New Zealand Credit Law Bulletin - Vol 6, No 1, February 2006
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:
- A “hydraulicked” finance deal goes wrong
An insight into the more dubious side of finance broking - Reckless trading claim against director of failed company
Was it a normal trade debt or did the creditor accept that it would only be repaid out of profits? - Daddy made me sign the document
Can daughter-directors escape their liability under guarantees? - How long can you wait before enforcing a judgment?
After 6 years you need to ask leave of the court - When the defendant fails to take action, he bears the costs
Act promptly or the court will award costs against you
1. A “hydraulicked” finance deal goes wrong
CRUDEN and WILSON V FUTURE HOPE HOLDINGS LTD and Ors HC DUN CIV 2002-412-000036 [3 September 2004]
Miss Wilson and Mr Cruden were a young couple eager to buy their first home from Miss Wilson’s father. Her father agreed to sell the property to them for $80,000 which was a substantial discount from its value of $115,000. With very little savings the couple approached a mortgage broker, Scott, who put them in touch with a solicitor, Munro, (who did not in fact hold a practising certificate).
It was unlikely that a bank would lend them the full $80,000 purchase price. The arrangement that was then entered into was, in the judge’s opinion, a variation on “hydraulic financing”. Typically, in a “hydraulicked” deal, the asset will made to appear to have been sold for more than the true price. For example, an $80,000 asset might appear to be being sold for $100,000. The lender will be led to believe that the would-be borrowers have a deposit of $20,000, therefore only need to borrow $80,000. The more equity the borrower has in the property, the more they have to lose if they default so the harder they are likely to try to keep paying their loan. Also, the the better the position of the lender. The customer has more incentive to the borrower lender has to sell As the judge in this case said, “that can be, and often is, a fraud on the bank who would not normally lend at that amount.”
The arrangement was considerably more complex here. Wilson’s father sold the house to a company called Southern Housing Corporation Ltd purchasing the house for $80,000 who then sold the house to Miss Wilson and Mr Cruden for $101,250. ANZ lent Wilson and Cruden just over $80,000 for this purchase.
The balance ($21,250 by our maths but $22,250 according to the judgment) was contributed by Future Hope Charitable Trust. This was a nominal payment – no money actually changed hands. Wilson and Cruden were to pay a company called Future Hope Holdings Ltd $5000 over three years, after which Future Hope Charitable Trust would forgive the rest of the debt. If this all seems complex, it should be noted that the judge suspected Scott, the mortgage broker, didn’t “fully grasp all the dealings between the plaintiffs and Mr Munro.”
Miss Wilson and her partner didn’t understand the structure of the arrangement, but they made their payments on time. Having paid Future Hope Holdings $5000 they had been attempting to contact Mr Munro to get the completion of the deal. Unbeknown to them, Scott then paid off the ANZ mortgage and, claiming to act under their power of attorney, transferred the property to Property Traders Society Ltd.
On October 23 when Wilson returned home after work and after picking up her children from school she found she was locked out of her house. Two men in a Chubb security van gave her a trespass notice warning her not to trespass on property now owned by Property Traders Society Ltd. The trespass notice was signed by Scott.
Wilson and Cruden sued Future Hope Holdings Ltd, Future Hope Charitable Trust, Scott, and Property Traders Society for the wrong that was done against them. The matter was brought before the High Court. None of the defendants made any appearance. The judge awarded $20,000 for damages for pain and suffering and $15,000 for exemplary damages. Exemplary damages are awarded when deliberate or reckless conduct is seen as plainly deserving of additional punishment to reflect the importance of maintaining the law.
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2. Reckless trading claim against director of failed company
APL V HARNETT HC AK CRI 2003-404-0633 [15 December 2004]
Advanced Plastics Limited (APL) carried out a plastic recycling business. APL’s governing director was Mr Van Duyn. APL supplied Petros Developments Limited with raw materials to mould a range of products like buckets and pots for plants. By 1994 it supplied nearly 60% of Petros’ raw material needs. In early 1995 Lin Marketing Ltd, a company associated with Van Duyn, took 35% of the shares in Petros.
APL had arranged to import a plastic moulding machine to manufacture a product for which it had obtained an exclusive licence, but lacked manufacturing capacity and experience. Instead of buying the machine itself, APL transferred it to Petros in exchange for $100,000 worth of shares in Petros.
In August 2000 APL asked for repayment of its debt. Van Duyn and his wife looked into a takeover of Petros but after looking at the financial records decided against it. Geoffrey Harnett, the governing director of Petros, elected to place Petros into liquidation.
When Petros went into liquidation, it owed to APL $818,368. APL claimed that its loss was directly attributable to reckless trading by Petros’s governing director, Harnett, and that he was liable personally. Mr Harnett claimed that APL was not simply a trade creditor and that APL caused Petros’s demise by calling up its debt, and if trading was ever reckless, Mr Harnett argued, that APL was complicit, as was Mr Van Duyn.
The judge saw the question as to whether Petros was insolvent as being intertwined with the issue of the underlying relationship between the two businesses. A company is considered solvent under the Companies Act if the value of total assets exceeds the value of total liabilities. The parties and their accountants disagreed as to whether Petros was solvent. Mr Downey for Petros believed assets of the company were to be valued on an ongoing basis until liquidation. However, Mr Ross for APL believed valuation of assets should be done by recourse to liquidators’ values.
The judge said that APL’s claim assumes that what it was owed by Petros was payable within 30 days of supply, or on demand, and within the financial year; and that the account increased dramatically in size only because APL accepted Mr Harnett’s every excuse and assurance. Petros, on the other hand, did not, after December 1994, never treated APL as a usual trade creditor. Petros treated APL’s debt as a term liability, first as to $360,000, and then as to almost the entire sum. The judge said that this “puts in issue … what was the true nature of the relationship between APL and Petros, between Mr Harnett and Mr and Mrs Van Duyn.”
Mr Harnett said APL and Petros entered into a joint venture in which APL was to be Petros’s exclusive supplier of raw materials. Petros was to expand its manufacturing capacity, and both were to work to develop the market to their mutual profit. Mr Harnett said that Petros was to pay APL’s invoices only when, after investing in plant and meeting trade and other liabilities, it had surplus funds. Where there was no surplus, any unpaid balance was to be treated as a term liability.
The judge considered that the parties had agreed to a shared strategy: Petros was to grow in capacity, taking as it did so increasing supplies from APL, and APL was to underwrite Petros’s expansion by deferring Petros’s debt. He concluded that “PDL could never have traded as it did without APL’s, and the Van Duyns’, active support. APL and the Van Duyns must willingly have shared the risk.” Harnett had not therefore traded recklessly and was not found to be personally liable.
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3. Daddy made me sign the document
NEW ZEALAND BREWERIES LIMITED V ROHAN CHARLES JAYS AND SIMON NEIL HEWSON AS TRUSTEES OF THE JAYS FAMILY TRUST OF 99A GUYTON STREET, WANGANUI And Ors C
Mr RC Jays set up a company and made his three daughters, (two aged 22 and one aged 23), the sole shareholders and directors of that company. The company, Grand International Limited (G.I. Limited), operated The Grand Hotel in Wanganui.
New Zealand Breweries Limited supplied The Grand Hotel with alcohol and made loans of $250,000.00 and $100,000.00 to the company which were payable over a term of about eighteen years. Those loans were guaranteed by Jays and his three daughters.
G.I Limited defaulted on its loan repayments and was put into liquidation. On 8 November 2004 G.I Limited applied for summary judgment against the trustees of the Jays Family Trust (Jays and Mr Hewson) and each of the daughters for $245,661.29. Hewson’s liability was limited to the assets of the trust, presumably by agreement with NZ Breweries at the time the guarantees were signed. Jays’ liability was not limited and if the trust had insufficient assets his own assets would be at risk. Jays did not defend the application.
However, the daughters did defend. They claimed first that the guarantee was signed under undue influence (from their father) and second that the guarantee was an unconscionable bargain. (Unconscionable means that it was completely unacceptable and unfair – beyond what anyone with a conscience could accept.)
The judge said that it was up to New Zealand Breweries Limited to prove that the daughters had no defence to the claim. However, the judge continued “it must also be emphasised that a robust approach needs to be taken in considering the defendants' defences, and the affidavit evidence placed by them before the Court.”
The judge said that even if the claim of undue influence could be established it would not necessarily be a defence. If NZ Breweries had no notice of the father’s alleged undue influence it had no responsibility for it.
A creditor will only be put on enquiry as to the possibility of undue influence if there is a relationship of trust and confidence between the guarantor and debtor. Clearly, daughters have a relationship of trust and confidence with their father but in this case their father was not the debtor. The debtor was G.I. Ltd. This was a fundamental problem for the daughters in trying to prove undue influence. “Ironically,” said the judge, “if anyone was in a position potentially to be able to invoke the doctrine of undue influence in the present case, it might be the father, Mr Jays.” He had no interest in the company and therefore stood to reap no benefit from his guarantee.
The judge also dismissed the argument of an unconscionable bargain. Even if the daughters were in a disadvantaged position on the basis that they had no previous business experience, there was nothing to show that NZ Breweries had any knowledge of this. The company was simply seeking a guarantee from the directors of the company to which it was extending a substantial loan – an ordinary business relationship. The daughters stood to gain from a loan made to a company in which they were the sole shareholders and directors. There was no apparent unfairness in this.
NZ Breweries was granted summary judgment against the defendants.
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4. How long can you wait before enforcing a judgment?
BLAIR V ELLERY HC AK CP2618188 [20 August 2004]
Mr and Mrs Blair obtained a judgment of $50,000 against Mr Ellery in May 1993. Ellery appealed to the Court of Appeal. In October 1994, before the case was decided, the parties agreed in writing that the Blairs would not execute judgment against Ellery. In other words they wouldn’t use any of the enforcement options available to a judgment creditor – attachment order, distress warrant, bankruptcy proceedings, etc.
The consideration – what they got in return for this undertaking – was that Ellery was to provide security for the debt and pay interest. The security was that Mr Ellery gave Mr and Mrs Blair a mortgage over a property he owned. However, they were unable to obtain the certificate of title to register the mortgage. The property was sold by a prior mortgagee, and there was no money to pay Mr and Mrs Blair. They were left without security.
Under the agreement, Mr and Mrs Blair were to be paid the principal sum ($50,000) after the appeal was decided. Ellery failed to follow through with the appeal and it was ultimately struck out in 1998. The principal sum became payable to Mr and Mrs Blair when Mr Ellery's appeal was struck out.
In 2004, the Blairs tried to enforce their judgment. Eleven years had passed since judgement had been given. Judgment creditors have up to twelve years to enforce a judgment but after six years they have to seek permission from the High Court first. The law recognises that after such a long time it may be inappropriate or unjust to allow the judgment to be executed.
Mr and Mrs Blair asked the High Court for permission to enforce. Unfortunately for them, the judge concluded that things had changed. The agreement of October 1994 said, among other things, “The Mortgagee has agreed to a stay of execution of the said judgment upon the Mortgagor executing this mortgage in favour of the Mortgagee.” Even though the mortgage didn’t do the Blairs any good, they were bound by this. The judge said that, “If they wish to seek redress from Mr Ellery they will need to sue Mr Ellery under his personal covenant in the mortgage.”
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5. When the defendant fails to take action, he bears the costs
Paul Chong HC AK CIV 2003-404-6837
Mr Chong obtained a summary judgment in the District Court against Mr Choi in September 2003. In December 2003 Chong issued a bankruptcy notice against Choi. This is the first stage in bankrupting a debtor. In January 2004, Choi applied to set aside the bankruptcy notice. The application failed because it was filed and served one day outside the statutory time period. In February, five months after it was entered, he applied to set aside the summary judgment. In March 2004 Chong issued a bankruptcy petition.
Chong adjourned his petition pending the outcome of the application to set aside his summary judgment. Choi then filed a lengthy affidavit raising issues regarding an alleged overpayment to Chong. Chong agreed to withdraw his opposition to setting aside the summary judgment. He said that there was not sufficient time to have an independent accountant review the financial records that Mr Choi had produced, so he made a pragmatic decision not to pursue his opposition to the application to set aside. He was awarded costs of $1500 by the District Court judge.
In light of this, Chong was given leave by the High Court to withdraw his bankruptcy petition. The question then was, which side would be awarded costs? High Court Rule 476C which provides that: "Unless the defendant otherwise agrees or the Court otherwise orders, a plaintiff who discontinues a proceeding against a defendant must pay costs to the defendant of and incidental to the proceeding up to and including a discontinuance".
So on the face of it if there was a presumption that Chong should pay costs. However, the judge said that “for the purpose of determining the matter of costs …a relevant factor is whether or not the plaintiff acted reasonably in commencing the proceedings and whether a particular defendant acted reasonably in defending the proceedings.”
He said, “Mr Choi must face the consequences of his failure to take prompt steps to have the summary judgment set aside and the fact that he only did so after the bankruptcy notice had been issued.” Chong was awarded costs and disbursements.
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