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constructive trusts, General

No good deed goes unpunished

Daisley v Ark Contractors Limited relates to a commercial venture that came into fruition over a decade ago.   The venture involved transfer of properties owned by the first (Daisley) and second (SDD Limited) plaintiffs, which were about to be sold at mortgagee auction. The Kellers (the second defendants) contributed capital  and setting up the first defendant (Ark Contractors Limited (Ark)) as the corporate vehicle for the venture. It was intended that the plaintiffs be issued shares in the first defendant pursuant to a preliminary shareholder agreement.  However, following the transfer of the properties to Ark, a dispute arose as to the number of shares to which the plaintiffs were entitled. Daisley sued for monetary compensation rather than issue of shares given the passage of time and failure of the “joint” aspect of the venture.  The proceedings were filed 1 day shy of the relevant limitation period.  A fundamental aspect of the proceedings was the relevant witness’s diminution of recall due to the passage of time.

The genesis of the matter was the plaintiffs’ financial position.  Mr Daisley was under immense financial pressure to repay or restructure debt owing to Westpac  and other debt.  Four properties were set to be sold by Westpac as mortgagee. A chance encounter between Mr Daisley and Mr Keller resulted in to a restructure that lead to Ark acquiring the distressed properties and the mortgagors being repaid.  The question for the court was what was agreed?  Complex negotiations were convened in a short space of time between 22 November and 9 December 2009. The proposal or agreement, or what the court later considered an unbinding heads of agreement can is explained at [43] as follows:

“Mr Keller says the basic idea discussed was to halt the mortgagee sale by a combination of the Kellers’ cash together with a new loan to buy the properties, through a new company to be formed. The proposed shareholding of the company was to be in proportion to the respective contributions of each of the Kellers and Daisley interests. The property values to be used were the registered valuations in the 2009 Finance Proposal, less a 25 percent discount to reflect the mortgagee sale context and lack of currency of the valuations.”

A summary of “agreed points” is set out at [49] to [52]:

[49] …

(a) The Kellers are keen to progress the deal;
(b) The accepted property values of the four properties to be transferred total $2,895,000 less a discount of 25 percent ($724,000) leaving a combined base total of $2,171,000;
(c) A new company is to be incorporated to run the “JV”;
(d) The “Shareholding/finance” split is set out as follows:
Cash x Keller (57%) $800,000
Borrowing $770,000 over coy assets plus Keller private props

Equity Daisley (43%) $601,000
$2171,000
This provides $1570K to clear Westpac may need to revisit actual split & consequent shareholding split in Ark when final Payout date & amount owing plus Auction cancelation (sic) fees known & negotiated with Westpac. The above shows the formula we will use to arrive at shareholdings in Ark.

(e) Need to be able to produce an offer to Westpac by 1 December, as clean and unconditional as possible, a deposit a substantial amount, say, $100,000K. Possible personal guarantee x Paul & Karen

[50] A further agreed point deals with the shareholding in the proposed joint venture company. It records:
a JV coy will be set up Ark Enterprises Ltd Share Holding Daisley 43% Keller 57% (to be confirmed when final payout to Westpac confirmed) Voting Shares “A” non Dividend PK 50 KK 25 JD 25 “B” Shares Dividend participating, non voting 50 Paul Keller 5600 Keller Family Trust 5700 4250 Jim Daisley This split to be confirmed by Chris/Jim 50 Scott Daisley 4300 Directors PK KK JD
[51] The summary then records “Other Agreements”. This includes that Thomson Wilson are to be the legal representatives of Ark, Mr Daisley should be able to purchase his house back at agreed value, the aim should be to free the Kellers’ house from security tie up and Mr Daisley is to pay rent for the house and yard transferred.

[52] Finally, there is long to do list summarised which allocates tasks to the participants and to Mr Badham. Three highlighted tasks on the list were described by Mr Lay in his covering email as “not so urgent they can be addressed over next couple of weeks”. One of the non-urgent tasks was a shareholder agreement for duties and responsibilities in the new company.

Matters became more complicated when the Kellers learned about further debts owed to another lender.  However, matters progressed and an agreement “the Ark Agreement” was finalised.  The operative part of the agreement is set out in [80] as follows:

1. Once settlement of the Sale and Purchase Agreements has taken place, the debts owed by Ark to SDD under clause 20.0(b) of the SDD Agreement, and to Jim under clause 20.0(b) of the Daisley Agreement shall be repaid by the issue to SDD and Jim, of shares in Ark, such that the resulting shareholdings of Paul and Karen (or their nominees), and SDD and Jim (or their nominees) shall be determined in accordance with Schedule B.

2. In the event that settlement of the Sale and Purchase Agreements does not occur as a result of any default by SDD or Jim in their obligations as vendors under those agreements, then Jim and SDD acknowledge liability to Paul and Karen for all costs and losses incurred by Paul and Karen in relation to the Sale and Purchase Agreements (including the negotiation and preparation of the agreements and all related documentation), including accountancy and legal fees, lost deposit moneys, and interest thereon at the interest rate for late settlement in the Sale and Purchase Agreements.

3. Prior to the issue of shares in Ark to Jim and SDD in accordance with clause 1, Ark will adopt a constitution in usual form, subject to the following specific provisions, some of which may, in the absolute discretion of Paul and Karen, be provided for in a Shareholders Agreement that will be signed by all of the shareholders of Ark at the time of the issue of the shares to SDD and Jim.

4. There shall be two classes of shares. Paul and Karen’s shares shall be A shares. Jim and SDD’s shares shall be B shares.

5. The A shares shall have all the usual rights and powers, including voting powers, provided that the A shares shall not entitle the holders to make any changes to the company’s constitution without the prior written consent of the holders of all of the B shares. The A shares shall entitle the holders to appoint two directors.

6. The B shares shall have no voting rights or powers but shall have all other usual rights and powers. The B shares shall entitle the holders to appoint one director.

7. A quorum for a directors’ meeting shall be two directors.

The day after the parties signed the Ark Agreement, the Daiseley’s lawyer proposed to the Keller’s lawyer that the Ark Agreement is amended by the addition of an addendum recording Mr Daisley’s entitlement to repurchase the Depot at Ark’s cost price for a period of up to one year but in a manner which would remove the Depot (the Diasley’s home and business premises) from the Ark arrangements with no impact on shareholding interests.

As set out in [84] to [86] the foundations for the later proceedings were in train:

[84] That same afternoon [of the day following], Mr Jackson contacted Mr Keller directly by email, copying in Mr Badham. His email referred to a discussion between Mr Daisley and Mr Keller around the repurchase of the Depot by Mr Daisley. This time, Mr Jackson suggested that the option might be indefinite but not exercisable until Mr Keller’s house and bach no longer provided security for bank lending as part of the Ark venture. Mr Jackson stressed in his email that “it’s not a new thing; it’s just what was always expected by everyone”.

[85] It seems that the issue of the Depot was one of the factors which caused Mr Daisley to have second thoughts. Within days after signing the Ark Agreement, he engaged an Auckland lawyer, Graeme Skeates. It is evident that Mr Daisley was scouring for a way to re-jig the deal. Mr Skeates reached out to Mr Badham to inquire about any potential to increase Mr Daisley’s shareholding and was invited to put any proposal in writing, although it had not been contemplated by the Kellers.

[86] On 9 December 2009 Mr Skeates wrote to Mr Badham asserting that the Daisleys signed the agreements under duress without adequate opportunity for independent advice. He claimed the Kellers and Thomson Wilson were in breach of fiduciary obligations owed to the Daisleys. He claimed, among other things, that the Ark Agreement could be rescued provided the “joint venture” could be conducted with a shareholding/equity in the range previously discussed and with the Daisleys’ voting rights restored to their agreed percentage of equity.

Further negotiations took place and by 5 January 2010 as noted at [92] “The venture was back on track, or so it seemed.”  However, unbeknownst to the other parties (see [98]) Mr Daisley was looking for alternatives and in the Court’s assessment “Mr Daisley was deliberately stalling settlement of the Ark Agreement and working behind the scenes to find a way to retreat from the deal. The consequence was that the property settlement was delayed for the second time.”

Last minute amendments proposed by the Daisley’s new lawyer were accepted on 29 January 2010, the day of settlement.  As at 30 January 2010 Ark appeared ready to proceed while Mr Daisley and his businesses were still occupying the Depot.

However, two weeks later the Kellers’ lawyer presented an “abrupt change of position” whereby the last minute changes to the agreement were voided on the basis of duress.

Matters rumbled on.  Mr Daisley remained in the Depot but no lease was finalised and rent was soon in arrears.  Companies associated with Mr Daisley were liquidated following which two office buildings were removed from the Depot “in the dead of night” culminating in “the point of no return.”

Eventually proceedings were filed.

The first question for the court was whether  Ark and the Kellers could legitimately avoid the 29 January 2010 variations to the Ark Agreement by reason of duress.  The court determined that the Kellers and Ark were not induced to enter into the January 2010 Variations by duress and therefore were not entitled to “rescind”.   The reasons given for this are fact specific and are set out at [143] to [147].  For the same reason the Ark Agreement was held to not be voidable due to duress or undue influence.

The third question for the court was whether “it just and in accordance with good conscience that a constructive trust be imposed.”  As noted at [160]:

“A constructive trust is a proprietary remedy. As such, it offers certain advantages such as an entitlement to the benefit of any increase in the value of the asset in which rights in rem are held after the defendants’ receipt.”

The following passages set out the nature of the claim and the hurdles faced.

[164] The plaintiffs assert that the transfer of land to the Kellers was never contemplated as being part of the joint venture and, in itself, it amounts to an unequivocal repudiation of any contractual arrangement between the parties and an equitable fraud on the plaintiffs’ interests. It follows that it is just that a constructive trust “be imposed” requiring both defendants to disgorge any benefit derived, to account for the current market value of the properties or to return the property and to reconvey to the plaintiff the land “dishonestly” conveyed to the Kellers.

[165] There are intractable problems with this cause of action as pleaded. One problem is that not all the trustees of the family trust which now owns the Depot are parties to the proceeding. More materially, there is no reliable evidence establishing that the transfer was at an undervalue or involved any impropriety.31 On the contrary, I am satisfied that the trustees of the Keller family trust were bona fide purchasers for value of the Depot after Mr Daisley made clear he had no intention of exercising any option to purchase. The transfer was properly recorded, with settlement occurring on 30 April 2014. The transfer value was based on a full registered valuation by a registered valuer. That valuation has not been challenged. The consideration “paid” to Ark was a combination of inwards cash ($200,000) and reduction of debt owed to Electrical Marine Systems Limited for its cash contributions to Ark, all of which are also documented.

[167] Ark has retained only one of the properties transferred by Mr Daisley and SDD under the Ark Agreement, albeit the most valuable. There is no suggestion that any of the other transfers to third parties were other than arms-length transactions to bona fide purchasers. That leaves only the Knights Road quarry over which a constructive trust could, in theory, attach or any identifiable substitute for the properties transferred to third parties. There has not however been any endeavour to show that Ark retains the property in a form traceable by substitution.

[168] This brings into sharp relief the second substantive problem. The type of constructive trust relied on in the pleading is within the class of ‘vindicatory constructive trust’ described by Jessica Palmer as follows:

The effect of a transaction being voided is to create a legal fiction that the transaction never occurred and thus ownership must be located in the transferor. The constructive trust arises to vindicate the transferor’s ownership in circumstances where the legal title has passed and must be reversed. It is a case of recognising subsisting property rights and is not dependant on notions of intention or unconscionability of the transferee except to the extent that a bona fide purchaser without notice will take the property free of any trust because his interest will always defeat the transferor’s subsisting interest.

The claim was fundamentally flawed juxtaposing contract and trust law to wrench a remedy from the mire of the facts.  The plaintiffs, in recognition of the hurdles faced, sought the imposition of an remedial constructive trust over Ark’s property commensurate with their contribution to the property.

A remedial constructive trust does not require pre-existing equitable interests but allows the creation of an equitable property right by way of a remedy.  However, as the arguments were based on the more conventional Lankow v Rose style constructive trust, the arguments did not get off the ground.  For further discussion regarding the scope of constrictive trust cases see Another tributary in the trickle of constructive trust cases 

Claims against the Keller’s lawyer were similarly unsuccessful.

The next cause of action asked whether the Kellers breached fiduciary obligations owed to the Daisleys and SDD Limited.  At this point the table turned.  The court held that once the parties entered into the joint venture recorded in the Ark Agreement, from that point the Kellers owed the Daisleys and SDD Limited fiduciary obligations. The reasoning is set out at [218] to [221]:

[218] However, on execution of the Ark Agreement the relationship fundamentally changed. The Ark Agreement was intended to be a preliminary shareholders’ agreement. The Daisley parties contracted for more than a simple minority shareholding in Ark. They contracted to participate in the development of and the profit potential arising from the subdivision opportunity and the operation of the quarry, among other things. In my assessment, it is arguable once the Daisleys were contractually bound to transfer properties as their contribution to the joint venture, and certainly once the property settlements had taken place, the Kellers had equitable or fiduciary obligations until issue of the contractually promised shareholding. Four factors support this conclusion.

[219] First, Mr Daisley and SDD were particularly vulnerable before any issue of shares because of the imbalance of power through lack of participation in Ark and the relinquishment of legal ownership of the properties transferred to Ark.

[220] Second, the nature of the Ark Agreement required the Daisley interests to repose trust in the Kellers. Contractually, the Kellers had an absolute discretion to determine which of the specific provisions stipulated in the Ark Agreement may be provided for in the shareholder agreement. This compounded the imbalance.

[221] Third, once the properties were transferred, the relationship had advanced to the implementation stage of the venture, ostensibly with the Daisley interests on board. There was a common purpose and a goal to develop the properties for joint profit as evidenced by the operational discussions in late December and early January 2010. Fourth, the venture was ostensibly one in which both participated despite the evidence that the Daisleys’ participation was in fact ad hoc, even fleeting. While characterising the venture as a “joint venture” is not determinative of the question of whether fiduciary obligations are owed, it informs the analysis

[222] Once matters were agreed as at 29 January 2010, the obligation on the Kellers was to issue shares to the Daisley interests reflecting their proportionate contribution to assets in Ark. Once issued, the obligations of each shareholder to the other would have been of a different character. Until that point, in my judgment, the relationship was a fiduciary one. The Kellers were in an analogous position to Mr Fay in Chirnside notwithstanding they considered they had a legitimate reason to withhold the issue of shares. The result of not issuing shares was a de facto appropriation of the venture.

[223] The fiduciary obligations each owed to the other party once the venture had commenced after 29 January 2010 included duties of loyalty and a duty of good faith. Good faith has been described as a facet of the duty of loyalty. As Millett LJ stated in Bristol & West Building Society v Mothew:

The distinguishing obligation of a fiduciary is the obligation of loyalty. The principal is entitled to the single-minded loyalty of his fiduciary. This core liability has several facets. A fiduciary must act in good faith; he must not make a profit out of his trust; he must not place himself in a position where his duty and his interest may conflict; he may not act for his own benefit or the benefit of a third person without the informed consent of his principal.

[224] I also consider that each party had obligations to the other to act equitably to bring the affairs of the joint venture to a conclusion in a way fair to all parties once the point of no return was reached.

Essentially, what this decision sheets home is that all parties to negotiations can fend for themselves.  But once parties are legally committed to a joint course of action where there is a power imbalance, as was the case here, the stronger party must consider and promote, and therefore not abuse, the interests of the weaker party.  Notwithstanding the strict legal ability to do so.

Damages were awarded in the amount  of $541,721 as equitable compensation. This is the value of the Daisleys’ contribution of equity in the venture, which was retained by Ark and thereby enriched the Kellers.  The court was also satisfied that there was a breach of contract.  However, given the decision regarding the breach of fiduciary obligations this was not quantified.

It is imaginable that the Kellers may feel an extraordinary sense of confusion at the result of a good deed that ended so badly.  It is easy with the benefit of hindsight to see how high pressure negotiations between parties who did not have the benefit of even playing field ended up in the mud.  Where matters derailed was when the structure adopted required a departure from the negotiating stance to operating in the new joint venture for the benefit of all parties.

References:

  • Peter Blanchard (ed) Civil Remedies in New Zealand (2nd ed, Thomson Reuters, Wellington, 2011) at 423
  • Daisley v Keller [2020] NZHC 793
  • Jessica Palmer “Attempting Clarification of Constructive Trusts” (2010) 24 NZULR 113
  • Lankow v Rose [1995] 1 NZLR 277 (CA) at 294
  • Bristol & West Building Society v Mothew [1998] Ch 1 (CA) at 18
  • Chirnside v Fay [2006] NZSC 68, [2007] 1 NZLR 433 at[93]

 

 

 

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