Credit Costs: Sportszone v. Commerce Commission

Finance companies cannot load general business overheads into specific fees charged borrowers in consumer credit contracts the Court of Appeal ruled in a Commerce Commission case against Motor Trade Finances Ltd.  Artifically inflated fees enable dealers to advertise an otherwise misleadingly lower interest rate.

The motor trade failed in attempts to gut consumer protection provisions out of the Credit Contracts and Consumer Finance Act.  The Act is designed to give consumers a clear description of the cost of credit which is able to be directly compared with alternative credit terms on offer.    

The Commerce Commission took aim at the motor trade with action against Sportzone Motorcycles (a Christchurch motorcycle dealer, now in liquidation) and Motor Trade Finances Ltd (a co-op owned exclusively by motor vehicle dealers).  The Commission alleged they failed to correctly calculate specific fees charged in hire purchase contracts for: the cost of setting up individual credit contracts; maintenance fees for ongoing supervision of each account; prepossession fees for notices on default and reposssession charges.

Motor Trade Finances complained the “fine-grained costs-based approach” demanded by the Commission is unworkable in practice, produces results that are of little or no practical use to borrowers; discourages innovation and efficiency and is unfair to creditors.  The Commission said that Motor Trade Finances was failing to comply with the Act and that Motor Trade was arguing for an approach that would require only a vague link between costs incurred and the fee charged with the only control being a test of whether the specific fees charged were unreasonable as compared with other lenders.  On this approach, any specific fee a finance company might charge, benchmarked against charges imposed by other finance companies, could be reasonable.  This, said the Commission, would amount to self-regulation of fees by the finance industry.

The Court of Appeal said the Act clearly restricts the costs that can be recovered as specific fees.  The emphasis is on actual, specific costs.  Fees imposed must relate to a specific credit transaction, not recover general business expenses.

There was evidence that Motor Finances Ltd altered its fee structure from 2005, developing a cost allocation model which aggressively recovered more of its operating costs through specific fees.  Boosting fee income was viewed as a profit opportunity.  Buried in specific fees charged individual borrowers were staff training costs, travel costs, directors’ fees together with accounting, legal and audit fees.  Also included were costs of running the treasury section and a figure for cost of capital.  These were all dissallowed as general overhead expenses which should not be taken into account when calculating specific fees charged individual borrowers.

For a finance company, the primary source of cost recovery is through net interest: the margin between interest on funds lent and the cost of acquiring those funds.

The Court of Appeal said guidelines set out in an earlier High Court ruling provided an illustration of what general business overheads could properly be spread across specific establishment fees charged for setting up a new customer account: ten per cent of staff salaries and performance fees; ten per cent of bank activity fees and ten per cent of banking costs for direct credit and debit facilities.

Sportzone v. Commerce Commission – Court of Appeal (30.03.15)

15.027

Leaky Homes: Salamanca Investments v. Wellington City

Facing a $21 million leaky building claim from owners of St Paul’s apartments in Thorndon, Wellington City had the High Court bring liquidated developer Salamanca Investments back to life so it could chase Salamanca’s holding company for a contribution to repair costs.

Developers commonly create single project companies to undertake property developments, liquidating the company quickly after extracting their profit.  Others are left to carry the can should building defects later emerge.  Local authorities are often left as “last man standing” with any money to pay repair costs.

St Paul’s was built at Mulgrave Street, Thorndon in the late 1990s as a staged development.  Salamanca, then part of the Newcrest Group, was developer.  Salamanca’s shareholders liquidated their company in 2005.  Three years later, St Paul’s owners made a claim for repair costs through the Weathertight Homes Resolution Services Act.  An assessor’s report estimated repair costs at $5.1 million.  St Paul’s owners are claiming $21 million.  Wellington City is being sued because it issued the Building Act compliance certificate for the construction.

The High Court was told Wellington City suspects the Newcrest Group made about three million dollars from St Paul’s.  The City asked that the now liquidated developer, Salamanca Investments, be revived and be restored to the register so that Salamanca could be joined as a party to the Weathertight claim.  Wellington City proposes to “follow the money”, attempting to extract from Salamanca’s holding company any amount the Weathertight Tribunal might find as being Salamanca’s share of the repair costs.    

Company law allows unpaid company creditors, with court approval, to reinstate an already liquidated company to get what they are owed.  Salamanca said this should not apply to Wellington City: the City was not a creditor when the company went into liquidation.  In 2005 there were no building defects apparent.  Judge Bell ruled that Wellington City had status as a creditor with what the judge styled as a “future tort”.  Contingent claims can be made in a liquidation.  St Paul’s owners had a contingent claim against Salamanca as at the date the company was liquidated even though the building’s defects were not then apparent.  Wellington City similarly had a contingent claim for a contribution from Salamanca for repair costs as at the date Salamanca went into liquidation.

Judge Bell reinstated Salamanca Investments to the companies register.  This brought Salamanca back into legal existence.  The company remains in liquidation.  Wellington City are allowed to take action against Salamanca in the Weathertight Tribunal to determine how much money, if any, Wellington City is entitled from Salamanca as a contribution towards St Paul’s repair costs.  In other cases, the courts have divided liability between developer:council in the ratio 4:1.

Salamanca Investments v. Wellington City – High Court (26.03.15)

15.026

Fraud: Rosenberg v. R

The Court of Appeal dismissed an appeal by former E-Gas chief executive Ronald Peter Rosenberg against his sentence for fraud of three years’ imprisonment and reparations of $400,000 describing the sentence as being lenient.  Benefits to E-Gas following the fraud were estimated at $17.4 million.

Mr Rosenberg was convicted in April 2014 on 41 charges of dishonestly using a document in relation to under-reported gas usage over a four year period up to 2008.  As a “non-incumbent” gas retailer, E-Gas was required to report customer usage to each area’s incumbent default retailer.  The default retailer had to pay the wholesale price for gas passing through the metered “gate” for its area, collecting payment from non-incumbent retailers for gas on-sold to their customers within its area.  It had to bear the cost of any inaccurate, incomplete or dishonest reporting by non-incumbent retailers.

Mr Rosenberg and fellow E-Gas director Sydney Hunt manipulated customer records for E-Gas to understate gas usage, under-reporting  nearly one million gigajoules of gas used over a four year period.  This resulted in a $17.4 million windfall for E-Gas.

On conviction for fraud: Mr Rosenberg was sentenced to three years’ imprisonment and ordered to pay reparations of $400,000; Mr Hunt was sentenced to three and a half years’ imprisonment with no order for reparations since he was bankrupt.

Mr Rosenberg appealed the order for reparations stating the sentencing judge had not taken into account the financial contribution he made by giving up potential legal claims he had against E-Gas.

The Court of Appeal was told Mr Rosenberg controlled a company called Multi Gas (NZ) Ltd which held security over E-Gas assets for a claimed debt of some $7.58 million.  An out-of-court settlement between Mr Rosenberg and the liquidators of E-Gas saw Mr Rosenberg surrender legal rights he claimed against E-Gas.  This settlement increased the payout for E-Gas unsecured creditors from sixteen cents in the dollar to about 67 cents in the dollar.  Mr Rosenberg said this benefit is in the nature of reparations and the court ordered $400,000 reparations should be reduced.

At sentencing, Mr Rosenberg declared personal net assets of $383,170.  He lived in a $3.2 million home owned by his wife’s family trust.

The Court of Appeal observed that a sentence of three years’ imprisonment could be regarded as merciful given the extent of the fraud (which was estimated to benefit Mr Rosenberg personally to the tune of at least $9.75 million), its sustained deliberate and systematic nature, and the associated damage caused the gas supply system.  He undoubtedly deserved an unusually significant credit for his outstanding contribution to the community, particularly professional and religious groups, as well as recognition for his age (then aged 73) and his ill-health, the court said.

Reparations can still be ordered when defendants have made an out-of-court settlement with those they have injured, the court ruled.  In this case, the settlement was not in the nature of a payment of cash from savings by a remorseful defendant, but rather the settlement of contested litigation claims, the court said.  If the claim had gone to trial, the result might have been worse for Mr Rosenberg.

The Court of Appeal said the amount of reparations ordered at $400,000 was high, but the sentence as a whole is not manifestly excessive.  We have no doubt, said the court, that the sentencing judge was putting together the most lenient package that he could for Mr Rosenberg, given his understandable sympathy for him.

Rosenberg v. R – Court of Appeal (26.03.15)

15.025

Yarrows: Gilles Bakery v. Gillespie

Westpac and Yarrows Group management have fended off claims by former owners of a Rotorua bakery claiming $6.5 million compensation for losses following Yarrows’ 2011 receivership.

Short of working capital to finance expansion in New Zealand and into Australia, baking conglomerate Yarrows Group was put into receivership in May 2011.  Yarrows had negotiated heads of agreement in early 2011 with Japanese company Sumitomo for funding in return for a half share in the Group.  Nothing came of the deal following an acrimonious split within the Yarrow board of directors.  Director Paul Yarrow fell out with fellow directors and trustees of his father’s charitable trust over his exercising greater management control.   Sumitomo dropped out.  Owed $55.2 million, Yarrows’ banker Westpac appointed BDO Spicers as receivers.  Mr Finnigan, Yarrows finance director was to describe BDO’s performance as “dismal”.  He alleged the receivers’ decision to break up Yarrows and sell the parts piecemeal resulted in recoveries considerably lower that the amount Sumitomo had been prepared to pay. 

Caught in downstrean eddies were Mr Trevor Boss and Mr Jean-Philippe Jacquet, former managers and owners of Rotorua bakery, Gilles Bakery Ltd.  For some time, Gilles had baked bread under contract to Yarrows.   

The Court of Appeal was told Yarrows purchased a 75 per cent stake in Gilles in 2001, paying cash.  Five years later, Yarrows bought out the remaining 25 per cent stake but payment this time was in fully paid redeemable preference shares issued to family interests associated with Messrs Boss and Jacquet.  While Gilles then became a fully-owned subsidiary of Yarrows, Messrs Boss and Jacquet remained as directors of Gilles to better protect their interests as preference shareholders.  Gilles was caught up in the 2011 receivership as a Yarrow subsidiary, with losses to preference shareholders.  There was evidence that Messrs Boss and Jacquet attempted to buy back their bakery from the receivers but were out-bid by Mr John Yarrow, Paul Yarrow’s younger brother.

Through Gilles, Messrs Boss and Jacquet sued alleging losses of $2.42 million caused by the actions of Yarrow and  $4.12 million caused by Westpac.  Both claims were dismissed.

It was alleged Yarrows as shareholder interfered with the management of Gilles to such an extent that it was a de facto director of Gilles and as such was in breach of a director’s duties to act in good faith and in the best interests of the company.  The main complaint concerned documentation surrounding Group refinancing.  In early 2008 Yarrows renegotiated loan facilities with Westpac, increasing the bank’s level of security to $60 million.  Gilles’ directors were required to complete documentation giving security over Gilles’ assets and having the company guarantee Group borrowing.  Boss and Jacquet were to later allege that Group management “cracked the whip” and  “demanded and insisted” that they sign such that they simply acted under instructions, meaning Yarrow was the real director of Gilles.  Signing had the effect of seriously reducing Gilles’ assets available to meet claims by Gilles’ redeemable preference shareholders, a scenario which came into play on receivership.  

The Court of Appeal said the refinancing was a straightforward commercial transaction.  Documentation signed by Messrs Boss and Jacquet did not support their allegations.  As directors of Gilles they signed resolutions stating the refinancing was in the best interests of the company and of the Group.  They knew how the transaction would “water down” the security available to redeemable preference shareholders.  They had signed acknowledgements that lawyers for the company were acting on behalf of Yarrows as a group and that the directors should seek independent legal advice in respect of their separate interests as redeemable preference shareholders of Yarrows’ subsidiary Gilles.

The court ruled that Yarrows’ actions in forwarding documentation for signature did not amount to “an instruction”.  Directors exercise their own independent judgment in deciding whether to sign or not.  Yarrows was not a de facto director of Gilles.

The court dismissed claims that Westpac had acted dishonestly, allegedly joining with Yarrows to prejudice Gilles redeemable preference shareholders.   

Gilles Bakery v. Gillespie – Court of Appeal (25.03.15)

15.024