Elberg v Fraval

IN THE SUPREME COURT OF VICTORIA

Not Restricted

AT MELBOURNE

COMMERCIAL AND EQUITY DIVISION

S CI 2008 05825

ALEX ELBERG	Plaintiff
v
SACHLAN FRAVAL	Defendant
And Between
SACHLAN FRAVAL	Plaintiff by Counterclaim
v
ALEX ELBERG	Defendant by Counterclaim

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JUDGE:	HABERSBERGER J
WHERE HELD:	MELBOURNE
DATE OF HEARING:	21, 22, 25-29 JULY; 3, 19 and 22 AUGUST 2011
DATE OF JUDGMENT:	14 AUGUST 2012
CASE MAY BE CITED AS:	ELBERG v FRAVAL
MEDIUM NEUTRAL CITATION:	[2012] VSC 342

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Contract – Whether agreement to transfer shares in first loan agreement conditional – Whether agreement to transfer shares in second loan agreement conditional – Whether second loan agreement varied – Assessment of value of shares not transferred – Whether agreement to pay extra $5,000 per day interest if loan not repaid on due date a penalty.

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APPEARANCES:	Counsel	Solicitors
For the Plaintiff	Mr GR McCormick	Goldsmiths
For the Defendant	Mr CWR Harrison SC with Mr S Metaxas	Tress Cox Lawyers

TABLE OF CONTENTS

Introduction......................................................................................................................................... 1

The Parties........................................................................................................................................... 2

The First Loan Agreement................................................................................................................ 2

The Second Loan Agreement........................................................................................................... 6

Was the Agreement to Pay the Extra $5,000 Interest Per Day Enforceable?.......................... 31

Was the Extra $5,000 Interest Per Day a Penalty?....................................................................... 32

The Selling of Mr Fraval’s ESI Shares......................................................................................... 41

The Amount of the $500,000 Loan Outstanding......................................................................... 44

Assessment of Quantum of Damages........................................................................................... 45

Final Orders....................................................................................................................................... 61

HIS HONOUR:

Introduction

This proceeding was brought in April 2008 by the plaintiff, Alex Elberg, alleging breach by the defendant, Sachlan Fraval, of two agreements between them pursuant to which Mr Fraval borrowed money from Mr Elberg. The plaintiff’s principal claim was for 6 million shares in a company called Computronics Holdings Limited (“Computronics”) in consideration for a loan of US $20,000 for one month, and a further 14 million shares in Computronics in part consideration for a loan of $500,000 for two months. Alternatively, Mr Elberg sought damages for Mr Fraval’s failure to transfer the 20 million Computronics shares to him. Mr Elberg also sought payment from Mr Fraval of what he said was the outstanding balance of the loan of $500,000 plus interest after the debt had been partly repaid by Mr Elberg selling shares in another company, Environmental Clean Technologies Limited (formerly Environmental Solutions International Limited) (“ESI”), which had been provided as security for the loan. At the time of issuing, Mr Elberg calculated that this amount was $36,000. His amended calculation had reduced this amount at the start of the trial to the sum of $29,783.

Mr Fraval denied that he was obliged to transfer any of the 20 million shares in Computronics to Mr Elberg. Further, Mr Fraval counterclaimed against Mr Elberg alleging that Mr Elberg owed him a substantial amount from the sale of the ESI shares because he had converted those shares by selling them when Mr Fraval was not in default and at prices higher than those for later sales which had been included in Mr Elberg’s calculation of the amount owing. Mr Fraval also disputed other parts of Mr Elberg’s calculation.

At various times during the interlocutory stage Mr Fraval had represented himself. Even apart from this difficulty, the pleadings were complicated by the many issues raised by the defendant. Some of these issues were struck out by order of the Court and others, such as whether the correct parties had been named, simply disappeared by the time of the trial. However, other issues were raised by the defendant for the first time at the trial, such as whether an agreement to pay an extra $5,000 per day interest in respect of the loan of $500,000 constituted a penalty and whether Mr Elberg could have sold 20 million shares in Computronics at the price he claimed, which disrupted the normal course of evidence. Costs orders were foreshadowed by me as the price of the defendant obtaining leave to raise these issues.

The Parties

Mr Elberg holds a bachelor of engineering degree from Monash University, although he has never practised as an engineer. He worked in various sales jobs before becoming in about 2003 a full time day trader in shares. A year or so later he incorporated a company, Fiori Pty Ltd (“Fiori”), through which he traded. Mr Elberg met Mr Fraval through an associate of the latter. Subsequently through Mr Fraval’s son, they became friendly as they both had a mutual interest in the stock market. This friendship survived some losses made by Mr Elberg following investments recommended by Mr Fraval.

Mr Fraval was a chartered accountant in the United Kingdom. After a rather chequered career in that country he emigrated to Australia. He worked on the financial side of a private family company involved in biometrics. He said that he first met Mr Elberg in about 1999. Mr Fraval had been a director of a number of mainly high technology based companies, advising on business development strategies. He was a non-executive director of ESI until July 2007 and was involved with a consortium of investors seeking to have Computronics, a company then in administration, re-listed on the Australian Stock Exchange (“the ASX”). Mr Fraval later became chairman of Computronics.

The First Loan Agreement

According to Mr Elberg, on 4 or 5 March 2007, Mr Fraval asked Mr Elberg to lend him US$20,000 urgently for a short term so that he could “secure … a desalination technology called Desal”. Mr Fraval agreed to give Mr Elberg 3 million shares and 6 million options in Computronics. The desalination technology and something else called polyoptics would be transferred into Computronics. Mr Fraval agreed to provide Mr Elberg with 126,000 shares in ESI as security for the loan, which could be realised in the event that the loan was not repaid in 30 days.

On 5 March 2007, Mr Elberg sent the following email to Mr Fraval:

Hi Sach,
Just confirming our DESAL arrangement:
1. I will transfer $20,000 USD to the account you have nominated.
2.For the funds transferred you will issue me with 3 mill shares and 6 mill options in an entity which will inherit desal and polyoptics.
3.The time frame to market you indicated is approx 1 month so we will use 5 April as the date.
4.If we are unable to meet that time frame or there are problems with desal I will use your ESI stock as realisation for the funds I have advanced ie. $20,000 USD.

Please confirm your ok by return e-mail so I can affect the transfer.

Mr Elberg said that Mr Fraval accepted the terms of the agreement in a follow up telephone call from Mr Elberg. I will refer to this agreement as “the first loan agreement”.

Mr Fraval did not dispute this evidence, apart from saying that the agreement was that Mr Elberg’s entitlement to receive the shares and options in Computronics was conditional on Computronics or some other entity “inheriting” the Desal and polyoptics technology. Mr Fraval said that this was how he read Mr Elberg’s email of 5 March 2007.

Mr Elberg borrowed the funds lent to Mr Fraval from his mother’s company, L Elberg Pty Ltd. That company’s bank statement showed the amount of $25,816.45 being debited to its account on 5 March 2007 as a result of an overseas telegraphic transfer.

Mr Elberg said that, in early April 2007, he spoke to Mr Fraval by telephone. Mr Elberg advised Mr Fraval that he was going to sell the 126,000 ESI shares “to realise the loan”. He had been provided with a signed off-market transfer form for the 126,000 shares. Mr Fraval raised no objection. Mr Elberg said that Mr Fraval sought a loan of a further US$25,000 which he rejected. But they did agree to vary the price payable to Mr Elberg for the loan to 6 million shares in Computronics and no options. Mr Fraval said that it was also agreed at this time that “polyoptics was no longer part of the picture”.

Following this discussion, on 3 April 2007, Mr Fraval sent the following email to Mr Elberg:

Hi Alex,
Attached as agreed.

The relevant part of attached document read:
Alex
Computronics Ltd (in Administration)
2^nd April 2007
Set out below is both the revised agreement in relation to the transfer made by you as well as the proposal for a further US$25,000 transfer this week.

Investment amount US$ 20,000

Shares Allocated in successful bid for Computronics Ltd the target company for the desalination technology
6,000,000

Proposal

Investment amount US$ 25,000

Shares Allocated in successful bid for Computronics Ltd the target company for the desalination technology
5,000,000

In the event that the bid for Computronics is unsuccessful then the rights will transfer to a proportional allocation in another listed vehicle.
Negotiation is under way with Ben Sia to input $5m into the relisting of Computronics and then acquire a further 144m shares. In giving these half of your allocation would be sold and the proceeds loaned to you at 25 cents per share.

Mr Elberg said that he again declined to lend the further US$25,000. He gave evidence that the reference to “the rights” transferring if the bid for Computronics was unsuccessful referred to their agreement that if that occurred he would receive a proportional allocation in another listed vehicle.

Mr Elberg sold the 126,000 ESI shares which had been provided as security for the loan of US$20,000. He could not recall the exact amount realised, but some time later he paid $5,000 to Mr Fraval for his daughter when she was going overseas, which he understood Mr Fraval accepted as satisfying the requirement to repay any surplus from the sale of the ESI shares. But Mr Elberg did not receive the 6 million shares in Computronics from Mr Fraval when it was successfully re-listed on the ASX in January 2008.

Mr Fraval agreed that Mr Elberg had paid him the $5,000 when his daughter was going overseas. He said that he accepted that payment as the end of the deal in question. Mr Fraval said that no entity associated with him had ever received the world marketing rights to the desalination technology and therefore that he was not in breach for not transferring the 6 million Computronics shares because Mr Elberg’s entitlement to the shares depended on the rights being successfully obtained.

This claim became the sole issue for determination in respect of the first loan agreement. I do not accept Mr Fraval’s defence. It would involve acceptance of the proposition that Mr Elberg agreed to lend US$20,000 for a month with the only reward for him being the chance of receiving the 6 million Computronics shares if it was successful in obtaining the rights to the Desal technology. In my opinion, the natural meaning of the two emails in question does not support Mr Fraval’s construction. Mr Elberg’s entitlement to the 6 million Computronics shares was the price Mr Fraval agreed to pay for the loan of US$20,000. It was not conditional on Computronics or some other company obtaining the rights to the Desal technology. The consideration does appear to be steep for a loan of only one month. But as will be seen in respect of the loan of $500,000 Mr Fraval was quite prepared to agree to extraordinary rates of interest when he desperately needed money to close out what he saw as a financially advantageous deal for him. Moreover, Mr Fraval knew that if Computronics was re-listed, he along with the other investors involved in the consortium would almost certainly be receiving millions of shares at a cost of one-tenth of a cent per share, which meant that he would be paying $6,000 as the price for the loan from Mr Elberg. Finally, although numerous emails were subsequently exchanged between Mr Fraval and Mr Elberg containing references to Computronics shares, Mr Fraval never mentioned this alleged condition.

I, therefore, find that, subject to any further agreement about the 6 million shares as part of the agreement by Mr Elberg to lend $500,000 to Mr Fraval, Mr Elberg was entitled to receive 6 million Computronics shares from Mr Fraval or damages for his failure to transfer such shares.

The Second Loan Agreement

In July 2007, Mr Fraval rang Mr Elberg to ask for a loan of $500,000 to pay to the administrators of Computronics to obtain an extension of time within which to finalise the negotiations for the purchase of that company.

Mr Elberg sent the following email to Mr Fraval on 25 July 2007:

Hi Sach,
As discussed here are the terms of the loan requested:
1. The Loan amount being $500,000 AUD.
2.The interest component is $100,000 dollars for the first month or any of that month and $3,500 per day for the next month.

3. The term not to exceed 2 months from start date.
4. The start date is the date the money leaves my account.
5.The collateral provided will be 3 million ESI shares and 6 million ESI options. The options will be converted into shares by payment of $60,000 AUD which will attract interest of $12,000 per month or any part of the 1st months and $1,000 per day thereafter if required. The start date for this loan will be the date the money leaves my account. All shares will be transferred to Fiori P/L.
7.If the loan amount reaches 70% of original collateral (i.e. $700,000 AUD) I will begin to liquidate ESI stock to payout the loan plus any interest owing.
8.Closing date of the loan is the date all the funds have been received into my account.
9.Any residual stock will transferred [sic] back to you or your nominated entity.

If you are happy with the terms and would like to proceed, could you please acknowledge by return e-mail, and organise signed transfer forms for me by tomorrow.

Mr Fraval replied by email on 26 July 2007 agreeing to the terms set out in Mr Elberg’s email.

Mr Elberg said that there were further conversations in the next few days. He raised with Mr Fraval that he “wanted more Computronics shares than the 6 million already allocated for providing the [first] loan”. He sought 40 million but Mr Fraval did not agree. Mr Fraval disputed that Mr Elberg asked him for 40 million shares.

A general meeting of Computronics was held on 26 July 2007. The notice of that meeting, dated 14 June 2007, set out the proposal by the consortium of investors for the restructuring and recapitalisation of that company. Relevantly it was proposed that:

(a) the existing capital be consolidated on a one for four basis;
(b)262 million shares be allotted at an issue price of one-tenth of a cent per share to raise $262,000;
(c)20 million shares be allotted at an issue price of 25 cents per share to raise $5 million;
(d)20 million options be allotted to be exercised within four years at 1 cent each; and
(e)from the above funds $2 million be paid to the creditors of the company and 4 million shares be allotted to them at a nominal issue price of 25 cents per share.

The 262 million shares were to be shared between the members of the consortium of investors. It was proposed that Mr Fraval would receive 40 million shares at one-tenth of a cent per share and that 42 million shares would remain unallocated. Mr Elberg said that he did not recall seeing the notice of meeting on the website at the time, but agreed that he knew about the 42 million unallocated shares. He said that he was seeking the unallocated shares not the shares to be allotted to Mr Fraval.

On 29 July 2007, Mr Fraval went to Mr Elberg’s house to finalise the loan. Mr Elberg said that first he tried to talk Mr Fraval out of the loan because he thought it was “incredibly risky” for Mr Fraval as the $500,000 would be lost if he could not raise the rest of the purchase price. But Mr Fraval was adamant that he had everything under control. They then negotiated “quite aggressively” about the Computronics shares and eventually settled on 20 million.

Mr Fraval agreed that Mr Elberg “went to great lengths” to tell him not to take the loan. However, he told Mr Elberg that he wanted to go ahead. He said in evidence in chief that he had his “eyes wide open” when he agreed to do this transaction. Mr Fraval also said that it was briefly discussed that Mr Elberg would be entitled to 14 million further shares in Computronics “in addition to the 6 million which was part of a separate agreement”.

Mr Elberg said that a written agreement was prepared with the assistance of his wife. He said that originally a printed version had the Computronics shares included in it, but this was deleted at Mr Fraval’s insistence. It was to be a separate agreement which Mr Fraval would confirm by email. Mr Elberg said that Mr Fraval explained that he did not want the Computronics shares mentioned in the written loan agreement because he did not yet control Computronics. Mr Elberg also said that the original agreement about the further 14 million shares was not “conditional upon anything”. There was no discussion at his house about him being involved in a capital raising.

Mr Elberg’s wife, Milliana Elberg, gave evidence that on 29 July 2007 when Mr Fraval came to their house, she “transcribed” into a loan agreement the contents of her husband’s email of 25 July 2007. She had previously emailed to herself at home a precedent loan agreement which she had obtained from the firm of solicitors for whom she worked as a family lawyer. Mrs Elberg said that her husband “pleaded” with Mr Fraval not “to take the deal”. She said that she heard Mr Elberg and Mr Fraval negotiating about the number of Computronics shares. They agreed on 20 million. There were no conditions concerning the shares. Mrs Elberg said that the first version of the agreement she typed contained another recital relating to the 20 million Computronics shares. Her husband had dictated this recital to her. She continued:

I printed the first version of the agreement, and Alex handed it to Mr Fraval, and Mr Fraval asked him to delete the recital including the 20 million shares. [So] I deleted it from the agreement. … And reprinted this final version of the agreement. …

Mrs Elberg also said that Mr Fraval assured her husband that he would confirm the agreement about the 20 million Computronics shares by email rather than putting it into the written agreement. She said that the reason given by Mr Fraval was that:
He couldn’t put it in the agreement because he hadn’t secured the company yet.

Mr Fraval denied that he had been shown a printed version of the agreement containing a reference to Mr Elberg receiving 20 million Computronics shares. He said that the discussion about this topic was “almost non existent” and he simply said that he would contact Mr Elberg about it in the evening. Mr Fraval further said, in answer to a question from me, that the reason why he wanted the agreement about the Computronics shares removed from the written loan agreement was because “they stood separately and on their own”. One was a loan agreement and the other was for a potential reward subject to Mr Elberg “providing some benefit to the company”.

I prefer the evidence of Mr and Mrs Elberg on this point to that of Mr Fraval. Having reached agreement on the 20 million Computronics shares, it seems logical to me that Mr Elberg would have asked his wife to add in a recital concerning that topic. The fact that Mr Fraval apparently did not object when that request was made but only when he read the printed version could be explained by Mr Fraval’s hearing difficulties. However, nothing turns on this factual dispute. Part of the initial consideration for the promise to transfer more Computronics shares was Mr Elberg’s agreement to lend Mr Fraval $500,000. Whether the parties made one agreement or two agreements, being the main agreement and a collateral agreement, the result is the same.

What I will refer to as “the second loan agreement” was signed on 29 July 2007 by Mr Elberg and Mr Fraval at Mr Elberg’s house. Recitals A to J were as follows:

A.The lender is willing to enter into an agreement with the borrower subject to and in accordance with the terms of this agreement dated the date set forth in the schedule between the lender and the borrower.

B. The lender will loan to the borrower $500,000.00 Australian dollars.
C.The interest component is $100,000.00 Australian dollars for the first month or any of that month and $3,500.00 Australian dollars per day for the next month.
D.The repayment term of the loan not to exceed two months from the 30^th day of July 2007.
E.The borrower to provide collateral of 3 million ESI shares and 6 million ESI options. The options will be converted into shares by payment of $60,000.00 Australian dollars which will attract interest of $12,000.00 Australian dollars per month or any part of the first month and $1,000.00 Australian dollars per day thereafter up to a maximum term of two (2) months.
F.The lender at liberty to transfer all shares and options held as collateral to Fiori Pty Ltd.
G.The lender be at liberty to liquidate stock upon the loan amount reaching $700,000.00 Australian dollars or the value of the ESI shares and options provided as collateral being valued less than 70% of the loan at a specified time.
H.The closing date of the loan is the date that all funds owing including but not limited to interest have been received in the lender’s nominated bank account.
I.The lender will only sell the ESI shares and options required to cover the amount of the loan. Any residual ESI shares and options will be returned to the borrower.
J.The borrower personally guarantees the repayment of the loan in full. If the borrower fails to repay the loan as specified in this agreement, the lender be at liberty to enforce this agreement against any personal and/or joint assets of the borrower.

The parties agreed that Recital G was not correctly expressed. What they intended was that the lender could sell the shares if the loan amount exceeded 70% of the current value of the security provided by the ESI shares (“the loan valuation ratio” or “LVR”). At that time an LVR of 70% represented approximately $700,000. An application during the hearing by Mr Elberg to amend his statement of claim to include a claim for rectification was not opposed by Mr Fraval. Accordingly, there will be an order rectifying the second loan agreement in the form sought by the plaintiff.

Later on 29 July 2007, Mr Fraval sent the following email to Mr Elberg:

Hi Alex,
This is to confirm agreement to allocate a further 14m shares in Computronics to you making a total of 20m subject to:
a)The successful completion of the Computronics shell to our group.
b)Your ongoing support both in the capital raising with your network in the sell down in part or whole of the $5m placement underwritten by Virtual Capital.

Mr Elberg said that he rang Mr Fraval after receiving this email to ask him what he meant by the part (b). He said that Mr Fraval said that:

… he needed to put something down to explain to his counter parties of what I’m actually doing to assist them, and he explained that my role would be very similar, to be able to talk to brokers, talk to other traders to get them involved in the stock, once the stock lists.

Mr Elberg said that he was “happy to do that”. At one stage in his evidence he said that these conditions became part of the agreement but then he said that the reference to him giving “ongoing support” was:

a by the by. It was an opportunity to introduce Mr Fraval to potential investors. … I will introduce people to the stock, I’ll introduce Mr Fraval to potential brokers, and I’ll introduce him to the people who invest, but it wasn’t conditional upon that. … I was going to get the 14 million, I was happy to help. That was over and above type of thing. I was going to do that anyway.

I do not accept Mr Elberg’s evidence on this point. It seems to me to be clear that he agreed to vary the initial collateral agreement by making his entitlement to receive the Computronics shares subject to satisfaction of Mr Fraval’s two conditions. Further, I agree with Mr Fraval’s evidence that the conditions in his email of 29 July 2007 related only to the further 14 million shares. As he said, the 6 million shares had been “dealt with previously”.

Signed transfer forms were given to Mr Elberg. The shares were transferred by a company called Research and Development Consulting Services Pty Ltd, which was controlled by a Dr Ian Bennett, and by a company called Hadrian Fraval Nominees Pty Ltd, which was controlled by Mr Fraval’s brother, Hadrian Fraval. Both Dr Bennett and Mr Hadrian Fraval were members of the consortium of investors seeking to obtain the “back door” listing of Computronics.

Having been told the relevant SRNs for the companies making the ESI shares available as security, Mr Elberg’s broker was able on the following day to ascertain the exact number of shares and options. There was a total of 3,750,000 shares and 5,477,857 options. This change in the security was, not surprisingly, satisfactory to Mr Elberg. These shares and options were transferred into the name of Fiori. In an attempt to simplify matters I will refer hereafter to these shares and options as “Mr Fraval’s ESI shares” even though they were made available as security by the two companies mentioned above and not by Mr Fraval.

It was common ground that Mr Elberg could only sell Mr Fraval’s ESI shares if Mr Fraval was in default under the second loan agreement. It was also common ground that there was no agreement that Mr Elberg would not trade in his own or Fiori’s ESI shares during the term of the loan.

Mr Elberg arranged to extend the mortgage on his house to the tune of $300,000. He borrowed another $250,000 from a Mr Khan but Mr Elberg then repaid $50,000 to a Mr Faldi Ismail, an associate of Mr Khan, which had previously been advanced to the administrators. Mr Elberg said that he agreed to borrow the net $200,000 from Mr Khan at an interest rate similar to that which he was charging Mr Fraval, that is without any return to him on that portion, because of the potential significant upside of the deal. He thought that the 20 million shares in Computronics would be worth between $4 and $5 million, based on the issue price of 25 cents a share for investors then being proposed in the initial capital raising. The $500,000 was paid directly to the administrators.

Mr Fraval said in evidence in chief that he spoke to Mr Elberg a “couple of days” after his email of 29 July 2007. He said that it was discussed that the 6 million shares were still subject to the previous agreement they had that the entitlement to the shares depended on the successful acquisition of the “Desal” technology. Mr Fraval said that they also discussed his requirement that Mr Elberg, with his network, help in the process of raising the $5 million at 25 cents per share. He said that Mr Elberg said that there was no way that he or anybody associated with him would pay 25 cents a share. Mr Fraval also said that Mr Elberg “was trying to globalise the 6 million and the 14 million” and so he told Mr Elberg that “there were two separate agreements within the 20 million which had their own agreements”. Mr Elberg said that he did not recall any such conversation and I do not accept that it occurred.

On 14 August 2007, ESI shares traded at 10.5 cents per share. Mr Elberg then sent the following email to Mr Fraval:

Hi mate,
We have just hit the critical 70% level on the stock you have provided as collateral.
I am sorry, but I need to start liquidating to cover the 700,000 AUD liability. I am happy to hold of [sic] for 1 day if you deposit 100,000 AUD into my account by close of business tomorrow to reduce liability and hence it will give us room until about 9.5c when the critical level will come into play again.

Mr Elberg agreed, however, in evidence in chief that he had done the calculation incorrectly and that there had been no breach by Mr Fraval because he had incorrectly used the figure of $700,000 for the principal rather than $600,000.

One of the issues in final submissions was the amount of Mr Fraval’s debt from time to time. It is appropriate to consider this question at this stage. Counsel for Mr Fraval submitted that Mr Fraval’s debt remained at $500,000 and did not increase to $600,000 until the end of August 2007 because the loan was not repayable until the end of the following month. I do not agree. It seems to me clear that the debt increased to $600,000 on the first day of the loan because the agreement was that interest of $100,000 was payable “for the first month or any of that month”. Thereafter, throughout the month of August Mr Fraval’s debt stood at $600,000.

Calculations using the lowest recorded price for ESI shares on a particular day were prepared by the defendant and accepted by the plaintiff (exhibit 15). They showed that, according to this calculation which was based on a debt of $600,000, the LVR on 14 August 2007 was 65.6%. However, two days later when the ESI share price dropped in one trade to 9.1 cents per share, the LVR was 76.4%. This was the only occasion when the LVR exceeded 70% during the two month term of the loan. The closing price on 16 August 2007 was 11 cents per share. Whether it was correct to use the lowest share price for the day no matter how few shares were sold at that price or that the price had increased by the end of the day is a question I do not need to decide for reasons I will set out in due course.

Mr Elberg said that under the second loan agreement once there was a breach he was entitled to sell Mr Fraval’s ESI shares until the debt was repaid in full, even if by selling some shares and reducing the debt, or by the price of the shares increasing, the LVR again went below 70%. As Mr Elberg said:

One day, one below, all bets are off.

The contrary argument was that the wording of the loan agreement indicated that the parties contemplated that sufficient of the shares would be “liquidated” to bring the LVR back below 70% or that the same result would be achieved by extra security being provided or the price of the shares rising and that if this could be achieved the loan was to continue for the remainder of the term and not be brought to an end by one possibly fleeting default. However, I do not need to decide whether Mr Elberg’s construction of the agreement was correct, because, as he pointed out, he had not acted on the initial breach. He also said that, in any event, in both of the suggested scenarios he would have contacted Mr Fraval first before selling any of Mr Fraval’s ESI shares.

Mr Fraval did not take issue, at that time, with Mr Elberg’s allegation that the 70% LVR had been exceeded on 14 August 2007. Discussions followed in the next few days between Mr Elberg and Mr Fraval. On 16 August 2007, Mr Elberg sent the following email to Mr Fraval:

Sachlan,
I have sent you an e-mail 14^th of August, requesting additional collateral to be offered due to the value of ESI stock deteriorating below the agreed 70% value. To date I have not formally heard back from you on this matter. We have spoken on the phone and you committed to me that you will provide me with something concrete from Westpac Bank draw down facility by last night, but nothing has been delivered.
If you have not produced additional collateral by mid-day today, I will be forced to execute the liquidation of ESI stock I hold as collateral and any short fall will become your personal liability as per the documentation signed by you on the 29^th July 2007.
Please treat this e-mail with outmost urgency as this is the final warning.
Regards,
Alex Elberg.

Mr Fraval responded by email less than an hour later as follows:

Alex
When you start your agreement with a threat or deadline you put my back up rather than find a resolution to the problem. I do not do the same to you when you do not meet your obligations – the Hadrian 1m shares is an example.
By the way legally if alternate proposals are made for such things as collateral you are LEGALLY obliged to look at the collateral alternative otherwise it is regarded as reckless. You also have a personal guarantee – does that mean you can enforce that BEFORE a default occurs.
I am not going to give you some half baked document just to support my case. Collateral can be put in place.
Sachlan.

This elicited a very quick answer from Mr Elberg:

Sachlan,
I am willing to work with you to resolve this situation of collateral, however you have not provided me with any alternatives which can be considered as security. I appreciate that your personal guarantees are in place but that I would hope that would be the last resort, and all I am trying to do is prevent your position being liquidated.
I look forward to receiving the Shepparton land information you suggested on the phone which may provide additional collateral required.
Regards,
Alex Elberg.

One of the proposals put forward by Mr Fraval was that a company would give a fixed and floating charge. It held 40 units in a development at Shepparton. Another proposal was that Mr Fraval would assign $200,000 from a loan of $3.55 million he was negotiating with BankWest to reduce the debt owed to Mr Elberg. The details of that offer were sent by Mr Fraval by email at 2.59 pm on 16 August 2007. It read:

Alex,
Attached is the BankWest offer letter. I hereby offer under the personal guarantee that [sic]
I have already signed the sum of $200,000 from proceeds of the drawdown from BankWest.
This amount to be in reduction of the trigger mechanism for the sale of ESI shares which should now be reduced to 5 cents per share. If the price nears these levels please give me notice and I will seek to further replace this side as I do not want a forced sale on these shares.

Mr Elberg replied at 3.42 pm on the same day:

Sachlan,
I have discussed your offer with the relevant parties and have explained to them that you have a draw down facility in place with Westpac bank, which will be used to pay Computronics administrators 1.5 mil tomorrow in a way of a bank guarantee. The total draw down facility indicated by you is for 3.3 mil AUD. You will then use the balance of the facility to repay the loan as the funds will be made available to you on 31^st of August.
As a good will gesture they are prepared to wait till close of business tomorrow for that to occur and to demonstrate that that facility actually exists and will be used to repay the loan.
They would also like your agreement, so that there are no miss understandings [sic], that should that transaction not occur no further extensions will be granted and I will call in the loan.
I would also like for you to confirm that my allocation in Computronics of 20mil fully paid shares at zero cost to me is unconditional and you will not put any escrow conditions around it.
I have bent over backwards for you on this one mate and was extremely disappointed with your comments earlier. I know you are under the pump, so I will just let it go.
I await your urgent response.

Mr Elberg explained that he referred to discussions with other parties because he had “represented” to Mr Fraval that he had raised the $500,000 from “third parties”. In my opinion, nothing turns on this misrepresentation about the source of the funds.

Mr Elberg said that he mentioned the 20 million Computronics shares because he was concerned about the defensive tone of Mr Fraval’s preceding emails. When asked about this reference to the Computronics shares, Mr Fraval said that he agreed that there were no “escrow conditions” but said that he never agreed to give Mr Elberg 20 million shares unconditionally. He said that there were other conditions “attached to both the 6 million and the … 14 million so there was never agreement”. Mr Fraval said that Mr Elberg would have had to pay at least one-tenth of a cent per share because that was what had been paid for them. His evidence suggested that he told Mr Elberg this in their negotiations.

I have concluded that this attempt by Mr Elberg to vary the terms on which he was entitled to receive the further 14 million Computronics shares by making his entitlement unconditional was not accepted by Mr Fraval. Moreover, Mr Fraval was now wanting payment of one-tenth of a cent per share not “zero cost”. However, as previously stated, I do not agree that the 6 million shares were subject to the alleged condition about successfully obtaining the Desal rights.

Following the provision of further information by Mr Fraval about the financing of the purchase of the Computronics company, Mr Elberg sent the following email to him on 20 August 2007:

Hi Sachlan,
Thank you for the update. I have discussed the attached with my parties and they are satisfied that there is or will be a facility in place to secure their loan and Computronics. They have no problem in extending the time line till Friday 24^th Aug 5 pm.
If you could please address the matter of 20 mil Computronics share allocation at a .001c cost to me and confirm your agreement in writing via return e-mail, I would greatly appreciated [sic]. As discussed on the phone I am happy to provide you with the first right of purchase on any of that stock should I consider selling.

Mr Elberg said that what he meant to say in the email was a cost to him of one-tenth of a cent per share. Mr Elberg agreed that in this email he was claiming that he was entitled to 20 million shares at one-tenth of a cent and that this was a change from the existing agreements pursuant to which he was to get the shares for free. He said that he had to accept Mr Fraval’s assertion that he pay one-tenth of a cent per share:

I could start an email warfare but I’d rather get something rather than nothing, and end up in court, sir.

Mr Fraval said that he did not recall the telephone conversation mentioned by Mr Elberg in his email or any discussion of a first right of purchase. Mr Fraval maintained that he “was consistent all the way through … that it was a cost of one-tenth of a cent if an allocation was made, and that it was conditional on certain things, 6 million and the 14 million”.

I accept that there was such a telephone conversation during which Mr Fraval stipulated that the 20 million shares would cost Mr Elberg one-tenth of a cent per share and that he had to agree to give Mr Fraval a first right of purchase should he consider selling. I read Mr Elberg’s email of 20 August 2007 as indicating that he was now agreeing to pay the price required by Mr Fraval, namely one-tenth of a cent per share for all 20 million shares, and that he also was agreeing with the new condition required by Mr Fraval, that Mr Elberg give him a first right of purchase. I consider that Mr Fraval clearly understood from the telephone conversation and the email that Mr Elberg meant one-tenth of a cent per share, which according to Mr Fraval was the price consistently demanded by him.

In my opinion, this exchange constituted a variation of the terms on which Mr Elberg was to receive both the 6 million and the 14 million shares in Computronics. He was to pay one-tenth of a cent for all 20 million shares, and he was to give Mr Fraval a first right of purchase. The condition about providing ongoing support in the capital raising was omitted. It was never mentioned again in the correspondence.

Mr Elberg sent a further email to Mr Fraval on 29 August 2007. Mr Fraval replied on 3 September 2007 by email, with his responses in capitals within Mr Elberg’s email:

Hi Sachlan,
Further to our telephone discussion of this morning. I shall agree to extend the time frame (until 14 September 2007) for you to provide documentation which clearly demonstrate that you have clear funds available to you for the repayment of the loan of $500,000 (plus interest) by no later than 30 September 2007. The extension of the timeframe is conditional upon the following:
1.        That you agree to the loan of $500,000 (plus interest) and all charges to be paid in full by no later that 30^th September 2007. THIS WAS ALREADY OUR AGREEMENT AND WE CONTINUE TO AGREE TO IT.
2.        In the event that any part of the loan remains outstanding past 30 September 2007, the daily penalty rate will be $5,000.00 per day which is in addition to the interest component of $3,750.00 previously agreed to.
AGREED
3.        You provide second mortgage documents on 324 Glenferrie Rd Apartments, (due for settlement by you and Rohana), to be used as an additional settlement source (security) for repayment of the total loan strictly within 7 days of the settlement date. THIS IS NOT ACCEPTABLE. I AM IN THE PROCESS OF CLEARING A NUMBER OF ITEMS WITH THIS INCLUDING COSTS RELATING TO ONE OF THE UNITS WHICH I AM PUTTING ON THE MARKET. I CANNOT HAVE MY HANDS TIED BY THIS.
4.        That you pay a minimum of $200,000.00 to me on the date of settlement of the 324 Glenferrie Rd apartments from the funds you obtain from Bank West for the purchase of 324 Glenferrie Rd. You instruct Mr Peter Purcell (your solicitor) forthwith to acknowledge your written instructions within 7 days to include me in the disbursement/adjustments schedule at settlement of 324 Glenferrie Rd apartments. Please forward to me a copy of Mr Purcell’s acknowledgment of instructions for my records. SEE 3 ABOVE.
5.        That you agree to allot the 20,000,000 Computronics shares to me as previously committed free of charge and unconditionally. WE AGREED THAT THIS WOULD BE ISSUED BUT THAT YOU AND I WOULD TREAT IT AS A SEPARATE AGREEMENT.
6.        In the event that more than half the loan amount remains outstanding past 30 September 2007, you agree to full liquidation of the 324 Glenferrie Rd apartments and full liquidation of any shares owned by you or your associated entities upon receipt of my written request for repayment of the loan of $500,000.00 plus penalty interest and costs strictly within 7 days of receipt of my written request. SEE 3 ABOVE – NOT [sic] ALSO THAT I AM SELLING ONE UNIT VERY QUICKLY AND YOU ARE AWARE OF BOTH THE MARKET AND THE VALUATION.
Kindly acknowledge forthwith that your [sic] amenable to the above terms and conditions.

Mr Elberg agreed in evidence in chief that the interest of $3,750 per day referred to in point 2 of the above email was $250 too much because he never funded the conversion of the options from his own pocket. In fact, recital E of the second loan agreement provided for a charge of $1,000 per day for the second month if Mr Elberg himself paid for the conversion of the options.

Mr Fraval said that when he verbally agreed to the extra interest of $5,000 per day he understood that it would reduce proportionately as any principal was paid back. That was what he understood by the words “interest rate”. However, just what was meant was not discussed with Mr Elberg. I cannot accept this attempt by Mr Fraval to construe this variation of the second loan agreement contrary to the plain meaning of both the relevant part of the original agreement and the agreed variation. The interest was to be charged at a flat daily rate of, first, $3,500 and, then, $8,500. There was no mention of any reduction in this charge if part of the principal had been repaid.

Although Mr Fraval stated that he verbally agreed to the increased interest payment, he denied that he inserted the word “AGREED” at the end of point 2 in the above document. He said that he left his response to that point blank. It was pointed out that the font of this answer appeared to be smaller than the font used in the rest of Mr Fraval’s responses. When the summary of Mr Fraval’s evidence to come was put to Mr Elberg, he said:

That is a false statement, sir. He did put that in, and that’s the email in the format that I received on my computer.

In these circumstances, both sides agreed that it was unnecessary for me to reach a conclusion, if such was possible, about who was telling the truth in respect of this factual dispute.

With respect to point 5, Mr Fraval said that he had not felt it necessary to go into further detail because that would have been in the separate agreement which reflected the terms or conditions concerning the 6 million and the 14 million Computronics shares. In his evidence, he maintained that the 6 million shares were still conditional on the desalination technology going into the public company and that the 14 million shares were still subject to Mr Elberg’s performance in helping to raise the $5 million at 25 cents. I have previously rejected this evidence.

Mr Elberg said that he regarded Mr Fraval’s response to point 5 as acceptance of Mr Elberg’s requirement that the 20 million shares be allotted “free of charge and unconditionally”.

Point 5 was, of course, a further attempt by Mr Elberg to vary the second loan agreement, whether or not it had been varied on 20 August 2007. The 20 million shares were only free of charge if there had been no variation on that day and at least 14 of the 20 million of the shares were at all times subject to a condition. Moreover, I do not agree with Mr Elberg that Mr Fraval’s response to point 5 meant that he was agreeing that the 20 million shares were to be allotted “free of charge and unconditionally”. Mr Fraval’s response, in my opinion, was deliberately non-committal. He simply stated that he had agreed that 20 million shares “would be issued” as part of “a separate agreement”. He did not say what the terms of that agreement were and he certainly did not say that he agreed that the shares would be allotted “free of charge and unconditionally”.

In my opinion, therefore, the terms of agreement about the 20 million Computronics shares remained as agreed by Mr Elberg and Mr Fraval on or about 20 August 2007, namely Mr Elberg to pay one-tenth of a cent per share and give Mr Fraval a first right of purchase.

Mr Elberg sent the following email to Mr Fraval on 20 September 2007:

Hi Sach,
This is just an agreed reminder that the loan amount is due and payable in full by 30 Sept 2007. If it is not repayed [sic] in full by that date, penalty interest will apply over and above to the accruing interest on the total loan, as agreed by you, and we will need to start liquidating the security, being ESI shares and options until the total amount is repaid.
If you have already made arrangements to repay the loan by the specified date, please let me know.

Mr Elberg said that, as agreed with Mr Fraval, he had sold a small amount of Mr Fraval’s ESI shares “at a very late stage in September” to have enough money to exercise the options should he need to do so. Mr Fraval said that that was “absolutely not correct”. He said that they never talked about trading those shares. I accept Mr Elberg’s evidence on this point.

Mr Elberg repaid the net amount of $200,000 which he had borrowed from Mr Khan on the due date, 30 September 2007. This sum plus interest of $80,000 was paid to Mr Khan’s company, Kardwi Pharmaceuticals Pty Ltd.

However, the loan to Mr Fraval was not repaid on 30 September 2007. Accordingly, Mr Elberg sent Mr Fraval an email at 9.26 am on 3 October 2007. It read:

Hi Sach,
As you are aware the loan term ended 30^th September 2007, and it is now 3 days over due. The daily interest rate of $8,500 per day is applicable. My investors are getting extremely nervous and are applying pressure on me to liquidate your collateral position. I require a part payment of $200,000 no later than 5^th October 2007 to be deposited into my bank account, otherwise I will liquidate your position without any further correspondence. If in the event that the ESI stock sale does not payout the loan in its entirety plus interest I will be forced to pursue the balance via the personal guaranty [sic] you have signed.
Please treat this matter as most urgent.

Mr Elberg said that he then spoke to Mr Fraval who agreed that Mr Elberg could “slowly start selling off stock in small amounts because there was money coming in the short term and the loan would get paid out in full”.

Also on 3 October 2007, at 11.03 am Mr Fraval forwarded to Mr Elberg an indicative loan offer he had received. His email read:

Alex,
Attached is the loan offer I have received.
I have taken advice from Peter Purcell relating to the loan. His advice is:
·The document I signed at your house had no default terms in it and that legally the agreed rate is still in force even though you have written me an email saying what you wanted it to be.
·I seek to extend the loan at the same $100,000 rate for a further month to ensure that we have sufficient time even though I intend to close this within the next week.

Mr Elberg responded by email at 12.38 pm on the same day:

Sachlan,
You were made aware of the penalty rates via e-mail, and you agreed to them on your own accord. You have been given plenty of prior opportunity to clear this facility with in [sic] the specified period, but have chosen not to do so and hence putting yourself in this predicament.
I can not extend the loan for a further month at the same rate as the term of the loan was clearly spelled out as a maximum of 2 month from date of borrowing. The penalty rate of 8,500 per day will continue to be enforced until the total loan plus interest is cleared in full. I remind you that I have no obligation to you in keeping this facility open to provide you with additional time.
I also remind you of the 20,000,000 Computronics shares which are to be issued to myself or my nominated entity at zero consideration basis as per previous e-mail to you on that matter.

The email exchange continued an hour or two later. Mr Fraval replied:

Hi mate,
You know I am not trying to duck out of things but my legal advice is:
The document I signed is the agreement in place.
Anything you sent me by email is subsequent to the agreement and is one sided ie not signed or agreed by me. 20% a month is well above any normal rates out in the market and I doubt whether your lenders (or your father in law) have a licence anyway.
I have had many loans before and they can always be extended which is the cleanest way to proceed when you can clearly see the exit that I have provided by way of the indicative offer.
As you know the 20m shares is another matter and you have anyway agreed to 2 things in relation to them in the event that the allocation is completed.
·That they are not free or zero as you state but at one tenth cent as per the notice of meeting. So at very least there is $20,000 payable
·You have verbally agreed to set aside 10m which are the subject of convertible notes as you said “for the benefit of the company”.

Mr Fraval’s only explanation for why he did not mention in this email the condition which he said applied to the entitlement to the 6 million Computronics shares and the condition which he said applied to the entitlement to the 14 million Computronics shares was that he had said it “so many times” in the earlier correspondence.

With respect to the setting aside of 10 million shares, Mr Elberg said that he did agree to this with Mr Fraval. He explained:

Mr Fraval was endeavouring to raise money, and one of the ways of raising money is putting a convertible note in place where somebody is able to draw down on that convertible note into shares by providing the company money. That provides capital for the company and is able to convert on the stock.

With respect to the cost of the Computronics shares, Mr Elberg said in evidence in chief:

My understanding was, they were free of charge, then they went to .0001 of a cent, then they went to free of charge, then they went to .1 of a cent again. So every time I had an agreement on it, he reverted back in the next email with a change of price. Until in the previous email I asked him to confirm that they were free of charge and he did so for me. So my assumption was that they were now free of charge and the only obligation I had is to give him the first right of refusal on the sale of those shares.

By “the previous email”, Mr Elberg said he meant Mr Fraval’s capitalised response to point 5 of his email of 29 August 2007. This evidence by Mr Elberg is rather confused. If the agreement was as per point 5 of his email of 29 August 2007, then the 20 million shares were free of charge and unconditional. If the agreement was varied on or about 29 August 2007, then Mr Elberg was correct to say that his “only obligation” was to give Mr Fraval first right of purchase if he decided to sell the shares. But Mr Elberg agreed that there had been a further variation, namely that he would set aside 10 million of the 20 million shares for a convertible note. That had become his obligation in place of giving Mr Fraval first right of purchase.

There was yet another email exchange on 3 October 2007. Mr Elberg wrote to Mr Fraval and he replied with his responses in capitals within Mr Elberg’s email:

Hi mate,
I know you are not trying to duck out of things, and my legal advise [sic] states the following:
1. The contract you have entered into and signed ended 30^th Sept 2007.
2. You are in default of the contract that has now ended.
3.You have been clearly advised and you agreed to penalty rates over and above in an e-mail at least 2 weeks prior to the previous contract lapsing If you were unhappy with the terms you should have sourced alternative lending in time to clear your obligation under that contract. WHERE HAVE I AGREED TO PENALTY RATES – THERE WERE NONE IN THE DOC I SIGNED.
4.To date not 1c has been paid towards reducing your liability nor is there any money committed to do so. YOU REFUSED MY OFFER OF PAYMENT OF INTEREST. I AM COMMITTED.
5.The loan document you have attached addresses a potential clearance source of 700,000 AUD which is not sufficient to clear your debt any way.
6.As of end of today your debt is 725,500 and will increase by 8,500 tomorrow. I HAVE NOT AGREED TO THE PENALTY INTEREST. AS FAR AS I AM CONCERNED THE AMOUNT IS $3500 A DAY.

In regards to Computronics shares I will be happy to set aside 10m of those shares as part of the convertible note on the proviso that I get paid for them. YOU WILL IF THEY ARE CONVERTED.
Finally Sach, I remind you that it is you who came to me for help and asked for this money, and I specifically asked you not to go ahead as you were taking on enormous risk. You chose to ignore my advice and now we have to resort to this conversation.
I hope to find a speedy resolution to this problem ASAP as the problem is compounding daily.

Further discussions followed. On 12 October 2007, Mr Elberg sent the following email to Mr Fraval:

Sachlan,
After numerous requests you have not provide [sic] any time frame of how and when the loan will be paid out. As agreed earlier in the week you are to provide me with a firm timetable by 5 pm close of business today. If this does not occur or I am unsatisfied with the proposed time frames I will begin to liquidate ESI stock (your collateral) as of Monday 15^th October, without any further notice. Please note that the balance of your loan to date is $805,000 and is currently increasing at $8,750 per day. The currently [sic] value of the stock you have provided as collateral (3,500,000 shares and 5,500,000 options approx.) is $1,145,000 based on yesterdays closing price and taking into account that $55,000 is required to exercise the options prior to them being able to be sold on market. Should the sale of ESI stock and options not pay out the loan in full, we will be pursuing the outstanding balance via the personal guarantee you have signed.
Please treat is [sic] as FINAL NOTICE TO SETTLE.

Once again, the claimed interest figure of $8,750 per day was conceded by Mr Elberg to be $250 too much.

After more discussions and emails, Mr Elberg sent the following email to Mr Fraval on 12 October 2007:

Hi Sachlan,
As agreed on the phone we will grant 1 final extension for cleared funds to be transferred in to my account by Friday 17^th October 5pm as a sign of good will.

It was then clarified that Friday was 19 October, not 17 October. Although Mr Fraval denied that there had been any agreement about this further “indulgence” period, I accept that Mr Elberg’s email accurately stated the position.

Mr Elberg said that he sold the balance of Mr Fraval’s ESI shares in the period between 20 October and 14 November 2007 realising a net amount of $1,069,717. He said that in total he sold 10,327,857 ESI shares. After conversion of the options, the collateral provided by Mr Fraval was 9,227,857 shares. Mr Elberg explained why there were the additional shares sold. First, he said that there was an extra one million shares included because:

Mr Fraval advanced me some shares in previous history which I needed to return back to him, and I used those shares which were mine at the time to extinguish some of the loan so I applied it to the loan. So a million shares were over and above the collateral that was provided to me …

Secondly, he had subsequently realised that in doing his calculation of the amount of the loan outstanding he had incorrectly included the proceeds of sale from 100,000 shares which were his and not part of the security. I will return to the question of these 100,000 ESI shares when considering the amount of the $500,000 loan outstanding.

On 13 November 2007, Mr Elberg sent the following email to Mr Fraval:

Hi Sachlan,
Please find attached a total account of every transaction to date on the ESI stock which had to be liquidated to attempt to repay part of your loan obligation. As you are aware you are currently incurring $8,750 per day interest plus the interest component for the exercise of the options which was triggered on the 1^st of November 2007, where by you are obliged to pay an additional $12,000 for any part of the 1^st month the money remains outstanding. You will note that we are now in a situation where the sale of the stock alone no longer covers the loan commitments and your personal guarantee will be called in if you do not settle the loan in full by Friday 16^th November 5 pm.
As of today the number of shares remaining is 137,216 at a closing price value of 9.7c, which is approximately $13,310 without brokerage costs. Today’s loan liability is $40,929.42, as you will see from the spreadsheet attached. Taking into account additional interest by Friday and assuming the sale of the remaining stock at 9.7c tomorrow, you will require $53,869.42 to pay out the loan.
Please make arrangements urgently to deposit clear funds into my bank account as I would like to complete this transaction without any further losses being incurred by you.

Mr Elberg agreed that the amount outstanding was not correct because he had used the figure of $8,750 per day.

Mr Fraval responded by email on 14 November 2007. It read:

Alex
I have shown below yours an amended calculation which does what all normal loans do – reduces the principal when repayments are made. I have taken the $100,000 per month interest rate of 171% on the reducing balance and have taken the default amount apportioned to the outstanding balance. (I am not at this stage dealing with the legality of

a) you as the borrower on behalf of some unnamed third parties
b)your legal right to charge any default rate that comes into your head and get me under coercion to agree to it
c)whether as an unlicenced lender you have the right to charge 171% interest and up to 600%
d)whether you have the right not to recognise repayments of the principal).

I hereby make formal demand for the transfer of the balance per the attached amended schedule to $164,262 together with a transfer of 137,216 shares from Fiori to RDCS.

Mr Elberg replied by email on the same day, and Mr Fraval sent his answer shortly afterwards in bold type within Mr Elberg’s email:

Sachlan,
I am extremely disappointed by your e-mail, especially when you are the one who asked for the facility. I have sold remainder of the stock you have provided as collateral today as I indicated I would. That leaves the balance of approximately $36k outstanding. Your basis of calculation is “cowboy”. Please review with a professional lender in relation to where repayments of principal of a loan are made and the calculation of the interest on the diminishing balance. The default rate has also to be calculated on a diminishing balance basis.
I will now leave it in my investor’s [sic] hands whether they want to pursue the balance from you via the personal guarantee signed. I would encourage you to make every effort to bring this to its completion as this has the potential to ruin the relationship we have built up over the years. Since all our previous dealings have been with Michael and the onerous documents were drawn up by Liliana go and calmly revisit my professional calculation of already usurious rates. Under your calculations if $1 was outstanding you would be entitled to charge $8750 the next day. I don’t know any judge or lawyer or even hardnosed mafia would not see the reasonableness of reducing the balance by payments and be satisfied by with [sic] my not challenging the extortionate rate. I believe I have stuck with the terms of a very unfavourable agreement.
I also put you on notice that I will be perusing (do you mean pursuing) all of my 20,000,000 Computronics shares as agreed and I am no longer (be) willing to consider you using any of them as a presold parcel to attract financial investors into Computronics. I don’t think this is your call. I have paid for the allocated shares which are being held in trust and as you know the deal has changed considerably. Note changes to the deal in NSL where you were on the other side of the fence meant that people don’t get what was originally proposed. We DO NOT have a binding contract with no account for change.
Ask yourself how I could do business with someone who looks after his own interest to the detriment of the party he is dealing with. I am still seeking full accounting on ALL our previous transactions. What I do know is that when shares are in your name in your control that you can pick and choose which sales you have put on the sheet. I have trusted you even though I have been told by mutual colleagues how you have boasted. “Whenever I need a bit of gravy I make a loan to Sachlan”. Well mate everything that goes around comes around and that is not in my hands.

Mr Fraval said that the reference to a payment by him for the allocated shares was in fact made by Virtual Capital House Pty Ltd, another company owned by Dr Bennett. Mr Fraval was a director of that company. He also said that the reference to no “binding contract” was saying that there had never been “any binding contract on any Computronics shares”. This claim did Mr Fraval no credit given his email of 29 July 2007. It was certainly arguable that the agreement referred to in that email remained the relevant agreement despite all the attempts to vary the terms on which the shares were to be allotted, but it was quite wrong, in my opinion, to suggest that there had never been a “binding contract” concerning the further 14 million Computronics shares.

Mr Elberg responded with yet another email on 14 November 2007. It read:

Just to set a few things straight so that we are both on the same page:
1. On every occasion you needed money you have come to me.
2. On every occasion you have defaulted on your commitments.
3.In relation to this loan I chased you daily to reduce your loan so that it would be paid out with in 2 month originally agreed too. Instead you threatened to sue me if I sold 1 share prior to 30 September as I was not entitled to do so.
4.When the market was at 13 cents you didn’t want to sell and then you cry when it moves against you.

My wife was a witness to the fact that I told you not to enter into this arrangement but you insisted, now you blame every one but yourself.
I am not going to enter into this childish e-mail war. All I am after is the stock as per our agreement and we will not be dealing in the future.
As you have indicated in your response to my e-mail that the stock has already been allocated, which I was not aware of, I will give you 7 days to allocate it to me or my nominated entity as agreed.
If this does not occur within 7 days I will be left with no other option but to seek advice as to take legal action against you and Computronics as a company.

Computronics was acquired by the consortium of investors in late 2007 and re-listed in January 2008. However, Mr Elberg never received any of the 20 million Computronics shares from Mr Fraval. In February 2010, Computronics was suspended from trading and it remained so at the time of the trial.

Mr Fraval gave evidence that Mr Elberg “never did anything” in respect of assisting in the raising of the further $5 million of capital. He agreed that Mr Elberg had spoken to his brokers and associates about Computronics but said that this was not “support” because Mr Elberg was saying he could not justify paying 25 cents a share.

Mr Elberg agreed that he did not put Mr Fraval in front of brokers or potential investors to give him the opportunity to persuade them to take up shares in Computronics at 25 cents per share. He said that he was never asked to do anything. He agreed that he had never procured an investor to put anything in towards the $5 million placement.

The first issue for determination in respect of the second loan agreement was whether Mr Fraval’s denial that there was a “binding contract” was correct. I have already expressed the view that this denial did Mr Fraval no credit given his email of 29 July 2007. Nevertheless, such a submission was made on behalf of Mr Fraval. It was argued that there were so many conflicting claims and assertions about what were the terms relating to the Computronics shares that one could not be satisfied that there was any agreement reached. I reject that submission. In my opinion, agreement was reached on 29 July 2007 by Mr Elberg and Mr Fraval about the further 14 million Computronics shares, on the terms discussed above.

The defendant’s fall back position was that even if there was an agreement that Mr Elberg would receive a further 14 million shares, that entitlement was subject to two conditions and that Mr Elberg did not satisfy the condition that he provide ongoing support for the $5 million placement. I agree that initially this was a condition of Mr Elberg receiving the further 14 million shares and that Mr Elberg did not satisfy it.

However, as discussed above I consider that the two agreements about Mr Elberg receiving Computronics shares were subsequently varied twice. First, on or about 29 August 2007 Mr Elberg and Mr Fraval agreed that Mr Elberg would be entitled to receive both the 6 million and the 14 million shares if he paid one-tenth of a cent per share for all 20 million shares, and Mr Elberg agreed to give Mr Fraval a first right of purchase if he were to sell any of the 20 million shares. Secondly, on or about 3 October 2007 Mr Elberg and Mr Fraval agreed that instead of a first right of purchase, Mr Elberg would set aside half of the 20 million shares to be used for a convertible note. Thus, the obligation to provide ongoing support was no longer a condition and the evidence about what Mr Elberg did or did not do is not relevant.

I, therefore, conclude that Mr Elberg was entitled to receive a total of 20 million Computronics shares from Mr Fraval at a cost of one-tenth of a cent per share or damages for the failure to transfer such shares. The condition about 10 million of the shares being used for a convertible note did not come into operation because Mr Elberg never received the 20 million shares.

Before dealing with the question of the quantification of Mr Elberg’s damages, it is convenient to address the other issues raised by the parties.

Was the Agreement to Pay the Extra $5,000 Interest Per Day Enforceable?

Counsel for the defendant submitted that, as Mr Fraval was not in breach of the second loan agreement on 14 August 2007, there was no consideration for the variation on 3 September 2007 when he agreed to Mr Elberg’s demand that the interest rate would increase by $5,000 per day if the loan was not repaid on the due date of 30 September 2007.

I reject this submission. The agreement to pay the extra $5,000 per day was reached as a result of a compromise when Mr Elberg agreed to delay taking any action in respect of Mr Fraval’s alleged default. Whether or not there was a default, the bona fide compromise constituted good consideration.[1]
[1]Wigan v Edwards (1973) 47 ALJR 586, 594-595 (Mason J).

The next submission by counsel for the defendant was that as it was Mr Elberg (or more accurately his company Fiori) who on 16 August 2007 sold the ESI shares at 9.1 cents which in fact led to the only default by Mr Fraval, Mr Elberg cannot rely on that default, which was brought about by his breach of an implied term of the agreement to act reasonably and in good faith, to benefit himself. Therefore, it was submitted, the compromise of 16 August 2007 could not provide good consideration.

I also reject this submission. However, I do not need to decide whether there was any such implied term or whether Mr Elberg’s own action caused Mr Fraval to be in default on 16 August 2007 or whether Mr Elberg’s action in selling ESI shares was in breach of any implied term or whether the compromise related only to the breach alleged by Mr Elberg on 14 August 2007 or also included what had occurred on 16 August 2007, because the position remains that on or about 3 September 2007 the parties entered into a bona fide compromise of their dispute by Mr Elberg agreeing to hold his hand on liquidation of the security and Mr Fraval agreeing to pay an extra $5,000 interest per day if the loan was not repaid on the due date. That compromise constituted good consideration.

Accordingly, apart from the submission that the agreement to pay an extra interest of $5,000 per day was a penalty, to which I turn to next, I would have held that it was enforceable by Mr Elberg.

Was the Extra $5,000 Interest Per Day a Penalty?

At the commencement of the hearing, the defendant sought, and was granted leave, to amend his defence to plead that the extra $5,000 interest per day was a penalty and therefore unenforceable. One of the matters considered in deciding that application was whether the plaintiff would be in a position to call expert evidence in opposition to this new defence. Counsel for the defendant submitted that there could be no prejudice to the plaintiff because such evidence would be irrelevant and inadmissible and that whether or not the variation was a penalty was simply a matter of legal argument. I deferred ruling on that question until I had considered the content of any expert evidence sought to be adduced by the plaintiff. I also allowed the plaintiff time to gather such evidence.

I turn first to consider the legal principles governing penalties. In Dunlop Pneumatic Tyre Company Limited v New Garage and Motor Company Limited,[2] Lord Dunedin stated the following “various propositions … deducible from the decisions which rank as authoritative”[3]:
[2][1915] AC 79.
[3][1915] AC 79, 86.

1.Though the parties to a contract who use the words “penalty” or “liquidated damages” may prima facie be supposed to mean what they say, yet the expression used is not conclusive. The Court must find out whether the payment stipulated is in truth a penalty or liquidated damages. This doctrine may be said to be found passim in nearly every case.
2.The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the essence of liquidated damages is a genuine covenanted pre-estimate of damage …
3.The question whether a sum stipulated is penalty or liquidated damages is a question of construction to be decided upon the terms and inherent circumstances of each particular contract, judged of as at the time of the making of the contract, not as at the time of the breach …
4.To assist this task of construction various tests have been suggested, which … may prove helpful, or even conclusive. Such are:
(a)It will be held to be penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach …
(b)It will be held to be a penalty if the breach consists only in not paying a sum of money, and the sum stipulated is a sum greater than the sum which ought to have been paid … This though one of the most ancient instances is truly a corollary to the last test…[4]

[4][1915] AC 79, 86-87.

In Ringrow Pty Ltd v BP Australia Pty Ltd,[5] the High Court of Australia unanimously stated that Dunlop Pneumatic “continues to express the law applicable in this country”.[6] Their Honours went on to say:

The principles of law relating to penalties require only that the money stipulated to be paid on breach … will produce for the payee … advantages significantly greater than the advantages which would flow from a genuine pre-estimate of damage.[7]

Further, the Court emphasised that before a payment required by contract can be regarded as a penalty:
… the propounded penalty must be judged “extravagant and unconscionable in amount”. It is not enough that it should be lacking in proportion. It must be “out of all proportion”.[8]

[5](2005) 224 CLR 656.

[6](2005) 224 CLR 656 [12] (Gleeson CJ, Gummow, Kirby, Hayne, Callinan and Heydon JJ).

[7](2005) 224 CLR 656 [27].

[8](2005) 224 CLR 656 [32].

That appropriate evidence may be called on the penalty question was made clear, in my opinion, by the following passage from the judgment of Diplock LJ in Robophone Facilities Ltd v Blank:

The onus of showing that such a stipulation is a “penalty clause” lies upon the party who is sued upon it. The terms of the clause may themselves be sufficient to give rise to the inference that it is not a genuine estimate of damage likely to be suffered but is a penalty … Thus it may seem … that the stipulated sum is extravagantly greater than any loss which is liable to result from the breach in the ordinary course of things, ie, the damages recoverable under the so-called “first rule” in Hadley v Baxendale. This would give rise to the prima facie inference that the stipulated sum was a penalty. But the plaintiff may be able to show that owing to special circumstances outside “the ordinary course of things” a breach in those special circumstances would be liable to cause him a greater loss of which the stipulated sum does represent a genuine estimate.[9]

[9][1966] 1 WLR 1428, 1447.

All of these cases were referred to by Chesterman J in his very helpful decision in Beil v Pacific View (Qld) Pty Ltd.[10] In that case clause 5 of the agreement provided that in the event of any failure to repay the loan on the due date some four months later the interest rate would increase from 16% to 25% per annum. Evidence was called from both sides addressing such issues as whether the increased risk to the lender upon default by the borrower justified the 9% increase in the interest rate and what interest rates were charged in the market place under short term loans both initially and on default by the borrower.
[10][2006] QSC 199.

Chesterman J considered the submission by the defendants’ counsel that the 25% interest rate was a penalty because of the rule that if a mortgagee wished to stipulate for a higher rate of interest in default of punctual payment he must reserve the higher rate as the interest payable under the mortgage and provide for its reduction in case of punctual payment. His Honour referred[11] to the statement by the learned authors of the second Australian edition of Fisher & Lightwood’s Law of Mortgages that this was “a well settled, if not an intelligible, rule”,[12] referring to cases such as Strode v Parker[13] and Wallingford v Mutual Society.[14] The learned authors also referred to Lord Eldon’s criticism that this distinction preferred form over substance,[15] but concluded that the distinction was “now too well entrenched to be altered”.[16]
[11][2006] QSC 199 [24].
[12]Tyler, Young and Croft: Fisher & Lightwood’s Law of Mortgages, 2^nd Australian edition, para 3-18.
[13](1694) 2 Vern 316; 23 ER 804.
[14](1880) 5 App Cas 685.
[15]Seton v Slade (1802) 7 Ves 265, 273-274; 32 ER 108, 111.
[16]Tyler, Young and Croft: Fisher & Lightwood’s Law of Mortgages, 2^nd Australian edition, para 3-18.

Chesterman J also referred[17] to the decision of the Full Court of the Federal Court of Australia in David Securities Pty Ltd v Commonwealth Bank of Australia.[18] In that case it was held that a provision in a loan agreement that if the borrower failed to pay an amount on its due date the borrower should on demand pay interest on the overdue amount at a rate of 1.5% in addition to the interest rate ordinarily payable was not a penalty because, not being retrospective, it was not seen as a punishment for default “but as a genuine pre-estimate of compensation to the Bank with respect to funds it would otherwise have had available to it to re-invest”.[19]
[17][2006] QSC 199 [33].
[18](1990) 23 FCR 1 (Lockhart, Beaumont and Gummow JJ) (Reversed on other grounds (1992) 175 CLR 353).
[19](1990) 23 FCR 1, 31 (Lockhart, Beaumont and Gummow JJ).

Finally, his Honour referred[20] to the decision of Colman J in Lordsvale Finance plc v Bank of Zambia[21] where in the event of default by the borrower there was an increase of 1% in the interest rate payable during the period of default. Colman J said that the speeches in Dunlop Pneumatic showed that:

whether a provision is to be treated as a penalty is a matter of construction to be resolved by asking whether, at the time the contract was entered into, the predominant contractual function of the provision was to deter a party from breaking the contract or to compensate the innocent party for the breach. That the contractual function is deterrent rather than compensatory can be deduced by comparing the amount that would be payable on breach with the loss that might be sustained if breach occurred.[22]

[20][2006] QSC 199 [34]-[36].

[21][1996] QB 752.

[22][1996] QB 752, 762.

Colman J also pointed out that:

… the borrower in default is not the same credit risk as the prospective borrower with whom the loan agreement was first negotiated. Merely for the pre-existing rate of interest to continue to accrue on the outstanding amount of the debt would not reflect the fact that the borrower no longer has a clean record. Given that money is more expensive for a less good credit risk than for a good credit risk, there would in principle seem to be no reason to deduce that a small rateable increase in interest charged prospectively upon default would have the dominant purpose of deterring default. That is not because there is in any real sense a genuine pre-estimate of loss, but because there is a good commercial reason for deducing that deterrence of breach is not the dominant contractual purpose of the term.[23]

This amount of $197,128 should have been repaid by Mr Elberg to Mr Fraval.
Assessment of Quantum of Damages

Mr Elberg gave evidence that if he had received the 20 million Computronics shares he would have sold them “over a period of time”. He said that he was “definitely a seller of the stock”, adding:

When you start at .1 [of a cent] … and the stock opens at 20 cents, you’re a seller of the stock, sir … Well you’ve got to take the profits when they’re there sir.

He said that if he had offered to sell at a 25% discount he may have found “somebody to buy the whole line off me”. But his claim was for $2 million, being the 20 million shares at 10 cents a share. However, he gave no evidence about trading in Computronics shares (for example, volume and price) in support of his claim.

The defendant sought, and was granted, leave to re-open his case to lead evidence concerning the quantification of the plaintiff’s claim for damages for the defendant’s failure to transfer 6, 14 or 20 million Computronics shares to the plaintiff. In granting the leave I was influenced by the consideration that the only evidence about this critical issue was Mr Elberg’s assertion that he could have sold the 20 million shares at an average price of 10 cents a share. It seemed to me that both sides would benefit from the opportunity to lead independent expert evidence on this question.

The defendant called Jon Bjarnason to give evidence on this issue. Mr Bjarnason holds a Bachelor of Economics (Actuarial Studies and Finance) from Macquarie University and a Graduate Diploma from the Securities Institute of Australia. He has had more than 25 years of financial services experience mostly as an investment dealer for a large Australian superannuation fund manager. He had also worked for two leading stockbrokers and as an operator on the Stock Exchange floor.

Mr Bjarnason was asked by the defendant’s solicitors to answer the same three questions in respect of 6, 14 and 20 million shares in Computronics. They were as follows:

If a person holding 6/14/20 million shares in Computronics in January 2008 wished to sell those shares:
(i)what would be his likely total proceeds from the sale or sales assuming he wished to maximise his proceeds?
(ii)if he was intent on selling all of his shares over the period, what would be the likely proceeds from the sale or sales?
(iii)if it is unlikely that he would have been able to sell all of the shares over the period, what amount would he have been likely been able to sell and for what total proceeds?

In his statement of evidence dated 2 August 2011, Mr Bjarnason said that in the period between the re-listing of Computronics in January 2008 and its subsequent suspension in February 2010 “Computronics was very thinly traded” as demonstrated by the following table:

Year

Volume

Value

Range

Average Price

2008 1,007,284 $59,964 $0.20   - $0.018 $0.060

2009 8,620,372 $127,086 $0.035 - $0.004 $0.015

2010     592,350   $25,174 $0.05   - $0.029 $0.042

Total

10,220,006

$212,223

     $0.20   - $0.004

$0.021

Mr Bjarnason also pointed out that in this period of about 544 share market trading days, Computronics shares traded on only 117 days or 21.5% of the available time. The 10.22 million shares traded represented an average turnover of about 18,750 shares for each of the 544 days available for Computronics shares to be traded.

Mr Bjarnason said that the common method of selling securities on the ASX was for the share broker to enter the number of shares to be sold and the price at which they are to be offered into the electronic share market. It was Mr Bjarnason’s view that if it had been disclosed to the ASX that even 6 million shares were available for sale that news would have overwhelmed the market as it was a very large volume of shares to be sold when compared to the average daily volume of shares traded.

Mr Bjarnason said that in his experience “it is sometimes possible to sell 20% of daily traded volume without significantly lowering the market price of the shares”. Typically that was more the case with liquid stocks which did not include this company. Nevertheless, being “generous” he considered, in answer to the first question, that Mr Elberg could have achieved sales of 2,044,000 shares at an average price of 2.1 cents per share for total proceeds of $42,900, whether he had 6, 14 or 20 million shares to sell.

Next, Mr Bjarnason said that in his experience:

if a seller of such large volumes of a thinly traded security were to stand a chance of realising in their investment, they would need to offer Computronics shares at a very large discount to the prevailing share price. In my view, the larger the volume to be sold the larger the discount required to induce others to acquire Computronics shares.

Thus, in answer to the second question, Mr Bjarnason considered that:

(a)the 6 million shares would have had to be sold at a 30% discount to the average share price, or 1.47 cents per share, which would have realised total proceeds of $88,200;
(b)the 14 million shares would have had to be sold at a 40% discount, or 1.26 cents per share, which would have realised total proceeds of $176,000; and
(c)the 20 million shares would have had to be sold at a 50% discount, or 1.05 cents per share, which would have realised total proceeds of $210,000.

Whilst these discounts were “fairly arbitrary”, they were his opinion based on his experience.

In answer to the third question, Mr Bjarnason repeated that he considered that 2,044,000 shares could be sold at an average price of 2.1 cents per share yielding total proceeds in each case of $42,900.

Mr Bjarnason said that an alternative approach to selling on market would be to ask a share broker familiar with Computronics and its shareholders to find investors in buying Computronics shares off-market. However, it was his opinion that this alternative approach would not have significantly improved the total proceeds because it was unlikely that a buyer would have been found for 6 million or more Computronics shares for the following reasons:

(a)Confidence in share investing was negatively affected during the relevant period by the start of the Global Financial Crisis, with the stock market starting its downward spiral in the third quarter of calendar year 2007. In his evidence in chief, Mr Bjarnason said that the downfall accelerated approximately a year later in about August 2008 with the market reaching the bottom in about March 2009.
(b)Computronics had a poor financial and operating history so that it was not attractive to investors.
(c)Computronics was a relatively thinly traded stock which meant that investors who purchased shares ran the risk of being “locked in”.
(d)Computronics had just undergone a major re-capitalisation with new shareholders being issued 97% of the company’s capital at an average price of 1.7 to 1.8 cents per share. Mr Bjarnason calculated an average price of 1.8 cents a share by dividing the 281,032,000 shares issued prior to the re-listing into the $5,020,000 capital raised by the issue of those shares. If all 20 million options were converted into shares, the average price decreased to 1.7 cents a share.

Mr Bjarnason concluded that the 281 million shares issued prior to the re-listing at 1.8 cents per share represented:

(a)the view of the directors of Computronics concerning the value of an ordinary share in that company because they had authorised the issue of those shares at the varying prices;
(b)a reasonable assessment of what investors thought Computronics shares were worth in the period prior to the re-listing because it was at that average price that the $5.02 million capital had been raised.

Mr Bjarnason also considered the “order watching system known as ‘dark pools’ where clients can make bids or offers on large quantities of stock without the other party knowing that any such line exists”. It was his opinion that there would be a very low probability of success using this method because a company such as Computronics was unlikely to be of interest to more sophisticated investors like large institutions which often used dark pools as a selling strategy. Mr Bjarnason also said that in his opinion there would have been a very low probability of selling a large parcel of Computronics shares off-market because the stock did not seem to attract much trading, any large demand would probably have already been fulfilled during the capital reconstruction (which was undersubscribed) and the stock was trading at a premium to its net tangible asset backing (“NTA”) of 0.987 cents per share as at 31 December 2007.

In evidence, Mr Bjarnason said that there were several bases to his valuation – the average price obtained in the capital restructuring of 1.8 cents a shares; the average market price obtained over the two year period of 2.1 cents a share; the prices of the large volumes transferred off-market at between one-tenth of a cent and one cent per share; and the NTA of 0.987 cents a share. He said that he would not “hang his hat” on any one of those methods but that it gave “great confidence” that they were “all in the same ball park”.

Mr Francis was recalled by the plaintiff to give evidence on this topic. He prepared a report dated 16 August 2011 in which he concluded that “it was almost certain” that Mr Elberg would have achieved “a price above 2 cents a share and probably at 10 cents a share or better”, and that it was “more certain than not” that Mr Elberg would have been able to dispose of all of the 20 million shares at that price.

Mr Francis expressed the view that “there would have been other buyers in the market at prices just below the prices traded”. However, he said that he was unable to estimate the volume of these bids.

Mr Francis placed a lot of emphasis on the possibility of the existence of “latent demand” for Computronics shares which was not revealed in the electronic market. He said that in his experience latent demand fell into the following three categories:

(a)The first was where instructions had been given to a broker but the broker had not entered the order into the electronic market. He said that this could occur because buyers might not show their demand on the screen for tactical reasons. Entering orders on the screen amounted to disclosing one’s hand.
(b)The second was where an investor had not made a decision to invest or to sell, but was prepared to make a decision on becoming aware of facts or circumstances that will persuade him to do so. These included but were not limited to movements in price, recommendations from a broker, announcements by a company and events occurring in the external environment, for example, falling commodity prices.
(c)The third category involved trades which occurred off-market. In general, most institutional investors conducted very little of their trading in particular stocks off-market. Off-market trading by institutions was generally limited to trading in portfolios of stocks, and was most commonly related to the transfer of capital between managers or between sectors, futures trades, options expiries, and so on. However, off-market trades did commonly occur in securities like Computronics.

Nevertheless, Mr Francis concluded that it was “impossible to be certain as to the extent of latent demand” which might exist in the market, both in respect of individual stocks, and in respect of the market generally. He said that:

Latent demand is something about which one can only speak in general terms until after an attempt is actually made to sell the stock.

Some of the factors relevant to attempting to assess the latent demand in a particular stock discussed by Mr Francis, such as lack of liquidity, market capitalisation and size of sale volume, seem to me to point towards a lack of latent demand in respect of Computronics shares. However, “the two most critical elements”, according to Mr Francis, in assessing whether sufficient demand would have arrived in the market to have enabled Mr Elberg to sell his stock were the length of time spent offering the shares to the market and the degree of price movement which would serve to attract demand, of which the first was “by far the dominant factor”.

In response to the question of whether Mr Elberg could have disposed of 20 million Computronics shares at a price of 10 cents a share or better, Mr Francis listed a number of factors which he considered it was necessary to examine and understand. First, he pointed out that Mr Elberg’s 20 million shares would have represented 6.89% of the 290,107,325 shares issued and 7.69% of the holding of the Top 20 shareholders, who would normally be the parties interested in a major parcel of shares. Mr Francis also noted that Mr Elberg’s 20 million shares would have increased the pool size of shareholders willing to sell by almost 100% and thereby increased turnover. He also relied on three changes in substantial shareholders mainly as a result of off-market transactions as evidence that there was latent demand of at least 30 million shares which was nearly three times higher than the volume traded on the ASX. These changes were as follows:

(a)Between 9 January and 1 October 2008, Breakaway Technologies Pty Ltd (“Breakaway”) (being the fourth biggest shareholder as at the earlier date) was able to dispose of 20 million shares to Research and Development Consulting Services Pty Ltd (“RDCS”) at a price he was unable to determine.
(b)Between 9 January 2008 and 1 October 2009, Kardwi Pharmaceutical Pty Ltd (“Kardwi”) (being the fourteenth biggest shareholder as at the earlier date) was able to dispose of 6.8 million shares at a price he was unable to determine.
(c)Between 9 January 2008 and 1 October 2009, Computronics Corp Creditors Account (being the nineteenth biggest shareholder at the earlier date) was able to dispose of 4 million shares at a price he was unable to determine.

Thus, Mr Francis based his conclusion that “it was almost certain” that Mr Elberg would have achieved “a price above 2 cents a share and probably at 10 cents a share or better” on his opinion that if Mr Elberg had:

(a)started selling the shares on the ASX market and started selling those shares down (that is, by reducing the price), and
(b)informed the major shareholders and subscribers of his intention to sell it down to 10 cents a share,

he would have been able to attract a reasonable level of latent demand and there would also have been a bid by the major shareholders for a parcel of shares in order to support the market price of their shares.

Mr Francis also reviewed Mr Bjarnason’s statement of evidence and criticised his conclusion that the value of Computronics shares was 1.7 to 1.8 cents per share. In evidence, he described it as “a meaningless analysis”. In his report, Mr Francis argued that “the true independent price” for the shares prior to the re-listing was 25 cents a share because that was the price at which investors had subscribed for 19,032,000 shares. He said that this price had to be the view of the directors if they were complying with their obligations under the Prospectus provisions in Chapter 6D of the Corporations Act 2001. Mr Francis also pointed out that the independent expert had reported that the deal was fair. Further, Mr Francis said that given that 97% of the shares were in the hands of parties associated with the reconstruction, it would not have been unreasonable for the shareholders to have the expectation that the shares would trade above 25 cents a share, as the reconstructing parties would not have been willing sellers below 25 cents a share. A value of 25 cents a share was also more in line with the first day’s trading at 20 cents a share.

Mr Bjarnason responded to this criticism with a second report dated 18 August 2011. He disputed Mr Francis’ opinion that 25 cents a share was the fair market price at the time of re-listing. First, he said that Mr Francis was wrong in saying 19,032,000 shares had been subscribed for at 25 cents per share because 4 million of those were issued to the creditors at the “notional value” of 25 cents.

Secondly, Mr Bjarnason pointed out that only two parties subscribed for shares at 25 cents. Virtual Capital House Pty Ltd (“VCH”) (wholly owned by Dr Bennett) had paid $2,258,000 for 9,032,000 shares. But three other companies owned by Dr Bennett received large parcels of shares at one-tenth of a cent per share – 20 million to Breakaway, 15 million to ICB Nominees Pty Ltd and 15 million to ILB Investment Holdings Pty Ltd. This averaged Dr Bennett’s price down to less than 5 cents.[27] Kardwi (owned by Mr Khan) paid $1,500,000 for 6 million shares but it received 800,000 at one-tenth of a cent per share. Also, Saju Pty Ltd, another company owned by Mr Khan, later received 11,040,000 at a price of one-tenth of a cent per share from Mr Ismail, an associate of Mr Khan. This averaged Mr Khan’s price down to less than nine cents. Further, the fact that there were no other subscriptions at 25 cents a share meant that the proposed raising of $5 million had not been completely successful.
[27]3.9 cents per share by my calculation.

Thirdly, Mr Bjarnason drew attention to the fact that the independent expert’s conclusion that the proposed recapitalisation was “fair and reasonable” was on the basis that if it were not approved the likely outcome would be far worse for the existing shareholders in that Computronics would probably go into liquidation. In effect, the independent expert said that the value of Computronics was nil.

Fourthly, Mr Bjarnason disputed Mr Francis’ assertion that the new shareholders who held 97% of the shares would not have been willing sellers below 25 cents a share. All of them had received their shares on average for less than ten cents a share, many of them at only one-tenth of a cent per share. Mr Bjarnason said:

if I got shares at 0.1 of a cent and … I had opportunities to sell a large parcel of them at 25 cents or 24 cents I would take it, unless I think it’s the next Google … or Facebook company that’s going to give me big returns.

In my opinion, Mr Elberg’s evidence about his attitude to selling the shares supported Mr Bjarnason’s point.

Mr Bjarnason stated that he did not understand “Mr Francis’ reluctance to examine the issuance of shares via the capital reconstruction as a whole”. He said that in his opinion:

if the beneficial owners were getting a significant number of shares at 0.1 cents, this would indeed influence their willingness to pay 25 cents for other shares, thereby averaging down their cost. In my opinion, they would look at the two issues together.

Mr Bjarnason also argued that:

given that Computronics narrowly missed being wound up and only had $2,020,000 cash after the capital raising, in my opinion, it seems very generous for Mr Francis to value the company at $72.5 million (based on 290 million shares at 25 cents each).

In his evidence in chief he also referred to the auditors’ doubts about the ability of the company to continue as a going concern.

Mr Bjarnason queried Mr Francis’ opinion that there would have been “other buyers in the market at prices just below the prices traded”. He asked whether there was any proof that there were any and, if so, how many there were, suggesting it was just speculation on Mr Francis’ part. Mr Bjarnason argued that it was “extremely rare” for an ASX listed company to trade so infrequently and to have so little daily dollar turnover. He also pointed out that the price of Computronics shares fell significantly (generally to prices at one cent or less) when larger volumes were offered. This would not have happened if what Mr Francis had said was true. In evidence in chief Mr Bjarnason referred to the fact that Computronics shares dropped from 8 cents a share on 30 September 2008 to 1.8 cents a share on 24 October 2008 “without any significant news” and with only about 100,000 shares being traded.

Mr Bjarnason agreed with Mr Francis that it was “impossible to be certain as to the extent of latent demand” which might exist in the market. He said in evidence that it was “a very subjective, unknown sort of thing”.

Mr Bjarnason agreed with Mr Francis that the Top 20 shareholders would normally be interested in a major parcel of shares. However, in his opinion, “as these shareholders had just bought 244.8 million of the 259.832 million shares that they owned … at 0.1 cents … it was very unlikely that they would be interested in buying a large parcel of shares at 10 cents or more”. In cross-examination, Mr Bjarnason said that he thought the members of the consortium:

would have been interested in seeing a large parcel of shares at … .1 cent. Yes, very interested. Interest would wane as it gets closer to 1 cent and wane much further above 1 cent. But yes, they would have some interest. …

Some telling criticisms were made by Mr Bjarnason of Mr Francis’ reliance on the off-market transactions. Mr Bjarnason pointed out that the two largest off-market transactions did not actually involve a change of beneficial owner – the transfer of 17,782,147 shares from Breakaway to RDCS (both owned by Dr Bennett), and the transfer of 6,720,000 shares from Kardwi to Saju (both owned by Mr Khan). Further, 3.5 million of the shares transferred from the Creditors’ Account were sold at a price of 1 cent per share. Other large off-market transactions were a transfer of 10,040,000 shares from Romfal Sifat Pty Ltd (a company associated with Mr Ismail) to Saju at one-tenth of a cent per share and a transfer of 2 million shares from RDCS to Jason Fischman at 1 cent per share.

Mr Bjarnason therefore concluded that it seemed that “there was a fair bit of latent demand by the Top 20 shareholders, but only at prices of 0.1―1.0 cents”. He also expressed the view that:

The fact that buyers could only be found at 1.0 cents supports the opinion I expressed in my report that a large parcel could probably have been sold for 1.05―1.47 cents.

Mr Francis was present in Court when Mr Bjarnason gave his evidence. Mr Francis’ evidence in chief was partly completed when the hearing was adjourned for the weekend. On the Monday morning Mr Francis said that he had “re-examined” his evidence over the weekend and formed the view that it was lacking in certain respects. He then gave evidence about the further matters that he wanted to raise. To a large degree they addressed Mr Bjarnason’s four bases to his valuation.

The first point made by Mr Francis was that because Mr Elberg had lodged his writ in April 2008, his analysis of the on-market transactions was “really based” on the January to April 2008 period. This meant that the only trades he had taken into account were at 20 and 18 cents per share.

Mr Francis criticised Mr Bjarnason’s reliance on the average price obtained for on-market sales between January 2008 and February 2010. He said that no-one would attempt to sell shares over a period of two years. Nevertheless, it was “a consideration” that he “took into account”. He also rejected Mr Bjarnason’s evidence that Mr Elberg could have sold an extra 20% of the 10.22 million shares sold in this period without significantly lowering the market price. He considered the percentage would be higher.

Secondly, Mr Francis made the point that Mr Khan’s largest transfer of shares at one-tenth of a cent did not occur until after 3 February 2010, which was at least two years after the re-listing. This meant that at the time of re-listing Mr Khan received 6,800,000 shares at a price of about 22 cents per share.

Mr Francis then said that after analysing all of Dr Bennett’s positions he had calculated that Dr Bennett’s initial average price was 8.2 cents per share. Unfortunately, I cannot follow Mr Francis’ explanation of how he has come up with that figure. Apparently, he included 20 million shares at 25 cents a share in his calculation because he was under the impression that VCH had underwritten the whole capital raising of $5 million. Mr Fraval said that the underwriting obligation was only for $3 million and that this was satisfied by VCH’s and Kardwi’s purchases. In any event, even using the figures of 20 million shares at 25 cents a share the average price by my calculations comes to 7.2 cents a share. As stated previously, my calculation for Dr Bennett’s initial average price across all of his holdings was 3.9 cents per share.

Next, Mr Francis referred to the fact that the creditors, in addition to receiving $2 million in cash and their 4 million shares, had waived $1,364,962 in bad debts. He argued that this meant that they were paying about 34 cents a share. In my opinion, this calculation could only be correct if one assumed that the creditors would have been paid their $1.36 million debt in full. Clearly, that was not going to happen. If the creditors had not accepted the consortium’s proposed restructuring, the likely result would have been that Computronics went into liquidation and the creditors would have received neither $2 million in cash nor 4 million shares. Any price put on these shares was purely notional.

Mr Francis also pointed out that the creditors’ sales of 3.5 million shares at 1 cent a share, which Mr Bjarnason relied on, were made some two years later.

Finally, Mr Francis said that he found Mr Bjarnason’s use of the NTA value as an indicator of fair value to be “quite laughable”. He said that most ASX listed companies (other than property companies and investment vehicles) traded at a premium to NTA, particularly large technology companies.

In answer to a question from me, Mr Francis said that after his further work he still reached the conclusion that Mr Elberg could have sold 20 million shares at 10 cents a share. Perhaps the only change was that he no longer seemed to say that even more than 10 cents could have been obtained. Indeed, after some encouragement from the plaintiff’s counsel, he agreed that 8, 9 or 10 cents was “within the range”. However, later answers by him confirmed that he was really sticking with the 10 cents a share valuation. He regarded that as a big discount from the price at which the shares first traded. Mr Francis said that his opinion resulted from 30 years of experience “in looking at these types of companies”.

At the conclusion of his evidence Mr Francis said that in his view Mr Elberg would have sold “almost none” of the Computronics shares on market. Rather, he said that Mr Elberg would have sold his parcel of shares to the consortium at 10 cents a share because they would not have wanted the share price damaged by a major shareholder disposing of his shares. This represented a change from the view expressed in his earlier report which was based on selling both on-market and off-market to the major shareholders.

I found Mr Bjarnason’s evidence on the likely proceeds from the sale of 20 million Computronics shares to be more convincing than that of Mr Francis. I am not persuaded by Mr Francis that Mr Elberg could have sold 20 million Computronics shares at 10 cents a share.

In my opinion, one cannot ignore what actually occurred with the on-market trading of Computronics shares in this period, when only 10.22 million shares were traded at an average price of 2.1 cents a share. Mr Francis very frankly conceded, in effect, that he had reached his 10 cent a share conclusion without taking into account the prices at which Computronics shares sold after April 2008. Thus, he had in mind prices of 20 and 18 cents per share, not an average of only 2.1 cents. Yet the sales at the higher prices were extremely limited, only 35,177 shares at 20 cents and 4,000 shares at 18 cents. It seems to me that it was more likely than not that the 20 million shares could only have been sold at a discount to that average price. As demonstrated by the actual trading in this period, generally as volume increased the price dropped. Thus, in my opinion, the suggestion that 20 million shares could have been sold for 10 cents per share is quite unrealistic.

Mr Francis’ conclusion that Mr Elberg could have sold 20 million shares at 10 cents a share was largely dependent on his view that the consortium would have been prepared to pay this price to Mr Elberg in order to support the market price of their shares. Where the consortium, which had been unable to fulfil the proposed capital raising of $5 million, would get the $2 million from was not explained. Indeed, Mr Francis said that probably they did not have “the financial clout to do it”. It would appear from the fact that Mr Fraval agreed to such extraordinarily high interest rates when he borrowed the $500,000 from Mr Elberg, that the members of the consortium were not flush with funds at this time. Moreover, nothing appears to have been done by the members of the consortium to protect the share price when it fell from 18 cents to 5 cents on 16 May 2008 or from 8 cents to 1.8 cents in October 2008. Thus, Mr Francis’ view was not supported by the facts.

Thirdly, another important basis for Mr Francis’ conclusion that millions of shares could have been sold at 10 cents a share was the existence of three changes in the substantial shareholders mainly as a result of large off-market transactions. However, Mr Bjarnason established that two of these three changes were between related companies without any change of beneficial owner so that the price at which the shares were transferred was largely meaningless, even if it had been known, and that the other change involved the transfer of at least 3.5 million shares at 1 cent a share. Other large off-market transactions referred to by Mr Bjarnason were at 1 cent a share or less.

The surprising aspect about the above points was that Mr Francis was not prepared to alter his conclusion despite this significant further evidence. I fail to see how they could not have affected his initial assessment.

I accept Mr Bjarnason’s evidence that 20% of the daily traded volume could have been sold “without significantly lowering the market price of the shares”. To some extent this accords with Mr Francis’ reliance on latent demand, the extent of which he was unable to estimate.

I also accept the general thrust of Mr Bjarnason’s evidence about discounting the price as the volume increases. Even his price of 1.05 cents for 20 million shares, which resulted from his greatest discount of 50%, was slightly higher than the 1 cent which seemed to be a common price for the larger volumes of sales.

Although Mr Bjarnason did not consider this approach to be feasible in practice, I would merge his two methods, as I consider that this gives the best estimate of Mr Elberg’s loss. Thus, I would take into account the 20% of actual sales at the average price and the balance of the 20 million shares at the 50% discount to the average price. My calculation is, therefore, as follows:

Number

Average Price

Value

2,044,000 $0.021 $ 42,924

17,956,000 $0.0105 $188,538

20,000,000

$0.01157

$231,462

As I have found that Mr Elberg eventually agreed to pay one-tenth of a share for all 20 million shares, I assess his damages at $211,462, being $231,462 less $20,000.

Final Orders

Once the parties have had the opportunity to consider my reasons for judgment, I will hear submissions on the form of judgment, including the questions of interest and costs.

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Investment amount	US$	20,000
Shares Allocated in successful bid for Computronics Ltd the target company for the desalination technology	6,000,000
Proposal
Investment amount	US$	25,000
Shares Allocated in successful bid for Computronics Ltd the target company for the desalination technology	5,000,000

Year	Volume	Value	Range	Average Price
2008	1,007,284	$59,964	$0.20 - $0.018	$0.060
2009	8,620,372	$127,086	$0.035 - $0.004	$0.015
2010	592,350	$25,174	$0.05 - $0.029	$0.042
Total	10,220,006	$212,223	$0.20 - $0.004	$0.021

Number	Average Price	Value
2,044,000	$0.021	$ 42,924
17,956,000	$0.0105	$188,538
20,000,000	$0.01157	$231,462

[2012] VSC 342

14 AUGUST 2012