Directors liable to contribute to their companies' tax debts but IRD delay can reduce contribution

MJ Pidgeon Builder Limited (in liquidation) v Pidgeon [2016] NZHC 1566

Kiwi Best Realty Limited (in liquidation) v Kashkari [2016] NZHC 2738.

Two recent cases have highlighted that company directors can be liable for their company’s tax debts where they have breached their statutory duties. A liquidator, creditor or shareholder may apply to the Court for an order that a past or present director repay money or return property to a company (section 301 of the Companies Act 1993 (“CA 1993”)). The intention of the provision is to reimburse the company for money or property that has been misapplied or misappropriated by directors and others.

There are two circumstances where section 301 might apply to a director: firstly where the director owes a specific item of money or property to the company and secondly, where the director has breached duties owed to the company and caused loss to it. For section 301 to be engaged on the basis of a breach of duty by a director, it must first be shown that the director has actually breached their statutory duties to the company.

In two recent unrelated cases the High Court has found that a breach of statutory duties by a director led to the company being unable to pay its debts and ordered the directors to make repayment of the sums owed). In both cases the major creditor was the Commissioner of Inland Revenue. In Pidgeon the amount owed to the Commissioner at the time that it was placed in liquidation (on application of the Commissioner) was $198,446. In Kashkari it was $620,210.

The Court had little difficulty concluding that the directors had breached their duties. In both cases the period of non-compliance had been lengthy – approximately 4 years – and the levels of indebtedness high. The extent of the breaches is set out below.

  • Both director allowed their companies to continue trading and to incur accumulating debt for several years after they had become insolvent. The directors they knew of the rising debts to Inland Revenue yet they continued to allow their companies to trade in breach of their duty to act in good faith and in the best interests of the company (section 131 of the CA 1993).
  • By causing the business of the companies to be carried on in the face of mounting tax bills, the directors created a substantial risk of serious loss to the creditors generally and to Inland Revenue in particular and so were in breach of their obligation to avoid reckless trading (section 135 of the CA Act 1993).
  • From the date the companies became insolvent or shortly thereafter, there were no reasonable grounds for the directors to believe their companies would be able to meet further ongoing tax liabilities by continuing to trade. The existing and overdue debts represented an insurmountable obstacle to the companies’ ability to meet ongoing obligations to Inland Revenue. Both directors therefore also breached their obligations under section 136 of the CA Act 1993.

The issue in both cases then became how calculate the directors’ contribution to compensation. It was common ground that general principles to be applied when assessing the contribution from a director under section 301 are:
  • Ascertain the amount of deterioration in the company’s financial position between the “breach” date and the liquidation;
  • Consider causation, culpability and duration of trading; and
  • Take a  broad-brush approach to the amount because the jurisdiction to order recompense is essentially equitable in nature.
The Court in Pidgeon, in considering the timing of the “breach”, allowed a grace period of five months after the company was probably insolvent. It noted that where a breach of duty is involved the operative date of the breach, for the purposes of calculating contribution under section 301, is not necessarily the date a company was probably insolvent, but is the date on which it was no longer reasonable for a director to consider the company could trade its way out of its financial predicament. In Pidgeon the Court accepted that, based on financial records and evidence, the company was probably insolvent by October 2011, and that its dire financial situation was probably irreversible by April 2012. In the light of this finding it considered that the director was liable for the loss incurred by the company from April 2012 onwards, limiting the director’s liability by $32,785.

In Kashkari the Court considered that Inland Revenue’s delay was a relevant factor in determining what was a just amount to order the director pay. In that case there was a 2 year delay in making default assessments and petitioning to liquidate the company. Noting that in October 2012 Inland Revenue had written to the company in what it styled a “Final Notice”, the Court regarded it as inexplicable why, in the face of serial failure to provide returns, Inland Revenue waited a further 2 years to make default assessments and wind up the company. The Court thought it just to deduct 25% (or approximately $155,052) from the debts incurred to Inland Revenue to reflect the delay.

It is not uncommon for Inland Revenue to allow months or even years of non-compliance pass without much more than standard warnings being issued to a defaulting company. In cases where compensation is subsequently sought from a director, it seems appropriate that an acknowledgement be made of the Commissioners’ own contribution to her loss – after all, liquidation proceedings may well have been available to her for quite some time.

It is possible that the argument made in Kashkari could also have been made with success in Pidgeon, but unfortunately no appearance was made by or on behalf of the director at the hearing of the case.

© G D Clews, 2017

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