Just like the mythical bird that rises from the ashes, a phoenix company rises from the ashes of an old, failed company.
It has become commonplace for directors of failed companies to simply burn the old company and set up a new company with a similar name, trading in the same business as if nothing had happened. This is a phoenix company.
Directors typically use a similar name because they see some value to the trading name of the old failed business.
There are strict rules that apply to phoenix companies. There is a general prohibition on directors from being involved in phoenix companies. However, like all good laws, there are exceptions.
Understandably, if a director does this, it can be a source of contention for creditors of the failed company. As far as they are concerned, the director is still trading, using the old company assets and staff and is trading as if nothing happened. Meanwhile, they are owed money for goods or services provided. They naturally get frustrated.
Implementing the restructure of a company into a phoenix is just as much a legal exercise as it is an accounting and public relations one.
Why incorporate a phoenix company?
Phoenix companies are usually created due to the company being in financial difficulty or a dispute with creditors or a claimant.
A new company is formed and, largely, the old company is transferred into the new one (selected staff, assets, business etc). However, the old company’s debts are not.
However, usually directors ensure that ‘key’ suppliers are looked after, as are secured creditors (such as the bank). In fact, a proper restructure will not be possible without obtaining consent of secured creditors, as this is usually a requirement under security documents.
This doesn’t seem fair?
To creditors, it is not fair. In fact, there is a general prohibition on directors of a failed company becoming directors of phoenix companies.
If the assets have been transferred from the old company to the new for less than market value, then there are numerous remedies and recourses for creditors of the old company. These include:
Suing the director or persons acting on the director’s instructions; for
Breach of director’s duties; or
Fraud.
Actions recovering unlawful distributions.
Transactions at an undervalue, as set out in s 297 of the Companies Act.
There is no duty on owners of a company to keep a business running. The common law position is also that directors cannot be prevented from working for a company in the same line of business as the company for which they formerly worked. The starting point is that a director of a failed company is prohibited from:
Being the director of the phoenix company;
Taking part directly or indirectly in promotion, formation or management of the phoenix company; and
Being directly or indirectly be concerned in or take part in the carrying on of the business of a phoenix company.
As mentioned above, assets themselves can be transferred for market value. This should be done using the method which generates the most value, but only once this transfer has been approved by the shareholders (see s 129 of the Companies Act 1993).
Directors need to ensure that in any transfer they comply with the many duties of directors, for example, use of company information and rules around self-interested transactions.
How to become a director of the phoenix company
There are three statutory exceptions in the Companies Act which allow directors to become directors of the new phoenix company, despite having been a director of the previous company. They include the exception for a person named in a successor company notice, exception for a temporary period while application for exemption is made and exception in relation to non-dormant phoenix company known by pre-liquidation name of failed company for at least 12 months before liquidation.
The first statutory exception can happen in a situation where the phoenix company has bought the old business from the failed company’s liquidator or receiver, and the director has notified all creditors in a way that complies with the statutory requirements, via a successor company notice.
The second exception is only a temporary solution and lasts for up to 6 weeks after the commencement of the liquidation.
The third exception is applicable if the phoenix company has been trading for at least 12 months before the failed company’s liquidation, with the same or a similar name.
Risks to directors who participate in a phoenix company
There is the potential for directors to be accused of fraud if they allow the failed company to enter into contracts knowing that the company is about to stop trading and that the contracts being entered will not be performed. Directors also need to be mindful of voidable preference claims. The risk here is that transactions can be set aside under some circumstances, if a payment from the company has preferred one creditor over another and the creditor has received more than they would have under the liquidation.
If a director breaches the phoenix company rules, they can be liable upon conviction for up to 5 years’ imprisonment or a fine of up to $200,000, banishment from acting as the director of any company or being personally liable for the debts of the phoenix company.
Phoenix companies are often used because they maintain a connection with the previous company. There are however, risks that directors need to be aware of before engaging in this process.
No director of a failed company ought to contemplate a phoenix restructure without first obtaining expert legal (and accounting) advice.
More information
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It is well reported that New Zealanders are keen establishers of trusts. Thanks to trusts, property owners are able to create comfort that if they ever fail, they will be able to retain the benefit of their property.
A trust is not a separate legal entity, as such the trustees are generally personally liable. That is unless they limit their liability, however, this is usually reserved for “independent” trustees.
As a result, it has become popular to appoint companies as trustees. This way the individuals who are the governing mind of the trust are able to place another layer of protection to their personal liability.
Corporate trustees also provide certain practical efficiencies. For example, when the individual behind the trustee changes, the appointer can simply change the director of the company; there is no need to convey the property to a new trustee and as such, legal fees are lower.
However, as with individuals, there could be significant consequences if the corporate trustee incurs debts and does not pay them. Some believe that by replacing an insolvent corporate trustee with another entity, and transferring all trust assets to that entity, it ensures that the assets are safe from the creditors. Such belief is “usually” wrong, as the Companies Act 1993 applies to corporate trustees in the same way it applies to any other company, meaning that the corporate trustee can be placed into liquidation and then the liquidator is able to investigate potential methods of recovery.
Liquidators who get involved with liquidations of corporate trustees get themselves into an area that is governed not only by the insolvency law, but also by the trust law. This imposes additional duties on the liquidators and creates issues that are not straight forward.
Appointment of liquidator
If a corporate trustee is placed into liquidation, and that trustee still holds its office as a trustee, the liquidator essentially assumes duties to take control and administer the trust assets until a new trustee is appointed. As a result, it is important that the liquidator consenting to the appointment of a corporate trustee is familiar with the duties owed by trustees in equity and under the Trustee Act 1956. Also, it is important that upon appointment the liquidator reviews the trust deed as it might impose additional duties that the liquidator should be aware of.
Payment of debts
A commonly held belief is that the assets of the trust are not assets of the company, and therefore they are not available to pay creditors. However, this is not always the case.
By virtue of s 38 of the Trustee Act 1956, a corporate trustee, as any individual trustee, is entitled to be indemnified from the trust property for debts that are properly incurred in the course of administering the trust (“the trust debts”). It is questionable and has not been determined in New Zealand whether the right to indemnity can be limited or removed by a trust deed. However, in our view, it is relatively arguable that it cannot.
The trustee’s right of indemnity gives rise to an equitable charge over the trust assets. Such charge entitles the trustee to keep the assets until it has indemnified itself. As a result, where a corporate trustee, which has not been replaced yet, is placed into liquidation, the liquidator has a right to retain the trust assets and seek indemnity to repay the trust debts.
In cases of corporate trustees which existed solely to administer the trust, most, if not all, debts would be the trust debts and could be repaid by the liquidator by pursuing the trust assets.
Further, it is well established that the trustee’s equitable charge can survive replacement by a new trustee. As a result, if the retired corporate trustee is replaced as trustee and does not hold trust assets any more, the liquidator has a right to request payment from the new trustee, and where there is no cooperation, commence proceedings seeking a sale order and payment from the trust assets.
Similar orders have recently been sought and obtained by the liquidators in Ranolf Company Limited (in Liq) v Bhana [2017] NZHC 1183. Ranolf Company Limited (in Liq) (“Ranolf”) was a corporate trustee of a family trust and incurred trust debts. When Ranolf was placed into liquidation, certain members of the family attempted to hinder the trust assets by removing Ranolf from its position as trustee and failing to indemnify Ranolf from the trust assets. Consequently, the Court made orders charging land owned by the trust with payment of Ranolf’s trust debts and a sales order.
Further, the replacing trustee is under an obligation not to treat the assets in any manner which would compromise the original trustee’s lien. As such, if the corporate trustee in liquidation has been removed as a trustee (either prior or post liquidation), and the replacing trustee has done something that would compromise the original’s trustee’s lien (for example, disposed of the assets or distributed all assets to the beneficiaries), the liquidator could pursue the replacing trustee for breach of constructive trust. If the replacing trustee is a shell (which would usually be the case), tracing of the assets could also be available. However, obviously, at this stage litigation and recovery of the assets would be costly.
The Court is very unlikely to allow trust assets to be used to satisfy claims by creditors of the corporate trustee in circumstances where the debts were not incurred for the trust.
Where the trust property is insufficient to meet a trustee’s right of indemnity, the liquidator could also pursue the beneficiaries of the trust. However, this would be possible only in very limited circumstances where the trust structure satisfies certain pre-requisites.
Payment of liquidators’ fees
In addition to the payment of trust debts, the trust assets can be used to pay for costs, expenses and remuneration of the liquidators. This can be ordered either pursuant to s 38(2) of the Trustee Act 1956, which establishes the trustee’s right to remuneration out of trust assets, or the inherent jurisdiction of the Court.
However, the Courts allow recovery of the costs and expenses related to administration of the trust only. Generally, the costs of liquidation which are not related to the administration of the trust, will not be recoverable. Although, where a corporate trustee operated for the sole purpose of being a trustee, the general expenses of liquidation will be usually recoverable on the basis that they are related to the administration of the trust.
In Ranolf Company Limited (in Liq) v Bhana [2017] NZHC 1183, the liquidators have also successfully obtained orders charging the trust’s land with the payment of their reasonable fees and disbursements. Because of continuous attempts by certain family members to hinder the assets and prejudice the proceedings, the liquidators’ fees and disbursements were substantial. This case serves as an example of where the attempts to hinder assets from the creditors went wrong. Had the trust cooperated with the liquidators from the outset, the financial burden borne by the trust would have been significantly lower.
Distributions to beneficiaries
The liquidator may also set aside all distributions to beneficiaries made by the corporate trustee within 2 years of liquidation if, at the time of distributions, the corporate trustee was unable to pay its debts. This is pursuant to the voidable transaction regime in the Companies Act 1993. While beneficiaries could raise a statutory defence to voidable transactions under s 296(3) of the Companies Act 1993, usually these defences would be unsuccessful due to the fact that the beneficiaries usually provide no ‘value’ in return for the distributions. Further, the beneficiaries may have inside knowledge which means that the have knowledge of the financial position of the trust.
If the trust made distributions to beneficiaries with intend to prejudice creditors, or without receiving equivalent value in exchange, these distributions can also be set side within 6 years of the distributions being made under ss 334 – 450 of the Property Law Act 2007.
Duties of directors of corporate trustee
Directors of corporate trustees owe the same duties that are owed by directors generally in common law and under the Companies Act 1993.
In order to comply with their obligations, a director of a corporate trustee needs to be aware of the availability and value of the right of indemnity owned by the trustee.
Failure to know about the availability of indemnity and/or failure to pursue it, could potentially result in the breach of duty to act in the best interests of the company and/or being negligent. Similarly, if the value of the trust assets is insufficient to meet the liabilities incurred by the corporate trustee, arguably the director may be liable for reckless trading under the Companies Act 1993.
Further, a director of a retiring trustee, which causes the company to transfer the trust assets to the new trustee without satisfying the company’s indemnity rights, could also be in breach of a number of duties under the Companies Act 1993.
On liquidation, a director who breached his duties, could be pursued by the liquidator and held personally liable for all losses of the company (creditors and liquidator fees and disbursements).
What does come as a surprise to many is that this can still be the case for “independent” trustees as the Companies Act 1993 draws no distinction between directors. One is either a director or they are not. There was either a breach of duty, or there was not. However, the ‘independence’ may be relevant when it comes to the Court’s discretion in quantifying any liability. Although, there are currently no cases in New Zealand on this particular point.
Conclusion
Some liquidators still find liquidations of corporate trustees challenging and the pursuit of claims often requires specialist legal assistance. . Usually, only those liquidators who are either able to be self-funded or have a funder in place can pursue such claims.
As a result, those transferring trust assets from the insolvent corporate trustee to the new entity ‘sometimes’ succeed in removing trust assets from the creditors. However, with the growing number of corporate trustees going into liquidation, and the law becoming more settled in this area, it is expected that liquidation of corporate trustees will over time become more straightforward.
This artcile was also published in the March 2018 edition of Law Talk.
Despite what the name suggests, hiving-down has nothing to do with bees or itchy skin.
A “hive-down” involves transferring the most valuable parts of a business (that is usually insolvent) to a wholly owned subsidiary and then selling off the subsidiary.
This is a tried and tested technique in corporate rescues and has been used routinely in New Zealand.
The purpose of a hive-down is to preserve the value of a failing company by transferring the valuable parts of the business (the queen bee and the honey) to a subsidiary. The shares in the subsidiary or the assets are then sold off to a third party.
Crucially, as a company and its business are separate, debts of the company won’t be transferred to the new subsidiary.
The process is usually triggered by receivers and security holders, who have full cooperation of company directors.
Why hive-down?
Hiving-down is most commonly undertaken by a company facing insolvency (for example, liquidation or receivership). Usually a hive-down situation is done to protect a good business or assets which have suffered through poor management. This process will deprive poor managers with good assets.
Hiving-down can enable a separation of profitable business from others which are struggling or are risky. This can be an effective ring-fencing strategy to remove important assets (Intellectual property, real estate) from operational risks.
By this restructure, the value of the key assets can be largely retained, or at least, not completely lost in a liquidation.
When should a company hive-down?
A hive-down is legal. However, careful consideration should be given to the circumstances before it is done.
Some of the considerations that should be taken into account when considering whether or not to undertake a hive-down include:
What benefits could be derived if the viability of the profitable parts of the business was sufficiently demonstrated;
Taxation implications;
The practical legal difficulties such as those concerning assignment of leases or licences, or supply and manufacturing agreements;
Issues relating to restructuring and employees, including those specified under the Employment Relations Act 2000;
Issues surrounding voidable payments; and
Practical difficulties involved with hiving-down (discussed below).
Potential issues:
Robust accounting and legal advice is critical in any hive-down. A robust due diligence process is needed.
There is a risk that a hiving-down restructure could trigger a “change of control” which may result in terminating rights in the operating company’s banking or trading agreements. It is advisable, therefore, to undertake comprehensive due diligence prior to hiving-down.
Hiving-down is a time-consuming process and in reality, it may be more prudent for a receiver to trade the business through the company that is in receivership. Alternatively, the receiver could arrange an auctioneer to sell off the chattels and assets at auction.
Further, if a receiver has been appointed, they may continue trading the business pending its sale. The difficulties, on a practical level, that this causes with suppliers, customers and the like, could be more effort than it is worth.
Keeping all this in mind, it must be determined as accurately as possible prior to the commencement of a hive-down whether the process will be worthwhile on a broad analysis. Transaction costs as described above, should be measured against the potential net return when contrasted with the option of continuing to trade the business “in receivership”, versus a straightforward sale of company assets.
How to hive-down
The first step is to incorporate a new subsidiary company (the Hivee). The shareholders in this subsidiary will be the parent company (the Hivor). In most cases, the receiver will be appointed as director of this new subsidiary. It is interesting to note that the receiver, has no liability under the Receiverships Act 1993 for operating a company in this manner, as they are acting as director and not a receiver for the subsidiary company.
The next step is to decide which assets the parent company should transfer to its subsidiary. In most cases these will be the most profitable parts of the business (chattels for example machinery). There can be numerous tax implications involved with the transfer of assets and robust accounting advice is required. At this stage in the hive-down , the shareholders of the Hivor hold only an indirect interest in the Hivee though the Hivor. This interest will, however, be lost if the Hivor itself is liquidated prior to the sale of the Hivee to a third party.
Naturally, the receiver wants to sell the Hivee for the best possible price. This would usually involve the procurement of an independent valuation of the Hivee and selling the Hivee on the open market (after a fair and robust marketing campaign).
Dealing with employees can also be challenging. They could be a large asset. Conversely, the can also be part of the original problem.
Other “hiving” options
It is possible, although less common, to “hive-up” or “hive-across”. One of the benefits of this is that the Hivee will not be owned through the Hivor as is the case with hiving down. This means, should the Hivor fail, the owners of the Hivor still own the Hivee with all the key assets.
More information
Hiving-down is a complicated process and not always appropriate to use.
If a liquidator is appointed, the liquidator may elect to pursue the director. This will likely include claiming:
All losses of the company (creditors);
Liquidation costs (i.e. cost of administering the liquidation);
Legal costs
We have been involved in pursuing many directors for breaching their duties. We have also assisted directors who have had allegations of breaches made against them. We can see this debate from both sides of the table.
While there has been a mixed reaction, many directors have been found liable to cover the costs of the liquidator.
The Court of Appeal has sent a firm message to liquidators.
The outcome is that the historical approach may not be viable going forward.
Mr and Mrs Shaw
Mr and Mrs Shaw are trustees of their family trust.
Their trust owned a farming enterprise and later a glazier and manufacturer of aluminium joinery.
One of its supplies refused to supply materials to a trust, rather it required supply to a corporate entity.
Consequentially, the Shaw’s incorporated Aluminium Plus for this purpose. The Shaw’s were the sole directors.
Aluminium Plus was a conduit for the Trust. It didn’t have a bank account. It simply passed supplied from the supplier to the Trust. The Trust paid the suppliers invoices directly.
However, the Shaw’s later took the view that supplies were defective and caused both entities not to pay.
The supplier later obtained judgment by default against Aluminium Plus (not defended).
Aluminium Plus was later liquidated by the High Court.
The Liquidators’ Claim
The liquidators issued a proceeding in the High Court. Justice Brown upheld the liquidators’ claims that the Shaw’s were guilty of reckless trading and negligence in breach of their duties.
The Shaws’ recklessness arose from their election to release the Trust from its obligation to pay its suppliers on Aluminium Plus’ behalf for supplies of materials. This decision exposed the supplier to the risk of loss because Aluminium Plus had no income or assets to pay the invoices then outstanding. The Shaws’ negligence lay in releasing the Trust from its agreed role as funder of Aluminium Plus’ purchases in circumstances where there was no other source of funding and the prospect of an offsetting counterclaim was speculative.
Brown J ordered the Shaws to pay compensation of $125,884.59, comprising Aluminium Plus’ debts of $99,005.03 plus the costs and disbursements of the liquidation of $26,879.56.
The Court of Appeal Decision on Breach of Duty
The Shaws challenged the decision of Brown J. They say they were not reckless.
The Court of Appeal agreed with Brown J. The nature of Aluminium Plus was that it had no assets or income to meet its liabilities other than from recourse to matching payments made by the Trust. Its solvency was entirely dependent upon the Trust’s financial support. The nature of the directors’ decision was to release the Trust from its contractual obligation to indemnify Aluminium Plus against all liabilities. Insolvency was its inevitable and immediate consequence, leaving the creditors’ interests without protection.
The Court of Appeal was satisfied that the Shaws’ decision to release the Trust for Aluminium Plus’ liability, at a time when it was otherwise indebted to its supplier, was in breach of their duty to exercise the care, diligence and skill expected of a reasonable director in those circumstances given that its inevitable and immediate consequence was to render Aluminium Plus insolvent.
The Court of Appeal Decision on Compensation
However, the Court of Appeal held that Brown J erred in allowing all the liquidators’ costs of $26,879.56 within the compensation award.
It was held that:
Section 301 provides, among other things, that if a director has been guilty of negligence the court may order the director to contribute such sum to the assets of the company by way of compensation as the court thinks just in the light of the director’s conduct. As the Judge correctly observed, the s 301 power is guided by the standard approach outlined by this Court in Mason v Lewis: by looking first to the deterioration in the company’s financial position between the date the inadequate corporate governance became evident and the date of liquidation, and then exercising judicial discretion by reference to the three factors of causation, culpability and the duration of the trading.
The Court considered that a compensation award should reflect the financial measure of the director’s contribution to the loss suffered by a company as a result of the acts or omissions underpinning his or her relevant breach of duty. However, the question of whether compensation should include the liquidators’ costs in undertaking the liquidation is less straightforward. The costs of administering a liquidation will generally be incurred regardless of whether the company’s directors are liable.
This was not an orthodox company liquidation or liquidator’s claim. The Supplier was Aluminium Plus’ only significant creditor when it was wound up. The other two creditors were for relatively minor amounts. The Court of Appeal held:
It would have been immediately plain to the liquidators that the company’s indebtedness was very modest; and that it had no assets available to meet creditors’ claims except for a contingent right of action against the Shaws.
Nevertheless, Ms Louise Craig, an employee of the liquidators, deposed at trial that the liquidators’ costs amounted to $38,404. However, unusually, the liquidators sought to recover costs of $43,187. Later at Brown J’s direction they amended their claim. They reduced it to $26,879 for costs which they say were not attributable to the litigation against the Shaws.
The Court of Appeal held that it was not easy to follow how non-litigation costs of $26,879 could justifiably be incurred in a liquidation relating to a very modest level of indebtedness.
Ultimately, The Court of Appeal held that the Liquidators were entitled to follow the course pursued. But they cannot expect to recover more than the usual award of legal costs and disbursements if successful. The purpose of an award of compensation is to recoup or indemnify the company for its losses attributable to a director’s breaches. While it may be appropriate to incorporate an allowance for the liquidator’s costs where they are necessarily incurred because of the relevant breach, care is required to ensure that the award is truly proportionate to the company’s actual loss.
The Court of Appeal held:
It is telling that the final award in the High Court — inflated by credit consultant’s and liquidation costs — more than doubled the suppliers actual debt. On any cost-benefit analysis, pursuit of this litigation was not a commercially rational exercise.
Ultimately the Court of Appeal removed the costs of the liquidation as compensation awarded to the Liquidators.
Our Comments
It has become a common practice in New Zealand for Liquidators to seek delinquent directors to pay liquidation costs.
Some well-respected commentators criticise this practice and would suggest that this should never occur.
We somewhat disagree.
On a practical level, many delinquent directors substantially increase the costs of the liquidation by the way in which they engage (or not engage) with the Liquidators. For example, they hide assets. They hide information and documents. They frustrate the process by being untruthful. The level of behaviour and the impact on liquidators and their resources cannot be underestimated. These directors ought to pay these increased costs of liquidation. The creditors ought not bear that cost out of any recovery (ultimately creditors would receive less).
However, for other directors, who have not engaged in this delinquent behaviour, like the Shaw’s, the Court ought to be slow to burden them with these additional costs. The purpose and scheme of the Act does not justify such an approach.
This is the third and last issue in our series of articles on enforcement of judgments. These series discuss different methods of enforcing judgments in Court and outline best ways to get paid depending on the debtor’s financial position.
In this issue, we discuss applications for bankruptcy and liquidation. For completeness, we also discuss an option of selling the judgment debt. All these options are generally considered as options of last resort and usually recommended where other enforcement options are not available, or have already been exercised and have not resulted in the repayment of judgment debt in full.
Bankruptcy
If the judgment debtor is an individual, and the judgment debt is over $1,000.00, the judgment creditor may apply for the individual to be adjudicated bankrupt.
Before an application can be made, the judgment debtor must commit an act of bankruptcy within 3 months of the application. The most common example of an act of bankruptcy is where a bankruptcy notice requiring payment is served on the judgment debtor, and the judgment debtor fails to make payment or apply for the setting aside of the notice within 10 working days.
Once the person is an adjudicated bankrupt, the Official Assignee will take control of the person’s income and assets and will exercise that control for the full duration of bankruptcy. The Official Assignee will represent the interests of all creditors and will attempt to realise funds for distribution to the creditors.
Bankruptcy usually lasts for 3 years. During that period, the bankrupt usually cannot manage a business, travel overseas or be employed by relatives without the consent of an Official Assignee.
Our bankruptcy series has much more information from our bankruptcy lawyers.
Liquidation
If the judgment debtor is a company, and the judgment debt is over $1,000.00, the judgment creditor may apply for the company to be placed into liquidation.
Usually, the judgment debtor would first be required to serve a statutory demand on the company pursuant to s 289 of the Companies Act 1993. The company would then have 10 working days to apply for the statutory demand to be set aside, and 15 working days to pay the debt. If no payment or application to set aside is made, the judgment creditor can apply for liquidation.
Once the company is in liquidation, the liquidator will take total control of the company. The liquidator will represent the interests of all creditors and will realise the company’s assets, and repay the company’s debts in accordance with the Companies Act 1993.
The liquidator will check whether the directors or shareholders owe any money to the company and whether any offences have been committed. If offences have been committed, the liquidator will report them to authorities.
The liquidator will also investigate the activities of the directors and affairs of the company and commence legal proceedings if circumstances warrant so. Proceedings could be commenced to:
Recover payments made by the company to directors and shareholders. These payments could be recovered where certain requirements were not satisfied or a prescribed procedure was not followed at the time the payments were made.
Pursue transactions made by the company at undervalue. The liquidator can claim the difference between what the assets were sold for and what the assets were worth.
Pursue preferential payments made by the company to its creditors. The liquidator can claim a refund of all preferential payments made by the company within 2 years of liquidation if they were related party transactions, or within 6 months of liquidation for transactions with other parties.
Pursue preferential dispositions of property made by the company. The liquidator can seek to reverse, or seek a compensation for, a disposition of the company’s property made during the period starting on the date on which an application was made to court to place the company into liquidation and ending at the time the Court orders appointment of a liquidator.
Pursue directors for breach of their duties. Breaches can include actions like reckless trading, failure to act in the best interests of the company, causing the company to incur debts when the company was unable to repay them, failing to exercise due care, diligence and skills when exercising its powers and performing duties as a director. Breaches may also be in the form of failing to ensure that the company kept accounting and financial records that comply with the Companies Act 1993. If established, directors may be held personally liable for all debts of the company, without exception.
Once the company’s funds are distributed and the liquidation is complete, the company is usually removed from the Companies Office Register.
Find out more information about insolvency and restructuring options for debtors from our insolvency lawyers.
Sale of debt
The process of enforcing judgment debts can be too stressful and costly for a judgment creditor. If the judgment creditor does not want to get involved in this process, the alternative option is to sell your debt to a debt purchaser. Once the debt is sold, the debt purchaser will pursue the debt using their own time and resources.
The sale process is usually structured through one of the following methods:
The judgment debtor can sell the debt for a fixed price that is repayable immediately.
The judgment debtor can assign the debt and be paid once the debt purchaser makes recoveries. Then, the recoveries are split by percentage between the judgment debtor and the debt purchaser.
Usually, selling your debt will result in lower recoveries than enforcing the debt yourself, as the debt purchaser will cut a substantial portion of all recoveries. However, this might be still a preferred option for those who do not want to get involved with enforcement.
If a sale of debt is pursued, we recommend www.90nine.co.nz as a great choice to pursue.
Conclusion
Applications for bankruptcy and liquidation are usually the options of last resort as there is always a risk that there will be a minimal recovery (or no recovery at all).
However, the threat of bankruptcy or liquidation often encourages debtors to enter into settlement discussions and settle the debt.
In relation to companies, the chances of recovery could be increased with the appointment of a robust liquidator.
If you are considering applying for bankruptcy or liquidation, or require legal assistance with the application, we invite you to contact our specialists for a no obligation discussion.
The High Court has ordered the (funded) liquidators of Property Ventures Limited (“PVL”) and other related entities (“the PVL Group”), to provide security of costs of $2.78 million in their $302 million lawsuit against the directors of the entities from the PVL Group and PricewaterhouseCoopers (“PWC”).
This decision provides guidance to prospective plaintiffs as to how the Court will assess security for costs when the plaintiff has litigation funding. Funders and prospective plaintiffs ought to take note.
Background
The PVL Group operated business in property developments and investments and was led by Christchurch based property developer Dave Henderson.
The PVL Group collapsed in the aftermath of the 2008 global financial crisis, leaving in its wake significant debts and insufficient assets to meet those debts. The liquidators of the entities, Robert Walker and John Scutter, claim that the entities should have been wound up in 2007, which would have allowed the loans to be called in, asset sales and a more orderly liquidation. Instead, majority of the entities were liquidated in 2010 or even later.
In 2012, the liquidators commenced proceedings against the directors of the PVL Group for a total sum of approximately $302 million. The liquidators claim that the companies in the PVL Group suffered losses of that amount as a result of alleged breaches of their director duties. These breaches are mainly based on the facts that the directors allegedly allowed the companies to trade whilst they were insolvent, and permitted Mr Henderson to use the entities for personal interests.
The liquidators also sue PWC for the same sum in respect of breaches of duties it is alleged to have owed to the PVL Group when auditing the financial statements in respect of the 2006 – 2008 financial years. The liquidators argue that if not for PWC giving positive audits and advising how to skirt insolvency, the entities would have been liquidated sooner.
The liquidators have engaged a litigation funder, SPF No 10 Limited (“SPF”), to fund the proceeding. The funding agreement requires SPF to fund the cost of the litigation, including any sum the plaintiffs might be required to provide by way of security for costs. SPF will also fund any adverse award of costs. In return for meeting these obligations, SPF will receive 42.5% of any proceeds of the proceeding, or a sum equivalent to twice the amount expended by way of project costs, whichever is the greater. SPF also holds a first ranking general security agreement over the assets of PVL.
The proceeding has been set down for a 12 weeks trial starting in February 2018.
In 2013, PWC applied for the plaintiffs’ claim to be stayed on the ground that it was an abuse of process for the plaintiffs to pursue a claim that was for the sole benefit of SPF. The application failed at first instance, and the Court of Appeal upheld that decision. The Supreme Court has granted leave to PWC to appeal, but the appeal is yet to be heard.
Subsequently, the defendants applied for an order that the plaintiffs provide security for their costs.
Issues
In order to determine the application, Lang J relied on well-established principles and in the context of a case such as the present, was requited to consider the following issues:
If there was a reason to believe that the plaintiffs would not be able to pay the defendants’ costs if the claim is unsuccessful.
If the Court should exercise its discretion.
Ability of the plaintiffs to meet a cost award
The Judge recorded that there was no dispute that, without third party assistance, the plaintiffs would be unable to meet the awards of costs that would inevitably be made if their claims were unsuccessful.
Lang J held that the litigation funder was not a party to the proceeding, and had no direct interest in it other than the right to share in the proceeds of a successful outcome.
Discretion
Two factors were particularly relevant to Lang J in the exercise of the discretion: the involvement of the litigation funder and the alleged merits of the plaintiffs’ case.
In relation to the former factor, Lang J firstly considered an earlier High Court decision in Saunders v Houghton [2009] NZCA 610, the litigation involving representative claims by shareholders of a failed company. In that case, Dobson J was similarly required to determine an application by the defendants for security for costs. When considering the weight to be given to the fact that a litigation funder was involved, Dobson J referred to the approach taken by the New South Wales Court of Appeal in Green (as liquidator of Arimco Mining Pty Ltd v CGU Insurance Ltd) [2008] NSWCA 148. In that case, the New South Wales Court of Appeal ordered security for costs as it considered that a person whose involvement in litigation is purely for commercial profit should not avoid responsibility for costs if the litigation fails. In Saunders v Houghton, Dobson J agreed with this point and ordered security for costs.
Lang J agreed with the approaches taken by both decisions and held:
…The existence of a litigation funder in the present case is an important factor that influences the exercise of the discretion for several reasons. The first of these is that the plaintiffs will not be precluded from continuing with their claims if a significant order for security is made. Further, SPF stands to receive most, if not all, of the proceeds of any successful claim. It has no interest in the litigation beyond the profit it hopes to derive form what it clearly regards as a commercial venture. Commercial ventures generally require an investor to take risks and to incur expenditure as the price to be paid for the chance of success. SPF should therefore be required, as a matter of policy, to contribute significantly to the defendants’ costs if the claims are unsuccessful.
In relation to the merits of the case, Lang J held that the material before the court did not allow him to make a meaningful assessment on the merits. As such, he concluded that the merits of the claim were largely a neutral factor.
Nevertheless, Lang J could identify two areas of potential vulnerability for PWC, which were its alleged failure to ensure valuations ascribed to PVL’s key assets such as undeveloped land “were robust and could be relied upon”. Another area of risk was PWC’s failure to scrutinise the arrangement pursuant to which Mr Henderson and other companies owed PVL approximately $7.5 million by early 2008.
Making a modest allowance for the likely merits that could be identified, Lang J ordered that the plaintiffs are to provide security for costs in the sum of $2.78 million.
Conclusion
It appears that where plaintiffs have litigation funding, the Court is likely to require that the funder provides security for costs upfront.
The likelihood of security for costs being ordered in these situations ought to be considered by litigants who have litigation funding and funders alike.
Depending on the specific funder, security for costs of this magnitude could be a deal breaker for funding.
