Stone & Rolls Ltd v Micro Communications Inc

This is a claim brought by the liquidators of Stone & Rolls Limited (“SR”) a company incorporated in England and Wales against Micro Communications Inc (“MCI”) a Delaware incorporated company. The claim is in respect of 7 transactions (“T1-T7”) whereby various sums were paid by SR and credited to MCI. The relevant transactions are as follows:-

There is no doubt that these payments were made by SR and credited to MCI.

There are 2 claims arising out of these transactions. First there is a debt claim (“ the Debt Claim”) and second the undervalue claim (“ the Undervalue Claim”).

The Debt Claim is for $928,272.00 plus interest. This is based upon a balance set out in a statement prepared by a Mr Price, SR’s Senior Financial Manager. This claim is on the basis that T1-T7 involved the lending of monies by SR to MCI.

The Undervalue Claim is a claim under section 238 (4) Insolvency Act 1986 on the basis that if T1-T7 were not loans then they were transactions at an undervalue with a connected person at a relevant time under sections 238 (4) and 240 IA 1986 in that SR received consideration of little or no value for them.

The contention that SR and MCI are connected is made because they were both, it is alleged, under the ultimate control of one Zvonko Stojevic (“ZS”). For the purpose of these proceedings only MCI acknowledged that SR was insolvent at the time of the 7 transactions. This meant that technically MCI acknowledged it did not seek to challenge the burden of proof as to insolvency required by section 240 (2) IA 1986. The time limit for claims against persons connected in respect of a transfer at an undervalue is two years ending with the date of insolvency.

SR became insolvent on 15^th November 2002 so that T1-T7 all fall within the requisite 2 year period provided the liquidators establish SR and MCI were connected.

I shall say more about SR and MCI and various other associated companies and the shareholders and officers of those companies in this judgment below.

This action springs fully armed from an earlier foray in the Commercial Court Komercni Banka v Stone & Rolls [2003] 1 Lloyds Law Rep 383. In this action (“The Commercial Court Action”) a bank brought proceedings against SR and ZS alleging that various purported sales of grain in warehouses in Russia or the Ukraine were fraudulent and that the documentation intending to support such transactions was fraudulent. The documentation had been presented under letters of credit in respect of purported sales by SR to a company trading as BCL Trading GMBH (“BCL”). The total amount of the loss was $94,720,382.80 (excluding interest). The letters of credit after they were obtained were assigned by SR to a discounting bank or in some cases forfeited by Komercni Banka itself. The proceeds were mostly paid over by SR to BCL (the buyer) or connected companies.

Ultimately after a hearing Toulson J gave judgment on 15^th November 2002 against SR and ZS for fraudulent representations amounting to the sum claimed. Neither satisfied the judgment. SR as I have said went into liquidation on that day.

ZS was found by the Judge to have been evasive and untruthful in the evidence that he gave before him. The present action is part of the liquidators efforts to recover SR’s assets for the benefit of its legitimate creditors.

Komercni Banka issued its claim in November 2000 and the present transactions took place in a period after that but before the judgment. The liquidators claim has apparently been hampered by a large amount of missing documents and (more importantly perhaps) a lack of evidence of an oral nature to put forward a case. They are unable to provide any evidence of people involved in SR at the time of the events.

The trial has been dominated by the brooding presence of ZS, in that virtually every significant document has been created by him. After the judgment in the Commercial Court Action, ZS was subject to criminal investigations (amongst other things, money laundering) in Austria. He was made bankrupt in the United Kingdom in March 2003. He is alleged to be in contempt of court and hardly surprisingly did not give evidence before me.

The liquidators invite me to infer that ZS’s actions and the documents created by him should be treated with great caution, bearing in mind his dishonest conduct as exemplified in the Commercial Court Action. There is a danger in simply accepting submissions that a person who has already been found to have been evasive, should be found to be dishonest in every aspect of documents which are put before this court. I have not had any ZS explanation for any of the dealings or transactions which I set out in this judgment. I approach anything done or said by ZS with caution but it would be quite wrong in my view to assume that everything he does is dishonest or fraudulent and should not be accepted. Equally it is important not to speculate as to what motivation ZS might have had behind various transactions. Where they are not challenged by the liquidators and remain effective. This is a major point in the dispute before me. The short point of MCI is that all monies it received were received at the direction of another company Mercury Consultants Limited (“Mercury”), an Isle of Man company controlled either by Kresimir Fancev (“KF”) or by ZS. MCI’s defence is that at the time of all the payments in question SR was substantially indebted to Mercury and that the payments made were in effect part reductions of SR’s debt to Mercury. SR does not dispute that substantial monies were owed by it to Mercury (and continue to be owed). Mercury is in provisional liquidation but there has been no proof in SR’s liquidation and no attempt to settle an account as between SR and Mercury.

MCI’s case is that the utilisation of SR’s debt to Mercury is well documented; SR’s case is that that documentation should not be taken at its face value when contrasted with other documentation. SR submits that other documentation shows that the payments made to MCI were independent of any discharge of any debt due to Mercury so that there must either be no consideration for them or alternatively the court should on the facts imply that the monies were lent to MCI by SR and are therefore repayable to it without any deduction or set off in respect of debts due from SR to Mercury.

There is no express evidence showing the existence of a loan; SR’s case is entirely on inference.

In addition MCI contends that part of the monies advanced by SR were utilised to enable another company, Melborough Properties Limited (“Melborough”), a UK company allegedly controlled by KF, to acquire a property in Vienna, Austria for Austrian Schillings 28,000,000. This property (“Vienna Property”) was in turn used as security for SR’s increased borrowing from one of its banks, Fortis Bank. That security has been forfeited to Fortis Bank following SR’s default.

I have already mentioned ZS and KF. Other people who gave evidence in front of me were Dr Faulhaber, an Austrian lawyer who acted for ZS and some other companies, Ivan Ljubas (“IL”), an IT consultant originally engaged by SR and alleged to be the owner of MCI, and a Mr John O’Donnnell, a company secretary and/or director of MCI. Mr O’Donnell provided professional services in that regard through two companies in which he was interested, JP Audit Ltd and JP Companies Registration (IOM) Limited. Finally Paul Price gave evidence before me, being the former senior financial manager of SR.

As I have said the evidence brought by the liquidators of SR comprised witness statements which were essentially formal and referred to documentation and made submissions via the witness statements. Nobody called by SR was able to give primary evidence as I have said.

I have already referred to SR, Mercury, Melborough and MCI. In addition SR had a number of bankers including Fortis Bank and HSBC. At some stage it was also indebted to CW Bank and Bank of Austria. It’s indebtedness to those banks was acquired by Mercury as I shall set out later in this judgment. In addition to those companies reference was made to Law Investments Limited, an Isle of Man registered company now in provisional liquidation controlled by ZS, and Lucia Trust, a Stojevic Family Trust set up in the Isle of Man.

SR was a UK company and it’s shareholder was Law Investments. Law Investments in turn was owned by Lucia Trust. ZS held no official position at SR.

In respect of Melborough, Mercury and MCI, it is difficult to see who are the ultimate beneficiaries. At all material times they were operated by nominee directors (such as Mr O’Donnell) who by and large followed the instructions of ZS.

The obscurity is exemplified by examination of 2 documents in 2001. First on 27^th June 2001 Mr O’Donnell wrote to ZS giving advice as to the structure and ownership of “some of your companies”. First, he referred to the Lucia Trust, Law Investments and SR and said that that structure been in existence for some time and should be left alone. Second, he referred to Melborough being a UK company and that the directors were Jessie Hester and Mr O’Donnell and the secretary was Earthstreet Limited. Only one share was issued and this was stated to be held on trust for an unspecified beneficiary. The proposal was to convert each share into a bearer share. Third, he referred to MCI stating the company was incorporated on 27^th April 1988 with an issued share capital of 3000 shares. He advised that as the company was a US company there could be no bearer shares. He then referred to another company United Consultants Limited, a BVI company where the shares were issued in bearer form and had been in the possession of ZS since December 2000. Finally he referred to a clutch of Isle of Man companies including United Consultants International Limited (“UCI”) and Mercury. It was stated that the beneficial owner of these companies was KF. In addition he made reference to the establishment of a Panama Foundation which could own the shares in the Isle of Man companies, with the Isle of Man companies being owned by a UK bearer and KF could hold the bearer share certificate. Documents disclosed by Mr O’Donnell pursuant to a witness summons showed that he prepared this letter.

On 1^st August 2001 a document described as “Protocol” was signed under SR notepaper. This stated that on 1^st August 2001 ZS received into his possession from Mr O’Donnell a certificate of 3000 shares in respect of MCI, bearer share warrant for one share in respect of Melborough and bearer share certificate of 50,000 fully paid shares in UCI. It stated then that he confirmed he would deliver the originals into the possession of KF who was the beneficial owner of the bearer shares. This curious document is signed by ZS and Mr O’Donnell although it was said in evidence by Mr O’Donnell that ZS prepared the document. A year later (20^th August 2002) Mr O’Donnell wrote again to ZS reiterating the shareholding of UCI, MCI, SR and Melborough. Also enclosed was a nominee agreement in respect of Melborough.

I have come to the firm conclusion that the true beneficial owner and controller of SR, Mercury, MCI, Melborough and UCI is ZS and I reject the contentions that KF and IL at various times were interested beneficially in Melborough, Mercury or MCI as the case might be. I will explain this in more detail in a later part of this judgment. The evidence in my view is overwhelming.

The Debt Claim is as I have said based on a statement prepared by Mr Price, SR’s Financial Manager. This is a schedule he prepared shortly after SR’s liquidation in November 2002. He prepared two schedules, one to year ended 31^st December 2001 and the second one to period ended 15^th November 2002 (ie the date of insolvency). He started the two schedules with a nil opening balance as at 1^st January 2001. In his evidence before me at trial he resiled from that opening balance as I shall set out below. In the year to 31^st December 2001 only T4 ($700,000) and T5 ($630,000) are recorded. That produced a net debit of $908,171.61 for the yearend, which is carried forward into 1^st January 2002. Further transactions are thereafter recorded (including T7) but not T6. Thus the debit figure of $928,272.17 is accounted for.

However the Debt Claim does not address T1-T3 nor does it address T6. The only justification for this was the somewhat unconvincing submission by Mr Slade who appeared for the Liquidators that they had limited their claim on the loan basis to the amount which was currently available, i.e. the amount frozen by the Freezing Order. The paradox is that all the same transactions are treated as being transactions at an undervalue for the purposes of the Undervalue Claim. This to my mind is illogical. This illogical approach is further compounded by an examination of the instructions given to the bank in respect to the various transactions.

In respect of T1 the instructions are to HSBC (SR’s Hanover Square branch) to transfer $180,000 to MCI. The instructions are signed by ZS and the message to the beneficiary is “return of debt according contracts with Mercury Consultants”.

T2 is dated 22^nd November 2000 and is in respect of the same bank with MCI a beneficiary for $600,000 and again described as “return of debt according contracts with Mercury Consultants”. This mandate is not signed by ZS; it is signed by Alex Protsenko.

T3 is dated 29^th December 2000, is signed by Micheal McMahon on behalf of SR and is addressed to Stone & Rolls Rostov on Don directing it to transfer $289,000 to MCI. There is no advice to the beneficiary although a draft which was made out but not sent to SR’s bank (as opposed to S&R Rostov on Don) of the same date again describes it as “return of debt”.

T4 follows a similar practice as that of T3 except there is no draft.

T5 is different in that the message to the beneficiary is “short term loan”.

T6 is the sum of $330,000 less $19,000, (net $311,000), removed from SR’s account with Fortis Bank and credited to its account with HSBC. This is significant because one of the arguments on the part of the liquidators was that payments made to the benefit of Mercury (which is MCI’s contention) at this time would be a breach of a subordination agreement entered into between SR Mercury and Fortis Bank. Yet this transaction is sanctioned by Fortis in the sense that it permits it to happen without any complaint.

T7 is a payment dated 26^th February 2002 out of SR’s HSBC bank account to MCI stated to be “on behalf of Mercury Consultants”. The amount in question is $200,000 and took effect on 27^th February 2002.

As I have said the liquidators are unable to identify any express loan documentation. Their case is primarily one based on Mr Price’s schedules coupled with an inference that the payments, absent any other explanation, must be a loan. Heavy reliance is therefore placed upon the sschedules of Mr Price but unfortunately for the liquidators he resiled from them.

The liquidator’s case once again is put forward with disarming simplicity. It is said that all of these payments were made to MCI. It was controlled by ZS (a point with which I would concur) and it provided no consideration. It follows therefore that the payments were gifts or for no consideration at all and the entirety of the seven payments becomes returnable under section 238 IA 1986.

I have earlier averted to the fact that MCI’s main defence is that the payments were made in part discharge of admitted indebtedness due from SR to Mercury.

I set out now in this part of the judgment how SR became indebted to Mercury and the interrelation between that indebtedness and the indebtedness due to Fortis Bank (“Fortis”).

The first debt acquired was SR’s debt owed to Central Wechsel Und Credit Bank (“CW Bank”). As at 2^nd May 2000 SR owed CW Bank, $8,890,597 (including interest). Mercury by an agreement dated 2^nd May 2000 with CW Bank agreed to purchase this debt for $2,900,000. Dr Faulhaber acted for Mercury. On the same day SR and Mercury entered into an “acknowledgement of debt agreement” whereby SR irrevocably acknowledged it owed Mercury $8,890,597. Thus Mercury acquired a debt for a little under a third of its face value. Of course the worth of the debt was dependent on SR’s ability to repay it. CW Bank might well have been willing to take a discount for the certainty of achieving a definite sum. What is significant is that the $2,900,000 was acquired from SR. That was disguised because monies were transferred from SR to UCI and UCI transferred the sums to CW Bank. Why the transaction was effected in this way is a matter of pure speculation. I have little doubt that ZS procured the transfer by suggesting to CW Bank that (1) SR could not pay but (2) Mercury (nothing to do with him) would pay a cash sum to take over this at risk debt. However, that is pure speculation on my part. Equally why the debt was kept alive at $8,900,000 odd as against SR when SR’s own money had been utilised to affect the purchase is also a matter of speculation. All of this is speculative and unnecessary because the Liquidators accept the validity of the transaction. Thus they do not suggest that Mercury did not acquire the $8.9 million debt claim against SR. This is despite the fact that all of the transactions appear to have been engineered by ZS and utilise SR’s money to put into the hands of Mercury an asset which can be used against SR despite having been acquired by SR’s own money. This I should however point out is one of the many instances which show that the reality is that Mercury and SR belong beneficially to ZS. Whatever else ZS’s characteristics are nobody has suggested he was not a clever businessman. If Mercury at the time was owned by KF (as alleged by him) it would be quite extraordinary for a businessman of the nature of ZS to agree to enable KF to acquire a debt claim of $8.9 million against SR not only without spending any money but also using SR’s own money to acquire it. No logical explanation for such a transaction was put forward by MCI in the proceedings before me.

Nevertheless, the liquidators have proceeded as I have said on the basis that the transaction was genuine and not capable of challenge by SR in these proceedings. A reservation was attempted in respect of other proceedings as the Liquidators might bring. Whilst this is not a matter for me now I have difficulty with the concept of the liquidators blowing hot and cold as regards the effect of transactions in different sets of proceedings.

Having acquired the CW Bank debt negotiations took place between in effect ZS and Fortis Bank to address the borrowings from Fortis Bank which was prepared (in August 2000) to make available a $4,000,000 facility to SR.

This was preceded by a fax sent by ZS to Dr Faulhaber on 14^th August 2000. That letter referred to the acquisition of the CW Bank debt and the acknowledgement of debt agreement. The letter was copied to KF. However I am firmly of the view that that was a deception put forward by ZS to give the impression that KF was the beneficial owner. It was in fact a pointless exercise because KF does not speak English so there was no point in copying in to him a fax sent in English. The body of the letter was self-serving as regards the beneficial ownership of Mercury (stated to be KF’s) and MCI stated to be IL’s. None of this makes sense for the reasons that I have set out above. The fax (apart from recording the transaction which is not challenged) was a deception desiring to give the impression that ZS had nothing to do with Mercury or MCI.

Fortis Bank on 29^th August 2000 set out its lending terms in a facility letter. One of the conditions was “subordination of the loan from [Mercury] amounting to GBP £5,000,000, equal (as per the attached agreement)”.

There was much debate as to whether this sum of £5,000,000 introduced a cap as regards the amount of subordination of the Mercury debt. It is difficult to see what the purpose of the £5,000,000 figure is if it is not intended to introduce some kind of cap. Where the £5,000,000 came from is shrouded in mystery. It might (on an approximate basis) reflect a currency conversion of the US dollar capital of the debt to a sterling equivalent. The facility letter clearly gives an intention that there should be a cap of the subordination in the sum of £5,000,000.

This understanding is confirmed in a further fax from ZS to Dr Faulhaber dated 29^th September 2000 (once again copied to KF). The first item there refers to a £5,000,000 cap. The evidence of Dr Faulhaber was that he believed that there was a £5,000,000 cap but he did not actually see the subordination agreement at that time. Once again in my view the introduction of the references to KF were purely self-serving but that does not affect the intent as regards the subordination.

On 20th October 2000 Mercury, SR and Fortis entered into the subordination agreement. The amount subordinated is in my view different from the figure of £5,000,000. Clause 1 provides:-

“creditor hereby irrevocably subordinate and to the extent required hereby irrevocably undertakes to subordinate it’s claim against [SR] in the amount of GBP £5,000,000 …along with all other future claims on SR and any rights associated therewith including without limitation interest claims (hereafter jointly and severally referred to as the “Claim”) to all present and future claims of Fortis against SR irrespective how arising either in current account or otherwise and whether in course of ordinary banking business or otherwise”

I have already observed that it is not clear where the figure of £5,000,000 came from. Notes prepared by Moore Stephens SR’s auditors to year ended 31^st December 2001 attempt a reconciliation which suggests that Mercury was owed $9,680,937.68 with a sterling figure of £5,191,224. Note 3 refers to the purchase with an illuminating comment about the possible connection between Mercury, SR and how CW were “persuaded” to complete this transaction. That might be where the figure of £5,000,000 came from but it is not clear.

Mr Gourgey submits that Clause 1 of the subordination agreement enables repayment of debt to be paid (ie capital) but not interest provided that there is at least £5,000,000 equivalent capital still outstanding. I do not accept that is the correct construction. It seems to me clear that not only the debt and accumulated interest and charges on it are subordinated but also any further advances are subordinated.

In draft accounts for SR prepared for the year ended 31^st December 1999 there is a post balance sheet event item referred to in note 9. This refers to the Mercury-CW purchase and that it was subordinated. Mercury is not identified. This note appears to have been created by SR’s bookkeeper Sabiha Chakera and passed onto Moore Stephens.

When Fortis saw this they sought clarification and also clarification of a subordination of an earlier loan by another company West-East Private Investments. That was addressed by ZS in his letter to Fortis Bank and dated 15^th December 2000. He referred back to the notes to the accounts. In my view the concerns of Fortis Bank were not in relation to the subordination of the agreement in respect of Mercury but rather the earlier one.

Finally on 23^rd January 2001 Mercury and SR entered in to a further agreement following on the acknowledgement of debt agreement dated 2nd May 2000. By Clause 2 the parties agreed that for the duration of the subordination agreement i.e. until the full release by Fortis Bank service of the debt should be frozen and should only be resumed upon granting of a full release by Fortis Bank but that interest would accrue and remain due although not payable until the release by Fortis Bank of MCIs subordination undertaking. The liquidators contend that any payments made that are attributable to reduction of Mercury’s debt would be in breach of the subordination agreement and in breach of this acknowledgment of debt agreement. What is curious of course is that the day before this variation to the acknowledgement of debt agreement MCI received the benefit of T4. Accordingly the liquidators contend none of the sums paid to MCI can be attributable to a pro tanto reduction of the Mercury debt.

For that contention to succeed it seems to me that the subordination agreement must be construed as not being limited to £5,000,000. There are difficulties over its interpretation. I can see no reason for the introduction of the figure of £5,000,000 unless that is intended to be a cap figure with accrued interest thereon. Whilst I reject Mr Gourgey’s submission that capital payments can be made it seems to me that if there was a balance of the sterling equivalent of £5,000,000 together with accumulated interest from time to time that was the amount subordinated and any excess could be dealt with without infringing the subordination agreement. The acknowledgement of debt agreement simply is capped by implication by its reference to the original debt of 2^nd May 2000 and the subordination agreement.

This debate ultimately, however, in my opinion is sterile. It is sterile for two reasons. First, as between SR and Mercury it does not seem to me to matter whether or not in fact the subordination agreement has been broken unless Fortis intervenes. Fortis has the benefit of the Vienna property. I understand it has not submitted a proof or claim in SR’s liquidation despite that having occurred over two years ago. Second, if the payments have been treated as having been made on behalf of Mercury it is impossible for Mercury I would have thought to gainsay that. There is no net figure agreed as between SR and Mercury because Mercury too has not submitted any proof in SR’s liquidation.

I therefore conclude that even if the construction of the subordination agreement is as contended by SR’s liquidators that in itself is not evidence which prevents MCI showing that “in fact” the payments were utilised to discharge Mercury’s debt.

At the same time that the documents in respect of the subordination agreement were being entered into, correspondence was taking place between ZS and Dr Faulhaber. I have already referred to the 14^th August 2000 fax.

On 9^th October 2000 ZS sent a further fax to Dr Faulhaber (once again copied to KF). This refers to a proposed purchase of the Vienna property by Melborough. Much of the letter is a self-serving deception designed to show that KF is the beneficial owner of the Vienna property. Once again an examination of the actual way in which the property was acquired demonstrates that this cannot possibly be the case. The fax itself shows that. SR is repaying part of its debt due to Mercury and that repayment is to be used to purchase the property. It is then suggested that KF agrees that SR can immediately use the property as security for credit facilities of SR provided to Fortis. This indeed happened (as I have said above). Fortis has realised the benefit of that security. The purchase price was a little over $2,000,000. As will be seen the monies were provided by SR. If those payments are not payments in partial discharge of SR’s debt to Mercury the transaction makes no sense. Although it is true that SR has the benefit of the use of the property’s security if Melborough/Mercury pay out on that security they would of course be subrogated to Fortis’s claims in the liquidation. It makes no commercial sense for SR to pay $2,000,000 for the privilege of having a substituted creditor with no corresponding reduction in debt. Equally the transaction having been funded by SR, it makes no sense for ZS to make a gift of the beneficial ownership of the property to KF if KF is beneficially interested in Mercury/Melborough. The suggestion that this is part of a “beneficial” creditor arrangement to enable more favourable speculative operations in Russia to take place, as suggested by KF do not in my view bear scrutiny. This therefore is another example of clear evidence showing ZS’s beneficial ownership and control of Melborough, Mercury, SR and MCI.

The fax concludes (item F) that when the deal is completed inter company balances can be confirmed.

On 5^th March 2001 ZS sent a further fax to Dr Faulhaber (copied to KF in the usual way). In that he first stated that KF had asked him to confirm the inter company balances. He refers to discussions with KF and telephone and written instructions addressed to Dr Faulhaber. He when giving evidence was unable to identify any such written instructions. The fax then refers to T1-T5. The narrative to each of those payments says “paid to MCI according instruction of Mercury (KF)”. A total of $2,399,000 is arrived at.

There are then 3 paragraphs which I set out in full because of the controversial debate that took place before me over the meaning of those paragraphs. The fax continues:-

“[Mercury] has subordinated it’s claim against [SR] to [Fortis] in the amount of £5,000,000 GBP.

[Mercury] on disposal to SR property in Austria…. registered on Melborough (nominee asset holder) to be used as a collateral to cover Russian risk…

By these two operations balance between SR as debtor and Mercury as creditor has not changed”

The next paragraph says:-

“Please contact [SR] and regulate all what is necessary for bookkeeping and accountancy”

Mr Slade submitted that the letter shows when taken as a whole that there was to be no change on the Mercury/SR balance i.e. the 5 payments listed (which are T1-T5) are to be ignored as regards Mercury. He further submitted that whilst in October 2000 ZS had an intent to make debt repayments to Mercury that changed towards the end of 2000 when Fortis became concerned and the desire of ZS to make debt repayments was only in respect of T1-T2 which had already taken place before Fortis allegedly became concerned.

This analysis does not in my view bear scrutiny. On 6^th November 2000 Melborough contracted to buy the Austrian property for 30,250,000 Austrian Schillings. That equated to a purchase price $2,075,961 (as confirmed by Dr Faulhaber). The monies comprising T1-T5 that were paid to MCI ultimately were utilised to pay the purchase price. I refer to the payments identified in MCI’s opening skeleton and closing skeleton (paragraph 17 of the latter).

This is completely in accordance with the narrative put on the fax of 5^th March 2001, namely payment on behalf of Mercury. The true construction of the fax in my view is that there are two separate parts. The first part deals with the clearly identified payments utilised by Mercury to acquire the property but subject to corresponding pro tanto debt reduction as regards SR. The second part relates to two transactions namely the subordinated claim and the charge of the Vienna property in favour of Fortis. The letter correctly says that the debtor balance has not changed by those two later operations as no further money has been advanced or repaid by those two transactions; it is merely that Melborough/Mercury has charged it’s property which it has acquired utilising money received in respect to the earlier 5 transactions in part reduction of its debt. In this context the description of Melborough Properties Limited as “nominee asset holder” refers to it being a nominee for Mercury and thus ZS.

In my view all of that makes sense and reflects the way in which the monies ultimately were utilised.

The arrangements suggested by SR’s liquidators do not make sense. On their analysis $2,300,000 was advanced to MCI on an unsecured basis. MCI then used it to fund Melborough’s acquisition but there was no corresponding benefit accruing to SR in debt reduction. Why would ZS agree on behalf of SR that it should handover money for no purpose, leaving a complete stranger company in ownership of property like that, especially when that company was in a position of having subrogated claims through Fortis?

In addition, of course as I have already observed, the narratives on T1-T3 instructions to the bank reflect debt reduction. They are consistent with Dr Faulhaber’s understanding and the liquidators acknowledged that he was a truthful and honest witness.

I am urged to reject that construction in favour of the other documentation referred to above. The only reason for so doing is based on the unreliability of anything that ZS says. I see no basis, however, for rejecting that particular aspect of ZS’s operations in favour of the other one. This is the more so when the effect of the faxes to Dr Faulhaber reflect what actually happened to the monies that left SR and went to MCI.

On 27^th November 2001 SR wrote to Mercury stating that SR’s auditors (Moore Stephens) requested that Mercury confirm the amount due to it was $9,667,588.51. Mercury confirmed that by countersigning the letter 27^th November 2001. The signatory was Samantha Parkes, a nominee director from the Isle of Man.

On the same day SR wrote to MCI requesting confirmation that the debt as between them was $1,079,535.56. That was acknowledged by MCI on 29^th November 2001. The signatory was Mr O’Donnell. He attached a qualification however that “this confirmation is based on information supplied by a person involved in the running of the company and no independent checks have been made”. On the next day ZS wrote to Mr O’Donnell confirming the MCI balance as being $1,079,535.56 as at 31^st December 2000. ZS sent a further fax to the like effect on 20^th December 2001 to Mr O’Donnell. He wrote back by hand on 4^th January 2002 saying that before he signed they must send their accountants to check the accounts. That never took place. On 22^nd January 2002 a Mr McMahon drafted a further letter for Samantha Parkes to sign which reduced the Mercury debt to $8,590,580.98. That takes into account T1-T3 which were discovered by Mr McMahon. As at 31^st December 2000 being the date confirmed in the draft letter dated 22^nd January 2002 only T1-T3 had taken place.

On 7^th June 2002 Mercury, SR and Fortis entered into a further subordination agreement. This subordination agreement initially as typed purported to subordinate Mercury debt totalling $20,000,000. It was then altered in manuscript to $8,600,000 and accrued interest. That looks like the original debt minus T1-T3 (as set out in the draft letter referred to above). The balance between that figure and $20,000,000 is not explained. It might be drawn from a letter from SR signed by ZS dated 17^th June 2002 (i.e. 10 days after the subordination agreement) and sent to Fortis Bank. That purports to summarise SR’s current debt position. Reference is made to Mercury Consultant’s £5,000,000 loan to SR subordinated in favour of Fortis. However the total debt is described as being $16,900,000 due to Mercury. By way of footnote I observe again that KF simply did not understand these documents and the amounts despite his contention that he was the beneficial owner of Mercury. There is nothing to suggest that Fortis challenged this letter. It might well equally be that the figure of $8,600,000 represents the currency equivalent of £5,000,000 at that time hence the manuscript alteration. The balance of the $16,900,000 is I suspect derived from an additional acquisition from Bank of Austria (see below). Mr Gourgey submitted that this was not inconsistent because McMahon had calculated the amount a year earlier at $8,220,000 and the $8,600,000 reflected the extra interest.

Mr Price has done a reconciliation of the account as between Mercury and SR following the CW Bank purchase. That reconciliation is not contemporaneous and is based on assumption of SR being liable to pay interest at Libor plus 3.5% plus capitalised and applying an exchange rate on a monthly basis (which he took from Bank of Canada’s website). The effect of that analysis is to show that if the subordinated loan debt is £5,000,000 when applying the varying exchange rates there are substantial unsubordinated debts available, which exceed the amount of the payments T1-T5. This provides further indirect justification for the conclusion that the subordination agreement was limited to the dollar equivalent of £5,000,000 plus accumulated interest. As I have already indicated I do not think it actually matters in respect of the present dispute whether or not there was such a cap. It is however supportive of the contention on the part of MCI that T1-T5 were used for debt reduction.

It does support the contention that T1-T5 were utilised to purchase the Vienna property. The liquidators of SR do not dispute the validity of the Vienna property acquisition i.e. that is was acquired by Melborough and is not the subject of a claim by SR despite it having been funded as I have said by SR’s monies albeit routed through MCI.

On 21^st December 2001 Mercury agreed to acquire the Bank of Austria’s debt claim due under a loan agreement dated 13^th January 1998 (as subsequently amended) as between it and SR. As at 30^th November 2001 the amount allegedly due was $6,647,921.78. That was confirmed by SR in the Sale Agreement. Bank of Austria agreed to sell that debt for $4,250,000. The monies were paid in two tranches. The first tranche of $1,000,000 was to be paid 14 days after the date of the agreement and second amount ($3,250,000) was to be paid on 31^st January 2002.

Clause 2.5 provided that upon payment of the $1,000,000 15% of the claim should be deemed to be transferred to Mercury.

On 4^th December 2002 Mr Price approved payment of $1,036,000 to Bank of Austria via Finagrain (a Geneva based company). The notation to that is “DR Mercury Consultants Limited”. Mr Price confirmed that transaction by fax dated 7^th January 2002 sent to a Patrick Chabrier, SR’s Swiss lawyer (copied to ZS). Bank of Austria acknowledged receipt by fax of 7^th January 2002 addressed both to SR (reference ZS) and Mercury (reference Dr Faulhaber). Those payments came from SR Rostov.

On 19^th February 2002 Bank of Austria granted an extension of time to make the second payment but required by 28^th February 2002 a further payment of at least $500,000. This sum was provided by SR via MCI. T6 & T7 amount to $500,000 paid by SR to MCI. The message to beneficiary in each case is “on behalf of Mercury Consultants” The payments were transferred to MCI on 22^nd and 26^th February 2002 and then transferred by MCI to UCI and transferred by UCI to Bank of Austria.

Once again SR’s liquidators do not challenge the validity of the Bank of Austia/Mercury agreement. Thus Mercury acquired the debt utilising monies of which part ($500,000) came from SR. It is by no means clear just how much debt was thereby acquired but the parties have proceeded in the case on the basis that approximately $1,500,000 was acquired. ZS’s letter to Fortis dated 17^th June 2002 appears to have included the entirety of the Bank of Austria debt. However apart from the first tranche there is no suggestion that the full amount was ever subsequently acquired nor that the final payment was ever made. No evidence has been adduced showing the proof of Bank of Austria in the liquidation of SR. T6 & T7 are included in the Undervalue Claim but they are not included in the Debt Claim. The Debt Claim is based on T1-T5 and Mr Price’s analysis as 15^th November 2002. That reconciliation takes into account T7 as being a payment made on behalf of Mercury (which calls into question T7 as an undervalue claim). The schedule does not make any reference to T6.

Mr Gourgey in his closing submissions, submitted that he could not see the liquidators’ case in respect of T6 & T7. I have to agree with him. It seems clear on the documentation that those monies were used partially to acquire the Bank of Austria debt (the underlying transaction not being disputed). He produced the copies of the Bank instructions received. I have already observed that T6 came from an account with Fortis which is at odds with the suggestion that the payments would be a breach of the Subordination Agreement.

I can see no basis for disregarding what the contemporary documents show. Those documents show in my view that T6 & T7 were transferred to MCI in part reduction of the Mercury debt and used by Mercury to acquire part of the Bank of Austria debt due from SR. There is no material to justify any contrary conclusion. In the liquidator’s opening (paragraph 62) it was suggested that there was some mystery about transactions T6 & T7 but no clear elucidation was provided as regards that mystery. The matter was not advanced in the written reply and the oral submissions on closing either.

There is therefore only one conclusion namely that SR’s money was used at the behest of Mercury (by way of debt reduction) to enable Mercury to acquire the Bank of Austria debt. Once again the decision makes commercial sense as regards SR only if the monies paid to MCI achieve a benefit for it, namely a pro tanto reduction of its debt and ZS is beneficially interested in Mercury.

As I have set out above the statement produced by Mr Price was utilised by the liquidators to justify the Debt Claim. Relying on that statement it was contended that the arrangements necessarily implied a loan and as the statement included interest at 10% it also included quarterly compound interest rates at 10%.

Mr Price gave evidence for MCI. In his first witness statement he explained why he started with a nil balance as at 31^st December 2000. He said that he made the decision for a nil balance but adjusted them to take into account that T1-T3 represented payments made to MCI by the direction of Mercury in partial reduction of Mercury’s debt. I have already commented that the transfer instructions appear to record that fact.

Second Mr Price explained that the entry of the 10% was a default entry in the Excel spreadsheet. He says that he was unaware of any loan agreement existing between SR and MCI during the period of his employment at SR and never saw any reference anywhere to require interest being charged. He also readjusted his accounts to take into account T5 & T6.

In his second witness statement Mr Price amplified the dealing in the accounts in so far as was possible for transactions T1-T3. They are shown in the schedule relating to SR’s loan account with Mercury for the year ending 31^st December 2000. Those accounts taking into account interest produce a net figure of £8,590,580.98. That is precisely the same figure in the draft letter dated 22^nd January 2002 produced by Mr McMahon for Samantha Parkes to send to SR’s auditors Moore Stephens. That as I have said earlier is a result of Mr McMahon finding these three payments. In those accounts T4 & T5 did not have to be taken into account because they had not yet been made. Mr Price however took those into account in his reconstituted accounts to which I have already made reference.

In between the transactions and Mr Price’s reconciliations are a number of other documents. For example an extract from SR’s draft accounts prepared by Moore Stephens to 31^st December 2001 shows an increased figure ($9,680,937.68) for the Mercury indebtedness. However that to my mind is a provisional figure and is overtaken by the later adjustments as referred to in the draft letter sent by Mr McMahon to Samantha Parkes in the following year. It will be noted that the sterling equivalent in that schedule is based on an exchange rate of 1.61 US Dollars to the Pound Sterling, whereas Mr Price’s reconciliation is at a rate ranging between 1.41 and 1.49. That of course creates a greater surplus of Dollars above the £5,000,000 cap.

In addition there is the exchange of letters which took place on 27^th November 2001 to which I have already made reference. The existence of a debt due from MCI is inconsistent with its case. Another inconsistent document is the letter of 20^th December 2001 from ZS to Mr O’Donnell confirming again a balance owed by MCI as a little over $1,000,000. The best Mr Gourgey could do to explain these was that they were errors and that those errors were corrected as shown in Mr Price’s reconciliation. Therefore they should not be accepted on their face value.

I can understand that submission in the context of arithmetical errors but I cannot understand it in the context of MCI’s case which is that there was no loan made to MCI.

Mr Gourgey equally acknowledged that the figures on the second subordination agreement do not necessarily rest easily with MCI’s case either. I accept however that the second subordination agreement of 7^th June 2002 is more damaging to the liquidators case. I say that because Mr Slade was constrained to acknowledge in his closing that the figure of $8,600,000 in that document can only reflect at least “repayments of T1-T3 being acknowledged as being partial repayment of the Mercury debt”. That concession to my mind seriously undermines the liquidators’ case.

When one analyses the instructions the only damaging instruction is that to be found in T5 where the payment is described as a short term loan. Against that as I have said there is evidence showing that T1-T3 and T6-T7 are more consistent with them being debt repayments. The second damaging aspect is that the liquidators’ argument requires the 5 payments identified in the letter 5^th March 2001 which are given the identical explanation “paid to MCI according instruction of Mercury ([KF])”, to be treated differently as regards T1-T3. I can see no logical basis for justifying a different treatment of the effect of that letter in respect of T1-T3 from that in respect of T4-T5. It is simply in my view an attempt by the Liquidators to fasten on the differentiation in T4-T5.

I remind myself that a Judge should be alert to attempting his own reconstruction of all the documentation in order to come to a perceived putting together of all the facts inconsistent or otherwise. Cases can sometimes be decided on burden of proof see: Rhesa Shipping Co S.A. v Edmunds [1985] 2 Lloyds Rep 1(HL).

There are difficulties in the documents in respect of both sides’ cases. However, the difficulties which face the liquidators far outweigh the difficulties posed on MCI by the documentation referred to above. I have been handicapped of course by the absence of ZS and any of the other persons who were involved in preparing calculations.

Mr O’Donnell’s evidence was of no assistance for example. His evidence was unsatisfactory as regards one credit issue, namely it is plain in my view that he back-dated his resignation as a director of MCI to 15^th November 2002. It is quite plain, as the cross examination of Mr Slade showed, that he created documents in respect of such resignation in February 2003. In respect of the figures however, I am quite satisfied that, like a lot of nominee offshore directors, Mr O’Donnell knew absolutely nothing about the actual documentation. He was cautious, however, to include reservations when he was asked to verify figures. He never did verify the figures which itself undermines the effect of the acknowledgements of indebtedness on behalf of MCI. That does not of course explain ZS’s letter of 20^th December 2001.

Nevertheless, as Mr Slade conceded in his closing submission, both Mr Price and Dr Faulharber were honest witnesses, although he submitted that their recollection was sometimes at fault. When one looks at the discrepancies between the documents it seems to me that I should prefer the analysis put forward by MCI as enshrined in the fax of 5^th March 2001.

The liquidators I have said accept the CW Bank acquisition, the Bank of Austria acquisition and the Vienna property acquisition as being genuine transactions. All of those, it is acknowledged, were funded by monies drawn indirectly from SR. It makes no commercial sense for SR to make those payments via MCI on the basis of either gifts of money to MCI or loans to MCI when those monies are then turned around and put into the possession of Mercury to enable it to acquire those assets. That fundamental logic in my view supports the cases put forward by MCI on the balance of probabilities.

As I have said above, there are documents which are inconsistent but there may be some explanation for those documents which nobody had been able to give before me. I do not think however, that those documents are such as to undermine MCI’s defence. It should of course, as I have said, be borne in mind that the burden of proof that there was a loan or a transaction at an undervalue is on the liquidators. There is nothing in their case which compels a rejection of the case relied upon by MCI.

It follows from that that I reject both the Debt Claim and the Undervalue Claim.

As a necessary ingredient of the Undervalue Claim the liquidators had to show that any transactions between SR and MCI were connected. The connection is ZS. A lot of time was devoted to attacking the credibility of KF and IL.

KF’s case was that he was the owner of Melborough and Mercury at the time when all of the transactions took place. That does not make commercial sense for the reasons that I have set out in this judgment. On KF’s evidence he obtained Mercury and Melborough without providing any monies at all. It was plain he knew nothing in reality about all the transactions. It was all in my view orchestrated by ZS. I accept the analysis provided by Mr Slade in his written submissions showing that KF was in reality a front for ZS who at all material times exercised control.

The position as regards IL is the same. I do not accept, for the reasons again set out in Mr Slade’s closing submissions, that IL was ever the ultimate beneficial owner of MCI.

In my view the ultimate beneficial owner of SR, MCI, Mercury and Melborough is ZS. That of course has no impact on the present claim but might be of significance to the trustee in bankruptcy of ZS.

For all of the above reasons however, despite establishing the connection between the companies via ZS, the liquidators’ claims nevertheless fail and the actions must be dismissed.