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September 2010

Investment Scheme Rules Oppressive

A victory for Blue Chip investors

Facts

The investors in this case were pensioners who owned an unencumbered home worth approximately $400,000.00 with savings of approximately $48,000.00. They lived on a pension of approximately $21,700.00 per annum. Accordingly they had assets but relatively low income and fell within the description of being “asset rich but cash poor” investors to whom a particular Blue Chip investment opportunity was targeted.

The Promise

The investors were promised that by their participation in the investment their fortnightly income would be increased by approximately $450.00 (before tax) in the form of rental on an investment unit that they purchased utilising the equity in their home. They were further promised that the property would be sold in four years’ time with the investors receiving approximately 10% of any capital gain.

The Reality

The reality of the transaction was that the investors were borrowing heavily against their previously unencumbered home to secure a relatively small income stream for a four year period, which was essentially paid from their own borrowings. On the other hand Blue Chip was “clipping the ticket at every point”. The investors ended up borrowing approximately $630,000.00 to purchase a property for approximately $550,000.00 (with the surplus going to Blue Chip in the form of fees). The investors believed that they were only borrowing a small part of the amount required to finance the purchase, with Blue Chip providing the remainder of the funding but in fact they were responsible for providing all of the funding through their borrowings. The reality of the position was that the investors bore all of the risk, and shared only in a modest proportion of the capital gain (even if a capital gain had eventuated) whereas Blue Chip stood to be the principal beneficiary of the scheme. The success of the scheme was entirely dependent on a rising property market.

The Outcome

Following the widely-publicised collapse of Blue Chip, the investment did not deliver what was promised. When the unit was eventually sold following the investors going into default under their mortgage, it fetched only $250,000.00.

The Court of Appeal overturned an earlier High Court decision and found that the loan transactions in question were oppressive and ought to be reopened and referred back to the High Court for the appropriate remedy to be determined. The Court held that the lender (GE) could not avoid the application of the Consumer Credit and Consumer Finance Act 2003 merely because it outsourced many of its lending functions to an intermediary. GE had argued that if anyone had acted oppressively, it was the intermediary rather than the lender itself.

Amongst the reasons why the loan contract was considered oppressive were:

  • The contract departed from reasonable standards of commercial practice. GE’s own evidence was that if the investors true financial position had been made known to them, they would not have made the advance.

  • It was a murky and disjunctive transaction.

  • The loan transaction was in reality an asset lending scheme (lending on the basis of the value of the security provided without the borrowers necessarily having the means to service the loan) that was largely unsuitable for the investors’ circumstances and under which Blue Chip was entitled to nearly all of the potential gains.

  • It was a “Fastdoc” loan pursuant to which the investors simply had to complete a statutory declaration stating that they were able to service the loan and, provided they had sufficient equity in their property and insurance, the loan would be granted.

  • The investors were in receipt of negligent legal advice provided by a solicitor who was not independent.

  • The investors had little comprehension of the scheme and were described as “hopelessly handicapped from the outset in forming a proper appreciation of what the overall finance transaction really was”.

The case was essentially something of a test case. As such, the decision is likely to open the door for other investors caught in similar schemes to seek relief from the financial ruin that is otherwise likely to have resulted from the failure of the schemes. Of course, the real answer was for investors to get truly independent legal advice first.

PS. GE has recently been granted leave to appeal the case to the Supreme Court