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Court of Appeal of New Zealand |
Last Updated: 2 February 2018
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IN THE COURT OF APPEAL OF NEW
ZEALAND
CA39/2009
[2009] NZCA 396
BETWEEN PEACE AND GLORY SOCIETY LIMITED (IN
LIQUIDATION)
First Appellant
AND DAVID STEWART VANCE AND HENRY DAVID LEVIN
LIQUIDATORS OF PEACE AND GLORY SOCIETY LIMITED (IN LIQUIDATION)
Second Appellant
Hearing: 16 June 2009
Court: Glazebrook, Potter and Keane JJ
Counsel: B H Dickey for Appellants
A M Swan for Respondent
Judgment: 10 September 2009 at
10.00 am
|
JUDGMENT OF THE COURT
|
B There are no costs
orders.
____________________________________________________________________
REASONS OF THE COURT
(Given by Glazebrook J)
Table of Contents
Para No
Introduction [1]
Background [7]
High Court judgment [22]
The legal position [43]
The liquidators’
position [49]
Mr
Samsa’s position [57]
Our assessment [64]
Result and costs [76]
Introduction
[1] Peace and Glory Society Ltd (Peace and Glory) was incorporated on 26 November 1999 with Mr Samsa as its sole director and shareholder. It was placed in liquidation on 13 October 2005 on the application of the Commissioner of Inland Revenue. Messrs Vance and Levin were appointed liquidators. The unpaid debt leading to liquidation was for GST, penalties and interest then totalling $57,629.47.
[2] In the High Court, the liquidators claimed that Mr Samsa was in breach of his duties as a director contained in ss 131(1), 135, 136 and 137 of the Companies Act 1993 and that he had failed to keep proper accounting records for the company. They sought orders requiring Mr Samsa to pay Peace and Glory an amount which, in effect, was unpaid GST plus interest and penalties (totalling $63,349.31 at the date of the High Court hearing) plus the liquidators’ fees, a total approaching $120,000.
[3] In a judgment of 9 October 2008, Hugh Williams J rejected the liquidators’ claim in its entirety. The liquidators appeal only with regard to the Judge’s rejection of their claim under ss 136 and 301 of the Companies Act (set out in relevant part at [43] [46] below) with regard to GST.
[4] The liquidators’ position is that, in selling the company’s sole asset (the Northcote property), the company incurred an obligation to pay GST. They say that Mr Samsa was aware that the company was insolvent and acknowledged in correspondence with the IRD that the GST obligation on the sale could not be met. In breach of s 136 Companies Act, Mr Samsa then caused the company to incur an obligation (GST) knowing that it could not be met.
[5] The liquidators say that Hugh Williams J failed to take the correct approach when considering the appropriate contribution Mr Samsa should make. The Judge should first have considered whether there had been a breach of s 136 and could only have concluded that there had been for the reasons set out at [4]. The Court should then have considered, in terms of s 301 of the Companies Act, the extent to which Mr Samsa, as director, should be made to contribute to the debts of the company. In the circumstances, the liquidators say that Mr Samsa should have been ordered to pay an amount equivalent to the GST plus interest and penalties.
[6] Before examining the liquidators’ contentions, we first set out the background in more detail, summarise High Williams J’s judgment, discuss the legal test and summarise the submissions of the parties.
Background
[7] On 22 April 2000, Peace and Glory entered into an agreement to purchase a property in Northcote (the Northcote property) for $350,000. A deposit of $70,000 was paid. On 25 May 2001, a mortgage in favour of the ASB for the amount of $281,733.25 was registered on the title of the property.
[8] On 31 May 2001, Mr Samsa filed a GST return on behalf of Peace and Glory claiming the amount of $39,255.27, being the amount of GST paid in the purchase of the property. This amount was paid to Mr Samsa.
[9] On 28 August 2002, Mr Samsa executed a mortgage document on behalf of Peace and Glory granting a mortgage in favour of Mr Samsa’s mother, Mrs Rosalia Samsa, in the amount of $160,000. On 19 January 2004, this mortgage was registered on the title of the Northcote property. We note that, on 12 November 1999, Mrs Samsa had transferred $159,881.54 to Mr Samsa.
[10] Between 1 January 2000 and March 2004, Peace and Glory spent approximately $129,000 from its cheque account. Of this sum, approximately $125,000 was spent attempting to improve the property and increase its value.
[11] In October 2003, the IRD began investigating Peace and Glory in relation to the GST returns filed by Mr Samsa on behalf of the company. On 7 October 2003, Mr Samsa wrote a letter to the IRD on Peace and Glory’s behalf, explaining that he had envisaged developing the Northcote property in two stages: first the redevelopment of the current house and then the building of another house. Stage One had taken longer and been more expensive than he had anticipated. As a consequence, he had moved into the property to complete the renovations. He, however, paid a market rental to the company and GST was accounted for. Mr Samsa indicated that, if the company were forced to sell the property in its current state, it would not be able even to clear the first mortgage debt and thus the company would not be able to “refund GST back to the IRD”. In relevant part the letter said:
My prime objective is to complete stage one, with the view to revalue the property then refinance which will allow me to commence stage two. I am also depending on some financial help from my family in Italy and there is a prospect that I may be able to borrow funds from my family and assist me to complete stage two. Once again, the prime objective is to complete both stages and in turn sell both properties. However, I have tried to sell the property in the past but I was recommended by real estate agents that I was to totally complete the property prior to placement on the market. I am also facing the problem that I have borrowed $380,000 on first mortgage and regretfully, the valuation only came up to $357,000. It is quite clear that should I sell the property at this present stage I will not be able to clear my encumbrance, refund GST back to the IRD, and without a doubt I will incur a big loss. It is paramount that both stages are completed to maximise the full value of the property. If I am forced to sell the property at this point in time, unless it is completed, I will not be able to achieve the true value, nor will I be able to clear my indebtedness.
[12] On 9 October 2003, Mr Samsa went to the offices of the IRD to discuss Peace and Glory’s GST returns. The IRD wrote a letter after that meeting saying that it would be necessary for the investigator to view the property and asking for some further information. In particular, the letter asked for:
Confirmation that the property is again listed for sale and what the asking price is.
[13] In March 2004, Mr Samsa entered into a written contract to purchase the property from Peace and Glory for $395,000. No deposit was paid. In order to fund the purchase Mr Samsa borrowed $330,000 from the TSB. From the $330,000 borrowed, Mr Samsa made the following payments: $287,854.33 to the ASB in settlement of the loan to Peace and Glory on 23 April 2004; $10,000 to his solicitor’s trust account on 29 June 2004; and $30,000 to his solicitor’s trust account on 13 August 2004: see at [20] below.
[14] The date on which the purchase was settled is not clear but the loan agreement between Mr Samsa and the TSB with regard to the $330,000 was entered into on 6 April 2004, with the funds being advanced on 23 April 2004. The title for the Northcote property shows registration of the transfer (dated 6 April 2004) to Mr Samsa on 5 May 2004, followed by registration of the mortgage to TSB on 6 May 2004. Registration of a deed reversing the priority of the mortgage to Mrs Samsa (see at [9] above) and the TSB mortgage occurred on the date of registration of the TSB mortgage.
[15] The settlement statement with regard to the property rendered to Mr Samsa by his solicitor shows the purchase price of $395,000, the TSB advance of $330,000, a “second mortgage taken over $160,000” followed by “reduction in second mortgage $40,000”, with the debit balance of $52,854.33 shown as “loan to Peace and Glory Society to enable settlement”. The date on the settlement statement, 7 November 2005, was five weeks after Peace and Glory’s liquidation. Mr Samsa’s explanation was that the settlement statement was furnished after the liquidators contacted the company’s solicitor requesting the document.
[16] In a letter sent on 4 May 2004, Mr Samsa, on Peace and Glory’s behalf, wrote to the IRD setting out the rationale for his purchase of the Northcote property from Peace and Glory: essentially that there were no funds available to complete the development and any sale on the open market would achieve a worse financial result for the company. Mr Samsa also said that he believed that the lack of real estate fees would help the company meet its obligations. After explaining the financial position of the company post sale, Mr Samsa offered $30,000 to the IRD in full and final settlement of the GST liability of Peace and Glory. In relevant part the letter said:
As you have been carrying out independent investigation regarding this property as well as my and Peace and Glory Society finance status. However, you must have concluded as I have, that no matter how this property is sold with renovations completed or as it is, the outcome is that there is not enough money to settle all my encumbrances on the above property, nor do I have the facilities to do so.
Consequently, I have reviewed my financial position and have concluded that I am not in the foreseeable future in a position financially to complete the remaining alterations to my property within the time frame stipulated by the IRD. Assuming that I was in a position to complete the remaining work on the property it is quite clear, irrespective of sale price achieved, it would not enhance my financial position and thus enables me to refund or partly refund the Inland Revenue of the outstanding GST, according I consulted my Solicitor and Financial Advisor as to how to deal with this matter.
In their view, the only alternative under the circumstances was to sell the property in its present state to myself. In order not to disadvantage the IRD I took precaution to ascertain the real value of the property as it is or completed prior me entering into a Sale and Purchase Agreement. ...
The rationale behind this transaction is:
However, having clarified the above factors, I believe it made commercial sense the course that I have chosen to follow. All this has only been made possible due to the following agreement reached with the second mortgagee.
Terms and conditions as follows:
Taking into consideration all the factors described above, as well as my present financial position, I would be grateful if the IRD would please accept $30,000.00 as in full and final settlement for the indebtedness of Peace and Glory Society. ...
In the event that you are not prepared to accept the above proposal, I am aware that the IRD could wind up Peace and Glory Society Ltd.
Nevertheless, I do not see any commercial merit or benefit by the IRD pursuing this route. Bearing in mind that Peace and Glory Society Ltd at this point in time has no assets whatsoever and is an empty shell.
[17] On Peace and Glory’s behalf, Mr Samsa had filed GST returns for the two periods ended 31 March 2004 and 30 April 2004 stating that no GST was payable by the company to the IRD. On 16 July 2004, the IRD wrote to Mr Samsa and the company acknowledging receipt of statements of financial position and enclosing an Agreed Adjustment form detailing the “necessary adjustments required to correct the tax position adopted by you on 27 May 2004 when you lodged the company return for the period ended 30 April 2004 as nil”. The IRD said that possible penalty imposition was to be considered, and the “first step towards resolution is to either accept or decline the Agreed Adjustment as proposed” and the second was to require resolution of any penalty which could apply. This would necessitate Mr Samsa providing a written explanation as to the reasons for filing nil GST tax returns for March and April 2004.
[18] On 21 July 2004, Mr Samsa wrote to the IRD stating that he had “inadvertently” filed a nil GST return for the period ended 31 May 2004 and that it should have included the GST component ($43,888.89) of the sale by the company of the property to Mr Samsa. On 22 July 2004, Mr Samsa filed an amended GST return for the period ended 30 April 2004 including the GST payable on the sale of the property. Mr Samsa’s letter of 21 July read as follows:
As you may be aware, the issues between Peace and Glory Society Limited and the IRD have been in progress for several months. I had sought advice from many sources and received correspondence from the IRD.
I found the situation to be very confusing so far as procedures goes, and until I got things further clarified I thought it would be acceptable to file a nil return for an interim period. I was also waiting for a response to my proposal but have since been advised this cannot be discussed further until the GST on the sale is declared.
My apologies for the inconvenience. I now enclose the GST return which declares the sale of the house at $395,000 with a GST component of $43,888.89.
I have been advised this will assist in establishing outstanding sums to the IRD and help in resolving matters.
At your earliest convenience, please assign a case officer to me who can discuss my proposal to settle my debt with the IRD, I am very anxious about this situation and wish to bring matters to a close as I am sure the department does.
[19] On 5 August 2004, the IRD issued a summary of account to the company showing the amount of $46,035.71 as being required to clear the company’s account with the IRD. This included some small GST amounts owing from earlier periods.
[20] After the IRD declined to compromise the company’s GST debt at $30,000 (see the offer noted at [16] above), Mr Samsa’s solicitor’s trust account records show payments to reduce the second mortgage of $10,000 on 29 June 2004 and of $30,000 on 13 August 2004. While the trust account records show payments of $10,000 and $30,000, the request from the solicitors to the bank dated 20 September 2004 was to transfer the sum of $38,120.16 converted to euros to Mrs Samsa’s bank. A receipt from the bank in Mrs Samsa’s name dated 21 September 2004 acknowledges receipt of €20321,86.
[21] Peace and Glory was placed into liquidation on the petition of the IRD on 13 October 2005. The debt owed to the IRD at the date of liquidation was $63,349.31. The actual GST amount was $46,209.13. The remainder was made up of late payment penalties and interest.
High Court judgment
[22] In the High Court, the liquidators claimed that Mr Samsa, as director of Peace and Glory, allowed it to incur obligations without believing on reasonable grounds that it would be able to perform these obligations. It was also claimed that Mr Samsa breached his duty to act in good faith and in the best interests of the company, his duty not to allow the company’s business to be carried on in a manner likely to cause serious loss to creditors and his duty to exercise the care, diligence and skill of a reasonable director (Companies Act ss 131(1), 135, 136 and 137).
[23] A second cause of action was that Mr Samsa failed to keep proper accounting records under ss 194 and 300(1)(b) of the Companies Act by failing to have a minute book, annual accounts or financial records or statements for Peace and Glory thus contributing to its failure to pay the IRD, its only proved creditor, which in its turn “resulted in substantial uncertainty as to the liabilities” of Peace and Glory or “substantially impeded the ordinary conduct” of its litigation.
[24] While admitting most of the factual assertions, Mr Samsa denied the pleaded legal consequences.
[25] It was first alleged that Mr Samsa did not act in good faith and in the best interests of the company by “constructing documentation” transferring Mrs Samsa’s loan to him into a loan to an unincorporated company; permitting Peace and Glory to grant a mortgage to Mrs Samsa for $160,000 when that amount had not been received by the company; by not transferring to Peace and Glory the $159,881.54 received from his mother; and including in Mrs Samsa’s mortgage the amount payable “to the company when [Mr Samsa] purchased the property when this mortgage/loan was never owed by the company”. These allegations were rejected by Hugh Williams J. The Judge held that Mr Samsa was, in effect, merely holding the funds on his parents’ behalf until it was legally possible to transfer them to Peace and Glory or alternatively, that Mr Samsa assigned the burden of his debt to his parents to the company to perfect the arrangement as set out in the acknowledgement of the debt, and, later, the required second mortgage.
[26] The next allegation was that Mr Samsa had failed to pay a market price for the property and either permitted the company not to pay GST when it arose or failed to ensure sufficient funds were retained for that purpose. Hugh Williams J noted that there was not a great deal of evidence as to how the $395,000 price for which Mr Samsa agreed to buy the Northcote property from Peace and Glory in early 2004 was settled upon, but considered that it had a certain comparability with the $350,000 paid in April 2000 plus the costs of the renovations and, more importantly, was accepted on 25 May 2004 by the IRD as “fair and reasonable based on the market aspirations applied by your real estate agent”. That acceptance, supported as it apparently was at the time by those operating in the property market, was sufficient in Hugh Williams J’s judgment to dispel the suggestion that Peace and Glory sold the Northcote property to Mr Samsa at an under-value.
[27] The Judge noted that Peace and Glory had apparently met its renovation costs to date but had no funds to complete the renovations and could not raise more either from institutional lenders or from Mr Samsa and his family. The company’s sole asset was accordingly a partly-renovated property on which it owed significantly more than the property was worth. The property was unsaleable on the open market in its then condition at anything like a price that would meet its debts, including GST payable on sale.
[28] At trial, evidence for the liquidators was given by Mr Levin. His evidence was that Mr Samsa, had he kept proper financial records for the company, would have known of the company’s insolvency and would have taken professional advice as to the courses open to the company. They would have included placing the company in liquidation, inviting the ASB to sell by way of mortgagee sale or endeavouring to sell the property on the open market. However, the Judge noted that each of these was likely to result, first, in GST liability and, secondly, in an overall deficiency in the company’s financial affairs.
[29] Of those options, Mr Samsa gave evidence that he had endeavoured to sell the property on the open market but, in its unfinished state, was unable to find a buyer, or at least not one at a price high enough to meet the company’s debts. The Judge said that selling by way of an invited mortgagee sale may have been the option which would have yielded the least deficiency but, so far as the evidence goes, the possible impact on that means of disposal of GST was not expressly considered. Nor did Mr Samsa approach ASB to sell. Had he done so and the house been sold, a deficiency would still have resulted. There is also no evidence that Mr Samsa seriously contemplated liquidation at that point. Nor did he consider the possible GST impact were that course of action followed. There was limited evidence that he took legal or other advice at the time on the company’s behalf as to the best course of action.
[30] The Judge held that in the circumstances, Mr Samsa took what he regarded as the least unattractive of those options and bought the company’s asset for an appropriate price, taking on additional debt to do so. The Judge accepted that, in doing so, Mr Samsa freed himself from his guarantee of the ASB mortgage but he took on $40,000 extra in institutional debt, lent the company over $52,000 to settle when he must have known that loan was likely to be irrecoverable and also remained liable to his mother. Therefore, what the sale by Peace and Glory to Mr Samsa did achieve was to free the company from the secured debts but at the loss of its only valuable asset, albeit at a fair and reasonable price. On the other hand, Mr Samsa acquired an asset then worth $395,000 but with debts totalling $450,000.
[31] Further, the Judge considered that it could not be said Mr Samsa was unmindful of Peace and Glory’s GST debt arising from the sale. As the correspondence shows, he made earnest attempts to compromise a debt then of $43,888.89 for $30,000 and it would appear it was only the IRD’s rigid adherence to its standard practices and its refusal to compromise that led to Mr Samsa later utilising the $40,000 held by the solicitor towards Peace and Glory’s GST liability in partial repayment of his indebtedness to his mother.
[32] In the end, the Judge’s view was that Mr Samsa, acting as Peace and Glory’s director, chose the least unattractive of the few choices available to the company in buying the Northcote property from it. In short, Mr Samsa knew that, because of its insolvency, Peace and Glory could not continue to incur debt or trade and he arranged for it to do the best it could in the circumstances, namely to sell its only asset at the best price and on the best terms available. In the Judge’s view, that did not attract liability in terms of the present claim.
[33] Further, although Mr Samsa’s actions as director of Peace and Glory may not have complied to the letter with what was the optimal behaviour for directors in such circumstances, the view to be taken is that Mr Samsa had an honest belief that what he was doing was taking the best choice of the poor choices available to the company. The Judge considered that it had not been demonstrated that, when viewed objectively, a reasonable director in the same circumstances would not have made the same choices.
[34] The Judge then turned to the allegation that Mr Samsa had failed to exercise the care of a reasonable director in allowing the company to spend $125,000 on the property and that he had permitted its solicitor to prepare a “false” settlement statement for the purchase of the property. The Judge noted that precisely how much first Peace and Glory and then Mr Samsa had spent on improving the Northcote property could almost certainly not be calculated. Mr Samsa said it was at least $125,000 to about October 2003 and there seemed to be no basis to dispute that. Accepting that estimate, the Judge noted that the $125,000 did no more than increase the value of the Northcote property from $350,000 at purchase by the company to $395,000 when it was bought by Mr Samsa. Seen just in that light, it was a poor investment at that stage. The Judge remarked that it may remain so currently, although it is noteworthy that a September 2008 valuation assessed the value of the house at $460,000 and omits all reference to the possibility of subdivision.
[35] More particularly in terms of the pleading, although the conclusion was somewhat speculative, the Judge considered that it could not be said that in permitting Peace and Glory to spend perhaps $125,000 on the Northcote property prior to early 2004 Mr Samsa failed to exercise the care, diligence and skill expected of a reasonable director. In the rapidly rising market which existed throughout the period, there was no evidence the purchase price and the substantial sums expended on renovation might not ultimately be recouped.
[36] As far as the settlement statement is concerned, while there was no explanation as to why it was not prepared until 7 November 2005 and why it was drawn up in Mr Samsa’s name not that of the company, the Judge did not consider that these factors would justify a conclusion that it was “false”.
[37] Turning to the allegation of failing to keep proper accounting records, the liquidators had pleaded that Mr Samsa failed to ensure that Peace and Glory kept accounting records in accordance with s 194 of the Companies Act and that contributed to its inability to pay all its debts including GST. It also allegedly resulted in “substantial uncertainty” as to its liabilities and “substantially impeded” the liquidation.
[38] Hugh Williams J accepted Mr Levin’s evidence that Mr Samsa had failed to ensure Peace and Glory kept financial records in a form which would satisfy s 194. But he considered that this would not necessarily lead to the view that Mr Samsa’s failure in that regard contributed to the company’s failure to pay all its debts on liquidation.
[39] The Judge held that in late 2003 Mr Samsa knew in a general way, even without the required financial records, that the company was significantly insolvent. It was not therefore the lack of proper financial records which contributed to Peace and Glory’s inability to meet all its debts but simply the fact the company’s debt burden was too great for the value of its asset and it was under-capitalised. Thus, the necessary causative link between lack of the required financial records on the one hand and their absence contributing to the company’s inability to meet its debts on the other was not proved.
[40] As to the allegation that the lack of financial records substantially impeded the orderly conduct of the liquidation, the Judge noted that there certainly seemed to have been difficulty in Mr Samsa complying with all the liquidators’ demands for the provision of documents and information and he was open to criticism on that score. However, the Judge noted that it equally seemed that much of the material sought by the liquidators was in the possession of the IRD for a lengthy period and it was noteworthy that the liquidators never sought third party discovery to access that material earlier. Lack of strict compliance with s 194 of the Companies Act did not therefore lead to the conclusion that that factor impeded the liquidation.
[41] The Judge remarked that it was a curious feature of this case that no accounts from the liquidators were put in evidence. On the face of it, with a company having no assets at the date of liquidation and only one proved creditor, this would have all the appearances of a straightforward liquidation able to be completed at modest cost. Yet the liquidators’ costs exceeded $60,000. However, it appeared that the liquidators’ charges included all their solicitors’ fees, both generally in relation to the liquidation and specifically in relation to this litigation. The liquidators accepted that, at best, only the former could be included in the claim, leaving the latter to be dealt with in the usual way. However, because of the result reached on the legal issues, no further consideration of that aspect of the matter was required.
[42] In the result all the claims against Mr Samsa were dismissed.
The legal position
[43] Section 136 of the Companies Act provides:
Duty in relation to obligations
A director of a company must not agree to the company incurring an obligation unless the director believes at that time on reasonable grounds that the company will be able to perform the obligation when it is required to do so.
[44] Professor Farrar in Corporate Governance, Theories, Principles and Practice (2008 3ed) at 174 has described the purpose of s 136 as being to deal with obligations on capital account such as major investments. It focuses on a particular transaction rather than the general conduct of the company’s business. By contrast, s 135 deals with the debts on revenue account.
[45] As Mr Dickey submits, there are three key elements to a claim for a breach of s 136:
(a) That the defendant was a director of the company;
(b) That an obligation was incurred by the company; and
(c) That at the time of incurring the obligation, the defendant did not honestly believe on reasonable grounds that the company would be able to perform the obligation when it was required to do so.
[46] Section 301 of the Companies Act provides in relevant part:
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 ... 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— ...
(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.
[47] As Mr Dickey noted in his submissions, s 301 has been described by this Court as being analogous to a derivative type of 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” inter alia its directors: Sojourner v Robb [2007] NZCA 493; [2008] 1 NZLR 751 at [15] and [53]. Section 301 does not of itself impose any duties on directors, but is rather a means of enforcement against directors who have 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.
[48] We accept Mr Dickey’s submission that claims brought pursuant to s 301 are to be approached in two stages. First, the Court should consider whether there has been breach of duty (or duties). Secondly, the Court should, in its discretion, determine whether and to what extent a director should be required to contribute to the assets of the company. This approach was approved by this Court in Mason v Lewis [2006] NZCA 55; [2006] 3 NZLR 225, when dealing with an alleged breach of s 135, at [55]:
What the legislature has done is to enact an objective requirement in s 135(b). But if there has been a breach, the Court has discretion as to what the recovery should be required under s 301 of the Act. This is why it is important not to conflate the two sections at the outset.
The liquidators’ position
[49] Mr Dickey submits that Hugh Williams J failed to follow the two stage approach set out at [46] above. While Mr Dickey accepts the factual findings of Hugh Williams J, Mr Dickey submits that the Judge erred in applying s 136 to those facts. In Mr Dickey’s submission, the Judge did not directly address s 136 but erroneously dealt with the matter “in the round”. Mr Dickey submits that a layer has been added to s 136 whereby a director may escape liability provided he or she can demonstrate an honest belief that what he or she was doing was taking the best choice of the poor choices available. This approach conflated distinct considerations and led the Judge to deny liability on the basis of Mr Samsa’s “predicament”. In Mr Dickey’s submission, while this could properly have been taken into account when assessing the contribution to be made under s 301, it should not have affected the Court’s determination as to whether s 136 had been breached.
[50] Mr Dickey submits that all three elements in s 136 are met (set out at [45] above). Mr Samsa was a director of Peace and Glory. He, by purchasing the property from Peace and Glory, caused a GST obligation to arise for the company, which he knew the company could not meet. As evidence that Mr Samsa knew the GST could not be paid, Mr Dickey points to the letter of 7 October 2003 (see at [11] above) where he said that, if the property were to be sold, the amount received would not cover the encumbrances and the GST payable on the sale. Mr Dickey also points to the letter of 4 May 2004, which was written after entering into an agreement to purchase the property. In Mr Dickey’s submission, that letter demonstrates that there had been no change in Mr Samsa’s belief that the GST incurred on the sale could not be paid.
[51] Turning to the discretion as to contribution, Mr Dickey referred to the test promulgated by this Court in Mason v Lewis. In that case it was held that the three factors relevant to the exercise of the Court’s discretion under s 301 are causation, culpability and duration, he submitted that the last factor cannot sensibly be applied where a breach of s 136 (as against s 135) is involved. Mr Dickey did submit, however, that although the duration of a company’s insolvency before a debt caught by s 136 is incurred would be a factor weighing in favour of contribution.
[52] In this case, Mr Samsa clearly caused the GST liability to arise and, in Mr Dickey’s submission, Mr Samsa’s culpability was high. If this Court does deem that Mr Samsa’s contribution should be less than 100 percent, then any discount must be minimal.
[53] Mr Dickey points out that, after the company had reached an insolvent position, Mr Samsa created a new creditor (the IRD) so as to improve the position of the existing creditors. In undertaking the sale Mr Samsa was acting in the position of a quasi liquidator and against the fundamental principles of this part of the Companies Act. Mr Dickey submits that when Mr Samsa identified that the company was irretrievably insolvent, he should have caused it to cease trading and immediately appointed liquidators. At the very least, he should have sought professional advice.
[54] Mr Dickey notes that, on any scenario, GST would have been paid on a sale and so the IRD’s position was compromised by the course Mr Samsa took:
(a) In the event of a solvent company selling a property, GST is paid in the normal course.
(b) Had the company ceased to trade and gone into liquidation, GST on the sale would had to have been paid by the liquidator.
(c) Had the mortgagee entered into possession, the mortgagee would have met the GST obligation on the sale.
[55] Mr Dickey submits that, when considering the exercise of the discretion as to contribution, the Court should take into account the fact that the IRD is an involuntary creditor. It is therefore entitled to a significant level of protection. This is particularly so where a company has had the benefit of a GST refund on the purchase of the property.
[56] Mr Dickey also invites the Court to look globally at Mr Samsa’s conduct during the period 1999 to 2004 and points to Mr Levin’s evidence that the proper time to have sold the property was immediately after purchase.
Mr Samsa’s position
[57] Mr Swan, for Mr Samsa, accepts that Mr Samsa fits squarely into the three key elements of s 136 of the Companies Act in that as a director he agreed to incur an obligation when he knew that the company was not able to perform it. However, he submits that whether or not Mr Samsa can be found liable for breaching his duties in relation to obligations must be viewed in light of the purpose of s 136. In Löwer v Traveller [2005] NZCA 187; [2005] 3 NZLR 479 (CA) McGrath J stated, at [78], that the principal purpose of the predecessor section to s 136 was to compensate those who suffer loss as a result of illegitimate trading. Mr Swan submits that Mr Samsa did not benefit and in fact incurred a greater personal debt by the purchase of the property from the company. Mr Swan submits that this can hardly be seen as illegitimate trading.
[58] Further, Mr Swan points out that, when Mr Samsa realised that Peace and Glory was insolvent, he took immediate action to sell the company’s only asset for a fair value, unlike in Fatupaito v Bates [2001] NZHC 401; [2001] 3 NZLR 386 (HC) where Mr Bates continued trading for several months when it was apparent that the financial position of the company had deteriorated significantly. Equally, in Goatlands Limited (in Liquidation) v Borrell [2006] NZHC 1576; (2007) 23 NZTC 21,107 (HC) Goatlands used a GST refund from an agreement to purchase a property at a time when it was highly uncertain that it could settle the purchase. As it turned out Goatlands could not raise settlement funds to enable the purchase to be completed.
[59] Mr Swan submits that even if he is wrong in submitting that there has been no breach of s 136, Hugh Williams J was correct to concentrate on Mr Samsa’s awareness of the company’s insolvency and his restricted and “unenviable range of options” when determining what the recovery against Mr Samsa should be in his s 301 determination. Mr Samsa took the least unattractive of those options, which was the purchasing of the company’s only asset at an appropriate price and taking on additional debt to do so. Of significance too, in Mr Swan’s submission, were the earnest attempts made by Mr Samsa to settle the outstanding GST debt arising from the sale by offering $30,000.
[60] In the circumstances, it is submitted that Mr Samsa acted genuinely (albeit perhaps incorrectly) in effecting the purchase, which he thought was the best solution. He acted quickly and decisively in an attempt to protect creditors’ and investors’ money. It is further submitted by Mr Swan that the IRD essentially gave its blessing to the sale. It considered the value was fair and took no steps to stop the sale. Nor did it attempt to put the company into liquidation at an earlier stage. Mr Swan submits that it is apparent that the IRD stood by as Mr Samsa undertook the steps he did.
[61] Mr Swan also submits that the liquidators are wrong to submit that whatever course Mr Samsa had taken, whether by the sale by the company or the mortgagee or the liquidator, GST was to be paid as a priority debt. In Rob Mitchell Builder Limited (In Liquidation) v The National Bank of New Zealand Limited [2003] NZCA 276; (2004) 21 NZTC 18,397 at [1], [13] and [29] this Court addressed that exact situation. The Court set out the different consequences under the Goods and Services Tax Act 1985 depending on who sold the property. Essentially, if a mortgagor completes a sale before liquidation the Commissioner ranks as an unsecured creditor. Alternatively, if a mortgagee sells the property then the Commissioner obtains priority. Finally, if a liquidator sells a property, he or she will be personally liable for the GST on any sale. In those circumstances, a liquidator is likely to insist on the mortgagee selling the property.
[62] Mr Swan submits that essentially the liquidators are saying that the company should have been put into liquidation prior to the sale so that the IRD would then obtain priority from the sale proceeds. The liquidators disregard what price could have been obtained for the property if that course had been followed but rather stress the interest in the IRD obtaining full repayment in priority over the secured creditors. In his submission, that approach is wrong in principle.
[63] In summary, whether or not the High Court took the correct two stage approach, it is submitted by Mr Swan that, in the circumstances of the present case, the result was correct and Mr Samsa should make no contribution to the liquidation.
Our assessment
[64] Mr Swan accepts on behalf of Mr Samsa that the three elements in s 136 of the Act were met. This concession was well made. Mr Swan submits, however, that there should be a gloss added to s 136 (see at [57]). We do not accept that submission. If the three elements set out in s 136 are present then there is a breach of duty. In order to assess the consequences of that breach of duty, a Court must turn to s 301 of the Act. It is at that stage that the matters regarding Mr Samsa’s culpability, which Mr Swan refers to at [57] and [58], may be taken into account.
[65] Turning to the High Court judgment, Mr Dickey submits that Hugh Williams J dealt with the matter “in the round” and that he made an error of principle in failing to carry out the required two-step analysis of first considering any breach of duty and then determining an appropriate contribution (if any): see at [48] above.
[66] In our view, it is unsurprising that Hugh Williams J dealt with the matter “in the round”. The liquidators’ claim constituted a wide-ranging attack on Mr Samsa’s actions as director from the inception of the company. We summarised Hugh Williams J’s judgment in some detail to give a flavour of the extent of the challenge. While we do not have a copy of the liquidators’ submissions in the High Court, it does not appear from Hugh Williams J’s judgment that there was the same focus on s 136 as there has been in this Court. In the High Court, the issue of GST was tied in with allegations of the purchase being at an undervalue and the second mortgage not being genuine. It is understandable that there was concentration by the liquidators (and therefore by the Judge) on those aspects. If either of these allegations had been upheld, then there would have been active dishonesty on the part of Mr Samsa and a clear case for contribution. However, in the event, both of these allegations were rejected.
[67] We do accept that the proper two stage analysis was not explicitly addressed in Hugh Williams J’s judgment. However, while the Judge expressed his judgment in terms of whether or not there was a breach of duty, in our view he was implicitly assessing the level of culpability involved in Mr Samsa’s actions (as would be required in any analysis under s 301), having accepted that the purchase of the property by him had triggered a GST liability which clearly could not be met by Peace and Glory (ie the breach of s 136). Thus, although not explicitly following the two stage process set out in Mason v Lewis, in our view Hugh Williams J took into account both stages in his overall analysis.
[68] Even if Hugh Williams J failed to find a breach of s 136 and then to consider s 301 separately, this would not necessarily lead to the appeal being allowed. If the factors taken into account by Hugh Williams J could legitimately have been taken into account by him in any s 301 analysis and his decision in light of those factors has not been shown to be wrong, then the appeal must be dismissed.
[69] We do not consider Hugh Williams J was wrong to take into account, when considering the proper contribution under s 301, what he called Mr Samsa’s dilemma: to allow the insolvent Peace and Glory to continue to accrue the holding costs of the property (ie incur more debt) or to bring the matter to a head by purchasing the property. It seems clear that the property was unsaleable on the open market, at least for a price that would have cleared the company’s debts. Indeed, Mr Dickey accepts that Mr Samsa’s dilemma was a relevant consideration in considering the extent of any contribution under s 301, as noted above at [49].
[70] Mr Dickey submits, however, that the history of Mr Samsa’s running of the company throughout its life should be taken into account. This submission cannot survive the findings of Hugh Williams J in this regard: see at [34], [35] and [39] above. Mr Dickey also submits that, instead of causing Peace and Glory to sell the Northcote property to him knowing that the resulting GST liability could not be met, Mr Samsa should instead have placed the company into liquidation or asked the ASB to sell the property. If he had done that then, so Mr Dickey argues, the IRD would have recovered GST as a priority debt.
[71] We are not sure that matter is quite so clear cut. It is not explicitly set out in the evidence what path the IRD investigation of Peace and Glory was following. However, reading between the lines, it appears that the IRD was investigating whether there had been a change of use in relation to the Northcote property from use in a taxable activity (development) to private or exempt (residential renting) use. A change of use would have triggered a GST adjustment, even without any sale of the property.
[72] If we are right about the focus of the IRD investigation, then Mr Samsa’s dilemma was even more marked than Hugh Williams J noted. Peace and Glory risked being considered liable for output tax whether or not there was a sale because the IRD, if there had been no sale, may well have taken the view that there had been a change of use triggering an output tax obligation. We note that the IRD, in its letter of 9 October 2003 (see at [12] above), effectively required the property to be put on the market, despite being told that there would be a GST shortfall. We accept Mr Swan’s submission that this diminishes Mr Samsa’s culpability considerably.
[73] It is also relevant in our view that (on the findings of the High Court) Mr Samsa paid fair value for the property. There were some personal advantages to him in the course he took but also additional debt. Further, he made a genuine effort (by way of an arrangement with his mother, the second mortgagee) to provide a suggested settlement of the GST liability of $30,000. Although Mr Samsa did not expressly consider the different effects of other means of disposal (such as via mortgagee sale), at least this means that he did not deliberately choose a course designed to disadvantage the IRD.
[74] We do accept that the IRD was in an unenviable position as an involuntary potential creditor of Peace and Glory. An input tax credit had been claimed by the company but the control over the timing of any liability for output tax rested with the taxpayer (in terms of the decision when to sell the property and/or whether there would be a change of use triggering an output tax liability). Further, until the liability to pay output tax actually arose upon sale or change of use, there was no debt and therefore no ability to undertake enforcement steps (such as taking steps to liquidate the company). It is also true that the IRD is an unsecured creditor if there is a sale by the taxpayer but that it is in a privileged position with regard to GST if there are enforcement steps by a mortgagee. In the case of a mortgagee sale, GST effectively becomes a priority debt. The same applies if there is a sale by a liquidator: see at [61] above. We remark that this could conceivably create a reluctance on the part of secured creditors to undertake enforcement steps and may impede a liquidation. But these consequences appear to us to be an issue with the design of the system where the nature of the priority for the debt depends on who sells.
[75] As a final point, we note that s 301 refers to a contribution by the director by way of compensation. This means that any contribution has to be equated with what was lost. If Mr Samsa had done what Mr Dickey submits he should have done (ie liquidated the company or asked the ASB to enforce its security), GST output tax on the sale would have been paid. No question of penalties or late payment interest would have arisen. Thus the loss from the wrongful act could not, it seems to us, extend to other than the actual GST amount (and not to penalties or use of money interest), although possibly interest at an appropriate rate could have been awarded pursuant to s 301(1)(c).
Result and costs
[76] For the reasons set out above, we have not been persuaded that Hugh Williams J’s assessment was wrong. The appeal is therefore dismissed.
[77] Given the clear breach of s 136 of the Companies Act by Mr Samsa, however, there are no costs orders.
Solicitors:
Meredith Connell, Auckland for Appellants
Walker
Associates, Auckland for Respondent
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URL: http://www.nzlii.org/nz/cases/NZCA/2009/396.html