SDG Group Limited (in liquidation) v Watson [2018] NZHC 398 (12 March 2018)

Last Updated: 10 April 2018

IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY I TE KŌTI MATUA O AOTEAROA TĀMAKI MAKAURAU ROHE

CIV-2017-404-1994 [2018] NZHC 398

BETWEEN	SDG GROUP LIMITED (in liquidation) Plaintiff
AND	GARY PHILLIP WATSON Defendant

Hearing:	27 February 2018
Appearances:	R B Hucker and J E Tomlinson for the plaintiff A G Rowe and A C Foley for the defendant
Judgment:	12 March 2018

JUDGMENT OF ASSOCIATE JUDGE JOHNSTON

Introduction

[1] This is an application for summary judgment by the liquidators of SDG Group Ltd (in liquidation) (SDG) against the former shareholder and director of the company, Gary Phillip Watson.

[2] On its face the liquidators’ claim could not be more straight forward. They sue for the net debit balance of a shareholder current account as at the date of the liquidation. It is not until the surface is scratched that the complexities emerge.

[3] At the commencement of the hearing, Mr Hucker drew attention to the fact that the defendant’s third affidavit was filed shortly before the hearing. He expressly declined to seek an adjournment. But he suggested that as a result the liquidators were disadvantaged by having to deal with the matters raised in that affidavit, and that, if it were to be read, then I should treat it with caution. For his part, Mr Rowe accepted

SDG GROUP LIMITED (in liq) v WATSON [2018] NZHC 398 [12 March 2018]

that the defendant’s third affidavit had been filed late in the day, and explained that this had resulted from difficulties he had experienced in obtaining access to certain information.

[4] I allowed the affidavit to be read. It did not appear to me during the course of argument that Mr Hucker faced any particular difficulties as a result.

Background

[5] The defendant’s older brother was an entrepreneur with a number of business interests. The defendant himself has an engineering background. During the 1980’s the defendant, who had been made redundant from an engineering role elsewhere, became involved in his brother’s businesses. In particular, he was engaged as the General Manager of the business that was to become SDG.

[6] During 2006 the defendant’s older brother became unwell, and he died in 2009. His widow asked the defendant to “take over ownership” of the company. He apparently felt that he was not in a position to do so at that stage, but was instrumental in negotiating alternative arrangements with a Mr Stephen Howell to form a new company to take over the business. The details of these arrangements were not in evidence. But Mr Howell incorporated SDG on 17 March 2011 and during the course of 2011 SDG effectively took over the earlier company’s business. Mr Howell was the shareholder and director of SDG. The company employed the defendant as its General Manager. The arrangement was that Mr Howell would take responsibility for the financial side of the business, and the defendant would manage its day-to-day affairs.

[7] This arrangement appears to have continued through until about mid-2013 when the company began to experience financial difficulties. It would seem that by that stage it had accumulated significant obligations to the Inland Revenue Department in respect of unpaid taxes.

[8] At this stage, Mr Howell appears to have lost interest in SDG. As a result, on 2 April 2013, he retired as the company’s sole director and the defendant was appointed. On 21 June 2013, the shares in the company were transferred from
Mr Howell to the defendant. The terms upon which the shares were transferred were not recorded.

[9] As at 31 March 2013, when Mr Howell was still SDG’s shareholder and director, a shareholder current account maintained by the company had a total debit balance of $187,634.

[10] There is next to no evidence before the court concerning the terms of the (oral) arrangements for the transfer of the shares between Mr Howell and the defendant, other than the fact that the transfer was effected without consideration.

[11] The defendant continued as SDG’s shareholder and director until 9 May 2016, on which date SDG was put into liquidation and the plaintiffs appointed as liquidators.

[12] During that time, the defendant signed the company’s financial statements for the financial years ending 2014 and 2015. The former, of course, contained comparative figures for the financial year ending 2013. The company’s accountants also prepared draft financial statements for the financial year ending 2016. All of these financial statements include an entry showing the shareholder current account, which was always overdrawn and the debit balance of which increased year on year. The draft financial statements for the financial year ending 2016 record the account as having a $609.481 debit balance.

Pre-transfer component of claim

[13] For the purposes of analysis it is necessary to distinguish between the balance of the shareholder current account as at the date of transfer between Mr Howell and the defendant ($187,634) and the balance as at the date of liquidation ($609,481).

[14] Following their appointment, and review of the company’s position, the liquidators identified the shareholder current account as an asset that was recoverable by them in the context of the liquidation. On 18 October 2017, they wrote to the former shareholder, Mr Howell, seeking to recover from him the $187,634 debit balance of the account as at the date of the transfer of the shares from him to the defendant.
[15] On 30 October 2017, Mr Howell replied. He asserted that the balance reflected wages paid by the company to the defendant “... as per his timesheets and should not have been allocated to my current account without my knowledge or consent”. He also claimed that it was the defendant who arranged for the preparation of the financial statements for the financial year ending 2013, and this was the first time he had seen them.

[16] The liquidator’s solicitors queried this by letter dated 8 November 2017. In his reply, dated 16 November 2016, Mr Howell maintained the position already described.

[17] At first blush, it seems remarkable to suggest that SDG’s accountants would debit salary or wages paid to a company employee to the shareholder current account.

[18] Yet, in his affidavit evidence, the defendant accepted that the $187,634 debit balance of the account as at the financial year ending 31 March 2013 did indeed reflect salary or wages paid to him.

[19] Unfortunately, there is no evidence at all before the court as to the actual make-up of this $187,634.

[20] On the evidence before me, I am not prepared to accept that it reflects salary or wages paid to the defendant. For a start, SDG’s financial statements show regular payments of salary or wages to the defendant, which appear to have been handled conventionally, with PAYE deductions being paid to the Inland Revenue Department. Second, it beggars belief that the company’s accountants would regard it as appropriate to debit to a shareholder current account, salary or wages paid to an employee. Third, if indeed salary or wages paid to the defendant had mistakenly been debited to the shareholder current account, it seems incredible that no one — Mr Howell; the defendant; or the accountants — picked this up at any stage prior to the company’s liquidation.

[21] It appears to me most likely that the debit balance of the shareholder current account for the financial year ending 31 March 2013 was the net result of credits and
debits properly posted to that account over the years when Mr Howell was the shareholder.

[22] Whilst it is by no means uncommon for the shares in a company to change hands at a time when there exists a shareholder current account with a balance — credit or debit — as a rule, that will be reflected in the sale and purchase arrangements between vendor and purchaser of the shares, generally by way of an adjustment on the amount to be paid on settlement.

[23] The difficulty in this case is of course that there is no contemporaneous evidence as to the terms of the arrangements for the transfer of the shares.

[24] It is elementary that the sale and purchase of the shares in a company does not, in and of itself, give rise to a transfer of any obligations as between the company and the vendor arising from a shareholder current account.¹ Those obligations are personal as between company and shareholder, so a sale of shares, which does not involve the company as a party, can have no impact on them.

[25] In the course of argument, Mr Hucker responsibly accepted that in order to establish the component of their claim against the defendant reflected by the debit balance of the shareholder current account as at the financial year ending 2013, the liquidators would need to establish either a novation whereby Mr Howell’s obligations to the company were transferred to the defendant with the agreement of all three parties (Mr Howell; the defendant; and the company), or, alternatively, something in the nature of an estoppel preventing the defendant from contending as against the company, and therefore the liquidators, that he had not assumed those obligations.

[26] On the liquidators’ behalf, Mr Hucker relied on the defendant having signed the company’s financial statements referred to earlier, as a means of establishing either a novation or an estoppel.

¹ Taylor v Seahorse World Aquarium [2007] NZHC 1034; [2008] NZCCLR 21 at [26].

[27] A novation would require an agreement between Mr Howell, the defendant and SDG.² In my judgement, it is going too far to suggest that the signing of the relevant financial statements is sufficient to infer a tripartite agreement having the effect of transferring from Mr Howell to the defendant the former’s obligations to SDG. This is especially the case in light of the evidence that there were, by that stage, already indications that the company was facing significant financial difficulties and that Mr Howell was effectively turning his back on those difficulties by giving away his shares.

[28] Certainly, I do not accept that it is a conclusion that it is open to me to reach on a summary judgment application, without the evidence of Mr Howell and the defendant being properly tested.

[29] In order to establish an estoppel by representation, the party seeking to rely on the doctrine must establish four elements which are summarised in the following terms in Equity and Trusts in New Zealand.³

• (a) A belief or expectation has been created or encouraged through some action, representation, or omission to act by the party against whom the estoppel is alleged;

(b) The belief or expectation has been reasonably relied on by the party alleging the estoppel;

(c) Detriment will be suffered if the belief or expectation is departed from; and

(d) It would be unconscionable for the party against whom the estoppel is alleged to depart from the belief or expectation.

[30] The most obvious hurdle for the liquidators here is reliance, that is to say that the company relied on the defendant’s signing of the financial statements in concluding that the debit balance of the shareholder current account as at the date of the transfer of the shares was payable by him.

[31] Given that the historical financial statements included a shareholder current account that reflected the debit balance prior to the defendant becoming the shareholder, it is hard to see how the company could have been lead to believe that the

² Ferguson v Road Metal Company Ltd [2016] NZHC 847 at [9].

3. Andrew Butler (Ed), Equity and Trusts in New Zealand (2^nd ed), Thomson Reuters, para 19.2, pp 613–614.

debit balance of the shareholder current account as at the date of transfer was a debt owed to it by the defendant by reason of his subsequent signing of the financial statements.

[32] Moreover, as already mentioned, the liquidators’ instinctive reactions were to seek to claim in the company’s name against the former shareholder, which is some evidence pointing to the absence of such reliance.

[33] This too it seems to me is an issue that can only be resolved at trial.

[34] In short, I am not satisfied that the liquidators can establish that the defendant has no arguable defence to this component of their claim.

Post-transfer component of claim

[35] The debit balance of the shareholder current account at the date of liquidation was $609,481.

[36] Deducting the $187,634 debit balance of the account as at the date of the transfer of the shares from that leaves $421,847.

[37] The evidence is that the liquidators have already allowed certain credits against that amount totalling $252,528.70. These relate to transactions that the liquidators accept have concluded were undertaken for the company’s benefit, rather than the defendant’s. The deduction of that amount from the $421,847 referred to above reduces the claim to $169,318.30.

[38] The issue in relation to this component of the claim is the extent to which the liquidators are entitled to rely on the accuracy of the company’s financial statements, and most particularly as against the defendant who, as the director of the company, signed off on the same as being accurate.
[39] In Thom Contractors Ltd (in liq) v Thom,⁴ Keane J outlined the governing principles in these terms:

[16] As long as the financial statements are to be accepted at face the liquidators are able to contend as they do, that advances made to Mr Thom on his shareholders’ current account remain a debt due to the company repayable on demand: Samarang Developments Ltd (in liq); Alt Cit Walker v Campbell HC CHCH CIV-2003-409-2094 30 September 2004, John Hansen J; New Zealand Game Meats Export Ltd (in liq) v Yat Fan Lau HC WHA CP 34/98 19 March 1999, Master Gambrill.

[17] As to the financial statements, to which Mr Thom as not subscribed, the liquidators are also able to say that insofar as they, or the company’s records from which they derive, are deficient Mr Thom must accept responsibility. As sole director he was obliged under s 194(1) of the Companies Act 1993 to ensure that the company’s records, amongst other things, correctly recorded and explained the company’s transactions (subpara (a)), and enabled its financial position to be determined with reasonable accuracy at any time (subpara (b)) and its financial statements to be readily and properly audited (subpara (d)). He is accountable for any failure in the accounting records to record entries of money received and spent each day and the matters to which they relate: s 194(2). These instances are not exhaustive.

[18] The liquidators are also able to say that Mr Thom now faces this in all likelihood insuperable difficulty. He cannot claim remuneration or any other benefit unless at the time he received the one or the other he first, as sole director, authorised that to happen on the basis that it was fair to the company: s 161(1). Further, he gave a certificate supporting that conclusion: s 161(4). Absent that, he is personally liable for the amount of any payment or benefit except to the extent that he now proves that it was fair to the company at the time it was made: s 161(5): National Trade Manuals Ltd (in liq) v Watson (2006) 9 NZCLC 264, 163.

[19] Mr Thom, as the liquidators say, also faces an allied difficulty. Now that the company is in liquidation he can only have a claim admitted after an account is taken of what is due to him from the company and what he owes it: s 310(1). And as a director of the company he cannot advance a set-off within two years of the liquidation commencing unless he can show that he did not have reason to suspect that the company was unable to pay its debts as they became due: s 310(3), (7).

[40] In EBR Holdings Ltd (in liq) & Anor v van Duyn and Ors,⁵ Heath J took a rather different view. Here is how Heath J analysed the position:

[73] On the liquidator’s argument, I would need to be satisfied on the balance of probabilities that a different amount was owed. Mr Murray, for the liquidators, relied on cases such as Thom Contractors Ltd (in liq) v Thom,

⁴ Thom Contractors Ltd (in liq) v Thom HC Auckland CIV-2008-404-6829, 28 April 2009.

⁵ EBR Holdings Ltd (in liq) & Anor v van Duyn and Ors [2017] NZHC 1698.

Chesterton Holdings Ltd (in liq) v Durney and CGES Ltd (in rec and in liq) v Kelly to support that stance. With respect, I take a different view.

[74] The authorities to which I was referred by Mr Murray tend to conflate notions of legal and evidential onus. In those cases, it was not necessary to dwell on the difference between them. For that reason, it is not surprising that the Judges who decided them did not embark on a review of the applicable principles.

[75] In my view, the legal onus remains on EBR to prove that the alleged debtors owe money to EBR I the amounts claimed. The standard of proof is the balance of probabilities. In the absence of evidence to the contrary, that standard will be met if signed financial statements acknowledge a debt owing to one of the signatories.

[76] In a case where the alleged debtor can point to evidence that tends to cast doubt on whether the amount claimed is owing, the Court must determine both liability and quantum by reference to whether the liquidator has proved a debt on a balance of probabilities, having regard to the totality of evidence adduced on the issue. For example, in this case, if I took the view that the financial statements were unreliable, they should be put to one side and the claims determined on the balance of available evidence.

[41] It will be evident from the contrasting approaches of Keane J and Heath J, that there may be more to be said on this issue. However, in the context of a summary judgment application, in which the legal onus is on the plaintiffs to establish that the defendant has no arguable defence, signed financial statements will provide prima facie evidence of the indebtedness, unless the defendant can point to credible evidence of their unreliability.

[42] The defendant contended before me that there were errors in the financial statements, and that he was entitled to credits that exceeded this residual indebtedness.

[43] I approach this contention by categorising the transactions to which I was referred into two groups:

(a) amounts which it is said were incorrectly debited to the shareholder current account in the first place because they involved expenditure on the company’s behalf;

(b) claims which the defendant asserts he has against the company and is entitled to set off against any residual indebtedness.
[44] I deal with these below in the order I have summarised them.

Alleged improper debits

[45] The defendant points to a number of transactions identifiable in the company’s financial statements that he says resulted in debits being posted to the shareholder current account improperly, or inappropriately.

[46] In summary these consist of:

(a) five transactions between July and December 2013 totalling $83,000 which the defendant asserts consisted either of payments to the company’s creditors or transfers to the company’s other banking accounts;

(b) a transaction that occurred in August 2014, which appears to have involved another transfer of $27,000 between the company’s banking accounts;

(c) a series of transactions that occurred between August 2015 and January 2016 totalling $13,918, which appear to be recorded as transfers for provisional tax purposes;

(d) a transaction that occurred in November 2015 which appears to have been a payment of $2,115.25 to one of the company’s creditors;

(e) the inclusion of the sum of $30,915 worth of payments on company credit cards which have been treated as being personal but which the defendant says were expenses incurred on company business. In relation to these transactions, the defendant says that he has insufficient information to unravel exactly what was company expenditure and what was personal.

[47] Thus the defendant says that as much as $155,948.25 of the balance in the shareholder current account may have been wrongly debited to that account.
[48] I accept Mr Rowe’s submission that there are unresolved questions in relation to these transactions. Whilst the company’s financial records are by no means conclusive, there is evidence that these amounts were wrongly debited to the shareholder current account. These too are questions which can only be resolved at trial.

[49] Deducting these amounts from the $169,318.30 figure further reduces the liquidators’ potential recovery on summary judgment to $12,370.05.

The claimed set-offs

[50] The defendant’s evidence is that the company underpaid him. He puts before the court a considerable number of timesheets, which I understand to have been prepared ex-post facto for the purposes of his affidavit and which were intended to demonstrate that he worked many more hours than he was paid for.

[51] The defendant also asserts that he was the owner of certain intellectual property used by SDG in the course of its business. He says that he had an oral agreement with the company that it would pay him a license fee or royalties for its use.

[52] The defendant faces a range of difficulties in relation to these claims. For a start, there is no evidence of the existence or terms of either a contract concerning intellectual property, or the employment arrangement between the parties. Second, there is no contemporaneous evidence as far as I can see supporting any of these claims. Third, there is no evidence of any claim being raised until after this proceeding was commenced. For those reasons, the defendant’s position lacks credibility in my judgement.

[53] Quite apart from those considerations, s 310 of the Companies Act 1993 provides that in the context of a liquidation, a “related person”, which the defendant as the shareholder and director certainly was, is only entitled to claim a set-off in respect of transactions within the two-year period prior to liquidation, if he or she can establish that at the time of the transaction he or she did not have reason to suspect that the company was unable to pay its debts as they became due. The reality is that a majority of the transactions on which the defendant relies occurred within the two
years prior to the liquidation and he has not made any attempt in his evidence to establish his state of knowledge as to the company’s financial position during that period of time. Furthermore, any “payment of remuneration or the provision of other benefits by the company to a director” would have to have been authorised by the board, even if those payments were to be made to the defendant in his capacity as an employee.⁶ There is no evidence of such authorisation. Nor did the defendant attempt to establish that such payments would have been fair to the company as required by s 161(1) of the Act. For those reasons, I find that the defendant is unable to establish an arguable defence on this ground.

Conclusion

[54] It will be evident that the liquidators have been unable to satisfy me that the defendant has no arguable defence to the bulk of the claim.

[55] However, I am satisfied to the necessary standard that the defendant has no arguable defence to the residual claim of $12,370.05, and the plaintiffs are entitled to summary judgment for that amount, together with interest.

[56] Costs were not addressed by counsel. If costs cannot be agreed, then the parties may submit memoranda within 15 working days of the date of this judgment and I will deal with costs on the papers.



Associate Judge Johnston

Solicitors:

Hucker & Associates, Auckland for plaintiffs Wells & Co, Auckland for defendant

⁶ Companies Act 1993, s 161(1)(a).