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Court of Appeal of New Zealand |
Last Updated: 28 February 2018
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IN THE COURT OF APPEAL OF NEW ZEALAND
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CA |
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BETWEEN
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Appellant |
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AND
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First Respondent
Continued over... |
JUDGMENT OF THE COURT
____________________________________________________________________
PAUL ANDREW CHEESEMAN AND
SARAH FRANCES CHEESEMAN
Second
Respondents
PPD INVESTMENTS LIMITED
Third Respondent
PEAK
ASSETS LIMITED
Fourth Respondent
PAUL GRAHAM ROSE AND
JOYCE
MARY ROSE
Fifth Respondents
ANDREW JOHN MILLWARD AND
SALI-ANN
MILLWARD
Sixth Respondents
MATTHEW JUSTIN MORRIS AND
JILL ANITA
MORRIS
Seventh Respondents
TAMSIN JUDITH RAISTRICK AND
DAVID IAN
RAISTRICK
Eighth Respondents
JOHN DAVID SHACKLETON AND
MARILYN
FREDA SHACKLETON
Ninth Respondents
HERBERT MICHAEL TATE
Tenth
Respondent
MARC VAN GELDER AND
ANN WATZEELS
Eleventh
Respondents
REASONS
OF THE COURT
(Given by Gilbert J)
Table of Contents
offers were not entitled to claim? [53]
[1] The question in this appeal is whether the High Court was correct to find that the respondents were entitled to escape their purchases of units in a resort development on the basis that the purchase agreements constituted void allotments of securities under the Securities Act 1978 (the Act). The appellant, Scott Sanders, the sole director of the developer at the relevant time, was ordered to repay the subscriptions being the purchase price paid by each respondent plus interest. The key issue on appeal is whether the offers to sell the units amounted to offers of securities. Subsidiary issues include whether the exemption under s 5(1)(b) of the Act for interests in land for which a certificate of title can be issued applied, whether the default in repayment of subscriptions was due to any misconduct or negligence on Mr Sanders’ part in terms of the proviso in s 37(6) of the Act, and whether a relief order ought to have been made under s 37AH.
[2] The Monaco Hotel and Resort (the resort) is located near Nelson and was designed to resemble an English village. The resort was Michael Gepp’s idea and he was the initial owner and developer. The resort was developed in stages. Mr Gepp commenced the development in 2002 and it was finally completed by Mr Sanders’ company, Monaco Village Ltd, in late 2008. The resort offers luxury tourist accommodation in a hotel complex and in seven separate terrace-style cottage complexes providing a choice of studio, one or two-bedroom units built around a central village green. Associated amenities include a restaurant, village hall, pavilion, retail shopping, health spa, gymnasium and a swimming pool.
[3] The background to the marketing and development of the resort and Mr Sanders’ involvement are explored in greater detail later in the judgment when we consider whether any default in repayment of subscriptions was due to misconduct or negligence on his part.
[4] The respondents agreed to purchase units from Monaco Village subject to a lease to Monaco Management Ltd which was to manage the units on their behalf, including by arranging guest lettings.[1] These leases were in a standard form described as the “cottage lease”. Mr Sanders was the sole director of Monaco Village and a director of Monaco Management. Settlement of the purchase was due following practical completion, the issue of title or the issue of a code compliance certificate, whichever came later. Settlement of the respondents’ purchases occurred on various dates from March 2008 to April 2009.
[5] The respondents’ purchases were limited to their individual units for which separate certificates of title were issued. They did not acquire any estate or interest in the associated amenities. The respondents’ units are mostly located in the “High Street” cottage complex but two are in “Village Green Stage 2” and one is in “Riverside”.
[6] The initial term of the cottage lease was 10 years and there were two rights of renewal each for a further 10 years. The maximum term of the lease in each case is therefore 30 years.
[7] The standard form purchase agreements made provision for an optional base rental under the lease equal to eight per cent of the purchase price for the first two years following settlement. Thereafter, the rent, payable quarterly in arrears, was to be calculated by aggregating the revenue actually received by the lessee for letting the particular unit (Gross Unit Revenue) and deducting outgoings relating to the unit (Unit Outgoings) and outgoings relating to the conduct of the business from the unit (Business Outgoings). The Business Outgoings include a management fee equal to 20 per cent of Gross Unit Revenue and is payable to Monaco Management as lessee.
[8] The permitted business use under the lease is for tourist accommodation or letting the unit to the public for use as accommodation as part of the resort. The respondents had limited occupation rights. If a guaranteed base rental was payable, the occupation right was limited to 14 days per year. Otherwise, the unit owners were permitted to occupy their unit for up to 90 days per year.
[9] Because Monaco Management as lessee manages all of the units and guest allocation, the cottage lease contains a provision requiring it to use reasonable endeavours to ensure that the allocation is fair and equitable (the guest allocation clause). This is the key provision relied on by the respondents to support their contention that the agreements conferred rights on individual unit owners to participate in the earnings of other unit owners in the same complex and the offers therefore amounted to securities. Because of its central importance to the appeal, we set the clause out in full:
44 Allocation of Guests
44.1 The Lessee shall use all reasonable endeavours to ensure that the Guests of the Units in the Complex are allocated to the respective Units on a fair and equitable basis and shall, to such extent as is reasonably practicable, adopt systems which facilitate compliance with its obligations under this clause.
[10] Despite the resort winning awards for the quality of its accommodation (best hotel accommodation in New Zealand in 2008 and 2010 and the supreme tourism award in 2008), the forecasted financial returns to unit owners were not achieved. The reasons for this are said to include fallout from the global financial crisis, the loss to Nelson of the popular World of Wearable Art festival and a significant increase in new tourist accommodation in the area without a corresponding increase in demand.
[11] In November 2013, some five years after settling the purchase of their agreements, the respondents issued proceedings in the High Court against Monaco Management, Monaco Village and Mr Sanders. They did not claim that there had been any pre-contractual misrepresentation in the forecasted returns or any breach of the leases. The respondents’ sole claim was that the offers made by Monaco Village inviting them to purchase units subject to the cottage lease were offers of participatory securities to the public for subscription in breach of the Act in that there was no authorised advertisement or registered prospectus and no statutory supervisor was appointed. They sought a declaration that the purchase agreements and the leases were invalid and of no effect and an order requiring Monaco Village (as the issuer) and Mr Sanders (as director) to repay the subscriptions being the purchase price paid by each respondent.
[12] A “security” is defined under the Act to mean “any interest or right to participate in any capital, assets, earnings, royalties, or other property of any person”.[2] The respondents pleaded that they each had “a share in the Business run from [the particular] Complex by each of them taking a proportionate share of the earnings of the Business”. They relied particularly on the guest allocation clause in the cottage lease to support their contention that the overall earnings from each complex were shared by all unit owners in that complex.
[13] Mr Sanders defended the claim on four principal bases.
[14] First, he contended that the offers did not amount to offers of participatory securities. He argued that the respondents did not acquire any right to participate in any earnings of any other unit owner. On the contrary, he claimed that each respondent was entitled only to the earnings generated from guests occupying their particular unit.
[15] Second, Mr Sanders claimed that the exemption in s 5(1)(b) of the Act applied:
5 Exemptions from this Act
(1) Nothing in Part 2 shall apply in respect of —
...
(b) any estate or interest in land for which a separate certificate of title can be issued under the Land Transfer Act 1952 or the Unit Titles Act 2010, other than any such estate or interest that —
(i) forms part of a contributory scheme; and
(ii) does not entitle the holder to a right in respect of a specified part of the land for which a separate certificate of title can be so issued; or
...
[16] Third, Mr Sanders said that he was not liable to repay the subscriptions because the default in repayment was not due to any misconduct or negligence on his part. Mr Sanders argued that the generally accepted view at the relevant time was that so long as revenue derived from letting each unit was separately accounted for, the offers would not constitute offers of participatory securities. He says that this view was shared by Mr Gepp’s lawyers, Westpac lawyers, his own lawyers, Lombard Finance’s lawyers and the Securities Commission. In these circumstances, Mr Sanders claimed that he was entitled to the protection of the proviso to s 37(6) of the Act which reads:
... provided that a director shall not be so liable if he or she proves that the default in the repayment of the subscriptions was not due to any misconduct or negligence on his or her part.
[17] Finally, Mr Sanders sought a relief order under s 37AH of the Act which empowers the Court to grant relief on the application of an issuer if the Court considers it is just and equitable to make such an order.
[18] In a judgment delivered on 28 November 2016, Dunningham J found that the offers to purchase units in the resort subject to a cottage lease constituted offers or participatory securities; the exemption in s 5(1)(b) of the Act did not apply; and Mr Sanders had not proved that there was no negligence or misconduct on his part.[3] Accordingly, the Judge found that Mr Sanders was liable to repay the subscriptions plus interest calculated in accordance with the Act. Mr Sanders’ appeal in CA671/2016 is brought against this judgment.
[19] In a separate judgment delivered on 7 July 2017, Dunningham J declined to make a relief order under s 37AH of the Act.[4] Mr Sanders’ appeal in CA379/2017 is brought against that judgment.
[20] Mr Sanders advances the same grounds on appeal as he relied on in the High Court to resist the respondents’ claims. He also seeks to raise an additional defence, not pleaded in the High Court, that those respondents who were outside New Zealand when they received their offers are not entitled to the protection of pt 2 of the Act and cannot recover their subscriptions. The respondents oppose Mr Sanders’ attempt to advance this additional defence claiming that they would be prejudiced. They say that had this defence been pleaded, they would have sought detailed particulars and addressed the issue in evidence at the trial.
[21] The issues are:
- (a) Did the offers to purchase units subject to the cottage lease constitute offers of participatory securities under the Act?
- (b) Did the exemption under s 5(1)(b) of the Act apply?
- (c) Should Mr Sanders be permitted to argue on appeal that any respondents who were outside New Zealand when they received their offers were not entitled to claim?
- (d) If the answer to (c) is “yes”, is this an available defence?
- (e) Did Mr Sanders prove that the default in repayment of the subscriptions was not due to any misconduct or negligence on his part in terms of the proviso to s 37(6) of the Act?
- (f) Should a relief order have been made under s 37AH of the Act?
Issue 1 — did the offers to purchase units subject to the cottage lease constitute offers of participatory securities under the Act?
[22] The respondents pleaded that there were eight separate businesses forming part of the resort, one conducted from each “Complex”. They defined each “Business” as the business of tourist accommodation and the letting of units to members of the public. They alleged that each respondent owning a unit in each complex “has a share in the Business run from that Complex by each of them taking a proportionate share of the earnings of the Business”. They pleaded that earnings were generated from each “Business” by:
- (a) Letting each [Respondent’s] Unit in a Cottage Complex to guests;
- (b) Allocating those guests to each of the Units in a Complex on a fair and equitable basis so that the income generated from such guests are shared between all unit owners in that Complex. [the guest allocation clause]
- (c) Sharing the costs incurred in respect of that Complex.
[23] The respondents further alleged that they each had a “right to participate and share in the earnings of their respective Business” and that this was a participatory security being a share of a proportionate ownership scheme.
[24] The Judge accepted the respondents’ contention that the offers constituted offers of participatory securities for reasons summarised in the following passages of her judgment:
[108] ... The real distinction is whether they were earning a conventional rental derived from owning a piece of real estate ..., or whether they were, in practical terms, investing in a business where their earnings came from a business venture jointly undertaken with others.
[109] Were this simply an investment in real property ... investors could expect to receive rental, subject only to the usual risks of being a lessor, for example, difficulty in finding a tenant, or a particular tenant failing to pay the agreed rent. In this case, however, I accept the [respondents’] submission that, in practical terms, the tourism accommodation business is the business of the investors. This is because under the terms of the lease it is the investors, not [Monaco Management], who are assuming the business risk in relation to the resort. ...
[110] Were it [Monaco Management’s] business, one would expect [Monaco Management] to pay a fixed rental to investors (perhaps with some additional portion to be determined on a percentage basis according to net profit), but for [Monaco Management] to be the entity which is exposed to the costs and risks of running the tourism business. However, that is not the case. Instead the investors are responsible for paying all of the unit and business outgoings, including the salaries of the manager and other staff, and it is they who make the loss if the business outgoings exceed its income.
[111] Furthermore, under the terms of the lease, the investors have had much of the security of investing in real estate removed. They have no right to terminate the tenancy, even though it may be generating negative returns. In practical terms the lease lasts for 30 years, so most investors will not be free of the lease in their lifetime. Even when the lease ends, there are practical constraints on how the property can be used because it is required to be used for tourist accommodation under the terms of the resource consent which was granted when the resort was constructed. At present, there is only a limited range of exceptions to the units being used for this purpose.
[112] In summary, I consider that, in substance, investment in the resort is an investment in a form of participatory security. The investors, whether with other investors, or with [Monaco Management], are participating in the costs and earnings generated by the tourist accommodation business. The investments had very few of the features of an ordinary purchase of real estate. Very few purchasers took any interest in which unit they bought, as they viewed it primarily as an investment vehicle as opposed to a purchase of real estate. The investors have very limited rights of occupation and are significantly constrained in how they can use the property they own. For these reasons, I consider the offers to purchase units in the resort, whether using the Hotel or the Cottage Lease, were offers of participatory securities as defined in the Act.
[25] The Judge saw the critical issue as being whether the investors were “investing in a business” or “earning a conventional rental derived from owning a piece of real estate”. She described this as “the real distinction”. The Judge’s conclusion followed from her assessment that the “tourism accommodation business” was the business of the investors, not Monaco Management. It is clear that when the Judge referred to the “tourism accommodation business” she meant the business conducted from the resort as a whole because she found that the investors were “assuming the business risk in relation to the resort” and described the “investment in the resort” as “a form of participatory security”. The Judge concluded that the “offers to purchase units in the resort, whether using the Hotel or the Cottage Lease, were offers of participatory securities”. It appears that the Judge did not focus on the guest allocation clause or on the separate “business” allegedly conducted from each of the eight complexes in reaching this conclusion.
[26] Mr Goddard QC for Mr Sanders submits that neither the title to the unit nor the cottage lease is a security because neither confers any interest or right to participate in property owned by any other person and neither confers any interest or right to participate in the earnings of any other person. Instead, each respondent is entitled only to the earnings generated by their particular unit.
[27] Mr Skelton QC for the respondents submits that “the substance of the arrangement ... is that each investor participates in the revenue (and shared in the expenses) of the accommodation business in the complex their unit forms part of”. He says that under the lease the investors cannot manage their units as “a standalone business”. Instead, he argues that the respondents “take the profit (or loss) from a shared business undertaking, the risk of which lies upon them”. In summary, Mr Skelton contends that revenue from each complex is apportioned amongst individual unit owners in that complex through the guest allocation clause in the cottage lease.
[28] Ms Graham for the Financial Markets Authority offered no submissions on any of the issues and declined to take a position one way or the other.
[29] The definition of “security” includes the right to participate in any earnings of any other person. The respondents’ pleading focuses on earnings and alleges that each respondent has a “right to participate and share in the earnings of their respective business”.
[30] The critical issue is whether the guest allocation clause confers a right on individual unit owners to participate in the earnings derived not only from their own unit but also from guests occupying other units in the same complex. For the reasons that follow, we consider that the answer is “no”.
[31] The only earnings to which a unit owner is entitled is the rent payable under the cottage lease for that particular unit. The initial base rent, if one is payable, is calculated as a percentage of the purchase price of the particular unit. Thereafter, the rent payable for each unit is limited by the revenue derived from letting that unit. The earnings achieved from letting other units in the same complex do not form part of the rent calculation and are irrelevant to the rental assessment.
[32] “Rent” is defined in the cottage lease as follows:
Rent
1. Subject to deductions made in accordance with this Lease, including (without limitation) any amounts deducted in accordance with clause 2.3, the Rent payable to the Lessor (ie unit proprietor) will be the Gross Unit Revenue less the aggregate of:
(a) The Unit Outgoings;
(b) The Business Outgoings.
2. The Lessee will use its best endeavours to calculate and pay the Rent quarterly in arrears (or otherwise by agreement) by direct payment to the Lessor (or as the Lessor directs) without deduction other than as set out in this Lease.
[33] “Gross Unit Revenue” means “all revenue actually received by the Lessee (or any person on behalf of the Lessee) from the letting of the Unit to Guests (accommodation units only) but excluding all revenue relating to the provision of Ancillary Services”.
[34] “Unit Outgoings” means “all outgoings relating to the Unit as distinct from the Business”.
[35] “Business Outgoings” means “all outgoings relating to the conduct of the Business from the Unit”.
[36] It can be seen from these provisions that the revenue component of the rent calculation is restricted to the revenue actually received from letting the particular unit. The guest allocation clause does not alter this. It expresses what would otherwise be an implied obligation on the part of Monaco Management to allocate guests to units on a fair and equitable basis, subject to guest preference and selection. This provision goes some way to ensuring that each unit owner has an equal opportunity to earn revenue from their unit. However, the revenue achieved from letting a particular unit depends on a range of factors including its location, whether it is on the ground floor or an upper level, whether it has one or two bedrooms and the nature of the facilities provided. The Judge noted the evidence that the highest earning cottage in the High Street complex (where most of the respondents’ units are located) earned 58 per cent more than the lowest earning unit in that complex.[5] In Riverside, the disparity was 162 per cent whereas in Village Green Stage 2 the difference was only 13 per cent.
[37] We consider that the Judge was wrong to focus on the respondents’ exposure to “the business risk in relation to the resort” at the expense of applying the statutory language. While it is correct that the rent for each unit will inevitably depend on the success of the resort as a whole, this does not mean that an individual unit owner has a “right” to participate in any earnings other than those generated from his or her particular unit.
[38] If the cottage lease conferred a right to participate in the earnings of another then this “right” would be enforceable by suit. There is no such enforceable right here. A unit owner can only sue to recover the rent payable for his or her unit based on the revenue generated by letting that unit to guests. A breach of the guest allocation clause could sound in damages in a claim against Monaco Management but it could not found a claim against other unit owners for a share of the earnings achieved from letting their units. The guest allocation clause does not permit earnings to be re-allocated among unit owners.
[39] That some costs are shared is irrelevant. The definition of “security” relevantly focuses on earnings, not outgoings.
[40] We conclude that a unit owner has no right to participate in any earnings of any other unit owner. The offers therefore did not involve offers of securities in terms of the Act.
[41] Although this conclusion is sufficient to dispose of the appeal, we consider the remaining issues in case the matter goes further.
Issue 2 — did the exemption under s 5(1)(b) of the Act apply?
[42] Mr Sanders pleaded that separate certificates of title under the Land Transfer Act 1952 can be issued for each unit and for each of the cottage leases and accordingly the exemption in s 5(1)(b) of the Act applies. The respondents pleaded in their reply that s 5(1)(b)(i) of the Act does not exempt estates or interests in land which form part of a contributory scheme as in this case.
[43] The Judge found that the exemption in s 5(1) of the Act did not apply:
[122] In the present case I am satisfied that an investment in units in the resort falls within the exception to the s 5(1)(b) exemption, because what was being offered to investors was a “contributory scheme” as defined. ...
[44] Mr Goddard submits that the Judge fell into error by addressing only the first limb of the exception to the exemption under s 5(1)(b)(i) relating to whether the estate or interest forms part of a contributory scheme. He accepts that this limb of the exception is made out. However, he argues that the Judge failed to address the cumulative requirement under s 5(1)(b)(ii) as to whether the estate or interest entitles the holder to a right in respect of a specified part of the land for which a separate certificate of title can be issued. Mr Goddard submits that this limb of the exception does not apply because the respondents acquired an estate or interest in a specified part of the land and a separate certificate of title was issued for it.
[45] Mr Skelton again supports the Judge’s analysis and conclusion. He submits that Mr Goddard’s approach is flawed for two principal reasons.
[46] First, he contends that it would render the contributory scheme exception otiose because any estate or interest falling within the introductory words of the exemption in s 5(1)(b) would necessarily also come within the second limb of the exception (s 5(1)(b)(ii)).
[47] Second, Mr Skelton submits that if Mr Goddard’s interpretation was correct, it would mean that any component of a transaction qualifying as a security could be sheltered by the exemption by including it in a lease. He says that this would be contrary to the approach of the Privy Council in Culverden Retirement Village v Registrar of Companies:[6]
A single offer may lead to a single transaction containing several components, one or more of which may be within the statutory definition of securities and others not. Separate and quite different securities may be comprised in one contract. The offer of one right in conjunction with other rights and obligations cannot of itself exempt that right from being tested against the statutory definitions.
[48] Mr Skelton argues that Mr Sanders’ approach is also contrary to the Supreme Court’s decision in Hickman v Turn and Wave Ltd.[7] He relies particularly on the following observations of William Young J:
[82] We note that the Court of Appeal considered that some aspects of the promises made by Blue Chip were “ancillary” to the purchase of interests in land and thus protected by the exemption. This was in respect of the right under the JVA to receive interest payments and the right under the PIP to receive option fees. As is no doubt apparent, we disagree. The financial promises made by Blue Chip must be addressed in the way they were intended to be considered by the investors, that is, as a whole. And we think it perfectly clear that as a whole, those promises are not protected by the exemption.
[49] It follows from our conclusion under issue 1 that no component of the transaction came within the statutory definition of a security. There is no issue in this case of any separate right qualifying as a security being sheltered from the purview of the Act by including it in the lease.
[50] We are satisfied that these agreements came within the statutory exemption (quoted in [15] above). It is common ground that the offers came within the opening words in s 5(1)(b) — these were offers of estates or interests in land for which a separate certificate of title can be issued under the Unit Titles Act.
[51] While the first limb of the exception relating to contributory schemes applies (as the Judge found), the second limb does not. We accept Mr Goddard’s submission that the exception to the exemption in s 5(1)(b) is directed to contributory schemes involving fractional ownership of undivided shares in land. This interpretation gives meaning to the second limb under s 5(1)(b)(ii) and does not render it otiose as Mr Skelton suggests. It seems clear that Parliament intended that the mere purchase of an interest in specified land for which a separate indefeasible registered title can be obtained would fall outside the scope of the Act. However, where the purchaser’s interest in land is not protected by a separate certificate of title for a specified part of the land, the exemption would not apply.
[52] Here, the offers were for an estate or interest in land entitling the holder to a right in respect of a specified part of the land for which a separate certificate of title can be (and was) issued. The offers did not include any other interest or right to participate in any assets or earnings of another. There was no other security such as the associated debt securities that were cardinal features of the transactions in Culverden and Hickman. Accordingly, the offers fell squarely within the statutory exemption in s 5(1)(b) of the Act.
Issue 3 — should Mr Sanders be permitted to argue on appeal that any respondents who were outside New Zealand when they received their offers were not entitled to claim?
[53] Mr Goddard did not appear for Mr Sanders at the initial hearing in the High Court. He was instructed at the time of the relief hearing. He seeks to argue on appeal that any respondents who were outside New Zealand when they received their offers are outside the intended scope of the Act and cannot claim. Because this issue was not pleaded in the High Court and has therefore not been tested in evidence, the question arises as to whether Mr Sanders should be permitted to raise the point on appeal.
[54] An appeal is by way of rehearing but that does not mean that parties are free to recast their case and raise new issues that they regret not having raised at the time of the trial in the High Court. The appeal proceeds on the basis of the record in the Court below subject to the right to apply to introduce further evidence in the limited circumstances permitted under r 45 of the Court of Appeal (Civil) Rules 2005.
[55] The Supreme Court explained in Paper Reclaim Ltd v Aotearoa International Ltd why it is appropriate to take a cautious approach to applications by parties to alter the basis of their case after judgment has been given:[8]
[15] There are strong policy reasons why the courts should take a restrictive approach to applications by parties to litigation who seek to alter the basis of the case that they presented at trial, after judgment has been given. They reflect a strong societal interest in the final determination of concluded litigation. This interest must be balanced against the individual interests of particular litigants who, having received an adverse judgment, consider that the approach they took at the trial of their dispute was based on an incorrect premise and that a new approach is necessary to achieve the right result. It has been said that part of the societal interest lies in the risk that a liberal approach would lead to temptation by dissatisfied litigants to commit perjury. Another consideration is the unfairness to a successful litigant in allowing the protraction of proceedings by its opponent because its witnesses now say their evidence was mistaken. To these ends courts are required to function within prescribed limits framed to ensure there is an end to litigation.
[56] The Supreme Court considered in that case that it would be outside the “appropriate bounds” of the appellate process to allow an application to add a new ground of appeal and permit further evidence to be called in support of it.[9]
[57] We accept Mr Skelton’s submission that the respondents would be unfairly prejudiced if they were required to meet this new ground of defence at this stage. Had the defence been pleaded, the factual issues would have been explored before the trial by the respondents seeking detailed particulars and through the discovery process. The issue would then have been addressed in the evidence at the trial. As it is, the relevant factual issues have not been canvassed by the parties and no findings have been made by the Judge. It is too late now to attempt to raise this defence which cannot be resolved without hearing further evidence, none of which would qualify as fresh evidence, and making factual findings. That is not this Court’s function in hearing an appeal. It would be unfair to the respondents and contrary to the public interest in finality in litigation to allow this issue to be raised at this stage.
Issue 4 — if the answer to issue 3 is “yes”, is this an available defence?
[58] This issue falls away because of our answer to issue 3. It is not necessary to express any view on the availability of this defence had it been pleaded and we decline to do so in circumstances where the issue has not been tested in the High Court and there is no first instance determination in respect of it.
Issue 5 — did Mr Sanders prove that the default in repayment of the subscriptions was not due to any misconduct or negligence on his part in terms of the proviso to s 37(6) of the Act?
[59] Section 37(1) of the Act provides that no allotment of a security offered to the public for subscription shall be made unless there was a registered prospectus at the time of subscription. Any allotment made in contravention of this provision is invalid and of no effect (s 37(4)). The issuer is obliged to return any subscriptions received for such securities as soon as reasonably practicable (s 37(5)). If any subscriptions are not repaid within two months of receipt, the issuer and all directors of the issuer shall be jointly and severally liable to repay them together with prescribed interest (s 37(6)). The liability on the issuer is absolute subject to any relief order made under ss 37AC or 37AH of the Act. However, individual directors are not liable at all if they can prove that the default in repayment was not due to any misconduct or negligence on their part (the proviso is quoted in [16] above).
[60] The subscriptions were not repaid in 2008. Until the proceedings were issued in late 2013, no one suggested that these particular offers, which did not involve income pooling, amounted to offers of securities. Mr Sanders contends that he was not negligent in holding the view at the relevant time that these were not securities and that Monaco Village was therefore not required to refund the purchase prices paid. Accordingly, he argues that even if the Judge was correct that the subscriptions were repayable in 2008, the failure to repay them at that time was not due to any misconduct or negligence on his part.
[61] It is necessary to review the relevant background in further detail before addressing the competing contentions.
Hotel lease — income pooling
[62] As noted, Mr Gepp was the initial owner of the land and developer of the resort. In 2003, he was joined by Rod Duke and together they formed Monaco Village Holdings Ltd (Monaco Village Holdings) as their development vehicle. They adopted a standard form “hotel lease” which was drafted by Mr Gepp’s lawyers, McFadden McMeeken Phillips. This lease provided for a rental based on the gross unit revenue pooled from all hotel units. After deduction of costs and a management fee, the pooled revenue would be allocated based on the purchase price paid for a particular unit expressed as a percentage of the total purchase price for all hotel units.
Income pooling identified as Securities Act issue
[63] By mid-2004, Monaco Village Holdings had settled the sale of most of the hotel units and the hotel was open for business. The development had run into financial problems and further funding was needed. Westpac was approached to provide this funding. It was in this context that a potential Securities Act issue with income pooling under the hotel lease was identified by Anthony Harper, lawyers acting for Westpac, and drawn to the attention of McFadden McMeeken Phillips, Mr Gepp’s lawyers.
Cottage lease — separate accounting
[64] Westpac agreed to provide funding on conditions that Messrs Gepp and Duke approach the Securities Commission to address the issue with the income pooling under the hotel leases and adopt an individual accounting structure for the leases offered in connection with the sale of all further units. This is what led to the cottage lease being drafted by McFadden McMeeken Phillips with input from Anthony Harper. The purpose of the cottage lease was to avoid any Securities Act issues and it was used exclusively by Messrs Gepp and Duke for all sales from mid-2004 and later by Mr Sanders after he became involved in late 2005.
Securities Commission grants exemption to Monaco Village Holdings
[65] In July 2005 the Securities Commission granted an exemption to Monaco Village Holdings for participatory securities for the proportionate ownership scheme offered under the hotel lease at the resort. The exemption notice was supported by an enforceable undertaking given by Monaco Village Holdings and Messrs Gepp and Duke and accepted by the Securities Commission. It is clear from this document that all parties, including the Securities Commission, regarded the income pooling arrangements under the hotel lease as giving rise to the Securities Act issue and that there would be no such issue if the income for each unit was accounted for separately. The undertaking relevantly states:
- Background
...
2.5 The Company [Monaco Village Holdings] and Monaco Management wish to administer the rental income payable to each unit owner on a pooled income basis, with income/expenses derived from guests occupying all accommodation units pooled together within each relevant block of units, on a block by block basis. The Company and Monaco Management believe that income pooling is more efficient allowing cost savings, provides a fairer return to unit owners, and has a measure of support within the tourist accommodation industry. The rental income for some units is already being administered on a pooled income basis for each block.
Contravention of Securities Act 1978 and Securities Regulations 1983
2.6 The Company and Monaco Management accept that the offer or allotment of securities in the form of an interest in the income pooling scheme to existing or prospective unit holders, constitutes the offer of a participatory security to the public for the purposes of the Securities Act 1978. ...
2.7 The Company and its Directors were, at the time of the offer and allotment of the interests in the income pooling scheme arrangements (“the Securities”), unaware that such offers and allotment were made in contravention of the Securities Act 1978. ...
...
...
4.2 In relation to the Securities already offered to persons who have entered into sale and purchase agreements to purchase property in the Development, whether settled or unsettled, the Company:
(a) Will give written notice to each such person ... of the contravention or possible contravention of the Securities Act 1978 ...
(b) Will re-offer to each such person the “lease back” arrangements of all accommodation units to Monaco Management on the basis of the income pooling scheme whereby net pooled income will be distributed to unit owners, on a block by block basis.
(c) Will request that each such person approve their willingness to participate in such income pooling scheme.
(d) In circumstances where such persons do not request to participate under the re-offer proposal in an income pooling scheme regarding net rental, administered on a block by block basis, the Company will take appropriate steps to administer and account for the rental income derived from the relevant person’s unit on a per unit basis and take appropriate steps to separately account for income and expenditure regarding the relevant unit.
[66] The Securities Commission issued a news release at the same time as granting the exemption notice. This related to three developers, including Monaco Village Holdings. This news release reinforced that the issue was with income pooling. It relevantly reads:
...
All three companies had come to the Commission once they realised the law had been breached. All three companies are offering units in developments together with rights to join an income pooling scheme. These rights give owners a proportional share in the income from all or some of the units in the development. The rights are participatory securities under the law, and their offer and allotment must comply with the law.
... The recent enforceable undertakings accepted by the Commission have all required the developers to re-offer the interests, in compliance with the law. If subscribers decide not to take up the re-offer the enforceable undertakings require the companies to allow investors to withdraw from the income pooling schemes (and in the case of Monaco, to instead have their units administered on an individual basis).
...
[67] In November 2015 counsel for Mr Sanders made a request under the Official Information Act 1982 to the Financial Markets Authority relating to the exemption notice issued by the Securities Commission. In responding to this request in January 2016 Joanne Davis-Calvert, head of governance, policy & strategy, stated:
The Commission did not consider that the structure under which Monaco administered and accounted for the rental income derived from the relevant person’s unit on a per unit basis would be a security under the Act. In the Commission’s view the sale of a unit itself was not a Securities Act matter but if existing and prospective purchasers took part in an income pooling scheme then such investors would be joining a participatory scheme. ...
[68] In May 2016 Mr Sanders’ counsel sought further clarification by asking Ms Davis-Calvert “what elements of the offered interest were considered by the Commission to be the participatory security?” Her answer was:
The offer and allotment of the interest in the income pooling scheme arrangements were considered as constituting the offer of a participatory security for the purpose of the Securities Act 1978.
Mr Sanders’ involvement
[69] Westpac withdrew its support for the development in mid-2005. Mr Gepp then approached Lombard Finance to see if it would assist. Lombard engaged Mr Sanders to carry out due diligence on its behalf. Mr Sanders was chosen because of his considerable experience in the development, management and operation of successful hospitality businesses, including Terrace Downs in Canterbury. Lombard ultimately agreed to refinance the project on condition that Mr Sanders be involved. Mr Gepp had fallen out with Mr Duke by that stage and it was agreed that Mr Sanders would purchase Mr Duke’s shares. That occurred in November 2005. Mr Sanders later also acquired Mr Gepp’s interest, in August 2006.
Legal advice received
[70] During the due diligence period in 2005, Mr Sanders met with David Phillips of McFadden McMeeken Phillips who had drafted the hotel lease and worked with Westpac’s lawyers, Anthony Harper, in drafting the cottage lease and applying to the Securities Commission for an exemption for the income pooling arrangements under the hotel lease. Mr Sanders understood from Mr Phillips that the cottage lease had been drafted with assistance from Westpac’s lawyers to avoid any Securities Act issues.
[71] Mr Sanders also consulted his own lawyer, Geoff Saunders of Saunders Robinson Brown. Mr Saunders advised:
From you have said, the securities issues may only apply in respect of the hotel. If all the hotel units have been sold, I presume that if you formed a new company and then started selling the new units off with freehold titles and separate leases, accounting to owners for their own separate rental (unpooled), then there may be no securities issues. Anna [a staff solicitor] could have a look at all the securities documents that you have and let us know on this specific point.
[72] Mr Sanders said that the issue was also considered by Lombard’s solicitors, Gibson Sheat, and they also reached the conclusion that units offered subject to the cottage lease would not be offers of a security.
[73] The Judge found that Mr Sanders had failed to prove that he was not negligent. This was because the Securities Commission was not given the cottage lease and therefore did not specifically address whether the particular offers amounted to securities. Further, although his lawyers advised him that the offers may not raise any securities issue, Mr Sanders did not seek further advice from them to confirm this. The Judge dealt with the issue in the following two paragraphs of her judgment
[206] ... Mr Sanders argues that it was reasonable for him to consider that the Cottage Lease avoided a breach of the Act particularly when the Securities Commission highlighted the income pooling as the offending aspect of the transaction. However, the plaintiffs say that nothing said or done by the Securities Commission was relevant to Mr Sanders’ views on the Cottage Lease. The Securities Commission was never provided with a copy of it nor asked for a view as to whether the contributory scheme involving a Cottage Lease constituted a participatory security. Furthermore, Mr Sanders cannot show that he expressly sought and obtained legal advice on the validity of the Cottage Lease. At best, he obtained written legal advice which, in passing, noted that if he proceeded to sell units in the resort subject to the Cottage Lease “then there may be no securities issues”. That same lawyer offered to have another solicitor in his firm look further into the issue, but that suggestion was never taken up.
[207] The plaintiffs therefore say that what Mr Sanders did was to choose to take the risk that an offer of the units in the complexes subject to a Cottage Lease was not the offer of a participatory security. His own lawyer did not give him comfort that, by setting up a new company and using the Cottage Lease, he avoided a breach of the Act. He failed to take up the suggestion to seek legal advice confirming this to demonstrate there was no negligence or misconduct on his part and he, too, is jointly and severally liable to repay ...
[74] There are two issues under the proviso to s 37(6). The first is whether there was misconduct or negligence on the part of the director. If so, the question becomes whether there was a sufficient causative link between that misconduct or negligence and the default in repayment — was the default in repayment due to that misconduct or negligence? The Judge considered only the first of these questions.
[75] It is clear from the evidence that Mr Sanders genuinely believed that offers of units subject to the cottage lease would not pose any issue under the Securities Act. He had good grounds for holding that view. The whole purpose of replacing the hotel lease with the cottage lease was to avoid any issue arising under the Securities Act. Mr Sanders was entitled to have confidence that this had been achieved. Mr Gepp’s lawyers, Westpac’s lawyers and Lombard’s lawyers plainly all thought so. Westpac obviously would not have been prepared to advance further funding if they had been concerned that ongoing sales and leases would be void with all purchase prices being repayable with interest. Nor would Lombard have been prepared to advance substantial funding if it considered this was a material risk. The Securities Commission clearly thought that the problem arose because of the pooling arrangements under the hotel lease and would not arise if earnings for each unit were accounted for separately. Mr Saunders did not identify any issue with the cottage lease, even though his advice was somewhat tentative.
[76] In these circumstances, we do not accept that Mr Sanders was negligent in holding the belief in 2008 and 2009 that unit sales subject to the cottage lease were not securities and there was no obligation to refund the purchase prices paid. The Judge herself accepted in her relief judgment that “the prevailing view at the time these offers were made was that a lease arrangement where there was no income pooling would not breach the Act”.[10]
[77] Even if Mr Sanders ought to have followed up on Mr Saunders’ suggestion that a staff solicitor investigate further, which we do not accept, there is no reason to suppose that she would have reached a different view. It is clear that at the time the Securities Commission regarded income pooling as the issue creating the security. That was the view of Mr Gepp’s lawyers, Westpac’s lawyers, Lombard’s lawyers and the preliminary view of Mr Sanders’ lawyers. It is also the unanimous view of this Court. Any negligence in Mr Sanders not making further enquiry of his solicitors or the Securities Commission at the time cannot therefore be regarded as causative of the default in repayment.
[78] For these reasons, even if the guest allocation clause in the cottage lease did mean that a security was offered (contrary to our conclusion), we consider that Mr Sanders has demonstrated that the default in repayment of the subscriptions was not due to any misconduct or negligence on his part.
Issue 6 — should a relief order have been made under s 37AH of the Act?
[79] It is not necessary for us to consider this issue. We make only one brief observation about it. The effect of a relief order under s 37AH of the Act is that s 37(4) to (6) does not apply.[11] These are the provisions that require the subscriptions to be repaid. Any application for a relief order must be considered before any final judgment is entered against an issuer or a director under s 37(6). Once a final judgment has been entered requiring a director to repay subscriptions in terms of s 37(6), it is not possible to enter a further judgment finding (in the context of a relief application) that s 37(6) does not apply after all and there is no liability to repay the subscriptions as determined in the first judgment. Such judgments would be contradictory and could not stand together.
[80] The appeal in CA671/2016 is allowed.
[81] The orders made in the High Court are set aside and judgment is entered for the appellant on the respondents’ claims.
[82] The appeal in CA379/2017 is dismissed.
[83] The respondents must pay the appellant costs in CA671/2016 for a standard appeal on a band A basis and usual disbursements. We certify for second counsel.
[84] We make no order for costs on the dismissal of the appeal in CA379/2017.
Solicitors:
Meredith Connell,
Wellington for Appellant
GCA Lawyers, Christchurch for Respondents
[1] The statement of claim does not specify the date each agreement was entered into. The evidence of three of the respondents was included in the case on appeal and shows that their agreements were entered into in October 2006 (second respondents), June 2007 (seventh respondent) and July 2008 (first respondent).
[2] Securities Act 1978, s 2D.
[3] Bannock v Monaco Management Ltd [2016] NZHC 2842 [Principal High Court judgment].
[4] Bannock v Monaco Management Ltd [2017] NZHC 1575 [Relief judgment].
[5] At [107].
[6] Culverden Retirement Village v Registrar of Companies [1997] 1 NZLR 257 (PC) at 260.
[7] Hickman v Turn and Wave Ltd [2012] NZSC 72, [2013] 1 NZLR 741.
[8] Paper Reclaim Ltd v Aotearoa International Ltd [2007] NZSC 1.
[9] At [16].
[10] Relief judgment, above n 3, at [45].
[11] Securities Act 1978, s 37AB.
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