Vance v Jefferys [2015] NZHC 1202 (2 June 2015)

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IN THE MATTER OF	an application under sections 136 and 301 Companies Act 1993
BETWEEN	DAVID STUART VANCE AND COLIN DAVID OWENS AS LIQUIDATORS OF BROOKLYN RISE LIMITED (IN LIQUIDATION) Plaintiffs
AND	NEVILLE WARREN JEFFERYS Defendant

Hearing:	25 May 2015
Counsel:	G J Toebes for plaintiffs P C Gilbert for defendant (on adjournment application)
_Judgment:	_{2 June 2015}

[1] In this proceeding, the plaintiffs (the liquidators) seek judgment for the GST liability of Brooklyn Rise Limited (in liquidation) (Brooklyn Rise) on the sales of five residential units in a development in suburban Wellington. The liquidators have brought the claim against the defendant (Mr Jefferys) on the basis that he was the sole director of Brooklyn Rise and responsible for the conduct of its business. The liquidators claimed that Mr Jefferys breached his duty not to incur obligations when there were no reasonable grounds for believing that Brooklyn Rise would be able to

[2] The unpaid GST liabilities arose between May and August 2012 and these proceedings were commenced in February 2014. In June 2014, the liquidators

pursued an application for summary judgment on their claim, which was successfully defended by counsel then acting for Mr Jefferys.

[3] In declining summary judgment,²Associate Judge Smith found that Mr Jefferys had breached the relevant duty under the Companies Act 1993 (the Act). He declined to enter judgment, preferring that the quantum of the compensation Mr Jefferys should be ordered to pay should be determined at trial.

[4] In October 2014, Associate Judge Smith made timetabling orders for completion of discovery and other pre-trial steps.

[5] On 18 November 2014, counsel then acting for Mr Jefferys filed a memorandum seeking leave to withdraw. On the same day, Mr Jefferys filed a memorandum as to change of representation and address for service, indicating that he was acting for himself.

[6] In December 2014, the liquidators completed discovery by filing and serving an affidavit of documents. Discovery was not completed by Mr Jefferys. The present fixture was allocated on 5 November 2014.

[7] On 18 May 2015, I convened a telephone conference with the parties to review readiness for the hearing. Mr Jefferys advised that he believed Mr John Langford, a Wellington solicitor, had accepted instructions but had not advised Mr Jefferys that he would be unable to prepare for and represent him at the hearing. Because of that, Mr Jefferys anticipated making an application to adjourn the fixture. Mr Langford advised the Court by email that he had not received instructions, and had not been involved apart from a brief discussion with Mr Jefferys late in 2014. In part because of apparent discrepancies between the indications the Court had received from Messrs Langford and Jefferys, I made the following direction:

I have directed Mr Jefferys to make any application for an adjournment, in writing, before the end of this week. He should formalise any factual assertions that he wishes the Court to consider in support of any such

application by way of an affidavit, and should be aware that he may be subject to cross-examination on it. All documents that he intends to rely on should be filed and promptly served on Mr Toebes’s office.

[8] When the matter was called on 25 May 2015, Mr Gilbert appeared on behalf of Mr Jefferys. He advised that he was counsel instructed by Mr Langford to apply for an adjournment. No document had been filed to regularise the involvement of either practitioner, nor had any documents been filed in terms of the direction I had given in respect of any application for an adjournment.

[9] Mr Gilbert’s instructions were to apply for an adjournment on the basis that Mr Jefferys needed to find counsel prepared to act on the matter on legal aid. Mr Gilbert advised that Mr Jefferys had recently taken steps to instruct Mr Chris Tennet, who had indicated a preparedness to defend the case for Mr Jefferys on legal aid. It then transpired that no application for legal aid has thus far been made. Mr Gilbert was unaware of the terms of my 19 May 2015 direction. After reviewing the circumstances with Mr Gilbert, he acknowledged that the position he was instructed to advance was “not good enough”.

[10] Mr Toebes opposed the application for adjournment. He submitted that Mr Jefferys had had more than sufficient time to instruct counsel and prepare his defence, if he was serious about doing so. He submitted that, for a case of its type, it had progressed slowly and the debt was now almost three years old. The liquidators were not proceeding for interest on the unpaid GST, and the issues to be determined were well-defined by the judgment of the Associate Judge.

[11] I was satisfied that grounds for an adjournment were not made out and indicated to Mr Gilbert that the hearing would proceed. On that basis, he sought, and was granted, leave to withdraw. Mr Jefferys, who was present in the back of the Court, left at the same time as Mr Gilbert.

[13] Spinnaker Investments No 1 Limited (Spinnaker) was the first mortgagee of the relevant property on which five residential units were being developed. In or about 2011, Spinnaker sold the property, with units then in various stages of completion, to another company, Gordon Place Development Limited (Gordon Place).

[14] By early 2012, Gordon Place had failed to satisfactorily complete the development to the stage of obtaining code compliance certificates and marketing the units. Spinnaker therefore exercised its mortgagee powers to take back effective control of the properties, with a view to substituting a new entity to be responsible for completion and marketing.

[15] Under Mr Jefferys’ control as its sole director, Brooklyn Rise contracted with Spinnaker to purchase the property with a view to completing and marketing the five residential units. The purchase price was set at $1.95 million, which coincided with the amount Spinnaker was owed by Gordon Place. Spinnaker committed to providing a development facility to fund the additional work required to complete the units, as well as financing 100 per cent of the purchase price. No personal guarantee was sought from Mr Jefferys.

[16] Spinnaker remained closely involved in the completion of the units. It directly retained and paid all the contractors, and accounted in its own GST returns for that expenditure. Spinnaker also retained a project manager and charged $2,000 per month for the project manager’s services to the development facility it was providing to Brooklyn Rise.

[17] Gordon Place had entered into an agreement for sale of one of the five units, and Brooklyn Rise inherited its position as vendor in terms of that contract. In the first half of 2012, Brooklyn Rise completed contracts to sell the remaining four units. All of the five contracts proceeded to settlement in the period up to July 2012.

consequences of the sales were reflected in returns for the periods to 31 March, May and July 2012. The amounts of GST payable in those periods were as follows:

31 March 2012	$ 44,711.62
31 May 2012	90,646.14
31 July 2012	116,949.42
	$252,307.18

[19] A subsequent return for the period to 31 March 2013 reflected a liability of

$2,540.12. This liability was the result of a shortfall in the returns for previous taxable periods.

[20] Brooklyn Rise accounted for the proceeds of sale by paying agents’ commissions, legal expenses related to the sales and other miscellaneous expenses connected with the sales. It then paid Spinnaker the balance, in reduction of the amounts owing to it as mortgagee. There is no evidence that Brooklyn Rise made any provision for payment of the GST liability arising on its sales.

[21] On 15 July 2013, Brooklyn Rise was placed into liquidation on the application of the Commissioner of Inland Revenue. The company in liquidation had no assets. Apart from approximately $84,000 still owing to Spinnaker and less than $3,500 owed to sundry trade creditors, the only creditor was the Commissioner of Inland Revenue for the unpaid GST.

[22] The five properties bought and sold by Brooklyn Rise were treated as stage one of a larger development under Spinnaker’s control. Mr Jefferys characterised his involvement in stage one as a commitment without the prospect of either profit or loss. Brooklyn Rise was taking over a problem exposure for Spinnaker with no prospect of a profit because of the extent of the indebtedness to Spinnaker. Similarly there was no personal risk for Mr Jefferys as he was not required to provide any personal guarantee. Mr Jefferys said his motivation for becoming involved was that it gave him a means of entry to a larger second stage of the development. He had conditional arrangements with Spinnaker to acquire the land in stage two for

$600,000, which he considered to be a substantial discount to its market value. On Mr Jefferys’ rationale, Spinnaker had assumed liability to fund all costs associated with the sale of units in stage one, including GST. Accordingly, although he signed at least one of the relevant GST returns for Brooklyn Rise, and can be taken to have authorised the completion of all the others acknowledging the extent of liability for GST, he considered that he was able to leave the funding of those GST commitments to Spinnaker.

[23] In a statement of defence, and in argument on his behalf opposing summary judgment, Mr Jefferys advanced two arguments in support of his denial that there had been any breach of his statutory duty as a director. First, he pleaded that there had been substantial cost over-runs in completing the properties so that code compliance certificates could issue. In particular, a retaining wall required by the Wellington City Council, which had not been planned, cost approximately $280,000. Mr Jefferys pleaded that the proceeds of sales would have been sufficient for Brooklyn Rise to fund the GST obligations, had the amount required to repay Spinnaker not been increased by the extent of the cost over-runs. Secondly, Mr Jefferys argued that when the GST liabilities were incurred there was a reasonable prospect of profitable returns on a subsequent stage of the development, so that those proceeds were reasonably seen as a source of funding.

[24] Mr Jefferys also pleaded that Spinnaker was to be treated as a deemed director, or shadow director, under s 126(1)(b) of the Act because he was obliged to act at its direction. Spinnaker was in substance the developer and controlled the transactions, being aware that Brooklyn Rise had no assets of its own. Mr Jefferys pleaded that if indeed he had breached his duty, which was denied, then compensation ought to be paid by Spinnaker, and not by him.

[25] These grounds for opposing relief were argued on the summary judgment application and carefully considered by the Associate Judge. Mr Toebes submitted before me that it was unnecessary for the Court to make a finding of breach of

Mr Jefferys’ duty under s 136 of the Act because this aspect of the liquidators’ claim

was the subject of a positive finding by the Associate Judge in the following terms:

[55] In summary on this issue, I conclude that the liquidators have proved that, on each of the relevant dates, Mr Jefferys had no reasonable grounds to believe that Brooklyn would be able to meet its net GST liabilities for the periods within which the sales of particular townhouses were settled, in full. The extent of the shortfall which he should have anticipated, and the extent of his culpability for the shortfall which eventually resulted, have not been established.

[26] In a subsequent minute, the Associate Judge approved a concession on behalf of the liquidators that they would not treat this finding in his summary judgment decision as binding in favour of the liquidators on liability.³

[27] It is accordingly appropriate that I reach my own conclusion on the liquidators’ claim of a breach of the s 136 duty by Mr Jefferys, notwithstanding that the scope of analysis in the substantive context is little different from that which was before the Associate Judge on summary judgment.

[28] Mr Toebes sought leave under r 9.56 of the High Court Rules to adduce the affidavits previously filed by and on behalf of the liquidators as the evidence for the substantive determination. That was appropriate, particularly as Mr Toebes accepted the admissibility of Mr Jefferys’ affidavits in response to the liquidators’ claim.

[29] In response to the pleaded defence that there had been cost over-runs, Mr Toebes submitted there was no evidence of that, and that is borne out by a consideration of Mr Jefferys’ two affidavits. It is reasonable to expect that Mr Jefferys would identify when, and to what extent, cost over-runs occurred, relative to the extent of GST liabilities, if he had anticipated that those were to be funded by Spinnaker.

[30] Mr Jefferys’ description of the relationship between Brooklyn Rise and Spinnaker leaves a different impression. It was not a case where a finite amount of funding from Spinnaker had dried up because there were cost over-runs. Rather, the

impression is that Spinnaker changed its approach to managing its interest as mortgagee of the property, particularly in relation to stage two.

[31] The Associate Judge found Mr Jefferys’ claim that Spinnaker assured him it

would cover the GST liabilities to be “implausible”.⁴I agree with that assessment.

[32] Mr Toebes argued that the evidence showed Spinnaker played a clearly defined and lesser role. It assumed responsibility for paying all the construction and supervision costs of completing the properties to enable them to be sold, but did no more than that. GST on the sales arguably had the same character as other expenses such as legal fees and real estate agents’ commissions. Costs of that type were met by Brooklyn Rise.

[33] Mr Toebes invited me to reject Mr Jefferys’ claim that Spinnaker had assumed liability to fund the GST payments on the basis of the complete absence of documentation. I accept this argument. It is reasonable to expect that there would have been some record of Mr Jefferys’ requests for Spinnaker to provide funding for the GST payments, and presumably some form of protest at its refusal to do so. There is no evidence of that sort. It follows that Mr Jefferys cannot avoid a finding of breach of duty by claiming a reasonable belief that the GST liabilities would be met by Spinnaker.

[34] Mr Jefferys’ alternative argument was that there existed a possible source of funds to meet the GST liabilities resulting from Brooklyn Rise’s prospects of profits from undertaking stage two of the development. Both Mr Jefferys’ affidavits explained that his motivation in taking on stage one, when there was no prospect of profit for his company, was because of what he anticipated as the prospect of profitable returns on development of stage two. Neither Brooklyn Rise nor another of Mr Jefferys’ companies, National Auto Wholesalers Limited, secured a contract to purchase the land in stage two for the supposedly advantageous price of $600,000 that was proposed. Although earlier exchanges between Mr Jefferys and Spinnaker indicated its preparedness to undertake the transaction on such terms, it always required the consent of the second and third mortgagees. These necessary consents

were never obtained. As circumstances changed over time, it appears that Spinnaker decided it would achieve a better net outcome by selling the land on the open market. Accordingly, neither of Mr Jefferys’ companies that may have pursued the development of stage two became entitled to deal with the land.

[35] Mr Toebes took the point that the documentation nearest to a contract to acquire the stage two land was in the name of National Auto Wholesalers Limited or its nominee, and not Brooklyn Rise. If a timely contract had been completed, I am not persuaded that the use of another of Mr Jefferys’ companies would have been fatal to his argument that it represented a possible source of funds to meet Brooklyn Rise’s GST liabilities.

[36] More fundamentally, at the time Brooklyn Rise’s relevant GST liabilities arose, a profitable return on development of any of the sites in stage two was too far in the future. It was also too uncertain to be relied on as a realistic source of funding to meet Brooklyn Rise’s GST liabilities.

[37] I am accordingly satisfied that the liquidators have made out a relevant breach of Mr Jefferys’ duty as director of Brooklyn Rise to not incur obligations unless he believed at the time, on reasonable grounds, that the company would be able to perform the obligation when required to do so.

[38] Mr Jefferys’ statement of defence pleaded that any liability for compensation ought to be allocated to, or at least shared by, Spinnaker. Its control over the company’s affairs, and Mr Jefferys’ pattern of complying with its directions, constituted Spinnaker a director of Brooklyn Rise. His argument depended on s 126(1)(b) of the Act, which provides:

299, 301, 318(1)(bb), 383, 385, 385AA, 386A to 386F, and clause 3(4)(b) of Schedule 7,—

(i) a person in accordance with whose directions or instructions a person referred to in paragraph (a) of this subsection may be required or is accustomed to act; and

(ii) a person in accordance with whose directions or instructions the board of the company may be required or is accustomed to act; and

(iii) a person who exercises or who is entitled to exercise or who controls or who is entitled to control the exercise of powers which, apart from the constitution of the company, would fall to be exercised by the board; and

[39] This point was argued for Mr Jefferys in the summary judgment application. The Associate Judge concluded that it was arguable that Spinnaker acted as a shadow director. The Associate Judge found that it was not appropriate to assess Mr Jefferys’ culpability to pay compensation without also considering the culpability, if any, of Spinnaker.⁵

[40] The liquidators objected to a finding that Spinnaker was a shadow director. Mr Toebes raised the fact that Mr Jefferys has taken no steps to join Spinnaker as a party to the proceedings, which would be the appropriate context in which to advance the claim he had pleaded. He submitted it would be untenable to make a finding against Spinnaker that it was a shadow director, leading to the prospect of liability, without affording Spinnaker an opportunity to be heard. On Mr Toebes’s approach, that was sufficient to dispose of the argument raised by Mr Jefferys’ statement of defence.

[41] Mr Toebes submitted that, in any event, the evidence was not sufficient to bring Spinnaker within the terms of s 126(1)(b) of the Act. Mr Toebes characterised Spinnaker’s “close supervision of completion of the units” as what he termed an “intense funder”. He argued it was usual and sensible commercial practice for an exposed mortgagee to involve itself in the completion of works needed to render

_{mortgaged property saleable. That interest is distinct from that of a
shadow director.}

Mr Toebes emphasised that there was no evidence that Spinnaker was involved in instructing agents to sell the properties, nor did it veto any particular sale or approve of others. The essence of Brooklyn Rise’s task was to market and complete the sale of the lots and that was achieved without Spinnaker’s involvement. For example, Brooklyn Rise’s own solicitor completed the agreements for sale and purchase and attended to settlement of the sales.

[42] This analysis is not inconsistent with the examples of Spinnaker’s involvement that were cited in Mr Jefferys’ affidavits. On the material available, I agree with the liquidators’ analysis that Spinnaker’s involvement did not make it a shadow director. That is not to preclude any separate claim Mr Jefferys may wish to pursue against Spinnaker to that effect, if he seeks a contribution to the extent of his liability to compensate the liquidators, as determined in this judgment. As matters presently stand, I have to assess the appropriate level of compensation that Mr Jefferys ought to pay as a director in breach of his s 136 duty on the basis that no one else will be sharing that liability.

[43] The liquidators’ entitlement to compensation, once a breach of a director’s duty is made out in such circumstances, is set out in s 301 of the Act in the following terms:

(1) If, in the course of the liquidation of a company, it appears to the Court that a person who has taken part in the formation or promotion of the company, or a past or present director, manager, administrator, liquidator, or receiver of the company, has misapplied, or retained, or become liable or accountable for, money or property of the company, or been guilty of negligence, default, or breach of duty or trust in relation to the company, the Court may, on the application of the liquidator or a creditor or shareholder,—

(a) Inquire into the conduct of the promoter, director, manager, administrator, liquidator, or receiver; and

(i) To repay or restore the money or property or any part of it with interest at a rate the Court thinks just; or

(ii) To contribute such sum to the assets of the company by way of compensation as the Court thinks just; or

(c) Where the application is made by a creditor, order that person to pay or transfer the money or property or any part of it with interest at a rate the Court thinks just to the creditor.

[44] Subsection (1)(b)(ii) is relevant here. On the application of the liquidator, a director found guilty of breach of duty may be ordered to contribute such sum to the assets of the company by way of compensation as the Court thinks just. The appropriate extent of compensation to be ordered will depend on the director’s causative contribution to the loss, culpability of the director and the duration of the

trading.⁶The Court of Appeal has observed that the Court should be conservative in

its approach where there is any uncertainty as to the calculation of any deficiency.⁷

[45] Here, the liquidators advance a claim to recover the core debt owing to the Commissioner of Inland Revenue for GST. The Commissioner has acknowledged minor adjustments since demand was initially made, and the final figure sought is

$243,908.12. This is after allowing for certain credits and is exclusive of interest and penalties.

[46] The implicit premise in seeking compensation for the full amount of unpaid GST is that, had Mr Jefferys responsibly directed the company so as to only trade whilst solvent, as a preferential creditor the Commissioner would have recovered all of the GST. This would render the sum claimed an appropriate measure of the compensation that should be paid.

[47] I am not satisfied that the quantification of compensation should start from that premise. Brooklyn Rise is appropriately treated as a shell, where the assets of the properties in stage one were exceeded by, or at least closely matched, the

_{liabilities assumed in acquiring and developing them. However, the
prospect of}

better than projected sale prices being sufficient to provide a contribution to the additional cost of meeting the GST liability cannot be eliminated entirely.

[48] I am satisfied that Mr Jefferys’ mode of operating Brooklyn Rise is a direct cause of the loss suffered by the petitioning creditor in the company’s liquidation. I am not, however, persuaded that the circumstances in which he conducted the company’s business render him culpable for reckless trading in a more serious form. Rather, the operation has the hallmarks of a cavalier and somewhat irresponsible attitude.

[49] A further factor relevant to the appropriate level of compensation is Mr Jefferys’ claim that he considered Spinnaker would fund the GST payments. I have rejected that as a component of his defence to the claim of breach of duty. However, Brooklyn Rise was party to somewhat unusual arrangements. It was involved as the developer of the properties with legal title to them being funded by a mortgagee closely involved in the remaining physical works. The mortgagee assumed direct liability for paying contractors, and added the costs it paid to the extent of indebtedness secured against the properties. Had sales been concluded on better terms, or had Spinnaker been persuaded to defer some part of the repayment of its principal or interest, then Brooklyn Rise may have been in a position to pay at least part of the GST.

[50] If indeed Mr Jefferys laboured under a subjective misapprehension that Spinnaker would fund the GST (however unreasonable that was), then he would not have been disabused of that until a demand to fund the first GST payment was ignored or declined. I accept that there is no evidence to substantiate Mr Jefferys’ claimed apprehension, but in measuring his culpability I am concerned that it would be unfair to disregard this claim entirely.

[51] For these reasons, I consider the appropriately conservative level of compensation to be less than the full extent of unpaid GST. On one view, these aspects of the facts warrant reducing the compensation by the first GST payment of some $44,700. More generally, the prospect that Mr Jefferys (unreasonably) treated

Brooklyn Rise as having at least a chance of meeting part of the GST liability can be acknowledged in assessing his relative culpability.

[52] In the end, I consider the appropriate quantum to be 80 per cent of the two later unpaid GST liabilities ($207,595.56 x 80% = $166,076.49). In round terms, Mr Jefferys is to contribute $165,000 by way of compensation to the liquidators on this claim.

[53] The liquidators are also entitled to costs on a 2B basis for a one hour formal proof hearing.

High Court of New Zealand Decisions

Vance v Jefferys [2015] NZHC 1202 (2 June 2015)