New Zealand Credit Law Bulletin - Vol 9, No 2, February 2009
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:
- Guarantor appeals judgment obtained when his lawyer fails to turn up for hearing (and is later struck off)
High Court critical of creditor (and credit manager) - NAP apps up but rejections up proportionately more
Good news for creditors as Insolvency & Trustee Service appears to be taking a harder line - Council tries to pass on the credit risk and ends up out of pocket
An important case for councils to take note of - Businessman owing millions tries to get proposal approved
An example of a process used by some debtors to try to avoid bankruptcy
1. Guarantor appeals judgment obtained when his lawyer fails to turn up for hearing (and is later struck off)
PULMAN V ORIX NEW ZEALAND LTD HC AK CIV-2007-404-005569 [2008] NZHC 218 (29 February 2008)
Orix New Zealand Ltd leases vehicles. CP Developments Limited entered into a number of contracts with Orix. Mrs Pulman was the sole director of CP Developments. Both Mr and Mrs Pulman had guaranteed some of the contracts. The company defaulted, and $99,338 apparently remained unpaid. Orix issued summary judgment proceedings against the Pulmans for the amounts it claimed each had guaranteed. In Mr Pulman’s case, this was, apparently, $44,085.41 plus interest and costs.
Mr and Mrs Pulman briefed a solicitor to defend the matter and to appear on their behalf. However, he failed to appear in court and failed to take any proper steps to protect their position. The lawyer concerned was subsequently the subject of professional disciplinary proceedings and was struck off the roll of practitioners.
Because their lawyer didn’t appear, summary judgment was entered in the Pulmans’ absence.
Mrs Pulman later went bankrupt. Mr Pulman applied to the District Court to set aside the summary judgment. The application failed because the Judge concluded that, although his failure to appear at the hearing was excusable, and although there had been a miscarriage of justice, Mr Pulman had no defence to the claim.
However, he did find that there had been an arithmetical error in calculating the amount Mr Pulman was alleged to owe. He adjusted the judgment debt down to $43,798.41.
Pulman appealed to the High Court.
On appeal, the Judge said that he had “the clear impression that, for reasons not apparent from the judgment, the [District Court] Judge did not fully turn his mind to the principle that an irregularly obtained judgment can be set aside [as of right] and without the need to prove an available defence.”
So was the judgment “irregularly obtained”? He considered the case as it was presented to the Judge who had originally entered summary judgment against Mr Pulman. In general, a judge hearing a summary judgment application is not supposed to carry out an analysis of evidence not challenged by a defendant. In other words, if the defendant doesn’t argue about the plaintiff’s evidence, the judge is supposed to accept that evidence. However, the High Court judge concluded that as Mr Pulman had not been represented at the hearing, an exception should be made.
The pleadings on which summary judgment was entered included the affidavit of Carolyn Louise Newton, the credit manager of Orix, in support of the summary judgment. The judge was concerned that the affidavit was contradictory. At one point it referred to particular contracts as being guaranteed solely by Mr Pulman, but in another place it said they were guaranteed solely by Mrs Pulman.
Another problem was that “[o]f the total amount of $99,338.00 allegedly owing by CP Developments Limited, Ms Newton's affidavit only attached the primary documents [the invoices] to prove approximately $10,000 of that amount. The only proof of the bulk of the total amount was the narration in Ms Newton's affidavit…” Apart from the “approximately $10,000”, the remainder of the evidence to prove Orix's claim was inadmissible!
“Until Orix acted to rectify the evidential deficiencies in its case there was no proper basis for a court to enter summary judgment. No plaintiff is entitled to judgment based on inadmissible evidence. Since Orix never rectified its case before summary judgment was entered it follows that the judgment was irregularly obtained… In short, Orix's summary judgment application was badly prepared and incapable of obtaining a properly entered judgment.”
A further problem was that the judge became aware that about half (either $21,106.50 or $23,405.47, there being more confusion over figures on the part of Orix) of the amount that was claimed as an overdue account was actually for the cost of repairs which were carried out by third parties, to the hired vehicles.
The judge was somewhat scathing over this. “Neither the statement of claim nor Ms Newton's affidavit in support of the summary judgment reveal that approximately half of what is presented as liquidated amounts [i.e. contractual debt] due to the plaintiff under hire contracts is in fact a damages claim [which would therefore require additional evidence]. This only becomes clear when the primary documents to prove the claim are examined… There was simply no evidential foundation before the District Court to support the entry of judgment of money sums that represented this type of loss.”
The judge concluded that, “[t]he evidence before me is too unclear for me confidently to determine if there is any part of the judgment that can survive scrutiny and, therefore, be severed. I think the irregularities are so substantial that … [i]t follows that the judgment obtained should be set aside in its entirety.
“I have reached my decision on the basis that the judgment was so irregularly obtained that to allow it to remain in force would in itself be a miscarriage of justice.”
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2. NAP apps up but rejections up proportionately more
While the number of applications by debtors wanting to use the No Asset Procedure is rising, the total number accepted is not going up nearly as fast. The reason is that the percentage of applicants rejected by the Insolvency & Trustee Service has dramatically increased, as shown in the second graph. The percentage rejected went from a low of 8% in February 2008 to a high of 36% in November.
The sort of complaint that I was hearing from creditors early last year was that the picture debtors were painting for the ITS was a lot worse than they’d painted to the creditor when they ran up debt not long before. So they either lied to the creditor, or ran up more debt in anticipation of entering a NAP and getting off the hook.
We would speculate that perhaps the team assessing the applications is now looking more closely to see whether people have run up debts immediately before their application, and are rejecting them on this ground.
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3. Council tries to pass on the credit risk and ends up out of pocket
The North Shore City Council provides a weekly curbside refuse collection and disposal service for households and businesses within its district. Chequer Packaging Ltd supplied the council’s branded bags and distributed them to retailers.
The retailers paid Chequer for the bags at prices which were agreed between the council and Chequer. Later, Chequer passed on to the council the amounts which the retailers had agreed to pay for the bags less an agreed margin for Chequer. This was convenient for the council, which therefore didn’t have to manage the process of selling the bags itself. In fact, Chequer had to pay the council for bag sales even if the retailers hadn’t paid Chequer, meaning that the council didn’t have to worry about credit risk in respect of the retailers. The council’s contract purported to create a trust relationship with Chequer, meaning that Chequer held the money “in trust” for the council.
In January 2007 Chequer was placed in receivership. The council claimed that the money Chequer had received from the retailers belonged to the council.
Both the High Court and the Court of Appeal rejected this argument. It is fundamental to the existence of a trust that the trustee is bound to keep the trust property separate from his own (i.e. keep the money in a separate bank account) and apply it exclusively for the benefit of his beneficiary. This wasn’t required of Chequer. The fact that the contract required Chequer to pay the council even if the retailers hadn’t paid was also inconsistent with a trust arrangement.
The Court of Appeal pointed out that, “[w]ith the benefit of hindsight, it would be easy to conclude that the [council] should have made unequivocal provision for an agency-trust arrangement.” But this didn’t fit in well with the council’s “ancillary objectives” – getting Chequer to bear the hassle of sales, inventory stock, and credit risk.
In fact, if there had been a trust obligation, this would have created a security interest under the Personal Property Securities Act 1999. The Court of Appeal didn’t dwell on this as they had already decided that there was no trust, but it appears that this would have been unregistered and would have had a lesser priority that that of the secured party which appointed the receivers.
It is clear is that any council which wants to have this sort of arrangement with the supplier of its rubbish bags in future, should set it up in a way which is more watertight than was the case here.
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4. Businessman owing millions tries to get proposal approved
KELLY V STRUCTURED FINANCE LIMITED HC AK CIV-2008-404-002891 [2008] NZHC 1775 (17 November 2008)
Stephen Robert Kelly controlled or had an interest in a number of property developments through various companies. Kelly guaranteed the mortgages over these properties. By 2008, some or all of these developments had stalled.
On 30 July 2008, when Kelly was facing three applications for an order adjudicating him bankrupt, he filed an application for an order "halting" the applications on the ground that he was filing a proposal to creditors. Such a proposal asks creditors to agree to accept less than the full amount of their debts, and to wait for their money. If a majority of the creditors in number and 75% by value feel that this is a better option than bankrupting the debtor, it will be approved.
The proposal was filed the same day. Grant Bruce Reynolds, an insolvency practitioner of Auckland, filed an affidavit stating that he was willing to accept appointment as trustee in respect of the proposal.
Putting a proposal into effect is a three-stage process. First, a proposal must be filed and a meeting of creditors called. Second, the meeting of creditors must be held and the required creditors' acceptance secured. Third, the Court must consider and approve the accepted proposal.
A creditors’ meeting took place on 28 August 2008. Kelly's proposal was that the creditors would receive 55 cents in the dollar as assets of a "property development enterprise managed by me" sold over a six to 24-month period.
Reynolds, the provisional trustee, asserted that at the meeting eight unsecured creditors representing 82 per cent in value voted in favour of the proposal, as against three creditors representing 18 per cent in value who voted against the proposal. Creditors who subsequently opposed the proposal claimed that some significant creditors who voted in favour of the proposal were trusts and other interests closely associated with Kelly. (In some cases, debtors have been known to manufacture debts to related parties in order to give those related parties a majority vote in this sort of meeting.)
By his own account Kelly owed unsecured creditors $3,166,959. He stated that his total assets amounted to $15,000. However, if his contingent debts including personal guarantees were taken into account before credit was given for securities, he appeared to owe in excess of $28 million. However, creditors worth at least $10 million had not attend the meeting.
Kelly said in a subsequent affidavit, “I have not included some $10 million of purely contingent and fully secured creditors about which I will say more below on the basis that they are not affected by the proposal.” Kelly and the provisional trustee, Reynolds, appear (incredibly) to have assumed that only unsecured or partially secured creditors had to be served.
Kelly applied to the High Court for approval of the proposal, the third stage of the process of putting a proposal into effect. Three creditors, Southland Building Society, the Bank of New Zealand and Davies & Co. Solicitors Nominee Company Limited, opposed the application. They said that the that the provisional trustee did not post a copy of the proposal and other necessary information to every known creditor, as he was required to do under the s 330(1) of the Insolvency Act 2006.
Bank of New Zealand (owed $1,716,000) and Auckland City Council (owed $550,000) were not served and did not attend the meeting and vote. Kelly and the provisional trustee did not provide details of the secured creditors to the Court. The judge said that “it seems likely that others of the $10 million worth of secured creditors who did not attend the meeting were also not served.”
In general, if the majority of creditors approve the proposal, the Court should accept the view of the creditors, unless it is apparent that one of the grounds for refusing approval exists. However, the Court will consider the wider public interest so even unanimous support from the creditors will not assure that the proposal will succeed. But unless it is clear that the creditors generally would fare better under a bankruptcy, approval ought normally to be given unless other special circumstances militate against it.
The substance of the proposal actually voted on was not made clear to the Judge. It appeared in one document that “administration costs and professional fees and disbursements were to be deducted from the 55 cents per dollar prior to any payment to creditors.” It is a breach of the Insolvency Act 2006, s 328(2), for such changes to be made to a proposal without the Court's permission.
“Unfortunately the documents filed by Mr Kelly, including the minutes, do not disclose the passing of a resolution setting out the proposal in its final form. … Eight creditors who amounted to 82 per cent in value were stated to have accepted ‘the proposal’. It is, however, quite simply unclear what the proposal voted on was…”,
The judge noted that Kelly’s “business problems extend back before the present property slump to a time when property prices were stable or rising… [Kelly] appeared to have sought to delay Southland Building Society from exercising its rights as mortgagee from as early as August 2006… [He] had actively sought to frustrate the sale and as a result Southland Building Society was unable to settle with the purchaser.”
He concluded that were three areas of significant non-compliance with the requirements of the Insolvency Act:
- the failure to give notice to eligible creditors
- the proposal filed in the Court was different to that considered by the creditors
- it is not clear what resolution was passed
The judge was also critical of Kelly’s “extraordinarily brief” proposal. “The terms of the proposal … can give no comfort to a commercial experienced prudent creditor. The proposal refers to companies forming an undefined ‘property development enterprise’, which Mr Kelly says he manages. The proposal refers to the enterprise selling and developing its ‘assets’, which are also not defined. Mr Kelly states that he ‘believes’ that the sale of development assets will occur over six to 24 months. He states: ‘I believe that all claims by my secured and contingent secured creditors will be satisfied in full.’ No explanation is offered as to how Mr Kelly might be able to access any of this money. It is clear he has no legal right to any funds. No reference is made as to what should happen should there be any default. The language used, in particular the phrase ‘I believe’, is tentative. I am driven to conclude that the proposal in its original form contains no comprehensible plan to obtain funds to pay creditors.”
Whilst acknowledging that the purpose of the Act is not to punish a debtor, the judge adopted the reasoning on the public interest in bankruptcy from another case which said:
“An insolvent's misconduct may be so irresponsible and its effects on creditors or others so devastating that a Court may conclude that it is in the public interest that the person responsible should not escape the stigma of bankruptcy. Rather, it may be in the public interest that such a person should be marked as a bankrupt and further, that he should suffer the various disqualifications that go with bankruptcy. Those disqualifications are after all designed to protect the unsuspecting community from the ravages of irresponsible financial conduct. And the stigma of bankruptcy is itself a deterrent to others from behaving in a like manner.”
The judge said, “[T]here are potential benefits to creditors and the public if Mr Kelly is adjudicated bankrupt. The Official Assignee will then take charge of his affairs. The chaotic situation at present indicates that the control of an independent third party is desirable to ensure that the costs of Mr Kelly's financial failures are allocated fairly and to avoid an improper shifting of consequences. There will be restrictions on his ability to trade in the marketplace, and given his very poor record this may be for the benefit of the public. Further, any past irregularities on his part are likely to be discovered, which could have a material benefit for creditors.”
The application to approve Kelly's proposal was rejected and he was adjudicated bankrupt.
Note that, despite the Judge’s comments about protection of the public, it is likely that Kelly will be out of bankruptcy and back in business in three years. His bankruptcy will be cleared from credit reporting databases in 7 years.
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