On 24 September 2020, the Supreme Court delivered its judgment on a case taken by the liquidators of Debut Homes Limited (In Liquidation) (Debut) against its director, Leonard Wayne Cooper.

In this case, the liquidators alleged that the director had been in breach of duties as director under the Companies Act 1993 (the Act) and were seeking orders against the director.

The liquidators were successful in the High Court, but that decision was overturned by the Court of Appeal. The liquidators were then granted leave to appeal to the Supreme Court, where they were successful, and the orders made in the High Court were restored.

The background to the case was that Debut was a property developer and Mr Cooper was its sole director. At the end of 2012 Mr Cooper decided to wind down Debut’s operations. It would complete existing projects but would not take on any new ones. At the time the decision was made, it was predicted there would be a deficit of over $300,000 in GST once the wind-down was completed.

Section 135 of the Act relates to reckless trading and contains duties of particular relevance to insolvency situations. Section 135 states –

135 Reckless Trading

A director of a company must not-

(a) Agree to the business of the company being carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors; or

(b) Cause or allow the business of the company to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors.

Mr Cooper submitted that continuing to trade in circumstances of insolvency can be a legitimate business risk, not a breach of duty, if there is a probability of improving the position of most of the creditors, as was the case in this matter. He submitted that the reasonableness of such actions must be assessed in terms of the benefit to the company as a whole and not by reference to any detriment to individual creditors.

The Supreme Court found that there was a breach of section 135. It was known by Mr Cooper that there would be a GST shortfall of at least $300,000, which is a serious loss. It also said that it was not possible to compartmentalise creditors and held that it was a breach whether or not some creditors were better off and whether or not any overall deficit was projected to be reduced.

Section 136 of the Act also relates to insolvency situations and provides as follows-

136 Duty in relation to obligations

A director of a company must not agree to the company incurring an obligation unless the director believes at that time on reasonable grounds that the company will be able to perform the obligation when it is required to do so.

The liquidators accepted that by continuing to trade, Mr Cooper may have reduced the company’s obligations to secured creditors. However, continuing to trade caused the company to incur new debt to the IRD and 10 new unsecured creditors who had supplied goods and services to complete the properties.

They submit that Mr Cooper knew, when signing the sale and purchase agreements, that the GST obligation at least would not be met and that therefore he had breached the duty under section 136.
The Supreme Court decided that it is clear from the existence of section 136 that it is not legitimate to enter into a course of action to ensure some creditors receive a higher return where this is at the expense of incurring new liabilities which will not be paid.

Section 131 of the Act requires the directors to act in good faith and in the best interests of the company and provides –

131 Duty of directors to act in good faith and in best interests of company

(1) Subject to this section, a director of a company, when exercising powers or performing duties, must act in good faith and in what the director believes to be the best interests of the company.

The High Court held that Mr Cooper breached this duty in two respects. First, when he applied the funds realised from the sale of properties to fund further work and to satisfy secured debts which he had personally guaranteed. In doing so, the High Court said, he was not acting in good faith as he was not considering the obligations Debut owed to all its creditors. Secondly, Mr Cooper was acting in his own interests above those of Debut as, by failing to pay GST to the IRD, Mr Cooper was creating a new debt for Debut which would be subject to penalties and interest, while limiting his own liability for debts guaranteed by himself.

The Supreme Court held that Mr Cooper had breached his duties under section 131 because he failed to consider the interests of all creditors and acted in his own interests in direct conflict with Debut’s best interests.

The Judgment also includes decisions in relation to a possible defence for Mr Cooper under section 138 of the Act, whether or not a security in favour of a related trust should be set aside in part or in full, and the level of compensation to be ordered under section 301 of the Act, which we have not summarised.

As can be seen from the Judgment of the Supreme Court, which resulted in the restoration of the High Court orders against Mr Cooper to pay $280,000, there is a strong requirement on the directors of insolvent companies to consider the interests of the company, and all of its creditors, ahead of their own best interests.

It is also clear, when considering the interests of creditors, that a director has to consider them individually – not lump them together and say that while some creditors have lost more than they would have if trading hadn’t continued, overall the creditors are better off.

The practice of “robbing Peter to pay Paul” is not legitimate and can lead to directors facing allegations of breach of duty and, potentially, substantial orders to compensate the company and its creditors.

If you would like more information on the duties of directors, please contact one of the team at McDonald Vague.

Link to the Judgment Of The Court 

The country is in the process of working its way back from the economic standstill that most industries experienced as a result of the Level 4 lockdown. For those that traded at Level 3 and Level 2, they had to shift their business models to meet the COVID-19 trading requirements. Many of those requirements squeezed margins.

In the coming months, many business owners will need to look at their businesses and decide whether to continue to trade going forward. While the Government has provided some support, recovering from lockdown is just one more hurdle for businesses that have been experiencing year on year increases in operating expenses and the minimum wage, both of which have made tight margins even tighter.

How lockdown and decreases to many people’s take home pay has affected consumer spending is not yet known.

As business owners look to the future, what can they do if they find themselves in a spot of financial hardship and what options do they have available to continue to operate while the economy recovers?

Business Restructuring and Turnaround

If a business addresses the stumbling blocks that it is facing at an early stage, many are able to work through those obstacles though decision making and implementing change.

A business restructuring or turnaround can be done by the business owners, usually with the assistance of third parties. The fact that a business is going through a restructuring or turnaround is usually only known to the company’s directors, its lenders, and its key stakeholders.

The process includes:
- assessing/reviewing the business
- identifying areas of strength and weakness within the business
- determining what areas of the business need to be changed
- assessing what changes are best suited to the business and its stakeholders
- making an action plan and implementing the decided upon changes

By undertaking a financial and strategic analysis of the company, you have the tools you need to create an action plan that maximises the return on investment in the business and improves the business’ performance.

It is important to have stakeholder buy in around the timeframes for the turnaround, the KPIs being measured, and the responsibilities of those involved in the turnaround. It is also important that the key stakeholders monitor the plan to ensure that the objectives and milestones are met and that corrective action is taken to get back on track, if targets are not met.

Business Debt Hibernation (BDH)

If a business was doing well before COVID-19 hit and now needs some breathing space to get itself back on track, entering into a BDH scheme may be the right option. While BDH does not compromise any of the business’ debts, it gives the business extra time to pay those debts off.

Creditors Compromise

If a business needs the support of its creditors as well as its lenders and key stakeholders to continue and it is not in a position to pay its creditors in full, the business’ creditors may agree to a creditor compromise. The key ingredient to a successful compromise is for the business to have a credible and achievable plan that, when implemented, is likely to result in a better return to creditors than they would receive if the company was put into liquidation.

Compromises can propose that specified unencumbered assets be sold and the net proceeds of sale be paid to creditors and/or for a third party to inject funds into the business so that creditors can receive an agreed payment in satisfaction of their debts.

Voluntary Administration (VA)

The aim of entering into a VA is for the business to enlist outside assistance to provide the business with an opportunity to restructure its debt and ultimately trade out of difficulty. VA gives a business a way to maximise the chances of the business recovering or, if that is not possible, for it to be administered for a time so that creditors receive a better return than they would from immediately liquidating the company.

A voluntary administrator may be appointed to a company by the directors, a liquidator or interim liquidator, a creditor holding security over the whole or substantially the whole of the company's property, or the Court.

Receivership

Receivers can be appointed by a creditor that holds security over the whole or substantially the whole of the company's property, which means that receivers are usually appointed by banks or private lenders. The aim of the receivers is always the same - to protect the interests of the secured creditor and ensure that the secured creditor’s debt is repaid as quickly as possible.

Liquidation

Both solvent and insolvent companies can be put into liquidation.

A company can be placed into liquidation by its shareholders (by shareholders’ resolution) or by the High Court (usually at the request of a creditor but can also be at the request of a shareholder or director of the company).

A solvent company might be placed into liquidation by its shareholders after the business has been sold, closed down, and/or reorganised for tax and/or management purposes.

An insolvent company can be put into liquidation by its shareholders by resolution, usually after the directors and/or shareholders have identified that the company is insolvent and that it is in all stakeholders’ best interests for there to be an orderly winding-down of the business’ affairs.

If a company owes an undisputed debt, the creditor can issue a statutory demand for that debt. If the debt is not paid within 15 workings days, the creditor can apply to the High Court for the company’s liquidation. If the High Court puts the company into liquidation, the liquidators nominated by the applicant are usually appointed.

If a company is facing liquidation by a creditor, the shareholders can put the company into liquidation themselves as long as they do so within 10 working days of being served with the liquidation proceedings. Some shareholders choose this option because they consider that liquidation is inevitable and liquidation by shareholder resolution allows them to appoint liquidators of their choosing.

Practical Considerations For Businesses Facing Tough Times

Early Intervention: The earlier issues are acknowledged and addressed, the more options a business has to tackle those issues and the easier they are to deal with. If you need outside assistance, seek it. In our experience, issues left unaddressed for too long can become insurmountable.

Personal Guarantees: While directors are not automatically liable to pay company debts, most directors will have some exposure to a company’s creditors because they have given personal guarantees. As a director, it is important to know what your personal exposure could be, if the company fails.

Have Up to Date Business Records: If your company’s financial information is not up to date, it is harder for you to make accurate financial decisions. If the information is up to date, you will be able to see where your money is going and where you might be able to make savings.

Review Your Business Model: Now is a good time to look at where your revenue comes from, who your ideal customer is, and whether you are catering to that customer’s wants/needs. If there is a mismatch, what changes can you implement to reach that market?

Landlords and Leases: For many businesses, rent is a large portion of their fixed outgoings. In response to COVID-19, the Government has made some amendments to the Property Law Act that affects landlords and tenants’ rights, including in relation to timeframes for terminating leases for non-payment of rent and introducing a fair reduction in rent term for some small businesses (this amendment has not yet been enacted). If you are concerned about steps being taken by your landlord, seek professional advice.

Our Offer of Support to You

If you are working through the effects of the lockdown on your business and you have questions about the Government support available or your recovery and restructuring options and you want some specialist advice, we are offering free 30-minute consultations with one of our recovery specialists. We can be reached on 0800 30 30 34 or at This email address is being protected from spambots. You need JavaScript enabled to view it..

There are many very small companies in New Zealand, where the sole director and shareholder is also the sole employee, or a couple are the directors and shareholders and one is the sole employee. 

These companies don’t have some of the issues faced by bigger companies in the normal course of business, such as dealing with employees and paying wages, but do have to deal with suppliers and clients and maintain workflow and profitability.  

In this article, we look at a couple of the issues facing very small companies and how the Covid-19 lockdown period could provide a chance for review.

Objective Assessment:

One of the problems for the directors of these very small companies is that they can get so involved in the operation that they can’t see the forest for the trees. Their time and energy is put into the day to day operation and they don’t take the time to stand back and look objectively at what they are doing, how they are doing it, and whether it could be done better to achieve what they want.

One possible upside of the lockdown period imposed in response to Covid-19 is that it could provide the opportunity for that objective review. 

It is likely that the business has suffered as a result of the lockdown – being unable to trade means little to no income for the people involved and no money coming in from which to pay mortgages, business loans, rent etc – so the director is likely to be looking closely at the business anyway.

Various support packages are available from the Government and the trading banks but before going to the bank to borrow money to support the company through the lockdown, the director needs to look closely at the financial position of the company.  If the company was insolvent, or marginal, prior to the lockdown, the bank may not agree to a further loan.

 While doing that assessment, directors should take the opportunity to go back to basics and look at why they are in business, what they are doing, and how they are doing it.  Some things to consider are: 

• Is the company’s business purely to provide a wage for the director or is it an investment to provide a retirement fund?
• If it is an investment, what plans are in place to sustain and grow the business so that there is a going concern business to sell when the director is ready to retire?
• Are the job costing or product pricing systems current and set at the right level?
• Is the manner in which the work is done up to date and efficient?
• Are the advertising / promotional strategies currently being used proving to be cost effective? 

Separate Identity:

Another issue that is particularly relevant to very small companies is the blurring of the line between what is company business and what is the director/shareholder’s personal business. 

It is not uncommon in small businesses for the director to take drawings from the company rather than paying a regular salary and deducting and paying PAYE, etc. Sometimes, the mortgage over the family home is paid from the company’s bank account and the company vehicle is paid for by the company and used for both business and private travel.

If the company remains solvent, the merging of the private and business assets and activities won’t cause any issue but, if the company becomes insolvent and is placed into liquidation, the director’s actions and the shareholder’s current account will come under scrutiny.

The shareholder’s current account records the funds introduced into the company and the amounts taken out in drawings by the shareholder. If more is taken out than is introduced, then the difference is a debt owed by the shareholder to the company and it is repayable on demand.

During an objective review of the company, directors and shareholders should look at whether they are creditors or debtors of the company and how the money they are taking from the company is being treated such as:

Are drawings being taken instead of or in addition to a salary?

• Are the drawings taken as a regular fixed amount or is the company bank account used for all personal expenses?
• Is there an overdrawn shareholder current account? If yes, how big is it?
• Have the annual financial accounts for the company credited a salary to the shareholder each year? Have the necessary resolutions been passed?
• Are there any personal assets recorded in the company’s asset register?

Directors and shareholders also need to consider whether the amount that they are taking from the company is fair to the company, when looked at objectively.  When salaries are taken by director/shareholders, section 161 of the Companies Act 1993 requires that the company’s board (which would be the director or directors):

• Authorise the remuneration and/or benefit;
• Record the authorisation on the company’s interests register; and
• Sign a certificate confirming that, in their opinion, the authorised remuneration and/or benefit is fair to the company and the reasons for that opinion.

If the company fails and the section 161 requirements were not met or they were met but it was not reasonable for the directors to believe that the authorised remuneration was fair to the company, the directors can be held personally liable for the remuneration paid to the director.  While there is some limited relief available to the directors if they can show that the remuneration and/or benefits paid were fair to the company at the time it was given or paid, any payments above what was fair at the time will need to be repaid.

Conclusion:

The issues faced by very small businesses can sometimes be overlooked by the directors involved in the day to day operation, but the issues are still there. 

Take the opportunity to look at those issues and discuss them with your accountants or other professional business advisors.

SMEs make up a large part of the insolvency work that we at McDonald Vague handle and the reasons for those insolvencies range from events beyond the control of the company officers to a complete lack of knowledge and understanding by the company officers of what is required of them.

• What led to those companies failing?
• What were some of the red flags that might have been seen along the way?

CAUSES OF FAILURE:

The causes of company failures, as reported to us by the directors, are many and varied and the real reason is not always identified correctly by the directors.

There are, however, common themes that come through in the reasons for company failures.

All the Eggs in one Basket:

It is not uncommon in insolvencies to find that the failure of the company has come about because they have all, or at least most, of their eggs in one basket. The sudden failure of their major client or the decision by that client to go elsewhere leaves a yawning gap in their cash flow.

In tight economic times there is not always the ability to find new business in a short period of time to enable the business to continue to operate. They can also be left holding stock that is particular to that client and have no ability to move it on.

Company directors don’t always have the marketing skills to get out and promote their business nor the financial understanding to see ways to restructure their business to take account of the sudden loss of a major client.

The unexpected loss of a vital staff member can have the same effect, leaving the business unable to operate to its potential while another suitable employee is hired or trained up.

The Economic Climate:

Often directors will point to a particular period and claim that this was when orders dried up.

A sudden down turn can sometimes lead to the company cutting its prices in an endeavour to obtain work but without giving enough thought to what it actually costs them to do that work. So they continue to operate but have no margin or insufficient margin to enable them to meet their costs and catch up on old debt.

Lack of Knowledge:

A number of the small companies that we manage the liquidation of are companies incorporated by a tradesman to charge out their services. Many of these are tradesmen who have moved from employee status to company director and employer because they have been advised that they will be better off working for themselves through a company structure.

While they may all be very capable plumbers, builders, electricians etc many know next to nothing about the requirements of running a company and managing the finances.

They often start with a few tools and a vehicle, no operating capital and no administration systems in place.

They fall behind in filing their PAYE and GST returns, they fall behind in invoicing out the work that they have done. They fail to differentiate between what is the company’s and what are their own personal assets and the company bank account is used for everything, including buying the groceries.

They do not keep accurate records of the income and expenses and fail to carry out even basic functions like checking off bank statements. They have no prepared budgets or cash flow forecasts and, essentially, exist day to day. If there is money in the bank account they can spend it without giving any thought to things like GST & PAYE that may be falling due in the next month.

The cumulative effect of these failings is the downward spiral of the business until a creditor, generally the Inland Revenue Department, puts the brakes on them by threatening to wind them up unless payment is made.

Related Party Loans:

This can include loans to shareholders, family and friends, as well as related companies. The temptation is there, if one company is flush with cash at any stage, to lend the funds to related parties.

Problems arise when there is no clear documentation of the loans and no specific requirement on the related party to make repayments.

While the related entities are still in existence and the loan sits on the company’s statement of financial position as an asset – giving a semblance of solvency – the truth of the matter is that there is no substance to the asset with no likelihood of the loan being repaid.

Allied to this is the giving by the company of guarantees for related entities leading to claims made on the company in the event of default by the related party.

RED FLAGS:

What are the red flags, or danger signs, that the company’s directors or professional advisors might note along the way that indicate all is not well with the business?

• Notifications that PAYE or GST returns haven’t been filed

• GST refunds for 2 or 3 periods in a row. If the company is consistently spending more than it earns, what are the reasons.

• Failure to pay PAYE and GST. PAYE, in particular, is “trust” money deducted from employees’ wages. It should not be available for operational purposes.

• A steady increase in the outstanding creditors and increased age of the debt.

• A constant need for the shareholders to support the company with funds without any light at the end of the tunnel. How long can the shareholders continue to fund the company?

• A sudden change by creditors to expecting COD for supplies rather than place the amount on credit.

CONCLUSION:

The vast majority of company directors and shareholders don’t deliberately set up their company to fail but sometimes, through a combination of matters beyond their control and a lack of skills and understanding of the requirements, that is what happens.

Good advice at the outset and continued support and assistance during the operation of the business from accounting and legal professionals could go a long way to reducing the likelihood of failure.

If you would like more information about the causes and symptoms of company insolvency, please contact one of the team at McDonald Vague.

All companies must keep company records, minutes, resolutions and a share register. This article discusses what is required and what can happen when there is a failure to maintain company, statutory and financial records.

Failure to keep accounting records and to comply with Section 194 Companies Act 1993 can render director(s) liable to conviction for an offence.

Failing to maintain books and records may cause a presumption of insolvency and directors could be held personally liable.

Companies have an obligation to keep company records under S189 of the Companies Act 1993. Minutes, resolutions and financial statements must be maintained for the last 7 years. S190 of the Act requires that the records must be kept in a written form or in form or manner that allows the documents and information that comprise the records to be easily accessible and convertible into written form.

Shareholders Resolutions

Best practice dictates that an annual shareholder resolution recording that the shareholders have received special purpose financial statements, prepared by the directors for compliance purposes, and believe these adequately meet their needs for information is recommended.

The purpose of such a resolution is to record that shareholders have received the taxation statements and to record that these adequately inform them of the progress of their company. These resolutions overcome any dispute at a later date, particularly where the directors and shareholders are not all the same people.

Shareholders also should approve the remuneration paid to the directors (even or often the same) when they record they have received the special purpose financial statements. Shareholders should also approve any major transactions as defined, by special resolution.

Directors Certificates of fairness are required for Director/shareholder remuneration and for interest on loans to/from shareholders.

Register of Directors Interests

If you are a registered office, you are required to maintain an Interests Register in the statutory records for each company.

The Register is required to disclose the directors:
• interests in company transactions, including those where the relationship is indirect, which may include other directorships or trusteeships (includes the initial issue of shares on formation (S. 140)
• use of company information (S. 145)
• share dealings, including the directors’ own holdings or holdings by trusts of which he/she is a beneficiary (S. 148)
• remuneration and other benefits (S. 161)
• indemnity and insurance (S. 162)

The Companies Act 1993 envisages an annual disclosure by way of entry to the register.

Company Constitution

If the company has a constitution this must be kept at the registered office.

Share Register

A company must maintain a share register that records shares issued, shareholders names and addresses’ and the number of shares held. The details of all shareholders and movements in shareholdings must be maintained for the last 10year period.

Financial Statements

Good records help business management. Financial records must record and explain company transactions and comply with generally accepted accounting practice. Companies have different reporting requirements depending on annual revenue and assets.

Large New Zealand and large overseas companies must file annual audited financial statements under the Companies Act 1993. Smaller businesses must maintain financial statements unless it is not part of a group and has not derived income of more than $30,000 and not incurred expenditure of more then $30,000.

A company falling below these thresholds must still keep tax records and employer records.

Director Duties to Maintain Books and Records

The obligation to keep accounting records is codified under section 194 of the Companies Act 1993. A breach of accounting requirements under Section 194 and 189 may constitute a default or breach of duties under Section 301. The potential liability for failing to keep books and records can be significant and is avoidable. Directors may face court action from the company, shareholders or creditors for failing to keep proper records. The Court can order compensation and hold the director personally liable.

Personal Liability following Company Insolvency

A director can be held personally liable (s300(1)) if a company is unable to pay all its debts and has failed to comply with its duty to keep accounting records (s194) or (if applicable) to keep financial statements (s201 or 202) and the Court considers the failure to comply has contributed to an inability to pay all its debts or has resulted in substantial uncertainty as to the assets and liabilities.

Poor records hinder a liquidators’ ability to investigate company affairs. The lack of records can mean there is no way for a company of determining the likelihood of an impending insolvency. This breach can support a reckless trading action.

In the liquidation of Global Print Strategies Ltd (in liq) v Lewis (2006) the directors knew there was no adequate accounting system. The Court said that a director cannot be heard to say “I did not realise we were in such a pickle, because we did not have any or adequate books of account.” The Court held it was fundamental that books must be kept and directors must see to it that they are kept.

The recent judgment against Robert Walker for a breach in the confidence and privacy rights of David Henderson a prior director of Property Ventures Limited is a timely reminder that even liquidators can be held liable for breach of privacy.  In this case Mr Walker is required to pay $5,000 in damages. What rights do you have when you are dealing with a liquidator who has control of the company books and records?

When a liquidator is appointed over a company, either by the shareholders or by order of the High Court, one of the first steps taken will be to locate and uplift the books and records of the company and to seek information about the business, accounts or affairs of the company to ensure that any potential avenue of recovery for creditors is identified. The liquidator has the ability under section 261 of the Companies Act 1993 to require a party with information on the company to provide it to the liquidator. Unfortunately, there may also be some personal information of the company directors, shareholders, staff and customers that may be included in the information they collect.

As an individual it is important to understand what your personal information is and what an interference with privacy looks like. Your personal information is any information that can identify you as an individual. This can include, but is not limited to your name, address, a picture of your face, a record of your opinion and views, employment information, health records and personal financial information.

If a liquidator doesn’t handle your personal information properly, they could interfere with your privacy. There are several different ways in which this can occur including giving your information to someone you didn’t authorise, using incorrect information about you or refusing to give you access to your information. In most cases, an interference with privacy occurs when a liquidator has breached a privacy principle and or caused significant harm through doing so.

The privacy principles are set out on the Privacy Commissioners website and are important to be mindful of: https://www.privacy.org.nz/your-rights/your-privacy-rights/the-privacy-principles/

It is a timely reminder that as liquidators if we realise there is confidential personal information on say a laptop or in company records then even if the information is commingled with company information the confidence in the personal information needs to be preserved.

The confidential information must not be disseminated or the contents of it discussed with outsiders, except to proper authorities, potentially the OA and maybe the Police.

Court imposed stays also need to be obeyed in their entirety.  For example, if a stay on liquidation is imposed don’t do anything, don’t continue to investigate etc until the stay is lifted.

When in doubt Court direction needs to be sought.

An example of a simple and easy step that a liquidator can take to protect your privacy as an employee is to withhold personal address details from the 1^st report.  This does not apply to a director/shareholder who has address details on the Companies Office as a public record.

If you think a liquidator may have interfered with your privacy, contact them first. However, if they are not able to resolve the issue for you contact the office of the Privacy Commissioner.

If you would like more information about liquidations and their powers under the Companies Act and how they can affect your privacy, please contact one of the team at McDonald Vague.

It is, unfortunately, an all too common result of a company failure – customers who have paid a deposit for an item or service only to have the provider placed into liquidation before the goods or service are delivered, are left as unsecured creditors in the liquidation or receivership, with little likelihood of any recovery.

Why are Prepayments Made?

Prepayments by customers help give certainty to a business that the customer is genuine in their intention to complete the transaction proposed and will not leave the business holding unwanted stock or with preparation costs incurred that will not be met.

Paying a deposit to a property developer when buying off the plans secures one of the planned properties in the development for the customer and gives the developer certainty of sale to ensure on-going support from financiers.

What happens in an insolvency?

If the company to which you made the prepayment goes into receivership or liquidation, before the goods or services have been delivered, you will most likely lose the amount you have paid and rank as an unsecured creditor in the insolvency. The same would apply to amounts paid for gift cards issued by the company as generally they will not be honoured by the insolvent company.

In most insolvencies, there are little or no funds available for unsecured creditors.

If the receivers or liquidators decide that it is economically viable to trade the business on to try and complete some contracts, it is possible that your transaction may be able to be completed with the goods or services being provided on payment of the full price.

How can you protect prepayments?

Do as much due diligence as you can on the business you are dealing with. Have there been any adverse reports in the media or are there on-line comments or reviews that suggest the business has financial issues?

If you are purchasing from a retailer and enter into a layby agreement, you will be a preferential creditor in the insolvency, ranking behind other preferential creditors such as employees and the Inland Revenue Department but ahead of the unsecured creditors. This does not guarantee you will receive payment, but it does improve your chances.

The Fair Trading Act 1986 describes a layby sale agreement as any agreement, whether or not described as a layby sale agreement, that provides that –
• The consumer will not take possession of the goods until all, or a specified amount, has been paid and either -
o the price of the goods will be paid by 3 or more instalments: or
o if the agreement specifies that it is a layby agreement, 2 or more instalments

A layby sales agreement does not apply if the purchase price of the goods is more than $15,000.

If prepayment is included in a contract, such as for building or renovating a property, get independent legal advice on the contract. Can you require the deposit be paid into a solicitor’s trust account or an escrow account? Can you register a security interest in the assets of the company for the funds you have paid?

What are your remedies?

In normal circumstances, if a contractor fails to complete the project in accordance with the terms of the contract, consideration could be given to taking legal proceedings to have it completed or to recover any deposit paid or extra costs incurred.

However, if the party that breaches the contract is a company in liquidation, there is limited ability to do this as the liquidator can, and usually does, refuse to agree to legal proceedings commencing or continuing against a company in liquidation.

Application to the High Court can be made to allow the proceedings but any financial orders made against the company would rank as an unsecured claim in the liquidation.

Liquidators will investigate the affairs of the company and, if breaches of director’s duties are identified, may initiate legal proceedings against the directors personally, seeking orders from the Court that the directors make a contribution towards settling the losses incurred by creditors.

If there are grounds to show that the company’s directors were dishonest in their dealings with clients and by doing so obtained funds when they knew that they were not going to be able to complete their end of the agreement, consideration could be given to reporting the matter to the Police.

If sufficient evidence is available, the Police could prosecute and seek reimbursement of losses caused to the complainant. The standard of proof in criminal trial is “beyond reasonable doubt” much higher than is required in civil matters. The mere fact that the person didn’t do what they said they would is not generally evidence of fraud. There is also no guarantee that a Judge will order an offender to make payment to the victim.

Conclusion:

Other than if the funds are paid into a trust account, it is difficult to safeguard prepayments totally in the case of a company going into liquidation or receivership. Doing some background enquiries or gaining professional advice before committing yourself may help avoid the issue but, if you have to make the payment, pay as little as possible before gaining access to the goods to limit the damage if things go wrong.

Accounts receivable, or debtors, are recorded as an asset on the company balance sheet on the basis that they represent funds that will be paid to the company by customers in the normal course of business.

That’s fine if the amount recorded is accurate and properly reflects the anticipated level of income but, if it isn’t accurate, it inflates the level of current assets and may be disguising the true financial position of the company and becomes a potential liability for the company’s directors.

In a recent liquidation, the accounts receivable figure for the company, at the date of liquidation, was approximately $155,000 however, when the process of collecting the outstanding amounts was started, it was quickly discovered that the amount outstanding was markedly different to the amount that was likely to be realised.

Many of the outstanding amounts were disputed for various reasons. Some of the debts were 6 years old or more and many more were 3 to 5 years old.

The process of collection is on-going but, to date, only 14% of the total has been recovered and over 50% has been written off as uncollectable. The balance is still to be decided but appears more likely to be written off than collected.

This is a case where a proper review of the accounts receivable had not been carried out and uncollectable debts had not been written off.

Management of the accounts receivable needs to be an on-going process –

• dealing with disputes as they arise;
• making pragmatic decisions about whether or not to pursue an unpaid debt through Court proceedings; and
• writing debts off when they fall into the uncollectable category.

If unrealistically high values are attributed to company assets, including accounts receivable, it could be the difference between a company being solvent or insolvent and this could leave the directors vulnerable to claims that they were trading whilst insolvent.

Companies cease trading for many reasons including technological change, competition, ill health, directors’ retirement, ongoing financial problems, or simply because the company has sold its business or assets and serves no further purpose.

When a business is profitable, a business can cease to trade following sale of its business or sale of its business assets and can resolve to wind up via a section 318(1)(d) procedure (known as the “short form removal”) or follow a formal solvent liquidation. In current New Zealand law, solvent liquidations are advanced to distribute capital gains and capital reserves tax free and to provide more certainty of finality.

In insolvency, directors have a legal obligation to cease trading in accordance with insolvency laws and to ensure they do not breach directors’ duties. Failing to do so, can have significant consequences for the directors personally.

What happens when a company ceases to trade?

When a company ceases to trade, business stops, trading accounts are closed, employees are terminated and assets are realised and distributed. There can be a surplus or a deficit arising.

Solvent Companies

If trading has ceased voluntarily in a solvent company, directors and shareholders resolve to wind up the company. Surplus funds from the sale of assets are distributed among shareholders after all creditors have been repaid. A final tax return is filed and then following tax clearance, an application can be filed with the Registrar of Companies for company strike off. This is a short form removal. In larger companies or where large capital gains have been realised, a solvent liquidation is advanced.

Insolvent Companies

If a deficit is anticipated on windup and where the directors/shareholders do not plan to top up the shortfall, an insolvent voluntary liquidation should be advanced so that an independent practitioner appropriately deals with the distribution of assets taking into account priorities established by legislation. This adds some independence and avoids directors inadvertently preferring certain creditors who then face claw back later when liquidation is advanced by a creditor.

What should happen to a company that is risking trading insolvently?

The Shareholders should look to appoint a liquidator, or the board to appoint an Administrator (if the company is worth rescuing). The practitioner appointed then deals with the company’s affairs and assesses whether it can be rescued or sold as a going concern or wound up. Under a rescue/restructure some staff may be maintained and the business may continue often under a new structure. Sometimes a director or manager has the opportunity to buy back the assets from the liquidator or administrator or receiver in a new entity. This is often called a “hive down”.

If business rescue isn’t an option, assets are sold to repay the company’s creditors as far as possible, following a strict order of priority set out in the Companies Act 1993.

Creditors’ claims when a business has ceased trading or faces liquidation

If you are a creditor of a company that has ceased trading, you need to find out the circumstances in which the business has ceased to trade. If it’s solvent and being wound up, you should be contacted by the director(s) and you should make a claim by providing evidence of your debt to be paid. If trading has ceased due to insolvency and an insolvency practitioner has been appointed, you should contact the liquidator or Administrator to register as a creditor and file a formal claim (if the practitioner has not contacted you). The liquidator will assess your claim and arrange to pay creditors from available funds in the order of priority set by the seventh schedule of the Act.

Creditors of a Company facing strike off from the Companies Register

If you are owed funds, and the company that owes you is facing strike off by the Registrar (often for failing to file an annual return), you can object to the strike off by objecting on the Companies Office website:

https://companies-register.companiesoffice.govt.nz/help-centre/closing-a-company/objecting-to-the-removal-of-a-company/

If you suspect the company has or had assets, or there has been some untoward dealings, as a creditor you can apply to the Court for the appointment of a liquidator after following a proper process. The liquidator can investigate and take recovery action. As the applicant creditor, your applicant Court costs are preferential and rank in priority to the distributions to unsecured creditors.

Creditors of Companies struck off the Companies Office Register

To take action to recover against a struck off company, you must apply for the company to be restored to the Register first. This involves a formal application to the Registrar of Companies and you will need to provide evidence of the debt due. Once reinstated follow a formal demand process.
The two most common ways of restoring a company are as follows:
1. An application made to the Registrar under section 328 of the Companies Act 1993 by a:
o shareholder/director,
o liquidator/receiver, or
o creditor of the company.
Note | This process can take up to six to eight weeks to complete.

2. An application made to the High Court under section 329 of the Act. This option could be considered if there is some urgency to your application such as a property settlement. This is also the only option available if the Registrar received an objection to your section 328 application.

For more information on the implications of a company ceasing to trade, call one of the team at McDonald Vague Limited. We offer no obligation up to one hour free same-day consultations and can quickly assess your best options.

The Tax Working Group at recommendation 61 have said for closely held companies, that IRD should be granted the ability to require shareholders to provide security to IRD if debt is owed by the shareholders to the company and the company owes debt to IRD. This enhances the position of IRD in insolvency and essentially breaks the corporate veil.

Accountants need to monitor the current account positions of their clients and ensure that dividends and salaries are being declared to ensure current accounts are not overdrawn.

Recommendation 61 provides:
61. that, for closely held companies, Inland Revenue have the ability to require a shareholder to provide security to Inland Revenue if:
(a) the company owes a debt to Inland Revenue.
(b) the company is owed a debt by the shareholder.
(c) there is doubt as to the ability/and or the intention of the shareholder to repay the debt.

The impact on companies will vary. For many it will make no difference – for example, public companies, those whose directors/shareholders only receive tax paid salaries, those who annually declare a return and pay tax and where salaries equate to the amount of drawings taken, and those who pay tax and make distributions to shareholders fully imputed.

For closely held companies that routinely have a low taxable profit and material non cash tax deductible expenses resulting in cash surpluses that are paid to shareholders without the shareholders declaring income, issues will arise.

Accountants need to be more proactive for their clients and ensure current accounts are managed.

For more information refer to the following links:

https://www.simpsongrierson.com/articles/2019/tax-working-group-offer-security-to-inland-revenue

Tax Working Group Interim Report

https://taxworkinggroup.govt.nz/sites/default/files/2018-09/twg-interim-report-sep18.pdf pg. 111.

The Government’s response to the recommendations of the Tax Working Group – 17 April 2019

https://www.beehive.govt.nz/sites/default/files/2019-04/TWG%20Government%20response%20table.pdf

https://taxworkinggroup.govt.nz/sites/default/files/2018-09/twg-bg-3987029-minutes-19-july-2018.pdf (page 6)