Banks v Farmer
[2021] NZHC 1922
•28 July 2021
IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY
I TE KŌTI MATUA O AOTEAROA TĀMAKI MAKAURAU ROHE
CIV-2016-404-000057
[2021] NZHC 1922
BETWEEN ADAM DAVID BANKS
Plaintiff
AND
WILLIAM ROBERT FARMER
First Defendant
AND
SIMON MATHEW GAMBLE
Second Defendant
AND
CHRISTOPHER JAMES MASSAM
Third Defendant
AND
DOUGLAS LEROY FREDERICK
Fourth Defendant
Hearing: 1 to 24 July 2019, 11 December 2019 and 5 and 6 October 2020 Appearances:
Jeremy Johnson, Gregory Simms and William Porter for the Plaintiff
Robert Hollyman QC, Alec Steel, Lance Green and Ana Lenard for the First Defendant
Second Defendant in Person Third Defendant in Person
No appearance for the Fourth Defendant
Judgment:
28 July 2021
JUDGMENT OF MOORE J
This judgment was delivered me on 28 July 2021 at 2:00 pm pursuant to Rule 11.5 of the High Court Rules.
Registrar/ Deputy Registrar Date:
BANKS v FARMER & ORS [2021] NZHC 1922 [28 July 2021]
Contents
Paragraph Number
INTRODUCTION
THE CLAIM............................................................................................................ [9]
BACKGROUND................................................................................................... [12]
The beginnings of YellowTuna and Mako...................................................... [14]
Corporate structure.......................................................................................... [19]
Growth and development of Mako.................................................................. [22]
Mako in 2007 to 2009 and PCI-DSS certification.......................................... [27]
Telecom funding................................................................................................ [29]
The Private Placement Memorandum (2010)................................................ [31]
Mr Banks meets Mr Farmer............................................................................ [38]
Agreement 1....................................................................................................... [50]
Mako in 2011 and 2012
Customers and marketing............................................................................ [54]
Mr Frederick and Mr Frawley join the Board and Mr Gamble moves to
the United States.......................................................................................... [66]
Finances and cashflow................................................................................ [71]
Mako in 2013
Telecom Rentals........................................................................................... [79]
Agreement 2....................................................................................................... [85]
Initial Public Offering (“IPO”)........................................................................ [90]
The Norcal Reports
Norcal Marketing Report (15 March 2013)................................................. [92]
The Norcal Pipeline Report (1 July 2013)................................................... [98]
Solvency test paper......................................................................................... [102]
Deloitte Planning Report................................................................................ [105]
Restated accounts for year ended 30 June 2012........................................... [107]
Bell Gully instructions.................................................................................... [108]
The Weldon Report......................................................................................... [109]
Telecom Rentals raises concerns.................................................................... [114]
Customers and marketing.............................................................................. [117]
Mr Frawley raises concerns........................................................................... [121]
Mr Frawley resigns......................................................................................... [127]
Telecom Rentals restructures debt................................................................ [130]
Agreement 3..................................................................................................... [137]
Mako in 2014.................................................................................................... [153]
Sprint.......................................................................................................... [155]
D&S Communications............................................................................... [156]
Goldman Sachs.......................................................................................... [157]
BP North America...................................................................................... [158]
Mako in 2015................................................................................................... [160]
Post-receivership events................................................................................. [164]
DEFENCE APPLICATIONS FOR POST-TRIAL PRODUCTION ORDERS AND TO RECALL MR BANKS
Introduction..................................................................................................... [166]
Background..................................................................................................... [168]
The evidence.................................................................................................... [177]
Discussion and findings.................................................................................. [180]
Credibility findings......................................................................................... [191]
FIRST CAUSE OF ACTION – S 37 OF THE SECURITIES ACT................ [210]
The parties’ positions...................................................................................... [211]
What is the correct approach for this cause of action?............................... [213]
Can the Agreements be considered security allotments?............................. [219]
Agreement 1..................................................................................................... [224]
Agreements 2 and 3......................................................................................... [225]
Were there offers of securities made to the public?
Legal principles.......................................................................................... [228]
What is the effect of the chosen approach?.................................................. [248]
Was there an offer to the public?
Agreement 1
(a)Factual circumstances................................................................ [249]
(b)Analysis on Agreement 1.......................................................... [289]
(c)Conclusion................................................................................. [300]
(d)Was Mr Banks a habitual investor?........................................... [301]
Agreement 2
(a)Factual circumstances................................................................ [312]
(b)Analysis on Agreement 2.......................................................... [318]
Agreement 3
(a)Factual circumstances................................................................ [323]
(b)Analysis on Agreement 3.......................................................... [326]
Liability and relief?......................................................................................... [329]
Conclusion on Securities Act claims............................................................... [332]
THIRD CAUSE OF ACTION – BREACH OF DIRECTORS’ DUTIES CLAIMS (COMPANIES ACT CLAIM)
Introduction..................................................................................................... [334]
The plaintiff’s case in summary..................................................................... [339]
The Board and its decision-making processes
The Board.................................................................................................. [341]
Board discussions at meetings................................................................... [348]
Adverse inferences and the affirmative defence of reliance on advice [353]
Policy rationale for directors’ duties in an insolvency context [364]
Section 135 – Reckless trading
Legal principles.......................................................................................... [377]
Plaintiff ’s submissions............................................................................... [388]
Was Mako insolvent at any point during its trading history?.................... [391]
(a)Was Mako ever balance sheet insolvent and, if so, when?....... [392]
(b)Was Mako cashflow insolvent and, if so, when?...................... [402]
(i)From Telecom Rentals’ withdrawal of funding to the February 2014 debt restructure........................................................................ [408]
(ii)From the Telecom Rentals debt restructure to the
failure of the Sprint deal.................................................. [420]
At what point after the failure of the Sprint deal were the directors in
breach of s 135?......................................................................................... [442]
Conclusion as to breach............................................................................ [454]
Section 136 – Improperly incurring obligations
Legal principles.......................................................................................... [457]
Plaintiff ’s submissions............................................................................... [466]
Agreement 1 – 4 February 2011................................................................ [468]
(a)Subjective belief [470]
(b)Reasonable grounds for that belief [472]
Agreement 2 – 30 June 2013..................................................................... [475]
(a)Subjective belief [479]
(b)Reasonable grounds for that belief [482]
Agreement 3 – 24 April 2014..................................................................... [492]
(a)Subjective belief [493]
(b)Reasonable grounds for that belief [495]
Conclusion as to breach............................................................................ [505]
Section 137 – Duty to exercise skill and care
Legal principles.......................................................................................... [506]
Plaintiff ’s submissions............................................................................... [509]
Did the defendants fail to exercise the skill and care that a reasonable
director would in the same circumstances?............................................... [512]
(a)Mako’s financial position, including liabilities to Telecom
and Mr Banks............................................................................ [513]
(b)Prioritising interests as shareholders over the company’s
interests..................................................................................... [517]
(c)Overlap between Mr Banks’ claims under ss 135, 136
and 137...................................................................................... [523]
Section 301 – Remedy
Introduction................................................................................................ [541]
Legal principles.......................................................................................... [542]
(a)Is the remedy available given Mako was not in the course of
liquidation?................................................................................ [544]
(b)Can creditors be personally compensated under s 301 for
breach of directors’ duties? [557]
Section 383 – Banning orders......................................................................... [586]
Legal principles.......................................................................................... [588]
SECOND AND FOURTH CAUSES OF ACTION: MISREPRESENTATIONS
–S 55G OF THE SECURITIES ACT AND S 9 OF THE FAIR TRADING ACT Introduction.......................................................................................................................... [592]
Section 55G of the Securities Act................................................................... [594]
Section 9 of the Fair Trading Act
Mr Banks’ case........................................................................................... [598]
Legal principles
Misleading and deceptive conduct in trade............................................... [602]
Analysis...................................................................................................... [616]
(a)Was Mr Farmer “in trade”?....................................................... [618]
(b)Did Mr Farmer engage in conduct? [622]
(c)Was Mr Farmer’s conduct misleading or deceptive? [625]
(i)Verbal representations [628]
(ii)Written representations [638]
Representations 20, 24 and 31.................................................................. [641]
Representations prior to Agreement 1....................................................... [644]
Representations prior to Agreement 2....................................................... [660]
Representations prior to Agreement 3....................................................... [669]
Liability of the other directors and relief................................................... [678]
SUMMARY OF CONCLUSIONS
(a)First cause of action............................................................................ [680]
(b)Third cause of action........................................................................... [681]
(c)Second and fourth cause of action...................................................... [684]
COSTS.................................................................................................................. [686]
Appendix 1
INTRODUCTION
"Whāia te pae tawhiti kia tata, ko te pae tata whakamaua kia tina!"
[1] This case is about the rise and fall of a technology company which held so much promise but which ended up in failure. It is also about a young man who invested part of his family inheritance and lost it.
[2] The company was called Mako. It was established by two enthusiasts with information technology (“IT”) skills and a vision. They saw a gap in the emerging technology security market and they developed a technological solution to meet that gap. The system they developed was innovative and world-leading. Mako grew rapidly, initially locally and then globally.
[3] Revenue projections were estimated to reach tens, if not hundreds of millions of dollars. But Mako had an Achilles’ heel; it lacked the capital to fully realise its potential. It looked for and found investors. One of those was the plaintiff. Between 2011 and 2014 he invested over $3.2 million in the form of unsecured loans. He lost his money when Mako went into liquidation and receivership owing creditors around
$34.5 million.
[4] The plaintiff sues the four defendants who were directors of Mako. He says they took his money in circumstances where there was a significant information asymmetry; the defendants knew many important and relevant facts about the company’s performance and the plaintiff did not. The plaintiff says that if the defendants had acted as they should have as directors of Mako, consistent with their legal obligations, he would not have lost his money.
[5] In particular, the plaintiff says the defendants breached their obligations by taking investments from him as a member of the public without a registered prospectus, making misrepresentations about Mako’s state and prospects which had no reasonable foundation, failing to disclose critical information about the company before the plaintiff made his investments and continuing to trade the company in circumstances where it was insolvent, under-capitalised and, with no realistic prospect
of receiving further capital, allowed Mako to continue to trade to the detriment of its creditors, including the plaintiff.
[6] These alleged defaults are reflected in the four causes of actions the plaintiff brings against the defendants.
[7] The defendants respond that the failure of Mako was not due to any actionable failure on their part. Mako, despite its promise, never realised its potential and the plaintiff lost his investment as did every other investor, including the defendants and their families. The defendants point out that some companies succeed. Most do not. The nature and purpose of corporate limited liability is to allow individuals, such as the plaintiff, the defendants, and the other investors, to limit the amount of money which they place at risk.
[8] The defendants say that the closer the evidence is examined the clearer it becomes that the actions of the defendants were commercially responsible when judged in the context of the particular circumstances which faced them and Mako at all relevant times.
THE CLAIM
[9] In this judgment,1 the four causes of action are not addressed in the order pleaded, but rather in the same order both counsel addressed them in submissions. I consider this to be a logical approach which I shall also adopt.
[10]In summary, the plaintiff’s claim is that:
(a)in breach of the Securities Act 1978 (“the Securities Act”):
(i)First cause of action: Mako offered an allotment of a debt security to Mr Banks without having a registered prospectus. Under s 37 of the Securities Act, Mr Banks is entitled to be repaid the subscription amount and, as the company is unable to repay, the directors are liable; and
(ii)Fourth cause of action: Mr Banks was induced to subscribe for securities on the basis of advertisements that included untrue statements. Under ss 55G and 56 of the Securities Act, the directors are liable to compensate Mr Banks for loss and damage he sustained as a result;
(b)Second cause of action: in breach of the Fair Trading Act 1986 (“the FTA”), the defendants engaged in misleading and deceptive conduct which induced Mr Banks to invest and keep his money invested in
1 The substantive hearing occupied 18 sitting days. I reserved my decision on 24 July 2019. On 27 September 2019, the defendants filed an interlocutory application seeking orders that the plaintiff deliver up certain electronic devices on the grounds that it appeared the plaintiff may have forged certain documents he produced in evidence. That application was heard on 11 December 2019 and granted. The devices were delivered, inspected and analysed by experts retained by the plaintiff and the defendants. COVID-19 intervened. The forensic examination took until July 2020 to complete. On 16 July 2020, I made timetabling orders for the filing of evidence and the common bundle. A two day fixture on 5 and 6 October 2020 was allocated, that being the earliest available date given the scheduling pressures imposed by COVID-19. I heard evidence from witnesses and received oral and written submissions from counsel. On 31 March 2021, the Court of Appeal delivered its judgment in Yan v Mainzeal Property & Construction Limited (In liq) [2021] NZCA 99. Given the significance of that judgment to these proceedings, on 14 April 2021 I invited counsel to make supplementary submissions. These were received from the plaintiff and the first defendant on 29 April 2021 and 14 May 2021 respectively and from the plaintiff in reply on 17 May 2021.
Mako. Under s 43 of the FTA, the defendants are liable to compensate Mr Banks for the loss and damage he suffered as a result; and
(c)Third cause of action: in breach of the Companies Act 1993 (“the Companies Act”) the defendants:
(i)failed to act in good faith and in the best interests of the company (s 131 of the Companies Act);
(ii)carried on business in a manner that was likely to create a substantial risk of serious loss to creditors (s 135 of the Companies Act);
(iii)agreed to the company incurring obligations that it was not able to perform (s 136 of the Companies Act); and
(iv)failed to exercise the care, diligence and skill that a reasonable director would exercise in the circumstances (s 137 of the Companies Act).
Under s 301 of the Companies Act, the directors are liable to compensate Mr Banks for the loss and damage he suffered as a result.
[11]Mr Banks seeks compensation for the sums he invested, plus interest and costs.
BACKGROUND
[12] Mako operated for 13 years between 2002 and 2015. In the course of the hearing, the primary focus was on the four-and-a-half (or so) years from December 2010 when the prospect of the plaintiff investing funds in the company was first raised, until August 2015 when Mako went into liquidation. The fortunes of Mako, the actions of the directors and the involvement of the plaintiff were examined in minute and painstaking detail. For that, there can be no criticism of any party. That course was necessary for the trier of fact to properly understand and evaluate the actions of the parties and the context within which those actions took place.
[13] However, given the level of detail engaged, it is necessary to set out in far greater detail than would usually be the case, the factual background.
The beginnings of YellowTuna and Mako
[14] In the late 1990s the second and third defendants, Messrs Gamble and Massam,2 were both working on the help desk at Telecom’s then new internet service provider, Xtra. These responsibilities evolved into operational roles at Telecom with a focus on IT. Mr Gamble, particularly, was interested in IT solutions designed to protect Xtra’s servers from intrusion and hacking.
[15] It was about this time that Mr Farmer, the first defendant, who Mr Gamble had known for some years, approached Mr Gamble about joining his business, E-Force, as its IT Manager. Although Mr Gamble was excited by this prospect, he was not confident that he could deliver all that Mr Farmer hoped for. He thus introduced Mr Massam who, with Mr Gamble, joined Mr Farmer at E-Force. Together they built networks and introduced various technologies. Despite their efforts, E-Force failed towards the end of 2000.
[16] This proved to be the impetus for Messrs Massam and Gamble to set out on their own. They decided to start a business together focusing on networking technology. It was a timely initiative because, at the time, New Zealand’s small
2 Messrs Gamble and Massam represented themselves. They each filed a brief of evidence but were led by Mr Hollyman QC, acting for Mr Farmer, the first defendant.
business sector was just starting to embrace computer networks, broadband and the internet.
[17] Throughout the trial the names of the companies involved were used interchangeably. It appears that in 2001 Messrs Massam and Gamble, with another, Mr Dennis Monks, set up YellowTuna Networks Ltd (“YellowTuna”), later renamed Mako Networks Ltd (“Mako Networks”).
[18] Messrs Massam and Gamble maintained contact with Mr Farmer. They sought out his advice on various financial and strategic matters. Mr Farmer indicated an interest in getting involved in the YellowTuna business and in 2002 joined YellowTuna as its Chief Executive Officer (“CEO”). YellowTuna Holdings Ltd (“YellowTuna Holdings”) was formed in September 2002 as a holding company and was later renamed to Mako Networks Holdings Ltd (“Mako Holdings”). Messrs Massam, Gamble, Monks and Farmer each took a 25 per cent share in YellowTuna Holdings. Mr Farmer was appointed a director of YellowTuna Holdings in September 2002 and of YellowTuna in May 2004.
Corporate structure
[19]
To avoid later confusion, it may be helpful to explain the corporate structure of YellowTuna and its relationship with Mako. The following corporate structure diagram and explanatory notes (with some additions and deletions which reflect changes in the company names) are taken from the Private Placement Memorandum which is discussed later in this judgment.Mako Networks Holdings Ltd (formerly YellowTuna Holdings Ltd)
Owner of all Intellectual Property – Proprietary Software, Patents and Trademarks
100% Owned Subsidiaries
Mako Networks Ltd
Fully Operatonal Sales, Marketing, Administration, for New Zealand, Research and Development contractor to YTH. Network Operations worldwide. Owner of and administrator for PCI compliance Certification.
Mako Networks Finance and Leasing Ltd
Hardware Specification, Procurement and Supply worldwide
Mako Networks Ltd – UK
Fully Operational Sales and Marketing for the United Kingdom and South Africa
Mako Networks Australia Pty Ltd
Research and Development contractor to YTH through MNL
Mako Networks Sales and Marketing Inc – USA
Non-operatoinal Sales and Marketing for USA structured for tax efficiency
Mako Networks North America Ltd
Non-operatoinal US Licence holder for future operations
[20] Mako Holdings (which until 2013 was known as YellowTuna Holdings), is recorded as the “holding company” in the group’s financial statements. It not only held shares in the subsidiary companies but also owned the business’ core asset, its intellectual property. It made that property available to its subsidiaries to exploit in the marketplace. Mako Networks was the New Zealand arm of the business and the research and development contractor to Mako Holdings. It owned the Mako PCI-DSS compliance certification which is discussed more fully later. Mako Networks Finance and Leasing Ltd (“Mako Finance & Leasing”) was the worldwide hardware specification, procurement and supply arm of the business. There were also other Mako companies, both operational and non-operational, set up for the primary international markets in North America, the United Kingdom and Australia.
[21] As is evident from the minutes of the Board of Directors (“the Board”), the directors tended to treat the various companies as a single business enterprise or group, including preparing the financial statements on a consolidated basis. For the purposes of this judgment, references to “Mako”, without further specificity, relate to the Mako businesses generally, including the period during which the business was run under the YellowTuna banner.
Growth and development of Mako
[22] The new business grew and the technology the defendants developed with YellowTuna would later provide the foundation for Mako’s innovative business.
[23] Mako’s commercial focus narrowed from the provision of general IT services to specialising in internet connectivity, protection and control. The platform developed by Mako was unique and world leading. It was an automated network security system which enabled computers to update firewalls, a task previously undertaken by technicians. These technological advances led to the development of the “Mako system” which was comprised of hardware connecting business sites to the internet and a cloud-based, centrally-managed server platform. The innovative aspect of the Mako system was (and remains) such that it cut through the technical complexities of firewalls and network security. The technology also had the advantage of being capable of being installed and maintained cheaply. The Mako system became an industry leader in cloud-based network management systems.
[24] Initially, the company’s marketing and sales energies were directed at persuading either TelstraClear or Telecom to purchase the Mako system because each had large numbers of customers connected to the internet, operating small businesses and distribution enterprises which reflected Mako’s business targets.
[25] It was something of a strategic triumph when, on 25 October 2005, Mako entered into its first supply agreement with Telecom. Under this agreement, Telecom adopted the Mako system which it marketed to its customers as SecureME. The product remains a successful one today, now under the ownership of Spark New Zealand.3 Shortly afterwards the Mako system was purchased by the Ministry of Health under the name SecureME for Health. Through its association with Telecom, Mako also secured a number of key customers including Fonterra, Z-Energy, St Johns, Mobil New Zealand, Lotto New Zealand and the New Zealand Racing Board.
3 Telecom was rebranded as Spark on 8 August 2014.
[26] In 2006, Mako successfully completed its first security audit with ICSA Labs4 which opened up markets further afield.
Mako in 2007 to 2009 and PCI-DSS certification
[27] In 2007, Mako established a relationship with NetComm, an Australian technology manufacturer and distributor. Mako gave NetComm exclusive rights to the Mako system in Australia which NetComm rebranded in the Australian market as NetAssure.
[28] In 2009, apparently at the request of Telecom, which wished to roll out the Mako system to its large corporate customers, the directors of Mako investigated what appeared to be a gap in the credit card security market. This required Payment Card Industry Data Security Standard (“PCI-DSS”) accreditation of the Mako system. The PCI-DSS standard was developed in 2006 by the five major western credit card companies as a means to improve cardholder data protection and reduce instances of fraud. If accreditation was obtained it would differentiate Mako as a unique provider and market leader in the industry and thus open up access to large global businesses which accept payment by credit card. On 3 February 2010, after months of work to secure accreditation, the Mako system was certified as PCI-DSS compliant. Later that month Mako launched its PCI-DSS compliant management system, the first of its type in the world. This was a commercial coup which differentiated Mako from any of its competitors. It was common ground at the hearing that Mako’s achievements in this regard were massive. From this point, the company looked to expand globally, particularly into the United States.
Telecom funding
[29] From 2009, Mako primarily funded its business through one of Telecom’s subsidiary companies, Telecom Rentals Ltd (“Telecom Rentals”). Telecom Rental’s core business was providing IT and telecommunications equipment leasing services. Essentially, Telecom Rentals provided Mako with a working capital facility using its equipment leases and committed future business as security for advances. Despite
4 ICSA Labs is a US-based agency specialising in security hosting and certification network and computing systems.
normally offering sale and lease back services, Telecom Rentals agreed to release funds as working capital to Mako to support the upfront costs of developing its business, particularly internationally. This agreement was formally governed by a series of rental agreements and an associated general security deed (“GSD”) between Mako Finance & Leasing and Telecom Rentals. The agreement was executed on 26 October 2010. The GSD had a priority limit of $5 million.
[30] The agreement was varied in August 2011 with Mako Networks agreeing to guarantee 30 per cent of the debt owed by Mako Finance & Leasing to Telecom Rentals. This variation, in part, was to allow equipment financed by Telecom Rentals to be used offshore without breaching the agreement. This arrangement remained in place until early 2013 when the limit was increased from $5 million to $35 million. There were further variations to the arrangements between Mako and Telecom Rentals, the latest of which was when the debt arrangements were restructured in early 2014. These variations are discussed more fully later.
The Private Placement Memorandum (2010)
[31] Through 2010, Mako began looking to raise capital from wealthy investors. In September 2010, Mr Farmer and Mr Gamble started work on a draft information memorandum for capital raising purposes. It would come to be known as the Private Placement Memorandum (“PPM”). Mr Farmer said that the PPM was specifically aimed at investors who were not members of the public in order to avoid the obligations and strictures imposed by the Securities Act. He received legal advice from internal and external providers on the definition of “members of the public” under the Securities Act and in particular, the various exclusions.
[32] This approach is reflected in the opening parts of the PPM which are reproduced below:
“Mako Networks
Private Placement Memorandum
This Private Placement Memorandum (“Memorandum”) has been prepared by Mako Networks Ltd (Mako) its related companies and its directors and shareholders. This Memorandum is not an Investment Statement nor
Prospectus and does not constitute an offer of securities to the public for the purposes of the Securities Act 1978 (“the Act”).
No offer of securities is made to any person except such persons excluded from being members of the public under s 3(2)(a) of the Act, (together being “Qualified Investors”). These include persons:
A.WHO ARE RELATIVES OR CLOSE BUSINESS ASSOCIATES OF MAKO OR A DIRECTOR OF MAKO;
B.WHOSE PRINCIPLE (sic) BUSINESS IS THE INVESTMENT OF MONEY OR WHO, IN THE COURSE OF AND FOR THE PURPOSE OF THEIR BUSINESS, HABITUALLY INVEST MONEY;
C.ANY OTHER PERSON WHO IN ALL THE CIRCUMSTANCES CAN PROPERLY BE REGARDED AS HAVING BEEN SELECTED OTHERWISE THAN AS A MEMBER OF THE PUBLIC.
Provision of Memorandum
This Memorandum is provided to Qualified Investors in New Zealand who have expressed an interest in investing in Common Stock (“the Shares”) offered by YellowTuna Holdings Limited (“Mako” or “the Company”) (“the Opportunity”). The sole purpose of the Memorandum is to provide information to Qualified Investors and is not intended to form the basis of any investment decision or any decision in connection with the Opportunity.”
[33]The PPM also contained extensive exclusions:
“No Representations or Warranty
No information contained in this Memorandum has been independently verified by any person and no representation or warranty, express or implied, is made nor is any responsibility accepted by Mako with respect to the completeness or accuracy of any information contained in this Memorandum or any further information supplied in connection with the Opportunity.
This Memorandum and specifically the financials have been prepared on the basis of numerous assumptions, projections and best estimates. Because projections involve risk and uncertainties actual results are likely to vary and such variations could be material. No representations are made by the Company, its directors or its management that the results set out in this Memorandum will be achieved.
Independent Review
This Memorandum does not purport to contain all of the information that may be required to evaluate the Opportunity. Any intending Qualified Investor and their respective advisors should conduct their own independent review, investigations and analysis of the operations and affairs of Mako and the information contained or referred to in this Memorandum.
…
Limitation of Liability
Except insofar as liability under any law cannot be excluded, Mako shall not have any responsibility or liability arising in respect of the information contained in this Memorandum or in any way for errors or omissions (including responsibility to any person by reason of negligence).
No Guarantee
No party is guaranteeing the Opportunity or the future performance of Mako.
If these conditions are not acceptable, this Memorandum should be returned immediately to Mako.”
[34]A footer appeared at the bottom of each of the 24 pages, stating:
“This document is strictly confidential and circulation is restricted to Qualified Investors as outlined on pages 3 and 4 of this Private Placement Memorandum. All copies should be returned immediately to Mako Networks and copies destroyed if the conditions outlined are not acceptable.”
[35] The PPM also set out the company’s plans for expansion and the development of the Mako system with its PCI-DSS compliance. Under the heading, “Mako Opportunities”, it described its markets in Australia, the United Kingdom and the United States, prefaced by the following:
“The following information is included as an outline to demonstrate the quality and quantum of business opportunities that Mako is actively working on. All PCI-DSS opportunities are subject to Commercial In-Confidence Non-Disclosure Agreements and/or Letters of Engagement and as such cannot be elaborated upon.”
[36] Towards the end of the document, the revenue projections for the period 2011 to 2015 were set out. The predicted revenue in 2011 was $17,036,707, in 2012 it was
$41,575,828, in 2013 it was $63,034,008, in 2014 it was $97,588,393 and in 2015 it was $133,967,197.
[37]The document concluded:
“Investment Proposal Capital Raising
The company seeks to raise NZD$7.5m from an invitation-only private placement of its Common Stock. The offer will open on 1st November and
close on 30th November 2010. The Company expects to increase its share plan to 25 million shares of which 3.75 million will be allocated in the capital raising…”
Mr Banks meets Mr Farmer
[38] It was about this time, in late 2010, that the plaintiff, Mr Adam Banks (“Mr Banks”), first met Mr Farmer. At the time Mr Farmer was living in a rural lifestyle complex in Albany, Auckland. Amongst his neighbours was a Mr David Winslade (“Mr Winslade”). At the time Mr Winslade’s partner was Mr Banks’ mother, Ms Caroline Banks (“Ms Banks”).5 There is some disagreement between the parties as to how the question of Mr Banks investing in Mako first arose and what was said. This is covered in more detail later in relation to the first cause of action.
[39] According to Mr Farmer, investing in Mako was first raised when Mr Winslade mentioned to him that Ms Banks could be interested in an investment. Sometime later Mr Winslade told him Ms Banks was interested and Mr Farmer gave him a copy of the PPM, saying Ms Banks should contact him if she was interested. Mr Farmer said Ms Banks later made contact and over the course of two meetings, they discussed a possible investment. Mr Farmer said that from their discussions, it was obvious to him that Ms Banks was “well versed in the business world” and that a Mako investment would represent a small part of her total investment portfolio. He said that he told Ms Banks that Mako was a high-risk technology investment and nothing like any of her previous investments. He claimed he told her that if she could not afford to lose the money, then she should not invest in Mako. Later she emailed him, confirmed that she would like to proceed with the investment and advised Mr Farmer that her son, Mr Banks, would “take it from here”.
[40] In contrast, Ms Banks’ evidence was that it was Mr Farmer who first raised the question of investing in Mako. He raised it directly with her and talked about investing in Mako at a good rate of return. Ms Banks said she told Mr Farmer that Mr Banks might be interested and gave him her son’s contact details. She believed Mr Banks would be interested in the opportunity to help the family financially because,
5 In the course of her evidence Ms Banks indicated that “Ms” was her preferred honorific.
according to her, “he was keen to learn about New Zealand laws and cultural norms and to generate money via employment or investment”. Ms Banks was adamant that she did not initiate the approach to Mr Farmer herself, that Mr Winslade never spoke to her about an investment in Mako, and that she did not have any business or investment meetings with Mr Farmer apart from a much later occasion on 18 February 2015. She said that other than assisting Mr Banks with some of the international money transfers to Mako, she had very little to do with the loans although, occasionally, she said she was copied in on correspondence between Mr Banks and Mr Farmer or she would discuss, in general terms only, Mr Banks’ investment when she saw Mr Farmer socially. She claimed that she had no real involvement or knowledge of any detail around the loans.
[41] The funds which Mr Banks would later lend to Mako across all three advances originated from accounts controlled by Ms Banks and trusts associated with her. The original source was derived from inheritance and residential property lending undertaken by Ms Banks in England before she emigrated to New Zealand in 2007.
[42] However they were introduced, it is common ground that Mr Farmer and Mr Banks first met in late December 2010. Mr Farmer claimed they spoke about Mr Banks’ UK investment experience and his knowledge of the New Zealand technology investment landscape. He said that Mr Banks presented as many high wealth individuals do. These discussions led to more detailed correspondence. Mr Farmer claimed that throughout, Mr Banks presented as a financially astute and experienced investor. He said his belief was that Mr Banks’ involvement was to oversee the investment for his mother.
[43] Mr Banks’ evidence was that he was interested in investing in Mako because it involved IT and provided an opportunity to learn about technology. He said that Mr Farmer told him that Mako would be carrying out capital raisings of tens or hundreds of millions of dollars, that the company had no secured debts and that his investment would be safe. He said Mr Farmer explained that the loans would be made to Mako Holdings, a company which did not trade but simply received and distributed its income. According to Mr Banks, Mr Farmer said that Mako was obliged to take
“several solvency steps per year” and that any investment by Mr Banks would rank equally with all other unsecured creditors.
[44] On 22 December 2010, Mr Farmer emailed Mr Banks a copy of the PPM. Later the same day, Mr Banks responded to Mr Farmer with a series of questions regarding the potential investment. Amongst the various questions he asked, was whether the offer expired on 30 November 2010 or whether the expiry date on the PPM was meant to be 2011. He asked how often the solvency tests were taken and who regulated them. He asked whether his investment ranked ahead of wages and he made some suggestions as to how any investment might be structured.
[45] A few days later, Mr Banks asked Mr Farmer if the company would consider providing a personal, limited guarantee to “give us confidence”. By email, Mr Farmer flatly rejected that option. Mr Banks then emailed Mr Farmer a proposal; a loan of
£1.05 million in return for quarterly interest payments. He said he would be the lender. He commented:
“It isn’t always convenient to have my name on bank accounts and in this deal we will be using accounts that are owned by related entities which often handle money for my benefit. The UK accounts are owned by Caroline and the NZ account is owned by a trust of which I am a beneficiary and an administrator. A copy of a bill and the passport of me and Caroline isn’t a problem…”
[46] He advised that he was treating the investment as a UK deal on his books. The Inland Revenue Department had given him a tax exemption on foreign income and he said he wanted to receive as much interest as possible before the exemption expired.
[47] Between this time and the end of January 2011, Mr Farmer and Mr Banks exchanged numerous emails and spoke on the telephone. Mr Farmer also met with Ms Banks. He said this was because he needed to satisfy himself that she was content with the proposed investment.
[48] By the end of January 2011, the agreement was starting to take shape. The parties’ legal advisors were working on the documentation and exchanging drafts. One matter, which was creating some difficulties, was the structure of the proposed loan; a simple loan or a loan-to-equity conversion. On 1 February 2011, Mr Farmer received
an updated draft of the agreement from Mako’s lawyers. They, or possibly Mr Farmer, had a query regarding the equitisation of the debt. Mr Farmer’s email to Mr Banks is reproduced below:
“You mentioned on Thursday evening that it would be unlikely that you would want to convert any of the loans to equity. As this is the area that is giving me the greatest difficulty with complying with securities requirements, should we just delete the option and leave it as a straight loan with repayment due as prescribed?
I would be happy to talk through if you called.”
[49] Mr Banks responded almost immediately advising that he was happy to delete the equity option because he did not wish to delay matters further.
Agreement 1
[50] On 4 February 2011, Mr Banks executed the loan agreement with Mako (“Agreement 1”). He agreed to lend Mako £1,177,000 in three tranches as follows;
(a)the first tranche would be £130,000 for a minimum term of two years with a minimum notice period of six months in the event Mr Banks wished to call it up (“Tranche 1”);
(b)the second tranche would be £547,000 for a minimum term of two years with a notice period of six months (“Tranche 2”); and
(c)the third tranche would be £500,000 for a minimum term of three months with a notice period of three months (“Tranche 3”).
[51]Other key terms of the agreement included:
(a)Mako would not make any external bank borrowings or give security (other than in the ordinary course of business where the secured assets were not more than 15 per cent of the net value of the borrower) over any of Mako’s assets without first obtaining Mr Banks’ consent or giving Mr Banks the option to demand repayment of all tranches prior to Mako entering into any financing;
(b)Mr Banks acknowledged that the loan was unsecured and not guaranteed by any person;
(c)Mr Banks would provide both financial and capital raising advice to Mako; and
(d)both parties acknowledged that the loan was the entire agreement between them and superseded all prior agreements, negotiations and representations. Mr Banks confirmed that he had entered into the agreement on his own judgement and had not relied on any representation by Mako, its agents, officers and personnel.
[52] Although Mr Banks and his mother experienced some difficulties in extracting the funds from the United Kingdom, the final payment was made by mid-April 2011.
[53] It is common ground, supported by the contemporaneous documentary record, that over the next two years or so Mr Farmer and Mr Banks corresponded by email and from time to time met in person. There is also evidence of the same between Ms Banks and Mr Farmer. Over this period Mr Farmer accepted that he portrayed Mako as a company which was doing well with growing investor and customer interest and strong financial projections. As will be discussed, there was some reasonable basis for those expressions of confidence.
Mako in 2011 and 2012
Customers and marketing
[54] In 2010 and 2011 Messrs Massam and Gamble travelled widely through Asia, the United States and the United Kingdom promoting the Mako system and its PCI- DSS certification. The target markets were banks, payment processors and credit card companies. They also attended international trade shows.
[55] In May 2011 Messrs Massam and Gamble attended a technology trade show in Las Vegas. They were joined by the fourth defendant, Mr Frederick, who at that time was providing consultancy services to the company. It seems it was here that they
all gained a fuller appreciation of just how ground-breaking and attractive the Mako system and its PCI-DSS accreditation was to potential customers. The unique technology piqued the interest of large organisations, including Chevron, which invited Mako to “pitch their product” against other competitors for a request for proposal (“RFP”) at Chevron’s headquarters in California. At the time, Chevron was the third largest listed company in the world with approximately 7,000 internet- connected petrol stations. The presentation resulted in Chevron entering into an agreement with Mako which led to it successfully rolling out over 4,000 Mako systems to its sites.
[56] Other large potential customers began to show an interest, particularly because the incidence of credit card fraud was increasing globally.
[57] At about the same time the company was engaged in discussions with Heartland Payment Systems and Alon Brands. The former is one of the United States’ largest payment processors with revenues of the order of USD 2 billion. Alon is a mid-sized petroleum company with approximately 1,500 sites and revenues of approximately USD 1 billion.
[58] In December 2011, Mako signed a non-exclusive distribution agreement with UK-based Phoenix Managed Networks (“Phoenix”) for North America and Europe. This required Phoenix to pre-purchase 10,000 Mako licences and 4,000 appliances.
[59] The same year, Mako received a $4.2 million technology development grant from the then Ministry of Science and Innovation (“MSI”). Unsurprisingly, that process required MSI to undertake a thorough review of Mako’s business operation including its financials and the testing of its components before Mako could draw down the grant. That scrutiny continued beyond the receipt of the grant.
[60] In early 2012, the Board conducted a two day strategic planning exercise. An internal target, regarded as achievable, of $100 million of earnings before interest, taxes, depreciation and amortisation by June 2015 was set.
[61] The monthly Board minutes over 2012 reveal the Board undertook regular reviews of the cashflow position and customer prospects in the pipeline. Some of the larger projects in the pipeline included Metcash and Phoenix, both of which led to contracts.
[62] Market penetration reports were considered by the Board which indicated a target of 150,000 licences by 2015 was achievable. Promising marketing initiatives included Heartland Payment Systems, Bullseye Telecom (“Bullseye”), Earthlink and Phoenix.
[63] Live trials at a limited number of Chevron sites were underway. The full roll out was expected to start in mid-2013.
[64] At the end of 2012, the Phoenix contract was amended to 10,000 units by the end of 2015. The Phoenix pipeline had very significant revenue potential.
[65] In late 2012, Mako commenced a trial with Bullseye, a business-to-business telecommunications company operating out of Michigan. This led to a reseller agreement entered into in May 2013 to deliver a combined solution to Bullseye customers. Under this agreement the Mako product was on-sold to major United States businesses including Triton Management, Fisher Auto Parts and Title Max. By April 2014 the system had been installed at many of their sites.
Mr Frederick and Mr Frawley join the Board and Mr Gamble moves to the United States
[66] In December 2011, Messrs Michael Frawley and Douglas Frederick were invited to join the Board as independent, non-executive directors.
[67] Mr Frederick is a citizen of the United States and is resident there.6 His background is in software technology and technology services having been involved in that field in various offshore markets, most notably, in the United States. He worked for the Boeing Company as a research analyst before joining the software technology
6 Mr Frederick’s evidence was received in the form of an affidavit. He did not attend the trial, did not give viva voce evidence and did not file written submissions.
company BAAN as Executive Vice President in 1997. He served on the boards for BAAN subsidiaries in Israel and Japan. In 1999 he joined Electronic Data Systems (“EDS”), one of the United States’ largest technology companies, where he was Executive Vice President responsible for some 80,000 staff and annual revenues of approximately USD 15 billion.
[68] Mr Frederick first met Mr Farmer in London in late 2009 after Mako had successfully obtained PCI-DSS certification. In the course of his discussions with Mr Farmer, he indicated that although he knew nothing about networking specifically, he could help facilitate the company’s entry into the United States market through his contacts and experience in technology and IT. Initially, he provided consulting services to the company and later joined the Board of Mako Networks in June 2010. In December 2012 he was invited to join the YellowTuna board as its non-executive chairman and was elected to that position at the company’s AGM in April the following year.
[69] Mr Frawley joined the YellowTuna Holdings board at the same time as Mr Frederick. He did so after returning from the United Kingdom having worked in the legal profession there for 25 years, notably as managing partner in a leading London law firm.
[70] In addition to Mr Frederick’s influence in the lucrative United States market, it was decided that Mr Gamble should join him by relocating there to promote the Mako technology to other Silicon Valley technology firms. Mr Gamble and his family moved to the United States in March 2012.
Finances and cashflow
[71] The potential success of the initiatives discussed above, were not reflected in the company’s balance sheet. In November 2011, the Mako group’s income, as recorded in its financial statement for the year ended 30 June 2011, showed revenue of $4,780,446 against the previous year of $5,176,317 and a loss of $3,220,804, figures which starkly contrasted with the PPM’s total revenue projection for that year of over
$17 million.
[72] The Board minutes of April 2012 reflect the directors’ understanding and consideration of Mako’s cashflow position. The following are extracts:
“6. Current Cash Flow Forecast.
Paul [CFO] explained the workings of the current cashflow forecast for the Group to July 2012. It was noted that only sales confirmed and billed were included. It was noted that the Group had sufficient cash to the end of May 2012 but needed to close further sales by then to fund outgoings in June, July and beyond. [Mr Farmer] then discussed the sales pipeline below.
7. Current Sales Pipeline.
…
The Board noted that [Mr Farmer] as CEO was reasonably confident that the sales pipeline was sufficient to enable the company to trade through August 2012. Subsequent larger sales will then be needed to enable the company to trade beyond this point. [Mr Farmer] emphasised that the business was still relatively high risk and large expected sales had to be realised by the end of May and beyond. The Board agreed it was a very fluid situation that required close management. It was agreed another Board meeting would occur on 29 May 2012 at 9:00 am NZ time to review the Group’s solvency and cash flow position. In the interim [Mr Farmer] would send to the Directors a weekly summary of sales activity following Monday’s management meetings.”
[73] However, by the time the Board met in May 2012, the cash position was little improved as the following extract from the minutes reveals:
“…[Mr Farmer] advised the Board that this Metcash contract was expected to be finalised on May 31st and funds expected to be received from either buy upfront volumes or leases will be used to repay the [Telecom Rentals] loan for this deal. A further discussion took place on the status of the Phoenix contract and possible timing of their next orders and receipts. The Board were reminded that the company had already borrowed under leasing contracts with [Telecom Rentals] for the entire 10,000 licences Phoenix have agreed to in their contract (4000) and subsequent purchase orders issued for the remaining 6000 licences that had been copied to the Board. [The CFO] advised the Board that current debt due to [Telecom Rentals] was approx $10.2m by [Mako Finance].
[The CFO] advised the Board that the cashflow projection now showed sufficient funds through to late July 2012 but new receipts would be required from then onwards and this needed to be looked at in conjunction with the sales pipeline.”
[74] Two months later the position had still not improved. The Board minutes for July 2012 reveal similar themes. These record that Mr Paul McGregor, the CFO:
“…emphasised the monthly minimum cash requirements to meet salaries and opex was $700K and debt repayments to Telecom Rentals were building shortly to $500K. Without cash inflows from sales or other means, the group had insufficient cash to meet outgoings from early August and this built to a need for $5m of cash by the end of October to meet known outgoings growing by an additional $1.2m per month…
…
[Mr Farmer] emphasised to the board how tight cash flow was and that the best case was contracts would be closed and revenue received from customers…but the likely case was that further funding would be needed from Telecom Rentals
…
It was agreed for the record that the company was currently meeting its debts as they fell due but the next three to four weeks would need to be monitored carefully in the light of the payments that were coming up.”
[75] The Board minutes for August 2012 record the Board’s view that Mako had sufficient funds to meet expenses until the end of September. Mr Farmer expressed confidence that there were sufficient sales in the pipeline to cover any ongoing costs beyond that.
[76] The minutes for September 2012 record that Mr Farmer presented an updated cashflow analysis which showed that after additional funding arranged with Telecom Rentals, Mako had sufficient funds through to the end of October 2012. The directors then examined the likely short term cash receipts from Phoenix, the BullsEye trials, Telecom and BankServ/InfoGuard.
[77] The minutes for December 2012 record that Mr Farmer advised that Mako had sufficient cash to cover the period through to the end of January 2013. He expected another draw down from Telecom Rentals to carry the company through to February. Final negotiations with Phoenix over their next draw down of the inventory were underway and it was anticipated they would take 500 units with licences by the end of December 2012 and would formalise an increase in the contracted commitment to 10,000 as provided for in the purchase orders.
[78] The question of undertaking an Initial Public Offering (“IPO”) was also discussed at the December meeting. The possibility of an IPO had been in the wings since the global significance of PCI-DSS certification first became apparent. Mr Farmer told the Board that information had been collected over the previous two months from merchant banks. He sought and obtained Board approval to proceed to the next stage which would likely include an independent market analysis by Mr Sidorenko, of Norcal Growth Partners (“Norcal”) and the engagement of investment bankers, Cameron Partners.
Mako in 2013
Telecom Rentals
[79] Through to the middle of 2013 Telecom Rentals continued to assure Mako of its ongoing financial support. By email on 11 April 2013 Telecom Rentals confirmed that with an exposure to Mako of about $23 million it was prepared to provide an agreed “ceiling” of $35 million for the short to medium term.
[80] The Board minutes for June 2013 record the discussion around increasing the limit on the Telecom Rentals debt. The Board resolved to capitalise Mr Banks’ loan to equity. The Board also resolved to enter into discussions with Telecom Rentals relative to the loan agreement.
[81] What no one on the Board appears to have appreciated at the time, is that any purported grant of security in favour of Telecom Rentals would be in breach of Mr Banks’ rights under Agreement 1.
[82] On 28 June 2013 Mako Finance & Leasing, Mako Networks and Telecom Rentals executed a deed of assignment under which Mako Finance & Leasing assigned the Telecom Rentals rental agreements to Mako Networks, and Mako Finance & Leasing assigned the GSD between Mako Finance and Leasing and Telecom Rentals to Mako Holdings.
[83] On the evidence it seems that the agreement of 28 June 2013 was not the end of discussions between Mako and Telecom Rentals because, at a special meeting on
3 July 2013, the Board met to review and approve recommendations for the Deeds of Assignment relating to the funding restructure between Mako and Telecom Rentals. The minutes record:
“Mr Farmer provided a summary to the Directors, explaining that a thorough review had been performed on the account. [Telecom Rentals] had a concern that the shareholder equity invested in the business was disproportionate to [Telecom Rentals’] risk exposure. The proposed lease construct would solve this matter with the assignment of the General Security Deed (GSD) from an operating company to the ultimate Holding company.
…
The Directors had a general discussion on the risks, business implications including cash flow, alternative financiers, the cost of the transaction and execution of forecast sales.
Mr Farmer read out to the directors, Mr Frawley’s email support for the resolutions…”
[84] Mr Frawley’s email which had been sent earlier the same day to Mr Farmer and copied to the other directors said of this arrangement:
“Good morning Bill
As per our conversation I confirm that the proposed transaction is in my view “a no brainer”.
The transaction:
1. Rationalises and simplifies the arrangements between Telecom Rentals and Mako.
2. Gives Telecom Rental additional and identifiable security;
3. Improves in the short to mid term Mako’s cashflow by substantially reducing its interest payments to Telecom Rentals. It will also hopefully result in an additional advance of $3m which will help with the expansion of Mako’s business in the US.
…
So in short I support the resolutions. Regards
Michael Frawley”
Agreement 2
[85] On 30 June 2013, Mr Banks and Mako entered into Agreement 2. The background to this follows.
[86] On 9 March 2013, Mr Banks emailed Mr Farmer indicating he would like to invest more funds with Mako. He suggested certain terms. Mr Farmer responded two days later. This led to an agreement in April which was superseded when Mr Banks found himself in a position to advance a greater sum. In May 2013, in performing his obligations under Agreement 2, Mr Banks advanced funds in two separate tranches;
£237,722.43 on 15 May 2013 and £24,779.14 on 31 May 2013.7
[87] A month later, on 30 June 2013, Agreement 2 was recorded in writing. Mr Banks used the trading name Leopard Investments. He said he did this because he valued his privacy and did not want his real name recorded amongst Mako’s creditors.
[88] The terms of Agreement 2 supplemented those in Agreement 1, additionally provided that all Mr Banks’ advances (plus interest) due as at the date of the agreement would convert to equity in Mako on completion of Mako’s listing on the New Zealand Stock Exchange (“NZX”). At the subsequent June Board meeting Mako’s directors resolved to capitalise Mr Banks’ loan, although noting that the shares would not be issued until any IPO.
[89] In his evidence Mr Farmer accepted that cashflow throughout this time was tight. However, it seems that two aspects of Mako’s business gave the directors a sufficient level of comfort that the company would be able to continue to trade. The first were the various business opportunities sitting in the pipeline of which some, such as Chevron, were expected to be highly lucrative when realised. The other was the
$35 million Telecom Rentals’ loan facility which was being used as working capital.
7 Mr Banks actioned these two transfers on 14 and 30 May 2013 respectively but Mako did not receive the funds until each of the following days.
Initial Public Offering (“IPO”)
[90] As noted, the possibility of an IPO had been under consideration from the early days. The minutes record its discussion from time to time. It was a topic of discussion between Mr Farmer and Mr Banks prior to Agreement 1 being entered into.
[91] In March 2013, Mr Farmer approached investment bankers, Cameron Partners, to advise the directors on the logistics of a potential IPO to raise capital of up to
$25 million with a view to launching an IPO in the second half of 2013. On 22 March 2013 Cameron Partners provided the directors with a comprehensive nine page proposal which detailed a four step process towards Mako achieving an IPO. Cameron Partners’ advice was that it was not appropriate for Mako to list on the NZX with any debt on its balance sheet, including the Telecom Rentals’ debt. They thus recommended that as a first step, Mako should address that debt and where possible, capitalise it.
The Norcal Reports
Norcal Marketing Report (15 March 2013)
[92] In January 2013, Mr Farmer engaged Mr Paul Sidorenko (“Mr Sidorenko”) of Norcal to carry out market research to ascertain Mako’s long term prospects in the United States and other global markets.
[93] Mr Farmer and Mr Gamble had met Mr Sidorenko in the United States. He was, according to Mr Farmer, someone with an “in-depth knowledge of the specific market sector Mako operated in”. In cross-examination Mr Farmer described Mr Sidorenko as “a talented salesperson and general sales consultant…a lawyer…[who] is very good at writing documents”.8
8 Mr Sidorenko described himself in a second and later report as “…a business executive and attorney with over 20 years of sale & alliance management, business development and corporate development experience in the technology industry. As the former Vice President of Corporate Development for Clearpath Networks, Mr Sidorenko has had extensive experience with the market for cloud-based networks security, monitoring and management solutions and has engaged with many of the sales channels listed in Mako’s pipeline. Mr Sidorenko was provided with unrestricted access to the Mako sales organisation, the Mako sales channel and supporting services.”
[94] The resulting document dated 15 March 2013 (“the Norcal Marketing Report”) is very detailed. It runs to nearly 40 pages. Mr Sidorenko undertook a comprehensive market analysis of the United States and other global markets for Mako products and solutions in network security, management and monitoring. Because Mako was anticipating further expansion into the United States market, Mr Sidorenko focused on Mako’s potential in that region. The report which followed did not analyse the likely sales in the pipeline nor was it a formal valuation of the business.
[95] Notwithstanding, the Norcal Marketing Report concluded that the company was worth a multiple of eight to 10 times its revenue. Set out below are extracts taken from the executive summary:
“Competitive Landscape Summary – Mako’s competition ranges from small niche players to large, Fortune 50 companies. The competitive landscape can be segregated vertically in terms of customer size and horizontally in terms of solutions set. In the vertical realm, competitors are large enterprise players in the managed services and Unified Threat Management (“UTM”) space that focused predominantly on the large enterprise market. These vendors offer bespoke security and network management solutions delivered by third parties. Due to their “up-market” focus, total costs of purchase, management, support and ownership for these vendors are uniformly not competitive with Mako. In the horizontal realm, competitors are primarily niche players specialising in managed security services, security appliances and software. While some of these competitors focus to varying degrees on Payment Card Industry-Data Security Standard (PCI), none have attained PCI certification and provide only partial coverage for the total requirements of PCI. In all cases, competitors are seeking to expand their ability to deliver a comprehensive suite of cloud-based storage, security and networking services and related business analytics that can leverage the services due to a growing consolidation trend favouring “one stop” solutions.
Valuation Analysis Summary – As a rough guideline, valuations and/or market capitalisation for companies in the Network Management, Network Security and Financial Technology space range from 4 to 6 times revenue to 8 to 12 times revenue with Financial Technology companies historically valued at the lower end of this range. However, recent valuations for strategic players have considered booking run rates in addition to revenues and been edging upward for companies that have healthy bookings, demonstrated innovative solutions and have seen accelerated adoption by customers. A guideline of 10 times revenue can be justified for companies that are (1) growing quickly, (2) in an active sector, (3) with solid growth and defensible IP that is relevant to its differentiation. By this measure, an 8-10x revenue multiple for Mako appears justified based on its revenue growth, current pipeline, focus on sales operations, continued vitality of its core market, renewed investor focus on cloud management solutions and its protected intellectual property. Recent acquisition activity with companies in the cloud networking, management and security areas also support this multiple.”
[96] Mr Sidorenko also undertook a SWOT analysis. Introducing this topic, he noted that the market analysis he had undertaken revealed that no single player dominated the market and that innovation was accelerating at an extremely rapid pace. Thus, he observed, it was imperative that Mako leverage its unique technology, IP and PCI certification to take advantage of the current market void of a “clear brand leader in this space”.
[97] In terms of Mako’s strengths, he referred to the unique and exclusive technological strengths the product had. As for weaknesses, he referred to a limited number of issues which included public IP address requirements, maintaining PCI compliance, remote access limitations and the fact that there was no current long term evolution (“LTE”) certification. As for opportunities, he listed many, particularly in relation to potential markets. Of the threats, he noted market innovation from competitors, Mako’s lack of recognition in the commercial market and Mako’s inability to control the pipeline as the market evolved.
The Norcal Pipeline Report (1 July 2013)
[98] In April 2013, Mako retained Norcal to undertake further research, this time to conduct an independent analysis of the work pipeline identified in the Norcal Marketing Report. This was the “Norcal Pipeline Report”.
[99] The Norcal Pipeline Report, dated 1 July 2013, recorded that it was prepared on the directors’ instructions as part of Mako’s continuing market due diligence. Its stated purpose was to provide an “objective and realistic assessment of opportunities being currently pursued by Mako’s business development…teams in light of current sales activities, market conditions and end user buying preferences.”
[100] The report was compiled from various sources; the pipeline considerations published in January 2013, interviews with business development managers in the sales regions, research into the opportunities listed in the pipeline reports, the development of a common assessment framework capturing the priorities identified by various industry business development managers, sales operations, and a scoring analysis which calculated the likelihood of success of each business endeavour as measured against objective criteria.
[101]The report summarised Mako’s business and client pipeline as follows:
“Overall, the pipeline reviewed for this report appears to be reasonably constructed with a high level of engagement in partner channels and a realistic approach to specific regional challenges. This overall assessment is bolstered by the accelerated sale progress that Mako has seen in 2013 in general and some specific customer wins that will enhance Mako’s brand recognition in the future.
…
On balance, sales support resources that need to be expanded are pre-sales technical support, partner programs to encourage the inclusion of smaller channel partners…and improved marketing and sales execution collateral…Overall, demand generation activity, market profiling research and channel modelling needs to be expanded in order to proactively pursue additional sales opportunities and partner channels…”
Solvency test paper
[102] On 30 June 2013, an internally generated Board paper reviewed Mako’s solvency. It seems the primary purpose of this exercise was to provide a going concern confirmation for Mako’s auditors, Deloitte, for the purposes of the IPO. The report, prepared by management, applied the two-limbed test under s 4 of the Companies Act; the first being the cash flow test, namely whether the company is able to pay its debts as they become due in the normal course of business and the second, the balance sheet test, that is whether the value of the company’s assets is greater than its liabilities, including contingent liabilities. The report noted that as at 30 June 2013 Mako’s unaudited consolidated financial accounts reported an equity deficit of $8,667,000 and total liabilities exceeding assets by the same amount. The working capital deficit was
$3.5 million. The Mako group had recorded a loss before tax for the year ended 30 June 2013 of $7,397,000 compared with the previous year’s loss of $6,274,000.
[103]The two primary stated objectives of the paper were;
(a)“to demonstrate to the directors that the company had sufficient cash resources to meet its obligations in the normal course of business”; and
(b)“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
that this value exceeds the equity deficit and could potentially settle the outstanding liabilities of the Company…”.
[104] The paper concluded that Mako was solvent on the basis of the value of the work in the pipeline and the value of the business. It forecast revenue for 2014 at over three times the revenue of the preceding financial year.
Deloitte Planning Report
[105] On 6 August 2013, Deloitte prepared a planning report at the directors’ request for the year ended 30 June 2013 for the purpose of reviewing Mako’s accounts for a possible IPO. Deloitte listed the key areas of audit risk which were considered appropriate to bring to the attention of the Board for that purpose.
[106] Identified as an area of focus was whether Mako could continue as a going concern. The relevant part is reproduced in full below.
Focus area Response Going concern Consider and perform appropriate tests on the documentation prepared by the company to evidence and support the entity having the ability to continue as a going-concern. (We understand the business has adequate cash surplus ($3.9 million) as at 30 June 2013, plus additional liquidity via access to $35 million financing facility with TRL, currently drawn to $24.5 million as at 30 June 2013). As at 30 June 2013 the (unaudited) consolidated financial accounts of Mako Networks Holdings Limited has an equity deficit of approximately $8.667 million and a working capital deficit of $3.476 million. Deloitte will review managements discounted cash flow model, including assumptions used in the model including support for the cash flows and the supporting contracts. Disclosure has been made in the notes to the financial statements and the audit report in relation to assumptions supporting the going concern basis and that Mako will require funding by way of securing future contracts and successful capital raising) to
continue as a going concern.
Restated accounts for year ended 30 June 2012
[107] As part of Deloitte’s audit, it was discovered that Mako’s accountants, Duns Accounts Ltd had wrongly included anticipated forward sales from Phoenix as
revenue. The original accounts recorded Mako’s positive equity position of
$1,873,896 for the period ended 30 June 2012. As a result of Deloitte’s intervention, the revenue was restated from $10.3 million to $4.6 million. Assets were restated from
$17.1 million to $8.9 million.
Bell Gully instructions
[108] The same month Mako instructed solicitors, Bell Gully to provide legal advice and support in relation to Mako’s proposed IPO. It was anticipated the work would involve due diligence, preparing and reviewing all relevant documents, assisting Mako and its investment bankers and providing general liaison services involving the NZX and the Financial Markets Authority.
The Weldon Report
[109] In mid-2013 Cameron Partners introduced Mr Farmer to Mr Mark Weldon, formerly the CEO of the NZX. The directors engaged Mr Weldon to undertake a review of Mako’s organisational structure. In July 2013 Mr Weldon wrote to Mr Farmer setting out his proposal for a six-week project. As part of that plan he anticipated joining the Board. He also indicated he would personally invest between
$1 million and $3 million in Mako.
[110] The resultant 37-page report was dated 7 October 2013. It described the purpose of the review as twofold:
“1. Undertake for the Board an organisational assessment, including identifying current organisational strengths, weaknesses, opportunities and risks for the company; and
2.Develop a set of recommendation that will ensure Mako can manage its growth profitability (sic) and effectively, with the goal of creating the maximum shareholder value.”
[111] In summary, the report’s authors recognised that while Mako had one or two areas of “true distinctiveness (product and sales)” and was a “market disruptor” there were issues around its supply chain, capital and operations. The report stated that Mako’s capital structure was highly risky with both current debt levels and the projected debt track being too high. This, the report stated, created two significant
risks; first Mako’s ability to control its own destiny and secondly, how Mako could fund near term growth at an acceptable cost. Contributing to the working capital issues was what the report described as:
“…an ad hoc organisation approach in the areas of inventory supply, customer delivery, contractual terms, pricing, internal budgeting and key operational metrics”.
[112] It stated that while that situation might be appropriate for a small, simple business, it was not adequate for an international and complex business. The report noted that if Mako’s debt was not kept under control, the company, despite its promising sales and pipeline could “grow bust”. The report concluded that Mako was a company with some:
“extremely world class aspects, and some aspects that are counter to that. What this means in practical terms is that the balance of the organization is critical to address. If addressed, the value realization potential will become realizable, tangible, and potentially quite large …”
[113] Mr Farmer gave evidence that the Weldon Report was tabled at Mako’s AGM in October 2013. The minutes for the meeting record Mr Weldon’s attendance.
Telecom Rentals raises concerns
[114] On 13 October 2013 Telcom Rentals’ General Manager wrote to Mr Farmer expressing concerns over Mako’s viability and warning that without a cash injection Telecom Rentals would have to consider halting further funding. In summary the advice from Telecom Rentals was:
(a)without Telecom Rentals’ continued support Mako was technically insolvent;
(b)Mako’s negative equity provided challenges when justifying further lending;
(c)the anticipated growth in Mako’s revenue was unlikely to cover the loan repayments to Telecom Rentals let alone the company’s overheads and working capital requirements;
(d)the likelihood of repayment of the sums owed to Telecom Rentals without restructuring or further equity was low;
(e)a cash/equity injection of $20 million to $50 million was needed by March 2014 to cover Mako’s losses and working capital requirements; and
(f)without such an injection, Telecom Rentals might halt further funding leading to potential insolvency and/or conversion or sale of Telecom Rentals’ debt.
[115] A few weeks later Telecom Rentals clarified its position. Mr Farmer was told that the reference to $20 million to $50 million of cash/equity by March 2014 was not a requirement to repay the debt by March 2014. Mr Farmer took this to mean that Telecom Rentals would continue to fund Mako until at least March the following year.
[651] For completeness, I note here a related verbal representation,178 which I have already determined was not made. I do not accept Mr Banks’ evidence that Mr Farmer advised him at a meeting on 13 June 2011 that he could ignore the “No Authorisation” section of the PPM. Mr Farmer denied saying this and for the reasons already set out, I prefer his evidence over Mr Banks’. In any event, the alleged statements are claimed
178 Representation 12.
to have been made on a date more than four months after Mr Banks entered into Agreement 1. They could not have caused him to enter the Agreement.
[652] Further, a contemporaneous email was sent by Mr Farmer to Mr Banks on 17 January 2011, two weeks before Agreement 1 was executed. It described the PPM as:
“…a fair snap shot of the complete business (including all subsidiaries) as at the date it was released. As outlined in the document, neither the company, its Directors or Employees are responsible for its content. The Directors have signed off each of the years Financial Statements included.”
[653] For the reasons just discussed, I cannot see how this representation can be viewed as misleading.
[654] It is also worth noting that this same email stated that neither Mr Farmer nor the company would offer any guarantees, which Mr Banks wished included. The correspondence is direct and bland. None of the language used by Mr Farmer in this email is consistent with the extravagance and hyperbole which Mr Banks claims characterised so many of his dealings with Mr Farmer.
[655] Thirdly, I regard it as significant that Mr Banks said that he undertook independent research on Mako and its competitors before deciding to invest. In other words, his decision to invest in Mako was influenced by his own enquiries into the business. On this point, Mr Banks said during cross-examination:
“I will repeat myself. I looked at Mako, its competitors and IT companies that wanted investment. I saw lots of information being presented to the public, some of it was bad and none of this included such a list. And I thought, ‘Well, I see an absence in the marketplace, wouldn’t it be a good idea if a business actually had something clear like this’ and I thought I would give this business the benefit of my very unprofessional advice.”
[656]Later in this evidence, Mr Banks said:
“Before the Mako opportunity presented to myself, I wouldn’t say I was shopping around for investments. What I can definitely say is once it presented itself I thought, “Mhm, this looks interesting”. But I did what I always do, or would say at least 99% of cases, I researched it and associated matters. I like to have a holistic picture of the world. So, in the, sure, in the years in which I was an investor of Mako I read about it. I read about IT security in general, its competitors, its customers and so on. So it’s certainly
safe to say that I read about associated matters, but definitely what you said. I was not shopping around for other investments when Mako came along.”
[657] Finally, there is little or no evidence that Mr Banks was, at the time he entered Agreement 1, looking for an investment with the potential for realising massive gains. This is apparent from his repeated references to the loan being an investment and that projected profits estimated in the tens of millions were not material to his decision or assessment of Mako’s ability to repay him.
[658] I am easily satisfied that the optimistic projections contained in the PPM, read in conjunction with its extensive reservations, represented the reasonably held and honest views of the directors at and about that time.
[659] For the above reasons I am not satisfied that the representations made prior to Agreement 1 were misleading or deceptive and led to or caused Mr Banks’ loss.
Representations prior to Agreement 2
[660] The representations falling into this subcategory concern whether the “good news” Mr Banks was given regarding Mako’s financial position prior to entering Agreement 2, and the representations and omissions concerning the likelihood of an IPO amounted to misleading and deceptive conduct.
[661] The “good news” Mr Banks referred to consists of emails from Mr Farmer where he remarked positively on Mako’s business,179 progress with capital raising,180 meetings he was attending,181 events he had attended,182 and investments or contracts which were being finalised or confirmed.183
[662] Mr Banks asserted in evidence that after two years of good news from Mr Farmer he agreed to lend more money to Mako. However, the documentary record contradicts that claim. It was, in fact, Mr Banks who initiated the steps which led him
179 Representations 11, 16 and 19. Representation 19 is not as described in the pleadings, with the email referring to Mako as having a “great week”.
180 Representation 9.
181 Representation 16.
182 Representation 13.
183 Representation 13.
to advance the funds under Agreement 2. He approached Mr Farmer by email on 2 March 2013:
“How are things with Mako? In very roughly four weeks I’ll have about
£234k become available in the UK. I was wondering if Mako needed to borrow any more. I’d be happy to have you create a new tranche with the same terms as the others except the time periods, which we can discuss.”
[663] In cross-examination, Mr Banks said he had no recollection of this particular communication, although he accepted that these things were being talked about.
[664] Even if Mr Farmer’s representations had inspired Mr Banks to initiate a second investment, I consider the representations to be honestly and reasonably held opinions. Mr Farmer was reporting on Mako’s business as he then knew and experienced it. The emails in question shared Mako’s successes, informing Mr Banks of the outcomes of different negotiations, and of the meetings Mr Farmer was attending on Mako’s behalf. Having examined the emails, I find that on both an individual and collective level they are simply statements of fact (such as when Mr Farmer announced Mako “had a great finish to the year end with 3 significant contracts confirmed”)184 or convey Mr Farmer’s opinion of Mako’s business at that point (such as when Mr Farmer wrote “great week this week with the team refining our strategy…”)185.
[665] Mr Johnson also submits that there was a failure to inform Mr Banks that the security terms under Agreement 1 and the soon to be signed Agreement 2 were to be breached. I have already addressed the circumstances surrounding this at [514]-[516]. There I found that although there was an inadvertent breach, Mr Banks would likely have waived his rights had he been given the opportunity to do so.
[666] The other set of representations relevant to Agreement 2 relate to the possibility of a future IPO. Mr Johnson places considerable emphasis on these representations. He submits there were multiple representations that an IPO was likely when patently it was not. Agreement 2 expressly contained this representation when it stated that Mako had “initiated a further capitisation (sic) programme” and was likely to list on the NZX. Mr Johnson says there was no reasonable foundation as at
184 Representation 13, email dated 13 January 2012.
185 Representation 19.
30 June 2013 to make such a representation given the implications of the Telecom Rentals debt, the unlikelihood of Telecom Rentals agreeing to convert their debt to equity, and the consequences of restating the accounts.
[667] I cannot agree that any of these representations were misleading or deceptive. Prior to Agreement 2, the only professional advice Mako had received about a possible NZX listing was from Cameron Partners. The Weldon Report would not be received until 7 October 2013, some four months after Agreement 2 was concluded and even it did not refer to an IPO. Agreement 2 made express reference to Cameron Partners’ strong recommendation that any debt on the balance sheet should be removed. This was an appropriate disclosure made on the face of the lending document itself. Significantly, Cameron Partners had never suggested to the directors of Mako that an IPO was an unattainable or unrealistic ambition. Indeed, in its report to Mako, Cameron Partners set out a number of strategic proposals which could be implemented to achieve a successful listing. They would not have done that had they believed this was a forlorn or deluded aspiration. Furthermore, Deloitte were only engaged to audit Mako’s accounts on 30 June 2013. The later restatement of accounts was not in contemplation at any earlier point. The directors had taken advice from Duns Accounts Ltd as to their financial position prior to the audit and acted in good faith in reliance on that advice. As Mako’s auditors, Deloitte determined the treatment of sales required a re-characterisation and a restatement of the accounts. I do not detect any sinister implications attributable to the conduct of the directors.
[668] Thus, it follows I am satisfied that there were no material representations made by Mr Farmer which were misleading or deceptive relative to Agreement 2.
Representations prior to Agreement 3
[669] The alleged misrepresentations relating to this period also concern the possibility of an IPO186 and Mako’s financial position.
[670] Mr Johnson submits the position in relation to Agreement 3 “could almost be described as cynical”. He suggests a failure to disclose critical information about
186 Representations 26, 27, 28, 33 and 34.
Mako’s prospects meant Mr Banks was fundamentally misled before he made his final investment. Mr Johnson submits Mr Farmer could not have held a reasonable belief at that point that an IPO was a possibility given Mako’s parlous financial state at the time.
[671] In the period between 15 May 2013 and 24 April 2014, Mr Farmer made representations as to Mako’s finances and the contracts it had in the pipeline. He advised Mr Banks of the completion of the contract with Bullseye in the United States,187 and announced the Telstra deal.188 Both of these events were true and based on Mr Farmer’s honest and reasonable belief at the time. The deals continued to progress as revealed in the September 2013 Board minutes. Mr Gamble provided updates, describing the Bullseye sales opportunities as “very positive” with the first two proposals underway and the first order of 104 units expected. He also commented on the finalisation of the Telstra contract, noting there was potential for Telstra to be a “node operator”, which would have had favourable cashflow benefits for Mako. The fact these opportunities remained alive months after the representation goes to Mr Farmer’s honest and reasonably held opinion at the relevant time.
[672] Mr Johnson also submits the directors failed to advise Mr Banks of the collapse of the Sprint deal. Four days prior to Mr Banks’ transfer of funds under Agreement 3 Mr Gamble received news from Mr Callender at Sprint that the deal was unlikely to proceed in the form earlier proposed. Mr Farmer and Mr Gamble described this change in stance by Sprint as occurring “for no apparent reason”. Neither considered it represented a complete or terminal collapse in the negotiations or the reasonable prospect of achieving a successful conclusion to the deal.
[673] Earlier, beginning at [427], I discussed the chronology around the Sprint deal and its collapse. I determined that until 26 April 2014 at the earliest, the directors had a reasonable belief that the Sprint deal would result in binding contracts.189 I consider this finding is supported by the fact Mr Farmer did not tell Mr Banks to hold off on transferring funds, as he had previously done in late 2013 and early 2014 when the
187 Representation 22.
188 Representation 34.
189 At [435] of this judgment.
Telecom Rentals negotiations were in train. On that occasion Mr Farmer made it plain to Mr Banks that an investment at that time was too uncertain and risky. Mr Farmer’s failure to adopt a similar approach relative to the Sprint deal serves only to emphasise that the directors at that time still honestly believed the agreement with Sprint was salvageable and were working towards achieving that. Mr Gamble was looking into alternative financers for Sprint, and a meeting with Mr Nasser was imminent.
[674] Mr Johnson submits the directors failed to advise Mr Banks of updates to Mako’s financial situation as professional advice was received, and what that meant for a potential IPO. By this time the Weldon Report had been published, Deloitte had advised of the restatement of accounts and Telecom Rentals had cemented its position against equitising. For these reasons, Mr Johnson submits, the defendants were well aware of the combination of factors which made an IPO all but unattainable.
[675] Mr Johnson also submits Mr Banks was not informed of these updates. However, that is not strictly correct on the evidence. Mr Farmer’s evidence is that the Weldon Report was tabled at the 8 October 2013 shareholders AGM meeting. Mr Weldon attended in person. This was an important meeting to which Mr Banks had been invited. Mr Banks did not attend. Mr Farmer’s evidence is that at a meeting with Mr Banks at Occam Café on 29 November 2013,190 he told Mr Banks about the challenges Mako was facing with Telecom Rentals and its deteriorating financial position. Mr Banks said he had no recollection of this conversation. The meeting was followed by Mr Farmer emailing Mr Banks and advising him to hold off on any advances and that he would make contact again when it was “all clear to do the same”. Nonetheless, Mr Banks accepted he was made aware of the situation with Telecom Rentals via emails in January and February 2014. I have earlier discussed and set out the relevant correspondence. Mr Banks also received the shareholder update and the attached draft special resolution on 5 February 2014. Furthermore, in an email to Mr Farmer, Mr Banks referred back to the resolution, commenting on his disappointment that Mako had “panic” sold the SecureME business to Telecom Rentals. In my view it is inconceivable that Mr Banks was not fully aware of Mako’s
190 Representation 29.
situation before he made his last advance, although I do accept that he still believed an IPO was possible.
[676] Regardless, I am satisfied that even if any such representation or omission as to the potential of an IPO was misleading or deceptive, it did not cause Mr Banks any recoverable loss that would warrant relief under s 43. Mr Banks’ evidence was that the prospect of an IPO did not cause him to enter either Agreement 2 or Agreement 3. This is evident from an answer that he offered in cross-examination:
“…but you mention the IPO, yes, of course, that was on my mind as well. When making investments 2 and 3 I had in my mind the possibility of an IPO, that certainly motivated me but it was never more than a bonus, given how complex IPOs are no one can guarantee when they are going to happen. I never banked on that happening. It was just, it was a nice addition to the positive story that I (inaudible) had every year.”
[677] Relief under s 43 requires that the claimant has suffered, or is likely to suffer, loss or damage by misleading or deceptive conduct of the defendant. Mr Banks’ claim therefore must fail; there is no causative nexus between the alleged representations or omissions and his loss. He would have advanced the funds regardless of those representations or omissions.
Liability of the other directors and relief
[678] Considering my findings that Mr Farmer is not liable under s 9 of the FTA, there is no need to consider the secondary liability of the other directors under s 43.
SUMMARY OF CONCLUSIONS
[679]In conclusion and by way of summary, I have determined:
(a)First cause of action
[680] On the first cause of action under s 37 of the Securities Act, I am satisfied that in respect of all three Agreements there was no offer to the public. As a consequence, none of the defendants are liable, and relief under s 37(6) of the Securities Act is not available to Mr Banks.
(b)Third cause of action
[681] On the third cause of action, that is breach of directors’ duties under Part 8 of the Companies Act:
(a)in respect of s 135 of the Companies Act (reckless trading), I am satisfied that although there was a breach of this duty, it was not causative of any loss suffered by Mr Banks;
(b)in respect of s 136 (improperly incurring obligations), I am not satisfied that any of the defendants breached this duty in respect of any of the Agreements. Accordingly, no relief is available to Mr Banks; and
(c)in respect of s 137 (duty to exercise skill and care), I am satisfied that although there was a breach of its duty, it was not causative of any loss suffered by Mr Banks.
[682] In any event, I conclude that relief by way of compensation under s 301 of the Companies Act would not be available to Mr Banks because Mako was not in the course of liquidation and in the circumstances of this case, s 301 does not permit Mr Banks to be personally compensated for any breach of the directors’ duties.
[683]No banning order is made under s 383 of the Companies Act.
(c)Second and fourth cause of action
[684]Given my finding in respect of the first cause of action:
(a)in respect of s 55G of the Securities Act, I am satisfied that this section is not engaged because Mr Banks did not subscribe for any security; and
(b)in respect of s 9 of the FTA, I am satisfied that neither Mr Farmer, nor any of the other defendants is liable because the pleaded representations (or omissions) were not misleading and/or deceptive conduct and, in any event, no representation caused Mr Banks any loss.
[685]Accordingly, judgment is entered in favour of the defendants.
COSTS
[686] The defendants, as the successful parties, are entitled to costs. I invite counsel to confer with a view to reaching agreement on the question of costs. In the event of no such agreement, I direct that the parties file memoranda, not exceeding 10 pages (excluding appendices) no later than 5:00 pm on Friday, 10 September 2021 and I shall determine the issue of costs on the papers.
Moore J
Solicitors:
Mr Johnson, Auckland Mr Porter, Auckland
Mr Hollyman QC, Auckland Mr Steel, Auckland
Copy to:
Second, Third and Fourth Defendants
Appendix 1
Mr Farmer’s representations to Mr Banks included (without limitation):
1Providing Mr Banks with the PPM dated November 2010.
2An email on 22 December 2010 reporting that according to the PPM:
(a)Mako's financial performance from 2007 to 2010 was acceptable; and
(b)Mako was projected to have a pre-tax net profit of $8 million in 2012 and tens of millions in 2013, 2014 and 2015.
3An email on 15 January 2011 intimating that the cash flow of Mako is more important than salaries of shareholder employees.
4A phone call on 27 January 2011 that about $4.5 million had been committed by prospective investors to Mako.
5A meeting at Mr Farmer's house on 27 January 2011 where Mr Farmer, his wife Jenny, Mr Banks and Mr Banks’ friend Isabel were present, Mr Farmer represented that:
(a)Mako was liquid and would remain that way. He could not guarantee in writing that employees will be paid less in case of future illiquidity but assured Mr Banks that keeping the company liquid was more important than keeping people employed. If there were liquidity problems in the future the employees would probably be asked to take their money later; if they refused they would have to be fired;
(b)during the decade that the Mako group had existed it had never failed its obligations to its creditors with the exception of a few cases where creditors had to wait one – three months (one month being more usual) to be paid;
(c)the Plaintiff could expect Mr Farmer to continue to take those obligations seriously; and
(d)Mako was Mr Farmer's most significant project and he was dedicated to ensuring its success.
6An email on 3 February 2011 regarding Mako's expansion initiative into the United States that it was raising money for.
7An email on 3 February 2011 stating that Mako would close off Mr Banks’ loan at $4.73 million, it was in discussions with another significant investor for a further $5 million investment and that further investment opportunities would increase the company's value by tens of millions of dollars.
8An email on 4 February 2011 from Mr Farmer to Mr Banks asking him to keep Mako’s business strategies to himself because Mako’s product was considered a disruptor in the market.
9An email on 3 March 2011 intimating that Mako's PPM had seen applications for $4.35 million and expressions of interest from three further investors in excess of $5 million each.
10A phone call on 9 March 2011 stating that business was good and customers (including telecommunications customers) were happy.
11An email on 31 May 2011 that stated "Business is going particularly well for Mako currently and the prospects look encouraging from our initiatives into new markets".
12The parties had a meeting at Mr Banks’ home on 13 June 2011 where Mr Farmer stated:
(a)Mako was doing well and there were plenty of interested customers;
(b)he was unlike those who take investment monies from others without being fully committed to the business in question;
(c)Mr Banks could rely on the figures and representations in the PPM and that the clauses in it which excluded reliance only applied to Mako’s earlier capital raising efforts which finished on 30 November 2010;
(d)in relation to page three of the PPM:
(1)he was happy to accept money from any member of the public as long as the amount was large enough to be worth his time. This followed Mr Banks questioning Mr Farmer about the first section on page three relating to "qualified investors", which Mr Banks said to Mr Farmer he did not believe himself to be;
(2)that it was not a problem that Mr Banks was not interested in buying shares and that he was more interested in lending money;
(3)Mr Banks could ignore the "No Authorisation" section and that Mr Farmer's representations could be relied upon;
(4)clauses like the “No Authorisation” section are not always applicable to every investor but are always required by lawyers to be included in such documents; and
(5)Mr Banks could be assured that he was the right kind of investor and everything was being done appropriately.
13Emails on 29 June 2011, 13 January 2012, 27 February 2012 and 15 March 2012 intimating to Mr Banks that business activity was strong for Mako.
14A meeting at Kokako cafe in Grey Lynn on 20 June 2012 where Mr Farmer reported that Mako was going well.
15A meeting at SPQR restaurant in Ponsonby on 8 August 2012 stating:
(a)the business was going well; and
(b)Mr Banks and Mr Farmer both agreed that they disliked business people who do not fulfil their obligations.
16Emails on 26 November 2012, 4 March 2013 and 6 March 2013 intimating that Mako's business activity was high and encouraging.
17A meeting at Kokako café on 30 November 2012 where Mr Farmer said that there were many barriers to a NZ listing. A NZ listing was expected to occur in 2013 and Mr Farmer expected enough interest to allow him to reward employees and investors like Mr Banks with shares. Mako could raise $250 million and a Nasdaq listing may occur after about 5 years.
18A meeting at Café People, Grey Lynn on 8 March 2013 where Mr Farmer intimated:
(a)there were many parties interested in Mako including the company that handled Xero's IPO;
(b)that company would handle Mako's IPO;
(c)there would be a NZ and probably a Nasdaq listing;
(d)Mako was very likely to grow to over ten times its size over a period of 7 years;
(e)Mr Farmer wished to make Mako NZ's largest company; and
(f)Mako had many current and interested customers, and during the next 12 months was going to receive in the order of $100 million from customers and investors.
19An email on 5 April 2013 intimating that other investors were interested in Mako.
20An email on 13 April 2013 stating "As always I am most concerned with fairness for all parties so you (as always) can be assured of my objective consideration".
21A meeting on 26 April 2013 at Kokako café where Mr Farmer talked about sales pitches made by him and his staff to potential customers and intimated that business was strong and that he could be relied upon as a source of information.
22An email on 24 June 2013 stating "Last week we completed a contract with Bullseye Telecom in the US and they already have their first customers lined up. We also got the first full version of a product supply agreement with Sprint. They too have their first customers lined up".
23A meeting at Pescado restaurant, Wynyard Quarter on 17 September 2013 where Mr Farmer reported that business was great.
An email on 23 September 2013 stating, "I have all our best interests at heart".
25A meeting at Café People, Grey Lynn on 23 October 2013 where Mr Farmer reported that:
(a)NZ investors were showing a lot of interest and that he wanted an American investor to impress them;
(b)Mr Banks’ investment was going to be worth a lot in a few years' time;
(c)Mr Banks was able to buy shares at that time but would be better off by 20-50% if he waited until listing (estimated to occur March - April 2014).
26An email on 5 November 2013 reporting that:
(a)Mako had secured a lot of business with Sprint (a large United States business);
(b)"Sprint’s U.S. business customer base offers a significant growth opportunity for Mako";
(c)"Mako’s technology is leading the way in secure, PCI-compliant networking for the distributed enterprise. (Mako's) business customers will appreciate the ease of use and powerful connectivity options the Mako System provides".
27Emails on 12 November 2013 and 18 November 2013 reporting that there was a significant amount of business for Mako to capitalise on.
28An email on 18 November 2013 stating "With the opportunities building in Oz 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".
29A meeting at Occam café in Grey Lynn on 29 November 2013 where Mr Farmer reported that:
(a)the latest capital raising proposal involves $5 million and that Mr Farmer would contribute $250,000 - $300,000;
(b)Mako had been valued by multiple parties with the range being from
$26 - $256 million; and
(c)Mr Farmer did not "bullshit people".
30A meeting at Occam café on 4 March 2014, Grey Lynn where Mr Farmer reported that he might be able to sell Mako for USD 150 million and was open to the idea of continuing to grow Mako while considering purchasers. Mr Farmer was not enthusiastic about selling a portion of Mako because of various problems including the likelihood of it being a venture capital arrangement.
31An email on 16 March 2014 where Mr Farmer stated he was working to get "the best arrangement that is available" for Mr Banks.
32A meeting at Café People, Grey Lynn on 26 March 2014 where Mr Farmer reported that the next capital raising effort would probably seek around $100 million.
33An email on 2 April 2014 reporting that $700,000 of investment money was committed to Mako from a shareholder.
34An email on 24 April 2014 informing Mr Banks that Mako was "able to finally announce the Telstra deal".
35An email on 25 August 2014 reporting that there was strong interest from Mako's customers.
36An email on 2 September 2014 that Mr Farmer's objectives were 'totally aligned' with those of Mr Banks.
37A meeting at Toru restaurant, Ponsonby on 3 September 2014 where Mr Farmer reported that:
(a)the Sprint deal was the largest Mako had ever been presented with and that Mako needed working capital to handle the deal;
(b)in response to Mr Banks’ queries regarding directors being paid less and taking their pay later that Mako's expenses were being handled well and that everything that could be done to reduce expenses, especially directors' salaries, had been done or was being done.
38Mr Farmer was selling his house and would use the proceeds to support Mako to raise capital.
39An email on 10 September 2014 that the Lotto deal with Telecom was all but closed.
40An email to Mr Banks on 16 September 2014 that he could expect to soon receive an information pack regarding the Sprint deal (pack was never received by Mr Banks).
41Emails on 18 September 2014 in response to Mr Banks’ query about what to tell other potential investors stating:
(a)"If you are OK with working with the Customer names i.e. Chevron, BullsEye, Sprint, FedEx and the sales pipeline being rebuilt of close to
$2.1b in total that would be best. We are really looking for an equity investor who should expect a 3-5 times return over 4 years if we execute well and either list or sell"; and
(b)"Sales pipeline of $2.1b. Expect revenue of $150m 3-4 years out".
42An email on 21 October 2014 reporting that three capital raising options were progressing.
43An email on 20 October 2014 from Mr Farmer stating "I am...working through acceptable investment arrangements out of the US and think I am close to a deal that is going to work for everyone both short and long term".
44A meeting at Mr Banks’ home on 7 November 2014 where Mr Farmer intimated that:
(a)Mako was valuable and had been for years;
(b)D&S (a company) were interested in a merger based on net values of each company of USD 50 million and that this may happen in December 2014; and
(c)since April 2011 all people investing in Mako had done so at a valuation of greater than $50 million.
45A meeting at the home of the mediator on 21 November 2014. At the meeting Mr Farmer reported that Mako was considered by investors that had recently spoken to him to be worth in the order of $100 million.
46In a conversation on 21 November 2014 outside the mediator’s home following the meeting Mr Banks questioned why Mr Farmer was so eager to equitize the investment because if the representations were true Mr Farmer should want to keep as many shares as possible as the expected return was much higher than the 10% p.a. of Mr Banks’ debt. Mr Farmer responded that he wanted to compensate Mr Banks for his loyalty by making him a shareholder, thus giving him access to much greater returns.
47An email on 17 December 2014 stating "there has not at any point in time been a cessation of capital raising initiatives and there is still a strong option being pursued to list on the New Zealand stock exchange amongst other alternatives...the listing along with all other capital raising initiatives are still a reality".
48An email on 12 January 2015 stating "As most of my summer break has been taken up supporting the US sales initiative I am hopeful of an announcement within days that will give us all reason for cheer in starting 2015".
49An email on 20 January 2015 stating "We have had a lot of positive feedback from the current sales prospects in the States and expect a wider announcement in 10 odd days".
50An email on 8 February 2015 stating "at the moment I am expecting to be in the (US) to finalise our latest win, that being the award of the BP fuel site business we have been chasing for the past year".
51An email on 11 March 2015 stating "The situation is significantly improved from our position late last year. Arrangements for an IPO are being resurrected as discussed. I have engaged with some investment bankers and expect to have a plan to take to Telecom (Spark) for consideration by the end of April. At this point in time they are not aware of the current initiative (although they know we are working on various capital raising options) but I expect them to respond favourably once we have consolidated our plans. Arrangements that Mako have in place with our US distribution partners should ensure short term cash requirements are met whilst we finalise plans going forward. Once the large contract rollouts begin this position will be further reinforced".
52An email on 22 March 2015 reporting that:
(a)Mr Farmer was working to improve the balance sheet; and
(b)the solvency situation was fine.
53An email on 11 June 2015 stating "we received confirmation that the final elements being negotiated with BP for the preferential supply of BYOB services in the US have been agreed. We expect to complete the contract in short order and have everybody ready for an immediate customer acquisition initiative".
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