Treasury Corporation v Victorian Bullion Securities Pty Ltd
[1998] VSC 127
•6 November 1998
SUPREME COURT OF VICTORIA
COMMERCIAL LIST
Not Restricted
No. 2215 of 1996
F.4634
| TREASURY CORPORATION OF | Plaintiff |
| VICTORIA | |
| v | |
| VICTORIAN BULLION SECURITIES | Defendants |
| PTY LTD AND ORS |
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| JUDGE: | Mandie, J. |
| WHERE HELD: | Melbourne |
| DATES OF HEARING: | 9-12, 16-20, 23-27 February 1998, 2 March 1998 |
| CASE MAY BE CITED AS: | Treasury Corporation v Victorian Bullion Securities Pty Ltd |
| DATE OF JUDGMENT: | 6 November 1998 |
| MEDIA NEUTRAL CITATION: | [1998] VSC 127 |
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CONTRACT - gold loan transaction - construction of agreement
TRADE PRACTICES - misleading and deceptive conduct by packager of transaction -
whether packager agent for investors.
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| APPEARANCES: | Counsel | Solicitors | |||
| For the Plaintiff | Mr B.J. Shaw QC | Mallesons Stephen Jaques | |||
| with Mr P. Anastassiou and Mr P. Fox | |||||
| For the first, third and | Mr A.C. Archibald QC |
| |||
| fourth Defendants | with Mr J. Elliott | Page | |||
| For the second Defendant | Mr G. Nettle QC | Norton Smith & Co | |||
| with Mr M. Pearce |
HIS HONOUR:
In this judgment it will be convenient to use the following abbreviations:-
“ATO” Australian Taxation Office/Commissioner of Taxation “Blakes” Blake & Riggall, later Blake Dawson Waldron, solicitors for
VICFIN“Carruthers” David Carruthers, Managing Director of TCV “Corlett” Robert Bruce Corlett, Executive Director of FAI Insurances Ltd “Cullinan” Clive V. Cullinan QC, a partner in Freehills “CWA” Victorian Capital Works Authority “DMB” Victorian Department of Management and Budget “DTF” Victorian Department of Treasury and Finance “Eldridge” Elizabeth Helen Eldridge, legal officer in DMB “Elzink” Frederick John Hendrik Rudolph Elzink, Director, Financial
Operations of DMB“FAI General” FAI General Insurance Company Ltd, the fourth defendant “FAI Group” Group comprising FAI Investors and other FAI companies “FAI FAI Insurances Ltd, the third defendant Insurances”
“FAI Investors” FAI Insurances and FAI General, the third and fourth
defendants
“FAIFR” FAI Financial Resources Pty Ltd (now QML), the second
defendant“Fazen” Fazen Pty Ltd “Field” John Patrick Field, solicitor and a partner in Blakes “Freehills” Freehill, Hollingdale & Page, solicitors for FAIFR “Gray” Richard Simon Gray, solicitor and a partner in Freehills “GFSC” Gold Forward Sale Contract “Herman” Robert Lawrence Herman, Director and Secretary of FAI
Insurances Ltd“L.J. Adler” Lawrence Adler, Chairman of FAI Group until late 1988 “Mallesons” Mallesons Stephen Jaques, solicitors for TCV “Mercer” Mercer Campbell Cook & Knight, actuaries “Nayna” Herve Jean Nayna, Director of FAIFR (QML) “Part IVA” Part IVA of the Income Tax Assessment Act (Clth) “QML” Quantitative Management Pty Ltd (formerly FAIFR), the
second defendant“Ross” Alan Maxwell Ross, General Manager - Finance of FAIFR “Rothschild” Rothschild Australia Ltd “R.S. Adler” Rodney Stephen Adler, Group Investment Manager for FAI
Group until late 1988 then CEO“SAFA” South Australian Government Financing Authority “SBNSW” State Bank of New South Wales “Sharah” John Matthew Sharah, Managing Director of FAIFR (QML) “Sheehan” Dr Peter Sheehan, Director-General of DMB “TCV” Treasury Corporation of Victoria, the plaintiff, and the
successor to VICFIN“VBS” Victorian Bullion Securities Pty Ltd, the first defendant “VICFIN” Victorian Public Authorities Finance Agency “Yeoh” Barbara May Yeoh, General Manager of VICFIN
In November 1987 a number of parties entered into a series of interlocking transactions which I will refer to as the "gold loan transaction" or “the transaction”. The gold loan transaction comprised a large number of written agreements and some side letters. The gold loan transaction may be broadly described as follows.
There was a loan of gold worth $200M by Rothschild to VICFIN. VICFIN had to pay back the gold over a period of 15 years. VICFIN arranged with Rothschild that Rothschild would sell the borrowed gold and provide the monetary sale price of $200M to VICFIN. That sale of gold by Rothschild on behalf of VICFIN was a sale to VBS which paid $200M for the gold. VBS did not take possession of the gold which it bought but left it on deposit with Rothschild under the terms of a gold entitlement certificate which entitled VBS to recover the gold as it was required in order to sell it to VICFIN to enable VICFIN to pay back the gold originally borrowed from Rothschild.
In order to put VICFIN into a position to give equivalent gold back to Rothschild at the time the gold loan agreement provided, VICFIN bought gold, on a forward sale basis, from VBS in the same quantity that it had borrowed from Rothschild.
The sum of $200M which VBS injected into the transaction was obtained from the FAI Investors who subscribed to units in a unit trust of which VBS was trustee. The FAI Investors in turn borrowed money and provided money of their own (“equity”) in order to make up the $200M.
The gold loan transaction was put together or "packaged" by FAIFR through its directors Sharah and Nayna. A deed of agreement made 15 April 1987 between FAI Insurances, FAIFR, FAI Financial Holdings Pty Ltd, Sharah and Nayna recorded that FAI Insurances, Sharah and Nayna had been joint venturers since October 1985 pursuant to oral arrangements. The deed provided for Sharah and Nayna to hold 40% of the issued shares in FAI Financial Holdings Pty Ltd and FAI Insurances to hold the other 60%. FAI Financial Holdings held all the issued shares in FAIFR which was the “operating company” for the purpose of conducting the business of arranging finance and managing financial arrangements.
FAIFR had arranged for the borrowing of the necessary funds by the FAI Investors from SBNSW and then there was an assignment or novation of that bank's rights to Fazen.
There were a number of associated agreements. One was a swap agreement by which rights to interest were swapped between Fazen and VICFIN so that VICFIN converted that portion of its interest liability which was fixed to a floating rate. There were also government guarantees and a financing of the arrangement by the issue of bills.
An important transaction document was the GFSC. This was a deed dated 4 November 1987 between VBS (described as "the Vendor") and VICFIN and it made provision for VICFIN to acquire gold from VBS on specified future dates for specified amounts referred to as Gold Payments (cl.2.1 and Sch.1).
The GFSC (cl.5) made provision in certain circumstances for the recalculation of these Gold Payments by first listing a large number of "assumptions bases and criteria" upon which the amounts of the Gold Payments had been based (cl.5.1). The listed assumptions included a number of assumptions about the tax treatment which would be given by the ATO to various aspects affecting the tax liability of the FAI Investors (including the amounts of assessable income and deductions, the timing of income derivation and expense deductibility and the like, the rates of tax applicable and the non-imposition of penalty or additional tax on the Investors). If any of the assumptions became incorrect, either party was entitled to elect to have the amount of the Gold Payments recalculated (cl.5.2(a)). The recalculation (up or down) was to be done by the Manager (FAIFR) so as to cause the Investors' "Actual Rate of Return" to be equal to their "Required Rate of Return" (as defined).
The parties each had an option to terminate or cancel the transaction in accordance with cl.8.
Clause 8.3 provided, so far as material:
"8.3 VICFIN's Option based on Certain Events
The option of VICFIN pursuant to Clause 8.1 may only be exercised by
forty five (45) days notice in writing to the Vendor given at any time after
the occurrence of any of the following events, namely if:-
(a) (i) the Assumptions or any of them shall be or become incorrect; ...
and as a result thereof the amounts payable by VICFIN hereunder or
thereunder will be increased to an extent unacceptable to VICFIN (in its
absolute discretion);...
8.4 Effect of exercise of Cancellation Option If:- ...
(b) VICFIN gives notice to the Vendor pursuant to Clause 8.3, then on that date (the 'Relevant Date') being:- ...
(d)
the date upon which the notice by VICFIN given pursuant to Clause 8.3 expires,
...
(e)
VICFIN shall pay to the Vendor an amount (herein called the 'Lump Sum') equal to the aggregate of the following (assuming that the Vendor has delivered all Gold Tranches then and thereafter to be delivered hereunder:-
(i) the Gold Payment (if any) due hereunder on the Relevant Date;
(ii) any other moneys due and payable by VICFIN hereunder on or before the Relevant Date but unpaid as at the Relevant Date;
(iii) such amount as calculated by the Manager, which when aggregated with the amount referred to in paragraphs (i) and (ii) above will be equal to the aggregate amount required to:-
(aa) enable the Investors to pay to the Lender the aggregate amount then due and payable by the Investors under the Financing Documents assuming that the relevant amount is received by the Investors on the date of payment of the relevant amount; and (bb) give to the Investors respectively an Actual Rate of Return for the period referred to in the Investors' Letter equal to their respective Required Rates of Return; calculated up to the date of payment of the Lump Sum, but having regard to Clause 8.5, taking into account any moneys received by the Vendor under this Deed prior to the payment of the Lump Sum;
..."
TCV as successor to VICFIN ultimately terminated the transaction and some questions of construction are raised in the proceeding in relation to this. A variety of other causes of action are pleaded the principal of which is that TCV alleges that FAIFR engaged in misleading and deceptive conduct in contravention of s.52 of the Trade Practices Act 1974 (Cth). Paragraphs 44 and 45 of the amended statement of claim allege that FAIFR made eight misrepresentations to VICFIN in relation to the gold loan transaction - of these five misrepresentations were ultimately relied upon. These were that:
(i)
the investors were contributing equity in the approximate amount of $35M whereas in fact the investors contributed equity in the amount of $56M;
(ii)
the investors were agreeing to pay initial fees to FAIFR (as the manager) of approximately $3M whereas in fact the investors paid FAIFR an initial management fee in excess of $15M;
(iii)
save for the loan agreement, the financial accommodation arrangements for VICFIN at settlement were not materially different from the arrangement outlined to VICFIN in the indicative proposal of July 1987 whereas there were material differences;
(iv)
there was no material difference between the financial accommodation arrangements for VICFIN considered in the Cullinan opinion of July 1987 and the arrangements made at settlement whereas there were material differences;
(v)
FAIFR had recently made arrangements for the financial accommodation of SAFA upon terms almost identical to those in the proposal whereas in fact this was not so in that the SAFA arrangements were subject to obtaining a favourable tax ruling from the ATO.
The Facts
Sharah is and was in 1985 a chartered accountant with experience in “tax based financing”. In December 1985 he and Nayna agreed to set up with the FAI Group a joint venture company, FAIFR, “to initiate financial structures to introduce to the market” and thereby to derive fees. Nayna was a mathematician who also had experience in taxed based financing and the use of computers in producing relevant complex models, calculations and schedules. In 1986 FAIFR organised such a financing transaction involving VICFIN which I will refer to as “the annuities transaction”.
VICFIN was established by the Victorian Public Authorities Finance Act 1984. VICFIN’s functions included raising funds to be on-lent to participating government authorities and agencies. Yeoh had been appointed General Manager of VICFIN in December 1985. She had tertiary qualifications in mathematics and statistics and had previous experience of some length in financial management with the Victorian Ministry of Transport and with Telecom.
Yeoh was in charge of the day to day operations of VICFIN and reported directly to the Board which normally met monthly. The Chairman of the Board in 1987 was Sheehan who was also the Director General of DMB, the predecessor to the DTF.
Sharah first met Yeoh and also had a number of telephone discussions with her in or about January 1986, having been referred to VICFIN by a senior official in DMB. Sharah wished to market a financing package based on the concept of “leveraged annuities”. The concept was based upon certain perceived tax advantages, including the timing of assessable income under the specific income tax provisions relating to annuities, which might enhance the after-tax return of investors. Sharah was at about this time also discussing the concept with the New South Wales Treasury Corporation and obtaining senior counsel’s advice. Yeoh told Sharah that in order to consider the annuity funding concept VICFIN would need to seek a tax opinion, and be provided with the full mathematics for the methodology relating to the investor’s yield, illustrative termination values and final verification by an actuary.
Sharah told Yeoh at an early stage of their discussions concerning the annuity concept that VICFIN would have no rights to be involved in the negotiation of the manager’s fee or the yield structure for the other parties as this would be confidential. Sharah said that VICFIN would be offered a cost of funds subject to termination values. He told Yeoh that tax indemnities from VICFIN would be required by the investors.
In a letter dated 28 January 1986 on FAI Group letterhead, Sharah as “General Manager, Financial Markets Group, FAI Insurances Ltd”, submitted a proposal to VICFIN “for authorising [FAIFR] a wholly owned subsidiary of FAI Insurances Ltd” to arrange an annuities transaction. Correspondence between VICFIN and FAI Insurances concerning the proposed annuities transaction continued and further discussions took place in the first half of 1986. During this period, Sharah successfully organised two substantial annuity transactions for the New South Wales Treasury Corporation, raising $150M (April 1986) and $116M (May 1986) with investors being some of the major trading banks. Nayna advised Yeoh when the first of these was about to be signed.
In February 1986 VICFIN (Yeoh) obtained Sharah’s consent to disclose the contents of the “indicative proposal” to Blakes (Field) for advice as to the taxation aspects of the transaction.
In a letter dated 10 March 1986 from VICFIN (Yeoh) to DMB (Sheehan) the proposal by FAI Insurances relating to fixed rate annuity funding was summarised. Yeoh said that the proposal was structured along the lines of a leveraged lease. She pointed out that certain “tax breaks” would be relied upon and referred to the “taxation risks” including the “wide discretion and powers” of the Commissioner including the powers under Part IVA. She noted that there was on up-front fee to the manager of 1% on the face value of the purchase price of annuities and that FAIFR “have stated that the level of fees payable by the investors is not to be subject to negotiation by VICFIN”. In late May 1986 Sharah and Nayna met with Yeoh to further discuss the proposed annuity transaction. Sharah again told Yeoh that their requirements included that VICFIN would have no right to know the proposed yield and fee of other parties, including the manager, during the negotiations and that VICFIN would be offered a cost of funds subject to illustrative termination values which would be calculated when negotiations were completed. Yeoh agreed to these requirements.
On or about 22 May 1986, the Federal government introduced into Parliament amendments to the Income Tax Assessment Act inserting Divisions 16E and 16D covering financing arrangements involving deferred interest security and tax exempt bodies. Sharah told Yeoh that Division 16E had been introduced to give effect to a 16 December 1984 press statement of the Treasurer against deferred interest and zero coupon securities. Shortly thereafter, Sharah obtained senior counsel's opinion (a copy of which was provided to Yeoh) to the effect that the amending legislation did not cover annuities.
Draft documents for the annuities transaction were produced and VICFIN gave FAI Insurances a mandate to organise the transaction. Various aspects of the transaction were subsequently negotiated and agreed.
In mid-June 1986, in the course of a telephone discussion, Yeoh told Sharah that it was government policy not to include as a termination cost for VICFIN any compensation for the loss of future service fees incurred by any party because of the early termination by VICFIN. Sharah told Yeoh that that was a concern. Yeoh replied that it would be in accordance with government policy if fees were structured to be payable up front and included in the calculation of VICFIN's cost of funds at the outset. Sharah then said that that approach would be adopted when structuring transaction payments. Yeoh said that was acceptable.
On or about 17 June 1986 a draft of an "Investors' Letter" was faxed to Yeoh. The Manager’s fees were left blank.
On 26 June 1986 the transaction documents for the annuities transaction were executed. The investor was “Fire and All Risks Insurance Company Ltd” (a member of the FAI Group) and the Manager was FAIFR. A copy of the relevant investor’s letter was placed in a sealed envelope and provided to VICFIN's solicitors.
The overriding object of VICFIN in entering this and a number of other “tax based” or “tax advantaged” transactions at around this time was to obtain a lower cost of borrowed funds. This was achieved by the investor passing on or sharing the value of the benefits of accelerated tax deductions, deferred assessable income and of whatever other tax benefits or “breaks” the transaction attracted. Yeoh well understood these fundamental aspects and appreciated that there was a risk that the ATO would attack such transactions under Part IVA or otherwise.
The true quantum of FAIFR’s fees in the annuities transaction were hidden from VICFIN. The indicative proposal provided for fees of 1% on the amount of finance arranged. This appears from Sharah’s cross-examination:
“So that the position is that you had made a proposal to Mrs Yeoh in relation to the annuities transaction which showed, on the face of it, fees of half a million dollars in respect of annuities of 50,000,000, and the ultimate transaction involved, in relation to annuities of 92,000,000, fees of something like 5 or 6 million. That’s right, isn’t it? --- Yes that’s right.
That had happened, had it not, by 8 July 1987? --- Sorry? The transaction in relation to the annuities had been entered into before 8 July 1987? --- Yes it was entered into on 26 June 86.
So you knew at that point in relation to that transaction, the fees were very much higher than fees of the order of which had been indicated in the documents which you’d sent to Mrs Yeoh? --- Yes.”
It was confirmed in Nayna’s cross-examination:
“Did Mr Sharah tell you to hide the fee in the up-front payment of interest and in an inflated interest rate? --- Mr Sharah told me to show the fees as interest - show the - increase the interest to cover fees.
Did he tell you to do that in order to hide the fees? --- Yes.”
During August and September 1986 FAIFR worked on an annuity funding arrangement for SAFA with the investor being the Commonwealth Bank.
On 19 September 1986, the Federal Treasurer issued a press release announcing that the Federal government intended to put in place measures preventing tax exempt bodies entering into financial arrangements using leveraged and/or deferred annuities to raise funds at confessional rates at the expense of the revenue. On 22 September 1986 Sharah faxed to Yeoh a copy of that press release.
During the week commencing 22 September 1986 Sharah prepared an outline of the concept of a gold loan and gold hedge based on SAFA’s required cost of funds, rates and cashflow parameters identified during the course of the negotiations of the proposed SAFA annuity arrangement.
In October 1986 and again in April 1987, Sharah had lunch with Yeoh. At one of those lunches Yeoh said she was happy with the way in which the annuities transaction had been implemented. Sharah asked Yeoh whether VICFIN would be interested in any new tax based structured financing arrangements now that the Federal government had announced that Division 16E would be applied to annuities issued by State governments. Yeoh said yes but that she would prefer that VICFIN’s transaction not be the first transaction negotiated.
In late 1986 SAFA informed Sharah that it would require the option to seek a tax ruling before becoming obliged to draw down under any gold loan transaction which it entered.
Between November 1986 and the end of June 1987 Sharah was “heavily involved in structuring the [SAFA] transactions and negotiating documentation.” SAFA and the other parties agreed upon procedures for SAFA to seek a tax ruling after the signing date. It was agreed that SAFA would have the right but not the obligation to seek a tax ruling after the signing date and before being bound to proceed. On 26 June 1987 the SAFA gold transaction documents were signed.
In or about July 1987, SAFA lodged a request for a ruling with the ATO. Shortly after 26 June 1987, Sharah telephoned Yeoh and told her that FAIFR had arranged a financial accommodation structure involving a gold loan to a state government which might be of interest to VICFIN and that the gold risk was hedged. Yeoh and Sharah agreed to have a meeting in Melbourne to discuss the concept. Prior to meeting with Yeoh, Sharah asked L.J. Adler whether FAI would have an interest in investing in the gold hedge. He said it was not out of the question.
On or about 1 July 1987 Sharah and Nayna met with Yeoh. Sharah told Yeoh that FAIFR had recently signed a fully hedged gold loan transaction with another state government party. Sharah told Yeoh that it was a tax aggressive structure because gold deliveries would not start until the second half of the term and that this caused major interest capitalisation. He outlined the fully hedged gold loan concept with the analogy of a zero coupon bond. He said that a bar of gold would be similar to a zero coupon bond whose A$ value accumulated to maturity but that Division 16E should not apply. He told Yeoh that VICFIN would be receiving an A$ cost of funds subject to early termination values. He also told her that the Investors’ Letter would be confidential during negotiations. He asked Yeoh a number of questions to ascertain the size and nature of VICFIN’s possible cashflow and commercial requirements.
Sharah told Yeoh that the amount of the fully hedged gold loan which could be arranged for VICFIN would depend on, amongst other things, the finding of investors to provide equity to invest in the gold hedge transaction. He told Yeoh that he was not sure whether FAI would be interested in providing enough equity for a total hedge of $200M and that they might need to approach some other equity participants. He told Yeoh that FAIFR had had the benefit of the experience of negotiating transaction documents and that they could have prepared draft documents to assist VICFIN’s understanding of the concept. Subsequently, Sharah telephoned Gray, of Freehills, the firm which had acted for FAIFR in respect of the 1986 VICFIN annuities transaction and in respect of the 1987 SAFA gold loan transaction. Sharah instructed Gray to prepare documents.
Prior to 8 July 1987 Nayna telephoned Yeoh. He told her that he had run some initial calculations and based on those calculations VICFIN would be able to achieve a rate saving in the order of 1.3% below the Bank Bill Rate on the floating rate component of funding and 0.3% below the Commonwealth Bond Rate on the fixed rate component of funding. Yeoh said that these savings would be of interest to VICFIN.
| 39 | By letter dated 8 July 1987 from FAIFR to VICFIN, Sharah provided to Yeoh an “indicative proposal”. The heading of the letter referred to a “gold loan and gold hedge: A$100 million - A$200 million” and went on to state, so far as relevant: |
"I refer to our discussions on the possibility of VICFIN raising a gold loan in Australia from a reputable gold bank such as [Rothschild] and hedging the gold risk into fixed and floating rate Australian dollars by means of a gold forward purchase agreement with an introduced gold vendor.
Attached for your consideration is an indicative proposal which includes computer output based on a gold loan worth A$100 million at drawdown. The attached numerical data should be proportionally scaled up to reflect the actual amount of the gold loan to be drawndown.
Under the proposal the gold loan would be fully hedged into Australian dollars by means of a gold forward purchase contract. Combined with a fixed to floating rate swap the fully hedged gold loan will provide fixed and floating rate debt funding, net of establishment fees, at the following rates:
1. on the fixed rate liabilities (about 20% of the total funding) : 0.3% p.a. on half-yearly rests below, say, the weighted average Commonwealth bond rate based on the principal repayments of the fixed rate component of the total funding; and
2. on the floating rate liabilities (about 80% of the total funding) : 1.3% p.a. below the bank accepted bill rate determined by reference to the Reuters BBSW page and/or a reference panel.
The actual ratio of fixed and floating rate liabilities will be determined by the prevailing market conditions at the time when the gold loan is advanced.
The basis for achieving rate savings is VICFIN’s comparative advantage in the longer term markets arising from its credit status.
As you are aware, gold loans are commonly used by borrowers which have a natural hedge in respect of gold e.g. gold producers. Nevertheless, gold loans can be made available to any borrower with a suitable credit rating or where the gold exposure is adequately hedged with a person with access to gold. The main advantage of a gold loan is that periodic fee payments are generally very low, around 2% p.a. on half-yearly rests. The low periodic payments in respect of the gold loan will permit the borrower to make additional payments in purchasing gold to hedge out the gold risks without increasing the periodic payments which would have been payable under a conventional Australian dollar loan.
The combined effect of the gold loan and gold forward purchase is that the borrower may arbitrage rate savings where the borrower has a comparative advantage in the markets concerned. VICFIN, as an Agency whose financial transactions are guaranteed by the Victorian Government, can reasonably expect to use its comparative advantage in the longer term markets to arbitrage rate savings through a hedged gold loan.
As discussed we have identified a number of parties interested in participating in one or more of the abovementioned transactions.
[Rothschild] is prepared to provide the gold loan on terms which will not affect its balance sheet. [FAI General] (“FAI”) is currently considering participation in the gold hedging facility to VICFIN. Subject to final approvals we understand that FAI is likely to purchase units in the gold investment trust currently worth between A$100 million and A$200 million.
We are at an early stage of discussions with the Australian Mutual Provident Society as a potential gold investor and have not endeavoured to approach any other potential investors on the current proposal such as the major Australian banks.
In light of the interest expressed by the parties we would be grateful if you could advise whether VICFIN would be interested in proceeding with the proposal...” (Emphases added)
The letter went on to refer to a number of enclosures and to discuss what were described as “the main matters for your consideration”, namely, gold risk; security; Victorian stamp duty; gold forward sale premium calculation; acceptance facility; termination value calculations; assumption indemnities; transaction duties; fixed and floating rates; increased costs; life insurance companies; and the nature of gold loans.
Under the heading “Termination Values Calculations”, Sharah stated:
"Two methods for determining termination values are attached. They show that VICFIN’s cost of funds would be increased if the gold transactions are terminated early and that the extent of the increase would depend upon the method of termination.
The two alternative methods illustrated are:
(i) VICFIN concurrently terminates the Gold Loan and Gold Forward Sale Contract and pays the relevant Lump Sum amount to the Investors who repay their loan obligations in full and recover their equity investment after maintaining their required rate of return on equity until that event; and (ii) VICFIN initially does not terminate either the Gold Loan or Gold Forward Sale Contract but initially acquires substantially all of partnership interests of the Investors (assuming some invest by way of a partnership) in return for the payment of a lesser Lump Sum than under method (i), and would thereafter terminate the Gold Loan and Gold Forward Sale Contract. These methods of termination can be discussed in more detail in due course. The Transaction Documents have been drafted to provide flexibility on the method of termination.”
Sharah concluded the letter by stating that he and Nayna were proposing to be in Melbourne in the next week to discuss the proposal “if it is generally acceptable to you”. In one attachment dealing with the parties to the proposed transaction, the Investor was described as “Australian institutional investors severally, or jointly between associated investors” although it was clear from the letter that FAI General was likely to purchase a large part if not the whole of the units. Also attached to the letter were seven schedules containing tables of “indicative cashflows” relevant to the gold borrower. Schedule “1T” set out what the “termination values” would be at six monthly intervals throughout the period of a transaction commencing in August 1987 based on the cash flows assumed in the preceding schedules. The earliest termination payment was shown as $103,144,559 as at February 1988 being a cost of funds ($100M) of 19.04% to that date. [The excess of $3,144,559 over the funds of $100M represented the “up-front” fees, costs involved in the transaction, and interest.] The table showed a gradually decreasing cost of funds, the later the termination date.
The attachments also contained lists in short form of “assumed gold loan terms”, “assumed gold forward purchase contract terms” and the like and a list of what the legal documentation relating to the transaction was “likely to include” including a unit trust deed, a management agreement appointing FAIFR as Manager and various contractual and security documents. One attachment stated that arrangement and administration and establishment fees would be “[t]o account of Investor”.
Sharah provided to Yeoh, either with the indicative proposal or shortly thereafter, a copy of a letter from Sharah on behalf of FAIFR to Cullinan dated 8 July 1987. This letter sought Cullinan’s “urgent opinion on the attached investment proposal from the viewpoint of the potential investors”. The letter, addressed to “Dear Clive”, said that FAIFR was currently talking to a major Australian life assurance company and a general insurance company as potential investors and that those parties “would require to see an income tax opinion on aspects of the proposal before making any decision to invest”. Sharah summarised the proposal as follows:
"The proposal is that each investor would invest in a suitable investment vehicle, trust or partnership, which would purchase allocated gold in the spot market and arbitrage profits by hedging the gold in the forward market by means of a gold forward sales contract with an introduced buyer. The buyer would pay for the gold as and when it is delivered and would use it to hedge its own gold position. As you are aware, we have been negotiating with a major potential forward buyer of gold which would use the gold forward purchase contract to hedge its gold loan liabilities.
The proposal can be summarized as follows assuming a unit trust investment of A$100 million by an investor, alone or in partnership with an associated company:
1. the Investor will contribute equity of about A$16.6 million;
2. the Investor will borrow 2 fixed rate Loan Advances totalling about A$85 million as shown in attached Schedule 4A and Schedule 5A where interest is payable half-yearly in arrears;
3. the Investor will pay Loan Establishment Fees to the Bank, Loan Arrangement Fees to the Manager and an Initial Management Fee to the Manager;
4. the net cash of the Investor will be applied to subscribe for units in a gold Trust;
5. the Trust capital subscriptions would be applied to purchase allocated gold in the spot market from a bullion supplier at the prevailing market price;
6. the Trustee would deposit the gold with a Gold Bank in consideration for a Gold Entitlement Certificate issued by the Gold Bank under which the Trust would receive an equivalent amount of gold (not necessarily the same gold) together with gold fees denominated in Australian dollars which accrue on a daily basis and are payable half-yearly in arrears;
7. the Trustee would hedge the gold by selling it under a Gold Forward Sales Contract with the introduced counterparty Gold Borrower whereby the Trust would be entitled to Australian dollar payments in respect of gold sold as and when the gold is delivered;
8. the Trustee would distribute the gold sale profits and gold fees of the Trust as net income and would redeem at no profit the Trust units out of the gold sale proceeds representing the original cost price of the gold sold; and
9. the Investor would apply the net income distributions and unit redemption proceeds to service half-yearly principal and interest payments under the Loan Agreement throughout the 15 year term and to derive its required rate of return.”
The letter went on to supply some details of the various elements of the transaction and the documents involved and attached, inter alia, tables dealing with cash flows and the investor’s loan profile and the like on an assumed $100M transaction. Amongst those tables was a table (schedule 6A) headed “Investors’ taxable income profile” showing deductible fees to be incurred by the Investors totalling $1.5M. Another table (schedule 7A) headed “Investors monthly cashflow schedule” showed a fee of $1.5M to be paid by the Investors at the commencement of the transaction. The copies of schedules 6A and 7A received by VICFIN and produced to the Court each bore two pencilled commas by Yeoh in the figures relating to the fee so that “1500000” became “1,500,000” and Yeoh’s evidence confirmed that she became aware at the time of the proposed $1.5M fee payable by the Investors to FAIFR in its capacity as Manager.
The letter asked Cullinan for his opinion as to whether certain taxation assumptions underlying the calculation of income or loss for each year of income were correct including such matters as the time of deductibility of loan interest and fees and the time of derivation of gold sale profits and the like and as to whether various provisions of the Income Tax Assessment Act, including Part IVA, might affect those assumptions. The letter concluded by pointing out:
"...that negotiations are still in progress with the potential participants and that the terms set out in the attached proposal are potentially subject to variation in line with market requirements which may come to light. Meanwhile could you please provide your opinion in the context of the facts given in this letter and the attachment.”
By a second letter of the same date to Cullinan, Nayna on behalf of FAIFR provided certain further “information” to him for his consideration. The information comprised calculations of the present value to the investor of the tax effect of the tax deductions involved in the transaction (at most $7.3M) and the present value of the net cashflows pre-tax ($9.3M) and a comparison of those amounts with a hypothetical leveraged lease of an aircraft involving the same rate parameters. It was known to FAIFR that the efficacy of the transaction for tax purposes might, in Cullinan’s opinion, depend to a significant extent on whether the pre-tax cashflows outweighed the tax benefits.
By letter dated 14 July 1987 Sharah on behalf of FAIFR provided Yeoh on behalf of VICFIN with draft documents for the transaction which had been prepared by Freehills.
By letter dated 15 July 1987 Nayna on behalf of FAIFR supplied Cullinan with two more detailed schedules. The first of these showed investment funds of $101.5M ($100M plus $1.5M fees) made available from borrowings by the investor of $84,901,304 and equity provided by the investor of $16,598,696.
On 17 July 1987 Sharah faxed to Yeoh a copy of Nayna’s letter of 15 July 1987 and a copy of Cullinan’s tax opinion on the indicative proposal (and also a “letter dated 9 October 1986 from [Cullinan] setting out his tax opinion on the transaction signed recently - this is provided merely as background information”). In his opinion on the indicative proposal (by letter on behalf of Freehills dated that day), Cullinan summarised the proposal - he referred to the investor contributing equity of $16.6M. After summarising the proposal, he noted some general matters. He wrote that although the transaction involved a considerable deferment of taxable income in that positive taxable income for the investors did not emerge until the 13th year, the transaction was “tax positive overall in that it produces an alternative total taxable income of $8.3 million”. He then said:
"The second advance as I have already noted is interest only over the first 12 years and the Commissioner, in his guidelines in relation to leverage leases, has indicated that an interest only loan is not acceptable to him. Another requirement of the Commissioner in relation to leverage leases is that the equity provided by the Investor should be at least 20% of the investment. In the present transaction I am instructed that the equity may be slightly below that. At least it is in the general vicinity of a 20% investment. The features to which I have referred may be considered of consequence by the Commissioner in relation to the application of Part IVA. He has made clear in his various Rulings (IT 2051, IT 2169, and IT 2220) that his concern is as to the undue deferment of tax, particularly where that is due to the advance in timing of deductions or deferring the receipt of income. Although there are large deferrals as have been indicated, the interest expense has not been abnormally advanced: it is uniformly payable in arrears. The fact that interest is payable throughout the period of the transaction on the second loan with no principal repayments should not automatically result in the application of Part IVA.
Calculations have been provided to me which indicate that the present value of the tax benefits is $7.3 million whereas the present value of the net cash flows pre-tax is $9.3 million. Prima facie, therefore, viewed purely objectively, the pre-tax cash flows will be perceived as of more importance than the tax benefits achieved. I have also been provided with details of the tax calculations of a comparable investment in a leverage lease. These figures show that under such an investment the present value of the tax benefits would be $7.6 million compared with the present value of the net cash flow pre-tax of $9 million. In other words the tax deferral and other benefits arising under this transaction are less than those arising under a leverage lease transaction meeting the Commissioner’s parameters.
Again it may, in a sense, provide a false picture if the interest deductions are considered only in relation to the taxable incomes produced by the transaction itself. The use of borrowed moneys to partly finance the transaction leaves the Investors free to employ their working capital in other directions and so earn assessable income outside the transaction. Indeed, from figures provided with your letter dated 15 July 1987 you have calculated that additional income totalling $170,090,073 could result outside the transaction by virtue of a borrowing of funds to finance the transaction. These considerations suggest that too much significance should not be placed upon the fact negative taxable incomes generated by the transaction.
In addition I am instructed that the transaction being offered to the Investors is necessarily structured in a way which is acceptable to VICFIN. It has not been structured in this way in order to provide tax benefits for the Investors.”
Cullinan went on to consider whether Part IVA would apply to the transaction and, after consideration of the issues, expressed his opinion that it “should not apply”. The opinion was expressed subject to the qualification that:
“In the end the determination of what was the dominant purpose of the Investors would require the Commissioner, and in turn a Court, to examine the evidence both documentary and verbal testimony, as to the reasons for them entering into the transaction. I have no information of this kind before me.”
In addition Cullinan added a “further caution” concerning Part IVA:
“I must further caution that the provisions are couched in extremely wide language and they have not been the subject of judicial scrutiny. In these circumstances it is not possible to speak in absolute terms. It would be possible for a view to be taken of the provisions such as to enable this transaction to be brought within their scope. All I can say, however, is that having regard to the considerations to which I have adverted that in my opinion the Part should not apply.”
Cullinan’s opinion concluded as follows:
“(9) Finally, my opinion is given to you for your purposes only and is not to be relied upon by any other party to the transaction. Those parties should seek their own independent legal advice as to the taxation implications for them. I should also add that the views I have expressed are based upon the facts as set out and described in your letter to me of 8 July 1987. If the transaction proceeds and the documentation implementing it is put before me I can give my final opinion based upon that documentation.”
Yeoh read the material supplied to her by FAIFR. A matter of particular concern to Yeoh was the cost of terminating the transaction. She was aware that early termination would increase VICFIN’s effective cost of funds. She examined the termination values set out in Schedule 1T to the indicative proposal. She was aware that taxation issues were important to the transaction, particularly as VICFIN would be asked to indemnify the Investors in relation to certain taxation assumptions. She also saw that the proposal was described as an “indicative” proposal based upon finance of $100M. She assumed that the fundamental parameters of the transaction would be the same as set out in the indicative proposal, scaled up in proportion to the ultimate funding to be provided.
Then, on Tuesday 21 July 1987, Sharah and Nayna met with Yeoh in her office. This was a long meeting. Sharah and Nayna went through the indicative proposal and the schedules with Yeoh. During the course of that process Sharah asked Yeoh whether VICFIN would require a tax ruling before the drawdown. Yeoh said that VICFIN would not. She said it would not be appropriate for this type of transaction. Sharah told Yeoh that in their experience some providers of tax indemnities required a prior tax ruling on tax assumptions for certainty and to minimise their tax risks. Yeoh said she knew that some governments may require a prior tax ruling, but it was not Victorian government policy for this type of transaction. She said VICFIN would rely on its legal advice and wait for the assessment process to take its course. Sharah told Yeoh that if VICFIN decided that it required a ruling they would need to know this before they approached the market so that there would not be unnecessary changes throughout the negotiation process.
Late in the meeting Sharah pointed out to Yeoh that the 8 July 1986 letter to Cullinan assumed that an investor paid interest in arrears and that an investor contributed equity up front. Sharah said to Yeoh that the VICFIN annuities transaction involved the investor paying interest in advance and contributing equity over a period of about a year. Sharah said it would be better for them if they could arrange an investor’s debt structure and equity contributions on a similar basis for the current proposal. Yeoh said she would consider this and agreed that prospective lenders and other parties might be approached on this basis.
After earlier oral communication, on 11 August 1987 VICFIN wrote to its solicitors, Blakes (Field), concerning the gold loan transaction seeking that firm’s “assistance in reviewing the material forwarded to you, including draft documentation prepared by FAI’s legal adviser, Freehill, Hollingdale & Page.” Field was a very experienced solicitor in banking and finance matters. Specific advice was sought on a number of aspects including a review of the taxation assumptions and of Cullinan’s opinions. In relation to “equity contributions”, advice was sought as to whether Cullinan’s opinion would be affected if there was not a “full equity contribution by the investor(s) at the commencement of the transaction” in that “FAI” had proposed that “an alternative approach be adopted whereby FAI, as investor, would progressively inject equity over an 18 month period”.
On 18 August 1987 Yeoh advised Sharah (and in turn Sharah advised L.J. Adler and Herman) that she had received legal advice to support a recommendation to the Board of VICFIN to appoint FAIFR to raise a gold loan equivalent to $200M for a 15 year term and that, in order to hedge VICFIN’s gold risk, the recommendation to the VICFIN Board would be to appoint FAIFR to arrange a gold hedge and, further that the VICFIN Board would meet at the end of August, 1987 and if the recommendations were accepted the proposal would be referred to DMB for the authority necessary to secure a Victorian government guarantee for the transaction. In his memorandum to L.J. Adler, Sharah said that in the context of the gold hedge the participation of FAI General (or any other suitable FAI Group company) was sought as investor. He attached details of the indicative investment proposal and went on to say:
“The Victorian Government guaranteed after-tax yield would be 14% p.a. using the multiple sinking fund method of analysis as shown (equivalent pre-tax yield of 27.451% p.a. assuming a tax rate of 49%).
FAI’s required investment over an 18 months period would be a total equity contribution of about $47 million. This equity contribution will be substantially recovered by FAI within 2 years from tax credits (see Investor Tax Profile).
Could you please confirm FAI’s likely interest in participating as the investor on the indicative terms attached so that we can convey this information to VICFIN for inclusion in the VICFIN Board submission.”
On 18 August 1987, Nayna also prepared a new schedule for internal use showing the following investors’ equity contributions totalling $46.5M:
“EQUITY CONTRIBUTIONS
CONTRIBUTION ON 15-SEP-87 $11261579.99 CONTRIBUTION ON 01-FEB-88 $1770821.92 CONTRIBUTION ON 01-AUG-88 $17318630.14 CONTRIBUTION ON 01-FEB-89 $16172054.79
TOTAL EQUITY CONTRIBUTIONS $46523086.84”
At that time Nayna had in mind that those contributions would produce a result which would cover a fee for FAIFR of $10M.
On 27 August 1987 Yeoh informed Field by telephone that VICFIN would probably be prepared to accept the credit risk involved in deferral of equity contributions but not if Blakes advised that equity up-front was preferable for tax reasons. Field advised her (as he noted) that the equity contributions should be all up-front in order to adopt the prudent course for leveraged financing using a leveraged lease model.
Yeoh provided a paper for the Board of VICFIN for its meeting on 27 August 1987 concerning the gold transaction. The paper summarised the proposed transaction.
The paper commenced by stating that:
“An innovative financing proposal has been received from [FAIFR] which would provide VicFin with the opportunity to raise long term funds of A$200 million at the following concessional rates:
(a)
Approximately 15 - 20% of the total funding (A$30 to 40 million) at 0.3% p.a. on half-yearly rests below the weighted average Commonwealth Bond Rate based on the principal repayments of the fixed rate component of the total funding.
(The total term of the funding is 15 years with principal repayments
occurring in years 12 to 15.)(b) Approximately 80 - 85% of the total funding (A$160 - $180 million) at 1.3% p.a. below the bank accepted bill rate...”
The paper then referred to participating authorities and said as to on-
lending:
“Given the complex nature of the transaction it is considered preferable that the
total proceeds be on-lent to only one participating authority.
The CWA has indicated that it is prepared to accept some A$240 million of floating rate funding this financial year, and would be expected to find long term funding at 1.3% p.a. below the Commonwealth Bond rate attractive.”
The paper then set out a summary of the transaction structure stating:
“In summary VicFin would raise a gold loan in Australia from a reputable gold bank such as [Rothschild] and hedge its gold risk into Australian dollars by means of a gold forward purchase contract.
The structure of the transaction would involve the following:
(a) Gold Investment... (i) The investor will contribute equity of A$30 - 40 million;
(ii) The investor will borrow two fixed rate Loan Advances totalling some A$160 - 180 million where interest is payable half-yearly in arrears; the first loan is a principal and interest loan over a 10 year period whilst the latter loan is an interest only loan for the first 12 years and thereafter is principal and interest until end of term (ie year 15).
Interest will accrue on a daily basis at a fixed rate and will be payable half-yearly in arrears without any capitalisation. The first advance is to enable the Investor to pay fees as set out in (iii) below and the second advance represents the debt component of the investment in the Unit Trust by the Investor. The advances will be on normal limited recourse terms where recourse is limited to the cash-flows generated by the Trust.
(iii) The Investor will pay
• Loan Establishment fees to the lending bank • Loan Arrangement fees to the Manager, FAI Financial
Resources Limited• Initial Management fee to the Manager; (iv) The net cash of the Investor will be applied to subscribe for units in a gold Trust;
(v) The Trust capital subscriptions to be applied to the purchase of allocated gold. This purchase will be effected through a recognised bullion dealer in Australia (Rothschild Australia Limited) who will arrange for loco London [gold] delivery bars to be allocated and bar details to be made available. The gold will not actually leave London but will be warehoused with one of the London Gold Market Clearing Members, expected to be N.M. Rothschild & Sons Limited. N.M. Rothschild & Sons Limited is one of five members of the official London Gold Market and traditionally chairs the fixing meetings held twice daily by the official London Gold Market;
(vi) The Trustees would deposit the gold with a Gold Bank in consideration of a Gold Entitlement Certificate issued by the Gold Bank. The Gold Entitlement will provide for the delivery of gold and the payment of Australian dollar gold fees of 1.875% p.a. at scheduled half-yearly dates to the Trust.
A feature of gold loans is that periodic gold fees are generally very low, around 2% p.a. at scheduled half yearly rests.
Gold to be delivered under the Gold Entitlement Certificate need not necessarily be the same gold delivered by the Trustee to the Gold Bank, ie. unallocated gold. Rather, in consideration for the gold fees, the Gold Bank may use the Trust’s gold provided an equivalent amount of gold is returned to the Trust;
(vii) the Trustee would hedge the gold by selling it under a Gold Forward Sales Contract with the introduced counterparty Gold Borrower (‘VicFin’) whereby the Trust would be entitled to Australian dollar payments in respect of gold sold as and when the gold is delivered.
The Gold Forward Sales Contract will provide for the payment by VicFin of pre-determined forward sale prices in consideration for the delivery of gold by the Trustee at half-yearly intervals over 15 years.
The gold forward price for each deliver[y] date for each amount of gold to be delivered is calculated at a premium over the spot gold price at the date of the Gold Forward Sales Contract where the forward premium is calculated so that the present value of the gold forward price for the relevant amount of gold equals the spot gold price for the same amount of gold at the date of the Gold Forward Sales Contract. This method of calculation of the forward premium is acceptable market practice as advised by Mercer Campbell Cook and Knight Pty Ltd., Consulting Actuaries, and will allow the investor to recover the cost of borrowed funds and contributed equity plus a return on contributed equity.
The return on the Investor’s equity investment balance is determined as an after-tax rate of return using the multiple investment sinking fund method of analysis assuming that the gold forward prices determined by using the method above, the Investor’s cost of borrowing and the current tax regime apply throughout the term of the Gold Forward Sales Contract. In the event that the Investor’s cost of borrowing or the tax regime changes during that period, the gold forward prices would be adjusted upwards or downwards to maintain the Investor’s Required Rate of Return After-Tax on its equity investment balances throughout the term after fully servicing the Investor’s debt obligations;
(viii) the Trustee would distribute the gold sale profits the gold fees of the Trust as net income and would redeem at no profit the Trust units out of the gold sale proceeds representing the original cost price of the gold sold; and
(ix) the Investor would apply the net income distributions and unit redemption proceeds to service half-yearly principal and interest payments under the Loan Agreement throughout the 15 year term and to derive its required rate of return.
(x) Security
(i)
The Bank will generally require a mortgage over the cashflows available to the Investor from the gold trust investment. The Gold Borrower (VicFin) will be party to any required deed of mortgage in order to give legal effect to any payment directions contained it.
The Investor will mortgage its Gold Entitlement Certificate and Gold Forward Sale Contract in favour of the lending Bank and all cash payments and gold deliveries will be subject to directions controlled by the Security Trustee, being State Bank of New South Wales...
(ii) VicFin Section 28 Guarantee
The payments to be made by VicFin under the Gold Forward Sales Contract (refer to (vii) above) to have the benefit of Section 28 guarantee under the VicFin Act.
(b) Refinancing Transactions (Annexure 2 refers)
The lending Bank will refinance its loans to the Investor in order to remove the loans from its balance sheet and thereby effect a lower interest rate on the loans to the Investor.
(i) The Bank will establish an off-balance sheet company of the Bank (Refinancier) which will draw commercial bills of exchange for discounting in the market. (ii) VicFin, as Gold Borrower, will provide a bill acceptance and guarantee facility to the Refinancier. (iii) The Bank will arrange a syndicate of financial institutions to underwrite the accepted bills of exchange. In return for providing the acceptance facility the lending Bank will be in a position to offer loan funds to the Investor at a lower rate and in turn the gold forward sale prices required by the Trust to maintain the Investor’s return on equity would be lower, thereby reducing the Gold Borrower’s (VicFin) cost of gold.
These arrangements are essentially the same as those employed for the Agency’s FAI annuity transaction in June 1986 and have been deliberately structured by FAI in this way.
(c) Swap Transaction
VicFin will participate in these benefits under the swap agreement which will provide for VicFin to receive fixed rate payments equal to the fixed interest payments payable by the Investor under the Second Advance (ie. interest payable on debt component) and in turn will make floating rate payments on the notional principal amount.
(d) Transaction Overview (Annexure 3 refers)
To commence the transaction cycle, VicFin would obtain a gold loan equivalent to A$200 million at drawdown. VicFin would simultaneously instruct that the Gold advance be sold in the spot market for gold delivered loco the London Gold Market, thereby VicFin receiving A$200 million funds.
VicFin would, in turn, be required to make payments of a gold fee at 2.0% p.a. payable semi-annually in arrears.
Taxation Aspects
The taxation assumptions which are unique to this transaction, given the utilisation of a gold loan and gold forward purchase contract, to enable financial accommodation to be provided to the Agency are as follows:
(a) That gold sale profits are derived by the Trustee on the days when the profits accrue due and payable ie. as when the gold is delivered;
(b) that gold sale profits required to be recognised as assessable income derived by the Trustee in respect of each gold sale on each delivery date are calculated as the sale proceeds under the gold forward sale contact less the original purchase cost of the gold units sold by the Trustee on that delivery date;
(c) that the gold fees to the Trust under the gold Entitlement Certificate are assessable on an accruals basis; and
(d) that capital gains tax does not apply to the gold sale profits derived by the Trust.
FAI has provided to the Agency favourable legal opinion from Clive V.
Cullinan Q.C. in respect of the proposed transaction...”
The paper then dealt with “Other Matters” including the following:
“(e) Termination Values Annexure 5 (attached) illustrates the termination values required to be paid by VicFin in the case of early termination.
The method of termination would require VicFin to concurrently terminate the Gold Loan and Gold Forward Sale Contract and pay the relevant Lump Sum amount to the Investor who will repay its loan obligations in full and recover its equity investment after maintaining its required rate of return on equity until that event.”
“6. Precedence (sic) FAI recently concluded a $200 million structure for SAFA on almost identical terms as that proposed by FAI to VicFin. Equity for the SAFA transaction is understood to have been provided by the Commonwealth Bank.” “7. Equity FAI General Insurance Company Ltd has indicated to the Agency that it would be prepared to provide the total equity required for the transaction, subject to an early response by the Agency given the strong demand for equity funding at present...” “FAI has proposed that in order to avoid full injection of equity at commencement of the transaction an alternative approach be adopted whereby FAI, as investor, would progressively inject equity, as required, over an 18 month period. This is also FAI’s preferred approach to equity funding for the transaction.
Under this proposed alternative arrangement, the Agency will be exposed to the credit risk of FAI, but at the same time this would result in slight reduction in termination payments, in the first two years of the transaction.
FAI’s 3 year unsecured rating by Australia Ratings is A- and would appear to be the market average for ratings of General Insurance Companies (Annexure 6 refers). Its recent sale of interests in Pioneer Concrete has resulted in a large profit to be reflected in FAI’s 1987/88 results.
As the risks of early termination are greatest in the early years of the transaction when the first tax assessment is made, the alternative approach to the injection of equity merits consideration by Members.”
“8. VicFin Legal Advice The General Manager has sought the legal opinion of Blake & Riggall on the transaction, including...
(vi) the alternative approach to injection of equity as outlined in 7 above. Unfortunately the solicitor advising the Agency has been ill and therefore a final opinion form Blake & Riggall is not available but it is anticipated that this opinion will be available at the Board Meeting. The Agency has received a preliminary indication from Blake & Riggall that a favourable opinion is contemplated. The following recommendations are therefore made, subject to confirmation from Blake & Riggall of its favourable opinion on the transaction. Members will also note the strong similarity of this transaction to the FAI annuity funding and should be aware that the first tax assessment of the Agency’s annuity transaction was successful.”
The paper concluded by recommending:
“That, subject to the Treasurer’s approval, a mandate be awarded to FAI Financial Resources Limited to arrange A$200 million financial accommodation for the Agency by way of a transaction as outlined above, involving a gold loan and a gold hedge, subject to
(i)
the Agency obtaining fixed rate funding not to exceed 0.3% p.a. on half yearly rests below the weighted average Commonwealth Bond rate based on the principal repayments of the fixed rate component of the total funding;
(ii)
the Agency obtaining floating rate funding not to exceed 1.3% p.a. below the bank accepted bill rate; and
(iii) subject to satisfactory documentation.”
At the meeting on 27 August 1987 the Board of VicFin resolved as follows:
“That, subject to the Treasurer’s approval, a mandate be awarded to FAI Financial Resources Ltd. to arrange A$200 million financial accommodation for the Agency by way of a transaction as outlined in Members Meeting Paper No.8, involving a gold loan and a gold hedge, subject to:
(i) the agency obtaining fixed rate funding not to exceed 0.3% p.a. half yearly rate below the weighted average Commonwealth Bond Rate based on the principal repayments of the fixed rate component of the total funding;
(ii) the Agency obtaining floating rate funding not to exceed 1.3% p.a. below the bank accepted bill rate;
(iii) satisfactory documentation; and
(iv) full equity injection at the time of entering into the proposed transaction.”
On 28 August 1987 Sharah received a telephone call from a Mr Fuller in the South Australian Government Crown Law Office. He told Sharah that he had been advised that the ATO had prepared a draft income tax ruling on the SAFA gold transaction. He said that the investigating officer had recommended a favourable ruling but that the recommendation was to be subject to a review by senior ATO officials.
On 28 August 1987 Sharah also received a telephone call from Yeoh. Yeoh told Sharah that VICFIN Board approval had been granted for FAIFR to arrange a fully hedged gold loan for an amount of $200M. She said that Victorian Treasurer still had to approve the financing arrangements in principle before a mandate could be issued to FAIFR. She said that the Treasurer’s consideration should take a week or so. Sharah again asked Yeoh whether VICFIN would require a tax ruling before a drawdown. Yeoh said no.
On 28 August 1987, Sharah reported by memorandum to L.J. Adler, R.S. Adler, and Herman that, inter alia:
“The purpose of this memo is to outline the tax effective financial investments
currently being developed by [FAIFR].
GOLD: INDEMNIFIED AFTER-TAX MISF YIELD 14% P.A. 1. South Australian Government Financing Authority The SAFA gold transaction offers an after-tax yield in the order of 14% p.a. effective on an MISF basis of analysis. The South Australian Government Crown Law Department advised today that the Australian Taxation Office has prepared a draft income tax ruling on this transaction. The investigating officer has recommended a favourable ruling but this recommendation is subject to review by senior Taxation Office officials and it is not certain whether the recommendation will necessarily be approved.
2. Victorian Public Authorities Finance Agency
The VICFIN gold investment is on essentially the same yield terms as the SAFA investment without a requirement to obtain a prior Taxation Office ruling. VICFIN Board approval has now been granted for FAI Financial Resources to arrange the equivalent of A$200 million in the form of a fully hedged gold loan. However the Victorian Treasurer needs to approve the financing arrangements before a mandate can be issued to FAI Financial Resources. VICFIN are keen for FAI to be the investor given the existing relationships.
Both of the gold investments are subject to Government guarantees and the after- tax yields are fully indemnified. These 15 year investments would provide significant yields to the FAI Group and the cash investments would be recouped by the FAI Group within 2 years by virtue of the tax credits and group fees derived. Accordingly the investments are very attractive...
The gold transactions would appear to provide FAI with a high after-tax yielding investment with low risk given the Government guarantee and the indemnification of the after-tax yield, and return FAI’s cash investment within about 2 years...”
On 1 September 1987, Yeoh on behalf of VICFIN wrote to DMB (Sheehan/Elzink) advising of the 27 August resolution to seek the Treasurer’s approval to award the mandate to FAIFR. The letter summarised the proposed transaction and enclosed “a favourable opinion from [Blakes]” (by letter of the same date). Blakes’ letter advised on various aspects of the transaction including “equity contributions”. Under that heading, Blakes advised that, from a taxation point of view, they had reservations about FAI’s proposal to inject equity progressively over an 18 month period rather than in full at the commencement and expressed the opinion that the progressive injection of equity “would increase the risk of the transaction being challenged under Part IVA..., on the grounds that it would not constitute a strict adherence to the analogous leveraged leasing guidelines issued by the [ATO]”. They advised that “the prudent course would be for the equity investment of at [least] 20% of the total funding to be injected at the outset”.
In relation to the last-mentioned piece of advice, Yeoh in her letter to Sheehan said, without giving any reason or explanation, that “the advice... is no longer a consideration and should be ignored”. In this regard, it is to be noted that Yeoh’s letter sought that the Treasurer’s approval be granted subject to the first three conditions set out in VICFIN’s resolution of 27 August 1987 but omitted all reference to the fourth condition of “full equity injection at the time of entering into of the proposed transaction.” Yeoh swore that she had a telephone conversation with Sharah, after the Board resolution of 27 August 1987, in which she told him that deferred equity contributions would not be permitted and that Sharah replied that it was no longer an issue. Having regard to the uncertain way in which she expressed this evidence and to the absence of any reference to it in her witness statement and having regard to her cross-examination upon the point, I am unable to accept her evidence. Sharah denied the conversation and I accept his denial. This leaves unexplained the reason for dropping the fourth condition.
In any event, it was subsequently made perfectly plain in the draft Investors’ letters provided to VICFIN (see below), that equity contributions were to be made progressively upon specified dates over eighteen months (although the amounts were not disclosed). How or why Yeoh continued to believe that there was no deferred equity after receiving these drafts is also unexplained but I am not satisfied that the explanation lies in any misrepresentation by FAIFR.
Blakes’ advice concluded by pointing out that they had not provided detailed advice on the draft documentation, intimating in substance that this might be appropriate at a later stage.
On 14 September 1987 SAFA wrote to Sharah in relation to its gold loan transaction stating that “[a]s we have not received a ruling from the Commissioner of Taxation in respect of the proposed transaction... we wish to advise that we are unable to proceed with the transaction”. SAFA went on to indicate in effect that, if a favourable ruling was subsequently obtained, each of the parties would be free to reconsider at that time.
Shortly before receiving that letter, Sharah had a telephone call from a Mr Emery of SAFA. Emery said that he was faxing to Sharah a letter and was calling to explain it. Emery said that SAFA had not as yet received the tax ruling hoped for although he remained hopeful. He said that because the ATO was unable to give SAFA an issue date, SAFA had decided not to drawdown on 30 September 1987 (the scheduled “Acquisition Date”). Emery said that SAFA was mindful of the costs if SAFA were required to continue to pay commitment fees for debt and equity after 30 September 1987 whilst awaiting the tax ruling for an indefinite period and therefore preferred not to propose another Acquisition Date as allowed under the SAFA contract. Emery asked whether Sharah would contact the other parties and ascertain whether they would be likely to participate after 30 September 1987 if and when the favourable ruling were received. Emery said to Sharah that he would like them to continue to be available for the funding when SAFA got its tax ruling but did not want to pay further commitment fees or costs to any of them.
On or about 15 September 1987 the Victorian Treasurer (Mr Jolly) received a departmental minute recommending that he give his in principle approval for VICFIN to award the mandate to FAIFR to arrange the gold loan transaction. The minute stated, inter alia:
“...2.
The transaction involves VicFin raising a Gold Loan from a reputable gold bank and hedging its gold risk into Australian dollars by means of a gold forward purchase contract with a Unit Trust owned directly or indirectly by Australian investors.
3.
The transaction is similar to a leverage lease and in particular the FAI Annuity Facility arranged by VicFin, except that instead of issuing fixed rate annuities to a unit trust VicFin sells gold to a Unit Trust, hence the Gold Loan. The investor in the unit trust leverages his equity with debt (Ratio of about 15:85).
4.
VicFin has provided favourable legal opinions that the taxation assumptions that are unique to this transaction are reasonable and has further advised that the first tax assessment of the Annuity Funding was successful.
5.
VicFin are informed by FAI that it has recently concluded a $200 million structure for SAFA on almost identical terms. Equity for the SAFA transaction is understood to have been provided by the Commonwealth Bank...”
The minute recommended to the Treasurer:
“... that you give your ‘in principle’ approval for VicFin to award a mandate to FAI Financial Resources Limited to arrange A$200 million financial accommodation involving a gold loan and gold hedge transaction, subject to:
(i) the Agency obtaining fixed rate funding not to exceed 0.3% p.a. on half yearly rests below the weighted average Commonwealth Bond rate based on the principal repayments of the fixed rate component of the total funding.
(ii) the Agency obtaining floating rate funding not to exceed 1.3% p.a. below the bank accepted bill rate,
(iii) final terms and conditions, including documentation, to be subject to your approval; and
(iv) the credit risk of the transaction Counterparties be assessed and approved by you before the transaction is finalised.”
By letter dated 18 September 1987 VICFIN was advised of the Treasurer’s in principle approval in the terms requested. On the same date, Yeoh wrote to Sharah:
“We refer to your correspondence of 8th July 1987 and subsequent correspondence
in relation to the above matter.
We are pleased to advise that the Agency has obtained the Treasurer’s approval to award a mandate to FAI Financial Resources Limited to arrange A$200 million financial accommodation as outlined in your proposal to the Agency, subject to:
(i) the Agency obtaining fixed rate funding not to exceed 0.3% p.a. on half yearly rests below the weighted average Commonwealth Bond rate, based on the principal repayments of the fixed rate component of the total funding;
(ii) the Agency obtaining floating rate funding not to exceed 1.3% p.a. below the Bank Accepted Bill Rate; and
(iii) final terms and conditions, including documentation, to be subject to the Treasurer’s approval.
We trust that you will accept this mandate and we look forward to working, once again, with you and your staff, towards the successful completion of the transaction.”
Immediately on receiving the mandate letter I find that Sharah telephoned Yeoh and said that he was uncertain about the meaning of the first sentence of the letter. He said that he would like to clarify that before accepting the mandate. Yeoh asked what Sharah meant and he said that the letter made no reference to the structural changes to the proposal mentioned when they discussed FAIFR’s 8 July 1987 letter (at the meeting on 21 July 1987). In particular, it made no reference to the Investors’ debt structure including interest in advance. Yeoh said she had forgotten about interest in advance. Sharah said that he had already sent indicative debt profiles to the banks, after the meeting on 21 July 1987, on the basis of interest in advance. Yeoh said she thought FAIFR could proceed on the basis of interest in advance.
Sharah formally replied on behalf of FAIFR to the mandate letter by letter to Yeoh dated 23 September 1987:
“We express our thanks for the mandate advised in your letter dated 18 September
1987.
We have briefed Mr Marc Hutchinson and Richard Gray, Partners of Freehill, Hollingdale and Page to act for FAI Financial Resources and FAI General Insurance Company Limited.
We have asked that Mr Phillip Cornwell, Partner, and Mr Robert Topfa of Allen Allen and Hemsley act for the State Bank of New South Wales and Rothschild Australia Limited, given their prior experience.
All of the parties are confident that the transactions can be put in place quickly. Accordingly, we have agreed that we should try for a signing and drawdown on Friday 23 October 1987. Mr Marc Hutchinson will be leaving for the U.K. shortly afterwards to get married on 1 November 1987 and Richard Gray can finalize the transactions if we overrun the proposed signing date of 23 October 1987.
If you have any difficulties with 23 October 1987 please let me know.”
I note that, although L. J. Adler had instructed Sharah to retain Freehills to act for the FAI Investors and Sharah told Yeoh that he had done so (and believed that he had), in fact Freehills was not so instructed. Gray of Freehills believed that he was acting only for FAIFR at all times and I am satisfied that Gray was given no instructions which should have led him to a contrary belief. Mr Hutchinson was not involved with the matter.
By letter of the same date Sharah on behalf of FAIFR wrote to the SBNSW, inter alia, as follows:
“I refer to my letter of 28 July 1987 and to your letters of 6 August 1987 and 13 August 1987 and now advise that FAI Financial Resources Limited (‘FAIFR’) has been mandated by the Victorian Public Authorities Finance Agency (‘VICFIN’) to arrange a gold loan equivalent to A$200 million upon drawdown and a gold hedge to cover VICFIN’s gold risk.
The purpose of my current letter is to confirm the debt financing arrangements for the subscription by FAI General Insurance Company Limited (‘FAI’) of A$200 million of units in a unit trust which will provide a 15 year gold hedge facility to VICFIN and, subject to the terms contained in the abovementioned letters and herein, to mandate the State Bank of New South Wales to:
1. provide the necessary cash advances to FAI totalling about A$237.4 million; and
2. underwrite the VICFIN bill acceptance facility for substantially refinancing the cash advances.
The proposed drawdown is 23 October 1987.
FAI will be the only holder of investment units in the unit trust.
In order to facilitate your understanding of FAI’s proposed investment attached for your consideration is a copy of a letter dated 8 July 1987 to Mr C V Cullinan Q.C. which summarises the investment proposal.
This information is provided on a strictly confidential basis and is not to be disclosed to any person, apart from your legal advisors specifically for the VICFIN transaction, without our prior consent.
The attached computer output shows the indicative debt and refinancing structure based on a unit trust investment of A$200 million.
DEBT STRUCTURE
FAI would borrow 4 fixed rate cash advances from State Bank of New South Wales as ‘Lender’. The Lender would assign the First Advance and Second Advance to an off-balance sheet company (‘Refinancier’) which would fund itself by means of an acceptance facility provided by VICFIN. VICFIN will also provide a fixed to floating payments swap to the Refinancier in relation to the floating rate bill funds applied to purchase the Second Advance from the Lender.
This debt structure is identical to that provided by the State Bank of New South
Wales to FAI last year in relation to another VICFIN facility.
First Advance (Schedule LA1)
The First Advance would be for a principal amount of about A$9.7 million for a total term of 10 years, with principal repayments half-yearly from the drawdown date to year 10 and interest half-yearly in arrears. The First Advance would be repaid fully from cashflows from the unit trust investment.
Second Advance (Schedule LA2)
The Second Advance would be for a principal amount of about A$197.7 million for a total term of 15 years, with principal repayments predominantly between years 12 and 15. Interest would be paid annually in advance, with the first interest payment being made on the drawdown date for the interim period from that date to 1 April 1988 plus 12 months. The Second Advance would be repaid fully from cashflows from the unit trust investment.
Third Advances (Schedule LA3)
The Third Advances would be far principal amounts of about A$12.1 million which would be repaid on the next half-yearly payment date following the respective drawdown. The Third Advances would be applied to pay interest on the Second Advance. The Third Advances would be repaid fully from cashflows from the unit trust investment.
Fourth Advances (Schedule LA4)
The Fourth Advance would be for a principal amount of about A$30 million for a total term of about 18 months with interest payments half-yearly in arrears. This Advance would be repaid by FAI out of its own funds being part of its irrevocable equity commitment. An FAI Insurances Limited guarantee will be provided to cover those payments...”
Sharah wrote to Rothschild by letter dated 24 September 1987 stating:
“We are pleased to advise that we have been mandated by the Victorian Public Authorities Finance Agency (‘VICFIN’) to arrange a gold loan for the equivalent of A$200 million where FAI General Insurance Company Limited (‘FAI’) provides a matching gold hedge.
Could we please urgently have a meeting to agree the terms for Rothschild Australia Limited to provide the gold loan to VICFIN and a gold entitlement certificate to FAI where Rothschild is in a position to enter into the transactions on an off-balance sheet basis.
The documentation for the transactions is expected to be in the substantial form as agreed previously...”
Sharah also sent a memorandum dated 24 September to LJ Adler, Herman, Corlett and R.S. Adler as follows:
“I attach a copy of a letter dated 18 September 1987 from the General Manager of the Victorian Public Authorities Finance Agency (‘VICFIN’) advising that FAI Financial Resources Limited has been granted a mandate (subject to documentation), to arrange a A$200 million financial accommodation in accordance with the proposal made to VICFIN.
VICFIN has verbally advised that it wishes to deal expeditiously with the arrangement and has indicated 23 October 1987 as a desirable drawdown date. Please note that the indicative total estimated equity contribution from the FAI Group is A$50 million with estimated contribution amounts and payment dates, at this time, as follows:
A$ Million
In September 1995 DTF took over management responsibility for the gold
loan transaction.
On 5 October 1995 Sharah attended a meeting in Melbourne. Those present included Carruthers, Mr Hambly of Mallesons, Mr Peiris of the FAI Group, and its legal representatives, and Nayna and Ross. Also present representing DTF was Mr Rose, Director, Structured Finance, who said at the commencement of the meeting that he was part of a special task force giving effect to a Victorian policy goal of restructuring or winding up tax based transactions and other inefficient structured financing transactions. Mr Rose said that DTF had appointed Mr Hambly as their legal adviser on the VICFIN gold transaction. Mr Hambly then took over the meeting. Mr Hambly made a number of points which were strongly critical of FAI and QML and a number of issues were debated but it is unnecessary to refer to the details. However at this stage no misleading conduct was alleged.
On 13 May 1996 the board of TCV resolved that the GFSC be terminated. An explanatory paper put before the Board at its meeting stated:
“...TCV has delegated to the Department of Treasury the management of the Gold Loan. The Department of Treasury has recommended that the Gold Loan be terminated. It will be necessary for the notice of termination to be executed by TCV. The Board is requested to approve the termination of the Gold Loan and authorise David Carruthers to sign the notice of termination and any other necessary document in connection with the termination on behalf of TCV...”
On 13 May 1996 TCV gave VBS notice in writing of termination in the
following terms:
“Pursuant to clauses 8.1 and 8.3 of the GFSC TCV give the Vendor notice to terminate the GFSC in accordance with clause 8 thereof because certain Assumptions viz those set out in clauses 5.1(i)(i), 5.1(o), 5.1(p) and 5.1(q) have become incorrect and as a result thereof the amounts payable by TCV under the GFSC will be increased to an extent unacceptable to TCV.
VBS responded by letter dated 20 May 1996 raising a number of issues relating to termination and challenging the efficacy of the notice. This in turn drew a response from Mallesons by letter dated 4 May 1996. By letter in reply dated 7 June 1996 Freehills asserted that on their instructions the circumstances had not arisen entitling TCV to give such a notice. Mallesons by letter to all parties concerned dated 12 June 1996 contended that as a result of the notice the transaction would terminate on 28 June 1996 and that QML should calculate the lump sum payable by TCV. This dispute was continued by further correspondence. Then on or about 21 June 1996 TCV gave further notice of termination (without prejudice to the prior notice) in the following terms:
“TCV GIVES THE VENDOR NOTICE TO TERMINATE the GFSC, pursuant to and in accordance with clauses 8.1 of the GFSC, because the Assumption set out in clause 5.1(j) has become incorrect and as a result thereof the amounts payable by TCV under the GFSC will be increased to an extent unacceptable to TCV.”
The principal witnesses
Although I have not accepted the whole of her evidence, I found Yeoh to be an honest witness but one who did not have a particularly good recollection of events which admittedly had occurred some eleven years earlier. The cross-examination placed her under considerable pressure which, as I saw it, stemmed to some extent from the contents of her witness statement which had been framed in a manner beyond what she was able to fully substantiate and, in some cases, was clearly contradicted by the relevant documents. It also stemmed to some extent, I think, from her apprehension that she had done less than a perfect job in protecting the interests of VICFIN.
Yeoh was asked: “As you are sitting there now today, Mrs Yeoh, what is your belief about whether or not you have been deceived, commencing with the gold loan transaction?” She replied: “I am shocked” She was then asked: “You’re shocked. What about in relation to the annuities transaction, Mrs Yeoh?” She replied: “I am also shocked.”
It was not clear to me at the time whether Yeoh believed she had been deceived or whether she was shocked at her own naiveté - on balance, perhaps, a little of both.
As to Sharah and Nayna, I found them to be highly intelligent and astute witnesses with a good recollection of the relevant events. However, their evidence as to a number of key conversations with Yeoh stretched the limits of credulity.
Commencement of proceeding
By writ dated 28 June 1996 TCV commenced this proceeding against VBS, QML, and the FAI Investors. The statement of claim sought a declaration that the notice given by TCV on 14 May 1996 was effective to terminate the GFSC and that the Lump Sum which TCV was required to pay was $171,559,192. Declarations were also sought as to the mode of calculation of the Lump Sum. VBS and the FAI Investors filed a Defence and Counterclaim dated 6 September 1996 contending, inter alia, that the first notice of termination was ineffective but, if it was effective, the Lump Sum payable by TCV was $357,509,184.42. The counterclaim alleged that the second notice dated 21 June 1996 was effective, that the Lump Sum payable by TCV was $355,805,758.75 and sought judgment accordingly.
It was not until November 1996 that the Statement of Claim was (by leave) substantially amended by the introduction of many new allegations including those of misleading and deceptive conduct, fraud and breach of fiduciary duty.
I mentioned at the outset that the termination of the transaction gave rise to some questions of construction and it is convenient that I deal with those first.
The validity of the first termination notice
Mr Shaw QC, who appeared with Mr Anastassiou and Mr Fox for TCV, submitted that, upon a proper construction of the GFSC, the first termination notice (given by TCV on 28 June 1996) was effective.
Clause 8.1 gives each of VICFIN and VBS the option to terminate the GFSC. Clause 8.3 deals with the conditions upon which VICFIN’s options to terminate may be exercised and provides, so far as relevant, that VICFIN’s option may only be exercised by 45 days’ notice in writing to VBS given at any time after the occurrence of the following event:
“...if... the Assumptions or any of them shall be or become incorrect... and as a result thereof the amounts payable by VICFIN hereunder will be increased to an extent unacceptable to VICFIN (in its absolute discretion)...”
The principal Assumptions which had become incorrect were that the Commissioner did not disallow certain deductions of the FAI Investors and did not impose any penalty or additional tax (cl.5.1(p) and (q)).
172 Clause 5.2(a) provides:
“If the Assumptions shall for any reason whatsoever be or become incorrect then and on each such occasion either of the parties hereto may by notice in writing to the other elect:-
(i) to have the amount of the Gold Payments set out in Schedule One recalculated and redetermined pursuant to Clause 5.3(a)...”
Clause 5.3 provides:
“If either party exercises its election under Clause 5.2 then and on each such
occasion:-
(a) (in a case to which Clause 5.2(a)(i) applies) the remaining Gold Payments set out in Schedule One shall, with effect from the date of exercise of the said election, be recalculated and redetermined by the Manager so as to cause the Investors’ respective Actual Rates of Return throughout the period referred to in the Investors’ Letter to be equal to their respective Required Rates of Return...”
Clearly if an Assumption becomes incorrect and a party elects to have the amount of the Gold Payments recalculated under cl.5.3(a) the amounts payable by VICFIN might be increased and, if so, “to an extent unacceptable to VICFIN (in its absolute discretion)” under cl.8.3 thereby giving VICFIN an option to terminate. However, Mr Shaw submitted that, in addition to the foregoing, if it could be said that the termination payments “will increase” as a result of an Assumption becoming incorrect, then if VICFIN concluded in its discretion (as, so it was submitted, it had) that the termination payments would increase to an extent unacceptable to it, it was entitled to give notice of termination under cl.8.3.
The short answer to that submission is, I think, that the termination payments are not “amounts payable by VICFIN hereunder” within the meaning of cl. 8.3, they are merely amounts which would become payable only if the GFSC was duly terminated.
Furthermore, in my opinion, the evidence given by Carruthers shows that TCV did not form and could not have formed any view at all that amounts payable by it would be increased to an unacceptable extent before giving the first notice because it had no relevant material before it.
I conclude that the first notice was ineffective. It was common ground that the second notice was effective.
Proper Construction of the Investors’ Letter
After termination of the transaction, TCV became liable to pay the “Lump Sum”, being the aggregate of a number of items set out in cl. 8.4(e) of the GFSC, including the amount necessary to pay out the monies borrowed by the FAI Investors then outstanding (cl. 8.4(e)(iii)(aa)). However, the contentious item is “the bb amount” (cl. 8.4(e)(iii)(bb)), namely, such amount as calculated by the Manager which will (together with or allowing for certain other amounts):
“(bb) give to the Investors respectively an Actual Rate of Return for the period referred to in the Investors’ Letter equal to their respective Required Rates of Return...”
Clause 1.1 of the GFSC contains the following relevant definitions:
“‘Actual Rate of Return’ means, in relation to an Investor, the after Tax rate of return of that Investor earned under the Transaction Documents and the transactions described therein or contemplated thereby as calculated by the Manager using the methods of analysis reflected in the Investors’ Letter and on the basis of the Assumptions but having regard to any of the Assumptions which shall have been or become incorrect.”
“‘Required Rate of Return’ means in relation to an Investor, the after-tax rate of return required by that Investor to be earned by it under the Transaction Documents and the transactions described therein or contemplated thereby, being that rate ascertained in accordance with the Investors’ Letter.”
“‘Investors’ Letter’ means the letter dated the same date as this Deed from the Manager to the Investors and includes the computer printouts and other information and documents annexed to that letter a copy of which, initialled by the Investors and the Manager for the purposes of identification, has been lodged with Messrs. Freehill, Hollingdale & Page, Sydney and with Messrs Blake & Riggall, Melbourne on the date hereof.”
The Required Rate of Return as defined by the Investors’ Letter is as follows:
“The Investors’ Required Rate of Return... is to be calculated by the multiple investment sinking fund method of analysis applied from the date of payment for the... [$200M worth of Units in the Trust]... until... the payment by VICFIN of the Lump Sum... being:
an after-tax-yield of 14% per annum effective on the Investors’ outstanding after-tax equity balance from month to month assuming an after-tax nominal monthly sinking fund rate of 3.5% per annum where each monthly after-tax equity balance is determined by accumulating the previous month’s after tax equity balance at the after tax rate per month equivalent to the after-tax yield and adjusting the result by the after-tax cashflows of the Investors during that month. For purposes of calculation of the relevant after-tax yield of the Investors, the interim period from the date of purchase of the [Units] to 1 December 1987 will be treated as a proportion of a thirty day month... The Investors’ initial after-tax equity balance for purposes of calculating the Investors’ Required Rate of Return is equal to the initial equity contribution by the Investors on the Drawdown Date and will not be reduced by the Investors’ Fee Rebate payable by the Manager.” (Emphases added)
The immediately following paragraph in the Investors’ Letter must also be
noted:
“INVESTORS’ FEE REBATE
The Manager commits upon the signing of this Investors’ Letter by the Investors to immediately rebate $15 million of the initial management fee paid to the Manager by the Investors under Clause 2.5(a)(i) of the Management Agreement less the sum of $1 million and the interest rate hedge cost (if any) payable to the Lender in relation to the interest payable on the First Advance and it is assumed that such rebate will reduce the Investors’ management fee deductions in respect of the year of income ending 30 June 1988 to the extent that it is non-assessable to the Investors in respect of that year.”
Mr Shaw submitted that, whilst the Investors’ initial after-tax equity balance (as at 5 November 1987) was $21,127,544 (say $21M) which included and was not reduced by the fee rebate of $14M, nevertheless the Investors’ outstanding after-tax equity balance as at 1 December 1987 was $7M having regard to the cashflow of and to the Investors of $14M (the rebate) on 10 November 1987 (i.e. in the previous month).
Mr Shaw submitted that the Investors’ Letter did not say that the rebate was not to be taken into account for the purpose of calculating the outstanding equity balance from month to month but only that the initial equity balance should not be reduced by the rebate.
Mr Shaw added that this construction also made good commercial sense because (and I paraphrase his submission) it would be surprising if the Investors were to be entitled to a yield on funds which did not remain as part of the equity invested in the transaction after 10 November 1987.
Mr Archibald QC, who appeared with Mr Elliott for VBS and the FAI Investors, submitted that it would have been absurd, unrealistic and illogical for the parties to agree that the rebate should not be taken into account in November but should be taken into account one month later. He pointed out that by the Investors’ Letter the Manager committed to “immediately rebate” the defined part of the initial management fee and it was provided that the Investors’ equity balance “will not be reduced” by this payment.
Mr Archibald further submitted that regard should be had to the annexures and computer printouts forming part of the Investors’ Letter. The sheet entitled “Investors’ Equity Financial Analysis” showed the equity contribution on 5 November 1987 of $21M and showed no reduction of a rebate before arriving at total contributions of $56M over eighteen months. Schedule 7A showed fees incurred of $15M for the year ending 30 June 1988 and schedule 8A showing the investment balance from month to month without any provision for reduction by any rebate. Then schedule 9A showed the initial management fee of $15M. Finally, the annexed Mercer letter dated 29 October 1987 showed the same management fee and no reference was made to a rebate. However, I think that Mr Shaw was right when he contended that the annexures did not assist in this respect with the proper construction of the Investors’ Letter. It is plain that the schedules were prepared without regard to the rebate and the inference is inescapable that Mercer knew nothing of it when it confirmed that the “cash flows had been correctly calculated and that they support the yields mentioned...”
Mr Archibald also called in aid the surrounding circumstances, or matrix, in that the representatives of FAIFR and the FAI Investors had referred to the “rebate” as an “equity fee” or “fee” payable to the Investors. He contended that this strengthened a conclusion that the rebate was a fee receivable by the Investors but not detracting from their equity contribution. In my view, no assistance can be gained from these prior circumstances. The Investors’ Letter itself sets out the method adopted for the treatment and payment of the amount to be returned; it recognises that the initial management fee is to be paid to the Manager by the Investors and that there is to be a rebate of part of that fee (for whatever reason) to the Investors by the Manager.
The meaning must be determined by a reasonable and commercial construction of the words used in the Investors’ Letter, a document incorporated by reference into the GFSC and thus forming part of the contract between VICFIN and VBS. It is inappropriate, in my view, to consider extraneous material which goes to intention of, and as between, the Manager and the Investors.
In my opinion, it is tolerably plain when the letter is read as a whole that the words “and will not be reduced” are being used to effect a continuing bar to the reduction of the Investors’ equity balance by the amount of the rebate. It is clear from the letter that the Investors’ initial equity contribution is $21M and that therefore the Investors’ initial equity balance is also $21M. Given that the Manager was committed by the letter immediately upon receipt of the fee to pay the defined rebate to the Investors this would be a cash flow reducing the initial equity contribution whether paid on 5 November 1987 or later - accordingly the words “and will not be reduced by the ... rebate” are in my opinion intended to and do prohibit such a reduction whenever the rebate was in fact paid.
I do not regard the result as commercially unreasonable. The fee was $15M and the proceeds were simply redistributed to the immediate benefit of the FAI Investors and to the ultimate detriment of Sharah and Nayna. VICFIN was no better and no worse off as a result.
I therefore reject the plaintiff’s submissions.
Misleading and Deceptive Conduct
(i) Misrepresentation as to amounts of equity
TCV submitted that FAIFR had represented to VICFIN that the amount of equity to be contributed by the Investors was in the order of $30M - $40M. This representation had its origin in the documentation supplied to VICFIN in July 1987 which, when scaled up, proposed equity from the investors of $33M. Then Yeoh in her Transaction Summary set out that the Investors were to provide equity of $35M. It was submitted that when Sharah failed to correct this statement and (I would add) when the Transaction Summary received Sharah’s okay, the representation was confirmed or repeated. I consider this to be correct. FAIFR represented to VICFIN that the equity to be provided by the investors was of the order of $35M. At the time when Sharah commented on the Transaction Summary, FAIFR was planning that the Investors should contribute not less than $55M and ultimately they provided in excess of $56M but VICFIN was not informed at any time prior to the execution of the transaction documents.
QML submitted that Yeoh must have been aware that the equity to be contributed by the Investors exceeded $30M - $40M because the termination value schedules supplied by Nayna in late October 1987 made it clear that the pool of funds was considerably larger than the monies to be borrowed and that therefore Yeoh must have been aware that the balance was equity. It was submitted that having regard to the importance which Yeoh placed on termination values and the close attention which she gave to them (which she did), Yeoh must have realised at the time that the equity contribution had been substantially increased. However, I am satisfied that Yeoh did not conduct this analysis or reach this conclusion - nor am I persuaded that VICFIN or its advisers (or anyone in DMB) did so. I find that Yeoh relied on the actuarial verification by Mercer to satisfy her that the tables correctly reflected the figures which had already been supplied to her. She assumed that Mercer was working with those figures and not new figures. Moreover, having regard to the total pool of funds put into the transaction on 5 November 1987, it is far from evident to me that Yeoh or her advisers or colleagues must or even should have realised or suspected that the equity position had been altered by looking at the termination values.
QML further submitted that when Yeoh was informed in June 1988 (by provision of the Investors’ Letter and accounts) that the total equity contributions were in fact $56M, her lack of complaint or adverse reaction demonstrated that she must have known all along. That is, no doubt, one of a variety of possible explanations for a lack of reaction at that stage but I am not persuaded that it is a likely one in the light of the evidence as a whole (both oral and documentary).
I conclude that FAIFR substantially misrepresented to VICFIN the amount of equity to be provided by the Investors in the transaction. The mere supply of the termination value schedules did not negate or cure that misrepresentation in circumstances where no analysis was conducted by or on behalf of VICFIN of a kind which may have uncovered the true position. This misrepresentation constituted misleading and deceptive conduct by FAIFR.
(ii) Misrepresentation as to amount of fees
TCV submitted that FAIFR had represented to VICFIN that the initial management fee would be of the order of $3M. This representation had its sole origin in the documentation supplied to Cullinan, copies of which were provided to Yeoh in July 1987, and in particular the schedules which showed fees of $1.5M (which would double when scaled up for the actual transaction). In fact, the initial management fee was ultimately in excess of $15M.
Yeoh gave some vague evidence that Nayna had in a conversation in late October 1987 confirmed that the fee was $3M. I found this evidence unconvincing and it was most improbable in all the circumstances. The only basis for the representation was the initial documentation.
In my opinion, FAIFR cannot reasonably be considered to have made a representation to VICFIN as to the quantum of its fees, even by way of approximation, when it had been made abundantly clear that its fees were secret and would not be disclosed to VICFIN prior to the execution of the transaction documents. In early July 1987 Sharah told Yeoh that the Investors’ Letter would be confidential during the negotiations which, in the context of the previous annuities transaction, conveyed that the investor’s yield and the manager’s fees would not be disclosed. This was expressly confirmed in the meeting between Sharah and Yeoh in late September or early October 1987. It was again conveyed when, on 21 October 1987, Nayna refused to provide Yeoh with copies of the schedules to the Investors’ Letter because some of them showed FAIFR’s fees. Again, at some stage, Sharah had said to Yeoh that they did not want her to see the amount of the management fee lest she sought to negotiate it down. Finally, having previously received the revised draft of the Investors’ Letter containing the references to the management fee and to a rebate of undisclosed amounts, Yeoh accompanied Field on the day the documents were to be executed when Field asked to see the Investors’ Letter. Again, this was refused.
I am satisfied that Yeoh believed at all times prior to the execution of the documents that the Manager’s fees were of the order of $3M (see her letter to DMB dated 23 October 1987). However, the conduct of FAIFR taken as a whole, when objectively assessed, did not in my view convey to Yeoh that its management fee would be of the order of $3M or that there was any particular limit to the fee it might charge to the Investors.
I conclude that there was no misleading or deceptive conduct by FAIFR concerning the amount of its fees. QML submitted in the alternative that having regard to the rebate the initial management fee was in truth only $1M. I would not have accepted that submission because the fee itself remained as nominally $15M and from VICFIN’s viewpoint the rebate did not remove $14M from the Investors’ equity balance.
(iii) Misrepresentation as to no material differences between the arrangements described in the indicative proposal and in the Cullinan opinion and the final transaction.
TCV submitted that FAIFR represented by proffering as it did to VICFIN the indicative proposal and the Cullinan opinion that there would not be material or significant differences in the final transaction. In that regard, TCV contended that the matters which were material or significant were those which related to the taxation consequences or taxation risks of the transaction.
Although the submission was made in terms that FAIFR represented to VICFIN that there would not in the final transaction be material or significant differences from the arrangements described in the indicative proposal or in the Cullinan opinion, the first question to ask in relation to s.52 of the Trade Practices Act is whether there was misleading and deceptive conduct in that respect. The question, as I see it, is whether FAIFR by its conduct led VICFIN to believe or assume that the transaction had a material feature or features which in fact it did not have or came not to have in circumstances in which VICFIN was reasonably entitled to expect that the true position would be disclosed to it (see Demagogue Pty Ltd v Ramensky (1992) 39 FCR 31, 32, 40-41).
FAIFR knew that VICFIN had sought its own taxation and other advice upon the indicative proposal, the Cullinan opinion and associated documentation provided to it and the decision to enter the transaction was made by the Board of VICFIN after obtaining that advice. If material changes were then made to the transaction in the course of negotiations and settlement of the transaction documents, VICFIN was in a position to obtain further advice provided those changes were made known to it. In my opinion, VICFIN was reasonably entitled to expect that FAIFR would advise it of any such material changes which would otherwise not be known to it, in order that those changes might be considered and, if necessary, advice obtained. To the extent that such changes were not known or made known to VICFIN, FAIFR’s conduct in failing to make them known might constitute misleading and deceptive conduct.
TCV pointed to what it said were four material differences or changes:
(a) equity of about $33M was to be contributed up-front whereas the “real initial equity” was $7M and the balance was being contributed over 18 months;
(b) initial fees of about $3M were to be paid by the Investors to the Manager (instead the fees were $15M);
(c) interest was to be paid in arrears on the Investors’ borrowings (whereas interest was paid in advance on the advance of $201M);
(d) the net present value of the pre-tax cashflows under the transaction was to exceed the net present value of the tax benefits (but in fact, it was alleged, it did not).
Items (b) and (c) can in my view be put to one side immediately. I have already dealt with the matter of fees and, as to interest, it was clearly known to VICFIN that interest was to be paid in advance, as appears from Yeoh’s Transaction Summary.
As to item (a), I have already concluded that FAIFR engaged in misleading and deceptive conduct by misrepresenting the total amount of equity to be contributed by the Investors. However, VICFIN was clearly aware that the contributions of equity were to be made over 18 months. Yeoh was made generally aware that “deferred equity” was proposed by virtue of the draft Investors’ Letter provided to her on 15 October 1987, in her telephone conversation with Sharah after 19 October 1987 concerning the requirements of SBNSW and by virtue of the further draft of the Investors’ Letter provided to her on 2 November 1987. It was open to VICFIN to require precise information as to the amount to be contributed on each date but it failed to do so. Nevertheless, this item draws attention to another aspect of the misleading conduct constituted by FAIFR’s failure to inform VICFIN that the equity contribution of the Investors was not of the order of $30M - $40M. In my view, VICFIN was reasonably entitled to expect that it would be informed that of the amount of equity ($21M) to be contributed up front the sum of $14M was to be immediately repaid to the Investors by way of a rebate of the management fee. This was a new feature of the transaction which was unknown to VICFIN and the significance of which was not likely to be (and was not) appreciated by mere reference to a rebate without disclosing the size of the amount involved. It seems to me that the artificiality of this aspect of the transaction might well have attracted the attention of the ATO and it was at least a material matter for VICFIN to consider and upon which to obtain legal advice. That disclosure of the amount of the rebate would have defeated FAIFR’s desire to maintain secrecy as to the amount of its fee is, to my mind, irrelevant in this context.
As to item (d), this does not represent an actual or direct change in any material feature of the transaction, even if proven. It is really a conclusion reached by analysing the consequences of any actual changes in the transaction and testing them against criteria which Cullinan saw as relevant to the “taxation risks” of the transaction. It adds nothing to the other allegations (considered above) and depends upon them.
(iv) Misrepresentation as to the SAFA transaction
TCV submitted that FAIFR’s representation to VICFIN that a transaction similar to the gold loan transaction had recently been signed by a state government party was a half-truth because SAFA had a right not to proceed with its transaction if a satisfactory tax ruling was not obtained. Furthermore, prior to 4 November 1987 when the gold loan transaction documents were executed, FAIFR knew but did not inform VICFIN that SAFA did not propose to proceed because a favourable tax ruling had not been obtained.
In my view, FAIFR’s conduct in relation to the SAFA transaction was misleading and deceptive as to a matter which it knew that VICFIN regarded as material to its decision to enter the transaction.
Damages for misleading conduct
The hearing of this proceeding was as to liability only but in order to establish a cause of action based on misleading and deceptive conduct against QML it is necessary for TCV to establish that it suffered at least some loss or damage by the conduct (s. 82 Trade Practices Act).
I am satisfied on all the evidence that VICFIN entered the gold loan transaction in part in reliance upon the conduct of FAIFR which I have found to be misleading and deceptive. The question remains whether VICFIN suffered any loss or damage as a result.
TCV put its damages in this way, as set out in the particulars of its amended
statement of claim:
“OF WHAT VICFIN WOULD HAVE DONE
(a) VICFIN would not have entered into the financial accommodation arrangements for VicFin at settlement. It would have raised the sum of $200 million directly from the financial markets (‘alternative accommodation’).
(b) But for [FAIFR’s] conduct VicFin would not have entered into the financial accommodation arrangements for VicFin at settlement.
OF ESTIMATED LOSS
VicFin’s loss is the difference between the costs incurred by entering into the financial accommodation arrangements for VicFin at settlement and the costs which it would have incurred to June 1996 if it had entered into alternative accommodation. The costs incurred by entering into the financial accommodation arrangements for VicFin at settlement cannot be ascertained and will not be known until the determination of this proceeding. The estimated costs of alternative accommodation are calculated (‘the calculations’) as follows on the following assumption -
(i) using the equivalent notional loans in schedule VA6;
(ii) for the floating rate on the first component interest at the six monthly BBR;
(iii) for the second and third component loans on a fixed rate basis, interest at a rate of 14.4% per annum convertible half yearly.”
I am satisfied that VICFIN probably would not have entered the gold loan transaction had the misleading conduct not occurred. However, the evidence does not show that VICFIN would have been in a better position by entering into the “alternative accommodation” referred to in its particulars. TCV has failed to show that it has suffered any loss or damage as particularised. It seems that at the commencement of the proceedings this may not have been the case but it was common ground that, as a result of a settlement with the ATO, the amount which TCV was required to pay to satisfy “the bb component” of the Lump Sum had been substantially reduced. It was faintly pressed that loss or damage had still been suffered but I am not persuaded that this is so. Other arguments were put challenging the proof of loss and damage including the proof of causation but it is unnecessary to decide them.
In argument TCV relied upon both s. 82 and s. 87 of the Trade Practices Act in relation to its claim for damages under that Act but it was not suggested on the facts of this case that s.87 provided any wider or different basis for the damages claim.
I should add that it was at least strongly arguable that TCV’s claim under s. 82 of the Trade Practices Act and various of the other causes of action were barred by relevant limitation periods but it is also unnecessary to decide that aspect.
Fraud
A cause of action claiming damages in deceit was pleaded against QML relying upon the same facts as to the alleged misrepresentations and damages as those relied upon under the misleading and deceptive conduct claim. Having regard to my conclusion that no loss or damage has been proven, it is unnecessary to consider this claim further.
Collateral contract
The amended statement of claim also pleaded a claim against QML for damages for breach of a collateral contract between VICFIN and FAIFR (QML) but Mr Shaw said that TCV wished to make no submissions about it.
Breach of fiduciary duty
The amended statement of claim (paragraphs 50 - 57) claimed damages against QML for breaches of a fiduciary duty owed to VICFIN. I am of the view that FAIFR as the “packager” of the transaction, and in all the circumstances and notwithstanding the “mandate” given to it, owed no fiduciary duty to VICFIN but it is unnecessary to detail the various submissions made and my conclusions upon them because the damages claimed for breach of this duty are the same as those claimed for misleading and deceptive conduct and none have been proven. I also note that TCV abandoned its contentions that the FAI Investors were liable in relation to this claim.
Other causes of action against QML
There is an allegation of later misleading conduct in paragraph 70 of the amended statement of claim but I am satisfied that none of the contested elements of the cause of action were established.
A number of further claims were pleaded against QML but none were relied
upon.
Claims against the FAI Investors
It was central to TCV’s pleaded case that, loosely speaking, the FAI Investors (and presumably VBS) were liable for or parties to such wrongful conduct of FAIFR as was able to be proved. A number of allegations and claims were pleaded based upon the establishment of that liability or responsibility.
A prime submission of TCV was that FAIFR acted throughout as the authorised agent of the FAI Investors, alternatively that the FAI Investors held out FAIFR as their agent to VICFIN.
FAIFR’s business was to market financial arrangements and as a “packager” to put the transaction together in order to earn fee revenue therefrom. In the course of this business, FAIFR acted as a “go-between” in organising and communicating with the various parties and, indeed, in this case in obtaining and retaining the two FAI companies as investors when there was no certainty about it. I am satisfied that, in making the relevant representations to VICFIN concerning the nature of the transaction and generally in conducting business with and communicating with VICFIN, FAIFR was not acting as agent of or for or on behalf of the FAI Investors, but in its own right. It did not have their authority, express or implied, to act on their behalf in any relevant respect.
It was put that the FAI Investors had no-one acting for them in the transaction other than FAIFR. However, I am satisfied that both Sharah and L.J. Adler believed that Freehills were acting for the FAI Investors (although this was not properly conveyed to Gray). Further, L.J. Adler and Corlett were themselves looking after the interests of the FAI Investors.
It was submitted in the alternative that the FAI Investors held out FAIFR as their agent in the transaction.
The head office of the FAI Group was in a 12 storey office building in Macquarie Street, Sydney. FAIFR had some rooms on a floor occupied by a number of commercial tenants. FAIFR at all times used the FAI Group telephone number and switchboard and the FAI Group letterhead was also used on an interim basis (until about February 1986). The FAI Group annual reports for 1986 and 1987 referred to FAIFR as a member of the FAI Group. Of course, the ultimate beneficial owner of FAIFR at the relevant times was FAI Insurances as to 60%.
In my opinion, however, the evidence does not show that these two companies (the FAI Investors) held out FAIFR as their agent to VICFIN in the negotiations and in the arrangement of the gold loan transaction.
It is further pertinent, although not determinative, that cl.4.6 of the draft management agreement (ultimately executed) provided that the Manager should not at any time hold itself out as being entitled to act for or bind either of the FAI Investors.
Agency, I think, became the sole basis pressed to bring FAIFR’s conduct into play in order to establish the alleged liability of the FAI Investors because Mr Shaw disclaimed any reliance on “the aiding or abetting provisions” or upon “knowing assistance”. I think the disclaimer was rightly made but in case I misunderstood the breadth of Mr Shaw’s concession I will expressly state that I am not satisfied on all the evidence that the FAI Investors knew of or authorised or were involved in any of the misconduct alleged against FAIFR in this proceeding.
All claims against any defendant for damages or any other relief under the Trade Practices Act have therefore failed.
It also follows from the foregoing that there is no basis established to mount the estoppel claim pleaded against VBS and the FAI Investors in paragraphs 47A to 47E of the amended statement of claim, or for the other claims pleaded against them in paragraphs 47F to 47H, or in paragraphs 48 to 49 or elsewhere in the amended statement of claim.
Wilful act or omission
TCV also relied (in paragraphs 66 to 69 of the amended statement of claim) upon cl. 5.4 of the GFSC which provided in substance that in calculating the Actual Rate of Return of the Investors the Manager was bound to disregard any reduction in the Actual Rate of Return of the Investors arising directly as a consequence of any wilful act or omission by the Investors which directly caused such reduction in their Actual Rate of Return. This was opened but it was not finally pressed although not, I think, abandoned. It is sufficient to say that there was in my view no wilful act or omission by the FAI Investors as alleged and, in any event, none which directly caused any reduction in their Actual Rate of Return.
Conclusion
The plaintiff has failed to establish the liability of any of the defendants or that the matters relied upon give rise to any defence to the counterclaim. I will hear counsel as to appropriate orders on claim and counterclaim and as to costs.
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