New Zealand Credit Law Bulletin - Vol 5, No 4, April 2005
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:
- IRD sues financier claiming entitlement to unclaimed money
Privy Council examines Unclaimed Monies Act - Shareholder issues statutory demand in attempt to get shareholder advances repaid
Court gives good summary of factors that determine solvency - Creditor challenges voidable preference ruling of liquidators
Court examines "ordinary course of business" defence - Debt factoring arrangement used to fraudulently obtain $1.4m
How did they think they were going to get away with this?
1. IRD sues financier claiming entitlement to unclaimed money
Thomas Cook (NZ) Ltd v CIR (2004) 21 NZTC 18,933
Thomas Cook (NZ) Ltd v CIR (2004) 21 NZTC 18,933
Thomas Cook (NZ) Ltd operated as a financial intermediary which took NZ dollars and issued the equivalent in overseas currency. Thomas Cook would make money by charging commission on amounts transferred to foreign currencies.
Thomas Cook had a general cash account in New Zealand and numerous other bank accounts in various countries around the world.
A customer would request from Thomas Cook a sum of money in a foreign currency. The customer would pay Thomas Cook the equivalent sum in NZ dollars, together with a commission fee.
Thomas Cook would then prepare and issue a cheque, in the overseas currency, and hand it to the customer. The customer could request that the cheque was written out to whoever they wanted.
The money that Thomas Cook received from its NZ customers was paid into a general cash account at a bank in New Zealand. Thomas Cook had to take steps to ensure that the balance standing to its credit at the relevant foreign bank was enough to meet the outstanding cheques as well as the current cheque just issued.
However, for whatever reason, not everyone would bank the overseas cheques. This meant that Thomas Cook accumulated a large sum of unclaimed money, some NZ$500,000 up to December 1992.
For over a hundred years NZ has had as part of its law that holders of unclaimed monies are required, in certain circumstances, to pay it over to the IRD. The IRD collects the unclaimed monies for use by the government for the benefit of the community. The current law is the Unclaimed Money Act 1971. For different types of unclaimed money there are various defined time limits as to when the money becomes legally “unclaimed”. For example, a savings account at an ordinary savings bank becomes “unclaimed” if it hasn’t been touched (i.e. no transactions whatsoever on behalf of the holder of the account) for 25 years (per s4(1)(c)(i) of the Act).
Here, the money paid into Thomas Cook’s account becomes “unclaimed”, under the Act, if it was not claimed within 6 years. The problem was that Thomas Cook and the IRD couldn’t agree as to when the time was to start running for the 6 year period. Thomas Cook argued that the time should run from when the money became “stale”. This concept relates to cheques. Cheques become stale if they have not been banked within 6 months of their issue.
The Privy Council (which has been recently replaced by the Supreme Court of New Zealand) determined ultimately that the time ran from the date of issue. Therefore Thomas Cook had to pay to the Inland Revenue Commissioner the amounts for any drafts that had not been claimed within 6 years of their issue.
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2. Shareholder issues statutory demand in attempt to get shareholder advances repaid
Rocklands Park Ltd v Logan Samuel Ltd
Rocklands Park Ltd v Logan Samuel Ltd
Rocklands Park Ltd was incorporated in 2000. Collin Elliot, David Pooch and Brian Stafford-Bush each owned a 20% stake. The remaining 40% stake was held by Logan Samuel Ltd, which in turn was owned by Trevor Barrett and David Samuel.
Rocklands Park Ltd, soon after incorporation, purchased the Rocklands Halls of Residence, in Auckland. This was made possible by shareholder advances totalling $300,000 coupled with external finance of $2.7m. Between 2000 and 2003 Rockland’s shareholders made further advances to the company. By 31 March 2003 $900,000 had been advanced by shareholders, with $360,000 of it coming from Logan Samuel Ltd.
In 2002, disputes arose between shareholders. Logan Samuel subsequently sought repayment of its advances to the company. In November of 2003 they served Rocklands with a statutory demand requiring it to repay the sum of $360,000 within 15 working days.
Rocklands applied to have the statutory demand set aside. Their application was based on three main arguments.
The first argument was that Rocklands was in fact solvent within s290(4) of the Companies Act 1993 and therefore the demand must be set aside.
The court examined Rocklands’ solvency. Solvency, under the Companies Act, is defined as:
1. The ability of the company to pay its debts as they become due; and
2. Having assets greater than liabilities.
In looking at the companies ability to pay its debts, the court said that it would not only look at the cash reserves of Rocklands but also any “banking accommodation” that would be available to it. The court said “it can also take into account the availability of readily realisable assets, or of assets capable of being mortgaged or pledged within a relatively short period of time”. Here, the court took into account a bank overdraft ($100,000) that was available (but not yet in use) in measuring whether it was solvent. Taking this into account, Rocklands had sufficient finances to cover debts as they fell due.
The court also looked at liabilities which Rocklands had listed on their books. One liability was to cover a specific contingency - an expense which was expected to arise. In regard to this, the court held that “a liability is not taken into account before it becomes legally due”, so, the contingency was not factored into the company’s solvency. Overall, the court determined that a company's solvency “must be approached with a sense of commercial reality”. This meant that the fact that Rocklands’ business operation was incurring a current cash-flow deficit of $29,000 was of “no real significance in the overall equation”.
Overall the court found that Rocklands was in fact solvent. The statutory demand was immediately set aside.
The second argument by Rocklands was that Logan Samuel could not demand repayment of the advances because the shareholders had agreed, at the outset, that they would not require repayment of their advances until Rocklands was in a position to pay.
The court looked at the apparent agreement between the shareholders. There was no written record of any shareholding agreement with respect to the advances. There were also large differences between the evidence of each shareholder as to the terms of the agreement. The court was not willing construct an agreement “from nothing”. The court found case law which raised a presumption that shareholder advances are payable on demand unless there is strong evidence to the contrary.
The only term that each shareholder appeared to be agree upon, was that shareholders were to be treated equally and on a pro rata basis. The court refused to allow Logan Samuel to withdraw their shareholder advances on this basis. The judge reasoned that “given the importance previously attached to the need for parity between shareholders, it would be somewhat incongruous for Logan Samuel now to be able to demand repayment of the full amount owing to it when the company may not be in a position to deal with the other shareholders in the same manner.”
The third and final argument by Rocklands was that Logan Samuel's statutory demand was an abuse of process. They argued that by issuing a statutory demand, Logan Samuel’s real motive was actually to place pressure on the remaining shareholders to purchase its shares at an inflated price. However, on the facts, the court found no evidence of any scheme. The court refused to uphold Rocklands submission this point.
Overall, Rocklands were successful in setting aside the statutory demand. Rocklands was awarded costs.
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3. Creditor challenges voidable preference ruling of liquidators
Re: Liquidation of Eastern Bay Forestry Contractors Ltd
digger was part based on rental income from the digger, and part based on the strategic benefit of the digger loading logs onto Watchorn’s trucks. If the digger was removed, then Watchorn’s trucks would not be used to transport the logs.
Watchorn invoiced Eastern Bay for each month of hiring the digger. Payments for the last 6 invoices were late and the amounts paid never corresponded with the actual invoice. However, when the company was placed in liquidation Eastern Bay had a zero balance with Watchorn.
Eastern Bay Forestry was placed in liquidation on 30 May 2003 by a special resolution of its shareholders. The liquidators took the view that several payments made to Watchorn were “voidable transactions”. In essense, insolvency law tries to ensure that all creditors suffer equally. It's not fair if one creditor gets an overdue debt paid shortly before the company fails, while others miss out. In such a case, the liquidator can claw back the payment and share it amongst all the creditors.
S292 of the Companies Act 1993 allows for a liquidator to overturn a “voidable transaction” of the company if it was:
a) Made at a time when the company was unable to pay its due debts; and
b) Made within a 2 year period before the company was placed in liquidation; and
c) Enabled another person to receive more towards satisfaction of a debt than the person would have otherwise received in the liquidation
The liquidators applied to the court seeking to have 6 transactions, totalling $53,000, set aside. Watchorn challenged the application. At the trial, it was not disputed that the transactions in question occurred in the 2 years preceding Eastern Bay liquidation, nor was there any dispute that the payments enabled Watchorn to receive more than it would otherwise have received in the liquidation.
Watchorn, however, contended that the payments were received in the "ordinary course of business" in accordance with the terms of trade that were in force between itself and Eastern Bay. The transaction will not be overturned, if the payment was made in the ordinary course of business.
The law states that the court is required to objectively view the transaction and determine whether it was an ordinary transaction for the parties to have entered into. The court takes into account the particular industries or business sectors involved. Here, the companies were operating in the forestry contracting sector. In that sector, the judge found, it was ordinary for payments to be paid on the 20th of the month following that which the invoice was received. The judge noted that “the fact that late payments [were] treated with tolerance does not, however, alter the strict terms of the contractual relationship”.
The court is also to have regard to the prior course of conduct of the company towards the recipient creditor and towards its creditors generally. Here, the court found that for each payment made before July 2001 Eastern Bay routinely paid its invoices by the end of the month. Each payment brought it back to a nil balance on Watchorn’s debtor ledger.
Then from July 2001 the pattern significantly changed – payments no longer matched the invoices – rather the payments were for even amounts – e.g. $7,000, $4,000 and $5,000. The judge noted that Eastern Bay had never paid a rounded sum payment (in a partial reduction of its indebtedness) before; and that such practice usually indicates “that the debtor is paying as much as it can afford, and no more”. The judge concluded that the last 6 payments were not “routine in nature”.
Overall, the judge found that the payments were not made in the ordinary routine of business. “The nature and timing of each is such that it must have been in response to Eastern Bay’s financial situation and not in fulfilment of its contractual obligation to Watchorn.” The judge said that the ordinary course of business proviso could not apply.
Watchorn then pleaded relief under s296(3) of the Act. Here, Watchorn had to show:
a) That it received payments in “good faith”, and
b) That it altered its position in the reasonably held belief that the payments had been validly made, and
c) It would be inequitable, in the opinion of the court, to order recovery.
Here, “good faith” required Watchorn to show that it believed that the transaction would not involve any element of undue influence on its part. The court held that Watchorn had knowledge of Eastern Bay financial strife and that liquidation was a possibility. Therefore, Watchorn should have realised that the transactions could be overturned by a liquidator.
In terms of “altering its position”, Watchorn claimed that by continuing to hire the digger they had altered their position. It said that, had payment not been received, it would not have continued to let Eastern Bay use the digger. However the court found that Watchorn’s decision to lend the digger was based not only on receiving payment from Eastern Bay, but also on the strategic use of its fleet of trucks. Ultimately, the court held, Watchorn had not proved that it had altered its position.
Lastly, in terms of what would be classed as inequitable, above, the court deemed the present case was not sufficient to warrant the court intervening. The court said that “Watchorn received payment of all of its invoices in full. It did so when other creditors, who are owed a total sum of $140,249.61, were not treated in the same way. The effect of the payments has been to give Watchorn preference over the other creditors.”
The Judge ordered that Watchorn repay the 6 voidable transactions to the liquidators, who were then to distribute them equally amongst all creditors.
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4. Debt factoring arrangement used to fraudulently obtain $1.4m
R v Grant (CA 326/04, 28 February 2005)
On 5 October 2000 Graeme Grant, a director and substantial owner of Global Print Strategies Ltd (GPSL) entered into a debt factoring arrangement with Commercial Factors Ltd (CFL).
The arrangement called for GPSL to submit invoices to CFL. Once CLF were satisfied that the invoices were genuine, it would accept the debt and pay GPSL approximately 80% of the invoiced amount (less an administration fee). CFL would recover the sum owing from the invoice. Then, upon successful recovery, CFL would pay GPSL a further 20% of its value.
CFL had to ensure that the invoices were authentic. This usually involved CFL telephoning GPSL’s customers. One such customer was Thorn Lighting Ltd, where Grant’s sister worked as an accounts payable officer. In late February 2001 Grant persuaded his sister to verify fictional invoices that GPSL had issued to her company. In March and April 2001 GPSL submitted to CFL a total of 31 invoices, made out to Thorn Lighting, for a total of $265,000. Each invoice was marked for the attention of Grant’s sister. Each invoice was accompanied by a declaration from Grant to CFL that the goods and services had been delivered or performed. All of these invoices and declarations were false.
When CFL telephoned Grant’s sister for confirmation that the invoiced goods and services had been provided, she fraudulently confirmed that the goods and services had been provided. This resulted in CFL forwarding $200,000 to GPSL.
Similar frauds were also committed in relation to Partner Print in August and September 2001. A Mr Sommerville, a part owner of Partner Print, fraudulently verified four fictional invoices from GPSL for $400,000, resulting in approximately $300,000 being paid to GPSL from CFL. Sommerville was paid $16,000 from Grant for his help in the verifying the false invoices.
By late December 2001, Grant’s company, GPSL, was in serious financial trouble. CFL began to withhold all payments until it had received the $400,000 from Partner Print. Grant sought to stave off CFL by offering to transfer his life insurance policy. He represented to CFL that he only had two months to live and they would therefore benefit from his policy in a relatively short time. He backed this up with a fictitious letter from a case manager of his life insurance company. The letter gave details of how the insurance company were to make two payments of approximately $500,000 to two separate bank accounts within the next month (presumably after his death). CFL, doubting the legitimacy of the letter, contacted the case manager. The case manager knew nothing about the matter. Nothing was lost or gained as the result of this letter.
Another week later, Grant then opened three bank accounts at the ASB in Albany. Grant deposited a cheque for $405,000 into one of them, drawn from an account from Westpac (which had no funds in it to cover it). The following day, Grant then drew from the newly deposited account a cheque for $397,000 to pay CFL. CFL deposited the cheque into their ANZ account with a request for an urgent clearance. To facilitate the clearance, Grant then forged a Westpac letter purporting to clear the funds and faxed it to ASB. This forgery was also discovered and the cheques were dishonoured.
At the district court trial, Sommerville pleaded guilty to one count of fraudulent use of a document. He was sentenced to 300 hours community work and ordered to pay $50,000. Grant’s sister also pleaded guilty to one count of fraudulent use of a document in respect of her employer, Thorn Lighting. She had also been cheating her employer, independently of the invoice frauds, to the tune of $18,000. She had pleaded guilty to four counts in respect of that crime. She was sentenced to two years imprisonment (although she later successfully applied for home detention).
The judge noted that CFL had paid out $507,000 due to the fraud, but had been able to recover approximately $300,000 of it. The prosecution claimed that, including those frauds for which evidence was lacking, Grant had obtained approximately $1.5m. Grant was originally charged with five counts of fraudulent use of a document and two counts of forgery. He eventually pleaded guilty to the forgery and three counts of fraud. The other two charges were discharged because of a lack of evidence. He was sentenced to two and a half years imprisonment.
Grant appealed on the ground that the sentence was too harsh. The appeal court ruled that the sentence was not “manifestly excessive” and therefore would not be changed.
