Timothy Bates and Bodene Robertson-Wright of Auckland law firm TM Bates & Co review a recent case regarding liability, construction contracts and possible reckless trading.
In this article, we review the High Court decision of Watts & Hughes Construction Ltd v Biala [2020] NZHC 3041, in which the construction company sued the director of the company in liquidation for reckless trading and sought compensation for $39,629.
Watts & Hughes claimed that Mr Biala carried on the company’s business recklessly, and without making appropriate provision for construction costs.
Background
Mr Biala operated a successful restaurant business for a decade but, as a result of the Christchurch earthquakes of 2010 and 2011, the premises of the restaurant were destroyed.
Following an inoperative period of almost two years, the restaurant relocated. Subsequently, an opportunity arose to expand the restaurant, and the company acquired newly-built premises for the restaurant that required a fit-out.
Biala sought professional advice in relation to budgets, and agreed to lease the new premises from August 2014 for a term of eight years.
Architects were employed to design the fit-out, with an emphasis being placed on completion within the budget and time frame.
Watts & Hughes was successful in the construction tender process, with a price of $124,000 and completion date of September 20, 2014.
The completion date was pushed out to mid-October, but the fit-out was not completed until November/December.
Following a dispute over the final payment owed to Watts & Hughes, the company maintained an agreement was entered into whereby Mr Biala was to pay, initially, $39,829.88, followed by a payment of $12,908.19. The existence of this agreement was denied by Mr Biala.
In May 2015, Watts & Hughes served a statutory demand on Mr Biala’s company for the amount of $39,629, and the company was subsequently placed in liquidation with the amount outstanding.
Reckless trading
In these proceedings Watts & Hughes claimed Mr Biala operated the company recklessly under s 135 of the (NZ) Companies Act 1993 by not making provision for the final costs of the fit-out of the new premises, and sought compensation under s 301 for the amount outstanding.
Justice Cull summarised the position and approach to s 135, including the recent Supreme Court decision of Debut Homes Ltd v Cooper as having a high threshold:
• The way in which business of the company is undertaken must be “likely” to give rise to a “substantial” risk of “serious” loss to the company’s creditors;
• That the “substantial risk of serious” loss includes a consideration of orthodox commercial practices;
• If a company is not salvageable and continues trading which results in a shortfall to credits, such trading will constitute a breach of s 135; and
• That s 135 is forward looking to future losses.
The court held that, as the authorities emphasise, the test is an objective one, which focuses not on the objective belief, but how the company’s business is carried out, and whether that creates a substantial risk of serious loss.
The question for the court was whether Mr Biala took a sober assessment of the company’s likely future income stream, and whether there were reasonable assumptions underpinning his forecast of future liquidity.
Conclusion
There was ultimately a finding that Mr Biala did not carry on the company’s business in a reckless manner because the decision to engage Watts & Hughes was considered as a planned and calculated risk made from Mr Biala’s years of restaurant business experience.
Justice Cull found that Mr Biala’s decisions did not depart from orthodox business practice, and did not involve such extensive and unusual risk to creditors as to meet the high threshold required by s 135.
The context of this case that was considered in coming to this conclusion included the experience Mr Biala had in the restaurant business in Christchurch, the commitment the company made with the eight-year lease to a long-term operation of the business, the fact that Mr Biala sought professional advice on budgets and the architectural design, and established the intention to have the budget and schedule tightly controlled, and had a specified tender price.
The court found that there was no breach of
s 135, and no order for compensation was appropriate because Watts & Hughes’ loss was both uncertain and not serious.
The court held that the agreement relied upon by Watts & Hughes was not made out, and it was not clear how the amounts sought were calculated.
This case shows that establishing a breach of
s 135 of the Companies Act 1993 and then obtaining compensation against a director pursuant to s 301 of the Act is not simply a formality where a company goes into liquidation owing monies to creditors.
A planned, informed and calculated risk in business would not fall into the definition of “reckless trading”.
Note: This article is not intended to be legal advice (nor a substitute for legal advice). No responsibility or liability is accepted by TM Bates & Co or Building Today to anyone who relies on the information in this article.
