EAST COAST ALUMINIUM LTD (IN LIQUIDATION) & ORS v PERRY & ORS [2017] NZHC 317 [5 March 2018]

EAST COAST ALUMINIUM LTD (IN LIQUIDATION) & ORS v PERRY & ORS [2017] NZHC 317 [5 March2018]IN THE HIGH COURT OF NEW ZEALANDROTORUA REGISTRYI TE KŌTI MATUA O AOTEAROATE ROTORUA-NUI-Ā-KAHU ROHECIV-2016-463-000184[2018] NZHC 317BETWEEN EAST COAST ALUMINIUM LIMITED(IN LIQUIDATION)First PlaintiffVIVIEN JUDITH MADSEN-RIES ANDHENRY DAVID LEVIN as Liquidators ofEast Coast Aluminium Limited (InLiquidation)Second PlaintiffsAND PATRICIA MERTLE PERRYFirst DefendantDONALD GRAEME PERRYSecond DefendantANTONY DAVID SANDFORDFLEMINGThird DefendantHearing: 11-14 September 2017, further submissions on 31 January 2018Appearances: N H Malarao and G A Campbell for the PlaintiffsD M Fraundorfer and T J Conder for the First and SecondDefendantsAppearance excused for the Third DefendantJudgment: 5 March 2018JUDGMENT OF PALMER JThis judgment is delivered by me on 5 March 2018 at 11.30 ampursuant to r 11.5 of the High Court Rules......................................................Registrar / Deputy RegistrarSolicitors:Meredith Connell, AucklandHolland Beckett, TaurangaSummary[1] There can be a great temptation, when running a closely-held company, to mixpersonal and business expenditure. And when in financial difficulties, it may betempting to pay creditors with funds that should be used for tax. But a company islegally distinct from its shareholders and directors even when closely held. And PAYEand GST are not a company's or its directors' funds to use. East Coast Aluminium Ltd(ECA) got into financial difficulty and was eventually liquidated by Inland Revenuein 2013. Mr Perry, the principal operator and one of its shareholders and directors,was bankrupted by Inland Revenue. The other shareholder and director was his wifeMrs Perry, who did the accounts. Now the liquidators, on behalf of ECA, seekcompensation for the Perrys' use of ECA funds and breaches of director duties.[2] I accept ECA was insolvent by 31 March 2010. Mrs Perry must repay the jointdrawings taken since then, which make up the shareholders' Current Account debt of$132,980 plus interest. That includes payments of mortgage instalments on theWestpac 91 and 92 loans for the house owned by the Perrys' family trust. It does notinclude payments on the Westpac 93 loan which was for the benefit of ECA. Giventhat conclusion, I do not need to decide whether the Perrys made prejudicialdispositions which should be restored under s 346 of the Property Law Act 2007.[3] The remedies of backwards tracing into the house, or an equitable lien arisingon it, are not available here. The remedy of equitable subrogation is potentiallyavailable but should not be granted here because the recovery of a monetary sum issufficient to restore the unsecured plaintiff to the position they should have been in.Given the liquidators' success otherwise, I do not award further compensation under s301 of the Companies Act 1993 for the Perrys' breaches of directors' duties.What happened?The Perrys and ECA[4] Mr Don Perry and Mr Brian Monk incorporated ECA in June 1984. Mr Monkleft the company around 1986 and in 1988 Mrs Trish Perry became a director andequal shareholder. The Company was initially established to supply aluminiumjoinery in the Eastern Bay of Plenty under a franchise-type arrangement with CarterHolt Harvey Ltd.[5] ECA operated successfully for a number of years, employing around12 workers. However, in the late 1990s competition reduced its market share. ECAsignificantly reduced staffing and sold its premises. Its purchase of stock in advancewas limited by its overdraft facility from this point on. But it traded out of itsdifficulties. From 2000 to 2009, ECA was profitable or operated at a small loss.Mr Perry was the principal person operating the business and Mrs Perry did the day-to-day accounts in an office in her house, on top of her day-job in the healthcareindustry. The new leased premises had less storage space so the Perrys' house wasused for some storage.The house[6] The Perrys purchased their house in Ōpōtiki in April 1991, with a registeredmortgage in favour of BNZ. In December 1998 ownership of the house wastransferred to the DG & PM Family Trust, with a registered mortgage in favour ofWestpac. In return for the mortgage, Westpac made two loans to the Perrys, of $65,000(the 91 loan) and $78,000 (the 92 loan). In January 2000, the 91 loan was increasedby $20,000 and the funds injected into ECA. On 9 February 2009, the Perrys took outa third loan of $20,000 from Westpac, secured by mortgage over the house (the 93loan). These funds were also injected into ECA.Illness and financial difficulties[7] From around 2009, Mr Perry suffered from significant health problems.Because he was integral to the business, ECA's revenue dropped significantly and itexperienced financial difficulties.1 ECA could not afford to generate annual accountsduring this period.2 Mrs Perry continued to keep a ledger, reconciling bank statementswith invoices and cheque butts. Where there was no identifiable invoice or cheque-butt notation, Mrs Perry responsibly coded the item as "Perrys", indicating it was to1 Notes of Evidence (NOE) at 116/28–30 and 135/24–26.2 NOE at 95/17–19be listed as drawings. The annual accounts for this period were subsequently preparedby Ezebiz Accountants Ltd, based on Mrs Perry's coding in November 2013, just priorto liquidation.3[8] Under cross-examination, Mr Perry stated ECA was not able to pay its GST, orall its PAYE on time.4 He conceded these were signs ECA was in significant financialdifficulty.5 He agreed that, in the first half of 2010, he decided to pay off Westpac andrent, to continue trading and to ignore Inland Revenue.6 The Perrys submit Mr Perryelected to defer paying GST in March 2010, until he was able to return to the businesson a full-time basis.7 The Perrys submit this decision was based on: the potential ofthe business to trade out of its difficulties; the non-urgency of tax obligationscompared with other debts which would have immediately have prevented trading; theavailability of assets from which the tax obligations could be met; and the chanceInland Revenue would not require ECA to pay the full debt.8 Under cross-examination Mr Perry accepted he decided not to use the equity in the house to payInland Revenue.9 He also accepted it would be fair to say that, in managing anddirecting ECA, he didn't really distinguish between ECA and himself and Mrs Perry.10[9] The Perrys say they believed ECA was solvent in terms of the balance bookand liquidity, during this period, because they considered ECA was able to call onfurther shareholder injection of funds, drawing on the equity in the house, if ECA wasrequired to meet repayments.11Liquidation[10] In 2013, Inland Revenue took steps to collect its debts from ECA. Paymentand compromises was discussed. Annual accounts and tax returns were filed. Butultimately, in late 2013, Inland Revenue decided to put ECA into liquidation. ECA3 NOE at 129/15-18.4 NOE at 97/21-25 and 111/4-6 corroborated by Mrs Perry in relation to GST at NOE 133/1-10.5 NOE at 111/17-19.6 NOE at 105/2-5 and 109/1-9.7 Defendants' closing submissions of 15 September 2017 [Defendants' Closing] at [3.14].8 Brief of Evidence of Donald Perry [Donald Perry Brief] at [43].9 NOE at 114/25-28.10 NOE at 121/19-24.11 Donald Perry Brief at [26] and [57]; Brief of Evidence of Patricia Perry [Patricia Perry Brief] at[9].was liquidated by the High Court on 2 December 2013. ECA's debt to Inland Revenuehad risen from $3,163.29 in GST, interest and penalties at end of the 2010 tax year, to$41,542.79 on liquidation.12[11] On liquidation, six claims totalling $81,200 were accepted from InlandRevenue, Chevron NZ Ltd, Ezebiz, McKechnie Aluminium Solutions Ltd(McKechnie), Mainfreight Ltd and Westpac. The Perrys have repaid McKechnie andWestpac in full and Ezebiz in part. ECA now owes $52,008 to Inland Revenue,Chevron, Ezebiz, and Mainfreight.[12] Mr Perry was bankrupted as a result of failure to pay personal income tax inJune 2014.13 He was discharged from bankruptcy in July 2017, after these proceedingscommenced.Proceedings[13] The liquidators, Ms Vivien Madsen-Ries and Mr David Levin, pursue thefollowing causes of action against the Perrys:(a) repayment by Mrs Perry of the amounts paid by ECA to the Perrys viathe shareholders' current account (the Current Account debt), totalling$143,452;(b) alternatively, repayment by Mrs Perry of the Current Account debtentered into after 31 March 2010 (when the liquidators say ECAbecame insolvent) as prejudicial dispositions under the Property LawAct 2007, totalling $104,558;(c) a proprietary interest of $72,032 in the Perrys' house due to thembreaching their fiduciary duties as directors by misapplying ECA fundsin using them to repay the Perrys' own mortgage;12 Bundle of Documents (BOD) at 565.13 NOE at 20–25.(d) compensation from Mrs Perry of $224,652 plus interest anddeclarations against both of the Perrys, under s 301 of the CompaniesAct 1993 for breach of directors' duties.[14] The trial was conducted in Rotorua over four days. I heard evidence fromMr Levin for the liquidators and from Mr and Mrs Perry for themselves.[15] At the beginning of the hearing counsel addressed me on objections toMr Levin's evidence as opinion evidence, submissions and evidence that requiresexpertise he does not possess. Mr Conder, for the Perrys, submitted the outcome ofthe litigation affected whether Mr Levin's fees would be paid as liquidator andquestioned his independence on the basis of potential unconscious bias. Mr Malaraowas content for Mr Levin's lack of independence to bear on the weight I accord hisevidence. He pointed out Mr Levin had been appointed liquidator by the Court. I donot consider Mr Levin's status as a liquidator disqualifies him from giving evidence.I did not take into account evidence that constituted submissions. I have takenMr Levin's position into account in assessing the weight to be accorded his evidence.[16] The third cause of action claiming a proprietary interest in the house is alsobrought against Mr Fleming, the third trustee in the Perry Family Trust. He abides theCourt's decision on certain conditions recorded in a joint memorandum of counseldated 9 August 2017, and was excused from the hearing by consent of the other parties.When did ECA become insolvent?[17] Mr Malarao, for the liquidators, submits ECA was insolvent by 31 March 2010,relying on the evidence of Mr Levin. Mr Perry conceded in cross-examination ECAwas not able to pay GST as it fell due from 2010.14 Mrs Perry also agreed that, around2010, there was not enough money to pay Inland Revenue.15 ECA's failure to pay itsdebts to Inland Revenue as they fell due from that date are a signal indication of seriousfinancial difficulties.14 NOE at 97/21–25.15 NOE at 133/26.[18] Mr Fraundorfer, for the Perrys, submits ECA remained solvent because of thepossibility of a cash injection from them as shareholders. He also pointed to goodwillas an asset. The possibility of converting a non-cash asset into a cash asset shouldonly be taken into account for the purpose of assessing solvency if realisation of theasset in that way was in contemplation by the debtor at the time.16 There is no hardevidence of that here. Indeed, the shareholders decided not to make such an injection.Neither the shareholders' Current Account debt nor goodwill were realisable assets, sothe company's net liabilities exceeded its assets. I accept Mr Levin's evidence thatECA did not satisfy either the cash flow test or the balance sheet test on 31 March2010. I accept the liquidators' submissions that ECA was insolvent from that date.Issue one: Does Mrs Perry have to repay the Current Account debt?Law[19] It is well-established that advances made by a company to its shareholders aredebts owed to the company by the shareholders, which are (absent a companyresolution to the contrary) repayable on demand.17 The liquidators are entitled to relyon the company's records.18 Insofar as a company's records, from which its financialstatements are derived, are deficient, the directors must accept responsibility.19[20] Where parties to a dispute about a transaction between a director and acompany rely on company records, the Court of Appeal has found it is appropriate toimpose an onus of proof on the director to establish the transaction was for fair value.20Otherwise, and except in relation to questions of excuse or justification raised by thedefendants, the onus of proof is on the plaintiffs. The standard of proof is the balanceof probabilities.16 Re Northridge Properties Ltd (in liq) SC Auckland M46/75, 13 December 1977 at 28.17 Thom Contractors Ltd (in liq) v Thom HC Auckland, CIV 2008-404-6829, 28 April 2009 at [16].18 New Zealand Game Meats Exports Ltd (in liq) v Lau HC Whangarei, CP34/98, 19 March 1999 at13; Chesterton Holdings Ltd (in liq) v Durney HC Napier, CIV-2011-441-007, 19 May 2011 at[27].19 Thom Contractors Ltd (in liq) v Thom, above n 17, at [17].20 Morgenstern v Jeffreys [2014] NZCA 449, (2014) 11 NZCLC 98-024 at [58], endorsed by theSupreme Court in Morgenstern v Jeffreys [2014] NZSC 176 at [8].Submissions[21] The liquidators seek to recover from Mrs Perry $143,452, the value of thetransactions they say comprise the Current Account debt owed by the Perrys to ECA,repayable on demand. They also seek interest from the date demand was made forrepayment, which was 6 August 2014. The liquidators do not pursue Mr Perry as hewas an undischarged bankrupt at the commencement of the proceeding. Theliquidators calculate the amount of the debt by:(a) adopting the closing balance of the current account as at 31 March2010;(b) adding the drawings recorded in the ledgers, subtracting interestcharges, adding the Westpac 93 loan repayments; and(c) adding the personal transactions in the ECA bank statements from1 April 2013 until liquidation.[22] Mr Fraundorfer, for the Perrys, submits the Current Account debt to ECA wasowed exclusively by Mr Perry. This is the subject of a late application for leave toamend the Amended Statement of Defence, which is opposed by the liquidators.Alternatively, if it were owed by Mrs Perry, Mr Fraundorfer submits the amount islower than that claimed by the liquidators because a number of items should berecorded as genuine business expenses such as salary and Mrs Perry should only beliable for half of the debt. Mr Fraundorfer submits Mrs Perry has paid that part of thedebt that was required to be paid, directly to the creditors concerned. He submits thelack of available evidence favours the Perrys, not the liquidators.[23] In respect of the payments he submits were salary, Mr Fraundorfer relies ons 161(5) of the Companies Act 1993 which provides that, where payment ofremuneration is made to a director without compliance with the requirements ins 161(1) and (4), the director will avoid liability to the extent he or she can prove thepayment was fair to the company at the time it was made.Decision[24] The claim the Current Account debt was owed by Mr Perry and not Mrs Perryis not sustainable. The references to the nominal "shareholder 1" by Ezebiz inreconstructing drawings on the accounts does not provide sufficient basis for theargument. Both Mr and Mrs Perry admitted the opposite in their Amended Statementsof Defence. Mrs Perry accepted, under cross-examination, the current account was ajoint responsibility.21 She coded the expenses as "Perrys". The Current Account wasin both of their names, as Mr Perry had to accept.22 They were both equal shareholdersand they were both directors. Even if I granted the application for leave for a latechange in the Perrys' pleadings, I would find as a matter of fact the Current Accountdebt was a joint liability of both of them. And since the liability is joint in law, MrsPerry is liable for the whole amount.[25] I consider the liquidators are entitled to adopt the methodology they do, tocalculate the Current Account debt, relying on the company's records consistent withthe case law referred to above. I agree the starting balance of $18,989 taken as at1 April 2009 is appropriate. It reconciles, through the 2008 and 2007 financialstatements, with the last timely set of financial statements from 2007.23[26] I also accept the drawings identified by Ezebiz as shareholder salary inreconstructing the accounts before liquidation from 2010 onwards, are not reallysalaries. Mr Levin agreed under cross-examination the Perrys had been paid salariesbefore 2010.24 And he agreed that less well-run companies allocate shareholdersalaries by deciding at the end of the year how much of the drawings taken during theyear should be kept, retrospectively creating a journal entry.25[27] But the drawings at issue here were individual transactions coded by Mrs Perryat the time as "Perrys". They were retrospectively coded by Ezebiz as salary in theaccounts formalised in November 2013, just prior to liquidation. Mr Perry's statement21 NOE at 137/14.22 NOE at 117/28–30.23 Brief of Henry Levin dated 11 September 2017 [Levin Brief] at [6.4] and BoD at 452A and 492.24 NOE at 42/30–43/7.25 NOE at 44/23–35.as director to the liquidators was that he did not take a regular salary.26 In Court, MrPerry stated the coding practice was "because we weren't actually drawing a salaryper se", suggested other payments may have been for building materials and said itwas "a little bit of a grey area".27 Mr Perry said he could not explain why Ezebiz hadallocated payments as salary as he did not take a regular salary, though he would haveliked to be able to pay himself one if the business was able to afford it.28 The evidenceof both of the Perrys was some payments may have been groceries bought by MrPerry.29 No PAYE was paid in relation to these payments, unlike in Madsen-Ries vPetera, relied upon by Mr Fraundorfer.30 Mr Perry confirmed there were no contracts,resolutions, minutes or anything like that in relation to what was coded as salary.31[28] I conclude the drawings coded as salaries after 1 March 2010, and as personaltransactions in the bank accounts from 1 April 2013 until liquidation, should beregarded as drawings, not expenses, in calculating the Current Account debt. For thatreason, s 161 is not relevant. Section 56 of the Companies Act 1993 (the Act) entitlesa company to recover, from the shareholder or directors, distributions made toshareholders when a company could not satisfy the solvency test.[29] Even if some of the drawings were remuneration falling under s 161, I wouldnot consider the Perrys proved they were fair to ECA at the time. Mr Levin acceptedthe small-scale drawings were "not an unreasonable amount for what I believe to bethe hours likely to be worked".32 Mr Perry continued working in the business and MrsPerry did accounts. But there is little to prove any salary was fair. These paymentswere not explicitly authorised, in advance or at all, by the directors collectively. ThePerrys did not distinguish, in advance, between their own expenditure and ECA's.There was no control over the amounts or the purposes of the drawings. There is noevidence to suggest any connection between the Perrys' work and the amount ofdrawings taken.26 NOE at 16/15–20, 114/9–10.27 NOE at 81/2–11.28 NOE at 114/9–10 and 114/21–22.29 NOE at 135/15–18 and 81/2–11.30 Madsen-Ries v Petera [2015] NZHC 538 at [50], upheld on appeal in Madsen-Ries v Petera [2016]NZCA 103.31 NOE at 114/17–20.32 NOE at 43/3.[30] I also do not agree ECA owed money to the Perrys in three respects, offeredby Mr Fraundorfer as alternative arguments:(a) Mr Fraundorfer submits ECA used the Current Account to paylegitimate business expenses totalling $65,000. But there is noevidence to support this proposition. The closest was Mr Perry'sevidence implying a $2,000 cheque for cash was related to ECA'snegotiation with a client over goods ECA purchased on TradeMe.33 Butthere is no evidence about what was purchased, or from whom, to allowme to assess whether that was a legitimate business expense.(b) The Perrys pleaded ECA was indebted to the Perrys (or their FamilyTrust) for use of the house, to the value of $22,000. This is notsupported by evidence. At trial, Mr Fraundorfer submitted anallowance should be made for ECA receiving value from the ongoinguse of the house. There is no evidence of documentation of such anagreement or its time-period or what the debt related to. Neither is thatamount allowed for in the financial statements of ECA.(c) The Perrys pleaded ECA was indebted to them for loans in 1995 and2000 for a total of $80,000. The liquidators submit that means theymust have been reflected in the 2001 accounts showing the Perrys owedECA almost $120,000 in 2001. If these loans were made, they shouldhave been reflected in the company's accounts and therefore in theCurrent Account debt. They were not.[31] I do agree with Mrs Perry's submission the Westpac 93 account was for thepurposes of a cash injection of $20,000 by the Perrys made on 9 February 2009. It isclassified in the ECA accounts as a term loan. Mr Levin accepted under cross-examination there was a "real question at large" regarding the $20,000 loan.34 But theliquidators maintained their submission this was a loan to the Perrys personally. I33 NOE at 87/26–35.34 NOE at 29/24–33.agree the payments of $10,472 made by ECA to Westpac in respect of the 93 loanshould not be added to the Current Account debt.[32] I conclude the Perrys are jointly liable, and therefore Mrs Perry is liable, torepay the Current Account debt to ECA (other than the payments for the Westpac 93loan) in the amount of $132,980, plus interest from 6 August 2014. It may be thiswould lead to a surplus in the liquidation, which would lead to some funds beingreturned to the Perrys as shareholders. But that repayment to ECA properly reflectswhat was the Perrys' money and what was ECA's.35Issue two: Are some debts preferential dispositions?Relevant law[33] Under s 344, the purpose of subpt 6 of pt 6 of the Property Law Act 2007 is "toenable a court to order that property acquired or received under or through certainprejudicial dispositions made by a debtor (or its value) be restored for the benefit ofcreditors ". Sections 345 and 346 clarify the dispositions to which that applies:(a) dispositions of property (including proceeds of property) made by adebtor;(b) "with intent to prejudice a creditor, or by way of gift, or withoutreceiving reasonably equivalent value in exchange";36(c) which includes where a debtor "must have known that in . . . hindering,delaying or defeating creditors' recourse to that property" the debtor"was exposing them to a significantly enhanced risk of not recoveringthe amounts owing to them";37 and35 Morgenstern v Jeffreys (CA), above n 20 at [103], Morgenstern v Jeffreys (SC), above n 20, at[11].36 Property Law Act 2007, s 346(1)(b).37 Regal Castings Ltd v Lightbody [2008] NZSC 87, [2009] 2 NZLR 433 at [52] (per Blanchard andWilson JJ), see also Property Law Act 2007 s 345(1)(a).(d) when the debtor was insolvent or engaging in a transaction for whichthe remaining assets were unreasonably small, or intended to incur (orbelieved, or reasonably should have believed) that the debtor wouldincur debts beyond the debtor's ability to pay.[34] Section 348 empowers a Court to vest property or require payment ofreasonable compensation, by a person who acquired or received property through thedisposition, if satisfied the applicant has been prejudiced by a disposition. Section 349prohibits a Court from making such an order where a person proves they acquiredproperty for valuable consideration, in good faith and without knowledge it was aprejudicial disposition. It also empowers the Court to decline to make such an order,or may make a more limited order, if there was no valuable consideration but theperson's circumstances have changed so it is unjust to order restoration of the property.Submissions on preferential dispositions[35] If the liquidators failed on issue one, Mr Malarao submits Mrs Perry is liableto repay the Current Account debt entered into after 31 March 2010, totalling$104,558, as prejudicial dispositions under the PLA. He submits all the requirementsof s 346 are satisfied by the transactions between ECA and the Perrys between 1 April2010 and 31 March 2013 and, after 31 March 2013, by the loan repayments by ECAfor the Westpac 91, 92 and 93 loans and the $2,000 cash cheque.[36] Mr Fraundorfer submits ECA was solvent when the relevant payments weremade and Mrs Perry did not receive the dispositions. I rejected those submissionsabove. Alternatively, he submits the amount required to be restored was limited bythe amount of creditors' debt unable to be repaid at the time. He submits they werenot unequal exchanges intended to prejudice creditors, so the requirements of s 346are not met.Decision on prejudicial dispositions[37] Given my conclusion on issue one, I do not have to decide this issue. If I didhave to, I would decide as follows.[38] Because the dispositions resulted in increased liabilities of ECA throughpayments jointly benefitting the Perrys, Mrs Perry "acquired or received property"under s 348(2). They were not personal only to Mr Perry. And s 344 limits the amountrequired to be restored by the value of the property acquired or received under theprejudicial dispositions, not the amount of the creditor's debt at the time.[39] But I do not accept the liquidators have proven the relatively small drawingsmade by the Perrys between 1 April 2010 and 31 March 2013, or the subsequent cashcheque of $2,000, were made with intent to prejudice a creditor or without receivingreasonably equivalent value. As I noted above, there is evidence the Perrys eachcontributed time and effort to the business for which they were otherwiseunremunerated. And there is no evidence the Perrys intended to prejudice a creditoror "must have known", in making each of these small drawings, ECA was exposingthe creditors to a significantly enhanced risk of not recovering the amounts owing tothem. So I consider the liquidators would not have not proved, on the balance ofprobabilities, their s 344 claim in respect of those transactions.[40] Neither were the payments in respect of the Westpac 93 loan prejudicial, forthe reasons given above. But the payments in respect of the Westpac 91 and 92 loansare different. It seems clear the Perrys consciously accorded other creditors,particularly Inland Revenue, lower priority than Westpac.38 The suggestion theybelieved repaying Westpac would allow them to make capital injections to ECA isundermined by the fact no such injections were made. In making these payments thePerrys "must have known" ECA was exposing Inland Revenue to a significantlyenhanced risk of not recovering the amounts owed. And ECA did not receiveequivalent value for its payment. It lost funds that could have been called upon to payits creditors. Mr Fraundorfer submits ECA gained extinguishment of a debt, but thedebt was the Perrys' not that of ECA.[41] I would not consider the s 349 defence to be made out in relation to the Westpac91 and 92 payments. I would consider Mrs Perry established she received thedispositions in good faith. She considered she and her husband were entitled to38 NOE at 105/2-5 and 109/1-9.drawings from ECA. She believed ECA would trade out of its difficulties as it haddone in the past.39 But I would not accept she has proven the Perrys did not know thepayments in respect of the Westpac 91 and 92 loans were prejudicial. That followsfrom my finding about the Current Account above.[42] Accordingly, if I had to decide this issue, I would grant the liquidators'application for prejudicial dispositions in relation to the Westpac 91 and 92 loans butdecline it in relation to the other drawings.Issue three: Does ECA have a proprietary interest in the Perrys' house?Law of proprietary interests arising from breach of fiduciary duties[43] A company director owes fiduciary duties to the company and is trustee of thecompany's property that is under his or her control.40 As the Court of Appeal hasstated recently, in The Fish Man Ltd (in liquidation) v Hadfield "[t]here is no doubtthat it is a breach of fiduciary duty for a director of a company to use its funds to paypersonal debts".41 When that is done, a constructive trust arises regarding the funds.[44] Such a constructive trust does not necessarily create a traceable interest in themortgaged property.42 Such "backwards tracing" of funds may be possible when itcan be shown a debt was incurred to purchase a specific and identifiable asset.43Backwards tracing can "transform the unsecured breach of fiduciary duty claim into apropriety interest in property by showing that company funds have, in breach ofconstructive trust, been put into a property which represents those funds in whole orin part, and from which they can be recovered".44 But the Court of Appeal in TheFishman Ltd found it was not correct broadly to assume regular mortgage paymentsafter purchase can be traced into secured property.45 The Court of Appeal held "[a]court should look at the substance of a transaction, rather than the strict order in which39 NOE at 134/21–22.40 Shannon Agricultural Consulting Ltd (in liq) v Shannon 2015] NZHC 1133 at [25].41 The Fishman Ltd (in liq) v Hadfield [2017] NZCA 589 at [57], citing Selangor United RubberEstates Ltd v Cradock [1968] 1 WLR 1555 (Ch) at 1577.42 At [58].43 At [59].44 At [62].45 At [71].events occur", "the focus must be on what the payment of the trust funds actuallyachieves and in particular whether it leads to the acquisition of ownership of the asset"and "a claimant has to establish a coordination between the depletion of the trust fundand the acquisition of the asset which is the subject of the tracing claim".46[45] The Court of Appeal in The Fishman Ltd also considered what it characterisedas an alternative way of putting the tracing argument, by way of an equitable lienarising in favour of the company because the repayments improved the property. TheCourt held the concept of an equitable lien turns on the plaintiff being able to show aspecific interest in the property and there was none there.47 In Intext Coatings Ltd (inliq) v Deo, Fitzgerald J considered repayment of a mortgage debt does not amount toan improvement in the defendant's property so was not available.48[46] In Intext Coatings Ltd, Fitzgerald J's approach to backwards tracing andcreation of equitable lien was similar in outcome to the Court of Appeal's subsequentapproach in The Fishman Ltd. However, she considered the alternative remedy ofequitable subrogation is available for using misappropriated money to discharge asecured debt.49 The Court of Appeal in The Fishman Ltd declined to consider thatbecause the argument arose only on appeal.50 After comprehensive review of theauthorities in Intext Coatings Ltd, Fitzgerald J concluded:51[143] In light of the authorities and commentaries referred to above, Iconsider subrogation is a sufficiently broad remedy to encompass the conceptof using misappropriated money, or money used in breach of a fiduciary duty,to discharge a secured debt. The leading authorities recognise the flexibilityof the remedy. They emphasise its breadth and discretionary nature, and thefact there need not be any intention as to how the money is to be used. Whilethere are certainly "classic cases" of subrogation, I do not read any of theauthorities as standing for the proposition that the remedy can only bedeployed in such cases. What is required, however, is close consideration ofwhether the defendant has been enriched at the plaintiff's expenses, and if so,whether that is unjust. And that is not be considered in a moral or overarching"fairness" sense. Rather, a principled approach must be taken.46 At [69] and [71]. This is generally consistent with the comprehensive review of authorities byFitzgerald J in Intext Coatings (in liq) v Deo [2016] NZHC 2754, [2017] NZAR 47 at [59]–[102].47 At [77].48 Intext Coatings (in liq) v Deo, above n 46, at [109].49 At [112]–[146].50 At [81].51 At [143].[47] In that case, of judgment by formal proof, where a company director usedcompany funds in breach of a fiduciary duty to discharge a secured debt, Fitzgerald Jconsidered the remedy was available. She ordered an equitable charge over theproperty in favour of the company as a result of subrogation.Submissions on proprietary interest[48] Mr Malarao, for the liquidators, submits the Perrys breached their fiduciaryduties as directors, in using $72,032 of ECA funds to repay their family trust'smortgage when ECA was insolvent, from 31 March 2010 until liquidation on 2December 2013. He submits:(a) ECA is entitled to a declaration it has a proprietary interest in the housethrough a constructive trust being created on the basis of equitabletracing principles, relying on The Fishman Ltd. He submits that claimcan be pursued against Mr Perry as well as Mrs Perry, under s 104 ofthe Insolvency Act 2006.(b) Alternatively, ECA is entitled to an equitable charge over the propertyin the amount of the principal and interest, based on subrogationprinciples, ranking immediately behind the Westpac mortgage.(c) Alternatively, in supplementary submissions, judgment for themonetary sum plus interest is justified for breach of duty by the Perrysas trustees, leaving the Trust unjustly enriched at ECA's expense.[49] Mr Fraundorfer, for the Perrys, submits:(a) The loan repayments of $72,032 should be adjusted to represent whatMr Fraundorfer submits is the true insolvency period, to take intoaccount that $10,472 relates to ECA refinancing of the Westpac 93 loanand to not include interest.(b) The duty on company directors to act honestly and with a proper motiveis largely subjective and the courts show reasonable deference tobusiness considerations in presuming directors have complied with theduty. The threshold of actual or constructive bad faith or a decision toact in self-interest and contrary to the interests of the company is arelatively high threshold which is not met here.(c) The payments to Westpac were legitimate, and there was no breach ofduty, because: some of the payments were made while ECA wassolvent; the Westpac 93 repayments were part of a plan for cashinjections and done in the best interests of ECA; and the house was usedfor business purposes as an office and overflow storage facility whichhad real commercial benefits. Mr Fraundorfer also submits thetreatment of drawings was based on information provided by Ezebizand a previous accountant but he accepted there was no evidence advicewas provided that would have qualified for the defence under s 138 ofthe Companies Act 1993.(d) The Court of Appeal's judgment in The Fishman Ltd is whollyanalogous to the situation here, meaning backward tracing into theproperty is unavailable and no equitable lien is available because theplaintiffs cannot show a specific interest in the property.(e) The courts should be slow to allow proprietary remedies, includingsubrogation, without clear evidence. Subrogation is only availablewhere the secured creditor has been paid in full, which it has not been,and has been heard, which Westpac has not been. An unsecuredcreditor should not be entitled to gain security through subrogation. Itwould be inequitable for the Perrys' home to be in jeopardy when themonies were received in good faith and for proper value. The Perryshave relied on the payments in paying other debts of ECA themselves.Decision on proprietary interest[50] The Westpac 91 and 92 accounts were the Perrys' obligations, secured byguarantee and by mortgage over the property owned by the Perrys' family trust. Thepayments made by ECA reduced the Perrys' debt and increased the trust's equity inthe property. The $20,000 Westpac 93 loan is in Mr and Mrs Perry's names and issecured by a mortgage over their family trust's house.52 But it corresponds with a$20,000 deposit into ECA's bank account on 9 February 2009 labelled as "Perry DGLoan/Drawdown". Both of the Perrys were adamant the 93 loan was only taken outfor ECA's purposes.53 It is classified in the ECA accounts as a term loan. It benefitedECA as a capital injection. It follows that ECA's payments of the Westpac 93 mortgageinstalments were not in breach of the Perrys' fiduciary duties but payments of the 92and 92 mortgage instalments were in breach of those duties.[51] In relation to the payments of the 91 and 92 mortgage instalments, I considerthe remedies of backwards tracing into the Perry trust's property or of an equitable lienarising are not available here for the same reasons as the Court of Appeal consideredthey were not in The Fishman Ltd. Looking at the substance of the transactions, themortgage instalment payments from 2010 to 2013 were well removed in time andnature from acquisition of the property, which occurred in 1991. There is insufficientcoordination of depletion of ECA's funds and acquisition of the house to sustain atracing claim. Neither have the liquidators shown ECA had a specific interest in theproperty or that the payments improved it, so as to found creation of an equitable lien.[52] Did the Perrys' misappropriation of funds to pay the mortgage instalmentsfound equitable subrogation such that ECA should have an equitable charge over theproperty such as Westpac had? I agree with Fitzgerald J in Intext Coatings Ltd theremedy of equitable subrogation is potentially available where a director usedcompany funds in breach of a fiduciary duty to discharge a secured debt. And it seemsclear there was unjust enrichment here.[53] However, I am not persuaded I should grant the discretionary remedy ofequitable subrogation. As Mr Fraundorfer submits, the ability of the Court to grantsuch a charge is a practical remedy designed to prevent unconscionable trusteesdefeating a claim. It is not intended to create secured property rights out of unsecuredrights unless that is equitable. In the interests of equity, it would have to be fashionedso as to not to exceed the value of the pre-existing obligation and not to change the52 NOE at 136/13–23.53 NOE at 136/23 and Donald Perry Brief at [68]–70].priorities between creditors without reason. Consideration of the Perrys' intentions inrelation to the house and loan would be relevant, about which there is a lack ofevidence here. As Professor Jessica Palmer has suggested:54Subrogation is justified because it protects existing proprietary interests. If itis applied to create proprietary interests within an unjust enrichmentframework, then a compelling explanation is required so that the sanctity andsecurity of property rights are not too easily disrupted.[54] Where judgment for a monetary sum is sufficient to restore an unsecuredplaintiff to the position they should have been in, I consider granting a remedy ofequitable subrogation will rarely be justified. That is the case here, as Mr Malarao'sthird alternative submission suggests. The repayment I have ordered of the CurrentAccount debt in the first cause of action involves repayment of the amounts paid byECA to Westpac in relation to the principal and interest on the 91 and 92 loans.Accordingly, I make no further award under this cause of action.Issue four: Should the Perrys repay money for breach of directors' duties?Law of repayment[55] Section 301 of the Companies Act 1993 applies if, in the course of liquidationof a company, it appears to the court that a past or present director "has misapplied, orretained, or become liable or accountable for" money of the company "or been guiltyof negligence, default or breach of duty or trust in relation to the company". Itempowers the court, on the application of the liquidator, to inquire into the conduct ofthe director and order that person to repay or restore the money with interest at a ratethe court thinks just.Submissions[56] Mr Malarao submits the Perrys breached their duties as directors to act in thebest interests of ECA (s 131), not to trade recklessly (s 135) and by causing ECA toincur obligations without reasonably believing it could perform them (s 136). The54 Jessica Palmer, "Restitution" [2016] 2 NZ L Rev 436 at 454. And see Jessica Palmer, "UnjustEnrichment, Proprietary Subrogation and Unsatisfactory Explanations" (2016) 28 SAcLJ 955 at[17] (arguing the language of subrogation in these circumstances confuses and conceals what isreally taking place) and pt IV.liquidators seek restitution for breach of s 131, and compensation under ss 135 and236, from Mrs Perry and a declaration in relation to Mr Perry.[57] Mr Fraundorfer submits the evidence establishes the Perrys always believedthey could trade out of ECA's financial difficulties. He submits the Perrys' conductdid not reach the relatively high threshold of bad faith or acting in self-interest requiredfor breach of s 131 and nor did the Perrys trade recklessly or incur obligations withoutreasonably believing they could be performed, breaching ss 135 and 136. MrFraundorfer submits any award should not exceed the total value of claims in theliquidation, $52,008, and that amount must be reduced by any award under the othercauses of action.Decision on repayment[58] I consider the Perrys did breach their duties in the three respects alleged. Thisfollows from my findings above. They took non-salary drawings from ECA withoutprior authorisation by the directors collectively, or authorisation at all. Mr Perry didnot distinguish between ECA and himself and Mrs Perry. Mrs Perry did distinguishbetween them, but only afterwards in coding expenses retrospectively. The drawingswere taken from ECA after it became insolvent, instead of being used to meet ECA'sobligations to its creditors. During this period, Westpac was repaid, in respect of itsloans 91 and 92 to the Perrys personally. Yet a conscious decision was made not topay Inland Revenue for the GST and PAYE it was owed. I consider thesecircumstances were sufficient to mean:(a) The Perrys were not acting in good faith and what they believed to bethe best interests of the company (s 131). No director who properlyunderstood his or her duties would take such actions.(b) The Perrys caused or allowed the business of ECA being carried on ina manner likely to create a substantial risk of serious loss to its creditors(s 135). These actions were not open to a reasonable director in thecircumstances.(c) The Perrys agreed to ECA incurring obligations when they did notbelieve at the time, on reasonable grounds, ECA would be able toperform the obligation when required to do so (s 136).[59] If none of the other causes of action against the Perrys had succeeded, I wouldhave considered ordering Mrs Perry to pay restitution or compensation for thesebreaches. However, the liquidators have already succeeded in relation to the firstcause of action. The amount Mrs Perry has to repay broadly restores ECA for theeffects of the Perrys' breaches. I do not consider further payments by the Perrys unders 301 are justified on top of that.55Result[60] I order Mrs Perry to repay ECA the shareholders Current Account debt of$132,980 plus interest from 6 August 2014.[61] I award costs to the liquidators. If the amount of costs cannot be agreedbetween the parties I grant leave for the liquidators to file and serve submissions of upto five pages within 10 working days and the Perrys to file and serve submissions inreply of up to five pages within a further 10 working days.Palmer J55 Madsen-Ries v Petera [2015] NZHC 538 at [96].