Why don’t Liquidators sue the Directors?
There is a common misconception among unsecured creditors of companies in liquidation that all that is required to recover the situation is for the liquidators to sue the directors. Many are aware that reckless trading provides grounds for action by liquidators against directors. However they are often less clear on what reckless trading involves.
In practice, it is no longer simply a case of proving that a company has continued trading while insolvent.
That option doesn’t exist under the Companies Act 1993. What is now required is for the liquidators to prove in terms of section 301 of that Act that the director:
Agreed to or caused or allowed the business of the company
to be carried on in a manner likely to create a substantial risk
of serious loss to the company’s creditors
Proof of such actions is not straight forward. The director is permitted by the Courts to try to demonstrate that his actions were a reasonable attempt to earn profits for the company, bearing in mind that all business involves the balancing of risk and reward.
The Court and legal costs for liquidators taking such an action can easily reach $100,000. If the liquidators lose, they will be required in addition, to pay the Court ordered costs of the defendant.
In many liquidations, there are significantly less funds than required to mount such an action. Creditors when approached are usually less than enthusiastic about providing funding for Court action. In our experience, litigation funders are also unlikely to come to the party, unless there is a substantial claim and evidence that the defendant has adequate assets or insurance cover.
Creditors normally ask whether the police will be advised of the directors actions. Where there is clear evidence of illegality, we always advise the appropriate authorities. Indeed, a liquidator has the obligation to do just that. However, even if the police do decide that prosecution is warranted, there is usually no provision for any recovery to be ordered for the benefit of creditors.
A successful action by the Serious Fraud Office is more likely to generate grounds for a claim by creditors. However, the SFO is particular about the cases it takes. Its base requirement is that there is a general public interest in the matter. A recent case involving a finance company liquidation may help demonstrate.
As liquidators we had been successful in gaining judgment against the wife of a director in respect $505,000 paid to her out of the company without any apparent justification. Before we could collect this, the defendant declared herself bankrupt. The directors also declared themselves bankrupt.
On the release of the directors from bankruptcy, we drew to the attention of the SFO the $3.9 million of funds which had, in addition, been paid out to the directors, their wives or companies associated with them. Although no formal determination has yet been advised, it appears that since no debenture trust deed was involved, the SFO believes the matter will not pass its threshold for public interest.
Justice in New Zealand’s user pays environment is often beyond the reach of liquidators. However, section 301 of the Companies Act provides an opportunity, not just for liquidators but, for creditors to take action to recoup their losses to a company in liquidation. Where a director has misapplied money, been guilty of negligence, default of duty or trust, the Court may, on the application of a creditor, order the director to repay money or property or such compensation as it thinks just to that creditor.
We hope to see in the future, more creditors considering the possibility of director actions against directors under section 301. The proof in such cases should usually be much more straightforward than that required for reckless trading.