With many organisations currently feeling the pinch of the recession, suppliers are tending to be very strict with the amount of credit they will extend to customers in order not to expose themselves to significant debtors.
In some instances, suppliers may resort to obtaining securities for the debt or personal guarantees from directors or shareholders.
A recent High Court case in Timaru is an example of how the Fair Trading Act came into play when a director's promise to pay her company's debt was not honoured.
In McKeown Group Limited v Russell, Mrs Russell was a 50% shareholder and sole director of PDSA Limited, which operated a service station in Fairlie.
McKeown Group was a petrol supplier to PDSA, and by November 2004, the debt owing to McKeown Group amounted to $180,000.
McKeown Group told Russell it could not continue to supply PDSA unless an arrangement was put in place to ensure payment, at which point Russell promised to pay the full amount of the arrears when her property at Lincoln was sold.
McKeown Group accepted that assurance from Russell, though it did not require the arrangement to be recorded in writing - McKeown's position being that its business ethos was to trust its customers and take people at their word.
In a later meeting, Russell told McKeown the Lincoln house had sold but the sale proceeds were not sufficient to pay the debt.
Subsequently, McKeown issued proceedings against Russell under the Fair Trading Act claiming about $160,000.
The Fair Trading Act claim was based on alleged infringement of section 9 of the Act, which states no person shall, in trade, engage in conduct that is misleading or deceptive or is likely to mislead or deceive.
For an unfulfilled promise to constitute a misrepresentation under that Act, it has to be established that, at the time the promise was made, the promisor had no intention of honouring the promise.
Justice French decided that, based on the facts, this was a rare case in which it had been proven that Russell had no intention to pay McKeown when she made the promise. She therefore had a dishonest intention which amounted to a misrepresentation that was actionable under the Fair Trading Act.
Russell's lawyers argued that McKeown's claim to enforce the verbal guarantee by Russell under the provisions of the Fair Trading Act should not be allowed, as it was a backdoor method of circumventing the Contracts Enforcement Act, which required personal guarantees to be in writing.
Justice French did not accept that submission, as McKeown's claim was not based on a guarantee contract - it was based on misleading and deceptive conduct and therefore the Fair Trading Act claim was allowed.
However, Justice French did accept Russell's submission that the amount of the damages should be reduced to take into account the fact that McKeown had failed to take reasonable care to look after its own interests.
McKeown had allowed a large debt to accumulate and remain in place, and it had not checked the amount owing under the mortgage on the Lincoln property or obtained valuations for the residence or put any documentation in place to record a guarantee or security.
Justice French considered that McKeown's attitude had been too careless, even allowing for the company's ethos of trusting the customer, and accordingly she held McKeown responsible for 50% of the loss.
While this case depended on its particular facts in establishing liability under the Fair Trading Act, it does illustrate timely lessons for both company directors and suppliers alike.
- David Smillie is a partner in Gallaway Cook Allan.
