Banks v Farmer
[2023] NZCA 383
•23 August 2023 at 3 pm
| IN THE COURT OF APPEAL OF NEW ZEALAND I TE KŌTI PĪRA O AOTEAROA |
| CA531/2021 [2023] NZCA 383 |
| BETWEEN | ADAM DAVID BANKS |
| AND | WILLIAM ROBERT FARMER |
| CA164/2022 | ||
| BETWEEN | WILLIAM ROBERT FARMER | |
| AND | ADAM DAVID BANKS | |
| Hearing: | 18–19 May 2022 |
Court: | Cooper P, Gilbert and Katz JJ |
Counsel: | J W A Johnson, W L Porter and G D Simms for Mr Banks |
Judgment: | 23 August 2023 at 3 pm |
JUDGMENT OF THE COURT
A The application to adduce further evidence in CA531/2021 is granted in part, but only in respect of the liquidator’s updating affidavit.
B The appeal in CA531/2021 is dismissed.
C The appellant in CA531/2021 must pay costs to the respondents for a complex appeal on a band A basis and usual disbursements. We certify for second counsel.
DThe appeal in CA164/2022 is dismissed.
EThe appellant in CA164/2022 must pay costs to the first respondent in the sum of $2,500.
____________________________________________________________________
REASONS OF THE COURT
(Given by Gilbert J)
Table of Contents
Introduction [1]
The claims [3]
High Court trial [5]
Substantive judgment [7]
First cause of action — breach of s 37 of the Securities Act [8]
Second cause of action — breach of s 9 of the Fair Trading Act [9]
Third cause of action — breach of directors’ duties [12]
Fourth cause of action — breach of s 55G of the Securities Act [18]
Costs judgment [19]
Grounds of appeal against Substantive judgment [20]
Grounds of appeal against Costs judgment [21]
Application to adduce further evidence [22]
The issues [27]
Factual background [29]
Company formation and key personnel [31]
Mako’s network security system [35]
Initial commercialisation in New Zealand [36]
Expansion into overseas markets [37]
Funding from Telecom Rentals [41]
Private placement memorandum [42]
Introduction to Mr Banks [43]
Agreement 1 — 4 February 2011 [44]
Business development 2011–2013 [48]
Proposed IPO [55]
Agreement 2 — 30 June 2013 [71]
July to December 2013 [73]
Restructure of Telecom Rentals’ debt [88]
Agreement 3 — 24 April 2014 [91]
Failure of Sprint deal [114]
Financial statements [118]
Fair Trading Act claims [120]
Representations prior to Agreement 1 [124]
Submissions [130]
Analysis [133]
Representations prior to Agreement 2 [150]
Submissions [155]
Analysis [159]
Representations prior to Agreement 3[190]
Submissions [207]
Analysis [208]
Companies Act claims
Section 135 — reckless trading
Legal principles [223]Substantive judgment [230]
Submissions [232]
Analysis [240]
Section 136 — duty in relation to obligations [256]
Agreement 1 [258]
Agreement 2 [269]
Agreement 3 [275]
Section 138 — reliance on information and advice [290]
Section 301 — court’s power to require repayment of money [301]
Securities Act claims
Relevant provisions [302]
Substantive judgment
Agreement 1 [307]
Agreement 2 [309]
Agreement 3 [310]
Submissions [311]
Analysis
Agreement 1 [321]
Agreement 2 [329]
Agreement 3[331]
The Nuves emails [337]
Costs appeal [346]
Result [354]
Introduction
During the period from 4 February 2011 to 24 April 2014, Mr Banks made various unsecured advances to Mako Network Holdings Ltd (Mako), a company that had developed and patented an innovative network security management system. Mr Banks’ advances were made pursuant to three agreements and totalled approximately $3.5 million. The respondents were directors of Mako. Unfortunately, due to a lack of capital, Mako was unable to realise the significant commercial potential of its technology. It was placed in receivership and liquidation in August 2015 owing creditors more than $30 million, including almost $27 million to its sole secured creditor, Telecom Rentals Ltd.
The receivers sold Mako’s assets for around $3 million. The liquidators filed their final report in January 2018 and Mako was removed from the Companies Register in February 2018. Unsecured creditors received nothing. Mr Banks lost all of the money he had invested in the company.
The claims
In the meantime, in 2016, Mr Banks issued proceedings in the High Court seeking recovery of his losses from the directors. The central feature of his claim was that he was misled about the true financial state of Mako and its business prospects at the time he made each of his investments.
In his second amended statement of claim, he advanced four causes of action:
(a)Breach of s 37 of the Securities Act 1978 — Mr Banks alleged that the agreements constituted allotments of debt securities to the public without a registered prospectus in breach of s 37(1) of the Securities Act. He claimed that the allotments were accordingly void and the respondents were jointly and severally liable as directors to repay the subscriptions with interest.
(b)Breach of s 9 of the Fair Trading Act 1986 (FTA) — Mr Banks alleged that Mr Farmer made 53 oral or written misrepresentations which variously induced him to enter into each of the three agreements. He sought orders under s 43(3)(e) and (f) requiring the respondents to refund or pay the amount of his advances and interest at the contractual rate under the first agreement.
(c)Breach of directors’ duties under the Companies Act 1993 — Mr Banks alleged the directors failed to act in good faith and in the best interests of Mako (s 131), agreed to or allowed Mako to carry on business in a manner which created a substantial risk of serious loss to creditors (s 135), agreed to Mako incurring obligations to Mr Banks and the secured creditor without a belief on reasonable grounds that Mako would be able to perform its obligations when required (s 136), and failed to exercise due care, diligence and skill in performing their duties as directors (s 137). Mr Banks sought orders under s 301(1)(c) requiring the respondents to pay him the amount of his advances and interest. Alternatively, he sought an order under s 301(1)(b) requiring the respondents to contribute approximately $30 million to Mako. Mr Banks also sought an order pursuant to s 383(1) permanently banning the respondents from acting as directors or promoters of any company or taking part in the management of any company without leave of the court.
(d)Breach of s 55G of the Securities Act — Mr Banks alleged that he subscribed for securities on the faith of advertisements that included untrue statements. He sought compensation from the respondents for the amounts lost together with interest.
High Court trial
The claims were heard in the High Court over a three-and-a-half-week period before Moore J in July 2019. After the hearing, but before the judgment was delivered, the respondents obtained an order from the Judge requiring Mr Banks to deliver up for inspection various electronic devices in his possession. This was to enable the respondents’ experts to investigate their concerns that Mr Banks had fabricated 28 emails he had produced in evidence at the trial.[1] These emails were purportedly between Mr Banks and Mr “Chris Nuves” concerning a project allegedly being undertaken at the University of Auckland’s business school researching the utility of software relating to “people, money and/or online shopping”. The emails purported to show that deposits Mr Banks made exceeding $500,000 between September 2011 and January 2012 with CMC Markets and Vantage FX Pty Ltd were for the purposes of the research project and were not true investments. These emails were produced by Mr Banks to support his contention that he was not a habitual investor and this exemption from the requirement for a registered prospectus under the Securities Act could not be relied on by the respondents.
[1]Banks v Farmer [2019] NZHC 3415.
After the devices were delivered up and further investigations undertaken, the hearing resumed in October 2020 to consider the evidence as to the authenticity of the emails. For reasons set out in his Substantive judgment delivered in July 2021, the Judge was satisfied that Mr Banks forged the emails at some stage after the proceedings commenced to provide an explanation for the significant advances he had made to CMC Markets and Vantage FX.[2] The Judge considered this finding had wider implications for Mr Banks’ claims because it was relevant to his credibility.[3] It supported the Judge’s findings that Mr Banks also lied in other parts of his evidence.[4]
Substantive judgment
[2]Banks v Farmer [2021] NZHC 1922 [Substantive judgment] at [180]–[190].
[3]At [191].
[4]At [200].
The Judge dismissed each of Mr Banks’ causes of action for reasons which we briefly summarise as follows.
First cause of action — breach of s 37 of the Securities Act
The three agreements were not the product of any offer of securities to the public and accordingly there was no need for a registered prospectus in terms of s 37.[5]
Second cause of action — breach of s 9 of the FTA
[5]At [300], [322] and [328].
Nineteen of the 53 alleged misrepresentations were made after the transfer of funds under the third agreement (Agreement 3) and, accordingly, Mr Banks suffered no loss in consequence of any such misrepresentation.[6]
[6]At [626].
Of the remaining 34 alleged misrepresentations, 14 were verbal. The Judge did not believe Mr Banks’ evidence concerning the verbal representations where it differed from that of Mr Farmer.[7] The Judge considered that material aspects of Mr Banks’ claims of misrepresentation were implausible.[8] Mr Banks said he had no independent recollection of the various meetings and discussions at which these representations were allegedly made and he urged reliance on his brief of evidence which he claimed had been prepared with the benefit of detailed contemporaneous notes.[9] However, none of these notes had been discovered and counsel for Mr Banks knew nothing about them.[10] In rejecting Mr Banks’ evidence about these verbal misrepresentations, the Judge said:[11]
It beggars belief that such detailed notes would have been maintained and used as the foundation for the particulars under the second cause of action and the preparation of Mr Banks’ brief of evidence only to be destroyed, lost or otherwise misplaced between then and the time of trial. This is yet another example of Mr Banks’ facility for bending the truth when it comes to the evidence he is prepared (and not prepared) to adduce in pursuit of his claim against the defendants.
[7]At [636].
[8]At [629].
[9]At [630]–[633].
[10]At [634].
[11]At [635].
As to the written representations, three were too general and remote in time to have been causative of Mr Banks’ loss.[12] The Judge found that the written representations concerning Mako’s prospects contained in a private placement memorandum (PPM) received by Mr Banks prior to the advances made pursuant to the first agreement (Agreement 1) were not actionable because they represented the honest and reasonably held views of the directors at the time.[13] Likewise, Mr Farmer’s written representations prior to the second agreement (Agreement 2), including that Mako was likely to list on the NZX, were his honest and reasonably held opinions and were not misleading or deceptive.[14] The remaining five written representations also concerned the possibility of an initial public offering (IPO) and Mako’s financial position. The Judge considered it was “inconceivable that Mr Banks was not fully aware of Mako’s situation before he made his last advance”, although he accepted Mr Banks still believed an IPO was possible.[15] Even if any such representation was misleading or deceptive, the Judge was satisfied it did not cause Mr Banks any loss because his evidence was that the prospect of an IPO did not cause him to enter into Agreement 2 or Agreement 3.[16] The Judge found that Mr Banks would have advanced the funds regardless and there was therefore no causal nexus between the alleged representations and his loss.[17]
Third cause of action — breach of directors’ duties
[12]At [641]–[643].
[13]At [658].
[14]At [664]–[668].
[15]At [675].
[16]At [676].
[17]At [677].
The Judge accepted that the directors breached their duties under s 135 in continuing to trade from around late-April to mid-May 2014. By this time, the directors could not have had a reasonable expectation that Mako would be able to secure a significant agreement (expected to generate revenue of USD42.5 million over two years) with Sprint Corporation, a United States telecommunications giant and mobile network operator. Mako’s other prospects for generating cashflow at that time would not realistically have been sufficient to fill the funding gap to allow it to continue to trade.[18]
[18]At [452].
The Judge reached the same conclusion in respect of the claim under s 137.[19]
[19]At [539].
The Judge rejected the claim that the respondents breached s 136, finding that they believed on reasonable grounds at the time each of the three agreements with Mr Banks was entered into that Mako would be able to meet its obligations when they fell due.[20]
[20]At [505].
However, despite establishing a breach of ss 135 and 137 from around late‑April to mid-May 2014, the Judge found that Mr Banks was not entitled to relief pursuant to s 301. This section relevantly provides:
301Power of court to require persons to repay money or return property
(1)If, in the course of the liquidation of a company, it appears to the court that a person who has taken part in the formation or promotion of the company, or a past or present director, manager, administrator, liquidator, or receiver of the company, has misapplied, or retained, or become liable or accountable for, money or property of the company, or been guilty of negligence, default, or breach of duty or trust in relation to the company, the court may, on the application of the liquidator or a creditor or shareholder,—
(a)inquire into the conduct of the promoter, director, manager, administrator, liquidator, or receiver; and
(b)order that person—
(i)to repay or restore the money or property or any part of it with interest at a rate the court thinks just; or
(ii)to contribute such sum to the assets of the company by way of compensation as the court thinks just; or
(c)where the application is made by a creditor, order that person to pay or transfer the money or property or any part of it with interest at a rate the court thinks just to the creditor.
The Judge considered that Mr Banks was unable to recover directly under s 301(1)(c); any recovery could only be ordered under s 301(1)(b), by way of compensation to the company.[21] However, the liquidation of Mako had concluded, and it had been removed from the Companies Register.[22] Although the proceedings commenced before this occurred, Mr Banks had not notified the liquidators of his claim or applied for orders restoring the company to the register and reversing the final report. He was therefore not able to apply for any remedy under s 301.[23]
[21]At [585].
[22]At [544].
[23]At [556].
The Judge did not consider there was any proper basis to make banning orders against any of the respondents. While they had breached their duties under ss 135 and 137, these were not gross departures from the required standards and did not cause loss to Mr Banks. The decision to trade beyond the point where the Judge considered Mako should have been placed in liquidation did not materially add to creditors’ losses. There was no need to protect the public or those dealing with companies from the respondents’ conduct.[24]
Fourth cause of action — breach of s 55G of the Securities Act
[24]At [590]–[591].
This cause of action overlapped with the FTA claim.[25] Mr Banks accepted that it could not succeed if the FTA claim failed.[26] It necessarily failed in any event because the Judge found that Mr Banks did not subscribe for any security.[27]
Costs judgment
[25]At [592].
[26]At [593(b)] and [597].
[27]At [596].
In his subsequent Costs judgment, the Judge ordered Mr Banks to pay indemnity costs for post-trial steps relating to the forged emails and scale costs for the balance with an uplift of 40 per cent on the remaining steps, principally to recognise Mr Banks’ misconduct, and a further uplift of 20 per cent to account for the additional time incurred and complexity involved in running a case for multiple defendants.[28]
Grounds of appeal against Substantive judgment
[28]Banks v Farmer [2022] NZHC 458 [Costs judgment].
Mr Banks appeals against the Substantive judgment arguing that the High Court “erred on the entirety of its reasoning: fact, law and procedure”. In summary, he argues that the Judge:
(a)erred in making credibility findings that he says were not available on the evidence;
(b)placed inappropriate weight on the credibility findings and paid insufficient regard to the documentary records;
(c)conflated the analysis under ss 9 and 43 of the FTA leading to erroneous findings on both breach and causation;
(d)misapprehended the law in relation to the Companies Act claims, paid insufficient regard to objective financial metrics on which such cases are typically decided, gave excessive leeway to the directors, and erred in its jurisdictional findings; and
(e)wrongly conflated the expansive concept of an offer to the public with the restrictive exceptions under the Securities Act, confused the relevant burdens and ought to have found that the respondents failed to prove that all persons to whom offers were made were exempt.
Grounds of appeal against Costs judgment
Mr Farmer appeals against the Costs judgment. First, he argues that the award of indemnity costs should not have been limited to post-trial steps. He says that indemnity costs should have been awarded for all steps taken in the proceeding after the forged emails were first provided by Mr Banks. Secondly, Mr Farmer contends that a separate costs award should have been made in his favour, not just one set of costs for all respondents.
Application to adduce further evidence
Mr Banks applies to adduce further evidence in support of his appeal against the Substantive judgment.
First, Mr Banks seeks to produce an affidavit from Ms Emily Moreton, a solicitor employed by the solicitors acting for him in this proceeding. Ms Moreton produces evidence of three unrelated proceedings brought against Mr Farmer (and others):
(a)In 2016, a prosecution initiated by the police in the District Court at North Shore against Mr Farmer for aiding and abetting Mako Networks Ltd to apply deductions of PAYE to other company purposes. Mr Farmer pleaded guilty to this offending and was sentenced in December 2016 to 120 hours of community work and four months of community detention.[29]
(b)In 2019, a prosecution initiated by Auckland Council in the District Court at Auckland against Mr Farmer and his company, Radius Contracting Ltd, for contraventions of the Resource Management Act 1991 and the Building Act 2004. Mr Farmer pleaded guilty and in January 2021 he was fined a total of $45,000 for this offending.[30]
(c)In 2021, proceedings filed in the High Court at Auckland by the Commissioner of Police under the Criminal Proceeds (Recovery) Act 2009 against Mr Farmer and others seeking a restraining order over a property in Manurewa. The alleged “significant criminal activity” underpinning this application was said to be a scheme to derive income from the use of property as residential accommodation when the relevant zoning only permitted it to be used for light industrial purposes.[31]
[29]Commissioner of Inland Revenue v Farmer [2016] NZDC 25721.
[30]Auckland Council v Radius Contracting Ltd [2021] NZDC 938.
[31]Commissioner of Police v Farmer [2022] NZHC 965.
We are not prepared to receive this affidavit as it does not provide any material assistance on any of the issues we must decide on this appeal. The latter two proceedings are wholly unrelated to the present proceedings and post-date the events forming the basis of Mr Banks’ claims. They also post-date the substantive hearing in the High Court. The evidence relating to these proceedings comes nowhere near satisfying the narrow gateway available for the introduction of fresh evidence in the context of a civil appeal.[32] While the evidence of the proceedings commenced by the police relating to non-payment of PAYE has some limited connection to the present case, it is debateable whether this evidence is fresh. However, even if that criterion is met, the relevance of the evidence is questionable. Mr Banks made his final advance on 24 April 2014. The non-payment of PAYE occurred later. It appears to have related to the six-month period ended 31 December 2014. If anything, this evidence supports Moore J’s finding that Mr Farmer breached his duties as a director of the company by allowing it to continue to trade while insolvent from mid-May 2014. The evidence cannot have any material bearing on the outcome of this appeal. In other words, we do not consider the evidence is cogent.
[32]Court of Appeal (Civil) Rules 2005, r 45; and Paper Reclaim Ltd v Aotearoa International Ltd (Further Evidence) (No 1) [2006] NZSC 59, [2007] 2 NZLR 1 at [6] and [8] confirming Rae v International Insurance Brokers (Nelson Marlborough) Ltd [1998] 3 NZLR 190 (CA) at 192.
.
Secondly, Mr Banks seeks to rely on an updating affidavit from Mr Kieran Jones, one of the liquidators of Mako. Mr Jones deposes that Mako was restored to the Companies Register on 18 August 2021, after the Substantive judgment was delivered. The liquidators then filed a proceeding against Mr Farmer and the other directors in the High Court at Auckland. By agreement, those proceedings have been stayed pending the outcome of this appeal. The secured creditor, Spark New Zealand Trading Ltd, was served with a notice under s 305(8) of the Companies Act requiring it to elect whether it wished to enforce its security. Mr Jones advises that Spark New Zealand Trading has elected to surrender its security and would claim in the liquidation of Mako as an unsecured creditor. Mr Jones says that the liquidators abide the decision of this Court as to whether it makes an award to Mr Banks subject to him accounting for their outstanding fees and disbursements and so long as the amount awarded does not exceed the amount Mr Banks would otherwise be entitled to under cl 1(e) of sch 7 of the Companies Act.
We are prepared to receive this updating affidavit. It is clearly fresh and credible. It is also cogent in that it addresses questions as to whether relief can and ought to be granted if Mr Banks succeeds on appeal with his claims under the Companies Act.
The issues
The parties have agreed the issues to be determined. In respect of the substantive appeal, they can be summarised as follows:
(a)FTA claims
(i)Did the High Court err in finding that the representations made prior to each of the three agreements were not misleading or deceptive in breach of s 9 of the FTA?
(ii)If so, is Mr Banks entitled to relief under s 43 of the FTA?
(iii)Did the High Court err in failing to find that Messrs Gamble and Massam were liable as principals or as accessories?
(b)Companies Act claims
(i)Did the High Court err in its analysis of s 138 of the Companies Act (reliance by directors on information and advice)?
(ii)Did the High Court err in finding that the directors did not breach s 135 of the Companies Act prior to late-April/mid-May 2014 (reckless trading)?[33]
[33]Mr Banks acknowledged that the factors relevant to ss 135 and 137 largely overlap in this case. The focus of his appeal on this aspect is confined to s 135.
(iii)Did the High Court err in finding that the directors did not breach s 136 of the Companies Act (incurring obligations without reasonable grounds to believe the company will be able to perform)?.
(iv)Did the High Court err in finding that it had no jurisdiction under s 301 of the Companies Act to make the orders sought?
(v)If so, should the High Court have made an award either directly to Mr Banks or to Mako, and if so, what is the appropriate award?
(c)Securities Act claims
(i)Did the High Court err in finding that Mr Banks’ investments did not result from offers of securities to the public for the purposes of s 37 of the Securities Act?
(ii)Did the High Court err in finding that Mr Banks was a habitual investor?
(d)The “Nuves emails”
(i)Did the High Court err in finding that Mr Banks had forged the Nuves emails?
(ii)If so, was the High Court entitled to have regard to this finding in assessing Mr Banks’ credibility generally and in supporting its finding that Mr Banks was a habitual investor by way of an adverse inference?
The agreed issues on the costs appeal are:
(a)Did the High Court err in finding that indemnity costs were not payable for steps taken after 24 April 2019 when the Nuves emails were provided?
(b)Did the High Court err in not making separate costs awards?
Factual background
We will commence by summarising the factual background. This will broadly map Mako’s trajectory and provide the context in which Mr Banks’ advances were made.
The following summary of the key factual narrative is largely drawn from the reasonably comprehensive documentary record. It is desirable to focus primarily on the documents for two reasons. First, this will facilitate scrutiny of Mr Banks’ complaint that the Judge was unduly swayed by his adverse credibility findings. Secondly, this approach is preferable because the relevant events occurred many years before the trial. We will address the contest relating to the Nuves emails at the end.
Company formation and key personnel
Mako was incorporated in September 2002 as the holding company for various wholly owned subsidiaries in the group. The main operating company and New Zealand arm of the business, Mako Networks Ltd, was formed a year earlier. Mr Farmer was the chief executive officer, Mr Gamble was the business development director, and Mr Massam was the technical director. Mr Frederick entered into a services agreement with the company in February 2010. He was later appointed a director and served as chairman at all relevant times.
Messrs Gamble and Massam had previously worked together in the email and security teams in Telecom’s Xtra division. By the end of 1999, Mr Gamble was looking for a new challenge. He had known Mr Farmer for many years, having originally met him through his father. In early 2000, Mr Gamble accepted an offer from Mr Farmer to take on the role of IT manager for one of his companies. Soon after accepting this offer, Mr Gamble arranged for Mr Massam to become involved as well. Messrs Gamble and Massam worked for this business for about a year before forming Mako Networks Ltd in February 2001.
Mr Farmer has a business background. He had previously developed and sold two large and successful companies in New Zealand. One of these operated nationwide with 26 retail outlets and the other was an import/export business with annual revenue in excess of $45 million operating in New Zealand, Australia, China, and the United States.
Mr Michael Frawley joined the board in December 2011. He had recently returned to New Zealand from England having worked in the legal profession for 25 years. His last position was as the managing partner of a large law firm in London, with offices worldwide. Mr Frawley resigned as a director at the end of 2013.
Mako’s network security system
Mako developed and patented a network security management system which comprised hardware that connected a customer’s business premises to the internet and a cloud-based centrally managed server platform. The two key functions performed by the system were, first, to monitor incoming and outgoing network traffic to prevent hackers from diverting data streams, and secondly, to respond in real-time to security threats by sending alerts and other commands to other parts of the network as soon as any threat arose. Mr Farmer described the second function as effectively being an early version of “artificial intelligence” or “machine-learning”. The Mako system was designed to protect against internet misuse by employees, guest users, hackers, and other external parties as well as viruses, identity theft and reputational damage caused by security breaches. Mako sold the hardware to its customers and an annual licence to use the system.
Initial commercialisation in New Zealand
Mako achieved considerable early success in commercialising this technology. In October 2005, it entered into a supply agreement with Telecom (now Spark) which marketed the Mako system to its customers under the name SecureMe. The product continues to be successful under the ownership of Spark, which acquired it from Mako in February 2014. The Mako system was purchased by a number of key customers including the Ministry of Health, Fonterra, Z Energy, Mobil, Lotto, and the New Zealand Racing Board.
Expansion into overseas markets
In 2007, Mako entered the Australian market selling exclusive rights to the Mako system to NetComm, a technology manufacturer and distributor which marketed the product in Australia as NetAssure.
In 2009, Mako identified an opportunity for its system in the potentially lucrative credit card security market. In February 2010, Mako obtained certified compliance with the Payment Card Industry Data Security Standard (PCI-DSS). This standard was developed in 2006 by the five major credit card companies based in Japan and the United States as a means of improving cardholder data protection and reducing credit card fraud. Obtaining PCI-DSS compliance was a major coup as Mako was the first network security provider to achieve this certification. It opened up opportunities for it to offer its system to the vast number of businesses that accept payment by credit card. Mako looked to capitalise on this achievement by expanding globally, particularly in the United States market. Mr Frederick became involved in the business to assist with this expansion.
Mr Farmer had met Mr Frederick in London through a mutual acquaintance in late 2009 and he attended the launch of Mako’s PCI-DSS certified product in Auckland in February 2010. As noted, Mr Frederick joined the board as chairman a short time later. This was to help facilitate Mako’s entry into the United States market utilising Mr Frederick’s contacts and considerable experience in the information technology sector.
Mr Frederick is American and lives in Texas. After graduating from university, he joined The Boeing Company as a research analyst in 1979. In 1997, he joined the BAAN Company, a major software technology company, as executive vice president and relocated to the Netherlands. His role was to manage and coordinate services for the company’s worldwide customer care and support operations. He also served on the boards of BAAN’s subsidiaries in Israel and Japan. In 1999, Mr Frederick was recruited by EDS, one of the largest technology services companies in the world. He was appointed president of the Information Solutions Group and executive vice president of EDS corporate. In this role, he was responsible for some 80,000 technical and service professionals, revenue of over USD15 billion and 80 per cent of the core IT service outsourcing business. In 2003, he started his own consulting company to reduce his workload and partially retire. In 2008, he was offered the position of chief executive officer of a small technology start-up company, Whitney University Systems, which owned and operated colleges and universities in Colombia, Argentina, Brazil, Panama, and the United States. The company created distributed technology system solutions that allowed it to offer degree programmes to underserved, less wealthy populations. Mr Frederick retired from this position in 2010, shortly before he joined Mako.
Funding from Telecom Rentals
Mako primarily funded its business through an equipment finance facility between Telecom Rentals and Mako Networks Finance & Leasing Ltd, one of Mako’s subsidiaries. This facility comprised a master rental agreement dated 22 October 2010,[34] a general security agreement (GSA) dated 26 October 2010 between Mako Networks Finance & Leasing Ltd as grantor and Telecom Rentals as the secured party, and various rental agreements detailing specific items of equipment and referred to as rental schedules to the master rental agreement. Telecom Rentals financed the purchase of the hardware and rented it to Mako Networks Financing & Leasing with rental payments spread over a three-year term.[35] The master rental agreement was varied on 5 August 2011 to authorise the financed equipment to be used by Mako’s customers offshore. At the same time, Mako, which owned the intellectual property, guaranteed the obligations of Mako Networks Finance & Leasing to Telecom Rentals.
Private placement memorandum
[34]There is also reference to an earlier agreement dated 26 July 2010 called the Telecom Master Rental Agreement.
[35]There were also “Finance Leases” for up to five years and “Equipment Sales Schedules” for shorter terms.
In late 2010, Mako sought to raise capital from wealthy investors and the PPM was prepared for this purpose. The proposal was to raise $7.5 million by issuing 3.75 million new shares. At the same time, the total number of shares would be increased from approximately 110,000 shares to 25 million shares. The PPM stated prominently on the first page of the introductory section that the offer would be open only to persons excluded from being members of the public pursuant to s 3(2) of the Securities Act, namely relatives or close business associates of Mako or a director of Mako, persons whose principal business is the investment of money or who, in the course of and for the purpose of their business, habitually invest money, or any other person who in all the circumstances can properly be regarded as having been selected otherwise than as a member of the public. The offer to subscribe for shares on the terms set out was to open on 1 November and close on 30 November 2010. Mr Banks did not participate in this capital raising.
Introduction to Mr Banks
Mr Farmer’s first introduction to the Banks family was through Mr Dave Winslade. Mr Winslade was Mr Banks’ mother’s then partner. He lived nearby and the two met at a local social event where Mr Farmer told him about Mako and its plan to raise capital. Mr Winslade indicated that Ms Banks had family money to invest and could be interested. Mr Farmer subsequently met with Ms Banks and Mr Banks, on separate occasions, in late 2010. Mr Farmer sent Mr Banks a copy of the PPM on 22 December 2010. This contained considerable information about Mako including its historical and projected financial performance and business prospects. Mr Banks relies on this document to found some of his misrepresentation claims. We will discuss these in more detail when addressing the FTA claims.
Agreement 1 — 4 February 2011
Rather than subscribing for shares, Mr Banks proposed advancing monies to Mako on terms tailored to meet his personal circumstances and tax position. These were negotiated over the following weeks and led to the execution of a loan agreement dated 4 February 2011 (Agreement 1). This provided for an advance of £1,177,000 in three tranches, all to be made on 10 March 2011. The first two tranches (£130,000 and £547,000) were for a minimum term of two years and the third tranche of £500,000 was for a minimum term of three months. All three tranches were otherwise repayable on demand with prior notice (six months for the first two tranches and three months for the third). Interest (expressed as an “increase [in] the debt magnitude”) would accrue at a rate of 10 per cent per annum.
The agreement provided that Mako would not, without Mr Banks’ prior consent, undertake any external borrowings or give security over any of its assets other than in the ordinary course of business where the secured assets were not more than 15 per cent of its total assets. Mr Banks would also be entitled to the same information provided by Mako to its shareholders and to regular informal updates on the business.
In the course of the negotiations leading to the agreement, Mr Banks made various claims about his commercial acumen. For example, in an email he sent to Mr Farmer immediately after receiving the PPM, he added a postscript: “[i]n case it is of interest in the future: I’m a good proof-reader of legal and financial documents and to a lesser extent, computer code.” It was thought that Mr Banks might be able to provide some assistance to Mako utilising his skills in these areas. It was in this context that one of the terms of the agreement envisaged that Mr Banks would provide advice to Mako regarding capital raising and other financial advice as may be agreed:
4. Other terms
(a)[Mr Banks] shall provide advice to [Mako] regarding capital raising of [Mako] and shall provide financial advice to [Mako] as agreed between [Mr Banks] and [Mako].
This section of the agreement also contained an entire agreement clause and an acknowledgement by Mr Banks that in entering into the agreement he had relied on his own judgment and not on any representation:
(f)This letter agreement is the entire agreement between the parties and supersedes all prior agreements, negotiations, representations and the like concerning its subject matter. [Mr Banks] confirms [he] has entered into this agreement on [his] own judgment and has not relied on any representation of [Mako] or its agents, officers and personnel.
Business development 2011–2013
Between 2011 and 2013, Mako extensively promoted its product overseas, particularly in Asia, the United States and the United Kingdom.
In December 2011, Mako Networks Ltd achieved a significant milestone by signing a three-year non-exclusive distributor agreement and a companion hardware supply agreement with Phoenix Managed Networks Ltd, a company based in the United Kingdom that supplied secure payment systems globally. The distribution agreement extended to any country where Phoenix had a presence, which included North America and Europe, and required it to purchase at least 10,000 Mako licences and 4,000 hardware devices in the first 12 months. This agreement was varied in December 2012 to require Phoenix to purchase 10,000 devices and associated licences by the end of July 2015 at the latest.
Mako opened an office in San Francisco in February 2012 and Mr Gamble relocated there to support the opportunities presented by the Phoenix relationship and pursue other business opportunities.
In December 2012, Mako Networks Sales & Marketing Inc, Mako’s American subsidiary, entered into a service provider agreement with Chevron with a view to the Mako system being rolled out to Chevron sites across the United States. At the time, Chevron was the third largest listed company in the world and had approximately 9,000 fuel stations across America. By the end of 2014, the Mako system had been deployed to around 4,500 of these sites.
In May 2013, Mako entered into a non-exclusive reseller agreement for the United States and Canada with BullsEye Telecom Inc, a business-to-business telecommunications company based in Michigan. By April 2014, BullsEye had on‑sold the product to a number of its customers including Triton Management (70 sites), Fisher Auto Parts (100 sites) and Title Max (30 sites).
Also in May 2013, Mako entered into a non-exclusive reseller agreement with Aperia Solutions Inc for distribution of Mako’s system in the United States. Aperia was based in Dallas and provided electronic banking services. Although initial trials were successfully completed, this agreement did not ultimately bear fruit.
Cashflow remained tight throughout this period as Mako expanded into overseas markets. The directors closely monitored Mako’s financial position to ensure there would be sufficient cash to meet its commitments. Telecom Rentals remained the primary source of funding. Mr Farmer maintained a good relationship with Mr Geoff Hamilton, the general manager of Telecom Rentals, and they kept in contact on a regular basis.
Proposed IPO
In late 2012, the possibility of an IPO was discussed by the board. Mr Farmer took some preparatory steps to progress this initiative including by engaging with Cameron Partners, an independent investment bank based in Wellington. Around this time, Norcal Growth Partners, a business development consultancy in California specialising in IT services, was retained to prepare a comprehensive independent market analysis for the purposes of the intended IPO. Mr Farmer also held preliminary discussions with Telecom Rentals about the possibility of it becoming a cornerstone shareholder through a debt to equity conversion in the context of an IPO.
In an email sent on 18 January 2013, Mr Dragan Gasic, business development manager at Telecom Rentals, confirmed that Telecom Rentals would continue to provide a short to mid-term financing facility to support Mako’s sales until alternative funding was available through the intended IPO. He expected this would require Telecom Rentals to provide an additional $5 to $7 million over the next six to eight months. A new general security deed was entered into by Mako Networks Financing & Leasing Ltd in February 2013, increasing the priority amount to $35 million to reflect the expected increase in the level of funding.
Norcal provided a preliminary report in January 2013 setting out its findings on the size of the target market and its likely development over the next five years, its assessment of Mako’s competition and prospects, and the range of valuation multiples for similar companies trading in that market. Drawing from independent research conducted by Gartner Inc, a technological research and consulting firm based in Connecticut, Norcal reported that the overall market for security software currently stood at approximately USD18 billion, network management software and appliances at USD2.5 billion, IT operations management software at USD18 billion, and security and vulnerability software at USD3.8 billion. Compound growth rates in these areas ranged from seven to nine per cent. In North America alone, managed security services revenues exceeded USD3 billion annually.
Norcal observed that other similar companies were typically trading at values reflecting revenue multiples ranging from a low of four to a high of 10. The market for Mako’s products was described as “extremely healthy, vibrant and steadily growing”. Norcal considered that Mako had “a unique opportunity to expand [its] market penetration by many orders of magnitude over current sales”. Norcal assessed Mako as having a good culture with quality personnel and concluded that it had the “tools, resources, people and ability to pursue and win in a highly lucrative market”.
Cameron Partners advised Mr Farmer in an email in late February 2013 that they were “very enthusiastic” about Mako’s growth opportunity and the potential IPO. The key tasks to be undertaken were set out and they advised that it would be realistic for the listing to occur in August or September 2013. Deloitte was engaged in August 2013 on Cameron Partner’s recommendation to act as Mako’s accountants, to prepare audited accounts, and to assist with the IPO.
On 28 February 2013, Mr Farmer was contacted by Mr Nick Peace of Starfish Ventures, an Australian venture capital manager with investments in the information technology sector ranging from early stage start-up companies through to established technology businesses seeking capital for expansion or development. Mr Peace said he understood that Mako had been growing strongly over the past few years and expressed interest in assisting with any capital raising to fund future growth.
Norcal finalised its independent market analysis and sent this to Mr Farmer on 18 March 2013. This 37-page report entitled “Mako Market Survey” contained five sections and included an analysis of the size and dynamics of the market, the current and future potential for Mako’s products, the competitive landscape within the market, an analysis of Mako’s strengths and weaknesses, and comparable valuation metrics. This report was very positive.
Mr Farmer had discussions with senior executives of two other venture capital companies around this time, Mr Timothy Dick, a general partner at Startup Capital Ventures in California, and Mr Sean Joyce, the principal of a New Zealand boutique venture capital firm. Mr Joyce raised the possibility of an acquisition by a listed shell company in the United States associated with parties who were interested in making an acquisition in the tech sector and had the ability to raise significant new capital. Mr Dick said that his firm had good relations with many large venture capital firms that may find Mako an attractive proposition and he offered to help raise the capital Mako required to achieve major growth.
The formal terms of Cameron Partners’ engagement were recorded in a letter signed by Mr Farmer on 8 April 2013. Its primary role was to advise the board on the intended IPO which was expected to be launched in the second half of 2013. Cameron Partners advised that it would not be appropriate for Mako to list with any debt on its balance sheet, including the debt to Telecom Rentals. The first step in the process was therefore to seek to equitise all existing debts, including shareholder loans. One of Cameron Partners’ responsibilities was to support the board in its negotiations with Telecom Rentals.
Mr Farmer met with Mr Gasic on 11 April 2013. In a follow-up email to Mr Farmer later that day, Mr Gasic referred to the recent launch of Telecom Digital Ventures, a new business unit, and suggested that Mako could be a good fit with this new strategy. He said the “[t]hree pillars of current IT hype” were mobility, security, and cloud and that Mako was “ahead of the curve” on all three, globally and locally. Mr Gasic noted that Mako’s current exposure to Telecom Rentals was approximately $23 million including interest and the agreed debt ceiling for the short to medium term was $35 million.
In April and May 2013, Norcal provided drafts of a further report entitled “Mako Pipeline Assessment”. The purpose of this report was to provide an independent, objective, and realistic assessment of the opportunities available to Mako in the light of existing sales activities, market conditions and end user buying preferences. In preparing this assessment, Norcal conducted interviews with business development managers in each sales region, researched Mako’s opportunity with each target taking account of capabilities and alignment with selected performance metrics and applied weighted assessment criteria designed to predict likely future sales. The resulting analysis projected global sales of the order of 500,000 units over the next three years, primarily in the United States but also taking account of expected sales in Europe, Asia, Australia, and New Zealand. A little over half of all projected sales in Europe were expected to be achieved through the Phoenix relationship. By comparison, existing contracts with Phoenix, Chevron, BullsEye and Aperia were each predicted to contribute only two per cent (eight per cent in total) of all projected sales over the three-year period in the United States. One of the prospects identified was with telecommunications giant, Sprint, to which we have already briefly referred. Norcal’s analysis forecasted that 13 per cent of total sales in the United States over the next three-year period would be derived from Sprint. On that basis, it would be the third largest contributor globally and was expected to account for the sale of 55,000 units over the three-year period.
On 13 May 2013, Cameron Partners prepared a draft investor presentation. This referred to the mandate by major credit card schemes requiring all credit card merchants worldwide (around 58 million merchant sites) to achieve PCI-DSS compliance by December 2015. It was noted that 10 states in the United States had already regulated that merchants must attain PCI-DSS compliance. These developments were occurring in the context of an increasing incidence of credit card fraud (estimated to cost around USD5.5 billion annually and growing) and cybercrime fuelling demand by larger corporates for higher levels of digital security. The investor presentation described Mako’s network security offering, the global market opportunity, Mako’s strategic positioning, and set out Mako’s plan to raise $20 million through an IPO to scale the business as an emerging global leader in the secure payment networks market.
In late May 2013, Cameron Partners produced a proposal for Mako to present to Telecom Rentals for conversion of its debt to equity. Supported by Norcal’s market analysis and sales pipeline validation, future operating revenue was projected to be $11 million in the first year, $75 million in year two and rising to $158 million in year three. These projections assumed sufficient capital would be raised to fund the company’s growth.
In early June 2013, Mako entered into preliminary discussions with Time Dotcom Berhad, a listed telecommunications company in Malaysia which expressed interest in forming a strategic partnership with Mako. It indicated a preparedness to invest USD50 million subject to gaining a better understanding of the product offering, the company’s long-term plans and its risk profile.
The minutes of the meeting of the board on 20 June 2013 recorded that Mako had agreed in principle to a new financing structure with Telecom Rentals for the next five-year period. It was expected that this would improve Mako’s short to mid-term cashflow by substantially reducing its interest payments to Telecom Rentals. It was also expected to result in an additional advance of $3 million which would assist Mako to expand its business in the United States. Telecom Rentals’ security position would be improved as part of the restructure. The board minutes summarised the discussions on this topic and a related recommendation from management that the IPO be delayed until March 2014:
Mr McGregor went on to update Directors on managements rationale for extending the timing of the capital raising to March 2014. With the financing from TRL in place this provides certainty for the short term and would allow the company to focus on growing revenues from executed contracts. Revenue growth would drive valuation for purposes of an IPO and provide scope for an increased offer size from $30 million to $50 million. Mr Farmer added that an extended timeline would allow other sales prospects to materialise these included; Telestra, Time, Riverbed, Aperia and Airtight. Extending the timeline would also allow personnel and infrastructure to be better implemented.
Directors went on to have a general discussion on the merits of an extended timeline. Mr Frawley agreed to an extended timeline and acknowledged that the new funding arrangement would strengthen [Telecom Rentals’] security interest. The reduced monthly cash outflow was also beneficial. Mr Farmer mentioned the extended timeline comes at a cost of circa $5m. However the responsibility to the Shareholders to maximise value warranted this extension and increase cost
Two deeds of assignment, each dated 28 June 2013, were subsequently executed with Telecom Rentals. The first assigned rights and obligations of Mako Networks Finance & Leasing Ltd under the Telecom Master Rental Agreement (as varied) including the associated rental schedules to Mako Networks Ltd. The second assigned to Mako the rights and obligations of Mako Networks Finance & Leasing under the general security deed. Mako covenanted with Telecom Rentals to perform Mako Networks Finance & Leasing’s obligations under that deed. Mako’s agreement to provide security to Telecom Rentals was in breach of Agreement 1. Mr Banks’ consent ought to have been sought but the need for this was overlooked.
Agreement 2 — 30 June 2013
In the meantime, in March 2013, Mr Banks indicated that he wished to invest further monies in Mako on the same terms as the existing agreement but with the option of converting the debt to equity in the event of an IPO. In an email to Mr Farmer on 14 March 2013, Mr Banks said he expected to have a further £243,000 coming soon with the possibility of a further $1.5 million, but this would be more difficult to access. He indicated that if the debt was able to be converted to equity at a discount of 20 per cent or more, he would investigate whether he could access this money.
On 30 June 2013, a second agreement (Agreement 2) was executed recording the terms on which Mr Banks made two further advances, £237,722.43 on 14 May 2013 and £24,779.14 on 3 June 2013. These advances were made on the same terms and conditions as Agreement 1 except that all advances, including those made under Agreement 1, would be converted to equity in Mako at a discount of 15 per cent upon completion of the anticipated listing on the New Zealand Exchange (NZX).
July to December 2013
In early July 2013, Mako engaged Bell Gully to act as its solicitors on the proposed IPO.
Cameron Partners introduced Mr Farmer to Mr Mark Weldon, the former chief executive of NZX and an experienced company director. Following an initial briefing, Mr Weldon sent an email to Mr Farmer on 9 July 2013 expressing an interest in assisting with the IPO, personally investing between $1 and $3 million in Mako, and contributing his skills by joining the board as a director. Mr Weldon proposed undertaking a detailed investigative process with a view to providing a report to the board on how it should organise the business to allow “supercharged sales growth”. The report would address a wide range of issues including governance; organisational structure and reporting lines covering matters such as supply chain, operations, finance and legal; compliance; risk management with a specific focus on risks over the next 12 months; finance function, including accounting policies, financial reporting, board support, and investor relations; and IPO preparation and timing. It was agreed that Mr Weldon be engaged to carry out this work.
Mr Ian McGregor, Mako’s chief financial officer, prepared a detailed board paper addressing the solvency test as at 30 June 2013. He circulated this paper to the directors on 18 July 2013. Mr McGregor stated that the paper had been reviewed by Bell Gully and Deloitte, although he noted that Deloitte had not yet reviewed the financial information. The primary objectives of the paper were set out at the outset. These were to demonstrate to the directors that Mako had sufficient cash resources to meet its obligations in the normal course of business, and secondly, to provide the directors with adequate information to determine a true and fair view as to the value of Mako on a going concern basis and satisfy them that the value exceeded the equity deficit and could settle outstanding liabilities.
Mr McGregor reported that Mako satisfied the cashflow solvency test because it had adequate cash surplus of $3.9 million as at 30 June 2013 plus additional liquidity via access to the $35 million financing facility with Telecom Rentals currently drawn to $24.5 million as at 30 June 2013.[36] In considering balance sheet solvency, Mr McGregor assessed the enterprise value range as being between $52.8 million (based on the last twelve months’ revenue) and $101.6 million (based on revenue projections for the next twelve months). He adopted a multiple of eight times revenue in arriving at these assessments. He noted that the mid-point of $77.2 million exceeded the equity deficit of $8.667 million.
[36]There were various versions of this solvency paper. We refer to the one discussed by Mr Hussey in his evidence.
Mr Weldon and Ms Claire McGowan subsequently presented a detailed report dated 7 October 2013 (the Weldon report) in which they sought to identify the strengths and weakness of Mako’s business and made recommendations to enable substantial growth in shareholder value over the next 12 to 18 months. They considered that Mako had reached the point where its sales prospects were “strong and exciting” and, if executed profitably, would “create real value for shareholders”. They noted that Mako had focused to date on its product, associated research and development, and developing a significant sales pipeline. They said Mako had “developed excellence” in these areas and they rated its product as being in the top decile. However, they considered that Mako’s future growth would require significant improvements in the areas of supply chain and delivery, operations, capital structure and management.
Mr Weldon and Ms McGowan warned that if Mako’s debt was not kept under control, the company could “grow bust” despite its promising sales pipeline. They said that Mako’s net debt position was too high for the near term (24 months) and some form of equity would need to be issued to ensure the business can “navigate the next 12–18 months and deliver the customer pipeline”. They made comprehensive recommendations to improve Mako’s managerial, operational, and financial competence. These changes were considered necessary to enable Mako to meet the demands of the next phase of its development and facilitate careful management of its cashflow over the near term.
The report concluded by likening Mako to “a weightlifter with strong arms, strong legs, but with weak core strength”. The authors described Mako as a company possessing some “extremely world class aspects” but having others that are “the counter to that”. They considered that if their recommendations were implemented, the increase in Mako’s valuation over the 12–18 month period would be a minimum of $30 million, and could be up to $100 million, above its current value.
By this time, Mako had secured two other potentially valuable business relationships in the United States. The first was with Spacenet Inc, an IT service management company based in Virginia. This agreement, dated 28 August 2013, was styled as a business partner agreement, and conferred non-exclusive rights to sell Mako’s products and services anywhere in the United States. The second, executed on 18 September 2013, was a “Teaming Agreement” with Sprint. Under the teaming agreement the parties agreed to explore potential co-marketing opportunities, and Sprint agreed to promote and sell the Mako system throughout the United States.
Mr Farmer produced a briefing paper for the directors to consider at the board meeting on 30 October 2013. The paper covered various matters including present sales initiatives, the Weldon report, the draft audited financial statements, and the current status of the relationship with Telecom Rentals. Mr Farmer had previously circulated to the other directors an email he and Mr McGregor had received from Mr Hamilton setting out his view of the funding challenges Mako currently faced and a follow-up email from him. Because of the critical importance of the relationship with Telecom Rentals and its ongoing funding and support, we set out some of the key points Mr Hamilton made in his first email:
Our assessment on the draft information and conversations to date are:
· The business is seriously undercapitalised;
· Mako is growing at an extraordinary rate, having reached the tipping point of product conversion in the US;
· The Mako [PCI-DSS] solution offering has significant value and is gaining in market penetration;
· The anticipated balance sheet capitalisation of newly signed contracts (Bulls[E]ye / Chevron etc) was not included in the audited accounts as planned. Without this planned asset, the draft accounts show a negative equity position of $13m;
· Mako may require continued funding for two more years before the business becomes cash-flow positive, or recurring revenue is sufficient to cover overheads;
· Large US sales pipeline opportunities provide the potential to “up-front” the revenue from new Nodes, significantly reducing external funding requirements (nothing contracted to date however);
· The $35m figure included in the guarantee document, was based on an expected Fair Market Valuation of the [PCI-DSS] solution Intellectual Property of around $30m. This IP is valued in the draft accounts at $6.2m;
· [Telecom Rentals] has principal outstanding of $26.3m and a total exposure of $34.53m once future interest payments are included;
· There does not appear to be an alternative funder in place for now, or when [Telecom Rentals’] maximum exposure is reached (whatever that is);
· Without [Telecom Rentals’] support, or an alternative funding source available, the business is technically insolvent;
· We expect a further loss in FY14 will mean the equity position will be roughly $20m in the red by June 2014;
· The business has a lot of work to do to be ready for an IPO. This not only includes improving the financial processes and governance, but also delivery of the already signed contracts. It does not seem like the March IPO timeframe is achievable;
Mr Hamilton queried why the intellectual property had not been re-valued and suggested this would result in a much healthier balance sheet. He said the negative equity position would make it difficult to keep “things ticking over as before”. Alternative funding options needed to be explored urgently in the event Telecom Rentals was not able to continue to lend. He said that a $20 to $50 million injection of cash/equity needed to occur by 14 March 2014 to cover the losses to date and fund some of the future growth. He expected this would likely be a private placement rather than an IPO. Mr Hamilton acknowledged that some of this would be “challenging to read” but he wanted to ensure the seriousness of the situation was fully grasped by Mako’s board. He concluded by saying that Mako had done “a fantastic job of building an internationally marketable product”, and that Telecom Rentals was “proud to be part of this fantastically successful Kiwi business”. He said Telecom Rentals would “do everything in [its] power to continue to support the Mako team”.
Mr Farmer said this email came as a shock. Mako had been relying on Telecom Rentals’ continued support up to a debt ceiling of $35 million. Following further discussions, Mr Hamilton clarified Telecom Rentals’ position in an email on 27 October 2013:
My comment that Mako needs to source between $20m–$50m of cash / equity by March 2014 is not a request or demand that [Telecom Rentals’] debt is repaid by that date.
We believe that the business is undercapitalised and has an ongoing need for working capital, probably for a further 2 years. FY14 will likely show another loss, compounding the negative equity position and further exposing [Telecom Rentals]. An injection of say, $35m, will not only address the negative equity position in the balance sheet, but will also go a long way to funding future growth.
We do not expect, nor have we asked for, our debt to be repaid from this cash injection. That will need to be an economic decision made by the Mako Board at the time.
The board discussed these matters at a directors’ meeting on 30 October 2013. The directors noted that it was difficult to assess accurately Mako’s working capital requirements in the “changing sales environment”. A best endeavours assessment was the only practical option. After some discussion, the directors considered there were reasonable grounds to conclude that the company could continue on a going concern basis until October 2014 but noted that the position would have to be closely monitored. It was agreed that Telecom Rentals be provided with regular reports to maintain its confidence. The directors resolved unanimously to approve the audited financial statements and the representation letter to the auditors.
In November 2013, Telecom Rentals unexpectedly and without forewarning did not advance $5 million that Mako had anticipated receiving that month. As a result, in order to meet immediate cashflow requirements, Mako’s shareholders (including Mr Farmer’s trust, Mr Gamble and Mr Frederick) advanced approximately $1.1 million to the company.
On 19 December 2013, Mr Hamilton wrote to Mr Farmer advising that he had been “working hard behind the scenes” to see if a solution could be found but Telecom senior management had requested an independent review of the business before any decisions were made regarding Telecom’s further involvement. Agreement was sought for the appointment of insolvency specialists, KordaMentha, to carry out this review at Telecom’s expense. Mako’s board agreed to this. On 27 December 2013, Telecom Rentals formally suspended all further advances to Mako under the existing facility agreement pending KordaMentha’s report which was expected at the end of January 2014.
These developments led Mr Frawley to resign as a director on 29 December 2013.
Restructure of Telecom Rentals’ debt
Mr Farmer sought legal advice on the directors’ duties and potential liabilities, including from Mr Murray Tingey, a senior insolvency partner at Bell Gully. Mr Tingey attended part of the board meeting held on 18 January 2014 to provide further guidance. Numerous attempts were made to urgently secure further investment from a venture capital funder or other large investor, but these endeavours were hindered by the debt to Telecom Rentals.
On 24 January 2014, Telecom put forward a proposal to restructure the debt. Mako had limited options. Agreement was reached and the documentation was executed on 7 February 2014. The terms of the restructure were broadly as follows:
(a)Telecom would acquire for $3 million the assets required to ensure continuity of current and future New Zealand business operations including the provision of products and services to its New Zealand customers (the “SecureMe” business).
(b)Telecom Rentals agreed to advance $2 million to Mako and Mako Networks for the purpose of repaying part of the existing indebtedness ($26,876,372.92).
(c)Mako Networks and Telecom Rentals entered into amended finance lease arrangements in terms of which the amended indebtedness ($24,876,372.92) would be repaid with interest by equal monthly instalments of $838,183.32 commencing in two years’ time, with the first payment due on 29 February 2016.
(d)Mako, Mako Networks and Mako Finance & Leasing gave cross‑guarantees and securities over their assets in favour of Telecom.
(e)All intercompany debt in the Mako group was subordinated to the debt owed to Telecom Rentals.
As part of the restructure, approximately half of the company’s personnel in the areas of research and development, operations, and administration had to be let go. Mr Farmer described this as “gut wrenching”. He wrote to the majority shareholders (Messrs Gamble, Massam and Dennis Monks) on 13 February 2014 to discuss future strategy and identify options. He said that the New Zealand capital markets were unlikely to provide the required funding and all indications were that United States venture capital investors were very unlikely to participate in a New Zealand-based IPO. Mako’s future lay offshore and he suggested the business needed to be driven from the jurisdictions that were providing the revenues. He said that the company was at a crossroads and must consider how to move forward. In his view, the company’s administration should move to the United States.
Agreement 3 — 24 April 2014
Mr Banks and Mr Farmer remained in contact from time to time after Agreement 2 was completed. At that time, an IPO in the second half of 2013 was being worked towards. Mr Banks was informed after this timing was pushed out to 2014. He was concerned that he could be prejudiced by this delay because it extended the period over which interest would not be paid in terms of Agreement 2. He discussed this with Mr Farmer at a meeting over lunch on 17 September 2013. They had a further catchup meeting at a café on 23 October 2013. Following this meeting, Mr Banks sent an email to Mr Farmer in which he commented:
I have the feeling that we’re going to be chuffed in about 5y. I’m now a lot clearer re the benefit of waiting longer for the float.
On 5 November 2013, Mr Farmer sent Mr Banks a link to a United States business news article dated 4 November 2013 announcing the new teaming agreement concluded between Mako and Sprint. This appeared to be a very positive development for Mako. The article referred to Sprint’s strong market presence, serving more than 54 million customers, and being widely recognised for developing, engineering, and deploying innovative technologies, including the first wireless 4G service from a national carrier in the United States, and offering industry-leading mobile data services. Sprint was quoted as describing Mako’s technology as “leading the way in secure, PCI-compliant networking for the distributed enterprise”.
The possibility of Mr Banks providing further funds to assist Mako’s liquidity was discussed around this time. To put this in context, this was not long after Telecom Rentals had failed to advance the $5 million expected in November 2013 and around the time Mako’s shareholders, including Mr Farmer’s family trust, made additional advances to cover the short-term cashflow deficit.
Mr Banks sent an email to Mr Farmer on 15 November 2013 which provides some insight into his understanding at that time:
If it happens, great, if not, I’ll simply assume that I’ll have [a] big smile post‑float.
I don’t have any mortgages but if you ever needed me to apply for one and provide Mako with liquidity I’d be happy to. I know you said you don’t need this but I just wanted to remind you that I’m here to do whatever little I can for Mako.
Mr Farmer, who was then in Bangkok on the Prime Minister’s trade mission, responded on 18 November 2013:
With the opportunities building in [Australia] and the US we may look to list earlier and require extra capital to ramp up as quickly as we can. This could also play a little better into your hands with a more robust story and greater opportunity of uplift.
Could I ask if you were to provide further capital what level you would feel comfortable with.
Mr Banks replied by email on 20 November 2013 with the subject heading “Mako - investment 3” seeking further information and indicating that he could be prepared to invest $1 million at a discount of 16 per cent if and when debt was converted to equity, or $2 million if the discount was 20 per cent:
Ages ago you said that we will go to the market and discover what they are willing to pay per share. That plus my discount would yield the share price that I will buy in at. I understand how this works and am happy with it. On 23.10.13 you said I would get my shares then we would go to the market; in that case how is the price set?
I assume you have already personally borrowed and lent to Mako as much as you reasonably can. Perhaps I could match the amount then any extra could come from other investors. Obviously I need to see how readily the bank will lend to me. Some are too conservative and difficult to deal with. If it’s not private: who did you use? At the moment my gut is saying if you could offer a discount re this investment (#3) of 16% I would consider $1m. For 20% I would consider $2m.
Could you please tell me the current and est. 2y from now revenue? Please feel free to state that the latter is conditional e.g. upon securing deals with 75% of desired clients.
Clearly there are some issues that I’d like to sort and that takes time. If you can get the money quicker from the other investors then please do that. It might be a good idea to deal with us in parallel and go with the one that agrees first.
It appears that Mr Banks experienced difficulty raising the money from his bank, so he again asked Mr Farmer on 2 December 2013 who his mortgage provider was. He said he would not ordinarily ask but it was “for Mako and [his] bank [was] already giving [him] a very hard time”.
The next recorded communication was on 24 December 2013 when Mr Farmer advised Mr Banks by email to “hold off on transferring funds to Mako at this time”. Mr Farmer added that he would come back to him “when we are all clear to accept the same”. This followed shortly after Telecom sought the appointment of KordaMentha and was three days before all further lending by Telecom Rentals was formally suspended.
On 21 January 2014, Mr Farmer sent an email to Mr Banks to arrange a catchup meeting. He said there were some “real challenges at the moment” which he wanted to talk through.
Mr Farmer wrote to all shareholders and Mr Banks on 5 February 2014 providing an update on the debt restructure with Telecom Rentals which required shareholder approval:
Dear Shareholders
As you will see [from] the attached documents the last 6 weeks [have] been a challenging time for the Board and Management of the Company as we have dealt with the severance of funding to support the business from Telecom Rentals. Circumstances have changed on literally a daily basis from one where Directors have had to consider various options as cash reserves have been depleted.
Ultimately we have come to an arrangement with Telecom Corporate for a Sale of the SecureMe business to Gen-i and a complete restructuring of our current debt arrangement. This agreement was finally reached on Monday and full Documentation received last evening.
Further to this the Management have completed a comprehensive review of all expenses in the business and initiated a major restructuring of the same. This will result [in] a significant reduction in personnel in research and development and absolute alignment of sales resources to take advantage of the opportunities in the US and Australia with the UK being covered by Phoenix Managed Networks.
To complete the arrangements agreed with Telecom I am requesting an urgent Special Meeting is convened to discuss and if agreed approve the transaction as outlined in the Draft Resolution attached. I realise this is very short notice but time is of the essence with funds depleted.
The resolution was passed, and the debt restructure and other transaction documents were executed on 7 February 2014.
Mako continued to make progress in its overseas markets in the first quarter of 2014.
In November 2013, Mako engaged in negotiations with Sprint with a view to concluding a “productisation agreement” to augment the recently completed teaming agreement. This agreement would be very attractive to Mako because Sprint indicated it would commit to supplying 50,000 sites over two years (better than Norcal forecast in its three-year pipeline assessment (see above at [65]) with an initial drawdown of hardware and licences for 5,000 sites to be paid for upfront. Leaving aside the value of this major source of business, an obvious and immediate benefit would be a significant improvement in Mako’s cashflow. Unfortunately, as we will come to, Sprint unexpectedly reversed its position on making upfront payments and withdrew from these negotiations around the time Mr Banks made his final advance on 24 April 2014.
On 11 February 2014, Mako’s Australian subsidiary concluded a procurement and reseller agreement for a three-year term with Telstra Corporation Ltd, the largest telecommunications company in Australia. Telstra agreed to purchase Mako’s products and services for its own use and for provision to its customers under the reseller agreement. Telstra was the most significant opportunity identified by Norcal in the Australasian market, expected to account for just over half of all Mako’s sales in that region.
In arranging a further catchup meeting, Mr Banks made the following comments to Mr Farmer in an email on 19 February 2014:
It’s a shame that we had to panic-sell that business chunk. Will the IPO cash eliminate the reliance on a credit provider?
I hope that you have put out the fire and things have changed such that if I put my $500k in now it would be as safe as my existing money was 6m ago.
The further meeting between Mr Farmer and Mr Banks took place on 4 March 2014. Mr Farmer followed up with an email on 5 March 2014:
Thanks for getting together yesterday. I still feel the best option for Mako would be for you (or your Nominee) to become a Mako Shareholder. We will discuss again but could you please review the Shareholder Agreement attached in anticipation of going down that track.
Mr Banks responded to Mr Farmer on 8 March 2014:
The agreement looks good. Let’s do this when you’re ready.
On 15 March 2014, Mr Farmer sent an email to all existing and proposed shareholders (including Mr Banks) stating that he was finalising the deed of accession for the issue of new shares and seeking confirmation that relevant details had been recorded correctly in an attached table. Mr Banks replied by email on 16 March 2014 indicating that he was reconsidering his position:
I’ve had some 2nd thoughts. Our arrangement was that I’m a creditor and the debt increases by 10%/y. We then entered into an agreement that stated that the debt would cease to increase and I’d get a share price discount. I was looking forward to things happening as per that agreement and am used to agreements being adhered to unless both agree to dissolve them. Unfortunately that agreement has been effectively dissolved without my say. Circumstances have changed so I guess I’m ok with that. One would imagine that we’d revert to how things were before but it seems we are keeping just one part of the agreement: the part re the debt ceasing to increase. If you can find the time I’d like to sort this before handling the below.
As per my email of a while ago I would prefer shares to be in the name of Beta Trust and for my name to not appear anywhere public. If it appears as a “key person” in a list viewable by senior Mako people that’s fine. If it’s a bother then my name will do.
Mr Farmer was in the United States at the time but proposed a meeting early the following week to discuss. He gave Mr Banks his assurance that while there had been a number of changes, he was working to get the best arrangement available for him. He confirmed that there would be no problem for the Beta Trust being the owner of the shares, adding that he and his wife owned shares through their trust. Mr Farmer sent a follow-up email later that day:
Just so we are on the same page the public offer shareholding value was $100m less the discount whereas the current proposal is at $50m with the expectation of a better upside.
Mr Banks replied on 18 March 2014:
That’s all good re the trust and names.
I was happy not having my money grow in exchange for a discount. I now have the option of buying in @ $50m but it seems that that is something that any investor has had the option of doing for a while: on 29.11.13 we chatted about the then latest capital raising of $5m. You said that we would use the same valuation as was used in the capital raising before that: $50m.
If I have misunderstood sure perhaps we should chat. Maybe there’s a simpler way of looking at it: you’ve already done some legwork re the IPO and ascertained that the market was prepared to buy in @ $100m. If that’s true then I’m getting a great discount and I’d be happy to buy in (to keep things simple we’ll forget about the extra $500k).
The two met at a café on 25 March 2014. There is no record of what was discussed at this meeting, but it appears Mr Banks decided to proceed with a further investment of $500,000.
On 2 April 2014, Mr Farmer sent an email to Mr Banks:
I am back from [Hawai’i] now. Before I went away I checked my emails and for the life of me can’t find the one relating to the Beta Trust Co. No biggie at the moment as I have noted the allocation and held it in the shareholder reserve account. If you wouldn’t mind re-sending and then I will complete the arrangements.
Whilst I was away one of the other shareholders committed the proceeds of a building sale he has ~$700k so that will help as well. If you could let me know when you will transfer the $500k that would be appreciated. I remember you had it in a 14 day call account.
On 10 April 2014, Mr Banks advised Mr Farmer that he should receive the money around 24 April 2014. The next recorded communication was on 24 April 2014, when Mr Farmer sent an email to Mr Banks thanking him for the investment funds received that day ($500,000). No formal documentation was ever prepared setting out the terms of this investment, but Mr Banks pleaded the terms of this agreement as follows:
61Agreement 3 was discussed further on 4 March 2014 on the basis that a written agreement would be entered into recording that:
(a)[Mr Banks] would invest a further $500,000.00, adding to the existing debt;
(b)conversion of [Mr Banks’] total advances into shares would occur at a valuation of $50 million (when Mako listed on the NZX, as under Agreement 2); and
(c)future investors would invest at a valuation of at least $100 million.
Section 37 provides that no allotment of a security offered to the public for subscription shall be made unless at the time there is a registered prospectus relating to the security. Any allotment made in contravention of this section is invalid and of no effect.[109] Where subscriptions for securities are received by or on behalf of an issuer but may not be allotted by virtue of s 37, the issuer is required to ensure that the subscriptions together with interest are repaid as soon as reasonably practicable.[110] If the subscriptions are not repaid within two months, the directors are jointly and severally liable with the issuer to repay the subscriptions plus interest.[111]
[109]Securities Act, s 37(4).
[110]Section 37(5).
[111]Section 37(6).
A security is relevantly defined to include a debt security.[112] Subject to some exceptions that do not apply, a debt security means any interest in or right to be paid money that is, or is to be, deposited with, lent to, or otherwise owing by, any person (whether or not the interest or right is secured by a charge over any property).[113]
[112]Section 2D(1)(b).
[113]Section 2 definition of “debt security”.
An “offer” is broadly defined in s 2 to include an invitation, and any proposal or invitation to make an offer. The words “to offer” have a corresponding meaning. “Subscribe” is defined to include purchase and contribute to, whether by way of cash or otherwise. “Subscription” has a corresponding meaning. “Allot” includes sell, issue, assign and convey and “allotment” has a corresponding meaning.
It is common ground that Mr Banks’ advances constituted debt securities and there was no registered prospectus. The question is whether the debt securities were offered to the public in terms of the inclusive definition in s 3(1) and whether any of the exceptions in s 3(2) applied. Because of its central importance, we set out the key parts of s 3:
3 Construction of references to offering securities to the public
(1)Any reference in this Act to an offer of securities to the public shall be construed as including—
(a)a reference to offering the securities to any section of the public, however selected; and
(b)a reference to offering the securities to individual members of the public selected at random; and
(c)a reference to offering the securities to a person if the person became known to the offeror as a result of any advertisement made by or on behalf of the offeror and that was intended or likely to result in the public seeking further information or advice about any investment opportunity or services,—
whether or not any such offer is calculated to result in the securities becoming available for subscription by persons other than those receiving the offer.
(2)None of the following offers shall constitute an offer of securities to the public:
(a)an offer of securities made to any or all of the following persons only:
(i)relatives or close business associates of the issuer or of a director of the issuer:
(ii)persons whose principal business is the investment of money or who, in the course of and for the purposes of their business, habitually invest money:
(iia)persons who are each required to pay a minimum subscription price of at least $500,000 for the securities before the allotment of those securities:
(iib)persons who have each previously paid a minimum subscription price of at least $500,000 for securities (the initial securities) in a single transaction before the allotment of the initial securities, provided that—
(A)the offer of the securities is made by the issuer of the initial securities; and
(B)the offer of the securities is made within 18 months of the date of the first allotment of the initial securities.
(iii)any other person who in all the circumstances can properly be regarded as having been selected otherwise than as a member of the public:
…
(3)A person shall not be precluded from being regarded as a member of the public in regard to any offer of securities by reason only that he or she is a purchaser of goods from, or an employee or client of, or a holder of securities previously issued by, the issuer or any promoter of the securities.
(4)Any reference in this Act to an offer of securities to the public shall be construed as including a reference to distributing an advertisement, a prospectus, a registered prospectus, or an application form for the subscription of securities.
(5)Proof of an offer of securities to one person selected as a member of the public shall be prima facie evidence of an offer of securities to the public.
Substantive judgment
Agreement 1
The Judge considered there was no offer by Mako because it was Ms Banks who first approached Mr Farmer to invest in Mako, having been appraised of the investment opportunity through Mr Winslade. She then combined her energies with Mr Banks’ “to bring about the investment”.[114] However, even if that was not correct, the Judge was satisfied it was not an offer to the public.[115] First, Mako never intended to engage with the public and sought to exclude the requirements of the Securities Act by making it clear in the PPM that the offer was not available to the public, only to exempt persons.[116] Secondly, even if Mr Banks and the other investors targeted (who would be exempt under s 3(2)(a)(ii) as high net worth individuals with investing experience) could be considered a section of the public, they were selected otherwise than as a member of the public in terms of s 3(2)(a)(iii).[117] Thirdly, the Judge rejected the idea that a single individual, engaged with privately in the circumstances of this case as he found them to be, could conceivably be described as a section of the public.[118] Fourthly, there was no offer of securities to individual members of the public selected at random in terms of s 3(1)(b).[119] Finally, there was no advertisement by or on behalf of Mako that was intended or likely to result in the public seeking further information about any investment opportunity in terms of s 3(1)(c).[120] The Judge concluded that there was no offer of security to the public that could be linked to Agreement 1 or the first allotment of debt security.[121]
[114]Substantive judgment, above n 2, at [289].
[115]At [290].
[116]At [291]–[293].
[117]At [294]–[296].
[118]At [297].
[119]At [298].
[120]At [299].
[121]At [300].
In any event, the Judge considered that the exception in s 3(2)(a)(ii) applied, finding that Mr Banks was a person whose principal business was the investment of money or who, in the course of and for the purposes of his business, habitually invested money.[122]
Agreement 2
[122]At [301]–[311].
The Judge found that Agreement 2 came about through Mr Banks’ existing business relationship with Mr Farmer and Mako. It was Mr Banks who suggested a further investment and there was no prior approach by Mako or Mr Farmer. The Judge’s earlier findings, that neither Ms Banks nor Mr Banks were members of the public for the purposes of Agreement 1, applied equally to Agreement 2.[123]
Agreement 3
[123]At [321].
The Judge concluded that Agreement 3 also came about as a result of the pre‑existing relationship, not as a result of any offer to the public. If Mr Banks approached Mr Farmer, as he did prior to Agreement 2, the Judge considered no offer could have been made by Mako. On the other hand, if Mr Farmer approached Mr Banks seeking further investment, he did so because of the pre-existing relationship. Either way, the Judge reasoned the investment was not made as a result of an offer to the public.[124]
Submissions
[124]At [327].
Mr Johnson submits that the word “offer” is to be construed broadly. An offer includes an invitation to make an offer. Mr Farmer’s discussions with Mr Winslade, providing him with the PPM and then giving a copy of the PPM to Mr Banks, must amount to an invitation to make an offer.
Mr Johnson submits that the Judge conflated the general rule relating to offers of securities to the public under s 3(1) with the exception applying to offers to persons selected otherwise than as members of the public under s 3(2)(a)(iii). This distinction is important because the burden of proving the former falls on Mr Banks as the claimant, whereas the burden of proving the latter falls on the directors.
Mr Johnson contends that the Judge erred in finding there was no offer to the public for the purposes of Agreement 1. He says it was not appropriate to make the assessment only as between Messrs Farmer and Banks and ignore the wider context that Mako was seeking to raise funds at the time the agreement was being negotiated. As the Court observed, there was little evidence about other participating investors. In Mr Johnson’s submission, it follows that the Judge’s assessment that everyone to whom an offer was made would be otherwise excluded is unsustainable. Mako’s intention to confine any offer to exempt persons is irrelevant. An intention to comply does not equate to compliance. Further, relying on this Court’s decision in Lawrence v Registrar of Companies, he emphasised the need to take account of the context of the prior exceptions in s 3(2), including persons having a close relationship with the issuer such that they would be able to obtain relevant information and protect themselves.[125] Mr Johnson submits that Mr Banks did not come within this category given the comparatively few meetings he had with Mr Farmer over the relevant period. He also says that there was insufficient evidence to show Mr Banks was a habitual investor, even if the CMC Markets and Vantage FX transactions were genuine investments as found by the Judge.
[125]Lawrence v Registrar of Companies [2004] 3 NZLR 37 (CA).
Mr Johnson submits that these same considerations apply in respect of Agreements 2 and 3. He points out that Agreement 3 occurred in the context of a general capital raise. The minutes of the board meeting held on 27 November 2013 record that Mr Farmer was actively seeking an immediate cash injection from a range of investors, including Mr Banks.
Mr Hollyman supports the Judge’s analysis. As to Agreement 1, he says that no offer was made to Mr Banks because it was the Banks family who approached Mako seeking to invest. Further, the securities offered to Mr Banks were bespoke agreements unavailable to anyone else. The securities to which Mr Banks subscribed were therefore not offered to the public unless Mr Banks, standing alone, qualified as a member of the public.
Mr Hollyman contends that the Judge correctly held that no offer was made to the public because:
(a)Mako never intended to engage with the public — the PPM was carefully worded to avoid classification as an offer of securities to the public.
(b)Ms Banks, like other investors, was selected otherwise than as a member of the public (s 3(2)(a)(iii)).
(c)A single individual, engaged with privately in the circumstances of this case, cannot be described as a section of the public (s 3(1)(a)).
(d)The investors Mako was seeking to attract were not individual members of the public selected at random (s 3(1)(b)).
(e)No advertisement was made by or on behalf of Mako that was intended or likely to result in the public seeking further information advice about any investment opportunity (s 3(1)(c)).
In any case, Mr Hollyman submits that Mr Banks came within the habitual investor exception in s 3(2)(a)(ii). He was engaged in managing his family’s significant wealth through the administration of the trusts controlling the investments and he lived off investment income. Mr Hollyman says the evidence establishes that Mr Banks’ investment in Mako was simply another large, but otherwise unremarkable, investment in Mr Banks’ business life. For example, in July 2010, he invested over $1 million in debenture stock in Marac Finance Ltd and he deposited significant funds in trading accounts with CMC Markets and Vantage FX in late 2011.
Mr Hollyman submits the Judge was correct to find that Agreement 2 arose from the existing business relationship. Mr Banks suggested the further investment and there was no offer to the public. The second allotment superseded the first allotment by converting the loan to a convertible note.
With respect to Agreement 3, Mr Hollyman submits that this too was not the product of an offer to the public. Additionally, he says it fell within two further statutory exceptions:
(a)No security was allotted before Mr Banks paid $500,000 to Mako (s 3(2)(a)(iia)).
(b)Mr Banks had paid in excess of $500,000 for securities less than a year earlier (s 3(2)(a)(iib)).
In summary, Mr Hollyman supports the Judge’s conclusion that the Securities Act did not apply to any of Mr Banks’ investments in Mako.
Analysis
Agreement 1
The word “offer” in this context is to be given a wide construction. We agree with Mr Johnson that the circumstances found by the Judge — including Mr Farmer’s informal discussions with Mr Winslade at a social event, providing him with the PPM and later giving a copy to Mr Banks at his request — are sufficient to amount to an invitation to make an offer. Mr Farmer had let it be known that Mako was looking to raise capital and that is enough.[126]
[126]Re Dingwall v Paulger Ltd (in rec) (1990) 5 NZCLC 66,780 (HC) at 66,790; DFC Financial Services Ltd v Abel [1991] 2 NZLR 619 (HC) at 626; and Robert Jones Investments Ltd v Gardner (1993) 6 NZCLC 68,514 (HC) at 68,530.
To the extent the Judge relied on this Court’s decision in Society of Lloyd’s v Hyslop in finding there was no offer, we consider this was misplaced.[127] In that case, Richardson J observed that there was no suggestion that the Securities Act would be engaged in circumstances where contact was initiated by persons seeking to become Lloyd’s Names. However, there had been a departure from this usual practice when an agent contacted six or so of his long-standing friends, including Mr and Mrs Hyslop, and asked whether they might be interested in joining Lloyd’s. The Securities Act was held not to apply, not because no offer had been made, but because there was no offer to the public. Those solicited were not a section of the public within s 3(1)(a), nor were they selected at random under s 3(1)(b), and, in the absence of an advertisement, s 3(1)(c) could not apply.[128] In any case, these individuals were selected otherwise than as members of the public and therefore fell within the exception in s 3(2)(a)(iii).
[127]Society of Lloyd’s v Hyslop [1993] 3 NZLR 135 (CA).
[128]At 142.
The critical question in the present case is similarly whether the offer of securities was made to the public. By the time Mr Banks became involved, the offer set out in the PPM to raise capital by the issue of shares had closed. That offer expired on 30 November 2010 and Mr Farmer’s first meeting with Mr Banks was not until December 2010. Mr Farmer gave Mr Banks a copy of the PPM at his request as it contained background information about Mako. However, Mr Banks was not interested in subscribing to shares along the lines of that earlier offer; rather, he sought a bespoke arrangement tailored to meet his personal requirements and taking the form of a debt security backed by a personal guarantee with an option to convert the debt to equity. No debt security was offered to anyone else at that time. The offer, in the sense of an invitation to make an offer, was made to Mr Banks alone. He did not come within s 3(1)(a) as “any section of the public”, or s 3(1)(b) as coming within “individual members of the public selected at random”. As in Society ofLloyd’s vHyslop, there was no advertisement in the ordinary sense of that word and s 3(1)(c) does not apply.[129]
[129]Orr v Martin (1991) 5 NZCLC 67,383 (HC) at 67,391.
It follows that there was no offer of securities to the public within the inclusive part of the definition in s 3(1) of the Securities Act. Even if that were not the case, we consider that in all the circumstances Mr Banks can properly be regarded as having been selected otherwise than as a member of the public and therefore the exclusion in s 3(2)(a)(iii) applies. In Lawrence v Registrar of Companies, this Court considered the scope of the exception in s 3(2)(a)(iii) and concluded that, read in context, what was intended was a relationship analogous to those described in s 3(2)(a)(i) and (ii).[130] Such an interpretation was considered to be consistent with the policy of excluding categories of “persons able to protect themselves either by being able to require the issuer to provide them with relevant information or because of general sophistication in investment matters”.[131] Lawrence was decided prior to the insertion of s 3(2)(2)(iia) and (iib)[132] which introduced additional indicia not concerned with the relationship between the offeree and the issuer or a director of the issuer.[133] However, consistent with the policy and purpose of the Securities Act and reading the provision in context, the residual category of excluded persons captured by s 3(2)(a)(iii) will, by analogy with the other categories of persons described in s 3(2)(a), be able to look after their own interests and have less need for the disclosure protections provided. This is consistent with what this Court said in Lawrence:[134]
[The] question of who is in the category of persons protected because they are part of the public remains a question of fact to be determined as a matter of impression having regard to all the relevant circumstances rather than by reference to fixed criteria.
[130]Lawrence v Registrar of Companies, above n 125, at [33].
[131]At [33].
[132]Section 3(2)(a)(iia) was inserted by s 5(2) of the Securities Amendment Act 2004 with effect from 15 April 2004. Section 3(2)(a)(iib) was inserted by s 5(1) of the Securities (Disclosure) Amendment Act 2009 with effect from 28 July 2009.
[133]See further Victoria Stace Securities Law in New Zealand (2010, LexisNexis, Wellington) at 2.4.2(d).
[134]Lawrence v Registrar of Companies, above n 125, at [35].
Mr Banks was not responding to an offer of securities available to the public. He suggested to Mr Farmer that Mako consider issuing a debt security on terms that he proposed, and which were designed to meet his personal requirements and tax position. The offer of a debt security was made only to him. This was a bespoke private offer instigated by Mr Banks. The subscription in terms of Agreement 1 far exceeded (by more than four times) the $500,000 minimum subscription price set in terms of the exclusion in s 3(2)(a)(iia). Whether or not Mr Banks qualified as a professional or habitual investor in terms of s 3(2)(a)(ii), in all the circumstances we consider he was well able to protect his own interests in respect of this significant investment, including by taking legal and other professional advice if required. It is also relevant that a term of Agreement 1 proposed by Mr Banks was that he would provide advice to Mako regarding capital raising and other financial advice.
For these reasons, we agree with the Judge that the Securities Act did not apply to Agreement 1.
Although we strictly do not need to determine the issue, we briefly consider whether the Judge was right to find that Mr Banks’ principal business was the investment of money or a habitual investor, engaging the further exclusion in s 3(2)(a)(ii). Mr Banks stated that he has never had, or needed to have, paid employment. The Judge found:[135]
… Mr Banks lives off investment income. He has no other visible means of support. He described himself as self-employed. He spoke of administering the trusts from which his substantial investment funds appear to have been derived. Certainly, at the relevant periods, he was in control of significant funds.
[135]Substantive judgment, above n 2, at [305].
While we reach no concluded view, we doubt that Mr Banks could be classified, on the basis of these findings, as a professional or habitual investor within the intended scope of this exception. He does not appear to have been in the business of investing money, nor does he appear to have habitually invested money for the purposes of his business. We reach this tentative conclusion even on the basis most favourable to the respondents, namely that the Nuves emails were fabricated, and the Vantage FX and CMC Markets investments were true investments, not simulated activity undertaken for the sole purposes of a research project at the university.
Agreement 2
For similar reasons, the Securities Act did not apply to Agreement 2. Mako was not at that time offering debt securities to the public. Mr Banks had other investments maturing and he contacted Mr Farmer proposing to add to his existing investment in Mako. The proposal was again tailored to meet Mr Banks’ requirements. The arrangement involved a debt security on the same terms as Agreement 1 except that all debt, including the amounts paid under Agreement 1, would be converted to equity at an agreed discount in the context of the anticipated IPO. In our view, this was not an offer of securities to the public.
Even if the offer could be regarded as coming within the inclusive part of the definition in s 3(1), we take the view that Mr Banks was in all the circumstances selected otherwise than as a member of the public. In addition to the factors discussed above, we consider it of some relevance that pursuant to Agreement 1 Mr Banks was entitled to receive all information available to Mako’s shareholders and to regular informal updates about the business. This forms part of the context in which he was “selected” and lends weight to our conclusion that this was otherwise than as a member of the public in terms of s 3(2)(a)(iii).
Agreement 3
The discussions leading to Mr Banks’ final investment occurred in the context of the acute cashflow problems caused by Telecom Rentals’ sudden decision to withdraw ongoing funding support under the finance facility in November 2013. Messrs Gamble, Frederick and Farmer, and Mr Farmer’s family trust contributed by way of cash contributions and/or by foregoing salary and directors’ fees. The minutes of the board meeting held on 27 November 2013 record that Mr Farmer was seeking an immediate cash injection of around $1 to $2 million from various investors, including Mr Banks. The evidence shows that these other prospective investors were selected otherwise than as members of the public, being professional investors, fund managers, and relatives or close business associates of Mako or its directors.
Mr Banks did not take up the offer to subscribe to the equity securities available to him and these other investors in late 2013. Mr Farmer withdrew the offer when he sent his email to Mr Banks on 24 December 2013 asking him to “hold off” transferring any funds to Mako at that time. The prospect of Mr Banks making a further investment did not resurface until February 2014. The offer Mr Banks subscribed to was not an equity security as had been offered to the other investors. Instead, he subscribed for a debt security with an option of converting the debt to equity along with his earlier advances. There is no evidence that any such security was offered to anyone else at that or any other time.
We agree with the Judge that the Securities Act requirements did not apply as there was no offer of securities to the public. We consider it to be clear that Mr Banks was selected otherwise than as a member of the public.
While it does not detract from this conclusion, we are not prepared to accept Mr Hollyman’s invitation to find that the exclusions in s 3(2)(a)(iia) and (iib) also applied. The Judge made no such finding, and the respondents did not file any notice to support the judgment on other grounds.
As to the exclusion in s 3(2)(a)(iia), the discussions between Messrs Banks and Farmer all appear to have proceeded on the basis that Mr Banks would be making an advance of $500,000. Mr Banks offered to pay that sum but there is no evidence of any requirement by Mako that he had to pay a minimum subscription price of at least $500,000.
The only “transaction” that could qualify as involving an allotment of initial securities coming within the requisite 18-month period in terms of s 3(2)(a)(iib) is Agreement 2. Properly analysed, the advances set out in the letter agreement referred to as Agreement 2 comprised two earlier transactions, two subscriptions and two allotments. Neither of the advances met the $500,000 threshold, based on the applicable conversion rates at the time. Even in combination, they just fell short. Mr Banks had therefore not previously paid a minimum subscription price of at least $500,000 for securities in a single transaction within 18 months of any offer of securities for the purposes of Agreement 3.
The Nuves emails
Given our analysis of the Securities Act claims and our primary reliance on the contemporary record rather than credibility findings, the authenticity of the Nuves emails has diminished importance. The issue is now mainly relevant to the question of costs. For that reason, we do not propose to engage with all the detail of the factual contest that was reprised on appeal.
This issue was the subject of intense scrutiny post-trial. The Judge considered evidence from seven witnesses, including experts, during the two-day resumed hearing convened for the sole purpose of determining the authenticity of the emails. The Judge gave numerous reasons in his Substantive judgment explaining why he was driven to the conclusion that these emails were fabricated by Mr Banks for the purpose of assisting his case.[136]
[136]At [166]–[204].
While Mr Johnson was able to demonstrate that the Judge was mistaken in one respect,[137] this does not materially detract from the overall strength of the reasoning. Having reviewed the evidence on the topic, we are not at all persuaded that we should depart from the Judge’s careful analysis and firm finding. Like the Judge, we consider Mr Banks’ explanation for these emails is implausible on many levels. We mention only a few by way of illustration.
[137]At [190].
Mr Nuves could not be found, nor was there any trace of him on the internet or elsewhere. This was surprising, if Mr Nuves truly did exist, given the numerous teaching and treasury positions he was said to have held at the Auckland University and the fact that Mr Banks claimed to have previously “vetted” him and considered him to be “a respectable person”. Mr Banks’ response to this difficulty was to suggest that Chris Nuves may not have been Mr Nuves’ legal name, even though “Chris Nuves” was the name that appeared on all the emails.
Mr Banks’ explanation of the claimed research project was also implausible. He said he was approached by Mr Nuves at the University on 16 August 2011 and asked if he wanted to be part of a group which was going to “research the usability of software that related to people, money and/or online shopping”. This seems an unlikely topic for a university research project.
We also agree with the Judge’s view that it “stretches credulity” that Mr Banks would “advance more than $500,000 to support research into the utility of software to assist a man who is virtually unknown to him”.[138]
[138]At [186].
The format and content of the emails was strongly suggestive of fabrication, although the experts could not categorically confirm this. The experts filed a joint statement agreeing:
(a)No email containing Mr Nuves’ email address ([email protected]) for the 2011 to 2012 time period was located in either the hardware or Mr Banks’ Gmail account.
(b)No contact record with the name Nuves, Nooves or Noovs was located for the entire Google account, nor was “[email protected]” attached to any contact.
(c)The Nuves emails have very little header information and are missing much of what would be expected to be standard email header data. There is no means to verify the authenticity of these emails.
Mr Banks offered an explanation in his affidavit for the absence of any reference to Mr Nuves in his Gmail account but, like the Judge, we consider this is also highly implausible:
Inquiries I made since this issue was raised
25 After Mr Farmer indicated that he was planning on filing this application, on 3 September 2019 I decided to check the flash drive’s functionality. I did this by moving a few files on and off the drive.
26 On 24 September 2019 I was looking through my Gmail account for anything relating to Chris and noticed and that his email address appeared in my “Frequently contacted” list. A screenshot showing this is annexed …
27 After I took this screenshot, I decided to add Chris’ name to the entry (thinking that this might reveal more information about the email address).
28 When I did this, Google automatically moved the entry to the “Contacts” list. I did not want to have disturbed the original entry, so I deleted it from the “Contacts” list, thinking that [i]t would reappear on the “Frequently Contacted” list. It did not.
We see no reason to differ from the Judge’s conclusion that the emails were fabrications.
Costs appeal
There were three primary components to the Judge’s costs assessment:
(a)Indemnity costs for post-trial steps through which it was established that Mr Banks had forged the 28 Nuves emails he produced in evidence. Mr Banks did not resist this award. The Judge considered that while Mr Banks’ misconduct was flagrant and designed to deceive, it was confined to particular steps in the proceedings, and it would be overly punitive to award indemnity costs for the entire proceeding as sought by the respondents.[139]
(b)Increased costs (uplift of 40 per cent on scale) for other steps to take account of the following factors:[140]
(i)The need for censure in connection with the forged emails.[141]
(ii)Mr Banks’ evasive, defensive, and uncooperative approach to giving evidence, including giving lengthy and often circular responses to questions put in cross-examination. The Judge was satisfied Mr Banks gave evidence that, “to put it generously, bent the truth”.[142]
(iii)Mr Banks’ “voluminous claims”, including his pleading of 53 allegedly actionable misrepresentations, added considerable time and expense to the proceeding.[143]
(iv)Mr Banks refused a settlement offer of $150,000 shortly before the commencement of the trial.[144]
(c)Rather than awarding costs to each respondent, the Judge awarded one set of costs, but he applied an uplift of 20 per cent to take account of the additional time incurred and complexity involved in running the case for multiple defendants. This resulted in the total costs being increased by approximately $50,000 to recognise the costs incurred by the second to fourth respondents. The Judge considered this was reasonable given their actual legal costs were approximately $150,000.[145]
[139]Costs judgment, above n 28, at [28]–[31].
[140]At [60].
[141]At [52].
[142]At [53].
[143]At [54].
[144]At [55]–[57].
[145]At [61]–[67].
Mr Farmer appeals against the Costs judgment on two grounds. First, he argues that indemnity costs ought to have been awarded for all steps taken after 24 April 2019, being the date Mr Banks served his brief of evidence together with the forged emails. Secondly, he contends that a separate costs award should have been made in his favour.
Mr Hollyman submits that the fabrication of 28 emails to be used in evidence constitutes deception on a large scale. It was an attempt to mislead the Court on a material issue and is sufficiently serious to warrant indemnity costs from the time the evidence was served on the respondents. Further, the Judge’s findings about Mr Banks’ lack of veracity extended beyond these emails. Mr Hollyman submits that Mr Banks pursued his claim on bases which he knew to be false and continued it in wilful disregard of known facts within the scope of r 14.6(4)(a) of the High Court Rules 2016 and this justifies indemnity costs being awarded for the trial.
We agree with Mr Johnson that there is no appealable error in the Judge’s approach to the exercise of the costs discretion on this issue. The award of indemnity costs for all post-trial steps and an uplift on scale costs for other steps was a measured and appropriate response to Mr Banks’ deceitful misconduct in respect of the emails and the other unsatisfactory aspects of his evidence. The deception did not go to the heart of any of the claims. We would not characterise Mr Banks’ claims as being wholly without merit, as Mr Hollyman contends. Mr Banks succeeded in establishing that the directors breached their duties in continuing to trade after May 2014 and there was a proper foundation for his other claims.
Mr Hollyman does not take issue with the Judge’s summary of principle in considering whether more than one set of costs should be awarded. The general rule is that the court will not allow more than one set of costs if several defendants defended a proceeding separately and all or some of them could have joined in their defence.[146] There must be good reason to depart from this general rule.
[146]High Court Rules 2016, r 14.15.
Mr Hollyman submits that although there was a degree of overlap in the litigation position of the respondents, Mr Banks’ FTA claims were based almost entirely on Mr Farmer. The other respondents had no direct contact with Mr Banks. Mr Hollyman contends that this gave rise to an actual or potential conflict of interest justifying separate representation for Mr Farmer from the other respondents. But the other respondents were not represented at the trial and were therefore not entitled to a costs award for any steps after they ceased to have representation.
The Judge’s reasoning on this issue is encapsulated in the following paragraph of his Costs judgment:
[65] The defendants in the present case were represented by the same counsel for some time. While some aspects of Mr Banks’ claim were primarily directed at Mr Farmer, much of the case against the defendants overlapped. Mr Banks sought relief from the defendants collectively, all of whom were directors of Mako. The defendants’ interest in defending the claim, to that end, was materially identical. The defendants could have, and did, rely upon the evidence and submissions of one another. Nor was there any conflict of interest between the defendants’ cases, particularly because Mr Banks pleaded that the defendants were joint[ly] and severally liable for any relief. There was clearly an overlap in the litigation position of the defendants. It is therefore my view that only one set of costs should be awarded.
We see no appealable error in this reasoning. Mr Banks pursued all of the respondents in respect of each of his causes of action and he sought the same relief from each of them. The same defences were advanced (Mr Farmer advanced some additional defences that were particular to him), and the respondents presented a united front. There were no cross claims. There does not appear to have been any actual or potential conflict of interest. We consider the Judge was right to award one set of costs and to allow an uplift of 20 per cent to account for the added cost and complexity of running a case for multiple defendants.
Result
The application to adduce further evidence in CA531/2021 is granted in part, but only in respect of the liquidator’s updating affidavit.
The appeal in CA531/2021 is dismissed.
The appellant in CA531/2021 must pay costs to the respondents for a complex appeal on a band A basis and usual disbursements. We certify for second counsel.
The appeal in CA164/2022 is dismissed.
The appellant in CA164/2022 must pay costs to the first respondent in the sum of $2,500.
Solicitors:
Wynn Williams, Auckland for Mr Banks
Lodder Law Ltd, Auckland for Mr Farmer
Maberly & Co, Auckland for Second to Fourth Respondents