Reckless Directors
When, in the course of talking to groups of credit staff, I raise the subject of insolvent trading by directors, I usually ask who remembers the problems of Aoteoroa Television Ltd. The first time it came to my attention was when the government gave it more funding, and at the same time the directors resigned on mass. Why did they resign? They made no bones about the fact that it was because, at that point, the company was apparently solvent, and by getting out then they avoided the threat of liability for trading while insolvent. Subsequent events suggest that this was a wise move.
What I want to cover in this column is the creditor’s ability to pursue the directors for "reckless trading" - failing to avoid "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." (Section 135, Companies Act 1993)
There have been very few reckless trading actions in New Zealand. "It’s unfortunate that some of these cases don’t get to court," says Christchurch liquidator David Chrichton of Chrichton Horne & Associates. "Lack of precedents and cost are the problem. Of those that do proceed, the majority are settled before judgment."
The liquidator has to establish the point of insolvency and this can require a considerable amount of work. In addition, considerable costs can be incurred by the defence of a motivated director. Then, if the case is lost, the liquidator faces not only the problem of having to meet the costs of the action but also the risk of having costs awarded against him or her. For these reasons, Willy Palmer of Buddle Findlay in Christchurch suggests that actions usually have to be of some substance, say $100,000 minimum.
There are two relatively recent reported cases, both under equivalent provisions in the 1955 Companies Act. The first is Re Wait Investments Ltd (in liq); McCallum and Petterson v Webster (1997) 1 BCSLR 360; 8 NZCLC 261. In this case, the company, Wait Investments, had capital of $100. Of its 100 shares, 99 were owned by Mrs Wait. She had no hands-on role in the company but she did, on her husband’s instructions, sign the contract in question. Her husband ran the company under a management contract. The company contracted to buy a building worth $1.6 million. It defaulted and shortly afterwards went into liquidation.
To be liable, the Waits each had to be an officer of the company and either knowingly a party to the contracting of a debt by the company when they didn’t honestly believe on reasonable grounds that the company would be able to pay the debt when it fell due for payment, or knowingly a party to the carrying on of any business of the company in a reckless manner.
Both Mr and Mrs Wait were found to be personally liable. The court found that they either knew the company couldn’t pay or were reckless as to whether it could or not. It may not have helped Mr Wait’s case that he was, at the relevant time, already the subject of an insolvency proposal relating to over $18m. He was ordered to pay $342,179 while his wife - less culpable - was only ordered to pay half this amount. (The Court has the power to order repayment as it seems just.)
The points to note are that the non-executive directors can be liable, and that individuals such as Mr Wait who are de facto directors may also be liable. A third defendant, the bookkeeper, was the company secretary was not liable. She was only the company secretary and only knew of the transaction after it had been signed.
The second reported case was brought by an unsecured creditor. The company was mismanaged by a fraudulent managing director and eventually put into liquidation. The two non-executive defendant directors, by not removing the managing director or putting the company into liquidation once they knew they couldn’t rely on him had "at least allowed and also caused or agreed" to the company's business being carried on in a manner likely to create a substantial risk of serious loss to the company's creditors. The fact that they had acted in good faith did not excuse them from liability. Nippon Express (NZ) Ltd v Woodward 7/9/98, Anderson J, HC Auckland CP394/96
Generally, the orderly liquidation of a company means that a liquidator will distribute any money available proportionately to all unsecured creditors. In other words, unsecured creditors share equally in the proceeds from this type of action.
However, in Australia there is authority that a liquidator can strike a deal with one creditor who will fund an action against the director and get paid first from any proceeds. The most obvious way of doing this would be to assign the claim to that creditor.. The liquidator has authority to sell assets of the company. We don’t know whether Nippon Express (which was owed about half of the unsecured debt) had an arrangement of this type in place but Willy Palmer believes this approach certainly can be taken in New Zealand.
In Australia, insurers and other outside parties have been willing, in recent years, to fund such actions. One such organisation - Insolvency Management Fund - has now set up an office in Auckland and is actively pursuing business.
"There is no doubt that we will be using this funding mechanism," says David Chrichton. "We have about seven liquidations on the go at the moment that we could have used it on."
"Liquidators," he says, "have a moral, as well as a legal, obligation to pursue these matters."
Chartered Accountants Journal of New Zealand