Mountfort v Tasman Pacific Airlines of NZ Ltd HC Auckland CIV 2004-404-1843 [2005] NZHC 514; [2006] 1 NZLR 104; (2005) 9 NZCLC 263,864; (2005) 2 NZCCLR 428 (12 July 2005)

MOUNTFORT V TASMAN PACIFIC AIRLINES OF NZ LIMITED HC AK CIV-2004-404-1843 [12 July

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Issue (1): the policy of the Companies Act 1993 concerning insolvent trading and the effect of the replacement of the former capital

Airlines’ submissions [11] Submissions for Regional [16] Analysis [17] The intensity of review [31]

The facts [33] The companies [33] Management [36] The financial position of Airlines [38] The financial position of Regional [48] The $650,000 payment [49] Regional’s continued trading [51] The position at 29 July 2000 [54]

Appraisal of the financial evidence [75] Issue (2): the principles for making a pooling order; s 131(2); s 272(2) [80] Approach [80]

Combined [92] Such other matters as the Court thinks fit [93] Decision [95]

Appendix D: Airlines’ indebtedness to Regional in comparison to Regional’s net

[1] The liquidator of Tasman Pacific Regional Airlines Limited (in liquidation) (“Regional”) applies under ss 271-2 of the Companies Act 1993 for a pooling order against its holding company, Tasman Pacific Airlines of NZ Limited (in receivership and liquidation) (“Airlines”) so that the creditors of both companies are treated alike.

[2] The 1993 reform of New Zealand company law confirmed the fundamental rule given effect in Salomon v Salomon & Co [1896] UKHL 1; [1897] AC 22:

A company is a legal entity in its own right separate from its shareholders and continues in existence until it is removed from the New Zealand register.

[3] That rule has been confirmed by high judicial authority in New Zealand and elsewhere: Lee v Lee’s Air Farming Ltd [1961] AC 12, [1961] NZLR 325. But the Parliament of New Zealand has permitted departure from that rule in order to deal with its abuse, a problem with which the Irish legislature, adapting the New Zealand legislation, and the US judiciary by development of judge-made law have also sought to deal. This case concerns how upon the facts of this case the pooling provisions and s 15 are to be reconciled.

[4] Sections 271(1)(b) and 271(2) empower the Court to order the liquidations of related companies to proceed as if they were a single company to such extent and subject to such terms and conditions as the Court orders. Section 272 provides guidance. The material passages follow:

(b) Where 2 or more related companies are in liquidation, the liquidations in respect of each company must proceed together as if they were one company to the extent that the Court so orders and subject to such terms and conditions as the Court may impose.

(2) The Court may make such other order or give such directions to facilitate giving effect to an order under subsection (1) of this section as it thinks fit.

(2) In deciding whether it is just and equitable to make an order under section 271(1)(b) of this Act, the Court must have regard to the following matters:

(a) The extent to which any of the companies took part in the management of any of the other companies:

(b) The conduct of any of the companies towards the creditors of any of the other companies:

(c) The extent to which the circumstances that gave rise to the liquidation of any of the companies are attributable to the actions of any of the other companies:

(3) The fact that creditors of a company in liquidation relied on the fact that another company is, or was, related to it is not a ground for making an order under section 271 of this Act.

[5] Given its fundamental role in the very concept of the limited liability company, a pooling order departing from the policies of s 15 must be consistent with other policies of the legislation. The legal issues are:

(1) what is the policy of the Companies Act 1993 concerning insolvent trading and the effect of the replacement of the former capital maintenance regime by provisions restricting trading while insolvent;

(2) whether and if so on what principles the Court should order the gloss on s 15 that pooling entails; which requires consideration of

• potentially, the effect of s 131(2) which provides that, if a subsidiary’s constitution permits, its directors may act in a manner they believe is in the best interests of the subsidiary’s holding company even though it may not be in the best interests of the subsidiary; and

[6] The factual issues concern the financial position of Airlines and of Regional at the material times and what the directors knew and should have known about it.

[7] It is convenient to consider the first legal issue before turning to the facts.

Issue (1): the policy of the Companies Act 1993 concerning insolvent trading and the effect of the replacement of the former capital maintenance regime by provisions restricting trading while insolvent

(a) To reaffirm the value of the company as a means of achieving economic and social benefits through the aggregation of capital for productive purposes, the spreading of economic risk, and the taking of business risks; and

(b) To provide basic and adaptable requirements for the incorporation, organisation, and operation of companies; and

(d) To encourage efficient and responsible management of companies by allowing directors a wide discretion in matters of business judgment while at the same time providing protection for shareholders and creditors against the abuse of management power; and

(e) To provide straightforward and fair procedures for realising and distributing the assets of insolvent companies

The first emphasised passage gives as a starting point the public interest in encouraging risky activities that may become profitable; or may lead to insolvency. The courts will therefore be slow to permit departure from the basic rule of s 15 by “lifting the corporate veil”.

[9] New Zealand has replaced the former capital maintenance regime with provisions dealing with solvency. Section 4 employs as tests of solvency both cash flow, used in Australia (e.g. Corporations Act 2001 s 588G) and balance sheet, used in England (e.g. Insolvency Act 1986 s 214):

(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.

It is notable that while one of Airlines’ experts, Mr Bridgman, preferred the cash flow test, the other, Mr Todd preferred the balance sheet formula. The section goes on to emphasise the need to consider both the company’s latest accounts and its real prospects:

(2) ... 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—

(i) The most recent financial statements of the company that comply with section 10 of the Financial Reporting Act

(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.

(4) In determining, for the purposes of this section, the value of a contingent liability, account may be taken of—

(b) Any claim the company is entitled to make and can reasonably expect to be met to reduce or extinguish the contingent liability.

[10] There is a dispute as to the significance of the solvency test. Regional submitted that there is a general obligation of directors to maintain solvency. Airlines challenged the existence of such general obligation.

[11] Its counsel submitted that the two limbs of the s 4 solvency test apply only to six specific cases as a condition of authorising a distribution to shareholders (s 52); approving a discount scheme (s 55); acquiring its own shares (ss 60, 67); redeeming shares (ss 68, 70); giving financial assistance to a person for the purpose of purchase of a share in the company (ss 76-7); and authorising such action by unanimous shareholder assent (ss 107-8). In addition the Court may grant an exemption from the prohibition of purchase of shares under the minority buyout provisions if the company would fail a solvency test (ss 110, 115).

[12] They emphasise that the solvency test does not apply where the Court is considering whether to grant an order putting a company into liquidation. Section 241(4) provides that the Court may appoint a liquidator if it is satisfied that

the company is unable to pay its debts or that it is just and equitable that the company be put into liquidation.

[13] They point out that a company’s failure to satisfy the solvency test is not a ground for setting aside a voidable transaction under s 292 or a voidable charge under s 293. Each requires that the company be unable to pay its due debts. And they submit that all cases where a director is held to have breached the duty to avoid reckless trading (ss 135-6) the company has been unable to pay its debts at the same time or very shortly after the company’s liability has exceeded its assets.

[14] They submit, in short, expressio unius est exclusio alterius: that the solvency test in s 4 applies only to the sections in the Act making specific reference to that test and has no application elsewhere. Despite Mr Todd’s evidence, they submit that when the Court is considering whether a company is actually insolvent the true and only test is whether it can pay its debts when they fall due. This they say accords with accounting principle and practice and with practical realities. They submit that the definition in s 95A of the Australian Corporations Act 2001 of “solvency” and “insolvency” is of general application:

(1) A person is solvent if, and only if, the person is able to pay all the person’s debts, as and when they become due and payable.

Its predecessor was discussed by Barwick CJ in Sandell v Porter (1966) 115 CLR

Insolvency is... an inability to pay debts as they fall due... But the debtor’s own moneys are not limited to his cash resources immediately available. They extend to moneys which he can procure by realisation by sale or by mortgage or pledge of his assets within a relatively short time – relative to the nature and amount of the debts and to the circumstances, including the nature of the business, of the debtor. The conclusion of insolvency ought to be clear from a consideration of the debtor’s financial position in its entirety and generally speaking ought not to be drawn simply from evidence of a temporary lack of liquidity. It is the debtor’s inability, utilising such cash resources as he has or can command through the use of his assets, to meet his debts as they fall due which indicates insolvency. Whether that state of his affairs has arrived is a question for the Court...

Such definition coincides with the test in s 241(4)(a) of the New Zealand statute.

[15] Applying that test they submit that during 2000 Airlines was able to pay its debts as and when they fell due and on the evidence before the Court there is no basis for concluding that Airlines was insolvent.

The capital maintenance doctrine was intended to ensure that buffer was maintained to protect creditors. The Companies Act 1993 requires, by comparison, that directors ensure that the company satisfy a statutory solvency test before returning company resources to shareholders [s 4 of the Act]. This is novel.

Under the 1993 Act, directors are required to have accounting records kept [s 194 of the Act], financial statements prepared [s 10 of the Financial Reporting Act 1993] and presented to shareholders [ss 210 and 211 of the Act; they must expressly consider the company’s solvency when making distributions [s 52 of the Act]; and they incur personal liability should the company trade while insolvent [ss 135, 136 and 300 of the Act]. Solvency is also relevant when making share repurchases [ss 2(1) and 58 of the Act] and redemption [ss 2(1) and 70 of the Act] providing financial assistance for the purchase of shares [ss 2(1) and 77(1) of the Act] and completing a merger or amalgamation of companies under Pt VIII of the Companies Act 1993.

But since ss 135, 136 and 300 do not and cannot impose automatic liability for trading while insolvent, Airlines can argue that Professor Ross’s reasoning is consistent with its argument that the solvency test is to be satisfied in a number of particular situations rather than as an over-arching duty.

[18] It is unnecessary to consider the position under former legislation. Now, as was suggested in CIR v Chester Trustee Services Ltd [2002] NZCA 258; [2003] 1 NZLR 395, 405-6 para 42:

[42] The very purpose of the [1993] legislation creating a legal entity distinct from its directors and shareholders is to allow it to engage in business activities entailing risk without exposing shareholders to greater liability than the amount of their investment. The condition of the privilege is that the company be able to pay its due debts. Inability to pay debts triggers a series of consequences. These include voidability of transactions having preferential effect (s 292(2)(a)(i)), voidability of charges (s 293(1)(b)), liability of transactions at undervalue to be set aside (s 297(1)(c)(i)), vulnerability of certain securities and charges (s 299(1)) and being presumptively deemed to have failed to keep proper accounting records (s 300(1)(a)).

[19] Underlying the reasoning is a general obligation on directors of a company of doubtful solvency to pay regard to the interests of creditors, as Cooke J in Nicholson v Permakraft (NZ) Ltd [1985] NZCA 15; [1985] 1 NZLR 242, 249-50 (CA) decided under the former legislation. His decision, which did not carry the endorsement of Richardson J, was followed by both the House of Lords in Brady v Brady [1989] AC 755, 758 and the High Court of Australia in Spies v The Queen [2000] HCA 43; (2000) 201 CLR 603, 636.

[20] Lord Cooke’s opinion is powerfully reinforced by the basic concept of the

1993 reform - abandonment of share capital as the fundamental element of a company in favour of a solvency requirement. While not stated in terms, I am satisfied that the “general obligation [under the former legislation] to maintain the company’s capital” recorded by Richardson J in Nicholson v Permakraft at p 255 has now been superseded by what may be expressed as a general albeit imperfect obligation not to trade while insolvent, which is to be inferred from the whole scheme of the Act. 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 the failure that is both a regular fact of business life and the justification for limited liability. The obligation is imperfect because breach does not, per se, attract legal consequences for the directors. But it is nevertheless an obligation because it is the premise on which there is unconditional entitlement to continue to trade.

[21] Such conclusion is consistent with the explicit obligations now stated in ss

131 (to act in good faith in the best interests of the company (or holding company)),

135 (not to allow substantial risk of serious loss), 136 (need for belief on reasonable grounds in ability to perform obligations) and 194/300 (need to keep accounting records) are mandatory.

[22] I do not accept Airlines’ submission that inability to pay debts as they fall due is the sole legitimate measure of insolvency. As will later appear, this case presents an excellent example of why the submission cannot succeed. Airlines was able to pay its debts to Regional until a very late stage; the terms of trade were changed from an obligation to pay within 14 days after supply to the conventional payment on the 20^thof the following month; it managed for a time to continue to trade by building up debt. But with 99% of Regional’s business derived from Airlines, the liabilities of which substantially exceeded its assets at all stages, it had long been inevitable that unless somehow Airlines’ assets increased it would in the foreseeable future be unable to meet Regional’s most recent accounts.

[23] The policy of the New Zealand legislation is to require compliance with both the English and the Australian tests (para [9] above); whether or not there is liability on directors is a related but not identical question. On that approach either inability to pay debts or increase in liabilities over assets is a watershed: up until that point the company may lawfully expose its capital and assets to the risks of trade; after that the emphasis is on the position of creditors.

[24] Given such policy it can be said that, since solvency is the premise of the s 15 rule as to separate corporate identity, to trade while insolvent may justify some departure from the s 15 protection. But the acid question is how far such departure should go. To permit pooling to the extent required to restore solvency to a subsidiary would remove from its creditors the very risk of failure which is fundamental to the scheme of the legislation.

[25] Comparable issues arise in relation to claims against directors and it is of interest to consider the authorities in that sphere. They suggest that the test of liability is whether the risk to which they have exposed the company is “legitimate”.

Such approach is consistent with the Long Title. It was advocated by Tompkins J in an essay “Directing the Directors: the Duties of Directors under the Companies Act

1993” [1994] WkoLawRw 2; (1994) 2 Waikato Law Review 13 and provisionally preferred by William Young J in Re South Pacific Shipping Ltd (in liquidation) (2004) 9 NZCLC 263,570 paras 120 and 127-130 (under appeal). At para 125, William Young J stated “No-one suggests that a company must cease trading the moment it becomes insolvent in a balance sheet sense”. But since, for the reasons earlier given, solvency is now the condition of unconditional entitlement to trade, the true point in my view is that the law must recognise that assessments of the ability of a company to survive are a matter of judgment and a substantial margin of tolerance must be allowed to directors to perform their function of taking legitimate risks.

[26] The “legitimate risk” approach does not altogether square with the decision of O’Regan J in Fatupaito v Bates [2001] NZHC 401; [2001] 3 NZLR 386, 400 paras [62]-[63] that the language of the statute imposed a narrower test. But it is consistent with Facia Footwear Ltd (in administration) v Hinchliffe [1998] 1 BCLC 218 at pp 227-228), with the Australian decisions Kinsela v Russell Kinsela Pty Ltd (1986)

4 NSWLR 722 and Walker v Wimborne [1976] HCA 7; (1976) 137 CLR 1 and with Peoples Department Store Inc v Wise (2004) 244 DLR 4^th564. It is also in my view consistent with s 137 which provides:

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,—

So in considering directors’ duties it is open to a New Zealand Court to treat as its lodestar what directors in good standing do. This suggests that a legitimate risk is one it was open to a reasonable director to believe amounted to a reasonable business prospect.

[27] In short, New Zealand law comprising legislation and its judicial construction has applied to directors a test analogous to that applied to medical negligence in the English cases of Bolam v Friern Hospital Management Committee [1957] 1 WLR

582 and Bolitho v City and Hackney Health Authority [1997] UKHL 46; [1998] AC 232: compliance with accepted professional standards will be a defence unless those standards are shown to be wholly unreasonable.

[28] Such standards shed light on how the general language of the pooling provisions should be applied: creditors of a subsidiary cannot be entitled to recover on a pooling application more than they would have secured had the directors complied meticulously with their obligations.

[29] As to what is a legitimate risk, one factor may be inferred from the legislation: while risk of adventitious events must be accepted, risks resulting from adoption of a systemic policy to trade while insolvent is another matter. As will later be seen, US courts will respond to the latter problem by piercing the corporate veil. I have concluded that it may be approached more directly under ss 271-2.

[30] In considering what was a legitimate risk in this case appraisal is required of how the directors should have valued Airlines’ debt to Regional. That requires consideration of how the Court should approach its task.

[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. That is spelt out in para (d) of the long title and emphasised in such judgments as Peoples Department Stores Inc v Wise. Selecting the correct degree of intensity of judicial review is a topic that has loomed large in administrative law (Progressive v North Shore City Council HC AK CIV-2004-404-7139 15 June 2005 para [63] ff cites authority in England, Canada, Australia and New Zealand) and is of no less importance in this sphere. 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 establishes 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. The ss 271-2 power is to be read in that light.

[32] It will be convenient to turn to the other issues after discussing the facts.

[33] Airlines was incorporated in 1980 as Ansett New Zealand Limited by Ansett Australia Pty Limited, itself owned by the large media company News Limited. Its purpose was to compete with Air New Zealand on the major New Zealand domestic routes. Regional, incorporated in 1986 as Rex Aviation Limited, was also owned by Ansett Australia until it was wholly acquired by Airlines on 1 July 1999. Regional did not itself own or lease aircraft, which were leased by Airlines. Regional employed pilots and other staff to provide to Airlines, under the “Ansett Regional” banner, regional “feeder” flights and also certain maintenance services, as well as some ground handling services.

[34] It initially provided in addition services to third parties, including corporate jet operations, charters and maintenance, but ultimately relied on Airlines for over

99% of its income. Airlines handled and received the proceeds of all ticket sales. A Service Level Agreement (SLA) formally recorded the arrangements between the two companies. Regional’s income derived from a charge per flying hour defined in the SLA irrespective of the number of passengers, and charges for the maintenance and ground handling labour calculated to produce a profit to it. So wages comprised a major proportion of the Regional costs. Bonuses and penalties were applied to Regional’s hourly fees for early and late arrivals.

[35] On 24 March 2000 Zazu Limited, owned by a group of New Zealand investment companies, acquired from Ansett Australia all the shares in Airlines. Airlines procured Regional to change its bankers from the ANZ to the BNZ and to execute a guarantee of group liabilities and a supporting debenture. Following the sale the work performed by Regional for third parties reduced. Although Airlines’ combining engineering and ramp services was a factor, I accept Mr Doddrell’s evidence as to the importance of market conditions in the result. In the expectation of securing the Qantas franchise for New Zealand, Airlines and Regional each included “Tasman Pacific” in its name. Qantas ultimately decided not to support Airlines and on 20-21 April 2001 in consultation with the Airlines board BNZ made demand on both companies and appointed receivers to each. Each company was placed into liquidation by a resolution of shareholders, Airlines on 8 June 2001 and Regional on 9 November 2001. Regional is no longer in receivership and has a subrogation claim against Airlines for receivers’ costs charged against it.

[36] The directors of Airlines included Mr Dodwell, its CEO who was appointed to the two member Regional board in 1998, and Mr Belcher, appointed to the Airlines board on 24 March 2000 and to the Regional board on 8 August 2000. No formal directors meetings of Regional were held, the Regional directors meeting in the course of Regional and Airlines management meetings and at Airlines board meetings. Regional’s management was headed by Mr G M Geddes, who provided services as General Manager to both Airlines and Regional, his fees being paid by Airlines, I accept by oversight. Monthly review meetings were attended by the flight operations manager Dale Webb, the engineering manager Peter Morgan who as an employee of Airlines was seconded to Regional (with Airlines reimbursed by Regional for his salary), Peter Alletson the quality assurance manager and Philip Young financial accountant.

[37] Subject to the SLA Regional enjoyed autonomy in the day-to-day running of its business, employing and supervising its own staff and dealing with unions,

[39] Prior to Zazu’s purchase of Airlines it had had an unrelieved pattern of losses amounting to some $250m over some eight years. Its shareholder was News Ltd, the Australian holding company for the substantial international media group. No doubt motivated by the prospect of securing sufficient market share to bring Airlines into profit, News Ltd had both provided Airlines’ bank with its own substantial guarantee and been in the habit of injecting funds to keep it operating. That guarantee provided a justifiable expectation of its continuing to do so and meant that no issue of insolvency arose. But on the sale of Airlines to Zazu, with the shift from ANZ to BNZ and Zazu’s appointment of new directors, the News Ltd guarantee was of course withdrawn. Zazu’s guarantee to BNZ was supported by Zazu’s shareholders only to the extent of a debenture and sufficient uncalled capital to protect the BNZ. There was no evidence that Zazu ever gave the Airlines directors any assurance that its own substantial shareholders would adopt News Ltd’s policy of continuing to fund Airlines’ losses.

[40] Regional prepared from Airlines’ monthly records, available to its directors, a schedule showing Airlines’ financial position for the period February 2000, being the last month before Zazu’s purchase, until March 2001. It is attached as Appendix A.

[41] The Appendix shows that, while Zazu recapitalised Airlines to a degree and improved its negative working capital of -$57.201m in February 2000 (immediately prior to purchase) to -$27.312m (immediately after the purchase), the pattern of negative working capital remained and deteriorated over the period to receivership in April 2001 to -$65,478. Likewise negative net assets of -$35.314m immediately prior to purchase improved to -$3.060 m the following month but progressively

deteriorated over the period to -$45.773m. Despite some recapitalisation the net operating result, of -$1.079 m in February 2000 immediately prior to purchase, which improved to -$3,000 in March 2000, remained negative in each month until receivership.

$3m was less than half of the $6.9m required to rebrand Airlines, that its current financial position was poor with equity minimal, profitability was barely evident, and debt-servicing was non-existent. Forecasts were said to have taken unrealistic views of current exchange rates and recent rises in fuel costs. It was considered that such risks as fuel price increases were not adequately covered. Moreover because Zazu lacked independent assets the validity of the Zazu guarantee depended on its having sufficient uncalled capital to allow its own shareholders to be called upon.

[43] On 1 September 2000 Airlines and Qantas entered into a seven year franchise agreement under which, for an initial fee plus an annual share of revenue, Airlines was entitled to and did use the Qantas name and was listed in Qantas timetables, inflight magazines and the Qantas website. But Appendix A shows that whatever improvement of monthly performance resulted failed to bring it into profit.

[44] On 1 November 2000 BNZ provided bridging finance of $12m secured by entitlement to call on $12.12m of uncalled capital which, coupled with the debenture security, was tantamount to a shareholders’ guarantee. That advance was made until

22 December 2000. It was made on the basis that it would be repaid by an equity injection which the shareholders were negotiating.

[45] On 7 December the BNZ advance was increased to $15m. The term was extended to 31 January 2001, conditional on the bank being satisfied that the proposals for additional equity would provide the bank with comfort that its funding would be repaid before maturity. The three options being pursued by Airlines had been recorded by the bank on 5 December:

a) Qantas buying it outright. The bank was told that Airlines representatives had met with the CEO of Qantas and received “a clear indication that Qantas’s long term intention was to own the business.”

b) There were a number of smaller investors including existing shareholders who were reviewing the option to purchase Airlines and had proceeded to due diligence.

$25.55m in 5 year convertible notes. This option did not appeal to Airlines because it would entail a preference over existing shareholders.

On 14 December its head office credit controller described the proposals as “all a bit warm and fuzzy”.

Airlines with an optimistic report. It recorded that, while during the last quarter of

2000 the airline industry had suffered adverse movements in both key costs – fuel and foreign exchange rates – which Airlines had been unable to absorb, trading performance had improved significantly. That was due to fuel and foreign exchange prices moving positively, passenger numbers increasing significantly helped by the Qantas franchise, and 10% fare increases which Air New Zealand had followed. The forward booking profile was said to be better than ever before. Cash flow forecasts projected attaining profit in March. The report also stated that, while helpful operationally, Qantas would be unlikely to acquire Airlines unless forced to in a distressed sale. So instead of dealing with Qantas, the board had resolved to seek from additional professional investors $15m of new equity being the sum said to be needed for recapitalisation. It said that there had been strong expressions of interest from two parties for some $25m of new capital. It recorded a high level of comfort with the forecasts.

[47] The response of 1 March 2001 by the bank’s credit manager and credit controller was less enthusiastic. It recorded that over the previous four months

Airlines had sought increased facilities to finance trading losses pending an injection of equity capital. Airlines now sought a further two month loan of $13m on terms that the $12m would become a permanent core debt facility and the $13m would be repaid out of expected profit. The bank noted its lack of appetite for providing bridging finance for a loss making airline; further assistance would be conditional on recapitalisation or Zazu’s shareholders guarantee of a further $13m facility and of its being repaid within sixty days. Such terms were not accepted and the further loan was not made. Receivership and liquidation followed.

[48] At the time of its purchase by Airlines on 1 July 1999 Regional was solvent. Its audited accounts to 30 June 1999 recorded net assets of $901,012. It held

$1,271,662 in its bank account. Throughout the period from 1994 to 1999 it had traded at a profit.

[49] On 6 or 7 July 2000 Mr Rea, Chief Financial Officer of Airlines, with the approval of Mr Doddrell, directed Mr Young, Manager Finance/Administration of Regional, to transfer $650,000 from Regional’s account to Airlines. Mr Chisholm for Regional accepted that such directions would have been legitimate if both companies were solvent, as simply substituting for a debt by Regional’s bank a debt by its holding company. But he submitted that at the time Airlines was insolvent and by Airlines’ creation of what risked being, and proved in the end to be, a substantially bad debt Airlines unlawfully improved its financial position at the expense of Regional. Without a pooling order the unsecured creditors of Airlines would receive a dividend of 15c in the dollar and those of Regional nil. Such an order, which would reduce the Airlines creditors’ return by only 1/2c in the dollar but bring the Regional creditors to equality, should be made to remove an injustice caused by Airlines’ wrongful abstraction of Regional’s funds.

[50] Mr Latton and Ms Cameron for Airlines submitted that Airlines was not insolvent at the time and that even if it was, Regional continued to be solvent before and after the payment. The payment was to be characterised as effectively a dividend paid by Regional and since it could and would have secured board approval the absence of the Regional board resolution required by s 52 was immaterial.

[51] Mr Chisholm further submitted that even if Regional was solvent at and immediately after the payment of the $650,000 it became insolvent well before March 2001 and as a result Regional’s position was worsened. Mr Latton and Ms Cameron argued to the contrary.

[52] The competing contentions are highlighted by the comparison between Regional’s balance sheet as at 29 July 2000 and the adjustments proposed by Regional’s expert Mr McDonald and shown in Appendix B. It will be seen that the value of the Airlines trade debt has been removed from the adjusted balance sheet and that, on the basis that Regional was insolvent, its fixed assets were revalued to recognise the prospect of liquidation and forced sale. It shows deficiency in net working capital of some $70,000 as at 29 July 2000. Mr McDonald also extended the analysis to 31 March 2001. He considered that the fixed assets should have been decreased radically to allow for the risk of loss of value on possible insolvency: that item realised only $9,500 following receivership.

[53] Airlines’ contention is that Regional was and remained solvent until the eve of receivership. Its expert Mr Bridgman endorsed Mr McDonald’s figures down as far as “Net Working Capital” being an analysis of Regional’s records of its working capital and net asset position on a going concern basis for the period 25 March to

2 September 2000. Properly allowing for circumstances that the directors would have known might affect the value of the assets, he accepted the need for the Regional board to allow for the risk of Airlines failure by deleting the debts by Airlines in the “Trade Debtors” figure and the “Advance to Tasman Pacific” under “Fixed Assets”. Mr Bridgman retained in full the other items of “Fixed Assets” averaging something over $220,000 over the period. He said he did not know

enough about the cash flow position of Regional to offer an opinion whether Regional was solvent in that sense. His opinion that the Regional directors would have been justified in concluding that in balance sheet terms the statutory solvency test was met during that time was based on the assumption that the fixed assets would realise at least $75,000 and so avoid a deficit.

[54] The agreement of Mr Bridgman and Mr McDonald that the value of the Airlines debt to Regional as at 29 July 2000 should be treated as nil is striking. It means that the risk of Airlines’ failure was plainly evident.

[55] Their opinion was shared by the liquidators of Airlines who asserted that Airlines was insolvent from December 2000 and obtained a substantial settlement as a result from claims against the Regional directors. I am unaware of its terms and must form my own view in accordance with the principles already outlined.

[56] For Airlines Mr Latton and Ms Cameron emphasised the clear distinction maintained between Airlines and Regional as individual entities. That is true in regard to the excellent accounting procedures and records and to the extent recorded in paras [33]-[34]. It is inaccurate in that the directors held no separate board meetings in respect of Regional and, as the payment of the $650,000 shows, placed its interests ahead of those of Airlines.

[57] Counsel contrasted the s 271(1)(b) pooling regime (para [4] above) with that under s 271(1)(a) which empowers the Court to order contribution by a company not in liquidation to claims made by a related company in liquidation. The s 272(1) guidelines as to the latter do not include the s 272(2)(d) guideline “The extent to which the businesses of the companies have been combined”.

[58] They submitted that there is a difference between s 272(1) (which concerns claims against a related solvent company) and s 272(2). It is that it may be unjust for a related solvent company to be able to abandon its insolvent subsidiary/related company where the solvent company has acted inappropriately towards the subsidiary. Allowing this to happen will result in detriment to the insolvent company’s creditors and perhaps in a windfall to the shareholders of the solvent company. So on an application under s 271(1)(a) the Court must consider the rights of shareholders against those of creditors; not the competing rights of each company’s creditors. An application under s 271(b) by contrast directly affects the rights of each company’s creditors. What must be considered is whether it is just and equitable if the funds payable to one group of creditors should be reduced because of pooling with another group of creditors. For that reason Parliament has directed that the Court must consider the extent to which the businesses of the companies are being merged. Counsel submit that s 272(2) is directed at conduct by the companies that is inconsistent with the concept of separate corporate identity. The purpose of s 271(1)(b) is to provide a remedy in the cases where to keep the liquidation separately would:

belatedly recognise a legal separation which has never in fact operated. It would be to prefer some creditors over others and to do so fortuitously since there [has not] been any principle on which the activities of the [companies] were divided... (Re Dalhoff v King Holdings Ltd (in liquidation) (1991) 5 NZCLC 66,959 at 66,971)

Nominees Ltd [1990] 3 NZLR 513, 532; [1991] 1 AC 187, 221 for the principle that:

In the absence of fraud or bad faith... a shareholder or other person who controls the appointment of a director owes no duty to creditors of the company to take reasonable care to see that directors so appointed discharge their duties with due diligence and competence.

The decision was followed by Thomas J in Dairy Containers Ltd v NZI Bank Ltd [1995] 2 NZLR 30 especially at 89-90. His decision like that of the Privy Council concerned an allegation of duty of care in tort.

[60] Counsel submit that the policy reasons are similar to those that limit the lifting of the corporate veil. The law has set its face against such liability and should not extend it in the present context.

ii) it is not established that Airlines was insolvent when the liabilities to Regional, including the $650,000 inter-company debt, were incurred

e) There are no other matters which justify the proposed order f) It is not just and equitable to make the order sought.

[62] Mr Chisholm’s essential submission was that Airlines and its Regional directors caused both companies to trade while insolvent and thereby caused Regional’s losses. So pooling is required to redress that wrong.

[63] Except for the Republic of Ireland (Companies Act 1990 ss140-1, in broadly similar terms to New Zealand legislation: see McCormack “Ireland: Pooling of Assets and Insolvency in Ireland” (1992) 13 Company Lawyer 191-2) the pooling provisions are said to be unique among common law jurisdictions. Although they were introduced in 1980 as ss 315A, 315B and 315C of the Companies Act 1955 there is little academic or judicial comment upon them. They followed a recommendation in the 1973 Report on the Reform of Companies (chaired by Sir Ian MacArthur). It responded to a submission that in at least two recent cases well known public companies had abandoned subsidiaries.

[64] The same mischief had been the subject of comment in Walker v Winbourne at p 6-7 where misfeasance proceedings a board against directors of companies administered as a group. Mason J emphasised:

...the fundamental principles that each of the companies was a separate and independent legal entity, and that it was the duty of the directors of [each company] to consult its interests and its interests alone in deciding whether payment should be made to other companies. In this respect it should be emphasised that the directors of a company in discharging their duty to the company must take account of the interests of its shareholders and its creditors. Any failure by the directors to take into account the interests of creditors will have adverse consequences for the company as well as for them. The creditor of a company, whether it be a member of a ‘group’ of companies in the accepted sense of that term or not, must look to that company for payment. His interests may be prejudiced by the movement of funds between companies in the event that the companies become insolvent.

[65] In the United States courts have been prepared to respond to the mischief by piercing the corporate veil and imposing liability on shareholders which have permitted a company to trade without adequate capital: Lopez v TDI Services Inc 631

So.2d 679 (La.Ap.3ar.1994); In re Healthco International, Inc, Brandt v Hicks, Muse

& Co Inc. 208 B.R. 288 (Bkrtcy.D.Mass.1997). In Lopez the shareholders had contributed only $1 per share for a 1,000 shares. All other funding for the companies running to billions of dollars, came from outside creditors who for the most part had not been fully repaid. At p 687 the Court adopted the theory that veil piercing should be permitted where a single shareholder controls a number of

different corporations and moves assets back and forth between the various corporations. In In re Healthco a leveraged buyout of a business left the vendor company with insufficient assets to pay creditors. The Court stated at p 301:

The terms “insolvency” and “unreasonably small capital” require explanation. Insolvency has a settled meaning under fraudulent transfer law, whether the relevant statute be section 548 of the Bankruptcy Code, the Uniform Fraudulent Transfer Act or the Uniform Fraudulent Conveyance Act. Its statutory definition is, in essence, an excess of liabilities over the value of assets (see e.g. James F Queenan Jr et al Chapter 11 Theory and Practice: A Guide to Reorganisation 27.07 (1994)). This is sometimes referred to as insolvency in the bankruptcy sense (Id.)

The Trustee’s claims against the directors are based on principles of fiduciary obligations rather than fraudulent transfer law. Here another form of insolvency is equally relevant – insolvency in the equity sense. This is an inability to pay debts as they mature (Id.). Even though not insolvent in the bankruptcy sense, a business is insolvent in the equity sense if its assets lack liquidity.

The LBO may or may not have rendered Healthco insolvent in either the bankruptcy or equity sense. The core of the Trustee’s case appears to lie in his more easily provable allegation that the [leveraged buyout] left Healthco with unreasonably small capital. The meaning of this term, which is undefined in the fraudulent transfer statutes, has been developed by the courts. It connotes a condition of financial debility short of insolvency (in either the bankruptcy or equity sense) but which makes insolvency reasonably foreseeable (see Moody v. Sec. Pac. Bus. Credit, Inc., 971 F.2d

Morse Tool, Inc.), 148 B.R. 97, 133 (Bankr.D.Mass.1992); see e.g., Queenan, supra note 26, 27.08 (1994).) In other words, a transaction leaves a company with unreasonably small capital when it creates an unreasonable risk of insolvency, not necessarily a likelihood of insolvency. This is similar to the concept of negligence, which is conduct that creates an unreasonable risk of harm, to another’s person or property (see Restatement (Second) of Torts 282 (1985)). Whether a leveraged buyout leaves a company with unreasonably small capital typically depends upon the reasonableness of the parties’ cash flow projections (see Moody, 971 F.2d at 1073; Ferrari, 148

B.R. at 133; Brandt v. Hicks, Muse & Co., Inc. (In re Healthco Int’l, Inc.),

195 B.R. 971, 981 (Bankr.D.Mass.1996); Murphy v. Meritor Sav. Bank (In re O’Day Corp.), 126 B.R. 370, 404-07 (Bankr.D.Mass.1991)). To be reasonable, the projections must leave some margin for error (see Moody,

[66] Since in New Zealand the mischief has been the subject of legislative response it has been unnecessary for New Zealand judges to review the reluctance with which they, like English judges, have approached invitations to extend the narrow exceptions to s 15. The English Court of Appeal’s decision in DHN Food

Distributors Ltd v London Borough of Tower Hamlet [1976] 1 WLR 852, 861 to “look at the realities of the situation and pierce the corporate veil” was not followed by the House of Lords in Woolfson v Strathclyde Regional Council 1978 SC (HL)

90. In England the conservative approach of the Court of Appeal in Adams v Cape Industries Plc [1990] 1 Ch 433 is now dominant despite the academic criticism of it: see Holding Companies and Subsidiaries – The Corporate Veil (1991)

Our law, for better or worse, recognises the creation of subsidiary companies, which though in one sense the creatures of their parent companies, will nevertheless under the general law fall to be treated as separate legal entities with all the rights and liabilities which would normally attach to separate legal entities... [in no] class of case is it open to this court to disregard the principle of Salomon...

[67] Savill v Chase Holdings (Wellington) Ltd [1988] NZCA 113; [1989] 1 NZLR 257, 306-312, 316 is to broadly similar effect. The challenge for New Zealand courts is to give due effect to the pooling provisions without impairing the interest of commercial certainty that underlies the Savill decision. Counsel for Airlines cited the judgment of McMullin J in Savill at p 306 that:

For a variety of reasons the Chase Group considered it desirable to form subsidiary companies, each with specific functions. But the specific structures are not to be regarded merely as part of a façade which is aimed to conceal the true facts.

The statement clearly supports the proposition that companies are entitled to structure their affairs as they see fit. The Court will uphold a group of companies’ right to run their businesses through subsidiary and related companies except where there is some conduct that disentitles the companies from relying on the concept of separate corporate identities. The group’s desire to avoid all limited liability to creditors through the use of limited companies is not disentitling conduct.

[28] It follows that a company must be entitled to establish subsidiaries to undertake the different areas of its business rather than to operate those areas of divisions. If companies are not entitled to spread their risk then there is disincentive for companies to undertake new business.

In essence the corporate veil should be lifted only if in the particular context and circumstances its presence would create a substantial injustice which the Court simply cannot countenance. Whether that is so must be judged against the fact that corporate structures and the concept of separate corporate identity are legitimate facets of commerce. They are firmly and deeply engrained in our commercial life. If they are genuinely and honestly used they should not be set aside. In any event something really compelling must be shown to go behind them.

[69] The Judge’s statement of principle, like any judgment, it is to be read in the context of its particular facts. It did not concern an application under s 271; in particular the case had nothing to do with undercapitalisation to which a more exacting test than genuine and honest use is required. Lord Cooke of Thorndon Turning Points in the Common Law: a Real Thing The Hamlyn Lectures 1997 p 13 and Professor Watts Piercing the Corporate Veil – a device of convenience or a last resort? (2001) Butterworths Company and Securities Law Bulletin pp 93-4 respectively stress the need for tight application of the policy of the companies legislation and to treat veil lifting as a last resort.

[70] Re Dalhoff v King Holdings Ltd (in liquidation) was a confusion case where three companies had been operated substantially as one entity. There was significant confusion among creditors of the companies whose management had used them indiscriminately. An order under s 315(b) of the 1955 Act was inevitable.

[71] In re Pacific Syndicates (NZ) Ltd (in liquidation) [1988] NZHC 511; (1989) 4 NZCLC 64,757 was similar. Investors funds from separate companies had been pooled in a single account. There were complex inter-company debts and intertwined liability. There was no possibility of properly dividing the funds among the companies in liquidation. With the consent of all parties the Court granted the order sought under s 271(1)(b).

[72] Counsel for Airlines submitted that the Court will not make orders under s 271(1)(a) where the contribution will penalise the creditors of that company. In Lewis v Poultry Processors (Holdings) Ltd [1988] NZHC 243; (1988) 4 NZCLC 64,508 Tipping J said (at 64,513):

I doubt very much whether s 351A is intended to prejudice the position of bona fide unsecured creditors of the related company.

This is not of course a s 351A/271(1)(a) case. But I am with respect unable to agree with the proposition as of general application. The rights of creditors and shareholders of the related company are a function of the financial position of that company. The purpose of ss 271-2 includes the power to require the related company to disgorge benefits received at the expense of the applicant. The interests of the creditors of the related company are no doubt germane to whether a pooling order “is just and equitable” and, if so, what its terms ought to be. But they are not a bar to exercise of the statutory power to diminish by such order the assets of the related company and, in consequence, the interests of its creditors.

[73] I do not regard the distinction between ss 272(1) and (2) as of present relevance. I accept that the businesses were not “combined” (except economically); the guidelines include cases where businesses have been carried on in such a manner that their operations cannot readily be disentangled. I do not consider that the distinction from s 271(1)(a) cases sheds light on the present case.

[74] The MacArthur Committee and the US authorities have recognised the mischief that can result from an unyielding application of separate corporate identity. To carry it across into construction of ss 271-2 would defy the legislative policy, which is that within limits pooling can properly occur. In construing what is relatively open textured legislation I consider it appropriate that, in an undercapitalisation case such as this, the remedy which provides an exception to s 15 should be proportionate to the breach of the equally fundamental principle that solvency must be maintained. It is no answer to such breach to assert that requirements of separate accounting have been scrupulously adhered to; if they had not that conduct would be a further factor to take into account in the overall judgment.

[75] The question whether and to what extent the Airlines debt should have been reduced as an asset in the minds of the Regional board at the time they acquiesced in the $650,000 payment and continued to permit Regional’s subsequent trading invites attention to how it should be appraised. Since the Regional directors Messrs Doddrell and Belcher were concurrently Airlines directors it would be unreal not to attribute to the Regional board the knowledge they possessed about Airlines’ position.

[76] The history of Airlines’ $250m losses would have been well known to them as the facts for each month recorded in Appendix A show. Mr Bridgman agreed that the information in that document suggested a state of insolvency for Airlines unless there was other information giving its directors grounds for forming a view that funds would be available to meet its liabilities. I am satisfied that the prospects of third party funding were insubstantial. There was aspiration by the Airlines board that it would be bought by Qantas. There were hopes of other third party funding. But while certain funds were introduced by Zazu there was no preparedness on the part of the shareholders of Zazu to emulate News Ltd and undertake to continue to fund losses. In those circumstances Regional argues in effect that the hope of Airlines’ better future performance, with the consequential advantages to the Zazu shareholders, was that of a Micawber and was sought to be achieved at the expense of creditors.

[77] Airlines’ argument is that the prospects of Airlines and of Regional were such that the Airlines debt should not be discounted and that no particular conduct on the part of Airlines drove Regional into liquidation: Regional went into liquidation because its biggest customer, Airlines, failed.

[78] I do not accept the perspective implicit in the submission. What in substance put Regional into liquidation was the decision of Airlines, given effect by the Airlines directors who controlled Regional, itself to trade and to cause Regional to trade while both were insolvent.

[79] I prefer and accept Regional’s argument. It was objectively plain to any reasonable reader of Airlines’ accounts that at all material times after withdrawal of the News Ltd guarantee it was insolvent in both balance sheet and cash flow terms. That impacted in turn on the value of Regional’s debt from Airlines. Zazu sought to have and eat its cake - to take the advantage of the benefits that would result from a Qantas takeover but not to provide the additional capital that would take Airlines across the solvency threshold. The result was that Airlines was undercapitalised and, as shown in Appendix B, its debt to Regional, which was essential to Regional’s survival, was discounted to nil by the experts on both sides. So Regional was tethered to an insolvent company whose debt, which had rapidly increased (Appendix C) to 99% of its revenue, was not only worthless but comprised (Appendix D) over 80% of its net assets (Appendix D).

[80] The s 272(2) criteria are to be read in the light of the fundamental principles of the legislation. As Salomon confirmed, s 15 like its predecessors is a pivotal provision creating the corporate veil which judicial decision and commercial practice alike have treated as difficult to pierce. Despite the apparent breadth of s 272(2)(e) Parliament is not to be attributed with an intention to allow judges to use the discretion it provides to disapply or dilute s 15 without solid reason grounded in the policies of the Act. But trading while insolvent provides such reason.

(2) A director of a company that is a wholly-owned subsidiary may, when exercising powers or performing duties as a director, if expressly permitted to do so by the constitution of the company, act in a manner which he or she believes is in the best interests of that company’s holding company even though it may not be in the best interests of the company.

[82] Since the subsection requires that recourse to it be “expressly permitted” by the constitution of the company, which was not produced, the point is academic. But since it was discussed in argument and may be germane to the perspective of the legislation I discuss it briefly. In cases where it applies it legitimates the settled commercial practice of sweeping cash from subsidiaries into the financing member of a group. In Dairy Containers Ltd v NZI Bank Ltd [1995] 2 NZLR 30, 87

Thomas J referred to an observation of the Privy Council in Kuwait Asia Bank EC v National Mutual Life Nominees Ltd [1990] 3 NZLR 513, 534; [1991] AC 187, 223 as having in effect:

...recognised the commercial reality that nominee directors do at times respond to instructions from their appointers in a manner which makes the appointer directly liable

in tort. No doubt in cases to which s 131(2) applies that statement requires modification. But s 131(2) is an ancillary rather than a core provision of the scheme of the Companies Act and cannot be permitted to override the fundamental requirement of solvency. I sought the assistance of Mr Todd, called as an expert for the defence:

Q In terms of entitlement to sweep cash out of a division or a subsidiary provided the holding company is solvent I think your opinion is there is no problem perfectly legitimate. Where the holding company is insolvent at the time of the cash sweep from its subsidiary would not the position of the holding company be different?

A I think that’s a fair point. The cash position and the position of solvency within the parent company would be relevant in terms of the sweep of cash insofar as that affected the creditors.

Q If an insolvent parent sweeps money from a subsidiary in circumstances where there’s real risk of inability to repay the debt it owes to the subsidiary is there not risk of abuse by the holding company of potential creditors of the subsidiary?

Q And in those circumstances the premise on which distinct corporate identity is accorded to the parent and to the subsidiary namely solvency is not satisfied correct?

Q What the plaintiff says is that those are the circumstances of this case and that in those circumstances the corporate veil should be pierced and the holding company required to take the rind of the subsidiary’s creditors together with the fruit of the cash that it’s swept. In principle if those are the facts is that a sound argument?

A I understand the framework that you’ve developed and from my understanding I’d have to give some weight to that argument I think there is some substance to it.

While s 131(2) will relieve directors of the obligation to put the interests of the subsidiary ahead of those of the holding company, such a side wind cannot relieve them of the fundamental obligation to cease trading upon insolvency.

[83] Regional did not seek pooling on a more extensive basis than equality of treatment. If the constitution of Regional did engage s 131(2) such a claim would have raised an interesting question as to that subsection’s effect on such fundamental failure of the Regional directors, by advancing the $650,000 to its insolvent parent, to act in the best interests of Regional. But the answer may be left to another case.

The extent to which any of the companies took part in the management of any of the other companies

[84] Section 272(2)(a) requires the Court to have regard to the extent to which any of the companies took part in the management of any of the other companies. “Taking part in the management” has quantitative and qualitative elements.

[85] As indicated at paras [33]-[34], I accept Mr Doddrell’s evidence that at an operational level although Regional provided services to Airlines it operated as a separate and autonomous entity. Although described by a former director Mr Hopkins in August 2000 as a “division” within a group, a proposal in October that year to formalise its position in that way was not adopted. Regional had its own

staff of 70 whom it appointed, ran its own management structure, maintained its own accounting system, and was not grouped with Airlines for GST purposes. Its operations were based in Wellington whereas Airlines’ were mainly in Christchurch with a separate office in Auckland. Regional and Airlines invoiced one another for services performed under the SLA.

[86] Mere participation of the holding company in the management of a subsidiary will not of itself justify a pooling order. Nor would participation in the securities provided to the group’s bank. Nor in my view would the making of a cash sweep of unneeded subsidiary funds, even without recourse to s 131(2). Removed from its context, the fact that Regional had $1.3m of cash at the time of Zazu’s takeover of Airlines and that Airlines chose to remove it by creating an inter-company advance was not of itself necessarily significant. To hold otherwise would defy the settled commercial practice which is the backdrop against which the legislation falls to be construed.

[87] It is essential however not to miss the wood for the trees. While at the micro operational level Regional appeared distinct, at a policy level Regional was a slave of the insolvent Airlines, at the end dependent upon it for 99% of its business, something regarded by Mr Todd as exceptional. The vulnerability of Regional, being so heavily dependent on Airlines, is seen from Appendices C (showing the evolution over time) and D. If the holding company uses its authority to cause the subsidiary to trade whilst insolvent that fact is obviously relevant to a pooling application. A fortiori when the subsidiary is a slave of the holding company, dependent on the health of the holding company for its own survival. The two were so closely linked as to make unreal the attempt by Airlines to assert that, even if Airlines was insolvent, Regional was not. Airlines’ insolvency made Regional insolvent.

[88] The holding company cannot have the fruit of s 15 without the rind of the solvency requirements. Once the insolvency threshold is crossed, as may occur with such a transaction as the cash sweep, the settled commercial practice rationale disappears.

The conduct of any of the companies towards the creditors of any of the other companies

[89] Subclause (b) requires regard to be had to the conduct of any of the companies towards the creditors of any of the other companies. This point overlaps with the last. If the holding company removes funding which would permit the subsidiary to survive independently of it, or causes or permits the subsidiary to trade while insolvent, it is putting at risk the subsidiary’s creditors, again in breach of the solvency requirements.

Whether the subsidiary’s liquidation is attributable to the actions of the holding company

[90] Subclause (c) requires examination of whether the subsidiary’s liquidation is attributable to the actions of the holding company.

[91] Again causing the subsidiary to trade while insolvent by providing it with bad debt is material.

[92] Subclause (d) concerns the extent to which the businesses of the companies have been combined. Causing a subsidiary to grant credit to an insolvent holding company falls squarely within the subclause.

[94] The solvency provisions are again important among these. So too is the fact, already noticed, that benefits to Airlines have resulted from breach of duty by Regional’s directors, appointed by Airlines. The case falls within the principle that a

[95] On a superficial glance Regional was solvent until very shortly before the appointment of receivers. Mr Young, Regional’s former Manager Finance/Administration, agreed that invoices had been paid in accordance with the parties’ terms of trade. Mr Heath, one of the liquidators of Airlines, demonstrated that Airlines treated Regional no worse than it treated its other trade creditors. At the time of the Airlines’ receivership on 21 April 2001 all Regional invoices up to and including February 2001 and some of March 2001 had been paid. The earliest outstanding Regional invoice was entered into Airlines’ creditors ledger on

[96] The removal of the cash of $650,000 would not have mattered had Airlines been solvent, because the resulting debt owed by it to Regional would simply have replaced in Regional’s balance sheet a debt for the same amount owed by its bank. Even without it Regional could have continued to trade so long as Airlines’ debt was sound. Mr Young agreed that the terms of credit to Airlines, originally 14 days, had been extended to the conventional payment on the 20^thof the month following supply. On the assumption that the debt owed by Airlines was ordinary trade debt that one would expect to be paid in the ordinary course of events, that company’s collapse and the consequential failure to pay about a month’s payments would be treated as within the conventional terms of payment by the 20^thof the month following supply.

[97] But such analysis in this case would be not only superficial but wrong. Section s 4(2) requires the Court to appraise what reasonable directors would have made of the situation had they stood back and made a commercial reality check of the contingencies. Because Airlines’ liabilities exceeded its assets at all material times it was itself insolvent throughout. That was no paper position divorced from reality; there were no such prospects, as of collecting pre-existing debts or generating significant income from a reasonably minor expenditure as O’Regan J

contemplated in Fatupaito v Bates [2001] NZHC 401; [2001] 3 NZLR 386, 404, which might justify continued trading. The risk to Regional’s creditors was therefore systemic, not adventitious; at all material times the value of the Airlines debt required radical discounting in Regional’s books, as the Airlines directors of Regional well knew. To permit Regional to continue to extend credit to Airlines meant that it would be the Regional creditors who carried the risk of Airlines’ failure to secure a Qantas takeover.

[98] The systemic insolvency of Airlines carried with it high risk that if Qantas or another investor did not take over the business Airlines’ creditors, among them Regional, would suffer loss for the very reason that eventuated – Airlines’ undercapitalisation. But there were no solid prospects of such takeover.

[99] This situation resulted from Zazu’s policy of undercapitalising Airlines and the policies given effect by the Airlines board, members of which controlled Regional’s extending credit to Airlines and incurring the debt to its creditors. I can see no reason for exercising discretion against treating Regional’s creditors in the same fashion as the creditors of Airlines which was responsible for their position.

[100] There will be an order as moved, with leave to apply for more specific directions.

	Net operating profit including Regional’s contribution (before Abnormal costs)	Current assets	Current liabilities	Negative working capital	Net assets	Performance comment
Feb 2000	(1,079)	35,535	92,736	-57,201	(35,314)	Behind budget and forecast
March 2000	(3)	40,464	67,776	-27,312	(3,060)	Behind budget and forecast
April 2000	(154)	41,060	68,243	-27,183	(3,452)	Above budget, below model
June 2000	(4,805)	35,524	73,390	-37,866	(13,244)	Behind model behind budget
July 2000	(2,463)	36,661	76,539	-39,878	(16,215)	Above budget
Aug 2000	(3,275)	36,317	78,123	-41,806	(20,237)	Behind budget
Sept 2000	(5,909)	37,140	85,868	-48,728	(26,803)	Behind budget
October 2000	(4,581)	41,789	95,005	-53,216	(31,570)	Behind budget
Nov 2000	(2,698)	37,803	91,856	-54,053	(32,736)	Behind budget
Dec 2000	(1,550)	29,378	83,788	-54,410	(33,469)	Behind budget
Jan 2001	(4,081)	27,474	86,008	-58,534	(37,879)	Behind budget
Feb 2001	(2,623)	22,758	84,105	-61,347	(41,346)	Behind budget
March 2001	(4,413)	33,836	99,314	-65,478	(45,773)	Behind budget

APPENDIX B: Regional’s solvency as at July 2000, after the payment of the $650,000 to Airlines

	Trade Debt due by Airlines $	Other Trade Debtors $	Total Trade Debtors $	% Total Trade Debt Due by Airlines %
Jun 1999-AB1/350/361	138,904	92,655	231,559	60
Jun 2000-AB1/342	161,189	111,225	272,414	59
July 2000-AB1/370	147,130	111,207	258,337	57
Aug 2000-AB2/455	100,458	79,824	180,282	56
Sept 2000-AB2/485	352,257	83,200	435,457	81
Oct 2000-AB2/504	204,779	89,194	293,973	70
Nov 2000-AB2/540	218,480	65,834	284,314	77
Dec 2000-AB2/577	503,598	63,057	566,655	89
Jan 2001-AB2/613	408,101	83,423	491,524	83
Feb 2001-AB2/633	513,609	64,834	578,443	89
Mar 2001-AB2/648	619,171	59,909	679,080	91

	Trade Debt due by Airlines $	Advance to Airlines $	Total Intercompany debt due by Airlines $	Regional Net Assets $
Jun 1999-AB350,361	138,904	-	-	901,102
Jun 2000-AB1/342	161,189	-	-	1,033,278
Jul 2000-AB1/370	147,130	650,000	797,130	969,367
Aug 2000-AB2/455	100,458	650,000	750,458	944,526
Sept 2000-AB2/485	352,257	650,000	1,002,257	922,705
Oct 2000-AB2/504	204,779	650,000	854,779	916,961
Nov 2000-AB2/540	218,480	650,000	868,480	875,305
Dec 2000-AB2/577	503,598	650,000	1,153,598	890,569
Jan 2001-AB2/613	408,101	650,000	1,058,101	1,005,806
Feb 2001-AB2/633	513,609	650,000	1,163,609	1,034,959
Mar 2001-AB2/648	619,171	650,000	1,269,161	1,069,243

	Balance Sheet	Adjusted by applicant
CURRENT ASSETS Cash	(in 000’s) 172	(in 000’s) 172
Trade debtors: Airlines	147	-
Trade debtors: Others	111	111

High Court of New Zealand Decisions

Mountfort v Tasman Pacific Airlines of NZ Ltd HC Auckland CIV 2004-404-1843 [2005] NZHC 514; [2006] 1 NZLR 104; (2005) 9 NZCLC 263,864; (2005) 2 NZCCLR 428 (12 July 2005)