Prudential’s directors face the music

Press, 27 April 1989, Page 41

Prudential’s directors face the music

About 700 depositors from Auckland to Invercargill packed a creditors’ meeting in Christchurch yesterday to hear directors of the Prudential Building and Investment Society of Canterbury explain the $19.5 million deficit of the society, which is in liquidation. They queued almost to Colombo Street, causing such a backlog in registration that the Official Assignee, Mr Lynn Saunders, finally called off the attempt and let the meeting begin, about three-quar-ters of an hour late.

A freezing worker from Invercargill -who came north on the all-night bus service to hear the fate of his $60,000 retirement funds, which he had on short-term deposit while he waited to buy a house, was typical of those who came.

The meeting appointed Mr Tony Lewis, of Cooper Lybrand, liquidator. He told creditors they would get about 18c to 20c in the dollar owed or 80c, depending on a dispute between the liquidator and the DFC about security over $l2 million.

The directors, apart from Mr Martin Coffey, who is in hospital, and Mr Mervyll Reid, of Duke Securities, the Australian company, were on stage to face the music from Mr Lewis and from the creditors, some of whom who were almost in guillotining mood by the end of the examination. But their questions elicited little if anything that Mr Lewis had not established.

Mr Lewis said possible breaches of regulations and laws were being investigated and further actions might follow.

The statement of affairs at February 23 showed an estimated total deficiency of $19,576,955. The society had $99,227 in Government stock. Mortgages and advances with a book value of $6,776,216, were listed with a realisable value of $1,300,000. Advances to Brookstock No. 17, Ltd, a wholly-owned shelf company transferred by Kearns to the society, have a book value of $12,307,395, and a realisable value of $3,000,000. Advances to Kearns Corporation .of $5,982,093, are listed as having no realisable value. There is a deficit of $731,992 on the society’s mortgaged office. The society has assets of $4,399,227 available to meet call and term deposits of $22,042,252, savings accounts of $14,000, trade creditors of $BB,OOO, and an overdraft of $9918 at Westpac. There will be nothing left for the holders of $1,025,718 in listed ordinary share capital and $64,300 in preference capital — mostly held by Kearns Corporation. In addition the liquidation bill is likely to be $200,000.

The depositors stand equally in line: there is no ranking for what money is available.

The pay-out to them may take two years. Mr Lynn Saunders, the Official Assignee in Christchurch, said Mr Lewis and Mr Steven Tubbs, of Coopers and Lybrand, were appointed provisional liquidators by the High Court on the application of the Registrar of Building Societies, Mr K. F. P. McCormack, after the chairman of the society, Mr Jim Dawson, another director, Mr Mark Ballantyne, and the secretary, Mr Peter Blacklaws, resigned late in February. On April 10, Master Hansen in the High Court at Christ-

church on the application of the Registrar of Building Societies ordered the winding up of the building society. Messrs Lewis and Tubbs were appointed special managers under the Official Assignee at Christchurch as liquidator. They were given the powers of the Official Assignee up to yesterday’s meeting of creditors.

Deposits had increased dramatically over the four financial years from 1987 to 1989, Mr Lewis told the creditors (see table 1). The funds had ultimately been used to make advances to Kearns Corporation and a subsidiary of Prudential, Brookstock No. 17, Ltd.

At February 23, the day of liquidation, $12.3 million was advanced to Brookstock No. 17 on an unsecured basis and $5.9M was advanced to the Kearns Corporation.

The advances to the associated companies began during the 1987 year when Kearns obtained control of Prudential.

When Kearns took control, Mr Martin Coffey and Mr Peter Roberts were appointed directors on September 14, 1987, and Mr G. M. McEwan was appointed secretary on October 1. On November 16, the former directors of the society resigned after a disagreement with the Kearns directors about running the society. They were replaced by Mr Dawson in November and by Mr Ballantyne in March, 1988. Mr McEwan on moving to Auckland resigned as secretary on December 7, 1987, and was succeeded by Mr Blacklaws, secretary of Kearns Corporation.

On February 22 this year, Mr Dawson, Mr Ballantyne, and Mr Blacklaws resigned. The building society, Kearns, Action Finance (a 100 per cent owned subsidiary of Kearns), Leaseco Finance (100 per cent owned by Kearns) and Brookstock No. 17 (100 per cent owned by the building society) had interlocking directors. Common directors to all the companies and society were Mr Coffey and Mr Roberts. The independent directors not connected with the other companies were Mr Ballantyne and Mr Dawson. Two assignments of mortgages were made to Brookstock No. 17 by the building society. The first, dated December 19, 1988, assigned 100 mortgages and advances to Brookstock No. 17 for SIO.BM. The assignment was paid for on January 13 this year when the building society lent Brookstock No. 17 $10.813M. This was deposited in the Brookstock No. 17 bank account and the building society was paid back the same day. The second assignment, on January 18, assigned 19 mortgages and advances, totalling SB.4M. On January 20, the building society advanced to Brookstock No. 17 $8.29M to pay for the advances. Brookstock No. 17 had repaid SSM to the building society, leaving the outstanding debt to the society of $12.3M. Brookstock No. 17 was placed in receivership on February 27 by the DFC Finance Corporation. “We have reviewed the

assets and liabilities of Brookstock No. 17 and consider the

realisable value would be about $l5 million,” Mr Lewis told the creditors. After repayment of the SI2M debenture held over Brookstock No. 17 by the DFC, S3M would be left. "We believe there are a number of points about the assignments that may make them invalid,” said Mr Lewis. He had initiated action to try to keep the investments for the benefit of the building society depositors. • First, Brookstock No. 17 did not actually pay for the assignments, but was advanced sums from Prudential and on the same day returned those funds, Mr Lewis said. • Second, the contracts were executed on February 23 this year, the day he and Mr Tubbs were appointed provisional liquidators by the High Court. • Third, the first assignment was signed on behalf of the building society by Mr Peter Roberts as a director and Mr Blacklaws as secretary. They both also signed the assignments on behalf of Brookstock No. 17. The second assignment was signed by Mr Roberts and Mr Coffey on behalf of the building society, and by Mr Roberts and Mr Blacklaws on behalf of Brookstock No. 17, “wearing their hats as directors and secretaries of those companies — and in my view lacking independence.”

“We understand Mr Blacklaws resigned as secretary of both Prudential (the building society) and Brookstock No. 17, on February 22, the day before they signed the docu-

Preliminary legal advice indicated that, given the size, value, and number of mortgages and advances assigned, and the content of the mortgages and advances remaining in the building society, the directors should have sought the consent of members in a general meeting to approve the assignment of the debt to Brookstock No. 17, Mr Lewis said. “In our opinion, the two assignments aren’t legal preferences in favour of the DFC.” The effect of this would reduce the exposure of various guarantors to the DFC — "in particular probably the directors who signed the assignments for both companies.” Outstanding advances of $5.92M to the Kearns Corporation arose from many advances made by the building society to Kearns from October, 1987, to February, 1989. The advances were meant to be secured by a S4M unregistered mortgage over 224 to 240 Cashel Street, Christchurch, and a car-park at Bedford Row. The State Bank of Australia had a first charge over this property of S6M, which ranked ahead of the building society’s claim. "We consider it is unlikely that these properties will be sold for more than $6 million in their present state," Mr Lewis said. The valuation of the car park, on a completed basis, at October, 1987 was $3.7M. The Cashel Street property on August 8, 1988, was $5.6M. The total valuation

was $9.262M. "If S6M was already advanced by State Bank, then where does the security for another S4M lie?” asked Mr Lewis. Also as security to the building society, Kearns had assigned to the society an agreement for subscription of shares with Duke Securities (N.Z.), Ltd, whereby Duke Securities (N.Z.) agreed to take up shares in Kearns at a value of 180 c, with a total value of $2,026,530. No payment had been received on those shares by March 31, and notice was issued for the winding up of the company. One meeting had been held with a representative of Duke Securities (the listed Australian parent of the $2 New Zealand subsidiary). “It is our belief that the payment of that sum will be contested.” A debenture over Kearns Corporation was meant to have been given to secure the advance of $5.9M, but Kearns itself was now in receivership and any return to depositors and creditors of the company would depend on the realisation of the assets of Kearns. “In our opinion it is unlikely there will be any significant return to the Prudential Building Society. “There may well also be argument about the validity of the security given by Kearns Corporation relating to prior advances relative to the date of the execution of the debenture,” Mr Lewis said.

On the building society’s office in Hereford Street, valued at $500,000, a total of SI.2M was owed to secured creditors, chief among them the National Bank of New Zealand.

Mr Lewis discussed a prospectus dated August 30, 1988, which was amended and finally registered on December 5. It stated that the prospectus ranked as the first and only charge, and deposits received under it had priority.

“Preliminary legal advice we have states that there is no enforceable debt instrument relating to the deposits, and that in fact they are unsecured. That applies to deposits made since December 5.” The prospectus included

financial statements for the six months ended June 30. Between then and December 5, 61 mortgages and advances were assigned from the Kearns fully owned subsidiaries, Action Finance and Leaseco. On December 16, the prospectus was amended to disclose loans to directors and related companies more fully.

Three days after the December 17 prospectus amendment, the first 100 mortgages were assigned to Brookstock No. 17. One month later further mortgages were assigned. "This represented a major difference from the financial statements presented in the prospectus,” Mr Lewis said. If the liquidators were successful in challenging the assignment of the securities which totalled SI2M (the debt owed to the DFC), this might come in as an asset owed to the building society, he added.

“If the liquidator is not successful in challenging the assignment then we believe a return of between 15c and 19c in the dollar can be expected. Should the mortgage assignment to Brookstock be overturned, an additional estimated $l5 million would be available for distribution, and would result in an estimated return to creditors of 80c in the dollar.” Mr Jim Dawson, who was chairman of the building society from November 12, 1987, read a statement to the meeting.

The building society was controlled by its shareholders just as in any other registered company, Mr Dawson said. It had A and B class shares. The A share of $1 par value, were listed on the Stock Exchange, and each carried one vote. The unlisted B (preferential) shares, with a par value of $lOO, each carried 100 votes.

Mr Coffey, chairman of Kearns Corporation, obtained control of the building society in 1987 by buying shares in addition to those he had held for some time. Advantage Corporation also held a large number of the shares and Kearns obtained control of that parcel, lifting the Kearns-Coffey holding to more than 80 per cent.

Mr Dawson said he had become a director when the pre-Kearns directors of the building society resigned.

Before he and Mr Ballantyne joined the board, Kearns had obtained a contract to manage the building society. Mr Coffey, chairman of Kearns, Mr Roberts, and Mr Blacklaws, the secretary of both, provided the liaison between the society and Kearns.

Brookstock No. 17 was a subsidiary of Kearns which had arranged a funding line with the DFC. When Kearns obtained control of the building society it was clear the society was “quite unrealistically” exposed to the withdrawal of depositors’ funds, as most of these deposits were held at call.

“To protect the building society against that, Kearns corporation transferred Brookstock No. 17 to the building society,” Mr Dawson said. This gave it access to the DFC funds.

The DFC was provided with details of the advances monthly, and in this way maintained a check on the margins for its lending.

“At all times it was understood by the directors of the building society that Kearns Corporation guaranteed the performance of any security transferred to Brookstock No. 17...”

There was some difficulty in defining the terms of the guarantee, and the building society had to ask Kearns Corporation to allow Mr Dawson to attend Kearns board meetings to clarify the issues. "These issues did not concern whether Kearns Corporation had guaranteed the accounts, but rather the question of timing.” The loans originally made by the other subsidiaries were transferred to the building society. In the last part of 1988, the building society suffered a downturn in deposits, Mr Dawson said. The situation had been caused by a number of factors:

• Unfavourable publicity. • A major change in the Building Societies Act.

• The inadvertent omission from the building society in a change of statute. • A change of require-

rnents under the Securities Act for filing prospectuses.

• Difficulties over .the use of the main debenture.

• A greatly changed investment climate. Allied to this were the run on the United Building Society and the failures of Burbery Finance and Equiticorp. Duke Securities (N.Z.).was due to pay the society S2M by March 31. This was part of the Australian financial group which held a significant stake in Kearns. Mr Reid, the Duke representative on the Kearns board, was at the beginning of February appointed mana-

ger in charge of the day-to-day control of Kearns. On February 22, Mr Reid resigned. “Until that day I had been confident that the expertise the Duke group brought to the management of Kearns, the funding position, which included confirmation from Duke’s that the money expected would be paid would enable the cash flow expected for the period to be coped with. My discussion with the Duke representatives gave me no undue reason for concern ..

Mr Mark Ballantyne, a Christchurch retail manager, said he was appointed a director of the society on March 4, 1988, and resigned on February 22 this year. “At no stage during the time I was a director did I knowingly do anything that may have been wrong or reckless, or omit doing anything which perhaps I should have.”

The affairs of the society were to a substantial degree run by Kearns Corporation and the two directors representing Kearns.

But details of the affairs down to copies of mortgage securities were presented at directors’ meetings.

“I had no reason to believe other than that the affairs of the society were being competently managed on a day-to-day basis during the time that I was a director.”

Mr Ballantyne said he was aware that the society had substantial sums on deposit with Kearns but he had no reason until shortly before he resigned to be concerned about this in so far. as the security of these funds was concerned.

Directors’ meetings did not merely rubber-stamp the affairs of the society. Reports and documents produced. by Kearns Corporation under its management contract and other matters were fully considered and discussed. The directors had taken steps to reduce the debt owed by Kearns, with the object of having it cleared by March 31.

"I knew that there were advances to employees of Kearns Corporation, but understood that these were guaranteed by Kearns Cor-

poration, and that likewise programmes to refinance the advances from outside sources had been agreed to.”

Mr Roberts read a statement on behalf of himself and Mr Coffey. For the last 10 years Kearns had operated a successful loans business that grew from a small to a major operation. In each of the 10 years the business was successful and the profits increased each year. The company was always in need of funds for lending. In 1987 an opportunity arose for Kearns to acquire control of the building society to solve the funding problem.

About the same time Kearns had arranged a substantial facility with DFC to allow for an expansion into mortgage lending. Kearns used the surplus DFC funding to cover the call obligations of the Prudential and began managing the funding and mortgage lending. Kearns staff was in a short time increased to some 50 persons to operate the business nationally.

The practice of assigning mortgages to Prudential and Brookstock No. 17 to make use of the DFC facility began in this period and was always part of the business operation.

The flow of funds from the public was exceptionally good but the Prudential was unable to lend the funds out on housing mortgages because the trading banks and major lenders were becoming extremely competitive in domestic housing and the Prudential did not have an assured long-term funding base to match the market terms. For these reasons the Prudential chose to lend short term on bridging or refinance type mortgages until the domestic mortgage market settled.

In February, 1988, Kearns entered into a series of loans for a substantial amount that ultimately proved uncollectable and contributed to the failure. The loan application was by a major financial institution involving a publiclisted company and associated persons. There were certain material irregularities in

the application and Kearns has initiated litigation for recompense from the institution and executives for the loss suffered.

During 1988 economic factors turned dramatically against the business. Commercial property values dropped substantially and refinancing opportunities diminished as many finance organisations failed. The Prudential suffered as a consequence of the litigation with Prudential Insurance and the associated publicity. Also some of the borrowers of less substance failed during the year causing further difficulties as the properties could not be readily realised.

By the end of 1988 it was clear that Kearns and Prudential had made some poor loans and had serious problems Mr Roberts said.

“We suggest that Kearns and the Prudential were in the process of reorganising shareholders. management and staff as well as realising cash from every available source when some unfortunate and inaccurate media coverage coupled with poor management decisions caused the failure."

The building society continued accepting deposits in February because it had a strong cash-drive programme and was due to receive S2M from Dukes in March. Mr Lewis asked the directors whether they advised depositors of difficulties with the trustee status. (He referred to a letter sent to customers on September 27 in which reference was made to the society's having authorised trustee status, although the law changed on October 1.)

There was no response from the directors present.

Mr Lewis asked why the directors allowed the society to continue soliciting funds from the public when they knew of the deteriorating financial position of the society as far back as October, 1987. He said that in the minutes of the board, Kearns Corporation itself said the society was insolvent. Mr Roberts said that the understanding then was that the problem would be solved by the DFC facility.

TABLE 1: Advances and investments by the Prudential Building and Investment Society of Canterbury (in liquidation). Dec 31 Dec 31 Dec 31 Dec 31 1986 1987 1988 1989 $ $ $ $ Deposits, 4,958,792 10,934,109 24,996,789 21,801,203 Loans, investments 7,679,317 10,404,965 15,215,935 6,902,238 Kearns internal advances 8,230,510 13,011.564 18,581,639 Total advances, investments 7,679,317 18,635,475 28,227,499 25,483,877 The internal advances include advances to the wholly owned subsidiary, Brookstock No. 17, Ltd, as well as to Kearns Corporation.