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Watson & Son Limited v Daniell [2013] NZHC 2807 (24 October 2013)

Last Updated: 1 November 2013

IN THE HIGH COURT OF NEW ZEALAND MASTERTON REGISTRY

CIV-2013-435-000110 [2013] NZHC 2807

BETWEEN WATSON & SON LIMITED Plaintiff

AND DEREK MONTGOMERY DANIELL AND JOSHUA MARK DANIELL as trustees of the DEREK DANIELL TRUST Defendant

Hearing: 22 October 2013

Counsel: K P Sullivan and F Zhao for Plaintiff

M G Colson and G M Boos for Defendant

Judgment: 24 October 2013

_{JUDGMENT OF COLLINS J}

Introduction

[1] The defendant (Daniell Trust) signed a deed of acknowledgement of debt which contained a priority clause acknowledging that a debt owed to it by the plaintiff (Watson Ltd) ranked behind a debt which Watson Ltd owed its bank. Watson Ltd now wishes to significantly increase its loan and credit facilities from its bank.

[2] The question I have to consider is whether the priority clause requires the Daniell Trust to sign a new deed of priority acknowledging that its debt will rank behind the new level of debt which Watson Ltd will owe its bank.

WATSON & SON LIMITED v DANIELL [2013] NZHC 2807 [24 October 2013]

Context

[3] Watson Ltd has sought urgent¹ interim orders:

(1) for a “declaration that the [Daniell Trust] is required to sign the new deed of priority”; and

(2) “that the [Daniell Trust] sign a new deed of priority forthwith”.

[4] When questioned on the appropriateness of me making “interim” orders, Mr Sullivan, counsel for Watson Ltd, acknowledged that in fact I was being asked to make a declaration under s 3 of the Declaratory Judgments Act 1908, and that, subject to any rights of appeal, any declaration I make will be final. Both parties acknowledged the suitability of the jurisdiction conferred by s 3 of the Declaratory

Judgments Act 1908 in this case.²

[5] Mr Sullivan acknowledged that it would be sufficient if I made a declaration and that it was not necessary for me to issue a mandatory injunction. I will therefore only issue a declaration on the meaning of the priority clause.

Background

[6] The background to the application has been characterised by a series of disputes between Watson Ltd and the Daniell Trust and the two principal figures behind those entities, Mr Dennis Watson and Mr Derek Daniell.

[7] Watson Ltd produces and markets Manuka honey and Manuka honey products. It is one of New Zealand’s largest suppliers of Manuka honey products. It obtains Manuka honey from its hives and from other hive owners throughout New Zealand. Watson Ltd produces its Manuka honey products in a factory in the

_{Wairarapa and currently employs over 70 staff.}

¹ The parties asked that I deliver my judgment by 25 October 2013 because Watson Ltd’s ability to complete the settlement of the purchase of land on 1 November 2013 may depend on the outcome of my judgment.

² See generally Mandic v Cornwall Park Trust Board (Inc) [2011] NZSC 135, [2012] 2 NZLR 194 at [6]- [9] per Elias CJ and William Young J at [82].

[8] In April 2004 the Daniell Trust purchased 25 per cent of the shares in Watson Ltd. Mr Daniell became a director of Watson Ltd. The Daniell Trust invested $336,250 in Watson Ltd at that time.

[9] In 2005 Watson Ltd guaranteed a General Security Agreement (GSA) to the

Daniell Trust and to Mr Watson’s family trust.

[10] In 2007 Watson Ltd granted a GSA to the ANZ National Bank (ANZ National). At the same time the Daniell Trust and Mr Watson’s family trust entered into a deed of priority granting ANZ National first priority for $3.5 million plus

24 months interest. Mr Daniell also personally guaranteed Watson Ltd’s loans from

ANZ National.

[11] During the year ending 30 June 2009 Watson Ltd suffered a number of setbacks and recorded a loss of $3.6 million. Thereafter the relationship between Mr Watson and Mr Daniell deteriorated. By 2010 the Daniell Trust had advanced

$1.5 million to Watson Ltd and related Daniell Trust entities had invested a further

$1,960,000 in beehives owned by Watson Ltd. The Daniell Trust and related entities wanted to recover their debt.

[12] The Daniell Trust demanded repayment of its debt pursuant to the GSA held by the Daniell Trust and Mr Watson’s family trust. This demand was met with a negative response from Watson Ltd, which obtained an ex parte interim injunction to restrain the Daniell Trust from exercising its right as a secured creditor to liquidate the company. In turn, the Daniell Trust obtained an injunction to restrain Watson Ltd from unlawfully disposing of certain of its assets.

[13] Initial attempts at a resolution of the parties’ dispute were unsuccessful. The Daniell Trust then applied to appoint a voluntary administrator or a liquidator. This application was resolved when the parties reached an agreement on 9 March 2012.

Heads of agreement

[14] The settlement of 9 March 2012 was recorded in a heads of agreement. That agreement was reached in the context of:

(1) The Daniell Trust and related entities being owed a significant sum by

Watson Ltd and wanting to be repaid.

(2) The Daniell Trust (and Mr Watson’s family trust) having a GSA from

Watson Ltd.

(3) ANZ National being owed $1.4 million and having a priority security for $3.5 million.

(4) Watson Ltd needing to reorganise its debt arrangements with a new bank as it could not increase its level of debt with ANZ National.

[15] Under the heads of agreement:

(1) Watson Ltd agreed to pay the Daniell Trust $3,960,000 over 36 consecutive months. For the first 12 months Watson Ltd was to pay the Daniell Trust $80,000 each month. During the second 12 months Watson Ltd was to pay the Daniell Trust $100,000 each month. During the final 12 months Watson Ltd was to pay the Daniell Trust

$150,000 each month. These payments were to commence on

20 April 2012.

(2) Watson Ltd and/or Mr Watson acquired an option to purchase the shares the Daniell Trust held in Watson Ltd for $1.250 million. This option was to remain open until 31 March 2013.

[16] Clause 2.2 of the heads of the agreement provided:

The deferred payment agreement ... will be secured by way of a General Security Agreement [GSA] provided by [Watson Ltd] in favour of the [Daniell Trust].

The parties acknowledged that this GSA would be subordinate only to any

GSA held by [Watson Ltd’s] current bank, ANZ National Bank Ltd.

If [Watson Ltd] were to refinance its lending, resulting in ANZ National Bank Ltd’s GSA being released, the [Daniell Trust] acknowledge that any GSA provided by [Watson Ltd] to the new bank would rank in priority to the [Daniell Trust] GSA.

The intention is that the [Daniell Trust] GSA rank second in priority (alone) after the related bank GSA. The existing GSA and financing statement will be released.

...

[17] The heads of agreement was converted into a final agreement by way of:

(1) a deed of acknowledgement of debt dated 21 March 2012 which contains the priority clause; and

(2) a GSA, also dated 21 March 2012.

Deed of acknowledgement of debt

[18] The interpretation clause of the deed of acknowledgement of debt provides that singular words in the deed include plural words and vice versa, unless the context otherwise requires.

[19] Clause 2.2 of the deed of acknowledgement of debt records Watson Ltd’s agreement to pay the Daniell Trust $3,960,000 over 36 months at the graduated rates agreed to in the heads of agreement.

[20] Clause 6.1 of the deed of acknowledgement of debt records that Watson Ltd’s obligations under the deed would be secured by a GSA over the assets of Watson Ltd. This clause also records that if there are any inconsistencies between the GSA and the deed of acknowledgement of debt, the provisions of the deed of acknowledgement of debt prevail.

[21] Clause 6.3 of the deed of acknowledgement of debt is the priority clause. It provides:

6.3 Priority of Bank GSA:

The [Daniell Trust] acknowledges that its GSA, and the subject of the deed of assignment of existing GSA, will both rank behind one of: the current GSA provided by [Watson Ltd] to ANZ National Bank Ltd, or any other GSA in substitution thereof in favour of another bank upon a bona fide refinance. The [Daniell Trust] further agrees to sign a deed of subordination and/or priority to reflect this agreement forthwith upon request.

General Security Agreement

[22] The GSA records in paragraph 5.1(d) that Watson Ltd will not permit any security interest over secured property except as created by the GSA “or in favour of [Watson Ltd’s] primary bank or pursuant to that bank’s refinancing of [Watson Ltd’s] lending ...”.

[23] The provisions of the GSA are consistent with the provisions of the deed of acknowledgement of debt.

The appointment of ASB as Watson Ltd’s banker

[24] In October 2012 Watson Ltd negotiated new banking arrangements with the ASB Bank Ltd (ASB). At this time Watson Ltd’s lawyers wrote to the Daniell Trust’s lawyers seeking the Trust’s agreement to sign a deed of priority pursuant to the priority clause in the deed of acknowledgement of debt.

[25] The correspondence between the parties’ lawyers shows that the initial deed of priority provided no cap to the amount of ASB’s secured priority sum, whereas the ANZ National deed that the Daniell Trust had previously entered into, capped that bank’s priority at $3.5 million. The lawyers for the Daniell Trust pointed out that an unlimited priority was unusual because of the financial exposure that would be borne by the deferred creditor. The lawyers for Watson Ltd promptly responded and advised that ASB’s secured priority sum would be capped at $3.5 million.

[26] The change in banks for Watson Ltd meant Mr Daniell would no longer be a guarantor of Watson Ltd’s loan facilities with ANZ National.

Repayment of the Daniell Trust debt

[27] Watson Ltd has paid all of the 19 monthly instalments to date that have been required to be paid under the heads of agreement and deed of acknowledgement of debt. At the time of the hearing Watson Ltd had paid the Daniell Trust $1.66 million and intends to pay over the next 17 months the balance of $2.6 million which the parties agreed to.

[28] In March 2013 Watson Ltd purchased the Daniell Trust shares in Watson Ltd for $1.250 million. Thus, the Daniell Trust has to date received payments from Watson Ltd that total $2,910,000.

Watson Ltd’s expansion plans

[29] Watson Ltd has commenced a programme of asset expansion. It has purchased new vehicles, plant, equipment, and upgraded its factory. In addition, Watson Ltd has committed to purchasing new manuka blocks. These are strategic blocks with staged settlements. The first settlement was on 10 October 2013 and had to be financed from Watson Ltd’s cash reserves. A second settlement is to occur on

1 November 2013. Two further settlements are to occur in March 2014.

[30] To help fund its capital expansion Watson Ltd has negotiated a new loan facility with the ASB which would increase the amount secured by the GSA in favour of the ASB to $7 million. However, before any of the additional loan facility can be drawn down, ASB requires the Daniell Trust to sign a new deed of priority.

[31] The Daniell Trust has “withheld” its consent “but not refused” to sign a new deed of priority because it does not believe that the priority clause in the deed of acknowledgement of debt requires it to sign an acknowledgement of priority on terms which it believes will weaken its security position.

[32] In his affidavit in support of the application, Mr Watson strongly disagrees with the stance taken by the Daniell Trust. He explains that when the heads of agreement were reached the Daniell Trust was owed $5.2 million and at that time the Daniell Trust thought Watson Ltd was insolvent. Mr Watson says the Daniell Trust is now owed only $2.4 million and Watson Ltd has, in the intervening period, “almost doubled” its turnover and increased its gross profit in the last financial year to $5 million. Mr Watson also says that the increased ASB loan is not working capital to be used in relation to day-to-day operations but is all committed capital expenditure which increases the pool of assets available as security in the unlikely event Watson Ltd defaults on its obligations. Mr Watson says the land Watson Ltd is purchasing, which represents about $2 million of the increased priority sum, will provide ASB with additional mortgage security over that land.

[33] The Daniell Trust is not convinced of the commercial soundness of Watson Ltd’s expansions and additional borrowings. It is particularly concerned that its security position may be significantly weakened if the level of ASB’s priority is effectively doubled.

Principles of contract interpretation

[34] I have to establish the meaning the parties intended when they agreed to the priority clause.³

[35] The deed of acknowledgement of debt has to be considered as a whole, and the words used by the parties should be interpreted in light of their natural and ordinary meaning, and the surrounding circumstances.⁴

[36] The priority clause is to be given the meaning that a reasonable person would understand the clause to mean having regard to the background and commercial context in which it was agreed to.⁵

[37] The subjective intentions of the parties are not relevant when interpreting the terms of the priority clause.⁶

[38] I can resort to both pre-contractual negotiations and post-contractual conduct as evidence, to the extent that it is relevant to the objective meaning of the priority clause.⁷

The meaning of the priority clause

[39] The Daniell Trust believes that the priority clause:

(1) provides for only one refinancing of Watson Ltd’s loan arrangements

_{with its bank;}

³ _{Vector Gas Ltd v Bay of Plenty Energy Ltd [2010] NZSC 5, [2010] 2 NZLR 444 at [19].}

⁴ Boat Park Ltd v Hutchinson [1999] 2 NZLR 74 (CA) at 82; Vector Gas Ltd v Bay of Plenty

_{Energy Ltd at [22].}

⁵ _{Vector Gas Ltd v Bay of Plenty Energy Ltd at [19].}

⁶ _{White v White [2001] UKHL 9, [2001] All ER 43 at [34].}

⁷ Vector Gas Ltd v Bay of Plenty Energy Ltd, above n 3, at [29]; Gibbons Holdings Ltd v

Wholesale Distributors Ltd [2007] NZSC 37, [2008] 1 NZLR 277.

(2) does not permit Watson Ltd’s bank to have a secured priority sum greater than that which was enjoyed by ANZ National, namely

$3.5 million.

[40] Mr Colson, counsel for the Daniell Trust, provided very helpful submissions on how the priority clause should be interpreted. His submissions can be distilled to the following points.

(A) Priority clause permits only one refinancing

The use of the singular “a”

[41] Mr Colson points to the following parts of the priority clause:

(1) Upon a bona fide refinance;

(2) The lender further agrees to sign a deed of subordination and/or priority;

(3) To reflect in this arrangement.

(emphasis added).

[42] Mr Colson stated that the use of the singular “a” and “this” clearly shows the parties did not anticipate or provide for Watson Ltd to undertake multiple refinancings of its loan arrangements.

The meaning of “refinance”

[43] Mr Colson also submitted that the word “refinance” in the priority clause clearly means the parties only contemplated and provided for Watson Ltd to move its borrowing arrangements from ANZ National to another bank. Mr Colson said the new proposal submitted by Watson Ltd to the Daniell Trust was not a refinancing but an extension of Watson Ltd’s current lending arrangements.

Meaning of “in substitution”

[44] Mr Colson has also emphasised the dictionary definitions of “substitute” meaning that a substitution can only occur once.⁸ He submitted that the words “in substitution” mean that the parties intended that the ANZ National loan facility would only be replaced with one other loan arrangement from another bank. He pointed to the surrounding circumstances that both parties knew a refinance of the ANZ National loan was imminent, as that bank had declined to make further finance

available and had insisted on a reduction in the debt Watson Ltd owed to it. Mr Colson submitted that the refinancing referred to in the priority clause was confined to that which the parties had in mind when the priority clause was agreed to. He contends that because a refinance has occurred, the Daniell Trust has discharged its obligation under the priority clause to provide consent to a new deed of priority.

[45] I do not think that these aspects of Mr Colson’s submissions are particularly persuasive.

[46] The interpretation clause of the deed of acknowledgement of debt clearly provides that singular words in the deed of acknowledgement of debt includes plural and vice versa, unless the context otherwise requires.

[47] Mr Colson is on stronger grounds when he submits that the context of the parties’ agreement, and the use of the words “refinance” and “in substitution thereof” must be interpreted to mean a substitution of the GSA in favour of the ANZ National with one other GSA in favour of another bank.

[48] However, Mr Colson’s focus on the meaning of “refinance” and “in substitution thereof” do not give appropriate weight to the parties’ use of the word

⁸ The Collins Concise Dictionary (4^th ed, 1999): substitute: 1. To serve or cause to serve in place of another person or thing; 2. To replace (an atom or group in a molecule) with (another atom or group); 3a. A person or thing that serves in place of another, such as a player in a game who takes the place of injured colleague.

The Shorter Oxford English Dictionary (5^th ed, 2002): substitute: (Noun) 1. A person exercising deputed authority; a deputy, a delegate; 2. A thing which is used or stands in place of something else; ... (Verb) 1. Appoint (a person) to office as a deputy or delegate; set up as a ruler or official in the place of another; 2. Nominate in remainder; 3. Put (a person or thing) in place of another; 4. Put in the place of, replace by a substitute.

“any” in the expression “... or any other GSA in substitution thereof ...”. The parties’ decision to refer to “any” other GSA strongly suggests that there could be more than one refinancing arrangement entered into by Watson Ltd and that the Daniell Trust debt would rank behind any of the refinancing arrangements provided the refinancing was “bona fide”.

[49] This interpretation also makes commercial sense. It would be surprising if the parties agreed to limit Watson Ltd’s ability to refinance on just one occasion. An apparently commercially active and expanding company like Watson Ltd would normally be able to negotiate whatever lending arrangements it could with any bank as often as it needed.

(B) The priority clause does not permit a priority greater than $3.5 million

[50] Mr Colson submits that the parties must have intended the priority amount that applied to the ANZ National financing arrangements would also apply to the arrangements for any substituted banking arrangements. Mr Colson emphasises this was the status quo at the time of the deed of acknowledgement of debt and that any refinancing must have been intended by the parties to reflect the status quo at the time the priority clause was agreed to. Mr Colson based part of his submission on this point on what he said was the true meaning of “refinancing”, namely the replacement of one debt with the same level of debt with another bank. Mr Colson also points to the exchanges between the parties’ solicitors at the time ASB became the banker to Watson Ltd as further evidence of the parties’ intention that ASB’s priority security sum would be the same as that which previously existed with ANZ National.

[51] There is, however, a major difficulty with the approach advocated by Mr Colson. Neither the heads of agreement nor the priority clause placed any cap on the priority sum which Watson Ltd’s bankers would enjoy.

[52] If the parties had intended that the $3.5 million cap enjoyed by ANZ National would apply to any future refinancing arrangements, then this should have been stated clearly and explicitly in the heads of agreement and the priority clause. The

fact the parties did not do so clearly demonstrates that no cap of the kind advocated by Mr Colson was contemplated at the time the priority clause was executed.

[53] The fact that the refinancing with ASB in October 2012 involved a replication of the priority cap enjoyed by ANZ National does not advance matters. That was the priority secured amount which ASB required at that time and does not mean that when the priority clause was agreed any future priority secured amount would be limited to $3.5 million.

[54] Mr Colson submits that it would be commercially absurd for the parties to have agreed to an unlimited priority. That submission has considerable force. However, the parties did not agree to an unlimited priority. They agreed to a priority that would arise from a “bona fide” refinancing by Watson Ltd. In my assessment, a bona fide reassessment must contemplate a refinancing arrangement that is commercially sound and which does not unfairly jeopardise Daniell Trust’s security position. That would not include the examples Mr Colson gave of, for instance, further borrowing to address trading losses.

[55] I am therefore driven to the conclusion that the priority clause does permit Watson Ltd to extend its loan facilities with ASB and to increase the secured sum for which ASB would have priority, provided the refinancing arrangements are bona fide. Watson Ltd is adamant that its refinancing arrangements are bona fide and will not unfairly jeopardise the Daniell Trust security. The Daniell Trust is not convinced of the commercial soundness of Watson Ltd’s proposed refinancing arrangements. I am in no position to determine who is right and who is wrong. All I can say is that if the refinancing arrangements are bona fide then the priority clause requires the Daniell Trust to agree to the new financing arrangements.

[56] It is entirely for the parties to decide how they reach agreement on whether or not the new financing arrangements are bona fide. I would hope that the parties could promptly agree that the new financial arrangements are bona fide or agree on the appointment of a trusted third person to examine the proposed financial arrangements and advise whether or not the new financial arrangements are indeed bona fide.

[57] In reaching this conclusion I have placed to one side Mr Peat’s reply affidavit and the attachments to that affidavit. Those attachments were based on without prejudice communications and should not have been tendered in evidence.

Conclusion

[58] Provided the new financing arrangements are bona fide, the Daniell Trust must sign the new deed of priority.

[59] Either the parties or a trusted third person will have to decide whether or not the new financial arrangements which Watson Ltd wishes to put in place are bona fide.

[60] Watson Ltd has substantially succeeded in its request for a declaration. It is therefore entitled to costs on a scale 2B basis.

_{D B Collins J}

Solicitors:

Wilson & Co, Wellington for Plaintiff

Bell Gully, Wellington for Defendant