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?
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.
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.
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.
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.
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.
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.
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.
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.
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.
If the company has a constitution this must be kept at the registered office.
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.
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.
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.
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 1st 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.
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.
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.
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?
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.
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.
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.
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.
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.
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.
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.
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:
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.
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 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.
Tax Working Group Interim Report
Section 15 of the Companies Act 1993 states that a company is a separate legal entity, in its own right, separate from the shareholders, and continues in existence until it is removed from the New Zealand Register.
Effectively that means it has the rights and obligations of person. It can own property, carry on a business, initiate legal action etc. It is also responsible for its actions and can be sued.
The use of the company structure, with its separate identity, allows people to operate more than one business at the same time but keep the assets and liabilities of those separate businesses apart – so one business doesn’t drag the other down.
We were appointed as receivers of a company, based in a provincial city, for default on amounts owed to a secured creditor. On appointment we established that the company ran two totally different businesses.
The first business had been operated by one of the directors for several years and had been a reasonable business trading in a field with continuing demand and we think making a small but regular profit.
The second business was purchased more recently as an interest for the other director. A manager was employed as the other director had full time employment. It sold local art so sales revenue relied completely on peoples taste.
The 2nd business was not profitable and within a few months the manager’s employment was terminated, and the directors were left to operate both businesses.
Funds generated in the 1st business were being used up to cover the losses incurred in the 2nd.
The businesses, under their separate trading names, are not separate legal entities – the company, as the owner of the businesses is holder of the assets and responsible for the liabilities.
To complicate matters further, the accounts for both businesses were recorded as one through the same Xero account and all funds were banked into the same bank account in the company name.
The unprofitable 2nd business ceased trading immediately on our appointment. The 1st business continued to trade for a short period while attempts were made to find a buyer.
The ability to provide any potential purchaser with accurate accounting information on the good business was limited by the fact that the activities of both businesses were amalgamated in Xero and in the bank account and no separate trading accounts or sub ledgers had been created for accounting purposes.
The failure to keep the records of the two businesses separate made an unfortunate situation worse.
If there are two businesses operating under 1 company at least keep separate accounting records and bank accounts. The company director(s) would still be liable for the actions of both businesses.
A better option, one that keeps the two businesses totally separate, would be to take advantage of the company structure so that each business stands or falls on it merits and doesn’t impact on the other.
If you would like further information on company structuring, please contact the team at McDonald Vague.
We are often asked ‘how do liquidators’ work’ and what are their rights regarding access to company records and information. To clarify we have put together this article.
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 enable a full review to be undertaken.
The purpose of the review is to –
The books and records are generally in the possession or control of the director or are held by the company’s professional advisors, such as accountants and lawyers.
When we are appointed as liquidators, our first approach in relation to obtaining company records, is by way of a letter to the relevant person or entity requesting details of the records held and seeking arrangements to uplift those records.
In most cases that initial letter is sufficient but, on occasion, the request is either ignored or refused.
When the records requested are not provided in a timely manner, the liquidator has powers under section 261 of the Companies Act 1993 (“the Act”) to issue a written notice demanding the records and it is an offence to fail to comply with a notice.
Pursuant to section 263 of the Act, a person is not entitled to claim or enforce a lien, over the books and records of the company, against the liquidator, that arises in relation to a debt for the provision of services to the company prior to the liquidation commencing. However, the debt is a preferential claim in the liquidation to the extent of 10% of the total debt up to a maximum of $2,000.
When it comes to obtaining information about the company’s affairs, again our initial approach is to ask the people concerned to provide it.
But, if that doesn’t happen, section 261 of the Act also gives the liquidator the power to issue a notice in writing to various categories of people who have knowledge of the company’s affairs, to attend on the liquidator in person to provide the information that they have.
The people who can be required to attend are –
The person to whom the Notice is issued may be required –
A person who fails to comply with a notice given under this section commits an offence and, if convicted, is liable to a fine not exceeding $50,000 or imprisonment for up to 2 years.
When appointed over a company, the liquidator doesn’t know what they don’t know so they have been given statutory powers to uplift company records and to obtain information from those people who do know to ensure that any potential avenue of recovery for creditors is identified.
If you would like to find about more about the different insolvency services available you can read more here. If you would like more information about the powers of the liquidators to obtain information and records or how liquidators work, please contact one of the team at McDonald Vague.
The Court of Appeal has upheld the decision of the High Court in Lewis Holdings Limited v Steel & Tube Holdings Limited, and held the parent company responsible to pay the debts of its subsidiary.
In this case the level of involvement of the parent compromised the independence of the subsidiary. There was no clear distinction between parent and subsidiary. The parent treated the subsidiary as an economic division of itself, akin to a "de facto amalgamation". The cumulative factors supporting lack of independence led to this decision.
The case relied on a rarely used section of the Companies Act 1993 ("the Act"). It highlights the importance of subsidiary companies maintaining independence from their parents. Failure to do so may result in the Court lifting the corporate veil under Section 271 of the Act.
Section 271 of the Act gives the Court the power to make a contribution order where the parent has stripped the subsidiary of separate legal status. It creates an exception to the general principal that a company is a legal entity separate from its shareholders.
Usually a corporation is treated as a separate legal person who is solely responsible for the debts it incurs and the sole beneficiary of the credit it is owed. In exceptional circumstances such as under Section 271 the Court may "pierce" or "lift" the corporate veil.
Lewis Holdings Limited ("Lewis") as owner leased a property to Stube Industries Limited ("Stube"). Stube was a wholly owned subsidiary of Steel & Tube Holdings Limited ("STH"). Stube (by virtue of STH's management inaction) renewed a 21 year lease. STH, after renewal and some years passing the renewal withdraw funding to Stube. The rent and rates for Stube prior to this were paid by STH.
Stube was put into liquidation on 4 June 2013 by STH and shortly after its liquidators disclaimed the lease as onerous property. Lewis filed a claim in the liquidation for its losses. Lewis and the liquidators claimed against STH under Section 271(1)(a) of the Act seeking that STH pay the whole Lewis claim in the liquidation.
Lewis and the liquidators sought an order under Section 271(1)(a) of the Act that STH pay damages related to Stube. The High Court found it just and equitable that STH pay the Lewis claim. That judgment was appealed on legal basis and quantum however the Court of Appeal dismissed the appeal.
Section 272 of the Act provided guidelines for the orders. The Court had regard to and took a detailed factual assessment under the guidelines. These required consideration of:
It was argued that the conduct of a parent company and a subsidiary must be addressed on an ongoing basis. In the submissions legal counsel said:
"Section 271 is not there to attack the underlying principles of the corporate veil and limited liability. It was enacted to address situations where subsidiaries are treated as a branch and ignored."
"If parents want the benefit of a subsidiary with separate personality then the subsidiary must act with that degree of separation at both management and board level."
The judgment is a reminder to directors of group companies to improve the standards of corporate governance.
The Court ultimately held that whilst it is common practice in company groups that a range of services are undertaken centrally, the level of involvement from STH in Stube's affairs supported the claim Stube was a "slave of STH". Additionally, it was held that the circumstances that gave rise to Stube's liquidation were attributable to the actions of STH. The Court held that STH was liable for the total claims made in the liquidation of Stube, being to Lewis.
While the company law regime is grounded in the principle that a company is a separate legal entity in its own right from its shareholders, the Courts are willing to depart from this principle in certain circumstances and the consequences can be far reaching. Proper steps and commercial practices need to be adopted so that the separate identities of each company are maintained. These should include:
Separate corporate personality within a group of companies and limited liability of the corporate shareholders are cornerstones in company law. Subsidiary companies must act with a degree of separation at management and board level to protect the parent against liability for the subsidiary's debts.