Legal update on banking and commercial law - March 2012

12 March 2012
In this issue - Select Committee calls for submissions on Financial Markets Conduct Bill, Security may come to nought without perfection, Trustee duty of care for failed finance companies, AML/CFT update, Lombard decision - does this change the current law?, An expansive approach to finding a trust and "offsets" versus "set-off", Reserve Bank update, Securities Act exemption notice expiry and renewal, FMA guidance: "effective disclosure", Additional guidance for financial service providers, Constraints on "unilateral" rights, Increased government powers for counterfeit goods, Could New Zealand's privacy tort be extended further?, A red bus on Westminster Bridge - copyright in photos, The impact of death on guarantees, and Unsigned guarantees and the doctrine of estoppel - Cardrona case on appeal.

Banking

Select Committee calls for submissions on Financial Markets Conduct Bill

The Financial Markets Conduct Bill (FMCB) has received its first reading and has been referred to the Commerce Select Committee. The Committee has called for submissions by 26 April 2012. The FMCB will fundamentally change New Zealand's securities laws, and everyone involved in New Zealand's financial markets should carefully consider making a submission.

For further information, see Parliament's website and Buddle Findlay's previous legal update.

Security may come to nought without perfection

When security is taken over specific personal property a lender's security interest under the Personal Property Securities Act (PPSA) extends to cover the proceeds of that property.  But if the borrower becomes insolvent that may come to nought in the hurly burly of competing securities unless the interest in those proceeds, as well as the specific collateral, has been correctly registered on the register (PPSR).  This is easy to do.  Yet, 10 years on from the commencement of the PPSA, we are still encountering in our searches of the PPSR financing statements where the interest in proceeds is registered either incorrectly or not at all.  These errors and oversights could have a big adverse impact on the value of the security in the receivership, liquidation or bankruptcy of the borrower.  Those who lend on the security of specific assets should ensure that their PPSR registrations cover not only those assets but also all possible proceeds.

Trustee duty of care for failed finance companies

As part of the fallout from the failure of National Finance 2000 Limited (the Company), the Company has sued its auditors in contract and tort for their negligence in failing to report on breaches of the trust deed provisions, alleged to have exacerbated National Finance's overall loss.  The auditors sought to join the Company's trustee as a concurrent tortfeasor and claimed contribution under section 17(1)(c) of the Law Reform Act 1936.  In the latest instalment of this action (National Finance 2000 Limited (In Receivership and In Liquidation) v William Buck New Zealand Limited HC AK CIV-2010-404-7157, 7 December 2011), the trustee applied to have the auditor's joinder application struck out. 

The High Court struck out the auditors' first cause of action that the trustee breached any statutory duty – any duties found under the Securities Act were deemed "exclusively for the protection of investors".  However, the High Court found that the auditors have an arguable case that the trustee owed National Finance duties of care at common law, in terms of the reasonable diligence duties assumed as a trustee via their contractual relationship.

The short approach adopts the dictum of Lord Goff in Henderson v Merrett Syndicates Ltd [1995] 2 AC 145 (HL)The duties of care stem from the trustee assuming responsibility, in contract, towards National Finance: having been paid for their "special skills" and "providing services to someone relying on them".  As the issuer's reputation is intrinsically linked to the trustee's performance, they clearly have a legitimate interest in the trustee upholding reasonable diligence duties.  Even when taking the longer approach of establishing proximity and then taking any wider policy considerations into account, the Court found none of the potential policy considerations were significant enough to warrant not imposing a duty of care on the trustee, once they had assumed responsibility in contract toward the issuer.

It was also found that an indemnity clause in the trust deed, granted by National Finance in favour of the trustee, may not be effective if the trustee is found to have failed to exercise due care and diligence.

The case continues; we will provide further updates in the future.

AML/CFT update

The anti-money laundering / countering the financing of terrorism (AML/CFT) supervisors (the Reserve Bank, Financial Markets Authority and Department of Internal Affairs) released an "Insurance Business Coverage" guideline on 13 December 2011 and an "AML/CFT Programme" guideline on 10 February 2012.

The Insurance Business Coverage guideline clarifies how the exemptions (to the Anti-Money Laundering and Countering Financing of Terrorism Act 2009 (the Act)) set out in the Anti-Money Laundering and Countering Financing of Terrorism (Exemptions) Regulations 2011 will apply to Insurance Companies.

The AML/CFT Programme guideline provides guidance to reporting entities (as defined in the Act) regarding the requirements of the AML/CFT Programmes required under the Act.  The AML/CFT Programme should be prepared by reporting entities after they have completed a risk assessment and be tailored to address the specific risks of the reporting entity that are identified.  Section 57 of the Act sets out the requirements for the AML/CFT Programme and this guideline provides further guidance on what is required.

The release of the AML/CFT Programme guideline serves as a reminder that reporting entities must be compliant when the remaining provisions of the Act and regulations come in to force on 30 June 2013.  Reporting entities must have appointed an employee as a compliance officer and have prepared a AML/CFT Programme that includes policies, procedures and controls for the following:

  • Vetting and training of compliance officers, senior managers and other employees who have roles that involve duties relevant to AML/CFT
  • Customer due diligence
  • Written findings for activities related to AML/CFT
  • Interaction with countries that do not regulate AML/CFT
  • Suspicious transaction reporting
  • Record keeping
  • Products and transactions that favour anonymity
  • Future changes in risk and ability to adapt Programme
  • Monitoring compliance with Programme.

Lombard decision - does this change the current law?

The verdict R v Graham & Ors [2012] NZHC 265 (prosecution of the directors of Lombard Finance, another failed finance company) was released on 24 February 2012.  All the directors were found guilty in relation to material omissions relating to the liquidity risk in the amended prospectus and an untrue statement in relation to Lombard's adherence to its lending and credit approval policies in the investment statement.

Interesting points include: 

  • While the defendants ran a general defence based on their governance as directors and the competence of their judgment (i.e. that their standards of corporate governance were appropriate), the judge noted that the focus was not on general competence, but the adequacy and accuracy of disclosure.
  • In relation to the argument that directors can reasonably rely on advice by others such as senior management, the judge took the approach in R v Moses HC Auckland CRI-2009-004-1388, 8 July 2011 (concerning Nathans Finance), which was that while each situation is fact specific, any circumstances that would lead a reasonable director to question the reliability of what he or she was told triggers an obligation to make further enquiry, and brings to an end the entitlement to rely on the information provided. 
  • As to the level of detail to be disclosed in offer documents, the judge adopted the test of "everything of relevance that is likely to be material to the investment decision" from the Moses case, as well as agreeing that the type of investor that was being targeted was a "prudent but non-expert investor" (however while this test in the Moses case assumed that an investor would seek financial advice, the judge here did not).
  • The judge agreed with R v Steigrad [2011] NZCA 304 (concerning Bridgecorp) in that representations in an offer document are continuing in nature (i.e. they do not just have to be true on the day the offer document is signed by the directors or registered, but must continue to be true so long as the offer is in the public arena).  However, in establishing a case against a director, the Court held that the Crown has to be able to point to either an event or events in the period between when the offer was signed and when the company ran into receivership as triggering the requirement to amend the documents. 

It appears then that this case is generally in line with the current case law (which reinforces the high expectations on directors to meet the disclosure obligations required under the Securities Act).  It has, however, clarified what is required to prove a breach under the Steigrad approach, perhaps giving some comfort to directors.

An expansive approach to finding a trust and "offsets" versus "set-off"

Pearson v Lehman Brothers Finance S.A. [2011] EWCA 1544 is a decision of the English Court of Appeal arising out of the collapse of the Lehman Brothers group.  The issue was who had beneficial ownership of securities which Lehman Brothers International (Europe) (LBIE) had acquired from third parties for the account of Lehman Brothers Finance S.A. (LBF) before the collapse of the group, and which remained vested in LBIE (as against the outside world).

In the course of its detailed judgment, the Court made useful statements on both the finding of a trust relationship and payment by "offset" (short of actual set-off).

It had been argued that LBIE could not hold the securities on trust for LBF because the subject matter of the trust was insufficiently certain.  In relation to intangible property such as securities, LBIE argued that proprietary rights do not attach to an unappropriated part of a larger mass if the person holding legal title (i.e. the putative trustee) is free to deal with the property as it pleases and to mix it with property held for other third parties or for its own benefit.  The Court rejected this argument, finding that these factors might make working out the parties' respective entitlements harder but did not undermine the fundamental trustee relationship.  While LBIE's duties as a trustee were less extensive than an ordinary trustee (as it was not required to keep the trust assets segregated, and could deal with the trust assets), the securities were nevertheless held on trust from the time of their first acquisition, and difficulties in accounting as a result of what happened later did not subvert that.  Nor did the fact that the securities held by LBIE at any given time might not be (or bear any relationship) to those originally acquired for LBF.  As such, the Court took an expansive approach to finding that a trust was established.

On the second point, in order to show that title was transferred back to LBIE, LBIE argued that payment for the sale back was effected by "offset" against the acquisition price (i.e. the price it paid the third party for the securities, which LBF in turn owed to it).  However, the relevant accounting entries showed that no actual set-off had occurred (i.e. no net balance was struck at any given stage; rather there were successive and separate entries in different ledgers).  Departing from the lower Court's approach, the Court of Appeal held that such an "offset" – absent a true set-off – was not enough to establish payment.  In doing so, they differentiated a current account at a bank, where it has been said that successive mutual debits and credits really only create a net debt owing.  As such, parties wishing to effect payment by set-off should be careful to ensure that an actual set-off is effected rather than seeking to rely on a mere "offset".

Reserve Bank update

The Reserve Bank of New Zealand has released a slew of policy and consultation documents over recent months.

RBNZ Significant Acquisitions Policy

In December 2011 the Reserve Bank introduced its new significant acquisitions policy, which will apply to transactions planned to take effect on or after 1 April 2012.  The purpose of the policy is to strengthen the Reserve Bank's supervisory powers over significant acquisitions undertaken by New Zealand banks (as significant acquisitions can materially affect the risk profile of the acquiring bank).

The policy does not materially differ from the draft final decisions previously released. 

It imposes a new condition of registration on locally incorporated banks to:

  • Notify the Reserve Bank before undertaking a significant acquisition which meets the "notification" threshold as defined in the policy
  • Obtain a notice of non-objection from the Reserve Bank before undertaking a significant acquisition which meets the "non-objection" threshold as defined in the policy.

The notification threshold is where total consideration for an acquisition exceeds 15% of the bank's capital base or where the total value of assets purchased exceeds 15% of the bank's total assets.  The "non-objection" threshold is defined similarly but at 25% of capital or assets

RBNZ Open Bank Resolution

The Reserve Bank has consulted banks on the Open Bank Resolution (OBR) policy.  The purpose of OBR is to place responsibility for failure on the shareholders and creditors (rather than the taxpayer), while allowing the bank to continue to operate as a going concern.  The next stage of the process is for banks to provide detailed implementation plans setting out how they meet the required outputs of the pre-positioning. 

RBNZ Covered Bonds

The Reserve Bank has released a consultation paper on a framework for covered bonds issued by New Zealand banks.  Covered bonds are bank issued debt securities where the bond holder is both an unsecured creditor of the bank and holds a secured interest in a pool of assets (the "cover pool").  The framework is aimed at clarifying the treatment of cover pool assets in the event an issuing bank fails.  Currently, issues of covered bonds are governed by contract.   A legislative framework is intended to increase investor confidence in covered bonds, and contribute to financial system stability.  The proposals include:

  • Covered bond issues must be registered with the Reserve Bank
  • The cover pool assets must be held by a special purpose vehicle
  • An asset pool monitor must also be appointed to monitor the cover pool
  • Legislative amendment to provide that the SPV cannot be included in the statutory management of the issuing bank.

It would apply to both New Zealand incorporated registered banks and New Zealand registered banks that are branches of overseas incorporated banks.

The Reserve Bank considers the proposed framework to be simple and low cost, and in line with current industry practice.  The Reserve Bank also proposes to develop transition rules to allow pre-existing issues to be registered.

In April 2011 the Reserve Bank imposed a condition of registration on locally incorporated banks restricting the bank's level of covered bonds to 10% of total assets.  That limit is not proposed to be changed and is not being consulted on.

The consultation paper is available here.  Submissions are due by 16 March 2012.

RBNZ Liquidity

Last month the Reserve Bank issued a consultation paper setting out its proposal on how its liquidity policy requirements (BS13) should be adapted to apply to New Zealand branches of overseas banks.

The Reserve Bank notes a key difference between branches and locally incorporated banks is that a branch is part of a single legal entity – and in theory only needs to own sufficient liquid assets on its whole balance sheet to meet potential outflows across that balance sheet.  However, the Reserve Bank notes that the currency of liquid assets, and the jurisdiction where the control of those assets resides, matters in a short term crisis.  The Reserve Bank considers there is a strong starting presumption that overseas bank branches in New Zealand need to hold an adequate stock of (mainly NZD) liquid assets in New Zealand.  It therefore intends to apply the mismatch ratios to branches.

The Reserve Bank notes that Basel III will require each home country supervisor to apply the Basel Liquidity Coverage Ratio (LCR) on a consolidated basis to each overseas bank group represented in New Zealand, but indicates that it intends (for the foreseeable future at least) to keep BS13 in place, as opposed to adopting the LCR.

BS13 is intended to be applied to overseas bank branches by way of a new condition to existing conditions of registration.

The Reserve Bank aims to formally consult with branches on the new condition by the end of June, with the condition to come into effect on 1 October 2012.

The consultation paper is available here.  The deadline for comments is 30 March 2012.

Securities Act exemption notice expiry and renewal

A large number of securities-related exemption notices are due to expire this year, including the exemptions for:

  • Australian issuers
  • Authorised futures contracts
  • Registered bank futures contracts
  • Building societies
  • Continuous debt issues
  • Cooperative companies
  • Industrial and provident societies
  • Employee share schemes
  • Overseas listed issuers
  • Property developments and proportionate ownership schemes
  • Takeovers.

The Financial Markets Authority has initiated several review projects to deal with renewals and will be seeking comments from market participants over the coming months.  If you think you will be affected by the expiry of an exemption notice, or would like the full list of notices and expiry dates, please contact us for further information.

FMA guidance: "effective disclosure"

The Financial Markets Authority is currently working on its "effective disclosure" guidance note.  The FMA has recently completed consulting on a draft of the guidance note, and has stated it intends to issue the final version by 31 March 2012.  For further information, see our January 2012 legal update.

Additional guidance for financial service providers

With much less fanfare, the Financial Markets Authority has also promulgated additional guidance in relation to financial services under the Financial Service Providers (Registration and Dispute Resolution) Act 2008 (the Act).

Most notably, the guidance takes the view that entities need to register, even if they are only servicing outstanding loans (and not providing new credit):

[an] entity provides credit (and needs to be registered) until the credit is completely repaid (or forgiven). Providing credit includes having a loan due to you that was originally made by another provider. For example, you will usually need to register if you have bought or been assigned a loan.

We are not convinced that this is the correct interpretation of the Act, and it does not accord with our experience of market practice.  Affected entities should consider their position.  Financial service providers already registered (and, if applicable, already members of dispute resolution schemes) may merely have to tick another box on their registration.  However unregistered entities and (in certain circumstances), entities that are only registered in respect of issuing securities may be more significantly affected.

The remainder of the guidance is straightforward and accords with current market practice and understanding.  The guidance also helpfully confirms the FMA's view as to the position of individual trustees of superannuation schemes (which also reflects current market practice).

For further information, see the "Help & Support" section of the Financial Service Providers Register.

Commercial

Constraints on "unilateral" rights

In the recent High Court case of Olsen Consulting Ltd v Goodman Fielder New Zealand Ltd (HC Auckland CIV 2011-404-5622, 23/11/2011, Keane J), nine companies contracted to provide bread delivery services for Goodman Fielder challenged a reduction in the fees they were paid.

Goodman Fielder's agreement with its delivery contractors provided that a contractor's fee would be fixed by Goodman Fielder on the basis of Goodman Fielder's "costing model".  The agreement also provided that the rates for the fee would be reviewed by the parties annually and could be reviewed and revised by Goodman Fielder at any time by notice to the contractor (subject to the Goodman Fielder review being based on its costing model).

In August 2011, Goodman Fielder notified its contractors that it had reviewed each contractor's delivery and merchandising costs and, as a result, was amending the fee that each contractor would receive.  The contractors contended that the annual review had to occur before Goodman Fielder could rely on the unilateral review right.  Goodman Fielder maintained that it was entitled to make unilateral changes to the rates following review and to give them immediate effect.

The High Court had two key issues to resolve: firstly, whether the relationship between Goodman Fielder and a contractor was solely contractual or whether it was also fiduciary; and secondly, whether the unilateral review right was constrained in any way.

The Court found that the relationship was solely contractual.  Despite the contractor's vulnerability in the relationship (under a contract in which Goodman Fielder "retained almost complete control") the contractor was independent and Goodman Fielder had no duty to act for or on behalf of that contractor so long as it acted within the scope of its contractual powers and not maliciously, capriciously or arbitrarily.

In relation to fee reviews, the Court found that Goodman Fielder had a unilateral right to review the fee payable to the contractor.  However, the Court considered that the review could not be exercised consistently with its purpose (to ensure the costing model calculation is accurate) without engaging the contractor in that process.  A completely unilateral review would "always carry the risk of being inaccurate and indeed arbitrary".  The Court found that the review right was subject to an implied duty to give the contractor notice of the review, explain what is proposed, enable the contractor to respond, and only then (in light of the contractor's response) make a decision.  If the change proposed by Goodman Fielder was a radical revision, the level of consultation (and related notice period) associated with the review would have to be commensurate.  This could mean giving the contractor sufficient time, before the change takes effect, to assess it and to adjust to it or to consider its options.

The case illustrates that even where rights under a contract are unambiguous, a Court may imply additional terms to ensure those rights are exercised consistently with their purposes.  If a party wishes to exercise a unilateral right under a contract (particularly if it intends to make a significant change) it should give the other party a reasonable period of notice and the opportunity to discuss the change.

Increased government powers for counterfeit goods

The Copyright Amendment Act and Trade Marks Amendment Act, which came into force recently, give increased powers of search and seizure to the New Zealand Customs Service and the National Enforcement Unit of the Ministry of Economic Development in respect of counterfeit and pirated goods.  The increased powers will allow Customs to seize goods at the border without a warrant where Customs staff reasonably believe that those goods are relevant to investigating offences under the Trade Marks or Copyright Acts and will allow the National Enforcement Unit to investigate goods that are being offered for sale in a public place and to seize any counterfeit or pirate goods.

For more information about this topic see here.

Could New Zealand's privacy tort be extended further?

In Hosking v Runting [2005] 1 NZLR 1, the New Zealand Court of Appeal found that a person can sue another in tort if that person offensively publishes their sensitive private facts.  The recent Canadian judgment of Jones v Tsige 2012 ONCA 32 provides some insight into the direction that New Zealand's privacy tort might take in the future.

The Court of Appeal of Ontario judgment involved two employees of the Bank of Montreal.  Over a period of four years, one of the employees, Tsige, without authorisation and contrary to bank policy, accessed and viewed the bank records of Jones at least 17 times.  Jones sued Tsige claiming that Ontario law recognises a right to privacy, including a right to be free from intrusion upon one's seclusion or solitude, or one's private affairs.

The Court of Appeal confirmed the existence of a tort of privacy in Ontario and expressed this as a right of action for unreasonable intrusion into seclusion.  The Court said that recognition of such a cause of action is an incremental step that is consistent with the role of the Court to develop the common law in a manner consistent with the changing needs of society.  The Court was persuaded that the rapid change in technology and the increasing levels of personal and sensitive information being aggregated and stored online supported the finding.

The key difference between the finding in this case and the tort described in Hosking is the absence of the requirement for publication.  In Jones v Tsige, Tsige had not published the bank details she had accessed.  However, the Court protected Jones' right to be free from intrusion into Jones' personal affairs.  This right was breached by Tsige's intrusion, regardless of whether the information was published to anyone else.

The New Zealand Court of Appeal in Hosking did not address the question of whether a remedy is available for unreasonable intrusion into a person's solitude or affairs.  It is possible that if the same set of facts arose here as arose in Ontario, a New Zealand court might extend the tort of privacy to include intrusion as a cause of action in its own right.  If New Zealand law were to develop in that manner, publication might be treated as an aggravating factor that would be considered in deciding on the quantum of damages. 

We will have to wait and see whether New Zealand law develops in this way.  In the meantime, the case serves as a reminder to businesses of the importance of maintaining policies and practices to protect personal information.

A red bus on Westminster Bridge - copyright in photos

Temple Island Collection, a UK souvenir company, recently successfully sued tea company New English Teas (NET) in the case of Temple Island Collections Ltd v New English Teas Ltd & Anor [2012] EWPCC 1 for copyright infringement after NET used a photo of a red London bus crossing Westminster Bridge on tea packaging.

Judge Birss QC decided that NET's photograph of a red London bus against a black and white background of Big Ben and the Houses of Parliament, with a blank sky, was similar enough to another photograph of the same subject matter to infringe Temple's copyright.

The case is unusual as in no sense was there any "photocopying" or facsimile style reproduction of Temple's photo.  Temple produced its photo in 2005.  Temple's photographer stood where many tourists also stand with their cameras to take pictures of the bridge to get the Houses of Parliament and Big Ben in the background.  In contrast, NET took three photos and combined them with a stock image of a Roadmaster bus to produce its final image.  The Temple photo and the NET photo "see" the view from different angles and were taken on different days.  One image has a lot more detail in the foreground than the other.  However in both photos the bus is shown in red, travelling in the same direction and against a black and white background.  The judge held that NET had reproduced a substantial part of Temple's photograph.

The judge considered that NET knew about Temple's existing photo and had deliberately created its photo to avoid infringing Temple's copyright.

The judge said, "the composition of the image can be the product of the skill and labour (or intellectual creation) of a photographer and it seems to me that skill and labour/intellectual creation directed to that end can give rise to copyright".  On this basis the judge decided that the similarity of the "visual contrast" features of the red bus and monochrome background in the NET photo infringed the "intellectual creation" in Temple's photo.  The Court believed there were a myriad of ways a bus could be portrayed in front of the Houses of Parliament without inappropriately using Temple's image.

This decision seems to expand the ways you might infringe the copyright in another photographer's photo where you portray the same subject matter.  It seems to suggest you can infringe copyright in a photo by using the idea expressed in it.  Traditionally copyright has been thought to protect only a photographer's expression of an idea, not the idea itself.  What if two photographers are standing next to each other and snap the same celebrity opening the same supermarket?  Won’t they depict the same idea?

Interestingly, Judge Birss did say NET could have sent a photographer to Westminster and taken a picture which includes at least a London bus, Big Ben and the Houses of Parliament and no such image would have infringed Temple's copyright.  Maybe NET just went too far in an effort not to infringe.

The impact of death on guarantees

In the recent case of Hieber v Reddington [2011] NZCA 679, the Court of Appeal affirmed the general position that when a guarantor dies, a guarantee that he or she has given over a lease does not automatically terminate unless this is specified in the guarantee.

In the case the parties had agreed that the guarantee was limited in certain respects (including as to when the guarantee would lapse), but had not agreed that it would be terminated on the death of Hieber.  The Court held that, if the parties had intended for the guarantee to terminate on death, they could have inserted a provision to that effect. In the absence of such a provision, the guarantee was not discharged on Hieber's death.

This is a well established rule, and indeed a standard guarantee will usually include wording to the effect that a guarantor’s liability will not be affected or diminished if the guarantor's position changes, including by death, incapacity or retirement.  Nevertheless, this case is a good reminder of the importance of careful drafting and the need for guarantors to get independent legal advice explaining the nature and effect of the guarantee.

Unsigned guarantees and the doctrine of estoppel - Cardrona case on appeal

Further to our October 2011 legal update, leave has been given to appeal the decision in Tait-Jamieson v Cardrona Ski Resort Limited.  In that decision, Justice French held that Mr Tait-Jamieson was liable under an unsigned guarantee in favour of Cardrona Ski Resort Limited (on the basis of estoppel).  In granting leave to appeal, French J noted that her decision "appears to have been the first time anyone has held in New Zealand that an unwritten or unsigned guarantee can be enforced by the doctrine of estoppel".  We will keep you updated on the progress of this case.