Project News

21 Jul 2008

Defective Building Works – When Will Directors Be Personally Liable?

In light of the well-known leaky building saga, the issue of personal liability in tort for directors and others involved in the development or construction of leaky buildings has become an issue of great significance in recent times, not only for directors of the vast array of companies involved in the building industry, but also for owners of defective dwellings seeking compensation.

In the long line of cases under the Weathertight Homes Resolution Services Acts, directors have certainly been in the firing line of claimants seeking to recover monies for their defective dwellings. However, there has been some uncertainty in determining whether "personal liability" for any defects will extend to directors of companies or whether it will be limited to those particular companies that they control.

The recent High Court decision of Body Corporate No 188273 and Anor v Leuschke Group Architects Limited (Leuschke) has seemingly provided some comfort to those directors caught up in leaky building disputes, by giving clear directions on the circumstances in which directors may be found personally liable for defective works.

Why directors?

Claimants involved in defective building disputes often seek to sue company directors personally. There is a good reason for this: by the date of the hearing, the companies concerned will often have gone into liquidation. The only possible avenue to recover money, is therefore proceeding against the individuals behind such companies. However, this is no easy task, as the courts are reluctant to allow actions against directors personally (or to lift the "corporate veil") unless there are special circumstances attracting liability (such as fraud, or an assumption of personal responsibility).

In Morton v Douglas Homes, the claimant's dwelling suffered defects as a result of unstable foundations. The directors were found liable but only in respect of the specific areas where they had direct involvement and therefore responsibility (the director had been expressly told by an engineer of the dangers of placing certain loadings on unstable ground and he ignored that advice). Personal liability followed because he failed to inform the person in charge of building operations to have him take remedial action.

This issue became the subject of commentary and debate essentially because, post Morton, the Court of Appeal in Trevor Ivory Ltd v Anderson (where Justice Hardie-Boys who decided Morton sat on the Appeal bench) held that a Mr Ivory had not assumed personal responsibility to the Andersons for the accuracy of a statement/advice about crop spraying that proved to be negligent, and which caused damage and loss to the Anderson's raspberry crop. Cooke P's judgment in Trevor Ivory appeared to limit Morton to its particular facts where there was an assumption of responsibility and the Trevor Ivory decision was thought therefore to mean little prospects of a director having a personal duty of care to a third party, the breach of which would result in personal liability in tort i.e. there was a presumption of immunity from personal liability for directors unless there was an assumption of responsibility for the tortuous act.

In terms of defective building cases, what amounts to personal responsibility and personal involvement, is a crucial issue to all directors involved. Unfortunately, many of the decisions on this issue have been in the context of summary judgment claims seeking to "strike out" claims against directors in their personal capacity. As a result, the decisions are of limited value in determining exactly where the law is heading on this issue. This is because in most instances all that was necessary for the courts to determine at summary judgment applications was that an enquiry into and analysis of the facts was necessary and that this could not occur until trial. So, the summary judgment applications ultimately failed.

The Leuschke case, however, was a defended hearing and the Judge's comments and observations on this issue are therefore of particular use to us all.

The Leuschke case

In Leuschke, the owners of an 18-unit residential apartment complex in Rendall Terrace brought an action in the High Court against the architect, the builder, the Auckland City Council (the Council), and the directors and shareholders (Messrs Leuschke and Cooper) of the developer company (Colmark). The action was to recover the $1.879 million needed to rectify the defects associated with the apartments which suffered from water ingress. 

On the eve of the High Court hearing, the Council settled the claim for $1.5million, and in doing so it had obtained the rights to pursue the other defendants to attain a contribution to this. The architects and builder were insolvent, so the Council turned to Messrs Leuschke and Cooper as Colmark had also become insolvent. Mr Leuschke (who had also acted as architect) paid out $100,000. Mr Cooper, however, denied responsibility, and refused to make any payment to the Council.

The Court had no issue with finding that Colmark owed a non-delegable duty of care:

"The developer was 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."

Given that Colmark was insolvent, the real issue for the owners was whether Mr Cooper owed such a duty. The Judge warned that "the status of director does not carry any special immunities from personal liability". The real question is whether all of the elements of the tort in issue can be made out against a director. If they can, the director will be liable. In claims concerning defective building, the elements a claimant needs to show are:

• that the director assumed some personal responsibility for the defective work, and
• that their negligence caused the defect.

(These are the principles determined in Trevor Ivory). 

Essentially Justice Harrison rejected the Council's assertion that Mr Cooper was personally liable, and the Judge gave some useful observations as to why Mr Cooper could not be considered to have assumed any personal responsibility. While these specific instances are particular to this case, they are certainly of assistance in deciding whether to formulate an action against a director:

• Mr Cooper did not undertake any project management: the company engaged Lastel Construction Ltd (a company that Mr Cooper was in fact a sole shareholder) to undertake project management;
• The directors did not engage the builders personally: acting in their capacities as directors and agents, they resolved to accept the builder's tender.
• Mr Cooper never attended on site during development: he gave no directions at all relating to the design and construction process;
• The fact that the directors were authorised to sign cheques did not mean that they were exercising any new or separate degree of control: they were simply acting in their capacities as Colmark's controlling mind and force;
• An agreement by Mr Cooper to advance funds to Colmark if it was unable to perform its financial commitments did not attract any personal liability: this obligation is frequently assumed by a shareholder;
• The fact that they were sole directors did not vest them with absolute control of the building project: Colmark owned and controlled the development, and acted through the agency of its two directors. Performance of the powers and duties inherent in that agency does not mean that either agent was in personal control of the project. Their duties as directors were owed to Colmark - the entity with absolute control of the project;
• The fact that Mr Cooper was in the business of constructing houses for others for profit; that he would be making a half share of any profit earned; and that Colmark would be wound up at the conclusion of the development, did not attract any personal responsibility in itself: the prospect of a dividend is the rationale for subscribing for shares;
• All preparatory work, such as incorporating Colmark and nominating its directors; preparing the budget and establishing the framework for the project; arranging finances; participating in the resource consent process and inviting tenders, were plainly performed for or on Colmark's behalf;
• The engagement work, such as the appointment of contractors and professionals; the appointment of the project management company; liaising with a house removal company; authorising real estate agents to market the development; reviewing market material and selling units to members of the public; attending weekly site meeting with builders and writing to builders regarding time over-runs (which Mr Cooper did not do), are again things that were performed on a company's behalf; and
• Mr Cooper did not involve himself in the actual building process, let alone have any knowledge of the defects in design or construction leading to damage. 

Claimants need to think carefully

Claimants need to give careful thought before pursuing directors personally. If court proceedings against a party fail, there will usually be cost consequences. However, many claimants will face practical difficulties in making this initial decision. Unless a director's involvement is obvious, i.e the director also acted as the builder, claims against directors may become difficult to prove with the passing of time.

The following key points may be useful for both directors and claimants:

• Directors do not enjoy automatic immunity from tort liability (Leuschke confirmed this in case there was any uncertainty). The focus needs to be whether the elements of any tort action are made out against a particular director.
• Where negligence is the tort in issue, the question is whether there has been any "personal assumption of responsibility" over the particular defective works by the director.
• Directors can protect themselves by distancing themselves from building sites and site meetings and refraining from taking any active role in building works.
• Directors of smaller or "one-person" companies currently have a greater risk of personal responsibility (see Dicks v Hobson Swan Construction Ltd (In Liq) & Ors.

Author

Michael Weatherall

Partner - Property & Infrastructure

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