Twentieth Century Fox Film Corporation v Dotcom [2016] NZHC 88 (5 February 2016)

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BETWEEN	TWENTIETH CENTURY FOX FILM CORPORATION, DISNEY ENTERPRISES INC, PARAMOUNT PICTURES CORPORATION, UNIVERSAL CITY STUDIOS PRODUCTIONS LLLP, WARNER BROS ENTERTAINMENT INC. Applicants
AND	KIM DOTCOM First Respondent _{intituling cont'd over...}

Hearing:	18 December 2015
Appearances:	M C Sumpter and L L Fraser for Applicants S L Cogan and H Wild for First Respondent L L C Cooney (excused) for Second Respondent A R B Barker and A J Steele for Fourth Respondent D J Boldt and A Dixon for Interested Party (Commissioner) M J Gavin for Recording Industry J E M Lethbridge for Custodians
_Judgment:	_{5 February 2016}

[1] The applicants in this proceeding are a group of US film studios. In civil proceedings brought in the United Sates they allege large scale breaches of copyright by Mr Dotcom and others. In 2015 they obtained a freezing order over Mr Dotcom’s assets and, subsequently, over the assets of the Trust Me Trust, alleging that Mr Dotcom is the beneficial owner of the trust’s assets (the named beneficiaries are Mr Dotcom’s former wife, Mona Dotcom, and their children).

[2] One of the frozen assets is 5H The Prom, Coatesville, which Mr Dotcom, owns.¹In December 2015 I dismissed Mr Dotcom’s application to vary the freezing order to allow him to use that property as security for personal borrowings that he planned to on-lend to the trustee of the Trust Me Trust, Coatesville Trustee Service Ltd (CTSL). CTSL is a shareholder in Mega Ltd and need the funds to participate in a rights issue offered by the company.

[3] In this judgment I give reasons for my decisions (1) rejecting Mr Dotcom’s challenge to the standing of the Commissioner of Police to be heard (2) dismissing Mr Dotcom’s application and (3) refusing to require the studios to give an extended undertaking in favour of CTSL.

[4] The Commissioner originally became an interested party in this proceeding by virtue of an agreement between Mr Dotcom, the studios and the Commissioner; the Commissioner withdrew his application to register a foreign restraining order against Mr Dotcom’s assets under the Mutual Assistance in Criminal Matters Act

1992 on the basis that all Mr Dotcom’s assets would be the subject of the civil freezing order obtained by the studios so that the Commissioner’s interest would be adequately protected. However, in submissions filed in support of the application to vary the freezing order Mr Dotcom asserted that the Commissioner of Police lacked

_{standing to oppose the application. Given the pressure of time, it was
agreed that I}

¹Under a relationship property agreement between Mr Dotcom and Ms Dotcom the property is, as between those parties, regarded as Ms Dotcom’s separate property. That does not affect the application.

would hear submissions on behalf of the Commissioner and determine the issue of his standing along with the other issues that fell to be decided.

[5] Mr Cogan, for Mr Dotcom, argued that the time for registering the foreign restraining order expired in April 2015 and that, in the absence of any restraining orders, the Commissioner’s interest had subsided. Mr Cogan did not suggest that the Commissioner should actually be struck out of the proceeding, though that would be the logical next step if his submission were correct. I do not, however, accept that it is correct.

[6] I am satisfied that the Commissioner does have an interest in seeing that Mr Dotcom’s assets that are subject to the freezing order are properly dealt with in terms of r 32. First, the Commissioner is in the position of an interested party rather than having the benefit of a foreign restraining order as a result of the agreement reached with Mr Dotcom. It is not open for Mr Dotcom to resile from that agreement on the basis that no foreign restraining order exists. Secondly, as Mr Boldt pointed out, 5H The Prom is still subject to forfeiture proceedings in the United States and remains restrained in that jurisdiction. Any variation to the freezing order made here will affect the US government’s interest such that it is entitled to remain (through the Commissioner) an interested party and to be heard on the application to vary the freezing order.

[7] For these reasons I took the submissions that Mr Boldt made on behalf of the

[8] Mr Dotcom founded Mega Ltd in 2013 but is no longer associated with it. The company has been plagued by financial difficulties. These were substantially caused by Pay Pal’s refusal in mid-2015 to process credit card transactions. Last year the company undertook three rights issues to raise urgently needed working capital. Each rights issue had a dilutive effect on existing shareholders. The first, in July 2015 was a 2:1 offer. CTSL did not participate in that. The second was 50:1. CTSL participated to maintain its interest in the company (then just over 7%).

[9] Mr Dotcom’s application related to the third rights issue. It was offered on a two tiered basis, potentially at 50:1 and closed on 22 December 2015. If CTSL did not participate its shareholding would effectively be obliterated. CTSL did not have funds to participate and could not borrow to do so because it could only offer security over the Mega shares, which was unacceptable to the proposed lender.

[10] Mr Dotcom planned to borrow the necessary funds using 5H The Prom as security and on-lend them to CTSL. Although Mr Dotcom has no interest in Mega Ltd and is not a beneficiary of the Trust Me Trust, he was motivated to ensure that the trust’s assets were preserved for the benefit of his children. Despite public criticism of Mega Ltd’s current management and shareholders, Mr Dotcom maintained that the company was worth investing in and was anxious to assist CTSL to maintain its interest in the company.

[11] In evidence given in February 2015 on an unrelated application Mr Dotcom estimated the value of Mega Ltd to be approximately $320m. At that time CTSL held 21,697 Mega shares. By the end of 2015, two new, unrelated, parties held the majority of the Mega shares. There was no clear evidence before me as to the value of the Mega Ltd shares in December 2015. The studios provided an affidavit from a consultant in company finance, Mr Anderson, who considered that, on the basis of the company’s own documents relating to share transactions in July and August

2015, the total value of the company was approximately $12.5m. Mr Dotcom did not accept this but did not offer any independent evidence to challenge Mr Anderson’s analysis.

[12] Rule 32 codifies the Mareva jurisdiction developed at common law in the United Kingdom and exercised here under the previous r 236B. It permits freezing orders to be made where there is a danger that a judgment or prospective judgment will be wholly or partly unsatisfied either because the debtor or prospective debtor

might abscond or because the assets of the debtor or prospective debtor might be removed, disposed of, dealt with or diminished in value.²

[13] Because of their effect freezing orders are commonly described as draconian.³However they are not intended to prevent respondents from carrying on their usual private and business activities nor from defending the substantive proceedings. To this end r 32.6(3) limits the scope of freezing orders:

The freezing order must not prohibit the respondent from dealing with the assets covered by the order for the purpose of –

(c) Disposing of assets, or making payments, in the ordinary course of the respondent’s business, including business expenses incurred in good faith.

[14] In addition, r 32.8 permits a respondent to apply to discharge or vary the order:

(1) A freezing order must reserve leave to the respondent to apply to the courts to discharge or vary the freezing order on whatever period of notice to the applicant the court considers just.

(2) An application by the respondent to discharge or vary the freezing order must be treated as an urgent application by the court.

[15] Mr Dotcom’s application to vary the freezing order raised a question not previously addressed: can the court vary a freezing order to allow assets to be used for purposes other than those specified in r 32.6(3). Mr Cogan, for Mr Dotcom, argued that freezing orders could be varied to accommodate other purposes. His main argument was that r 32.6(3) only prescribes what a freezing order must not do and cannot be treated as fettering the power to vary under r 32.8; rather, the power to vary was to be determined by reference to the interests of justice.

[16] Neither Mr Sumpter, for the film studios, nor Mr Boldt, advanced any substantive argument against Mr Cogan’s interpretation of r 32.8. Instead, they

³See e.g. Watt v Sharma HC Auckland CIV-2006-404-002975, 14 December 2011 at [17].

argued that even if the interests of justice was the test, the application should fail. Their main objection was that further investment in Mega Ltd was too risky and, more likely than not, would result in the loss of the borrowed funds.

[17] CTSL supported the application and advanced a different argument; its counsel, Mr Barker, argued that Mr Dotcom’s proposed borrowing came within the scope of Mr Dotcom’s ordinary course of business as an individual and an internet entrepreneur. I do not accept that argument. It is unnecessary to consider it in detail. It is sufficient to say that the proposed borrowing was motivated by Mr Dotcom’s desire to provide financially for his children which, even on the most generous interpretation of r 32.6(3)(c), could not be described as being in the ordinary course of his business.

[18] Rule 32.8 is silent as to the circumstances in which a freezing order may be varied and gives no indication as to what the relevant considerations are. However, it is clear that the power to vary was not intended to be limited to the circumstances specified in r 32.6(3). First, since those limitations apply automatically there would be no utility in an application to vary on those grounds (questions as to whether particular expenditure falls within those categories would not result in variations to the order, merely clarification). Secondly, because applications for freezing orders are usually made without notice and under urgency, the full circumstances of the respondent will usually be unknown to the court making the order. Inevitably, the generic protection afforded by r 32.6 will be inadequate for the circumstances of some respondents, for example those facing a one-off emergency.

[19] I therefore agree that the power to vary was intended to accommodate circumstances beyond those recognised by s 32.6(3). However, given the purpose of freezing orders and the substantial limitations on their scope imposed by r 32.6(3) the power to vary is properly viewed as a residual discretion. I also agree that, in the absence of any indication as to the correct approach to be taken, the court should consider whether the proposed course is in the interests of justice. This approach ensures that any variation will recognise both the purpose of the freezer order (to respond to the risk of a judgment or award going unsatisfied as a result of a

defendant dissipating or disposing of assets so as to render himself “judgment proof”),⁴and that the jurisdiction is not intended to provide security over the respondent’s assets.

[20] It is also the approach taken in the United Kingdom, where the common law Mareva jurisdiction is still exercised. In Iraqi Ministry of Defence v Arcepey Shipping Co SA the Court observed that:⁵

It does not follow that, having established the injunction, the Court should not thereafter permit a qualification to it to allow a transfer of assets by the defendant if the defendant satisfies the Court that he requires the money for a purpose which does not conflict the policy underlying the Mareva jurisdiction.

[21] In PCW (Underwriting Agencies) Ltd v Dixon the Court, having observed that

In my view justice and convenience require in the present case that the first defendant should be allowed the means of defending himself, even if it could be said that the plaintiffs had laid claim to the whole of his assets as the trust fund. Similarly, justice and convenience require that he should be able to pay his ordinary bills and live as he has been accustomed to live heretofore.

[22] In Noga v Australia and New Zealand Banking Group, which concerned an application to vary a worldwide freezing order for the purposes of paying a bail bond for a friend of the respondent accused of money laundering, Christopher Clarke J summarised the relevant principles as being:⁷

(i) The essential test is whether it is in the interests of justice to make the variation sought;

(ii) Since the Court has already determined that, in the absence of a freezing order, there is a real risk of dissipation sufficient to justify the making of an order it is for the applicant to satisfy the court that it is appropriate to make the variation sought and to adduce any evidence that is necessary to persuade the court that is so;

(iii) In determining whether or not to allow the variation proposed the Court is concerned to examine whether to do so would be consistent with the policy that underpins the jurisdiction, namely that a defendant should be restrained from evading justice by disposing of assets otherwise than in the ordinary course of business with the

⁴Bank of New Zealand v Hawkins [1989] NZHC 198; (1989) 1 PRNZ 451 (HC) at 454; Shaw v Narain [1992] 2

result that any judgment goes unsatisfied; Gangway Ltd v Caledonian Park Investments (Jersey) Ltd [2001] 2 Lloyds Rep 715; TTMI of England v ASM Shipping of India [2005] EWHC 2666 (Comm).

(iv) The correct test is “to consider objectively the overall justice of allowing the payment to be made including the likely consequence of permitting it on the prospects of a future judgment being left unsatisfied, and bearing in mind that the assets belong to the defendant and that the injunction is not intended to provide the claimant with security for his claim or to create an untouchable pot which will be available to satisfy an eventual judgment”: Gee, paragraph 20.054.

(v) If the question is whether or not the Mareva should be varied so as to allow frozen monies to be used to fund a defence it may be necessary to show that there are no other funds or sources of payment which should as a matter of objective fairness be used for that purpose in preference to the frozen funds. The same principle must apply if what is sought is to fund the giving of a recognizance in favour of another.

(vi) Because the Court has already been satisfied of a risk of dissipation judges are entitled, on an application to vary, to have a healthy scepticism about assertions made by the applicant particularly where the applicant, or those to whom his evidence or contentions relate, have been less than frank in dealing with the Court or the claimant.

[23] In Abbey Forwarding Ltd v Home Morgan J drew on a number of authorities, including Noga, as establishing the relevant principles:⁸

I have regard to the interests of justice. I have regard to the purpose of a freezing order. I have regard to the policy behind the making of a freezing order. I should consider the overall justice of allowing the payment to be made, including the consequence if I do permit it to be made and if I do not permit it to be made. I also have regard to the alternatives ... in particular whether there are other funds or sources of money which would be available

[24] Finally, determining applications to vary freezing orders by reference to the interests of justice is consistent with the way the power to make freezing orders is exercised. In Hunt v BP Exploration Company (Libya) Ltd Barker J examined the source of the Mareva jurisdiction in the UK and in New Zealand and concluded that

_{in New Zealand the Mareva jurisdiction represented an
exercise of the court’s}

⁸Abbey Forwarding Ltd v Home [2010] EWHC 1532 (CH) at [20], citing Avant Petroleum v Gat Oil Overseas (Inc) [1986] 2 Lloyds LR 236; Atlas Maritime v Avalon Maritime (the Coral Rose) [1991] 1 Lloyds LR 563; Noga v Australia and New Zealand Banking Group [2006] EWHC 602 (Comm).

general jurisdiction conferred by s 16 of the Judicature Act 1908.⁹The source of the freezing order jurisdiction under r 32 is to be regarded in the same way. In granting applications for freezing orders judges of this Court frequently refer to the flexible nature of the jurisdiction. For example, in Covington Group Holdings Ltd v Zhong (No 3) Allan J referred to the prerequisites for a Mareva injunction (good arguable case, assets within the jurisdiction and a real risk that the defendants would dissipate or dispose of assets so as to render themselves judgment proof) but added that:¹⁰

... the need to protect the plaintiff so as to ensure that any judgment is not rendered barren must be balanced against any prejudice or hardship to the defendants and third parties; that is, the overall justice of the case must be considered; ...

... it is necessary to bear in mind the importance of flexibility; where the justice of the case so requires, slavish adherence to the basic criteria is not inexorably required.

[25] Acknowledging that the freezing order did not confer any security rights on the film studios, Mr Sumpter nevertheless pointed out that the purpose of the order was to prevent the dissipation of assets so that funds would be available for a prospective judgment creditor (within the scope permitted by r 32.6(3)). He and Mr Boldt argued that the proposed variation was not in the interests of justice because it was so speculative that the borrowed funds were likely to be lost altogether, with the consequent loss of 5H The Prom because neither Mr Dotcom nor CTSL had any other means of repaying the loan.

[26] Mr Cogan argued that it was in the interests of all parties, including the film studios, that the Mega shareholding be preserved. If Mr Dotcom was not permitted to raise the funds needed for CTSL to participate in the rights issue, that shareholding would be lost altogether. He also emphasised that the property belonged to Mr Dotcom, the purpose of the borrowing was genuine and legitimate and it was for Mr Dotcom to make the risk assessment, which he was well capable of

⁹_{Hunt v BP Exploration Company (Libya) Ltd [1980] 1
NZLR 104 at [116]–[118].}

¹⁰Covington Group Holdings Ltd v Zhong (No 3) (2004) 17 PRNZ 819 (HC) at [54].

[27] It was never suggested that Mr Dotcom’s concern to ensure his children’s financial wellbeing was not genuine. However, Mr Dotcom’s children are presently well supported and, in the absence of very unusual circumstances I am doubtful that disposing of assets solely to make future provision for one’s children could be viewed as a disposition that is in the interests of justice.

[28] Nor do I consider that it is in the interests of justice to facilitate the trust’s participation in the rights issue as a means of preserving the trust assets for the benefit of all parties, including the studios. I accept that it is in the studios’ interests that the shareholding is preserved if possible. But where the proposed means of preservation can only be achieved at the risk of other restrained assets a careful balancing exercise is required. I do not accept that this risk assessment should be left solely to Mr Dotcom. This is because the risk assessment must take account of the purpose of the freezing order and is therefore a matter for the Court, not for the party seeking to vary the order.

[29] I considered that the level of risk to the restrained assets was too high to justify varying the order to allow 5H The Prom to be used as security for Mr Dotcom’s proposed borrowing. First, neither Mr Dotcom nor CTSL has the funds to repay the borrowing. The only means by which the borrowing could be repaid, thereby avoiding the security over 5H The Prom being enforced, would have been for the shares in Mega Ltd to be sold. But the overwhelming weight of the evidence suggested that, given Mega Ltd’s financial position, the shares are unlikely to be saleable.

[30] Secondly, this third rights issue is unlikely to be the last so that participation in it was unlikely to preserve CTSL’s level of shareholding for very long. Mr Anderson considered that the offer of three rights issues in the same year, together with the information provided in support of the third showed a financially distressed company with very limited funding options. This was apparent from the terms of offer of the third rights issue:

Currently the Company does not have sufficient capital to maintain its business operations for a prolonged period of time. The Company will run out of sufficient capital to fund its business operations in approximately 2 months. The Board is investigating a number of capital raising initiatives to

provide the requisite funding needed to satisfy the ongoing working capital requirements of the company.

This capital raising initiative is intended to raise approximately NZ$8,000,000 which will provide the Company with an additional six months of working capital during which period the Board are hopeful that they will be able to develop monetisation and make progress towards implementing a capital raising strategy which will raise the funding that the Company requires to be able to undertake its business operations for the foreseeable future.

The Company is an early stage technology company which is still in the process of developing products based on its unique user controlled, simple, browser-based, user controlled encryption technology (UCE). The Company is not yet profitable so its likelihood of becoming profitable will depend on the Company’s ability to continue to develop products based on its unique technology that people want to use and its ability to monetise those products through subscription fees, advertising and other sources of revenue. The Company’s ability to do so is far from assured at this early stage and there is a risk that the Company may never become profitable.

The Company operates a “freemium” business model. The Company has not yet attempted to fully monetise its business model and is not trading profitably at this time. Monetisation depends on having suitable payment processing systems and at this date the Company is still unable to directly process credit cards.

[31] Although Mr Dotcom asserted that the difficulties caused by Pay Pal’s position have now been overcome, the company’s statement strongly suggests that Mega Ltd’s financial circumstances are still precarious. Even if the third rights issue raised the funds needed immediately, it was highly likely that still more funding would be needed, probably within a matter of months, with the likelihood of yet another rights issue. This meant that even if CTSL participated in the third rights issue it would almost certainly be faced with another similar situation within a short time. The risk of the trust ultimately losing the shareholding through dilution was very real.

[32] This is a convenient point at which to address the custodians’ position. The freezing order as sealed on 16 December 2014 appointed Neale Jackson and Grant Graham custodians to hold the assets of the Trust Me Trust with the power to “do anything reasonably necessary to preserve the value of the frozen property, subject to

any court order” though they were not required to preserve the value of the frozen assets.

[33] When the freezing order was made it was expected that Mega Ltd would be listed by way of a reverse listing and the appointment of the custodians made provision for the future exchange of Mega shares for shares in the listing vehicle and the subsequent sale of any such shares. Mega Ltd was, however, required to provide relevant information about the proposed issue of new shares to the custodians within a specified time. Concerns were expressed by the custodians that this was not being done. In the event, the proposed reverse listing did not proceed. Later in the year, when CTSL participated in the October rights issue (funded by a gift from Mr Dotcom) the custodians were not advised. The custodians also complained of lack of timely notice about the December rights issue.

[34] Despite the lack of notice in relation to the earlier rights issue the custodians did not object to CTSL’s earlier participation because it did not result in any liability either for the trustee or for the custodians. However, Ms Lethbridge, for the custodians, pointed out that the draft term loan agreement recorded the advance from Mr Dotcom to CTSL as imposing on CTSL a liability to repay the loan, with interest. She submitted that it would be imprudent for CTSL, which has no assets and no income, to incur this liability. She noted, too, that CTSL itself could not borrow directly to participate in the rights issue because the proposed lender would not accept Mega shares as security. It appears from submissions filed after the hearing that this objection could have been met, with the agreement being redrafted to remove any direct liability on CTSL. However, even if that were done, my decision would have been the same, for the reasons already explained.

[35] Mr Barker argued that, if the application to vary the freezing order was refused, then the studios should be required to provide an extended undertaking to CTSL to abide by any court order in respect of damages sustained as a result (amongst other things) of the refusal to vary the freezing orders. In essence, CTSL wanted to ensure that it would have a claim against the studios for any loss sustained as a result of not being able to participate in the rights issue.

[36] This extended undertaking was sought primarily on the basis that the studios have not provided any undertaking to CTSL in respect of the freezing orders as required by r 32.6(4) and 32.2(5) because undertakings given were provided before CTSL was joined in to the proceeding. However, I accepted Mr Sumpter’s submission that the undertakings provided at the outset apply to all respondents, including those subsequently joined to the proceeding.

[37] Alternatively, Mr Barker invited me to view CTSL’s position as that of a third party potentially affected by the freezing order over Mr Dotcom’s assets. He submitted that where a third party could potentially suffer loss as a result of a freezing order the party with the benefit of the freezing order should ordinarily undertake to indemnify the third party for any loss resulting from the freezing order.

He cited Clipper Maritime Ltd of Monrovia v Mineral Import Export.¹¹However,

that case involved entirely different circumstances, in which an unrelated third party

(a port company) would sustain direct costs as a result of the arrest of a ship in port.

[38] In this case CTSL is not at risk of incurring costs. Its risk is the potential loss of value if it cannot participate in the rights issue. That is a step that CTSL would be free to undertake if it could do so using its own assets. Its complaint is that it is being precluded from using Mr Dotcom’s assets. I do not accept CTSL’s complaint that the studios’ position is artificial. There is no basis on which to require a more

¹¹Clipper Maritime Ltd of Monrovia v Mineral Import Export (The Marine Leonhardt) [1981] 1

High Court of New Zealand Decisions

Twentieth Century Fox Film Corporation v Dotcom [2016] NZHC 88 (5 February 2016)