Fitzpatrick v Cheal

[2010] NSWSC 717

CITATION:	Fitzpatrick v Cheal [2010] NSWSC 717
HEARING DATE(S):	25 May 2010
JUDGMENT DATE :	1 July 2010
JURISDICTION:	Equity - Corporations List
JUDGMENT OF:	Bergin CJ in Eq
DECISION:	Leave granted under s 237 of Corporations Act 2001 (Cth) to bring proceedings on behalf of the company.
CATCHWORDS:	CORPORATIONS - application for leave to bring action pursuant to s 237 of Corporations Act 2001 (Cth) - consideration of factors in establishing that the applicant is acting in good faith (s 237(2)(b)) - whether action in best interests of the company - whether serious question to be tried
LEGISLATION CITED:	Corporations Act 2001 (Cth)
CASES CITED:	Charlton v Baber (2003) 47 ACSR 31 Degiorgio v Dunn (No 2) (2005) 62 NSWLR 284 Fiduciary Ltd v Morningstar Research Pty Ltd (2005) 53 ACSR 732 Gerard Cassegrain & Co Pty Ltd v Cassegrain; Cassegrain v Gerard Cassegrain & Co [2010] NSWSC 91 Showtime Management Australia Pty Ltd v Showtime Presents Pty Ltd [2008] NSWSC 618 Swansson v R A Pratt Properties Pty Ltd (2002) 42 ACSR 313
PARTIES:	Simone Leah Fitzpatrick (First Plaintiff) ACN 089 142 870 Pty Ltd (Second Plaintiff) James Mitchell Cheal (First Defendant) Cheal Industries Pty Ltd (Second Defendant) Chilli Surfboards Pty Ltd (Third Defendant)
FILE NUMBER(S):	SC 5097/09
COUNSEL:	MB Evans (First Plaintiff) R Francois (Defendants)
SOLICITORS:	Lathams Lawyers (First Plaintiff) Simon William Griesz (Defendants)

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IN THE SUPREME COURT
OF NEW SOUTH WALES
EQUITY DIVISION
CORPORATIONS LIST

BERGIN CJ in Eq

1 JULY 2010

2009/291052 SIMONE LEAH FITZPATRICK & ANOR v JAMES MITCHELL CHEAL & ORS

JUDGMENT

1 The first plaintiff, Simone Leah Fitzpatrick (the plaintiff), seeks leave under s 237 of the Corporations Act 2001 (Cth) (the Act) to bring proceedings on behalf of the second plaintiff, ACN 089 142 870 Pty Ltd (formerly known as Chilli Surfboards Pty Ltd) (“Chilli #1”). The plaintiff makes her application under s 236(1)(a)(i) of the Act as the owner of 50 percent of the ordinary issued shares of Chilli # 1.

2 The plaintiff alleges that the first defendant, James Mitchell Cheal (the defendant), who is and was at all material times the sole director of Chilli #1, acted in breach of his statutory and fiduciary duties to Chilli #1 by transferring the intellectual property and associated goodwill of Chilli #1 to the second defendant, Cheal Industries Pty Ltd (“Cheal Industries”) and/or the third defendant, Chilli Surfboards Pty Ltd (“Chilli # 2”), companies of which he is also a director. I will refer to the defendants collectively as the defendants.

3 The matter was heard on 25 May 2010 when Mr MB Evans, of counsel, appeared for the plaintiff, and Ms R Francois, of counsel, appeared for the defendants.

Background

4 The plaintiff and the defendant lived together in a de facto relationship from about 1990 until October 2003. The only child of the relationship, a son, was born on 3 November 1995.

Business commences - 1996

5 In 1996 the defendant began learning how to shape surfboards with Aloha Surfboards in Brookvale on the northern beaches of Sydney. He had a growing clientele wanting him to shape boards so he decided that it was an opportunity to start up his own business. From a young age the defendant had the nickname "Chilli" and he decided to operate the business under the name "Chilli Surfboards". The business operated out of the Aloha factory premises at Brookvale and it soon expanded to supplying the surfboards to surf shops for re-sale. In the early days of the business the plaintiff handled all the administration, paperwork and correspondence, with the assistance of a part-time bookkeeper. The defendant shaped the surfboards, managed quality control and negotiated contracts with customers and suppliers. The defendant also arranged for a graphic artist to design the Chilli Surfboards logo, a chilli vegetable.

Trade Mark - 17 July 1998

6 On 17 July 1998, the defendant lodged an application under s 27 of the Trade Marks Act 1995 (Cth) for registration of a Trade Mark the words "Chilli Shapes by James Cheal" and the image of a chilli vegetable in respect of “surfboards, body boards, leg-ropes, board bags/covers” and “sunglasses”. These words and image were subsequently registered as Trade Mark 767677.

Chilli #1 Established – 18 August 1999

7 Chilli #1 was incorporated on 18 August 1999 and the defendant was appointed as the Director and Secretary of the company. The issued capital of the company was one A class ordinary share owned by the defendant and one B class ordinary share owned by the plaintiff. The plaintiff and defendant each own one of the two issued ordinary shares. Chilli #1 conducted the business of manufacturing and selling surfboards under the brand name and logo “Chilli Surfboards”.

Trade Mark – 19 August 1999

8 On 19 August 1999 an application was made under s 27 of the Trade Marks Act for registration of a Trade Mark the words “Chilli Surfboards Clothing Shaped by James Cheal” and the image of a chilli vegetable in respect of “clothes, headgear and footwear”. The words and image were subsequently registered as Trade Mark 804353. Although Cheal Industries is recorded as the owner of the Trade Mark, it was not incorporated until 2005. The evidence does not disclose the identity of the original applicant for this Trade Mark.

Chilli #1 growth 2001-2005

9 There was steady growth in operating sales revenue of Chilli #1 in the period 2001 to 2005, recorded as $262,188 in 2001, $312,424 in 2002, $398,887 in 2003, $400,901 in 2004 and $554,047 in 2005. The financial statements for the years 2001 to 2004 inclusive included “Intangibles” of $9,183 for “Patents & Trademarks”.

10 In mid 2002 the business operation was relocated to leased premises in Warriewood that included a factory area and an office. The plaintiff managed the office as administrator and co-ordinator up to 13 October 2003 when her relationship with the defendant concluded. By this time there were 12 employees in the business.

Defendant and Mrs Cheal

11 In late 2003 the defendant commenced a relationship with Simone Ann Vincze-Cheal (Mrs Cheal) whom he married in October 2004. In November 2004 Mrs Cheal and the defendant purchased a property in Newport on the Northern Beaches of Sydney secured by first mortgage over that property and second mortgage over a home unit in Tweed Heads that Mrs Cheal had owned for some time.

Fixed Charge over Chilli #1

12 On 30 December 2004 a fixed charge in favour of the National Australia Bank was granted over the assets of Chilli #1 and registered on 2 February 2005. There is no evidence of the detail of this charge or the underlying transactions in respect of which it was granted however it appears that the charge is still registered.

Trademarks are removed from Chilli #1 – 30 June 2005

13 The entry in Chilli’s financial statements for the years 2001 to 2004 inclusive for “Intangibles” of $9,183 for “Patents & Trademarks” did not appear in Chilli #1’s financial statements for the year ending 30 June 2005. However a figure of $9,183 under the heading “Current Receivables” described as “James Cheal (Patents & Trademarks)” was recorded. Those financial statements also record that this had been the case in 2004, inconsistently with the financial statements that were produced as at 30 June 2004. There was no explanation in the 2005 financial statements in relation to these entries.

Licence Agreement – 1 July 2005

14 On 1 July 2005, the defendant, as Owner, and Chilli #1, as Licensee, entered into an Intellectual Property Licence Agreement (the Chilli #1 Licence Agreement) for the period 1 July 2005 to 30 June 2006 (the period) pursuant to which the defendant granted to Chilli #1 an exclusive licence for the period "to use the Intellectual Property for the Permitted Use”: (cl 4.2 and 6.2). The defendant warranted that he was the owner of the Intellectual Property (cl 8.1) which was defined as follows (cl 26.1):

Intellectual Property means and includes all of the rights of the Owner in respect of all Trade Marks and copyright in Chilli Surfboard logos, and all other Patent and Design Rights, rights in confidential information, rights in the name and reputation, rights for actions for passing off design rights, methods of manufacture and rights in respect of business systems and methods.

15 Permitted Use was defined as "the manufacture of surfboards, and all associated and related uses" (cl 26.2). The Licence Fee was $10 per surfboard manufactured, excluding all team and promotional boards (cl 7.2).

16 The parties agreed that the defendant was entitled to assign all or any part of the Intellectual Property and/or his rights under the Licence Agreement (cl 11.1). As a condition of any assignment the defendant promised to procure from the Assignee a covenant for the benefit of Chilli #1 to the effect of the Chilli #1 Licence Agreement binding the Assignee to perform the defendant's obligations under the Agreement (cl 11.2).

Cheal Industries Established – 12 July 2005

17 Cheal Industries was incorporated on 12 July 2005. The defendant and Mrs Cheal are directors and the defendant is also the company secretary. The defendant and Mrs Cheal each own one “Class A” share, one “Class B” share and one hundred ordinary shares.

The Hunga Trust – 28 July 2005

18 By Deed dated 28 July 2005, the Hunga Trust was established with Cheal Industries as Trustee and the defendant, Mrs Cheal and the “children and remoter issue of each of them”, as beneficiaries.

The Eskmon Trust – 20 February 2006

19 By Deed dated 20 February 2006 the Eskmon Family Trust was established with Cheal Industries as Trustee and Mr and Mrs Cheal and the “children and remoter issue of each of them” as beneficiaries.

Assignment Agreement – 9 February 2006

20 On 9 February 2006, prior to the conclusion of the Chilli #1 Licence Agreement, the defendant, as Assignor, entered into an Assignment of Intellectual Property Agreement (the Assignment Agreement) with Cheal Industries as Trustee for the Hunga Trust (the Trustee), as Assignee, pursuant to which the defendant agreed to assign the Intellectual Property to the Trustee (cl 3.2). The Intellectual Property was defined in terms identical to the same definition in the Chilli #1 Licence Agreement (cl 10.1).

21 The Assignment Agreement provided as follows:

4. In consideration of the sum of $14,500.00 (being $12,000 for patents/trademarks and $2,500 for other intellectual property) now paid by [the Trustee] (the receipt whereof is hereby acknowledged by the [defendant]) the [defendant] hereby assigns to the [Trustee] all the property, right, title and interest in the Intellectual Property, including and together with the whole of all and any goodwill possessed and held by the [defendant] in the business and goods for which the Intellectual Property are used.

…

7. The [defendant] undertakes to provide reasonable assistance to the [Trustee] by way of the provision of information and documents, declarations and affidavits relating to the goodwill held in the Intellectual Property for use in any intellectual property opposition, infringement or revocation proceedings which may arise in the Territory.

22 There is no evidence at this stage of any information, documents, declarations or affidavits relating to the goodwill that the defendant may have provided to the Trustee. Although in the Chilli #1 Licence Agreement the defendant had agreed with Chilli #1 to procure from any Assignee a covenant for the benefit of Chilli #1 to the effect of the Licence Agreement binding the Assignee to perform the defendant's obligations under that Agreement, no such covenant was contained in the Assignment Agreement.

23 The only Trade Marks apparently in existence at the time of this Agreement were Trade Marks 767677 and 804353 referred to above.

Trade Marks – 19 May 2006

24 On 19 May 2006 Cheal Industries made application under s 27 of the Trade Marks Act for registration of a Trade Mark for the word “Chilli” and the image of a chilli vegetable in respect of “clothing, footwear, headgear, beachwear, swimwear, including shorts, shirts, skirts, dresses, T-shirts, swimsuits, wetsuits, wetsuit gloves, rash shirts, board shorts, jumpers and jackets, underclothing, hats, caps, sun visors, sandals, footwear for beach use, including booties for surfing and other water sports; accessories in this class for the aforesaid goods”. This word and the image were subsequently registered as Trade Mark 1114509.

25 Also on 19 May 2006 Cheal Industries made application under s 27 of the Trade Marks Act for registration of a Trade Mark for the word “Chilli” and the image containing the word “Chilli” repeated in various fonts in respect of “surfboards, surfboard bags/covers, surfboard leashes, surfboard fins, deck grip, wax for surfboards, wax combs, surfboard repair kits and parts of such kits, and surfboard nose protectors”. This word and the image were subsequently registered as Trade Mark 1114575.

Trade Marks - 30 May 2006

26 On 30 May 2006 Cheal Industries made a further application under s 27 of the Trade Marks Act for registration of a Trade Mark for the word “Chilli” and silhouette images of three chilli vegetables in respect of “Sports equipment, including equipment for water sports and snow sports; surfboards, surfskis, waveskis, sailboards and other surfcraft; parts, fittings and accessories for surfboards, surfskis, waveskis, sailboards and other surfcraft, including leashes and leg ropes for surfboards, bags, shoulder bags, slings and covers for surfboards, surfskis, waveskis, sailboards and other surfcraft”. This word and the image were subsequently registered as Trade Mark 1116169.

27 Also on 30 May 2006 Cheal Industries made application under s 27 of the Trade Marks Act for registration of a Trade Mark for the word “Chilli” and the silhouette image of a chilli vegetable for goods and services of the same description as Trade Mark 1114509. This word and image were subsequently registered as Trade Mark 1116172.

Licence Agreement –16 June 2006

28 On 16 June 2006, prior to the conclusion of the period of the Chilli #1 Licence Agreement, and prior to Chilli #2’s incorporation, the Trustee, as Owner, and Chilli #2, as Licensee, entered into an Intellectual Property Licence Agreement (the Chilli #2 Licence Agreement) commencing on 1 July 2006 until terminated (cl 4.1-4.2). The Trustee granted to Chilli #2 an exclusive licence to “use the Intellectual Property for the Permitted Use” (cl 6.1). The Intellectual Property was defined in identical terms as it had been in the Chilli #1 Licence Agreement (cl 25.1). The Permitted Use was also defined in identical terms as it had been in the Chilli #1 Licence Agreement (cl 25.2). The Licence Fee for the first year of the Chilli #2 Licence Agreement was $25 per surfboard sold, excluding all promotional or team surfboards, or as otherwise mutually agreed by the parties (cl 7.2).

29 The defendant had purportedly assigned intellectual property including the Trade Marks registered in 1998 and 1999 to the Trustee in the Assignment Agreement on 9 February 2006. Accordingly in the Chilli #2 Licence Agreement the Trustee licensed to Chilli #2 not only the Trade Marks registered by Cheal Industries in May 2006 but also the 1998 and 1999 Trade Marks.

Chilli #1 name change – 23 June 2006

30 On 23 June 2006 Chilli #1’s name was changed from Chilli Surfboards Pty Ltd to ACN 089 142 870 Pty Ltd. At that time the directorships and shareholdings remained as they had been prior to the change of name.

31 Chilli #1’s 2006 financial statements show operating sales revenue of $879,374. The “Receivable” in the 2005 financial statement described as “James Cheal (Patents & Trademarks)” was not in the 2006 accounts. Rather two new entries of $202 and $1,620 for an “Eskmon Loan A/c” and the “Hunga Trust (Cheal Industries Pty Ltd)” respectively were recorded. There was no explanation in the accounts in respect of these entries.

Chilli #2 established – 23 June 2006

32 Chilli #2 was incorporated on 23 June 2006. The defendant is a director and secretary of the company. There is a co-director, Taylor Eaton, who has been working in the business for some years. Cheal Industries owns one A class share and 90 ordinary shares. Tecro Management Pty Ltd owns one B class share and 10 ordinary shares. The Company Tax return for Chilli #2 for the year ending 30 June 2006 recorded taxable income as “0”.

2007 Financial Statements

33 The operating sales revenue recorded in Chilli #1’s 2007 financial statements dropped from $879,374 in 2006 to $65,258. There was no mention of any receivables for Patents & Trademarks. Once again the two entries of $202 and $1,620 for an “Eskmon Loan A/c” and the “Hunga Trust (Cheal Industries Pty Ltd)” respectively were recorded.

34 The operating sales revenue recorded in the Chilli #2 2007 financial statements was $1,669,598. There were no intangibles or Patents or Trademarks recorded in the financial statements nor was there any entry recorded as the Licence Fee payable to the Trustee under the Chilli #2 Licence Agreement.

2008 Financial Statements

35 The operating sales revenue in the Chilli #1 2008 financial statements was $8,033.

36 The operating sales revenue in the Chilli #2 2008 financial statements was recorded as $1,605,551. There were no intangibles or Patents or Trademarks recorded, nor was there any express entry recorded as the Licence Fee payable to the Trustee under the Chilli #2 Licence Agreement.

Proposed Claim

37 In the Amended Originating Process filed on 16 April 2010, the plaintiff alleges that the defendant acted in breach of his statutory and fiduciary duties as a director of Chilli #1 in procuring the Chilli #1 Licence Agreement, the Assignment Agreement, and the Chilli #2 Licence Agreement, the effect of which is alleged to transfer and misappropriate the intellectual property and associated goodwill of Chilli #1 to Cheal Industries and/or Chilli #2. The plaintiff contends that leave should be granted to bring proceedings on behalf of Chilli #1 so that it may obtain relief in the nature of inter alia, equitable compensation, or in the alternative, an order setting aside the Assignment Agreement. The plaintiff also makes an alternative claim on her own behalf pursuant to s 232 of the Act that the defendant conducted the affairs of Chilli #1 in a manner oppressive to her and seeks an order that the defendant purchase her shares in Chilli #1.

Consideration

38 Section 237 of the Act provides relevantly:

Applying for and granting leave

(1) A person referred to in paragraph 236(1)(a) may apply to the Court for leave to bring, or to intervene in, proceedings.

(2) The Court must grant the application if it is satisfied that:


(a) it is probable that the company will not itself bring the proceedings, or properly take responsibility for them, or for the steps in them; and

(b) the applicant is acting in good faith; and

(c) it is in the best interests of the company that the applicant be granted leave; and

(d) if the applicant is applying for leave to bring proceedings—there is a serious question to be tried; and

(e) either:
(i) at least 14 days before making the application, the applicant gave written notice to the company of the intention to apply for leave and of the reasons for applying; or
(ii) it is appropriate to grant leave even though subparagraph (i) is not satisfied.

39 Ms Francois conceded that the plaintiff has satisfied the requirements in s 237(2)(a) and s 237(2)(e). The issues to be determined on the application for leave are therefore: (1) whether the plaintiff is acting in good faith: 237(2)(b); (2) whether it is in the best interests of Chilli #1 that leave be granted: 237(2)(c); and (3) whether there is a serious question to be tried: 237(2)(d).

Acting in good faith

40 In determining whether the good faith requirement in s 237(2)(b) is satisfied, it is appropriate to have regard to whether the plaintiff honestly believes that a good cause of action exists and has a reasonable prospect of success, and whether the applicant is seeking to bring the derivative suit for such a collateral purpose as would amount to an abuse of process: Swansson v R A Pratt Properties Pty Ltd (2002) 42 ACSR 313, per Palmer J at 320, [36]. Palmer J also said:

[37] These two factors will, in most but not all, cases entirely overlap: if the court is not satisfied that the applicant actually holds the requisite belief, that fact alone would be sufficient to lead to the conclusion that the application must be made for a collateral purpose, so as to be an abuse of process. The applicant may, however, believe that the company has a good cause of action with a reasonable prospect of success but nevertheless may be intent on bringing the derivative action, not prosecut it to a conclusion, but to use it as a means for obtaining some advantage for which the action is not designed or for some collateral advantage beyond what the law offers. If that is shown, the application and the derivative suit itself would be an abuse of the court's process: Williams v Spautz (1992) 174 CLR 509 at 526; 107 ALR 635 at 648. The applicant would fail the requirement of s 237(2)(b).

[38] Where the application is made by a current shareholder of a company who has more than a token shareholding and the derivative action seeks recovery of property so that the value of the applicant’s shares would be increased, good faith will be relatively easy for the applicant to demonstrate to the Court’s satisfaction. …

41 It seems to me important to note that the factor that Palmer J was referring to in paragraph [36] of Swansson was not whether the claim has reasonable prospects of success but whether the applicant honestly believed the claim had reasonable prospects of success. However his Honour went on to say that an applicant may be disbelieved in respect of such a claimed belief if “no reasonable person in the circumstances could hold that belief”: [36]. I do not think that his Honour intended that in dealing with the assessment of whether the applicant believed that the claim had reasonable prospects of success, the Court is required to assess the merits of the case. Having regard to the context in which the expression “acting in good faith” appears, I am satisfied that the legislature would not have intended that the Court should consider the merits of the claim in deciding whether the applicant has satisfied the requirements under s 237(2)(b) of the Act whilst requiring the Court to consider only whether the applicant has established that there is a serious question to be tried under s 237(2)(d) of the Act.

42 The test referred to by Palmer J that “no reasonable person in the circumstances could hold that belief” seems to me to be akin to deciding that the claim is “so lacking in merit or substance as to be not fairly arguable”: Degiorgio v Dunn (No 2) (2005) 62 NSWLR 284 per Barrett J at [28]. I will therefore consider the question of the plaintiff’s belief that the claim has a reasonable prospect of success on this basis.

43 In the present case the plaintiff did not give evidence of a belief that the claim has reasonable prospects of success. Rather she made a bald claim that she was "acting in good faith in seeking leave to bring these proceedings". There was no objection to that evidence, however it is necessary to consider all the circumstances of the claim to decide whether the plaintiff is acting in good faith.

44 The analysis of Chilli #1’s financial statements between 2001 and 2005 shows a steady increase in revenue from the operation of the surfboard business with the benefit of the use of Patents and Trade Marks as recorded in the Intangibles section of those financial statements. Although the Patents and Trade Marks are not particularised, it is probable that they were the Trade Marks lodged on 17 July 1998 and 19 August 1999. It is alleged that in breach of his fiduciary duty to Chilli #1 and in breach of his statutory duties as a director of Chilli #1 the defendant appropriated for himself the property of Chilli #1, being the Trade Marks and the goodwill of the company.

45 Ms Francois submitted that there are no reasonable prospects of success of the proposed claim because the evidence establishes that it was the defendant personally, rather than Chilli #1, who owned the Trade Mark lodged on 17 July 1998, and thus there is no property to be restored to Chilli #1. I will deal with this submission on the basis that the claim is so lacking in merit as to not be fairly arguable.

46 The defendant did not give evidence on this application. There was no evidence as to the arrangements that were made between the defendant and Chilli #1 for the use of the Trade Marks other than the Chilli #1 Licence Agreement. There is no evidence as to what happened when the Trade Marks disappeared from the Chilli #1 financial statements. However the entry in Chilli #1’s 2005 financial statements of a Receivable of $9183 for “James Cheal (Patents & Trade Marks)” suggests a purported purchase or other transaction in respect of those Trade Marks. The irresistible inference at this stage of the claim is that defendant decided to transfer the business operations into the new company, Chilli #2, leaving Chilli #1 with no source of revenue.

47 It seems to me, on the evidence in this application, that this claim is not so lacking in merit that it is not fairly arguable. Although the plaintiff did not descend into stating that she honestly believes that a good cause of action exists and has a reasonable prospect of success, I regard her evidence that she is acting in good faith as inclusive of such a belief and I accept that the plaintiff genuinely holds that belief.

48 There was no evidence in relation to any previous litigation or claims between the plaintiff and the defendant as a consequence of the break up of their relationship nor was it suggested to the plaintiff that she could obtain relief otherwise than involving Chilli #1 in litigation.

49 The plaintiff is a current shareholder who has more than a token shareholding seeks recovery for the purpose of increasing the value of her shareholding. However Ms Francois submitted the plaintiff’s real motive is to seek compensation for having helped the defendant establish the business when they were in a de facto relationship. In cross- examination, the plaintiff agreed that she did not own any land, property, shares other than those in Chilli #1, or a car. She also agreed that she did not have any savings and that her average net weekly income was $715 with rental outgoings per week at $270. The plaintiff rejected the suggestion that she was bringing the application because she had been in a relationship with the defendant and believes that he owes her something. The plaintiff was totally unaware of the transfer of the business operations from Chilli #1 to Cheal Industries or Chilli #2 until after the event. The defendant did not advise the plaintiff of his intention to remove the business from Chilli #1 and to set up a new company to operate the business.

50 Mrs Cheal gave evidence that she was not willing to provide financial support for Chilli #1 because she was not a shareholder and because the plaintiff had a shareholding in the company. Mrs Cheal also gave evidence that she did not consider buying out the plaintiff’s share in Chilli #1. When asked why she did not inform the plaintiff of the defendant's intention to transfer the business of selling surfboards to Chilli #2, Mrs Cheal said that she did not think what she and the defendant did "together as a couple" had anything to do with the plaintiff.

51 Although it is obvious that the plaintiff was in a relationship with the defendant for some years I am not persuaded that she is motivated by a collateral purpose in bringing these proceedings. It is true that Mrs Cheal was a friend of the plaintiff prior to commencing her relationship with the defendant, however that occurred in late 2003. The evidence does not support a finding that the plaintiff is pursuing this application for a collateral purpose.

52 I am satisfied that the plaintiff has established that she is acting in good faith in bringing this application.

Best interests of the company

53 The defendants submitted that even if I were to find that there is a serious question to be tried, the application should be rejected on the ground that it is not in the best interests of Chilli #1 that leave be granted.

54 The requirement of “the best interests of the company” was considered in Swansson by Palmer J as follows :

[55] At the outset, it is important to note that s. 237(2)(c) requires the Court to be satisfied, not that the proposed derivative action may be , appears to be , or is likely to be , in the best interests of the company but, rather, that it is in its best interests. …
[56] The requirement of s.237(2)(c) that the applicant satisfy the Court that the proposed action is in the best interests of the company is a far higher threshold for an applicant to cross. It requires the applicant to establish, on the balance of probabilities, a fact which can only be determined by taking into account all of the relevant circumstances.

55 His Honour proceeded to describe the relevant matters in relation to which the applicant would normally be required to adduce evidence. They include: (1) the character of the company (for example, whether it is a small private company or a large public listed company, as different considerations would apply); (2) evidence of the business of the company so that the effects of the proposed litigation on that business may be understood; (3) whether the substance of the redress that the applicant seeks to achieve is available by other means such that the company does not need to be brought into litigation to achieve the desired result; and (4) the ability of the defendant to meet at least a substantial part of any judgment in favour of the company so as to determine whether the action would be of any practical benefit to the company.

56 In Fiduciary Ltd v Morningstar Research Pty Ltd (2005) 53 ACSR 732 Austin J referred to the “best interests of the company” criterion as described in the Explanatory Memorandum to the Corporate Law Economic Reform Program Bill 1998, as follows at [44]:

6.38 This criterion would allow the Court to focus on the true nature and purpose of the proceedings. It would recognise that a company might have sound business reasons for not pursuing a cause of action open to it and that its management might legitimately have decided that the best interests of the company would be served by not taking action. For example, a decision may be taken in a case where, although it may be clear that there has been a breach of duty by a director, the loss to the company may only be nominal. In this case, the costs of taking proceedings may outweigh any benefit to the company.

6.39 The inclusion of this criterion would allow the Court to refuse to grant leave in these circumstances because the applicant for leave would not be able to show that to do so would be in the best interests of the company.

57 His Honour also referred to Charlton v Baber (2003) 47 ACSR 31 in which, after reviewing the expression “best interests” in the context of other areas of the law, including the parens patriae jurisdiction of the Court, trusteeship, and the field of unconscionability and undue influence, Barrett J concluded that it is an expression concerned with a “person’s separate and independent welfare”: [47]- [52]. In the context of this case, the question is whether, having regard to the separate and independent welfare of Chilli #1, it is in its best interests that leave be granted.

58 The defendants submitted that Chilli #1 is a very small company incorporated for the purpose of providing the defendant with a corporate structure for the business that he had been conducting as a sole-trader. It was submitted that the intellectual property the subject of these proceedings is, on its own, of little value because the “real value of the business” lies in the craftsmanship and personal labour of the defendant. In support of this submission, the defendant relied on the following evidence given by the plaintiff in cross-examination (tr 5-6):

Q. And would you agree that in shaping surfboards involves manual labour?
A. Yes.

Q. And would you agree that in so far as he is shaping surfboards, he is a craftsman?
A. Yes.

…

Q. The companies and organisations dealing with James learnt to trust his craftsmanship in his surfboards?
A. Yes.

Q. And those companies and organisations are buying a piece of work that’s been undertaken by James under his supervision?
A. Now, do you mean?

Q. I will time set it. When Chilli was incorporated and traded with Chilli Surfboards, the companies the Chilli #1 was dealing with were buying products that were shaped by James or someone under his supervision?
A. Yes.

59 The defendants argued that there is little, if any, benefit to Chilli #1 in having the intellectual property returned to it in the absence of the defendant. There is no evidence that the defendant would not return to Chilli #1 if the intellectual property were returned to it. However Ms Francois submitted that the Court could infer that the defendant would no longer manufacture surfboards for Chilli #1 given that he is now a director of Cheal Industries and Chilli #2 and that he has his “other life”. The defendants contended that it would therefore not be in the best interests of Chilli #1 for leave to be granted, particularly in light of the costs associated with the proceedings and the difficulty that Chilli #1 might have in meeting those costs. The reason Chilli #1 is in the particular financial position in which it finds itself is prima facie a direct result of the defendant transferring its business and intellectual property to Cheal Industries and/or Chilli #2.

60 The defendants submitted that the only remedy sought by Chilli #1 is the return of the intellectual property, that is, an order setting aside the Assignment Agreement. However in paragraph 10 of the Amended Originating Process the plaintiff seeks an order that the defendants pay equitable compensation or damages for the plaintiff’s loss in value resulting from the alleged breaches of duty. The recovery of equitable compensation from a director alleged to have breached his duties can be of practical benefit to a company: Gerard Cassegrain & Co Pty Ltd v Cassegrain; Cassegrain v Gerard Cassegrain & Co [2010] NSWSC 91 per Austin J at [114].

61 In Showtime Management Australia Pty Ltd v Showtime Presents Pty Ltd [2008] NSWSC 618, Austin J, in dealing with the “best interests of the company” requirement in a case that involved claims in relation to intellectual property rights in respect of shows referred to as QIAKM and CW, said:

[97] … According to the evidence of Mr Van Grinsven, the Company cannot produce the QIAKM and CW shows without his co-operation. However, assuming that to be correct, it does not follow that the Company will be unable to operate if the derivative action is successful. The derivative action might lead, for example, to a negotiated buy-out of Mr Anderson's interests by Mr Van Grinsven or to the sale of the business to a third party, with the co-operation of Mr Van Grinsven. There is also the prospect that Mr Anderson's concurrent oppression proceedings may lead to some form of relief that will re-establish the company's business. On balance, it seems to me more likely than not that the company's interests will be best served by establishing its rights and putting it in a position to negotiate a favourable outcome, one-way or another, for itself as a separate entity.

62 If the plaintiff succeeds in proving that the defendant’s transfer of the business out of Chilli #1 was in breach of his fiduciary duty and/or statutory duties, the plaintiffs could obtain an order for the return of the Trade Marks or equitable compensation. It seems to me that Chilli #1’s interests would be best served by putting it in the position to negotiate a favourable outcome for itself as a separate entity. This was an opportunity that was denied to Chilli #1 when the defendant purportedly sold himself the Trade Marks and commenced operating a business in direct competition with Chilli #1. The Financial Statements of the defendants and the Trustees establish that there is an ability to meet at least a substantial part of any judgment in favour of Chilli #1. In those circumstances there would be a practical benefit to Chilli #1 in granting leave to the plaintiff to bring the proposed action.

63 The plaintiff has satisfied the requirement in s 237(2)(c) of the Act.

Serious question to be tried

64 The defendants submitted that there is no serious question to be tried in respect of the claim that the defendant breached his duties to Chilli #1 by misappropriating its intellectual property and associated goodwill because: (1) the relevant intellectual property belonged to the defendant and not Chilli #1; and (2) there is no evidence in the accounts to indicate that Chilli #1 in fact owned any goodwill.

65 The defendant drew a distinction between Trade Mark 767677, which relates to “surfboards” and associated surfing equipment, and Trade Mark 804353, which relates to “clothes, headgear and footgear”. It was submitted that because Trade Mark 767677 was lodged by the defendant on 17 July 1998, one year before the incorporation of Chilli #1 and at a time when the defendant was operating as a sole-trader, the entry in the accounts of Chilli #1 for “Patents and Trademarks” of $9,183 could only relate to Trade Mark 804353. It was submitted that this Trade Mark is irrelevant to the proposed proceedings because Chilli #1 has never been engaged in the business of “clothes, headgear and footgear”.

66 It was only after the defendant and Mrs Cheal were married that the financial statements of Chilli #1 were adjusted to include the Receivable described as “James Cheal (Patents & Trade Marks)”. There is no evidence of the underlying transaction that such entry purports to reflect, albeit that the Chilli #1 Licence Agreement describes the defendant as the “Owner” of the Intellectual Property defined to include Trade Marks. This raises the serious question as to whether Chilli #1 owned the Trade Marks prior to that entry in its accounts.

67 There is also the purported assignment of the intellectual property to the Trustee on 9 February 2006 without apparent notice to Chilli #1. This appears to be a step along the way of transferring Chilli #1’s business to Chilli #2 or Cheal Industries. On the evidence on this application there is a serious question to be tried in relation whether the defendant was in breach of his fiduciary duty to Chilli #1 in effecting the transfer of the business from Chilli #1 to Chilli #2 and/or Cheal Industries.

68 It was submitted that the defendant, as the owner of the relevant Trade Mark, and in the absence of any claims for breaching any agreement in relation to its use, is free to deal with it as he chooses. It was further submitted that in those circumstances there can be no serious question to be tried as to whether the defendant breached his duties to Chilli #1.

69 The accounts of Chilli #1 establish that from 2001 to 2004, the company owned intellectual property worth $9,183 and recorded it as “Patents & Trademarks” under the heading “Intangibles”. I do not accept the defendant’s submission that this figure must only relate to Trade Mark 804353. It is common ground that Chilli #1 has never been engaged in the business of “clothes, headgear and footgear”. It would seem unlikely that the only intellectual property reflected in the company accounts for a period of four years was a Trade Mark that the company never used.

70 It is also apparent that at some point during the year ending 30 June 2005, the defendant purported to purchase or use/lease Chilli #1’s intellectual property, reflected in the company’s accounts as a current receivable of $9,183 for “James Cheal (Patents & Trademarks)”. The close proximity between this event and the subsequent entry into the Chilli #1 Licence Agreement suggests that the intellectual property reported in Chilli #1’s accounts relates to Trade Mark 767677, that the defendant purported to purchase it and that it was licensed back to the company in exchange for a fee of $10.00 for each surfboard manufactured by Chilli #1.

71 There is a serious question to be tried as to whether whether the defendant breached his duties to Chilli #1 in obtaining that property by procuring the above-mentioned agreements. I do not accept the submission that there was no goodwill in the business because none was recorded in the financial statements of Chilli #1. The Assignment Agreement referred expressly to “the goodwill held in the Intellectual Property”: (cl 7). In any event the growth in the operating sales revenue of Chilli #1 was clearly a result of the willingness of certain surf shops to remain as customers of the business. It is apparent from the evidence that most of the sales of surfboards were to surf shops for resale. Although there is no evidence identifying the particular customer base, it is clear that there would have been goodwill in this business.

72 I am satisfied that there are serious questions to be tried in the proposed claim and that the requirement in s 237(2)(d) is satisfied.

Orders

73 Apart from those parts of the proceedings in which the first plaintiff, Simone Fitzpatrick, seeks relief on her own behalf, the first plaintiff is granted leave under s 237 of the Corporations Act to bring these proceedings on behalf of the second plaintiff, ACN 098 142 870 Pty Ltd.

74 The parties are to prepare Short Minutes of Order reflecting this outcome and including an agreed order for costs and a timetable for the preparation of the matter for hearing. I list the matter for the purpose of making those orders and hearing any argument as to costs if the parties are unable to reach agreement in this regard on 9 July 2010 at 10 am.

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