Ipsofactoj.com: International Cases [2002] Part 6 Case 9 [NZCA]


COURT OF APPEAL, NEW ZEALAND

Coram

Thexton

- vs -

Thexton

RICHARDSON P

TIPPING J

McGRATH J

27 NOVEMBER 2001


Judgment

Richardson P

(delivered judgment of the court)

  1. The crucial issue in this appeal against the judgment of Salmon J reported at [2000] 1 NZLR 237 concerns the interpretation of s149 of the Companies Act 1993 directed to share dealing by directors. It is whether the purchase by a director who has information in his or her capacity as a director, which is material to an assessment of the value of the shares purchased, is impeachable if purchased for less than the fair value of the shares at the time.

    BACKGROUND FACTS

  2. The transaction was between father and son (who are referred to for convenience as "David Senior" and "David Junior"). David Senior went to work in David Junior's business. David Senior retired in 1995. On the facts as found by Salmon J, David Senior had 19.75% of the shares in the company. He was not a director. David Junior was.

  3. In early 1997, following extensive negotiations conducted by David Junior, the company merged its interests with those of Cerebos Greggs. A new company was formed to carry on the combined business. Around the same time David Senior agreed to sell his shares in the old company to David Junior. The price agreed was $250,000 with David Senior to have the continued use of a company motor vehicle and to be released from certain guarantees. It was common ground at the trial that the fair value of the shares as at 28 February 1997, when the agreement was reached, was $790,000. It was acknowledged on behalf of David Junior at trial that the son, as director, had information material to an assessment of the value of the shares. His argument was that through discussions with him and in reading material relating to merger proposals, his father had obtained all the material information.

  4. After David Senior's death on 4 September 1997 his widow, who at the time of the sale had expressed concern about the amount to be received, instituted proceedings as executor of the will and trustee of the estate.

  5. Following a seven day trial Salmon J rejected various causes of action raised by the pleadings. On the s149 claim, he held that on a proper interpretation of the section Mrs. Thexton was entitled to succeed because the purchase price was less than the fair value of the shares at the time of purchase. The Judge ordered that the plaintiff, Mrs. Thexton, transfer David Senior's shares to David Junior for $790,000, less what had been paid, the value of the car, and the value of the release of the guarantees which the Judge assessed at $10,000.

  6. On the question of liability under s149 the Judge went on to consider information available to father and son respectively at the relevant time. That was in case he was wrong in his interpretation of the section. He concluded that David Senior did not have all the information material to an assessment of the value of the shares to which David Junior was privy as a result of his, the son's, complete immersion in the negotiations. The Judge went on to hold that by failing to disclose material information David Junior had breached the separately pleaded fiduciary duty cause of action.

  7. On the argument of the appeal Mr. Judd QC, for David Junior, challenged the asymmetrical information finding and, as well, the Judge's conclusions as to breach of fiduciary duty. It is convenient, however, to go straight to the interpretation of s149.

    SECTION 149

  8. The section reads:

    149.

    Restrictions on share dealing by directors

    (1)

    If a director of a company has information in his or her capacity as a director or employee of the company or a related company, being information that would not otherwise be available to him or her, but which is information material to an assessment of the value of shares or other securities issued by the company or a related company, the director may acquire or dispose of those shares or securities only if,

    (a)

    In the case of an acquisition, the consideration given for the acquisition is not less than the fair value of the shares or securities; or

    (b)

    In the case of a disposition, the consideration received for the disposition is not more than the fair value of the shares or securities.

    (2)

    For the purposes of subsection (1) of this section, the fair value of shares or securities is to be determined on the basis of all information known to the director or publicly available at the time.

    (3)

    Subsection (1) of this section does not apply in relation to a share or security that is acquired or disposed of by a director only as a nominee for the company or a related company.

    (4)

    Where a director acquires shares or securities in contravention of subsection (1)(a) of this section, the director is liable to the person from whom the shares or securities were acquired for the amount by which the fair value of the shares or securities exceeds the amount paid by the director.

    (5)

    Where a director disposes of shares or securities in contravention of subsection (1)(b) of this section, the director is liable to the person to whom the shares or securities were disposed of for the amount by which the consideration received by the director exceeds the fair value of the shares or securities.

    (6)

    Nothing in this section applies in relation to a company to which Part 1 of the Securities Amendment Act 1988 applies.

    SALMON J's INTERPRETATION CONCLUSIONS

  9. Counsel for Mrs. Thexton had submitted that liability under the section existed once it was established that the shares were sold at other than a fair value and it did not matter whether the same information was available to the offeror as was also available to the offeree. Counsel for David Thexton had submitted that the section was intended to deal with the abuse of insider information and was not intended to apply to circumstances where the parties to the transaction either both had the information or were not relying on it to work out what should be paid; and that fair value in terms of s149 is whatever value two properly informed people put on the shares.

  10. Salmon J accepted that s149 was intended by Parliament to deal with the abuse of insider information but went on to reject Mr. Judd's further submissions and to uphold Mr. Dale's:

    [65]

    There are at least two ways in which Parliament might restrict insider trading in order to prevent the abuse of insider information. One is to require the insider to disclose the information to the other party. The other is to require the insider to trade at a price that reflects the value of the information. There are sound law and economics arguments which suggest that the first of these two methods is the better. Nonetheless, I consider that the wording of s149 points conclusively to the second. Subsection (1) of s149 allows a director to buy (sell) shares only if the consideration given (received) is not less (greater) than fair value. The section is concerned with the price at which the shares are traded and there is nothing from which one may infer a requirement of disclosure.

    [66]

    In my view, neither of the subjective interpretations suggested by Mr. Judd are possible in light of the section's clear wording. I deal first with his submission that fair value is whatever value two properly informed people put on the shares. The Act does not define "fair value". Nonetheless, subs (2) suggests it is an objective concept. The information to be relied upon in determining fair value is information that is known to the director and information that is publicly available. (I accept Mr. Judd's submission that the "or" in subs (2) cannot be intended to be disjunctive.) A subjective interpretation would require information which comes within one of these categories but which is known to both the director and the other party to be nonetheless excluded from the assessment of fair value. However, the subsection clearly does not allow such an interpretation. I note that references to fair value are also to be found in ss80 and 141 of the Companies Act and that subs (3) of s141 suggests an objective definition.

    [67]

    I now turn to Mr. Judd's second suggested interpretation, and the one on which he placed the greater weight, namely that information known to both parties or not relied upon is not "material to an assessment of the value of the shares .... issued by the company". This argument has some attraction. If both parties know information but decide not to rely upon it then this may suggest that the information was not material. Nonetheless, I consider that the argument cannot be made out. If information is material to an assessment of the value of the shares at one point, I cannot see how either its subsequent disclosure or the parties' decision not to rely upon it subsequently makes the information immaterial. In my view, the phrase allows only of an objective interpretation.

    [68]

    I therefore conclude that s149 does not allow an exception where the relevant information is known to both parties or is not relied upon. I am encouraged in this conclusion by extracts from the Law Commission reports. In NZLC PP5 (1987), the Law Commission recommended at para [249] that directors be prohibited from dealing in shares where they have acquired material inside information and that any transaction in breach of the prohibition would be liable to be set aside. However, the recommendation of an absolute bar was modified in NZLC R9 (1989) which provides:

    542.

    The director who is in possession of material price-sensitive information has two options: to abstain from trading or to ensure that the person with whom he or she is dealing receives fair value.

    [69]

    The Law Commission does not mention a third option: to require disclosure of the information. This third option seems to have been adopted in the United Kingdom and Australia where legislation dealing with insider trading contains a defence where the information relied upon is reasonably believed to be generally available. Such a defence is noticeably absent from s149.

    SECTION 149: DISCUSSION

  11. The company law reforms embodied in the 1993 Act, including those relating to insider trading, had a long gestation from the report of the Macarthur Committee in 1973 to the expansive Law Commission studies culminating in its June 1989 report, Company Law Reform and Restatement NZLC R9, which appended a draft Companies Bill 1990; and to the lengthy consideration by the Justice and Law Reform Committee of the House of Representatives of the Companies Bill 1990, including in that regard an extensive submission process and a series of reports to the Committee from the Department of Justice. While cl 113 of the Law Commission's Bill, cl 125 of the Companies Bill, and s149 of the 1994 Act differ in certain respects, s149(1) and (2) are in essentially the same language as the earlier drafts. Certainly there is nothing in the legislative history that could justify any departure from the plain meaning of the statutory provisions.

  12. The reports and the provisions were all directed to the abuse of insider trading. The Macarthur Committee had identified the problem arising from Percival v Wright [1902] 2 Ch 421 which held that a director had fiduciary duties to the company but not to shareholders and, it followed, was not liable to another party for having withheld insider information materially affecting the value of shares in the company which the director bought or sold. But there are different ways in which insider trading problems can be addressed legislatively. At one extreme legislation may prohibit any buying or selling by a director or a person in any other designated position which the legislation presumes will give the holder information bearing on value. Blind trust regimes may be allowed for. Leaving that aside, the legislative choices in various jurisdictions tend to cluster around two approaches: abstain or disclose; and abstain or pay fair value. The interpretation answer becomes a matter of construction of the particular statutory provision.

  13. Section 149(1) proceeds in two steps. The first may be restated in the form of a question to be answered at the time the deal (acquisition or disposition) is agreed on:

    Has the director information in his or her capacity as a director .... being information that would not otherwise be available to him or her, but which is information material to an assessment of the value of shares .... issued by the company?

    If the answer is "Yes", then the second step, the consequence of that answer, is that the director may acquire or dispose of the shares only if the consideration given or received, as the case may be, is not less than or not more than the fair value of the shares.

  14. Three conclusions follow from that analysis of s149(1). The first concerns the availability of information relevant to value. If such information is publicly available but the director also has it in his or her capacity as a director, the answer to the question posed is "No". That is because the information is available to the director otherwise than through his or her position with the company. But the mere fact that a director is willing to disclose confidential information to someone else cannot mean that the information is available to him or her, i.e. the director, otherwise than in his or her capacity as a director. If a director has confidential information it does not matter whether the director discloses that information to the other party. Nor does it matter whether the other party has or has access to that information, except where it is publicly available in which event it will not, of course, be confidential. In short, the statutory control is based on the possession by the director of the information, rather than on its disclosure by the director.

  15. The second conclusion is that information does not cease to be "material to an assessment of the value of shares" once disclosed by a director to a prospective buyer or seller of the shares. The relevant materiality is to an assessment of the value of the shares, which is not the same thing as the ultimate agreed price. Even if the information is disclosed, it is still material as affecting the price willing but not anxious buyers and sellers would consider fair. To put it another way, the price will change depending on whether or not they both have that information.

  16. The third conclusion which follows from the two stage analysis of s149(1) is that, if the question at the first stage is answered "Yes", the consequence is that the director may only buy or sell at fair value (or above fair value if buying and below fair value if selling). Neither disclosure to the other party nor the agreement of the other party can avoid that consequence.

  17. We turn next to s149(2). It is directed to the determination of fair value for the purposes of s149(1). Clearly, both sections must be read together. Section 149(2) reinforces the interpretation of s149(1) looked at on its own. Section 149(2) requires the fair value of shares "to be determined on the basis of all information known to the director or publicly available at the time". There is no qualification or exception where the director has disclosed all or any information to the prospective buyer or seller of the shares. In its terms the subsection implements the abstain or pay fair value premise underlying s149(1).

  18. Section 149(4) and (5) similarly reflect the abstain or pay fair value premise. Where a director buys or sells shares in contravention of para (a) or para (b) of subs (1), the director is liable to the other party for the amount of the difference between the consideration given or received as the case may be and the fair value. In that objective assessment neither disclosure by the director to the other party nor the information available to the other party is a factor relevant to the quantification of the ensuing liability to pay.

  19. In our view there is nothing in the section to support the proposition that a director intending to deal in shares in the company has a duty to disclose to the prospective buyer or seller information material to value which the director has in his or her capacity as a director and that disclosure frees the director from liability and renders the agreed price unassailable. The section does not even contemplate the passing of information from the director to the other party as a consideration relevant to liability or to quantification of the resulting liability for breach. On the contrary, on an ordinary reading of the section at each step the provisions of the section adopt the abstain or pay fair value premise.

  20. Finally, while there may be competing policy views as to the preferred way to deal with insider trading concerns, abstain or pay fair value has some obvious policy advantages. It is a clear rule which has the advantage of simplicity. The Law Commission saw it as clear in para 542 of its report, cited by Salmon J in para [68] of his judgment (para [10] above). So did the Department of Justice in reporting to the Justice and Law Reform Committee on 3 June 1992. It concluded that the clause "permits a director to sell or dispose of shares on the basis of confidential information only if fair value is given which is defined as the value the shares would have had if the confidential information was known to the public". The abstain or pay fair value rule also avoids any arguments as to whether all the confidential information had been adequately conveyed to the prospective buyer or seller and had been sufficiently appreciated by that person.

  21. Two points which were raised in the course of argument, while not militating against these policy considerations, should nevertheless be mentioned. The first is that the director could not obtain protection against the risk of impeachment of the transaction perhaps years later, even by providing a timely independent appraisal and evaluation. In that situation, it was argued, the court should not be able to re-write the bargain. Apart from abstaining and so avoiding the risk, the director could ask the company to release publicly all information material to an assessment of the value of shares or could obtain in advance the board's authority to disclose the "company information" and enter particulars in the interests registered pursuant to s145. This approach would be consistent with the policy behind s149. Fair value must be paid unless the director shows that all relevant information in his or her possession was publicly available. Also, if an independent valuer provided at the time with all information known to the director or publicly available which was material to an assessment of value certified that the price was fair, it would be difficult subsequently for the other party to impeach the resulting transaction.

  22. The second argument was that a strict abstain or pay fair value interpretation would preclude parties in family companies, or family transactions, who both had access to the same confidential information, from settling on less than a fair market value. The short answer is that if the agreed price conceals a gift, that can be no justification for seeking to bypass gift duty implications. The fair value should be stated transparently. If one wants to make the other a gift they can adopt the traditional gift and estate planning course of a sale at market value and the reduction of all or part of the resulting debt by annual gifts.

    CONCLUSION AND RESULT

  23. For these reasons we are satisfied that Salmon J did not err in his interpretation of s149 and its application in this case. In the result it is unnecessary to go into the Judge's alternative information asymmetric assessment and his conclusions as to breach of fiduciary duty (para [6] above) except, perhaps, to note that the difficulty and complexity of the factual assessment in this case highlights the advantages of a blunt abstain or pay fair value rule.

  24. The appeal is dismissed with costs of $5,000 to the respondent plus reasonable disbursements as fixed, if necessary, by the Registrar.


Cases

Percival v Wright [1902] 2 Ch 421

Legislations

Companies Act 1993: s.149

Authors and other references

Report of the Macarthur Committee, 1973

Company Law Reform and Restatement NZLC R9

Representations

G J Judd QC for Appellant (instructed by Stephen Dudding, Auckland)
P J Dale for Respondents (instructed by Grove Darlow & Partners, Auckland)


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