.
The start-up decision
[38] A matter of contention between the parties was whether there was a sufficient funding facility or finance for the Company to access sufficient capital funding to negate the risk of serious loss to creditors. The Bialas arranged finance through FlexiGroup and Silverchef, financiers used in the restaurant trade. Silverchef agreed to provide a facility of up to $80,000, and Watts & Hughes invoiced Silverchef directly in relation to that facility. The FlexiGroup facility was up to $35,000 and it too was dedicated to the fit-out work. Sher-e-punjab also had a $40,000 facility with ANZ that was able to be drawn down and was intended to be used to pay part of the fit-out costs.
[39] At the time of making the decision to fit out the leased premises then, Mr Biala and the Company had at least $155,000 worth of finance available. In addition, a further facility of up to $60,000 was organised with AABAAS finance and Sher-e- punjab supplied over $200,000 to the Company. As described above, Watts & Hughes received $137,000, which is almost the original tender price plus GST.
[40] It is not disputed that the Company became insolvent and ceased trading around June 2015, although the exact date is not agreed by the parties. The question is whether, prior to that point, Mr Biala carried on the Company in a manner likely to create a substantial risk of serious loss to its creditors. In other words, did the potential insolvency become an issue such that the Company’s continued trading entered into the “troubled waters” of insolvency, near insolvency or doubtful solvency where a contemplated payment or other cause of action would jeopardise its solvency.23
23 Mainzeal, above n 2, at [164]; and Nicholson v Permakraft (New Zealand) Ltd (in liq) [1985] 1 NZLR 242 (CA) at [249].
[41] The only evidence relating to the Company’s solvency at the time of making the decision to engage Watts & Hughes is from the Company’s accountant, Mr Shi. He said:
At the start of the venture the Company is certainly solvent in terms of the funding that’s available to it, comparing to the budgeted construction costs, budgeted fit-out costs. Later on, because of the delays and the budget blowout,
… it may have put the business into a more difficult trading situation.
[42] Mr Shi described the Bialas as ready “to grab onto an opportunity they saw.” He noted the Company sought accountancy advice in terms of its business focus plans, cash flow and funding options, which in his opinion did not equate to Mr Biala chasing a “dream”. He rejected Mr Jackson’s proposition that the Company accessing loans from a third-tier finance company was “desperate”. Mr Shi reinforced that there is no requirement to choose a banking institution for the source of funding and said it is “typically quite difficult for even [those with an] established history in the hospitality industry” to get funding for a new venture.
[43] Mr Shi concluded that on the basis of the funding received and the initial price of the fit-out, as well as significant amounts of shareholder support from Sher-e- punjab, appropriate planning was undertaken to pay for the fit-out work with a margin for buffer. He conceded that with the benefit of hindsight it is apparent a bigger contingency margin was required, but Mr Shi did not consider Mr Biala’s actions to be reckless.
[44] Mrs Brewster, the accountant for Watts & Hughes, assessed that the Company was trading while insolvent. It did not have access to sufficient capital funding, in her view, to negate the risk of serious loss to creditors. Her evidence was that the absence of a shareholder current account confirms the lack of shareholder capital introduced and the reliance on terms of finance brought the business conduct into question. She says that it must have been plain to the Company that it did not have the funds to pay Watts & Hughes and this is evidenced by having to access expensive finance early on, such as from the third-tier lender Quick Finance, secured by two second mortgages over properties. While the Company met its immediate trade and supply creditors, its reliance on debt funding and its lack of capital support meant that the risk to creditors of non-payment was real. Mrs Brewster says this was borne out by the Company’s
ultimate failure. In summary, her evidence is that the Company entered into “troubled waters” when it was forced to apply for equipment and third-tier finance in order to pay the first payment claims from Watts & Hughes and those submitted thereafter.
[45] Mrs Brewster also rejected the suggestion that the delays in the fit-out completion, which meant the Company could not trade at the most profitable time in Christchurch, contributed to the Company’s ultimate failure. The Company had “bitten off more than it could chew”, to use Mr Jackson’s wording, and this should have been obvious to Mr Biala when the Company was looking at third-tier lenders to pay part of the first payment claim, namely 67 per cent of the fit-out costs to Watts & Hughes.
[46] On questioning, Mrs Brewster could not comment on the Company’s solvency at the time the initial decision was made to open the wine bar and café, but qualified her evidence to say that her view of the insolvency of the Company was limited to the 31 March 2015 balance sheet date.
[47] Both accountants agreed, however, that there was nothing in the bank statements or other records of the Company to indicate recklessness or the sort of behaviour that might otherwise be of concern, like large amounts of funds being removed from the business, extravagant lifestyle expenses or expensive vehicle finance.
[48] The decision to engage Watts & Hughes to enable the new Company to commence trading was a decision that involves ordinary and legitimate business risks. In contrast to the director’s decision in Debut Homes Ltd to continue trading when it was a certainty that there was going to be serious loss to creditors, this case does not compare. The decision that incurred the loss to Watts & Hughes was not a decision that was reckless in these circumstances. This was a start-up company and, as in Jordan v O’Sullivan, Mr Biala’s conduct did not depart markedly from orthodox business practice involving extensive or unusual risk to creditors.24 For that reason, I do not find the start-up decision to be reckless.
24 Jordan v O’Sullivan, above n 8.
[49]This Court in Mountfort v Tasman Pacific Airlines of New Zealand Ltd
observed:25
The obligation to maintain solvency could not be absolute, because that would destroy the very justification for limited liability which requires the protection of directors who, acting reasonably and in good faith, are unable to prevent failure that is both a regular fact of business life and the justification for limited liability.
This accords with the evidence of Mr Shi, who considered that the Company was not chasing a “dream” without an assessment and calculation of the future risks.
[50] The Biala family were experienced restauranteurs and had planned for and calculated the most profitable trading times for the Christchurch hospitality industry, based on their experience. With the financial support from Sher-e-punjab, the Company had sufficient funding available to pay for the fit-out on the tender price they accepted. They stipulated to the architect that the end-date was important as they wanted to start trading at the most beneficial time of the year, from Cup Week to Christmas. They accepted Watts & Hughes’ pricing and completion date on that basis.
[51] I consider, therefore, that the decision to commence this new small business and to commission Watts & Hughes to complete the fit-out was not likely to create a substantial risk of serious loss to creditors, such that it was “reckless” in terms of s 135. I reject the plaintiff’s claim that the Company was in “troubled waters” at the outset. Mrs Brewster could not support that contention at the time of the initial decision, although she was critical of the Company’s lack of capital support and its funding arrangements. Mr Biala made a calculated assessment of future risk, relied on the back-up support of the related family company and started a new venture. This was not reckless. The business ultimately failed, but applying the principles from the authorities, that does not equate to reckless trading.
The decision to continue trading
[52] To complete my assessment, I now turn to the allegation by the plaintiff that the Company was insolvent on both a balance sheet and a cash flow limb basis and the
25 Mountfort v Tasman Pacific Airlines of New Zealand Ltd [2006] 1 NZLR 104 (HC) at [20].
decision of the Company to continue trading, after the initial start-up decision was made, was reckless. The allegation essentially is that the Company was ignoring a liability incurred to the plaintiff when it was continuing to trade and pay its trade creditors.
[53] The timeframe for this allegation is December 2014, when the Company commenced trading. From the factual chronology set out at [9]-[11], the revised final account claim by Watts & Hughes was sent on 12 November 2014, with further payment being received by 8 December leaving a balance owing of $48,021.67. The Company’s architect had queried some of the items that were sent in the original estimated final account claim on 5 November 2014. Although that account was updated in the revised final account claim of 12 November, by December Rajiv and Watts & Hughes were still not clear on the amounts claimed for the variations.
[54] This uncertainty led to the disputed agreement of 12 February 2015, described at [12]-[14] above, in which Mr Gamlen from Watts & Hughes emailed Rajiv seeking confirmation of this agreement on what was owed and how it was to be met. I deal with this agreement in more detail in the next section.
[55] For present purposes, the decision to engage Watts & Hughes had been made in August 2014 and it is accepted that the Company paid a total of $137,887.21 over the period of 30 October 2014 to 27 February 2015, as the table at [15] above shows. The variations to the fit-out construction price had already occurred by November 2014, before the Company had started trading in December. In my view, this is not the “classic reckless trading” as alleged by the plaintiff. The Company commenced trading and as the timeline shows, the Company paid Watts & Hughes in October, prior to trading, and in December and February, while trading.
[56] Unfortunately, trade was less than expected during December 2014 to February 2015. For whatever reason, be it delays in the opening of the café/wine bar or lack of custom that caused the Company to cease trading and become insolvent, the question for the Court is whether Mr Biala carried on the Company in a manner likely to create a substantial risk of serious loss to its creditors.
[57] The timeline of events in my view does not support the plaintiff’s case. If the Company did not commence trading or ceased trading in December, including the payment of its trade accounts, this would have increased the risk of loss. The debt had been already been incurred by November when Watts & Hughes confirmed the final invoice. I accept Mr Cottrell’s submission that halting the fitout mid-way through and “throwing in the towel” was not an appropriate option when there was a reasonable expectation that the new business would trade profitably.
[58] Further, the evidence from Mrs Brewster on the Company’s insolvency was limited to the 31 March 2015 balance sheet. It was acceptable for the Company to press on from December to trade in the hope that it would flourish. Such trading in a difficult or insolvent position in the hope things would get better, where no further losses are created, was considered to be permissible by William Young J in Re South Pacific Shipping Ltd.26 Here, no further loss was caused by the continued trading, and I do not consider such trading to be reckless in terms of s 135.
[59] For completeness, Sher-e-punjab contributed $200,000 worth of funds to enable the Company to trade. This demonstrates the Bialas’ willingness to support the Company’s trading, which Clifford J found was a critical factor in Jordan v O’Sullivan negating the existence of reckless trading.27 I consider Mr Biala’s focus was on trading to meet creditors, with a potential for future income and prospects, as Mr Shi confirmed. All of this shareholder support has been lost by the Biala family, with obvious adverse financial consequences for them.
Conclusion
[60] I find that Mr Biala did not carry on the business of the Company in a reckless manner. The decision of Mr Biala to engage Watts & Hughes in August 2014 was not made recklessly but was a planned and calculated risk, assessed from Mr Biala’s experience in the industry. Nor was the decision to continue trading, as there was a reasonable expectation that the new business would trade profitably. Neither decision
26 Re South Pacific Shipping, above n 7, at [125(3)].
27 Jordan v O’Sullivan, above n 8, at [254].
departed “so markedly from orthodox business practice and involved such extensive and unusual risk to the creditors” as to be considered reckless.28
[61] This was a start-up business that ultimately failed. In order for the Company to start trading, it required a fit-out of an empty shell to set up the café and wine bar, as many start-up businesses do. Trading did not meet the expectation for whatever reason. Even if the Bialas had under-estimated the risks involved in the start-up phase, they demonstrated a willingness to support the Company’s trading by providing further capital through their company Sher-e-punjab.
[62]I find that s 135 of the Act has not been breached.
The plaintiff’s loss
[63] Even if I had found Mr Biala to have carried on the business of the Company in a reckless manner and was considering an order for compensation under s 301 of the Act, the plaintiff’s loss is both uncertain and not “serious”.
[64] The outstanding amount of $39,629.88 to be paid to Watts & Hughes was re- calculated in February 2015 in the disputed “agreement”, three months after completion of the fit-out. It is not clear how this sum was reached. The re-calculation did not detail specific amounts in the relevant invoices, including any amounts of interest or GST. Mr Gamlen accepted in cross-examination that interest at two per cent per month was included in the February demand and was compounding from December to February. However, he was unable to clarify how the sum of $39,629 was reached. Even at the hearing before me, Mr Jackson for the plaintiff was unable to identify the makeup of the $39,629. Mr Cottrell for Mr Biala assessed the additional costs of the variations and GST to be approximately $34,000, and on my calculations it appeared to be closer to $32,000. The final sum and how it was made up remains uncertain.
[65] Mr Jackson, however, pointed to “the agreement” reached between Rajiv and Watts & Hughes on 17 February, following the email exchange as conclusive evidence
28 At [254].
of the sum to be paid. As noted, the email exchange between Watts & Hughes and the Company on 12 and 17 February 2015 is disputed. Watts & Hughes says the Company agreed to pay $39,629.88 with $12,908.19 being paid immediately, whereas the Company says the email exchange “indicated” that it would pay but it was not an agreement or an admission of the amount remaining payable.
[66] I am not satisfied that the email exchange was an agreement by the Bialas to pay those sums in their entirety. Although he questioned the amounts sought by Watts & Hughes on 8 December, Rajiv nevertheless tried to obtain funding to meet them. Watts & Hughes had been pressurising the Bialas for payment. Rajiv told the Court he was placed under pressure and confirmed “the agreement” was okay.
[67] I am unable to find this was a binding agreement. Under pressure, Rajiv organised for a further payment of $12,908 on 27 February 2015. This was the maximum that was obtainable from the third-party financier. No further monies were extended by that financier. Rajiv then questioned Watts & Hughes about the nature and extent of the increased variation amounts and no further payments were made by the Company.
[68] Mr Cottrell drew my attention to the fact that the variations were never formally signed off by the Company as a variation to the original contract or agreement. I note that the original contract was never formally drafted or executed. However, when Watts & Hughes forwarded the scope of the first set of variations to Rajiv and the architects on 4 September 2014, Ms Fisk from Stufkens and Chambers sent an Architect/Designer’s Advice Notice to Watts & Hughes, responding to the proposed variations with this caveat:
The following items have been brought to the attention of the Architect and the following details are provided to the Client as a suggestion only. If the Contractor [Watts & Hughes] believes that the information presented in this advice note will result in a variation to the contract they shall inform the Principal [Rajiv Biala] as per the conditions of their signed contract or agreement.
There was no formal sign-off by Rajiv, although the 4 September email from Watts & Hughes was sent to him.
[69] Further, the amount outstanding for the variations appears to include GST and interest, although the amounts of each was unclear. The actual loss to Watts & Hughes is difficult to quantify with any certainty.
[70] Despite the uncertainty, I consider the plaintiff’s loss cannot be considered “serious”. Watts & Hughes is a national construction company, which has been in operation for over 30 years. An outstanding account of $39,000 or less is a small sum. When pressed, Mr Gamlen conceded that this was not a significant loss to Watts & Hughes. While a relatively minor financial amount may be serious for some creditors, it plainly did not meet the threshold of serious loss here, as contemplated by s 135 of the Act.
[71] Finally, I add that in oral arguments, Mr Cottrell raised the issue of a creditor seeking recovery of its own losses from a director of a liquidated company, as opposed to the losses of the company’s creditors as a whole. I did not hear full argument on this issue and in light of my findings, nothing turns on the issue in this case and I take it no further.
Conclusion
[72] The plaintiff’s claim has been brought under s 135 of the Act only and I have found that the Company was not trading recklessly. Accordingly, no order is made for compensation under s 301 of the Act.
Result
[73]The plaintiff’s claim is dismissed.
[74] The defendant is entitled to costs. If Counsel cannot agree, memoranda of no more than five pages are to be filed within 20 working days of receipt of this decision by the defendant and a further working 10 days by the plaintiff.
Cull J
Solicitors:
Davidson Legal, Christchurch for the Plaintiff GCA Lawyers, Christchurch for the Respondent
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