Directors ordered to pay up

In the continuing saga of the Mason v Lewis litigation, the Court of Appeal has provided some relief for the two directors' overall liability to the company, but in all other respects its most recent decision echoes the High Court's earlier message: "delinquent directors beware".

Background

This is the second time this litigation has been before the Court of Appeal. In the Autumn 2006 issue of Commercial Quarterly we discussed the Court of Appeal's decision in Mason v Lewis¹ in which Mr and Mrs Lewis, in their capacity as directors of Global Print Strategies Limited (in liquidation) (Global), were held to have breached their statutory duties under section 135 of the Companies Act 1993 for reckless trading and sections 194 and 300 of the Act for failing to keep financial records. However, at the time, the Court of Appeal was unable to make contribution and compensation orders for the Lewises' breaches because the High Court had not considered all of the issues relating to quantum at the initial hearing. This part of the liquidator's claim was remitted back to the High Court for it to determine what quantum orders were appropriate. A case note on the High Court's decision² was included in the Spring 2008 issue of Commercial Quarterly.

This recent Court of Appeal decision³ was the outcome of an appeal by the Lewises from the High Court judgment in which orders were made under sections 300(1) and 301 of the Companies Act 1993 that they both pay substantial amounts (being over twice the amount of the Court of Appeal's cap) for breaches of their duties as directors.

The principal issue was whether the High Court had erred in not following the Court of Appeal's stipulation that the liability of the Lewises was not to exceed $560,000. The High Court had seen this stipulation as something which it was not bound by on the basis that the amount did not form part of the Court of Appeal's reasoning in its finding of liability against the Lewises.

The Court of Appeal's decision

The Court of Appeal agreed with the Lewises that the High Court had been wrong to exceed the sum stipulated by it. The $560,000 figure was the amount that had been claimed by the liquidators at the first hearing of the Court of Appeal and the court had made it a condition on which the matter had been remitted back to the High Court (rather than a step in the court's reasoning).

The Lewises however were not content with this finding and asked that the Court of Appeal proceed with the appeal on the basis that they could establish that the appropriate quantum of liability was less than $560,000.

In determining the total amount of the Lewises' liability, the High Court had followed the "standard approach" under sections 300 and 301 which had been referred to by the Court of Appeal in its previous decision. The approach begins by looking at the deterioration in the company's financial position between the date inadequate corporate governance became evident and the date of liquidation. Once that figure has been ascertained, there are three factors which are relevant to the exercise of the court's discretion:

• causation (in so far as there is a clear link between the Lewises allowing the company to continue to trade beyond August 2000 and the indebtedness to creditors that subsequently arose);

• the duration of the trading; and

• the extent of the Lewises' culpability.

This appeal required the Court of Appeal to consider whether the High Court judge had been in error in various assessments he had made under the "standard approach", including his assessment of:

• the creditor pool;

• the causation; and

• the culpability of the Lewises.

The Court of Appeal rejected all of the Lewises' arguments on these issues and ordered Mr and Mrs Lewis to contribute the sum of $560,000 to the assets of Global by way of compensation for their breach of duty to Global under section 135.

In reaching this decision, the court:

• agreed that the High Court had been correct to include post-liquidation interest in calculating the creditor pool, noting that the fact that the interest payment obligation will continue post-liquidation will be obvious to directors, and will be a relevant factor in deciding whether continued trading is consistent with the section 135 duty;

• Disagreed with the argument that Global's losses would have resulted whether or not the Lewises had complied with their directors' duties, since they were the minority shareholders and did not actively participate in the management of the day-to-day operations of the company. The court found this argument untenable as it was equivalent to saying that directors could "wash their hands of their duties except where they held a majority of the shares." As to what action was expected of directors in a similar situation to the Lewises, the court notes:

"They could have obtained advice about how to manage the dire financial position into which the company had fallen. They could have resolved that the company would stop trading. They could have taken steps to ensure further debts were not incurred in circumstances where the company was not able to pay them. The reality is they took no meaningful action at all. They cannot throw their hands in the air and say it was not their fault."

• Agreed with the High Court's assessment that there was no reason to find Mrs Lewis any less culpable than her husband, despite only having become a director at the instigation of her husband and having had less involvement with the company than her husband.

The Lewises had also argued that the compensation should have been reduced because of the contributory conduct of the main secured creditor of Global which was set to benefit from the proceedings. The court made no finding on this point as it agreed with the High Court's conclusion that the involvement of the creditor in question did not have the effect of increasing the overall indebtedness of Global, albeit it had the effect of converting what would otherwise have been unsecured debts into a secured debt. The court, however, did acknowledge that there was a case for taking into account the contributory conduct by a creditor where that creditor will be the only beneficiary of an award and any reduction in the amount that would otherwise be awarded has no effect on other creditors. Conduct of a creditor may also be relevant where the s 301 proceedings are instigated by a creditor seeking an order under s 301(1)(c) that money be paid to the creditor.

Comment

The Lewises may have achieved a partial victory in this case thanks to inadequate pleadings by the liquidators in the initial Court of Appeal hearing, but the case stands as an example of the significant personal liabilities directors may face if they fail to meet the standards required of their office.

In the High Court decision Justice Stevens noted that this case was a timely reminder of a fundamental principle of the Companies Act 1993 that company directors must take proper steps to place themselves in a position to guide and monitor the management of the company and noted that:

"The responsibility for the governance of the company is theirs. They cannot simply treat the appointment as a sinecure and then leave to management, or other advisers, the duties of running the company and ensuring compliance with legal obligations. Let delinquent directors beware."

This message still holds true.

¹ [2006] 3 NZLR 225

² Mason v. Lewis & Anor (Unreported Judgment, Stevens J, H.C., Auckland, CIV 2003-404-0936; 1 October 2008)

³ Lewis & Anor v Mason [2009] NZCA 306

Enquiries and information

For more information on any of the cases, articles and features in Commercial Quarterly, please email Diane Graham or call her on 64 9 916 8849.