The
High Court has ordered that $7.8 million dollars held by LDC Finance supposedly
as a secured creditor of failed Nelson finance company Finance &
Investments (F&I) be returned to F&I and refunded to depositors owed
some $15.9 million. F&I had been
borrowing from the public without issuing a prospectus.
The 2008 recession
affected many finance companies operating like banks, borrowing short and lending
long. A liquidity crunch propelled them
into liquidation when investors demanded repayment.
LDC Finance along with
F&I both went into receivership in 2008 after runs by depositors. LDC Finance claimed security over F&I
assets: 706 loans outstanding with a total face value of $13.3 million. LDC had provided working capital finance to
F&I.
Evidence was given
that F&I was established in the 1960s by two car salesmen: Andrew Harding
and Murray Schofield. It operated like a
small informal bank with transactions washing through the company’s cheque
account. F&I operated as a
partnership. In the 1960s, this did not
require formal registration of a prospectus when soliciting working capital
from the public. Investors placed money
with F&I on call, or for short term six months periods.
The rules changed in
1983 when securities legislation required partnerships like F&I to issue a
prospectus when borrowing from the public.
F&I did not catch up with the new rules. One of the penalties for trading without a
prospectus is that the transaction is void: the money received has to be repaid
in full, immediately. A trust exists in
relation to the unpaid money.
After F&I went
into receivership, unpaid investors sued claiming LDC as a secured creditor had
no right to seize assets which represented “their” money. In the normal course of events these investors
would need to point to physical assets funded by their money. But in this case, their funds had been banked
in F&I’s bank account which had been overdrawn at various times. Detailed investigations by forensic
accountants established that individual investor’s deposits could not be
tracked through F&I’s bank account into specific assets: individual F&I
loans.
Justice Fogarty ruled
that securities law created a trust over F&I’s assets in favour of the
unpaid investors. He further ruled that
LDC was aware that F&I was trading without a registered prospectus at the
time it took security over F&I assets.
This came to LDC’s knowledge when negotiating terms with F&I over
the injection of further working capital after a seven million dollar F&I
loan went sour in 2006.
This knowledge meant assets
covered by LDC’s claimed security were subject to a trust in favour of unpaid
F&I investors. LDC could have what
was left over only after F&I investors were repaid out of F&I assets.
The owners of F&I
will be personally liable to make up any shortfall in payments due to F&I
investors.
Eaton
& Marshall v. LDC Finance Ltd – High Court (23.05.12)
12.014