The Supreme Court has released a much-awaited decision in McIntosh v Fisk whereby the Liquidators of Ross Asset Management Limited (“RAM”) sought to claw back all amounts paid to Mr McIntosh as insolvent transactions under the Property Law Act 2007 (“PLA”) and the Companies Act 1993 (“CA”).
Facts
Mr McIntosh entered into a funds management arrangement with RAM in April 2007. Mr McIntosh appointed RAM as his agent to manage his investment portfolio. He paid $500,000 to RAM in 2007, having borrowed that sum from his bank. The contract provided that RAM would hold the funds in a separate account in the name of Mr McIntosh and that securities purchased from the fund would be held by an associate company of RAM, Dagger Nominees Limited (Dagger), as nominee.
Unfortunately for Mr McIntosh and RAM’s other investors, RAM did not comply with the terms of its management contracts with its clients, but rather operated a Ponzi scheme.
When “investors” paid money or transferred securities to RAM for management under the terms of their individual management contracts, RAM did not hold the money or securities on trust and did not arrange for Dagger to hold securities it acquired as nominee. Rather, it misappropriated the funds or securities.
In the case of Mr McIntosh, the $500,000 he paid to RAM was misappropriated within days of him making the investment and became part of a co-mingled pool of cash and securities held by RAM and associated entities. RAM paid money from this pool to other investors who wished to cash up their investments, and also paid various operating expenses of RAM, including personal drawings of its principal, David Ross. Funds received from new investors were treated in the same way as Mr McIntosh’s investment.
RAM perpetuated the fraudulent Ponzi scheme by reporting to its clients in terms which led them to believe that investments had been made in securities in accordance with the management contracts. These quarterly reports listed individual securities with details that matched what was occurring in the market for the relevant securities. But all the transactions recorded in these reports were fictitious. “Bevis Marks”, the entity which was said to hold the securities, was, in fact, non-existent. As other investors, Mr McIntosh was led to believe that his portfolio was increasing in value and yielding an attractive rate of return.
The scale of the fraud perpetuated by RAM was considerable and many investors have suffered significant losses.
In September 2011, Mr McIntosh decided to cash up his portfolio and withdraw the amount which, according to the fictitious reports he had received from RAM, totaled $954,047. The $454,047 in excess of the original investment of $500,000 was the amount said to have been earned on Mr McIntosh’s portfolio in the four and a half years from the time of his investment.
The reality was that none of the securities listed in the reports received by Mr McIntosh actually existed and the money paid to Mr McIntosh was not derived from the sale of securities held on his behalf, as he had been led to believe.
In November 2011, RAM made six payments to Mr McIntosh totaling $954,047, in accordance with the notice he had given under the management contract to withdraw the funds.
In December 2012, RAM was placed in liquidation by the order of the High Court. The Liquidators revealed the scale of the fraud perpetuated by RAM on its clients.
The proceedings
The Liquidators sought to claw back all of the $954,047 Mr McIntosh received from RAM.
High Court
At the High Court, the Liquidators were given orders to recover the fictitious profits obtained by the investor (in this case $454,047), but denied the claim to the initial investment (in this case $500,000).
MacKenzie J held that pursuant to the PLA, there had been a disposition of property, by a debtor, with the debtor being insolvent at the time of the disposition since each investor had an accrued cause of action in November 2011 for a breach of trust, and that the disposition would have prejudiced the creditors. Similarly, under the CA, there had been a transaction by an insolvent company that enabled Mr McIntosh to receive more towards the satisfaction of his debt than he would have received in liquidation.
However, the claims failed under the PLA and the CA regarding the initial investment. Mr McIntosh had acted in good faith, and gave value for the initial investment, but the value given did not extend to the fictitious profits. Additionally, there was insufficient evidence to demonstrate that Mr McIntosh had altered his position upon receipt of the fictitious profits.
The Court of Appeal
The majority of the Court of Appeal upheld the High Court decision.
The Supreme Court
The Majority of the Supreme Court has upheld the decision of the Court of Appeal.
The result is that the payment of $454,047.62, being the fictitious interest, is to be repaid by Mr McIntosh to the Liquidators.
Summary
Ponzi schemes may be rare but there does seem to be more risk for Investors . Investors ought to be vigilant.
This decision has been much awaited by liquidators who have been appointed to Ponzi schemes.
We expect that liquidators in control of failed Ponzi schemes will now be looking to finalise and commence proceedings against Investors who have received fictitious profits.
The Court may appoint an interim liquidator in order to maintain the value of a company’s assets during the period following the filing of a liquidation application.
This is a powerful safeguard in regard to the assets of a company and it is often overlooked by those seeking to liquidate a company. The Court may appoint an interim liquidators if:
The company’s assets are in jeopardy;
The status quo should be maintained; and
The interests of creditors require a safeguard.
However, there are three main preconditions to the interim liquidator’s appointment:
A liquidation application must be filed which discloses good grounds for putting the company into liquidation.
There must be a need for urgency.
The circumstances must justify the appointment of an interim liquidator.
The Court retains discretion as to whether the appointment ought to be made. The Court will only exercise its discretion if it necessary or expedient for the purpose of maintaining the value of the assets owned or managed by the company. The word expedient means “fitting, suitable, desirable or convenient”. This has been said to import a relatively low threshold.
Associate Judge Gendall (as he then was) in Apostolakis v Café Italiano Wellington Limited was to decide a case between the two co-proprietors of the company who had fallen out.
In that case, the liquidation application had been made on “just and equitable grounds”, and one of the co-proprietors of the company led evidence that the assets of the company were in danger of being dissipated by the other co-proprietor. The Court granted the application for the appointment of an interim liquidator, on the grounds of preserving the status quo and on the grounds of urgency.
This case emphasises the power of s 246 of the Companies Act 1993. It may allow an independent party to take control of the company in order to protect the assets at a crucial time.
As per Williams J in Elders Pastoral Holdings Ltd v NZ Ostriches Ltd:
It is nonetheless to be borne in mind that the appointment of an interim liquidator trenches across director’s powers, affects a major irruption into the company’s business and, to a large degree, amounts to a pre-judgment on the winding-up application itself. Hence the necessity for an applicant to demonstrate a good prima facie case for liquidation and a cautious approach to the question as to whether the Court is satisfied that the statutory criteria have been met.
Interim liquidators will be given very similar powers to ‘actual’ liquidators. For example, they will be able to take possession of and protect assets, take possession of books and records and documents of the company, examine under oath those with knowledge of the company’s affairs. Accordingly, the appointment of an interim liquidator can be a powerful tool to ensure that the company’s assets and records are maintained while the liquidation application works its way through the Court’s processes.
Associate Judge Bell in NZNet Internet Services Ltd (in Liq) v Engini Ltd was of the view that the appointment of an interim liquidator was useful to recover assets that may have been disposed of. His Honour was also minded to appoint the same liquidators as the appointed to the creditor because of the way in which they had conducted the liquidation of the creditor and because “unlikely some vanilla liquidations, they have pursued the interests of creditors of NZNet Internet Services Ltd vigorously”.
The primary duty of interim liquidators is to preserve the status quo with the least harm to interested persons. However, in certain circumstances interim liquidators will be authorised by the Court to take positive steps outside of preservation of the status quo. For example, sale of assets, trading the business of the company, examination of officers of the company, and conduct, defend and compromise claims against the company.
The interim liquidator’s remuneration is usually paid from the assets of the company in the same way a liquidator is paid.
Failure to appoint an interim liquidator can sometimes result in a pyrrhic victory for the creditors. In particular, by the time the liquidation application is determined, the assets of the company may be whittled away by those who retain control. While a liquidator may seek to claw back assets, often the time and expense involved can be onerous to such an extent that a liquidator may not pursue those matters.
There is a process to be followed should one seek such an appointment and one needs to move the Court promptly to avoid losing the opportunity that an interim liquidator provides.
This artcile was also published in the October 2016 edition of Law Talk.
Most commonly, creditors appoint a liquidator by utilising the statutory demand process (if the debt is more than $1000) and then if unsatisfied, file an application at the High Court seeking a liquidation order.
Due diligence on the debt
Obtaining instructions and assessing the file is a crucial part of the process. Get it wrong and the consequences can be disastrous for the client and the lawyer.
At the point the client walks in the door, the solicitor ought to assess the ‘debt’. It is advisable that the solicitor confirms:
The debt is due;
There is no substantial dispute as to whether the debt is due or owing;
The debt is owed by a company registered in accordance with the Companies Act 1993; and
The company is not struck off, in the process of being struck off, or already placed into liquidation, by checking with the Companies Office.
The last two points may seem obvious.However, it is worth ticking those boxes, especially in the wake of the companies being regularly struck off by the Ministry of Business, Innovation and Employment (“MBIE”) for non-compliance with the Act. On a number of occasions, statutory demands have been issued, and while the statutory timeframes are ticking, MBIE (without knowledge of the statutory demand) attempts to strike off the company because annual returns were not filed or because of some other statutory non-compliance by the company.
Before a statutory demand is served, it is the obligation of the solicitor to ensure that the debt is due and owing and there is no substantial dispute as to whether it is due and owing. Failure to do so may result in the lawyer being held accountable for an abuse of the Court process (see Rule 2.3 of the Lawyers and Conveyancers Act (Lawyers: Conduct and Client Care) Rules 2008).
It is also worth considering less formal options. A letter from a solicitor, on letterhead, is often all that is required to ensure that a bad debtor pays. It is, therefore, a good practice for the solicitor to initially write to the debtor and demand payment. This approach has a secondary advantage of shaking out potentially unidentified defences. On that basis, this is an important informal part of the process.
It is also good practice to attach invoices (or similar documents) to the demand letter. This will close the door to any dispute that the debtor did not know to what the debt related.
If a statutory demand is issued and a potential defence is pleaded in an application pursuant to s 290 of the Companies Act 1993, defending the application can be costly to the issuer of the statutory demand.
Purpose of statutory demand
In the last few years there has been a move away from the traditional view held that a statutory demand cannot be used to collect debts. For instance, in 2009 the Court of Appeal in Pioneer Insurance Company Ltd v White Heron Motor Lodge Ltd held that:
A statutory demand is issued to obtain payment for a debt. If payment is not made, the demand fulfils a secondary purpose, namely to provide a basis on which the debtor’s inability to pay its debts as they fall due may be proved, if liquidation proceedings were brought: see s 287(a) which creates a presumption that the debtor company is “unable to pay its debts” for, among other things, the purpose of bringing a proceeding to put the company into liquidation. Proof of insolvency is a prerequisite to the making of a liquidation order: see s 241(4)(a) of the Act.
Additionally, in AMC Construction Ltd v Frews Contracting Ltd, the Court of Appeal also held that:
If the debt is indisputably owing, then it should be paid. If the company simply refuses to pay, without good reason, it should not be able to avoid the statutory demand process by proving, at the statutory demand stage, that it is solvent. The demand should be allowed to proceed.
These decisions are in line with commercial realities. Creditors take such steps to increase their chances of a recovery, not to provide a public service to liquidate insolvent companies.
Due debt
Surprisingly, whether there is a debt which is due can be subject to fierce debate. Accordingly, examples outside the usual simple scenarios are necessary.
In OPC Managed Rehab Ltd v Accident Compensation Corporation, ACC issued a statutory demand to OPC for funds that it had overpaid to OPC. ACC claimed that the fact that it had overpaid created an obligation on the part of OPC to refund the amount overpaid and that obligation was a ‘debt due’. OPC claimed that ACC may have a restitutionary claim in money had and received but that there was no ‘debt due’ until ACC had obtained judgment in respect of that claim.
The Court of Appeal held that actions such as money had and received have such similarity to an action for a recovery of a debt that an obligation to repay money received in circumstances where there is no entitlement to receive or retain it can be treated as a ‘due debt’ for the purposes of s 289(2)(a) of the Act. The Court of Appeal added:
If a payment is received in circumstances where the recipient is obliged to repay it, whether because of a contractual or statutory provision to that effect or because the circumstances give rise to an obligation to repay on the basis of money had and received, the amount can be treated as a “debt due” for the purposes of s 289(2)(a).
This principle has been extended further by the Court of Appeal in Grant v Lotus Gardens Ltd.
In that case, the liquidators, sought to set aside transactions that were made by an insolvent company to Lotus Gardens Ltd (“LGL”). The liquidators issued a voidable transaction notice against LGL. LGL failed to respond to the notice within the statutory timeframe. The statutory effect of this was that the transactions were automatically set aside.
Subsequently, the liquidators elected to treat the set aside transactions as a debt due and issued a statutory demand.
The High Court held that there can be no debt due until a liquidator obtains an order of the Court setting aside the transactions pursuant to s 295 of the Companies Act 1993.
However, the Court of Appeal held that a liquidator can recover an automatically set aside transaction through the statutory demand regime.
However, if a statutory demand is issued in circumstances that would make it plainly unjust for liquidation to ensue, no liquidation will be ordered. This is a sensible approach which strikes a fair balance.
Timeframes
After a statutory demand is served on a debtor company, the debtor company has 15 working days to either pay the debt, enter into a compromise or compound with the creditor, or give a charge over property, to the reasonable satisfaction of the creditor.
An application for liquidation of the debtor company cannot be made until the expiry of 15 working days.
However, pursuant to s 290 of the Companies Act 1993, the debtor company may also apply to set aside the statutory demand within 10 working days of service if:
There is a substantial dispute whether or not the debt is owing or is due; or
The company appears to have a counterclaim, set-off, or cross-demand and the amount specified in the demand less the amount of the counterclaim, set-off, or cross-demand is less than the prescribed amount; or
The demand ought to be set aside on other grounds.
If an application is made, for it to be valid it must be filed and served within 10 working days or it will not be heard by the High Court.
If the debtor company does not comply with the statutory demand within 15 working days of service, it gives rise to a rebuttable presumption that the debtor company is unable to pay its due debts. That presumption lasts for 30 working days from the last day for compliance with the demand. Within these 30 days the creditor may apply for a liquidation order.
The creditor must serve the statement of claim, notice of proceeding and affidavit on the debtor company not less than 15 working days prior to the hearing.
The creditor must also advertise the liquidation, in the prescribed form, at least five working days after serve and at least five working days before the hearing.
Before the hearing the creditor must file an affidavit proving service of the documents on the debtor company together with copies of the advertisements.
At the hearing a solicitor must certify or the creditor must depose that the debt remains due.
Conclusions
The liquidation process is fairly straight forward, but it is riddled with mandatory timeframes where the Court does not retain discretion. These timeframes must be adhered to in order to avoid onerous consequences.
This artcile was also published in the October 2016 edition of Law Talk.
So you or your client have been served with a statutory demand. What does it mean? What are the consequences? What must I do and by when? These are all questions that need to be asked and answered within a tight space of time.
A statutory demand is a demand made pursuant to s 289 of the Companies Act 1993. If one is received, the defendant company is required to pay the specified sum, enter into a compromise or give a charge over property to secure payment of the debt to the reasonable satisfaction of the creditor within 15 working days of the date of service, or such longer period as the Court may order.
Failure to comply
If you do not comply with the statutory demand, the creditor is able to apply to the Court to liquidate the company. The creditor will usually choose a liquidator and the Court usually appoints the liquidator of the creditor’s choosing.
However, you are able to apply to set aside the statutory demand within 10 working days of service. Unless you file and serve the application within this time frame, the company will be deemed to be insolvent and liquidation is more likely to follow.
Setting aside the statutory demand
The Court may set aside the statutory demand if it is satisfied that there is a substantial dispute as to whether the debt is due and owing, there is a counter-claim, set-off or cross-demand or such other ground that the Court thinks fit.
If the application fails, the court may forthwith liquidate the company or grant further time to the debtor company to comply with the demand.
Liquidation proceedings
The creditor has 30 working days from the last day of compliance with the statutory demand to file a liquidation application which relies on the statutory presumption of insolvency by reason of failing to comply with a statutory demand.
The debtor company may appoint its own liquidator before liquidation proceedings are filed and served or it will lose the opportunity to do so. Once liquidation proceedings are served, the shareholders are not able to appoint a liquidator of their choice, unless the creditor who commenced proceedings consents to this. This time frame is strict. As such, if the shareholders are considering appointing a liquidator of their choice, it is important that they assess this prior to the expiry of the statutory demand.
A debtor company may use this as a last opportunity to defend the demand from the creditor and defend the liquidation proceedings, if appropriate.
The creditor may advertise the liquidation of the debtor company in the gazette and local newspaper. The advertisement may be published after 5 working days after service of the liquidation application. If you want to stop this from occurring, then you must move quickly to restrain advertising.
What should you do?
The answer to this question is always case dependent. Once served with any of the above documents, it is advisable that you seek legal advice promptly. There are many strict statutory time frames that must be navigated without delay to avoid any irretrievable damage being caused.
Companies are an excellent structure to ring-fence liability for a trading enterprise. Such a structure provides that the liability of the directors and shareholders are limited. This corporate shield can be useful if things do not go to plan and the company fails.
I am a firm believer in hoping for the best but preparing for the worst. If you fail to prepare, prepare to fail!
Cautionary tale
On a number of occasions, I have acted as Counsel on behalf of liquidators who are pursuing directors for breaching their duties. A recent example is the case of Central Tyres Waipukurau Limited (in Liquidation) v Pallesen.
In that case the liquidators alleged that Mr Pallesen:
had an overdrawn current account and was obligated to repay it;
failed to keep proper accounting records;
traded the company recklessly; and
was negligent in his duties as a director.
At the commencement of the proceeding, we obtained a freezing order over the assets of Mr Pallesen, including two properties. This freezing order ensured that the assets would be available to the liquidators for sale if their claim was successful.
Overdrawn current accounts are commonplace in NZ. If the account is overdrawn, the company (or a liquidator acting as its agent) can demand repayment. Further, if appropriate resolutions are not completed for remuneration of a director, salaries can be treated as loans repayable on demand! It is common for liquidators to claw back salaries going back six years because appropriate resolutions were not completed pursuant to s 161 of the Companies Act 1993 (“the Act”). Accordingly, a small amount of compliance with the Act can have a huge impact on director liability.
In this case the liquidators were successful in obtaining judgment for the overdrawn current account.
The liquidators were also successful in all other claims in respect of Mr Pallesen’s failures and breaches of duties as a director. As a result, Mr Pallesen was held liable to all the creditors of the company, and for the liquidators’ fees and legal costs.
As a result of the judgment and their pre-existing freezing order, the liquidators are now in the process of selling the properties of Mr Pallesen.
Key lessons
Director’s liability is only limited if they comply with all of their obligations as directors. Failures may result in personal liability.
Having a background in pursuing directors for their failures gives me a unique perspective in terms of company structures, compliance, governance and asset protection.
It is important that directors assess their corporate structure, governance practices and reconcile this with the potential liability that may flow on from this.
The key lessons to be drawn from Mr Pallesen’s story are as follows:
Make sure that you have your finger on the pulse of the business. If you don’t know precisely the financial position of your company, take immediate steps to find out. Talk to a professional adviser who may be able to assist you in that regard.
Make sure that you prepare proper accounting records that comply with your minimum financial reporting obligations.
Insure against your risk! Directors and Officers insurance may have assisted Mr Pallesen.
Put your personal assets in a secure trust.
I say ‘secure’ trust because the Supreme Court in Clayton v Clayton has recently decided a case that may result in many New Zealand trusts being venerable to attack. Such an attack, if made, could result in many trusts being busted and their assets being clawed back and available for distribution to creditors of the settlors.
Too many of us have a ‘she’ll be right’ attitude that results in large disputes down the line.
I recognise that this is not an easy topic to think about, or discuss. But, it is smart business practice to ensure that proper structures are in place to protect you against unforeseen events.
How we can help you
We are happy to conduct a number of heath checks in respect of:
Trust Deed checks to ensure that your trust is secure from attack;
Governance checks to ensure that you are operating your company in full compliance with your obligations as a director.
Shareholder structures to ensure that the appropriate agreements are in place between shareholders.
We also recognise that cash is king! We have a debt collection and security enforcement practice which is able to collect your debt efficiently to ease your cash flow demands.
We are advocates for transparency. As such, where possible we will fix our fees so that you know the cost upfront.
For more information as to the services that we provide head to www.norlinglaw.co.nz or please do not hesitate to contact me for a no obligation discussion by emailing brent@norlinglaw.co.nz. We are here to help you get the best from your business.
Liquidators often interview persons under oath pursuant to s 261 of the Companies Act. Interviews under oath are a useful power for a liquidator. Particularly because liquidators often come to the affairs of the company with very little knowledge of its affairs and little knowledge of the ins and outs of the books, records and documents of the company.
With this gap in knowledge, parliament saw fit to give liquidators the power to reconstruct this knowledge by persons who have knowledge. Most commonly this will be directors, shareholders, employees, accountants and lawyers. But the liquidators can interview any person with knowledge of the company’s affairs.
Liquidators often use the information gathered to further their understanding of the affairs and also to consider potential litigation and whether proceedings ought to be filed.
In EBR Holdings Limited (in Liquidation) v McLaren Guise Associates Limited the High Court considered whether an accountant, who had been allegedly untruthful ought to be liable to the liquidator for those statements which caused a loss to EBR Holdings Limited (in Liquidation) (“EBR”).
The facts as pled to the Court
Prior to the liquidation of EBR, Mr Harrison of McLaren Guise Associates Ltd (“MGA”) provided it with accounting services. On the last set of financial statements prepared by MGA. Those financial statements stated that the director/shareholders (“the Van Duyns”) of EBR owed funds by way of an overdrawn current account.
Just a few months prior to the liquidation, MGA also advised the Van Duyns that “the shareholders current accounts are overdrawn and should the company be liquidated the overdrawn shareholders current accounts became assets to the company which the liquidator could call on.”
Despite the prepared financials and the advice recorded to the Van Duyns, when the liquidators called for repayment, MGA, after liquidation, created journal entries which effectively removed the overdrawn current accounts. MGA, through Mr Harrison, then put in an affidavit confirming that there was no current account. The liquidators further interviewed Mr Harrison from MGA under oath, pursuant to s 261. At the interview the comments in the affidavit was confirmed as being correct.
EBR then pursued MGA on the basis that prior to giving the statements under oath, Mr Harrison knew them to be false, he had no belief in the truth of the statements and/or he was at least reckless as to its truth.
EBR states that it incurred significant cost to investigate and respond to the false statements.
EBR pursued MGA under the tort of deceit/injurious false representations, misuse of confidential information and negligence.
MGA and the Van Duyns sought to strike out the claims on the basis that they are, as witnesses, immune from such action.
The High Court decision
The Court was tasked with considering whether EBR can sue an accountant for alleged false statements which were made in an examination by a liquidator.
The Court held that witness immunity can be extended to liquidation examinations under s 261 because the examination process is analogous to a Court proceeding. In particular:
Examinees are compelled under oath, are entitled to legal representation, are detained so far as the Bill of Rights Act is concerned, and are subject to criminal penalties for non-compliance. Legal professional privilege may also apply. The process is carried out by Court-appointed liquidators and is supervised by the Court to prevent abuses of process. It is also clear that the Court is concerned to prevent examinees being interrogated for the ulterior purpose of exposing them to civil liability.
Justice Brewer struck out two of the three causes of action and has allowed one cause of action to proceed to a full trial, being misuse of confidential information.
Key take outs
While liquidators are unable to pursue those who make false statements for the losses that result from those statements, there is no restriction on prosecutions for perjury or professional disciplinary sanctions. Although, these remedies are more punitive in nature and are unlikely to restore a liquidator to the position they were in prior to incurring costs based on false statements.
Liquidators may still use evidence obtained from their examinations under s 261 in civil proceedings but it cannot be used to pursue the maker of the statement for making the statement.
