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Taxation, Trustee liability, Trusts

Details, devils and directors

The devil is in the detail.  Sometimes, so is the GST.  Prior to compulsory zero rating of land transactions it was common to use the GST-refund to fund the deposit.   However, in the event the sale did not go ahead, the GST needed to be re-paid.  So if the deposit was forfeited then, well, that would be a bit bad.  But if a company has been incorporated to make the purchase, and it doesn’t have any assets, well no harm no foul.  Or not.  What if Inland Revenue is a bit riled up, and the liquidator looks a bit more closely at the transaction and pursues not just the directors but the trustees who were the original party to the agreement for sale and purchase?  What if?

Obviously I am going somewhere with this. 

Consider the essential facts:

  • two of three trustees enter into an agreement for sale and purchase of farm on behalf of two mirror trusts, wrongly named as a single trust with a different name [seriously this happens all the time, really]
  • the mirror trusts borrow the deposit
  • agreement is unconditional
  • 5% deposit is paid
  • the “ultimate” purchaser was incorporated
  • vendor issues a GST invoice to the company
  • GST refund claimed by the company
  • refund paid
  • further 5% deposit paid
  • deed of novation executed by all three trustees of the mirror trusts (but not the vendor)
  • GFC occurs
  • settlement does not occur
  • the mirror trusts make a further payment to the vendors in settlement of the matter
  • settlement with Inland Revenue (IR) fails – $17,500 was offered against the $737,500 GST refund that is due for repayment
  • company is liquidated by IR

The liquidators then pursue the directors for trading recklessly, amongst other things for being party to the purchase despite having no capital.

The liquidators also rely on the Property Law Act, s 348 and the Companies Act s 292,297 and 298 claiming a transaction at an undervalue as the company paid the deposit for the purchase of the farm despite not being obliged to do so.

The first matter to be determind was who purchased the farm?  The company did not.  The liquidators argued the mirror trusts did.  The defendants say – can’t have been the name on the agreement was wrong and all the trustees did not sign.  The court found that the matter was determined by intention and although the mirror trusts’ names were not correctly identified – there were no other trusts, and the mirror trusts were the intended purchaser at the time.  The incomplete novation, signed by all trustees ratified the agreement.

The third trustee exits about now.  Although equally liable he has and indemnity from the mirror trusts that stands unless his passive stance and ill considered decisions reflect a breach of trust.  However, as none was claimed (as noted by the court, perhaps pointedly) that ends that.

Reckless trading

By paying the deposit, did the company’s director’s know there was a substantial risk of serious loss to the company?

Taking all matters into consideration – objectively there was no reasonable basis to belive the company could repay the GST refund.

The directors failed to act in the best interests of the company by using the GST refund to repay the advance from the mirror trusts and thus exposing the company to a liability it could not meet.

So far so bad.  But was it bad enough for the directors to be personally liable for the breach of the directors’ duties requiring the payment of reparation or compensation?  As the court put it, “[t]he real issue here is the culpability of the director’s conduct.”

To quote the judge, the  “[directors] were unrealistically optimistic and extremely naive in their approach to the purchase.  I agree they actively blinded themselves to the economic storm clouds gathering around the transaction … [they showed] no regard at all for the wellbeing of [the company].  They simply trudged forward, come what may, trusting the shelter that [the company] could provide them, and willing to sacrifice the company if rquired to protect their interests.”

While the directors were not culpable for the fall out of the GFC, they were for paying the GST back to the mirror trusts.  Here they were found to prefer their own interests over IR and the company, “that is the essence of their culpability here.”  For this they were liable for 70% of the loss pursuant to s 301 of the Companies Act.

From bad to worse

The company should never have been paid the GST as the requirements of the GST Act were not met – see the time of supply rules.  Although this is in part academic – even if not entitled to the GST, the company had an obligation to repay it one way or another.  Instead it was paid for no legal reason, to the mirror trusts.  Accordingly, the transaction was at an undervalue and the $720,000 paid to the mirror trusts could be clawed back by the liquidators pursuant to s 297 of the Companies Act (insolvent transactions).  A claim in restitution was also made out.

So at the end of the day, the trustees were ordered to repy the full amount of the deposit, plus interest and costs.

It is a sorry story that shows how a trust can be compromised from an unexpected quarter.  The transaction could have been structured so that the result was not like this.  Moving forward CZR practically prevents such financing options in many cases. 

Regardless, the message is in the detail.  The case is lengthy running to over 50 pages.  It is worth the read for anyone interested in the area as it contains a wealth of useful analysis that is only para-phrased here.  It is important to focus on the facts – becuase once these are  clear, the decision here stacks up.

References:

Rowmata Holdings Limited (in Liquidation) v Hildred, Hildred and Cole [2013] NZHC 2435

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