New Zealand Credit Law Bulletin - Vol 4, No 3, March 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:
- Australian company asks NZ court to make NZ company sue in Australian courts but applying NZ law
Here's something that we've never seen before - New Zealand's first SOE business failure - can the lawyers keep their payment?
Did picking up a cheque by courier take it outside "the normal course of business". - Creditor's liquidator or debtor's liquidator?
- Shareholder tries to get company out of liquidation - too late!
- When good businesses go bad (and assets are flicked on)
Things get messy for the creditors.
1. Australian company asks NZ court to make NZ company sue in Australian courts but applying NZ law
Rimini was a New Zealand company but only operated in Australia. It was selling franchises in its dry cleaning business and signed a Master Franchise Agreement with an Australian company, Manning for AU$250,000. The agreement was for 5 years and included rights of renewal up to a maximum of 40 years plus the right to create sub-franchises. The agreement allowed Manning was to set up a ‘Cleantastic’ business in Sydney but the agreement stipulated that it was to be governed by New Zealand law.
When difficulties arose between Rimini and Manning over the payment of royalties and other agreed amounts, Rimini terminated the agreement. Rimini then went to court to try to get back all the relevant manuals and business information, as well as to have any sub-franchises assigned to them. They also wanted the outstanding franchise fees paid. Manning argued that the dispute should be heard in an Australian court not in New Zealand.
The court said that because the contract was governed by New Zealand law, Rimini had the right to sue Manning in New Zealand. The court could however, decide whether or not to assume jurisdiction. That is, the court had the discretion to decide whether New Zealand was the right place for the case to be heard. Manning said that because all the witnesses and documents were in Australia, that was the most convenient place for the case to be heard (an argument known in legalese as forum conveniens). It also claimed that the costs would increase significantly if the case were heard in New Zealand. For their part, Rimini doubted that Manning had the finances to be able to defend themselves wherever the case was heard.
The court accepted Manning’s reasoning and decided that that there was really no difficulty for the Australian court to apply New Zealand law as called for in the contract. The judge commented that “there are very substantial commercial dealings between the two countries and as far as possible, courts should give effect to the laws of the other country. The action was dismissed in New Zealand which forced Rimini to pursue Manning in the New South Wales legal system.
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2. New Zealand's first SOE business failure - can the lawyers keep their payment?
KPMG Legal v Shephard (M122/02; HC, Wgtn; 13/11/02)
Terralink, a SOE, was a client of KPMG Legal. Terralink usually paid KPMG’s invoices by the 20th of the month following. At times invoices were paid late but KPMG’s accounts staff was often in close contact with Terralink staff at those times. Late payments were usually blamed on such things as computer system problems although the late payment in December 2000 was put down to new management being “fairly slow”.
Terralink paid $20,887.45 to KPMG on 22 December 2000 to settle thirteen invoices issued during October. KPMG arranged for the cheque to be collected by courier. It was KPMG’s normal practice to occasionally use couriers to collect cheques directly from clients on the last working day of the month. In this case, 22 December was their last working day before Christmas.
Terralink went into receivership in January 2001 and was placed in liquidation in May. The liquidator (Shephard) gave notice under s 292 Companies Act 1993 that the December payment was to be set aside as a transaction having preferential effect. The broad principle in insolvency matters is that all unsecured creditors should suffer equally. It's not fair if one gets paid all their old debt just before the business fails. The liquidator may be able to claw back payments made up to two years before the liquidation but in general the key period is the six months prior to liquidation. Within this period, the creditor has to prove they can keep the payment rather than the liquidator having to prove they should give it back.
KPMG asked the court for an order that the payment not be set aside. KPMG conceded that the December payment had been made within the restricted period of 6 months before the liquidation of Terralink. It was also clear that Terralink was insolvent at the time with unsecured creditors totalling $13,016,353. KPMG also accepted that the payment meant KPMG received more than it would otherwise have received in the liquidation. However, KPMG argued that the payment had been made in the ordinary course of business. If so, it would be exempt from clawback by the liquidator.
To find out if this was "the ordinary course of business" the court had to examine the circumstances of the particular transaction and the past patterns of behaviour between Terralink and KPMG.
KPMG said that it had put no unusual pressure on Terralink to make the payment. Its normal credit control practices had been followed and none of the usual credit indicators that a client was experiencing financial difficulties at a level where payment was at risk were evident. The late payment was not of concern as it was only one month late and delays had occurred in the past. While Shephard argued that it was not normal practice for cheques to be collected by courier it was significant that four of Terralink’s last six monthly payments had been collected by KPMG courier. The judge said, “the circumstances of this particular transaction … were usual and unremarkable in all respects”. The payment was not unusual when viewed against the background of previous dealings between KPMG and Terralink.
The payment was declared to have been made in the ordinary course of business and KPMG was allowed to keep it.
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3. Creditor's liquidator or debtor's liquidator?
Flightline Aviation Ltd v Mason Air Ltd (t/a Mason Helicopters) (M268/00; HC, Hamilton; 11/12/00)
Flightline Aviation Ltd (FAL) applied to the court to have Mason Air Ltd wound up. Flightline also provided the names of two liquidators who had consented to act as liquidators. One working day before the application was to be heard Mason Air informed Flightline that the three shareholders of Mason Air had passed a resolution that declared the company was insolvent and appointed Mr Thompson as liquidator. Flightline opposed the appointment of Thompson because it was worried that advances made by the shareholders would have the effect of reducing, if not removing, any effective recovery of outstanding debts. It was also concerned that the shareholders’ debt should be inspected so that justice would be done between all creditors.
Section 241 (2)(a) of the Companies Act allows a company to appoint a liquidator by special resolution. Section 2 of the Companies Act 1993 says that a special resolution must be approved by a majority of 75 per cent of entitled shareholders. All three shareholders of Mason Air had signed the resolution, so it met these requirements.
Section 241A (1)(a) however, requires that the special resolution appointing the liquidator must record the date and time at which the special resolution was passed. Mason Air’s resolution did not include the time. The judge said that the shareholders’ resolution was therefore not a valid appointment of a liquidator. If there was no valid appointment of a liquidator then Mason Air had not been put into liquidation.
It followed that the court still had the jurisdiction to make an order appointing a liquidator. It invalidated Thompson’s appointment, ordered Mason Air to be put into liquidation and appointed FAL’s choice of liquidator in his place.
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4. Shareholder tries to get company out of liquidation - too late!
Southcom Limited v Orbital Transport Solutions Limited (in liq) (2000) 8 NZCLC 262,181
Southcom Ltd supplied computer software to rental car company, Orbital Transport Solutions Ltd. Orbital maintained that there were major difficulties with the software and that they were forced to abandon it and purchase a new system. Orbital also spent hours trying to overcome the difficulties with the software and so did not pay Southcom.
In April 1995 Orbital tried to set off $7,025 of the outstanding debt but by November 1997 Orbital had admitted that it owed $20,050.03. Southcom demanded payment. In July 1998 Orbital paid $1,000 and said it disputed the balance but acknowledged that Orbital would continue to make payments as funds become due. The agreement was broken by Orbital and the debt was referred to a debt collection agency.
In May 1999 Southcom issued a statutory demand. There was a further statutory demand in July and in November Southcom applied for a winding up order. Throughout this process Orbital took no active steps to resist Southcom’s claims.
The former director, 99% shareholder and creditor of Orbital, Mr Allen, had already sold the car hire business even though he still disputed the debt. Although he was advised to defend a statutory demand, Allen decided not to try to set aside the statutory demand or defend the liquidation proceedings. Orbital was ordered to be wound up on 18 November 1999. However, the order was not filed for sealing until 6 December. High Court Rules require that it should be done within two days.
After Orbital was liquidated its accountant discovered that Orbital did have assets. These consisted of a debt from a company called Snappy Car Rentals Limited which had purchased vehicles from Orbital valued at approximately $70,000. This led Allen to apply to the court under s. 250 of the Companies Act to terminate the liquidation on the grounds that it was just and equitable to do so.
The court was first concerned whether there was a valid liquidation order as it had not been sealed in time. It dispensed with that problem quickly – s. 241(5) of the Companies Act says that the liquidation of a company “commences on the date on which, and at the time at which, the liquidator is appointed”. This meant that Orbital had been in liquidation since 18 November although the court noted that this was an unusual result. The judge said that “there is no other similar order … in the civil jurisdiction made in a court room which is not sealed before becoming a final and unchallengeable order subject only to appeal”.
In opposing the application to terminate Orbital’s liquidation, Southcom argued that to allow Orbital out of liquidation would be “manifestly unfair”. Southcom said that it had been denied its money for a long time and put to considerable expense in trying to locate Orbital’s assets. The court explained that it would only allow a liquidation to be overturned where:
(a) all creditors had been paid in full or satisfactory provision had been made for payment in full; and
(b) the liquidator's fees and expenses have been safeguarded; and
(c) all shareholders consented they would be no worse off than if the liquidation had proceeded to its conclusion.
In Orbital’s case, there was clearly no consent from Southcom (the creditor which had begun the liquidation). It was also clear that while Allen was now complaining, Orbital had had two opportunities to be heard in court but had declined both. Orbital was not currently solvent even though it had paid $70,000 into a solicitor’s trust account in case Southcom’s debt needed to be paid. It had not compromised or paid the contingent or finalised debts with its creditors. Orbital’s affairs had not been investigated and it was dependent on funding from its shareholder and not from within the company itself. In fact, it appeared that Orbital, by its shareholder (Allen), wanted to revive or resurrect the company to litigate its dispute with Southcom further.
The judge concluded that “as [Orbital] has failed to avail itself of the right to be heard for reasons which have nothing to do with [Southcom], and as the shareholders and directors have made a concrete decision initially that there would be no point in opposing a liquidation, [the court] cannot see any just and equitable ground for allowing the company to be removed from its present status as a company in liquidation”.
Orbital remained in liquidation and Allen even had to pay the $600 in costs for bringing his application.
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5. When good businesses go bad (and assets are flicked on)
St Laurence Mortgages Ltd v Prudent Shipping and Processing & ors [2002] NZCA 43
Kings Wharf Coldstore Ltd (Kings) owned and operated a profitable business in Wanganui known as Advanced Storage and Processing. The sole director of Kings was Mr Wilson. Kings granted three debentures over its assets. The second-ranked debenture was to St Laurence Mortgages Ltd (SLM) and the third-ranked debenture was to Wilson Investment Management Ltd (WIM) which was the vehicle that Wilson used to manage Kings. The terms of the debenture to SLM meant that the sale of Kings’ assets was forbidden without SLM’s consent.
Late in 2000 Kings got into financial difficulties. Its landlord terminated Advanced Storage’s lease so the necessary permits required to carry on the business were lost. Soon after, Kings, under Wilson’s management and control, agreed to sell Advanced Storage’s assets to Prudent Shipping and Processing for $28,500. It was later suggested that in fact, it was Wilson who was the beneficial owner of Prudent. SLM calculated that the value was actually between $990,000 and $2.3m. In fact, in the 3 months following the sale, Advanced Storage generated profits (for the benefit of Prudent) averaging $20,000 per week.
Kings was put into receivership and liquidation. The receivers and liquidators began a claim to recover Advanced Storage’s assets based on the alleged under-value of the sale. Soon after, SLM issued a statutory demand on Prudent and Wilson. SLM claimed that the sale of Advanced Storage’s plant and equipment to Prudent had been done to defeat SLM’s security interest. SLM also obtained an injunction which stopped the further disposal of Kings' former assets.
In the High Court the judge dismissed the summary judgment application. Unusually, SLM had requested that the court declare the existence of a constructive trust – that is, that Prudent held the assets they had bought on trust for the benefit of Kings. The judge pointed out that even though the terms of the debenture had been broken by the sale, SLM could still enforce its security interest against those assets. Prudent had legal title to the plant and equipment but they remained subject to SLM’s charge. That made the imposition of a trust unnecessary.
To impose a trust would, in any case, cut across the liquidator’s claim for the sale at undervalue. The judge made clear that he felt that the dispute could not be resolved without the liquidator being involved, along with the receiver and the first debenture holder. In fact, the contest between the debenture holder, the purchaser of the assets, and other creditors would be one of priorities and was a matter for the liquidator to resolve.
SLM appealed but the Court of Appeal agreed with the High Court. The Appeal Court judges did point out that SLM’s application seemed to arise from a concern that the more conventional course for a debenture holder (i.e. appointing a receiver and taking possession of the charged assets) was likely to prove unsatisfactory. That was because of the difficulties in linking the assets now used by Prudent to those secured by Kings. It was possible however, that Prudent and Wilson had diverted a valuable income stream for their own benefit, knowing it would be to the detriment of the creditors of Kings. If that was the case the judges said a more precise claim, other than mere allegations about the sale of assets without the consent of the debenture holder, would be necessary.
The court could also see no merit in the argument that the director and shareholder of a company (Wilson) and his management company (WIM) owed a fiduciary duty to a secured creditor. What fiduciary duties Wilson did owe were clear—his duties as a director of Kings, such as those contained in s. 131 of the Companies Act (a duty to act in good faith and in best interests of company). In fact, disposing of Advanced Storage’s assets, as he had done, had probably been in the best interests of Kings given its insolvency at the time. SLM’s summary judgment application remained dismissed.
