New Zealand Credit Law Bulletin - Vol 7, No 2, February 2007
A free, plain English review of recent law and items of interest for creditors, produced by Hattaway & Associates Ltd, Credit Consultants. To subscribe, visit the New Zealand bulletin index and enter your details on the right
Plain language disclaimer:
This bulletin is not legal advice. Do not make decisions on legal matters based on a brief commentary. Instead, get professional legal advice.
In this issue:
- Construction Contracts Act stops debtors defending a stat demand
But who does it apply to? Are boat painters covered? - A credit union strikes financial problems and the board gets sued
A surprising and interesting case about the downside of volunteering for a board - Guarantees from wives - an excellent recent summary of the law
Essential reading for those taking guarantees from family members and family trusts
1. Construction Contracts Act stops debtors defending a stat demand
Y Gulf Harbour Limited (formerly Global Yacht Finishers Limited), was, it believed, owed money by either or both Marine Painting Solutions Limited and Gulf Harbour Investments Ltd. The matter related to a contract for painting vessels at Gulf Harbour Marina. In December 2005, it issued payment claims on the companies under the Construction Contracts Act 2002.
Under the Act, if the alleged debtor does not respond by providing a payment schedule to the creditor within either the time required by the relevant construction contract; or 20 working days if the contract does not provide for a time period, , after the payment claim is served, it becomes liable to pay. In this case, Marine Painting Gulf Harbour Investments didn't respond, so Y Gulf Harbour Limited served statutory demands on them for $94,989.68 each on 17 January 2006.
They applied to have them set aside, saying there was a dispute and a counterclaim or set-off. The statutory demand process can't be used where there is a genuine dispute. The judge said was sufficient evidence of a dispute and that normally this would be enough to justify setting aside the statutory demands. However, the payment claim process under the Construction Contracts Act is designed to identify disputes and if the debtor companies don't follow it, it was arguable that the judge could not set them aside.
The question was: did the Construction Contracts Act apply?
The Act applies to every construction contract (with limited exceptions that have no application in this case) that relates to carrying out construction work in New Zealand (s 9).
The judge said that "the Act was explicitly designed to reform the construction industry's methods of paying contractors and subcontractors, as well as providing new dispute resolution procedures and remedies for the recovery of moneys due. The provision's aim is to protect traditionally vulnerable construction subcontractors from the inequitable payment practice of those above them in the contractual chain. A decision that the Act applies beyond land base construction and includes the painting or decorating of a vessel, could lead to the opening of the flood gates to industries well outside the scope of this policy. If structures referred to vessels then it should also refer to cars, buses, aeroplanes and trains...[and] would also have to have application to a wide variety of contractors including automotive engineers, vehicle painters and upholsterers. Even those that clean such transport vehicles in the course of their construction, erection, alteration or repair would also come within the ambit of the Act."
Boat painting was not construction work therefore the Act didn't apply. The statutory demand was set aside.
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2. A credit union strikes financial problems and the board gets sued
Mr Fitzgerald is a retired accountant. He was employed as an accountant by the Inland Revenue Department from 1958 until 1974 then was a partner in a firm of chartered accountants until he retired in the mid-1990s.
He participated to some extent as a contributor to the predecessor of Capital Wide Credit Union. In 1999 he was asked to join the board of the Credit Union. He says that this occurred as a result of a decision by the New Zealand Association of Credit Unions (NZACU) to bring new members with some commercial expertise and acumen to the affairs of Capital Wide. Mr Fitzgerald suggests that the plaintiff must have believed at that time that the Credit Union was in serious difficulty and possibly insolvent, and as a result they wanted him and others to join the Board.
He was appointed on 11 May 1999 and attended his first Board meeting on 28 May 1999. The NZACU claims that during the time he was a director of the Credit Union, the Board told the NZACU that it was insolvent as at 30 June 1999 to the extent of $73,556.00. At that time it had provided a guarantee of $100,000. Relying on this information, the NZACU provided another guarantee of an extra $150,000, as requested by the board.
The loan portfolio of Capital Wide was transferred to Harbour City Credit Union and the shortfall was found to be $344,892.12. The Board (including Mr Fitzgerald) had, it seems, "approved" and provided to the NZACU financial statements and reports that did not show a true and fair view of the Credit Union. The NZACU claimed that the directors of the Credit Union, breached their duty of care.
Fitzgerald applied for summary judgment - a decision based on affidavit evidence in cases where the judge can conclude that the other side can't succeed. It can only be used when the matter is straightforward and a full hearing is not necessary. He claimed that since he had only been a director for a brief period and, according to the NZACU, Capital Wide had been insolvent since 1998, their loss wasn't his fault. he had limited participation in the affairs of the Credit Union Board, he attended minimal Board meetings and consequently had no substantial input into the accounts and statements of the Board.
Summary judgment is rarely awarded in negligence cases. They generally require a full trial. The judge said, "I am satisfied here on the material before the Court that Mr Fitzgerald has not done sufficient to show a "king hit" in the sense that none of the plaintiff's claims against him could succeed."
He added, "That said, some sympathy must be expressed for the position in which MrFitzgerald finds himself. It is clear that he joined the Board of the Credit Union as a volunteer. He did so it seems to bring some accounting expertise to the Board given the plight in which the Credit Union found itself at the time. He attended only a small number of Board meetings (it seems somewhere between four and six meetings) and thus had a relatively short history with the organisation.
"Further ...the [NZACU] itself at the time was involved to some degree in a relatively hands-on role in considering the difficult financial position of the Credit Union."
On the other hand, he pointed out that "Mr Fitzgerald as an experienced accountant clearly played some significant role as a director of the Board, and it seems he attended crucial meetings ...including one of significance on 28 October 1999. ... Mr Fitzgerald acknowledges ...that he had input into the accounts and statements which the plaintiff relied on, albeit limited input. In addition, correspondence from Mr Fitzgerald to the plaintiff dated 21 June 1999 appears to confirm that he may have known the risk he was taking in becoming a director of the Credit Union."
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3. Guarantees from wives - an excellent recent summary of the law
In 2001, Peter Harland and Logan Balderston set up a freight company called Southern Cross Logistics (2001) Limited They were the sole directors of Southern Cross. The shares were held by the Harland Family Trust and the L J C Balderston Trust.
The company bought two truck and trailer units, financed by Rabobank. Rabobank required the directors, the trustees of the family trusts, and Peter Harland's wife, Kay Harland to personally guarantee payment.
Southern Cross fell behind on its payments, the trucks and trailers were repossessed and sold, and Rabobank made demand on the guarantors for payment of $283,144.51. Mr Harland was killed in a motor accident late in 2004, and Southern Cross went into liquidation early in 2005.
Rabobank wasn't paid so it sued, seeking summary judgment. The summary judgment application can allow a straight-forward case to proceed to judgment without the cost and delay of a full trial. If there is an arguable defence, the judge won't award a summary judgment.
Mrs Harland and her son, Mark Harland, were trustees of the Harland Family Trust. They claimed that they signed the guarantees as trustees, and Mrs Harland signed her guarantee in her own right, only because Mr Harland exerted undue influence over them.
For this defence, the guarantors must establish three elements. The first of these is that they were subject to undue influence by the debtor;
Was Mrs Harland subject to undue influence by the debtor?
Mrs Harland said that Mr Harland made the financial and business decisions. She maintains that she had little involvement in, and no knowledge of, his business enterprises. In all business matters she simply trusted his judgement. He directed her to sign the documentation he had brought home. She says that she did not understand what this made her liable for.
In New Zealand, the Court of Appeal in Wilkinson v is ASB Bank Ltd said that undue influence is likely to be presumed:
1. where a guarantor first has limited commercial ability;
2. has no more than a minimal financial stake in the enterprise guaranteed under the transaction, and
3. has a relationship involving an emotional tie or dependency with the debtor.
If the guarantor was able to establish these three matters, Wilkinson concludes that a Court would be likely to accept that undue influence had been exerted upon the guarantor.
The Court of Appeal in Hogan v Commercial Factors Ltd also suggested that a wife can only avoid liability by establishing that her husband actually exercised undue influence over her in relation to the guarantee. Mrs Harland claimed in her affidavit that undue influence was exercised. There was apparently no evidence that she wasn't, so this was sufficient.
The judge considered that the three criteria from Wilkinson and the additional factor from Hogan were met. He said, "As I see it, unremarkable, traditional relationships are often the very ones that end up in Court, because (commonly) a wife has readily relied, without question, on her husband's financial and business decisions."
Was Rabobank put "on inquiry" as to the risk of undue influence?
The second element is that the creditor had been put "on inquiry" as to the risk of undue influence.
Here, Rabobank had no actual knowledge of the potential problem. Was there constructive knowledge of the potential problem? In other words, were they put "on inquiry" of the potential problem
The leading English case on the subject, is Royal Bank of Scotland v Etridge (No 2). In Etridge, Lord Nicholls, one of the judges, emphasises that the bank is put "on inquiry" in every case in which a wife guarantees her husband's debts. He says that the only practical way forward is to regard banks as `put on inquiry' in every case where the relationship between the surety (guarantor) and the debtor is non-commercial.
The New Zealand Court of Appeal indicated in Hogan that it intended to follow Etridge when an appropriate case on the issue came before it. This hasn't happened yet, so the approach in Etridge is not actually binding on lower courts at this stage. This means that the principles set out in Wilkinson, still apply. In the current case, the Court was bound to accept the Wilkinson approach. (However, creditors should take note that the Etridge approach is likely to become law, at which point any existing guarantees will be subject to the rules in Etridge.)
Wilkinson says that the creditor should be put on notice where the transaction is on its face not to the financial advantage of the wife; and, in essence, that it was the type of transaction where there is a substantial risk of undue influence on the wife.
Rabobank said that because Mrs Harland was a trustee of the Harland Family Trust, she was a shareholder of the company and got a financial advantage. However, the judge said that any potential benefit (including any benefit as wife of a director or beneficiary of the trust) was too indirect. He also said that, in England, "the threshold for a bank to be put "on inquiry" is very low indeed" and, given that the Court of Appeal had said that it was stated "very likely" to follow Etridge, it would be "inconsistent ...to adopt here a formalistic or pedantic assessment of whether Mrs Harland personally had a financial advantage in this case."
He also commented, "These English developments may, at first glance, appear to be overly-demanding on creditors. However, as I outline below, a Bank lender which has constructive knowledge of undue influence by a debtor can adopt processes to protect itself reasonably easily..."
He doesn't consider whether they might be overly demanding on any creditor other than a bank.
Did Rabobank take "reasonable steps" to insulate itself against a potential claim by the guarantor?
The third and last element the guarantor must prove for a defence of undue influence is that the creditor failed to take "reasonable steps" to insulate itself against a potential defence by the guarantor.
The guarantee document had a strongly worded warning about the potential adverse consequences to guarantors. It also had a waiver of the right to legal advice which said:
1. RABO has advised me to obtain independent legal advice before signing this agreement;
2. I do not require independent legal advice;
3. I fully understand my obligations and the extend [sic] of my liability under this agreement and any lease or hire
agreement entered into by the renter.
Mrs Harland signed this.
Rabobank argued that this meant it had taken all reasonable steps to protect itself against Mrs Harland's current claim.
"In Wilkinson... the Court of Appeal [said] that the prudent course for a creditor who is "on inquiry" is to insist that the guarantor be given advice by an independent solicitor and to obtain a certificate from the solicitor indicating that the advice had been given and was understood...Unless it can be shown that an explanation was given, it may be hard to argue plausibly that guarantor did understand. In that circumstance, without proof that the guarantor what he or she was doing, the financier will be unable to remove the suspicion.
"In Hogan ...the Court of Appeal held that "on any conceivable view of the law", the creditor sending a letter to the guarantor strongly recommending that he take independent legal advice, was insufficient to insulate itself from the consequences of undue influence.
"...[S]he was never instructed face to face to seek independent legal advice, nor were the possible consequences of the transaction explained to her in this way [and]... without actually giving Mrs Harland an explanation of the relevant documents and their consequences, it is hard for Rabobank to now insist that Mrs Harland did understand fully."
In short, the waiver wasn't enough.
Rabobank's summary judgment application against Mrs Harland personally, failed. This means that if Rabobank seeks a judgment against her, it must go through a full hearing before the court, with, of course, no certainty of success.
However, Mrs Harland's claim (and that of her son, Mark) of undue influence by Mr Harland in obtaining their signatures as trustees of the Harland Family Trust, failed.
"Mark Harland was almost 32 years old at the time of signing the guarantee, he had his own family, was financially independent, and was not involved in his father's business. There was absolutely no evidence before the Court to suggest that Mark Harland was in any way unable to cope with his day-to-day business and financial affairs."
As for Mrs Harland, Rabobank was not put on enquiry about the risk of undue influence in respect of her signature as trustee of the Harland Family Trust. The trust was a 50% shareholder in Southern Cross. It therefore stood to gain from the transaction. The judge said that "from Rabobank's perspective I am satisfied that there was nothing out of the ordinary in the Trust acting as surety for the loan agreement."
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