New Zealand Credit Law Bulletin - Vol 9, No 5, June 2009

A free, plain English review of recent law and items of interest for creditors, produced by Hattaway & Associates Ltd, Credit Consultants. To subscribe send a blank email to:

Plain language disclaimer:
This bulletin is not legal advice. Do not make decisions on legal matters based on a brief commentary. Instead, get professional legal advice.

In this issue:

  1. Recovering debt from a fraudster’s trusts
    A long and tortuous process starts to look like bearing fruit
  2. Commerce Commission decides not to appeal Avanti decision
    No surprise there
  3. The dangers of setting up a second business and mixing up the accounts of the two
    A $175,513.53 mistake for the business owners… almost.
  4. “$2,225,000 has been paid” and is being “held… as a deposit”
    Is setoff “payment” and is the accountant liable for misleading the lender with this statement?

1. Recovering debt from a fraudster’s trusts


Michael John Reid, the director of Established Investments Ltd (EIL) suffered from Alzheimers disease, and as a result of this, resigned as a director in October 2002.  Between May 2001 and April 2003, Allan Cliff Armitage cashed $818,000 worth of bearer cheques issued by EIL. 

Armitage was bankrupt for much of this time, being discharged from bankruptcy in July 2002.  Reid and his successor, Norman Harry Pollard, were both, at times, trustees of trusts Armitage was associated with.

Armitage admitted cashing the cheques and collecting the proceeds, but claimed that he paid the money to various persons and entities on the instructions of Reid. He said that the majority of the money (about $600,000) was paid to “Jim Williams”.  He said he did not know Williams' full name nor have any means of contacting him.  He said that the funds were going into high risk speculative investments. 

Because of his Alzheimers disease, Reid was unable to comment on this allegation. (He has since died).  EIL was put into liquidation on 10 July 2003.  Since that date EIL's liquidators have been trying to recover the $818,000 from Armitage.  

Armitage told the liquidators that some seven boxes of EIL documents were lost in the course of moving documents to Pollard's house when he took over from Reid as EIL’s director.  He also said the Serious Fraud Office had taken documents from him which could have included EIL documents.

The liquidators of EIL sued Armitage for the money in 2004.  He defended.  EIL tried to use the court process of “discovery “, where a party has to reveal the relevant documents it holds, to establish what had happened to the money, and to obtain information about financial transactions between EIL and trusts and companies with which Armitage was involved. 

Generally the courts are very reluctant to strike out defences for non-compliance with discovery orders.  However, in April 2007, Armitage's defence was struck out for persistent failure to comply with discovery obligations, and judgment was entered.  See ESTABLISHED INVESTMENTS LTD (IN LIQUIDATION) V A C ARMITAGE HC AK CIV 2004-404-4084 [2007] NZHC 245 (2 April 2007).

While EIL was pursuing its claim against Armitage, he was convicted of 21 charges of fraud and sent to prison.

EIL then issued bankruptcy proceedings against Armitage.  After various attempts to oppose the bankruptcy petition and to appeal, Armitage was granted an adjournment to allow him to make arrangements to pay the judgment debt after telling the court that he was a beneficiary of two trusts, the Guardette Trust and the Sanctuary Trust, which could advance him the necessary money.  

He failed to pay and was adjudicated bankrupt at the next hearing in October 2007.  However, this admission led to investigations into the Guardette Trust by the liquidators of EIL.  Guardette Investments Ltd was the trustee.  Armitage controlled who ran Guardette Investments.

On 9 October 2007 EIL lodged a caveat against the 10 titles comprising Guardette Trust's property at Charlemont Street, Hamilton.  “Caveat”, in Latin, means “beware”.  It tells the world that the caveator has an interest in the property which must be satisfied before the property can be sold or otherwise dealt with.

In July 2008 Guardette Investments applied to the Registrar-General of Land to have the caveat lapse. EIL applied to the court to allow the caveat to remain in place.

If money obtained dishonestly has been used to acquire or improve a property, the party defrauded arguably has an interest in the property which allows it to lodge a caveat.  The problem for EIL was that there was no direct evidence linking its money to Guardette.   However, the judge looked at “Mr Armitage's reluctance to provide full and frank disclosure … and the mysterious loss of EIL's records …” as well as “Guardette's failure to disclose the source of its funding for the purchase of the caveated property, or its later development into unit titles.”

He said, “I find that the coincidence of [the] taking of EIL's money, the establishment of Guardette Trust and Guardette, Guardette's acquisition of the caveated property and subsequent development into unit titles, and the lack of disclosure of Guardette's funding, coupled with evidence of Mr Armitage's control of Guardette and Guardette Trust, are sufficient to establish an arguable case for a caveatable interest.  EIL’s caveat was allowed to remain in place.

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2. Commerce Commission decides not to appeal Avanti decision

The Commerce Commission has decided that it will not appeal against the recent decision of the High Court in Commerce Commission v Avanti Finance Limited. This High Court decision was discussed in our May Bulletin item, Commerce Commission Bully, which was previously published in the NBR.

In discussions with Commerce Commission staff prior to this decision I was told that the Commission would not take criminal prosecutions against finance companies in this type of case in future, but instead would use the civil enforcement options in the Credit Contracts & Consumer Finance Act.

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3. The dangers of setting up a second business and mixing up the accounts of the two


Base Control Ltd carried on business in the construction industry.  Barry and Deborah McCullough were shareholders.  Mrs McCullough was also a director.

In 2004, Base Control borrowed $150,000 from ASB Bank and set up an overdraft facility of $50,000.  The McCulloughs provided guarantees to the bank, supported by a mortgage over their house. 

Of this finance, $66,219.10 was paid to the McCulloughs for their own purposes, and $83,761.72 was used for the ordinary purposes of Base Control.  For the financial years ending 31 March 2004 and 31 March 2005 respectively, the loan and the overdraft were each recorded in the Base Control's accounts as liabilities of the company. 

About 2004, the McCulloughs set up a separate business venture, a partnership between the husband and wife, importing outdoor furniture and fittings. They developed a showroom at their house.  In January 2005 the partnership established a separate bank account. Of the cost of establishing the showroom, $38,633.48 was paid by Base Control and the balance of $32,885.17 by Mr McCullough.

However, the showroom was recorded as an asset of Base Control in the 2005 accounts, prepared by Mr Brumby, their accountant.  In March 2006, Brumby became aware of the partnership and its separate bank account.  About that time he also learnt that the outdoor furniture business was not owned by Base Control.  After consulting with the McCulloughs, he decided, in accordance with what he believed to be standard accounting practice, that the value of the showroom ought to be removed from Base Control’s books as an asset, and that instead it should be recorded as an asset of the partnership. 

He made journal entries in the company's accounts, the effect of which was to remove $196,076.94 from the company's liabilities (the debt to ASB) and replace it with a similar sum shown as shareholder advances from the McCulloughs to Base Control. Where McCulloughs had owed the company $175,513.53, they now had a credit balance with Base Control of $24,558.  Brumby did this because he believed the loan and overdraft from the ASB were used to fund the partnership's activities and not those of Base Control. 

On 12 May 2006, the McCulloughs placed Base Control in liquidation.  Mrs McCullough signed a certificate of solvency.  About six weeks later, on 27 June 2006, the McCulloughs paid off the debts to the ASB, a total of $198,554.72.

It turned out that the company was not solvent.  The liquidator initially appointed by the McCulloughs was replaced by two new liquidators who brought proceedings against the McCulloughs in the District Court.  The judgment does not say why the change of liquidators occurred, but in this sort of case, such a change is often at the instigation of creditors who want liquidators whose independence they can be confident of. 

The liquidators claimed $175,513.53 from the McCulloughs, the amount which they claimed had been wrongly credited to the shareholder account.  In the District Court, the Judge held that Base Control was entitled to judgment for that amount, plus interest.  The McCulloughs appealed.

The McCulloughs claimed that the court should accept Brumby’s accounting opinion.  In effect, Brumby's position was that the substance of the arrangements with the ASB was that the loans were to the McCulloughs and not to the company.   He relied upon certain accounting standards which direct practising accountants to use their judgment in developing and applying an accounting policy "... that results in information that ... reflect[s] the economic substance of transactions, other events and conditions, and not merely the legal form."  (This was despite the fact that, it was accepted by the McCulloughs that $83,761.72 of the loan was used for the ordinary purposes of Base Control.) 

The judge in the High Court rejected this argument.  “The question of whether the [McCulloughs] are indebted to [Base Control] is a matter of law and not a matter of good accounting practice. As a matter of law [Base Control] entered into the table loan and overdraft arrangements with the ASB as principal debtor. … There is no suggestion … that … there was an intention that the funds be advanced to the [McCulloughs] rather than [Base Control]…  Mr Brumby's amendments do not in my view give a true and fair view of the [company’s] financial position.”

However, the McCulloughs also argued that the $198,554.72 they had paid to the ASB should be set off (under section 310 of the Companies Act 1993) against the $175,513.53 that the liquidators claimed they owed the company.  The Judge in the District Court rejected this argument but the Judge in the High Court accepted it.  The judgment against the McCulloughs was set aside.

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4. “$2,225,000 has been paid” and is being “held… as a deposit”

Securities Registry Limited and also suing in its capacity as the Trustee of the Securities Registry Trust and Securities Registry (No 2) Trust v Gome

Tikitere Springs Estate Ltd, one of two companies controlled by Mr Barry Brill, wanted to borrow $6 million for the development of a property at Rotorua.  One lot of the property was subject to a sale agreement to another of Brill’s companies, Pupuke Holdings Ltd, as trustee for the Pupuke Trust.  Securities Register Ltd (SRL) made a conditional offer to lend Tikitere the money. 

One of the conditions was that SRL “and its legal advisers are to receive confirmation that the deposit of $2,225,000 in respect of the … purchase by Pupuke Holdings Ltd has been paid.”  Tikitere owed Pupuke over $5 million. Unknown to SRL, the companies agreed that the deposit would be paid by way of setoff against Tikitere’s debt to Pupuke.

Brill asked Ms Gomes, a chartered accountant, to send SRL a letter which he had drafted. It stated:

“I act as the Accountant for Tikitere Springs Estate Limited and am able to confirm that the amount of $2,225,000 has been paid to the company by Pupuke Holdings Limited. This is being held by the company as a deposit under an agreement to sell the Spa Centre to Pupuke Holdings Limited.”

SRL treated the condition of its loan agreement as satisfied and advanced the $6 million to Tikitere.  Tikitere defaulted four months later and subsequently went into liquidation. Despite a personal guarantee from Brill, the lender lost over $7 million (presumably including interest and costs).  The development was never completed.

On discovering that the deposit had been “paid” by setoff rather than by cash, SRL sued Gomes.  It claimed she had breached an assumed duty of care or alternatively she had made a negligent misstatement, and her conduct was “misleading or deceptive” under the Fair Trading Act.

SRL claimed that it sought, as a condition of its loan to Tikitere, an actual injection of fresh money.  However, in its offer it did not require that to occur.

In the High Court, the judge held that SRL had failed to establish that the statement by Ms Gomes was inaccurate in any respect and dismissed the claim. Nor, in her judgment, did any losses fall within the scope of the duty of care owed by Ms Gomes. She held that the Fair Trading Act claim was time barred but that in any event there was no misleading or deceptive conduct on the part of Gomes.

A majority of the Court of Appeal agreed.  “Payment in a legal sense means ... any act offered and accepted in performance of a money obligation.  It follows that payment may be effected by setoff…”  The setoff was, in law, a payment.

Robertson J in the Court of Appeal said, “Ms Gomes’ letter contains an error. Had Ms Gomes enquired, she would have discovered that the deposit was not being “held” as a separate and accessible sum. There was merely a book entry, recording that the deposit sum had been transferred, and there was no intention that the money should be held.”  However, there was no condition in the contract that the deposit would be held frozen.

Baragwanath J said that “while it is difficult to find commercial justification for the transaction between Tikitere and Pupuke, and the comfort SRL sought from the special condition of the loan offer for payment of the deposit has proved illusory, the responsibility for SRL’s losses does not lie at the door of Ms Gomes whose letter did not in the circumstances contain a misrepresentation.”

SRL witnesses said that they believed that $2.225 million had been inserted into the development project by Pupuke.  However, the Court of Appeal found it “difficult to see why Mr Brill would have organised his affairs in that way.  If he, via Pupuke, had been able to put up $2.225 million in cash, he would presumably have sought only $3.775 million from SRL instead of the $6 million that was borrowed.”

The majority found that Gomes was not liable.  Court of Appeal President, William Young dissented, concluding that Gomes was liable.  He said, “[t]o put this in very simple terms:

(a) When Ms Gomes said the deposit was paid and held she represented to SRL that the sum of $2.225 million had been paid by Pupuke to Tikitere and existed as an identifiable asset as at 2 February 2001;

(b) This was untrue;

(c) Ms Gomes acted negligently when she wrote the letter;

(d) As a result of her negligent misrepresentation, SRL entered into the loan agreement under which it lost in excess of $7 million; and

(e) … on my assessment of the counter-factual (ie the position that would have been obtained had the representation been true) Tikitere would have had an asset of $2.225 million which would have been available to SRL when Tikitere defaulted.”

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