Bannock v Monaco Management Limited
[2017] NZHC 1575
•7 July 2017
IN THE HIGH COURT OF NEW ZEALAND CHRISTCHURCH REGISTRY
CIV-2013-409-001701 [2017] NZHC 1575
BETWEEN MICHAEL WILLIAM BANNOCK AND
ANNE MARGARET BANNOCK AND OXFORD STREET TRUSTEES (2010) LIMITED & ORS
Plaintiffs
AND
MONACO MANAGEMENT LIMITED First Defendant
AND
MONACO VILLAGE LIMITED (IN LIQUIDATION AND RECEIVERSHIP) Second Defendant
AND
SCOTT PATRICK SANDERS Third Defendant
AND
FINANCIAL MARKETS AUTHORITY Non Party
Hearing: 8 May 2017 Appearances:
P G Skelton QC for Plaintiffs
D J Goddard QC and L Theron for First and Third Defendants
No appearance for Second Defendant
K S Graham for Non PartyJudgment:
7 July 2017
JUDGMENT OF DUNNINGHAM J
Introduction
[1] In a judgment which issued on 28 November 2016, I held that the offer of units for sale in the Monaco Resort in Nelson, which were subject to a lease known as the “Cottage Lease”, was an offer of a participatory security. Because the offer was not accompanied by a registered prospectus, it was invalid under the
Securities Act 1978 (the Act). Mr Sanders, as a director of the issuer, the second
BANNOCK v MONACO MANAGEMENT LIMITED [2017] NZHC 1575 [7 July 2017]
defendant, was therefore liable under s 37(6) of the Act to repay subscriptions to certain plaintiffs who had bought units from the second defendant.
[2] At the conclusion of the judgment I reserved leave for any party to seek any consequential orders on my findings, including relief orders. Mr Sanders now seeks an order under s 37AH of the Act granting relief from the application of s 37 to the subscriptions made by the successful plaintiffs, on the following grounds:
(a) He was not involved in the original design of the arrangement which was put in place on the advice of two sets of lawyers, and which the Securities Commission treated as an alternative approach that was compliant with the Act;
(b)The Securities Commission’s view through the relevant period was that an unpooled arrangement did not engage securities legislation or policy concerns;
(c) In these circumstances, it was not reasonable to expect Mr Sanders to revisit whether the unpooled arrangements complied with the Act. He acted in good faith, on the basis of a belief that was shared by the former owners, their lawyers and bankers, and by the Securities Commission;
(d)There is no material prejudice to the plaintiffs in circumstances where the purchasers have received title to their units and to a registered lease, and where any further disclosure that might have been required was not likely to affect purchase decisions, especially given the access that purchasers had to legal advice about the nature of the assets they were purchasing and the agreements they were entering into;
(e) Where plaintiffs were offered the security outside New Zealand, relief should be granted in any event, because the Act is only intended to protect offers made to the public in New Zealand, except in specified circumstances.
[3] The plaintiffs, however, say that s 37AH is only intended to afford relief where there has been a minor or technical breach of the Act and where, unless relief is granted, the consequences would be out of all proportion to the wrong. In this case, Mr Sanders is not entitled to relief because:
(a) he has no standing to apply for such an order;
(b)the breaches in this case are of the most serious kind, amounting to a total disregard of the disclosure obligations imposed by the Act;
(c) the breaches meant that investors lacked the information they needed to make an informed decision to invest, and the plaintiffs have suffered financially as a result of investing;
(d) his conduct does not justify relief.
[4] The key issue for determination is whether relief from the obligation to repay subscription monies with interest, to the 11 plaintiffs who were successful, should be afforded. This relief is only sought for the benefit of the third defendant as no order was made against the first defendant, and the second defendant is in liquidation and receivership, and has no capacity to meet its liability in any event.
[5] An associated application was made by the unsuccessful plaintiffs for an order under s 37AC which was not opposed, and my order in relation to that is also recorded in this judgment.
Background to application
[6] The circumstances which gave rise to my finding that the offer of units with Cottage Leases were offers of a participatory security as defined by the Act, were outlined in full in the substantive judgment.1 However, in summary, two entrepreneurs, Mr Gepp and Mr Duke, incorporated a company to develop a conference and accommodation complex on the Monaco Peninsula in Nelson. The
facilities were developed in stages and, as each accommodation block commenced construction, the accommodation units were offered for sale to individual investors.
[7] The units were sold subject to a registered lease which required the purchaser of the units to lease the units back to a separate management company which managed the resort and made the units available to guests of the resort. The terms of the lease which was initially used provided that the unit owners received a specified share of the pooled income for all the hotel units after deduction of costs (the Hotel Lease).
[8] By mid-2004, most of the units in the first stage of the development, the hotel, had been sold. However, the resort then ran into financial problems. In addition, the project’s funder, Westpac Bank, raised concerns about compliance with the Act with the developers. The bank thought it likely that the pooling of income earned from each hotel unit required by the Hotel Lease breached the Act. It imposed conditions on its continued funding of the resort which required the developers to approach the Securities Commission and seek an exemption from the Act and, in the interim, to adopt an individual accounting structure for the leases of the accommodation. To meet the second part of this requirement, the developers no longer sold units using the original management lease, the Hotel Lease, and instead adopted a lease which did not pool each unit holder’s income with the income from other units in that complex (the Cottage Lease). From that point on, all the tourist accommodation units were sold with a registered Cottage Lease.
[9] The approach to the Securities Commission resulted in an exemption being granted for “specified participatory securities”, which the plaintiffs say were the units sold subject to the Hotel Lease.2
[10] Mr Sanders became involved in the development around this time. However, differences between him and Mr Gepp over how to get the project back on track financially led to a breakdown of that relationship, and Mr Gepp agreed to end his involvement with the resort. Mr Sanders then incorporated Monaco Village Limited (MVL) to continue developing the resort, and Monaco Management Limited (MML)
to take over the management of the units under the lease. In August 2006 the project was transferred from Mr Gepp’s companies to MML and MVL, the first and second defendants.
[11] Although an exemption notice had been granted by the Securities Commission, the terms of that notice were not complied with. Instead, MVL continued to use the Cottage Lease for the sale of units in subsequent stages of the development. This was because there was an assumption by the defendants that the individual accounting system used in the Cottage Lease meant it would not be treated as a participatory security under the Act.
[12] The real issue though, from the plaintiffs’ perspective, is that throughout the time they have owned their units, the income that they have received from them has not matched the promises made at the time of purchase. Indeed, because the management lease requires the investor to meet the outgoings of the accommodation business, and these have exceeded the rental income, most of the owners have been paying to keep the accommodation business afloat. Consequently, the value of the units has also fallen dramatically, and they have proved impossible to sell at anywhere near their purchase price.
[13] Eventually, dissatisfaction with this state of affairs, and with the plaintiffs’ inability to extract themselves from this unsatisfactory arrangement, resulted in the current proceedings being brought. In the proceedings they asserted that even under the Cottage Lease, the arrangement was a participatory security as defined in the Act, and MVL, as issuer, was liable under s 37 of the Act to make repayment of their subscription money, plus interest. In addition, Mr Sanders, as a director of the issuer, was jointly and severally liable to make repayment of the subscription money and could not avail himself of the exception to that liability provided in s 37(6).
[14] The practical effect of that finding is that Mr Sanders is liable to repay a sum of around $7,000,000 to 11 of the plaintiffs, albeit that it is on condition that the units are transferred back to him. He applies for relief from the invalidity that gives rise to that obligation, under s 37AH of the Act.
Legal principles
[15] Section 37AH provides:
37AH When court may make relief order in respect of section 37
(1) The court may in the course of any proceedings, or on the application of the issuer under this section, make a relief order in respect of the application of section 37 to the allotment of a security if the court considers that it is just and equitable to do so.
(2) An order may be made under this section regardless of whether the contravention of section 37 occurred before or after this section comes into force.
(3) In determining whether to make a relief order under this section, the court must have regard to–
(a) all of the circumstances relating to the allotment of the security; and
(b) the nature and seriousness of the contravention of section 37;
and
(c) whether the contravention has materially prejudiced the interests of the subscriber; and
(d) whether the subscriber has disposed of the security to any other person; and
(e) any other matters that the court thinks fit.
(4) An application under this section may be made in conjunction with an application under section 37AC or section 37AI.
[16] This section confers a discretion on the Court to take account of all relevant factors and come to a view on whether it is just and equitable to validate the allotment of a security, thereby relieving the issuer from the obligation to repay subscriptions, despite a breach of the Act. In determining whether to grant relief the Court must have regard to the specific matters set out at s 37AH(3)(a)-(d) but also to “any other matters that the Court thinks fit”. In that regard, the third defendant says that it is relevant to consider whether the breach offends the policy of Part 2 of the Act and the plaintiffs say that it is relevant to consider the wider conduct of the
parties and whether granting relief would be in the public interest.3
3 Henderson Global Funds v Securities Commission (2009) 10 NZCLC 264,477 (HC) at [122]- [123].
[17] The parties inevitably place emphasis on different considerations to support their respective views on whether relief should be granted. I deal with each of these in turn.
Does the third defendant lack standing?
Submissions
[18] As a preliminary issue, Mr Skelton QC says that the third defendant lacks standing to seek relief. Section 37AH(1) allows the Court to grant relief “on the application of an issuer under this section”. In the plaintiffs’ submission, Mr Sanders is not an issuer. MVL is the issuer of the securities in question and is therefore the only party with standing to seek relief under s 37AH.
[19] Mr Sanders’ liability arises derivatively as a result of his directorship of MVL. The plaintiffs submit there is no provision in s 37AH for a director to seek relief on his own account as the Court cannot relieve a director of his or her derivative liability without also relieving the issuer of its primary liability. The relief provisions are simply not designed to provide individual relief to a director. Instead, the Act provides directors with the statutory defence under s 37(6) if they can establish there was no misconduct or negligence on their part. At trial, Mr Sanders was unable to satisfy the Court he had met that standard. Furthermore, the plaintiffs say, this is not a case where the Court should exercise its own motion jurisdiction to grant relief after judgment has been delivered. The own motion jurisdiction only arises during the course of the proceeding, not after judgment. In any event, it would not be just and equitable to make a relief order in this case.
[20] In response, Mr Goddard QC simply says that there are two routes to making a relief order as set out in s 37AH(1): on the application of the issuer, or by the Court “in the course of the proceedings”. In relation to the first option, there is no conceivable policy rationale to exclude a director of an issuer from making such an application. If he is to be fixed with liability, then equally he should not be precluded from seeking relief from the application of s 37. Alternatively, it is not too late to ask the Court to consider making an order because the proceeding is still on foot. In my 28 November 2016 judgment I expressly reserved a range of issues, and
these included relief orders, and so the order is sought “in the course of any
proceedings”.
Discussion
[21] The circumstances in this case are somewhat unusual, in that the issuer, MVL, is in liquidation and has no assets to meet the obligation to repay subscription monies plus interest. That means the only party practically affected by my decision is the director, Mr Sanders. While, technically, the issuer could make the application for relief, it has not participated in these proceedings and is not in a position to do so. I consider it would be artificial to suggest that the third defendant has no standing to apply for relief, simply because the issuer has not done so.
[22] However, in any event, the order for relief is sought in the course of the proceedings and, under s 37AH(1), I can consider and make a relief order if I find that it is just and equitable to do so. I do not consider that the fact Mr Sanders has initiated consideration of this issue alters the position or is a barrier to relief being granted.
[23] Accordingly, I determine there is no jurisdictional barrier to considering the application for relief under s 37AH(1).
Nature and seriousness of the breach
Submissions
[24] In considering an application for relief, the first matter to have regard to is the nature and seriousness of the breach. The relief provisions are, in part, designed to prevent the harsh consequences of s 37(4) to s 37(6) from applying to minor or technical breaches of s 37 that have caused no real prejudice to the investor. As Gendall J observed in Re Perpetual Investment Management Ltd (Perpetual
Investment):4
4 Re Perpetual Investment Management Ltd (2006) 9 NZCLC 264,207 (HC) at [14].
The Court must be mindful of the purpose of the legislation. If there are purely technical breaches such as late filing of documents and no cogent reasons given by an objector as to how his or her interests have been “materially prejudiced” by such technical contravention, then it is obvious that the purpose of the legislation was to ensure that relief be granted.
[25] The plaintiffs submit that the breach in this case is not simply technical; it involves a substantive failure to disclose the information prescribed by the Act. It meant that the policy of the Act, which is to protect the investing public by requiring that issuers give investors the information they need to make informed investment decisions, has been undermined and the breach is therefore serious.
[26] To illustrate the strict standards that the Court applies when assessing the seriousness of a breach, the plaintiffs refer to Henderson Global Funds v Securities Commission.5 In that case, two English investment companies and their local agent, AMP Capital, relied on notices exempting them from having to issue a New Zealand prospectus. Information disclosure was instead to be achieved by providing investors with an investment statement and lodging a United Kingdom prospectus
with the New Zealand Registrar of Companies. The companies had breached the terms of the exemption notices on occasion by not lodging prospectuses on time. While on its face, this was not a serious breach, the Court declined to grant relief on the basis that it was not clear that investors had in fact been provided with investment statements. The Court concluded it could not be sure the breaches were merely technical and that the substantive disclosure obligations had been complied with, and therefore it was not just and equitable to grant relief.
[27] In this case, the plaintiffs say that the second defendant breached s 37(1) of the Act by failing to register a prospectus for the Cottage Lease investments, and also by failing to comply with the requirements of s 37(3). This was not the result of a simple oversight or error. Rather, a prospectus was never prepared, let alone provided to investors, and this was a serious and substantive breach of the Act’s disclosure regime.
[28] Had a prospectus been registered, it would have included financial statements, feasibility studies, disclosure of any risks an ordinary investor might not
5 Henderson Global Funds v Securities Commission, above n 3, at 477.
anticipate, projected cashflows and the assumptions on which those projections were based, full disclosure of the promoters’ and managers’ interests in the scheme, a description and quantification of all liabilities (including potential and contingent liabilities an investor might incur) and a report by a qualified auditor. Any references to expected earnings or rates of returns, such as those provided by the second and third defendants when promoting the Cottage Lease investments, would need to be accompanied by information showing the method of calculation used.
[29] Alternatively, the plaintiffs say the second defendant could have avoided these obligations by complying with the 2005 Exemption Notice issued by the Securities Commission6 or by seeking a fresh exemption which would in all likelihood have been on the same or similar terms. That exemption required investors to be given a range of information set out in Schedule 1 of the notice, plus a report from an independent registered valuer, and that would have provided
disclosure of a similar nature to that required in a registered prospectus.
[30] In this case, the second defendant chose to do neither, which the plaintiffs submit amounts to a very serious breach of s 37. It goes to the heart of the Act’s policy of protecting investors through information disclosure.
[31] The third defendant does not suggest the breach is trivial or technical. Rather his response is that in all the circumstances no material prejudice arose, so relief should be granted.
Discussion
[32] It is clear, given my finding that the offer of units in the resort was the offer of a participatory security, that there was a major shortcoming in the information the issuer provided to the purchasers. In my earlier decision I held that the terms of the lease (whether the Hotel Lease or Cottage Lease) meant this was not, in substance, an investment in commercial real estate. Instead, it was an investment in a hotel business where the earnings (if any) were dependent on the success of that business
venture that was being jointly undertaken with other unit owners. Had either the
6 On the basis that the definition of “specified participatory securities” contained in the 2005
Exemption Notice captured the offer of units subject to the Cottage Lease.
requirements of the Act in terms of information disclosure been complied with, or the requirements of the Exemption Notice, the investors would have been armed with significantly more information on which to make their investment decision than they had received from the issuer.
[33] In those circumstances I consider that the breach was not simply a technical
one, but was a substantive breach of the Act’s disclosure regime.
The circumstances relating to the allotment of the security
Submissions
[34] The plaintiffs do not comment on the circumstances in which the securities were allotted. However, the defendants say in this case the circumstances are of particular relevance, and support the grant of relief. Mr Sanders was not involved in the original design of the structure by which unit owners acquired and leased their units. He became involved in the development at a time when the Cottage Lease was already in place, and in the context of an exemption having been granted by the Securities Commission which treated a system of individual accounting as the legally compliant alternative to a lease which pooled unit owners’ income.
[35] The plaintiffs say that, at the time, the Securities Commission’s policy was to exempt such arrangements, recognising that:
(a) the disclosure provisions of the Act were not well suited to offers of real property; and
(b) the Certificate of Title for the unit afforded investors protection.
Importantly, the Securities Commission did not see any policy concern with these arrangements in the absence of income pooling. The exemption granted by the Commission effectively provided for a choice between continued use of a pooling arrangement, with the provision of additional information required by the exemption, or an unpooled arrangement.
[36] Furthermore, each purchaser of a unit received a registered title to the unit and an interest in the registered lease of the unit. Their property rights did not depend on the ongoing solvency or performance of the issuer, rather, the return on the investment would depend on how successfully the letting activities in respect of the unit were carried on.
[37] Another factor the third defendant says is relevant to the circumstances of the allotment is that each purchaser of a unit needed to instruct a solicitor to act for them in connection with the purchase and to carry out the associated conveyancing. The solicitor had the opportunity, and the professional responsibility, to advise his or her client about the rights and obligations associated with purchasing the unit and entering the lease.
[38] By way of example, a number of the plaintiffs engaged the law firm Gault Mitchell to act for them on the purchase and that firm prepared a report on the purchase transaction. The third defendant considers that the report provided a full legal analysis of what the client was purchasing, including the benefits and obligations of the lease. It is reasonable to expect that advice along the lines of that provided by Gault Mitchell, was provided to all purchasers of units. Thus, unlike a retail investment, where a purchaser was exposed to making an investment decision without the protection of obtaining professional advice, each purchaser was separately advised on the transaction.
[39] For all these reasons, the defendants say that the circumstances of allotment were quite different from the circumstances associated with a more conventional allotment of a security and that points in favour of relief being granted.
[40] The plaintiffs, however, dispute the degree of reliance which can be placed on the fact that each of the plaintiffs had a solicitor handling the transaction. They say it cannot be assumed that the conveyancing advice given addressed the investment aspects of the transaction. There can be no certainty therefore about what advice was given and received in respect of each of these plaintiffs. In particular, there is no evidence on which I can be satisfied that they were advised on the key investment aspects of the transaction such as what returns they would get and what
their risks were. These were matters which they would be advised on if a prospectus had been issued, or if the terms of clauses 18 and 19 of Schedule 1 of the Exemption Notice were complied with.
[41] In response to the suggestion that Mr Sanders simply inherited the leasing arrangements at a point where it was reasonable for him to rely on the position adopted by the Securities Commission at that point, the plaintiffs place considerable reliance on Mr Sanders’ failure to take his own advice on this issue. In a letter dated
6 October 2005 Mr Sanders’ lawyer offered to have one of his staff look further at the securities issues when the legal advice he had received to that point went no further than saying there “may be no securities issues” with the existing arrangements. The plaintiffs say Mr Sanders chose not to seek further advice on that issue but to continue with the Cottage Lease and “take the risk”. It was Mr Sanders’ failure to actively check that what he was doing was compliant with the Act which meant he was not able to avail himself of the exemption from liability in s 37(6). It would be contradictory if he could, nevertheless, avoid liability through the relief provisions.
[42] For all these reasons, the plaintiffs assert that nothing that Mr Sanders raised regarding the circumstances in which the allotment was made supported the grant of relief when there had been a serious and substantive breach of the Act’s disclosure regime.
[43] On this issue it is also relevant to note that the Financial Markets Authority (FMA) appeared at this hearing, albeit not as a party supporting or opposing relief. Its submissions were limited to the following points:
(a) the Securities Commission (now the FMA) does not (and does not purport to) give legal advice;
(b) notwithstanding this position, any views expressed by the Security
Commission are subject to determination by the High Court;
(c) the overall purpose of the Act is investor protection and the views expressed, or not expressed, by the Securities Commission should not impinge on the ability of investors to exercise their rights under the law;
(d)the FMA’s view in this case is that it is not relevant whether comfort was, rightly or wrongly, taken from the Securities Commission in relation to whether there may be a contravention of the Act. What is relevant is the extent to which investors were disadvantaged by the contravention.
[44] In summary, the FMA emphasised that the stance of the Securities Commission at the time should not be relied on in deciding to grant relief to an issuer and thereby disentitling plaintiffs to protection under the Act.
Discussion
[45] I accept that the prevailing view at the time these offers were made was that a lease arrangement where there was no income pooling would not breach the Act. There was also not in existence at the time the body of decided caselaw which now exists and which identifies how arrangements which purport to be investments in real property can, in substance, be debt or participatory securities with the same kind
of risks that more conventional securities of that type might pose.7 Thus I accept that
Mr Sanders, and those advising him, were far less likely to have identified Securities Act concerns with the Cottage Lease than this Court was when assessing the investment through the lens of subsequently decided cases. To that extent I consider it was at least understandable that Mr Sanders did not do more to investigate whether the Cottage Lease raised securities legislation concerns.
[46] That said, I must weigh up the fact that it was not surprising that MVL relied on the Cottage Lease to avoid issues under the Act, against the plaintiffs’ rights to a remedy given that there was nevertheless a breach. This approach is reflected in the
FMA’s submission. Thus, while it is relevant to observe that the breaches were the
7 Braemar Lodge 2004 Ltd (in rec) v Owers [2010] NZCA 300, (2010) 10 NZCLC 264,703;
Hickman v Turner and Waverley Ltd [2012] NZSC 72, [2013] 1 NZLR 741.
result of an understanding held at the time of what constituted a participatory security at the time, that is not determinative of whether relief should be granted. It must be considered alongside the other factors, including whether there was material prejudice to the subscribers.
Has the contravention materially prejudiced the interests of the subscribers?
Submissions
[47] The defendants say that the failure to comply with the Act cannot be shown to have caused material prejudice to the plaintiffs, bearing in mind the legal advice they had obtained and what would have occurred had the Securities Commission been consulted at the time. In these circumstances, any further disclosure that might have been required was not likely to affect purchase decisions. As was said in Perpetual Investment, when a subscriber asserts that he or she has been materially prejudiced, some “causative nexus has to be described and shown” between the
contravention and the prejudice.8 The mere fact the investment was not a successful
investment is not enough to satisfy this test.
[48] In this case the defendants say the plaintiffs have received title to their units and to a registered lease. They received the returns from their unit after deduction of agreed costs. When these factors are taken into account, along with the reality that they were all legally advised on the transaction, it is unrealistic to suggest they did not know what they were investing in. This is not a case where investors acquired rights against an issuer that differed materially from what they would reasonably have expected to receive as a result of inadequate disclosure. Accordingly, the plaintiffs have failed to demonstrate material prejudice resulted from the breach.
[49] The plaintiffs, however, put considerable weight on this factor. They say that failure to disclose information prescribed by the Act cannot be considered a minor technical breach such as a delay in filing a prospectus. Rather it is inherently prejudicial because it deprives an investor of the information he or she needs to
make an informed decision to invest. This may be highly prejudicial to investors
8 Re Perpetual Investment Management Ltd, above n 4, at [13].
who are not otherwise familiar with the details of the investment or experienced in investments of that type.
[50] While the third defendant pointed to the fact that in Perpetual Investment the onus was placed on the one subscriber who opposed relief to demonstrate the material prejudice, the plaintiffs say the circumstances in this case are quite different from in that case. Here the breaches were not mere technical or procedural oversights as in Perpetual Investment. Furthermore, this is not an application made under s 37AC(1)(e), as was the case in Perpetual Investment, where, in the absence of an objection, relief is mandatory. Rather, under s 37AH, the question is whether, in all the circumstances, it is just and equitable to grant relief.
[51] More importantly though, the plaintiffs say that the breaches in this case did materially prejudice them. They and other investors in the resort did not have the information they needed to make a fully informed investment decision. They are now locked into long term investments that have not produced anything like the returns promised by the defendants, and the value of these investments has fallen dramatically as a result.
[52] The plaintiffs say that the fact they had access to legal advice does not alleviate the position. The disclosure requirements in the legislation are designed to bridge the gap between what the issuer knows about an investment being offered and what the investor knows, and without proper disclosure an investor’s lawyer is no better informed than the investor. Furthermore, the disclosure requirements in the Act are an important safeguard against the natural tendency of promoters to exaggerate the expected returns from an investment. In this case, the promoters
made “very rosy financial predictions” in order to entice investors.9 Had they
complied with the Act, the second and third defendants would have had to disclose the basis on which their financial predictions were made, and the plaintiffs and their
lawyers would have had an informed opportunity to evaluate those predictions.
9 The resort was initially promoted as producing returns of 11.14 per cent on investment and later on, as producing returns of 8 - 11 per cent on investment.
[53] The plaintiffs have said in evidence that, had they been more fully informed of the risks, they would not have invested. The Court should prefer that evidence over the defendants’ unsubstantiated assertions that no material prejudice arose.
Discussion
[54] I accept the defendants’ submission that the involvement of solicitors in the transaction goes some way to ameliorating the disadvantage subscribers were at when they invested in the resort. However, it cannot compensate for the lack of information about the basis on which the investment return projections were made. While any legal advice obtained was likely to have described the investment and ensured the mechanics of the transaction were explained, I accept the plaintiffs’ submission that the solicitors were in no better position than the plaintiffs to assess the full range of risks associated with the investment as they did not have adequate information on the assumptions which underpinned the projected investment returns, nor on the full range of risks which could affect those assumptions.
[55] By way of example, the advice leaflet provided by the law firm Gault Mitchell did not identify the risk that the developer may not obtain consent for, or proceed with, the later stages of the resort, including facilities which had been promoted as part of the resort’s future offering. Furthermore, while the advice referred to risk of the Management Company bearing a loss during the period in which it offered some investors a guaranteed return, the advice did not expressly identify the risk that the investor could be required to pay more than the investor earned.
[56] While it is possible that, even with full information on the risks the investment carried, the plaintiffs would have proceeded to invest, I cannot rule out that some would not have rethought their investment decision with that additional information. Indeed, while their evidence may have been coloured with the benefit of hindsight, I cannot ignore that the plaintiffs have said in evidence that, had they known more about the risks from the outset, they would not have invested.
[57] For these reasons, I consider that there was a causal connection between the breach and the prejudice suffered by investors and this factor points against the grant of relief.
Attitude of subscribers to relief
Submissions
[58] The plaintiffs say that the caselaw on s 37AH suggests that the attitude of subscribers towards the application will be a highly relevant consideration. While it is correct that the Court has, on occasions, granted relief in cases where the breach was more than merely minor or technical, in those cases, no opposition was raised by
subscribers and no material prejudice was demonstrated.10 The Court has only
granted relief in the face of opposition from a subscriber in cases where the breach is minor or technical and has not caused material prejudice. Where that is not the case, then the fact of subscriber opposition has been fatal to the grant of the application.11
In this case, the plaintiffs say their opposition to the application for relief should point against it being granted.
Discussion
[59] I do not accept that the fact there was subscriber opposition was a relevant consideration in the cases relied on by the plaintiffs. Rather, it was the fact that the breach was not minor or technical, and there was at least a risk of material prejudice to the subscriber, which was determinative of whether relief was granted. In my view, while the attitude of the subscribers to relief might be relevant where they support relief being granted, it is not, of itself, relevant to declining relief. What is relevant is whether the subscribers’ opposition is based on grounds which otherwise make it proper to decline relief. In this case, that turns on the other factors raised in
the parties’ submission.
10 See for example Re Foodstuffs (Wellington) Cooperative Society Ltd HC Wellington CIV-2008-485-1534, 15 December 2008 and The New Zealand Guardian Trust Company Ltd v Parr [2013] NZHC 393 at [18], [22].
11 See for example, Henderson Global Funds v Securities Commission, above n 3, at [120]-[127]
and Frimley Estate v Fog [2015] NZHC 1010, [2015] NZAR 1019 at [73] - [75].
Policy concerns
Submissions on attitude of the Securities Commission
[60] The defendants made a range of submissions around the theme that the policy concerns of the Act were not engaged in the circumstances of this case, to support the grant of relief.
[61] The first issue raised by the defendants is that the Securities Commission, at the time, was not concerned with transactions such as these where there was individual accounting, and would have either declined an exemption on the grounds it was not necessary, or granted the exemption without requiring any additional information to be provided.
[62] The plaintiffs respond to that assertion by saying that that is a hypothetical proposition. The Securities Commission never saw the Cottage Lease nor had an opportunity to comment on it, and I can not assume that outcome.
Discussion
[63] This issue has already been raised in relation to the question of material prejudice. In my view, the focus in such an application is not on what might have transpired had the issuer sought an exemption, but rather, on how serious the breach was and whether subscribers were materially prejudiced by it. The comparison is thus between what actually happened, and what would have occurred if there was compliance under the Act. The fact that an exemption might have been obtained would have meant the issuer was excused from compliance under s 37. Alternatively, if advice was received from the Commission that an exemption was not required, then the third defendant could have satisfied the Court that he had not been negligent and so would not have been fixed with joint and several liability along with the issuer. Neither of those circumstances transpired and I must consider the application in the circumstances as they were.
Submissions on territorial issues
[64] The second point raised as an additional consideration justifying relief is that the Act was not intended to apply to offers made outside New Zealand and so relief should be granted in respect of the plaintiffs who received the offer overseas.
[65] This was a new point which had not been raised in the substantive hearing. However, Mr Goddard QC did not consider that prevented it from being considered in the context of an application for relief. In his view, the evidence of seven of the successful plaintiffs showed that they were overseas at the time the offer was made
to them and was accepted.12 It was also possible that an eighth plaintiff was overseas
when he received and accepted the offer.13 The Act was not intended to protect such subscribers and relief should be granted having regard to this policy consideration.
[66] In support of this submission, the defendants relied on s 7 which governs the territorial scope of Part 2 of the Act. It provides as follows:
7 Territorial scope of Part 2
(1) Part 2 applies to securities offered to the public in New Zealand, regardless of–
(a) where any resulting allotment occurs:
(b) where the issuer is resident, incorporated, or carries on business.
(2) For the purposes of this Act, a security is offered to a person in New Zealand if an offer of that security for subscription is received by a person in New Zealand, unless the issuer demonstrates that it took all reasonable steps to ensure that members of the public in New Zealand may not accept the offer.
(3) Sections 38B and 58 (except section 58(3) and (4)) also apply to any advertisement that contains or refers to an offer of securities to the public outside New Zealand and that is distributed or to be distributed to a person outside New Zealand by,-
(a) in the case of section 38B, a person resident or having a place of business in New Zealand:
(b) in the case of section 58, a person resident or having a principal place of business in New Zealand.
12 Being plaintiffs 14, 28, 31, 32, 34, 37 and 43.
13 Being plaintiff 39.
(4) For the purpose of subsection (3), the definitions of advertisement and offer extend to communications or offers received by persons outside New Zealand.
(5) The territorial scope of Part 2 may be further extended under Part 5. (6) For the avoidance of doubt, nothing in Part 2 applies to a security or
an advertisement unless it applies under subsections (1) to (5).
[67] The first subsection makes it clear that the primary concern is the effect on the public in New Zealand, and subsections (1) and (2) are designed to ensure that overseas issuers are captured if they offer securities to the public in New Zealand. Subsection (3) and (4) provide a specific extension to the territorial scope of Part 2 to include, in relation to misleading advertisements, a communication or offer which is received by a person outside New Zealand. Furthermore, subsection (5) allows the territorial scope of Part 2 to be further extended under Part 5 through the mechanism of treaties with other countries. The overall effect of s 7 is to focus on where the investors are located, rather than on where the investment, or the issuer, is located.
[68] In Mr Goddard’s submission, the inclusion of express provisions extending the scope of the Act to certain categories of offers received by persons outside New Zealand means that, by implication, other offers received overseas were not intended to be covered by the Act. Thus, while a security is captured by the provisions of Part 2 as long as it is offered to at least one member of the public in New Zealand, there is scope, at least under the relief provisions, to exclude relief for persons who receive the offer overseas and who were intended to be protected by their own jurisdiction’s securities legislation.
[69] In support of this submission he referred to the decision in Sun v Peninsula Road Ltd (in rec and in liq),14 where it was claimed agreements to purchase units in a residential apartment complex being developed near Queenstown was the offer of a participatory security because the plaintiffs were obliged by the agreements to be members of a precinct society which managed communal facilities in the development. The Court held that there was no breach of the Act, because
membership simply imposed the burden of sharing costs, without any investment
element. However, Gilbert J also observed that, had he found the agreements
14 Sun v Peninsula Road Ltd (in rec and in liq) [2015] NZHC 126.
constituted allotments of securities in breach of s 37, he would have made a relief order under s 37AH on the basis that Part 2 of the Act applies to securities offered to the public in New Zealand and is intended to protect investors in New Zealand. In this case all the plaintiffs resided outside New Zealand, so they did not fit within the class of investors that the Act was designed to protect.
[70] Mr Goddard acknowledged, though, that the High Court in Little v Jull also considered the phrase “received by a person in New Zealand” found in s 7(2), and rejected an argument that the plaintiffs, who were residents of Norfolk Island, were excluded by s 7(2) from the protection provided by s 37 of the Act.15 Instead the
Court said:16
…s 7 is to be read as having the same implication as s 37. That is, as long as the offer is generally made in New Zealand (and there is no argument that … [the] standing offer as that term is broadly defined in the Act, was made in New Zealand), offshore investors are not excluded from the protection of s 37. Subsection 7(2) provides that a security is offered to a person in New Zealand if the offer is “received by a person in New Zealand”. The standing offer was received by persons in New Zealand. In any event, on the facts, the resident Norfolk Island plaintiffs all came to New Zealand to do business and made subscriptions to a greater or lesser extent while here. [The] offer to treat over subscriptions was therefore received by them in New Zealand at various times.
[71] The defendants submitted the preferable view is that acknowledged in Peninsula Road, albeit obiter, that a relief order is available under s 37AH where the investor is not based or present in New Zealand.
Discussion
[72] I accept the thrust of the Act is to protect New Zealand subscribers regardless of where the issuer is located. That said, s 7 means that the Act’s provisions are engaged as long as any of the offers are received by a person in New Zealand. The question is whether it is relevant to relieve the issuer, or in this case, its director, from liability to overseas subscribers. While Peninsula Road suggests this as a possibility it is clear that neither it nor Little v Jull deal with the exact circumstances
which arise in the present case. In Peninsula Road, the Court was satisfied that the
15 Little v Jull [2013] NZHC 3123.
16 At [115].
offer was only made to overseas investors, so s 7(2) was not engaged at all, and the question of relief could not have arisen. In Little v Jull, the position of those who received the offer outside New Zealand was not directly considered because the Court also held that the plaintiffs all came to New Zealand to do business, and the business conducted with the issuer on those occasions was sufficient to conclude that the offer was received by them in New Zealand at various times.
[73] In my view, this is a relevant consideration, but not necessarily determinative. I have to consider whether declining relief to such investors would be “just and equitable” in all the circumstances. In this case, there was no suggestion that the overseas investors might have their entitlement to relief opposed on this ground until after the substantive decision had been issued and they have been allowed to pursue these proceedings to judgment on the basis they have the same entitlement to relief under s 37 as investors based in New Zealand. I consider this points against it being just and equitable to grant relief on the basis of this consideration in this case.
Is it just and equitable to grant relief?
[74] In drawing together all the matters the parties have raised to consider whether it is just and equitable to grant relief from the consequences of s 37, I bear in mind the competing interests of the parties. The plaintiffs have made investments, which for some were retirement investments into which a significant portion of their life savings were invested, on the promise of returns of eight to 11 per cent. They are now faced with the choice of selling their investment, if they can, at significant loss, or continuing to subsidise the resort business, in the hope that its fortunes change in the future. Had they received the comprehensive suite of information required to be provided under the Act (or even under an exemption), they would have been better informed before they made that decision and some may have chosen not to invest.
[75] Against that, I have the position where Mr Sanders is now personally liable to repay a sum which will devastate him financially and where, while he could not satisfy me that he had not been negligent by failing to check the position, it was at least understandable that he did not take up his solicitor’s offer to do this.
[76] The phrase “just and equitable” is to be construed by reference to the overall purpose of the Act which is that of investor protection based on disclosure.17 While I have considerable sympathy for the circumstances of Mr Sanders, the Act’s provisions are clear, and those directors and companies offering investments which are caught by the relevant securities legislation must abide by rigorous standards. This promotes investor protection not just by providing a remedy in an individual
case of breach, but by having a deterrent function for other issuers of securities.
[77] In the present case, I have found that there was simply no compliance with the Act and, as a consequence, investors were not given the relevant information to assess the claims made in the promotional material for this investment. I cannot bridge that gap by simply assuming that, because solicitors were involved, the risks of the investment were fully explained to the purchasers and so there was no causal connection between the breach and the material prejudice suffered by the investors.
[78] While I take into account the views of the Securities Commission at the time, which meant it was quite possible the Cottage Lease would have been considered by it to comply with the Act, no steps were taken to refer the issue to the Commission. I am therefore not prepared to simply assume the Cottage Lease would have been considered compliant with the Act. Furthermore, where there is any room for doubt, I consider it important to encourage issuers to take advice to confirm the position, rather than to avoid the issue and hope the risks of being found in breach do not arise.
[79] While I acknowledge that the position of overseas investors is different, and the Act is not designed to protect them, I consider it would not be just and equitable in the particular circumstances of this case to treat them differently from the New Zealand investors, and to decline relief. The outcome might have been different had they known before the substantive hearing that their entitlement to repayment of their subscription with interest was challenged on that basis.
[80] Having regard to all those circumstances, I consider it would not be just and equitable to grant relief under s 37AH of the Act and I decline to do so.
17 Henderson Global Funds v Securities Commission, above n 3 at [121].
Application for order under s 37AC
[81] The unsuccessful plaintiffs also sought a relief order under s 37AC, to clarify that the provisions of s 37 invalidating the allocation of the unit to them would not apply to them. That was not opposed by the defendants. I therefore record that I have ordered that:
(a) Relief is granted to the plaintiffs listed in Schedule 1 to the Statement of Claim, with the exception of the plaintiffs identified at paragraph 218(a) of the Court’s judgment, being plaintiffs 2, 14, 20,
21, 28, 31, 32, 34, 37, 39 and 43, under s 37AC of the Securities Act
1978, so that s 37(4) to (6) does not apply to those allotments. [82] Costs on these applications are reserved.
Solicitors:
P G Skelton QC, Auckland
GCA Lawyers, Christchurch
Mr David Goddard QC, Barrister, Wellington
Meredith Connell, Wellington
Copy To:
K S Graham, Financial Markets Authority
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