T A ROBB AND M C ROBB V C L SOJOURNER AND ANOR CA CA148/06

T A ROBB AND M C ROBB V C L SOJOURNER AND ANOR CA CA148/06 12 November 2007IN THE COURT OF APPEAL OF NEW ZEALAND CA148/06 [2007] NZCA 493BETWEEN TREVOR ALLAN ROBB AND MARGARET CHRISTINE ROBB Appellant AND CLIFF LEE SOJOURNER First Respondent AND SAILING CAT CRUISES LIMITED Second Respondent Hearing: 26 September 2007 Court: William Young P, Ellen France and Wilson JJ Counsel: J C D Guest and N J Scott for Appellant R C Laurenson for Respondents Judgment: 12 November 2007 at 3 pmJUDGMENT OF THE COURT A The appeal is dismissed save as to the award of costs in the High Court. B Costs in the High Court are to be assessed on a 2C rather than a 3C basis. C In this Court, the appellants are to pay to the respondents costs of $6,000 and usual disbursements.REASONS OF THE COURT(Given by William Young P)Table of ContentsPara NoIntroduction [1]Factual background - overview [4]The basis of the claim [14]The judgment of Fogarty J – an overview [16]Mr and Mrs Robb's challenge to the finding that they acted in breach of section 131 [21]The duties of the Robbs as directors of Aeromarine 1 in February 2003 [21]Was the sale for fair value? [32]Can Mr and Mrs Robb rely on s 138 of the Companies Act 1993? [48]Conclusion as to the challenge to the liability finding [51]Mr and Mrs Robb's challenge to the Judge's approach to relief [52]The nature of the jurisdiction under s 301 – preliminary observations [52]Compensatory and restitutionary relief [56]The approach of the Judge [61]Is the assessment of relief controlled by the likely outcome of a liquidation of Aeromarine 1 in February 2003? [70]Was the Judge's approach to the onus of proof correct? [76]Our approach [78]Mr and Mrs Robb's challenge to the costs award [90]Disposition [95]Introduction[1] Trevor and Christine Robb owned and were the only directors of a company which ran into financial difficulties. They responded to those difficulties by causing the distressed company to transfer its undertaking and the bulk of its assets to a phoenix company and later placing the distressed company in liquidation. Disappointed creditors of that company sued them under s 301 of the Companies Act 1993 ("the Act") on the footing that the sale to the phoenix company involved a breach of the duty of good faith which they owed under s 131 of the Act as directors of the distressed company. Fogarty J found in favour of the creditors. He required Mr and Mrs Robb to pay what was owed to them along with interest and costs on a 3C basis (see Sojourner v Robb [2006] 3 NZLR 808 (HC)).[2] Mr and Mrs Robb now appeal. [3] We will discuss the case under the following headings: (a) Factual background – overview; (b) The basis of the claim; (c) The judgment of Fogarty J – an overview; (d) Mr and Mrs Robb's challenge to the finding that they acted in breach of section 131; (e) Mr and Mrs Robb's challenge to the Judge's approach to relief; and (f) Mr and Mrs Robb's challenge to the costs award.Factual background - overview[4] In 1978, Mr and Mrs Robb established Aeromarine (Robb & Co) Ltd. This company specialised in the manufacture of fibreglass products and, in particular, boats. Its product range also included hydroslides, shower enclosures and components for the bus industry. The company changed its name twice, first to Aeromarine Ltd (which was its name when most of the key events relevant to this litigation occurred) and then to Kut Price Yachts Ltd. For ease of reference we will refer to it as "Aeromarine 1". Mr and Mrs Robb were the shareholders and directors of Aeromarine 1 but Mrs Robb very much left the running of the company to Mr Robb. [5] In 1999, Aeromarine 1 began to construct large yachts. In the end five catamarans were constructed. Contracts associated with the construction of the last two catamarans set the scene for this litigation. These contracts were entered into on 16 August 2000 and 1 October 2001. The first was with the first respondent, Mr Cliff Sojourner and the second with the second respondent, Sailing Cat Cruises Ltd.Sailing Cat Cruises is associated with Mr Hiscock. For ease of reference we will treat Mr Hiscock as if he were the purchaser. [6] By October 2002, Mr Robb recognised that Aeromarine 1 was in trouble. The prices at which Aeromarine 1 had agreed to supply the two catamarans were less than the costs of construction. As well, Aeromarine 1 had lost the services of one key staff member and another had died. Mr Robb decided to put to one side the completion of Mr Sojourner's boat and concentrate on finishing Mr Hiscock's. He also set out to re-focus the business on what had previously been its core activities before it became involved in the construction of the large catamarans. [7] This re-focussing of the business achieved some success. But the contracts with Messrs Sojourner and Hiscock continued to be troublesome. When Mr Hiscock took possession of his boat in December 2002, he was very dissatisfied with the finish and this resulted in acrimonious correspondence and threats of litigation. As well, by February 2003, Mr Sojourner was in serious dispute with Aeromarine 1 and had issued a stop work notice on 27 January 2003. [8] Between the end of January and the beginning of March 2003, Mr Robb, with the assistance and advice of his accountant Mr Russell Hornsey, planned and implemented a restructuring of the business. It is this restructuring which is at the heart of the current litigation. [9] On the Judge's findings of fact, Aeromarine 1 did not face an immediate cash crisis in February and March 2003. In part this was associated with the length of time (at least months) which would necessarily elapse before claims by Messrs Sojourner and Hiscock needed to be addressed. As well, providing the Robbs (and associated entities) continued to support Aeromarine 1, credit was available from the ASB Bank. To put this in context, Aeromarine 1 was part of an interconnected group of trading entities involving or controlled by the Robbs, including a farming partnership (which owned a farm), Hadlow Farming Co Ltd (which operated the farm), Lonica Holdings Ltd (which owned the premises from which Aeromarine 1 operated), Robb Marine Ltd (which also owned property used by Aeromarine 1) and Magnum Boats Ltd (which sold small pleasure boats).[10] The restructuring was effected in the following way: (a) Pursuant to an agreement dated 28 February 2003 Aeromarine 1 sold for $218,000 the bulk of its assets (including goodwill) to Aeromarine Industries Ltd ("Aeromarine 2"), a company which was set up with the same ownership and control as Aeromarine 1. Aeromarine 2 took over the staff of Aeromarine 1 and continued to deal with its customers. This transaction left approximately $50,000 in trade debts owed to Aeromarine 1. (b) Shares held by Aeromarine 1 in other entities associated with Mr and Mrs Robb were later transferred to Aeromarine 2 at cost. (c) On 30 June 2003, Hadlow Farming Co took over the ASB debt and the associated security. (d) Virtually all the external creditors of Aeromarine 1 save for Messrs Sojourner and Hiscock were paid in full. (The other external creditors who were not paid were owed comparatively small and usually disputed amounts of money). The repayment of external creditors was in part achieved from the cashflow which was generated when debts retained by Aeromarine 1 were paid. It may be (although this was not made clear to us) that Mr and Mrs Robb and/or Hadlow Farming Co put in some further money to facilitate payment. In any event, Hadlow Farming Co was left unpaid and the payments made to the external creditors at the very least required forbearance on its part. [11] Aeromarine 1 (by now renamed Kut Price Yachts Ltd) continued to be involved in the dispute with Mr Sojourner. That dispute resulted in High Court proceedings which were to be heard in September 2003. Very much on the eve of the hearing, Aeromarine 1 was placed in liquidation. Mr Hiscock also issued proceedings in March 2003 but these were discontinued after he learnt that Aeromarine 1 had been placed in liquidation.[12] Messrs Sojourner and Hiscock received nothing from the liquidation of Aeromarine 1. Their total losses amount to approximately $320,000 (in terms of proofs of debt which were eventually accepted by the liquidator). In the case of Mr Sojourner, the amount for which he proved included costs and disbursements which he recovered in his proceedings against Aeromarine 1. [13] In its first full year of operation (ie for the 12 months ending 31 March 2004), Aeromarine 2 made a profit of $239,000 on sales of $1.35 million and after paying Mr Robb a management fee of $82,535. It reduced its debt to Hadlow Farming Co by $214,000 and the Robb group as a whole was able to reduce its external debt by $277,000, largely as a result of the cash surpluses generated by Aeromarine 2. In the two subsequent years, ie the years ending 31 March 2005 and 31 March 2006, Aeromarine 2's EBIT adjusted for management fees at the 2003 level were $62,000 and $31,000 respectively. Fogarty J, however, plainly did not see these latter figures as particularly material as he concluded that Mr Robb did not adequately explain the reduced profitability for those years.The basis of the claim[14] The claims made by Messrs Sojourner and Hiscock alleged no less than six causes of action. But the case turns entirely on the first cause of action which alleged breach by Mr and Mrs Robb of their duty to Aeromarine 1 under s 131 of the Act. The core complaint was that Mr and Mrs Robb had not acted in good faith and in the best interests of Aeromarine 1 when they caused that company to enter into the transaction with Aeromarine 2. [15] Messrs Sojourner and Hiscock relied on s 301 of the Companies Act which permits creditors to seek relief based on breaches of duty owed to a company which is in liquidation. Section 301 is set out in full later in this judgment, at [52]. It is sufficient for the present to note that claims were analogous to a derivative action in that the Judge was required to address the nature and extent of the liability of Mr and Mrs Robb to Aerormarine 1 and, at least broadly, to structure the relief he awarded to Messrs Sojourner and Hiscock accordingly.The judgment of Fogarty J – an overview[16] Fogarty J held that the purpose of the sale of Aeromarine 2 was to ring fence Aeromarine 1's core business (and associated assets) and that a necessary collorary of that purpose was an intention to defeat probable claims by Messrs Sojourner and Hiscock. He also concluded that the sale was at an undervalue because the price as calculated included no real allowance for Aeromarine 1's goodwill. On the basis of those findings he concluded that Mr and Mrs Robb had not acted in good faith and that accordingly they were in breach of s 131. [17] A major plank of the case presented on behalf of Mr and Mrs Robb in the High Court was that the maximum that could be awarded to Messrs Sojourner and Hiscock was the difference between what they were paid on the liquidation of Aeromarine 1 (which was nothing) and what they would have been paid if Aeromarine 1 had been placed in liquidation at the time of the restructuring (which would have been nothing or next to nothing). Fogarty J did not agree with this line of argument. In his view:[124] the focus needs to be upon the implications of the directors selling the assets of the company to a new company owned by themselves and continuing to trade profitably.[18] The Judge felt unable to make a finding on the balance of probabilities that, in the absence of a breach of duty, Aeromarine 1 could have traded on and met its liabilities to Messrs Sojourner and Hiscock. He was likewise not able to conclude on the balance of probabilities that a sale of the business would have produced sufficient funds to clear all liabilities. [19] The Judge, however, concluded that the breach of duty by Mr and Mrs Robb was material to the loss suffered by Messrs Sojourner and Hiscock. In his view, the burden was "on the directors then to prove that the plaintiffs would not have recovered all or part of their claim" and he concluded that Mr and Mrs Robb had not satisfied that burden. In adopting this approach to remedy, the Judge was applying what he described as "the trust analogy to the relationship of the directors to the old company for the purpose of deriving the remedy that equity would impose": at [157].[20] The Judge therefore found that Messrs Sojourner and Hiscock were entitled to be paid the amount of their present debts as accepted by the liquidator and that any other disappointed unsecured creditors were likewise entitled to be paid. To give effect to this entitlement, he required Mr and Mrs Robb to pay to the liquidator whatever was necessary for those entitlements to be met. He made incidental orders as to interest and costs.Mr and Mrs Robb's challenge to the finding that they acted in breach of section 131The duties of the Robbs as directors of Aeromarine 1 in February 2003[21] In the period between 1 April 2002 and 31 January 2003, Aeromarine 1 had made a trading loss of $123,000. As at 31 January 2003, Mr Hornsey assessed a shortfall of assets against liabilities of $110,000. This figure did allow for what were in effect overpayments (when viewed against actual progress on the catamarans) up to 31 March 2002 but cannot be regarded as incorporating a realistic assessment of Aeromarine 1's likely exposure on the claims of Messrs Sojourner and Hiscock. In their evidence, Mr Robb and his witnesses sought to portray the situation at this time as one of crisis. But the existence of such a crisis was strongly denied by Murray Lazelle, the expert witness called on behalf of Messrs Sojourner and Hiscock. [22] Mr Lazelle pointed out that cash flow forecasts prepared in October 2002 (after the problems with the contracts were identified) had predicted deficits to February 2003 and surpluses thereafter. A cashflow dated 19 February predicted cashflow surpluses of $137,000 to March 2004. Aeromarine 1's core business was profitable and February 2003 sales were buoyant. Aeromarine 1 was able to continue to trade within the existing credit arrangements (as Mr Robb had explained to ASB Bank on 12 February 2003). The shortfall of assets as against liabilities was in part a function of artificial transactions with other entities associated with Mr and Mrs Robb.[23] The Judge broadly accepted Mr Lazelle's view of the situation and we agree with him. Provided Mr and Mrs Robb were prepared to stand behind Aeromarine 1, there was, as the Judge put it, a "good prospect" of the company being able to trade on indefinitely. The subsequent trading performance of Aeromarine 2 rather suggests that the underlying business may have been sufficiently robust to accommodate, at least over time, payments of the level which would have been required to settle with Messrs Sojourner and Hiscock. There was, in any event, no immediate crisis in February 2003. [24] That said, Mr and Mrs Robb were entitled to resign as directors if they were unwilling to continue to be associated with Aeromarine 1's trading. As shareholders, Mr and Mrs Robb owed no obligations to anyone in relation to the company. They were perfectly entitled to place it in liquidation if they chose. Likewise, as financial backers of Aeromarine 1, Mr and Mrs Robb (and associated entities) had no legal requirement to provide it with capital. Decisions made by Mr and Mrs Robb as shareholders or financial backers of Aeromarine 1 are not susceptible to challenge under s 131 of the Companies Act. So a decision by them, as shareholders, to place Aeromarine 1 in liquidation would not have been in breach of their directors' duties. It follows that the primary complaint against Mr and Mrs Robb must be as to the way in which they disposed of the assets of Aeromarine 1 rather than their decision that Aeromarine 1 should stop trading. Further, the case against them must be assessed in light of the reality that a decision by them to liquidate Aeromarine 1 in February 2003 would have given rise to no liability. [25] Whatever the commercial prospects of Aeromarine 1 prior to restructuring, it was certainly insolvent immediately afterwards. It was common ground before us that the obligations of Mr and Mrs Robb to the company extended to a requirement to take into account the interests of the creditors; cf Nicholson v Permakraft (NZ) Ltd[1985] 1 NZLR 242 (CA). Further, and importantly, their assent to the restructuring as shareholders (which is at least implicit in what happened) does not justify their actions as directors. On this point we refer to the views expressed by Cumming Bruce and Templeman LJJ in Re Horsely & Weight Ltd [1982] Ch 442 (CA) at 454 and 455 and adopted by Cooke J in Permakraft at 250. As Gummow J put it in ReNew World Alliance Pty Ltd; Sycotex Pty Ltd v Baseler (1994) 51 FCR 425 at 445 (FCA):It is clear that the duty to take into account the interests of creditors is merely a restriction on the right of shareholders to ratify breaches of the duty owed to the company. The restriction is similar to that found in cases involving fraud on the minority. Where a company is insolvent or nearing insolvency, the creditors are to be seen as having a direct interest in the company and that interest cannot be overridden by the shareholders. This restriction does not, in the absence of any conferral of such a right by statute, confer upon creditors any general law right against former directors of the company to recover loses suffered by those creditors ... the result is that there is a duty of imperfect obligation owed to creditors, one which the creditors cannot enforce save to the extent that the company acts on its own motion or through a liquidator.To the same effect is the judgment of the New South Wales Court of Appeal inKinsella v Russell Kinsella Pty Ltd (in liq) (1986) 4 NSWLR 722 at 730 which in turn has been followed and applied by the English Court of Appeal in West Mercia Safetywear Ltd (in liq) v Dodd [1988] BCLC 250 at 252. [26] The present case involves a restructuring carried out with the intention of ring fencing in a phoenix company the profitable core of a distressed company's business. This is not an entirely uncommon situation. It has the advantage of preserving value which would likely be lost in a liquidation. It may well preserve the jobs of existing employees. Further, in the nature of things, such a restructuring is likely to result in the payment of trade creditors. But such restructuring will almost inevitably involve some element of conflict of interest. This will be most obvious where those who own and control the distressed company are also in behind the phoenix company. [27] It is helpful to look first at how the present situation falls in terms of the usual equitable principles associated with self-dealing. Mr and Mrs Robb owed a fiduciary duty to Aeromarine 1. They could not, as shareholders, dispense with that duty given the company's insolvency (for the reasons given in [25]). They were therefore not entitled to deal with the assets of Aeromarine 1 in circumstances in which there was a conflict of interest. Obviously there was a conflict of interest as to price. On this basis the sale of the assets to Aeromarine 2 (which they owned and controlled) might be thought to be objectionable irrespective of whether full value was paid. Iffull value were paid, there could be no claim for compensation, but they (and Aeromarine 2) might be thought to be accountable for any profits which they made. All of this follows from the principles which were established in Keech v Sandford(1726) Sel Cas t King 61; 25 ER 223 and which plainly apply to company directors; cf Aberdeen Railway Co v Blaikie (1854) 1 Macq 461; [1843-60] All ER Rep 249 (HL). [28] In practice the courts have not applied rigorously the self-dealing rules in this context. Instead the focus has been on whether the restructuring caused loss to the company with the counter-factual being an immediate liquidation, see for instanceRe Welfab Engineers Ltd [1990] BCLC 833 (Ch D), Gray v Wilson (1998) 8 NZCLC 261,530 (HC) and Lion Nathan Ltd v Lee (1997) 8 NZCLC 261,360 (HC). The flavour of this approach appears in the following passage from the judgment of Hoffmann J in the Welfab decision at 837 – 838):In my view the respondents were entitled to take the view that, if the business could not be saved, its liquidation was not a task which they were required to undertake. If they had decided to invite a receiver or wind up the company, with all the consequences which that would have involved, they could not possibly have been criticised. I therefore consider that, in judging the propriety of the respondents' actions, they should be compared with the alternatives of receivership or liquidation. This seems to me in accordance with recent developments in insolvency law, such as the institution of administration, which are intended to encourage trying to save the business rather than destroy it. Of course directors are not entitled to sell the business to save their jobs and those of other employees on terms which would clearly leave creditors in a worse position than on a liquidation. But I do not think that an honest attempt to save the business should be judged by a stricter standard.[29] As well, regard must be had to ss 139 – 149 of the Act. The arguments before us did not focus in detail on these sections and the relevant statutory language does not closely fit the circumstances of this case. Section 141, however, does perhaps provide some assistance:141 Avoidance of transactions(1) A transaction entered into by the company in which a director of the company is interested may be avoided by the company at any time before the expiration of 3 months after the transaction is disclosed to all the shareholders (whether by means of the company's annual report or otherwise).(2) A transaction cannot be avoided if the company receives fair value under it. (3) For the purposes of subsection (2) of this section, the question whether a company receives fair value under a transaction is to be determined on the basis of the information known to the company and to the interested director at the time the transaction is entered into. (4) If a transaction is entered into by the company in the ordinary course of its business and on usual terms and conditions, the company is presumed to receive fair value under the transaction. (5) For the purposes of this section,— (a) A person seeking to uphold a transaction and who knew or ought to have known of the director's interest at the time the transaction was entered into has the onus of establishing fair value; and (b) In any other case, the company has the onus of establishing that it did not receive fair value. (6) A transaction in which a director is interested can only be avoided on the ground of the director's interest in accordance with this section or the company's constitution.[30] Section 141 is not directly engaged as the case does not concern an attempt to avoid the contract between Aeromarine 1 and Aeromarine 2. As a consequence, s 141(1) and (6) do not apply. Moreover, the section also is not well adapted to the circumstances of an insolvent company (given that the directors of such a company are required to have regard to the interests of creditors and not just shareholders). But if the sale to Aeromarine 2 was for "fair value", Aeromarine 1 necessarily suffered no loss. On the assumption that Aeromarine 2 paid "fair value", the contract could not avoided by reason of s 141(2) (which might be regarded as reflecting the substance of s 141). Under the ordinary equitable principles which apply in self-dealing cases, the fairness of the consideration is no answer to a later claim for an account of profits, see for instance the remarks of Tipping J in Estate Realties Ltd v Wignall [1991] 3 NZLR 482 at 493 – 94 (HC) and the discussion inChirnside v Fay [2007] 1 NZLR 433 (SC) at [16] – [19] per Elias CJ and [121] et seq per Blanchard and Tipping JJ. But if s 141(2) has the consequence in this case that the transaction between Aeromarine 1 and Aeromarine 2 could not be avoided, it would be anomalous to allow a related claim to be advanced against Mr and Mrs Robb and (perhaps Aeromarine 2) for an account of profits. This is because there isa sense in which an account of profits is the other side of the coin to an actual or notional rescission of the relevant contract; cf Chirnside v Fay at [16] per Elias CJ. [31] We propose to proceed on the basis that the liability of Mr and Mrs Robb depends upon whether the sale to Aeromarine 2 was for fair value, an approach which is consistent with s 141 and also recognises the policy considerations which may favour the ring-fencing of losses and the associated setting up of a phoenix company to preserve a salvageable business. Directors who propose to adopt this course, however, should take care to ensure that the value paid by the phoenix company is fair. This is likely to involve, at the very least, a contemporaneous independent valuation of the assets being acquired. In terms of both the process adopted and the price which is eventually fixed, directors would be well advised to err of the side of caution as if the sale is later held to have been at an undervalue, the liability of directors may well exceed the discrepancy between the contract price and fair value. This is because, if the sale is not for fair value, ss 139–149 of the Companies Act will be of no assistance to the directors and there will thus be no limitation on the application of the usual equitable principles as to relief (which extend to compulsory disgorging of gains).Was the sale for fair value?[32] The Judge concluded that the sale was at an undervalue essentially because no genuine allowance was made in the agreed price for goodwill associated with the business. In fact the agreement did provide that the purchase price included $50,000 for "goodwill (including the use of moulds)" but the evidence of Mr Hornsey confirmed that this figure represented the value of the moulds alone. [33] As will become apparent, Mr Robb did not, in February 2003, commission an independent valuation of the goodwill of Aeromarine 1. At trial Messrs Sojourner and Hiscock did produce some valuation evidence. But that evidence represented very much an outsider's view of the situation and did not square up to some of the particular difficulties associated with a valuation of Aeromarine 1's goodwill in February 2003.[34] We have analysed the Judge's reasons and, as well, the evidence which was before him. The key considerations which support the Judge's conclusion that the sale was at an undervalue are as follows: (a) In a letter from Mr Hornsey to Mr Robb of 12 February 2003 which was written when the proposal for the sale of Aeromarine 1's assets first began to be formulated, Mr Hornsey said:There is no reason for Aeromarine Limited not to enter into negotiations for the sale of its assets to a third party provided independent valuations of any assets to be sold are obtained commercial values are obtained prior to disposition [sic].The letter concludedTo pursue the matter further after your meeting with ASB Bank Limited we would suggest that a valuation of the assets of Aeromarine be identified, that a contract for sale and purchase of the existing assets be negotiated with a new company or other parties, and from the proceeds of that sale all known creditors be settled.(b) At the time of the transaction, Mr and Mrs Robb forecast an EBIT in excess of $200,000 for the new company in its first year of operations. On the evidence of Mr Lazelle, the expert called for Messrs Sojourner and Hiscock, this EBIT, if maintainable, implied a total value of goodwill of around $700,000. As it turned out Aeromarine 2's actual EBIT for the year ending 31 March 2004 was in excess of $200,000. (c) On 18 February 2003, Mr Hornsey prepared calculations suggesting a goodwill figure of $750,000. This was for the purposes of Ms Annette Prier, a business broker who, in what was in effect a cold call on Mr Robb, had become involved in the possible sale of the business. (d) Mr Hornsey plainly discussed this valuation with Mr Robb because on the same day (ie 18 February) he wrote to him in these terms: Assuming no profit or loss on the yachts [ie the catamarans belonging to Messrs Sojourner and Hiscock],and including the Magnum boat sales, we have calculated the EBIT to provide a basis for the goodwill valuation. Your comments today of goodwill equating to approx one years ebit is challenged with the basis we have used by applying the basis of John Isaac [the author of a recent article on business valuation]. A compromise is necessary, but with the low cost of plant and stock levels generating very good profits identifies the skill level of your business. Perhaps a capitalisation factor of 30% would give a goodwill figure of $600,000, 40% $400,000. I look forward to your comments.This letter can only sensibly be read as referable to an "internal" sale of the business. Otherwise there would be no logic in Mr Robb trying to talk down and Mr Hornsey talking up the value of the goodwill of the business. (e) Despite references in the first letter of 12 February to independent valuations being obtained and the debate between Messrs Hornsey and Robb about an appropriate goodwill figure (with a range of values ranging between a low of around $200,000 advanced by Mr Robb and a high of around $700,000 (or perhaps $750,000) advanced by Mr Hornsey) no attempt was ever made to obtain a valuation of the goodwill of Aeromarine 1. The Judge inferred that this was because Mr Robb had instructed Mr Hornsey not to prepare or obtain an independent valuation of the goodwill of the company. Mr Guest, for Mr and Mrs Robb, did not seek to challenge this particular finding of fact which seems to us to follow naturally from the evidence to which we have referred and the course which events took. (f) The agreement as finally entered into did allow $50,000 for goodwill but it was acknowledged by Mr Hornsey that this figure related to the value of certain moulds owned by Aeromarine 1. So the purchase price as ultimately fixed made no genuine allowance for goodwill even though goodwill was transferred.(g) In late March 2003 the possibility of a sale of the business to an independent third party was still under consideration. Ms Prier wrote to Mr Robb indicating that, depending on the value of the plant, an asking price of around $850,000 - $900,000 may be realistic. Mr Robb did not take this proposal any further. As to this the Judge drew the inference that Mr Robb did not want to negotiate the sale of the business at that figure because he regarded the business as having a higher value than the figures suggested by Ms Prier. (h) As we have already noted, in its first full year of trading Aeromarine 2 made a profit of $239,000 of sales of $1.35 million after paying Mr Robb a management fee of $82,535. The Judge discounted the significance of the later less profitable years. [35] In challenging the Judge's conclusions on this aspect of the case, Mr Guest advanced a number of weighty points. He stressed the absence of any direct evidence on behalf of Messrs Sojourner and Hiscock in the form of an acceptable expert valuation of the goodwill associated with the business as at February 2003. Further, at that time there had been some negative publicity associated with Aeromarine 1 which had been generated by Mr Hiscock. The difficulties with the large catamarans had resulted in Aeromarine 1 not focussing on its core business clientele. Further there would have been some difficulty in negotiations with a potential purchaser given the unprofitable trading associated with the construction of the large catamarans. These considerations are all part of a broader problem, that of quantifying goodwill for a distressed company which was able to trade only by reason of support from other entities. Mr Guest also stressed the uncertainty of the position of Mr Robb. While Mr Robb was no longer involved in the operational management of Aeromarine 1 (spending most of his time on the farm) he was, nonetheless, the brains of the company because of his substantial expertise in the manufacture of the fibreglass products. Importantly, one of Aeromarine 1's major clients was Magnum Boats, a company associated with Mr and Mrs Robb (albeit a subsidiary of Aeromarine 1) and its other major customer, Design Line, had some personal connections with Mr Robb. As well, the premises from which Aeromarine 1 operated were owned by Lonica Holdings, a company also owned byMr and Mrs Robb. Commonsense suggests that a purchaser of Aeromarine 1's business would have sought a covenant in restraint and trade from Mr Robb (albeit that there was no developed evidence at trial on this issue). Moreover, such a purchaser might, conceivably, only have been prepared to buy the business if Mr Robb continued working in it in the short to medium term. [36] We agree that it is not easy to envisage a sale of the business of Aeromarine 1 to a third party without Mr Robb (and perhaps associated entities) being prepared to give contractual commitments which would enable, in a practical sense, the associated goodwill to be enjoyed by the purchaser. On the other hand, it is clear enough that Aeromarine 2 did obtain something of value when it took over the business from Aeromarine 1. Does it matter that Aeromarine 1 could not otherwise have realised this value (in terms of selling the business to a third party) without the co-operation of Mr and Mrs Robb – co-operation which they were not required to provide? [37] Analogous problems have arisen under the Property (Relationships) Act 1976. [38] In Z v Z [1989] 3 NZLR 413 (CA) the Court was concerned with the value of the husband's legal practice and in particular whether it should be valued on the basis that the husband would be giving a covenant in restraint of trade in relation to the notional sale. In the High Court the Judge concluded that a covenant would involve a surrender by the husband of his right to receive personal income from his exertions in his chosen field of economic activity, that such right was not itself relationship property and that accordingly the value of the business should be assessed on the basis of a sale without a covenant in restraint of trade. This Court disagreed. The lead judgment was given by Richardson J with the most relevant passage starting at 415:In the hypothetical market the willing but not anxious seller must be taken to seek the maximum price obtainable from what is available for sale. Protection against the hypothetical seller's competition through a covenant of restraint of trade is an element of goodwill increasing the price a hypothetical buyer would otherwise be prepared to pay. As an element in the goodwill the covenant attaches to the business and cannot properly be characterised as a purely personal attribute.In my view it is no answer to say that the husband in this case, or more accurately the hypothetical seller, was entitled to practise post separation. The test is the value of the property on a hypothetical sale, and on that hypothetical sale the husband may be included in the classes of hypothetical sellers and hypothetical buyers. The valuation does not vary depending on whether the actual disposal of the practice is to the husband or a third party. If he is to continue the practice in his own right he should not have it at a concessionary price. Furthermore, a properly limited covenant in restraint of trade does not stop a practitioner from practising his or her profession in the future. It does not affect his or her future personal earning capacity in that sense. What it does is to protect the goodwill attaching to the practice by preventing the practitioner from taking business away through retaining access to the existing and potential clientele notwithstanding the sale of the business. As Lord Macnaghten said in Inland Revenue Commissioners v Muller & Co's Margarine Ltd [1901] AC 217, 223: "[Goodwill] is the benefit and advantage of the good name, reputation, and connection of a business. It is the attractive force which brings in custom. It is the one thing that distinguishes an old established business from a new business at the start."It is independent of the current owner. The value of goodwill is the additional value attaching to the business as a going concern over and beyond the value of the assets employed in the business. It is concerned with the earning capacity of the business, here a professional practice, and so, with the present value of the expected income flow whether calculated on a capitalisation of earnings basis or on a super profits approach, or by market rule of thumb methods. As the agreed valuation figures vividly demonstrate, the existence of a covenant restraining hypothetical seller of this business from competing with the business following sale is an important element in estimating the value of the goodwill. It is in that sense an attribute of existing property. (Emphasis added)The passages which we have emphasised are perhaps most relevant in the present context. [39] Also of some interest is the later (and unrelated) judgment Z v Z (No 2)[1997] 2 NZLR 258 (CA). In issue there was the value of the husband's interest in a partnership, an interest which he could not sell. This Court rejected the view that the inability of the husband to sell his interest meant that it had no value. The reasons for this approach were given by Richardson P at 289– 91:That his rights are not assignable and there is no market for them does not mean they have no value. Further, the fact that as between themselves the partners have agreed that their interest in the goodwill of the firm should have a nil value is not determinative of actual value. It may be that there willbe great difficulty in arriving at a value but that does not mean that there is none. In the end the assessment must be approached as a jury question with the assistance of the best evidence available. ... In Ambler v Bolton (1872) LR 14 Eq 427 an asset (government contract) held by one partner for the benefit of the firm, though unassignable, was required to be valued and brought into account upon dissolution. In Kerr v Morris [1987] Ch 90 the goodwill of a National Health Service general medical practice, though sale was prohibited, was held capable of supporting a restrictive covenant and so plainly had value. In Foster v Commissioner of Stamps [1966] WAR 144 a provision in a partnership agreement that the firm had no goodwill was held not to preclude a finding that there was goodwill of substantial value for stamp duty purposes. In the United States in Mitchell v Mitchell 732 P 2d 208 (1987) (Ariz) the partnership agreement of an accounting firm recorded agreement by the partners that no value be placed on the goodwill of the firm. The wife of the partner had signed the agreement yet succeeded in having her husband's interest in the goodwill valued and divided as marital property. The Supreme Court of Arizona acknowledged the difficult task in arriving at a value for the intangible component of a professional practice attributed to goodwill and, referring to earlier authority, indicated that no rigid or unvarying rule has been laid down and each case must be determined on its own facts and circumstances. In Dugan v Dugan 457 A 2d 1 (1983) (NJ) the prohibition on sale of a law practice was considered to be merely a significant factor in assessing the value of the practice for the purpose of marital division of assets which was required notwithstanding the difficulties in fixing the value. Just as the Court must arrive at values for losses of opportunity, losses of profits or earning capacity and similar nebulous intangibles in the assessment of damages, so the loss of an interest in benefits under a deed of partnership, or any other contract, can be valued. In this case it is undisputed that, looked at as a whole, the husband's partnership interest as a bundle of rights has value. That is at least the value of the expected retirement benefit fixed in light of such contingencies and obligations as attach to its expected payment. What must be determined is whether the husband's bundle of rights has any greater value. It was an essential part of Mr Asher's argument that for property to be taken into account for matrimonial property division it must have a market or exchange value. That rests on only one (though the common) approach to value – value in exchange. But it is generally recognised that value may express utility – value in use: 91 Corpus Juris Secundum United States 799; Callard and Pallot, Business Valuation Practice (1994) pp 146 – 171. This could be an appropriate concept for the measurement of any benefit flowing from access to the goodwill as distinct from ownership of it. However, more directly, valuation of the husband's entitlement may be seen as calling for an approach akin to that identifying super profits to measure the extent, if any, by which the husband's expected income as a partner will exceed the earnings appropriate as remuneration for his skills (which are his own) and future efforts.Accordingly, to define and value the rights flowing from the partnership deed need not call for more than the adoption and application to the circumstances of known principles of valuation. (Emphasis added)[40] We are inclined to the view that the approach in the first Z v Z case of valuing the business on the basis that a usual covenant in restraint of trade was available is not directly applicable to an assessment of the fair value of Aeromarine 1's goodwill as at February 2003. As well as being directors with fiduciary duties, Mr and Mrs Robb were independent actors with their own rights. If Aeromarine 1 had been liquidated, they could have bought up the assets and set about establishing a similar business (save for the any limitations associated with the use of confidential information). They certainly had no obligation either to give covenants in restraint of trade or to work with a purchaser in the aftermath of a sale. [41] Identifying what Aeromarine 1 could have realised in or around February 2003 from the sale of its business thus requires assessments to be made as to: (a) The willingness of Mr and Mrs Robb to give contractual commitments to the purchaser of the business of Aeromarine 1; and (b) The extent of any financial allowance which should be made in favour of Mr and Mrs Robb as consideration for those commitments. To put the latter point in more concrete terms, if we were to conclude that with appropriate contractual commitments from Mr and Mrs Robb, Aeromarine 1's goodwill was worth $700,000, what, if any, portion of that $700,000 should be attributed to Mr and Mrs Robb personally rather than to Aeromarine 1? [42] Recognising the difficulties in all of this, it is also important to bear in mind that Mr and Mrs Robb had no entitlement to take the assets of Aeromarine 1 on a concessionary basis, a point on which the first Z v Z case does seem to be applicable. [43] It would not be right to understate the value of the business to Mr and Mrs Robb. They had had a long association with Aeromarine 1 and a very goodunderstanding of its financial potential. Freed of the awkwardness associated with the catamaran contracts, Aeromarine 1 was undoubtedly very profitable. In this context it seems clear that the business had a real value to them for which they would necessarily have been prepared to pay something, perhaps something substantial, rather than see it dissipated. [44] Nor would it be right to overstate the sort of allowance which would be appropriate for the giving by them of appropriate contractual commitments. In his written evidence, Mr Robb said that he had no particular desire to carry on in business as at February 2003. He noted:I had no particular personal ambition at that time to continue. I was de- motivated by what had happened, the business was not profitable, and one option would have been to walk away.[45] In the course of argument we suggested to Mr Guest that a possible approach to this conundrum would be to look at the situation which would have resulted if Aeromarine 1 had been acting independently of Mr and Mrs Robb. We suggested that if this had been the case, it is almost inconceivable that the transaction would have occurred at the value provided for in the agreement as executed. Mr Guest accepted that this was so. [46] Against that background, we are satisfied that there was an adequate evidential basis for the Judge's conclusion that the sale was at an undervalue. Indeed we concur with his conclusion. Further, given the pattern of events and correspondence in the period February – March 2003, it is clear enough that Mr and Mrs Robb appreciated that this was so. The conscious decision not to seek a valuation of the goodwill implies that. So to does Mr Robb's complete disinterest in the proposal which was made by Ms Prier in March 2003. [47] For those reasons we uphold the Judge's conclusion that Mr and Mrs Robb were in breach of s 131 of the Act.Can Mr and Mrs Robb rely on s 138 of the Companies Act 1993?[48] A secondary argument advanced by Mr Guest was a contention that the reliance of Mr and Mrs Robb on the advice given to them by Mr Hornsey enables them to invoke s 138 of the Act. This section provides:138 Use of information and advice(1) Subject to subsection (2) of this section, a director of a company, when exercising powers or performing duties as a director, may rely on reports, statements, and financial data and other information prepared or supplied, and on professional or expert advice given, by any of the following persons: (a) An employee of the company whom the director believes on reasonable grounds to be reliable and competent in relation to the matters concerned: (b) A professional adviser or expert in relation to matters which the director believes on reasonable grounds to be within the person's professional or expert competence: (c) Any other director or committee of directors upon which the director did not serve in relation to matters within the director's or committee's designated authority. (2) Subsection (1) of this section applies to a director only if the director— (a) Acts in good faith; and (b) Makes proper inquiry where the need for inquiry is indicated by the circumstances; and (c) Has no knowledge that such reliance is unwarranted.[49] Mr Laurenson, relying on subsection (2)(a), contended that s 138 does not apply where the cause of action is based on s 131 (ie alleges want of good faith). We doubt if this, rather literal, argument is correct. Instead, we are inclined to accept the view urged on us by Mr Guest that the expression "good faith" in s 138(2)(a) refers to the good faith of the director viz a viz the advice given. [50] This, however, is of no assistance to Mr and Mrs Robb because there was no relevant advice from Mr Hornsey on which they can fairly be said to have relied on. It is perfectly clear that Mr Hornsey did not advise them that the business had no goodwill. Likewise, he did not advise them to proceed without a goodwill valuation.Looking at communications between Messrs Hornsey and Robb in the round, the Judge's conclusion that Mr Robb instructed Mr Hornsey not to obtain a goodwill valuation is self-evidently correct. In light of this, it cannot be said that Mr Robb was acting on advice in relation to the objectionable elements of the transaction.Conclusion as to the challenge to the liability finding[51] For the reasons given, the challenge by Mr and Mrs Robb to the Judge's finding on liability fails.Mr and Mrs Robb's challenge to the Judge's approach to reliefThe nature of the jurisdiction under s 301 – preliminary observations[52] Section 301(1) of the Companies Act provides:301 Power of Court to require persons to repay money or return property(1) If, in the course of the liquidation of a company, it appears to the Court that a person who has taken part in the formation or promotion of the company, or a past or present director, manager, liquidator, or receiver of the company, has misapplied, or retained, or become liable or accountable for, money or property of the company, or been guilty of negligence, default, or breach of duty or trust in relation to the company, the Court may, on the application of the liquidator or a creditor or shareholder,— (a) Inquire into the conduct of the promoter, director, manager, liquidator, or receiver; and (b) Order that person— (i) To repay or restore the money or property or any part of it with interest at a rate the Court thinks just; or (ii) To contribute such sum to the assets of the company by way of compensation as the Court thinks just; or (c) Where the application is made by a creditor, order that person to pay or transfer the money or property or any part of it with interest at a rate the Court thinks just to the creditor.[53] The section provides a procedural short-cut by which a liquidator, creditor or shareholder may pursue the claims which a company in liquidation may have against, inter alia, its former directors. Proceedings under s 301 can extend to claims that directors have "misapplied or become liable or accountable for money or property of the company" or are otherwise liable for a "breach of duty or trust". This language naturally encompasses restitutionary claims (including a claim for an account of profits). It follows, logically, that relief under s 301(1)(b) may be calculated on a restitutionary and not just a compensatory basis. As to s 301(b)(ii), we note that "compensation" can, depending of course on context, encompass restitutionary remedies: see Charter plc v City Index Ltd [2007] 1 WLR 26 (Ch). (We note that in City Index the defendant's gain – for which restitutionary relief was sought – was equivalent to the plaintiff's loss, something which is not always the case.) As well, there is s 301(b)(i) which could be invoked. We note that there are some semantic issues associated with all of this to which we revert at [60]. [54] Logic also dictates that the liability of the former directors to the company in liquidation must cap the extent to which relief under s 301 may be granted. To put this another way, former directors cannot be required to pay more under s 301 than could have been awarded against them in a claim by the company in liquidation. [55] The section is cast in discretionary terms. It also covers a wide range of possible causes of action. The courts have sometimes emphasised the discretionary nature of the jurisdiction and have treated as relevant the degree of the defendant's culpability. But in a context such as the present, where the s 301 claim is very much a proxy for a direct claim by Aeromarine 1 against the former directors, it is difficult to identify any reason for leaving Messrs Sojourner and Hiscock worse off under s 301 than they would have been if Aeromarine 1 had sued Mr and Mrs Robb, recovered what was due and owing and distributed the proceeds of the claims to the creditors.Compensatory and restitutionary relief[56] Given the approach which the Judge took (which we are about to discuss) it is appropriate to make some comments on the nature of the relief to which Aeromarine 1 might have been entitled against Mr and Mrs Robb. [57] Such relief could have been truly compensatory, to make up for the loss suffered by Aeromarine 1 by reason of the breach of duty. That such relief is available in these circumstances is apparent from the cases cited in the City Indexjudgment. Since the breach of duty involved a sale at less than fair value, such compensation would be the difference between the contract price paid by Aeromarine 2 and the fair value of the assets acquired. It is fair to say that the assessment of compensation on that basis in this case poses some real problems as it is far easier to conclude that the fair value of the assets exceeded the sale price than to be specific as to that fair value. As we have noted already, the key difficulty with an assessment of fair value as at February 2003 is how to accommodate the reality that a sale to a third party of Aeromarine 1's goodwill at that time would have required some contractual commitments from Mr and Mrs Robb. [58] One way around this difficulty would be to provide relief on the basis that Mr and Mrs Robb must disgorge any gains made. The gain made by Mr and Mrs Robb is not necessarily the correlative of the loss to Aeromarine 1. In calculating the value of the business for this exercise, it might not be necessary to take into account their hypothetical contractual commitments and the associated allowance – the factors which make the assessment of fair value so conceptually difficult. Instead, the focus might simply be on the carrying value of the business, or its value to them. For the purposes of this exercise, the approach taken in the first Z v Z case might be appropriate. We will come back to discuss this approach later in the judgment. [59] As will become apparent, the Judge recognised the relevance of the general equitable approach of requiring defaulting fiduciaries to disgorge their gains. There are indeed some indications in his judgment that he saw this approach as appropriate here, with a focus on the position of Aeromarine 2 as it was in the financial year ending 31 March 2004. In the end, however, he proceeded on what seems to us tohave been a compensatory basis, albeit with the twist that he put the burden of proof on Mr and Mrs Robb. This had the practical effect of turning back on Mr and Mrs Robb the conceptual difficulties associated with a fair value assessment. [60] Before we turn to discuss the judgment under appeal, there are two associated semantic points which we should mention. Although "compensation" primarily has the meaning ascribed to it in [57], "restitutionary compensation" is not an oxymoron. In Chirnside v Fay at [94] Blanchard and Tipping JJ referred to "damages based on a notional disgorgement of profits made, but not realised". As to this, reference can also be made to Edelman, Gain-Based Damages (Hart 2003). Often, as perhaps in the City Index case, the gain to the defendant is merely the corollary of the loss to the plaintiff. But where there is a duty to account for profits, it is not necessarily an abuse of language to describe as "compensation" a monetary award in lieu of such an account. Such an award compensates the beneficiary, not for losses associated with the original breach but rather for not having an account of profits. In the balance of this judgment we will use "compensation" in its strict sense of compensation for loss. Further, although it is possible to question whether an account of profits is a "restitutionary" form of relief (cf Elias CJ in Chirnside v Fay at [17]), it is convenient in this case to describe a monetary award in lieu of an account of profits as restitutionary.The approach of the Judge[61] The Judge's approach to relief was very much predicated on his view that the claim against Mr and Mrs Robb should be assessed in light of equitable principles. He noted:[143] Originally equity did not award damages as a remedy against delinquent trustees and other fiduciaries. See Ex parte Adamson (1878) Ch D 807 at 819 per James and Baggallay LJJ: The Court of Chancery never entertained a suit for damages occasioned by fraudulent conduct or for breach of trust. The suit was always for an equitable debt or liability in the nature of a debt. It was a suit for the restitution of the actual money or thing, or value of the thing, of which the cheated party had been cheated.[144] In Hanbury and Martin's 'Modern Equity' (17th ed 2005) the learned authors state the principal remedy in this way: A trustee who fails to comply with his duties is liable to make good the loss to the trust estate. Even if there is no loss, the trustee is accountable for any profit made in breach of trust. The object of the rule is not to punish the trustee, but to compensate the beneficiaries. (at 656, 23-001) Applying the trust analogy, the directors had a continuing obligation to make good the loss to the old company, Aeromarine. And they were accountable for the profit being derived in the new company, Aeromarine Industries. [145] It may be noted immediately that this formulation of principle is consistent with the compensatory power given to the Court in s 301 of the Companies Act. That section, however, is remedial, in that the Court is not tied to the detailed application of that principle as applying in the law of equity, such as the need for an election between an account of profits or compensation for loss. [146] From an equity perspective the new company was trading with the intangible assets of the old during 2003 to 31 March 2004 very profitably. During that period it appears to have shrugged off any taint on goodwill, and thereafter would have been marketable. [147] In that context, the directors in default had a continuous duty to restitute to the old company. Rather than do that, during the year ended 31 March 2004 the directors of the old company were realising the fruits of the sale as the owners of the new company and distributing the benefits within their group of companies and their partnership. After the sale to the new company the core business could still have been sold to the benefit of the old, or the transaction reversed. The sale transaction to the new company was a paper transaction. The staff continued. The trade suppliers continued. The customer relationships remained. The core business and stock and plant and the goodwill could have been sold within, or independently of, the new incorporation.[62] So, on Fogarty J's approach (as revealed in this passage of the judgment) the directors had a continuing duty to make restitution to Aeromarine 1, a duty which extended into the financial year ending 31 March 2004. On this approach it would have been open to a Court trying a claim by Aeromarine I against Mr and Mrs Robb to have granted relief on the basis that, acting honestly and in good faith, this is what Mr and Mrs Robb should have done. [63] On this approach, the Judge was able to reject the argument advanced by Mr Guest for Mr and Mrs Robb that the appropriate counter-factual for the compensation assessment was a liquidation in February 2003. In large part this wasbecause of his reliance on equitable principles. But also material were a number of his factual findings, in particular: (a) In February 2003 there was no immediate cash flow difficulty as Aeromarine 1 was in a position to pay current creditors, its core business was trading profitability, the group as a whole was within its credit facility and Mr Robb had advised the bank on 12 February 2003 that no extension of credit was required. (b) There was thus time for an orderly sale of the business at arms length supported by independent valuations to guide the sale. (c) The directors did not have a simple liquidation option as Aeromarine 1 was part of the group of companies with only one group financing facility. (d) Further, the suggestion that a liquidator would have been able to sell the business as a going concern was regarded as "a very optimistic proposition". In other words, the Judge thought that liquidation would likely have resulted in the dissipation of the value of Aeromarine 1's goodwill, a result which the Judge clearly thought would have been unpalatable for Mr and Mrs Robb. (e) There was no evidence that Mr and Mrs Robb or their advisers ever seriously considered that an immediate liquidation was a serious option. (f) In any event, the directors had decided to sell to a new company in order to avoid the loss of what had been described by Mr Hornsey to Mr Robb in a letter as "your business" – a business which Mr Robb had built up since 1978.[64] Based on those conclusions the Judge said:[124] Against these facts there is no merit in deriving as a just sum to compensate the plaintiffs, a sum likely to be equivalent to a dividend from a liquidation of the company in February 2003. Rather, the focus needs to be upon the implications of the directors selling the assets of the company to a new company owned by themselves, and continuing to trade profitably. [125] The situation of the Robbs having sold the assets of the company in breach of s 131 is more accurately characterised in the passage already quoted from Gower which I repeat: Moreover, when it comes to remedies for breach of duty, the trust analogy can provide a strong remedial structure. Directors who dispose of the company's assets in breach of duty are regarded as committing a breach of trust, and the persons (including the directors themselves) into whose hands those assets come may find that the company has proprietary as well as personal remedies for their recovery. (380) Hereafter I adopt that trust analogy as a strong guide to determining "compensation as the Court thinks just", s 301(1)(b)(ii). [126] It was the famous decision of Regal (Hastings) Ltd v Gulliver and Others [1942] 1 All ER 378; [1967] 2 AC 134, which settled that this trust principle applies to directors. The most quoted speech was by Lord Russell of Killowen. But for present purposes it is sufficient to quote the following passage from the speech of Lord MacMillan: The equitable doctrine invoked is one of the most deeply rooted in our law. It is amply illustrated in the authoritative decisions which my noble and learned friend Lord Russell of Killowen has cited. I should like only to add a passage from PRINCIPLES OF EQUITY, by Lord Kames, which puts the whole matter in a sentence (3rd Edn., 1778, vol 2, p.87): "Equity," he says, "prohibits a trustee from making any profit by his management, directly or indirectly." (at 391) Equity's enquiry is not thwarted by the fact that the directors did not purchase directly. Accordingly, equity does not ignore the fact that the new company, Aeromarine Industries Limited, is owned by Mr and Mrs Robb in equal shares. Similarly, they owned the shares in Hadlow Farming Company Limited. The focus is on whether the persons in breach obtained a benefit or profit, not how. Section 301 itself necessitates an enquiry past the corporate structure when assessing a just award. The enquiry does not depend on fraud or absence of bona fides. See Lord Russell of Killowen in Regal at page 386. [127] The plaintiffs might have brought proceedings against Aeromarine [2]. This could have been on the basis that that company received the intangible assets/goodwill of the old company with knowledge of the breach of duty so as to be treated as holding it upon trust. See J J Harrison (Properties) Ltd v Harrison [2002] 1 BCLC 162, 173 – cited by Gower for the passage quoted above.There is a mistake in [127] as Messrs Sojourner and Hiscock had no claim against Aeromarine 2. Presumably what the Judge meant is that Aeromarine 1 might have brought a claim against Aeromarine 2 (along with Mr and Mrs Robb). What is interesting is that the Judge's focus at this point in the judgment continues to be on a monetary award intended to capture the gains made by Mr and Mrs Robb rather than the loss caused by the breach of duty. [65] The Judge's analysis of the relevant financial figures appears in a number of separate parts of his judgment. But the salient features of his conclusions are as follows: (a) If Aeromarine 1 had realised $634,000 from the sale of its business and associated assets, it could have paid out all creditors including Messrs Sojourner and Hiscock. On the Judge's arithmetic – which was not challenged before us – this would imply a goodwill of $390,000. For obvious reasons the amount required to meet creditors was something of a moving target (particularly as the claim by Mr Sojourner came to be inflated by costs associated with his litigation against Aeromarine 1). In practical terms, it seems sensible to proceed on the basis that if the goodwill of Aeromarine 1 had a realisable value of around $400,000, a realisation of the assets of Aeromarine 1 would have enabled its creditors to be paid in full. We will revert to the significance of this figure later in the judgment. (b) The Judge discounted the evidence given by the expert witness called for the defendants (Mr Jordan) which he considered was based on "inappropriately negative instructions, not borne out by the facts". (c) He concluded that that by mid 2004 Aeromarine 2's trading confirmed "an EBIT in excess of $200,000 per annum" which he considered would support a goodwill valuation of $700,000. He also noted that an EBIT of $200,000 per annum for Aeromarine 2 had been predicted by Mr Robb on 27 February 2003. The Judge's figure of$700,000 was based on evidence, which he plainly accepted, from Mr Lazelle. (d) The actions of Mr Robb in March 2003 in refusing to engage with Ms Prier in relation to the still proposed sale of the business indicated that he attributed the value to the business as a whole which was in the order of $850,000. [66] The Judge was not prepared to make an express finding as to the value of the goodwill in February 2003:[138] It is speculation as to what the business would have sold for if it had been offered on the open market in February 2003, in the immediate aftermath of the yacht debacle. The assumption, of course, is that the viable business would be sold leaving the contingent liability with the vendor. A prudent buyer would do due diligence and explore whether or not the customer relationships associated with the core business had been damaged by the diversion of the internal resources of the company to the yachts during 2002 and by the adverse publicity on 8 February 2003. A buyer would have approached some of the main customers of the business. A buyer would have looked for some kind of protection against the directors and owners of the business seeking to take advantage of its goodwill by setting up a competing business post sale. It is unrealistic to expect expert evidence as to the outcome. It may be noted that the budget that Mr Robb provided the bank on 27 February for the new firm contains an EBIT in excess of $200,000 per annum.[67] It is at this point in the judgment that the Judge seems to have drifted away from a restitutionary approach. [68] On the Judge's approach to onus of proof, however, the uncertainties associated with a compensatory exercise were resolved against Mr and Mrs Robb:[150] It is not possible to find, as more probable than not, that the old business would have traded on solvent up to the trial date. Similarly, it is not possible to find that the business would have sold in 2004 for a sum sufficient to discharge all the liabilities. As noted, Mr Guest submitted that the focus should be on the plaintiffs' case. Essentially he was inviting the Court to follow common law principles of onus of proof and causation and remoteness. However, equity does not follow the law, in this respect, when assessing compensation for breach of duties of loyalty. [151] It does not lie upon the directors as fiduciaries in breach of a duty of loyalty to place an evidential onus continuously on the plaintiffs to prove that either the profit on trading after the sale could accommodate all theliabilities of the old business, and/or that the business could have been sold and netted sufficient funds. The onus shifts in the course of analysis. [153] Equity proceeds on the basis that where fiduciary is found in breach, in a situation where property has been transferred, there is an immediate and continuing obligation to return the property. If the property cannot be returned then there is an obligation on the fiduciary to make good by way of damages. In a restitutionary context, it would be plainly inconsistent with that principle for the fiduciary in breach to be able to say: "well I cannot restore the asset, now you prove on the probabilities how much you have lost". Once the plaintiff has scoped the loss, the burden shifts to the defendant beneficiary to reduce the compensation by arguing that the loss, or part of it, would have been suffered anyway notwithstanding the breach. [155] It is sufficient that the plaintiffs have demonstrated that there was a good prospect of the business trading on and meeting its liabilities to them, or being sold for a sum sufficient to discharge its liabilities to them. Second, the plaintiffs have shown that the defendants deliberately rejected the opportunity to try to sell to a third party. Third, the plaintiffs have shown that the defendants acquired the intangible assets (goodwill) of the business for no consideration. [156] The burden was on directors then to prove that the plaintiffs would not have recovered all or part of their claims, as admitted to proof. The defendants have not done so. The poor trading in the last two years was described as disastrous by Mr Robb, but he did not explain why, and when it was anticipated. As already noted he did not explain why he terminated the agency of Ms Prior. Accordingly, at equity the plaintiffs would be entitled to damages for the full amount of their proofs of debt accepted by the liquidator. [157] So far I have been applying the trust analogy to the relationship of the directors to the old company for the purpose of deriving the remedy that equity would impose. I now test that outcome against the purpose of s 301 when applying a standard of what the Court thinks just by way of compensation. I see no reason why these equitable principles should not apply. On the contrary, they are of longstanding, and well thought out, and very much applicable to the situation that has arisen here.In reaching the conclusion that the onus of proof was on Mr and Mrs Robb, the Judge relied on Bank of New Zealand v New Zealand Guardian Trust Co Ltd [1999] 1 NZLR 664 (CA), Thomson v Eastwood (1877) 2 App Cas 215 (HL), Erlanger v New Sombrero Phosphates Co (1878) 3 App Cas 1218 (HL) and Brickenden v London Loan and Savings Co [1934] 3 DLR 465 (PC). [69] Slightly confusing in this section of the judgment are the references to the losses of Messrs Sojourner and Hiscock. If losses were material at this point in the exercise it was the loss to Aeromarine 1 rather than to its creditors which shouldhave been the subject of attention. More to the point, on the logic of the Judge's general restitutionary approach, there was no need to focus on loss – whether to Aeromarine 1 or its creditors – and likewise no need to focus on causation.Is the assessment of relief controlled by the likely outcome of a liquidation of Aeromarine 1 in February 2003?[70] A major part of the argument of Mr Guest was that Messrs Sojourner and Hiscock could not be any better off on their s 301 claim than they would have been if Aeromarine 1 had been liquidated in February 2003. [71] Any assessment of compensatory damages necessarily involves a comparison between the situation as it eventuated with an assessment (usually called the counter factual) of what would have happened absent the commission of the legal wrong in issue. [72] Claims against directors for reckless trading customarily involve a comparison between the situation as it eventuated and what would have happened if the directors had stopped trading at the appropriate time. As well, some of the phoenix company cases appear to proceed on the same basis, see for instance Welfaband Lion Nathan discussed above at [28]. But the Judge rejected the appropriateness of this approach in this case and so do we. Our reasons for doing so largely duplicate those given by the Judge. [73] The reckless trading cases are not a good analogy. A reckless trading case proceeds on the hypothesis that at a particular time, well ahead of the company eventually ceasing to trade, the directors ought to have stopped trading. For reasons given in L
wer v Traveller [2005] 3 NZLR 479 (CA) at [79] and [89] the appropriate counter-factual in such a case is the financial position of the company as it would have been if it had stopped trading at the appropriate time. In the phoenix company cases where a similar approach has been adopted, the point does not appear to have been argued and, in any event, in those cases the only commercial alternative to the course of action taken by the directors was liquidation.[74] In this case, it would be capricious to adopt a February 2003 liquidation as the relevant counter-factual. At that time, there was no practical requirement for an immediate liquidation. Such a liquidation would have damaged the business reputation of Mr and Mrs Robb, destabilised their relationships with trade creditors and resulted in the loss of a business in which they invested so much time and effort over the preceding 25 years. If Mr Robb had insisted on such a liquidation, he would have been cutting off his nose to spite his face. Unsurprisingly, such a liquidation was, as the Judge concluded, never the subject of serious consideration. [75] A third reason why we reject Mr Guest's submission, and perhaps the most important, is that it fails to address the equitable overlay to the claim against Mr and Mrs Robb. They were self-dealing. Because they (via Aeromarine 2) acquired the assets in Aeromarine 1 at less than fair value, they necessarily made a gain at he expense of Aeromarine 1 in circumstances where s 141(2) of the Act provided no immunity. As we have noted, there is nothing in the language of s 301 to suggest that the relief available is solely compensatory. On the basis of the findings of the Judge, Mr and Mrs Robb had an obligation to account to Aeromarine 1 for their gains, including of necessity the difference between what they (via Aeromarine 2) paid for the assets of Aeromarine 1 and the fair value of those assets together with any other profits which they derived from that acquisition.Was the Judge's approach to the onus of proof correct?[76] Mr Guest complained about the Judge's approach to onus of proof, indicating that it came as a surprise to him. But, given s 141(5)(a) of the Act and the cases referred to by the Judge, the question of onus naturally arose. As well, some allowance must be made for the dynamics of the situation. Mr and Mrs Robb were far better placed that Messrs Sojourner and Hiscock to establish a "fair value" of the assets of Aeromarine 1. Further, given that they were acquiring (albeit indirectly) the assets of a company of which they were directors and deliberately (as the Judge concluded in the case of Mr Robb) did not commission an independent valuation of the goodwill, there was nothing unjust in the resulting uncertainties (of which they were the authors) being resolved against them.[77] We are nonetheless left with view that the onus of proof issue is more relevant to establishing liability than the quantification of relief. Further, as we consider that the appropriate approach to this case lies in the application of restitutionary and not compensatory principles, issues of loss (and thus onus of proof as to losses) are irrelevant.Our approach[78] The Judge's assessment of what relief should be granted started with some assessment of the liability of Mr and Mrs Robb (and Aeromarine 2) to Aeromarine 1 if assessed in the year ending 31 March 2004. To the extent to which this focused on the gains made by Mr and Mrs Robb, the exercise is broadly comparable to that carried out in Chirnside v Fay. Instead of there being a formal account of profits, an assessment is made of the gains made by the defaulting fiduciary and this forms the basis of the monetary award which is made. The exercise also in a sense reflects what would have been a sensible and proper approach by Mr and Mrs Robb to the problems they faced in February 2003. They might sensibly have transferred the assets (including the business) of Aeromarine 1 to Aeromarine 2 with a view to consolidating for on-sale the viable and profitable core business activities. This would have created a situation in which the value of the goodwill of the business could have been realised. And if they (or Aeromarine 2) had then accounted to Aeromarine 1 for the proceeds of sale, that would likely have maximised the return for Aeromarine 1 and its creditors. [79] Where a fiduciary wrongfully takes over a business, there are necessarily discretionary (or, as some might prefer to say, very evaluative) assessments to be made as to relief, a point illustrated by Re Jarvis [1958] 1 WLR 336 (Ch D),Hospital Products Ltd v United States Surgical Corporation (1984) 156 CLR 41 andWarman International Ltd v Dwyer (1995) 182 CLR 544. Of interest in this context are the remarks of Mason J in the Hospital Products case at 110:One approach, more favourable to the fiduciary, is that he should be held liable to account as constructive trustee not of the entire business but of the particular benefits which flowed to him in breach of his duty. Another approach, less favourable to the fiduciary, is that he should be heldaccountable for the entire business and its profits, due allowance being made for the time, energy, skill and financial contribution that he has expended or made. In each case the form of inquiry to be directed is that which will reflect as accurately as possible the true measure of the profit or benefit obtained by the fiduciary in breach of his duty.[80] As a matter of common-sense (and justice) the longer the delay between the breach of fiduciary duty and the subsequent accounting exercise, the greater the difficulty distinguishing profits truly associated with the underlying breach of fiduciary duty from the fruits of the defendant's own skill, effort and entrepreneurial risk taking. Associated with this are the difficulties (and scope the disagreement) as to what is an appropriate allowance for a defendant's own skill, effort and entrepreneurial risk taking; cf Chirnside v Fay at [121] – [131] per Blanchard and Tipping JJ. [81] The approach taken by the Judge requires Mr and Mrs Robb to ensure that Messrs Sojourner and Hiscock are paid in full. It is not entirely easy to identify what that approach presupposes as to the extent of the liability of Mr and Mrs Robb to Aeromarine 1: (a) We mentioned earlier that if Aeromarine 1's assets had been sold on a basis which provided $400,000 more than was achieved, all creditors would have been paid. In saying this we recognise that Aeromarine 1 would have almost certainly been able to settle with Messrs Sojourner and Hiscock for less than the full amount of their debts. But given the restitutionary approach we prefer to adopt, this consideration does not appear to be relevant. (b) The $400,000 figure we have mentioned is referable to the situation which obtained in February 2003. As time went by the debts to Messrs Sojourner and Hiscock increased in part by reason of interest and in part as costs and disbursements came to be incurred. It follows that the Judge's award under s 301 presupposes a liability on the part of Mr and Mrs Robb to Aeromarine 1 of more than $400,000.(c) Looking at the case in the round we think that the considerations just referred to can be fairly allowed for by an additional $100,000. (d) For those reasons we propose to proceed on the basis that the relief which the Judge awarded was justified if the liability of Mr and Mrs Robb to Aeromarine 1 was in the order of $500,000. [82] We are inclined to focus (as did the Judge) on the position as it was in the year ending 31 March 2004. Given that Aeromarine 2 simply stepped into the shoes of Aeromarine 1, the gains made by Mr and Mrs Robb include the value of the goodwill of Aeromarine 1 which they had acquired for nothing and which was reflected in the value of the goodwill of Aeromarine 2. Also to be allowed for are the associated profits made by Aeromarine 2 which were at their disposal. The management fee charged to Aeromarine 2 might be thought to make fair (and perhaps generous) allowance for their own contributions. By stopping the exercise at 31 March 2004, fair (and perhaps generous allowance) would be made for the reality that an account of profits covering a period of indefinite duration would be neither fair nor practicable. [83] We recognise that carrying out this assessment by reference to the position in the 2004 year carries some disadvantages for Mr and Mrs Robb as Aeromarine 2 was not as profitable in the 2005 and 2006 years as it was in the 2004 year. On the other hand, given that the Judge did not receive the advantage of a full analysis of the figures for those years, it is understandable that he should focus of the period which was the subject of detailed evidence. As well, in a situation where an account of profits (or equivalent exercise which is a proxy for such an account) is in issue, some closing date must be fixed. We see nothing objectionable in assessing, in a broad- brush way, the gains made by Mr and Mrs Robb by reference to the 2004 year on the basis that subsequent gains (which of course include profits made by Aeromarine 2) and losses are to their account. [84] On this basis we would allow $240,000 for the profits of Aeromarine 2 in the year ending 31 March 2004. The correctness of the Judge's award of relief thereforedepends upon a conclusion that it is appropriate to attribute a value to the goodwill, in the hands of Mrs and Mrs Robb (via Aeromarine 2), of $260,000 or more. [85] Having regard to the evidence given, including the February 2003 EBIT and goodwill calculations carried out by Mr Hornsey, Mr Robb's own assessment on 27 February 2003 of an EBIT of $200,000 and the very profitable trading performance of Aeromarine 2 for the year ending 31 March 2004 and placing all of this in context provided by the evidence of Mr Lazelle, it seems reasonable to us to attribute $700,000 to the goodwill which Aeromarine 2 (and thus Mr and Mrs Robb) had the advantage of in 2004. It is at least implicit in the judgment that Fogarty J thought that this was so. [86] It follows that we should proceed on the basis that this goodwill value would have been realisable at the instance of Mr and Mrs Robb in 2004 if they had chosen to sell Aeromarine 1. The fact that they did not do so is not an obstacle to a monetary award which in effect captures that value. But since such value could not have been achieved without Mr and Mrs Robb giving appropriate contractual commitments, this leaves the question whether an adjustment is required to give them value for such notional contractual commitments. [87] Given that the whole exercise is a proxy for an account of profits, we consider that such allowance ought not to be required. Mr and Mrs Robb had obtained the business on concessionary terms, a business which was plainly of real value to them. There is no injustice about valuing it on the basis of its carrying value which represents its value to them and a value which they could have realised if they wished to exit the industry. [88] Further, even if we are wrong in this approach, the comments made in [44] above suggest that any allowance for their contractual commitments could fairly be accommodated within the headroom between a "gross" goodwill figure of $700,000 and the $260,000 which we have identified. [89] Accordingly we dismiss the challenge to the quantification of relief.Mr and Mrs Robb's challenge to the costs award[90] At the end of his primary judgment, the Judge said:[167] The plaintiffs are entitled to costs on a 3C basis. Mr Guest has submitted the trial was unduly long. I will receive submissions on that point.Despite the comment attributed to Mr Guest, it appears that the Judge had not heard submissions (at least in any detail) about costs. As a result, he was apparently not aware that the parties had agreed, at an early stage in the proceedings, to costs being calculated on a 2C basis, an agreement which recorded in a Court minute made on 6 December 2004. Subsequently, two orders for costs were made in relation to specific interlocutory applications, one on a 2B basis and the other on a 1C basis. [91] When the Judge came to fix costs (in a later judgment) he referred to the procedural history which we have just mentioned. He also referred to r 48(2) of the High Court Rules which provides:The Court may at any time determine in advance an applicable category in relation to a proceeding. If it does, the category applies to all subsequent determinations of costs in the proceeding unless there are special reasons to the contrary.He made it clear that he had not intended to revisit costs orders which had already been made. But he otherwise did not address the original category 2 classification of the proceedings and did not attempt to identify "special reasons" for departing from that classification. In the result he confirmed his 3C assessment but with an allowance for six days only of the eight day trial. [92] When the Judge originally adopted a category 3 classification, he had plainly overlooked the earlier classification, a factor which was of relevance to the exercise of his discretion. When the issue was brought to his attention, the Judge did not identify special reasons which justified a departure. Interestingly, even in this Court counsel for Messrs Sojourner and Hiscock did not advance special reasons for departing from the original classification.[93] The costs rules do not envisage that a single band (other than band B) should be applied on a blanket basis across the proceedings; cf McLachlan v Mercury Geotherm Ltd (in rec) CA117/05 4 December 2006 at [62]–[64]. On the other hand, the major differences between bands B and C for present purposes relate to commencement of proceedings and discovery and inspection. Given the nature of the case (which practically required Messrs Sojourner and Hiscock to make out their case from Mr and Mrs Robbs' documents) and the subtlety and complexity of the issues, we see nothing untoward in the adoption of band C (particularly given that this was agreed to by the parties at the outset). [94] Accordingly we allow the appeal against the award of costs by substituting that costs be assessed on a 2C rather than a 3C basis.Disposition[95] The appeal is dismissed save as to the award of costs in the High Court. Costs in the High Court are to be assessed on a 2C rather than a 3C basis. In this Court, the appellants are to pay to the respondents' costs of $6,000 and usual disbursements.Solicitors: Downie Stewart, Dunedin, for Appellants Kiely Thompson Caisley, Wellington, for Respondents