Trends Publishing International Ltd v Callaghan Innovation
[2019] NZHC 907
•30 April 2019
IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY
I TE KŌTI MATUA O AOTEAROA TĀMAKI MAKAURAU ROHE
CIV-2015-404-1274
[2019] NZHC 907
BETWEEN TRENDS PUBLISHING INTERNATIONAL LIMITED
Counterclaim PlaintiffAND
CALLAGHAN INNOVATION
Counterclaim Defendant
Hearing: 31 July 2018 – 3 August 2018, 6-10 August 2018, 13-17 August
2018, 23-24 August 2018
Appearances:
M A Corlett QC and H Lawson for the Counterclaim Plaintiff D H McLellan QC, S M Collier and T J Burgess for the Counterclaim Defendant
Judgment:
30 April 2019
JUDGMENT OF POWELL J
This judgment was delivered by me on 30 April 2019 at 3.30 pm pursuant to R 11.5 of the High Court Rules
Registrar/Deputy Registrar Date:
Solicitors/Counsel:
Anderson Creagh Lai Limited, Auckland Wilson Harle, Auckland
M A Corlett QC Auckland
D H McLellan QC Auckland
TRENDS PUBLISHING INTERNATIONAL LIMITED v CALLAGHAN INNOVATION [2019] NZHC 907 [30
April 2019]
Introduction 1
Background to the Funding Agreement 15
Trends’ application for a Growth Grant 32The Funding Agreement 39
Issue One - Did the Funding Agreement include an implied term and statutory obligations in addition to its written terms? 53
Discussion – Issue One 57
Conclusion – Issue One 60
Trends’ claims under the Funding Agreement 62
Issue Two - Did Callaghan breach the Funding Agreement by withholding payment of Trends’ Q3 claim? 73
Discussion – Issue Two 74
Conclusion – Issue Two 78
Deloitte is brought in to investigate 80
Issue Three – Did Deloitte undertake an audit or review for the purposes of the Funding Agreement? 89
Discussion – Issue Three 91
Conclusion – Issue Three 97Issue Four - Did Callaghan comply with the procedural requirements of the Funding Agreement as the Deloitte investigation began? 98
Discussion – Issue Four 100
Conclusion – Issue Four 104
The initial Deloitte investigation 105
Issue Five - Was Callaghan entitled to suspend the Funding Agreement on 17 December 2014? 131
Discussion – Issue Five 133
Conclusion – Issue Five 135Issue Six - Did Callaghan breach the Funding Agreement by issuing the Suspension Press Release? 136
Discussion – Issue Six 143
Conclusion – Issue Six 153
The Trends response to the suspension decision 154
Issue Seven - Did Callaghan comply with the procedural requirements of the Funding Agreement in providing an opportunity for Trends to respond? 180
Discussion – Issue Seven 183
Conclusion – Issue Seven 184
The termination of the Funding Agreement 185
Issue Eight - Did Callaghan have grounds to terminate the Funding Agreement on 21 April 2015? 192
Discussion – Issue Eight 195
Conclusion – Issue Eight 228
Issue Nine - Did Callaghan breach the Funding Agreement by issuing the termination press release? 231
Discussion - Issue Nine 232
Conclusion – Issue Nine 233
Decision 234
Introduction
[1] The counterclaim plaintiff, Trends Publishing International Limited (“Trends”), seeks damages in the sum of $61 million from Callaghan Innovation (“Callaghan”). The damages are for alleged breaches of contract and statutory duties arising out of a Funding Agreement for a Growth Grant entered into by Trends and Callaghan on 2 April 2014 (“the Funding Agreement”).
[2] The Funding Agreement, which was backdated to 1 January 2014, entitled Trends to seek reimbursement from Callaghan for 20 per cent of “eligible research and development expenditure” (“Eligible R&D Expenditure”) over a three-year period, with an option to extend the Funding Agreement for a further two years.
[3] Claims for reimbursement made by Trends for the periods 1 January 2014 – 31 March 2014 (“the Q1 claim”) and 1 April 2014 – 30 June 2014 (“the Q2 claim”) were reimbursed by Callaghan in accordance with the terms of the Funding Agreement. When Trends sought reimbursement for the period 1 July 2014 – 30 September 2014 (“the Q3 claim”) Callaghan sought further information from Trends with regard to the amounts claimed. Following the provision of further information from Trends, Callaghan appointed Deloitte New Zealand Ltd (“Deloitte”) to undertake an investigation of Trends’ compliance with the Funding Agreement.
[4] Deloitte commenced the investigation on 6 November 2014. Following initial investigations which included meeting with Trends and reporting back to Callaghan, Deloitte prepared a draft report in December 2014 (“the Deloitte Draft Report”) which advised Callaghan “Trends may have intentionally set out to mislead Callaghan to obtain funds to keep its business afloat financially whilst transforming from a paper based to an online business operation”. The Deloitte Draft Report went on to identify a number of concerns including:
(a)the labour costs claimed as a result of the number of Trends’ employees working on research and development activity;
(b)other expenses claimed in relation to research and development activity; and
(c)the quality of Trends’ accounting records and financial management practices.
[5] Following receipt of the Deloitte Draft Report, Callaghan referred the concerns raised to the Serious Fraud Office which later, in December 2014, confirmed it had begun a formal investigation of Trends.
[6] Callaghan met with Trends on 17 December 2014 and by letter of the same date (“the Suspension Letter”) gave notice of immediate suspension of the Funding Agreement. The Suspension Letter noted that Callaghan had received a copy of the Deloitte Draft Report and considered that Trends had:
(a)in breach of cl 10.4(a) used some or all of the research and development funding provided under the Funding Agreement other than as set out in the agreement; and
(b)in breach of cl 10.4(c) claimed funding that it was not entitled to claim, including by claiming for expenditure that was not Eligible R&D Expenditure in breach of cl 10.4(c).
[7] In addition, Callaghan advised that it considered Trends had breached its obligation to keep appropriate accounting and other records of its Eligible R&D Expenditure and its use of the funding pursuant to cl 5.1 of the Funding Agreement. Callaghan also advised that Trends had failed to provide all information that Deloitte required in the course of the investigation.
[8] At the same time as the Suspension Letter notified Trends it was suspending the Funding Agreement, Callaghan provided Trends with a copy of the executive summary of the Deloitte Draft Report. Callaghan also gave Trends a copy of a draft press release (“the Suspension Press Release”) which it proceeded to issue later the same day. In addition to announcing the suspension of the Funding Agreement, the
press release also specifically stated “[t]he matter has also been referred to the Serious Fraud Office”.
[9] Trends provided an initial response to Callaghan and Deloitte in January 2015, followed by further responses in February and March 2015 after Callaghan had provided a redacted version of the Deloitte Draft Report to Trends. Despite these responses, Deloitte raised further concerns which were discussed at a meeting between Deloitte and Trends on 11 March 2015. Following this meeting, Deloitte proceeded to finalise its report to Callaghan in April 2015 (“the Deloitte Final Report”).
[10] Following receipt of the Deloitte Final Report, Callaghan met again with Trends on 21 April 2015. At the meeting, a letter of the same date was given to Trends advising that the Funding Agreement had been terminated for breach of contract (“the Termination Letter”). The grounds for termination cited by Callaghan, based on the conclusions contained in the Deloitte Final Report, were that Trends was in:
(a)Breach of cl 5.1 of the Funding Agreement “on the basis that Trends has not kept appropriate accounting and other records of its Eligible R&D Expenditure and in its use of the Funding, nor managed its records in accordance with recognised research in accounting best practice standards, so as to enable Callaghan Innovation to carry out an audit to determine whether Trends is complying or has complied with the [Funding] Agreement”.
(b)Breach of cl 10.4(b) of Funding Agreement “on the basis that Trends has provided Callaghan Innovation with misleading or inaccurate information”; and
(c)Breach of cl 10.4 (c) of the Funding Agreement “on the basis that Trends has claimed for funding that it is not entitled to claim under the Funding Agreement, including claiming for expenditure that is not Eligible R&D Expenditure as described in clauses 3.1 and 3.2, by reference to NZ IAS 38 and NZ FRS 13”.
[11] At the same meeting Trends was provided a copy of a draft press release (“the Termination Press Release”) which Callaghan subsequently issued, publicly confirming the termination of the Funding Agreement.
[12] Trends contends the investigation carried out by Deloitte failed to comply with the Funding Agreement and disputes that Callaghan was entitled to either suspend or terminate the Funding Agreement. In addition, Trends argues that Callaghan further breached the contract by issuing both the suspension and termination press releases alleging that the release of that information was in breach of the terms of the Funding Agreement.
[13] Trends maintains that at all times it complied with its obligations under the Funding Agreement and contends that, as a result of Callaghan’s breaches, it lost a chance to commercialise the development work it was undertaking and, in particular following the issue of the suspension press release, lost the opportunity to attract third party investors. Trends argues that this had a catastrophic effect on Trends’ business, both in terms of its existing business model and its ability to utilise the digital platform it had been developing.
[14] The present trial was originally intended to cover all aspects of Trends’ claim against Callaghan. However, in the course of the hearing it was necessary to split Trends’ claims between liability and quantum. As a result, this judgment deals with the question of liability only and, in particular, the following issues:
Issue One - Did the Funding Agreement include an implied term and/or specific statutory obligations in addition to its written terms?
Issue Two - Did Callaghan breach the Funding Agreement by withholding payment of Trends’ Q3 claim?
Issue Three – Was the Deloitte investigation an audit or a review in terms of the Funding Agreement?
Issue Four - Did Callaghan comply with the procedural requirements of the Funding Agreement as the Deloitte investigation began?
Issue Five - Was Callaghan entitled to suspend the Funding Agreement on 17 December 2014?
Issue Six - Did Callaghan breach the Funding Agreement by issuing the Suspension Press Release?
Issue Seven - Did Callaghan comply with the procedural requirements of the Funding Agreement in providing an opportunity for Trends to respond?
Issue Eight - Did Callaghan have grounds to terminate the Funding Agreement on 21 April 2015?
Issue Nine - Did Callaghan breach the Funding Agreement by issuing the Termination Press Release?
Background to the Funding Agreement
[15] Trends is a marketing and publishing company first founded in 1982. Under the direction of its sole director, David Johnson, Trends was able to expand globally throughout the late 1990s and, by 2007, was conducting its business in the United States of America, Australia, Singapore, Malaysia, Hong Kong, Indonesia, Dubai, China, India, Canada and New Zealand.
[16] Trends developed a particular niche in the home interest market with publications that combined home design ideas with extensive supplier advertising. There is no dispute that Trends developed a reputation for innovation and, in particular, with the way it was able to template its publications in a manner that significantly reduced its production cost relative to its competitors. Such innovations were recognised when Mr Johnson won the Ernst & Young New Zealand Entrepreneur of the Year Award in 1998.
[17] Although Trends established its first website relatively early, in 1998, like other print media companies Trends experienced declining advertising revenue and the global financial crises of 2008/2009 also had an effect on Trends’ business. As a result, Trends sought to further develop its digital business in order to “create revenue in new ways”. Much of the responsibility for this new direction fell to David Johnson’s son, Andrew Johnson. By 2012, Andrew Johnson was looking to “create an online environment that was the blending of a mini search engine combined with the socialisation of the content in order to connect people”.
[18] To assist in achieving its goals, Trends sought support from the Ministry of Science and Innovation (“MSI”). It applied for a Project Grant from MSI and in the application set out what it was trying to do in the following terms:
Our Audience, Our Brand
Trends has spent nearly 30 years creating an internationally recognised media brand in the home and commercial building industry. It presents its audience with quality products, beautiful content, and factually useful information.
Since 1999 Trends has published all of its content online for users to browse. This has created both a media website and the in-house services to produce the various content - ie photography, video, animation, etc.
The Trends series of publications connects people in an engaged and enduring way in many countries around the world. As a result Trends already has a massive real world community following that far outweighs the size of the current online audience. We now want to enable these people to meet and interact more effectively on our online platform.
Our Opportunity
We can create an online environment where our audience are able to connect and exchange information and services in a brand new way. By studying and understanding the successful formulas of other online content communities such as Google, YouTube, iStock, Facebook, Trends can enable its online community to be better communicators, using our world class content to express themselves. They will also be able to plan design projects, and to share their own ideas or content in a forum associated with the Trends brand. The platform will explore the use of search results, social search and engagement techniques to provide market trends and metric data direct from our clients’ perspective target audience. ‘Suggestion engines’ helping to run the content display will use inspiration as a sales and marketing technique by displaying information proactively to the user. This means listening and watching user behaviour to predict the kind of styles, products or services they may be looking for but don't know are out there. Additional subject matters such as travel, health, food and property will be introduced to this highly sought after demographic.
We can also provide our platform as ‘software as a service' to our clients and partners to support their own communications.
Our Point of Difference
Trends has strong and direct relationships with our clients and the products and services that they represent. Only about 2% of our contact with clients is through advertising agencies, as the majority of our national and international relationships are with the CEO’s of businesses.
Trends provides many additional business communication solutions outside of advertising requirements. Other media companies are becoming stronger in multimedia and multi platform, but they are still struggling to understand how to [maximise] the digital world successfully as they continue to look at a ‘controlled access to content’ model for revenue.
At the same time the majority of web users are still leaning towards ‘free content for all’. So there is a limited number who will pay for access which ultimately leads to a reduction in platform and channel market share.
Our Solution
Trends will offer registered users free access to all our content, and will create revenue incomes by monetising the resulting actions taken by our audience when they are presented with beautiful images, words and videos full of great ideas, products and services.
Our web platform clients will invest in the successful outcomes by paying for the leads generated when users engages with them and request to learn more, enquire, visit or purchase. This is combined with the unique ability to offer selected product and services clients free print advertising and web space to give exposure and generate enquiries.
Trends also provides all the content creation services clients need to have their stories well-told and discussed or used by members of the online community. This means that the sales and marketing ‘advertising’ content of the web platform is seen as integrated and informative content, and not just banner advertising. The platform is designed to be accessed on devices such as desktop computers, laptops, touch devices, tablets, smart phones and smart TV’s.
Our Facts
The new structure will replace the current website which contains 10,000 stories and over 40,000 images, hundreds of videos and other media promotions and competitions. It is currently number 3 in NZ for $100k + incomes and is the number 1 home interest website in NZ. It’s one of 5 main magazines in India with a magazine and website combined offering for the market.
[19] The application was successful and in July 2012 Trends received a Project Grant of $347,506 (“the Project Grant”).
[20] Technical support for the project was provided by Jason Liddiard and his company AnotherInnovation. After Andrew Johnson provided a brief to Mr Liddiard, Mr Liddiard confirmed his instructions in a briefing document entitled Project RedBull dated 2 February 2013. Mr Liddiard saw the Trends project in the following terms:
2.1Background
With the current world-wide “trend” of an ever increasing digitally demanding audience, every traditional publishing company around world is facing the challenge of monetizing their content online and becoming “digital”.
With lower profit margins than print and easy access for new competitors to enter the market, speed of execution is essential. [Trends] is embarking on a journey to enhance their current digital offering through the rapid application development of a new digital web-based content delivery platform.
This platform will enable the business to become more “nimble” and “digitally savvy” and quickly respond to market demands for solving consumer’s problems. i.e.: “Where can I learn about different kitchen bench tops?” This will allow [Trends] to solve these problems by creating profitable information products and services.
Such a platform will become a key enabler for the next level of two-way engagement that [Trends] can monetize in the effort to create new revenue streams for the business to rebuild the declining profit margins in from printed media advertorials and subscriptions.
A careful thought-out strategy is required for [Trends] deeper transition into the online space to ensure profitable digital products are created that allow the continued funding for the expected on-going development of the web platform solution.
These products will use as much leverage as possible in terms of existing digital assets such as articles, videos, images and advertorials. Leveraging also the non-tangible assets such as client relationships, brand awareness, good will, existing traffic sources and joint venture opportunities.
2.2Description
Project RedBull forms part of the wider digital strategic plan to implement modular components of the [Trends] web platform in a sustainable approach that ensures that each project within the Energise Program sees deliverables that can realise measurable revenue benefits immediately.
RedBull seeks approval to do this through the development and implementation of a global online vertical marketing platform. These are sophisticated localised search engines on a web platform that creates multiple directory websites focussed on highly focussed super niches. Kitchen Design, Bathroom Design, Interior Design, Landscape Design and Commercial Design could all be super niche vertical markets in which the platform can create to enable micro-targeted advertising revenue streams.
[21] Specifically, Mr Liddiard identified the objectives and deliverables of Project RedBull in the following terms:
2.4Objectives
The Project shall:
Key Objective # 1
·Complete development of the platform within 12 weeks beginning on Monday 28th January 2013 till Friday 19th April 2013.
Key Objective #2
·Facilitate change management to implement the new business processes required to support the new revenue streams.
Key Objective # 3
·Launch multiple new verticals populated by the platforms global database under [TRENDS] ’s choice of niche branded domain names.
2.5Deliverables
RedBull will deliver the following
Vertical Marketing Platforms host clients that pay to promote their businesses products and services on. Some of the key features for the platform are listed below.
• Cloud-based Software-as-a-Service marketing platform
• Highly available and scalable platform infrastructure
• Content Delivery Network for efficient serving of media files
• Multiple domain sites populated from data-driven dynamic
• Fully automated and self-service registration
• Shopping cart for advertising packages and additional offers (up-sells)
• E-commerce enabled for credit card payments (one-off and recurring)
• Purchase Order e-commerce for invoicing large purchases (agency model)
• A Pay-per-Lead “Multi-Quote” system where suppliers pay for leads
• Modern HTML5 & CSS3 responsive layout design
• Web font face for headings, tags, credits and links
• Modern look and feel, clean, clear and simple web publishing
• Social two-way engagement through comments and sharing
• Search engine and visitor data analytics
[22] In an undated report at the conclusion of the Project Grant in July 2013, Andrew Johnson confirmed what had been achieved up to that point:
OVERVIEW:
The Trends Media Group is proud to announce the launch of our new digital platform project, stage one - The Trends Ideas Space: Search Engine.
Our new digital platform aims to change the ways we communicate about our homes.
The platform is a technology foundation that allows us to deploy diverse applications or functionality across the Internet. At its heart are the algorithms that drive heart of social technologies. And it allows us to provide users with information that they seek, or to inspire them with ideas they didn't even know about.
Our first application is a search engine of images, articles and videos that allows consumers, specifiers, and product and service suppliers to communicate with each other. By building company profiles and connecting with other people through content, the search engine provides a new meeting space for the industry.
We believe that our new platform really is the future of ‘where ideas take shape’.
TECHNOLOGY OUTCOMES:
The main technology outcomes are centered around searching, saving and sharing content and the functionality to allow consumers to connect with each other and the industry. The project has also seen the development of sophisticated systems for content management loading and collating, together with user registration and social sign up. The technology is also designed to observe and learn by watching user behavior and activity, in order to create suggestion and prediction engines that will inspire the need for a product or service.
Some of the key technology areas include: Image Process and Gallery Display
Video engine and Distribution Content ID Software Social Media Integration
Front end Usability
Free Access Library Online shop CRM
User Personal Profile Builder Subscription Digital Website Subscription
Automated Personalization engine Professional Directory
Drag N Drop uploading for Client Profiles Multiple Photo Title & Description Editing Photo titles and description
Email Login
Tooltips for icons on the Photo and Article view Selection of Cover Image for Collected objects Attaching Partners to Master profile
Click - through to Profile from Photo and Article view New Look Dashboard for Client Profiles
New Contact Us: 2-step direct enquiry process
New category menu slider for the side bar navigation Performance enhancements with client browser caching Stability enhancements for PC IE 9+ and Mac Safari Video and eBook uploading
Search ranking ration controls for profiles and content Search engine optimization of search results
New direct enquiry email template
COMMERCIAL SUCCESS
The web platform has already experienced a great commercial success. We have secured 35 major brands in New Zealand to be part of our launch phase, with an initial investment of $20k each. They bring with them a network of 900 business partners/outlets to fill the platform with places and people that users can contact/visit to find products or services. This has been achieved in less than 6 weeks from a standing start. We have secured an extended spend from these clients within the additional business units of the media group (such as advertising and digital services). We have also extended the platform to Australia, with the same launch process having started 2 weeks ago.
The Trends Platform has been designed to work across many global territories, as well as creating the opportunity for additional industries to use the software with or without the Trends brand. The current Trends territories are being rolled out on an individual basis, with a number of distinct regional business factors shaping the pathway to market for the platform. In some cases this will be done with existing Trends Media Partners. Additional industries outside residential and commercial building have been identified and prepped to understand the benefits of the platform. After completing the initial launch phase in New Zealand, Australia, and North America (July 2013 - Sept 2013) some of these additional industries will partner to create new Trends Topics.
R & D - IMPACT AND ONGOlNG IMPLICATIONS
The platform has started a shift within the company. It is creating a ‘vortex’ effect as we redeploy staff and focus resources to look towards the platform as a central point for the company.
This has seen significant change in roles and responsibilities, plus the addition of new staff with skill sets and activities that are brand new to the company. The connections with key industry players have also effected the perception of Trends within both the home building industry and the media communications world. The platform will continue to have significant R&D requirements, as it becomes a living and breathing entity that requires constant feeding and development. It has gone from a project on the side and in secret to become the center and very public focus for the Trends brand. This is illustrated by the fact we have taken the message onto mainstream TV to showcase the project and build an awareness of the new platform.
MINISTRY OF SCIENCE AND INNOVATION - THE EXPERIENCE
Working with the Ministry of Science and Innovation has been an interesting and successful process in terms of helping our company move forward with this project.
The relationship management teams are very good in assisting us to process the required information into the system. And in our case, there have been various helpful connections made with other organizations as well.
Being able to refer to the Ministry’s association by way of founding with the Ideas and Concepts behind the new Web Platform has provided added credibility to the project.
We are looking forward to a continued relationship moving forward.
[23] Following the successful completion of the Project Grant, Trends investigated obtaining a further tranche of similar funding. In the meantime, however, MSI’s role in the allocation of Crown research and development funding had been replaced by Callaghan.
[24] Callaghan was established in February 2013, pursuant to the Callaghan Innovation Act 2012. The Act established Callaghan as a Crown agency in the terms of the Crown Entities Act 2004, with its main object “to support science and technology based innovation and its commercialisation by businesses in order to improve their growth and competitiveness”.1
[25]Section 15 of the Callaghan Innovation Act went on to relevantly provide:
Operating principles
(1)In meeting its main objective, and performing its functions, Callaghan Innovation must—
(a)aim to ensure that any activities it undertakes are for the benefit of New Zealand; and
…
(2)In addition, in performing the function specified in section 14(1)(f) (which relates to allocating and administering RS&T funding), Callaghan Innovation must—
(a)act fairly and transparently; and
(b)implement systems and procedures to enable it to give effect to the principle set out in paragraph (a); and
(c)make information about those systems and procedures available on its Internet site; and
1 Callaghan Innovation Act 2012, s 13.
(d)include in its annual report under section 150 of the Crown Entities Act 2004 a report on its implementation of those systems and procedures.
…
[26] One of Callaghan’s primary functions is to allocate and administer research, science and technology funding.2 It does this through administering a number of different grants, which in 2013 and 2014 included project grants of the type previously obtained by Trends, and a Growth Grant.
[27] The grants administered by Callaghan were established by a ministerial direction from the Minister of Science and Innovation.3 In allocating and administering the funding Callaghan was, and is required, to perform any additional function that the Minister directs pursuant to s 112 of the Crown Entities Act 2004.4 The relevant direction to Callaghan, setting out the criteria for assessing proposals for funding, was signed off on 23 October 2013, by the then Minister of Science and Innovation the Hon Stephen Joyce (“the Minister’s Direction”).
[28] The Minister’s Direction set out the types of funding available and the criteria for assessing proposals. The Minister directed Callaghan to “develop and implement processes for vetting and auditing businesses to ensure that claimed research and development is legitimate” and contained “clawback provisions” whereupon:
Businesses may be expected to return some or all grant funding, during or following a grant agreement, to Callaghan Innovation, if:
o The business breaches any grant agreement, misappropriates funding, provides incorrect information to Callaghan Innovation, or claims ineligible expenditure …
[29] In addition, the Minister directed that any business that was found to be wilfully misreporting its research and development expenditure “at any point will be immediately removed from the initiative and will be ineligible to reapply for three years”.
2 Section 14(1)(f).
3 Crown Entities Act 2004, s 103.
4 Callaghan Innovation Act 2012, s 14(1)(i).
[30] The Minister’s Direction went on to define “eligible research and development expenditure for research and development growth grants” in the following terms:
Eligible R&D expenditure is defined as those meeting the New Zealand Equivalent to International Account Standard 38 (NZ IAS 38) definition of research and development and expensed under that standard.
The NZ IAS 38 definitions of R&D are:
o Research is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.
o Development is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use.
Clarifying Principle
If necessary, when seeking to distinguish R&D from non R&D, the further advice provided by the New Zealand Financial Reporting Standard 13 (NZ FRS 13) should be applied:
o R&D is distinguished from non-R&D by the presence or absence of an appreciable element of innovation. If the activity departs from routine and breaks new ground it is normally R&D; if it follows an established pattern it is normally not R&D.
[31] The Minister’s Direction went on to detail a wide range of general and specific exclusions for research and development otherwise within the definitions set out above.
Trends’ application for a Growth Grant
[32] On 5 December 2013, Trends applied to Callaghan for a Growth Grant. The application provided considerable detail about Trends’ current business and leadership and what was intended to be undertaken, building off what had been completed in the course of the Project Grant. Specifically, Trends confirmed the following had already been completed:
Engagement platform successfully designed and architectured to provide the foundation for future application module development. Platform populated with 13,944 articles, 78,866 images and 817 business profiles, all indexed and searchable within the platforms search engine. This achieves stage ones Engagement Platform Build 1 & 2 milestones. Some key features include the
commercialisation of business profiles on the platform enabling revenue. Reference customers include, Lockwood Homes, G.J Gardner Homes, Laminex, Plumbing World, Landmark Homes, and Resene who are using their business profiles and product content on the platform to engage with consumers within a Social Media environement [sic].
Platform Social Media modules implemented include User and Business Profiles, User and Business Collections, Business Profile Owner Creation with Drag'N'Drop Content Uploading, User Public and Private Messaging, Business Profiles Reviews, User Comments, User Followers and Following, Photo, Video and Article Content Editing. An analytic engine is tracking consumer visits and behaviour on business profiles to inform customers on consumer behaviour.
Research & Development successes include HTML5 Application cache development using an MVC JavaScript framework running client-side within users browsers. Complete RestJSON API web services providing storage and search capability acheiveing [sic] both horizontal and vertical scalability with the Amazon Web Services cloud infrastructure. Success has been achieved in implementing the design into a production environment under the trendsideas.com domain.
[33] Trends identified “8 main areas that the research teams are going to focus on that offer the largest and most significant growth for the business over the next 3 years”. Those areas were identified as:
1.Lead Generation
2.Metric Data
3.Project Purchase and Sales commissions.
4.Platform and Social Software as a service.
5.Self Publishing
6.Mobile
7.Suggestion and recommendation engine
8.Project Management and time lining.
[34] Elaborating on each of those areas, Trends made it clear that much of the research planned by Trends was not technical research or development but rather research aimed at optimising the commercial use of the existing platform, including identifying what technology was available; developing subscription and pricing models; researching social media platforms; and how other e-commerce providers had successfully used social media and e-commence. This was confirmed by the research
and development programme set out in the Growth Grant application which identified the following technical objectives and work plans:
Technical objective 1 Objective name:
Relations, Leads & Subscriptions
Work plan:
Research options for selection of an suitable Customer Relationship Management Solution to use for the Platform Lead Management module. Design to possible Use Case Diagrams and process flows for Lead Management. Research and develop a recommended business product around a subscription model for lead generation.
Technical objective 1 > Milestone 1.1
Milestone:
Relationship Management Use Cases, Business Requirements & Wireframes
Milestone work plan:
Research and document all the requirements for a suitable CRM solution.
Technical objective 1 > Milestone 1.2
Milestone:
Lead Management Use Cases, Business Requirements & Wireframes
Milestone work plan:
Researching market solutions to gain insights on how current technology providers are managing and commercialising leads.
Technical objective 1 > Milestone 1.3
Milestone:
Subscription Management Use Cases, Business Requirements & Wireframes
Milestone work plan:
Research how to implement a successful subscription and pricing model for leads.
Technical objective 2 Objective name:
Message, Notifications & Tagging
Work plan:
Research all current social platform trends and future thinking into the possible solutions designs for messaging, notifications and tagging. Documenting what is currently available on the global marketplace for organisations to enable their audience to communicate effectively. This phase of the [the] project focuses heavily on researching communication trends on social platforms and creating future-based thinking solutions to give the platform a clear and specific competitive advantage in the immediate future.
Technical objective 2 > Milestone 2.1
Milestone:
Message Centre Use Cases, Business Requirements and Wireframes
Milestone work plan:
Research all the worlds most popular social media platforms and create a future design, building on the existing standards, discovering enhancement for a messaging centre with competitive advantages for commercialisation.
Technical objective 2 > Milestone 2.2
Milestone:
Notification Cases, Business Requirements and Wireframes
Milestone work plan:
Research into social media success stories such as WeChat, Weibo, Sina, Qq, FaceBook, Pinterest, Google Plus and Twitter to identify common notification features that social media platform audiences have come to expect and high engagement rates.
Technical objective 2 > Milestone 2.3
Milestone:
Tagging Use Cases, Business Requirements and Wireframes
Milestone work plan:
Research the phenomenon that is tagging content with links to social pages on the worlds top 10 social media platforms. Look to identify and document opportunities for new use cases.
Technical objective 3 Objective name:
E-Commerce, Products & Services
Work plan:
Research social commerce and document how successful commerce providers that have commercial benefits at the core of their business model have implemented a social media strategy. Survey successfully on-line retailers to discover how social media is changing the way their retailers market to their target consumers.
Technical objective 3 > Milestone 3.1
Milestone:
E-Commerce Use Cases, Business Requirements and Wireframes
Milestone work plan:
E-Commerce Use Cases for popular social commerce platforms such as ASOS and Shopify that have successfully used social commerce strategies to grow conversions while increasing brand reputation. Research the most popular features and those that are driving increased conversions. Document these features and the functionality they provide to the user.
Technical objective 3 > Milestone 3.2
Milestone:
Product Use Cases, Business Requirements and Wireframes
Milestone work plan:
Research popular social platforms that have implemented product search, product details and online e-commerce transactions. Examples would be amazon.com, taoboa.com and ebay.com. Discover and document the social media integration implemented on these properties to facilitate social engagement around the products they list. Research their back-office features to learn how they enable a great user experience around product inventory management and stock/price control.
Technical objective 3 > Milestone 3.3
Milestone:
Services Use Cases, Business Requirements and Wireframes
Milestone work plan:
Research popular trends for start-up service websites that have captured large audiences overnight with their service listing features such as fiverr.com, airtasker.com and odesk.com. Document the driving factors for high audience numbers and repeat traffic.
Technical objective 4 Objective name:
Big Data Storage, Analytics & Subscriptions
Work plan:
Research and develop plans for solution design for enabling big data activities and events created by users on the platform. Survey and question our prospective buyers and subscribers for data subs to discover what metrics are important for their business decisions. Prioritise a metrics list based on future customer needs.
Technical objective 4 > Milestone 4.1
Milestone:
Big Data Use Cases, Business Requirements and Wireframes
Milestone work plan:
Research how giant social media platforms such as Facebook construct their platform around being able to mine and resell user data. Discover and document what technology stacks are being deployed and infrastructure designs are popular.
Technical objective 4 > Milestone 4.2
Milestone:
Data Analytics Use Cases, Business Requirements and Wireframes
Milestone work plan:
Research current solutions designs and architecture used to manage data rivers and streams. Document possible solution designs for managing data analytics on demand. Survey our prospective customers to discover how they currently use social media analytics for business planning.
Technical objective 4 > Milestone 4.3
Milestone:
Data Subscription Use Cases, Business Requirements and Wireframes
Milestone work plan:
Research current competitors business models for data subscription services to social analytics to discover current trends within the market on which to develop. Document those trends and services currently offered also covering off any future business models that could be created from making social data available to the global market place.
Technical objective 5 Objective name:
Multi-Lingual + Internationalisation
Work plan:
Research the current trends for providing true internationalisation across the platform.
Technical objective 5 > Milestone 5.1
Milestone:
Multi-Lingual Use Cases, Business Requirements and Wireframes
Milestone work plan:
Research the User interface designs and user experience when using global web platforms that have the multi-lingual functionality to store and distribute data across many common languages.
Technical objective 5 > Milestone 5.2
Milestone:
Internationalisation Use Cases, Business Requirements and Wireframes
Milestone work plan:
Perform research and prototyping to understand how current web standards and best practise offers a true global experience to international users. Document a high-level solution for the technology implementations required to adhere to global standards for true internationalisation.
Technical objective 6 Objective name:
Native Mobile Platform Application
Work plan:
Research the current leading native mobile operating systems and their respective users bases to determine a short-list of targets for the platforms mobile offering. Likely leaders are iOS, Apple's leading mobile operating system and the lightweight version of the Linux OS, Android. Confirm the recommended targeted operating systems and create use case diagrams for the minimum required feature set that the platforms users could benefit from. Survey current mobile application users of similar application to discover what features are most popular and gain insight into any potential market gaps from which to seize opportunities. Perform raw data analysis on the survey results and drive out the first set of business requirements and wire frames for the first released version of the platforms mobile application.
Technical objective 6 > Milestone 6.1
Milestone:
Native Mobile Platform Use Cases, Business Requirements and Wireframes
Milestone work plan:
Research the current options with mobile development trends for providing users with a great mobile experience.
Technical objective 7 Objective name:
Platform Solution Design & Architectural Development
Work plan:
* Component Architecture
* APl/lntegration Architecture
* Technology Stack Architecture
* AAA Architecture
* Project Mandate
* Project Investment Proposal
* Project Plan.
Technical objective 7 > Milestone 7.1
Milestone:
Low-Level Platform Solution Design Document
Milestone work plan:
Using all the previous research documents and knowledge acquired within the R&D programme, complete the detailed version of the Platform Solution Design documentation for all the leading edge components and features for the development team to execute.
Technical objective 8 Objective name:
Custom Self-Publishing
Work plan:
Research and understand how current on-line custom printing solutions are functioning from both a end-users and publishers perspective. Document all leading and popular features and create a high-level solution outline on which to base the business requirements. Digest this high-level data and provide deep business analysis to produce a set of wire frames from a detailed business requirements document.
Technical objective 9 Objective name:
Recommendation Engine Design
Work plan:
Research and test drive the world's recommendation engine software services to deepen our understanding of the components and algorithms them utilise to enhance the consumers experience when they themselves are researching products and services to purchase. Pick the best technologies from the selection and use this data to drive out a high-level design for a prototype for a recommendation engine.
Technical objective 10 Objective name:
Real-Time Video + Chat Collaboration
Work plan:
Research browsers capability, consumers network connection speeds and technology advances that would enable consumers to reliably and cost- effectively perform real-time visual collaboration. Document a high-level design to enable the minimum expected baseline for a platforms functionality.
Technical objective 11 Objective name:
Contribution + Subscription OpenAPI Service
Work plan:
Research successful organisations that are hosting a series of web services that are profitably and growing to understand what makes a companies data source worth subscribing too. Also research why contributors are compelled to distribute their contributions through popular on-line providers.
[35] It appears only Technical Objective 7 suggested active “Platform Solution Design & Architectural Development”, a component due to start in July 2015 and be completed in December 2015. However, even this appeared limited to a “Low Level Platform Solution Design Document” rather than actual research and development.
[36] In assessing Trends’ application, Callaghan took a very narrow view of what it was required to assess. The majority of those considering the application concluded that Callaghan was bound to approve Trends’ application if Trends could establish that
it met the business eligibility criteria as a New Zealand business and, as outlined in the Minister’s Direction:
•have had at least $300,000 in eligible R&D expenditure … sourced from non-government funds in each of the two most recent years;
•have had eligible R&D expenditure of at least 1.5 per cent of revenues in each of the two most recent years;
•meet financial and management due diligence requirements sufficient to justify three years of funding; and
•provide Callaghan Innovation with a R&D plan including an estimate of R&D expenditures over the next three years. Businesses must compile the R&D plan to a level of detail and clarity sufficient to assess progress in the businesses' R&D programme over time.
[37] As a result, Callaghan did not consider the nature of the research and development proposed to be undertaken by Trends but instead limited its analysis to the factors set out in [36] above. Callaghan therefore obtained auditor’s reports with regard to Trends’ financial position, as well as a statement from Moore Stephens Markhams confirming Trends’ historical research and development expenditure. While this confirmed Trends had undertaken research and development over a two year period,5 it did not identify whether that historical research and development expenditure was Eligible R&D Expenditure for the purposes of the Growth Grant. Indeed, Moore Stephens Markhams confirmed:
The Research and Development expenditure disclosed above is related to expenditure on research, particularly in areas of gaining understanding of marketing opportunities, insight into current and future users experiences on large scale global platform, established a pathway for the current media to digital transition. Research expenditure it is recognised as expense when it is incurred.
(emphasis added)
[38] Thus while Callaghan identified some issues around Trends’ financial position, it did not look at what Trends said it was intending to develop, the Project itself. It therefore made no real attempt to understand and/or provide feedback to Trends on what parts of Trends’ stated research and development programme would constitute
5 The Moore Stephens Markhams certificate confirmed only that the salaries of four Trends’ staff had been research and development expenditure in terms of the Project Grant. No other expenditure appears to have been claimed.
Eligible R&D Expenditure for the purposes of the Growth Grant. The lack of focus on what Trends was actually intending to do clearly concerned a number of the Callaghan staff tasked with assessing the application, but ultimately Callaghan concluded it could not decline the application.6 A funding agreement in what appears to have been standard terms was then prepared by Callaghan and sent to Trends for execution. There does not appear to have been any negotiations in the terms of the Funding Agreement before it was signed on 2 April 2014, although it was agreed it would retrospectively have effect from 1 January 2014, thereby enabling Trends to seek payment of Eligible R&D Expenditure it had incurred in the first quarter of 2014. Trends’ success, along with 14 other companies in securing Growth Grant funding was subsequently the subject of a press release by Callaghan.
The Funding Agreement
[39]The Funding Agreement began by confirming:
You have applied to Callaghan Innovation for a funding grant to cover a portion of the costs of your research and development programme ("Programme") for a minimum of 3 years. The Programme is referred to in the schedule to this Agreement ("Schedule") and described in detail in your application and your research and development plan ("Application").
Your Application has been approved, and Callaghan Innovation will provide the funding specified in the Schedule to enable you to carry out the Programme ("Funding").
[40] The next section of the Funding Agreement made it clear that Callaghan’s support of Trends, and its research and development programme set out in the Growth Grant application, was limited to “an amount that is 20% of your eligible R&D expenditure” up to a maximum of $5 million in each contract year”.7 Eligible R&D Expenditure as defined in the Funding Agreement followed closely the formulation contained in the Minister’s Direction; namely research or development as those terms were defined in NZ IAS 38 and NZ FRS 138 and adopted almost without exception the specific exclusions contained in the Minister’s Directions. Those confirmed that
6 A subsequent investigation undertaken by Deloitte on behalf of Callaghan ultimately concluded that Callaghan's approach was too narrow.
7 The Funding Agreement, cl 1.1 and Schedule.
8 Clause 3.1. See [29] above.
Eligible R&D Expenditure, for the purposes of the Funding Agreement, did not include expenditure:9
(a)that is capitalised as an intangible asset for the purposes of NZ IAS 38;
…
(g)on routine, ongoing efforts to refine, enrich, or otherwise improve on the quality of an existing product or process, or to make cosmetic or stylistic changes to it;
…
(j)on adapting an existing product or process to a particular customer's need or site;
(k)on supporting, de-bugging, or making minor improvements to existing computer software;
(1)on market research or surveys, market testing, market development or sales promotion, management studies, efficiency surveys, or the routine collection of information;
…
(n) on interest expenses or lease payments of any kind, and any overheads that are not closely linked to research and development activities, except for finance, personnel, training, travel, administration, and library activities associated with the Programme, and reasonable costs associated with transportation, storage, cleaning, repairs, maintenance and security activities in relation to the Programme;
…
(p) on research in the social sciences, arts, or humanities; …
[41] In return Trends confirmed relevantly it would “… comply with the requirements of [the Funding] Agreement in respect of the Programme and [its] claims for Funding”.10 Callaghan made it clear in cl 6 of the Funding Agreement that it relied upon Trends to report regularly and accurately on any matter that may affect the funding, noting that Callaghan needed:11
… to monitor its provision of Funding for the Programme so that it can identify and report the benefits to New Zealand arising from the Programme, and take appropriate action if [Trends does] not comply with this Agreement.
9 Clause 3.2.
10 Clause 1.2(a).
11 Clause 6.1.
[42] Nowhere in the Funding Agreement was there any kind of approval for the Technical Objectives and Milestones set out in Trends’ Growth Grant application. Nor was there any acknowledgement that any of the research and/or development identified in the Growth Grant application would, if undertaken, amount to Eligible R&D Expenditure for the purposes of the Funding Agreement.
[43] Instead, the Schedule to the Funding Agreement provided that Eligible R&D Expenditure was to be invoiced by Trends on a quarterly basis, together with a report setting out details of Trends’ performance in the programme and the Eligible R&D Expenditure incurred. Furthermore:12
Each invoice must specify the actual amount of Eligible R&D Expenditure spent by you in the quarter, and the amount of Funding you are claiming. The Funding claimed by you must be 20% of the amount of Eligible R&D Expenditure spent by you in the quarter.
(emphasis added)
[44]At that point Trends was advised:13
If your invoice is satisfactory to Callaghan Innovation in all respects, Callaghan Innovation will pay you the Funding, except that Callaghan Innovation:
a.will withhold 10% of each amount claimed by you; and
b.is not required to pay you more than the maximum Funding Amount specified in this Agreement in a Contract Year (including the 10% withheld under paragraph a).
(emphasis added)
[45] The Schedule went on to confirm that at the end of each year Trends could issue an invoice for the amounts retained by Callaghan at which point:14
If your invoice is satisfactory to Callaghan Innovation in all respects, Callaghan Innovation will pay you the Funding, including any Funding previously withheld from you, so that the total amount of Funding paid to you for the Contract Year is 20% of your Eligible R&D Expenditure, up to the maximum Funding Amount specified in this Agreement.
12 Schedule to the Funding Agreement Quarterly Claims at 3.
13 At 4.
14 Schedule to the Funding Agreement End of year claims at 8.
[46] Although the recitals of the Funding Agreement confirmed that the funding was for a minimum of three years, and that after two years Trends could apply for a two-year extension to the funding which would be granted if the relevant criteria were met, there was in fact no guarantee that the Funding Agreement would in fact continue for the whole of that period. In particular, cl 10.1 of the Funding Agreement provided:
This Agreement may be terminated by either of us at any time by giving
2 months notice to the other party.
[47] Two mechanisms were provided for Callaghan to monitor Trends’ performance under the Funding Agreement, an audit process under cl 5 and a review mechanism in cl 7. Clause 5 of the Funding Agreement enabled an audit to occur at any point until two years after the Funding Agreement had ended.15 Clause 5.1 required Trends to:
… keep appropriate accounting and other records of your Eligible R&D Expenditure and your use of the Funding (including payslips, invoices, and receipts) and manage your records in accordance with recognised research and accounting best practice standards, so as to enable Callaghan Innovation to carry out an audit to determine whether you are complying or have complied with this Agreement. …
[48] Clauses 5.3 – 5.6 specified how the audit was to be conducted and will be considered in detail under the heading of Issue Four.16 Clause 5.7 set out what options were available in the event a breach of the Funding Agreement was identified.17 Clause 5.10 then provided:
Callaghan Innovation may suspend payment of the Funding from the date of the notice of Audit if Callaghan Innovation considers that you may have breached this Agreement. In such case:
(a)Callaghan Innovation will give notice that specifies that payment of the Funding has been suspended; and
(b)if the final Audit report shows that you have not breached this Agreement, Callaghan Innovation will recommence payment of the Funding, and provide an amount equivalent to the amount of Funding that would have accrued if the Funding had not been suspended. If there has been a material delay to the Programme as a result of the suspension of Funding under this clause, the matter will be deemed to be a Change Event.
15 The Funding Agreement, cl 5.2.
16 See [98] of this judgment.
17 See Issue Eight from [192] of this judgment.
[49] Likewise, at the conclusion of the audit cl 5.7 provided Callaghan with a range of remedies including taking no further action,18 terminating the agreement,19 and recovering all or part of the funding previously provided).20
[50] The review process under cl 7 was not as detailed as the audit process. Clause 7.1 required Trends to participate in a review “as reasonably required by Callaghan”, and provided that if the review was not satisfactory to Callaghan “the matter may be considered and managed in accordance with the Change Event provisions of [the Funding] Agreement.21 The “Change Event” procedures were in turn set out in cl 9, with a Change Event being defined as including:
(a)an event that prevents, or is likely to prevent, either of us from being able to meet our obligations under this Agreement;
(b)an event, including an actual or likely change in your ownership or sale of any of your assets, which materially affects, or is likely to materially affect the anticipated benefits for New Zealand of the Programme, including planned research and development activity in New Zealand, and the timing of those benefits; or
(c)Callaghan Innovation determines, at any time, that your actual Eligible R&D Expenditure is or is likely to be significantly different from the amount of Eligible R&D Expenditure that you anticipated investing in the Programme that is specified in your Application.
[51] Importantly, while the procedures to be followed in the event of a Change Event being identified included a range of responses, cl 9.6 provided:
Discussion - Issue Nine
[232] For the same reasons I have concluded that Callaghan was entitled to issue the Suspension Press Release,101 it follows it was also entitled to issue the Termination Press Release. As noted, the Funding Agreement specifically provided that Callaghan could release information about when funding was approved, and the corollary of this was for Callaghan to advise when funding had been suspended or terminated. In this case, the requirement that Callaghan acted fairly and transparently, and to comply with the Minister’s Direction, imposed an obligation to advise publicly that the Funding Agreement had been terminated following the investigation carried out by Deloitte.
101 See Issue Six from [136] of this judgment.
Conclusion – Issue Nine
[233] Upon termination of the Funding Agreement, Callaghan was entitled to issue the Termination Press Release on 21 April 2015.
Decision
[234] Trends’ claims fail in their entirety and Callaghan is entitled to judgment accordingly.
[235] Callaghan is entitled to costs. In the event that the costs payable cannot be agreed I will determine the issue following the filing of memoranda.
Powell J
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