The following are some issues which tend to crop up on many of our liquidations.

Vehicles claimed by directors

A minor, but often emotive issue, is the car "owned" by the director. The director states it is their car, and it is registered in their name. Registration, however, does not prove ownership and if the car is in the company's accounts and shown on the depreciation schedule, the liquidator will fulfill one of their principal duties by taking possession of the car and selling it.

Share capital not paid up

Under modern company law, shares have no nominal value. Too many times we hear that if a company has 1,000 shares then there is an obligation on the shareholders to pay $1,000. This is not the case. The consideration for shares is determined by the board of directors pursuant to Section 47 of the Companies Act 1993. If a 100 share company goes into liquidation and the directors have not determined the consideration for the shares, there is a risk that the liquidator will take a stance that the consideration for the shares should have been $1,000 each and will instigate legal proceedings accordingly.

Tools of trade - machinery etc

These are a little like the car. The director/shareholder regards them as theirs. They have built them up over the years and owned them in the period when they were a sole trader. Unfortunately, these too may be in the company's accounts, usually for one or more of three reasons:-

• So that the accountant can claim depreciation on them
• To help pay up the share capital
• To wipe out an overdrawn shareholder's/director's current account

Again, the liquidator will insist on taking control of these items and selling them.

Personal guarantees

Unfortunately for directors (but not for creditors), limited liability is often negated by personal guarantees. Few directors are conscious of the guarantees they have signed. Such personal guarantees can lead to a director becoming bankrupt. Some common situations where personal guarantees are required are as follows:-

• The bank
• Hire purchase and leasing agreements - a personal guarantee is usually required
• The landlord - lease documents invariably include a personal guarantee
• Trade creditors - the catch here is in the application for credit. This often has a personal guarantee incorporated into it and the director scarcely realises what they have signed

The big bluff

A creditor states they are holding a personal guarantee. A guarantee to be effective must be in writing. Ask for a copy of it. It may not even exist.

Construction companies

Did the director build themselves a house and charge the kitchen and laundry and roofing material to other jobs? The liquidator tends to find out about such matters.

The accountant's or solicitor's lien

Where an accountant or lawyer is owed money and the liquidator requires their files, that professional can claim a lien over them. The Companies Act 1993 provides that in such circumstances the liquidator must agree to accept a preferential claim of 10% of the total value of the debt, up to a maximum amount of $2,000. The important thing here is to claim a lien before handing over the books. If the books and records are simply handed over on request it is too late afterwards to claim preferential status.

Conclusion

Liquidation is a tricky business, and the issues involved are often more complex than they may appear at first sight. We are always available to discuss with accountants, lawyers and their clients any issues they have in this area.

Note: This article was written by Jonathan Barrett who has subsequently left the firm.

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.

Introduction

A Chartered Accountant providing business services arrives at results through double entry bookkeeping. That is, for every debit there must be a credit. That same accountant, although they are excellent at their job, may be confused if they are asked to draw conclusions from inadequate records.

On the other hand, the forensic accountant thrives on inadequate records and is used to coming to conclusions by drawing information from different places and bringing it together to a meaningful conclusion.

One of the duties of a liquidator is to realise the assets of a company. Often those assets take the form of a claim against someone who has defrauded a company. For a liquidator to do their job properly they must recognise that fraud has occurred and that everything may not be what it appears at face value.

Common types of fraud include the following:-

• Business assets such as cars and equipment somehow being regarded as directors' personal property
• Sale of assets to the director or an entity controlled by them at an undervalue
• Sale by director to company of assets at overvalue
• False invoices from companies controlled by director or perhaps in-house accountant
• Valid invoices to customers, but showing the director's own bank account details
• Non-existent people on the payroll
• Suppression of creditors at the time of preparation of annual accounts
• Showing stock that does not exist in the annual accounts
• Giving personal trading trusts the good profitable contracts and leaving the failing company with unprofitable contracts
• Taking money and showing it as having been invested in an overseas investment

The skills of a forensic accountant

For a forensic accountant to succeed they need more than ordinary accounting skills. They need legal skills, an enquiring mind, and to be a student of human behaviour. A degree of cynicism also would not go astray.

Psychological skills

These become very important. What is the best way to approach someone to get information out of them:-

• Do you flatter them?
• Do you make them believe you already have the answers?
• Do you suggest they might be more lightly treated if they come clean?
• Do you give them the impression that you know more than you actually do?

Following this:-

• What does the person's body language tell you?
• Is the person hiding something?
• Is the person telling the truth?

Accounting skills

The accounting skills required are unlike those of the usual accountant. For a start, in the usual accountant's office the detailed work such as posting individual items to the ledger is done by clerks. On the other hand the forensic accountant must themselves be prepared to trawl through a mass of detail.

The forensic accountant must be aware of creative accounting practices and have an instinct as to where something unusual might have happened. In particular, they must be able to differentiate between the ordinary and extraordinary.

They will notice things which would not be normally noticed in a Chartered Accountant's office; such things as abnormal behaviour and the timing and sequence of events. They will be on the look out at all time for possible manipulation. They will understand information flows and be in a position to compare ratios and results with those of similar businesses.

Legal skills

The duties of directors are set out in the Companies Act 1993. The forensic accountant will have those duties in mind at all times.

For example:-

• Have the directors exercised their powers for a proper purpose?
• Have they acted in the best interests of the company?

An example of the enquiring mind

An actual case which comes to mind came about when the director of a company had a new boat. The forensic accountant, with his enquiring mind, wondered how the director could afford such a luxury while the company was making losses?

An examination of the books and records solved both the problem of the losses and the acquisition of the vessel. The company was in the business of importing machinery to order for its customers. An invoice to one customer simply stated as follows:-

Needless to say, the motor yacht never appeared in the books of the company. The director of the importing company simply treated the vessel as a personal asset.

Computer forensics

Because they understand the flow of information, the forensic accountant will recognise when information is missing from a computer. They will then use forensic software such as 'Encase' to examine the computer. The forensic accountant connects to the target computer and selects the media (disc, hard drive, USB device etc) for investigation. A duplicate of the original media is created. This protects the integrity of the base data. Investigation is performed on the data image using the tools in Encase. These tools include keyword searches, hash analysis, file signature analysis, filters and compound queries and data encryption. Evidence and investigation results are documented using the Encase reporting function. Any hard drive of any size can be compressed and stored on removable media, allowing the forensic accountant to take evidence with them. Even files that have been deleted, hidden or renamed can be located quickly and easily.

Conclusion

For a liquidator to properly do their job they must take control of the assets and realise them. Without good forensic skills it is not possible for liquidators to recognise all those assets which are capable of being realised.

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.

Introduction

In August 2011, the High Court issued an important decision in Burns v Commissioner of Inland Revenue on the widely argued question of "what is an account receivable?". This followed an earlier decision (re Northshore Taverns, 2008) in which the High Court decided that "accounts receivable" amounted to "book debts" only. This may sound like an academic point, but it is very important in determining which creditors receive distributions from the various sources of funds realised in a receivership or liquidation. The decision has positive implications for employees and the IRD as preferential creditors, and negative implications for General Security Agreement ("GSA") holders and guarantors.

The legal issue

The Seventh Schedule to the Companies Act 1993 sets out the order in which receivers and liquidators must pay preferential claims. This relies on definitions in the Personal Property Securities Act 1999 ("the PPSA"). The current wording took effect from 2002 but the meaning of some of the definitions is still being debated in insolvency circles.

The Seventh Schedule provides that, where a creditor holds a GSA over a company's assets, they rank ahead of most other creditors in the distribution of funds from the insolvent estate, except where the assets comprise "accounts receivable" or "inventory", in which case the proceeds must first be used to pay preferential claims, ahead of the GSA holder.

These preferential claims mainly comprise employee debts for wages, holiday pay and redundancy pay, and amounts owing to IRD for GST and PAYE.

While inventory is relatively easy to assess, there are many assets that could potentially be considered accounts receivable. Whether these assets are categorised as accounts receivable or not can have a major impact on the returns to secured and preferential creditors. In many cases, these items are the only assets and therefore the interests of preferential and secured creditors are directly in competition, with one or other of these groups potentially standing to recover nothing.

The PPSA defines an account receivable as "a monetary obligation...whether or not that obligation has been earned by performance". In most cases it is easy to determine whether an asset is an "account receivable" within that definition.  There is no question that routine trade debtors, properly invoiced and appearing in the company's accounts as a trade debt, fit the definition. This had already been confirmed in the earlier High Court decision. Where problems arise is in situations where money is due to a company for some other reason.

The Burns v IRD decision considered this definition in the context of such items as:-

• Council bond refunds
• Amounts refundable following overpayments
• Amounts held for the company in a lawyer's trust account

These, and similar items, have in the past proved difficult to categorise for distribution purposes and therefore entitlement to the proceeds of these assets has been potentially contestable.

The decision in Burns v CIR

The Burns decision stated that a broad interpretation should be applied to the phrase "account receivable". It held that bond refunds, refunds of overpayments and amounts held for the company in a lawyer's trust account all fitted the definition of accounts receivable and were therefore available to preferential creditors. The decision thus clarifies the position regarding a range of assets which were previously seen by practitioners and their lawyers as a "grey area". The decision also resolved the question of at what point a debt is classed as an "account receivable". Is it at the date of liquidation, or could it also refer to amounts which only become due after liquidation or receivership? The Court confirmed that the wording only refers to amounts due at the date of liquidation, and therefore only these amounts will be payable to preferential creditors. This is unsurprising, as otherwise many anomalies would arise.

For instance, if a liquidator trades on for a short period and sells inventory purchased after liquidation on credit, or sells a company's plant and gives the buyer 30 days to pay, should the amounts due suddenly become payable to the preferential creditors? The High Court has said no; the asset type is tested and determined as it exists at the date of appointment.

Implications for preferential and secured creditors

This decision will clearly not be welcomed by banks, finance companies and other parties who have lent against GSA securities (for instance, private individuals including investors, directors, and their spouses, friends and family members). It will, however, be welcomed by employees and the IRD, who will see themselves pushed to the front of the queue in cases where they might otherwise have ranked behind a GSA holder. For our part, there remains the question of which other assets the definition could capture. We are concerned that the two decisions have not provided total clarity as to what assets may constitute an account receivable. Instead, there is the potential for the definition to capture even more assets.

We understand that the case may be subject to an appeal in mid 2012, but for now it is the precedent and we must follow it. There may well be other cases on this issue, as there unfortunately remain some unanswered questions.

This decision should be brought to the attention of GSA holders, and also to guarantors under those GSAs. It means that there are likely to be less proceeds available to secured creditors and consequently there is a greater likelihood that secured creditors will be pursuing other repayment rights and remedies. The decision, and consequent expectations of loan collectability, will also impact on the holding values of loans in the financial accounts of secured lenders.

Update - December 2012

The Burns v IRD case is the subject of an appeal to the Court of Appeal. We understand that this is likely to be heard in mid 2013.

Note: This article was written by Jonathan Barrett who has subsequently left the firm.

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.

Introduction

It is now almost ten years since the Personal Property Securities Act 1999 ("PPSA") was enacted. Despite this, in our insolvency work we still regularly come across suppliers who have not performed the necessary registrations, and as a result lose priority to other creditors. This is highly unfortunate, given that a PPSR registration is simple to do and costs only $3.07. A PPSR registration is a little like income protection insurance - not terribly exciting to think about now, but it can make all the difference if the unexpected happens. We encourage all our clients to check that they, and their own clients, are fully conversant with this vital area. In this short article we attempt to explain the main points of the PPSA and its implications for suppliers.

The PPSA - a brief summary

The PPSA came into force on 1 May 2002. It constituted a major reform of the law relating to security interests in "personal property". The new law was closely modelled on a similar act in the Canadian province of Saskatchewan.

Prior to the PPSA, such interests were registered at a variety of locations including the Companies Office. The previous law was regarded as inadequate and cumbersome. The PPSA set out to provide a single online location where suppliers could find out at minimal cost what existing security interests there were against their customers' assets.

The PPSA affects lending, leasing and other types of credit-providing activities. Personal property is given a wide definition. With few exceptions it covers any property someone can own, notable exceptions being land (interests over which are still registered at the Land Registry), and ships over 24 metres in length.

The Personal Property Securities Register ("PPSR")

The PPSA introduced a registration system for what are termed "security interests" in personal property. This is run through an online registry called the PPSR, which anyone can search for just $1.02. Registration is not compulsory. However, failure to register means a creditor may lose priority to another creditor who does register, and is therefore inadvisable. A supplier generally only has to register once in respect of each customer (not every time goods are supplied), and then renew the registration every five years. There are strict time limits for registration - generally on or before delivery in the case of inventory, and within 10 working days for other assets.

"Security interest" is a broad term. Some of the most important examples of a security interest are:-

• A General Security Agreement - previously known as a debenture
• A retention of title clause
• A lease of goods/equipment of more than one year
• A lease of goods/equipment for an indefinite term
• An agreement to provide goods on consignment

Where things tend to go wrong

Where problems arise for many suppliers is when a bank or other lender has been granted a General Security Agreement ("GSA"). This is because most GSAs refer to "all present and after acquired personal property" and therefore potentially cover all company assets.

Because a supplier of stock or equipment has provided new value for its security, it normally ranks ahead of the GSA holder's general security in respect of those goods (this is known as 'super-priority'). However, this is only true if the supplier registers its interest on the PPSR. If not, it is likely to lose priority in those goods to the GSA holder (and also potentially the preferential creditors) in the event of its customer's insolvency. In most cases this means a supplier with a retention of title clause or a lessor of goods who has not registered walks away with nothing.

This is despite the fact that the retention of title clause may be perfectly valid in itself. This is because the PPSA only concerns itself with priority between security interests, not legal ownership. This subtle distinction is not often understood and tends to result in some understandably very disgruntled creditors.

Even where there is no GSA, a supplier of stock with no PPSR registration is still at risk of losing priority to the preferential creditors.

What are the key areas of risk for suppliers and lessors?

For most normal trading businesses, the main risk areas tend to be:-

Retention of title/"Romalpa" clauses

These should be agreed in writing rather than just stated on the back of invoices. However, even with a full set of signed terms and conditions, a retention of title ("ROT") clause is likely to be worthless in an insolvency if a PPSR registration has not been made. We have been involved in numerous cases where we have had to tell suppliers that their unregistered ROT clauses had no practical use and they could not recover any stock.

Consignment stock

The same principle applies to stock supplied on a consignment or "sale or return" basis. Even though legal title may not have passed to the customer, the consignment is a security interest and therefore has to be registered to rank ahead of a GSA holder or preferential creditors. Again, an unregistered supplier is likely to be unable to recover stock supplied in the event of its customer's insolvency.

Leased goods

Where a lease is for a term greater than one year (or for an indefinite term), the lessor must register its interest in the goods on the PPSR. If it fails to do so, the lessor may lose priority over those goods to a GSA holder. A lease agreement may be held to be of an indefinite term if it does not contain a clearly stated term, or end date. This is where many lessors run into problems.

General Security Agreements

GSA holders need to be aware that the old priority rules no longer apply. Previously, the first GSA to be executed ranked first, unless specific accommodation had been given to a subsequent GSA holder. The date of a GSA's execution is now irrelevant when assessing priorities. What matters now is the date of registration on the PPSR. The first GSA to be registered ranks first.

Conclusion

This is only a brief summary of this complex legal area. However, two very important points are clear. Suppliers/lessors of goods must ensure that their terms and conditions are properly worded to reflect the current law. They must also ensure that they have a valid PPSR registration to protect those legal rights. We recommend that all businesses selling goods on credit (or leasing goods) carefully review both their terms of trade and their PPSR registration procedures. We are happy to answer further questions, and can also recommend appropriate commercial lawyers with expertise in this field.

Note 1 -PPSR fees increased on 1 August 2012 to $3 for a search and $20 to register or renew a financing statement.

Note 2: This article was written by Jonathan Barrett who has subsequently left the firm.

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.

Business involves hard work and a bit of luck (or magic, given that only 29% of new businesses survive their tenth year). When things go wrong, a news release or a prosecution does not help creditors. Money in the hand does.

Remedying the situation monetarily is, however, interesting in a liquidation. Commonly, particularly in a High Court liquidation, any tangible assets of material value have been disposed of prior to liquidation, and the directors may be facing the prospect of bankruptcy. The unsecured creditor often throws their hands up in the air and writes off yet another debt.

In 2012, Peri Finnigan and Boris van Delden of McDonald Vague were appointed liquidators by the High Court of a small investment company, and subsequently by way of shareholders' resolution, of a wholly owned subsidiary that had operated as a retailer and wholesaler of 'fashion'. The companies' director, who was facing numerous personal guarantee claims and bankruptcy, advised McDonald Vague that neither company had any material value, all assets having already been disposed of essentially by fire sale. Money had been spent as if it was water.

However, within three months of the appointment, McDonald Vague had settled in full all third party unsecured claims against the companies (totalling 22 in number, or approximately half a million dollars by value) after entering into a settlement with the director.

The case is instructive, not only because it illustrates McDonald Vague's commitment to paying a distribution to creditors, but also because it confirms several practical points.

1. Not all company assets are disclosed in its financial accounts and you do not need a Court order to prove it

Too often we see grand statements based solely upon a company's set of financial accounts. Financial accounts, however, only provide a person's judgment on the company's financial position, and may not record, for example, unreconciled debtors, any contingent claims that the company or liquidators may have (such as over insolvent/voidable transactions), or how an unprofitable business can be turned around and made profitable.

In the case mentioned above, the distribution arose from an investigation that located payments that did not agree with the cashbook and financial accounts, and that confirmed the long term value of accrued tax losses to the director. Most importantly, the distribution arose from negotiation, persuasion and the receipt of funds from an insolvent person (through a third party). No claims were brought through the Courts.

2. Not all security interests registered on the Personal Property Securities Register ("PPSR") are valid or in relation to unpaid debts

Many creditors fail to remove their PPSR registration, even when they no longer do business with a company and have been repaid. Furthermore, creditors occasionally register an invalid and unenforceable security interest by, for example, registering their security against the wrong entity. This can mean that the position of an unsecured creditor is significantly better than that recorded on the PPSR. In the case mentioned above, General Security Agreements were registered against the companies on the PPSR at the date of the liquidators' appointment in relation to debts that had already been repaid.

3. The viability of all of your trading partners matters

When gaining a new customer, a business may perform a credit check and obtain security for goods and services supplied. However, it is relatively uncommon for a business to check the viability of its other trading partners, such as suppliers of materials, insurers and tax agents. In the case mentioned above, one of the companies had entered into and relied upon a licence agreement with an overseas sub-licensor covering a single brand. Expensive legal advice was obtained over the licence agreement, but the financial viability of the sub-licensor was never verified or checked. The sub-licensor subsequently went into administration, leading to the licence being lost, as well as the loss of stock that the company had paid for.

4. When things go wrong, get professional help

When a business is in financial difficulty, it gets difficult. A director is burdened with additional duties under the Companies Act 1993, gets chased by creditors and gets stressed. Sometimes it becomes too difficult for them, and they give up on their business and the creditors. In the case mentioned above, the companies unsuccessfully attempted to recover from the situation by changing the product offering sold in the retail premises, and then through a fire sale of assets. Notably, a key business engaged during the fire sale was unable to provide a financial account of the assets that they had dealt with. Had professional advice been obtained earlier, it is highly likely that the companies' debts would have been significantly less.

McDonald Vague is often instructed at the crisis point to provide a third party perspective, options, and assist a turnaround of a company wherever possible. We have consistently and successfully completed this across a wide range of industries in a confidential and successful manner for over twenty years.

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.

Many of our clients don't deal with insolvency on a daily basis, and therefore have only a fairly generalised idea of what we do. This article seeks to provide a better understanding of how the liquidation process works. It also demonstrates how choosing the right insolvency practitioner can result in funds being recovered for creditors that would otherwise not be available.

The liquidation process 

Most people have a basic intuitive feel for a liquidator's role. This is usually that he or she closes down a business, dismisses staff, sells assets and collects debts. This may well be true, but generally such activities form only part of a much more involved process.

Liquidators have very wide powers to investigate a company's affairs and seek recoveries from various parties. Many claims a liquidator brings (eg to set aside insolvent transactions or insolvent set-offs) are not available to directors, and only arise out of the liquidation process. Liquidators can also require those connected to a company to provide documents and information, and can examine those parties under oath.

Trading on 

It does not follow that a business must be closed down when liquidators are appointed. We frequently trade on businesses and sell them as going concerns. Often the fundamental problem is not the business itself, which may be highly cash-generative, but the unrealistic debt burden the purchaser took on when it bought the business. Trading on invariably results in a better outcome for creditors than an immediate shutdown.

Investigative work 

One of a liquidator's most important roles is to investigate a company's affairs. This involves taking possession of its accounting and other records and identifying those assets or claims which may be available. We recover records from a variety of sources, including the company's accountants and lawyers, and review electronic records including emails. This often produces recoveries which the directors had either overlooked or did not have powers to pursue.

Debtor reviews 

Our investigative work includes carefully examining the company's debtors ledger. In one case we recovered a three year old debt of $10,000, where the directors advised us that the customer had 'disappeared'. We did a company search on the business name and wrote to that party. They had bought the business from the previous owner but happily gave us that party's details. We then wrote to them and received full payment. The entire process involved only an hour or so's work, but enabled a dividend to be paid to creditors who would otherwise have received nothing. We never assume that simply because a debt is old, it must be uncollectable.

Overlooked assets 

There are often sums due to a company which the directors have either overlooked, or were not even aware of. An example is a liquidation where the company had subdivided land. On our appointment all the sections had been sold and there were no remaining assets. However, on reviewing the records we noted that the company had paid a council bond for required landscaping works. The council stated that the work had not been performed, so no refund was due. On closer questioning it emerged that the bond included a 50% uplift to cover possible contractor price increases. We asked for the costs to be requoted at current prices. Due to the property slump, prices had fallen and the amount held was well in excess of that required. This resulted in $28,000 being refunded.

On the same case, we were aware from other liquidations that the North Shore Council was paying refunds of development levies to property developers, following a High Court case. We contacted the Council, and kept the liquidation open pending a possible refund. As a result we received approximately $100,000. This, together with the recovery above, enabled the main creditor to receive a substantial repayment.

Insolvent transactions 

Previously known as voidable preferences, these are payments from a company to a creditor whilst it is insolvent, and where the creditor has reasonable grounds to suspect this. A liquidator can have such payments set aside, going back up to two years before liquidation. Part of our investigative role involves forensically examining accounting records and reviewing creditor payments. We pursue those cases where it is clear that the creditor had reason to suspect the company's insolvency, and has obtained an unfair advantage over other creditors.

Insolvent set-offs 

These are similar to insolvent transactions. They arise where a creditor recovers its debt by setting it off against some other amount it owes the company, at a time when it has reason to believe the company is insolvent. In one case a supplier had not been paid for ten months and was owed in excess of $250,000. Two months before liquidation it suddenly became a customer, but set off the $65,000 due against its unpaid debt, thereby effectively recovering this amount in full. We recovered 95% of the amount set off, in an out-of-court settlement. As a result, the bank was repaid in full and there will be a dividend to unsecured creditors.

GST recoveries 

There are often potential GST recoveries in a liquidation. Where a company is on the Invoice basis, there can be unclaimed refunds relating to bad debts. There can also be refunds due in respect of final supplier invoices which are only issued after liquidation, or where returns have simply not been filed. The amounts involved are often significant.

Overdrawn shareholder current accounts 

It is common for directors to owe their company money in respect of drawings over and above any advances they have made to the company. Sometimes there are no accounting records, but we reconstruct the current account from bank statements. In one case we reconstructed the current account entirely from bank statements and recovered $27,500 from the director.

Conclusion 

These are just a few examples of how liquidators can add value by a thorough investigation of a company's affairs. Whilst liquidation inevitably has a cost, the skill of an experienced liquidator is to ensure that these costs are more than compensated for by additional, and often substantial, recoveries which would otherwise not have arisen.

Note: This article was written by Jonathan Barrett who has subsequently left the firm.

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.

Usain Bolt flashed through the 100 metres at the London Olympics in 9.63 seconds - a new Olympic record. Imagine the uproar there would have been if, at the end of the race, the officials had asked, 'What is the current record?' only to be told, 'I don't know. It's not written down anywhere. From memory it's about ....'

Accurate records need to be kept for many different reasons, and in relation to companies the requirements are set out in the Companies Act 1993 and also the Tax Administration Act 1994.

Accounting records to be kept - Section 194 Companies Act 1993

The board of a company must cause accounting records to be kept that -

• Correctly record and explain the transactions of the company; and
• Will at any time enable the financial position of the company to be determined with reasonable accuracy; and
• Will enable the directors to ensure that the financial statements of the company comply with section 10 of the Financial Reporting Act 1993 and any group financial statements comply with section 13 of that Act; and
• Will enable the financial statements of the company to be readily and properly audited.

The section goes on to describe the type of information that the accounting records must contain and this includes details of money received and spent each day and the matters to which it relates, a record of the assets and liabilities of the company and, if the company's business involves dealing in goods, a record of the stock bought and sold.

The records must be kept in English or in a form or manner that is easily accessible and convertible into written form in English.

If the board of a company fails to comply with these requirements every director commits an offence and is liable on conviction to a fine of up to $10,000.

However, the problems don't necessarily stop there for the director of a company that has failed to maintain proper accounting records, as Selvathas Ariyathas discovered in a recent case decided in the High Court in Auckland (Walker v Ariyathas HC AK CIV-2011-404-1894).

If a company goes into liquidation the liquidator may seek an order pursuant to Section 300 of the Companies Act 1993 making the directors personally liable for all or part of the company's debts.

If the Court considers that the failure to keep proper records has -

• Contributed to the company's inability to pay all of its debts; or
• Resulted in substantial uncertainty as to the assets and liabilities of the company; or
• Substantially impeded the orderly liquidation

Then the Court may, if it thinks it proper to do so, declare that any one or more of the directors and former directors of the company is or are personally liable for all or any part of the company's debts and other liabilities.

In Mr Ariyathas' case the Court made an order that he was to pay the liquidator $998,505 plus interest and costs.

But keeping proper accounting records isn't only about compliance with the law. The records are a very important tool for company directors to use in their day-to-day operation of the company.

A director should, at any point in time, be able to refer to the accounting records to establish how their business is trading and whether or not there are issues that need addressing. Without proper records a director can not tell, with any degree of certainty, if the company is trading profitably and has sufficient cash flow to meet its liabilities.

The complexity of the records and the manner in which transactions are recorded will depend, to some extent, on the size and nature of the company but the basic requirements will remain the same.

If a company does not have a proper accounting system in place then its directors should seek advice from its accounting professional, or contact one of our business recovery specialists for advice. In the long run it could save the company and also save its directors from personal liability.

There is a requirement under the Tax Administration Act that a company's accounting records are retained for at least seven years from the end of the tax year or the taxable period that they relate to.

Company records

There are various other records that a company is required to keep at its registered office. These are set out in Section 189 of the Companies Act 1993 and include -

• The company's constitution (if it has one)
• Minutes of all meetings and resolutions of shareholders and of directors within the last seven years
• An interests register
• Certificates given by directors under the Companies Act within the last seven years
• The full names and addresses of the current directors

As with the accounting records, it is an offence to fail to comply with the requirements of Section 189 and both the company and its individual directors may be liable.

Conclusion

It is essential that directors protect both themselves and their companies from potential liability, and ensure that they have the financial information available to properly manage their business. We recommend that all directors look at Sections 189 and 194 of the Companies Act 1993, or discuss them with their professional advisors, to ascertain the type of company and accounting records that they need to keep.

We are happy to discuss any of the issues raised in this article. Please contact the author or any of our Partners or senior staff members.

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.

With the recent activity in high profile prosecutions of company directors by the Serious Fraud Office ("SFO"), we thought it opportune to revisit a case in which our firm was involved highlighting the point that it is not only the high profile directors that pay a heavy penalty when events do not go according to plan.

We pinpoint some useful tips for your clients who may be considering taking on a governance role in a company for which they do not necessarily have all of the prerequisite skills or experience.

The judgment for FXHT was released on 9 April 2009.

This case concerns a foreign exchange investment broker. The elements of the case involved fraud, breaches of directors' duties and ultimately the need to define the role and responsibilities of non-executive directors.

The defendant was a non-executive director in the company (by profession he was a medical practitioner). The defendant absolved all responsibilities to the executive director. He did however sign on behalf of the company, an employment contract, that required the executive director to report directly to him.

The defendant allowed the executive director to have sole charge of the running of the company, including being the only signatory to the cheque account. Directors' meetings were never held, no accounting records were ever maintained, no budgets or plans existed and segregation of duties were non-existent.

As a consequence, the executive director committed fraud whilst in charge of investors' funds. The defendant relied upon the executive director's "vast experience" which amounted to learning about Forex trading on a rugby trip.

No checks were made into the background of the executive director. If checks had been carried out, even the most basic of enquiry would have revealed that he had been involved in suspected fraudulent activities in South Africa.

As a consequence, the executive director faced seven counts of theft brought by the Serious Fraud Office in relation to these matters. The court in its judgment, found against the non-executive director for $300,000.

The message is clear for all professionals, when advising their clients who may be considering taking on directorships involving companies in which they have no experience-:

• Be fully aware of the financial situation of the business at all times;
• Ensure basic controls are firmly in place
• Attend all board meetings;
• If they do not have experience, they must be prepared to find out;
• Seek advice where possible from experts in the industry;
• Understand the risks and rewards associated with the industry.

Unless the clients are prepared to take on these responsibilities and put in both the time and effort required they should either:

• Decline the directorship;
• Take out expensive insurance protection;
• Be prepared to face the extremely punitive consequences if things go pear shaped.

In conclusion, we are left with the opening statement of Justice J Venning:

"This case highlights the risk of a director becoming involved in a company whose business is outside the director's expertise. It also highlights the risk to investors who pursue high returns in speculative investments such as foreign exchange. It has led to loss by all parties concerned."

As an addendum to this article it is also pertinent to note that this case ultimately resulted in a successful prosecution by the SFO against the executive director, concluding with a term of imprisonment. This, however, was of little help to the non-executive director who ultimately paid the financial penalty.

Note: This article was written by Roy Horrocks who has subsequently left the firm.

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.

This month we conclude our discussion of the rights of unsecured creditors in various insolvency proceedings, by looking at the position in a liquidation.

Introduction
A liquidator is normally appointed either by the shareholders or the High Court. The shareholders choose their own liquidator. The High Court appoints a liquidator chosen by the applicant creditor. More unusually, a liquidator can also be appointed by creditors at the 'watershed meeting' in a voluntary administration - seePart 1of this article.

A liquidator has a duty to take possession of, protect, realise, and distribute the proceeds of realisation of the company's assets to its creditors. He or she looks after the interests of all creditors.

The plight of the unsecured creditor
Unsecured creditors do not have it easy. They rank after General Security Agreement holders, employees for wages, holiday pay and redundancy, Inland Revenue for GST, PAYE and other payroll deductions, and NZ Customs. Any money remaining may also have to be shared with directors who advanced money to the company through their shareholder current accounts. What rights then do creditors have?

The right to receive reports
A liquidator must prepare a report containing a statement of the company's affairs, proposals for conducting the liquidation and if practicable, the estimated date of its completion. It must also contain a list of creditors' names and addresses, but not amounts due. This must be issued within five working days of liquidation (shareholder appointments) or 20 working days (court appointed liquidations).

An update report must also be issued every six months, and a final report on ceasing to act. All these reports are filed at the Companies Office and sent to creditors.

The right to have a first meeting of creditors
A liquidator is obliged to call a meeting of creditors for the purpose of resolving whether to confirm the appointment of that liquidator, or to decide upon a replacement liquidator. There is a power for a liquidator to dispense with meetings of creditors (and this power is usually exercised). However, he or she must call a meeting if a creditor gives the liquidator notice in writing requiring a meeting, within ten working days of receiving the notice that the liquidator intends to dispense with the meeting. In practice creditors' meetings are now very rare, but they do serve a valid purpose where creditors are unhappy with the choice of liquidator.

The right to have a liquidation committee
If requested by a creditor, a liquidator must call a meeting of creditors to vote on a proposal that a liquidation committee be appointed, and to choose its members. A liquidation committee represents creditors as a whole and assists the liquidator in the conduct of the liquidation. The committee can call for reports from the liquidator on the liquidation's progress. It can also call a meeting of creditors. Again, creditors' committees are now very rare.

The right to call further meetings of creditors
A liquidator must summon a meeting of creditors if this is requested by creditors owed at least 10% of the amount owed to all creditors. It is necessary to advise the liquidator of the purpose of the proposed meeting. This is because voting can be conducted by post. The intention is that creditors should not be disadvantaged simply because they cannot attend the meeting. Again, such meetings are very rare in practice, and usually only occur if creditors are unhappy with a liquidator's conduct.

The right to express views
The liquidator must have regard to the views of creditors. Those views might be expressed by the creditors or a liquidation committee representing them.

The right to apply to the court for supervision of the liquidator
A creditor with the Court's leave, or a liquidation committee without leave, can apply to the Court to supervise the liquidator. The Court may give directions in relation to any matter arising in connection with the liquidation. It may also confirm, reverse, or modify the liquidator's acts or decisions.

The right to take action to make the directors personally liable for the debts of the company
While the ability to bring civil actions against directors and others primarily lies with a liquidator, a creditor may apply directly to the Court in an effort to make recovery from company officers. The circumstances that give rise to such proceedings are:-

• Where it appears to the Court that a past or present director or manager has misapplied or retained company money or property
• Where it appears to the Court that the company has incurred an obligation without reasonable grounds for believing that it could meet that obligation
• Where it appears to the Court that the company has continued to trade when there was substantial risk of serious loss to creditors ('reckless trading')
• Where it appears to the Court that a distribution to shareholders has been made when the company could not satisfy the solvency test

Conclusion
Creditors have many rights, depending on the nature of the particular insolvency proceeding. If they want a return they should be aware of those rights and take an active interest in the recovery process. Creditors should also be prepared to assist and pass information to an insolvency practitioner appointed to act on their behalf.

Note:this is an expanded and updated version of an earlier article written by John Vague and was subsequently revised by Jonathan Barrett.

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.

Our clients sometimes express frustration and disbelief when directors of insolvent companies form new companies, often trading as normal, especially when these new companies then also fail.  A frequent question is along the lines of "surely this can't be legal?". In this short article we seek to clarify the law in this complex area.

It is important to understand that there is no general prohibition on directors starting out again, even with an essentially identical business which has risen from the ashes of the old, like the mythical "Phoenix".  Instead the law seeks simply to ensure that suppliers are not misled or confused as to which entity they are dealing with, and are aware of any insolvency and also any related sale of assets to a new company.  It is then up to those suppliers to make an informed decision as to whether to provide credit to the new entity.

The 'phoenix company' rules were only introduced into the Companies Act in late 2007 at Sections 386A to 386F.  They are slightly complicated, and perhaps not very well understood.

What the law says

A phoenix company is defined as one that has been known by the same, or a similar, name or trading name as a company in liquidation (at any time before or within five years after the date of liquidation).  A person cannot be a director of a phoenix company within five years after the insolvent company's liquidation without the court's approval, with one major exception.  This is where the phoenix company has bought the business from the insolvent company's liquidator or receiver, and the directors notify all creditors of the insolvent company of this situation in writing.  There is a strict 20 working day deadline to issue a 'successor company notice' (or apply to the court for a dispensation).

A further exception is where the phoenix company has already traded for at least 12 months prior to the insolvent company's liquidation with the same/similar name or trading name.

Should a company/person commence under a phoenix arrangement prior to or shortly after the liquidation of the failed company, that company/person must apply to the Court for an exemption from prohibition within five working days after the commencement of the liquidation of the failed company.  A recent case has shown that this deadline will be strictly enforced.

Where the rules are not followed at all, it is possible that suppliers end up trading with one company without being aware that the previous company has failed.  This is particularly an issue when trading is conducted on behalf of an entity that is described as "trading as", and the original entity is not formally liquidated, leaving a supplier potentially without any agreed trading terms with the new entity.

Penalties for non-compliance

There are severe penalties for breach of the phoenix company rules - a fine of up to $200,000 or up to five years in jail. These penalties also apply where the phoenix entity is an unincorporated business.  The directors will also be personally liable for all debts incurred by the phoenix company.  It is therefore essential that directors follow the rules, and take specialist legal advice should they find themselves in this position.

When the rules do not apply

The rules do not apply in the case of a solvent liquidation, as there will have been no loss to creditors.  More problematically, however, they do not appear to apply where a company is in receivership but not liquidation.

They also do not apply if the new company has a completely different name (and also trading name).  This is why it is always important to enquire as to who is behind a new customer, and perform your own checks including company and director searches.  It is very easy to search on the Companies Register by director name, and this will list all current and past directorships.

Where a business has already been sold pre-liquidation to a phoenix company, as liquidators we review the price paid and whether this reflected fair value.  If not, we may be able to bring a claim against the phoenix company under the Companies Act provisions regarding transactions at an undervalue.

Conclusion

The phoenix company rules provide some clarity for creditors, assuming of course the rules are followed.   Where a creditor suspects that there is a phoenix situation and the proper procedures have not been followed, they should discuss this firstly with the company's liquidator and also their own lawyer.   They may then be able to hold the directors personally liable for any unpaid debts of the phoenix company, and also make a complaint to the Registrar of Companies leading to prosecution.

Great care is still required by businesses when being asked to supply a new customer, especially when they know or suspect that the directors have a history of insolvency behind them.   We are happy to answer any questions creditors and their advisors may have on specific situations they are dealing with.

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.