Use of Company Name — s 25 of the Companies Act 1993
Under s 25(1) of the Companies Act 1993 (the Act), a company’s registered name must be clearly stated in every written communication sent by or on behalf of the company. The company’s name must also be clearly stated in every document issued or signed by or on behalf of the company that evidences or creates a legal obligation of the company.
Failure to comply with s 25(1) can result in a maximum fine of $5,000 for the company and every director of the company (see ss 25(5), 373(1) and 374(1) of the Act).
Further, where a document that evidences or creates a legal obligation of a company is issued or signed, and the name of the company is incorrectly stated in the document, every person who issued or signed the document may be liable to the same extent as the company if the company fails to discharge the obligation. However, there are two exceptions.
First exception — s 25(2)(c)
If the person who issued or signed the document can prove that the person in whose favour the obligation was incurred was aware at the time the document was issued or signed that the obligation was incurred by the company, then that person may avoid personal liability.
The Employment Relations Authority in Oldridge v Mukund and Priyanka Enterprises Ltd [2016] NZERA Auckland 333 found that, despite the omission of the word “Limited” in describing a company as the employer under an employment agreement, the company was liable under the agreement as all parties confirmed that the company was the employer under the agreement.
Second exception — s 25(2)(d)
If the court is satisfied that it would not be just and equitable for the person who issued or signed the document to be liable, the Court may relief the personal liability.
Section 25(2)(d) applies to where the company’s name has been included in a document but has been technically misstated. The High Court in Southland Building Society v Austin [2012] NZHC 497 observed that if s 25 had applied, it “would not regard the omission of the word ‘Limited’ as misleading in the circumstances”.
Section 25(2)(d) may also apply where it may be unfair to require a director who signed to incur the obligation owed by the company if the document was prepared by another director.
The exception may even apply where the wrong company is named in a document. In Clarence Holdings Ltd v Hall (2001) 9 NZCLC 262, 566 (CA), the directors of a new company entered into a fresh lease agreement with the lessor using the name of the original company rather than that of the new one. This gave rise to a legal dispute when the directors of the new company decided it should vacate the premises. The Court of Appeal noted that the policy of the section was to make a person who signed a document that misdescribed the name of a company personally liable concurrently with the company. However, the exception in s 25(2)(d) applied because no disadvantage had been caused to the appellant.
In contrast, in Ede t/a Electro Sheetmetals Ltd v J A Russell Ltd (2001) 9 NZCLC 262, 539, the director misstated the name of the trading company in a credit application form. He signed the document to create a legal obligation for Electro Sheetmetals and failed to make clear that Stephen Ede Limited (trading as Electro Sheetmetals Ltd) was responsible. The High Court held that the director was personally responsible for the debts of the company under s 25.
The High Court in Rebnik Properties Ltd v Dobbs [2020] NZHC 3494 also held that a person using a trading name could be personally liable if they did not disclose that they were representing a company at the time of contracting.
Importance of updating company address details on the Companies Register
It is important to keep the company’s address details on the Companies Register updated at all times. Yet, we often come across situations where this does not happen, and what seems like a small omission may lead to serious consequences. For example, important legal documents can be missed, and consequently, judgment can be entered into against the company without the company’s knowledge. Further, there can be personal consequences for company directors under the Companies Act 1993 (“the Act”) if the registered address is unmanaged.
Requirement under the Act
A company must always have:
A physical registered office in New Zealand. This is the address where the company’s records (described under s 189 of the Act) are stored.
A physical address for service in New Zealand, which can be the same as the registered office or another place. This is the address where legal documents are served.
The registered office and address for service of a company at any particular time are the places that are described as those on the Companies Register at that time. This information is publicly available on the Companies Register website.
Subject to the company’s constitution, the Board of the Company can change the registered office or addresses for service at any time. If the registered office or address for service change, then notice of that change (in the prescribed form) must be given to the Registrar of Companies. Otherwise, the registered office or address for service will remain in the previous place specified on the Companies Register.
Also, s 188 of the Act allows the Registrar of Companies to require a company to change its registered office by notice in writing. In such a case, a company will have two options: change its registered office by the date stated in the notice; or appeal to the Court. Failure to comply with s 188 is an offense and renders every director of the company liable on conviction to a fine not exceeding $5,000.
If the company’s records are moved to a location other than the registered office, a notice of this must be given to the Registrar of Companies within 10 working days. If the company fails to comply with this requirement, the company and every director personally commit an offense and are liable on conviction to a penalty not exceeding $10,000.
Risks of not updating address details
Section 387 of the Act prescribes how documents in legal proceedings are to be served on New Zealand registered companies. There are several options to serve, however, service by leaving the documents at the company’s registered office or address for service are the most commonly used options. If the office is closed, the documents in question can simply be affixed to the front door.
As a result, if the company’s office or address for service is not updated, the company may risk missing essential legal documents, notices, and deadlines and be subjected to a judgment entered against them or, worse, liquidation proceedings. In our experience, unfortunately, this is common. While in certain circumstances it could be possible to reverse judgment or order that was entered into without the company knowing it, this process is expensive and procedurally complicated as an application to Court would be required.
If any of the addresses are in a building with other businesses, it is equally important to provide full details of the address, such as the level of the building, office number, and/or name. If no details are provided, the service of documents could be conducted anywhere in the building. This could again result in the essential documents being unnoticed by the company.
If the company suffers a detriment as a result of the addresses not being properly maintained on the Companies Register, the director could be personally liable for breach of his director duties.
It is also important to ensure that the address that is stated as the company’s office or the address for service is checked regularly. Some documents, such as statutory demands, when served, have a very strict and short timeframe for compliance, or making an application to set it aside. If that time lapses, the consequences could be serious as there is a risk that the company will be liquidated. If the address is not checked regularly (for example, staff usually work offsite), it is recommended that the registered office and/or address for service are at another location, such as the accountant’s or solicitor’s office.
Our expert receivership lawyers assist clients to navigate this process throughout New Zealand. There are many pitfalls if implemented incorrectly.
Please refer to our People for more information on who we are, our experience, and how we can help you.
This article deals with the seminal Court of Appeal decision (CoA Decision) released on 31 March 2021 in the proceedings commenced by the liquidators of Mainzeal Property and Construction Ltd (in Liq) (Mainzeal) against its directors for breach of director duties.
We have previously published an article regarding the High Court decision (HC Decision), which can be found here.
We have also released a comprehensive video outlining the rise and fall of Mainzeal which can be found here.
For the sake of brevity, this article will not discuss the distressed history of Mainzeal, but rather, will focus on the CoA Decision and its implications on directors of insolvent or near insolvent companies. This article is not a full discussion of the 178-page decision, rather, it is aimed to provide a brief summary. If you would like to read more about the history and context, the HC Decision and the video referred to above provide excellent context.
Importantly, when Mainzeal failed, it owed $110m to unsecured creditors.
Companies Act 1993 (Act)
The relevant director duties under the Act which were subject to the HC Decision and the CoA Decision are:
Section 135: Reckless trading
A director of a company must not—
(a) agree to the business of the company being carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors; or
(b) cause or allow the business of the company to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors.
Section 136: Duty in relation to obligations
A director of a company must not agree to the company incurring an obligation unless the director believes at that time on reasonable grounds that the company will be able to perform the obligation when it is required to do so.
HC Decision
Section 135
To give context to the CoA Decision, the conclusions of the High Court in determining that the directors of Mainzeal were in breach of s 135 are:
Mainzeal was balance sheet insolvent while trading, as the intercompany loan was not recoverable. The directors should have seen the warning signs and should not have classified it as an asset on their balance sheet.
The assurances provided by Mr Yan could not be reasonably relied upon by the directors. Further, they were contingent on Mainzeal’s continued operation.
Mainzeal’s usage of creditor funds as their working capital combined with the fact that its financial trading performance was poor and prone to significant one-off losses meant that the risk of creditors losing out was high.
The directors failed to seek independent legal advice regarding their obligations. This would have alerted them to the fact that the assurances provided by Mr Yan were not legally enforceable.
As a result, the directors were found to be in breach of their obligations under s 135. Consequently, they were ordered to pay $36m in compensation, with three of the directors liable for a maximum $6m each and the fourth director, Mr Yan, liable for a maximum of the full amount.
Section 136
The High Court held that the directors of Mainzeal did not breach s 136, as s 136 required “a focus on particular obligations under specific construction contracts that Mainzeal was entering into”. The specific transactions or obligations entered into were not identified in the pleadings.
The High Court further held that, even if the specific transactions were plead, the High Court would have still rejected the s 136 claim, stating that:
There would be no reason to conclude that the directors either did not believe that those obligations would be fulfilled, or that the reasons for believing they would be fulfilled were unreasonable. It would not have been apparent to the directors that Mainzeal’s failure would occur, or would likely occur immediately, or within a particular period of time, at least until very near to the point when Mainzeal failed.
In the High Court’s view, this “seems to be critical to establish liability under s 136 in these circumstances”.
CoA Decision
The issues on appeal in the context of insolvency and directors’ duties can be summarised as:
Did the directors breach s 135 of the Act?
Did the directors breach s 136 of the Act?
If the directors breached s 135, on what basis should compensation be assessed whilst also considering s 301 of the Act?
Section 135
The Court of Appeal agreed with the HC Decision’s findings of fact and also agreed with the finding that the directors breached s 135.
The Court, however, found that the s 135 breach did not result in any recoverable losses. The arguments that the liquidators put forward, being the ‘entire deficiency’, ‘net deficiency’ and ‘new debt’ approaches were in Court’s view inappropriate under s 135 and in the current scenario. In particular:
As the breaches of s 135 did not cause the company to become insolvent, the ‘entire deficiency’ approach was not relevant.
As the liquidators could not satisfy the Court that there had in fact been a ‘net deficiency’ between the date of the breaches of s 135 and the eventual liquidation, the ‘net deficiency’ approach could not be used. In particular, on a net basis, Mainzeal had fewer debts at the time of liquidation, then when the directors’ breaches of their duties started.
The Court also provided a definitive ruling that the ‘new debt’ approach cannot be used in assessing the quantum of damages for a s 135 breach. This is because the duties of a director under s 135 are owed to the company, rather than individual creditors. To allow a ‘new debt’ approach would necessarily involve a calculation of losses to individual creditors, rather than to the Company itself. In essence, it would allow for older creditors to achieve a windfall, and newer, unpaid creditors would receive a shortfall. This is because distributions would have to be made on a pari passu
Section 136
The Court of Appeal overturned the High Court’s decision regarding s 136.
The Court held that claims for s 136 did not have to be specifically plead, as they do not have to relate to discrete defined acts. Rather, they apply to all obligations entered into by the company.
The Court then held that it would take the narrow interpretation, whether, as a matter of fact, there were reasonable grounds for believing that obligations would be performed when due. If there are reasonable grounds, then there would be no breach of s 136. This is to be determined objectively. It did not matter that the directors of Mainzeal believed that obligations would be performed when due; the Court held that a reasonable director would not have believed that there were reasonable grounds for the performance of obligations.
The Court found that the creditors who dealt with Mainzeal were exposed to an abnormal level of risk, which the Court stated was the precise harm that s 136 was designed to prevent.
Accordingly, the Court held that the ‘new debts’ approach is appropriate for claims under s 136.
This is because any new obligations undertaken by the directors when there is no reasonable belief that these obligations can be performed when due are likely to be ‘new debts’.
If new debts cannot be accounted for under s 136, there is no logical link behind the wording of the provision and potential claims for losses.
The Court of Appeal has subsequently reverted the case back to High Court to determine the appropriate quantum of compensation under s 136.
We are yet to receive a Decision on this.
But we expect this amount to be significantly higher than $36m that was previously ordered. Based on the approach adopted by the Court of Appeal, our view is that the High Court ought to order that the directors pay $64m – $75m in compensation. However, this amount may be adjusted through the process of the Court exercising discretion available under s 301.
Implications in the Insolvency Context
There are three potential starting points in quantifying claims against directors who are trading companies insolvently or potentially near insolvently:
Net Deficiency: This is usually the starting point in most cases for breaches of s 135 and is calculated by taking the financial position of the company at the date that it should have stopped trading, and the date of liquidation. The difference is then considered a net deficiency (if negative) and becomes a starting point in quantifying the director’s liability.
Entire deficiency (or whole debt): This is generally used when a single or multiple discrete quantifiable breaches of s 135 are the cause of the insolvent liquidation, and but for these breaches, the company would otherwise be solvent. The whole debt(s) of the company are treated as a deficiency and become a starting point in quantifying the director’s liability.
New debt: This is unavailable for breaches of s 135, however, this will likely be the new starting point for breaches of s 136. All new debts incurred after the start of the breach of director’s duties are added and this amount then becomes a starting point in quantifying the director’s liability.
For directors, this means that there will be additional risks when dealing with insolvent or nearly insolvent companies. The new debt approach for breaches of s 136 presents a big hurdle for any attempts to trade out of insolvency, as the determination of reasonable grounds to believe that an obligation will be able to be performed when due is of an objective standard.
We expect to see more claims against directors who may have honestly believed that they were trying to achieve the best outcome for their creditors by trading out of insolvency but would be liable for new debts if they are ultimately unsuccessful.
Both the HC Decision and the CoA Decision reiterate that the risk to directors who are reckless, or do not fully appreciate their solvency status, is high. Directors need to carefully evaluate a company’s position once it becomes insolvent and to soberly consider the prospect of continuing to trade.
At the time of this article, it is not known whether the decision will be appealed to the Supreme Court. Although, appeals are likely for cases of this magnitude.
If you are in a challenging position as a director, our team of experts can assist and guide you through your company’s insolvency. contact the team at Norling Law at info@norlinglaw.co.nz or you can book a consultation here: https://norlinglaw.co.nz/consultation-brent/
