IN THE HIGH COURT OF NEW ZEALAND CP 13/00
(Part Heard in Wellington Registry)
UNDER THE Companies Act 1955, the Companies Act 1955 as amended by the Companies Amendment Act 1993 and the Companies Act 1993
IN THE MATTER of Cellar House Limited (In Liquidation)
BETWEEN ROBERT BRUCE WALKER
Plaintiff
AND DONALD WINTON ALLEN
Defendant
Hearing: 19 – 22 August (in Nelson Registry) and 15 – 17 October 2003 (in Wellington Registry)
Counsel: P J Andrews and K F Quinn for the Plaintiff
D W Allen in Person with F Donaldson as McKenzie Friend
Judgment: 18 March 2004
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Para No. |
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Introduction Chronology The pleadings Did defendant meet duty to keep accounting records? Affirmative defence to records claim Reckless trading? Acting in good faith and in best interests? Exercising care, diligence, etc? Affirmative defence to breach of duties claims Relief Other matters Result Costs |
[6] [7] [155] [181] [212] [216] [217] [223] [244] [246] [247] |
Introduction
[2] In 1992 Cellar House was audited by Customs as part of one of Customs’ routine audits. Cellar House was subsequently assessed for substantial amounts of unpaid excise duty. Cellar House continued to trade until 1998 although the debt to Customs was not paid. Customs obtained judgment in relation to the unpaid excise duty in May 1999 and then the plaintiff was appointed as liquidator on Customs’ petition.
[3] The liquidator seeks orders that Donald Winton Allen, who has been Managing Director of Cellar House from the outset, should be held personally liable for all or some of Cellar House’s liabilities and that he be required to contribute personally to the assets of Cellar House.
[4] Mr Allen denies the breaches as a Director. He says Cellar House did keep proper records; that he took all reasonable steps to ensure compliance with the statutory requirements; and that he reasonably relied on a competent and reliable person who was charged with the duty of seeing that proper accounting records were kept and was in a position to discharge that duty.
[5] The issues revolve around the nature of the duties, whether they were met and whether there was reasonable reliance on others, and the quantum of any contribution to be made by Mr Allen.
Chronology
[6] There is no dispute over the chronology of events which is as follows:
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15 August 1985 |
Cellar House incorporated as Redwood Cellars (1985) Limited. |
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15 August 1985 |
Don Allen takes position as Managing Director of Cellar House. |
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1988 |
Customs audits Cellar House. |
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20 July 1989 |
Timothy Goulter and Bevan Inglis take positions as directors of Cellar House. |
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October 1992 |
Customs audits Cellar House. |
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30 October 1992 |
Customs writes to Cellar House telling them its requirements. |
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13 November 1992 |
Customs writes to Cellar House outlining changes to records required. |
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17 November 1992 |
Customs sends Cellar House an amended procedure statement. |
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26 April 1993 |
Customs issues assessment to Cellar House demanding $1,435,705.00 excise duty plus payment of $80,000 credit claim. |
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19 July 1993 |
Customs issues Cellar House with a new licence and procedure statement. |
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20 October 1993 |
Cellar House directors’ meeting discusses Customs’ assessment. |
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8 November 1993 |
Auditor’s report for Cellar House for 1992 financial year notes no provision made for Customs debt. |
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15 November 1993 |
Customs sends Cellar House a “short payment” notice for $1,526,130.00. |
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28 July 1994 |
Bevan Inglis resigns as director of Cellar House. |
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28 July 1994 |
Peter Inglis (Bevan’s son) takes up position as director of Cellar House. |
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October 1995 |
Tariff Mediator gives decision on reclassification issue. |
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21 August 1996 |
Customs sends revised assessment to Cellar House. |
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14 October 1996 |
Customs issues proceedings against Cellar House. |
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March 1997 |
Customs audits Cellar House. |
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21 April 1997 |
Customs sends Cellar House short paid notice concerning unpaid excise duty. |
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20 July 1997 |
Timothy Goulter and Peter Inglis resign as directors of Cellar House. |
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1998 |
Cellar House ceases to trade. |
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21 April 1998 |
Cellar House’s shareholders agree to sell its stock and lease land plant etc to Haumi Corporation Limited a company formed by Don Allen. |
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6 June 1998 |
Agreement between Cellar House and Haumi for sale of stock entered into. |
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3 August 1998 |
Agreement between Cellar House and Haumi for lease of Cellar House’s plant and equipment entered into. Haumi starts to trade. Cellar House required to provide a guarantee to the National Bank to support Haumi’s borrowings from the bank. |
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21 August 1998 |
Cellar House changes its name from Redwood Cellars (1985) Limited to allow Haumi to trade using Redwood Cellars name. |
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19 May 1999 |
Judgment issued against Cellar House in favour of Customs for $5,755,647.15. |
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24 May 1999 |
National Bank appoints receivers of Haumi and Cellar House. |
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8 June 1999 |
National Bank calls for payment of Cellar House’s guarantee in respect of Haumi. |
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Mid 1999 |
Customs conducts “exit” audit of Haumi and Cellar House. |
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10 September 1999 |
Haumi ceases to trade and business sold to Hansa Cellars Limited. |
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16 December 1999 |
Plaintiff appointed liquidator on petition of Customs. |
The pleadings
[7] There are four causes of action. The first cause of action alleges a failure to keep proper accounting records under s 300 of the Companies Act 1993 (“the 1993 Act”). This cause of action covers the accounting records for three periods, namely, April 1992 to June 1994; July 1994 to June 1997; and 27 June 1997 to December 1999. The relevant requirements in terms of that first period are set out in s 151 of the Companies Act 1955 (“the 1955 Act”). For the next period the relevant provisions are s 151 of the Amended 1955 Act (in terms of accounting records) and s 10 of the Financial Reporting Act 1993 (for financial statements). Finally, for the third period, accounting records are dealt with in s 194 of the 1993 Act and financial statements in s 10 of the Financial Reporting Act.
[8] For each of the three periods the statement of claim alleges how the records were inadequate.
[9] It is then alleged that the defendant’s failure to ensure that Cellar House caused proper accounting records to be kept contributed to the company’s inability to pay all of its debts. The statement of claim then sets out the allegations under this head in relation to the financial years from 1993 up to and including 1999.
[10] The plaintiff seeks an order under s 300 of the 1993 Act that the defendant is personally liable to the plaintiff for Cellar House’s outstanding liabilities of $11,081,024.63 or such other part of its debts and liabilities as the Court may direct together with interest.
[11] The second cause of action is one of reckless trading with reference to s 135 of the 1993 Act and s 189 of the 1955 Act as amended by the Companies Amendment Act 1993.
[12] The plaintiff alleges that during the period from 4 August 1994 to June 1997 and then also from 27 June 1997 to on or about 16 December 1999 the defendant’s actions amounted to reckless trading. For example, in terms of that first period, the allegation is that the defendant agreed to the business of Cellar House being carried out in a manner likely to create a substantial risk of loss to creditors and/or caused or allowed the business to be carried on in a manner likely to create a substantial risk of serious loss to the creditors. These claims are further particularised, for example, by reference to the Customs debt.
[13] The relief sought in terms of this cause of action includes a declaration the defendant has breached his duty to Cellar House. Further, orders are sought under s 301 declaring that the defendant repay such sum as the Court thinks just etc together with interest.
[14] The third cause of action alleges a failure to act in good faith and in the best interests of the company with reference to s 131 of the 1993 Act and s 185 of the 1955 Act as amended by the 1993 Act. Again, two periods of time are covered reflecting the changes in the relevant legislation. The periods are from 4 August 1994 until 26 June 1997 and from 27 June 1997 to on or about 16 December 1999. The previous particulars are relied on in support of the allegation.
[15] Orders are sought that the defendant has breached his duty to Cellar House under the relevant sections. Again, a declaration is sought that the defendant repay to Cellar House such sum as the Court thinks just, or contribute such sum to the assets of Cellar House as the Court thinks just together with interest.
[16] The fourth and final cause of action is a failure to exercise the care, diligence, and skill that a reasonable director will exercise (s 137 of the 1993 Act and s 191 of the 1955 Act as amended by the 1993 Amendment).
[17] In terms of the period from 22 February 1995 to 26 June 1997, the defendant’s actions when exercising his powers or performing his duties as director are said to be a failure to exercise the care, diligence and skill that a reasonable director would exercise in the same circumstances.
[18] The previous particulars are relied on. It is further said that a reasonable director in the defendant’s position would have ensured that sufficient accounting records were maintained to enable the financial position of Cellar House to be accurately determined and, further, such a reasonable director would have ensured that Cellar House was able to meet its obligations as they became legally due including its obligation to pay excise duty, GST and income tax.
[19] There is a similar allegation for the period from 27 June 1997 to 16 December 1999. Much the same particulars are relied on.
[20] Similar declarations of a breach of the relevant provisions are sought together with orders declaring that the defendant is to repay a sum to Cellar House or contribute a sum to the assets of Cellar House together with interest.
[21] In addition to general denials, the defendant asserts that he:
a) Took all reasonable steps to secure compliance by the company.
b) And/or relied on reports, financial data and other information prepared or supplied and on professional and expert advice given by any of the following persons including employees of the company, professional advisors or experts, and other directors in relation to that director’s designated authority. In addition, in terms of the allegations relating to his performance of director’s duties, the defendant avers that he exercised the care, diligence and skill that a reasonable director would exercise in the same circumstances taking into account but without limitation the nature of the company and of the decisions; and the position of the director and the nature of his responsibility.
[22] By way of an affirmative defence, the defendant says he:
a) Did not act or agree to act or agree to the company acting in such a manner as contravened any statutory provisions.
b) Did not agree to the company incurring any obligation without believing, at that time and on reasonable grounds, that the company could perform the obligation when required.
c) Acted in good faith.
d) Made such proper inquiry when he felt the need for inquiry was indicated by the circumstances.
e) Had no knowledge that such reliance was unwarranted.
f) Took all reasonable steps to secure compliance with s 300.
g) Alternatively, had reasonable grounds to believe and did believe that a competent and reliable person was charged with the duty of seeing that all provisions were complied with and was in a position to discharge that duty.
Did defendant meet duty to keep accounting records?
“(b) The Court considers that¾
(i) The failure to comply has contributed to the company’s inability to pay all its debts, or has resulted in substantial uncertainty as to the assets and liabilities of the company, or has substantially impeded the orderly liquidation; or
(ii) For any other reason it is proper to make a declaration under this section,¾
the Court, on the application of the liquidator, may, .. declare that any one or more of the directors .. is, or are, personally responsible, without limitation of liability, for all or any part of the debts and other liabilities of the company as the Court may direct.”
[24] Section 194 sets out the duties of the Board of a company to keep accounting records. Those records must:
a) Correctly record and explain the transactions of the company.
b) At any time enable the financial position of the company to be determined with reasonable accuracy.
c) Be such as to enable the directors to ensure that the financial statements of the company comply with s 10 of the Financial Reporting Act.
d) Enable the financial statements of the company to be readily and properly audited.
[25] Section 194(2) then sets out a number of matters with which the accounting records must deal such as a record of the assets and liabilities of the company and various stock records.
[26] The effect of Walker v Allen [2002] 1 NZLR 278 is that s 300 should be read as including the antecedents to s 194 of the 1993 Act, that is, s 151 of the 1955 Act and s 151 of the amended 1955 Act. In all cases, financial statements must give a true and fair view of the company. The Financial Reporting Act also requires financial statements to comply with generally accepted accounting practice (“GAAP”) (ss 10 and 11).
[27] GAAP has been incorporated into the Financial Reporting Act, the amended 1955 Act and the 1993 Act. The definition of GAAP is set out in s 3 of the Financial Reporting Act as follows:
“For the purposes of this Act, financial statements .. comply with [GAAP] only if those statements comply with¾
(a) Applicable financial reporting standards; and
(b) In relation to matters for which no provision is made in applicable financial reporting standards and that are not subject to any applicable rule of law, accounting polices that¾
(i) Are appropriate to the circumstances of the reporting entity; and
(ii) Have authoritative support within the accounting profession in New Zealand.”
[28] The plaintiff alleges that the defendant’s records failed in two ways, and these are:
a) The financial statements did not accurately record the company’s liability for excise duty after the 1992 Customs audit and so did not give a true and fair view of the company’s financial position.
b) The quality of the accounting records from 1992 onwards did not meet the requirements of the Companies Acts.
[29] The plaintiff says the consequences to the company of non-compliance were that Cellar House incurred substantial liabilities for excise duty; the financial statements did not give a true and fair view; Cellar House was insolvent from at least 1993 (if not earlier) but continued to trade until 1998; and its liabilities increased substantially during this time.
(i) Adequacy of recording liability for excise duty?
[30] The plaintiff argues that the defendant knew or should have known of the importance of ensuring that its records were such that excise duty was determined accurately. In this context, the plaintiff relies on an audit undertaken by Customs in 1992 which the plaintiff says revealed serious failures in the company’s records and led to its excise duty having been substantially under-declared with the result that the company was liable for substantial payments of additional duties including additional GST.
[31] After the 1992 Customs audit, Customs wrote to Mr Allen as Managing Director on 26 April 1993. The letter set out what was described as a “series of analyses” of the company’s excise liability. The letter concluded that Cellar House,
“.. is considered to owe .. Customs .. $1,453,705 plus the $80,000 credit claimed in February 1993.”
[32] The company was given 20 working days,
“.. to respond to this statement of debt and disclose any matters considered to affect the balances shown on the analyses .. If a reply is not received twenty days from the date of this letter debt recovery through the justice system will be initiated.”
[33] Excise duty on unaccounted ethyl alcohol purchases made up most of the assessed excise duty. A further $207,711 of additional duty was payable on the unpaid duty. Additional duty continues to accrue for as long as the excise duty remains unpaid.
[34] On 15 November 1993, Customs sent Mr Allen a notice of short payment being excise duty, ALAC levy, and GST for $1,526,130. The notice said this amount was due for payment by 21 December 1993. If not paid by then, there would be penalties payable on that amount. The letter acknowledged the classification appeal made by the company.
[35] Because the duty referred to in the short payment notice was not paid, Cellar House was assessed with additional (penalty) duty of $3,116,159.52 in a letter sent on 21 August 1996. It was acknowledged in evidence that the original assessment was incorrect and was adjusted down following the intervention of the Tariff Mediator. This related to the product classification adopted in relation to some products but this aspect was relatively minor in terms of the overall amount owing to Customs ($192,392.60 off the original amount of some $1.5 million).
[36] The liquidator, Mr Walker, and John Robert Buchanan who gave evidence for the plaintiff both said that the liability owed by Cellar House in respect of the 1992 audit was a liability which should have been disclosed in the company’s financial statements from as early as the 1992 financial year. Mr Buchanan is a chartered accountant who has acted as a receiver or liquidator over 600 times since 1987 and he also has experience in the wine and spirit industry. There was no evidence challenging that of Messrs Walker and Buchanan on this point.
[37] In this context, Mr Walker used the definition of a liability from the “Statement of Concepts for General Purpose Financial Reporting” issued by the Council of the New Zealand Society of Accountants (1993). That Statement notes that liabilities have three essential characteristics:
a) A present obligation, not yet satisfied, for the company to act or perform in a certain way.
b) Adverse financial consequences for the company.
c) The transaction or event giving rise to the obligation must have occurred.
[38] The plaintiff’s case is that these characteristics are met in relation to the payment of excise duty.
[39] The financial statements for the year ended 31 March 1993 do not make any provision for the debt owing to Customs. The notes to the financial statements state that:
“There were no Contingent Liabilities at balance date other than Customs Department claims as outlined in the Directors Report”.
[40] There is reference in the directors’ report attached to the 1992 financial statements, signed by Mr Allen, about the dispute with Customs. Mr Allen referred to the overall decision making at Cellar House “sometimes” being “distracted” by the “very large problems” the company had and was having with Customs. Mr Allen continued:
“Your Directors have not made any provision in the accounts for the extra duty as they believe it is not due, for two reasons:-
1. That no other producer has paid or has been asked to pay the increased duty for the period in dispute.
2. [Cellar House’s] product does not qualify as a fruit wine and therefore does not attract the duty for fruit wine, that is the increased duty rate ..
The second dispute concerns duty paid on alcohol sold during the period January 1989 to December 1992.
The Customs have assessed [Cellar House] for extra duty based on a reconciliation done by themselves.
Your directors consider the Customs .. calculations incorrect as they have made incorrect assumptions and incorrect calculations, ..
No provision has been made in accounts for any liability as your directors do not believe that any duty is owing but if some is it will be a fraction of the amount claimed by the Department.”
[41] In the audit report dated 8 November 1993 dealing with the 1992 financial year statements John Black, a chartered accountant and the company’s auditor, states that reference had been made in the directors’ report to the Customs’ claim and the absence of any provision made for that. Mr Black continued:
“At this time it is not possible to determine with reasonable accuracy the ultimate cost, if any, which may become payable.”
[42] Mr Walker’s evidence also refers to a letter to Pitt & Moore, solicitors, from Cellar House’s external accountant, Bruce Gilkison. The letter is dated 1 September 1993 and asks Pitt & Moore to provide information about any liabilities Pitt & Moore were aware of concerning Cellar House. Mr Gilkison asked for this information to be provided to himself and to Mr Black. The letter states that:
“Mr Black is prepared to accept that the liability to Customs is not able to be determined and is covered in the Directors Report”.
[43] Again, in terms of the financial statements for the year ended 31 March 1994, there is no provision made for the debt owing to Customs in respect of the 1992 audit. No contingent liabilities are listed in the notes to the accounts.
[44] The position is the same in the financial statements for the year ended 31 March 1995. The notes to the accounts do record a contingent liability to Customs but state that:
“[T]he Directors do not consider that the amounts assessed will be payable and no provision has been made for these.”
[45] The position is the same in the financial statements for the year ended 31 March 1996, that is, no provision made for the debt owing to Customs but there is a record of a contingent liability in the notes with the observation that the directors do not consider that the amounts assessed will be payable.
[46] The directors’ report presented at the annual general meeting held on 12 December 1996 states:
“Another problem which has recently reared its very ugly head is the .. Customs after losing their classification case against us have now after four years filed a case against us for so called unpaid excise – we totally denigh [sic] this but will need money to fight them – this action could take several years to get to Court, so in the meantime we must put this behind us and get on with business as usual.”
[47] For the year ended 31 March 1997 the notes to the accounts record a contingent liability to Customs in respect of the 1992 audit and also make reference to the debt arising out of the 1997 audit. Again, the directors’ view that it is unlikely the company will have to pay the amounts assessed is noted. That approach is also reflected in the minutes of a special general meeting of the company held on 5 March 1997. Mr Don Allen is recorded as having advised the meeting that the company does not accept the validity of the Customs’ claim.
[48] The directors’ report for the year ended 31 March 1997 also refers to the “war” with Customs over the 1992 audit. The report continues:
“Due to what I felt was a lack of fighting spirit by our solicitors Pitt & Moore we made a change and are now represented by Austin Powell of Duncan Cotterill. .. given the chance to fight this in Court I certainly feel a lot more optimistic. This unfortunately is going to cost a very large amount of money.
With this exception, the state of the company’s affairs is considered satisfactory, and the nature of the company’s business has not changed during the year.”
[49] No financial statements were produced for the year ended 31 March 1998. Mr Gilkison did prepare a summarised statement of financial position in August 1998 and that showed Cellar House was still solvent. The summarised statement of financial position did not make any provision for the debt owing to Customs for either the 1992 or the 1997 audits.
[50] Mr Walker’s view is that the liability to Customs should have been recorded as an actual liability and provision made in Cellar House’s financial statements. Even if Cellar House’s directors were correct in treating the liability as a contingent one, they were wrong not to recognise it in the statements of financial position.
[51] Next, Mr Walker says, such mention as the Customs debt was given in the financial statements did not give a true and fair view of the company’s affairs because the amount payable to Customs was never specified. Mr Walker also says the company’s bank was given the financial statements without the liability being included. He believes the Bank continued to support the company because it understood the debt was not payable.
[52] Mr Buchanan’s evidence was that to treat the Customs debt as a contingent liability was wrong. He said that even if the contingent liability had been accompanied by a more explicit note, this was not the correct treatment.
[53] The failure to show that liability in the financial statements would, Mr Buchanan says, have misled any creditor who looked at those statements and indeed could have misled the unsophisticated shareholder.
Defendant’s arguments
[54] In response to this aspect of the claim, Mr Allen makes a general submission discussed in more detail below about the company’s record keeping. Essentially, he says the company could not have continued to operate as it did without adequate record keeping.
[55] In terms of this particular aspect of record keeping, that is, adequacy of treatment of excise liability, Mr Allen says excise duty was acknowledged by the company as a particular form of “debt” to be accounted for each month. Had the Customs requirement not been met, Mr Allen submits Customs would have taken the company to task.
[56] Mr Allen also says the parameters of the self-reporting exercise required by Customs are defined in terms of “outputs” for home consumption. There is no requirement under the Act to record alcohol received into the licensed manufacturing area (“LMA”). Nor is there any duty payable on alcohol retained within a LMA. Mr Allen’s argument is that since duty has to be paid on goods invoiced out of a LMA, then a properly maintained invoicing system would be all that is required.
[57] Customs’ procedure statements, on Mr Allen’s analysis, are no more or less a basic management reporting system whereby any losses may be mitigated.
Discussion of treatment of Customs’ liability
[58] Mr Allen’s approach does not adequately deal with the treatment of the debt to Customs in the financial statements. The uncontested evidence is that the debt should have been recorded as a liability in those statements.
[59] That evidence is consistent with the nature of the liability to pay excise duty which is set out in Part IVA of the Customs Act 1966 (“the 1966 Act”) and in Part 7 of the Customs Act 1996 (“the 1996 Act”). Liability arises when excisable product is removed from the LMA to a non-licensed area (s 118F 1966 Act and s 76 1996 Act). Defined areas of Cellar House’s premises were designated as LMAs. Hence, from the time of removal, there is a liability. Excise duty is a debt due to the Crown.
[60] Further, liability to pay excise duty was critical to the Cellar House business. The excise duty regime is one of self-assessment. If the company makes errors in its self-assessment then substantial additional duties may be payable. Monthly excise returns had to be made to Customs by Cellar House. Customs then makes an assessment of excise duty based on the returns. An amended assessment can be produced if the original assessment prepared by the company is found to be incorrect.
[61] There is an issue about the point from which the liability should have been recorded.
[62] The plaintiff’s position is that the liability for excise duty should have been included in Cellar House’s financial statements for the 1992 financial year ending 31 March 1993 and thereafter. The plaintiff relies on the fact that liability to pay excise duty arose at the time the product was removed from the LMA. In terms of the debt arising out of the 1992 Customs audit, the “removal” occurred at some time during the 1992 financial year although the actual dates cannot be precisely determined because Cellar House did not keep proper records. The plaintiff relies, however, on the letter of 26 April 1993 which set out Customs’ assessment of the unpaid duty.
[63] The financial statements for the 1992 financial year are dated 16 November 1993. The plaintiff relies on the relevant financial reporting standard which provides that post-balance date events should be included in the financial statements if those statements post-date those events.
[64] Mr Allen relies on the fact the formal assessment of any underpaid excise was not made by Customs until 15 November 1993. He says this is the earliest time where even the Customs Act provides for recognition of any debt by triggering the right to appeal under the Act.
[65] Duty is payable on removal from the LMA. However, in terms of the 1992 accounts, Customs’ letter of 26 April 1993 did envisage a response from the company that might affect the amount owing. In the cirucumstances, I am not satisfied that the amount had to be shown in the 1992 financial statements. Thereafter, however, reference should have been made in the financial statements and it was not. The debt was then a payment due even if Cellar House disputed the amount and the failure to disclose the debt did mean that the accounts did not give a true and fair view.
[66] It is not therefore necessary to consider the plaintiff’s alternative argument that, even if the liability to Customs could have been correctly characterised as a contingent liability, the financial statements should have given an expected loss.
(ii) Ongoing compliance with Companies Acts
[67] The plaintiff’s case is that between the 1992 audit and a subsequent audit in 1997, Cellar House’s record keeping did not improve sufficiently so as to provide accurate self-assessments of excise duty liability. Again, additional duty liability was incurred.
[68] In terms of the ongoing failure of the records, the plaintiff submits that one of the key factors was the failure to correctly record and explain the company’s usage of ethyl alcohol which was discovered in the course of the 1992 audit.
[69] Also under this head, the plaintiff relies on the ongoing failure to present a true and fair view of the accounts and non-compliance with the GAAP requirement to keep certain underlying records, namely, an inventory, records with sufficient inter-linking and cross-checking, and sufficient internal controls. The plaintiff emphasises the need for the records to “speak for themselves”. It is also submitted in this context that the stock was over-valued.
[70] The submission is that in order to comply with GAAP, Cellar House’s records were required also to comply with the applicable financial reporting standards in force at the time. Those financial reporting standards are called “FRS”. FRS4 – Accounting for Inventories – approved by the Accounting Standards Review Board in June 1994 and came into force for accounting periods which ended after 30 September 1994. It replaced a “Statement of Standard Accounting Practice” (“SSAP4”) which was in similar terms and which had been in force since 1 April 1986. Accordingly, prior to September 1994, a company would have been required to comply with SSAP4 because that standard had the authoritative support within the accounting profession New Zealand.
[71] The requirements for FRS4 are set out by Mr Walker in his evidence. Generally, in order to comply with this reporting standard, an organisation would keep detailed records of the costs of all items which contribute towards its work in progress or its inventory. This involves keeping records of all purchases of raw material and tracking those through the production process, allocating the costs of production in overheads to the finished items, recording faulty or lost work in progress and tracking the removal of goods whether for sale or for some other reason, for example, when they are damaged.
Evidence
[72] The plaintiff called evidence from Richard Ewing Robertson who was the Regional Excise Auditor for New Zealand Customs from September 1991 until June 1997. One of Mr Robertson’s functions was to audit LMAs to assess whether the excise duty declared by a licensee had been accurately declared.
[73] Mr Robertson gives evidence about the audit he undertook of Cellar House in 1992. He explains that because excise duty for alcoholic products is based on the percentage of alcohol in the product, it is necessary to be able to reconcile records of purchases, manufacturing, inventory and sales. What Mr Robertson says is that, as a result, he would have expected any licensee to have systems for maintaining a number of matters including the following:
a) Records of receipts of alcohol into the LMA.
b) Calibration of storage tanks for alcohol.
c) Production and manufacturing records for each batch of product so that the way in which production and manufacture are recorded in a licensee’s stock records can be seen.
d) A month end stock reconciliation procedure which recorded opening stock at the beginning of the month plus receipts from production less sales and adjustments for matters such as breakages or faulty equipment which equals closing stock.
e) Month end accounting system reports summarising removals from the LMA by excise item; and inventory reports of stock in the LMA at month end reconciled with the physical stock take inventory totals in the LMA warehouse.
[74] His experience is that licensees keep these or similar records so that they can meet their excise obligations.
[75] In cross-examination, Mr Robertson acknowledged that the procedure statement issued to Cellar House by Customs in 1990 did not include either a requirement for calibration of the tanks nor for a monthly stock take. (The procedure statements are issued as a condition of the licence and set out the records that are to be kept and the procedures Customs requires the company to follow.) However, Mr Robertson emphasised the need for what he described as “an audit trail” to show what happened to that alcohol so that the duty liability could be adequately assessed. In his view, the core requirement was a statutory one to keep sufficient records, particularly, for an inventory of raw materials including production records, stock records and sales records or records of goods removed from the LMA.
[76] Mr Robertson’s evidence is that the records at Cellar House were insufficient to enable a systems-based audit to be carried out. By that, Mr Robertson meant an audit which reviewed documentation and flow charting of the licensee’s systems, analysis of internal control procedures to determine their adequacy, tests to establish whether the internal control procedures operate effectively and tests to determine the accuracy and completeness of the licensee’s excise declaration.
[77] Because of this insufficiency of the records, Mr Robertson said he had to carry out what he calls a “transactions based” audit. This involves a reconstruction of the company’s records, in this case, for a one month period. The defendant was critical of the scope of the transactions based audit in questions to Mr Robertson in cross-examination but nothing turns on that.
[78] Mr Robertson’s evidence about the 1992 audit was supported by the evidence of William Gerard Gill, an experienced Customs officer with some 26 years at Customs. Mr Gill undertook a detailed analysis of the audit.
[79] In terms of the 1992 audit, Mr Gill said that the major problem was that there were insufficient records of matters such as purchases of raw materials and products, production, stock and dispatch. Mr Gill says, for example, there were no or insufficient records to verify excise credits claimed by Cellar House for some periods.
[80] Both Mr Robertson and Mr Gill gave evidence about the destruction of records for the period prior to April 1992 relating to manufacturing and excise. Mr Robertson said that records of purchases of alcohol and stock stored off-site had been destroyed for all but the six month period since April 1992. This meant it was not possible to carry out the normal verification exercise. In cross-examination, Mr Robertson accepted that this evidence was better put as an acknowledgement that the key records from his point of view were destroyed because, as he accepted, there was a debtors and creditors ledger.
[81] Mr Robertson explained that the company maintained the following records for excise duty purposes:
a) An excise book with a hand compiled summary of individual invoices by excise item number. For each invoice there was a brief reference and then a summary total of quantity sold for that invoice and a grand total used for excise declarations.
b) Copies of home consumption entries submitted to Customs. This is a standard form and it sets out the product excise item number, the quantity of product removed from the LMA and the appropriate duty rate with a calculation of duty.
c) Invoices and sales dockets.
[82] A particular concern Mr Robertson had in the audit was that there were not adequate systems in place to account for ethyl alcohol purchased. There were “occasional” invoices from Anchor Ethanol (ethyl alcohol is a by-product of the dairy industry) but he would have expected to see a full record of ethyl alcohol received, such as metering of the storage tanks or pump. There were none.
[83] Mr Robertson explains that not all ethyl alcohol is subject to excise duty. There is, for example, no excise duty charged on ethyl alcohol used to make vinegar. A licensee must therefore keep accurate records of ethyl alcohol purchased and used so that excise duty is paid only where it is due.
[84] In the 1992 audit, Cellar House could not account for all ethyl alcohol purchased. After the audit and investigation Customs decided that some 29,000 litres of ethyl alcohol purchased in the period from January 1989 to October 1992 were unaccounted for after allowance had been made for wastage and uses exempt from excise duty. (The 29,000 litres comprised more than 25 percent of the company’s purchase of ethyl alcohol in the period.)
[85] Mr Robertson then explained other problems that he came across in the audit. For example, excise duty credits had been claimed from September 1991 to October 1992 which could not be confirmed. Credits can be claimed, for example, if quantities of excisable goods have been invoiced incorrectly, or if goods had been repurchased for resale. However, the claim must be supplemented by full documentation. The credits claimed by Cellar House were accordingly disallowed.
[86] Another problem was that Cellar House had under-declared excise duty by recording sales of product such as gin, whiskey and vodka, and also non-spirits product in 20-litre plastic containers when it was actually sold in 25-litre plastic containers known as “cubes”. Mr Gill confirmed this evidence. The cubes were supplied by Rheem New Zealand Limited but inquiries with Rheem showed that during the period from January 1989 to October 1992, Rheem had only ever supplied Cellar House with 480 20-litre cubes compared with 10,816 25-litre cubes. Every sale of product in a 25-litre cube rather than a 20-litre cube resulted in five litres of product being undeclared for excise duty.
[87] The explanation Mr Robertson was given was that cubes were on occasion reused but there were no records to verify this.
[88] Accordingly, there were insufficient records Mr Robertson says to enable the true liability for excise duty to be determined on Cellar House’s own records. Mr Robertson had to make an assessment from the few records that did exist and information obtained from external sources.
[89] The end result was that Customs made an assessment of unpaid duty in early 1993.
[90] Mark Henrick Ditzel, a Customs officer, gave evidence for the defendant. Mr Ditzel has been based in Nelson since his first year after joining Customs in 1984. Mr Ditzel assisted Mr Robertson in carrying out the 1992 audit. He confirmed it was not possible to undertake a systems-based audit. That was because that type of audit requires systems and internal controls which Cellar House did not have.
[91] Mr Ditzel confirmed that during the 1992 audit, the company was asked to provide some records which it was unable to provide. He says he can remember looking unsuccessfully for the records. Mr Ditzel’s evidence is that Don Allen explained that, by mistake, the person instructed to destroy some old company records had destroyed other records as well.
[92] Mr Ditzel’s evidence is that although the theory of tracking ethanol usage is simple, it can be quite complex in practice. This was particularly so for Cellar House because they made many products which use various amounts of ethanol, together with vinegar which is not liable to excise duty.
[93] Cellar House was issued with a new licence and procedure statement on 9 July 1993. That revised procedure statement referred to the requirement to keep records including calibrating bulk storage tanks and other production and stock control records. A further licence and procedure statement was issued on 16 October 1996.
[94] In 1997, Mr Robertson audited Cellar House for the period June 1995 to January 1997. This audit reviewed Cellar House’s excise returns for the months of July 1995, January 1996, March 1996 and December 1996.
[95] Mr Robertson says he found there were errors in the excise returns for each of the four months reviewed. For three of these months duty had been short paid by $23,638, $22,199, and $31,155 respectively. This short payment arose by declaring 3-litre casks as 1-litre. For the fourth month, duty had been overpaid by $436.
[96] There were still, at this stage, insufficient internal controls to enable anything other than a transaction-based audit and Mr Ditzel confirmed that. Mr Robertson acknowledges that there had been improvements in the record keeping since 1992. There was now a production book listing the product name, the number of bottles produced and the litres equivalent of the bottle number. A daily production sheet was compiled from this record and input into the inventory system but the book was not sufficient, Mr Robertson says, to show the true liability for excise duty as it did not produce a clear trail from purchase of bulk alcohol to manufacturing to stock and then to sales.
[97] In addition, Cellar House was by that stage accounting for ethyl alcohol purchases in an ethyl alcohol book. Mr Ditzel describes both a bulk ethanol book and a bulk wine book as being kept after 1992. However, the bulk storage tanks were not calibrated as by then required by the procedure statement.
[98] Mr Ditzel says that during the audits after 1992, he found that the company was complying with “most” of the improvements requested. He acknowledged that although the bulk stock records may have been being completed, absent calibration of the tanks,
“when we went to do an audit and the tank was half full we had no way of verifying the tank was half full or what half full was.”
[99] Following on from the 1997 audit, Customs calculated that $75,258.77 of unpaid excise duty including ALAC levies and GST was payable.
[100] A further audit was undertaken by Customs in 1999. This is what is described as a “exit” audit. Mr Gill explained that Customs became aware that Cellar House had been put into receivership and might be sold as a going concern or otherwise disposed of. An exit audit is normal for any licensee that is sold or ceases business. This audit concentrated on Cellar House’s stock controls only. That is because excise duty is a volume based taxation regime and movement of goods through its stock control mechanism is seen as a good indicator of the accuracy of a company’s record system due to triggers caused by manufacturing/inputs and sales/outputs.
[101] At this point in time, Mr Gill found improvements in the company’s record keeping. All product recorded as manufactured for the period May 1998 to May 1999 could be accounted for in Cellar House’s stock records. There was a five percent loss factor for spillage, evaporation, bottle breakages and so on during manufacture which in the circumstances was deemed to be acceptable.
[102] Mr Gill explained that he analysed all stock records attached to the excise entries and all stock adjustments. He found that stock takes had taken place each month and stock variance reports had been generated detailing the differences between the physical stock and the data records. What was lacking however were records explaining stock variances and there was no investigation of those variances. The closing physical stock figures became the opening figures for the next month with the difference between physical stock and data records ignored. Mr Gill gave an example of this from February 1999 where Allen’s Gin had an opening stock balance of 1599 bottles on hand, 61 bottles were sold during that month yet only 138 bottles were in stock at the end of the month. March’s opening stock of Allen’s Gin was recorded as being 138 and the variance of 1400 bottles was not investigated. There were no records showing what had become of these 1400 bottles. Customs issued a claim against Cellar House for $25,854.58 in relation to the missing product.
[103] Mr Gill points out that an error such as this affects the company’s excise returns and excise duty payable. If goods cannot be accounted for as in this case, excise duty is triggered for the month in which the movement out of the LMA occurred. If the duty is not returned and paid when due, additional duty is payable. Accordingly, as a result of this error, Cellar House was required to pay both the excise duty that should have been returned and paid in February 1999 as well as additional duty for the period since then.
[104] Mr Gill also notes that although Cellar House had sold its business to Haumi Corporation in August 1998, the licence was not transferred from Cellar House to Haumi. This meant Cellar House remained liable for any unpaid excise duty while Haumi was manufacturing excisable product. The two companies operated from the same premises and employed the same staff. However, Mr Ditzel’s unchallenged evidence was that Cellar House applied for its manufacturing area licence to be cancelled in June 1998 on the condition that Haumi become a licensed operator in its own name. He says there was correspondence from Wellington head office which advised against issuing the licence to Haumi.
[105] Mr Gill’s evidence is that Cellar House did not ever request to pay the Customs duty assessed over time although they did offer to make a payment by way of settlement of the amounts owing. The offer was minimal, in the order of $220,000.
[106] Messrs Robertson and Gills’ evidence about the inadequacy Cellar House’s record keeping for the purposes of excise duty was confirmed by Mr Buchanan.
[107] There was no challenge to Mr Buchanan’s expertise and indeed the defendant referred to his expertise both as a receiver/liquidator and as an accountant. The defendant did, however, challenge Mr Buchanan’s independence. There was nothing in Mr Buchanan’s evidence to support any such challenge. Mr Buchanan was careful and measured in his response and kept to his areas of expertise.
[108] Mr Buchanan said that to ensure that the monthly return to Customs is accurate, a manufacturer needs to have an accounting system that fully documents the manufacturing process and which accounts for all input into and output of that process. Because excise duty is calculated from the alcohol content of the volume of each product removed from the LMA, the manufacturer has to be able to calculate accurately the quantity of raw materials purchased, the quantity of those materials used to manufacture excisable and non-excisable product, or used for any other purpose, as well as the alcohol content of every excisable product manufactured. Just counting the number of bottles on the shelf at the end of the month is, Mr Buchanan says, a small part of the process.
[109] He explains that in his view the manufacturer also has to be able to account for variances between raw materials purchased and consumed in manufacture and for any variances between excisable products manufactured, sold and held in stock. This is because, for example, excise duty may not be payable where there is wastage or faults in the manufacturing process.
[110] Mr Buchanan’s evidence on the need to account for such variances is confirmed by Mr Ditzel. Mr Ditzel says the difficulties he experienced in auditing the company were in tracing the relationship between raw ingredients and finished products. He acknowledged, that one of the problems was in matching the finished product within the particular coding or classification system used by the company. To illustrate this, he said:
“What I mean by that is that bulk wine at around 13 percent was broken down and blended into 3-litre casks of various named fruit wines which covered a number of codes but they were in fact the same product so when I was tracing 1000 litres of bulk wine I was looking for 3k of packaged finished wine and that may have been spread across a number of products.”
[111] Mr Ditzel agreed that the problems would have related also to different sizes of packaging commenting that,
“From the raw ingredients you can work out the total volume of finished product you’re searching to trace that into stock is the quantity of stock times the number of packages and then across various stock codes.”
[112] Mr Buchanan is particularly critical of the lack of any internal control procedures in Cellar House to ensure accuracy.
[113] Based on a review of the failures identified in the 1992 Customs audit, Mr Buchanan concludes that it would be very unlikely that the company would be able to make accurate returns on information of this poor standard.
[114] The other point that Mr Buchanan makes in this context is that all areas in which Cellar House was assessed as owing excise duty should have been included in the returns filed each month. If they had been included, Cellar House would have been able to price its products so as to recover the excise duty.
[115] In addition to the question of excise duty, Mr Walker’s evidence is that after Cellar House’s liquidation, the Inland Revenue Department determined that Cellar House must also have under-declared its revenue on the basis of the amount of missing ethyl alcohol and other discrepancies which led Cellar House to under-declare its excise duty. Inland Revenue reassessed Cellar House’s income tax and GST liabilities and issued assessments for $2,706,738.90.
[116] Because Mr Walker was unable to rely on the records of Cellar House to correctly record and explain its transactions he had little choice but to estimate Cellar House’s liabilities when trying to determine the company’s financial position.
[117] On 13 August 2003, the solicitors for the plaintiff received a box of records from Mr Allen. These records related to Cellar House and it appears they had been kept at Cellar House’s former premises now occupied by Hansa. Despite written requests to Mr Allen, these documents were not produced to Mr Walker earlier. The types of records discovered are set out in Appendix A to this decision.
Defendant’s arguments
[118] Mr Allen’s argument is that, first, the company must have had the basic accounting systems required or it could not have continued to operate. For example, workers would not have been paid if wage records were not kept and without keeping a debtors ledger the company was not capable of ensuring payment for goods. Further, annual accounts were done by an external accountant who obviously had to have some records in order to prepare those accounts. Further, Mr Allen submits that the earlier Customs audit which took place in 1988 was satisfactory and it was, subsequently, that records were inadvertently destroyed and it is that destruction of records, he says, which led the company to the unfortunate position it was in in 1992.
[119] Second, against this background, Mr Allen says that the plaintiff is forced to say that the records kept are insufficient or inaccurate. He considers both of those terms are subjective and, further, records had to be kept before any inaccuracies were able to be detected and insufficiency relates to the quantity of records.
[120] Third, Mr Allen says that the records discovered immediately prior to the hearing were of the type that Mr Walker said he was looking for. Further, Mr Buchanan says that the information in those records was of the type he would expect to be produced to satisfy the statutory requirements.
[121] Fourth, Mr Allen makes something of Mr Walker’s inability to access information on a disk or disks. Presumably, the inference is that the records said to be lacking were on those disks.
[122] Finally, Mr Allen says that Mr Walker’s approach would have the Court accept that there is no distinction between those records kept in order to satisfy the requirements of a company’s assets and liabilities as required by law and those produced for internal, management, reporting. Mr Allen submits that the difference between financial and management reports was recognised by Mr Buchanan. Mr Buchanan did acknowledge, he says, the types of records sought by Customs under the terms of their procedure statements were more correctly management reports. These related to costs, losses and production throughput and control rather than the financial status of the company at any given time. Such reports would be meaningless to any creditor trying to determine the financial position of the company with reasonable accuracy. Hence, it is submitted that Mr Walker has made an erroneous assumption in law.
Analysis
[123] There is a helpful discussion in Maloc Construction Ltd (in liq) v Chadwick & Ors (1986) 3 NZCLC 99,795 at 99,802 as to the relevant requirements. In that case, Tompkins J notes that the expression “accounting records” is not defined in the Act. His Honour continued:
“This is no doubt deliberate. Instead of defining accounting records, the scheme of the section is to require the company to keep whatever records in whatever form as may be necessary to achieve the objectives specified in the four paragraphs of subsec(1) [of s 151].”
[124] Further, Tompkins J stated:
“The records must speak for themselves. They must, without more, do or enable to be done, the matters spelt out in the four paragraphs of subsec (1). It does not avail a company to say,.. that those objectives could be achieved by reference to the accounting records available, plus further information and explanations that can be furnished by a company officer or employee.” (at 99,802)
[125] Both Mr Allen and Mr Walker agreed that Cellar House’s business was complex because of the range of products produced. Mr Ditzel confirmed that. There is also no dispute about the importance to the company of excise duty.
[126] There was a requirement to keep adequate records and it is no answer to refer to the inadvertent destruction although I find the destruction of the records is relevant to quantum. Further, although there is a difference between types of records, there is no question that there were gaps in the record keeping in terms of the ongoing Companies Act requirements. Hence, while there may have been enough records for the company to keep going, that does not mean the records kept met the statutory requirements.
[127] Evidence of the gaps came from the deponents called on behalf of the defendant. For example, Nick Allen, Don Allen’s son who had various roles in the company including office manager and then, later, production manager, was asked about the incorporation of the wage costs into the general ledger. He answered that they would not get into the general ledger, he thought, because the costings were done manually. Nor could he explain how to trace bulk wine through to stocks of finished product, adjustments in the stock movement reports or the “negative” opening stock balances.
[128] Ms Elizabeth Riddoch also gave evidence for the defendant. She worked in the office at Cellar House and was responsible for producing the stock movements reports but she could not provide an explanation of the “adjustments” column in that report which she never used although it regularly had adjustments in it. Nor could she explain the “negative” opening stock numbers or how it is that the individual stock line entries did not appear to make sense.
[129] As to the material on the disks, no such material was ever produced. There was nothing in the evidence for the defendant to support the submission that the disks contained the sort of information that Mr Walker and Mr Buchanan say was necessary.
[130] A software system was used to deal with inventory between 1992 and 1996. The Rees Software system was introduced around 1996. The uncontested evidence is that the capability in that system to control stock in the manufacturing process from point of receipt of raw material was not used. The only stock feature used was that which recorded quantities (not cost values) of finished goods.
[131] Finally, Mr Ditzel said his experience was that at the end of his inquiries he could account for all of the finished product but to do so needed the assistance of the company’s production staff. In other words, the records did not “speak for themselves”. Mr Ditzel accepted in cross-examination that he would not have expected to have had to make inquiries of staff in order to make sense of what had happened.
[132] There are then two issues in relation to this aspect. The first is whether the records discovered shortly before the hearing are such as to meet the requirements of the Companies Act. Second, whether the improvement in the records which undoubtedly did occur after the 1992 audit was sufficient to meet the Companies Act requirements.
[133] I have concluded that the answer to both of these questions is no. As to the latter, I am satisfied the improvements were not such as to meet the Companies Act requirements. Obviously, there were still difficulties from Customs’ perspective although less substantive than those identified in 1992. Overall, I accept the evidence of Messrs Buchanan and Walker that underlying records such as inventories (stock or work in progress) were not sufficient or were non-existent, and records relating to raw materials were inadequate as were those reflecting work in progress. In addition, there continued to be an absence of internal control procedures. In this case, the plaintiff is correct that there is overlap between the record keeping requirements of Customs and those of the Companies Acts, given the importance to the company of the accurate declaration of excise duty.
[134] The absence of internal control procedures is supported by Nick Allen’s evidence. He acknowledged that the variances identified in the stock movement reports were not checked or verified and no one verified the entries in the bulk wine book.
[135] Mr Nick Allen also confirmed that there were times when product was recorded as being produced but there was nothing readily apparent to suggest it had then been entered into the company’s records or that anyone checked that.
[136] Finally, if further confirmation is needed, that comes from Mr Gilkison’s memorandum of 26 September 1997 which records unsatisfactory aspects of the company’s record keeping including:
“1. Sales report doesn’t agree with general ledger as this is a “made up” report. Figures from computer but then adjusted for GST etc and then adjusted again by Don…
9. John says posting to correct accounts sometimes inaccurate…
13. Cash receipts only recorded from bank statement!!! – No control over any banking missing from bank statement.
14. GST return report doesn’t seem to work. – John fiddles it to agree with general ledger.”
[137] Mr Walker’s evidence on the effect of the recently discovered documents was that in the short time he had had to appraise them, they would not alter his view that there had been non-compliance with the Companies Act. I accept that evidence.
[138] His evidence is that the new records do not meet all of the functions he envisaged as necessary, for example, as the manufacturing process unfolds, it is necessary to track both quantities and costs of goods and that can only be done if there is some sort of batch summary process used. The records do go some way towards controlling physical quantities of goods from the point of manufacture. However, he says it is “not likely”, given the “complexity of excisable and non-excisable product lines” that these would be adequate to enable an observer to establish definitively how much product was produced and removed from home consumption. The 1996 Customs audit confirmed that.
[139] In terms of the gaps, Mr Walker identified that there were no:
“a) Inwards delivery notes, sequentially controlled so as to ensure that all goods received are accounted for;
b) Documents which record costs related to transportation;
c) Sequentially completed documentation which controls requisition of raw materials into production;
d) Systematic recording of production by batch which records all quantities and costs, and reconciles variances against recipes;
e) Time sheets which are configured to enable accurate allocation of labour to production;
f) Method for allocating sundry costs and overheads; and
g) Explanation for adjustments from inventory to physical stock which would result in a relevant adjustment to excise.”
[140] Next, Mr Walker says, the records do not support the costings applied to the inventory for the purposes of financial reporting. The stock costing sheets had entered onto them the quantities from the physical stock count. These would then be valued with cost prices which did not vary. There was no ongoing reappraisal of costs as required by FRS4. The resultant stock figures would then be entered by a simple journal to the financial reports.
[141] Mr Walker identified various anomalies with the whey spirit book. Similarly, he identified discrepancies on a comparison of this book against production records.
[142] The wine production records Mr Walker considered were “inherently unreliable”. Where it was possible to trace a product through the entire production process and into the stock of finished goods, there were “serious” anomalies.
[143] Because of these sorts of difficulties, I am satisfied that these documents were not such as to mean there was compliance with the statutory requirements.
Consequences of failure to keep records
[144] In terms of s 300 of the 1993 Act, failure to comply with the record keeping requirements must have one of a list of consequences, namely:
a) Contributed to the failure of the company to pay all its debts; or
b) Resulted in substantial uncertainty as to the assets and liability of the company; or
c) Has substantially impeded the orderly conduct of the liquidation.
[145] The plaintiff says that all three consequences have occurred.
[146] In terms of whether the non-compliance has led to substantial uncertainty as to assets and liabilities, it is clear from Mr Walker’s evidence that he was unable to determine precisely the assets of Cellar House. He says he has determined that it is likely that Cellar House manufactured more product than it disclosed, which he concludes was probably sold. The receivables associated with the sales represent a significant asset to the company but Mr Walker has no way of determining who the product was sold to or for how much. Thus, he cannot ascertain how much the asset is worth.
[147] There are similar difficulties in determining precisely the company’s liabilities. Mr Walker’s view is that as Cellar House was found to have underdeclared its liability for excise duty for every month it was audited, it was likely that this had always occurred. He could not calculate exactly what the under declaration would have been so he took an average of the amounts of duty found to have been understated in the various Customs audits and averaged that out over all of the months after the end of the 1992 financial year. This calculation produced a figure of $20,000 underdeclared duty per month.
[148] This approach was approved by Mr Buchanan who said he would have used that approach in order to determine the liability. This estimate of Cellar House’s liabilities is not contested by Mr Allen.
[149] In cross-examination, Mr Allen put it to Mr Walker that it would not make any difference if the liabilities were any greater than the judgment entered against the company. However, as one of the liquidator’s duties is to prepare a statement of the company’s affairs which must comply with GAAP, Mr Walker is required to at least try to ascertain these liabilities.
[150] Accordingly, on the basis of Messrs Walker and Buchanan’s evidence, which I accept, the record keeping failure has resulted in substantial uncertainty as to assets and liability.
[151] As to whether there has been a substantial impediment to the orderly conduct of the liquidation, the difficulties in determining the assets and liabilities are relevant to this as well. Mr Walker has been unable to collect receivables owed to the company which may have gone some way to providing a dividend to the creditors.
[152] Mr Walker has also had to spend a considerable amount of time trying to ascertain the company’s liabilities. Further time was expended in trying to determine what records should have been available to him and then in trying to locate those records. Again, I accept Mr Walker’s evidence and so there is a link between the record keeping failures and conduct of the liquidation.
[153] There is some link between the Customs debt and the failure to keep proper records, including records of the usage of ethyl alcohol. If better records had been kept, for example, it may have been possible for the company to account for its usage of ethyl alcohol at the time of the 1992 audit. The inadvertent destruction of the records, and I accept destruction was inadvertent, is no answer. Additional duty on the debt then outstanding has no doubt then contributed to the company’s financial state. Hence, the receiver’s report records that the substantial debt owed to Customs was “the key factor” in the receivership.
[154] However, the substantial cause of the company’s inability to pay its debts is the decision to carry on trading and to do so in the knowledge that the debt was higher than disclosed. Further, s 300 refers to the failure having contributed to the company’s inability to pay all its debts. In the circumstances, while there has been a breach of s 300, the question of any relief is better addressed under s 301 as a breach of duties/reckless trading.
Affirmative defence to records claim
[155] There is a defence to the claim under s 300 where the Court considers the defendant:
“(a) Took all reasonable steps to secure compliance by the company with the applicable provision referred to in paragraph (a) of [s 300(1)]; or
(b) Had reasonable grounds to believe and did believe that a competent and reliable person was charged with the duty of seeing that that provision was complied with and was in a position to discharge that duty.”
[156] The defendant says he “took all reasonable steps” and “relied on advice”. Essentially, the defendant argues that functions were allocated to various people and those persons were relied on. It was not possible for him as Managing Director to do everything and, in addition, he relied on outside expert advice.
[157] The defendant argues the inter-relationship between s 300(1) and (2) means s 300(2) is the default situation. Only if the plaintiff proves s 300(2) is not met does s 300(1) become an option. That is not correct. Rather, the defendant has a defence where s 300(1) is satisfied but the defendant has to prove the defence applies.
[158] Having dealt with that aspect, I note next that Mr Allen emphasises that this was not a one-man business and that he was physically located in Christchurch until 1996.
[159] He relies on Nick Allen’s evidence that it was the winemaker’s duty to maintain all records in relation to alcohol purchases and submits that a defendant must be able to rely on a fellow director’s ability to shoulder his or her responsibility. This, he says, is especially so in an area where he himself professed neither competence nor immediate involvement. That area being recognised as the “crux of the whole operation” of the company.
[160] Finally, Mr Allen refers to the fact that Customs did not deal with him, did not interview him about the problems but, instead, dealt with Mr Goulter, the winemaker.
[161] In terms of taking all reasonable steps to ensure compliance, the plaintiff’s submission is that Mr Allen has not provided any evidence that he took any steps at all to secure compliance by Cellar House with the applicable statutory provisions. There is no evidence that he gave any consideration to whether the records did comply with those provisions.
[162] The plaintiff acknowledges the improvement in its record keeping after the 1992 audit and that the defendant began to keep records of its purchases of raw materials and some sort of production records. However, the plaintiff points to Mr Nick Allen’s evidence that despite being expressly required by Customs to calibrate the bulk storage tanks this was not done by the company because it was seen as very expensive and of “little practical purpose”.
[163] The plaintiff refers to Mr Allen’s apparent reliance on Cellar House having installed a computer system. However, the evidence was that this system was used for invoicing and control of debtors and creditors. Stock movement reports were also generated from this system but the evidence was that only the “front end” of the system was used and the stock control part not implemented. Both Mr Ditzel and Mr Robertson were critical of how the system worked and Mr Robertson said he had doubts as to the accuracy of the information the computer produced.
[164] Dealing then with whether Mr Allen had reasonable grounds to rely on another person, the plaintiff says no particulars have been provided as to who was charged with this duty.
[165] Nick Allen explained that his father lived in Christchurch until 1996. He would travel to the business to attend board meetings but otherwise chose to leave the “normal” running of the business of production to those who knew or were supposed to know what they were doing.
[166] Ms Riddoch also said that Mr Don Allen employed people to do a specific task and would then “leave them to get on with it with a minimum of interference”.
[167] The plaintiff submits that in order for this defence to succeed, Mr Allen must show that he had reasonable grounds to believe that a particular person was given the duty of ensuring that Cellar House kept proper accounting records. As the Managing Director, he must show that he exercised adequate supervision over those he says were responsible for the records. This submission is in reliance on Maloc, above at 99,808.
[168] The plaintiff’s submission is that there is no evidence that Mr Allen relied on anyone including the external accountant Mr Gilkison, and Mr Black, the auditor. Neither Mr Gilkison nor Mr Black were called to give evidence. Mr Black’s role at Cellar House is a little unclear although he was appointed as auditor for the 1993 financial statements but not for those prepared after that date. It seems he provided some accounting services to the company and helped Ms Riddoch in checking the excise returns when she first started preparing them.
[169] Mr Allen in cross-examining Mr Walker referred to the fact that both the auditor and the accountant did request legal advice before the auditor signed off the Customs debt as a contingent liability. Mr Walker made the point this was subject to a very significant qualification as to what was required .
[170] Mr Walker notes that from the Minute Book of Cellar House it appears that only one directors meeting was held in 1993, on 20 October. The minutes for that meeting record that:
“The problem we are having with Customs was discussed and then filed in the rubbish bin.”
[171] Further, as Mr Walker noted, Mr Gilkison provided a disclaimer to each set of financial statements he prepared to the effect that he was relying on information supplied to him by Cellar House’s directors including Mr Allen.
[172] Accordingly, the plaintiff’s submission is that as Managing Director and the person in charge of the day to day management of the company, the defendant was responsible for exercising proper supervision over the employees. There is no evidence that he ever charged anyone with the responsibility of ensuring that the records complied with the Companies Acts. That question was put to Ms Riddoch who denied ever having been asked to prepare records which complied with those requirements.
[173] It is not necessary for me to reach a conclusion on the plaintiff’s submission that the prime thrust of this defence should be for the directors of a large company who rely on their accountants and other financial staff to provide them with the information in the first place. Regardless of the size of the company, I agree it is not appropriate for this defence to be extended to a director who provided the information and base records as to the company’s position to external accountants and then seeks to claim that he should not be held responsible for failing to keep proper accounting records. When external accountants are not given the correct information by the director who responsibility it is to provide it, the director cannot then be excused from liability because the records do not then comply.
[174] As to Mr Goulter’s role, it is the case that Mr Robertson said that he dealt primarily with Timothy Goulter . He did not, however, think that Mr Goulter was responsible for the whole operation and his dealings with Mr Goulter were in respect of the production side of the business. Further, Mr Robertson had the clear impression that Mr Allen was a “hands on” manager who made the key policy decisions.
[175] In the course of the 1992 audit, Mr Robertson had discussions with Cellar House about its record keeping. He acknowledged in cross-examination that apart from discussions with Mr Goulter, the winemaker, there was no referral of particular matters to any of the other directors of the company. However, the key letters were sent to Cellar House for the attention of Mr Don Allen.
[176] From Mr Ditzel’s perspective, Timothy Goulter was the winemaker who was primarily in charge of creating the finished products and he was assisted by an assistant winemaker. Nick Allen had an engineering background and was the production manager primarily responsible for taking bulk product and packaging it and so he was in charge of the bottling line. Elizabeth Riddoch was the office manager and was one of the key persons that Customs related to during their audit. She maintained control of the computerised accounting programme.
[177] Ms Riddoch was asked if she prepared board reports or financial statements. She was also asked if she was instructed to ensure that the company’s records complied with any of the requirements of the Companies Act. Her response was that she only prepared information up to trial balance and that anything else was someone else’s responsibility.
[178] Ms Riddoch prepared daily cashflow and sales reports which were given to Mr Don Allen every morning. If he was not present at Cellar House’s premises, the reports would have been faxed to him. Ms Riddoch agreed that Mr Don Allen was a hands-on manager who kept close control.
[179] Mr Nick Allen also confirmed that his father had day to day control over the business including approval of spending over $500. When asked who the overall boss was, Mr Nick Allen responded that it was his father. He also said that his father took over the day to day management of Cellar House from 1996 because he wanted to be more involved in the actual running of the business.
[180] Accordingly, it is clear that Mr Allen did have overall management control. I am satisfied that there was no reliance of the sort envisaged by s 300(2). However, as I have said, I consider the question of relief is better addressed under s 301.
Reckless trading?
[182] The language of s 135 has its origin in observations by Bisson J in a reckless trading case under the 1955 amendment. In Thompson v Innes (1985) 2 NZCLC 99,463 Bisson J stated:
“Was there something in the financial position of this company which would have drawn the attention of an ordinary prudent director to the real possibility not so slight as to be a negligible risk, that his continuing to carry on the business of the company would cause the kind of serious loss to creditors of the company which [the predecessor to s 135] was intended to prevent?”
[183] There is discussion of the predecessor to s 135 in a very recent decision, delivered after the hearing in this matter, of William Young J in South Pacific Shipping Ltd v Traveller and Waller (High Court Christchurch, CIV-1998-409-000069, 12 February 2004).
[184] In that case, William Young J considered Bisson J’s observations and discussion amongst commentators on what is now s 135 and concluded:
“[123] .. I am of the view that it is only the taking of illegitimate business risks which warrants a finding of reckless trading.”
[185] William Young J noted the contrary view of O’Regan J in Fatupaito v Bates [2001] 3 NZLR 386.
[186] His Honour then sets out a number of factors which assist in deciding whether a business risk is legitimate. In terms of the present case, the following of the factors identified by William Young J are particularly relevant:
“[125] ..
3. No-one suggests that a company must cease trading the moment it becomes insolvent (in a balance sheet sense). Such a cessation of business may inflict serious loss on creditors and, where there is a probability of salvage, such loss can fairly be regarded as unnecessary. The cases, however, make it perfectly clear that there are limits to the extent to which directors can trade companies while they are insolvent (in the balance sheet sense to which I referred) in the hope that things will improve. In most of the cases, the time allowance has been limited, a matter of months.
4. Was the conduct of the director in question in accordance with orthodox commercial practice? .. Implicit at least in all of this is that liability for reckless trading is likely where the directors have acted otherwise than in accordance with orthodox commercial practice.”
[187] I consider the present case can be decided without resolving the exact reach of s 135.
(ii) Discussion
[188] The submission for the plaintiff is that by continuing to trade when it had a substantial liability which was not recognised, the defendant put the creditors at a substantial risk of serious loss. It is submitted that it was always a risk that the company would go into liquidation. Further, it is submitted that:
a) Mr Allen knew or should have known the importance of the excise duty to the cost of business and that therefore it was particularly important to account for the duty.
b) Mr Allen knew when the duty was payable and accordingly knew that it was payable even if he objected to it.
c) He knew that additional duty would continue to accrue.
d) He was advised in April and November 1993 of the amounts assessed and owing.
[189] The only possible conclusion, the plaintiff submits, is that Mr Allen intentionally made no provision for the debt and continued to trade. Accordingly, it is submitted that, at the latest, from 15 November 1993 the company was trading recklessly. Further, as Manager, Managing Director and then sole Director, Mr Allen can and should be held responsible.
[190] The defendant argues, first, that he took steps to mitigate the effects of the debt. Mr Allen relies on the evidence of the lawyers who acted for the company, initially, Mr Rainey and then Mr Powell, in this regard. Mr Allen refers to the memorandum dated 13 May 1993 produced by the plaintiff which he says indicates that at least from that point, the defendant was fully aware of the consequences of the debt being enforced. Further, that was the reason he instructed the company’s solicitors, particularly Mr Rainey, to pursue various causes of action. It is submitted that this does not fit comfortably with any suggestion of recklessness.
[191] Mr Allen says that Mr Rainey in his evidence confirmed the level of concern expressed at that time. Further, Mr Rainey was requested to give his expert opinion on the matter of the debt. Mr Allen says it is unclear in Mr Rainey’s mind now as to the total extent of that advice.
[192] Second, Mr Allen submits that Customs should have done something earlier. The submission is that Customs accordingly adopted the same pragmatic view as the directors at the time, that is, to keep on trading. Finally, Mr Allen says that the directors could have reached a compromise.
[193] After April 1993, Mr Buchanan’s evidence is that the options for the company were three-fold. First, the company could do nothing, which is what it did. In Mr Buchanan’s opinion this was not a good option. The second option was to cease trading and in his view this was the correct option because the situation got worse. If the company took up the third option, that is, a conscious choice to trade then three things were necessary:
a) Ensuring the accounting system was adequate from that time on to produce accurate excise returns so the shortages did not continue.
b) Some very careful forward budgeting and modelling to produce some cash budgets with which they would go to Customs and say here is an affordable monthly payment on the backlog debt and get Customs’ agreement on the instalment plan to remove the threat of liquidation.
c) The shareholders would have had to input extra capital to balance the company’s assets and liabilities at that point.
[194] Essentially then, Mr Buchanan’s evidence is that after April 1993 Cellar House either had to stop trading or come to some credible arrangement with Customs to continue.
[195] On the question of insolvency, Mr Walker’s evidence is first, that Cellar House’s stock was over-valued. He bases this on the sale of stock to Haumi. At the end of June 1998, Cellar House’s stock was valued at $653, 399.31. At the end of July, the stock transferred to Haumi was transferred at a value of $362,837.47 the difference of $300,000 being a loss in value of Cellar House’s assets. Mr Walker cannot be sure when the stock over-valuation occurred because of the quality of the accounting records. He considers it likely the stock had been over-valued for some considerable time.
[196] Mr Allen provided the Court with an undated letter from Oenological Services Limited which stated that on 20 July 1998, Malcolm Reeves had undertaken a valuation of the stock listing of Redwood Cellars and considered the value assigned to the various items of stock was fair and accurate.
[197] Assuming the assets were likely to have been overstated for some time, Cellar House’s solvency, Mr Walker says, was marginal from 1995 onwards.
[198] Second, Mr Walker considers that once the financial statements include the Customs debt, Cellar House was insolvent from 1992. In this context, the plaintiff relies on a memorandum from the Pitt & Moore file from a solicitor looking after Cellar House’s file while Mr Rainey, Cellar House’s then solicitor, was away. The memorandum recorded the following:
“There is a further issue on this file which Don [Allen] wants to talk to you about. Customs have sent them a $1.6 million bill, which could wipe them out. Don wants your assistance in working through a list of questions that Customs has provided. Further, I am advising him with the assistance of JMH as to ways that Don can personally lend the Company money on a secured basis to help liquidity on a short term basis.”
[199] Ms Andrews for the plaintiff accepts that this is hearsay. But the question is what weight should be given to it. It is not necessary to consider this at all because I am satisfied, in any event, that at least after the point in time when the short payment notices were issued, the company’s debts exceeded its assets. For that reason also it is not necessary for me to make any finding on the value of the stock.
[200] The point is made in the directors’ report, presented at the Annual General Meeting held on 1 November 1995, which refers to Cellar House’s loss and in which Mr Allen stated:
“For 18 months – 2 years we have been unable to make proper commercial decisions because of the large financial threat hanging over us. If they had gone retrospect [sic] we could have received a bill for up to $1 million which obviously we could not have paid. The Customs mediator who our case went to .. found one month ago totally in our favour. Customs still have not made a comment but we would be very surprised if they try to fight us further on this classification issue and therefore it has not been shown in our balance sheet as a liability.”
[201] Mr Allen did not advance any evidence to challenge Mr Walker’s evidence on this.
[202] Further, the minutes of the directors’ meetings from 1994 onwards discuss restructuring the business by selling its assets to a new company.
[203] Mr Walker’s view was that the prudent course would have been to progressively account. Once the assessment was issued, there were two options: liquidate the company; or undertake a formal compromise proposal or restructuring. Mr Walker says he has not found any evidence these options were considered. There was consideration of a “phoenix” company operation but no suggestion of liquidation or formal compromise.
[204] Mr Buchanan accepts that Customs could have taken action to liquidate the company after April 1993 and that is confirmed by the evidence for the defendant from Mr Powell and Mr Ditzel. Mr Ditzel says that Customs “obviously” recognised that one way Cellar House could pay the claim issued was to continue to trade.
[205] I accept the submission for the plaintiff that in terms of the approach to the two law firms engaged by the defendant, each of the solicitors of those two firms were asked to advise on specific issues in relation to litigation matters. They were not asked more generally, about what the company should do. In any event, the directors were best placed to know the company’s financial situation and to have acted appropriately in relation to that.
[206] There is no evidence of any compromise arrangements. In any event, a pre-condition to compromise is insolvency and Mr Allen maintains that the company was not insolvent at the relevant time. At best, there is some evidence the second law firm was instructed to try and reach some settlement with Customs.
[207] Finally, it is relevant that Mr Allen was a hands-on director and in full control of the company.
[208] The evidence of Mr Walker was that if Cellar House had gone into liquidation when the liability to Customs arose then the secured creditors and the preferential unsecured creditors, which included Customs, would have been paid in full. Mr Walker’s evidence is that when the company was finally put into liquidation only the secured creditors who included Mr Allen had been paid in the course of the receivership. The preferential and unsecured creditors are unlikely to receive any dividend in the liquidation. In other words, the risk to creditors did eventuate.
[209] I am satisfied that it was reckless trading to carry on from early 1994. In fixing on early 1994, I am allowing a few months (from 15 November 1993) for the defendant to decide what steps were necessary and to initiate some action, although in fact, no such steps were taken. The fact Customs took no action at that point did not absolve Mr Allen from his responsibility. At best, some steps were taken in relation to pursuing an appeal but that was not enough in the circumstances. Mr Allen was well aware of the Customs debt and the need to take some action in relation to it but did nothing.
[210] Taking into account the evidence overall, I characterise Mr Allen’s approach as going beyond “hopelessly optimistic” to stubborn or obdurate. It appears that Mr Allen thought that the company was being treated differently from other companies by Customs in terms of the payment of excise duty. He then “put his foot down” and refused to alter his position “filing” the Customs’ matter in the rubbish bin although he must have known and indeed was advised, at the latest by the second law firm, about the effect of non-payment. Mr Allen also had his own views about what was needed in terms of record keeping and again, while making some moves to improve matters, largely “stuck to his guns” as to what was required. The latter aspect is apparent in the approach to calibration of the alcohol storage tanks.
[211] Mr Allen’s actions accordingly went beyond any legitimate business decision and comprised the taking of illegitimate business risks.
Acting in good faith and in best interests?
[213] The plaintiff submits that it is not in the company’s best interests to allow it to continue to trade when it is insolvent and when no provision or recognition has been made for a substantial liability.
[214] Further, the submission is that a reasonable director aware of the significance of correctly declaring a company’s liability for excise duty and the exposure to additional duties where returns are inaccurate would have taken sufficient steps to ensure that:
a) The company’s records were such as to account for all purchases of raw materials and to trace those materials through the manufacturing process, accounting for them and/or finished or other product which left the manufacturing area.
b) Further, when deficiencies were highlighted by the Customs audits, record keeping systems were introduced or improved so as to ensure that self-assessment was accurate in the future.
c) Where the company had a debt to be paid like the Customs debt, that the company’s financial statements made provision for payment of that debt.
d) That steps were taken to ensure that the company could pay the excise and additional duty if the challenge to Customs calculation of liability did not succeed.
[215] It is submitted that Mr Allen did none of these things and so was in breach of the duties he owed as a director of Cellar House. Further, that the breaches continued throughout the period from 1992 until liquidation in 1994 although Mr Allen can only be liable for breaches from 4 August 1994. It is submitted that the nature of the breaches justifies this Court in making an order that Mr Allen be held personally liable to the plaintiff for all or a very substantial portion of Cellar House’s outstanding liabilities. I accept the plaintiff’s submission as to breach of these duties.
Exercising care, diligence, etc?
Affirmative defence to breach of duties claims
“(1) .. 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 advisor 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 serve in relation to matters within the director’s or committee’s designated authority.”
[218] The affirmative defence applies to a director only if the director acts in good faith, and makes proper inquiry where the need for such inquiry is indicated by the circumstances, and has no knowledge that reliance is unwarranted.
[219] The defendant maintains:
a) The decision to continue to trade was not taken lightly.
b) The debt was treated as being of a major concern by the directors.
c) Customs could have done something earlier but in fact re-issued the licenses and so in that respect Cellar House directors followed the advice of the ultimate expert.
[220] All of this occurred while the defendant was in active pursuit of an appeal against the Customs’ assessment.
[221] The plaintiff refers to Re Hilltop Group Ltd (in liq); Lawrence v Jacobson (2001) 9 NZCLC 262, 477 where Potter J at para [35] stated that:
“Reliance may be placed only if the director acts in good faith, makes proper inquiry where the need for inquiry is indicated by the circumstances, and has no knowledge that such reliance is unwarranted.”
[222] The plaintiff’s argument is that the defendant did not in fact take any advice and so there is no need for the Court to consider any question of reliance. I agree. The tenor of the discussion above also makes it plain the defendant has not established any basis for this defence.
Relief
[223] This is a case where it is appropriate to make an order requiring the defendant to pay a sum to the company. The issue is as to the quantum of such a payment. As I have said, I consider relief under s 301 is appropriate, rather than s 300. I note that s 300 envisages orders which are directed to particular debts owed by a company. Section 301 contemplates compensation payable to the company itself (see: South Pacific, above, at para [161]). Section 301 allows of a global enforcement of breaches of director’s duties as I have found have occurred here.
(i) Arguments
[224] The plaintiff notes that judgment was entered against Cellar House for approximately $5.8 million on the basis of the liquidation proceedings. On liquidation, Mr Walker estimated that Cellar House’s total debts were $11,081,024.63 against assets of $378,754. The company’s liabilities comprised unpaid excise duty, together with additional duty in the amount of $8,581,024.60 and unpaid income tax and goods and services tax of $2,706,738.90. There are also a number of trade creditors who are owed $176,302.00. Mr Walker’s estimate has not been contested.
[225] It is submitted that the substantial uncertainty as to the assets and liabilities of Cellar House makes it difficult to assess with any degree of precision the effect of the failure to comply on the company’s liabilities. Mr Walker has made the best estimate he can given the accounting records. Mr Walker’s approach was approved by Mr Buchanan. The plaintiff refers to Maloc, above, where the liquidator had not even made an accurate assessment of the deficiency on liquidation and there had been no attempt by the liquidator to provide the Court with detailed accounting information. However, the Court held that while it should be conservative in those circumstances, it did not mean that no order should be made.
[226] The submission is that the authorities suggest that taking a conservative estimate of when the directors may have been in breach, personal liability should accrue from that point since, if there was no breach of duty, the company’s liability would not have been incurred.
[227] The plaintiff relies on the following factors in this case:
a) The liability to Customs arose out of Cellar House’s failure to keep the records that were required for its particular business and Mr Allen’s failure to ensure that it did. It was this which exposed the company to the assessment made following the audit in October 1992.
b) Mr Allen knew the amount of the liability to Customs as the letters of 26 April 1993 and 15 November 1993 were addressed to him.
c) The amount owing to Customs was not contingent. The assessment was payable whether or not Cellar House disputed that amount or appealed the assessment.
d) Mr Allen chose to ignore the liability - he “filed the problem in the rubbish bin”.
e) Mr Allen chose to make no provision for the liability in Cellar House’s accounts which ensured that the accounts were misleading as to the company’s financial position.
f) Mr Allen made no effort to cause Cellar House to cease trading and it continued to trade under his day-to-day management and control for five years after the assessment.
g) Mr Allen made no attempt to find a way to pay the liability but rather sought advice as to ways of restructuring the company so that payment could be avoided. This eventuated in August 1998 with the sale of the assets to Haumi but with a continuing liability for excise duty being left with Cellar House.
h) He advanced money to Cellar House after the Customs assessment. The company gave a debenture to secure the advance and Mr Allen was paid on the company’s receivership.
[228] Accordingly, it is submitted that Cellar House should have ceased trading at the latest in November 1993. At that time it had a liability to Customs of approximately $1.5 million. In the intervening period until its actual liquidation the Customs debt alone increased by $4.3 million. The submission is that in the circumstances there is ample justification for the Court making an order that Mr Allen is to contribute to the assets of Cellar House a sum that is at least equivalent to the difference between the November 1993 debt and the estimated total debts on liquidation.
[229] Mr Allen submits that there were other directors who were responsible and lived geographically closer to the company premises. Further, it is submitted that neither the core debt to Customs nor any amounts “outstanding” to ordinary trade creditors had increased by any significant amount after five years of trading “while insolvent”.
(ii) Discussion
[230] O’Regan J in Fatupaito v Bates [2001] 3 NZLR 386 at para [93] states that s 301 requires the Court to assess,
“the contribution to be made by the director by reference to what the Court thinks is just. I have already referred to the comments made by Anderson J in Nippon Express (New Zealand) [Ltd v Woodward & Anor (1998) 8 NZCLC 261,765 at 261,778] on the appropriate method of assessing the amount of liability, which he summarised as being no more and no less than the directors’ ‘just desserts [sic]’.”
[231] Broadly, I accept the starting point as to quantum adopted by the plaintiff. Once the Customs’ claim was made known to the company, the company chose to carry on trading without factoring in the Customs’ demand in any way. Mr Allen knew that in so doing, the true position of the company had not been disclosed. The risk inherent in carrying on in those circumstances then in fact eventuated, that is, other people’s money was put at risk including that of the trade creditors. Further, the breach of duties continued for some time. The company should have ceased trading or taken some action such as entering into a formal arrangement with Customs from early 1994. The company did not cease to trade until 1998.
[232] There are, however, some factors which reduce the quantum of the award.
[233] First, it is relevant that the breach of duties claims can only run from August 1994 (that is the effect of the relevant statutory provisions). Further, no Limitation Act point is pleaded but some of the events occur more than six years before this proceeding was commenced. (Contrast: re Network Agencies International Ltd [1992] 3 NZLR 325 and see also Arataki Properties Ltd v Craig [1986] 2 NZLR 294 (CA), Benton v Priore [2003] 1 NZLR 564, and Official Assignee v Fuller [1982] 1 NZLR 671 (CA).)
[234] Second, it is also relevant that Customs delayed taking action to recover the debt owed to it. Customs may have had reasons for their approach. But, while Customs’ delay is not a factor that could give rise to an affirmative defence it must be relevant in considering the amount now appropriately payable by Mr Allen. Further, Customs declined the company’s application for the licence to be transferred to Haumi.
[235] Third, without absolving Mr Allen in any way for his failures, the evidence before me suggests failings in the actions of others and those aspects must be taken into account together in assessing quantum.
[236] Fourth, as in South Pacific, above, although that case was dealt with under s 300, it would be inappropriate to make as an extensive an order as the plaintiff seeks without knowing the full extent of Mr Allen’s resources.
[237] Fifth, as I have indicated earlier, the fact the destruction of records prior to the 1992 audit was inadvertent must be relevant to an assessment of quantum.
[238] Finally, in the context of a restitutionary order it would be inappropriate for recovery to exceed the amount outstanding. I accordingly sought information from the parties on the amount paid by the other directors in a settlement with the liquidator. I received a memorandum from the plaintiff dated 24 February 2004 which advised that a settlement was reached between the plaintiff and the second to fourth defendants (B J Inglis, P G Inglis, and T G Goulter) for payment of a total of $75,000. The plaintiff’s memorandum advises that in reaching this agreement, the plaintiff took into account the second to fourth defendants’ respective roles in Cellar House, namely:
a) The second and third defendants were independent directors who were not involved in the day to day running of the company;
b) The fourth defendant was an employee of the company, subject to direction from the first defendant, Mr Allen;
c) The first defendant was the sole director of the company after July 1997.
[239] The defendant in his memorandum dated 8 March 2004, confirmed the total amount paid was $75,000. Mr Allen also said he did not consider any particular apportionment of liability was attached to any individual director in assessing the amount against each individual.
[240] Mr Allen also said he had read the South Pacific judgment which was referred to in my Minute of 23 February 2004. He drew the Court’s attention to William Young J’s comments particularly para [174]. That paragraph discusses the conflicting views as to whether the liability of directors ought to be joint and several or several. William Young J expressed a preference for assessment on a joint basis.
[241] I deduct $75,000 from the total of the award I would otherwise have made.
[242] The mathematics of deriving the ultimate figure are of course not able to be very scientific. As William Young J put it in South Pacific albeit in the context of s 300, “some element of rough justice may be called for.” (para [163])
[243] In this case I assess the quantum at $1.75 million being the difference between the initial debt of $1.5 million and the final debt of some $11 million less a reduction for each of the matters referred to above. Interest is payable on that figure from 1 January 1995 to the date of payment at the rate of 7.5 percent.
Other matters
[245] In the end, no objection was taken by Mrs Andrews for the plaintiff. The defendant and Mr Donaldson were advised of the potential issues for them by a Minute of the Court and, again, no objection raised. In the circumstances, Mr Donaldson was permitted to remain as a McKenzie friend.
Result
[246] The plaintiff’s application is successful. Orders are made:
a) Pursuant to s 301(1)(b)(i) of the Companies Act 1993 that the defendant is personally responsible for $1.75 million of the debts and liabilities of Cellar House.
b) Pursuant to s 301(1)(b)(i), I make directions to give effect to that declaration. I direct that there be judgment for the plaintiff against Mr Allen in the sum of $1.75 million together with interest from 1 January 1995 to the date of payment at the rate of 7.5 percent per annum.
Costs
[247] Costs are reserved. Memoranda may be filed if the parties are unable to agree as to costs. If memoranda are necessary, they are to be filed by the plaintiff within 21 days from 18 March 2004 and by the defendant within a further 10 days of that date.
_____________________________
E France J
Delivered at 11.20am on 18th March 2004.
Solicitors:
Kensington Swan, Wellington, for the Plaintiff
D W Allen, Defendant, Christchurch
Attachment: Appendix A
Documents produced shortly before hearing
1. Stock takes – monthly and annual.
2. Whey alcohol (bulk) book – to record whey or grain spirit purchased and used to manufacture the company’s products. Records for days in the month the opening stock, less stock used by volume.
3. Bulk wine book from 1997 onwards – records volume, product.
4. Bulk wine bought and manufactured on site 1992-1997 showing tank number, quantity produced by litres, date finished product produced and record of usage.
5. Daily production figures – records product description, number produced, “value of production”, wages paid and variances.
6. Daily production figures cumulative.
7. Stock movements report – lists stock code, description (e.g. Cabernet Sauvignon), opening stock, receipts, sales, adjustment transfers, and invoice/job close stock.
8. Excise duty forms.