KUMAR v SMARTPAY LTD [2023] NZCA 410

KUMAR v SMARTPAY LTD [2023] NZCA 410 [31 August 2023]IN THE COURT OF APPEAL OF NEW ZEALANDI TE KŌTI PĪRA O AOTEAROACA427/2022[2023] NZCA 410BETWEEN MANAS DHARMENDRA KUMARAppellantAND SMARTPAY LIMITEDRespondentHearing: 25 July 2023Court: Collins, Lang and Woolford JJCounsel: Appellant in personD J Chisholm KC and J D Ryan for RespondentJudgment: 31 August 2023 at 9.30 amJUDGMENT OF THE COURTA The appeal is dismissed.B The appellant is to pay the respondent costs for a standard appeal on aband A basis together with usual disbursements. We certify for twocounsel.____________________________________________________________________REASONS OF THE COURT(Given by Collins J)Introduction[1] Mr Kumar's appeal challenges two judgments of the High Court in whichDowns J concluded Mr Kumar is liable to pay $850,427 to the liquidators ofOptimizer Corporation Ltd (OCL).1 This was the loss claimed by Smartpay Ltd(Smartpay), a creditor of OCL, arising from what the High Court found wereMr Kumar's breaches of three sections of the Companies Act 1993 (the Act) when hewas a director of OCL.2[2] The three sections of the Act that Mr Kumar was found to have breached, are:(a) Section 131, which concerns the duty of a director to act in good faithand in what the director believes to be the best interests of the company.(b) Section 135, which prohibits a director from allowing a company tocarry on business in a manner likely to create a substantial risk ofserious loss to the company's creditors.(c) Section 136, which provides a director must not agree to the companyincurring obligations unless he or she reasonably believes at the timethat the company will be able to perform its obligations when requiredto do so.We will explain these and other provisions of the Act in further detail at [35] to [66].[3] In addition to disputing that he breached the Act, Mr Kumar maintains theHigh Court miscalculated the amount of Smartpay's losses.Background[4] The litigation focuses upon three companies:(a) OCL, which was incorporated on 5 June 2013 and placed intoliquidation on 10 December 2015.(b) Odev Ltd (Odev), which was incorporated on 21 January 2005 and alsoplaced into liquidation on 10 December 2015.1 Smartpay Ltd v Kumar [2022] NZHC 997 [Interim judgment]; and Smartpay Ltd v Kumar [2022]NZHC 2685 [Quantum judgment].2 Interim judgment, above n 1, at [42].(c) Optimizer HQ Ltd (HQ), which was incorporated on 11 April 2013 andplaced into liquidation on 27 November 2020.Together, these three companies shall be referred to as the group of companies.[5] At all relevant times Mr Kumar was the managing shareholder of HQ, the soledirector of Odev, and a director of OCL. When OCL was incorporated it issued 1,000shares at $1 per share. All of OCL's shares were owned by HQ.[6] Odev developed a product called Swipe HQ, which was a debit and credit cardsystem that enabled merchants to process Eftpos transactions through a mobile Eftposterminal.[7] Two agreements are central to the dispute.Spark agreement[8] Pursuant to the first agreement, dated 28 May 2014, OCL providedSpark NZ Ltd with the right to market and sell Swipe HQ and supplied Spark withmobile Eftpos terminals. This agreement was for one year. No fee was payable bySpark to OCL. It appears to have been assumed that OCL would gain revenue fromSpark's clients who used the Swipe HQ system.Smartpay agreement[9] Under the second agreement, dated 18 September 2014, Smartpay, whichmakes and supplies Eftpos terminals, agreed to supply OCL with Eftpos terminals.Specifically:(a) Under cl 6.1 and schedule 1 of the agreement, OCL was to rent Eftposterminals from Smartpay and pay Smartpay $48 per terminal, a fee of$18 per month for each terminal and 0.35 per cent (plus GST) of the"Gross Transaction Value from credit cards processed through the[Eftpos] Terminals per month".(b) Under cl 3, the agreement between OCL and Smartpay was fortwo years.Both agreements were signed by Mr Kumar on behalf of OCL.[10] In addition to the Spark and Smartpay agreements, OCL entered into othersignificant financial commitments, including the lease of commercial premises for afive-year period commencing 1 March 2015 at an annual rent of $103,327 plus GST.This lease followed an earlier lease that OCL had executed for the same premises on30 September 2014.[11] Contrary to the assumption that underpinned the Smartpay agreement, OCLreceived no revenue from Spark's clients. Rather, revenue generated from the Sparkagreement went to HQ. In reality, OCL had no revenue and was dependent on HQ orOdev to meet its obligations to its creditors, including Smartpay.[12] The gravamen of Smartpay's claim against Mr Kumar is that he allowed OCLto incur significant liabilities knowing that it had no revenue or meaningful assets andwas therefore not in a position to meet its liabilities and obligations to Smartpay.[13] In 2014, OCL began to default on its obligations to provide Spark withSwipe HQ and mobile Eftpos terminals. OCL also began to default in its obligationto pay Smartpay the debts it owed Smartpay under the Smartpay agreement. As aconsequence:(a) Spark terminated the Spark agreement on 22 May 2015.(b) Smartpay began to issue OCL with statutory demands, some of whichwere paid by Odev and a shareholder of Odev. Ultimately, however,HQ placed OCL and Odev into liquidation on 10 December 2015.High Court judgment[14] Following a four-day hearing during which Mr Kumar was represented bysenior counsel, Downs J issued an interim judgment in which he made the followingkey factual findings:3[41] First, OCL had no assets beyond the $1,000 it presumably receivedfor its shares. So, as soon as OCL incurred liabilities of more than $1,000, itbecame balance sheet insolvent. Second, OCL had no revenue. So, as soonas OCL incurred liabilities, it became cashflow insolvent. Third, OCL was,therefore, balance sheet and cashflow insolvent from near inception. OCLcannot have been other than insolvent in both respects when it entered theSpark agreement [on] 28 May 2014. Fourth, the revenue anticipated to OCLby the Spark agreement went not to OCL, but HQ. Fifth, OCL was thereforereliant on others—HQ, Odev or both—to meet its obligations under the Sparkagreement. Indeed, OCL was reliant on others to meet every obligation it had,including those to Smartpay under the Smartpay agreement. Sixth, OCL hadno legally enforceable means of securing financial help from HQ or Odev. So,at all material times, OCL was (a) insolvent; and (b) absent legally enforceableaid. Seventh, in testimony, Mr Kumar acknowledged he did not considerOCL's interests, only the interests of the group. Mr Kumar alsoacknowledged, again in testimony, OCL gained nothing by entering the Sparkagreement. Eighth, Mr Kumar's interests conflicted in these circumstances:he was a director of every company in the group; the majority shareholder ofHQ; and HQ wholly owned OCL.[15] The Judge was satisfied Mr Kumar "unquestionably breached" ss 131, 135 and136 of the Act and that he failed to understand his duties as a director of OCL. Insteadof focusing on his responsibilities to OCL Mr Kumar believed it sufficient to considerthe interests of the group of companies as a whole.4[16] Downs J conducted a second hearing in relation to quantum. By that stageMr Kumar was no longer represented by counsel and he did not appear at the secondhearing.5 In assessing liability under s 301(1)(b)(ii) of the Act, Downs J relied on theevidence of Smartpay's Chief Business Officer, and Mr Van Delden, the liquidator ofOCL. In his quantum judgment, Downs J summarised the evidence in relation toquantum in the following way:[3] Smartpay supplied OCL 2161 terminals, of which 1002 wererecovered or returned to Smartpay. So, 1159 terminals remain outstanding ata cost of $345 per terminal—a total of $399,855. To this must be added two3 Interim judgment, above n 1 (footnotes omitted).4 At [42].5 Quantum judgment, above n 1, at [4] and [7]–[8].amounts. First, what Smartpay was owed by OCL at the date of its liquidation:$120,407.43. Second, post-termination fees payable by OCL to Smartpayunder the distribution agreement. These come to $330,165. The three sumstotal $850,427.43, a figure the liquidators have accepted.Accordingly, Downs J ordered Mr Kumar to pay $850,427.43 (plus interest) to theliquidators by way of compensation.6Grounds of appeal[17] Mr Kumar appeared for himself in this Court. He did so by way of AVL fromIndia. Mr Kumar filed very comprehensive written submissions and argued his appealwith considerable diligence.[18] Mr Kumar appeared to accept that OCL by itself had no assets or income.He submitted, however, that when the assets of HQ and Odev were factored into theequation, the financial position of the group of companies as a whole was very secure.[19] Mr Kumar said, by way of example, that between 2013 and 2015 HQ raised atotal of $9.912 million in fresh capital from local and offshore investors. He contendedthat while there was no documentary evidence of the financial interdependency of thethree companies, the following three factors, at least implicitly, provided him with a"Tripod of Confidence" in OCL's abilities to meet its debts and obligations:(a) the overall financial strength of the company;(b) the business partnerships that were in place; and(c) the potential for business growth.[20] When inviting us to consider the substance of the financial viability of theoverall group of companies Mr Kumar drew attention to the judgment of Lord Reed Pin BTI 2014 LLC v Sequana SA [Sequana].7 We shall explain that judgment whendiscussing the relevant legal principles.6 At [12(a)].7 BTI 2014 LLC v Sequana SA [2022] UKSC 25, [2023] 2 All ER 303 [Sequana].Section 131 Companies Act[21] In relation to the claim under s 131 of the Act, Mr Kumar argued:(a) The High Court failed to properly consider s 131(2) of the Act, whichprovides that where a company is a wholly owned subsidiary, thedirector of the subsidiary can consider the best interests of the holdingcompany when the constitution of the subsidiary company permits thatcourse of action, even though such an approach may not be in the bestinterests of the subsidiary company.(b) A subsidiary company cannot be considered insolvent when itscircumstances equate to those in Sequana.(c) The High Court erred when it rejected Mr Kumar's testimony that heacted in good faith.(d) OCL did generate revenue, although it was not recorded as such in itsaccounts.Section 135 Companies Act[22] In addition to repeating many of the points raised in relation to s 131 of theAct, Mr Kumar submitted:(a) He had no reason to think that OCL was unable to meet its obligations,particularly in light of the ability of HQ to raise capital and the "Tripodof Confidence" concerning the viability of the overall group ofcompanies.(b) The argument that OCL had no way of compelling HQ and or Odev tolend assistance to OCL was a "narrow technical view" because HQ andOdev often met OCL's obligations.Section 136 Companies Act[23] In addition to the submissions raised in relation to the claims under ss 131 and135 of the Act, Mr Kumar said that the distribution agreement involved Spark clientsbeing billed in advance, $399 for each device. Hence, Mr Kumar submitted, he didnot breach s 136 of the Act because he had every reason to believe OCL could meetits obligations when required to do so.Causation[24] In a separate argument that applied to all three claims, Mr Kumar said thatthere was a high failure rate among the devices supplied by Smartpay and that as aconsequence, the actions of OCL did not cause the losses alleged by Smartpay.Miscellaneous matters[25] At the commencement of the trial, Downs J declined to receive evidence fromMr Damien Grant, an insolvency practitioner, whom Mr Kumar wished to rely upon.The Judge was not satisfied Mr Grant had the requisite experience to be an expert inthis case and, in any event, parts of Mr Grant's evidence were problematic because ofits partisan nature and therefore not substantially helpful.8 Mr Kumar submits that theevidence of Mr Graham, Smartpay's expert witness at trial, should have also beenexcluded.Quantum[26] Mr Kumar submitted that a separate hearing on quantum was only requiredbecause significant discrepancies emerged at trial concerning Smartpay's allegedlosses. Mr Kumar contended that the way the High Court Judge went aboutconsidering quantum constituted a breach of due process and that the Judgeover-assessed Smartpay's losses.8 Interim judgment, above n 1, at [52]–[65].Summary of respondent's case[27] It is not necessary for us to explain in any depth the comprehensivesubmissions made on behalf of Smartpay by Mr Chisholm KC.[28] Mr Chisholm submitted that Mr Kumar had misstated important parts of theevidence and that there was no doubt OCL had no income and did not itself benefitfrom the way the group's businesses were structured.Section 131 Companies Act[29] In relation to the claim under s 131 of the Act, Mr Chisholm contendedMr Kumar's obligation was to OCL and that he could not simply rely on unenforceablepossibilities of support from HQ and Odev to excuse his failure to discharge hisobligations as a director of OCL.Section 135 Companies Act[30] Mr Chisholm's primary point in relation to s 135 of the Act was that it was notreasonable for Mr Kumar to rely on voluntary support from HQ and Odev.Section 136 Companies Act[31] The arguments in relation to s 136 of the Act substantially overlapped withthose in relation to ss 131 and 135 of the Act.Miscellaneous matters[32] Smartpay argued that Mr Grant did not meet the qualifications for being anexpert witness in this case.Quantum[33] Similarly, it was submitted on behalf of Smartpay that the process followed todetermine quantum and the calculation of quantum was unimpeachable.Relevant legal principles[34] We shall now explain further the three key provisions of the Act that we havesummarised at [2] as well as other parts of the Act that are relevant to the claim.Section 131 Companies Act[35] Sections 131(1) and (2) state:131 Duty of directors to act in good faith and in best interests ofcompany(1) Subject to this section, a director of a company, when exercisingpowers or performing duties, must act in good faith and in what thedirector believes to be the best interests of the company.(2) A director of a company that is a wholly-owned subsidiary may, whenexercising powers or performing duties as a director, if expresslypermitted to do so by the constitution of the company, act in a mannerwhich he or she believes is in the best interests of that company'sholding company even though it may not be in the best interests of thecompany.[36] In Madsen-Ries v Cooper [Debut Homes],9 the Supreme Court analysed theduties of directors under ss 131, 135 and 136 of the Act. The Court observed that "theinterests of creditors have to be considered where the company is insolvent or nearlyinsolvent."10[37] When explaining the application of s 131 of the Act, the Supreme Court tookadvantage of the opportunity to dispel early suggestions that s 131 involved anamalgam of objective standards and subjective criteria.11 The Court said:12[112] The test [under s 131] is subjective. This follows from the wordingof s 131 (expressed subjectively) and the legislative history This alignswith the common law test and policy considerations. Courts are not wellequipped, even with the benefit of expert evidence, to second-guess thebusiness decisions made by directors in what they honestly believed to be in9 Madsen-Ries (as liquidators of Debut Homes Ltd (in liq)) v Cooper [2020] NZSC 100, [2021] 1NZLR 43 [Debut Homes].10 At [31], citing Nicholson v Permakraft (NZ) Ltd [1985] 1 NZLR 242 (CA) at 250 and 255;Sojourner v Robb [2006] 3 NZLR 808 (HC) at [102]. .11 See for example, Sojourner v Robb, above n 10, at [102].12 Debut Homes, above n 9 (footnote omitted).the best interests of the company. The courts would also be judging directors'decisions with all the dangers of judging with the benefit of hindsight. [38] The Supreme Court also explained however, that although the test under s 131of the Act is subjective, the section may be breached, for example:13(a) where there is no evidence of actual consideration of the best interestsof the company;(b) where, in an insolvency or near-insolvency situation, there is a failureto consider the interests of creditors;(c) where there is a conflict of interest or where the action was one nodirector with any understanding of fiduciary duties could have takenSequana[39] As we have noted at [20], Mr Kumar placed weight on the judgment of theUnited Kingdom Supreme Court in Sequana. In particular, Mr Kumar drew comfortfrom the following passage from Lord Reed P:14[46] The interests of a company, an artificial person, cannot bedistinguished from the interests of the persons who are interested in it. Whoare those persons? Where a company is both going and solvent, first andforemost come the shareholders, present and no doubt future as well. Howmaterial are the interest of creditors in such a case? Admittedly existingcreditors are interested in the assets of the company as the only source for thesatisfaction of their debts. But in a case where the assets are enormous andthe debts minimal it is reasonable to suppose that the interests of the creditorsought not to count for very much.[47] So long as a company is financially stable, and is therefore able topay its creditors in a timely manner, the interests of its shareholders as a whole,understood as a continuing body, can be treated as the company's interests forthe purposes of the directors' duty to act in its interests. It is the shareholderswhose interests are affected by fluctuations in its profits and reserves, as theyare the persons entitled to share in its distributions and its surplus assets. [S]o long as the company is financially stable, the creditors' interests do notrequire to be considered as a discrete aspect of the company's interests for thepurposes of the directors' fiduciary duty to the company. It is sufficient forthe directors to promote the interests of the shareholders in order for thecompany's business to be carried on over the long term and for the company'sdebts to be paid as part of the conduct of its business.[48] That situation alters if the company is insolvent or bordering oninsolvency. As losses are incurred, and the company's surplus of assets overliabilities disappears, the company's creditors as a whole become persons with13 At [113].14 Sequana, above n 7, citing Brady v Brady [1988] BCLC 20 at 40 per Nourse LJ.a distinct interest (possibly, depending on the gravity of the company'sfinancial difficulties, the predominant interest) in its affairs, as they aredependent on its residual assets, or on the possibility of a turnaround in itsfortunes, for repayment. I refer to the creditors 'as a whole' for two reasons.First, individual creditors may be in different positions, and may even haveconflicting interests: that may be the position, for example, of securedcreditors as compared with unsecured creditors. Secondly, the interests of thecompany cannot be confined to the interests of current creditors as at the timeof a given decision by the directors, any more than they can be confined to theinterests of current shareholders. Since the identities of the company'screditors constantly change so long as debts continue to be incurred anddischarged, any consideration of the company's long term interests mustinclude consideration of the interests of its creditors as a class rather than as afixed group of individuals.[40] Properly understood however, that judgment does not provide the panacea thatMr Kumar suggested. In Sequana, the Court considered the scope of s 214 InsolvencyAct 1986 (UK) which has some similarities to ss 135 and 136 of the Act.[41] Section 214 of the Insolvency Act (UK) states:214 Wrongful trading.(1) Subject to subsection (3) below, if in the course of the winding up ofa company it appears that subsection (2) of this section applies inrelation to a person who is or has been a director of the company, thecourt, on the application of the liquidator, may declare that that personis to be liable to make such contribution (if any) to the company'sassets as the court thinks proper.(2) This subsection applies in relation to a person if—(a) the company has gone into insolvent liquidation,(b) at some time before the commencement of the winding up ofthe company, that person knew or ought to have concludedthat there was no reasonable prospect that the company wouldavoid going into insolvent liquidation or entering insolventadministration, and(c) that person was a director of the company at that time;but the court shall not make a declaration under this section in anycase where the time mentioned in paragraph (b) above was before 28thApril 1986.(3) The court shall not make a declaration under this section with respectto any person if it is satisfied that after the condition specified insubsection (2)(b) was first satisfied in relation to him that person tookevery step with a view to minimising the potential loss to thecompany's creditors as (on the assumption that he had knowledge ofthe matter mentioned in subsection (2)(b)) he ought to have taken.[42] As we shall explain when discussing ss 135 and 136 of the Act, theUnited Kingdom Supreme Court recognised in Sequana that directors have a commonlaw duty to the company that includes considering the interests of the company'screditors where the company faces imminent insolvency or insolvent liquidation isprobable.15 It is only when insolvent liquidation becomes inevitable that the interestsof creditors become paramount.16 It will be noted that s 214 is engaged only if adirector knew, or ought to have known there was no reasonable prospects of avoidinginsolvent liquidation.[43] Last week, the Supreme Court in Yan v Mainzeal Property and ConstructionLtd (in liq) [Mainzeal] affirmed that:17[142] the courts have also recognised that in circumstances of doubtfulsolvency, actual insolvency or inevitable insolvent liquidation, directors maybe required to have regard to the interests of creditors [although] anyrequirement to have regard to the interests of creditors was a subset of theduties owed by directors to the company.[44] Mainzeal had some similarities to the case before us. Mainzeal becameinsolvent when, contrary to the expectations of its directors, a related overseascompany did not provide financial support for Mainzeal.[45] The Supreme Court also discussed in some detail the reasoning in Sequana inrelation to consideration of the interests of creditors, highlighting the key policyconsiderations as follows:18[180] A policy consideration that underlies the Sequana reasoning is thatas the financial affairs of a company deteriorate the economic stake (which isnot a proprietary interest) that the creditors have in the company's residualasset increases. As will become apparent, we see this policy consideration asunderpinning ss 135 and 136 and 301. 15 Sequana, above n 7, at [48]–[51].16 At [50] per Lord Reed P; [171]–[176] per Lord Briggs and Lord Kitchin; and [222]–[227]per Lord Hodge DP.17 Yan v Mainzeal Property and Construction Ltd (in liq) [2023] NZSC 113 [Mainzeal (SC)].See also [143] where the Supreme Court discusses Nicholson v Permakraft (NZ) Ltd [1985] 1NZLR 242 (CA); Kinsela v Russell Kinsela Pty Ltd (in liq) (1986) 4 NSWLR 722 (NSWCA); andWest Mercia Safetywear Ltd (in liq) v Dodd [1988] BCLC 250 (CA).18 Footnote omitted.[46] In relation to the finding in Sequana that the interests of creditors becomeparamount when insolvent liquidation is inevitable, the Supreme Court in Mainzealstated that:19We are not called upon in this case to decide whether, and at what point, theinterests of creditors become paramount. Rather we are required to interpretand apply ss 135 and 136. We propose to do this on the basis that, in thecircumstances in which those sections are likely to be engaged, directorsare required to have at least substantial regard for the interests ofcreditors, a policy consideration that is plainly material to the way thosesections should be applied.[47] The Supreme Court's conclusion is that a lower level of consideration appliesfor creditors once ss 135 and 136 are engaged – being "substantial regard" rather thantheir interests becoming "paramount" as in Sequana. However, this must be read incontext. The Supreme Court stated that the relevant liability threshold in the UK is"distinctly higher than that implied by s 135", which is "likely to occur beforeliquidation becomes practically inevitable".20[48] Therefore, Sequana is not as helpful to him as Mr Kumar submitted.Section 135 will generally be triggered earlier than the UK provision. Once s 135 istriggered, "significant regard" must be given to the interests of creditors. However,this does not preclude the application of the finding in Sequana that once insolventliquidation is practically inevitable – which may occur after the s 135 threshold ispassed – the interests of creditors become paramount.[49] The conclusions in Mainzeal and Sequana coexist, to create a sliding scale ofconsideration that must be given to the interests of creditors starting with "significantregard" once s 135 is triggered, and moving towards paramountcy as the company getscloser to insolvent liquidation. This is entirely consistent with the policy rationaledescribed by the Supreme Court at [45], that "as the financial affairs of a companydeteriorate the economic stake that the creditors have in the company's residualasset increases."2119 At [184(a)] (emphasis added).20 At [182] and [182(a)] (emphasis added).21 At [180].Section 135 Companies Act[50] Section 135 of the Act provides:135 Reckless tradingA director of a company must not—(a) agree to the business of the company being carried on in a mannerlikely to create a substantial risk of serious loss to the company'screditors; or(b) cause or allow the business of the company to be carried on in amanner likely to create a substantial risk of serious loss to thecompany's creditors.[51] The scope of s 135 of the Act was also discussed by the Supreme Court inMainzeal. The Supreme Court came to the following conclusions in relation to s 135:22(a) An objective approach is to be taken in determining whether the businessof the company was carried on in the prohibited manner (so that subjectiveawareness of the likelihood of substantial risk or serious loss is not necessary).(b) However, when assessing whether the actions of the directors in agreeingto, or causing or allowing that trading were in breach of s 135, the courts willproceed on the basis of those facts and circumstances of which the directorswere aware, or should have been aware, if exercising appropriate care, skilland diligence.[52] The Court made the following observations in relation to the wording of s 135;"likely to create a substantial risk of serious loss to the company's creditors":[198] "Risk" generally is a product of the probability of an adversecontingency occurring and the severity of the consequences of thatcontingency should it occur. In this context, "substantial" refers to probabilityof loss to creditors and "serious" to the extent of that loss. For this reason,"likely" might be thought to introduce an element of tautology. However, incompany with Cooke J and the Court of Appeal, we see it as adding emphasisto the probability of substantial risk of serious loss.[199] In most circumstances, a risk of the magnitude just described willengage s 135. This is appropriate as those who extend credit to a company willgenerally not anticipate exposure to risk that goes beyond the usual vagariesof commercial life. That said, the business of a company may carry arecognised heightened risk of loss — in respect of which potential creditors(or some of them) may be able to protect themselves (for instance by notextending credit or doing so only on terms that reflect the risk). In such a case,the recognised heightened risk of loss may provide a baseline against whichthe language of s 135 should be applied. This, however, is not an issue in this22 At [211].case. How s 135 will work in such a situation is better determined against thefacts of a case in which the issue actually arises.[53] The Court also commented on the relevance of assurances of support, sayingthat:[216] Assurances of support on which the directors can reasonably rely maybe material to whether they can be appropriately satisfied that continuedtrading will not breach s 135. If assurances were not legally binding orpractically enforceable and were not honoured (as in this case), there are likelyto be questions as to the reasonableness of reliance on them.Section 136 Companies Act[54] Section 136 of the Act states:136 Duty in relation to obligationsA director of a company must not agree to the company incurring an obligationunless the director believes at that time on reasonable grounds that thecompany will be able to perform the obligation when it is required to do so.[55] In Debut Homes, the Supreme Court explained that s 136 of the Act is notlimited to situations when directors cause a company to incur direct contractualobligations in circumstances where the director does not reasonably believe thecompany will be able to perform its obligations under the contract.23 The respondentin that case was held to have breached s 136 of the Act when he authorisedDebut Homes to enter into sale and purchase agreements knowing the company wouldincur GST obligations that it would not be able to fulfil.[56] Section 136 was also considered by the Supreme Court in Mainzeal, where itconcluded that that "s 136 is not confined to obligations of a particular kind, andmay be invoked in relation to a course of trading to which the director has agreed."24[57] The Court also said:[272] Directors should also recognise that a long-term strategy of tradingwhile balance sheet insolvent is generally not acceptable. As will be noted, wehave used the word "generally" as we accept that there may be circumstancesin which it will be legitimate for such a long-term policy to be followed, most23 Debut Homes, above n 9, at [91].24 Mainzeal, above n 17, at [249], affirming Yan v Mainzeal Property and Construction Ltd (in liq)[2021] NZCA 99, [2021] 3 NZLR 598 [Mainzeal (CA)] at [280].particularly where there are assurances of support from a parent or sistercompany or third parties that can reasonably be relied on.Section 301 Companies Act[58] The relevant portion of s 301(1) of the Act states:301 Power of court to require persons to repay money or returnproperty(1) If, in the course of the liquidation of a company, it appears to the courtthat a person who has taken part in the formation or promotion of thecompany, or a past or present director, has been guilty ofnegligence, default, or breach of duty or trust in relation to thecompany, the court may, on the application of the liquidator or acreditor or shareholder,—(a) inquire into the conduct of the director ; and(b) order that person—(ii) to contribute such sum to the assets of the companyby way of compensation as the court thinks just; or(c) where the application is made by a creditor, order that personto pay or transfer the money or property or any part of it withinterest at a rate the court thinks just to the creditor.[59] As we have noted at [16], in this case, the orders made by Downs J werepursuant to s 301(1)(b)(ii) of the Act.[60] Claims for breach of the fiduciary obligations set out in s 131 of the Act areassessed in accordance with the principles governing claims for breach of fiduciaryduty.25[61] Claims under s 135 will normally, but not invariably, be assessed by examiningthe net deterioration in the company's financial position between the date tradingshould have ceased and the date of actual liquidation. As the Court explained in Debut25 Mainzeal (CA), above n 24, at [255(f)] and [288].Homes, the usual starting point in s 135 cases is net deterioration "because the sectionlooks at the creditors and the business as a whole."26[62] The Supreme Court in Mainzeal discussed some situations where the netdeterioration approach would not be appropriate:[282] Assessment of loss based on net deterioration is necessarily premised ona counterfactual that assumes cessation of trading, and in practical termsliquidation, at breach date. Where that is not the appropriate counterfactual,there is no occasion for a net deterioration calculation. As well, there may beother situations in which other measures of loss will be appropriate. Measuresof loss other than net deterioration may be necessary, or appropriate, where:(a) the breach of s 135 is itself the cause of the company's failure, inwhich case the entire deficiency may be the basis of the award;[63] In particular, the Court noted that in the example under (a), "liquidation atbreach date would not be the relevant counterfactual. Rather, the counterfactual wouldsimply be not trading in breach of s 135."27[64] Breaches of s 136 of the Act, however, are not necessarily amenable to the netdeterioration approach to assessing compensation:28[165] We do not, however, consider that the same measure of compensationwould necessarily respond adequately to breaches of s 136. The breach ofduty under s 136 is the incurring of obligations without a reasonable beliefthat they will be met. This section therefore concentrates on individualcreditors. Section 136 is, however, like s 135 and others, framed as a duty tothe company. It follows that Parliament must have considered any breach ofthe duty would harm the company. It is therefore appropriate that any reliefordered should operate to reverse that harm and thus be restitutionary innature.[166] In cases where the breach is of s 136, limiting compensation to the netdeficiency (the usual measure for s 135) would not respond to the breach andmake good the harm, especially in cases where new obligations are incurredand used to pay other debts ("robbing Peter to pay Paul"). There is much forcein the liquidators' submission that limiting compensation to the net increase inamounts owing would provide directors with the perverse incentive tocontinue to trade in breach of s 136 as long as they are careful to make surethat the net deficit remains constant. If relief under s 301 is calculated on anet deficiency basis in such cases, there would be no deterrent effect anddirectors would not properly be held to account. Nor would the harm to thecompany be reversed.26 Debut Homes, above n 9, at [164].27 Mainzeal (SC), above n 17, at [282(a)], n 185.28 Debut Homes, above n 9 (footnotes omitted).[65] The Supreme Court in Mainzeal summarised that:[117] Debut Homes stands as authority for the propositions that:(a) for the purposes of s 136, the harm to the company is theincurring of debts in breach of that section and all that flowsfrom that;(b) it is therefore appropriate that relief ordered should operate toreverse that harm; [291] Dealing first with the logic of s 136, there is an apparent difference infocus between ss 135 and 136. Whereas s 135 is concerned with the generalconduct of the business of the company and the risk that such conduct posesto creditors, s 136 addresses the incurring of obligations to creditors.Section 135 is expressed in terms that are consistent with treating creditors asa class in relation to compensation. In contrast, s 136, as we construe it, doesnot treat all creditors as a class but rather contemplates both (a) an obligation-by-obligation, and thus a creditor-by-creditor, approach and (b) as we havefound, an approach based on categories of obligations and therefore creditors.So, the wording is consistent with the view that the damage for whichcompensation should be available under s 136 is the incurring of obligationsthat were not met and that such damage is most logically measured by thedeficiency in respect of those obligations. [66] Importantly, the Court concluded that the court has flexibility in assessingcompensation under s 301:[351] For the reasons just outlined, we consider that flexibility in remedialresponse for breach of ss 135 and 136 is appropriate to respond to facts ofparticular cases, making it appropriate for the courts to be free to tailor reliefin ways that respond to the particular breach or wrong, to the harm that flowsfrom that and, at least to some extent, the culpability (particularly amongstthemselves) of the directors.AnalysisCausation[67] It is convenient to deal first with the question of causation which underpinnedMr Kumar's defence to all three claims.[68] Mr Kumar described causation as being the "Cancerous Leg" of the "Tripod ofConfidence" we have referred to at [19].[69] Mr Kumar pointed to a number of factors that undermined the viability of thegroup's business venture, but his principal concern related to what he described asbeing a high failure rate of Smartpay's devices. Mr Kumar said the issue went from"bad to worse" and that no resolution was forthcoming from Smartpay.[70] From this, Mr Kumar submitted that it was not the fact OCL was thecontracting party with Smartpay that caused Smartpay's losses. Rather, "it was thefact that HQ and [Odev] could no longer fund OCL's payment obligations" that causedSmartpay's loss, and that those losses would have arisen, in any event, if the Smartpayagreement was with HQ.[71] In the High Court, Downs J declined to engage with this argument becauseSmartpay's claim under s 301 of the Act was concerned with OCL's losses caused byMr Kumar's breaches of ss 131, 135 and 136 of the Act.[72] We agree with the High Court and Mr Chisholm that Mr Kumar hasmisunderstood the issue of causation.[73] The claim against Mr Kumar is because of the way he failed to discharge hisresponsibilities as a director of OCL and in particular, how he allowed OCL to incursignificant debts without having its own income or meaningful assets.[74] In any event, we cannot on the evidence before us conclude that Smartpaywould have incurred the same or similar losses if its contract had been with HQ. Whatwe can say is that although Odev was placed into liquidation at the same time as OCL,it appears HQ had income and assets and was able to stave off liquidation untilfive years after OCL and Odev were placed into liquidation. Thus, it is conceivable,that in 2015 Smartpay may not have suffered as much loss as it did if its contract hadbeen with HQ.Section 131 Companies Act[75] As we have noted at [21(a)], Mr Kumar relied on s 131(2) of the Act. We canquickly dispose of Mr Kumar's submissions based on s 131(2) because there was noevidence that OCL's constitutional documents permitted its directors to act in the bestinterests of HQ and contrary to the best interests of OCL, as is expressly requiredunder s 131(2).[76] The issue raised by the appeal in relation to s 131 of the Act is whether Downs Jerred when he found that Mr Kumar did not act in good faith and in what he believedwere the best interests of OCL when he authorised OCL to enter into theSmartpay agreement.[77] Mr Kumar is correct when he argues s 131, in general, entails a subjectiveanalysis of a director's intentions and understanding. There are, however, as we haveset out at [38], circumstances in which s 131 will clearly be breached including: wherea director fails to consider the best interests of the company; where there was a failureto consider the interests of creditors in an insolvency or near insolvency situation; andwhere a director breaches their fiduciary duty by failing to properly manage conflictsof interest.29 All three of these circumstances were engaged in this case.(i) Mr Kumar's failure to consider the interests of OCL[78] The focus of Mr Kumar's attention was always on the overall best interests ofthe group of companies. In particular, Mr Kumar did not specifically consider the bestinterests of OCL to the exclusion of the other companies in the group. The evidencethat supports this conclusion came from Mr Kumar. For example, Mr Kumar told theHigh Court:(a) That the "group structure" was designed to be "seen as a single unifiedbody operating as one [entity]".(b) That he agreed that OCL did "not [have] any revenue of its own" andhad "no assets with the exception of [its] $1,000 share capital".(c) That OCL had obligations to Spark and Smartpay under the respectiveagreements with those companies.29 Debut Homes, above n 9, at [113].(d) That the revenue from the Spark and Smartpay agreements wasreceived by HQ and not OCL.(e) That OCL did not benefit from the liabilities it incurred as a result ofentering into the Spark and Smartpay agreements.(f) That there was no "legally enforceable obligation" to compel HQ, Odevor any other entity to meet OCL's liabilities.[79] Mr Kumar's overall approach to OCL was encapsulated in hisacknowledgement that OCL was merely a "shell company" in the sense that it had no"revenue stream" or meaningful assets. Mr Kumar's approach meant that he did notconsider OCL's best interests independently from the group.(ii) OCL was insolvent, or near insolvent from the time it commenced trading[80] Without income or meaningful assets OCL was always in a precarious financialposition from the time it incurred liabilities to Spark and other creditors (such as itslandlord). By the time OCL entered into the Smartpay agreement, the only way itcould meet its liabilities was through voluntary contributions from HQ, Odev or otherentities willing to prop up OCL. In reality, however, OCL was incurring liabilitieswithout any revenue or enforceable means of securing funding.[81] As the High Court found, OCL was insolvent, or close to insolvent from thetime it started trading. This was therefore a paradigm example of a company tradingin circumstances in which the director needed to consider the position of thecompany's creditors.[82] Contrary to Mr Kumar's submissions, the judgment of Lord Reed in Sequanais of no assistance to Mr Kumar. The United Kingdom Supreme Court recognised thatdirectors are required to consider the interests of a company's creditors whereinsolvency is imminent and that the interests of creditors become paramount when itis inevitable the debtor company will face liquidation.30 The position articulated inSequana is very similar to that articulated by the Supreme Court in Debut Homes,which we have set out at [38]. The Supreme Court in Mainzeal also confirmed thatdirectors are required to consider the interests of the company's creditors as insolvencybecomes imminent.[83] We understand Mr Kumar's submission that he believed the financial strengthof the overall group of companies was solid. Mr Chisholm disputed this saying thatas at 31 September 2015 the group had a cash trading deficit of $804,388.[84] Even if Mr Kumar genuinely believed that the overall financial position of thegroup of companies was sound, the reality is that OCL was never solvent from thetime it commenced trading and it never had any ability to require HQ or Odev to meetits liabilities.[85] We do not accept Mr Kumar's submission that he should avoid liability unders 131 of the Act because, according to him, OCL generated revenue. What actuallyhappened was that any revenue generated by OCL was paid to HQ, not OCL.(iii) Breaches of fiduciary duty[86] When structuring the business affairs of the group of companies, and inparticular the way OCL incurred liabilities without having any revenue or meaningfulassets, Mr Kumar placed himself in an impossible conflict of interest. That conflictarose through his failure to consider his responsibilities as a director of OCL and hisconflicting position as a director and shareholder of HQ and Odev. This conflict ofinterest also establishes a breach of s 131.[87] We are therefore satisfied that the High Court was correct in finding thatMr Kumar breached s 131 of the Act and was liable to pay compensation to theliquidator. We shall address the use of quantum separately.30 Sequana, above n 7, at [50] per Lord Reed P; [171]–[176] per Lord Briggs and Lord Kitchin; and[222]–[227] per Lord Hodge DP.Section 135 Companies Act[88] Mr Kumar maintained that he did not breach s 135 of the Act because of hisbelief in:(a) the overall financial viability of the group of companies; and(b) the "Tripod of Confidence" he had in the business model.[89] We need not repeat the evidence concerning Mr Kumar's acknowledgementsthat OCL did not itself have income or significant assets but at the same time itincurred significant debts without having in place any enforceable way to meet itsobligations.[90] When we apply the criteria concerning breaches of s 135 set out in Mainzeal,we reach the following two key conclusions:31(a) On an objective assessment OCL's business was carried on in a mannerlikely to create a substantial risk of serious losses to OCL's creditors.(b) A director exercising an appropriate level of care, skill and diligencewould have been aware that OCL was in "troubled financial waters"and would have undertaken a "sober assessment" of OCL's likely futureincome and prospects, including obtaining professional advice.32 MrKumar failed to do so.[91] We find that the High Court was correct to find that Mr Kumar breached s 135of the Act.31 Mainzeal (SC), above n 17 at [211].32 Mainzeal (CA), above n 24, at [263] and [269]; and Mainzeal (SC), above n 17, at [211(b)], [215],and [271].Section 136 Companies Act[92] The evidence from Mr Kumar, which we have summarised at [78]demonstrates that he arranged for OCL to incur obligations when he did not reasonablybelieve OCL would be able to fulfil its obligations to entities such as Smartpay.[93] The liability which Smartpay incurred as a result of its contract with OCL wasoutside the normal and acceptable range of business risks that a creditor could expectto face when dealing with a company.[94] The High Court therefore correctly held Mr Kumar breached s 136 of the Act.Miscellaneous matters[95] Mr Kumar challenges the decision of Downs J to exclude proposed evidencefrom Mr Grant, an insolvency practitioner.33[96] Mr Grant's evidence was excluded because:(a) Although Mr Grant had experience in managing or liquidatinginsolvent companies his qualifications did not extend to determiningwhether a company is solvent. That type of expertise is usually thepreserve of chartered accountants.34(b) Significant parts of Mr Grant's evidence were unhelpful as he engagedin partisan commentary, such as describing Mr Kumar as "animpressive individual" whose business achievements were remarkable.Mr Grant made assumptions about causation and concluded Mr Kumardid not act with intention to defeat creditors.35[97] We have reviewed Mr Grant's evidence and for the reasons we havesummarised at [96], we agree with Downs J that Mr Grant lacked the requisite33 Interim judgment, above n 1, at [52]–[65].34 At [56]–[57].35 At [58]–[63].qualifications to give evidence about OCL's lack of solvency and therefore hisproposed evidence was not substantially helpful.[98] Mr Grant's proposed evidence contrasted markedly from that of Mr Graham,who qualified as an expert witness and whose evidence was substantially helpful.Quantum[99] Downs J was entitled to conduct a separate hearing on quantum when questionsarose during the trial about how many Eftpos devices were recovered by Smartpayfrom OCL. That evidence, which was accepted by the liquidator and not challengedat the quantum hearing demonstrated:(a) The value of the unpaid fees and invoices at the time OCL was placedinto liquidation was $120,407.43.(b) 1,159 terminals were not recovered. These were worth $399,855.(c) The post-termination fees payable under cl 13.4 of the Smartpayagreement totalled $330,165.(d) This produced a total sum of $850,427.43.[100] Ordinarily, the net deterioration approach would be used under s 135.However, we consider that this situation exemplifies that contemplated by theSupreme Court in Mainzeal, where "the breach of s 135 is itself the cause of thecompany's failure".36 Thus, the "entire deterioration" is appropriate as the basis of theaward. In this case, the entire deterioration is the same as adopting the new debtapproach under s 136 with effect from the Smartpay agreement, namely 18 September2014.36 Mainzeal (SC), above n 17, at [282(a)].[101] Therefore, in assessing quantum, we consider the best approach is to followthe course taken in Mainzeal,37 namely to focus upon the measure of damages thatadequately responds to Mr Kumar's breach of s 136 of the Act.[102] We follow this course because the claim before us is from one creditor thatarose through OCL's breaches of its obligations under the Smartpay agreement.Mr Kumar should not have allowed OCL to enter into the Smartpay agreementbecause, as we have explained, he could not possibly have believed on reasonablegrounds that OCL would be able to fulfil its obligations to Smartpay under theSmartpay agreement.[103] The evidence demonstrates that the actual loss suffered by Smartpay is$850,427.43. That loss arises specifically from OCL's breach of its obligations underthe Smartpay agreement. OCL's breaches occurred solely because Mr Kumar plainlyfailed to discharge his responsibilities as a director of OCL. It is therefore theappropriate measure of compensation under s 301(1)(b)(ii) of the Act.38Result[104] The appeal is dismissed.[105] The appellant is to pay the respondent costs for a standard appeal on a band Abasis together with usual disbursements. We certify for two counsel.Solicitors:Claymore Partners Ltd, Auckland for Respondent37 Mainzeal (CA), above n 24, at [542], affirmed in Mainzeal (SC), above n 17, at [289].38 Mainzeal (SC), above n 17, at [351].