November 2008

Contents:

 

CASES Unclaimed money: banks lose first round with Inland Revenue The appointment of interim liquidators Confusion of company accounts and a statutory demand Requirements for the court to terminate a liquidation Setting aside of transfer of property, which is security for a term loan, to a family trust Purchase agreements LEGISLATION Retail deposit guarantee scheme Collective investment schemes Wholesale guarantee

SNIPPETS Shareholders as creditors: a response to the CAMAC discussion paper on law reform Perspectives on the position of shareholders and creditors Risk allocation and efficient administration: system design and adherence to first principles in treatment of securities claims in insolvency proceedings The Cross-Border Insolvency Act 2008 (CTH) - issues and implications Misunderstanding margin loans Expert evidence in banking law When is a bond not a bond? Are we there yet? The journey of the insider trading provisions US lending terms Creditor lottery: UK special resolution regime UBS v Nordbank

Westpac Banking Corporation v CIR (HC Wellington, CIV 2006-485-2448, 3 November 2008, MacKenzie J)

In a judgment delivered on 3 November 2008 Justice Alan MacKenzie ruled against Westpac, BNZ and ANZ, granting the Commissioner of Inland Revenue an order for summary judgment in a case concerning what happens to bank cheques and foreign currency drafts not presented for payment.

The case turned on whether unclaimed bank cheques and foreign currency drafts fell within section 4(1)(e) of the Unclaimed Money Act 1971 and therefore should be paid to the Commissioner.

Justice MacKenzie held that an earlier Privy Council decision Thomas Cook (New Zealand) Limited [2005] 2 NZLR 722 applied,  which meant that the bank cheques and foreign currency drafts did fall within the section.  However, he recognised the likelihood of his judgment being appealed and accordingly went on to consider the arguments presented to him as if the Thomas Cook case was not applicable.  In doing so he arrived at the same conclusion as the Privy Council in Thomas Cook: that the bank cheques and foreign currency drafts had become "payable" within the meaning of section 4(1)(e), and accordingly that the Commissioner should be entitled to payment of them.

Horton v Advantage Power Systems Ltd (HC Auckland, CIV 2008-404-001001, 14 April 2008, Abbott J)

This case concerned an ex parte application to have interim liquidators appointed and contains a useful summary of the law in that area.  A director of the Defendant was also a director of the Second Plaintiff, the Second Plaintiff having earlier been placed in receivership and liquidation.  The First Plaintiffs were the liquidators of the Second Plaintiff.

An application to put the Defendant into liquidation had been made prior to the current proceedings.  Pending the hearing, the Plaintiffs wished to put an interim liquidator in place, due in part to fears that the assets of the Defendant would become difficult to recover later.  Abbott J agreed and granted the order.  It was held that the object of an interim liquidation order is to maintain assets owned or managed by a company until a liquidation proceeding is resolved.  Where "it is necessary or expedient for the purpose of maintaining the value of assets owned or managed by the company…" (section 246 of the Companies Act 1993) the Court may appoint an interim liquidator at its discretion, provided three pre-requisites are met (although these are acknowledged to be a "litmus test" and not exhaustive. 

Firstly, an application for liquidation must be pending.

Secondly, there must be a likelihood that the application for liquidation will succeed.  Abbott J was of the opinion that the application had a strong likelihood of success.  The Defendant had acknowledged in a deed of settlement that it owed the Second Plaintiff $150,000 from a voidable transaction, and no application had been made to set aside the statutory demand calling for payment of that acknowledged debt.  Further, the Defendant had taken no steps in relation to the proceeding.

Thirdly, there must be a need for interim control of the company's assets.  Abbott J was also satisfied that this was true, due to the surrounding facts.  The First Plaintiffs, as liquidators, had found difficulty in establishing the existence of debts owed to the Second Plaintiff by another company of which Mr Kevin Whitely, the common director of the Defendant and Second Plaintiff, was also a director.  There was also evidence to show that office furniture of the Defendant had been removed and taken to the premises of another company directed by Mr Whitely, and the "unease" created by the Defendant's sudden closure (apparently unannounced to both staff and landlord) assisting Abbott J in his finding that interim control was necessary.

The Court then addressed the appropriateness of an ex parte order.  As there would be little or no risk to the Defendant (as it had ceased trading), other creditors were unlikely to be harmed by the appointment, and there was an obvious need to maintain assets (regardless of the reasons behind the removal of the office furniture), Abbott J found that an ex parte order was warranted.

Finally, the powers to be granted to the interim liquidators were considered.  Following Ming Shen v An Ying International Financial Ltd (HC Auckland, CIV 2006-404-003088, 28 July 2006, Heath J), the interim liquidators were granted powers to get in and preserve assets, meet expenses necessary to preserve the value of those assets, and to trade the business to the extent necessary to preserve assets.  Further requested powers to sell assets (to ensure the best return on assets whose value might be declining) and commence recovery from debtors with accounts receivable owing were also considered sensible and granted.

Alexiam Developments Limited v Fegan Building Supplies Limited trading as Placemakers (HC Auckland, CIV 2007-404-005988, 6 March 2008, Abbott J)

Alexiam Developments Limited ("Alexiam Developments") applied to set aside a statutory demand issued by Fegan Building Supplies Limited ("Fegan") in respect of an alleged debt owed for the price of building supplies.  This application was made under section 290(4)(c) of the Companies Act 1993, seeking to set aside the statutory demand on "other grounds". 

Fegan sold building supplies to two Alexiam companies: Alexiam Developments and Alexiam Construction Limited ("Alexiam Construction").  Mr Woodhams ("Mr W"), a director of both Alexiam companies, guaranteed the debts owed by Alexiam Construction to Fegan.  In the matter before the court, Fegan was pursuing a claim for a debt owed by Alexiam Developments.  Fegan was also pursuing a concurrent claim against Mr W under the guarantee given in respect of Alexiam Construction's account. 

Alexiam Developments sought to set aside the statutory demand on "other grounds", namely that Fegan was pursuing the same claim at the same time against Mr W, on the basis that Alexiam Construction owed the debt.

During the trial Fegan accepted that the primary debt was that owed by Alexiam Developments but argued it could separately pursue Mr W under the guarantee because Alexiam Developments had placed orders through Alexiam Constructions account.

This acknowledgement by Fegan appeared to remove the apparent conundrum arising out of the debt being possibly owed by both parties. 

While the judge found this argument "unusual", there was now no dispute that the debt was owed by Alexiam Developments and no "other reasons" for setting aside the statutory demand.  The application by Alexiam Developments was dismissed.  The time for Alexiam Developments to pay the statutory demand was extended for a period of six further weeks due to the circumstances arising from the case.  The issue of whether Mr W's guarantee applied was not a matter before the court nor had evidence been advanced to decide that point.

Hardie v Agnew (HC Auckland, CIV 2007-404-001224, 6 March 2008, Abbott J)

This case considered whether the requirements of s250 of the Companies Act 1993 (the "Act") had been satisfied, in respect of an application for a termination of liquidation.

Under s250 of the Act the Court can terminate a liquidation if:

1. all creditors have been paid in full, or satisfactory provision is made for them to be paid, or they have consented to termination;
2. the liquidator's costs have been paid or secured; and
3. the shareholders have consented to the termination.

In this case Mr H (the sole director of Finis Limited) applied for termination of liquidation in the belief he had satisfied the above requirements.

Mr H had provided the liquidators with a bank cheque for $100,000 which he claimed satisfied the monies owed under (a) and (b) above.  This amount was insufficient to pay the costs claimed by the liquidators.

The Court was not prepared to terminate the liquidation.  Mr H could not provide clear evidence of the source of the $100,000.  For satisfaction of the monies owed under (a) and (b) above the payment had to be from Finis Limited's own funds.  If the funds were provided by a third party the terms of such provision would need to be determined.  Mr H could not provide evidence of either of these requirements and the application failed.

In addition, Mr H challenged the liquidator's cost claims.  The Court held that fees charged since the application for termination of liquidation were legitimate as they were the consequence of Mr H's delays.  However the Court did hold that the liquidators shall produce time records before the Court conclusively settled the reasonableness of the fees.

Regal Castings Ltd v Lightbody [2008] NZSC 87
This case involved an application by Regal Castings Limited ("Regal") for the setting aside of a transfer of a house, which Regal had a security interest over, to a family trust.

Mr Lightbody owned a jewellery business called Capro Three Limited ("Capro").  Regal was Capro's major supplier.  In the course of business Capro had become heavily indebted to Regal.  In 1995 Regal agreed to convert Capro's indebtedness to a term loan and conditionally wrote off the interest then accrued.  The term loan was to be paid off by monthly instalments with the balance to be paid at the end of 5 years.  Mr Lightbody accepted personal liability for the term loan.  Regal continued to supply Capro.

In 1998 Capro fell into arrears on its current account with Regal.  At this point, without the knowledge of Regal, Mr & Mrs Lightbody transferred their house, their only substantial asset, to a family trust.  Transfer was in exchange for an unsecured acknowledgement of indebtedness, equal to the amount of purchase price, payable 7 years later.  Over the next 4 years Mr and Mrs Lightbody gradually forgave the debt.

The company was then put into liquidation.  A substantial sum was still owing to Regal, including part of the term loan.  Mr Lightbody was made bankrupt.

Application was made to the Supreme Court to have the transfer set aside under section 60 of the Property Law Act 1952. 
Section 60 of the Property Law Act 1952 provided that every alienation of property with intent to defraud creditors shall be voidable.

The Supreme Court held that the wording "intent to defraud" in section 60(1) had been regarded as shorthand for intent to hinder, delay or defeat a creditor.  This is how the concept is now expressed in section 345(1)(a) of the Property Law Act 2007.  Therefore the Court held that the real reason for the transfer of the house was to protect it against a claim by Regal; to hinder or defeat a right of recourse to the house.  As such the Supreme Court held that the transfer was made with fraudulent intent under section 60 and the transfer of Mr Lightbody's half interest in the house should be set aside.

As Regal's claim to the half-share of the house was 'in personam' (personal) there was no conflict with the Torrens System (land passes with title).

Jenkins v New Zealand Bloodstock Leasing Limited [2008] NZCA 413

This case concerned an unsuccessful appeal by the Jenkins against the High Court judgment (New Zealand Bloodstock Leasing Limited v Jenkins 19/4/07, Winkelmann J, HC Auckland CIV-2004-404-5795) that a series of contractual agreements, among them a lease to purchase agreement ("LPA") were not governed by the Hire Purchase Act 1971 ("HP Act") during the claim period. 

The Jenkins were shareholders and directors of an equine bloodstock company, Glenmorgan Farms Limited ("GFL"), which acquired elite stock for breeding racehorses.  GFL granted a debenture to S H Lock (New Zealand) Limited ("Lock") to secure a trade facility.  GFL subsequently "leased to purchase" a stallion, 'Generous', from New Zealand Bloodstock Leasing Limited ("NZBLL") for an initial three-year period under LPA1.

LPA1 specified that the title to 'Generous' remained with NZBLL until all payments were made.  The Jenkins guaranteed payments under LPA1.  Lock registered a financing statement in respect of the security interest created by its debenture.  NZBLL took no steps to register its security interest in 'Generous'.

By 2002, GFL was in arrears under LPA1 and the debt was restructured under a second agreement, LPA2.  NZBLL assigned to New Zealand Bloodstock Finance Limited ("NZBFL") all its rights and obligations relating to the leasing of 'Generous'.  The Jenkins remained guarantors under LPA2. 

GFL fell in arrears under LPA2 and entered into a refinancing agreement ("RA") with NZBFL.  The RA provided that NZBFL would assist GFL to meet its obligations under LPA2 by advancing funds sufficient for it to make payments under LPA2.  Loans were documented in a contract for current advances ("CCA").  The CCA provided that, in exchange for the advances, NZBFL was to be granted a security interest in GFL's present and future rights in its livestock (which included 'Generous').  The Jenkins guaranteed the CCA also.

GFL subsequently met its obligations under LPA2 but fell into arrears in respect of its obligations under the CCA and RA. 

On appeal, the Jenkins contended that the LPA was an operative hire purchase agreement and that the two subsequent refinancing documents were so connected to LPA2 that the documents should be considered collectively to constitute a single hire purchase agreement.  The significance of this was that under the HP Act the guarantors' liability would have been limited to that of the purchaser and, it was argued, NZBFL not have had title at the time the property was to pass to Glenmorgan, as it had not registered its security interest, and therefore the guarantors had no liability.

The Court of Appeal, in dismissing the appeal, held that Winkelmann J was correct in finding no hire purchase character in the contractual arrangement between the parties at the relevant time.  The RA and CCA were stand-alone financing arrangements.  LPA2 was extinguished and the RA and CCA were not contingent upon it.  These were distinct agreements with their own terms.  The parties were serious commercial operators, not a vulnerable individual acquiring household consumer goods prone to misapprehension all of whom were independently advised.  The circular nature of the lending was not contrived to avoid the protections under the HP Act.

On 12 October 2008, it was announced that the Crown will offer an opt-in retail deposit guarantee scheme to eligible entities, namely registered banks, building societies/credit unions, and other non-bank deposit takers such as finance companies.  Under the scheme, the Crown will guarantee the payment by a participating deposit taker of:

1. any obligation of the deposit taker to pay money to a creditor (whether present or future) under debt securities issued or to be issued by the deposit taker ("Indebtedness") that becomes due and payable during the period beginning 12 October 2008 and expiring 12 October 2010 ("Guarantee Period"); and
2. if a specific Default Event (eg the deposit taker becomes insolvent or becomes subject to the appointment of a voluntary administrator, liquidator, receiver or similar person) occurs during the Guarantee Period, all Indebtedness that exists on the date of that Default Event (whether or not due and payable during the Guarantee Period) and all interest accruing thereon in accordance with the terms of the Indebtedness.

In addition, the Crown undertakes to each creditor of a participating deposit taker that, if the deposit taker does not pay to any creditor any Indebtedness or interest guaranteed when due and payable, the Crown will pay.   

The definition of "creditor" will differ depending on the type of deposit taker.  For example, the retail scheme will not cover creditors of non-bank deposit takers or building societies/credit unions who are neither New Zealand citizens (as defined in the Citizen Act 1977) nor New Zealand residents (as defined in the Income Tax Act 2007).  However, creditors of registered banks incorporated in New Zealand (and creditors of New Zealand branches of registered banks in certain circumstances) who are non citizens and non residents will be covered.

The guarantee is "retail" because a creditor cannot be (among others) a financial institution as defined in section 2 of the Reserve Bank of New Zealand Act 1989.  Further, the Crown has a capped liability to each creditor of NZ$1,000,000. 

The price that a deposit taker will pay for the guarantee depends on a number of factors, including the credit rating of the deposit taker.

On 13 October 2008, the retail guarantee was extended to collective investment schemes (eg an arrangement or scheme to which a participatory security relates, a superannuation scheme, or a unit trust) that have been nominated by a Crown Deed of Nomination so that members of the public who invest through such vehicles obtain the benefit of the Crown's guarantee.  The criteria for nomination includes that the collective investment scheme must invest solely in debt securities of:

1. the New Zealand government; and/or
2. Institutions covered by the retail deposit scheme,

and that during the Guarantee Period (defined above) the collective investment scheme must not make any new investment in anything other than New Zealand government securities and/or debt securities issued by a registered bank that has opted into the retail guarantee scheme.

On 1 November 2008, the Minister of Finance further announced that the Crown will also offer a wholesale funding guarantee facility to financial institutions with an investment grade credit rating (BBB- or better) who have substantial New Zealand borrowing and lending operations.  Some features (as found at http://www.treasury.govt.nz/economy/guarantee/wholesale/operationalguidelines) of the wholesale scheme are:

1. The scheme does not include non-financial (eg corporate and local authority) issuers. 
2. Collective investment schemes will not be eligible as guaranteed issuers (although their holdings of guaranteed issues would be covered by the guarantee).
3. All newly issued senior unsecured negotiable or transferable debt securities would be eligible for inclusion.  Any new issues of these instruments by eligible financial institutions, including ones targeted partly or wholly at retail investors, would be eligible for coverage under the wholesale scheme. 
4. Any retail security, issued under the prospectus requirements of the Securities Act and eligible for coverage under the Crown retail deposit guarantee scheme,  would remain covered under the retail deposit guarantee facility, unless the issuer sought a guarantee under the wholesale guarantee facility.
5. Any institution signing up to the wholesale guarantee facility will also be required to agree that all securities eligible for a wholesale guarantee (whether actually guaranteed or not) will not be covered under its retail deposit guarantee scheme agreement   An exception will be made for retail bonds, as outlined above.
6. Eligible instruments in all major currencies would be eligible for cover.  Specifically, the scheme would cover NZD, AUD, USD, EUR, GBP, CHF, JPY, HKD, and SGD issuance. 
7. Branches of foreign banks would be included among the institutions eligible for a wholesale guarantee scheme, but only in respect of their New Zealand dollar issuance.

The September 2008 issue of the Australian Journal of Corporate Law contains four articles of interest.

The first article is by Anil Hargovan and Jason Harris entitled Shareholders as creditors: A response to the CAMAC discussion paper on law reform.

The article examines  both the decision of the High Court of Australia in Sons of Gwalia Ltd v Margaretic (2007) 231 CLR 160 and the subsequent Corporations and Markets Advisory Committee ("CAMAC") discussion paper regarding how to address shareholder claims against insolvent companies.  The decision in Sons of Gwalia allowed aggrieved shareholders to stand as creditors in a corporate insolvency by making a claim for damages based on statutory rights to compensation for defective disclosure.

The CAMAC discussion paper identified three possible options for addressing the implications of the Sons of Gwalia decision. The authors examine these options and the advantages of each of them as indentified by CAMAC.

The authors suggest a model of limited subordination, which goes beyond that contemplated by CAMAC for the claims of aggrieved shareholders and call for a more balanced approach to considering the impact of Sons of Gwalia on the capital markets, both debt and equity.

The second article is entitled After Sons of Gwalia - Some perspectives on the position of shareholders and creditors and the question of law reform by Michael J Duffy.

This article examines the principles underlying the traditional position of shareholders and creditors when a company is insolvent, and how they have been treated by the High Court of Australia's decision in Sons of Gwalia v Margaretic (2007) 232 ALR 232 ("Sons of Gwalia case").  The author then explores the theoretical bases underpinning this position, and makes some suggestions for how this priority issue could be resolved.

The 1880 case of Houldsworth v City of Glasgow Bank and Liquidators (1880) 5 App Cas 317 ("Houldsworth's case") first articulated the rule that a person who had subscribed for shares in a company may not, while they retain those shares, recover damages against the company on the ground that they were induced to subscribe for those shares by fraud or misrepresentation.  This is premised on the following ideas:

• The capital of a limited liability company should be preserved for the benefit of its creditors (the maintenance of capital doctrine, as described in Trevor v Whitworth (1887) 12 App Cas 409); and
• A shareholder has contracted that the assets and contributions shall be applied in payment of the debts and liabilities of the company, and, so long as the contract remains, he cannot make a claim which is inconsistent with it (the subscriber as contractor justification, as described in Houldsworth's case).

In the Sons of Gwalia case, several of the judges cast doubt on the relevance of the doctrine of capital maintenance.  First, Gleeson CJ noted that the reality of modern commercial conditions was that the assets of the company are usually more significant for creditors than paid-up capital.  Indeed, many companies are registered with a nominal amount of capital.  In addition, there is no guarantee that subscribed capital will remain; it can be easily reduced or eliminated in the course of trading or by authorised capital reductions.  Second, Hayne J noted that the doctrine bore no direct relevance to situations where the shareholder did not subscribe for the shares himself but obtained them from another shareholder, as their action in misrepresentation does not seek a return of what was subscribed as capital when the shares were first allotted.

The case also questions the logic behind the subscriber as contractor idea, as it presumes that an action will be a breach of the contract relationship and prejudice the equity of other shareholders.  Gleeson CJ noted that, following the decision in Salomon v Salomon & Co Ltd (1897) AC 22, a company has a legal existence distinct from its members.  This necessarily meant that the creditors of the company were not also creditors of its shareholders either collectively or individually.  As such, any claim that a shareholder may have in fraud or misrepresentation should not be barred by the fact that the claimant is also a shareholder.  This is in line with the recent Australian trend to provide greater remedial investor protection through the existence of representative 'class action' procedural machinery and the increased acceptance of litigation funding.

The third article is entitled Risk allocation and efficient administration: System design and adherence to first principles in treatment of securities claims in insolvency proceedings by Dr Janis Sarra.

The article examines a number of foundational principles underlying risk allocation in commercial law and the interaction between those principles and the design of insolvency and securities laws. The author in particular focuses on whether, in light of the principles, claims brought by equity holders for remedies following alleged corporate misconduct should be treated as unsecured claims in insolvency proceedings.

The article begins by reviewing three foundational principles in statutory risk allocation, transparency, certainty and fairness. The author then conducts a lengthy analysis which compares four possible policy solutions currently in place in different jurisdictions which regulate the claims of equity holders in circumstances of corporate misconduct. This analysis assesses the practical impact of each policy option on debt and equity markets and the relative level of support from a policy perspective.

The first policy option put forward is the "complete subordination option" which is the approach taken in the United States whereby all claims brought by equity holders are subordinated regardless of the circumstances in which they arise. The author considers that this option meets the certainty and transparency principles but fails considerably in terms of fairness.

The second policy option considered is the "concurrent strategies option". This approach is simply the "complete subordination option" but in addition to this gives concurrent authority to securities regulators to impose penalties for corporate misconduct. The author prefers this approach to the "complete subordination option" as it advances all three foundational principles together with limiting costs to claimants through having a gatekeeper securities regulator.

The third policy option noted is the "parity option". Under this option all shareholder claims arising out of securities law violations are treated as unsecured creditor claims except in the circumstances of fraud. In the author's view this creates difficulties with certainty and fairness in the absence of express statutory provisions, and points to case law to add weight to this conclusion.

The fourth policy option is the "new purchaser option". This provides that only those shareholders who purchased the securities in the time period following the corporate misconduct would have any claim. The author states that this option would be efficient and certain, but points to issues with fairness on the grounds that existing equity investors also suffer from the misconduct and would be uncompensated under this approach.

The article concludes by highlighting the problems which arise with having such varying approaches in different jurisdictions. The author accepts there is a substantial challenge faced by legislators when faced with the competing objectives of advancing the protection of equity investors whilst continuing to recognise the importance of the priority scheme for creditors in insolvency situations.

The fourth article, by Anil Hargovan, is entitled The Cross-Border Insolvency Act 2008 (Cth) - Issues and implications.  This article discusses the introduction, in Australia, of the Cross-Border Insolvency Act 2008 (Cth) ("the Act").  The article provides an overview of the Act's contents and identifies key issues that are likely to challenge the courts when interpreting it.  The article states the in particular, the centre of main interest ("COMI") of the debtor, which is integral to the recognition procedures of foreign proceedings under the Act, has troubled the courts in other jurisdictions, and indicates that that experience may be repeated in Australia.  The article also highlights the problems that arise as a result of the Act's treatment of insolvent corporate groups.

The article explains that the purpose of the Act is to give effect to the Model Law on Cross-Border Insolvency (UNCITRAL) following its introduction in 1997.  It seeks to do this by offering a framework for administering cross border insolvencies.  It allows for judicial cooperation between states, rights of access for foreign insolvency administrators, and recognition of foreign insolvency proceedings by participating states.

There are two categories of recognition under the Act.  The foreign proceeding may qualify as a 'main' or 'non-main' proceeding.  The distinction between the two categories of recognition turns upon the concept of COMI.  The concept is not defined in the Act, nor is it defined in the Model Law; the author states that it is likely, therefore, that this will become a central issue in Australian cross-border insolvencies.  This is also the case as neither the Act or the Model law prescribe the type of evidence that courts should consider in a COMI analysis.

The experience of other jurisdictions also illustrates how the COMI concept has been prone to diverging interpretations, for example the cases of In re SPhinX, Ltd and In re Bear Stearns High Grade Structured Credit Strategies Master Fund Ltd. 

The second issue highlighted by the article is the failure of the Act to explicitly address corporate groups in the definition of COMI.  The omission to expressly accommodate group insolvencies, according to the author, has the potential to undermine some of the key objectives of the Act dealing with efficient and effective administration of cross-border insolvency proceedings. 

In conclusion, the article highlights that some of the main aims of the Act are to encourage cooperation between courts and insolvency practitioners of different jurisdictions and to provide the same legal rights to foreign creditors and liquidators as local creditors over the assets of the debtor in Australia.  This is to be achieved via the key mechanism of recognition.

The Model Law was enacted in New Zealand by The Insolvency (cross-border) Act 2006 which came into force on 24 July 2008.

Issue 11, 2008 of the Journal of International Banking Law and Regulation contains two articles of interest.

The first article is entitled Margin loans: Secured credit or securities lending by Rasiah Gengatharen.

The article considers margin loans and securities lending, particularly in light of the recent Australian Federal Court decision in Beconwood Securities Pty Ltd v Australia and New Zealand Banking Group Limited [2008] F.C.A 594. 

The author comments that the decision in Beconwood highlights the risks inherent in margin loans.  He implicitly criticises the Australian government for leaving margin loans largely unregulated by using Beconwood as an example of the lack of understanding demonstrated by consumers in relation to margin loans, and the losses consumers have suffered as a result of this misunderstanding.
 
Specifically, the author points to the risk of consumers misunderstanding the legal substance of margin loans.  In Beconwood, Beconwood, a cash borrower, transferred ownership in certain shares to a margin lender, Opes Prime, and in return, obtained a contractual right to have the shares returned.  To fund the loan to Beconwood, Opes Prime entered into a separate securities lending agreement with ANZ, under which Opes Prime transferred the shares to ANZ.  When Opes Prime went into receivership, ANZ sold the shares to recover the money it had lent to Opes Prime. 

Beconwood argued that the margin loan was, on its true construction, a mortgage.  Beconwood's argument was rejected and it was held Beaconwood had no beneficial interest in the shares.  It had a contractual right to have the same number of shares in the same companies returned on termination of the transaction.  Consequently ANZ was in a priority position to Beconwood.  The decision has been warmly received by the securities lending industry.

The author likens the losses suffered by borrowers pursuant to margin loans as reminiscent of the derivatives linked-losses suffered by investors in the 1990s.  Investors in both instances failed to fully appreciate the risks involved.

Finally, the author comments that the one positive coming out of the Opes Prime debacle is the closer regulatory attention being paid to margin lending.  In June 2008, the Australian Treasury released a Green Paper, entitled "Financial Services and Credit Reform: Improving, Simplifying and Standardising Financial Services and Credit Regulation".  The Paper proposes that the Commonwealth Government assume responsibility for the regulation of margin lending.  The preferred option of enacting this regulation is through amending chapter 7 of the Corporations Act 2001 to allow margin loans to be included as a "financial product".      

The second article, by Professor Peter Ellinger, is entitled Expert evidence in banking law.

This article starts with an initial discussion on when expert evidence is relevant to commercial litigation generally and moves on to discuss the limited circumstances of when expert evidence is relevant in banking litigation.  This often arises, for example in relation to letters of credit litigation and determinations of jurisdiction.  Expert evidence is also needed in banking law litigation when it is necessary to explain certain technical terms (for example LIBOR) or how a process works.
 
The author sets out the basic principles of expert evidence and discusses the role of an expert in giving evidence, which is to put the evidence adduced and communicated to them in the context of the practice and profession to which it relates.  The author uses examples from case law to show when a court will allow an expert to give evidence, and when it determines that it is not necessary to use an expert witness, for example, when the matter to be determined is a matter of law and not practice.

The second half of the paper contains a discussion on who actually is an expert, the form of their report and the appropriateness of using a single joint expert witness.  One of the problems the author identifies in banking litigation is that often the most appropriate expert witnesses are employees of the bank concerned.  It is difficult to induce these types of people to be witnesses due to the consequences for them in their positions. Retired employees are not seen as ideal as they may be out of touch with recent developments The author notes that the use of a single joint witness has not yet been widely used in banking law issues. 

The September 2008 issue of the Butterworths Journal of International Banking and Financial Law contains the article When is a bond not a bond? by Michael Lazarus.  The article examines the issue of whether an instrument is a "guarantee" imposing only secondary liability or a "bond" imposing primary liability.  The distinction arose in the English case IIG Capital Llc v Van De Merwe and Another [2008] All ER (D) 297 before the Court of Appeal.

In the case the defendants executed instruments entitled a "deed of guarantee" to secure a loan by the beneficiary, the lender, to their company.  The company failed to repay the loan and the lender sued the defendants under the terms of the deeds.  The issue was whether the defendants were able to raise a defence by asserting they were not liable because the company was not liable to repay the loan (ie theirs was a secondary liability to the primary liability of the company).    The Court of Appeal concluded that the deeds did confer primary liability on the defendants so the question of whether the company had a defence and was not liable to repay the loan was immaterial. 

The deed was described as a deed of guarantee and the defendants were referred to as guarantors. In addition, the deeds also contained clauses of the kind that are commonly included in "true" guarantees to protect the beneficiary from events that would stop them from claiming under a true guarantee but would be unnecessary in the case of an instrument conferring primary liability. 

However, the deeds also contained provisions that referred to the defendants as principal obligors, not merely as sureties and that "[a]s an original and independent obligation" the defendants would indemnify the lender against any loss incurred as a result of the company's failure to pay any sum due or expressed to be due from the company.  This was tied to a provision that a certificate from the lender would be conclusive proof (save for manifest error) of the amount due and payable. 

The Court stated that the starting point for construing the true nature of the deed was to look at it as a whole without preconceptions.  The Court found the failure to use language in which demand bonds are usually expressed created a strong presumption against an interpretation as a bond.  Further evidence for this was provided by the inclusion of those clauses relevant to a guarantee.  The presumption was rebutted.  The defendants' obligation was as principal obligor and not merely as surety and for sums only expressed to be due.  This created an obligation greater than merely a secondary one.

A further question arose of what, if any, remedy the defendants would have if they were forced under the deed to pay more than the amount of the loan actually owed by the company to the lender.  In passing, the Court answered that the defendants would have a right of indemnity against the company and that the company would have a right to recover the excess amount from the lender.  Alternatively, the defendants may also have a right to be subrogated to that right of the company to recover the excess.

The October 2008 issue of the Company & Securities Law Journal contains an article by Jennifer Butler entitled Are we there yet?: The journey of the insider trading provisions. The article looks at the elements of the insider trading prohibition in Australia and considers whether the provisions are adequate in monitoring insider trading and prosecuting those who engage in the practice.

The author addresses each element of the insider trading provisions set out in Pt 7.10, Div 3 of the Corporations Act 2001. The elements required for an offence to have been committed are:

• a person must possess information;
• that information is not generally available;
• the person knows, or reasonably ought to know, that the information is not generally available;
• if the information were generally available, a reasonable person would expect it to have a material effect on the price or value of the financial products;
• the person knows, or ought reasonably to have known, that if the information were generally available, a reasonable person would expect it to be material; and
• while the person is in possession of the information, the person trades in the financial products or procures another person to trade in the financial products.

The author covers each requirement in her article, noting how requirements have been judicially considered.

There has been a growing number of Australian cases addressing the issue of insider trading. The author refers to Australian Securities and Investments Commission v Citigroup Global Markets Australia Pty Ltd (No 4) (2007) 160 FCR 35. In this case the Australian Securities and Investments Commission ("ASIC") failed to prosecute Citigroup in relation to an employee's trades when in possession of information that was not generally available. The Court decided that the trader was an employee not an officer of the company and the knowledge of an employee could not be attributed to the company. This failure cost ASIC over AUD$1.5 million.

The author does illustrate ASIC's success in other insider trading cases against individuals noting that although offences of insider trading are considered serious, several of the successful prosecutions have resulted in sentences of periodic detention and even community service.

Butler concludes that the insider trading provisions are working well.  However there are still concerns about how the provisions apply to corporations, as illustrated by the Citigroup case. Butler suggests that the knowledge that can be attributed to a corporation should relate to the knowledge of an employee. This would broaden the scope of the provisions. The author acknowledges that as the provisions stand, ASIC has sent out a strong message that insider trading will not be tolerated and they have the legislative arsenal to get results from prosecutions under the insider trading provisions. That being so, Butler believes that there is still some work to be done to ensure that the provisions operate to maintain the integrity of the Australian markets.

The October 2008 issue of the International Financial Law Review contains three articles of interest.

The first article entitled Banks will be pleased to know the Adelphia decision has been reversed.

The decision 2006 "Adelphia" decision of the US Bankruptcy Court for the Southern District of New York has been reversed by the US District Court in the August 2008 decision of The Bank of Nova Scotia and Citibank v Adelphia Communications Corporation and the Official Committee of Unsecured Creditors (06- Civ. 4983 JGK), 2008 WL 3919198 (S.D.N.Y. Aug 22, 2008).

Under Adelphia's credit agreements, the interest rate was based on Adelphia's reported leverage ratio for the preceding four fiscal quarters.  This type of provision is designed to reward a borrower for good financial performance and provide down-side protection for lenders against declines in a borrower's financial condition.  The dispute arose because Adelphia's reported leverage ratio, on which interest was calculated, did not reflect its actual leverage ratio, which was much higher. 

In the 2006 decision the judge did not allow the banks' claim, stating that the manner in which interest was calculated was clearly based on the ratio as reported, and the banks could have chosen to draft the agreements differently so that, for instance, interest was based on the actual leverage ratio, or that the banks were able to claw-back interest if Adelphia inaccurately certified its ratio.

This decision prompted many financial institutions to add language to their credit agreements that is now referred to as "Adelphia language".  However, in August 2008 the District Court reversed the 2006 decision and found in favour of the banks.  However, the author does not expect the "Adelphia language" to disappear as lenders act conservatively.

In addition the decision does not end the controversy as the case has been remanded to the bankruptcy courts to determine whether the banks waived the right to increased, corrected pricing. 

The second article is entitled Creditor lottery:  The wrong way to rescue a bank. An analysis of the UK Special Resolution Regime.  This looks at the proposed Special Resolution Regime ("SRR") contained in two discussion papers released by the Financial Services Authority, Bank of England and UK Treasury (the "Tripartite Authorities") to deal with failed banks (the British Bankers' Association response to the papers was previously discussed in the September edition of BLU).

The author believes that the proposals are at risk of being a knee-jerk reaction and that the aim of introducing final legislation by next February is ambitious.  Produced in response to the Northern Rock collapse, the discussion papers focus on two areas, financial stability and depositor protection.  The proposals appear to be based on the systems in place in the United States and the author argues this is not necessarily an appropriate model for the UK.  While the UK banking market is dominated by a few large banks, the US banking market has several large banks but also thousands of smaller banks for whom the US scheme is primarily designed, and which normally undertake more limited activities than their UK counterparts.  The US scheme has also been criticised as stifling innovation and competitiveness because of the restrictions it places on new products.

The article focuses on the powers of the Tripartite Authorities under the SRR in relation to a bank that is failing but not yet insolvent.  The available options under the SRR would include nationalisation, sale of all or part of the bank to a third party or sale of all or part of the bank to a 'bridge bank'.  A 'bridge bank' would be a vehicle owned and operated by the Bank of England to run all or part of the failing bank's business to then be sold as a going concern with the proceeds being passed back to creditors and shareholders of the failing bank.

It is argued that the SRR does not achieve an appropriate balance between the powers granted to the Tripartite Authorities and the private law rights of parties that contract with banks.  In particular the article examines:

• nationalisation and share transfers;
• rights under whole business transfers;
• rights under partial business transfers; and
• general powers to alter, nullify or create contracts ancillary to action under the SRR.

In each of these areas, the author believes there are key issues which have not been fully dealt with in the discussion papers, especially on the safeguards and limits to be put on the Tripartite Authorities.  The author argues this needs to be clarified before meaningful consultation can occur.  Furthermore, the author notes, the uncertainty created by these issues could make parties unwilling to deal with UK banks or demand higher risk premiums for doing so, which could handicap UK banks at a time when they can ill afford any further setbacks.

The third article entitled Lessons of UBS v Nordbank discusses jurisdiction clauses and draws on the Nordbank case to highlight the approach the courts will take when competing jurisdiction clauses are in play.

In the Nordbank case, UBS entered into a credit swap transaction with LB Kiel, a predecessor firm of Nordbank.  The details of the transaction were complicated and involved a number of agreements and credit notes.  In short, LB Kiel purchased exposure to a debt securities portfolio managed by UBS. 

The sale was made pursuant to a letter agreement which was to be governed by New York law, although it did not contain a jurisdiction clause.  There were four other key agreements underpinning the transaction, two of which were governed by New York with the other two being governed by English law.  Nordbank subsequently brought a claim against UBS for, inter alia, breach of contract, fraud and negligent misrepresentation.  UBS issued a claim form in England seeking negative declaratory relief, and Nordbank applied for an order that the English court did not have jurisdiction.

The Court upheld Nordbank's application, and stated that there was no basis for the English court to assume jurisdiction over the claim.  The Court was of the view that the correct approach was for the court to look at the contracts that contained competing jurisdiction clauses and establish which of the contracts the disputes most closely pertained to.  The focus of Nordbank's claim was the sale of the Notes; the relevant agreement was subject to New York law.  The Court therefore held that New York was the appropriate forum.

The article illustrates the limits to the broad and robust approach for interpreting jurisdiction clauses that had previously been followed in similar cases; particularly where there are competing jurisdiction clauses.  The author goes on to advise contracting parties to make clear provision in their agreements should they wish to select a particular jurisdiction for dispute resolution as the courts are not prepared to adopt a wide approach in all cases.

© Russell McVeagh 2008. All rights reserved. www.russellmcveagh.com