Directors have various duties imposed on them, and company law constantly develops on application. While risk is an inherent part of business, it is important to follow the evolution of the company and insolvency law. Particularly how directors’ duties affect company’s financial and trading status. Below are some key takeaways of influential decisions, particularly useful for directors to navigate the complexities of their duties.
Key Insolvency Cases
Fatupaito v Bates [1]
Summary: The Court of Appeal emphasised that directors must consider creditors’ interests when a company is approaching insolvency, reinforcing their duty to act responsibly.
Takeaway: Considerations of reckless trading include – (a) whether a director ought to have known that the prospects of continued trading would amount to a substantial risk of serious loss to creditors is considered under a claim of reckless trading (b) whether the director agreed to incur an obligation on the company at a time when he did not believe (subjective test) on reasonable grounds (objective test) that the company would be able to perform that obligation when required. Prioritising creditor interests can prevent personal liability and enhance the chances of business recovery. Directors should seek early advice and take proactive measures when financial difficulties arise.
Portacom New Zealand Ltd v McKenzie [2]
Summary: Portacom New Zealand Ltd (Portacom) leased portable buildings to NDG Pine Ltd (NDG). NDG, in turn, granted a debenture to a bank, which was registered on the Personal Property Securities Register (PPSR) as per the Personal Properties Securities Act 1999 (PPSA). When NDG went into receivership, receivers appointed by the bank claimed the right to sell the buildings. Portacom argued that NDG could not confer such a right since it only had a possessory interest in the buildings. The Court found that the debenture created a security interest in the buildings; the security interest attached to the buildings when NDG took possession; and therefore the receivers (representing the bank) had the right to sell the buildings – it was perfected and had priority over Portacom’s unperfected interest.
Takeaway: the proper registration of securities. Businesses should diligently register their security interests under the PPSA to protect their rights. Regular reviews of security registrations can safeguard against lapses that might jeopardise priority.
Re South Pacific Shipping Ltd (in liq) [3]
Summary: Whilst this was the largest ordered award in New Zealand ($7 Million) under the reckless trading provisions, Justice William Young J found that the taking of risks in business is inherent and therefore not, in itself, illegitimate, and a literal approach to the interpretation of the provision will be too onerous.
Takeaway: Directors are allowed a certain degree of risk taking in the ordinary course of business, as reckless trading centres more on illegitimate risks. Determinations of legitimacy will depend on (a) whether the risk is fully understood, (b) regards for the interests of creditors, (c) continuation and salvageability of the company, and (d) whether the conduct was in accordance with orthodox commercial practice.
Allied Concrete Ltd v Meltzer [4]
Summary: This decision provided guidance on voidable transactions, focusing on the ability of liquidators to reclaim payments made when a company is insolvent. Guidance was provided on the interpretation of “giving value” in the context of clawback provisions,[5] in that it includes value given when the debt is initially incurred. Creditors can defend against clawbacks if they acted in good faith and had no reasonable grounds to suspect the company’s insolvency, and the value given was real and substantial, even if provided when the debt was first incurred.
Takeaway: Companies must maintain accurate financial records and be cautious of making payments when insolvency looms to mitigate the risk of transactions being voided. Payments for goods on delivery or in advance are not considered voidable since no old debt repayment is involved, further protecting certain types of transactions. The ruling provides certainty for unsecured creditors, like sub-contractors, that their transactions are less likely to be voided if they meet the criteria of good faith and lack of insolvency suspicion. Creditors must demonstrate good faith and lack of reasonable grounds for suspecting insolvency to invoke the defence successfully. This adds significant protection but also places a burden of proof on creditors.
Yan v Mainzeal Property & Construction Ltd (in liq) [6]
Summary: Mainzeal was a major construction company in New Zealand with significant financial instability. Informal and non-enforceable assurances of support left it reliant on creditors. Mainzeal faced critical cashflow issues and was placed in receivership and then liquidation, with a substantial debt owed to unsecured creditors. The High Court found that Mainzeal’s directors had breached their duties by continuing to trade while insolvent and were personally liable for the losses incurred by creditors due to reckless trading.
Takeaway: Directors must exercise a high degree of caution and diligence when a company is nearing insolvency. Relying on informal assurances of financial support is inadequate; formal and reliable financial support agreements are crucial to protect creditors and avoid personal liability. Diligent, well-informed, and reasonable decision-making by directors is required in managing companies nearing insolvency.
Madsen-Ries v Cooper [7]
Summary: This case sets out the principles for assessing whether a director has breached their duties,[8] and the correct approach to determining compensation.[9] guidance on directors’ liability for reckless trading, clarifying the standard of care required and personal liability for company debts.
Takeaway:
- If continued trading will lead to a shortfall to creditors and the company is unsalvageable, directors will breach their duties regardless of whether:
- Continued trading is projected or believed to improve returns for some creditors compared to immediate liquidation.
- The overall deficit is projected to be reduced.
- Instead, alternatives like creditor compromises or voluntary administration,[10] or potentially informal mechanisms, should be considered.
- For informal mechanisms, all affected creditors must be consulted and agree with the proposed course of action, or arrangements must ensure all existing and future debts from continued trading are met.
- Compensation for breach depends on the duty breached:
- For reckless trading breaches, compensation starts with the financial deterioration from when trading should have ceased to the liquidation date.
- For incurring obligations breaches, compensation starts with the amount of new debt incurred.
BTI 2014 LLC v Sequana SA [11]
Summary: This case defined circumstances in which directors must have regard to the interest of creditors when exercising duties owed to the company. case confirmed that in the UK, creditors have an economic interest. The Supreme Court adopted this in the Mainzeal case (below).
Takeaway: Directors must consider and properly regard creditor interests when the company is insolvent/nearing insolvency. Whilst directors must balance creditors’ interests with those of shareholders, creditors’ interests become paramount as the company’s financial situation worsens. The duty is activated when insolvency is imminent or when directors know or should know that insolvent liquidation is probable.
Conclusion
The landmark cases influencing company and insolvency law in New Zealand offers crucial insights for businesses. Understanding their application equips businessmen with the confidence in upholding their fiduciary duties and protecting the interests of creditors and other stakeholders. Through these learnings, businesses can adopt best practices for commercial resilience and stability.
[1] Fatupaito v Bates [2001] 3 NZLR 386 (CA).
[2] Portacom New Zealand Ltd v McKenzie [2002] 1 NZLR 466 (HC).
[3] Re South Pacific Shipping Ltd (in liq) (2004) 9 NZCLC 263,670 (HC).
[4] Allied Concrete Ltd v Meltzer [2015] NZSC 7.
[5] Section 296(3)(c) of the Companies Act 1993.
[6] Richard Ciliang Yan v Mainzeal Property and Construction Limited (In Liq) [2023] NZSC 113 [25 August 2023].
[7] Vivien Judith Madsen-Ries and Henry David Levin as liquidators of Debut Homes Limited (In Liquidation) v Leonard Wayne Cooper [2020] NZSC 100 [24 September 2020].
[8] Under section 131 (duty to act in good faith and best interests of the company), section 135 (Reckless trading), section 136 (duty not to incur obligations when cannot meet them), of the Companies Act 1993.
[9] To be ordered under section 301 of the Companies Act 1993.
[10] Under Part 14 and Part 15 of the Companies Act 1993.
[11] BTI 2014 LLC v Sequana SA [2022] UKSC 25.
