January 25 2004
Julian Manduca, Kurt
Sansone and Matthew Vella reporting
The court evidence presented two months ago audit expert John Zarb on the Priceclub saga has caused shock waves throughout the business community, but not even the slightest hint of public concern from the authorities.
The evidence highlights the story of a company, Priceclub Operators Ltd, burdened with loans and payments incurred by other companies within the Priceclub chain in circumstances that often benefited the directors’ personal interests, putting suppliers at risk.
Today, Priceclub is no more and the directors are enjoying the fruits of their labour while creditors and suppliers are still chasing the thousands owed to them by the defunct supermarket chain.
In the first months of the new Priceclub’s operations, popular opinion was that of a flagship company that was strong enough to corner the supermarket business in Malta, enjoying the hype of its high-profile marketing.
Zarb’s affidavit on the beleaguered supermarket giant however displays a company that had been weak at its foundations from the start of its operations, with its director-shareholders never having exercised the necessary care to keep it solvent.
John Zarb is a leading auditor with PricewaterhouseCoopers and unknown to many was a consultant to the big six creditors that lost money in Priceclub’s fall from glory. He was asked by liquidator Dr Andrew Borg Cardona to examine the books of account of Priceclub in relation to allegations against the Priceclub directors.
MaltaToday contacted Victor Zammit, Birkirkara FC president and fifty percent shareholder in Priceclub and asked him to comment on John Zarb’s report and accusations. Zammit said: "I did nothing wrong. In fact I am convinced that when our side of the story is heard people will understand us and realise we were right."
Asked whether he would reply to accusations that he helped create a weak company that put its suppliers at risk, Zammit said: "My replies will be given at the right time and through the right channels."
When MaltaToday contacted Wallace Fino, who held 25 percent of the Priceclub shares, a calm Mr Fino said he would not make comments at this stage. When MaltaToday pointed out that people could be arriving at their own conclusions following John Zarb’s report, Fino said: "When we make our submissions then they will be able to make their conclusions on what we have to say."
Attempts made by MaltaToday during the past days to contact the other director and shareholder Christopher Gauci proved fruitless.
According to the Zarb affidavit, instead of concerning themselves with keeping their company afloat, the directors put their suppliers of goods and services at great risk from the outset – and later at increasingly greater and greater risk.
Zarb told the court that, in his view, the Priceclub venture required "management experience and competence – which was sadly lacking at the outset and which became even more so as events developed… A business model consistent with the funding available… and shareholders adequate financial resources."
Zarb outlined how the Priceclub directors should have exercised particular care "to ensure the company remained solvent at all times, to avoid wrongful trading." However, "the directors unfortunately did subject Priceclub Operators Ltd to further burdens, often in circumstances that benefited their personal interests at the expense of company and its creditors."
At the outset the new Priceclub directors enabled the company to generate more available cash by paying their suppliers at a slower pace. However, the Zarb affidavit noted how the first months of operation were punctured by a loan of Lm400,000 to a company owned by Georgina and Giosue Gauci, the parents of Priceclub’s 25 per cent shareholder Christopher Gauci.
Milking the cow
The company set up by the owners to run the Priceclub supermarkets – Priceclub Operators - was not just somewhat of a non-starter, according to Zarb, but quickly became a cow to be milked by the directors and Priceclub related companies which borrowed money whilst its lean cousin took the brunt of loan repayments.
According to Zarb, in a period where Priceclub incurred losses in excess of Lm4 million, directors had diverted Lm794,000 of cash into their personal businesses, and incurred costs of Lm600,000 on the Birkirkara ‘Day to Day’ supermarket and Lm224,000 on the ‘Happy Saver’ supermarket "without in any way seeking to strengthen the equity base," of the company. The directors, Zarb added, also caused Price Club (Birkirkara) Limited to borrow a further Lm1.4 million to buy property already owned by a related company and retaining the money without alleviating the cash crisis and capital shortage of Priceclub operators which was owed Lm800,000 by Priceclub Birkirkara.
Perhaps most seriously, the directors diverted "further cash of Lm913,000 to meet capital and interest repayments on this and other borrowings taken out by other companies within the Priceclub group." Zarb’s conclusion: "The burden of all this was passed on to the creditors."
While the position of the company was clearly dangerous, the directors and shareholders chose not to invest additional money in the company, Zarb noted. His testimony emphasised that, assuming the directors had no accounting records apart from those made available to him – and his report was based on "information gathered from the companies premises after physical access was assumed by the liquidator" – the directors "failed to exercise proper control over the business, in that they were not even aware of the loss being incurred."
Zarb added that this failing was "rendered more serious given that they under-funded the business, at great risk to creditors, increasing the level of care they should have applied", implying according to the leading PricewaterhouseCoopers auditor, that Priceclub relied on its suppliers for cash to expand its business, "without the directors taking proper account of the business circumstances."
Even from the time when the original Priceclub owner Frans Gauci sold his business to eventual owners Victor Zammit, Wallace Fino and Chistopher Gauci, it was clear that a weak company had been created. The financial records obtained by Zarb show how at the time of purchase "the purchaser managed to reduce its initial capital outlay by assuming trade and other liabilities which totalled Lm2.9 million."
When the company that ran the supermarkets was created, its assets were the Lm101,000 share capital and a loan from its parent company of Lm237,748. Zarb told the court that in his opinion, "the manner on which this transaction was structured placed Priceclub Operators Limited in a precarious and disadvantaged position from the outset of its operations."
Zarb explained how Priceclub Operators was structured to bear the financial commitments of its parent company: "As the only operating company within the group, it was to be the ultimate source of all the cash payments which needed to be effected by Priceclub Holdings to meet the capital and interest repayments due on the bank and shareholders’ loans.
"It was obvious at the outset, therefore, that Priceclub Operators was going to be burdened with cash commitments for amounts materially higher than a fair rent on the properties concerned."
Never mentioned in the John Zarb report but confirmed by MaltaToday is the fact that the accounts of Priceclub were audited for the periods ending December 1998 and 1999 by Deliotte and Touche, but the firm never finished auditing the accounts of 2000, because of "audit differences related to debtors and stocks."
Can Price Club’s corporate veil be lifted?
Lifting the corporate veil describes a method of imposing liability for corporate activity or misconduct on the persons or entities other than the corporation itself, irrespective of companies being legal entities distinct from its shareholders or owners.
Since companies have a distinct ‘legal personality,’ it follows that members are not as such liable for its debts, and that only the company is liable and not its members. The shareholders’ liability is limited to the unpaid nominal value of their shares.
However, there have been instances in case history where the courts disregarded companies as separate entities, and instead proceeded to ‘lift the corporate veil’ and hold shareholders liable. Its necessity arises from the need to prevent abuse by members free from personal liability, since it would be an injustice to defraud a company with impunity at the expense of creditors, and escape punishment on the grounds that the company is at law a different person altogether.
On the 20 December, 2001, Valle del Miele Ltd, a creditor of Price Club Operators Ltd, sued the company and its auditors for damages. Valle del Miele declared that the shareholders, acting in their capacity as directors, had acted in a fraudulent or negligent manner and had caused the company to sustain damages, by presenting accounts showing a status which had not reflected the reality that the company was sustaining millions in losses.
Trade creditors totalling over Lm8 million hope the courts will not apply the doctrine of separate judicial corporate personality, to be able to recover their monies from the company’s assets (of which in this case the company holds none), for the corporate veil to be lifted and hold Price Club’s shareholders personally liable for these losses. However, it is hard to predict when the courts will lift the veil, which also depends on the mentality of the judge presiding any particular case.
There have been instances in Maltese courts that have shown this predisposition to lift the veil when it is clear that the company was being used for fraudulent or criminal purposes. The heart of the matter lies in determining where the abuse lies, but wherever there is strong evidence that a company is set up or acts in bad faith, with the intention of hiding behind the legal veil to defraud innocent parties, the judge will diverge from the beaten track of separate corporate legal personality.