REGISTRAR OF COMPANIES V NEARZERO INCORPORATED HC NEL CIV 2007 442 240

REGISTRAR OF COMPANIES V NEARZERO INCORPORATED HC NEL CIV 2007 442 240 16 July 2007IN THE HIGH COURT OF NEW ZEALAND NELSON REGISTRY CIV 2007 442 240UNDER The Companies Act 1993 and the Securities Act 1978 IN THE MATTER OF Applications for rescission of appointment of interim liquidators under s342 Companies Act 1993 and under s37AH Securities Act 1978 for relief BETWEEN REGISTRAR OF COMPANIES Plaintiff AND NEARZERO INCORPORATED Defendant Hearing: 11 July 2007 Counsel: R B Hucker and A C Cumming for Defendant in Support B H Dickey and S M B Wimsett for Plaintiff to Oppose Judgment: 16 July 2007JUDGMENT OF WILD J Introduction[1] The defendant (Nearzero) applies for rescission of an order made by Associate Judge Gendall here in the High Court at Nelson on 22 May. Pursuant to s342 Companies Act 1993, the order appointed two interim liquidators for the liquidation of the assets in New Zealand of Nearzero. Nearzero is an overseas company, incorporated in Nevada in the United States of America on 10 July 2006. It is not in liquidation in Nevada. Liquidation seems unlikely to occur there, as its business activities appear all to be here in New Zealand.[2] The New Zealand Securities Commission believed Nearzero was issuing shares when it had not registered a prospectus, as required by s37 Securities Act 1978. On 9 May 2007 the Commission requested the plaintiff (the Registrar of Companies) to investigate Nearzero and related persons or entities for the purpose of ascertaining whether securities had been offered or allotted to the New Zealand public in breach of the Securities Act and the Securities Regulations 1983. On 11 May 2007 the Commission issued a public warning to would be investors in Nearzero. [3] As a result of his investigation the Registrar applied on 21 May 2007, ex parte, to appoint interim liquidators of the New Zealand assets of Nearzero. There was a supporting memorandum of counsel, and a supporting affidavit sworn by Mr J R McPherson, an Assistant Registrar of Companies in the Auckland office of the Ministry of Economic Development, outlining the position of Nearzero as revealed by the investigation, and expressing the view that Nearzero was unable to pay its debts, and accordingly ought to be liquidated on that ground, and also because it was just and equitable that the Company be put into liquidation. [4] It is the order made the following day, 22 May, by Associate Judge Gendall which Nearzero now applies to rescind.Jurisdiction[5] Both parties made submissions as to the Court's jurisdiction to hear the rescission application. Nearzero's counsel submitted that r259 High Court Rules, s250 Companies Act 1993 and the Court's inherent jurisdiction were all available sources of jurisdiction. Mr Hucker also pointed out that the Registrar of Companies concedes that r61C High Court Rules provides jurisdiction, although the Registrar opposes the application because it was made well outside the time period stipulated in r61C. [6] I do not need to decide the jurisdiction point. That is because I do not intend granting Nearzero's rescission application, but instead intend giving directions in respect of Nearzero's application under s37AH Securities Act 1978. I record that mytentative view that jurisdiction exists under r259, because r259(2)(c) is not a bar here, as the corporate insolvency jurisdiction the Associate Judge was exercising is an "open Court" and not a "Chambers" jurisdiction.EvidenceFor the Registrar of Companies[7] At the hearing on 11 July I was confronted with a large amount of evidence, much of it filed at the last moment. [8] I intend covering only those parts of the evidence which I consider relevant to the course I take in this judgment, and then only in brief summary form. I start with the affidavit of Mr McPherson, to which I referred in [3] above. Mr McPherson's affidavit makes the following relevant points:• Nearzero had held share purchase meetings in Auckland, Wellington and possibly in other places during February and April 2007. People attending these meetings were handed a Nearzero brochure headed 'Investment Opportunity'.• This brochure represented that Nearzero's technology: has SOLVED the Last Mile Problem for telecommunications service providers. This technology has an unprecedented level of predictability as a bases for a new industrial revolution.The brochure continued:NO COMPETITORS exist for Nearzero. The Nearzero solution to the Last Mile Problem is Trillions of USD less than any other alternative. Nearzero offers limited pre- exchange based IPO shares to investors for the purpose of rapidly expanding its business and market penetrations during the earliest period of its patent applications. In this way, capital gained by Nearzero from shares sold are planned to be rapidly returned with revenue generatingactivities. Revenue in the first several years of operation is expected to exceed several Billion USD yearly. Nearzero's market cap is estimated to be a near-term minimum of 482-780 Billion USD, with expectation of exceeding a Trillion USD.(the errors are in the brochure)• Members of the public attending the share purchase meetings were also handed copies of Nearzero documentation headed "Representations and affidavit, Nearzero Inc.". This document is dated 6 September 2006 and ends:Sincerely, Operations Director, Nearzero, Inc. Sherif SafwatIt is not actually signed by Mr Safwat.• Amongst the representations in this document are:Nearzero Inc. has established patent pending status on the technology with rights reserved in all regions and nations of interest to Nearzero. Market valuation: In simple terms, to use a common measure, Nearzero's market valuation is expected for good reason to substantially exceed the market valuation of Microsoft Corporation at any time in its history. Specifically, Microsoft is primarily marketing toward PCs, while Nearzero's products apply to all devices containing a microprocessor.• Members of the public attending the share purchase meetings were also handed documents entitled "Share Purchase Procedure", "Common Share Purchase Agreement" and "Unilateral Non-Disclosure Agreement".• Nearzero is not registered in New Zealand as an overseas company. It has not filed any documents with the Companies Office. In particular, it has not filed an investment statement or registered prospectus under theSecurities Act. As a result, the offer and allotment of securities by Nearzero to the New Zealand public was invalid and of no effect. Subscribers are entitled to a refund of their subscription monies.• Members of the New Zealand public had subscribed $3.4 million for shares in Nearzero.• Only $491,000 of that remained in the Company's bank account at the Nelson branch of the ASB.• Monies have been disbursed by Nearzero as follows: - $1.3 million to a company called Syntiro Ltd. - $1.2 million to Mr Whitley and/or his wife. - $800,000 to Mr Safwat. - $190,000 to the Richmond Academy of Soccer.• Mr Phillip J Whitley of 40 Rochford Drive, Richmond in Nelson is the president, treasurer and director of Nearzero, and Mr Sharif A Safwat of Washington State in the United States of America is its secretary.• Mr Whitley told Mr McPherson that Nearzero's intellectual property was "in his head and was going to stay there even if it meant going to jail". [9] On 28 June Ms B J Fatupaito, one of the interim liquidators, swore an affidavit annexing the Report of Interim Liquidators to this Court dated 27 June 2007. Points made in that report include:• Mr Whitley said that Nearzero was incorporated to hold the technology he had developed and to be the vehicle for the initial public offering of Nearzero's shares in the United States of America. Members of the New Zealand public were provided with an opportunity to invest in Nearzero at$3,000 per share and were advised that each share could be valued at over $400,000 upon the IPO in the USA. That was scheduled to commence in mid-2007.• Mr Safwat denied involvement in the patent process or the IPO of Nearzero, and refused to provide any information about the $800,000 Nearzero had paid him, or to return the money.• Mr Whitley had not supplied any evidence or details of any testing of the technology to support his claims about it. He advised that he had burnt or otherwise destroyed all information relating to the technology in the fortnight prior to the appointment of interim liquidators as he was fearful that someone may steal it from him. He continued to assert the technology worked.• The report contains detail of the testing and review of the technology, including by Logical Networks and by Professor Bell. Mr Kahu of Logical advised that the testing was carried out in a very controlled environment (controlled by Mr Whitley), and Mr Kahu did not examine how it worked or check whether there were hidden files that would make the technology appear to work, when it did not.• Of the $5.3 million deposited into Nearzero's bank account, $2 million has been traced to Mr Whitley's personal bank accounts, or to payments on his credit cards, or for payments to purchase real property, vehicles, boats and household furniture. $1 million has been transferred to Syntiro Limited and $800,000 to Mr Safwat in the USA.• It appeared Mr and Mrs Whitley paid substantially over-value when on 4 May 2007 they purchased a property in Richmond for $2.4 million, Nearzero providing all the $800,000 paid in cash (the remaining $1.6 million was borrowed). It was unlikely that Nearzero's creditors would receive much if anything from the sale of this property.• The vehicles purchased with Nearzero monies in the last six months comprised four Chrysler 300 vehicles, a Holden Commodore Executive, a Jeep Wrangler, two Jeep Grand Cherokees and two motor boats.• The estimated realisations from assets of Nearzero which the interim liquidators have managed to secure will not exceed $1 million.• 172 claim forms totalling $1.9 million have been received by the interim liquidators, five investors have since withdrawn claims totalling $87,000.• Mr Whitley and his advisers held a meeting in Nelson on 19 June for the purpose of encouraging investors to oppose the application for the full liquidation of Nearzero and to withdraw any claims they had submitted to the interim liquidators.• If all investors claimed in the liquidation, the dividend in the liquidation would be between 7.5 and 15 cents in the dollar. [10] On 5 July Dr Timothy Bell swore an affidavit. Dr Bell is an Associate Professor in Computer Science and Software Engineering at the University of Canterbury. He holds a PhD in Computer Science. His doctoral thesis was on "text compression". His area of expertise is data compression i.e. exactly the technology that Nearzero claims to have invented and own. In his affidavit Dr Bell makes these points:• He described the results of a compression test he had been asked to undertake for Astute (now Nearzero) in Nelson around January 2001. He deposed that as a result of these tests he: had clear evidence that the system did not function, and (he) could find no evidence at all that it was able to do what was claimed.• Mr Whitley told him that a person called Falconbridge (or something similar) at the University of Melbourne had done positive tests onNearzero's technology. He checked with academic colleagues at Melbourne University and none had heard of this.• Mr Whitley claimed to have an NZCE, a BSc in computer science from Auckland and to have worked on a PhD from the UCLA in computer science theory under Allan Duncan. He (Dr Bell) could find no evidence of an Allan Duncan when he searched the Internet under UCLA.• He had reviewed the report by Mr Kahu of Logical Networks which is relied upon by Nearzero as authenticating the existence and effectiveness of its technology. The report contained several flaws in the methodology which could easily have been taken advantage of to make the compression appear to work. He considered the report's conclusion invalid.For Nearzero[11] The thrust of an affidavit sworn on 10 July by Mr Whitley in support of Nearzero's rescission application is that the representations about the existence and potential of Nearzero's technology are true, and that the Company was in the process of seeking patent protection for that technology, when the interim liquidation intervened. Amongst points made by Mr Whitley are:• Mr Safwat is a patent expert employed by a fishing gear manufacturer. He purchased a shareholding in Nearzero from Mr Whitley for USD100,000.• Dr Tim Bell has never undertaken thorough testing of Nearzero's technology; and Mr Whitley did not make to Dr Bell the claims about his qualifications that Dr Bell alleges.• Of the $800,000 Mr Whitley remitted to Mr Safwat, USD300,000 was a loan and the balance was for Nearzero expenses, for which Mr Whitley awaits a full accounting.• He denied he had ever asserted to investors that provisional patent application had been made or that patents were pending or registered in the United States of America.• He denied he had spent over $2 million of Nearzero's funds as alleged by the interim liquidators. The $505,000 spent on a vehicle and boats was "company expenditure not personal expenditure" and "the $825,000 spent on the house property was an expense my security adviser and Sharif Safwat said I needed to make pre IPO". [12] Another of the affidavits filed by Nearzero in support of its rescission application is one sworn by Mr W D Day on 9 July. Mr Day deposes that he has been working with Mr Whitley since about January 2005. Mr Day confirms that Nearzero held a shareholders' meeting at the Suter Theatre in mid-June. He deposes that, subsequent to that meeting, he contacted as many shareholders as he could "to see who was in support and who wasn't". He annexes to his affidavit a summary suggesting that shareholders who have subscribed $2.66 million are in favour of rescission of the interim liquidation as opposed to subscribers of $192,000 supporting the continuation of the interim liquidation.Conflicting positions and the Court's position on them[13] Thus, at the hearing earlier this week, I was confronted with two diametrically opposing viewpoints. On the one hand, Mr Whitley and his supporters continue to assert that Nearzero owns revolutionary and potentially extremely valuable technology which will reap rich rewards for the Company's shareholders if and when the Company is floated to the public in the United States of America. Shares for which New Zealand investors have paid $3000 should return them $400,000, indeed, if the claims made in Nearzero's brochure are accepted, that $400,000 understates of the potential value of Nearzero's shares. [14] On the other hand, the interim liquidators' investigation to date suggests that Nearzero's representations are false and that its technology, if it any longer exists, isworthless. Although not put so bluntly, the interim liquidators consider Nearzero is a scam, Nigerian style, perpetrated by Mr Whitley. [15] The evidence I have indicates that significant numbers of investors in Nearzero both:• Agree with the interim liquidators' assessment, and wish to have their subscription monies refunded.• Continue to believe in Nearzero, and want to retain their shares. [16] It is no task of this Court to decide which of the opposing viewpoints (that of the interim liquidators or that of Nearzero) is correct, or which body of investors has made the correct assessment. The decision as to whether to stick with the investment in Nearzero or to take whatever refund of subscription monies is available is a decision for each investor. My concern is to direct a process which will give each investor the best available information on which to base that decision. I also want to ensure that each investor is made aware that sticking with their investment or taking a refund of their subscription monies are true and final alternatives. In other words, they must elect one course or the other. They cannot adopt both courses. And, having made their election, they cannot alter it. [17] The parties were able to agree on some points which I consider dictate what now needs to be done, although not who should do it. I list those points: a) Nearzero has never registered in New Zealand a prospectus or an investment statement for its shares. b) Accordingly, if Nearzero issued shares to the New Zealand public, that issue was in breach of s37 Securities Act and the subscribers are entitled to their money back: s37(4), (5) and (6). c) Subscribers who, despite breach of s37, wish to retain their shares can apply under s37AA for relief from the effect of s37. Alternatively,they can consent, in the terms required by ss 37AC(1)(c) and 37AD, to Nearzero itself applying for relief. d) Nearzero has applied under s37AH for relief. Its application is contained in the statement of defence it filed in this proceeding on 22 June 2007, by way of this affirmative defence:7. To the extent it is held that there have been breaches of the Securities Act 1978 and the Securities Regulations 1983 (which are denied), the Court ought to grant a relief order pursuant to Section 37AH of the Securities Act 1978 validating any offer held to have been made.e) If relief is to be given, the most convenient course now is via that s37AH application. f) The decision whether to be paid back their subscription monies under s37(5)(b) and (6), or whether to consent to Nearzero's s37AH relief application, is properly one for each subscriber to make. The scheme of Part 2 of the Securities Act bears that out. g) In order to decide whether to consent to Nearzero's s37AH relief application, each subscriber needs the best available information: i) As to the current state of Nearzero. ii) About Nearzero's prospects. iii) As to the application Neazero has made pursuant to s37AH for relief, and their ability to consent to that application. iv) Explaining in clear terms that consenting to relief under s37AH and reimbursement under s37(5)(b) and (6) are alternatives. It needs to be explained clearly to subscribers that each must elect one course or the other and will be bound by it.h) That information needs to be sent to subscribers and promptly. [18] There is no agreement on who should do that. I am in no doubt that the interim liquidators should undertake that task. Why? There are three reasons. First, the interim liquidators have been in control of Nearzero's New Zealand assets since their appointment almost two months ago and they are familiar with them. Second, the interim liquidators are officers of this Court appointed specifically to take control of Nearzero's New Zealand assets for the benefit of the Company's creditors and shareholders. Third, the interim liquidators are competent and experienced in relevant ways, and they are well resourced. One is a partner of PriceWaterhouseCoopers, the other is a director of PWC. [19] Nearzero submitted that its own solicitors could and should undertake the task. That would require releasing monies held by the interim liquidators to meet the legal costs involved. Although I would be prepared to do that, for the reasons I have given, I consider the interim liquidators are best suited and placed to undertake the task. I accept that Nearzero's New Zealand solicitors are, like all barristers and solicitors of this Court, also officers of the Court. But they owe duties not only to the Court but also to their client Nearzero and I do not wish to place them in a position where conflicts obstruct the task in hand. The interim liquidators have no such conflicts. [20] Accordingly, I decline at this point to rescind the order appointing the interim liqudators. Nearzero's application to rescind their appointment is adjourned sine die, with leave reserved to Nearzero to renew that application if the outcome of the orders I am about to make makes renewal and the termination of the liquidation appropriate. [21] Pursuant to the Court's powers under s37AK Securities Act and under the High Court Rules, I give the following directions: a) As soon as practicable the interim liquidators are to send an information "package" to each subscriber for shares in Nearzero whose subscription monies the interim liquidators consider have goneinto the Company's New Zealand assets. That information package is to comprise: i) An up-to-date report by the interim liquidators on the current position of Nearzero and as to their assessment of its prospects. As the interim liquidators have only been concerned with the Company's New Zealand assets, this report will need to be similarly restricted, but I have already indicated that it appears that Nearzero is in reality a New Zealand operation. The report is to be as succinct as practicable, not over three A4 pages in length, double-spaced type. The aim should be to give shareholders a summary of the interim liquidators' 27 June report to the Court, up-dated where required. ii) An up-to-date report on the same matters by Nearzero. That report is to be provided to the interim liquidators by Nearzero's New Zealand solicitors. The same brevity requirement and length restriction apply. iii) An outline by the interim liquidators of the alternatives open to each subscriber, as I have outlined them in [16] above, plus an explanation of the steps the subscriber must take if the subscriber elects to consent to Nearzero's s37AH relief application, and the date(s) by which those steps must be taken. Nearzero will need to have input into that outline, since the relief application is its application. The required steps should include notification to the interim liquidators, in a form acceptable to the interim liquidators, by each subscriber of the election that subscriber has made.b) At the earliest opportunity, the interim liquidators are to report to the Court on the outcome of the process required by order a). [22] Once it has the interim liquidators' report, the Court will arrange a telephone conference with counsel to decide on the nature and timing of future steps in this proceeding.Funds for defence of this proceeding[23] This proceeding was commenced by statement of claim on 21 May 2007. The statement of claim seeks an order that the New Zealand assets of the defendant be put into liquidation by the Court under s241 Companies Act 1993. The grounds on which the Registrar of Companies seeks that order are that Nearzero is unable to pay its debts, and that it is just and equitable that Nearzero be put in liquidation. [24] In its rescission application of 22 June Nearzero also sought an order that:3. The funds held in the ASB account to the extent of $50,000.00 be made available to the Defendant to defend this proceeding.[25] Nearzero relied primarily on the judgment of Allan J in An Ying International Financial Ltd and An Ying (Wellington) Ltd v Li and Jiang HC AK CIV 2004 404 6952 6 April 2005, in which the Judge indicated that release of monies to fund the companies' defence of the proceeding was permissible, even when those monies were subject to a proprietary claim. [26] The Registrar submits that the monies in the ASB account of Nearzero are impressed with a trust in favour of the subscribers who contributed them. I do not think that is correct. I think Mr Hucker is correct in submitting that that trust (constituted by s36A) terminated upon allotment of shares to the subscribers, and it seems clear that shares have been allotted to each subscriber. Accordingly, s37(5) and (6) constitutes those subscribers creditors of the Company i.e. they are owed a statutory debt.[27] I am not prepared to make an order in the terms sought by Nearzero. However, faced with the situation I have outlined in [13] above (diametrically opposed viewpoints, both apparently held by significant numbers of shareholders), I am prepared to release monies to Nearzero for the purpose of funding its s37AH relief application, and the work that will be required of it to give effect to the orders I have made which aim to provide the Court with the information it will need to deal with that application. Whether the liquidation proceeds or is terminated may depend on the outcome of the s37AH application. Accordingly, I make orders in these terms: a) Nearzero's solicitors, Hucker & Associates, are to submit, to the interim liquidators, their account for preparation of Nearzero's statement of defence (which contained its s37AH application) and for Wednesday's hearing (including preparing and filing the rescission application and preparation) and in respect of involvement in the "information to subscribers" process outlined in [21] above. b) If the interim liquidators consider those bills to be in order for payment, they are to pay them. In assessing whether the bills are in order for payment, the interim liquidators are to be guided by the costs which would be payable to Nearzero if awarded on a 3B basis under the High Court Rules, and by the actual and reasonable legal costs incurred by the Registrar of Companies in this proceeding, as billed to him by Meredith Connell. The Registrar is to cooperate with the interim liquidators in providing information and advice in those respects. c) If they do not, they are to seek the Court's direction.Costs[28] Those orders render it unnecessary to make any other order as to the costs of the rescission application.Solicitors: Meredith Connell, Auckland for the Plaintiff Hucker & Associates, Auckland for the Defendant