Published 13 August 2012
2 years ago, the Supreme Court overturned a Court of Appeal finding that investors in Blue Chip Financial Solutions Ltd schemes were lending their assets to Blue Chip, taking an unreasonable amount of risk and getting the chance of only a small portion of any profit.
The Court of Appeal view written by Justice Grant Hammond was novel: The borrowers on apartment investments were the lenders?
Last Thursday, the Supreme Court came down with confirmation – in a different Blue Chip case – that that was precisely what had happened. The apartment investments were incidental parts of an arrangement in which those investors – many elderly, many facing the loss of their homes over investments gone wrong – lent their money to a listed company so it could build up an inventory of stock for future transactions.
The Supreme Court this time unanimously allowed appeals by about 250 investors in Blue Chip schemes and decreed that sale & purchase agreements on apartments they bought were unenforceable.
That means deposits must be returned and mortgagee sales of investors’ homes must stop.
New Zealand’s highest court produced a nonsense judgment 2 years ago on the Bartle case, a case taken on behalf of an elderly Whangarei couple against GE Finance, which lent them money to participate in a Blue Chip scheme. That Supreme Court judgment reverted to the view of the original High Court judge, Tony Randerson, who ignored the reality of relationships.
The second major Blue Chip case to track through the courts was taken against 3 developers by investors who decided not to settle on apartments bought through their investment schemes. In the Auckland High Court in 2009, Justice Geoffrey Venning found the investors hadn’t validly cancelled their agreements for sale & purchase.
The Court of Appeal backed Justice Venning in a decision issued in March 2011 and written by Justice Randerson, who’d ruled against the Bartles in the High Court before being elevated to the Appeal Court.
Justice Randerson said in the Court of Appeal decision a breach of the Securities Act wasn’t, strictly speaking, a ground entitling the investors to cancel the agreements: “However, if the separate arrangements between Blue Chip and the investors could be shown to have breached the act, they would be invalid & of no effect. The next step would be to attempt to establish that the agreements were tainted by that illegality and were also invalid & of no effect.”
That next step was taken in the Supreme Court, where all 5 judges agreed Blue Chip offered debt securities (and maybe equity securities, but the judgment didn’t go into detail on that), and that the 3 developers were also securities issuers.
The Supreme Court appeal in the developer case was heard last November by a panel of Chief Justice Dame Sian Elias and Justices Andrew Tipping, Sir John McGrath, Sir Willie Young & Sir Noel Anderson. The main reasons in the judgment, issued last Thursday, were written by Justice Young. Justice Tipping supplied a supplementary view on the enforceability of the sale & purchase agreements between investors & developers (as distinct from the investors’ agreements to participate in wider Blue Chip packages).
The court declared unenforceable, under section 37 of the Securities Act, all the sale & purchase agreements executed at the same time as, or soon after, each investor entered into the corresponding Blue Chip investment product agreement. Some investors executed apartment purchase agreements with the developer well before they subscribed for Blue Chip investment packages, and the Supreme Court remitted those cases to the High Court to determine what should happen.
The appellants in the developer case were a group of Blue Chip investors headed by Neil Hickman and represented by Paul Dale. The respondents were Turner & Waverley Ltd (ex-Turn & Wave Ltd, director Tim Manning), 74 Albert St Ltd (ex-Greenstone Barclay Trustees Ltd, directors John Abel Pattinson & Kevin Cox) and Grafton Projects Ltd (ex-Icon Central Ltd, director Leonard Ross; former director Craig Mudgway, who’s now bankrupt; the original director, Blue Chip chief Mark Bryers, was director & shareholder when the relevant agreements were entered into).
The central question in the developer case was whether Blue Chip had offered securities to the public in contravention of section 37 of the Securities Act, which required a prospectus, and that the offer wasn’t exempted by section 5 of the act.
The Supreme Court found Blue Chip was in breach and didn’t have an exemption, rendering its allotment of securities unenforceable. The court then extended that unenforceability to the sale & purchase agreements with the developers, held that the developers were also issuers under the Securities Act and thereby found the investors were entitled to relief from the developers.
Justice Young said the investors argued that, although money they said Blue Chip owed them hadn’t been deposited with or lent to anyone, it was nonetheless “otherwise owing”. However, the Court of Appeal accepted the developers’ argument that this should be confined to repayment of money previously paid by the subscriber to the issuer. Justice Venning had accepted the developer argument that Blue Chip wasn’t the “person on whose behalf any money paid in consideration of the allotment of the security is received”, because the money had gone to the developers. On that basis, Blue Chip wasn’t an issuer in relation to its PIP & PAC investment products, through which investors acquired their apartments.
The Supreme Court regarded the Blue Chip products as financing in nature, “meaning that the money & obligations Blue Chip owed the investors were ‘rather like’ those owed by a borrower to a lender. To put the same proposition in different words, we see the Blue Chip products as providing mechanisms by which Blue Chip sought & obtained financing from the public.”
Justice Young explained it a little more: “The investors paid or put up money or money’s worth and accepted financial obligations to the developers on the basis of promises by Blue Chip that they would:
(a) be reimbursed for their financial outlay, and
(b) receive a return for their outlay & risk.
“It is true that they were also buying apartments, but under the investment schemes the apartments had a very limited function. Provided all went according to plan, the investors were never to occupy the apartments. Nor were they ever to receive, directly, the rents which were derived from the apartments. And when the apartments were sold on, the investors received either nothing or next to nothing of any capital gain. Instead, for each investor, the apartment was there primarily as a long-stop against the contingency that Blue Chip might not perform. The apartment thus merely provided a measure of security for Blue Chip’s performance.
“And from the point of view of Blue Chip, the role of the investors was, in part at least, to finance the creation of an inventory of apartments which Blue Chip could resell in the future. It is unsurprising therefore that the Turn & Wave and Icon sale & purchase agreements allowed the vendor to substitute another unit for the agreed unit if the substituted unit provided a similar rate of return. All in all, we are left in no doubt that the products can be properly regarded as providing finance for Blue Chip, whose obligations back to the investors were indeed ‘rather like’ those of a borrower.”
The Supreme Court judgment causes some confusion at clause 63, where Justice Young wrote: “In the argument before us, as in both the High Court & Court of Appeal, the developers argued that Blue Chip was an issuer in relation to the PIP & PAC products. Blue Chip’s status as an issuer was fundamental to the argument as presented because the section 33(1) & (2) prohibitions apply only to such offers as are made ‘by or on behalf of an issuer’. So if there is no issuer, there could not be a breach of sections 33(1) & (2). And the only party nominated by the appellants as an issuer was Blue Chip.” The clause makes sense if it’s the investors arguing this point, not the developers.
Justice Young said the developers argued that no money went to Blue Chip under the PIP & PAC agreements, so Blue Chip wasn’t an issuer. However, some of the money put up by JVA investors did go to Blue Chip. In the end, the judge said, the court ruled that the developers were issuers, rendering this argument irrelevant.
“The idea underlying the PIP & PAC agreements was that Blue Chip would, before or after settlement, take out the investors and in that way be credited (in relation to the developer) with any money paid by the investor. In this admittedly non-technical sense, the payments made by the investors to the developers were received on behalf of Blue Chip. Given the underlying purpose of the Securities Act, we consider that a non-technical approach is the appropriate way to resolve this issue.
“The same result can be arrived at in a more roundabout way: ‘money’ is defined as including ‘money’s worth’ and the definition of ‘subscribe’ includes ‘contribute to, whether by way of cash or otherwise’. It follows that where the subscription is not in cash but is rather ‘otherwise’ or in ‘money’s worth’, anyone who receives all or part of the ‘otherwise’ or ‘money’s worth’ benefit is an issuer. It is perfectly clear that Blue Chip received such benefits.
“The entering into the sale & purchase agreements by the investors conferred a number of benefits on Blue Chip, facilitating the payment of the underwriting fees and conferring on Blue Chip control over the apartments. In those circumstances we see no difficulty in treating the relevant subscription as encompassing the entering into of the sale & purchase agreements, given that they provided a mechanism by which the investors provided benefits to Blue Chip, which for this reason also was an issuer.”
The Supreme Court has gone further into the nature of the commercial setup in its section of the judgment on the investors’ argument that the Blue Chip joint venture agreement involved an offer of equity securities.
The Court of Appeal dismissed the investors’ argument on this point with reasoning that went right back to Justice Randerson’s view in the High Court Bartle case, where he ignored the reality of relationships (a cursory glance would also show he ignored form at crucial moments).
The Court of Appeal said in its developer case judgment: “But the more substantial difficulty with the appellants’ case … is that there was no offer to the public for subscription in terms of section 33. The JVA provided that the investor was entitled to all the shares in the company to be incorporated and to appoint the directors of the company. The shares were not purchased from Blue Chip or issued by a company that was offering them to the public for subscription. They were issued to the investor by a company incorporated by the investor himself or herself.
“The appellants maintain that this reasoning does not address the argument that what Blue Chip was marketing were the rights to have shares in a joint venture company. That the joint venture companies were apparently formed on the instructions of the investors is, according to the appellants, beside the point.”
The Supreme Court found the investors’ argument on this point “at least at first sight, logically compelling”: “What Blue Chip was offering was, inter alia, the right to go into business with it on a joint venture basis. This right was to be given effect in a number of ways, including the entitlement to be a shareholder, along with Blue Chip, in a company which was to play a particular role in the investment. Looking at what was proposed in this broad way, the detail of the manner in which the joint venture company was formed and its capital subscribed may be beside the point.
“That said, we have reservations as to both the substance of the argument and whether it leads anywhere in the context of this case. The joint venture companies were bare trustees for the investors & Blue Chip and their role was thus not particularly material to the way in which the JVA product operated. And if the financial components of what was marketed by Blue Chip (which included the sale & purchase agreements) did not engage the definitions of ‘security’ & ‘debt security’, it would be difficult to see how the entitlement of the developers to insist on performance of the sale & purchase agreements would be impeached by a rather technical breach in relation to the shares in the joint venture companies. Accordingly, we see no point in reviewing the arguments on this issue in any more detail.”
At this point, the way out for the developers was through the Securities Act exemption in section 5(1)(b), in relation to interests in real estate. Justice Venning concluded this was a complete answer to the investors’ Securities Act arguments. The Supreme Court disagreed with Justice Venning and said the Court of Appeal still took too narrow a view on the point.
Justice Young wrote in the Supreme Court decision: “It could not seriously be suggested that the transactions entered into between the investors and Blue Chip in relation to the apartments (for instance, the option arrangements in relation to the PIP & PAC products) involved ‘the ordinary purchase of land’ or that the Blue Chip obligations to the investors in relation to the apartments were in the nature of ‘an unexceptional term ancillary to the purchase of an interest in land’. It follows that the argument – that section 5(1)(b) excludes a Securities Act challenge to the marketing of the Blue Chip products – is flatly inconsistent with the approach taken by the Privy Council (in the Culverden retirement village case).”
Justice Young went on: “The reality is that, from the point of view of the investor – and assuming of course that all went according to plan – the apartments were of only peripheral significance. Such profits as the investors could expect to derive were to come substantially from the efforts & substance of Blue Chip.
“And, as events have shown, the practical ability of the investors to recover their outlays was very dependent on Blue Chip honouring its promises. Those promises were well removed from what could be seen as ancillary to ordinary real property transactions. Rather, in our appreciation, they fell four-square within the intended regulatory scope of the act.
“We note that the Court of Appeal considered that some aspects of the promises made by Blue Chip were ‘ancillary’ to the purchase of interests in land and thus protected by the exemption. This was in respect of the right under the JVA to receive interest payments, and the right under the PIP to receive option fees. As is no doubt apparent, we disagree. The financial promises made by Blue Chip must be addressed in the way they were intended to be considered by the investors, that is, as a whole. And we think it perfectly clear that, as a whole, those promises are not protected by the exemption.”
The developers argued in the Supreme Court that, even if the court reached the conclusion it did on exemption, they could still insist that the investors perform on the sale & purchase agreements. Both Justice Venning & the Court of Appeal had supported the developers on that point.
Justice Young said the Supreme Court wouldn’t respond to all the arguments on this, which included the operation of the exemption, the extent of the developers’ knowledge of the detail of Blue Chip’s investment products, whether the actions & knowledge of Blue Chip should be imputed to the developers and, more generally, the application of the law of illegal contracts and the extent to which a contract, in itself lawful, might be tainted & rendered unenforceable by reason of associated illegality.
“We accept that the developers were perfectly entitled to insulate themselves from the legal consequences of misrepresentations & nonperformance by Blue Chip. What they could not do, however, is contract out of the Securities Act. For this reason, the appropriate Securities Act categorisation of the actions of the developers & Blue Chip is not controlled by the way in which they were described in the contractual documents.
“From the point of view of the investors, the Blue Chip products which they acquired were inextricably linked to the sale & purchase agreements they signed. This is because the Blue Chip products simply could not work independently of the sale & purchase agreements. This means that the sale & purchase agreements and the Blue Chip investments products were integrated packages. This is not affected by the precise order in which the various agreements were entered into, in particular whether the sale & purchase agreement was completed before the JVA, PIP or PAC, providing they occurred at practically the same time and in circumstances where the investor & Blue Chip intended them to operate together. Given the consumer protection focus of the statute, we see this consideration as dominant….
“The promises & payments made by the investors to the developers were pursuant to, and in that sense part of, the consideration for the promises made by Blue Chip. This supports the view that the subscriptions which were invalidated by section 37(4) included the contractual commitments of the investors to the developers and the payments the investors made pursuant to those commitments…..
“The investors are directly challenging enforcement of what, on their face, look to be reasonably orthodox agreements for the sale & purchase of apartments which were being sold off the plans. At first sight, therefore, the transactions between the developers and the investors might be thought to fall four-square within the section 5(1)(b) exemption. Such an approach, however, ignores the bigger picture:
(a) The investors subscribed for the securities which Blue Chip was issuing by, inter alia, entering into the sale & purchase agreements and, as we have explained, the operation of the Blue Chip products (which we have held to be debt securities) were inextricably associated with the sale & purchase agreements
(b) Icon & Greenstone knew either the detail (in the case of Icon) or at least the substance (in the case of Greenstone) of the investment products which Blue Chip was marketing
(c) The knowledge of Blue Chip & its actions (which included marketing the apartments & investment products as integrated packages) is to be attributed to each of the developers
(d) So the developers were parties to the actions of Blue Chip & its sales force, with full attributed knowledge of the substance & detail of the Blue Chip products and that those products & the sale & purchase agreements were marketed as integrated financial packages.”
The Supreme Court went further after the hearing than the submissions made, when Justice Young said it occurred to the panel that section 37(5) of the Securities Act provided an alternative approach to the question of whether the developers were issuers.
Justice Young said the court thought considering this issuer point was warranted, given the case had to go back to the High Court for final orders and other investors not party to this case might enter new litigation.
Justice Young said this subsection could apply directly to the developers only if they were issuers: “And despite the case not having been argued on this basis, it seemed to us to be well arguable that they were issuers:
(a) The consideration provided by the investors for the allotment by Blue Chip of the securities included entering into the sale & purchase agreements & any payments made under them
(b) The developers thus received what was provided by the investors to Blue Chip as consideration for the allotments, in the form of money (being deposits) & money’s worth (in the form of the obligations under the sale & purchase agreements), and were thus ‘issuers’ within the section 2 definition
(c) The sale & purchase agreements (along with any payments made by the investors to the developers under them) were subscriptions within the meaning of the section 2 definition
(d) Applying section 37(5) to the circumstances as they now are, the developers must repay any money received and must cancel the sale & purchase agreements or are otherwise disqualified from enforcing them.”
I’ve left the detail of Justice Tipping’s tainting examination out of this story.
Related story today:
13 August 2012: What was the Blue Chip business all about?
Earlier Blue Chip court stories:
7 September 2011: Supreme Court allows Blue Chip appeal on prospectus question
30 March 2011: Blue Chip investors lose appeal against developers
4 December 2010: Starting point for Supreme Court’s Bartle ruling flawed
3 December 2010: Supreme Court sides with GE in Blue Chip-related Bartle case
2 October 2009: Judgment abjectly wrong in Blue Chip case
1 July 2009: Second Blue Chip-based trial set to close next week
22 April 2009: Blue Chip clients point at GE in test case
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Attribution: Judgments, story written by Bob Dey for the Bob Dey Property Report.