Harrington v Sensible Funerals P/L
[2007] SASC 66
•2 March 2007
SUPREME COURT OF SOUTH AUSTRALIA
(Civil)
HARRINGTON v SENSIBLE FUNERALS P/L & ORS
[2007] SASC 66
Judgment of The Honourable Justice Duggan
2 March 2007
CORPORATIONS - MEMBERSHIP, RIGHTS AND REMEDIES - MEMBERS' REMEDIES AND INTERNAL DISPUTES - OPPRESSIVE OR UNFAIR CONDUCT - RELIEF - GENERALLY
CORPORATIONS - MANAGEMENT AND ADMINISTRATION - OFFICERS OF CORPORATION - DIRECTOR - APPOINTMENT - BY OTHER DIRECTOR OR DIRECTORS
Dilution of plaintiff's original shareholding in company - whether defendants acted in an oppressive, unfairly prejudicial and unfairly discriminatory manner pursuant to s 232 of The Corporations Act 2001 (CA) - company set up in the form of a quasi-partnership - agreed that founding members to each hold 50 per cent interest in the business - unlawful removal of plaintiff as director of company by 2nd and 3rd defendants - shareholder loan agreement a means by 2nd and 3rd defendants to dilute shareholding of plaintiff - Held: order made pursuant to s 233 of CA to set aside various share allotments and restore plaintiff's original shareholding.
The Corporations Act 2001 s 232, 233, referred to.
Fexuto Pty Ltd v Bosnjak Holdings Pty Ltd (2001) 37 ACSR 672; Raymond v Cook (1998) 29 ACSR 252; Re Bagot Well Pastoral Company Pty Ltd (1993) 61 SASR 165; Ebrahimi v Westbourne Galleries Ltd [1973] AC 360, applied.
HARRINGTON v SENSIBLE FUNERALS P/L & ORS
[2007] SASC 66Civil
DUGGAN J. This action arises out of a dispute between shareholders of a company which conducts a funeral business. The share register of the company records that the plaintiff holds 23.9 per cent of the issued share capital. According to the plaintiff, he is entitled to 50 per cent of the issued share capital. The essence of his claim is that his original shareholding of 50 per cent was diluted by a manipulation of the company’s affairs by the second and third defendants who are shareholders and directors of the company. The plaintiff alleges that this conduct was oppressive to, unfairly prejudicial to and unfairly discriminatory against him within the meaning of s 232 of The Corporations Act 2001 and he seeks orders pursuant to s 233 of that Act, including the setting aside of various share allotments so as to restore his shareholding to 50 per cent ownership of the issued shares.
The first defendant is the company which has indicated it will abide by the orders of the court. The plaintiff, Mr Harrington, met Mr Russell, the second defendant, in 1992 at an Association of Funeral Directors meeting. Mr Harrington was 25 years of age at the time. Mr Harrington’s father, Mr Richard Harrington, operated a small family funeral company and Mr Harrington helped out with the operations of the business. Mr Russell is an experienced funeral director who has formed and operated a number of funeral businesses.
According to Mr Harrington, Mr Russell suggested that they form a partnership to conduct a funeral business. A company was incorporated and they started out on a “shoestring budget”.
Mr Harrington said that, in the course of the discussions which led to the setting up of their partnership, it was agreed that they would be equal partners. He gave evidence that he thought that only himself and Mr Russell would be involved, but he said that, in due course, Mr Russell said that his partner, Ms D’Andrea the third defendant, would share Mr Russell’s half-share.
The business commenced with very few facilities and it was agreed that, initially, the company would use some facilities and equipment owned by the plaintiff’s father. These included mortuary facilities, a vehicle and the use of a refrigerator for the storing of bodies.
A proprietary company to conduct the business was incorporated on 6 July 1999. The original name of the company was “Funerals for Life Pty Ltd”, but on 27 January 2000 the company’s name was changed to “Sensible Funerals Pty Ltd”. The company commenced business on 27 January 2000. Initially, it leased premises at Richmond.
It is common ground that the business commenced pursuant to an oral agreement which was negotiated between Mr Harrington and Mr Russell from late 1999 to early 2000. It is agreed that one of the terms of the original agreement was that Mr Harrington and Mr Russell would each have a 50 per cent interest in the business. When Ms D’Andrea became involved, it was agreed that the initial capital contributions would be $5,000 by Mr Harrington and $5,000 by Mr Russell and Ms D’Andrea jointly. This resulted in Mr Harrington being issued with 5,000 $1.00 fully paid ordinary shares and Mr Russell and Ms D’Andrea each being issued with 2,500 $1.00 fully paid ordinary shares.
The original directors were Mr Harrington and Ms D’Andrea.
According to the company records, Mr Harrington was a director from 27 January 2000 to 10 July 2000. He was re-appointed a director on 1 January 2003. Ms D’Andrea was a director from 6 July 1999 to 31 March 2003. Mr Russell was appointed as a director by Ms D’Andrea under the casual vacancy provision in the company’s constitution on 10 July 2000 when there was a purported termination of Mr Harrington’s directorship.
Mr Harrington said in evidence that his father did some work for the company in the first year of its operation. He said his father helped with the transfer of bodies and, as previously mentioned, he assisted by supplying a vehicle and a refrigerator.
In June or July 2000, there was a meeting at Ms D’Andrea’s home attended by Mr Russell, Ms D’Andrea, Mr Harrington and Mr Harrington senior. Mr Russell said he asked what involvement Mr Harrington senior wanted in the company. Mr Harrington said his father would be there to advise and help him. Mr Russell said that he did not like the idea of Mr Harrington senior being involved in any way. Mr Harrington senior reacted by saying that he was going to withdraw the facilities he had made available for use by the company. Mr Harrington said that, a short time later, Mr Russell told him that Ms D’Andrea’s son was going to come and work for the company.
On 3 July 2000 Ms D’Andrea wrote to Mr Harrington to advise him that as of 1 July 2000:
the office held by you as a Director of Sensible Funerals Pty Ltd has been declared vacant by reason of the operation of Clause 60(5) of the Constitution of the company, and that any contract entered into or intended to be entered into with any party or parties in which you have an interest, in particular Richard Harrington or Richard Harrington Funeral Services Pty Ltd or generally any other party which is in competition with Sensible Funerals Pty Ltd is, or will be, void.
The letter went on to state that Ms D’Andrea had invited Mr Russell to seek appointment as a director and that he had accepted.
The letter continued:
The Board of Directors has also resolved to invite you to be appointed as General Manager of the company, on terms to be negotiated, and that invitation will remain open up to and including July 6th 2000.
The Board also advises that should you accept the General Manager’s position, it has no objection to your engaging the services of either of the parties mentioned in paragraph 1 above, on a strictly casual basis to conduct removals for the company.
It would appear that the reference to clause 60(1) of the Constitution should have been a reference to clause 61(5) which states:
In addition to the circumstances in which the office of a Director becomes vacant by virtue of the Law, the office of a Director becomes vacant if the Director:
. . . . . .
(5)is directly or indirectly interested in any contract or proposed contract with the Company and fails to declare the nature of his interest as required by the Law (subject to the exception in Section 231(10) of the Law [Corporations Law] where the Director is the sole Director and the sole member of the Company).
Mr Harrington said he consulted solicitors about his removal as a director. Subsequently the solicitors wrote to Ms D’Andrea, in a letter dated 5 July 2000, to the effect that Mr Harrington’s position as director had not become vacant and the purported appointment of Mr Russell as a director was unlawful. The letter also stated:
Scott’s [Mr Harrington’s] connection with Richard Harrington Funeral Services is well known to you and there was no need to disclose that connection. Clause 61(5) of the Constitution refers to situations where fellow directors are not aware of any interest or connection which another director may have in a proposed contract.
Mr Russell gave evidence that Mr Harrington told him he had given his father the contract to carry out all the body removals and store the bodies for a fee of $120.00 for each removal. Mr Russell said that Mr Harrington told him the arrangement had started on that day. Mr Russell said there had been no consultation beforehand about this arrangement.
Mr Russell said that he told Mr Harrington that the contract with his father was “not on and would not happen”. He then gave the following explanation in his evidence for Mr Harrington’s removal as a director:
In my mind Richard Harrington, who appeared to me totally dominated Scott, had decided to move in and take over the business. The solution which I proposed and which Scott accepted with apparent relief was that June [Ms D’Andrea] and I would remove him as a director and I would replace him. Scott would then be genuinely powerless to fulfil the contract and Richard, the father, would have to deal directly with me. I recollected Scott saying that he had a friend who was a lawyer and he could get a letter to make it look as though Schott had tried his best to stay as a director and give his father the contract. In the same letter that we wrote advising Scott of his replacement as a director we appointed him general manager and life went on exactly as before. Scott was treated thereafter as if he was still the director and Richard retreated from the scene. Since we knew that the letter – the lawyer’s letter was a fiction for Scott’s father’s benefit we just ignored it. In any event, every single player knew the reason for Scott’s replacement and his agreement to it. The reinstatement of Scott as a director occurred exactly as [had] been intended and in the intervening period he acted in all respects as if he was a director and claims as much in his pleadings.
Mr Russell’s explanation of Mr Harrington’s removal as a director appears to be inconsistent with an explanation he gave in an affidavit sworn on 7 July 2004 in relation to an application to wind-up the company. In the affidavit he explained his understanding of what he was told about the role of Mr Harrington senior:
During the period March 2000 to June 2000 Sensible conducted about 45 funerals. Harrington with the assistance of his father Richard Harrington provided storage facilities for Sensible and another business Lady Claire Funerals which was operated by June. In June 2000 Harrington told me that his father would not provide the storage facilities unless he also did the pickups for an amount of $120.00 per service. On about 26 June 2000 Harrington failed to provide the storage facilities which he had promised to enable Sensible to conduct several funerals. Nor did he ever again provide such facilities.
He went on to say in the affidavit that he considered Mr Harrington’s requirement for the payment to his father of an additional fee for storage facilities to be a breach of the original agreement.
In para [10] of the affidavit Mr Russell said:
Because of Harrington’s failure to provide storage facilities and the growth of the funeral business conducted by Sensible further capital was required for the purchase of plant and equipment. On 10 July 2000 Harrington was replaced as a director of the company but remained as the General Manager. Harrington told me he obtained advice about this change as a director and had decided not to pursue the issue.
There is no mention in the affidavit of the removal of Mr Harrington as a director as being no more than a ruse to placate Mr Harrington senior.
Mr Russell’s evidence is also at odds with a letter he wrote to Mr Harrington, which was received by him on 3 July 2000. Mr Russell said in the letter:
I have assumed that you will now come under pressure to attempt to restore your directorship, probably through the Courts, but for the survival of the company, I have no choice but to defend any such action with all means at my disposal. If this is to be the case, then the internal struggle (if it should occur) will become very public. I am not in any way concerned for myself, but I would much prefer that we could continue to work together at what I believe we do very well, and for this reason I have proposed that you take up the appointment as General Manager. I think that we can forget about any buy out by a bigger company, so there is no reason why you cannot assume a more prominent role, if you want to.
Mr Harrington said in evidence that Mr Russell told him he was no longer a director. According to Mr Harrington, Mr Russell said this came about because he (Mr Harrington) was unable to make hard decisions. Mr Harrington said he took legal advice and his solicitors wrote the letter to Ms D’Andrea. He said he also told Mr Russell that he could not be removed as a director. According to his evidence, nothing further was said and he assumed he remained as a director.
There was no basis for removing Mr Harrington as a director pursuant to the company’s Constitution. This was not a case of a failure to declare a direct or indirect interest in a contract or proposed contract with the company as envisaged by cl 61(5) of the Constitution. The dispute arose because Mr Harrington revealed the proposal to remunerate his father. Furthermore, I find that Mr Harrington did not agree that he should be dismissed in order to provide an excuse for not going ahead with an arrangement entered into between him and his father. There is no suggestion in his evidence that he agreed to take part in a sham in order to placate his father.
I find that Mr Russell and Ms D’Andrea set out to remove Mr Harrington as a director in order to give them greater control over the administration of the company. I reject the claim that his removal was a sham in order to provide Mr Harrington with a reason to give to his father as to why he could not provide support for his father’s continued involvement in the company.
Share issues from 24 July 2000 to 4 July 2001
I have said that, originally, Mr Harrington held 5,000 shares and Mr Russell and Ms D’Andrea each held 2,500 shares.
Further share issues were recorded in the Company Share Journal over the period 24 July 2000 to 4 July 2001. The register indicates that 5,000 shares were issued to each of Mr Russell and Ms D’Andrea on 24 July 2000 and a further 5,000 shares to Mr Russell on 2 February 2001 and Ms D’Andrea on 29 January 2001. Then, on 4 July 2001, 20,000 shares were issued to Mr Harrington. After these issues, Mr Harrington remained the holder of 50 per cent of the issued shares in the company.
There was little said in evidence about these transactions. However, it is common ground on the pleadings that Mr Russell told Mr Harrington at this time that it was necessary to put more money into the company and that it was agreed there would be some delay before Mr Harrington put in his contribution. All of these shares were issued at par value.
The shareholder loan agreement
According to Mr Harrington’s case, Mr Russell and Ms D’Andrea then set out to increase their shareholding so as to dilute the shareholding of Mr Harrington. This process, so it was said, began with the signing of a document entitled “Shareholder Loan Agreement” dated 29 June 2001.
The agreement was between Sensible Funerals Pty Ltd on the one hand and Mr Harrington, Mr Russell and Ms D’Andrea who were referred to as “the Mortgagees”. The recital states that the mortgagees wished to lend and the company, by its directors, had resolved to borrow from the mortgagees, the sums of money set out in the first schedule to the agreement.
The agreement then provides for an interest rate of 5 per cent per annum with the monies repayable by the company no later than 31 December 2001.
A repayment schedule provides that the company’s repayments are to be made in instalments of one-sixth of the amount outstanding to each mortgagee to be paid on the first day of each month. A default clause provides as follows:
In the event that the Company shall default or be in arrears of either interest payment or capital repayment, the Mortgagees may, at their option, jointly or severally,
(a) require the Company to liquidate such assets as are necessary to satisfy the terms and conditions of this agreement, or
(b) require that the Company issue fully paid up $1 ordinary shares in lieu of the outstanding balance or balances, or part-balance or part-balances.
The First Schedule is as follows:
Name of Mortgagee
Amount of Loan
1 Scott Richard Harrington
$20,747.00
2 June Dorothea D’Andrea
$38,209.00
3 Keith Arthur Russell
$38,209.00
The agreement was signed by Ms D’Andrea and Mr Russell as directors of the company and by Mr Harrington, Ms D’Andrea and Mr Russell as mortgagees.
In view of the provision in the repayment schedule that one-sixth of the amount outstanding was due on the first day of each month, the first instalment was due two days after the date of the agreement, namely, 1 July 2001.
The evidence discloses that the company paid the instalments for 1 July and 1 August. However, it was determined that the company defaulted in respect of the third instalment due on 1 September 2001. There is no record of who made that assessment or why it was made. The minutes of a directors meeting held on 5 September 2001 record the following resolution:
Resolved that:
The Company issue new shares in accordance with the shareholder agreement dated 29/4/2001 (Copy annexed)
Scott Harrington issued 20,747 shares
June D’Andrea issued 38,209 shares
Keith Russell issued 38,209 shares
The result of these events was that Mr Harrington’s 50 per cent share in the company was reduced to approximately 33 per cent.
There are a number of comments to be made about this agreement.
If the company was in need of working capital, it is unclear why the directors could not leave the profits in the company for that purpose. Alternatively, the capital could have been raised by way of shareholder loans to the company on commercial interest rates. In view of the understanding which the parties had reached earlier that there be equal shareholdings, there was no good reason for an agreement of this nature. When this was put to Mr Russell in cross-examination, he said the only reason why the raising of capital had taken place in this way was because “that was the agreement we came to”.
The amounts recorded in the schedule as loans ensured that, in the event of default by the company, the combined shares issued to Mr Russell and Ms D’Andrea by reason of the company’s default would be almost four times the number of shares issued to Mr Harrington. There was no reason disclosed by the evidence as to why he would so readily abandon his determination to maintain a 50 per cent holding by being involved knowingly in such a transaction.
Next, there is the question of how the amounts of the loans in the First Schedule to the shareholder loan agreement were calculated. These amounts, in turn, determined the number of shares to be issued to each shareholder in the event of default on the loan.
Mr Russell said that the funds for the loans were characterised as shareholder bonuses. He said the amount of each bonus was calculated on the basis of a “return on investment”. He said it was worked out based upon how much money had been contributed by each shareholder for share issues over the period from 1 July 2000 to 30 June 2001. As Mr Harrington had not made certain contributions until after Mr Russell and Ms D’Andrea, the bonuses which he received were significantly lower. According to Mr Russell, purchase monies for shares by Mr Harrington had been available to the company for less time than the monies advanced by Ms D’Andrea and himself and this justified higher bonuses for Mr Russell and Ms D’Andrea. This is reflected in the first schedule.
Mr Russell said that Mr Harrington asked what would happen if the loan was not repaid by the company and Mr Russell said it was decided to add a clause enabling any shareholder to convert the loans into shares in the event of default. The linking of these amounts to entitlements to pro-rata share purchase options was tenuous and gave rise to a clear potential for an unfair dilution of the plaintiff’s shareholding.
Finally there was the assertion that the company had defaulted. The agreement provided for repayments at the rate of one-sixth of the amount outstanding to each mortgagee on the first day of each month. The total amount of each instalment for all loans was $16,194 plus interest at 5 per cent on the outstanding balance of the loan. As I have pointed out, the first instalment was due on 1 July 2001, two days after the signing of the shareholder loan agreement. The first two instalments were paid. The third instalment was due on 1 September 2001. Mr Russell was cross-examined about the decision to declare that the company was in default:
A… Now I can’t remember all the discussions that went on but a decision was taken, okay, we’re not going to be able to safely make the next payment. So what do we do, so what I think, I hadn’t thought of and certainly Scott didn’t think about was the fact that if anyone of us exercised that option, then the others would just about have to follow and that’s what happened. I can’t remember who triggered it but I suggest it might have been June. I can’t be sure, I don’t think it would have been me and I don’t think it would have been Scott so June’s the suspect.
QSo what you want his Honour to accept is that in September 2001 rather than have the company make one-sixth instalment payments off the debt, you and June D’Andrea and Scott Harrington agreed that there would be a share allotment to you and June of four times his share allotment; that’s what you want his Honour to accept?
AYes, well there were two of us so it was going to be two times anyway, so, yes, I would have to say yes.
. . . . . .
QAnother way to do all of this is, don’t you agree, is to treat undisturbed profits as being available capital for the company for its working capital rather than make share distributions at all?
AI would agree there’s probably a dozen ways of doing this and everyone of them would have been better. This was a messy document, it was very messy, I agree with that.
QSo there was no reason why there had to be any actual dividend distribution made to – or salary payments made out of profit to the shareholders and then they lend it back and have an instalment arrangement and then convert that into share allotments which gave you and Ms D’Andrea four times the amount of shares as it gave Mr Harrington. There was no reason in the world to do that, was there?
AThere are plenty of other ways it could have been done. I agree, no reason. Why we picked that way, I can’t remember.
Mr Russell agreed that the company was always able to pay its debts to creditors on time. The bank records show an increase over time in the credit in the company’s bank account. The financial records of the company indicate that the business was profitable.
On 1 September 2001 the company had a credit balance of $47,045 in its bank account. The credit balance rose to $65,975 on 4 September and $78,121 on 6 September. The average daily credit balance for September was $57,935. An examination of the bank account records for the remainder of September do not reveal any debits which substantially reduced the credit balance. The credit balance stood at $63,131 at the end of September.
There would seem to be no reason why the instalment due under the shareholder loans agreement could not have been paid on 1 September 2001 and on subsequent occasions when the instalments were to fall due. The evidence as to why it was decided that there were insufficient funds was unsatisfactory. Mr Russell was unable to recall the details. As I have said, there is nothing in the pattern of the banking or the other financial statements of the company which would support an assessment that the instalment for September 2001 could not be met.
Mr Russell and Ms D’Andrea were in a position where they could control the situation and declare that the company had insufficient funds. It was to their advantage to make this assessment and to the disadvantage of Mr Harrington.
I find that Mr Harrington was prepared to sign the shareholder loan agreement without having a real understanding of it or its implications. I have reached the firm conclusion that he is naive in matters of business and Mr Russell has a forceful nature. In the course of his evidence Mr Russell said:
A… I’ve got to say that if you’re putting to me that a lot of what went on, which was agreed to by Scott, came from me I’d have to say “yes”, I regarded myself, in some respects, as a mentor. There were things that I had to explain in detail to Scott and I did.
I accept that Mr Harrington consulted his accountant from time to time, but there is no evidence that the implications of the shareholder loan agreement were explained to him. I find that he was not involved in the all important assessment that the company had defaulted and that the appropriate course to take was to issue shares in the proportions in which they were issued. Although he signed the agreement, I am confident that he did not knowingly take part in what was an artificial arrangement which led to his percentage shareholding in the company being significantly reduced.
I accept Mr Harrington’s evidence as to when he became aware that he was no longer a 50 per cent shareholder:
A… It wasn’t until I paid my $20,000 in, it was quite sometime after that actually, I was on a phone call conversation and I was on the phone with June at the time and we were discussing a client that hadn’t paid the account, and I stressed “Well, it’s pretty important for him to come back in” because, you know, I consider that the profits from the funeral – you know, that’s 50% of my profits, and June then told me “Oh, no no, you don’t have 50%, you only have a 33 and a third per cent share”.
QWhen was that?
AThat was on a phone conversation. I couldn’t tell you the exact date. It was well after I put $20,000 in.
QWas it that year or the year after or the year after that?
AIt may have been towards the end of the year, I imagine. It might have even been early in the year after.
QWas that the first time you’d heard of that suggestion?
AAbsolutely.
It is acknowledged that Mr Harrington was particularly anxious to maintain his 50 per cent shareholding. Mr Russell was aware of this from the start. In a note to Mr Harrington which he received on 3 July 2000 Mr Russell said:
As a 50% shareholder, you are sitting on the opportunity of a lifetime, and what has transpired makes not the slightest difference to the fact that we agreed in the beginning, on a 50:50 deal, and that will not, as far as I am concerned, change in any way unless you choose to change it, whether you stay and help, or not. The opportunity is there for you to sit back, do nothing, and go for the ride if you wish, but if you want to stay in and help, that’s fine too.
Then, in a note which Mr Russell sent to Mr Harrington which has no date but which Mr Russell said was written between 5 September 2001 and 11 November 2003, Mr Russell wrote:
Scott:
I told you some time ago, that I would not prevent you from acquiring further shares to achieve a 50% shareholding in the company.
To resolve this matter of the 50% shareholding, for once and for all, I propose to hold a full meeting of the Board of Directors, and move the following resolution:
“That the company offer to its shareholders, 11339 new shares, at a premium to be determined on the basis of its current valuation.”
If the motion is passed, which it will be, because you and I will vote in favour, then I undertake that neither June nor myself will take up the offer, on the condition that your acceptance is limited to 37164 new shares.
This will make you a 50% shareholder.
It is important to note that these shares were being offered at the current valuation and not at par value.
Share allotments in November 2003 and May/June 2004
There were two further occasions when there were allotments of shares associated with the raising of capital.
In 2003 it was decided to purchase business premises at Ridleyton for the purpose of relocating to that site. Capital was raised from contributions by Russell, D’Andrea and Harrington. The following contributions were made:
K Russell $41,686
J D’Andrea $41,686
S Harrington $42,629
Shares were issued on a pro rata basis by reference to the amounts contributed.
The amounts contributed were determined by reference to the percentage shareholdings of the three shareholders. It is apparent that the diminution in the plaintiff’s shareholding as a result of the shareholder loan agreement had an ongoing effect so that the plaintiff’s percentage shareholding was further reduced as a result of this share issue.
Then, in early May 2004 it was decided to fit out premises which the company had leased. These premises were adjacent to the Ridleyton property. In May and June 2004, Russell and D’Andrea contributed $49,999 each to the company and were each allotted 49,999 shares. This was part of a pro rata offering of shares to the shareholders.
Mr Harrington sought legal advice at about this time and did not take part in the subscription.
The conduct of the trial
When the case began, Mr Harrington, Mr Russell and Ms D’Andrea were unrepresented. Mr Harrington gave evidence and Mr Russell commenced his cross-examination.
On the second day of the trial, Mr Ross-Smith announced his appearance for Mr Harrington. The trial proceeded with Mr Russell unrepresented. The only other witness called on behalf of Mr Harrington was Mr Ellery who gave evidence concerning his valuation of the company.
Mr Russell opened and called Mr Harrington senior. He also gave evidence himself and called Ms D’Andrea, Ms Robyn Warren and Ms Christine Williams.
Ms Warren is a supplier of memorial cards to Sensible Funerals. She said that, on one occasion, she had a conversation with Mr Harrington in the course of which he told her that he was a major shareholder in the company and Mr Russell was a minority shareholder. She also referred to a conversation with Mr Harrington senior which is not of relevance to the case. The conversation with Mr Harrington was not put to him when he was giving evidence but, in any event, the evidence does not assist the case for the defendants.
Ms Christine Williams, an employee of the company, gave evidence that Mr Harrington would often look at spreadsheets on the computer after they had been prepared by Mr Russell. She said Mr Harrington also spoke to his accountant on a regular basis.
Mr Ross-Smith pointed out on a number of occasions during Mr Russell’s evidence that he was making assertions which had not been put to Mr Harrington. However, he did not apply to recall Mr Harrington.
The contingency plan
Mr Russell was cross-examined about a document which he prepared pending the hearing of this matter. The document came to light in the course of an action by Mr G Stevens, a barrister, against Mr Russell. Mr Stevens was, for a time, a director of Sensible Funerals Pty Ltd.
On its face, the document discloses a plan to ensure that, if Mr Harrington were successful in the present action, he would not be advantaged financially.
The document, which was addressed to Mr Stevens, reads as follows:
1I will resign as both employee and Director of Sensible Funerals Pty Ltd.
2June will incorporate Keith Russell Funerals Pty Ltd.
3I will take up employment with June’s company.
4Sensible Funerals Pty Ltd will not use my name or image in any advertising.
5Keith Russell Funerals will use all the existing advertising.
6Sensible Funerals Pty Ltd will lease all the assets to Keith Russell Funerals Pty Ltd, for an amount exactly equal to the mortgage payments to BankWest. Any liquid assets will run down over time as income stops and employment costs continue during the interim period.
7I will not pay Scott’s award of costs, and a Trustee in Bankruptcy will be appointed to sell my one and only remaining asset, my 38% shareholding in a company that will never pay a dividend, and cannot be liquidated because the majority of shareholders will ensure its solvency.
8If the Trustee can ever sell the shares, it will be for a pittance. I will probably offer just enough to cover his fees. Scott gets nothing.
9At the end of the day, I am Bankrupt again, but still doing exactly what I am doing now.
10When the dust has settled, (1) June, as the sole shareholder and director of Keith Russell Funerals, will issue 76 shares to herself, and 24 to Greg Stevens. Or, (2) If I have re-acquired the shares, Keith Russell Funerals Pty Ltd can just sit on the shelf, or be used for some other purpose.
11No asset has been transferred, nothing has changed hands. Nothing which has been done is reversible or preventable by a Trustee. Everything is open and above board.
12The Russians called it a “Scorched earth Policy”, the Iraquis call it a “Jihad”, I call it “Moving over and taking all the goodies with me”.
Mr Stevens replied to the proposal pointing out the difficulties associated with it and advising that he was not prepared to participate in or condone such an arrangement.
Mr Russell said in evidence that it was not his intention to put the plan into effect but he wanted the solicitors for Mr Harrington to see the contingency plan so as to discourage them.
The contingency plan is a matter which is relevant to take into account in assessing Mr Russell’s motives and credibility.
The valuation agreement of 7 September 2004
On 7 July 2004 Mr Russell issued proceedings seeking to wind up the company. Mr Harrington sought to intervene in the proceedings and apply to have a receiver appointed to sell the business. When the matter was listed for hearing, the parties reached an in principal agreement which was formalised by an agreement in writing dated 7 September 2004.
The parties agreed that Mr Harrington would sell Mr Russell his shareholding in the company. It was acknowledged that the court in the present action would have to determine the extent of Mr Harrington’s shareholding. It was also agreed that Mr Brenton Ellery, an accountant, would be instructed to value the company and that the parties would be bound by that valuation.
In due course, Mr Ellery valued the company at $876,782. According to Mr Ellery, the value of the net business assets was $843,750. To this, he added loans to shareholders of $33,032. The valuation did not take into account the value of any loans to the company by shareholders.
In accordance with the purpose of the agreement of 7 September 2004, Mr Ellery provided valuations based on Mr Russell’s claim that Mr Harrington held 23.9 per cent of the shares and, alternatively, on the basis of Mr Harrington’s claim that he was entitled to 50 per cent of the company’s shares.
Mr Ellery summarised his opinion as follows:
10VALUATION OF COMPANY
10.1For the reasons set out above, I value the net business assets of Sensible Funerals Pty Ltd at $843,750. In addition, it has loans to shareholders of $33,032 in the balance sheet at 30 June 2004. Accordingly, I consider that the value of the company, excluding any loans from shareholders, to be $876,782.
11VALUATION OF HARRINGTON INTEREST – ALTERNATIVE 1
11.1Alternative 1 assumes that the company has issued shares of 340,774, and Mr Harrington holds 81,460, or 23.9%.
11.2On that basis, his shareholding has a value of $209,551.
11.3Mr Harrington would be liable to the company for his loan of $15,294. I note that Mr Harrington has not accepted this liability. If it is found to not exist, it should also be excluded from the assets of the company referred to in 10.1 above.
12VALUATION OF HARRINGTON INTEREST – ALTERNATIVE 2
12.1Alternative 2 assumes that the company has 50,000 issued shares, of which Mr Harrington holds 25,000.
12.2The alternative also assumes shareholder loans of $225,999. The financial statements show loans of $304,810 and Mr Russell has explained the difference as undrawn profit entitlements. I have assumed that the loans should be considered to be $304,810.
12.3Allowing loans of $304,810, the net value of all of the issued shares would be $876,782 less $304,810, or $571,972.
12.4Mr Harrington’s 50% shareholding would have a value of $285,986.
12.5Additionally, he would have loans owing to him of $60,524, less owing by him of $15,294.
As it was presented, the focus of the plaintiff’s case rested on the assertion that the conduct of the second and third defendants in the affairs of the company was “oppressive to, unfairly prejudicial to, or unfairly discriminatory against” the plaintiff: Corporations Act 2001 s 232. It was submitted that the court should make appropriate orders pursuant to s 233 of the Act.
The trend of more recent legislation aimed at providing remedies in cases of oppressive conduct in company management has been to enlarge the range of circumstances in which the courts are empowered to intervene: Fexuto Pty Ltd v Bosnjak Holdings Pty Ltd (2001) 37 ACSR 672 at [4], [300]; Raymond v Cook (1998) 29 ACSR 252 at 260 and Re Bagot Well Pastoral Company Pty Ltd (1993) 61 SASR 165 at 172-173.
The words “unfairly prejudicial” and “unfairly discriminatory” have broadened the scope of such legislation and taken it beyond the earlier and narrower concept of “oppression”: Fexuto at [300]. As Spigelman CJ observed in that case at [4]: “The jurisdiction should not be confined by technical distinctions”.
In the present case, there is no doubt in my mind that, if the plaintiff’s allegations are made out, the impugned conduct is both unfairly prejudicial and unfairly discriminatory. It is alleged that the defendants manipulated the affairs of the company so as to increase their percentage shareholding well above that of Mr Harrington.
The parties entered into their original arrangement on the basis that Mr Harrington would be a 50 per cent shareholder. All the circumstances point to the fact that the company was, in effect, an “incorporated partnership” or a “quasi-partnership”: Fexuto at [29] citing Ebrahimi v WestbourneGalleries Ltd [1973] AC 360.
The understanding was that Mr Harrington would have an equal say in the conduct of the business. Mr Russell claims that Mr Harrington did have such a role. However, it is significant that, within a very short time, Mr Harrington was removed as a director in circumstances which did not justify such action. The removal was not authorised by the Constitution.
The shareholder loan agreement is central to the claim of unfair conduct levelled against the defendants. I reject Mr Russell’s evidence that Mr Harrington took an active part in the discussions which led to the signing of this document and the events which followed it. I do not accept that Mr Harrington was prepared to so readily abandon his insistence that he be a 50 per cent shareholder. I accept the effect of his evidence that he simply signed the document when it was put in front of him and that he did not realise his shareholding had been reduced to approximately 33 per cent until advised by Ms D’Andrea that this was the case.
When dealing with a similar situation in Raymond v Cook, Pincus & Thomas JJA said at 261:
The effect of conversion of the loan accounts to “equity”, ie, share entitlement, would have produced a dramatic dilution of the appellant’s entitlements, and was inconsistent with the basis of the joint venture.
These comments are apposite in the present case where the scheme permitted the defendants to act in their own interests to the detriment of the plaintiff. The calculation of the amounts of loans deemed to have been made to the company and the decision that the company had defaulted were highly subjective assessments which I find were made by Mr Russell and Ms D’Andrea to produce a result which benefited them significantly and had a clear detrimental effect on Mr Harrington’s entitlements.
The share allotments which followed in November 2003 and May/June 2004 further diminished Mr Harrington’s shareholding causing him additional prejudice.
I have reached the conclusion that the plaintiff’s case for relief under s 232 has been made out. The conduct of the company’s affairs by the second and third defendants was unfairly prejudicial to the plaintiff and it discriminated against him in an unfair manner. Accordingly, it is appropriate to restore his position to an entitlement of 50 per cent of the company’s issued share capital.
I will hear the parties as to the orders which should be made.
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