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.

CASE STUDY

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.

CONCLUSION

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 –

• Establish the financial position of the company at liquidation;
• Ensure that all assets have been properly accounted for;
• Identify any other avenues of recovery for the benefit of the company’s creditors; and
• Examine the actions of the company’s officers to see if they have properly carried out their duties and take the appropriate steps where necessary.

Books & Records

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.

Information

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 –

• a director or former director of the company; or
• a shareholder of the company; or
• a person who was involved in the promotion or formation of the company; or
• a person who is, or has been, an employee of the company; or
• a receiver, accountant, auditor, bank officer, or other person having knowledge of the affairs of the company; or
• a person who is acting or who has at any time acted as a solicitor for the company.

The person to whom the Notice is issued may be required –

• to attend on the liquidator at such reasonable time or times and at such place as may be specified in the notice:
• to provide the liquidator with such information about the business, accounts, or affairs of the company as the liquidator requests:
• to be examined on oath or affirmation by the liquidator or by a barrister or solicitor acting on behalf of the liquidator on any matter relating to the business, accounts, or affairs of the company:
• to assist in the liquidation to the best of the person’s ability.

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.

Conclusion

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. 

The facts

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. 

The decision

1. It was held that the directors of Stube did not conduct its affairs separately from STH;
2. No independent management formal board meetings were held for Stube.  Decision making did not distinguish the subsidiaries interests sufficiently, it considered the group;
3. Stube did not gain independent advice.  Decisions for Stube were often made on advice of STH's legal counsel;
4. The subsidiary was run as a division of the parent company for accounting purposes and the parent gained tax advantages;
5. The directors of Stube and STH treated Stube's property as STH's;
6. Stube's liabilities were not considered separately from STH;
7. The subsidiary did not have the financial capacity to trade without the support of STH;
8. Invoices to Stube were addressed to STH and paid by STH;
9. The liquidation of Stube was attributable to the parent company;
10. No separate bank account was held by Stube;
11. Financial intermingling occurred such as board reports confirmed STH treating leashold assets as its own;
12. Stube had no employees of its own and STH did not charge Stube for employee time;
13. Employees used STH letterhead without stating that he or she was acting for Stube;
14. Lack of reporting supported the argument STH did not distinguish between divisions and subsidiaries;
15. There were no recorded arrangements for STH to provide management services to Stube;
16. STH obtained legal advice regarding Stube's liabilities but Stube did not obtain its own independent advice; and
17. A sub-lease recorded STH as sub-lessor.

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:

1. The extent to which the related company took part in the management of the company in liquidation;
2. The conduct of the related company towards creditors of the company in liquidation;
3. The extent to which the circumstances gave rise to the liquidation being attributable to the actions of the related company; and
4. Such other matters the Court thinks fit. 

Submissions in support of a contribution order

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. 

Key lessons

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:

1. Each subsidiary business should be run as a separate commercial and legal entity and not as a division of the parent;
2. In board meetings consideration should be given to the subsidiary's interests distinct from the parent;
3. Separate records should be kept for each subsidiary including board minutes and resolutions.  Get the paperwork right!
4. Separate meetings are recommended;
5. Any support, financial or management should be clearly documented;
6. Separate independent legal advice should be gained for the subsidiary to protect its own interests;
7. Liabilities of the subsidiary should be paid by the appropriate company and accounted for;
8. Communications should be clearly in the name of the subsidiary and not confused with the parent company;
9. Assets and liabilities of the subsidiary should be treated as its own and not that of the parent.

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.

Part 2 of 2

Following on from our earlier article dealing with how liens over company records are treated in a liquidation, we will now cover how liens are dealt with in receiverships and bankruptcies, and how to handle a lien held over the assets of the entity.

Bankruptcy lien over records and documents

Upon the adjudication of a bankrupt all of their property is vested in the Official Assignee under Section 101 of the Insolvency Act 2006.  For those records that are not in the possession of the Official Assignee a written request is made for their surrender under Section 171 of the Insolvency Act 2006.  This request encompasses any document that relates to the bankrupt's property, conduct, or dealings that is in a third party's possession or under the control of a third party.

Failure to comply with a request made under Section 171 will likely result in a summons being issued for your attendance at an examination before the Official Assignee or a District Court Judge Court under Section 165.  There are no sections under the Insolvency Act that allow the holder of the records to charge for any expenses or disbursements incurred in providing the requested records.

What happens if you are owed funds by the bankrupt and hold a valid lien over records?

Section 172 of the Insolvency Act 2006 sets out that a person is not alowed, against the Official Assignee, to claim a lien over business records or a deed or instrument that belongs to the bankrupt.  However, a person may be a preferential creditor under Section 274(2)(f) provided they fall into the criteria set out under Section 172(2)(a)-(c).

Section 172(3) sets the total preferential claim as 10% of the total value of the debt, up to a maximum amount of $2,000.  The remainder of the claim will be recorded in the bankruptcy as an unsecured creditor's claim and will rank pari passu with the other unsecured creditors in the bankruptcy.

Where does your preferential claim rank in accordance with Section 274 of the Insolvency Act 2006?

The Official Assignee must follow Section 274 when making a distribution from the assets of the bankrupt estate that are not subject to a charge, as it sets out the order in which preferential creditors rank.  Below is a list of preferential creditors that rank ahea dof valid lien holders:

1. Fees and expenses of the Official Assignee;

2. Costs of the applicant creditor;

3. Costs incurred and the claim of any funding creditors from the assets protected, preserved or recovered;

4. Wages/salary, PAYE, holiday pay, redundancy pay, any other deduction that would form part of an employee's weekly wage (child support and student loan payments) up to $20,340.  For wages/salary and PAYE this is limited to what is outstanding in the four months before adjudication.

Once the debts of the above preferential creditors have been satisfied in full the preferential claim of the lien holder will be paid.

Receivership lien over records and documents

With the appointment of receivers over the assets of the company by a secured creditor, the powers that are granted to the receiver will be dependent on those outlined in the appointment documents prepared by either the secured creditor or the High Court depending on the method of appointment.

Section 14 of the Receiverships Act 1993 outlines that the receiver may inspect at any reasonable time, books or documents that relate to the property in receivership and are in the possession or under the control of the grantor in addition to those that are in the possession or under the control of a person other than the grantor.

What happens if you are owed funds by the company in receivership and hold a valid lien?

While the lien will allow you to have a form of security interest in the books and documents of the company these rights are not directly dealt with under the Receiverships Act 1993 like the Companies and Insolvency Act.  The receivers will often find themselves in the same situation as the company would be if they required the records.  They will often only have the option to settle the debt or wait for liquidators to be appointed over the company.

A lien over the assets of the entity and how it is dealt with

Upon the commencement of an insolvency procedure there are a number of potential liens that may be held over the assets of the entity.  This includes contractual liens which are dealt with as a security interest in accordance with the PPSA, common law liens and statutory liens.

Common law liens and statutory liens

From a creditor's perspective if you have supplied services over an asset that has added value you may have priority to receive payment ahead of other creditors, however it is important to maintain possession of the asset that you are claiming their lien over, whether it is a tradesman's lien or other form of lien.  Once you have released possession you have effectively eroded any leverage that you may have had and detrimentally affected their standing which will result in increased difficulty in negotiating favourable settlement terms between the parties involved.

It should be noted however that each lien should be dealt with individually on a case by case basis as no two sets of facts are the same and will likely have an effect on the outcome.

If you wish to discuss liens further please contact McDonald Vague for free and confidential advice to find out how we can help.

Part 1 of 2 

Having a customer go into liquidation is never appreciated.  There is a potential loss of profit, and as such, creditors generally seek to secure and protect their situation through whatever means necessary.

In a perfect world, the creditor will be secured by way of a perfected security interest under the Personal Properties Security Act 1999 that leads to gaining a super priority to recovery of equipment or to unpaid stocks and potentially a recovery from proceeds relating to those unpaid stocks.  However, often there is no security and no assets on liquidation.

On occasion, however, the creditor will find themselves in possession of company assets and records over which they have no registered security, and the question then arises, can they retain possession until the debt that they are owed is discharged?  This is essentially a lien.

This article forms part one of a two part series on liens that will cover how liens over company records are treated in a liquidation.  Part two will look at liens in receiverships, bankruptcies and liens over assets. 

Who has ownership of the company records?

Under the common law, a company that is not in liquidation will retain ownership of their records even when they are not in their possession. What this effectively means is that if a company chooses to change their accountant or solicitor they are able to simply uplift their records after settling any outstanding liens that may be held over the records.

Upon liquidation, the right to ownership of the company's records granted under the common law is transferred to the liquidators of the company through the powers set out in Section 260 and the Sixth Schedule of the Companies Act 1993. What this allows the liquidators to do is effectively stand in the shoes of the company when making requests and uplifting records of the company.

The Courts have held that a request made by a liquidator for records of the company is not limited to those records owned by the company but extends to all documents related to the dealings of the company. 

What if you have received a request for documents under Section 261 of the Companies Act 1993?

Ordinarily, a liquidator will make a written or verbal request, however, a liquidator is able to, under Section 261 of the Companies Act 1993, make a written statutory request against a director, shareholder or other persons to deliver to the liquidator such books, records or documents of the company as the liquidator requires within a specified timeframe.  Section 261(6A) provides that a person who fails to comply with a notice given pursuant to the section commits an offence and is liable on conviction to a fine not exceeding $50,000 or to imprisonment for a term not exceeding two years.  Following receipt of a Section 261 letter you will be entitled to make a request for payment of reasonable travelling and other expenses in order to allow you to comply with the Act under Section 261(6).  This section does not apply however to a director, shareholder or other party involved in the formation of the company. 

What happens if you are owed funds by a company and hold a valid lien?

Section 263 of the Companies Act 1993 sets out that a person is not entitled as against a liquidator to claim a lien over books, records or documents of the company.  However, if the lien arises from a pre-liquidation debt and you have control over the records, which are held or have been produced for the company you will be able to claim a portion of the debt as a preferential claim in the liquidation.

Section 263(2) sets the total preferential claim as 10% of the total value of the debt up to a maximum amount of $2,000.  The remainder of the claim will be recorded in the liquidation as an unsecured creditor's claim and will rank pari passu (side by side) with the other unsecured creditors in the liquidation. 

On what occasions will you not have to comply with Section 263?

There are a number of situations in which Section 263 will not apply, the first of these being where the company has entered into a compromise with its creditors.  The Court has determined that it will only apply when a company is in liquidation.

The next situation is when the company has been placed into liquidation via a shareholder's resolution or by way of the company's board in accordance with its constitution, but they have passed a resolution as to its solvency and would be considered a valid solvent liquidation.

Where does your preferential claim rank in accordance with the 7th Schedule?

The liquidators must follow Schedule 7 when making a distribution from the assets of the company that are not subject to a charge as it sets out the order in which preferential creditors rank.  Below is a list of preferential creditors that rank ahead of valid lien holders: 

1. Fees and expenses of the liquidator;
2. Fees and expenses of the administrator;
3. Costs of the applicant creditor;
4. Expenses of the liquidation committee;
5. Costs incurred and the claim of any funding creditors;
6. Wages/salary, holiday pay and redundancy pay of employees up to a statutory maximum of gross $20,340.

Once the debts of the above preferential creditors have been satisfied in full the preferential claim of the lien holder will be paid.

What does an accountant's lien cover?

An accountant's lien is by default limited to the records on which work has been completed and the resulting records from this work.  It does not however cover records that have not yet had work completed on them.

An accountant may have recourse to a general lien provided that the terms of engagement between the company and the accountant explicitly establish a right to exercise a general lien.

What does a solicitor's lien cover?

A solicitor's lien on the other hand is by default a general lien under the common law.

It is important to note however that solicitors are unable to claim legal professional privilege in relation to the documents of the company.  As outlined earlier, the liquidator effectively stands in the shoes of the company under the common law when making a request for documents in accordance with the powers granted to them under the Companies Act 1993.

Part 2 in this series will look at how liens are dealt with in receiverships and bankruptcies and will also look at the situation where a lien is held over the assets of the entity.

If you wish to discuss liens further please contact This email address is being protected from spambots. You need JavaScript enabled to view it. for free and confidential advice to find out how we can help.