SCALES TRADING LIMITED v GEO H SCALES LIMITED & ANOR [1999] NZCA 207 (28 September 1999)

IN THE COURT OF APPEAL OF NEW ZEALAND

ca61/99

	between	SCALES TRADING LIMITED
		First Appellant

	AND	GEO H SCALES LIMITED
		Second Appellant

	and	FAR EASTERN SHIPPING COMPANY PUBLIC LIMITED
		Respondent

Hearing:	31 May 1999
Coram:	Thomas J Keith J Tipping J
Appearances:	M R Camp QC and G M Brodie for the Appellants A J Forbes QC and S F Lennon for the Respondent
Judgment:	28 September 1999

judgment of THE COURT DELIVERED BY KEITH J

[1] The plaintiffs (referred to collectively as Scales) appeal against the judgment of Young J, his second in this case, fixing at $US2,483,362.80 the amount payable by the defendant, Far Eastern Shipping Company Public Limited (FESCO), as the guarantor of debts owed to the plaintiffs by an associated company, Far Eastern Manufacturing and Commerce Corporation (ACFES).The plaintiffs claim that a further amount of $US997,944.58 is also covered by the guarantee.In its first judgment in this proceeding, this Court agreed with the conclusion reached by Young J in his first judgment that the guarantee signed on 17 April 1995 related only (1) to payments due under past contracts as specifically quantified at $US1,854,511.09 in a schedule to the guarantee and (2) payments which would become due under the 1995 apple contracts, but excluding any element of the "RFK margin" (explained in para [4] below).

[2] The sum was awarded by the High Court in response to the ruling of this Court (CA 85/98, 18 December 1998) that the High Court determine the precise sum payable under the guarantee.In this Court FESCO does not dispute its liability to pay the $2,483,362.80, that being the amount payable in respect of the 1995 season apple debts.(Those apples were sent in two shipments, 9511 and 9512, in August and September 1995.)The only quantum issue in dispute before us is about a single issue : whether Young J was correct in holding that FESCO has no obligation in respect of any part of the preguarantee debt.

[3] Scales also challenge the Judge's refusal to award them interest and to make an order for costs in their favour.

[4] Young J helpfully describes the "RFK margin" in the following way in the judgment under appeal:

Starting in mid to late 1994, STL, at the request of ACFES, added a margin to the prices of some, but not all, of the product which it sold.This margin later became known as the "RFK margin".The margin was referred to in this way because the operation of the scheme was associated with a Cypriot company, RFK Holding Ltd.The letters "RFK" also appear in the names of other Cypriot companies, RFK Trading Ltd and RFK Shipping Ltd.They also form part of the name of an Australian company, RFK Australia Pty Ltd.Although some inferences might be able to be drawn as to the parties to the RFK margin arrangements from the identities of the shareholders and directors of these companies, it is not possible to be confident on this score.Nor indeed is it possible to identify with confidence the reasons which underlay the establishment of the RFK margin arrangements.What can be said with confidence, however, is that the operation of the RFK margin arrangement involved a fraud on the Russian exchange control system;that is by facilitating the remission from Russia of hard currency ostensibly in relations to goods imported by ACFES but in reality for other purposes.This fraud was at the instance of ACFES (or at least its senior management).It is inescapable that Scales was a knowing participant in the fraud.

The High Court Judgment

[5] Given his approach to establishing quantum, Young J did not have to resolve whether payments totalling $189,858.28 were "elements of the RFK margin" as FESCO contended.Because of "the likelihood of further appeals", he did however make a ruling on that matter and concluded that the payments were part of that margin.The first component was a payment of $US116,530.80 made by Scales Trading Ltd (STL) to RFK Holdings Ltd on 12 June 1995 and the second comprised a series of payments by STL on behalf of and at the direction of ACFES totalling $US73,327.48.The relationship of the first payment to the RFK margin arrangements was demonstrated, in the Judge's mind, by the mechanism by which STL had sufficient funds to make the payment and by the identity of the payee.He also had no doubt that STL made the second series of payments only because they could be absorbed by the difference between what ACFES was paying (by reason of the RFK margin) and its liabilities on a true basis to STL.

[6] The Judge then turned to the question, which was also the major question in this Court, whether Scales through its actions, including those of its counsel at trial, had appropriated or allocated an apparent overpayment of $993,482 and if so in what manner.That apparent ACFES overpayment was a balance derived from the invoices rendered before the shipments 9511 and 9512 of August and September 1995 containing the 1995 apples.That figure is taken from a schedule prepared by Scales' company accountant, Mr S B Kennelly, for the purposes of the initial hearing in the High Court.If payments had not been earlier allocated by either the debtor or creditor they can be allocated even as late as in the course of trial, eg Seymour v Pickett [1905] 1 KB 715. Young J ruled that Scales had appropriated the payments made by ACFES in such a way that all the liabilities prior to those arising out of shipments 9511 and 9512 were discharged.That is to say, all previous shipments (including those which would have been covered by the guarantee) must be treated as having been paid in full.He summarised his reasons in this way:

1. The figure $US993,482 has no meaning other than as a balance derived from the invoices rendered in respect of the shipments prior to 9511 and 9512.The appropriation of that sum strongly implies that the overpayments had otherwise been appropriated to earlier invoices.

2. The remarks made by Mr Camp [counsel for Scales] in opening are likewise consistent only with the view that all prior shipments must be treated as having been paid in full.

[7] Young J rejected Scales' request for an award of interest on the basis that this Court had decided that no interest was payable and that it was not for him to review the correctness of that decision.

[8] In refusing to make an order for costs in respect of the two hearings before him, Young J considered, first, the fact that Scales succeeded in this Court on a ground not argued before him and, second, the deliberate dishonesty - "fraud" - relating to the RFK margin, together with a fraud concerning withholding tax committed by Geo H Scales Ltd.While he would not have refused costs for the first reason, he did for the second which was "far more significant".

Quantum

[9] Scales' first ground of appeal on quantum is that they have at all times been free to allocate the surplus from the overpaid contracts to non-guaranteed debts with the result that the guaranteed debts have been left unpaid and recoverable from FESCO as guarantor.By suing both the debtor and the guarantor for the total debt of $3,481,307.38 Scales say that they have by necessary implication allocated the surpluses to the non-guaranteed invoices. They invoke the principle in The Mecca [1897] AC 286.The allocation, they say, is to be in terms of the Court's interpretation of the guarantee, notwithstanding that they originally contended that the guarantee applied comprehensively.They must have been taken to have made an allocation which left them free to sue the guarantor for the full amount covered by the guarantee.

[10] FESCO's reply to this ground is essentially that given by Young J. Scales' position throughout the initial trial and on appeal was that the guarantee liability was not limited in the way that both Courts later ruled. That "undifferentiated claim" could not "sensibly be treated as being an appropriation by Scales" of the ACFES surplus to non-guaranteed debt.

[11] We, similarly, cannot see how the bringing of the claims on the guarantee against FESCO on a basis which exactly matched their debt action against ACFES can involve any allocation at all.On Scales' approach, there could be no non-guaranteed debt to which the over payments could be allocated.We cannot see how the claims made in the statement of claim can later be adjusted in the light of the Court's interpretation of the guarantee, to take a radically different form.It follows that any allocation of overpayments to non-guaranteed debt is to be found, if at all, in other actions of Scales.The particular actions which Young J identified at the end of the relevant part of his judgment are set out in para [6] above.They led him to the conclusion that all the pre-guarantee debt had been satisfied from ACFES overpayments.

[12] In response to the first reason given by Young J, Mr Camp's submission was that the fact that the $US993,482 figure was a net figure was overlooked at the initial hearing (and not simply "rather overlooked" as the Judge said in his second judgment).The total overpayments shown on a schedule prepared by Mr Kennelly came to $US3,680,582.61.At the resumed hearing in the High Court, Mr Camp accordingly sought to appropriate all over payments to non-guaranteed liabilities.The answer to that submission is that if the overpayments have already been allocated, an attempted allocation at a later stage is too late;the creditor is irrevocably bound by the earlier allocation, see eg Laws of New Zealand, Contract para 308.The use of the $US993,482 figure, even if a net figure, throughout the earlier hearing assumes that other overpayments had been appropriated to earlier invoices including the preguarantee debts which fell within the scope of the guarantee. The emphasis on that figure and the implied consequential appropriation is supported by Mr Kennelly's schedules which in evidence he accepted, in terms of a reworking of his figures by a witness called by FESCO, showed an "accumulated credit just before 9511 sales [of] $US993,480[sic]".

[13] One of Mr Kennelly's schedules, prepared on a chronological basis, and his evidence make a related point which has a separate significance.It appears to indicate - certainly Mr Camp provided no other explanation - that on 26 April 1995 (just eight days after the signing of the guarantee) ACFES was in credit with Scales if the RFK margin were deducted.Mr Kennelly said this in his briefs of evidence:

On the 17^th April 1995 we received a payment of $2,900,000 reducing the balance owing to $1,854,481.09.This is the amount in respect of which the guarantee has been given.

...

The correct state of the account between ACFES and STL as at 18 April 1995 is therefore as follows:

Gross Net of RFK

Total due per Exhibit B 1,902,433.17 828,806.22

Less amounts not yet due:

Shipment 9411 - Invoice STL328 due 20/5/95 32,047.80 32,047.80

Shipment 9502 - Invoice STL365 due 17/5/95 769,774,80 697,817.75

1,100,610,57 98,940.67

[14] His schedule then shows the recording on 24 and 26 April of several credit items, totalling over $1m, leaving ACFES with a credit of $253,143.53 on 26 April 1995.On that date there is of course still a deficit if the RFK element of more than $1m is not deducted.

[15] This Court in December 1998 ruled that FESCO was entitled to cancel the guarantee or treat the guarantee as vitiated because that RFK margin included in the guarantee had not been disclosed to it.That reasoning also provided the basis for this Court's direction in the exercise of its discretion that the guarantee liability was to exclude any elements of the RFK margin.On the basis of Scales' own documentation, once that margin is excluded, the pre-guarantee debt was removed by the various credits made on 24 and 26 April 1995.At that point FESCO, as guarantor, no longer had any obligations in respect of the pre-guarantee debt.That debt no longer existed.It could not be unilaterally revived by some action of Scales.

[16] This reason would provide an independent basis for dismissing the appeal.

[17] We return to the second ground for Young J's conclusion that all the shipments earlier than 9511 and 9512 must be treated as having been paid in full - that is the remarks made by Mr Camp in opening (see para [6] above).As the differing treatment of this matter in the submissions in this Court show, it can be related either to the pleadings together with the overall way in which the Scales case was presented or to Mr Kennelly's evidence including the schedules he prepared.As is to be expected, the opening is consistent with those features of Scales' case.Given our conclusions in respect of those matters, we need not take this particular issue further.

[18] It follows that we agree with the conclusion which Young J reached on quantum.

The RFK margin

[19] Like Young J we need not rule on the RFK margin, but given the pending appeal to the Privy Council, we briefly indicate our reasons for agreeing with him.Scales argue that Young J characterised the two figures, payments made on 12 June 1995 and later, as RFK payments "more because the expression `RFK' features somewhere in the accounting treatment of those items".We agree with FESCO that the Judge's reasoning goes further than that.We cannot improve on Ms Lennon's written submission:

The whole purpose of the RFK margin was to allow ACFES to export money which it would not otherwise be able to do because of the Russian foreign exchange control regulations.The only reason it was possible for ACFES to request Scales to make the payment of $116,530.80 to RFK Cyprus was because ACFES anticipated being able to illegally export at least that much by way of surplus funds on top of what it was legally allowed to export.Scales also understood this.

It is against the background of Scales knowing that ACFES anticipated the illegal export of cash that it was willing to make the payment.Thus, both in form and in substance, this was a true RFK margin payment.The difference between it and earlier RFK margin payments (for instance, the one made on 18 July 1994 of $350,000) (see Kennelly Schedule F C229) was that Scales was asked to make the payment without having received funds in first.It never did receive funds in reference to this payment and accordingly the debt of $116,530.80 is included in Kennelly's Schedule A.It clearly inflates the amount claimed against FESCO and is clearly an RFK margin claim.

A similar analysis can be applied to the second sum recorded as an RFK payment in Kennelly Schedule A totalling $73,327.48.Although it was disbursed in small increments over a considerable timeframe by Scales on behalf of ACFES, the reason that Scales was willing to discharge it was exactly the same.

Interest

[20] Scales submit that the previous judgment of this Court rejecting an award of interest does not stand in the way of this ground of appeal, and that an award should be made:

Scales is out of pocket.It paid interest on the money retained by it at the contractual rate of 6% up to 25 February 1997.The judgment in favour of FESCO itself included interest on the retained moneys from 25 February 1997 to 6 June 1997 at 11% in the total sum of $196,024.84.Thereafter the judgment carried interest at 11%.The Court of Appeal was not told of this [at the first appeal] and certainly the Case on Appeal did not cover these matters. Accordingly, it was suggested to the Court below that the December judgment of the Court of Appeal should be interpreted as meaning only that Scales should not have interest in excess of, or beyond the extent that it has not been out of pocket.It was submitted that Scales should have interest on its judgment at the same rate that interest has been awarded against it with respect to the moneys that it is holding.

[21] Whatever the strength of the arguments on the merits, the earlier judgment of this Court clearly prevents the issue being revisited.The Court, when indicating that it would be for the High Court to determine the precise sum payable and remitting the case for the "determination of quantum and the entry of judgment", stated clearly that "it is not appropriate STL/GHSL have interest at 15% per annum under the guarantee or otherwise on money so recoverable". Earlier in the judgment it had similarly said that "this interest recovery should not be allowed".The "this" is a reference to the 15% interest rate provided for in the guarantee.

Costs

[22] The award of costs is of course a matter in the discretion of the trial Judge.As indicated (para [8] above) his reason for refusing to make an order in favour of Scales which was prima facie entitled to an order was "deliberate dishonesty [relating to the RFK margin] in which STL and its relevant personnel were knowing and necessary participants.It was a fraud."

[23] Scales' submissions in the High Court stressed that they had faced significant legal costs, overcoming at summary judgment and trial every imaginable defence.In their submissions in this Court they list nine arguments that failed and record that very shortly before trial FESCO advised that quantum was not in dispute - and this after they had needlessly incurred very substantial expenditure on that matter.Their costs, in addition to the summary judgment proceeding and the appeal to this Court, are about $300,000. They claim costs equal to that figure or near to it, given the complexity and the extensive scope of the litigation due to the inordinate, but largely unsuccessful, defences.They challenge the Judge's reasons for not making an order.

[24] FESCO supports those reasons and stresses that the decision is discretionary."This Court in its earlier judgment in this matter exercised that discretion against the award of costs on the appeal, because of Scales' conduct.The Judge did likewise.There is no ground upon which to disturb the exercise of the discretion."

[25] If the Court gets to quantum, FESCO argues that Scales should have no more than 55% of $162,000 - that being what Scales said were FESCO's reasonable costs and 55% being the proportion of FESCO's costs awarded to it in the other litigation where there were significant findings against FESCO.

[26] We agree with the Judge that the dishonesty relating to the RFK factor is a relevant factor telling against the award of costs.But there is no indication of his giving any weight to the extent to which Scales was successful in the High Court and the costs it incurred because of the defences unsuccessfully pleaded by FESCO.

[27] In all the circumstances we consider that Scales were entitled to an order for costs, but at a reduced level.We fix the figure at $60,000 all in.

Result

[28] Scales' appeals on quantum and interest are dismissed.Its appeal on costs succeeds and an award for $60,000 all in is made in its favour in respect of the High Court proceedings.

[29] Since FESCO has largely succeeded in this Court, it is entitled to costs of $5,000 and disbursements including the reasonable travel and accommodation costs of two counsel, to be fixed by the Registrar if agreement cannot be reached.

Solicitors:

Anthony Harper, Christchurch for the Appellants

Duncan Cotterill, Christchurch for the Respondent