In Financial Difficulties and Stuck?

What can happen and what you can do about it.

Geoff Hardy has 45 years’ experience as a commercial lawyer and is a partner in the Auckland firm “Martelli McKegg”. He guarantees personal attention to new clients at competitive rates. His phone number is (09) 379 0700 and email geoff@ martellimckegg.co.nz.

Joinery manufacture can be a risky business. It’s a capitalintensive industry that requires a big investment in expensive plant and equipment, most of which will need to come from borrowed money, and that plant and equipment can break down or become obsolete. Your business is labour-intensive and your staff require training. Unlike the average builder who does his manufacturing on the customer’s site, you also need your own premises, which will frequently be leased. You need to insure your premises and their contents. Your business consumes a lot of building materials which come at a significant cost, and often it’s a cost that you have to pay up front. The list goes on.

Most of you will take those costs in your stride and make a healthy profit. But sometimes things don’t turn out the way you planned. There is no shortage of competitors chipping away at your client base, and occasionally you will lose one or more major customers without any warning. You might get a substantial rent increase, or a hike in your payroll costs due to labour law changes. One or more critical staff members might move on, and prove very difficult to replace. Your could suffer an unexpected disability or illness. The economy might tank. You might have a large order cancelled on you without compensation, or a major customer might go bust or have a protracted dispute with you, and default in payment of your invoices. And then you might get hit with something totally out of left field, such as a covid-19 pandemic.

Sometimes these make such a big hole in your cash flow that you can’t pay your bills as they fall due. And when you get to that stage, technically you are insolvent.When you become insolvent, several things typically happen. Your suppliers put you on stop credit, and they hound you for payment. Your bank and landlord get twitchy. Your staff start to look for greener pastures. You can’t progress the work as promptly as you need to, which causes your customers to stop paying. You use deposits and progress payments from newer jobs to pay the bills on the older problematic ones. And your more aggressive creditors serve statutory demands on you.

What is a Statutory Demand? It is a form that your creditors can give you under the Companies Act that gives you 15 working days to pay their debt, otherwise your company is deemed to be insolvent. Failure to pay in time enables the creditor to apply to the court to put your company into liquidation. That takes a few months to achieve, and there are various defences you can raise, but the application to liquidate your company becomes public knowledge at a very early stage. You can take comfort in the fact that statutory demands can only be used for undisputed debts, so unless you have conceded that the debt is payable, then you can always dispute it. But in the meantime if you want to stop the word getting out then you only get 10 working days to apply to the court to shut the whole thing down, and that costs a lot.

What else can happen to you when you become insolvent? When your bank learns of your difficulties it can put your company in receivership. That means that all your company’s income is syphoned off until the bank’s debt is paid, and usually liquidation follows after that. Your bank, your landlord and some suppliers will hold personal guarantees from you, and they will call those up if your company defaults in payment. You might be comforted by the fact that you have your personal assets in trust, but they can still bankrupt you, in which case you lose a lot of freedom and most of your non-trust assets.

What are the consequences of the liquidation of your company? Well for a start, you lose control of it. The bank and any other secured creditors take most of the assets, and the liquidators convert the rest into cash. The liquidators distribute the cash to the preferential creditors (themselves, the employees, the IRD, etc.) and any surplus to the unsecured creditors. The company then ceases to exist.

What else can the liquidators do? They can terminate any unprofitable contracts, and they can bring to an end any claim against the company and prevent anyone from suing it. In certain circumstances they can group all your companies together and combine their assets. They can call up your shareholder loan account, and if you have looked after yourself or any particular creditors at the expense of the other creditors, they can reverse those transactions and claw back any payments made in the 6 months prior to liquidation while the company was insolvent.

What’s more, they can take action against you if you have breached any of your director’s duties under the Companies Act. That is exactly what happened in the recent case of Debut Homes Ltd v Cooper, which is New Zealand’s latest and most high-ranking decision on the subject. Debut Homes was a residential developer, and Mr. Cooper was a shareholder and the sole director. By October 2012 he knew it was in trouble, and the shortfall to the IRD was likely to be $300,000. Notwithstanding this he elected to complete all current projects that the company was engaged in. To be fair to him, he tried very hard to salvage the company, but it was all to no avail. 17 months later the IRD got the company placed into liquidation, and by that time it was owed $450,000 in GST.

Debut had completed and sold various homes, but Mr. Cooper decided where the proceeds went. He favoured the secured creditors who were holding personal guarantees from him, as well as his family trust, at the expense of the IRD. As a result, and because he had breached three of the directors’ duties under the Companies Act, he was ordered to pay $280,000 into the company, and $280,000 of the secured debt owed to the family trustees became unsecured instead. This was on top of the court costs and legal fees he had already incurred.

The Court said that once he knew Debut had no hope of returning to solvency and there would inevitably be a shortfall to one or more creditors, Mr. Cooper should not have decided to continue to complete the developments. He could have put the company into liquidation. He could have invited the BNZ to put it into receivership. Or he could have gone for a creditors’ compromise, a scheme of arrangement, or a voluntary administration.

I can’t help thinking that this is an unrealistic expectation of human beings who are desperate to salvage their only source of income and ever-optimistic that their fortunes will change given enough time. Admittedly directors of large building companies who have little or no skin in the game and plenty of opportunity to earn a good living elsewhere might be more inclined to follow the Supreme Court’s guidance. However I suspect that owner/ operators of smaller companies like Mr. Cooper are more likely to take the risk regardless, and simply pay the penalty if it all comes unstuck.

Finally, you may recall that for a short period during the height of the covid-19 pandemic, the Government relaxed the rules relating to directors’ duties under what was known as the “safe harbour” scheme. If you were inclined to battle on, and you met the relevant criteria, then up until 30 September 2020 you were allowed to take more of a gamble than you can during normal times. However this relaxation was only temporary, the criteria were quite strict, and it didn’t apply to one of the directors’ duties that Mr. Cooper was found to have breached. It remains to be seen whether covid-19 lockdowns will make a comeback, and if so, whether the Government will introduce the safe harbour regime once again.