Many legal minds making NZ LAW work

We are an association of independent legal practices, proactively sharing ideas and expertise for the benefit of our clients.

Directorships mean significant obligations

Published: 18th November 2020

Author: Tim Oliver, Horsley Christie

Published in: Fineprint

Hefty consequences for getting it wrong when company was in financial distress

In September 2020, the Supreme Court released its keenly anticipated decision in the Debut Homes case (1). This decision illustrates the risks for directors where a company is experiencing irrecoverable financial distress.

In the Debut Homes decision, the court clearly spelt out that in insolvency, or near-insolvency situations, it is not acceptable to simply try to ‘trade through’ in the belief that this will

improve the company’s financial position. Instead, directors must ensure they use the formal (or informal) mechanisms provided in the Companies Act 1993 to address the company’s financial predicament.

If directors fail to meet their duties, they face a very real risk of incurring personal liability — as occurred in the Debut Homes case.

The law
Before we look at the implications of the Debut Homes case, it is helpful to summarise the legal duties of company directors. Directors have a range of specific legal duties, including to:

• Act in good faith and in what they believe to be the best interests of the company (which includes an obligation to consider the interests of creditors in near-insolvency situations)
• Use their powers for a proper purpose
• Follow the Companies Act 1993 and the company’s constitution
• Only allow the company to make commitments that they believe, on reasonable grounds, that the company can perform when required to do so
• Trade in a manner that is not likely to put creditors at a substantial risk of serious loss, i.e. trading recklessly, and
• Use company information appropriately.

As these duties are active, rather than passive, it is impossible to be a ‘silent’ or ‘sleeping’ director. All directors are responsible for fulfilling these duties, which means that you cannot simply default your duties to your fellow directors.

Why is it important to fulfil your director duties? If you breach your duties as a director and the company is placed into liquidation, you risk being held personally liable to repay or restore funds, or to contribute a sum of money to the assets of the company (as the court thinks just).

Setting the scene
Debut Homes Limited operated a residential property development business; Mr Cooper was its sole director. In October 2012, the company was in financial difficulty and, in November 2012, Mr Cooper decided to wind down Debut’s operations. Mr Cooper made the decision to not take on any further work, but to complete and sell the company’s existing projects. At the time of this decision, it was forecast the company would be unable to meet its GST obligations of over $300,000 once the winddown was complete.

The company was not salvageable in the sense that even after continued trading it would still be insolvent. Mr Cooper, however, believed that completing the company’s existing projects, rather than selling them half-finished, would provide a higher overall return to creditors. Mr Cooper did not, however, consider the interests of all creditors, namely Inland Revenue.

Mr Cooper ran the company (without drawing any salary) until February 2014, when the company’s last project was completed and sold. In finalising these projects, Debut Homes had incurred further debt of approximately $28,000. In March 2014, Debut Homes was placed into liquidation by the IRD. At this point, the company owed more than $450,000 to the IRD. The liquidators brought proceedings against Mr Cooper for (amongst other things) breach of his director duties under the Companies Act, and sought an order under s 301 for compensation against him personally.

The High Court and Court of Appeal decisions
The key issue was whether Mr Cooper had breached his director duties by continuing to trade when the company was insolvent (or nearly insolvent). The particular director duties in question were the duties to:

• Act in good faith and in the best interests of the company (s 131 of the Act)
• Not allow the company to be carried on in a manner likely to create a substantial risk of
• serious loss to the company’s creditors, commonly known as ‘reckless trading’ (s 135), and
• Not agree to the company incurring an obligation unless the director believes at that time, on reasonable grounds, that the company will be able to perform the obligation when due (s 136).

The High Court found that Mr Cooper had breached his director duties and he was ordered to pay $280,000 to the liquidators. Mr Cooper appealed.

The Court of Appeal overturned the High Court’s decision, on the basis that Mr Cooper’s decision to complete the existing developments was a sensible business decision. The court noted that if Debut Homes had sold its projects while incomplete, then the losses to creditors would have been even greater. The liquidators appealed.

To the Supreme Court
The Supreme Court considered whether it was a defence for Mr Cooper to assert that completing the company’s existing projects was a justifiable decision, given this would provide higher returns than immediate liquidation would have.

The court held that if a company reaches the point where continued trading will result in a shortfall to creditors and the company is not salvageable, then continued trading will be reckless and a breach of director duties.

It was not a defence for Debut Homes to assert that completing the properties was a sensible business decision. Mr Cooper knew that continued trading would still result in a shortfall, and accordingly he had breached s 135 of the Act, regardless of the fact some creditors would be better off and despite the overall deficit to all creditors being reduced.

Where there are no prospects of a company returning to solvency, it makes no difference that a director honestly thinks some of the creditors will be better off by continuing trading. Directors should not enter into a course of action that may result in some creditors receiving a higher return at the expense of incurring new liabilities which will not be paid. In this case, by continuing to trade, some creditors received more at the expense of the IRD. As the court put it, it is not legitimate ‘to rob Peter to pay Paul.’

The result
The Supreme Court reinstated the decision of the High Court and Mr Cooper was ordered to personally pay compensation of $280,000 to the company. The compensation sum could have been more, but the Supreme Court agreed with the High Court that a discount was warranted on the basis that Mr Cooper had worked for 18 months without pay to complete Debut Home’s projects. Mr Cooper was also ordered to pay the liquidators’ legal costs.

Options for directors
The Debut Homes case highlights that directors must be aware of the various mechanisms that are available if a company is facing insolvency or near-insolvency. The key mechanisms are:

• Liquidation: winding up the company
• Creditors’ compromise: this usually involves part of a company’s debts being forgiven. It must be approved by a majority of creditors, representing at least 75% of the debt owed to each class of creditor
• Court-approved creditors’ compromise: where the court agrees that a compromise is fair and reasonable to creditors, and
• Voluntary administration: an administrator is appointed to increase the prospects of a company surviving. This must be approved by a majority of creditors, representing at least 75% of the debt owed to each class of creditor.

Directors must take care
The decision in the Debut Homes case is relevant to directors of all New Zealand companies. The case highlights the risks for directors who continue trading when the company faces actual, or near, insolvency. If, as a director, you allow your insolvent company to continue trading without using one of the available formal or informal mechanisms, then you will breach your director duties and you are likely to incur personal liability.

A critical decision for directors is whether or not to continue trading. If you are a director of a company in financial distress, it is essential that you deal promptly with the situation and seek both legal and accounting advice as to your options. This should include considering the mechanisms available through the Companies Act 1993, such as liquidation, voluntary
administration or a creditors’ compromise.

(1) Vivien Judith Madsen-Ries and Henry David Levin as Liquidators of Debut Homes Limited (In Liquidation) v Leonard Wayne Cooper [2020] NZSC 100.

Related Articles

  • Auckland
  • Bay of Plenty
  • Canterbury
  • Coromandel
  • Gisborne
  • Hawke's Bay
  • Kapiti Coast
  • Manawatu - Wanganui
  • Marlborough
  • Nelson
  • Northland
  • Otago
  • Southland
  • Taranaki
  • Waikato
  • Wairarapa
  • Wellington
  • West Coast

Boyle Mathieson

Boyle Mathieson was established on a foundation of strategic, practical advice that focuses on solutions. Based in West Auckland, we offer a complete legal service for businesses and individuals.

At Boyle Mathieson we believe in building lasting relationships with our clients, based on trust and confidence in the consistently high standard we perform to

Region: Auckland

Phone: 09 837 6004

Sandford & Partners Lawyers

We are a medium sized Rotorua law firm practicing in areas of business and property law, public law and personal legal services.

We are professionals who listen, who seek to understand your needs, and give practical and usable advice. We thrive on the challenge of providing excellent legal work and aim to give you the highest level of service. For us, working for you means dealing with the little details as well as the big picture.

Region: Bay of Plenty

Phone: 07 348 6039

Argyle Welsh Finnigan

Argyle Welsh Finnigan is a leading law firm in Ashburton,  the town servicing mid Canterbury, New Zealand.

The firm employs a team of over 25 legal professionals, including three Senior Associate Solicitors, three Staff Solicitors and five Legal Executives.  Our firm provides quality legal services with a commitment to our clients and to understanding their individual needs and requirements. 

With more than one hundred years of combined legal experience, we are able to offer prompt and professional advice on a wide range of legal matters.

Region: Canterbury

Phone: 03 308 8228

Purnell Lawyers

There is nothing as inevitable as change. Since opening for business early last century, we at Purnell Lawyers have seen many changes both in name and in the people who have made up the members of our team. We have been privileged to have served the public throughout all of these times. 

We are confident that we will continue to bring top quality legal services to our clients well into the future.

Region: Coromandel

Phone: 07 868 8680

Woodward Chrisp

At Woodward Chrisp we strive to meet the needs of our clients by providing a wide range of high quality legal services within a supportive and collaborative environment.

Woodward Chrisp is the amalgamation of two long established Gisborne legal firms: Woodward Iles & Co and Chrisp and Chrisp. 

Region: Gisborne

Phone: 06 869 0900

Gifford Devine

For all life’s matters, the team at Gifford Devine have your back. Since 1896, our lawyers have been providing straight-talking, practical advice and advocacy to people, families and businesses in Hawke’s Bay.

As your legal champions, we’ll serve you as a trusted adviser, listen to your needs, offer plain English advice, and find a solution to get you the best possible outcome.

We have the expertise to identify potential legal issues, to help you make important decisions, and to realise your goals. We’re your legal champions for all reasons and at all stages of life.

Region: Hawke's Bay

Phone: 06 873 0420

BMC Lawyers

BMC lawyers has built a reputation for providing quality service and delivering real results. Our strength is our broad-ranging legal experience that gives us the ability to match clients with the right mix of legal skills for their particular needs.

Our legal professionals are passionate about what they do and work alongside a talented team of support and administration staff to make a real positive difference to our clients.”

Region: Kapiti Coast

Phone: 04 296 1105

Horsley Christie

Horsley Christie is a successful law firm based in Whanganui which offers a diverse range of legal services to the Whanganui Region and beyond and has done for over 100 years.

When you deal with Horsley Christie you do so in the knowledge that the firm is one of many law practices nationwide who are members of NZ LAW.

Region: Manawatu - Wanganui

Phone: 06 349 0090

Wain & Naysmith

Based in Blenheim, Wain & Naysmith Lawyers is a full service law firm, and a powerhouse for property, family and business law.

We pride ourselves in providing clear and cost effective legal solutions and practical advice for you, your family and your business.

Region: Marlborough

Phone: 03 520 6103

Knapps Lawyers

As a firm, we promise to look after you and treat you in a manner that we would expect to be treated by a professional services provider; we promise to use every available legal remedy available to us to resolve your issue and to do what you ask us to do in a timely manner.

We will hold in strict confidence all information that we acquire through our work for you and which concerns your business or personal information.  The only exceptions are where you authorise us to disclose such information or where we must do so by law.

Region: Nelson

Phone: 03 544 7888

Thomson Wilson

Thomson Wilson is a full service law firm based in Whangarei. We’ve been trusted lawyers for the Northland community and beyond for 75 years.

We act for individuals and families, businesses, public sector and other organisations. Whether you need no-fuss advice on a simple matter, or a team of legal experts. 

Our staff provide advice in most areas of the law, including property law, business law, trusts and estates, separation and divorce, resource management, criminal law and more.

We also offer expertise in specialist areas such as Maori land, local government law, farming and forestry.

Region: Northland

Phone: 09 430 4380

Sumpter Moore

Sumpter Moore is based in South Otago and has a proud history of having provided a broad range of legal services to personal clients and businesses since 1873. Generations of families have been able to rely on our advice and assistance, because Sumpter Moore has stood behind that advice for over 100 years.

Sumpter Moore has fully serviced offices in both Balclutha and Milton, our relatively small size means we can work closely with our clients and you know who will be personally responsible for your legal affairs. It allows us to have close control over the quality and timeliness of the advice you receive.

Region: Otago

Phone: 03 418 0066

Cruickshank Pryde

We are proud to provide a full suite of legal services to the regions of Southland and Central Otago. With our offices, located in Invercargill, Gore and Queenstown, equipped with the latest modern technology, we can service wider New Zealand and international clients with ease. Our areas of expertise include commercial, rural, business, employment, family, criminal, property, resource management and estate planning law.

Region: Southland

Phone: 03 214 4069

Welsh McCarthy

Welsh McCarthy practises in Hawera, South Taranaki. Predominant industries in the South Taranaki district are dairy farming, oil and gas. The South Taranaki area also has the largest one-site multi product milk processing facility in the world

We deal with company and commercial transactions, commercial and family law, farm and residential sales and purchases, estate planning and family and charitable trusts. A large part of the firm also deals in the area of family law.

Region: Taranaki

Phone: 06 278 5039

Edmonds Marshall

Edmonds Marshall, Lawyers, Matamata has been providing legal services to individuals and businesses since 1918, when the partnership was known as Buchanan & Purnell.

John Buchanan moved from Thames to Matamata to open another office of Buchanan & Purnell in 1918. Mr Buchanan was also Mayor of the Matamata Borough Council from 1941-1942 and he played a large part within the Matamata community, inaugurating several of the local sports clubs.

Region: Waikato

Phone: 07 888 8137

Gawith Burridge

Gawith Burridge traces its history back to 1875 when Charles Gawith first set up his practice. Since then the firm has undergone many changes, including a merger between Gawith & Co and Burridge & Co in 1998 to form our current practice.

Our firm draws on the breadth of expertise available from some of the region’s most senior legal practitioners, as well as the skills of those who have moved here from larger corporate environments.

As a result, we provide clients with a comprehensive range of legal services right here in the Wairarapa. We can provide you with legal assistance whether you are an individual or a company, with everything from setting up a Will to selling your farming business. 

Region: Wairarapa

Phone: 06 370 0000

Gillespie Young Watson

We specialise in Property, Commercial and Trust Law. When it comes to law firm size we are bigger than smaller and smaller than big. By limiting the work we do to our specialist areas, we like to think we bring together the best of big firm skill sets with the personal care, attention and relationships of small firms.

We expect our clients to receive clear, practical and timely advice. We place a premium on accessibility and convenience to our clients. We value and appreciate all of our clients and want to do the best possible job for each of them. When we close a file we want the client to feel they have received exceptional advice, service and value.

Region: Wellington

Phone: 04 569 3997

No firms in West Coast

All the information published on this website, or in any article herein is true and accurate to the best of the authors' knowledge. Information on this site should not be a substitute for legal advice. No liability is assumed by NZ LAW Limited, or individual NZ LAW member firms for losses suffered by any person or organisation relying directly or indirectly on information published on this site. Views expressed in any article are the views of the authors individually and do not necessarily reflect the view of NZ LAW or their member firms. Information appearing on this site may only be reproduced with prior approval from NZ LAW Limited Head Office, and credit being given to the source. © NZ LAW Limited