Directors
making an honest but ultimately fruitless effort to rescue insolvent companies
are treated sympathetically by the courts when assessing damages.
A non-executive director of NZNet
Internet Services Ltd did not have to pay any damages despite being in breach
of directors’ duties before the company went into liquidation in November 2011
with unpaid debts of some $1.08 million.
Three NZNet directors were held liable in the High Court for breaches of
the Companies Act; managing director and majority shareholder Mr Stephen
Andrews was held liable for $1.08 million (for acting recklessly and in breach
of his duty of care as a director); marketing director Mr George Thomas was
held liable for $83,800 (for failing to look after creditors’ interests in the
last three months of the company’s life); and financial adviser and
non-executive director Mr Rowan Johnston was held liable for acting recklessly
as a director, but was not ordered to pay damages. He had lent over $460,000 of his own money to
the company in a failed attempt to turn round the business. The debt owed him by NZNet exceeded any loss
attributable to his breach of directors’ duties.
Liquidators Waterstone Insolvency
appealed the High Court ruling that Mr Johnston was not liable to contribute
cash despite being held to have acted recklessly.
Evidence was given that majority
shareholder Mr Andrews sought financial help from Mr Johnston for NZNet two
years before the company went into liquidation.
The company was short of cash. The
two were personal friends of over 30 years standing. With degrees in economics and finance, Mr
Johnstone was employed by Forsyth Barr.
He agreed to inject $220,000 equity capital into the business after asking
searching questions of Mr Andrews about the company’s financial position. He was to later learn on becoming a
non-executive director that Mr Andrews had lied: tax debts were seriously
understated and there was no full disclosure of the extent of company spending
on Mr Andrews’ corporate credit card. A
manic period of fire-fighting followed as Mr Johnstone kept pouring his own
money into the company to pay pressing company debts. He spent weekends free of his Forsyth Barr
responsibilities attempting to identify NZNet’s current financial position, to finalise
budgets to achieve profitable trading and to find ways to boost future revenue. After Mr Andrews’ unilateral decision to
commit the company to an advertising contract costing some $89,800, NZNet went
into liquidation insolvent.
The Court ruled that a non-executive
director cannot be liable for trading recklessly where the company’s true
financial position is not known, despite reasonable enquries, because of
concealment by other directors or by senior management. By contrast, a “sleeping” director who does
not make any attempt to ask questions or make enquiries will be liable.
The Court said Mr Johnston made a
thorough assessment of the company before becoming a director. He had no way of knowing at that point that
his long-standing friend was lying about the company’s financial position and
its prospects. He had no independent way
of knowing the true state of the company’s tax debts.
Six months into his involvement with the
company, Mr Johnston had a better picture of the company’s difficult financial
position, the Court said. He then used
his expertise and best endeavours to improve the company’s position including
paying company debts and seeking to improve its financial management. A further six months on, Mr Johnston should
have been aware there was little hope, the Court said. Sales were growing, but so too did mounting
evidence of Mr Andrew’s ill-disciplined and incompetent management. Mr Johnston should have resigned, the Court said. He was reckless and in breach of creditor
interests to carry on from this point.
Mr Johnston was liable to contribute to creditor losses arising from
this date.
The Court of Appeal confirmed the earlier
High Court ruling that any damages payable for a breach of directors’ duties
beyond this point were less than the $460,000 Mr Johnston had lent the company
to meet pressing debts. He was not
required to contribute further. In the
liquidation, Mr Johnston is the company’s biggest creditor.
Grant
v. Johnston – Court of Appeal (29.04.16)
16.070