Superior Blocklayers Limited (in liquidation) v Bacon [2016] NZHC 2601 (2 November 2016)

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UNDER	the Companies Act 1993
IN THE MATTER	of the liquidation of Superior Blocklayers Limited (in Liquidation)
BETWEEN	SUPERIOR BLOCKLAYERS LIMITED (IN LIQUIDATION) First Plaintiff VIVIEN JUDITH MADSEN-RIES AND HENRY DAVID LEVIN as liquidators of Superior Blocklayers Limited (In Liquidation) Second Plaintiffs
AND	MICHAEL EDWARD BACON First Defendant LAURA JEAN SIMPSON Second Defendant

Hearing:	3 October 2016
Appearances:	K Morrison and J Angelson for the Plaintiffs No appearance by or on behalf of the Defendants
_Judgment:	_{2 November 2016}

judgment against the Company’s directors, being the first and second defendants. [2] The claims are as follows:

136 and 137 of the Companies Act 1993 (Act) and pursuant to s 301. Damages are sought in the sum of $96,175.95, being the amount owed to the Inland Revenue Department (IRD), which is the Company’s only creditor to have made a claim in the liquidation.

[3] The proceeding was filed in the High Court at Auckland on 10 June 2016, and was served on the defendants on 20 June 2016. An affidavit of service sworn on

[4] Any statement of defence was due to be filed and served by the defendants on

25 July 2016.¹No statement of defence has been received and there has been no other communication from either defendant in relation to the claim. Accordingly, the plaintiffs seek judgment by way of formal proof under r 15.9.

[5] To obtain judgment by way of formal proof, r 15.9(4) requires the plaintiffs to file affidavit evidence establishing, to a Judge’s satisfaction, each cause of action relied on and providing sufficient information to enable the Judge to calculate and fix the damages. This sub-r imposes an onus which is “much the same” as if the

[6] The Company was incorporated on 7 May 2004. It traded in the block-laying business. The defendants were the directors of the Company since its incorporation. They were each allocated one share as shareholders with the remaining 98 shares allocated to Annette Giles Trustee Ltd and each of the defendants.

[7] The Company ceased trading on 27 November 2015. It was placed into liquidation on the same day on the application of the Commissioner of the IRD. The second plaintiffs were appointed as liquidators at that time.

[8] The only significant assets as at liquidation were a Company car sold by the liquidators for $7,000, legal claims, and advances made to the defendants through the shareholders’ current accounts.

[9] At liquidation, the Company owed a significant debt to its sole creditor, the

$96,175.95, which includes a preferential claim of $48,741.81 for unpaid GST which has accrued from 31 May 2009 and a preferential claim of $4,280.36 for court liquidation costs. The total sum includes interest and penalties of $42,953.78.

[10] Mr Levin, the first-named liquidator, has sworn a comprehensive affidavit in support of the plaintiffs’ claims. Mr Levin is an insolvency specialist with extensive experience dealing with insolvent companies, liquidations and receiverships.

[11] Most of the Company’s claims rest on the allegation that the Company had been unable to satisfy the solvency test in s 4 of the Act for some time.³Mr Levin’s evidence is that the Company was balance sheet insolvent from 31 March 2009, and

³Under s 4 of the Companies Act 1993, a company satisfies the solvency test if (a) the company is able to pay its debts as they become due in the normal course of business; and (b) the value of the company’s assets is greater than the value of its liabilities, including contingent liabilities.

[12] Financial statements for the Company narrate the shareholders’ current account as an asset of the Company. However, Mr Levin deposes that he has found no evidence that the shareholders’ current account was realised or was practically realisable to meet the Company’s accumulating GST debts.

[13] Mr Levin states that the book value of the asset represented by the shareholders’ current account does not reflect its actual realisable value to the Company at the material time. If the value of that asset is reduced to nil, the Company was balance sheet insolvent from, at the latest, 31 March 2009.

[14] In any respect, Mr Levin deposes to the Company becoming cashflow insolvent from 31 May 2009. This is when it defaulted on its obligations to account to the IRD for GST in the GST period ending 31 May 2009.

[15] The Company consistently defaulted on its GST obligations for every GST period from the period ending 31 May 2009 to the period ending 31 July 2015 inclusive. During that timeframe it only made nominal payments of GST in two GST periods ending 31 May 2009 and 30 September 2011.

[16] The Company continued to fail to meet its GST obligations, and the debt to the IRD continued to grow, compounded by interest and penalties. As at the date of liquidation, the balance owing by the Company totalled $91,695.59.

[17] Mr Levin’s evidence is that, based on his experience, a failure to pay GST on a regular basis is a sure sign of a company in trouble. That is because these funds are only ever meant to be held by the company for a short period of time prior to payment to the IRD and unlike other creditors, the Commissioner cannot withhold services or materials.

[18] Following the liquidation, both defendants completed a business profile questionnaire and attended an interview with the liquidators. Neither of them contested the insolvency of the Company. The file note of the interview records Mr Bacon (the first defendant) as explaining that during 2009 they were on one income, the recession hit and rates dropped, and they fell behind on their taxes. Mr

Bacon is also recorded as saying that the Company tried to borrow money but could not and the IRD began taking money from contractors that owed the Company money.

[19] I accept Mr Levin’s evidence. I am satisfied that the Company was unable to

satisfy the solvency test in s 4 of the Act and was therefore insolvent from at least

[21] As at financial year end 31 March 2015, the Company’s financial statements record a shareholders’ current account debt owed by the defendants to the Company in the sum of $63,819.

[22] Advances by a company to its shareholders are debts owed by the shareholders to the company. Such advances are repayable on demand.⁴

[23] The plaintiffs are entitled to rely on the financial statements in order to prove the quantum of the debt owed by the defendants. The accounts of the Company are prepared at the direction of the Company directors who are responsible for the accuracy of those accounts.⁵Under s 194 of the Act, the Company’s board is also responsible for the accounting records of the Company.

[24] The Company’s financial statements record shareholders’ current accounts as being held in Mr Bacon and Ms Simpson’s names. Although the accounts were not

_{signed by either defendant, it appears that they were prepared at their
direction.}

⁴Thom Contractors Ltd (in liq) v Thom HC Auckland CIV-2008-404-6829, 28 April 2009 at [16];

New Zealand Game Meats Exports Ltd (in liq) v Lau HC Whangarei CP34/98, 19 March 1999 at

12–13; and Re Samarang Developments Ltd (in liq) HC Christchurch CIV-2003-409-2094,

⁵Chesterton Holdings Ltd (in liq) v Durney HC Napier CIV-2011-441-7, 19 May 2011 at [31].

[25] On 8 December 2015 the Company made demand on the defendants to repay the debt of $63,819. To date no payment has been made.

[26] I am satisfied that the plaintiffs have proved their claim against the defendants for the shareholders’ current account debt in reliance on the debt as stated in the financial statements. Judgment will be entered on the first cause of action accordingly.

[27] In the second cause of action the plaintiffs seek relief under s 301 of the Act for alleged breaches of duties by the defendants as contained in ss 131, 135, 136 and

[28] Section 301 of the Act provides a mechanism by which compensation may be sought for illegitimate trading. It provides a means of enforcement of directors’ duties, including those statutory duties under the Act.

(b) If so, to what extent should the director contribute to the losses of the company?

Section 131 – breach of good faith and failure to act in the best interests of the company

[31] Section 131(1) of the Act provides that a director of a company, when exercising powers or performing duties, must act in good faith and in what the

[32] In Sojourner v Robb, Fogarty J observed that the duty imposed under s 131 was an amalgam of objective standards as to how people of business might be expected to act, coupled with a subjective criterion as to whether the directors have done what they honestly believe to be right.⁷Further, as observed in that case, the duty is owed to creditors once a company is of doubtful solvency.⁸

[33] The plaintiffs rely on the defendants’ failure to ensure the Company met its tax obligations as they fell due as evidence of a breach of s 131. In addition, they rely on the significant drawings the defendants made from the shareholders’ current account for their own benefit. These drawings were not documented, they were unsecured and there was no interest payable. The plaintiffs also say that the defendants did not cause the Company to call up the repayment of these drawings, despite the Company’s insolvency, nor did the defendants voluntarily repay them. They also rely on the defendants’ acts in allowing the Company to continue trading and incurring further tax debts for a period of approximately six and a half years after it had become insolvent as further evidence of breach.

[34] I am satisfied that the Company was unable to meet its tax obligations as they fell due. This was due to the defendants failing to act in the best interests of the Company. Instead of meeting tax obligations, or ceasing trading when it became apparent that the Company could no longer meet those obligations, the defendants resolved to continue trading.

[35] Furthermore, the defendants preferred their own interests to those of the Company by continuing to draw funds from the Company when it had no prospect of meeting its overdue tax debts, let alone any further debts that it might accrue. From the financial year ending 31 March 2009 to the financial year ending 31 March 2015, the defendants took drawings totalling $559,289 from the Company (including

⁸Sojourner v Robb, above n 7, at [102]; and Nicholson v Permakraft (New Zealand) Ltd (in liq)

[36] As a result of the defendants taking money from the Company and continuing to trade whilst insolvent, the Company and its creditor suffered increasing losses over the six and a half year period.

[37] I am satisfied that the plaintiffs have proved a breach of s 131(1) of the Act.

[38] Section 135 of the Act provides that a director must not agree to, 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.

[39] The duty is one owed by the directors to the company, as opposed to particular creditors. The test is an objective one and focuses not on the director’s belief but on the manner in which the company’s business is carried on and whether that creates a substantial risk of serious loss. What is required under the Act is a “sober assessment” by the directors of an on-going character as to the company’s likely future income and prospects.⁹

[40] The plaintiffs submit that the case of Boutique Tanneries Ltd (in liq) v Handley is similar to this case.¹⁰As the name would suggest, the company carried on business as a tannery and leather goods retailer. The Court formed the view that the company had only been kept afloat for a number of years by paying all its creditors with the exception of the IRD, and it was the IRD’s forbearance that prolonged the company’s trading.¹¹The director was found to have breached various duties including that contained in s 135. The Court accepted that the deferral of tax obligations to the IRD for any significant period reflected very poor business judgment.¹²

[41] I accept the plaintiffs’ submission that the only responsible course in this case was to cease trading the Company from at least 31 May 2009 when it became

_{apparent that it had no realistic prospect of paying its tax. The
defendants chose not}

¹⁰_{Boutique Tanneries Ltd (in liq) v Handley HC
Auckland CIV-2006-404-2713, 24 July 2008.}

to follow that pathway and continued to deplete cash funds by taking drawings which were undocumented, unsecured and did not attract any obligation to pay interest, at the expense of the Company. That created a substantial risk of serious loss to the Company’s creditors. A “sober assessment” of the Company’s prospects at any time during this period would have left no room for doubt that the Company should cease trading.

Section 136 – obligations incurred without reasonable belief that the Company could perform them

[43] Section 136 of the Act provides that a director must not agree to the company incurring an obligation unless he or she believes on reasonable grounds that the company will be able to perform the obligation when required to do so.

(c) That at the time of incurring the obligation, the defendant did not honestly believe on reasonable grounds that the company would be able to perform the obligation when it was required to do so.

[45] In Fatupaito v Bates, O’Regan J held that to establish a breach of s 136, the plaintiff must show that the defendant agreed to the company incurring an obligation at a time when he or she did not believe (a subjective test), on reasonable grounds (an objective test), that the company would be able to perform the obligation when

¹³_{Peace and Glory Society Ltd (in liq) v Samsa [2009]
NZCA 396, [2010] 2 NZLR 57 at [45].}

[46] The purpose of s 136 has been described as dealing with obligations on capital accounts such as major investments, and more appropriately directed to particular transactions or specific liabilities, rather than the general conduct of the company’s business.¹⁵However, failure to meet on-going tax obligations has been found to be sufficient proof of breach of s 136 in a number of cases.¹⁶

[47] Where the primary liability incurred is a steadily mounting tax debt, including penalties and interest, I consider s 135 is the better route to relief than s 136. Liability having been established under s 135, it is unnecessary to find a breach of s 136 also and I decline to do so.

[48] Section 137 of the Act provides that a director must exercise the care, diligence and skill of a reasonable director in the same circumstances.

[49] The test under s 137 is an objective one based on the standard of a reasonable director.¹⁷The particular position or circumstances of the director must be taken into account, which in this case means someone assuming responsibilities as a director of a relatively small trading business without the opportunity for detached guidance from a board.¹⁸

[50] I accept that a reasonable director in the position of the defendants would not have continued to trade the Company after 31 May 2009, when it was insolvent. Neither would they have used the Company’s cash funds for their personal benefit by taking substantial drawings from the financial year ending 31 March 2009 to the financial year ending 31 March 2015 inclusive and failing to document or secure those advances nor require interest to be paid.

[51] Furthermore, a reasonable director in the position of the defendants would not have allowed the Company to default on its obligations to account to the IRD for

¹⁵See Peace and Glory Society Ltd (in liq) v Samsa, above n 13, at [44]; and Richard Geewhiz Gee

¹⁶See Mizeen Painters Ltd (in liq) v Tapusoa [2015] NZHC 826, [2016] NZAR 423 at [46]; and

GST, nor failed to repay the shareholders’ current account debt to the Company when payment would have substantially discharged the Company’s tax debts.

[53] Section 301 of the Act provides a mechanism by which relief for breach of any or all of the above statutory duties may be granted.

[54] The standard approach to the grant of relief has been to look at the deterioration in the Company’s financial position between the date that the inadequate corporate governance became evident and the date of liquidation. Once that figure has been ascertained, the Court will consider causation, culpability and the duration of the trading as matters relevant to the exercise of the Court’s discretion.¹⁹

[55] I have found that the defendants breached ss 131, 135 and 137 of the Act by allowing the Company to keep trading after 31 May 2009, when it became insolvent.

[56] The amount sought by the plaintiffs ($96,175.95) is the amount owed to the IRD calculated from the effective date of insolvency to the date of liquidation. I am satisfied that by continuing to trade the Company past 31 March 2009, the defendants’ actions effectively caused the Company to suffer losses. The first and second defendants had the sole responsibility for the management of the Company as its directors. The loss largely comprises of unpaid GST. Those GST funds were never beneficially owned by the Company but were only ever temporarily held by the Company prior to accounting for them to the IRD. The failure by the Company to account for those GST funds is directly due to the decisions of the defendants as directors, and the ballooning of the debt is due to the defendants’ decision to continue trading the Company in these circumstances. Further, I am satisfied that the defendants’ actions were causative of the Company’s liquidation and therefore

¹⁹Mason v Lewis, above n 6, at [109] and [110]; and Löwer v Traveller [2005] NZCA 187; [2005] 3 NZLR 479 (CA)

[57] The fact that the defendants continued to trade for six and a half years elevates the culpability in this case. In Löwer, a duration of two years and

10 months was considered a lengthy one for the Company to continue its wrongful trading.²⁰

$96,175.95. This is the total amount of the loss to creditors which has accrued after the Company became insolvent. Judgment will therefore be entered for that sum on the second cause of action.

[60] This award is in addition to the amount awarded for the shareholders’ current account debt. As noted in other similar cases, the claims are conceptually different. Recovery of the current account debt does not depend on findings of breach of directors’ duties.²¹

[61] Judgment is entered on the first cause of action against the defendants jointly and severally in the sum of $63,819. Interest is awarded at the Judicature Act 1908 rate from the date of demand, being 8 December 2015, to the date of judgment.

[62] Judgment is entered on the second cause of action against the defendants jointly and severally in the sum of $96,175.95. Interest is awarded at the Judicature Act rate from the date of liquidation to the date of judgment.

²¹See for example Mizeen Painters Ltd (in liq) v Tapusoa, above n 16, at [61].

High Court of New Zealand Decisions

Superior Blocklayers Limited (in liquidation) v Bacon [2016] NZHC 2601 (2 November 2016)