Janus v Fairhall
Fair Trading Act applied to tax provisions of contract
Janus Nominees Ltd v Fairhall (2008) 23 NZTC 21,978
It was held in this case that the vendor had breached section 9 of the Fair Trading Act 1986 for misleading or deceptive conduct in relation to a tax warranty. The warranty arose in connection with a contract for the sale of shares in a company to the defendants (the Fairhalls), and stated the vendor had ‘no current tax liability of any kind’.
The deal was initially structured as an option entitling Janus Nominees Ltd (“Janus”) to call on the Fairhalls to purchase a residential property. It was then restructured as an acquisition of all the shares in a company called Courageous Holdings Ltd (“Courageous”), the essential asset of which was the residential property.
Various factors, including the warranty, meant the Fairhalls did not realize that Courageous had been registered for GST or had claimed an input tax credit for the original acquisition price of the property. It was only when Janus exercised its option to sell the shares in Courageous that the Fairhalls discovered the company was registered for GST and there was a corresponding liability for output tax in relation to the property.
At the time the balance of the purchase price became payable a year later, the Fairhalls had sold the property to a family trust for $1.55 million. This triggered a GST liability of $172,778 which was paid to the Inland Revenue Department. Accordingly, the Fairhalls paid only $128,000 of the remaining $300,000 of the purchase price owing to Janus, withholding $172,000 on the basis that it represented the vendor's obligation to pay the GST output tax liability. Janus did not accept it had any liability for the GST and commenced proceedings for the $172,000.
The Fairhalls denied liability to pay the remaining $172,000 on the following four grounds:
(1) breach of an express warranty that Courageous did not have any current tax liability of any kind, or any other debt or liability;
(2) misrepresentation to the effect that the activities of Courageous were exempt from GST;
(3) breach of the Fair Trading Act 1986; and
(4) relief sought under the Contractual Mistakes Act 1977 because the Fairhalls were materially influenced by their belief that Courageous undertook activities that were exempt from GST and that Janus knew of this mistake.
The Fairhalls were successful in their claim of misleading and deceptive conduct under the Fair Trading Act 1986. In his judgment Dobson J commented that “context is everything”, and found that Janus had conducted itself, in trade, in a way likely to mislead or deceive in relation to the potential GST liabilities.
The court first considered whether the warranty was capable of misleading the Fairhalls, finding that it was. Firstly, the transaction related to shares which are exempt from GST under the GST Act 1985. Secondly, a warranty that it had no current liability for GST was capable of misleading the recipient of that warranty into believing that the company was indeed only undertaking activities which were exempt from GST.
The evolution of the tax warranty was also critical. The restructuring of the form of the transaction was accepted by the purchaser on the understanding there was no change to the substance of the transaction. Janus also incorrectly asserted that the company that owned the property was merely a shelf company that did not conduct taxable activities.
The other elements of the cause of action were also met. The High Court found the Fairhalls were in fact misled by the vendor’s conduct and it reasonable for them to have been misled, despite receiving legal advice. This was because the warranty that there were no current tax liabilities was technically incorrect as there was a current GST output tax liability. Accordingly, it was reasonable that the Fairhalls’ lawyers did not consider a potential GST liability.
This case shows that the court is willing to apply the Fair Trading Act 1986 to tax warranties. Accordingly, it is not wise to actively attempt to disguise tax liabilities and tax clauses should be clearly drafted to avoid dispute. Furthermore, a vendor’s conduct should not be such that a purchaser is likely to be misled into thinking or given the impression that their tax liabilities will be less than they are.
The High Court decision in Janus has been overturned on appeal. To read a note on the Court of Appeal decision, click here