Dotcom Family Trustees Limited; ; and; Mega Cloud Services Limited (Formerly Named Mega Limited) & Ors; s
[2024] NZHC 2763
•24 September 2024
IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY
I TE KŌTI MATUA O AOTEAROA TĀMAKI MAKAURAU ROHE
CIV-2021-404-2044
[2024] NZHC 2763
UNDER the Companies Act 1993 BETWEEN
DOTCOM FAMILY TRUSTEES LIMITED
Plaintiff
AND
MEGA CLOUD SERVICES LIMITED (FORMERLY NAMED MEGA LIMITED) AND OTHERS
Defendants
Hearing: 3 October 2023 Appearances:
S Cogan for the plaintiff/respondent
J Long and S Nicolson for the first and sixth defendants/applicants T Braun for the second defendant/applicant
Judgment:
24 September 2024
JUDGMENT OF ROBINSON J
[Applications for strike-out or security for costs]
This judgment was delivered by me on 24 September 2024 at 4:00 pm pursuant to Rule 11.5 of the High Court Rules
…………………………………………………………………… Registrar/Deputy Registrar
Solicitors/counsel:
Braun Bond & Lomas, Hamilton Lowndes Jordan, Auckland
S L Cogan, Auckland
DOTCOM FAMILY TRUSTEES LIMITED v MEGA CLOUD SERVICES LIMITED [2024] NZHC 2763 [24
September 2024]
Introduction
[1] The plaintiff, Dotcom Family Trustees Limited (DFTL) owns a very small parcel of shares in the first defendant, Mega Cloud Services Limited (Mega) which operates a cloud storage business. The sixth defendant, Cloud Tech Services Limited (CTSL) holds 99.83 per cent of the shares in Mega. The second defendant, Mr Hall, is a director of Mega.
[2] This proceeding arises out of three issues of shares in Mega that took place in 2015 (2015 Rights Issues). The sixteen named defendants are the directors who allegedly procured the 2015 Rights Issues and some of the participating shareholders. Amongst other things, DFTL alleges that the 2015 Rights Issues were part of a strategy to dilute DFTL’s shareholding in Mega; and/or to facilitate a backdoor takeover of Mega.
[3] There are two causes of action. First, DFTL alleges oppressive, unfairly discriminatory or unfairly prejudicial conduct by all defendants and seeks relief under s 174 of the Companies Act 1993 (the Act). Secondly, DFTL pleads a derivative action alleging that Mr Hall and his co-directors have breached their duties as directors of Mega, thereby causing Mega loss. DFTL claims damages in an amount to be particularised prior to trial.
[4] Mega, CTSL and Mr Hall apply for orders striking out DFTL’s claims. They say DFTL has commenced these proceedings in breach of freezing orders made in separate proceedings that various film studios have issued against Mr Kim Dotcom, DFTL and others (the 1272 Proceeding).1 The applicants say the Court should therefore strike-out the claims as an abuse of process.2
[5] Mr Hall says further that the second (derivative) cause of action is untenable because DFTL has brought it without first obtaining leave of the Court as required by s 165 of the Act. He says that any application for leave would now be time-barred.
1 Twentieth Century Fox Film Corporation v Dotcom [2016] NZHC 88.
2 High Court Rules 2016, r 15.1(1)(d).
Mr Hall appears under protest to the Court’s jurisdiction to hear DFTL’s second cause of action.
[6] Alternatively, to the extent the claims are not struck out, the applicants apply for security for costs.
[7]DFTL opposes.
Background
The freezing order
[8] The relevant background is set out in the pleadings, Mr Hall’s affidavit and earlier judgments issued in the 1272 Proceeding.
[9] It is well known that the United States of America (USA) alleges that Mr Dotcom and others, through the business known as Megaupload, engaged in criminal copyright infringement and money laundering. Copyright holders are alleged to have suffered losses in excess of USD 500,000,000.3 The USA have been seeking extradition of Mr Dotcom (and others) since early 2012.
[10] In January 2012, the District Court for the Eastern District of Virginia issued post-indictment restraining orders against Mr Dotcom’s property. The restraining orders applied worldwide and extended to Mr Dotcom’s real and personal property in New Zealand. The orders prohibited any person from disposing or otherwise dealing with the restrained property.4 The orders were made on the basis that the Judge was satisfied the property constituted the proceeds of Mr Dotcom’s alleged offending.
[11] On 18 April 2012 the Auckland High Court registered the USA’s restraining order over Mr Dotcom’s assets under the Mutual Assistance in Criminal Matters Act 1992 (Restraining Order).5 The Court of Appeal extended the duration of the Restraining Order in August 2014.6
3 Ortmann v United States of America [2017] NZHC 189 at [1].
4 At [431].
5 Commissioner of Police v Dotcom [2012] NZHC 634.
6 Commissioner of Police v Dotcom [2014] NZCA 408.
[12] In 2014, various film studios based in the USA who claimed to have been affected by the alleged copyright infringements launched the 1272 Proceeding against Mr Dotcom. Following disclosure by Mr Dotcom the film studios identified that he was (at that time) a discretionary beneficiary of the Trust Me Trust (the Trust).7 On or around 28 November 2014, on the application of the plaintiff film studios, the High Court issued a freezing order pursuant to Part 32 of the High Court Rules in respect of assets held by Mr Dotcom, and by DFTL as trustee of the Trust.8
[13]Relevantly, and after some variation, the freezing order provides that:
Until further order of the Court, any assets held [Mr Dotcom and DFTL] in their capacity as trustee, former trustee, or, in the case of [Mr Dotcom], as a beneficiary or appointer, of the “Trust Me Trust” may not be diminished in value, disposed of or dealt with by [Mr Dotcom or DFTL], and are to be held by Neale Jackson and Grant Graham of KordaMentha (Custodians) under the direction of the Court, and on the terms set out in the Schedule to this order, until further order of the Court, save, …
Schedule
1The Custodians may do anything reasonably necessary to preserve the value of the frozen property, subject to any Court order.
…
4The Custodians are entitled to recover the following of their costs from the frozen assets:
4.1costs, charges and expenses properly incurred or payable by or on behalf of the Custodians in connection with the exercise or performance, by them or their delegates, of their custody and control of the frozen assets pursuant to the freezing orders;
…
[14] The extended Restraining Order against Mr Dotcom’s property expired on 18 April 2015. By consent, the Court directed that all the property previously subject to the Restraining Order automatically fell under the terms of the freezing order.
7 Twentieth Century Fox Film Corp v Dotcom [2016] NZHC 1948 at [5].
8 At the time DFTL was named Coatesville Trustee Services Ltd.
The 2015 Rights Issues
[15] DFTL has been a shareholder in Mega since 27 November 2014. For a period up until approximately May 2015, Mega was planning a “reverse listing” on the NZX via a listed company then known as TRS Investments Limited (TRS).
[16] On 21 July 2015, Mega offered to issue shareholders two fully paid shares for each share held. It proposed that 279,156 new shares would be issued at a price of
$1.79 per share. The offer was conditional on Mega receiving subscriptions from existing shareholders for not less than 50 per cent of the total number of new shares offered. The closing date for acceptance was 5 August 2015 (August 2015 Rights Issue).
[17] DFTL subscribed for the August 2015 Rights Issue and was allotted 65,091 shares.
[18] On 12 October 2015, Mega offered to issue to shareholders 50 ordinary fully paid shares for each share held. It proposed that 42,578,050 new shares would be issued at a price of $0.07. Again, the issue was conditional on a 50 per cent uptake of new shares. The closing date for acceptance was 28 October 2015 (October 2015 Rights Issue).
[19] DFTL subscribed for the October 2015 Rights Issue and was allotted 3,319,641 shares. Eleven of Mega’s 18 shareholders subscribed, following which DFTL held
7.63 per cent of the shares in Mega.
[20] On 1 December 2015, Mega offered to issue shareholders one share for every 25 existing shares at a price of $4.5946 per new share. This offer was conditional on 99 per cent of the new shares offered being accepted. Alternatively, Mega offered to issue 50 shares for every existing share held at an issue price of $0.0036757 per share. The closing date for acceptance was 22 December 2015.
[21] The number of new shares to be issued was 1,741,190 in the first scenario, or 2,176,485,600 in the second scenario. In either scenario, $8,000,000 would be raised and the cost to DFTL to participate would be $610,000 (December 2015 Rights Issue).
[22] DFTL and Mr Dotcom applied to the High Court for a variation of the freezing order to enable DFTL to participate in the December 2015 Rights Issue. They proposed that Mr Dotcom be permitted to use a frozen asset as security to borrow funds which he would on-lend to DFTL.
[23] The Court declined the application.9 The Court accepted that it was in the film studio plaintiffs’ interests for DFTL’s shareholding in Mega to be preserved. However, where that could only be achieved at the risk of the restrained assets a careful risk assessment is required, taking into account the purpose of the freezing order.10 This assessment is a matter for the Court, not the party seeking to vary the order.11
[24] The Court considered that the risk was too high to allow Mr Dotcom’s assets to be used as security for his proposed borrowing and on-lending to DFTL. Neither Mr Dotcom nor DFTL had funds to repay their proposed borrowings, and the “overwhelming weight of the evidence” suggested that DFTL’s shares in Mega are unlikely to be saleable.12 The Court also considered the December 2015 Rights Issue was unlikely to be the last.13
[25] Unable to raise funds, DFTL did not subscribe for the December 2015 Rights Issue. Neither did some other shareholders. As a result, the December 2015 Rights Issue proceeded on the “50 for 1” basis. DFTL’s shareholding reduced from 7.63 per cent to 0.16 per cent of the shares in Mega.
[26] Before each of the August 2015, October 2015 and December 2015 Rights Issues, the board of Mega was required to resolve that, in its opinion, the consideration for and terms of the issue were fair and reasonable to Mega and all existing shareholders.14 The directors who voted in favour of that resolution were required to sign a certificate to that effect.15 On 23 December 2015, Mr Hall, together with his
9 Twentieth Century Fox Film Corp v Dotcom, above n 1.
10 At [28].
11 At [28].
12 At [29].
13 At [30].
14 Companies Act 1993, s 47(1)(c).
15 Companies Act, s 47(2)(d).
co-directors, Messrs Sorenson and Nguy (the third and fourth defendants) respectively signed the s 47 certificate.
[27] Other shareholders in Mega, including the shareholder defendants in this proceeding, have subsequently swapped their shares in Mega for shares in the sixth defendant, CTSL.
The 11 September 2017 variation to the freezing order
[28] On 11 September 2017 counsel for the studios, DFTL, Messrs Jackson and Graham of KordaMentha (custodians of the Trust Me Trust) (the Custodians), and Mr Dotcom’s former wife (as an interested party) each signed a joint memorandum of counsel recording their agreement to vary the freezing order to allow DFTL to apply to bring a derivative action under ss 165 to 168 of the Act in the name of Mega Limited. It is unclear whether the Court ever made the proposed variation, but for present purposes I presume that it did.
[29]Counsel’s joint memorandum recorded as follows:
…
7The parties respectfully request that the Court insert new order 3.2(a)(I) into the extant asset freezing orders against assets of the “Trust Me Trust”. Order 3.2(a)(I) is set out in the Schedule to this memorandum.
8For the avoidance of doubt, this request is:
8.1Without prejudice to [DFTL’s] right to challenge the asset freeze over “Trust Me Trust” assets;
8.2Not intended to alter the asset freeze save for permitting [DFTL] to bring its proposed derivative action on the terms set out in the Schedule; and
8.3agreed notwithstanding (and without prejudice to) the applicants’ various challenges to the validity and efficacy of the Trust Me Trust on which the applicants’ asset freeze is founded.
[30] The variation would take effect as an exception to the freezing order, adding a further exception as follows:
SCHEDULE
3.2(a)(i) [DFTL] may apply to bring an action under ss 165 – 168 of the Companies Act 1993 (Derivative Action) in the name of Mega Limited, provided that:
(I) save as provided in this Order no assets frozen by this order, or previously frozen by this order but released to meet any person or persons’ living expenses, (or currently or previously frozen or restrained by any order of a Court of competent jurisdiction in either the United States or Hong Kong) may be used in the course of the trustee pursuing the Derivative Action;
(II) neither the asset custodians nor the applicants are endorsing or participating in the Derivative Action, and neither the asset custodians nor the applicants shall have any liability for costs or for any other loss or damage to any person or entity arising out of the Derivative Action;
(III) [DFTL] shall be responsible for ensuring that any relevant counterparty, stakeholder or Court is aware of the terms of this order;
(IV) the applicants, Custodians and fourth respondent shall each have leave to apply to amend 3.2(a)(i) of this order on 2 working days’ notice; and
(V) any proceeds of the Derivative Action shall be immediately frozen pursuant to the terms of the applicants’ asset freezing orders, and the ability of any respondent to access such proceeds for expenses shall be governed by the terms of the applicants’ asset freezing orders and Part 32 of the High Court Rules 2016.
DFTL’s causes of action
[31] As noted above, in DFTL’s first cause of action it alleges oppressive and unfairly discriminatory and prejudicial conduct by the directors and former shareholders of Mega. DFTL sues Messrs Hall, Nguy and Sorenson as directors for procuring the 2015 Rights Issues;16 and the shareholder defendants for having participated in the 2015 Rights Issues. DFTL seeks relief under s 174 of the Act, including damages “[in] an amount equivalent to the difference in value between [DFTL’s] shareholding in Mega prior to the rights issues and 0.16 per cent of the current market value of Mega”.
16 DFTL also alleges the fifth defendant Mr Liu to be liable as a deemed director of Mega.
[32] In its second cause of action DFTL alleges that Messrs Hall and his co-directors breached their duties as directors of Mega. DFTL claims damages for the loss it alleges Mega has suffered as a result.
[33] In both causes of action, DFTL alleges that the 2015 Rights Issues were undertaken in bad faith and for the improper purpose of diluting DFTL’s shareholding in Mega down to effectively zero, and for facilitating a backdoor take-over of Mega by Mr Liu and his associates. DFTL says that each of the 2015 Rights Issues, “for no legitimate reason”, were made at “gross undervalue[s]” and that a reasonable director would have raised any necessary working capital by other, non-dilutive means.
[34] DFTL allege that the s 47 certificates signed by Mr Hall and his co-directors did not comply with s 47 because when they signed those certificates they did not believe, and could not have reasonably believed, that the consideration and terms of the 2015 Rights Issues were fair and reasonable to Mega and all other shareholders. Non-compliance with s 47 is deemed to be unfairly prejudicial for the purposes of s 174.17
The strike-out application
[35] The applicants say that in bringing these proceedings DFTL has “dealt with” its frozen assets, namely its shares in Mega and/or its causes of action, in breach of the freezing orders. DFTL did not obtain the consent of the Custodians or the Court to deal with its assets in this way. The applicants say this is an abuse of process and the Court should strike the proceedings out.
[36] The applicants say that any variation to the freezing order in accordance with the 11 September 2017 agreement would not permit the present proceedings. That variation only permitted DFTL to apply to bring a derivative claim under ss 165 to 168 of the Act, which it has not done. Instead, DFTL has sought relief under s 174 of the Act and purported to bring a substantive derivative action without first applying for and obtaining leave to do so, as required by s 165 of the Act (and as permitted by the proposed variation).
17 Companies Act, s 175.
[37] Separately, and putting the freezing order to one side, Mr Hall says that DFTL’s failure to obtain the Court’s leave to commence the second (derivative) cause of action renders it untenable. Mr Braun, counsel for Mr Hall, submits that under s 165 of the Act it is mandatory for a plaintiff to obtain leave to bring a derivative action before doing so. Any application for leave would now be time barred and the Court cannot and should not grant leave retrospectively (nunc pro tunc).
Did DFTL issue proceedings in breach of the freezing orders?
[38] DFTL accepts that its shares in Mega are subject to the freezing orders, but disputes that those orders restrain it from issuing these proceedings.
[39] Mr Cogan for DFTL submits that the freezing orders should be strictly construed. He emphasises the following passage of the United Kingdom Supreme Court’s judgment in JSC BTA Bank v Ablyazov:18
[19] I further agree that orders of this kind are to be restrictively construed in accordance with Beatson LJ’s strict construction principle, which he described in this way ([2014] 1 All ER (Comm) 700, [2014] 1 WLR 1414 (at [37])):
‘The third principle follows from the “fundamental requirement of an injunction directed to an individual that it shall be certain”: Z Ltd v A [1982] 1 All ER 556 at 570, [1982] QB 558 at 582 per Eveleigh LJ. It is that, because of the penal consequences of breaching a freezing order and the need of the defendant to know where he, she or its stands, such orders should be clear and unequivocal, and should be strictly construed… In the Anglo-Eastern Trust case [2002] EWHC 1702 (Ch) at [26] Neuberger J stated that “[a] freezing order, which has been referred to as a nuclear weapon, should … be construed strictly” because the court is “concerned with an order which has a potentially draconian effect on the commercial and economic freedom of an individual against whom no substantive judgment has yet been granted”.’
[40] In reliance on this principle of strict construction, Mr Cogan submits that the freezing orders, properly construed, apply only to assets DFTL held when the orders were made on 26 November 2014, but not to assets DFTL may have acquired after that date. The causes of action arise out of the subsequent 2015 Rights Issues.
18 JSC BTA Bank v Ablyazov [2015] UKSC 64, [2016] 1 All ER 608 at [19].
[41] Secondly, and in any event, Mr Cogan submits that the causes of action are not “assets” subject to the freezing orders. Although DFTL’s shares are frozen, the causes of action are not rights attached to the frozen shares but are merely statutory rights arising under ss 165 to 168 and 174 of the Act. Mr Cogan contrasts these statutory rights with the “rights and powers attaching to shares” as set out in s 36 of the Act.
[42] On this basis, Mr Cogan suggests that the September 2017 application to vary the freezing orders to permit DFTL to apply to bring a derivative action under ss 165 to 168 of the Act was unnecessary.19
[43] Thirdly, Mr Cogan submits that even if the causes of action are subject to the freezing orders, DFTL has not diminished their value, or disposed or dealt with them. If anything, by issuing these proceedings DFTL has maintained the causes of action and preserved their value. He submits that “dealt with”, in the context of the freezing order, only restrains DFTL from dealing with its assets in a way that could affect the ability of the film studio plaintiffs in the 1272 Proceeding to execute any judgment they may ultimately obtain against DFTL. Mr Cogan submits that the studios are in no worse, and arguably a better position by DFTL pursuing these causes of action.
[44] Finally, Mr Cogan submits that even if the causes of action are subject to the freezing orders, and DFTL has “dealt with” the causes of action by issuing these proceedings, this would come within r 32.6(3)(c) of the High Court Rules 2016 which provides that a freezing order:
(3)… must not prohibit the respondent from dealing with the assets covered by the order for the purpose of—
…
(c) disposing of assets, or making payments, in the ordinary course of the respondent’s business, including business expenses incurred in good faith.
[45] Mr Cogan says that it is in the ordinary course of DFTL’s business as a shareholder of Mega and a corporate trustee to exercise causes of action accruing to it under the Act.
19 I note that neither Mr Cogan nor his instructing solicitor were acting for DFTL at the time.
Discussion
[46] The expression “any assets” is capable of a wide meaning. On its face, this could include after-acquired assets, causes of action and other choses in action. Like any document, a freezing order must be construed in its context, to give effect to its intended purpose.20
[47] The purpose of the freezing orders is to prevent dissipation of DFTL’s assets that could be available to prospective judgment creditors in the 1272 Proceeding. To achieve that purpose the Court has ordered that DFTL is not to diminish, dispose of or deal with its assets; and that those assets are to be held by the Custodians under the direction of the Court.
[48] In this context I am satisfied that the first cause of action, and any right DFTL might have to pursue the second cause of action, are “assets” that are subject to the freezing orders. I do not accept Mr Cogan’s submission that there is any material distinction between rights that attach to DFTL’s shares as described in s 36 of the Act, and any statutory rights to issue proceedings claiming relief under ss 165 to 168 and 174.
[49] The relief DFTL seeks under s 174 of the Act includes damages calculated on the value of its shareholding in Mega at different times. DFTL clearly perceives that claim to have value. However, DFTL will likely incur costs by pursuing the claim, and it certainly runs the risk of a significant costs liability if the claim is unsuccessful. These are precisely the sorts of risks the Court intended to manage by making the freezing orders and placing DFTL’s assets in the hands of the Custodians.
[50] I accept the position is arguably different in the context of the purported derivative action. Derivative actions are bought (with the leave of the Court) by shareholders in the name of, or on behalf of, the company in which they own shares.21 The Court shall order that the company meet all or part of the costs of bringing, settling or compromising the proceeding, unless it is unjust or inequitable to do so.22 However,
20 JSC BTA Bank v Ablyazov, above n 17, at [21].
21 Companies Act, s 165(1) and (6).
22 Companies Act, s 166.
for present purposes I am satisfied that any right DFTL has (or had) to apply for leave to bring a derivative action is an asset for the purposes of the freezing order. DFTL is still purporting to issue proceedings in its capacity as a shareholder of Mega. In doing so it is potentially incurring costs and running the risk of adverse costs awards.
[51] In terms of timing, I agree with Mr Cogan that the causes of action, allegedly arising out of the 2015 Rights Issues, could not have accrued until after the Court made the freezing orders in 2014. However, I reject the submission that the freezing orders do not apply to after-acquired assets.
[52] The orders apply to “any assets” held by DFTL in its capacity as trustee of the Trust, until further order of the Court. To limit this to assets held by DFTL when the orders were made would exclude, for example, any dividends paid and capital gains made on DFTL’s shares; and any damages DFTL might recover based on the value of its shares at different times. That is too narrow an interpretation of the phrase “any assets” and would defeat the purpose of the freezing order. I accept Mr Long for the first and sixth defendants’ submission that in the present context the freezing orders are to have an “ambulatory effect”, applying to all assets DFTL holds as trustee at any time while the freezing order remains on foot.23
[53] In my view it is also abundantly clear that by issuing these proceedings DFTL has “dealt with” its causes of action. Even if Mr Cogan is correct that the freezing order only restrains dealings which could affect the ability of the plaintiffs in the 1272 Proceeding to execute judgment, I consider that issuing the proceedings is a dealing that falls within that category. As noted, DFTL will likely incur costs in pursuing the proceedings, and certainly runs the risk of a substantial costs liability if it is unsuccessful. Having made the freezing orders on the terms it did, it is for the Court, not DFTL, to manage those risks.24
[54] Finally, I do not accept Mr Cogan’s submission that it is in the ordinary course of DFTL’s business for the purposes of r 32.6(3)(c) to pursue causes of action accruing to it under the Act. The purpose of that rule is to ensure that freezing orders do not
23 Citing Cretanor Maritime Co Ltd v Irish Marine Management Ltd [1978] 3 All ER 164, at 169.
24 Twentieth Century Fox Film Corp v Dotcom, above n 1.
interfere with a defendant’s ability to carry on business before judgment by making payments or disposing of assets in the ordinary way. DFTL owns Mega shares in its capacity as a trustee of a family trust. I do not consider it is in the ordinary course of DFTL’s business to issue proceedings claiming relief under s 174 or pursuing derivative actions.
[55] For these reasons I am satisfied that DFTL’s causes of action are assets subject to the freezing orders, and that by issuing these proceedings DFTL has dealt with these assets in breach of the freezing orders. I would also accept Mr Long’s submission that by issuing these proceedings DFTL has “dealt with” its Mega shares in breach of the freezing orders. DFTL has brought the proceedings in its capacity as a shareholder. The relief it seeks in its s 174 claim is inextricably linked to its shareholding in Mega. The damages it claims in the derivative action is as shareholder on behalf of Mega.
[56] I also accept Mr Long’s submission that the 2017 variation did not authorise this proceeding. It only authorised an application under s 165 for leave to bring a derivative action, which it has not done. This is not a matter of semantics. As noted, the costs of a derivative action are usually met by the company, wholly or in part. Conversely, the costs of a s 174 proceeding would be funded by DFTL, exposing frozen assets to a risk of dissipation.
[57] If DFTL had applied for leave to bring the derivative action, the Court would have been required to have regard to, amongst other things, the costs of the proceedings in relation to the relief likely to be obtained,25 and the interests of the company in the proceeding being commenced.26 Instead, DFTL purports to have bought the derivative action without obtaining leave.27 This is outside the scope of any variation to the freezing order.
25 Companies Act, s 165(2)(b).
26 Companies Act, s 165(2)(d).
27 This is discussed further at [63]–[65] below.
Should the proceedings be struck-out as an abuse of process?
[58] Having found that DFTL has issued the proceedings in breach of freezing orders, I accept the submission of counsel for the applicants that the proceedings should be struck-out as an abuse of process.
[59] An abuse of process may take several different forms, including: attempts to relitigate matters already determined;28 issuing proceedings with an improper motive or the aim of obtaining a collateral advantage;29 duplication of proceedings;30 and bringing claims which are statute-barred.31
[60] I accept Mr Long’s submission that it is also an abuse of process for a plaintiff to issue proceedings in breach of freezing orders made to protect third parties. I also agree that DFTL cannot retrospectively cure its breach of the freezing orders by contending that a variation authorising the proceedings would have been granted.32 Nor could the Court treat this application as one for a retrospective variation of the freezing orders.33
[61] Any fresh application by DFTL to vary the freezing orders would need to be made in the 1272 Proceeding, on notice to the Custodians and the film studios. There is no evidential basis for the Court in this proceeding to infer whether the studios and/or the Custodians would consent to a variation. In any event, the Court would need to be satisfied that the potential benefit to DFTL in pursuing the proceedings would outweigh the risk of an adverse costs order if the proceedings were unsuccessful.
[62] For these reasons I am satisfied it is appropriate to strike-out the proceedings as an abuse of process.
28 Hunter v Chief Constable of West Midlands Police [1982] AC 529 (HL) at [54].
29 Commissioner of Inland Revenue v Chesterfield Preschools Ltd [2013] NZCA 53 at [89].
30 Otis Elevator Co Ltd v Linnel Builders Ltd (1991) 5 PRNZ 72 (HC).
31 Matai Industries Ltd v Jensen [1989] 1 NZLR 525 (HC) at [532].
32 Steven Gee Mareva Injunctions and Anton Piller Relief (4th ed, Sweet & Maxwell, London, 1998) at 283.
33 TDK Tape Distributor (UK) Ltd v Videochoice Ltd [1985] 3 All ER 345 (QBD) at 350.
DFTL’s failure to obtain leave under s 165
[63] Mr Hall also applies to strike-out DFTL’s second cause of action on the basis that it is untenable. Mr Braun for Mr Hall submits that the derivative action is a nullity because DFTL failed to obtain leave under s 165 of the Act. He says any application for leave would fail because the proceedings would now be time-barred, and DFTL’s non-compliance with s 165 cannot be cured retrospectively.
[64] DFTL accepts that leave is required under s 165 and that leave has not been granted. However, Mr Cogan submits that the second cause of action is not untenable because leave would likely be granted under s 165 of the Act. He points out that Mega does not intend to pursue the directors.34 He submits that the conduct of the proceedings cannot be left to the defendant directors, or the shareholder group who benefited from the 2015 Rights Issues about which DFTL complains.35
[65]Section 165 of the Act provides as follows:
165 Derivative Actions
(1)Subject to subsection (3), the court may, on the application of a shareholder or director of a company, grant leave to that shareholder or director to—
(a)bring proceedings in the name and on behalf of the company or any related company; or
(b)intervene in proceedings to which the company or any related company is a party for the purpose of continuing, defending, or discontinuing the proceedings on behalf of the company or related company, as the case may be.
(2)Without limiting subsection (1), in determining whether to grant leave under that subsection, the court shall have regard to—
(a)the likelihood of the proceedings succeeding:
(b)the costs of the proceedings in relation to the relief likely to be obtained:
(c)any action already taken by the company or related company to obtain relief:
34 Companies Act, s 165(3)(a).
35 Companies Act, s 165(3)(b).
(d)the interests of the company or related company in the proceedings being commenced, continued, defended, or discontinued, as the case may be.
(3)Leave to bring proceedings or intervene in proceedings may be granted under subsection (1), only if the court is satisfied that either—
(a)the company or related company does not intend to bring, diligently continue or defend, or discontinue the proceedings, as the case may be; or
(b)it is in the interests of the company or related company that the conduct of the proceedings should not be left to the directors or to the determination of the shareholders as a whole.
(4)Notice of the application must be served on the company or related company.
(5)The company or related company—
(a)may appear and be heard; and
(b)must inform the court, whether or not it intends to bring, continue, defend, or discontinue the proceedings, as the case may be.
(6)Except as provided in this section, a shareholder is not entitled to bring or intervene in any proceedings in the name of, or on behalf of, a company or a related company.
[66] The question is whether DFTL’s failure to obtain leave renders its pleaded derivative proceeding a nullity, or whether that failure is merely a procedural defect that can be cured retrospectively. The answer depends on the proper construction of s 165.36 There are many cases in which Courts have had to deal with a plaintiff’s failure to comply with a statutory requirement to obtain leave. Consequences vary. Care must be taken when referring to decisions involving differently worded leave provisions in different contexts where different policy considerations will arise.37 In Seal v Chief Constable of South Wales Police, concerning s 139 of the Mental Health Act 1983 (UK), Lord Bingham held that:38
36 Body Corporate No 195843 v North Shore City Council [The Grange] [2011] 2 NZLR 222 (HC) at [9]–[15].
37 At [11], citing Emanuele v Australian Securities Commission (1997) 188 CLR 114 at 146–158 per Kirby J. See also Lord Bingham’s statement of the relevant interpretive principle in Seal v Chief Constable of South Wales Police [2007] UKHL 31, [2007] 4 All ER 177 at [5]–[7].
38 Seal v Chief Constable of South Wales Police, above n 37, at [7].
While, therefore, I incline to favour the Chief Constable’s reading of section 139(2), I do not think the answer to a question such as this should ordinarily turn on a detailed consideration of the language used by Parliament in one provision as compared with that used in another. The important question is whether, in requiring a particular condition to be satisfied before proceedings are brought, parliament intended to confer a substantial protection on the putative defendant, such as to invalidate proceedings brought without meeting the condition, or to impose a procedural requirement giving rights to the defendant if a claimant should fail to comply with the requirements; but not nullifying the proceeding… To answer this question a broader inquiry is called for.
[67] In the present context I accept Mr Braun’s submission that a plaintiff cannot commence a valid derivative action without first obtaining the leave of the Court to do so.
[68] Section 165(6) is clear. Without obtaining leave in accordance with s 165 a shareholder “is not entitled” to bring proceedings in the name of, or on behalf of, a company. In determining whether to grant leave under s 165, the Court must have regard to four mandatory considerations, including the likelihood of success and the interests of the company.39 The Court may only grant leave if one of two thresholds is met.40 The company must be served.41 It has a right to be heard, and must inform the Court whether it intends to bring a proceeding.42
[69] The overall scheme of ss 165 to 168 of the Act, which is an exhaustive code governing derivative actions,43 also reinforces that leave is a mandatory prerequisite to the Court’s jurisdiction to make orders in respect of a derivative action. The Court has various powers and supervisory functions set out in ss 166 to 168 which expressly apply only to proceedings brought by a shareholder “with leave of the Court under s 165”.
[70] This legislative history of ss 165 to 168 also confirms that the mandatory requirement for a plaintiff to seek leave to bring a derivative action was intended to provide substantive protection, not merely to impose a procedural step. In 1989, Te
39 Companies Act, s 165(2).
40 Companies Act, s 165(3).
41 Companies Act, s 165(4).
42 Companies Act, s 165(5).
43 Peters Watts, Neil Campbell and Christopher Hare Company Law in New Zealand (2nd ed, LexisNexis, Wellington, 2016) at [20.42].
Aka Matua o te Ture | Law Commission, introducing its proposed derivative action, explained that:44
Any shareholder, with the leave of the Court, may bring a derivative action to remedy a wrong done to the company (section 127). This provision, which is modelled on the Canadian reforms, does away with the rule in Foss v Harbottle while preserving, through court supervision, protection against abuse.
[71] In Parkinson v O’Brien the Court of Appeal has recently had to consider the nature of an application for leave under s 165.45 In the High Court, the respondent had commenced her (ultimately successful) application for leave as an interlocutory application, which she filed together with a statement of claim.46 Associate Judge Andrew (as he then was) held that the statement of claim must be treated as a draft pleading because, under s 165, no proceedings can be brought until leave is granted. The respondent subsequently argued that the appellant required leave to appeal from the High Court under s 56(3) of the Senior Courts Act 2016, contending that the leave application was an interlocutory application as defined in s 4(1) of the Senior Courts Act.
[72] The Court of Appeal disagreed. It found that, regardless of the form of the application in the High Court, it was not an interlocutory application as defined in s 4(1) of the Senior Courts Act 2016. Significantly, the Court of Appeal held:47
[31] The relief sought on the leave application under s 165 is a prerequisite to bringing a proceeding. Hence it cannot fairly be described as either ancillary or collateral to the ultimate relief in the proceeding that the applicant is seeking permission to commence. It is not a station a long the line but a destination in itself. That reality was recognised in Ms McCartney’s memorandum of 28 July 2020 in the High Court which referred to the s 165 application as having “concluded” and to the subsequently filed claim as “the separate substantive proceeding”.
[73] The Court of Appeal accepted counsel for the respondent’s submission that in a normal course an application for leave under s 165 should be made by originating application.48
44 Te Aka Matua o te Ture | Law Commission Company Law: Reform and Restatement (NZLC R9, 1989) at [568].
45 Parkinson v O’Brien [2021] NZCA 309.
46 O’Brien v Parkinson [2020] NZHC 1681 at [36].
47 Parkinson v O’Brien, above n 45, at [31].
48 At [32].
[74] For these reasons, I consider it is clear that Parliament intended the courts to have a substantive gatekeeping function, supervising the commencement as well as the conduct of the proceedings in which derivative actions are pursued. Section 165 is not simply a procedural mechanism governing the conduct of validly commenced proceedings. Unless s 165(6) is applied strictly in accordance with its terms, the prior supervision of the courts which Parliament clearly intended would be rendered nugatory. The court’s assessment of the mandatory considerations set out in s 165(3) could not adequately be undertaken retrospectively once proceedings are underway.
[75] For these reasons I also consider DFTL’s second cause of action is an abuse of process and should be struck out. I accept Mr Braun’s submission that the second cause of action is untenable, and the Court cannot retrospectively cure DFTL’s failure to seek leave. It may well be that any application for leave would fail because the proposed derivative action is time-barred. However, as Lord Bingham observed in Seal v Chief Constable of South Wales Police:49
[17] Counsel for Mr Seal made much of the injustice to a litigant such as Mr Seal if he learns that his proceedings are invalidated by failure to comply with a statutory requirement of which he was ignorant at a time when a statutory time bar effectively precluded him from retrieving his position by complying with the requirement. It must be accepted that a strict rule… may bear hardly on some litigants, of whom Mr Seal may be one. But, the [respondent] is entitled to reply that if Mr Seal had issued proceedings before the very end of the six-year limitation period his failure to obtain leave … would not have debarred him from prosecuting his claim. Thus the provision which effectively denies him the opportunity to proceed is not [the leave provision] but s 2 of the [Limitation Act 1980]. [The respondent] is also able to reply that Parliament must, in legislating as it did, have recognised the risk that hard cases, such as Mr Seal’s, may occur but have considered the occasional occurrence of such a case to be a price worth paying…
[76] Of course, in the present case DFTL was not ignorant of the need to apply for leave to bring the derivative action. As far back as September 2017, DFTL had arranged the consent of the plaintiffs in the 1272 Proceeding, and the Custodians, to a variation of the freezing orders to permit an application. But for reasons unknown it chose not to make that application, but instead to commence a substantive derivative action without leave. That option was not available to DFTL.
49 Seal v Chief Constable of South Wales Police, above n 37, at [17].
Security for costs
[77] Having determined that DFTL’s proceedings should be struck-out, it is not strictly necessary to deal with the application for security for costs. However, for completeness, I record that I would have made an award for security for costs, but not on the terms the applicants sought.
[78] The applicants jointly seek security for costs in the sum of $297,000 with leave reserved to apply for further security. The $297,000 figure represents costs calculated on a 3B basis, estimating a 10-day fixture; multiplied by two to cover the three applicants; with a discount which the applicants say accounts for their overlapping interests. The applicants seek orders that the security be paid in three equal tranches, with the first tranche to be paid immediately; the second tranche to be paid on the making of discovery orders; and the third tranche to be paid when the plaintiffs serve their briefs of evidence. The applicants also seek orders that if DFTL does not pay security when ordered to do so the proceedings be stayed or struck out.
[79] The relevant principles are well established and not in dispute. If a Judge is satisfied there is reason to believe that a plaintiff will be unable to pay the defendant’s costs if the plaintiff is unsuccessful, the Judge may order the plaintiff to pay security for costs where, in the Judge’s discretion, it is just and reasonable to do so.50
[80] DFTL acknowledges that its primary asset, namely its shareholding in Mega, is subject to the freezing orders. However, Mr Cogan submits that the more operative cause of any difficulties DFTL might have paying costs is the dilution of DFTL’s shareholding because of the defendants’ pleaded misconduct. Mr Cogan also submits that the amount of security the applicants seek is unreasonable, as would be an order that DFTL’s claim be struck out if the first tranche is not paid immediately.
50 High Court Rules, r 5.45; see A S McLachlan Ltd v MEL Network Ltd (2002) 16 PRNZ 747 (CA).
[81] DFTL is clearly impecunious. Its primary assets are frozen, so should be put to one side when assessing DFTL’s ability to pay costs.51 The applicants are not responsible for the freezing orders. Nor can the Court conclude at this stage that the applicants are responsible for the dilution of its shareholding in Mega. That dilution came about at least in part because the Court declined DFTL and Mr Dotcom’s application to vary the freezing orders in a way that would enable DFTL to participate in the December 2015 Rights Issue. In any event, the Courts have previously warned of the inherent circularity in a plaintiff’s argument, in the context of a security for costs application, that the defendants have caused the plaintiff’s impecuniosity.52
[82] In assessing the appropriate amount of security for costs it is obviously relevant that Mega is almost wholly owned by CTSL. And Mr Hall is a director of Mega. I do not consider the security the applicants seek adequately reflects their overlapping interests.
[83] In circumstances where DFTL’s assets are unlikely to be available to meet any costs awards, I would have ordered DFTL to provide security for costs of $150,000 to be paid in three equal tranches: first, within 20 working days from the date of the order; second, when discovery orders are made; and third, when the plaintiff served its briefs of evidence. I would have ordered further that the proceedings would be stayed if any of these payments were not made at these times, and that the applicants have leave to apply further.
Result
[84]The application to strike-out the proceedings is granted.
[85] The applicants are entitled to costs. My initial view is that these should be calculated on a 2b basis. If the parties are unable to agree the applicants should file submissions of not more than five pages in length (excluding attachments) within 20
51 Sisson v IAG New Zealand Ltd [2014] NZHC 616 at [61].
52 Computer Training Services Ltd v Universal Data Systems Ltd (2001) 15 NZ 401 (CA) at [43]; Birnie Capital Property Partnership Ltd v Birnie HC Auckland CIV-2010-404-3000, 29 October 2010 at [48]-[49].
working days. DFTL should file submissions of the same length 10 working days after that. I will deal with the matter on the papers unless I require any further assistance.
Robinson J
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