It has been widely predicted that the effect of Covid-19 on businesses, and the individuals involved with those businesses as owners and employees, is going to be widespread. Despite the Government support rolled out to date, many are worried about possible redundancies and the predicted failure of many businesses.
In this article we look at what can be done to survive the lockdown, what effect the lockdown could have on new insolvency appointments during the lockdown period, and what the flow on effects could be, once the lockdown ends. We will also consider the opportunities available to businesses so that they survive the lockdown.
The Government and banks have provided avenues of financial support for individuals and companies to help get through this initial lockdown period.
The government packages are primarily designed to assist businesses to be able to maintain contact with staff by payment of a level of wages to staff, who would otherwise be made redundant, and keep those employees available so that the business can continue once the lockdown ends. If you are considering staff redundancies to reduce your outgoings over the lockdown period, we strongly urge you to speak to your lawyers before taking any restructuring steps, especially if the business has received the Government Wage Subsidy. The government has been very clear that it expects all of the wage subsidy to be passed to employees. The only exception is when an employee’s normal weekly wage exceeds the wage subsidy in which case the normal wage should be paid.
Other Government measures put in place include tax relief in relation to provisional tax and depreciation allowances.
The retail banks have also agreed to a six-month principal and interest payment holiday for mortgage holders and small business customers whose incomes have been affected.
The Government and banks have also put a business finance guarantee scheme in place for small and medium sized business (annual revenue between $250k and $18 million) to further protect jobs, cashflow and support the economy. The Government will take 80% of the risk on this lending and banks the other 20%. These loans are available to business that, but for the effects of Covid-19, were solvent and viable businesses. The banks retain the ability to decide who will be able to get the loans under the system.
Business owners also need to talk to their bankers and financial advisors to see what options are available to them, both in relation to taking out new loans and taking advantage of refinancing options and repayment holidays on existing business and personal lending.
Now is the important time for business owners to look closely at cashflow and the on-going costs their business faces during the lockdown period to see what, if any, reductions can be made. For example, some leases include “no access” provisions, which provide for the tenant to pay a fair proportion of the rent and outgoings during the no access period. We have also seen instances where landlords have agreed to reduced rental payments in leases without a “no access” clause. If your business cannot use its premises and have not already spoken to your landlord, we suggest that you speak to your landlord. The Government signalled on 1 April 2020 it was considering intervening, and that an announcement could be a couple of days away.
We have noted that many debtors and creditors and contracting parties have between themselves been reaching pragmatic arrangements around payments. Negotiating these sorts of arrangements is encouraged. Please be sure that when they are being negotiated that you allow yourselves enough time and money after the lockdown to be able to meet critical obligations and to start up, as it could easily be months after lockdown before business returns to normal. The arrangements agreed need to be documented.
Please also be certain that you haven’t overcommitted, or, committed the same money to many parties.
Now more than ever working with your advisers around cashflow and any other issues is important.
Try also to use this time to try to resolve the disputes and niggly issues that sit around (sometimes in the background) in all businesses. Having those out of the way will assist you with focussing on the restart when it occurs.
And look after yourselves. Talk things through. Get some advice. You could find you remove some stress from this very difficult period. Get some rest. Smile once in a while.
If, despite the support available, you doubt your business will survive, or restart, give your adviser, or us a call to discuss your options.
If what you need is time to pay your creditors, a formal compromise or putting the company into Voluntary Administration (VA) might help your business make it through the lockdown.
Compromises with company creditors allows creditors to agree to accept payment of their outstanding debt in part or in full, usually over a period of time, on the basis that they will receive more under the compromise than they would if the company was liquidated.
For some businesses, Voluntary Administration (VA) might be a better option. The aim of the VA is to maximise the chances of the company, or its business, continuing in existence with the help of the administrators and so provide a better return to creditors and shareholders than from an immediate liquidation.
If a compromise or VA are not realistic options for your company, we can talk to you about putting your company into liquidation by shareholder resolution. If your business does not carry out an essential service, appointing liquidators could help alleviate your immediate stress. While some steps can be taken by the liquidators immediately, we anticipate that any asset recoveries will not occur until after the lockdown restrictions are eased.
These need to be managed along with business obligations. For many small businesses the two go hand in hand.
Just as company compromises are possible, personal compromises are also an option for those that have the ability to pay their creditors over time but need some immediate breathing room. If your company is struggling, you are personally exposed if your company fails because you have given personal guarantees, and you have funds or access to funds that would not be available if you were made bankrupt, you can put forward a compromise to creditors under Part 5 Subpart 2 of the Insolvency Act 2006. This is an alternative to bankruptcy that aims to provide your creditors with a better result than bankruptcy and, if the proposal succeeds, you and your creditors will be bound by the proposal.
At McDonald Vague, we hope that the message of “we are all in it together” will send that message of providing support and kindness in this difficult time.
Court Appointments and Process
We do not expect that there will be Court appointed liquidations during the lockdown period, except in exceptional circumstances, as the Courts are now restricted in the types of cases they can hear to those that affect the liberty of the individual, the personal safety and wellbeing of citizens, and/or where resolution of issues raised by proceedings is time critical.
We anticipate that some unpaid suppliers may feel obliged to put pressure on customers during the lockdown because they are under pressure (the domino effect). If you are under pressure and are considering issuing a statutory demand to a customer, we urge you to speak to your lawyers, as validly serving the statutory demand may be an issue. As the Court Registry is still open, we expect that creditors will still be able to file liquidation proceedings relying on statutory demands served prior to the lockdown (provided those proceedings are filed within 30 working days of the statutory demand expiring).
Meetings During Lockdown
The Companies Act 1993 provides that creditors’ meetings can be held by audio, or audio visual communication, as long as all creditors participating can simultaneously hear each other throughout the meeting. While the Act requires written notice of the meeting to be given to creditors, we anticipate that, in most instances, all creditors will be able to be notified of any creditors’ meeting by email. In most cases, we anticipate that, with some additional effort, creditors’ meetings could still be notified to creditors and held during the lockdown period.
Risks to Directors
In the event of a company failure, regardless of when it occurs, the actions of the directors are reviewed by the company’s liquidators. Directors who breach their directors’ duties, including in relation to insolvent or reckless trading, could face claims against them if the company’s directors ignored the company’s dire financial position or they did not act quickly enough to stop the company’s indebtedness to creditors increasing after the company became insolvent.
We consider that any review of a director’s recent actions, taken since Covid-19 impacted the business, would need to be taken into account but directors could still be held accountable for breaching their duties if they have not exercised the care, diligence and skill that a reasonable director would exercise in the same circumstances.
The initial Level 4 lockdown period of 4 weeks could be extended further. When the lockdown level decreases, it is unlikely that business will return to our previous “normal” quickly. Some economic consultants are suggesting that it could take 18 to 24 months to recover but it could be quicker or slower than that depending on the success or otherwise of the lockdown action.
As we emerge to our “new normal”, there will be new challenges. We are here to assist, as and where we can.
The start-up period could be as difficult as the close down. Cash flow is almost certainly going to be tight for the first weeks and months after restart. The ability to meet rent and employee obligations is going to be tested in many businesses unless you have used the time and options to get cashflow in order.
If you don’t think your pre-Covid-19 business can survive the effects of Covid-19, give us a call to discuss your options. There may steps you can take now that will allow you to reinvent your business after the lockdown ends.
As always, there will also be new business opportunities that come out of the lockdown. If you are looking at starting a new business, talk to us. We can suggest a few simple steps that you can take when setting up your new business to protect your investment into the future.
Covid-19 means that business owners and employees are facing unprecedented challenges at the moment.
The Government and retail banks are providing a range of financial assistance packages to try to ease the current burden and allow businesses to survive and, hopefully, prosper when things get back to normal. Unfortunately, even with those packages and, hopefully, the goodwill of New Zealanders, significant business failures and job losses are still predicted.
Business owners need to be reviewing their business models, talking to their banks, industry organisations, key debtors and creditors, and trusted advisors about how they can best survive the turmoil or, if they do not believe that they have the ability to carry on, to an Accredited Insolvency Practitioner about the options available to them. If you need help, call us on 0800 30 30 34 or 027 359 0823 or reach out to one of our team.
We are all responding to the various impacts of Covid-19 containment measures over the past days. The Government has ordered wide ranging travel and event restrictions although it is important to note the restrictions apply to people and not goods and services.
NZ is in the early stages of the coronavirus outbreak but many small and medium-sized businesses are already feeling its effects on cashflow to which will be added impending cost increases such as the 1 April increase in the minimum wage.
From the commentary we have seen it is possible that our summer has insulated us from the worst of the virus to date, however that could change as we move into colder temperatures. It is also likely that spending across all sectors (except perhaps government) is down as families and individuals react to the uncertainty that is emerging. Certainly hospitality, events, and tourism are taking a big hit. In some areas, industries such as logging have not worked for 5 weeks or so.
Discussion has been that a 30% drop in revenue is forecast. If that becomes reality many businesses large and small will struggle. The message to support businesses is for consumers to try to live as normally as possible and that includes maintaining your spending habits as best and as safely as you can, and to look after yourself and those around you. In other words “Support your local”. This could reduce the harm that enforced isolation has on the country and its communities and businesses.
The first option to assist you and/or your business is to check what insurances you have to cover your business and personal issues. Read Here - Chapman Tripp - COVID-19 business protection check list
Banks and financiers may also be able assist. The RB measures to reduce the interest rate will probably have a small impact. The larger impact will be from the RB deferring the increase in capital that banks hold, and will support any increase in the banks’ ability but not necessarily willingness to lend further or to reschedule repayments, as we expect that the fundamental rules around lending will continue to apply. So a sound underlying business with good history and prospects, security and cashflow will be required.
The government support package announced yesterday is aimed to inject money into the economy to support job retention. The sick leave and one off 12 week wage subsidy packages look to be available to every business that has experienced or expects to experience a 30% or more drop in revenue due to Covid 19. There are limits to how much each of the packages will assist for example the wages subsidy is capped at $7,029.60 per employee working 20 hours or more per week and $150,000 per employer. Assuming a 40 hour week the subsidy will assist business payroll funding by paying $14.62 per hour per employee up to a maximum of $150,000. As the subsidy does not abate, the per hour impact of the subsidy increases if employees work less hours until the minimum subsidy per employee of $350.00 per week for employees working less than 20 hours per week kicks in.
Some steps toward mitigation need to have been taken such as discussions with your bank, and you have a best endeavours obligation to maintain employment levels and to pay each employee at least 80% of their normal income for the subsidy period.
While property owners receive some other income tax support with cashflow impacts into the years ahead, unfortunately for those who lease there is no other support than the wages subsidy.
For businesses which have lost large percentages of revenue and support either a large number of employees, or have high fixed overheads the government measures will make some difference but probably not enough to trade without running the risk of breaching directors duties, if the company trades while insolvent.
So despite the support package it seems inevitable that some businesses will close, and possibly never re open unless arrangements can be made with their creditors.
If maintaining your business is too hard – there are a range of options
If your business was facing difficult times pre coronavirus and the impact of coronavirus is the last straw, then we can provide a number of options to wind up your company. If you think you can trade out and it is time that is needed to pay suppliers, then a formal or informal compromise with creditors may be an answer.
It is our business to help struggling businesses and to provide stress free advice. We seek to bring an end to messy situations and we are here to support you/your business. We may not always have the answer you want to hear, but we can offer options.
Some early advice is:
* If you are having difficulties or concerns about meeting your normal tax obligations due to the effects of COVID-19, Inland Revenue has a range of ways to help depending on your circumstances.
* Get in contact with your bank if you’re experiencing cash flow issues, especially in regards to loans repayments or lack of funding. They might be able to help or put you in touch with someone who can.
* Support local business
* Be health conscious
* Get advice if by trading you could be creating serous loss to suppliers/creditors
* Seek advice from your Chartered Accountant or Trusted advisor
Options for insolvent/struggling companies are:
* Company Compromises
* Voluntary Administration
We assist companies and individuals facing financial difficulties through a range of insolvency services including liquidations, company compromises and receiverships. Our specialist advisors will guide you through your options.
Benjamin Franklin said, “There are only two certainties in life – death and taxes”. Whilst failure to pay the second shouldn’t lead to the first, it can cause significant problems for individuals, as outlined in a recent Court decision.
Nicola Joy Dargie was sentenced to two years six months imprisonment for failing to pay PAYE deducted from employees’ salary to the IRD.
Ms Dargie’s explanation for the non-payment of $740,000, which occurred over a period of 10 years, was that she had withheld the tax payments from the IRD to keep her employees in a job.
It is a practice that we encounter on a reasonably regular basis in liquidations - directors using the amounts they have deducted from their employees’ wages for things such as PAYE, Kiwisaver, Child Support and Student Loans, to boost the cashflow of their business. Their priority being to keep suppliers paid so they can continue to employ staff.
There are several problems with this course of action.
First and foremost, the funds are not the directors, or the company’s, to spend. They are the employees’ funds deducted from their wage entitlement for specific purposes and should be held in trust.
Secondly, there can be severe penalties imposed on directors who follow this course, as evidenced by the sentence imposed on Ms Dargie.
Thirdly, even if the intention was that the payments would be withheld for only a short time, to get through a tough trading period for example, the penalties and interest charged by the IRD for non-payment are at such a level that it does not make economic sense to do it. It would be better (and safer) to go to the bank for a short-term loan.
By continuing to operate a business that is not able to pay its debts, including taxes, as they fall due, directors expose themselves to potential claims against them personally that they have breached their duties as directors by trading whilst insolvent.
The amounts deducted from employees’ wages, and, to a similar degree, the GST collected on sales, are not funds available to a company to cover operating expenses and pay trade suppliers. These funds should be put into a separate account and only accessed to pay to the IRD as they fall due.
If directors find themselves in the position of having to dip into those funds to pay other expenses, then they need to review the financial position of the company to assess its on-going viability.
If you are in arrears with PAYE you are in a far better position if you consult with IRD and reach an instalment plan on arrears. If hardship applies, then notify IRD early on. If the company is insolvent, consult an accredited insolvency practitioner.
If you would like more information or advice on managing tax payments and the solvency of your business, please contact one of the team at McDonald Vague.
In our previous article, Internal Fraud – The Threat from Within (April 2017), we gave a broad outline of the basic steps that can be taken to help reduce the chances of internal fraud and increase the chances of fraud being identified if it is happening.
This article sets out in a bit more detail some of the policies and procedures you should consider implementing in your business, if they are not already in place. The size of your business, and the number of employees involved, will have a bearing on what can be done.
The employees of a company can be its greatest asset or its greatest liability. Employing the wrong person can have a devastating effect on the well-being of the company if they are able to cause financial or reputational damage.
There are no employment policies or procedures that will guarantee that an employee will not cause problems but having a good, robust process in place when employing a new person will give you the best chance of identifying issues before the candidate starts work.
• Do due diligence and make a proper assessment of the applicants who are applying for the position. Are there any gaps in their CV that need explanation?
• Establish the relationship between the applicant and the named referees and make personal contact with each referee. Are they independent enough that you can rely on their assessment of the applicant?
• Make any offer of employment conditional on getting a clear reference from the applicant’s current employer if they have asked you not to contact them until a position is offered. If the applicant won’t accept that condition you would want to know why.
• Take your time to assess the trustworthiness of the new employee before handing over access to bank accounts etc.
As with the employment process, there are no accounting policies and procedures, other than doing everything yourself, that will absolutely prevent any form of fraud being committed by an employee but having the right ones in place should lessen the chances of it happening and increase the chances of you finding it quickly if it does.
• As far as possible, separate the duties of staff so that no individual can control all aspects of a transaction – from ordering of stock or issuing purchase orders, to receiving the supplier’s invoice, to making payment of that invoice and reconciling the bank accounts;
• If your business is a small one and there is only one person responsible for the office administration, then you personally should be the one who clears and checks the mail and the one who carries out final checks on creditor batch payments and authorises the payments to be made.
• Have set systems and procedures in place for making payments that all staff are aware of and follow;
• Conduct stock reconciliations;
• Carry out spot checks, at irregular times, to ensure policies and procedures are being followed. Remember that the higher up the management hierarchy an employee is the greater the damage they can do to the business.
• Have a “whistle blower” policy in place and ensure that all staff have the confidence to report any activity by other employees that is in breach of the systems and procedures.
• As director, ensure that you understand the company’s financial performance and position, by monitoring transactions through the company’s bank accounts and regularly obtaining and reviewing profit and loss and cashflow information for the business;
• If there is any change in the financial performance or position that is not able to be explained by the trading conditions, investigate.
When you, as director of the company, are heavily involved in doing the work of your business, it is very easy to allow staff to look after the administration with little or no oversight, but the risks of doing so are high and the consequences, if an employee is defrauding your company, can be catastrophic.
If, from the beginning, all staff are aware of the policies and procedures that are in place and know that you will be checking on what they are doing, for their protection as much as for the business, this should reduce the chances of fraud occurring and increase the chances of identifying the fraud if it is.
If you would like more information or advice on your business systems and procedures, please contact McDonald Vague.
As a landlord of commercial property it is important for you to understand your rights and responsibilities to ensure you don’t inadvertently breach legislation and obligations. If you do, you may face significant liability.
A Deed of Lease details the relationship and terms/conditions between a commercial landlord and tenant. The Property Law Act 2007 (“PLA”) defines rights and obligations of landlords and tenants. The Unit Titles Act 2010 can also apply if the property is a unit title.
A commercial landlord has obligations to comply with the Building Act 2004 and Building Code and to complete a building warrant of fitness for Council.
A commercial landlord also has obligations to maintain the building, comply with health and safety standards. A tenant has obligations to maintain the premises and the Deed will often extend to obligations as to damage/loss, painting, floor coverings, rubbish removal, etc.
If the tenant is in breach of its obligations to the landlord, the landlord may be entitled to terminate the lease. Where a landlord wants to terminate a lease, the PLA requires notice to be served on the tenant in accordance with section 245 of the Property Law Act 2007.
The notice of intention to cancel a lease must expire before a landlord re-enters the premises. A notice must be sent setting out the nature of the breach and remedy required and the rights of the tenant.
The PLA says a landlord may only cancel a lease for non-payment of rent, if rent is at least 10 working days in arrears. A landlord may also cancel for reason of insolvency, liquidation or bankruptcy of the tenant. Once the statutory timeframe expires the landlord can re-enter and seek to mitigate its loss by re letting the premises. The landlord however needs to be wary of the rights of secured creditors to the company assets. There are however a myriad of priority issues that need to be considered and the landlord must give notice and reasonable time for the chattels to be removed.
What If Your Commercial Tenant Goes Bust?
A good commercial lease contains ‘ipso facto’ clauses, which specifically provide for insolvency, which is usually triggered by the tenant entering into liquidation or administration or receivership or becoming bankrupt. The lease usually survives the appointment of an administrator or receiver but may end on liquidation.
A landlord can seek judgment against the guarantor and following judgment issue bankruptcy proceedings against a guarantor on failure to pay.
Tenants by vacating the premises and leaving rents in arrears are not released from their legal liability. While the lease remains on foot, rent continues to accrue, and the tenant and guarantors are liable. The tenant under the Deed of Lease may be required to continue the lease obligation for the balance of the term of lease and can be liable for reasonable costs incurred in re-tenanting the premises. If the company has no ability to pay, a guarantor may be pursued.
A landlord can issue a statutory demand and following failure to make payment under that demand issue winding up proceedings against their tenant company if there is a failure to pay, a default under the terms of the lease and suspicion of insolvency.
Often landlords protect their position by requiring some form of deposit or a bank guarantee to avoid the more costly recovery options and for better protection.
A landlord has no right to take possession of the tenants’ belongings and sell them to cover unpaid rent. Some more current deeds of lease however can now require the tenant company to grant a GSA at the same time as granting the lease. Depending on the wording, this can provide the landlord with the entitlement to recovery of fixtures and fittings and potentially chattels. A well drafted Deed that grants security in assets can provide protection to the landlord in the event of insolvency of their tenant.
Most Deeds of Lease provide for the termination of lease in the event of the tenants’ company being placed into liquidation. If there are arrears, the landlord is entitled to file a claim in the liquidation.
Often a liquidator will seek to trade or to occupy the premises for a period to realise value in the company assets.
If the company occupies the premises then the liquidator can be liable for payment of rent from the date of liquidation. A liquidator may disclaim the lease at which time the rights and obligations of the tenant end.
In Receivership, a receiver has no right to disclaim a lease and can be held personally liable for rent and lease payments from 14 days after the appointment date until the occupation ends or receivership ends.
Most Deeds of Lease will allow the landlord to cancel the lease if a Receiver is appointed.
Liquidation or Receivership will more often than not end the landlord and tenant relationship.
Overall, a Landlord’s rights depend on the terms of their Lease Agreement. Always include specific provisions for liquidation or receivership or administration in a commercial lease. Remember, if the lessor has not given the tenant the notice specified in a commercial lease before enforcing a right of re-entry, the tenant may have remedies against the lessor and apply to the court for relief.
A well documented Deed of Lease will provide for a deposit or bank guarantee, a personal guarantee and/or general security over specific assets such as fixtures and fittings.
If your commercial tenant has vacated leaving rent arrears, or is potentially trading insolvently contact McDonald Vague as an option may be to start the winding up process.
A General Security Agreement (GSA) is a document recording a security provided by a debtor company to its creditor over a specific group of assets or over all assets of the business. The GSA records the terms which include a right of the creditor to register their interest on the Personal Property Securities Register (PPSR) so that there is a public record of that financial interest in the assets of the debtor company.
We always recommend to directors/shareholders investing moneys into their business on start-up that they attend to completing the appropriate loan documentation (between company and individual) and a General Security Agreement recording the terms. It is important that this GSA is registered on the PPSR. It is also important that the registration is maintained and updated every five years to preserve the position as secured creditor.
The registration on the PPSR is an important step and “perfects” the security interest. Perfection of the security interest and the timing of that perfection establishes the order of priority of secured parties who have an interest in the company assets.
The main exception to the priority rule is the Personal Money Security Interest (PMSI) which is where a supplier of goods or equipment takes a security over the goods supplied (but not yet paid). For example, a hire purchase agreement over a refrigerator or a loan by a Finance Company secured over a motor vehicle (a serial numbered good). A PMSI creditor has “super” priority for the recovery of their unpaid goods and/or equipment.
The first to register on the PPSR will usually have priority in the event of insolvency – unless there has been a Deed of subordination between secured parties changing the priority or if the security is not valid.
Under a GSA, a debtor has obligations to the secured creditor to pay amounts owing to the secured party when due, to perform obligations under any agreement, not to allow another party to take security in the same assets without consent, or not to change control of the company without consent.
An important right under a GSA, is for a secured creditor following a default by the debtor, to appoint a Receiver, who then takes control and takes steps to pay the secured creditor.
It is common for banks when they advance moneys to a company that they do this by way of a GSA.
To maintain priority, the GSA needs to be registered immediately on execution of the GSA.
A financing statement has a life of 5 years and then falls off the register. It must be renewed before it lapses, or priority is lost;
The collateral description and accuracy with the registration of the security on the PPSR is important. If there are material discrepancies the security can be invalid.
It is important to register on the PPSR. It is the difference between having some right of recovery and running the risk of losing it all if the debtor company fails leaving a shortfall to creditors.
It is common in New Zealand for the directors and shareholders of small companies to be the same people and many are also employees of the company – executive directors. Whether this is in the form of a family owned business or a just a small to medium sized enterprise made up of unrelated individuals this involvement on all levels can create difficulties.
The advantage of such a set up is that the individuals are motivated to make the business work and be profitable.
The downside is that the closed nature of the board can leave gaps in the knowledge and experience held by the directors and their closeness to the business can lead to subjective decision making.
Depending on the numbers on the board, this can also lead to a stalemate position if there is a difference of opinion on matters requiring board approval.
There are two other types of directors that can be brought into the board to help address these issues, non-executive directors and independent directors.
Whilst both can address the lack of knowledge and experience, a non-executive director may be representing a shareholder and, therefore, may not act without some bias.
An independent director will generally have no links with the company, other than sitting on the board, and have no affiliation to any of the other directors or shareholders.
A liquidation that we have been conducting involves a company with two directors with the shares held by entities associated with each of the directors. One director was an executive director, employed by the company. Two further non-executive directors were appointed to the board – one nominated by each of the other directors.
The board functioned properly, and in unity, until the company faced financial issues.
When the issues were identified, one director made a proposal to restructure the company’s business in an effort to remedy the problems. The restructure proposal was not accepted by the other executive director and, when it went to a vote, the non-executive directors voted with their appointer so there were two in favour and two against – stalemate.
As a consequence, the company continued to trade for a period and left all four directors with a potential liability for breaches of their duties as director.
The closely aligned shareholder interests did not want to change the boardroom dynamic by resigning as directors, or voting against their appointors interests and/or personal views. In the end the directors settled with the liquidator.
A truly independent director, with no affiliation to the other directors or the shareholding parties, could have looked at the restructure proposal in an objective way.
There is no way to know what decision an independent director might have made in the liquidation referred to above but at least a decision would have been made, and action taken accordingly, rather than having the company in limbo.
If you would like more information on appointment of directors and directors’ duties, please contact one of the team at McDonald Vague.
With financial year end, one of the considerations fresh in the minds of business owners and their advisors is the decision regarding appropriate directors’ remuneration.
In a previous article we reviewed the case of Madsen-Ries and Vance v Petera  NZHC 538. In this article, we consider an issue on appeal by the liquidators of Petranz Limited (“the company”) as to whether salaries paid by the company to the directors were fair to the company when they were paid (Madsen-Ries v Petera  NZCA 103). This article will also cover where creditor considerations fit in with such decision making, and the appropriate remedies for creditors if things go wrong.
Mr and Mrs Petera were the sole directors and shareholders of the company, which carried on business between 2002 and 2009 as a cartage contractor. Mr Petera drove one of the company’s trucks, and Mrs Petera worked on administrative tasks.
During this time, the company made various non-business related payments that the Court deemed shareholder drawings, which caused their shareholder current accounts to be overdrawn. However, regarding salaries, in contrast to journalising director salaries at year end, the company paid the Peteras regular fixed amounts between October 2007 and May 2008. During this period the salaries were declared and PAYE paid to the IRD.
In the High Court, the liquidators of the company sued the Peteras for:
- Compensation for breaches of various directors’ duties,
- Repayment of overdrawn shareholder current accounts,
- Repayment of directors’ salaries they argued were unfair to the company at the time they were paid.
In addition to the repayment of the Peteras’ shareholder current accounts, the liquidators claimed a total of $453,003.33 for breach of director’s duties, including $132,255.09 for creditor claims and $321,647.64 for liquidators’ costs up to and including the trial. At the time of liquidation, the company owed creditors $132,555.33.
The High Court, considered the extent of the liquidators’ claim, and stated that their approach to this type of litigation was “ …neither cost effective nor proportionate” to the claim involved, and went against the intentions of the Companies Act 1993 (“the Act”).
Justice Lang found that the language and intent of sections 300 and 301 of the Act narrowed the issues to:
- The amount of compensation to the company that should be paid by the Peteras for reckless trading for actual loss, and
- the amount of personal liability for failure to keep proper accounting records.
Justice Lang found the Peteras had breached various director’s duties under the Act: s 131 (to act in good faith and in the best interest of the company), s 135 (not to allow the company to be operated in a manner likely to create a risk of serious loss to creditors), s 136 (not to permit the company to incur debts unless they objectively believe the company will be able to repay those debts), and s 137 (to exercise the reasonable care, diligence and skill that a reasonable director would in the same circumstances).
For their breach of directors’ duties, Justice Lang ordered the Peteras to repay the company $64,708, being the losses suffered by the Commissioner of Inland Revenue from the time he determined that they should have stopped trading (31 July 2006).
The Court of Appeal approved of the decision by Justice Lang, to order payment of $64,708 as appropriate compensation to the company for breach of duty not to trade recklessly (s 135 of the Act). The amount determined as compensation also effectively limited the liquidators’ further claims under this cause of action.
The parties agreed that the directors had failed to comply with the procedures in s 161 of the Companies Act 1993 (“the Act”). The payments were not authorised by the board of directors (s 161(1), not recorded in the company’s interests register (s 161(2)), and finally the directors had not produced a certificate that the payments were fair to the company at the time they were made (s 161(4)).
Under s 161(5) the directors would be personally liable to repay their salaries unless they could show the payments were fair to the company at the time they were made.
In the High Court Justice Lang determined the salary payments were fair to the company at the times they were made, and allowed the Peteras to retain their salaries on the basis that:
- “(the liquidators’ concerns) are answered to some extent by the fact that the company paid PAYE in respect of those payments. To that extent the debt owing to the Commissioner did not become larger during the period in which the payments were made” , and
- “the company gained full value from the work carried out” , and
- “the company was able to derive profit from Mr Petera’s work because it was able to charge customers for the driving duties he undertook on the company’s behalf” and “the company’s administrative needs were handled by Mrs Petera” .
In the Court of Appeal, the liquidators argued that the requirements that the salary payments be fair to the company, reflected the directors’ fiduciary duty of good faith (s 131 of the Act), and that they owed a duty to consider the fairness of the payments in relation to their effect on creditors’ interests, especially given the poor financial situation of the company at the time. The liquidators argued that, from the date of insolvency, the directors should have stopped trading and stopped paying themselves a salary (which would have protected creditor interests by preserving the company’s assets such as they were at the time).
The Court of Appeal however disagreed, and stated:
“ The scheme of the Act is that creditors’ interests are a relevant consideration for directors where the directors authorise distributions and other transfers of benefit by a company to its shareholders. In those circumstances the Act uses the solvency test, not the concept of fairness, to protect creditor interests. Where directors are called upon to authorise transactions in which the interests of the company on the one hand, and its directors or shareholders on the other, may diverge (including the payment of their remuneration), the Act uses the concept of fairness. The issue for the directors in those circumstances is fairness as between directors and the company. When certifying fairness, including where required by s 161, directors do not need to consider creditor interests. Directors may nevertheless be liable to contribute to an insolvent company’s assets to reflect losses attributable to the payment of director remuneration and, in turn, a company’s failure to meet its obligations to creditors. Such liability could arise under s 301, by reference to a breach of the s 135 duty not to trade recklessly.”
The liquidators then sought leave to appeal to the Supreme Court, which although it accepted “ that the interpretation of the phrase “fair to the company” in s 161 raises an arguable issue of general importance”, declined to hear the appeal.
The Supreme Court found that such an appeal would require the Court to consider both a legal argument and conduct its own assessment of whether the payments were fair to the company, which it would not normally do, being a matter of “ application rather than principle”.
The Supreme Court also noted its concern over proportionality, given the amount already awarded in the High Court, the low level of company debt and the large claim of the liquidators.
Lastly, given the poor financial situation of the Peteras, who were facing bankruptcy, a further award against them would likely have no practical effect.
Regarding director remuneration, there is a distinction between fairness to creditors and fairness to the company. The duty of fairness is owed by directors to the company and indirectly to creditors, whose interests are directly addressed through solvency provisions and the enforcement of directors’ duties such as the duty not to trade recklessly.
The intent of sections 300 and 301 of the Act is to compensate the company and creditors for actual losses, and any further amounts claimed, such as liquidation costs, must be reasonable and proportional to the debts owed by the company.
Although s 161 contains a means of clawback of directors’ salaries, to claim both under this heading and the reckless trading provisions would involve a duplication of claim, and such approach has been rejected by the Court.
Nevertheless, directors must still take care to follow the procedures set out in s 161, and ensure their salaries are fair to the company at the time the salaries are paid.
Finally, if salaries are being paid to directors whilst ordinary creditors are not being paid, the company’s future viability should be reviewed. McDonald Vague can assist with that process.
If your business supplies goods to customers on credit, your terms of trade should include clauses relating to the PPSR. If your terms have PPSR provisions but you have not been registering those interests on the PPSR, you should start.
Once you are granted a security interest, you can (and should) register that interest on the PPSR as soon as possible. Registering your security interests on the PPSR is easy. It only takes a few minutes and the registration process can be completed online. The fee for registering your financing statement on the PPSR is $20.00. Your financing statement lasts five years but it can be renewed, if you still need it when it comes up for renewal.
The main benefit of having your financing statement registered on the PPSR is that, if your customer goes into liquidation or has receivers appointed, your goods will not be available to the general body of unsecured creditors. As a secured creditor, you can take back your goods (provided they have not yet been paid for) or, if your goods have been sold, you can trace into the proceeds of sale of your goods (when your goods are paid for by a third party).
If you don’t register your security interest on the PPSR and another creditor has been given and registered a General Security Agreement (“GSA”), the GSA holder will have priority over your goods. We often deal with creditors who have registered their security interests on the PPSR too late, if at all, and have lost their priority in goods to other parties’ security interests.
It’s a good idea to review your internal PPSR procedures on a regular basis. If you think it’s time for a review or you want to discuss how you can use the PPSR to your best advantage, get in touch with the team at McDonald Vague.