Honesty is no defence against creditor liability

By Paul Robertson

Friday 23rd November 2001

Directors face substantial personal liability to creditors even if they act honestly and in good faith, as a recent Hamilton High Court judgment made clear.

Computer retailer Michael Sanderson was ordered to pay $35,000 to a creditor after Justice John Priestley found he had breached the reckless trading provisions of the Companies Act.

Mr Sanderson, whose business traded as Group Hubb Ltd, closed a Rotorua outlet in 1995 to concentrate on the remaining Hamilton branch.

The closure lead to losses, although no more capital was invested in his $1 company.

The court held that because of these losses from the last quarter of 1995 Group Hubb was insolvent.

Mr Sanderson hoped to recoup those losses by trading on but in early 1996 he was told that his principal supplier, The PC Company, planned to open a branch in Hamilton.

Mr Sanderson was given a copy of the new business's price list and was told that his terms of trade were being tightened up.

Mr Sanderson appreciated that he could not compete against the prices being offered by The PC Company and five days later appointed a liquidator for Group Hubb.

Justice Priestly accepted The PC Company's allegation that Mr Sanderson had been trading while insolvent.

He found Mr Sanderson in breach of the reckless trading provisions of the Companies Act.

These sections make it clear that if a company goes into liquidation a director, or any other person involved in running the company, can be held liable to repay creditors if the business of the company has been "carried on in a manner likely to create a substantial risk of serious loss to the company's creditors."

Mr Sanderson argued that the majority of his company's debt was owed to other companies he owned, so those inter-company debts should be ignored.

He also relied on The PC Company being the major creditor and its accounts having been paid regularly and promptly up to the date of the liquidation.

It was argued that company directors should not be punished for taking modest risks and it was reasonable for him to take the view that the company could meet its debts.

Justice Priestly had sympathy for Mr Sanderson's position but held that his optimistic decision to trade on after closing the Rotorua store was misguided.

Because of the company's lack of capital "it was a disaster waiting to happen and of course it did happen," he ruled.

He was critical of Mr Sanderson's failure to recognise the problem, "to take the requisite step back to assess whether his ongoing optimism was justified."

He found there had been a breach of section 135 of the Companies Act.

The PC Company claimed its total outstanding debt of $89,642.15.

Justice Priestly looked carefully at the creditors' balances outstanding over the months the company traded while insolvent and, taking into account Mr Sanderson's conduct ordered him to pay $35,000.

This case is a timely reminder of the need to consider a company's solvency and where necessary seek additional capital.

Company directors should also consider the implementation of a risk management programme to avoid the risk of personal liability including possible transfer of the risk by way of insurance.

Paul Robertson is an associate with insurance law practitioner Heaney & Co

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