Lost Soul

Negotiation and Customary Law

2012-01-29T17:37:00.003+13:00

This post sets out the relationship between negotiation -- where the substance of a deal or resolution is up to the parties to seek agreement on -- and customary law -- where the substance of the deal or resolution is mandated by reference to the practices of others. It would seem that these forms of dispute resolution are at odds, and have little relationship with each other. However, the two are not in tension, and have a clear logical link.

The wider problem of social co-operation is solved be negotiation. To gain the benefits of the division of labour, we must coordinate specialised and scaled production and exchanges with others. These activities are coordinated by negotiation of all manner of transactions. Each transaction may be effected by binding legal contracts, or by less formal understandings and arrangements. Disputes can arise from the dishonouring of contracts (or non-contractual arrangements), or from conflicting activities that result in losses. The link between negotiation and customary law is the limited scope of any particular negotiation. Because of the costs of negotiation, some terms of the contract are speficially agreed on, while others are agreed implicitly. Although modern contract law has a list of conditions that must be met before a term can be implied into a contract, when it comes to the wider underpinnings of the contractual relationship (or non-contractual social relationship), we can be more liberal in admitting acceptance of the terms of membership of a civilised community as forming part of all dealings. On this basis, the law of the society is implied into every social interaction, and, to the extent that this law accepted by the parties, a good basis for its moral authority is also provided.

Turning to the actual process of resolving disputes, the use of negotiation always remains a possibility. The parties can always settle the dispute by negotiation and agreement. Since a dispute is by definition a disagreement, it can always be resolved by agreement. This applies even in the absence of any legal institutions that can provide an authoritative or final decision binding on the parties to the dispute.

One option for all disputants is not to agree on the substantial matter under dispute, but to agree on a procedure to settle the dispute. Typically this procedure will involve a third party who can assist the parties to negotiate more reasonably, or ultimately render a decision binding on the parties. Again it should not be assumed that negotiation and third party determination are at odds. Typically, any third party will only make a decision for the parties if the negotiations have been unproductive and are believed will take too long or cost too much to justify further efforts.

It is only a short step between negotiation and customary law. The custom of dispute resolution is to negotiate, and in the absence of an agreed solution after some effort at negotiation, the next thing any third party facilitator will do is to suggest what accommodations the parties could make to resolve the dispute. Such suggestions are suggestions not primarily about what would be a fair or just resolution to the case, instead they are suggestions about what concessions or accommodations reasonable disputants would accept in the dispute. Customary law boils down to not much more than this:

For procedural law: what procedures would a reasonable disputant accept in resolving disputes such as this? and
For substantial law: what accomodiations, positions and concessions would a reasonable disputant hold or offer in resolving disputes such as this?

From this stand point, customary law means law princially by negotiation. In the vast majority of cases, one would expect negotiation would be the full solution to all social issues including disputes, it is only as a back up that the customs of others are imposed, and these customs are the customs of negotiating disputants.

Allan Hubbard's Life and Death

2011-09-04T17:46:00.005+12:00

Death forces us to confront the meaning of life, which is perhaps why death is so full of euphemisms and other ways of sugar-coating its sting. The death of Allan Hubbard is no different: it forces us to think of not just what he did, and the trouble he faced, but who he was.

Who he was to those who knew him personally, to those whose lives he touched by his donations, his financial accommodation, to those who counted him dear and to those who admired the good things he did, is, to some extent, not the answer to this question. It is these people, and their image of him, or personal experience with him, that we do not want to upset by speaking ill of the dead. We don't want to take away who he was to them by contradicting how they wish to remember him.

Of course those who knew him personally, or whose lives were touched by his dealings, and came away with adverse perceptions of the man exist, but take his death as an opportunity to show some tact and restraint towards those for whom Allan Hubbard was a different man. They don't speak ill of the dead but not because it changes their perceptions.

More than most, Allan Hubbard was a man who, when in financial trouble and accused of an expanding list of misdeeds, created a gulf between those who were convinced he was an honourable man and those who thought he was intentionally engaged in serious and complex fraud over a long period of time. This polarisation of opinion highlights the difference between who he really was, and who he was to those who knew him or knew of him.

In reality the man was an enigma. We don't know who he was, or what was really going through his head when he was doing the doings that earned him praise or those that resulted in criminal charges. In the same way we don't know what was really going through the minds of those who are accused of persecuting him either.

I've always analysed Mr Hubbard's affairs and accusations with the nagging doubt that I can't figure the man out. Sure I've got theories, but none have the status of knowledge, and few would even have the status of belief. The biggest unanswered question about is about the man himself rather than his conduct: Is Allan Hubbard a fraud, is the perception and image just a handy facade for building a business empire operated with widespread corner cutting, obligation breaching and trust-abusing practices? If I answered this in the affirmative, it would have to be the most total dismissal of the man and his life and work. Of course I never answered my question, probably never would have, and now never will.

Being unable to answer the question of who Mr Hubbard really was with any confidence brings me to two places:

back to who he was to us, and
what lessons can we make from his life (and possibly, his death).

Out of respect for those who knew or admired the man, I'll not comment any further about who Mr Hubbard was to them, or how they wish to remember him. If they want to believe that he died with a clear conscience, I'll not question their warrant for believing it. Likewise for those who want to remember him as being one of the finest or most honourable men in New Zealand.

This leaves us with some more general lessons we can take from his life and death:

No one forced us to trust Mr Hubbard or invest money with him. Even if Mr Hubbard let down people who trusted him or invested money with him, it is not solely Mr Hubbard's fault. We should be careful who we trust and how much we trust them. This applies not only to money, but with power. As absolute power corrupts, blind trust in anyone is an invitation to be visited by human frailty. (I should write a lenghty rant about governance here but I'll save that for another day).

The virtue of simplicity of affairs is also a lesson from Mr Hubbard's life. Whether it was a complex web of deceit or a complex web of mismanagement (or a complex web of mismanagement and deceit), the result of complexity is often poor. Complexity can hide both mismanagement and deceit. Simplicity and transparency are the anti-dote.

If we're going to have a government, and I'm not a fan of the idea despite its popularity, it should keep well away from regulating and supervising and guaranteeing or insuring financial instruments or financial institutions. Many of the highly questionable transactions and practices of South Canterbury Finance while it was distressed would not have happened if the Crown Retail Deposit Gurantee had not been put in place. Sure the company would still have failed, but sooner and with a lower toll of financial and social loss.

The final lesson is that we should question the merits of punishing people who are associated with business failures. Punishment is expensive, and its effectiveness is questionable. That is not to say there should not be consequences for failure, but those consequences need not involve trying people on criminal charges, putting people in jail and so forth. I'll not elaborate on the manner in which investors can get remedies from wrongdoers or avoid suffering wrongdoing in the future, as they are manifold and complex. The point is that the use of criminal prosecution and punishment involves a regressive and legalistic approach to our problems in life and to those who do wrong or are accused of it. This approach polarises people and creates needless contention in society. It raises the stakes and creates a highly adversarial and legalistic environment rather than promoting an open-ended process of seeking composure of disputes, work out of problems and restoration of peace to the community.

Tripe on OBR de minimis

2011-07-09T08:16:00.005+12:00

Today's news article Freezing deposits plan slammed, David Tripe criticises the RBNZ's Open Bank Resolution policy as causing 'widespread hardship'. This is fairly surprising, as the proposal incorporates a facility for a de minimis that would shelter small depositors from taking any losses. The figure I've heard suggested was $20k, but David Tripe suggests a figure of $50k which he suggests would 'ring-fence 30 per cent or 40 per cent of the bank's assets'.

The problems with a discretionary, political and de facto de minimis are numerous:

The impact of the policy in shifting risks and losses, if David Tripe's suggestion of 30-40% of bank assets, is far more than de minimis. This amounts to a major redistribution of the bank's losses and would very substantially reduce recoveries for large creditors.
The discretionary and political nature of the de minimis is a licence to screw institutional investors to save 'mum and dad investors.' In this environment the bank's capacity to raise money in wholesale markets at reasonable costs could be compromised.
The pre-positioning policy, especially with the Settlement Before Interchange system for retail payments, means that it is feasible to apply the haircut to all deposit accounts en masse with minimal disruption to bank customers and the financial system.
The policy lacks a sound legal basis. Bank customers and depositors are creditors of the same class and rank, and must, according to law and equity, be treated equally, i.e. according to the pari passu principle. It is necessary to change the de jure ranking of small depositors in order to safely implement the de minimis scheme.
Even Allan Hubbard's statutory managers, who are not directed to consider preserving the ranking and position of creditors (under the Companies (investigations and management) Act rather than the Reserve Bank of New Zealand Act), recognise that they cannot play favourites with creditors of a person in statutory management (see http://www.lostsoulblog.com/2011/07/statutory-managers-no-longer-playing.html )

See section 5 of my submission to the RBNZ for more on this.

Statutory Manager's SCF claim: WIll it pay off?

2011-07-07T16:55:00.003+12:00

The Seventh Aorangi Statutory Manager's report states that Aorangi will be making a major claim on assets that were contributed as capital to South Canterbury Finance. I believe the principal means by which this transaction took place as the issue of $67.2m in preference shares in South Island Farm Holdings Ltd (SIFHL). The transaction was reported as follows in the 12th April 2010 SCF prospectus in notes 25 (i) and 26 (v).

There appears to be two ways this transaction could have been done improperly, and the results in terms of remedies are opposite.

Before explaining the posible course of the transactions, the history of the company and its shareholdings and directors will be explained. The company was incorporated on 9th March 2009, with 10,000 shares held by Forresters Nominee Company Ltd and Mr and Mrs Hubbard as directors. Forresters Nominee Company Ltd was directed by Mr Hubbard and 2 other directors at the time. This shareholding was then transferred to Mr Allan Hubbard on an unknown date before 15th June 2009. On the 4th May 2009, 67,200,000 preference shares were issued to SCF (see the second page of this for the share register copy).

The first way is as follows: SIFHL was set up as an entity to hold 21 farms, and Mr Hubbard or Forresters Nominees Ltd held the shares in the company as nominee or trustee for Aorangi or other outside investors. Mr and Mrs Hubbard, as directors, we'll assume in this illustration, then stripped out the ordinary share equity by way of an issue of preference shares for nil consideration, and either did not comply with section 44 of the Companies Act or more likely this section didn't apply (the company either has no constitution or it failed to comply with section 32). Alternatively, Mr Hubbard may have signed the approval as shareholder despite this being a breach of trust.

The first way gives the investors, as far as I can find, only one remedy under the Companies Act: a claim under section 298 (2) against SCF. However, this would amount to an unsecured claim on an insolvent company that is going to pay unsecured creditors 0c in the dollar. The investors would also have a claim against Mr Hubbard personally for any losses caused by breach of trust or other wrongs, which claim would be paid possibly some dividends from Mr Hubbard's personal insolvency. (Mr Hubbard could also be criminally liable for breach of trust or fraud.)

The second way is this: SIFHL held the farms as nominee or trustee on behalf of Aorangi or other investors. This would mean that SIFHL would not have any substantial equity in these farms. Mr and Mrs Hubbard, under this scenario, may have nevertheless included the assets and liabilities as company assets and liabilities, and not disclosed the trust or nominee relationship with the investors, and thereby booked the equity in the farms as belonging to SIFHL. The issue of the preference shares to SCF could therefore be a valid transaction except that the company didn't have the equity purportedly injected into SCF, i.e. SCF got apparently worthless preference shares. In this scenario, the investors still have beneficial ownership of the farms and SCF has nothing. SCF would have a claim on Mr Hubbard for deceit, and Mr Hubbard could also be criminally liable for fraud, and so SCF would share in any dividends from Mr Hubbard's insolvency.

It is hard to say which of these scenarios, if any, are the more likely. I'd guess some lawyers will be busy for a while getting us some answers.

Statutory managers no longer playing favourites

2011-07-02T16:36:00.005+12:00

The seventh Aorangi Statutory Manager's report dated 29th June 2011 records a reconsideration of their previous plans to allow Mr Allan Hubbard, also in statutory management, to play favourites among his creditors. The sixth report dated 4th March 2011 presents the plan as agreed in principle and pending formalisation:

'The formalisation of this process is in progress. This is being conducted in three parts:

A global “pledge” by Mr and Mrs Hubbard is to be sent to their solicitors to confirm acceptance and to formalise the promises Mr Hubbard has made.
The annulment of transfers of shares to Charitable Trusts in conjunction with the other farming shareholders.
Mr and Mrs Hubbard’s interests in various assets are to be transferred to Aorangi for the benefit of investors. These assets have a recorded value in the region of $50-60 million, and are already included in the Aorangi portfolio.'

But in seventh report, the deal has been called off:

'In our introduction to this report we commented on the difficulty being encountered with the purported introduction of Hubbard Interests into Aorangi. Most of the Hubbard Interests recorded in Aorangi were introduced by way of journal entry. There are no records of cash transactions in return for the introduction of the Hubbard Interests. Legal advice provided to us means that we cannot rely upon the purported transfer of Hubbard Interests into Aorangi at this time and as a result, and given the financial position of Mr & Mrs Hubbard, Aorangi investors may face a large shortfall. This means that any proceeds from the disposal of these assets cannot be repaid to investors until the financial position of Mr Hubbard is known, which may take some time and may be subject to dispute from personal creditors.'

So what happened between the 4th March and the 29th June? I've been expressing reservations about the legitimacy of the distribution of Mr Hubbard's estate, for example in a comment 26th May 2011 here and on the 30th May 2011 I wrote to the statutory managers an email as follows:

Hi,

I'm wanting to ask the Statutory Managers of Mr Allan Hubbard about the subordination of his interest in Aorangi Securities to investors. As the Statutory Manager has reported Mr Hubbard as being insolvent, this use of Mr Hubbard's assets benefits some creditors at the expense of others. I'm interested in the Statutory Management of failed registered banks under the RBNZ Act rather than the Corporations (Investigations and Management) Act, and the RBNZ's proposal to apply a de minimis to depositor haircuts. Other than this case of Mr Hubbard's interest in Aorangi Securities, I am unaware of any other cases where a statutory manager has systematically and intentionally favoured some creditors of a person or entity under statutory management at the expense of others. I understand that in other insolvency contexts such as receiverships the insolvency practioners have no liberty to favour some creditors at the expense of others as compared to their rights and rankings under insolvency law. So, I would like to hear from one of the Statutory Managers about their perspective on the issue of fairness between different creditors in the Statutory Management context and in the context of other insolvency institutions such as company liquidations and receiverships. E.g.:

Concerns of the Statutory Manager in allowing Mr Hubbard's disposition of his interest in Aorangi Securities, such as what level of concern did this create, did they seek legal advice on the issue, what were the factors considered in allowing this disposition etc. Or, put another way, how close were the Statutory Managers from refusing the disposition?
Comments on the extent to which statutory management law/practice differs from company liquidations, receiverships and bankruptcies etc. (e.g. does or should the legal contrast impact on the practice, or to what extent?)

I also note that the Reserve Bank of New Zealand Act includes 'preserving the position of creditors and maintaining the ranking of claims of creditors' as a consideration for Statutory Managers (http://legislation.govt.nz/act/public/1989/0011/latest/DLM144947.html ) but no such provision applies under the Corporations (Investigations and Management) Act (see http://legislation.govt.nz/act/public/1989/0011/latest/DLM144947.html ). If the statutory managers were appointed to a failed registered bank, would this difference be significant to the issue raised in my email?

The reply from the statutory managers was:

The points you raised will be covered in the next report to investors due out at the end of this month.

On the 30th June I made a submission on the RBNZ's Open Bank Resolution policy that included the following criticism of the RBNZ's de minimis plans:

5. Dubious de minimis

The proposed de minimis rests on shaky ethical, policy and legal grounds. It firstly offends against the most fundamental concept of equity in insolvency law: the pari passu principle. Equitable treatment within a class of creditors or shareholders is a pervasive requirement of company law and insolvency law. It offends not only against company law to pay dividends to shareholders of the same class on any basis other than shareholding, but against equity and common sense as well. The same applies to payment of creditors of the same class other than on a pari passu basis.

It is not surprising that there is absolutely no precedent for any insolvency procedure to systematically and intentionally undertaking post hoc re-ordering of creditor claims. (footnote 1) It is important to note that in the wider policy and legal context, preserving the position and ranking of creditors is normally considered inviolable. Not only are exigencies considered inadequate to violate creditor rights within classes, insolvency law goes as far as voiding transactions to "support the system of collective realisation and thereby the underlying pari passu principle‟ (MED, 2005). In this context the proposed casual and back-door violation of the principle is rather puzzling.

The statutory manager is required to resolve the affairs of the failed bank and to consider "preserving the position of creditors and maintaining the ranking of claims of creditors" as far as possible. (footnote 2) Elsewhere in insolvency law and policy there is absolutely no room for any liquidator, receiver, administrator or bankruptcy trustee to effect a post hoc discretionary re-ordering of creditor claims, regardless of exigencies. A de minimis also has not been anticipated in discussions on insolvency procedures including Statutory Management, for example the Law Commission's 2001 report to the Ministry of Economic Development on insolvency law has no mention of it as a criticism of statutory management or elsewhere in the report.

Finally, it would appear that the pre-positioning of a bank would enable it to treat all time-critical liabilities of the same ranking equally, regardless of size, further undermining the rationale and justification for applying a de minimis.

Clearly a de minimis would make the following statement in the consultation document
false: "The haircut process has no impact on the ranking of creditors that would apply in
a conventional liquidation." (25)

This leaves only one official argument in favour of a de minimis that I know of:

a de minimus [sic] limit could effectively deal with a large number of small
accounts that would be costly and time-consuming to separate into frozen and
released funds. In New Zealand the statutory manager has the power to impose
a de minimus [sic] limit and have a non-parri passu [sic] treatment (see Section
3.2) provided it is consistent with the considerations he or she must have regard
to when exercising his or her powers. (Pre-positioning for effective resolution of
bank failures, RBNZ, 2007, 3.4.1 (i))

This argument indicates that the issue is not the balance of the account, nor even the
number of accounts affected per se but the number of transactions in progress at the
time the statutory manager is appointed. In section 3 I provided an alternative approach
to processing pending payments that should be feasible to perform for all transactions
on all accounts. This means that the haircut procedure can be applied pari passu to all
bank customer account balances, eliminating the need for the statutory manager to
balance competing objectives. Also the Settlement Before Interchange (SBI) procedure
will significantly reduce the number of transactions "in the pipeline" at the point of failure.

It would appear that the de minimis policy is being suggested or justified on other –
unstated – grounds. Perhaps it is a market discipline efficiency argument: small
depositors have less incentive to monitor the bank's creditworthiness and therefore
provide less market discipline as compared to larger investors. A de minimis for small
depositors shifts the risks to larger creditors and "enhancing the disciplines on banks
which are naturally present" (Statement of Principles Bank Registration and Supervision,
6)) . Alternatively, a political/compassionate argument that smaller depositors ought to
be sheltered from losses. It can be good politics to shift the losses to the "rich" and
institutional investors rather than "mum and dad" investors/households.

However, neither of these two arguments are strong, and the second shows a distinct
danger: if the government can set the de minimis amount, it is basically a political
licence to screw institutional investors and the rich to save "mum and dad" investors by
setting the de minimis at a high level (e.g. $500k). The first argument is also too weak to
be sound, as it is not a consideration listed in s 121 of the Reserve Bank of New Zealand Act.

This leaves policy makers with two options:

Abandon the policy and go back to pari passu. This would also reduce the scope of pre-positioning requirements.
Increase the de jure creditor ranking of small depositors to by a provision in the security trust deed or by a statutory preference.

footnote 1

That is other than the subordination of Mr Allan Hubbard‟s interest in Aorangi Securities Limited to investors in Aorangi Securities Limited by the Statutory Manager – an instance I find dubious rather than an example to follow. I have sought comment from the statutory manager about this and have been told a response will be included in the next Statutory Manager‟s report due 30 June 2011. This report will be released in early July. It is also possible that the Statutory Manager of Idea Services Limited and Tamatia Hou Limited may be paying, or may intend to pay, its suppliers ahead of the class of employee creditors owed money for under-paid sleep-overs, However this cannot be determined as Sir John Anderson, the Statutory Manager, has not issued any reports and the resolution of its affairs is incomplete.

Footnote 2
This clause is in the Reserve Bank of New Zealand Act, which provides for Registered Bank Statutory Managements, but is not in the Companies (Investigations and Management) Act under which the possible cases of post-hoc re-ordering of creditor claims occurred in Statutory Managements.

Royal Justice: A Litigant's Experience

2011-06-03T13:34:00.008+12:00

Yesterday we resolved a dispute with a former boarder from late last year, and the experience illustrates the consequences of the dominance of royal courts on dispute resolution, and the organisation of the royal courts into a formal hierarchy applying a body of rules under the stare decisis doctrine. I will contrast this experience with the alternative of a non-royal tribunals resolving disputes under customary law (i.e. anarchist institutions).

We had a private boarder staying with us who proved unsuitable for our household and family, so we gave him 3 weeks notice to leave, as per the contract terms. After about a week, his behaviour became intolerably obnoxious so we asked hm to pack up his things and leave immediately. He refused to leave so we called the police, who refused to remove him and threatened to arrest me. We then locked him out and packed his things for him and put them out for him to collect. He packed them in his car and parked up in our driveway next to our house. When he left the car we had it towed. He got his car back and parked it up again, and so we had it towed again. About a month later we received a Disputes Tribunal case in the mail claiming for his bond, missing and damaged personal items, tow fees and damage to his car, about $2,500 all up.

Although the substantial law the case was decided on was nothing unusual or controversial, what was remarkable was the quality of the service provided and the process that was followed. Our former boarder, Mr Greening, tried to file the case in the Tenancy Tribunal, and here is where the issue of jurisdiction started: under the royal courts, competition between royal courts has been eliminated as each court's jurisdiction is non-overlapping. The Tenancy Tribunal rejected Mr Greening's case as he didn't provide a tenancy agreement -- a document Mr Greening appeared to have lost (actually it was a boarding contract). The Tenancy Tribunal told him to file in the Disputes Tribunal.

The Disputes Tribunal hearing was conducted by a referee Mr Gower, a very strict man who liked to use a lot of legal jargon without explaining it. I'm sure Mr Greening had no idea what the terms 'repudiation' or 'bailment' meant and Mr Gower didn't explain them. He also liked to apply common law and statutory legal rules with a very high degree of strictness (despite not being 'bound to give effect to strict legal rights and obligations or to legal forms and technicalities'). Soon after opening the proceedings, when he found out that I wanted my wife to be joined as a party to the case and that I intended to set off the bond against damage caused by Mr Greening, he threatened to award costs against me for not having filed a counterclaim or a request to join my wife as a party. The legal rule, Mr Gower said, was that only undisputed debts could be set off, and this rule was to be applied strictly. Mr Gower was also an adjudicator in the Tenancy Tribunal.

Mr Gower became concerned that the Disputes Tribunal may not have jurisdiction to hear the case, as the Tenancy Tribunal may have jurisdiction. Despite being a Tenancy Tribunal adjudicator, he felt it necessary to refer the matter to the Tenancy Tribunal to rule on whether or not it had jurisdiction - this being the designated tribunal to make such a ruling on jurisdiction. Mr Greening duly re-filed his case in the Tenancy Tribunal and we filed a counterclaim and requested both my wife and I to be parties to the case.

The Tenancy Tribunal adjudicator was a lady who appeared to have some difficulty in deliberating on whether or not the Tenancy Tribunal had jurisdiction. Mr Greening had nothing to submit, and I submitted two arguments, one that we were a 'boarding house' and came under the recent legislation (which allowed us to terminate a boarding house tenancy immediately for a serious breach) and another that we were exempted by a provision for properties primarily used as the landlord's residence, which would send us back to the Disputes Tribunal. She appeared to want to avoid putting us under the provisions of the Residential Tenancies Act and decided that we had discharged the burden of proof to show the house was primarily the landlord's residence. The decision appeared to stretch the otherwise rigid legislation and common law rulings under the stare decisis doctrine.

Yesterday, back at the Disputes Tribunal, the substantial issues were resolved by a new referee, Mr Kay. Mr Kay told us Mr Gower had asked for the case to be re-assigned because he was a Tenancy Tribunal adjudicator also. Somehow, we are supposed to have a better service from someone who is less familiar with the area of law concerned. Mr Kay's style was very different from that of Mr Gower. Mr Kay used little legal jargon, and he explained the terms he did use. Mr Kay looked for a prompt, reasonable resolution rather than attempting to follow every particular legal rule strictly. He appealed to custom rather than legal rules in allowing us to set of the loss caused by Mr Greening's breach of contract against the bond balance of Mr Greening. He also found the easiest way to resolve the case: he said Mr Greening's case was too weak, and that he did not discharge the burden of proof (a nice legal way of telling Mr Greening he didn't believe him).

How would this dispute have played out in an alternative legal system of competing private tribunals under customary law?

Firstly, the question of jurisdiction would be much less important: any tribunal that wanted the business and could get at least 1 party to the dispute to agree to accept its jurisdiction could have heard the case. This could have avoided the need to go back and forward between tribunals looking for the sole tribunal with the authority and capacity to resolve the dispute.

Secondly the dispute would not have been determined by appeal to legislation and case law. Put another way, the pretense of upholding the 'rule of law' would no longer apply. In the absence of legislation and binding case law would have been three approaches: negotiation, custom and innovation. Negotiation is always a possibility for resolving any particular dispute. By definition, a dispute is a disagreement, so it can be ended by agreement. Custom is applying the practices of people dealing with issues successfully or tolerably well in the past to the present dispute. Such past resolutions, if they are accepted in the community and by the parties, create valid expectations that they are likely to be applied in future disputes of the same nature. Innovation is trying new techniques or rules for resolving disputes as a feature of the service selected by the parties or for resolving new types of disputes.

Thirdly, in addressing the immediate conflict when Mr Greening refused to vacate the house, it would not be the Royal police attending, but a private security agency. Even if I was a difficult customer, I would not expect such an agency to threaten to arrest me, as the police did several times. Indeed my previous experiences with the NZ Police have also involved actual rather than threatened unnecessary and illegal use of police powers against me. A private security agency would probably perform two functions: firstly, it would seek to make or keep peace through negotiation. The NZ Police did not attempt any negotiation whatsoever in this case, we tried it several times though the ordeal, both directly and through other people including even the local MP (who accurately foretold us Mr Greening would sue us, and use the police against us). Secondly, it would assist people to exercise self-help legal remedies such as the eviction of trespassers, effecting lock outs, removal of chattels, and defence of land, people and property. The tow companies were examples of this: they both towed away Mr Greening's car on my orders and at Mr Greening's expense. Such an agency would be careful to act lawfully, because goon-squad behaviour would result in costly settlements for wrongs.

Statutory Management: Will it work for Open Bank Resolution?

2011-05-20T15:48:00.008+12:00

Would statutory management of a failed bank actually work? It appears that this institution is so rarely used that we can't really be sure, unlike the institution of receivership which I suggested as being better suited to Open Bank Resolution.

'The main purpose of bankruptcy and liquidation systems is to provide for an orderly, compulsory and collective realisation of a debtor's assets' (MED, 2005). Statutory Management provides a compulsory and collective realisation of the assets and business of a failed registered bank that incorporates consideration of wider market and financial system damage concerns and provides an alternative to the more conventional institutions for resolving insolvent companies such as receivership and liquidation.

The key features of statutory management of failed banks are:
• It over-rides other resolution institutions by suspending creditors' other remedies.
• It provides priority to new obligations incurred after the commencement of the statutory management.

Both of these features appear to be designed to enable the statutory manager to continue the bank's access to the payment system, provision of payment services to its customers and its access to funding to restore its liquidity. I make this inference based on the assumption that the 'damage to the financial system' the regime is supposed to avoid primarily refers to the disruptive effects of a loss of payment services to a substantial portion of households and businesses that may rely on the single failed bank for access to the payments system.

The specific provisions of statutory management, as they related to the proposed Open Bank Resolution procedures are listed below with my comments and concerns.

Moratorium (s 122)
This section suspends the rights of creditors in respect of the bank's obligations as at the time the statutory management began – the exclusive remedy for creditors is to wait for the statutory manager to pay them, or to receive a claim on a successor entity that has purchased the bank's assets and assumed its liabilities. This applies to secured creditors as well as unsecured creditors. Creditor rights and remedies for obligations 'in relation to an obligation incurred or a right granted under a deed, instrument, trust, or contract entered into by a registered bank after the date on which, and the time at which, that registered bank was declared to be subject to statutory management' are excluded from this moratorium.

The concern is about the effect of a purported 'freezing' of a part of a customer's balance on current account, and a purported 'release' of the remaining balance in the customer's account as at the time the statutory management began. The statutory manager may effect this 'freezing' and 'release' by debiting the customer's account by the amount 'frozen' and enabling the customer to continue using the account to make and receive payments.

The customer's right to repayment of the balance at the time the statutory management began is on account of earlier deposits less withdrawals. The bank and the statutory manager has no right or power to convert a portion of a creditor's claim into a subordinated claim on the bank, so any debit the statutory manager unilaterally makes to the customer account, as part of the proposed OBR procedure, has potentially no legal basis or effect. In the same way the purported 'release' of the rest of the account balance has no legal effect as the statutory manager has no specific power of release, and any amount released was already owed to the customer before the statutory manager was appointed.

The practical effect of the part 'freeze' and 'release' of the balance is to enable the customer to continue to operate the account to receive and make payments. The rule in Clayton's case is that the bank's payments to the customer discharge the oldest deposits first when the account is in credit. The oldest deposits will include all pre-statutory management deposits, including the purportedly 'frozen' funds, before any of the post statutory management deposits. To illustrate this, consider the following hypothetical example, showing the bank's records and comparing this with the legal position if the rule in Clayton’s case cannot be avoided by the failed bank.

The customer's $100k of pre-statutory management funds has now been fully withdrawn because the second $50k withdrawal discharges the oldest funds first, and the Statutory Manager's $50k debit had potentially no legal effect. The customer can now enforce his 'inaccessible' $50k balance against the bank.

By contrast, a customer who did not operate his account has no protection against the Statutory Manager deciding to 'freeze' some more of the customer's funds in the bank later. The purported 'release' by the statutory manager does not give the customer any legal rights he did not already have against the bank, and as the bank's obligations were not incurred after the statutory management, nor were they granted to him by the statutory manager's purported 'release'. Such a customer has a good reason to withdraw his funds and re-deposit them even if the rule in Clayton's case does not apply.

The principal counter-argument is to say that the bank has a right to determine the appropriation of payments made from the account, and that by debiting the 'frozen' amount to a separate 'suspense' account that bank has made a valid election that this amount of the pre-statutory management funds are not being paid when the customer continues to operate the account. The statutory manager's right to suspend and pay debts is clear from sections 127 and 131 respectively, however the validity of this proposed use of the powers depends on the bank's right of appropriation over-riding the rule in Clayton's case. I’ll examine this next along with section 127.

Suspension of money owing (s 127)
The statutory manager may: ‘suspend in whole or in part the repayment of any deposit, or the payment of any debt, or the discharge of any obligation, to any person’ without breaching or repudiating any contract. Obligations incurred by the bank or the statutory manager after appointment of the statutory manager can’t be suspended under this section. There are several difficulties with this section.

Firstly, there is no reference to any notice given or to be given by the statutory manager when suspending payment, in contrast with section 22 of the Insolvency Act 2006 – this being the principal or only other reference to suspension of payment of debts in New Zealand legislation. Without a reference to notice, the suspension of payment would appear to be an action by the failed bank in contrast with the action of paying creditors under section 131.

Secondly, there is no indication of the legal effect of the suspension or any notice of suspension given by the statutory manager, or of any debit made by the statutory manager to a creditor’s current account. This leaves us in the dark about whether the rule in Clayton’s case applies to any subsequent current account transactions.

Thirdly, there is no safety for bank creditors on the unsuspended amounts. There is nothing stopping the statutory manager having another bite at the cherry. For example, if a creditor was owed $100,000 on term deposit, and the statutory manager purported to suspend 50% of the amount owing by public notice, the statutory manager can suspend another $20,000 of the term deposit at a later date if it has not yet been repaid.

Fourthly, the suspension of any amount owing does not change its ranking, nor the ranking of any unsuspended amounts. Combined with the power of the statutory manager to be selective, this can lead to problems in treating different creditors fairly. It would appear to be a fairer approach to have a more prescriptive and an entity wide power of suspension and release which would operate something like this:

The suspension and release would be made with reference to the registered bank’s capital structure e.g. 100% of all subordinated creditor claims and 30% of all unsecured unsubordinated creditor claims (perhaps with a de minimis if you must)
The RBNZ must make an assessment and recommendation on the aggregate amount of losses/capital to be provided for and the allocation as part of the recommendation to place the bank in statutory management unless this is not possible.
The Statutory Manager must make a suspension and release order or notice within 1 business day of being appointed, and before re-opening the bank (if applicable)
The legal effect would be to legally suspend these amounts as from the time the statutory manager was appointed, and to void any payments in contravention of the suspension, with a power to recover any amounts paid in excess of the suspended amounts and charge interest on any unrecovered amounts (to ensure fairness)
The amounts not suspended would rank equally with new debts, i.e. in priority to other debts.
The statutory manager could release more over time but could not suspend any more than the initial amounts suspended.

Fifthly and finally the section does not apply to pre-statutory management suspension of payment. Previously there has been some suggestion that the RBNZ use its direction giving powers pre-statutory management:

In New Zealand, one way to minimise the extent of transactions “in the pipeline”
when statutory management is declared is for authorities to use their
direction-giving powers ... to direct the bank to close its customers’ access
channels prior to it being put into statutory management. Fewer transactions “in
the pipeline” at the point of statutory management reduces the scale of any
sorting of transactions into pre- and post-statutory management groups.
(Pre-positioning for effective resolution of bank failures, RBNZ, 2007)

The result is that customer remedies may differ from the situation of the statutory manager suspending payment: it will be a breach (or possibly repudiation) of contract. Of course there is always the chanceof the bank running out of cash and suspending payment before being put into statutory management.

Obligations Incurred by statutory manager (s 145)

This section provides priority to new obligations incurred by the bank while under statutory management. The resulting or desired capital structure of the failed bank from this clause is unclear. As noted, this provision does not apply to any amounts ‘released’ by the statutory manager, and may inadvertently apply to amounts ‘frozen’ by the statutory manager if the rule in Clayton’s case cannot be avoided on current accounts. This is in contrast to the situation under a receivership where the trust deed can make express position for the ranking of creditors and creditors can rely on their ranking to know their position with certainty.

The section only gives priority to new obligations in a liquidation or winding up, and there are other possible resolutions of the failed bank and its business, e.g. subsequent receivership, assumption of liabilities or amalgamation or restructuring/creditor compromise under company law.

This section should, if properly drafted and supported by pre-positioning, enable the failed bank to continue its business while the statutory manager is resolving its affairs without the need for loans or guarantees from the Crown. The issues raised above make it questionable whether the failed bank could continue to operate under statutory management.

Unwinding the Helicopters NZ transaction: an analysis

2011-05-04T17:42:00.003+12:00

With the news that both Helicopters NZ and Scales Corp shares have been sold, South Canterbury Finance's Feb 2010 acquisition has been fully unwound. This presents an opportunity to evaluate the amounts realised as compared to the related party transaction value, and the impact on the pre-existing loan and exposure to Southbury Group and Southbury Corp.

To get started with the analysis requires a measure of the fish-hooks in the Helicopters NZ sale. I have this from a confidential source I'll not name who got it from Goldman Sachs: $145.3m. This figure was the 'net debt', being cash less borrowings, that were excluded from the deal. The borrowings included loans from SCF as well as third party borrowings (e.g. UDC).

The total proceeds were:
Helicopters NZ $160m
Scales Corp shares $44m
Total $204m

Subtracting the value of the 'net debt' excluded from Helicopters NZ and the $20m of preference shares SCF held in Helicopters NZ gives net proceeds of $38.7m. This can be compared to the $162.5m in value ascribed to the assets when they were acquired by SCF.

Here's where it gets a bit tricky in analysing the Feb 2010 acquisition transaction: if the assets are not valued at $162.5m but at their realised value of $38.7m, it makes Southbury Corp and Southbury Group insolvent and the $77.2m loan from SCF impaired. I've added a couple more columns to my spreadsheet showing what happens when realisation values are used, see here. Whether the transaction took place or not, this money was gone at these asset values. So what's the difference between the transaction happening, and it not happening? The answer is:

The $10m paid for the assets would have been saved, and
The $15.6m third party debts of Southbury Corp would have absorbed up to $3.9m in losses, saving SCF this amount

This analysis comes from comparing the actual realisation with the same realisation by Southbury Corp, see here for the details.

The conclusion of the analysis is that, should the values attributed to the assets not be recovered, the transaction cost SCF $13.9m rather than providing benefits of $11.8m I calculated in June 2010 using the higher values. Officials do not appear to have assessed the transaction fully: no consideration was paid to the recoverability of the loan and other exposures to Southbury Group and Southbury Corp, or the impact of lower recoverable values on the assets acquired. For all the insight and foresight Treasury displayed during this episode, they swallowed this deal hook-line and sinker. They booked $150m in benefits from the transaction that resulted in additional losses of $13.9m.

Unwinding 'Systemic Support' from Big Bank Ratings

2011-03-22T19:25:00.002+13:00

I've always been perplexed at how the big credit rating agencies respond to the distress of a large bank: typically they might reduce the rating from, say, AA to A. Meanwhile, smaller, better capitalised banks with higher quality assets that are not in distress are rated lower, e.g. BBB. Now I would have thought a financial institution that is so weak as to be getting official financial assistance should be rated something like BB or less by multi-notch downgrades -- after all, a bank's liquidity situation can change rapidly should it strike trouble!

In a world of official financial assistance to large banks in difficulty, creditors are effectively sheltered from credit risk, and this explains the higher ratings. Since these elevated ratings rest on bad policy, is it a bad thing if ratings are bought down a notch in recognition that NZ banks aren't to expect it in the event they falter or fail, as a result of steps taken to avoid this bad policy?

Today's article Bank failure plan may pressure ratings: Moody's, Moody's confess a 1 notch rating allowance for 'systemic support'. Although this seems fair and correct, the business end of the policy is at the time when an institution is suffering some distress, and is not bearing up well under pressure: in these conditions I would hope that the ratings would be dropped sooner, further and faster, implying stronger market discipline and a stronger banking system.

Crown's kid gloves for SCF Directors

2011-03-22T16:07:00.009+13:00

It is now more than 6 months since South Canterbury Finance was placed into receivership. Yet, as far as we know, the Crown, despite provisioning around $600m for its losses on making good the company's debenture holders, appears to have allowed to lapse perhaps its best chance at making the directors personally liable to contribute what they can.

Under the Securities Act 1978 (sec 37A), directors of issuers are responsible for ensuring that no allotment of securities takes place if:

at the time of allotment, the investment statement or registered prospectus relating to the security is known by the issuer of the security, or any director of the issuer, to be false or misleading in a material particular by reason of failing to refer, or give proper emphasis, to adverse circumstance.

In such cirsumstances the subscriber has the option to avoid the allotment, and the directors are personally liable to repay the securities with interest if the the issuer does not:

(3) An allotment made in contravention of this section is (whether or not the issuer is in liquidation) voidable at the instance of the subscriber by notice in writing to the issuer at any time within the prescribed period.
(4) For the purpose of subsection (3) of this section, prescribed period means—
(a) a period of one year after the security or a certificate of the security has been sent to the subscriber; or
(b) a period of 6 months after the subscriber knows, or ought reasonably to know, that the allotment was made in contravention of the provisions of this section—
whichever is the lesser.
(5) Without limiting any enactment or rule of law, an allotment made in contravention of this section shall be valid unless notice avoiding the allotment is given by the subscriber in accordance with subsection (3) of this section.
(6) Where an allotment made in contravention of this section is avoided by the subscriber under subsection (3) of this section, the issuer shall forthwith upon receiving notice under that subsection, repay the subscriptions to the subscriber.
(7) If such subscriptions are not so repaid within one month after the date of the receipt by the issuer of notice under subsection (3) of this section, the issuer and all the directors thereof shall be jointly and severally liable to repay the subscriptions with interest at a rate prescribed from time to time by regulations made under this Act from the date on which such notice was received:
Provided that a director shall not be so liable if he or she proves that the default in the repayment of the subscriptions was not due to any misconduct or negligence on his or her part.

As is clear from the above, this time frame has probably now lapsed, letting all the directors of the company off the hook of this section for these irregular allotments. The Crown, as guarantor of the subscribers, was in a position on 31st August 2010 to step into the subscribers' shoes and exercise these rights over the portion of the debenture stock that was issued within the last 6 months and was alloted when disclosure was bad enough. As the amounts the Crown would be likely to recover from the directors would be limited to their personal assets, even if they only avoided subscriptions of, say, $20m, at least the Crown would recover something more, and the directors would have been held accountable for their breaches to the extent of their personal assets, and future directors of financial institutions would have some additional reason to comply with these laws.

Another recovery avenue that the Crown does not appear to be going down is appointing a liquidator to the company who can chase the directors and shareholders (including preference shareholders) under the Companies Act 1993. Again time limits apply to the best courses of action: for example, within 6 months of the commencement of liquidation transactions are presumed to have happened when the company was unable to pay its debts, opening the door to remedies that could benefit the Crown.

Likewise, recovery of distributions, including preference dividends paid to preference shareholders, while the company did not satisfy the solvency test, also recoverable from shareholders and directors, have not been challenged by the Crown.

So, in summary, we've heard no word on the Crown doing anything whatsoever to recover funds from:

The directors of the comapny
The shareholders of the company, including preference shareholders
The USPP noteholders who were advantaged by the company

The words of the Crown are that investors in financial institutions are not to be sheltered from losses, and directors to be held responsible for the government of the financial institution. The Crown's actions in the case of South Canterbury Finance make its words ring hollow.

Open Bank Resolution: Open to Non-Government Alternatives?

2011-03-15T17:26:00.008+13:00

The Reserve Bank of New Zealand is pushing to enhance the bank creditor recapitalisation option for dealing with bank failures under a new term: Open Bank Resolution. To make this option more palatable, and thereby more credible, registered banks will soon be required to pre-position their systems so that they can screw their creditors while remaining open for business (or more correctly, to be able to partly screw their creditors and to be able to re-open the next banking day). So far so good. Well it's fantastic really, and much better than the bank bail-out practices we've seen displayed in Europe and America in the last few years.

However, unlike the covered bonds consultation paper, a full range of options does not appear to have been considered. The bank failure laws and the Open Bank Resolution policy involve a high amount of government/RBNZ involvement such as:

RBNZ supervision of registered banks
RBNZ powers to give directions to registered banks, with Ministerial consent (including for failure management purposes)
Ministerial and government involvement in appointing a statutory manager to a failed or failing registered bank
Government guarantees given to failed banks to guarantee the portion of deposits not haircut.
RBNZ liquidity facilities provided to the failed bank
Government involvement in selecting a resolution, including any taxpayer socialisation of losses.

As an example of an alternative regulatory policy, Non-Bank Deposit Takers are supervised by security trustees, who have powers to deal with the NBDT in the event of failure, and could, if the trust deed so allowed, effect a creditor recapitalisation and/or a trading receivership that would continue access to the payments system and other facilities for the institution's creditors and debtors. This approach to bank regulation, supervision and failure management does not appear to have been considered.

This post looks at this alternative in some detail, considering the issues presented by a bank failure, and the options for resolving them without government being directly involved in supervising banks or failure management. I argue that the further the government is from dealing with bank supervision and failure, the less the chance of government funds being used to socialise bank losses.

There appears to be three issues emerging from a bank failure:

Loss of principal
Loss of liquidity, and
Loss of access the payments system.

These points are accepted by the RBNZ document in point 14:

What is required is an option which not only places the cost of a failure in the first instance on shareholders, but also provides flexibility to assign losses to creditors, without causing unnecessary disruptions to the payments system and bank customers’ access to liquidity

However, elsewhere, and in the policy considers as a whole, The Open Bank Resolution policy appears to conflate 2. and 3. :

a solution is sought that solves the urgent liquidity problems associated with a bank failure, but does not force all of the losses to be borne by the government. (point 16)

Loss of access to the payments system can be a significant part of the cost of a bank failure. Consider, for example, that your wages are paid into your bank account, and from your bank account your automatic payments are set up, and your direct debits, and your EFTPOS card. In the event that your bank failed, and you had, say $500 in the account, the loss of, say, $200 out of the $500, would hurt you by $200, and the loss of access to the other $300 for, say, 6-12 months, might hurt you by $10, but the cost of trying to re-set up all your wage payments, automatic payments, direct debits and EFTPOS facilities might be such a pain in the arse as to be worth $100 or $200 to you (especially when hundreds of thousands of other customers are trying to do the same thing at the same time resulting in large queues). In fact being without EFTPOS access even for a day could leave you stranded without fuel for your car or the means to buy food or other urgent small purchases, an experience that could cost you a day's wages ($150) or similar loss.

The RBNZ does not appear to have seriously considered that the cost of a total loss of liquidity might be tolerable so long as the bank accounts in question continue to function for receiving new payments and making payments from these new funds.

There appear to be two ways of keeping a bank 'open' after its failure:

Rapidly recapitalising the bank with creditor funds, i.e. a proportional and part conversion of debt to equity. This could be in the form of tranches of preferred shares in the failed bank, or by way of diluting or cancelling existing ordinary shareholders (and subordinated creditors) and converting creditors claims partly to ordinary shares. This could (or should) also involve appointment of new directors by or on behalf of the new shareholders. Under this approach, the bank's insolvency is rapidly remedied, and the bank, as an entity, is saved.
Leaving creditor claims intact, but selectively subordinating and freezing part of them, while leaving the balance as good. Under this approach the bank remains insolvent but can keep trading because it has enough creditors claims frozen and available to absorb losses. Eventually the bank can be liquidated, and its business either closed or sold.

The Open Bank Resolution adopts the second approach -- the 'bank creditor recapitalisation' is not a literal recapitalisation but a selective default that allows ongoing trading:

The haircut represents that portion of the accounts that is effectively frozen, but is not legally cancelled, i.e. they are still obligations of the bank, but the bank has no capacity to repay them. (42 (f))

So, how could the Open Bank Resolution policy work without government supervision, failure management, guarantees and so forth?

Both registered banks and Non-Bank Deposit Takers should register a prospectus, execute a trust deed and appoint a security trustee to supervise them, rather than the RBNZ being the supervisor of registered banks but not NBDTs. This would provide a more consistent and more private treatment of financial institution supervision, in line with the Securities Act.
Registered banks would incorporate a General Security Agreement into their trust deeds, providing a security interest over all the present and after acquired property of the bank, to be held by the trustee for the benefit of all creditors generally. This means that the trustee, and any receiver appointed by the trustee, would have the power to failure-manage the bank.
In the event of a bank failure, the trustee would appoint a receiver. The receiver would be the agent of the bank, pusuant to the trust deed, and have the power to carry on the bank's business, including accepting new deposits and (part) paying creditors (this is actually nothing new or unusual about receiverships).
New deposits would rank ahead of creditor claims existing at the point of failure (it is standard in finance company trust deeds for receivers to have the power to issue such securities ranking ahead of existing creditors (e.g. see 20.5 (g) of South Canterbury Finance's trust deed). This means that creditors can still have confidence in the failed bank with any new funds, while not having any confidence in its capacity to repay balances at the time of failure (as was the case with the engineered Australian large bank failures of the 1890s, although the process here is intended to take place within 1 business day rather than weeks or months as in that episode).
The receiver can make a portion of old funds available to depositors by either (a) providing over-draft facilities secured over balances existing at the time of failure (e.g. the receiver could grant all customers of the bank an overdraft facility equal to, say 50% of their balances as at the time of failure), or (b) converting a portion of the balances as at the time of failure into a security ranking prior to the rest of the balances, and ranking equally with new deposits. Option (a) can encourage existing customers to retain their balances with the bank by way of charging a fairly high interest rate on such overdrafts so that only those who need the liquidity will withdraw the funds.
Another alternative to providing liquidity for bank customers is to securitise the funds at the point of failure and list them on a securities exchange. Customers with large balances can get involved in liquidating their holdings on the market, while customers with smaller balances can either rely on the receiver using the above options, or the receiver can sell a modest quantity of the securities on the market during the first week or two of the listing and settle large numbers of customers with smaller balances cost efficiently (the trust deed would need to authorise this).
The receiver can then consider a wide range of resolution options to the failed bank's situation including (a) a debt for equity swap, to be voted on by relevant investors according to the provisions of the trust deed, (b) selling the bank as a going concern to new owners and paying the proceeds to creditors by rank or (c) winding down the business of the bank and progressively paying out creditors over time.
Another approach is to empower the trustee to effect a rapid creditor recapitalisation at the point of failure without going through a receivership. (Receivership would still be possible, but the trustee could select recapitalisation as an alternative resolution.) The trustee would be issued with warrants that would enable it to require issue of large amounts of new ordinary shares, and to appoint new directors in respect of this new super-majority of shareholding in the bank (existing shareholders could be either be diluted or extinguished, depending on the set up).
Pre-positioning requirements could be regulated by the Securities Commission and/or the RBNZ to enable or prescribe particular trust deed provisions and/or operational capability to be in place to execute such restructurings/trading receiverships. The same would apply to regulation of payment and settlement systems for the purpose of minimising disruption in the event of bank failures. Likewise for out-sourcing policies and other regulations now in place to facilitate statutory management and Open Bank Resolutions.
Securities and/or banking laws would need to be reviewed to enable disclosure and other requirements to be met or waived throughout a trading receivership or restructuring of a continuous issuer.

The Tax Return that Toppled a King: the story of Ehud

2011-02-25T10:59:00.007+13:00

A vivid story about taxpaying from the bible is in Judges 3, and it's a story of rebellion against paying taxes rather than an endorsement of the practice.

At the time of Ehud the nation of Israel had no king, a time I've characterised as anarchy in my post Anarchy, Monarchy, Tyranny and Sucession in Ancient Israel, as 'In those days Israel had no king; everyone did as he saw fit.' From time to time Israel would be invaded and occupied by foreign powers (as incidentally also happened when Israel did have a king). These foreign powers would tax Israel and Ehud enters the picture as a taxpayer:

Again the Israelites cried out to the LORD, and he gave them a deliverer—Ehud, a left-handed man, the son of Gera the Benjamite. The Israelites sent him with tribute to Eglon king of Moab. Now Ehud had made a double-edged sword about a cubit long, which he strapped to his right thigh under his clothing. He presented the tribute to Eglon king of Moab, who was a very fat man. After Ehud had presented the tribute, he sent on their way those who had carried it. But on reaching the stone images near Gilgal he himself went back to Eglon and said,
“Your Majesty, I have a secret message for you.”
The king said to his attendants, “Leave us!” And they all left.
Ehud then approached him while he was sitting alone in the upper room of his palace and said, “I have a message from God for you.” As the king rose from his seat, Ehud reached with his left hand, drew the sword from his right thigh and plunged it into the king’s belly. Even the handle sank in after the blade, and his bowels discharged. Ehud did not pull the sword out, and the fat closed in over it. Then Ehud went out to the porch; he shut the doors of the upper room behind him and locked them.

After he had gone, the servants came and found the doors of the upper room locked. They said, “He must be relieving himself in the inner room of the palace.” They waited to the point of embarrassment, but when he did not open the doors of the room, they took a key and unlocked them. There they saw their lord fallen to the floor, dead. While they waited, Ehud got away. He passed by the stone images and escaped to Seirah. When he arrived there, he blew a trumpet in the hill country of Ephraim, and the Israelites went down with him from the hills, with him leading them.
“Follow me,” he ordered, “for the LORD has given Moab, your enemy, into your hands.” So they followed him down and took possession of the fords of the Jordan that led to Moab; they allowed no one to cross over. At that time they struck down about ten thousand Moabites, all vigorous and strong; not one escaped. That day
Moab was made subject to Israel, and the land had peace for eighty years.

Religious Experience and Social Perspective

2011-01-12T15:53:00.003+13:00

Once upon a time I was a devout Christian, and since I've lost that bug I've found my social perspective has changed. I still keep in contact with some of my old Christian sparing partners, including Matt and Madeleine Flannagan. One of Matt's favourite moral theories these days is the Divine Command Theory of Ethics. This theorys hold that an action is moral if it does not transgress God's commands, and is immoral if it does. All social problems and social issues are therefore resolved by discerning, or arguing about, what the will of God is. Necessarily, human will and human wants, and human origins of law and morality are necessarily only of moral importance as a means of upholding God's will (for example if God's command is to do unto others as you would have them do unto you). To me this is the extreme form of absolutising a set of rules, and potentially the law and moral rules as a tool for some, or some in the name of God, to rule over others.

Although Christianity is sometimes described as a crutch for the weak, as Madeleine Flannagan posted recently, its power and strength derives from its ability to provide rationale, reason and to make sense of the world. For this reason Madeleine Flannagan encourages Christians to express and engage their doubts and their pains, and to treat Christianity as a serious intellectual system rather than selling it as a superficial emotional experience. However, Christianity isn't the only way of explaining the world or making sense of it, including our social problems and the rules we develop or recognise in order to deal with them. Consider this from John Hasnas:

When I teach Torts, I ask the students to account for these rules. Being products of the legislative age, they inevitably launch into some theory of justice or moral desert or human rights, which invariably fails to account for the contours of the law. After all, attempting to batter someone is morally blameworthy whether or not the intended victim is aware of it, and one hardly has the right not to be offended.
The students fail because they think of the law as created by conscious human agency to serve an intended end. Thus, they miss the simpler evolutionary explanation. In earlier centuries, one of the most urgent social needs was to reduce the level of violence in society. This meant discouraging people from taking the kind of actions that were likely to provoke an immediate violent response. Quite naturally, then, when disputes arising out of violent clashes were settled, the resolutions tended to penalize those who had taken such actions. But what type of actions are these? Direct physical attacks on one’s person are obviously included. But affronts to one’s dignity or other attacks on one’s honor are equally if not more likely to provoke violence. Hence, the law of battery evolved to forbid not merely harmful contacts, but offensive ones as well. Furthermore, an attack that failed was just as likely to provoke violence as one that succeeded, and thus gave rise to liability. But if the intended victim was not aware of the attack, it could not provoke a violent response, and if the threat was not immediate, the threatened party had time to escape, enlist the aid of others, or otherwise respond in a nonviolent manner. Hence, the law of assault evolved to forbid only threats of immediate battery of which the target was aware.
This example shows how the common law creates the rules necessary for a peaceful society with minimal infringement upon individual freedom. Law that arises from the settlement of actual conflicts, settles conflicts. It does not create a mechanism for social control. Common law is law that is created by non-political forces.

In this perspective, in the same way that the law can and should develop spontaneously, in order to provide order without rulers, it would seem natural to explain moral rules as the spontaneous result of human life and culture.

Law without Rulers

2011-01-09T07:56:00.004+13:00

Rulers and law-makers purport to be men as rulers over other men. They claim the power to govern and ultimately coerce other men, ranging from prohibitions on criticising them or challenging their authority to regulating their conduct by requiring or prohibiting terms of contracts or creating offences, to naked impositions of tribute, conscription or even genocide.

Yet what is the alternative form of social organisation and government? Can we have law without lawmakers, and if so, is it coercive or compulsory, and what is its form and substance? Many free market theorists have tried to develop the idea of opt-in law, the idea that people can contract for or choose the law they will live under on a conscious basis, as a consumer decision from a range of market suppliers. This approach is needless and unfruitful: the law can develop, like language, not as a consumer product but as a shared tool for human interaction. John Hasnas writes, in The Depoliticization of Law :

Depoliticized law is law. Hence, it is coercive. The duty to obey has not been voluntarily assumed and compliance is not optional. However, depoliticized law is not the conscious creation of any identifiable person or group of persons. It evolves out of the effort of human beings to resolve interpersonal disputes in the absence of a centralized authority. The slow accretion of successful resolutions of individual disputes eventually produces recognizable rules of law of binding effect. Such rules do not represent the command of any identifiable person and are not an embodiment of anyone’s will. Therefore, one can be bound by depoliticized law without thereby being rendered subject to the will of another. In a system of depoliticized law, it really is the law and not men or women that rule.

As with all writings of John Hasnas, it seems, I highly recommend this work to those interested in the basis for and development of law, and to those interested in alternative social institutions.

No Jury, no Justice?

2011-01-07T19:29:00.003+13:00

It looks that way for 18 men charged with firearms offences under dubious circumstances (on the part of the authorities as well as the men). See this from No Right Turn.

Is there a demon in you?

2011-01-05T07:44:00.006+13:00

Do you become a different person behind the wheel of a car? Do you curse and swear at others, or use the one fingered salute? Perhaps you're a little more constrained, and limit yourself to whinging about the inefficiency of the traffic lights or why you need to stop at a stop sign when there's no traffic to give way to. And let's not get started with arbitrary speed limits and the fear we live with every time we see a police car, watching in the rear view mirror if we'll see the U turn and the flashing lights come on. When you're sitting at a red light and it turns green, and the vehicle you're waiting behind hesitates, don't you give them a little toot? or a couple of annoyed ones?

If there is one argument raised most often about why we need to pay taxes and why we need governments to impose rules on us, it's the roads. Roads are our classical public good, and the road rules our classical call for rules. The governments organise and fund the roads with tax money, they register and licence vehicles, and enact road rules and make new drivers pass tests on the rules to get driver licences. Although it doesn't take a lot of imagination to envisage private and commercial provision of roads via tolling, envisaging the end of traffic lights is beyond the comprehension of most people -- they're so ubiquitious, and the realities of congestion and crashes makes them seem so necessary. And yet, they're not only not necessary, in most cases they're not desirable either.

Frustration, anger, rudeness and conflict are signs of poor institutions, and yet this is what the government's traffic rules and traffic lights have produced. With traffic lights we can change the institutions at the flick of a switch: turning the lights off. Perhaps it is obvious that few would have the courage to even give it a try, yet we're blessed with some examples of courage to help us contemplate a more civilised (and efficient) world. If you want to exorcise the road rage demon, turn off the lights! (and for the observant, you will notice that the 'interactional expectancies' John Hasnas talked about in this paper as the basis of the development of customary law I covered here develop rapidly in response to turning out the lights.)

How to Book Goodwill as a Tangible Asset (SCF style)

2010-12-28T08:09:00.006+13:00

It appears that the purchase of 100% of the ordinary shares of Helicopters NZ on 28th Feb 2010 by South Canterbury Finance for $90.25m may have consisted of net tangible assets of minus $51m, and goodwill of $141.25m. This is based on the following figures:
Helicopters NZ fleet, as at 30 June 2010 worth a claimed US$111m
Exchange rate of 69.81USc/NZD as at 28 Feb 2010
Gives fleet value in NZD of 159m as at 28 Feb 2010
Less $71m of Helicopter equipment owned by SCF and leased to HNZ (see note 26 of 31 Dec 2009 accounts)
This gives a value of the identifiable assets of Helicopters NZ of $88m.
Subtracting from this the $20m in preference shares and $119m in loans (see p 3 of my complaint for the working) from SCF gives a net tangible assets on the ordinary shares of minus $51m. Goodwill on consolidating the investment into SCF group is worked out as $90.25m purchase price less minus $51m in identifiable net assets ($90.25m- - 51m = $141.25m). For simplicity I've assumed that the fleet is the only asset, that SCF's loans are the only debts, and that the values have not changed between the end of February and the end of June, and that the total exposures figure just counts the loans rather than the equity investments in HNZ.

Quite how subtracting $51m in tangible assets from the group (not counting the $10m cash paid) can remedy the breach of clause 16.1(c) by augmenting 'Total Other Tangible Assets' is another story. By making Helicopters NZ a non-charging subsidiary, it is not required to be consolidated for the purposes of testing the financial covenants, and leaves the shareholding as an equity investment which is counted as a tangible asset.

So the overall effect of the scheme, if my inferences and calculations are correct, is to count what is goodwill for financial reporting purposes, as a tangible asset for the purposes of the trust deed. It also enables Helicopters NZ to borrow money ranked ahead of SCF, without it counting as a prior charge security.

The business is now on the market as a going concern, so, about a year after it was valued for the purpose of a related party transaction, its value will be market-tested. My guess is that the goodwill in the business next time it is sold will be a lot less than $141.25m -- my guess would be more like zero or less.

"Jesus of Nazareth, King of the Jews": Tax Protester or Rebel?

2010-12-23T13:09:00.006+13:00

Back in May I wrote Jesus on the Law: Taxpayer or Illegal Tax Protester? and looked into Jesus teaching on taxes, and whether he was executed for teaching his followers not to pay taxes. Since then I have been trying to resolve this riddle: if Jesus was executed for tax resistance, why was the charge against him that was put on his cross "Jesus of Nazareth, King of the Jews"? As Christmas, celebrating the birth of Jesus approaches, I attempt to answer this riddle by suggesting that the charge of proclaiming himself King of the Jews incorporates both resistance to Rome's rule as well as its taxes.

I will divide this post into three parts:

Jesus arrest by the Jewish religious leaders
Jesus hearing before the Sanhedrin (the Jewish religious council)
Jesus hearing before Pilate and Herod (the Roman authorities), and execution

The Arrest

The arrest of Jesus was well organised. The Jewish religious leaders were scared of the Jewish people, so they paid Judas Iscariot to betray him and enable his arrest to take place secretly. The implication is that the Jewish religious leaders were concerned that his followers would use force to prevent his arrest. But an even stronger implication can also be drawn from the story: Jesus said "Am I leading a rebellion, that you have come with swords and clubs? Every day I was with you in the temple courts, and you did not lay a hand on me." Clearly Jesus was not leading a rebellion, however it appears that the Jewish religious leaders either a) were concerned that he was and/or b) wanted to portray him as such, in order to have him executed by the Roman authorities as a rebel.

Jesus rebuked Peter for using his sword to prevent his arrest:

When Jesus’ followers saw what was going to happen, they said, “Lord, should we strike with our swords?” And one of them struck the servant of the high priest, cutting off his right ear.
But Jesus answered, “No more of this!” And he touched the man’s ear and healed him.

Jesus hearing before the Sanhedrin

The Jewish religious leaders appear to have been the most motivated to have Jesus executed: they were the ones who arrested him, they were the ones who sought usable evidence against him, and they were the ones laying charges against him to have him executed by the Roman authorities.

Our concern here is what kind of charges they made against him, and the evidence they assembled, and their tactics to seek his conviction. Here is the record of the proceedings from Matthew:

The chief priests and the whole Sanhedrin were looking for false evidence against Jesus so that they could put him to death. But they did not find any, though many false witnesses came forward.
Finally two came forward and declared, “This fellow said, ‘I am able to destroy the temple of God and rebuild it in three days.’”
Then the high priest stood up and said to Jesus, “Are you not going to answer? What is this testimony that these men are bringing against you?” But Jesus remained silent.
The high priest said to him, “I charge you under oath by the living God: Tell us if you are the Messiah, the Son of God.”
“You have said so,” Jesus replied. “But I say to all of you: From now on you will see the Son of Man sitting at the right hand of the Mighty One and coming on the clouds of heaven.”
Then the high priest tore his clothes and said, “He has spoken blasphemy! Why do we need any more witnesses? Look, now you have heard the blasphemy. What do you think?”
“He is worthy of death,” they answered.
Then they spit in his face and struck him with their fists. Others slapped him and said, “Prophesy to us, Messiah. Who hit you?”

Mark records a several problems with conflicting witnesses:

The chief priests and the whole Sanhedrin were looking for evidence against Jesus so that they could put him to death, but they did not find any. Many testified falsely against him, but their statements did not agree.
Then some stood up and gave this false testimony against him: “We heard him say, ‘I will destroy this temple made with human hands and in three days will build another, not made with hands.’” Yet even then their testimony did not agree.

So it appears that they concluded their proceedings by fixing on Jesus' claim to be the Messiah, a strong charge as they interpreted their religious law, but a weak charge in terms of the Roman authorities. As we'll see, they had to stretch the meaning and significance of the term in order to secure a conviction.

Jesus hearing before Pilate and Herod

Luke presents the proceedings before Pilate and Herod as follows:

Then the whole assembly rose and led him off to Pilate. And they began to accuse him, saying, “We have found this man subverting our nation. He opposes payment of taxes to Caesar and claims to be Messiah, a king.”
So Pilate asked Jesus, “Are you the king of the Jews?”
“You have said so,” Jesus replied.
Then Pilate announced to the chief priests and the crowd, “I find no basis for a charge against this man.”
But they insisted, “He stirs up the people all over Judea by his teaching. He started in Galilee and has come all the way here.”
On hearing this, Pilate asked if the man was a Galilean. When he learned that Jesus was under Herod’s jurisdiction, he sent him to Herod, who was also in Jerusalem at that time.
When Herod saw Jesus, he was greatly pleased, because for a long time he had been wanting to see him. From what he had heard about him, he hoped to see him perform a sign of some sort. He plied him with many questions, but Jesus gave him no answer. The chief priests and the teachers of the law were standing there, vehemently accusing him. Then Herod and his soldiers ridiculed and mocked him. Dressing him in an elegant robe, they sent him back to Pilate. That day Herod and Pilate became friends—before this they had been enemies.
Pilate called together the chief priests, the rulers and the people, and said to them, “You brought me this man as one who was inciting the people to rebellion. I have examined him in your presence and have found no basis for your charges against him. Neither has Herod, for he sent him back to us; as you can see, he has done nothing to deserve death. Therefore, I will punish him and then release him.”
But the whole crowd shouted, “Away with this man! Release Barabbas to us!” (Barabbas had been thrown into prison for an insurrection in the city, and for murder.)
Wanting to release Jesus, Pilate appealed to them again. But they kept shouting, “Crucify him! Crucify him!”
For the third time he spoke to them: “Why? What crime has this man committed? I have found in him no grounds for the death penalty. Therefore I will have him punished and then release him.”
But with loud shouts they insistently demanded that he be crucified, and their shouts prevailed. So Pilate decided to grant their demand. He released the man who had been thrown into prison for insurrection and murder, the one they asked for, and surrendered Jesus to their will.

A careful reading of Luke's account makes several things clear:

Jesus claim to be the Messiah, and a king, was construed as a rebellion against the Roman authorities, aided by the charge of opposing payment of taxes. He was specifically accused of 'He stirs up the people all over Judea by his teaching'.
Pilate summarised the charge against him as 'one who was inciting the people to rebellion'
Pilate did not find sufficient evidence for the charge: apparently, merely claiming to be a king without actually leading a rebellion was insufficient, compared with Barabbas who was 'in prison with the insurrectionists who had committed murder in the uprising.' (Mark 15:7). Jesus legal situation of being a claimant king under arrest and on trial appeared not to provoke the full force of the law but mockery. Jesus claim was treated as a great joke (not only on Jesus but on the Jews) for the Roman authorities, it appears, rather than a serious crime. In fact Pilate continued to seek other charges against him that would warrant his conviction for an offense that carried the death penalty.

John's account highlights the legal problem between the Jewish religious authorities and the Roman authorities: the former could not execute anyone, and the latter found insufficient basis for execution, and how the former portrayed Jesus claim to be a king in conflict with Roman law:

Then the Jewish leaders took Jesus from Caiaphas to the palace of the Roman governor. By now it was early morning, and to avoid ceremonial uncleanness they did not enter the palace, because they wanted to be able to eat the Passover. So Pilate came out to them and asked, “What charges are you bringing against this man?”
“If he were not a criminal,” they replied, “we would not have handed him over to you.”
Pilate said, “Take him yourselves and judge him by your own law.”
“But we have no right to execute anyone,” they objected. This took place to fulfill what Jesus had said about the kind of death he was going to die.
Pilate then went back inside the palace, summoned Jesus and asked him, “Are you the king of the Jews?”
“Is that your own idea,” Jesus asked, “or did others talk to you about me?”
“Am I a Jew?” Pilate replied. “Your own people and chief priests handed you over to me. What is it you have done?”
Jesus said, “My kingdom is not of this world. If it were, my servants would fight to prevent my arrest by the Jewish leaders. But now my kingdom is from another place.”
“You are a king, then!” said Pilate.
Jesus answered, “You say that I am a king. In fact, the reason I was born and came into the world is to testify to the truth. Everyone on the side of truth listens to me.”
“What is truth?” retorted Pilate. With this he went out again to the Jews gathered there and said, “I find no basis for a charge against him. But it is your custom for me to release to you one prisoner at the time of the Passover. Do you want me to release ‘the king of the Jews’?”
They shouted back, “No, not him! Give us Barabbas!” Now Barabbas had taken part in an uprising.
Then Pilate took Jesus and had him flogged. The soldiers twisted together a crown of thorns and put it on his head. They clothed him in a purple robe and went up to him again and again, saying, “Hail, king of the Jews!” And they slapped him in the face.
Once more Pilate came out and said to the Jews gathered there, “Look, I am bringing him out to you to let you know that I find no basis for a charge against him.” When Jesus came out wearing the crown of thorns and the purple robe, Pilate said to them, “Here is the man!”
As soon as the chief priests and their officials saw him, they shouted, “Crucify! Crucify!”
But Pilate answered, “You take him and crucify him. As for me, I find no basis for a charge against him.”
The Jewish leaders insisted, “We have a law, and according to that law he must die, because he claimed to be the Son of God.”
When Pilate heard this, he was even more afraid, and he went back inside the palace. “Where do you come from?” he asked Jesus, but Jesus gave him no answer. “Do you refuse to speak to me?” Pilate said. “Don’t you realize I have power either to free you or to crucify you?”
Jesus answered, “You would have no power over me if it were not given to you from above. Therefore the one who handed me over to you is guilty of a greater sin.”
From then on, Pilate tried to set Jesus free, but the Jewish leaders kept shouting, “If you let this man go, you are no friend of Caesar. Anyone who claims to be a king opposes Caesar.”
When Pilate heard this, he brought Jesus out and sat down on the judge’s seat at a place known as the Stone Pavement (which in Aramaic is Gabbatha). It was the day of Preparation of the Passover; it was about noon.
“Here is your king,” Pilate said to the Jews.
But they shouted, “Take him away! Take him away! Crucify him!”
“Shall I crucify your king?” Pilate asked.
“We have no king but Caesar,” the chief priests answered.
Finally Pilate handed him over to them to be crucified.

Jesus was handed over to Roman soldiers who crucified him under the following charge:

The written notice of the charge against him read: THE KING OF THE JEWS. (Mark 15:26)

John's account provides more details about the notice and the reaction of the Jewish religious authorities:

Pilate had a notice prepared and fastened to the cross. It read: JESUS OF NAZARETH, THE KING OF THE JEWS. Many of the Jews read this sign, for the place where Jesus was crucified was near the city, and the sign was written in Aramaic, Latin and Greek. The chief priests of the Jews protested to Pilate, “Do not write ‘The King of the Jews,’ but that this man claimed to be king of the Jews.”
Pilate answered, “What I have written, I have written.”

This also suggests to me that perhaps claiming to be a king did not warrant the death penalty.

So, in summary, the charges against Jesus brought by his accusers were many, but the ones listed specifically, in the words of his accusers were:

“We have found this man subverting our nation. He opposes payment of taxes to Caesar and claims to be Messiah, a king.”
He stirs up the people all over Judea by his teaching
“We have a law, and according to that law he must die, because he claimed to be the Son of God.”
“If you let this man go, you are no friend of Caesar. Anyone who claims to be a king opposes Caesar.”

In the words of the Roman authorities, the charges entertained against him, in the words of the authorities were:

“You brought me this man as one who was inciting the people to rebellion."
The written notice of the charge against him read: THE KING OF THE JEWS.

It is also clear from the records that Jesus only responded to charge of being a king, and his response was to admit it, but that many times Pilate (and Herod) stated that this was insufficient for any death sentence, before yielding to the crowd.

Southbury Corp Accounts Perplexing

2010-12-22T08:35:00.007+13:00

Yesterday Southbury Corporation Limited's receiver's first report was registered with the Companies Office. Although the prospect of zero recoveries are obvious, the basis of the numbers in the company's accounts are anything but obvious.

On the asset side of the balance sheet, in addition to the investment in South Canterbury Finance Limited, there is an $18m advance to Southbury Group Limited. This may be related to the USPP refinancing fee paid by Southbury Group Limited and funded from related party loans from South Canterbury Finance, which may have been funded through the intermediate parent:

The payments made by the ultimate parent were funded through related party loans to the ultimate parent for $20.9 million at 10%p.a.,advanced at the time payments became due by the ultimate parent subsequent to year end. (note 38, 31 Dec 2009 accounts)

The $245m carrying value of Southbury Corporation's investment in South Canterbury Finance obviously does not correspond to any value that investment presently has, nor to the book value at any time since 30 June 2009 that I know of (Southbury Corporation acquired South Canterbury Finance in December 2009, see p 4 of the 12th April 2010 prospectus 61).

On the liability side, total liabilities to South Canterbury Finance are shown as $103.9m rather than the $42.6m I was expecting. Even if you add $18m for the USPP refinancing fee financing going through Southbury Corporation, that still leaves about $40m I can't explain. However, the total between Southbury Corporation and Southbury Group was reported as $156m, leaving only $52.1m owed by Southbury Group, rather than the $98.1 I had figured. I also note that the total is consistent with why I had figured. When the Southbury Group receivers report comes out we'll have some more answers, and probably a lot more questions, too.

UPDATE: the first receivers report of Southbury Group has now been registered, and it shows that Southbury Group owes $84.7m to South Canterbury Finance, giving a total between the two companies of $188.6m, which is $52.1m more than I had figured. Unfortunately the company's accounts as at the date of receivership aren't available, with Allan Hubbard and HC Partners still working on them -- not a great look for Mr Hubbard, although he's had and got a lot on his plate.

A More Radical Anti-Legislative Law

2010-12-18T09:04:00.005+13:00

In Legislation: The Anarchist Critique, I reviewed Stephan Kinsella's 1995 work Legislation and the Discovery of Law in a Free Society, which promoted the benefits of non-legislative law discovery and development. In the last few days I've been captivated by an even more radical critique of legislation: what if the development of a coherent body of judge made common law was itself akin to legislating? Can 'amorphous notions of equity or fairness to the parties' be a superior basis for an efficient and just system of law?

John Hasnas, whose essay The Obviousness of Anarchy I reviewed in November, argues that a purely customary law represents a) a distinct body of law and system of finding law compared to modern common law, b) that modern common law incorporates undesirable rigidity in the form of the stare decisis doctrine and an undesirable conscious planning consideration on the part of judges whose role extends to making rather than merely finding law, and c) that a just and efficient law best arises as a purely spontaneous order resulting as a by-product of doing backward-looking justice between litigants. The law as we know it today, is perhaps like an onion, and the most outer most visible crust is the legislation, a conscious planning scheme, imposed on society, and providing a framework of rules for the future. Beneath this is lies another layer, common law, consisting of a body of rules read and interpreted from past cases that provide binding precedents for the future, that judges must synthesize, rationalise, and at times patch up or alter at the margins. But at the core, and the origin of most substantive law, is customs, the ways that people interact with each other to get things done, lacking justification, rationality and purpose. Like language, customary law has no purpose or end, it is only means to ends that diverse people employ for diverse ends. Social order results not from law or language having agreed or common ends, but from the advantages of cooperation and the division of labour. These advantages pay for the transaction costs of exchange, and the resulting social order is both spontaneous and dynamic. I highly recommend John Hasnas's HAYEK, THE COMMON LAW, AND FLUID DRIVE to my readers who have an interest in natural law, natural justice and alternative social institutions.

Securities Commission: We were already investigating SCF's Helicopters transaction

2010-12-07T16:06:00.005+13:00

Today I heard from the Securities Commission in response to the complaint I lodged on 17th November 2010 and was pleased to hear that the transaction had already come to their attention, and was considered as one of the major transactions of concern to them about South Canterbury Finance. The email also stated that the Securities Commission would consider laying criminal charges and/or taking civil action against the directors of the company. I spoke with a representative who confirmed they had picked up the transaction as part of their Financial Surveillance Programme, and their concerns with the transaction included how it was disclosed and accounted for -- i.e. exactly the same concerns I had and have. The representative also stated that the actions of the Securities Commission so far had included contacting the company and engaging with it, and that the Securities Commission staff were looking into a range of issues related to regulatory enforcement issues on South Canterbury Finance.

Thinking the Unthinkable in Europe

2010-12-01T06:32:00.004+13:00

The idea that governments can go broke is anathema to most people, especially employees of the state and investors in government bonds. Government bonds are the benchmark 'risk-free' investments, despite being unsecured, and despite being issued by entities with the powers to screw anyone, including their creditors. Governments could repudiate their debts at any time, and no unsecured creditor can force the liquidation of the debtor. And when the government controls the a central bank that issued unanchored currency, it can theoretically issue as much of the means of payment to discharge any or all of its debts, however big they may be, at the cost of the value of this currency. However, despite the idea that governments aren't supposed to go broke, they can and do.

In contrast to this, the idea that banks can go broke is not anathema in theory, but in practice troubled large banks are frequently rescued by governments, so that, in practice, large banks almost never fail. In theory failed large banks can be liquidated, or creditor-recapitalised, but largely aren't.

I find it puzzling that in Europe today, the idea of government defaults is being linked to membership of the Euro. I can't see any problem with sovereign defaults, while the defaulting government is and remains a Euro member and its people use the Euro currency. Surely, at a time of government default, there is great value in having a currency that cannot be devalued by the defaulting government. It means private debts and transactions can continue as normal, while the government's creditors take a loss, and the government gets relief from its debts. It also means that government creditors will not finance extreme levels of debt that have a high risk of non-payment -- everyone wins, no?

Nevertheless, the unthinkable is being thought in Europe: let's make sure that, after this once off rescue of ailing Euro governments, creditors will have to take their losses. And the reason the unthinkable is being thought? In part it is because the thinkable -- liquidating or creditor-recapitalising failed large banks -- is not being done: in Ireland, the government guarantees on large failed banks has driven the Irish government to the brink of default.

The Obviousness of Anarchy

2010-11-29T08:03:00.003+13:00

Do you ever wonder why people believed in the divine right of kings, despite the fact that the monarchs of their time were patently not the type of individuals an all-knowing, all-good god would choose to reign over them? They believed in it because they were taught to believe in it and because they could imagine that it was so, regardless of all evidence to the contrary. We no longer believe in such silly things as the divine right of kings. We believe that government is necessary for an orderly peaceful society and that it can be made to function according to the rule of law. We believe this because we have been taught to believe it from infancy and because we can imagine that it is so, regardless of all contrary evidence.
One should never underestimate the power of abstract concepts to shape how human beings see the world. Once one accepts the idea that government is necessary for peace and order and that it can function objectively, one’s imagination will allow one to see the hand of government wherever there is law, police, and courts and render the non-political provision of these services invisible. But if you lay aside this conceptual framework long enough to ask where these services originated and where, to a large extent, they still come from, the world assumes a different aspect. If you want the strongest argument for anarchy, simply remove your self-imposed blinders and look around.

So writes John Hasnas in his argument The Obviousness of Anarchy. This appears to be the same person I quoted from in my essay Agency and Stakeholder Theories: Social Perspectives, although I didn't suspect him to be an anarchist from his work I read on that topic. I recommend The Obviousness of Anarchy to those interested in seeing how the world could be, as well as reconsidering how it is now -- so much of the world we assume we know is based on how we see it.

Neil Paviour-Smith responds

2010-11-26T17:03:00.006+13:00

When I spoke with Allan Hubbard on Wednesday 17th November 2010, and I asked him who master-minded the Helicopters NZ transaction, he said it was Neil Paviour-Smith from Forsyth Barr, and that I should call him. I assured Mr Hubbard I would, but I didn't, before submitting my Securities Commission/SFO complaint and writing my post on the same day.

Neil Paviour-Smith has since called me to put me straight on a couple of factual matters, so I said fair enough, fire away! So this post lets Neil Paviour-Smith respond, and also enables me to correct some incorrect information from Chris Lee.

Firstly he said "there's comment in your blog that Forsyth Barr was paid fees in relation to the transaction involving Scales and Helicopters being injected into South Canterbury Finance . The fact is we didn't get paid a transaction fee or investment banking fee on that transaction and it is wrong to say we did and then make malicious statements based on incorrect information. Forsyth Barr were certainly paid fees over the year or so we were mandated by SCF as you would expect, but to say that were were in receipt of a transaction fee or an investment banking fee in relation to that transaction is completely wrong."

So I stand corrected (note to self: don't trust Chris Lee). I understand only direct fees and transaction costs are deducted from equity, so that means any advisory fees would be expensed separately.

Secondly, he was concerned about the description of his role in the transaction. He highlighted that Allan Hubbard had been thinking of consolidating Southbury Group with South Canterbury Finance for some time. He said that from early 2009 the idea had been mooted, and that the proposal was even presented to the trustee (during 2009 and before Forsyth Barr's involvement with SCF) and the trustee consented, however, the transaction did not happen at that time. He also described the role of others in assessing, approving, scrutinising or otherwise reviewing the transaction:

"we had a large team of people at Forsyth Barr that were helping the company - not just me. And the transaction had the involvement of many parties including Allan Hubbard as the ultimate owner, but also the Board of SCF, CEO Sandy Maier, and his management team including the likes of company CFO David Jarman, and that transaction was consented to by Treasury under the guarantee scheme, signed off by the Trustee, scrutinised by the auditors Ernst & Young, involved two leading law firms working for SCF, was subject to briefings with S & P, and was subject to two independent expert reports from Northington Partners and Simmons Corporate Finance. So, I know there is a lot of scrutiny and you've got some concerns about the transaction, but bear in mind that all of those parties who had an interest in this whole situation , and under the glaring spotlight of the wider views on SCF at the time, had reviewed those transactions."

Neil Paviour-Smith also provided a perspective on the urgency of the need for this transaction, and the absence of feasible alternatives, and of the consequences in terms of giving a company a chance to do a further deal to save it.

"At the time there was no capital raising transaction possible for the company to do, or for us to do for them, in the absence of audited accounts for the December half-year and in the absence of confirmation of SCF's acceptance into the extended guarantee scheme. Who was otherwise going to invest without those certainties? And the only option available was for SCF's owner, ultimately Allan Hubbard, to do what he had said he was willing to do a year before. By doing this transaction, SCF was able to stay in compliance with its Trust Deed ratios, complete its audited accounts given confirmation of it being a going concern and ultimately was accepted into the extended guarantee scheme."

Neil also said

"there has also been a lot of other rubbish written about there being some other deals that were going to save the company in 2009 (before Forsyth Barr was mandated). Well, there was certainly a lot of things that had been going on but when we were asked by SCF to help, we saw no evidence of any transaction that would have raised sufficient capital for SCF to maintain a going concern position at the time. Deals at the time, being speculated on now, all required the Crown to bailout SCF in some capacity and the response was the same as the response SCF got in August, that the Crown would not use taxpayer money to bailout SCF. The Crown wanted a private market solution and Allan Hubbard's willingness to inject Scales and Helicopters into SCF was his way of doing what he could to try to save the company. Bear in mind too that in the 2009 year these two companies had combined EBITDA of $65 million so there was a view that this earnings base would help offset any further trading losses in SCF."

I did discuss with Neil Paviour-Smith about the substance of the transaction, its effects on the parties, the accounting for it, its significance to the auditor and the going concern assumption, and issues with my analysis of and criticism of the transaction and how it was accounted for. I hope to be able to refine the alternative assumptions, judgements and conditions that lie behind my perspective on the transaction and to present an alternative view that represents how the transaction may have been viewed at the time or explain how it was accounted for. Watch this space.

Northington Partners Report: What it Says

2010-11-19T10:40:00.009+13:00

In my complaint to the Serious Fraud Office and the Securities Commission about South Canterbury Finance's Helicopters NZ transaction in February 2010, I stated:

17th Feb 2010, Northington Partners write to Treasury, applying to be approved to be engaged as an independent expert in relation to the transaction, as required under the DGS. They contracted as follows:
'The Independent Expert is required to certify whether or not in the expert’s view the Proposed Transaction is on arms’ length terms. In general terms, we expect to form our opinion based on due inquiry into the following factors:
the fair market value of the shares in Scales;
the independent interests of SCF and the related party;
the conduct of SCF and the related party; and
conditions associated with the transaction as a whole.

We will provide a summary report that sets out the background, reasoning and information sources relevant to determining our opinion. That report will be addressed to both SCF and the Crown.' (emphasis added, see http://www.treasury.govt.nz/publications/informationreleases/scf/pdfs/scf-l-np-tsy-17feb10.pdf ).

I then noted that, unlike the Simmons Corporate Finance report, which was released (along with their engagement letter and approval letter), the Northington Partners report was not. This lead me to ask the authorities to seek it:

28th Feb 2010, presumably, Northington Partners write to Treasury with an opinion supposedly including an evaluation of the transaction as a whole and its impact on SCF's overall position -- this document has not been released by the Treasury, but it is likely to be important to any enforcement investigation, and should be sought. This unreleased document may be the basis for Treasury's view later disclosed in Parliament (see below).

I suggested that their report, which unlike the Simmons Corporate Finance report, was not released by the Treasury, could contain damning evidence that the transaction was not on arms' length terms, because of its effects on other exposures South Canterbury Finance had to its parents. However, after I submitted the complaint I thought perhaps the report was never completed, so I called Northington Partners who confirmed it was completed and they didn't know why it would not have been released. I also contacted the Treasury who confirmed this and suggested the non-release of the document was caused by an oversight:

The report by Northington Partners found that the transaction whereby South Canterbury Finance acquired Scales Corporation was at arm’s length. The Treasury intends to include the report by Northington Partners in its next release of documentation relating to South Canterbury Finance. We expect this release to happen in late February or Early March 2011.

The Treasury will not be commenting further on this matter.

I also spoke with the analyst at Northington Partners who wrote the report. I asked him about what matters were considered and asked him about the meaning of all the terms in the engagement letter about arms' length terms, independent interests of SCF, conduct of the parties and conditions associated with the transaction as a whole and he simply said all they did was a valuation of Scales Corp, and he could not explain what all those terms in the engagement letter were supposed to mean. So I'm left scratching my head as to what all those points in the engagement letter could have possibly meant. If the report was only a valuation, shouldn't that have been in the engagement letter (and the guarantee deed)? It appears to me that Northington Partners (and Simmons Corporate Finance) engaged to do something more than a valuation of the assets being acquired, as per the guarantee deed text and the engagement letters.

Authorities Should Investigate Helicopters NZ Transaction

2010-11-17T11:19:00.002+13:00

This morning I filed a complaint with the Serious Fraud Office and the Securities Commission requesting investigations into apparent criminal breaches of the Crimes Act 1961, Securities Act 1978, Financial Reporting Act 1993, Companies Act 1993 and/or the Fair Trading Act 1986 by the directors of South Canterbury Finance Limited and others. This follows my original analysis in June, and has been updated with a large amount of additional material released by the Treasury and the Reserve Bank of New Zealand, with my further analysis.

I also spoke with Allan Hubbard this morning and asked him who master-minded and planned the Helicopters NZ transaction. He said that it was Neil Paviour-Smith from Forsyth Barr who looked into all the companies affected and inter-company balances and their valuations.

I asked him specifically about the loan from South Canterbury Finance Limited made to Southbury Group Limited, and whether it was impaired as a result of the transaction the following comments:

AH: "It was done at full value ... you either paid the debt off and got fewer shares, didn't you?"

DH "That was the issue, when I looked at the transaction much later in June, I thought that if you had have done it that way, and paid off the debt, and then see what's left over to support the company with new shares, the amount of new shares would be much much less"

AH "It would have been, but it mightn't have been enough to make the company kosher with its trust deed requirements"

Later I asked him about the how the transaction worked or didn't work, and he said:

"theoretically, it should have worked, they were good companies, and you know they had good earnings"

Thankful for some recognition

2010-11-15T17:40:00.002+13:00

Some of my correspondents have written to congratulate me on having my analysis endorsed by Reserve Bank of New Zealand staffer Douglas Widdowson as being 'substantially correct'. Although the release of all the documents from the RBNZ and the Treasury provides an amazing treasure trove, it appears that officials have told their staff they can't discuss anything about the South Canterbury Finance affair (I've tried without avail).

The $150m Fudge that might not be Swept Under the Carpet

2010-11-10T14:14:00.004+13:00

The Helicopters NZ transaction undertaken by South Canterbury Finance on 28th Feb 2010, whereby SCF purported to book $152.5m in new equity, but actually booked more like $11.8m (less commission paid to Forsyth Barr and other transaction costs) perhaps will not be swept under the carpet, not least as a result of my efforts. Chalkie has written a more stinging piece on it today after an earlier one in July. The National Business Review has also picked up on my analysis several times. David Cunliffe has also extracted an extraordinary admission from Treasury in Parliament:

'Treasury’s view of the transaction was that at worst it made no difference to the Crown. ... That view has proven to be correct, and I do not believe the cost to taxpayers was impacted by this transaction.

I take this to mean that they knew that the net effect of the transaction (i.e. closer to $12m than $150m) was recognised by Treasury when they were being asked to approve it.

Subsequent to the transaction, materials released by Treasury indicate that Craig Murphy, Senior Analyst, The Treasury, expected that the provisioning for the Crown's loss on SCF should decrease by $150m as a result of this transaction, however, whoever had the seniority and authority to sign off the actual provisioning levels must have been in the know, as no material change in the provisioning levels happened as a result of this transaction.

I have a hope that this sleight of hand accounting for this transaction will see more scrutiny. Sandy Maier and the Board have a lot to answer for on this transaction, as do the trustee and the Treasury (I'm still planning on writing something on the Crown's role in this saga).

I'll bet this won't be the last we'll hear about this transaction.

Legalising Cannabis: Baby Step Welcome

2010-11-06T07:04:00.003+13:00

I can't confess to paying a lot of attention to drugs, however it does seem to be something of a litmus test of a person's perspective: is it a matter of free personal choice or a matter of overriding public concern for the 'authorities' to determine? This topic appears to be rich in the issues it brings forth:

Is it a matter of personal choice on principle, notwithstanding its effects (whether evidenced or merely alleged)?
Can a substance make an honest and civilised person a dangerous lawbreaker? It is like the question of whether guns kill people or people kill people, i.e. do people take hard drugs because they are dangerous lawbreakers, or are they dangerous lawbreakers because they take hard drugs?
Can a government agency enforcing a policy of prohibition or restriction be effective, or what policy is actually going to result in harm minimisation?
Is harm minimisation a proper measure of social welfare? What about the enjoyment or benefits of taking drugs?
Do 'externalities' justify government intervention such as regulations and taxes?

Today's news that the government had legalised some forms of cannabis for medical use is to be welcomed -- only the hard core addicts of prohibition could object, in my view.

Is Punishment Moral?

2010-11-05T20:52:00.005+13:00

I'm not very comfortable with the idea of justice requiring the punishment of misdeeds, as its end or purpose. To me it seems more natural and proper to consider the purpose of justice should be providing remedies for wrongs, i.e. remedies to help a person impacted by the wrong of another person. Such remedies can include both awards of damages (i.e. restitution or paying back for wrongs done) as well as injunctions (i.e. stopping or hindering, or perhaps even preventing (a rarer case) wrongs). This principle is summed up in the 'an eye for an eye' rule: that is to say, the wrongdoer should pay for the value of an eye, for an eye, and not two eyes nor half an eye. To levy more than was done is not a just remedy, and to levy less than what was done falls short of justice too.

The economics of such an approach to justice is for people to take various actions and expend resources on avoiding damage that the law is not expected to provide a reliable remedy. For example, if the chances of finding the wrongdoer are 50%, and the chances of them having the means to pay the cost of what they did is 50%, then, people will expect that they have a 25% chance of getting compensation for the wrong, and a 75% chance of getting nothing. This means they expect to recover 25% of the costs, and will therefore consider how they can reduce the chance of suffering from such wrongdoing. Such costs of such expected losses can be considered like a transaction cost, a cost of interacting with other people, that is to be traded off against the gains from trade. People can be expected to discover ways of interacting that will maximise gains from trade, net of transaction costs, through free interaction -- social welfare maximisation, subject to the constraint of justice limiting remedies.

The next layer of analysis is to suggest cranking up the restitution to partly offset the cases where no remedy is available -- i.e. treating wrongdoers as a class. This appears to be a utilitarian approach of optimising the remedy, even if it means two eyes for an eye. This would appear to be the basis of the law finding room for additional damages, particularly for intentional wrongs. For example the same law of Moses that provides an eye for an eye law, also provides:

Whoever steals an ox or a sheep and slaughters it or sells it must pay back five head of cattle for the ox and four sheep for the sheep

Today's common law also operates on a standard basis of awards for actual damages suffered (or those that flow naturally or normally from the wrong), but also provides for punitive damages as an exceptional remedy.

Today I read a short defense of punishment, and found it interesting to see someone try to express and explain why they think punishment can be considered to be right and just as an end or purpose of the law.

Voidable Allotments? Directors Liable?

2010-11-01T21:02:00.004+13:00

With the shocking news that South Canterbury Finance continued to trade and raise funds from the public notwithstanding a $315m negative equity position, we have to ask whether the directors of the company are at risk of liability for reckless trading and whether the debentures issued by the company were voidable, rendering the directors liable to repay them with interest. Under the Securities Act 1978, section 34:

No registered prospectus shall be distributed by or on behalf of an issuer,—
(b) if it is false or misleading in a material particular by reason of failing to refer, or give proper emphasis, to adverse circumstances (whether or not it became so misleading as a result of a change in circumstances occurring after the date of the prospectus).

Furthermore, under section 37A:

No allotment of a security offered to the public for subscription shall be made if—

(b) at the time of allotment, the investment statement or registered prospectus relating to the security is known by the issuer of the security, or any director of the issuer, to be false or misleading in a material particular by reason of failing to refer, or give proper emphasis, to adverse circumstances (whether or not the investment statement or registered prospectus became so false or misleading as a result of a change of circumstances occurring after the date of the investment statement or registered prospectus); or

This means that the Crown, using its subrogation rights as guarantor of the subscribers of the securities, can give notice to the company avoiding the subscriptions, and, should the company fail to repay them with interest, the directors of the company are jointly and severally liable to repay them with interest. Time limits apply, and the Crown should act now! Let's see the directors face the music over their decision to trade on and accept public funds in breach of the Securities Act.

Receivers' Report Shock: $315m negative equity as at 31 August 2010

2010-11-01T19:47:00.004+13:00

With the receivers' first report comes the shock that the directors and management of South Canterbury Finance continued to trade the business, and the trustee allowed them to do so, notwithstanding that their equity position was grossly negative, as recognised in the management accounts to 31 August 2010, the date of the receivership. The $315m negative equity still includes $25m in deferred tax (down from about $82m as at 31 Dec 2009), which surely has a recoverable value of zero. So, in effect, their net equity position is $340m by their own account. Unbelievable that the trustee allowed them to keep trading so long, and that the directors were willing to keep trading as long as they did, or that they put out the fiction in April 2010 that they wouldn't book any more losses and had a profitable future.

Hubbard's Sign-off Practice Illegal

2010-11-01T16:37:00.003+13:00

Allan Hubbard's sign-off practice reported in 22nd Oct 2010's National Business Review, appears to be illegal. Allan Hubbard confirmed he signed up farmer Andrew Morris to be a company director, and claimed he had authority to do so under a power of attorney issued by Mr Morris.

The responsibilities of signing up to be a company director are, however personal, and the documentation required must include 'a document in the prescribed form signed by every person named as a director, containing his or her consent to be a director and a certificate that he or she is not disqualified from being appointed or holding office as a director of a company' (emphasis added). This contrasts with shareholders consents where the requirements are:

'(i) a document in the prescribed form signed by every person named as a shareholder, or by an agent of that person authorised in writing, containing his or her consent to being a shareholder and to taking the class and number of shares specified in the document; and
(ii) if the document has been signed by an agent, the instrument authorising the agent to sign it'

The contrast is very clear: for directors, they must sign it themselves, for shareholders they may appoint an agent, but the agent must produce evidence of their authority. Mr Hubbard signed it as Mr Morris, without any indication he was purporting to sign as an agent, and without including the document providing his authority.

The provisions for replacement directors also include the requirement of personally signed consent and certification.

It is hard to say whether signing in someone else's name in this case is fraud or forgery. But is sure isn't regular or legal! Allan Hubbard appears to be a person who uses those who trust him: the Aorangi Securities and Hubbard Management Funds cases appear to be similar, except involving people's money rather than their authority. The Hyatt hotel affair appears to be a similar use of a person who trusted Mr Hubbard (and/or his brother-in-law Ed Sullivan) for dubious purposes.

Forsyth Barr's South Canterbury Finance Collateral Damage

2010-11-01T16:06:00.003+13:00

Forsyth Barr's boast on 4th May 2010 that they had 'had not lost a dollar for its clients in any of the finance company collapses in the past three years' now looks totally unhinged, with clients complaining about losing money on Strategic Finance preference shares, Credit Sails and South Canterbury Finance preference shares.

Anarchy, Monarchy, Tyranny and Sucession in Ancient Israel

2010-10-30T12:29:00.007+13:00

Ancient Israel's history gives us an example of different forms of government, and the different social perspectives that support or criticise the different forms or the way they may be practiced. I've perceived an anti-state and pro-anarchist perspective in the law of Moses, the book of Samuel as well as the teachings of Jesus of Nazareth. This post highlights some of those through the history of man and of the Israelites written by Moses and Samuel.

In the Beginning

Moses wrote five books that are known as the Torah, or the law of Moses. The book of Genesis provides a history of man, beginning with the creation, representing the ideal state of man, starting with the creation of one man, Adam, and one woman, Eve, from which man fell. The problems of man are portrayed as being the result of man turning away from the ideal. Some of the problems of man covered include:

Conflicts between the sexes: Adam blames his wife Eve, for his wrongdoing, and God told the woman, as a result of her role in the fall: To the woman he said,
"I will greatly increase your pains in childbearing;
with pain you will give birth to children.
Your desire will be for your husband,
and he will rule over you."
Scarcity and death: To Adam he said, "Because you listened to your wife and ate from the tree about which I commanded you, 'You must not eat of it,'
"Cursed is the ground because of you;
through painful toil you will eat of it
all the days of your life.
It will produce thorns and thistles for you,
and you will eat the plants of the field.
By the sweat of your brow
you will eat your food
until you return to the ground,
since from it you were taken;
for dust you are
and to dust you will return."

Adam and Eve then produce children who will populate the world. Before long, Cain kills Abel, and this story illustrates a number of ideas:

The idea that man is prone to extreme violence, that social relations among men can be expected to result in conflicts rather than cooperation and harmony. Such conflicts may arise partly as a result of scarcity brought about by the fall, as mentioned above
The idea that justice requires an accounting for bloodshed: 'The LORD said, "What have you done? Listen! Your brother's blood cries out to me from the ground. Now you are under a curse and driven from the ground, which opened its mouth to receive your brother's blood from your hand. When you work the ground, it will no longer yield its crops for you. You will be a restless wanderer on the earth."
The idea that justice may be dispensed by man is foreshadowed, but also excluded: Cain said to the LORD, "My punishment is more than I can bear. Today you are driving me from the land, and I will be hidden from your presence; I will be a restless wanderer on the earth, and whoever finds me will kill me." But the LORD said to him, "Not so; if anyone kills Cain, he will suffer vengeance seven times over." Then the LORD put a mark on Cain so that no one who found him would kill him.

The second murder follows a few generations later when Lamech, the descendant of Cain, kills a young man for injuring him, and claims impunity:

Lamech married two women, one named Adah and the other Zillah. Adah gave birth to Jabal; he was the father of those who live in tents and raise livestock. His brother's name was Jubal; he was the father of all who play the harp and flute. Zillah also had a son, Tubal-Cain, who forged all kinds of tools out of bronze and iron. Tubal-Cain's sister was Naamah.
Lamech said to his wives,
"Adah and Zillah, listen to me;
wives of Lamech, hear my words.
I have killed a man for wounding me,
a young man for injuring me.
If Cain is avenged seven times,
then Lamech seventy-seven times."

Apparently with no accounting for bloodshed, and no administration of justice on earth, the earth become filled with violence:

The LORD saw how great man's wickedness on the earth had become, and that every inclination of the thoughts of his heart was only evil all the time. The LORD was grieved that he had made man on the earth, and his heart was filled with pain. So the LORD said, "I will wipe mankind, whom I have created, from the face of the earth—men and animals, and creatures that move along the ground, and birds of the air—for I am grieved that I have made them." But Noah found favor in the eyes of the LORD.
This is the account of Noah.
Noah was a righteous man, blameless among the people of his time, and he walked with God. Noah had three sons: Shem, Ham and Japheth.
Now the earth was corrupt in God's sight and was full of violence. God saw how corrupt the earth had become, for all the people on earth had corrupted their ways. So God said to Noah, "I am going to put an end to all people, for the earth is filled with violence because of them. I am surely going to destroy both them and the earth.

A New Beginning

After the flood, Noah and his sons are told to fill the earth again, but apparently a new set of rules are instituted to dispense justice on the earth, at the hand of man:

for your lifeblood I will surely demand an accounting. I will demand an accounting from every animal. And from each man, too, I will demand an accounting for the life of his fellow man.
"Whoever sheds the blood of man,
by man shall his blood be shed;
for in the image of God
has God made man.

Note that this rule does not imply or require a state or a centralised government to administer justice: it puts the right to administer justice in the hands of man, but does not presuppose or require any particular form or organisation. The 'how' is not specified, leaving open anarchy, monarchy and other forms of the administration of law.

After this point there are references to kings two generations later (Nimrod whose kingdom includes a number of cities). Actually it may more than two generations, since the term 'father' may mean ancestor.

Israelites Liberated from Egypt and get the Law of Moses

Moving on now to the Israelites, the Israelites were enslaved in Egypt for 400 years. Egypt was a large and strong kingdom, with apparently absolute power over the affairs of those who lived there. The Israelites appear to have picked up a number of lessons from being enslaved and being subject to a strong power:

The institution of slavery is not accepted or continued among the Israelites: under the law of Moses working to pay off debt is allowed, but subject to a 6 year limit, and such servants were afforded various protections that treated them equally with free men, other than their obligation to serve.
Oppression of foreigners is not accepted or allowed: "Do not mistreat an alien or oppress him, for you were aliens in Egypt."

Egypt represents the kind of society and government the Israelites wanted to be different from.

Moses lead the people of Israel from slavery in Egypt, and also served as a judge for the people, hearing and settling their disputes. This administration of justice was tiresome for Moses so he listened to his father in law and appointed a system of judges:

The next day Moses took his seat to serve as judge for the people, and they stood around him from morning till evening. When his father-in-law saw all that Moses was doing for the people, he said, "What is this you are doing for the people? Why do you alone sit as judge, while all these people stand around you from morning till evening?"
Moses answered him, "Because the people come to me to seek God's will. Whenever they have a dispute, it is brought to me, and I decide between the parties and inform them of God's decrees and laws."
Moses' father-in-law replied, "What you are doing is not good. You and these people who come to you will only wear yourselves out. The work is too heavy for you; you cannot handle it alone. Listen now to me and I will give you some advice, and may God be with you. You must be the people's representative before God and bring their disputes to him. Teach them the decrees and laws, and show them the way to live and the duties they are to perform. But select capable men from all the people—men who fear God, trustworthy men who hate dishonest gain—and appoint them as officials over thousands, hundreds, fifties and tens. Have them serve as judges for the people at all times, but have them bring every difficult case to you; the simple cases they can decide themselves. That will make your load lighter, because they will share it with you. If you do this and God so commands, you will be able to stand the strain, and all these people will go home satisfied."
Moses listened to his father-in-law and did everything he said. He chose capable men from all Israel and made them leaders of the people, officials over thousands, hundreds, fifties and tens. They served as judges for the people at all times. The difficult cases they brought to Moses, but the simple ones they decided themselves.

The law of Moses recognised personal and property rights, provided for the administration of justice (e.g. evidential and procedural requirements), but also provided various rules for hygiene, religious rituals, and other issues. The religious system was highly organised, with one of the 12 tribes serving as priests, but the system of administration of justice and civil matters was not centralised. For example, there was no police force, no monarchy, no taxes payable to a central authority.

After Moses died, Israel was lead by judges rather than kings. The book of Judges details the exploits of the judges, and some of the social and political conditions of this time, with the common refrain: 'In those days Israel had no king; everyone did as he saw fit.' It appears this was a lament and that the writer was fond of the monarchy, although when it was introduced, as we shall see, it was the monarchy that was lamented.

The Monarchy

The people ask for a king:

When Samuel grew old, he appointed his sons as judges for Israel. The name of his firstborn was Joel and the name of his second was Abijah, and they served at Beersheba. But his sons did not walk in his ways. They turned aside after dishonest gain and accepted bribes and perverted justice.
So all the elders of Israel gathered together and came to Samuel at Ramah. They said to him, "You are old, and your sons do not walk in your ways; now appoint a king to lead us, such as all the other nations have."
But when they said, "Give us a king to lead us," this displeased Samuel; so he prayed to the LORD. And the LORD told him: "Listen to all that the people are saying to you; it is not you they have rejected, but they have rejected me as their king. As they have done from the day I brought them up out of Egypt until this day, forsaking me and serving other gods, so they are doing to you. Now listen to them; but warn them solemnly and let them know what the king who will reign over them will do."
Samuel told all the words of the LORD to the people who were asking him for a king. He said, "This is what the king who will reign over you will do: He will take your sons and make them serve with his chariots and horses, and they will run in front of his chariots. Some he will assign to be commanders of thousands and commanders of fifties, and others to plow his ground and reap his harvest, and still others to make weapons of war and equipment for his chariots. He will take your daughters to be perfumers and cooks and bakers. He will take the best of your fields and vineyards and olive groves and give them to his attendants. He will take a tenth of your grain and of your vintage and give it to his officials and attendants. Your menservants and maidservants and the best of your cattle and donkeys he will take for his own use. He will take a tenth of your flocks, and you yourselves will become his slaves. When that day comes, you will cry out for relief from the king you have chosen, and the LORD will not answer you in that day."
But the people refused to listen to Samuel. "No!" they said. "We want a king over us. Then we will be like all the other nations, with a king to lead us and to go out before us and fight our battles."
When Samuel heard all that the people said, he repeated it before the LORD. The LORD answered, "Listen to them and give them a king."
Then Samuel said to the men of Israel, "Everyone go back to his town."

This is a remarkable passage: The institution of a monarchy is represented as a repressive, and as fundamentally wrong, and its primary demerits are its propensity to war, taxation and subjugation, which is ill-fitting to a free people who love justice.

When Samuel was about to die, he proclaimed his own good record, and condemned again the people for asking for a king.

The problems of the monarchy soon surfaced. The first king, Saul, ended up going a bit mad, and chasing is loyal servant David, whose principal crime was being successful, around the country. Saul and his sons are killed in battle, and David replaces him as king. David has woman trouble, and murders a woman's husband so he can marry her, and is duly rebuked. He has many wives and sons. Heir to the throne Amnon, David's eldest son, fell in love with his half-sister Tamar, and rapes her and despises her. David fails to see that justice is done, so Absalom, Tamar's full brother, kills Amnon. Absalom flees to Egypt. David has a soft spot for his son Absolom and allows him to come back to Israel, and later, agrees to see him -- still no sign of justice for Absalom's wrongdoing. David doesn't pay much attention to seeing justice done, so Absalom, with an eye on the throne, decks himself out with a chariot, horses and 50 men to run ahead of him, charms the people. David is told of Absalom's plans at the last moment, and escapes, organises a response, and ends up having his own son defeated and killed, before mourning his death. This kind of intrigue is the fruit of monarchy, it appears.

Tyranny

David's son Solomon, whom he had with the wife Bathsheba that he stole from Uriah by having him killed in battle, succeeds David on the throne, but not before his son Adonijah had a go at being proclaimed king. Solomon, the wisest man, was wealthy and successful, however, the people were not happy with his taxes. When Rehoboam his son succeeded him as king the people complained to their new king:

"Your father put a heavy yoke on us, but now lighten the harsh labor and the heavy yoke he put on us, and we will serve you."

Rehoboam asked the advisers he had inherited from his father, who advised him to lighten the burden of taxes:

"If today you will be a servant to these people and serve them and give them a favorable answer, they will always be your servants."

However, Rehoboam didn't like that idea, so he consulted the younger men his own age:

The young men who had grown up with him replied, "Tell these people who have said to you, 'Your father put a heavy yoke on us, but make our yoke lighter'-tell them, 'My little finger is thicker than my father's waist. My father laid on you a heavy yoke; I will make it even heavier. My father scourged you with whips; I will scourge you with scorpions.' "

Sucession

With the prospect of a king bent on heavy taxes, 10 of the 12 tribes secede from Israel and Rehoboam's reign:

Three days later Jeroboam and all the people returned to Rehoboam, as the king had said, "Come back to me in three days." The king answered the people harshly. Rejecting the advice given him by the elders, he followed the advice of the young men and said, "My father made your yoke heavy; I will make it even heavier. My father scourged you with whips; I will scourge you with scorpions." So the king did not listen to the people, for this turn of events was from the LORD, to fulfill the word the LORD had spoken to Jeroboam son of Nebat through Ahijah the Shilonite.
When all Israel saw that the king refused to listen to them, they answered the king:
"What share do we have in David,
what part in Jesse's son?
To your tents, O Israel!
Look after your own house, O David!"
So the Israelites went home. But as for the Israelites who were living in the towns of Judah, Rehoboam still ruled over them.
King Rehoboam sent out Adoniram, who was in charge of forced labor, but all Israel stoned him to death. King Rehoboam, however, managed to get into his chariot and escape to Jerusalem. So Israel has been in rebellion against the house of David to this day.
When all the Israelites heard that Jeroboam had returned, they sent and called him to the assembly and made him king over all Israel. Only the tribe of Judah remained loyal to the house of David.
When Rehoboam arrived in Jerusalem, he mustered the whole house of Judah and the tribe of Benjamin—a hundred and eighty thousand fighting men—to make war against the house of Israel and to regain the kingdom for Rehoboam son of Solomon.
But this word of God came to Shemaiah the man of God: "Say to Rehoboam son of Solomon king of Judah, to the whole house of Judah and Benjamin, and to the rest of the people, 'This is what the LORD says: Do not go up to fight against your brothers, the Israelites. Go home, every one of you, for this is my doing.' " So they obeyed the word of the LORD and went home again, as the LORD had ordered.

Conclusion

It appears that in the early history of Israel, that the concept of a monarchy and its association with a centralised state and heavy taxation, was not well regarded, and that the practice of the monarchy was bloody and retrogressive. The Israelites appear to have had the desire to be different from the nations around them, with a different, and better, conception of justice and the good society. Sucession was available and used, when toleration of heavy taxes ran out. Some of the best leaders of the Israeli nation, such as Moses, were not kings but judges or prophets.

Treasury: We're 'dealing with a “certain to fail” situation'

2010-10-16T10:49:00.006+13:00

Another gem from the Treasury documents released, this one from 15 August 2009:

Managing associated risks: Mitigation through managing flow-on effects to the
next firm at high risk
The options are similar to the above except you are avoiding a failure that might not otherwise have happened rather than dealing with a “certain to fail” situation. The risks are still significant but there is likely to be some time and more options available. The next most at risk firm also has good governance and tidier asset management. The details of how these options could be put into place can be developed.
Summary of options
We would expect to recover $$800 million over time. The other options that require Crown support do not, in our view, prevent the inevitable collapse of the firm, although they may delay this at some cost to the Crown.

It appears that the Treasury not only expected SCF would more likely fail than not fail, but that its failure was 'inevitable' and 'certain'.

SCF: The Government's $700m Problem Since 2009

2010-10-15T21:04:00.002+13:00

Well there we have it: almost all the government's near $900m provisions for the DGS, since it was first provided for, was for SCF: $742m in June 2009 through to $672m in Jan 2010, according to this.

Private Courts Booming in New Zealand

2010-10-15T07:11:00.004+13:00

Today's NBR online article Why 'private courts' are booming gives a good real world example of law as a privately provided service and product -- not only the service of hearing the case, but the rules to be applied. If you think about it, all aspects of the law can be private: the terms of the deal between the parties (the contract), the terms of the rules for settling disputes (as written into the contract, e.g. arbitration clauses), the representation of the parties and advocacy (lawyers), through to the hearing of the case (the private arbitration service) and even the particular rules and procedures applied to the case (the private arbitration service has freedom to set its own procedure and to adopt particular positions on rules, e.g. evidence or delimitation of rights). It can even be taken to the point of enforcement, where security interests in property can be arranged so that in the event of default, the other party can appoint a receiver and manager (another private business) to enforce the contract through taking control over the other parties assets and operations (or some part of them). The only impediment to such arrangements is the need to arrange them in advance of the dispute.

UPDATE: here is the text of the article, which seems to be unavailable a lot of the time:

Why 'private courts' are booming

It is fitting in the week when former Auckland Crown prosecutor Mark Woolford was sworn in as a new High Court judge to consider why judges risk redundancy.

MORE FROM JOCK ANDERSON: Weird courtroom slanging match

Judge Jock’s mate Anthony Grant, of Radcliffe Chambers, was on the ball the other day when he spoke about the flight of potential litigants away from the courts.

Mr Grant reckoned more and more folk were being driven to arbitration, mediation and other initiatives to resolve disputes rather than go to court.

He is quite right. The swing towards “private courts” has been in full swing for some years.

With membership of the Arbitrators and Mediators Institute (AMINZ) now standing at 700, more disputes are being settled through this route because it is cheaper, quicker and binding.

If you don’t want your dispute picked over in a public courtroom or exposed by creepy little newsmen this is the way to go.

While AMINZ president Ann Edge couldn’t give figures on how many disputes went AMINZ’s way, Mrs Edge told Judge Jock a significant increase in membership in the last year indicated a greater use of arbitration, mediation and adjudication.

Leading lights in the “private court” system include Auckland law professor Bill Hodge and former High Court judges Sir Ian Barker, Bob Fisher and Barry Paterson and former Master Tomas Kennedy-Grant.

Anthony Grant was on the button when he noted there was hardly any High Court civil litigation outside Auckland. Some High Courts go for weeks without any civil cases.

At a recent Bar Association conference one judge was heard to wonder if the system was in a “death spiral.”

Lawyers also want judges to deal with cases within their designated specialist area. Some judges want a broader range of work.

But as Judge Jock has long campaigned, the courts do not exist for the convenience of judges – nor, for that matter, do they exist for the convenience and purses of lawyers.

Courts are for the maintenance of a credible system of civil justice, as Mr Grant rightly agreed.

But wait there’s more.

In his latest utterance, Mr Grant said he was aware of at least one enterprise that was so mistrustful of the senior courts it would not do business in New Zealand, unless the parties it contracted with agreed that all disputes would be litigated offshore.

He also reckoned other enterprises were not willing to do any business in New Zealand because of their lack of confidence in the courts.

Chief High Court judge Justice Helen Winkelmann is so concerned she’s got together with Justices Geoff Venning and Forrie Miller to figure out how the High Court can be made a more satisfactory forum for dispute resolution.

So where does that leave former Meredith Connell partner and now Justice Woolford, as he steps out on the next stage of his legal career?

Twiddling his thumbs on the criminal bench where, one droll observer opined, a judge’s most useful talent was observing tea breaks and keeping jury members awake?

Meanwhile, down at The Northern Club, members mourn – after 70-odd years of coining it at the estate’s expense - the hasty settlement in Jarndyce and Jarndyce.

Frock up or frock off
Judge Jock is partial to a bit of dressing up.

He is delighted to see a revival in courtroom custumery being led by law society big wigs.

Bring back wigs, gowns, bibs, tuckers, knicker-bockers, frock-coats, lum hats, buckled shoes, the works.

As a baby jurist Judge Jock was always pleased to observe a certain delightful lady brief before him, fetchingly clad in racy gown, wig, black stockings, suspenders, high heels, a saucy smile and little else, Yer Honour…(Quick, get his pills…Ed).

Legislation: the Anarchist Critique

2010-10-14T15:54:00.003+13:00

Today I read Stephan Kinsella's article Legislation and the Discovery of Law in a Free Society and I'd like to share it with my readers. The principal distinction Kinsella (and other anarchists and natural law theorists) make is between law discovered and applied to cases by judges, and 'law' that is enacted by a legislature. Kinsella provides a good coverage of the following issues:

Common law and civil law legal systems -- similarities and differences
Codification and commentaries of the law
The disadvantages of legislation and how these disadvantages might be mitigated
Evolution and correction of the law
Judicial services, including different legal rules, as potentially private and competitive services/products
Theoretical problems with legislation (public choice theory, socialist calculation debate analogy etc.).

I recommend this article for my readers who are interested in exploring alternative social institutions and the libertarian perspective on the law. His work against 'intellectual property' is also very good and what he is best known for.

The only drawbacks of Kinsella's article, in my opinion, is the reductionist moral-legal theory that everything comes back to property rights and self-ownership, that is common in libertarian writings. I see this approach as inappropriate and inadequate to deal with important social issues such as family law and economic torts (e.g. defamation). I believe the natural law/common law tradition is richer and better than some libertarians give it credit for.

Governance Deficit: Asking the Wrong Questions

2010-10-12T16:42:00.006+13:00

In politics we suffer an unfortunate deficit in questioning the fundamental issues, in order to be concerned about superficial issues. We don't ask whether or not the state should own and operate the roads, but whether it should build this road or that road, or increase the overall road building or maintenance budget -- government ownership and operation of the road being a given, an assumption that is neither acknowledged nor justified. We don't ask whether the state should own and operate the railways either, just whether or not it overpaid for the asset, or whether or not it is operating it well.

With the news today that the Crown Retail Deposit Guarantee Scheme is to be audited by the Auditor General we have a great example of a governance deficit in action, asking all the questions of limited relevance and avoiding the most relevant issue: was the scheme good policy? The punchline in the article:

It would not consider whether the scheme was an appropriate response to the international financial crisis, nor the appropriateness of the scheme or the adequacy of its provisions.

So there you have it: never mind that the scheme was bad policy and that the Treasury and RBNZ advised against it, never mind that we had very good reasons to believe that the government would not be a position to contribute to our welfare by running such a scheme, but let's just see if those charged with running this particular fool's errand can be criticised for how they ran it. It's a bit like a cop criticising a boy racer for his drifting technique, doncha reckon?

Throwing the Book at High Profile Failures

2010-10-08T17:54:00.003+13:00

My commercial law lecturer commented to me yesterday that commercial crimes didn't result in jail time in New Zealand, and suggested Mr Hubbard would end up facing a raft of criminal charges. Today, just to contradict her, a finance company fraudster was told to expect jail time:

A former company accountant at failed motor vehicle finance company National Finance 2000 has pleaded guilty to three of four charges laid by the Serious Fraud Office. ...

At the Auckland District Court Gray was convicted of three charges and was remanded for sentence on November 26.

Mr Gray had been seeking an indication of home detention but Judge Rod Joyce indicated the conviction would still carry an imprisonment term.

The indication given today was reduced to between 18 months and two years compared to an earlier indication of two and a half years.

The SFO CEO Adam Feeley's comments don't auger well for Mr Hubbard chances:

Mr Feeley said that in the past 12 months the SFO had significantly shifted its priorities to ensure there were speedier outcomes on the corporate failures which had generated the most public concern.

“Results such as this demonstrate that there are serious consequences for breaching the law and help ensure the investing public can have greater confidence in the integrity of our financial markets.”

Crimes Allan Hubbard Could Be Suspected Of

2010-10-05T18:06:00.007+13:00

For all the reports from the Statutory Manager and others detailing their findings and evidence, some people are still commenting that Allan Hubbard does not appear to have been dishonest or to have have acted fraudulently. Unfortunately for Mr Hubbard such sentiments indicate not only blind loyalty but also ignorance of the law. So, what has Mr Hubbard been reported as doing that involves dishonesty or fraud?

In the original Statutory Management announcement, the attached fact sheet detailed funds being raised 'Investment authority for first mortgage security' and then being paid to entities associated with Mr Hubbard on an unsecured and undocumented basis. It is unclear if Aorangi Securities was acting as nominee/trustee or as principal: 'Aorangi appears to have originally been a nominee company or contributory mortgage company but seems to have since transformed into a finance company, raising funds from investors and on-lending those funds to borrowers'.

If Aorangi was acting as a nominee, it was acting as a trustee, and the funds were trust funds, and misappropriation or misapplication of them in breach of the trust constitutes criminal breach of trust: 'Every one is guilty of a criminal breach of trust who, as a trustee of any trust, dishonestly and contrary to the terms of that trust, converts anything to any use not authorised by the trust.'

It could also be theft by a person in a special relationship: '(1) This section applies to any person who has received or is in possession of, or has control over, any property on terms or in circumstances that the person knows require the person—(a) to account to any other person for the property, or for any proceeds arising from the property; or (b) to deal with the property, or any proceeds arising from the property, in accordance with the requirements of any other person.

(2) Every one to whom subsection (1) applies commits theft who intentionally fails to account to the other person as so required or intentionally deals with the property, or any proceeds of the property, otherwise than in accordance with those requirements.'

On the other hand, if Aorangi Securities was acting as principal, and was borrowing the funds from investors, the raising of the funds on the basis that it would be lent on first mortgage security could be a false statement by a promoter: 'Every one is liable to imprisonment for a term not exceeding 10 years who, in respect of any body, whether incorporated or unincorporated and whether formed or intended to be formed, makes or concurs in making or publishes any false statement, whether in any prospectus, account, or otherwise, with intent—(a) to induce any person, whether ascertained or not, to subscribe to any security within the meaning of the Securities Act 1978; or (b) to deceive or cause loss to any person, whether ascertained or not; or (c) to induce any person, whether ascertained or not, to entrust or advance any property to any other person.'

Note that the statutory manager's first report stated:

A number of investors provided a formal authority to the company with specific direction on how their funds were to be invested.
A limited number of investors have signed a formal authority for investment in a contributory first mortgage over land.

This statement suggests that Aorangi Securities was acting as trustee for the investors rather than as a borrower in at least some cases. However, the same report also suggests the contrary by stating: 'Aorangi started as a contributory mortgage company [i.e. a nominee company] in 1974. Over time it seems that its operation has changed so that it now appears to operate in a manner which bears similarities to a finance company, and it appears to have lent to or invested in both entities related to Mr and Mrs Hubbard and third parties.' The second report also appears to confirm Aorangi Securities was acting as a borrower (note that 'deposits' are debt securities):

The problem we face as statutory managers of Aorangi is that Mr Hubbard has allowed Aorangi to accept deposits from investors at call and to invest those funds in investments or loans which are nearly all long term in nature.

Hubbard Management Funds, however, could only have been operating as a trustee holding the funds and securities on behalf of investors, with Mr Hubbard having discretion about how the funds were invested, according to this from the first report:

Hubbard Management Funds is an investment management business operated by Mr Hubbard. ... It seems that Mr Hubbard makes all or most of the investment decisions regarding HMF and undertakes communications with share brokers.

This analysis shows why 'The Registrar of Companies has referred a number of matters relating to Aorangi Securities Ltd to the Serious Fraud Office to investigate potential breaches of the Crimes Act.' All these offences have the character of theft or fraud, and are dishonesty offences and serious crimes. These are also the most serious offences that may be inferred from reports to date.

The second statutory managers report identifies some further potential criminal offences in relation to Hubbard Management Funds (HMF):

Shares and other investments in excess of $13 million which do not exist have been allocated by Mr Hubbard to investors within the HMF portfolio.
Uninvested funds on hand of $6 million has been reported to investors by Mr Hubbard as at 31 March 2010 however cash available at that date was less than $350,000.

On the second point, Forresters, subsequently also placed into Statutory Management, held $2.25m in cash on behalf of HMF, although it is unclear if these funds were held on 31 March 2010.

These statements to investors could be considered to be a 'book or account or other document required or used for accounting purposes' which, if they included false amounts placed there by Mr Hubbard could be a crime of false accounting. Alternatively or additionally, they could be considered false statements by a promoter. A third possibility, also additional, if the assets were over-reported due to them having been misappropriated to Mr Hubbard or his interests, would be criminal breach of trust and/or theft by a person in a special relationship.

In the third report, $7.57m in security interests of third parties over HMF had been registered, securing the liabilities of Mr and Mrs Hubbard and entities associated with them. This would appear to be criminal breach of trust as above: it constitutes a misdealing by the trustee of the investors assets held in trust.

So that's just 1 Act, the Crimes Act 1961. Mr Hubbard also appears to have breached the Companies Act 1993, the Securities Act 1978 in relation to issues such as keeping proper accounting records and requirements for prospectuses, security trust deeds, security trustees/statutory supervisors, annual audits, registration of financial statements and so on (and probably other important business laws too). However, it is clear from the above that lax or old fashioned business practices and inadequate paperwork are not the major part of what Mr Hubbard is suspected of nor why he's being investigated by the Serious Fraud Office. The SFO has stated that they still believe they are investigating a case of serious and complex fraud, and from the Statutory Managers reports it's not hard to see why.

Hubbard: "If I don't repay you, just take my investors' assets"

2010-10-02T09:02:00.005+13:00

Yesterday's third Statutory Manager's Report contains further updates for the affairs of Aorangi Securities and Hubbard Management Funds and associated persons and entities. One of the most notable new disclosures (p 12) was that Mr Hubbard had used investors assets as security for borrowings of entities associated with himself:

During our investigations we have noted that third parties have recorded security interests or charges against some HMF investments to secure liabilities related to Mr and Mrs Hubbard and other entities they are associated with. Should all of these charges prove to be valid, the overall assets available to investors would be reduced by approximately $7.57 million.

I'm still trying to get my head around quite what this conduct amounts to. Is it fraud? Is it equivalent to misappropriation of the assets? Is it criminal breach of trust?

Chalkie's On the Money Again

2010-09-29T09:25:00.005+13:00

As I've always commented, the woes of Mr Hubbard's investors in Aorangi Securities and Hubbard Management Funds are largely the result of full trust in the man while the internal controls, governance and external scrutiny and safeguards were almost entirely absent. Wise investors check not only the reputation of the people running an investment, but also the adequacy of the investment's structure, governance arrangements and other safeguards. (Indeed, many such safeguards are required by the Securities Act 1978 for investments offered to the public in New Zealand, a law that it appears that Mr Hubbard did not comply with whatsoever in relation to Aorangi Securities, at least.)

The approach of Mr Hubbard's supporters (and investors) is revealed by this statement:

'We believe in him wholeheartedly, and in his innocence, and will continue to do
so'

This was included in a letter claimed to have been voted for unanimously 200 investors/supporters on 20th Sept 2010. So there you have it: no matter what evidence is found against Mr Hubbard, no matter what he confesses to, no matter what he is convicted of, its all a giant conspiracy against Mr Hubbard by the government and its rouge ministers, departments, etc. acting to benefit dark horses like George Kerr, with the Statutory Manager using Mr Hubbard's own wealth against him and his investors.

Perhaps this is a good time to point out the difference between someone being guilty of a criminal offence and convicted for it in a court of law, and merely losing their reputation as a good investor or good manager. Although Mr Hubbard hasn't even been charged with anything, his ability to get new funds from investors has been almost totally removed as a result of his commercial troubles, and the reports about how many of his entities have been managed. His honesty and integrity are very much in question before the first shot has been fired against him in a court of law on a criminal matter. Through receivership and statutory management, even existing funds under his control have been taken over by independent professionals.

Getting back to the heading of this post, Chalkie is right on the money again with this article (by contrast, Fran O'Sullivan latest missive appears to be going off half-cocked).

A Taste of a Real Banking Crisis

2010-09-28T15:50:00.003+13:00

Sometimes rhetoric doesn't keep pace with reality. Our recent example of South Canterbury Finance's distress and belated failure lead to many commenting that the company was too big to fail, that the Crown honouring its obligation under the its unwise Crown Deposit Guarantee Scheme with a large pay out make South Canterbury Finance debenture investors whole would put a strain on the government's finances or credit rating, and of course the oft repeated allegation that without the Crown Deposit Guarantee Scheme, investors would have moved their funds offshore and that our banks would have failed. Perhaps the best way to put these untrue claims into perspective is to examine a case where the losses generated by the major banks was so large that the major banks would have failed, and government bail outs to rescue the major banks have indeed placed a great strain on the government's finances: the Republic of Ireland. A recent Irish Times article tallies the figures as:

€440 billion Bank deposits and liabilities covered by guarantee on the night it was introduced
€334 billion Deposits and liabilities covered by the guarantee and last year's longer-term guarantee
€1 billion Fees earned by the Government from the banks on the guarantees
€33 billion Amount of State money injected or pledged to the banking system
€25 billion Current estimated cost of bailing out Anglo; expected to rise further

These figures indicate a very serious crop of bank losses, and show the major public cost of not being able to restructure the major banks promptly and at the expense of their creditors and shareholders. In my mind it is when the major banks are in trouble that the creditor recapitalisation becomes compelling, and a 'must have' for policy makers and for the authorities (I'd favour trustee supervision of banks and trustee supervision of creditor recapitalisation events, but that's another story). Whatever the merits or failures of prudential regulation, surely it is when major banks are in deep trouble that credible and effective options for prompt restructuring are required.

How would a creditor recapitalisation option work? Let's say you have $5000 in your current account with a bank that turns out to be in trouble. Perhaps you're not paying attention to its condition or weren't quick enough to get your funds out before the bank failed (if you had a term deposit you'd be stuck in there until the maturity date). So the bank runs out of cash and fails. The creditor recapitalisation option means that your balance of $5000 is debited by, say $2000, and the other creditors of the bank likewise take a 40% haircut, and the bank re-opens for business the next day. The bank's liabilities are now 40% less, and its capital position is now strong, so it can raise the funds it needs in the market, restoring its liquidity, and your access to your remaining $3000 balance. All your incoming and outgoing payments carry on as before, subject to your reduced balance. In exchange for your $2000 debited from your current account, you are issued with shares in the bank that might be worth, say, $1000. The shares could be issued at a very low price to dilute the existing shareholders to, say, 1% of the bank's total capital after restructuring, or they could be wiped out, depending on the plan and policy, and how it is executed.

Relentless Criminalisation and Regulation

2010-09-24T13:36:00.007+12:00

In the last ten years in the finance and commercial sector, there has been a relentless increase in government regulation and in criminalisation of commercial misdeeds. Government regulation is becoming more centralised and consolidated, and with greater powers and a stronger enforcement role. Whatever the problem, the solution is more regulation and more powers to government regulators and enforcement bodies. Although you can argue about the specifics here or there, my concern is the lack of intellectual and moral rigour in assessing and questioning such proposals, and the general acceptance of the proposition that criminalisation is the solution and that commercial affairs need to be governed by criminal law. It is commonly suggested that civil remedies amount to a 'wild west' mentality, and assumed that criminal laws will somehow automatically produce prudence, propriety and probity.

This direction of commercial law in New Zealand can be seen from:

The regulation of consumer credit enacted in 2003
The introduction of registration requirements and dispute resolution schemes for financial service providers enacted in 2008
The introduction of authorisation requirements for financial advisers enacted in 2008
The onerous new anti-money laundering requirements enacted in 2009
The proposed introduction of regulations and licencing of auditors, including criminal liability for auditors
The proposed centralisation of financial regulators into the new Financial Markets Authority, and the proposed new powers for it
The proposed new licencing requirements for security trustees and supervisors
The new capital and related party and credit rating requirements for non-bank deposit takers
The new prudential requirements for insurers enacted in 2010
The criminalisation of insider trading and market manipulation and other secondary market issues enacted in 2006.
The introduction of the Crown Deposit Guarantee Scheme in Oct 2008 was also a major change in the financial environment and will have enduring effects on expectations on the government in cases of institutional failure and market stress.

With all these new laws on the books, all these new criminal offenses, all these new regulatory powers and super-agencies surely we will have good conduct on the part of market participants and develop a culture of ethical and honest practice in finance and financial services, no? Clearly this is a matter of perspective and ideology: for some, our problems with finance companies and some listed companies and some audits and so on are seen as fairly mild, and that through the cleansing process of failures and lessons learned the hard way commercial practice and market behaviour these problems are seen to be resolved as well as can be expected. But for others, the problems represent scandals, and the result of 'weak' laws, inadequate resourcing of regulators, fragmentation of regulators, and 'cracks' in the regulatory system leading to a 'wild west' commercial culture where 'cowboys' run amok. This second perspective appears to be dominating the discourse, and any opposition to it appears to be fairly reticent and more reactionary than principled.

Yet as technology and management practices evolve, it appears that the merits of this criminal approach to commercial problems ought even more to be questioned. Information Technology developments enable us to record and access the conduct and history of companies and individuals more easily. This makes reputation checking the more expected tool to use in decision making, and therefore the value of goodwill in a good name etc. to be more valuable than in the past. For example, in the small transactions, we have Trade Me tracking transactions and recording any unfavourable events (as well as the favourable ones), and making even non-professional traders largely honourable and honest. Surely, for larger transactions, credit reference databases, professional membership databases and so on are all the more important in influencing the conduct of professionals and businesses! Modern database systems and the management information and control systems enable far greater and more efficient controls over the key business processes that customers and clients rely on. Such systems more easily enable external as well as internal parties to observe and/or approve transactions or monitor compliance with any contract. The concerns about insider trading and money laundering appear to be more capable of detection and analysis in real time with modern technology than in the past, indeed this technology has been credited with controlling credit card fraud notwithstanding its vulnerability to fraud. Investor access to financial information has never been better, not only with direct access to financial statements, but with the opportunity for third parties to aggregate information from different providers for comparison. Indeed, the latest suspected fraudster is no computer whizz kid but a technophobic elderly man who kept handwritten paper ledgers that proved both unreliable and missing any means of proper control.

For an honourable exception to the reactionary approach against the criminalising trend, see this from Bell Gully.

Failures and Imperfections: Horwitz on Agent Failures and Market Failures

2010-09-12T14:04:00.003+12:00

From St Lawrence University Professor Steve Horwitz, and with my recommendation.

Agent Failure and Market Failure

Steven Horwitz

The Buchanan conference is off to a great start. One issue that came up this morning is the role of behavioral economics and psychology within political economy. What's interesting is that it came up in a session also devoted to talking about externalities.

One thing that has always struck me about behavioral economics are the parallels to arguments about market failure (such as externalities). Much of BE shows us that economic agents are not the rational utility-maximizers of standard theory (as does much of psychology of course). But what this result implies for economics and policy depends upon whose hands the results are in.

One school of thought seems to say "a-ha! Agents don't act like our ideal models of behavior, therefore agents fail to behave in the way necessary for those models to work." Thus, in this view, "agent failure" leads to "market failure." And notice the parallel structure of the two "failures:" in both cases, failure is defined as not matching the idealized, perfect result, either perfect rationality or perfect competition/general equilibrium. The remedy, of course, is some combination of paternalism and intervention to bring the failed agent or market closer to the modeled ideal.

In the hands of some others, especially those working in the Vernon Smith tradition, the "agent failure" discovered by BE becomes not a cause to castigate the real world for not matching the model, but an opportunity to explore how imperfect agents ever in fact learn sufficiently well to generate outcomes that are still not perfect, but are much closer to rational than any alternative. In Vernon's "ecological rationality," it is institutions that do, to use Pete's phrase, the "heavy lifting" of generating social order, not the behavioral assumptions we make about agents. In other words, the imperfections of agents are an opportunity to use market institutions to achieve outcomes comparatively superior to any alternative set of institutions (though those results are still "imperfect"). Rather than condemning agents for their imperfections ("failure"), we should ask how order still gets generated despite those imperfect agents and whether that order is better or worse than alternatives.

Notice how this too parallels the market failure literature. The response by various approaches (e.g. UCLA, Virginia, Austrians, NIE,) to Samuelsonian externality arguments has been to see such supposed market failures not as cause for condemnation but as an opportunity to do one of two things:

1. Engage in comparative institutional analysis and ask whether "failed" markets are still better than "failed" government intervention

2. View market "failures" as opportunities for entrepreneurs to step in with ways of solving the externality problem and reducing the relative imperfection of the market outcome.

Both solutions are not only possible, they are compatible: part of what makes imperfect markets better is that welfare-enhancing entrepreneurial action is more likely there than in politics.

It would also be interesting to see whether the move to BE in recent years is the result of market failure arguments failing to be as persuasive in light of decades of criticisms of the sort noted above. If one wants to be more cynical, one might see the failure of market failure theories (there's a great paper title!) as the motivating force to turn away from markets and toward agents as the element that fails to match the model and thereby brings down, in the eyes of the market failure crowd, the argument for the market.

Part of the problem here is language: we need to jettison the language of "market failure" and perhaps replace it with "market imperfections." At least the latter suggests there is still a functioning market there capable of correcting its imperfections. A "failed" market would not seem to be capable of self-correction. Or to use some language Dick Wagner has used: an "imperfect" market still is capable of "becoming," while a failed market is just "being" failed.

Similarly, we should be sure to avoid using the results of behavioral economics to talk about the equivalent of "agent failure." As we've known since Menger, human beings are imperfect actors, caught between alluring hopes and haunting fears and stumbling and bumbling our way through an uncertain world. We "fail" all the time and it is because of the institutions of the market such as property rights, contracts, prices and profit/loss, and the possibility of economic calculation that they bring, that we are able to overcome our limits and produce the order that we do.

Where externality theory sees market failure and behavioral economics sees agent failure, Austrians and others see the normal imperfections of human life and the opportunity to understand how the rules and institutions of the market are resilient enough to enable us to overcome those imperfections and get Paris fed.

Govt: We Expected SCF to Fail since June 2009

2010-09-08T15:48:00.011+12:00

The Minister of Finance Bill English has issued a ministerial statement this afternoon disclosing that the government had expected South Canterbury Finance to fail and that most of the $831m provisioned against the Deposit Guarantee Scheme in the Crown's June 2009 accounts was to provide for making good the company's investors' losses. Mr English stated:

During the period of the guarantee, the Treasury and their advisors were in close contact with the firm. Once it became apparent the firm was in difficulty, there were proposals either to acquire parts of the firm or to recapitalise.
I instructed Treasury officials to work co-operatively with the firm on these options. However, all effectively amounted to a bailout by the Crown, with extra cost and risk to taxpayers.
At no stage would the Treasury have recommended accepting any of these proposals.

This confirms the worst as far as the government's management of the Deposit Guarantee Scheme and the difficulties of South Canterbury Finance: despite knowing that the company's real equity position was negative, the government let it trade on for a whole year, and even admitted it into the Extended Guarantee on 1st April 2010.

I have a theory about the government's management of this affair: they wanted it to be visible and evident and widely known that the company was in deep trouble and beyond rescue, so that when it was eventually allowed to go into receivership, there would not be any comment that the company could have been saved, or should have been saved. If my theory is correct, I think the government owes me some back pay for highlighting the weaknesses of its 'problem child'!

Mr English is trying to spin the cost of making whole the company's investors as reasonable and unavoidable. On both points he needs to be challenged: all of the cost was avoidable along with the Crown Deposit Guarantee Scheme, and the actual cost given the scheme is $100m to $200m higher than necessary as a result of the Crown's accommodative approach to dealing with the company's difficulties in the last 12-18 months.

Firstly, on the need for the deposit guarantee scheme:

Advice from RBNZ and Treasury on 10th Oct 2008 was that it was not necessary nor desirable (see http://www.treasury.govt.nz/publications/informationreleases/guarantee/p... ).

The major NZ banks retained access to the supposedly closed US commercial paper market as affirmed in the above advice and confirmed in the May 2009 Financial Stability Report by the RBNZ: 'New Zealand banks were generally able to issue CP during this period, maturities were typically very short and the cost was relatively high by historical standards.' NZ major banks retained ample other sources of funding including selling assets to their parents, borrowing from their parents, and using their residential mortgage assets as security for borrowings from the RBNZ, and US CP funding becoming more expensive, of course they used some of these cheaper alternatives (see http://www.lostsoulblog.com/2010/01/even-more-evidence-nz-big-banks-had.... ). In the situation of late 2008, the NZ major banks were well capitalised, and able to pass on the higher funding costs to borrowers, meaning that neither their capital adequacy, profitability or liquidity was threatened: 'These costs are being passed on to both households and businesses and credit conditions are tightening.' (Financial Stability Report May 2008, p 24).

Even if one or more of the major NZ banks were faltering or had failed, this does not imply that the NZ financial system was in jeopardy, or that NZ taxpayers were on the hook. Any of the major NZ banks could have been put into statutory management, depositors and other creditors funds partly converted to equity, and the bank re-opened within days. This creditor recapitalisation method means that the bank creditors take their losses and the disruption to the banks customers and the financial system is limited, and taxpayers are not required to socialise the bank's losses. The benefits of this policy were outlined in 2001 by then Deputy Governor of the RBNZ Dr Rod Carr (seehttp://www.rbnz.govt.nz/research/bulletin/1997_2001/2001jun64_2Carr27jun... )

Secondly, the costs of a tardy and soft approach to dealing with a problem they knew about were significant: perhaps $200m. My estimate is worked out as follows: If SCF was placed into receivership in Oct 2009 the losses would have been shared with the USPP noteholders (about $40m) before those investors were granted prior charge security, and the refinancing fees (about $20m), would not have been incurred, and the company would have saved about $100m in financing costs (5% p.a. additional costs times $2b times 1 year), and perhaps $10m in fees for transactions that didn't happen or didn't help, and about $7m in preference dividends and who knows how much from discounted sales of good assets to avoid running out of cash.

Let the finger pointing continue: the Trustee

2010-09-05T16:15:00.012+12:00

(UPDATED 17th Sept with 1 correction and adding additional information disclosed on 16th Sept by the government re its assessment of the Helicopters NZ transaction) This post reviews the role of the trustee and comments on the trustee's performance in supervising South Canterbury Finance and ultimately enforcing the security created by the trust deed and appointing a receiver on 31st August 2010. As this is a long post, let me summarise the main points first:

The trustee should have been aware from October 2009 that the company was likely to be breaching its trust deed financial covenants from after 30 June 2009. At this point the company was very close to its main covenant dealing with overall risk weighted capital, and had high funding costs and other costs, and a lot of assets exposed to adverse trading conditions.
By February 2010, the trustee was aware the company was in gross breach of its trust deed financial covenants, and knew (or should have known) that its parent was unable to provide enough financial support to remedy the breaches. Nevertheless, the trustee approved the Helicopters NZ transaction that a) provided insignificant benefits to the company and b) caused further breaches of the trust deed that the trustee provided waivers for and c) involved lending money to related parties on unfavourable terms in breach of the trust deed.
By 31 May 2010, the trustee was aware that the company's position had continued to deteriorate, and that its chances of being able to remedy its breaches were a long shot. The trustee provided further waivers and allowed the company to continue to trade for another 3 months until it had almost run out of cash notwithstanding offering high interest rates with the government deposit guarantee.
The trustee allowed the company to continue to pay dividends to preference shareholders even when the company was known to be in breach of its trust deed

South Canterbury Finance was primarily financed by the issue of debenture stock constituted under a trust deed. In the trust deed, the company and its charging subsidiaries, grant a security interest (also called a charge) over all its present and after acquired property to the trustee, Trustees Executors Limited, to hold for the benefit of investors who invest in debenture stock constituted under the trust deed. Debenture stock (and the other classes of security issued under the trust deed) are debt securities, i.e. the company is borrowing money and the investors are lending it to the company. The trust deed contains covenants (undertakings) by the company, such as financial and general covenants, that set out the terms of the securities. The trustee is responsible for not only holding the security interest, and enforcing it in the event of default, but also for exercising reasonable diligence to ascertain whether or not any breach of the terms of the trust deed have occurred, and doing all the things that it is empowered to do to cause any breach of those terms to be remedied.

The advantages of this type of arrangement include:

It provides a single point of contact for all creditors under the issue, so that the issuer can negotiate any changes or resolve minor issues without having to get the consent of all creditors
It provides the flexibility to incorporate any terms into the contract that may be desired
It provides investors with an efficient and hopefully effective means of monitoring and enforcing the terms agreed, through the trustee who acts as a professional on their behalf
It provides the flexibility to make major changes or concessions by the creditors collectively (i.e. by treating the all the creditors as if they were a single creditor making decisions by majority or super-majority vote, for example a debt restructuring or moratorium)

As a business model, or market model, the issuers decide their business model and the terms of their offer, and investors decide whether to accept it or not, considering all the terms of the offer, and their own needs. This means that non-price competition, as well as price competition are to be expected in the market, and that the specific covenants and ways of supervising compliance with them can develop and evolve over time. It also means that the administrative, protective and enforcement rules can be standardised through experience and customs and professional standards.

I am not aware of the history of this type of transaction structure, however I am aware that it is considered the proper and regular way that debt security issues should be arranged, and that the public investment legislation, in the form of the Securities Act 1978, requires it for all debt securities offered for subscription to the public in New Zealand. The Securities Act 1978 also requires the trustee to be approved by the Securities Commission (s 48). The contents of the trust deed also must include all the items required by the regulations, and are deemed to contain those terms (s 45). The Securities Regulations 2009 contain the main regulations made under this Act, and Schedule 15 details the particulars, including additional requirements that apply to continuous issuers of debt securities that carry on the business of lending money or providing financial services such as South Canterbury Finance.

The key statutory requirements for trustees of debt security issuers (which have applied from at least 1983 when the Securities Regulations 1983 were ordered) include:

The trustee must—(a) exercise reasonable diligence to ascertain whether or not any breach of the terms of the deed or of the terms of the offer of the debt securities has occurred; and (b) do all the things that it is empowered to do to cause any breach of those terms to be remedied (except if it is satisfied that the breach will not materially prejudice the security (if any) of the debt securities or the interests of the holders of debt securities).
The trustee must exercise reasonable diligence to ascertain whether or not the assets of the borrowing group that are or may be available, whether by way of security or otherwise, are sufficient or likely to be sufficient to discharge the amounts of the debt securities as they become due.

To support the trustee's capacity to ascertain the borrower's compliance with the trust deed and solvency, in the case of continuous debt issuers who carry on the business of lending money or providing financial services, since 21 September 2007, the trustee is required to be granted additional minimum powers and the borrower is subject to additional minimum duties to be included in the trust deed as a result of the Securities Amendment Regulations 2007. These regulations were specifically directed at finance companies, and intended to strengthen the capacity of trustees to supervise finance companies. The additional minimum standards were summarised by the Securities Commission as follows:

Reporting

A finance company must give to its trustee:

Annual and half-yearly audited financial statements
Quarterly attestations by the directors on compliance with prospectus and trust deed requirements
Monthly management accounts
Monthly reports on liquidity, asset quality, reinvestment rates, and any breaches of financing arrangements with third parties
Notice of any changes in controlling shareholders, directors, and senior management
Advance notice of any major transactions.

The trustee may also require further reports.

Verification

The trustee may:

Appoint an independent expert such as an investigating accountant or valuer to report on the true financial situation of the finance company
Enter a finance company's offices to inspect its books and other papers

Audit

A finance company must:

Consult its trustee before appointing an auditor
Tell its trustee if an auditor has refused appointment or resigned together with reasons
Engage its auditors to:
- confirm their audit opinion to the trustee
- give a copy of the audit management letter to the trustee
- report separately to the trustee on matters relevant to the powers and duties of the trustee or the interests of investors, and on whether all reports given by the company to the trustee were accurate
- meet privately with the trustee after each audit and answer any questions the trustee may ask

A trustee may appoint an additional auditor at the finance company's expense if the audit firm chosen by the finance company does not have at least five partners and earn at least 20% of its revenue from assurance work, or otherwise, in the trustee's opinion, does not have sufficient experience or capacity to undertake the audit of the finance company.

These provisions have been retained in the Securities Regulations 2009. I note that the trustee could have used these powers to require the company to change its auditor from Woodnorth Myers to an auditor suitable for a large financial institution at a much earlier stage.

I now turn to South Canterbury Finance's specific trust deed and its covenants and other relevant terms. Probably the most well known parts of this trust deed are the financial covenants in section 16.1. These include:

A restriction on equity holdings to 100% of shareholders funds.
A restriction of the ratio debt (including contingent liabilities) to shareholders funds of 12:1.
A restriction on the ratio of weighted assets to secured liabilities (this is a form of risk weighted capital requirement)
A restriction on single exposures to 35% of shareholders funds
A restriction on contingent liabilities to 150% of shareholders funds

An obvious link exists between the company's accounts and its compliance with these terms. Most of the financial covenants include shareholders funds as part of the ratio or measure. If the company's accounting records and its accounting system and the accounting policies and their application is faulty, or distorted, the company could appear to be complying with its trust deed financial covenants when it is not. For example, if the company recognises a large amount of deferred tax 'assets' that do not rightly qualify as assets, it boosts its 'shareholder funds' figure and this could help it appear to comply with many of these financial covenants when it does not. In the same way, if it books its owners financial position with the company in gross terms rather than net of debts owing by the owner to the company, again its 'shareholders funds' figure is distorted (increased in this case).

Another weakness in these financial covenants is 16.1(d) which is the 35% of shareholders funds as an exposure limit. There is an exception for exposures existing at the time the deed was executed and notified to the trustee in writing. It appears that the company's exposure to its parent group was in excess of this amount, and so notified, meaning that any further exposure was not in breach of the covenant. The company's exposure to its parent group appears to be well over $100m, and since March 2010 there appears to have been nothing significant other than the ordinary shares in SCF standing behind that obligation, yet the trustee appeared to be powerless to stop increasing this money-go-round loan.

Correction: this exposure was actually incurred in 2008, however, it appears that when the covenant was breached in the 31 Dec 2009 financial statements (and probably before that in the company's management accounts), we never heard anything about it or any waivers granted in respect of it.)

Another weakness was in 16.1(c), the weighted assets requirement, the company tried to exploit was to use prior charges in support of contingent obligations to fund its own pseudo-equity. I interpreted the covenant differently from the trustee at the time, but the trustee assured me I was wrong and they were right.

Other than some of these financial covenants, the company and its trustee have not mentioned any breaches of the trust deed. The adequacy of these financial covenants appears to be somewhat questionable, given how the company appears to have been able to manipulate its accounting numbers and undertake questionable transactions to seek to comply or to avoid non-compliance. Does the trustee have any other arrows in its quiver?

The trust deed also has a long list of general covenants that provide a broad array of requirements and restrictions. Section 17.1 includes a wide range of requirements and restrictions. Section 17.2 sets out a range of transaction types or characteristics that the borrowing group could undertake if its real capital was exhausted, and, having no capital left to lose, the interests of other parties such as directors or owners could be served by unfair transactions with the company. These also include some transactions that could artificially prop up the apparent position of the company. The general covenants most relevant to analysing South Canterbury Finance appears to be 17.1 (u) which restricts the payment of dividends if it would result in a breach of the trust deed and 17.2 (f) which restricts borrowing or lending on unfavourable terms with related parties. The company's loans to its parent and ultimate parent appear to be extremely unfavourable to the company. In 31 March 2010 and 30 June 2010 the company paid dividends to preference shareholders while in breach of financial covenant 16.1(c).

The trustee also has the broad duty to: 'exercise reasonable diligence to ascertain whether or not the assets of the borrowing group that are or may be available, whether by way of security or otherwise, are sufficient or likely to be sufficient to discharge the amounts of the debt securities as they become due.'

The most significant concern I have with the performance of the trustee was its approval of the Helicopters NZ transaction in February 2010. At this time the company was in gross breach of its trust deed financial covenants, and the company stated 'The transactions will initially restore then improve the capital position of South Canterbury Finance'. However, this transaction was not all it was cranked up to be. The main problem was that the $162.5m in assets they were receiving were offset by $10m in cash paid, $15.6m in unrecoverable subordinated loans made back to the immediate parent Southbury Corporation, $98.1m in existing loans to its ultimate parent company Southbury Group rendered irrecoverable, and $27m of convertible notes issued by Southbury Corporation but guaranteed on prior charge security by the company rendered substance liabilities of the company. Furthermore, the transaction actually caused new and ongoing breaches of the financial covenants regarding individual exposures and aggregate equity exposures, and, by the time the auditor finished with the 31 Dec 2009 accounts, the company was still unable to remedy its overall weighted assets (risk weighted capital adequacy) financial covenant. The trustee did not need to approve this transaction, or provide the related waivers. The trustee used its discretion to approve the transaction and to provide the related waivers, and for that decision I believe it should be held accountable.

Before this transaction, the company, which was at the limit of its weighted assets covenant as at 30 June 2009 and subsequently experiencing adverse trading conditions and high funding costs, would already be expected to be in breach of its financial covenants. A prudent trustee, I would have thought, should be exercising reasonable diligence to ascertain whether breaches were in progress even though it would be months before audited accounts would be available to confirm it. However, when I spoke with Yogesh Mody from Trustees Executors on 18th November 2009, and I asked him about the new losses being reported he confidently stated that the company still had about quarter of a billion dollars in equity, and also commented that if they happened to breach their financial covenants the trustee could grant a 3 month waiver (how prescient: they ended up giving them two 3 month waivers). A prudent trustee, I would have thought, would consider the overall effect of any proposed transaction with its parent company, especially when the parent company's capacity to support it was highly questionable (its net assets as at Oct 2009 appeared to be little more than NZ$50m). Instead, Yogesh Mody of Trustees Executors was reported on 10th August 2010 as stating, in effect that he accepted accepted the extra assets and disregarded the effect on the company's largest borrower:

"They have insufficient capital for the types of business they are operating in, so we are absolutely entitled to take enforcement action and we have chosen not to. We did that back in February fundamentally as a quid pro quo for receipt of the extra assets [Helicopters and Scales Corporation]."

(additional information from 16th Sept 2010:
The government disclosed that it recognised that this transaction was potentially not beneficial to the company whatsoever, and that in fact it was not beneficial to the company whatsoever in the end. If the government recognised this at the time, why did the trustee accept it as contributing a massive $152.5m in additional equity?)

After this transaction, things appear to go from bad to worse for the trustee. Now was the time to be more pro-active and more careful to assess if or when the company's capacity to remedy its breaches went from a reasonable prospect to a long shot. Now was the time to be more careful to determine if its breaches were getting materially worse. Instead of turning off the music, the noise control waited for the song to end and then cried encore for one last dance, before finally going through the motions of shutting the party down. By the time the trustee had finished with all the formalities of giving two 3 month waivers, and receivers were finally appointed, CEO Sandy Maier confessed:

“We’ve got more liabilities than assets and we’ve got precious little cash. In the absence of discovering oil on some property of ours, equity holders can’t look forward to any return.”

With the government expecting to recover $600m less than the company's liabilities from its assets, besides waiting a few more weeks until they ran out of cash despite offering 8% p.a. on government guaranteed debentures and selling off their good assets at discounts as fast as they could, I'm not sure they could have acted any slower or done anything less to mitigate the losses.

Registrar of Companies to Consider Banning Mr Hubbard

2010-09-02T10:40:00.010+12:00

See also NZICA watching Hubbard probe
The Registrar of Companies will consider banning Mr Allan Hubbard, the Ministry of Economic Development has confirmed. Under section 385 of the Companies Act the Registrar of Companies may prohibit persons who managed companies that failed from being a director or taking part in the management of a company for up to 5 years. This section applies if the Registrar is also satisfied that the manner in which the affairs of it were managed was wholly or partly responsible for the company's failure.

Companies Office records show Mr Hubbard has been a director of over 400 companies, and he remains a director of a large number of currently registered companies. Mr Hubbard is currently being investigated by the Serious Fraud Office following evidence of serious and complex fraud found by a Companies Office investigation that resulted in Mr Hubbard being placed in Statutory Management under the section 38 of the Corporations (Investigation and Management) Act 1989. Mr Hubbard's South Canterbury Finance Limited was placed into receivership on Tuesday 31st August 2010.

"The Registrar's priority so far has of course been matters relating to the Statutory Management of Mr Hubbard and entities associated with him," added Emilia Mazur, Communications Adviser at the Ministry of Economic Development. Although undischarged bankrupts are disqualified from being company directors under section 151 of the Companies Act 1993, debts against persons under Statutory Management cannot be enforced due to section 42, meaning that even if Mr Hubbard is insolvent, he cannot be bankrupted.

From the Horse's Mouth: Guarantee Prompted Reckless Lending

2010-09-01T15:32:00.005+12:00

Well here we have it all out in the open, and with a $600m bill to prove it: The deposit guarantee prompted one of the country's largest and worst run finance companies to commence an orgy of risky loans that is likely to cost taxpayers about $600m.

Mr Maier's role in the affair, in cynically exploiting the gaurantee to distort finance markets and in spending vast amounts on consultants and brokers doing a 'capital raising' that resulted in a negligable amount of net new capital and changed its form to risky equity exposures and junk related party loans, and trying to do a 'capital raising' that didn't raise any capital and was rejected by the authorities, and trying to raise capital from a position he later acknowledged was hopelessly under-water, and re-financing the US notes on disadvantageous terms and so on (whoops, correction: that last one was before Mr Maier was appointed), is something I intend to comment on later when the dust settled a bit more. Nevertheless, from Mr Maier himself, some honest and damning admissions!

Risky loans followed guarantee

5:30 AM Wednesday Sep 1, 2010

South Canterbury Finance chief executive Sandy Maier. Photo / Simon Baker

South Canterbury Finance ramped up its risky real estate loans after it signed up to the Government's scheme that protected its investors' money, the company's chief executive Sandy Maier said last night.

SCF went into receivership yesterday and the Government is paying out $1.6 billion under the Retail Deposit Guarantee Scheme.

Bad loans were the main reason for its downfall, and Mr Maier revealed the high-risk tactic in an interview on TV3's Campbell Live programme.

Asked whether it had been cynically exploiting the government guarantee, Mr Maier replied: "It might have been cynical, it might have been merely incompetent ... it probably violated a lot of prudent lending criteria."

He said he didn't know exactly why it had happened.

"Personal egotism, misreading, out of control ... whatever it was, there's no real positive name for it," he said.

"I guess the best you could say was it was somebody's idea of aggressive growth. This happens in the lending industry, cyclical excesses and rushes of blood to the head. South Canterbury Finance was poorly controlled and managed for some time."

Finance Minister Bill English, appearing on the same programme, said the management team at the time would have to be asked why they acted the way they did.

"Certainly they made loans which turned out to be bad loans and can't be recovered," he said. "They essentially lost $500 million or $600 million and the taxpayer is obliged to make up the difference to the depositors."

Mr English said the company's managers might argue they were caught by the global financial crisis.

"For the last 12 months or so we've had advisers in there ... and until last week there was still a chance the taxpayers wouldn't have to pay up at all," he said. "However, that didn't happen and so we've got this bill for what is essentially bad management and bad decisions by a company that was probably growing a bit fast."

But Mr Maier indicated the Government could take even heavier losses.

"It's good not to have a fire sale but taking three to four years would be a fantastically expensive way to go in this. Having receivers, lawyers and all the rest - the cost eats your head off.

"Salvaging value in these sorts of situations really depends on speed, it's a going concern business right now, but my view is it will deteriorate rapidly over time," he told Radio NZ.

"I've long believed the highest, best value would be gained by selling it as a going concern."

But the company's majority shareholder and founder, Allan Hubbard, says he could have saved the business if he had not been removed from the board. Mr Hubbard said he had invested hundreds of millions of his own investments in the company.

"It has been deeply frustrating and hurtful, over the last nine months, to have been sidelined by my fellow SCF directors, and subsequently strait-jacketed by the government regulators, from working to save South Canterbury," he said in a statement.

"Surely they realised that by freezing me out and taking over control of my affairs that they would be dealing a body blow to South Canterbury Finance?"

- NZPA, ADDITIONAL REPORTING: ADAM BENNETT

Let the Finger Pointing Begin

2010-08-31T08:59:00.013+12:00

(posted 3 Sept. 2010, partly drafted earlier, hence the earlier date) Finally, after 10 months of predicting the receivership of South Canterbury Finance, receivers were duly appointed on Tuesday 31 August 2010. While the delay in appointing a receiver was hard to work out, now that the receivers have been appointed it's time to evaluate the conduct of the various players in this drawn out saga.

I'll take this one at a time, with a new post for each player. I encourage my readers to have their say too, and I'll let you know which player will be next.

The logical place to start is the directors. Next will be the trustee. Later I'll include Allan Hubbard personally, Lachie McLeod, Sandy Maier, Forsyth Barr, the two auditors, Standard and Poors, the authorities, the Crown, and whoever else I may think worthy of some comment.

Firstly, I must examine what is the role of the director and the duties directors must perform, and the standard to which they are to be held. These are primarily detailed in the Companies Act 1993.

The business and affairs of a company must be managed by, or under the direction or supervision of, the board of the company (s 128) . A director of a company, when exercising powers or performing duties, must act in good faith and in what the director believes to be the best interests of the company (s 131). A director must exercise a power for a proper purpose (s 133). A director of a company must not—(a) agree to the business of the company being carried on in a manner likely to create a substantial risk of serious loss to the company's creditors; or (b) cause or allow the business of the company to be carried on in a manner likely to create a substantial risk of serious loss to the company's creditors (s 135). A director of a company must not agree to the company incurring an obligation unless the director believes at that time on reasonable grounds that the company will be able to perform the obligation when it is required to do so (s 136). A director of a company, when exercising powers or performing duties as a director, must exercise the care, diligence, and skill that a reasonable director would exercise in the same circumstances (s 137). The board of a company must cause accounting records to be kept that—(a) correctly record and explain the transactions of the company; and (b) will at any time enable the financial position of the company to be determined with reasonable accuracy; and (c) will enable the directors to ensure that the financial statements of the company comply with section 10 of the Financial Reporting Act 1993 and any group financial statements comply with section 13 of that Act; and (d) will enable the financial statements of the company to be readily and properly audited (s 194). The directors of every reporting entity must ensure that, within 5 months after the balance date of the entity or, where the entity is required by any other Act to prepare financial statements or accounts within a shorter period after the end of its financial year or balance date, within that period, financial statements that comply with section 11 of this Act are—(a) completed in relation to the entity and that balance date; and (b) dated and signed on behalf of the directors by 2 directors of the entity, or, if the entity has only 1 director, by that director (s 10, Financial Reporting Act 1993).

The Companies Act 1993 also requires that distributions to shareholders be approved by the board, and for the board to certify that the company will pass the solvency test immediately after the distribution (s 52).

From the above sections, it is clear that:

The board has the primary responsibility for the governance and performance of the company, the stewardship of its assets, the performance of its obligations and the conduct of its affairs.
The board's obligations are general, and extend to all classes of shareholder and creditor, and apply regardless of whether the shareholder(s) or creditor(s) have any particular security or other arrangement to help protect their interest in the company.
The board's obligations and directors' duties are of a positive nature as well as a negative nature. They are obliged to do things to see that the company is properly administered etc. and obliged not to do other things that could harm the company or shareholders or creditors or other parties.

So, how did the board measure up? There appear to be two main issues in this company failure:

The way the company's affairs were conducted during the property price boom, and during the early stages of the turn of the credit cycle, and
The way the company continued on in the face of severe and increasingly visible difficulties from mid 2009 until 31 August 2010, and the significant transactions during that time.

The board of the company has primary responsibility for both of these issues. It is their job to manage or supervise the management of the company, to ensure that the company's accounting records are kept up to date, to make correct disclosures in the company's financial statements, and to make the significant decisions such as whether to stop paying dividends, raise additional capital or ask the trustee to appoint a receiver.

With the benefit of hindsight, it is clear that credit standards were too loose during the property price boom. It is also clear that the credit controls were not working effectively. It's hard to avoid concluding that it appears the board was not complying with s 135: such a strategy and inadequate controls appears to constitute reckless trading rather than reasonable or acceptable business risk. Indeed, for a second tier lender, one would expect that as they were lending to more risky propositions, they would need to allocate more resources into monitoring and managing these more sensitive risks (i.e. they would have a higher net interest margin, but also a higher expense ratio due to more active management and monitoring of their portfolio, and a higher bad loan expense ratio).

There have also been reports that the accounting records of the company were inadequate, and this would not be something arising from or in the last year or two. The delays in releasing audited accounts also suggest that this area may have been below the legal requirements. These records and the associated accounting system are important for assessing, for example, whether the company can pass the solvency test after payment of dividends. In the case of a company in some distress, it is also important to enable the directors to make decisions about whether to continue to trade or whether to call for the appointment of a receiver or liquidator. These decisions require accounting records and and accounting system that 'will at any time enable the financial position of the company to be determined with reasonable accuracy' (s 194).

There were several decisions the board made during the emergence of serious difficulties that should be questioned and evaluated. These decisions generally coincide with the company withdrawing its prospectus and amending it or registering a new prospectus. Included in these are:

The decision to offer the US note holders prior charge security, and the decision to accept disadvantageous terms on the re-financing of those notes. The alternative was to ask the trustee to appoint a receiver in Oct 2009. This would have had a significant impact on the size and distribution of losses (i.e. the US note holders would have shared the loss with the debenture holders/Crown, and many unnecessary expenses would have been avoided, most obviously, the exorbitant re-financing fees). The prior charge security does not appear to have been disclosed in the 20th Oct 2009 prospectus (which includes the noteholder standstill agreement), but only later when the incomplete interim financial statements were released on 9th April 2010 (my comments at the time) (see note 23 in the 12th April 2010 prospectus). I believe it is worthwhile to consider the information available to directors at this time. I have found that there is a covenant in the noteholder standstill agreement requiring Southbury Group to maintain a net assets of NZ$50m. Southbury Group, as at 30 June 2009, was the company's parent and its largest borrower with a $75m loan (note 25 of financial statements to 30 June 2009, in prospectus 60), while at the same time Southbury Group held $102.7m in SCF ordinary shares. This gives Southbury Group a net position in SCF of $37.7m. Now why would the noteholders have stipulated such a figure for Southbury Group's net assets? Presumably to ensure that company's position didn't deteriorate, and by implication its net assets was probably not much more than that figure. If this was the case, Southbury Group's net assets outside of SCF was just $12.3m. This in turn implies that any losses booked by either SCF or Southbury Group would impair SCF's loan to Southbury Group, and that Southbury Group was not in a position to support SCF. Perhaps this is one of the considerations for the resignations of Robert Alexander White (28 Aug 2009), and John Stuart Natrass (28 Aug 2009) -- why didn't the other directors (Allan Hubbard and Edward Sullivan) recognise that by restructuring the notes at a very high finance rate and ontinuing to trade that they were they likely to create a substantial risk of serious loss to the company's creditors? Remember: A director of a company, when exercising powers or performing duties as a director, must exercise the care, diligence, and skill that a reasonable director would exercise in the same circumstances (s 137). So it appears that we have two careful directors (Mr Natrass and Mr White), and two reckless ones. Mr Natrass was reported today in the National Business Review (p 1) as saying that at this stage the company needed more capital, and that Mr Hubbard had refused to pursue a heavily dilutive capital raising as Marac owner PGC had: "Allan [Hubbard] was adamant to keep a solid shareholding all the way through." Robert Alexander White indicated he resigned for the same reason by saying he resigned because John Natrass had. The directors went on to offer retail debenture investors an 8% p.a. return to try to avoid running out of cash, giving the company a funding cost that was so high that the company could not be profitable, and that would only increase the eventual deficit that would be paid by the Crown under the Deposit Guarantee Scheme. New directors Stuart James McLauchlan, Arthur William Baylis and James Denham Shale joined the board on 20th Oct 2009.
The decision to recognise about $100m in deferred and prepaid tax 'assets' in the accounts as at 31 Dec 2009. This was the board's most significant accounting decision, and at the time it was made, the board knew that the company's situation was dire. The accounting standard requires that it be probable that the company can earn taxable future profits, and at the time it was made, earning future taxable profits appeared to be improbable rather than probable -- the company's funding cost was so high that profits were difficult to make, and the company's assets were highly exposed to further losses in the foreseeable future. Furthermore, the company's planned capital raising would result in a loss of the 49% ownership continuity under the tax laws, and thereby the availability of the tax losses the deferred tax asset relied on (and if it failed to raise capital, it could not make taxable future profits either). Without recognising this asset, the company's assets were less than its liabilities. I first criticised the recognition of this 'asset' on 17th March 2010 here: $84m deferred taxation potentially worthless The implications of this decision were that it allowed the directors to rationalise the decision to keep on trading. The decisions around provisioning levels also appears to be unreasonably low given the state of the company's assets and its operating environment as at 31 Dec 2009. This decision was made before 9th April 2010, probably around or before the time they made the decision to acquire helicopters NZ and Scales corp (see next point). Directors at this time included Allan Hubbard, Edward Sullivan, Stuart James McLauchlan, Arthur William Baylis and James Denham Shale.
The decision to acquire Helicopters NZ and Scales Corp in Feb 2010. This transaction was not all it was cranked up to be, and it left the company's largest borrower without assets with which to pay its debt to the company. The transaction also included a $15.6m subordinated loan to its immediate parent Southbury Corporation, which had no other assets with which to pay the loan. See this spreadsheet for a clear analysis of the impact of this transaction on Southbury Group's loan from SCF. This was another time that the board should have, on review, decided to ask the trustee to appoint a receiver.
The decision to pursue a further prior charge secured 'capital raising' in April 2010. This transaction was obviously nothing like it was cranked up to be, and was rejected by the Crown. I can't think of a more small-minded transaction that puts form over substance in such a transparent way. Is this kind of transaction in the best interests of the company? Are the directors really acting for proper purpose? If the company needs capital, it needs real capital, not smoke and mirrors.
The decision to keep on trading in June 2010 after the Crown rejected the 'capital raising' transaction above. At this time the trustee's waiver had expired and it was a good time for the board to review the company's position and the chances of it obtaining a substantial amount of capital from a new investor. As things were going from bad to worse, with more losses booked, and more in the pipeline, and low cash levels and an adverse trading environment, you would hope that the directors would fess up to the company's inability to remedy its breach of the trust deed, and its inability to continue to trade. But no, they sought another waiver for another 3 months, and kept on trading to the very last day. Even Mr Hubbard being put into Statutory Management, and having their credit rating downgraded to CC/C didn't put these directors off keeping the company trading. CEO Sandy Maier recently commented that the company knew it had negative equity at this point, but still the directors traded on.

During this whole time, on 31 Dec 2009, 31 March 2010, and 30 June 2010, the company paid preference dividends on preference shares that are now wiped out about 5 times over. In relation to each dividend, the board passed a resolution authorising the dividend, and certifying the company's solvency. None of these dividends needed to be paid, and the company should have stopped paying them probably some time in 2009 when the company's difficulties began to emerge, and arranged a restructuring that would have converted them to ordinary shares, to allow a better opportunity for a capital raising.

I have to conclude from this history of information that the board of directors were well aware of the extent of the company's difficulties, and that its parent was unable to support it, and that it would not be able to raise capital by issuing new shares, since any incoming investor would not be able to be given a reasonable investment with a price greater than zero. Clearly the board kept on trading and kept on paying dividends anyway.

NZICA Watching Hubbard Probe

2010-08-30T17:36:00.003+12:00

The New Zealand Institute of Chartered Accountants has confirmed it is monitoring the status of the Serious Fraud Office investigation into and the Statutory Manager's reports on Chartered Accountant Allan Hubbard. Mr Hubbard was, along with his wife, Aorangi Securities Limited, and seven charitable trusts, placed in Statutory Management on 20th June 2010 following a Companies Office investigation that found evidence of fraudulent management. The Serious Fraud Office commenced an investigation into Mr Hubbard and the other entities at the same time.

The Statutory Manager's second report released on 26th August 2010 revealed evidence of failure to keep proper accounting records and false accounting, and indications that a large proportion of investor funds were lent on a subordinated basis to a large number of financially struggling farms and other entities in which Mr Hubbard has a financial interest.

However, NZICA General Counsel Richard Moon stated that the Institute generally would allow the investigation to run its course before commencing their own investigation. "This is particularly so where the public have been alerted to the conduct at issue" he stated.

Mr Moon also said he was unable to comment on whether NZICA had received any complaints about Mr Hubbard's conduct.

Bail Out: Why not?

2010-08-29T15:57:00.004+12:00

Since Friday observers have been listening to reports of possible bids for South Canterbury Finance, and talk of government support for a chosen bidder. The commenting classes have been discussing whether SCF is too big to fail, and what impacts a failure may have on particular sectors of the economy. Some have even been wise enough to discuss some of the principles that should apply to such a case, and the possible impact a bail out would have on future expectations by those investing in and managing financial institutions.

Little of this discussion would be taking place, and the level of public concern about it would not exist but for the Crown Deposit Guarantee Scheme. I have been writing against this scheme since day after it was announced, and I'm glad that, now that a huge pay out is on the cards, people have some concern about it, and some resentment about a) being on the paying end of the scheme as taxpayers and b) the impacts of the scheme on financial markets, financial institutions and managers.

So, now that we're on the hook for hundreds of millions of dollars for SCF's failure, what should we do? Firstly, we must face up to the facts that:

SCF is not a successful business, and it does not have a successful 'good bank' to salvage. The damage to SCF's brand is total, SCF has been selling its best loans, and encouraging its best customers to re-finance elsewhere for probably a year now, leaving it with few good assets left. Its asset origination and management systems and personnel are the problem, and it is what needs to be closed down, not saved.
SCF's unwanted assets and customers do not deserve anymore credit, or more time to pay. Giving unsuccessful businesses and business people more time means wasting more social resources that should be used by other more viable businesses instead. Losses need to be recognised, realised and the large volumes of distressed market transactions need to take place clean up the rot.
SCF is not a major part of the financial system. It is about 1% of the New Zealand finance market, and the other 99% can fill any holes left behind that are viable to fill.

These being the facts, I now turn to the decision that these facts demand: to liquidate the business. Why liquidate the company and its assets?

SCF's governance, leadership, culture and practices have been and are so bad that the company's problems are pervasive, and this means that its liquidation value is likely to be higher than trying to keep it as a going concern.
We have no reason to have confidence in the management of SCF to deliver us the best deal, or that the deal they are backing is the best deal for taxpayers. The process of liquidation of the company, and identification of any parts of it that can and should be sold as going concerns should be done by a receiver who is independent of past management decisions and accountable to the appointer.
A liquidator has more powers against directors and others to claw back transactions etc. and to promote holding managers and directors and others accountable -- do we really want to let them off the hook without scrutiny? Surely not!

Now to the how: how should the government or trustee ensure that the liquidation takes place with minimal cost to the taxpayer, and minimal disruption and trouble? My suggestion is:

The government is on the hook for practically all debentures and all prior ranking debts, and for none of the preference shares. The government is liable (legally or economically) to pay interest on these debts at rates substantially higher than its cost of funds under the Deposit Guarantee Scheme, so it might as well bite the bullet and pay them all out at once, dispensing with the claims process. This can be done by making a secured loan to SCF, on the condition that the company use the funds to retire all debenture stock and all prior ranking debts (this would be about $1.75b). The loan would rank equal with existing debenture stock.
Then the government calls up its debt, which the company is unable to pay. The government then appoints a receiver, and ensures a liquidator is also appointed to the company.
The receiver can recover whatever can be recovered, over whatever time-frame is appropriate. It can sell major parts or minor parts, or hold and recover assets over time. The liquidator can initiate whatever legal action is appropriate to hold directors and managers and others to account.
The government will obviously make losses on its loan, which losses are to be booked to the DGS provisions.

The result is that the taxpayer gets full control over the liquidation process, minimises taxpayer losses, closes down a failed business with a failed business model and dodgy systems, processes and management, gives managers and directors and others who have been responsible for or benefited from irregular dealings the best chance to be held liable for them, and hopefully sends a lesson to future managers and directors of failing financial institutions.

Come on John Key and Bill English and Treasury boffins: be brave, do what's right and clean this fiasco up without any further delay!

South Canterbury Finance: The Final Countdown

2010-08-26T07:24:00.002+12:00

In the coming days South Canterbury Finance is coming to the end of the road. I remember an engineer friend of mine saying to me once that it was a sign of good design if a power pylon failed in several ways at once: no part of it was over-engineered, and thus no resources were wasted making one part stronger than the weakest part. In a way, South Canterbury Finance is like that: it is running out of cash at the same time it is booking losses that exhaust its equity.

South Canterbury Finance's cash position is down to $10.6m as at 23 August 2010 according to the new prospectus (p 7), while its capital position as at 30 June 2010 is still being determined, but I expect it to show no remaining equity by the time the auditors have signed off on it (which might be a while by the time they're re-done on a liquidation basis rather than a going concern basis). The company and the trustee have promised us financial statements (unaudited, I expect) on 31 August 2010, at which time the trustee is likely to make their decision and/or the board will make it for them by requesting receivers be appointed. The new prospectus also confirms that the company will be unable to comply with the non-bank deposit taker capital and related party regulations (p 44).

Perhaps the Smallest Bank Run in the World?

2010-08-15T08:45:00.003+12:00

Today's news report that holdings of $50 and $100 RBNZ bank notes leaped $310m in the recent financial crisis gives some indication about the size of the problem. For a banking system with over $100b in retail funding (see Figure 4.8 of this) this is less than 0.3% of retail bank funding, showing that even during panic situations only a very small proportion of a strong bank's retail funding will run off (weak banks are another story -- apparently retail depositors (in aggregate) can tell the difference).

Hubbard: Saint or Sinner?

2010-08-12T15:06:00.005+12:00

Mr Allan Hubbard has some very loyal supporters, and it appears that the most edifying thing they can say about him is that he has given, some say, $200m of his personal weath away to charitable causes. Mr Hubbard has never admitted to any wrongdoing, and claims all of his dealings have been 'kosher.' Whatever his motives, living a life of luxury and leisure clearly aren't among them.

Many of us are wondering what to make of Mr Hubbard's Statutory Management and the Serious Fraud Office investigation into his affairs. Some have taken sides, as supporters or critics, with the more vocal being the supporters. The gentlemen who venture to comment about the man and his affairs have avoided condeming the man for the fairly obvious reasons that:

He seems to be a nice guy, and not a greedy person, and

He hasn't been found guilty of anything, nor charged, and neither has any significant evidence against him come out.

So Mr Hubbard is getting the benefit of the doubt, in the court of public opinion, and by the pundits. Some commentators such as this one are even giving him the benefit of the rumour that the whole affair could be a storm in a tea cup.

Today I spoke with a man who did not look or act like a gentleman, in fact he sported a beard, wore sandals, and swore without restraint -- perhaps he's Mr Hubbard's opposite. He provided me with a less gentlemanly theory, that doesn't give Mr Hubbard the benefit of the doubt, that I'll outline later.

Let me present three possible theories that could explain Mr Hubbard's circumstances, actions and motives.

The first one is that Mr Hubbard has been doing ok, is still solvent, but is being picked on for upsetting someone, and that the authorities targeting the man and his dealings, and will only find lax paperwork. This is a bit of a conspiracy theory, the theory that the government and the regulators are over-reacting to past finance company problems, and the trigger being a disgruntled investor or a powerful person with money stuck inside the Hubbard empire somewhere. Mr Hubbard may yet emerge with some dignity, some wealth, and a chance to sue someone for his troubles with the authorities and the law. I don't find this theory plausible.

The second one is that Mr Hubbard is a good man, but is facing financial difficulties. He has ended up being involved in finance, dairy and aviation at an unfortunate time and with a bit too much debt. Perhaps, under pressure, he may have misapplied some money. Technically it may be fraud, but he intends to pay it back and perhaps he could still pay it back one day if he doesn't lose everything. I have previously found this theory plausible, but I'm beginning to wonder if there is another explanation that is worth looking into.

The third theory is that Mr Hubbard is not a good man, and that he is some kind of financial psychopath, appearing to be a good man on the outside, even building an aura of benevolence, generosity, confidence and modesty. This theory would be that he's been robbing Peter to pay Paul all of his life, and getting away with it until now. He doesn't believe, according to this theory, that it is wrong to misappropriate funds so long as they're going to a good cause.

I believe that the end is near for SCF, Southbury Corp, Southbury Group, Dairy Holdings, North Wind Holdings (2009), South Island Farm Holdings, Commtest Instruments, and the whole Hubbard empire. The SFO is due to report next week, and I wouldn't be surprised if theory three turns out to be painfully close to the truth. The trustee appears to be reading SCF its last rites, with financials due and waivers expiring at the end of this month. The criticism of the government and the authorities for putting Mr Hubbard into Statutory Management and having the Serious Fraud Office investigate him will probably pale into the background of the eruption of finger pointing at everyone involved in the Hubbard empire. The house of cards is beginning to sway.

Directors' Liability: Drawing the line

2010-08-10T19:35:00.004+12:00

Although it is well known that shareholders of a company incorporated under the Companies Act 1993 have limited liability, that the directors face potentially unlimited liability is often not appreciated even by many directors. Although the company is recognised as a separate legal person, responsible for its own obligations and separate from its shareholders and directors, where the directors have breached their duties to the company, the creditors of the company can have a go at the directors personally. Before discussing the details and how the rules could apply, as I often do I'll begin by discussing the principles and wider policy issues, options and perspectives. (sorry about the length of the discussion, I do get back to the point eventually, and even an application to SCF)

Firstly it should be noted that our companies law, concerning separate legal personality and limited liability, arose from statute and its interpretation by the courts. The landmark case Salomon v Salomon & Co Ltd appears to show that:

The courts and the common law have been hostile to the concept of separate legal entity and limited liability - the High Court and the Court of Appeal both accepted various arguments that denied or found their way around the provisions of the statute (being the Companies Act 1862), and thereby treated the person controlling the affairs of the company and benefiting from its trading as liable for the company's obligations,
The courts appear to have taken a substance-over-form approach - effectively looking through the company back to the individuals who controlled it and benefited from it, and
It was only by appealing to the words of the statute that the House of Lords could find support for the concept of separate legal personality and limited liability - the concepts appeared to be both foreign to the previous position and policy of the law and bringing about consequences that many at the time regarded as lamentable or inequitable.

Secondly, this brings us to two separate issues as far as companies are concerned:

Whether the innovations of limited liability and/or separate legal personality are desirable, and, if so
Whether the common law could have accommodated such innovations, and if so how would they be created, regulated and governed.

The basic reading of Salomon v Salomon & Co. Ltd would suggest that, and even today some argue that, the innovations of separate legal personality and limited liability are undesirable, because they enable inequitable or unjust results, in particular, people carrying on or owning businesses can incur liabilities, in both contract and tort, and be let off the obligations incurred, and leaving creditors and tort plaintiffs without adequate remedies, while others, who may have been personally directing or benefiting from the business, can rank ahead through the use of, for example, debentures secured by floating charges over all the company's present and after acquired assets. Such critiques can arise from or find a home in a number of perspectives including libertarian and green.

I have noticed that the concept of limited liability is not restricted to company law, and that it seems to spring up in many places, or, perhaps it is a natural principle of law. Examples are:

in a bankruptcy, the creditor's claims are limited to the assets of the debtor, and/or the surplus assets he can produce during a bankruptcy administration period.
in a tort claim, the plaintiff must prove not only the wrong, but that it caused their loss, resulting in a) no remedy being available where the wrong cannot be proven (on balance of probabilities) and b) no remedy being available where the wrong caused no loss. In such cases, therefore, the liability of the wrongdoer is limited by evidence and by the extent of the loss so caused. It also means that if the loss was caused by someone, but not by his wrongdoing, he is not liable, for example accidental losses that aren't, legally, anyone's fault.

It appears that remedies available at law are always limited by evidence, causation, fault, the resources of the party, and other limits such as time limits on seeking remedies. The law does justice not by giving everyone what he deserves, but by giving him only what he can prove he deserves and can be recovered for him. The law limits remedies in this way because remedies are granted as against other parties, and involve taking away their property or resources or freedoms.

Whether or not limited liability and separate legal personality are recognised as desirable, I now turn to whether or not, or the extent to which, the common law, and organisers and promoters of businesses or investment vehicles could achieve limited liability or separate legal personality through their own devices. Before elaborating on innovative ways of using contracts, trusts etc. to do this, I will address the common law origin of the company, and show that the statutory law on the incorporation of companies overtook the development of companies and company law.

The early companies legislation retains the word 'company' but changes its legal form into a corporation, i.e. a body corporate. A body corporate is a separate legal entity, an artificial person, and appears to be an invention of statute (or Royal Charter or similar royal dispensation). A company, however, is, or was, a partnership. Even today partnerships can call themselves companies, e.g. Smith and Company. The early companies legislation not only enabled 7 or more persons to incorporate a company, it required partnerships, companies and associations for profit with more than 20 partners to be registered as companies, and thereby be incorporated. Thus, companies or partnerships with more than 20 members or partners, were denied the right to form or continue as unincorporated entities, and large companies necessarily became corporations whether their members liked it or not. It also means that the evolution of company law (i.e. partnership law) for large, widely held companies ceased, and was replaced with the developments of 'companies' legislation and its interpretation by the courts.

I believe that there are several ways that limited liability and/or separate legal personality can be created or recognised under common law, such that it would allow for investment or business vehicles to issue stock or shares that would function in a similar way that incorporated company shares listed on securities exchanges do today. They are:

A company can consist of a proprietor, or two or more general partners with unlimited liability, and shareholders with limited liability. The Partnership Act 1908 specifies 'The advance of money by way of loan to a person engaged or about to engage in any business on a contract with that person that the lender shall receive a rate of interest varying with the profits, or shall receive a share of the profits arising from carrying on the business, does not of itself make the lender a partner with the person or persons carrying on the business, or liable as such:
Provided that the contract is in writing, and signed by or on behalf of all the parties thereto:' (emphasis added) I will take this provision to be a restatement of rules developed at common law. It appears such rules were developed to narrow the scope of the definition of partnerships to protect some people with an interest in the firm from being deemed partners and liable as such, and thus opens the doors to passive investors with limited liability.
A company can likewise raise money by operating as a unit trustee: it would accept funds and issue units in exchange, and the funds would be invested in the business and share in the profits of the business in the same way that incorporated company shares do today. Although the Unit Trusts Act 1960 regulates unit trusts today, obviously, if companies law had developed in this way the particulars of the regulations would accommodate such structures rather than restricting them as it does in its present form.
An entity could be constituted by its members on the basis that its investors or partners invested on a limited recourse basis, and the directors or managers of such an entity would be required to give notice to each counter-party of this limitation, and to obtain acceptance in writing of such terms on behalf of any investor in any debenture issued by the entity. In this way anyone contracting or doing business with the entity would be accepting the limited recourse terms. The entity could take insurance against any losses in excess of capital arising from torts where the plaintiff was not bound by the limited recourse terms. Alternatively, the courts and the law could have accommodated or recognised such entities as having the limited recourse rule generalised to cover all forms of claim against the entity.
Another approach is for a person to act as a trustee or unit trustee, and likewise to contract with third parties on a limited recourse basis (i.e. the trustee's liability would be limited to the assets of the trust, and not his personal assets). As it is I understand that trustees can sue and be sued in their capacity as a trustee of a particular trust, and that the trustee can even sue himself in a different capacity. As with all issues of name, and capacity to contract and sue, it appears that there is no absolute reason why the courts cannot allow or recognise contracts between and suits between entities or names that are not natural persons. Already partnerships can contract using the firm name, and trusts can sue in their capacity as trustees, so it seems that the law and the courts can and should accommodate the types of entity or structure investors or promoters may wish to employ.

A final note on limited liability under the common law: it appears that the common law's ultra vires doctrine in relation to companies/partnerships developed to provide some kind of substitute to limited liability. Basically the idea is that partners agree to carry on a particular kind of business and to engage in a particular kind of transaction, and their authority to bind one another is limited to that scope of transactions. This means that for transactions a partner purports to enter on behalf of the partnership that are outside this scope, and not an 'act for carrying on in the usual way business of the kind carried on by the firm' create no liability for the other partners (carefully read Sec 8 of the Partnership Act 1908).

So, getting back to having a go at directors of companies incorporated under the Companies Act 1993. Directors are obliged to 'not agree to the company incurring an obligation unless the director believes at that time on reasonable grounds that the company will be able to perform the obligation when it is required to do so.' This test sounds fairly straightforward: don't allow the company to promise what it won't be able to do. But this test actually represents a high level of assurance or confidence, rather than merely a likelihood or a good faith intention, as this case demonstrates. The directors got nailed for purchasing a property, in anticipation of the sale of another property that didn't eventuate despite genuine efforts and a 75% chance of success. I feel that this case represents perhaps a too high standard on directors.

Companies are intended to, and have a purpose of, taking business risks, in search of profit, and therefore there will always be some level of risk for any counter-party of a company that the company will fail and leave them with economic losses. When the company is in difficulty, and directors are assessing what to do, may they not trade on if they agree a plan to address those difficulties that they have reasonable grounds for thinking they have a 75% chance of success?

The directors of South Canterbury Finance are agreeing to the company incurring new obligations on new debentures issued. Do they believe, on reasonable grounds, that the company will be able to pay them when due?

Dairy Holdings: What's it worth?

2010-08-06T14:55:00.013+12:00

(UPDATED 7 August) One of South Canterbury Finance's largest assets is a 33.59% shareholding in Dairy Holdings Limited. This post casts doubt on the value of this asset: The most recent disclosure of Dairy Holdings Limited's books works out to about $48,900/effective hectare, and about $46/KgMS. I understand that these values appear to be about 58-71% more than the $29/KgMS and $28,523/ha similar farms are currently offered for sale at (adjusted to remove livestock that Dairy Holdings largely does not own). Dairy Holding's debt levels are 60.6% of total assets, calling into question the company's solvency.

Firstly, I have collated the figures from SCF's disclosures in the 30 June 2009 and 31 Dec 2009 financial statements, with the key metrics disclosed on the Dairy Holdings website (58 dairy units on 14,201 effective hectares, milking 43,439 cows to produce approximately 15.1 million kilograms of milk solids.) here.

My comments on notable figures or ratios are:

The two years of financials are probably for the years to 30 June 2008 and 30 June 2009, the first being released by SCF on 20 Oct 2009 and the second in April 2010.
The revenue and profit figures, and implied expenses figures have extreme variation and don't make sense: Profits run from a $66.1m loss to a $19.4m profit, revenues from $56.3m to $33.8m, and by implication, expenses from an unexplained massive $122.4m to a figure of 19.4m which is less than the 33.7m interest cost that would be expected at 8% p.a. on the company's disclosed debts.
Revenues on a per KgMS basis are $3.73 and $2.24. This implies that the company is sharing a large proportion of its revenues with sharemilkers or similar, and that it does not own most of its own livestock (as indeed the company's website confirms for the present situation from 1 July 2010). Likewise expenses in the most recently reported year work out to just $0.95/KgMS, again implying that sharemilkers are paying most of the operating costs and that the company owns little of the livestock running on its farms (quite where the interest expense on the debt fits in is anyone's guess)

Secondly, I compare the likes of this proposal for details of current farm values (as hoped for by the promoter): $33/KgMS, $32,593/effective hectare, including about $4/KgMS for the livestock that, in the case of Dairy Holdings, is not be owned by them.

Dairy Holdings do disclose some additional land assets: 14 farms and 3795 Ha, and although this is about 20% by area, the value of this non-milking land will be worth a lot less per hectare, and so it doesn't change this analysis greatly.

I plan to update this post again with some comments or more analysis from some people who know about the dairy industry, please feel free to add any comments that may help.

Intellectual Property and International Agreements: A Dangerous Mix

2010-08-04T08:15:00.004+12:00

When a dubious concept is mixed with international agreements, we should be concerned that bad ideas are gaining or holding ground that they would lose through the weight of their own absurdities. Gennady Stolyarov II takes an international agreement on 'intellectual property' being negotiated between United States, Canada, New Zealand, the European Union, Japan, Singapore, and Morocco to task:

A clandestine international treaty is currently being negotiated among parties including the United States, Canada, New Zealand, the European Union, Japan, Singapore, and Morocco. It can justly be called the greatest threat of our time to the advancement of human civilization. Considering the magnitude of the other abuses of power pervading the world today, this might seem an exaggeration, but the Anti-Counterfeiting Trade Agreement (ACTA) contravenes every principle of civilized society, both in its content and in the nature of the proceedings leading to its creation.

It threatens to undo the accomplishments of the great Internet revolution and to thrust humankind back to a time when individuals had no public voice and no countervailing power against politically privileged mercantilist institutions. ACTA tramples on essential rights that have achieved even mainstream recognition: innocence until one is proven guilty, due process, personal privacy, and fair use of published content. Moreover, because of its designation as a trade agreement, ACTA could be imposed on the people of the United States by the president, without even a vote of Congress.

Some excellent background information on ACTA can be found in posts by Stephan Kinsella (here and here) and Justin Ptak (here), as well as in a detailed communiqué from the American University Washington College of Law. The first official draft text of ACTA was released only as late as April 20, 2010, even though the treaty has been negotiated since 2006. A subsequent draft text was leaked on July 1, 2010. An earlier discussion draft was made available on WikiLeaks on May 22, 2008. Indeed, the extreme secrecy in which the ACTA negotiations have been shrouded should itself lead to the strongest doubts regarding the merits and desirability of its framers' intentions.

See here for the rest of the article.

Totally Irrelevant: CEO Responds to a Disaster

2010-08-03T07:47:00.002+12:00

Special Rules for Special Interests

2010-07-31T16:13:00.008+12:00

Here is an example of where stakeholder theory and agency theory can be applied: the recent bankruptcies (insolvency administration and restructuring) of General Motors and Chrysler. Both companies' businesses had onerous contracts with their workforces, and in both cases managers -- in this case the courts and others involved in the process -- needed to address the status, priority and treatment of different stakeholders (or counter-parties):

Employees and former employees, with employment contracts and outstanding benefits due from the company
Secured creditors such as bondholders,
Customers (e.g. with outstanding product liability claims),
Suppliers with outstanding claims,
Actual and potential buyers of the business or its assets, and
Other creditors, counter-parties and stakeholders.

Of course this was a highly political affair and so the US (and Canadian) federal governments were heavy-weight players in this high stakes game. Before going into the details of what happened, I believe it is important to address the principles by which such decisions should be decided, and to discuss some of the alternative approaches. In particular I wish to highlight the agency theory oriented approach and contrast this with the stakeholder theory oriented approach (see here for my essay discussing these two approaches and perspectives generally).

The stakeholder theory approach seeks to balance and trade off the interests between the various stakeholders or stakeholder classes. This approach seeks compromise by stakeholders, negotiation, and some kind of balance resulting. In a business bankruptcy or insolvency case, this in effect means some kind of fair or equitable sharing of the pain or shortfall that is to go around, perhaps coloured by concerns such as the capacity of the party to bear the loss, the degree of involvement in or responsibility for the business's difficulties and so on. Another angle would be the kind of deal or resolution that would enable the restructured business to be as viable as possible.

The agency theory approach has a much greater focus on the legal form of the stakeholder's interest (or class of stakeholders), representing the deals struck in the past. Such deals have implied or express terms of priority as far as payment or settlement of obligations, for example, shareholders rank last, after subordinated creditors, who in turn rank after unsecured creditors, who rank after secured creditors. These terms of the deals struck in the past provide a sequence of who must bear the losses generated. The agency theory approach would also emphasize the obligation on the managers, be they shareholder appointed, court appointed or otherwise, to seek to maximise the economic value of the business through efficient management so that the amount of the loss that needs to be allocated is minimised. This approach therefore sees stakeholders as autonomous to promote their own interests and to do their own deals before the insolvency, and the role of managers is to maximise economic value and to honour the terms of the deals done with stakeholders, including those related to creditor priority.

I also want to emphasize the role of the law, in the agency theory approach, to regulating stakeholder conflicts. The law provides a sufficiently specific set of institutions for both a) creditor priority in a liquidation, restructuring or reorganisation and b) for the procedures and powers for administering the affairs of an insolvent party. The role of managers (including liquidators, receivers, trustees and administrators) is maximise economic value added by the business but also to work within the law that provides the procedures and priority rules. The insolvency law provides for a liquidator of a company to, for example, disclaim onerous property including unprofitable contracts. Given that most stakeholders' relationship with the company is created and governed by contract, such a power amounts to a power to a) cancel any contract with a stakeholder that is not adding economic value to the company's business and b) convert any loss to the stakeholder resulting from such a disclaimer into a claim on the company to pay money. Such a step is not necessarily an end to the stakeholder relationship, of course, as such a relationship can be continued on re-negotiated market terms should that be in the interests of both the business and the stakeholder.

In the cases of GM and Chrysler, the bankruptcies are alleged, by Richard A. Epstein, to have involved not disclaiming an onerous employment contract that should have been disclaimed, and thereby giving employees' and former employees' unsecured claims satisfaction ahead of secured creditors.

Quote of the Day

2010-07-29T19:16:00.002+12:00

Today I had the pleasure of attending a lecture by Annabel Cotton, a commissioner on the Securities Commission and to talk with her afterwards. "I'd love to talk to you about Aorangi Securities," she told me, getting my full attention, "but its confidential."

Ah well, worth a go, I suppose!

Thanks Annabel Cotton for your time. It was good to hear about the work they're doing on the finance company sector re enforcing the Securities Act where there have been breaches.

Chalkie Cottons On to SCF's Position

2010-07-28T09:46:00.003+12:00

Today is the first time that a major mainstream media source has published an analysis of South Canterbury Finance's and Southbury Group's position. The story is basically a replication of my analysis on this post on the 7th June 2010, and this spreadsheet I added in the comments on the 9th June 2010.

Taking a Bath on a Pea Trader

2010-07-21T14:24:00.002+12:00

Today's news that a single business borrower, being pea trader Fernfresh Growers and Exporters to the World Ltd, owed $14m to South Canterbury Finance but had only $50,000 in realisable assets (being 'low quality frozen peas') is a bit of a head-scratcher. I'm left wondering:

How could a financial institution lend such a large sum of money to such a precarious trading business on such hopelessly inadequate security?
Is this the kind of transaction that those who wring their hands at the loss of second tier financier are mourning the loss of?
how much had SCF provisioned for this bad loan as at 31 Dec 2010? This transaction is large enough to impact on SCF's results for the 6 months to 30 June 2010 if the amount had not been fully provisioned for as at 31 dec 2009. The receivership was started 22 April 2010, and the security agreement was created on 10 Nov 2009.

The $64m question: South Canterbury Finance's Cash Balance

2010-07-19T16:07:00.002+12:00

It has been nearly 1 month since South Canterbury Finance last registered amendments to its prospectus (quite a long time by SCF's standards these days) following the Statutory Management of ultimate shareholder Allan Hubbard. That amended prospectus discloses (p 5):

As at 21 June 2010, the Company had approximately $64 million cash on deposit and realisable investments of approximately $12 million.

Since that time we've been left in the dark as to SCF's cash balance and remaining forward maturities of the company's obligations, and hence we can't see if they're on track to get through 12th Oct 2010, the end date of the original Crown Deposit Guarantee Scheme. Prospectus 61 does not give any disclosure of maturities before the 12th Oct 2010, instead disclosing maturities before 31 Dec 2011 under the extended scheme. This could prove to be a material omission, especially if the company runs out of cash leading up to that date. On the 16th July 2010, CEO Sandy Maier was reported to have commented:

Between now and October the company would continue to go out with new offers to debenture holders "to see if we can get the fire ignited again", Maier said.
SCF had also in the period from January to June 30 gathered $256m from targeted larger maturing loans related to non-core or problem business. This money was being used to pay off debentures.
"That for the last two weeks has been the primary source of cashflows, not the [debenture] offers."

This statement could fairly be interpreted to mean that investors are now largely holding off investing in the company, notwithstanding the government guarantee, while they wait for the dust to settle, or have decided that they've seen enough smoke and a flames conclude that they'd rather invest elsewhere. For those of us watching the saga we're without the aid of any up to date and meaningful data of the company's short term liquidity profile to figure if they're about to run out of cash in the next month or two.

Natural Justice for Hubbard (take 2)

2010-07-14T10:23:00.002+12:00

In a previous post I explored the juxtaposition of Mr Hubbard's Statutory Management and the concepts of natural justice. In particular, I explored the different types of law (civil and criminal), and the different types of remedies that may be available under civil law, such as:

money damages after the event, being the normal remedy
injunctions, for exceptional circumstances before the event, or while it is happening
remedies in kind such as vesting of property, variation of contracts, awards of specific performance etc.
punitive damages
administration of insolvent debtors, including possible loss of freedoms or liberties of insolvent debtors in particular circumstances, as an alternative to throwing people in jail under the criminal law.

I tied this discussion to Mr Hubbard's Statutory Management as follows:

So, how does all this relate to Mr Hubbard's statutory management? From this digression it appears that natural justice and natural law are consistent with actions of a preventative nature, i.e. injunctions, as exceptions to the normal rule of posterior restraint (i.e. leave people free and let them face actions for their wrongs if and as required). Such injunctions would be granted by a court rather than an executive body of the government (as suggested by the Law Commission as a reform to the procedure under the Corporations (Investigation and Management) Act 1989, according to this article by Damien Grant in the NZ Herald). Mr Hubbard is seeking a judicial review of the decision to place him into statutory management, according to today's National Business Review, so even under the present institutions, the courts still provide some avenue for review and possible relief.

I understand many of Mr Hubbard's supporters would find that discussion and application to overlook the true meaning of the term 'natural justice' and to overlook the possible breaches of natural justice in this case. Let me concede that indeed I have failed to really address the issue of what is natural justice and whether Mr Hubbard had benefit of it. To make up for that failing, let me clarify that:

Natural justice incorporates concepts of fair process, hearing both sides, impartial hearings and so forth
The process of putting Mr Hubbard into Statutory Management was done by the executive, and does not require a court order. Others have criticised this process and suggested that a court make the order instead. I agree: as an advocate of natural law and a critic of legislation and organised government how can I not prefer a judicial and legal remedy rather than government action? Whether or not there was a conflict of interest is an issue that should be debated, and it has been, although whether or not it has been resolved is probably an open question at this stage.
I understand that injunctions are not inconsistent with the principles of natural justice: the other side can normally and should where possible be heard, and the standard of proof -- on balance of probabilities -- must be met.
It should also be appreciated that Statutory Management is not a punishment or a finding of wrongdoing, and that the purpose and hopefully the effect of it is to preserve the interests of owners, investors, creditors and trust beneficiaries, and to preserve economic value and prevent unnecessary dissipation of wealth. Injunctions are also not punishments either, they are ways of protecting the rights and interests of third parties.

We should have a discussion on alternative remedies for situations such as what is alleged to have taken place with Mr Hubbard and Aorangi Securities and the other entities in Statutory Management. For example, if Aorangi Securities was acting as a nominee or trustee, then could a court not have appointed another person as trustee in its place under the laws relating to trusts? If Mr Hubbard was doing a fraud on creditors, could this not be an act of bankruptcy, the remedy for which, being adjudicated bankrupt, could have put another person in control of Mr Hubbard's personal affairs? Could not company law, like trust law relating to replacement of a trustee, have a remedy for emergency replacement of the directors and thereby the control of the company? I don't see any reason why the Securities Commission, for example, could not apply to the High Court for several orders at the same time in respect of the Hubbards, Aorangi Securities, and any trusts affected, for respective adjudications and appointments -- so long as the law recognised the remedies, of course. Or potentially an aggrieved investor or trust beneficiary could have applied, and the court could have awarded such remedies as it saw fit.

I should also acknowledge that in an alternative civil based legal system, without government executive bodies to investigate and seek remedies, a remedy similar to Statutory Management in this case would be unlikely. Investors and trust beneficiaries would be likely to be lambs to the slaughter, with administrators, liquidators, replacement trustees and trustees in bankruptcy etc. left to administer estates with negligible value remaining. Of course it is this outcome that the Corporations (Investigation and Management) Act is intended to mitigate by providing a remedy at an earlier stage of the development of affairs. Hubbard's investors appear to be true believers who probably had what they thought were good reasons for trusting the man. A Chartered Accountant, astute investor, wealthy, church-going, frugal living, giving to good causes -- where are the red flags? Nevertheless, they neglected the importance of organisational governance, internal controls, simplicity of affairs and accountability, audit-able records and the scrutiny of auditors, security trustees for debt securities and so on, and probably also, in many cases, did not satisfy themselves about the level of risk that was being taken with their funds. These were the red flags they didn't see, and if you pointed it out to them they would probably laugh it off and tell you that it didn't matter. Unfortunately for them, it does matter, especially when the chips are down, the property market crashes, the old guy is pushing past 80, and it turns out you've been providing additional layers and levels of leverage to support risky dairy farms etc. on top of what he's got out of the banks and his own South Canterbury Finance.

Small Increase in Crown Guarantee Provisions

2010-07-13T16:35:00.002+12:00

The government's accounts show a small increase in provisions for deposits guaranteed by the Crown, as reported today. The provisions relate to entities the government believes are more likely to fail than to survive. Last March I estimated the cost of paying out for South Canterbury Finance here:

South Canterbury Finance Could Cost Crown $420m

As the government has provisioned only $934m in total, either it is not expecting many other failures, or it has not included any amount for SCF. My previous estimate was based on a bearish view of dairy and property developments. Since that time the dairy pay out has increased, but property developments and commercial properties have kept going down.

South Canterbury Finance: Regulatory Capital Recalculation

2010-07-13T10:09:00.007+12:00

On my third and hopefully last attempt to calculate SCF's regulatory capital shortfall, it has blown out to over $650m, and related party exposures to $330m in excess of the limit that would apply if it could achieve the required regulatory capital level. These amounts do not, however, equal the amounts of capital that SCF and/or its parents would have to raise to comply with the new regulations: as I have said each time previously, the sale of non-core assets would go a long way towards compliance, although by no means far enough to achieve compliance by themselves.

I have incorporated more transactions, and more rules, and done the calculations systematically on a spreadsheet, and referenced the sources for the figures. This is probably as accurate as can be done by an outsider. The only caveat is that it does not incorporate any reduction in old assets since 31 Dec 2009, but it does incorporate the new assets it has acquired since that time that we know about. This will overstate the regulatory capital requirement by about $20m.

Click here to see the spreadsheet.

Lachie McLeod's 'Settlement'

2010-07-10T07:59:00.004+12:00

Today's news article in the Timaru Herald, that Lachie McLeod paid off his $15m loan to South Canterbury Finance in November 2009 is not to be believed. The article states:

Mr McLeod confirmed yesterday the $15m he was loaned while he was with SCF has been paid back.
"It was settled last November. I cannot say any more because the details are covered by a confidentiality agreement."

As you can see Mr McLeod never said he paid it back, he said he settled it. His statements also appear to be inconsistent with the company's audited financial statements for the 6 months ending 31 Dec 2009, which show $38m in advances outstanding to key management personnel, and an impairment provision of $14.8m (note 26), and in note 27 the company disclosed:

The remaining $23 million are secured by shares in the ultimate parent company of the Charging Group and were advanced at 6% which is not considered normal commercial terms. These advances have been impaired by $14.8 million.

Chris Lee claimed that these loans were limited recourse loans, so that the borrowers would not be obliged to pay back more than the value of the security held. The security for the loans is Southbury Group shares, not Southbury Corporation shares mentioned in the article, and the value of Southbury Group shares is probably close to zero now, hence the $14.8m impairment on $23m of loans (perhaps only McLeod's $15m was on a limited recourse basis, and the rest were still considered good as at 31 Dec 2009). If the loan was settled, any loss would have been written off rather than booked as an impairment. Expect to hear some sort of correction on this matter sooner or later.

Natural Justice for Hubbard

2010-07-09T14:27:00.006+12:00

As a self-described advocate of natural rights and natural justice, it is hard to see Mr Hubbard and his wife and some entities associated with him be put into statutory management, a process whereby a person's natural rights to deal with their property are suspended, without some misgivings. Is such a step consistent with justice and natural law?

To answer this question requires a wider examination of alternative social and legal institutions. Our current justice and legal system is based on two types of law: criminal and civil. The former is a type of offence created by statute -- in our monarchist government construed as offences against the Crown -- and punished by penalties such as fines and jail time stipulated by statute. The latter is a type of offence or wrong recognised by common law, as being a wrong against another party, and the normal remedy is an award of money damages in favour of the wronged party.

I favour the second type of law as being the proper and more desirable social institution, at the expense of the first type of law: i.e. I favour the use of the civil law, at the expense of the use of criminal law. Civil law, which can be subdivided into contract and tort, I believe provide a good and satisfactory basis for dealing with social conflicts. This approach leads to the question of how matters currently dealt with under criminal law would be handled by the civil law. I will briefly attempt to provide an answer here:

Most criminal wrongs are also recognised as civil wrongs, generally torts. This includes the crime of theft, which is the tort of conversion, the crime of assault, which is the tort of tresspass and so on for most other crimes.
Contract law is supposed to provide a sufficient basis for commerce, i.e. contracting parties create and discharge their own obligations according to their own needs, with legal support in the form adjudicating disputes and awarding remedies (normally money damages) for breaches of contract.

In proposing the exclusion of criminal law, then, one is likely to be thrown such objections as:

Is it really OK for murderers or rapists to be able to pay for their wrongs with money? Doesn't that mean rich people will be able to kill as many people as they can afford?
What should be done when people can't pay money damages for their wrongs, e.g. a career house burglar with no assets?

These objections are worthy of serious consideration. Let me proffer some solutions:

Money damages is the normal remedy for wrongs under civil law, but not the exclusive remedy. On this basis, then, there is nothing stopping a civil based legal system from using other remedies where money damages are not effective or appropriate remedies. Alternative remedies include: injunctions, specific performance and vesting property. This list could be expanded to include, for example, some loss of freedom or forced labour (although I would consider complete loss of liberty in jail to be impermissible, or permissible in only fairly restricted circumstances).
Punitive damages can serve as a deterrent and punishing function for wrongs that are especially deliberate, malicious etc. This would be most likely to apply to cases that are presently treated as crimes but would under a civil system be treated as torts.
Insolvency law could be developed to handle the cases of career house burglars and others whose wrongs are of a serious or intentional character, and whose insolvency results from awards of damages for such wrongs.

In all the above cases it is important to note that law and the practice of law is evolutionary, and developed to deal with social concerns. It is therefore likely that many of the desirable features of the criminal law today would be replicated under a civil law substitute, since they deal with the same underlying issues, albeit in law of a different form.

So, how does all this relate to Mr Hubbard's statutory management? From this digression it appears that natural justice and natural law are consistent with actions of a preventative nature, i.e. injunctions, as exceptions to the normal rule of posterior restraint (i.e. leave people free and let them face actions for their wrongs if and as required). Such injunctions would be granted by a court rather than an executive body of the government (as suggested by the Law Commission as a reform to the procedure under the Corporations (Investigation and Management) Act 1989, according to this article by Damien Grant in the NZ Herald). Mr Hubbard is seeking a judicial review of the decision to place him into statutory management, according to today's National Business Review, so even under the present institutions, the courts still provide some avenue for review and possible relief.

Hope Fades from South Canterbury Finance

2010-06-30T15:41:00.004+12:00

Today is the end of the financial year for South Canterbury Finance, and today investors pushed the company's listed preference shares down to an all time low of just 10c in the dollar. Recent trading in the preferred shares is graphed below:
These preference shares pay 1.4c per quarter, with a payment today (record date was around the middle of this month, so recent buyers won't get today's payment). Quite why someone would pay 10c for a security that has a significant chance of not paying any further payments of 1.4c per quarter I'm not sure, but at this price it shows at least some investors have confidence that the company has a chance of lasting a while longer or even recovering. However, at 10-15c in the dollar, investors appear to rate their chances of recovering at well under 50%.

Investors in these preference shares could be shafted even if the company survives. For example, suppose an outside investor invested $200m in new capital, in the form of senior preference shares, on the condition that they be given 5 places around the board room table, and that the company restructure its share capital after, say, 3 months. The company could then write off the deferred tax (due to the pending loss of 49% continuity of ownership under the tax laws), and some of the related party advances etc. leaving the company with $200m in capital. This would wipe out ordinary shares and preference shares, and leave the new investor with 100% of the ordinary shares in the restructured company.

The alternative, of an outside investor buying shares in Southbury Corp, would be far too unattractive: Southbury Corp's shares have a book value of only $40m, because of the debts of Southbury Corp, and the preference shares in SCF. Such a transaction would cost the company its deferred tax assets, leaving it starting off with a loss on its investment.

However, even the first scenario is not particularly attractive: the company would still not be able to comply with the NBDT regulations by 1st Dec 2010, without another $200m. And who would pump $400m into the likes of SCF?

Meanwhile, SCF managers or directors will be explaining to the trustee in the next week or two the company's position as at the 30 June 2010, including the $1.683m in capital lost by paying a dividend to preferred shareholders even while they're in breach of their capital requirement in their trust deed. In addition, the company's trading performance in the quarter will ultimately have to be attested to by the auditor, who will require:

new or additional provisions for other losses that are pending (development properties, investment properties, property development loans, related party loans, general business and agricultural books)
a review of their deferred tax position with a) the company tax rate cut b) the lack of progress on getting the tax laws changed to their advantage c) their lack of progress in getting new capital, maintaining prospective liquidity, and lack of prospective taxable profits against which the deferred tax assets can be used.
a review of the related party loans now that Southbury Group and Southbury Corp's positions are changed with the transfer of Helicopters NZ and Scales Corp into SCF the loans back to these entities are less recoverable than previously.
a review of exposures to the Hubbards and Aorangi Securities and the charitable trusts and the impact of the statutory management of them on exposures of SCF to them.