New Zealand Tiny Homes (Tiny Homes) fell victim to liquidation on 15 November 2022. After its incorporation in 2020 this was a short, but most certainly not sweet, business affair for its director James Cameron of New Plymouth.
The liquidation of Tiny Homes was said to be linked to the liquidation of Tiny Town Projects Limited (Tiny Town) which was also liquidated on 15 November 2022, another of Mr Cameron’s companies incorporated in 2017.
Tiny Town and Tiny Homes were related companies. Tiny Homes held the intellectual property for the creation of building small properties in New Zealand, whereas Tiny Town was the company that actually attended to the building of these properties
The business of Tiny Homes and Tiny Town
Tiny Homes and Tiny Town were in the business of building small properties for consumers in New Zealand. The size of these properties allowed for a far more accessible fixed purchase price for home buyers.
At the time of liquidation of Tiny Homes and Tiny Town, there were a number of these homes that were virtually completed. The only hurdle being procedural matters of gaining compliance before title in the property could pass from Tiny Town to the purchaser.
It is important to note that each of these homes was customised and built on the purchaser’s instructions. A sale and purchase agreement was signed for each home and payment of the purchase price was paid to Tiny Town in instalments.
The first liquidator’s report of Tiny Town that the issues stemming from COVID-19, a spike in building costs and supply chain issues impacted the company’s ability to ‘fulfil fixed price contracts.’ This inability to fufil fixed price contracts led to both Tiny Town and Tiny Homes demise.
The liquidation
In November 2022, Tiny Town was placed into liquidation. At the point of liquidation there were 6 homes that were partially completed. Of the 6 purchasers of these homes, 3 had paid the full purchase price of their respective homes and were awaiting small changes to be made to be issued a code of compliance before the homes could be delivered. The remaining 3 purchasers had homes that were 40%-50% complete.
The first liquidators report for Tiny Town showed the company had very few assets, bar the 6 homes in question.
The liquidators filed proceedings in the High Court seeking directions on how to best deal with the 6 homes.
The proceedings
The case of Manginness v Tiny Town Projects Limited (In Liquidation) [2023] NZHC 494 (the Proceeding) was heard before Venning J on 20 February 2023 with the judgment being delivered on 14 March 2023.
One of the issues to be decided in the Proceeding was whether the 3 fully paid purchasers were entitled to take ownership of the homes, or whether they belonged to Tiny Town. There were also issues raised in relation to the Personal Property Securities Act 1993 (PPSA) as to whether an equitable lien was granted over all 6 homes.
When does property pass?
The first issue was whether property in the homes had passed to the 3 fully paid purchasers. Counsel for the purchasers argued that as the purchase price had been paid in full, the homes should pass to the purchasers. Counsel argued the compliance certificate should not be the decisive factor as in the liquidator’s evidence it was accepted delivery of the homes would occur when full payment was made, not when the compliance certificate was issued.
Venning J rejected this argument, stating that, property will only pass when the homes are ‘in a deliverable state.’ Venning J defined the deliverable state as when the compliance certificate was issued.
It was concluded on the first issue that property in the homes had not passed to the purchasers.
An equitable lien
Counsel for the purchasers argued that even though there was uncertainty on the property passing, that under section 53 of the PPSA the purchasers had an interest in the homes, whether by way of an equitable lien or a constructive trust.
An equitable lien is a form of equity which the Court can grant to give an indemnity or priority over other creditors. On the other hand, a constructive trust is a trust created whereby one person holds property for the benefit of another, it prevents someone holding property from unjustly benefitting from the holding of that property.
Venning J considered that section 53 of the PPSA did not apply here. However, His Honour’s view was different on the topic of an equitable lien. It was argued by counsel for the purchasers that an equitable lien should be granted to all purchasers over the homes based on the extent of money paid to Tiny Town by them.
A key argument is that these homes were identifiable to each purchaser, and had been built to their specifications. Counsel for the purchasers argued that “the purchasers’ equitable lien confirmed their in rem rights in the tiny homes that trumped any competing claim in the liquidation.”
Venning J submitted this was a difficult issue to ascertain based on the facts of this case. His Honour laid weight on the fact these homes were specified to each purchaser and could not reasonably have been sold by the liquidators to other parties. Venning J concluded there was an equitable lien over the 6 homes.
The next issue was whether the lien was subject to the PPSA, to which Venning J referred to it as being excluded under section 23(b) of the PPSA. His Honour’s full conclusion was “I conclude that the individual purchasers are entitled to equitable liens for the extent of the value of the purchase moneys paid by them and that their equitable liens sit outside and are not affected by the provisions of the PPSA.”
The result of the judgment was that the purchasers of the 6 homes were entitled to an equitable lien against the homes to the extent of the purchase moneys paid by them.
Summary
This judgment has been described as ‘ground-breaking’ and that certainly is the case. This judgment will change the way assets in liquidation are dealt with. The judgment gives rights to the purchasers in a situation where in the normal course of the liquidation it would be common for them to lose their assets.
This decision plays on the fairness of the justice system and emphasises the importance of natural justice in a situation where typically there really are no winners. Although it is arguable this ruling is to the disadvantage of other unsecured creditors in the liquidation, it is weighed on the balance of taking away homes from 6 individuals who in some cases may have been left homeless without this judgment.
The judgment will cast a positive light on the prospects of recovery in liquidations for some creditors, showing them the law of equity can assist in certain circumstances. However, it also results in some doubt for secured creditors whose position is ultimately worsened if equity prevails.
In this case it seems as If on the balance the correct decision was made, however this may not always be the case. If you require assistance on your position as a creditor in a liquidation or want some further information on your rights please do not hesitate to contact us for a free no obligation discussion.
Our lawyers at Norling Law can discuss the outcome of this case as part of our no obligation legal consultation. To book a free 30-minute consultation please click this link
On 20 June 2022, the highly anticipated decision of the Supreme Court in Deng v Zheng matter was released. The Supreme Court was to decide whether the Court of Appeal was correct in its findings that there was a partnership between the two parties, of which they were allegedly equal partners. As part of this, the Supreme Court was faced with a raft of potential issues surrounding the interpretation of documents, specifically documents which were translated from Mandarin. Another important consideration of this hearing were the cultural elements present between the two Chinese parties, and the impact it should have on the understanding of the parties’ relationship.
The Judges recognised the increasing presence of different cultures in New Zealand which differ from our Western system, including that of Eastern culture. As such, the Supreme Court has taken the first step into recognising how different cultures may impact decisions in a Western Court system.
Background
Donglin Deng (Mr Deng) and Lu Zheng (Mr Zheng) entered into a business relationship in the late 1990s. The relationship was carried out until 2015 when the parties agreed to end their associations. By trade, Mr Deng is a project manager and land developer, whilst Mr Zheng is a property developer. In 2004, Mr Deng acquired ownership interests in some of the projects Mr Zheng was involved in.
The heart of the dispute stems from the Bella Vista Agreement, a short agreement dated 27 April 2008. Its title was variously translated into English from the original Mandarin as “partnership agreement” or “cooperation agreement”. Mr Zheng signed the Bella Vista Agreement, however, Mr Deng did not. Mr Zheng contends he signed this agreement on behalf of himself and Mr Deng.
By 2015, the strained business relationship between Mr Deng and Mr Zheng came to an end. No settlement could be reached between the parties as to the separation of their affairs and High Court proceedings were brought to resolve the issues at hand. The most relevant issue being Mr Zheng’s claims that there was a partnership between him and Mr Deng or, alternatively, a joint venture. Mr Deng argued that his relationship with Mr Zheng was based on various corporate and contractual structures but with no overarching partnership or fiduciary elements.
There was quite a contrast between the findings of fact of the High Court Judge (which were firmly in favour of Mr Deng) and those of the Court of Appeal (which were equally firmly expressed but went in favour of Mr Zheng and found the existence of a partnership between the parties).
Barriers in translation
Within their decision, the Supreme Court referred to cultural considerations. Specific reference was made to whether the meaning of specific Chinese characters goes beyond “company” and can extend to “firm” or “enterprise.”
In the Court of Appeal decision, a note of caution was intertwined into the findings. Nearly all of the documents in this case, including the parties’ correspondence and evidence given by witnesses, was provided in Mandarin. The Court had the challenging task of ascertaining what the true purpose of each piece of evidence was. As stated at paragraph [86] of the Court of Appeal judgment:We are conscious that when referring to relevant documents, it is necessary to bear in mind that Court is referring to English translations prepared by different people at different times, who may or may not have understood and taken into account the legal nuances of particular words and phrases that they have used.
The Court of Appeal noted that none of the translators gave evidence on why they had used certain terms in favour of others in specific documents. There was a lack of consistency throughout the use of terms, with no clarity on which term was correct. This poses a stark contrast between Western and Eastern cultures. Whilst the true purpose of words and documents is quite clear in a Westernised dispute, when different cultures enter the Western court system, a high degree of caution is required by Judges and lawyers before placing any significance to the specific terms that appear in the various English translations.
The Supreme Court dealt with this issue relatively quickly, stating the Court of Appeal was “entitled to have regard to a Chinese-English dictionary and [they] are not persuaded that it placed inappropriate weight on that dictionary.”
Guānxi
The second cultural element of relevance was the significance of Guānxi. Guānxi is a cultural concept in China. It has strong roots in rural society, stemming from where people have known each other for generations and there are strong family connections. The Supreme Court described Guānxi as a complex term with multi-faceted meanings:
Guānxi may be understood as “interpersonal connections”, “social capital”, or the “set of personal connections which an individual may draw upon to secure resources or advantage when doing business or in the course of social life”. Important bases of guānxi for an individual include kinship and co-working.
Guānxi is closely linked with Chinese Confucian culture. It rules the social behaviours between people and dictates how a large proportion of those engaged in Chinese business relationships work. Chinese parties will often deal with each other on the basis of trusting relationships, resulting in no or inadequate documentary evidence that could assist the courts when it comes to civil disputes.
It was clear to the Supreme Court that the relationship between Mr Zheng and Mr Deng fell within the bounds of Guānxi. Little evidence on Guānxi, if any at all, was referred to by the High Court. However, the Court found that this was not needed in this case, as the relationship of Guānxi or partnership between the parties was clear from the documents.
In situations where the relationship may not be as clear, a Judge will need to act with caution when referring to Guānxi. In its comments, the Supreme Court noted “first, people who share a particular ethnic or cultural background should not be treated as a homogeneous group,” and that merely because “guānxi is important for some people of Chinese ethnicity does not mean that it important for everyone of Chinese ethnicity.” If considerations are not taken on a case by case basis, the Western system runs the risk of stereotyping Eastern, and other cultures, into a mere checkbox. Whilst “Guānxi influences the behaviour of some Chinese people, it should not be assumed that this is so with all Chinese people.”
Effect on our legal system
The key lesson for the legal practitioners and Judges in areas of cultural difference is to approach each case with caution. As explained by Emilios Kyrou, Judges specifically should develop “a mental red-flag cultural alert system which gives them a sense of when a cultural dimension may be present so that they may actively consider what, if anything, is to be done about it.”
Legal practitioners should consider whether cultural elements would be of use in their arguments and take great care in introducing it.
Regardless of any information presented, Judges will have to take great care in these types of situations. Specifically, where the evidence comes from an expert, or in reliance on ss 128 and 129 of the Evidence Act:
Assuming, without case-specific evidence, that the parties have behaved in ways said to be characteristic of that ethnicity or culture is as inappropriate as assuming that they will behave according to Western norms of behaviour.
Sections 128 and 129 of the Evidence Act allow Judges to have all the information in front of them, information which is of unquestionable accuracy. It also allows the admission of reliable published documents in relation to matters of public history, literature, science, or art. A key skill for legal practitioners and Judges alike to learn is that of recognition. Recognising and interpreting when cultural aspects will be of use, or when will hold no credibility.
Conclusion
The Supreme Court’s decision is a step in the right direction of ensuring the New Zealand Courts meet the needs of an increasingly diverse population.
Our current legal system provides for several “tests” based on the behaviour of a hypothetical “ordinary reasonable person.” However, it is becoming more common to question who the ordinary reasonable person is. Let alone who the ordinary reasonable person in New Zealand will be in years to come.
It is easier to filter out different cultures, on the assumption that despite cultural differences that everyone operates the same way. However, trying to decide an Eastern cultural case with a Westernised system is like trying to open a door with the wrong key. At first, it may seem like it will work, but upon further inspection, it becomes clear there is a mismatch, and the door will never open.
Deng v Zheng does not provide a detailed guidance on how to interpret different cultures in our Western system. However, the Supreme Court held that the “relevant information can be brought to the attention of the court” and recognised that the Courts shall, in appropriate cases, consider evidence about the cultural framework of the parties.
The onus is on Counsel to bring forward and explain cultural considerations for their clients, and to ensure that adequate evidence (including evidence from experts) is produced to assist the Court.
The door-in-the-face (DITF) technique is a well-known psychological compliance technique that recently has come under scrutiny with regard to its practicality. The technique is commonly used by parties in negotiations.
The technique in essence works in the following manner. An individual is presented with a large request that is likely to be turned down. Once that request is rejected, the individual is then presented with a more reasonable request. The individual is more likely to accept the second, more reasonable request, after denying the first request, when compared in isolation to only being asked the reasonable request. For instance, imagine an employer is asked to provide a pay increase of $20,000, followed by a request to provide a pay increase of $5,000 when the request for $20,000 is rejected. The employer is more likely to provide a pay increase of $5,000, more reasonable request, after denying the first one, than if they were asked to provide a pay increase of $5,000 in the first instance.
According to Arizona State University professor Robert Cialdini and his colleagues, the original conductors, and publishers of the experiment, when a request is rejected and subsequently a lesser request is proposed, the other party sees this as a concession and feels a sense of obligation to reciprocate the concession. It can also be explained by the refusing party experiencing a sense of guilt for denying the first request, and subsequently, being more open to accepting future requests. In the experiment, Cialdini and his colleagues asked participants to accompany a group of young criminals to a zoo for free. Only 17% of participants agreed to do this. Then, different participants were asked to volunteer for a young criminal’s centre for a period of 2 years in the role of a counsellor. Most participants (unsurprisingly) said no, however, when a second request was made to accompany the young criminals to a zoo, 50% agreed to participate.
In theory, this can be a very useful tool in the context of negotiations, however, Cialdini and his colleagues only studied it in one-off interactions.
A more recent experiment conducted by Professor Ricky S. Wong of Hang Send Management College in Hong Kong has explored the possibility of impacts on subsequent negotiations. In this experiment, there were two rounds of negotiations. For the first round, some buyers were educated and instructed to use DITF, with the control group instructed to negotiate as they see fit. After the first round, the sellers were also educated on DITF. In the second round of negotiations, the sellers that detected that the buyers were employing the use of DITF obtained better results than the sellers that did not detect the buyers using DITF. The same sellers that detected their buyer’s use of DITF made more demanding offers and viewed their counterparts as less trustworthy. In the second round of negotiations, when given the opportunity, they also chose a new partner for a collaborative project if they detected the buyer using DITF.
It follows that if your negotiating counterpart detects manipulation, they will likely draw negative inferences and reciprocate those findings, much like if they drew positive inferences from a supposed concession and reciprocated those findings.
These findings may suggest the use of persuasion techniques may ultimately result in worse outcomes for repeated negotiations. In a small commercial environment like New Zealand, DITF and other persuasion techniques must be used with care; if the use of DITF is detected, future commercial relationships could be compromised.
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Footnotes:
[1] Robert B. Cialdini, Joyce E. Vincent, Stephen K. Lewis, Jose Catalan, Diane Wheeler, and Betty Lee Darby Reciprocal Concessions Procedure for Inducing Compliance: The Door-in-the-Face Technique (Arizona State University, 1975).
[2]The Door in the Face Technique: Will It Backfire? (Program on Negotiation, Harvard University, 2021) retrieved from: https://www.pon.harvard.edu/daily/dispute-resolution/the-door-in-the-face-technique-will-it-backfire-nb/
The High Court has clarified the scope of directions under s 284(1)(a) of the Companies Act (the Act).
Liquidators are considered officers of the Court and operate under the Court’s supervision. Pursuant to s 284(1)(a) of the Act, a liquidator may apply to the Court for directions in relation to any matter arising in connection with the liquidation. Generally, if a liquidator has obtained directions from the Court, they will have immunity from claims when following those directions.
In Dalton v Mackley, the liquidators applied for directions under s 284(1)(a) of the Act, specifically, they requested directions that certain assets set out in a purchase order are owned by the company and delivered to the company by the respondent.
In this case, the liquidators say that the company owned the assets. They say that they were transferred from Mr Mackley to the company.
Mr Mackley disagreed. He said that the assets were not actually transferred as the transaction never completed.
As such, the ownership of the assets were in dispute.
Despite this dispute, the liquidators sought directions from the Court, declaring the assets to be owned by company in liquidation.
This essentially asks the Court to provide judgment, to determine ownership of the assets. Norling Law acted on this matter. It was our submission that it was inappropriate for the proceeding to be commenced under s284 of the Act. This is because s 284 of the Act is about either supervising liquidators or providing them with directions.
It is not about determining substantive property or contractual rights.
Where substantive rights are to be determined, a proper, full process is required. A process that will allow for:
Proper pleading;
The opportunity for discovery.
The opportunity to interrogate.
The opportunity to cross examine witnesses.
It was our view that this shortcut is inappropriate.
Relevant Law
A handy starting point is the section itself:
S 284 Court supervision of liquidation
(1) On the application of the liquidator, a liquidation committee, or, with the leave of the court, a creditor, shareholder, other entitled person, or director of a company in liquidation, the court may—
(a) give directions in relation to any matter arising in connection with the liquidation:
(b) confirm, reverse, or modify an act or decision of the liquidator:
(c) order an audit of the accounts of the liquidation:
(d) order the liquidator to produce the accounts and records of the liquidation for audit and to provide the auditor with such information concerning the conduct of the liquidation as the auditor requests:
(e) in respect of any period, review or fix the remuneration of the liquidator at a level which is reasonable in the circumstances:
(f) to the extent that an amount retained by the liquidator as remuneration is found by the court to be unreasonable in the circumstances, order the liquidator to refund the amount:
(g) declare whether or not the liquidator was validly appointed or validly assumed custody or control of property:
(h) make an order concerning the retention or the disposition of the accounts and records of the liquidation or of the company.
(2) The powers given by subsection (1) are in addition to any other powers a court may exercise in its jurisdiction relating to liquidators under this Part, and may be exercised in relation to a matter occurring either before or after the commencement of the liquidation, or the removal of the company from the New Zealand register, and whether or not the liquidator has ceased to act as liquidator when the application or the order is made.
(3) Subject to subsection (4), a liquidator who has—
(a) obtained a direction of a court with respect to a matter connected with the exercise of the powers or functions of liquidator; and
(b) acted in accordance with the direction—
is entitled to rely on having so acted as a defence to a claim in relation to anything done or not done in accordance with the direction.
(4) A court may, on the application of any person, order that, by reason of the circumstances in which a direction was obtained under subsection (1), the liquidator does not have the protection given by subsection (3).
Discussion
The purpose of s 284(1)(a) was considered by Associate Judge Paulsen in Dalton v Mackley in depth, stating that, prima facie, the Court had the power to make a wide variety of orders in its supervisory jurisdiction over liquidators.
This was the first fully reasoned consideration of s 284(1)(a) in this context in New Zealand.
Despite s 284(1)(a)’s broad wording, the Associate Judge confirmed the purpose and wording of the section, that is, to allow for expedient proceedings without particularised pleadings, or where there are no significant factual disputes.
Paulsen AJ further states that the text of s 284 and other indications provided by the Companies Act do not support the interpretation of making binding orders in the nature of judgments, rather, they support the view that the proper subject of directions should be confined to the manner in which a liquidation should be carried out under the control of the liquidator.
Further, Paulsen AJ considered s 284(3) of the Act, stating that the protection offered by the provision was concerned with the proper discharge of a liquidator’s functions, and that the protection was offered against allegations of breach of duty by creditors and shareholders. Accordingly, in the present scenario, it would not be of much use.
As there had been relatively little discussion as to the scope of the type of directions that can be sought under s 284(1)(a) in New Zealand, we referred his honour to Australian provisions under the corresponding legislation.
The position in Australian Courts is unambiguous. It has a long history.
The Australian position did not enable the Court to make binding orders in the nature of judgments when asked for directions by a liquidator.
The Associate Judge found comfort in relying more heavily on Australian authorities, noting that Kelly (Liquidator), in the matter of Halifax Investment Services Pty Ltd (in liq) v Loo (Kelly v Loo) was heard concurrently with Re Halifax New Zealand Ltd (in liq) v Loo, in the Federal Court of Australia and the High Court of New Zealand respectively, with the Federal Court emphasising the desirability in a consistency of approach between the two jurisdictions.
Our Comments
It is unfortunate that this matter needed to be litigated. It is of a modest amount.
In our practice, we see countless examples of modest claims being pursued by liquidators in the hopes of shaking money out of inexperienced or under resourced litigants. It can be tough for counterparts of liquidators to succeed given the resource imbalance.
This case demonstrates the risk to liquidators in taking short cuts. Sometimes those who take short cuts get cut short.
We welcome this clarification by the High Court, as this issue had not been previously examined in depth. We trust that this will ensure a clear boundary for liquidators moving forward.
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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.
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Bankruptcy is an incredibly onerous process; upon adjudication, all property belonging to the bankrupt or vested in the bankrupt automatically vests in the Official Assignee (OA) (s 101 Insolvency Act 2006 (the Act)). The definition of property under the Act is wide and includes “property of every kind, whether tangible or intangible, real or personal, corporeal or incorporeal, and includes rights, interests, and claims of every kind in relation to property however they arise” (s 3(1)). As a result, shares in a company are included in this definition.
Context
We have recently been engaged to act for the spouse of a discharged bankrupt. Our client and their spouse both held 50% shareholding in a company that was essentially their retirement fund. Upon bankruptcy, 50% of the shareholding vested in the OA pursuant to s 101 of the Act. As there was no shareholders’ agreement for the company, there were very few restrictions on what could be done with the shares.
What happened
The OA wanted to realize the value of the shares that the bankrupt held in the company for the benefit of the creditors of the bankrupt. The OA offered to sell the shares to the remaining shareholder (our client) for circa $110,000.00 and warned that the OA would take steps to either liquidate the company or sell the shares on the open market, if this offer was not accepted. The basis of the OA’s valuation of the company’s shares was to simply ascertain the value of the net assets of the company. After calculating the value of the net assets, the OA then halved this to represent the 50% shareholding it held and then adjusted this figure for the shareholders’ current accounts.
The previous advisors of our client recommended accepting the value prescribed to the shares by the OA.
Upon being engaged by the client, we ascertained that:
The company had only been able to retain a level of value in the assets it owned due to the efforts, including unpaid work, of our client and the spouse.
They had not received any remuneration for work carried out for the company since its incorporation, over 20 years ago.
Taking a simple net asset position divorced from all other factors is not a reliable method of assessing the value of shares in a company in these circumstances.
As our client’s spouse had been adjudicated bankrupt and no longer eligible to be a director, this left our client as the sole director of the Company, and subsequently, our client had the power to set the director’s remuneration pursuant to s 161 of the Companies Act 1993. In such circumstances, any excess in the company could simply be remunerated to our client, making the shares worthless even with the net asset valuation method. The company was not simply profitable without our client’s unpaid services as a going concern.
We explained these concerns to the OA. After negotiations, our client was able to purchase the shares at a fraction of the amounts that the OA had been offering, which was also in full and final settlement of any claims that the OA may have had against our client and the company.
Key takeaways
This case demonstrates the importance of having a comprehensive shareholders’ agreement in the event a situation as this occurs, and also to obtain a valuation before purchasing items like shares, the value of which is not always obvious.
