Coco v Westpac Banking Corporation

CATCHWORDS: CONTRACT - construction - commercial agreement - structured equity investment - Guaranteed Portfolio Service - meaning of "fixed income portfolio value" - meaning and effect of formula to calculate value of zero coupon bonds

LEGISLATION CITED: Australian Securities and Investments Commission Act 2001 (Cth), s 12GM Supreme Court Act 1970 (NSW), s 75

Coco v Westpac Banking Corporation [2010] NSWSC 457 Forster v Jododex Australia Pty Ltd [1972] HCA 61; 129 CLR 421 CASES CITED: Franklins Pty Ltd v Metcash Trading Ltd [2009] NSWCA 407; 264 ALR 15 Ross v Ice TV Pty Ltd [2010] NSWCA 272 Whitlock v Brew (No 2) [1967] VR 803 Whitlock v Brew [1968] HCA 71; 118 CLR 445

PARTIES: Salvatore Coco (Appellant) Westpac Banking Corporation (Respondent)

COUNSEL: J Kelly SC, E Finnane (Appellant) I Jackman SC, C Colquhoun (Respondent)

SOLICITORS: Uther Webster & Evans (Appellant) Mallesons Stephen Jaques (Respondent)

LOWER COURT JURISDICTION: Supreme Court - Equity Division

LOWER COURT MEDIUM NEUTRAL CITATION: Coco v Westpac Banking Corporation [2010] NSWSC 457

IN THE SUPREME COURT OF NEW SOUTH WALES COURT OF APPEAL 2009/298753

ALLSOP P GILES JA SACKVILLE AJA

Friday 12 November 2010 COCO v WESTPAC BANKING CORPORATION Judgment 1 ALLSOP P: Mr Salvatore Coco and Westpac Banking Corporation have a commercial dispute about the operation of a structured equity investment known as the "Westpac Guaranteed Portfolio Service" entered into by Mr Coco and Westpac in June 2007. It matures in June 2012. As part of the resolution of that dispute, over the opposition of Westpac, the learned primary judge (Tamberlin AJ) answered separate questions and made a declaration as to the proper construction of a clause in the relevant agreement. The separate questions, the answers given by his Honour and the declaration were as follows: "Questions:

'Upon the proper construction of the Westpac Guaranteed Portfolio Service Asset Allocation Advisory Agreement entered into between the plaintiff and the defendant on or about 25 June 2007, and in the events which have happened, is the defendant obliged to:

(a) pay the plaintiff $3,008,183.72 (or any other amount and if so what sum) in respect of the Guaranteed Payment Amount referred to in that agreement (minus any outstanding bank fees and charges) on 25 June 2012; and

(b) account to the plaintiff for $10,024,567.06 (or any other and if so what sum) in respect of the redemption of the zero coupon bonds made the subject of the agreement?'

On its proper construction the Westpac Guaranteed Portfolio Service Asset Allocation Advisory Agreement does not oblige Westpac to pay the plaintiff the sum of $3,008,183.72 claimed but Westpac is obliged to account to the plaintiff for $10,024,567.06." 2 I agree with the substance of the views expressed by the primary judge in his succinct and clear reasons: see Coco v Westpac Banking Corporation [2010] NSWSC 457, subject to a reservation in his Honour's expression of the relevant principles of construction as concerns the place of ambiguity, 3 Whilst there is some force in the submission of Westpac that the separate questions and declaration may turn out to be inutile, depending on future events, the Court, having embarked upon the process of clarification of the rights of the parties under their contract, should not now abandon that task: cf Supreme Court Act 1970 (NSW), s 75; Forster v Jododex Australia Pty Ltd [1972] HCA 61; 129 CLR 421, at 433-435, per Gibbs J. The declaration should be reformulated to reflect the question of construction argued, though to the same likely practical effect as formulated by the primary judge, and made, substantially for the reasons of the primary judge and the following reasons. 4 The primary judge described at [2] of his reasons the operation of the product by reference to a brochure published by Westpac. It is unnecessary to set out again that material that runs to over four pages. It is sufficient to describe the product very briefly to aid comprehension of these reasons. 5 Before describing the product, however, it is important to bear in mind that the parties agreed to the terms of the detailed commercial agreements, relevantly for present purposes the Westpac Guaranteed Portfolio Service Asset Allocation Advisory Agreement (the "Agreement"). It is the meaning of that agreement that is to be objectively ascertained. That meaning is to be understood in the mutually known and understood context in which the parties operated. It is unnecessary to discuss the principles of construction of commercial contracts. No debate took place on that subject, and the place, if any, for the ascertainment of ambiguity before examining context, beyond the prefatory written submissions of both parties. I refer only to the reasons for judgment in Franklins Pty Ltd v Metcash Trading Ltd [2009] NSWCA 407; 264 ALR 15, as a convenient source of the references to the binding High Court authorities. Each side stressed the words of the Agreement; each side called in aid the evident commercial good sense of his and its arguments. 6 The product was available to investors with considerable sums to invest (the minimum being $500,000 or $250,000 in more than one fund). Mr Coco invested $10 million. The product was said by the promotional brochure to provide "capital protection" by Westpac guaranteeing "that your initial investment amount will be 100% protected at maturity". Westpac was also prepared to lend 100% of the investment to the investor, as it did to Mr Coco. 7 The investor was invited to place funds in one or more of six wholesale managed funds. Five of the six were share funds (local and international) and one was based on property. Mr Coco invested in five funds, four of which were shares and one was based on property. 8 Westpac was to manage the investments by what was termed "Dynamic Portfolio Management" which was described in the brochure as a "capital preservation technique which involves the active allocation between 'active' and 'passive' assets." Two paragraphs of the brochure explain this as follows: "When you enter into the GPS, 100% of the investment capital will be placed into the Fund, thus offering the greatest potential for capital growth. However, should the value of the Fund drop to a point where a Sell Trigger is reached, the exposure to the Fund will be reduced and the exposure to the Westpac Bond will be increased. Conversely when the value of the Fund recovers and a Buy Trigger is reached, the exposure to the Fund will be increased and the exposure to the Westpac Bond will be decreased.

These triggers are defined as the percentage fall in the value of the Fund that will result in the value of the Dynamic Portfolio falling to a value equal to the Bond Floor. The Dynamic Portfolio is an investment portfolio comprising the investment in the Fund and the Westpac Bond. The Bond Floor is the present value of the capital protected amount. The table below shows the Buy, Sell and Profit Triggers for each of the Funds." 9 The brochure described what would occur at maturity (25 June 2012) as follows: "On the Maturity Date, you can either: 1 Continue to hold your units in the Fund without capital protection. Westpac may offer a capital protected investment with similar terms at that time.

In either case, if the value of the Dynamic Portfolio on the Maturity Date is less than your original investment amount (adjusted for any early redemptions), Westpac will make a guarantee payment to you for the difference.

If the Dynamic Portfolio contains any Westpac Bonds on the Maturity Date, the Westpac Bonds will be redeemed and the proceeds will be paid to you." 10 The relevant terms of the Agreement can be found at [7]-[14] of the primary judge's reasons. I do not set out all the clauses out here. 11 By cl 3.1 of the Agreement, Westpac agreed to pay Mr Coco: "… an amount equal to the Guaranteed Payment Amount for a Dynamic Portfolio on, or as soon as practicable after, the Guarantee Payment Date …"

That obligation was subject to cl 3.2 which dealt with a defined term being a "Guarantee Fallaway Event", that deals with default of the investor and certain events of a force majeure character. It is unnecessary to consider this qualification to cl 3.1, save to note that it is possible that some of these events might occur before 25 June 2012. 12 The "Guarantee Payment Amount" was defined relevantly for present purposes as the greater of zero and the Guarantee Amount (here, $10 million) minus the "Dynamic Portfolio NAV" for that "Dynamic Portfolio on the Maturity Date". 13 The crucial definition is that of Dynamic Portfolio NAV. (There is no separate definition but I would understand NAV to be an abbreviation or acronym for net asset value. It may, however, be beyond the evidence to make this assumption. No argument took place about that. For present purposes I will not give any weight to this assumption that that is what NAV stands for.) 14 The definition of "Dynamic Portfolio NAV" was: " Dynamic Portfolio NAV means, in respect of a date, the sum of the Active Asset Portfolio Value and the Fixed Income Portfolio Value minus the sum of any outstanding fees, expenses or liabilities of an Investor in connection with this agreement on that date." 15 The presently relevant date is, of course, the Maturity Date, being 25 June 2012, for the calculation of the Guarantee Payment Amount on that date. However, the Dynamic Portfolio NAV was relevant for other purposes beyond the calculation of the Guarantee Amount: importantly, the calculation of the "Equity Gap" determining when shares or other "Active Assets" were to be sold and the investor was to be moved into (wholly or partly) "Fixed Income Assets" and vice versa. These points of change are defined as the "Sell Trigger" and the "Buy Trigger". In those calculations, as in the calculation of the Guarantee Payment Amount, it is clear from the terms and the structure of the Agreement that the purpose of the ascertainment of the "Dynamic Portfolio NAV" is to arrive at a value referable to the market for the assets concerned. 16 The two crucial elements of any Dynamic Portfolio NAV are, first, the "Active Asset Portfolio Value" and, secondly, the "Fixed Income Portfolio Value". The former is not relevant, for present purposes, because all relevant Sell Triggers were activated during the Global Financial Crisis and all "Active Assets" being Units in the Managed Funds were switched to "Fixed Income Assets". These latter assets were initially, after the operation of the Sell Triggers, cash and units in cash management trusts. Later, all these funds were used to purchase zero coupon bonds in amounts and for sums set out in the table in [5] of the primary judge's reasons. 17 The zero coupon bonds were bonds under which Westpac promised to pay the face value of the bonds on maturity (25 June 2012) totalling $10,024,567.07. These bonds were purchased by the values of the funds the product of redemption of the Active Assets, such redemption amounts totalling $7,791,168.82. These funds represented 6,991,816.29 Units in the five funds prior to redemption. (See the table in [5] of the primary judge's reasons.) 18 Two things may be noted at this point. First, the difference between $7,791,168.82 and $10,024,567.07 is the discount to face value of the zero coupon bonds at maturity and is a function of the market and interest rate conditions at the point of purchase by reference to the time to maturity. This discount may be likely to be appropriately viewed on revenue, rather than capital, account for an investor such as Mr Coco for either accounting or tax purposes. Secondly, whilst both the figures of $7,791,168.82 and $10,024,567.07 have a relationship to the value of the zero coupon bond, the former being the market value at the time of purchase pursuant to the agreement with Mr Coco, and the latter being the face value at the time of maturity, the number of Units sold or redeemed from the Funds (6,991,816.29) is a figure completely unrelated to value. It is simply the number of Units or divisions into which the five funds were divided and which were owned beneficially by Mr Coco and which were the subject of redemption. It has no necessary conceptual link with value, certainly not at any particular day. The number of units held by or for an investor in a given fund simply reflected the amount invested in the fund divided by the price of a unit in that fund at the date of purchase. The number of units held by Mr Coco in each of the five funds comprising his Active Asset Portfolio varied considerably despite his investment in each being the identical sum of $2 million. 19 One then comes to the crucial integer of the definition of "Dynamic Portfolio NAV", being the definition of "Fixed Income Portfolio Value" (there now being no Active Assets and so no relevant "Active Asset Portfolio Value"): " Fixed Income Portfolio Value means for a day, the aggregate value of the Fixed Income Assets in the Fixed Income Portfolio on that date, which is to be calculated by multiplying the number of Units invested in zero coupon bonds by the market value for such zero coupon bonds, as determined by the Asset Allocation Advisor in its sole discretion from time to time." 20 Whilst there are no Active Assets, the definition of "Active Asset Portfolio Value" should be noted: " Active Asset Portfolio Value means for a day, the aggregate value of the Active Asset in the Active Asset Portfolio on that date, which is to be calculated by multiplying the number of Units in the Managed Fund by the most recent exit price published with respect to the Managed Fund." 21 The debate before the Court centred upon the meaning of the phrase in the definition of "Fixed Income Portfolio Value" "which is to be calculated by multiplying the number of Units invested in zero coupon bonds by the market value for such zero coupon bonds." 22 Two aspects of the whole clause that are contrary to its literal wording should be noted at the outset. First, no provision is made for the valuation of cash or units in a cash management trust, they being the other two types of Defined Fixed Income Asset, apart from zero coupon bonds issued by Westpac having a maturity on the Maturity Date. No doubt, they could be taken as having a nominal value equivalent with their apparent face value; but they obviously should be valued, as both parties agreed. Thus, the phrase commencing with "which is to be calculated …" only applies to zero coupon bonds. 23 Secondly, the formula commencing with "which is to be calculated …" cannot be taken literally. The value of the zero coupon bond at maturity is its face value. To multiply $10,024,567.07 by 6,991,816.29 would produce an absurd result which both sides say is wrong. 24 Mr Coco's submission was that the market value of each zero coupon bond was $1. This was produced by recognising that at maturity the value of the zero coupon bond was the same as its face value - dollar for dollar. Thus the value was $1 for $1. There are some difficulties with this approach in terms of the underlying evidence. I am, however, prepared to approach the resolution of the appeal on the basis that this approach has some legitimate resonance in the evidence and is a shorthand way of expressing value. 25 The difficulty with accepting the argument is, however, the absurdity of this as a multiplicand of the "number of Units invested in zero coupon bonds" for the stated purpose. The number produced by this multiplication has no relationship to value, standing alone. To multiply the number of Units in the Managed Funds that were redeemed by any number such as one or less representing the per dollar value of the zero coupon bond purchased with the funds produced by the redemption of those Units to derive a sum representing value of the zero coupon bond is irrational and absurd. Here, by chance, it gives $6,991,816.29, which has a rough equivalence to a capital value of the bonds (which was in fact $7,791,168.82). However, there is no reason in principle why a particular fund should not have relatively few units, each having a much higher value than units in another fund. The approach taken by Mr Coco, if the units in that fund were converted into zero coupon bonds, would produce a figure bearing no relationship to the capital value. 26 Nor would the multiplication of the two figures identified by Mr Coco make any sense at any earlier point in time in order to calculate the Equity Gap. In such circumstances, the figure would be a fraction of 1 (the precise fraction depending upon the discount attributed by market forces to the bonds). Thus a sum would be derived as the present value of the bonds as a percentage of the number of Units in unrelated Managed Funds that were redeemed in order to produce funds with which to invest in the zero coupon bonds. 27 I reject a construction of the relevant definition that produces a value for the bonds that is disconnected from underlying notions of value. 28 Westpac submitted that the market value of "such zero coupon bonds" had to be calculated by reference to the value per Unit. That is, there had to be an attribution of the value per Unit of the value (discounted or face, depending upon the time at which one was assessing the value) of the bonds. This would give one, by multiplying this per Unit value by the number of Units, the value of the bonds. 29 Whilst this meaning requires some inserted reading of "per Unit", it does make logical use in the calculation of the number of Units. It does, however, work backwards from a known value (that of the zero coupon bonds) being the very value derived. Thus, subject to one possibility, the calculation is redundant. 30 The possible circumstances that would make this part of the definition not redundant would be if the investor in the position of Mr Coco had only (by the product of the redemption of his Units) contributed in part to the purchase of the zero coupon bond. In that case a valuation based on this calculation would be meaningful, separating out his share of the value of the bond from its discounted or face value as a whole. 31 There was some doubt in the Agreement as to whether it would be possible for this to occur. In any event, this way of looking at the clause does reflect a similar structure as found in the definition of "Active Asset Portfolio Value." 32 Mr Coco submitted that a construction should be preferred which best brought about a result which saw only capital protected, not one which captured a revenue return to restore the guarantee amount. One can understand the intrinsic fairness in what promotes this approach. I do not, however, accept that this supports the adoption of an illogical and arbitrary approach merely because it brings about a practical result, in the circumstances that have happened. 33 Even if it be accepted that Westpac's interpretation is redundant, I prefer it to an arbitrary and absurd approach to a clause attempting to reach a real value. 34 Whether or not the contract, properly construed, accords with pre-contractual representations and conduct will be the subject of the balance of the proceedings. The utility of the proceedings for damages may have to await maturity of the investment. There would, however, be immediate utility in the proceedings if a claim under the Australian Securities and Investments Commission Act 2001 (Cth), s 12GM were to be propounded, as was obliquely foreshadowed on the appeal. 35 For the above reasons, the Court should, in my view, make a declaration as follows: "On the proper construction of the Westpac Guarantee Portfolio Service Asset Allocation Advisory Agreement between the appellant and the respondent, the definition of "Fixed Income Portfolio Value" in the definitions in the Asset Allocation Rules in the said agreement should be construed such that the part of the definition being 'which is to be calculated by multiplying the number of Units invested in zero coupon bonds by the market value for such zero coupon bonds' means that the number of Units invested in zero coupon bonds is multiplied by the market value per Unit for such zero coupon bonds, which latter value is to be derived by dividing the market value of the zero coupon bonds at the relevant date by the number of Units sold in order to invest in the zero coupon bonds". 36 The orders that I would make are:

(a) Set aside the separate questions, the answers thereto and the declaration made by the Court on 14 May 2010.

(d) The appellant pay the respondent's costs. 37 GILES JA: I agree with Allsop P. 38 SACKVILLE AJA: I agree with the orders proposed by Allsop P and with his Honour's reasons. I add the following observations. 39 The foundation for the submission advanced on behalf of Mr Coco was that the definition of "Fixed Income Portfolio Value", when it refers to "such zero coupon bonds", does not mean the actual zero coupon bonds in which Mr Coco's Units have been invested. Rather, it means zero coupon bonds of a similar character. From this foundation, Mr Kelly SC argued on Mr Coco's behalf that the expression "such zero coupon bonds" refers to a hypothetical unit price for each $1 invested in zero coupon bonds. 40 Assuming that the expression "such zero coupon bonds" means something other than the zero coupon bonds actually acquired in lieu of an investor's Units, I think that it is very doubtful whether the expression can be construed to refer to the multiplier used to calculate the present value of a sum payable now or some time in the future. 41 In any event, it seems tolerably clear that the expression "such zero coupon bonds" is intended to refer to the zero coupon bonds acquired on behalf of the investor in consequence of the realisation of his or her Units in the Active Asset Portfolio. The word "such" must refer to the expression "zero coupon bonds" appearing a few words earlier in the definition. 42 A further point should be noted. The parties agreed, as Allsop P has pointed out, that the relevant expression in the definition of "Fixed Income Portfolio Value" simply cannot mean what it says. In these circumstances, it is arguable that the expression, which seems to have been adapted inappropriately from the definition of "Active Asset Portfolio Value", is meaningless. If that is the case, the result for which Westpac contends may be available by another route. Where subsidiary contractual provisions are too uncertain to be enforced or are meaningless, they can very often be severed: Whitlock v Brew (No 2) [1967] VR 803, at 807-808, per curiam; affirmed Whitlock v Brew [1968] HCA 71; 118 CLR 445; Ross v Ice TV Pty Ltd [2010] NSWCA 272, at [82]-[84], per Sackville AJA. If the expression is indeed meaningless, there would seem to be little difficulty in severing it from the remainder of the definition. 43 However, as the point was not argued, it is neither necessary nor appropriate to express a view on its merits. **********

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