Companies and Limited Partnerships Amendment Bill – Supplementary Order Paper

Companies and Limited Partnerships Amendment Bill – Supplementary Order Paper

Introduction

I have previously commented on the Companies and Limited Partnerships Amendment Bill (“Co & LP Amendment Bill”), to require companies to have either:

•  a director who lives in New Zealand; or

• a director who lives in and is a director of a company in an “enforcement country”.

At the same time, I noted the unfortunate path of the provisions in the Co & LP Amendment Bill affecting the criminalisation of the breach of certain directors’ duties.

The latest development in this unhappy tale is a Supplementary Order Paper (“SOP”) released on 5 June 2013 which contains a significant change to the Co & LP Amendment Bill relating to mechanism for this criminalisation proposal.

As an aside, ideally, Supplementary Order Papers introduced after a bill is reported back from Select Committee following public submissions should be a vehicle for minor or technical changes (such as improvements to drafting, consequential or consistency changes) – rather than a vehicle for introducing substantive changes.  Whilst this is not always possible, this is an important change that is proposed without Select Committee scrutiny or public consultation.  This is doubly concerning because the proposed changes are a bit of a pickle.

Criminalisation of breaches of certain directors’ duties

The SOP proposes to “develop” the earlier proposals in the Co & LP Amendment Bill to criminalise serious breaches of 2 duties of directors providing for offences in relation to serious breaches of:

•  the duty provided for in section 131 of the Companies Act (the duty of directors to act in good faith and in the best interests of the company); and

•  the duty provided for in section 135 of the Companies Act (the duty of directors not to agree to, or cause or allow, company business to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors).

Section 131 duty

The SOP proposes to change the offence created by the Co & LP Amendment Bill relating to the section 131 duty.  Now, the offence is to become one of exercising powers or performing duties as a director of a company (or omitting to exercise those powers or duties) in bad faith towards the company and in a manner that the director believes is not in the best interests of the company.  To be proven, there must also be knowledge or recklessness as to whether the conduct will cause the company serious loss or will benefit or advantage a person who is not the company (including, for example, the director).

The SOP provides defences to the revised offence relating to the section 131, based on the qualifications in section 131(2) to (4) of the Companies Act.  Specifically, to be able to rely on those defences, the director will need to prove he or she had the requisite authority for the relevant conduct, along with the belief that the conduct was in the best interests of that company’s holding company (in relation to subsidiaries) or shareholder or shareholders (in relation to joint ventures between shareholders), rather than in the best interests of the company.

The concept of bad faith appears to be used as a synonym for the absence of good faith – and the (primary) directors’ duty under section 131 is to act in good faith.

The second element of the offence, namely “believing the conduct is not in the best interests of the company” should not capture an honestly-held, but objectively wrong, belief by a director.  However, recent case law arising out of the finance company collapses would indicate that the New Zealand courts may find that there is a potential exception where the director’s belief is based on a wholly inappropriate appreciation of the interests of the company.

The introduction of the alternative recklessness requirement in the proof element of the offence reflects the drafting of the Financial Markets Conduct Bill, which adopts the “knowing or reckless” standard to most criminal offences in the FMC Bill.  Also, the proof element introduces the concept of “serious loss to the company” in place of a requirement that the director knew the breach of the section 131 duty would be “seriously detrimental to the interests of the company”.

As a result, it seems that this new offence (like previous proposals) will create liability for conduct that falls far below the threshold of the “most egregious breaches of directors’ duties” – which seems to be the policy driver for criminalisation.

One example I am aware of that highlights concerns about this proposal, is that it could be triggered where a director acted without bad faith or dishonesty, simply by protecting the company’s best interests in disputes involving one or more creditors.

Reckless trading

The SOP removes the previous attempts at lumping an offence on top of section 135.  Instead, the SOP amends the existing offence provision in section 380 of the Companies Act by creating a new offence where a director agrees to, or causes or allows, the business of the company to be carried on in a manner that causes serious loss to 1 or more of the company’s creditors and knows that serious loss will be suffered.

Note that:

•  a ‘serious loss’ is a loss of a kind that is more significant than a material loss; and

•  the offence is not committed if the creditors concerned consented to the business being carried on in that manner (on the basis that companies that are close to insolvency should be allowed to enter into arrangements with their creditors to save the company without the directors facing a risk of prosecution).

The explanatory notes to the SOP state that the requirements of the new offence are based on those of the [directors’] duty in section 135 not to agree to, or cause or allow, reckless trading.  However, the proposed new offence requires both:

•  actual serious loss to be suffered (rather than a substantial risk of such a loss); and

•  knowledge on the part of the director that such a loss will be suffered.

A director convicted of the new offence is liable to imprisonment for a term not exceeding 5 years or to a fine not exceeding $200,000.

The new wording of the offence differs from the section 135 duty – requiring the prosecution to overcome a much higher hurdle than was evident in the previous iterations of the new offence.

However, the safe harbour of creditor consent seems unworkable because:

•  criminal liability could arise where only a single creditor suffers a serious loss (even if the directors achieve a ‘work out’ for all other creditors); and

•  this provision would provide an even stronger incentive for directors to cease trading as soon as there is a likelihood that any creditor may suffer loss if the company continues to carry on business – which is the criticism of aspects of the Australian regime (that are under review in Australia and which I thought we were seeking not to follow).

As a result, it is likely that a number of interested parties will make strong representations not to implement this latest proposal – because it would create serious risks for company directors, even in the absence of bad faith or dishonesty.

Again, this seems to be a problem of inadequate problem definition and the unintended consequences that follow from a solution that still seems to be search of a problem.  This is not the hallmark of good law reform.

Further information

If you would like more information about the Co & LP Amendment Bill, please contact me.