Secretary for Internal Affairs v Administration Management Services Limited
[2013] NZHC 3498
•19 December 2013
IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY
CIV 2013-463-192 [2013] NZHC 3498
BETWEEN THE SECRETARY FOR INTERNAL AFFAIRS
Applicant
ANDADMINISTRATION MANAGEMENT SERVICES LIMITED
First Respondent
ANDSIDEWALK INVESTMENTS LIMITED Second Respondent
ANDKERRY JACKSON BIRD Third Respondent
Hearing: 16 September 2013
Counsel: D G Johnstone and M Harborrow for Applicant
F M R Cooke QC, M Smith and J E Lethbridge for Respondents
Judgment: 19 December 2013
JUDGMENT OF SIMON FRANCE J
INTERNAL AFFAIRS v ADMINISTRATION MANAGEMENT SERVICES [2013] NZHC 3498 [19 December
2013]
Table of Contents
Paragraph No.
A Introduction [1] B The scheme of class 4 gambling [7]
C First Sovereign Trust [12] D The management contract [20] (a) The genesis and legitimacy of the contract [21]
(b) The length of the contract [32] (c) The remuneration clause [45] (i) The formula itself [50]
The quantum changed under the formula [56]
(d) Conclusion on the contract [60] E The licence is cancelled [64] F The AMS buyout [79] G The Secretary’s application [96] (a) Section 112 [99]
(b) First issue – was the $2.4 million buyout payment the
distribution of net proceeds? [113]
(c) A breach of s 106 of the Act [132]
(d) A breach of the requirement to maximise
net returns and minimise costs [136]
(e) Breach of reg 10 of the Gambling
(Class 4 Net Proceeds) Regulations 2004 [139] H Other matters [146] I Conclusion [148]
A Introduction
[1] First Sovereign Trust (“First Sovereign” or “the Trust”) held a class 4 gambling machine licence. This authorised it to operate gaming (pokie) machines in venues other than casinos. First Sovereign contracted out day to day responsibility for its operation to the first respondent, Administration Management Limited (AMS).
[2] The structure of the management contract with AMS was not satisfactory to the Secretary for Internal Affairs (“the Secretary” or “the Department”) who is the person charged with overseeing the gambling industry. Eventually, after a number of years of dispute and audits, the Secretary advised First Sovereign that its licence would not be renewed. One of the key reasons was that the Secretary did not consider that whilst bound by the AMS contract, First Sovereign could operate itself in accordance with the Act.
[3] At the time its licence was imperilled First Sovereign had grown, rapidly, to be a significant player in the gambling machine arena. To illustrate, in its first year of operation its gross proceeds were $3 million. By the end of its fourth year they were $14 million and the next year would see this increase by a further $3.5 million, eventually reaching $22 million. The loss of its licence would, therefore, mean the end of what was by now a substantial business, so obviously different strategies were considered and implemented.
[4] The particular strategy in issue in these proceedings is the decision to buy out the AMS contract for $2.4 million. First Sovereign was aware that other societies had been permitted to spend machine proceeds on the buyout of management contracts, and so it obtained a valuation, as did AMS, and a deal was struck.
[5] Section 112 of the Gambling Act 2003 (“the Act”) allows the Secretary to seek orders from the High Court to:
... recover net proceeds from class 4 gambling that have been improperly paid to a person.
[6] The Secretary contends the $2.4 million is such a payment and he brings these proceedings to recover the money from the recipient.
B The scheme of class 4 gambling
[7] In order to operate gaming machines it is necessary to have a class 4 gaming licence. They are issued by the Secretary and may only be held by corporate societies. Section 52 of the Act identifies various criteria with which the Secretary must be satisfied before a licence may be issued. The licensing criteria include:
(a) suitability of the key personnel; (b) financial viability;
(c) a structure that will maximise returns to the community; and
(d) a likelihood that the licence holder will comply with the Act.
[8] The licence authorises the corporate society to operate gaming machines, but there are still obstacles. It is far from being the case that a licence holder can just buy machines and put them in a venue. Whilst the licence itself imposes no limit on the number of machines an operator may have, the reality is that, nationally, permissible machine numbers are frozen at their existing level. So to start up, or to grow, an operator must get access to an existing machine entitlement.
[9] Machines are housed in approved venues for which the existing class 4 operator will have obtained a venue licence. These venue licences are not transferable so what must happen is either that the licence expires (every three years) and the venue chooses to switch to a different operator, or the existing operator relinquishes it. Once a relationship is secured, the class 4 operator enters into an approved contract with the venue.
[10] Once the gaming machines are acquired, the Act and associated regulations then contain various rules for controlling expenditure and maximising returns to the community. Each class 4 operator will have identified, at the time of obtaining the licence, which of the permitted purposes it will distribute its proceeds to. The basic scheme is that all the turnover, less authorised expenditure, must be returned to community groups aligned with those nominated authorised purposes.
[11] A key provision in this regard is reg 10 of the Gambling (Class 4 Net
Proceeds) Regulations 2004 which requires that the operator, as a minimum, return
37.12 per cent of gross turnover (i.e. turnover less prizes) to the community. Complementing this minimum return requirement are specific limits on expenses, such as on how much an operator may pay a venue for the use of the premises. There is also a general overriding limit on all expenditure, namely that costs must be actual, reasonable and necessary.
C First Sovereign Trust
[12] Mr Bird (the third respondent) is an accountant who in the course of his early employment was given the job of managing a small gambling trust based in Rotorua. That experience led him to believe there was a need for a bigger class 4 operator to be based in the central North Island. One of the existing policies around gaming machines at the time was that, to the extent possible, the proceeds should be returned to the community from where they came. That was not happening in the central North Island because there was not a suitably sized licence holder to which local groups could apply.
[13] As well as a need, Mr Bird saw a business opportunity. His idea was to form a trust, and then provide his expertise to the trust via a management arrangement. He believed he could deliver a more efficient, venue friendly operation that would prove attractive to existing operators. The aim was to expand quite rapidly to a mid size enterprise based in the central North Island. Mr Bird believed there was efficiency in numbers and he could promote a trust that gave him a good income and which provided good returns to the Rotorua and central North Island area.
[14] Mr Bird began by incorporating First Sovereign Trustee Ltd in September 2002. He was the sole shareholder. That company in turn settled the First Sovereign Trust which, five months later in March 2003, obtained its class 4 operator’s licence. At this stage the Gaming and Lotteries Act 1977 applied.
[15] The initial trustees were Messrs Short, Anaru and King. All were known to Mr Bird. None had experience in the gaming industry, but each had other skills and standing in the community. They remained the trustees of First Sovereign until it
was eventually wound up, and then became trustees of its replacement trust, First
Sovereign Trust Ltd.
[16] The plan progressed as Mr Bird envisaged. The Trust adopted the business model Mr Bird proposed, and AMS began running the Trust. First Sovereign was, as Mr Bird had hoped, able to attract venues and did rapidly grow. As the Trust grew so did Mr Bird’s fee pursuant to the management contract. However, his vision of efficiency also proved legitimate. Whilst the quantum of the fee increased, as a percentage of gross turnover it consistently decreased – initially it was 9.41 per cent, but then it declined each year to 8.53, 5.31, 5.22 and then 3.20 per cent.
[17] Although Mr Bird/AMS was providing management services from the outset, it was not until 18 June 2004 that a formal contract was signed. The Gambling Act 2003 was due to commence on 1 July 2004 and this seems to have been a reason for the contract being finalised. The contract was backdated to 1 May 2003. The period prior to 1 May 2003 seems to have been treated as Mr Bird providing input in a personal and unpaid capacity.
[18] At the time of finalising the contract, the Trustees engaged a Christchurch law firm, Grant Cameron Associates,1 to provide legal advice. Mr Cameron, who was a witness in these proceedings, had extensive experience working for clients in the gambling industry. He had been the first independent chair of the Gaming Machine Trusts Association which was a body formed by six of the seven largest gaming trusts. On behalf of that body he worked intensively on the Gambling Bill, a role which led him not only to familiarity with the industry but with relevant personnel in the Department. He was, in short, a sensible and legitimate person for
the trustees of First Sovereign to engage.
1 Now GCA Lawyers.
[19] Mr Cameron drafted the management contract that is in issue in these proceedings. I was left a little unclear as to the level of his input into the final form of the remuneration provision. It seems that the specific terms emerged from discussions between the Trustees (at least two of whom were experienced businessman) and Mr Bird. Mr Cameron thought the clause was expressed unusually, but when he analysed it he could see no issues, so included it in the contract.
D The management contract
[20] I propose to deal with the issues around the contract in four sections – first, a discussion of its genesis and commercial legitimacy, then an analysis of the particular criticisms of the length of the contract, and the remuneration provision, and finally some general conclusions about it.
(a) The genesis and legitimacy of the contract
[21] The contract is relatively simple. It appointed AMS to manage the Trust’s business for a 10 year period. AMS was also given a right of renewal for at least a further 10 years. The contract empowered AMS to do all that was necessary to run a gaming operation – enter into contracts, lease venues and buy machines.
[22] The effect of the contract was that all outgoings were the responsibility of AMS. This meant it hired and paid staff, pay all fees, and purchased machines, computers and software. It also loaned the Trust $100,000 as initial working capital. In this way it can be seen AMS took all the initial risks. If the business failed it was AMS that would suffer the financial loss.
[23] The remuneration arrangements were twofold. First, the Trust was to reimburse AMS all disbursements. Second, it agreed to pay, by way of a management fee, three times the salary that AMS paid its staff.
[24] The evidence I have on the contract comes only from the respondents. Mr Bird set out why he considered it an appropriate arrangement. Second, the respondents called Mr Cameron, the Trust’s legal adviser. Finally, the respondents
also called Mr Grant Graham. Mr Graham is a partner in KordaMentha, and an expert on corporate finance issues, the valuation of corporate entities and their intangible assets, and the analysis of loss of profits.
[25] The significance of Mr Cameron’s evidence on this topic is that I accept that in relation to the contract the trustees had independent legal advice from an experienced solicitor with a particular knowledge of the gaming industry.
[26] Mr Bird explained that the contract represented how he had envisaged things. Through his company he would run the business and take all the risks. If it worked both the Trust and he would be successful. The length of contract was important because he was taking the risks and so needed a length of tenure that enabled him to reap the benefits downstream.
[27] Mr Graham was asked to give an opinion on whether he considered the structure of the management contract to be a commercially reasonable model. He was also asked to consider that from the perspective of whether it aided First Sovereign to maximise proceeds.
[28] Mr Graham analysed First Sovereign’s position in its early days and the risks associated with start up entities. He noted that the benefits it received from entering the contract included the fact that AMS would accept responsibility for paying staff, would provide working capital to fund the acquisition of machines and would loan First Sovereign $100,000 by way of working capital. Further, AMS had agreed to defer its management fee as to the extent necessary in this start up phase. Mr Graham was of the view the Trust could not have achieved its exceptional growth without these arrangements in place.
[29] The other side of the equation is that AMS was assuming considerable risks. If the enterprise failed the financial losses would be suffered by AMS. For such a bargain to be commercially viable, AMS needed a contract that protected its opportunity to receive the financial rewards that would emerge downstream if the enterprise succeeded. Accordingly, he considered it a commercially reasonable bargain.
[30] The Secretary called no countering evidence, and cross-examination did not cause me to have any concerns about the value of Mr Graham’s evidence. As regards the issue of whether the contract was a commercially reasonable contract from the viewpoint of both parties to the contract, the evidence leaves me in no doubt that it was. This conclusion covers, from a commercial perspective, the two issues of the contract length and the remuneration clause. There is a separate issue, shortly to be addressed, of whether those provisions, even if commercially sound, are appropriate for the regulatory context in which the management contract sits. But standing alone as a commercial contract, it was a reasonable bargain.
[31] It can be added it was also a very successful one for both parties. First Sovereign achieved an annual growth of almost 40 per cent and was able to deal with all the issues such growth brings. AMS’s management fee grew over five years from
$283,471 to $768,992. At the same time that gross figure represented an ever-decreasing percentage of First Sovereign’s turnover. It might have been thought that this was a package that seemed to meet well the purposes of the Act, but that was not the Department’s viewpoint. I turn then to the two particular aspects with which the Department took issue.
(b) The length of the contract
[32] The contract was for 10 years. The renewal provision, as relevant to these proceedings, provided:
3.4The parties shall enter into a new agreement which is to be identical with this agreement except that:
a.the commencement date of the new agreement is to be the day after the Expiry Date;
b. the term of the new agreement is to be ten (10) years;
c.the expiry date of the new agreement is to be the last day of the term of the new agreement;
d. this clause 3 is to remain in the new agreement; and e. the Management Fee is to be either:
i. the fee agreed between the Trust and the Manager;
or
ii. in the absence of agreement, the fee shall be determined, in accordance with the provisions of the First Schedule.
[33] There was a dispute about the meaning of this clause. Mr Bird, and I infer the trustees, thought it provided for a 20 year contract – 10 years plus one right of renewal. Mr Bird’s evidence, which I accept, is that the parties to the contract only ever treated it as allowing for a 20 year contract. Mr Cameron testified that he believed he had explained to the trustees that it was perpetually renewable. I do not doubt this, but accept the parties did not treat it that way.
[34] The Secretary is plainly right that on its face it is an agreement in perpetuity. Clause 3.4(d) provides that the renewal term is to be included in any new contract, so will continuously apply at the end of each 10 years.
[35] However, whether it is a contract for 10 years, or 10 years plus one renewal, or 10 years plus continual renewals is not really of significance. What is of significance are two related issues. The first is whether a contract of this length prevents the licence holder from carrying out the purposes of the Act. The second is a factual issue of whether Mr Bird, on behalf of AMS, agreed to give up his rights of renewal at any point before the buyout agreement was entered into. The alleged significance of that would be that such a concession by Mr Bird would affect the need for the Trust to buy out the management contract, and/or the value of a buyout.
[36] Turning first to the proposition that the length of the contract is inconsistent with the purposes of the Act, the Department’s objection is that a contract of this length prevents the class 4 licence holder from testing the market and ascertaining if it can do better. Conceptually that is a valid point. It gains further merit when one recalls that one of the licensing criteria the Secretary must consider on an annual basis is the capacity of the operator:2
... to maximise the net proceeds from the class 4 gambling and minimise the operating costs of that gambling.
2 Gambling Act 2003, s 52(1)(d).
[37] Given that the management contract is a significant cost, it is legitimate to criticise the inability to see if one can purchase a product more cheaply. However, it is difficult to assess what sort of market there actually is for these management contracts. The evidence suggested that about 10 of the trusts used management groups to run their trust, but with, as I understand it, the encouragement of the Secretary, this number is dwindling. The more important point is that there is no evidence that any other management company, real or imaginary, is performing, or would perform, for fees that were less than the amount AMS were charging, the services AMS provides. It is at best a theoretical concern with no evidence that testing the market would make any difference.
[38] The second issue is whether Mr Bird had indicated AMS would forego its rights to exercise a renewal. As noted the significance is said to be its effect on the need for, and value of, any buyout, given that, with this concession in place, the contract would end after 10 years. The basis on which the Secretary contends Mr Bird agreed to give up his right to renew the contract is a statement by the Trustees in a letter written to the Department around the time of the proposed non-renewal of the licence. The trustees, by their lawyer, wrote:
Renegotiation
These discussions are on-going however we can advise as follows:
... the Trustees have reached a tentative agreement (the exact terms of any variation to the agreement remain to be resolved) with AMS whereby the offending provision (clause 3) will not be relied up on by AMS ... The effect of this change is that the present contract comes to an end at the expiry of the
10 year period and a fresh contract will need to be negotiated.
[39] As it happens this olive branch was insufficient to satisfy the Department which responded that it was obliged to make a decision based on the situation as it currently was. Further, the proposal still allowed the first 10 year term of the contract to run its course, and that was unacceptable. The Secretary also noted there was no indication from AMS that it would accept any change that would address the Secretary’s concerns.
[40] Mr Cameron was not personally involved in discussions prior to the letter being sent, so could not comment on the accuracy of what was said in it. Mr Bird
says the letter is wrong. Whilst there were discussions about changing things to solve the present impasse with the Department, Mr Bird says that he never agreed, tentatively or otherwise, to waive AMS’s contractual rights. Mr Bird accepts the document containing this statement would probably have come across his desk. He is unsure if it did, but if it did, he never noticed this paragraph.
[41] I accept Mr Bird’s evidence. Generally I found him a truthful witness and I see no reason why he would have given up an important contractual right. The Department submits otherwise. It cannot call on any evidence to support its contention but submits the connection of Mr Bird to the Trust was such that he would in the end have done whatever it took to secure the Trust’s future.
[42] I consider this is an area where the absence of evidence from the trustees counts against the applicant. The Secretary is relying on a statement contained in a letter written on their behalf; the author of the letter is not a witness nor are the trustees. However, the other party to the alleged statement is a witness and says the statement is incorrect. Mr Bird supports this with sound reasons as to why he would not have agreed to that. Further, the statement itself describes only a tentative agreement, an expression that implies there is no certainty around it. That is consistent with it being an impression held by the trustees that could be mistaken.
[43] It can also be noted that what happened soon after in relation to the buyout agreement is also inconsistent with this statement. The parties each obtained independent valuations of the contract as it stood. The valuation obtained by AMS says there is one right of renewal, and if exercised, the contract will end in 2023. The valuation prepared for the trustees likewise refers to the ultimate expiry date of the contract being April 2023, again if the renewal is exercised. These valuations are consistent with there being no agreement between the Trustees and Mr Bird to waive the renewal right, and are also consistent with my earlier conclusion that the parties treated the contract as containing one right of renewal.
[44] My conclusion, therefore, is the independent valuation process proceeded on the basis that the contract had a potential life, at AMS’s choice, of another 13 years, and this assumption reflected the mutually agreed position of the parties. The
valuations were not, therefore, invalid because based on an incorrect understanding of the term of the contract.
(c) The remuneration clause
[45] The remuneration clause provided:
1.Until such time as the Trust is operating 180 of gaming machines the Management Fee shall be calculated on a time and attendance basis (calculated as three times the hourly rate paid by the Manager to its staff or independent contractors performing the Management Duties on behalf of the Manager) plus GST.
2.Once the Trust operates a minimum of 180 of gaming machines the Manager shall be entitled to elect to charge the Management Fee on the basis set out in clause 1 of this First Schedule or at the rate of $35.00 plus GST per machine per week.
3.The charge out rate per machine specified in clause 2 of this First Schedule shall be reviewed on each anniversary of the Commencement Date during the Term or at any time the Trust’s gaming licence conditions require it to be reviewed. On each of the annual review dates, the manager shall elect whether to charge the Management Fee calculated on the basis specified in clause 1 or clause 2 of this First Schedule and such election shall apply until the next review of the machine charge out rate pursuant to clause 2 of this First Schedule.
[46] Clause 1 is the operative clause. The alternative payment option contained in cls 2 and 3 was never triggered by AMS, essentially because it would have produced a lesser fee.
[47] Focussing then on cl 1, the charge out rate of three times the hourly rate paid to staff is an unusual formula. The evidence suggests the formula had its genesis in a methodology used by professional firms whereby the aim is to spend one third of income on fixed costs, one third on salaries, and have one third left to pay tax and remunerate the partners.
[48] The evidence is not firm on the point but the best inference is that this particular wording was not in the original draft, but suggested by Mr Bird. However, the trustee’s lawyer, Mr Cameron, though thinking it unusual, decided it was
acceptable from the trustee’s viewpoint, advised them accordingly, and included it in
the contract.
[49] Because of this remuneration clause, the Department has consistently found fault with the remuneration paid to AMS. It criticises the formula itself, and the quantum paid to AMS under it. It is necessary to address each.
(i) The formula itself
[50] The Department’s objections are that the formula allows Mr Bird to be doubly reimbursed. His salary is included in the three times formula and he gets the final ⅓ profit as well. The second objection is that the Trust has no capacity to control what salaries Mr Bird pays himself, or his staff. As those salaries increase, so does the AMS fee, by three times that salary. It provides the wrong incentives and gives the trustee no right to object. That being so, they are not in a position to minimise costs.
[51] Reflecting further on the wording of the clause, I am unsure why it was accepted that Mr Bird’s costs were included in the formula. He seems to have been the Manager throughout and not obviously within the expression “the Manager’s staff”. However, it seems common ground his salary was included for calculation purposes.
[52] This complaint about the structure of the contract is the strongest aspect of the Department’s case. Mr Bird says AMS never charged as much as it could have. It seems that initially he was charged out at nothing, and then later at $50 per hour. His office staff were initially charged out at two times their rate, and it is not clear when that altered to the three times formula.
[53] There are two complementary points that emerge from this. First, the trustees indeed could not control the fee, and second, the formula did allow Mr Bird to charge what he liked subject to the maximum it imposed. What it in effect allowed was for Mr Bird to see how much money there was available and take it, subject to ensuring the Trust met all its statutory obligations.
[54] I accept the Department proposition that such an arrangement is not consistent with the Act’s scheme. It is, for example, very difficult for the Secretary to assess whether a licence holder is minimising costs when the control of what it pays is in the hands of the manager rather than the Trust. Further, there should be an objective measure other than “all that is available”.
[55] I, therefore, accept it was reasonable for the Secretary to have concerns about the remuneration formula.
(ii) The quantum changed under the formula
[56] It is when one shifts to the quantum, however, that the Secretary’s position is much less compelling. The reality is that there are no benchmarks, or guidelines for what is reasonable. The Secretary conducted a review of these types of costs and concluded that he could not reach a definite position. As a Departmental witness accepted, the Department was unable to make a call on what was a reasonable or average fee. Consequently, no rules were put in place, nor were any guidelines issued. So how is one to say the quantum is too much?
[57] Mr Bird’s unchallenged evidence is that by the end of the fifth year, when AMS’s fees were projected to be 3.2 per cent of turnover, as a percentage of gross turnover that level of fee would be in the middle of industry norms. The Departmental witnesses did not dispute this.
[58] So what one has is a formula that is conceptually flawed and inconsistent with the statutory scheme, but which is producing outcomes that suggest the licence holder is meeting its statutory obligations and is spending no more on management costs than other comparable licence holders.
[59] I do not consider the Department is capable of establishing that at the time of cancellation the quantum of the management fee was too high. I was taken to the various audits carried out by the Department, and the Trust’s replies. It is noticeable that the Department failed to ever respond to the licence holder’s submissions about the reasonableness of the fee. The Department consistently listed the quantum of the
fee as a concern, but never justified that or referenced it to anything. It is not a sensible measure just to look at the total figure in isolation. The reality is that the Department simply cannot say, or give reasons why, at least in later years as the Trust emerged from the start up phase, the figure was excessive.
(d) Conclusion on the contract
[60] My findings on the contract are that it was a commercially reasonable contract from the viewpoint of both parties. It was also a success, and led to a situation where the outcomes, in terms of costs and returns to the community, have not been shown to be inconsistent with the scheme, or outside industry norms.
[61] I do not accept the Secretary has shown that the length of the contract had any effect on compliance with the Act, although I accept it was reasonable to be concerned about it. Likewise, I accept that the remuneration formula, in particular the lack of certainty and the lack of any capacity in the trustees to control the fee, was legitimately a source of concern.
[62] I am not called on to formally resolve whether it was rational, after six years of this contract operating and at a time when in fact it was producing Act compliant outcomes, to cancel the licence because of the theoretical concerns. I do observe, however, that if the contract actually started producing measurably disproportionate or excessive fees, the annual licensing system provided an opportunity to monitor and respond.
[63] Overall, to the extent there has been a focus on the contract to support the applicant’s position that the buyout payment was unreasonable because it was itself the product of an unreasonable contract, I reject that proposition.
E The licence is cancelled
[64] As noted there were a series of Departmental audits of First Sovereign. These are regular occurrences and not particular to First Sovereign. These audits flag matters that need to be improved, and on occasions make findings of specific non-compliance. A history of non-compliance can lead to the licence not being
renewed. In this section I focus only on topics of alleged non-compliance that have relevance.
[65] The parties are in dispute as to whether the Secretary initially agreed to the contract and then changed his mind. The respondents place heavy reliance on a statement by the Secretary in one of the exchanges of correspondence, where it is said that whilst the cost structure might have been alright in the start up phase, it now was not. This is said by the respondents to be a statement that the contract was initially approved. I consider that reads too much into it. It is just one of those things that gets said when debates are being had, and when one is trying to draw a contrast between what has gone (and now is not in issue) and the present. It is not a statement that should be seen as some definitive approval of the past.
[66] First Sovereign already had its licence before the contract was signed. The Secretary never had to formally approve the contract or otherwise. From the time the Secretary first became aware of it, issues were raised. I do not, therefore, consider it can be said the Secretary is changing his position.
[67] The system of annual audit consists of a draft audit, an opportunity to reply, and then a final audit report. I have commented earlier that the Trust gave detailed replies to the Departmental concerns, and it is fair to say they were often not rewarded with a reasoned reply but instead met with a repeated assertion of the Department’s position. It is not necessary to delve into this in greater detail, other than to record that eventually the Secretary, in the absence of changes to the contract, gave notice that he was considering not renewing the class 4 operator licence. This was in June 2009.
[68] The contract was not the only source of conflict or reason for the proposal not to renew the licence. By June 2009, when the Secretary took this decision, a separate inquiry into First Sovereign and Mr Bird’s relationship with a particular racing club had led to criminal charges being laid against both. The main focus was Mr Bird who was charged with Crimes Act 1961 offending as well as a Gambling Act charge. First Sovereign faced only the latter allegation. The essential allegation was that Mr Bird and an official of the club had an arrangement whereby net
proceeds were received and improperly used to renovate First Sovereign gaming venues.
[69] The charges were eventually dismissed by the District Court. Opinions on these outcomes always vary, but it is not unreasonable in this case to say Mr Bird was exonerated. The significance of all this is that a second theme running through the cancellation of licence discussions was Mr Bird’s suitability to be involved in First Sovereign’s business. At the time of the licence cancellation, and the buyout, the charges against Mr Bird had not been resolved.
[70] There is a second concurrent event that it is also necessary to mention for context. First Sovereign has traditionally distributed a significant proportion of its proceeds to the racing industry. This is an approved purpose under the Act. However, in proceedings not involving First Sovereign, the High Court held that distribution to racing was not a charitable purpose.3 For organisations like First Sovereign, this meant that whilst distribution to racing was permitted under the Act, it was in conflict with First Sovereign’s own purposes which were limited to charitable purposes.
[71] This High Court decision led to a new trust being formed in October 2009. It was called First Sovereign Trust Limited.4 Its purposes were more broadly drawn to allow continued distribution to purposes that were permitted by the Act but might fall outside the definition of charitable purposes. The idea was that First Sovereign venues would progressively be transferred across to the new trust, First Sovereign Trust Ltd.
[72] It can be seen, however, that the creation of the new trust had potential advantages for First Sovereign at a time when its class 4 operator’s licence was threatened. Provided, of course, that the new trust received a class 4 licence, First Sovereign could reinvent itself and put the existing issues behind it. Accordingly, the new trust applied in December 2009 for a class 4 operator’s licence. Perhaps not
surprisingly given that it was largely First Sovereign, the application was declined in
3 Travis Trust v Charities Commission (2009) 24 NZTC 23, 273.
4 Not to be confused with the company that settled the original trust. That company was called
First Sovereign Trustee Ltd.
March 2010. One of the reasons given for declining was Mr Bird’s suitability. An appeal was filed and concurrent judicial review proceedings were brought by First Sovereign challenging the capacity of the Secretary to rely on the allegations against Mr Bird when they were still unresolved. The Court ruled that there should be a deferral of the licensing dispute until the criminal charges were resolved. Eventually, after Mr Bird was acquitted, in March 2011 the new trust received a class 4 licence in March 2011.
[73] Returning to the non-renewal decision, First Sovereign filed a detailed reply to the Secretary’s interim decision. The reply included the passage cited earlier5 about trying to renegotiate the contract. As was noted, the Secretary was not persuaded and in March 2010 confirmed his decision.
[74] First Sovereign appealed. The effect of an appeal is to preserve the status quo until the appeal is heard and determined. That meant First Sovereign could continue operating whilst it sought a solution. It seems its strategy was to change things (the contract) so that it could convince the Secretary to reconsider, or present its appeal to the Commission against an improved factual situation, or be able to carry on under the new trust.
[75] Three months after the non-renewal decision, in June 2010 the trustees bought out the AMS contract. This did not become known to the Secretary until September 2010 at the time when First Sovereign applied for renewal of its licence. The renewal application was required because although an appeal preserves the status quo, it does not otherwise suspend the operation of the Act. So First Sovereign’s annual licence was up for renewal, and notwithstanding the existing non-renewal decision, a fresh application had to be made and processed.
[76] The charges against Mr Bird were dismissed in October 2010 (no case to answer on the Crimes Act charge) and November 2010 (his evidence preferred to that of the prosecution in relation to the Gambling Act charge). In March 2011 a
class 4 operator’s licence was issued to First Sovereign Trust Ltd. This enabled the
5 At [38] above.
trustees of First Sovereign to transfer all the venues to the new trust, which it did. At the time these proceedings were heard, only one venue remained to be transferred.
[77] As for how the new First Sovereign Trust managed itself, the buyout of AMS had effectively involved acquiring the AMS business, its systems and its staff. Mr Bird was also now available, having been acquitted, so First Sovereign Trust Ltd contracted with one of Mr Bird’s companies, the second respondent, for it to provide management services. These services involve only Mr Bird. Otherwise the management of the Trust is now run in-house (using former AMS systems and staff).
[78] Since the potential to use the new trust had become a reality, First Sovereign abandoned its appeal to the Gambling Commission, surrendered its licence and commenced an orderly winding up and distribution in accordance with the Act.
F The AMS buyout
[79] Focussing now on the buyout agreement, at the time it was negotiated the formal position was that:
(a) The Secretary had decided not to renew First Sovereign’s licence.
(b)The Trust had appealed. If unsuccessful in the appeal First Sovereign would no longer be able to run a gaming operation, which was its only activity.
(c) Mr Bird was facing charges under both the Crimes Act 1961, and the Gambling Act 2003. (First Sovereign was facing the same Gambling Act 2003 charge).
[80] Any analysis of whether the buyout agreement was a necessary and reasonable expenditure of gambling proceeds will need to have regard to these factors.
[81] I have not heard directly from the Trustees as to what advantages they considered ridding themselves of the contract would bring. It remains my view that
it was the applicant’s responsibility to bring the Trustees before the Court if he wished. It is, after all, the trustees who are said to have made the improper payment, and the Secretary who asserts it was an unnecessary and unreasonable payment. I am not prepared to infer anything untoward as regards the Trustees in their absence. Accordingly, I proceed on the assumption that, as independent trustees, they thought it was reasonable, necessary, and made commercial sense. That does not mean that objectively it did, but I do not accept any claim of a lack of independence or improper motives or conduct amounting to a breach of trust.
[82] Mr Cameron testifies, and I accept, that the trustees had independent legal advice about the buyout. He believes his firm first became involved on the topic in mid-2009 (the buyout was June 2010). From Mr Cameron’s viewpoint, the retention of Mr Bird and his business was a vital issue for the Trustees to address.
[83] What occurred was that each party to the management contract had their own legal adviser, and their own independent valuer. A common information pack was provided to both valuers. The ranges suggested by the valuers were $2.4 million–
$2.6 million (AMS’s valuer) and $1.5 million–$2.9 million (First Sovereign’s valuer). It can be seen the final figure of $2.4 million is the bottom of AMS’s, and around the middle of First Sovereign’s.
[84] Objectively it is difficult to discern a problem with the process. Each party had appropriate independent advice and the figure settled upon was within the range identified separately by both valuations. The Secretary, however, challenges the legitimacy of the valuations on the basis that they proceeded on flawed information. It is noted by the Secretary that in neither the information pack, nor the valuations themselves, is there express reference to the fact that the licence had been cancelled and First Sovereign was surviving only on a stay of proceedings. The Secretary also points to the claim in the valuations of a “stable client base” and says this is illegitimate in the Gambling Act context where venue licences are only for three years, and venues can and do switch.
[85] The point about the cancelled licence is correct to the extent that neither the information pack nor the valuation expressly mention it. Mr Cameron did not know if the valuers had otherwise been told, but believes they would have been.
[86] Mr Bird says his valuers were told. In evidence was an email he sent to his valuer with attachments, one of which was a letter written by Grant Cameron Associates at the time the Secretary gave notice of his intention to not renew. The letter addressed the Trustee’s options. I saw no reason to query Mr Bird’s evidence on this and accept his valuers were told.
[87] That said, it is still the case there is no overt reference to it. Does the evidence satisfy me that this is a reason for the Court to hold the valuation figure on which the contract was based is not reliable?
[88] Based on the evidence available the answer can only be no. I begin with the evidence of the applicant who has the burden of establishing the point. The Secretary called three witnesses – two Departmental investigators and an expert. The expert is an expert forensic accountant who worked for 19 years with the Serious Fraud Office. He is not a valuer and claims no expertise. The effect of his evidence, as far as I could discern, was to make the point that the valuers should have been told. The witness expressly said he was not in a position to say whether it would in fact make a difference.
[89] The other witness to comment on the matter was one of the two Departmental investigators. He also is an accountant whose function generally is to provide advice to the Secretary on the financial viability of licence holders. He is not a valuer but purported to explain why the valuations were not legitimate and what he thought the value was. The witness had no qualifications to give such evidence and should not have done so. I could simply rule that part of his evidence inadmissible as being unqualified opinion evidence, or alternatively give it no weight. The effect is the same.
[90] It follows that the Secretary cannot make good on his challenge to the credibility of the contract price. This conclusion is reinforced, however, by the
evidence of the respondents who did call expert valuation evidence in support of the valuation process. That witness explained how a valuer would approach the issue, and was of the view the information about the licence cancellation would not necessarily affect the outcome.
[91] There are two explanations for this. The primary one is that the valuations were done on the basis that the business was a going concern. That means the risk of it not continuing is less dominant in reaching a value, but is of course a separate factor for the purchaser to consider when deciding whether to make the buyout.
[92] The second reason why it would not necessarily be that significant is a point which I consider the Departmental witnesses had not taken on board. The $2.4 million was not expended just to get out of the contract. It represented the purchase price of the AMS business as well. As Mr Cameron said, securing on-going access to AMS, its systems, its staff, and Mr Bird was crucial to First Sovereign if it was to continue to run its business. If it could work out a solution to its licence issue, then it needed to be able to carry on seamlessly and this was how to do it.
[93] There is a further aspect supporting the commercial sense of the buyout. At the time of the buyout Mr Bird’s status was uncertain because the charges were still pending. The structure of the buyout enabled the trustees to secure his services as well as the AMS business, or jettison him but have the rest of the business, staff and systems. The buyout contract positioned the Trustees ideally to carry on if they were able.
[94] My conclusions, therefore, on the buyout are that:
(a) for the reasons given I decline to infer that the trustees were other than properly motivated (and no other evidence suggests otherwise);
(b)the effect of the buyout was to leave the Trustees in a sound position to continue if that were possible;
(c) the price of the buyout was ascertained by a proper process; and
(d)the actual price paid falls within the range of both valuations and the Secretary has failed by a margin to satisfy me it should be regarded as other than an appropriate price.
[95] Against these factual conclusions I turn to the formal bases advanced by the
Secretary in support of his application.
G The Secretary’s application
[96] The application is made under s 112 of the Act. Originally the Secretary alleged the payment was not reasonable and/or necessary in the conduct of gambling. The effect was to significantly reduce First Sovereign Trust’s net proceeds to the detriment of the community.
[97] The respondents sought precision in what obligation was breached. The Secretary was reluctant to do so, and does not concede the need to so, but did particularise to allege:
(a) a breach of s 106 of the Act;
(b)a breach of the requirement to maximise net returns and minimise costs; and
(c) a breach of cl 10 of the Gambling (Class 4 Net Proceeds) Regulations 2004 in that it prevented First Sovereign Trust from distributing 37.12 per cent of its gross proceeds.
[98] I consider an analysis of s 112 will resolve this dispute about the need for particulars, so turn to that first.
(a) Section 112
[99] Section 112 allows the Secretary to apply for orders if the Secretary considers it is necessary to recover net proceeds that have been improperly paid to a person. The Court is given a broad discretion to make whatever orders it considers necessary to recover the amount improperly paid out.
[100] Section 112 was considered in Secretary for Internal Affairs v Integrated Commercial Solutions Ltd (Integrated Solutions).6 That case proceeded as an unopposed application to recover monies paid, although the Court was assisted by an amicus.
[101] I admit that I do not find the wording of s 112 easy. What it requires, on its face, is the improper payment of net proceeds. So first, forgetting the issue of proper or improper, what has to be shown is that it was net proceeds that were used. Net proceeds are the gross turnover less actual reasonable and necessary costs. So for s 112 to apply to the $2.4 million payment, it has first to be shown it was a cost incurred that was not reasonable and not necessary. The question then arises, if this is established, what more if anything is required to show it was an “improper” application of net proceeds?
[102] The Secretary’s position is that nothing more is needed; the respondents submit improper must add a knowledge component, at least to the extent of requiring proof that the payer ought to have been aware the payment was inconsistent with the Act. The respondents submit that “improper” would not be the statutory test if all that was intended was that it be shown it was not a reasonable or necessary cost.
[103] In Integrated Solutions, Ellis J agreed with the Secretary’s position and
observed of s 112 and the impropriety test:7
If, after this inquiry, the Court is satisfied that the amounts paid are not referable to actual, reasonable and necessary costs of conducting the gambling operation and therefore qualify as “net proceeds” then the next question is whether they were paid out “improperly”. In the vast majority of cases the answer to that question would no doubt coincide with the outcome of the first inquiry. An exception might be where there is room on the facts for debate about whether a particular payment had in fact been made for an authorised purpose (as defined).
[104] There are, in my view, valid arguments both ways. The effect of the
Secretary’s interpretation, which has been accepted in Integrated Solutions, is to
deprive “improper” of any content. It just becomes a label used for payments that
6 Secretary for Internal Affairs v Integrated Commercial Solutions Ltd HC Auckland
CIV 2010-404-5253, 18 April 2011.
7 At [59] (footnote omitted).
are not in accordance with the Act. As such it is perhaps an unexpected way to express that concept. Usually improper is intended to mark out something as having a culpability beyond a mere mistake.
[105] On the other hand, the purposes of s 112 would seem to be thwarted by requiring proof of some form of guilty mind. It would still be a payment that should not have been made whether or not the maker of the payment knew that. And in this case the target is the recipient of the funds; establishing impropriety or otherwise on the part of the payer does not particularly affect the circumstances in which the payee received it or whether an order should be made against the payee. In other words the fault inquiry is directed at the wrong person.
[106] Resolution of the issue is not pivotal to the outcome of the case so I am content to apply existing authority whilst acknowledging I see some force in the respondents’ position.
[107] The third step is the issue of the Court’s discretion. The wording is that the Court “may make whatever orders are necessary to recover an amount improperly paid out”. This could be seen as directive in the sense of doing what is necessary to recover the money. But it plainly is a discretion (“may make”), and I see no reason to curtail it to prevent a court from assessing the fairness and justice of the orders. I recognise that the statute does not say to make such orders as are “just and necessary” but I do not consider the non-inclusion of “just” is intended to exclude its applicability. The Secretary does not contend otherwise.
[108] I note for completeness that in Integrated Solutions the Court identified an alternative route to the existence of this type of discretion. Ellis J concluded that a finding of impropriety will make any contract underlying the payment an illegal contract in terms of the Illegal Contracts Act 1970. This conclusion is consistent with s 116(5) of the Act which provides that contracts entered into that are contrary to any specific cost limit prescribed under s 116 are illegal for the purposes of the Illegal Contracts Act 1970.
[109] Her Honour considered the same analysis can apply to a contract affected by s 112 with the effect that:
(a) any order under s 112 cannot render ineffective dispositions for valuable consideration to third parties who have acted in good faith; and
(b)the Court has a discretion (s 7 of the Illegal Contracts Act 1970) to grant relief if the interests of justice require.
[110] This analysis of s 112 leads me to conclude that the Secretary’s original pleading, although not fully in accordance with how I have analysed s 112, was generally appropriate. In particular I do not consider it was necessary to particularise breaches of other provisions of the Act. The correct key allegation was that the expenditure was not reasonable and necessary.
[111] Mr Cooke submitted at the hearing that the respondents would be prejudiced if I took this approach of the particulars not being required because the respondents’ case was prepared as a response to the pleaded particulars. I am unsure if he would maintain that position given how I have now identified the elements. The issue of reasonable and necessary was the matter concerning which all the evidence was addressed, so it is difficult to discern prejudice.
[112] However, as a precaution I will address the case both in terms of what I consider s 112 requires, and the particulars identified by the Secretary. The outcome will not differ.
(b) First issue – was the $2.4 million buyout payment the distribution of net proceeds?
[113] The payment will be net proceeds if it was not the actual, reasonable and necessary distribution of turnover from gaming machines. “Actual” is not in issue in this case, so I turn to the other two requirements.
[114] The matters relied on by the Secretary for establishing the payment was not reasonable and necessary overlap the two concepts so I will address them together. The factors relied upon were:
(a) the fact that First Sovereign’s future was in serious jeopardy;
(b)the valuations were predicated on misinformation, or the omission of key facts;
(c) the idea of “negotiations” is unrealistic when “in reality, First
Sovereign Trust was controlled by Mr Bird”;
(d)First Sovereign was winding down anyway, even if the appeal succeeded; and
(e) the new arrangements entered into by First Sovereign Trust Ltd.
[115] There is no doubt that First Sovereign’s position was in jeopardy. The Secretary had cancelled its licence. However, it is not clear why that means that taking steps to secure its future were thereby unreasonable or unnecessary. Instinctively one would think the opposite. I have previously outlined the advantages to First Sovereign of the buyout – it ended a contract that the Secretary was opposed to; it gave First Sovereign the means to carry on by securing its administration structures and personnel; it prevented that same package from going to a competitor; and it gave the trustees options as regards Mr Bird depending on the outcome of the prosecutions against him.
[116] First Sovereign was a $22 million plus operation, and in a business sense it would be surprising for it not to take steps to prevent its demise. Sorting out the contract and securing its management arrangements were understandable priorities, so I do not consider the expenditure of money to advance this was inappropriate.
[117] It is important to appreciate that no hint of impropriety should be attached to the idea of using gambling proceeds to buy out a management contract. The evidence establishes this has happened three times previously without challenge
from the Secretary, and indeed on one occasion with Departmental input into the final figure.
[118] It is worth dwelling on this because it is an important factor in the reasonableness of what First Sovereign did. The three other contract buyouts have involved the sums of $1.9 million, $825,000 and $2.23 million. None of these has been challenged by the Secretary as being conceptually an illegitimate cost. The fact that these buyouts had happened was known in the industry. It was known to Mr Cameron. It was known to Mr Bird and it would have been known to the Trustees. In one of the situations the Secretary approved the $1.9 million figure.
[119] If this is an acceptable use of proceeds in an appropriate situation, then all one is left with is a challenge to the quantum, or to the fact that a buyout was negotiated at all. On the former the evidence all points against the Secretary. On the latter, the Secretary’s case requires acceptance of the proposition that First Sovereign should either have folded, or tried to start again with a whole new management group and arrangements. Neither proposition is commercially sensible, at least on the evidence presented to me.
[120] The second matter relied on by the Secretary is what is alleged to be flaws in the valuations. I have already commented to some extent on this. I consider the price was arrived at by a proper process and was reasonable given the identified ranges. A point not yet addressed is the Secretary’s criticism of the fact that the valuations refer to First Sovereign as having a “stable client base”.
[121] I have not been convinced that the fact that venue licences are limited to three years, and that venues have options, means it was incorrect to refer, for valuation purposes, to a stable client base. It must still be possible to show that the nature of a relationship with venues is such that loyalty can be legitimately expected. As it happens it seems to have proved the case for First Sovereign with its venues all moving to the new Trust.
[122] I accordingly conclude there is nothing about the valuations that causes me to see the payment as unreasonable or unnecessary.
[123] Next, the point is made that any “negotiations” were an illusion, because Mr Bird is First Sovereign. There are several points to make in response, some of which have already been said. First, First Sovereign had independent trustees bound by the rules that role imposes. The Trustees have not been given an opportunity to respond to what is an allegation that they have acted deliberately or negligently in breach of that Trust. The other “evidence” on which the Secretary relies, some cross-examination of Mr Bird and inferences from the circumstances, has failed to establish the proposition that there were no genuine negotiations.
[124] Second, and related, the Trustees had an independent legal adviser who was experienced in the industry. He has testified they took independent advice on the matters they needed to.
[125] Third, merely pointing to Mr Bird’s pivotal role in things over the years achieves nothing. It is to be expected that he would have most dealings with the Department, and be involved in audit discussions. That was his job under the contract. It does not mean the trustees were not acting independently where they had to. I accordingly reject that the contract is invalid because the trustees did not bring an independent mind on behalf of the Trust.
[126] The final basis relied on by the Secretary is that the buyout was unnecessary because First Sovereign was winding down anyway. Underlying this seems to be the idea it could just wind itself up and start again as a new entity leaving AMS and Mr Bird behind. In my view that is unrealistic and reflects the fact that the Department inconsistently misunderstood the nature of the buyout contract. A new First Sovereign entity, without AMS and Mr Bird, would have to start from scratch yet be able to service a large number of venues. It would also have to (potentially) withstand challenge for these venues from any licence holder (existing or new) that Mr Bird aligned with. The relationships with venues were very much with him and his staff. It is this expertise and goodwill that First Sovereign bought. It could also face threat from other Trusts seeking prime venues.
[127] In saying that I recognise there is an issue about the appropriateness of spending money for reasons of obtaining or maintaining a competitive advantage. It
is not a straight forward issue because the Act sets up an environment of competition by providing for unlimited licensees but capped machine numbers. My observation about First Sovereign legitimately securing its management arrangements is not intended to be a more general comment on competition expenditure. It merely responds to a specific challenge by the Secretary in this case. For all the reasons I have explored I consider it was reasonable to purchase the AMS business. In doing so First Sovereign did exactly what other Trusts have been permitted to do in the past.
[128] The final matter relied on by the Secretary are the new arrangements between First Sovereign Trust and Mr Bird. The Trust has contracted with another Bird entity, the second respondent, for Mr Bird’s services at $3,000 a week plus a $3,899 a month car allowance before GST. I am unsure if the significance of this is said to be it shows he was always going to stick with the Trust, or it shows it can be done more cheaply.
[129] As to the former, the contract buyout agreement obliged Mr Bird to do so. As to the latter, it is an invalid comparison since all the other AMS costs – staff, assets, expenditure – are now carried in-house by the Trust. What that all comes to as a total has not been advised to me. Overall, there is nothing in this factor that assists the Secretary.
[130] It follows, therefore, that the application fails because the $2.4 million was not the payment of net proceeds. Rather, it represented an actual reasonable and necessary expenditure of gross proceeds.
[131] As indicated, for completeness, I briefly address the particularised breaches of the Act alleged by the Secretary.
(c) A breach of s 106 of the Act
[132] Section 106 of the Act provides:
106 Corporate society must apply or distribute net proceeds from class 4 gambling to or for authorised purpose
(1) A corporate society must apply or distribute the net proceeds from class 4 gambling only to or for an authorised purpose specified in the corporate society's licence.
(2) A corporate society that fails to comply with subsection (1) commits an offence and is liable on conviction to a fine not exceeding
$10,000.
(3) A Court that convicts a corporate society of an offence under this section may—
(a) make whatever orders are necessary to recover an amount of proceeds wrongly applied or distributed or to safeguard an amount not applied or distributed; and
(b) order the application or distribution of an amount of proceeds not yet distributed.
(4) The effect of a conviction under this section is that—
(a) the class 4 operator's licence and all class 4 venue licences held by the corporate society are cancelled; and
(b) the corporate society does not have a right to appeal the cancellation.
[133] The Secretary’s reliance on this reflects an interpretation of the Act that has been rejected by me in The Trillian Trust v The Secretary for Internal Affairs,8 and then more importantly, in a subsequent decision of a Full Court of the High Court in Pub Charity v The Gambling Commission.9
[134] In brief the Secretary contends that any expenditure that is above what is “actual reasonable and necessary” constitutes a breach of s 106. I do not accept that. Section 106 does not prevent the incurring of expenditure which exceeds the actual necessary and reasonable costs of the gambling operation. As discussed net proceeds
is a label that can only be attached after the “reasonable and necessary” analysis has
8 The Trillian Trust v The Secretary for Internal Affairs HC Wellington CIV 2010-285-2411,
14 November 2011.
9 Pub Charity v The Gambling Commission [2012] NZHC 3530.
been done. What s 106 does control is where net proceeds may be distributed – only to an authorised purpose. Authorised purpose is defined in s 4, and is the term used to cover the permissible recipients of gambling proceeds, i.e. life-saving, sports clubs, community groups etc. The particular authorised purposes available to a licence holder are recorded as part of the class 4 licence.
[135] As has been pointed out, s 106 would otherwise be draconian to an unexpected extent. If any legitimate expense contained a degree of excess, then if the Secretary’s interpretation were right the consequence would be immediate exposure to potential cancellation of all venue licences and the class 4 operators’ licence, as well as a criminal conviction and exposure to a fine of $10,000. These sanctions make perfect sense if the targeted conduct is seen as illegitimate distributions of community funds to unauthorised recipients. They make no sense if the only error is a miscalculation of whether a legitimate expense was also reasonable in its quantum. It follows that this specific challenge would not have succeeded.
(d) A breach of the requirement to maximise net returns and minimise costs
[136] This “requirement” that First Sovereign is said to have breached is said to be found in s 52(1)(d) of the Act. The proposition is flawed for the same reasons as the s 106(1) proposition. Again it is a point made in The Trillian Trust and Pub Charity.
[137] Section 52 sets out the criteria to which the Secretary must have regard when considering whether to issue or renew a licence. He must consider whether the applicant:
... will maximise the net proceeds ... and minimise the operating costs.
[138] This is a licensing criterion, and the only obligation created by s 52 is on the Secretary. A licence holder cannot be in breach of s 52. That is not to say the overall scheme of the Act does not have the effect of requiring licence holders to minimise costs, but that is very different from saying s 52 creates a specific obligation that a licence holder may breach.
(e) Breach of reg 10 of the Gambling (Class 4 Net Proceeds) Regulations 2004
[139] Regulation 10 is the obligation to return 37.12 per cent of gross proceeds to the community. The Gambling Commission has interpreted this provision as requiring the 37.12 percent distribution to come from the particular year’s turnover. The impact of this is that a licence holder cannot use its reserves to meet the obligation.10 It must be paid from funds generated in that year.
[140] The alleged breach by First Sovereign of this rule arose this way. When the buyout cost of $2.4 million was incurred, it was intended to amortise the expenditure over a number of years. This depreciation approach was consistent with the Secretary’s instructions that a depreciation model was to be used. It is common ground that had this occurred as was intended, there would have been no issue of non-compliance with reg 10.
[141] However, subsequent to the buyout expenditure, First Sovereign decided to wind up. It received permission from the Department to do accounts for a final
14 month period. The auditors required that, since they were the final accounts of the Trust, the whole of the cost of $2.4 million buyout be included. That meant that within the 14 month period, a breach of reg 10 occurred. The total expenses incurred in that 14 month period, now including all of the $2.4 million, meant First Sovereign did not generate in the same 14 month period surplus proceeds equating to
37.12 percent of gross turnover.
[142] I do not consider the Secretary’s reliance on this breach is sustainable. First, it is the total costs that have caused a breach by the Trustees. It is not correct to say this particular expenditure caused it. Had the other expenses been lower there would equally have been no issue. Regulation 10 is an inapt vehicle for the use of s 112, especially when the target of the orders is the recipient of the one expense.
[143] Second, although the accounts were prepared for a 14 month period, I am not convinced that is a permissible basis to allege a breach of reg 10. Regulation 10
speaks of a financial year which had always been 12 months. If a breach is to be
10 Societies are presently allowed to keep seven per cent of turnover as working capital, so long as the 37.12 per cent obligation is met.
alleged, I consider the Secretary’s calculation had to be in relation to the 12 month period immediately following the end of the preceding 12 month period.
[144] This is not merely a technical point. If that had been done, there would be a two month period left over to which a specific rule (s 116 of the Act) applies, rather than the reg 10 obligation. Or alternatively, out of fairness, the returns of First Sovereign Trust (two months) and First Sovereign Trust Ltd (its first 10 months) could have been considered together, since the same gaming machines were involved.
[145] Third, and flowing from these points, in the exercise of discretion I would not have ordered a return of the money for this reason. It has not been shown to have caused any actual loss of funds to the community.
H Other matters
[146] There were other issues raised during the proceedings which I do not consider it necessary to address. Two I mention only to record that they were not overlooked. First, the respondents argued that the entire application was an abuse of process. This was based on what, on a preliminary view, seemed to me to be an unduly restrictive view of the circumstances in which s 112 could be resorted to.
[147] Second, the respondents also argued that the only subject of an order could be the direct recipient, AMS. Again I do not resolve that but note that s 112 is broadly worded. If a proper tracing of the funds could be achieved, it is not immediately obvious why s 112 should be interpreted so as to prevent orders following that money. Whether such extended orders would be appropriate in a given case is a different matter.
I Conclusion
[148] All bases advanced by the applicant fail. The payment was reasonable and necessary and is not, therefore, the expenditure of net proceeds. Section 112 does not, therefore, apply.
[149] The respondents are entitled to costs. Memoranda may be filed if agreement cannot be reached.
Simon France J
Solicitors:
Meredith Connell, Crown Solicitors, Auckland
F M R Cooke QC, Wellington
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