McAlister v Lai
[2017] NZHC 791
•27 April 2017
IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY
CIV-2015-404-2839 [2017] NZHC 791
UNDER the Fair Trading Act 1986 BETWEEN
GREGORY JOHN NEALE MCALISTER Plaintiff
AND
JEFFREY KENG YEW LAI First Defendant
ANDERSON CREAGH LAI LIMITED Second Defendant
Hearing: 20, 21, 22, 23 March 2017 Appearances:
R J Hollyman and T F Cleary for Plaintiff
A M Challis and MA Cavanaugh for DefendantsJudgment:
27 April 2017
JUDGMENT OF FOGARTY J
This judgment was delivered by Justice Fogarty on
27 April 2017 at 10.00 a.m., pursuant to r 11.5 of the High Court Rules
Registrar/Deputy Registrar
Date:
Solicitors:
Spencer Legal, Auckland
McElroys, Auckland
MCALISTER v LAI [2017] NZHC 791 [27 April 2017]
Introduction
[1] Orcon Ltd is a telecommunications company. It provides a variety of telecommunications services, such as broadband, internet hosting and voice solutions to residential, business and wholesale customers.
[2] The setting of this case is in April 2013. Orcon had experienced significant growth from June 2010 through to June 2012, however a decline had been experienced from January 2013. It was owned by a company called Kordia, which in turn was wholly-owned by the Crown. Kordia had wished to sell Orcon for some time.
[3] A businessman, Mr Warren Hurst, was inclined to purchase Orcon. He, and a consortium of other investors, entered into a contract to purchase Orcon for $38 million. Mr Hurst eventually managed to negotiate a $22 million finance loan from ASB Bank. Kordia was prepared to offer a $10 million loan as vendor financing. That left $6 million to find.
[4] The remaining $6 million proved problematic. The consortium missed two closing dates on the contract. The third, and likely final, opportunity to purchase the company was a closing set for 12 April 2013. By 19 March 2013, the company formed to buy Orcon, called Orcon Holdings Ltd (OHL), was attempting to raise funds to achieve its largely debt-driven purchase. Its internal documents show that on 12 April it still needed to find $1 million to settle. The funds flow statement at
1.36 pm on that day allocated:
$22 million – ASB $10 million – Kordia $1 million – Shareholders’ funds $4 million – “already settled” $37 million
[5] The “already settled” figure comprised $3,250,000 from a working capital facility belonging to Orcon, as well as $750,000 in cash from a “sweep” of Orcon’s operating account. Those cash assets were agreed by representatives of both vendor and buyer, to belong to the buyer.
[6] The working capital facility was known as “CPE Finance”. It was in the nature of the business of Orcon that when it won a new customer it would deliver to and fit on the premises of the customer modems/routers, known as customer premises equipment or CPE. Without these, the customer was not able to receive Orcon’s services. CPE Finance was a bank facility to raise working capital for the business, through a sale and lease-back arrangement. CPE could not be used for any other purposes than working capital without the prior written permission of the bank.
[7] It was in these circumstances that the plaintiff, Mr McAlister, entered the picture. He is an experienced businessman who had held various managerial and directorial positions at telecommunications companies. He was offered the office of CEO of Orcon if the deal went through. Quite separate to his involvement with Orcon, Mr McAlister had loaned Mr Hurst $100,000, unsecured, in his private capacity. It was in this context that Mr Hurst approached Mr McAlister to see if he wished to invest in the acquisition of Orcon.
[8] Mr McAlister was initially tentative and would not invest without adequate security. He eventually settled on terms for a convertible note, in exchange for a
$200,000 investment. The $200,000 advanced by Mr McAlister was one of a number of small contributions to the outstanding million (plus fees) required for settlement. The funds flow statement of 3.10 pm on 12 April records $1,281,000 held in the Anderson Creagh Lai Law (ACL) trust account. ACL is the second defendant. It acted for OHL, Mr Hurst and the consortium on the deal. The Court knows that $200,000 of that trust account sum came from Mr McAlister.
[9] What is undisputable is that the acquisition by OHL of Orcon was effectively almost fully-funded by debt. Neither OHL, nor its parent company, Semple, ever contributed any equity (debt free) money to the purchase, except possibly a deposit of $1 million. It will be recollected that the ASB thought a prudent amount of money to lend on the purchase of the sale of this business for $38 million was $22 million. ASB knew about the vendor finance of $10 million but had negotiated priority of its debt. However, ASB did not know that the consortium was planning on drawing-down the CPE Finance facility to fund the purchase of Orcon.
[10] On 12 April the deal went through. Mr McAlister later became CEO. He discovered that there was less equity in the transaction than he thought. Mr Hurst went bankrupt. The company with which Mr McAlister held his convertible note went into liquidation. He has received only $7,864 of his $200,000 from the liquidators.
Mr McAlister’s Claim
[11] Mr McAlister has brought these proceedings under the Fair Trading Act 1986 (the Act). He says he invested $200,000 in the deal was after being misled into believing there was at least $6 million of equity in the purchase. In other words, that at least $6 million of the $38 million reflected a contribution of that sum to the purchase price, free of debt. He says it was represented to him by Mr Hurst that the
$38 million purchase price was to be structured as follows: (a) Vendor debt of $10 million;
(b) Bank debt of $22 million; and
(c) Equity of $6 million (to include Mr McAlister’s funds if he agreed to
invest).
[12] Mr McAlister seeks to recover the balance of his $200,000 advanced, plus interest. His claim is made out under s 9 of the Act, which provides:
9 Misleading and deceptive conduct generally
No person shall, in trade, engage in conduct that is misleading or deceptive or is likely to mislead or deceive.
[13] The claim is brought against Mr Hurst’s solicitor, Mr Lai, and Mr Lai’s incorporated law firm, ACL. Mr McAlister claims that Mr Hurst and Mr Lai falsely represented that the equity in the transaction would be $6 million. That Mr Lai knew or was reckless as to the truth of the structure of the transaction; there was not in fact
$6 million of equity — $3.25 million was obtained through CPE financing. That Mr Lai authorised the payment of the $200,000 deposited by Mr McAlister into his law firm’s trust account despite knowing the transaction would not have the $6 million in
equity represented to Mr McAlister and that at all relevant times Mr Lai was acting in his capacity as a director of ACL.
[14] Alternatively, it is pleaded that Mr Lai was a party to misrepresentations by
Mr Hurst.
[15] Accordingly, the plaintiff claims an order under s 43 of the Fair Trading Act directing Mr Lai and/or ACL to repay Mr McAlister plus interest under s 87 of the Judicature Act 1908 and costs.1 To reflect that Mr Lai faces claims of primary and secondary liability, the claims under s 43 are on two bases. First, s 43(1)(a), that Mr Lai personally was engaging in misleading or deceptive conduct in breach of s 9; or, secondly, he was party to a breach and so liable under s 43(1)(b)–(e).
[16] Section 43(1) of the Fair Trading Act provides:
43 Other orders
(1) This section applies if, in proceedings under this Part or on the application of any person, a court or the Disputes Tribunal finds that a person (person A) has suffered, or is likely to suffer, loss or damage by conduct of another person (person B) that does or may constitute any of the following:
(a) a contravention of a provision of Parts 1 to 4A (a relevant provision):
(b) aiding, abetting, counselling, or procuring a contravention of a relevant provision:
(c) inducing by threats, promises, or otherwise a contravention of a relevant provision:
(d) being in any way directly or indirectly knowingly concerned in, or party to, a contravention of a relevant provision:
(e) conspiring with any other person in the contravention of a relevant provision.
(Emphasis added.)
1 Section 87 of the Judicature Act 1908 was repealed by s 182(4) of the Senior Courts Act 2016.
Despite that repeal, s 87 remains in force under cl 1 of sch 1 of the Interest on Money Claims
Act 2016, until that Act comes into force in 2018.
Arguments by the Parties
[17] Mr Lai and ACL deny liability, pleading that at no time could Mr Lai recall there was a mention of “equity” and that he did not personally refer to the $6 million funding gap. The pleadings acknowledge that there was in fact a $6 million funding gap between the $32 million of the vendor and the bank debt and that the purchase price to be met.
[18] The defence pleads that Mr Hurst considered the value of Orcon to be higher than the $38 million purchase price, so neither Mr Hurst nor Mr Lai would have considered there was $6 million equity in any event. Mr Hurst valued the transaction over $38 million because he was proposing to amalgamate a company he owned, Vivid Networks Ltd (VNL), into the Orcon group. He valued VNL at $2.5 million and therefore considered the value of the purchase of Orcon to be correspondingly greater than $38 million.
[19] The pleadings also rely on the fact that, when the convertible note was prepared, Mr McAlister was told by Mr Lai that Mr Lai was not acting for Mr McAlister in this transaction and he should get advice on the transaction from another lawyer if he chose to do so.
[20] The convertible note gave Mr McAlister an option to take effectively 2.85 per cent of the shares of OHL. This was to be achieved by a conversion of shares in Semple. Semple held 48 per cent of the shares in OHL. Mr McAlister pleaded that Mr Lai told him that this option in the convertible note was designed to reflect that the value that Mr McAlister’s contribution of $200,000 had to the total equity (not total shares) in OHL and that this value would be 2.85 per cent of the total equity in OHL.
[21] At the trial Mr Lai denied making any representation as to $6 million of equity before the convertible note was signed, and he denied that it was made by anybody at the meeting on 11 April 2013. This was the day before closing. At that meeting three persons were present – Mr Hurst, Mr Lai and Mr McAlister. By that day Mr McAlister had deposited $200,000 in ACL’s trust account. That had been done two days earlier. Mr Lai says he understood the meeting was simply to finalise
the terms of the convertible note. He appreciated Mr McAlister would be trying to get the best terms. He gave evidence that if any representation was made on 11
April, it was made by Mr Hurst, not by Mr Lai. As a result, Ms Challis, acting for Mr Lai, argued that he could have no liability as a principal under s 9 of the Act nor could there be liability arising from his silence. Mr Lai would have had to adopt any representation by Mr Hurst in some way before liability could be established and he did not.
[22] It was also argued that even if the Court found that at that meeting Mr Hurst represented there would be $6 million in equity, in Mr Lai’s presence, there was no principled basis on which a solicitor, as Mr Lai is, can be liable for his or her client’s statements in the absence of some kind of dishonest participation, and there was no such evidence in this case. Ms Challis phrased this argument on the basis of a solicitor’s duty of confidentiality to his or her client.2 She argued that to hold Mr Lai accountable for a representation made by Mr Hurst would amount to holding that Mr Lai was under a positive duty to interrupt or correct his client when a
misrepresentation was made; but this, she argued, would amount to a breach of the lawyer’s duty of confidence. Under the Lawyers and Conveyancers Act (Lawyers: Conduct and Client Care) Rules 2008, a lawyer can only make disclosure of confidential information under certain conditions.3 She argued those conditions were not met, so disclosure would not have been permitted.
[23] I am not persuaded by the solicitor’s duty of confidentiality argument. First, s 9 of the Fair Trading Act imputes liability for conduct that either is or is likely to be misleading or deceptive. The legislature has made no suggestion that conduct cannot be misleading or deceptive by virtue because there was a duty not to disclose confidential information relevant to such conduct.
[24] Rather, the position is more nuanced. It is possible that the misleading conduct could be remedied by a positive affirmation that does not disclose confidential information. It is not a blanket rule that a duty of confidentiality
necessarily renders s 9 defunct. Secondly, on the facts, Mr Lai cannot argue that he
2 Lawyers and Conveyancers Act (Lawyers: Conduct and Client Care) Rules 2008, ch 8.
3 See rr 8.2–8.6.
had a duty of confidentiality in relation to the equity in the deal. It was stated in evidence by Mr McAlister and Mr Lai that Mr Lai had been at the meeting on 11
April to negotiate and explain the terms of the convertible note. Mr Lai had been instructed to discuss the terms of the deal by his client, Mr Hurst. He too was involved in the preparation of terms. In those circumstances I am satisfied that Mr Lai cannot seek to defend any misleading conduct on his part by claiming that he was under a positive duty not to correct a misleading or deceptive statement by his client.
[25] At all material times Mr Lai knew that Mr Hurst intended to draw down on the CPE facility as a means of raising capital or freeing up cash through the sale of assets. It was believed by him, and it would seem also by Mr Hurst, that this was going to be an “off balance sheet” exercise.4 It was Mr Lai’s evidence that this was something that all the parties, including Mr McAlister, were aware of and that he believed, from Mr Hurst, that the banks were aware of this.
[26] Mr McAlister’s evidence was that the representation that there was $6 million of equity was repeated in that meeting in Mr Lai’s presence, when the convertible note terms were negotiated. As corroboration, Mr McAlister’s notebook contains a file note that he made once the formula in the convertible note had been agreed. His file note records the following:
Equity 8.5
$6 from Orcon
2.5 for Vivid
8.5
10% discount
7.65m
200
$200k for 2.85%
share
convert in 90 Days or money back @
12%
4 The CPE assets would be sold to Kordia, taking them off Orcon’s books. The ongoing lease obligations would be recorded on the books, but only as they arose each month as an ongoing liability. The terms of the deal were that Kordia would own the assets for less than three months, after which time they would be sold to a third party, and the lease assigned. Through this method, Kordia would not be required to have the assets in its books either.
[27] This note was not challenged at the trial. It is a contemporaneous file note. It is consistent with Mr McAlister’s oral evidence. It is also consistent with the funds flow statement for the ASB which showed $5 million “already settled” and a further
$1 million of “shareholder funds”.
[28] Mr Hurst was called to give evidence and candidly told the Court these were the same figures he had used in discussions with all investors. For example they are reflected in the term sheet for another advance from a company, Pelorus Finance Ltd. Mr Hurst did not specifically admit that these figures were discussed at the meeting. He could not recall precisely what was discussed.
[29] A key issue becomes as to whether or not Mr Lai was aware of this representation of equity at the meeting. It was a misrepresentation. There was not
$6 million or $8.5 million equity in the transaction. CPE financing, which carried with it an ongoing lease obligation, amounted to $3.25 million.
[30] In her closing submissions Ms Challis, lead counsel for the defence, did not dispute that Mr Hurst would have been using these numbers. But she added that his concept of equity was a concept of the “equitable value” of the business after the purchase, including the amalgamation of his other company, VNL. That this was based on the normalised financials and forecasts prepared by independent valuers.
[31] Mr Hollyman, lead counsel for the plaintiffs, submitted that the figure of 2.85 per cent, the conversion rate of shares in the convertible note, could only be derived if the parties were working on the assumption that at least $6 million of the purchase price would be equity. That is, to negotiate the terms, Mr Lai and Mr Hurst must have represented a false value of the actual equity in the transaction.
[32] Mr Lai’s evidence was that when he was negotiating the terms of the convertible note in the presence of Mr McAlister and Mr Hurst, he derived a formula of 2.81 per cent. He was not sure now how he did it and could not replicate it. He said Mr McAlister derived the conversion rate of 2.85 per cent and the higher figure was agreed upon as a “sweetener” for Mr McAlister. That it was not because there was any agreement that one of the appropriate integers was $6 million of equity. Mr
McAlister disputes the “sweetener” proposition. Neither of these two percentages
fall out of the draft or final calculation formulas.
[33] The first draft of the convertible note was based on the total purchase price
discounted by 10 per cent. Mr McAlister’s contribution of $200,000 was divided by
34.2 million and the result multiplied by 10,000 being the shares in Orcon Holdings, with an adjustment to convert to the shares in Semple.
[34] Mr McAlister rejected that draft. He made it clear he wanted the convertible note to give him the benefit of his contribution to the intended equity in the purchase. A new formula was then drawn up by Mr Lai at the meeting on 11 April where the contribution of $200,000 from Mr McAlister was divided by 8.5 million expressed as the total equity in OHL times 0.90 (representing a 10 per cent discount).
[35] It was in this context that Mr Lai said he worked through that second formula and this resulted in a conversion rate of 2.81 per cent which, in his evidence, was “sweetened” to 2.85 per cent. However, the night before he gave his evidence Mr Lai looked at the calculation again and could not reach the figure of 2.81 per cent, but was sure in his mind that that was the figure he had computed.
[36] For Mr McAlister, his counsel Mr Hollyman conceded that this second formula would equally not derive 2.81 or the figure agreed of 2.85 per cent. Rather, it would derive a figure of 2.54 per cent of the shares in OHL. Though if the discount multiplier was changed from 0.9 to 0.8 this would give Mr McAlister a 2.85 per cent interest, being the figure agreed on.
[37] I do not think it is necessary, nor possible, to resolve precisely the provenances of the two competing figures of 2.81 per cent or 2.85 per cent. Nor is it necessary to resolve whether the higher figure was a sweetener.
[38] Rather, the material fact is that the second formula uses the sum of
$8,500,000 as being the total equity in OHL on purchase, and that figure reappears in the note Mr McAlister made at the time being $6 million equity from Orcon plus
$2.5 million from Mr Hurst’s other company, VNL. That note was never challenged
in evidence. Nor was it challenged that it was Mr Lai who was doing the drafting and recalculations of the convertible note formula.
[39] It is a necessary consequence of these findings that Mr Lai was present when Mr Hurst was telling Mr McAlister that the equity was $8.5 million made up of $6 million from Orcon and $2.5 million from VNL.
[40] It was Mr Hurst’s evidence that he was representing to would-be lenders (and so on the probabilities, to Mr McAlister) that the company post-acquisition would have equity of $8.5 million.
[41] It is more probable than not that the figures of $6 million and $2.5 million as recorded by Mr McAlister at this meeting on 11 April, came from Mr Hurst. There is no evidence of these figures originating from Mr Lai. But it is a necessary conclusion that these figures were advanced by Mr Hurst in the presence of Mr Lai. There was no evidence that the proposition of the $6 million equity was qualified by a disclosure that it was obtained by use of CPE finance.
[42] It was Mr McAlister’s evidence that when he found out about the CPE
funding a few weeks after becoming the CEO, raising a monthly liability of
$150,000 to pay interest and reduce the loan, he was shocked and angry, and confronted Mr Hurst. Mr Hurst denied he had been confronted, saying he would have recalled that. He said the first time he became aware of any complaint by Mr McAlister about misrepresentations was when Semple Investments received a letter from Mr McAlister’s solicitors in 2015. Mr Hurst denied he misrepresented anything to Mr McAlister.
[43] The plaintiff called several corroborating witnesses to the stance taken by Mr McAlister. Mr Lee, the head of Capital Solutions at the ASB Bank, said in evidence that he could recall Mr Hurst saying the consortium was planning to put $6 million of equity into the purchase and to seek the remaining amount from ASB. He said ASB was not prepared to lend $32 million over the proposed equity (of $6 million) as that was beyond their appetite for the transaction.
[44] Mr Farrugia, a partner at Buddle Findlay who provided legal services to the ASB Bank, was called to quash any suggestion that Buddle Findlay would have consented on behalf of the bank to the use of the CPE facility. In particular he denied he had been informed as much by Mr Lai during the negotiations. It had been Mr Lai’s evidence that Buddle Findlay should have worked it out at the time. Mr Farrugia was clear:
I categorically reject Mr Lai’s evidence that he spoke with me a couple of times regarding the use of at least $3 million CPE finance to fund the share price. At no point did Mr Lai ever raise this issue in relation to funding the share price with me. Nor was ASB’s approval ever sought in return for this. The CPE equipment was only ever discussed in the context of working capital funding.
[45] This evidence from Mr Farrugia is the complete answer to an argument I received from Ms Challis that ASB knew about the CPE funding. She argued that the share purchase agreement and the consolidated share purchase agreement made it evident that CPE funding was being used.
[46] Mr Farrugia also commented on a proposition of Mr Lai’s, made under cross- examination, where Mr Lai said that he did not need to specifically draw to Buddle Findlay’s attention that there was a $3.25 million further advance being used by moving assets off the balance sheet, as that did appear in the final document sent by Buddle Findlay at 3.59 pm on the last day.
[47] Referring to the receipt of the final SPA at 3.59 pm Mr Farrugia said:
AThe way settlements occur, we generally say CPs5 need to be satisfied by 2.30 to allow banks to move money around especially when there are other sources of funds, anything after 2.30 and you’re up against the reality of being very unlikely to settle, same day cleared funds can’t occur after about 4 o’clock, sometimes 4.30. So in the interests of time is, at 3.59, you know being aware that the bank needed to receive the signed SPA which they still hadn’t received at that point because it was a mark up, but to allow CPs to be satisfied, bearing in mind we’d been chasing a large number of outstanding conditions precedent all afternoon.
5 Conditions precedent, conditions that need to be satisfied before funds can flow from the bank.
QSo you’re saying that no one from your firm on receipt of this would have gone through the changes to the document that was attached to it?6
AIf I was required to, money wouldn’t have flowed until Monday, there is no way in one minute, one hour, two hours I would have been able to review and report to the bank on that. I wasn’t asked to, otherwise I would have [and] settlement, would have occurred on the Monday.
[48] From this evidence it is clear that ASB did not have an opportunity to study the final version of the sale and purchase agreement (SPA), which arrived at 3.59 pm on the day of settlement. That lack of opportunity led to the bank releasing the funds, while not being aware that the settlement also relied upon four draw downs on the CPE working capital facility, totalling $3.25 million, without the bank’s permission. And it was clear that such consent would not have been granted.
[49] Ms Challis also submitted that Mr Lai in his position knew that the amended SPA with the amount required in closing which referred to the SPA funding had been sent to the ASB’s solicitors.
[50] It is not quite clear from Ms Challis’ submissions which draft of the SPA she was referring to. Certainly the last SPA which arrived at 3.59 pm on the day of settlement, when read as a whole, did reveal the intended use of the CPE. However, as Mr Farrugia and Mr Lee’s evidence make clear, at no point prior to settlement was the ASB informed in any meaningful sense of the use of CPE finance to fund the purchase of Orcon.
Is there liability on Mr Lai arising from these facts?
[51] Any relief depends on proving first breach of s 9, then proving loss, by conduct of another person, which falls within any of paragraphs (a) to (e) of s 43(1). Either primary or secondary liability may follow from this two-step approach.
[52] This distinction of the issues into two steps is examined by the New Zealand
Supreme Court in Red Eagle Corp Ltd v Ellis:7
6 Recall this is the first document to the bank which recorded use of the CPEs to be drawn down on.
7 Red Eagle Corp Ltd v Ellis [2010] NZSC 20, [2010] 2 NZLR 492.
[28] It is, to begin with, necessary to decide whether the claimant has proved a breach of s 9. That section is directed to promoting fair dealing in trade by proscribing conduct which, examined objectively, is deceptive or misleading in the particular circumstances. Naturally that will depend upon the context, including the characteristics of the person or persons said to be affected. Conduct towards a sophisticated businessman may, for instance, be less likely to be objectively regarded as capable of misleading or deceiving such a person than similar conduct directed towards a consumer or, to take an extreme case, towards an individual known by the defendant to have intellectual difficulties. Richardson J in Goldsbro v Walker said that there must be an assessment of the circumstances in which the conduct occurred and the person or persons likely to be affected by it. The question to be answered in relation to s 9 in a case of this kind is accordingly whether a reasonable person in the claimant’s situation – that is, with the characteristics known to the defendant or of which the defendant ought to have been aware
– would likely have been misled or deceived. If so, a breach of s 9 has been established. It is not necessary under s 9 to prove that the defendant’s
conduct actually misled or deceived the particular plaintiff or anyone else. If
the conduct objectively had the capacity to mislead or deceive the hypothetical reasonable person, there has been a breach of s 9. If it is likely
to do so, it has the capacity to do so. Of course the fact that someone was
actually misled or deceived may well be enough to show that the requisite capacity existed.
[29] Then, with breach proved and moving to s 43, the court must look to see whether it is proved that the claimant has suffered loss or damage “by” the conduct of the defendant. The language of s 43 has been said to require a “common law practical or common-sense concept of causation”. The court must first ask itself whether the particular claimant was actually misled or deceived by the defendant’s conduct. It does not follow from the fact that a reasonable person would have been misled or deceived (the capacity of the conduct) that the particular claimant was actually misled or deceived. If the court takes the view, usually by drawing an inference from the evidence as a whole, that the claimant was indeed misled or deceived, it needs then to ask whether the defendant’s conduct in breach of s 9 was an operating cause of the claimant’s loss or damage. Put another way, was the defendant’s breach the effective cause or an effective cause? Richardson J in Goldsbro spoke of the need for, or, as he put it, the sufficiency of, a “clear nexus” between the conduct and the loss or damage. The impugned conduct, in breach of s 9, does not have to be the sole cause, but it must be an effective cause, not merely something which was, in the end, immaterial to the suffering of the loss or damage. The claimant may, for instance, have been materially influenced exclusively by some other matter, such as advice from a third party.
[30] Another operating cause of loss or damage may perhaps have been the claimant’s own conduct in failing to take reasonable care to look after his or her own interests. The court should therefore ask itself whether the claimant’s carelessness, if there were any, should be regarded as the sole or a contributory operative cause of the loss. The fact that the claimant may have contributed by carelessness to his or her own downfall does not disqualify the claim. … As the Goldsboro case has established, the court has discretion under s 43 (it “may” make an order), and the proper exercise of that discretion may lead it to decide that part only of the amount of the loss or damage should be paid by the defendant to the claimant (or, in some cases of
reckless behaviour by the claimant, even that no order for payment should be made).
[31] The exercise of the power to make an order for payment under s 43 is, in the end, as Richardson J also said [in] Goldsboro, a matter of doing justice to the parties in the circumstances of the particular case and in terms of the policy of the Act.
(Emphasis added, footnotes omitted.)
[53] I consider the approach laid down by the Supreme Court in Red Eagle
sufficient to deal with this case.
Examined objectively, did Mr Lai’s conduct actually mislead or have the
capacity to do so?
[54] Dealing with that question, I have no doubt that the conduct of Mr Hurst considered objectively was capable of misleading a reasonably sophisticated investor like Mr McAlister. Mr Hurst said that he was using the term “equity” as meaning equitable value, being the total realisable value of the business at the point of sale should it be placed on the market, less total debt. Such a value is very much a matter of opinion, it is not verified by a sale transaction. When business persons talk naturally about the equity in a company they are talking about the value of the company after repayment of debts. But where one is talking about the purchase of a business and equity in that context, such persons are usually identifying the difference between the purchase price and the funding of the purchase, in the same way that a person who buys a dwelling for $2 million, using $1 million on equity obtained from the sale of the former house and borrowing $1 million, will naturally say he or she has equity of $1 million, being the purchase price less borrowings. Of course a year or two later that equity will change as the asset rises or falls in value and as the borrowings are paid off.
[55] It needs to be kept in mind that the context here was Mr Hurst seeking to persuade investors to put up money to purchase a small tech company. His comments about there being equity of $6 million in the purchase naturally refers to the net value after deducting the borrowing from the settlement figure. The greater that equity, the easier it is to service the company’s liabilities and the more attractive
the investment becomes to a long term investor. So the representation is material to assessment of risk of the investment.
[56] Any prudent investor knowing that the purchase is going to be financed by nearly 100 per cent debt will usually become very cautious and think carefully about the wisdom of investing. This caution reflects common experience and wisdom. So to talk about there being $6 million of equity in this context amounted to telling a sophisticated businessman like Mr McAlister, who was also on an offer to become the CEO of the company, that $6 million of the purchase price of $38 million was not borrowed money. But it is not even necessary to go that far. Under the law as enunciated in paragraph [28] of Red Eagle it is sufficient that the advice of $6 million of equity “had the capacity to mislead or deceive the hypothetical reasonable person”. I conclude it did and so there has been a breach of s 9 by Mr Hurst.
[57] Mr Hollyman submitted that it would be unusual in a three-way conversation for only Mr Hurst to make these representations about equity. As we have seen clearly Mr Lai on the probabilities was using the equity number when he was amending the convertible note so that it reflected the $200,000 from Mr McAlister as a share of the equity in the funding of the purchase price and costs. Mr McAlister must have known that and appreciated the materiality of the total equity of $8.5 million when writing it down.
[58] So the first submission was that this Court should find Mr Lai did, upon an objective analysis, engage in conduct (misleading conduct) by calculating Mr McAlister’s convertible shareholding interest in OHL by reference to a proportion of equity of $8.5 million. Mr Hollyman submitted all the evidence points to this and there is no legitimate explanation otherwise. I have found that Mr Lai was present when Mr Hurst misrepresented the quantity of equity in the transaction.
[59] I find that Mr Lai used at least part of the total equity of $8.5 million, probably the $6 million quantum, when deriving and/or agreeing to the percentage of
2.85. We know he used that sum because he agreed that he abandoned the first draft note, in order to substitute a percentage of interest in the equity.
[60] This is buttressed by the term sheet of a contemporaneous advance by another investor, Pelorus Finance Ltd, of $400,000. That investment was also made through a convertible note.
[61] In that convertible note the conversion calculation records:
Conversion Calculation The loan will convert to Ordinary Equity on the basis of: Proportionate interest = Total Loan Value
(Total Equity Invested . 0.9) + Total Loan Value
Where:
Total Loan Value is the Aggregate of the drawn amount of the Facility plus the Facility Fee plus Termination Fee plus Lender’s Costs plus accrued Interest.
Total Equity Invested is $8,500,000.
[62] The conversion calculation is not spelt out that way in the terms of the note that Mr McAlister executed. But Mr Lai was cross-examined utilising similar formulae reflecting the $8.5 million figure without any demure on his behalf. The Pelorus term sheet was signed by Mr Hurst. It is more probable than not, that the same equity was being taken into account in the convertible note in respect of Mr McAlister executed on the same day. The only difference being the conversion is set out simply as of 2.85 per cent, with no information as to how it was arrived at.
[63] With reference to Red Eagle I am satisfied that examined objectively the utilisation of the $8.5 million of equity was factored into the equations by Mr Lai who knew it was not equity, at least as to the CPE component. He did not, however, caution or alert Mr McAlister. Objectively, the failure to caution contributed to Mr Hurst’s misleading conduct, in breach of s 9. This conclusion does not rest on Mr Lai’s omission to warn Mr McAlister of a misleading or deceptive statement by Mr Hurst. Rather, by completing the calculation in this way, whilst explaining and negotiating the terms, Mr Lai himself contributed to conduct that was in breach of s 9.
Has Mr McAlister suffered loss “by” the conduct of Mr Lai?8
[64] Had Mr Lai intervened in the process and explained that the $6 million was substantially made up of $3.5 million of funds obtained by exercising the CPE finance, the question is whether that would bother Mr McAlister sufficiently so that on the probabilities he would no longer lend. Or to use the language of the Supreme Court in Red Eagle at [29], was Mr Lai’s conduct “an operating cause of the … loss”.
[65] The considerations here include keeping in mind that Mr McAlister is economically literate. He is educated as a chartered accountant. Secondly, he was the putative CEO of the company. Thirdly, he would from his business experience have realised that raising funds of $3.5 million on a working capital facility would raise significant liability requiring monthly cash flow (at $150,000) to both pay interest on the outstanding debt and reduce the capital.
[66] The convertible note finally signed needs to be read in the context with the first draft of the convertible note which contained the formula of the conversion. It also needs to be kept in mind that Mr Hurst in his evidence agreed that if there was an introduction of equity of $8.5 million then the 2.85 per cent factor derives from that.
[67] There is no doubt that Mr Lai had an opportunity when negotiating the convertible note to point out to Mr Hurst that the $8.5 million in equity included
$3.25 million being an unauthorised draw down of working capital in the CPE facility so that it was wrong to think of total equity as being $8.5 million. The question becomes, how would Mr McAlister have reacted if he was given that information? Or, how would Mr McAlister have responded if a correct figure of equity had been used to calculate the convertible note?
[68] Mr McAlister had an incentive for the deal to be closed. He had a standing offer to become the CEO and he had accepted it. It was, of course, conditional on
there being a closing. But the evidence is that he was initially reluctant to advance
8 Red Eagle, above n Error! Bookmark not defined., at [29].
more money. He had previously loaned Mr Hurst $100,000. He originally declined to put in the $200,000. He was persuaded to put that in. As the likely CEO he would have rapidly appreciated the cost burden imposed on the company by having to service drawings of four tranches of the CPE facility in excess of $3 million. As it was he found out it was at the rate of $150,000 per month. It was also part of his evidence that he understood that when growing the company every new connection generated a negative cash flow because in order to provide the connection the company had to purchase or lease the necessary modem/router, the physical equipment, to be fixed to the customer’s property. The customer only turned a profit after the fees the customer was paying recouped the cost of installation. So the CPE facility was there for a purpose, including funding the initial cost of acquisition of a new customer.
[69] Mr McAlister was not cross-examined on the proposition that he would have gone ahead anyway. The defence was that Mr Lai had no obligation to tell him about the equity. Given the way the case was run, together with the facts that I have just marshalled, I am satisfied that it is more probable than not that Mr McAlister’s evidence that he was very angry when he found out about the use of the CPE facility was correct. As a putative CEO he would have had a similar reaction, but prior to advancing the $200,000, on balance, and partly because he was not challenged in this way at the trial, I find on the probabilities that he would not have advanced the
$200,000 in these conditions. He may well not have agreed to be the CEO faced with the significant utilisation of the CPE facility without the consent of the bank.
[70] I conclude that Mr McAlister has discharged the burden of proving that he did suffer a loss by the misleading conduct of Mr Hurst and Mr Lai.
[71] For all these reasons I conclude that the plaintiff has made out its case that s 9 was breached by Mr Lai in trade engaging in conduct that was misleading or deceptive, by omitting to clarify that there was no injection of equity as in a sum of money not bearing interest in the purchase price in the sums either of $6 million or
$8.5 million.
[72] It does not follow there is a remedy. The analysis so far has been objective as to Mr Lai’s conduct. The availability of a remedy depends on an exercise of discretion. Section 43(2) grants the Court a discretion to provide any of the remedies described in subs (3). Subsection (3)(f) provides for:
An order directing person B to pay to person A the amount of the loss or damage.
[73] On the findings so far this Court has a discretion to choose a remedy in s 43. Section 43(1)(d) provides for liability for:
being in any way directly or indirectly knowingly concerned in, or party to, a contravention of a relevant provision.
[74] There is an argument that (d) is a qualifier to (a) because the matters in (d) could be regarded as a contravention yet they have been separated out into a separate paragraph. Any relief is discretionary. In my judgment conduct which falls within s 43(1)(d) is obviously best applicable to a person who was not the prime actor but was rather concerned in, or party to a contravention. For these reasons I think that any relief in response to Mr Lai’s conduct, properly falls to depend upon the application of s 43(1)(d). It is necessary under s 43(1)(d) to find that he was knowingly concerned. So far I have found he caused loss, by an objective analysis of his conduct. But to recover damages under s 43(1)(d) his state of mind must be proved. The word “knowingly” invites a finding of culpability, an awareness of being party to a contravention of the Fair Trading Act.
[75] I follow Dobson J in Hinton v Smith:9
To qualify for relief under s 43(1)(d), the Hintons have to establish that the Smiths were “directly or indirectly knowingly concerned in or party to” the misrepresentations made by Mr Donnithorne. This test requires a claimant to establish that the defendant knew the essential aspects of the misleading conduct, and was a conscious or intentional participant in it. For example, see NZ Bus Ltd v Commerce Commission [2008] 3 NZLR 433 (CA) at [137].
[76] There is a distinction between Mr Lai knowing that Mr Hurst was talking about equity where no equity existed and being knowingly concerned in or party to a
contravention of a relevant provision. The latter requires some degree of culpable
9 Hinton v Smith HC Hamilton CIV-2007-419-001047, 16 July 2009 at [110].
knowledge, although without there being a necessary element of intent. On these facts it is necessary for the plaintiff to prove that Mr Lai was knowingly party to conduct which he knew was misleading or deceptive or likely to mislead or deceive.
[77] The setting of all of this conduct was of Mr Lai, a property lawyer, trying to get his client Mr Hurst over the line to close the deal, third time around. He gave evidence that he was extremely busy on both days, 11 and 12 April, the day before closing and the closing day. He had not been party to the negotiations leading to the commitment of Mr McAlister to advance $200,000. I am not positively satisfied that he did in fact turn his mind to whether the assumed equity, being used to calculate the formula for the convertible note, was itself misleading or capable of misleading Mr McAlister.
[78] Mr Lai is an experienced commercial lawyer and a principal in his firm. This settlement was important to Mr McAlister, but not so important as to risk the reputation of Mr Lai personally, or his firm. Having seen and heard Mr Lai I do not think that he knowingly was party to misleading conduct. Rather, the better explanation is that on a very busy day, he used the $8.5 million equity figure to calculate the share entitlements of Mr McAlister, amidst many other attendances on the settlement, without consideration as to whether this assumption of the presence of capital was misleading Mr McAlister.
[79] It follows that I am not satisfied that the plaintiff has proved on the balance of probabilities, having regard to the seriousness of the allegation, that Mr Lai and his firm was directly or indirectly knowingly concerned in or party to a contravention of s 9 of the Fair Trading Act.
Conclusion
[80] I find that Mr Hurst engaged in conduct in breach of s 9 and that Mr Lai through his silence contributed unwittingly to that breach. This breach caused Mr McAlister’s loss. However I am not satisfied that Mr Lai was directly or indirectly knowingly concerned in that breach. I therefore exercise my discretion not to award a remedy under s 43 of the Fair Trading Act.
[81] It follows that the plaintiff’s claim fails against Mr Lai and against his firm.
[82] There is judgment for the first and second defendants.
[83] Costs are reserved. I am inclined to favour costs on a 2B basis.