Deloitte Touche Tohmatsu Trustee Company Ltd v Christchurch Pavilion Partnership No 1

IN THE COURT OF APPEAL OF NEW ZEALAND

CA79/99

BETWEEN	DELOITTE TOUCHE TOHMATSU TRUSTEE COMPANY LTD
Appellant

AND	CHRISTCHURCH PAVILION PARTNERSHIP NO. 1 AND OTHERS
First Respondents

AND	KPMG PEAT MARWICK
Second Respondent

CA206/99

BETWEEN	DELOITTE TOUCHE TOHMATSU TRUSTEE COMPANY LTD
Appellant

AND	CHRISTCHURCH PAVILION PARTNERSHIP NO. 1 AND OTHERS
First Respondents

AND	COONEY LEES AND MORGAN
Second Respondent

AND	KPMG PEAT MARWICK
Third Respondent

Hearing:	10 & 11 April 2000, 9 & 10 August 2000
Coram:	Elias CJ Keith J Tipping J
Appearances:	A A Lusk QC and R B Lange for Appellant W M Wilson QC and R P Harley for First Respondents
Judgment:	18 September 2000

JUDGMENT OF THE COURT DELIVERED BY TIPPING J

Introduction

The appellant Deloitte Touche Tohmatsu Trustee Company Ltd (Deloitte) was the statutory supervisor under the Securities Act 1978 (the Act) of an offering of securities to the public made by Horner Greenlees Corporation Ltd (HGC) in 1987. The respondents, Christchurch Pavilion Partnerships Nos 1, 2, 3, 4 and 5, comprise groups of investors who subscribed for the securities which HGC offered. Two forms of security were issued: first, shares in a company called Christchurch Pavilion Holding Company Ltd (C P Holdings) which was formed to acquire land in Papanui Road, Christchurch on which a motel/hotel complex was to be built; and second, units in five partnerships which were to be formed to lease and operate the complex.
The two forms of security were linked. Each investor had to subscribe for both partnership units, of which a total of 90 were on issue, and the associated shares - 90,000 per partnership unit. Each overall subscription was worth $50,000 and comprised 1 partnership unit valued at $5,000 together with the 90,000 shares @ 50 cents each. Each overall subscription therefore comprised $45,000 for the shares and $5,000 for the partnership unit. There being 90 units in all, the total capital to be raised amounted to $4.5 million comprising 8.1m shares raising $4.05m and 90 partnership units raising $450,000.00.
A management company was also formed with a share capital of $1,000.00 divided in 1000 $1.00 shares, subscribed as to 999 shares by HGC and as to 1 share by Mr D W Horner of HGC. Its name was Christchurch Pavilion Management Co Ltd (CP Management). The shares and units were allotted on 23 December 1987. The complex was built and opened in November 1988 but failed financially. The investors lost all their money and through the partnerships sued Deloitte, KPMG Peat Marwick who were the auditors for the venture, and Cooney Lees and Morgan, the solicitors who acted for HGC. The appeal is at this stage concerned only with the position of Deloitte and nothing more needs to be said about those other parties.
The investors' case against Deloitte, reduced to the simplest terms, was that Deloitte was in breach of its duty to the investors in failing to ensure that the share capital for the venture had been properly subscribed and paid at the time of allotment. The investors contended that the venture was substantially under-capitalised and this is what caused it to fail with the consequent loss of their money. There was a related contention that Deloitte, as statutory supervisor, did not hold or had not sighted all the necessary subscription applications at the time of allotment. In essence the investors contended that Deloitte, as statutory supervisor, should not have allowed the allotment to proceed and that if Deloitte had done its job properly their subscription money should have been held in trust and returned to them.
Deloitte's reply was twofold. First it contended that there was no material under-capitalisation and second, even if there was, the shortfall was not responsible for the collapse of the venture. That was caused, so Deloitte contended, by the failure of the venture to trade up to expectations. In the High Court Cartwright J found for the investors on the basis that the venture was under-capitalised, that Deloitte should have recognised that fact and taken steps to prevent the allotment, and that it was the under-capitalisation, not the trading problems which caused the failure of the project. The two key issues in the case, as it developed in this Court, were: (1) whether there was under-capitalisation at the outset which Deloitte should have identified, and (2) whether any such under-capitalisation caused the failure of the venture and thus the loss of the investors' money.

The basis of the offering

HGC issued a prospectus in terms of which subscriptions for the securities offered (shares and partnership units) opened on 23 November 1987 and closed on 18 December 1987. That date was extended to 23 December 1987 and all future references will be to that date as the date at which the investors say the necessary capital was not subscribed and paid for. The prospectus provided for each multiple of $50,000 to be paid in two parts, the first of $36,000 by 23 December 1987 and the second of $14,000 by 12 August 1988. The first part represented a payment of 40 cents per share and the second the balance of 10 cents per share plus the amount due for each partnership unit. Fully subscribed the first tranche would produce a capital sum of $3.24m (8,100,000 shares at 40 cents each) and the second tranche $1.26m (8,100,000 shares at 10 cents each, plus 90 partnership units at $5,000 each).
The prospectus also stated that the minimum amount required to be raised by the issue in terms of s37(2) of the Act was the full sum of $4.5m. Section 37(2) is in these terms:
37 VOID IRREGULAR ALLOTMENTS-
(2)      No allotment shall be made of an equity security or a participatory security [or a unit in a unit trust] offered to the public for subscription if the allotment is the first allotment of such security to the public unless the amount stated in the registered prospectus relating thereto as the minimum amount which, in the opinion of the directors of the issuer, must be raised by the issue of the securities in order to provide for the matters specified in regulations made under this Act, is subscribed, and that amount is paid to, and received by, the issuer within 4 months after the date of the registered prospectus; and, for the purposes of this subsection--
(a)      A sum shall be deemed to have been paid to, and received by, the issuer if a cheque for that sum is received in good faith by the issuer and the directors of the issuer have no reason to suspect that the cheque will not be paid:
(b)      The amount so stated in the registered prospectus shall be reckoned exclusively of any amount payable otherwise than in cash.
The fact that the total subscription was designed to be paid in two tranches raises other issues but the investors cannot claim they were expecting more capital to be raised as at 23 December 1987 than the first tranche totalling $3.24m. There is a question whether in legal terms the second tranche was payable too long after the first. But the investors cannot complain that the full amount of $4.5m was not paid as at 23 December 1987. This is because the prospectus required only $3.24m to have been paid at that date, which was the date on which allotment was to take place. Indeed there was nothing legally wrong, in terms of s37(2) with the second tranche being delayed beyond the date of allotment provided it was paid within 4 months of the date of the prospectus. That date was 12 November 1987.
Deloitte's role as statutory supervisor was provided for under Deeds of Participation for each partnership. HGC underwrote the issue pursuant to an underwriting agreement with CP Holdings. HGC agreed to subscribe or procure subscription for half of the 90 partnership units and associated shares; but only if at least 45 units had been subscribed for by outside investors. There was however nothing to stop HGC subscribing for more than 45 units if it chose to do so. Indeed as at 23 December 1987 only 39.5 overall units were the subject of public subscription and HGC elected to subscribe for the remaining 50.5 units. Hence the offer was fully subscribed. By 31 March 1988 HGC had arranged to on-sell all its units to subsequent investors. Those investors signed deeds of accession to the various partnerships and the requisite numbers of shares in CP Holdings were transferred into their names.

The duties of a statutory supervisor

The securities offered to the public in this case were in part (the partnership units) participatory securities as defined in the Act. Section 33(3) prohibits such an offer unless the issuer and the statutory supervisor have signed a deed of participation and it has been registered. While the role of a statutory supervisor is thus recognised, the Act gives the statutory supervisor no express rights or duties except the power under s49 to apply to the Court in two circumstances neither of which became relevant in this case. It should be noted however that s37(3) prohibits the allotment of a participatory security unless at its date the statutory supervisor "has received a written statement from the subscriber authorising the subscription for that particular security".
While this provision is cast as a prohibition on the issuer it implicitly requires the statutory supervisor to have received the required written authorities, and to take appropriate action if it has not. Of course if no such written authority has been received from a subscriber but that subscriber's subscription moneys are held, no question of under subscription or non payment of capital at the date of allotment could arise as regards that subscriber, whatever other difficulties the lack of authority might involve. That is why, on the causation front, the key issue is whether the subscription moneys required at the date of allotment were all in hand rather than whether the necessary application forms containing appropriate authority were all in hand. To focus independently on any absence of written authorities would involve an inappropriate "but for" approach to the causation issue.
Section 45 of the Act has the effect of including in deeds of participation all clauses prescribed by the Securities Regulations 1983 (the Regulations). This means that in terms of Clause 1 of the 7th schedule to the Regulations Deloitte had the obligation to:
exercise reasonable diligence to ascertain whether or not any breach of the terms of the deed or of the offer of the participatory securities has occurred and, except where he is satisfied that the breach will not materially prejudice the interests of the holders of the participatory securities, shall do all such things as he is empowered to do to cause any breach of those terms to be remedied.
In addition Clause 17(a) of the Deed imposed on Deloitte a similar duty to:
exercise reasonable diligence to ascertain whether or not any breach of the terms of this Deed or of any offer of interests to members of the public has occurred and, except where it is satisfied that the breach will not materially prejudice the interests of the Participants, shall do all such things as it is empowered to do to cause any breach of those terms to be remedied.

Minimum subscription

Section 37(2) of the Act prohibits the allotment of equity and participatory securities unless the prospectus states the minimum amount the directors of the issuer consider must be raised by the issue and that amount is paid to and received by the issuer within 4 months after the date of the prospectus. In this case the 4 month period expired on 12 March 1988 and the minimum amount was stated to be the full $4.5m. As will be recalled the prospectus provided for payment of the second tranche on 12 August 1988. Thus, in this respect, the prospectus was in prima facie breach of the Act.
There was a similar problem in the Deeds of Participation. They called for minimum subscription of $4.5m but allowed payment of the second tranche outside the 4 month period prescribed by s37(2) of the Act. It is of course implicit in these provisions that there can be fulfilment of the minimum subscription requirement but non fulfilment of the provisions of s37(2) so far as payment is concerned. Whatever the minimum subscription is, that minimum must be fulfilled by subscription prior to allotment. There may be a delay in payment of the subscription money but not beyond the 4 months provided for by s37(2). It is clear that ex facie the prospectus and the Deeds there was a breach of s37(2) as regards payment, unless, as Deloitte contends, the Securities Act (Minimum Subscription) Exemption Notice 1987 saves the position. Cartwright J did not have to consider this issue as she found that even if the minimum figure was $3.24m it had not been achieved.

The Exemption Notice

This Notice which came into force on 13 August 1987 exempted issuers of specified participatory securities (as defined) from compliance with s37(2) so far as it required payment within the 4 month period, provided the subscriber had become bound within the 4 month period to make the necessary payment or payments. The key question for present purposes is whether the securities involved in this case were "specified participatory securities" in terms of the definition of that expression in the Notice:
Specified participatory security" means a participatory security the terms of which require that the price for the security is payable by instalments over a period specified in the registered prospectus relating to the security with the first such instalment payable on subscription for the security.
That takes us back to the definition of "participatory security" in the Act which defines a participatory security as being any security other than an equity security or a debt security. Mr Lusk argued that as the "interest or right" offered by HGC's prospectus was neither a debt security nor an equity security, it fell by default within the definition of a participatory security. That submission was made on the basis that the shares and partnership units were a single security as they had to be subscribed for together. Mr Wilson contended that, although tied in that way, the securities should be viewed as two separate forms of security, albeit linked in the sense that one could not be subscribed for without the other.
The shares in CP Holdings were, if viewed individually, undoubtedly equity securities, being interests in or rights to share in the share capital of a company. The partnership units viewed individually were clearly participatory securities, being neither equity nor debt securities. The Statutory Information in the prospectus described the securities which were being offered as "equity or participatory securities" and in other places as "equity and participatory securities". Two forms of certificate were issued - a share certificate for the shares and a unit certificate for the partnership units.
We consider it artificial and unrealistic to view the securities issued as if they were a single hybrid kind of security falling by default into the category of a participatory security. In reality two forms of security were being issued, albeit, as is not uncommon, it was a condition of having to subscribe for one that the investor had to subscribe for the other. This conclusion has two consequences. So far as the equity securities, the shares, were concerned their second payment of 10 cents per share was outside the permitted 4 month period. There was thus in this respect a breach of s37(2). With the participatory securities, the partnership units, only one payment was contemplated, to be made as part of the second tranche on 12 August 1988 No question of payment by instalments arose. No first instalment was payable on subscription.
Thus, although the partnership units were participatory securities, the Exemption Notice did not apply to them. The allotment was therefore in breach of s37(2). Deloitte should have picked this up and taken such steps as it could to prevent the allotment from taking place. It is fair to record that if we held that the Exemption Notice did not apply, Mr Lusk properly accepted that Deloitte was in breach of duty in this respect. He argued however that the breach was not material in causative terms because from the point of view of cash flow the venture was always structured on the basis of two tranches; the fact that the second was outside the time permitted by s37(2) can therefore have had no causative effect on the ultimate financial failure.
We accept that proposition which Mr Wilson did not seriously challenge. The fact that the second tranche was paid outside the parameters of s37(2) cannot logically have had any causative bearing on the investors' losses because they subscribed on the premise that their second payment would be made some 8 months after the first and, if and to the extent this caused difficulties for the venture, the investors must be deemed to have taken the risk that would be so. They cannot complain in causative terms of what they knew full well was to be the position, albeit strictly an unlawful one. Thus although Deloitte was in default in this respect its default did not cause the loss. The only way it could be said to have done so is by the application of a wholly "but for" approach to causation which in present circumstances would not be appropriate, as Mr Wilson properly recognised.

The building contract

It is necessary to discuss the essentials of this topic before moving to consider the question whether the necessary capital was subscribed and paid on allotment as it should have been. As a material contract the building contract was summarised in the prospectus. It was described as being between CP Management, CP Holdings and an HGC subsidiary called Horner Greenlees Developments Ltd (HG Developments) for the construction, furnishing and landscaping of the motor lodge at a fixed price of $4.875m. The work was to be done by HG Developments. In fact the development was carried out by another HGC subsidiary called Farnsworth Equities Ltd, but that change was of no moment in itself.
The original contract contained a schedule of progress payments spread over a period of 12 months. Largely for taxation reasons that approach was varied and a further building contract was entered into on 11 November 1987 whereby a single up front sum of $4.625m was payable at the outset, indeed on the date of allotment. There was a somewhat contradictory provision in the further contract, apparently simply carried forward from the first, providing that payments could not be "compelled" unless supported by an architect's certificate, but in causative terms nothing turns on this feature and nothing more needs be said about it.
The investors contended that there was something devious (or at least inappropriate) in the change from a series of progress payments to a single up front payment. We do not accept that proposition or the inherent contention that Deloitte were somehow in dereliction of duty in this respect. The second building contract was entered into some 6 weeks before subscriptions closed and the commercial purpose of and reasons for the change to a single up front payment were adequately explained. Nor do we consider that this change in the building contract had any causative bearing on the investors' losses.
Whether the lesser price was a sufficient reflection of the advantages to the builder and the disadvantages to the investors of the change in the timing of the moneys due under the building contract was not explored and in any event does not have to be further considered for similar reasons, ie. lack of causative effect. The crucial importance of the change from staged progress payments to a single up front payment lies in its relationship with the capital subscription issue to which we now turn.

Capital subscription

We will examine first the findings and conclusions of the trial Judge. Cartwright J commenced her discussion of this issue by saying that on the date of allotment, 23 December 1987, HGC "collated" a total of $4.99m which it paid to CP Management. This total she analysed as follows:
(a)       Subscribers listed as having paid cash:  $   804,000
(b)       Subscribers who were to seek finance from NZI:     $   293,000
(c)       Subscribers who were to seek finance from HGC:    $   289,000
(d)      Advance from HGC to cover investor Noonan:        $     36,000
(e)       Amount subscribed by HGC for 50.5 units:              $1,818,000
Sub total  $3,240,000
(f)       Advance by HGC   $1,750,000
Total  $4,990,000
Not all of this was capital money. The advance of $1.75m clearly was not. But as we have seen only $3.24m was at this stage required as capital in terms of the prospectus. That is exactly the amount of the Judge's subtotal before the $1.75m advance is added. The question becomes whether the moneys making up the subtotal can all appropriately be regarded as properly subscribed capital moneys. Clearly the cash subscribers totalling $804,000 provided capital.
The next three categories represent the amount of advances made by HGC on a temporary basis to subscribers pending their arranging permanent finance for their capital subscriptions. These moneys totalling $618,000 represent further moneys paid by subscribers but using money advanced to them by HGC for the purpose. The relevant aspect of these moneys is as money paid by the investors, not as money lent to the investors by HGC. The fact the HGC paid these moneys direct to CP Management, rather than routing them through the individual investors is not material. It is also immaterial that the subscribers who obtained temporary unsecured finance to make these payments obtained that finance from HGC. The position is the same as if they had borrowed that money from their banks or elsewhere.
The moneys paid in were capital subscriptions by the investors concerned, albeit they owed HGC the amounts involved. The Judge's categories (a), (b) and (c) can properly be compressed into a single category representing capital contributions made by outside investors as at 23 December 1987. The position thus becomes:
(a)       Subscriptions of capital by outside investors representing
39.5 multiples of 90,000 shares each @ 40c per share          $1,422,000
(b)       Amount subscribed by HGC representing 50.5 multiples
of 90,000 shares each @ 40c per share  $1,818,000
Total: 90 multiples of 90,000 shares each @ 40c per share            $3,240,000
Up to this point, and with respect to the Judge's contrary view, the matter appears uncontroversial. Capital subscriptions totalling $3.24m were paid as at 23 December 1987. The outside investors provided $1.422m (some with money borrowed from HGC) and HGC itself provided $1.818m. What happened to the total sum of $3.24m when it reached CP Management is also said to have created or resulted in a substantial under-capitalisation. To that issue we will come shortly. We note in passing the Judge's observation that between $178,000 and $439,000 of the $804,000 in her category (a) was paid not by subscribers but by HGC. We observe simply that if, and to the extent that was so, the amount concerned must be in like case to categories (b), (c) and (d). There is no question that $804,000 was involved, however made up, and formed part of a total, which as the Judge correctly said, came to $3.24m and which, on the basis discussed, represented capital subscriptions. For reasons earlier mentioned, essentially the lack of any causative effect on the investors' losses, we find it unnecessary to go into the detailed question of how many actual application forms were in hand on 23 December 1987. What matters is the state of the money count and what happened to that money.
The Judge expressed the view that "on an objective analysis the venture was seriously under-subscribed as at the date of allotment". To this point of the inquiry that cannot be said, for the reasons already given. Nor to this point can we agree with the Judge's further observation:
The implications are obvious. The requirement to fund subscription for 50.5 units and advance both short and longer term finance placed HGC in a vulnerable situation and seriously endangered the project.
HGC had on-sold all the units it subscribed for by 31 March 1988 and in any event the funding implications of that subscription were external to the funding of the development and its subsequent operations. A similar position obtains with the short and longer term finance made available by HGC. There is no suggestion any of the investors defaulted in this respect and even if they had, the financial ramifications would have been external to the venture whose financial collapse is what is in issue.
That brings us to what the Judge later described as the "real issue", that is whether HGC provided "the necessary capital, or whether by paying the subscriptions to CPM and simultaneously receiving its fees and the sum for the building contract, the capital was not in fact available for the development". That way of putting the matter correctly presupposes, contrary to the impression created earlier in the judgment, that the money paid by HGC to CP Management represented, as to $3.24m, capital subscriptions which would otherwise "have been available for the development". The issue arises because after it received $4.99m from HGC on 23 December 1987 CP Management paid back the sum of $4,973,995 to HGC on the same day. This amount comprised the sums due to HGC for various fees and promotion expenses plus the up front payment due under the building contract which was $4.625m.
The advance which HGC made to CP Management of $1.75m was necessarily made in addition to the $3.24m capital payment in order to allow the full amount of the up front payment due under the building contract to be paid. There is nothing sinister in this advance when properly analysed and understood. It never purported to be capital subscribed. Its payment was necessary only to bridge the gap between the $3.24m due and paid on allotment, and the amount of the up front payment due under the building contract on the same day.
Everything really depends on what HGC did with the up front payment. It will be recalled that it was always intended that one of its subsidiaries would undertake and be paid for the building project. Originally it was HG Developments but that was changed to Farnsworth Equities, with the building actually being constructed by another company called Renroh Buildings Limited. Under the prospectus the building contract moneys were intended to be channelled through CP Holdings, but again what matters is whether the subscription moneys which found their way back to HGC on 23 December 1987 were applied to the building project. The route the money took is immaterial if the sum of $4.625m which formed part of the return payment of $4.973m was in fact used to pay the necessary up front payment under the building contract.
One very significant fact which should be noted at this point is that the building project was completed without any further call on the investors and on land acquired and owned by CP Holdings in which the subscribers owned all the share capital. There is no evidence that the capital moneys subscribed for this venture were applied elsewhere. It is true that loan moneys were used but that was always intended. If more had to be borrowed than anticipated the cause of that was not a shortfall in capital subscriptions or the failure by HGC to apply those subscriptions to the Christchurch Pavilions project.Of course any delays in paying the building contractor could have cost the project additional moneys by way of interest or penalties on the building contract, but there is no suggestion that such costs were incurred, and even if they had been, they can hardly have undermined the financial viability of the whole project.
If the up front payment, effectively made by CP Management to HGC on 23 December 1987 had stayed in HGC's hands and had not been used to pay for the building work and associated items, there could have been validity in the suggestion that what happened on that day was simply a "money-go-round". That the Judge saw matters as such is evident from her contrasting what actually happened with what the position would have been had the building contractor been completely independent of the HGC or CP Management. On that basis the Judge said:
The advances made by HGC would be a legitimate part of the capital available to CPM and CP Holdings. The payment made to the building contractor would have been available as capital for the project. Instead, the true sum available to settle the purchase of the land and to meet the building costs was the cash received from investors, a sum which barely covered HGC's fees. The true capital available for these purposes, pending on-sale of HGC's units and the payment of advances from independent financiers such as NZI and UDC, was the mortgage finance advanced by the BNZ against the security of the assets of CPM and CP Holdings, being the land and buildings and the motor hotel business.
By its payment out and back to itself in the circular arrangement described by Professor Trow and illustrated above, HGC avoided having to find the full amount of the capital. [our emphasis]
We have major difficulties with that analysis both in itself and as regards the circumstances of the case. Whether the building contractor was independent is not the determining issue. The issue is whether the up front payment, which essentially included the $3.24m of capital subscriptions, reached the company with the financial responsibility for performing or procuring performance of the building contract. In a sense CP Management, by making the return payment to HGC, was treating HGC as the building contractor. It thereby ran the risk (unrealised in the event) that HGC would not apply the money to the building contract. The money thus paid by CP Management to HGC was, if properly applied by HGC, a perfectly legitimate use of the capital subscriptions which had come into CP Management's hands.
The crucial next question is therefore what happened to the up front payment after it reached HGC's hands on 23 December 1987. We are satisfied that during 1988 HGC paid to Farnsworth Equities, in various instalments and on account of the Christchurch Pavilions building contract, a total closely approximating the up front payment of $4.625m. The analysis put forward on behalf of the investors suggested that only some $800,000 had passed between HGC and Farnsworth Equities on this account. That may well have been the position as at 31 March 1988 but the position subsequent to that date must also be brought into account. There is no logic in limiting the present inquiry to the year ending 31 March 1988, albeit the rationale for the up front payment was primarily to achieve taxation consequences in that year.
We are satisfied from the evidence of Mr Hagen and Mr Cook that up to July 1988 the sum of $3.708m had passed from HGC to Farnsworth in addition to the sum of $800,000 which had so passed prior to 31 March 1988. There was a small supplementary payment of $125,000 and, as one might expect, GST was accounted for as well. The ultimate position is therefore that, having received the up front payment, HGC passed on a total exceeding $4.625m to Farnsworth and thereby procured full payment of what was required to satisfy the up front obligations under the building contract. The same position was therefore reached as would have obtained if the building contractor had been an independent party.

The money trail

Mr Hagen, giving evidence for Deloitte, confirmed that a total of $3.708m went out of HGC's Properties account representing payments to contractors in relation to the construction of the Christchurch Pavilions complex. He verified the payments by reference to the relevant cashbook. The sum of $4.675m received by HGC from CP Management was initially placed in account number 9975030 described as the Properties account. The money was subsequently transferred by journal entry to another account designated specifically for the Christchurch Pavilions project. That was account number 9975025. The payments totalling $3.708m were identified by Mr Hagen as moving from that second Properties account to an account in the name of Farnsworth. The entry in the records showing the total sum of $3.708m was not a reference to a single sum of that amount but to a series of payments totalling that amount and representing sums spent on the Christchurch Pavilions project. The payments were shown in the cashbook of HGC as having been made on account of Christchurch Pavilions.
Mr Hagen also made reference to returns prepared by Mr Chibnall which indicated that the first $3.24m worth of expenditure on the building contract was sourced from what Mr Hagen accurately described as "partner contributions", ie. capital moneys rather than loan moneys. Mr Hagen's analysis was supported by the evidence given by Mr Cook from Peat Marwick. He had prepared a timeline showing the way the payment made by CP Management was treated in the ledgers of HGC. At the end of December 1987 there was $4.675m in account number 9975030. The money was then transferred into account 9975025 and thereby earmarked for the Christchurch Pavilions development. In July the relevant Farnsworth entries recorded the use of $3.708m for the Christchurch Pavilions project. Thus both Mr Hagen and Mr Cook were able to demonstrate by reference to the financial records that by July 1988 the further sum of $3.708m had been spent on the construction of the Pavilions complex.
We should also mention tax invoice number 4541 dated 15 October 1988 and rendered by Farnsworth to CP Holdings. It represents a statement of account in relation to the building contract. The statement reflects the fact that the building contract made a distinction between the amount owed by CP Holdings (described as the first employer) and CP Management (described as the second employer). This distinction has not been mentioned before because it has no general relevance. It is, however, relevant to the present point. The total due by CP Holdings under the building contract was $4.025m. The invoice commences with that total. GST is then added. Credit is given for $3.825m described as a deposit. This sum equates the sums of $3.708m, and the small additional amount of $125,000 earlier referred to, which were paid by HGC from the Properties account to Farnsworth between April and July 1988. The earlier sum of $800,000 paid to Farnsworth prior to 31 March 1988 broadly equates with the sum of $850,000 payable by CP Management as the second employer under the building contract. Thus, although these figures do not balance exactly, they clearly confirm that $3.825m was paid to Farnsworth on account of the building contract by the first employer and via the Properties account in HGC.
Reference must also be made to Professor Trow's evidence. In his evidence-in-chief he expressed the view, accepted by the Judge, that HGC had not paid the sum of $1.818m required of it for its capital subscription. He asserted there had been "merely a swap of cheques". He described HGC's subscription as a "phantom subscription that was created because of a circular arrangement and the swap of cheques of much the same amount". It emerged in cross-examination that Professor Trow was at a disadvantage through not having been supplied with a complete set of records and not having had the opportunity to investigate what happened to the return payment once it reached HGC's hands. He was constrained to accept that HGC's use of the money was relevant to whether his criticism of the arrangement could be maintained. He pointed out that it appeared that the money had not been paid to HG Developments as was required. But that criticism must be seen as effectively answered by the money having been paid by HGC into the Properties account, from which payments were made on account of the building contract.
Professor Trow said his real quarrel with the cheque swap, as he called it, was that the payment back should have been to HG Developments. He accepted that if the return payment had gone to HG Developments the cheque swap would not have had significance. Furthermore, he accepted that he did not know whether HGC had subsequently paid the money to HG Developments. When it was pointed out that HG Developments did not have its own separate bank account, and was therefore operating on a separate account in the name of HGC, the Professor indicated he had not been aware of that.
As a result of this cross-examination it became tolerably plain that Professor Trow's thesis of a cheque swap resulting in a sham subscription by HGC could not really withstand the reality of what occurred. The money paid back by CP Management was effectively paid to HG Developments by means of the separate account in HGC. What is more, the moneys were subsequently placed in a new and dedicated account and were in fact expended on the Pavilions project. The Judge did not address any of this evidence and in particular did not take account of what Professor Trow had said in cross-examination. Nor did she recognise the blinkered view which Professor Trow's instructions and lack of access to relevant material had caused him to take.
One aspect of the error which the Judge made can be found in this passage of her judgment:
In cross-examination, Mr Hagen, representing the statutory supervisor, was asked to isolate from HGC Properties ledger how much had been spent towards the Pavilions' building project by 31 March 1988. He could point to only $800,000 net. Although in fairness to him there may have been sums he missed, the inference I have drawn is that by that date only a small proportion of the certified value had been expended. Mr Hagen's evidence also confirms that as at that date capital of approximately $3.8m was not in hand for the project.
The Judge appears to have overlooked that the position as at 31 March 1988 could not be regarded as representing the position ultimately reached. Her observation that Mr Hagen's evidence also confirmed that as at that date capital of approximately $3.8m was not in hand for the project must also represent a misunderstanding both of Mr Hagen's evidence and of the true position. Certainly the second tranche of capital was not in hand at 31 March 1988. It was never meant to be. Vis a vis the building contract HGC's advance of $1.75m covered that shortfall in the meantime, and as earlier demonstrated, the capital moneys of $3.24m which were due on allotment in terms of the prospectus were paid on 23 December 1987, and were thus in hand as at 31 March 1988.
On a correct analysis of the position the only possible damage suffered by the investors from the way the up front payment was passed on by HGC to Farnsworth might lie in the cost of the delay. But, as mentioned earlier, this was not the basis of the investors' claim, and no evidence was directed to whether there was any loss on this basis and, if so, what it was. That is not surprising against the erroneous general proposition that only some $800,000 found its way from HGC to Farnsworth.
It follows that we are satisfied that Deloitte cannot be regarded as being at fault on the basis that the venture was under-capitalised. It was not. What might have appeared to be a circularity of payment, and only that, was in reality a proper application to the up front payment of capital moneys subscribed in terms of the prospectus. Thus Deloitte is not liable to the investors on account of under-subscription or under-capitalisation because there was none. The appeal must accordingly be allowed; but because the point is independently important and leads to the same consequence we will, more briefly, address the causation issue.

Causation

Deloitte argued that even if it was at fault in any respect, the real cause of the loss suffered by the investors was not any such default on its part but the inability of the venture to attain its forecast trading results. The contrary thesis put forward by the investors was that due to under-capitalisation the venture had to borrow more heavily and expensively than had been projected and this is what caused its collapse. It is a little artificial to be discussing these opposing contentions, having already found there was in the result no under-capitalisation and no cause for concern on that front. But with that reservation we will address what we see as the essentials of this issue.
The Judge recorded that Mr Murray Compton, a chartered accountant and specialist consultant to the tourism and hospitality industries, was of the view that the greater than projected loss for the period to 31 March 1989 was the result of trading being at levels below those forecast in the prospectus. Mr Compton had however also noted that the high costs of borrowing at this time were influential in what he called a disastrous result in the first period.
The Judge took the view overall that Mr Compton's evidence showed that the "extremely high ongoing interest costs were the pivotal factor in the failure". She concluded there was therefore "a close nexus between the statutory supervisor's failure to note the deficiencies in the investment [sic] and attempt to delay or halt the allotment and the ultimate failure of the project."
It is useful however to compare the prospectus forecast figures with those which were actually achieved in relation to interest costs and revenue. It is only by addressing this comparison that one can move from the generalities upon which the Judge based her conclusion to the necessary close analysis of how far the actual results departed from the forecasts which underlay the prospectus. Basing ourselves on the figures collected by Deloitte in its submissions, which appear to us to be well founded, the following emerges.
In the year ended 31 March 1988 actual interest expenditure was less than that forecast by $66,954. In the year to 31 March 1989 interest costs exceeded forecast by $307,280; to 31 March 1990 the excess was $65,721; and to 31 July 1990, when the venture collapsed, the excess was $48,064. On the revenue side there is a stark contrast. To 31 March 1989 revenue was less than forecast by $415,953. To 31 March 1990 the deficiency was $1,448,467 and to 31 July 1991 the deficiency was $527,560. Overall therefore interest costs throughout were $354,111 more than forecast whereas revenue was $2,391,980 less than forecast.
These figures speak for themselves. The overwhelming inference is that it was the complex's failure to trade up to expectations that caused its cash flow problems and thus its demise rather than the comparatively small excess of interest costs over what was expected. It would be difficult to conclude on the balance of probabilities that had the revenue been anywhere near forecast levels the hotel would nevertheless have been brought down by the extra interest costs. It is that which the investors would have to show in order to sustain a claim for the loss of their whole investment rather than such loss, if any, as might have occurred on some different basis. Thus, even if Deloitte had been at fault in some material respect, the investors would still have faced major difficulties in showing that such default caused the loss of their investment.

Summary

The investors' essential complaint is that the project was seriously under-capitalised from the start. We are satisfied it was capitalised exactly as the prospectus required. The outside investors subscribed capital of $1.422m. The fact that some of them borrowed money from HGC for the purpose does not make their payments any the less payments of capital. HGC subscribed capital of $1.818m. The total of $3.24m is exactly what the prospectus required as at the date of allotment. HGC paid the capital subscriptions to CP Management which returned them to HGC, not as a return of capital but as moneys paid under the building contract. HGC held the moneys returned to it on account of the building contract and duly used them to discharge the liabilities due under that contract. There was thus no sham or improper circularity in the return payment. Deloitte cannot be liable for the consequences of the alleged under-capitalisation because there was none. In any event, even if there had been a failure to identify some under-capitalisation on Deloitte's part, or indeed any other breach of duty by it, the probabilities are that the collapse of the venture was not caused thereby, but rather by its failure to trade up to expectations.

Miscellaneous issues

In the light of our conclusions to this point other issues which were raised do not require decision. As Deloitte was not in material breach of duty, whether it owed duties to subsequent investors, ie. those who joined the venture after the date of allotment, does not arise. Similarly the separate position of Mr Sutton is immaterial. Nor it is necessary to address Deloitte's challenge to the Judge's approach to prejudgment interest, or the investors' cross-appeal on the interest front.

Conclusion

For the reasons given the appeal is allowed. The cross appeal is dismissed. The judgment entered for the investors against Deloitte in the High Court is set aside. In its place judgment is entered for Deloitte with costs in its favour to be fixed by the High Court if the parties cannot agree. The first respondents are to pay the appellant costs in this Court in the sum of $25,000 plus disbursements including the reasonable travel and accommodation expenses of both counsel to be fixed if necessary by the Registrar.

Solicitors
Simpson Grierson, Auckland, for Appellant
Izard Weston, Auckland, for First Respondents

[2000] NZCA 206

18 September 2000