With power comes responsibility, and the duties imposed on company directors are extensive and onerous. Whilst business is brisk and revenues swell, breaches of directors’ duties often go unnoticed and without serious repercussions. When fortunes change, a director’s conduct, even years before, can come under close scrutiny from various quarters. As matters go from bad to worse, these parties include shareholders, creditors, receivers, liquidators and regulatory enforcement.
Section 126 of the Companies Act 1993 (“the Act”) widely defines directors; effectively including shadow and silent directors, as well as those who although not duly appointed, exercise certain powers of a director.
Calling to account
Under the Act, liquidators have extensive powers to investigate the affairs of failed companies and the conduct of its officers. They can also seek recovery of funds or property where companies’ officers have acted improperly.
It is important to note that although a director may be guilty of breach of duty or law, a liquidator will be more concerned with recovery of money or property lost as a result of that breach, than looking to have the director sanctioned.
After selling or realising company assets, liquidators turn to other avenues of recovery such as:
- Recovery of insolvent transactions - simply put, claw back of preferential payments to creditors which were made whilst the company was insolvent, and
- Recoveries against directors for breach of their duties.
After the recent Supreme Court decisions in Allied Concrete Limited v Meltzer (SC 51/2013); Fences & Kerbs Limited v Farrell (SC 80/2013); Hiway Stabilisers New Zealand Limited v Meltzer (SC 81/2013) [2015] NZSC 7, recovery actions under the insolvent transaction regime have been limited. On the other hand liquidators are increasingly focussed on potential recoveries for breach of directors’ duties.
Directors duties under the Act
The Act details various directors’ duties: some individual and some collective. Furthermore, certain decisions require higher approval from shareholders through special resolution, such as for major transactions or directors’ salaries.
Directors’ duties include but are not limited to the following:
- “Section 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...”
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“Section 133 Powers to be exercised for proper purpose
A director must exercise a power for a proper purpose.”
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“Section 134 Directors to comply with Act and constitution
A director of a company must not act, or agree to the company acting, in a manner that contravenes this Act or the constitution of the company.”
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“Section 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.”
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“Section 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.”
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“Section 137 Director’s duty of care
A director of a company, when exercising powers or performing duties as a director, must exercise the care, diligence, and skill that a reasonable director would exercise in the same circumstances taking into account, but without limitation,—
(a) the nature of the company; and
(b) the nature of the decision; and
(c) the position of the director and the nature of the responsibilities undertaken by him or her.”
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“Section 194 Accounting records to be kept
(1) The board of a company must cause accounting records to be kept that—
(a) correctly record and explain the transactions of the company; ...”
Penalties and consequences of breach of director’s duties
The Act imposes criminal penalties up to a maximum of five years imprisonment or $200,000 for certain serious breaches of duties by directors.
Whilst fines accrue to the Crown, a liquidator is more concerned about what can be recovered for the company, and will petition the Court for orders under sections 300 and 301 of the Act.
Section 300 of the Act allows the Court to order directors personally liable for some or all the debts of a company for failure to keep proper accounting records. That is subject to the proviso that such failure contributed to the cause of the company’s failure.
Section 301 applies to a variety of relevant people, and includes directors for breach of their duties. Under subsection 301(1)(b) the Court may order a director:
“(i) to repay or restore the money or property or any part of it with interest at a rate the court thinks just; or
(ii) to contribute such sum to the assets of the company by way of compensation as the court thinks just;”
As the focus of this article is on breaches of directors’ duties generally, we have set out the facts and findings from two recent cases where liquidators have sought orders under section 301.
Recent cases: Section 301 of the Act
Two recent cases we will consider are:
- Morgenstern v Jeffreys [2014] NZCA 449, and [2014]NZSC 176, and
- Alpha Box Property Holdings Limited (in liquidation) v Wiekart [2015] NZHC 1257
Morgenstern v Jeffreys [2014] NZCA 449
Morgenstern was the sole director and shareholder of Morning Star Enterprises Limited (“MSE”), primarily through which he had been a successful property developer. Another of his companies was Morning Star (St Lukes Garden Apartments) Limited (MS St Lukes) which undertook a $67,000,000 development in St Lukes Auckland. The first phase of the development was successfully completed in 2005, however the second phase stalled during 2006, due to resource consent issues, which were not fully resolved until 2008. The delay ultimately caused major losses on the project.
MSE came under financial pressure in 2007, and Morgenstern, who’s shareholder current account was overdrawn by $1,776,336, sold his 99% and another’s 1% shareholding in MS St Lukes to MSE for a total consideration of $3,500,000, crediting his current account in payment.
There was no formal valuation done on the shares, and the price was determined after an informal valuation of land, building and future development, by the financial manager of the St Lukes project.
As to the value of the shares, Morgenstern admitted under cross-examination that his shares had no actual value when he sold them in 2007, but asserted that they would have the necessary value once the project was completed. MSE in fact sold the same shares in 2008 for $1.
The Court of Appeal affirmed the findings of the High Court with regard to Mr Morgenstern’s breaches of director’s duties, that:
- Firstly “Mr Morgenstern breached his duty under s 131(1) of the Act by failing to act in good faith and in the best interests of MSE in putting his own personal interests in satisfying his current account ahead of the interests of MSE.” Further, that he “did not honestly believe the sale to be in the best interests of MSE.”[44-46]
- Secondly “Mr Morgenstern was in breach of his duty under s 135 not to agree to or cause or allow the business of MSE to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors.”[47]
- Thirdly that Mr Morgenstern breached his duty of care under section 137, in that his actions:
- “fell well short of the standard to be expected of a reasonable director. ...the company’s recordkeeping was deficient.. failure to produce timely accounts;... omission to ratify the share sale, as a major transaction, by special resolution... the most egregious omission was Mr Morgenstern’s failure to obtain an independent share valuation by a suitably qualified person.”
The Court of Appeal stated the applicable legal principles as follows:
“[55] There is no dispute that the duties imposed on directors by ss 131, 135 and 137 are owed to the company and require directors to act in the best interests of the company. A director must not put his or her personal interests ahead of those of the company. The duties arise regardless of the size of a director’s shareholding and role in the company.”
Alpha Box Property Holdings Limited (in liquidation) v Wiekart [2015] NZHC 1257
Alpha Box Property Holdings was part of the Circle Group of companies. Mr Wiekart was Alpha Box’s only director and shareholder. He was also a shareholder and director of the other companies in the group, along with another director, Mr Saunders.
Alpha Box traded in residential properties. Its business slowed to a point when in late 2007 it ceased operations. Over approximately six months Alpha Box’s last settlements came through, during which time the company made several payments to other group companies totalling $1,021,692.83. Mr Wiekart maintained that the payments were reimbursements of expenses paid by the other companies on Alpha Box’s behalf. The payments by Alpha Box had left the company without funds to pay $108,947.79 GST incurred in its final six months of trading, to the IRD (the company’s only creditor in the liquidation).
In her judgement Justice Peters noted the other Circle Group companies had liabilities over which Mr Wiekart and Circle Group fellow director Mark Saunders and his parents had personal guarantees. Her Honour also found the payments to those companies were not reimbursements but unsecured and undocumented loans.
Justice Peters found Mr Wiekart guilty of breaches of sections 131(1), 133, 135(b) and 137 of the Act. In paragraph [42] her Honour found that Mr Wiekart:
- had not acted “in good faith and in what he believed to be the best interests of Alpha Box, and Alpha Box alone”, and
- “did not exercise his power to make advances for a proper purpose”, and
- “failed to exercise the care, diligence, and skill that a reasonable director would have exercised in the same circumstances…”
Justice Peters then made an order pursuant to section 301 of the Act that Mr Wiekart repay the full amount of $1,021,692.83 which he had caused to be paid by Alpha Box. This was in spite of the debt owed to the IRD being considerably lower, and acknowledging that the net surplus after payment to the IRD, the liquidators’ fees and costs had been paid would revert to Mr Wiekart.
Conclusions
From the above case law and given the requirements of the Act, it is important for directors to know their responsibilities and duties both in terms of the Act and their company’s constitution. Sound risk management policy will have checks and balances to ensure directors’ duties are complied with; not only for the benefit of the company, its shareholders and creditors, but also to avoid subsequent personal liability for directors’ actions.