Whisk Deli Co Ltd (in liquidation) v Williams [2016] NZHC 2345 (4 October 2016)

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UNDER	the Companies Act 1993
BETWEEN	WHISK DELI CO LTD (IN LIQ) First Plaintiff HENRY DAVID LEVIN and VIVIEN JUDITH MADSEN-RIES Second Plaintiffs
AND	KARYN ANNE WILLIAMS First Defendant GAVIN MURRAY PAULSEN Second Defendant

Hearing:	26 September 2016 (formal proof)
Appearances:	Michael Heard/Adam McDonald for Plaintiffs
_Judgment:	_{4 October 2016}

[1] The liquidators of Whisk Deli Co Ltd seek relief from the defendants under s 301 of the Companies Act 1993 for breaches of duty as directors. The defendants did not file and serve statements of defence. As s 301 of the Companies Act is within the court jurisdiction of an Associate Judge, I heard the formal proof.¹

[2] Whisk Deli Co Ltd was incorporated on 26 October 2011. On incorporation the defendants were its directors. They were equal shareholders. The company ran a café in Waihi. It stopped trading in June 2015. It was ordered into liquidation on

9 February 2016 on the application of the Commissioner of Inland Revenue. [3] The claims in the liquidation are:

The Commissioner has valued the preferential part of her claim at $41,972.90. Her

Student loan – employer	$116.82
Kiwisaver – employee deductions	$4,648.67
Kiwisaver – employer contributions	$1,120.34
PAYE deductions	$74,825.06
Goods and services tax	$32,428.07
Employer superannuation contributions	$94.39
Income tax for returns not filed	$100.00

$43,641.31. For the first few months of its business, the company met its tax obligations, but defaults began in 2012. It paid its PAYE deduction for 29 February

2012 late and did not pay any PAYE deductions from March 2012 to June 2015. It did not pay any GST between March 2012 and July 2015. The defaults in paying other taxes cover shorter periods.

[4] The liquidators’ case is that the company traded insolvently almost from incorporation. Financial statements prepared by professional accountants bear out the insolvency. For the year ending 31 March 2012, the company made a loss of

$12,944, which also represented the company’s net liabilities. For the year ending

31 March 2013 the company made a loss of $21,415.00 (taking into account remuneration to Ms Williams of $9,500.00). The company had negative equity of

$14,366 (including $1,700 for Ms Williams’ remuneration). Its negative equity was

$48,626.00. The company’s indebtedness to the Commissioner of Inland Revenue never reduced.

[5] The liquidators say that the company’s losses are attributable to breaches of

duty by the directors. The liquidators rely on these duties under the Companies Act:

(1) Subject to this section, a director of a company, when exercising powers or performing duties, must act in good faith and in what the director believes to be the best interests of the company.

(a) Agree to the business of the company being carried on in a manner likely to create a substantial risk of serious loss to the company's creditors; or

(b) Cause or allow the business of the company to be carried on in a manner likely to create a substantial risk of serious loss to the company's creditors.

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.

A director of a company, when exercising powers or performing duties as a director, must exercise the care, diligence, and skill that a reasonable director would exercise in the same circumstances taking into account, but without limitation,—

[6] The duties under ss 135 and 136 bear directly on directors’ obligations to avoid insolvency. The other duties may also be relevant, but they do not add anything to the obligations in this case. I deal only with the duties under ss 135 and

[7] I deal with Ms Williams first, as she had day-to-day management of the company and was clearly a director throughout. Mr Paulsen’s directorship is not so straight-forward.

[8] In Mason v Lewis, the Court of Appeal noted that s 135 is not concerned with mere risk but with substantial risk of serious loss.²Substantial risk requires a sober assessment by directors of the company’s likely future income stream. Courts have recognised the difference between taking legitimate and illegitimate risks.³The Court stated the essential pillars of s 135, which I paraphrase here:⁴

• it focuses not on a director’s belief, but rather on the manner in which a company’s business is carried on, and whether that modus operandi creates a substantial risk of serious loss; and

• what is required when the company enters troubled financial waters is a sober assessment by the directors, of an ongoing character, as to the company’s likely future income and prospects.

[9] Even when hindsight shows that a company was insolvent, directors may require time to take stock and carry out the “sober assessment”. In Re South Pacific Shipping Ltd (in liq), William Young J said:⁵

No-one suggests that a company must cease trading the moment it becomes insolvent (in a balance sheet sense). Such a cessation of business may inflict serious loss on creditors and, where there is a probability of salvage, such loss can fairly be regarded as unnecessary. The cases, however, make it perfectly clear that there are limits to the extent to which directors can trade companies while they are insolvent (in the balance sheet sense to which I referred) in the hope that things will improve. In most of the cases, the time allowance has been limited, a matter of months.

[10] In Syntax Holdings (Auckland) Ltd (in liq) v Bishop,⁶Heath J recognised that in the case of GST and PAYE payable to the Commissioner of Inland Revenue, the funds have a quasi-trust character because they are only ever meant to be held by a company for a short period before payment to the Inland Revenue. Regular non- payment of GST and PAYE is a sign of insolvency. In Fatupaito v Bates, O’Regan J held that in situations where a company has little or no equity directors will need to consider very carefully whether continuing to trade has realistic prospects of generating cash that will service both a pre-existing debt and commitments which

_{such trading will inevitably attract.}⁷_{In
considering claims under s 135, the court}

exercises its discretion, fixing an amount with regard to causation, culpability and duration.⁸

[11] At some point before the company stopped business, a reasonable director would realise that continuing in business was likely to create a substantial risk of serious loss to the company’s creditors. The question is: when? The liquidators say that was no later than March 2012, when the company delayed in paying PAYE for the month ending 29 February 2012. That is consistent with their usual desire to maximise recovery for the creditors. But it reflects a misunderstanding of the duty of a director in Ms Williams’ position. There is no suggestion that even before any default in paying debts, the business was doomed to fail and that there was substantial risk under the section. Financial statements had not been prepared and did not become available until much later. Instead, what triggers the duty under s 135 in this case is the company’s ongoing inability for months to pay PAYE and GST. A single delay in payment, and even a single failure to pay, may not be enough to require the “sober assessment” under Mason v Lewis.

[12] In Richard Geewiz Gee Consultants Ltd (in liq) v Gee, Brown J allowed six months for the director in that case to take stock and make a sober assessment.⁹The company in that case ran a marketing and consulting business, which may have significant fluctuations in earnings. Given that potential volatility, more time to assess may be required.

[13] In this case by 31 August 2012, the company had delayed in making one PAYE payment, had failed to pay any PAYE deductions for five months, and did not have funds in hand to pay the deduction for that month. It had also failed to pay GST that had fallen due for the two monthly periods ending 31 March 2012, 31 May

2012 and 31 July 2012, and it did not have the funds in hand to pay the GST for the

[14] By then, the business had been running for ten months. Ms Williams had filed PAYE and GST returns but failed to pay the taxes. She must accordingly have been aware of the company’s inability to meet these tax obligations. There is no evidence that the company did not pay or was slow in paying suppliers during this period. Even so, the company’s earnings were clearly not enough to allow it to meet all its ongoing commitments. Non-payment of PAYE and GST results in heavy penalties and interest. These are made deliberately severe to encourage compliance. The continued inability to meet these payments would tell a director that the company had a significant cash flow problem. On 31 August 2012, Ms Williams had enough information to tell her that the company could not carry on trading as it had been until then.

[15] After 31 August 2012, Ms Williams allowed the business to carry on. Its trading history gave no reason to believe that the company would be able to meet its ongoing tax liabilities. In keeping on trading she was doing the same thing over and over again and expecting different results. By 31 August 2012 there was a substantial risk of loss to creditors given the company’s trading pattern. The loss to creditors was serious in that the Commissioner of Inland Revenue stood to receive no payments for any taxes that would fall due after 1 September 2012.

[16] I have taken 31 August 2012 as the time for breach of duty, as I have allowed for time in which Ms Williams could address the cash flow problems by measures short of closing the business. As to other possible options, in a business profile¹⁰

Ms Williams was asked: “What actions, if any, were taken to remedy the insolvency of the company?” Her answer was: “New menus, revised hours etcetera”. Whether she did try other strategies before the end of August 2012 does not matter. By then she could no longer say that there was hope of turning the business round.

[17] Without any viable ways to trade out of insolvency, Ms Williams had an unpalatable choice – either close the business or carry on trading at a loss. This choice was unpalatable, because closing the business would also cause losses. As an

_{example, the business operated in leased premises and used rented
equipment. Even}

¹⁰The business profile is a questionnaire prepared by the liquidators that Ms Williams was required to answer as part of her duty under s 261 of the Companies Act to give information to the liquidators.

if current suppliers could be paid, the company would incur expenses in extricating itself from leases of equipment and premises. Those extra costs would crystallise very shortly after closure of the business. On the other hand, superficially the unpaid taxes may have appeared minor when compared to the immediate losses upon stopping business. Psychologically, these factors might make it easier for a director to defer making the hard decision to close the business. There is some evidence that Ms Williams herself was not able to face the choice. In 2015 Inland Revenue officers visited her at the business and raised the question of liquidation, but her reaction was emotional. She was unable to give the matter the sober assessment required by s 135. Even so, Ms Williams could not justify continuing to trade after August 2012. She should have closed the business.

[18] With breach of s 135 established, it is necessary to measure the losses it caused. The liquidators say the measure of damages is the value of all the claims in the liquidation - $117,703.73. By taking the value of the creditors’ claims as the measure of damages, the liquidators say that the appropriate measure is the amount required to repay external creditors only. There would be no point in requiring the loss to the shareholders to be added, because the defendants are the shareholders.

[19] The value of all the claims is only the starting point. Some adjustments are required. As the company had already made losses before the breach of duty at the end of August 2012, the breach of duty cannot have caused them. They are therefore excluded. They are:

[20] It is necessary to estimate the notional costs of closing down the business, if the correct decision had been made in August 2012. That is because those are the costs of making the correct decision. They are not losses that flow from failing to close the business down. The damages are to be measured as the amount by which the losses from trading on exceed the costs of closing down.

[21] The liquidators’ evidence does not address the closing down costs. But that does not mean that they should be ignored. Some allowance is required, even if it involves a rough assessment. While it did not pay its taxes, the company appears to have paid its suppliers, staff, landlord and owners of equipment it hired. I assume that those ongoing costs would have been met out of earnings during the closing down phase. The company would still need to extricate itself from its lease of the premises and from equipment hire agreements. Some payments would likely be required for surrenders and would likely be made because of the usual personal guarantees that lessors require from directors.

[22] The profit and loss statement for the year ending 31 March 2013 shows rent of $15,491. There are also expenses for hire charges of $656 and operating lease payments of $3,960. The company would also need to pay PAYE and GST that accrued while closing down. As the company had negative equity, the closing down costs would not be met out of assets but would be added to the accrued losses. The allowance is conjectural, especially how much a surrender of the lease of the premises would costs. Very much as a jury assessment, I fix the costs of closing down at $10,000.

[23] Part of the Commissioner’s claim includes default assessments for GST for

31 July 2015, even if it did not pay GST. The evidence shows that the company stopped business in June 2015. Accordingly the default assessment of 30 September

2015 for $661.96 is based on fictitious transactions. I take it the Commissioner made the assessment in the absence of any deregistration for GST. All the same, Ms Williams can take the point that a tax liability on fictitious transactions is not a loss caused by her breach of s 135. The same goes for the assessment for not filing a GST return by 30 November 2015. That gives a further adjustment of $835.70.

Less PAYE already accrued	$18,004.58
Less GST already accrued	$7,025.94
Less GST in September/November 2015	$835.70
Less loss on closure	$10,000.00 $35,866.22

[25] As to culpability, Ms Williams, as the director with hands-on day-to-day management of the company, is primarily responsible for the losses from breach of s 135. I accordingly find that she is liable for $81,837.51 for her breach of s 135 of the Companies Act.

[26] Under s 136, a director 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. There is no evidence as to Ms Williams’ actual belief as to the company’s ability to pay its taxes as they fell due. If she did not believe that the company could pay its taxes as they fell due, she breached s 136. Given that she allowed the company to continue trading, a kinder explanation is that she did believe. That leaves the question whether she had reasonable grounds for that belief.

[27] As with the duty under s 135, she is entitled to time to take stock of the situation and to assess whether the company should incur fresh obligations. As with the duty under s 135, time for taking stock and making a sober assessment ran out at the end of August 2012. Given the company’s failures to pay any PAYE and GST from March 2012 onwards, and the company’s apparently stable but insolvent trading pattern, she could not reasonably believe that if the company carried on employing staff the company would be able to meet all its responsibilities including its PAYE payments. Nor could she reasonably believe that if the company continued its taxable activity under the Goods and Services Tax Act, it would be able to meet its liabilities for GST. Put broadly, for the same reasons as I find that she

breached her duty under s 135, Ms Williams also breached her duty under s 136. The questions of causation, culpability and duration have the same answers as for the breach under s 135.

[28] There is no doubt that Ms Williams was a director of the company throughout. She also had day-to-day control of its business. The matter is not quite so clear-cut with Mr Paulsen. There is no doubt that he was a director on incorporation. The question is: for how long afterwards? The liquidators have provided documents suggesting that Mr Paulsen resigned in January 2012 - a resignation letter dated 17 January 2012 addressed to Ms Williams, a shareholders’ resolution of the same date signed by Ms Williams accepting his resignation, a share transfer dated 17 January 2012 of his shares to Ms Williams, a resolution by Ms Williams as sole director approving the share transfer, an entry signed by Mr Paulsen for the directors’ interests register recording his disposal of the shares on

17 January 2012 and a like entry by Ms Williams showing her acquisition of those shares.

[29] There is, however, evidence going the other way. The business profile the liquidators required Ms Williams to answer included a question as to shareholder drawings. In response she showed that she and Mr Paulsen took drawings in 2012 and 2013 but she alone took drawings in 2014. That was consistent with his continuing to be involved in the company after his disposal of his shares and resignation as director. As Ms Williams was under a duty to provide information to

the liquidators,¹¹the business profile is a business record under s 16(1) of the

Evidence Act 2006 and is admissible against Mr Paulsen under s 19 of that act. I accept there would be undue expense or delay if Ms Williams were required to appear as a witness.¹²

[30] Mr Paulsen signed documents consistent with his continuing as director after

_{January 2012. In October 2012 he signed resolutions as a director to
adopt the}

annual report for the year ending 31 March 2012, set directors’ remuneration for that year, to convene an annual general meeting of shareholders, set remuneration for the following year and related resolutions. Later in October 2012 he signed other shareholders’ resolutions, consistent with his remaining a shareholder of the company. The financial statements for the company for the year ending 31 March

2012 included a directory which showed him as a director and a 50 per cent shareholder. In December 2013 he signed the directors’ annual report and in doing so confirmed the statement in the report that he was a director. In November 2013 he signed resolutions as director, similar to those he had signed in October 2012. In December 2013 he signed a shareholders’ resolution similar to those signed in October 2012. The financial statements for the year ending 31 March 2013 included a directory showing him as a director and 50 per cent shareholder. In February 2014 he signed the directors’ annual report. The liquidators did not put in evidence any documents signed by Mr Paulsen on any later date. The liquidators have shown that Mr Paulsen’s resignation as director and the sale of shares was not registered in the Companies Office until 2015.

[31] The documents showing Mr Paulsen’s resignation in January 2012 and the transfer of his shares at the same time are inconsistent with the documents he signed later as director and shareholder. Both sets of documents cannot be right. It is more likely that Mr Paulsen remained a director up to 2015, given that Ms Williams showed him as also taking drawings from the company and that he continued to sign documents as a director and shareholder even after his purported resignation. There was no reason for him to sign those documents if he no longer had any role in the company. On the other hand, there is a plausible explanation for backdating his share transfer and resignation – the desire to avoid responsibility for the company’s insolvency, especially any liability for unpaid PAYE. By early 2015, the Inland Revenue was in touch with the company and was threatening prosecution over non- payment of PAYE. The liquidators have satisfied me that it is more likely that Mr Paulsen remained a director until early 2015.

[32] As I have found that Mr Paulsen was a de jure director, it is unnecessary to

[33] The evidence does not show that Mr Paulsen took an active part in running the business of the company. Notwithstanding that, he could not ignore the company’s growing insolvency. In Mason v Lewis the Court of Appeal said:¹³

Directors must take reasonable steps to put themselves in a position not only to guide but to monitor the management of a company. The days of sleeping directors with merely an investment interest are long gone: the limitation of liability given by incorporation is conditional on proper compliance with the statute.

[34] Under s 138 of the Companies Act, Mr Paulsen would have a defence for relying on reports, statements and other information given by Ms Williams, his co- director, so long as he acted in good faith, made proper enquiry, and had no knowledge that such reliance was unwarranted. If Mr Paulsen had made any enquiry at all, he must have found out that the company was not meeting its PAYE and GST obligations. He could have learnt about the company’s growing insolvency without waiting for end-of-year financial statements to be prepared. Ms Williams could have told him. By his inactivity, he also allowed the company to carry on trading insolvently and breached s 135 and s 136. He has equal culpability with Ms Williams. The measure of damages for his breaches is the same as for Ms Williams. By the time he did resign in early March 2015, it was too late to avoid the losses caused by his breaches.

[b] they are to pay interest on that sum at five per cent per annum from the date of liquidation to the date of judgment; and

[c] they are to pay costs on a category 2 basis plus disbursements as fixed by the Registrar.

High Court of New Zealand Decisions

Whisk Deli Co Ltd (in liquidation) v Williams [2016] NZHC 2345 (4 October 2016)