The Risk Of Being Criticised By A Judge Of The High Court

The content of this article may be out of date - please refer to our more recent articles for up-to-date information.

The intention of these articles was to give Chartered Accountants an appreciation of insolvency matters. If I have concentrated on the potential liability of the Chartered Accountant this is because the risks of the accountant being sued are very real and are not just theoretical or perceived.

THE CASE
In the recent case which I am about to discuss, the accountant was not on trial. He was merely a witness. He was however, severely criticised by the Judge.

The case has two aspects which are common to many companies in financial difficulties:-

•The directors were conscientious and put more money into the business when it ran short of funds
•The accountant was also conscientious and assisted the directors by preparing two-monthly accounts and discussing the position with them
Despite this the directors were found personally liable for the debts of the company, and the accountant was criticised. So what went wrong?

THE FACTS
The brief facts are as follows:-

In 1996 a company called B M & B B Jackson was incorporated. The two directors from date of incorporation were Brian Jackson and his wife Carole Jackson. Over the latter years the company was selling completed houses on a section and was also in the business of non-residential construction including rest homes and extensions to schools.

•The chief supplier to the company was Benchmark.
•After the company had traded profitably for some years it ran into financial difficulties.
•The Benchmark account ran out to 120 days where it stayed.
•Benchmark put of a stop credit on the company's account and on legal advice the shareholders placed the company in liquidation. This happened on 25 March 1997.
•Benchmark brought action against the officers of the company claiming that at the time the company incurred debts, the directors could not have believed on reasonable grounds that the company could repay those debts.
•Prior to liquidation the company had been making losses.
Loss for Year
1993          $218,000
1994          $   1,200
1995          $113,000
The position had deteriorated significantly in the latter part of 1996 and in the early part of 1997.
•The defendants through their Family Trusts had injected cash of $195,000 into the company in September 1995.
THE VERDICT - DIRECTORS FOUND GUILTY OF RECKLESS TRADING
The Judge found that the directors carried on business in a manner likely to create a substantial risk of serious loss to the Company's creditors. The directors had knowingly exposed creditors to a real risk of non-payment. He ordered that the directors pay the trade debts totalling $387,746 incurred by the company from June 1996 to liquidation. In effect the creditors got 100 cents in the $1.00.

So the directors were found liable but this does not explain why the Judge criticised the accountant. The following extracts from the Judgement reveal all:-

THE ACCOUNTANT IS CONSCIENTIOUS BUT FAILS TO ADVISE
Points arising from the evidence of the company's accountant are:-

[37]   [a]   He accepted the company was "technically insolvent" from the end of 1995, in that its liabilities exceeded its assets.
[b]   Particularly because of the bank's concerns, he met regularly (at least two monthly) with Mr Jackson throughout 1996 and provided him with timely (i.e. up-to-date) information as to the company's financial position. The discussions focused on the position to date as disclosed by the two monthly financial reports, and the company's outlook, in terms of work on hand or ahead and the company's ability to trade its was though its difficulties. He was satisfied that Mr Jackson appreciated the company's financial position.
[c]   From receipt (in March or April 1996) of the company's accounts for the year ended 31 December 1995, he recognised, and believed Mr Jackson also recognised, that there was a real risk that the debts the company continued to incur by trading on would not be paid. That risk remained right through until the company went into liquidation.
[d]   Early in 1996 both he and Mr Jackson recognised the risk of any one of the company's trade creditors losing patience with the level of overdue debt and putting the company in difficulties, and they discussed this risk with the Bank. Notwithstanding that risk, the company did not make any formal arrangements with trade creditors to remove or reduce that risk.

THE ACCOUNTANT IS DAMNED BY THE JUDGE

[52b]   I am unimpressed by the company's accountant. Having prepared the company's financial statements for the year ended 31 December 1996 he did not immediately contact the directors and suggest that the accounts disclosed a hopeless financial predicament, and required immediate cessation of trading. Instead, he actually penned the letter to Benchmark I have outlined in paragraph [21] above. To put it figuratively, he invited Benchmark to apply CPR to the corporate corpse. By contrast, the company's solicitor, upon seeing the 31 December1996 accounts, immediately advised that the directors had no alternative to immediate liquidation. I do not wish to be unduly harsh about the company's accountant. But, having assessed him in the witness box, I do not think he was capable of advising the directors to take the hard but irresistible decision to liquidate. It was a case of the blind leading the blind.

THE LESSONS
So what are the lessons -

•Why was the wife a director? Whose idea was it? Did the accountant advise on the issue? In any event the matter was clearly explained by the Judge. The bold type is my emphasis.
[65]   Reckless directors range from the crooked to the honest, but hopelessly and unreasonably optimistic. Mrs Jackson was much less involved in the running of the company than was her husband, and was probably not at all involved in the critical decisions as to whether to continue trading or liquidate. But I do not regard that as absolving her from full responsibility. Directorships of any company involves acceptance of all the directional duties imposed by the law. There is no halfway house.
•Directors can face action from creditors as well as liquidators.
•Why put good money after bad?
The directors and their Trusts lost at the very least -
Share Capital                            20,000
Advances                                 218,000
Payments to Creditors          387,746     Plus interest
Repay Bank Overdraft              10,000

$635,746
•If you are a Chartered Accountant and a client is in financial difficulties give clear advice and put it in writing. Where appropriate seek a further opinion from an insolvency specialist.

My next article will be on creditors compromises and I will try not to give accountants a hard time.

If anyone wants a copy of the case I have discussed, the reference is:-

Benchmark Building Supplies Limited v B M Jackson & C B Jackson (2001) unreported Palmerston North High Court Registry CP 26/99 Wild J 29 March 2001.

The Judgement is 29 pages long and can be obtained from Judgements Unlimited, telephone: 0-4-472 4953 or we will photocopy and send you a copy for $12.00 GST inclusive.

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.

Read 2513 times