Supreme Court ruling may have implications for Covid-19 financial hardship, lawyers say

More than 600,000 New Zealand companies risk losing limited liability protection unless they are more cautious when faced with financial difficulties, say attorneys who acted in a landmark Supreme Court case.

The litigation, which focused on Debut Homes Limited (Debut) and the actions of its director Leonard Cooper, is the first time that the country’s highest court has fully considered the duties of directors.

The Supreme Court ruled that if a business reaches the point where it is clearly unrecoverable and continued trading will result in a deficit for creditors, directors must immediately close or at least ensure that creditors fully understand the risks.

The ruling, issued late last month, may have implications for directors facing financial difficulties due to Covid-19.

It could also have a major impact on other proceedings, including the upcoming Appeals Court decision in Mainzeal v Yan, involving former Prime Minister Jenny Shipley, lawyers who were successful in the Debut case said.

Meredith Connell’s Nick Malarao and Phil Shackleton, who acted for the Debut liquidators, said the directors of the country’s more than 600,000 companies must realize the implications of the ruling.

“If your business is in trouble, failure means you have to carefully consider whether to continue and by whom. [this decision] it can affect, including the IRD, your bank and other people to whom you owe money, “said the specialist in tax and company law.

“Unless creditors know what is happening and support you, you cannot continue to operate without risking violating reckless business operations and other provisions of the Corporation Law, and if you breach these provisions, you risk losing protection. limited liability “.

Malarao, who was a member of the Fiscal Working Group, added that the decision has become even more relevant to directors after the government’s Covid-19 “Safe Harbor” protections ended on September 30.

Shackleton, who acts in banking, financial and insolvency cases, said the guidance provided by the Supreme Court will help directors and creditors navigate the challenges companies face in the Covid-19 era.

“The ruling encourages collaboration with creditors, and that collaboration should result in fewer companies getting into really serious trouble,” he said.

The case: ‘I should have stopped trading’

In 2012, Cooper, a residential property developer, decided to shut down Debut Homes due to financial problems.

While existing developments will be completed, no new developments will be undertaken.

When this decision was made, it was forecast that there would be a deficit of more than $ 300,000 in goods and services taxes (GST) once the settlement was complete.

Debut was then placed in liquidation in March 2014 through the application of the Public Treasury.

When the case went to court, the main question was whether Cooper had breached the duties of its directors under the Companies Act of 1993. There was also a debate as to whether a blanket security arrangement that secured advances from Cooper’s family trust should partially void.

In 2018, the High Court initially determined that he had breached his obligations and rejected a defense based on professional advice.

He ordered Cooper to contribute $ 280,000 to Debut assets and struck down the blanket security agreement.

However, Cooper challenged the ruling and won, and the Court of Appeal overturned the Superior Court orders.

This case was later appealed by Debut liquidators to the Supreme Court with a hearing held in October of last year, before a ruling was issued on September 24 of this year.

The tribunal of Chief Justice Helen Winkelmann and Justices Joe Williams, Susan Glazebrook, Mark O’Regan and Ellen France unanimously reinstated the Superior Court orders.

Cooper was also ordered to pay costs of $ 25,000.

“Debut was insolvent at the beginning of November 2012. It could not pay its debts and it was projected that the continuation of operations would cause a GST deficit of at least $ 300,000,” the ruling read.

“It should have stopped operating at that time unless a viable formal or informal mechanism was found.”

The course of action taken by Cooper, the judges found, meant that he was violating his
obligations under the law.

“This is because there was a certainty of a loss of at least $ 300,000 to Inland Revenue.

“Additionally, at no time did Cooper revise his strategy, despite the overall business position being worse than the projected cost estimates in November 2012.”

Cooper did not consider the interests of all creditors and the breach was also compounded by his conflict of interest, the court said.

Looking at the bigger picture of directors’ duties, the justices said that if a business reaches the point where continuation of trade will result in a deficit for creditors and the business cannot be salvaged, continuation of trade will violate Article 135 of the Public Limited Companies Law.

“When there is no prospect of a company returning to solvency, it doesn’t matter if a director honestly thinks that some of the creditors would be better off if they continued to operate.”

“There are other alternatives to liquidation open to directors where continued operations are projected to result in a deficit.”

The full ruling of the Supreme Court can be read below or at this link.