The appeal against the refusal to strike out the cause of action alleging breach of fiduciary duty is allowed and that cause of action is struck out.

The order of the High Court for interim stay of proceedings will continue until further order of that Court.

E There is no order as to costs.
____________________________________________________________________

REASONS OF THE COURT

(Given by Baragwanath J)

Table of Contents
Para No

Introduction [1]
Issue (1) What principles determine whether Mr Houghton is entitled
to sue the respondents in a representative capacity? [10]
Rule 4.24 and class actions [10]
(a) What is the nature of the claim and the claimant group? [18]
(b) What are the likely issues? [20]
Issue (2) What principles govern consent to the use of a litigation
funder? [21]
Issue (3) What approach should be taken to the application
for security for costs? [35]
Issue (4) What other mechanisms can be devised to achieve the
objectives of r 1.2? [38]
Issue (5) What is the apparent strength of the claim? [42]
Issue (6) How should the principles be applied? [43]
(a) The nature of the claim and the claimant group [43]
(b) The likely issues [48]
The Fair Trading Act: pre-float period [49]
The Fair Trading Act: post-float period [52]
Securities Act 1978 [55]
Negligence [58]
Breach of fiduciary duty [60]
The need for close court control of representative proceedings [63]
(c) The specific funding arrangements [64]
(d) The strength of the claim [67]
The argument for a maintenance/champerty bar [67]
The issue of reliance [83]
Issue (7) Should the claim for breach of fiduciary duty be struck out? [95]
Decision [109]

Introduction

[1] Feltex Carpets Ltd (Feltex) was wholly owned by Credit Suisse First Boston Asian Merchant Partners LP (Credit Suisse MP) which decided to sell its shares by way of a public offering. In conjunction with the sale it undertook a public float of $50m of new shares.
[2] The signatories of the prospectus and investment statement required by the Securities Act 1978 occupied four distinct roles: seven were directors of Feltex acting in that capacity; Credit Suisse First Boston Private Equity (now Credit Suisse Private Equity Inc) (Credit Suisse PE) was promoter; First New Zealand Capital and Forsyth Barr Ltd were organising participants and joint lead managers of the share issue; and Credit Suisse MP was vendor of the issued shares. They are the defendants and appellants in this case.
[3] The float on 4 June 2004, at a price of $1.70 per share, is said to have raised more than $250m. The major part of the proceeds, some $180m, was received by Credit Suisse PE as vendor of the shares. By March 2006 the share value had declined to about 60c per share. The company was placed in liquidation on 13 December 2006 and the shareholders’ funds were entirely lost, while creditors were owed some $30-40m.
[4] Mr AJ Gavigan, who had not held shares in Feltex, incorporated a litigation funder Joint Action Funding Ltd (Joint Funding). At his instigation Eric Meserve Houghton, who had bought Feltex shares on the Initial Public Offer and Darryl Alexander Jones, who later bought shares on the market prior to the collapse of their price, issued proceedings supported by Joint Funding against the directors, Credit Suisse PE, First New Zealand Capital and Forsyth Barr. Messrs Houghton and Jones are the plaintiffs in this case and the first and second respondents to this appeal, in which Mr Jones did not participate. We declined to read a memorandum by the former solicitor for the respondents, said by him to be written without Mr Jones’ authority and to the use of which Mr Eichelbaum objected.
[5] The statement of claim alleged against all defendants breach of the Fair Trading Act 1986, negligence and breach of fiduciary duty. Breach of the Securities Act was also alleged against the directors and Credit Suisse PE. Messrs Houghton and Jones obtained from Associate Judge Christiansen an order appointing them as representatives of others who had bought on the Initial Public Offer and on the market respectively.
[6] The High Court, in a judgment delivered by French J, struck out the claims by Mr Jones in negligence and for breach of fiduciary duty. The order appointing Mr Jones as representative of others who had bought shares on the market, rather than on the initial offering, was discharged. The defendants’ appeal is against other aspects of that judgment:

(a) confirming that Mr Houghton is entitled to sue them in a representative capacity;

(b) dismissing their application for stay of the proceedings on the ground that the litigation funding and management agreement is an abuse of process; and

(c) declining to strike out the cause of action pleaded by Mr Houghton for breach of fiduciary duty.

[7] In a subsequent judgment French J stayed the proceeding pending the appeal to this Court.
[8] The appellants firmly deny any misconduct on their part. A Securities Commission investigation, while finding subsequent deficiencies in Feltex’s performance of its disclosure obligation, found that the prospectus was not misleading in any material respect. Counsel for the first respondent, who was instructed very shortly before the hearing of the appeal, was unable to provide specific evidence of the major allegations contained in his clients’ current and proposed amended pleadings. As will appear, we offer no opinion as to the merits of the respective parties’ cases.
[9] The principal issues are:

(a) What principles determine whether Mr Houghton is entitled to sue the respondents in a representative capacity?

(i) The nature of the claim and the claimant group.

(ii) The likely issues.

(iii) Absent detailed class action rules, the need for close court control on representative proceedings.

(b) What principles govern consent to the use of a litigation funder?

(c) What approach should be taken to the application for security for costs?

(d) What other mechanisms can be devised to achieve the object of r 1.2 of the High Court Rules (“just, speedy and inexpensive determination of the proceeding”)?

(e) What is the apparent strength of the claim?

(f) How should the principles be applied? This requires consideration of defences relating to maintenance and champerty and the issue of reliance.

(g) Should the breach of fiduciary duty claim be struck out?

Issue (1) What principles determine whether Mr Houghton is entitled to sue the respondents in a representative capacity?

Rule 4.24 and class actions

[10] Rule 4.24 of the High Court Rules (formerly r 78) states:

Persons having same interest

One or more persons may sue or be sued on behalf of, or for the benefit of, all persons with the same interest in the subject matter of a proceeding—

(a) with the consent of the other persons who have the same interest; or

(b) as directed by the court on an application made by a party or intending party to the proceeding.

The rule permits the making of representation orders. They are a form of what elsewhere are called class action orders. Rule 4.24 substantially reproduces a 19^th century English rule which is retained also in other common law states including Canada and Australia. There are different lines of authority, some such as Taff Vale Railway Co v Amalgamated Society of Railway Servants [1901] UKHL 1; [1901] AC 426 (HL) adopting a generous approach to representation applications and others that do not.

[11] Rule 4.24 speaks of “persons with the same interest”. That phrase, or its equivalent in other jurisdictions, has been read more and less widely. The Chief Justice of Canada in Western Canadian Shopping Centres v Dutton [2001] 2 SCR 534 recounted at [24]-[26] the flexible and generous approach to class actions which preceded and immediately followed the Supreme Court of Judicature Act 1873 and the adoption of the r 4.24 equivalent. This was followed by a subsequent more restrictive approach. Finally, the effects of mass production and consumption revived the problem of many suitors with the same grievance, and the resulted in the need for recourse to the class action.
[12] Nowadays, as is seen in RJ Flowers Ltd v Burns [1986] NZHC 243; [1987] 1 NZLR 260 at 271 (HC) per McGechan J, the Taff Dale approach to an application for a representation order, with its relatively low threshold, is preferred as being consistent with r 1.2 of the High Court Rules:

The objective of these rules is to secure the just, speedy, and inexpensive determination of any proceeding or interlocutory application.

Applied to claims by a group of plaintiffs such an order allows proceedings to be conducted in an efficient manner and avoiding their multiplication by the need (in this case) for at least 800 separate filings. If it is an “opt-in” form, as Mr Galbraith QC conceded, it thereby protects members of the represented group against a limitation bar arising after the date of their election to opt-in to the proceeding. In New Zealand the jurisdiction in the opt-in form has been employed whenever the justice of the case requires. The validity of an “opt-out” order in the absence of legislation was not argued and we offer no comment upon that or whether it can stop time running or create res judicata for those who have opted out.

[13] The overriding ‘just” requirement of r 1.2 requires careful consideration of the position of the defendants. If a class action procedure would leave an element of the defence unaddressed, the application for a representation order may fail. That is why it was for long considered that there could be no class action which included a damages claim. Following criticism by the Australian Law Reform Commission of such constraint, in New Zealand McGechan J in Flowers and Barker J in Taspac Oysters v James Hardie Ltd [1990] 1 NZLR 442 (HC), each with specialist knowledge and experience of the High Court Rules, preferred the more expansive approach of Vinelott J in Prudential Assurance Co Ltd v Newman Industries Ltd [1981] Ch 229 at 254-255 (Ch D). The principles now established are that a representative action can be brought where each member of the class is alleged to have a separate cause of action, provided:

(a) the order may not confer a right of action on the member of the class represented who could not have asserted such a right in separate proceedings, nor may it bar a defence which might have been available to the defendant in such separate proceeding;

(b) there must be an interest shared in common by all members of the group; and

(c) it must be for the benefit of other members of the class that the plaintiff is permitted to sue in a representative capacity.

[14] We endorse the statement by Barker J in Taspac at 446 that representative proceedings for damages are not foreclosed. Provided the foregoing conditions are met it is proper to claim a declaration of liability, thus establishing res judicata on the common issue, and permitting individual claims to establish individual damage to follow. The issues that are the subject of the proposed declaration would be identified either by explicit pleading or by application for determination of a specific issue. The more likely that their determination would be both practicable and resolve most or much of the proceeding, the more likely it is that the court would be minded to grant the declaration sought. As will appear, it became common ground in this case that the representative procedure is likely to be appropriate for determining whether the prospectus complied with the law.
[15] In most jurisdictions, such as England, Australia, South Africa and the United States, complex representation questions are answered by additional detailed modern rules providing for class actions. The New Zealand Rules Committee has recently submitted proposals for legislation and rules in New Zealand which, when a draft is available, are likely to provide a framework that will be useful to the judiciary. But in the meantime the courts must deal with applications in terms of r 4.24 and the inherent powers of the superior courts (held directly by the High Court and derivatively by this Court via r 48(4) of the Court of Appeal (Civil) Rules 2005) which are recognised by s 16 of the Judicature Act 1908. Those powers were described by Turner J in McKnight v Davis: Davis v McKnight [1968] NZLR 1164 at 1170 (CA):

... we think that the Court must always be the master of its own procedure, and must when necessary use its inherent jurisdiction to ensure that justice is done. Due inquiry for the truth is not to be stifled by outmoded procedural restrictions.

The statement applies equally to due delivery of justice. In Dutton at 32 McLachlin CJ observed that a similar Alberta rule did not specify what is meant by the interest that the parties must have in common. At 34 she stated that, absent comprehensive legislation, the courts must fill the void under their inherent power and determine the availability of the class action and the mechanics of class action practice.

[16] The perceived advantages and disadvantages of class actions have been debated in Australia: Cashman Class Action Law and Practice (2007) at [5.1]-[5.2]; in England: Hodges The Multi-Party Action (2000) at [16.22]; in the United States: Hensler & ors Class Action Dilemmas (2000); and elsewhere: Mulherron The Class Action in Common Law Legal Systems: a Comparative Perspective (2006). Identified advantages are:

(a) enabling access to justice which would otherwise be unaffordable;

(b) economy of scale;

(c) efficient resolution of a large number of claims;

(d) deterrence of misconduct that would otherwise persist;

(e) promotion of beneficial change in (here) financial practices;

(f) adding to public sector mechanisms for identifying and responding to unlawful conduct; and

(g) suspending limitation statutes while the litigation proceeds.

Disadvantages can include:

(a) class actions provide a mechanism for advancing claims without legal merit;
(b) exposure to massive damages claims may compel a defendant to settle regardless of merit;
(c) where a litigation funder is involved decision-making effectively shifts from the injured party to others, notably the funder; and
(d) there can be opportunity for unethical practices.
[17] In determining whether to make or sustain a representation order involving a litigation funder the Court must take special care to meet the objective of the High Court Rules, stated in r 1.2 ([12] above). We return to that topic. Putting that aside for the present there are two sub-issues:

(a) What is the nature of the claim and the claimant group?

[18] In Fostif Pty Ltd v Campbells Cash & Carry Pty Ltd [2005] NSWCA 83; (2005) 63 NSWLR 203 (CA), Mason P at 187 adopted the formulation by Brennan J in Carnie v Esanda Finance Corporation Ltd [1995] HCA 9; (1995) 182 CLR 398 at 408:

[The equivalent rule] requires ‘the same interest’ in the proceeding, not necessarily the same cause of action nor an entitlement to have or to share in the same relief.

[19] One must always have in mind the threefold test in r 1.2 of “just, speedy and inexpensive”. As ever, judgments of substantiality and proportionality must dictate the result. “The same interest” must mean that, subject to other considerations, the more the parties have in common, the more the strength of that facet of the application. Greater precision is unattainable.

(b) What are the likely issues?

[20] For the reasons stated at [12] identification of the likely issues is a vital enquiry, which overlaps with the enquiry under (a). It is essential to the decision as to the practicability of a representative order and identification of whether, and, if so, what res judicata arises or limitation is prevented from running. We discuss the issues in that case at [48]ff.

Issue (2) What principles govern consent to the use of a litigation funder?

[21] While the issues of representation order and litigation funding are distinct, Jeffery & Katauskas Pty Limited v SST Consulting Pty Limited [2009] HCA 43; (2009) 260 ALR 34 (HCA) shows that where, as here, the representation order is largely premised upon involvement of a third party litigation funder, the resulting human and practical problems can give rise to deep-seated differences of approach among judges and oscillation of the law’s response. Such problems may need at least careful control of the funder by suitable conditions and, if that is insufficient protection for the defendant, possibly even consideration of whether a representation order can be sustained.
[22] An interlocutory appeal is not the occasion for this Court to detail the legitimate scope of litigation funding. But to decide the appeal requires that we engage with that question in general terms.
[23] As latecomers to the topic of representation applications involving a litigation funder New Zealand courts have the advantage of a considerable literature and jurisprudence elsewhere.
[24] Until quite recently common law courts held the firm position that, in the absence of legislation to the contrary, funding of litigation for profit was an abuse of process, offending against ancient doctrines of maintenance and champerty, and was unlawful per se. Recent accounts of the history appear in Dutton, by Steyn LJ in Giles v Thompson [1993] UKHL 2; [1993] 3 All ER 321 (CA) (on appeal [1993] UKHL 2; [1994] 1 AC 142 (HL)), in the notable judgment of Mason P in Fostif at 224-230, in the judgments of Gummow, Hayne and Crennan JJ on appeal in that case [2006] HCA 41; (2006) 229 ALR 58 at [68]- [82] and in the majority judgment in Jeffery & Katauskas at [25]-[30]. The New Zealand Law Commission reported on the topic in 2001: Subsidising Litigation (NZLC R72 2001). In England, as the High Court in this case noted at [176], many authorities appear actively to support litigation funding as a matter of public policy: see Gulf Azov Shipping Co Limited v Idisi [2004] EWCA Civ 292 at [54]. A more nuanced approach has emerged. The sequence has been, in summary:

(a) Anglo-Saxon sanctions for abuse of process, focusing largely on false accusations and including loss of the accuser’s tongue, followed by the mediaeval prohibition of maintenance (assisting another to sue) and champerty (taking part of the proceeds) to deal with unruly nobles (NZLC R72 at [1]);

(b) Acceptance by the common law that champerty is “a particularly obnoxious form of maintenance”: Trendtex Trading Corporation v Credit Suisse [1980] QB 629, 654 (CA) per Lord Denning MR;

(c) The common law’s acceptance, seen in the statement by the House of Lords in Giles v Thompson at 164 per Lord Mustill, of a test that:

... all the aspects of the transaction should be taken together for the purpose of considering the single question whether... there is wanton and officious intermeddling with the disputes of others where the meddler has no interest whatever, and where the assistance he renders to one or the other party is without justification or excuse;

(d) The common law’s acceptance, as by the Court of Appeal of New South Wales in Fostif at 132 per Mason P, of a test:

... whether the role of the particular funder has corrupted or is likely to corrupt the processes of the court to a degree that attracts the extraordinary jurisdiction to dismiss or stay permanently for abuse of process. The standard of proof is high where (as here) the plaintiff has a genuine and viable cause of action. The court will lean in favour of moulding its remedy so as to eliminate the abuse, resorting to dismissal only as a last resort where this is impossible (see generally Jago v District Court (NSW) [1989] HCA 46; (1989) 168 CLR 23 and Clairs Keeley [v Treacy (2005) 29 WAR 479]).

[25] In Jeffery & Katauskas v SST at [28]-[29] the High Court of Australia has employed the general test of abuse of process. The powerful dissent of Heydon J points to the potential for such abuse and argues that, despite a rule change limiting the power to award costs against a third party, a funder, who for financial gain facilitates bringing the state power of the courts to bear on a defendant, must be liable for costs if the claim fails.
[26] The justice requirement of r 1.2 includes the fundamental principle, on which recent cases tend to turn, that there must be no abuse of process.
[27] The pendulum has swung a good distance from Lord Denning’s utter rejection of maintenance and champerty, which the Law Commission endorsed in 2001. But examination of experience elsewhere, especially in the United States, satisfies us that there is still force in the concerns there expressed. Subjection to litigation can be a heavy burden for any defendant. Lives can be put on hold for the duration of the case which, if complex, may last a long time and be punctuated by appeals. The resulting cost and anxiety can exact a heavy toll.
[28] Nevertheless, the interests of justice can require the court to unshackle itself from the constraints of the former simple rule against champerty and maintenance. Access to justice is a fundamental principle of the rule of law. It can require flexibility to meet the harsh reality of the current cost to the injured party of litigation, which is often more than a would-be plaintiff can sensibly be expected to bear. The result can be a failure of justice: a plaintiff with merits can be excluded from relief against the defendant who has committed a legal wrong.
[29] It follows that a more discriminating test is required. At first sight that formulated by Lord Mustill in Giles v Thompson has appeal. But the emotive phrase “wanton and officious intermeddling” does not engage with the reality that the only funding available may be from a professional funder who has no prior involvement in the case. Should that be rejected out of hand? The English courts have declined to do so. So has the predominant opinion in Australia.
[30] The Australian courts have become well familiar with litigation funders and, despite continued resistance from some judges, have gone a considerable distance to accepting them. In Fostif, Kirby J in the High Court of Australia recounted the fees (there up to one third of the recovery) and conditions in that case (power subject to certain constraints to settle the proceeding; obligation to conduct the litigation and accept responsibility for any adverse costs order). He observed at [120]:

To lawyers raised in the era before such multiple claims, representative actions and litigation funding, such fees and conditions may seem unconventional or horrible. However, when compared with the conditions approved by experienced judges in knowledgeable courts in comparable circumstances, they are not at all unusual. Furthermore, the alternative is that very many persons, with distinctly arguable legal claims, repeatedly vindicated in other like cases, are unable to recover upon those claims in accordance with their legal rights.

[31] Recent Australian decisions have taken into account in favour of a representation order that a responsible professional funder has assessed that the case has sufficient merits to warrant putting money and effort into it. But a more sinister element is conceivable. The United States text Henlser at 79-80 recounts the temptation of plaintiff attorneys in class actions, unfettered as are the New Zealand and Australian professions by stringent legislation prohibiting champerty, lacking any real control by clients and subject to the attractions of large fee awards, not only to fail to prosecute meritorious claims fully but to bring unmeritorious suits, expecting to benefit from them. Hensler records that it may be in the attorney’s interests to pursue a case to maximum advantage, thus serving his or her interests and those of the class members. It goes on to speak of another risk, of defendants’ deciding it is cheaper to settle rather than incur the costs of defending. It is thus conceivable that, unless there is a suitable order for security for costs, an unscrupulous funder might orchestrate a class action on an insubstantial basis with a view to extorting an unjustified settlement from the defence.
[32] Junior counsel for the directors, Mr Cooper, provided a list of criteria suggested as appropriate for the Court to apply when considering whether to grant a representation order involving a particular funder:

Court supervision of litigation funding arrangements

1. The litigation funding agreement should be submitted to the Court for approval at the time when the litigation is commenced.

2. In approving the litigation funding agreement the Court may have regard to the identity of the litigation funder, including its qualifications and its prior conduct in litigation funding matters.

3. There should be a direct client-solicitor relationship between the members of the represented group and the lawyer acting in the litigation.

4. The lawyer acting in the litigation should be responsible for advising the named plaintiffs and members of the represented group about the merits of the case and all material developments in the case. That advice should be prepared and provided without interference by the litigation funder.

5. Any communications inviting people to join the represented group (i.e. “opt in” communications) should be submitted to the Court for approval before being distributed.

6. Any communications between the litigation funder and members of the represented group, or potential members of the represented group, should be balanced and accurate and should not include misleading or deceptive statements. Any material breach of this requirement should lead to disqualification of the litigation funder from continuing to fund the litigation, but should not preclude the plaintiffs or represented group from pursuing the claim (including with a different litigation funder).

7. The litigation funder, including the directors and employees of the litigation funder, should not provide expert evidence in the litigation. Expert witnesses should be instructed directly by the lawyers acting in the litigation and the litigation funder should have no direct involvement in that process.

8. The litigation funder is to certify to the court that it has funding available to meet the costs of the litigation and to pay any order of security for costs made by the Court.

We make no judgment on these proposals, which were not the subject of argument and should first be considered by the High Court as part of its overall evaluation. But they identify questions which warrant recording for future consideration.

[33] So too does the Code of Conduct for the United Kingdom of the Third Party Litigation Funders Association (2009) which sets out standards of good practice for Third Party Litigation Funders operating in the United Kingdom. It requires commitments from funders that:

(a) an individual claimant must have a solicitor, whose obligations are spelt out and who must not cede control of the conduct of the case to the funder;

(b) promotional literature must be clear and not misleading;

(c) funders will not accept claims for funding that they consider frivolous, vexatious or lacking merit;

(d) funders will not engage in anti-competitive conduct; and

(e) funders will comply with specified funding requirements.

[34] The Australian experience is that a professional funder can add value to the administration of justice. Where the funder engages able counsel and performs the research needed to establish that the case has merit the public interest in giving access to the courts for proceedings against a wrong-doer in favour of those who have been wronged can be promoted. But as was shown in Clairs Keeley (a firm) v Treacy [2004] WASCA 277; [2005] WASCA 86, the court will pay close attention to the protection of the funded parties and may stay the litigation until their interests are properly protected.

Issue (3) what approach should be taken to the application for security for costs?

[35] Security for costs is often a vexed question. The principle of access to justice is no doubt why r 5.45 our High Court Rules does not empower orders for security against a natural person who is resident in New Zealand. Many, if not most, of the persons represented in this litigation are natural persons resident in New Zealand, although among them is an Australian trustee company in which a large number of investors are interested; it may be ordered to provide security under r 5.45(a)(ii). It is the risk of impecuniosity and failure to pay an adverse costs order that leads a court to order security where it has jurisdiction to do so. Yet a large security order may deter a plaintiff from pursuing a claim with merit. Further, as earlier noted, Jeffery & Katauskas shows that the presence of a litigation funder can give rise to a range of judicial responses.
[36] The making of orders for both representation and admission of a funder substantially alters the balance between plaintiffs and defendants. We consider that the change is so radical as to justify the High Court, in exercise of its inherent jurisdiction under s 16 of the Judicature Act 1908, to consider ordering security as a term of such orders, even where numerous natural persons are among the plaintiffs, as the price of the privilege to employ such a procedure. That is in order to protect defendant against the effect of a procedure which could otherwise be oppressive. The facts that the funder has no personal right at stake, that takes part of the proceeds of any claim, and that it is is motivated by the financial considerations that gave rise to the common law prohibition of champerty point to the need for the funder to provide security for costs in most cases. Arkin v Borchard Lines Ltd (Nos 2 and 3) [2005] 1 WLR 3055 (CA) applied to a litigation funder Lord Denning MR’s dictum in Hill v Archbold [1968] 1 QB 686 (CA) that maintenance “[i]s lawful, provided always that the one who supports the litigation if it fails, pays the costs of the other side”. Where there is doubt about the bona fides of the funder or bad behaviour on the funder’s part, the case for declining approval or ordering such security, perhaps on an indemnity basis, is strengthened. Where an application for approval of a funder is met by an application for security for costs the enquiry may include not only the funder’s means but also whether it is of such standing that its decision to fund provides a worthwhile pointer to the merits of the case. We make no comment on the competing views in Jeffery & Katauskas, which turned on the terms of a costs rule which has no New Zealand equivalent. But the result, where the funder of a failed case escaped liability for costs, provides a cautionary example.
[37] McGechan on Procedure records at HR5.45.03(2) that in considering applications for security the court will try as far as possible to assess the merits and prospects even though in a case of any complexity that will be no more than an impression. It must do its best with what is before it. Security for costs can be a matter for continuous review, with a staged process for reappraisal which might increase or reduce security as more is learned about the case. There is a sliding scale: a case with slight merits may warrant a substantial order for security at least for an initial stage and may extend to provide indemnity to the opposing party. An apparently strong case may warrant reduced or no security. There will be cases where an order under r 7.70 for interim payment by the defendant is justified.

Issue (4) What other mechanisms can be devised to achieve the objectives of r 1.2?

[38] The judge must bring a critical and creative mind to bear on all aspects and implications of the initial representation decision. While the threshold for representation orders is low, when accompanied by an order admitting a funder it may prove desirable to view the total package of orders as a stool supported by four legs, each essential to its stability:

(a) the order for representation (considered along with its funding element);

(b) the court’s approval of the funder and the funding arrangement;

(c) the application for security (which may include consideration of the final leg); and

(d) the provisional appraisal of the merits. An erroneous decision on any element may either wrongly exclude worthy plaintiffs from access to the court, or wrongly impose on defendants who have committed no fault such burden of costs and distraction from their other affairs so as to pressure them to yield to a baseless demand and settle.

[39] In some cases it may be appropriate to identify an initial issue, success or failure which is likely in practice, if not in law, to determine the result of the case. The initial representation order may be limited to that element, reserving the question whether at a further stage the order will be extended or the parties left to continue their cases as individuals.
[40] We have mentioned the option of limiting the initial security to a first phase, perhaps up to assessment of the primary issue and ordered concurrently with discovery (which may include interrogatories) or even the filing of briefs of evidence or affidavits confined to that. If the representation order is granted, in whatever form, the judge must maintain as the case develops a continuous appraisal of whether it should be sustained, varied, or rescinded. The more the judge learns about the case the more discriminating and confident that continuing appraisal will be. Indeed all elements of the representation and security orders and the approval of the funder and its terms should be regularly reviewed.
[41] In determining the way forward, the judge may be assisted by the experience in other jurisdictions. Absent developed rules designed to facilitate consideration of class actions there are likely to be heavy burdens on both counsel and the judge. The Rules Committee’s proposals, which it is intended should be presented to Parliament, may be expected to ease those burdens.

Issue (5) What is the apparent strength of the claim?

[42] We have referred to the low threshold for a representation application at [12]. But when it is coupled with an application to approve a funding arrangement the position may alter. We endorse the observation of Heydon J in Jeffery & Katauskas at [110] that litigation is capable of causing immense harm unless its use is properly controlled. A funding approval order added to a representation order can create a mechanism of such size and potential complexity that there may be justification for some consideration of the merits beyond the sphere of security.

Issue (6) How should the principles be applied?

(a) The nature of the claim and the claimant group

[43] Because of the stay order, the original statement of claim has not formally been superseded by the draft amended statement of claim presented by Mr Eichelbaum shortly before the hearing. It will be for the High Court to determine whether, and, if so, when and to what extent the stay may be lifted; for example, a first stage might be to permit the amended statement of claim to be filed to avoid future limitation bars and to permit others to opt in.
[44] The original pleading asserts that the respective plaintiff:

... is issuing this proceeding in a representative capacity pursuant to r 78 High Court Rules.

It was accompanied by an application for an “opt-out” representation order: that Messrs Houghton and Jones sue:

... as representatives of all shareholders and former shareholders in FELTEX CARPETS LIMITED ... who acquired and/or beneficially owned shares in Feltex:

Between 4 June 2004 (being the Initial Public Offer allotment date); and

31 March 2005 or thereabouts (being the profit downgrade announcement date); and

Suffered a loss on that investment.

...

Unless they elect to opt-out of the proceedings by 4pm on 11 April 2008. The members of the group election to Opt-out can do so by:

(a) sending a written notice to the following address:

The Registrar of the High Court (Christchurch)

Private Bag 4618

Christchurch

New Zealand

Or:

(b) by entering their details onto the database list on the Internet website located at http://feltex.investment.co.nz//comleteoptout.aspx which will be submitted to the Court.

The application further sought opt-out directions in relation to the funding proposal by the litigation funder Joint Funding of which Mr Gavagan is the principal.

[45] The application was made ex parte because of the plaintiff’s concern about a pending limitation bar, and was granted by Associate Judge Christiansen. On a defence application to review and rescind the order, French J permitted the proceeding by Mr Houghton to continue as a representative action subject to:

(a) the representative order being limited to the claims by Mr Houghton;

(b) the claims brought under the Securities Act and Fair Trading Act being amended to include alternative allegations of loss based on an inflated share price and the lost opportunity to apply for a s 37A Securities Act refund;

[46] Some 800 people have exercised the right to opt in. Some may have bought their shares on the market after the initial offering and would fall outside the amended representation order. Mr Galbraith submitted that the new causes of action in the proposed amended statement of claim will be statute-barred but did not invite us to rule on the point. Since the point was not argued before us we offer no comment on that or on the application of limitation provisions, including whether they were halted by the original opt-out order. Further opting in has been prevented by the stay order of the High Court. We have stated that it will be for that Court to decide whether, and, if so, when and on what terms the High Court might consider that the stay should be lifted. It might be appropriate to do so in a limited manner to avoid any forthcoming limitation bar but we offer no comment on whether it should do so.
[47] Mr Eichelbaum told us that, if the stay is lifted, a further pleading will be filed to record both the changes signalled in the draft pleading and also a change in approach responding to the argument on this appeal. Further investigations are being undertaken to that end. Because of the High Court’s stay order, which we have decided to maintain until further order of that Court, it is desirable that this judgment be issued promptly. We have therefore declined to receive an updated draft which counsel advised could not be finalised in acceptable form in time for us to receive submissions from the appellants and give judgment before Christmas. We must therefore deal with the arguments at a relatively general level and leave the timetabling of specific future stages to the Judge.

(b) The likely issues

[48] The heart of the claim is the contents of the registered prospectus required by s 33 of the Securities Act which was issued by the appellants on 5 May 2004. The directors were concerned that allegations were raised in argument but not pleaded. We repeat that we make no comment on them, nor have we knowledge of whether there is sufficient evidence to allow them properly to be pleaded.

The Fair Trading Act: pre-float period

[49] The shareholders pleaded that the appellants marketed Feltex to the public in a manner constituting misleading or deceptive conduct and therefore in breach of the Fair Trading Act. In the draft amended pleading they propose to assert in particular that prior to the float Feltex had unilaterally slashed expected end-of-year rebates to major customers, a technique which Mr Eichelbaum told us would show a one-off $10m increase in profits for the year but in the process gravely damage Feltex’s goodwill with those suppliers and risk losing their future business. They claim that as a result of the breaches they have suffered loss.
[50] The relief sought is by way of declarations of liability and for an order following enquiry to pay the amount of the plaintiffs’ loss.
[51] We comment that we see the allegations of rebate cancelling and channel stuffing to which we next refer, as essentially allegations of deceit. That is what the appellants said they were accused of and Mr Eichelbaum essentially accepted that. He said that he had not pleaded deceit because he did not yet have the evidence but that does not meet the fact that the allegations have been made. In Commerce Commission v Carter Holt Harvey Ltd [2009] NZCA 40; [2009] 3 NZLR 573 at [80] (CA) the responsibilities of counsel advancing a pleading of fraud were mentioned. If fraud is asserted it must be expressly pleaded, whether at common law or via the Fair Trading Act. Sufficient evidence must be available whatever the head it is pleaded under.

The Fair Trading Act: post-float period

[52] The respondents have given notice of their desire to plead that after the float Feltex engaged in the deceptive practice of “channel stuffing”, by which a supplier of goods sends to customers more product than usual and enters the transaction in its books as a sale, notwithstanding the likelihood that the customer will decline to accept the additional unordered stock. The respondents contend that the purpose of such conduct was to avoid the operation of s 37A of the Securities Act which requires repayment of moneys received as a result of a misleading prospectus but only if the necessary claim is made within twelve months after a certificate of the security had been sent to the subscriber. It is unclear from the pleadings whether, and, if so, how it is alleged that Credit Suisse MP, Credit Suisse PE, First New Zealand Capital and Forsyth Barr Ltd were involved, but Mr Eichelbaum says that this is asserted.
[53] Mr Eichelbaum was unable to advise us whether it is alleged that there was infringement by Feltex of the New Zealand Equivalent to International Accounting Standard 18 (2008) issued by the Financial Reporting Standards Board of the Institute of Chartered Accountants of New Zealand relating to the sale of goods.
[54] The relief sought is again by way of declarations of liability and for an order following enquiry to pay the amount of the plaintiffs’ loss allegedly due to deceptive conduct by the defendants.

Securities Act 1978

[55] The claim is against the directors and Credit Suisse PE. Section 56 of the Securities Act stated during the material period:

56 Civil liability for misstatements in advertisement or registered prospectus

(1) Subject to the provisions of this section, the following persons shall be liable to pay compensation to all persons who subscribe for any securities on the faith of a... registered prospectus which contains any untrue statement for the loss or damage they may have sustained by reason of such untrue statement, that is to say:

...

(The Feltex directors are sued under (c).)

(d) Every promoter of the securities.

(Credit Suisse PE is sued under (d).)

...

(3) No person shall be liable under subsection (1) of this section in respect of any untrue statement included in a... registered prospectus, as the case may be, if he or she proves that—

...

(c) As regards every untrue statement not purporting to be made on the authority of an expert or of a public official document or statement, he or she had reasonable grounds to believe and did, up to the time of the subscription for the securities, believe that the statement was true;

...

[56] The pleading asserts the making of untrue statements in the prospectus and purchases by the plaintiffs in reliance upon them.
[57] The relief sought is again by way of declarations of liability and for an order following enquiry to pay the amount of the plaintiffs’ loss.

Negligence

[58] The pleading is against all defendants. It alleges a duty of care owed to the plaintiffs and breach of that duty causing them loss.
[59] The relief sought is by way of declarations of liability and for an order following enquiry to pay damages.

Breach of fiduciary duty

[60] The pleading, now by Mr Houghton only, is against all defendants. It alleges that they were in a position of confidence and owed fiduciary duties to the plaintiffs.
[61] It asserts breach of that duty.
[62] The relief sought is by way of declarations of liability and for equitable relief.

The need for close court control of representative proceedings

[63] In the absence of specific class action rules, to reduce the disadvantages to the appellants as much as possible the courts must make interim provision for the types of safeguard they may be expected to provide. Some are covered by Mr Cooper’s suggestions: for example that counsel and the solicitor on the record (as officers of the court and subject to duties towards and control of the court) be responsible for communication with the class; that there are adequate arrangements in place to ensure all those represented are informed of all steps and are consulted on those steps (the representative plaintiff is probably the principal client); and that no misleading information is given to encourage new participants.

(c) The specific funding arrangements

[64] Mr Gavigan is an accountant who had had some experience in litigation support. He has never been a shareholder in Feltex. He began an investigation into its affairs and embarked on organising shareholders into an action group. In an affidavit sworn on 30 May 2008 he stated that individuals who support this litigation had contributed some $450,000 to get the case to its then stage. On 20 December 2007, following the decision of an established Australian funder not to undertake the case, he incorporated Joint Funding, of which he is the sole shareholder and director. An elaborate “Feltex investigation, management & funding agreement” was prepared by solicitors.
[65] Under the agreement, decisions about the conduct of the litigation on behalf of all claimants are made by a committee of up to three persons. The committee members are nominated by Joint Funding and must be accepted by defined “lawyers”, being the firm originally instructed by Mr Gavigan and including any other solicitors appointed in their place. Since Mr Gavigan is both the nominator and the appointer of the lawyers, as French J found, the agreement vests in Joint Funding, effectively Mr Gavigan, very significant control over the conduct of the litigation, including the sole right to decide whether to appeal, a prohibition on the parties’ communicating with opposite parties and the absence of any express termination clause. There is an outstanding issue whether the extent of such control is appropriate. Policy considerations include the court’s reluctance to scrutinise private bargains. Telling the other way is the fact that parties not before the court are potentially affected. A further consideration is that there are also the concerns to be discussed about the risks entailed in modifying the former common law of champerty.
[66] Under the agreement, Joint Funding is to receive 33 per cent of any damages or settlement received, increasing to 38 per cent if there is an appeal, together with all costs plus a “project management fee” of 25 per cent of the total cost of the project. The respondents have calculated that on a recovery of $250m the profit for Joint Funding in addition to its costs would be to the order of $82.5m or $95m if there were an appeal. While the figures are speculative and based on a number of assumptions, the potential profit for Joint Funding if the claim should succeed would be very substantial.

(d) The strength of the claim

The argument for a maintenance/champerty bar

[67] No party advanced any jurisdictional threshold challenge to the claim. They accepted that funding arrangements are possible subject to proper controls and no abuse of process. But since the point is arguable we must resolve it. It is that in New Zealand, unlike Australia where the torts of maintenance and champerty have been abolished by statute, maintenance and champerty remain common law torts and the funding arrangement that lies at the heart of the respondent’s claim is contrary to public policy. In its report Subsidising Litigation ([24] above) the Law Commission recommended against abolishing the torts. They are specifically referred to in s 334 of the Lawyers and Conveyancers Act 2006, which states that a conditional fee agreement is not an illegal contract or an unenforceable contract if certain stipulations are met. Such agreement is defined in s 333 as one under which a lawyer and client agree that some or all of the lawyer's fees and expenses for advocacy or litigation services are payable only if the client wins. Section 334 states:

Conditional fee agreements

(1) A conditional fee agreement is not an illegal contract or an unenforceable contract by reason only of the fact that the remuneration the lawyer may receive under it is dependent on the outcome of the matter to which the remuneration relates if—

(a) that remuneration is either—

(i) a normal fee; or

(ii) a normal fee plus a premium; and

(b) the application of this section is not excluded by section 335; and

(c) the agreement complies with such requirements (if any) as are prescribed by the practice rules. (“Rules of conduct and client care” rr 9.8-9.12).

(2) If a conditional fee agreement is, by virtue of subsection (1), not an illegal contract or an unenforceable contract, a lawyer does not by entering into that agreement make himself or herself liable to proceedings founded on the tort of maintenance or the tort of champerty.

[68] The use of the premium is restricted to an uplift compensating the lawyer for the risk of not being paid and the disadvantage of not receiving payment on account. It must not be calculated as a proportion of the amount recovered. Section 335 prohibits such agreements in respect of criminal, immigration and family law proceedings.
[69] It is therefore arguable that, since Parliament has acknowledged the continuing existence of the common law torts of champerty and maintenance, the Courts should leave any adjustment of the law to the legislature. We have noted that in 2001 the Law Commission recommended that the common law be left unchanged.
[70] The competing argument is that the common law elsewhere has moved on even since 2001 and to disregard its evolution would abdicate this Court’s responsibility for incremental refashioning of the common law of New Zealand in spheres where it has particular experience.
[71] New Zealand will develop its laws and practices according to the evaluation of New Zealand lawmakers. Those lawmakers are Parliament, with the plenary authority resulting from the legitimacy of its elected representatives and the superior courts, within their relatively narrow sphere: see for example Accused (CA 60/97) v Attorney-General (1997) 15 CRNZ 148 at 151 (CA) per Henry J:

The High Court derives its general jurisdiction from its status as a superior Court and in particular from s 16 of the Judicature Act 1908.

[72] Among the considerations relevant to whether and how the judicial lawmaking power should be employed is the practical administration of justice. Bearing on that is the important reality of our relationship with Australia. There are powerful reasons to minimise any unnecessary differences in the ways we deliver justice from those of our close friend and partner in most kinds of activity in which litigation can arise.
[73] In Australia there has been legislative removal of the torts of maintenance and champerty. But Australian legislatures have taken care to ensure that their removal does not lead to abuse by members of the legal profession. So the New South Wales Parliament, in ss 322-329 of the Legal Profession Act 2004 (NSW), has legislated in terms not dissimilar to those of our ss 333-336. The uplift fee, while permitted, must not exceed 25 per cent of the costs otherwise payable.
[74] Notwithstanding such constraints on legal practitioners, the High Court of Australia has declined to reason that litigation funders, not officers of the court nor subject to Law Society discipline, should be subjected to analogous controls: Carnie v Esanda cited at [18] above; Fostif; Jeffery & Kauskas. Compare Burrows and Carter Statute Law in New Zealand (4ed 2009) at 535. We must consider: (1) whether the absence of New Zealand legislation abolishing the torts of champerty and maintenance coupled with the reference to those torts in s 334(2) bars this Court from reviewing the common law; and (2) if not, whether and to what extent we should follow the Australian lead.
[75] In Kleinwort Benson Ltd v Lincoln City Council [1998] UKHL 38; [1999] 2 AC 349 the House of Lords reversed the judge-made rule of law established in Bilbie v Lumley [1802] EngR 245; (1802) 2 East 469; 102 ER 448 that moneys paid under a mistake of law were irrecoverable by restitutionary claim. At 358 Lord Browne-Wilkinson referred to and dismissed the conventional:

... theoretical position ... that judges do not make or change law: they discover and declare the law which is throughout the same. According to this theory, when an earlier decision is overruled the law is not changed: its true nature is disclosed, having existed in that form all along. This theoretical position is, as Lord Reid said in the article "The Judge As Law Maker" (1972-1973) 12 J.S.P.T.L. (N.S.) 22, a fairy tale in which no one any longer believes. In truth, judges make and change the law. The whole of the common law is judge-made and only by judicial change in the law is the common law kept relevant in a changing world

[76] In Deutsche Morgan Grenfell Group plc v IRC [2006] EWCA Civ 118; [2007] 1 AC 558 (HL) counsel for the Inland Revenue Commissioners argued that Kleinwort Benson did not apply to tax because Parliament had provided a qualified statutory remedy for one category of mistaken payments of tax (when “the assessment was excessive by reason of some error or mistake in a return”). Giving the leading speech in the House of Lords, Lord Hoffmann held at 568 that the question is one of construction. Where a special or qualified statutory remedy is provided it may well be inferred that Parliament meant to exclude any common law remedy which might have arisen on the same facts, as in Marcic v Thames Water Utilities Ltd [2003] UKHL 66; [2004] 2 AC 42 (HL). The question here is whether such intent should be imputed to Parliament.
[77] The common law torts of maintenance and champerty were created in an era before the courts had the capacity to deal with unruly nobles. By the time of Trendtex there had not emerged the fact, or perhaps the appreciation, now so evident, that access to justice may not be available without the assistance of funders prepared to fund the litigation in exchange for a cut of the proceeds. The modern Australian approach, seen also in Canada, is to face these realities directly and make a judgment according to the merits of each case. In New Zealand also, funding arrangements have been approved by Anderson, Glazebrook and Heath JJ in Re Nautilus Developments Ltd [2000] 2 NZLR 505 (HC), Re Gellert Developments Ltd (in liq) (2001) 9 NZCLC 262,714 (HC), and Auckland City Council as Assignee of Body Corporate 16113 v Auckland City Council [2007] NZHC 1411; [2008] 1 NZLR 838 (HC) respectively, albeit with control of the proceedings remaining with the litigants. There remains cause for anxious care in assessing them. But like the majority in Jeffery & Katauskas we are not deterred by Heydon J’s dissenting comment at [111]:

The court’s procedure exists primarily to serve the function of enabling rights to be vindicated rather than profits to be made.

Such a binary test overlooks the fact that its application is likely to ensure that rights are not vindicated. A more nuanced approach is required. We should add that the appellants did not argue otherwise.

[78] We have concluded that the common law in other jurisdictions has moved on and access to justice and comity with other states mean we should follow. We already have decisions at High Court level (see cases at [77]) approving funding arrangements and Parliament must be assumed to have passed the Lawyers and Conveyancers Act in knowledge of that trend. Moreover, the context of that legislation was very different from non-lawyer cases: lawyers are officers of the court and when arguing a case they owe what may be conflicting duties to clients as well as to the court. Parliament could well have thought that the sort of objectivity needed to fulfil their role could be compromised by a financial stake in the outcome.
[79] We have concluded that, like the common law of Australia and that of Canada, the common law of New Zealand should refrain from condemning as tortious or otherwise unlawful maintenance and champerty where:

(a) the court is satisfied there is an arguable case for rights that warrant vindicating;

(b) there is no abuse of process; and

(c) the proposal is approved by the court.

We have discussed the need for proper controls, appropriate to the nature of the case and the particular funder and funding terms proposed.

[80] We are not in a position to determine whether any of these conditions should be found to be satisfied in this case. Whether there is an arguable case and the strength of that case cannot be assessed by this Court which has not received the respondents’ intimated amended statement of claim. The same is to be said about the issues of abuse of process and approval.
[81] Certainly on the limited material before us we are unable to say that, despite the Securities Commission report, they must necessarily be answered in favour of the appellants. There are some aspects of the accounts of Feltex which may be unusual. The collapse of the company occurred very quickly. There is some evidence from Mr Gavigan, from Mr Terence Harrison, a director of a customer of Feltex, and from Associate Professor Newberry that may offer some support for the respondents’ contentions. Mr Eichelbaum accepted that more investigation is needed and clearer pleadings are required.
[82] But there are also issues about the reliability of Mr Gavigan which will require resolution as part of the overall evaluation, which can be made only by the High Court. They may include an allegation of materially misleading people as to the strength of the proposed claim.

The issue of reliance

[83] At the forefront of the appellants’ argument was the submission that there can be no representation order because reliance is integral to each cause of action and the position of each of those who have opted in to the claim will be different. Mr Galbraith cited as supporting that submission the judgment of this Court in Boyd Knight v Purdue [1999] 2 NZLR 278. Blanchard J, with whose judgment Gault and Salmon JJ agreed, allowed the appeal by auditors of a company who had issued a report contained in the prospectus as required by cl 36(1) of the Third Schedule to the Securities Regulations 1983. It is necessary to cite a lengthy passage from the judgment:

[49] In Deloitte Haskins and Sells v National Mutual Life Nominees Ltd [1993] UKPC 24; [1993] 3 NZLR 1 the Privy Council placed a narrow construction, some might say a surprisingly narrow one, on the auditor's duty towards the trustee under s 50(2) of the Securities Act, saying that the effect of the decisions in the Courts below, which were reversed, “was to impose upon the auditor a common law duty more extensive than that imposed by the Act'' (p 7). There is a need, therefore, to give close consideration to the form of the report required by the regulations in order to determine the extent of the responsibility assumed by the auditors in signing and delivering it for incorporation in a prospectus.

...

[54] When auditors furnish a report for inclusion in a prospectus they express an opinion about the financial statements of the company which they have audited: they confirm the accuracy of those statements, in the sense of that word used above. However, they are not called upon to make any comment on the state of the company's affairs. They undertake no duty to assess for would-be investors whether it is creditworthy. Their duty is to inform, not to give advice. The record shown by the financial statement speaks for itself. The true and fair view may be one of prosperity or poverty. The report therefore has no context for anyone who has not read the accounts. Without such a reading the report tells the reader nothing except that the company has a set of accounts which comply with the regulations and present a true and fair view. In so far as such a report refers to a true and fair view, it is almost meaningless unless read in conjunction with the figures in the accounts. It must follow, it seems to me, that in so certifying the accounts the auditors cannot be taken to have accepted an obligation to an investor who has not read and relied upon them. Reliance, and a consequential duty of care, cannot be asserted, as it were, in a vacuum. There must first have been a specific influence of the financial statements on the mind of the investor. It is not enough for the investor to say that, without troubling to look at the accounts, he or she relied in a general way upon the statutory scheme, making an assumption that an investment is sound or the issuer creditworthy because there was a trustee playing a supervisory role in connection with the prospectus and an auditor had furnished the report required by the regulations.

[55] It would be casting upon an auditor a burden going even beyond anything suggested for the unsuccessful plaintiff in Caparo [Industries Plc v Dickman [1990] 2 AC 65 (HL)] if this Court were to hold careless auditors liable for the accuracy of figures which were not directly relied upon by plaintiff investors. Since the purpose of the legislation is to ensure information is available to investors, so that they can make their own assessment of the prospects of the issuer, it would be exceeding the statutory scheme if the Court were to find auditors responsible for inaccuracies in information which was not utilised by an investor. There is no room in this context for an indirect reliance which Cooke P adverted to in a rather different case (South Pacific Manufacturing Co Ltd v New Zealand Security Consultants & Investigations Ltd [[1992] 2 NZLR 282 (CA)] at p 297). And, like the British Columbia Court of Appeal in Kripps v Touche Ross & Co (1992) 94 DLR (4th) 284, I find no attraction in the doctrine of reliance on the integrity of the market which has been developed in some jurisdictions in the United States. It is quite contrary to the position taken in Caparo.

[56] In circumstances in which, if the true position had been revealed, the accounts could have been corrected and a prospectus would probably still have issued seeking the investment a plaintiff investor must, I think, show reliance on a particular item or items in the financial statements which were inaccurate. It must be proved that, if the true and fair view in that regard had been known to the plaintiff, the investment decision would have been different. For, if the inaccurate material was not an influence on the investor, how can it be alleged that the investor would not have gone ahead with the investment?

[84] Unlike the directors and the promoter the auditors receive no mention in s 56 of the Securities Act and (together with directors and officers of a body) they are excluded from the definition of “experts” in s 2. We repeat that in its relevant form s 56 stated:

(1) ... the following persons shall be liable to pay compensation to all persons who subscribe for any securities on the faith of a prospectus for the loss or damage they may have sustained by reason of any untrue statement included in the prospectus, that is to say:

...

(b) Every person who is a director of the issuer at the time of the issue of the prospectus:

...

(d) Every promoter of the securities.

[85] The clause “all persons who subscribe for any securities on the faith of a prospectus” may refer to reliance generally on the prospectus rather than specific passages or figures. It may be compared with the passages we have emphasised Boyd Knight which show how narrowly the Privy Council and this Court have set the limits of a common law negligence claim against auditors. Very specific reliance is needed upon the specific language of the audit report and underlying accounts. The appellants argue that similar reliance is needed for the claims against the defendants in this case who do not include the auditors. That is so, they contend, in relation to all causes of action.
[86] We do not propose to determine at this stage the scope of reliance required against the defendants in relation to each cause of action. That is for four reasons.
[87] The first is that the very narrow duty owed by auditors has nothing in common with the duty owed by those who are party to the issue of the prospectus. The vendor is selling its shares to the public. The directors are immediately responsible for knowing the financial position of the company and for approving the terms of the public float and the promoter is promoting it: both are identified in s 56 as subject to particular responsibility. The organising participants and joint lead managers are closely involved in the float. The position of each is very different from that of the auditor, who has no role of promotion.
[88] The second reason is that, while in this case the document received by investors was a combined investment statement/prospectus, so the prospectus required to be registered under the Securities Act was made available to every potential investor, that is no longer a requirement of the Securities Act, and the actual offer to invest can now be made in an investment statement, which refers to the registered prospectus but does not contain a copy of it. That may be significant in cases where an investor wishes to rely on an untruth in the prospectus but, because of the offer being made in the investment statement, cannot claim to have read the prospectus. It is unnecessary to consider whether the current practice, as a result of which investments are commonly made without reference to the single copy of the prospectus filed with the Companies Office, could cast fresh light on the position of auditors. But it may well be relevant to that of the appellants. We would expect that an analysis of their respective duties will establish that they differ markedly from that of auditors. But such analysis is better performed when the facts are known.
[89] The third reason is that just mentioned: much will turn on what facts are pleaded and proved. Counsel for the appellants accepted in argument that, if in truth Feltex were proved to have been without substance, there would be no need in a negligence claim against the parties to the float to prove reliance of the kind required against auditors. The very float would contain an implied representation that the company had substance. It is true, as Mr Galbraith submitted, that one can float anything as long as there is full disclosure. But to avoid being untrue, the disclosure required in the case of a company lacking substance would need to be very explicit. What might be the case, in relation to the various causes of action, if lesser misrepresentations were established does not warrant consideration at this stage.
[90] The fourth reason is that it may be possible that indirect reliance may nevertheless be “on the faith of a ... prospectus” where that forms the basis of advice from a broker or a news report.
[91] We record that Mr Eichelbaum said that the fraud on the market theory discussed in United States authorities would be available to his clients. While we cannot rule out that argument we express no view upon it. If advanced, it should be pleaded to give fair notice to the appellants of the facts relied on.
[92] Counsel for the appellants accepted that an issue of misrepresentation can properly be the subject of a representation order in this case. Mr Galbraith stated the final position of his clients, with which the other appellants agreed as:

The interim stay should remain, the representation order should not be overturned, but this Court should order that the funding agreement be stopped and replaced by a new funding agreement approved by the High Court.

[93] We agree that the interim stay should remain and that the representation order should not be overturned by this Court, but subject to the High Court’s imposing suitable conditions (see [63] above). In relation to funding, the court would have to be satisfied, before lifting the interim stay (except perhaps to allow a new statement of claim to be filed) as to the conditions we have listed at [79] above. What course should be adopted in relation to the funding agreement is a facet of the application for permanent stay. Among the options is whether, as a condition of allowing the case to continue both in representative form and with a funder, there should be a change to either the funder, the funding agreement, or both. That cannot be determined in this Court where we are not seized of the issues. It must be determined in the High Court.
[94] The representation order should be subject to its own distinct conditions (such as having the solicitor responsible for all communications). The funding arrangement will be subject to other conditions (some of which may overlap) but which may include the posting of security for costs and may require that the representation order is stayed until those funding conditions are met. One would not, however, discharge a representation order without giving the parties fair opportunity to resolve the funding arrangements.

Issue (7) Should the claim for breach of fiduciary duty be struck out?

[95] In their draft amended statement of claim the respondents wished to plead against all defendants (with underlined addition to the existing pleading):

35. That the defendants respectfully were in a position of confidence and trust and owed fiduciary duties to the plaintiffs, and those whom the first plaintiff represents, to ensure that in the preparation, compilation and issue of the prospectus that they made full and fair disclosure and that it did not contain any misleading or deceptive material, either by reason of what was stated or what was omitted.

36. That in breach of those fiduciary duties the defendants issued a prospectus which:

(a) Contained and gave undue prominence to material, namely the EBITDA, referred to in paragraph 28(a) hereof which was an unreliable measurement of accurate information concerning Feltex’s financial performance.

(b) Contained and gave undue prominence to misleading or deceptive financial projections and forecasts as particularised in paragraph 28(b) hereof.

(c) Omitted reference to material facts which caused the prospectus to mislead the first plaintiff and those whom he represents as particularised in paragraph 28(c) – 28(ff) hereof.

36A. That in breach of those fiduciary duties the defendants represented Feltex as a sustainable high yielding investment which it was not.

37. That as a result of the breach of the fiduciary duties by the defendants, the plaintiff/s and those whom the first plaintiff represents have suffered loss and damage, being in the case of each individual shareholder the purchase price paid for the shares.

37A That as a result of the breaches of fiduciary duties by the defendants, the plaintiff and those whom he represents have suffered loss and damage in that they have been induced to invest in the Feltex IPO at an inflated share price.

They seek consequential declarations and equitable relief.

[96] The Judge considered that as a matter of law the claim for breach of fiduciary duty was unlikely to succeed. But she decided that given the state of the pleadings she could not be certain that the cause of action was so clearly untenable as to be suitable for pre-emptory determination on untested facts. She was of the view (at [91]) that the full ramifications of recognising fiduciary duty arising out of the public offering of shares are something that can only be properly explored and tested at a substantive hearing.
[97] We have reached a different conclusion. The leading cases, which include Coleman v Myers [1976] NZHC 5; [1977] 2 NZLR 225 (CA), Chirnside v Fay [2006] NZSC 68; [2007] 1 NZLR 433 (SC), Hospital Products Ltd v United States Surgical Corp [1984] HCA 64; (1984) 156 CLR 41 and United Dominions Corporation Ltd v Bryon Pty Ltd [1985] HCA 49; (1985) 157 CLR 1, involve a relationship of close proximity between the parties either before or at the time of the alleged breach.
[98] As to the test, in Watson v Dolmark Industries Ltd [1992] 3 NZLR 311 at 315 (CA) Cooke P stated that:

... vulnerability is an important, indeed cardinal, feature of a fiduciary relationship.

The argument by La Forest J dissenting in LAC Minerals Ltd v International Corona Resources Ltd (1989) 61 DLR (4^th) 14 at 39-40, that vulnerability is not essential to a fiduciary relationship, is not supported by his citation of Keech v Sandford (1726) Sel Cas t King 61. There the trustee of a market obtained for himself a renewal of a lease which had been refused to his infant beneficiary. The very ratio of the decision was the child’s vulnerability, Lord King LC remarking that if the law were otherwise “few trust-estates would be renewed to cestui-que use”.

[99] A thoughtful essay by Anthony Holmes “De Facto Commercial Relationships: Still Dancing at Arm’s Length?” (2009) 15 NZULR 80 discusses the leading authorities and argues against an assumption that fiduciary principles are necessarily excluded because the parties’ relationship is commercial. But the argument does not assist the first respondent’s submission.
[100] We consider, as was suggested in argument, that for a fiduciary duty to exist in a case like this the plaintiff must establish, to speak in metaphor, a stabbing when his or her guard was down by someone whom, by reason of a special relationship, there was reason to trust. The conduct of the principal defendant in Coleman v Myers, who secured shares from his aunts at what he knew to be an undervalue, exemplifies the point.
[101] If a fiduciary duty were found in these circumstances, the promoters would effectively owe a duty to the entire investing public (ie any potential offeree of the shares) which seems to us to be unduly wide. We would add that the pleaded breach is the same as those pleaded in relation to the Fair Trading Act and Securities Act.
[102] The high point of the respondents’ argument was the decision of the House of Lords in Erlanger v New Sombrero Phosphate Company (1878) 3 App Cas 1218. There, Erlanger had acquired for £55,000 the lease of a small island in the West Indies entitling the lessee to work its phosphate beds for a rent of £1000 per year. Erlanger incorporated a company with a compliant board which he induced to buy the lease for £110,000 and to approve a prospectus for sale of shares in the company for public float to raise part of the purchase price. The prospectus did not disclose the terms of Erlanger’s purchase. On a claim by the company against Erlanger, the House of Lords held that he had taken unfair advantage of his ability to get the directors’ consent while withholding from them the fact of his involvement and profit. Mr Eichelbaum argued that where a company is solvent it is the property of the shareholders, that to a substantial extent the sale was by Erlanger to the new shareholders, and that is indistinguishable from the sale by Credit Suisse MP effectively of its shares to the public.
[103] The difficulty with that analysis is that Credit Suisse MP did not deceive the directors. The company through its directors knew that Credit Suisse MP was disposing of its shares and supported the transaction by which the new shares were issued and sold to the public. The directors, with that knowledge, authorised the float. Credit Suisse MP did not stab an unwitting company in the back.
[104] The next phase, the float, was of course between the company and the public. There is a vulnerability by reasons of knowledge imbalance. But the public were not vulnerable in the relevant sense by reason of a special relationship. Certainly they are likely to have relied, whether on a broker, via the market, or in some other way on there being substantial truth in what was asserted in the prospectus. But their only relationship with the appellants was, as the Fair Trading Act cause of action asserts, in trade. Parliament has turned its mind to the topic in the Securities Act. There is no occasion for the common law to add to its provisions. Nor is there anything in the facts pleaded to bring the case within any exception to the general norm that vendor-purchaser cases are unlikely contenders for the exceptional remedies attending breach of fiduciary duty.
[105] In Erlanger, by contrast, one of the reasons the fiduciary duty was found to exist was because otherwise the wrongdoer would have got away with it. In the present case that is not a concern because of the statutory remedies available to the investors for the conduct that is said to be the breach of the fiduciary duty. It may be noted that in Erlanger Lord Blackburn stated at 1269:

Some reference was made in the argument to the Companies Act, 1867 (30 & 31 Vict. c. 131, s. 38), on the construction of which there has been a great diversity of judicial opinion. That section does contain the word "promoters," which ... is not to be found in the Companies Act, 1862, but it imposes no fresh duty on them with regard to the company. It imposes a fresh duty towards, and gives a new cause of action to, persons who take shares in the company as individuals; it does not affect the obligation of the promoters towards the corporation.

So he saw as material to the creation of the fiduciary duty owed by the company that, unlike the case of shareholders, there was a statutory gap that needed to be filled. Here, there is no such gap.

[106] Even if it could be said that the appellants were fiduciaries, as Mr Olney submitted it does not follow that they are liable for anything that could be called a relevant breach of fiduciary duty: compare Bank of New Zealand v New Zealand Guardian Trust Ltd [1999] 1 NZLR 664 (CA). Here that would require breach of the principle we have stated at [100].
[107] There is no reason of principle or policy to justify extension of such a duty to the present facts.
[108] We allow the appeal against the decision not to strike out the fiduciary duty cause of action brought by Mr Houghton.

Decision

[109] For the foregoing reasons the appeal against the representation order fails and is dismissed. The appeal against dismissal of the application for permanent stay is also dismissed. The cause of action alleging breach of fiduciary duty is struck out.
[110] Because the decision whether to maintain the representation cannot be made at least until an amended statement of claim has been prepared, the order of the High Court for interim stay of proceedings will continue until further order of that Court. We contemplate that the respondents will tender to the High Court and to the appellants what they propose by way of draft amended statement of claim and that the High Court will then convene an early conference to review the case.
[111] We envisage that once the new draft pleading is tendered, there will be a hearing in the High Court to determine whether the interim stay should be lifted so that that pleading can be filed. Such lifting would not necessarily be unconditional and might be limited to a specific purpose (such as the filing of the amended statement of claim). Conditions of the lifting of the stay might include changes to the representation order, changes to the litigation funding arrangement either to exclude Mr Gavigan’s funding company or to put in place new directions taking account of the suggestion made by Mr Cooper, so that the funder is placed firmly under the control of the Court and required to act responsibly. In addition a security for costs order may be made. We have drawn together themes earlier discussed to emphasise the need for a hearing which brings all those issues together and calls for a combined assessment of them and then a decision about the future of the litigation and the rules of the game from now on.
[112] Because of the mixed fortunes on this appeal there is no order as to costs.

Solicitors:
Bell Gully, Auckland for Appellants in CA684/2008
Clendons, Auckland for the Fourth named Appellant in CA684/2008
Russell McVeagh, Wellington for Appellants in CA693/2008

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