Insolvency

Case Alert - Director's duties and insolvency

Madsen-Ries v Cooper

Overview

In Madsen-Ries v Cooper [2020] NZSC 100, the Supreme Court has overturned the Court of Appeal and restored the outcome in the High Court.  The decision contains a useful analysis of the scope of director duties under ss131, 135 and 136 of the Companies Act 1993, and the correct approach under s301 to determine the quantum of relief for any breaches.

Madsen-Ries v Debut Homes quote

Facts

Mr Cooper was the sole director of Debut Homes Ltd, a residential property developer.  At the end of 2012 Mr Cooper decided to wind down the operations of the company.  He decided to complete existing developments, believing that creditors would be better off overall from the profits thereby expected, even though this was forecast to produce a GST deficit of over $300,000 once the wind-down was completed.  Debut was eventually placed into liquidation on 7 March 2014, owing GST of more than $450,000.

Legal analysis

The High Court held that Mr Cooper breached his duties under ss131(1), 135(b) and 136 of the Companies Act 1993.  Under s301(1)(b)(ii) it ordered Mr Cooper to make a contribution of $280,000.

The Court of Appeal allowed Mr Cooper's appeal against the findings of breach, and quashed the relief granted in the High Court.

The Supreme Court overturned the Court of Appeal decision and restored the outcome in the High Court.  The Supreme Court's analysis began with a consideration of the various formal mechanisms available for dealing with insolvency concerns, including a creditors' compromise under Part 14, compromises approved by the High Court under Part 15, and voluntary administrations under Part 15A. This was relevant because any informal mechanisms available to directors must accord with directors' duties and the scheme of the Act, including the importance it places on maintaining solvency ([47] and [178]). This suggests a need, under any informal scheme, to ensure the agreement of all creditors, or at least ensure that those not consulted are paid in full ([48] and [180]).

Contrary to the outcome reached in the Court of Appeal, the Supreme Court held that s135 does not permit continuing to trade if directors know that the company cannot be salvaged (ie if a shortfall will result), even if some creditors might be better off or the overall deficit is projected to be thereby reduced ([70]-[73] and [174]). A discretion to continue trading in those circumstances would be inconsistent with the scheme of the formal procedures that require all creditors to be consulted and vote by value and class [75].

Under s136, it is not legitimate to enter into a course of action to ensure some creditors have a higher return where this is at the expense of incurring new liabilities that will not be paid ([94] and [175]). Unlike the Court of Appeal, the Supreme Court did not accept that s136 was limited to direct contractual obligations.

The test under s131 was held to be a subjective one [112]. Directors cannot subjectively believe that they are acting in the best interests of the company if they have failed to consider the interests of the company or, where required (ie in an insolvency or near-insolvency situation), the interests of all of the creditors, including prospective creditors ([114] and [177]).  In this case, Mr Cooper considered the interests of some, but not all, creditors in an insolvency situation [116], and accordingly he breached s131.

The appropriate relief under s301 must respond to the duty or duties actually breached [160]. Relief cannot be more than is required to compensate and/or to provide restitution, but within those limits it can take into account general deterrence [162]. For a breach of s135, in most cases the appropriate starting point would be an amount equal to the deterioration in the company's financial position between the date when trading should have ceased and the date of actual liquidation (the net deficiency approach). However, in this case that measure would not reverse the different harm addressed by s136. For that reason, the High Court's starting point of all new debt incurred after the beginning of November 2012 was appropriate [168].

Conclusion

In dealing with the economic fallout of COVID-19, many directors will unfortunately be required to assess their company's financial position and whether to implement informal or formal mechanisms to address insolvency concerns.  The detail of this case will require careful consideration, including the degree to which creditors must be considered and consulted if a compromise is necessary to salvage the company.