SPCS

SOCIETY FOR PROMOTION OF COMMUNITY STANDARDS INC.

High Court looks at ‘shadow directors’, ‘de facto directors’ and reckless trading

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Shadow directors, de facto directors and duties not to trade recklessly

A recent decision of the High Court, Delegat v Norman [2012] NZHC 2358 provides a useful illustration of the application of the following Companies Act 1993 provisions:

  • when a person will be deemed to be the director of a company as either a ‘shadow director’ or a ‘de facto director’ under section 126 of the Act; and
  • when a director will be in breach of the duties relating to reckless trading and incurring obligations under sections 135 and 136 of the Act, or be in breach of the duty to act in good faith and in the best interests of the company (under section 131) or the duty to exercise the care, diligence and skill of a reasonable director (under section 137), particularly where a company is of doubtful solvency.
  • For analysis see Company Law in the Courts – Issue No. 19 of Corporate Reporter, Bell Gully’s regular round-up of corporate and general commercial matters (27 March 2013)
  • http://www.bellgully.co.nz/newsletters/corporate_reporter/27mar13.asp

Penalties for breaches of S. 385 Banning order by banned NZ Company Director

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In view of the growing numbers of New Zealand company directors, MPs and business leaders who have been convicted in the Courts for fraud, financial mismanagement, reckless trading and bribery; it is important that the penalties imposed by Judges on those convicted of such offences, be regularly reviewed, particularly in view of the financial suffering and social upheaval caused to shareholders, creditors and investors etc. by those responsible for such crimes.

Under s. 385 (1) of the Companies Act 1993, “the Registrar [of Companies] may, by notice in writing given to a person, prohibit that person from being a director or promoter of a company, or being concerned in, or taking part, whether directly or indirectly, in the management of, a company during such period not exceeding 5 years after the date of the notice as is specified in the notice. Every notice shall be published in the Gazette.”

Under S 373(4) of the Act, a person convicted of acting in contravention of a banning order notice issued under s. 385, is liable to imprisonment for a term not exceeding 5 years or to a fine not exceeding $200,000. Furthermore s. 386 sets out “Liability for contravening section 385 or section 385AA”

A person who acts in contravention of a notice under s. 385 or 385AA is personally liable to –

(a) a liquidator of the company for every unpaid debt incurred by the company; and

(b) a creditor of the company for a debt to that creditor incurred by the company—

while that person was so acting [against the banning order].

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Warning to company directors responsible for reckless trading during insolvency

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For a company director to allow a company to continue to trade while it is insolvent is a breach of duty under section 135 or 136 of the Companies Act.  It is the duty of a Liquidator to report on any such reckless trading that is uncovered in the course of his or her efforts on behalf of creditors to recover any debts owed once the company is put into liquidation. The identification of reckless trading does give rise to possible civil action from creditors against the directors: creditors who may choose to seek reimbursement from the company for any shortfall in debts owed them. Consider a company that purchases a property for $1.9 million dollars, borrowing all the money to pay the purchase price. A director who finds that the company is unable to meet interest repayments on a first and second mortgage, should realise that a mortgagee sale is inevitable unless he can refinance the loan, source capital from elsewhere or gain assistance from a kindly tooth fairy. If however, the director allows debts to mount up for months due to unpaid interest and persists in carrying out trading operations throughout the period of insolvency, that would constitute reckless trading by the company, for which he is directly responsible. All income gained by the company over the period of insolvency would be subject to a rightful compensation claim be creditors via a civil action in the Court. If the company director failed to produce a credible record of company income deposited in a company bank account over this period, he would have committed an offence under the Companies Act 1993. Directors who fail to file an annual return after an extended period of such reckless trading, should be banned from being company directors. A director who through mismanagement allows two of more of his companies to be put into liquidation is more than likely to be banned as a director by the Ministry of Economic Development under s. 385 of the Companies Act 1993.