Property developer breached director’s duties and the Fair Trading Act

Unsecured creditor successfully sued company director of a failed property development project for breaches of directors’ duties and of the Fair Trading Act.

Dempsey Wood Civil Ltd v Gapes [2021] NZHC 2362


Mr Gapes was an Auckland-based property developer. In 2013, through his company, Panama Road Development Ltd (PRDL), he started a new project called Springpark Development. Unfortunately, the project ran into problems and the mortgagee sold the development at a loss.

One of the unsecured creditors, Dempsey Wood, sued Mr Gapes in his capacity as a director of PRDL, alleging that he breached a number of his director’s duties under the Companies Act 1993, including reckless trading (s 135) and agreeing to PRDL incurring obligations when he did not have reasonable grounds to believe they could be met when due (s 136). 

Dempsey Wood also sued Mr Gapes pursuant to the Fair Trading Act 1986 alleging that it misled Mr Gapes when, in November 2015 (when Mr Gapes failed to secure ongoing finance for the project), Mr Gapes gave it an assurance that there were sufficient funds remaining in its credit facility to pay for work carried out after that time.

The facts

The Court considered the facts in detail. The project had finance through a credit facility secured overseas. But in 2015, it became clear that the project was going over budget and the development was no longer financially sustainable at the prices to which the houses were pre-sold in 2013. There was a Sunset Clause in the pre-sale agreements which gave each party (including the developer) the right to cancel the contract if the project was not completed by that date. Cancelling the contracts and re-selling the houses at the 2015 prices would have brought in a profit of around $7m and make the project financially viable. It was also likely to open the way for the project to be refinanced.

The developer’s credit facility expired on 15 September 2015, but the lender continued to allow money to be drawn from the credit facility while the developer was negotiating with an alternative lender. But the negotiations failed, and in the end, there was no refinance.  

Trading near insolvency not enough to trigger liability

The Court found that by 15 October 2015, PRDL was at least near insolvent. Despite that, the Court decided that it was still permissible for Mr Gapes to allow PRDL to continue to trade beyond that point. This was because the existing lender continued to allow monthly drawdowns.

Insolvency despite informal assurances

However, that changed by mid-November 2015. While the existing lender still allowed some funds to be drawn, the agreement was informal and there was no evidence of assurances given by the lender that it would continue to do so. The lender had already issued a notice under the Property Law Act and reserved its right to change its mind about the finance at any time. The developer’s efforts to find alternative finance failed. PRDL had no other means of funding the operations. The Court found that by allowing the company to trade in a “business as usual” mode was likely to give rise to a substantial risk of serious loss to the creditors, and that Mr Gapes breached s 135 of the Companies Act.

When creditors are paid in arrears

In his defence, Mr Gapes argued that given PRDL’s unsecured creditors were (largely) paid in arrears on a monthly basis, the losses actually incurred were simply the manifestation of the risk inherent in contracting with a limited liability company on this basis. The Court rejected that argument. While there was a risk in effectively providing “credit” for around a month to a limited liability company, that inherent risk was premised on the company’s directors fulfilling their statutory duties. A director had a duty not to permit the company to trade in a manner likely to give rise to a substantial risk of serious loss.

What is the relevant period for “agreeing” to a company incurring an obligation?

Another argument was about the relevant period in which the director’s knowledge was to be assessed. When the developer first engaged Dempsey Wood (the year prior), the company was well placed financially and was able to meet its obligations. Mr Gapes argued that the time of the original contract was the relevant period in which his obligations should be assessed. The Court rejected that argument saying that the circumstances existing at the time of entry into the contract might bear no resemblance to the circumstances existing when work is requested, carried out, invoiced and paid for, which could be many years after contract formation. At the time the work is requested or carried out, the director will know from the contractual framework when the obligation to pay for that work will fall due. That is the point at which the director’s knowledge is to be assessed.

What is the appropriate relief?

The Court considered whether the appropriate relief should be based on the net deficiency approach or the new debt approach; it decided on the former. This required an apportionment of the cost sought by Dempsey Wood with effect from mid-November 2015.

In addition, the Court decided to apply a discount to the claim because the period of breach was extremely short (just under three weeks), the culpability was low, and it was not a case where it was obvious that a company had been hopelessly insolvent for some time. In addition, the unpaid amounts to unsecured creditors largely related to work carried out in the last month of the development. In the end, the Court reduced the amount by a third, to $100,000.

The Court raised the question of whether the award resulting from the breach of director’s duties should be paid to Dempsey Wood or to the liquidators. If paid to the liquidators, Dempsey Wood would not receive any money because it was an unsecured creditor. No doubt, this was a terrifying prospect for Dempsey Wood, who incurred the cost of litigation. The Court allowed the parties to make further submissions on this issue.

Fair Trading Act

The Court also found that Mr Gapes mislead Dempsey Wood in giving assurances that there was sufficient money in the credit facility to meet the ongoing costs. That was in breach of the Fair Trading Act. The Court ordered that Mr Gapes pay Dempsey Wood just over $280,000 for this breach.

The Court asked for further submissions from the parties on the interaction of the award under the Companies Act and the award made pursuant to the Fair Trading Act. This issue was unresolved at the time of the judgment.