Eaton v LDC Finance Ltd ((in Receivership))

• Jurisdiction: New Zealand
• Judge: Fogarty J
• Judgment Date: 23 May 2012
• Neutral Citation: [2012] NZHC 1105
• Docket Number: CIV-2008-409-001140
• Court: High Court
• Date: 23 May 2012

Between

Stephen Desmond Eaton, Seddon James Marshall

Plaintiffs

and

Ldc Finance Limited (In Receivership)

First Defendant

and

Perpetual Trust Limited

Third and Counterclaim Defendant

and

Andrew John Harding, Murray Schofield

Second Counterclaim Defendants

[2012] NZHC 1105

CIV-2008-409-001140

IN THE HIGH COURT OF NEW ZEALAND CHRISTCHURCH REGISTRY

Application by plaintiffs that, as unpaid depositors, they had a proprietary interest in $8 million held by the defendant — knowing receipt claim — plaintiffs deposited money with F & I, an insolvent finance company — deposits mingled with other monies — defendant acquired F & I's assets — whether plaintiffs' money could be traced — whether defendant was a bona fide purchaser for value without notice — consideration of tests for notice (actual and constructive) — counterclaim, whether partners of F & I were liable to defendants for warranties that it was the sole, legal and beneficial owner of the assets — effect of s36A Securities Act 1978 (“SA”).

Appearances:

J B M Smith, P R W Chisnall and J D Haig for Plaintiffs and Second Counterclaim Defendants

D J Goddard QC, P J Woods and N K Caldwell for First Defendant

This judgment was delivered by Justice Fogarty on 23 May 2012 at 11.30 a.m., pursuant to r 11.5 of the High Court Rules

Registrar/Deputy Registrar

Date:

JUDGMENT OF Fogarty J

Table of Contents

Introduction	[1]
A Narrative of primary facts	[5]
F & I's business	[5]
LDC's business, with a prospectus	[13]
Dealings between F & I and LDC	[17]
F & I in receivership	[19]
The use of the deposits	[23]
B Do the plaintiffs have a proprietary interest in the $8 million held by LDC?	[42]
(i) Was F & I in breach of offering securities to the public?	[85]
(ii) Does s 3(2) exclude some deposits from the breach?	[93]
(iii) What is the character of the statutory trust, given that the deposits were used in trading?	[97]
(a) The plain language of s 36A	[105]
(b) Section 36A read in the light of its purpose	[115]
(c) Section 36A read in the context of involving the law of trusts	[117]
Conclusion that there is a trust for a class	[118]
(iv) Whether the sums being pursued by the plaintiffs are the property of this trust?	[122]
Conclusion that the receivables of F & I are trust property	[136]
C Are Perpetual and/or LDC bona fide purchasers for value without notice of the breach of trust?	[137]
Does Perpetual have the defence of being a bona fide purchase for value?	[141]
Did LDC have notice on 4 September 2006?	[160]
The test for notice	[162]
The Sinclair test	[167]
The Macmillan test	[182]
Was LDC on actual notice as at 4 September 2006?	[193]
Constructive notice of LDC as at 4 September 2006	[221]
Actual notice of LDC in 2007	[234]
Constructive notice of LDC	[258]
Was Perpetual on notice in 2006 and 2007?	[262]
Subsidiary issues	[276]
Re-assignment of the Three Stores and The Tavern loans	[276]
Counterclaim by LDC against Messrs Harding and Scholfieldfor breach of warranties	[285]
Counterclaim by LDC against Messrs Harding and Scholfield and Perpetual seeking a declaration of priority of Perpetual's security interest	[301]
Recovery of costs of the receivership of F & I	[304]
Judgment	[305]

Introduction

1 The plaintiffs seek relief in equity. This is a representative action. The plaintiffs are representatives of the remaining unpaid depositors of an insolvent money lending partnership which traded as “Finance & Investments” (“F & I”). They are pursuing a sum of about $8 million held by another failed finance company, LDC Finance Ltd (“LDC”). That sum is the cash equivalent of assets realised by the receivers derived from assets of F & I which were either assigned to LDC or over which LDC took a charge in two transactions, one in May 2006 and the other in March 2007.

2 These proceedings allege that the plaintiffs, as unpaid depositors, have a proprietary interest in that sum being held by LDC. LDC disputes that. Second, LDC argues that even if the plaintiffs have a proprietary interest, LDC has the defence of bona fide purchaser for value without notice. This is a knowing receipt claim. The pleadings also allege a knowing assistance claim, against other parties, which may be the subject of a separate trial. The names of these two parties have been removed from the intituling. There is no issue estoppel in respect of them.

3 These are the two principal contentions between the parties and are at the heart of the dispute. There are a number of other issues which can be approached as sub issues in the context of these two contentions or side issues.

4 The parties did not agree on the ordering of issues for analysis. This judgment follows the following organisation:

• A Sets out a narrative of the uncontested primary facts of the case.

• B Examines whether the plaintiffs have a proprietary interest in the $8 million held by LDC.

• C Examines whether LDC (and its trustee, Perpetual) have the defence of being bona fide purchasers for value of the F & I receivables, without notice.

• D Subsidiary Issues.

A Narrative of primary facts

F & I's business

5 F & I's partners were Mr A J Harding and Mr M Scholfield. In the 1960s both men were car salesmen and were involved in separate car sales businesses. By the early 1970s they had joined forces and each owned 50 per cent of Andrew Harding Car Sales. Mr Harding had been running a very small finance operation with his car sales business and when they became partners in the car sales they also became partners in that business which they then called “Finance and Investments”.

6 Of necessity, Mr Harding brought some capital to that business, but it was small, and not proved. The F & I business got its start in financing from a deposit of $20,000 (a substantial sum in 1973) from Mr Dick Shuttleworth and a deposit of $60,000 from Mr Lloyd Cole, the owner then of LDC Investments Ltd (“LDCI”). This was by a deposit from LDCI to F & I. It is not clear whether the whole of the $60,000 was taken at once. The scale of the new business was such that F & I did not want to have idle money sitting in the bank. On the probabilities, F & I took the advances from Mr Cole in small amounts. F & I had a separate ledger for the Cole/LDC deposits and ran it under a different business name, Nelson Vehicle Advances. This business was subsequently sold to Finance and Discounts Ltd in 1986.

7 F & I's businesses operated like a bank. It had only two operating bank accounts, a cheque account and a call account. The main account was the cheque account. All depositors' funds were deposited in the cheque account as were interest paid on loans and repayments of loans. Funds were drawn from the same cheque account to meet the business expenses, rent and wages etc, pay profits to the partners, and make loans to lenders, and to repay deposits.

8 Surplus funds in the cheque account were placed in the call account in order to be placed on term deposit and to earn some interest. Little use was made of overdraft facilities.

9 In the absence of a prospectus F & I were able to operate without any trustee oversight as to the adequacy of shareholder funds and the ability to repay depositors. F & I were trading on a basis of taking most deposits on call. Some depositors were on six months at an interest rate a percentage above the call rate. The call rate was always higher than that offered by the trading banks. Like banks, F & I was borrowing short and lending long. So it was always vulnerable to a run on its deposits if its depositors lost confidence.

10 In 1978 the Securities Act 1978 (“the Securities Act”) was enacted. The prohibition against allotting securities offered to the public without a prospectus came into effect when s 37 of the Securities Act came into force on 1 September 1983. Prior to that time there was no obligation on F & I to trade under a prospectus.

11 The purpose of the Securities Act is to ensure that before the public subscribe for securities they have access to reliable financial information enabling them to make an informed judgment as to whether to invest or not. The content of this information is scrutinised and its continuing validity supervised by both trustee and by a government agency, then the Securities Commission. These various obligations tend to be summarised by saying that the business has to operate within the terms of its prospectus. Any would be investor is provided with an investment statement and informed that there is a registered prospectus. Typically a registered prospectus will set limits on the liabilities that the business can assume, broken down into classes, relative to the businesses shareholder funds. 1 The content is fixed by regulations made under the Act. 2 If these limits are broken the trustee intervenes and the business can no longer trade normally, and indeed, it can only trade according to directions of the trustee, while in breach of the prospectus. 3 As we will see, this predicament happened twice to LDC. It needed more capital before it could register

a new prospectus. It accessed more capital on two occasions, both from F & I, one each in 2006 and 2007

12 F & I did not, however, change its manner of business to comply with the Act. Messrs Harding and Scholfield received, they said, legal advice that they did not need a prospectus because they were not advertising or otherwise actively soliciting deposits. They also believed that because they were trading as a partnership rather than limited liability company, that meant the Act did not apply.

LDC's business, with a prospectus

13 The business of LDC was started by Mr and Mrs Cole, as LDCI. In 1990 a significant borrower...