Complete Compliance Solutions Pty Ltd v Online OHS Pty Ltd

[2013] NSWSC 843

Supreme Court

New South Wales

• Amendment notes

Medium Neutral Citation:

Complete Compliance Solutions Pty Ltd v Online OHS Pty Ltd [2013] NSWSC 843

Hearing dates:

11 and 12 June 2013

Decision date:

21 June 2013

Jurisdiction:

Equity Division

Before:

Rein J

Decision:

1. Declares the First Defendant's purported termination of the Shareholder Agreement - Online Compliance Systems Pty Ltd between the Plaintiff and the First Defendant by notice dated 26 March 2012 was invalid and of no effect.

2. Declares that the First Defendant's purported exercise of the option contained in clause 14 of the said Shareholders Agreement by letter dated 26 March 2012 was invalid and of no effect.

3. Orders the First Defendant to pay the Plaintiff's costs. Reserves the issue of special costs order sought by the Plaintiff.

4. Directs the Plaintiff to provide to the First 5. Defendant with its submissions on costs by 5pm today.

6. Directs the First Defendant to provide the Plaintiff with its submissions on costs on Friday 28 June 2013.

7. Directs the Plaintiff's to provide the First Defendant any submissions in reply by 5pm on Monday 1 July 2013.

8. Direct the Plaintiff to provide his Honour's Associate with all submissions on the issue of costs by 5pm on Monday 1 July 2013.

Catchwords:

CONTRACTS - whether the plaintiff breached the Shareholders Agreement - whether the plaintiff's breach was capable of rectification and proper notice was given by the first defendant

Legislation Cited:

Conveyancing Act 1919 (NSW)

Cases Cited:

Burger King v Hungry Jacks [1999] NSWSC 1029
Haulage Management Services v Towns Haulage (Manson) Pty Ltd (BC9801764, 4 July 1998, unreported, Supreme Court of Victoria, Kellam J)
Kuwait Asia Bank EC v National Mutual Life Nominees Ltd [1991] 1 AC 187
Macquarie International Health Clinic Pty Ltd v Sydney South West Area Health Service [2010] NSWCA 268
Waters Lane Pty Ltd v Sweeney [2006] NSWSC 222
Waters Lane Pty Ltd v Sweeney [2007] NSWCA 200

Texts Cited:

H.A.J. Ford, R.P, Austin, I.M. Ramsay, Ford's Principles of Corporations Law, LexisNexis Butterworths, Loose leaf edition

Category:

Principal judgment

Parties:

Complete Compliance Solutions Pty Limited (Plaintiff)
Online OHS Pty Limited (First Defendant)
Online Compliance Systems Pty Limited (Second Defendant)

Representation:

Counsel: Mr G. McNally (Plaintiff)
Mr J. Johnson (First Defendant)
Solicitors: Breene & Breene Solicitors (Plaintiff)
DC Balog & Associates (First Defendant)

File Number(s):

2012/101705

Judgment

1. REIN J: The plaintiff, Complete Compliance Solutions Pty Ltd ("CCS"), and the first defendant, Online OHS Pty Ltd ("OOHS"), are equal shareholders in the second defendant, Online Compliance Solutions Pty Ltd ("OCS"). Mr G. McNally SC appears for CCS. Mr J. Johnson of counsel appears for OOHS. OCS is controlled by both CCS and OOHS and is deadlocked, and therefore the joinder of OCS as a defendant, whilst appropriate, is formal only.

1. CCS and OOHS entered into a Shareholders Agreement on or about 10 March 2010: see pp 27-52, Tab 8, of Exhibit A. The Shareholders Agreement contemplated the establishment of OCS and regulates the relations between CCS and OOHS.

1. It was envisaged that OCS would be involved in advising clients in relation to compliance with Occupational Health and Safety legislation and regulations. OCS would utilise software developed by OOHS and brought into OCS as an asset.

1. The proceedings concern the purported termination by OOHS of the Shareholders Agreement following what, OOHS claims, were material or fundamental breaches of CCS' obligations under Shareholders Agreement. One of the alleged breaches is the failure of CCS to advise that Mr Roger Cowan was a bankrupt at the time of entry into the Shareholders Agreement but this claim was abandoned at the hearing. The other ground related to the issue by OCS of Convertible Notes.

1. CCS contests the validity of the termination asserting that:

(1)   There was no breach by CCS of the Shareholders Agreement.

(2)   If there was a breach by CCS it was capable of remedy and that the notice given by OOHS was defective.

(3)   OOHS is, in any event, precluded from relying on the alleged breach, for reasons which I shall describe, and is therefore not entitled to purchase OCS software for $1, as clause 14 of the Shareholders Agreement permits it do, if there has been a material or fundamental breach that was not capable of rectification or, if capable of rectification, was not rectified within 30 days of receipt of notice.

1. To understand the competing arguments it is necessary to outline the history, (little, if any, of which is in dispute) and to refer to key provisions of Shareholders Agreement.

1. In March 2010 it was clear that OCS required the injection of capital. There was discussion about how that might be achieved. The directors of OCS at that time were:

(1)   Mr Joseph Dennis Bowers

(2)   Mr Jacob Farragher

(3)   Mr Colin McAlpine

(4)   Mr Phillip Bamford

1. Mr Bowers and Mr Farragher were the nominees of CCS for the Board of OCS and Mr McAlpine and Mr Bamford were the nominees of OOHS. The Shareholders Agreement recognised that Mr Cowan's services would be utilised by OCS through MSPR Pty Ltd, a service company.

1. CCS was looking at obtaining investors in CCS by an offer to investors of Convertible Notes in CCS, that is by a borrowing of funds with an option to the lender to convert the debt owed into shares in the relevant company. At a meeting of all of the directors of OCS, in late March or the first half of April and which Mr Cowan also attended, Mr Cowan proposed that $200K working capital was required for OCS and that he was confident he could find investors willing to take Convertible Notes from OCS just as he had, or was proposing to do, for CCS. He calculated that if OCS could raise $200K in this manner "this will dilute CCS and OOHS to about 46% each": see para 21 of Mr Bowers' affidavit of 24 May 2012, Tab 12, Exhibit A.

1. The reference to dilution was a reference to the shareholding by CCS and OOHS in OCS which, at that time, was 50% of the issued shares in OCS - that is each held 10,000 shares out of a total of 20,000.

1. Each of the directors present Mr Bowers, Mr Farragher, Mr McAlpine and Mr Bamford expressed their agreement with the proposal: see para 21 of Mr Bowers' affidavit of 24 May 2012, Tab 12, Exhibit A.

1. Following that meeting, Mr Cowan set about locating investors for the OCS Convertible Notes. A Mr Glenn Scott, as trustee for his superannuation fund, a Mr Glenn Mathews, as trustee for his superannuation fund, and a Mr McClelland, or an entity connected with him, were each prepared to lend money through the Convertible Notes in the respective amounts of $100K, $25K and $10K.

1. Convertible Notes were issued to Mr Scott and Mr Mathews but it is not clear if Convertible Notes were issued to Mr McClelland. All three investors however paid the requisite amounts and a register prepared by Mr Bowers records them each as holding in total of 135K Notes: see Tab 13, p 245 Exhibit A. I shall refer to each of these persons or funds as "the noteholders".

1. The Convertible Note Subscription Agreements entered into by Mr Scott and Mr Mathews are in evidence and they are also signed by Mr Farragher on behalf of OCS: see pp 271 and p 284, Tab 13 of Exhibit A. They grant the noteholder the right after 15 July 2010 and before 1 July 2013 to call for one share for each dollar lent. Interest is payable on the loan at a specified rate until the investor elects to take up shares in lieu of return of the monies lent to OCS. As at the date of the hearing none of the noteholders has exercised the right to convert his loan into shares. It came to light in the hearing that Mr Bowers at the time that he signed the Note Certificates (see p 273 and p 286, Tab 13, Exhibit A) had ceased a few days earlier to be a director. OOHS does not, however, assert that the Convertible Note Subscription Agreements are not binding on OCS.

1. I have referred to the fact that Mr McAlpine and Mr Bamford approved of the decision to market the Convertible Notes for OCS and for that to be undertaken by Mr Cowan. It is clear that:

(1)   Before the issue of the Convertible Notes on 14 June 2010, Mr McAlpine was shown a copy of the Convertible Notes Subscription Agreement that CSS was using, or proposing to use, and which Mr Bowers was indicating he would use for the OCS Notes (see T86-T87) and that Mr McAlpine accepted that that the CCS document would be the template for the OCS Notes Agreement as it was in fact: T87-T88. He was conscious of the need for an injection of cash and agreed with the proposal for use of the Notes: see T89-90.

(2)   Mr McAlpine was aware of the need for OCS to expand its share capital so that the issue of shares to noteholders, should they elect to take up shares, would not swamp OOHS and CCS: see Tab 8, pp 62-3, p 67 Exhibit A. This included a detailed assessment of the number of shares which would need to be issued to ensure that OOHS and CCS would hold "46% each", approximately of the total shares in OCS.

(3)   No share expansion, in fact, took place before or after the issue of the Convertible Notes in June 2010.

(4)   Mr McAlpine believed that it was not necessary for there to be a formal board approving of the issue of Convertible Notes: T89.5-22.

(5)   After the issue of the Convertible Notes Mr McAlpine, as the financial officer of OCS, attended to payment of interest to the noteholders.

(6)   Mr McAlpine was aware that an Information Memorandum had been prepared by Mr Bowers and Mr Cowan and that financial information prepared by Mr McAlpine was to be utilised for that Information Memorandum and that it had been given to investors: see Information Memorandum at pp187-225, Tab 13, Exhibit A (which includes reference to "New Investor" shareholding of 8% at p 206) and see the email referring to the provision to investors of the Information Memorandum at p 66, tab 8, Exhibit A.

(7)   Mr McAlpine saw the form of the Convertible Notes Subscription Agreements that were signed by Mr Scott and Mr Mathews (see p 248, Tab 13, Exhibit A) although not, it seems, the signed copy of the Agreements.

1. The following provisions of the Shareholders Agreement are relevant or said to be relevant:

(1)   Clause 2.1 provides for the issue of 10, 000 shares to each of OOHS and CCS.

(2)   Clause 2.2 provides:

The Directors must from time to time review the Company's capital requirements, and make decisions on whether the Parties or other entities may subscribe for such additional Shares and on such terms and conditions as the Directors may by majority resolution agree.

(3)   Clause 2.3 excludes subscriptions for shares (other than pursuant to subclause 2.2) except in accordance with the terms set out in clause 2.3.

(4)   Clause 4.1 permits each of OOHS and CCS to "appoint two directors".

(5)   Clause 5.1 deals with the formal requirements for convening a board meeting.

(6)   Clause 6.3 permits loans from third parties.

(7)   Clause 11.2 sets out the matters that require a majority of directors, these matters include OCS borrowing any sum other than from the company's bankers and establishing the capital requirement for the company: see Tab 8, p 38.

(8)   Clause 17 provides that the Constitution of OCS is to be the ASIC Replaceable Rules and that it and those rules are:

the instruments which govern the relationship between the shareholders and between each of them and the company

(see D42, Tab 8, Exhibit)

(9)   Clause 20.1(a) provides:

20.1 Termination on Default

A shareholder may terminate this agreement by written notice to the other shareholder if any of the following occurs:

a) the other shareholder commits a material or fundamental default or breach of its obligations under this agreement and

the default or breach is not capable of remedy; or

where the default or breach is capable of remedy, such default or breach is not rectified within 30 days of receipt of a written notice requiring it to do so; or

(10)   Clause 14 provides:

14. Intellectual Property

In the event of a shareholder terminating this agreement on default under clause 20.1, OOHS shall have the option to purchase the system known as Online OHS as it then exists at a cost of $1 plus any payments made to OOHS under clause 9.2

1. There is also a dispute resolution clause in the Shareholders Agreement but CCS abandoned its claim to enforce that clause and no party relied on it at the hearing.

1. On 29 December 2011, OOHS sent a letter to CCS which it relies on as the notice founding its right terminate the Shareholders Agreement pursuant to clause 20. The notice referred to Mr Cowan's role and said that the failure of CCS to disclose to OOHS Mr Cowan's bankruptcy at the time of entry into the Shareholders Agreement was:

"...a material breach which cannot be rectified by your company or, for that matter, [OCS]."

(p 58, Tab 8, Exhibit A)

1. The letter also states:

Of principle concern in relation to the relationship between our company and your company and the operations of Online Compliance Systems Pty Limited are the ongoing involvement of Mr Cowan and the steps apparently taken by nominees of your company to procure the issue of "Convertible Notes" (copies of which are not held by Online Compliance Systems Pty Limited nor approved at a board meeting of Online Compliance Systems Pty Limited) by representatives nominated by your company to the board of Online Compliance Systems Pty Limited.

So far as the issue of the Convertible Notes they are in clear breach of the Shareholder Agreement, as in particular, they may have given rights to the holders of the Convertible Notes to take up shares inconsistent with the agreed position under the Shareholders Agreement.

...

The provision of clause 20.1 of the Shareholders Agreement permit this company to terminate the Shareholders Agreement and exercise rights consequential upon such termination.

Before exercising any rights specifically under the terms of the Shareholders Agreement we write to give you an opportunity to advise on what basis you suggest that the conduct of your company and its representatives apparently in breach of the Corporations Act 2001 and/or terms of the Shareholders Agreement would be capable of being rectified.

1. I have referred to what was said in the letter about Mr Cowan because although that alleged breach is not pressed (Mr Cowan was not made bankrupt until after the entry of OOHS into the Shareholders Agreement), Mr McNally draws attention to the fact that in the letter that breach was stated to be not capable of rectification but the alleged Convertible Notes breach was not so described.

1. The first paragraph set out in [19] is rather odd (Mr McNally described it as disingenuous) because it reads as if OOHS has had no knowledge of the issue of the Convertible Notes, and as if OOHS is complaining about the entire process when it is clear beyond doubt that Mr McAlpine and Mr Bamford approved of the use of Convertible Notes, that Mr McAlpine was aware of the proposed form of the Convertible Notes Agreement and aware of the amount of the Notes that were to be issued, that they had been issued and the precise form of the Convertible Notes Agreement after they had been issued.

1. Mr Johnson, responding to the rather obvious points of weakness in the letter, articulated the complaint as being that Mr McAlpine and Mr Bamford had approved the use of Convertible Notes which, when issued, would give the noteholders 8% of the share capital in OCS not some considerably higher percentage. He explained OOHS's case as being that Mr Bowers and Mr Feragher as nominees of CCS were clearly acting on behalf of CCS and that what they did by issuing Notes without altering the share structure brought about a complete dilution of OOHS's interest in OCS and had a fundamental effect on OOHS's investment. Mr Johnson accepted that the result was the same for CCS but he contended that it did not matter. CCS, he said, had produced the result inimical to OOHS and that must be regarded as "material or fundamental default or breach" of CCS obligations under the Shareholder Agreement.

1. There are essentially four flaws in the argument advanced on behalf of OOHS. The first is that at the meeting of directors of April 2010 it is clear that OCS had, with the approval of all of the board of OCS including Mr McAlpine and Mr Bamford, decided to embark on the raising of capital (up to $200K) through Mr Cowan. Whatever Mr Bowers, Mr Farragher and Mr Cowan did was directed to that end. Mr Bowers and Mr Farragher in organising the Convertible Notes Subscription Agreements, the Information Memorandum and procuring the noteholders were clearly acting as directors of OCS and the steps taken were not undertaken for or on behalf of CCS. Any detriment suffered by OOHS by reason of the issue of Convertible Notes was equally suffered by CCS and hence it cannot be said that CCS procured the directors appointed by it to act to the benefit of CCS in contrast to the interests of OOHS. I would add that no authority was cited for the proposition that a company which nominates directors to the board of another company (not uncommon in the case of joint venture style companies: see Ford's Principles of Corporations Law, 9.420, Lexis Nexis Butterworths Looseleaf Service) is liable for the acts of that director, merely because he or she is the nominee of that other company; indeed there is authority to the contrary: Kuwait Asia Bank EC v National Mutual Life Nominees Ltd [1991] 1 AC 187, pp 222-223.

1. In short, whilst there have been serious shortcomings in the manner in which OCS has been conducted for which all of the directors must take responsibility I am unable to accept that whatever errors have occurred can be ascribed to CCS or involve a breach by it of its obligations under the Shareholders Agreement.

1. The second flaw is that the failure to restructure the share capital of OCS is a failure by all the directors of OCS and not simply those appointed by CCS. Neither Mr McAlpine or Mr Bamford called for board meeting or a meeting of shareholders to seek and approve the change to the structure that the April meeting had contemplated and of which by June 2010, Mr McAlpine was clearly was aware was required. Indeed, Mr McAlpine and Mr Bamford refused to even attend a meeting of directors called in February for 2 March 2012 (on another issue) saying on 8 March 2012 that it was inappropriate to hold a meeting due to the dispute: see Mr Taylor's affidavit, paras 21 to 27, tab 14, Exhibit A.

1. If the problem with the Convertible Notes was that no resolution of OCS had been passed expanding the capital to 3.5M shares, as Mr McAlpine thought was required (see pp 62-63, Tab 8 Exhibit A), then the default, if it was a default of CCS contrary to the conclusion to which I have come, was one capable of rectification at least with the participation of the directors appointed by OOHS.

1. I should add that there appears to be yet another problem with OOHS's case which was not the subject of submissions - namely only 20,000 shares in OCS have ever been issued. If before 30 June 2013 the investors exercise their rights to take up 135, 000 shares, to which they are collectively entitled, there are no shares to grant to them. Although that reality may give the noteholders remedies there has not to date been a dilution and it is not clear that there will be in fact any dilution of shares.

1. The third problem is closely linked to the second is that it has not been established by OOHS that the default, if there was one, cannot be rectified even now.

1. The fourth problem is that the notice issued did not assert that the issue of the Convertible Notes was not rectifiable. In Haulage Management Services v Towns Haulage (Manson) Pty Ltd (BC9801764, 4 July 1998, unreported, Supreme Court of Victoria, Kellam J) Kellam J said of a notice clause in a haulage contract:

...it is clear that the purpose of a notice such as that served in this case is to protect the recipient against the consequence of default (in this case termination of the agreement et al) without being informed of the default and without being given an opportunity to remedy it.

Mr McNally contended (and Mr Johnson did not dispute) that cases dealing with statutory requirement for notice (for example s 129 of the Conveyancing Act 1919 (NSW)) are relevant in the present context. These cases hold that for a notice to be valid it must "give the lessee an opportunity to remedy any alleged breaches" before the lessor exercises its legal rights of forfeiture and "a proper opportunity is not afforded unless the lessee is alerted to the particular breaches on which the lessor proposes to rely and what the lessor requires in order to bring about a position where termination would not occur" Macquarie International Health Clinic Pty Ltd v Sydney South West Area Health Service [2010] NSWCA 268, [308] - [309] and see [323] per Hodgson JA with whom Allsop P and Macfarlan JA agreed (emphasis added).

1. Clause 20 envisages two species of breach. The first is a breach that is not capable of rectification and the second is one that is capable of rectification. The party issuing the notice may consider that the breach is clearly within one category or the other. If the party issuing the notice considers that the breach is not capable of rectification, it is entitled to say so (as OOHS did in relation to the alleged breach relating to Mr Cowan's bankruptcy). If the party issuing the notice thinks that the breach is one capable of rectification, or may be, it is entitled to require rectification even if there is little practical possibility of it being rectified: see Burger King v Hungry Jacks [1999] NSWSC 1029 [248]-[256], [262], [264], [266] and [2001] NSWCA 187 [64] - [85] and see Waters Lane v Sweeney [2006] NSWSC 222 at [75]-[96], Waters Lane v Sweeney [2007] NSWCA 200 at [85]-[87].

1. If the breach relied on is in fact capable of rectification but the issuing party does not specify how the breach is to be rectified I think the notice is invalid. It must follow that if the notice asserts wrongly that the breach is one not capable of rectification and hence no steps for rectification are spelt out then the notice will be invalid for the same reason. The letter sent by OOHS invited CCS to state if CCS contended that the relevant breach could be remedied but did not assert that it was not remediable. I do not think such an invitation complies with the requirement for the party issuing the notice in respect of a remediable breach to specify what steps must be taken to cure the alleged breach.

Conclusion

1. It follows that, in my view, the notice issued by OOHS was not validly issued under clause 20 of the Shareholders Agreement and OOHS is not entitled to the software rights of OCS by virtue of clause 14. CCS is therefore entitled to the declarations sought by it paragraphs 3(a) and (b) of the Summons and the first defendant must to pay the CCS's costs of the proceedings.

**********

Amendments

19 July 2013 - Typographical error.

Amended paragraphs: 28

Decision last updated: 19 July 2013