Nathans Finance NZ Limited (in rec) v Doolan HC Auckland Civ-2010-404-002360
[2011] NZHC 1713
•10 November 2011
IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY
CIV-2010-404-002360
BETWEEN NATHANS FINANCE NZ LIMITED (IN RECEIVERSHIP)
Plaintiff
ANDMERVYN IAN DOOLAN First Defendant
ANDKENNETH ROGER MOSES Second Defendant
ANDDONALD MENZIES YOUNG Third Defendant
ANDJOHN LAURENCE HOTCHIN Fourth Defendant
ANDSTAPLES RODWAY Fifth Defendant
Hearing: 31 October 2011
Appearances: M Tingey for Plaintiff
K Murphy on instructions from N Gedye for First Defendant (granted leave to withdraw)
S Hunter for Second, Third and Fourth Defendants
P Fee and M Atkinson for Fifth Defendant
Judgment: 10 November 2011 at 4:00 PM
JUDGMENT OF VENNING J
On application for security for costs
This judgment was delivered by me on 10 November 2011 at 4.00 pm, pursuant to Rule 11.5 of the
High Court Rules.
Registrar/Deputy Registrar
Date……………
Solicitors: Bell Gully, Auckland
Cook Morris Quinn, Auckland
Lee Salmon Long, Auckland (K Murphy) Gilbert Walker, Auckland
Jones Fee, Auckland
NATHANS FINANCE NZ LIMITED (IN RECEIVERSHIP) V DOOLAN & ORS HC AK CIV-2010-404-
002360 10 November 2011
Copy to: N Gedye, Auckland
Mervyn Ian Doolan.
Introduction
[1] The first defendant Mervyn Ian Doolan and the fifth defendant Staples Rodway seek security for costs against the plaintiff Nathans Finance NZ Ltd (in receivership) (Nathans).
[2] Nathans was placed into receivership on 20 August 2007. The first to fourth defendants were directors of Nathans (the directors) and Staples Rodway acted as auditors to Nathans at material times.
[3] Nathans was a finance company. It sought deposits from the public, issued debenture stock to its investors and then lent the proceeds of the investments to third parties. However the bulk of Nathans’ lending was to its parent company VTL Group Ltd (in receivership) (VTL), companies directly or indirectly owned by VTL, Advanced Vending Systems Pty Ltd (AVS) and Intelligent Vending LLC (IVL) which purchased licences from VTL and trusts associated with Mr Doolan and the fourth defendant John Laurence Hotchin.
[4] By the time Nathans was placed into receivership in August 2007 the money advanced to those parties amounted to approximately $154 million of Nathans’ then recorded assets of $194 million.
[5] Following their appointment the receivers investigated the reasons for Nathans’ failure and its apparent lack of realisable assets. The receivers concluded the directors had breached the duties they owed the company relating to the loans and that the auditors had also failed in their duties to the company. These proceedings were commenced in early 2010.
[6] The directors were also prosecuted by the Securities Commission (now the Financial Markets Authority) for breaches of the Securities Act 1978. The directors have been convicted and sentenced in relation to offences under that Act.
Preliminary matters
[7] Ms Murphy appeared to support an application for an order that Mr Doolan’s solicitor has ceased to act. The application is not opposed by the plaintiff. Mr Hunter advised Mr Hotchin did not oppose the application either. The second and third defendants have not responded to it. Ms Murphy confirmed the application had been served on all relevant parties, including Mr Doolan. In the circumstances I granted leave and made an order declaring that Julian Long has ceased to be the solicitor on record for the first defendant Mervyn Ian Doolan. Mr Gedye was also granted leave to withdraw as counsel. The address for service of Mr Doolan will be c/- Northland Region Corrections Facility, PO Box 727, Kaikohe 0440 unless and until he provides an alternative address.
[8] Mr Doolan’s application for security was not pursued. As Mr Doolan is now unrepresented he would not generally be entitled to costs in any event: Re Collier (A Bankrupt).[1] His application is dismissed with costs to Nathans on a category 3B basis.
[1] Re Collier (A Bankrupt) [1996] 2 NZLR 438 (CA) at 440.
[9] When Mr Doolan made his application for security counsel responsibly agreed that there was no need for the other directors to make separate applications as all were effectively in the same position. Associate Judge Doogue recorded the position as follows in his minute of 9 September 2011:
[1] ... The plaintiff is prepared to accept that the outcome of the application as between the first defendant and the plaintiff will be determinative of the security for costs position as between second, third and fourth defendants (even though those defendants have not filed applications for security for costs).
[10] Mr Doolan’s application has now been determined but not on its merits. Given the change in circumstances I reserve the position of the second, third and fourth defendants in relation to an application for security in the future. However, it has to be observed that any such application will no doubt be faced by a strong argument the directors caused or contributed to Nathans’ impecuniosity given their
convictions in relation to the Securities Act charges. There is also the issue of
ongoing delay. I record Mr Hunter advised that Mr Hotchin had no immediate intention to make any such application.
[11] That leaves Staples Rodway’s application for security for costs for
determination.
Jurisdiction
[12] The application is made under r 5.45 of the High Court Rules. Nathans accepts it is impecunious. Nathans accepts it will be unable to pay Staples Rodway’s costs if it is unsuccessful in its claim against them. The issue in this case is whether, in terms of r 5.45(2), it is just in all the circumstances to order the giving of security for costs.
[13] The relevant principles are well settled. They are contained in the leading cases of Nikau Holdings Ltd v Bank of New Zealand,[2] Bell-Booth Group Ltd v Attorney-General[3] and A S McLachlan Ltd v MEL Network Ltd.[4]
[2] Nikau Holdings Ltd v Bank of New Zealand (1992) 5 PRNZ 430 (HC).
[3] Bell-Booth Group Ltd v Attorney-General (1986) 1 PRNZ 457 (HC).
[4] A S McLachlan Ltd v MEL Network Ltd (2002) 16 PRNZ 747 (CA).
[14] What is required is a careful assessment of the circumstances of the particular case before the Court. The following factors referred to by the Court of Appeal in the McLachlan case are also apposite:
[15] The rule itself contemplates an order for security where the plaintiff will be unable to meet an adverse award of costs. That must be taken as contemplating also that an order for substantial security may, in effect, prevent the plaintiff from pursuing the claim. An order having that effect should be made only after careful consideration and in a case in which the claim has little chance of success. Access to the Courts for a genuine plaintiff is not lightly to be denied.
[16] Of course, the interests of defendants must also be weighed. They must be protected against being drawn into unjustified litigation, particularly where it is over-complicated and unnecessarily protracted.
[15] As to the appropriate quantum the Court said:
[27] The amount of security is not necessarily to be fixed by reference to likely costs awards: National Bank of NZ Ltd v Donald Export Trading Ltd [1980] 1 NZLR 97 (CA), at p 103. It is rather to be what the Court thinks fit in all the circumstances.
[16] In that regard I note Mrs Fee calculated scale costs on a 3C basis for a 12 week hearing at $792,856. Mr Tingey does not accept that band C would be appropriate for all steps, and considers no more than six weeks should be required for hearing. A six week hearing (with preparation but without allowance for interlocutories) would lead to scale costs of $250,200. However, the difference is not material because Mr Tingey accepts that Nathans is not in a position to provide security for scale costs, even calculated on his basis. The receivers currently hold
$542,000 in reserve but that is required to complete the receivership and to fund this claim. An order to provide security even at the lower level would prevent Nathans from pursuing its claim.
[17] I turn to discuss the considerations that are particularly relevant to this case.
The position of Nathans as a company in receivership
[18] Nathans is a company in receivership. Mr Tingey submitted that the well established practice of the courts was to only order security for costs against liquidators and companies in liquidation in exceptional cases and that similar principles applied to companies in receivership. Mrs Fee countered that by submitting that the distinction between a company in liquidation and a company in receivership was important and had been noted by this Court in Lyttelton Marina Ltd
(in rec) v Thornton Estates Ltd[5] and Re Pacific Wools Ltd (in rec & in liq); Crott v
Touche Ross & Co.[6] In any event the law has now moved to the position that security for costs will be awarded against a liquidator where justice so requires: Cory-Wright and Salmon Ltd v KPMG Peat Marwick.[7]
[5] Lyttelton Marina Ltd (in rec) v Thornton Estates Ltd (2002) 9 NZCLC 262,803 (HC) at [14].
[6] Re Pacific Wools Ltd (in rec & in liq); Crott v Touche Ross & Co (1990) 5 NZCLC 66,730 (HC) at 66,736.
[7] Cory-Wright and Salmon Ltd v KPMG Peat Marwick [1993] 2 NZLR 701 (HC).
[19] Having reviewed the authorities I accept that the position is as stated by
Gallen J in Cory-Wright and Salmon Ltd. The discretion reposed in the Court is
expressed in wide terms. There is no exclusion of any class of case nor any specific reference to liquidators or persons in an analogous situation. There is therefore jurisdiction to order security for costs, in an appropriate case, against a liquidator (even the Official Assignee), a company in liquidation or, as in this case, a company in receivership. As Gallen J put it:[8]
In each case all of the surrounding circumstances must be considered. That will involve a consideration of the persons on whose behalf the litigation is being conducted and the general background to the litigation.
[8] At 706.
[20] In the present case the receivers have been appointed by the trustee for the secured debenture holders. The vast majority of the secured debenture holders are consumer investors who invested their personal savings with Nathans. The average investment size was less than $24,000 with the median investment approximately
$11,500. Unlike other cases where receivers have been appointed by substantial financial institutions or the principal creditor in a liquidation is a substantial financial institution, the parties standing to gain from this litigation are primarily the many individual consumer investors. Individually their resources are limited.[9]
[9] Cf Cory-Wright and Salmon Ltd v KPMG Peat Marwick at 706-707 where the secured creditors included a number of very substantial financial organisations and were likely funding the proceedings.
[21] That particular feature of this case is relevant in two ways. First, the position of the receivers in this case can be seen as more akin to the position of a liquidator appointed to represent the interests of a number of smaller unsecured creditors. Second, it supports Mr Tingey’s submission, based on receiver Colin Thomas McCloy’s evidence, that it is just not practical to seek funding for these proceedings from the individual investors. Mrs Fee suggested that if each of the 7,000 investors paid $100 then that would provide $700,000 for security for costs. However, there are obvious practical and legal issues arising out of that suggestion. Quite apart from the cost and difficulty of communicating with each of the investors in that way, there is no guarantee that all or even a majority of investors would respond favourably. The receivers would not be able to treat those investors who were able to and did pay in a different way to those who did not. They would not be able to prefer one class and exclude others. There would be no sanction for non-payment. Further, the
investors have received back only 3.7 per cent of their principal investment to date.
On the median investment of approximately $11,500 that represents a return to date of approximately $425.50. To ask such investors to in turn provide $100 each to fund the litigation is not realistic.
[22] I note that Mrs Fee accepted there are no third party funders standing behind
Nathans’ claim.
Nathans’ actions regarding funding
[23] Mrs Fee submitted the Court should not place weight on Nathans’ argument that it is unable to provide security and that an order for security would lead to these proceedings being abandoned. She submitted Nathans and the receivers had effectively put the company in that position. She noted the receivers had made two distributions to the debenture holders at a time when the receivers should have been aware that these proceedings were likely.
[24] She submitted that, by April 2009, the receivers had formed the view there had been a breach of duty by Staples Rodway yet still went ahead and made a second distribution of approximately $2.5 million in December 2009.
[25] A number of points can be made about that. Mr McCloy’s letter of April
2009 in which he set out his understanding of the possible claim was directed to the directors and insurers rather than the auditors and was provided, as Mr McCloy explained, to give notice to the directors to put the insurers on notice. The receivers’ investigation into the claims, including the claim against Staples Rodway, continued through 2009. These proceedings were not commenced until 21 April 2010.
[26] Further, the repayments the receivers have made to debenture holders have been very modest. The only repayments from funds recovered by the receivers were a distribution of 2.2 per cent of the principal investment in December 2008 and a subsequent distribution of 1.5 per cent of the principal investment a year later in December 2009. Given the very modest nature of the recovery and the nature of the investors it was an entirely reasonable decision for the receivers to make those distributions to the investors at the times and in the way they did.
Delay
[27] Staples Rodway’s application for security was not filed until 2 August 2011.
[28] As noted these proceedings were issued in April 2010. The defendants responded with an extensive request for particulars and a formal application for stay because of then extant criminal proceedings. That application for stay went to a defended hearing before Associate Judge Doogue in September 2010. The Judge
declined the application for stay.[10] There has, however, been little progress to date
with interlocutory steps. Discovery is now not expected to be completed before the end of January 2012.
[10] Nathans Finance Ltd (in rec) v Doolan HC Auckland CIV-2010-404-2360, 15 October 2010.
[29] While there has been a delay in the application for security the delay is not such as to be a major consideration in the circumstances of this case. The delay has not prejudiced Nathans. As noted the distributions to the investors were made prior to the issue of the proceedings themselves.
The merits of the Nathans’ claim against Staples Rodway
[30] Nathans raises two causes of action against Staples Rodway – breach of contract and negligence. Essentially it is alleged that Staples Rodway breached its contractual and common law duties in relation to audits between September 2004
and September 2006 by:
failing to conduct its work with reasonable professional skill, care and competence and in compliance with the auditing standards and the
regulations;
failing to use reasonable professional care and skill to ensure that Nathans
had adequate procedures in place and complied with those procedures; and
failing to review and evaluate the value of the loans approved by the
directors.
[31] Nathans says as a result of those breaches of contract or duty, it has suffered loss. It claims approximately $66 million calculated in relation to loans made during that time period. There are a number of alternative lesser claims.
[32] Mr Tingey submitted the evidence of the breaches is clear. Despite the receivers’ review of Nathans’ files there is no evidence that the auditors conducted the due inquiries into the recoverability of the loans. The auditors failed to detect that the loans were unlikely to be repaid or to take sufficient steps to satisfy themselves that the loans would be repaid.
[33] Nathans and its receivers point to the difference between the recorded value of the loans in the audited accounts at the time of receivership of $154 million and the approximately $6.5 million which has been the only recoverable sum able to be returned to the investors.
[34] Mr Tingey also noted that Mr Hughes, the partner responsible for the audit, pleaded guilty to charges laid by the New Zealand Institute of Chartered Accountants relating to his audit of Nathans. Mrs Fee made the point that Mr Hughes described the charges as technical accounting issues within audit practice. Further, even if taken as an indicator of a breach of duty, the charges only related to the audit for the June 2006 period. From a causation point of view Mrs Fee submitted that only approximately $600,000 had been taken in from investors after that date.
[35] The merits of Nathans’ claim against the auditors are very much in issue. As the Court of Appeal observed in the McLachlan case, in a complex matter such as this assessment of the merits at an interlocutory stage can be no more than impression and cannot be a definite indicator of the ultimate outcome after trial.[11]
[11] At [21].
[36] My assessment of the merits in the present case leads me to conclude that Nathans’ claim is responsibly brought. It cannot be categorised as an unjustified or speculative claim. As pleaded, and on the material available to the Court at present, it raises a number of issues which require an answer from Staples Rodway. Staples Rodway should have to answer those issues.
[37] I have regard to the special obligations of an auditor in these circumstances in relation to reporting to the trustee and the requirement for an auditor to send the trustee a copy of any report furnished by the auditor to an issuer of debt securities: s 50(1) of the Securities Act 1978. The auditor also has an obligation to report in writing to the issuer (sending a copy of the report to the trustee) if it becomes aware of any matter relevant to the exercise or performance of the powers or duties of the trustee: s 50(2). Those statutory provisions confirm the auditors’ responsibility in this case.
[38] Further, while it is not a case of res ipsa loquitur, the huge disparity between the reported value of the loans (to related parties in large part) and the recoverable assets provides a measure of support to Nathans’ case against the auditors.
[39] In the present case it is also relevant that the charges which Mr Hughes pleaded guilty to included charges that he failed to exercise due care and diligence in relation to his assessment of the adequacy of disclosure of material related party transactions (in relation to funds advanced to VTL); that in performing the audit he failed to comply with audit standards; that the audit was not planned and performed with an attitude of professional scepticism; and that he did not obtain sufficient audit evidence to be able to draw reasonable conclusions on which to base an audit opinion.
[40] I do accept that even if liability is established, quantum will be a major issue. However, taken overall, I am satisfied that the claim is a responsible one that should be heard.
Did Staples Rodway cause Nathans to suffer loss?
[41] Related to the merits issue is whether it can be said that the auditors caused Nathans to suffer loss. Mrs Fee submitted that it could not be said the actions of the auditors caused Nathans to sustain the losses it has suffered. She referred to the decision of Sew Hoy & Sons Ltd (in rec & in liq) v Coopers & Lybrand[12] and submitted that Staples Rodway was not responsible for the business decisions made
by the plaintiff, in particular its lending decisions, which were the effective cause of its losses. She also noted that even on its own claim Nathans pleaded that as from 30
June 2004 its liabilities exceeded its assets.
[12] Sew Hoy & Sons Ltd (in rec & in liq) v Coopers & Lybrand [1996] 1 NZLR 392 (CA).
[42] While I accept that the principal cause of Nathans’ loss was the lending decisions made by its directors, it does not follow that the auditors were not also responsible, if the alleged breaches are made out, for some at least of the losses arising from that lending. If Nathans is able to establish that the auditors were negligent in the ways pleaded, such action could have been causative of further relevant losses, and losses of the money that investors had deposited with Nathans after 30 June 2004.
Conclusion - summary
[43] In summary I find Nathans has an arguable but difficult claim against Staples Rodway. The claim is responsibly brought. It cannot be said to be of little merit or unjustified. I reject the criticism that Nathans deliberately put itself in the position that it is unable to provide security. I do not consider that it is practical for Nathans to seek funding from the individual investors who may ultimately benefit from the claim against the auditors in order to provide security for costs.
[44] I accept that if security is ordered in the sum sought by Staples Rodway (or even in a sum based on Nathans’ estimate of the hearing time required) the proceedings, which are otherwise meritorious, will not be pursued and will be brought to an end. That is a result that should be avoided if at all possible: Birnie Capital Property Partnership Ltd v Birnie.[13]
[13] Birnie Capital Property Partnership Ltd v Birnie HC Auckland CIV-2010-404-3000, 29 October
2010 at [27].
[45] However, I am also conscious of the commercial reality the defendants would
be placed in if they are required to face Nathans’ claim without Nathans facing any
sanction at all, however modest, in relation to risk or cost.
[46] In my judgment, balancing the above factors, I consider there should be an order for a tangible sum, even if unrelated to the potential scale costs, so that Nathans does not have an entirely risk free run at Staples Rodway. The quantum can be fixed at a level that should leave sufficient funding for Nathans to pursue these proceedings but which will ensure Nathans carefully considers the use of its limited resources. The payment can also be timed to follow the completion of discovery and, perhaps, also to follow any mediation or structured settlement conference the parties may seek.
Result
[47] I direct Nathans to give security for the costs of Staples Rodway in the sum of $75,000 by paying that sum into Court by 31 July 2012.
Costs
[48] Neither party has achieved what they were submitting for. In the circumstances I reserve the issue of costs to be dealt with in the substantive
proceedings.
Venning J
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