Groves v TSSN Ltd (in liquidation) [2012] NZHC 2402; [2013] 1 NZLR 111; [2013] NZCCLR 2 (17 September 2012)

Last Updated: 26 January 2018

For a Court ready (fee required) version please follow this link

IN THE HIGH COURT OF NEW ZEALAND WELLINGTON REGISTRY

CIV-2011-485-2643 [2012] NZHC 2402

BETWEEN ELLIOT MUNRO GROVES Applicant

AND TSSN LIMITED (IN LIQUIDATION) Respondent

Hearing: 22 August 2012

Counsel: K P Sullivan for Applicant

K J Crossland for Respondent

Judgment: 17 September 2012

In accordance with r 11.5 I direct that the delivery time of this judgment is 3.00 pm on the 17^th day of September 2012.

_{RESERVED JUDGMENT OF MACKENZIE J}

Table of Contents

Introduction ..............................................................................................................[1] Background...............................................................................................................[5] The legislation...........................................................................................................[9] The timing of this application ...............................................................................[12] The procedure for the application ........................................................................[20] The grounds of the application .............................................................................[26] The purposes of the phoenix company provisions ..............................................[27] The transaction between the failed company and the phoenix company .........[33] The test to be applied .............................................................................................[53] The application of the test .....................................................................................[58] Result .......................................................................................................................[72]

GROVES v TSSN LIMITED (IN LIQUIDATION) HC WN CIV-2011-485-2643 [17 September 2012]

Introduction

[1] This is an application for an order under s 386A of the Companies Act 1993 (the Act) granting the applicant permission to be a director and manager of Stepping Stones Nursery Ltd, a “phoenix company” within the definition in s 386B of the Act.

[2] The broad effect of the phoenix company provisions, s 386A to 386F of the Act, is to prohibit a person who has been a director of a company which has been placed in liquidation at a time when it was unable to pay its due debts (a failed company) from being a director of, or directly or indirectly involved in the management of a company which is known by the pre-liquidation name of the failed company or a similar name (a phoenix company), for a period of five years after the liquidation of the failed company.

[3] The permission of the Court is required in this case because Mr Groves was a director of TSSN Limited (in liquidation), a “failed company” in terms of the definition in s 386B, and has at all times since its incorporation been a director of the phoenix company.

[4] The phoenix company provisions were inserted by the Companies Amendment Act 2006, with effect from 1 November 2007. According to counsel’s researches, this is the first contested application to the Court for permission under s 386A. The only case which counsel could find on the section involved an uncontested application.¹

Background

[5] The company now called TSSN Limited was formed in June 1989. From December 1992 until June 2010, its name was The Stepping Stones Nursery Limited. I refer to it as “TSSN”, or “the failed company”. Its shareholders and directors were the applicant Elliot Munro Groves and his brother Peter William Groves. I will refer to them as Elliot and Peter. TSSN carried on a nursery business, growing and selling

_{deciduous ornamental trees primarily for export. TSSN carried out business}

¹ Bear v CDA Consulting Group Limited (in liq) HC Auckland CIV-2011-404-2837, 1 June 2011.

profitably until about early 2007. Its resources were stretched when it acquired the business of Duncan and Davies, a long established nursery business, in March 2006. Soon after, its business suffered a major setback from significant declines in its North American and Western European markets following the global financial crisis of 2008. TSSN incurred significant losses, particularly in the financial years ended October 2008 and October 2009.

[6] In late 2009,² TSSN’s bank, ASB, withdrew support. The directors and shareholders tried to refinance the company, but their proposal was rejected by all of the financial institutions they approached. They were then put in touch with a company which specialised in providing turnaround financial assistance for companies like TSSN. That company was Touchstone Capital Partners Ltd (Touchstone) whose chairman is Mr Bruce McCallum, previously a chartered accountant with experience in dealing with financially distressed companies.

[7] Touchstone agreed to become involved. In about January 2010, it purchased the debt owed to ASB, at a significant discount to its face value. Touchstone then negotiated the terms of purchase of the business and assets of TSSN, and of a number of other entities related to Elliot and Peter, which owned the core operating assets of the business. A heads of agreement was entered into, dated 18 May 2010. That was followed by a sale and purchase agreement dated 9 December 2010. A new company, Stepping Stones Nursery Limited, (“the phoenix company”) was formed. Touchstone held 60 per cent of the ordinary shares and Peter and Elliot held

40 per cent. Those shareholder groups each had the right to appoint two directors. Touchstone also held preference shares, and had board control through the chairman’s casting vote. The phoenix company purchased the business of TSSN as a going concern, with effect from 1 June 2010.

[8] TSSN was placed in liquidation, on the application of the Commissioner of

_{Inland Revenue, on 17 May 2011.}

2. Elliot’s affidavit says November/December 2010, but in the context of his affidavit it is clear that he means November/December 2009.

The legislation

[9] Sections 368A and 368B provide as follows:

386A Director of failed company must not be director, etc, of phoenix company with same or substantially similar name

(1) Except with the permission of the Court, or unless 1 of the exceptions in sections 386D to 386F applies, a director of a failed company must not, for a period of 5 years after the date of commencement of the liquidation of the failed company,—

(a) be a director of a phoenix company; or

(b) directly or indirectly be concerned in or take part in the promotion, formation, or management of a phoenix company; or

(c) directly or indirectly be concerned in or take part in the carrying on of a business that has the same name as the failed company's pre-liquidation name or a similar name.

(2) A person who contravenes subsection (1) commits an offence and is liable on conviction on indictment to the penalty set out in section

373(4).

386B Definitions for purpose of phoenix company provisions

(1) In sections 386A to 386F,—

director of a failed company means a person who was a director of a failed company at any time in the period of 12 months before the commencement of its liquidation, and director of the failed company has a corresponding meaning

failed company means a company that was placed in liquidation at a time when it was unable to pay its due debts

phoenix company means, in relation to a failed company, a company that, at any time before, or within 5 years after, the commencement of the liquidation of the failed company, is known by a name that is also—

(a) a pre-liquidation name of the failed company; or

(b) a similar name

pre-liquidation name means any name (including any trading name) of a failed company in the 12 months before the commencement of that company's liquidation

similar name means a name that is so similar to a preliquidation name of a failed company as to suggest an association with that company.

(2) For the purposes of sections 386A to 386F, a company is known by a name if that name is its registered name or if it carries on business, or carries on a part of its business, under that name.

[10] As the foregoing brief statement of the background makes clear, TSSN is a

“failed company” as defined in s 368B(1). Until 4 June 2010 (that is, within

12 months before the commencement of its liquidation) its name was The Stepping Stones Nursery Ltd. The new company, Stepping Stones Nursery Ltd, accordingly falls within the definition of “phoenix company” in s 386B. The applicant, Elliot, is a director of the failed company. The prohibition in s 386A(1) applies to him. He was a director of both TSSN and Stepping Stones Nursery Ltd on the date of liquidation. On that date, s 386A became applicable.

[11] There are three exceptions referred to in s 386A. Two of these, in ss 386D and 386F, are not relevant in this case. The third exception, in s 386E, was potentially relevant. That provides:

386E Exception for temporary period while application for exemption is made

(1) A person does not contravene a prohibition in section 386A for the temporary period set out in subsection (2) if that person applies to the Court within 5 working days after the commencement of the liquidation of the failed company for an order exempting that person from the prohibition in question.

(2) The temporary period in subsection (1) is the period beginning on the date of the commencement of the liquidation of the failed company and ending on the earlier of—

(a) the close of 6 weeks after the commencement of liquidation;

and

(b) the date on which the Court makes an order of exemption.

The timing of this application

[12] In his first affidavit, Elliot said that he became aware of the possible application of s 386A sometime in June 2011. Mr McCallum also said, in his first affidavit, that he became aware of the existence of s 386A sometime in June 2011. The liquidator of TSSN, Mr Blanchett, in his first affidavit in opposition, questioned that evidence. He produced the earlier e-mail exchange set out below. In their

affidavits in response, Elliot acknowledges that e-mail exchange, while Mr McCallum confirms the content of his earlier affidavit without specific reference to this point.

[13] The e-mail exchange establishes that Mr McCallum sent an e-mail to both

Elliot and Peter on 19 May 2011 in these terms:

I received notice of the liquidation of TSSN today (as I think you both did also) and in looking at some of the implications of this a provision of the Companies Act (ss 386A-F) was brought to my attention, relating to “Phoenix Companies”. This is a provision which has come into law since I retired from practice so I was not aware of it. These sections can lead, as I read them, to directors being held personally liable for old debts; in your case TSSN’s.

You should consider taking urgent personal advice relating to this. To help my understanding I have asked Peter Barker (Barrister) to have a look at these sections and, in particular, to the availability of being able to apply for an exemption (s 386E). There is a period of 5 working days to apply for such an exemption. It is not for me to advise you in relation to TSSN but I am happy to share with you any knowledge I gain from Peter. I will be talking to him in the morning once he has had time to research this.

[14] Mr McCallum followed that up with a further e-mail on 20 May in which he said:

I have spoken with Peter Barker and Justin Toebes today to help clarify my understanding of this. It is fair to say that there doesn’t appear to be much experience of these provisions (new law), however what I can say is my initial reading was incorrect. The provision does not lead to a risk of your incurring personal liability for old debts (TSSN’s). As I understand it the provisions are designed to stop directors who set up second (and possibly, subsequent) companies “Phoenix Companies” with the intention of leaving creditors behind and then moving on with a new company of the same or similar name, as if nothing had changed.

SSN does fall within the definition of a phoenix company and you are directors (or in Peter’s case, was) so you may still wish to take your own independent advice regarding possible future exposure. If you are of a mind to do so then there is a time limit of five working days from the date of TSSN’s liquidation.

As there are no implications for SSN I will not be taking any further steps regarding this matter.

[15] Peter replied to Mr McCallum, by an e-mail also dated 20 May, copied to

Elliot, in these terms:

Thanks for this Bruce.

Having had a look at the Act, its hard to see how Elliot and I could be seen to be at fault under the circumstances, we will get some advice all the same.

[16] That e-mail exchange establishes, and I find as a fact, that Elliot, Peter and Mr McCallum were all aware of the phoenix company provisions within the five working day period prescribed in s 386E(1). Despite their awareness, no application to the Court was made within the five working day period provided in s 386E. Accordingly, the exception in s 386E does not apply to this case.

[17] The advice to which Peter referred in his e-mail was obtained from the Groves’ usual legal adviser in New Plymouth. Subsequent to the hearing the liquidator produced a further e-mail, dated 20 May 2011, from Peter to that legal adviser, requesting an urgent meeting to discuss the issue. There is no evidence on whether, or when, there was such a meeting. Elliot’s evidence is that he received verbal advice in late June and early July, and written advice by e-mail on

21 July 2011.

[18] Elliot’s evidence is that once he received that advice and realised the potential application of s 386A he immediately took steps to initiate this application. He offered in the interim to resign as a director of the phoenix company, but the other directors refused to accept that offer, on the grounds that if he was to alter his current role it would adversely affect the company.

[19] Elliot’s evidence is that he engaged a specialist lawyer in the field with a view to making the application which is now before me, for permission to act as a director under s 386A(1). The first draft of a supporting affidavit was provided by the lawyer in early August 2011. It was considered desirable to explain the sale transaction in detail in the affidavit. This took a considerable time, and Elliot was out of the country for long periods of the following months. His affidavit was sworn on 16 December 2011 and the present application was filed on 20 December 2011.

The procedure for the application

[20] The application was filed as an originating application. At the same time, application was made under r 19.5(3) of the High Court Rules for permission to commence it by originating application under Part 19 of the High Court Rules. Counsel for the liquidator opposed that course, submitting that Part 18 applied. By a minute dated 9 May 2012, Associate Judge Christiansen granted permission under r 19.5.

[21] The issue of whether Part 18 or Part 19 was more appropriate became significant at the hearing. Lengthy affidavits in support of, and in opposition to, the application had been filed. Counsel for the liquidator wished to cross-examine both Elliot and Mr McCallum on their affidavits, though in the end Mr Crossland pursued that only for Elliot.

[22] In a Part 18 proceeding, r 18.15(1) provides that evidence may be given by affidavit in accordance with rr 9.72 to 9.89. Cross-examination of a deponent is permitted by r 9.74. In a Part 19 proceeding, some of the rules in Part 7 relating to interlocutory applications apply, by virtue of 19.10. Rule 7.29 applies. That rule in turn provides that some of the rules in Part 9, dealing with evidence, apply. Those include rr 9.75 to 9.88. Rule 9.74, which permits cross-examination, is not included. Rule 7.28, which allows cross-examination in special circumstances, does not apply. There is therefore no express right to cross-examine a deponent in a Part 19 proceeding.

[23] In a ruling given at trial, I allowed cross-examination, limited to cross- examination on the affidavit and not including the introduction, through exhibits, of further material.

[24] I consider that Part 18, not Part 19, should have applied to this application. Under r 18.1(b)(iii), Part 18 applies to “proceedings in which the relief is claimed solely under ... the Companies Act 1993 (not being a proceeding properly brought under Part 19 ...)”. Rule 19.2 provides that applications under certain specified provisions in the Companies Act, (not including s 386A) must be made under

Part 19. Rule 19.5 allows the Court to permit any proceeding not mentioned in rr 19.2 to 19.4 to be commenced by originating application. Further, r 18.4(2) provides that the application of Part 18 to a proceeding does not prevent its commencement by originating application if it is eligible to be so commenced under Part 19.

[25] The default position in this case is that, unless permission were granted under r 19.5, this proceeding comes within Part 18. With the benefit of hindsight, I do not consider that permission should have been granted. As McGechan J observed in Jones v H W Broe Ltd,³ the originating application procedure was designed as a genuine exception, and as an expedient for cases where there was in reality no opposing party. It was not intended for routine use in cases where there was another likely party with contrary interests. The stance taken by the liquidator clearly places this case in that latter category. In this case, there was extensive affidavit evidence. I consider that a procedure which permitted cross-examination, at least to the extent

provided for in r 7.28, was necessary. In addition to the affidavit evidence at cross- examination at the hearing both parties submitted further evidence after the hearing. I refer to that later.

The grounds of the application

[26] The grounds upon which permission is sought are set out in the notice of application in these terms:

(a) The applicant is not in control of the phoenix company;

(b) The applicant’s status as a director and manager is essential to the

continuation of the phoenix company;

(c) There are no allegations of impropriety before the Court in relation

to the applicant’s actions as a director of the previous company;

(d) The assets of the previous company were transferred in an arm’s length transaction at proper value to the phoenix company, whose controlling interests are an independent commercial entity which invests in financially distressed businesses like the previous company;

³ Jones v H W Broe Ltd (1989) 5 PRNZ 206 (HC).

(e) The majority of the creditors of the previous company have had their claims satisfied by the phoenix company;

(f) The creditors of the previous company have not been misled by the formation of the phoenix company;

The purposes of the phoenix company provisions

[27] The phoenix company provisions apply only in a quite specific set of circumstances. Counsel for the applicant referred to some academic comment about the targeting of these provisions, and the mischief which they are intended to address.⁴

[28] The phoenix company provisions are engaged when: (a) The name of the former company is used; and

(b) There are common directors or managers in both companies.

[29] One of the purposes of the enactment of the provisions was to address the risk that the assets available in the liquidation of a failed company might be reduced by the sale of the business of the failed company at less than market value to persons associated with the failed company. That purpose was stated in the executive summary of the report by the Minister of Commerce to the Cabinet Economic Committee in these terms:

A phoenix company is a business that has been sold as a going concern to another company or to its directors and/or managers usually soon after its failure. Provided the business is sold at market value, the phoenix arrangement will be in the interests of creditors, including employees. Where, however, the sale price is less than could have been realised outside the phoenix arrangement, the legitimate interests of creditors will be compromised.

Beside disadvantaging creditors, use of phoenix companies in this way would allow directors who mismanaged the original company to retain control of the business to their benefit but to the detriment of the new company and other businesses that deal with that company.

⁴ Trish Keeper “Phoenix Companies” (paper presented to the New Zealand Law Society Business Insolvency Intensive Conference, 2007) at 117; Duncan MacKenzie “Abusing the Corporate Form: Limited Liability, Phoenix Companies, and a Misguided Response” (LLB (Hons)) Dissertation, University of Otago, 2008; Lynne Taylor “The Regulation of Director Involvement in Phoenix Companies” (2008) 23 NZULR 11.

[30] A second purpose identified for the provisions is to address the risk that creditors may extend credit to the new company without being fully informed of the risk. Those two elements of mischief have also been identified in cases on the equivalent English legislation.⁵

[31] The two features in [29] are not, of themselves, objectionable. Indeed, they may be beneficial. If the business of a failing company can be sold at market value, that will generally be in the interests of creditors. It is not unusual, in the sale of a business, for the purchaser to be granted the right to use the business name, as part of the goodwill of the business which is being purchased. Sometimes, too, the involvement of key personnel may contribute value to the business, which a purchaser will wish to retain. There may accordingly be good commercial reasons, and commercial value to the vendor of the business, in making arrangements which come within the scope of the phoenix company provisions.

[32] The phoenix company provisions contain mechanisms to allow such beneficial arrangements to be entered into, under appropriate supervision and controls. Those controls include the ability to apply for the sanction of the Court, either under the exemption in s 386E or by permission under s 386A. There is also the ability, under s 386D, to make such arrangements in recognised insolvency situations.

The transaction between the failed company and the phoenix company

[33] Much of the contest in the affidavit evidence, and in the cross-examination of Mr Groves at the hearing, was focused on the issue of whether or not the sale from the failed company to the phoenix company was a transaction at an undervalue, and whether the creditors of the failed company have been prejudiced by the sale to the phoenix company. That is the essence of grounds (d) and (e) of the application. The issue of whether the sale to the phoenix company was, or was not, at an undervalue is dealt with in some detail in the affidavits, and was the subject of extensive

_submissions.

⁵ Penrose v Official Receiver [1996] 2 All ER 96 (Ch).

[34] As to ground (d), the applicant’s position on this issue is set out in the affidavits of Elliot and Mr McCallum filed in support of the application. They say in essence that, if the transaction with Touchstone had not proceeded, TSSN’s failure would have been inevitable. The secured debt to ASB, which had priority, would have exhausted the assets, and the unsecured creditors would have received nothing. The applicant’s affidavits assert that the transactions recorded in the heads of agreement and the agreement for sale and purchase, and the arrangements with ASB, were negotiated on an arm’s length basis. Mr McCallum asserts that because the purchase was an arm’s length transaction the phoenix company did not acquire the assets of TSSN at an undervalue. He asserts that it is now apparent that Touchstone and the phoenix company paid more than market value for the business and assets acquired from TSSN.

[35] The liquidators of TSSN contest the proposition that the failed company’s assets were not sold at an undervalue to the phoenix company. Mr Blanchett’s affidavit, and counsel’s submissions, assert that an analysis of the heads of agreement and the sale and purchase agreement demonstrates that the failed company’s assets were sold at an undervalue to the phoenix company.

[36] To the extent that the question of whether the sale was at an undervalue or not is relevant to the present application (an issue I later discuss), the onus is on the applicant to establish that the transaction was not at an undervalue. The essential question is whether the applicant has established, on the balance of probabilities, that the fair market value of that business was obtained.

[37] There are in essence two ways in which the proposition that the fair market value was achieved might be proved. First, there might be evidence of valuation on which the sale price was based. Second, there might be evidence that the sale price was established by a competitive sale process.

[38] No valuation of the business on a going concern basis was obtained to support the purchase price. The valuations which were relied on related to the value of individual assets. Elliot and Mr McCallum essentially contrast the outcome for the creditors of the failed company from the transactions which included the sale to

the phoenix company, on one hand, and the outcome for them which would have resulted if the failed company had failed, without a sale of the business, on the other. That is not the issue. The issue is whether full value has been obtained for the assets of the failed company. While the failed company had significant financial problems which severely restricted its ability to carry on business, there was clearly a business which had an underlying value. The purpose of the Touchstone involvement, and the sale of the business to the phoenix company, was to preserve and restructure that business. The essential question is whether, in the process, full value was paid to TSSN for that business. There is insufficient valuation evidence to establish, on the balance of probabilities, that it was.

[39] There was no competitive sale process to establish a market price. There were no negotiations with other possible purchasers. The heads of agreement with Touchstone contained an exclusive dealing clause which prohibited any such action. Mr McCallum says that the prices and conditions of the transaction were subject to intensive drafting and negotiation between the respective parties, each of which had its own legal advisers. He asserts that it was an arm’s length transaction and that it follows that the phoenix company did not acquire the assets of TSSN at an undervalue. I do not accept either of those assertions. This was not an arm’s length negotiation between unconnected parties. The Groves’ interests were involved on both sides of the transaction, representing TSSN and having an interest in the phoenix company. Even an arm’s length transaction will not necessarily result in the fair market value being achieved. The respective bargaining strengths of the parties is a relevant factor. This was not a transaction between the hypothetical willing buyer and willing seller.

[40] Mr McCallum also asserts that it is now apparent that Touchstone and the phoenix company paid more than market value for the business and assets acquired from TSSN. Mr McCallum’s view on that issue is not independent. He represents the purchaser. I attach little weight to Mr McCallum’s evidence that he considers that more than the market value was paid.

[41] I find that the evidence is not sufficient to establish, on the balance of probabilities, that the fair market value was obtained from this transaction.

[42] There was a contest in the evidence before me as to the time when the transaction was entered into. Elliot and Mr McCallum both say that the agreement for sale and purchase became binding on or about its stated date, 9 December 2010, and took effect from the operative date of 1 June 2010. Mr Crossland challenged that proposition, both in cross-examination and in documents produced in a third affidavit from Mr Blanchett, one of the liquidators of TSSN, filed with a supporting memorandum after the hearing. The additional evidence principally relied on by the liquidators is an e-mail exchange which indicates that Mr McCallum’s signature on the agreement for sale and purchase was subject to an escrow which had not been removed in May 2011, just before the liquidation of TSSN.

[43] Mr Sullivan has filed a memorandum in response objecting to this new evidence. I do not propose to address the admissibility of, or to review, this new evidence. On the view I take as to the significance of the transactions between the two companies on the present application, I do not need to determine whether the sale and purchase agreement became binding in December 2010, or later. There may be other issues arising from this transaction, as I have noted. In these circumstances, it is better that I do not go further than is necessary for this application.

[44] As to ground (e), the applicant’s case is that the majority of the creditors of TSSN have been paid. Mr McCallum’s evidence is that after the operative date of the transaction on 1 June 2010, negotiations were undertaken with those creditors of TSSN who were identified as critical to the ongoing business of the phoenix company. Payment terms were negotiated as necessary to retain those suppliers and the phoenix company paid those creditors. Two creditors were not paid, the Accident Compensation Corporation (ACC) and the Inland Revenue Department (IRD), neither of whom was viewed as an essential creditor for the ongoing business of the phoenix company. An offer to IRD to settle on the basis of the core tax debt, exclusive of interest and penalties, was not acceptable to IRD, which instituted the liquidation proceedings.

[45] The liquidator asserts that a number of aspects of the way in which the various transactions were structured have advantaged Touchstone, or the phoenix company, at the expense of the failed company and its unsecured creditors.

Mr Crossland submits that the position of IRD may have been adversely affected by the totality of the arrangements entered into, in that, prior to the transactions, a substantial part of the assets of the failed company consisted of inventory which, under cl 2 of sch 7 of the Act, would have ranked in priority ahead of the ASB securities. Mr Crossland further submits that the arrangements by which the phoenix company paid the supplier creditors of the failed company, and received a deduction in the purchase price payable to the failed company, may have constituted insolvent transactions voidable by the liquidator against the recipient creditors.

[46] I do not consider that it is necessary or appropriate, on the present application, to enter into an extensive examination of this issue. The matters which the liquidators raise might potentially give rise to challenges, under other provisions in the Act, to aspects of the way the transfer of the business was effected. It is not appropriate that I should, on this application, make findings which might be relevant on any such challenge, when it is not necessary for me to do so.

[47] If application had been made, either for an exemption under s 386E or for permission under s 386A, at the time when s 386A became applicable, then I consider that the question of whether the transaction was at an undervalue or not would have been very important. I do not consider it is so important now.

[48] The scheme of the legislation makes it clear that the question of whether or not a situation which falls within the scope of the legislation is within the mischief to which the legislation is directed, should be determined at the time the legislation becomes applicable.

[49] That is explicitly the case for the exception provided in s 386E. Where a person is already a director of the phoenix company at the date of liquidation of the failed company, the exception in s 386E is subject to tight timeframes, for both the making of the application and the obtaining of an order of the Court on the application. Those timeframes indicate a clear legislative intention that permission to act as a director must be sought urgently.

[50] There is no similar time constraint expressed in s 386A for an application for permission. An application for permission under s 386A might become necessary after the phoenix company situation has arisen. For example, if a former director of the failed company, who had not initially been a director of the phoenix company, wished to become a director at a later point within the five year period prescribed, permission would be needed. There may be other situations where the relevant arrangements between the failed company and the phoenix company have been effected some time earlier, without the phoenix company provisions having been engaged, because there were then no common directors or managers of the two companies. A legislative intention that an application under s 386A should be made and heard urgently when the need arises is apparent from the fact that, where a person is already a director of the phoenix company when the need for permission arises, the director commits an offence by continuing to act as a director before permission is obtained.

[51] The delay in making the application means that the questions whether the transaction was at an undervalue, and whether creditors might have been confused, are not, in my view, important considerations in this case. Those questions should have been addressed in a timely way. The objectives of the phoenix company provisions would be substantially undermined if, on this application, the Court were to grant permission for Elliot to continue to be a director, on the basis of an assessment by the Court, made now, that, at the earlier time when the phoenix provisions were engaged, the transaction did not deprive the failed company of value.

[52] It is not consistent with the purposes of the phoenix company provisions to allow a person to act for a considerable period of time as a director of a phoenix company in contravention of s 386A, and then to consider the granting of permission by applying a test which might have been appropriate if the application had been made before the person became a director. To do so would undermine the purpose of the legislation.

The test to be applied

[53] The appropriate test to apply in considering an application for permission to act as a director has been considered in a number of English cases on the equivalent provisions. In Re Bonus Breaks Ltd,⁶ the liquidator of the old company entered into an agreement with the new company under which the new company was to purchase certain assets. The parties had taken the view that the form of the transaction was such that the equivalent of the exception in s 386D did not apply. Morritt J considered the application under the equivalent of s 386A and was clearly of the opinion that the case fell within the purpose, if not the letter, of that exemption. He

noted that the application was supported by two of the major creditors of the old company and that the creditors of the old company knew what was proposed, and those who had responded did not object. Morritt J was concerned about the adequacy of the capital of the new company, some of which took the form of redeemable shares. He noted the existence of an undertaking not to redeem shares for two years. He said that there was no reason to think that the skills of the applicant in the artistic and promotion field in which he had been primarily concerned would not be perfectly well directed within the corporate structure proposed. He therefore approved the application on the giving of the undertaking as to the redemption of the shares.

[54] The test was considered in more detail in Penrose v Official Receiver.⁷

Chadwick J said:⁸

The appeal raises a question of some general importance on which there is little or no reported authority directly in point: namely what principles should guide the court in the exercise of its discretion to grant leave to those who, having been directors of a company which has gone into insolvent liquidation, wish to continue trading through a new company which bears a name which is the same as, or closely similar to, that of the company which has failed.

...

The question, therefore, which I have to consider is whether it is appropriate, when considering an application for leave under s 216 of the 1986 Act, to take into account the risk that the new company will fail by reason of the

⁶ _{Re Bonus Breaks Ltd [1991] BBC 546 (Ch).}

⁷ _{Penrose v Official Receiver, above n 5.}

⁸ At 98 and 102.

lack of experience of its directors and the undercapitalisation of the company.

[55] He considered whether it might be appropriate to have regard to the provisions dealing with the disqualification of unfit directors. On this, he said:⁹

The disqualification imposed by s 216 of the 1986 Act is not imposed for any of the reasons to be found in ss 2 to 6 of the Disqualification Act. It is not imposed because the applicant has been convicted of any offence, found guilty of any fraud, in persistent breach of any provision in company's legislation or found to be unfit to be a director of a company. It is imposed simply because the applicant wishes to continue trading through a limited company with a prohibited name.

In those circumstances, it seems to me wrong in principle to treat an applicant who seeks leave under s 216 of the 1986 Act to be a director of a company with a prohibited name as if he were a person who had been disqualified for any of the reasons under the Disqualification Act unless there is evidence which shows that he ought to be disqualified for one or more of those reasons. In particular, it is wrong to treat him, without evidence of misconduct, as if he were unfit to be a company director.

[56] He went on to say:¹⁰

But, unless the court is satisfied on the material which is before it on the application under s 216 of the 1986 Act that the applicant is a person whose conduct in relation to that liquidating company makes him unfit to be concerned in the management of a company, it should exercise its discretion under s 216(3) with regard only to the purposes for which s 216 was enacted and not on the more general basis that the public requires some protection from this applicant's activities as a company director.

The purposes for which s 216 was enacted can be gleaned—in part at least— from the excepted cases under the rules. Rule 4.228 permits a director of an insolvent company to act as director of a new company with a prohibited name provided that the business of the insolvent company has been acquired under arrangements made by an insolvency practitioner and notice has been given to the creditors of the insolvent company.

That rule identifies, and meets, two elements of mischief. First, the danger that the business of the old insolvent company has been acquired at an undervalue—or is otherwise to be expropriated—to the detriment of its creditors; and secondly, the danger that creditors of the old company may be misled into the belief that there has been no change in corporate vehicle. The

'phoenix' must be disclosed as such.

The third excepted case in r 4.230 shows that the mischief is not thought to exist in a case where the company having a prohibited name has been established and trading under that name for a period of not less than 12

⁹ _{At 103.}

¹⁰ At 103-104.

months before the liquidating company went into liquidation. The former director of the liquidating company can join, or can remain a member of, the board of such a company without restriction. That must be because the mischief is not perceived to exist when the company having a prohibited name is not a 'phoenix'.

In each of those excepted cases the director of the insolvent company can trade under the new name notwithstanding that the new company may be as undercapitalised as the old; and notwithstanding that his lack of management skills may persist. ...

[57] In Re Lightning Electrical Contractors Ltd,¹¹ the Judge noted that he did not have a report from the liquidator of the failed company or the Secretary of State, as there had been in both the Bonus Breaks case and the Penrose case. He said:¹²

... Like Chadwick J in the Penrose case (at p. 318 D-E; p. 490E-F), I am satisfied that there is no risk arising from the use of the prohibited name to the creditors of LEC or its subsidiaries and no risk to the creditors of the new company beyond that which is permitted under the law relating to the incorporation of limited liability companies, that is to say, no risk beyond that which the legislature, in permitting those who are inexperienced to trade through companies which are under-capitalised, must be taken to have regarded as acceptable. ...

The application of the test

[58] I consider that in this case it is appropriate to focus on factors relevant to the future governance of the phoenix company. The transfer of the business is a fait accompli. Any challenge to the transfer will have to be mounted in some other proceedings. The granting or refusal of permission to the applicant to remain a director of the phoenix company will not affect that.

[59] Also, the applicant’s status as a director from the date of liquidation, and the consequences which may flow from that, will not be affected. There is no express provision for permission to be granted retrospectively. Section 386E provides a very limited period of retrospectivity where that exemption applies. The absence of any similar mechanism in s 386A tells against any legislative intention to permit

_{retrospective approval. The English cases which address the issue of retrospectivity}

¹¹ _{Re Lightning Electrical Contractors Ltd [1996] BCC 950 (Ch).}

¹² At 955.

support conclusions that permission may not be granted retrospectively,¹³ and that the Court does not have express power to excuse a breach of the provision.¹⁴ I consider that, because retrospective approval is not possible, it is appropriate to consider the position for the future.

[60] There are two principal considerations. The first is the consequences for the phoenix company and those having dealings with it, of the applicant remaining, or not remaining, as a director. The second is whether the applicant is a person whose conduct in relation to the failed company or the phoenix company makes him unfit to be a director of the phoenix company.

[61] The consequences for the phoenix company of Elliot’s ability to continue or not as a director are a relevant consideration. Whether or not the transaction involving the sale of the business may have been within the mischief of the phoenix company provisions at the time, it would not be in anyone’s interests to prejudice the ongoing business now operated by the phoenix company.

[62] Both Elliot and Mr McCallum assert that the ongoing business would be damaged if permission were not granted. Elliot says that his involvement as a director was fundamental in resolving a major claim against the United States joint venture customer of the business. Mr McCallum describes Elliot as a key person for the phoenix company in his management role and as director, because there is no one else in the business with his knowledge of all facets of the industry, or with his selling and production skills. He describes his knowledge of the overseas markets and his relationship as crucial in key overseas markets. He expresses the opinion that if Elliot were forced to relinquish his current functions that could cause a loss of confidence to overseas customers which could be very damaging.

[63] The evidence leads me to the conclusion that Elliot’s experience and his contacts are important to the business, and that there is a risk of damage to the business if he is unable to perform his management and executive role. However, I

_{do not consider that his continued involvement as a director is necessary to avoid}

¹³ Churchill v First Independent Factors & Finance Ltd [2007] Bus LR 676, [2006] EWCA Civ

_{1623; Hawkes v Cuddy [2009] 2 BCLC 427, [2009] EWCA Civ 291.}

¹⁴ First Independent Factors & Finance Ltd v Mountford [2008] EWHC 835 (Ch).

that risk. The activities which he describes as important to the maintenance of the business involve management rather than governance. It is clear from Elliot’s evidence under cross-examination that he has not been closely involved in governance. On several important aspects, he was unable to answer questions within the province of a director and said that the questions would need to be directed to Peter, or to the financial advisers or others.

[64] I therefore find that there would be a significant risk of damage to the ongoing business if permission were not granted to Elliot to take part in the management of the phoenix company, but not a significant risk if permission were not granted to him to be a director.

[65] The second consideration which is relevant to whether Elliot should be granted permission to be a director (but less relevant to whether he should be granted permission to take part in management) is his conduct in relation to the failed company or the phoenix company. In considering that question, I adopt the test applied in Penrose v Official Receiver¹⁵ and Re Lightning Electrical Contractors

Ltd.¹⁶ It would be wrong to treat Elliot, without evidence of misconduct, as if he

were unfit to be a company director.

[66] The only matter which is relevant, as potential misconduct, is the fact that Elliot had been director of the phoenix company in breach of s 386A for about seven months before this application was filed, and has continued in office for a further nine months without permission. The period before the application was filed is particularly relevant.

[67] I consider that it was quite inappropriate for Elliot to have remained a director in that period. The legislation is quite clear, and he was aware of it. Urgent action to address the situation was required. The making of this application was not pursued by him with the urgency and vigour required. His deferral to the wishes of the other directors that he remain in office despite his offer to resign was not

_{appropriate. The responsibility for that decision rested squarely with him.}

¹⁵ _{Above n 7.}

¹⁶ Above n 11.

[68] I therefore consider that Elliot’s conduct in remaining a director in breach of s 386A, at least until the application was made, is relevant in considering whether he is fit to be a director.

[69] In making an assessment on the effect which that should have on this application, I find the decision of this Court in Ramsay v Sumich of assistance, by analogy.¹⁷ In that case, Mr Sumich was prosecuted for acting as a director of two companies, without the leave of the Court, after conviction for a crime involving dishonesty. He was fined a total of $150. On an appeal against sentence by the Crown, counsel for Mr Sumich sought to justify the low fines by submitting, inter

alia, that the position should be viewed as at the date on which he became involved with the two companies, and enquire whether, had he then applied for leave, that would have been granted.

[70] Sinclair J expressed the opinion, on the facts of that case, that if the matter were so viewed, it was extremely doubtful whether leave would have been granted. In this case, I have held that that is not the appropriate way to view the matter. I also have reservations about whether, if permission had been sought at that time, it would have been granted, having regard to the criticisms of the transaction made by counsel for the liquidator, as I have discussed.

[71] Sinclair J also took into account that Mr Sumich had taken legal advice and was not warned of the need to obtain leave. He said that those who wish to become directors must make themselves familiar with the requirements of the law. I agree with that view. In this case, Elliot was aware of the requirement. Despite that, he remained a director without permission. To do so constitutes a serious offence under s 373(4) of the Act. Conviction for such an offence would trigger the possibility of an order for disqualification under s 383. In those circumstances, his conduct must be viewed as a seriously adverse reflection on his fitness to be a director of the

_{phoenix company.}

¹⁷ Ramsay v Sumich [1989] NZHC 547; [1989] 3 NZLR 628 (HC).

Result

[72] For these reasons, I have reached the conclusion that permission should not be granted for the applicant to be a director of the phoenix company. That permission is refused. Permission should be granted for the applicant to take part in the management of the phoenix company. That permission is granted.

[73] Costs are reserved. The parties may submit memoranda.

“A D MacKenzie J”

Solicitors: Kevin Sullivan, Barrister, Wellington for Applicant

Stace Hammond, Hamilton for Respondent