Lombard: R v. Graham

Of the four Lombard directors convicted of Securities Act offences only two were ordered to pay reparations totalling $200,000: one director refused to make an offer of reparations and the other could not afford any contribution.

After an eight week trial, four Lombard directors were convicted of criminal offences following inadequate disclosures to investors about the finance company’s liquidity prior to its collapse. A total of $12.8 million in either new money or rolled over investments was placed with Lombard subsequent to these inadequate disclosures.

Lombard Finance went into receivership in April 2008. Unsecured creditors will receive nothing. Secured creditors face projected returns of 24 cents in the dollar.

There was no evidence of dishonesty by the directors but securities law regards the truth of statements made in a prospectus seeking funds from the public to be a question of “strict liability”. It is not enough that directors do not lie; they must have evidence to support statements made in a prospectus.

The court was told that delays in loan repayments to Lombard prior to its receivership were affecting the company’s cash position and these impairments together with the subsequent tightening liquidity were reported regularly to the board.

Particularly damning was an intra-company email sent by director Sir Douglas Graham in which he said the company was “sailing very close to the wind now [as regards liquidity] and the next two or three months will be critical”. While this pending liquidity crisis was known to board members, a far more optimistic picture was presented in public documents inviting investors to put money on deposit with Lombard.

In its prospectus, Lombard presented the management team as one of unparalleled probity. Directors convicted were Sir Douglas Graham (a former Minister of Justice, Attorney General and minister in charge of the Serious Fraud Office), William Patrick Jeffries (also a former politician who held the Justice and Transport portfolios), Lawrence Roland Valpy Bryant (with senior experience in a number of private and listed companies), plus Michael Howard Reeves as CEO and a member of the Lombard board. It was to come out in evidence that Reeves has a conviction back in 2000 for a breach of the same prospectus provisions of the Securities Act. He was fined $1000 on that conviction.

Lombard operated as a second-tier lender, financing property developments with funding secured predominately as second mortgages ranking after first mortgage financiers. It was very vulnerable: property developments needed to be finished on time and on budget with sales following rapidly before Lombard could be sure of getting its cash back.

But evidence before the court showed Lombard got its fingers burnt, repeatedly. It had a high concentration of loans with some 77% of loans outstanding tied up in just five major developments.

Its largest exposure started with six million dollars advanced on the Brooklyn residential subdivision in Wellington, later reaching twenty million dollars. The original developer failed to get the project off the ground. Rather than bailing out and taking its losses then, Lombard assisted a new developer into taking over the project – to no commercial advantage.

Lombard also provided working capital for the Blue Chip group of companies, property developers concentrating on inner city apartments. $15.3 million was outstanding at the time Lombard went into receivership.

Losses of just under $12 million followed the forced sale of a retirement village complex at Bayswater in Auckland. The developers initially borrowed eight million dollars to convert a private hospital into a retirement home. When they defaulted on this loan, an $18.5 million credit facility was granted to help complete the project. It failed.

The Bayswater developer also borrowed from Lombard to finance a residential subdivision at Mahia in the Hawkes Bay. An initial advance of $9.75 million eventually ballooned out to $12.45 million. Evidence was given that Lombard’s receivers best estimate is that only four million dollars is recoverable.

Loans to a different developer secured over a proposed residential subdivision in Raglan saw Lombard eventually lending close to 90 per cent of the land’s value. A total of $9.6 million was outstanding by the time Lombard went into receivership.

On conviction, Justice Dobson sentenced the four directors to various periods of community service: Sir Douglas Graham to 300 hours, Mr Jeffries 400 hours, Mr Bryant 300 hours and Mr Reeves 400 hours.

Two of the directors offered reparations. Reparations are seen as an acknowledgement of the harm caused investors.

Sir Douglas Graham offered reparation and was ordered to pay $100,000; Mr Bryant $100,000. Sir Douglas described his payment of $100,000 as “pretty well cleaning me out”. This conviction will wipe out any ability to earn a substantial income for now on, he said.

Mr Jeffries refused to make any offer of reparations. He said he couldn’t afford any reparations and was philosophically opposed to payment in any event. It imposed differing standards of justice depending upon a person’s net worth.

The prosecution argued for more severe penalties against Mr Reeves since he was in charge of day-to-day operations of the company as its CEO.

The court took into account his poor health (cancer has been diagnosed and he has been undergoing chemotherapy) and hardship faced by his dependent children (the details of which were supressed). Payment of any reparations was not feasible. Mr Reeves was described as living in reduced circumstances following two matrimonial property settlements and having invested his free funds in Lombard.

The court ordered that the $200,000 in reparations be held in trust in an interest bearing account pending any appeals.

After any appeals, reparations are to be paid to the receivers and distributed pro rata between those investors who put $12.8 million with Lombard over the period in which the misleading prospectus was in operation.

R. v. Graham – High Court (24.2.12) & (29.3.12)

12.007

Milk: Fonterra v. Grate Kiwi Cheese

Breaking into the lucrative value-added dairy market does not require ownership of a processing plant. New entrants can demand Fonterra provide raw milk to be processed by a third party processor in a “tolling operation”.

Fonterra dominates the raw milk market in New Zealand. To encourage competition after Fonterra was established, dairy industry regulations specified that raw milk was to be provided to competitors at a default price fixed by regulation. Currently, Goodman Fielder is entitled to 250 million litres per season. Any other applicants can get up to 50 million litres each with this supply capped at a total of 600 million litres.

Fonterra argued that this concession applied only to applicants with their own processing plant. The suggestion was that Fonterra considered the default price for selling raw milk was too low, leaving it at a commercial disadvantage to competitors producing dairy products. Limiting the field of applicants to only those with processing facilities would have the effect of lessening competition.

The Supreme Court ruled that dairy industry regulations should not be read narrowly.

It was open to any business to apply for an allocation of up to 50 million litres and this applicant was free to use any spare capacity offered by third parties to process the raw milk into dairy products. Third party processors would be charging a “tolling fee” for processing raw milk through their plant.

Requiring new entrants to establish their own processing plant would create a significant barrier to entry, the court said.

The court emphasised that this ruling did not force Fonterra to supply raw milk to applicants who would simply on sell the raw milk unprocessed.

Fonterra v. Grate Kiwi Cheese – Supreme Court (15.03.12)

12.006

Extradition: USA v. Dotcom

Bail conditions creating an personal electronic prison will suffice for individuals held in New Zealand pending extradition.

Internet entrepreneur, Kim Dotcom, is wanted by US authorities who allege criminal use of the internet for commercial gain. In particular, it is alleged Mr Dotcom facilitated illegal downloads of copyright material. His net worth has been speculatively put in the hundreds of millions of dollars.

In January 2012, he was arrested in New Zealand at the request of US authorities. An extradition hearing is scheduled for August 2012. US authorities strenuously objected to Mr Dotcom being released on bail. They said he had the resources and ability to flee New Zealand. It was proving difficult to track down his bank accounts: $US 17.8 million had been found in bank accounts under his name or under aliases; up to $US 68 million had passed through these accounts over a four year period. Assets to the value of $NZ 20 million had been seized in New Zealand.

The court was told Mr Dotcom held valid passports for both Germany and Finland. The US has extradition treaties with both those countries.

Justice Brewer said there was no certainty that Mr Dotcom would not attempt to flee New Zealand. Bail conditions required use of an electronic tag.

“It essentially puts a perimeter around Mr Dotcom’s home and if he breaches the perimeter then the authorities will know about it very shortly. That is a significant impediment to a person as recognisable as Mr Dotcom who seeks to flee the country clandestinely.”

USA v. Dotcom – High Court (29.02.12)

12.004

Company: Wilson v. Blanchett

Any failure to properly document drawings from a closely-held company can result in court orders for repayment. Liquidators of an Auckland company chased after drawings from one company totalling more than one million dollars.

APG Holdings Ltd was wound up in 2007. Liquidators, Messrs Blanchett & Burns, found a total of $1,081,000 had been paid to a Rita Wilson in the three years prior to liquidation. She had no identifiable role within the company. Enquiries showed she was the daughter of a former director and the wife of Terry Wilson who was a director at the time the company went into liquidation.

Rita Wilson did not respond to the liquidators’ specific enquiries about the payments. They sued.

She first argued that the various payments were received into her bank account without her knowledge and that they were in the main instalments of a company salary due to her husband.

This argument was dismissed in the High Court. There was no employment contract between Mr Wilson and the company, no PAYE was deducted from the payments and the company’s accounting records made no mention of the payments as salary.

In the Court of Appeal, Rita Wilson argued that the payments were loans made by the company to her husband. This argument was also dismissed. There was no documentary evidence of the terms of any loan or of any obligation to repay.

The payments received of $1,081,000 were in the nature of gifts to Mr and Mrs Wilson and had to be repaid by Mrs Wilson. The court was told that Mr Wilson was bankrupt.

The Wilsons said Terry Wilson had lent some $750,000 to APG when the company was operating and this amount should be set-off against the one million required to be repaid. A further court hearing is required to establish the validity of this claimed set-off. Meanwhile, the court ordered that $249,000 be handed over to the liquidators immediately.

Wilson v. Blanchett & Burns – High Court (15.07.11), Court of Appeal (15.12.11) & Supreme Court (24.02.12)

12.005

Crafar Farms: Tiroa E v. Land Information

Interests associated with Sir Michael Fay and David Richwhite are running a canny strategy of disruption against Chinese interests looking to buy the Crafar farms. Using rules governing overseas investment in New Zealand farmland, they challenged the Chinese purchase at a time when they had no firm offer on the table themselves.

By having the Chinese purchase referred back to government for further consideration, Fay Richwhite interests bought themselves more time and left Chinese investors pondering whether the whole deal was worth pursuing.

The Crafar family had borrowed heavily to assemble a portfolio of sixteen North Island dairy farms and drystock units. This debt burden proved unsustainable. The farms went into receivership in 2009 with Messrs Gibson and Stiassney appointed receivers.

Receivers advertised the properties widely, with top bid from Milk New Zealand Holdings Ltd, a subsidiary of Chinese company Shanghai Pengxin. The ultimate owner of Shanghai Pengxin is successful Chinese businessman, Zhaobai Jiang.

Fay Richwhite interests challenged this sale using the Overseas Investment Act 2005. Sales of farmland to foreign interests require government approval.

The court was told that Fay Richwhite had no firm offer on the table at this point, having only nominated an indicative price well below the Shanghai Pengxin offer.

In the High Court, Justice Miller ruled it was not enough by itself that Shanghai Pengxin was offering the highest price, an overseas buyer must provide economic benefits over and above any on offer from a New Zealand purchaser.

Benefits could include increased economic output, more on-shore processing which add economic value to goods produced, creation of new job opportunities or the retention of jobs otherwise lost, and consumer benefits arising from increased competition.

Justice Miller said these benefits count only if they will not, or might not, arise without the overseas buyer completing its investment. The likely investment behaviour of any alternative New Zealand purchaser must be taken into account.

He referred Shanghai Pengxin’s offer back to government for further consideration.

Tiroa E & Te Hape B Trusts v. Land Information – High Court (15.02.12)

12.003

Tax: Tannadyce Investments v. CIR

It was an abuse of process for a taxpayer to try and circumvent the prescribed tax disputes process by claiming Inland Revenue was refusing to disclose records it was holding. In refusing judicial review of Inland Revenue’s behaviour, the Supreme Court ruled the taxpayer did not specify how it was in any way prejudiced by Inland Revenue conduct.

Tannadyce Investments has been in a long running dispute with Inland Revenue. Controlling shareholder of the Christchurch-based company was David Ian Henderson.

The court was told Tannadyce claimed Inland Revenue was holding financial records needed by the company to file its tax returns for the years 1993-1998.

If Inland Revenue were acting in bad faith, withholding documents it knew a taxpayer required, judicial review is available to hold officials to account for an abuse of power. The Supreme Court ruled this was not such a case.

In March 1999, Inland Revenue issued Tannadyce with “nil” assessments for the tax years in question. The company responded with what it called a “global return” for these tax years claiming tax losses of $1,539,733. Inland Revenue argued that a “global return” does not comply with the statutory requirement to file returns for each tax year. It reissued its “nil” assessments, requiring Tannadyce to follow the normal tax disputes process to prove its claimed tax losses. In subsequent tax years, Inland Revenue disallowed the claimed tax losses as losses carried forward.

Tannadyce said it could not use the tax disputes process because Inland Revenue was holding all necessary records and was refusing to release them. Tannadyce stood by its global return.

The Supreme Court ruled that Tannydyce failed to show it was not practically possible for the normal rules to be followed. Its global return managed to claim a loss for the six tax years down to the last dollar. It is perfectly plain, said the court, that Tannydyce had sufficient information and records to file a global return. It should have been able to apportion this global figure between the various tax years, using reasonable estimates where needed.

While the claimed losses collectively covered six years, there was evidence that Tannydyce ceased trading in 1992 having traded for no more than 18 months at most.

Tannadyce Investments Ltd v. CIR – Supreme Court (20.12.11)

12.002

Blue Chip: re Northern Crest Investments

Australian investors needed High Court approval to support their claim to three million dollars used to prop up Blue Chip operations in Australia just before the company went into liquidation. New Zealand based liquidators had their doubts as to whether the money was ever available for use by the insolvent Australian Blue Chip company.

With Blue Chip operations in New Zealand going down the gurgler, promoter Mark Bryers set up shop in Australia with a company later named Northern Crest Investments. The company was listed on the Australian Stock Exchange (ASX) in 2006. The court was told some $A22 million was invested in the company by Manifest Capital Management Pty Ltd acting as a conduit for a number of investors.

In February 2008, Northern Crest was suspended from trading on the ASX. Attempts to rescue the company became problematic when Macquarie Bank withdrew previous offers of funding. With its large investment in Northern Crest, Manifest became deeply involved in refinancing negotiations. It agreed to provide $A3 million to help the company through its liquidity difficulties. Manifest described this advance as part of an underwriting agreement pending Northern Crest raising more equity capital, with the advance to be treated in the interim as a non-interest bearing loan.

In June 2011, Northern Crest was put into liquidation with New Zealand-based liquidators appointed: Messrs Lawrence and McCullagh.

Manifest’s claim in the liquidation for its purported $A3 million advance was rejected by the liquidators. They doubted whether there was a debt due because of concerns over the accuracy of Northern Crest’s financial records. Manifest was required to provide originals of any documents supporting their claim.

In the High Court, Justice Heath approved Manifest’s $3 million claim in the liquidation of Northern Crest. While the liquidators acted precipitately when initially rejecting the claim, he said, Manifest was criticised for not being more open with the liquidator about the circumstances of the debt.

The liquidators had been suspicious because documents supporting Manifest’s claim were miss-dated and the funds were paid not to Northern Crest but to a related company.

re Northern Crest Investments Ltd – High Court (20.12.11)

12.001

Tax avoidance: Alesco NZ Ltd v. CIR

Sixteen different taxpayers and revenue totalling $300 million is in dispute with Inland Revenue as it targets use of hybrid securities to fund intra-group transactions.

The first shot has felled ASX listed company Alesco after a High Court finding that use of optional convertible notes to buy into New Zealand companies amounted to tax avoidance. Tax deductions of $10.95 million were disallowed for the tax years 2003-2008. In addition to tax payable on an extra $4.9 million assessable income, Alesco was ordered to pay shortfall penalties of $2.4 million and use of money interest of $1.2 million.

Alesco spent $85 million investing in New Zealand companies. It relied on advice from chartered accountants KPMG in seeking the most tax effective way of documenting the transaction.

The court was told Alesco (NZ) issued convertible notes to its Australian parent in return for advances totalling $78 million for a term of ten years. On maturity, Alesco had the option of being repaid the $78 million or converting the notes into 78 million Alesco (NZ) shares. These notes were hybrid securities, split into debt and equity components. The beauty of this arrangement was that Australian and New Zealand taxing authorities treated hybrid securities in differing ways: in New Zealand Alesco (NZ) could claim a deduction for a notional interest expense arising from the debt component of the notes with no withholding tax deduction; in Australia this notional payment was not assessable to the parent company, Alesco.

No cash would change hands. But Alesco (NZ) would be claiming a deduction for this notional interest, reducing taxable income for its New Zealand operations.

This notional liability for interest arose because of the accruals regime operating in New Zealand tax law since the 1980s. The accruals regime seeks to reflect the economic effect of financial transactions and aligns tax law with general accounting principles.

Alesco argued the financial arrangement chosen was a legitimate business transaction. Inland Revenue was dismissive, calling these hybrid securities interest free advances stapled to valueless and purposeless warrants.

In the High Court, Justice Heath ruled the transaction was invalid for tax purposes as tax avoidance. While the accounting treatment for the notes was appropriate, the tax advantage gained was not within the intent of tax legislation, he said.

First: there was no taxable income arising from the deduction claimed. Secondly: the hybrid security used was artificial, designed only to secure a tax advantage in New Zealand. There was no arms length negotiation to settle the terms of the transaction. The hybrid security had no commercial value. No third party buyer would be interested in buying the security. Thirdly: no real interest had been incurred and the notional interest deduction did not represent a real economic cost.

A shortfall penalty of $2.4 million was imposed after the court ruled that Alesco had taken an “abusive tax position” entering into the financing arrangement with a dominant purpose of avoiding tax.

Alesco NZ Ltd v. CIR – High Court (12.12.11)

(12.11.003)

Bankruptcy: Taylor v. Official Assignee

A court ruling that $227,000 be repaid by a family trust following bankruptcy was reversed on appeal when the bankrupt argued that payments were not made fraudulently. The bankrupt said she had been suffering from depression and there was no intent to defraud creditors.

Auckland accountant Bronwyn Taylor set up a family trust in 2000 to protect the family home from business creditors. In what is normal commercial practice, the family home was transferred to the Trust and the value of her equity in the home was left as a loan owing by the Trust to her personally. This loan was not repayable until 2030, but interest could be demanded on the outstanding balance and the loan was immediately repayable if any interest was not paid. Further money was later lent to the Trust to finance the purchase of a replacement family property.

She was bankrupted in 2006. Two creditors claimed $207,700: the tax department $123,100 and her failed accounting business Bronwyn Taylor Accounting Services Ltd claiming about $84,600.

The High Court ordered her family trust to repay $227,000 of the outstanding loan to cover the amount claimed from Taylor by creditors plus an extra $20,000 to cover administrative costs of her bankruptcy.

Being under the impression that Taylor had no income from the date the family trust was set up, the High Court considered the act of transferring her home to the Trust as being a fraudulent scheme intended to cheat creditors.

In fact, household income at the time the Trust was established totalled some $200,000. For the first two years after the Trust was established all personal debts were able to be paid. Arrears began to accumulate after that period.

There was evidence that Taylor developed depression lasting several years following an acrimonious breakup with her business partner. During this time she did not keep proper business records and took money out of the business as and when needed, leaving creditors unpaid. Taylor’s depressive state was compounded by falling ill with hepatitis.

The Court of Appeal ruled the evidence did not amount to fraud. Her disturbed mental condition meant she did not focus on the practicalities of the business. And when the extent of debts due to the tax department became apparent Taylor presumed she would be able to negotiate a deal, though no deal ever eventuated.

While reversing the earlier court ruling that Taylor’s family trust pay $227,000 to the Official Assignee, the Court of Appeal pointed out that the Official Assignee could still recover some money for creditors by calling for interest to be paid on her loan to the Trust.

Taylor v. Official Assignee – Court of Appeal (9.12.11)

(12.11.001)

Maori: Takamore v. Clarke

In disputes over burial custom, it is the executor who has final responsibility for decisions over the manner and place of burial. With a high proportion of inter-racial relationships in New Zealand, Maori burial custom is coming into conflict more frequently with English-derived common law.

The 2007 death in Christchurch of Jim Takamore resulted in a cultural collision between his mother and sister on one side and his partner on the other. Ms Clarke, his partner, had lived with Mr Takamore for twenty years and was named as executrix in his will. Before his death, Mr Takamore had expressed the desire to be buried in Christchurch. This was also Ms Clarke’s preference as she would be remaining in Christchurch following his death.

Contrary to these wishes, Mr Takamore’s body was seized by Tuhoe whanau prior to burial and taken north to the Kutarere Marae near Taneatua for burial with ancestors on the home marae.

Following an urgent hearing, the High Court ruled that Mr Takamore’s body be returned to Christchurch.

Mr Takamore’s sister appealed against the court order, arguing Tuhoe custom was paramount and that he should remain with his people.

The Court of Appeal set out detailed rules governing the relationship between Maori customary law and English-derived common law.

For Maori custom to be part of the law of New Zealand it must be a long-standing custom, must have continued without interruption since its origin, must be reasonable, must be certain in its terms and must not have been overturned by any statute.

The court ruled that Tuhoe burial custom could not be considered reasonable because it allows the use of force to take a body without agreement. Use of physical force to settle private disputes is directly contrary to the rule of law.

It also ruled that any wishes of the deceased about the manner and place of burial are not directly relevant. It is something for the executor to take into account.

The court said Maori burial custom can be incorporated into the common law by having the executor discuss the manner and place of burial with the wider family, where possible. If no consensus can be reached, it is for the executor ultimately to decide.

The court ruled that Ms Clarke as executrix was entitled to possession of Mr Takamore’s body and was entitled to make the final decision as to burial.

Takamore v. Clarke – Court of Appeal (23.11.11)

(12.11.002)

Infrastructure valuations: Vodafone v. Telecom

Valuation of infrastructure assets got an airing in Supreme Court litigation closing out a long running dispute over the cost to Telecom of providing uneconomic residential phone coverage. The court ruling will impact on pricing policies for utilities enjoying natural monopolies such as airports, power, gas and water. The Supreme Court frowns on revaluation of legacy assets, saying this results in windfall gains for the owner leading to unjustified retail price rises.

There has been no love lost between Vodafone and Telecom in arguments over the cost to Telecom of its former statutory obligation to provide a “free” telephone service to all residential customers. The two telcos have held over 90% of the market between them. Over the years, Vodafone has been obliged to pay Telecom millions of dollars as compensation for Vodafone’s share of the subsidised cost of a residential service to uneconomic customers. Not surprisingly, this has lead to tortuous litigation over the methodology used by the Commerce Commission to determine Telecom’s cost of providing infrastructure assets used by Vodafone and other telcos to service their customers.

Telecom is to be set free as a stand alone retailer following the establishment of Chorus as the infrastructure operator. Telecom was forced to settle all outstanding legal disputes with Vodafone so it could clean up its balance sheet prior to the Telecom/Chorus demerger.

Despite Telecom and Vodafone reaching a confidential commercial settlement ending their disputes, the Commerce Commission had to see the long running litigation through to its end in order to get some finality on rules governing the valuation of Telecom’s infrastructure assets.

Asset valuations feed into formulae used to determine the rate of return on infrastructure assets and have an impact on retail prices. In common use are ORC (optimised replacement cost) and ODRC (optimised depreciated replacement cost).

ORC is the present-day cost of acquiring an asset to provide efficiently a specified quantity and quality of service. Replacement cost is based on current market values, taking current technology into account.

The Supreme Court warned against distortions caused by artificially revaluing old assets which were in reality not likely to be replaced or improved. It is not appropriate to attribute a modern equivalent value to an old asset which is not actually being replaced, said the court. This has the effect of artificially inflating the value of the asset, providing a windfall in the terms of an increased capital base resulting in a “free lunch” equal to the amount of the upward revaluation.

In the Telecom case, the Supreme Court said the Commerce Commission erred in its valuation of Telecom’s infrastructure assets by inappropriately increasing the value of its legacy copper fixed line network and by not allowing in its valuation for replacement of uneconomic parts of the fixed line network with the cost of an alternative mobile phone service for geographically isolated customers.

Vodafone v. Telecom – Supreme Court (17.11.11)

11.11.003

Earthquake Insurance: EQC v. Insurance Council

Losses following the Canterbury earthquakes have been shifted from the private sector to the Earthquake Commission following a High Court ruling. The Commission is liable for multiples of $100,000 for each earthquake during the currency of an insurance contract. Over 110,000 properties have multiple claims.

New Zealand is very unusual in having statutory insurance cover for earthquake damage. Private insurance cover is the norm in most of the world. In places such as California and Japan, the cost of private cover is so high that many go uninsured.

The Earthquake Commission Act 1993 in New Zealand creates a government-underwritten insurance scheme for all private dwellings having fire insurance cover. The statutory scheme does not apply to commercial buildings. For residential dwellings, a levy charged on top of the fire insurance premium is paid to the Commission as insurance against “natural disasters”, which includes earthquakes. This statutory levy amounts to fifty cents for every one thousand dollars cover.

This earthquake cover provides the first layer of insurance: $100,000 for loss of land and buildings; $20,000 for contents. Fire insurance policies typically provide private cover for the excess.

Since 2010, Canterbury has suffered an unprecedented series of earthquakes with over a dozen quakes registering magnitude five on the Richter scale, triggering Earthquake Commission (EQC) liability.

EQC together with the major fire insurers sought a High Court ruling on the application of statutory earthquake insurance cover to losses in Canterbury. Since fire insurers cover the “excess”, it was necessary to first establish the extent of EQC liability.

EQC argued that its full liability on each residential dwelling was $100,000 for each year of an annual fire insurance contract; the fire insurer was responsible for any further losses be it from one claim or multiple claims in that year.

The High Court did not agree. Wording of the 1993 Act together with provisions enabling EQC to charge a further premium for the period between an earthquake and the conclusion of an annual fire insurance policy meant that EQC was liable to multiples of up to $100,000 for buildings (and $20,000 for contents) for every claim during the one year currency of a fire insurance policy.

As a result, private insurers will have no liability for damage to many Canterbury homes suffering damage from successive quakes.

Earthquake Commission v. Insurance Council – High Court (2.09.11)

09.11.004

Nathans Finance: R. v. Moses, Doolan & Young

Two directors of Nathans Finance have been jailed for their part in the company’s failure; two others received home detention. Just over one million dollars in reparations is held by the High Court to be divided among investors. While imposing jail sentences, the judge emphasised that the directors had neither acted dishonestly nor intentionally misled investors but were being punished for inept performance, failing to do their job properly.

Penalties followed convictions for breaches of the Securities Act 1978 after Nathans issued a misleading prospectus and investment statement when seeking funds from the public. Investors were owed some $174 million when Nathans went into receivership in 2007. On current estimates, losses of about $168 million are expected.

Statements in Nathans’ prospectus about related party lending and the extent of bad debts were misleading. Investors could not make an informed decision before investing. Nathans received about $66 million by way of new investment or reinvestment after issuing the misleading prospectus.

Justice Heath said penalties imposed must reflect three consequences of the directors’ behaviour:

· their inept management discourages investors in future from lending to finance companies

· this will reduce venture capital investment, and

· might reduce overseas investment in New Zealand ventures because of doubts about the integrity and competence of New Zealand management.

He also said offers by a director to pay reparations should be taken into account as evidence of remorse for wrongful behaviour.

Kenneth Roger Moses was sentenced to two years and two months imprisonment and ordered to pay $425,000 reparations. He had expressed concerns about the high level of intercompany lending but while on the board and as chairman did little to correct the position. “Actions speak louder than words”, Justice Heath said.

Mervyn Ian Doolan was sentenced to two years and four months imprisonment and ordered to pay $150,000 reparation. He is a qualified chartered accountant and along with Moses was described as having a full understanding of Nathans finances.

Donald Menzies Young was sentenced to nine months home detention, 300 hours community service and ordered to pay reparation of $310,000. He joined Nathans’ board two years before receivership. He was described as the least culpable of the company’s directors, being reliant on information from his co-directors. The court indicated that Young was not given as complete a picture of the company’s position by his fellow directors as could be expected.

At an earlier High Court hearing, John Lawrence Hotchin, another Nathans director, was sentenced to eleven months home detention, 200 hours community work and ordered to pay $200,000 reparation. He was sentenced early, after pleading guilty to the charges and agreeing to give evidence at the trial of his fellow directors.

Reparations ordered against the four directors totals $1.085 million. Justice Heath directed that the money be paid into the High Court and distributed pro rata by the receivers among those investors who had invested in the company. A further court hearing will determine who is eligible for payment.

R. v. Moses, Doolan & Young – High Court (2.09.11) & R. v. Hotchin – High Court (4.03.11)

09.11.003

Leaky Homes: Tisch v. Body Corporate 318596

Proposals which force owners in leaky apartments to pay over the odds for water damage to other owners’ apartments do not find favour with the Court of Appeal.

Collective solutions dealing with the cost of repairs to leaky apartments have reached the courts. A collective solution minimises cost and disruption. And work is completed to a uniform standard.

Most apartment buildings are governed by Unit Titles legislation. Apartment owners, like shareholders in a company, get to vote on rules governing operation of their building.

With multi-million dollar costs arising from the repair of a leaky apartment building, owners of individual apartments have been voting on proposals to collectively repair the damage. This enables all the repairs to individual apartments in the building to be done at the same time, by the same contractor. If the court gives approval to the proposal, the cost of the scheme can be imposed on apartment owners who vote against, and also imposed on subsequent purchasers of an affected apartment. Court approval also enables costs to be imposed retrospectively on individual owners who refused to pay up.

Disputes arise over how these costs should be allocated between differing apartment owners. Arguments also arise over who has legal responsibility to maintain specific parts of the building and who will benefit most from particular repairs.

The Unit Titles Act 2010 sees property entitlements in an apartment building divided between a common area (which all owners may use and all must share the cost of maintaining) and owner’s exclusive areas (which are the responsibility of an individual owner).

The court was asked to rule on a two million dollar proposal for repairs to a leaky beachside apartment building in the Bay of Plenty. The building has a “wedding cake” configuration with each floor set back from the floor below. This results in the balcony fronting each of the upper apartments acting as part of the roof for the apartment below. The body corporate rules for the building specify that each balcony is an owner’s exclusive area and each apartment owner is responsible for its maintenance and repair. Repair of the building roof is a collective responsibility.

Eight of the ten Bay of Plenty apartment owners voted in favour of the two million dollar proposal. Owners of the two ground floor apartments voted against. They objected to $498,000 for balcony repairs being allocated as a collective cost. Even with the balcony above acting as a roof for their apartment, balconies were the responsibility of each apartment, they said.

The court said it was important in this case that body corporate rules assigned balcony repair costs to the owner of each individual apartment. It was an unwarranted departure from these rules for a proposal to treat these individual obligations as a collective cost.

The apartment owners were told to rework their proposal

Tisch v. Body Corporate No. 318596 – Court of Appeal (29.08.11)

09.11.002

Tax avoidance: Penny & Hooper v. CIR

Artificially low salaries having the effect of diverting taxable income to other taxpayers on a lower marginal tax rate will be hit as tax avoidance following strong words from the Supreme Court. If the salary is not commercially realistic or not supported by any commercially legitimate reason it is open to attack as tax avoidance.

These comments followed an unsuccessful appeal by two Christchurch orthopaedic surgeons who made use of company structures owned by family trusts to divert income from their medical practice to other family members. At the time, the company marginal tax rate was well below the rate imposed on personal income earned by the surgeons.

The two surgeons worked as salaried employees of their companies. The salaries paid were well below market rates payable to orthopaedic surgeons in private practice.

This re-arrangement of their business affairs resulted in tax savings of some $65,000 over three years for one surgeon, and $103,000 for the other.

The Supreme Court did highlight commercial circumstances where a company’s payment of a lower than market salary could be seen as legitimate and not tax avoidance: In a one-person company where an annual salary amounted to the company’s annual profit; where a company was looking to expand and retained earnings were necessary to support proposed capital expenditure; and in circumstances where a company was facing a liquidity crisis and cash was needed to pay creditors.

Penny & Hooper v. CIR – Supreme Court (24.08.11)

11.11.001

Money laundering: Westpac v. MAP Associates

While banks might have legitimate concerns about liability for assisting money laundering, they are not entitled to block money transfers unless they are positive that fraud is involved. Suspicions alone are not enough and there were suspicions aplenty for Westpac in a US$49 million deal.

Westpac forced MAP & Associates, a Hamilton firm of chartered accountants, to sue if they wanted to have client funds unfrozen. The accountants were acting as escrow agents, holding some US$49 million as trustee pending sale of a Bolivian bank.

Westpac argued it was entitled to be suspicious. It had been warned of frauds emanating from Bolivia and said it was not clear who were the ultimate recipients of the US$49 million.

The court was told a Panamanian businessman approached MAP Associates in 2006 asking if they would act as escrow agents in a sale of the bank. The bank chairman held a power of attorney stating he had authority to act on behalf of the twenty or so shareholders looking to sell. New Zealand banking facilities were sought to clear the transaction because a Venezuelan purchaser was “not very fond of the USA”.

It was intended that MAP Associates would act as trustee, holding the purchase price paid by the purchaser while due diligence was undertaken. When the purchaser was satisfied, it would authorise MAP Associates to release funds to the vendor. MAP Associates set up a non-interest bearing bank account with Westpac for the short period it expected to be holding the funds in escrow. There was evidence of some US$600,000 payable in fees as part of the transaction.

Funds for the purchase, amounting to some US$49 million arrived in the Westpac account in December 2006 and stayed there for nearly 14 months. When Westpac was instructed to pay out the money in February 2008 it refused.

Westpac said the Financial Transactions Reporting Act required it to be satisfied about the bona fides of the transaction and the identity of the parties. The court was told that Westpac had made inquiries about the Panamanian intermediary negotiating the transaction and was suspicious of his claimed identity. Further it refused to release funds to numbered bank accounts without disclosure of the named owners. When the names were provided, one recipient who was to receive US$11.8 million did not seem to be a shareholder in the Bolivian bank being sold.

Westpac refused to act on instructions delivered by MAP Associates. These instructions had come from overseas in a sealed envelope, held sealed by Westpac until told to open the envelope and pay out the money as the letter instructed.

The Supreme Court ruled that banks are under a strict obligation to carry out client instructions. They can refuse to act if there is fraud or a breach of trust involved. It is not enough that there are mere suspicions of fraud or a breach of trust. Here, Westpac had no proof of actual fraud and was obliged to release the funds as instructed.

Westpac v. MAP Associates – Supreme Court (16.08.11) & Court of Appeal (6.09.10)

11.11.002

Export Sales: Smallmon v. Transport Sales

Exporters selling into Australia are not directly responsible for ensuring goods comply with Australian regulations. A Queensland buyer of used trucks penalised after Australian regulators shifted the goalposts failed in an attempt to pass the problem back to a New Zealand exporter.

The Court of Appeal was told that Smallmons, a Queensland road transport business, purchased four Volvo trucks from Auckland-based Transport Sales Ltd in 2006. The vehicles, previously operated by Fonterra, were sold for NZ$72,000 each.

Smallmons had trouble registering the vehicles after unloading in Brisbane. The trucks were roadworthy, but did not have compliance plates fitted: plates attached at the time of manufacture which verify the vehicle satisfies Australian regulations. The trucks had been originally assembled in Australia and did in fact comply with Australian regulations at the time of manufacture. No compliance plates were fitted because the vehicles were assembled for immediate export to New Zealand.

Evidence was given that Queensland authorities had previously accepted for registration Australian assembled vehicles imported second-hand from New Zealand without compliance plates. In what was an apparent change in policy, registration was refused in this case.

Following political lobbying, the Smallmons were issued with restricted permits: the four trucks could be used on roads in Queensland, but not New South Wales, and if sold the trucks were again prohibited from being used on the road.

Given these difficulties, the Smallmons sued Transport Sales alleging the Auckland company was in breach of contract by selling vehicles which could not be used legally on Australian roads.

Export contracts are governed by a United Nations convention: Sale of Goods (United Nations Convention) Act 1994. The first rule is that goods delivered must comply with the agreed terms of the contract. There was no explicit agreement in this case about who was responsible for getting the trucks on the road in Queensland. Generally, an exporter is not responsible to see that exported goods comply with any regulations imposed by the importing country unless the same regulations exist in both countries, or the importer told the exporter of any special regulations and required the exporter to ensure the goods complied (exporters cannot be expected to know all the importer’s rules and regulations), or the exporter was in fact aware of the importing country’s regulations.

While part of Transport Sales business involved selling second-hand vehicles to Australia, the court said there was no evidence that the company knew of the detailed Australian registration requirements. There was no breach of contract and Transport Sales was not liable to pay damages.

Smallmon v. Transport Sales Ltd – Court of Appeal (22.07.11)

09.11.001

Bridgecorp: R. v. Petricevic

There is no injustice in having to do without a lawyer in a criminal trial. Rodney Michael Petricevic, charged with criminal offences following the collapse of Bridgecorp, claims to be broke and unable to afford a lawyer.

Attempts to stop these prosecutions failed when the High Court ruled there was no breach of the Bill of Rights Act 1990 should Mr Petricevic be forced to defend himself without legal representation.

The criminal trial will focus on allegations that Mr Petricevic took money from his companies without justification. Creditors suspect substantial sums were transferred to a family trust for the benefit of his wife and children. Mr Petricevic claims to have no assets. He was bankrupted in August 2008. His application for legal aid was refused on the basis that his wife could provide funds given that she is a beneficiary of the family trust. Legal aid rules treat assets available to a spouse as financial resources available to her husband.

The Court said that while the Bill of Rights Act says an accused is entitled to a lawyer, the State does not guarantee to pay for a lawyer.

A trial does not become unfair unless the accused cannot conduct his own defence because of legal complexities arising during the trial. Justice Venning ruled that was unlikely to happen in this case. Mr Petricevic has a substantial background in business, was the managing director of a public company and can be expected to be very familiar with documents which will feature as evidence in the trial.

R. v. Petricevic – High Court (12.07.11)

07.11.001

Nathans Finance: R. v. Moses & others

Directors of Nathan Finance have been convicted of misleading the public about the company’s financial position when they failed to disclose the full extent of intercompany debts and wrongly stated that these loans were on the same terms as loans to third party borrowers. The directors claim that they acted honestly, but that was not a defence in itself. They must have reasonable grounds for that belief.

Kenneth Roger Moses, Mervyn Ian Doolan and Donald Menzies Young were prosecuted in the High Court for breaches of the Securities Act 1978. Another director, John Lawrence Hotchin, earlier pleaded guilty.

Over 7000 investors were left out of pocket when Nathan Finance went into receivership in 2007, owing about $174 million.

Nathan acted as a conduit for funds borrowed from the public. Critical for Nathan investors were the lending policies and liquidity of the company. Nathan is a wholly owned subsidiary of the VTL group: a company which sold vending machines and installed proprietary software to record transactions. This was a type of business which found normal bank financing difficult to obtain.

The Nathan prospectus played down the extent of intercompany lending at a time when the bulk of funds were onlent to VTL companies. The prospectus stated there was no history of bad debts written off. While this was literally true, it was misleading as interest on VTL loans was rolled over and capitalised into loans at a time when there would be serious doubt about full recovery.

In the High Court, Justice Heath acknowledged that the directors honestly believed that comments made in the prospectus were not misleading, but this alone was not an adequate defence. They had to reach an independent judgment on the question. The directors relied on advice from management and professional advisers that everything was “compliant”. In particular, the directors said they were relying on company employees, the company auditors, the registrar of companies and the trustee appointed to represent debenture holders – each of which had a role in the preparation of a prospectus. A review of the content of a prospectus was not something directors could delegate to someone else, said Justice Heath. It was for the directors to read each prospectus and determine for themselves whether the statements made reflected the position of the company, as they knew it.

Following conviction, a decision on penalties was deferred for a later hearing.

R. v. Moses, Doolan & Young – High Court (8.07.11)

07.11.03