COOL CARS (WHOLESALE) LIMITED (IN LIQUIDATION) v SHARMA & ANOR, [2014] NZHC 256

COOL CARS (WHOLESALE) LIMITED (IN LIQUIDATION) v SHARMA & ANOR, [2014] NZHC 256 [24 February 2014]IN THE HIGH COURT OF NEW ZEALANDHAMILTON REGISTRYCIV-2013-419-818[2014] NZHC 256UNDER THE COMPANIES ACT 1993, SECTION301BETWEEN COOL CARS (WHOLESALE) LIMITED(IN LIQUIDATION) a duly incorporatedcompany with a registered office 12Tristam Ave, Te Rapa, HamiltonPlaintiffAND IRENE REENITA SHARMA AKAIRENE REENITA KUMAR, companydirector, HamiltonFirst DefendantPREM WATI KUMAR, business person,HamiltonHearing: 13 February 2014Appearances: Mr D Hayes for PlaintiffMr S McKenna and Ms A Brooke for DefendantsJudgment: 24 February 2014JUDGMENT OF ASSOCIATE JUDGE J P DOOGUEThis judgment was delivered by me on24.02.14 at 5 pm, pursuant toRule 11.5 of the High Court Rules.Registrar/Deputy RegistrarDateBackground[1] The plaintiff company which is in liquidation agreed to sell a property atAvalon Drive, Hamilton to a company called No 1 Motors Limited ("No 1"). Theparties entered into an unconditional agreement for sale and purchase. The agreed sale price was $790,000 plus GST and the date of settlement was fixed at 12 March 2008. However, No 1 failed to obtain finance and did not settle the transaction. On 18 April 2008 the plaintiff cancelled the agreement and subsequently resold the property on 16 May 2008 at a reduced price of $769,000 plus GST.[2] The plaintiff brought proceedings in the District Court to recover the loss thatit suffered as a result of No 1's failure to settle the transaction. On 20 September2010, Judge Spiller entered judgment for the plaintiff against No 1 for damages including loss on resale, real estate commission, legal fees and other matters with the total figure being $81,145.11. No 1 had no assets to satisfy this judgment and the plaintiff is now pursuing the first and second defendants personally.[3] Mr N J Hayes was appointed the liquidator of the plaintiff company on 30 September 2010. No 1 was placed in liquidation on 22 August 2013. Mr Hayes was apparently appointed liquidator of No 1 as well, a point which has been raised by the first defendant, but in the circumstances of this case that does not seem to affect the outcome of the present claim.[4] The plaintiff brings these proceedings against the first defendant, who was a director of No 1, alleging that she breached her obligations under ss 131 – 137 of the Companies Act 1993 ("the Act"). The second defendant is sued as a "deemed director" who allegedly, too, breached his obligations under ss 131-137. However summary judgment is not being sought against the second defendant.Summary judgment principles[5] The correct approach to summary judgment applications was explained in the following passage from Krukziener v Hanover Finance Ltd:11 Krukziener v Hanover Finance Ltd [2008] NZCA 187, [2010] NZAR 307 at [26] per Miller J (citations omitted).The principles are well settled. The question on a summary judgment application is whether the defendant has no defence to the claim; that is, that there is no real question to be tried. The Court must be left without any real doubt or uncertainty. The onus is on the plaintiff, but where its evidence is sufficient to show there is no defence, the defendant will have to respond if the application is to be defeated. The Court will not normally resolve material conflicts of evidence or assess the credibility of deponents.[6] I intend to be guided by that approach.Background to claim[7] The particulars of breaches alleged against the first defendant are stated in the following terms:Particulars of failingsIn particular the defendant: failed to act in good faith when she made a false representation that finance was available to complete the agreement; agreed or caused the company to enter into the agreement in such a way as it waslikely to create a substantial risk of serious loss to the company's creditorsand that the company had no means to finance the purchase; (or if it did have the means, failed to utilise that means); entered into the unconditional agreement without reasonable grounds for believing the company would perform the obligation to pay for the purchase; did not exercise the care, diligence and skill that a reasonable director would do in the circumstances which would require making the agreement conditional on finance.[8] Some additional features of the agreement for sale and purchase need to be explained. The funding of the purchase price was apparently to be made entirely from borrowed money. The $790,000, the first defendant says, was going to be paid as follows:$525,000 from a bank$ 90,000 vendor finance$100,000 from her parents$ 75,000 from Vikon Finance Limited.[9] In the affidavit which she has provided Ms Sharma said that shortly after the agreement was signed she approached a mortgage broker who was authorised on her behalf to arrange finance. She annexes to her affidavit a letter from that broker which is in the following terms:Hi IreneThank you for your application and had the opportunity to have it run past BNZ. They are prepared to provide finance for the sum of $525000 less our fees of $5000 therefore making the net advance to you for the sum of $520000.Can you please provide me with the details of how the balance of the purchase price will be made up or do you want me to source second mortgage on the property. If you do, I will need to meet and discuss with you. Can you also provide me with the copy of the lease so that this can be forwarded to the bank.[10] The significance of the reference to the lease needs to be explained. The agreement contained the following provision:16.0 The Purchaser shall continue to secure and guarantee the subject properties being leased to a company approved by the vendor at a monthly rent of $5,000.00 plus GST and outgoings for a term one(1) day after the date of settlement and the Purchaser shall be responsible for the performance of all obligations of the lessee and its liability.[11] It appeared that the property to be acquired was going to be occupied by some third party under a lease or tenancy. Further, the possession date under the agreement for sale and purchase was the date on which it was executed, 1 September 2007, while settlement of the transaction was not until March 2008.[12] It is not immediately apparent what the object of this clause was but it would seem that the purchaser would be required to arrange for the premises to be leased to"a company approved by the vendor". That taken together with the other provisionsof the leasing agreement suggest that a company other than the purchaser would be occupying the premises and that the purchaser would be liable for the rent up until one day after the date of settlement.[13] It is also necessary to mention in a more detail another aspect of the agreement and that is the reference to the proposed advance from Vikom Finance Limited. The director of that company was the second defendant Mr Kumar, the husband of the first defendant. Mr Kumar testified that:In 2008 Vikom Finance Ltd had agreed to provide finance of $75,000 to No 1 Motors Limited as partial funding for the purchase of commercial property at 30 and 32 Avalon Drive.Issues[14] The key issue in a summary judgment application is whether the plaintiff can satisfy the Court that the defendant has no defence.[15] The ground for defence which is stated by Ms Sharma in her notice of opposition is in the following terms:The First Defendant has a valid defence to the Plaintiff's claim, namely thatat the relevant time the Agreement was entered into, the First Defendant believed on reasonable grounds that the company would be able to complete the Agreement.[16] It is apparent from the way in which the defence is formulated in the notice of opposition that Ms Sharma does not dispute that she was a director of the company nor that the obligations in ss 131 to 137 of the Act apply to her. She does not contend that the company did not suffer the loss which is pleaded in the statement of claim and nor did she contend that she is not liable for that loss in the event that the Court concludes that she was in breach of the statutory duties to which I have just referred to.[17] The plaintiff asserts that the entry into an unconditional contract without first providing for finance amounted to a representation – to whom is not named but presumably to the vendor – that the purchaser had the necessary finance in place to enable it to complete its obligations under the contract. The second part of the grounds are more orthodox. The plaintiff contrasts the conduct of the first defendant with the required skill, care and diligence expected from a company director which is cast in statutory form particularly in ss 135 and 137 of the Act.Relevant Law[18] Mr McKenna made the following submission about the effect of the four sections which are under consideration in this case:13. Sections 131, 135, 136 and 137 of the Companies Act 1993 establish a series of duties owed by a director, primarily to the company and its shareholders, but in some circumstances, particularly when liquidity is in doubt, to creditors of the company.14. The Director's duties established by each of these sections arelargely interrelated. In this case the duties established by each section overlap to a large degree and ultimately converge in a few central issues.[19] There is much to be said for this submission. It is not necessary to review the scope of s 131 in detail. This fundamental duty in s 131 has primarily focussed on adirector's disloyalty and self-interest. In my view the circumstances of this case best match ss 135, 136 and 137. It is on those sections that this judgment will concentrate.135 Reckless tradingA director of a company must not—(a) agree to the business of the company being carried on in a manner likely to create a substantial risk of serious loss to the company's creditors; or(b) cause or allow the business of the company to be carried on in a manner likely to create a substantial risk of serious loss to the company's creditors.136 Duty in relation to obligationsA director of a company must 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 it is required to do so.137 Director's duty of careA director of a company, when exercising powers or performing duties as a director, must exercise the care, diligence, and skill that a reasonable director would exercise in the same circumstances taking into account, but without limitation,—(a) the nature of the company; and(b) the nature of the decision; and(c) the position of the director and the nature of the responsibilities undertaken by him or her.Discussion[20] The following comments can be made about the factual position leading up to the execution of the unconditional agreement to purchase the property at Avalon Drive.[21] The key component in the financing of the project was the proposed loan from the Bank of New Zealand ("BNZ") in the amount of $525,000. The letter which the finance broker sent to Ms Sharma drew attention to BNZ's interest in thedetails of the tenancy. While the enquiry from BNZ is not elaborated any further, it is obvious from the circumstances that the question of the lease of the building was relevant to the likelihood of BNZ proceeding with any finance offer. In general terms a company director would not be acting prudently by entering into an agreement for sale and purchase where money had to be borrowed to fund the acquisition without making the agreement subject to finance. There may be particular cases where the purchaser has a guaranteed credit line where there is no doubt that the purchaser will have the funds to settle. In such circumstances it may be acceptable for a company to contemplate an agreement which is not conditional upon finance. However that is a far cry from the fact situation in the present case. As Ms Sharma herself acknowledges, the bank required a copy of the lease of the premises. Obviously that requirement was so the bank could assure itself that the purchaser would be able to service the borrowings from income received from the lease and possibly other sources. But as Ms Sharma accepted in her affidavit:This was a problem however as the lease was a month to month lease and there was not actually any lease documentation available.[22] To conclude this part of the assessment, the position may be summarised by saying that BNZ may have been prepared to make an advance when suitable assurances were given to it about the lease. However, two points can be made. The first is that there was never going to be any suitable assurance available to give to the bank about the lease because the premises were not commercially leased but were subject to a monthly tenancy. It is unlikely that such an arrangement would provide the bank the level of assurance required before advancing the funds. The second point is that even if that were not the case, Ms Sharma cannot have had reasonablegrounds to suppose that the BNZ money was practically guaranteed as she did noteven have the minimal assurance that would come from the receipt of the broker'sletter at the time when she signed the unconditional agreement, on or about 1 September 2007. The broker's letter did not come to hand until nearly two monthslater.[23] Given that Ms Sharma knew that it was unlikely she would be able to satisfy the requirements of BNZ in relation to the lease, my conclusion is that the company took a risk in entering into an unconditional arrangement to purchase the building. The discussion concerning the factual situation in this case indicates that there have been breaches of the duties which the director owed to the company under a 135. In addition, I consider Ms Sharma has also acted in breach of ss 136 and 137 of the Act.[24] I will now address the arguments put forward by Mr McKenna.Submission concerning time at which finance ought to have been available[25] Mr McKenna submitted that where a company director commits his or her company to an agreement for sale and purchase without first having finance arranged, this does not necessarily constitute a breach of obligation. The key point of time at which finance must be arranged, he submitted, was at the time when the company would actually be required to settle.[26] No doubt that is strictly correct where a company does not have finance arranged but if there is a high probability that it will be able to arrange finance in time, the company director may not be running any great risk. However, that is not the situation here. There is no evidence that No 1 did not have finance available at the time of execution but had good prospects of getting it in time for settlement. In the absence of any other explanation such as an unexpected change of circumstances with the funding source, the Court has to infer that there never was a good prospect of finance being available in time.The unavailability of vendor finance[27] For the first defendant Mr McKenna also submitted that the company'sdifficulties resulted from the vendor company failing to provide the $90,000vendor's finance pursuant to a special condition under cl 15.0 of the agreement forsale and purchase.[28] The notification that vendor finance would not be available was communicated to No 1 on 20 March 2008. By that date a cheque which No 1 had paid for the rent of the property had been dishonoured. It seems clear that from that point the purchaser was in breach of the combined agreement for sale and purchase/renting arrangement. That being so, it is doubtful that the vendor would have been required to remain ready and able to provide vendor finance on settlement of the purchase. But in any case, it had become clear that the purchaser was not going to be able to raise the main part of the finance required from BNZ. This became apparent from the letter that No 1's solicitor wrote to the vendor's solicitorson 20 March 2008. In that letter the solicitor, Mr Nolan, did not rule out the possibility of solving the finance problem at some time in the future.[29] On 20 March the vendor's solicitor Mr Patel forwarded a settlement notice requiring the purchaser to be in a position to settle within 12 working days after the date the notice was served. When that was not complied with, the vendor cancelled the agreement on 18 April 2008.[30] Judged overall, what happened in this case was that a purchaser which did not have the required assurance of finance to settle a purchase agreement entered into an unconditional contract. Details of what the various components were of the financing package that it hoped to put together are irrelevant. No 1 was never in a position to finance this purchase. If it was not insolvent at the time that it entered into the contract it was insolvent not long afterwards. This is a fact that is demonstrated by the dishonour of the rental cheque.Loss to third parties[31] The first defendant submitted that the obligations which are contained in the sections of the Act under consideration are primarily owed by the officer of the company to the company itself. Mr McKenna however, responsibly, accepted that in circumstances where the conduct poses a risk to creditors of the company, theresulting risk may be sufficiently cogent to represent a breach of directors' duties.Cases such as Nicholson v Permakraft (New Zealand) Ltd (in liq) stand for the proposition that directors must consider the interests of creditors once the company becomes insolvent or is operating in circumstances of marginal solvency.2[32] This case is one of a company entering into a 100 percent financed arrangement for the purchase of a property. The fact that it was putting none of its own resources into the transaction gives rise to an inference that it had none to contribute. Further the default under the cheque and the very circumstance that the company was unable to rescue itself when a failure under the contract was imminent further gives rise to inferences that it was not seen as a good prospect by financiers and that it had no substantial resources of its own. No 1 was still looking to outside financing right until the end. In such circumstances I have no doubt that the conduct of the affairs of the company carried with them a substantial and proximate risk to creditors. The liquidator is therefore entitled to invoke the statutory duties that it does as the basis for a claim.An acceptable level of risk under s 135?[33] Mr McKenna made the valid point that it has always been accepted that commercial undertakings take risks and that is one of the reasons why the benefit of limited liability was conceived. However, it is made clear by s 135 that there are limits to the type of risks that business people are entitled to take.[34] The assessment of whether a risk contravenes s 135 requires consideration of the spectrum between a legitimate risk to creditors and a "substantial risk". It must2 Nicholson v Permakraft (New Zealand) Ltd (in liq) [1985] 1 NZLR 242 (CA).be noted that directors cannot be penalised for merely taking risks as such risk to creditors is implicit in business.3[35] The term "a substantial risk" appears to indicate that the section is notconcerned with minor risks or risks that are unlikely to cause serious loss to thecompany's creditors. The probability that there will be loss and the extent of thatloss would seem to be key indicators of whether there has been a breach of the section.[36] Again, "serious loss" is a context-sensitive expression. The company may have thousands of creditors who are only owed a small amount and yet the aggregate losses on a failure might come to hundreds of thousands or millions of dollars. The smaller total loss but one which is incurred by only one creditor may qualify as"serious loss", depending upon the circumstances of that creditor and its ability toabsorb the loss.[37] An acceptable level of risk is considered in Re South Pacific Shipping Ltd (in liq).4 In his judgment in that case William Young J considered earlier authority including Thompson v Innes where Bisson J concluded that any risk in excess of a"negligible risk" that loss would be caused would suffice.5 William Young J referred to an article in which Professor L S Sealey stated:6What the law has to ensure is that the risks which the company elects to embrace fall within the range of legitimate business risks, consistently with the expectations of all those whose interests are at stake, creditors and members alike.[38] William Young J then went on to say:7For the reasons referred to by Professor Sealy, I am perfectly satisfied that s 320 cannot have been intended to penalise directors merely for taking risks. This section presupposes the distinction between what Professor Sealywould regard as "legitimate business risks" and illegitimate business risks. I3 Re South Pacific Shipping Ltd (in liq) (2004) 9 NZCLC 263,570 at [123].4 Re South Pacific Shipping Ltd (in liq) (2004) 9 NZCLC 263,570 (HC).5 Thompson v Innis (1985) 2 NZCLC 99,463 (HC).6 LS Sealy "Directors' wider responsibilities – Problems Conceptual, Practical and Procedural" (1987)13 Mon LR 164 at 181.7 Re South Pacific Shipping Ltd (in liq) (2004) 9 NZCLC 263,570 (HC) at [123].am of the view that it is only the taking of illegitimate business risks which warrants a finding of reckless trading.[39] After reviewing other authorities William Young J set out a number of considerations which provided an indication of whether a business risk was legitimate. One of the indicia was whether the risk was fully understood by those whose funds were in peril. The Judge said: 8It would be contrary to the principles of limited liability (which, amongst other things, promote the taking of risks) to find directors liable where risks which were recognised by creditors have crystallised ...[40] I have mentioned this authority because Mr McKenna suggested that the plaintiff as the vendor would have had some understanding of the risk inherent in dealing with the defendant company. The risk was said to have arisen from the fact that No 1 was incorporated on 1 September 2006 which is apparently the date when the sale and purchase agreement was signed. It was said that the vendor could have made enquiries that would have made it aware that it was entering into a contract with a newly formed company with no existing business activities and therefore no cashflow and no assets. However the submission proceeds on the basis of an erroneous assumption. The company was apparently incorporated a year before the date of the agreement for sale and purchase. Even had the submission being correct as to the chronology, I would not have regarded the point as being a weighty one. There are other more significant considerations which bear upon the question ofwhether the vendor was taking a risk in entering into a contract with Mrs Sharma'scompany.[41] In my assessment, the general position must be that a vendor of real estate is able to assume that the purchasers, if they are behaving rationally, will only enter into an unconditional contract to purchase real estate where they have a realistic and sensible understanding that they will be able to obtain the necessary finance to proceed with the transaction. There is no reason in this case to assume that the vendors knew otherwise. A vendor does not have to assume that the counter party to the transaction is behaving so improvidently that there is a serious risk that they will8 At [125].not be able to complete the transaction – at least where there is no circumstances that come to the attention of the vendor which suggest that there is such a risk.[42] I do not accept the submission made for the defendant about knowledge of risks on the part of the purchaser/plaintiff constituting a reason for declining relief.[43] Knowledge can be relevant as a factor that indicates against the breach of the obligation in s 135. The reason is that another party can hardly complain about loss that it suffers where it has entered into arrangements with its eyes open to circumstances relating to the other party which means that there is a high level ofrisk. If William Young J's comments in Re South Pacific Shipping Ltd (in liq) wereto be interpreted as imposing an obligation on parties to arm's length commercialtransactions for the sale of real estate to conduct enquiries into the solvency of the counter-party, this would partially deprive s 135 of its efficacy.[44] Another indicia which William Young J considered relevant was whether the transaction was commercially orthodox in nature. When such a criterion is applied in this case, the answer must be in the negative. Even though there was no expert evidence as to the undesirability of parties entering into unconditional contracts for the sale of real estate without finance arranged, I am prepared to regard that as being self-evidently what orthodox business practice would not call for in most cases.[45] Little information is available here about the nature, the capital structure and size of the vendor company which is the creditor that was exposed to the loss. One can say that such evidence as is before the Court suggests that it is the owner of a commercial site of moderate value in the suburbs of Hamilton. It is a private company.[46] The failure of the vendor to settle exposed it to potential loss on the resale of its property, together with legal and associated costs. It is unclear what the position was as to the rental income from the property. There is no suggestion that it terminated a tenancy in order to provide possession to the purchaser.[47] The losses that were actually incurred in this case are not trivial. Nor could it be said that the first defendant could not reasonably foresee that they were likely. I therefore consider that in this case the director of No 1 breached s 135 in that she carried on business in a manner likely to create a substantial risk of loss to thecompany's creditors. The risk that the purchaser ran in entering into an unconditional contract without first arranging finance was outside the range of what could fairly be described as a legitimate business risk. In coming to that conclusion I also have regard to the fact that there is nothing in the evidence which suggested that there was going to be any advantage to the purchaser which justified the hazardous element in its dealings.[48] In my view the requirements of s 135 are established.Section 136[49] Mr McKenna referred to the fact that the duty imposes both subjective and objective tests. The director must have actually believed that the company would be able to perform the obligation when it was required to do so and that belief must be based upon reasonable grounds. I will assume for present purposes that the first part of the test, the subjective element, is satisfied in this case. There is no evidential basis, bearing in mind that this is a summary judgment application, for concluding to the contrary.[50] The s 136 duty is satisfied if the director holds a reasonably based opinionthat the company "will be able to" perform the obligation when required. Theterminology in my view requires a belief that there is a reasonably high level of certainty which is reasonable in the circumstances that the company will be able to perform the obligation. Absolute certainty that the obligation would be performed is not required. Such a requirement would not make due allowance for the inherent uncertainty in human affairs. The director is however required to believe that there is no apparent risk that the company will not be able to perform the obligation.[51] The director in this case had no reasonable basis for coming to such a conclusion. At the time when the obligation that was incurred – that is the time when the unconditional agreement was signed – there was no certainty that the100 percent funding required would be forthcoming. There was no justification to assume that if borrowing was not successful, the company could complete the transaction from its own resources. Nor could it have been a realistic prospect that those standing behind the company could make up any shortfall from their private resources. There is no indication of any source of income which would satisfy a lender that the company would be able to service borrowings. In her affidavit Ms Sharma refers to the fact that income could be expected from the lease over the property which was to be acquired. However that tenancy was on a monthly basis and there was no documentation of it.[52] Because that inference will stand unless rebutted by evidence from the director, and because there is no evidence showing the basis for a relevant reasonable belief, the plaintiff has established on the balance of probabilities that there was a breach of s 136.[53] Mr McKenna made a submission that the borrowings from the bank would have only constituted 73 percent of the required purchase price. He contrasted thatpercentage with what he described as the "industry standard" of an 80 percent lending threshold.[54] I do not consider that as a realistic submission.[55] As I have already noted, the vendor was dependent upon 100 percent finance. I note that the evidence is unparticularised and uncorroborated so far as the allegedadvance from Ms Sharma's parents is concerned. Nothing is said about the details of the alleged arrangement and what was required in terms of security, term, interest rates. The same shortcomings are evident in the suggested finance from Vikom Finance Limited. There is no evidence whatsoever that it would have been possible for the second defendant to observe the requirements of prudential lending in the matter of security and debt servicing ability of the borrower.[56] The Court cannot enter judgment on these matters if it is satisfied that there is an arguable defence. Applying the principle in Krukzeiner, it becomes evident that once the plaintiff established that No 1 had entered into a transaction without firstarranging finance, it became incumbent upon the first defendant to produce some evidence to show that she had a belief based on reasonable grounds that financewould be available. A bland statement that the purchase price was "going to be paid" by the various borrowings is not sufficient. I accept that Ms Sharma was not subject to a burden of proving that that her belief was reasonably based but she needed to provide some evidence which would enable the Court to conclude that it was fairly arguable. After reading her affidavit the Court is left no wiser as to whether the belief which she claims to have was reasonably based.[57] In my assessment, the plaintiff is entitled to judgment on the s 136 cause of action.Relief[58] In the notice of opposition which the first defendant filed she did not state any grounds upon which relief against her should be limited or reduced in the event that liability was established. Mr McKenna sought to go into such matters at the hearing but because of the absence of any stated ground of defence I would not permit that course to be followed.[59] The position then is that there is no material before the Court which would lead to other than the conclusion that the loss that was suffered was attributable to the defaults of the first defendant. An attempt was made to show in relation to the question of liability, that the proprietor of the vendor company, Ms Jacobs, may havecontributed to the plaintiff's problems by failing to make any or sufficient enquiriesabout the ability of the vendor company to complete the transaction. I thenexpressed the view that in what appeared to be an arm's length transaction of thiskind, it was unlikely that the vendor was under such an obligation.[60] There are no other grounds upon which the Court should excuse or exonerate the first defendant in regard to part of the loss. Therefore, my view is that the first defendant is obliged to bear the entire loss. There will therefore be judgment against her in the sum of $81,145.11 plus interest that the rate of $338.10 per month since 21 September 2010.[61] The parties should confer on the question of costs and if they are unable to agree they are to file memoranda not exceeding five pages on each side within 10 working days of the date of this judgment._____________J.P. DoogueAssociate Judge