In my earlier article in June 2007 I examined recent decisions at adjudications in the Weathertight Homes Resolution Service and in the High Court involving the potential liability of directors of development companies in the leaky building context.
Some of the decisions in the WHRS had resulted in confusion as to when a director might be held liable, but, generally, unless there was evidence of control by a director in an area causative of defects, directors would escape personal liability. I suggested that this could be easier where directors had established an appropriate contractual structure for a development to ensure that the work would be completed according to appropriate standards. Such a structure might include the engagement by the developer of an architect, or a project manager, to supervise construction.
What had also been unclear in the leaky building context is the extent to which a director of a development company can be held liable where he/she does not actually carry out any building works, but exercises control over the way in which the building works are carried out. The extent of the control necessary to find liability was unclear in the leaky building context because the only decision of the High Court (Dicks v Hobson Swan Construction Limited (in liquidation) (HC Auckland, CIV-2004-404-1065, 22 December 2006, Baragwanath J), had involved a builder being personally liable, where his company was insolvent, because he had actually built the house.
The recent decision of Harrison J in Body Corporate 188273 & Anor v Leuschke Group Architects Limited & Ors (HC Auckland, CIV2004-404-2003, 28 September 2007) (“Leuschke”) (PDF) confirms that evidence of control in an area which resulted in defects is necessary to establish liability against a director. It also confirms that where there is an appropriate contractual structure in place, it will be very hard to prove such control: a fortiori, causative negligence. In this decision, the director escaped liability because there was no evidence that he had exercised control in any area resulting in defects, largely because he had employed others to ensure that the works were constructed appropriately.
Harrison J had no hesitation in applying the law in accordance with established legal principles. For a director to be personally liable, he/she must have assumed responsibility for a particular task and been negligent in an area which has resulted in the creation of defects. In practice, these two requirements will often be high hurdles for home owners to surmount, as they will often have limited access to evidence of what role a director took during construction of their house.
The case came before the High Court as a result of an attempt by Auckland City Council (“Council”) to share the burden of liability in respect of a leaky complex with other potentially liable (and importantly, solvent) parties. The owners of a unit title development in Rendall Terrace, Newton, sued Council and four other parties, including the architect, Leuschke Group Architects Limited, and Colin Leuschke (a director of the architect) and Mark Cooper. The latter two were the directors of a now insolvent company, formed by them as a joint venture to develop the units. On the eve of trial, Council settled the plaintiffs’ claim for remedial costs of $1.8 million, by payment of $1.4 million, including a contribution of $100,010 by Mr Leuschke. As a term of the settlement, the owners assigned their rights against Mr Cooper to Council.
Harrison J identified succinctly why the Council had chosen this course of action:
[17] A finding of negligence at trial would have exposed Council to liability for the full amount of the owners’ claims plus substantial costs. While its culpability relative to other joint tortfeasors such as the architect, builder and developer may have been low, this factor would not have protected the local authority from a judgment for $1.9m. Apart from Mr Cooper, Council was effectively the only solvent defendant. It is a victim of the rigour of the principle which imposes liability for all proven losses on a defendant whose responsibility might be as low as 10% when measured against the wrongdoing of other defendants, against whom its only remedy is to seek to recover a contribution on a cross-claim.
[18] Council was in an invidious position; it had no choice but to attempt to settle the owners’ claim for the lowest possible amount, and then pursue any other solvent tortfeasors. Ms Murphy abandoned her original argument that Council acted unreasonably in agreeing to pay the owners $1.4m. Without doubt, settlement at this figure was in Council’s best interests, given the inevitability of an adverse judgment at trial for $1.9m plus costs.
Council sought to recover from Mr Cooper, first, by way of a contribution as a concurrent tortfeasor towards the settlement sum, and second, the balance of the owners’ claim of about $500,000.
Council ran the case against Mr Cooper on two alternative bases. First, it alleged that Mr Cooper was either the developer, or a developer, of the property. Second, more critically to the issue of directors’ liability, it alleged that he had assumed personal responsibility to the owners, as a director of the development company.
Factual Background
Mr Leuschke through his company Bouffant Holdings Limited entered into a contract to purchase two sites in Rendall Terrace. He entered into a joint venture with Mr Cooper through a limited liability company formed for that purpose (Colmark Developments Limited (“Colmark”)). Bouffant Holdings Limited applied for resource consent; Colmark purchased the property; became the registered owner; and applied for and was granted a building consent for the development.
Colmark engaged MacRennie Construction to construct the apartments. Mr Leuschke’s company Leuschke Group Architects Limited provided architectural services to Colmark for the development. MacRennie issued a producer statement certifying that the building works were carried out in accordance with the plans and specifications in the building consent. Colmark deposited a unit plan under the Unit Titles Act 1972, a Body Corporate was created and titles issued for the 18 units.
The architect and the builder issued certificates of practical completion and Council issued a Code Compliance Certificate. Colmark then handled the sale of all 18 units. It was wound up in April 2000, and the builder was placed in liquidation in 2006.
Role of Colmark and Mr Cooper
The claim against Mr Cooper alleging that he was personally the developer, or a developer, was based principally on the written joint venture agreement with Mr Leuschke. The agreement provided, amongst other things, for the formation of Colmark, jointly owned by Mr Leuschke, and Mr Cooper’s interests, to develop the project. It also set out that costs were to be shared equally, and that Mr Cooper would, at no cost to the development company, oversee and manage the development generally, oversee and monitor the construction process, and oversee sales and settlement of the units on completion.
Council relied on the joint venture agreement to argue that Colmark was simply a vehicle used by the directors to isolate themselves from personal liability and that they personally were the actual developers owing non-delegable duties to ensure that works were carried out with proper skill and care.
Harrison J reviewed the relevant authorities in relation to the liability of a developer, principally Body Corporate 187820 v Auckland City Council (2005) 6 NZCPR 536, Associate Judge Doogue (known as the "Trimac" case), and Mt Albert Borough Council v Johnson [1979] 2 NZLR 234 (CA). He said:
[31] The word ‘developer’ is not a term of art or a label of ready identification like a local authority, builder, architect or engineer, whose functions are well understood and settled within the hierarchy of involvement. It is a loose description, applied to the legal entity which by virtue of its ownership of the property and control of the consent, design, construction, approval and marketing process qualifies for the imposition of liability in appropriate circumstances.
[32] The developer, and I accept there can be more than one, is the party sitting at the centre of and directing the project, invariably for its own financial benefit. It is the entity which decides on and engages the builder and any professional advisors. It is responsible for the implementation and completion of the development process. It has the power to make all important decisions. Policy demands that the developer owes actionable duties to owners of the buildings it develops.
Harrison J referred to the joint venture agreement and held that Messrs Cooper and Leuschke had intended to form Colmark to carry out the development; that Mr Cooper had in the joint venture agreement agreed only to participate through his shareholding in the company and carry out certain tasks in relation to the development; that he had no control over the project or its process; and he had no property ownership rights in or related to the proposed development. Harrison J held that any obligations he owed were owed solely to and enforceable by Mr Leuschke, the other contracting party (para 36).
His Honour said that Council’s submission could only succeed if it established that Colmark was no more than a sham, which it did not do.
His Honour held that:
[38] Messrs Cooper and Leuschke were entitled to form Colmark to undertake the Rendall Terrace development. Its defining characteristic was its legal personality separate from its shareholders. Its legitimacy is not diminished by virtue of its intended function of isolating or protecting Messers Leuschke and Cooper from personal liability. That intention is not to be confused with the separate question of whether or not, when performing duties as a director or employee, a shareholder assumes a direct personal responsibility to third parties, to which I will come later.
[39] I am satisfied that, upon its incorporation, Colmark became the entity which assumed legal responsibility for and controlled all aspects of the development. As Ms Murphy points out, Colmark settled the purchase of the property (taking over Mr Leuschke’s personal obligations) and became registered proprietor; obtained resource consent in its name; applied for and obtained the building consent; carried out the tender process, contracted with MacRennie to build the apartments, and paid the company for its contractual services; borrowed monies from Westpac to fund the development; deposited the title plan; and completed the sale of all 18 units. Colmark was the developer of the Rendall Terrace project.
Council next submitted that Mr Cooper was a developer in his personal capacity, as well as Colmark. The Court considered the matters referred to in support of this submission by Council under three categories: the joint venture agreement/construction process, financial control, and the allegation that Mr Cooper was in the business of developing houses for other people for profit.
Joint Venture agreement / Building process
Council submitted that Mr Cooper entered into an obligation pursuant to the joint venture agreement to “…manage the development generally and oversee and monitor the construction and sales and settlement process.” It submitted that he “…assumed actual responsibility for constructing and monitoring the onsite work and progress of the development through his employees or those under his control…“, and that he personally engaged the builder.
The weight of evidence persuaded Harrison J that the contrary was the case. Despite his agreement to carry out these services, Mr Cooper did not in fact carry them out. Colmark engaged Lastel Construction Limited (a company of which he or his interests was the sole shareholder) to project manage the construction. The builder was obliged pursuant to its contract to oversee and monitor construction. Lastel and Colmark were responsible for the sales and settlement process.
He also found that Mr Cooper did not engage the builder personally: the contract was entered into between Colmark and the builder.
Critically, Harrison J found that Mr Cooper never went to the site during development. He gave no directions relating to the design and construction process. An employee of the project manager attended, but was only there in his capacity as a quantity surveyor to oversee the financial administration of the project for Colmark, not to monitor nor control quality issues.
Financial Management
The Council then submitted that Mr Cooper and Mr Leuschke had control over the development because no payments could be made without them signing cheques; Mr Cooper was obliged under the joint venture agreement to finance the development if Colmark could not; and Mr Cooper and Mr Leuschke were the only directors of Colmark.
Harrison J rejected these 3 submissions. He said that in signing cheques Messrs Cooper and Leuschke were acting in accordance with directions given in another capacity and “…were not exercising any new or separate degree of control by that act…” (para 45).
Mr Cooper’s agreement to personally provide funds did not make him the developer. Such an obligation was in the view of Harrison J “…frequently assumed by a shareholder, and does not operate to change or elevate his legal status.” (para 45(2))
The fact that Messers Cooper and Leuschke were sole directors did not mean that they controlled the development. Harrison J noted that Colmark owned and controlled the development but could only act through the agency of its two directors who owed duties to the company. In Harrison J’s view this proposition “…equates and confuses agency control through the office of director with personal control of the principal’s operations simply by virtue of that agency.” (para 45(3)).
Profit Share
Council submitted that Mr Cooper was personally the developer because: he built houses for profit, and in respect of this development, he was entitled under the joint venture agreement to receive a half share of the profits of the company as a shareholder’s salary; he, rather than Colmark, would profit, and nor would Colmark pay any tax; he intended to wind Colmark up at the end of the development; he provided a guarantee for the finance to complete the development; he took half the profits; and he sold the units.
Harrison J said that these submissions were “... largely undisputed but they do not advance counsel’s case” (para 47). He noted that Mr Cooper did not personally invest in the project at all other than as a shareholder and that any receipt of profits in that capacity was neutral. So was the guarantee by the shareholders for the “…substantial borrowings of their minimally capitalised company…” (para 48).
Accordingly Council failed in its burden of proving that Mr Cooper was personally the developer such as would give rise to personal duties of care. This was, perhaps a predictable outcome, given the facts of the case.
Assumption of responsibility
Of more significance is Council’s attempt to use accepted authority to allege that Mr Cooper owed a personal responsibility to the owners by virtue of control of the project. In support of this submission, Council referred to various tasks carried out by Mr Cooper which were “…integral to completion of the development…” (para 51).
His Honour began by commenting:
[52] The ground in this jurisprudential area has been furrowed many times before. The starting point is that a director of a corporate entity may assume a personal responsibly to third parties for his acts or omissions while performing that office. That is because an individual who commits all the elements of a tort or other cause of action will be held directly liable for the consequences, whether solely or concurrently with his principal according to the rule of attribution and irrespective of whether or not he was acting as a director or pursuant to any other agency. The status of director does not carry any special immunities from personal liability. (emphasis added)
Council’s submitted that Mr Cooper assumed a personal responsibility to the owners by virtue of his total control over the project as a director of Colmark (Trevor Ivory Limited v Anderson [1992] 2 NZLR 517 ("Trevor Ivory") and Morton v Douglas Homes Limited [1984] 2 NZLR 548 ("Morton")).
His Honour noted that the issue of assumption of responsibility is part of the enquiry into proximity, being the first step of the two-stage enquiry to determine the existence of a duty of care in a claim of negligence. He then went on to identify that what was critical in the examination of assumption of responsibility was the level of control exercised by a director over a particular operation or activity (Trevor Ivory).
On this issue of control, he referred to the longstanding authority of Morton as being the landmark judgment in building cases. In particular he noted the requirement of Hardie Boys J that a director’s acts or omissions must be directly linked to the defects or damage. It was not enough to find individual control of the company of a development in a general sense: per Hardie Boys J at pp. 593-600. Control of the development is not enough to found liability in the absence of evidence of an assumption by the director of personal responsibility for defective work.
His Honour held that the basis upon which Hardie Boys J found liability in Morton was “…of particular significance to this case…” (para 58). The directors in Morton v Douglas Homes Ltd were held liable specifically because one director (the father) failed to “…adopt and implement advice from the engineer to overcome possible problems with the pilings. The father’s express knowledge of the problem, and his omission to rectify it, was the source of liability.” (para 59)
The other director, the son, was held to have owed a duty because he sought an engineer’s assistance, but then did not ensure that assistance was obtained and utilised.
Harrison J referred to the earlier decision of Speight J in Callahan v Robert Ronayne Limited (Auckland Registry, A1112/76, 17 September 1979), where Speight J upheld this approach in declining liability because “…there was no evidence of individual participation in the project by one or more in the work leading to the defects.” (para 61)
By contrast, Harrison J referred to the decision of Stevens J in Hartley v Balemi HC Auckland, CIV2006-404-2589, 29 March 2007. Stevens J refused an appeal against the finding of an adjudicator in the WHRS that “The director performed so many functions that to the casual observer he appeared to be the builder of the house.” The adjudicator found the director personally involved in many daily decisions causing the creation of defects (in particular, receiving but ignoring advice from a plasterer that the sill detail on external windows and doors was inadequate and instructing him to carry out work in a way which caused leaks).
Harrison J contrasted that decision with that of Associate Judge Faire in Drillen v Tubberty (2005) 6 NZCPR 470, where the uncontested evidence on a defended application for summary of judgment by the defendant director was that he did not participate in the building process, and was not involved in any areas of construction which subsequently were found to be defective. Harrison J commented that the Council simply identified every task carried out by Mr Cooper on the development without any attempt to link them with the creation of defects in the units.
Council recounted the functions apparently performed by Mr Cooper in connection with the development. The Court looked first at the work which was preparatory to the development, including budgeting and predevelopment activities. Harrison J found that these were not only carried out on behalf of the company, but they were unrelated to the actual building process or any construction defects.
Next it considered the work relating to the actual development, including appointing contractors and involvement in marketing. Here Harrison J found that there was no evidence of Mr Cooper’s involvement in the actual building process “…let alone any knowledge of the defects and design or construction leading to the damage” (para 68). He pointed to the architect’s and builder’s obligations to perform their services in accordance with their contract with Colmark. Council led no evidence that Mr Cooper played any part in the construction process, or that he knew of any design or construction defects. Harrison J found that he took no part in the building process and did not exercise any control over the design and construction process.
Accordingly, Harrison J rejected the final argument, and dismissed both the claim for contribution by Council, and the owners’ claim for the balance of their loss.
Harrison J commented that it may seem unfair for the local authority, which played a limited role in the development, to be liable for the failure of the apartments, whereas a shareholder of the extinct development company, who financially gained from the development, escaped liability. This was, he said (at para 75), “the necessary consequence of applying established legal principles”, which would enure unless parliament “radically reforms the Companies Act 1993, to ensure among other things that all companies are capitalised to a level consistent to the financial obligations they assume” (para 76). In a comment which will resonate with many unfortunate participants in the leaky building process who have seen directors of insolvent companies escape liability, he said that “… the time may be appropriate to examine whether a corporate model designed in the United Kingdom a long time ago is apt to meet the commercial and moral demands of and standards set by modern society” (para 76).
This case confirms in the leaky building context the difficulties associated with establishing liability on the part of directors of development companies. It is clear that an assumption of responsibility and control of an area which resulted in defects and proof of negligence is still required. For most leaky building claimants, the difficulty of obtaining such evidence, when they were not directly involved in the construction process will be a considerable impediment to a successful claim. Where companies were “one-man bands” and the director had a higher degree of control over the construction process, such claims may be more likely to succeed. (At the time of writing this article, a Court of Appeal consisting of five judges was hearing an appeal which may shed further light of the liability of directors of the “one-man band” type of company: Body Corporate 202245 and Anor v Taylor CA 205/06).
Directors of development companies will no doubt welcome the emphatic confirmation of the ability of a director to protect him/herself from personal liability through the existing corporate model. The case also seems to indicate that any discussion of the difficult policy issues raised by such cases (namely, whether individuals who profit from a development ought to be able to protect themselves through the incorporation of minimally capitalised limited liability companies), if it is to occur, will need to occur at a much higher level than the High Court.