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Potential double liability for directors of insolvent companies

A High Court decision highlights that a director of an insolvent company may potentially have concurrent liability under the Companies Act 1993 and the Fair Trading Act 1986.

type
Article
author
By Institute of Directors
date
25 Jan 2022
read time
4 min to read
Gavel on a table

A September 2021 High Court decision highlights that a director of an insolvent company may potentially have concurrent liability under the Companies Act 1993 (the “Companies Act”) and the Fair Trading Act 1986 (the “Fair Trading Act”).

The decision in Dempsey Woods Civil Limited v Gapes found that the director of a near insolvent property development company who had breached Companies Act directors duties to the company was also liable for essentially the same conduct under the Fair Trading Act – namely, falsely representing that the company can and will pay its debts.

  • The director was found liable to pay compensation for breaches of directors duties under the Companies Act - section 135 (not to trade recklessly) and section 136 (not agreeing to company incurring inappropriate obligations).
  • It also held the director personally liable under section 9 of the Fair Trading Act, for misleading a creditor in the same set of circumstances, and ordered him to pay for the cost of work completed in reliance on that misrepresentation.

Background

The defendant was the sole director of a property development company, PRDL, incorporated to carry out the “Springpark Development” (the Development) in Mt Wellington, Auckland commencing in 2013. Dempsey Wood Civil Limited (Dempsey Wood) was contracted by PRDL to carry out civil works on the Development in 2014. PRDL had obtained pre-sales with a total value of approximately $60 million for completed lots within the Development “off the plan”. There was a “sunset clause” in the pre-sale agreements which enabled each party (including the developer) to cancel the contracts if the project was not completed by the Sunset Date (20 December 2015). Funding was provided through a credit facility secured overseas, by a lender named Koi.

By mid-2015 PRDL had run into serious trouble, with significant cost overruns and associated delays and it was clear the Development would not be completed by the Sunset Date. Cancelling the contracts and re-selling at 2015 prices would have returned the project to financial viability, and the director actively sought new funding, although ultimately unsuccessfully. The Koi facility expired on 15 October 2015, but Koi continued to fund the development in November 2015 while PRDL negotiated with a potential new financier.   

After the alternate funding fell through in November 2015, and with the company clearly in a “very vulnerable position”, the company continued to trade. By that stage, it was clear that the project was no longer viable, and there were no longer reasonable grounds for believing that contractors engaged in the project would be paid for any new work completed after that date – in breach of both sections 135 and 136 of the Companies Act.  

By late 2015 Dempsey Wood were concerned about completing further work on the Development, as they were aware of the company’s financial difficulties. However, it agreed to complete further work on the basis of the director’s assurance, given at the critical November 2015 date, that funds were available to pay it. Shortly afterwards in early December 2015, the company was placed in receivership, then wound up in early 2016, leaving Dempsey Wood unpaid for the final work completed and the main unsecured creditor in the liquidation (claiming approximately $750,000 was owed to it).

Breaches of the Companies Act and the Fair Trading Act?

Dempsey Wood sued the director alleging a number of breaches of his duties under the Companies Act, including to act in the best interests of the company (section 131), not to carry on the business in a manner likely to create a substantial risk of serious loss to creditors (section 135), and not to allow the company to incur inappropriate obligations when he had no reasonable grounds for believing those obligations would be met (section 136).

Dempsey Wood also sued the director alleging it had been misled by the director in breach of section 9 of the Fair Trading Act, when in November 2015 (after the alternate funding had fallen through) the director gave the assurance that there was sufficient funds remaining to pay for work carried out after that time.

Directors’ duties decision

The Court considered the facts in detail and found the director liable to pay compensation of $100,000 for breaches of the section 135 and 136 Companies Act duties (approximately one third of the $300,000 loss the Court held resulted from these breaches).

Notably the Court considered there was no breach of the section 131 Companies Act duty to act in the best interests of the company, finding that the director genuinely believed that creditors would be paid by his ongoing efforts to refinance the project. The Court found that although the director misjudged matters at the critical time later on in the project, there was nothing to suggest the director did not subjectively believe he was acting in the best interests of the company.

Fair Trading Act decision  

The Court found the director had mislead Dempsey Wood in giving the assurances there were sufficient funds to pay for ongoing work, in breach of the Fair Trading Act, and ordered the director pay Dempsey Wood just over $300,000 for this breach.

Double punishment?

In a second judgment in November 2021 dealing with the payment of awards and interest in the case, the High Court dismissed any suggestion of “double punishment” of the director under the Companies Act and Fair Trading Act regimes, and found that the amounts awarded under each Act could be cumulative.  

The Court held the Companies Act awards responded to the director breaching both section 135 and section 136 – duties owed to the company. 

  • Section 135 concerns the director carrying on the business of the company in a manner likely to expose creditors to a substantial risk of serious loss (or “culpably exacerbating the company’s insolvency”); and,
  • Section 136 concerns the director permitting the company to continue to trade when he did not have reasonable grounds for believing it would be able to meet it debts when due.

On the other hand, the breach of section 9 of the Fair Trading Act concerned a specific misrepresentation by the director about the availability of funds. 

The Court held that neither of the two Companies Act breaches involved the director making representations to creditors. Both Companies Act breaches were different and broader “wrongs” than the specific misrepresentation made to Dempsey Wood about the availability of funds for the purposes of the section 9 Fair Trading Act claim.

Summary

Although the Court held that there wasn’t double punishment of the director, the case does highlight the potential for liability under both the Fair Trading Act and the Companies Act for insolvency related breaches.

The full decisions are available here:

Dempsey Wood Civil Ltd v Gapes [2021] NZHC 2362

Dempsey Wood Civil Ltd v Gapes [2021] NZHC 2933

For further reference, see also the Supreme Court decision in Debut Homes Ltd v Cooper (2020) in which that Court considered directors’ duties under the Companies Act for the first time in detail.  The decision is particularly relevant to directors of financially distressed companies. See link here: Four Pillars Chapter 4.2.1 Landmark Supreme Court directors duties case  

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