Stephen Layburn

Last week, I had the opportunity to present the submission of the Commercial & Business Law Committee of the New Zealand Law Society to the Economic Development Select Committee.

Whilst I have worked around central Government a little bit, opportunities to participate in the engine room of Government, such as at Select Committee level, are still something that I regard as novel – and a bit of a privilege.

Like all of the work of the NZLS law reform committees, this sub was the product of time and effort by a team of volunteers – and marked the swansong from the CBLC of my former Simpson Grierson colleague Charlotte McLaughlin. 

The mainstream media seem to have picked up the day’s proceedings but the reporting is a bit hard to follow.

The Bill, which started life as a private member’s bill, seeks to amend section 131 of the Companies Act, by adding a ‘for the avoidance of doubt’ provision that is said to enable directors to consider a list of matters when determining how to discharge their duty to act in the best interests of the company.

As presently drafted in the Bill – that list is not exhaustive.

On one level, the Bill can be seen as an attempt to bring to a head, at a policy level, the debate in company law over “shareholder primacy” versus “stakeholder theory”.

The Law Society’s submission is that the Bill should not proceed.  In summary form, this on the basis of four headline points:

• The Bill seeks to solve a problem that does not exist:  Company directors can already consider the range of matters proposed. 

The sub refers to the 2020 Supreme Court, in Debut Homes – which confirmed that the legislative test in section 131 of the Companies Act is subjective.  It already allows directors to consider all the factors described in the Bill (and others) – if that is what a director believes to be in the company’s best interests.

• Caution against ad-hoc changes to the directors’ duties regime:  Attempts to reiterate or reinforce law on directors’ duties should not be made in an ad-hoc manner.  This is a fundamental element of company law, and changes should not be made piece-meal.  Instead, they should be the subject of a thorough and comprehensive law reform process, including early public consultation.  Making ad-hoc changes in this manner risks unintended and unconsidered consequences.

Here, a range of concerns about the Bill were highlighted:

• how the proposed add-on will impact director liability – in a regime that is already the subject of some uncertainty;

• the lack of clarity about what is meant by “recognised environmental, social and governance factors” (“recognised” by whom and to what extent?); and

• although the Bill intends a (permissive) ‘for the avoidance of doubt’ add-on to the section 131 duty – there is a real risk that it will be interpreted by some as a sort of ‘default setting’ for directors.  Coupled with a lack of clarity about its purpose – this raises the prospect of uncertain interaction with other legislation and the risk of unintended and unforeseen consequences.

• Any thorough examination of the drivers for law change must have an eye to overseas experience:  In this way, we not only benefit from overseas experience – but also manage the risk of being seen to take important elements of company law in directions that might be seen to be out-of-step with Australia.

• Law reform should focus on changing the right law, for the rights reasons:  No matter how well-intentioned, the Bill has not been through a comprehensive law reform process, and it is not clear if it is intended to achieve more substantive changes to the company law regime.  The Law Society has strongly and consistently advocated that significant changes in commercial law should follow a full policy development process and be clear in their intended effect.

If the Bill seeks to promote meaningful progress on issues such as reducing adverse environmental impacts then:

• this goal should be addressed in the context of an all-embracing review; and

• clear legal obligations (coupled with efficient enforcement mechanisms) are likely to have a more realistic chance of achieving their goal. 

The Bill, as presently drafted, does not do that.

Trying to distil rules of general application from a case involving a bottom feeder that prays on vulnerable people is no easy task.

So it is with the recent High Court decision declaring terms to be unfair in the context of the Fair Trading Act unfair contract terms regime. 

I won’t dwell on the facts relating to the successful action by the Commerce Commission against the eponymously named Ace Marketing.  The contract terms in question were those from a consumer contract.  The reason why the case is noteworthy is the Court’s findings about what constitutes terms that are ‘unfair’ is of direct relevance to B2B transactions as a result of the Fair Trading Act changes that came into force in August – as the apply to ‘standard form small trade contracts’ (bringing them into the unfair contract terms regime).

Business model – unenforceable

Ace Marketing was a cellar-dweller, a mobile trader selling at high prices on deferred payment plans, with the goods only being delivered after a specified number of payments had been made.  Its contract terms included a penalty, in the form of delaying delivery even further, if a payment was missed.   The Court found that these provisions gave rise to a significant imbalance in rights (to the customer’s detriment).  The Court also found that the length of the deferral periods was out of proportion to the impact on the seller of the missed payment and wasn’t reasonably necessary to protect its legitimate business interests.

Not surprisingly, the Court considered that the risk of delay to the delivery date was a key risk for customers.  Therefore, the provisions should have been clearly highlighted and brought to the attention of customers.  Instead, they were neither clearly highlighted nor properly explained – in part because the reader had to get to page 10 of the contract to find them.  This was a breach of the seller’s obligation to ensure information is not presented in a manner that is, or is likely to be, misleading, deceptive or confusing.

As a result, the Court concluded that both the inclusion of the deferral (penalty) and failing to make it clear how the contract terms worked to the vulnerable people on whom it preyed, meant that it had included an unfair contract term in its standard terms and conditions – which was declared unenforceable.

Other criticisms

The judge also criticised the drafting and layout of the standard t’s and c’s because the offending provisions were:

• hard to find, inconsistent, and buried in, literally, the fine print (small font, narrowly-spaced and printed in a dual-column layout);
• not set out logically and difficult to follow; and
• not highlighted or given the necessary prominence.

Unfair contract terms – for consumer contracts

The Commerce Commission claim was brought under the unfair contract terms regime in the Fair Trading Act that regulates standard form consumer contracts.  However, since August, this regime also applies to standard form small trade contracts.

The regime enables the Commerce Commission to seek a declaration (from the High Court) that a term included in a standard form contract is an ‘unfair contract term’.  The impact of such a declaration is that it must not:

• be included in a standard form contract; or
• applied or enforced.

The grounds for which a (Court) declaration of unfairness are that the term:

• would cause a significant imbalance in the parties’ rights and obligations under the contract; and
• is not reasonably necessary to protect the legitimate interests of the party who benefits from the term; and
• would cause detriment to a party if enforced or relied on.

Importantly, there are no other penalties for including an unfair contract term in a standard form – prior to being declared unfair. 

Review standard contract terms

The expansion of the unfair contracts regime to standard form small trade (B2B) contracts points to the need to review standard terms and conditions and consider the risk of being declared unfair – and therefore enforceable.

In particular, some care should be taken to ensure that standard terms and conditions:

• Plain English:  Some care should be taken to use wording that is in plain, transparent, language.  They key terms should be expressed clearly and logically (and consistently).  The absence of use of hidden meanings (or unexplained legal or technical terms) will aid against a declaration of unfairness.
• Avoid complexity:  The High Court had little difficult in finding Ace Marketing’s deferred payment plan to be complex and unusual.  Whilst the target audience were vulnerable consumers, there is a lesson her for B2B contracts too – that complexity is not helpful in engendering comfort on the part of the user or the Commerce Commission – should it come knocking.  And clearly does not impress a High Court judge.
• Explain the commercial rationale:  Where a contract term is important in the scheme of the contractual relationship, it should be explained.  Often, these will be the ‘what do I get’ terms.  But they will also be those which re-allocate or limit risk.  The key point here is that a contractual term that is accompanied by an explanation or which can be backstopped by a (sound) commercial driver for its inclusion is much less likely to be found to be ‘unfair’ if it is reasonably necessary to protect the legitimate business interests of the author.

And while the unfair contracts regime in the Fair Trading Act only applies to ‘standard form contracts’, many of the factors that are relevant in a determination as to whether a term is unfair can have a broader relevance.  The inclusion of terms in any type of contract that are manifestly unfair or that are unclear can impact negotiations, and those which cause confusion or nasty surprises such as unexpected offloading of risk, can underline the commercial relationship.

Further information

For more information, including information about the extension of the unfair contract terms regime to small B2B contracts (standard form contracts with an expected annual value of less than $250k) – please contact me.

The press release this week noting the response of the Auckland Mayor into a consultant’s report into the management of conflicts of interest at Eke Panuku (the urban regeneration and property management CCO for Auckland Council) may raise one or two eyebrows. 

Specifically, the comments that:

• the report highlights that there is still work to be done to ensure the Council-controlled organisation has good processes in place; and
• this is a matter of concern that requires attention,

led me to go searching for a copy of the report itself.

The Mayor continued by saying that conflicts of interest will arise given the need for boards to have directors with experience and expertise in the relevant industry.  In the case of Eke Panuku, the property industry.  However, the recommendations in the report needed careful review, including those that the Council consider appointing a minimum number of independent directors and an independent chair.

Whilst the report is specific to Eke Panuku (and pleasingly found no clear evidence of unmitigated conflicts of interest or private benefits arising from a conflict of interest) it highlights:

• That controls to identify and manage conflicts of interest can be made more robust to safeguard the interests of Eke Panuku and protect the board and staff.
• Eke Panuku and the Council should consider the board appointment settings to ensure there is an appropriate balance between the necessary commercial expertise – while ensuring public trust.  The report proposes ways to achieve this and identified where management controls are not solely sufficient to mitigate conflicts of interest risks.  The proposals included:
  • setting a minimum number of independent directors and an independent chair; and
  • limits on the extent of the business relationships that board members may have with Eke Panuku.
• Training and guidance can be improved to support effective management of conflicts of interest.

Comments

The review process for Eke Panuku is ongoing and will not be complete until next year.

Actual or potential conflicts of interest can be perceived or actually arise where and interested board or staff member can either influence or approve decisions or obtain information that may give an unfair advantage if exploited.  Whilst these issues are very important in the context of a publicly-owned entity such as a CCO, they can arise in a wide variety of contexts.  

Consequently, embedding good policies and practices, coupled with effective training and guidance to support the effective management of those policies and practices, is an integral part of good governance.

For a copy of the Eke Panuku report, please see: Eke Panuku – Conflicts of Interest Controls Assessment.

Last week the followed up its workstream from earlier in the year by issuing a report on a ‘Thematic Review’ of the wholesale investor exclusion.  It is clear that the FMA has followed up its earlier actions by undertaking a more detailed review of the activities of a number of property syndicators targeting wholesale investors.  This included inspecting the investor certificates obtained.

The outcome is a report that includes guidance for offerors relying on the wholesale investor exclusion under the FMC Act – as well as those confirming investor certificates.

Advertising

In keeping with the warnings issued earlier this year, the FMA has identified a number of concerns relating to the advertising of wholesale offers, including:

Advertising by means of a smorgasbord of advertising channels – rather than a narrow focus (directly) to suitable investors	Whilst some of the FMA’s concerns about straying from straying from previous channels that were better targeted – it seems unlikely that they are clutching at pearls or seeking to police the path to market.  Instead, a closer look at their comments and some of the examples highlights some unhealthy bait advertising that is both likely to draw in a retail investor audience and amplify the risk of some inexperienced investors being misled.
The use of digital advertising tools (e.g. Google AdWords and search engine optimisation) that may capture people who are not necessarily wholesale investors (and for whom such offers are not suitable)	Again, some of the examples highlight the risk of capturing both a retail audience and of conveying misleading information.
Misleading advertising featuring high returns and downplaying risk	The FMA notes (i) the overall impression must not be misleading or deceptive; (ii) any qualifications to headlines must be proximate, prominent, and effective so as not to be misleading or deceptive; (iii) comparisons must not be misleading (e.g. comparing a managed fund with a bank term deposit); and (iv) must not lead investors to draw comparisons between dissimilar financial products – especially if this appears to be intentional

Description of the wholesale investor exclusion

The FMA is concerned that promotional materials did not always make it clear that the offer was only available to wholesale investors – which could be misleading and deceptive (and a form of bait advertising). 

Also of concern was a lack of clarity about offers said to be available to “wholesale and eligible investors” (and the plain meaning of the words “eligible investor”) which may give the impression that an offer is available to someone other than a wholesale investor – which is also misleading. 

As a result, offerors are guided to ensuring that all advertising of a wholesale offer clearly states that it is open to wholesale investors only – using that statement with sufficient prominence to bring it to the attention of the audience.  (It is also recommended that the term “eligible investor” not be used alongside “wholesale investor”.

Eligible investor certificates

The FMA highlights a number of examples incomplete or inadequate eligible investor certificates, including a range of irrelevant and vague grounds that were not capable of supporting the matters certified.

Importantly, the FMA notes that the offeror does not need to verify the information in the certificate, but it says that the grounds stated by the investor in their certificate should:

“demonstrate a connection between the investor’s prior relevant experience in acquiring or disposing of financial products, and the transaction to which the certificate relates”

Consequently, it says that where the stated grounds are not relevant to the certification, the certificate will not meet the legislative requirements (i.e. those in Schedule 1 of the FMC Act).

The FMA then refer to certificates that use ‘tick-box’ options for investors to select from a list of pre-populated grounds for certification that refer only to prior investment activity.  It states that, without further detail, it is not clear that the prior experience enables the investor to assess the merits of the relevant transaction.  As a result, it says that further information will be required before the certificate can be relied upon.  The FMA prefers free-form text boxes so that investors can articulate the grounds for certification themselves – which it regards as clear evidence for the investor understanding the financial products they are about to acquire.

Here, the FMA’s concern is that some offerors are endeavouring to create the appearance of sufficient grounds to support certification, when no grounds exist.  And the check-box approach provides an increased chance investors will invest without adequately understanding the risks involved and the value offered.

Provision of advice and confirming self-certification

The FMA noted multiple examples of unacceptable practices by professional advisers confirming eligible investor certificates.

It noted that financial advisers, qualified statutory accountants or lawyers who confirm eligible investor certificates must:

• consider the grounds for an investor qualifying for the certification set out in the certificate;
• be satisfied that the investor has been sufficiently advised of the consequences of certification; and
• have no reason to believe the certification is incorrect or that further information or investigation is required as to whether or not the certification is correct.

It notes that where a professional adviser fails to meet these requirements, they may breach their duties and obligations under the rules of professional conduct that govern them – which could cause the FMA to consider referring this conduct to the relevant professional body.

The FMA says that its previous views that the offeror need not independently verify the information in the certificate has not changed – but that its new guidance supplements those previous views by describing what the offeror does need to do.

Observations

Whilst the FMA has set some clear expectations in relation to reliance on the wholesale investor exclusion and some of what was said makes for quite sobering reading (especially for professional advisers confirming certificates) there remain some lingering questions.

I think the FMA was right to focus on the activities of property syndicators if only because Kiwis love affair with real estate seems to lead to trouble.  As a result, I am less convinced that the findings are necessarily applicable to all wholesale offers – simply because of some entrenched behaviours.  Nonetheless, that may be more good luck than good management. 

And whilst the FMA says that it has [now] set its expectations, and expects a higher level of compliance – including by acting in ways that are properly focused on the outcome that, where the eligible investor certificate is used, only investors with sufficient knowledge and experience in dealing in financial products are accepted into the offer, there is a distinct risk that the manner I which they have portrayed some of their examples will prove to be incorrect (as a technical legal matter).  And I have some policy concerns too.

Clearly, the wholesale investor / eligible investor pathway (and self-certification) was enacted to provide easier and lower cost access to capital from investors who are capable of looking after themselves.  And by allowing self-certification and imposing only a negative assurance (that a certificate cannot be relied on where the offeror has actual knowledge that the certificate is untrue) – is not the same as requiring the offeror to vet the grounds given in certificates.

Regardless of the merits of the FMA’s concerns about the actions of sampled, there is no other way to read the guidance that an offeror should, when relying on a certificate, ensure that the grounds stated are relevant and support the certification of previous experience in acquiring or disposing of financial products that is relevant to an assessment of the financial products on offer – than as imposing a requirement for positive vetting of each certificate.  That obligation does not exist in the FMC Act and, arguably, would defeat the policy objective of the self-certification regime.

Where the FMA is on solid ground is where it says that whilst extensive and broad investment experience over a long period will be relevant grounds for the certification, so too will be other limited but specific experience in some cases.  But that self-certifiers should include sufficient detail to identify the relevance of investment activity to the matters certified.  This is key to a process of educating investors as much as offerors. 

But it should take some care not to visit problems in one, high-risk, sector on the broad spectrum of wholesale investment activity.  And here, the Productivity Commission and others with skin in the game might care to point out that the last thing that high growth businesses seeking leverage and develop innovative new technologies need right now are barriers to capital that should not exist (and do not exist).

For more information about offers to a wholesale audience – please contact me.

With the Supreme Court decision in Mainzeal said to be imminent, there has been quite a bit of interest in a recent decision of the UK Supreme Court in case called Sequana about the duties of directors of a company in the twilight zone.  One UK commentator has said that Sequana represents the most significant ruling on the duties of directors of distressed companies in the past 30 years.

Whilst there are many similarities between the relevant law in the UK and that of New Zealand and existing (New Zealand) case law on the need for directors to consider the interests of creditors when a company is in the twilight zone approaching insolvency, there are also a few important points of difference.  As a result, there are mixed views about the extent to which Sequana will have an impact here.

It should also be noted that Goddard J., in the Court of Appeal decision in Mainzeal, described New Zealand’s insolvent trading regime as not fit for purposes and in need of reform.  Across the Tasman, the Australians have already started such a review.  As a result, Sequana and (in all likelihood) the Supreme Court decision in Mainzeal could buttress the calls for law reform.

Importantly, or perhaps unhelpfully, Sequana did not identify a ‘bright line test’ pointing to some sort of tipping point at which the interests of creditors must receive greater prominence than the other interests being juggled by directors.  Instead, it seems to reinforce the point already reached by the New Zealand courts that, once insolvency exists or is likely, the duty of directors to act in the best interests of the company must accommodate a consideration of the interests of creditors. 

Sliding scale

The UK Supreme Court sought to address what was seen as ambiguity regarding the contents of the “creditor duty” by seeking to make it clear that the way in which directors discharge the “creditor duty” differs as the company’s financial difficulties company become more acute.  

Some commentators have tried to characterise this as involving distinct stages (in the ‘twilight zone’), but it is clearly a sliding scale, ranging from:

• entry into the twilight zone – when approaching insolvency, the directors must consider creditors’ interests – which may require a balancing act (and inevitably, a greater level of financial distress points to the need for more attention to be paid to the interests of creditors); and
• to a point when insolvency (and a formal insolvency process) is “inevitable” – then the interests of creditors become paramount.

To repeat the point above, the “creditor duty” is not a separate (freestanding) duty owed directly to creditors.  Instead, it is permutation of the (primary) duty to act in the best interests of the company by having regard to the interests of the company’s creditors – when the company becomes insolvent or approaches insolvency.  The UK Supreme Court judgment refers to something labelled “modern corporate rescue culture” in the UK.  And, in doing so, it referred to the 1985 New Zealand Court of Appeal decision in Nicholson v Permakraft.

Importantly, when the “creditor duty” is engaged (triggered) the shareholders’ ability to ratify decisions and actions of the directors ceases to exist.

Sequana – background

The insolvency in question (of a company called AWA) was a long time in the making.  In 2009, AWA had paid its parent company (Sequana) a dividend of €135 million extinguishing a significant amount of inter-company debt.  At the time the dividend was distributed, AWA was solvent (on both limbs of the solvency test – balance sheet and cash flow).  However, AWA had a significant contingent liability in the form of pollution clean-up costs.  There was also uncertainty about the value of one of its major assets.  The amount and likelihood of those liabilities (and the question mark about the asset value) was uncertain.  Nonetheless, they gave rise to a real risk (but not then a probability) that AWA could become insolvent at some point in the distant future.

Nearly 10 years after paying the dividend, AWA went into administration.  BTI purchased AWA’s claim against its directors and sought to recover the amount of the dividend payment from AWA’s directors – arguing a breach of the “creditor duty” by failing to consider or act in the best interests of creditors at a time when AWA was insolvent or there was a real risk of insolvency.

Sequana – decision

The unanimous decision of the UK Supreme Court was that:

• The AWA directors were not subject to a duty to have regard to the consider the interests of creditors at the time that the dividend was paid.  At that time, AWA was not either insolvent or imminently insolvent, nor was insolvency even a probability.
• A director, as part of their (primary) duty to act in good faith in the best interests of the company, must also consider the interests of creditors in certain circumstances.  This is because creditors have the main economic stake in the outcome of a liquidation – pointing to the need to consider their interests at an earlier stage.

As noted above, the UK Supreme Court did not identify a bright line test for directors.  But, the majority found that the “creditor duty” would be engaged when directors knew, or ought to have known, that the company was insolvent or bordering on insolvency, or that a formal insolvency process is probable.

Relevance to New Zealand

The Sequana decision underlined the point that the “creditor duty” dovetails with the provisions in the UK Companies Act relating to wrongful trading (which are said to roughly equate to reckless trading regime under section 135 of the New Zealand Companies Act).

However, there are (as a result of recent New Zealand decisions – notably Debut Homes) a number of important points of difference between the present state of the law on insolvent trading in New Zealand with that in the UK.  For example, directors of a UK company (once there is no reasonable prospect of the company avoiding insolvent liquidation) have a duty to take every step that a reasonably diligent director would take to minimise potential loss to the company’s creditors.  

UK directors can continue to trade, prior to a formal insolvency process, if by doing so they will achieve a better return for existing creditors.  As a result, the majority decision in Sequana is seen as being careful not to apply the “creditor duty” too early in the cycle of distress – to support a “rescue culture”.  By contrast, if directors were to face an earlier, or vaguer, trigger point this would be seen as unduly burdensome – and (to paraphrase one of the drivers for reform in Australia) might lead to too many good businesses being subjected to formal insolvency processes because directors were unwilling to take the risk of a rescue mission.  This approach can be contrasted with the approach of the New Zealand Supreme Court in Debut Homes which pointed to the need for a director to cease trading once it was clear that the company would not recover, even if continued trading for a finite period would reduce the amount of the loss to stakeholders.

The balancing act in the treatment of the “creditor duty” adopted by the majority in Sequana (and the understanding of the need to promote a rescue culture) encourages considered risk taking, based on expert advice, to achieve a better outcome for creditors.  Perhaps, the Supreme Court will take the opportunity in Mainzeal to echo the comments of Goodard J. in the Court of Appeal about the need (for Parliament) to reconsider the insolvent trading regime.  Any such reflection may only be strengthened by developments in Australia.

The Sequana judgment suggests a sliding scale, that when a company is entering into the twilight zone (but it is not inevitable that a formal insolvency process will follow), the directors must undertake a balancing act for directors of creditors’ interests against those of shareholders’ interests.  When applying that scale, the weight to be given to each group’s interests will depend on what the directors reasonably regard as the likelihood that a proposed course of action will lead the company away from vs tip it over the brink.

As well as the need for evidence and expert advice, the application of the sliding scale may require directors to assess who has the most at risk.  For many companies in the twilight zone, this is likely to be creditors – as (typically) the prospect of a return on shareholders’ funds is very low.

In this regard, Debut Homes does not provide much assistance because the company was already beyond a point where it could have been brought back from the brink at the time that the critical decisions (to complete the remaining houses) were made.  To this I would also add that our leading cases seem to be those where large/lumpy transactions are under the spotlight – and not those affecting more bread & butter trading businesses where it is the trend or the compass bearing on which the business is headed with which directors must wrestle – and not single, identifiable, mission critical transactions.

The other question is what to make of the UK Supreme Court’s treatment of Permakraft.  A common view is that the comments (in technical terms – strictly obiter and a statement of opinion that was not essential to the judgment and therefore not binding as a precedent) by Cooke J. in 1985 left open the possibility that directors’ duties might be owed directly to creditors and not (in a dogleg) via the company.  In the intervening four decades those views have not received much support and are regarded as likely to be confined to special circumstances where the directors actively/deliberately assumed some responsibility towards specific creditors.

The majority decision in Sequana rejected the idea that Permakraft had led to New Zealand courts requiring the directors of companies teetering on the brink to consider the interests of creditors.  Instead, this was rationalised as part of the sliding scale approach – that the directors of a company on the brink should recognise that creditors have an economic stake in a formal insolvency process.  Obviously, the narrowing of the impact of Permakraft evidenced by references to the need for directors to conduct a balancing act narrows the scope of any duty to consider the interests of creditors.

Where does this leave directors?

Helpfully, the majority judgment in Sequana suggests that any duty to consider the interests of creditors only arises when a director knows or ought to know that the company is insolvent or bordering on insolvency, or that formal insolvency procedures are probable.  Contrast this with the situation in Debut Homes where the director knew and had been advised the company was incapable of being brought back from the brink. 

This might help limit the impact of Debut Homes – and not risk concerns about Debut Homes opening the floodgates for claims against directors based on arguments about the point at which a company was “unsalvageable”.  I also repeat my concern about the Courts needing to differentiate between a lumpy transaction that tipped the business over the brink vs the situation faced by a routine trading business with lots of small, regular, transactions.

Comments

The UK Supreme Court’s decision in Sequana reinforces and refines a trend that has been evident in New Zealand for some time – that directors of a company teetering on the brink have a duty (owed to the company) to consider the interests of creditors (generally).  This is consistent with the Law Commission’s formulation a director’s obligation under section 135 of the Companies Act (and the Law Commission’s specific rejection of the idea that the directors of a company teetering on the brink owed a specific duty to creditors that was directly enforceable by them). 

And whilst the focus of Mainzeal is on sections 135 and 136 of the Companies Act, it will be very interesting to see whether the New Zealand Supreme Court decision (which is said to be imminent) impacts further on the extent of directors’ duties – perhaps by echoing some of the comments of the majority in Sequana.  The approach that the directors of a company teetering on the brink need to have regard to the interests of creditors, as well as those of shareholders, when making critical decisions appears solidly based on the economic rationale that at that stage the creditors also have skin in the game.

Nonetheless, a number of questions remain unanswered, including:

• Absent a bright line test, it is not always easy to identify when the “creditor duty” is engaged.  There have been different formulations – such as “real risk of insolvency” or “imminent insolvency” (when the directors know or ought to know insolvency is just around the corner and going to happen) or the probability of a formal insolvency process or “bordering on insolvency”.

This leaves directors in a difficult position of (say) identifying a tipping point – when the risk of insolvency transitions from 49/51 – to that of being unsalvageable.

As noted, a number of times above, this may be much easier to identify for single/lumpy transactions.  Ultimately, it seems, the question needs to be considered on a case-by-case in light of the particular factual matrix affecting each specific company.

• There are some quirks in the majority decision.  And those affecting AWA itself (primarily a passive investment vehicle) which also call into question whether the trigger point must be viewed differently when dealing with an active trading business.

As a result, it is possible that the comprehensive review of the effectiveness of Australia’s corporate insolvency laws holds the key to sensible clarification in New Zealand.  The objective of the Australian review is that of protecting and maximising value for the benefit of all interested parties and the economy – in the face of a hybrid of 19th century companies’ legislation as well as a hotch-potch of more recent additions and amendments.

A recent UK High Court case has placed the spotlight, once again, on the reasonable reliance defence of directors.

In an April 2022 decision, Hunt v Balfour-Lynn, the UK High Court dismissed a liquidator’s claim that the directors had breached their duties to the company by entering into a tax avoidance scheme.  (In the alternative, the liquidator argued that entry into the scheme had defrauded creditors, by transferring assets at an undervalue, in breach of the UK insolvency regime).

Over an extended period, Marylebone Warwick Balfour Management Ltd (the Company) incurred tax losses under a tax avoidance scheme that meant that the Company avoided paying over £27m in PAYE and National Insurance contributions.  It had distributed dividends – and was unable to fund the shortfall ultimately held to be payable to the UK Revenue.

The directors denied any breach of duty.  Central to their defence was that before entering into the tax avoidance scheme, and at all times during involvement in the scheme, the directors had relied on the financial and professional advice received from expert tax advisers at a well-known accounting firm.

The liquidator, in strongly-worded terms, claimed that the directors’ reliance was not reasonable and was

“…in fact, reckless and irrational and reckless given the financial and reputational consequences for the Company in circumstances where [the UK Revenue] had made it clear that it did not consider that the scheme was legitimate and had commenced proceedings to challenge it”.

The liquidator’s claims failed.  The Court held that the expert tax advisers were engaged on an ongoing basis to provide advice.  The directors had relied on this advice, and they were entitled to do so.  And while it was the directors who were making decisions on the part of the Company, and not the tax advisers, in the making of those decisions there was:

“nothing on this evidence which ought to have led them to be second-guessing the advice of [advisers], experts in this field.” 

Interestingly, the judge went on to note that the directors considered the tax advisers particular and cumulative and consistent advice and took it at face value.  They were entitled to do so.  In proper discharge of their duties, they had the wisdom to take this top-level advice throughout, and to use the tax advisers to oversee the scheme.  The fact that the Court of Appeal later found that the equivalent to the scheme [did not work] to protect again the UK Revenue for PAYE and National Insurance claims did not affect that reasonable reliance (defence).

Directors and reasonable reliance

Some aspects of the decision in Hunt v Balfour-Lynn are unsurprising.  Directors have been able to relay on professional advice when discharging their duties.  Despite the fact that the UK Revenue had repeatedly advised the directors of their potential liability, the Court held that there was nothing wrong with the director’s adopting a “sit and wait” policy on the basis of professional advice from the expert tax advisers.  But I wonder if a New Zealand Court would reach the same conclusion.

The reasonable reliance defence is embodied in section138 of the Companies Act – but it is subject to the qualifications that the director acts in good faith, makes proper inquiry, and does not believe that reliance on such advice is unwarranted. 

Part of the difficult legacy of Debut Homes, appears to be that the High Court doubted whether section 138 actually provided a defence – as reliance on such advice appeared to be contrary to a finding of a breach of duty.  But then the judge said (if the defence is to hold up) the professional advice must be of a type contemplated by the wording of section 138, and cannot be reliance on “generalised and loose statements”.  The Court of Appeal agreed.  And the Supreme Court agreed with both lower courts, and found that (as a matter of fact) the accountant’s views were generalised and not the type of advice contemplated by section 138.

As a result, some care should be taken to ensure that (to make out the reasonable reliance defence) all of the limbs of section 138 are shown to exist.  But I still wonder how a New Zealand court might react when a Board relying on expert advice, but faced with an uncertain or contingent liability, did not make some provision for it.  Absent an Australia-style ‘business judgement rule’ embedded in the Companies Act, would a New Zealand court find that this was a matter for commercial judgment, which was exercised by the Board, informed by expert advice (which met the section 138 test) which the directors had consistently sought and obtained?

Comments

On some levels, the decision in Hunt v Balfour-Lynn is positive reinforcement for the reasonable reliance defence.  There are points of difference in New Zealand and directors should take care to make sure that the limbs of section 138 are ticked off. 

But, until we see whether the courts are going to pursue (or distinguish) the type of critical scrutiny of the advice relied on that was seen in Debut Homes, and perhaps until Goddard J’s calls (in the Court of Appeal decision in Mainzeal) for a review of the law governing insolvent trading get some traction, close attention will need to be paid to the limits on a reasonable reliance defence.

At the end of last week, the High Court upheld a direction order by the Financial Markets Authority (FMA) to property developer and syndicator Du Val to remove advertisements published on social media on the basis that they were likely to mislead or deceive investors, and contravene the ‘fair dealing’ provisions in the FMC Act.

The FMA said the advertisements (for offers relying on the wholesale investor exclusion in the FMC Act) created the impression investing in financial products connected to property development was low risk when, in fact, property development, including associated finance, is inherently risky.

FMA direction to remove advertisements

The background to the action brought by Du Val was an October 2021 direction by the FMA to remove advertising materials that the FMA believed were likely to mislead or deceive investors, and thereby breach the ‘fair dealing’ provisions in Part 2 of the FMC Act.  The FMA said that Du Val’s advertising of its Mortgage Fund Limited Partnership (Mortgage Fund):

• represented that the Mortgage Fund had “the best of both worlds”, with high security and high return and comparing it favourably to bank term deposits but without a balanced view of the risks; and
• claimed there were “no fees” associated with the Mortgage Fund, despite Du Val retaining any profit on projects above the return to investors.

Target audience – wholesale investors

Du Val’s target audience for the Mortgage Fund were ‘wholesale investors’.  That is, Du Val was seeking to offer investment in the Mortgage Fund relying on the wholesale investor exclusion from the disclosure regime in the FMC Act.

Du Val’s adverting appeared at various times on Du Val’s website and social media channels.  The FMA initially raised concerns with Du Val, which took some steps to amend or remove the advertising material.  However, the FMA considered its concerns were only partially addressed and continued to see the advertisements as likely to be misleading.  As a result, it issued a direction order.  In doing so, the FMA also stated that it considered the direction order was appropriate because (among other things) the marketing channels used by Du Val did not target experienced investors but appear to target inexperienced investors by using social media and other online channels.

This was in keeping with signals by the FMA, since early 2021, that it was monitoring use of the wholesale investor exclusion.  This was, because of the low returns on fixed term deposits and other low-risk investments, less-experienced investors were increasingly interested in different types of offers – and the FMA was concerned that some (possibly vulnerable) investors were being drawn to high-risk products claiming to better term deposit returns with similar low risk.

Appeal against direction order

For technical reasons, the action brought by Du Val was in the form of an appeal against the FMA’s direction order – which must be confined to questions of law.  The questions of law were:

• First, what is the correct legal test to determine whether material is likely to mislead and deceive?  In the case of a fund that is only open to wholesale or eligible investors, should it be whether an average wholesale or eligible investor is likely to be misled or deceived and is that a higher standard than an ordinary reasonable person?
• Secondly, had the FMA applied the appropriate legal test in determining that Du Val’s promotional material has, or is likely to, mislead and deceive?
• Thirdly, is retained profit properly characterised as a ‘fee’?

First issue – likely to mislead and deceive?

This was the first appeal (aka a test case) against a direction order by the FMA under the FMC Act.   

After an explanation of the basis for applying the test, the High Court judge found that the correct approach when determining whether Du Val’s advertising material is likely to mislead or deceive requires (as a first step) an identification of the target audience for the representations.  That is, whether it is the public at large or a particular class (subset) who is targeted and, in either case, excluding outliers.

The concern for the FMA (and the problem for Du Val) was the use of social media – which might not be the usual home/channel for reaching a non-retail audience.

Second issue – appropriate test

The fact that, ultimately, only wholesale investors could participate in the Mortgage Fund – did not prevent the Court accepting the FMA’s submissions that the ‘fair dealing’ provisions are intended to protect all investors.

This seemed to colour the Court’s thinking about identifying the standard of care that can be expected from the target audience.  Specifically, the Court did not consider the FMA erred in law by declining to accept that wholesale investors are inherently more sophisticated than non-wholesale investors and are considered to be capable of evaluating the merits of an offer or accessing necessary information.

Consequently, the inclusion of unsophisticated wholesale investors in the catchment for the advertising supported the FMA’s view that the advertising could be misleading and deceptive (and led to the Court finding that there was no error in law in the direction order).

Third issue – is retained profit a fee?

The Mortgage Fund promised investors a fixed return of 10% p.a. with Du Val, as the General Partner, retaining any profits over and above the 10% return.  This meant that it also wore any shortfall.

In the direction order the FMA found that Du Val’s “no fee” representations to be misleading and described the General Partner’s right to all profits (above the 10% return) made by the Mortgage Fund as effectively a performance-based fee.

By contrast, Du Val argued the “no fees” statement would not mislead the reasonable wholesale investor.

The Court noted that the FMA’s direction order provided for two alternative prescriptions:  either (i) omit the “no fees” representations; or (ii) include proximately to those representations a statement that “We retain any profit in excess of the 10% p.a. return to investors” or similar words.  That indicated the concern about the lack of clarity about the Du Val’s remuneration.  

The Court also noted that earlier correspondence made it evident that the FMA did not accept an analogy with bank term deposits, where no such statement is required.

From this, the Court concluded that while the FMA’s reference to a “fee” might have been inapt, this was not one of those rare cases in which there was no evidence to support the FMA’s determination or in which the only reasonable conclusion contradicts the determination.  As a result, because of the nature of the appeal (being confined to questions of law), it was not for the Court to impose its own view as to whether the representations are likely to mislead or deceive in the particular circumstances of the representations, their target audience and the investment product structure.

Comments

There are aspects of this decision that I find difficult to follow.  Particularly the Court’s apparent willingness to accept that, despite meeting the statutory criteria to be considered as wholesale investors – some investors within that group may still not be able to look after themselves. 

But, much as I dislike having a bob each way, I have some sympathy for the FMA’s approach – because direction orders are at the lower end of the FMA’s enforcement toolkit and are designed to be used in circumstances where the FMA needs to act quickly.  And, in this case, it did provide Du Val with the chance to modify its advertisements.

And, although the Court did not refer to it, the judgment aligns with the FMA’s October 2021 guidance note on the advertising of financial products where that guidance indicates that, if an offer is only available to wholesale investors, the advertising should make it “immediately and prominently clear that it is not suitable for retail investors”.

Here, both the medium used (social media) and the references to bank deposits acted like red flags.  As a result, the FMA was clearly concerned about audience spillover and an unfair use of benchmarking.

The FMA has previously signalled concerns about offers on the fringe of the wholesale market.  Amongst the takeaways from this test case, is a clear steer towards taking greater care about targeting a channel that is appropriate to the audience for the investment. 

Unfortunately, as a test case, the technical constraints of being confined to issues of law only mean that what I think was a muddily handling of the distinctions between a wholesale and retain audience may not be explored more fully.

In recent weeks the FMA’s concern about wholesale investment vehicles have crystallised into the issue of an ‘interim stop order regarding an offer in relation to a fund (imaginatively named ‘The One in Longhorn Partnership Fund’) that was established apparently as the conduit funding vehicle for a property development in South Auckland.

In keeping with a number of similar funding vehicles, the promoter of the offer was seeking capital for the development via a dogleg route – rather than directly into the development itself.  That is, investors were being offered interests in a limited partnership in return for a “guaranteed” pre-tax return.

The offer was structured to take advantage of one of the hard-wired exceptions to the FMC Act disclosure regime – by being restricted to ‘wholesale’ investors.  As well as limiting the level of disclosure, a wholesale offer avoids the need for licensing and supervision (as a managed investment scheme) – and content requirements for its governing documents.

The FMA’s reasons for issuing the interim stop order as being desirable in the public interest noted that:

“The FMA considers that making this Order is desirable in the public interest as significant financial harm to investors could result from investing in units of the Fund in reliance on restricted communications that may be false or misleading, or likely to mislead or confuse in respect of the returns payable to investors and the level of risks in the investment, being material particulars. “

There are a series of technical and macroeconomic reasons why the market is experiencing an uptick in such ‘wholesale’ offers.  In addition to the usual suspects of seeking to reduce the compliance burden and cost associated with raising development capital, the low interest rate environment, coupled with constraints (real or otherwise) on access to bank funding for some property development and working capital expansion has made the (relatively) unregulated sector an attractive destination for a growing spread of businesses both old and new. 

Nonetheless, it is important to be reminded access to a wholesale market is not a free lunch and even the hard-wired exclusions from the FMC Act disclosure regime come with some compliance obligations, particularly at the front end in terms of:

• health warnings for would-be investors;
• conduct requirements – under the general heading of ‘fair dealing’ – particularly those aimed at preventing or penalising misleading or deceptive conduct.

I doubt that Longhorn will be the last example of the FMA stepping in.  And the next steps taken by the FMA will be worth watching.  But the reported nature of Longhorn’s advertising would suggest that its promoters did a lot to make sure that they came to the attention of the authorities. 

The FMA has a new CEO, Samantha Barras, whose first public outing has signalled new priorities for the FMA.  To date, she said that the FMA will be focused on issues of investor vulnerability and outcomes – and the conduct of participants in the financial sector.  This, she has said, quite clearly includes the wholesale market (which she described as being on the edge of the FMA’s regulatory remit).  Clearly, the FMA wants to understand who is investing in the wholesale market and the level of risk for investors.  This includes seeking to understand to people who are, actually, retail investors are accessing wholesale markets (and thereby exposing themselves to risk).

As always, there is no substitute for good advice in the capital markets matters.  Just because the development next door was able to tap into a wholesale audience does not necessarily mean that an entire slew of development can be funded in the same manner.  With issues such as the Reserve Bank’s recently disclosed warnings about debt serviceability risks, the prospect that decisions and advice are revisited after a failure, rather than being intercepted ahead of investment by the FMA issuing a stop order, mean that anyone seeking to raise capital in the wholesale market should take then time and effort to ensure that they do qualify.  And any temptation to indulge in bait advertising that might attract would-be investors who are not able to make properly informed investment decisions without a much higher level of mandated disclosure and protection mechanisms should be strenuously resisted.

For more information about offers to a wholesale audience – please contact me.

In August 2020, Parliament enacted the Forests (Log Traders and Forestry Advisers) Amendment Act.  The Amendment Act (which was grandfathered under the Forests Act 1949 – presumably to speed its implementation pathway) provides a new regime for log traders and forestry advisers to be registered and subject to certain professional standards.

That new regime is to operate from 6 August 2022. From that date – there is a one-year transition period for log traders and forestry advisers to get registered before penalties will apply.

Public consultation on the proposed registration system closed in January and MPI is currently working on (and seeking feedback about) the new registration system.

The new regime introduces a professional compliance (aka occupational licensing) regime on a previously unregulated part of the forestry sector. 

The regime came about as a sort of kneejerk reaction from public discussion about the high proportion of raw logs which were being directly exported – and the concern that this was leaving a lower proportion of logs available for processing in New Zealand sawmills and/or impacting on the domestic lumber price.

This background is reflected in the stated purpose of the Amendment Act:

• support the continuous, predictable, and long-term supply of timber, and equity of access to timber, for domestic processing and export; and
• support a more transparent and open market for log sales through the provision of professional advice; and
• improve the confidence and informed participation of businesses and investors in the forestry and wood-processing sector; and
• contribute to improved economic, employment, and environmental outcomes from the forestry and wood-processing sector, nationally and for local communities; and
• contribute to improved climate change outcomes from the forestry and wood-processing sector; and
• contribute to the development, and improve the long-term sustainability, of the forestry and wood-processing sector.

The Amendment Act seeks to achieve this purpose by introducing an occupational licensing and compliance regime for log traders and advisors operating in the forestry sector.  This seems to be despite the fact that the captured activities operate in a commercial or business context – and not at a consumer or retail level.  Amongst other things this seems rather puzzling – and arises the concern that, perhaps rather like the RMA, it will be used as a sword and not a shield by those (in trade) seeking some sort of commercial advantage over their rivals.

Captured activities – log traders

The Amendment Act seeks to capture the activities of ‘log traders’, being a person in trade who:

• buys New Zealand logs, whether after harvest or in the form of trees to be harvested at an agreed time, and whether or not the person intends to on-sell the logs; or
• exports New Zealand logs; or
• processes New Zealand logs that the person has grown themselves,

and includes a person who does any of these things as the agent for another person:

(Also captured is a company that, in trade, transfers the ownership of New Zealand logs to or from a related company, whether the transfer relates to logs after harvest or in the form of trees to be harvested at an agreed time).

There is a prescribed volume threshold of 2,000m3 of New Zealand logs per year.  

Businesses involved in shipping and logistics are not caught by the Amendment Act.

Forestry adviser service

The Amendment Act also captures ‘forestry advisor services’.

This is defined as someone who, in the ordinary course of business, provides advice on:

• the establishment, management, or protection of a forest;
• the management or protection of land used, or intended to be used, for any purpose in connection with a forest or proposed forest;
• the appraisal, harvest, sale, or utilisation of timber or other forest produce;
• the appraisal of a forest, forest land, or other forestry sector assets;
• the application of the emissions trading scheme to forestry activities (within the meaning of the Climate Change Response Act 2002); or
• the beneficial effects of forests (including, for example, how they contribute to environmental and economic outcomes).

(Also captured are those acting on behalf of others in relation to their sale or purchase of timber or other forest produce).

However, the Amendment Act does not cover the provision of advice, in a professional capacity, by those professional advisers who are already regulated by another professional body (e.g. real estate agents, financial advisors, lawyers and accountants).

Compliance and reporting standards

Those who are required to register as:

• a log trader; or
• a forestry advisor,

will need to satisfy the Forestry Authority (under the umbrella of MPI) that they meet the ‘fit and proper person’ standard.

They may also have to provide evidence of their qualifications and experience in the forestry and wood processing sector – (the details of this requirement is s till being developed by MPI).

Once registered, log traders and forestry advisors will be subject to ongoing compliance, reporting and record keeping obligations.

A disputes (complaints) body is also established under the Amendment Act to hear and administer complaints.

Standard setting

The Forestry Authority has the power to set standards for any matter relating to forestry operations and delivery of forestry advisor services including:

• land preparation, planting, forest management, harvest planning and site preparation and valuation;
• biosecurity, sustainable land use, biodiversity and emissions trading;
• sale and purchase agreements for domestic transactions or exports; and
• other sale and purchase requirements.

However, the rule-making power must not impose any condition or requirement which would be a matter for commercial agreement between parties.

Code of ethics

The Forestry Authority may make rules that set a code of ethics for registered forestry advisers.

The code of ethics may include matters relating to:

• professional responsibility (maintaining the highest standards of integrity and technical accuracy); and
• responsibility to clients (including issues of confidence and conflicts of interest); and
• professional work standards by registered forestry advisers in employment; and
• maintaining professional competency.

Penalties

Penalties for non-compliance with the occupational licensing and compliance regimes established under the Amendment Act provided for fines of up to $40,000 for individuals and up to $100,000 for companies.

Timeline

Te Uru Rākau – New Zealand Forest Service (part of MPI) is working on a registration system which is due to come into force on 6 August 2022. Under the Amendment Act, log traders and forestry advisers must register to operate from this date.

That is, from 6 August 2022, there is a one-year transition period for log traders and forestry advisers to get registered before penalties will apply. 

If you would like further information about the new regime, please contact me

The replacement of the Incorporated Societies Act 1908 took a major step this week with the Incorporated Societies Act 2022 receiving the royal assent and coming into force on 6 April 2022. 

As a result, in process that mirrors that for the replacement of the Companies Act in the 1990s, all existing incorporated societies will have a period of roughly 3 and a half years in which to transition (by means of re-registration) and the filing of a new constitution that complies with the 2022 Act.

The 2022 Act is designed to bring the legislative framework applying to incorporated societies into the 21^st century and, particularly, assist with governance matters. 

Headline changes

The headline changes made by the 2022 Act to the governance of incorporated societies include a ‘codification’ of the duties of officers – much like that for company directors.

Specifically, officers of an incorporated society must:

• act in good faith and in what the officer believes to be in the best interests of the society;
• exercise their powers for proper purposes;
• exercise the care and diligence that a reasonable person with the same responsibilities would in the same circumstances;
• not agree to (or cause or allow) the activities of the society to be carried on in a manner that is likely to create a substantial risk of serious loss to creditors;
• not agree to the society incurring an obligation unless they believe on reasonable grounds that the society will be able to perform the obligation when required to do so; and
• not act, or agree to the society acting, in a manner that contravenes the 2022 Act or the society’s constitution.

The alignment of officers’ duties with those of a company director is not without its problems.  A number of submitters during the legislative process have made the point that alignment with the “broken” provisions of sections 135 and 136 of the Companies Act 1993 only serves to highlight the need for sensible law reform in this area. 

The changes to governance also include:

• clarity about disqualifying factors applying to officers;
• measures designed to improve the accountability of officers – by providing a mechanism for members to obtain information from officers; and
• offence provisions, such as those applying officers dishonestly using their position, (knowingly) providing false or misleading statements, fraudulently use of society property and falsifying records and documents.

Other noteworthy changes include:

• requiring 10 members in order to incorporate (previously 15);
• requiring a minimum membership of 10 to be maintained (there is no minimum ongoing requirement under the 1908 Act) – and note that a body corporate will be treated as the equivalent of 3 members;
• a society must have a committee consisting of at least 3 members;
• a Membership Register must be kept (with certain data being prescribed);
• annual accounts must contain specified information – but only ‘large’ incorporated societies ($60m in assets or $30m in annual revenue) will be required to have their financial statements audited;
• lodgement of an annual return;
• requiring all societies to have a disputes resolution procedure in their constitution; and
• providing an amalgamation regime – a short form version of the regime under the Companies Act.

Next steps

As noted above, all existing incorporated societies will be required to re-register during a transition period that ends on 1 December 2025 (at the latest). 

The transition period will provide time and breathing space for incorporated societies to review their existing constitutions and update them for the requirements of the 2022 Act. 

The transition period will also provide an opportunity to assess the impact of the new governance framework on the society and its officers.