There is a firmly held misconception about the application of Limited Liability. This is a protection that is open to shareholders. It does not extend to directors and a Court of Appeal case has clarified the issues nicely.
Case 1: MASON V LEWIS
Mr and Mrs Lewis were minority shareholders and also directors of a printing company, Global Print Strategies Limited. The other director managed the business and was actively defrauding a factoring company.
When the company went into liquidation, the liquidator sued the couple to recover money lost to creditors.
The Lewis’ took no part in the day-to-day operations of the business yet the Courts found that they were negligent in their obligations as directors. They were blissfully unaware of the fraud and they failed to take any of the necessary steps a prudent director should have taken. When evidence was presented to them (in the form of IRD demands sent to them) they failed to act.
They were only held liable for a portion of the company losses, reflecting their shareholding in the company and the time that they were directors. No punitive damages were awarded against them.
Case 2: FXHT FUND MANAGERS LIMITED (IN LIQUIDATION) & PERI FINNIGAN AND BORIS VAN DELDEN AS LIQUIDATORS OF FXHT FUND MANAGERS LIMITED (IN LIQUIDATION) v DIRK OBERHOLSTER
The case of Dr Oberholster developed the case law further. The company was FXHT Fund Management Limited, based in Whangarei. The company used investors’ money to take foreign exchange positions. It was run by a Mr Hitchinson, formerly from South Africa
In December 2005 Oberholster, who also had emigrated from South Africa, invested in the business and became a director. Hitchinson’s parents were patients of Dr Oberholster, and once a director he helped solicit investors.
Hitchinson ran the business with minimal oversight from Oberholster. With no supervision, and access to large amounts of investors’ cash, Hitchinson began stealing client funds from April 2006. The total loss from these defalcations amounted to about $400,000.
Also in 2006 Hitchinson proposed moving investors funds from a European trading house to one in South Africa, a firm called FX Active. Oberholster was consulted and participated in this decision and this change occurred.
Unfortunately, FX Active subsequently failed and a million dollars of investor’s funds were lost. About the same time, late 2006, Oberholster became aware of the fraud and moved quickly to prevent further losses and managed to secure the companies liquidation. The liquidators, McDonald Vague, sued Oberholster for both the stolen money and for the money lost by FX Active.
The High Court found that the failure to supervise or put in place control measures over the company was a breach of Section 135, the Reckless Trading provision of the Companies Act. This failure allowed the fraud to occur, and to continue to occur for many months. The Court also found that the decision to switch to FX Active, although in hindsight a bad one, was not a breach of Section 135.
The High Court held Oberholster liable for half of the money stolen by his fellow director.The decision was upheld by the Court of Appeal.