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High Court of New Zealand Decisions |
Last Updated: 14 March 2019
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IN THE HIGH COURT OF NEW ZEALAND WELLINGTON REGISTRY
I TE KŌTI MATUA O AOTEAROA TE WHANGANUI-A-TARA ROHE
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CIV-2017-485-748
[2019] NZHC 210 |
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BETWEEN
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INSTALLER SERVICES (HUTT VALLEY) LIMITED
Plaintiff
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AND
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ANDREW LESLIE COLSON AND SUE JENNIFER COLSON
Defendants
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Hearing:
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20-23 August 2018
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Appearances:
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D M Lester for Plaintiff S J Iorns for Defendants
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Judgment:
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20 February 2019
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JUDGMENT OF GRICE J
Introduction [1]
Background [2]
The present claim [16]
Recovery of distributions [20]
Was a distribution made? [24]
Mr Colson’s salary [26]
Other drawings [32]
Solvency [36]
Franchise fees [52]
Goodwill [71]
Conclusion [78]
Directors duties to the company [84]
Duty of care [84]
Good faith [97]
Reparation [111]
Summary of the law [111]
Measure of the loss [115]
Contribution by the director for the loss [122]
INSTALLER SERVICES (HUTT VALLEY) LIMITED v COLSON [2019] NZHC 210 [20 February 2019]
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(a) Causation
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(b) Culpability
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Conclusion
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Conclusion
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Costs
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[1] Mr and Mrs Colson became the directors of Installer Services (Hutt Valley) Ltd in June 2000. They were also shareholders, holding 50 shares each. Installer Services (Hutt Valley) Ltd went into liquidation on 18 December 2013. It now seeks amounts from Mr and Mrs Colson, as shareholders and directors of the company, for the repayment of various shareholder drawings and alleged breaches of directors’ duties. Specifically, it claims:
(a) the company made distributions to Mr Colson, in his capacity as a shareholder, while failing to follow the required statutory processes when the company was insolvent. Repayment of the amount distributed is sought pursuant to s 56 of the Companies Act 1993 (the Act);
(b) Mr and Mrs Colson breached their duty as directors to act with reasonable care and skill pursuant to s 137 of the Act; and
(c) Mr and Mrs Colson breached their duty as directors to act in good faith and in the best interests of the company pursuant to s 131 of the Act.
Background
[2] Installer Services (Hutt Valley) Ltd was incorporated on 14 September 1999 and began trading later that year. Mr and Mrs Colson had been the directors of Installer Services (Hutt Valley) Ltd since 30 June 2000. Mrs Colson retired from her position on 27 February 2013, but Mr Colson remained a director until the company went into voluntary liquidation on 18 December 2013.
[3] Installer Services (Hutt Valley) Ltd was a franchisee of Installer Services (Group) Ltd (the franchiser). The franchise was related to sales of mobile electronic
goods and services such as car stereos, band expanders and mobile phones. Installer Services (Hutt Valley) Ltd paid $80,000 to the franchiser for the license rights. Annual licence fee payments of five per cent of the franchisee’s turnover were also payable. As will become clear, the franchiser and Mr Colson disagreed about when this fee was payable.
[4] Mr Corry was the representative of the franchiser that Mr Colson dealt with on the matters relevant to these proceedings. The relationship between Installer Services (Hutt Valley) Ltd and the franchiser became strained following disagreements over the level of service of the franchiser and payment of licence fees.
[5] No written franchise agreement was ever signed. Mr Colson maintains that the annual licence fee payments were only payable if the franchiser referred sufficient work to the company for it to cover the fees. Installer Services (Hutt Valley) Ltd paid franchise fees from 2001 to 2008. From 2008, however, the franchise fees were not paid.
[6] Mr Colson agrees that Installer Services (Hutt Valley) Ltd did purchase the franchise for $80,000 but says that the purchase was subject to the deal he had negotiated as to payment of franchise fees. In support of this contention he points to the fact that no franchise fees were paid in the first few years of trading when little work was referred by the franchiser. Mr Colson points to an arrangement, in 2001, where the franchiser confirmed a waiver of fees to that time. He said franchise fees were then paid for a number of years when the referred work flowed in but it dried up. Therefore, the company stopped paying the fees.
[7] Further Mr Colson says his version of the fee arrangement was confirmed at a meeting between him and Mr Corry in a Wellington hotel sometime between 2009 and 2012. The franchiser’s staff had been chasing up GST invoices and franchise fees. Mr Colson said that they were not forthcoming because he was not getting work from the franchiser. Mr Colson said Mr Corry did not dispute nor did he correct Mr Colsons’ understanding regarding the franchise fees.
[8] There was a hiatus in the emails concerning GST invoices between 2009 and 2012. Mr Lester says the franchiser, based in Christchurch, was preoccupied with the aftermath of the Christchurch earthquakes. It apparently lost many of its records. Mr Colson says the lull occurred because he had sorted things out with Mr Corry at the Wellington meeting. He maintained that position under cross-examination.
[9] In December 2012, a statutory demand was issued by the franchiser to Installer Services (Hutt Valley) Ltd for the “minimum” sum of $20,000. When Mr Colson received the statutory demand he instructed his lawyer to write seeking its withdrawal. He says he did not consider the demand had any merit at all and certainly did not believe the claim could be for over $80,000 as is now claimed. The demand was withdrawn shortly afterwards. The parties corresponded from December 2012 to March 2013 over disputed franchise fees.
[10] In March 2013, the franchiser issued proceedings in the District Court against Installer Services (Hutt Valley) Ltd seeking orders that it supply GST returns and financial accounts from February 2008 to enable the calculation of franchise fees due. Judgment for fees of an unspecified amount was sought. The notice of claim filed by the franchiser sought interest at “the contracted rate of 10 per cent per annum calculated daily” on franchise fees. The shareholders put Installer Services (Hutt Valley) Ltd into liquidation in December 2013 following Mr Colson’s decision that it was not economically feasible for the company to continue to defend the action. He had found the resources to initially defend it. However, given the likely legal costs and “contingent liability” present in any litigation, he said he could not afford to continue funding the company’s defence out of his own pocket. Therefore, while the company engaged initially to defend the action it then stepped away. Mr Colson says he believed that if the action had been defended the company would have succeeded.
[11] A judgment by default for $85,336 was entered against Installer Services (Hutt Valley) Ltd in the District Court on 30 January 2015.1
[12] The original liquidators resigned on 21 October 2016. They were replaced by the present liquidators.2 The largest of the non-related unsecured creditors is the franchiser (now Installer Services (Group) Ltd). The unsecured creditors are as follows:
[13] Mr Jenkins, one of the replacement liquidators, gave evidence. He said that the primary records of the company that he would have expected to be available to the replacement liquidators were not available. He said:
(e) What could be considered “primary records” of ISHV such as:
- bank statements
- cheque book butts
- lease agreements
- assignment of leases
- employment contracts
- wage records
- GST and PAYE schedules
- debtors’ ledgers
- creditors ledgers
- minute book
- accounting journal and ledgers
have not been made available to the replacement liquidators ...
2 These proceedings are funded by the franchiser.
3 Installer Services (Hutt Valley) Ltd.
[14] Mr Jenkins attempted to obtain these company records from the original liquidators as well as from the lawyers retained by those liquidators. He said he had made various enquiries of the original liquidators and others seeking those records to no avail.
[15] Mr Colson said the records kept by him for the company were kept in a computer program called MYOB. They were lost when the computer running the accounts crashed and was disposed of. Mr Colson said he had relied on the company’s accountant, Accountants Plus Limited, to retain copies of all the company material. However, Accountants Plus told the replacement liquidators that the accounts had been prepared by punching printouts of the “trial balance etc” and it did not have any backups of the MYOB file in this case. The accountant could not be sure whether it had returned the relevant documents to Mr Colson. In addition, it had moved office and at the time had a cleanout so it was possible the files of previous clients were returned or removed then, it said. Mr Eade, a principal of Accounting Plus, said he was of the view the records had gone to the original liquidators. The accountant did not hold any minutes or resolutions for Installer Services (Hutt Valley) Ltd.
The present claim
[16] Installer Services (Hutt Valley) Ltd seeks that Mr and Mrs Colson repay their share of the shareholders’ salaries that were drawn without following the required procedure at a time when the company had franchise fees outstanding that it could not meet. The company claims that:
(a) Mr Colson was paid a shareholder’s salary and took additional drawings over 2012 and 2013. As the company was insolvent at the time, those payments are repayable to the company under s 56 of the Act;
(b) Mr and Mrs Colson, as directors, were in breach of their duty to the company to exercise reasonable care and skill under s 137 of the Act during the period of 2005 to 2012; and
(c) Mr and Mrs Colson were in breach of their duty of good faith to the company under s 131 of the Act.
[17] Mr Colson was the active director and managed the company’s affairs. Mrs Colson was a “sleeping” director throughout. She resigned in February 2013. For the purposes of these proceedings I have focussed on Mr Colson and his actions.
[18] The repayment claim is based on the company being insolvent at the relevant dates. The claims at (b) and (c) above do not require proof of insolvency.
[19] For the repayment claim, the central question is whether the financial accounts incorrectly failed to recognise outstanding franchise fees and/or failed to write off or write down the goodwill. Secondly, whether, if the treatment suggested by the liquidators of those matters had been correct, the company’s financial accounts would have shown the company was insolvent.
Recovery of distributions
[20] Under s 56 of the Act, the directors and shareholders of a company are both liable to repay distributions made when the company fails to satisfy the solvency test in specific circumstances. Section 56 of the Act provides:
56 Recovery of distributions
(1) A distribution made to a shareholder at a time when the company did not, immediately after the distribution, satisfy the solvency test may be recovered by the company from the shareholder unless—
(a) The shareholder received the distribution in good faith and without knowledge of the company's failure to satisfy the solvency test; and
(b) The shareholder has altered the shareholder's position in reliance on the validity of the distribution; and
(c) It would be unfair to require repayment in full or at all.
(2) If, in relation to a distribution made to shareholders,—
(a) The procedure set out in section 52 ... of this Act, as the case may be, has not been followed; or
- (b) Reasonable grounds for believing that the company would satisfy the solvency test in accordance with section 52 ... of this Act, as the case may be, did not exist at the time the certificate was signed,—
a director who—
(c) Failed to take reasonable steps to ensure the procedure was followed; or
(d) Signed the certificate, as the case may be,—
is personally liable to the company to repay to the company so much of the distribution as is not able to be recovered from shareholders.
...
(5) If, in an action brought against a director or shareholder under this section, the Court is satisfied that the company could, by making a distribution of a lesser amount, have satisfied the solvency test, the Court may—
(a) Permit the shareholder to retain; or
(b) Relieve the director from liability in respect of—
an amount equal to the value of any distribution that could properly have been made.
[21] Installer Services (Hutt Valley) Ltd alleges that the following 2012 and 2013 distributions must be repaid to it pursuant to this section:
(a) Shareholder salary payments totalling $44,800 (2012: $33,706 and 2013: $11,094);
(b) Additional drawings4 totalling $81,000 (2012: $19,943 and 2013:
$61,057).
[22] Section 52 of the Act establishes procedural requirements that must be followed for a distribution to shareholders to be authorised by a company. It provides:
52 Board may authorise distributions
(1) The board of a company that is satisfied on reasonable grounds that the company will, immediately after the distribution, satisfy the solvency test may, subject to section 53 of this Act and the constitution
of the company, authorise a distribution by the company at a time, and of an amount, and to any shareholders it thinks fit.
(2) The directors who vote in favour of a distribution must sign a certificate stating that, in their opinion, the company will, immediately after the distribution, satisfy the solvency test and the grounds for that opinion.
(3) If, after a distribution is authorised and before it is made, the board ceases to be satisfied on reasonable grounds that the company will, immediately after the distribution is made, satisfy the solvency test, any distribution made by the company is deemed not to have been authorised
[23] In this case, that procedure was not followed. The board of directors did not turn its mind in any year to the solvency of the company but still allowed the shareholders distributions to be made. Mr Colson argues that these are not shareholders distributions but rather payments to him by way of shareholder salary for work done for the company. I deal with that issue below.
[24] A “distribution” from a company to a shareholder is defined in s 2 of the Act as “... [t]he direct or indirect transfer of money or property, other than the company’s own shares, to or for the benefit of the shareholder...”. The elements of a distribution were described by Heath J as follows:5
- [64] ... There are three cumulative elements to a ‘distribution’ as defined. They are:
(a) the direct or indirect transfer of money or property (or the incurring of a debt) by a company
(b) to or for the benefit of the shareholder and
(c) in relation to shares held by that shareholder.
The concepts captured by those elements are the transfer of property (or the incurring of a debt) by the company; the corresponding provision of a benefit to or for its shareholders and receipt of the benefit by, or on behalf of, the shareholder in its capacity as a shareholder. A link must be established between the outflow of wealth from the company and the benefit received by or on behalf of a shareholder.
[66] A distinction must be drawn between the transfer of wealth to a shareholder in its capacity as a shareholder and a bona fide transfer of wealth to that shareholder in some other capacity. Failure to draw that distinction would, in my view, undermine the purpose of the reforms made by enactment of the distribution provisions of the Act because those reforms were focussed squarely on the protection of creditors or higher ranking shareholders...
[67] ... Similarly, if a shareholder is employed by the company and receives wages, provided the services rendered are genuine any payments made to the shareholder, qua employee, could not be impugned under the distribution provisions. See also the factors mentioned in paras [57] and [58] of Kitchener Nominees Ltd at 262,893- 262,894.
[25] Mr Colson says that the shareholders’ salaries were not shareholder distributions but were salary payments or payments for work done by him for the company in its business. Mr Colson’s claim is partly supported by the treatment of the payments in the financial accounts and by Mr Eade’s (the company accountant) evidence. However, there is no written employment agreement or other documentation setting out this arrangement. I turn to deal with the arguments below.
Mr Colson’s salary
[26] Section 56 of the Act only applies to payments that can be defined as “distributions”. It does not apply to employee or directors’ salaries that are paid as remuneration.6 Mr Colson argues the shareholder salary payments totalling $44,800 were a salary rather than a distribution.
[27] Installer Services (Hutt Valley) Ltd says that the money taken by Mr Colson and labelled “shareholders salary” or “additional drawings” were sums taken for convenience to bring the profit of the company to zero or a small surplus. It says there was no proper calculation of the money owing for work done and Mr Colson cannot now claim that.
6 DML Resources Ltd v Bolton [2004] 3 NZLR 490 (HC) at [67].
[28] However, I am satisfied that Mr Colson worked for the company in the capacity of a manager, employee or contractor and was entitled to receive some payment for that work. Mr Colson’s evidence is that he put significant time into the company and it had established a good business reputation. He said he worked 60 hours a week. The financial accounts which were summarised by the liquidators for the years ending 2008 to 2013 show that in every year except 2009 the company made a net surplus before depreciation. It had annual gross revenue from sales and services ranging from
$105,173 to $247,232. The results showing in the company accounts support Mr Colson’s argument that the business was apparently benefiting from his attention. The company received the benefit of his work. He is entitled to some remuneration for that work.
[29] However, the issue is with quantum. Mr Colson was the person overseeing the company and looking after the records. Even if the company records were lost after the company went into liquidation, through no fault of Mr Colson’s, records such as employment agreements, management contracts or Inland Revenue returns should have been available from other sources. Mr Colson produced none of those to support his contentions. In the absence of such records the quantum of appropriate remuneration is difficult to assess.
[30] In the absence of records, I am of the view that only the amounts taken by Mr Colson that can be regarded remuneration for the work he did for the company are those described as “shareholders salary”. These amounts were recorded by his accountant so they have some validation. I accept that the fixing on the shareholder salary as the appropriate amount of remuneration is pragmatic in the absence of agreements or other records.
[31] The total amount described as shareholders’ salary is $44,800. This is $33,706 in 2012 and $11,094 in 2013.7 I consider those payments should not be impugned under the distribution provisions of the Act, as they are not “distributions”.
7 These figures were confirmed by Mr Eade as taken by Mr Colson for salary.
Other drawings
[32] Having found the shareholder salary was not a distribution, the next issue is the status of the other drawings taken of $81,000.
[33] Mr Colson says the amount of $81,000 recorded for additional drawings is incorrect. The company’s former accountant, Mr Eade, reconstructed the figures from the financial statements. He said that the drawings should not include payments made for Mr Colson’s health and medical policies of $2,956 in 2011 to 2012 and $9,118 in 2012 to 2013.
[34] There is no evidence to justify those insurance premium payments as part of Mr Colson’s remuneration. There is no detail as to what exactly the insurances were for, nor who could claim on the policies or who the beneficiaries were. Some employers pay or subsidise their employees’ medical or income protection insurance. That kind of arrangement, however, must be recognised as part of the employment or remuneration package; usually in a written agreement between the employer and employee or in the contract for services. In the absence of records of that kind, I consider it unlikely these formed part of Mr Colson’s remuneration for his work for the company. In those circumstances, I find they were personal payments made on behalf of Mr Colson and are, therefore, recoverable distributions.
[35] In the absence of any records supporting agreement as to the amount of the remuneration to which Mr Colson was entitled, I consider the balance of the drawings ($81,000) were distributions to him as a shareholder.
[36] The procedural requirements of s 52 of the Act were not complied with by the company’s directors before the shareholders distributions were made. On the face of things, Mr Colson as shareholder is liable to repay the distributions he received when the company was insolvent. The procedure prescribed for the Board of Directors to consider the solvency of the company before it authorises distributions is designed as to safeguard the company’s funds in a situation where the company cannot pay its creditors were a distribution made.
[37] In this case, the shareholders do not raise a defence based on receiving the payments in good faith, unfairness or reliance under s 56(1)(a), (b) or (c) of the Act. Instead, Mr Colson denies that the franchise fees were ever owing. He argues, therefore, if he had turned his mind to the solvency test, the company would not have failed it because it had no liability to the franchiser.
[38] The process to be followed before making distributions to shareholders under the Companies Act requires the board of directors to turn its mind to whether the company would be insolvent immediately after the distribution. The Act sets out the test to apply when considering the solvency of a company. Section 4 provides 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.
(2) Without limiting sections 52 and 55(3)8 of this Act, in determining for the purposes of this Act ... whether the value of a company's assets is greater than the value of its liabilities, including contingent liabilities, the directors—
(a) Must have regard to—
(i) the most recent financial statements of the company that are prepared under this Act or any other enactment (if any); and
(ia) the accounting records of the company; and
(ii) All other circumstances that the directors know or ought to know affect, or may affect, the value of the company's assets and the value of the company's liabilities, including its contingent liabilities:
(b) May rely on valuations of assets or estimates of liabilities that are reasonable in the circumstances.
[39] The liquidators say that Installer Services (Hutt Valley) Ltd was insolvent because it owed franchise fees which were not recognised in the company’s accounts for the relevant years. If they had been, the company’s liabilities would have exceeded its assets.
[40] The franchise fees said to be owing are set out in the Statement of Claim as a running (accumulating) total as follows:
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2008 - $6,645.00
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2009 - $23,504.00
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2010 - $40,915.00
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2011 - $52,572.00
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[41]
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2012 - $66,087.00
Judgment for franchise fees of $85,336 was entered by the District Court
on
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30 January 2015. The judgment reads:9
2. Judgment on formal proof for the plaintiff against the first defendant in the sum of $85,336.00, plus costs on a 2B basis and disbursements as fixed by the registrar.
[42] The judgment was entered by default in chambers. No reasons are provided in the judgment nor is there any breakdown of the franchise fees said to be owing. Counsel provided me with, by consent, a document marked Exhibit A to an affidavit of Dean Stephen Corry which had been sworn at Queenstown on 24 November 2014. The affidavit itself is not before this Court but was apparently the basis of the formal proof of the claim in the District Court.
[43] The following table shows the cumulative or running totals and, in brackets, the increase in each year. The table lists both the amounts put before the District Court in Exhibit A and the amounts set out in the statement of claim:
9 Installer Services (Group) Ltd v Installer Services Lower Hutt Ltd, above n 1.
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Running total (as per Statement of Claim)
These proceedings:
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Running total – Mr Corry:
Exhibit A in District Court
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2008
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$6,645
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-
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$3,815
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-
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2009
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$23,504
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($16,859)
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$14,072
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($10,257)
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2010
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$40,915
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($17,414)
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$25,779
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($11,707)
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2011
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$52,572
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($11,657)
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$34,441
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($8,662)
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2012
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$66,087
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($13,515)
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$44,710
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($10,269)
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201310
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-
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$56,710
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($12,000)
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Running total
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$66,087
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$56,709
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Debtors balance
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$839.00
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Invoice interest to
15/11/14
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$27,788
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Total (GST
exclusive)
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$85,336
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[44] There are discrepancies between the figures claimed in the statement of claim and those which were provided to the District Court as the basis for the judgment. These are explained in part, by the interest apparently incorporated in the figures set out in the statement of claim in these proceedings. In Exhibit A the interest is separated out as a lump sum.
[45] The liquidators summarised the company’s financial position from the information they had available for the relevant years as follows:
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FYE 2009
$ |
FYE 2010
$ |
FYE 2011
$ |
FYE 2012
$ |
FYE 2013
$ |
2013 **
$ |
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Gross revenue
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203,283
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247,232
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165,878
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202,002
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195,030
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105,173
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Net surplus
(deficit)
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(5,896)
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5,896
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0.00
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0.00
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47,285
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(522)
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Total Current
Assets
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17,257
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29,758
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24,195
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20,050
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10,619
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1,928
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Total Current
Liabilities
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112,476
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118,819
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111,441
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105,855
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44.651
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83,118
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Working Capital
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(95,219)
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(89,061)
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(87,246)
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(85,805)
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(34,032)
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(81,190)
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Non Current
Assets
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89,423
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89,161
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87,346
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85,905
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81,417
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83,218
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Non Current
Liabilities
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0.00
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0.00
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0.00
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0.00
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0.00
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0.00
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Net Assets /
Liabilities
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(5,796)
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100
|
100
|
100
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47,385
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100
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**For the period 1 April 2013 until December 2013
[46] The liquidators say that if the franchise fees had been accounted for from 2009, the company would have been insolvent immediately after the shareholder distributions. Therefore, its liabilities exceeded its assets. In addition, they allege that the financial accounts included goodwill of $80,000 which the liquidators say could
10 Estimated as information not supplied.
not be justified in light of the franchise fees outstanding and the dispute with the franchiser. The removal of the goodwill would have the effect of increasing the net liabilities of the company by the amount of the goodwill.
[47] The liquidators say the shareholders distributions should not have been made when the company would have failed the solvency test immediately after the distributions were made.11 Therefore the distributions must be repaid.
[48] The first issue raised is whether the franchise fees were owing. The liquidators say that the default judgment in favour of the franchiser operates to establish that the fees were due and owing in the years alleged. They say that even though the company denied the fees were owing the directors should have recognised they might be owing (or contingently owing) by making a provision in the accounts for the relevant years.
[49] The second adjustment sought by the liquidators is the goodwill figure. The liquidators say the goodwill in the financial accounts should have been written off or at least written down because it was based on the franchise purchase price of $80,000. Instead it was carried forward from year to year. The liquidators say that the collapse of the franchise relationship meant that the goodwill was worth little and so should have been written off. Therefore, again this would mean the liabilities of the company would exceed its assets and so it would fail the solvency test.
[50] Mr Colson says the liquidators are wrong on both issues. He says that the fees were disputed so they did not need to be recognised as liabilities whether contingent or otherwise. In addition, the company retained its goodwill regardless of the dispute with the franchiser.
[51] I consider each of these two matters below.
Franchise fees
[52] As I have noted, judgment for $85,336 was entered in the District Court on 30 January 2015 in the following terms:12
11 Companies Act 1993, s 4(1)(b).
12 Installer Services (Group) Ltd v Installer Services Lower Hutt Ltd, above n 1.
2. Judgment on formal proof for the plaintiff against the first defendant in the sum of $85,336.00, plus costs on a 2B basis and disbursements as fixed by the registrar.
[53] Installer Services (Hutt Valley) Ltd argues the District Court judgment is evidence that it was entitled to rely on, to prove that the franchise fees owing to the franchiser were due in each year. As these amounts should have been paid in the relevant years, the liquidators say Installer Services (Hutt Valley) Ltd was insolvent earlier than when the judgment was entered (2015). Installer Services (Hutt Valley) Ltd argue that Mr Colson was estopped from saying that the franchise fees were not due in each of those years. The company relies on the principle of res judicata or, more specifically, issue estoppel. The Colsons are, therefore, prevented from now denying those amounts were owing because the issue has been determined.
[54] The six requirements of res judicata estoppel, which includes both cause of action and issue estoppel, are as follows:13
(i) the decision ... was judicial in the relevant sense;
(ii) it was in fact pronounced;
(iii) the tribunal had jurisdiction over the parties and the subject matter;
(iv) the decision was —
(a) final;
(b) on the merits;
(v) it determined a question raised in the later litigation; and
(vi) the parties are the same or their privies, or the earlier decision was in rem.
[55] Issue estoppel is a question of fact and circumstance. In AEP v KM Mander J observed:14
[12] Issue estoppel requires a relatively strict analysis of commonality features as between the first occasion on which the issue was addressed and the second occasion on which a party seeks to again contest it in Court. In EBS v CAS, Dobson J observed that a case-specific form of discretionary assessment is required, which involves balancing the interests of finality
14 AEP v KM [2018] NZHC 380.
against the risk of creating injustice by preventing a substantive determination on the ground that the issue has previously been rejected.
[56] There is little doubt that of the six requirements for issue estoppel, four are clearly established. That is, the decision was pronounced, the Court had jurisdiction over the parties and the subject matter, and the decision was final and determined the question of whether franchise fees were owing (which is one of the issues in this litigation). The two requirements that require further consideration are whether the parties are the same or privies and, given the judgment was entered by default without argument, and whether the judgment was on the merits.
[57] Counsel for the Colsons argues that the parties were different in the District Court. The company was the defendant, not the Colsons.
[58] However, the Colsons were the directors. The board of directors is the directing mind of the company. The directors were effectively guiding the company in its defence. Mr Colson was giving instructions and he provided affidavits for the District Court on behalf of the company. He was effectively running the proceedings and instructing counsel. He was also funding the litigation, he says.
[59] Therefore, I am satisfied that there was sufficient privity between the Colsons and the company for res judicata to operate in respect of the default judgment.
[60] A further issue remains live. This is whether the District Court’s default judgment was on the merits.
[61] The issue of whether an overseas default judgment was on the merits arose in Johnston v Johnston.15 In the High Court decision, Asher J noted Lord Maugham’s dicta in New Brunswick Railway Company v British and French Trust Corporation Ltd:16
In my opinion we are at least justified in holding that an estoppel based on a default judgment must be very carefully limited. The true principle in such a
case would seem to be that the defendant is estopped from setting up in a subsequent action a defence which was necessarily, and with complete precision, decided by the previous judgment; in other words, by the res judicata in the accurate sense.
Asher J then cited the following statement of the Court of Appeal in Chean v De Alwis:17
[30] We agree with the Associate Judge that there is no reason to disapply issue estoppel in the present case. Although the judgment of Courtney J was reached as a result of a formal proof hearing, it was not a default judgment in the sense that it was entered without argument. We see the present case as falling within the class of cases where the issue was decided with precision in the previous judgment (to use Lord Maugham’s words).
His Honour concluded:18
[29] The judgment of the Oregon Court in this case unsurprisingly reads as similar to a default judgment, given that Ms Ellis had stopped actively taking steps in the proceedings, and there was no active opposition. There were no discussion of or findings of fact or law, and no determination of the value of relationship property. The relevant principles of law are not set out, and there is no application of law to fact. The judgment is in essence conclusory only. The lack of any reasoning at all distinguishes it from a New Zealand default judgment for an unliquidated sum, where it could be anticipated that a Court would explain why a particular decision was made.
[30] There is no such explanation by the Oregon Circuit Court, and no reference to the merits at all. While there is a brief procedural history set out at the start of the judgment, the history of the marriage in relation to the assets is not discussed, and there is no reference to the principles of law that may apply. The Court appears to be doing no more than rubberstamping the orders requested by Mr Johnson. Indeed, it does not appear that the Oregon Court has substantively considered any issues, in making the orders. In these circumstances I do not regard the Oregon decision as a decision on the merits capable of giving rise to an issue estoppel.
[62] The Court of Appeal upheld the High Court decision on the basis the overseas default judgment had been obtained by fraud. However, the appellate Court also made it clear that the judgment should have been treated as on the merits by the High Court.
The Court commented:19
[48] It is not in dispute that the Oregon judgment was final. Departing from the Judge, we think it likely that it was a decision on the merits. Asher J noted that it made no findings of fact or law and no determination of the value
17 Chean v De Alwis [2010] NZCA 30.
18 Johnston High Court, above n 15.
19 Johnston Court of Appeal, above n 15 (footnotes omitted).
of relationship property, but appears to have “rubberstamped” the orders proposed by the husband. As the Judge recognised however, a default judgment may qualify as final and conclusive where it decided the issues “with precision”. The Oregon judgment did that, in the sense that it identified and distributed the same assets that were in issue in the New Zealand proceeding.
[49] However, we need not decide that issue finally, since we have agreed with the Judge that the judgment was procured by the husband’s fraud, and so cannot found an estoppel.
[63] Applying those comments to the judgment in the present case, the conclusion follows that the judgment was on the merits despite the fact it was entered by default with no reasons. The liquidators are entitled to rely on the judgment for $85,336 entered in favour of Installer Services (Hutt Valley) Ltd on 30 January 2015. The Colsons, as directors, had the option to guide the company through the litigation. The Colsons are estopped from relitigating the decision itself or the merits of the dispute with the franchiser.
[64] However, the District Court judgment does not operate to retrospectively alter the circumstances existing at the time the solvency test should have been applied. The fees were disputed and therefore should have been treated as contingent liabilities. The extent that the contingency should have been recognised would have been based on an assessment of the risk of recovery. This would normally be carried out by the directors with the assistance of their advisors. In this case, the Colsons did not turn their minds to the contingent liability. Mr Eade, the accountant supervising the preparation of the financial accounts, was not consulted over the issue.
[65] Section 4(1)(b) of the Act requires that the value of the company’s liabilities include its contingent liabilities for the purposes of the solvency test. Section 4(4) of the Act specifies that the value of a contingent liability may be determined with reference to the likelihood of the contingency occurring. In my view, if Mr Colson had turned his mind to it, it should have been obvious by April 2012 at the latest that the franchise fees were to be pursued. The franchiser could not calculate the amount owing because it did not have the information required. In an email dated 19 April 2012 Mr Corry confirmed to Mr Colson that the franchise fees would be pursued and the statutory demand was issued in December 2012. While this was withdrawn and was for a nominal amount it was obvious from the correspondence that the franchiser
would not back down. The District Court legal proceedings were then commenced in March 2013.
[66] The Board of Directors did not turn its mind to the solvency of the company at all before making the distributions. Therefore, I have had to stand back and assess what a contingency might reasonably have been.
[67] While the assessment of contingencies is not an exact science, in the absence of any attempt to do so or obtain advice, I must make that assessment on the evidence which would have been available at the time. Mr Colson had no reasonable basis to assess the contingency at nil. In my view, a reasonable director would have recognised at least a 50 per cent risk of recovery of the whole amount of the accrued fees from the year ending 2012. I reach that conclusion based on the fact that the fees had been pursued for some years. While Mr Colson had managed to negotiate waivers of fees earlier, it did not appear this would be the result again. He was the only person, as the active director of the company who was aware of the company turnover or how much of that turnover was attributable to the franchiser. He was resistant to providing that information. The obvious conclusion about his reluctance to provide that information is that it would have supported the franchisers contentions.
[68] I conclude that the contingent risk attributable to the franchise fee dispute was 50 per cent of the full amount of the fees from the year ending 2012. Therefore, before making the distributions, a solvency assessment should have been made by the directors taking into account a contingent liability based on at least 50 per cent of the claimed fees and associated interest. Mr Colson did not take substantial issue with the the calculations based on company turnover on which the fees were calculated. He had had access to the records which enabled him to calculate the fees claimed.
[69] The following table sets out the fees set out in the statement of claim and applies a discount of 50 per cent to the franchise fees for the relevant years:
|
Running total (as per Statement of Claim) These proceedings:
|
Contingency calculation (50%)
|
||
|
2012
|
$66,087
|
($13,515)
|
$33,043 ($6757)
|
|
2013
|
$79,602
|
|
$39,800
|
|
Running total
|
$66,087
|
|
|
[70] In 2012 and 2013 the fees were in dispute and the directors should have provided a contingency of 50 per cent for those fees in the financial accounts.
Goodwill
[71] The liquidators argue that Installer Services (Hutt Valley) Ltd inappropriately maintained the sum of $80,000 in its accounts as goodwill. This was the amount that was originally paid for the franchise.
[72] Mr Colson said he was working 60 hours a week and had built up a good reputation for the company. He says that created value and goodwill for the company. This appears supported to some extent by the fact Mr Colson had attempted to start up a new company without the franchise services under a different name. He did not pursue this, due to advice that he might be susceptible to claims following the liquidation of Installer Services (Hutt Valley) Ltd.
[73] On the other hand, Mr Lester for Installer Services (Hutt Valley) Ltd submits the dispute with the franchiser meant the company was worthless and had no goodwill.
[74] The assessment of goodwill is a notoriously difficult task. It must take into account intangible assets such as work in progress, reputation and past and future anticipated performance to assess the company’s ability to generate income.20
[75] The liquidators said the goodwill was too high. This is with the benefit of hindsight. They were not privy to the operation of the company. It was paying its debts, and other than the franchise dispute, it appears to have been operating successfully.
20 Sojourner v Robb [2006] NZHC 1676; (2006) 3 NZLR 808 (HC) at [43].
[76] Mr Eade was the principal of the accounting firm which prepared the company’s annual accounts. He said the firm was not responsible for the day-to-day accounting work. He did agree that if he had known of the dispute he would have considered both the issue of treatment of the franchise fees in dispute and the goodwill. He did not say he would write down the goodwill but he would have reviewed it.
[77] The company was operating, and it did not have substantial outstanding debts. Despite the dispute about franchise fees, I am not satisfied that for the relevant years the goodwill should have been written off or written down.
Conclusion
[78] The distributions claimed back by the liquidators are:
(a) Shareholder salary payments totalling $44,800 (2012: $33,706 and 2013: $11,094);
(b) Additional drawings21 totalling $81,000 (2012: $19,943 and 2013:
$61,057)
[79] I have found that the shareholder salary payments were not distributions and therefore are not repayable. However, the additional drawings totalling $81,000 (2012: $19,943 and 2013: $61,057) are repayable unless the shareholder is able to satisfy the Court that a lesser repayment should be made under s 56(5) of the Act. The Court must be satisfied that:
(5) ... the company could, by making a distribution of a lesser amount, have satisfied the solvency test, the Court may—
(a) Permit the shareholder to retain; or
(b) Relieve the director from liability in respect of—
an amount equal to the value of any distribution that could properly have been made.
[80] The financial summaries provided by the liquidators indicate that for the year ending 2012, which recorded a surplus of $100, the additional contingent liability ($33,043)22 would have taken the company into deficit of $32,943. Adding back the shareholders distribution for that year of $19,943 the company would have remained insolvent. The company could not have satisfied the solvency test and so the prerequisite for the application of s 56(5) of the Act is not achieved.
[81] It follows that the distribution of $19,943 must be repaid to the company by Mr Colson as the shareholder receiving that distribution.
[82] As I have found that the distribution made in 2012 should be repaid, for the purposes of calculating the financial position for 2013, a deficit would have been brought forward of an amount of $13,000. The contingency for the franchise fees that had accrued in that year was $6,757.23 Deducting those amounts from the surplus recorded for that year of $47,385 leaves a surplus remaining for the year. Therefore, the company would have satisfied the solvency test by some margin immediately after the shareholders distribution had been taken in that year.
[83] In those circumstances, the shareholder distribution could appropriately be made and the company would have satisfied the solvency test. Mr Colson should be permitted to retain that distribution of $61,057 pursuant to s 56(5) of the Act.
Directors duties to the company
[84] The second cause of action against the Colsons is brought under s 137 of the Act. The claim is that the directors did not act with the care, diligence and skill of reasonable directors. Because of that alleged breach, an order for payment of the outstanding creditor’s claims of $101,026 is sought.
[85] Section 137 of the Act provides:
137 Director's duty of care
22 See [69] above.
23 See [69] above.
A director of a company, when exercising powers or performing duties as a director, must exercise the care, diligence, and skill that a reasonable director would exercise in the same circumstances taking into account, but without limitation,—
(a) The nature of the company; and
(b) The nature of the decision; and
(c) The position of the director and the nature of the responsibilities undertaken by him or her.
[86] The test is measured against the objective standard of a reasonable director. This includes an element of subjectivity in taking into account the director’s position in the company. The nature of the duties undertaken by the director must also be considered. In Richard Geewiz Gee Consultants Ltd (in liq) v Gee the Judge commented:24
[105] Section 137 is the statutory expression of the directors' duty of care and skill. The standard to be applied is that of the reasonably competent director. The director's personal knowledge and experience is no longer relevant. At the same time, however the reference in paragraph (c) to the position of the director and the nature of the responsibilities undertaken by him or her introduces an element of subjectivity.
[87] The duty of care owed to the company comes down to a simple test of what would a reasonable director do in these circumstances, taking into account the nature of the company, decision, their responsibilities and the position. A cautionary note was sounded by Baragwanath J in Mountford v Tasman Pacific Activities of NZ Ltd. In considering a claim for reckless trading, Baragwanath J commented on the intensity of review of directors’ actions. He said:25
[31] It follows from the foregoing analysis and is well settled by authority that the success of the limited liability company is to be encouraged by judicial deference to the standards of the responsible business community. ... The Court’s opinion on whether and when the insolvency watershed was crossed inevitably contains hindsight. For that reason, and because the Court does not claim particular specialist expertise, it will not lightly substitute its own opinion for that of the directors. They are to be judged by a standard that is deferential to them in assessing what a reasonable director would have known and done in the fog of uncertainty that commonly attends business judgments. But if the applicant established against such test that the directors should (and, a fortiori, would) have known the company was insolvent, the premise of entitlement to trade with limitation of liability has gone. ...
24 Richard Geewiz Gee Consultants Ltd (in liq) v Gee [2014] NZHC 1483 at [105].
25 Mountford v Tasman Pacific Activities of NZ Ltd [2005] NZHC 514; (2005) 2 NZCCLR 428.
[88] The first matter to consider is whether Mr Colson’s failure to provide for the franchise fees and failing to write down the goodwill in the relevant years amounted to a failure to meet the duty of care.
[89] I have found that there was no requirement to write down the goodwill in the circumstances. My findings on that point are based on the evidence that the company was not showing any downward trends in trading, it was apparently able to pay its creditors and Mr Colson’s view was that it had gained a reputation which was not dependant on the franchise. The difficulties of valuing goodwill are well known. Establishing the value for purposes such as in the present case requires a detailed consideration of the circumstances of the company at the relevant time not with the benefit of hindsight.
[90] I am of the view that there is nothing to suggest the directors were in breach of their duties at the relevant times by failing to write down the goodwill in this business.
[91] However, the board of directors did not follow the process prescribed by s 52 of the Act before authorising the distributions, which I have found were shareholders distribution. This failure led to the payment of distributions to shareholders when the company was insolvent. Apart from the failure to provide a solvency certificate, it appears that the company kept no minutes of the reasons for the payments nor did it pass any resolutions for the distributions.
[92] In addition, there were no agreements or other documents recording the employment or the contractual arrangements with Mr Colson. I have found Mr Colson was entitled to some remuneration, but that does not excuse his failure to ensure that appropriate records were kept of those arrangements. Failure to ensure these records were prepared in the circumstances supports my view that the directors were not acting with the care skill and diligence which would be reasonable in the circumstances.
[93] Mrs Colson was not actively involved but was a “sleeping director”. She, however, cannot escape liability by saying she did not know what was going on. A sleeping director has no immunity from liability.26 Abdication of responsibility does
26 Mason v Lewis [2006] NZCA 55; [2006] 3 NZLR 225 (CA) at [83].
not absolve a director from liability for breach of a director’s duties. All directors must act in a manner which will meet their obligations to direct the company and meet the duties and responsibilities of directors.
[94] Mr Colson ran the company business as if it were his own and not the company’s. That is a common situation in a small business, but the benefits provided by using a corporate vehicle also bring responsibilities. Mr Colson took money from the company for his personal use without considering the requirements of the Act. It appears that was because he did not know the requirements. However, that is not a defence.27
[95] The mandatory processes prescribed by s 52 of the Act are basic requirements designed to protect the company against shareholders withdrawing funds without considering the company’s solvency. The decision to distribute money to shareholders is a significant one. The directors not only must vote in favour of the distribution but must sign a certificate stating that in their opinion the company will, immediately after the distribution, satisfy the solvency test and the grounds for that opinion.28 Where the directors and the shareholders are the same it is even more important that the processes are followed.
[96] I am satisfied that the directors failed to act with the care skill and diligence which would be expected of directors in the circumstances by allowing the shareholders to take distributions without following the procedures under s 52 of the Act and by failing to properly record the nature of the payments made by the company to the shareholders.29
[97] The next cause of action alleges a breach of the directors’ duty of good faith. This duty requires directors to act in good faith and in the best interests of the company. Installer Services (Hutt Valley) Ltd largely relies on the failure of the directors to
27 At [83].
28 Companies Act 1993, s 56.
29 A director commits an offence under the Act if they fail to company with s 56(2) which contains the requirement for every director who votes in favour of a distribution to sign a solvency certificate; Companies Act 1993, s 52(5).
recognise the franchise fees as debts or contingencies in the accounts, meaning it was trading while insolvent. In addition, the directors failed to follow the prescribed processes under s 52 of the Act before making distributions to shareholders.
[98] Section 131 of the Act 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.
...
[99] No separate claim is made under the reckless trading provisions of the Act.
[100] The statutory test has both an objective and a subjective element. In the High Court decision of Sojourner v Robb, the standard in s 131 was described as an amalgam of an objective standard to help assess how people in business might be expected to act, coupled with a subjective criterion as to whether the directors did what they honestly believed to be right.30 It does not allow a director to discharge the duty by simply believing that they were acting in the interests of the company if that belief rests on a wholly inappropriate appreciation of what was in its best interests.
[101] The subjective standard of ‘honest belief’ can also be interpreted as a presumption that acts were in good faith, unless they were an action that no director with any understanding of fiduciary duties would make.31
[102] A company close to insolvency must also consider the interests of creditors.32 Mr Lester, for Installer Services (Hutt Valley) Ltd, noted that Nicholson v Permakraft (NZ) Ltd supported the proposition that the creditors’ interests must be considered if the company is insolvent, near-insolvent or of doubtful solvency, or if its solvency would be jeopardised by the proposed transaction.33 Putting the shareholders’ interests
30 Sojourner v Robb (HC), above n 20, at [102].
31 Delegat v Norman [2012] NZHC 2358 at [103].
32 Sojourner v Robb (HC), above n 20, at [102].
33 Nicholson v Permakraft (NZ) Limited [1985] NZCA 15; [1985] 1 NZLR 242.
above those of the creditors is a “wholly inappropriate appreciation” of the best interests of the company in that situation.34
[103] Installer Services (Hutt Valley) Ltd claims that the Colsons breached s 131 by their actions in preferring themselves over other creditors by making payments to shareholders in the following circumstances:
(a) Additional drawings totalling $81,000 were paid to the shareholders while the company was insolvent;
(b) This decision left Installer Services (Hutt Valley) Ltd unable to pay its creditors; and
(c) The decision preferred other creditors (i.e. the Colsons) between 2008 and 2012 and rendered the company unable to pay its debts.
[104] In the course of argument, Installer Services (Hutt Valley) Ltd also alleged that the directors failed to keep proper records. This allegation was put forward in support of its claim that the directors were in breach of s 131. However, the failure to provide the general accounting and other records as required by the replacement liquidators cannot be laid at the feet of the directors in the circumstances. Nevertheless, the directors did not record the reasons for the shareholders distributions, nor were there any written agreements concerning Mr Colson’s remuneration.35
[105] In my view, the fact that the directors failed to follow the process for authorisation of shareholder distributions together with the failure to properly record the franchise fees in the final accounts does not of itself amount to a breach of s 131.
[106] The Court of Appeal in Morgenstern v Jeffreys noted that a breach of s 131 involves a breach of fiduciary obligations and requires strict proof.36 It is intended to
34 At [86].
36 Morgenstern v Jeffreys [2014] NZCA 449 at [99].
catch acts of disloyalty to the company. It does not require evidence of corruption or a desire by the director to act against the company’s interests.
[107] Installer Services (Hutt Valley) Ltd points to the self-interest of the directors as the shareholders taking drawings when these franchise fees were owing. However, the evidence shows there was a dispute with the franchiser. Mr Colson considered that the company should dispute franchise fees based on his knowledge of the circumstances surrounding the franchise. He was acting in good faith and what he thought was in the best interests of the company by taking that stance.
[108] The Colsons’ failures were to properly record the contingency created by the dispute over franchise fees in the financial accounts and failing to ensure that the board of directors undertook the prescribed statutory processes before the distributions were made. Those fall short of evidencing a breach of the duty to act in good faith and in the best interests of the company in light of the disputed nature of the fees.37 The failures were of care, skill and diligence. They occurred due to lack of knowledge and skill. They were not done in bad faith or against the company’s interests. The fact that a director who was also a shareholder benefited from the failures does not lead to a conclusion that the director was mismotivated and so in breach of the obligation of good faith or of not acting in the best interests of the company.
[109] I find the Colsons did not breach their duty of good faith to the company.
[110] I now consider the approach to reparation.
Reparation
[111] Section 301 of the Act has been described as being analogous to a derivative action and as “a procedural short cut by which a liquidator, creditor or shareholder may pursue the claims which a company in liquidation may have against” the
37 Where a transaction involves a specific benefit to a director it does not automatically fail for “mismotivation” (in terms of failing to act in good faith and in the best interests of the company in breach of the duties in s 131 of the Act); see Peter Watts, Neil Campbell and Christopher Hare Company Law in New Zealand (2nd ed, LexisNexis, Wellington, 2016) at 403.
directors.38 It is an enforcement mechanism that allows specified parties to pursue directors who have misapplied, retained money or property rightfully belonging to the company, or have acted negligently, in default or in breach of duty/trust in such a way they should pay.39 This section “... is not however a vehicle for the creditor to enforce a duty owed directly to the individual creditor.”40
[112] 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, administrator, liquidator, or receiver of the company, has misapplied, or retained, or become liable or accountable for, money or property of the company, or been guilty of negligence, default, or breach of duty or trust in relation to the company, the court may, on the application of the liquidator or a creditor or shareholder,—
(a) inquire into the conduct of the promoter, director, manager, administrator, liquidator, or receiver; and
(b) order that person—
(i) to repay or restore the money or property or any part of it with interest at a rate the court thinks just; or
(ii) to contribute such sum to the assets of the company by way of compensation as the court thinks just; or
(c) where the application is made by a creditor, order that person to pay or transfer the money or property or any part of it with interest at a rate the court thinks just to the creditor.
(2) This section has effect even though the conduct may constitute an offence.
(3) An order for payment of money under this section is deemed to be a final judgment within the meaning of section 17(1)(a) of the Insolvency Act 2006.
(4) In making an order under subsection (1) against a past or present director, the court must, where relevant, take into account any action that person took for the appointment of an administrator to the company under Part 15A.”
38 Sojourner v Robb (HC), above n 20, at [15] and [53].
40 Commissioner of the Inland Revenue v Robertson [2017] NZHC 31 at [69].
[113] There are two stages to an assessment under s 301:
(a) First, has there been a breach of duty or duties by the relevant director?41
(b) Second, if, and to what extent, should the director contribute to the assets of the company now in liquidation.42
[114] Once the breach has been established the assessment of quantum of the contribution is “notoriously fact specific”.43 Nevertheless, there are some fundamental underlying principles that can help establish the amount.
[115] The standard first step is to look at the “deterioration in the company’s financial position between the date inadequate corporate governance became evident (usually the “breach” date) and the date of liquidation”.44 While this first step is based on the approach taken in a case on reckless trading under s 135 of the Act, it is useful to focus on the essential question as to what the company lost because of the potential breach. The director’s duties are owed to the company rather than directly to creditors or shareholders.
[116] The Court of Appeal in Sojourner v Robb, pointed out:45
[53] ... Proceedings under s 301 can extend to claims that directors have “misapplied or become liable or accountable for money or property of the company” or are otherwise liable for a “breach of duty or trust”. This language naturally encompasses restitutionary claims (including a claim for an account of profits). It follows, logically, that relief under s 301(1)(b) may be calculated on a restitutionary and not just a compensatory basis. As to s 301(b)(ii), we note that “compensation” can, depending of course on context, encompass restitutionary remedies: see Charter plc v City Index Ltd [2006] UKHL 26; [2007] 1 WLR 26 (Ch). (We note that in City Index the defendant’s gain – for which restitutionary relief was sought – was equivalent to the plaintiff’s loss, something which is not always the case.) As well, there is s 301(b)(i) which could be invoked.
41 Peace and Glory Society Ltd (in liq) v Samsa, above n 39, at [48].
42 At [48].
43 Mason v Lewis, above n 26, at [107].
44 At [109].
45 Sojourner v Robb [2007] NZCA 493; [2008] 1 NZLR 751 (CA).
[117] This indicates that the assessment might include not only compensation for loss, but also an account of profits in appropriate circumstances depending on the kind of loss that has been suffered by the company. In Sojourner v Robb the reason the Court of Appeal used account of profits was because the loss that was suffered by the company was the price that it should have received for the sale of its business but had not done so because the dealing involved interested directors. It took a different approach to that of the High Court, which had looked at the loss that the creditors suffered when their contracts for yachts were unfulfilled due to the liquidation.
[118] The Court of Appeal followed Sojourner v Robb in Morgenstern v Jeffreys. It said:46
[99] As this Court held in Sojourner v Robb,47 relief under s 301(1)(b) will, bearing in mind the Court’s ultimate discretion,48 be calculated by examining the nature of the breach of duty and by judging the appropriate amount of compensation to be awarded based on common law and equitable principles. A breach of s 131 involves the breach of a fiduciary obligation, requiring a strict standard of causation and imposition of the fiduciary measure of damages, including on a “restitutionary” or notional account of profits basis.49 A company’s loss, where “loss” is in any event the appropriate measure of compensation, is calculated based on the deterioration of its financial position between the date of the breach and the date of liquidation.50 The onus is on the delinquent director to prove that the loss, or part of it, would have been caused regardless of the breach.51
[100] Adopting this approach, the appropriate amount of compensation will be the company’s actual loss, that is the amount required to put it back into the position it would have been in but for the transaction.
[119] The Colsons’ argued that the liability of a director is limited to the amount the company in liquidation could claim against them.52 In other words, “former directors cannot be required to pay more under s 301 than could have been awarded against them in a claim by the company in liquidation”.53 Contrary to that suggestion in
46 Morgenstern v Jeffreys, above n 36.
47 Sojourner v Robb (HC), above n 20, at [53] and [58]–[59].
48 Mason v Lewis, above n 26, at [55].
49 FXHT Fund Managers Ltd (in liq) v Oberholster [2010] NZCA 197 at [28]–[30]: contrast the s 135 and s 137 duties (at [30]) and Robb v Sojourner [2007] NZCA 493, [2008] 1 NZLR 751 at [31] and [60]. Lynne Taylor “Liquidation” in John Farrar and Susan Watson (eds) Company and Securities Law in New Zealand (2nd ed, Brookers, Wellington, 2013) 837 at [31.7.2(2)(a)].
50 Mason v Lewis, above n 26, at [109].
51 FXHT Fund Managers Ltd (in liq) v Oberholster, above n 49, at [28].
52 Sojourner v Robb (CA), above n 45, at [54].
53 At [54].
Morgenstern v Jeffreys the Court of Appeal indicated the maximum amount payable under s 301 of the Act is not restricted to the loss suffered by the creditors as any surplus beyond that would go to the shareholders.54
[120] I have found that the directors breached their duty of care to the company. The breach generally related to the failure to undertake the procedures required under s 56 of the Act before making distributions to shareholders. This resulted in the company paying out distributions to shareholders in breach of the solvency requirements. Mrs Colson resigned in February 2013 as a director. In the ordinary course she is not liable for the directors’ breaches which occurred after that date.
[121] The appropriate figure for payment under s 301 is one based on the losses caused to the company by the breaches I have found were established.
Contribution by the director for the loss
[122] This is not a case in which the directors breaches resulted in a general deterioration of the company’s finances nor did they engage in a course of conduct which put the payment of creditors in jeopardy over a period of time.
[123] The quantum assessment should ‘tip its hat’ to the conceptual nature of whatever duty has been breached, to assist in the assessment of the appropriate compensation.55 Three factors govern consideration of contribution toward the company:56
(a) Causation;
(b) Culpability; and
(c) The duration of trading (in reckless trading cases).
54 Morgenstern v Jeffreys, above n 36, at [103].
56 Mason v Lewis, above n 26, at [110].
(a) Causation
[124] There has been a conceptual split in the assessment of causation under s 131, which is more akin to a fiduciary duty, and s 137, which is more akin a duty of reasonable care.
[125] Under s 131 if it is shown the relevant director has breached their duty of good faith, the strict “but for” causation test is applied. This effectively puts onus on the director to show why their actions did not cause that loss. The Court in FXHT Fund Managers Ltd (in liq) v Oberholster put it as follows:57
- [28] ... If the duty is of a truly fiduciary nature – that of loyalty or fidelity
– then liability is strict and the “but for” test applies, effectively reversing the onus onto the delinquent director to prove that the loss would have been caused regardless of the breach. However, if the breach is of a general duty of care, akin to one arising in common law rather than equity, then the less onerous orthodox or standard principles of causation apply, placing the onus throughout on the plaintiff to prove the necessary causal nexus or link or, in other words, that his loss is attributable to the director's breach.
[29] Accordingly, Fogarty J in Sojourner applied the fiduciary measure of causation once he found that the directors had committed a breach of a strictly fiduciary duty owed under s 131 to act in good faith and in what the director believed to be the company’s best interests.
(Footnotes omitted)
[126] Where s 135, reckless trading, or s 137, duty of care, are at issue, the “standard or orthodox approach” applies.58 That approach has been described as:59
[28] ...less onerous ..., placing the onus throughout on the plaintiff to prove the necessary causal nexus or link or, in other words, that his loss is attributable to the director’s breach.
[127] On that approach the loss caused by the directors’ breach of the duty of care in this case is limited to the amount which I have found should not have been paid out by way of the shareholder distributions for the year end 2012.
57 FXHT Fund Managers Ltd (in liq) v Oberholster, above n 49.
58 At [30].
59 At [28].
(b) Culpability
[128] Culpability does not equate to moral blameworthiness, but rather must be assessed with the relevant person’s position as a director in mind.60 For instance a director can be liable for a breach of s 135, even though that breach was borne of inattentiveness rather than any form of moral deceit.61
[129] In this case the Colsons did not follow the distributing procedures due to a lack of knowledge and appreciation of the process they needed to follow as directors to make a shareholder’s distribution. Mr Colson was more culpable as he took on the role of actively managing the company and was oblivious to the relevant provisions which as I have noted are important safeguards for monitoring and maintaining company solvency. Nevertheless, in the present case Mrs Colson is liable to the same extent as her husband. She cannot neglect her responsibility as a director and fail to follow important procedures required by the Companies Act.
Conclusion
[130] I am satisfied the amount payable by the directors should be limited to the amount I have found should be repaid by Mr Colson as a shareholder. The Colsons are liable to pay that in their capacities as a director.
[131] Therefore, Mr Colson as shareholder must repay the sum of $19,943 being the shareholders distribution made for the 2012 year. The order is made pursuant to s 56(1) of the Act.
[132] As directors, Mr and Ms Colson are also jointly and severally liable for the same sum of $19,943 payable as compensation to the company under s 301 of the Act.
[133] The intention is that if Mr Colson makes the repayment as shareholder then Mr and Mrs Colson are not required to pay the same amount in their capacity as directors.
60 Mason v Lewis, above n 26, at [112]–[115].
61 At [115].
Conclusion
[134] I have found that Mr Colson must pay to the company the sum of $19,943, being a repayment of the shareholders distribution made for the year end 2012. This order is made pursuant to s 56(1) of the Act.
[135] I have found Mr and Mrs Colson as directors breached their duty of care to the company to act with reasonable skill care and diligence. I have assessed compensation against them at $19,943. An order for payment of that amount is made under s 301 of the Act. This amount is not payable if Mr Colson pays the $19,943 due in his capacity as a shareholder.
[136] Given the nature of the orders made, if counsel require any clarification leave is reserved to file memoranda on any matters arising within seven days of the date of the judgment.
Costs
[137] I am of the view that the plaintiff has succeeded. I can see no reason it would not be entitled to costs in the usual course. If the parties are unable to agree on costs I direct that short memoranda be filed as follows:
(a) The plaintiff is to file its memorandum on or before 10 days from the date of delivery of this judgment;
(b) The defendants are to file their response within a further seven days;
(c) The plaintiff then has a further seven days to respond.
Grice J
Solicitors:
Simon Stock Lawyers, Christchurch
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URL: http://www.nzlii.org/nz/cases/NZHC/2019/210.html