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.

Our first article of the year reviews the significant issues and developments in insolvency from 2012 and looks at their impact on the industry into 2013 and beyond.

Insolvency practitioner licensing has not yet been adopted 

Legislation has been drafted however the approach and extent to a licensing regime seems to be difficult to agree and has generated much discussion within what is a relatively small industry. In late 2012 INSOL (the NZICA administered insolvency special interest group) proposed a voluntary registration regime, in an effort to provide all parties with more confidence when choosing and dealing with insolvency practitioners ("IPs").

IPs regularly hold significant funds for creditors, with minimal oversight.  The recent conviction of a liquidator for theft of funds from one of his liquidations highlights just one of the risks of having the wrong liquidator.  In that case the IP did not open bank accounts for each insolvency engagement and did not have access to or use a trust account.  Unfortunately, we note that neither of the proposed licensing regimes have any processes that would reduce the risk of theft by an IP, as they do not require audit of the trust or bank accounts.   We will cover the above points in detail in a future newsletter.

In our opinion, appropriate bank and independent practice verification arrangements are minimum engagement standards that need to be met, which anybody considering appointing a liquidator should raise with the prospective practitioner(s).

We recommend that creditors should maintain a lively interest in the progress of liquidations, and the results that liquidators are achieving in recovering assets and returning funds to creditors, so that they appoint liquidators who will achieve a good result for them if such a result is possible.

Creditors do have rights and remedies if they suspect wrongdoing by a liquidator, and these should be exercised.

Secured creditors versus preferential creditors - contest heads for rematch

We summarised the important Burns v IRD case on the definition of 'accounts receivable' in our February 2012 article.    Our latest information is that the case has been appealed and this is expected to be heard in late March 2013.  We await the outcome of the appeal, as we have experienced many instances in which it is uncertain whether preferential creditors or GSA holders are entitled to recoveries of assets, as those assets may arguably be classed as accounts receivable as a result of the Burns decision.

The PPSA - PMSI creditors still losing out due to non-registration

The Personal Property Securities Act 1999 ("PPSA") has been in force for a long time now and we expect most businesses will have been exposed to the power of the legislation at some point.  Despite this, businesses are still leaving themselves in a potentially worse position than they would have been had they registered a security interest on the PPSA.

Our April 2012 article summarised some of the key issues in this area.

Further, in our experience some suppliers have not understood the benefit of proper comprehensive terms of trade.  We have seen many instances where creditors have claimed rights and remedies and taken positions, which they were not able to maintain due to deficient terms of trade.

Ross Asset Management Liquidation - NZ's own version of the Madoff scandal?

You may have read of the recent liquidations of these Wellington based investment companies.  The liquidators' reports make grim reading.   Investors' funds supposedly totalled around $450m but the liquidators have only been able to identify assets worth around $10.5m.  Mr Ross and his entities seem to have operated a classic Ponzi type scheme, whereby money from new investors is used to pay high returns to previous investors based on non-existent profits.  Mr Ross evidently formed a number of companies with differing roles within the overall structure.  Each entity is likely to have its own creditors and will also possibly owe funds to investors on specific terms.

We note that the same liquidators were appointed over all entities.  This in our opinion could lead to a clash of interests as different groups of investors in different entities try to maximise their recoveries.  We were invited to attend one meeting of investors in Wellington in which the investors at that meeting were comfortable with that prospect. However we believe the potential for a conflict still exists and we remain available to discuss issues with investors or their advisers as they arise.

GST law change reduces funds available in a liquidation - issues for directors

In November 2012, the GST Act was amended to prevent a liquidator or receiver from changing a company's GST basis from the Payments basis to the Invoice basis and thereby triggering a refund.  We have considered the funds recovered from this procedure to be an asset of the company, and one aspect of a recovery process to maximise recoveries for creditors.  Sometimes it was the only recoverable asset that existed.  The change in legislation however, only arises once a company is in receivership or liquidation, so we suggest that directors, accountants and advisers consider the GST accounting basis, and whether the company could be assisted by changing the GST accounting basis. This may lead to a reduction in exposure to the IRD.

There is an accounting process to go through as a result of a change of GST accounting basis and issues to consider that may be time consuming or take company staff away from their normal duties.  We have staff members who are experienced in dealing with such issues and we would be happy to assist or advise.  Contact Boris van Delden for further information or to arrange a meeting.

Directors jailed for non-payment of PAYE

During 2012 we saw a continuation of successful prosecutions following IRD complaints against directors for failure to pay over PAYE.   Legally, such monies are held in trust for the IRD.  If not remedied quickly, directors will face prosecution with home detention and jail time as possible penalties.

We regularly advise directors/shareholders that if the company isn't generating a return for their efforts and investment after paying company creditors then they should seriously consider liquidation.  Escalating indebtedness to IRD is a clear signal to shareholders, directors and advisers that the company should not continue as it is.

A decision to liquidate in such cases is most often the right decision.  It is only a matter of time before IRD will take steps to liquidate if the inability to meet commitments continues without proper attention.

We are happy to meet with people to discuss their financial position, and the options available.

Insolvent Transaction claims

Since our June 2012 article, we have continued to see some IPs issuing Insolvent Transaction claims. In some cases this is within only 48 hours of the liquidators' appointment, and for amounts less than $1,000.    As a result we are regularly asked to assist creditors facing a challenge to look for potential defences to the challenge.

We suspect that the approach taken by a few IPs has meant that creditors have delayed the appointment of liquidators to companies that owe them funds, preferring perhaps to let the matter rest and avoid litigation.

Two High Court decisions from late 2012 have assisted creditors with the range of defences available to them.  In both decisions the High Court judges decided that a creditor/supplier did not have to repay funds to the respective liquidations because the creditor had given value for the payment before the payment was made.  This is a significant change from how the defences available to creditors had been previously interpreted.

We need to note that the decisions are being appealed, and that the good faith and no reason to suspect insolvency defences still need to be satisfied.

In response to numerous queries on this topic, we have prepared a presentation for interested parties.   Please contact us if this is of interest to you.

We welcome questions on any of these matters.  We are always available to provide advice regarding companies or individuals facing financial difficulty.

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.

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

A recent article discussed how companies on the verge of going bust are settling with trade and other creditors, then voluntarily winding up their businesses leaving the Inland Revenue Department out on a limb. This happens all too often. Also, there are as the title suggests too many "friendly liquidators".

Various solutions were offered. My view is that those solutions are not the only solutions.

Registration of Insolvency Practitioners
The one thing upon which many professionals agree is the need for the registration of insolvency professionals. As it stands, at the present time a liquidator needs no academic qualifications, no training and no experience. The only requirement is that the liquidator must not be less than 18 years old, must not be a creditor, must not be a director, must not be a bankrupt, and must not be committed under the Mental Health Act. No positive attributes whatsoever are required.

On the other hand, registration could demand the following:

•Membership of the Institute of Chartered Accountants of New Zealand or the New Zealand Law Society. Both of these bodies have a code of ethics under which professional independence is mandatory. Both bodies have a robust disciplinary system under which the acts of the members can be examined.
•The Institute of Chartered Accountants has a system under which the files of Insolvency Practioners are examined. Members of the Law Society would need to make arrangements for examination of their insolvency files.
•Registered practitioners would need to demonstrate they had appropriate
•experience and would need to show they had attended courses each year to enable them to keep up-to-date.
•They would have to show each year they had adequate Professional Indemnity Insurance.
•They would have to show they were respected by their peers as suitable persons to be registered.
Law changes required
To give creditors a say in the conduct of a liquidation the creditors need information. The principal duty of any liquidator is to take possession of, realise, and distribute the assets of the company to its creditors in accordance with the act. Another duty is to prepare and send to every creditor a report containing a statement of the company's affairs and proposals for conducting the liquidation. Progress reports are made every six months.

In theory this is fine. In practice there is one enormous loophole that enables the friendly liquidator and the cowboy liquidator to thrive and thumb their noses at the creditors.

None of the reporting including the statement of affairs needs to be done if the liquidator files a notice stating that he or she is satisfied that the value of assets available for distribution to unsecured creditors is not likely to exceed 20 cents in every dollar owed to such creditors. In practice, in order to properly hold that belief, a statement of affairs has to be prepared. Once prepared then it is not a large step to at least file at the company's office a first report and statement of affairs. Likewise progress in liquidations has to be reviewed and monitored by liquidators. Consequently, it is very little trouble to send six monthly reports to the company's office.

In practice the cowboy prepares neither a first report nor six monthly reports. The only report is a final report. Unfortunately once this has been filed, the liquidation is completed and the cowboy liquidator and his horse have disappeared into the sunset.

I believe that with the role of liquidation comes certain responsibilities. The section dealing with no reporting should be repeated and all liquidators should file a first report and six monthly reports. Without such reports there is no accountability to the creditors.

Friendly liquidators - who appoints them?
The original article suggested that it would be prudent to introduce legislation banning shareholders from appointing their own liquidator once a liquidation petition is before the Court.

The reasoning is that the shareholders would, at that stage, no longer have the opportunity to appoint a friendly liquidator. The idea has some merit but on the whole we do not agree with it. In the first place, the liquidator appointed by the shareholder might be a totally independent frontline liquidator. In the second place, the shareholders may have nothing to hide.

In practice, the shareholder of the failed company is often under immense stress. An immediate appointment is better than waiting six to eight weeks for a court hearing. The immediate appointment also places someone in charge who can seize the assets for the benefit of creditors. There is a real danger that in the six to eight week period assets will dissipate and creditors will do a raid on the company and take away assets to which they are not entitled.

If there is to be a change then it could be on the basis that if the shareholders appoint a liquidator in the five working day period prior to the application to the court, then that liquidator should be present in the court to answer any questions the judge might have.

Another law change? Meeting of creditors to change the liquidator

It is very difficult to change a liquidator for the simple reason that shareholders, in respect of the current account, and related parties have a vote on the same basis as unsecured creditors. This can lead to obvious unfairness.

•The shareholders are able to contact friendly creditors;
•The creditor wanting to change liquidators does not even have a list of creditors;
•In many cases the money owed to the shareholders has been inflated;
•In some cases the amount owed to shareholders could be regarded as part of their share capital.
It is arguable that the law should be changed so that at a creditors' meeting shareholders/directors do not get a vote in respect of any money the company might owe them.

The assumption that a court appointed liquidator would be independent
By friendly liquidator we mean a liquidator who is on the side of the directors rather than on the side of the shareholders. The assumption seems to be that shareholder appointments are bad, and court appointments are good. The argument is clearly fallacious. The front-row liquidators all do an excellent job regardless of whether they are appointed by either the shareholders or the court. The incompetent liquidators remain incompetent whether they are appointed by the shareholders or the court. What matters most is who is appointed rather than how they are appointed.

For example, in a recent case a creditor had a disputed debt. The liquidator was friendly to the creditor and was not in a position to independently examine the creditor's claim. Obviously, neither was the liquidator in a position to independently examine the issue of voidable preferences which had been received by the creditor. The point here is that this was a Court appointed liquidator. It underscores the point that Court appointed liquidators are nominated by the applicant creditor and on that basis they also are not always truly independent and impartial.

Conclusions
Friendly liquidators are a fact of life. Law changes to combat them are required urgently. Meantime, it remains a fact that regardless of how they are appointed, the front-line liquidators will demand of themselves and their staff a standard of excellence and independence on all appointments.

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.