Houghton v Saunders HC Christchurch CIV 2008-409-348
[2010] NZHC 778
•19 May 2010
IN THE HIGH COURT OF NEW ZEALAND CHRISTCHURCH REGISTRY
CIV-2008-409-000348
BETWEEN ERIC MESERVE HOUGHTON First Plaintiff
ANDDARRYL ALEXANDER JONES Second Plaintiff
ANDTIMOTHY ERNEST CORBETT SAUNDERS
SAMUEL JOHN MAGILL JOHN MICHAEL FEENEY
CRAIG EDGEWORTH HORROCKS PETER DAVID HUNTER
PETER THOMAS JOAN WITHERS First Defendants
ANDCREDIT SUISSE PRIVATE EQUITY INC (FORMERLY CREDIT SUISSE FIRST BOSTON PRIVATE EQUITY INC)
Second Defendant
ANDCREDIT SUISSE FIRST BOSTON ASIAN MERCHANT PARTNERS LP Third Defendant
ANDFIRST NEW ZEALAND CAPITAL Fourth Defendant
ANDFORSYTH BARR LIMITED Fifth Defendant
Hearing: 17 May 2010
Appearances: A J Forbes QC, J R Eichelbaum & Ms Mills for Plaintiff
D J Cooper for First Defendants
A Olney and N Hegan for Second & Third Defendants
D H McLellan for Fourth Defendants
A Challis for Fifth Defendants
Judgment: 19 May 2010
HOUGHTON AND ANOR V SAUNDERS AND ORS HC CHCH CIV-2008-409-000348 19 May 2010
Reasons: 26 May 2010
REASONS FOR JUDGMENT OF HON. JUSTICE FRENCH
as to Lifting of Stay for Limited Purpose
Introduction
[1] The plaintiff, Mr Houghton, is a former shareholder of the failed company Feltex Carpets Limited. He seeks to bring a representative proceeding on behalf of himself and other qualifying shareholders against the Feltex directors and others associated with a public float of shares that took place in June 2004. [The second plaintiff Mr Jones has advised the Court he is to file a discontinuance and accordingly I refer in this judgment to Mr Houghton simply as “the plaintiff”]
[2] In July 2009 I imposed a stay on the plaintiff taking any further steps in the proceeding, pending an appeal by the defendants against an earlier judgment to the Court of Appeal.
[3] As at that date, some 800 Feltex shareholders had signed consent forms agreeing to opt into the proceeding.
[4] The Court of Appeal delivered its decision in December 2009. The decision contemplated that the plaintiff would shortly thereafter tender a draft amended statement of claim, at which point I would need to convene a hearing to consider the lifting of the stay. The Court of Appeal’s decision also identified a number of issues which the hearing should canvass regarding the future conduct of the proceeding.
[5] Unfortunately, the plaintiff did not tender a draft amended statement of claim until early May 2010. The delay was particularly unsatisfactory because of an argument that some of the claims may possibly be statute barred as at 2 June 2010.
[6] Due to the exigencies of the situation, it was agreed that the application for lifting the stay would be dealt with in two stages. The first stage would be to
determine whether the stay should be lifted for the limited purpose of allowing an
2
amended statement of claim to be filed and an approved notice sent in time to all qualifying shareholders to give them an opportunity to join the proceeding before 2
June. That would require consideration of the draft amended statement of claim and a draft opt-in notice. The second stage would be to consider the balance of the issues identified by the Court of Appeal.
[7] The first hearing was accordingly held on an urgent basis on 17 May 2010 when the plaintiff presented a revised draft of the amended statement claim and a draft opt-in notice. After the hearing, I received further revised drafts of both documents as well as further written submissions from counsel. I then issued my decision, which is annexed to this judgment as appendix A.
[8] Detailed reasons for my rulings now follow.
The draft amended statement of claim
[9] The draft amended statement of claim pleads five causes of action, three of which involve claims of misleading and deceptive conduct under the Fair Trading Act 1986.
[10] Of particular concern to the defendants are allegations relating to a practice known as “channel stuffing”. The draft defines channel stuffing as a deceptive practice involving the manipulation of earnings by accounting for sales in an earlier accounting period when they should properly have been accounted for in a subsequent accounting period. This is said to have been done in the case of Feltex’s accounts, with the result that its financial statements were distorted and did not give a true and fair view of its financial position.
[11] The defendants’ argument is that the allegation is effectively one of fraud or deceit, and in accordance with well-established authority, must be pleaded with specific particularity and be supported by a sufficient evidential foundation.
[12] In response, counsel for the plaintiff Mr Forbes concedes that at this stage the plaintiff does not have the necessary evidence that any of the defendants (with one exception) actually personally engaged in channel stuffing or knew the practice was
occurring. However, he argued, that is not what the draft amended statement of claim is alleging. What the draft is alleging is that it was the company Feltex which engaged in the practice. The defendants’ liability under the Fair Trading Act arises from the failure of the share prospectus to disclose the fact of the channel stuffing, an omission that rendered the prospectus misleading. Knowledge of the falsity of a representation is not necessary for liability under the Fair Trading Act, and accordingly it is not necessary for the plaintiff to have evidence of actual knowledge or to be required to plead it. Mr Forbes responsibly drew my attention to a decision of Elias J to the contrary where it was held that silence should not render a party liable under the Fair Trading Act unless that person knew of the information which has been withheld: Des Forges v Wright [1996] 2 NZLR 758 at 765. However, in Mr Forbes’ submission, the decision is against the weight of authority and in any event was a matter for further argument, not a reason to prevent the claim from being filed.
[13] I accept that intention to mislead is not relevant for the purposes of s 9 of the Fair Trading Act. That is a well established proposition and arguably does extend to cases of non-disclosure.
[14] However, the draft amended statement of claim pleads not only that the defendants are liable under s 9, but that they also have accessory liability under s
43(1).
[15] That is significant because the cases treat accessory liability differently from liability as a principal. Where accessory liability is claimed, the claimant must prove that the secondary party had the necessary mens rea. Thus in Megavitamin Laboratories Ltd v Commerce Commission (1995) 6 TCLR 231 it was held that the accessory party could only be liable if they had knowledge of the falsity of the representation.
[16] Mr Forbes suggested all that meant on the facts of this case was actual knowledge of the contents of the prospectus. I do not accept that is a correct application of the law. In my view, it is clear from authorities such as Megavitamin, Specialised Livestock Imports Ltd v Borrie CA72/01, 20 September 2002 and Body
Corporate 202254 v Taylor [2009] 2 NZLR 17 that before any of these defendants could be liable as an accessory, they would need to have known of the channel stuffing practice and known that its non-disclosure rendered the prospectus misleading.
[17] There being no evidence that any of the defendants (subject to one exception) knew of the channel stuffing, I ruled that the allegations in the draft statement of claim pleading accessory liability in relation to channel stuffing must be removed. The rule requiring a proper evidential foundation is a strict one and applies even where a claim may be in jeopardy of being statute barred: see Commerce Commission v Carter Holt Harvey Ltd [2009] 3 NZLR 573.
[18] As I have mentioned, there is claimed to be one exception, namely a director who was also the chief executive, Mr Magill. The plaintiff’s lawyers say they have obtained evidence which suggests Mr Magill knew channel stuffing was taking place in the 12 month period after the allotment of the shares.
[19] That is reflected in the pleading of a cause of action solely against Mr Magill, pleaded in the following terms:
C. FOR A THIRD AND ALTERNATIVE CAUSE OF ACTION AGAINST THE FIRST DEFENDANT SAMUEL JOHN MAGILL (FTAs9 – post-allotment of shares)
41Feltex continued to engage in the deceptive practice of “channel stuffing”… over the 12 months period from the date of allotment of the Feltex shares on 4 June 2004 and beyond that date.
42This continued “channel stuffing”, in conjunction with the timing of the downgraded profit announcement in the April 2005 NZX announcement, had the effect [of disguising the availability to the qualifying shareholders of their statutory remedy under the Act s37A and they thereby lost the opportunity to give notices avoiding the allotments and to obtain repayment of their subscriptions].
43In respect of the matters referred to in paragraphs 41 and 42 above the first defendant Sam Magill engaged in conduct in breach of the FTA in the ways as are referred to in paragraphs 31.5 – 31.9 above (NB – The plaintiff may provide further particulars as to this allegation and as to the first defendants who engaged in this conduct following discovery).
44.As a result of the matters referred to in paragraphs 41 – 43 above each of the qualifying shareholders has suffered loss.
[20] The evidence on which counsel for the plaintiff rely to support this pleading is affidavit evidence from a carpet retailer for whom Feltex was a major supplier. The retailer alleges billing irregularities in Feltex’s invoicing in 2004 (early billing and an extra 30 days credit) that had not occurred the previous year. He says in December 2004 forward sales accelerated to the point that they represented approximately 53% of the invoices issued to his company for that month.
[21] The plaintiff’s junior counsel Mr Eichelbaum told me he has personally sighted the invoices in question. The contention is that these invoices were issued at a time when it would have been apparent to Feltex and its chief executive officer that the company was not going to be able to meet the financial forecasts provided in the prospectus. Accordingly, driven by the fear of having to repay the subscriptions under the Securities Act, Feltex allegedly decided to steal income out of the 2005 year so as to meet the forecast. Mr Eichelbaum submitted it was inconceivable the Chief Executive Officer would not have been aware of the dramatic shortfall in income contrary to the projections. There would have been meetings between him and his sales staff outlining the shortfall and the steps necessary to remedy it. The retailer in question is a significant retailer, and his evidence does justify the allegation being made.
[22] Mr Cooper, who represents Mr Magill and other directors, challenged the adequacy of the evidence.
[23] However, I am satisfied it is sufficient for present purposes, and have therefore allowed the pleading of the claim against Mr Magill to remain.
[24] For completeness, I should record that although the Court of Appeal decision suggests an allegation of rebate cancelling may be in the same category as channel stuffing, all counsel agree that is not the case because unlike channel stuffing, rebate cancelling is not an inherently deceptive practice.
The draft opt-in notice
[25] The draft opt-in notice which it is proposed to send out to qualifying shareholders is a ten page document. It summarises the history of the proceeding to date, and deals with such matters as eligibility for membership of the representative class, litigation funding arrangements, liability for legal costs, the funding agreement, the ongoing supervisory role of the Court, and the possibility of further amendments to the representation order and funding agreement. It encloses a consent form and advises the reader how to obtain further information.
[26] Counsel for the various defendants sought a number of amendments to the draft notice. Several were accepted by Mr Forbes and incorporated into his final draft but others remained in dispute.
[27] I turn now to deal with each of these in turn, bearing in mind Mr Olney’s submission that the over arching principle must be to ensure the notice is accurate and balanced. It is a document that should inform, not recruit. I agree but would also add that neither is it a platform for the defendants to advance their cause and attempt to deter prospective claimants.
Reference to the Securities Commission report
[28] The defendants contend the opt-in notice should refer to a Securities
Commission report which found nothing wrong with the prospectus.
[29] The plaintiff, of course, identifies shortcomings in the report and contends there is significant countervailing evidence as to why its finding was wrong.
[30] In my view, the opt-in notice should not be a vehicle for debating the merits of the claim. The omission of any reference to the Securities Commission finding does not render the notice inaccurate or misleading.
Involvement of Mr Gavigan
[31] Mr Gavigan is a merchant banker. While he himself was not a Feltex shareholder, he has played a central role in the creation of a shareholders’ action group and the filing of the original claim. Mr Gavigan has incorporated a company called Joint Action Funding Limited (JAFL) to fund the litigation.
[32] The draft opt-in notice makes Mr Gavigan a principal point of contact for qualifying shareholders. The defendants object to this because of concerns about Mr Gavigan’s credibility. The defendants accuse him of distributing misleading information about the claim in the past and of having made false statements in two affidavits. They also point to statements in the Court of Appeal decision which confirm that responsibility for communication with the members of the represented class should rest with the legal representatives, rather than the funder.
[33] The plaintiff however says that while Mr Gavigan’s role may fall to be reviewed at the second hearing, it would be quite impracticable to exclude him at this stage. Mr Forbes submits that sufficient safeguards have now been provided as a result of amendments to the funding agreement stipulating that any communications by JAFL must be cleared through the solicitors.
[34] In the circumstances, I have decided that the fairest approach is to allow Mr Gavigan to remain as a point of contact, but to require that any communications emanating from him to prospective members of the class must be approved first by the plaintiff’s legal representatives.
[35] Another issue raised concerning Mr Gavigan was that it was wrong to describe him as “a commercial funder” in the notice. I disagree. He is a shareholder and director of JAFL.
Exposure to personal liability for party and party costs
[36] The defendants submitted the opt-in notice should include a statement that there is a possibility of qualifying shareholders being exposed to personal liability for party and party costs.
[37] They accept there is well established authority to the effect that the members of a representative class are not personally liable for party and party costs, but submit that may no longer be good law or at least not an invariable proposition.
[38] In support of that submission, counsel collectively raised the following points:
i)In the Court of Appeal decision in this case, there is reference at [35] to the possibility of one of the qualifying shareholders being required to provide security for costs.
ii)The authorities which in the past have held there is no costs liability were decided at a time when there was no jurisdiction to award costs against non-parties. Now that there is such a jurisdiction, those authorities should not be followed.
iii) The circumstances of this case are unprecedented in New
Zealand and it is appropriate to fashion different rules. [39] I do not accept any of those arguments.
[40] First, I am confident that had the Court of Appeal intended to overturn long- established authority, they would have addressed the issue directly and given reasons. Before I would depart from well established authority, I would require much more than a passing observation in one paragraph.
[41] Secondly, while the earlier authorities may have been decided at a time when there was no jurisdiction to award costs against non-parties, more modern cases have reaffirmed the no costs principle notwithstanding the existence of the jurisdiction: see for example Hedley & Ors v Kiwi Co-operative Dairies Ltd & Ors (2000) 15
PRNZ 210.
[42] Thirdly, although the circumstances of this case may be unprecedented in New Zealand, the no liability for costs rule continues to apply in Australia where class actions of this sort are reasonably commonplace. Further, I note that our own
proposed draft High Court Amendment (Class Actions) Rules 2008 also preserve the existing position.
[43] In short, I am satisfied that as the law currently stands in New Zealand, the qualifying shareholders who are members of the represented class will not be personally exposed to an adverse costs order in favour of the defendants.
[44] I do accept, however, that there is a possibility the scope of the representative order may change over time. It is possible for example that Mr Houghton could end up representing qualifying shareholders for some purposes but not others. If that were to happen, it could conceivably have costs implications.
[45] However, the Court has the power to allow qualifying shareholders to opt out in appropriate circumstances. An amendment which had the effect of creating a personal exposure to costs which had not existed before must on anyone’s view of it be an appropriate circumstance.
[46] In my assessment, it is not necessary for this possibility to be mentioned in the opt-in notice. To do so would only serve to cause confusion.
Verification of funding
[47] The defendants were critical of the plaintiff’s failure to provide evidence of the funding that has been arranged to date and sought documentary verification. They opposed there being any reference to funding in the notice unless JAFL was able to confirm that funding by affidavit.
[48] JAFL concedes it has not yet arranged funding for the entire proceeding, but considers it has sufficient funding or will be able to arrange sufficient funding to enable it to pay any security for costs that may be awarded.
[49] Mr Forbes agreed to amend the notice so as to make it clear it was the company and not the Court that considers JAFL has sufficient funding.
[50] I am satisfied it is not necessary to require any further amendments. Security for costs will be ordered and unless and until the security is provided, the proceeding will not be allowed to continue.
[51] Nor do I consider it necessary to require the plaintiff to disclose what costs have been incurred to date nor to disclose to the defendants copies of a time line and budget mentioned in the notice.
Reference to funding agreement as having been approved by the Court
[52] Mr Forbes justified the inclusion of a reference to the Court having approved the funding agreement on the basis the agreement had been approved in the original representation order made by an Associate Judge.
[53] Further, the draft opt-in notice does make it clear that the funding agreement is subject to further review by the Court and may be further amended.
[54] In those circumstances, I see no objection to the reference remaining.
Reference to success fees reducing if interest is awarded
[55] The draft opt-in notice states that if interest or equivalent compensation is recovered, then this will be available to reduce the impact of JAFL’s success fees.
[56] The defendants say this is misleading because under the terms of the funding agreement, an award of interest would itself be subject to the success fee.
[57] However, interest recovered could still potentially have the effect of reducing the impact of the fees on the recovery of the full amount of the price paid by qualifying shareholders for their shares and this is now what the final version of the draft notice tendered by the plaintiff specifically states.
More explicit statement of the fact that Messrs Gavigan and Eichelbaum stand to benefit personally
[58] The draft opt-in notice discloses that Mr Gavigan has a 90 per cent shareholding in JAFL and in a separate stand alone paragraph also states that Mr Eichelbaum has an option to acquire 10 per cent of the shares in JAFL.
[59] I consider it is clear from the draft opt-in notice that the two men stand to benefit and that nothing further is required.
Qualifying shareholders should be made aware of their positive obligations
[60] The defendants submitted that qualifying shareholders should be made aware that joining the class may result in their being required to discover documents and give evidence.
[61] The funding agreement has express provisions to that effect but Mr Forbes agreed to include a specific statement in the notice.
[62] I required one further minor amendment and that was to remove wording which could have created the impression that discovery was a matter to be completed entirely by the legal adviser rather than the party giving discovery.
[63] The defendants also proposed the addition of a further paragraph stating that once the shareholder has entered into the funding agreement they will be bound by it unless permitted to withdraw by the Court or JAFL commits a serious breach.
[64] In my view the shareholders’ obligations in relation to the funding agreement are sufficiently clear as not to require another paragraph in an already detailed notice.
Contents of website
[65] Under the draft opt-in notice, qualifying shareholders are directed to a website to access a number of relevant documents.
[66] The defendants are concerned that the website in question contains other material which is or may be misleading.
[67] In response, Mr Forbes said he would be prepared to arrange for all material other than the listed documents to be removed from the website. I accordingly included a provision to that effect in my order.
Distribution of notice to client shareholders by fourth and fifth defendants
[68] Some of the shares in Feltex were purchased on behalf of investors in the name of the fourth or fifth defendants, or companies associated with them. The address for those shareholders is therefore the address of the company.
[69] In a memorandum filed after the hearing, Mr Forbes sought an order requiring the fourth and fifth defendants to notify affected clients of the claim. The fourth and fifth defendants opposed the making of such an order on the grounds that this was a matter that should have been raised at the hearing. It appears too that there may be some logistical difficulties. Further, such an order would require the fourth and fifth defendants to act with urgency and they submit that would be unfair because it was the plaintiff who left it to the last minute to tender the draft amended statement of claim.
[70] In the circumstances, I decided it would not be appropriate for me to issue an order, but indicated the Court expected the fourth and fifth defendants would use all reasonable endeavours to notify the shareholders in question.
Closing date
[71] The notice states that qualifying shareholders need to complete and return the consent form by 31 May 2010 and goes on to explain that consent forms received after that date may result in the shareholder facing a limitation defence. Another paragraph states that if the shareholder does nothing, they will not be able to participate in the proceeding.
[72] The defendants proposed an amendment to the effect that this latter paragraph should commence with the words “if you do not reply by 31 May 2010, then you will not be able to participate.”
[73] However, such an amendment would be potentially misleading because the limitation point is still only arguable.
Proposed newspaper and internet advertisement
[74] Mr Forbes sought approval for a notice to be published in one or more of the four main centre newspapers and on the internet. The defendants did not object in principle to publication, but did object to the content of the proposed advertisement because it provided for Mr Gavigan to be a point of contact. However, for the reasons given above, I am prepared to allow Mr Gavigan to remain a point of contact subject to the proviso that any communications emanating from him must first be approved by the legal representatives.
What is required to be filed in Court?
[75] It was agreed that rather than require the plaintiff to file all the returned consent forms, it would be sufficient for the solicitors simply to file a list of names.
[76] After the hearing, the defendants requested that the details provided to the Court should include the number of shares purchased by each shareholder and the price paid.
[77] The consent form does not presently ask qualifying shareholders to provide that information and Mr Forbes says (without explaining why) that the plaintiff does not wish to do so at this stage.
[78] Given the issue was never canvassed at the hearing, I have decided not to require the additional information at this stage, but it is a matter that must be traversed at the next hearing because it will obviously be important for the defendants to know the extent of the claim they are facing.
[79] Mr Forbes is to file and serve a copy of the documents as approved by the
Court and sent to the qualifying shareholders.
Solicitors:
A J Forbes QC, Christchurch Wakefield & Associates, Christchurch A R Galbraith QC, Auckland
Bell Gully, Auckland
Clendons, AucklandRussell McVeagh, Wellington
D McLellan, Auckland Jones Fee, Auckland McElroys, Auckland
IN THE HIGH COURT OF NEW ZEALAND CHRISTCHURCH REGISTRY
CIV-2008-409-000348
BETWEEN ERIC MESERVE HOUGHTON First Plaintiff
ANDDARRYL ALEXANDER JONES Second Plaintiff
ANDTIMOTHY ERNEST CORBETT SAUNDERS
SAMUEL JOHN MAGILL JOHN MICHAEL FEENEY
CRAIG EDGEWORTH HORROCKS PETER DAVID HUNTER
PETER THOMAS JOAN WITHERS First Defendants
ANDCREDIT SUISSE PRIVATE EQUITY INC (FORMERLY CREDIT SUISSE FIRST BOSTON PRIVATE EQUITY INC)
Second Defendant
ANDCREDIT SUISSE FIRST BOSTON ASIAN MERCHANT PARTNERS LP Third Defendant
ANDFIRST NEW ZEALAND CAPITAL Fourth Defendant
ANDFORSYTH BARR LIMITED Fifth Defendant
Hearing: 17 May 2010
Appearances: A J Forbes QC, J R Eichelbaum & Ms Mills for Plaintiff
D J Cooper for First Defendants
A Olney and N Hegan for Second & Third Defendants
D H McLellan for Fourth Defendants
A Challis for Fifth Defendants
Judgment: 19 May 2010
JUDGMENT OF HON. JUSTICE FRENCH As to outcome of hearing
HOUGHTON AND ANOR V SAUNDERS AND ORS HC CHCH CIV-2008-409-000348 19 May 2010
[1] The stay is lifted for the limited purpose of permitting:
i)The plaintiff to file the draft amended statement of claim tendered at the hearing on 17 May 2010.
ii) Other qualifying shareholders to opt-in.
[2] The lifting of the stay order is subject to the following conditions relating to the content of the statement of claim:
i)In relation to the first pleaded cause of action, the removal of the allegation of accessory liability under the Fair Trading Act
1986 (cl 31.8 and cl 31.9) in respect of the channel stuffing allegation.
ii)In relation to the second pleaded cause of action, the amendment of cl 39A so as to remove the allegation of accessory liability under the Fair Trading Act in respect of the channel stuffing allegation.
[3] The lifting of the stay order is also subject to the following further conditions:
(i)until further order of the Court all material is to be removed from the JAFL web site other than the documents specified at clause 30 of the opt-in notice.
(ii) thedeletion of the words in brackets , paragraph 17, second bullet point from the draft opt-in notice filed today
(iii) any communications from Mr Gavigan to prospective members of the class about the proceeding must first be approved by the plaintiff’s legal representatives.
[4] Subject to the amendment specified above, the draft opt-in notice filed today is approved.
[5] The plaintiff shall be entitled to publish a notice in terms of paragraph 7 of Mr Forbes’ memorandum dated 19 May 2010 in one or more of the four main centre newspapers and on the internet.
[6] While I am not prepared to order the fourth and fifth defendants to notify client shareholders as requested by the plaintiff, it is the Court’s expectation that the fourth and fifth defendants will make all reasonable endeavours to do so where they or an associated company acted as the nominee for an investor who purchased Feltex shares pursuant to the public offer.
[7] The plaintiff is to file and serve copies of the documents that are sent out to qualifying shareholders as well as a list of the names and Feltex CRN numbers (if available) of qualifying shareholders who subsequently elect to opt into the proceeding.
[8] Leave is reserved to the plaintiff to apply to the Court on notice for any further directions should the implementation of this order pose any difficulties.
[9] Counsel are to finalise a list of issues for the next hearing, with a conference call to take place at 10 a.m., 16 June 2010.
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