Creditors of companies that fail are often shocked and angered by the ability of directors of the failed company to start up a new business and carry on as though nothing happened.

They cannot accept that they are suffering because of the losses they are facing whilst the people they see as being responsible for the losses appear to suffer no ill effects.

Who is at fault?

It is important to note that the debt owed to the creditor is owed by the company, not the directors personally.  A limited liability company has its own separate legal identity and it is generally only when the directors have given personal guarantees in favour of particular creditors that they become personally liable for the debts concerned.

Furthermore, company failures are not always attributable to actions of the directors.  Failures come about for a variety of reasons including economic downturn, natural disasters, default in payments from customers and major clients changing supplier.

Starting over

There is no automatic bar to a director of a failed company starting up a new business on the failure of the old one.

There are provisions within the Companies Act 1993 in respect to starting and operating phoenix companies within five years of the commencement of the liquidation of the failed company.

Section 386B(1) of the Companies Act 1993 defines a phoenix company as follows:

A phoenix company means, in relation to a failed company, a company that, at any time before, or within five years after, the commencement of the liquidation of the failed company, is known by a name that is also -

1. a pre-liquidation name of the failed company; or
2. a similar name

A pre-liquidation name means any name (including any trading name) of a failed company in the 12 months before the commencement of that company's liquidation.

A similar name means a name that is so similar to a pre-liquidation name of a failed company as to suggest an association with that company.

There are some exceptions to the rules regarding phoenix companies, for instance Court approval can be obtained (Section 386A(1)) or a Successor Company Notice can be issued (Section 386D).

You can see more detail regarding phoenix companies in the article on our website written by Peri Finnigan, Phoenix companies:  what exactly are the rules here?

What can be done to stop them?

Directors don't always just walk away unscathed by the failure of their company.

There is a personal toll in the stress that they have been under leading up to the failure, the personal loss they may have suffered through funds they had put into the company or through personal guarantees provided to financiers or suppliers, and the sense of failure that most feel when their company is liquidated.

Their actions will also be subject to scrutiny by the liquidator of their company.

Liquidators will investigate, among other things, the activities of the directors to establish if the directors have breached their duties.  This can lead to legal proceedings being taken against the directors if they are considered to have acted in breach of those duties and caused loss to creditors by doing so.

If found to have been in breach of their duties or reckless in their actions the Court can impose monetary penalties on the directors to the level it thinks is appropriate to the circumstances.

One of the statutory duties imposed on liquidators is to report to the Registrar of Companies where they suspect the company or any director of the company has committed an offence that is material to the liquidation against the Companies Act 1993, the Crimes Act 1961, the Financial Markets Conduct Act 2013, the Takeovers Act 1993 and the Insurance (Prudential Supervision) Act 2010.

The liquidators will also report to the Registrar of Companies on any director who they believe should be banned from being director because of the belief that their actions were wholly or partly responsible for the failure of the company or because they have had two or more failed companies in the previous five years.

Breaches of the banning orders and operating a phoenix company can, on conviction, lead to penalties of up to five years' imprisonment or a $200,000 fine.

In conclusion, whilst it may seem unfair that the directors of a failed company can just carry on with business as usual after the failure, there are provisions available to have them brought to task and penalised where appropriate.

It seems like a typically Kiwi thing to do - a couple of mates decide to go into business together and start up a company to operate the business.  Everything is split down the middle - each director owning 50% of the shares and all agreed on a handshake.

What could go wrong?

The recent liquidation of a small business shows just what can happen.  Things went well for the first couple of years.  Business was going okay and making a small profit but then things started to go wrong.

The relationship broke down between the shareholders and got to the stage where they couldn't agree on anything to do with the business including staff management and business direction.

Legal advisors became involved and an attempt was made to resolve the issues by one of the shareholders buying out the other's interest.  Unfortunately, they couldn't agree on the value of the business.

As a result, the decision was made and agreed to by both shareholders to liquidate the company.  The liquidation process was made more protracted and costly by the sniping between the shareholders leading to higher liquidation fees and therefore a reduced payment to creditors.

There are no guarantees of course but this situation may have been avoided, or at least the damage mitigated to a certain extent, if there had been a shareholders' agreement put in place at the time the company was incorporated.

Shareholder agreements usually include

A shareholder agreement is like a business pre-nuptial agreement.  It sets out the basis of the relationship between the shareholders and can include matters such as:

• Defining the type of business the company will engage in;
• How the business will be managed and who will be responsible for particular areas of management such as staff employment etc;
• What types of decisions can be made by individuals alone and what types need majority or unanimous agreement;
• How any of the parties leaving the business will be handled - what happens to their shares etc;
• How any disagreements or disputes that arise will be handled.

It can contain confidential information as, unlike a company's constitution, it does not have to be filed with the Registrar of Companies and be available for public viewing.

Shareholder agreements may also include

They may also cover:

• Non-competition restrictions;
• Appointment and retirement of directors;
• Professional indemnity insurance;
• Transfer of shares and pre-emptive rights;
• Disability and insurance - what happens in the case of a trauma or death to insurance proceeds - does it pay company debts or does it go to the estate?  Who is the policy owner?
• Shareholder approvals, consent and voting.

The complexity and size of the shareholders' agreement will depend to a certain extent on the size of the business, the number of shareholders involved and the areas to be covered.

It will be different for every company and shareholders should seek proper legal advice when putting together any such agreement and before signing one.

How McDonald Vague can help

We regularly see the result of fallouts between company directors and shareholders.  We would advise all company directors and shareholders to put together a Shareholder Agreement at the time the company is incorporated to avoid prolonged and unnecessary expense to shareholders and their creditors.

If your relationship with fellow director(s) and/or shareholder(s) is breaking down contact us for free and confidential advice to find out how we can help.

Alternatively, download our Free Guide to Avoiding Business Failure

The earthquakes in Canterbury created a disaster on a scale not previously seen in New Zealand during our lifetime. Christchurch will be rebuilt and when it gets into full swing it will be the biggest building project in New Zealand history. Treasury has forecast that the cost of the rebuild will be circa NZ$40 billion. Fortunes will be made out of the rebuild, but like any boom, history tells us there will be some spectacular failures along the way.

In this article we will explore the issues facing construction companies waiting for the Christchurch rebuild, the chances of another large construction company collapse and some advice on how you as a professional advisor or construction industry contractor can help protect your clients or yourself from another construction company failure.

Issues facing the rebuild

The rebuild of the CBD hasn't started. The government announced the Christchurch CBD will be reconstructed around 10 major anchor projects. The city centre shows little evidence of activity or rebuild projects having been commenced. Private developers are waiting for the anchor projects to get started before they erect their buildings because of concerns of not being able to attract tenants to a building surrounded by empty sites.

Increased competition. A number of large offshore companies have indicated they will tender for some of Christchurch's anchor projects. For example a MOU has been signed between Arrow International, one of New Zealand's largest construction companies and global construction giant China State Construction Engineering Corporation Ltd targeting the anchor projects in Christchurch.

Labour shortage and small supply chain. Christchurch still needs to find another 17,000 workers, including carpenters, joiners, electricians and plasterers, before the rebuild reaches its peak. It is estimated the rebuild will need a total of 35,000 construction related workers. The shortage of skilled labour could result in poorly constructed buildings that could leak or fail.

Rising costs. Escalation in construction costs is already exceeding 10% per annum in the residential market, as a direct result of material shortages. This is likely to spill over into the commercial sector.

High compliance costs. The cost of constructing commercial property in the Christchurch CBD will be very high as the new buildings will require deep and expensive foundations. The draft plan wants to restrict CBD buildings to a maximum height of 7 storeys. The end result is that landlords will have to charge very high rents to get the same yield they had before the earthquake. Tenants may not accept these high rents and elect to keep their business in the suburbs.

Cashflow constraints while waiting for rebuild. Construction firms are desperate to hold on to their good workers and supply chains in anticipation of the rebuild. They have huge overheads to absorb while they wait for the profitable work to start. Initially, it looked as though the rebuild would peak in 2015/16 but it now looks as though it will be in 2016/2017. The flow on effect is that construction firms may have to accept a lower margin for another 12 months to keep their employees busy.

Insurance fraud. The vast sums of money involved in the rebuild and recovery create an unprecedented opportunity for fraud and corruption and we are now seeing large scale frauds being uncovered. International experience shows that, regardless of the country in which it occurs, fraud and corruption activity increases significantly following natural disasters.

What is the likelihood of another Mainzeal?

To answer this question we need to consider the common causes of construction firm failures. From our experience these usually involve:

• Tight margins
• Insufficient capital
• Lack of skills and experience
• Leaky buildings and non-compliant construction
• Over-investment in fixed assets
• Inability to manage growth
• Competition
• Lack of understanding for procuring products/supply chain
• Inaccurate estimates and tendering
• Poor pricing decisions
• Poor quality control
• Unsafe construction sites

How can you or your clients better protect themselves?

• Be familiar with the remedies under the Construction Contracts Act
• Keep good records and contract files
• Register on the PPSR a specific security over material supplies (a great defence if charged for a voidable transaction)
• Suspend work if not paid, or consider the adjudication regime
• Perform due diligence on developers or head contractors before commencing work
• Research/credit check developer or head contractors before starting/signing contract
• Get personal guarantees
• Moneys held in Trust accounts
• Set credit limits - enforce them!
• Search the directors on the companies office to see the number of liquidated companies (history)
• Be aware of phoenix companies and obligations of successor companies to give proper notice
• Get sign off from a quantity surveyor, architect or engineer before paying invoices/completing variations
• Review trading terms
• Get advice if you suspect the head contractor is insolvent. Any suspicion of insolvency can be detrimental when facing a voidable transaction claim from a liquidator

Conclusion

When you compare the list of the most common causes of construction company failures to the issues facing construction companies in Christchurch, it appears that there is a high chance of another significant construction company collapse.

As a first precaution we would advise you to look at the list we have provided to help protect yourself or your clients.

McDonald Vague has considerable experience advising clients in the construction industry. If you or one of your clients is facing financial difficulties in the construction industry please contact Tony Maginness or one of our other Partners.

DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.

The content of this article may be out of date - please refer to our more recent articles for up-to-date information.

New Zealand is the home of small business. Each year thousands of businesses are started, and each year many businesses fail. Traditionally a person starting a business formed a company, put some assets or cash into the company, and borrowed money from a bank under the security of a debenture. The debenture was a charge over the whole undertaking of the business, and invariably the bank was covered.

There are now so many preferential creditors who rank ahead of the debenture that the security of a debenture holder has been watered down. Those standing in front of the bank are not only wage earners, but the Inland Revenue Department for GST and for PAYE. These latter amounts can be substantial. Because of this the banks, instead of a debenture, now commonly require as security personal guarantees from the shareholders and directors supported by a mortgage over the family home. The effect of this is that if the business fails the bank will call up its securities. The family home is therefore at risk and often has to be sold.

The attitude of the banks is perfectly understandable. In the early days of a company's life it has little in the way of assets and invariably the company from its own resources is not able to provide sufficient security for the banks purposes.

What is overlooked in this equation is the fact that by the time the company fails the assets of the company have built up and are greater than at the commencement. As well as physical assets there will be trade debtors which did not exist at commencement. This means that if from the outset there had been a debenture as well as a mortgage then the family home would not have been at risk. We have seen many cases where people have lost their home because of the mortgage held by the bank, whereas, if the bank had held a debenture as well as a mortgage the home would not have been at risk.

We strongly urge all advisors to companies that they should insist on their client's behalf that the banks as well as taking the personal guarantee and mortgage over the directors houses should also take a debenture over their companies. In most cases our experience has been that if this had happened the directors would be still living in their homes and their homes would not be sold from under them. In considering this, legal and accounting advisors should be aware that where the family home is lost then there is not only a loss of assets but invariably there is the emotional and personal cost of a broken relationship.

DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.