In a press release dated 23 December, the FMA announced that it had filed a case stated proceeding, seeking a High Court determination about the use, confirmation, and acceptance of ‘eligible investor certificates’ for ‘wholesale’ investments – relying on one of the key hard-wired exceptions from the FMC Act disclosure regime.
The press release says that the FMA has done so following investigations into the use of ‘eligible investor certificates’ by ‘wholesale’ property developers. And that the FMA’s investigations follow the FMA’s 2022 thematic review of ‘wholesale’ offers of financial products.
The press release says that the purpose of the case stated proceeding (seeking the Court’s opinion on a question of law) is to provide (market) clarity on the use of ‘eligible investor certificates’ – and ensure that those investors who require the protections provided by the FMC disclosure regime, receive them.
Whilst the case stated is not heralded as action taken against a specific party, the detail of the proceeding is a little more complicated and appears to focus on a sort of straw man (referred to as Offeror A) arising out of the FMA’s 2022 thematic review.
Questions for the Court
The press release says that the FMA is asking the Court’s opinion on the ‘eligible investor exclusion’ and a detailed series of questions of law.
The 2022 thematic review was triggered by an increase in complaints about practices by a number of offerors relying on the use of ‘eligible investor certificates’ and other branches of the ‘wholesale investor exclusion’ when seeking to raise funds. The use appeared to be particularly prevalent in relation to fundraising by property developers – although the straw man (Offeror A) referred to in the case stated proceeding may not be a property developer (because it is described as a licensed managed investment scheme manager – which the property developers referred to in the 2022 thematic review were not).
It is well known that the FMC Act disclosure regime contains important exclusions for offers of financial products made to ‘wholesale investors’. Financial products that are the subject of a ‘wholesale’ offer are also excluded from the governance and financial reporting requirements under the FMC Act that apply to regulated offers. These, hard-wired exclusions, are provided on the basis that ‘wholesale investors’ have sufficient knowledge and experience to assess an offer – as well as manage their ongoing reporting and other needs.
Some of the categories of ‘wholesale investor’ are determined by reference to objective criteria, whereas qualification for the ‘eligible investor’ sub-category relies on (arguably) more subjective matters and also requires a process of both self-certification and a third party sign-off.
The questions framed for the High Court in the case stated proceeding are described by the FMA as being questions of general application. However, the application states that, for context, and to assist the Court in its understanding of the proper interpretation of the ‘eligible investor’ exclusion and its application in practice – it is necessary to rely on the straw man.
Specifically, the application describes a number of practical scenarios and asks the Court to determine whether an ‘eligible investor’ certificate would be valid in each case. These include:
1. | Whether an ‘eligible investor certificate’ needs to expressly describe: (i) the previous experience that [the investor] has in acquiring or disposing of products; and (ii) the aspects financial of the investor’s] experience in acquiring or disposing of financial products which they consider would enable them to assess the matters required by paras (a) – (c) for the transaction to which it relates? | The position taken by the straw man and/or other ‘wholesale’ offerors – is that neither (i) nor (ii) is required. Instead, that [the investor] is required only to certify they have experience in acquiring and disposing of financial products (i.e. without stating what those financial products are). |
2. | For an offeror to rely on an ‘eligible investor certificate’, or otherwise treat an investor as an eligible investor, in respect of the transaction to which it relates, does the offeror need to be satisfied that – the ‘eligible investor certificate’ is valid? | Both the FMA and the straw man and/or other ‘wholesale’ offerors – see this as a must have. |
3. | Whether, in the context of an offer of financial products, based on the grounds stated in the certificate, [the investor] could make the assessments requirement by paras (a) – (c) in respect of: (A) a financial product of any kind; and (B) the financial products involved in the transaction to which the certificate relates. | The position taken by the straw man and/or other ‘wholesale’ offerors – is that neither (A) nor (B) is required. An offeror is not required to undertake any enquiries, and is able to rely on the experience of the third party certifier (an accountant, lawyer, or financial advisor) who, having considered the grounds provided, confirmed certification. |
4. | If the answer is Yes to either #2 or #3 – can an offeror rely on information which is not contained in the ‘eligible investor certificate’? | The straw man and/or other ‘wholesale’ offerors say Yes – the FMA disagrees. |
5. | If an offeror makes an offer of financial products to [the investor] in circumstances where it is not permitted to rely on [the investor’s] ‘eligible investor certificate’, is disclosure required under Part 3 of the FMC Act? | The FMA says Yes – the straw man and/or other ‘wholesale’ offerors disagree. |
Note: paras (a) – (c) are contained in clause 41(2) of Schedule 1 to the FMC Act.
What next?
The FMA says that its straw man does not wish to be involved in the case stated and has asked that it not be named. It also says that there is no readily identifiable industry body for the FMA to engage with in the absence of the straw man’s involvement – with the result that there is, at the stage of making its application, no available contradictor.
Therefore, while the FMA has set out (in broad terms) the position it understands to be taken by the straw man and/or other ‘wholesale’ offerors – to show the Court that a contrary position exists, and states that it both:
- wishes to file more detailed submissions in relation to its position; and
- intends to notify entities who may have an interest in the application – and who (along with any contradictor appointed by the Court) may also wish to be heard and file submissions.
There are a number of things that might be said about the application and the lack of an available contradictor. Some of that may depend on the level of canvassing (and any submissions) at the time of the 2022 thematic review. However, one immediate benchmark is available across the Tasman where, early in 2024, the Parliamentary Joint Committee on Corporations and Financial Services commenced an inquiry into the ‘wholesale investor’ test for offers of securities under the Corporations Act 2001. There, in the context of a much larger and deeper pool of industry experience, the inquiry drew submissions from a number of readily identifiable industry groups – including the investment advisory community, the main professional bodies (including the Law Council of Australia and Chartered Accountants Australia and New Zealand), the equivalent of the Law Commission, and most elements of the venture capital industry including the main industry body (previously called AVCAL) and a broad collection of angel investor groups.
The broad thrust of a number of those submissions was to underline the importance of the private capital industry as a critical source of capital for investment into start-ups and growth companies in Australia – and the need to balance regulatory certainty with the law of unintended consequences and not (for example) risk imposing a significantly adverse effect on the availability of capital for start-ups and growth businesses – starving them of capital or driving them offshore.
It is hoped that a broad representation of similar professional bodies and industry groups, including NZ Private Capital and the Shareholders’ Association express an interest in the FMA’s application. However, unlike the Parliamentary inquiry in Australia, the framing of the question as case stated proceedings may mean that some groups need to join forces and share resources.
Given the potential for severe impact on availability of capital to businesses that are additive to the New Zealand economy, and the risk of driving enforcement and/or policy change guided only by the bad examples provided by some property developers, it is hoped that that a some significant effort is made to both achieve the right outcome going forward and consider some sort of grandfathering exercise to ensure that (perhaps other than in cases of egregiously bad behaviour) the shape of capital raising at a wholesale level is not driven by raking over the coals with the benefit of hindsight.
Capital Markets Reforms
This morning, Commerce Minister Andrew Bayly announced that Government is progressing a package of reforms to strengthen New Zealand’s Capital Markets.
As part of the announcement, he said that MBIE has plans to reform a number of specific elements to address New Zealand’s long-term productivity challenge and enhance economic growth by strengthening our capital markets.
The reforms will progress in stages. Phase 1 is described in the announcements as occurring now, and Phase 2 will commence in 2025.
Phase 1
The Phase 1 reforms comprise:
- Amendments to the requirements for companies raising equity capital through an IPO – to make the provision of prospective financial information (projections / forecasts) voluntary. The goal here is better alignment with market practice in Australia.
- Consultation on proposals for:
- adjustments to the climate-related disclosures regime; and
- changes to enable KiwiSaver providers to increase investment in private assets.
Phase 2
Phase 2 will begin in 2025, and will include work to consider changes to:
- takeovers law as recommended by the Takeovers Panel;
- product disclosure requirements related to equity and debt offers; and
- liability settings for auditors, and for directors of listed companies in relation to their continuous disclosure obligations.
More detail will follow as the consultation documents become available. However, at first glance, it seems that the announcements (and the Cabinet decisions on which they are based) stem from the Capital Markets 2029 report from a steering committee headed by Martin Stearne. The steering committee generated 42 recommendations to unlock stronger capital markets and canvassed topics such as KiwiSaver, regulation, public sector assets and infrastructure, promotion of public markets, tax, new products and the impact of technology.
This year, particularly, has been a brutal one for local businesses seeking growth capital. As a result, changes to the regulatory settings that:
- enable companies to access the public capital market – including reducing the barriers to listing and encourage companies to remain listed;
- grow the private capital ecosystem in New Zealand;
- provide greater scope for the use the capital markets to fund infrastructure,
must be welcomed.
For more information, please do not hesitate to contact me.
In an interesting article earlier this week, BusinessDesk referred to commentary from some retail [investor] client advisers that was again quite critical of both the framing or the wholesale investors exclusions and some observed practices around their use.
Whilst not all of the criticism are new, a number of them (especially around practices/behaviours) are worth repeating.
Whilst the article was not overly critical, one point that wasn’t mentioned but which gets some airtime over coffee or around the BBQ, and with which I have some sympathy, is that the FMA should be prepared to lose a few cases. But that is not to say that the decision-making process would be easy. This is because of the concern that, at the taxpayer’s expense, a narrow loss might not hurt too much and may yield some useful lessons, there is the ever-present risk that a pattern (of losses) might be observed by some. So, possibly the taxpayer should only be exposed the costs/risk of fight the ones that they are likely to win/can’t afford to lose.
Where I do part company with some of the commentators cited in the article, is in the suggestions about re-branding the exclusions for wholesale investors or (worse still) shifting the bar – to have a bright line test that is so high, that very few will clear it. The wholesale investor exclusions are there for a reason. More on this below.
At the risk of sounding over-wrought, it needs the efforts of all members of the band to weed out the cheats. The business media has an important role to play – by asking the hard questions and putting a spotlight on questionable behaviour. But I suggest that so too do a range of other professional advisers, including investment advisors as well as lawyers and accountants advising private clients may be at risk of being preyed on by those at the fringes.
I think that retail [investor] client advisers are quite right to point to the advantages of a low doc / low disclosure regime applying to sourcing funds from wholesale investors. With that regime comes added risk. In part, that is the point – that wholesale investors (by definition) are better equipped to make enquiries and undertake their own risk management. Similarly, wholesale investors can do more to ensure that they price that risk – and gear (negotiate) their terms to adequately compensate them for that risk element.
But it is a bit too melodramatic (and inaccurate) to paint all wholesale investment as some sort of wild west – or worse. Maybe the use of such pejoratives will help educate a few more people who might be at risk of being swayed by the promise of above market returns and a too good to be true spiel. And, for those of us who have seen an economic cycle or two – we seem forget the baggage of history, rather too quickly.
The FMA, in its 2022 thematic review, was also quite right to draw attention to some poor compliance practices around enquiry and certification – affecting those being shoehorned into the ‘eligible investor’ subcategory of wholesale investor.
But the wholesale investor exclusions are not a ‘loophole’ – and where there are examples of issuers or their advisers who apparently deliberately seek to raise funds from investors who are (truly) retail – then that behaviour should be called out and dealt with. Any and all of the band members can shine that spotlight.
Whilst it is not central to the article, misleading and deceptive conduct, particularly in the content of advertising material or in subsequent dealings with investors should be dealt with – by the full force of the law.
As the article notes, the wholesale investor exclusions provide a means for SMEs to raise capital at a lower compliance burden and cost. Exclusions of this sort were present in the predecessor to the FMC Act and exist in many other OECD countries. The underlying rationale is the same – and proposals floated in Australia earlier this year to substantially increase the threshold to qualify as a ‘sophisticated investor’ (the first changes in over 20 years) were met with criticisms that are equally or more valid in New Zealand. These include:
- such a (blunt) change could adversely impact innovation and technology, with a loss of competitiveness against the US and the UK who maintain lower thresholds than those proposed;
- the apparent inflexibility – with one example being that it would rule out high earners with fluctuating incomes; and
- the risk of baking in a number of existing disparities, including those between regions (because, just like New Zealand, the value of the family home and other property investments differs between regions).
The Australian proposals have led to a list of innovative solutions being floated – including some that seek to better target the level of investor experience and financial literacy.
These are important discussions, and New Zealand could learn a lot from a country only next door, with a much deeper pool of capital and more years of experience in getting to grips with what works for funding start-ups and the SME sector. Getting this wrong could strangle a number of green shoots, stifle innovation and force SMEs to seek capital from offshore. It also risks amplifying the Kiwi love affairs with real estate.
I don’t share one of the correspondent’s pessimism about the risk of crooks outrunning the regulator. Whilst I continue to question if there is a place on social media for an investment pitch – in an increasingly online world, there is little hope of regulating how would-be investors get their information. And the flipside is that the online world provides much greater scope for the cheats to be found out – and disinfected with appropriate does of sunlight.
But enough of the pejorative labels – and no kneejerk reactions (please). Let’s pause, see how the very large market next door reacts to some of the same sorts of pressures – and be fast followers (right-sized for New Zealand). To finish, a recent probe has found water in molecular form in the far side of the moon – this type of water could be a potential resource for lunar habitation. Someone cleverer than me might find this a more useful analogy.
For more information, please do not hesitate to contact me.
Statutory management – again
There is a strong sense of déjà vu (all over again) as we start or finish the day with claim and counterclaim about the state of the nation in the Du Val statutory management. And here I make no criticism of the business media – after the initial news blackout (IMHO deplorable) they have been seeking to make sense of the key issues and report them. There will be a range of interested parties equally keen to receive something/anything to fill the vacuum.
The “haven’t we been here before” feeling has been amplified by the suggestion that, because the supervisory folk at the FMA had given the much talked about IM some sort of green light (subject to provisions of additional information, and a get out of jail card, to alleviate concerns that it may have been misleading and deceptive), apparently only a few weeks before the balloon went up. This sounds like the first rumblings of a claim against (ultimately) the taxpayer – for compensation.
But I digress. The complexities highlighted by PwC’s 16 August report – and the plate of spaghetti reference to the group structure serve to underline a substantial part of the problem that may (ultimately) justify the logic for some form of statutory management remaining on the statute books.
Where, deliberately or otherwise, the group structure is so complicated, or uncertain, that pooling under standardised insolvency processes is not possible – then statutory management may be the only answer.
2001, a Law Commission study paper
But, as far back as the Securities Commission’s 1992 report – and again in the Law Commission’s 2001 study paper, the problems with the current legislative regime for statutory management were clearly identified. And since then….crickets. The issue was not targeted in the terms of reference for the Insolvency Working Group (2015 – 2017).
One of the primary recommendations in the Law Commission’s 2001 study paper was the need for improvement of New Zealand’s insolvency laws by the introduction of a targeted rehabilitation regime for distressed businesses. Consequently, whilst the Law Commission considered that most of the potential benefits of statutory management would also be covered by the proposed rehabilitation regime, it concluded that statutory management may still be useful where:
- issues involving the public interest are involved; and
- a process is needed to bring order to chaos and then determine how to deal with the core business.
The Law Commission continued that, if statutory management is to be preserved as a remedy of last resort, then:
- Short/sharp: the maximum initial period of statutory management should be 3 months, with power to extend this for a further 3 months;
- High Court appointment: decisions to invoke statutory management should be made by the High Court, with provisions for notice of the hearing to be given, and reasons to be given;
- Reporting: a report be provided to creditors and other stakeholder within 1 month – with a meeting to be held in the second month to decide what action should be taken – on the basis that statutory management should be used as a filter to determine what insolvency procedure should ultimately be used, or whether the business can be returned to management in a solvent state; and
- Group structures: noting the need for special provisions to address any issues that arise where a smorgasbord of different types of entities are involved (not all of which may be corporates and/or domiciled in New Zealand – hampering the use of existing legislation for pooling of assets).
Interestingly, the Law Commission, whilst encouraging reporting and transparency, also recommended that statutory managers be given a privilege in respect of reports to enable them to:
“state with frankness the conclusions which they have reached”.
Deja Voodoo
Already, it seems that this statutory management contains many of the troubling features that hark back to the GFC. The claims by some stakeholders that their stake was in a different bucket and should be treated separately (in priority) to others being just one.
Finally, the lessons from this statutory management need to be adopted, quickly. If, as appears to be the case, this government is serious about modernising and improving the efficiency of our business laws, then in addition to dusting off the Law Commission’s recommendations – some serious re-thinking is needed about the demarcations for ‘wholesale investors’. As other jurisdictions have shown, those demarcations are important. To take one example, without clarity we risk depriving start-ups of capital – and shovelling more money into the property market.
More information
For more information, please do not hesitate to contact me.
I’ve been studiously ignoring the new RadioNZ series entitled ‘RICH: The meaning of wealth in Aotearoa’ – for no better reason than the title struck me as the sort of annoying clickbait that deserves to be ignored.
But the headlines this morning, as a result of an interview with Commerce Minister Andrew Bayly, caused me to weaken. (Don’t judge me.)
The article reported, breathlessly, that the Government is planning to drop what it calls a “huge layering of personal liabilities for directors” to encourage more listings on the stock exchange.
In the interview signposted by that article, the Commerce Minister underlines the importance of listing as a means for companies to attract investment and grow. And then the article says he revealed plans to scrap requirements for companies to tell prospective investors about future earnings forecasts. And hinted that other obligations on company directors may go – including possibly removing the personal liability for climate-related disclosures.
All good – but from where I sit, the article and/or the interview should have simply said that the Government is going to implement the 2019 recommendations of the industry-led group, chaired by Martin Stearne, called ‘Capital Markets 2029’.
And, perhaps, while he was at it, the Minister might have been moved to comment on (or perhaps engage independent industry experts like Martin to examine) the challenges being faced by the SME sector when seeking capital. Whilst the big end of town is very important, the SME sector makes up 95%+ of all New Zealand businesses, employs about 30% of all employees and generates over a quarter of GDP.
I have a few ideas, and so too do many other industry participants. Part of the solution (I think) already exists – but it needs to be better resourced (and have some of its goals re-purposed).
I also observe that RadioNZ completely missed the boat with the Rod Duke interview – that is part of the same series. The interviewer should have asked Rod to conduct a guided walk through of a couple of stores, and then a high street shopping precinct and finally a mall. From a personal experience, it is only by observing how dialled in to how people think and shop – could anyone begin to see both Rod’s competitive advantage and how various physical shopping formats can be improved. That applies not only for shoppers but also for other stakeholders – including business owners and local authorities. That is not to say that any of these things are easy and it is not just local authorities who appear to be struggling with their parts of the shopping equation. But, to take a leaf from Capital Markets 2029, anyone interested should start by talking to an expert – which Rod clearly is.
More information
More information about Capital Markets 2029 is available online.
Du Val statutory management
The news, last night, that the Government had placed companies associated with Du Val property development group into statutory management is surprising – but perhaps not surprising.
But I am no fan of statutory management as its presence on the statute books (even if not used) quite clearly adds a layer of country risk to the way overseas parties view lending and investing in New Zealand. More on this below.
I have been intrigued about the move, by the FMA at the end of last month, to obtain court orders to place 64 Du Val companies (as well as the group’s founders) into ‘interim receivership’. To date, the relevant Court orders (aka the reasons) are not publicly available.
The announcement, by Commerce Minister Andrew Bayly, has (for me) an unfortunate ring of the late 80s to it. In that announcement, he said that:
[Du Val] has recently gone into interim receivership leaving significant liabilities. The situation is complex and of such a scale that immediate intervention is required to prevent broader harm. |
The Minister than added that statutory management is last resort option – used to deal with complex corporate failure where ordinary insolvency law is inadequate. And that it is intended to protect investors and creditors from further losses, and to enable the orderly administration of a company’s affairs.
When we look at the numbers, The Minister’s announcement says that the Du Val group is made up of about 70 entities, including 46 subsidiaries, and 20 limited partnerships. There are between 120–150 investors, home buyers and commercial lenders tangled up. And that, given the number people involved, it’s important to ensure the process is orderly and fair.
By implementing statutory management, all current insolvency processes are suspended. As a result, the affairs of Du Val can be dealt with by one team – rather than multiple insolvency processes.
As it must, the decision to put Du Val into statutory management follows a recommendation by the FMA. In turn, that recommendation follows a report from the Court-appointed interim receivers. And the Minister also refers to the FMA’s ongoing investigations.
It seems that the list of entities wraps up the Du Val group with one exception. The Order in Council applies to four “core” Du Val companies plus associated persons (all limited partnerships), and 46 subsidiaries. But one subsidiary is excluded as it is 50% owned by a third party and operates independently of the Du Val group.
The statutory managers are the Court appointed interim receivers, PwC.
In a parallel media announcement last night, the FMA said that statutory management provides remedies to deal with complex corporate failures and is most appropriate where a company has, or may have been operating fraudulently or recklessly or, alternatively, where the ordinary law is inadequate to deal with an orderly wind up of the companies. It said that, in this case, the FMA considers both provisions apply.
It noted that the report from the Court- appointed interim receivers is currently subject to Court orders restricting its publication.
The FMA added that it considers that the conditions for appointing statutory managers have been met, and that it is satisfied that statutory management is the most appropriate available option for each of the Du Val group entity to which it has been applied, for the purpose of:
- limiting or preventing the risk of further deterioration of the financial affairs of those entities;
- limiting or preventing the carrying out, or the effects of, any fraudulent act or activity;
- preserving the interests of their creditors or beneficiaries or the public interest; and
- enabling the affairs of the Du Val group entities to be managed in a more orderly way.
Absent any detail, it is difficult to comment further. For example, as well as investor funds tied up in various projects and entities, it is apparent that there are third party creditors involved – such as contractors on building projects. Perhaps the Court orders will be illuminating, when they finally emerge.
Comments
There isn’t the time or space available to dissect statutory management and why New Zealand still has the tool available. It was used in the late 80s to literally protect Chase Corporation and Equiticorp from themselves. Such was the complexity of the banking and other arrangements that entwined those two groups. At about the same time, a parallel process available to the Reserve Bank was applied to the DFC.
Consequently, flotillas of Japanese banks and Belgian dentists, with substantial funds at stake in various loans and other financial instruments, were left very unhappy and largely powerless to apply their rights as creditors.
The US investment analysts that I worked for in London, on my Big OE in the early 90s, had two pieces about New Zealand in the database – both about statutory management. Coupled to this was a label affecting advice to clients thinking about venturing outside the mainstream – which simply said:
Country risk – avoid |
Statutory management went largely unused until the GFC – when it was applied to Allan Hubbard’s empire.
There must be a serious question as to why this legacy of the Depression, updated slightly in the 80s, continues to be necessary to deal with complex corporate failure – where ordinary insolvency law is inadequate. It does not have parallels in other countries – notably Australia.
For a country that continues to rely (for growth) on the savings of people in other countries, having an unusual statute available that deprives creditors (particularly), or their contractual rights needs to be carefully explained. By continuing to be an outlier and (worse still) showing a willingness to use this legacy sledgehammer – will come at an ongoing cost.
In the meantime, the Minister, the FMA and the statutory managers should be encouraged to communicate frequently and clearly with not only the affected stakeholders, but also the wider commercial community, to manage the optics better. I would suggest that a 3-week delay is not a promising start.
And the business media needs to do a better job too. Forget the salacious gossip – and start asking some hard questions and demanding details. Not only of the statutory managers, but also of the FMA and ultimately the Minister. There is quite a lot at stake – and must include a country risk weighting.
For more information, please do not hesitate to contact me.
Companies Act makeover
An article in the media this morning is billed as unveiling the Government’s vision for changes to the Companies Act.
The work was foreshadowed by Commerce Minister, Andrew Bayly, in a speech at the end of January that signalled a number of law reform workstreams, including work to simplify, modernise, and digitise the Companies Act.
Since then, work has been going on behind the scenes in MBIE and with a sort of ad hoc working group on a series of detailed proposals and some important supplementary points that have arisen in transit.
The Minister has said that the product of this work is the largest set of modifications in the 30-year history of the Companies Act. The result is proposals for changes to:
- major transactions
- identifying shareholders and directors on the Register
- modernisation to enable more things can be done online
- expanded scope for use of the New Zealand Business No
- changes to insolvency provisions
The Minister said that the introduction of a bill is still some months away and legislation is not likely to have its first reading until early 2025 – after which it will go through a full select committee process with a target completion date for the end of next year.
Regrettably, the review of concerns about the law relating to directors’ duties and liabilities will not start until the beginning of next year – pointing a longer road to law reform.
Major transactions
The proposed changes are designed to address some longstanding uncertainties by providing that transactions which relate solely to the company’s capital structure (share issues particularly – but also share buybacks, redemptions and dividends) would not fall into the major transactions bracket.
As well as improving efficiency, an anti-avoidance measure is also signalled, designed to prevent an end run around the need for major transaction approvals by breaking the transaction up into a series of smaller (related) transactions or by channelling through a subsidiary.
Shareholder/director identity
The media reports the Minister as saying that new identity rules would have a number of functions. Amongst other things, this would enable directors to keep their residential address confidential.
This is a change that has been requested for some time. However, directors will still need to provide an address for service and will be identifiable through an identification number which should allow the public to see what other companies they govern.
The address for service would need to be that of a professional firm (lawyers or accountants, etc) or another real-life permanent address of some kind. It could not just be a postbox or a temporary office.
Section 131(5) – a hero’s death
The Minister also signalled the repeal of section 131(5), brought in by the previous Government, with the aim of making it clearer that directors could consider things beyond profit maximisation (such as ESG factors) when considering the best interests of the company.
Whilst this ‘for the avoidance of doubt’ provision did not mandate a wider view of the company’s best interests, the Minister said that feedback supported his concerns that it was unfairly imposing one view across the board on the business community.
This, alone, should add some colour to the Select Committee process.
Phoenix companies
The Minister has made much of seeking to weed out fraudulent activity such as the problem of people registering companies under slightly different versions of their own name and reducing the risk confusion about company ownership involving people of the same name.
This, the Minister is reported as saying, would help combat the incidence of ‘phoenix companies’ – when companies transfer assets into another entity – sometimes with a similar name – and then liquidate leaving only debt.
In this regard, following the pattern overseas of using director identification numbers (whilst shielding director residential addresses from public view) was seen as another integrity measure whilst allaying the safety fears of would-be directors.
Changes to insolvency provisions
The Minister is also quoted as saying that the views of insolvency practitioners has been considered in relation to the need for tighter controls on transactions between related companies that are subsequently liquidated. In large part, this seems to be a response recommendations almost a decade ago from the Insolvency Working Group, proposing:
- an extension of the clawback period for voidable transactions with related parties – from 2 years to 4 years
- clarifying some matters relating to the classification of certain employee claims as ‘preferential claims’ in a liquidation
- measures designed to encourage liquidators to pursue claims for reckless trading
Better protection for the holders of gift cards and vouchers was also mentioned.
Digitisation
New measures are planned to enhance the scope for the digital / virtual performance of compliance and other measures by companies, and make better use of the Companies Office functionality – to address concerns that whilst its registries can operate digitally, the Companies Act had not kept pace with those technological developments.
Examples of this included specifically enabling companies to conduct virtual meetings as a sort of virtual default setting rather than having to (first) include specific provisions in the constitution enabling the company to do so.
According to the Minister, the plans for increased digitisation appear likely to include expanded use of the New Zealand Business Number (NZBN), both as a ready means of identification and to enable companies to better satisfy their AML/CFT obligations.
Other changes being suggested by the Minister for a wider remit for the use of NZBN, including by enabling the NZBN to be useable on other business registers and applications for using NZBN data for identity verification and preventing scams, as well as the addition of a small business identifier (making it easier to support a voluntary code on payment times for small businesses) look to be further afield.
Directors’ duties – review
It should also be noted that, at the beginning of June, the Minister of Justice announced that the Law Commission had been asked to undertake a review of directors’ duties and liabilities. Specifically:
- The announcement noted that duties in the Companies Act relating to reckless trading and incurring obligations are particularly unclear and difficult to apply as they are currently framed and may discourage directors from taking legitimate business risks.
- And because directors can be personally liable under a range of other legislation, the review is to consider the overall burden of liability on directors, including its impact on directors’ willingness to take legitimate business risks and its consistency with the underlying purpose of directors’ duties in the Companies Act.
Regrettably, in part (it seems) because the Law Commission’s work is set on an annual basis, this piece of work is not due to start until the first half of 2025. The law relating to directors’ duties and liabilities has been causing concern for some time – and a number of parties have been calling (and lobbying) for a review as a matter of urgency.
More information
For more information, please do not hesitate to contact me.
In 2020, I commented on a breach of warranty case, using the theme of a cautionary tale about due diligence[1]. Another recent decision, again from Christchurch, contains another stark illustration of the need for caution – this time coupled with a damages award, for breach of warranty under a SPA, that seems out of kilter.
The 2024 decision, Cunningham v European Interiors Limited (in liq), involved a claim about a turnover warranty in a SPA. Unfortunately, during the 2 years that the case was going through procedural skirmishing, the defendant and its sole director went broke. As a result, when the case came to trail, the only defendants left standing were the purchaser’s accountants – who settled out of court. As a result, there was little or no active defence. Despite this, aspects of the judgment seem quite curious.
The widely-used, at least for sales of SMEs, ADLS form of SPA contains a turnover warranty. The warranty speaks to past performance. Curiously, in this case, the Court awarded damages for breach of the turnover warranty in the SPA based on loss of [expected] profits – which appears to be out of step with the usual basis for compensating the purchaser on a diminution in value basis for receiving something that was worth less than what they contracted for.
Once again, if there is a cautionary tale – it hinges on due diligence.
Background
The buyer in this case had agreed to buy the Canterbury regional component of a kitchen supply and installation business. The SPA included a turnover warranty for the 9 months prior to the date of the SPA. The warranted turnover was $2.2 million – when the plaintiffs claimed that it was less than half that figure. The plaintiffs also brought a claim under the Fair Trading Act saying that the information provided by the vendor misrepresented business margins and the profit and loss information misrepresented matters relating to product cost price and the profitability of the business for that 9-month period. They also sued the sole shareholder and director of the vendor (as covenantor) for his personal covenants under the SPA – backstopping the warranties.
Because of the lack of any active defence by the (insolvent) defendants, the evidence comprises briefs of evidence (largely by experts – including the plaintiffs’ accountants – before they settled the claim against them).
Decision
Finding that the turnover warranty had been breached, the judge noted that, on the breach of contract causes of action, the plaintiffs must be put as nearly as possible into the position they would have occupied if the contract (SPA) had been performed. And that where a turnover warranty is breached, it is common to approach the calculation of the plaintiffs’ loss by reference to its loss of profits. In other words, the innocent party has an expectation interest, which the law requires to be fulfilled, by financially restoring them to the position they would have occupied if the contract had been performed.
He continued by noting that whilst the appropriate income period from which to assess damages arising from loss of profits is a matter for professional judgement – in this case the Court has the uncontradicted opinion of the plaintiffs’ expert that the 3-year period commencing with the (financial) year of purchase is reasonable. He said that there is no reason not to adopt that assessment.
It is noted that the plaintiffs pleaded that, had the turnover warranty been correct, they would have recovered profits of $2.3 million (in excess of what was recoverable as the business truly existed). Alternatively, they said the true value of the business at the date of settlement was $194k – and therefore (in the alternative) they claimed $1.1 million being the difference between the purchase price and the true value. And, they also claimed direct consequential trading losses of approx. $300k for the 3 financial years following the purchase – giving an aggregate for the alternative claim of approx. $1.4 million.
There was also a large costs award – largely relating to the costs of the plaintiffs’ expert accountant.
Comments
It is a pity that this case suffered from a lack of active defence. On its face, the truncated (for the reasons noted above) decision seems to depart from the usual approach for assessing damages for a breach of warranty. That approach, based on such notable decisions as that of the Privy Council in Lion Nathan Ltd v C-C Bottlers Ltd (1996), is on a diminution in value basis.
Applying that approach to damages claim for a breach of warranty requires a comparison between the actual value of the business with the value that [it] would have had if the warranty had been true. Importantly, in C-C Bottlers, the Privy Council drew an analogy between the sale and purchase of a company, and the sale and purchase of goods. In each case, the purchaser was entitled to assume that what it stood to receive would be of the warranted quality, which means that the purchaser could claim damages to compensate them for having received something that was worth less than what they contracted for.
As noted above, by definition a turnover warranty is backwards-looking. The outcome might be different had the warranty been about future performance (which itself would be quite rare). Instead, warranties as to historic matters (for example as to the performance or state of affairs disclosed by historic financial statements) are treated as a warranty as to quality – like that in a sale of goods context. And in such cases the usual (correct) measure of damages for claims for breach of warranty as to quality is the diminution in value measure – the difference between the value of the position as warranted and the actual value.
And whilst an application of usual valuation methodology (by capitalising future maintainable earnings – utilising past performance to determine the future maintainable earnings and capitalise those earnings by an expected rate of return on investment) to calculate the loss suffered contains an element of extrapolation of past earnings, that was not the measure applied here. Consequently, by using the loss of profits measure – the measure of damages appears to be greatly overstated.
Takeaways
Noting the truncated nature of the case and therefore the scarcity of evidence, this seems to be another example of due diligence gone wrong.
Even more distressing here for the plaintiffs is that, depending of course on the terms of the settlement reached with their accountants, the plaintiffs could have ended up seriously out of pocket. This is because both the defendants (the vendor company and the shareholder/director) are insolvent.
As a result, the additional takeaway is the importance of developing an understanding of the ability of those providing warranty cover to respond to a claim. If in doubt, any one or more of security for the warranty claim period, an earn out or an escrow arrangement may be called on to provide a would-be buyer with the necessary comfort that warranty claims can be met. In larger purchases, warranty & indemnity insurance cover may be obtainable.
Once again, for those who have experienced an economic cycle or two, a contracting economy with a lot of businesses seeking to jettison non-performing / non-core activities, will mean that such comfort will assume greater significance.
For more information, please do not hesitate to contact me.
[1] See https://stephenlayburn.co.nz/due-diligence-a-cautionary-tale-for-all-parties
Late last month, Commerce Minister Andrew Bayly gave a speech that reiterated the new Government’s economic priorities and then concluded with a list of things to be done in the financial services sector. Interesting, it concluded with an announcement of work to simplify, modernise, and digitise the Companies Act.
In an odd piece of timing, because of the ballot process involved, last week a [private] member’s bill emerged from the scrum that has its goal a single change to the Companies Act to allow directors to use an address for service where there would be a risk to making their home address publicly available.
Whilst piecemeal reform of important legislation is not always welcomed, this proposal is not new and has some support.
Overseas, the risks of doxxing and other anti-social behaviour has been recognised for some time. In the UK, director residential addresses are protected, and Australia began moves in this direction with the introduction of Director Identification Numbers (DINs) in 2021.
Locally, MBIE first began consulting on the issues relating to the idea of protecting director privacy in 2018.
The member’s bill is promoted by Labour MP Deborah Russell. A similar proposal was floated in 2021 by Brooke van Velden of ACT.
It is quite short and proposes to add a new section 360D to the Companies Act, enabling a company director to apply to the Registrar to replace the public details of their residential address – with a service address. Unfortunately, the mechanism proposed by the member’s bill then gets bogged down in process noise – by requiring a director to verify (by means of a statutory declaration) that public availability of this information is likely to result in harm (physical or mental) to the director or their family.
This seems unnecessarily clunky. Following similar models overseas, privacy (whether by means of a service address or, better still by use of a DIN which has an enhanced anti-fraud role) should be simple and available as of right. There doesn’t seem to be any need for extensive form-filling in order to demonstrate why privacy is needed.
Therefore, whilst there are provisions in the Companies Act that need work and the Minister’s announcement at the end of January is welcomed, this is one item of piecemeal reform that is needed. But it still needs work. As a result, whilst the strike rate for member’s bills is still quite low, and it will require cross party support, the bill is one that could do with progression and public submissions – and some panel-beating through the Select Committee process.
This week’s decision of the Employment Relations Authority, finding that the Government agency High Performance Sport New Zealand, is obligated to engage in good-faith collective bargaining with the newly-formed Athletes Cooperative, which represents around 60 elite athletes (mostly rowers and cyclists) – is a welcomed start to what I expect will be a lengthy journey.
The decision itself involves some of the more complicated outer reaches of employment law in circumstances where HPSNZ does not have a formal employment relationship with athletes. As a result, I do not propose to comment on the technicalities. That is best left to the experts, such as the very experienced employment lawyers who represented the parties.
However, as a parent of a couple of athletes in ‘the system’ and therefore someone with more than just a passing interest in the outcome of the journey, I share the concerns of many other sporting parents about the design and implementation of the funding model for athletes. From where I sit, there are aspects of the model that seem uncertain (and at times unfair) with, seemingly, constant changes and a high level of uncertainty.
Self-evidently, the application of the model is key factor in the matrix of things affecting athlete welfare and, therefore, performance.
These concerns are not new and have surfaced previously – such as in the 2022 inquiry in relation to Cycling New Zealand.
Some of the issues have manifested themselves as a result of the current pressures on the cost of living – because the model often results in low levels of funding to individual athletes. And they are not confined to New Zealand. A report at the end of last year noted that Australia risks losing elite athletes before the 2032 Brisbane Olympics unless philanthropic funding can help fill a funding shortfall. There it seems that, but for the intervention of an Australian billionaire to top-up some of the most high-profile Australian swimmers, they too would be suffering from the same cost-of-living pressures that are causing athlete wellbeing concerns for elite athletes in Australia.
The next stages of the journey are likely to be complicated. And in a period when all Government agencies are facing cost and spending pressures. The example provided by Australia, in a much bigger, apparently wealthier, environment points to the difficulties.
But, with all of the risks and regards of being a sporting parent, sponsor, gear fetcher and carrier etc, as well as a sports tragic – I would like to think that there are enough good people on both sides of this discussion to continue working on solutions for the best interests of all concerned. And I have some confidence that they are [all] aware that, without a working solution, the system risks undermining one of the key parts of the fabric of our society.