Morgenstern v Jeffreys

• Jurisdiction: New Zealand
• Judge: White J
• Judgment Date: 11 September 2014
• Neutral Citation: [2014] NZCA 449
• Docket Number: CA122/2014
• Court: Court of Appeal
• Date: 11 September 2014

BETWEEN

Arthur Sylvan Morgenstern

First Appellant

Tanya May Lavas

Second Appellant

and

Stephanie Beth Jeffreys and Timothy Wilson Downes

Respondents

[2014] NZCA 449

Court:

O'Regan P, Harrison and White JJ

CA122/2014

IN THE COURT OF APPEAL OF NEW ZEALAND

Appeal from a High Court (“HC”) decision which held the appellant had breached his director's duties under s131 Companies Act 1993 (“CA”) (duty of directors to act in good faith and in best interests of company), s135 CA (reckless trading) and s137 CA (directors duty of care) and ordered him to pay $3.5 million — cross-appeal by the respondents against the finding they had not made out a case for recovery under s298 CA (transactions for inadequate or excessive consideration with directors and certain other persons) — appellant operated property development companies — he sold his shares in one company to the other in order to repay his overdrawn account — the HC held that the consideration was excessive — appellant had based consideration on a profitability assessment undertaken by someone connected with the property development but had not obtained an expert valuation — whether the appellant had a defence because he had acted and relied on professional advice under s138 CA (use of information and advice) — whether the consideration paid represented the “fair value” of the shares — whether order to repay $3.5 million on a restitutionary basis was appropriate and consistent with the earlier finding in respect of s98 CA.

Counsel:

C T Walker for Appellants

M T Davies and K M Wakelin for Respondents

• A The appeal and the cross-appeals are dismissed.

• B The first appellant is to pay 90 per cent of the costs of the respondents for a standard appeal on a band A basis with usual disbursements to be fixed by the Registrar. We certify for two counsel.

JUDGMENT OF THE COURT

REASONS OF THE COURT

(Given by White J)

Table of Contents

	Para No
Introduction	[1]
Background	[10]
The St Lukes development	[11]
Mr Morgenstern's overdrawn current account with MSE	[18]
Professional advice	[20]
The value of the shares in MS St Lukes	[29]
The interests of MSE	[37]
Mr Morgenstern's financial position	[41]
The High Court judgment	[43]
The “fair value” of the shares in MS St Lukes
The Judge's approach	[52]
Submissions for Mr Morgenstern	[53]
Legal principles	[55]
Application here	[64]
Reliance on professional advice
The Judge's approach	[72]
Submissions for Mr Morgenstern	[74]
Legal principles	[75]
Application here	[79]
Breaches of duties	8[3]
Section 131	[84]
Section 135	[86]
Section 137	[89]
Inconsistent findings?	[90]
Relief
The Judge's approach	[92]
Submissions for Mr Morgenstern	[93]
Further submissions	[94]
Legal principles	[98]
Application here	[101]
Costs appeal	[105]
Cross-appeals	[108]
The s 298 cross-appeal	[109]
The carpark incentive fee cross-appeal	[113]
Result	[123]

Introduction

1 The appellants, Mr Morgenstern and his partner Ms Lavas, appeal against a judgment of the High Court finding Mr Morgenstern in breach of his duties as a director under ss 131, 135 and 137 of the Companies Act 1993 (the Act) and ordering him to pay the sum of $3,499,999 to Kingdon Undertaking Ltd, previously Morning Star Enterprises Ltd (in liq)) (MSE) under s 301 of the Act and costs. 1

2 The respondents Ms Jeffreys and Mr Downes, are the liquidators of MSE, Kingdon Development Ltd (KDL) and Axon House Carparking Ltd (previously GS & LD Lease Ltd) (GLL), all of which were Auckland property development companies operated by Mr Morgenstern. They cross-appeal against the High Court's dismissal of their alternative claim for the judgment sum based on s 298 of the Act (in law they seek to support the judgment on another ground) and their claim for an additional amount payable by GLL for a monthly carpark incentive fee ($100,000 annually) based on ss 135 and 136 of the Act.

3 Mr Morgenstern's appeal appeal relates to the sale of his 99 shares in Morning Star (St Lukes Garden Apartments) Ltd (MS St Lukes) to MSE on 30 March 2007 for $3,465,000 and the sale of the remaining one share held by Ms Lavas to MSE on or about 8 May 2007 for $35,000, a total of $3,500,000. The purpose of the sale was to enable Mr Morgenstern, who was the sole shareholder and director of MSE, to repay his overdrawn current account with MSE.

4 In the High Court Rodney Hansen J held that the consideration for the 99 shares of $3,465,000 was excessive. 2 Further, he found that, in authorising the purchase of the shares by MSE for an excessive consideration, Mr Morgenstern was in breach of:

• (a) his duty to act in good faith in the best interests of MSE under s 131 of the Act; 3

• (b) his duty not to agree to, cause or allow reckless trading by MSE under s 135; 4 and

• (c) his duty of care to MSE in his directorial role under s 137. 5

5 On this basis the Judge made an order under s 301(1)(b) of the Act requiring Mr Morgenstern to pay $3,499,999 to MSE, being the resultant loss to the company from the purchase of the shares less $1, being the price at which the shares were subsequently sold to St Lukes Holding Ltd. 6

6 As no relief was sought against Ms Lavas, no order was made against her. 7 She was not a director and therefore not in breach of any relevant duties under the Act. Her position therefore does not arise for consideration on this appeal.

7 Mr Morgenstern challenges the High Court judgment on the grounds that:

• (a) The Judge's finding that the consideration was excessive was inconsistent with his decision to dismiss the liquidators' claim under s 298 of the Act because the liquidators had failed to prove that the shares were worth less than MSE had paid for them.

• (b) Mr Morgenstern had acted and relied on professional advice in authorising MSE to purchase the shares for $3,465,000.

• (c) The consideration of $3,465,000 represented the “fair value” of the shares in MS St Lukes as at 30 March 2007.

• (d) Mr Morgenstern honestly believed that the purchase of the shares was in the best interests of MSE.

• (e) No loss was caused to MSE by the purchase of the shares on 30 March 2007. Any loss was caused by subsequent events.

8 As is apparent from these grounds, the principal focus of the appeal is on the circumstances surrounding the sale by Mr Morgenstern of his shares in MS St Lukes to MSE on 30 March 2007, including in particular the value of the shares on that date, and the consequential application of the relevant provisions of the Act to the transaction in the light of those circumstances.

9 We address the liquidators' cross-appeals separately. 8

Background

10 Mr Morgenstern, primarily through MSE, had been a successful property developer in Auckland. 9

The St Lukes development

11 For present purposes the relevant development was being undertaken at St Lukes, Auckland, by MS St Lukes. Mr Morgenstern was the sole director of the company.

12 St Lukes was a $67,000,000 development (with an anticipated profit in 2004 of $14,335,000) financed by the Bank of New Zealand (the BNZ) as first mortgage lender and Structured Finance (NZ) Ltd (Structured Finance) as second mortgage lender.

13 The financial side of the development was managed by Mr Martyn Reesby of Reesby & Co Ltd. All payments had to be made or approved by Structured Finance. Mr Reesby regularly prepared financial reports and feasibility studies reporting on the projected returns from the development.

14 The St Lukes development, which commenced in 2003, involved two stages. The first stage was completed in 2005 with the construction of 241 apartments and associated retail units. The second stage, comprising 53 apartments and six commercial units, together with a two-storey commercial building, commenced in December 2005 on the basis of building consents issued in June 2005.

15 It was assumed, wrongly, that the necessary resource consents for the second stage had been obtained. When it emerged in early 2006 that this was not the case work on stage two stopped.

16 For various reasons, including objections by a group of stage one apartment owners, there were unexpected delays and a retrospective resource consent was not granted until March 2008. As the consent conditions were more restrictive than sought, there was an appeal which was not resolved until 2010.

17 As Rodney Hansen J noted, 10 the delay and the modified terms of consent substantially impacted on the profitability of the project. Indeed it ultimately resulted in a loss. MS St Lukes' liabilities exceeded its assets (which included a debt due by MSE of $1,268,640) by $1,515,012 as at 31 March 2007. 11 In 2009, following its failure to pay a debt of $128,569.46, MS St Lukes was placed into liquidation on the application of creditors. 12 The liquidators' report indicates it owed more than $15,000,000 and had negligible assets.

Mr Morgenstern's overdrawn current account with MSE

18 In the meantime Mr Morgenstern was also facing difficulties with MSE which by March 2007 was coming under financial pressure, having undertaken a joint venture development (the Axon House development) which was not financially successful. MSE was balance sheet insolvent and being sued as guarantor of a rental underwrite deed for $127,077.80. 13

19 Mr Morgenstern had an overdrawn current account with MSE. As at 31 March 2005 the overdrawn balance was $1,776,336. Rodney Hansen J's finding that drawings during the year ended 31 March 2006 increased the overdrawn balance was not challenged on appeal. 14 It is now accepted by Mr Morgenstern that the best case from his point of view is that the overdrawn balance was $1,871,787 on 31 March 2007....