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High Court of New Zealand Decisions |
Last Updated: 4 March 2011
IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY
CRI-2009-092-20927
THE QUEEN
v
JOHN HOTCHIN
Hearing: 4 March 2011
Appearances: Mr B Dickey, Mr N Williams and Ms J M Blythe for Crown
Mr R B Stewart QC and Mr S Hunter for Prisoner
Judgment: 4 March 2011
SENTENCING REMARKS OF LANG J
R V JOHN HOTCHIN HC AK CRI-2009-092-20927 [4 March 2011]
[1] Mr Hotchin, you appear for sentence today having pleaded guilty to three charges laid under the provisions of the Securities Act 1978 (“the Act”). The maximum penalty in respect of each of those charges is a sentence of five years imprisonment.
[2] Your guilty pleas followed a sentence indication hearing that I held on 25
February 2011. At the conclusion of that hearing, having received full submissions from the Crown and your counsel, I indicated that an end sentence of 11 months home detention was available in the event that you pleaded guilty at that point. You entered guilty pleas following that indication.
[3] When I gave the sentence indication, I explained how I arrived at the end sentence. In sentencing you today, however, it is necessary for me to explain in a little further detail the reasons underlying the ultimate selection of that sentence.
[4] I begin by referring to the charges in respect of which you have entered guilty pleas.
The charges
[5] You were due to stand trial in this Court later this month on charges that you were a party to the making of untrue statements in three documents issued by Nathans Finance NZ Limited (“Nathans”) for the purposes of soliciting investments from the investing public. The untrue statements were said to have been made in an investment statement issued by Nathans for the purposes of the Act on or about
13 December 2006, a prospectus issued by Nathans and available to the investing public between 13 December 2006 and 30 March 2007 and an extension certificate issued in respect of that prospectus on or about 29 March 2007.
[6] In summary, the allegations that underpin those charges (as set out in particulars provided by the Crown in the indictment) relate to statements made in these documents regarding Nathans’ exposure to related parties, the lack of any bad debts, Nathans’ liquidity and the manner in which it assessed credit and managed its loan book.
[7] In order to understand these allegations it is necessary to traverse in some detail the factual background to your offending. This is contained in a summary of facts that has been prepared by the Crown with your agreement.
[8] It is also important to emphasise that the summary represents the factual basis that you and the Crown have agreed is appropriate for the purpose of sentencing you at this stage of the proceeding. Many of the facts contained in the summary may well remain in dispute so far as your co-accused are concerned. Whether or not the Crown will be able to establish them to the required standard is a matter that will be determined when they stand trial.
[9] I do not propose to recite the summary of facts. It will, however, be attached as an annexure to the written transcript of my sentencing remarks. This will enable those who may be interested in this case to fully understand the factual basis on which you are to be sentenced.
Nathans and VTL
[10] The charges against you flow from the fact that, along with your co-accused, you were a director of Nathans. You were appointed as a director on 23 July 2001 and you resigned on 31 March 2007. You were Nathans’ chairman until mid-2005.
[11] From the date upon which Nathans was incorporated, it operated as a finance company. Nathans funded its financing activities primarily by the issue of secured debentures to members of the public under a trust deed dated 15 November 2001.
[12] From the outset a very substantial part of Nathans’ business involved loans that it made to its parent company, VTL Group Limited (“VTL”). Nathans is a wholly owned subsidiary of that company, which had interests in numerous vending machine-related businesses operating in New Zealand, Australia, North America and Europe. You were appointed as a director of VTL on 16 February 1998 and you remained a director of that company until your resignation on 16 October 2007.
[13] VTL was incorporated in 1998, and you held a considerable number of shares in the company from the date of its incorporation. You then made some of those shares available to the public when the company listed on the New Zealand Stock Exchange in November 2000. You continued to own 33.2 per cent of the company after the date upon which shares in VTL were issued to the public.
[14] Nathans ultimately went into receivership on 20 August 2007. As at that date, more than 7,000 investors had advanced funds to the company. Those advances were secured by way of debenture. The total amount invested in the company was approximately $174 million. As at the date it went into receivership, Nathans had advanced approximately $170 million to VTL and entities associated with it. Thus far the receivers have been able to recover less than four per cent of the principal outstanding to Nathans. There appears little likelihood that further significant recoveries will be made other than through court action. As a result, the total loss that investors will suffer is likely to be in the region of $168 million.
The Securities Act 1978
[15] The Securities Act 1978 is designed to protect the investing public by prescribing the information that an issuer of securities must make available to potential investors. It prohibits debt securities from being offered to the public unless the issuer makes an offer in an authorised advertisement, an investment statement or prospectus that satisfies the requirements of the Act. The issuer must also appoint a trustee and sign a trust deed in relation to the securities.
[16] In New Zealand, an investment statement is now the principal method by which offers are made to the public. The purpose of an investment statement is to provide key information that will assist prudent, but non-expert, persons to decide whether or not to subscribe for securities. It also advises prospective investors that other important information about the security is available in the prospectus.
[17] A prospectus must be registered before any securities can be allotted, and the prospectus must be accompanied by audited financial statements. A prospectus has a finite life of nine months, but can be extended if at least two directors of the issuer
certify within a specified period that, after due enquiry by them, the financial position shown in the financial statements has not materially and adversely changed.
[18] The prospectus and investment statement are the cornerstone disclosure documents upon which the investing public bases its decision as to whether or not to take up a subscription for securities. It follows that, in the event that the issuer makes untrue statements in those documents, those who invest funds with the issuer will base their decision to do so on flawed or incorrect information.
[19] The Act defines an untrue statement as a statement that is actually not true, is misleading in the form or context in which it is made or is misleading by virtue of the omission of a particular that is material to the statement in the form or context in which it is made.
[20] It is important to bear in mind for present purposes that, as the summary of fact records, you have pleaded guilty on the basis that at the time that the statements in the critical documents were made you believed that they were true. You now accept that your belief was not reasonable in light of what you knew or ought to have known.
The documents on which the charges are based
[21] The first charge is based on a prospectus dated 13 December 2006 that Nathans registered with the Registrar of Companies on 15 December 2006. That prospectus contained an offer of secured debenture stock under the trust deed between Nathans and Perpetual Trust Limited as trustee. The prospectus was signed by the other three directors of the company and was also signed by one of those directors on your behalf. That prospectus was distributed between 15 December
2006 and 20 August 2007, when Nathans withdrew the offer of securities contained in the prospectus. The investment statement dated 13 December 2006 was made available to the public along with the prospectus.
[22] On 29 March 2007, whilst the prospectus was available to members of the investing public, Nathans registered an extension certificate with the Registrar. You
were one of the two directors who signed that document. When that certificate was registered, the period within which securities could be allotted pursuant to the prospectus was extended for a further nine months.
Summary of offending
[23] The summary of facts records that the three documents upon which the charges are based contained untrue statements in relation to a number of issues. In keeping with the particulars in the indictment, the summary of facts records that the documents contained untrue statements about lending to related parties, the lack of any bad debts, Nathans’ liquidity position and the manner in which Nathans carried out its credit assessment and the way in which it managed its loans.
Lending to related parties
[24] The Crown accepts that the prospectus and the financial statements that accompanied it disclosed to investors that a significant proportion of the company’s loan portfolio comprised loans to VTL, VTL’s subsidiaries, and individuals and entities associated with VTL. The prospectus said, however, that Nathans had made those advances on a commercial arm’s length basis, and normally for terms no longer than 12 months.
[25] The summary records a variety of ways in which the loans were not made on a commercial arm’s length basis. By way of example, it records that Nathans’ loan approval processes were below the standard that would be expected in cases involving normal commercial arm’s length lending. Inter-company facilities were permitted to exceed their limits before being extended, and on several occasions security was not taken until well after an advance had been made. In addition, advances were made from time to time on the basis of security in respect of which no valuations had been obtained.
[26] Your counsel points out that those matters need to be viewed in light of the fact that VTL had no substantial external creditors, and it was controlled and managed by the same board of directors that governed Nathans. The Nathans board
therefore effectively controlled any potential for other creditors to obtain priority over Nathans. He also points out that Nathans ultimately obtained security in February 2007, and its failure to obtain security at an earlier date did not cause any loss to investors. The fact that credit limits were exceeded before they were formally extended was likewise ultimately regularised, and that did not cause any loss either.
[27] Nathans also made advances to an Australian company and an American company, both of whom were associated with VTL’s operations in their home countries. In both cases existing loans to VTL were transferred to these entities in order to reduce VTL’s level of indebtedness. Although VTL continued to guarantee the loans and Nathans disclosed details of the loans to its trustee, it did not undertake any assessment of the financial position of the new borrowers. Your counsel points out that this shortcoming did not cause any loss for investors either.
[28] Further, Nathans made loans to trusts associated with its directors, including yourself. These were recorded in the prospectus and they were secured against shares in VTL that the trust owned. Although the trusts initially paid interest on the loans, the trusts were later permitted to capitalise interest and were not required to pay it on a periodic basis as had previously been the case. You accept that was the case, but say this was not your idea. It only came about, you say, when your trust decided to sell some shares in VTL to repay its obligations to Nathans. At that point you say that VTL’s chairman asked you not to sell the shares, and offered to allow the trust to begin capitalising the payments of interest that it had previously been making.
[29] The statement that loans were normally made for terms no longer than 12 months was misleading by omission, because the inter-company loans were typically rolled over at the end of each 12 month period. Interest was also capitalised rather than paid in cash. You accept that the prospectus should have contained this additional information, but your counsel says that at the time that the statement was made you did not consider that it was misleading by omission.
Bad debts
[30] The prospectus stated that Nathans had an “unblemished record of nil bad debts written off”. That statement was literally correct, but it was misleading because it omitted material information relating to loans that Nathans had made to VTL and two associated companies called Intelligent Vending LLC (“Intelligent”) and Advanced Vending Systems Pty Limited (“Advanced”).
The loans to VTL
[31] Nathans’ financial statements for the period ended June 2006 recorded that it had outstanding advances to VTL and its subsidiaries of $79 million. Interest on this sum was being capitalised. Nathans ability to recover these advances therefore depended on the value of VTL’s assets and the security that Nathans held over those assets. The Crown accepts that the debts would not need to be treated as bad or impaired debts if Nathans had held adequate security for them.
[32] You say that you believed that Nathans had adequate security for the advances to VTL and its subsidiaries because of the fact that in May 2006 it had obtained a valuation of VTL’s business from an independent valuer. This placed a value on VTL’s business as at 31 December 2005 of $228 million.
[33] The valuation relied, however, upon a discounted cash flow analysis based on a five year forecast prepared by VTL’s internal management. The information available to Nathans’ directors ought to have led them to conclude by December
2006 that it was not reasonable to rely on this valuation, because VTL’s actual business performance did not match the forecasts upon which the valuer had relied. This fact should have led Nathans to treat VTL’s loans as impaired, and it also called into question the validity of the valuation prepared seven months earlier.
Intelligent and Advanced
[34] Intelligent and Advanced were the master franchise holders for VTL’s
Californian and Australian operations respectively. As at 30 June 2006, Nathans had
loaned approximately $36 million to the two companies. By 31 December 2006 this figure stood at a little more than $37 million, including capitalised interest.
[35] The financial statements of the two companies were available to Nathans, and these confirmed that neither company was operating profitably. That was the case despite the fact that neither had been required to pay interest to Nathans. As a result, by December 2006 Nathans should have treated both loans as being substantially impaired. No provision for bad debts was made in respect of either loan by Nathans in its financial statements for the period ending 31 December 2006.
[36] You say that your belief in respect of Intelligent and Advanced was based on a valuation of Intelligent’s business by another independent valuer. That valuation had been peer reviewed by Nathans’ own auditors. You personally played no part in obtaining the valuation, which showed that the value of Intelligent’s business was greater than the sums that Nathans had advanced to it. You also relied upon that valuation as providing comfort in respect of the value of the business owned by Advanced.
[37] Again, however, you accept that by December 2006 it was not reasonable to continue to rely upon the valuation having regard to Intelligent’s actual performance levels after the date upon which the valuation was prepared. You accept that by that date Nathans ought to have treated VTL’s loans as being impaired.
Nathans’ liquidity
[38] The prospectus stated that Nathans had policies in place to ensure that all obligations were met within a timely and cost-effective manner, that prudential policies were regularly monitored, and that Nathans maintained sufficient liquid funds to meet its commitments based on historic and forecasted cash flow requirements.
[39] By December 2006, however, Nathans was reliant on the “rollover” of
existing investments and cash from new investors in order to be able to continue to
make advances to enable VTL to fund its ongoing work and capital requirements, and to pay interest due to existing debenture holders.
[40] The capitalisation of interest was a major contributor to this state of affairs. VTL alone accrued interest totalling approximately $5.5 million during the 2006 calendar year. It made no actual interest payments to Nathans during that year. Between January and June 2007 it accrued further interest of approximately $3.1 million, but similarly made no actual payments to Nathans.
[41] Interest was also charged to the VTL account in respect of other related party loans totalling $5.7 million for the 2006 calendar year and $3.5 million between 1
January and 30 June 2007. Once again, no actual payments were received by Nathans in respect of these interest charges. This meant that the company had significant negative cash flow.
[42] You accept that this was the case, but you say that the cash flow position was clearly disclosed in the prospectus and in the financial statements that accompanied it.
[43] Nathans’ claim that it had policies in place to ensure that all obligations were met would also appear to be incorrect in light of the analysis of the liquidity profile as at 31 December 2006. Nathans’ internal reports assumed that the loans to Advanced and Intelligent would be repaid on the due date, but it must have been reasonably obvious by December 2006 that this assumption was unsustainable.
[44] The prospectus also stated that Nathans liquidity was supported by inter- company borrowing from its parent company, VTL. This was incorrect as it was in fact VTL that was being supported by borrowings from Nathans. You say, however, that the true position would have been apparent to anybody who read the prospectus as a whole.
Culpability
[45] You have provided me with an affidavit in which you set out your background experience and the manner in which you became involved in VTL and Nathans. You acknowledge that you were involved with VTL from the outset. Its business operations expanded rapidly, first into Australia, then Europe and the United States. In those countries VTL’s approach was to sell a master licence to an operator who would then pursue VTL’s strategy of acquiring vending machines, installing VTL’s technology and then selling the rights to franchisees who would operate clusters of machines. Nathans was incorporated in order to raise funding for the expansion of VTL’s businesses by providing finance to its franchisees.
[46] You moved to the United Kingdom in April 2004 in order to focus on the expansion of VTL’s business into Europe. In 2005 VTL acquired an interest in a major United States machine vending company, and you joined the board of that company in January 2005. You then moved with your family to live in the United States in June 2005 after being appointed as the company’s Chief Executive.
[47] You say that from that point on you no longer held an executive position with Nathans or VTL. Thereafter you no longer received a salary or director’s fees from either company. You concentrated your efforts on developing and expanding your American employer’s business. You continued, however, to attend VTL and Nathans’ board meetings by telephone.
[48] You say that you were a non-executive director of Nathans, and point out that that is how you were described in agenda documents that were sent to members of Nathans’ board. Whether or not you are classified as an executive director or non- executive director does not really matter for present purposes. What is important is that, as the summary makes clear, you were fully involved in board decisions. Before doing so you received the same documents that were circulated to the other members of the board. The fact that you may not have been involved on a day-to- day basis in running the company or implementing the board’s decisions is of no real moment.
[49] The extent to which you were prepared to become involved in decisions relating to the drafting of the prospectus is demonstrated by an exchange of emails relating to the draft prospectus that occurred between you and other members of the board in October and November 2006. That exchange makes it clear that you were prepared to express firm views regarding the manner in which the prospectus should be worded. It also suggests that, although you were ultimately prepared to accept the legal advice that the board received, nevertheless you were reluctant to permit the prospectus to contain more information than was strictly necessary regarding the loans that Nathans had made to VTL. As the Crown submits, this gives an insight into the attitude that you adopted in relation to the drafting of the prospectus.
[50] The view that I take is that your involvement in both VTL and Nathans created a mindset in which you were committed to making every effort to ensure that VTL and its subsidiaries succeeded. Unfortunately, this severely compromised your ability to view the true financial position of those companies, and hence the risk to Nathans’ investors, reasonably and objectively.
[51] You were prepared to overlook or ignore the fact that VTL and its associated companies were performing poorly. This was despite the fact that the financial information that was made available to you made that fact plain. Your actions meant that Nathans and its investors became significantly exposed as a result of the loans that Nathans had made to the VTL companies. Had you viewed the financial performance of the VTL group as objectively and dispassionately as you should have done in December 2006, you would have quickly realised that those companies were not performing well. At the very least, you would have appreciated that the value of Nathans’ security was open to question, and that the loans to the VTL companies should be treated by Nathans as being impaired.
[52] I also view with concern the impression that the prospectus gave regarding Nathans’ liquidity. That statement suggested to prospective investors that Nathans had the ability to meet its obligations to investors as and when they fell due. The truth of the matter is that by December 2006 Nathans was not in a position to meet its obligations to existing investors unless those investors were prepared to roll over their loans and/or new investors were prepared to provide fresh advances.
[53] Those two aspects of your conduct are, in my view, the most culpable for present purposes.
Sentencing Act 2002
[54] Whenever a Court sentences an offender it must take into account the purposes and principles of sentencing set out in the Sentencing Act 2002.
[55] In your case, I accept that issues of deterrence and denunciation are important. It is also important to hold you accountable for your actions, and to promote in you a sense of responsibility for what your offending has done.
[56] This leads to another relevant consideration under the Sentencing Act, namely the harm that you have caused to the victims of your offending. As I have said, when Nathans went into receivership it owed approximately $170 million to investors. The Crown’s submissions appear to be premised on the basis that your offending is responsible for much, if not all, of that loss.
[57] I do not accept, however, that that can be the case. By December 2006 investors had already invested a very considerable sum with Nathans, presumably in reliance on the information contained in documents that Nathans had issued prior to that date. The Securities Commission clearly accepts that prospectuses and investment statements that Nathans issued before December 2006 did not contain untrue statements because, to the best of my knowledge, it has not laid any charges in relation to those documents.
[58] Your offending may, however, have been a material cause of loss to investors who invested new funds, or who allowed existing investments to be rolled over, after December 2006. Had such persons known the true position regarding Nathans’ liquidity and the state of the loans to VTL and its subsidiaries given their financial performance, they may well have declined to invest funds with Nathans.
[59] The Crown confirms that the public invested new funds totalling $12.3 million between 13 December 2006 and 31 March 2007. During the same period
existing investors reinvested, or rolled over, loans totalling $13.9 million. Potentially, therefore, your offending contributed to losses amounting to approximately $26 million.
[60] I accept that some of these funds may have been invested or re-invested with Nathans even if the prospectus and investment statement had not contained untrue statements. Nevertheless, had they painted a true picture, it is highly likely that some investors would have recognised that an investment with Nathans at that point carried a significant element of risk.
[61] Before the hearing last Friday counsel for the Crown provided me with victim impact statements from persons who have lost money through the investments that they have made in Nathans. For the most part they are ordinary New Zealanders who saved hard during their working lives in the hope that they would be able to enjoy their retirement. That hope has been destroyed because of the losses that they have suffered as a result of their investments. That is devastating for them, and it is something from which they have no ability to recover. You need to know that they hold you largely responsible for the losses they have suffered.
[62] My comments thus far relate only, however, to the direct harm that your offending may have caused. Added to that is the indirect and incalculable harm that has been suffered by the nation as a whole as a result of the collapse of finance companies such as Nathans.
[63] This has produced three immediate and long lasting effects. First, it has deterred would-be investors from investing their funds with finance companies and it is likely to do so for a very considerable period. They are no longer prepared to trust finance companies like Nathans with their hard earned money. Secondly, the absence of such investment removes venture capital that would otherwise be available for both “start up” and existing businesses and ventures in this country. That type of activity represents the lifeblood of New Zealand’s economic growth. Without it, many businesses and ventures will find it impossible to obtain affordable venture capital. Thirdly, those in the international business community lose faith in the integrity of New Zealand’s business people and this country’s securities
legislation. This means that it will be harder for New Zealand businesses to attract venture capital of this type from overseas.
[64] It is fair to say, as counsel for the Crown has pointed out, that the financial investment sector in which Nathans played a reasonably significant part has now effectively been removed completely from New Zealand’s financial landscape. That will inevitably have a serious and ongoing effect for the development of our economy.
[65] The harm to which your offending has contributed therefore forms an important factor in fixing the sentence to be imposed upon you. It is also important, however, not to lose sight of the other purposes and principles of sentencing prescribed by the Sentencing Act. These include the need to impose a sentence that reflects the gravity of your offending when compared to penalties imposed in broadly similar cases. I am also required to select a penalty that is the least restrictive outcome appropriate in the circumstances, and to give effect to the principle that the court should not impose a sentence of imprisonment unless the purposes of sentencing cannot be achieved in a less restrictive way.
Starting point
[66] The first step in the sentencing process is to select a starting point that properly reflects the culpability of your offending. This takes into account all relevant aspects of the offending, but does not reflect aggravating or mitigating factors that are personal to you.
[67] There is no tariff, or guideline, judgment of our Court of Appeal fixing a starting point for sentences to be imposed in this area. Counsel are not far apart, however, in their assessment of the range within which the starting point in your case should lie. The Crown submits that a starting point within the range of three to four years imprisonment is appropriate. Your counsel submits that a starting point of two years six months imprisonment should be adopted.
[68] Counsel have referred me to a number of sentencing authorities, many of which relate to sentences imposed in the District Court. Of these, I view the most useful as being R v Clegg[1]. Mr Clegg pleaded guilty to five charges under the Securities Act 1978 and the Companies Act 1993. Two of these were charges under s 58 of the Securities Act 1978, and related to untrue statements contained in a prospectus. The total losses in that case were estimated to be approximately $6.5 million. The sentencing Judge adopted a starting point of two and a half years imprisonment and imposed an end sentence of home detention.
[69] In R v MacDonald & Ors[2] (the Five Star Finance case) two of the three offenders had pleaded guilty to charges laid under both the Crimes Act 1961 and the Securities Act 1978. The remaining offender had pleaded guilty to charges laid under the Securities Act only. The starting points that the sentencing Judge selected on the Securities Act charges ranged from three years four months to four years imprisonment. Significantly higher starting points were selected on the Crimes Act charges, which had as a key ingredient elements of actual dishonesty. The offender who did not face any charges under the Crimes Act ultimately received a sentence of home detention, whilst the others were sentenced to terms of imprisonment.
[70] I consider the offending in that case to be more serious than that in the present, because the breaches were deliberate and more serious in several ways. The breaches continued over a very lengthy period, and the untrue statements in the prospectus included false information regarding the nature of the lender’s business, as well as false statements about the standards that it applied to its lending. For that reason I consider that a starting point slightly below those adopted in McDonald is appropriate.
[71] I consider that an appropriate starting point in your case is one of three years imprisonment.
Aggravating factors
[72] There are no aggravating factors personal to you that operate to increase the starting point that I have adopted.
Mitigating factors
[73] Your counsel has pointed to several mitigating factors. They are your otherwise good character, the remorse that you have expressed, the fact that you have paid $200,000 reparation and the fact that you are co-operating actively with the authorities in relation to the prosecution against your co-accused.
[74] You have provided me with a large number of references regarding your otherwise good character. You have some minor previous convictions that occurred some 28 years ago, but I put those to one side for present purposes. The difficulty with this aspect of your counsel’s submission is that, in many ways, you and Nathans relied on your good character and business acumen to persuade investors to invest money in Nathans. The description in the prospectus of your past experience and attributes was calculated to have that effect. I regard your previous good character as a neutral factor in the present context.
[75] Next, I consider the issue of remorse and the allied issue of the reparation that you are about to pay. You have apologised to investors and expressed your remorse for the losses that have been suffered by Nathans’ investors. You frankly acknowledge that you initially blamed the company’s demise on the global financial crisis, but say that you have now realised that you must take some of the responsibility for the losses that investors have suffered.
[76] I make some allowance for remorse, but this is principally within the context of the fact that you have been prepared to sell your remaining assets in New Zealand in order to pay reparation of $200,000 to Nathans’ receivers.
[77] Your counsel points out that you will not benefit in any material way from your involvement with VTL and Nathans. You face substantial civil claims relating
to your conduct as a director, and your guilty pleas mean that the insurer who has funded your defence to date will be seeking reimbursement of the monies that it has expended for that purpose. The only other asset that you have is a house in America, and the monies secured against that property appear to equal or exceed its value. It is virtually inevitable, as your counsel points out, that at 51 years of age you will be declared bankrupt.
[78] The most significant mitigating factor, in my view, is that you have co- operated with the authorities and signed an evidential statement that will be used at the trial of your co-accused. You have confirmed that you will give evidence for the Crown at their trial in accordance with the statement that you have made. The Crown accepts that you are entitled to substantial credit for this, although it points out that your evidence is not critical to the Crown case because will rely to a large extent upon contemporaneous documents.
[79] In R v Hadfield[3] the Court of Appeal confirmed that an offender who pleads guilty at an early stage, and who materially assists the prosecution in the way that you intend to, can expect to receive a total discount of up to 60 per cent. That will usually occur, however, in circumstances where the offender thereby places himself or herself at physical risk as a result of assisting the authorities. It will also generally be appropriate where the assistance that the offender provides is vital to the success of the prosecution. Neither of those factors is present in your case.
[80] I consider, however, that the reparation that you have paid, the remorse that you have shown and your assistance to the authorities combine to justify a discount of 30 per cent. When taken with the credit that I propose to give you in relation to your guilty plea, it means that the total credit that I propose to allow is one of 45 per cent. I record that the Crown submitted that a total discount of approximately 40 per cent was appropriate, whilst your counsel submitted that a discount of 50 per cent
should be applied.
[81] This leads me to consider the extent to which your sentence should be reduced to reflect your guilty plea. The credit to be given for guilty pleas is now determined by the Supreme Court in R v Hessell[4]. In that case the Supreme Court confirmed that a discount of 25 per cent is the maximum allowable to recognise this factor alone. Generally speaking, the earlier the plea the greater the discount that can be given.
[82] In your case the guilty pleas were entered at a very late stage, although I accept that discussions between your counsel and the Crown began approximately five months ago. It was also no doubt necessary for your counsel to fully understand the basis on which the Crown advanced its case before an offer to plead guilty could realistically be made. Having regard to those matters, I propose to allow a discount of 15 per cent to reflect your guilty pleas.
[83] This produces an end sentence of 21 months imprisonment.
Home detention
[84] The real issue that I need to determine is whether or not you should be sentenced to home detention rather than imprisonment. In your case I am not constrained by the two year limit that would otherwise apply. Your offending occurred whilst the transitional provisions of the home detention legislation were in force. This means that a sentence of home detention would potentially have been available, even if the end sentence that would otherwise be imposed had exceeded
two years.[5]
[85] The Crown does not oppose a sentence of home detention being imposed, but it does not support it either. It leaves the issue to be determined by the Court, but
emphasises that before imposing a sentence of home detention the Court will need to
be satisfied that such a sentence would adequately address the important issues of denunciation and deterrence.
[86] Had there been any suggestion that you deliberately attempted to mislead investors, a sentence of home detention would have been out of the question. That type of conduct could generally only properly be marked by a sentence of imprisonment. That is not, however, the position here.
[87] I accept without reservation that principles of denunciation and deterrence are important in dealing with offending in this area. Nevertheless, home detention is a significant sentence. It comprises a substantial deprivation of liberty, and the longer the sentence the longer that deprivation occurs.
[88] I take the view that a sentence of home detention is appropriate in the circumstances of the present case for three reasons. First, you have acknowledged your offending and candidly accept the basis on which the charges were laid. Second, you have shown remorse and you are about to pay reparation. Third, you have offered to co-operate in the fullest of ways with the prosecuting authorities by giving evidence against your co-accused. Those factors mean, in my view, that the principles set out in the Sentencing Act 2002 will not be compromised by a sentence of home detention.
Sentence
[89] For those reasons, I now impose upon you a sentence of 11 months home detention, coupled with 200 hours community work. In addition, you are ordered to pay reparation in the sum of $200,000 to Nathans’ receivers.
[90] I now impose the following conditions:
(a) You are to travel directly from Court to the nominated address and you are to remain at that address for the duration of your sentence.
(b) You are to notify your Probation Officer prior to starting, terminating or changing your position or place of employment. Any employment (paid or unpaid) is to be approved by your Probation Officer.
(c) You are to undertake such counselling as directed by the Probation
Officer.
[91] Stand down
Lang J
Solicitors:
Crown Solicitor, Auckland Gilbert Walker, Auckland Counsel:
Mr R B Stewart QC, Auckland
R v John Lawrence Hotchin
Agreed Statement of Facts for the Purposes of Sentencing Indication
Introduction
1. Mr John Hotchin faces three charges under section 58 of the Securities Act 1978 relating to the Prospectus and Investment Statement of Nathans Finance NZ Limited. Mr Hotchin seeks a sentencing indication in order that he may consider changing his plea prior to the commencement of an 8-week trial scheduled to commence on 15
March 2011. For the purposes of the sentencing indication, the Crown and Mr Hotchin have agreed on the summary of facts set out below.
The Companies
2. Nathans Finance NZ Limited (in receivership) (“Nathans”) is a wholly owned subsidiary of VTL Group Limited (in receivership) (“VTL”), a company listed on the New Zealand Stock Exchange.
3. Nathans was incorporated on 23 July 2001. The company’s principal business was as a finance company and it raised funds from the public by the issue of debenture securities under a Trust Deed dated 15
November 2001.
4. VTL was incorporated in December 1997. The company developed proprietary software and hardware systems for the vending industry. These systems allowed companies to remotely monitor sales and cash receipts on a real time basis. VTL also developed a franchising business based on its technology.
5. VTL had a number of high profile directors. The company was chaired successively by John Collinge (former president of the National Party), Richard Janes (former Chairman of Wools of New Zealand Limited), Warren Larsen (former CEO of the New Zealand Dairy Board) and
Gary Stevens. John Hotchin was a director of VTL from the date of its incorporation.
6. VTL was listed on the New Zealand stock exchange in 2000. 25.4 percent of the company’s shares were sold to the public. The remaining shares were owned as to 33.2 percent each by interests associated with John Hotchin and Mervyn Doolan and as to 4.1 percent each by interests associated with Gary Stevens and Roger Moses. VTL made a number of substantial investments overseas, including in All Seasons Services Inc (“All Seasons”) (a major United States vending company), Shop24 (a Belgian manufacturer of large vending systems), MAB Service Inc (a California vending company), Universal Vending Management Inc (a major United States vending broker) and in the vending assets of Nor-Cal Beverage Co (a major Californian bottler).
7. A substantial part of Nathans’ financing activities involved making loans to its parent company VTL and VTL’s subsidiaries and franchisees. These monies were used to fund VTL’s acquisitions and to develop its franchising network.
8. Nathans was placed into receivership by its trustee on 20 August 2007.
It owed approximately $174 million to over 7,000 secured debenture investors. The receivers have made payments to secured debenture holders totalling 3.7 percent of their principal investment.
The Directors
9. At all relevant times Nathans had four directors: Roger Moses (Chairman), Mervyn Doolan (Managing Director), John Hotchin and Donald Young.
10. Mr Moses is an accountant and director of the firm Moses Stevens. He was the Executive Chairman of Nathans and also chaired the audit and loan approvals committees. He had an office at Nathans’ premises in Auckland and worked there approximately four days per week. He was also a director of VTL.
11. Mr Doolan is an accountant and was a tax principal at Ernst & Young.
He was the Managing Director of VTL and Nathans and worked full time in the businesses.
12. Mr Hotchin was appointed a director of Nathans on 23 July 2001 and resigned on 31 March 2007. He was a director of VTL from 16
February 1998 to 16 October 2007. In connection with VTL’s business, he moved to the United Kingdom in 2004 and then to the United States in June 2005. He was, throughout the relevant period, based in Boston where he was Chief Executive of All Seasons in which VTL held an 18.9 percent shareholding (with a put option to increase this holding to 66.5 percent).
13. Mr Hotchin attended VTL’s and Nathans’ board meetings by telephone.
His role in relation to Nathans was described in Nathans’ investment
statement as follows:
“John‟s contribution to Nathans in the areas of strategic development and marketing, has ensured we have built a strong client base, which provides steady, balanced growth of our finance book.”
14. As noted above, Mr Hotchin resigned from Nathans on 31 March 2007.
His resignation was formally accepted on 15 April 2007.
15. Mr Young is an accountant. He was a non-executive director of VTL
and Nathans.
Charges
16. The directors have been charged under sections 58(1) and 58(3) of the Securities Act 1978 (the “Act”) in respect of untrue statements made in Nathans’ prospectus dated 13 December 2006 (the “Prospectus”), its investment statement of the same date (the “Investment Statement”) and an extension certificate dated 30 March 2007 (the “Extension Certificate”). Messrs Moses, Doolan and Young face further charges in relation to untrue statements in advertisements distributed after Mr
Hotchin’s resignation, in the months leading up to Nathans’
receivership.
17. The Act defines an untrue statement as a statement that is actually not true, is misleading in the form and context in which it is made, or is misleading by reason of the omission of a particular which is material to the statement in the form and context in which it is made.
Untrue statements in Prospectus
18. The Prospectus contained a number of untrue statements. Mr Hotchin accepts for the purposes of the sentencing indication that his belief that the statements were true was not reasonable in light of what he knew or ought to have known. Although Mr Hotchin was based in Boston at the time the Prospectus was prepared, it was sent to him in draft and he had an opportunity to review it.
19. A draft of the Prospectus was sent to Nathans’ directors by VTL’s Sales and Marketing Manager, Marion Short, on 31 October 2006. The draft Prospectus included an expanded “Risks” section which referred to Nathans’ “significant” advances to VTL. The draft also specified in the Risks section the quantum ($79,630,043) and percentage (46.2) of Nathans’ assets on intercompany loan to VTL. Mr Hotchin replied on
31 October 2006:
“Looks ok to me. Do we have to address the credit concentration issue, do we have to make reference [to it] at all”.
20. Ms Short forwarded the email to VTL’s General Counsel, David Steytler, who replied: “It‟s part of disclosure of risks. We should ask Minters [the company’s solicitors] for guidance on that point.”
21. Mr Steytler circulated a further draft on 30 November 2006. This also contained detailed information in the Risks section regarding Nathans’ lending to VTL. Mr Steytler wrote in his covering email that VTL’s solicitors had “strongly advised us to insert” the precise figures.
22. Mr Moses replied: “I hope the wording can be modified further to convey a true and realistic view of the risks without sticking it too far up investors‟ noses”. Mr Hotchin then replied:
“The Risk section is a major concern, I agree with Roger this will create a big problem for capital raising going forward. We need to tone this down if possible.”
23. Mr Steytler replied on 30 November 2006 reiterating that the company’s solicitors had advised that the figures be included in the Risks section of the Prospectus.
24. Mr Hotchin wrote further on 1 December 2006:
“I strongly urge that the RISK section is changed as if this is going to market NO cash will come in.
This is totally non commercial and I doubt that any other company would give such in depth detail as this, this is simply not commercial.
David, you keep quoting our external solicitor as the driving force behind this, who is the solicitor and when did a lawyer take control of decisions the BOARD makes.
I AM NOT HAPPY WITH THE RISK SECTION, IT NEEDS MODIFICATION URGENTLY.
David, do not copy management on your reply, please only address the DIRECTORS.”
25. VTL’s solicitors, Minter Ellison, subsequently advised:
“The Securities Commission Report on Disclosure by Finance Companies provides that where a company uses a finance company as a mechanism for gathering subscriptions from the public to fund the activities of another entity, detailed information is required about that other entity. In particular, the financial health of the other entity and the purposes for which the money is to be used must be disclosed in the investment statement. The current draft Investment Statement for NFL appears to comply with this requirement as it
contains information about VTL‟s activities and details about
its operating revenue.
In quantifying the amount of the advances made to VTL and its subsidiaries, NFL is indicating to the investor the extent to which the risks of VTL will be material to an investor in NFL. The amounts are not expressly required to be stated by law. However, we consider they provide a useful indication to the investor as to the level of risk involved. If you prefer not to include them, we recommend you convey the significance of the lending to VTL in other language, e.g. „very significant‟ or
„almost half‟.”
26. Following this correspondence, the Risks section of the Prospectus was amended to its final wording (discussed in the following paragraph), which removed the dollar value and percentage of total assets. The precise amount of the intercompany advance continued to be included in Nathans’ financial statements which were set out in full in a different section of the Prospectus.
Related party lending
27. The Prospectus stated that “a significant portion of the Company‟s loan portfolio comprises loans to the Company’s parent VTL and VTL‟s subsidiaries [...] and loans to individuals and entities participating in VTL‟s franchising programmes.” It further stated that Nathans provided “significant financial accommodation to its parent company VTL and to VTL subsidiaries”. It stated that these advances had been made “on a commercial arms length basis, normally for terms no longer than 12 months”.
28. The Prospectus conveyed to investors that there was a substantial level of related party lending. However, the statement that the lending was on a commercial arms-length basis was not accurate.
29. In particular, the loan approvals processes as between VTL and Nathans were below the standard that would be expected of normal commercial arms-length lending. For example:
(a) Nathans entered into an intercompany loan agreement with VTL
shortly after registration of its first prospectus on 15 November
2001 but: (i) only obtained a specific security agreement for the loan on 1 July 2004; (ii) only obtained a general security agreement (“GSA”) on 19 February 2007 which was registered on 27 February 2007. On 31 March 2004 it was suggested to Nathans’ board that given the size of Nathans’ exposure to VTL “it may be appropriate for NFL to consider taking a GSA over VTL”. Mr Hotchin was therefore aware that no GSA was in place;
(b) the loan facility with VTL was permitted to exceed its limit before being later extended. In February 2005 Nathans and VTL documented an increase in the facility from $13 million to
$50 million at a time when the loan balance was $44.2 million;
(c) the loan facility with VTL was permitted to expire on 1 August
2006 although funds continued to be advanced under it. This was drawn to the directors’ attention on 16 February 2007 following which the facility was renewed; and
(d) the advances made to VTL under the VTL loan agreement were at various times secured against assets for which no valuations had been obtained.
30. Nathans made advances to 24 Seven Vending (Australia) Limited and
24 Seven Vending (US) Inc, companies associated with VTL’s operations in Australia and the United States, respectively. In both cases existing loans to VTL were transferred to these entities in order to reduce VTL’s level of indebtedness. Although the loans were guaranteed by VTL and details of the transactions were disclosed to Nathans’ trustee, no assessment was made of the financial position of the new borrowers.
31. The statement that loans were normally for terms no longer than 12 months was misleading by omission. The inter-company loans were typically rolled over at the end of each 12-month period.
32. Nathans also made related-party loans of NZ$1,115,357.20 each to trusts associated with Mr Doolan and Mr Hotchin and of NZ$125,250 to a trust associated with Gary Stevens, a VTL director.
33. The loan to the trust associated with Mr Stevens (the Milford Way Trust) was originally NZ$75,000, and was approved by Mr Hotchin on the condition that it must be repaid prior to the end of 2005. The loan was nevertheless increased and extended to 22 June 2008, with interest only payments and a lump sum to be paid at the end of the term. Mr Hotchin was not involved in approving these extensions. This loan has not been repaid although Mr Stevens has claimed a right of set-off against work performed for Nathans’ receivers.
34. The trusts associated with Mr Hotchin (the McConnochie Trust) and Mr Doolan (the Boston Trust) used the money to invest in a fund, the Halpern Denny Fund III LP, which had made a term loan to All Seasons. The McConnochie Trust contributed a further US$450,000 (approximately NZ$643,475) to the investment.
35. The loans were secured against VTL shares owned by the respective trusts. In respect of the loan it received of NZ$1,115,357.20 the McConnochie Trust gave a security over 3 million VTL shares. The Trust’s assets also included its share of the term loan to All Seasons and a further 5.25 million VTL shares. On the date of the advance, 29
June 2005, VTL’s shares were trading at 80 cents, meaning that the McConnochie Trust’s 8,250,000 VTL shares were worth approximately NZ$6.6 million. The Trust’s total interest in the All Seasons loan was US$1.23 million. The Trust therefore had total assets of approximately NZ$8.4 million. The trustees did not give personal guarantees to Nathans.
36. Interest was initially paid on the loans to the McConnochie and Boston Trusts. In March 2006 Mr Hotchin suggested to Gary Stevens and Mervyn Doolan that the McConnochie Trust should sell 250,000 of its shares in VTL in order to meet its repayment obligations to Nathans. VTL’s Chairman, Mr Stevens, asked that the Trust refrain from selling its shares but instead suggested to other directors of Nathans (defendants Moses and Doolan) that the Trust be permitted to capitalise interest. Nathans’ lending manager, Mr Leong, initially sought further VTL shares as security but on 13 April 2006 recommended Mr Hotchin’s request on the basis that the loan to value ratio would remain below the agreed level of 75 percent. This request was approved by Mr Doolan and Mr Moses on 18 April 2006. The fact that interest on the McConnochie Trust loan was capitalised was recorded in the Nathans Prospectus which stated that “Nathans has a capitalised interest loan to Sally Hotchin as Trustee of The McConnochie Trust, a party associated with director John Hotchin [...]”)
37. The original period for interest to be capitalised on the McConnochie Trust loan was for 6 months from 28 February 2006 to 28 August 2006. As at 13 September 2006, due to the capitalised interest, the principal loan balance was NZ$1,189,218.28. Normal monthly interest-only payments were due to commence on 28 September 2006. However, Mr Hotchin (who still had not sold any VTL shares) requested that the interest on the loan be capitalised for a further 12 months from September 2006 to August 2007. Mr Leong recommended that the request be granted on the basis that Nathans held sufficient security (VTL shares were trading at 97 cents). Mr Hotchin’s request was approved by Roger Moses and Mervyn Doolan on 13 September 2006.
38. Similarly, on 22 January 2007, Edward Leong emailed Roger Moses and John Hotchin advising that their co-director Mervyn Doolan had requested that the interest on the loan to the Boston Trust be capitalised between January 2007 until the expiry of the loan in June
2008. No reason was given as to why interest needed to be capitalised but Mr Leong advised that based on VTL’s share price (then $1.25) Nathans held sufficient security for the loan inclusive of capitalised interest. Mr Hotchin approved the request to capitalise interest by email dated 22 January 2007.
Bad debts
(i) Nathans’ intercompany loan to VTL;
(ii) Nathans’ loan to Intelligent Vending LLC (“Intelligent”); and
(iii) Nathans’ loan to Advanced Vending Systems Pty Ltd
(“Advanced”).
VTL
42. Nathans’ June 2006 Financial Statements recorded that it had outstanding advances to VTL and its subsidiaries of $79,630,043. Interest on this sum was being capitalised. The ability of Nathans to recover these advances depended on the value of VTL’s assets and the security held by Nathans over those assets.
43. Nathans had received a valuation of VTL’s business from MC Capital
Limited dated 26 May 2006. This valued VTL’s business as at 31
December 2005 at $228 million using a discounted cash flow analysis based on a five year forecast prepared by internal management. Based on the information available to the directors they should have realised
by December 2006 that it was not reasonable to rely on this valuation. This should have led them to consider an impairment of the VTL loans.
44. VTL’s balance sheet also reflected sales of sub-licences for the Shop24 business in the United States for the states of New York, Texas and Massachusetts. The New York licence was sold for US$5 million and the Texas and Massachusetts licences were sold for US$3 million each. These sales were made to Services Systems Group LLC (“SSG”) and payment was by way of convertible notes issued by that company. The sum due under the notes (a total of approximate NZ$15 million) was recorded as an asset on VTL’s balance sheet. The directors knew that SSG had no tangible assets other than the licence itself and that VTL was otherwise unsecured in respect of payment under the note. This also should have led them to consider an impairment of the VTL loans.
Intelligent
45. Intelligent was the master franchise holder for VTL’s Californian operation. As at 30 June 2006 Nathans had loaned Intelligent approximately NZ$22,710,521 and as at 31 December 2006 this figure had increased to NZ$23,306,422 with capitalised interest. Other than a
$15,000 loan that was repaid in March 2006 Intelligent never repaid any principal or interest to Nathans.
46. Nathans’ directors including Mr Hotchin were aware of a deteriorating
relationship between VTL and Intelligent’s CEO, Paul Hyslop. On 27
January 2005 Mr Hyslop emailed Mr Hotchin and Mr Doolan stating:
“The business I borrowed and paid $13.5m for is basically
insolvent and cannot continue to operate. ...
The reason it is insolvent is that VTL have failed to deliver on
technology which is the main selling point of the business. ...
I have no exit strategy or any light at the end of the tunnel, my business will never be worth anything like $13.5m or will have the ability to pay interest or loan repayments. I am basically
just working for nothing with no ability to ever have a business of any value.”
47. Mr Hyslop was also critical of VTL’s technology and blamed this for the poor performance of his business, although in other emails he wrote positively about the business including in August 2005 when he wrote that “[b]asically its all good news here in California”. On 22
December 2005 Mr Hyslop wrote to Messrs Moses, Doolan and Hotchin (among others) stating that Intelligent intended to file for bankruptcy. Mr Hyslop denied that Intelligent had any obligation to repay its loan to Nathans.
48. Nathans also held Intelligent’s financial statements showing that: (i) for the ten months to October 2005, Intelligent made net operating income of $224,303.45 and, after amortisation of its franchise fee in the amount of $1.2 million, suffered a loss of $975,696; and (ii) as at 31 October
2005 the company was technically insolvent with negative net equity of
$1,736,931. A copy of these financial statements was provided by Nathans’ management to the company’s auditor, who advised (based on the value of the security, an issue discussed below) that the loan was not required to be impaired, based upon the position as at 31 October
2005.
49. Nathans’ security over the Intelligent loan was its ability to resell the master franchise granted to Intelligent and guarantees from Mr Hyslop and his trust. Nathans obtained a valuation of Intelligent’s business from Roger Cole-Baker in August 2006. The valuation was peer reviewed by a valuer at Staples Rodway and its assumptions were tested and accepted by the auditor. Mr Cole-Baker’s view was that in light of the value of Intelligent, Nathans was more than adequately secured.
50. In preparing his valuation, Mr Cole-Baker relied on a 20 year budget for Intelligent prepared by VTL’s management. The assumptions in the budget did not accurately reflect the past trading performance of
Intelligent and the fact that it was not profitable. In particular, they did not reflect the fact that a number of Intelligent’s own franchisees were not performing to the levels expected. Mr Hotchin was not involved in instructing Mr Cole-Baker but he now accepts that it was unreasonable of him to rely on the valuation given its flawed assumptions.
51. The loan to Intelligent should have been impaired by June 2006. Even an impairment of 22 percent of the loan would have eliminated Nathans’ net profit for the year ended 30 June 2006. By 31 December
2006 the loan should have been substantially impaired, which would have eliminated Nathans’ reported net profit of $2,575,395 for the six months to 31 December 2006.
Advanced
52. Advanced was the master franchise holder for VTL’s Australian operation. In 2003 Nathans lent AU$11.5m to Advanced and this had been rolled over a number of times including on 31 March 2006 for a further 12 month period. As at 30 June 2006 Nathans had loaned approximately NZ$13,513,080 to Advanced which by 31 December
2006 had increased to approximately NZ$13,543,640.
53. Financial statements submitted by Advanced to Nathans for the three months ended September 2006 reported losses of $311,055 (after the amortisation of its licence) without the payment of any interest in respect of its Nathans loan. As early as July 2006 these accounts showed the company to be technically insolvent.
54. The security held by Nathans in respect of this borrowing was the ability to resell the master franchise. Emails from Rob Seymour to VTL indicate that by May 2006 Mr Seymour had identified to VTL’s directors serious concerns that he had as to the viability and future of the master franchisee.
55. As with Intelligent, Advanced was unable to generate any profit as a master franchise holder and was unable to contribute towards the interest charges accruing in respect of its borrowing from Nathans.
56. Despite the financial statements of Advanced showing it to be technically insolvent as at September 2006, no provision for bad debts was made in respect of this loan by Nathans in its financial statements for the period ending 31 December 2006. The accounting treatment for the debt owed by Advanced should have been to make a provision to recognise the impairment of this loan. This is inconsistent with the statement in the Prospectus that the company had no bad debts.
57. The directors and Nathans’ auditors relied on the valuation of Intelligent prepared by Mr Cole-Baker as also indicating the value of Advanced’s business and on this basis the auditors advised that the loan did not need to be impaired for the 2006 accounts. Given the performance of Advanced Mr Hotchin now accepts that it was not reasonable for them to do so.
Credit assessment and management of loans
58. The Prospectus stated that Nathans’ lending was conducted in accordance with its credit policy and that the company had a robust credit assessment process. As recorded above, these statements were not accurate with respect to the inter-company lending to VTL and lending to the master franchisees. For example:
(a) in the case of loans to VTL, VTL was permitted to exceed its facility limits and Nathans did not obtain proper security in a timely manner;
(b) non-performing loans, particularly related-party loans, were frequently rolled over and interest was capitalised. These loans were never transferred to the credit recovery team for ongoing management and recovery;
(c) Nathans made substantial loans with no security registered in respect of them in the country of origin or with inadequate evidence of the value of security taken; and
(d) the loans to Intelligent and Advanced were not impaired when they should have been.
Liquidity
59. The Prospectus stated that Nathans had policies in place to ensure that all obligations were met within a timely and cost efficient manner, that prudential policies were regularly monitored, and that Nathans maintained sufficient liquid funds to meet its commitments based on historic and forecasted cash flow requirements.
60. Nathans was in fact reliant on reinvestments and funds received from new investors to meet its obligations to existing investors. Nathans’ financial statements for the year to 30 June 2006 (which were included in the Prospectus) show that the company received interest of approximately $4.9 million in cash whereas it paid interest of approximately $9.1 million to its debenture holders. This reflected the fact that Nathans was capitalising the interest on many of its loans, as outlined below. The difference was met by the funds received from subscriptions by new debenture holders.
61. In the 2006 calendar year under the intercompany loan that accrued interest at 13%, VTL accrued interest of approximately $5,583,450 but made no interest payments to Nathans. From 1 January 2007 to 30
June 2007, VTL accrued interest of approximately $3,112,834 but made
no interest payments to Nathans. VTL commenced interest payments of US$1 million per month in July 2007 using funds of approximately US$7.3 million (NZ$10.6 million) received from US based equity investors in return for a 19 percent stake in the company.
62. Advances made in March 2007 by Nathans to VTL included capitalised interest of $1.4m. This included interest which had been capitalised to the VTL account on the VTL advance and interest due on advances to VTL master franchise holders. Under the master franchise sale and finance agreements, VTL agreed that it would meet interest costs in respect of the Nathans advance until the franchise reached a certain level of profitability. The underwriting of these interest payments caused significant increases to the VTL intercompany account, approximately $270,000 in the month of March 2007 alone.
63. Interest was also charged to the VTL account in respect of other related party loans including 24 seven, 24 seven USA, 24 seven Australia, VT Leasing and 24 seven Vending. The interest on these additional related party loans totalled $5,758,166 for the 2006 calendar year and
$3,519,945 from 1 January 2007 to 30 June 2007. Again no payments were received by Nathans in respect of these interest charges. Combined, interest capitalised to the VTL account on account of VTL and its subsidiaries totalled $11,341,616 for the 2006 calendar year and
$6,632,778 from 1 January 2007 to 30 June 2007.
64. A total of $72,289,031 of related party lending as at 30 June 2006 and
$95,278,058 as at 31 December 2006 had therefore been granted by Nathans to related parties which generated little, if any, cash flow. At an average interest rate of 9.56% payable to investors Nathans needed to finance the cost of these funds from its own cash flow resources in the absence of payments from VTL and its subsidiaries. At the level of lending of $72,289,031 as at 30 June 2006, this would equate to a cost of funds of $6,910,831 per annum. At the level of lending of $95,278,058 as at 31 December 2006, this would equate to a cost of funds of
$9,108,582 per annum.
65. VTL was taking over the liability for interest for its subsidiaries which were effectively receiving funds from Nathans at zero cost to
themselves. As this interest was predominantly capitalised to VTL’s intercompany account, Nathans again received little, if any, cash payments against these loans.
66. The capitalisation of interest and rollover of Nathans’ loans meant that
the company had significant negative cash flow. In the year ended 30
June 2006, Nathans had negative cash flow from operating activities of
$5,805,780 (mainly interest paid to investors), negative cash flow from investing activities of $14,101,999 (due to advances made on intercompany loans) but positive cash flow from finance activities of
$26,768,585 (due to money received from new investors). These figures were disclosed in the Prospectus. Liquidity deteriorated further in the six months ended 31 December 2006, with negative cash flow from operating activities of $5,726,931, negative cash flow from investing activities of $1,826,483, positive cash flow from financing activities of $3,701,304 and a net reduction in cash of $3,852,110.
67. The capitalisation of interest on Nathans’ loans to VTL and its subsidiaries and the consequent increase in the intercompany account between Nathans and VTL were shown in the monthly statement of financial position which Nathans provided to its trustee.
68. A liquidity report that formed part of the December 2006 Board papers recorded that in the period of 0-3 months the company would have funding sufficiency of $17.08m. This projection depended on the assumption that the Advanced loan of approximately $13.3 million would be repaid when due in the next 0 to 3 months. Similarly, the 4-6 month projection assumed that the Intelligent loan of approximately
$10.2 million would be repaid when due. As discussed above, the Advanced and Intelligent loans were in difficulty and should have been impaired. For this reason alone the statements in the Prospectus regarding liquidity were misleading.
69. The disclosure that Nathans had policies in place to ensure that all obligations are met would appear incorrect in light of the analysis of the
liquidity profile as at 31 December 2006 showing that Nathans was reporting that certain loans would be repaid when it should have been known that settlement of these loans would not occur during that timeframe, if at all.
70. The Prospectus also stated that the liquidity of Nathans was supported by intercompany borrowings from its parent company, VTL. This was incorrect as it was in fact VTL which was supported by borrowings from Nathans. At the time the Prospectus was issued, Nathans was reliant on cash inflows from new investors in its secured debentures to make advances to VTL to fund its ongoing working capital requirements and to pay interest due to existing debenture holders.
Untrue statements in the investment statement
71. On 13 December 2006 Nathans issued the Investment Statement which related to the offer of secured debenture stock under the Prospectus. The Investment Statement is an advertisement under s2A(2)(b) of the Act.
72. The Investment Statement contained statements regarding the basis of lending to related parties, bad debts, credit assessment and management of loans and liquidity. These statements were untrue for the reasons set out above.
Extension certificate
73. The Certificate also contained stand alone untrue statements, namely:
(a) that the financial position in the statement of financial position referred to in the Prospectus had not materially and adversely changed, whereas it had because:
(i) as at 28 February 2007, Nathans reported negative net cashflow for the month from operating activities of
$1,378,275 and for the year to date of negative
$6,966,006;
(ii) as at 28 February 2007, Nathans' cash at bank balance was significantly adverse to budget ($6.37 million actual compared to $21.76 million budgeted);
(iii) the level of impairment which ought to have been made in respect of the Intelligent and Advanced loans had increased; and
(iv) the amount of interest capitalised on the VTL loan had increased.
(b) that the Prospectus was not, at 30 March 2007, false or misleading in a material particular by reason of failing to refer, or give proper emphasis, to adverse circumstances, whereas this statement was untrue because the overall financial position of Nathans had significantly deteriorated since the date of the Prospectus.
[1] DC Auckland
CRI-2009-004-25176, 15 December
2009
[2] DC Auckland
CRI-2009-004-24026, 21 December 2010
[3] CA337/06 14
December 2006
[4]
[2010] NZSC 135
[5]
R v Hill [2008] 2 NZLR 381
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