If you have received a payment claim, you must respond with a payment schedule within the prescribed timeframe or pay. If you fail to do so, s 23 of the Construction Contracts Act 2002 (the Act) states that:
the payee may recover from the payer, as a debt due, in any Court, the unpaid portion of the claimed amount, and the actual and reasonable costs of recovery awarded against the payer by Court; and
the payee may serve notice on the payer of its intention to suspend construction work.
A payment schedule must set out the undisputed amount which the payer acknowledges should be paid (if any), and also set out any disputed amount (if any) with reasons for the dispute.
A payment schedule is designed to allow a contractor to receive the funds that all parties acknowledge are due. This way, the contractor continues to receive cash flow and is notified of reasons why a certain payment is not received. This was summarised by the Court in Marsden Villas Limited v Wooding Construction Limited HC Auckland CIV-2006-404-809, 1 March 2006:
The Act therefore has a focus on a payment procedure, the results that arise from the observance or non-observance of those procedures, in quick resolutions of dispute. The processes that it sets up are designed to sidestep immediate engagement on the substantive issues such as set-off for poor workmanship which in the past were so often used as tools for unscrupulous principals and head contractors to delay payments. As far as the principle is set up, the regime is ‘sudden death’. Should the principal not follow the correct procedure, it can be obliged to pay in the interim what it was claimed, whatever the merits. In that way, if the principal does not act in accordance with the quick procedures of the Act, that principal, rather than the contractor and subcontractors, will have to bear the consequences of delay, in terms of cash flow.
Statutory requirements for a payment schedule
A payment schedule has no set form. However, s 21 of the Act states that a payment schedule must:
Be in writing;
Identify the payment claim to which it relates;
State the scheduled amount which it proposes to pay; and
If the scheduled amount is less than the claimed amount, the payment schedule must:
indicate how the scheduled amount was calculated;
explain reasons why the scheduled amount is less; and
if the difference is because the payer is withholding payment, the reasons why payment is being withheld.
A payer is allowed to dispute 100% of the claimed amount by stating that the scheduled amount is zero.
Payment schedules in the Courts
A variety of different payment schedules scenarios have been before the Courts, with varying outcomes.
In Westnorth Labour Hire Limited v SB Properties Limited HC Auckland, CIV-2006-404-1858, 19 December 2006, the payer responded to a payment claim by providing the contractor with a detailed letter on the various issues, cost overruns and a suspicion that work had been improperly charged for. The letter concluded with:
I must advise that we do not agree with your charges for the reasons noted above and until you provide the breakdown requested and until we have had suitable time to consider the information you provide, no further payments will be made …
Whilst not in any particular form, the Court held that the letter was a valid payment schedule. The Court held that the letter was in writing, it indicated that the scheduled amount was nil and provided reasons as to why the scheduled amount was less than the claimed amount.
The Court’s decision in Westnorth can be contrasted to the decision in Metalcraft Industries Limited v Christie HC Whangarei, CIV-2006-488-645, 15 February 2007. In that case, in response to the payment claim, the payer’s solicitors informed the contractor that:
In any event our client disputes liability for payment, and advises that she is unable to specify if any payment is to be made to your client, until she receives invoices for the remedial work undertaken by her replacement contractors. This, and our earlier correspondence, is to be regarded as our client’s reason for withholding payments. The cost of the remedial work is expected to exceed your client’s invoice.
Any summary judgment proceedings on the basis of your claim that the sum is a debt due, or otherwise, will be defended and costs will be sought.
The High Court held that the above statements, when read together with earlier correspondence, could not be construed to mean that the scheduled amount was nil. On the contrary, the above statements show that the payer was not in a position to specify the scheduled amount and there was no unequivocal denial of liability for all of the payment claim. Rather, the payer indicated that she would review her position at a later date.
Importantly, the Court held that:
… An assertion that remedial work is required at a cost which would exceed the payment claim could never constitute a valid reason either for the difference between the scheduled amount and the amount claimed or for withholding payment. General and unspecified allegations of defective workmanship are insufficient unless quantified within a reduction for the claimed cost of remedial work. Similarly a claim that excess materials were supplied is not enough; Ms Christie would have to identify them and their value to justify a further reduction in the scheduled amount. Delays in completing the work and consequential damage caused by leaking and water damage may give rise to a counterclaim for special damages, but even if quantified they could not be taken into account in the scheduled amount: s 79. None of the reasons given in Pegg Ayton’s correspondence justified withholding payment of any part of Metalcraft’s claim.
The Court in Metalcraft was of the view that the decision of Westnorth can be distinguished on the basis that the correspondence in Westnorth contained all the information required for the contractor to understand its position and make the appropriate decision. In particular, the Court noted that the correspondence:
…contained a number of arithmetical calculations, beginning with the amount of the invoices, their relationship to projected budgets and total previous payments and figures for materials returned – in substance a calculation indicating why no money was considered to be then payable.
In essence, a payment schedule must state a scheduled amount regardless of how detailed the complaint is. This is reinforced by the Court’s decision in Charles Beckhan v Betty DC Whangarei CIV-2007-090-2424, 21 February 2008. In that case, the Court rejected a letter from the payee’s solicitors as a payment schedule, claiming that the payee had already paid more for the value of the work and the materials, and further claimed that the invoices did not correspond with the time spent or the materials provided to site. The Court reasoned that there was no calculation at all as to how and by how much the payee claimed to have overpaid.
It is also worth noting that in Cube Buildings Solutions Ltd v King HC Christchurch CIV-2009-409-34, 17 December 2009, the High Court held that the inclusion of a deduction for amounts that had already been paid does not invalidate a payment schedule. The Court came to this conclusion because s 79 of the Act permits the Court to take account of a counterclaim, set-off or cross-demand in circumstances where there is no dispute in relation to the claimed amount.
It is less clear whether a payer is able to raise a set-off, crossclaim or counterclaim in a payment schedule in relation to items outside of the payment claim itself. For example, a contractor is contracted to construct a building. It starts this process by laying the foundations before proceeding to erect the frames. The contractor submitted monthly payment claims for the foundations and while erecting the frames, defects appear in the foundations which had already been claimed. The payer then issues a payment schedule in response to the payment claim for frames containing a deduction for remedial work to the foundations.
While there is no direct authority on point, the Court in Canam Construction Limited v George Developments Limited HC Auckland CIV-2004-404-3565 observed that s 21 “makes it clear any payment schedule is confined in scope to claims raised upon the payment claim.” If the payment schedule is restricted to the confined scope, then it could be argued that deductions for works not within the scope of the payment claim are inappropriate.
Additionally, the Court of Appeal in SOL Trustees Ltd v Giles Civil Ltd [2015] 2 NZLR 482 indicated that it would be inconsistent with s 79 of the Act if a counterclaim or set-off could be relied on as a response to an earlier payment claim. It is noted that the Court of Appeal’s statement is obiter as the issue was not fully argued before the Court.
These decisions can be contrasted to the holding in Metalcraft where the Court held that a payment schedule that “properly quantifies the amount incurred by a principal in remedying the allegedly defective workmanship by a contractor may … constitute a valid reason for withholding payment for that amount”.
Conclusion
Our view is that the holding in Metalcraft is likely to be the correct position. The High Court recently took guidance from Metalcraft in The Fletcher Construction Company Limited v Spotless Facility Services (NZ) Limited [2020] NZHC 1942 decision, where Justice van Bohemen echoed Harrison J’s words:
The specific purpose of the payment schedule is to give the contractor full and unequivocal notice of all areas of difference or dispute to enable it to properly assess its future options.
However, a payer must still be able to provide sufficient details of its counterclaim or set-off which can be difficult given that relevant information may not be available at the time.
Contact us if you have received a payment claim and need to respond with a payment schedule. Our lawyers at Norling Law can review your payment claim and discuss strategies to respond to your payment claim as part of our no obligation legal consultation. To book a free 30-minute consultation please click this link https://norlinglaw.co.nz/consultation-brent/.
A contractor is not required to complete extra work and cannot expect payment for completing extra work that has not been specified in the original contract, without either a new contract, a variation of the existing contract, or an order made under a term in the contract that permits variation of the work.
A variation is an alteration to the scope of works in a construction contract. It could be an addition, substitution, or omission from the original scope of works. A variation should always be within the scope of works originally required. It should not be of such different character or quality as to be totally different to the works originally contemplated. If that is the case, then the contractor could argue that it is not a variation, but extra work.
Almost all construction projects, whether small or large, will have variations. The three critical aspects of a variation are:
What can be varied,
The process of claiming a variation, and
Valuing the variation.
What can be varied?
The first step in identifying a variation to the scope of works is identifying the scope of works itself. The scope of works and services is defined by the contract, commonly by reference to documents such as plans and specifications or a project brief. If works or services are part of the scope of works, then they are not a variation.
A common dispute that arises in relation to variations is whether a variation is, in fact, a variation. These arguments are common where the scope of works is not clear. It is, therefore, important to define with as much precision as possible, exactly what the scope of works includes. Failing to do so could mean that work can be implied to be included within the scope of works if incidentally required.
For example, if a plan shows that the contractor is to install a door and the specifications do not specifically refer to any hinges on those doors, supplying the hinges are part of the scope of works as it is necessary for the completion of that work and likely to be the contractor’s responsibility.
The variation process
Most written construction contracts will specify a process for instructing or claiming a variation. This is because at common law, the principal does not have an automatic right to instruct variations. So, unless the contract empowers the principal to instruct variations, the contractor can refuse to perform the variation and insist on performing the original scope of works.
For example, in Ettridge v The Vermin Board of the District of Murat Bay [1928] SASR 124, a contractor was engaged by the principal to construct a fence along a railway line. During construction, the principal instructed the contractor to deviate from the original line. The contractor refused to accept the deviation and abandoned work claiming that the contract did not give the principal a power to vary the contract. The Court held that as the principal did not have the power to instruct variations, it had repudiated the contract by insisting on the deviation. Accordingly, the contractor was entitled to terminate.
Most written contracts allow the principal to instruct variations and the contractor to claim for variations. In respect of the former, the process will normally involve an instruction from the principal, which can be written or verbal, to vary the works. Depending on the construction contract, this power could be very wide and can represent a significant risk for the contractor.
For instance, the contractor could be required to undertake extra works even though it may not have the necessary resources, or the work may be uneconomic. Furthermore, instructions issued at a later stage in the project may entail extensive redesign and rework which can also force the contractor to remain on site for significantly longer than envisaged. Accordingly, contractors would be well-advised to seek advice on the extent of this power before entering the contract.
In respect of a contractor’s claim for variations, depending on the contract, it may provide specific instances when a variation is claimable. Under NZS 3910 for example, it provides that a variation is claimable where there is a significant discrepancy, late instructions, nominated subcontractor defaults, incorrect information supplied by principal, early occupancy by principal and etc.
In our experience, it is common for disputes to arise because the correct process prescribed by the contract in relation to variation is not followed. A common issue encountered by contractors is non-payment for variation works requested pursuant to verbal instructions from the principal. This issue is especially prevalent in residential building projects.
Typically, this scenario involves a verbal agreement between the principal and contractor for works to be varied. However, once the variations have been completed, the principal attempts to avoid payment by denying that it had instructed the contractor to undertake those variations. If the variation clause requires the variation to be recorded in writing, and the contractor fails to document this, the contractor takes on the risk of not getting paid for the variation as there would be no clear evidence of an agreement for the contractor to perform them.
This could lead to a costly and time-consuming dispute to establish the variation.
While it may seem unfair, the contractor is not entitled to payment if it cannot prove that the variation was instructed. This situation can be avoided by insisting that all variations, large or small, be documented before undertaking the variation in question or refusing to carry it out unless it is formally instructed in writing.
Valuing the variation
The written construction contracts will usually have clauses setting out how a variation is valued.
The variation could be valued by agreement and if so, such agreement should be documented to prevent disputes in the future.
If not done by agreement, the parties should be aware of the valuation procedure in the contract. Typically, the contract will include a schedule of rates that will apply to most variations. Contractors should therefore check how variations are valued and whether those prices are feasible before entering the contract. Failing to do so could mean that the contractor is obligated to carry out a variation at a loss.
Conclusion
In the next article, we will discuss potential avenues available to contractors outside of the contract where the variation process has not been complied with. They include quantum meruit, estoppel and the doctrine of free acceptance.
Variations are an inevitable component of many construction contracts, and to ensure a fair outcome for all parties involved, the scope of work in the contract needs to be comprehensive. Our lawyers at Norling Law can review your scope of works and variations, and can assist with dispute resolution, as part of our no obligation legal consultation. To book a free 30-minute consultation please click this link https://norlinglaw.co.nz/consultation-brent/.
If a creditor has served liquidation proceedings on your company, you may want to consider placing the company into liquidation before the matter is brought before the court and the court appoints a liquidator chosen by that creditor. In doing this, the company’s shareholders have the chance to appoint a liquidator (usually referred to as a voluntary liquidation) who could act more favourably towards them as opposed to the creditors throughout the course of the liquidation. Section 241AA of the Companies Act 1993 (“the CA”) forces companies to act quickly when considering this option. Creditors can bypass and replace the shareholder appointed liquidator with one who would act more favourably towards their interests. However, they too must act quickly.
Purpose of section 241AA
Under section 241AA of the CA, a company has 10 working days to appoint its own liquidator from the date when it was served with liquidation proceedings from a creditor. The 10 working-day provision in section 241AA(2)(a) pushes companies to take quick action to move into voluntary liquidation if appropriate. It also prevents a company from deferring voluntary liquidation until shortly before the court is due to consider the liquidation application, which can lead to excessive costs for the creditor.
In 2020, section 241AA(2) was amended and section 241AA(2)(b) was introduced to allow for the company shareholders to appoint a liquidator after the 10working day limit if the creditor that brought the liquidation proceedings consents to the appointment. This also assists in avoiding any unnecessary costs as the creditor may agree with the appointment of the liquidator suggested by the company shareholders.
The shareholder appointed liquidator
A company can place itself into liquidation by the passing of a special resolution of its shareholders (granted it is within 10 working days of being served liquidation proceedings from a creditor). Passing a special resolution requires 75% of all shareholders that are entitled to vote on the matter to then vote in favour of the resolution. A shareholder resolution is not required to be passed if the consent of the petitioning creditor to the appointment has been given.
If the shareholders appoint a liquidator, there is a perception that the liquidator is more likely to act in the interests of the shareholders as opposed to one appointed by the creditor. Although this is not true to every situation, it is still a strong trend in insolvency.
For example, a liquidator will have a contact network of lawyers and accountants. If a lawyer has a client that intends to place their company into liquidation, they will recommend a liquidator that would tend to act in the interests of shareholders. This would be a liquidator who is less likely to pursue areas such as an overdrawn current account or breach of director’s duties.
In many cases the shareholder appointed liquidator will typically remain appointed. Creditors do have an opportunity to replace them, however.
The creditor appointed liquidator
Creditors must act quickly to replace a liquidator if they are concerned by one appointed by the shareholders. In this circumstance, the most cost-effective way to achieve this is by passing a resolution to replace the liquidator at an initial creditors’ meeting.
The process to calling a creditors’ meeting is as follows:
The liquidator must give notice of the creditors’ meeting to every known creditor (see section 243 of the CA).
If the liquidator has decided not to call a meeting, they must give notice to the creditors advising that no meeting will be held and provide reasons for this (see section 245 of the CA).
If a creditor wishes for a creditors’ meeting to be held, the creditor must notify the liquidator in writing within 10 working days of the liquidators’ notice to dispense with a creditors’ meeting (also under section 245 of the CA).
The timeframes to call a creditors’ meeting are critical. If a creditor fails to notify within the statutory timeframes, the opportunity to attempt to replace the liquidator is lost.
A resolution to replace the liquidator may be put forward by a creditor at the creditors’ meeting and, if passed, the proposed liquidator will become the new liquidator of the company. The majority in number and value of the creditors voting must vote in favour of the resolution for it to succeed.
In many cases the creditors will be unsuccessful in replacing liquidators who have been appointed by the shareholders. The number of steps in the replacement process and the amount of lobbying of fellow creditors to vote in favour of the resolution to replace the liquidator can sometimes be too tall of a task.
Conclusion
If the perception of the favourable liquidator is legitimate, we suggest following our recommendations above to appoint a liquidator who will act more favourably toward your interests. As a word of caution, please note that although these perceptions exist, sometimes it can merely be a perception.
Whether it be creditors or shareholders that we act for, we encourage our clients to investigate a liquidator and their history to see if they are likely to act in the best interests of our clients. A liquidator’s reputation can be investigated either by publicly searching through judicial decisions or discussing with one of our insolvency experts.
If you require our legal assistance, please contact us for a no obligation discussion.
There are a variety of barriers to settlement throughout the mediation process. These include communication barriers, unrealistic expectations, emotional barriers, cultural barriers, intraparty conflict and fear of losing face.
This article discusses caucusing as an effective way of overcoming barriers and challenges of mediation.
Mediation caucusing
Mediation caucusing is the use of separate meetings between the mediator and the parties individually during a joint mediation session. Caucuses can be conducted at various stages of a mediation and sometimes in combination with joint sessions. Mediators often use caucus sessions to discuss the conflict and advance the negotiation.
David A Hoffman noted in his book on shuttle diplomacy that caucusing is widely used because it can overcome a variety of tactical and strategic barriers that would be difficult in joint sessions such as (to name a few):
communication barriers
emotional barriers
information barriers
cultural barriers
strategic barriers
unrealistic expectations
obstacles to generating options
need for negotiation coaching
need for process management
internal conflicts
fear of losing face
Communication barriers
In mediations with particularly high-conflict behaviour, the parties may communicate aggressively and may find it difficult to remain in the joint session. A skilled mediator will reframe the statements made by each party and may decide to meet separately with the parties to manage any barriers to communication between them.
Emotional barriers
Mediations often cause intense emotions, especially when the conflict is highly personal, or one party believes that the other party is not bargaining in good faith.
Hormonal changes occur when people are under stress. Adrenaline production rises, and people experience a fight or flight reaction. Caucusing provides parties with a space to recover from any confronting behaviour. Caucuses also create a space for safe venting of intense emotion without negatively affecting the atmosphere of the joint session.
Information barriers
The mediator is sometimes given critical information unknown to the other side on a confidential basis in a caucus session.
The parties are often reluctant to share such information because if it is shared in advance of trial, the other party will have time to prepare a response to lessen the impact of the damaging evidence. However, a mediator is obliged to obtain express permission to share information imparted confidentially in a private session. A skilled mediator will understand and adhere to professional obligations and will not compromise confidentiality or impartiality.
Cultural barriers
Mediators need to identify and manage any perceived power imbalances. Racial, cultural, class, and other differences may lead some people to perceive themselves to be less powerful so they prefer private caucuses in a mediation. This is especially the case if a party’s identity is a central element in the mediation and the aggrieved party perceives (accurately or inaccurately) a lack of respect from the other party because of that identity.
For example, a group of students at Columbia University in 1996 went on a hunger strike and requested the university to create an ethnic studies department. The anger and mistrust on both sides made joint meetings problematic so caucus sessions were particularly useful.
Strategic barriers
Most parties are reluctant to share their true bottom line out of fear that this will be exploited by the opposing party. Caucus sessions may help mediators determine a zone of possible agreement.
The mediator may ask each party separately what they believe the other side might be willing to offer to settle the case. The two answers may assist the parties to come to a range within which the parties are comfortable they can settle.
The mediator may also ask a range a party might be willing to bargain in. Such “range bargaining” communicates a willingness to be flexible and begin defining the parameters of a zone of possible agreement.
Unrealistic expectations
Parties often have overly optimistic assessments of their best alternative to a negotiated agreement (BATNA). A skilled mediator can assess a party’s BATNA by exploring what will happen in Court if the dispute is not settled. Overconfidence is one of the many cognitive miscalibrations to which the human mind is prone; others include self-serving bias and status quo bias, which likewise can skew a party’s assessment of his or her BATNA.
A skilled mediator will be able to test the inferences that have led each party to their conclusions about their BATNAs. In joint sessions, parties usually exaggerate their likelihood of success and minimise the other party’s likelihood of winning.
Lawyers commonly seek mediation when they believe the other side, or even their own clients, have an overly optimistic view of the case because the mediator can persuade each side to be more realistic.
Obstacles to generating options
The parties may fear that sharing something in a joint session could reveal their openness to solutions that they wish to keep private.
Mediators may encourage brainstorming first in caucus sessions and then in joint session to gain the trust of the parties and reduce the risk that an idea advanced in the mediation could be viewed as biased.
Need for negotiation coaching
Mediators commonly engage in negotiation coaching because disparities in negotiating skill and mediation experience can create an unlevel playing field.
Negotiation coaching may encourage parties to explore each side’s interests instead of focusing solely on positions, help parties generate options, and decide offers and counteroffers.
Coaching is impossible in joint sessions because it could give the appearance of partiality, and because the parties are rarely truthful about their bargaining strategies.
Need for process management
Caucus sessions may be required if there is a party displaying disruptive behaviour. Joint sessions may be harder to manage in some circumstances.
If a party, or party’s lawyer, cannot pick up on social cues and is unable to control the impulse to talk throughout the mediation, a skilled mediator may decide to separate the parties to create some time and structure to the mediation.
Internal conflicts
Parties often need internal mediation within their own team. A party, and his or her lawyer, may have differing ideas about the best negotiation strategy. There may also be an uneasy alliance or a difference in dynamics within a group.
Parties can be transparent about internal disagreements in caucus sessions and then achieve unity in joint sessions. Separate meetings may also be needed to determine whether there is a potential conflict of interest.
Fear of losing face
In commercial disputes, some executives or employees may have similar interests with respect to outside constituencies (shareholders, suppliers, and customers) and with internal constituencies (company’s officers, employees and board of directors). They may be motivated to avoid letting them believe that they gave up or left money on the table.
An effective mediator can help maximise everyone’s interests. Often, the most successful way to assist the parties to reach a resolution and save face in a negotiation is for the final proposal to come from the mediator.
In a “mediator’s proposal” procedure, the parties are less likely to dismiss a proposal and the mediator can discuss the proposal confidentially with the parties. Even when a mediator’s proposal is not accepted by a party, these separate conversations can often lead the way to resolution.
Conclusion
Mediation caucusing adds value to mediation by overcoming various tactical and strategic barriers and impediments to settlement. Although the no-caucus model may be appropriate for certain types of mediation (and preferred by some mediators), often parties prefer the efficiency that can be achieved with caucusing. Numerous variations and hybrid mediation formats may also be useful.
How can you find out more?
At Norling Law, we are passionate about solving commercial disputes and legal issues. We offer professional, independent, and impartial mediation services to users in a dispute.
Norling Law supports mediation as an efficient way of solving legal issues. Especially if the parties to the dispute want a negotiated outcome that remains private and confidential and that puts a prompt end to the costs of having the dispute ongoing.
As mediators and representatives, we assist the users to a mediation achieve their priorities throughout the mediation process and enable them to make informed decisions regarding the resolution of the disputes they are involved in.
Our mediator, Wendy Alexander, regularly assists with the facilitation of settlements through mediation.
At Norling Law, we receive a large number of commercial disputes. Commercial disputes can be extremely stressful and can often be suitable for mediation. The parties may have been negotiating directly to reach a solution that would meet the interests of both parties. However, the parties often find it difficult to reach agreement.
Using mediation is an option that could potentially resolve commercial problems quickly and efficiently. Mediation is a low-cost option to consider before deciding on whether to litigate. Traditional mediation is usually a more expensive process as it involves the users meeting physically and there are resulting costs involved with travel and booking a neutral meeting room (or rooms). Sometimes traditional mediation might not be available at all for urgent matters.
Wendy can effectively assist users of mediation with her extensive experience as a commercial mediator. Wendy can help parties decide whether the parties’ objectives would be best served using joint sessions, caucusing, or a combination of these approaches. Wendy completed training at Program on Negotiation at Harvard Law School, USA and the Arbitrators and Mediators Institute of New Zealand (AMINZ). Wendy is also an Associate Member of AMINZ. This training complements the skills she already has in negotiation and dispute resolution.
Wendy often receives feedback from the mediation parties that they felt relaxed and in safe hands with the management of the dispute and that Wendy truly understood where they were coming from.
If Wendy’s expertise can be of assistance, the first step is to send us the details of the situation here.
Creditors’ limited ability to pursue directors for breach of duties
The facts of Banks v Farmer [2021] NZHC 1922 will sound familiar to many. A gap in the market is identified and a business is set up to fill that gap. The issue many of these start-up businesses face is trying to convince investors to support them. Upon securing an investor there is subsequent pressure placed on the directors to make good on that investment. But sometimes everything might turn sour, with investors left trying to recover the money they put into these ventures.
The background of this case centres around a company named Mako Networks Holdings Limited (Mako), the company operated within the technology security market and the development of technological solutions for this area. Adam Banks (Mr Banks) was an investor in Mako, between 2011 and 2014 he had invested over $3.2 million in unsecured loans. Unfortunately, Mako was placed into liquidation and receivership when it owed creditors $34.5 million. Mr Banks brought these proceedings against the four directors of Mako (the Directors) on the basis they did not act in accordance with their obligations as directors.
Section 301 of the Companies Act 1993
Section 301 of the Companies Act 1993 (the Act) provides the High Court with the power to require a director (amongst other persons) to repay the money or return property of the company, or to make a contribution to the assets of the company by way of compensation. Under this section, liquidators, creditors, and shareholders are given the opportunity to make an application to the Court which is only triggered when the company in question is in liquidation.
An order made under this section will qualify as a judgment debt, therefore enabling liquidators, creditors, and shareholders to hold directors personally liable, resulting in the commencement of bankruptcy proceedings, if necessary, to enforce payment.
Application in Banks v Farmer
In the High Court decision, the third cause of action against the defendants was for a breach of their directors’ duties. Specifically, their failure to act in good faith and the best interests of the company, for carrying on business in a manner that was likely to create a substantial risk of serious loss to creditors, and for letting the company incur obligations that it was not able to perform and for their failure to exercise the care, diligence, and skill that a reasonable director would exercise in those circumstances.
Mr Banks relied on s 301(1)(c) of the Act to claim relief in the sum he advanced to Mako. In the alternative, Mr Banks sought the defendants restore or contribute $29,897,000.00 to Mako. He specifically referred to s 135 (reckless trading), s 136 (improperly incurring obligations), and s 137 (failing to exercise reasonable skill and care) as the directors’ duties that were breached.
In his discussion of the case, Moore J referred to the purpose of the Act regarding directors’ duties stating “Directors’ duties are not intended to prevent the taking of legitimate business risks or constrain genuine business judgment, but rather to protect shareholders and creditors against illegitimate abuses of directors’ power.” Moore J referenced that directors’ duties under ss 135 and 136 aim to protect shareholders and creditors from the directors taking big risks. These sections are intended to discourage directors from increasing their company indebtedness. Moore J also referenced that s 135 should only penalise illegitimate risk-taking. It was decided that there was no breach of s 135 before April 2014, and therefore this section failed.
Under s 136 it has to be established that when obligations were entered into a director of a company did not believe a company would be able to perform these obligations. Or that if there was a belief, it was an unreasonable one. Moore J also decided this section would fail as the defendants subjectively believed on reasonable grounds that Mako would be able to meet its obligation to Mr Banks as those obligations were due.
Section 137 relates to a duty of care. Moore J considered that by mid-2014, the Directors of Mako should have been aware of its looming cash flow issues. He considered that without a multi-million dollar contract coming into play, the company would not be able to meet its obligations. As such “at that point, a reasonable director, exercising due care, diligence, and skill, would have caused Mako to cease trading and go into liquidation” and it was concluded that a breach of s 137 was found.
Section 301 as a remedy for creditors
As s 137 was found to have been breached by the Directors, Moore J considered whether s 301(1)(c) could be used as a remedy with Mako no longer being at liquidation at the time of the trial.
Moore J held that s 301(1)(c) was unavailable as a remedy to Mr Banks as Mako was no longer in liquidation. At the time the proceedings were initiated, Mako was in liquidation, however, before the trial had begun, Mako was removed from the register. Moore J referred to the practical issues regarding the varying lengths of trials and securing a court date after an application has been filed. However, the law is clear, and the company must be in liquidation, otherwise, there will be no directors of a company to be held liable. It was noted that Mr Banks could have made an application under s 239 of the Act to restore Mako as a company. Yet, no applications were made.
The second consideration under this section was whether creditors could be personally compensated for a breach of directors’ duties. Moore J concluded that directors’ duties are owed to the company, not to specific creditors. As such, only a company is entitled to receive a remedy for a breach of directors’ duties. Moore J reviewed two conflicting decisions of the High Court on this issue. In Mitchell v Hesketh [1998] 8 NZLC 261,559 (HC), Master Venning was of the view there is a limit on the approach for creditors to obtain personal compensation. Where the claim was for “negligence, default, or breach of duty or trust about the company, the Court may only award relief by ordering that the director pay compensation to the company under s 301(1)(b)(ii).”
In the alternative decision, in Marshall Futures Ltd (in Liq) v Marshall [1992] 1 NZLR 316 (HC), Tipping J was of the view s 301(1)(c) permits creditors to be personally compensated in limited circumstances. Tipping considered whether “moneys which are the subject of the declaration of personal responsibility are payable to the company…for the benefit of the creditors of the company as a whole or whether they are payable directly to the creditor.” His conclusion was that monies would be payable if the claim was payable to the creditor directly, without needing the liquidator to be involved. However, this authority was not helpful to Mr Banks, as the liquidator would have had to be notified of the claim, which did not occur.
Conclusion of Moore J – what it means for creditors
In the decision Moore J decided in favour of the defendants, holding that Mr Banks was unable to recover directly under s 301(1)(c). Section 301(1)(c) allows the Court to order directors to pay or transfer money or property directly to applicant creditors. However, a relief under this section can only be ordered where a director has misappropriated specific funds or property. This was not the case in this case so there could be no relief ordered to Mr Banks. In this case, the directors were found in breach of directors’ duties, but not misappropriation.
Section 301(1)(b) allows for relief where there has been a breach of director duties (as was the case here), however, this section provides for such relief to be paid to the company (as opposed to directly to the creditor) and then liquidators could make distributions to creditors. Section 301(1)(b) allows for the pool of assets in a liquidation to increase as the Court can order a person to repay or restore money or property with interest, or to contribute a sum to the assets of the company by way of compensation. However, at the time of the trial, Mako was no longer in liquidation and had been struck off the companies register. As such, Mr Banks was not able to utilise s 301 as a creditor as there was no company in existence that could receive the payment.
This decision highlights the importance of having security over your investments in a company. In this case, Mr Banks was left without any proper avenue for recourse under s 301.
