Michael.1
Insolvency and related law and policy, and more

Michael Murray is an Australian author and commentator on corporate and personal insolvency law and related issues, in Australia and internationally. He has a strong law and policy background, is independent of any connections, and his views are his own. He gives no legal advice. 

Duties of directors of insolvent companies – New Zealand Supreme Court decision

The NZ Supreme Court has given a significant decision on the duties of directors in the face of their company’s financial difficulties. Comparison is made by the NZ government with Australia’s insolvent trading law; a decision in Mainzeal is pending; and there is a proposal for a NZ safe harbour.

 

When Australia was considering its safe harbour regime back in 2017, the comparison was made with New Zealand as to whether its equivalent laws were flexible enough such that a safe harbour was not required. In the end, rather than make s 588G less rigid, Australia opted for a separate safe harbour provision – s 588GA.  That has now been added to by a COVID-19 safe harbour provision, s 588GAAA, which expires on 31 December 2020.

When considering its own COVID-19 reforms, NZ decided it did not need an equivalent protection to Australia’s safe harbour section 588GAAA because Australian law imposed an

“insolvency-related duty, which is much more strict than the two New Zealand creditor protection duties. Unlike in Australia, there is no specific duty on New Zealand directors to not allow a company to trade while insolvent. The duties in New Zealand are principles-based and provide scope for directors to exercise judgment”.

That is, the safe harbour change made in Australia did not fit with New Zealand’s law: see Cabinet paper, Urgent Insolvency and Corporate Law Changes in Response To COVID-19, MBIE 9 April 2020.

Debut Homes v Cooper

New Zealand’s ‘reckless trading’ and related provisions on directors’ duties law have now been the subject of a significant decision by the Supreme Court of New Zealand, as to the duties of directors of a company trading in financial difficulties if not insolvency – Debut Homes Limited (in liquidation) v Cooper Vivien Judith Madsen-Ries And Ors v Leonard Wayne Cooper And Ors [2020] NZSC 100.

The sole director had been found liable by the High Court, the Court of Appeal then reversed that decision, going to the point of finding that trading the business on was a “perfectly sensible business decision” and one that was “[o]verall… likely to improve the return rather than cause loss to [Debut’s] creditors”: Cooper v Debut Homes Limited (in liquidation)[2019] NZCA 39.

But the Supreme Court has now restored the High Court’s findings – perhaps an unsatisfactory sequence in terms of the clarity of the legal obligations that apply given the strong endorsement by the Court of Appeal.  Nevertheless, the Supreme Court has attempted to clearly set out what a director needs to do to comply with the different provisions in NZ law.

Background

Debut Homes was a residential property developer. In the face of financial difficulties towards the end of 2012, the focus was on a decision of its director, Mr Cooper, to push on and complete and sell existing residential projects, rather than to stop trading.  But his decision to push on was based on projections that did not allow for GST and other debts.  Towards the end, he worked in the business without pay. But, as at the date of liquidation, on 7 March 2014, GST of around $450,000 was owing.

The liquidators brought proceedings against Cooper for (among other conduct) breach of sections 131, 135 and 136 of the NZ Companies Act 1993, and sought compensation under section 301.

Broadly, those sections are:

  •  Section 131: a duty to act in good faith and in the best interests of the company
  • Section 135: reckless trading, being the duty not to allow the business to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors
  • Section 136: the duty not to agree to the company incurring obligation unless the director believes on reasonable grounds that the company will be able to perform them.
  • Section 301, which empowers the court to order that director to pay compensation to the company if other sections are breached.

My comments on the decision are limited given that the provisions are different from those in Australia but the decision is nevertheless relevant in Australia, including from a law reform and policy perspective.

Informal negotiations

An aspect of the Supreme Court’s decision was the difficulty for a director trying to negotiate with creditors outside a formal arrangement under the Act. In NZ these include Parts 15 (court approval of arrangements, amalgamations and compromises), 15A (voluntary administration) and 16 (liquidation).

The Supreme Court said that [43]

“(t)he removal of decision-making powers from directors in such circumstances is a recognition that directors are not the appropriate decision-makers in times of insolvency or near‑insolvency. This is because their decisions may be compromised by conflicting interests and, even where that is not the case, they may be too close to the company and its business to be able to take a realistic and impartial view of the company’s situation”.

As I have explained, there are all sorts of behavioural responses to which business owners are subject when the business is in decline or under pressure, in particular because the owners are “too close” to their own company.  See Safe harbour – some inherent behavioural issues to overcome

But the Court of Appeal had thought otherwise of the director’s conduct:

[64] When things got rough he took stock of the company’s position, put the brakes on further projects, and focussed on completion of the developments to best serve the interests of creditors. He incurred further debt in order to complete, but he considered whether those creditors could ultimately be paid, and did his costings with that in mind, and by and large they were paid with the exception of the [Inland Revenue Department – IRD] and the Trust.

[65] In relation to that IRD debt, the GST situation was complex and the IRD was not necessarily going to be worse off, and could be better off, after completion and sales. The option which the respondent says should have been taken of some sort of walk away by Mr Cooper in November 2012 leaving the houses unfinished in our assessment was the less sensible commercial option. We conclude that Mr Cooper did not act in bad faith and was not reckless”. Cooper v Debut Homes Limited (in liquidation) [2019] NZCA 39.

The further comments of the Supreme Court as to informal negotiations included these:

[179] While informal mechanisms for dealing with an insolvency or near-insolvency situation can also be used, these must accord with directors’ duties, the scheme of the Act and the salient features of the available formal mechanisms, such as ensuring all affected creditors are consulted and agree with the course of action proposed.

[180] We do not suggest that directors must always consult all creditors if wishing to enter into an informal arrangement. It would be possible, for example, to make an arrangement with secured creditors for continued trading in order to increase the amount available for the secured creditors. But, if unsecured creditors are not to be consulted, any such arrangement would have to be on the basis that all existing debts and future debts arising from continued trading, including any GST, would be met.

Summary of findings

In its summary of its findings [as paraphrased], the Supreme Court explained that Debut was insolvent by the beginning of November 2012. It was unable to pay its debts and continued trading was projected to result in a shortfall of GST of at least $300,000. It should have stopped trading at that point unless a viable formal or informal mechanism was found. Liquidation was not the only available option. At no stage did he revise his strategy, even though the overall trading position was worse than the costings projected in November 2012.

Mainzeal

It remains to note that the NZ Court of Appeal decision in Mainzeal is pending; I assume that Court will need to have regard to this decision of the Supreme Court.

Is law reform needed?

I don’t know but I simply note that the Companies (Safe Harbour for Insolvent Trading) Amendment Bill is a private member’s Bill in the NZ parliament, yet to be debated: see An insolvency safe harbour in New Zealand?

Michael Murray

29 September 2020

==================================

 

 

Share on facebook
Share on google
Share on twitter
Share on linkedin

One Response

Leave a Reply

Your email address will not be published. Required fields are marked *

Latest

Popular

Featured

Stay Up To Date With Murrays Legal Commentary

Subscribe now