The Judicial Committee of the Privy Council Decisions

Far Eastern Shipping Company Public Limited Appellant

v.

(1) Scales Trading Limited and

(2) Geo. H. Scales Limited Respondents

FROM

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REASONS FOR REPORT OF THE LORDS OF THE JUDICIAL

COMMITTEE OF THE PRIVY COUNCIL OF THE 3rd October 2000 ,

Delivered the 20th November 2000

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Present at the hearing:-

Lord Clyde

[Delivered by Lord Scott of Foscote]

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1. At the conclusion of the hearing on 3rd October 2000 their Lordships agreed humbly to advise Her Majesty that the appeal should be allowed with costs and that they would give their reasons later. This they now do.

2. The appellant is a Russian company, Far Eastern Shipping Company Public Ltd. ("FESCO"). FESCO appeals against the judgment of the Court of Appeal of New Zealand (Thomas, Keith and McGechan J.J.) given on 18th December 1998. There are two respondents to the appeal: Scales Trading Ltd ("STL") and Geo. H. Scales Ltd. ("GHS"). STL and GHS are, as their corporate names indicate, members of the Scales group of companies. The Court of Appeal allowed an appeal by STL and GHS from a judgment of Young J. given in the High Court in Christchurch in April 1998. The litigation was about the enforceability of a guarantee given by FESCO to STL as security for trading debts owed to STL by Far Eastern Manufacturing and Commerce Corporation (ACFES). Young J. held the guarantee to be unenforceable on account of the non-disclosure to FESCO of a particular feature of the trading relationship between ACFES and STL that was unusual and of which FESCO was unaware. The Court of Appeal agreed that the guarantee was tainted by the non-disclosure in question but took the view that the court had a discretion, either in equity or under the provisions of the Contractual Remedies Act 1979 or the Fair Trading Act 1986, to allow STL to enforce the guarantee. The Court of Appeal, in exercise of that discretion, allowed the guarantee to stand as security for the trading debts of ACFES for the recovery of which STL was suing. FESCO has appealed, contending that the court, in a case where a guarantee is tainted by non-disclosure, has no power to relieve the beneficiary of the guarantee from the consequences of the non-disclosure and, in any event, that this was not a case in which an exercise of discretion to allow the guarantee to be enforced against FESCO could be justified.

3. The relevant facts can be shortly stated. ACFES, a Russian trading company, imported into Russia goods, and in particular apples, it purchased from STL. These goods were transported to Russia by FESCO, a shipping corporation operating out of Vladivostock. GHS acted as FESCO’s New Zealand shipping agent. FESCO and ACFES were associated companies; FESCO had a shareholding in ACFES which seems to have varied, over the period with which this litigation is concerned, between 21 per cent and 5 per cent. In addition, a Captain Miskov, an important witness at the trial before Young J., was chief executive of FESCO and non-executive chairman of ACFES.

4. By April 1995 STL had become anxious about the state of account between itself and ACFES. A sum of just under US$3 million was, by 16th April, overdue. A further US$821,000 odd would become due in May. Accordingly, Mr. Chinn, the Scales group’s chief executive and another important witness before Young J., travelled to Vladivostock to have urgent discussions with ACFES. Mr. Chinn wanted payment of the outstanding ACFES debt and some form of security for the future indebtedness that would arise out of substantial consignments of apples expected to be dispatched over the next few months. Mr. Chinn was particularly concerned about two shipments of apples due to be loaded on the Ipanema and the Lentsmanis, both FESCO vessels. The vessels were waiting at a New Zealand port but Mr. Chinn was not willing to give instructions for the apples to be loaded until he had received a satisfactory response to his request for payment of the current indebtedness and security for the future.

5. Mr. Chinn’s negotiations in Vladivostock were successful. ACFES agreed to arrange for an immediate payment of US$2.9 million to be made to STL on account of the existing indebtedness. Mr. Chinn was told that a Singapore company, Goldtron Ltd., had agreed to make a short term loan to ACFES and that payment of the money would be made direct from Goldtron in Singapore to STL in New Zealand. The $2.9 million was duly paid on 17th April. Repayment of the money, no doubt with interest as well, was not made direct by ACFES to Goldtron. Repayment took place over July and August 1995 by means of funds sent by ACFES to STL, ostensibly as payment for apples, and then remitted by STL to Goldtron in repayment of the loan.

6. As to security for future apple indebtedness that might arise between ACFES and STL, FESCO, acting by Captain Miskov, agreed to give a guarantee. FESCO, in agreeing to give the guarantee, was serving its own interests in two respects. First, it stood to gain from the trade between ACFES and STL in that it would obtain freight payments for the carriage of the apples. Second, it held a significant shareholding in ACFES and so had a particular interest in the prosperity of ACFES.

7. The Guarantee was dated 18th April 1995 and was signed by Captain Miskov on behalf of FESCO. ACFES and STL were parties to the Guarantee. The Guarantee recited that ACFES was "in arrears in collection to Scales with regards to the collections due" and that FESCO was "prepared to guarantee the collection of the amount of ACFES (sic) in the event of default by ACFES".

8. Paragraphs 1,2 and 3 of the Guarantee were in the following terms:-

"1. ACFES acknowledges the amount remaining to Scales as set forth in the First Schedule, which is appended hereto, and which is an integral part of the present GUARANTEE OF COLLECTION.

2. It is agreed that the terms of collection between ACFES and Scales shall be set out in the Second Schedule, which is appended hereto, and which is an integral part of the present GUARANTEE OF COLLECTION.

3. In consideration of the terms hereunder, FESCO guarantees to Scales collection of the amounts owing to Scales by ACFES pursuant to the contracts between ACFES and Scales, which includes the supply of current season 1995 apples as shall be agreed between ACFES and Scales all of which are integral to this agreement."

9. The Guarantee contained a number of other paragraphs to which reference need not be made, save to say that FESCO’s liability under the Guarantee was limited to US$5 million and that the law of New Zealand was to apply.

10. An issue of construction arose before Young J. as to whether the Guarantee covered ACFES’ indebtedness to STL arising out of trade in any goods or only out of trade in apples. Young J. held that, having regard to the circumstances in which the Guarantee had come into existence and to various textual indications, it covered only indebtedness arising out of the trade in apples. The Court of Appeal agreed with this construction, and although the respondents, STL and GHS, have cross appealed on this issue, Mr. Camp Q.C., their counsel, did not press the issue before their Lordships.

11. Subject to that issue of construction and to some oddities of language, no doubt arising from the translation of various drafts into and out of Russian, the Guarantee appears on its face to be relatively straightforward. It is expressed to cover ACFES’ existing indebtedness, put at US$1,854,511 odd (see the 1st and 2nd Schedules to the Guarantee) and future indebtedness arising (as construed by the Court) out of apple contracts. But appearances are in this case deceptive. The course of dealing between ACFES and STL, which had led (mistakenly as it turned out) to the inclusion in the Guarantee of US$1,854,511 as the existing indebtedness, had a highly unusual feature that must now be explained.

12. It had been agreed between ACFES and STL that, when invoicing ACFES for the consignments of apples, STL would, as and when requested to do so by ACFES, add a margin to the true price of the apples and submit an invoice for the inflated amount. ACFES would pay the inflated amount to STL and STL would remit the margin to a third party outside Russia at the direction of ACFES. The means by which the remission of funds to Goldtron in repayment to Goldtron of the short-term loan of US$2.9 million was arranged was somewhat similar.

13. By means of these false invoices currency from ACFES was channelled, via STL, to a Cypriot company, RFK Holding Ltd., of which the chief executive of ACFES, a Mr. Dalman, was one of the directors. The margin by which an apple invoice specified an inflated price became known as the "RFK margin". Credibility was sought to be given to this RFK margin scam by a Marketing Agreement dated 18th April 1995 signed on behalf of RFK and STL respectively. Paragraph 1 of the Agreement said that "RFK shall provide marketing services (the Services) to Scales relating to the purchase of … apples from New Zealand …" and paragraph 2 said that "… Scales shall pay to RFK an amount equivalent to USD 150.00 … per net metric ton of goods delivered to the Russian Federation …".

14. This Marketing Agreement was, as Young J. held, a sham. Its purpose was to provide an explanation for the payment by STL to RFK of the RFK margin. The explanation was a dishonest one. No marketing services were supplied, or were ever intended to be supplied, by RFK to STL.

15. Various explanations for this inflated invoice practice have been suggested. Mr. Chinn, is recorded by Young J. as giving the following explanation:-

"The RFK margin was a result of a request from ACFES personnel who complained that they could not sell at a sufficient price in the face of a falling rouble when its domestic price was pegged to the contract price. We were asked to provide an inflated invoice which we were prepared to do."

16. Mr. Camp Q.C. gave a slightly different explanation in his submissions to their Lordships. He, too, referred to the falling rouble and suggested that the purpose of the inflated invoices had been to enable ACFES to buy US dollars forward to the date when its indebtedness to STL would have to be satisfied.

17. The judge found that:-

"The immediate purposes of the RFK margin were to:

1. Enable ACFES to be in a position to send United States dollars to New Zealand ostensibly in relation to the sale by [STL] to ACFES but in fact in excess of the ‘true’ purchase price of the goods which were purchased; and

2. Facilitate thereby remission from New Zealand, on ACFES instructions, of hard currency (representing ‘the margin’) for other purposes."

He went on:-

"I am satisfied that the RFK margin arrangements involved a fraud. Documents are not falsified unless there is an intention that someone who will or may look at them is to be deceived. I have no doubt that the intention was that Russian officials responsible for its exchange control regime were intended to be deceived." (Judgment p.9)

18. And, later in his judgment (p.52):-

"The RFK margin was fraudulent. It involved the issue of false invoices…"

19. The Court of Appeal concurred in these findings. The Court said this:-

"The conclusion [of fraud] was one of law to be drawn from the facts otherwise before the Court, and was inevitable. One does not anywhere in the world request false invoices, and then pay out an excess in those false invoices with separate directions for supplementary payments to other persons, without knowing dishonesty and intention to deceive, in this case the Russian foreign exchange authorities." (pp. 34/35 of judgment)

20. Mr. Camp protested, in the courts below and before their Lordships, that no evidence had been given of the Russian exchange control regulations or restrictions. In their Lordships’ opinion these protestations have no weight. Judges live in the real world and as well as everyone else can draw the inferences that are inescapable. It is, in their Lordships’ view, plain that the RFK margin arrangements, and, for that matter, the arrangements for repayment of the Goldtron loan, were arrangements intended to avoid Russian exchange control restrictions and to enable ACFES to export hard currency in breach of, or without compliance with, those restrictions.

21. The courts below had to consider, as do their Lordships on this appeal, the consequences of these dishonest arrangements and their non-disclosure on the enforceability against FESCO of the Guarantee. ACFES and STL were parties to the arrangements. FESCO was not. Captain Miskov gave evidence that he knew nothing about these arrangements and that if he had known of them he would not have been willing to sign the Guarantee. This evidence was not challenged in cross-examination.

22. The RFK margin had led to a mistake on the face of the Guarantee. The current indebtedness of ACFES to STL was stated by the Guarantee to be US$1,854,511 odd. But this figure included just over $1 million of RFK sham debt. The true debt, on the date the Guarantee was signed, was only $828,806 of which only $97,337 was actually overdue. The inclusion of RFK margin in the figure given for the current indebtedness was an unfortunate error. Mr. Camp stressed, and their Lordships accept, that STL could never have sued, and never have sued, for recovery from ACFES (or for that matter FESCO) of any RFK margin. Nonetheless, the dishonest RFK margin arrangements had become an integral part of the apple trading arrangements between ACFES and STL and of the invoices and accounts that passed between the two companies.

23. Following the signing of the Guarantee, trade between STL and ACFES continued. Apples were shipped on FESCO vessels, with GHS acting as FESCO’s shipping agent. But by late 1995 ACFES was once more falling into arrears in its payments to STL. In response to this, and in order to remedy group cash-flow difficulties, GHS began to withhold freight payments due from it to FESCO. This appears to have been a purported offset against the debt owed by AFCES to STL. Nothing of any significance seems to have been done about this until February 1997when FESCO cancelled GHS’s shipping agency. Litigation then began.

24. In March 1997 FESCO sought summary judgment against GHS for payment of the overdue freight payments plus interest and costs. Judgment was given in FESCO’s favour for NZ$6,440,000 odd. On 11th December 1997 the Court of Appeal upheld this judgment. The judgment debt remains unsatisfied. GHS has been withholding payment pending the outcome of this appeal.

25. On 22nd March 1997 STL sued ACFES as principal debtor and FESCO as guarantor for recovery of the apple trading debt. GHS subsequently took an assignment of the debt from STL and was joined as second plaintiff in the proceedings. Judgment for US$3,481,307 odd plus costs was entered against ACFES. This judgment debt, too, is unsatisfied.

26. There remained the claim against FESCO on the Guarantee. This is the claim that was dismissed by Young J. on 9th April 1998. Young J. held that by reason of the non-disclosure to FESCO of the RFK margin element of the trading arrangements between ACFES and STL, FESCO was entitled to cancel the Guarantee and to repudiate liability under it. He took the view that, in the absence of any such disclosure, there had been a misrepresentation that the trading relationship had no unusual features. It does not appear to have been argued before Young J. that the court had a discretion to ameliorate the effects of rescission by placing FESCO on terms or to allow the Guarantee to be enforced notwithstanding FESCO’s right of rescission.

27. The Court of Appeal agreed with Young J. that the RFK margin arrangements were "unusual" and ought to have been disclosed to FESCO. There had, the court agreed, been a breach by STL of its duty of disclosure (judgment p. 26).

28. An issue before the Court of Appeal was whether the consequences of the non-disclosure/misrepresentation fell to be determined under the general law or whether the Contractual Remedies Act 1979 applied. If the Act applied FESCO would have been entitled, under section 7(3), to cancel the Guarantee but, under section 9, the court could, if it were "just and practicable to do so", grant relief under the section. In considering what to do, the court is required to have regard to, among other things, "the value, in its opinion, of any work or services performed by a party in or for the purpose of the performance of the contract" (section 9(4)(d)) and "Any benefit or advantage obtained by a party by reason of anything done by another party in or for the purpose of the performance of the contract" (subsection (4)(e)). Scales argued that FESCO should be ordered to pay the price of the apples that STL had dispatched to ACFES and would not have dispatched had it not been for the security of the Guarantee. FESCO contended that the general law and not the 1979 Act was applicable, that under the general law it was entitled to rescind the Guarantee on the ground of the non-disclosure/misrepresentation and that the Court had no power to impose any terms. The Guarantee had been rescinded and that was that. FESCO prayed in aid the judgment of the Court of Appeal in this country in T.S.B. Bank Plc v. Camfield [1995] 1 W.L.R. 430 in which it had been held that where a party entitled to rescind a transaction had done so, the court had no power to impose terms on him. Scales, in support of its argument that the court did have that power, not only under the 1979 Act but also under the general law, relied on Vadasz v. Pioneer Concrete (SA) Pty. Ltd. (1995) 130 A.L.R. 570, a decision of the High Court of Australia. In Vadasz the guarantee covered all moneys owing, both existing debt and future debt. But it had been represented that the guarantee would cover only future debt. The High Court declined to follow T.S.B. Bank v. Camfield, held that "the court must look at what is practically just for both parties, not only the appellant", and said that "To enforce the guarantee to the extent of future indebtedness is to do no more than hold the appellant to what he was prepared to undertake independently of any misrepresentation". (p. 579)

29. In addition to its reliance on Vadasz, if the general law were held applicable, and on section 9 of the 1979 Act, reliance was placed by Scales on section 43(2) of the Fair Trading Act 1986.

30. In the event, the Court of Appeal did not find it necessary to decide whether the general law applied or whether one or other or both of the two Acts applied. As to the Contractual Remedies Act 1979, the court held that in view of the non-disclosure of the RFK margin arrangements FESCO was entitled to cancel the Guarantee under section 7 and that the discretionary power under section 9 had, therefore, to be considered. As to the general law, the court expressed a strong preference for Vadasz v. Pioneer Concrete (SA) Pty. Ltd. over T.S.B. Bank v. Camfield:-

"To the extent questions of rescission in equity may still arise, we prefer without hesitation the approach taken in Vadasz … In allowing an element of flexibility designed to do justice in varying circumstances, it accords with the overall thrust of modern New Zealand legislation in the area such as the Contractual Remedies Act 1979, Fair Trading Act 1986 and Credit Contracts Act 1981. Importantly, it allows the court to do justice in guarantee situations, avoiding the rigidity of all or nothing solutions. It is the spirit of equity.

We find that where contracts of guarantee have been induced by misrepresentation, then if and to the extent the equitable remedy of vitiation is available that remedy may be granted on terms that the guarantor pay to the [creditor] such sum as the guarantor would have bound itself to pay if the misrepresentation had not been made." (pp. 38/39)

31. The above citation contains a correction of an obvious error in the record of the judgment in their Lordship’s papers.

32. The Court of Appeal regarded discretion as to the remedy, and as to whether FESCO should be required to pay something and if so how much under the Guarantee, as being exercisable by the court under the general law as well as under the 1979 Act or section 43(2) of the Fair Trading Act, 1986. Consequently the Court did not need to decide whether the statutory provisions had displaced the general law, and did not do so. The court expressed its conclusion as to the liability that should, in the exercise of its discretion, be imposed on FESCO in the following passage (at p. 56):-

"FESCO was entitled to cancel the guarantee, or treat the guarantee as vitiated, on account of non-disclosure of the included RFK margin. FESCO would, however, clearly have accepted a guarantee liability limited to the agreed debt of US$1,854,511.09 plus 1995 season apple debts excluding any element of RFK margin. Its actions in doing what it thought to be that speak for themselves. In terms of s.9(2)(b) Contractual Remedies Act 1979, s.43(2) Fair Trading Act 1986, and equitable principles recognised in Vadasz v. Pioneer Concrete (SA) Pty. Ltd. (1995) 130 A.L.R. 570 a condition of such cancellation or vitiation should be that FESCO pay that lesser liability, and discretion should be exercised to that effect. STL/GHSL have not been out of pocket significantly in respect of that lesser liability given retentions made by GHSL from freight due to FESCO."

33. The justification, or absence of justification, for this exercise of discretion has been the main issue debated before their Lordships. Their Lordships propose to express their conclusions on that issue without deciding whether Vadasz is to be preferred to T.S.B. Bank v. Camfield or whether the Contractual Remedies Act 1979 and/or the Fair Trading Act 1986 have displaced the general law as the source of the remedies to which FESCO is entitled. Each of those issues is an important one and should, their Lordships think, be left to be decided in a case where the decision is necessary to the result. In the present case their Lordships have come to the conclusion that, whether the general law and Vadasz is applied or whether section 9 of the 1979 Act or section 43(2) of the 1986 Act are applied, the result is the same. By none of these routes, in their Lordships’ opinion, is the imposition on FESCO of any liability under the Guarantee justified.

34. First, the liability imposed on FESCO by the Court of Appeal was not, as described in the judgment, a "lesser liability". Mr. Camp has throughout accepted (and rightly so) that neither ACFES nor FESCO could at any stage have been liable to pay any part of an invoiced sum that represented RFK margin. Indeed the point could never arise. STL did not make, and would obviously not have made, any payment to third parties otherwise than out of an RFK margin that it, STL, had actually received. The only debts for which ACFES could ever have been sued and for which FESCO could ever have been liable under the Guarantee were apple trade debts. The effect of the Court of Appeal’s order was to impose on FESCO full liability under the Guarantee, not a lesser liability. The effect of the order was, in their Lordships’ view, to render nugatory FESCO’s right, which the Court of Appeal had expressly recognised, to cancel the Guarantee.

35. Second, the factual premise on which the Court of Appeal exercised its discretion, namely, that FESCO would, if there had been proper disclosure, have accepted a Guarantee liability limited to apple trade debts, was not justified on the evidence. Captain Miskov, in his written evidence, said this about the RFK arrangements:-

"34. I was very angry when I learned that Scales Trading and ACFES were involved in this kind of improper dealing. If I had known that this kind of thing was going on before I was asked to sign this guarantee I would certainly have refused. FESCO values its own reputation for integrity and it expects the companies it deals with to display the same kind of integrity. When I signed the document, I believed that both AFCES and Scales were honourable but I now know I was being lied to …"

36. Captain Miskov was not cross-examined on these assertions. Young J. accepted that FESCO, at least in its dealings with GHS, was assiduous in complying with the Russian exchange control restrictions (p. 11 of judgment) and recorded Mr. Camp's acknowledgement that he (Mr. Camp) could not contend "that FESCO or Captain Miskov were party to, or aware of, the RFK margin arrangements" (p. 12 of judgment).

37. Accordingly there is no evidential basis upon which it can be said that if the RFK arrangements had been disclosed, FESCO would still have been willing to guarantee ACFES’ apple debts. The reverse is the case.

38. Mr. Camp has argued that FESCO obtained as a result of giving the Guarantee the continuance of the apple trade between ACFES and STL and the benefit of the freights resulting from carriage of the apples in its vessels. These things, he argued, should be regarded as "benefit or advantage" obtained by FESCO from the signing of the Guarantee (see section 9(4)(e) of the 1979 Act). Their Lordships follow the point and it deserves some weight.

39. But the other side of the coin is that STL, by its non-disclosure, deprived FESCO of the ability to decide for itself whether it wanted those benefits and advantages sufficiently strongly to be willing to become involved in a trade which included the dishonest RFK arrangements. Captain Miskov’s evidence was that it would not have been willing to do so.

40. The Court of Appeal itself gave cogent reasons why this evidence was credible:-

"It is equally obvious that apparent association with such a practice, even in the indirect fashion of a guarantee, could have severe consequences for the guarantor. Enforcement authorities can indeed be sceptical. The guarantee was put to FESCO as a guarantee of normal trading relationships, involving ‘nothing unusual’. By contrast, it was a guarantee of a relationship which involved, ostensibly, within contractual payments due, a Russian foreign exchange fraud. It is not in dispute that FESCO was scrupulous in its foreign exchange dealings. Evidently, and credibly, these things mattered."

41. The Court of Appeal was not, in their Lordships’ opinion, entitled to conclude that if the RFK margin arrangements had been disclosed Captain Miskov would nonetheless have signed the Guarantee.

42. There is a final consideration on which their Lordships place some weight. Reports in the press suggest that the Russian economy is experiencing difficulties. The rouble has been falling against the US$ and other hard currencies. Several cases litigated in this country have disclosed a degree of commercial corruption in Russia that would be unacceptable in any country where the rule of law prevails and the continuance of which must make more difficult the emergence of Russia from its economic problems. The exchange control fraud which the RFK margin involves is an example of commercial corruption. In their Lordships’ view it behoves the courts of Russia’s trading partners when practices of this sort are disclosed to offer no comfort to those who engage in them. Scales is seeking discretionary relief from the court in order to avoid the consequences of its participation in the dishonest RFK arrangements and its non-disclosure of those arrangements to FESCO. In their Lordships’ view, relief should be refused.

43. For these reasons their Lordships have humbly advised Her Majesty that FESCO’s appeal should be allowed, the judgment of the Court of Appeal set aside and the judgment of Young J. restored. FESCO are entitled to their costs in the Court of Appeal and before their Lordships’ Board.

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