CRISMAC LIMITED AND ANOR V TOTARA INVESTMENTS LIMITED CA CA599/2008

CRISMAC LIMITED AND ANOR V TOTARA INVESTMENTS LIMITED CA CA599/2008 21 August 2009IN THE COURT OF APPEAL OF NEW ZEALAND CA599/2008 [2009] NZCA 369BETWEEN CRISMAC LIMITED First Appellant AND ULSTER LIMITED Second Appellant AND TOTARA INVESTMENTS LIMITED Respondent Hearing: 20 July 2009 Court: William Young P, Randerson and Asher JJ Counsel: P J Dale and N R Campbell for Appellants C T Walker for Respondent M G Ring QC for Gosling Chapman Judgment: 21 August 2009 at 1 pmJUDGMENT OF THE COURT A The appeal is allowed. B We declare that the powers of attorney contained in the mortgages executed by the appellants did not authorise the taking by Totara of additional security. C We reserve leave to the parties to seek any other consequential declarations should this be seen as necessary. D The appellants are awarded costs as for a standard appeal, band A together with usual disbursements. The costs of the proceedings in the High Court are to be fixed in that Court.____________________________________________________________________REASONS OF THE COURT(Given by William Young P)Introduction[1] This case arises out of a tax scheme promoted by Mr John Reid under which: (a) Single purpose loss attributing qualifying companies ("LAQCs") (including the two appellants, Crismac Ltd and Ulster Ltd) subscribed for the purchase of shares in Digitech Communications Ltd or New Zealand Investments Ltd ("NZIL"). The vendors were n-Tech Ltd (in the case of the Digitech shares) and St Lucia Investments Ltd (in the case of the NZIL shares). In each instance, a deposit was paid and the LAQC agreed to make further annual payments but the bulk of the purchase price was to be paid ten years later. (b) Each LAQC took out an insurance policy under which the insurer guaranteed that the LAQC would be able to sell the shares for a particular minimum price after the ten year completion date; this in consideration for a substantial premium which was immediately payable. (c) A lender advanced to each LAQC on a limited recourse basis sufficient money to cover most of the initial expenditures. Pending settlement of the share purchase agreements, interest accrued but was not payable in cash. [2] The intended effect was that in the first year, the LAQCs would deduct the full amount of the premium and, in subsequent years, the interest which accrued (but was not actually paid) on the limited recourse loans. Providing such deductions were allowed, participation in the scheme was distinctly cashflow positive for thetaxpayers who were in behind the LAQCs. But the deductions were challenged by the Commissioner of Inland Revenue and this resulted in the taxpayers and LAQCs settling with the Commissioner on terms which required payment of core tax, penalties and use of money interest. The LAQCs made it clear that they would not complete the share acquisition agreements. The two appellants did not make payments due under the share purchase agreements with the result that the vendor company (in this instance n-Tech) cancelled the agreements in May 2001. While the rights and wrongs of all of this are still unresolved, it is common ground that, one way or another, those agreements are at an end. [3] We were told that there are four groups of LAQCs. The largest and most relevant for present purposes is what we will call "the investor group", the members of which are represented by Mr Dale and Mr Miles QC. The two appellants are part of this group. A second group of LAQCs is associated with partners in the accounting firm Gosling Chapman, which was involved (at least to some extent) in the set-up and marketing of the tax scheme. We understand that most of the individuals behind the LAQCs were clients of Gosling Chapman. A third group of LAQCs is represented by Lee Salmon Long and the fourth group consists of LAQCs which have adopted a passive role. [4] The vendor companies are associated with Mr Reid. The respondent company, Totara Investments Ltd, is the assignee of the original lenders and is also associated with Mr Reid. We will refer to these three companies collectively as "the Reid companies". [5] In relation to the investor group, there are presently proceedings before the High Court involving: (a) Claims by the vendor companies against the LAQCs seeking damages for breaches of the agreements for sale and purchase of the shares in Digitech and NZIL. The LAQCs contend they have no liability under those agreements. There may also be counterclaims although this is not apparent from the material before us.(b) Claims by Totara against the LAQCs on the loan agreements. The LAQCs deny liability. Again, there may be counterclaims. (c) Claims by the LAQCs against third parties, including Gosling Chapman, for damages associated with (1) the circumstances in which they entered into the relevant transactions ("the first order claims") and (2) the steps taken in 2000-2002 when the LAQCs sought to disengage from the scheme ("the second order claims"). [6] In February 2008 Mr Reid learned that the members of the investor group were close to settling their claims against third parties in relation to what we were told from the bar were second order claims. With a view to pre-empting such settlements (which he considered were likely to be on soft terms) and preserving, for the ultimate benefit of Totara, the value of the underlying claims, he took steps to place the LAQCs in receivership. So Totara, purporting to act pursuant to powers of attorney contained in mortgages between the LAQCs and the original lenders, executed general security deeds on behalf of the LAQCs in its favour which conferred security over all present and after-acquired assets. It then appointed receivers. [7] Totara's entitlement to execute the general security deed in this way was challenged by the investor group LAQCs. In the end, this challenge proceeded on the basis that, on the true interpretation of the loan agreement and mortgage, Totara did not have the authority to act as it did. This argument was advanced before Venning J by the appellants in what were effectively test cases on behalf of all the investor groups LAQCs. He rejected the argument and the appellants now appeal. [8] In succeeding sections of this judgment we will discuss the case under the following headings: (a) The commercial context. (b) The litigation context. (c) The documentation.(d) Our assessment. (e) Disposition. The arguments advanced to us differed at least in emphasis from those advanced to Venning J and in those circumstances we will discuss his interpretation of the relevant documents in the course of our own assessment of the case.The commercial context[9] We know something about the general commercial and taxation context because of judgments in other proceedings. Most relevantly Mr Reid and others involved in the promotion of the scheme were prosecuted for fraud and were found not guilty by Fogarty J, see R v Connelly (2007) 23 NZTC 21,172 (HC). We have read the judgment of Fogarty J and it provides a good deal of information about the way in which the tax scheme was promoted and operated. However, we have to deal with the appeal on the basis of the limited material which was formally before Venning J. [10] We think it fair to approach the case on the following basis: (a) The transactions were artificial and driven by tax considerations. (b) The intention was that the individual taxpayers and their LAQCs should be protected, as far as possible, from commercial risks. (c) For this and other reasons the LAQCs were single purpose companies, the taxpayers who were in behind them did not guarantee that the LAQCs would perform their obligations and the loans which were advanced were on a limited recourse basis. (d) Although it is not entirely clear as to what was likely to happen when the share purchase agreements fell due for settlement (and in particular the way and order in which funds would flow), the taxpayers were not intended have any personal exposure and theparties envisaged that the LAQCs could walk away from the transactions (or at least their liabilities to the lenders) by assigning the share purchase agreements and insurance policies to the lenders. [11] As we have indicated, the vendor companies and the assignee of the lenders (Totara) are all associated with Mr Reid. The investor group LAQCs maintain as well that the insurer and the original lenders were also corporate alter egos of Mr Reid or alternatively acting under his direction. Mr Walker, for Totara, told us that this contention is denied. For the purposes of the construction argument, therefore we cannot proceed on the basis that the lenders, insurer and vendors were all under the control of Mr Reid at the inception of the scheme.The litigation context[12] As we have noted, the present dispute is currently relevant only to the LAQCs in the investor group. [13] From the point of view of Mr Reid: (a) The vendor companies have claims against the LAQCs for breach of the share purchase agreements and Totara has claims under the loan agreement. (b) The LAQCs have no assets other than the value of the claims they have against third parties. (c) So the Reid companies can only recover financially if those claims result in the LAQCs receiving funds and those funds are available to their creditors (ie the Reid companies). (d) In the case of Totara's claims, the original security documentation appeared to provide a mechanism by which Mr Reid could ensure that the control of the third party claims was in the hands of receivers. This would have the effect of ensuring that those claims were notsettled cheaply and that the proceeds of those claims would be available for Totara. [14] From the point of view of the taxpayers whose LAQCs are affected, receivership is unwelcome and awkward, to say the least. We were told that under working arrangements which are either in place or proposed, the taxpayers (or the LAQCs) and their chosen lawyers are (or are likely) to remain in charge of the defence of the claims by Mr Reid's companies, while a legal team appointed by the receivers is (or is likely) to be responsible for the third party claims. Whether such an approach would be possible at trial is open to question, see McKnight v Davis[1968] NZLR 1164 (CA). In any event, the receiverships must tend to complicate further the prosecution of the litigation as a whole and impose significant constraints on possible settlement.The documentationOverview[15] The contracts of primary significance were the agreements for sale and purchase of shares, the insurance policies and the loan agreements. Associated with the loan agreements were mortgages. The mortgages gave the lenders security over the share purchase agreements and insurance policies. For present purposes we need refer in detail to only the loan agreements and mortgages and will do so by reference to those involving Crismac. We will also mention briefly the subsequent general security deed executed by Totara on behalf of Crismac.The loan agreement[16] The loan agreement dated 24 March 1997 between Armour Fidelity Ltd (which was one of the original lenders) and Crismac recorded in its operative part that:The Lender agrees to advance to the Borrower the Loan of NZ$1,029,333.33 (as hereinafter defined) by advancing the drawdown amount ofUS$699,946.66 on the terms and conditions and subject to the security specified in this Agreement and the parties covenant and agree with each other as set out in this Agreement and the schedules hereto, including the obligation under clause 4.1 to repay on the Expiry Date the amount of NZ$2,700,000. (Emphasis added.)[17] The loan agreement defined security as: the mortgage over the Policy and the Share Acquisition Agreement to be given to the Lender by the Borrower.[18] Clause 11 of the loan agreement is in these terms:11 LIMITED RECOURSE AND PROFIT PARTICIPATION ARRANGEMENTS11.1 Notwithstanding any other term or provision of this Agreement, in consideration of the profit participation arrangements contained in clause 11.2, the Lender acknowledges that this Agreement and the liability of the Borrower hereunder is limited to the value of the Security provided, namely the Policy and the Share Acquisition Agreement, to the intent that the Borrower can apply or assign all monies received thereunder or other value received thereunder, including but not limited to the benefit of the rights of the Borrower under the Policy and or the Share Acquisition Agreement, in full satisfaction of the obligations of the Borrower hereunder, and if the Borrower so applies or assigns all such monies, value or benefit this shall relieve the Borrower from any further or personal liability. 11.2 The Borrower, in consideration of the limitation of recourse contained in clause 11.1, hereby covenants with the Lender that if it sells the Shares either directly or by way of sale of the entity which holds the Shares at any time during the term of this Agreement or within 10 years of the date of final repayment of the Moneys Owing and realises a sale price in excess of NZ$450,000 per Share, then the Borrower shall pay 10% of the Loan to the Lender as an additional return to the Lender. (Emphasis added.)The mortgage[19] The mortgage executed on the same day recorded in its operative part:The Mortgagor agrees to and hereby does grant to the Mortgagee the security over the "Property" hereinafter defined and covenants with the Mortgagee as set out in this Deed and the schedules hereto.[20] Property was defined in cl 1.2 of the mortgage to mean:(i) the rights of the Mortgagor as purchaser under a contract ("Share Purchase Contract") between the Mortgagor as purchaser and St. Lucia Investments Limited of Auckland New Zealand as vendor and pursuant to which the Mortgagor is bound to acquire the number of fully paid ordinary shares ("Shares") in the capital of New Zealand Investments Limited of Auckland, New Zealand specified on page 1 on 31 March 2007; and (ii) loss of profits insurance policy terms which are set out in Schedule A hereto.[21] The mortgage provided for "Moneys Hereby Secured" in cl 3.1:3.1 THE Mortgagor acknowledges that these presents shall provide security for the Principal Sum interest and other monies payable under the Contract all of which are herein referred to as "the Moneys Hereby Secured".[22] Clause 4.1 provided:4.1 THE Mortgagor shall contemporaneously with the execution hereof: (a) Lodge or cause to be lodged with the Mortgagee or its nominee all Certificates or other contractual documents in respect of the Property or if Certificates or documents have not been issued for the Property, shall lodge or cause to be lodged with the Mortgagee or its nominee all such Certificates or documents immediately upon receipt thereof; (b) Hand to the Mortgagee a Notice of Assignment in respect of the Property signed by the Mortgagor. (The Mortgagee acknowledges that it will not utilise such Notices of Assignment until there has occurred an event of default by the Mortgagor).[23] Clause 5.1 concerned assignment of property and provided:5.1 THE Mortgagor shall contemporaneously herewith execute an Assignment of the Property (in respect of the Shares a transfer of the Shares in blank) in favour of the Mortgagee which shall be held by the Mortgagee in trust for the parties and shall only be utilised by the Mortgagee for the purposes of realising the Mortgagee's security pursuant to Clause 8 hereof.[24] The clause in particular issue for the purposes of this appeal is in Part IX of the mortgage:IX FURTHER SECURITY AND ATTORNEY9.1 THE Mortgagor shall if so requested by the Mortgagee do all such acts and execute all such documents and securities as the Mortgagee may in its absolute discretion require to further secure to the Mortgagee its title as mortgagee of the Property and the payment of the Moneys Hereby SecuredAND the Mortgagor in consideration of the Mortgagee providing thefinancial accommodation referred to in Recital B to the Mortgagor DOTH HEREBY IRREVOCABLY APPOINT the Mortgagee and each director, secretary, officer and solicitor for the time being of the Mortgagee severally to be the true and lawful attorney of the Mortgagor with full power and at the expense of the Mortgagor in the name of the Mortgagor and on behalf of the Mortgagor.(a) To do, execute and perform all and every act, deed, matter or thing which the Mortgagor by this Deed covenants or agrees to do or which in the opinion of the Mortgagee is necessary or expedient for more fully and perfectly transferring assigning and securing the Property or which the Mortgagee may deem necessary for the protection of its security or the preservation of its interest in the Property; (b) To demand, sue for, recover and receive the Property from all and every person whatsoever and to give effectual receipts for all or any parts of the Property and to commence, prosecute, settle and compromise all actions, suits and proceedings at law or in equity for obtaining or enforcing the same and to proceed to judgment, decree and execution or discontinue the same or become non-suit therein and to act in all respects therein as the processes of the court or occasion may require and to receive money out of court for any such action, suit or proceedings; (c) To exercise all or any of the powers of the Mortgagor with respect to the Property and to do, execute and perform any act, deed, matter or thing with respect to the Property as fully and effectively as the Mortgagor could; (d) Generally to do, execute and perform all such further acts, deeds, matters and things which may become necessary or be regarded by the Mortgagee or the said attorney as necessary for more satisfactorily securing the payment of the Moneys Hereby Secured as effectually as the Mortgagor could and for all or any of such purposes from time to time to appoint a substitute attorney and remove such substitute. AND the Mortgagor hereby agrees to ratify and confirm whatever the said attorney or substitute shall lawfully do or cause to be done pursuant to this power of attorney. (Emphasis added.)The general security deed[25] The general security deed executed by Totara as attorney for Crismac granted Totara security over all its present and after-acquired property, purports to secure the payment of any money or performance of any obligation owed by Crismac to Totaraand is generally in terms which differ (for instance as to events of default and enforcement) from those which are provided for in the original mortgage. [26] Although our attention was drawn to the differences between the mortgage and the general security deed, we did not receive detailed argument about this. As will become apparent, on the view we take of the case as a whole, there is no need for us to assess the possible significance of these differences.Our assessmentOverview[27] It is possible to construe the loan agreement and mortgage in a way which supports the Totara position. [28] Dealing first with the mortgage: (a) Totara wishes to recover the money which was advanced and will not be able to unless it can obtain access to all assets of the LAQCs (and not merely those covered by the original security). (b) Therefore, Totara presumably saw execution of the general security deeds as "necessary for more satisfactorily securing payment of the Moneys Hereby Secured". (c) Although the italicised words in cl 9.1(d) of the mortgage are in extremely general terms, they are sufficiently broad to encompass the relevant actions of Totara. [29] A similar approach can be taken to the loan agreement: (a) The acknowledgement in cl 11.1 of the loan agreement that the liability of the vendor is "limited to the value of the Security provided" is followed by the words "to the intent ". Arguably thiscould be read as suggesting that the effect of the acknowledgement is confined to circumstances where there is an assignment as contemplated in the balance of the subclause. (b) The assignments provided for in the mortgage were by way of security and thus did not purport to be in "full satisfaction" of the obligations of Crismac. (c) Accordingly, cl 11.1 is not directly engaged. (d) In any event, the words "to the value of the Security provided" do not restrict the entitlement of the lender to obtain further security. [30] Broadly speaking this was the approach taken by Venning J in the High Court and advanced before us by Mr Walker. Perhaps significantly, Venning J started his assessment with a consideration of cl 9.1(d) of the mortgage in which he concluded that it authorised the steps taken by Totara. Following this, Venning J then discretely assessed the effect of cl 11.1 of the loan agreement, which he considered had not been triggered (because there had been no qualifying assignment). [31] As will become apparent, we think it appropriate to seek an integrated interpretation of the loan agreement and mortgage and, importantly, to start with the loan agreement. Before we do this, however, we should discuss the temporal scope of the cl 11.1 acknowledgement.The temporal scope of the acknowledgement in cl 11.1 of the loan agreement[32] The acknowledgement in cl 11.1 of the loan agreement is plainly not confined in effect to the circumstances present at the date of signing. That would be inconsistent with the right conferred on each LAQC to extinguish its liability by assignment to the lender.The loan agreement[33] Mr Walker maintained that the loan agreement, when properly construed, did not limit the lender's security rights to the share purchase agreements and insurance policies. In particular, he argued that: (a) The cl 11.1 acknowledgement should be read as just a preamble to the rest of what follows in cl 11.1. On this approach, the acknowledgement is simply an explanation for the right of the borrower to extinguish liability for the loan by assigning to the lender the share purchase agreement and insurance policy. It thus has no substantive effect. And since the borrowers did not exercise their rights under the clause, their liability under the loan agreements is unimpaired. (b) Alternatively, and assuming that the opening words of the acknowledgement have some effect, they merely cap the extent of the monetary liability of the borrower and do not delimit the property which can be rendered subject to a charge to secure that liability. (c) These interpretations of clause 11.1 of the loan agreement (which leave scope for the obtaining of further security) are consistent with cl 9.1(d) of the mortgage. [34] We will address the first two of these arguments in this section of the judgment and the third in the next section. [35] We can illustrate the possible operation of cl 11.1 of the loan agreement on Mr Walker's approach by assuming that the share purchase agreement and insurance policy are still extant and that their value is $1m. On that basis, on Mr Walker's arguments, cl 11.1 of the loan agreement permits the lender to obtain security over other assets and to realise that security. On the [33](a) argument, the only constraint on the lender is the ability of the borrower to extinguish its liability under cl 11.1. On the alternative argument set out in [33](b), the liability of the borrower is capped by the value for the time being of the share purchase agreement and insurance policy (on this assumption $1m).[36] To move from the assumed example to the current context, on Totara's claimed entitlement to act under cl 9.1(d) of the mortgage: (a) On the [33](a) argument, the borrower is liable for the full amount owing under the loan and, because of the cancellation of the share purchase agreement, is no longer able to extinguish its liability under cl 11.1. (b) On the alternative [33](b) argument, the liability of the borrower is capped by the attributed value of the share purchase agreement and insurance policy but Totara is not precluded from obtaining other security to cover that liability. (c) On both arguments, and in the events which have happened, the loan remains limited recourse at most only in terms of quantum. [37] The approach referred to in [36](b) might be thought to give rise to conceptual and practical problems if, as is likely, the share purchase agreement and insurance policy have no current value. We were, however, invited by the parties not to determine the case on this basis, an invitation which we accept. [38] Loans, of course, are by definition limited as to quantum and the expression "limited recourse" is usually referable to limited realisation options. So Mr Walker's arguments are not a good fit for the limited recourse nature of the loan which was very much at the heart of the commercial structure offered to the taxpayers and LAQCs. [39] As well, his arguments do not sit altogether easily with the contractual language used in the loan agreement. It records (see [16] above) that the loan is subject "to the security specified in this Agreement". The definition of "security" (see [17] above) refers to the share purchase agreement and the insurance policy. There is no mention of a right to obtain additional security. Clause 11.1 of the loan agreement provides for not only the liability of the borrower but also states that "this Agreement" is "limited to the value of the Security provided ". Further, on the interpretation referred to in [33](a), clause 11.1 of the loan agreement has exactly thesame meaning as it would without all the words which come before "to the intent that". [40] In all of this, it is important to keep in mind the contra proferentem principle which we see as distinctly applicable. [41] For the reasons given in [38], [39] and [40], we provisionally (that is, subject to the effect of cl 9.1(d) of the mortgage) conclude that the loan agreement did not contemplate additional security being obtained by the borrower.Reading the loan agreement and cl 9.1(d) of the mortgage together[42] It is arguable that the breadth of the language of cl 9.1(d) of the mortgage means that the loan agreement should be interpreted as Mr Walker contended. We do not, however, see this as a convincing argument or as detracting from what we see as the most natural meaning of the words used in the loan agreement in their commercial context. [43] If cl 9.1(d) of the mortgage has the meaning contended for by Mr Walker, the acknowledgement in cl 11.1 of the loan agreement is inaccurate. On the Totara interpretation of cl 9.1(d) of the mortgage, the acknowledgement should have been along these lines:the Lender acknowledges that the liability of the Borrower hereunder is limited to the value of the Security provided, namely the Policy and the Share Acquisition Agreement save that this liability may, by virtue of cl 9.1(d) of the mortgage, be secured over other property as well.(Emphasis added.)To put this another way, cl 11.1 of the loan agreement, in what we take to be its most natural meaning, is inconsistent with cl 9.1(d) of the mortgage as interpreted by Totara. [44] We note that similar issues arise in relation to the operative part of the loan agreement (see [16] above). If cl 9.1(d) of the mortgage is to be given a broad and literal interpretation, the operative part should have read:The Lender agrees to advance to the Borrower the Loan of NZ$1,029,333.33 (as hereinafter defined) by advancing the drawdown amount of US$699,946.66 on the terms and conditions and subject to the security specified in this Agreement (along with any other security obtained under cl 9.1(d) of the mortgage) and the parties covenant and agree with each other as set out in this Agreement and the schedules hereto, including the obligation under clause 4.1 to repay on the Expiry Date the amount of NZ$2,700,000.But in the loan agreement entered into by the parties, the words we have italicised are not present. [45] In this context, we think it important to recognise that while both the loan agreement and the mortgage must be read together, the loan agreement should be regarded as the controlling document. Further, the operative part and cl 11.1 of that document record and provide for what was a central and fundamental feature of the contractual relationship: that the loan was on limited recourse terms and able to be enforced only against the share purchase agreement and policy. To put this a slightly different way, we see the specific language of the loan agreement as being of more significance than the general language of cl 9.1(d) of the mortgage. [46] Accordingly, we construe cl 9.1(d) of the mortgage so as to conform to the operative part and cl 11.1 of the loan agreement even though this means that cl 9.1(d) is rendered largely (and perhaps wholly) redundant. This approach is consistent with the contra proferentem interpretation of both documents (which we have no doubt is appropriate for this purpose as well as in the [40] context).Disposition[47] On our interpretation of cl 9.1(d), the mortgage did not authorise the lender to obtain security over additional property. It follows that the general security deeds are ineffective and that Totara did not have the authority to appoint receivers. So: (a) The appeal is allowed.(b) We declare that the powers of attorney contained in the mortgages executed by the appellants did not authorise the taking by Totara of additional security. (c) We reserve leave to the parties to seek any other consequential declarations should this be seen as necessary. (d) The appellants are awarded costs as for a standard appeal, band A together with usual disbursements. The costs of the proceedings in the High Court are to be fixed in that Court.Solicitors: Chancery Street Chambers, Auckland and Grove Darlow & Partners, Auckland for Appellants Gilbert Walker, Auckland for RespondentMcElroys, Auckland for Gosling Chapman