The Shoeshine Column: Russian roulette fails for Christchurch's Scales

Friday 1st June 2001

Playing legal hardball can have unexpected consequences, as Scales Corporation, once a leading light of Christchurch's close-knit business community, just found out.

Scales' interesting arrangements for the Russian apple trade have cost it $9.2 million, or $4.5 million depending on who you believe, after the Privy Council ruled against it in its dispute with Vladivostok-based shipping line Fesco.

Coming on top of a catastrophic trading record in recent years the lawlords' judgment has brought Scales to its ankles if not to its knees. Losses over the past four years have come to more than $21 million and the directors, who include Broadway Industries supremos Allan Hubbard and Humphry Rolleston, have had to dig deep to support a savage three-for-one rights issue.

"We have all felt the pain, none more so than myself as a major shareholder," Hubbard told his fellow investors in a February letter.

What he hasn't shared with them is an explanation of how the directors allowed the company to perpetrate a fraud on the Russian republic.

The story starts back before World War II when Scales built up close links with Pacific Russia. In particular it acted as the New Zealand shipping agent for Fesco, an outfit with a colourful past of its own.

The relationship began to sour, however, with the arrival of Acfes, a Russian importer in which Fesco has held a fluctuating shareholding. Acfes wanted apples so Scales bought them (from Apple Fields, as it happens), packed them up and put them on Fesco's boats. Fesco took them to Russia and Acfes flogged them off.

In April 1995 Scales began to get worried about the steadily building debt owed to it by Acfes and it despatched then managing director Michael Chinn to Vladivostok to fix things up.

Chinn succeeded in getting Acfes to clear its account and he also secured, from one Captain Miskov at Fesco, a guarantee for Acfes' future debts up to a maximum $US5 million.

All was not, however, quite as it seemed. Scales and Fesco, according to Captain Miskov's testimony to the High Court, neglected to tell him about the RFK margin.

This "highly unusual feature," as the lawlords put it, of trading between Acfes and Scales, involved deliberate inflation of the invoices Scales sent to Acfes for apples supplied.

The agreement was that Scales, when asked to do so, would add a margin to the true price of the apples. Acfes would pay the inflated amount to Scales and Scales would then send the margin to an Acfes confederate, Cyprus-based RFK Holding, of which Acfes' chief executive, one Mr Dalman, was a director.

The margin was $US150 a tonne of apples supplied. A "marketing agreement" was cooked up between RFK and Scales to explain the payments but the High Court's Justice Willie Young concluded this was a sham as no marketing services were in fact provided.

The payments allowed Acfes to build up outside Russia a stockpile of scarce foreign currency diverted from its legitimate purpose - providing Canterbury's finest to the toiling masses - into God knows what purposes, without the Russian foreign exchange authorities being any the wiser.

And their ignorance would have remained Scales' and Acfes' bliss. Unfortunately Acfes again began to fall behind on its payments. Even more unfortunately Scales decided to try to enforce Fesco's guarantee through the courts.

Shoeshine won't bore you with the details of the trial, save to note Fesco's Captain Miskov insisted successfully that his company wasn't in on Acfes and Scales' little secret.

Justice Young awarded Scales $US3.5 million against Acfes, a contingent asset that doesn't appear in Scales' balance sheet - probably rightly as Scales' chance of collecting is non-existent.

But, despite the brave attempts of Scales' counsel Michael Camp to offer a legitimate explanation for the RFK margin, Justice Young wasn't having a bar of the claim against Fesco.

Like the Privy Council he concluded the non-disclosure of the fraudulent RFK arrangement invalidated the guarantee.

While the litigation was in progress Scales withheld shipping payments from Fesco. The result of the lawlords' decision is that Scales' $10.9 million loss last year included $4.5 million it had to pay to Fesco. Fesco says it has received, including interest and legal costs, $9.2 million all up.

Scales' directors and their interests held around 85% of the shares before the recent rights issue. They now probably own virtually all of the company, having pledged to support the issue in full - it's unlikely too many of the minorities would have been keen to quadruple their investment.

One consideration the lawlords gave some weight to when arriving at their ruling was the fragile state of the Russian economy due, in part, to "a degree of commercial corruption ... that would be unacceptable in any country where the rule of law prevails."

The RFK margin was an example of commercial corruption and "in their lordships' view it behoves the courts of Russia's trading partners when practices of this sort are disclosed to offer no comfort to those who engage in them."

Siberia's salt mines are still in need of labour. Should any of Scales' directors happen to be on a flight that refuels at Moscow's Sheremetyevo Airport Shoeshine's advice is to stay on the plane.

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