N-Tech Ltd v Abooth Ltd

[2012] NZHC 1167

IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY

CIV-2006-404-003362

CIV-2007-404-000990 [2012] NZHC 1167

BETWEEN  N-TECH LIMITED AND ORS Plaintiffs

ANDABOOTH LIMITED AND ORS Defendants

Hearing:         14-19, 21-26 August; 5, 12-16, 19-20, 28 September, 27 October 2011

Counsel:         C T Walker with B Prewett for Plaintiffs

P J Dale with N Campbell and V Fletcher for Defendants

Judgment:      29 May 2012

RESERVED JUDGMENT OF THE HON JUSTICE KÓS (Costs)

Table of Contents

Introduction............................................................................................................................ [1] The schemes........................................................................................................................... [8] The outcome of the 2004 criminal trial................................................................................ [56] The present proceedings ...................................................................................................... [60] Issues on the present costs applications ............................................................................... [75] Issue 1:  Defendants entitled to indemnity or increased costs?............................................ [76] Issue 2: Defendants entitled to scale costs instead? ........................................................... [121] Issue 3 & 4: Plaintiffs entitled to costs on discontinuance of counterclaims? ................... [137] Conclusion ......................................................................................................................... [166]

Introduction

[1]      A trial abandoned on its 19th  day.  Claims all discontinued by the plaintiffs; counterclaims  all  discontinued  by the  defendants.    Only the  allocation  of  costs cannot be agreed.  The defendants ask for indemnity costs.  They say the plaintiffs’ claims  always  lacked  any  conceivable  merit,  and  the  plaintiffs  knew  it.    The

plaintiffs deny that. They say costs should just lie where they fall.

N-TECH LIMITED AND ORS v ABOOTH LIMITED AND ORS HC AK CIV-2006-404-003362 [29 May 2012]

[2]      Back in September 2004, four men associated with the Digitech investment scheme faced trial for fraud in the High Court at Auckland.

[3]      One of them, Mr John Reid, was the promoter of the scheme. The other three assisted him and carried it into effect.  Mr Reid gave evidence before me.  I will say more about him later.   But I say now, as I said at the trial,1  that I held serious reservations about the truthfulness of some of the evidence he gave before me.

[4]      A second  of  the  criminal  defendants,  Mr  Peter  Connolly,  gave  evidence before me also.  He cut a sorry figure.  Euphemistically, Mr Reid described him as “unnecessary”.  His role was to give apparent substance to the transactions if they were ever enquired into.  Certainly by the Revenue; perhaps by investors.  Presenting as a merchant banker of substance - albeit one operating from a garden flat in Peckham  rather  than  offices  in  the  City of  London  -  he  was  in  fact  the  mere amanuensis of Mr Reid, his solicitor Mr Darvell, and Mr Currie (of whom, more shortly).  Of an evening he would receive phone calls from Auckland or Hong Kong, note down what the other three dictated, get his wife to type it all up, and then send it straight back to them over his signature.

[5]      The third man, Mr Peter Russel, was still due to give evidence before me when the trial collapsed.  He had been an Inland Revenue Department tax inspector, and later became a partner in the Auckland accounting firm Gosling Chapman.  He took a substantial payment, $680,000, from the Reid interests to assist in promoting the scheme.  It seems he did not disclose that payment to his fellow partners.

[6]      The fourth man, Mr John Currie, did not give evidence.  He was an employee of a Hong Kong-based corporate services firm.   He described himself in his correspondence, variously, as a solicitor or an accountant in Hong Kong or Victoria. It is clear that he held legal and accounting qualifications academically, but there is no evidence that he held current practising certificates in either jurisdiction.  At most relevant times he was simply an employee of the Hong Kong corporate services firm.   Presenting as a solicitor for the purpose of receiving payments from the

investors, his “trust account” was an ordinary trading account at Standard Chartered

1      Minute, 28 September 2011.

Bank, Hong Kong.  Engaged to facilitate certain offshore aspects of the scheme for Mr Reid, he set about cheating his client in his own interests by organising without authority an increased fee for one of the participants, and then pocketing the difference.   He was subpoenaed to give evidence in the civil trial before me, but neither the plaintiffs (who might have gained assistance from his evidence) nor the defendants wished to call him.  Evidently because he was not regarded as reliable.

[7]      So  those  were the defendants  in  the criminal  trial.    None of them  gave evidence at that trial.  Two gave evidence before me in the 2011 civil trial, when the issue became one between the promoters of the scheme, the investors, and those who advised them.

The schemes

[8]      The  Digitech  scheme  (and  its  later  counterpart,  the  NZIL scheme)  were designed according to common template.  One concerned an investment in Digitech, a modestly successful IT company.   The other in a company called New Zealand Investments Limited.   Its interests were more diverse, but included a company manufacturing heavy road trailers.

[9]      The criminal charges in 2004 were that the two schemes were essentially shams, calculated to defraud members of the public investing in them (via loss attributed qualifying companies) and the Commissioner of Inland Revenue.

[10]     Digitech was owned 100 per cent by N-Tech Limited, the first plaintiff in the subsequent  civil  proceedings.     NZIL  was  owned  100  per  cent  by  St  Lucia Investments Limited, the second plaintiff in the civil proceeding.   N-Tech and St Lucia  were  beneficially  owned,  substantially  if  not  wholly,  by  family  trusts  of Messrs  Reid  and  Milloy.    They owned  a  company  called  Milloy Reid  and  Co

Limited (Milloy Reid).   Its name and ownership changed over the years.2     But

throughout it was controlled and substantially owned by Mr Reid and his business partner, Hugh Milloy.

2      Variously Milloy Reid Tong & Co Ltd, Milloy Reid Wong & Co Ltd and CMW & Co Ltd.

[11]     The structure of each scheme was as follows.  I will concentrate on Digitech. There were three essential features.

(1)      Share purchase

[12]     First, investors (generally via LAQCs)3  would purchase shares from N-Tech or  St  Lucia.    Each  Digitech  share  cost  $1.00.    That  was  a  high  price  when considering the underlying value of the company being invested in.   It effectively valued Digitech at $100 million.  This was highly speculative.  The company had valuable intellectual property, but its historical earnings could not justify a value of that order.  As an investment, it was very much a punt on future performance if that intellectual property could be leveraged successfully.  It did not appear investors had independently appraised value. A very significant part of the value of the investment was in anticipated tax benefits.  Importantly, also, payment of most of the purchase price was deferred.

[13]     The minimum investment was $500,000.   The purchase price was paid in instalments:

(a)       a deposit of 9.5 per cent of the purchase price, payable usually on execution of the purchase agreement;

(b)      seven further annual instalments of 1 per cent;

(c)       the balance of 83.5 per cent of the purchase price, payable at the end of year 10.

Shares would only be transferred by N-Tech to the investor in year 10, on payment of the final instalment.  The acquisition was made with the expectation of resale in due course.   As a result, the purchase price was a deductable expense, with sale proceeds being taxable income.   The evidential significance of the tax advantages

had not been fully traversed before me at the time the trial collapsed.  I did not get to

3      Loss attributing qualifying companies. They had two advantages: their net tax position was transferable to their shareholders, while their liability as an investor was non-transferable.

hear from the investors.   But Mr Reid was at pains to say that neither he nor

Mr Milloy ever promoted the tax advantages of the scheme.

[14]     The tax advantages were, however, obvious:  assuming the scheme was not an unlawful avoidance, it had the patent benefit of advancing the entitlement of investors to claim deductions for expenses.  The key to this lay in the second core component of the scheme (which I will discuss in a moment), the loss of profits insurance scheme.  Investors obtained the right to deduct the original share purchase price.   But that component was not deductible in full at the outset, but only as instalment payments were made.   The position with the loss of profits insurance policy was different.   Investors received tax advice (albeit not from N-Tech or St Lucia) that this could well be deductible in whole in the first year of the policy.  I have no doubt whatever that the designers of the scheme intended this potential advantage to be apprehended and acted upon by the investors.  Fogarty J reached a

similar view in the criminal case after hearing the evidence of a few of the investors.4

Those designers clearly included Mr Reid, despite his efforts to distance himself and attribute all architectural features of the scheme to his solicitor, the late Mr Paul Darvell.

(2)      Loss of profits insurance

[15]     Secondly, the loss of profits insurance policy.  This policy was issued by a company called Epicharmus Vastgoed BV (Epicharmus) in the Netherlands.  I will say more about it later.  The insurance premium was dollar for dollar.  If an investor bought one million $1 shares, and purchased the policy, the premium payable was also $1 million.  The premium was payable in year 1, but the investor just paid a 4 per cent deposit and borrowed the balance – that being the third part of the scheme.

[16]     So the investor would need to pay the 9.5 per cent share purchase deposit ($95,000) plus the 4 per cent deposit of the $1 million insurance premium ($40,000). The  insurance  component  was  optional.    It  was  however  essential  to  gain  the potential tax advantage.  All but one investor took up the insurance option.  I will

return to the way the policy would work in practice shortly, but the key benefit

4      See R v Connolly (2004) 21 NZTC 18,844 (HC) at [23]–[24].

promoted was that the insurance policy would guarantee a $3 sale price in year 10, six months after the last instalment of the original purchase price was payable.  The underlying benefit, indirectly promoted, was the tax advantage referred to a moment ago.

(3)      Limited recourse loan

[17]    The third essential component was a limited recourse loan.   The major immediate cost in year 1 was of course the insurance premium (in the example,

$1 million, cf $95,000 for the purchase price deposit).  The loan (from an offshore lender, nominally in the first instance the Bank of New York Intermaritime Bank of Geneva (BNY-IMBG)) was of 96 per cent of the insurance premium.

[18]     Security for the loan was a mortgage over the share purchase agreement and the insurance policy.  A limited recourse provision confined the lender’s recourse to the value of those two instruments.5

How it worked

[19]     The investor in the example would part with just $135,000 in year 1 ($95,000 share purchase price deposit and $40,000 loss of profits insurance policy deposit) while gaining the perceived tax deduction of an expense of $1 million (cost of the premium) in year 1.

[20]     Assuming the insurance premium could be deducted in year 1, the investor paid out 13.5 cents per share, and received a deduction of approximately 36 cents (the deductable premium plus a small deduction for the first purchase price instalment). Analysis presented to me showed that an investor would be better off on almost any view taking the insurance than not doing so.

[21]     The funds for the policy did not originate with BNY-IMBG.   Although a reputable bank based in Switzerland, its role was never more, in fact, than that of a

“fiduciary lender”.  That is, on closer inspection, the “loan” was funded by a circular

5      See Totara Investments Ltd v Crismac Ltd [2010] 3 NZLR 285 (SC).

series of transferable certificates of deposit.  BNY-IMBG was never at risk of having to contribute real funds.  In exchange for a fee of just 1.25 per cent it lent its name to the transaction.   But the back-to-back arrangement with the ultimate “lender” – Asian Growth Fund Limited – and use of transferable certificates of deposit meant that  BNY-IMBG  could  be told  it  had  “no  risk  whatsoever in  settlement  of the transaction”.  In fact its TCD would never leave its custody.

[22]     The  structure  is  shown  in  the  following  diagram,  which  collects  and summarises all five tranches of the Digitech (N-Tech) scheme:6

6      But not the NZIL scheme, although the structure was similar in most respects.

[23]     From this diagram the following can be seen.

[24]     First, the only solid cash entering the scheme comes from the Investors:

$7.08 million (9.5 per cent share purchase price deposit) + $2.98 million (4 per cent insurance deposit) = $10.06 million.

[25]     Secondly, the share purchase price component drops out immediately, going to N-Tech at the bottom of the diagram (as owner of the shares in Digitech and promoter of the scheme).  Ultimately those proceeds ended up with the Reid/Milloy interests.

[26]     Thirdly, the “Insurer”, Epicharmus (and I will explain shortly why I have used quotation marks around the word Insurer) clips the ticket on the cash premium component.  It takes 0.2 per cent of the $2.98 million cash received for the insurance component and that has not yet dropped out and gone to N-Tech.  That was its fee. From that modest clippage, it can be inferred that it was exposed to little actual risk. It was functioning as an arranger rather  than an indemnifier.   But  I accept the

submission made to me on behalf of the defendants generally by Mr Ring QC7   that

the clear impression investors would have had was that Epicharmus would have reserved not only the 4 per cent contribution by investors, but also the loan balance of 96 per cent, in real dollars, from BNY-IMBG, via Mr Currie’s “trust account”.  In fact BNY-IMBG  made no such payments to Mr Currie’s “trust account” (or at least Mr Currie’s nominated account at Standard Chartered Bank Hong Kong) and that aspect  of  the  diagram  (the  supposed  loan  payment  between  BNY-IMBG  and investors, via Mr Currie) never took place in real terms.

[27]     Fourthly, the balance of the money remaining – now $2.831 million – goes to the “Underwriter”, – Swiss Underwriters Group Limited (Swiss).  It is unclear what if any visibility investors had of Swiss Underwriters.  As Mr Campbell Walker (for the plaintiffs) candidly acknowledged in submissions, “its existence and identity was not disclosed from  investors  at  the time”.    It  is  clear from  the documents  that

investors would have expected a reinsurer to be involved.  The creation of a distinct

7      Mr Ring QC appeared for the Gosling Chapman third parties until day 11 of trial. It is right here to pay particular tribute to the outstanding quality of his opening submissions on behalf of all parties opposing the plaintiffs.

special purpose trust (to be funded by the insurer) was evident on the face of the documents received by investors.   Indeed it was essential if the transaction was to achieve the anticipated tax benefits.  Again I will come back in due course to the Underwriter and what became of the $2.8 million premium moneys.  I am satisfied on the evidence before me that Swiss (a British Virgin Islands company) was incorporated by Mr Connolly at the request, and for the benefit, of Mr Reid and his

associates.8

[28]     Fifthly,  the  Bermuda Purpose Trust  (correctly,  the Claims Administration Trust in the diagram) is the relevant purpose trust.  Much time was spent in evidence understanding the beneficial ownership of this entity, established in Bermuda by Harrington Trust Limited at the request of the Hong Kong law firm acting on the instructions of Messrs Reid and Currie.   Two purposes lay behind its formation. First,  to  maintain  and  improve  tax  effectiveness  for  the  purpose  of  enabling deduction of the insurance premium.   Legal advice obtained by Gosling Chapman and another accounting firm (who acted for many investors) was that the presence of the purpose trust “provided investors with an additional line of defence against the IRD”. The policy issued by Epicharmus to investors provided:

The Insurer will provide sufficient funds to the Trust in order that it may meet its obligations under the event of insurance and will procure the Trust to issue to the Insured no later than 30 days after the date of this policy conditional of undertaking in deed form to meet all payment obligations of the Insurer hereunder.   The delivery to the Insured of such a deed shall extinguish the obligation of the Insurer hereunder to the Insured which shall thereafter have a claim solely against the Trust.

[29]     The  tax-based  argument  against  the  Revenue  would  have  been  that  had investors had a right to enforce the policy directly against the insurer, they would have received a benefit from the trust for the life of the policy, and would only be able to deduct a portion of the premium in each year of the life of the policy.  As

Mr Gray QC submitted:9

The creation of a purpose trust enforced by a third party pursuant to a contract of enforcement enabled deduction of the whole of the insurance premium in the year in which it was paid.

8 See at [54] below.

9      Mr Gray QC appeared on behalf of the legal adviser, another third party.

The correctness of this view was never determined.  The investors of course thought the whole of the premium was being paid in year 1, but just 4 per cent of the cash for that was coming from them.  Again I have no doubt on the evidence before me that the purpose trust was established at the behest of Mr Reid.  In a letter dated 2 March

1995 to Gosling Chapman, Mr Reid explained that he had “received” the following further information about the insurer.  In fact, the letter appears to be entirely one of his own devising:

I can confirm that the insurer is controlled and operated in the Netherlands and that it is an insurance company.  The obligations which the insurer is undertaking in year 10 are fully covered and are able to be met by the insurer.  This is largely achieved by virtue of the insurer “quarantining” its risk by the establishment of the purpose trust which is adequately funded to meet these claims in year 10.  The Trust purchases assets such as “A” rated reinsured mortgages, government bonds or other such investments which have maturity values enabling it to cover the obligations it takes on, in this case the insurance of the Digitech shares.   These asset purchases are generally in US dollars denominated investments and to cover any interest or foreign exchange risks, the insurer uses interest rate and currency swaps, so as to hedge, in this case, an NZ dollar exposure in the year 2005.

Prima facie that letter implied to the reader a substantial, adequately funded insurer. Not a scheme the insurance aspects of which would largely be funded at the last minute by the investors’ own settlement of the insurance premium loan.10   Of course whether any particular investor read it that way, and relied on it, remained to be seen.

[30]     Mr Reid admitted in evidence that he had never intended to put any funds into the purpose trust:

Mr Dale:   What you are trying to do is avoid the issue because I am suggesting that, and I think His Honour has put to you as well, that this letter conveys a very different picture, it conveys tangible assets after year

1 and A rated assets available and growing, and that’s the way you wanted it to be put to the investors?

Mr Reid:   The – there was never any intention to put money into the

Purpose Trust day 1.

But not just day 1.  The evidence before me suggested the purpose trust was wholly unfunded.  Had a claim been made in 2005 under the insurance policy, on the basis

10     See R v Connolly (2004) 21 NZTC 18,844 (HC) at [166].

that the shares were now worthless, payment of the insurance claim (which might have totalled something in the order of $223 million) would have been met by investor loan repayments six months earlier (circa $208 million) and Mr Reid and his colleagues putting their hands in their pockets for the remaining $15 million or so. Their argument, however, was it was always commercially improbable that such a claim would be made.   I will come back to the commerciality of the transaction shortly.

[31]     The second reason for the establishment of the Claims Administration Trust was to remove liability from the nominated insurer, Epicharmus.  This entity, almost exclusively among the corporate cast paraded before me, was  not controlled by Mr Reid.   But the Dutch corporate service company Equity Trust Co NV became extremely   nervous   about   its   legal   position   as   shareholder   in   Epicharmus. Epicharmus had only “nominal assets”.  Ultimately it was necessary for Mr Reid to go to the Netherlands in February 1997 and sign an indemnity to Equity Trust in these terms:

In order to cover the above mentioned potential liability of [Epicharmus] and Equity Trust Co NV in its capacity as Managing Director of [Epicharmus], parties agreed to the following:

(1)     John Reid, on his own behalf and on behalf of Swiss & Claims Administration Limited, herewith guarantees that Swiss & Claims Administration  Limited  would  have  sufficient  funds  available  to meet the potential claims of the insured under the policy in the Trust deed.

(2)     John Reid indemnifies Equity Trust Co NV from and against any and all claims in contract or tort or suits, for any damages, taxes, costs and expenses sustained, incurred or expended, directly or indirectly, including without limitation, fees, costs and expenses of attorneys, accountants  and  other  experts  engaged  by  Equity  Trust  Co  NV and/or its directors or employees when [Epicharmus] and/or Equity Trust Co NV will be addressed by the insured and/or third parties in connection with any claims including but not limited to the policy and/or the Trust deed.

I regard that document as clear evidence as to the beneficial control of Swiss and the

Claims Administration Trust.

[32]     What then became of the $2.831 million paid by Epicharmus to Swiss?  This was money paid by investors by way of an instalment of the insurance premium.  It appears that this money went to pay fees for participants such as Mr Currie and his employer, and Mr Darvell who received fees of approximately NZD$400,000 for his involvement.  A substantial proportion, nearly $600,000 was also paid to interests associated with Mr Russel.  He was the former Gosling Chapman partner who was slated to give evidence shortly after the point at which the trial collapsed.   The balance was largely repatriated to New Zealand via a sequence of transactions the details of which need not trouble us for present purposes. Albeit, they should trouble someone.  But these were a series of payments for “modems” (the physical existence of which may be doubted) and other “royalty agreements”.   There was no basis available on the evidence to reach any other conclusion but that these deals were devices designed to repatriate funds to New Zealand in a way which would conceal their true nature from either the Revenue, the investors (to the extent they actually cared) or both.  Indeed Mr Reid accepted, in questioning from the Court, that these transactions were shams.

[33]     What can be said is that no real or substantial insurance scheme was put in place  –  real  in  the  sense  that  there  was  any  substantial  entity  with  substantial reserves from premium income, or underwriters (funded from the same source) to whom risk had been laid off, available to meet claims on the policy.  That requires consideration of the commerciality of the transaction.   And in turn that requires consideration of two scenarios: (1) Digitech going badly (so the insurance might be needed); and (2) Digitech going well.

(1)      If Digitech went badly

[34]     The insurance policy “guaranteed” that the shares would be worth $3 in year

10 – in which year the investor would be required to pay the balance of the purchase price ($0.835) plus the insurance premium loan (fixed at $2.80).  So let us take two examples.

[35]     First, assume in year 10 the shares are worth nothing.  If the investors wanted to claim on the insurance, they would first have to settle.  Pay $3.63 – the number in

the preceding paragraph - in order to get back $3 (but in truth, $2.00 because the insurance proceeds would be taxable).   Well, what would you do?  Especially you were a limited liability LAQC investor, without any shareholder guarantee.

[36]     Secondly, assume the shares were worth $2.50 in year 10. The investor might then want to claim on the insurance, which guaranteed a $3 value.  But to claim the investor would need first to settle.  So the investor would still be paying $3.63 to get

$3  (this  time  represented  by  shares  each  worth  $2.50  and  a  $0.50  insurance payment).  In short, as Mr Walker put it in opening, “there is no scenario in which an investor claims on the insurance and makes money on the investment.”

[37]     Evidence before me suggested that, allowing for holding costs and tax the true breakeven year 10 value of the shares needed to be about $4.18.   If Digitech went badly, the benefits of investment would largely be confined to the short term tax advantages, with the investor likely defaulting on settlement of the final purchase and loan repayment obligations.  (I note that full analysis of the tax position if the investor defaulted at year 10 was not presented to me.)   Any other benefit depended on Digitech (or NZIL) doing really well.

(2)      If Digitech went well

[38]     In evidence Mr Reid presented  two diagrams of what the cashflows looked like for participants if the Digitech shares were worth $5 in year 10.   This was a prospect that of necessity Mr Reid had to acknowledge was a real possibility.  The information  memorandum  issued  to  potential  investors  predicted  revenues  of

$138 million in year 10.

[39]     Obviously if the shares were worth $5 in year 10 no insurance claim could be made.  The cut-off point for a claim was $3.  But to gain access to the shares at that

$5 value, the investors obviously had to settle the purchase agreement.  So they had to  (1)  pay  the  balance  of  the  purchase  price  ($0.835);  (2)  repay  the  insurance premium loan ($2.80); and (3) pay a 10 per cent profit share over $3 (0.20).  $3.83 to gain $5.  This time, worth doing.   I have attached the diagrams, consolidated into one:

[40] As the diagram shows, the main winner at a $5 share value was the ultimate “lender”, Asian Growth Fund Limited (AGFL) – which we met earlier at [21]. Of the $373 million value, it would get almost half. It did not appear on the evidence before me that investors had any visibility of AGFL. But of course investors did not actually give evidence, so one cannot be absolutely sure. But there was no evidence on the face of the settlement documents or information memoranda supplied to

investors that would create an impression that the lender was anything other than BNY-IMBG (or a later subsequent substitute, Armour Fidelity Limited).  The latter was a cipher entity created by Messrs Reid and Currie. Armour Fidelity had a glossy brochure, but no substance.

[41]     AGFL was incorporated by Mr Currie’s employer, Byrne Corporate Services Limited (Byrne) in 1995 in Hong Kong.   It was (and in effect remained) a shelf company.  Mr Reid’s evidence was that AGFL’s potential year 10 windfall was not a benefit he would share in at all, and that AGFL was beneficially owned by Byrne or Grant Thornton Byrne.11   Having heard Mr Reid’s evidence I made clear in a Minute that I did not accept that evidence.  Mr Currie could have given evidence to confirm Mr Reid’s position, but the plaintiffs elected not to call him.

[42]     It is appropriate here to repeat what I said in that Minute:12

In the present case the Court has heard most of the plaintiffs’ evidence. But all the Court has formed, at most, is certain clear views on aspects of the veracity of the principal witness for the plaintiffs, Mr Reid.  In some significant respects, as I indicated this morning, my views are adverse to Mr Reid.  For instance, in relation to his evidence that all potential offshore profits (other than the skimming of premium payments which were repatriated to New Zealand via a series of falsified transactions) were to the account of Grant Thornton Byrne in Hong Kong.  That evidence I do not accept.  There are other problems with Mr Reid’s evidence, but this is not the time to catalogue them.   Suffice to say that I do not accept his attempts to distance himself from control of, or substantial influence over, the offshore entities, including Asian Growth Fund Ltd, Armour Fidelity Ltd, Swiss Underwriters Group Ltd, Malican Developments Ltd and Parabola Developments Ltd.

[43]     As is apparent, who ultimately controlled AGFL is of some importance.  As we have seen in the event that Digitech performed well – so that the investors willingly settled in year 10 and repaid the loans to BNY-IMBG – AGFL as the “true lender” standing above the ticket-clipping BNY-IMBG stood to find itself holding a

cash surplus of over $150 million.

11     They were associated entities.

12 Minute, 28 September 2011 at [14].

[44]     Mr Reid’s assertion that Byrne was the beneficial owner of AGFL, and that he and Mr Currie had “discussed that Grant Thornton Byrne would have the chance of significant upside in year 10” beggars belief when set aside three considerations.

[45]     First, the apparent ignorance of senior executives of Byrne of that fact.   If Byrne was the beneficial owner of AGFL, it is surprising to say the least that there was no evidence of that fact in either the documents or the transcript of the hearing in Hong Kong before Magistrate Ng in August 2003.  That hearing was conducted under the Mutual Legal Assistance in Criminal Matters Ordinance Cap 525 (HK). Two senior  executives  associated with Byrne, Thomas Corkhill  and Christopher Hall, gave evidence.

[46]     Mr  Corkhill  was  unclear  as  to  who  the  ultimate  owner  of AGFL  was. Certainly he did not think it was his company, Byrne. Mr Hall was asked:

Q        Who did you take to be the client of Asian Growth Fund?

AI took the client to be the Milloy Reid and that John Reid was giving instructions on behalf of Milloy Reid.

[47]     The reference to “client” in context is a synonym for “principal”.   Their evidence contains not the slightest suggestion that AGFL was beneficially owned by their (entirely reputable) business entities.  So far as they understood, the ultimate beneficiary of AGFL was not Byrne but either Mr Connolly (a cipher for Mr Reid), Mr Reid or Milloy Reid.

[48]     Secondly, there is the fact that when Byrne was making payments on behalf of AGFL in August 1995 they sought approval from Mr Reid.  He in turn asked them to obtain approval from his man of business in Peckham, Mr Connolly.  None of that makes sense if AGFL was Byrne’s.

[49]     Thirdly, it defies all rational belief that Mr Reid did not retain a significant interest in AGFL, given the prospect of its recovering funds so vastly in excess of the approximately $10 million that Mr Reid and his associates would derive from the bottom half of the transaction.   (That figure allows for additional receipts from

repatriation  of  a  proportion  of  the  investors’ 4  per  cent  premium  deposit  and

additional value earned in the NZIL transactions, not shown in the diagram at [22].)

[50]     If the year 10 $5 scenario panned out after all – a scenario that Mr Reid at all times insisted was credible – then as we have already seen in the last diagram:

(a)      N-Tech (the Reid interests) would capture a further $62.2 million (in addition to the $7.1 million proceeds plus the repatriated deposit moneys discussed earlier); and

(b)AGFL would capture a far healthier $222.9 million.   Of that, $71.5 million would have been payable to Swiss (also, I find, a Reid company).

[51]     The idea that this potential value was sacrificed to a corporate services firm in Hong Kong with which Mr Reid had scant association, and which itself was unaware of the fact, needs only to be stated to be disregarded.

[52]     I note that I made clear at trial my scepticism at this evidence.  I indicated the importance of Mr Reid’s claim being corroborated by Mr Currie when he gave evidence.  In doing so I bore in mind Mr Reid’s admission in cross-examination that he had previously lied while under oath in interviews with the Revenue.13    He lied to the Revenue about Mr Connolly’s role.   He appears also to have lied about the transactions used to repatriate the “surplus” insurance premium deposits back to New Zealand.  And Mr Reid also admitted before me that he had lied in interviews with the Serious Fraud Office (SFO), albeit not under oath.  He lied to the SFO about

who owned AGFL (saying he understood it was Mr Connolly) and he lied again about the premium repatriation transactions:

Court:  Can we start with, were you lying or weren’t you?

Mr Reid:   Well I don’t believe Peter Connolly ever owned Asian Growth

Fund, no.

Court:  So is that a lie?

13     Tax Administration Act 1994, s. 19.

Mr Reid:  In that context, yes sir.

The plaintiffs nonetheless preferred not to call Mr Currie.  The subpoena issued to him14 was discharged.

[53]     In  addition,  I conclude  that  Mr  Reid  was  ultimate  beneficial  owner  and controller of other entities significant to the narrative.  As I said in my Minute of

28 September 2011, I did not accept his attempts to distance himself from control of, or substantial influence over Swiss and Armour Fidelity.  Nor over the entities used to repatriate the “surplus” insurance premium deposits to New Zealand, Malican Developments Limited and Parabola Developments Limited, in what Mr Reid admitted eventually, under questioning from the Court, to be a series of sham transactions.

[54]     It is unnecessary here to rehearse all of these bodies’ affairs.   It will serve adequately to look at Swiss, which had in prospect one-third of the value falling out at the top of the diagram in [39] if Digitech did well.  I am satisfied on the evidence that I heard and saw that Swiss was incorporated in the British Virgin Islands by Mr Currie at Mr Reid’s behest.    I have mentioned already the personal guarantee given by Mr Reid on Swiss’s behalf in 1997.15   Costs to establish and maintain Swiss ultimately were sourced from Milloy Reid.  There were a number of invoices.  Byrne were billing for their time, as was a Hong Kong law firm.  One of its bills in 2000,

expressly  relating  to  their  services  in  connection  with  Swiss  (and  for  no  other matter), was directed at Mr Currie’s request to Milloy Reid.   Mr Reid had the headline changed from “Swiss Underwriters Group Ltd” to “New Zealand matters”. Mr Reid was party to engaging a division of the Hong Kong Trust Company Limited to act as Swiss’s corporate director.   That role was later filled by Malican Developments Limited, a company I find Mr Reid also controlled (and which was party to the sham premium repatriation transactions).   Mr Reid misrepresented to Equity Trust Co NV that Mr Connolly was the beneficial owner of Swiss, when as we have seen he was no such thing.  Equity Trust though continued dealing with Mr Reid in relation to Swiss and Epicharmus from time to time.  Mr Currie represented

that Mr Reid (not by name, but it can hardly have been Mr Connolly) was his client

14     He is now resident in Australia.

15 See [31] above.

in relation to Epicharmus and Swiss, in dealing with Equity Trust and the Hong Kong law firm referred to earlier.   Indeed he went so far in communicating with Claims Administration Limited (see the diagram at [22]) that in dealing with the purpose trust, Mr Reid is “your ultimate client”.

[55]     Having said all this, it is important to note that only in certain particular respects did I find Mr Reid to give evidence that was not credible.  In other respects his evidence appeared frank and truthful.  Those respects where his evidence was not credible concerned the ultimate beneficial ownership, and effective control, of the scheme.

The outcome of the 2004 criminal trial

[56]     Fogarty  J  acquitted  the  four  accused  (Messrs  Reid,  Currie,  Russel  and Connolly)  of  all  counts  faced  by  them  (principally  conspiracy  to  defraud).    In reasons delivered on 22 October 2004, Fogarty J reached the following conclusions:

(a)      The insurance  and  loan  aspects  of the  scheme  were not  “entirely fictional”, or shams, as the Crown had alleged.   The transactions, whatever their ultimate commercial or Revenue merit, created genuine legal obligations. The transactions were intended to have legal effect.

(b)The fact that the funding side of the transaction was circular, effected on a fiduciary basis by the apparent lender, and with promissory notes used rather than a genuine flow of funds,16 did not make the transactions a sham. They were “artificial”, true, but not shams.

(c)      There was reasonable doubt as to the existence of an intent to deceive given  the  extent  of  disclosure  made  by  Mr  Reid  in  particular  to Gosling Chapman and Gosling Chapman’s legal advisers, Denham

Martin & Associates.

16     “For practical purposes one can assume there were no funds there at all, other than the investors’

cash portion”. R v Connolly (2004) 21 NZTC 18,844 (HC) at [106].

[57]     As Fogarty J put it:17

... on the totality of the evidence Gosling Chapman was squarely on notice that there could be a close relationship between the insurer and the bank and thus that there be a circular transaction between two paper companies.

The transaction was structured to enable the LAQC investor to “walk away if the shares proved valueless”.18    It was inherently unlikely in that event that any claim would be made on the insurance policy because the cost of doing so ($0.83 per share to settle – a pre-requisite for the claim) plus $2.80 to repay the insurance loan =

$3.63 would exceed the insurance payment ($3.00).  A point I have noted already.19

The  indictment  was  so  drafted  in  its  allegation  of  conspiracy  (to  defraud  the Revenue) to make that allegation purely consequential on proof of fraud against the investors.   Fraud against investors not being established beyond reasonable doubt, conspiracy could not be found either.

[58]     That, then, was the essence of the criminal trial in 2004.  In the case before me there are some fundamental differences.

[59]     The issues were very different, as I will explain shortly.  Secondly, the burden of proof obviously differed.  Thirdly, very different evidence was given in the civil trial than in the criminal.  For a start, Messrs Reid and Connolly both gave evidence before me, but did not do so before Fogarty J.  Their evidence was, therefore, the subject of extensive cross-examination.   In addition, for the purposes of the civil proceeding, the plaintiffs readily conceded matters that at least initially were in contest in 2004 in the criminal proceedings.   Or which may have had a different emphasis in the criminal trial.   In the current civil proceedings, for instance, the plaintiffs acknowledged from the outset that Epicharmus, Swiss and Armour Fidelity were not substantial entities.   They acknowledged, readily, that the funding arrangement  was  circular.    They  acknowledged  that  Mr  Connolly was  a  “mere cipher”  and  that  his  correspondence  had  been  dictated  to  him  by  Mr  Reid, Mr Darvell and Mr Currie.  Finally, considerably greater analysis of the documentary

transactions occurred in the ensuing period between 2004 and 2011.

17 At [177].

18 At [188].

19     At [34] – [35].

The present proceedings

The parties

[60]     The  plaintiffs  I have  already  introduced.    N-Tech  Limited  promoted  the Digitech scheme, and sold shares in that company to the LAQC investors.  St Lucia Investments Limited promoted the NZIL scheme, and sold shares in that company to the LAQC investors.   Their claims were simple enough:   the defendants were in breach of their contractual obligations under the share purchase agreements; the plaintiffs had cancelled them; the plaintiffs now claimed the purchase price not paid (less resale value) plus interest.

[61]     The defendants in the proceedings were 121 companies which entered into either or (in few instances) both the Digitech and NZIL transactions.   The largest group of defendants, 60 in number, were known as the “Grove Darlow defendants”, because they are represented by that firm.  They are the remaining defendants at the time of this judgment.  They defended the plaintiffs’ claims for breach of the share purchase agreements.   They also brought claims against the third parties, whom I will introduce in a moment.   Thirty six of the defendants had filed admissions of the plaintiffs’ claims.   They continued in proceedings as claimants against the third parties.  Represented by the firm LeeSalmonLong, they were the “LSL defendants”.

[62]     Five defendants associated with Gosling Chapman were represented by the firm Lowndes Jordan (and were known as the “Lowndes Jordan defendants”).  They defended the plaintiffs’ claims, brought counterclaims against the plaintiffs and some of the counterclaim defendants (Messrs Reid, Milloy, Wong, Connolly and Currie in particular).  They advanced no third party claims.  The remaining defendants were not represented and did not take steps.  By the time trial started, claims continued against 107 defendants in all. The other 14 claims had been discontinued.

[63]     The third parties were, at the time of commencement of trial, partners of the accounting firm Gosling Chapman and a law firm Denham Martin & Associates.  A second law firm, Kensington Swan, was also a third party.   Proceedings against

Kensington Swan were discontinued immediately before the commencement of the trial.

Overview of the litigation

[64]     The   primary   claim   between   plaintiffs   and   defendants   concerned   the obligation of the LAQC investors to settle the share purchase agreement deficit ($0.85 per share) in year 10, starting in March 2005.  The purchase price was, as I have already related, to be paid by instalments.  All the defendants paid the initial purchase price instalment.  Most (if not all) defendants paid instalments due in each year up to the year 2000.  Thereafter they refused to make further payments.  The plaintiffs treated their refusals as repudiation, and cancelled the agreements.

[65]     The failure by the defendants to settle the agreements (which arose from the fact that by then the Revenue was challenging, in a vigorous manner, the legitimacy of the transactions) meant that the plaintiffs were left with ownership of the shares. The plaintiffs therefore resold the Digitech shares.  Far from being worth $3.00 as at September 2001 (when the sale took place), the Digitech shares were then worth only $0.33.    St  Lucia’s  NZIL shares  “had  little or no  value in  March  2001  or

subsequently”.20  They were not resold.

[66]     By 2011 when this proceeding came to trial (and indeed for the most part from 2006 when these proceedings were commenced) the defendant LAQCs were insolvent.  The plaintiffs had nothing, directly, to gain from suing them.  The patent objective of the plaintiffs in this litigation was not the insolvent LAQC investors.  It was, instead, to get at the professional advisers lying behind the defendants – principally the third parties Gosling Chapman, Denham Martin & Associates, and Kensington Swan. This they could achieve in two ways.

[67]     First, the plaintiffs entered into settlements with the LSL defendants.   The LSL defendants admitted the plaintiffs’ claims.   The plaintiffs undertook to discontinue their proceedings against the LSL defendants, and also not to sue their

directors for any claim the plaintiffs might have for “liability in connection with the

20     Evidence of Mr Reid.

share sale agreement or the operation of the investor (whether for breach of fiduciary duty, statutory duty or otherwise).”  The LSL defendants were required to make a payment to the plaintiffs for that release.  A substantial proportion of that payment would be by instalment.  But the LSL defendants were still required to pursue their third party claims against Gosling Chapman and the other third parties.   The settlement agreements agreed how the proceeds of claims against those third parties would be distributed.  While the copies of the settlement agreements provided to me are partially redacted, it is apparent that amounts probably in excess of 75 per cent of the gross proceeds (and perhaps as high as 90 per cent) were to be paid by the LSL defendants to the plaintiffs.

[68]     Secondly,  the  practical  effect  of  the  plaintiffs’  proceedings  against  the insolvent LAQC investors, with those defendants then pursuing claims against third parties, was to compulsorily recapitalise those LAQCs through the recovery of moneys from the third parties.   It is common ground that the Grove Darlow defendants had issued such third party proceedings, claiming something in the order of $30 million, which claims they settled before the commencement of trial for

$6 million.     To  that  extent,  therefore,  the  otherwise  insolvent  Grove  Darlow defendants (all being $100 LAQCs) were recapitalised.

[69] A third potential mechanism, a hovering spectre in the background like some sort of feral Cheshire cat, was the prospect of the plaintiffs bringing claims directly against directors of the investor LAQCs. This on the basis that they had, allegedly, undertaken reckless trading.21 The reference at [67] above to settlement with the LSL defendants and their directors was a direct reflection of that. It is clear that many of the investors took serious the threats made by the plaintiffs to pursue such

proceedings.   Mr Walker was inclined to play them down at the hearing, just as Mr Paul Dale (for the defendants) was inclined to play them up.  It was an essential component of the two schemes was that the insurance premium loan ($960,000 on a

$1 million investment) was on a non-recourse basis, with security limited to the share purchase agreement and the insurance policy.  The share purchase agreement contained no like limitation on potential recourse, although of course the obligation

was contractual and only the LAQC was party to that contract with N-Tech or

21     Companies Act 1993, s 135.

St Lucia.  It is understandable that directors of the LAQCs felt nervous when they received letters from the plaintiffs suggesting that a claim might be made against them personally.  As I said at the trial, however, and it remains my impression now, the prospect of such a claim was always improbable.   The reality was that the scheme always worked on the basis that there was a prospect of the LAQC investor walking away.   So it was in relation to the insurance premium loan, and so the designers of the scheme would also have understood in relation to entry into, and completion  of,  the share purchase agreement.    Reckless  trading liability in  that context would be surprising.  Obviously, no claims against directors were made in this proceeding.  It would have been difficult to have then mounted them later.

The settlements

[70]     On  8  August  2011  settlement  was  reached  between  the  parties  and Kensington Swan.  Kensington Swan, a third party, was struck out of the proceeding on 15 August 2011.

[71]     On 4 September 2011, day 11 of trial, I was advised of further settlement progress. A joint memorandum was filed by the parties recording the following:

(a)       the plaintiffs were to discontinue all claims against all defendants, except the Grove Darlow Investor group defendants;

(b)      the LSL defendants discontinued their claims against the third parties;

(c)       the  Lowndes  Jordan  defendants  discontinued  their  counterclaims against the counterclaim defendants;

(d)the Gosling Chapman and Denham Martin third parties discontinued their respective cross-claims against one another and the plaintiffs.

[72]   That left the remaining parties as the plaintiffs and the Grove Darlow defendants. Trial continued.

[73]     Then on day 19 of trial, 28 September 2011 there was a final and almost complete break-through.  On that day a joint memorandum was filed advising:

(a)      the plaintiffs would discontinue all claims against the Grove Darlow defendants;

(b)the Grove Darlow defendants would discontinue their counterclaims against the plaintiffs.

[74]     The only issues remaining concern costs.  Each sought costs.  The defendants principally on an indemnity or increased basis.  Failing that, scale.  The plaintiffs on the basis that the discontinued claims and counterclaims should be treated separately, costs should be paid on each, and the result effectively netted off to leave costs lying where they fell.  Less trenchantly, the plaintiffs suggested that they might be entitled to increased costs.

Issues on the present costs applications

[75]     The following issues arise on the present applications:

(a)      Issue 1:  Are the defendants entitled to indemnity or increased costs against the plaintiffs?

(b)      Issue 2:    If the answer to Issue 1 is “No”, then are the defendants

entitled to scale costs (and if so, in what amount)?

(c)      Issue 3:  Are the plaintiffs entitled to costs against the defendants on the discontinuance of their counterclaims?

(d)      Issue 4:  If the answer to Issue 3 is “Yes”, are the plaintiffs entitled to

increased costs against the defendants?

Issue 1:  Defendants entitled to indemnity or increased costs?

Submissions

[76]     Mr Dale for the defendants submitted that the defendants should be awarded indemnity costs on the discontinuance of the plaintiffs’ claims against his clients. Failing that, then increased costs.

[77]     First, he said that the plaintiffs pursued the claims knowing they “lacked any merit”.   He submitted that their lack of belief in the merits of their claim was revealed by what occurred once the LSL defendants settled with third parties, on day

11 of trial (following two weeks of openings, but before evidence was heard).  As

Mr Dale put it:

As soon as that happened, Mr Walker made it plain ... that the plaintiffs did not want to continue against the investor group, notwithstanding that the investor group was flush with funds from its own settlement with the third parties.

This, Mr Dale said, tells me “all [I] need to know about the plaintiffs’ view of the merits of [their] claims”.

[78]     Secondly,  he  submitted  that  the  plaintiffs  pursued  their  claims  for  an improper purpose: to coerce settlement of the defendants, and through those settlements to become entitled to share in the defendants’ claims against third parties. It was openly acknowledged by Mr Dale that his clients “had received $6 million in a settlement with the third and subsequent parties prior to the trial commencing”. Given the arrangements detailed in [67] above it is probable that the settlement between the LSL defendants and third and subsequent parties during trial produced a similar sum, most of which would have flowed through to the plaintiffs who otherwise were insolvent.

[79]     Mr Dale relied particularly on a decision of the Court of Appeal in Bradbury v  Westpac  Banking  Corporation.22      That  was  a  case  where  indemnity  costs  of

22     Bradbury v Westpac Banking Corporation [2009] NZCA 234, [2009] 3 NZLR 400.

$996,712 were awarded against the plaintiff who abandoned a case described by both  the  trial  Judge  (Harrison  J)  and  the  Court  of  Appeal  as  “hopeless”. Abandonment occurred after evidence had been concluded and closing submissions had  been  exchanged.    It  occurred  during  the  course  of  the  plaintiffs’  closing argument.

[80]     Mr Dale accepted:

There are obvious reasons why asking a Judge to speculate on the outcome of a case without having heard the evidence of it being tested by cross- examination carries very real risks.  Ordinarily it would not be appropriate to do so.

But, Mr Dale said, this is not a case where there is no evidence.  He submitted that I can make findings as to the likely outcome on the basis of the evidence given, in conjunction with the substantial number of documents that had been put to witnesses.23   Mr Dale submitted that the plaintiffs’ case in this case was clearly “built upon fraudulent transactions”.  The Court should not lend its authority to enforcing claims built around a fictitious document trail and fraudulent conduct.  He submitted

that  “even  in  the unlikely event  that  the investors  defences  failed  for  technical reasons”, the plaintiff still had obvious difficulties which meant proceeding with (and continuing with) the claim was obviously without merit:  the defendants had no assets,  and  the  plaintiffs  had  no  direct  claims  against  the  third  and  subsequent parties.  So, Mr Dale submitted, these proceedings should never have been issued.

[81] Mr Dale also submitted that Mr Reid’s evidence was untenable. In particular his continued assertions that there was an insurer that could meet its obligations, that there was a real loan, that the investors premiums had been applied to the payment of the insurance premium, that the investors would not call on the insurance policy because of the shortfall explained at [34]-[36] above and that Gosling Chapman had not wanted to know the true position in relation to lender and insurer. He submitted that in a number of respects, including those discussed in [41]–[55] above, but in

others also, Mr Reid’s evidence before the Court was false.

23     Note in this respect HCR 9.14(4): contents of a common bundle of documents are received in evidence only when referred to in opening submissions or put to a witness in the course of evidence.

[82]     He submitted that  by the  time the proceedings  were filed, there was  no justification for the plaintiffs maintaining the transactions were genuine (in the sense of being free of circularity or control of the lending and insurer entities), denying that Mr Reid controlled those entities, or that he had received part of the premium income and denying the existence of fictitious transactions such as the modem and royalties transactions used to repatriate the “surplus” insurance premium deposits.

[83]     Mr  Dale  had  to  accept,  though,  that  it  remained  a  possibility  –  albeit “unlikely” – that the investors’ defences might conceivably yet fail because, for example, they might have been shown to be wholly tax-driven and indifferent to the substance of the lender and insurer.   Or, conceivably, that they were directly or indirectly (via Gosling Chapman – asserted by the plaintiffs to be the defendants’ agents) aware of the insubstantiality of the insurance arrangements (although not, it would seem, of the lender).

[84]     I should note that Mr Dale wielded a broad sword here.  He disdained close analysis of particular respects in which the plaintiff’s conduct had added needlessly to cost – for the purposes of HCR 14.6(3)(b).   Rather, his argument was that the whole of the litigation by the plaintiffs lacked merit throughout.

[85]     For the plaintiffs, Mr Walker submitted, first, that the ordinary presumption under HCR 15.23 that costs (at scale) are payable on discontinuance was rebutted here.   The reason was that this was “a case of mutual discontinuance of obverse claims”.  Mr Walker said that both parties were in essentially the same position:  the sole source of funds for both sides was what could be recovered from the third and subsequent parties.  The defendants had their $6 million fund from that source, and the plaintiffs, via arrangements with the LSL defendants, were likewise funded when settlements between the LSL defendants and the third parties were secured on about day 11 of the trial.

[86]     Mr Walker submitted that their assessment was that by the end of trial the defendants  might  have  only  $2  million  of  their  $6  million  fund  given  total expenditure that would be compiled by the end of trial (which had another four weeks to run).  Against that, it was not worth the plaintiffs pursuing their claims in

the hope of collecting the balance, having regard to litigation risks, their own irrecoverable costs of trial and the prospect of competing with secured creditors (and potentially the Revenue) in the liquidations of the defendant LAQCs.   Mr Walker submitted:

Significantly, the decision was mutual in that each side was only prepared to discontinue if the other did so too.   In these, unusual, circumstances there is no winner.  Both sides have, in effect, admitted defeat on the same issues.  Costs should lie where they fall.

[87]     First, Mr Walker said that the plaintiffs believed that they had strong prima facie claims under the share purchase agreements.   Prima facie, legitimate share purchase  agreements  had  been  entered.    Further,  as  Mr Walker noted,  the  LSL defendants had admitted the plaintiffs’ claims.   However, it is a little difficult to know what to make of that circumstance given the matters referred to in [67] above.

[88]     Secondly, Mr Walker made the point for the plaintiffs that the defendants’

position rested on affirmative defences, for which they bore the onus of proof at trial.

[89]     Thirdly, the Court should not attempt to assess at this point the prospect that the  defences  would  succeed.    They  were  dependent  on  the  fact  evidence  of Mr Russel (the plaintiffs’ witness not called by the time trial ended) and the evidence of all the defendant investors (yet to be examined).   In particular, Mr Walker submitted that the plaintiffs had a reasonable basis to believe they could defeat the central allegations of misrepresentation and conspiracy.  The plaintiffs’ case was that Gosling Chapman was a willing participant in the paper trail facade undertaken by Messrs Reid, Currie, Connolly and Darvell.   Further, that the partners in that firm also knew or expected the transaction involved a back-to-back arrangement.  He said with the exception of the 2 March 1995 letter (which I have quoted in part in [29]), the “facade correspondence” was not passed on to investors.  Mr Walker submitted that whatever the appearance might have been, Gosling Chapman “were not making genuine inquiries about the loan or insurance, and were not placing any store in the answers.”  Evidence to that effect would have been given by Mr Russel, a former partner at Gosling Chapman.  A key argument that would have to be addressed and determined (which certainly had not been resolved by the time trial ended) was the status of Gosling Chapman.  In particular, whether they were agents for the investors

they introduced to the scheme.  In this trial, as in the case of the criminal trial, a real issue yet to be resolved (and dependent on evidence still to be given) was the significance of disclosures made (principally by Mr Reid) to partners of Gosling Chapman  (principally  Messrs  Russel  and  McGrath)  and  Denham  Martin  & Associates (principally a Mr Sidnam).  These disclosures formed a keystone of the defendants’ third party proceedings.  But as Mr Walker put it:

The defendants cannot approbate and reprobate. They cannot allege for the purpose of the third party claims that the plaintiffs told Gosling Chapman that there had to be a link or relationship between the loan and insurance but then maintain for the purpose of the claims that the plaintiffs kept the link or relationship hidden from Gosling Chapman and the defendants.

[149]   The principle in Medway Oil has been applied in many cases.   Most are mechanical applications of the rule in contexts somewhat different to this.   Few include any useful discussion of principle.  Mr Walker sought to rely on the decision in Millican  v Tucker.53    But the discussion there is obiter and does not explain the principle in Medway further.

[150]   In  Newbrook  v  Marshall54   Chambers  J  was  dealing  with  the  opposite situation in which claim and counterclaim had both succeeded, but the counterclaim had been substantially more remunerative than the claim.   A tactical error by the plaintiff,  as  the  defendants  had  earlier  made  a  drop  hands  offer.    In  that  case Chambers J said:55

Where a step involved both claim and counterclaim, it should be treated as a step on the claim and accordingly [the plaintiff] should be entitled to costs with respect to that step.  I give that direction for two reasons which are interrelated.

First, there must be an element of practicality about the exercise.  It would become thoroughly uneconomic if each mixed step had to be analysed as to whether it was principally concerned with the claim or principally concerned with the counterclaim.

Secondly, it the claim rather than the counterclaim which is fundamentally in issue between the parties ...

So even in a situation governed by HCR 14.16, it may be proper to treat claims and counterclaim other than independently, and regard the former as embracing part of the latter.

[151]   In principle it is proper to follow the decision of the House of Lords in

Medway Oil here.  First, it is a rule of substantial antiquity, restoring undiminished as

52 [1929] AC 88, 109 per Lord Blanesburgh.

53     Millican v Tucker [1980] 1 All ER 1083 (CA).

54     Newbrook v Marshall HC Rotorua CP 26/94, 11 September 2001.

55     At [17]–[19].

it did the even older rule in Saner v Bilton.56     It was therefore the predictable approach on which the parties might have based their decisions to initiate, enlarge and then compromise this litigation.   Secondly, the decision reflects expressly a preference for substance over form.  Such an approach is consonant with a proper approach to costs in this day and age.  Thirdly, I do not accept that Medway Oil can be distinguished on the basis Mr Walker suggested.  It is immaterial that what had happened there was that claims and counterclaims failed by judgment rather than abandonment.  The operative effect is the same.  Further, the very point made by the House in taking a marginal costs approach to the counterclaim was that in that case (as in this) the issues were substantially common as between claim (including defences) and counterclaim.

[152]   Turning to this case, it is appropriate first to note the chronology. The present proceedings were commenced on 16 June 2006.  The statement of claim was brief. Eighteen paragraphs.  It advanced two causes of action, each in contract, by N-Tech and St Lucia Investments.  The plaintiffs pleaded failure to pay by the defendants, consequent repudiation and cancellation, and a claim of damages for the purchase price not paid plus interest.   A pro forma statement of defence was filed by the defendants on 19 July 2006.  After a gestation of nine months an amended statement of defence and counterclaim was filed on 30 April 2007.  The defendants admitted the agreements on which the plaintiffs sued, and the payment obligations under those agreements.   But they advanced several affirmative defences and counterclaims: repudiation (affirmative defence and counterclaim), misrepresentation and fraud (both),  breach  (both),  deceit  (defence  only),  breach  of  the  Securities Act  1978 (defence only) and knowing assistance by the plaintiffs of a breach of fiduciary duty by Gosling Chapman (both).  The counterclaim sought monetary relief in the form of refunds of part of the deposits paid.

[153]   The plaintiffs repleaded (following consolidation) on 27 April 2009.   The amendments were not significant.  The defendants filed a consolidated statement of defence on 16 September 2009.   New defences were raised (misrepresentation by Gosling Chapman, as  agents  of  the plaintiffs, conspiracy and  limitations).   The

counterclaim for monetary relief was dropped.  Mr Dale said in his submissions that

56     Saner v Bilton (1879) 11 Ch D 416 (Ch).

this occurred because there was no point pursuing the plaintiffs for money because the security for costs process had shown them to be insolvent.   Nevertheless the pleading remained in substance a counterclaim as it sought various declarations declaratory of the affirmative defences themselves.

[154]   On 28 July 2011 – formally the setting down date, although trial was to commence on 15 August 2011 – the defence filed a second amendment statement of defence and counterclaim.  This reorganised the prior pleading, removed the prayers for relief from the body of the defence into a distinct counterclaim, added new particulars in misrepresentation, added some defences (in particular rescission) and added new and revised counterclaims for relief under s 9 of the Contract Remedies Act 1979 and repayment of the purchase price under s 37(6) of the Securities Act

1978.  This amended pleading, coming at a point where the trial die was well and truly cast, can have added but minimal cost to what thereafter followed.  To some extent that assessment is confirmed by the fact that the plaintiffs filed their reply and defence to counterclaim the very next day.  At the same time the plaintiffs applied in the alternative for relief under s 37AH of the Securities Act 1978.

[155]   Secondly, as the plaintiffs acknowledge in their submissions, most of the contested issues were common to the claim and counterclaim. The counterclaims are parasitic on the affirmative defences, and rely on those having been sustained.  As Mr Walker put it:

... the central factual and legal issues in the claims, being those raised by the affirmative defences, are essentially the same issues that arise in the counterclaims ... With limited exceptions, in particular limitation, the counterclaim is largely the obverse to the claim.   Success on the claim would generally entail success on the counterclaim and vice versa.   The issues are essentially common.

[156]   Thirdly, having sat through the trial up to the point of its demise, there is no question at all in my mind but that the function of the counterclaim (filed on 28 July

2011) was wholly defensive in nature.  This is a separate consideration from whether it is parasitic to the affirmative defences and whether it contributed any material marginal cost.   Functionally the renewal of claims for monetary relief (which had been entirely in abeyance between September 2009 and July 2011) was to provide a

last line of defiance (and defence) to, and potential discouragement of, the plaintiffs’

pursuit of their claims.

[157]   Fourthly, again I am very clear from my observation of the dynamics of trial that, but for the bringing of the claims by the plaintiffs, the counterclaims would never have seen the light of day.   The counterclaims are wholly responsive to the claims.  This was not a case where the identity of the plaintiffs was the result of a haphazard process as to who was first to file.   But for the plaintiffs filing, there would have been no “plaintiffs” at all pursuing any of the issues ventilated in these proceedings.

[158]   Against these observations, how am I to determine costs?

[159]   The plaintiffs’ argument that costs should in effect lie where they fall echoes the conclusion of the Court of Appeal in Medway Oil.  Mutual and exact set off is an apportionment by another name.   Yet had the defendants here not filed their counterclaims in 2009 (declaratory) and 2011 (declaratory and monetary), the parties would have incurred precisely the same costs.   Had the defendants done no more than file their affirmative defences (which were largely co-extensive with the counterclaims, although slightly broader), and the plaintiffs had abandoned their case part way through trial, the defendants would have been entitled to costs without set off, apportionment or diminution.  What difference in point of fact should the filing of a defensive counterclaim make?

[160]   The answer is none.   Another means of confirming that impression is to consider the draft list of issues prepared by the plaintiffs’ solicitors, in conjunction with those representing the defendants and third parties.   In its last draft iteration there were 138 issues.   Of them, 56 were confined to the present parties.  And of those, 8 arose on the plaintiffs’ claims, 45 on the affirmative defences, one additional issue on the counterclaim itself, and the last two on the plaintiffs’ limitation defences pleaded to the counterclaim.  The solo separate issue on the counterclaim confirms its parasitic nature:

If   the   [defendants]’   defences   based   on   breach,   misrepresentation,

conspiracy,  breach  of  the  Securities  Act  or  rescission  for  breach  of

fiduciary duty succeed, are those defendants entitled to recover the money paid to the plaintiffs, and other losses suffered by those defendants?

[161]   Certainly the fact that the plaintiffs now found themselves facing the risk of continuing litigation and substantial damages or compensation (beyond mere costs) if they abandoned their claim, diminished their freedom of action.  That was a point noted by Browne-Wilkinson J in Millican.57     In the present case, on Monday 12

September 2011, day 12 of trial, the plaintiffs signalled in chambers that they would drop hands if they could. 58   The relevant correspondence between the parties at the time was without prejudice save as  to costs.   So it has been produced for my inspection.  It is clear that as at that date (and indeed as from 1 September 2011) the defendants were willing to settle if the sum paid into Court by way of security – some $900,000 or so – was paid to them.  On 5 September 2011 the plaintiffs still

sought $2 million by way of settlement.  Four days later they were prepared to walk away (presumably taking the secured sums with them).   Another three days later came the statement by plaintiffs’ counsel in chambers mentioned above.  The spectre of the counterclaim was therefore diminishing.

[162]   The real sea anchor against mutual discontinuance was the question of costs. In particular, whether, in the event of mutual discontinuance, costs should lie where they fall or the defendants should be entitled of some margin in their favour. And, as I have noted already, no question arises in this case of the identity of the plaintiffs being the random result of a race to the Court door.  Had the plaintiffs not filed these proceedings, they would not have existed in any form.

[163]   It follows from the foregoing that the application of the rule in Medway Oil here is  clear,  and it produces no hard outcome.   The costs associated with the counterclaim  issues  were  all  ones  the  plaintiffs  would  have  had  to  meet  in responding to the affirmative defences to the claim.  Those defences must be taken by discontinuance to have succeeded.  There is no just basis for apportionment in

this case.

57     Millican v Tucker [1980] 1 All ER 1083 (CA) at 1086.

58     That is, walk away, costs lying where they fell.

[164]   No costs are awarded to the plaintiffs on the defendants’ discontinuance of

their counterclaim.

[165]   It follows that Issue 4 need not now be considered.

Conclusion

[166]   The defendants’ application for costs in the sum of $774,157 is granted, subject to agreement on, or failing that taxation of, actual costs for items 4.5 and 4.6.

[167]   The defendants will have their usual permissible disbursements, either as agreed or otherwise as fixed by the Registrar pursuant to HCR 14.22.

[168]   The parties having shared success on the outcome of each of the present applications, if not the final economic result, costs on those applications will lie where they fall.

Stephen Kós J

Solicitors:

Gilbert/Walker, Auckland

Grove Darlow, Auckland