Financial Markets Authority v Hotchin

[2012] NZHC 323

IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY

CIV 2010-404-8082 [2012] NZHC 323

UNDER  The Securities Act 1978 and Part 18 of the

High Court Rules 2009

IN THE MATTER OF     an application under section 65A of the

Securities Act 1978

BETWEEN  THE FINANCIAL MARKETS AUTHORITY

Plaintiff

ANDMARK STEPHEN HOTCHIN First Defendant

ANDKA NO 4 TRUSTEE LIMITED Second Defendant

ANDKA NO 3 TRUSTEE LIMITED Third Defendant

Hearing:         8 November 2011 (further submissions received 16, 18 November

2011)

Appearances: K McDonald QC, P Courtney, G Allan for plaintiff

R B Stewart QC and N Gedye for first defendant
J Long and I Hikaka for second and third defendants

Judgment:      21 February 2012

JUDGMENT OF WINKELMANN J

This judgment was delivered by me on 21 February 2012 at 10 am pursuant to

Rule 11.5 of the High Court Rules.

Registrar/ Deputy Registrar

FINANCIAL MARKETS AUTHORITY V HOTCHIN HC AK CIV 2010-404-8082 [21 February 2012]

[1]      The second and third defendants, KA No 4 Trustee Ltd and KA No 3 Trustee Ltd (KA4 and KA3 respectively) are corporate trustees of two trusts linked to the first defendant Mr Hotchin, and are joined as defendants in that capacity.   The plaintiff, the Financial Markets Authority (FMA), is investigating suspected breaches of the Securities Act 1978 (the Act) by Mr Hotchin in his role as a director of companies within the Hanover Group of companies.  All three defendants are presently the subject of interim asset preservation orders granted in December 2010,

pursuant to s 60I of the Act.1    The orders were made to ensure that assets that are

available to meet any claims of aggrieved persons are preserved.2

[2]      Earlier this year, KA4 and KA3 applied for summary judgment against the FMA on the grounds that there was no proper factual basis for the FMA‘s allegation that the trusts hold any property on behalf of Mr Hotchin or that he is in control of the trusts‘ property.   They also applied for orders striking out the claims on the grounds that they amounted to an abuse of process.   Although declining the applications, I found that the claim as pleaded against each trust disclosed no reasonably arguable claim, and gave leave to re-plead against those defendants.

[3]      The  FMA has  now  re-pleaded  its  claim  against  each  of  the  trusts.    In response, KA4 and KA3 have filed fresh applications to strike out, but this time on the grounds that some claims disclose no reasonably arguable cause of action and others amount to an abuse of process.  If successful with this application, KA4 and KA3 seek further orders removing KA3 as a defendant, and varying interim orders.

The statutory context

[4]      The difficulty identified in my May judgment,3  related to the jurisdictional preconditions under s 60H(1) which stipulates the categories of property which may

1      Although the initial orders were made in December 2010, they have been varied on several occasions since that time.

2      Aggrieved person is defined in s 60G of the Act as meaning any person to whom a relevant person is liable. Liable means liable, or may be or become liable, to pay money (whether in respect of a debt, by way of damages or compensation, or otherwise) or to account for securities or other property.

3      Financial Markets Authority v Hotchin [2011] 3 NZLR 469 (HC).

be subject to interim preservation orders made under ss 60G and 60I.    Section

60H(1) provides in material part:

60H     What orders may be made

(1)      The orders that may be made under section 60G are—

(a)       an order prohibiting the relevant person from transferring, charging,  or  otherwise  dealing with  money,  securities,  or other property held or controlled by the relevant person:

(b)       an order prohibiting a person who is indebted to the relevant person or to an associated person of the relevant person from making a payment in total or partial discharge of the debt to, or to another person at the direction or request of, the person to whom the debt is owed:

(c)       an order prohibiting a person holding money, securities, or other property, on behalf of the relevant person, or on behalf of an associated person of the relevant person, from paying all or any of the money, or transferring, or otherwise parting with possession of, the securities or other property, to, or to another person at the direction or request of, the person on whose behalf the money, securities, or other property, is or are held:

(d)       an  order  prohibiting  the  taking  or  sending  out  of  New Zealand by a person of money of the relevant person or of an associated person of the relevant person:

(e)       an order prohibiting the taking, sending, or transfer by a person of securities or other property of the relevant person, or of an associated person of the relevant person from a place in New Zealand to a place outside New Zealand (including the transfer of securities from a register in New Zealand to a register outside New Zealand):

(f)       an order requiring the relevant person, or any person holding money, securities, or other property on behalf of the relevant person or an associated person of the relevant person, to pay or transfer money, securities, or other property to a specified person to be held on trust pending determination of the investigation, prosecution, or civil proceeding:

(g)      an order appointing,—

(i)        if the relevant person is a natural person, a receiver or trustee, having any powers that the Court orders, of the property or of part of the property of that person; or

(ii)      if the relevant person is a body corporate, a receiver or receiver and manager, having any powers that the

Court  orders,  of  the  property  or  of  part  of  the property of that person:

(ga)     an order—

(i)        removing  a  person  from  being  a  manager  of  a scheme to which the investigation, prosecution, or proceedings  referred  to  in  section  60G(1)  relates; and

(ii)      appointing  another  person  as  the  manager  of  the scheme (with any powers that the court orders):

(h)       if the relevant person is a natural person, an order requiring that person to deliver up to the Court his or her passport and any other documents that the Court thinks fit:

(i)        if   the   relevant   person   is   a   natural   person,   an   order prohibiting that person from leaving New Zealand, without the consent of the Court.

(2)       A reference  in  subsection  (1)(e)  or  (g)  to  property  of  a  person includes a reference to property that the person holds otherwise than as sole beneficial owner, for example,—

(a)       as trustee for, as nominee for, or otherwise on behalf of or on account of, another person; or

(b)      in a fiduciary capacity.

(3)       An order may be expressed to operate for a specified period or until the order is discharged by a further order under this section.

[5]      In my May judgment, I held that the claim as pleaded did not disclose a possible or prima facie basis that any of the property of KA4 and KA3 fell within one of the s 60H categories.4

The amended claim

[6]      The FMA filed its third amended statement of claim in June 2011.5     As against KA4, it pleads that:

(a)       it holds property in Paratai Drive, Auckland, subject to an equitable

lease in Mr Hotchin‘s favour, arising from a contract between KA3

4      Hotchin, above n 3 at [59], [132] – [133].

5      Shortly after, and replacing, a second amended statement of claim.

and KA4 in which it was agreed that in return for KA3 funding part of the construction of a house on the site, KA4 would grant a lease to Mr Hotchin for a term of 10 years with two rights of renewal of 10 years each.

(b)      it   holds   the   same   property   subject   to   an   equitable   lease   in

Mr Hotchin‘s favour, arising from an estoppels and/or contract.

(c)      it owes Mr Hotchin approximately $12 million for money he has spent on the construction of a house on that Paratai Drive property.

(d)the  house  is  a  wrongly  placed  structure  for  the  purposes  of  the Property Law Act 2007 and Mr Hotchin is entitled to claim reasonable compensation for the construction of the house on the property.

[7]      In respect of KA3, the FMA pleads that it is indebted to Mr Hotchin in the sum of at least $105,104.  During the course of the hearing the FMA accepted that the amount owing by KA3 to Mr Hotchin had been repaid, so that basis of claim against KA3 falls away.6

[8]      In respect of both KA4 and KA3 it pleads that:

(a)       they  hold  funds  on  behalf  of  associated  persons,  as  that  term  is

defined in the Act, namely, Mr Hotchin‘s children;

(b)the Trusts were not intended to be legally binding, and so are void for lack of intention to create valid trusts;

(c)       the Trusts were a sham.

[9]      This last pleading is scant in detail, and as conceded by Ms MacDonald for the FMA, rather confusing, if not confused.  The FMA intends to encapsulate in this

6      This means that the allegation in [62] and the claim for relief at [85] are spent.

one pleading, three separate bases for contending that the trusts hold the corpus of the Trust on behalf of Mr Hotchin. These three bases are:

(a)      Mr  Hotchin  did  not  intend  to  create  a  binding  trust,  and  this  is evidenced  by  the  power  to  control  the  trusts  which  Mr  Hotchin retained on settlement.   Properly interpreted the arrangements were and were intended to be a legal structure to hold the property for the settlor;

(b)the Trusts were a ―sham‖ from settlement, and were therefore void from the beginning;

(c)      if not void from the date of settlement, because they were a sham, the Trusts became a sham (and therefore void) over time because of how they were operated.

[10]     KA4 and KA3 accept that the equitable lease, debt and Property Law Act claims disclose arguable causes of action that can only be determined at trial.  They share a common key issue, the proper characterisation of the development of the Paratai Drive site, and the money that Mr Hotchin contributed to that development. However, both KA4 and KA3 argue that the ―associated persons‖ pleading should be struck out as the trustees do not hold the property ―on behalf‖ of the children, as that expression is used in the Act.

[11]     The trustees argue that the sham pleading should be struck out as an abuse of process.  Such a pleading is in substance a pleading of fraud, and should be properly particularised.    It  is  not.    In  response  to  the  clarification  of  the  pleading  and particulars provided at hearing, Mr Long for KA4 and KA3 also submitted that all of the three variants of the cause of action described in [8] above have no prospect of success, and should be struck out.

[12]     Finally, KA4 argues that none of the pleadings in relation to the Paratai Drive property can found a claim that Mr Hotchin has an interest in the freehold.   The preservation orders should be varied to reflect this so that what is preserved is the

potential asset in Mr Hotchin‘s hands, a debt owed by the KA4 Trust, and not the

property, in which Mr Hotchin has no interest.

Strike out principles

[13]     The principles governing the determination of strike out applications are well established.

[14]     The court may strike out all or part of a pleading, under r 15.1, High Court

Rules, if it –

(a)      discloses no reasonably arguable cause of action, defence, or case appropriate to the nature of the pleading; or

(b)      is likely to cause prejudice or delay; or

(c)       is frivolous or vexatious; or

(d)      is otherwise an abuse of the process of the court.

[15]     The principles attaching to an application to strike out pleadings under r 15.1 were set out by the Court of Appeal in Attorney-General v Prince,7 and affirmed by the Supreme Court in Couch v Attorney-General.8    In summary:

(a)      Pleaded facts, whether or not admitted, are assumed to be true.  This does not extend to pleaded allegations which are entirely speculative and without foundation.

(b)The cause of action or defence must be clearly untenable so that it cannot possibly succeed.9

7      Attorney-General v Prince [1998] 1 NZLR 262 (CA).

8      Couch v Attorney-General [2010] 3 NZLR 149 (SC).

9      R v Lucas & Son (Nelson Mail) Ltd v O’Brien [1978] 2 NZLR 289 (CA) at 294-295; Takaro

Properties Ltd v Rowling [1987] 2 NZLR 314 (PC) at 316-317.

(c)         The jurisdiction is to be exercised sparingly, and only in clear cases.10

This reflects the Court‘s reluctance to terminate a claim or defence

short of trial.

(d)The  jurisdiction  is  not  excluded  by  the  need  to  decide  difficult questions of law, requiring extensive argument.

(e)         The Court should be slow to strike out a claim in any developing area of the law, particularly where a duty of care is alleged in a new situation.

[16]     Further, in Couch, Elias CJ said:11

It is inappropriate to strike out a claim summarily unless the court can be certain that it cannot succeed.  The case must be ―so certainly or clearly bad‖ that it should be precluded from going forward.  Particular care is required in areas where the law is confused or developing.

[17]     A claim may be struck out as an abuse of process where it is shown that process ancillary to a principal claim for relief has been used to effect an object not within the scope of that process and rather to seek a collateral advantage.12  However, a proceeding will not be an abuse of process merely because it appears to lack merit or the defendant considers it has a complete defence to the claim.13

First Issue:   Do the interests of the children in the corpus of the trusts fall within any of the categories of property in s 60H(1)?

[18]     The associated persons pleading invokes the provisions of s 60H(1)(f) as the grounds for making preservation orders against both trusts.  The FMA seeks orders that Mr Hotchin, or KA4 and KA3 be ordered to transfer the trust funds of the two

Trusts  to  a  specified  person  to  be  held  on  trust  pending  determination  of  the

10     Gartside v Sheffield, Young & Ellis [1983] NZLR 37 (CA) at 45; Electricity Corporation Ltd v

Geotherm Energy Ltd [1992] NZLR 641 (CA).

11     Couch, above n 7 at [33].

12     Ullrich v Ullrich (1996) 10 PRNZ 253 (HC) at 255-256; Hanrahan v Ainsworth (1990) 22

NSWLR 73 at 112.

13     Geotherm Energy Ltd v Electricorp Ltd (1991) 4 PRNZ 231 (CA).

investigation, or if they eventuate, the prosecution or civil proceeding.  I note that no interim order has been sought to this effect.

[19]     It is common ground that Mr Hotchin‘s children are associated persons for the purposes of this subsection.  But KA4 and KA3 contend that, in the context of the section, the expression ―on behalf of‖ means that the person on whose behalf the property is held must have such an interest in the property, or control over it that they are be able to make a demand for the property that the holder must comply with. Such a reading, it is said, is consistent with the purpose of sections 60G and 60H which is to preserve assets against which a judgment could be enforced.  In this case, the children are discretionary beneficiaries, and final beneficiaries.  Although final beneficiaries, the Trusts do not vest until May 2083 in respect of the KA4 Trust or 23

December 2079 in respect of the KA3 Trust.  The class of discretionary beneficiaries is not closed.  The children are not then able to make a demand for the corpus of the Trust with which the trustees must, or can be compelled to comply.

[20]     The FMA contends that trustees of both KA4 Trust and KA3 Trust hold the corpus of the Trusts on behalf of the entire class of beneficiaries (discretionary and final, actual and potential) who will, in the aggregate and one way or another, enjoy the benefit of the property during the period when the Trusts are administered in accordance with law.  Since a possible meaning of ―hold on behalf of‖ extends to a discretionary trust, s 60H(1)(f) applies to a discretionary trust.   The FMA submits that ultimately the Court will be asked to determine whether Mr Hotchin has any claims on the Trusts‘ funds, including a beneficial interest in the funds arising out of resulting trusts or out of an equitable lease relating to the Paratai Drive property.  It is therefore vital that KA4 and KA3 not dissipate the corpus of the Trusts as that could  prejudice  the  ability  of  aggrieved  persons  to  recover  damages  from Mr Hotchin.

Analysis

[21]     As with every issue of statutory interpretation, the starting point is s 5 of the

Interpretation Act 1999 which provides:

The meaning of an enactment must be ascertained from its text and in the light of its purpose.

[22]     Do the trustees (KA4 and KA3) hold the assets of the Trusts ―on behalf of‖ discretionary beneficiaries or final beneficiaries?  Neither category presently has a beneficial  interest  in  the  trust  funds.    A discretionary  beneficiary  has  a  ―mere expectancy‖ and a final beneficiary, a residual interest.   Neither category of beneficiary can presently compel the distribution of trust funds to them.

[23]     The expression ―on behalf of‖ is neither defined within the Act, nor a term with any accepted meaning in law.  In Cuthbertson & Richards Sawmills Pty Ltd v Thomas,14  the New South Wales Court of Appeal considered the meaning of the expression ―on behalf of‖ in a section of the Corporations Law dealing with transactions  which  may  be  set  aside  by  a  liquidator.    The  Court  referred  with approval to the following discussion by the High Court of Australia of the expression in R v Toohey; Ex parte Attorney General (NT):15

―it bears no single and constant significance.   Instead it may be used in conjunction with a wide range of relationships, all however, in some way concerned with the standing of one person as auxiliary or representative of another person or thing.

...

Context will always determine to which of the many possible relationships the phrase ‗on behalf of‘ is in a particular case being applied; ‗the context and subject matter‘ (authority cited) will be determinative‘

[24]     It is clear from the text, however, that the legislature has allowed a very wide net to be cast, sufficient to capture assets of the relevant person which are held or owned by others.  Caught within that net are the assets of associated persons,16 and also assets held by the relevant person other than beneficially, for example, assets held by the relevant person as a trustee or in a fiduciary capacity.17    These are not prima facie, assets available to meet a judgment against a relevant person.  For this

reason, the argument that the categories in s 60H should be construed as capturing

14 [1999] FCA 315.

15 (1980) 145 CLR 374 at 386.

16     Securities Act 1978, ss 60H(1)(c),(d), (e) and (f).

17     Securities Act 1978, ss 60H(1)(e), (g) and s 60H(2).

only assets against which judgment against the relevant person could be enforced is unsustainable.   Rather the scheme of the legislation seems to create a broad jurisdiction to grant preservation orders, leaving for the discretionary phase the issue of whether the assets are likely to be available to meet any judgment obtained by aggrieved  persons  against   the  relevant  person.     This  analysis  supports  the construction of s 60H(1)(f) contended for by the FMA.

[25]     As to the purpose of the legislation I have previously described that purpose as follows:18

The purpose of sections 60G to 60I is to ensure that the rights of aggrieved persons to damages, compensation or restitution are not frustrated through the assets of a liable person being dealt with in a way that renders them unavailable to meet those claims.  There is a public interest in ensuring that those who solicit public money through the use of untrue statements are brought to account.

This purpose is consistent with the interpretation contended for by the FMA.

[26]     For these reasons, I prefer the interpretation that the trustees hold the funds

―on behalf of‖ the discretionary beneficiaries, and the final beneficiaries, even if subject to the terms of the Trusts.  The applications by KA4 and KA3 to strike out this cause of action is therefore declined.

Second Issue: Do the trust documents create a trust?

[27]     The FMA argues that in the case of both of the Trusts, the substance of the trust deeds is such that the essential characteristics of a trust obligation are absent.  It is trite law that for there to be a valid express trust there must be a valid specific trust obligation in favour of a sufficiently certain group of people in respect of sufficiently certain property.  The FMA argues that through the powers Mr Hotchin has reserved to  himself  in  the  trust  deeds,  he  is  able  to  reclaim  the  property  for  himself beneficially.   He has not therefore truly transferred the beneficial interest in the property to the trustees to hold for the beneficiaries, and the requisite certainty of intention is missing.  Although not reflected in its third amended statement of claim, Ms MacDonald clarifies that this argument is intended to be encapsulated within the

present ‗sham‘ pleading, but accepts that it is to be distinguished from a pleading of

sham.

[28]     For KA4 and KA3, Mr Long submits that these are standard trust deeds, in which Mr Hotchin has clearly declared an intention to create a trust in favour of the discretionary and final beneficiaries.  The terms of the deeds cannot possibly support the argument put forward by the FMA.

Analysis

[29]     The distinction Ms MacDonald seeks to draw is that described by Dillon LJ in Welsh Development Agency v Export Finance Co Ltd.19   In that case a distinction was drawn between the class of case where parties entered into a written agreement which was ―a sham intended to mask their true agreement‖,  and the class of case where, without any question of sham, there ―has been held to be some objective criterion in law by which the courts can test whether the agreement that the parties have made does or does not fall into the legal category in which the parties have sought to place their agreement.‖

[30]     The issue in this case is therefore whether, in light of the provisions of the trust deeds, it is arguable that Mr Hotchin retains such control that the proper construction is that he did not intend to give or part with control over the property sufficient to constitute a trust.

[31]     Relevant facts are as follows.  The KA4 Trust was created by a written deed of trust dated 1 May 2003.   Mr Hotchin was the settlor.   Until 2005 he was sole trustee.  From then until May 2009 he was co-trustee with Mr Radley.  From May until the present, KA 4 has been the sole trustee.  Mr Thomas is the sole shareholder and director of KA 4 and of many other companies associated with Mr Hotchin.

[32]     Mr Hotchin is not presently a discretionary beneficiary of the trust, although the pool of discretionary beneficiaries is not closed.  Mr Hotchin has the power to nominate  and  remove  discretionary  beneficiaries  (cl  7.1).    He  is  not  a  final

beneficiary of the trust, the final beneficiaries are his children.  Mr Hotchin also has the power to appoint and remove trustees (cl 17.1).  Pursuant to cl 17.2, Mr Hotchin may transfer his powers in relation to the appointment and removal of trustees to another nominated person.

[33]     Clause 11.1 establishes the trustee‘s unfettered discretion.  It states:

[f]or the avoidance of doubt and notwithstanding anything in this deed or any rule of law which imposes upon the trustee the duty to act impartially towards beneficiaries, the trustee shall have unfettered discretion as to the exercise of the powers and discretions conferred upon them by this deed even though:

(a)       The interests of all beneficiaries are not considered by the trustee;

(b)      The exercise would or might be contrary to the interests of a future beneficiary [...]

[34]     The trust deed includes a self-dealing clause.   Clause 14.1 states that no trustee who is also a beneficiary shall exercise any power or discretion vested in the trustee in his own favour.  Clause 14.1 is subject to cl 14.2 which provides that any power or discretion vested in the trustee may be exercised in favour of a trustee who is also a beneficiary by the other trustee or trustees.

[35]     Clause 23.1 provides for the amendment of the trust deed.  It states:

The Trustee may, with the prior written consent of the Settlor while the Settlor is living, at any time or times during the Trust Period, and without infringing the rule against perpetuities, vary, revoke or enlarge all or any of the provisions of this deed concerning the management or administration of the Trust.

[36]     The KA 3 Trust was created by a written deed of trust dated 23 December

1999.  Mr Hotchin was the settlor and Mr Radley and Mr Michael Ward were the two initial trustees.  The trustees have changed over time, but since 2003 the trustee has been KA3.  Since April 2010, the sole director and shareholder of KA3 has been Mr Thomas.   Mr Hotchin is one of a number of discretionary beneficiaries of the Trust, but is not the sole discretionary beneficiary, nor is he a final beneficiary.  As with the KA4 Trust, the final beneficiaries of  the KA3 Trust are Mr Hotchin‘s children.

[37]     The terms of the KA3 trust deed are materially the same as those set out in the KA4 Trust deed.   Mr Hotchin has both the power to appoint and remove discretionary beneficiaries, and to appoint and  remove trustees.   The trust deed contains the same prohibition against a trustee distributing to himself and the same provision for amendment of the trust deed.

[38]     The arguments advanced by the FMA are not novel, although they do not previously seem to have come before the courts in New Zealand.   In Hughes v Stubb,20  Wigram VC said that questions of considerable difficulty may arise as to whether a trust has been constituted in cases where ―a person not intending to give or to part with the dominion over his property may retain such dominion, notwithstanding he may have vested the property in trustees, and have declared a

trust upon it in favour of third persons‖.  More recently, on an appeal from the Court of Appeal of the Cayman Islands, the Privy Council held that a power in the Settlor to revoke the trust deed, unconstrained by fiduciary duties, was tantamount to ownership.21

[39]     The FMA also referred me to a decision of the UK Court of Appeal, Whaley v Whaley in which the issue was what the resources of the parties were in the context of a matrimonial property dispute.  However, that case is of no assistance here, as the decision of the Court turned upon a particular statutory provision, which enabled the court to take into consideration the financial resources which each of the parties to the marriage, ―has or is likely to have in the foreseeable future‖.22

[40]     Mr Hotchin has the power of appointment of both trustees, and discretionary beneficiaries in respect of both trusts.  It is therefore within Mr Hotchin‘s power to appoint himself sole trustee and then appoint himself a discretionary beneficiary. The deeds confer unfettered discretion upon the trustees to distribute the property without considering the interests of any beneficiary, including future beneficiaries. Even so, no trustee, including Mr Hotchin, may use control as a trustee to distribute

trust property to himself. The prohibition on self dealing prevents that.

20 (1842) 1 Hare 476.

21     Tasarruf Merduati Sigorta Fonu v Merrill Lynch Bank and Trust Co Ltd [2011] UKPC 17.

22 [2011] EWCA Civ 617 (CA).

[41]     Is the prohibition against self dealing fatal to the FMA‘s argument?  Perhaps not.  There needs to be added to the picture the trustees‘ power to amend the deeds‘ provisions in relation to the administration and management of the trusts.  Does this permit a trustee to amend the deeds to revoke the prohibition on self dealing? Even if the prohibition against self dealing is properly construed as a matter affecting the administration or management of the trust, it would be impossible to justify such a step as a proper exercise of a power by the trustee or trustees.  Such an amendment would not be for the purposes of carrying the trusts created by the deeds into effect, but rather for Mr Hotchin‘s benefit.  It would itself be a breach of the prohibition on self dealing.  The beneficiaries would have good grounds to complain of a breach of fiduciary duty, and if necessary seek recovery of any distributions to the settlor achieved  by this  device.    This  case  is  therefore  distinguishable  from  the  Privy Council decision referred to, as in that case the power of revocation was a power retained by the settlor in his capacity as settlor, and was thus unconstrained by fiduciary duties.

[42]     I am therefore satisfied that the claim as articulated against KA4 and KA3 on the basis of lack of certainty of intention to create a trust, has no prospect of success. As Mr Long points out, we are in the unsatisfactory position that there currently is no pleading of this claim in the form now articulated, to strike out.

Third Issue:  Sham

[43]     At the hearing counsel for the FMA clarified that it intended by its pleading to allege that the Trusts were sham from the inception, or in the alternative, that the Trusts, although properly constituted, became sham (or emerged as a sham) because of how they operated, under the effective control of Mr Hotchin, the settlor.

[44]     KA4 and KA3 say that any sham pleading is a pleading of fraud, and so must be properly particularised, yet the existing pleading provides almost no particulars. The particulars that are provided are all post formation of the Trust, and therefore too late to be relevant to the parties intention at the time of the formation.  The trusts have requested particulars of the FMA, with the response that the information required to provide further particulars is in the hands of the Trust.  This, say KA4

and KA3, suggests that the claim is no more than a fishing expedition by the FMA, an abuse of process when the allegation involved entails fraud.  The claim should therefore be struck out.

[45]     KA3 and KA4 argue that even on the material that the FMA has, belatedly, offered by way of particularisation, the claim of sham cannot succeed, and should be struck out.

[46]     The FMA contends that after considering the terms of the trust deeds, the facts known about the relationship between the settlor and trustees, and after giving consideration to the nature of transactions entered into by the trustees, there is a tenable argument that the trusts were a sham from inception, or became a sham.

Relevant Principles

[47]     KA3 and KA4 have argued that any allegation of fraud or dishonesty must be supported by particulars.   An allegation of sham is an allegation of dishonesty, because it necessarily entails an intention to deceive.   As such it should not be pleaded unless there is a proper basis to allege fraud, and that basis should be particularised.  Particulars must be provided of facts which if proved, could properly

lead to an inference that the trusts are sham.23   However, the Court may be entitled to

take into account that further facts and evidence of dishonesty may turn up before trial.24

[48]     The classic statement of the sham doctrine is that of Diplock LJ in Snook v

London and West Riding Investments Limited:25

it means acts done or documents executed by the parties to the ‗sham‘ which are intended by them to give third parties or to the court the appearance of creating between the parties legal rights and obligation different from the actual legal rights and obligations (if any) which the parties intended to created.

[49]     The legal requirements for a sham to exist are:

23     Three Rivers District Council v Bank of England (No 3) [2003] 2 AC1.

24     Brown v Bennett (No 2 )[2002] 1 WLR 713 per Neuberger J at 750 at [112].

25 [1967] 2 QB 786, 802.

(a)      Documents are executed or created which are intended to generate a false or misleading appearance that certain rights and obligations have been created. The trust deed is effectively a mask, cloak, or facade for the true position between the parties.

(b)In a trust established by a bilateral transaction (such as a trust deed executed by both the settlor and by a separate trustee or trustees) the preponderance of authority suggests a requirement that there be a common intention to mislead, in the sense that both the settlor and the trustees so intend.  In a unilateral transaction, such as where the Trust is  settled  and  managed  (as  trustee)  by  the  same  person,  the requirement for common intention is not present.  In Official Assignee

v Wilson,26  the Court of Appeal held that for a self-declaratory trust

dependent only on the settlor‘s intention, it is only the settlor‘s intention that will be relevant.   Where a trust is created bilaterally between the settlor and a separate trustee it is necessary to consider their shared intention.27

(c)      Consideration of whether a trust or transaction is a sham requires a departure from the general rule that contractual and legal documents are to be construed on the objective meaning that their terms would convey to a reasonable person.  In examining whether an arrangement is a sham, it is inevitable that the parties‘ subjective intentions must be considered.    Therefore,  evidence  of  a  subjective  ―sham‖  intent  is

required.

26 [2008] 3 NZLR 45 (CA).

27 At [40]-[41]. I note there is some debate in academic writing as to whether common intention is required even in a bilateral trust situation, or whether it will be enough if it is the intention of the settlor to mislead. See M Conaglen ―Sham Trusts‖ (2008) 67 CLJ 176; J Palmer ―Dealing with the Emerging Popularity of Sham Trusts‖ [2007] NZLR 81 and Law Commission Some Issues with the Use of Trusts in New Zealand (NZLC IP20, 2010) at 42.

(d)There will be no sham where the parties have merely chosen one form of transaction over another where either were equally available to the parties in the circumstances.28

[50]     The  courts  have  adopted  a  cautious  approach  to  arguments  of  sham, recognising the need for certainty in property transactions and the allegation of deceit it involves.

[51]     In the third amended statement of claim, under a heading of ―sham‖,  the FMA alleges  that  the  Trusts  were  not  intended  to  be  legally  binding,  and  that Mr Hotchin continued to treat the assets of the KA4 and KA3 Trusts as his own, with particulars provided as follows:

80.1The first defendant took the steps referred to ….. leading to the construction of the Residence on land purportedly owned by the second defendant (KA4 Trustee), in circumstances where the trustee was not willing to be responsible for the cost of construction.

80.2The first defendant borrowed money personally to fund development of the Residence.

80.3The first  defendant‘s  residence at 46A Matapana Road, Waiheke Island, was sold by the first defendant and John Radley (purportedly as trustees of the KA4 Trust) to the third defendant (KA3 Trustee) on

23 December 2008:

80.3.1 for the purpose of enabling the first defendant to have the property pledged in support of the $10 million personal guarantee he had provided to back the shareholder support package under debt restructuring proposals relating to the companies, which had been put to depositors only weeks earlier, and

80.3.2with the results that (i) KA3 Trustee executed a deed of indemnity in favour of the first defendant to the value of $10 million (supported by recourse to the property) and (ii) a caveat was lodged over the property by New Zealand Guardian Trust.

80.3.4 Until 13 June 2011 the first defendant retained powers to enable him to control absolutely activities associated with the KA4 and KA3 Trusts but, from 14 June 2011, purported to divest himself of the unilateral power to appoint trustees,

28     Bateman Television Ltd v Coleridge Finance Co Ltd [1969] NZLR 794 (CA); Marac Finance

Ltd v Virtue [1981] 1 NZLR 586 (CA) at 587.

nominating as co-appointer his mother, while retaining all other relevant powers of control.

81.The KA4 and KA3 Trusts were void for lack of intention to create valid trusts.

82.Consequently, the trust funds are held by KA4 and KA3 Trustees on trust for the first defendant as settler of invalid trusts.

[52]     The pleading and the particulars are inadequate and I admit to frustration that after three attempts the FMA has still not managed to articulate a pleading of sham, however bold its heading.  It was not until argument before me that it became plain what is alleged by the FMA in relation to its ―conventional‖ sham argument.29    Ms MacDonald enlarged upon the pleadings considerably during the course of her oral submissions.30   She said that the FMA alleges that the Trusts were set up to conceal Mr Hotchin‘s continued enjoyment of all of the normal incidents of ownership in respect of the trust property.  He maintained full and effective control over the assets. She pointed to the following:

(a)       The structure of the trust deeds which give so much control to the

Settlor.31

(b)At the time that the KA4 Trust was established, Mr Hotchin was both the settlor, and sole Trustee.

(c)      Since May 2009 in the case of KA4, and April 2010 in the case of KA3, the sole shareholder and director has been Mr Tony Thomas. Mr Thomas is used by Mr Hotchin as a director and shareholder in many companies associated with Mr Hotchin and his interests.

(d)      There is an absence of evidence of ―push back‖ by trustees. The FMA

had found only one incident where trustees had declined to do what

Mr Hotchin had wanted with the assets of the Trusts.  This was in the

29     I say conventional to distinguish it from the argument or intended pleading in relation to an emerging sham.

30     The fact that KA3 and KA4 and I had to wait to hear oral submissions before being provided with any meaningful detail in relation to the allegation of sham is deplorable.

31     The features of the deeds set out at [30] to [36] above.

case of a trustee of the KA4 Trust in relation to the Paratai Drive property.

(e)      There are however instances where the trustees have acted purely in Mr Hotchin‘s interests, seemingly at his direction.  In the case of KA3 and KA4, the FMA points to the Matapana Road transaction.  In that transaction KA4 Trust transferred 46A Matapara Road to KA3 Trust in exchange for a forgiveness of a debt owed by KA4 Trust to KA 3

Trust.   KA3 Trust then provided an indemnity to support certain of Mr Hotchin‘s obligations in relation to one of the restructurings of the Hanover Group.   46A Matapara Road was used to support that indemnity.

(f)       It also points to dealings in respect of the Paratai Drive property.

Although it is as notionally owned by KA4 Trust, Mr Hotchin spent

$12 million dollars constructing a house on the property.  There was no  formal  documentation  as  to  the  basis  upon  which  this  was occurring, or even initially any informal understanding with the Trust. Then when Mr Hotchin ran out of money to fund the construction, KA3 Trust  advanced  KA4 Trust  $2.5  million,  on  the  basis  of  an understanding reached with KA4 Trust that it would grant Mr Hotchin and his family a long term lease, and that, if when the property was sold, the value of the house was less than the total cost, the amount of the loan by KA3 Trust to KA4 Trust would be reduced by the difference between valuation and cost.

Analysis

[53]     In the case of the KA4 Trust there are sufficient particulars to support an arguable case of sham.   The Trust was set up with a single trustee, Mr Hotchin. Aspects of how it was operated, particularly in relation to the Paritai Drive property suggest  that  assets  of  the  Trust  have  been,  and  been  allowed  to  be  treated  as Mr Hotchin‘s although these transactions occurred after settlement.  Although some

of this is evidence of conduct occurring after settlement of the trust, post-settlement evidence can shed light on what was intended at the time the Trust was settled.

[54]     The particulars suggested for the KA3 Trust are more scant.  It is significant that the settlement of the KA3 Trust was ‗bilateral‘ in the sense that it involved trustees other than Mr Hotchin.  There is no allegation that those trustees were party to any intention to set up the Trust as a sham, nor is there any evidence which could support such an allegation.   The Matapana Road property transaction and the indemnity were undoubtedly entered into by KA3 to benefit Mr Hotchin, but he was and is one of the discretionary beneficiaries for that Trust.   The post settlement transactions relied upon do not assist the FMA with its pleading.   The property transaction seems relatively conventional, a transfer of property for value from one Trust to another.  I do not attach any weight to the absence of ―push back‖  by the trustees as this would only have significance if viewed in the context of transactions in respect of which the trustees of the KA3 Trust should have ―pushed back‖.  There are no particulars to give any air of reality or substance to the FMA‘s contention that there was a lack of push back.

[55]     As  previously  noted,  my  difficulty  in  dealing  with  KA4  and  KA3‘s applications is that the present pleading for the FMA does not contain the FMA‘s case on sham.  That difficulty should not be visited on the Trusts in circumstances where even at hearing, a proper basis to plead sham in respect of the KA3 Trust could not be articulated.

[56]     Accordingly the application to strike out the sham pleading against KA4 is declined on condition that the FMA file an amended pleading which reflects how it now formulates it case.  The sham pleading in respect of the KA3 Trust is struck out on the ground that the pleading discloses no reasonable cause of action.  In making this order I take into account that the FMA is yet to formulate a coherent account of its allegation of sham against KA3.

[57]     Although it was not formally pleaded, I note that the FMA‘s emerging sham argument  also  has  no  prospect  of  success.    If  a trust  is  validly constituted  the beneficiaries  acquire their  rights  and  interests  under it.    If, at  some  point  after

settlement, the trustee and settlor act in a way which evidences a total disregard for the rights and obligations created by the trust, the proper response is to hold those parties accountable.  In the case of the trustees, for their breach of trust.  In the case of the settlor, he or she would be held accountable for involvement in that breach. The beneficiaries should not be deprived of their rights arising under the Trust Deed by such wrongful conduct on the part of the trustees and settlor.

Fourth Issue: Does an equitable lease create an interest in lease?

[58]     In the May judgment I said:32

From Mr Radley‘s evidence and the supporting minutes of the KA4 Trust it seems that Mr Hotchin has, or at least had, an option to take up a 30 year lease, which is arguably enforceable by him.  If he no longer has that option, for whatever reason, then the amount invested in the construction of the land remains a significant asset, since it seems the KA4 Trust acquiesce in the expenditure knowing that Mr Hotchin expected to acquire some interest in the property (in the form of a long term lease) in return for that investment.

[59]     In  both  the  written  and  oral  submissions  presented  at  the  8  November hearing, counsel for KA4 and KA3 argued that an equitable lease does not give any rights in the freehold, and as such, cannot form the basis of an asset preservation order against the freehold in the Paratai Drive property.  No authority was cited for this proposition.  It was also submitted ―that the alleged asset is not the freehold, it is a subset of it.‖ And further:

The order should be varied to recognise that any dealings with the Paratai

Drive Property must be subject to the potential equitable lease.

[60]     Following the hearing, and pursuant to leave reserved to it, the FMA filed additional submissions addressing the issue of whether an equitable lease created an interest in land.  From the submissions filed, it is clear that it does.33    That is now conceded by counsel for KA4 and KA3. They clarify that the only issue they raise in this regard, is whether an equitable lease gives a right in the freehold that can justify

a blanket freeze on dealing with the freehold, because, it is argued, the alleged

32     Hotchin, above n 3 at [110].

33     In particular, see Hinde McMorland & Sim  Land Law in New Zealand (2nd ed, LexisNexis, Wellington, 2003) at [11.042].

leasehold is properly protected by the entering of a caveat against the property noting that it is subject to a claim for a potential leasehold interest. That would be sufficient to alert potential purchasers to the claimed interest, if it can be upheld.

[61]     It is not appropriate or necessary to replace the existing preservation order with a caveat.  From the evidence filed to date, it seems that the property is to have substantial work done before it is ready for sale.  When it is ready for sale, there are simple mechanisms (already utilised in this proceeding) to allow the lifting of the order to enable a sale to proceed.   These procedures are more appropriate to this particular situation than the caveat procedure.  After all, it is, Mr Hotchin who has the caveatable interest, and who would have to defend the caveat if called upon by KA4 to remove it, yet it is the FMA, not Mr Hotchin, asserting the existence of the interest in the land.

Result

[62]     The applications by KA4 and KA3 to strike out the FMA‘s pleading that the

trusts hold funds on behalf of associated persons are declined.

[63]     The FMA‘s claim that the Trusts were not intended to be legally binding, and so are void for lack of intention to create valid trusts has no prospect of success. There is, however, no pleading of this claim in the form now articulated to strike out.

[64]     The application to strike out the sham pleading against KA4 is declined, on the condition that the FMA file an amended pleading which reflects how it now formulates its case.

[65]     The sham pleading in respect of the KA3 trust is struck out as an abuse of process and on the ground that it does not disclose a reasonable cause of action.

[66]     The FMA‘s emerging sham argument, although not formally pleaded, also has

no prospect of success.

[67]     KA4‘s application to replace the existing preservation order in relation to the

Paratai Drive property with a caveat is declined.

Winkelmann J

Solicitors:

Crown Law, Wellington

Lee Salmon Long, Auckland

Chapman Tripp, Auckland

Counsel:

Bruce Stewart QC, Auckland