New Zealand Credit Law Bulletin - Vol 4, No 1, January 2004
A free, plain English review of recent law and items of interest for creditors, produced by Hattaway & Associates Ltd, Credit Consultants. To subscribe send a blank email to: nz-bulletin-join@mailman.hattaways.com
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:
- Discharged bankrupt, now divorced, tries to get back the house he had signed over to his ex-wife when he was in financial difficulty
If you transfer your assets to your spouse, better hope you don't divorce - Champerty – not a disease, an illegal arrangement to fund litigation
Could the liquidator use outside funding to pursue directors of a liquidated company? - Company insolvent? Stop trading or risk personal liability
A supplier tries to recover debts from a director personally by claiming he traded recklessly - A director buys a Beamer - is this the first sign of impending business failure?
A lesson on not letting success in business go to your head! - Creditors are paid on a distress warrant but the debtor goes bankrupt - can they keep the money?
And to complicate matters further, the creditors are brother and sister-in-law to the debtor!
1. Discharged bankrupt, now divorced, tries to get back the house he had signed over to his ex-wife when he was in financial difficulty
Roland Michael Doyle v Michele Anne Doyle [2003] NZCA 216
Roland and Michele Doyle were married in 1978. Their home in Albany was registered in Roland’s name in 1988. In 1991 the Bank of New Zealand (BNZ) obtained judgment against him for more than $11,000,000. As a result Roland rearranged his assets.
A Matrimonial Property Agreement provided that the Albany property was matrimonial property but it was to be the separate property of Michele and was registered in her name late in 1991. Roland later explained that he had taken legal advice which indicated that the agreement would not have the effect of defeating his sole creditor (BNZ) and that it would ensure that Michele received some of the matrimonial property.
In 1993 Roland was declared bankrupt. He was discharged from bankruptcy in 1996. Later that year Roland registered a notice of claim against the Albany property and soon after, the Doyles separated.
In 2000 Roland made an application to set aside the 1991 agreement in order to share out the matrimonial property. He argued that he believed that the agreement unfairly benefited Michele given his indebtedness at the time the agreement was made and his later bankruptcy.
Michele applied to have the notice of claim on the property set aside and the High Court said that it should be. Roland had instigated the agreement and had obtained an advantage from it in relation to his creditors. He had been content with the arrangement for five years before he registered his notice of claim and had waited a further four years before pursuing his claim on the property. It also had to be recognised that Michele had no other assets other than the Albany property. The judge in the High Court felt that Roland's "refusal to remove his notice was so unreasonable as to lead to the conclusion that he was not acting bona fide and was using the notice of claim of interest for purposes other than the genuine protection of his interest in the property”.
Roland appealed. The Court of Appeal said that Roland's evidence was "that he did not enter into the Agreement with the intent to defeat creditors and that he wished his wife to have some share of the matrimonial property. We must assume therefore... that at the time he considered that this was a genuine estimate of Mrs Doyle’s entitlement." Roland’s notice of claim on the Albany property was removed.
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2. Champerty – not a disease, an illegal arrangement to fund litigation
Re Nautilus Developments Ltd (in liq); Montgomerie v Davison (M1285/99; HC, Akld; 14 April 2000)
Golden Gate Holdings Limited (GGH) contracted Nautilus Developments Limited to convert a building it owned in Hobson Street, Auckland into a multi-level apartment block. GGH arranged the funding and Nautilus was going to be paid from the sale of the apartments. In the course of development both companies were unable to pay their debts and were placed in liquidation. The Hobson Street apartments were sold in June 1999 for a total of $2.23 million, which was largely swallowed up in repaying money advanced by the shareholders of GGH which was secured by a second debenture. (Creditors take note - beware of companies where the shareholders have securities which will ensure they get paid before the unsecured creditors.)
Montgomerie was appointed liquidator of Nautilus and received proofs of debt from Nautilus’ unsecured creditors for $2.344 million. Those unsecured creditors, who included Inland Revenue, could not expect any dividend from the liquidation unless Montgomerie could extract funds from the directors of Nautilus and invalidate the loan securities.
Montgomerie used ss 131, 135, 136 and 137 of the Companies Act to claim that the directors of Nautilus had traded recklessly and had not acted in good faith. He wanted to ask the court to order the directors of Nautilus to pay $2.175 million which Montgomerie said was the loss arising from the directors’ mismanagement. However, none of the creditors were willing to fund the litigation necessary to get that court order.
Montgomerie therefore entered into an agreement with The Litigation Lending Services Partnership (LLSP) which agreed to provide him with the funding. Under the agreement Montgomerie had the right to direct, conduct, and possibly settle the proceedings but he had to consult with LLSP on any issues, particularly in relation to any settlement. As it was not a creditor, LLSP’s only interest was to take a share of the final settlement.
The Nautilus directors argued that this funding agreement was illegal as it created an interest in the outcome. The directors also sought to postpone proceedings until Montgomerie gave a security for costs of $30,000.
The funding arrangement by LLSP is known as maintenance. Maintenance is where a person (LLSP) maintains another (Montgomerie) in an action on the basis that they will share in the proceeds. However, such an arrangement would be "champertous", and therefore, illegal, if it allowed LLSP to interfere with the conduct of Montgomerie’s litigation or impede his recourse to the courts.
The court decided that the funding arrangement did not inhibit Montgomerie in the course of his litigation and so was not champertous. The judge observed however, that it would be prudent for liquidators and those who may be contemplating funding a similar arrangement to obtain the court’s assessment before organising anything.
Although Montgomerie successfully resisted the application to throw out the case on the grounds of champerty, the directors’ application for a postponement until security of $30,000 was paid in to the court was successful.
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3. Company insolvent? Stop trading or risk personal liability
Sanderson was a director and “alter ego” of Group Hub Ltd (GH) which operated in Hamilton. Sanderson would order CD-ROMS from The PC Company monthly and then pay for them around the 20th of the following month.
As GH only had paid up capital of $1 it needed to be trading at a profit to remain solvent. Otherwise the company’s trading would effectively be funded by creditors. GH had, however, traded at a loss for most of 1995. In September 1995 GH decided to close its Rotorua retail branch. The closure of the Rotorua branch greatly increased those losses.
In January 1996 The PC Company told Sanderson they were going to open a retail store in Hamilton. They would continue supplying him but only at the same prices they would be offering their new store. However, they would be strict on the fact that payment had to be within 7 days. Sanderson decided it was unlikely that GH would be able to continue trading in the face of such competition. As a result GH closed its doors in March and was placed in liquidation in May 1996.
The PC Company sought repayment of GH’s outstanding debt of $89,642.15 from Sanderson personally. Using s.135 of the Companies Act 1993, The PC Company claimed that Sanderson had traded recklessly and had created a substantial risk of serious loss to the company’s creditors. It said that given GH’s poor state of financial affairs, especially with the losses from the Rotorua branch closure, Sanderson should have shut up shop in January. That meant that after January, GH was carrying on business in a way likely to cause substantial risk of serious loss to its creditors. It was also incurring obligations that Sanderson must have lacked a serious belief, on reasonable grounds, that GH would be able to fulfill.
The focus of s.135 is not the director’s intentions but how the company is run and whether that incurs the substantial risk of a serious loss. GH had never had substantial reserves and its profits were modest. The closure of the Rotorua branch meant that any further downturn must have been likely to cause a substantial risk of serious loss for the creditors. Sanderson however, had done nothing to recognize or address that situation.
The court then had to determine compensation under s301(1)(c) of the Companies Act. The judge ordered Sanderson to pay $35,000, which was about one-third of The PC Company’s claims. It was felt that this fairly reflected Sanderson’s fault balanced against the fact that Sanderson was not acting dishonestly. It was also pointed that there were much worse cases of reckless trading than this.
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4. A director buys a Beamer - is this the first sign of impending business failure?
Namana v BMW Financial Services NZ Ltd (B No 67/02; HC, Rotorua; 20 Mar 2003)
Sidney Namana was the shareholder and director of House Removals Ltd. According to its accountant, the company was initially successful, showing a profit, on paper (though not in liquid assets) of $80,000. In order to enhance the image of the business Namana decided to purchase "an up-market vehicle", a BMW 328. He bought the car with financing from BMW Financial Services NZ Ltd.
Under the finance agreement Namana had to make monthly payments of $800 and a certain number of “balloon” payments. When the due date for the first balloon payment loomed, Namana became worried that he was not going to be able to meet it. He prepared a budget and decided that the best option was to trade down. He did so, replacing the BMW with a Landrover, but was only able to make two further monthly payments.
Namana sought specialist advice on his problems. This showed that there had been a significant error in House Removals’ earlier accounts. The business had in fact, at best been operating at break-even when Namana had decided to buy the BMW.
Namana was forced to return the Landrover. It was sold for $20,000 leaving a shortfall of $23,009.52. BMW Financial obtained summary judgment for this amount on 28 May 2002. When Namana failed to pay, BMW served a creditor’s petition and summons on him. In the meantime Namana had put a proposal to his creditors but BMW Financial was the only creditor to attend the meeting and the proposal was defeated.
Namana opposed the creditor’s petition arguing that he was blameless with respect to the debt because he was entitled to rely on the accounts of the company. The judge did not accept this argument. He thought Namana, who already had five HP or loan agreements and a first mortgage, was irresponsible.
Namana also claimed that he owned no assets, and that his home and business had been sold to pay his creditors. This meant, it was argued, that BMW Financial stood to gain nothing by his bankruptcy, making it pointless. The judge rejected this argument as well. By coincidence, the previous case the judge had dealt with related to the liquidation of Namana's company and evidence in that showed that Namana had at least one worthwhile asset, a first debenture over the assets of House Removals. He was therefore declared bankrupt.
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5. Creditors are paid on a distress warrant but the debtor goes bankrupt - can they keep the money?
Re: Le Sueur; alt cit Le Sueur v Le Sueur (B1479/99; HC, Akld; 19 Sept 2003)
In 1997 Ronald Le Sueur and his wife Anna loaned Ronald’s brother, Terence, $50,000 to help him buy a corn chip factory. When the loan was not repaid as agreed by September1998, Ronald and Anna obtained judgments totalling $32,664.31.
In October 2000 the District Court issued a distress warrant for packing and weighing equipment and empty containers belonging to Terence. A distress warrant is an enforcement process that authorises a bailiff to seize goods from the judgment debtor in order to satisfy the judgment.
When the bailiff went to execute the warrant, Terence refused to say which container held the goods. In this situation, the bailiff won't break in of his own accord. Ronald and Anna had to provide indemnities to cover forcible entry into the containers allowing the bailiff, with the assistance of a locksmith, to break the locks on four containers until the goods were found.
Terence continued to hold up proceedings by claiming that the seized goods were actually owned by another company (in which he held all the shares). However, a judge eventually ordered that the goods be sold by private sale and Ronald and Anna finally received the money owing to them at the end of February 2001. Unfortunately, a week before, on 24th January 2001, Terence had been declared bankrupt owing $535,876 (although Ronald and Anna did not find out until the end of May).
Two years later the Official Assignee told Ronald and Anna that as the sale of goods had not been completed before Terence was declared bankrupt, they had to pay the money to him. Ronald and Anna applied for an order to allow them to keep the proceeds of the seized goods. Section 50 of the Insolvency Act 1967 says that a creditor can keep the proceeds of the distress warrant if the "execution against goods is completed by seizure and sale" before the debtor commits any act of bankruptcy. The commonest relevant act of bankruptcy is that the debtor hasn't satisfied a creditor who has served a bankruptcy notice. In this case, not only had Ronald and Anna failed to sneak in ahead that deadline, they'd failed to sell the goods before the debtor was declared bankrupt. However, the judge has "a wide discretion to do what is right and fair according to the circumstances of each case."
The judge said that the most important factor was that Ronald and Anna had received a substantial amount of money without realising that they might have to repay it. They had understood that once they received the proceeds of the sale of the goods the matter was at an end. To pay the money to the Official Assignee now would require them to borrow more money and add to their current financial difficulties.
The judge also took in to account that the original loan was a family arrangement and not a commercial proposition. Added to the fact that Ronald and Anna had diligently sought repayment, the judge felt that the court’s discretion ought to be exercised in their favour. He said, "in my view there may be circumstances in which diligence alone may make it right and fair that the discretion be exercised in favour of a creditor who has taken extraordinary steps ... to ... obtain payment when other unsecured creditors have ... simply slumbered until bankruptcy." Ronald and Anna were able to keep the proceeds of the distress warrant.
