I have been asked what are my latest thoughts on the Ralan disaster after attending the creditors meeting on Friday.
The first thing to note is that the amount of money taken from investors is out of all proportion to the money the Group should have required to develop Ruby stage 1 and the Arncliffe project.
There are 243 apartments in Ruby stage 1. Assuming an average sales price of $700,000 per apartment that means a gross realisation of $170.1 million. Land and building costs are typically 2/3rds of gross realisation. That means $112 million. A developer is typically required to contribute 20% of costs as cash into the project. The balance is raised as construction finance from a bank (Westpac) and then topped with mezzanine debt (Wingate). Thus we are talking about cash requirement for Ruby of just $22.4 million!
Applying the same back-of-envelope figures to Ralan’s 318 unit development at Arncliffe, with a reputed gross realisation of $132,000, Ralan only had to put in $17.5 million in cash. This begs the question of why Ralan needed to borrow $280 million from investors when it only needed $39.9 million for its current projects.
The answer likely lies in a comment made by Said Jahani, one of the joint and several administrators, to the creditors meeting, he said “from what we can see Ralan was never profitable”. This suggest a Ponzi scheme. However before a Ponzi scheme can accumulate liabilities of this scale it needs to be able to hide its losses.
It is true that as a private group Ralan was not required to be audited. However developers’ accounts are, as a rule, closely scrutinised by their financiers. This scrutiny tends to be focussed the finances of the project being financed.
It is impossible for a development company to hide losses in a project from its financiers. This is because its financial position is totally transparent at the completion of the development. As the sale of units are settled the first ranking financier is paid back first, then the mezzanine funder is paid back, then, any money left over goes to the developer. The financiers have to approve the price of each sale. The mezzanine funder knows at what point it has been paid out and how many units remain to form the developer’s profit.
If there are no units remaining for the developer then there is no profit. If there are insufficient proceeds to payout even the mezzanine funder then the developer makes a loss in the form of the lost capital it contributed upfront and the shortfall it still owes the mezzanine funder.
Losses might be shifted from one project to another by taking money advanced by a bank for a new development and using it to payout the mezzanine funder on a completed loss-making development. However such a deception is unlikely to get far. The main focus of funders is to ensure that when a progress claim (an advance) is paid it goes to the right people, namely to the builder and subcontractors.
Thus the funders of a project are in a position to understand the profitability, or otherwise, of the projects they finance. Wingate, for example, which reputedly invested $36 million into Ruby stage 1, would have known exactly how profitable it was.
Indeed Wingate has been funding Ralan’s projects for over 10 years. If as the administrator suggested Ralan has never been profitable then Wingate would have known. This is because they would have known exactly how profitable each project was.
Some projects were clearly not profitable. In 2014 Ralan’s sole builder Steve Nolan Constructions became insolvent. At that time Ralan had four developments underway comprising a total of 325 units. William O’Dwyer was on record at the time saying that Ralan lost a $3.5 million loan to the defunct builder and that “it’s going to cost me millions and millions more to get a new builder to come in and finish these projects”.
That was not the worst of it. The CMFEU (a trade union) shut down one of those sites and forced Ralan to go to court to injunct the unlawful picketing. William O’Dwyer later said that the CMFEU ignored the court order and that he had to pay off all the sub-contractors which Steve Nolan Constructions owed for the Ralan sites.
Given the fact that:
- while those sites were shut down both senior and mezzanine funders would have been in default, and therefore on default rates of interest;
- Ralan had to effectively pay for much of the work twice;
- Ralan had to pay new builders additional millions to complete the projects;
it is likely that the Ralan Group suffered large losses at that time. These losses may or may not have been able to be absorbed by its balance sheet. If the losses could not be absorbed then Wingate, as mezzanine funder on these projects, would have suffered losses.
If so, the question is ‘how did the parties deal with those losses?’ Rather than Ralan going into liquidation, and William O’Dwyer being bankrupted on his personal guarantees, did they come to an agreement that Ralan would pay the shortfalls back at some future date?
If so how was Ralan to do that? Where would the lost capital come from? Given the enormous size of the Ralan Ponzi debt (by far exceeding the cash requirements for Ruby and Arncliffe projects) one could reasonably conclude the money came from the Investors in Ralan’s Ponzi scheme.
Construction funders and mezzanine funders closely scrutinise pre-sales. They rely on pre-sales as the most accurate forecast of whether the project will be able to be sold upon completion. In the last few years most financiers have required 100% debt coverage in pre-sales. This means they require 100% of the money projected to be owed at the completion of the project in pre-sales.
Developers are notorious for fabricating false pre-sales. I wrote a chapter on False Pre-Sales in my 2015 Lexis Nexis textbook Avoiding Mortgage Fraud in Australia. To avoid being duped financiers must perform due diligence on pre-sales. This means checking the existence and veracity of pre-sales contracts and making sure a genuine deposit is held in a real estate agent or solicitor’s trust account.
Usually this involves calling for the trust account ledgers. It is also common practice to periodically ensure that none of the contracts have been rescinded. This is to detect circumstances where the same deposit is recycled multiple times for multiple false purchases.
Ralan was not selling these units through an independent real estate agent. Instead Ralan was operating its own in-house real estate agency. All the deposits were going into trust accounts controlled by Ralan. There was obvious scope for fraud by Ralan in providing false ledgers for its trust accounts. Accordingly the financiers could only have done their due diligence by checking the actual balance of the trust accounts with the institution. Had they done this they would have seen the deposits were missing.
As such it seems it is difficult to comprehend how Westpac and Wingate could have been ignorant the deposits were being released and then loaned to another company in the Ralan Group. If they were aware, then it seems they would have also known that Ralan was operating an unlicensed debenture scheme which they were benefiting from.
The financiers were benefiting from the scheme because they were able to loan money out, and in Wingate’s case perhaps recover bad debts, through projects which Ralan, with no capital of its own, could not have otherwise undertaken.
If all this is the case the question arises are Westpac and/or Wingate liable for Ralan’s breach of the Corporations Act as accessories. It was held in The Bell Group Ltd (in liq) v Westpac Banking Corporation (No 9) (2008) WASC 239 that accessorial liability in Australia arises when the party in question:
- Has actual knowledge of the behaviour;
- Wilfully shuts their eyes to the obvious;
- Wilfully and recklessly fails to make such inquiries as an honest and reasonable person would make;
- Has knowledge of circumstances which would indicate the facts to an honest and reasonable person.
It is difficult to comprehend circumstances in which Wingate, in particular:
- As mezzanine funder;
- As mezzanine funder for Ralan for over a decade;
- As mezzanine funder during the Steve Nolan insolvency;
- As mezzanine funder on the Ruby project;
could avoid falling into one of these categories. If this is so the investors may be able to recover from Wingate, at least to the extent that Wingate profited from the loans they made. It also raises the spectre that Wingate and/or Westpac could be prosecuted by the corporate regulator.