Five former directors of Feltex Carpets Limited were found not guilty of charges brought under the Financial Reporting Act 1993 ("FRA"). The charges concerned a statement containing interim financial information for the half year ended 31 December 2005.
The charges related to a failure of the statement to disclose that Feltex had breached certain financial covenants contained in an ANZ Bank facility agreement, and a failure to classify the ANZ liability as a current liability. Feltex's 31 December 2005 financial statements were its first financial statements prepared under IFRS. The Judge found that under the previous, GAAP, accounting standards, because Feltex's directors, managers, and their accounting advisers, Ernst & Young, took the view that ANZ would not be relying on its strict legal rights and would be providing continuing financial support for the company, disclosure of those issues would not have been necessary. However, the more prescriptive, "form over substance" approach of IFRS required the ANZ liability to be classified as current and the covenant breach to be disclosed in the statement.
The directors accepted that the statement failed to comply with IFRS. The issue before the Court was whether the directors could rely on the defence under section 40 of the FRA that they took all reasonable and proper steps to ensure that the applicable requirements of the FRA would be complied with.
A fundamental principle underlying the decision was that the directors were entitled to seek and rely upon specialist accounting advice as to the complicated and specialised issues of the application of the IFRS. Under section 138 of the Companies Act 1993, directors are empowered to rely on professional or expert advice, provided that the directors act in good faith, make proper enquiry where the need for enquiry is indicated by the circumstances and have no knowledge that such reliance is unwarranted. Judge Doogue held that section 138 was relevant to whether the directors had taken "all reasonable and proper steps" and had a defence under the FRA.
This decision has caused officials to prioritise a reconsideration of regulatory legislation due to go to the House over the next few months.
The Registrar of Companies has confirmed that he will not appeal the decision.
Ministry of Economic Development v Feeney & Ors (DC Auckland CRI-2008-004-029199, 2 August 2010).
A more detailed analysis of this decision can be found here.
Blue Chip case to be heard by the Supreme Court
The Supreme Court has granted GE Custodians leave to appeal the Court of Appeal's decision that GE loans to a retired couple who were Blue Chip investors were oppressive within the meaning of the Credit Contracts and Consumer Finance Act 2003 (the Court of Appeal case was noted in June's Restructuring and Insolvency Law update, which can be viewed here). The appeal is expected to be heard in October 2010.
Law on priority of liens and other security interests clarified
The High Court has held that because a contractual lien is a "security interest" under the Personal Property Securities Act 1999 ("PPSA"), it is subject to the same priority rules as other security interests.
Scene 1 Entertainment Limited (in receivership) was a distributor of DVDs. Toll Logistics provided warehousing services for DVDs imported by Scene 1 from May 2008, although a formal agreement was only signed on 5 June 2009 (which granted Toll a general lien over Scene 1's DVDs). Receivers were appointed over Scene 1 on 22 June 2009. Toll claimed that it had priority over ASB's secured debt under section 93 of the PPSA, by virtue of a contractual or common law lien over the DVDs in its possession. The receivers applied for directions under section 34 of the Receiverships Act 1993.
Toll argued that it had a common law general lien as a packer. The Court held that there was insufficient proof of custom to support a packer's or warehouseman's lien. Accordingly, the case focussed on the priority of the contractual lien. A contractual lien was held to be a "security interest" under the PPSA, unlike liens created by other Acts or by operation of law.
Toll argued that section 93 of the PPSA - which gives "liens" priority over secured interests - applied both to common law or statutory law and contractual liens. The issue was whether a contractual lien, as a "security interest" under the PPSA, was also a "lien" under section 93. The Court considered that this would be inconsistent with the scheme and purpose of the PPSA, and accordingly ruled that only liens that were not security interests get priority under section 93.
Toll's contractual lien was therefore subject to the same priority rules as other security interests under the PPSA, and ranked behind ASB's secured debt which was registered prior in time.
Therefore, only a limited category of liens will enjoy priority over a regulated security interest (for example, a common law worker’s possessory lien). Those seeking to claim a contractual lien should register their interest on the PPSR.
McKay v Toll Logistics (NZ) Ltd (HC Auckland CIV-2009-404-7389, 22 June 2010)
Deeds of Company Arrangement cannot release a third party guarantee or indemnity
Following the Australian approach in Lehman Brothers, a District Court decision has confirmed that a Deed of Company Arrangement ("DOCA") which releases a company from a debt cannot release a third party guarantee or indemnity in relation to that debt. The implication is that creditors who are party to a DOCA may agree directly with the third party to release a third party guarantee or indemnity and, if they do not so agree, they are free to pursue their claim.
Atlas Resources Ltd v Aull and Timbers (DC North Shore CIV-2009-044-2051, 21 June 2010)
Increased costs for receivers following withdrawal of application to inspect documents
The High Court granted receivers costs with a 50% increase from the ordinary scale following the withdrawal of an application made against them by directors and shareholders of Cedenco Foods (in receivership and in liquidation) and Cedenco Ohakune (in receivership and in liquidation) for orders to make documents of the companies available for inspection. In the costs judgment, Heath J made a number of observations as to the grounds for such inspection orders.
Section 179(1) of the Companies Act 1993 permits a “shareholder or creditor of a company” to apply for an order authorising a named person to inspect and to make copies of, or take extracts from, specified records or other documents of the company. Heath J noted that, on the face of section 179(1), the only parties who could be subjected to such an order are the Cedenco companies themselves. Section 191 of the Companies Act 1993 entitles a director, on reasonable notice, to inspect the records of a company in written form, without charge and at a reasonable time specified by the director. Heath J considered that, while the Court has jurisdiction to prevent a director from inspecting records, it has no express authority to order that he or she do so. Finally, Heath J noted that it is doubtful whether any order of the type sought by the applicants could be made under section 34 of the Receiverships Act 1993, which deals with Court supervision of receivers.
Russell McVeagh acted for Brendon Gibson and Michael Stiassny of KordaMentha, the receivers of the Cedenco companies.
Alexander & Ors v Mayne Wetherell & Ors (High Court Auckland CIV-2009-404-7781, 28 July 2010)
When does shadow directorship extend to secured creditors?
The New South Wales Supreme Court has considered whether shadow directorship can extend to secured creditors of insolvent companies. The Court's decision sends a clear message that, while creditors (as do lenders) face a risk of being found to have been a shadow director in certain circumstances, a high threshold exists, and mere involvement in the company, or pressure to pay, will not automatically result in such a finding.
Apple Computer Australia Pty Ltd and Buzzle Operations Pty Ltd (in Liq) had entered into an agreement under which Buzzle purchased stock on credit and provided security for the debt. Buzzle became insolvent, Apple appointed receivers and Buzzle was wound up.
Buzzle's liquidators brought an action alleging that Apple acted as a shadow director, was therefore liable for insolvent trading, and should have its security treated as if granted to a related party. The Court considered legislation similar to section 126 of New Zealand's Companies Act 1993, under which a "director" includes persons in accordance with whose directions and instructions an appointed director may be required to act.
In dismissing the claim that Apple had acted as a shadow director, the Court commented that:
- A creditor is entitled to protect its position by putting pressure on a company, as long as it ensures it is not too closely involved in the management of its affairs.
- A creditor is entitled to impose conditions for continuing support, and may do so for an extended period. The directors might feel that they have no choice but to comply: the important feature being that the directors can and do exercise their own judgement whether it is in the interests of the company to comply with the conditions.
- It is necessary for a governing majority of the board to be accustomed to acting on the person's wishes, but it is not sufficient that non-director executives may be accustomed to acting on the person's wishes.
- In this case, the creditor took a proactive role in exploring the possibility of third party investors, in pursuing a demerger proposal and encouraging the company to continue to trade while those possibilities were explored, no instruction or wish was given on which the directors collectively acted.
- For a creditor to be liable as a shadow director, there must be a causal connection between the instructions of the creditor and the actions taken by the directors; and directors must be accustomed to act in accordance with the wishes or instructions of a shadow director.
- Documenting that a creditor does not wish to be involved in any of the company's corporate decision making will not in and of itself protect a creditor from becoming a shadow director, but will serve to highlight its position as a creditor, rather than a director, of the company.
This case recognises that while the door is open to extend the ambit of shadow directorship to include secured creditors, it is still a high threshold to establish secured creditors to be directors.
Buzzle Operations Pty Ltd (in Liq) v Apple Computer Australia Pty Ltd [2010] NSWSC 233
Orders for sale of property pending resolution of PPSA priority dispute
The circumstances in which a court order for the sale of disputed property can be granted prior to the resolution of the dispute were recently considered by the High Court in the context of the receivership of farming companies associated with the Crafar family.
The case arose out of a dispute between the receivers and Stockco Limited over the priority of a security interest of Westpac in certain cows which Stockco asserted were sold to it by one of the Crafar farm companies or acquired by Stockco from third parties. The receivers sought orders authorising the sale of disputed stock and the holding of the proceeds in trust pending determination of the substantive dispute between them, or alternatively that the Court allocate a priority fixture for the hearing of the dispute. The receivers sought these orders in order to be able to offer the stock for sale with the farms as a going concern in order to obtain the best possible price from potential purchasers.
Where there are court proceedings concerning property (other than land), a judge has a discretionary power to order the sale of that property before a hearing. However, an order for sale is only available if either (a) the property is perishable or likely to deteriorate; or (b) if the property should for any other reason be sold before the hearing. The receivers sought an order based on (b).
White J held that there must be a good reason why such an order is necessary or justified in the particular circumstances of the case. His Honour declined to grant the order for sale, holding that if the Overseas Investment Commission approves the conditional sale agreement between the receivers and UBNZ, there will be no need for the pre-trial sale order. UBNZ had agreed to a lease and put option arrangement in respect of the disputed stock, whereby they agreed to lease the stock until the priority dispute was resolved and thereafter purchase (from the successful party) the stock. His Honour was not satisfied that, in relation to other prospective purchasers, it was necessary to include the disputed stock in the sale of the farms to other prospective purchasers.
The approach that White J took to the question of necessity was perhaps surprisingly stringent. His Honour held that unless and until the receivers had offered to sell the farms on terms including a lease and put option in respect of the disputed stock, and there was a reaction from the market, it was not possible for the Court to be satisfied that the inclusion of such terms would necessarily adversely affect the price for the assets.
Gibson & Stiassny v Stockco Ltd & Ors (HC Auckland CIV-2009-404-007120, 5 July 2010)
A caveatable interest may not stand if it has "no practical benefit"
A recent High Court judgment highlights that a caveat, even if lodged on good grounds, may be removed if it can be shown that there is no practical benefit from maintaining the caveat. A caveatable interest will not always stand in the way of dealings with the title.
The estranged wife of Auckland property developer David Henderson lodged caveats against titles to properties associated with Mr Henderson to protect her interest pending the outcome of their separation. Meanwhile, Mr Henderson encountered business difficulties and was forced to sell all the properties in which he had an interest. The secured creditors were owed a total of approximately $81 million and the total to be realised under the sales was $37 million. The amount owed to secured creditors therefore far exceeded the amount to be distributed, leaving nothing for unsecured creditors.
In considering whether there was any "practical benefit" in maintaining Mrs Henderson’s caveat, the Court cited the decision of the Court of Appeal in Pacific Homes Ltd (In Receivership) v Consolidated Joineries Ltd [1996] 2 NZLR 652. This case commented that even if a caveat established a caveatable interest, if it could be shown that there was no practical benefit in maintaining a caveat, an order would be made for its removal. Such an order will only be made where the Court is completely satisfied that the legitimate interests of the caveator will not be prejudiced, and the caveator can have no reasonable expectation of obtaining any benefit from the continuance of the caveat, or if the caveator’s interest can reasonably be accommodated in some other way, then it may be appropriate for the caveat to be removed. In the current instance, there was insufficient equity to satisfy the secured creditors, let alone anyone with any subsequent unregistered interest. It was held that Mrs Henderson fell behind the secured creditors, there was no practical benefit for her in maintaining the caveats and the caveats were therefore ordered to be removed.
200 Victoria Street Ltd & Ors v Henderson & Anor (HC Auckland CIV-2010-404-003894, 30 June 2010)
Service of statutory demand at a vacant registered office
The High Court has commented on the validity of service of a statutory demand at a registered office that appears to have been abandoned. The Court noted the difficulty in reconciling the clear wording of section 387(1)(c) of the Companies Act 1993 (which provides for service by leaving the demand at the company's registered office) with judicial comment to the effect that service will be defective if the creditor knows that the debtor has no presence at that address.
The Court commented that leaving the demand at the company's registered office will generally constitute sufficient service, and did not require further Court direction or inquiry as to whether the demand actually came to the attention of a company officer. However, if service at an out-of-date registered office would result in injustice in the particular case, the Court's residual powers such as in relation to abuse of process might be invoked. For that reason, service should be made on a director (or other valid method) if the creditor is aware that a demand served would not come to the attention of the debtor at their registered office.
Re Spanbild New Zealand Ltd (HC Invercargill CIV-2010-425-000191, 27 May 2010)
Bankruptcy not foregone conclusion when debtor cannot pay
Bankruptcy is not inevitable even if the debtor cannot comply with a judgment debt. In a recent case, the Court found that the debtor had not caused loss to the business community in general, that bankruptcy would make no difference because the debtor was a 70 year old retired businessman with no assets, and that the bankruptcy application was fuelled by a collateral purpose to humiliate the debtor. The Court further found that the fact the debtor had signed a personal guarantee for the debt was not a decisive factor in the consideration. In these circumstances the Court held that it was not just and equitable to make an order of bankruptcy.
Re Cutting, ex parte Gitmans (HC Auckland CIV-2009-404-6537, 20 May 2010)
Creditor's proposals and the importance of complying with form
In this recovering economy, many individuals are continuing to battle to stay out of bankruptcy. Under Subpart 2 of Part 5 of the Insolvency Act 2006, an option for insolvent individuals is to make a proposal to all creditors for the payment or satisfaction of their debts. While this is a relatively straightforward exercise, given the potentially serious prejudice to creditors if a proposal is implemented without proper consultation and acceptance, it is important that procedural requirements are met and form complied with. These matters include:
- the proposal comply with the specifications as to form;
- the proposal be filed in the High Court;
- a meeting of creditors be called to examine the insolvent, vote on the proposal and approve or replace the provisional trustee;
- creditors be given notice of the court hearing to approve the proposal; and
- the Court approve the proposal before it becomes binding on all creditors.
The Court insists on strict compliance with these requirements and the process is additionally safeguarded in that the Court must hear any objections by creditors before approving a proposal. Failure to comply with these requirements could, in extreme cases, result in an order for indemnity costs against the insolvent and/or his or her representative as occurred in the judgment of Christiansen AJ in Re Liddle (HC Auckland CIV 2009-404-5377; CIV 2010-404-2349, 25 June 2010).
Would an order for security for costs prevent a challenge to a receiver's remuneration?
A recent High Court decision considered an application by the receivers of Pacific International Lodges Limited ("PCL") for security for costs against PCL in respect of an application by PCL under section 34 of the Receiverships Act 1993 for an order fixing the receiver's remuneration and under section 35 to terminate the receivership.
Counsel for PCL submitted that PCL should not be prevented from challenging the receivers' remuneration by having to meet an award of security for costs. Stevens J held that security for costs would not necessarily prevent PCL from challenging the receivers' remuneration under section 34 of the Receiverships Act 1993, and that it was incumbent on the shareholders to put the company in funds so that it could meet any security ordered. Importantly, there was no suggestion that the shareholders did not have the funds, and further, they would benefit from any decision. Security for costs was ordered.
Pacific International Lodges Ltd (in rec) v McCallum (HC Auckland CIV-2008-404-2009, 22 June 2010)
