Frimley Estate Ltd v Fog
[2015] NZHC 1010
•13 May 2015
IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY
CIV-2014-404-003364 [2015] NZHC 1010
IN THE MATTER of the Securities Act 1978 BETWEEN
FRIMLEY ESTATE LIMITED Applicant
AND
MARIANNE FOG Respondent
Hearing: 14-15 April 2015 Counsel:
EJ Grove for Applicant
RB Hucker and J Schwarcz for Respondent
KS Graham and C Allan for Financial Markets AuthorityJudgment:
13 May 2015
JUDGMENT OF ASHER J
This judgment was delivered by me on Wednesday, 13 May 2015 at 3:00pm pursuant to r 11.5 of the High Court Rules.
Registrar/Deputy Registrar
Solicitors/Counsel: KP Legal, Auckland.
Hucker Associates, Auckland. EJ Grove, Auckland.
Financial Markets Authority, Auckland.
FRIMLEY ESTATE LTD v FOG [2015] NZHC 1010 [13 May 2015]
Table of Contents
Para No
Introduction [1] Background [3] The legal framework [13] The respective positions of the parties [21] Was Ms Fog a member of the public? [24] Relief [37] Circumstances relating to the allotment of the security (s 37AH(3)(a)) [40] Nature and seriousness of the contravention (s 37AH(3)(b)) [41] Material prejudice to Ms Fog [53] Other matters [64] Limitation period expired [70] Overall assessment under s 37AH(3) [73] The other subscribers [78] Result [81] Costs [83]
Introduction
[1] Frimley Estate Ltd seeks relief under s 37AH of the Securities Act 1978 (the Act) from the consequences of issuing a security to the public without a registered prospectus. Under s 37 of the Act the allotments of security that have been subscribed for by members of the public are void unless relief is granted.
[2] The application is opposed by one of the subscribers, the respondent Marianne Fog. The Financial Markets Authority has appeared and has made submissions, but does not support or oppose the application. It is common ground that the Act applies.1
Background
[3] Frimley Estate Ltd (Frimley) has 21 shareholders. It was incorporated on
16 December 2004. The project proposed by Frimley was the subdivision into sections and sale of lots of a 7.86 hectare block of land in Hawkes Bay near
Hastings. At the time of its incorporation there were two directors, Stephen Duff and
1 The Securities Act 1978 has been repealed. However, under the Financial Markets Conduct Act
2013, sch 4, cls 15, 17 and 19, the Securities Act still applies.
Allan Duff. Stephen Duff, Allan Duff and a third person Tom Ellis between them held initially 1,900,000 shares in Frimley.
[4] In late 2004 and early 2005 Mr Stephen Duff promoted the company and invited persons to subscribe for shares in it. On 17 December 2004 he wrote to Ms Fog who was a client of his financial advisory company outlining the key features of Frimley’s proposal. A valuation of the property from Valuation Plus dated 8 December 2004 was provided. It is common ground that there was no registered prospectus and that no prospectus was provided to Ms Fog or any other subscribers.
[5] Ms Fog and other subscribers agreed to buy shares. Ms Fog initially acquired
180,000 shares for $99,000. She has paid two further capital calls, the first being on
30 September 2009 for $18,000 and the second on 1 October 2010 for $32,400. Her total shareholding in Frimley is therefore 432,000 shares, and she has made total cash investments of $149,400. While there was initially some contention about these figures, it was confirmed during the hearing that they were correct.
[6] In May 2005 Mr Stephen Duff and his family trust purchased the shares of Allan Duff and Tom Ellis. Mr Stephen Duff’s shareholding increased from 600,000 to 1,000,000 shares and his family trust acquired another 1,500,000 shares in 2007. Mr Stephen Duff’s interests have also taken up subsequent share offerings by Frimley.
[7] As a consequence of the promotion in December 2004 one million new shares were acquired by investors at 55 cents a share. Further land has been acquired with the further subscriptions. Some sections have been developed and sold and there has been some income. However, the development has not been completed and overall has not been a success. Mr Stephen Duff (hereafter referred to as Mr Duff) states that this is because of sales falling over during the global financial crisis, delays from unexpected remediation works on site, and consent delays in the acquisition of resource consents. In the interim, financing and holding costs have eroded capital.
[8] In 2014 the Financial Markets Authority (the FMA) determined that some of the shareholders were members of the public, and that Frimley should have issued a registered prospectus to them before seeking their subscription. At the hearing in front of me Frimley, the FMA and Ms Fog all agreed that to be the case in respect of at least one instance, and because no registered prospectus was issued, there had been an irregular allotment which was invalid under s 37 of the Act.
[9] There is, however, a difference between the parties as to the number of subscribers who were members of the public. It is argued for Frimley that only one couple, a Mr and Mrs Rinckes, who were approached in 2004 to subscribe for shares, were members of the public. Mr and Mrs Rinckes are not parties and have taken no steps in the proceeding. Ms Fog, while not seeking to comment on the Rinckes’ position, submits that she was a member of the public.
[10] Having accepted the allotments to be void, Frimley brings this originating application for discretionary relief under s 37AH of the Act. If relief is not granted Frimley has an obligation under s 37(5)(b) to repay the subscribers who were members of the public and to pay interest on their subscriptions. Further, under s 37(6) if the subscriptions are not repaid within the stated time periods both Frimley and all the directors are jointly and severally liable to repay the subscriptions together with interest.
[11] In its originating application Frimley asserts that the only source of funds to refund the shareholders who can claim repayment of their investments would be the Hawkes Bay property. Frimley believes that rather than selling the Hawkes Bay property, a better result would be achieved for the shareholders if the property development was completed.
[12] Frimley held a meeting of shareholders on 16 October 2014 to vote on whether or not the application for relief should be brought. Only one shareholder, Ms Fog, voted against the bringing of the application. One other shareholder did not attend the meeting, and one other shareholder provided her proxy form in support of the application late. All the remaining shareholders voted in favour of bringing the application.
The legal framework
[13] As I have noted the effect of s 37 is that subscriptions and allotments made to members of the public who have not received a registered prospectus are invalid. Section 37(1) and (4) of the Act provide:
37 Void irregular allotments
(1) No allotment of a security offered to the public for subscription shall be made unless at the time of the subscription for the security there was a registered prospectus relating to the security.
…
(4) Any allotment made in contravention of the provisions of this section shall be invalid and of no effect.
[14] Such subscriptions must be repaid, and can be recovered from the company and its directors by the subscriber. Section 37(5)(b) and (6) provide:
37 Void irregular allotments
…
(5) Where subscriptions for securities are received by or on behalf of an issuer, but, by virtue of this section, the securities may not be allotted, or for any reason the securities are not allotted, the issuer shall ensure that—
…
(b) The subscriptions, together with such interest (if any) as has been earned thereon, are repaid to the subscribers as soon as reasonably practicable.
(6) If any subscriptions to which this section applies are not so repaid within 2 months after the date on which the subscriptions were received by or on behalf of the issuer (or, in any case to which subsection (2) of this section applies, within 5 months after the date of the registered prospectus), the issuer and all the directors thereof shall be jointly and severally liable to repay the subscriptions, together with interest at a rate prescribed from time to time by regulations made under this Act from the date on which the subscriptions were received by or on behalf of the issuer:
Provided that a director shall not be so liable if he or she proves that the default in the repayment of the subscriptions was not due to any misconduct or negligence on his or her part.
[15] There are a number of relief provisions. Sections 37AA–37AL were introduced to address perceived deficiencies in the procedures for relief from
contractual illegality contained in the Illegal Contracts Act 1970, and their application to the Act, in particular the possibility that the Illegal Contracts Act did not apply to overseas issuers.2 If relief is granted, the effect is that ss 37(4)–(6) do not apply to the allotment of the security. The subscribers are not able to recover their subscriptions.
[16] Under s 37AC the Court is obliged to make orders providing relief in certain circumstances. Those circumstances arise when there is no contention concerning the order sought, so that orders will be made if the application is by the subscriber itself or the security holder, or the issuer if the subscriber consents, or the security holder consents, or in certain other specific circumstances. Frimley has not applied under this section. Rather, the application has been brought under s 37AH which provides:
37AH When Court may make relief order in respect of section 37
(1) The Court may in the course of any proceedings, or on the application of the issuer under this section, make a relief order in respect of the application of section 37 to the allotment of a security if the Court considers that it is just and equitable to do so.
(2) An order may be made under this section regardless of whether the contravention of section 37 occurred before or after this section comes into force.
(3) In determining whether to make a relief order under this section, the
Court must have regard to—
(a) all of the circumstances relating to the allotment of the security;
and
(b) the nature and seriousness of the contravention of section 37; and
(c) whether the contravention has materially prejudiced the interests of the subscriber; and
(d) whether the subscriber has disposed of the security to any other person; and
(e) any other matters that the Court thinks fit.
(4) An application under this section may be made in conjunction with an application under section 37AC or section 37AI.
2 Henderson Global Funds v The Securities Commission [2009] NZCCLR 18, (2009) 10 NZCLC
264,477 at [24]–[27]; and John Farrar and Susan Watson (eds) Company and Securities Law in
New Zealand (2nd ed, Brookers, Wellington, 2013) at [SE37AA.01].
[17] It is to be noted that this application before the Court is an application for relief in respect of all subscribers (even though Frimley submits that only the Rinckes are subscribers who were members of the public). In particular Frimley has submitted that save for the subscriber who did not attend the meeting and whose position is not known, and Ms Fog, all other shareholders support the application for relief.
[18] It is necessary to address the scope of the operation of ss 37(4) and 37AH. Section 37(4) provides that “any allotment” that is “made in contravention of the provisions of [the] section” is invalid. The reference is to the individual contravening allotment, not all the allotments globally. In the same way, an application under s 37AH(1) is in respect of the “application of s 37 to the allotment of a security”. Relief is to be applied therefore to the particular allotment in question that is void and requires an order to validate it. The sections are directed at the
individual allotments that are invalid, and not all the allotments globally.3
[19] This is a relevant consideration in this case, where the application of Frimley seeks relief “in respect of the application of section 37 to the allotment of securities”. Frimley, which denies that Ms Fog was a member of the public, in theory should therefore not need any relief against her, as relief is not required if she is not a member of the public, or indeed those other subscribers who were not members of the public. Section 37AH is not aimed at complying valid allotments.
[20] However, presumably against the possibility that its claim that Ms Fog was not a member of the public may fail, Frimley seeks relief in respect of her allotment. It does not seek specific relief against the Rinckes or any other specific shareholder, but the general way in which the application is worded would allow for relief in respect of any invalid allotment.
The respective positions of the parties
[21] Mr Grove for Frimley submitted that Ms Fog was not a member of the public, but that if she was the assessment of the factors listed in s 37AH(3) should lead to a
conclusion in favour of relief. He focused on the support of the shareholders other than Ms Fog of the application, and the practical problems that will arise should relief not be granted. He submitted that the level of fault on the part of Frimley was limited, and that there will be little material prejudice to Ms Fog should relief be granted. He argued that it is in the overall interests of all subscribers that there be relief.
[22] Mr Hucker for Ms Fog submitted that she was a member of the public. He did not engage on issues relating to the commercial merits of supporting the company in allowing the development to proceed, as distinct from Ms Fog requiring repayment and the consequent possible failure of the company and the subdivision. He submitted that this application is not the place to debate the commercial merits of requiring a refund or allowing the development to continue. His focus has been on the extent of the failures by Frimley to properly inform members of the public, and the material prejudice to Ms Fog and other subscribers, which he submits should result in relief being refused.
[23] The FMA neither supports or opposes the application. However, the FMA made submissions to assist the Court. The FMA has submitted that the contraventions by Frimley were serious, and that if the Court determines that relief should be granted, conditions should apply to the order to ensure that Frimley provides investors with any outstanding material information. The FMA’s submission was that there is an ongoing failure on Frimley’s part to provide the information which should have been provided with a registered prospectus, and referred in particular to the failure on Frimley’s part to provide audited statements right down to the present time.
Was Ms Fog a member of the public?
[24] Given the way the application is framed and the arguments developed, it is necessary to commence the consideration of the application for relief by determining whether Ms Fog was a member of the public.
[25] Mr Grove commented that I did not have to decide whether Ms Fog was in
fact a member of the public, given Frimley’s concession that at least one member of
the syndicate was not a member of the public. I do not agree. As I have stated relief is considered per allotment and not globally, and Frimley will not need relief against Ms Fog if she is not a member of the public.4
[26] Even if this were not so, it is desirable that I set out my view on whether Ms Fog was a member of the public. In the end, under s 37AH I must have regard to all the circumstances of the allotment, the nature and seriousness of the contravention of s 37, and the material prejudice to the subscriber in question in order to determine whether it is just and equitable to grant relief.
[27] Neither Mr Duff or Ms Fog in their affidavits discuss in detail the association that existed between them through the relevant time period. However, the following facts are clear:
(a) Ms Fog had been a client for at least two years of Mr Duff ’s financial advisory company, Financial Vision Ltd. Ms Fog had inherited
$900,000 that she invested through Mr Duff and his company, and he ran a portfolio for her from approximately February 2002.
(b)For approximately two years Ms Fog was a member of a syndicate that Mr Duff had set up named the Farmers Trading Property Syndicate.
(c) Ms Fog was introduced by Mr Duff to the Farmers Trading Property
Syndicate as a client of Financial Vision Ltd.
[28] In assessing whether Ms Fog was a member of the public, I refer to the definition of member of the public in s 3(2) of the Act. That section sets out certain offers which shall not constitute an offer of securities to the public. Section 3(2)(a)(i) provides:
3 Construction of references to offering securities to the public
…
(2) None of the following offers shall constitute an offer of securities to the public:
(a) An offer of securities made to any or all of the following persons only:
(i) Relatives or close business associates of the issuer or of a director of the issuer:
…
(emphasis added)
Pursuant to that section it is the submission of Mr Grove that Ms Fog was a close business associate of Frimley through her association with Mr Duff.
[29] There was some discussion between counsel as to what onus arose when a party made a s 37AH application. On the face of it s 37AH confers a wide discretion to the Court.5 Any general onus is on the persons seeking the discretionary relief, in this case Frimley, to provide with reference to the s 37AH(3) factors evidence to support their application.6
[30] The issue of what is a close business associate was considered in Securities Commission v Kiwi Co-op Dairies Ltd.7 The Court of Appeal noted that the words “close”, “business” and “associate” were all relatively imprecise terms. It said:8
Parliament has chosen to use the word “associate” rather than “association”, indicating that the focus of the exception is upon a connection of a personal nature between individuals, rather than upon a relationship with a corporate body. The Oxford English Dictionary (2nd ed) defines an “associate” as “One who is united to another by community of interest and shares with him in enterprise, business or action; a partner, comrade, companion” and also as “One who is frequently in company with another, on terms of social equality and intimacy; an intimate acquaintance, companion, mate”. Moreover, the Act is speaking not just of an associate but of a close associate. Closeness too involves nearness or intimacy.
Although an issuer and a holder of its securities have a relationship through business, the use of the terms “close” and “associate” requires more than this: there must be a degree of intimacy or “business friendship” in the relationship, though not necessarily a friendship away from business. It must be sufficient to overcome any inequality which might otherwise be present in the relationship.
5 Little v Jull [2013] NZHC 3123 at [122].
6 At [125](c).
7 Securities Commission v Kiwi Co-op Dairies Ltd [1995] 3 NZLR 26 (CA).
8 At 31–32.
Where the issuer is a body corporate an offeree can still be regarded as a close business associate if those individuals who control the issuer have an intimacy of business contact with the offeree (or, where the offeree is a corporation, with those individuals who control the offeree). By “control” in this context we are referring to the holding of a position in an issuer which properly enables the dissemination of corporate financial information, and the corresponding position in a corporate offeree.
(emphasis added)
[31] In Lawrence v Registrar of Companies, both the High Court and Court of Appeal decisions referred to the Court of Appeal’s comments in Securities Commission v Kiwi Co-op Dairies Ltd.9 Lawrence was an appeal against convictions for offences under the Act for making offers of a security to the public without a prospectus. The investors in question in that case were private individuals and not habitual investors who had been introduced to the issuer by an employee who had
been their investment advisor through his prior employment at a private bank. Morris J held that such persons did not have possession of all the means of obtaining information relevant to their investment to the extent that they could be regarded as close business associates.10 The Court of Appeal held that he was correct to hold that the “… offeree must have, or have the capacity to obtain information concerning the proposed investment, sufficient to be able to make an informed decision in relation to the offer.”11
[32] In the affidavit of Ms Fog and the two affidavits of Mr Duff (who was cross- examined), there is nothing to suggest that there was any particular friendship or indeed closeness between Mr Duff and Ms Fog, or that they met more than occasionally, perhaps once a year for general meetings. Their relationship appears to have been only a business relationship, and not particularly close in that they did not meet frequently. There is no evidence that they confided in each other. Although it
can be assumed that Ms Fog had confidence at that time in Mr Duff, this appeared to
9 Lawrence v Registrar of Companies (2003) 9 NZCLC 263,177 (HC); and Lawrence v Registrar of Companies [2004] 3 NZLR 37 (CA).
10 At [31]. See also other cases adopting the test in Securities Commission v Kiwi Co-op Dairies Ltd, above n 7, such as Dodge v Snow (1999) 8 NZCLC 261,803 (HC) (upheld on appeal: Dodge v Snow CA21/99, 22 February 2000); and de Alwis v Luvit Foods International Ltd (2007)
10 NZCLC 264,304 (HC).
11 Lawrence v Registrar of Companies, above n 9, at [1].
be no more than the confidence that could be expected between a business advisor and a client. When being cross-examined Mr Duff said:12
… But I did have a lot to do with the people that I got on board, like for example Ms Fog too, and in terms of the day-to-day management I had at least one meeting a year with people like Ms Fog and, amongst other things, we’d talk about what was going on in the syndicate. Each year I’d send people tax returns. They got paid their rent monthly, directly into their own bank accounts usually and so on. And from time to time if anything, for example if there were a rent review due or at one stage the Farmers Trading Company, who were the long term leasers of the property, wanted a variation of the lease, that sort of thing, so.
[33] This extract demonstrates that the relationship between Ms Fog (and possibly other investors) and Mr Duff was not close, but rather a business relationship where meetings were dictated by formal requirements. There was not the added degree of intimacy.
[34] I conclude that Ms Fog was a member of the public. The investor/advisor relationship between Ms Fog and Mr Duff did not amount to a close business relationship. Nor did her investment in the Farmers Trading Company Syndicate, which appears to have been a one-off investment in a developed property. The relationship was confined to occasional business matters and the regular yearly meeting of the syndicate. In terms of the mischief that s 37 is aimed at, Ms Fog could not be assumed to have all the relevant knowledge of Frimley, or know what to ask Mr Duff. The relationship did not overcome the inequality that existed between Mr Duff as the promoter of a complex risky development project, and Ms Fog as a passive investor.
[35] There was therefore a breach of the Act specifically in relation to Ms Fog. There appear to have been other subscribers who were in the same category as her, but I do not have details of them so I do not extend my finding beyond Ms Fog, and the Rinckes (who it is conceded were members of the public).
[36] I have put to one side a good deal of evidence by Ms Fog in her submissions, and Mr Duff in reply, concerning events after 2005, save for those that specifically
relate to the relationship in 2005 and the three subscriptions. That later evidence has
12 Notes of evidence, p 39, lines 17–26.
little relevance to the issue I have to determine, which is the nature of the relationship and events at the time of the subscriptions. The minutiae of the exchanges between Ms Fog and Mr Duff down to the present time cast no light on whether Ms Fog was a member of the public for the purposes of s 37.
Relief
[37] I will now proceed to consider the merits of the application. I respectfully agree with the observation of Warwick Gendall J in Re Perpetual Investment Management Ltd:13
[14] The Court must be mindful of the purpose of the legislation. If there are purely technical breaches such as late filing of documents and no cogent reasons given by an objector as to how his or her interests have been “materially prejudiced” by such technical contravention, then it is obvious that the purpose of the legislation was to ensure that relief be granted. …
[38] I also note the following written submission made by the Securities
Commission in Henderson Global Funds v The Securities Commission:14
The legislative changes made by the Securities Amendment Act 2004 (introduced in ss 37AA to 37AL) seek to provide some balance between the interests of issuers and those subscribers. These changes provide a route by which issuers can obtain relief from the otherwise absolute prohibition in s 37(1). Such amendments direct the Court to focus on both substantive prejudice to investors and the nexus between the contravention and the prejudice. The legislation recognises that breaches of some of the exemption notices may in many cases have been immaterial and of a technical nature. This is particularly the case for those contraventions falling within s 37AI.
[39] It is clear therefore relief is likely to be granted where there have been only technical breaches, and there is no real prejudice to subscribers.15
Circumstances relating to the allotment of the security (s 37AH(3)(a))
[40] I have traversed these circumstances already, and I will return these in considering the nature and seriousness of the contravention. In terms of the Rinckes, I received no affidavit material as to the circumstances of their subscription, and am
13 Re Perpetual Investment Management Ltd (2006) 2 NZCCLR 1203, (2006) 9 NZCLC 264,207.
14 Henderson Global Funds v The Securities Commission, above n 2, at [26].
15 Re Perpetual Investment Management Ltd, above n 13, at [14], [19]; applied in (for example) Re
APVC Ltd HC Auckland CIV-2007-404-6533, 9 June 2008 at [16]-[17].
not able to comment on the circumstances relating to the allotment of their security. I do, however, note the concession that the Rinckes who were subscribers were also members of the public. Certainly it is not open to Frimley to submit that the failure to register a prospectus was limited to only one subscriber. I approach the breach therefore from the perspective that it was a breach proven in relation to two subscribers. There was no evidence of a deliberate and flagrant breach.
Nature and seriousness of the contravention (s 37AH(3)(b))
[41] It is important to evaluate the nature and seriousness of the contravention. In my view, the nature and seriousness is to be considered at the time the relevant allotment is taken up, although subsequent events may have some relevance to assessing that seriousness. Of particular importance will be whether the breach can be regarded as technical or substantive, and if it is substantive how extreme.
[42] The purpose of the Act has been described as providing greater protection to the investing public by ensuring full disclosure of the company’s affairs and of the security it is offering.16 This then allows the investor to make an informed investment decision which in turn facilitates the functioning of financial markets.
[43] I received careful submissions from both Mr Grove for Frimley and Mr Hucker for Ms Fog on the extent of the non-disclosure. Any non-disclosure application must be considered against the requirements for a prospectus set out in sch 1 of the Securities Regulations 1983, which were the regulations in place at the time.17 Material matters that are referred to, and should have been disclosed, include
trading prospects and risks,18 securities paid out other than in cash,19 preliminary
issue expenses,20 other material matters21 and an audited statement of financial position.22
16 Re AIC Merchant Finance Ltd (in rec) [1990] 2 NZLR 385 (CA) at 392 per Richardson J.
17 See Securities Regulations 1983, reg 3(1), and sch 1.
18 Sch 1, cl 9.
19 Sch 1, cl 12.
20 Sch 1, cl 19.
21 Sch 1, cl 21.
22 Sch 1, cl 23.
[44] I have referred to the material provided to Ms Fog in the letter of
17 December 2004 and the attached valuation. This was the promotional document. It seems to me that there were a number of serious shortcomings in the information provided.
[45] There was no reference to the risks that would normally arise in relation to an investment in land for subdivision purposes, in particular the risks of extra costs and delays resulting from the resource management consent process, and the risk of a fall in land values. In fact these risks did indeed eventuate with serious consequences for the wellbeing of the subdivision. A considered reference to prospects and forecasts would have revealed these risks.
[46] More specifically there was a failure to refer realistically to the interest costs that would have inevitably accrued over the years. On the plan proposed it was anticipated that the subdivision would be completed by June 2007. However, despite the fact that there were therefore two and a half years to run on the forecast at the time it was made, interest for only three-quarters of a year was provided for. Other holding costs provided for expressly excluded interest. Thus, there was a whole area of expense that was to be incurred which was not listed.
[47] Further, it was not explained in any of the material that all the share capital of the Duffs and Mr Ellis was not paid up. The only cash that was available for Frimley was the actual cash from the subscriptions which amounted to approximately
$550,000. The modesty of capital, and the lack of cash other than the new investor subscriptions, was not made clear from the material provided. Rather, the letter and accompanying valuation would have led a potential subscriber to assume that the significant share capital owned by the Duff and Ellis interests was paid up and was helping to finance the subdivision. This was particularly so given the modest allowance for interest.
[48] There is no reference to management fees and guarantee fees which, as will be seen, materially increased costs. Even though these were not charged for in the initial months, the end fees were very significant and the issue should have been addressed, at least as a reference to the possibility of such fees.
[49] Further, the lack of any audited accounts at all was a significant omission, and it is to be noted that in the years that followed there were no audited accounts provided.
[50] If the proper procedures had been followed by Frimley, a prospectus would have been delivered to the Registrar of Companies for registration, and it can be fairly anticipated that these omissions would have been required to be remedied before the prospectus would have been accepted for registration.23
[51] I conclude that the contravention was serious. It was not a minor or technical breach. In relation to Ms Fog, there were omissions, which if corrected would have involved the provision of a considerable body of adverse information. It was information that would have given any prospective subscriber significant reservations about whether this was a sound investment. Ms Fog says if she had known what she now knows she would not have invested. Looking objectively at the nature of the investment, and what was actually disclosed, it is likely that a proper prospectus would have put off many possible investors because of the particular risks.
[52] In relation to the later subscriptions, I accept that the failure was less serious, as the problems with the subdivision were by then known.
Material prejudice to Ms Fog (s 37AH(3)(c))
[53] Section 37AH(3)(c) provides that the Court must have regard to whether the contravention has materially prejudiced the interests of “the subscriber”. As I have stated, Ms Fog is the relevant subscriber. The way the section is worded the focus should be on her, as the objecting party, rather than other subscribers about whom
there is no evidence.24 It would be a mistake to try and hypothesise about how they
might have been materially prejudiced, in the absence of evidence or concession.
[54] Bare assertions of prejudice are not sufficient. The Court must be able to discern prejudice when assessing the facts objectively. Applying this approach to the
23 Securities Act 1978, s 42.
24 See [18] above.
facts before me, on any objective approach the non-disclosures that I have referred to in the preceding section were highly prejudicial to a subscriber who was not fully familiar with all the details of the project, and experienced in such developments. There is a great deal of difference between investing in shares or investments in developed properties (the type of investment that Ms Fog had previously made under Mr Duff ’s guidance), and investing in an undeveloped green fields property project, the development of which would take work and time before income and profit was forthcoming.
[55] Further, Mr Duff did not in the material provided disclose what would happen in relation to management fees and guarantee fees. Shortly after the issue of the prospectus in May 2005, following his brother’s withdrawal from the project and his assumption of his brother’s role, Mr Duff commenced charging significant management fees and guarantee fees. These can be summarised as follows:
(a) $163,424 charged in 2006; (b) $254,190 charged in 2007; (c) $464,900 charged in 2008;
(d) $422,815 charged in 2009; and
(e) $425,000 charged in 2010.
[56] In total, $1,730,329 was charged in fees in the period up to 31 March 2010. I
do not have clear information about fees (if any) after that date.
[57] The failure to disclose the possibility of management fees and guarantee fees in my view materially prejudiced Ms Fog or any reasonable subscriber in her position. This went well beyond a mere technical or procedural oversight. I accept Mr Hucker’s submission that a reasonable subscriber could assume that given the extensive shareholding of the Duffs and Mr Ellis, they would be happy to provide their time without charging, as they stood to benefit the most from the project. There was going to obviously be a great deal of time involved in managing such a
subdivision, as well as an element of risk in guaranteeing any loans. A statement was required describing all special trade factors and risks unlikely to be known by the general public and that could materially affect the prospects of the issuing group.25 The issue of management and guarantee fees should have been disclosed and discussed.
[58] If there had been an indication of the possibility of expenses for management and guarantee fees it would have given any investor significant reason to pause. If there had been full disclosure and it had been revealed that the only cash held was the $550,000 subscribed for by persons other than the Duffs and Mr Ellis, then it would have been obvious to those subscribers that their entire investment could be spent in paying the fees within two years, leaving nothing for actual development costs. This was a significant omission.
[59] As the history of this development indicates, the subdivision of farmland inevitably involves significant risks, in particular the risk of unforeseen physical problems, large fees, the risk of Council delays in granting the necessary consents, and the risk of changes in the market which could render the development unprofitable. Given the extent of the prejudice, and in my assessment its relative predictability, I accept Ms Fog’s assertion that she would not have entered into the subdivision if she had known all the risks. Leave was not sought to cross-examine her.
[60] I accept Mr Grove’s submission that some of the risks that she refers to would not have been known at the time of subscription in 2005. In particular Mr Duff ’s later actions in employing family members would not have been known. However, Mr Duff knew that the share capital was not paid up, knew that there would have to be financing, should have known that guarantee and management fees were at least a possibility, and should have known that there were significant risks of cost overruns and delay. He did not address any of these matters in the material he sent to Ms Fog. If he had sought to register a prospectus, he would have been alerted to these obligations. In not doing so he materially disadvantaged Ms Fog.
[61] The disadvantage has been significant, as the risks that I have mentioned all came to pass and if the subdivision is wound up now the return will be limited. Mr Duff in his affidavit states that the current total government valuation of the Hawkes Bay property is $1,880,000, but Frimley’s financiers’ secured debt over the land totals $2,029,000. Although Mr Duff has significant assets in trust, he states that personally he would not have the means to make any material payment to the investors in the event the sale proceeds fall short of Frimley’s debts. If the development continues as planned the prognosis is for a realisation of a sum between
$1.5 and $2.4 million. Some capital will be returned, but it will have been a very poor investment. At least $1,730,329 has been spent in fees.
[62] Mr Duff on a number of occasions refers to the fact that as events transpired following Ms Fog’s subscription, she did not object. For instance she did not object when in May 2005 he advised that management fees and guarantee fees would be charged. However, I place little weight on this when assessing prejudice. Ms Fog may well have not protested because she felt locked in. Ultimately she did protest.
[63] It seems likely that in relation to the two smaller later subscriptions, the material prejudice was much less. By then, and despite the absence of a prospectus, Ms Fog would have been well aware of the risks because the risks had in fact been shown to have existed and the subdivision was in trouble. However, it could be equally said that there was an even greater need for Mr Duff at that point to provide a registered prospectus when he sought those further subscriptions and to have emphasised that the delays and extra costs that had been incurred to that point could well continue through the future. He gave no such warning.
Other matters (s 37AH(3)(e))
[64] In determining whether to make a relief order the Court must have regard to
“any other matters that the court thinks fit” in addition to those specifically listed.26
[65] Mr Duff in his affidavit acknowledged that no audited accounts and no
updated valuations had been provided. He stated that Frimley “simply does not have
the cashflow to prepare final accounts or obtain formal valuations”. He emphasised that Ms Fog was only one of 21 shareholders/investors, and she was the only subscriber who opposed the application for relief, and the only shareholder who voted at the shareholders’ meeting of 18 October 2014 against Frimley bringing the relief application.
[66] In submissions Mr Grove referred to the fact that if relief is refused in relation to Ms Fog, she would be in a position to seek liquidation of the company or seek to bankrupt Mr Duff, and this could mean that the development would collapse to the detriment of all the other subscribers who would like it to proceed. However, I note that while the other subscribers have not opposed this application for relief, none of them have actively supported it in this proceeding. In the absence of submissions from them, this submission is hard to evaluate, and I am not satisfied that the development must stop if relief is refused in respect of Ms Fog.
[67] Moreover, I do not consider that the overall commercial consequences of denying relief for the company and other subscribers can be a major factor when a Court makes a s 37AH assessment. Although s 37AH(3)(e) permits the Court to consider any other matters it thinks fit, the focus of the first three preceding factors is on circumstances at the time of subscription and the consequences of any contravention. It would be out of keeping with the factors that are specifically listed, which apply to the situation at the time the contravention was made and the consequences of the failure to register a prospectus, to extend the s 37AH relief analysis to a general evaluation of the best commercial options for the company today. As Mr Hucker pointed out, issues such as the present interest of other subscribers in the future of the company and their wishes could be taken into account if Ms Fog sought to enforce a judgment. For instance, the Court has a discretion
(although exercised with caution) as to whether to order liquidation of a company.27
[68] The effect of Mr Grove’s submission if accepted would be that a subscriber who should have received a prospectus and who has been materially prejudiced, could be forced to remain a subscriber and be unable to recover the subscription by the majority will. There is nothing to indicate that this is how the discretion reserved
in s 37AH(3)(e) is meant to operate. As I have noted, relief is granted on a per allotment basis, not globally for all subscribers. The focus is on the particular subscription, not the overall circumstances of the company.
[69] It could be the case that in particular circumstances events since the subscription could be considered, and I note that s 37AH(3)(d) does permit the Court to take into account whether the subscriber has disposed of a security to any other person. However, it would in my view run contrary to the purpose of the section to treat the wishes of the majority of shareholders as trumping a legitimate objection by a subscriber to relief. The obligation to register a prospectus and the consequences of failure cannot be put to one side because it may be for the benefit of the company to grant relief.
Limitation period expired
[70] As an argument against the objection by Ms Fog, Mr Grove submitted that any proceedings she might bring to recover her investment would be statute barred as her rights will have been in existence for more than six years.
[71] There was argument on this issue. Mr Hucker submitted that the limitation period may have only commenced to run when Ms Fog discovered all the relevant circumstances. He relied on s 23B of the Limitation Act 1950. He also submitted that the 2009 and 2010 allotments occurred within the relevant six year period. He argued that the subscriptions could be treated as trust property under s 21(1)(b) of the Limitation Act so that no limitation period was engaged and he argued that to the extent that repayment and/or compensation is treated as an action for account under s 4(2) of the Limitation Act, the filing of the relief application was an acknowledgement by Frimley for the purposes of s 25(4) of the Limitation Act.
[72] I do not consider it necessary to determine these limitation issues. Even if Ms Fog’s claim is statute barred, this does not necessarily assist Mr Grove’s argument as it undermines his contention that she has the ability to obtain a judgment against Frimley and stop its continued operation. If there is a limitation bar, then that
is an issue that will have to be resolved in future proceedings. It does not directly arise here.
Overall assessment under s 37AH(3)
[73] I have concluded that there was a serious contravention of s 37 in respect of
Ms Fog which materially prejudiced her interests.
[74] I consider that the primary focus must be on the circumstances of the particular allotment and the nature and seriousness of the contravention, and material prejudice at that time, rather than the general commercial factors at the present time which might militate for or against the granting of relief to ensure the best return for shareholders. Although there is a general discretion at the end of listed factors to consider other matters that the Court thinks fit, the likely commercial consequences of a refusal to grant relief are better considered in any enforcement proceedings brought by a subscriber that might follow the refusal.
[75] In general terms I must exercise the discretion under s 37AH and grant relief if I consider it to be “just and equitable to do so”. I do not consider it just and equitable to deny Ms Fog her rights under s 37 and to grant Frimley relief. This was a serious failure causing her serious prejudice. She should be able to require a refund of her investments from the parties at fault. I conclude that relief should be denied in relation to Ms Fog.
[76] I have been addressing seriousness and prejudice in the context of the first subscription. The two later subscriptions were not as serious as Ms Fog by then was very familiar with the investment. However, by then she was already bound into the subdivision and her options were limited given that further investment was being promoted to improve what would otherwise be a very poor return.
[77] The contraventions in respect of the later subscriptions were still serious. There was still no prospectus and there were still no audited accounts. I do not think it appropriate to grant relief in respect of any of the subscriptions.
The other subscribers
[78] Frimley’s application seeks relief in relation to all subscribers. The other subscribers have not opposed relief being granted. However, it is not clear which subscribers other than Ms Fog and the Rinckes were members of the public, and for whom relief is therefore needed. The application should always identify the subscriptions for which relief is sought, but unfortunately this application did not do so, and I have no material on which to assess the merits of the position of the other subscribers.
[79] The minutes of the special general meeting of 16 October 2014 where the shareholders voted on the resolution that relief be sought, showed support from all subscribers who had taken steps, save for Ms Fog. There was a report provided by Mr Duff for subscribers called “Further report for SGM” where the background was set out. Although it clearly set out the failure by Frimley to provide a prospectus and the fact that Frimley had never been audited, there appears to have been no real discussion of what might happen should relief in relation to Ms Fog be declined.
[80] The fact that relief is being declined in relation to Ms Fog might or might not lead the other subscribers to take a different view about whether relief should be granted in relation to other subscriptions, if there are indeed other members of the public to which s 37 applies. I think it is only fair to them to give them an opportunity to read and understand this decision and take advice before I finally determine the application. In any event, I have no information before me about these other subscribers, on which to base a s 37AH assessment. If there are other shareholders, Frimley may wish to bring an application under s 37AC.
Result
[81] The application for relief in respect of the respondent Ms Fog is declined.
[82] The application for relief in relation to the other subscribers is adjourned. I give leave to Frimley to seek relief for other specific subscriptions, if it wishes to do so. The applicant has 28 days to make submissions on these proposed orders, the
respondent (if any) and the FMA a further seven days to reply. If the parties can agree a joint memorandum can be filed.
Costs
[83] Mr Hucker on behalf of Ms Fog submitted that because the proceedings have resulted from a serious failing by Frimley to issue a registered prospectus, Ms Fog should get indemnity costs whether she failed or succeeded.
[84] Mr Grove for Frimley submitted that in the event of Frimley failing, costs should be as per scale.
[85] It is true that these proceedings have been necessary because of Frimley’s failure to register and serve a registered prospectus. However, there has been nothing to show bad faith on the part of Frimley or its directors, and the proceedings have been advanced promptly.
[86] In these circumstances I am not prepared to order indemnity or indeed increased costs. It seems to me that although Ms Fog has been successful and is entitled to costs, the usual approach of costs being in accordance with scale and being only a contribution to costs, should apply.
[87] Frimley is to pay costs on a 2B basis to Ms Fog. I am prepared to certify for two counsel given that there were some complexities in the case.
[88] The FMA did not seek costs whatever the outcome, and no order for costs is made in relation to its attendances.
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Asher J
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