In the case of small or closely held companies it is not uncommon to see people treating “their” companies as merely an extension of themselves. After all, if they are the sole director and sole shareholder, who else do they have to answer to? A recent decision of New Zealand’s highest court, the Supreme Court, cast the spotlight on the duties owed by directors to their companies. Directors need to leave their personal interests to one side and focus on what is in the best interests of the company.

 

The case involved Auckland property developer Mr M, a director of Morning Star (St Lukes Garden Apartments) Limited (MS St Lukes) and Morning Star Enterprises Limited (MSE). 

 

MS St Lukes was involved in a commercial and residential development which encountered unexpected delays and set backs spanning several years. Ultimately MS St Lukes was placed into liquidation by its creditors, owing more than $15,000,000.

 

MSE was also struggling financially as a result of another unsuccessful property development. Mr M had an overdrawn current account with MSE which he paid down by selling his shares in MS St Lukes to MSE for $3,500,000 thereby reducing the debt he owed to MSE. MSE failed within a year and the shares in MS St Lukes were sold by MSE for $1.

 

In selling his shares in MS St Lukes to MSE for $3,500,000, Mr M was found to have breached several director’s duties under the Companies Act. The case against Mr M was brought by the liquidators of MSE and focussed on the appropriateness of the sale of Mr M’s shares in MS St Lukes to MSE. 

 

Mr M acknowledged that his shares in MS St Lukes had no value on the open market in 2007, but claimed that the value of $3,500,000 to MSE was justified by his continued involvement in the project and the return it was expected to yield. However, no independent expert valuation of fair market value was obtained prior to the sale of the shares to MSE.

 

In the High Court, the Judge found that Mr M had failed in this duty to act in good faith and in the best interests of MSE by putting his own interests in satisfying his current account ahead of the interests of MSE. The purchase of the shares involved an unacceptable level of risk that could not be justified. In the Judge’s words “it involved the company surrendering a valuable asset [the debt owed by Mr M] in exchange for shares in a stalled property development… The risk of serious loss to creditors was palpable”. The High Court concluded that Mr M’s actions fell well short of the standard to be expected of a reasonable director, with the most “egregious omission” being Mr M’s failure to obtain an independent share valuation prior to the purchase of the MS St Lukes shares by MSE.

 

Mr M was ordered to pay MSE $3,499,999 which was the difference between the amount MSE paid for the shares and the amount MSE eventually sold the shares for. The Supreme Court upheld the award of this amount, noting that after creditors were paid, and liquidator costs recovered, any surplus in the liquidation would be returned to Mr M.

 

Mr M’s case serves as a reminder to all company directors that you do not need to be a director of a large or publicly listed company for the rules to apply to you. Directors of large and small companies should be constantly mindful of the legal duties that their role of director entails.