Eaton v LDC Finance Ltd ((in Receivership))

JurisdictionNew Zealand
CourtHigh Court
JudgeFogarty J
Judgment Date23 May 2012
Neutral Citation[2012] NZHC 1105
Docket NumberCIV-2008-409-001140
Date23 May 2012

[2012] NZHC 1105



Stephen Desmond Eaton, Seddon James Marshall
Ldc Finance Limited (In Receivership)
First Defendant


Perpetual Trust Limited
Third and Counterclaim Defendant


Andrew John Harding, Murray Schofield
Second Counterclaim Defendants

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

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”).

The issues were: whether F& I was offering securities to the public triggering s36A SA (subscriptions must be held in trust); whether the plaintiffs had a proprietary interest; whether LDC and/or Perpetual were bona fide purchasers for value without notice; whether LDC had actual or constructive knowledge of F & I's breach of the SA; and whether the partners of F & I were liable to LDC for warranties that it was the sole, legal and beneficial owner of the assets.

Held: LDC's argument that tracing was unavailable presupposed that one depositor was in conflict with another. This was contrary to the facts. It was an attempt to use the rule in Clayton's Case against the beneficiaries so as to destroy their claim against LDC, but there was no dispute between the beneficiaries. It was a basic principle of trust law that funds invested in breach of trust did not lose that character of being the property held by the fiduciary for the beneficiaries. The fact that it was an unlawful investment or that there were some costs incurred along the way did not mean that the resultant asset was no longer a trust asset. If it was a trust asset, it was subject to a claim by the beneficiaries.

Where money held on trust was mixed with the trustee's personal money, the whole of the resulting fund was treated as trust property and could be claimed by the beneficiaries following a tracing exercise. There was no difficulty with beneficiaries who formed a class claiming as a class against a mixed fund. The depositors in this case simply sought, as a class, to pursue assets of F & I which on the evidence were substantially acquired by misuse of depositors' money. It was irrelevant to the tracing exercise that historically the depositors' funds had been mixed with some bank credit and some modest equity introduced into the business by the partners.

LDC's argument that the unpaid depositors could not claim the proceeds of $8 million, because they could not prove that their contributions led to the acquisition of the asset held by LDC, could be answered by examining what exactly was the trust created by s36A SA. It was an error of law and a distraction to proceed on the basis that because each depositor was separate, the right to trace disappeared when the deposits were used by F & I to trade in breach of s36A SA.

At all times F & I had operated without a prospectus. It could only do this without breaching the SA if it was not offering securities to the public. Section 3(1)(b) SA (construction of references to offering securities to the public — offering securities to individual members of the public selected at random) applied. F & I had operated from a storefront and had a large sign in the window saying “Finance & Investments”. There was ample evidence that persons not being relatives or close business associates would learn of F & I's business and would make deposits. Therefore, F & I had breached the SA and had never complied with s36A SA.

As a result of the breach, the principals of F & I held the receivables of the partnership in trust for the unpaid depositors at any one time. This crystallised on receivership into the class of unpaid depositors who became the beneficiaries, according to their contributions, of the trust. The natural context for construing s36A SA was that there would be pooling of deposits. When Parliament used the term “trust” without defining it, it had clearly intended the Courts to apply the law of trusts. A trust was a relationship where a person held property on behalf of others. Section 36A SA had the purpose of reserving a proprietary claim by a depositor as a beneficiary. To achieve this purpose, it created a trust for a class of depositors, with proprietary claims surviving the mixing of deposits.

The trustees of F & I had, in breach of the trust, converted the deposits into another form of wealth, namely the receivables. So converted, they became subject to the same trust and were the property of the trust held for the benefit of all beneficiaries as a class. The beneficiaries could agree as to the division of the property once it was recovered, and if they failed to agree could seek directions from the Court.

LDC had actual notice by May 2006 that F & I had been operating in breach of the SA. The test of whether or not a person was sufficiently on notice so as to become a fiduciary was largely a question of fact. A person was deemed to have constructive knowledge of that which he would have received notice had he investigated a relevant fact which had come to his attention and into which a reasonable man would have inquired.

Such an inquiry was beyond the skills of the chartered accountant directors of LDC. They would be expected to instruct legal practitioners with the appropriate skills and experience. Such a practitioner should have immediately identified that F & I had been trading with the public and would have been aware of s36A SA creating a statutory trust. There were arguments for and against the ability to trace because of the mixing of the funds. But all trust practitioners knew that where trust assets were wrongly invested by a trustee, they remained the property of the trust. Trust obligations were not ended if the trust property was mixed with other assets. Such practitioners do not need to know whether a tracing remedy would be successful; only that there was a prior equitable claim at the time of transfer. At that time the purchaser could not proceed in good faith.

LDC had been on constructive notice that the depositors of F & I had a prior claim in equity in the receivables of F & I. When chartered accountants were engaged in doing unusual transactions, the need to examine the probity of the transactions as to comply with law and equity, was higher — not lesser. LDC was on constructive notice because it ought to have inquired and identified, with the assistance of expert advisors, that it was entering into a transaction to acquire assets over which there was a claim to a prior equity by F & I's depositors. Perpetual, as a specialist trustee, would know or ought to have known that the conduct impugned raised serious question marks as to the true beneficial ownership of F & I's receivables. The facts which LDC knew could be inferred as constructive notice of Perpetual. By that combination, Perpetual was on notice in May 2006 of a prior equity over the assets of F & I.

In respect of the counterclaim, LDC had been in a better position than F & I to judge the potential impairment or claims against the assigned loans than F & I. LDC knew F & I was trading in breach of the SA, whereas F & I believed they were trading within the law based on legal advice received. LDC had assumed the risk and it had not relied on the warranties at the time. The partners of F & I were not liable to LDC for their personal assets beyond assets they had put into the business. The counterclaim was dismissed.

Judgment for plaintiffs. The disputed sum was to be paid into Court for the benefit of the depositors.

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



Table of Contents



A Narrative of primary facts


F & I's business


LDC's business, with a prospectus


Dealings between F & I and LDC


F & I in receivership


The use of the deposits


B Do the plaintiffs have a proprietary interest in the $8 million held by LDC?


(i) Was F & I in breach of offering securities to the public?


(ii) Does s 3(2) exclude some deposits from the breach?


(iii) What is the character of the statutory trust, given that the deposits were used in trading?


(a) The plain language of s 36A


(b) Section 36A read in the light of its purpose


(c) Section 36A read in the context of involving the law of trusts


Conclusion that there is a trust for a class


(iv) Whether the sums being pursued by the plaintiffs are the property of this trust?


Conclusion that the receivables of F & I are trust property


C Are Perpetual and/or LDC bona fide purchasers for value without notice of the breach of trust?


Does Perpetual have the defence of being a bona fide purchase for value?


Did LDC have notice on 4 September 2006?


The test for notice


The Sinclair test


The Macmillan test


Was LDC on actual notice as at 4 September 2006?


Constructive notice of LDC as at 4 September 2006


Actual notice of LDC in...

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