Published 20 August 2012
The Court of Appeal agreed with Chief High Court Judge Helen Winkelmann, in a ruling on Friday, that the courts should not strike out the Financial Markets Authority’s allegation that a trust set up by Hanover Group director Mark Hotchin was a sham.
The trustees of KA No 3 Trustee Ltd & KA No 4 Trustee Ltd appealed in June against Justice Winkelmann’s decision last December making orders preserving the assets of trusts which might be liable to investors for breaches of the Securities Act.
Justice Winkelmann struck out the sham pleading in respect of the KA3 Trust but found there were sufficient particulars to support an arguable case of sham in the case of the KA4 Trust. The Court of Appeal dismissed Mr Hotchin’s appeal against Justice Winkelmann’s orders in April.
The Financial Markets Authority filed a $35 million civil claim against Mr Hotchin & 5 other Hanover Group directors & promoters in March over money invested & reinvested in the group in 2007-08. No hearing date has been allocated for this proceeding yet. In anticipation of these civil claims, the authority sought an order under section 60H(1)(f) of the Securities Act requiring the trustees to transfer the assets of each of the trusts to a specified person, to be held on trust pending determination of the civil proceedings against Mr Hotchin.
The basis of this application was the authority’s pleading that Mr Hotchin’s children, who are “associated persons” of Mr Hotchin under the Securities Act, are discretionary beneficiaries of the 2 trusts. The authority pleaded that the trust was a sham from inception, and the consequence of that was that property held by the KA4 trustee was in reality property of, or property held for the benefit of, Mr Hotchin.
The Court of Appeal said the argument on behalf of the trustees, that the categories of section 60H should be construed as capturing only assets against which judgment against the relevant person could be enforced, was unsustainable. “Rather, the scheme of the legislation seems to create a broad jurisdiction to grant preservation orders, leaving for the discretionary phase the issue of whether the assets are likely to be available to meet any judgment obtained by aggrieved persons against the relevant person.”
The Court of Appeal also saw no substance in the Bill of Rights argument run by counsel for the trusts, Dr Jim Farmer: “The essence of this argument was that an asset preservation order is an unreasonable search & seizure under section 21 of the Bill of Rights. That is predicated on the false assumption that the preservation order is ‘unreasonable’. It is also predicated on an assumption that section 21 is a measure for the protection of property rights, which appears to run counter to the views expressed by both the chief justice and Justice Peter Blanchard J in Hamed versus the Queen that section 21 is essentially a measure for the protection of privacy rights.”
The president of the Court of Appeal, Justice Mark O’Regan, delivering the court’s decision, said: “It would be surprising if a protective regime such as the provisions in issue in this case left outside of its net any assets held in discretionary trusts. Such vehicles are often established for the express purpose of placing assets beyond the reach of creditors, and can be vulnerable to successful challenges on the basis that the intention of their establishment was to defeat creditors.
“In our view, it would be premature to strike out the Financial Markets Authority’s pleading at this stage. Rather, the matter should proceed to discovery and to a substantive hearing, so the High Court can make a fully informed assessment of the interests of the beneficiaries, the need to protect the position of aggrieved persons and the likelihood or otherwise that such protection will yield any ultimate benefit to aggrieved persons, before deciding whether the order under section 60H(1)(f) should be made.”
The Financial Markets Authority argued in the High Court that the trusts were set up to conceal Mr Hotchin’s continued enjoyment of the trust property. The arguments were:
The structure of the trust deeds gave significant control to the settlerAt the time the KA4 Trust was established, Mr Hotchin was the settlor & sole trusteeSince May 2009 for KA4 trustee, and April 2010 for KA3 trustee, the sole shareholder & director has been accountant Tony Thomas. Mr Thomas is used by Mr Hotchin as a director & shareholder in many companies associated with Mr HotchinThere is an absence of evidence of “push back” by trustees. The Financial Markets Authority had found only one incident where the trustees declined to do what Mr Hotchin had wanted with the assets of the trust.There are instances where the trustees have acted purely in Mr Hotchin’s interests, seemingly at his discretion. In particular, the Financial Markets Authority pointed to the “Matapana Rd transaction”. The Matapana Rd property is a consolidation of 4 properties on Waiheke Island, purchased by interests associated with Mr Hotchin for development as a beach house. The Matapana Rd transaction involved the transfer by the KA4 Trust of one of the 4 Matapana Rd properties to KA3 Trust in exchange for a forgiveness of debt owed by KA4 Trust to KA3 Trust. KA3 Trust then provided an indemnity to support certain of Mr Hotchin’s obligations in relation to one of the restructurings of the Hanover Group. The Matapana Rd property was used in support of that indemnityThe authority also pointed to dealings in respect of a property at Paritai Drive, Auckland. This is a consolidation of 3 residential properties, on which a large & very expensive residence is partially constructed. Although the property is owned by the KA4 Trust, Mr Hotchin personally spent $12 million on the construction of the house on the property. There was no formal documentation as to the basis upon which this was occurring, or even initially any informal understanding with the trust. Then, when Mr Hotchin ran out of money to fund construction, KA3 Trust advanced KA4 Trust $2.5 million, on the basis of an understanding reached with KA4 Trust that: (i) the KA4 Trust would grant Mr Hotchin & his family a long-term lease of the Paritai Drive property, and (ii) if, when the property was sold, the value of the house was less than the total cost of its construction, the amount of the loan by KA3 Trust to KA4 Trust would be reduced by the difference between valuation & cost.
“Dr Farmer argued that any question of sham was effectively removed by the introduction of independent trustees, but that does not seem to us to necessarily follow. If the KA4 Trust was, when established, a sham, it is not clear to us that subsequent actions taken pursuant to the sham trust deed could convert a sham into a valid trust.
“We accept that the pleading is simplistic and needs amplification & refinement, but we do not see this as a reason to strike out the sham pleading in its entirety. It may be that, if the pleading remains as is, any order made under s 60H(1)(a) in respect of assets held by the KA4 trustee will be limited to assets in respect of which the court is satisfied a resulting trust in favour of Mr Hotchin should be imposed.”
1 April 2012: FMA names 6 directors in $35 million Hanover claim
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Attribution: Judgment, story written by Bob Dey for the Bob Dey Property Report.