Legal Updates

Supreme Court decision heightens risk of personal liability for directors

After a long gestation period, the Supreme Court has released its judgment in Debut Homes v Cooper [2020] NZSC 100 which clarifies the circumstances in which a director of a closely-held company will be personally liable for debts incurred by a company following a decision to continue trading when the company is in financial difficulty.

The facts

Debut Homes Limited (“Debut”) was a residential property developer run by its sole director, Mr Cooper. Throughout its trading history, Debut’s assets had been less than its liabilities (balance sheet insolvency) but it had always been supported by shareholder advances from Mr Cooper and his wife, along with the L & T Cooper Family Trust (“the Trust”). Debut had always been able to pay its debts as they fell due.  However, by late October 2012, due to cost overruns, Debut was facing the prospect of having to immediately cease its operations, leading what would have essentially been a fire sale of unfinished houses owned by Debut. Debut had two secured creditors and Mr Cooper had personally guaranteed these debts.

During November 2012, a watershed moment in Debut’s trading life occurred at a meeting between Mr Cooper and his accountant. On his accountant’s advice, Mr Cooper prepared forecasts for that meeting, including forecast expenditure to complete the remaining unfinished properties and estimated sale prices of these properties based on real estate agents’ advice. These forecasts showed a surplus of nearly $170,000 but no provision was made for interest costs or for the GST payable on the sales. The forecasts were designed to secure further funding from one of the secured creditors. Crucially, at the November meeting, Debut’s accountant told Mr Cooper that the GST deficit would be over $300,000.

The forecasts formed the basis of a decision by Mr Cooper (on Debut’s behalf) to continue trading to allow completion and sale of the unfinished houses, rather than immediately ceasing operations and selling them at whatever sale price was obtainable, or asking one of the secured creditors to do the same (the Court of Appeal later described this as Mr Cooper’s dilemma). This was on the basis that:

  • the proposed course of action would maximise returns to the two secured creditors;  and
  • given the complexity of the GST situation, IRD was not necessarily going to be worse off, and could be better off, after completion and sales of the unfinished houses.

An arrangement was also made with the Trust to provide working capital of $380,000 in exchange for a GSA over the assets of Debut securing repayment of that amount.

Debut was later placed into liquidation on the application of the Commissioner of Inland Revenue. The Commissioner sought to prove for unpaid GST on several property sales not paid from the proceeds of sale on settlement.

Debut’s liquidators brought a claim against Mr Cooper. The High Court found that Mr Cooper had breached his duties as a director of Debut under ss 131(1), 135(b) and 136 of the Companies Act 1993 (“the Act”) and made orders that:

  • Mr Cooper make a contribution towards the assets of Debut;
  • certain payments made by Debut to Mr Cooper be set aside as voidable transactions; and
  • setting aside the GSA held by the Trust.

Mr Cooper was successful in appealing the High Court decision to the Court of Appeal (aside from the voidable transactions order). The Supreme Court granted the liquidators’ leave to appeal the Court of Appeal judgment.

Supreme Court judgment

The Supreme Court has unanimously allowed the liquidators’ appeal and restored the orders made in the High Court. The reasons of the Court contain detailed analysis of ss 131, 135 and 136 of the Act, which are beyond the scope of this article to examine in detail.

As far as s 131 of the Act is concerned, the Court confirmed that the test for whether there had been a breach of the directors’ duty to act in good faith and in best interests of company is wholly subjective. However, there is an exception or qualification to this in circumstances where a company is in a position of doubtful solvency (as Debut was from November 2012). In those circumstances, a breach of s 131 will still be held to have occurred, notwithstanding a person in Mr Cooper’s position may have honestly believed that the decision to continue trading was in the company’s best interests.

The Supreme Court has also clarified that the duty in relation to obligations under s 136 of the Act is not confined to contractual obligations. The Court of Appeal had held that part of the reason why Mr Cooper was not liable under section 136 of the Act was because the obligations to pay GST on the sale of the properties owned by Debut had their origins in the original purchase of the properties years earlier, when there was no question about Debut’s solvency. The Supreme Court has held that the Court of Appeal’s approach was erroneous and that the relevant date for the purposes of this assessment is the date of settlement (which is regarded as the date of supply for the purposes of the Goods and Services Tax Act 1985), not the date of purchase.

The Court has made it clear that a company in a similar position to the one Debut found itself in at the beginning of November 2012, essentially has four available options (“Formal Mechanisms”) should the directors wish to continue trading:

  • a creditor compromise under Part 14 of the Act, approved following a vote at a creditors’ meeting carrying the support of 50% in number and 75% in value of the company’s creditors;
  • a creditor compromise, or scheme of arrangement approved by the High Court following an application made under Part 15 of the Act;
  • appointment of a voluntary administrator under Part 15A of the Act with a view to continued trading; or
  • having a secured creditor holding a power of appointment under a security agreement appoint a receiver under the Receiverships Act 1993.

Whilst the Court made it clear that it was not suggesting that informal procedures could not be used for dealing with an insolvency or near-insolvency situation, if they are to be used they ought to comply with the scheme of the Act and the salient features of the available Formal Mechanisms, such as ensuring all affected creditors are consulted and agree with the course of action proposed.

The Court set out its policy rationale for this approach as follows:

“The removal of decision-making powers from directors in such circumstances is a recognition that directors are not the appropriate decision-makers in times of insolvency or near-insolvency. This is because their decisions may be compromised by conflicting interests and, even where that is not the case, they may be too close to the company and its business to be able to take a realistic and impartial view of the company’s situation.”

I am a company director. How will the Supreme Court’s decision affect me?

In short, directors relying on favourable forecasts of a return to solvency and profitability which form the basis of a decision to trade on, do so at their own peril. A director will not avoid a later finding of breach of directors’ duties unless:

  • all creditors have formally agreed to the course of action; or
  • sufficient provision has been made for all existing and future debts arising from continued trading, including any GST.

Prior to the Supreme Court’s judgment those involved in the governance of closely-held companies (and their advisors) had operated on the basis that an informal mechanism to restructure the affairs of the company to maximise returns to the company’s secured creditors would be an entirely justifiable course of action if the company was not incurring new debt in order to do so, absent formal consultation with unsecured creditors. However, the Court’s judgment changes the playing field significantly.

The Court’s observations about use of the voluntary administration regime under Part 15A are interesting. In Debut’s case, voluntary administration under Part 15A of the Act would probably not have not been a viable alternative for Mr Cooper for a variety of reasons, including the fact that the Commissioner of Inland Revenue loses the statutory priority for GST and PAYE debt owed by the company that it receives in a liquidation (and so the Commissioner is unlikely to consent). The Court’s reasons note that a compromise proposal during 2013 had been rejected by the IRD. Appointment of a receiver would likely have led to the fire sale situation that Mr Cooper was desperately trying to avoid.

One other interesting aspect of the case is that the Court left open the question as to whether the same principles would apply in the case of a high risk/high reward business (which Debut’s wasn’t) or in circumstances where the company was facing temporary financial difficulties. The Court confirmed that they were dealing with a company where there was no possibility of salvage (although Mr Cooper had raised dispute about it, following the trial in the High Court it had been held that the $300,000 deficit to the IRD had in fact been discussed at the November 2012 meeting).


The Supreme Court’s judgment is a note of warning to all of those involved in the governance of companies or other bodies corporate which have reached the point of insolvency but nonetheless wish to trade on in any circumstances. A director or officer of the entity must step aside, or fully consult with all affected creditors and obtain agreement to proceed with a particular course of action, or make provision for all existing as well as future debt, lest they be found personally liable later for repayment of all of the unpaid debts of the relevant entity.

If you have any questions about the impacts of the Supreme Court’s decision or company and insolvency law in general, please get in touch with Jaesen, Jono or Dave.