IN THE HIGH COURT OF NEW ZEALAND CHRISTCHURCH REGISTRY
CIV-2013-409-1701 [2016] NZHC 2842
BETWEEN MICHAEL WILLIAM BANNOCK AND
ANNE MARGARET BANNOCK AND OXFORD STREET TRUSTEES (2010) LIMITED AND THE OTHER PLAINTIFFS LISTED IN SCHEDULE 1
TO THE STATEMENT OF CLAIM Plaintiffs
AND
MONACO MANAGEMENT LIMITED First Defendant
AND
MONACO VILLAGE LIMITED (IN LIQUIDATION AND RECEIVERSHIP) Second Defendant
AND
SCOTT PATRICK SANDERS Third Defendant
Hearing: 29-30 August, 1-2, 5-9, 12-16 and 19 September 2016 Appearances:
P G Skelton QC and S M Thompson for Plaintiffs
Q M Hay and A D Marsh for First and Third DefendantsJudgment:
28 November 2016
JUDGMENT OF DUNNINGHAM J
BANNOCK v MONACO MANAGEMENT LIMITED [2016] NZHC 2842 [28 November 2016]
Table of Contents
Summary of findings .................................................................................................. Introduction ............................................................................................................[1] Background ..........................................................................................................[10]
The development commences [10] The Hotel Lease [20] A problem with the Securities Act [23] The Enforceable Undertaking and the Exemption Notice [24] The Cottage Lease [30] Scott Sanders becomes involved [34] Sales under MVL’s ownership [46] Pooling or separate accounting? [48] Renewals and registration [54]
The plaintiffs ........................................................................................................[63] The defendants .....................................................................................................[65] The pleadings .......................................................................................................[69] The Securities Act ................................................................................................[75]
Were the sale and purchase agreements subject to a Cottage Lease participatory securities? .............................................................................................................[83]
Does the exemption in s 5(1)(b) apply? ............................................................. [113] Is s 37 invoked?..................................................................................................[123]
Where the sale and purchase of units was the “allotment” of a security, was it in
every case offered to the public? ........................................................................[126]
Were any of the plaintiffs close business associates? [136]
Were there any investors who were required to pay a minimum subscription price of at least $500,000 for the securities before the allotment of those securities? [146]
Were any of the plaintiffs selected otherwise than as members of the public? ..[149] Does s 6(1) mean that s 37(4) does not apply to subsequent purchasers? .........[152] Discussion [159] Can the plaintiffs get the declaratory relief they seek? ......................................[163] What is invalidated by s 37(4)?..........................................................................[164] Discussion [167]
Is declaratory relief precluded by s 37AL? ........................................................[175] Should declaratory relief be granted in the exercise of the Court’s discretion?.[181] Discussion [189] Orders under s 37(6)...........................................................................................[196]
Can Mr Sanders be made liable to repay the subscriptions of the relevant MVL
plaintiffs? [199]
Can MML be made liable to repay the subscriptions of the relevant MVL
plaintiffs?............................................................................................................[209] Conclusion..........................................................................................................[216]
Summary of findings
AThe sale of units in the Monaco Resort which are subject to Cottage Leases is the sale of a participatory security.
BSuch sales are not exempted from the securities law regime by s 5(1)(b) of the Securities Act 1978.
CThe second and third defendants are jointly and severally liable to repay the subscription monies (plus interest under s 37(6)), to those MVL plaintiffs whose claims are not statute-barred.
D There is no scope to declare the leases invalid and of no effect under s 37(4)
of the Act.
EFor that reason, I do not need to consider the defences raised by the defendants to such a finding.
FI decline to make a declaration that the agreements for sale and purchase of units to any other plaintiff are invalid and of no effect.
Introduction
[1] In 2003, Mr Mike Gepp began promoting investment in Monaco Village, a tourism development he was constructing on the Monaco peninsula in Nelson. Mr Gepp had been the developer behind The Honest Lawyer, a successful English style pub and restaurant in Nelson, and his new development offered more of the same, but on a much grander scale.
[2] The advertising brochure was enticing, promoting a “luxury lifestyle attractive investment – Monaco Village by the Sea”. It offered investors the right to buy hotel or apartment style accommodation units to be managed as tourism accommodation, and promised investors the following:
· enjoy 11.14 per cent return on your investment;
· invest direct in the project with no middleman, no broker fees and no set up costs;
· your investment will be easy to finance or resell;
· solid investment;
· regular income;
· your investment will provide a regular monthly income that will appreciate as the business develops;
· safe investment: it is a safe, bricks and mortar investment based on our successful and increasing tourist market.
[3] Those promises proved hollow. The investors are yet to see returns. Indeed, despite Monaco Resort’s1 success as a four and a half star rated accommodation
1 The development was initially marketed as “Monaco Village by the Sea”, but was subsequently
rebranded as Monaco Hotel and Resort. I will refer to it as the resort or the Monaco Resort.
provider, which has won awards as the best hotel accommodation in New Zealand, the plaintiffs are still paying to support it.
[4] It has also not been an entirely successful venture for the current defendants, who are the successors to the original developer and management company. Before the second defendant went into receivership and liquidation, its director, Mr Scott Sanders, sold personal assets, including his property in Christchurch, to provide further funding to the second defendant, all to no avail.
[5] As will become apparent, the factual circumstances relating to each plaintiff differ. Some bought from the original developer and some from the second defendant. Some bought a unit with a lease that provided for income to be pooled with other unit owners (the Hotel Lease) and others bought with a management lease that provided for payment of income from their unit alone, but with equitable allocation of guests to the various units (the Cottage Lease). Some did not buy from the developers at all but were subsequent purchasers from other investors.
[6] However, all say that what they purchased was, in practical terms, a form of participatory security under the Securities Act 1978 (the Act). It was sold without a prospectus, nor was there compliance with the Exemption Notice issued later by the Securities Commission. The plaintiffs therefore say that all the transactions are void and of no effect under s 37(4) of the Act, and they argue that certain declarations and orders should be made as a consequence of that finding.
[7] Specifically they seek:
(a) a declaration pursuant to s 37(4) of the Act that the agreements for sale and purchase of their units, and the associated leases, are invalid and of no effect; and
(b)an order pursuant to s 37(6) of the Act that the first and third defendants repay the subscription monies received by the second defendant (where the plaintiffs bought from the second defendant and the claim is not statute-barred).
[8] The defendants concede that the original sales pursuant to the Hotel Leases, where income was pooled, were participatory securities. However, they say the sales made by the second defendant were subject to the Cottage Lease and thus avoided breaching the Act. In any event, where s 37(4) is engaged, they say the first and third defendants cannot be visited with the consequences of that.
[9] As will be seen, the proceedings present a myriad of legal and factual issues. However, the key issues can be summarised as follows:
(a) Were the offers to sell units that were subject to the Cottage Lease offers of a participatory security as defined in the Act?
(b)If so, are any of the current defendants “issuers” who can be obliged to repay investors who purchased in the six years preceding the issue of these proceedings?
(c) If so, does s 37(4) have the effect of invalidating the sale and purchase transaction alone, or is the lease invalidated as well?
(d)If the lease is invalid under s 37(4), can the first defendant rely on indefeasibility of title to resist that consequence?
(e) Are plaintiffs who were subsequent purchasers in a different position in respect of their entitlement to remedies under the Act?
Background
The development commences
[10] Mr Gepp’s concept for the Monaco Resort was ambitious. He wanted to create a self-contained tourist accommodation development in an English village style setting. It was going to include a pub, restaurants, a small number of shops, accommodation and a conference centre, so that guests could find everything they needed within the one resort. The buildings were to be constructed in “an English
village style” featuring a red brick exterior, timber interior, window boxes, hanging
baskets and formal gardens.
[11] One of the first stages of the development was to be the Hotel Monaco, described initially as a “boutique 30 room hotel overlooking a large ornamental pond and the Waimea estuary”. Other accommodation complexes built in a terraced housing style were to be developed progressively on the grounds, and were identified by the following names: Orchard cottages, Summerhouse cottages, Riverside cottages, Village Green cottages and High Street cottages.
[12] Although Mr Gepp had owned the land for many years, once he decided to proceed with the development he teamed up with Mr Rod Duke, someone whom he believed had business and marketing skills which would complement his own skills in managing the construction of the development. The two men incorporated Monaco Group Limited (MGL), and that company, in turn, owned Monaco Village Holdings Limited (MVHL). MVHL owned the unsold hotel and cottage units and, while the first sale and purchase agreements named Mr Gepp and Mr Duke as the vendors, those agreements later assigned to MVHL as vendor, prior to settlement.
[13] Mr Gepp gathered a group of key personnel around him to undertake the development. Ironically, some of these people are now plaintiffs in the proceeding. They include Mr John Bolitho, who undertook sales and marketing, Mr Neil Johnstone, who worked in a project management role, Mr Alan Bartlett, the designer, and Mr Christopher Barnett, the builder. They are not the only plaintiffs who had a connection with the development. Companies owned by Mr Michael Cotton and Mr Ian Smith undertook work on the site, and Mr Leonard Bowman was involved in the early stages of the construction of the hotel.
[14] MVHL began promoting the development in late 2002, but took on Mr Bolitho in 2003 to market the proposed development. Prospective purchasers in this period were provided with brochures and other documents which described the investment opportunity. This material included an “investment profile” which provided information about the development and the personnel involved, along with
a table showing projected returns based on varying occupancy rates and room rates. Based on an occupancy rate of 67.59 per cent and a room rate of $149.33, the investment profile for the Hotel showed that there would be a return of 11.14 per cent to each owner “based on the purchase price of their room as a percentage basis”.
[15] In relation to the Cottage complexes, the information about the projected income stated “each owner shall receive a share of income less all the expenses that the Cottages generate. All income and expenses will be pooled between the completed Cottages”. Budget forecasts were also provided to show the projected income for various Cottage complexes based on the expected occupancy rate and the projected operating costs.
[16] Although there were subsequent iterations of the projected annual returns, all were in similarly optimistic terms showing significant positive returns. The promotional material developed often emphasised the most optimistic projected return of 11.14 per cent.
[17] The first sale and purchase agreements for the hotel units were signed in 2003 even though, at this time, the Hotel and initial Cottage units were still some way off being completed and having titles issued.
[18] The initial version of the sale and purchase agreement provided, at cl 8.3:
(a) The vendor may either appoint a Management Operator or alternatively enter into a Lease with a building manager and the decision to which alternative is followed shall be at the sole discretion of the Vendor.
(b) In the event a Lease is entered into by the Vendor, the Purchaser will take title subject to the Lease and will perform all of the covenants, duties and obligations of the Lessor under the Lease.
[19] In early 2004, MVHL elected to use a management lease, rather than to have a management agreement, and a draft management lease was provided to hotel investors. The draft lease was virtually identical to the Hotel Lease that was ultimately registered.
The Hotel Lease
[20] Key provisions of the Hotel Lease included:
(a) Use: the unit was to be used for the business of providing tourist accommodation and/or the letting of the units to the public for use as accommodation as part of the proposed Monaco Village tourist accommodation complex (cl 12.1 and Schedule 1);
(b)Outgoings: the lessor would be responsible for the payment of all outgoings in respect of the hotel specified in Schedule 3, but the lessee could elect to manage the collection and payment of those outgoings (cl 2). The Schedule 3 outgoings included body corporate charges and levies and the salaries of the hotel manager and all other staff. Clause 2.3(a)(iii) enabled the lessee to levy from the lessor any amounts by which the outgoings exceeded the rent;
(c) Term: 10 years with two 10 year rights of renewal;
(d)Rent: rent payable to each lessor was calculated from the gross unit revenue (GUR) pooled from all hotel units, less:
(i) 10 per cent of the GUR plus GST (a management fee);
(ii)all charges for the operation and management of the hotel at a rate charged by the lessee, pro-rated between units.
The rent payable to each lessor was based on the purchase price of that lessor’s unit as a percentage of the total purchase price for all hotel units. GUR was defined in cl 42 as “all the money actually received … by the lessee from guests occupying hotel Monaco (and pooled from all units) by way of accommodation charges”.
(e) The lessor’s rights of occupancy were restricted to 14 days per annum at a discounted rate, but not during peak season.
[21] Monaco Village Management Limited (MVML), another company wholly owned by MGL, was incorporated to be the management company, and the initial parties to the lease were MVHL as lessor and MVML as lessee.
[22] By mid-2004, MVHL had settled the sale of most of the hotel units and the hotel was open for business. However, by this time the resort had also run into financial problems. Mr Gepp’s explanation was that the Nelson City Council had taken a long time to issue titles to the Cottage units even though the units in question were finished, and the delay meant they could not settle the sale of those units. He also acknowledged that he put down the footings for the Riverside cottages without telling his funder, Westpac Bank, and in due course he had a “falling out” with Westpac.
A problem with the Securities Act
[23] It was also around this time that a potential problem with the Act was discovered. The concern was that the income pooling structure in the Hotel Leases meant the sale of units was the sale of a participatory security which had been offered and allotted without a registered prospectus as required under the Act. It seems that Westpac identified this issue and raised it with Mr Gepp’s advisers in mid-2004. The bank then imposed conditions on its continued funding which required Messrs Gepp and Duke to approach the Securities Commission and, also, to adopt an individual accounting structure for the tourist accommodation business as conducted in each unit from thereon. This resulted in MVHL ceasing to use the Hotel Lease and developing the lease which became referred to as the Cottage Lease. All the tourist accommodation units in the Cottage complexes were sold subject to a Cottage Lease.
The Enforceable Undertaking and the Exemption Notice
[24] Messrs Gepp and Duke, with the assistance of their legal advisers, approached the Securities Commission and, in due course, provided the Commission with an Enforceable Undertaking. In the text of the Undertaking, they explained that they wished to administer the rental income payable to each unit owner on a pooled income basis because this “provides a fairer return to the unit owners, and has a
measure of support within the tourist accommodation industry”. They then went on to undertake not to offer further securities to the public other than in accordance with an Exemption granted by the Commission or in compliance with the Act.
[25] In relation to the “securities already offered to persons who have entered into sale and purchase agreements to purchase development in the property, whether settled or unsettled”, the Undertaking required MVHL to give written notice to those purchasers of the “contravention or possible contravention of the Securities Act
1978”, and to provide each such person with the same documentation that was required to be provided before subscription or allotment (as the case may be) by the terms of the Exemption. The company was then to “re-offer” to all those who had entered into sale and purchase agreements, whether settled or unsettled, the choice of whether to participate in an income pooling scheme. Where those persons did not request to participate in an income pooling scheme for the rental for their unit, the company was to:
… take appropriate steps to administer and account for the rental income derived from the relevant person’s unit on a per unit basis and take appropriate steps to separately account for income and expenditure regarding the relevant unit.
[26] The Securities Commission issued the Securities Act (Monaco Village Holdings Limited) Exemption Notice 2005 on 7 July 2005. The Exemption Notice provided that MVHL and every person acting on its behalf were exempted from ss 33(3), 37, 37A and 51-54 of the Act in respect of “participatory securities issued by [MVHL] in respect of the proportionate ownership scheme at Monaco”.2 The term “proportionate ownership scheme” was defined as a contributory scheme involving the investment of money where each subscriber for specified participatory
securities would acquire a stratum estate in a unit and be issued a certificate of title for that estate (cl 4(1)).
[27] Clause 6 set out the conditions on which the exemptions in cl 5 were granted and included:
2 Securities Act (Monaco Village Holdings Limited) Exemption Notice 2005, cls 4(1) and (5)
(a) that each subscriber would be registered as the proprietor of a stratum estate for their unit;
(b)each subscriber would receive audited annual financial statements covering the performance, financial position and cash-flows of the proportionate ownership scheme; and
(c) before entering into the subscription contract, every subscriber would receive a written statement containing detailed information about the investment as set out in Schedule 1 of the Exemption Notice, including a valuation by an independent registered valuer.
[28] There was also a transitional provision, cl 7, which applied to parties who had entered into sale and purchase agreements, whether settled or unsettled, before the Exemption Notice commenced. MVHL could offer participatory securities after the commencement of the Notice to such parties, but it still had to comply with the same conditions as for new purchasers.
[29] At the same time as the Exemption Notice was issued, the Securities Commission issued a media release. The release explained that MVHL and its directors had “unintentionally breached securities laws when raising funds for a tourist development in Nelson”, and that MVHL, along with two other development companies which had also offered participatory securities for sale, had provided the Commission with Enforceable Undertakings. All three developments gave owners “a proportionate share in the income from all or some of the units in the development”, and those were “participatory securities under the law and their offer and allotment must comply with the law”. The media release stated that undertakings accepted by the Commission in all cases required the developers “to re-offer the interest in compliance with the law”. It concluded by saying:
… if subscribers decide not to take up the re-offer, the Enforceable Undertakings require the companies to allow investors to withdraw from the income pooling schemes (and in the case of Monaco, to instead have their units administered on an individual basis).
The Cottage Lease
[30] The Cottage Lease was drafted and adopted after the potential breaches of the Act came to light. Investors who were waiting for their Cottage contracts to go unconditional were provided with a draft lease instrument which reflected the new Cottage Lease from late September 2004 onwards.
[31] The Cottage Lease included the following terms:
(a) Rent: the rent payable to the lessor would be the GUR less the unit and business outgoings (Schedule 2). GUR was defined as “all the revenue actually received by the lessee … from the letting of the unit to guests”.
(b) Guest allocation: cl 44.1 provided:
The lessee shall use all reasonable endeavours to ensure that the guests of the units in the complex are allocated to the respective units on a fair and equitable basis and shall, to such extent as is reasonably practicable, adopt systems which facilitate compliance with its obligations under this clause.
The “complex” in each case was defined to describe each set of attached accommodation units, for example, the Summerhouse villas, the Orchard villas or the Riverside villas.
(c) Outgoings: unit outgoings were defined to mean:
All outgoings related to the Unit as distinct from the Business including outgoings specified in the Third Schedule.
These covered a range of expenses including the cost of utilities, insurance premiums, maintenance of shared services such as air conditioning and lifts, body corporate fees, the hotel manager’s salary, and all other staff wages or salaries.
(d) Business Outgoings were defined as:
All outgoings relating to the conduct of the business from the unit.
They included a management fee equal to a percentage of the GUR
which was initially 10 per cent in the leases to MVML and was
20 per cent in the leases to Monaco Management Limited leases. The
Business Outgoings definition also included the following proviso:
PROVIDED that where any such costs are incurred in relation to the Business as a whole are not incurred directly in respect of the Unit a proportion of such costs shall be allocated to the Unit pro-rata according to the proportion that the Gross Unit Revenue applicable to the Unit bears to the Gross Unit Revenue of all the Units … shown on the Unit Plan during the period in which such costs were paid.
(e) Term: 10 years plus two 10 year renewals.
[32] In response to questions about the reason for adopting the Cottage Lease, Mr Gepp simply said that it seemed to be “a slightly safer bet than the Hotel Lease, while we were waiting for a response from the Commission [to the request for the Exemption]”. He said, however, it was intended to re-offer the Cottage units to investors on the basis of an income pooling scheme, because that was what he preferred. Indeed, he had his lawyer, Mr David Phillips, prepare a draft offeror statement which set out the information required to go to investors under the terms of Schedule 1 of the Exemption Notice.
[33] Mr Sanders was more confident in his explanation of the reason for adopting the Cottage lease. He said that once Mr Gepp discovered the Securities Act issues, Mr Gepp engaged his lawyer to address this and the new leases were drafted with the assistance of Westpac’s lawyers to ensure that, in the interim, the Act was not being breached by adopting an individual accounting system. In that regard, it is clear that Westpac’s lawyers had input into the decision to adopt the Cottage Lease while the Exemption was sought to allow the units to be offered with pooling of income.
Scott Sanders becomes involved
[34] At around the same time as the Securities Act issues came to light, MVHL ran into financial difficulty. Its funder, Westpac, threatened to withdraw support and MVHL sought finance from Lombard Finance. Mr Sanders, an experienced tourist accommodation manager, was engaged by Lombard to conduct due diligence for it. In due course, Lombard agreed to finance the resort. However, Mr Sanders’ involvement soon went beyond his role for Lombard and he became directly involved in the business from September 2005.
[35] It was clear that, from at least early 2005, Mr Gepp’s relationship with Mr Duke had broken down. Indeed it was described in evidence as “toxic”, and Mr Gepp was looking for a new business partner. Mr Sanders, having reviewed the business for Lombard, was prepared to take up that role. Mr Sanders’ initial involvement was formalised in an agreement signed in September 2005 between MVHL, MGL, MVML, himself, Mr Duke, and by Mr Sanders and Mr Gepp as trustees of a company to be formed. The agreement, which came to be known as the Development Agreement, recorded that Mr Sanders and Mr Gepp would incorporate a new company to acquire the business of MVHL and MGL, and it also set out the terms of the proposed acquisition of the business. However, the agreement was conditional on various matters, including Mr Sanders completing due diligence on the Monaco land and business to his satisfaction.
[36] In due course, a new company, Monaco Village Limited (MVL), was incorporated and the land owned by MVHL, including the unsold and undeveloped units, was sold to Mr Sanders and Mr Gepp as trustees of MVL.
[37] Under cl 7.3(b) of the Development Agreement, MVML was to transfer its interests in the leases to Mr Sanders and Mr Gepp’s new company. However, the Development Agreement was later varied by a further agreement dated
15 November 2005, known as the Management Agreement. The parties to this agreement were MVHL, MVML and a new company incorporated by Mr Sanders, Monaco Management Limited (MML).
[38] Under the Management Agreement, MVML’s accommodation business would not be acquired by MVL on settlement of the Development Agreement sale and purchase, but only when the Securities Act issues were resolved to MVL’s satisfaction. In the interim, MML would manage MVML’s accommodation business. MML would be responsible for completing MVHL’s offeror statement and the “offer back” to previous investors in accordance with the Exemption Notice and Enforceable Undertaking, and to generally resolve the Securities Act issues. MML agreed to arrange for Mr Sanders to carry out and perform all MML’s responsibilities under the agreement.
[39] It is clear, however, that no formal steps were undertaken to comply with the Enforceable Undertaking, or the conditions of the Exemption. Instead, it seemed that relations quickly became strained between Mr Gepp and Mr Sanders. Mr Gepp took the view that Mr Sanders wanted to “dumb down” Mr Gepp’s vision for the resort and to focus only on selling units. Mr Sanders, on the other hand, said he “worked hard to make the development economically viable” but he could not make Mr Gepp’s “pipedream” for a Great Hall, at a cost of approximately $6,200,000, stack up financially.
[40] It is clear, having heard the evidence, that Mr Gepp had an ambitious vision for the resort, but little appreciation for financial realities. Despite his financial predicament in 2005, he downplayed the seriousness of the situation he was in, acknowledging only that he and Mr Duke were “stretched”, but that it was simply “part and parcel of doing a job like that”.
[41] From Mr Sanders’ perspective, the development had “pretty much stalled” at the time he came on board. He believed that until the project was completed and was not, in part, a building site, it could not achieve the room rates on which Mr Gepp had based his projections. This was why he wanted to concentrate on completing and selling the units. He also tried to assist Mr Gepp to resolve his personal solvency issues and to help him restructure his “delinquent debt”. However, it seems Mr Sanders did not get the co-operation he expected from Mr Gepp and, as a consequence, there was no success with restructuring Mr Gepp’s
debt. Inevitably, because the two had differing views about how to get the project on track financially, their relationship broke down as well.
[42] Finally, in August 2006, Mr Sanders bought out Mr Gepp. As a consequence, through MVL, he owned all of the land at the resort which had not yet been sold to investors and, through MML, the business of managing the accommodation. MVL was then responsible for the sale of units in the subsequently built complexes, being Village Green Stage 2, Riverside and High Street. Some of those units were sold for long term or residential use, contrary to the original plan for the resort to be exclusively tourist accommodation, although all the plaintiffs who own units in these complexes purchased units that were leased for tourist accommodation.
[43] The transfer of the business from Mr Gepp’s companies to Mr Sanders’ companies was recorded in a deed of settlement dated 21 August 2006. In it Mr Gepp, Mr Sanders, and various related entities referred back to both the Development Agreement of September 2005 and the Management Agreement of November 2005 and recorded that they had agreed to “settle their differences and disputes on the terms set out in this deed”.
[44] The details of this agreement are not material, except to note that MML exercised its option under the Management Agreement to acquire the management rights business held by Mr Gepp’s company MVML, and Mr Gepp was to vacate the resort and leave New Zealand in return for being released from his obligations to Lombard, both as guarantor and as borrower.
[45] When MML purchased MVML’s tourist accommodation management business, it took an assignment of MVML’s interests as lessee under the management leases and, in almost all cases, registered the relevant transfers on the titles to the units.
Sales under MVL’s ownership
[46] The subsequent sale of units in the resort were from MVL. The sale and purchase agreements provided that the vendor would lease the Cottage units for tourist accommodation and that the purchaser would take title subject to the lease.
The leases were on the same terms as the MVML Cottage Leases, except that the management fee was 20 per cent of GUR as opposed to 10 per cent. Most investors were offered a guaranteed return of eight per cent per annum of the purchase price for the first two years. This guaranteed return was usually documented in a separate covenant between MVL and the purchaser. Some, but not all, purchasers initially received this promised return, but thereafter all purchasers received negative returns.
[47] Once Mr Gepp left, it seems there was no appetite to comply with the Exemption Notice in order to allow pooling of income. Mr Sanders took the view that he was not bound by the Enforceable Undertaking which was given by MVHL and Messrs Gepp and Duke. He also understood that by using the Cottage Lease which provided for individual accounting of rental, he was avoiding offering a participatory security.
Pooling or separate accounting?
[48] Despite all units, except the hotel units, being sold on the basis of a Cottage Lease which provided for individual accounting, some of the promotional material for Cottage units continued to refer to income being pooled. Furthermore, income from the Summerhouse and Orchard units was, in fact, pooled right from the start. This may have been because, at the time, Mr Gepp was planning to re-offer the Cottage units on the basis of an income pooling scheme, using the offeror statement his lawyers had drafted.
[49] Mr Sanders, who was not involved at the time these units were first let for tourist accommodation, says he was subsequently told that those investors had agreed to pool their income shortly after the leases were signed. However, the complexes which were later built and sold by his company, MVL, were all sold subject to a Cottage Lease and each complex adopted an individual accounting structure. While Village Green Stage 1 units were accounted for on a pooled basis for a brief period, this was in error, and Mr Sanders quickly corrected this, telling his accounting staff “we have no mandate to pool Village Green or Riverside”.
[50] Pooling of income was discussed subsequently in some forums. Significantly, at a meeting on 4 October 2007, where representatives of the Hotel
unit owners, and of the Orchard, Summerhouse and Village Green cottages owners were present, all of whom are plaintiffs in the current case, Mr Sanders said that “he was aware that the Hotel [owners] had voted to pool their income”, but that he “had not had any instruction from any other body corporate and that each unit received the income that was generated through their unit/s”. It was then raised and accepted that Summerhouse cottage income and costs were also pooled and split equally. No-one at the meeting suggested Mr Sanders’ understanding was incorrect. It was moved by Mr Sanders and seconded by one of the plaintiffs, Mr Brodie, that the management company should be given “clear instructions as to how both income and revenue are to be apportioned in the hotel and each block of cottages”. It appears that never happened.
[51] In due course, the rest of the cottage complexes were developed under MVL’s ownership. These included the Riverside cottages (the first stage of which had been started by MVHL but which, along with the second stage of the Riverside complex, was completed by MVL), Village Green Stage 2 and High Street. Other facilities were also developed by MVL during this period, including a scaled-down conference and function centre, a permanent marquee, a gymnasium, a pool, a restaurant, an office, laundry and storage facilities, as well as completing general work on the balance of the grounds.
[52] However, despite completion of the resort, and the resort itself being outwardly successful, the unit owners have yet to see positive returns. Mr Sanders explained that by the time the resort was finished in late 2008, the circumstances which prevailed at the time Mr Gepp commenced the development had completely changed. The changes included the fallout from the global financial crisis, the fact Nelson had lost the World of Wearable Arts festival, and the fact there had been a significant increase in the number of rooms available for letting in the Nelson market without a commensurate increase in tourist numbers. For these, and other reasons, the forecasted room rates and occupancy levels could not be achieved and are still short of what had been projected.
[53] The lack of returns had been the source of tension between investors and management under Mr Gepp’s ownership, but it seems many investors were
prepared to accept that in the set up phase of the business, they may not achieve the projected returns. However these tensions continued to grow when, under Mr Sanders’ stewardship, investors were still not achieving a return on their investment. Eventually, in 2013, the present plaintiffs brought these proceedings. While a few have discontinued, there remain 37 plaintiffs who, between them, own
46 of the 82 units which are available as part of the inventory of tourist accommodation. The balance of the 106 units are privately owned or are subject to different letting or use arrangements.
Renewals and registration
[54] There is one final chapter in the narrative which must be covered before turning to the issues in dispute. That relates to the circumstances in which some of the leases were renewed and registered. The initial leases, whether a Hotel Lease or a Cottage Lease, were entered into prior to settlement of the sales of units in each complex, and they have also come up for renewal on varying dates.
[55] The Hotel Leases were the first to be due for renewal in 2014. Under the terms of the lease, MML was required to give notice of renewal at least three months before the lease terminated on 27 May 2014. Unfortunately, MML did not give formal notice of the renewal within the required time. Instead, notice was not given until 17 April 2014 and, even then, it appears some lessors may not have received the notice of renewal because it was sent to the wrong address. A follow-up email was sent to lessors on 22 May 2014 from Mr Sanders advising that if the lessors did not agree to renewal, MML would apply to the Courts for relief against their refusal, under s 261 of the Property Law Act 2007.
[56] As Mr Sanders explained, he did not receive responses from all hotel lessors and he realises now that the notice did not make it clear that he did need a response. There was also a threat by one lessor of re-entry.
[57] As MML did not receive confirmation from the hotel investors that they would consent to renewal, it sought and obtained a without notice interim injunction preventing re-entry by the lessors. Caveats were then also lodged against the titles to the hotel units where no consent had been received to renewal.
[58] In due course all of the hotel lessors gave their consent to the renewal of their leases, albeit some said they did so under duress, or gave their renewal on a “without prejudice” basis. Each of the hotel lessors then provided MML’s solicitors with the relevant authority and instruction forms (A & I forms) and, as a result, on
28 October 2014 the caveats were withdrawn from all but two of the titles and on the same date the renewed leases were registered.
[59] The two hotel units which do not have a lease to MML registered on their titles are two where, it appears through oversight, the assignment from MVML to MML had not been registered in August 2007. In the interim, both those plaintiffs still have caveats registered against their titles.
[60] In respect of the Cottage Lease renewals, renewal notices were provided on time, and A & I forms were forwarded to the relevant Orchard, Summerhouse and Village Green unit owners. However, for various reasons, registration was not always able to be completed in time and, on 23 August 2016, the plaintiffs’ lawyers wrote to MML’s lawyers revoking consent to registration of the renewed leases. Thus various plaintiffs do not, at present, have registered leases.
[61] In respect of Riverside Stage 1 units, these leases are due for renewal on
1 October 2016. Stage 2 leases are due for renewal in February 2018 so, at the time of hearing, plaintiffs who owned units in these complexes had leases registered against the titles to their units as, presumably, do the High Street unit owners.
[62] While these events are not relevant to whether the purchase of units was the allotment of a security, the events relating to the renewal and registration of the leases are relevant to the first defendant’s claimed defence that it has indefeasible leasehold titles.
The plaintiffs
[63] There are 37 extant plaintiffs and, as the defendants say, this is a multi-plaintiff action, not a class action. There are differences between the circumstances of each of the various plaintiffs. However, both the plaintiffs and defendants recognised the following categories of plaintiff:
(a) MVHL plaintiffs who own units in the hotel which were purchased from MVHL and originally subject to Hotel Leases to MVML (now assigned to MML);3
(b)other MVHL plaintiffs who own units in the Orchard, Summerhouse and Village Green Stage 1 cottages which were purchased from MVHL and originally subject to Cottage Leases to MVML (now assigned to MML);
(c) MVL plaintiffs who own units which were purchased from MVL (in High Street, Riverside and Village Green Stage 2) and leased to MML pursuant to Cottage Leases; and
(d)nine of the MVHL plaintiffs and one of the MVL plaintiffs who did not purchase their units directly from MVHL or MVL, and are referred to as subsequent purchasers.
[64] The defendants also consider that there is a separate category of plaintiffs who were not “members of the public” as defined in the Act at the time of the purchase. As a consequence, they say there was no requirement to comply with the Act in relation to these plaintiffs even if the sales would otherwise constitute an offer of participatory securities.
The defendants
[65] The initial vendor, MVHL, and the initial management company, MVML, are not defendants. Both have been removed from the Companies Register.
[66] MVL, the second defendant, was placed in receivership (now ended) and liquidation in February 2010. It was the developer of the Monaco Resort from November 2005 and sold the tourist accommodation units subject to Cottage Leases
owned by the MVL plaintiffs. It played no part in these proceedings.
3 Except for two plaintiffs, Zezora Holdings Ltd and Mr Timothy Boutle and Mr Robin Whalley as trustees of Redtech Trust, where the leases were never transferred from MVML to MML.
[67] The only active defendants in the proceeding were MML and Mr Sanders, the sole director of both MML and MVL. He is also connected to, or owns shares in, the entities which own the first defendant MML.
[68] It is clear from the background set out above that the plaintiffs now have no practical remedy against the entity they purchased their units from, whether MVHL or MVL. A live issue is whether, if the relief they seek can be granted, the practical implications of that relief can be visited on the remaining defendants.
The pleadings
[69] The plaintiffs claim that:
(a) there is an accommodation business conducted in each complex of accommodation units;
(b)each plaintiff’s right to participate in the earnings for their respective complex (whether under the Hotel Lease or Cottage Lease) is a participatory security under the Act;
(c) the offers of securities were in breach of the Act because there was non-compliance with the requirements of s 33;
(d)as a consequence, the allotment of securities was in breach of s 37(1) of the Act and the allotments, as embodied in the sale and purchase agreements and the associated leases, are “invalid and of no effect”.
[70] If I find that the Cottage Lease is a participatory security, then those plaintiffs whose claims are not statute-barred seek a refund of their subscription plus interest, as provided for in s 37(6) of the Act. They say that they are entitled to claim this from both MML and Mr Sanders as “issuers”. Even if the plaintiffs are statute-barred from seeking a refund, they say they are still entitled to declaratory relief under s 37(4) of the Act, and urge me to ignore the consequences for the parties as they are not relevant to the operation of s 37(4). In any event,
consequential relief can be sought once the rights and obligations of the parties are clarified.
[71] The defendants, “for themselves in the context of this case”, concede that the sale and purchase of units subject to Hotel Leases were sales of participatory securities and the Act was not complied with in respect of them. However, they assert that:
(a) the agreements for sale and purchase of units subject to the Cottage Leases were not participatory securities when they were “allotted”. Even though income from the Orchard and Summerhouse units was subsequently pooled for a time, s 37(4) applies only at the point of allotment and not retrospectively so as to avoid such an agreement because the owners pooled income after settlement; and
(b)in any event, s 5(1)(b) applies in respect of these agreements because, even if they were part of a contributory scheme, separate certificates of title were issued in respect of both the freehold and leasehold estates which were acquired by virtue of the agreements.
[72] The defendants also raise a number of affirmative defences. They say:
(a) in respect of the assertion that the leases should be declared invalid as a consequence of the application of s 37(4), the first defendant took an indefeasible title to the lessees’ interests in the Cottage Leases and s 182 of the Land Transfer Act 1952 applies;
(b)not all of the agreements for sale and purchase were “offered to the public in New Zealand”;
(c) each offer is “individual and relates solely to the relevant interest” and in that regard, some of the plaintiffs should not be considered as members of the public because they fall within the exception set out in s 3(2);
(d)the effect of s 6(1) of the Act means that none of the plaintiffs who are subsequent purchasers are entitled to relief;
(e) the defendants’ claim to indefeasible title is not affected by other matters raised by the plaintiffs, including their reliance upon s 63(1)(c) of the Land Transfer Act, or their pleading of an in personam claim; and
(f) the declaratory relief sought is a discretionary remedy and the circumstances are such that it should not be granted.
[73] In short there are a number of issues to consider, but many only arise if the plaintiffs are successful in their claims that:
(a) both the Hotel Lease and the Cottage Lease were offers of participatory securities, which did not fall within the exception in s 5(1)(b);
(b)if they are, the effect of s 37(4) is that the lease registered against the title to the unit is invalid and of no effect; and
(c) the relief they seek (whether return of their subscription plus interest under s 37(6), or a declaration that the lease is invalid and of no effect) can be effective against the defendants.
[74] These are the primary issues for resolution. The balance of the issues turn on whether findings are made on these issues in the plaintiffs’ favour.
The Securities Act
[75] Although offers of securities are now governed by the Financial Markets
Conduct Act 2013, there was no dispute that the Act applies to this proceeding.
[76] Section 37(1) of the Act provides that “no allotment of a security offered to
the public for subscription shall be made unless at the time of the subscription …
there was a registered prospectus relating to the security”. A breach of s 37(1) has the consequence provided for in s 37(4). That section provides: “Any allotment made in contravention of the provisions of this section shall be invalid and of no effect.”
[77] That in turn, has a consequence for the issuer and its directors under s 37(5) and (6) to ensure that “the subscriptions, together with such interest (if any), as has been earned thereon, are repaid to the subscribers as soon as reasonably practicable”.
[78] These provisions incorporate a number of terms which are all defined in the
Act. These terms are: (a) security;
(b) participatory security; (c) issuer;
(d) subscribe; (e) offer; and (f) allot.
[79] “Security” is defined in s 2D of the Act in the following way:
2D Meaning of security
(1) In this Act, unless the context otherwise requires, the term security means any interest or right to participate in any capital, assets, earnings, royalties, or other property of any person; …
[80] “Participatory security” is a security which encapsulates any interest or right which falls within the definition of security, but which is not one of the five specified types of security identified in both this definition and in the definition of security. It is, therefore, a catch-all definition which captures other types of interests
or rights to participate in the capital, assets, earnings, royalties or property of another person, unless, of course, it comes within a defined exception.
[81] “Issuer” is defined in relation to a participatory security as “the manager”.
The “manager” in turn is defined, in relation to a participatory security, as:
Aperson – (A) on whose behalf any money paid in consideration of the allotment of the security is received; or
(B) with a substantial obligation to security holders to act in the continuing administration or management of the scheme to which the security relates; or
(C) to whom both subparagraphs (A) and (B) apply;
…
[82] The definitions of “subscribe”, “offer”, and “allot”, under s 2 are as follows:
subscribe includes purchase and contribute to, whether by way of cash or otherwise; and subscription and subscriber have corresponding meanings.
offer includes an invitation, and any proposal or invitation to make an offer, and to offer has a corresponding meaning.
allot includes sell, issue, assign, and convey; and allotment has a corresponding meaning.
It is worth noting that Parliament has provided a broad definition of the terms “subscribe”, “offer” and “allot”, and the use of the word “includes” means that the definition is non-exhaustive in each case.
Were the sale and purchase agreements subject to a Cottage Lease participatory securities?
[83] The plaintiffs’ claim rests on the assertion that the offer of units subject to the Cottage Lease was the offer of a participatory security as defined by the Act. This assertion relies on the expansive approach to the application of the Act expressed by the Supreme Court in Hickman v Turner and Waverly Ltd,4 and by the Privy Council
in Culverden Retirement Village v Registrar of Companies.5
4 Hickman v Turner and Waverly Ltd [2012] NZSC 72 reported as Hickman v Turn and Wave Ltd
[2013] 1 NZLR 741.
5 Culverden Retirement Village v Registrar of Companies [1997] 1 NZLR 257 (PC).
[84] The defendants concede, for the purposes of this litigation, that the offer of units subject to Hotel Leases were offers of participatory securities. As the plaintiffs note, this is consistent with the position accepted in Braemar Lodge 2004 Ltd (in rec) v Owers.6 That case proceeded on the basis that an offer to investors who were to receive unit titles in, and a share of the pooled income of a luxury tourist lodge, comprised a right “to participate in any … earnings of any person”, and was
therefore a participatory security under the Act. However, the defendants dispute the plaintiffs’ assertion that the arrangements under the Cottage Lease comprised a participatory security.
[85] The plaintiffs’ case is that there was an accommodation business conducted in each complex, and the clause in the Cottage Lease providing for equitable allocation of guests was “simply a proxy for income sharing”, as it was intended to result in an approximately equal sharing of income over a period of time.
[86] In support of their case that units sold subject to the Cottage Lease were a form of participatory security, the plaintiffs say that the definition of “security” should be read broadly in order to further the purpose of the Act. In that regard, much reliance was placed on the decision in Hickman v Turner and Waverley Ltd,7 where the Court cited with approval the following conclusion of the Court of Appeal in Culverden Retirement Village v Registrar of Companies:8
The scheme of the Act appears to be to cast the net in the widest possible terms, and then to rely on specific exclusions to limit its scope.
Because the Act contains exemptions and there is an ability to issue further exemptions in regulations, the Supreme Court was satisfied that the primary definitions of “security” should be read as broadly as they were drafted.
[87] The plaintiffs also argued that a purposive approach should be taken to determining whether a particular arrangement is a security under the Act. A key
6 Braemar Lodge 2004 Ltd (in rec) v Owers [2010] NZCA 300, (2010) 10 NZCLC 264, 703.
7 Hickman v Turner and Waverley Ltd, above n 4, at [46].
8 Culverden Retirement Village v Registrar of Companies (1996) 1 BCSLR 162 (CA) at 166;
affirmed [1997] 1 NZLR 257 (PC).
purpose of the Act is investor protection. As was said in Re AIC Merchant Finances
Ltd:9
… the premise underlying the Securities Act … is the best protection of the public lies in full disclosure of the company’s affairs and of the security it is offering. That then allows the investor to make an informed investment decision, which in turn facilitates the functioning of financial markets.
[88] Here the investors purchased the units as a form of investment. However, the terms of the lease meant that the investors took on a significant business risk without having the degree of control over the asset that the owner of a conventional commercial property investment would have. It was for similar reasons that the Privy Council in Culverden Retirement Village v Registrar of Companies was fortified in its view that the buy-back requirements in the sale and purchase agreements for retirement units constituted a form of debt security and so the provisions concerning offer documents applied. The purchasers of the units were at risk that the vendor might not be able to honour its buy-back commitments and, therefore, holding that these arrangements were debt securities was “consistent with
the purpose of the Act”.10 Similarly, in this case the plaintiffs say the investors took
on risks which would have been brought to their attention more clearly if there had been compliance with the Act.
[89] Finally, the plaintiffs placed much emphasis on the need to look at the substance of the arrangement, rather than its form. The submission that a “substance over form” approach should be taken is supported by high authority. The Privy Council in Culverden emphasised the need to look for “the substance of the overall transaction”, and found that:11
In practical terms the substance of this transaction is that in return for a lump sum payment, a buyer acquires two rights: the right to occupy a unit and the right, when his occupation ends, to be repaid the price he paid adjusted [by various factors].12
That was held to be a form of debt security and so the provisions of the Act applied.
9 Re AIC Merchant Finances Ltd [1990] 2 NZLR 385 (CA) at 392.
10 Culverden Retirement Village v Registrar of Companies, above n 5, at 261.
11 At 260.
12 At 260.
[90] The analysis in that case turned on whether the additional terms and conditions accompanying the sale and purchase transaction were merely ancillary to the real estate transaction or were a “cardinal feature of the transaction”. Because the buyback provision comprised the “cardinal feature” of the transaction, the repayment right could not shelter behind the s 5(1)(b) exemption.13
[91] The Supreme Court in Hickman v Turner and Waverley Ltd held that the practical effect of the investments offered by the Blue Chip group of companies was that the investors enabled the developers to obtain the funding required to construct the apartments by entering into unconditional sale and purchase agreements for the apartments. The investors were generally intended to be temporary owners of the apartments until Blue Chip took over their obligations. However, when the developers’ plans unravelled and the investors were required to settle the sale and purchase agreements, they resisted, arguing that the Blue Chip arrangements constituted debt securities.
[92] Importantly, with the investment products discussed in Hickman, it was never intended that the investor would retain ownership and eventually live in, or personally rent out, the purchased apartment. For example, under what was described as the joint venture agreement arrangement, it was envisaged that the property would be on-sold after a period of time, with 95 per cent of the net proceeds of the sale going to Blue Chip, and, under what was called the premium income product, Blue Chip retained an option to acquire the apartment from the investor prior to settlement. It was envisaged that this right would be exercised after about two years. The financial gains in each case were derived primarily from the contractual arrangements with Blue Chip, not because of the investors’ ownership of the properties.
[93] The Supreme Court held that while the sale of apartments themselves amounted to the sale of an estate or interest in land, the purchase of land was ancillary or peripheral to the other elements of the transaction. The Court
concluded:14
13 At 260.
14 Hickman v Turner and Waverley Ltd, above n 4, at [81].
The reality is that from the point of view of the investor – and assuming of course that all went according to plan – the apartments were of only peripheral significance. Such profits as the investors could expect to derive were to come substantially from the efforts and substance of Blue Chip. And, as events have shown, the practical ability of the investors to recover their outlays was very dependent on Blue Chip honouring its promises. Those promises were well removed from what could be seen as ancillary to ordinary real property transactions. Rather, in our appreciation, they fell four square within the intended regulatory scope of the Act.
As a consequence, the Supreme Court was satisfied that the s 5(1)(b) exemption did not apply.
[94] However, none of the New Zealand cases to date involve transactions quite like the present case, where the transaction, on its face, is a purchase of an interest in land where the purchaser receives title to the property, and the only impugned aspect of the arrangement stems from the terms of a lease registered on that title.
[95] To support their position that such an arrangement could still be a participatory security if, in substance, what was offered was an investment product, the plaintiffs referred to cases from the United States where analogous arrangements were held to be securities under the United States Securities Act 1933.15 The plaintiffs also noted that the Supreme Court in Hickman referred to the “substance- over-form approach” adopted in the United States “when deciding whether offers of real property are securities”.16
[96] However, the relevant US legislation defines security by reference to a lengthy list of financial instruments including “investment contracts”.17 That term itself is not statutorily defined, and the courts in the United States have used a purposive approach to discern the term’s meaning. In contrast, the New Zealand legislation provides a definition for the term “securities” in s 2D of the Act, and sets out exceptions to the term in s 5. Where a definition is provided, the Court is bound to interpret the definition by its text and in light of its purpose.18 Any guidance to be
taken from the American cases cited must be subject to a consideration of the
15 Securities and Exchange Commission v W J Howey Co 328 US 203 (1946) and Cameron v
Outdoor Resorts of America Inc. 608 F.2d 187 (5th Cir 1979).
16 Hickman v Turner and Waverley, above n 4, at [79].
17 Securities Act 1933 15 USC 2(a)(1).
18 Interpretation Act 1999, s 5(1).
difference between a “security” as defined in the Act and the broader term, “investment contract”, used in the United States legislation. For that reason I focus on the approach taken in the New Zealand cases to the statutory definition of security.
[97] In Hickman, the Court discussed the distinction between a debt security and an exempted purchase of real estate under s 5(1)(b). The categorisation turned on whether the property transaction was critical to, or merely ancillary to, the financial package. The Supreme Court concluded that “it could not be seriously suggested” that the investors in the Blue Chip transactions were going to buy the apartments,
and so the transaction was not, in substance, a property transaction.19
[98] In the present circumstances, the sole transaction is the purchase of a property in the Monaco Resort, with a lease registered against the title to the property. That, on its face, is an unexceptional real estate transaction. The defendants relied on this to categorise these purchases as unexceptional purchases of real estate. They pointed out that in the Blue Chip proceedings, the High Court and Court of Appeal held that the purchase of a property subject to a lease, with no other ancillary conditions or arrangements (referred to in the cases as a mainstream investment), was not a security under the Act, and this conclusion was not revisited in the Supreme Court proceedings.
[99] Under the mainstream investments the plaintiffs purchased an apartment with a guaranteed lease in place which was assigned to ART Apartment on settlement. ART Apartment was contracted to pay a rental income to investors at “a fixed rate under a fixed-term lease”, and the investor paid 10 per cent of gross rental for management services. In such cases, Venning J held that the lease was properly described as ancillary to the purchase of the apartment and was therefore an exempt
transaction under s 5(1)(b) of the Act.20 He elaborated as follows:21
19 Hickman v Turner and Waverley, above n 4, at [78].
20 Lester v Greenstone Barclay Trustees [2010] 3 NZLR (HC) at [235]-[253].
21 See further [254] to [271].
[252] The exclusions to the [s 5(1)(b)] exemption do not apply in the present case. The lease does not form part of a contributory scheme. Further, a lease is an interest in land for which a separate title can be issued: s 66 of the Land Transfer Act. While the decision whether to issue a separate title is for the Registrar, there is a statutory provision for a title to be issued. That suggests Parliament accepted a lease can provide a special interest in land.
[253] I conclude that the Securities Act does not apply to the agreements for sale and purchase subject to a lease. Therefore, the mainstream investment is not subject to the provisions of the Act.
[100] In reaching that conclusion, Venning J referred to the Australian decision of
Maunder-Hartigan v Hamilton.22 In Maunder-Hartigan, the Court observed:23
What the [investors] did by way of investment was to enter into a transaction to purchase the unit subject to a lease with a guaranteed net return… for the duration of the lease.
…
What the [investors] enjoy is not profit from the management agreement considered as a business undertaking scheme, but rent by reason of their entitlement as reversioners to the benefit of the lease…
[101] Similarly, in the Court of Appeal, the Court referred to the mainstream investments, saying:24
[333] We agree with the conclusion reached by the Judge substantially for the reasons he gave. The lease was simply part and parcel of the SPA, the purchase price for which was fixed by the terms of the underwrite agreements. The right to the income stream from the lease could not in any sense be regarded as a repayment of funds by the issuer.
[102] The Supreme Court expressed its disapproval of the High Court’s interpretation of s 5(1)(b), insofar as it applied to the other Blue Chip investment products, saying:25
[74] The Court of Appeal concluded that if the marketing of the various products otherwise engaged s 33, s 5(1)(b) would not displace the application of the Act in respect of certain aspects of the various products. Venning J took a different view in the High Court in that he concluded that the s 5(1)(b) exemption was a complete answer to the investors’ Securities Act arguments. On this point, we disagree with Venning J and, as well, conclude that the Court of Appeal approach was too narrow.
22 Maunder-Hartigan v Hamilton (1984) 2 ACLC 438 (WASC).
23 At 447.
24 Hickman v Turn and Wave [2011] NZCA 100, [2011] 3 NZLR 318.
25 Hickman v Turner and Waverley, above n 4 (citations omitted).
[103] Of course this observation does not impugn the findings on what was described as a mainstream investment, which the Supreme Court did not have to consider. However, the issue in this case is whether the purchase of the units can be categorised as a “mainstream investment” where what investors are acquiring is an interest in land where profits are derived from rental income, or whether, looking at the substance of the transaction, it functions as the offer of a security, as in Hickman and Culverden, where investors are in fact expecting profit from a business undertaking, or taking on a form of debt security.
[104] The application of the Act must begin with a determination as to whether the scheme offers a form of security. To be a form of participatory security, there must be a right to participate in any “capital, assets, earnings, royalties, or other property of any person”.26 Clearly the income pooling scheme found in the Hotel Lease was such a right. Income earned in another unit in the complex could be shared between all the investors in the complex.
[105] The plaintiffs argued that the fair and equitable allocation of guests required by cl 44.1 of the Cottage Lease had much the same effect and therefore should be considered as an equivalent to income pooling, making these arrangements participatory securities. The defendants disagreed, asserting that no owner had a right to share in any other owner’s rental earned, as the lease provided for individual accounting, and there was, therefore, no “participation in the earnings of another person”.
[106] Much evidence was given about the application of cl 44.1 of the lease in practice. Mr Sanders explained that the way guests were allocated depended on a number of variables. Many of those were determined by guest requirements. For example, some of the complexes have one bedroom units, whereas others have two bedroom units, some units have baths or have full kitchens while others do not, and some people prefer upstairs units while others prefer downstairs units. These and other factors were the initial determinant of which unit a guest is allocated. However, once those guest requirements are determined and suitable units are
identified, then the resort’s booking system allows staff to allocate available units on
26 Securities Act 1978, s 2D.
a rotational basis. Furthermore, there is a manual check at regular intervals where staff look back over the previous two or three months and, if there is an uneven spread of bookings, they would send an email to the reservation team asking them to try to use certain units.
[107] I accept that, even with such systems in place, the financial records show that there is a range of returns to investors within the same complex. While, over time, there is some evening out of this, the variations remain material. For example, in Village Green Stage 1 the highest earning cottage earned 15 per cent more than the lowest earning cottage over a five year period, and in Village Green Stage 2 the difference was 13 per cent. In the Riverside and High Street Cottage complexes the differences over the same five year period were far more significant. The highest earning cottage in the High Street complex earned 58 per cent more than the lowest earning cottage and, in the Riverside complex, the highest earning cottage earned
162 per cent more than the lowest earning cottage.
[108] However, the focus on the difference between the earnings of individual investors is, in my view, not the only factor to be taken into account in deciding whether or not this was a participatory security. The real distinction is whether they were earning a conventional rental derived from owning a piece of real estate (like a mainstream investment), or whether they were, in practical terms, investing in a business where their earnings came from a business venture jointly undertaken with others.
[109] Were this simply an investment in real property like the mainstream investment described in Hickman, investors could expect to receive rental, subject only to the usual risks of being a lessor, for example, difficulty in finding a tenant, or a particular tenant failing to pay the agreed rent. In this case, however, I accept the plaintiffs’ submission that, in practical terms, the tourism accommodation business is the business of the investors. This is because under the terms of the lease it is the investors, not MML, who are assuming the business risk in relation to the resort. MML manages the business for the investors in exchange for a management fee. Indeed, the defendants’ own expert witness, Mr Pusinelli took the same view, saying that under the structure used by Monaco Resort, “the lessor of the unit is effectively
the owner of the hotel business” and the lessee “is simply the manager of the business”.
[110] Were it MML’s business, one would expect MML to pay a fixed rental to investors (perhaps with some additional portion to be determined on a percentage basis according to net profit), but for MML to be the entity which is exposed to the costs and risks of running the tourism business. However, that is not the case. Instead the investors are responsible for paying all of the unit and business outgoings, including the salaries of the manager and other staff, and it is they who make the loss if the business outgoings exceed its income.
[111] Furthermore, under the terms of the lease, the investors have had much of the security of investing in real estate removed. They have no right to terminate the tenancy, even though it may be generating negative returns. In practical terms the lease lasts for 30 years, so most investors will not be free of the lease in their lifetime. Even when the lease ends, there are practical constraints on how the property can be used because it is required to be used for tourist accommodation under the terms of the resource consent which was granted when the resort was constructed. At present, there is only a limited range of exceptions to the units being used for this purpose.
[112] In summary, I consider that, in substance, investment in the resort is an investment in a form of participatory security. The investors, whether with other investors, or with MML, are participating in the costs and earnings generated by the tourist accommodation business. The investments had very few of the features of an ordinary purchase of real estate. Very few purchasers took any interest in which unit they bought, as they viewed it primarily as an investment vehicle as opposed to a purchase of real estate. The investors have very limited rights of occupation and are significantly constrained in how they can use the property they own. For these reasons, I consider the offers to purchase units in the resort, whether using the Hotel or the Cottage Lease, were offers of participatory securities as defined in the Act.
Does the exemption in s 5(1)(b) apply?
[113] Having held that the arrangements under both leases were participatory securities, having regard to the substance of the transaction, I go on to consider whether, if they were, they would fall within the exemption provided for in s 5(1)(b) of the Act.
[114] Section 5(1)(b) provides:
5 Exemptions from this Act
(1) Nothing in Part 2 shall apply in respect of—
…
(b) any estate or interest in land for which a separate certificate of title can be issued under the Land Transfer Act 1952 or the Unit Titles Act 2010, other than any such estate or interest that—
(i) forms part of a contributory scheme; and
(ii) does not entitle the holder to a right in respect of a specified part of the land for which a separate certificate of title can be so issued;
…
[115] Section 5(1)(b) was briefly referred to in Culverden. There it was said: “Their Lordships accept that the Act was not intended to protect ordinary buyers of land. This is made clear by the exemption in s 5(1)(b).”27
[116] The rationale for this particular exemption is partially captured in the Securities Commission’s explanation for the Exemption granted for the Hotel Lease. The statement of reasons which accompanied the Exemption explained that:28
The Securities Commission considers that it is appropriate to grant the exemptions because –
· the detailed disclosure provisions of the Securities Act 1978 and Securities Regulations 1983 are not ideally suited to offers of real property; and
· the exemptions recognise the protection offered to investors by the receipt of a certificate of title for each unit under the Unit Titles Act
1972 and provide extended valuation information which provides the most relevant information for investors; and
· the exemptions are consistent with the policy of the Commission’s previous exemptions for similar offers of securities relating to interest in real property.
[117] In other words, the Act’s provisions were not obviously drafted with real property investments in mind and such investments do not involve the same level of risk if they are purchased at fair value and the owner receives title to the property.
[118] If I am wrong in assessing the purchase of units by analogy with the impugned transactions in Hickman and Culverden and instead should give primacy to the fact they are on their face, offers of real estate for which the investors will receive title, then I must go on to consider the exemption to the s 5(1)(b) exception. Specifically, s 5(1)(b) exempts securities which involve acquiring an interest or estate in land where a separate title can issue, except where they comprise a “contributory scheme”.
[119] A contributory scheme is defined in the Act as follows:29
contributory scheme means any scheme or arrangement that, in substance and irrespective of the form thereof, involves the investment of money in such circumstances that—
(a) the investor acquires or may acquire an interest in or right in respect of property; and
(b) pursuant to the terms of investment that interest or right will or may be used or exercised in conjunction with any other interest in or right in respect of property acquired in like circumstances, whether at the same time or not;—
but does not include such a scheme or arrangement if the number of investors therein does not exceed 5, and neither a manager of the scheme nor any associated person is a manager of any other such scheme or arrangement.
29 Securities Act 1978, s 2.
[120] In Culverden it was held that one of the everyday meanings of “investment” was the laying out of money in the acquisition of property in the hope of return. Because in that case, the units in the retirement village were bought solely for the purpose of providing the occupant with a secure home, the Court of Appeal did not consider that they were bought as an “investment”, and so there was no contributory
scheme.30
[121] However, the Privy Council reconsidered this issue. It held that the term “investment” as used in the definition of a “contributory scheme” should encompass all forms of investment and not just where the return from the outlay is anticipated to in the form of a financial repayment at the end. For that reason, the Privy Council held that the offers of units in the retirement village would come within the
exception to the s 5(1)(b) exemption, saying:31
Broadly stated, and subject to the somewhat obscure subpara (ii) in s 5(1)(b), the effect of the contributory scheme exception is to take outside the exemption and leave within the scope of the Act, interests in land forming part of a joint enterprise involving more than five investors.
[122] In the present case I am satisfied that an investment in units in the resort falls within the exception to the s 5(1)(b) exemption, because what was being offered to investors was a “contributory scheme” as defined. While both the purchase and the lease are interests in land for which a separate title can (and did), issue, the terms of the lease meant the purchasers were committed to participate in a joint enterprise, for investment purposes, involving more than five investors. Their returns were inextricably linked to the success of the resort as a whole. They shared the costs of running and promoting that joint enterprise with other investors. The risks they took on went well beyond those which they would be exposed to in a standard purchase of real estate which is subject to an existing lease. It follows that the exemption in s 5(1)(b) does not apply to these investments.
Is s 37 invoked?
[123] The purchase of units subject to the Hotel Leases is conceded to be the allotment of a participatory security and it is common ground that neither MVHL,
nor Mr Gepp or Mr Duke, complied with the Enforceable Undertaking or the relevant terms of cl 7 of the Exemption Notice.32
[124] Similarly, I have found the purchase of units subject to the Cottage Leases comprised the allotment of a participatory security and it is common ground that there was neither compliance with the Act or the Exemption Notice in respect of those allotments.33
[151] In conclusion, the only plaintiff I consider was not a member of the public was Mr Bartlett. Accordingly, the allotments which were made to him and his wife were not allotments of a security that was offered to the public, and s 37 cannot apply to invalidate those allotments.
Does s 6(1) mean that s 37(4) does not apply to subsequent purchasers?
[152] Even if s 37(4) applies to make the allotment of units invalid and of no effect, the defendants say that s 6(1) of the Act applies in respect of subsequent purchasers of the units, such that those purchasers have no right to relief under the Act.
[153] Section 6(1) provides:
6 Previously allotted securities
(1) Subject to this section, nothing in sections 33, 34, 37 to 38A,
38C to 43B, and 44B to 59 shall apply in respect of a security that has previously been allotted.
[154] As a consequence, a security which has previously been allotted (and which was not allotted in a way designed to avoid the Act as outlined in s 6(2)) is not governed by, or subject to, the Act.
[155] The defendants submit that s 6(1) makes it clear that ss 33 (which requires a prospectus) and 37 do not apply to secondary market offers, and consequently such allotments cannot be avoided on the ground there was no prospectus (or other
necessary compliance) when the initial allotment was made. Section 37 only applies to protect the subscriber in the primary market.
[156] In support of this submission, the defendants say that to exclude the application of s 37 to a security which is on-sold, irrespective of what occurred in the primary transaction, accords with reality. If it were otherwise, the circumstances in which the security was created, offered and allotted would have to be tracked, reviewed and determined for every secondary market transaction, and that would disrupt, and possibly destroy, the secondary market. Such an outcome has been avoided in all kinds of markets, for example, by the Torrens system and the bona fide purchaser for value rules. Nothing in the policy or language of s 6(1) requires that words concerning the status, validity or provenance of the interest involved should be added, or read into, this section. Put simply, secondary purchasers are not protected, primary purchasers are.
[157] The plaintiffs, however, argue that s 6(1) does not have the effect of “curing” an invalid allotment that results from a breach of the Act simply because the invalidly allotted security has purportedly been on-sold to a subsequent purchaser. Section 6(1) only applies to securities which have been “allotted” and, because of the effect of s 37(4) on the original allotment, that has never occurred. Furthermore, if the defendants’ interpretation of s 6 was correct then there would have been no need to enact the relief order provisions in ss 37AA to 37AL of the Act (the relief order provisions), which afford relief not just to the “subscriber” but, in certain circumstances, to the “security holder” who is expressly defined as “the person who
would be the current security holder but for the application of s 37(4)”.43 The
plaintiffs argue that if a “security holder”, as opposed to a subscriber, automatically received good title to the security by virtue of s 6(1), and was unaffected by a breach of s 37(1)-(3), there would be no need to make provision in s 37AC for the current security holder to be able to seek a mandatory relief order, or associated orders such as compensation under s 37AJ(b)(ii).
[158] In summary, the plaintiffs say that s 6(1) only excludes the operation of s 37 where a security has previously been allotted in compliance with the Act. It does not act to validate securities where the original allotment was invalid and of no effect by reason of a breach of s 37(1).
Discussion
[159] There are two alternative paths to address the situation where a breach of s 37(1)-(3) has occurred: relief under s 37, and relief under the relief order provisions. Under s 37, a subscriber’s primary remedy is a finding that the allotment is invalid and the subscription money must be returned (including with interest if the timeframes in s 37(6) are exceeded). The Act only gives the right to repayment of the subscription to the subscriber, and not to a subsequent security holder.
[160] However, the relief order provisions anticipate that where there has been a breach of s 37, the entitlement to relief can continue beyond the initial transaction between the issuer and the subscriber. That is why s 37AA(3) defines “security holder” to mean the person who “would be the current security holder but for the application of s 37(4)”. However, the relief order provisions are directed primarily at the interests of the subscriber, with limited reference to the interests of a subsequent security holder except where they can show that the contravention has caused that
security holder loss or damage.44
[161] As a consequence, I accept that s 37(4) can affect the validity of a subsequent purchase of a security. However, the subsequent purchaser does not have rights under s 37(5) or (6). It can only seek relief under the relief order provisions. If the subsequent purchaser does so and is granted relief, then the Act provides that s 37(4) no longer applies, so the allotment is not invalid, but compensation and certain other consequential orders can be made in relation to that security holder.
[162] For these reasons, I am satisfied that the subsequent purchasers cannot require an issuer, or its director, to repay a subscription, because the security holder
is not the subscriber. The only avenue to relief the subsequent purchaser has is through the relief order provisions and, if granted, s 37(4)-(6) does not apply.
Can the plaintiffs get the declaratory relief they seek?
[163] The defendants argue that the declaratory relief the plaintiffs seek should not be granted because:
(a) the form of declaration sought is inappropriate, as s 37(4) only invalidates the allotment and not the security itself;
(b)section 37AL specifies the relief which the Court may order and declaratory relief falls outside the scope of s 37AL; and
(c) even if there is jurisdiction, the Court has a discretion as to whether to make a declaration and these are circumstances where it should decline to do so.
What is invalidated by s 37(4)?
[164] Before considering whether the declaratory relief sought can be granted, it is necessary to address what the effect of s 37(4) is, as that determines the scope of any declaratory relief which may be available. The declaration sought by the plaintiffs, as a consequence of s 37(4) being engaged, is a declaration that “the agreements and the leases are invalid and of no effect”.
[165] The defendants dispute that the effect of s 37(4) could ever be to invalidate the lease registered on the title to the land purchased. It could only ever invalidate the sale and purchase transaction itself and give the purchaser the right to repayment of his or her “subscription”.
[166] The plaintiffs say, by reference to DFC Financial Services Ltd v Abel, that s 37(1) results in the contract forming part of the allotment being void.45 In this case
the security which was allotted comprises both the agreement for sale and purchase and the lease. Consequently both contracts should be declared invalid under s 37(4).
Discussion
[167] The answer turns on what is invalidated as a consequence of s 37(4). That subsection says that it is the “allotment” that is invalid and of no effect. As Fisher J said in Abel:46
… I take it that the “allotment” to be avoided under s 37(4) will normally be the contract formed by the issuer’s acceptance of a subscriber’s offer to provide valuable consideration in return for an interest in present or future property, which property had initially been the subject of an invitation to treat communicated to the public by the issuer.
[168] The Court of Appeal in Braemar agreed with the analysis in Abel, and applied that approach to the purchase of units in the retirement village as follows:47
To allot, in terms of the definition, includes to sell, issue, assign and convey. There is no reason why the participatory securities in this case cannot be referred to as having been both issued and sold under the agreements. Those events occurred when the contracts became unconditional.
[169] The Court rejected an alternative argument that allotment occurred at the point of registration, and held that, in the case of each subscriber, allotment occurred on the date when the contracts for sale and purchase of the units became unconditional. Thus an allotment is a contract which conveys or assigns the interest which is deemed to be the security.
[170] I do not accept the plaintiffs’ suggestion that, in Braemar, the effect of s 37(4) was to expressly invalidate the management agreement which was required to be entered into under the terms of the sale and purchase agreement. That was simply a consequential effect of invalidating the allotment effected by the sale and purchase agreement.
[171] The effect of s 37(4) was clearly summarised in Abel as follows:48
46 At 626.
47 Braemar Lodge 2004 Ltd v Owers, above n 6, at [55].
48 DFC Financial Services Ltd v Abel, above n 45, at 625-626.
… in a case involving breach of s 37(1) it is the “allotment” that is avoided under s 37(4), not the “security” or the “subscription” per se...
Of course, the avoidance of that primary contract will have far-reaching consequences for all other rights, liabilities and dispositions whose validity may happen to turn upon the existence of the primary contract.
[172] For example, collateral contracts will be void if their validity was dependent upon the validity of the allotments.
[173] The consequence is that s 37(4) does not make the security itself invalid, nor does it invalidate just those aspects of a transaction which make it a security. What it does do is invalidate the contractual obligation of the subscriber to acquire or retain the security, and it triggers the subscriber’s associated right to repayment of the subscription plus interest.
[174] Applying those principles in the present case, the practical consequence of s 37(4) is to render the contract for sale and purchase of the unit invalid and of no effect. The purchaser, being the subscriber, is then entitled to a refund of the purchase price (plus interest under s 37(6)), from any party which is deemed to be an issuer. It does not operate to allow the purchaser selective relief of any sort against those specific aspects of the interest purchased (in this case, the registered leases) which make it a security.
Is declaratory relief precluded by s 37AL?
[175] The defendants argue that the declaratory relief sought by the plaintiffs is not available because the relief order provisions in the Act preclude it. The defendants say the only way that relief can be sought under the Act is by the plaintiffs applying under ss 37AC and 37AG which they have not done. If relief is granted, s 37AB means that s 37(4) to (6) does not apply to the allotments.
[176] Furthermore, the range of relief the Court can order is constrained by the provisions of s 37AL. Section 37AL(2) expressly provides:
(2) The court must not, in respect of an allotment of a security made in contravention of section 37, make any order or declaration, including an order or declaration in respect of moneys payable, relief, validation, restitution, compensation, variation of a contract, or relief of a contract in whole or part or for any particular purpose, other than any of the following orders:
(a) any order in accordance with any of the provisions of sections 37AA to 37AK, this section, and sections 37B to
37G:
(b) any order or direction in relation to a matter of procedure: (c) any order as to costs:
(d) any order to require the repayment of any subscriptions or interest under section 37(5) or (6):
(e) any order in relation to proceedings under section 59:
(f) any order in relation to proceedings under section 60(2).
[177] The defendant submits that s 37AL limits both the form of relief and the parties against which it can be ordered. Accordingly, the Court does not have the power to make either the declaration sought in the plaintiffs’ prayer for relief nor any related order invalidating the first defendant’s title as lessee.
[178] The plaintiffs argue that s 37AL does not constrain the Court’s power to make a declaration that the circumstances in s 37(4) have arisen. They argue this proposition by reference to the majority judgment in Hickman.49 There, the Supreme Court noted that s 37AL(2) was intended to address concerns as to whether the Illegal Contracts Act 1970 could be relied on by issuers and did not preclude direct enforcement of s 37(4) and (5) by investors which was achieved by declaring the sale and purchase agreements to be unenforceable.50
[179] As already touched on, the Act provides alternative remedies to subscribers where there has been a breach of the Act. Under s 37(4) to (6), subscribers can be released from their contractual obligations under the allotment and be repaid their subscription monies. If repayment occurs, then there is no entitlement to a relief
order under the relief order provisions. If, however, a subscriber or a security holder
49 Hickman v Turner and Waverley, above n 4, at [121].
50 At [123(b)].
seeks and obtains a relief order under the relief order provisions, then s 37(4) to (6)
does not apply to the allotment of the security.51
[180] As relief under s 37(4) to (6) is not precluded by the provisions of s 37AL, the Court is not prevented from making a declaration that an allotment is unenforceable under s 37 of the Act.52 However, for the reasons already discussed, the plaintiffs cannot obtain relief which invalidates the lease by either route. As a result, an order under s 85 of the Land Transfer Act directing the Registrar to rectify the register by cancelling the lease entered on the certificates of title for each unit is also not available.53
Should declaratory relief be granted in the exercise of the Court’s discretion?
[181] Finally, the defendants contend that it is inappropriate for the Court to exercise its jurisdiction to give declaratory relief, in whatever form, regarding the effect of s 37(4) on statute-barred plaintiffs, even if the Court finds that the tourist accommodation units subject to a management lease were offered for sale in breach of s 37(1).
[182] The plaintiffs say they are not seeking declaratory relief under the Declaratory Judgments Act 1908. Their cause of action is based on breach of statute and they simply seek a declaration that the circumstances in s 37(4) have arisen, regardless of whether they are now precluded from recovering their subscription. The discretionary considerations raised by the defendants are not engaged.
[183] Even if such discretionary considerations were relevant, they say that the declaratory relief sought is not futile. The plaintiffs need to know the legal status of their leases. If the leases are invalid and of no effect, then they assert that the right to renew the lease is also invalid. They say they are entitled to a ruling from the Court
and the form that such a ruling must take is a declaration as to the parties’ rights.
51 As a consequence of s 37AB.
52 As was the result in Hickman.
53 Although, during the hearing, the plaintiffs did not pursue that relief, saying they would await the outcome of the initial judgment but potentially pursue that as a consequential order if the primary declaratory relief sought was granted.
[184] They also say that the concerns about effects on third parties are irrelevant as the declarations sought are only binding on the parties to this proceeding. They do not bind any other investors nor do they bind Heartland Bank, which has mortgages registered against MML’s leasehold estates. They go on to say that the Court:
… need not concern itself about what impact the making of its orders may or may not have on the respective parties. The Court’s role is to declare rights. It is then for the parties to negotiate over their respective positions once they are aware of their legal position following the Court’s judgment.
[185] They say it makes no difference to the operation of s 37(4) that the defendants may not have had any part in the offering or allotment of the securities prior to August 2006 and say it is “not for the Court to modify the effect of s 37(4) by, for example, in its discretion refusing to grant declaratory or other relief”.
[186] However, the defendants submit that regardless of the jurisdiction under which declaratory relief is sought, the Court has a discretion as to whether or not a declaration should be granted. They refer to a wide range of circumstances where the Courts have declined to grant declaratory relief, but particularly note cases where the Courts have declined to grant relief where it served no useful purpose or had no practical utility. They say that here, not only would granting a declaration in respect of plaintiffs whose claims are statute-barred serve no useful purpose, it would actually prejudice the plaintiffs. It would leave the plaintiffs in the position of being unsecured creditors for the repayment of their subscription monies from liquidated
entities.54 The units (subject to their respective leases) would still be in existence,
albeit in the ownership of other insolvent parties.
[187] The defendants query how, in practical terms, the transactions can now be set aside, given:
(a) the passage of time;
(b)the significant level of financial transactions that have occurred since then (in some cases now over 12 years since settlement);
54 Presumably where relief is not statute-barred.
(c) the number of sales of the units that have occurred since the alleged allotments;
(d)GST and other tax issues for the unit owners in the event of the alleged allotments being void;
(e) accounting issues for all parties involved who have prepared and signed financial statements;
(f) possible resource consent issues for units that are subject to a resource consent that requires managed tourist accommodation; and
(g) the original vendors being insolvent.
[188] In short, they consider that s 37(4) should have been invoked against the original issuers, and when the entitlement to a refund of the subscription price was not statute-barred. A declaration that is not linked to an existing entitlement to claim a refund of the purchase price under s 37(6) should not be made.
Discussion
[189] As Telecom Corporation of New Zealand Ltd v Commerce Commission demonstrates, the Court has jurisdiction to grant declaratory relief, even where other remedies are statute-barred.55 As Chambers J said, citing The Declaratory
Judgment:56
While the discretion is broad, it is not completely unfettered. A starting point … is that “if a party has succeeded in his action he should not usually be sent away empty handed”.
[190] In Telecom, declaratory relief was sought by the Commerce Commission confirming that Telecom had engaged in anti-competitive conduct under the
Commerce Act 1986, even though that conduct fell outside the limitation period
55 Telecom Corporation of New Zealand Ltd v Commerce Commission [2012] NZCA 278.
56 At [314], citing Lord Woolf and Jeremy Woolf The Declaratory Judgment (4th ed, Sweet and
Maxwell, London, 2011) at [4-05].
imposed by that Act. Telecom argued that the Court should decline to grant declaratory relief with respect to such conduct because:
(a) it would be contrary to the policies underlying the statutory limitation periods in the Commerce Act;
(b) it should be denied on grounds of delay;
(c) it would be “purely hypothetical” because no penalty could be
imposed; and
(d) Telecom faced difficulties in responding to pre-limitation date issues. [191] In discussing these issues the Court acknowledged that “delay could be a
ground for refusing declaratory relief, especially in circumstances where the delay is
unreasonable and prejudice has been caused to the defendant”.57
[192] However, the Court held that the jurisdiction to make declarations was broad and it was irrelevant that the Commission might have no other remedy available to it with respect to the conduct which occurred outside the limitation period. To suggest that other relief must be available before a party can obtain a declaration was contrary to s 2 of the Declaratory Judgments Act, which confirmed that the jurisdiction conferred by that Act to make a declaratory judgment or order “shall not be excluded by the fact that the Court has no power to give relief in the matter to
which the judgment or order relates”.58 Similarly, in The Sisters of Mercy (Roman
Catholic Diocese of Auckland Trust Board) v Attorney-General, it was held that the jurisdiction to grant declaratory relief was not proscribed by any provision of the Limitation Act 1950.59
[193] However, in the present case the character of the declaration sought differs from that sought in either Telecom or The Sisters of Mercy. The plaintiffs are not
simply seeking confirmation that there was a breach of the Act. They are seeking
57 At [317].
58 Declaratory Judgments Act 1908, ss 2 and 11.
59 Sisters of Mercy (Roman Catholic Diocese of Auckland Trust Board) v Attorney-General HC Auckland CP219/99, 6 June 2001 at [57].
confirmation that the relevant allotment was, as a result of being in breach, thereby rendered invalid and of no effect. That is a declaration which potentially has substantive and ongoing effect, and changes the assumed status quo on which a number of parties have relied, including subsequent purchasers, the lessor, and banks (whether lending to the owners or the lessor), for a period of up to 12 years.
[194] The Act does not address how, or even if, s 37(4) is intended to bite when it is invoked long after the subscriber has lost the practical remedy which flows from it under s 37(5) and (6). The fact that all other relief orders (and they are the only orders that can be made) override the effect of s 37(4) to (6) emphasise its limited application and the fact the Court anticipates only two options when there is a breach: invalidating the transaction and repaying the subscriber, or ordering relief in one of the prescribed ways under the relief order provisions.
[195] I consider this is a case where I should refuse to make the declaratory relief sought. I do so for the following reasons:
(a) I do not consider that the effect of s 37(4) is to invalidate the lease and so I would not make a declaration on the terms sought by the plaintiffs;
(b)the primary relief sought by the plaintiffs is a declaration as to the status of the lease. It is not clear to me that a declaration which does less than this is sought by the plaintiffs;
(c) section 37(4) is simply the precursor to the right to repayment of a subscription. Where that relief is not available, I see no utility in making such a declaration;
(d)because of the passage of time, it is now, in my view, impossible to undo all the transactions which have proceeded in reliance on the sale and purchase transactions being effective; and
(e) in any event, now that there has been registration under the Land Transfer Act, parties (including banks) will have acted in reliance on title to the relevant interests in land being indefeasible, and that also points against the appropriateness of declaratory relief.
Orders under s 37(6)
[196] The MVL plaintiffs (excluding plaintiff 16, being the trustees of Karmil Trust, where relief is statute-barred) all seek an order pursuant to s 37(6) of the Act that MVL (as issuer) and Mr Sanders are jointly and severally liable to repay them their subscription money, together with interest at the prescribed rate.60
[197] The total of that claim, with interest calculated to 1 October 2016, exceeds
$7,400,000.
[198] Given my findings that the offer of units subject to the Cottage Lease was the offer of a participatory security, these 11 plaintiffs (owning 14 of the properties), are entitled to reclaim their subscription payment from MVL, plus interest, under s 37(6). What is in contention is whether Mr Sanders, as director of MVL, can be made liable to pay in accordance with the provisions of s 37(6).
Can Mr Sanders be made liable to repay the subscriptions of the relevant MVL
plaintiffs?
[199] Section 37(6) requires that when subscriptions are not repaid within two months after the date on which they were received by or on behalf of the issuer, the issuer and/or the directors thereof shall be jointly and severally liable to repay the subscriptions, together with interest.
[200] A director can avoid such liability if “he or she proves that the default in the
repayment of the subscriptions was not due to any misconduct or negligence on his or her part”.61
60 While the plaintiffs’ closing statement sought relief against all three defendants, the plaintiffs’ pleadings only sought relief from the second and third defendants and I have therefore only addressed the pleaded claims for relief.
61 Securities Act 1978, s 37(6).
[201] Mr Sanders was a director at all relevant times. That is, both when the security was allotted, and subsequently, including when the plaintiffs issued these proceedings and demanded repayment. The only live issue is whether the s 37(6) proviso applies. I was not specifically addressed on that point by the parties.
[202] The misconduct or negligence must relate to the default referred to in s 37(6), which is “the failure to make the payment” (and presumably also the failure to pay interest, though the statute is silent about this).62 Much of the evidence focused on whether Mr Sanders was at fault for not taking adequate steps to satisfy himself that sales using the Cottage Lease were not participatory securities. Mr Sanders’ evidence was that he understood the offer of units subject to the Cottage Lease was lawful given:
(a) the terms on which the Securities Commission granted the Exemption (requiring reversion to individual accounting if unit owners did not agree to pooling);
(b) the fact that the Cottage Lease had been vetted by several law firms;
and
(c) his own confidence that the Cottage Lease was not a form of security. [203] As a consequence, he had no reason to believe that the obligation to repay the
money under s 37(5) had been triggered.
[204] However, the two are inter-related. MVL failed to repay the money because it proceeded on the (mistaken) belief that adopting the Cottage Lease was all that was required to comply with the Act. If Mr Sanders, as MVL’s director, was negligent in proceeding on that understanding, then he cannot avoid liability for the statutory consequences for MVL.
[205] The plaintiffs discussed the relative culpability of Mr Sanders’ actions in the
context of whether he had a defence should I declare the leases invalid. In summary,
62 Reunman v Paape (2002) 9 NZCLC 262, 988 (CA) at [17].
they pointed out that Mr Sanders knew the units were being offered without a registered prospectus. He knew with the Hotel Leases, there had been a requirement to comply with the Exemption and Enforceable Undertaking and that there had been no such compliance. Furthermore, his company MML entered the Management Agreement for the express purpose of deferring acquisition of the management rights until MML was satisfied that the Securities Act issues had been addressed to its satisfaction.
[206] However, those factors deal only with the Hotel Lease, and the MVL plaintiffs who are seeking a refund of their subscription price all owned units with the Cottage Lease. Mr Sanders argues that it was reasonable for him to consider that the Cottage Lease avoided a breach of the Act particularly when the Securities Commission highlighted the income pooling as the offending aspect of the transaction. However, the plaintiffs say that nothing said or done by the Securities Commission was relevant to Mr Sanders’ views on the Cottage Lease. The Securities Commission was never provided with a copy of it nor asked for a view as to whether the contributory scheme involving a Cottage Lease constituted a participatory security. Furthermore, Mr Sanders cannot show that he expressly sought and obtained legal advice on the validity of the Cottage Lease. At best, he obtained written legal advice which, in passing, noted that if he proceeded to sell units in the resort subject to the Cottage Lease “then there may be no securities issues”. That same lawyer offered to have another solicitor in his firm look further into the issue, but that suggestion was never taken up.
[207] The plaintiffs therefore say that what Mr Sanders did was to choose to take the risk that an offer of the units in the complexes subject to a Cottage Lease was not the offer of a participatory security. His own lawyer did not give him comfort that, by setting up a new company and using the Cottage Lease, he avoided a breach of the Act. He failed to take up the suggestion to seek legal advice confirming this position. I accept that in those circumstances he has not discharged the onus on him to demonstrate there was no negligence or misconduct on his part and he, too, is jointly and severally liable to repay the 11 identified MVL plaintiffs the purchase price, plus interest at the rate specified in s 37(6).
[208] The Act does not address what should occur to the security where a director refunds the subscription price because the issuing company does not. In my view, it would be appropriate in such circumstances for the security to be transferred to the person paying the refund and not returned to the issuer. I reserve leave for consequential orders to this effect to be sought if required.
Can MML be made liable to repay the subscriptions of the relevant MVL
plaintiffs?
[209] Although it was not pleaded in the statement of claim, in closing the plaintiff also sought an order be made against the first defendant MML, jointly and severally with the second and third defendants, for the repayment of subscription monies that were sought on the basis that MML is caught by the definition of “issuer” in its capacity as a “manager” of a participatory security.
[210] The plaintiffs argue that as MML is the lessee under the leases, it falls within the definition of manager in s 2 of the Act, as it has a “substantial obligation to security holders to act in the continuing administration or management of the scheme to which the security relates”.
[211] Given the invitation in the pleadings for the Court to grant any other relief under the Act or otherwise that the Court thinks fit, and because it was raised in closing submissions, I go on to consider whether MML is a manager of the participatory security and therefore liable, along with the first and third defendants, to make repayment.
[212] At the outset, it is worth noting that these provisions are not readily adapted to the circumstances where the securities regime deals with an investment in real estate, and I was not directed to any case where a company which was managing property subject to a lease which was held to create a participatory security had been considered to be a “manager” for the purpose of the Act.
[213] While the term “participatory security” is a catch-all provision to cover other investment products that are not a debt or equity security, the definition of manager appears intended to capture ordinary fund managers where such a manager holds the
capital sum of the investment and is responsible for deciding how that sum is to be utilised. In such cases it is clear why the statutory purpose of the Act is met by requiring the fund manager to be responsible for repayment of the subscription in the same manner as the issuer who initially received the subscription.
[214] While MML could be said, in a literal sense, to have a “substantial obligation to act in the continuing administration or management of the scheme to which the security relates”, I consider this phrase must be interpreted in the context of the legislation and the purpose of including a manager in the definition of an issuer. It cannot have been intended that a party such as MML, which did not receive the subscription or have any ongoing responsibility for holding it or investing it, but is merely the conduit for rental income from the arrangement which comprises the security, should be responsible for repayment.
[215] In my view, therefore, MML is not a manager in the sense required under the definition in the Act and cannot be ordered to repay the subscription price.
Conclusion
[216] In summary, the plaintiffs have succeeded in part in their claim by establishing that all the offers to invest in the Monaco Resort were offers of a participatory security, although only a limited number are entitled to relief under s 37(4)-(6). This is because most of the plaintiffs’ claims are statute-barred and one set of plaintiffs were not members of the public. However, that relief does not extend to making an order that the associated leases are invalid and of no effect. For that reason, I have not needed to consider the wide range of defences pleaded by the defendants to such an order being made.
[217] Specifically, I have found:
(a) The offer of units in the Monaco Resort subject to a Cottage Lease is the offer of a participatory security.
(b)The exception in s 5(1)(b) does not apply because, even categorised as a purchase of an estate or interest in land for which separate title can issue, the interest formed part of a contributory scheme.
(c) As a consequence, s 37 is invoked where the offer was to a member of the public.
(d)The offer of the participatory security was not an offer to the public in relation to the fourth plaintiffs, Alan and Margaret Bartlett.
(e) Section 6(1) does not mean that s 37(4) does not apply to subsequent purchasers. However, such persons are not entitled to a refund of their subscription but must seek relief under the relief order provisions of the Act and, if granted, s 37(4)-(6) will not apply.
(f) The declaratory relief sought by the plaintiffs to the effect that the lease is invalid and of no effect is not available, as s 37(4) only operates to invalidate the “allotment” of the security which, in this case, is the sale and purchase transaction.
(g)Declaratory relief is not precluded by s 37AL. However, for the reasons given, I decline to grant the declaratory relief sought in respect of those plaintiffs whose claims are statute-barred.
(h)The third defendant, Mr Sanders, as a director of the issuer, is jointly and severally liable to make repayment of the subscription money to those plaintiffs whose claims for a refund are not statute-barred or otherwise precluded, and he cannot avail himself of the exception to such liability provided in s 37(6).
(i) The first defendant, MML, is not a “manager” as defined in the Act
and so is not liable to make repayment under s 37(6), as an issuer.
[218] As a consequence of my findings, I make the following orders:
(a) the second and third defendants are jointly and severally liable to repay the subscription monies of the following plaintiffs, plus interest in accordance with s 37(6):
(i) P M A and Associates Ltd (plaintiff 2);
(ii) Paul Andrew Cheeseman and Sarah Frances Cheeseman
(plaintiff 14);
(iii) PPD Investments Ltd (plaintiff 20); (iv) Peak Assets Ltd (plaintiff 21);
(v) Paul Graham Rose and Joyce Mary Rose (plaintiff 28);
(vi) Andrew John Millward and Sali-Ann Millward (plaintiff 31); (vii) Matthew Justin Morris and Jill Anita Morris (plaintiff 32); (viii) Tamsin Judith Raistrick and David Ian Raistrick (plaintiff 34);
(ix) John David Shackleton and Marilyn Freda Shackleton
(plaintiff 37);
(x) Herbert Michael Tate (plaintiff 39);
(xi) Marc van Gelder and Ann Watzeels (plaintiff 43).
(b)that relief is conditional on each plaintiff transferring the unit to the second defendant or its nominee immediately upon deposit by the second defendant of the plaintiff’s subscription money in cleared funds into the trust account of the plaintiff’s solicitor;
(c) leave is reserved for any party to seek any consequential order, including relief orders; and
(d) costs are reserved.
Solicitors:
P G Skelton QC, Barrister, Auckland
Q M Hay, Barrister, WellingtonGCA Lawyers, Christchurch
Saunders Robinson Brown, Christchurch
- AGLC
- Bannock v Monaco Management Limited [2016] NZHC 2842
- Case
- [2016] NZHC 2842
- Decision Date
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