FLETCHER STEEL LTD V NAHAL CONTRACTORS LTD AND ORS HC AK CIV-2006-404-498

FLETCHER STEEL LTD V NAHAL CONTRACTORS LTD AND ORS HC AK CIV-2006-404-498 24 May 2007IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY CIV-2006-404-498BETWEEN FLETCHER STEEL LIMITED Plaintiff AND NAHAL CONTRACTORS LIMITED First Defendant AND BALVIR NAHAL Second Defendant AND NAHAL PROPERTIES LIMITED Third Defendant AND BN & MG HOLDINGS LIMITED Fourth Defendant AND BALVIR NAHAL, KAMALJIT NAHAL AND FASTCO TRUSTEES LIMITED Fifth Defendant Appearances: K W Fulton for Plaintiff D G Smith for First, Second, Third and Fourth Defendants H Sumich for Fifth Defendant Judgment: 24 May 2007 at 5:00 pmRESERVED JUDGMENT OF ASSOCIATE JUDGE D H ABBOTTIn accordance with R540(4) I direct that the Registrar endorse this judgment with the delivery time of 5:00pm on 24 May 2007Solicitors: Meredith Connell, PO Box 2213, Auckland Fax: (09) 336-7629 Frost & Sutcliffe, PO Box 23570, Papatoetoe Fax: (09) 277-6703Counsel: K W Fulton, PO Box 3735, Shortland Street, Auckland Fax: (09) 303 3948 D Smith/H Sumich PO Box 3799, Auckland Fax: (09) 368-7489Introduction[1] Fletcher Steel Limited (FSL), the plaintiff, has applied for an order that caveats lodged against two properties owned by the third and fifth defendants not lapse. [2] The caveats have been lodged to protect a claimed equitable interest in the land under a constructive trust. [3] FSL claims that money obtained from it by fraud has knowingly been used by the defendants to acquire or improve the land subject to the caveats. They are seeking to recover that money from the defendants, and wish to retain the caveat until their claims are determined. [4] The defendants oppose the application on the grounds that the alleged frauds do not give FSL an interest in the land which would support a caveat. They say that FSL has at best a right to trace, and to a money judgment.Background[5] FSL owns and operates steel manufacturing and related businesses in Penrose, Auckland. [6] Nahal Contractors Limited, the first defendant, provided services to FSL, initially as a sub-contractor to another party and, from April 2002, direct to FSL. [7] Mr Nahal, at all material times, was the managing director of Nahal Contractors, a director of Nahal Properties Limited (the third defendant) and together with the other fifth defendants a trustee of a family trust; the Nahal Trust. [8] After Nahal Contractors started providing services direct to FSL it came to an arrangement with one of FSL's employees (Mr Dean Purchase) under which Nahal Contractors paid money to Mr Purchase in return for him approving false invoicesand purchase orders. Mr Nahal has admitted making payments to Mr Purchase of approximately $242,000. He has also admitted false invoicing totalling $324,917. [9] FSL claims that the fraud was more extensive than has been admitted. It has accepted compensation of $242,000 from Mr Purchase, and $148,885 from Nahal Contractors, but without prejudice to its claim in respect of the alleged additional fraud. It has issued this proceeding to recover the additional sum that it says it has paid by reason of the fraud. [10] FSL has lodged a caveat against the titles of two properties which it claims have been acquired, or the equity in which has been improved, by use of money obtained by the fraud. One is a property at 16 Wintere Place, Manukau City, owned by Nahal Properties. The other is a property at 42A Gracechurch Drive, Manukau City, owned by the trustees of the Nahal Trust. [11] Nahal Properties and the trustees of the Nahal Trust have applied to the Registrar-General of Land for removal of the caveats. The present application followed. The defendants dispute that there is any additional fraud, but the principal matter of contention is whether FSL can show that the disputed right to any further money gives them an interest in the land capable of supporting a caveat.The application and principles that apply[12] FSL brings its application under s 145A of the Land Transfer Act 1952. Under that section a registered proprietor of land subject to a caveat may apply to the Registrar-General of Land for the caveat to lapse. The caveat will lapse unless the caveator applies (within a prescribed period) for an order that the caveat not lapse. [13] Section 145A does not set out the criteria on which the Court will decide whether or not the caveat is to lapse. However, the Court is guided by principles which have been developed in case law and are now well established. There being no difference between counsel on this, I adopt as relevant to the present case the following summary of principles put forward by counsel for the first and fourth defendants:a) The onus is on the caveator to show he had a reasonably arguable case for the interest he claims. Castle Hill Run Limited v NZI Finance[1985] 2 NZLR 104 at 106: b) It is not enough to show that the lodging and continued existence of the caveat would be in some way advantageous to the caveator:Guardian Trust & Executors Company of New Zealand Limited v Hall[1938] NZLR 1020 at 1025; c) The caveator must establish an arguable case for claiming an interest of the kind in s 137 of the Land Transfer Act; d) Where a caveator establishes an arguable case for the interest the Court still has a discretion: Pacific Homes Limited (in receivership) v Consolidated Joineries Limited [1996] 2 NZLR 652 at 656; e) Summary procedure for removal of a caveat is wholly unsuitable for determination of disputed questions of fact. [14] It is also well established that protection of equitable interests by the lodging of a caveat is an integral part of the Land Transfer Act 1952: Holt v Anchorage Management Limited [1987] 1 NZLR 108 (CA). This protection is also available to protect a claimed interest pending a determination of that interest at trial: Zhong v Wang CA282/05 5 September 2006. [15] Counsel for the defendants accepted, for the purposes of this application, that the facts were as pleaded by the plaintiff (given that the summary procedure for removal of a caveat is unsuitable for determining any disputed questions of fact). [16] The plaintiff claims that it has an interest in the land capable of supporting the caveats by reason of a constructive trust. It says that this trust attached to the money that it paid to Nahal Contractors as a result of the fraud, and that Nahal Properties and the Nahal Trust have knowledge of it, and are bound by it, through Mr Nahal. It says that its beneficial interest in the money (as the beneficiary of thetrust) later transferred to the land. This is said to have occurred when the money was used to repay a mortgage and thereby increase the equity in Wintere Place, or to acquire the land and later repay a mortgage and increase the equity in Gracechurch Drive. FSL claims entitlement to the caveat to protect its interest until the extent of that interest can be determined at trial. [17] In the alternative, FSL seeks a preservation order under rule 331 of the High Court Rules on the basis that there is reason to believe that the defendants will dissipate or transfer assets to defeat FSL's claim. [18] The defendants say that the thrust of the plaintiff's argument can only be that a remedial constructive trust should be ordered. They further say that an institutional constructive trust does not arise in the absence of any fiduciary relationship between FSL and Nahal Contractors, and that at best FSL has a right to trace which will only give rise to a remedial constructive trust, and that that will not come into being until the making of a court order. They also say that in any event there is no interest in the land as the equity in the land has not been improved (the money was loaned and used to replace earlier borrowing). [19] To determine whether there is an arguable case overall for an interest in the land, the following issues must be decided: a) Is FSL advancing an institutional or a remedial constructive trust? b) Does FSL have an arguable case for a constructive trust in the over- payments? c) Can a beneficial interest in the land arguably arise if the money was loaned and used to pay existing mortgages?Is FSL advancing an institutional or a remedial constructive trust?[20] Counsel for Nahal Properties and for the Nahal Trust argued that the case that FSL was advancing was for a remedial constructive trust. They raised three mattersin support of that proposition. The first was that this was how it was expressed in the grounds of the present application. The second was that although the claim pleaded a fiduciary relationship between FSL and its employee (Mr Purchase), there was no fiduciary relationship between FSL and Nahal Contractors which could give rise to an institutional constructive trust. The third aspect was that the right to trace gave no more than a remedial constructive trust. [21] The significance of the defendants' argument was that entitlement to a remedial constructive trust does not confer an interest in land. A court order is needed to bring such a trust into being, and there is no interest to support a caveat until then: Fortex Group Ltd (In receivership and liquidation) v McIntosh [1998] 3 NZLR 171 and Metalplas Engineering Pty Ltd v Ellis & Coker (HC AK M293- IM02, 21 August 2002, Master Lang). [22] The first of these points is answered by the pleading. FSL pleads that Nahal Contractors advanced sums to Nahal Properties to allow it to acquire and meet obligations on (inter alia) Wintere Place. It says when Nahal Properties received the funds it did so as constructive trustee for FS. It pleads expressly that the Wintere Place property is the subject of a constructive trust in favour of FSL. In its pleading against the Nahal Trust, FSL says that the Nahal Trust received from Nahal Constructing and Mr Nahal sums derived from the unlawful acts against FSL, and those sums have been used to acquire or sustain the Gracechurch Drive property. As such, FSL says that Gracechurch Drive is held by the trust as constructive trustee for FSL. In both causes of action the prayer is for a declaration that Nahal Properties or the Nahal Trust hold the properties as constructive trustee for such sum as is established as having been overpaid by reason of the fraud. This is pleading of an institutional rather than a remedial constructive transfer (as defined in Fortex). [23] The second point also does not assist the defendants. Counsel for FSL, whilst not conceding that there was no fiduciary relationship between FSL and Nahal Contractors, said that FSL's case is that a constructive trust arose regardless of any fiduciary duty. He submitted that the fiduciary relationship between FSL and Mr Purchase was context for the unlawful acts constituting the fraud. I will address the substantive argument shortly. I note it at this point simply as a factor countingagainst the defendants' general argument that FSL is seeking a remedial constructive trust. [24] Similarly, counsel for FSL says that its case is that tracing is merely a process to "locate" the constructive trust and is not to be taken as acceptance that a remedial constructive trust is being sought. [25] It is quite clear to me that FSL is pleading an institutional constructive trust.Does FSL have an arguable case for a constructive trust in the over-payments?[26] Counsel for FSL argued that an institution constructive trust arose in respect of the payments made by FSL as the frauds were committed. He relied on principles of trust law summarised by the House of Lords in Westdeutsche Landesbank Girozentrale v Islington London Borough Council [1996] AC 669, at 705, focussing on the comments in respect of constructive trusts:(i) Equity operates on the conscience of the owner of the legal interest. In the case of a trust, the conscience of the legal owner requires him to carry out the purposes which the law imposes on him by reason of his unconscionable conduct (constructive trust). (ii) Since the equitable jurisdiction to enforce trusts depends upon the conscience of the holder of the legal interest being affected, he cannot be a trustee of the property if and so long as he is ignorant in the case of a constructive trust, of the factors which are alleged to affect his conscience. (iii) . The only apparent exception to this rule is a constructive trust imposed on a person who dishonestly assists in a breach of trust who may come under fiduciary duties even if he does not receive identifiable trust property. (iv) Once a trust is established, as from the date of its establishment the beneficiary has, in equity, a proprietary interest in the trust property, which proprietary interest will be enforceable in equity against any subsequent holder of the property (whether the original property or substituted property into which it can be traced) other than a purchaser for value of the legal interest without notice.and later at p716:I agree that the stolen moneys are traceable in equity. But the proprietary interest which equity is enforcing in such circumstances arises under a constructive, not a resulting, trust. Although it is difficult to find clearauthority for the proposition, when property is obtained by fraud equity imposes a constructive trust on the fraudulent recipient: the property is recoverable and traceable in equity.[27] Counsel for FSL also submitted that if money obtained dishonestly is used in acquiring or improving equity in a property, this will give the defrauded party an equitable interest in the property: New Zealand Limousin Cattle Breeders Society Inc v Robertson [1984] 1 NZLR 41, 43:The alternative case was that fairness and equity, justice and good conscience required the imposition of a trust. On the normal classification this has reference to a constructive trust. The theft of the moneys from the Society was pressed as an upstairs feature of the case. If any of the stolen moneys had been used to acquire or improve Robertson's home this would give rise to an equitable interest and an equitable lien on the whole. But no such use of the moneys has been suggested. There is no link of any description between the stolen money and the house property. In equity the conscience of the respondent is not affected by his continued beneficial ownership of his home.[28] Counsel also relied upon the following propositions: a) The law recognises that a person induced by fraud to make a payment may rescind the payment and claim title to the money in equity, at least to the extent of supporting an equitable tracing claim: El Ajou v Dollar Land Holdings Plc [1993] 3 All ER 717, 734; and Snells Equity, 31st ed. at para 28-35; b) Where a person receives money, knowing it to be the result of a fraud, the recipient becomes a constructive trustee of that money on the basis of "knowing receipt': El Ajou at 738-739; c) It is not necessary for there to be a pre-existing fiduciary relationship before funds would be permitted to be traced into a property: Bracken Partners Ltd v Gutteridge [2003] 2 BCLC 84; d) Where a trustee uses part of the trust property to acquire an asset, the beneficiary of the trust can either claim a proportionate share of the asset, or enforce a lien on it, to secure a claim against the trustee:Foskett v McKeown [2001] 1 AC 102;e) A proprietary interest arising on receipt of fraudulently obtained funds will extend to substituted assets, and give the person from whom the payment has been fraudulently obtained a caveatable interest both in the original funds and in any substituted assets: Attorney-General for Hong Kong v Reid[1994] 1 NZLR 1. [29] Counsel for the defendants submitted that the authorities relied on by FSL were all cases where there was a proven or accepted fraud, with the defrauder being in an accepted fiduciary relationship with the caveator. They submitted that there was no legal basis for an institutional constructive trust in the absence of a fiduciary relationship, and that a right to trace did not give rise to an interest in the property until there were requisite findings which allowed a remedial constructive trust to be imposed. They argued that the fiduciary relationship between FSL and Mr Purchase could not be extended to what was an arms-length commercial arrangement (between FSL and Nahal Contractors) and that in the absence of a fiduciary relationship, knowledge of the unlawful acts was insufficient to give rise to a trust. They said that it only gave rise to a right to trace, and, in this case, a remedy in damages. [30] I am not persuaded that a trust cannot arise where a party receives funds knowing they have been dishonestly obtained. Adopting the general principles referred to in Westdeutsche, equity must be able to operate against the conscience of a recipient with knowledge of the fraud. I see no reason to restrict this to pre- existing fiduciary relationships. What equity focuses upon is not the relationship between the particular parties but the knowledge of the recipient. [31] On the basis of these authorities I am satisfied that it is at least arguable, as a matter of law, that a constructive trust in favour of FSL arose at the time that each payment was made on a fraudulent invoice, and to the extent that the payment made by FSL exceeded the sum that was properly payable. [32] The defendants dispute the claim that the fraud was more extensive than has been admitted. FSL have had an expert insolvency practitioner, Mr McLennan, undertake an analysis of the invoicing. He notes Mr Nahal's acknowledgement thathe issued certain false invoices, and Mr Nahal's contention that all sums improperly invoiced were paid over to Mr Purchase (and been repaid). Mr McLennan gives evidence of an analysis undertaken of the invoicing and other records (time schedules and bank statements). His analysis was not complete, but he concludes that Mr Nahal's explanation is totally implausible and that there was a systematic and continuous fraud going far beyond the sums acknowledged and repaid. He expresses the opinion that by the time his analysis is complete he expects to be able to support the allegations in the statement of claim. [33] Mr McLennan's evidence of his analysis of Nahal Contractors payment schedules as against invoicing to FSL identifies substantial disrepancies. In an affidavit filed in reply, the defendants' accountant has given evidence that a number of people who carried out work for Nahal Contractors were sub-contractors and not represented on the PAYE schedules used by Mr McLennan. [34] Although the fact and extent of any over-charging cannot be resolved on this summary application, I accept that FSL has established an arguable case for it. [35] I also consider it at least arguable that both Nahal Properties and the Nahal Trust had the requisite knowledge of the fraud conducted by Nahal Contractors (as a consequence of the knowledge of Mr Nahal) to constitute them constructive trustees. The critical further issue for this application is whether the manner in which the funds were received (recorded as a loan) precludes a finding of an interest in the land.Can a beneficial interest in the land arguably arise if the money was loaned and used to pay existing mortgages?[36] The defendants argued that the facts alleged by FSL cannot give rise to a constructive trust extend to the land. They say that there is no evidence that money stolen from FSL was used in acquiring or increasing equity in these properties, but in any event it was not separately identifiable, at least in respect of these two properties.[37] The plaintiff's case is that all of the funds paid over by FSL were impressed with a trust as a result of the fraud, including payments made for work that was in fact undertaken. It relies on Zhong v Wang as support for its submission that once a reasonably arguable case for a constructive trust is made out, the caveats should remain until the extent of the interest could be determined. [38] Mr McLennan's analysis identifies a sum of $140,000 coming from Nahal Contractors in September 2002, and being used by Nahal Properties to repay a loan in respect of Wintere Place. He also identifies a sum of $45,750 coming from Nahal Contractors being used as a deposit for Nahal Trust's purchase of Gracechurch Drive, and evidence of two payments of $150,000 and other payments (said to amount to $427,384) coming from Nahal Contractors to Nahal Trust, through Nahal Properties, and used to repay a bank loan obtained at the time the Trust purchased Gracechurch Drive. [39] The defendants argue that an institutional trust cannot arise as FSL cannot identify specific trust property. They further argue that until there is a finding against Nahal Contractors which justifies a remedial constructive trust, the only evidence is of loans (potentially recoverable upon demand) rather than an interest in the land. [40] I find it arguable, as a matter of law, that a constructive trust can arise even if the specific funds to which the trust attaches cannot be identified: Westdeutsche Landesbank Girozentrale v Islington London Borough Council. I also hold that it is arguable that the use of this money to repay or reduce loans from independent third parties could amount to an improvement in the equity in the property. That is another matter which cannot be determined on this summary application. There is no evidence of the terms on which the money has been advanced. It cannot be taken that it is a truly arms-length transaction. Nor were counsel able to refer me to any specific authority to the effect that the advance between these related parties would defeat a proprietary claim.Decision[41] I find that FSL has an arguable case for a constructive trust in respect of payments made as a result of the fraud, notwithstanding that the extent of the fraudulently obtained payments cannot yet be determined. I am also satisfied that the trust arguably extends to providing a beneficial interest in the two properties. I order that the caveats not lapse pending determination of FSL's claim and further order of the Court. [42] Given the findings I have made, I do not need to consider FSL's alternative claim for a preservation order. [43] As the successful party on the application, FSL is entitled to costs. The third and fifth defendants are to pay FSL's costs on a 2B basis, together with disbursements as fixed by the Registrar. If counsel are unable to agree on the claimable items under Schedule 3, they are to file memoranda: FSL within 14 days and the defendants within 21 days. __________________________Associate Judge DH Abbott