All companies must keep company records, minutes, resolutions and a share register. This article discusses what is required and what can happen when there is a failure to maintain company, statutory and financial records.
Failure to keep accounting records and to comply with Section 194 Companies Act 1993 can render director(s) liable to conviction for an offence.
Failing to maintain books and records may cause a presumption of insolvency and directors could be held personally liable.
Companies have an obligation to keep company records under S189 of the Companies Act 1993. Minutes, resolutions and financial statements must be maintained for the last 7 years. S190 of the Act requires that the records must be kept in a written form or in form or manner that allows the documents and information that comprise the records to be easily accessible and convertible into written form.
Best practice dictates that an annual shareholder resolution recording that the shareholders have received special purpose financial statements, prepared by the directors for compliance purposes, and believe these adequately meet their needs for information is recommended.
The purpose of such a resolution is to record that shareholders have received the taxation statements and to record that these adequately inform them of the progress of their company. These resolutions overcome any dispute at a later date, particularly where the directors and shareholders are not all the same people.
Shareholders also should approve the remuneration paid to the directors (even or often the same) when they record they have received the special purpose financial statements. Shareholders should also approve any major transactions as defined, by special resolution.
Directors Certificates of fairness are required for Director/shareholder remuneration and for interest on loans to/from shareholders.
If you are a registered office, you are required to maintain an Interests Register in the statutory records for each company.
The Register is required to disclose the directors:
• interests in company transactions, including those where the relationship is indirect, which may include other directorships or trusteeships (includes the initial issue of shares on formation (S. 140)
• use of company information (S. 145)
• share dealings, including the directors’ own holdings or holdings by trusts of which he/she is a beneficiary (S. 148)
• remuneration and other benefits (S. 161)
• indemnity and insurance (S. 162)
The Companies Act 1993 envisages an annual disclosure by way of entry to the register.
If the company has a constitution this must be kept at the registered office.
A company must maintain a share register that records shares issued, shareholders names and addresses’ and the number of shares held. The details of all shareholders and movements in shareholdings must be maintained for the last 10year period.
Good records help business management. Financial records must record and explain company transactions and comply with generally accepted accounting practice. Companies have different reporting requirements depending on annual revenue and assets.
Large New Zealand and large overseas companies must file annual audited financial statements under the Companies Act 1993. Smaller businesses must maintain financial statements unless it is not part of a group and has not derived income of more than $30,000 and not incurred expenditure of more then $30,000.
A company falling below these thresholds must still keep tax records and employer records.
The obligation to keep accounting records is codified under section 194 of the Companies Act 1993. A breach of accounting requirements under Section 194 and 189 may constitute a default or breach of duties under Section 301. The potential liability for failing to keep books and records can be significant and is avoidable. Directors may face court action from the company, shareholders or creditors for failing to keep proper records. The Court can order compensation and hold the director personally liable.
A director can be held personally liable (s300(1)) if a company is unable to pay all its debts and has failed to comply with its duty to keep accounting records (s194) or (if applicable) to keep financial statements (s201 or 202) and the Court considers the failure to comply has contributed to an inability to pay all its debts or has resulted in substantial uncertainty as to the assets and liabilities.
Poor records hinder a liquidators’ ability to investigate company affairs. The lack of records can mean there is no way for a company of determining the likelihood of an impending insolvency. This breach can support a reckless trading action.
In the liquidation of Global Print Strategies Ltd (in liq) v Lewis (2006) the directors knew there was no adequate accounting system. The Court said that a director cannot be heard to say “I did not realise we were in such a pickle, because we did not have any or adequate books of account.” The Court held it was fundamental that books must be kept and directors must see to it that they are kept.
A critical element of having a shareholder’s rights protected is how their exit rights are defined. In a publicly listed company, an aggrieved shareholder can simply sell their shares through the Stock Exchange to quit their shareholding in the company.
However, it’s not quite so straightforward and simple for minority shareholders to dispose of their shares in a private company. This is particularly so if the company’s Constitution limits its shareholders’ ability to sell or transfer their shareholding.
Hence, exit clauses are commonly included in the Shareholders’ Agreement to enable all private company shareholders to sell their shares and quit the business in a way that is equitable for all the company’s shareholders.
Are you a minority shareholder looking to sell your interest but struggling to gain agreement on an equitable price?
Have you got close to an agreement on price, only to have the majority shareholder opt out of buying your interest?
Then there are the complications that arise when lawyers get involved. You may discover proceeds from your sale are withheld to enable a clawback on warranties to be executed, leaving you exposed to not being paid in full?
What most minority shareholders want is to avoid having a potential argument dragged through the courts later in an effort to recover the funds owed to you.
There is another, more effective mechanism to allow minority shareholders to exit gracefully.
One of the main problems associated with negotiating the sale of your shares is damage to the value of your underlying business when your focus is not on the fundamentals. Profits suffer, key client relationships can be neglected and supplier relationships strained while you are disputing the value of the business in court it can decline precipitously.
One solution to resolve shareholder departures when a deadlock exists is to apply to the Court to have the company placed into liquidation, with an instruction from the Court that the liquidator be required to sell the business as soon as practicable and that the sale process is via competitive bids.
The liquidator prepares the required company documentation, advertises the business sale and negotiates with interested prospective buyers. During this time, it is business as usual commercially.
Existing shareholders have the opportunity to bid for the company during the tender process as can any other interested party. A purchaser is then identified and funds disbursed to the company’s shareholders upon settlement according to the shareholding percentage as mandated by the Court.
Court Liquidation is in an effective solution to an impasse between shareholders and can prove surprisingly cost-effective. Due to the Court’s involvement, the process is impartial and transparent. An alternative is shareholders agree voluntarily to appoint an independent liquidator.
Exit clauses are critical for shareholders, particularly for those minority shareholders who often don’t have the ability to contribute to the future direction of the company or who lack the ability to secure an enhanced sale price for their parcel of shares when they look to exit their shareholding in the company.
Incorporating effective exit clauses in the Shareholders’ Agreement, allows minority shareholders to exit easily. By mandating their fair treatment and maximizing their benefits in the event the majority shareholders look to dispose of their shareholding, an exit clause provides an element of protection for minority shareholders.
Prior to investing in a private business, it is sensible to review both the Company’s Constitution and its Shareholders’ Agreement. Ensure the exit rights of minority shareholders are adequately protected. Naturally, consult your lawyer about the adequacy of these documents before moving forward with your investment.
If you are caught in a company with shareholders disputing how the business is sold, a liquidation may be an option to consider. McDonald Vague have experience in liquidations in matrimonial disputes and where shareholders have reached an impasse.
One way of dealing with difficult shareholder disputes is to have an independent party control and sometimes deal with the company assets, while the dispute is worked through.
This allows the parties to focus on the dispute without further issues arising from current trading. Such a reliable independent party is a liquidator (solvent liquidation).
We were appointed by the High Court as liquidators of a solvent company to resolve a shareholder impasse. Two shareholders owned 70% and 30% respectively of the company shares. The companies only asset was its ownership of all the shares in a trading subsidiary company. The directors were in dispute on the management of this company.
The liquidators needed to control the subsidiary trading company. The liquidators consented to becoming directors of the trading subsidiary company for an interim period.
The High Court Order was to realise the assets of the holding company by whatever method the liquidators deemed to be practical and, after the realisation costs, the distribution of excess funds from the sale were to be distributed 70%/30% to the respective shareholders.
The court appointed solvent liquidation was due to a protracted disagreement and dispute between the 2 directors over a period of about 3 years over how a wholly owned subsidiary company was to be run and that the business profitability was declining rapidly.
The main issues centred around:
1. The sales price that the subsidiary on sold its product to one of the directors own private businesses. One director who was not involved in the separate private business, believed the price that the product was on sold for was too low and did not reflect the true value of the product.
2. A disagreement as to how and when a large capital expenditure for a factory upgrade would occur to meet Food Safety Authority regulations. The upgrade required a significant capital injection and the patience of the Food Safety Authority was near an end. Potentially the factory may have been forced to shut down.
3. On closing the business a significant redundancy liability would arise as many employees had worked for the company for a long time. In addition, the Union collective pay agreements were well overdue for settlement.
4. The directors were in a deadlock and could not agree on a correct sale price of the product to a related party and the upgrade development to the factory.
The plan was to sell the shares in the trading subsidiary. After discussion with the shareholders, agreement was settled on tendering these shares on the open market as the preferred method to obtain the best price.
The sale of shares in the trading subsidiary would also require continuity of supply agreements of raw material product for the factory to be agreed.
The trading business was profiled along with financial information, advertised in local and national newspapers and also directly marketed to interested parties that were identified. The sale process was by way of a tender of shares.
34 expressions of interest were received, and 20 confidentiality documents were signed and, after discussions with the highest tenderer, a sale was concluded with the 70% majority shareholder.
Of considerable concern to the liquidators throughout this process was to ensure that the return back to the shareholders was maximized, and that tax implications were properly addressed.
The liquidators sought tax advice and two options were available:
1. A bonus issue of retained earnings in the trading subsidiary then sale of that company.
2. Or the preferred proposal was that 30% of the shares that the successful tender did not own of the shares in the company in liquidation be sold direct to the successful tenderer.
Thereby the 70% majority shareholder would acquire the 30% of the shares it did not own in the company in liquidation that owned all the shares in the trading subsidiary.
Option 2 avoided a significant funding arrangement being organised as the successful tenderer only had to fund 30% of the tender price. The payment would be a tax free capital gain for the vendor of the shares and have no downside for the successful tenderer.
The shareholder/directors and their advisors agreed to this proposal, and the liquidators applied to the High Court to have the share transfer endorsed as required by section 248 of the Companies Act along with an application to take the company out of liquidation. The court approved this.
The shareholder dispute was resolved, the 70% majority shareholder now owns 100% of the holding company who in turn owns 100% of the trading company and the minority shareholder received the best price for their shares on an open tender.
The application to the High Court to place the company into liquidation to resolve the director impasse resulted in a good conclusion to the matter for both parties.
Shareholders are the foundation of our listed company system. One of the key protections given to shareholders is the right of minority shareholders to be treated on an equal footing to majority shareholders.
Under section 174 of the Companies Act of 1993, every minority shareholder in a company has the right to seek relief from the court if it feels its rights have been unfairly prejudiced or if they believe the officers of the court have been conducting the affairs of the company in a manner that is oppressive, unfairly discriminatory, or unfairly prejudicial to the interests of the shareholder.
"The Institute of Directors’ guidelines says “Directors should ensure fairness to all shareholders in disclosure of information, general communications and in any transaction potentially affecting the value of securities in the company”.
Common examples of unfair prejudice include directors exceeding their authorised powers, misapplication of company funds and selective share issues. The Act provides that a company, a director, shareholder or an entitled person may apply to the court for an order restraining a company or a director of a company from engaging in conduct that would contravene the Act or the companys constitution.
"A prejudiced shareholder may apply under Section 174(2) to the Court to appoint a receiver of the company or to put the company into liquidation to enable independent practitioners to take control. These applications will only succeed if the Court is satisfied that it is just and equitable to make such an order."
The Act provides that a company, a director, shareholder or an entitled person may apply to the court for orders requiring a director of the company, or the company itself to take any action that is required to be taken by the constitution of the company or the Act.
As well as the power to apply for an injunction, shareholders are entitled to apply to the court for orders requiring a director of the company, or the company itself to take any action that is required to be taken by the constitution of the company or the Act.
Shareholders are also entitled to bring an action against the directors of their company for a breach of the duty of care owed to them. These duties owed to shareholders include an obligation to supervise the company share register and to disclose their financial interests and share dealings.
Duties which directors owe to the company and not to shareholders include acting in good faith, exercising a director’s powers for a proper purpose, not trading recklessly, not incurring certain obligations, exercising a proper duty of care and using company information in accordance with the Act.
An order cannot be made in relation to past conduct. This provision is intended to provide a minority shareholder with an opportunity to bring the proposed actions of the Board under the scrutiny of the court as well as providing shareholders with an opportunity to ensure the company is being run in line with its constitution. Under the 1993 Act, a company’s directors are directly accountable to the company’s shareholders.
It is important for minority shareholders to remember the Court is conducting a delicate balancing act. Misconduct on the part of a minority shareholder may result in prejudicial conduct by a majority shareholder not being ruled unfair. Moreover even though there is no strict time limit for a minority shareholder to bring its claim, a delay in proceeding, particularly when combined with accepting benefits from the company in full knowledge of the facts, carries with it the risk of the court deciding the minority cannot really have been prejudiced or has accepted the unfairness.
Let us help you make the right legal decision regarding appointing a receiver or liquidator, call to request a consultation now!
You need to wear a lot of hats to be in business. As a business owner you start out wearing many ‘hats’ as you take on all the work yourself.
When your business starts to grow, reaching the next stage will involve handing one of these hats to someone else. But which hat? What should you look for in a future business partner or shareholder, and how can you avoid managing disputes between shareholders?
What’s the end goal for your business? Is it to build lifestyle, or generate revenue before selling? Make sure you’re on the same page with your potential business partner for the end game before you start out.
Yin and yang, light and shade, Superman and Batman. Find a business partner with skills that supplement and compliment yours. Someone whose strengths and weaknesses are an opposing match to you.
Spend time learning the other’s style and way of working so you know how to motivate and support each other. Business can be stressful, so being able to count on your partner is vital.
Are they financially stable, or are they likely to add more risk? A credit or background check plus an upfront chat about finances is important to avoid surprises down the track.
Even after due diligence, shareholders and business partners can still come to loggerheads. Disagreements can be stressful, seriously harming staff morale and business earnings.
How can you go about managing disputes between shareholders so they don't damage your company? Here are our tips.
Party A issues notice to Party B requiring them to either buy all of A’s shares, or sell their shares at a specified price. B then has the option of buying or selling at the offered prices. Ultimately Party A doesn’t know if they will be bought out or not, unless one side is unable to buy the shares, so has no option but to sell.
Party A notifies Party B they want to buy their shares. If B decides to purchase A’s shares instead, both parties bid for the shares in an auction. This only works if both parties are matched financially.
If Party A can prove Party B’s non-performance under a shareholder agreement, they can acquire the ‘right’ to buy B’s shares.
Unless one party has acted unlawfully, breached their contract or director duties, you don’t have grounds to go to court to settle your dispute. Liquidation may be an option with both parties sharing the costs, but only in extreme cases.
To save trouble and prevent dragged-out disputes, the best solution is a crafted shareholder agreement. Most standard agreements lack teeth and don’t facilitate proper mediation or negotiation. A tailored shareholder agreement will properly address the framework and structure of your company, and put in place a clear dispute resolution process.
For more information on shareholders and companies, download our free Guide for NZ Companies in Financial Difficulty to discover your different options.
In one of the final scenes of iconic movie Forrest Gump, Forrest discovers he’s a shareholder in “some kind of fruit company,” and that he “don’t have to worry about money no more.”
He unwittingly bought shares in Apple Computers, and if for argument’s sake he’d spent $100,000 in 1977, his shares today would be worth close to $7 billion dollars.
Of course, we all want to get as lucky as Forrest, but it’s pretty rare to blindly wander into a fortune. Becoming a shareholder can be a useful way to diversify your portfolio, and many people enjoy the experience. In our experience, many people in NZ become involved as a shareholder in a small company with a few other mates or acquaintances with a great idea and the best of intentions.
Over 80% of NZ registered companies are small to medium sized and do not offer shares to the public.
Things can and do go wrong however, so before you jump in with investing in a company, it’s important to conduct due diligence to protect your investment and ensure you’re safe should something go wrong.
When you come into a business, there are several key drivers you should investigate. First of all is the relationship you have with the other owners. If things are uncomfortable now, they could become toxic at the first sign of trouble. Secondly, you should have some understanding of the industry. Is it in a growth market, or on the decline? What is the market saturation/share? What’s the product’s reputation with consumers? Having inside knowledge of the market can help you see opportunities and add value, as well as avoid disasters.
As part of due diligence, you need to assess the returns from the proposed investment. The expected return may not always be financial, but often it will be. For example, one company we know of asked shareholders to inject a couple of million dollars into the business to allow it to continue to trade. Many factors were considered during the due diligence process, but the decision came down to the fact the particular industry worked on slim profit margins, the company concerned did not have a track record of profitable trading, had many competitors, and it would’ve taken the company approximately 20 years to repay the initial investment.
In that case, when comparing the costs of the shareholders either borrowing the funds or what they could get as a return on the same money elsewhere, the shareholders decided against making the additional investment
The company was placed into liquidation as a result of the shareholders’ decision. From what we have seen the prospect of liquidation should funds not be introduced had been one of the factors that the company directors had asked the shareholders to consider. Which leads to another due diligence point, that you need to consider the common grounds and potential conflict points between shareholders’ interests and those of the directors as they may be different people, and what agreements are in place to deal with these.
Forrest clearly didn’t involve any due diligence techniques, but it is a movie and he got lucky. In the real world, you can’t count on Forrest’s luck. If you’re looking at investing or becoming a shareholder due diligence is important. You must know about the people and company you’re about to enter into business with.
Here are elevan simple questions to ask when conducting due diligence for a shareholding. Finding the answers could save you big time in the long run:
Investing in a company is a bit like hiring an employee. With a formal process to work through, you will usually end up with a solid, dependable asset. But without that process, you are gambling based on instinct and first impressions, and that’s not ideal. There are always fish hooks when becoming a shareholder – disputes can ruin a business – but by following the process outlined above, you’ll avoid the majority of potential problems.
If you haven’t gone through due diligence, or you need some advice on what to do next, come and talk to the McDonald Vague team and they can help guide you toward a confident decision.
If your company is experiencing financial difficulty, download our free guide for NZ Companies to discover your different options.
It seems like a typically Kiwi thing to do - a couple of mates decide to go into business together and start up a company to operate the business. Everything is split down the middle - each director owning 50% of the shares and all agreed on a handshake.
What could go wrong?
The recent liquidation of a small business shows just what can happen. Things went well for the first couple of years. Business was going okay and making a small profit but then things started to go wrong.
The relationship broke down between the shareholders and got to the stage where they couldn't agree on anything to do with the business including staff management and business direction.
Legal advisors became involved and an attempt was made to resolve the issues by one of the shareholders buying out the other's interest. Unfortunately, they couldn't agree on the value of the business.
As a result, the decision was made and agreed to by both shareholders to liquidate the company. The liquidation process was made more protracted and costly by the sniping between the shareholders leading to higher liquidation fees and therefore a reduced payment to creditors.
There are no guarantees of course but this situation may have been avoided, or at least the damage mitigated to a certain extent, if there had been a shareholders' agreement put in place at the time the company was incorporated.
Shareholder agreements usually include
A shareholder agreement is like a business pre-nuptial agreement. It sets out the basis of the relationship between the shareholders and can include matters such as:
It can contain confidential information as, unlike a company's constitution, it does not have to be filed with the Registrar of Companies and be available for public viewing.
Shareholder agreements may also include
They may also cover:
The complexity and size of the shareholders' agreement will depend to a certain extent on the size of the business, the number of shareholders involved and the areas to be covered.
It will be different for every company and shareholders should seek proper legal advice when putting together any such agreement and before signing one.
How McDonald Vague can help
We regularly see the result of fallouts between company directors and shareholders. We would advise all company directors and shareholders to put together a Shareholder Agreement at the time the company is incorporated to avoid prolonged and unnecessary expense to shareholders and their creditors.
If your relationship with fellow director(s) and/or shareholder(s) is breaking down contact us for free and confidential advice to find out how we can help.
Alternatively, download our Free Guide to Avoiding Business Failure