Hydrocool Pty Ltd v Hepburn (No 4)
[2011] FCA 495
•16 May 2011
FEDERAL COURT OF AUSTRALIA
Hydrocool Pty Limited v Hepburn (No 4) [2011] FCA 495
Citation: Hydrocool Pty Limited v Hepburn (No 4) [2011] FCA 495 Parties: HYDROCOOL PTY LIMITED (ACN 067 525 366) v IAIN MACGREGOR HEPBURN, THERMOELECTRIC APPLICATIONS PTY LIMITED (ACN 112 217 124), PETER TERENCE CLARKE, BENJAMIN BANNEY, MONTAG DAVIS, BRETT MANNERS, ROBERT WEYMOUTH, RITA CLARKE, WATER MASTER LIMITED and GARTH CLIFFORD RICHARDSON File number: NSD 1754 of 2006 Judge: SIOPIS J Date of judgment: 16 May 2011 Corrigendum: 28 July 2011 Catchwords: EQUITY – fiduciary duties of company director – whether company director breached his fiduciary duty to avoid a conflict between his interest and his duty – whether a senior employee owed a fiduciary duty to the company – whether it was appropriate to apply a more stringent test for causation – whether the loss claimed by the company was caused by the director’s breach of fiduciary duty – whether the company is entitled to receive equitable compensation.
CORPORATIONS – whether the director improperly used his position to gain an advantage for himself or others ‑ whether the director improperly used information obtained because of his position as a director to gain an advantage for himself and others – whether the director of the company contravened s 182(1) and s 183(1) of the Corporations Act 2001 (Cth) – whether an officer of the company knowingly participated in the director’s contravention of s 182(1) and s 183(1) of the Corporations Act – whether the director and the officer should be exonerated under s 1318 of the Corporations Act – whether the company is entitled to compensation under s 1317H of the Corporations Act.
COSTS – non-cooperation in a joint approach to experts with a view to narrowing issues for trial – whether indemnity costs should be awarded.
Legislation: Corporations Act 2001 (Cth) ss 182(1), 182(2), 183(1), 183(2), 1317H, 1318 Cases cited: Aon Risk Services Australia Ltd v Australian National University (2009) 239 CLR 175
The Queen v Byrnes (1995) 183 CLR 501
Chew v The Queen (1992) 173 CLR 626
McNamara v Flavel (1988) 13 ACLR 619
Farah Constructions Pty Ltd v Say-Dee Pty Ltd (2007) 230 CLR 89
Adler v Australian Securities and Investments Commission (2003) 179 FLR 1
Brickenden v London Loan and Savings Co [1934] 3 DLR 465
Commonwealth Bank of Australia v Smith (1991) 42 FCR 390
Gemstone Corporaton v Grasso (1994) 62 SASR 239
O’Halloran v RT Thomas & Family Pty Ltd (1998) 45 NSWLR 262
Maguire v Makaronis (1997) 188 CLR 449
Youyang v Minter Ellison Morris Fletcher (2003) 212 CLR 484
Target Holdings Ltd v Redferns (a firm) [1996] 1 AC 421
AMP Services Limited v Manning [2006] FCA 256
March v Stramare (E & MH) Pty Ltd (1991) 171 CLR 506
Deputy Commissioner of Taxation v Dick (2007) 242 ALR 152
Australian Securities and Investments Commission v Macdonald (No 12) (2009) 259 ALR 116
Canson Enterprises Ltd v Boughton & Co (1991) 85 DLR (4th) 129
Malec v JC Hutton (1990) 169 CLR 638Date of hearing: 9-12, 15, 17, 22, 24-26, 29-30 March 2010, 18-20 August 2010 Date of last submissions: 8 September 2010 Place: Perth Division: GENERAL DIVISION Category: Catchwords Number of paragraphs: 654 Counsel for the Applicant: Mr R Cobden SC and Mr A Fernon Solicitor for the Applicant: Swaab Attorneys Counsel for the First and Third Respondents: Mr J Garas and Mr JC Yeldon
Solicitor for the First and Third Respondents: Corser & Corser
FEDERAL COURT OF AUSTRALIA
Hydrocool Pty Limited v Hepburn (No 4) [2011] FCA 495
CORRIGENDUM
1.In paragraph 543 of the Reasons for Judgment, in the second and third lines, the words and figures “AUD1,799,294, or alternatively AUD1,674,000” should be replaced with the words and figures “AUD1,543,910.55, or alternatively AUD1,436,400”.
2.In paragraph 544 of the Reasons for Judgment, in the first line, the notation “AUD1,799,294” should be replaced with the notation “AUD1,543,910.55”.
3.In paragraph 548 of the Reasons for Judgment, in the first line, the notation “AUD1,674,000” should be replaced with the notation “AUD1,436,400”.
4.In paragraph 558 of the Reasons for Judgment, in the first line, the notation “AUD270,000” should be replaced with the notation “AUD231,587”.
I certify that the preceding four (4) numbered paragraphs are a true copy of the Corrigendum to the Reasons for Judgment herein of the Honourable Justice Siopis. Associate:
Dated: 28 July 2011
IN THE FEDERAL COURT OF AUSTRALIA
WESTERN AUSTRALIA DISTRICT REGISTRY
GENERAL DIVISION
NSD 1754 of 2006
BETWEEN: HYDROCOOL PTY LIMITED (ACN 067 525 366)
ApplicantAND: IAIN MACGREGOR HEPBURN
First RespondentTHERMOELECTRIC APPLICATIONS PTY LIMITED (ACN 112 217 124)
Second RespondentPETER TERENCE CLARKE
Third RespondentBENJAMIN BANNEY
Fourth RespondentMONTAG DAVIS
Fifth RespondentBRETT MANNERS
Sixth RespondentROBERT WEYMOUTH
Seventh RespondentRITA CLARKE
Eighth RespondentWATER MASTER LIMITED
Ninth RespondentGARTH CLIFFORD RICHARDSON
Tenth Respondent
JUDGE:
SIOPIS J
DATE OF ORDER:
16 MAY 2011
WHERE MADE:
PERTH
THE COURT ORDERS THAT:
1.The parties are to make submissions as to the form of orders and the costs.
Note:Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
The text of entered orders can be located using Federal Law Search on the Court’s website.
IN THE FEDERAL COURT OF AUSTRALIA
WESTERN AUSTRALIA DISTRICT REGISTRY
GENERAL DIVISION
NSD 1754 of 2006
BETWEEN: HYDROCOOL PTY LIMITED (ACN 067 525 366)
ApplicantAND: IAIN MACGREGOR HEPBURN
First RespondentTHERMOELECTRIC APPLICATIONS PTY LIMITED (ACN 112 217 124)
Second RespondentPETER TERENCE CLARKE
Third RespondentBENJAMIN BANNEY
Fourth RespondentMONTAG DAVIS
Fifth RespondentBRETT MANNERS
Sixth RespondentROBERT WEYMOUTH
Seventh RespondentRITA CLARKE
Eighth RespondentWATER MASTER LIMITED
Ninth RespondentGARTH CLIFFORD RICHARDSON
Tenth Respondent
JUDGE:
SIOPIS J
DATE:
16 MAY 2011
PLACE:
PERTH
REASONS FOR JUDGMENT
At the beginning of 2004, the applicant, Hydrocool Pty Limited, was a company carrying on research and development activities in relation to thermoelectric technology. The research and development activities were carried out by four engineers. They were Mr Ben Banney, Mr Montag Davis, Mr Brett Manners and Mr Robert Weymouth. The engineers worked at premises leased by Hydrocool in Fremantle. I will refer to these gentlemen collectively as “the engineers”. Mr Peter Clarke, the third respondent, was also located at the Fremantle premises. In 2004, Mr Clarke, a senior engineer, held the position of research and development manager. The first respondent, Mr Iain Hepburn, the managing director of Hydrocool, was also located at the Fremantle premises.
Hydrocool was incorporated in 1994. By 2004, the shareholders of Hydrocool comprised Australian Technology Group Ltd (ATG), a company controlled by the Australian government, which held about 77% of the issued capital in Hydrocool, and two companies controlled by Mr Stephen Murphy, which together held about 23% of the issued capital of Hydrocool. These companies were Coolhydro (1) Pty Limited and Coolhydro (2) Pty Limited. Mr Donald Bourke, representing the interests of ATG, was a member of the board of directors of Hydrocool and Mr Stephen Murphy, representing the interests of Coolhydro (1) and Coolhydro (2), was also a member of the board of directors of Hydrocool. Dr David Teplitzky was a director and executive chairman of Hydrocool. Dr Teplitzky and Mr Hepburn were the only two executive directors of Hydrocool. The board meetings of Hydrocool were held in Sydney every two months or so.
By 2004, Hydrocool had registered a number of patents relating to the thermoelectric technology it had invented. In 1997, Hydrocool entered into a licence agreement with a Japanese company, Matsushita Refrigeration Company Ltd (referred to in trial as MARCO), for the manufacture and sale of Hydrocool’s first generation heat exchanger. The heat exchanger was used in a small domestic bar refrigerator and wine cooler which MARCO had developed. Hydrocool received a small amount from MARCO by way of annual royalties under the licence agreement. Later, Hydrocool also participated in a project with MARCO for the development of a sub-300 litre refrigerator freezer using thermoelectric, rather than compressor-based, technology. This led to Hydrocool producing a 126 litre refrigerator freezer prototype. However, this project did not lead to the receipt of any revenue for Hydrocool.
At the beginning of 2004, Hydrocool was also engaged in a research project with Symetrix Corporation, a company based in Colorado Springs, United States of America. The object of the research was to produce a more efficient peltier to be used in conjunction with Hydrocool’s heat exchanger. The board of directors of Hydrocool was of the view that there would be significant commercial advantages to Hydrocool if the Symetrix research achieved its objective. The Hydrocool board had supported the Symetrix research and contributed monies and the services of two of its engineers to the Symetrix project. Hydrocool was also in 2004, engaged in a research and development project to develop a CPU cooler device using its heat exchanger technology.
Hydrocool’s research and development activities had not led to the development of any substantial income producing assets. Hydrocool made a net loss in each of the years ended 30 June 2001 to 30 June 2004. For its working capital, Hydrocool depended upon grants from the Federal government and support from its principal shareholder, ATG. As at 30 June 2004, ATG had advanced to Hydrocool by way of an unsecured loan, the sum of AUD382,995. However, in 2003, the Australian government’s enthusiasm for research and technology investments had waned and it had directed that ATG divest all its technology investments by 30 June 2004.
By March 2004, Hydrocool was facing financial difficulties and there was talk of the need to make staff redundant.
In about May 2004, Water Master Limited, a New Zealand registered joint venture company, with a major Chinese shareholder, approached Hydrocool with a view to entering into negotiations with Hydrocool to develop a retail domestic product for the harvesting of water from air, using Hydrocool’s thermoelectric technology. The Hydrocool board assigned the responsibility for the day-to-day negotiations with Water Master to Mr Hepburn. Mr Garth Richardson represented Water Master in its day-to-day dealings with Mr Hepburn. By early July 2004, negotiations had progressed to the stage of Mr Hepburn forwarding to Mr Richardson a draft heads of agreement for a licence agreement between Hydrocool and Water Master, and another draft heads of agreement with Windsor Group Company Limited (Windsor), the Chinese company associated with Water Master.
On 16 July 2004, Mr Hepburn forwarded to Mr Clarke an email in which he stated that he had formulated a plan. Pursuant to that plan, Water Master would make the employment by Hydrocool of the Fremantle based employees for a term of two years, a condition of the proposed licence agreement, and Water Master would acquire the shareholding of ATG and then transfer part of that shareholding to himself, Mr Clarke and the engineers. The plan also contemplated that Mr Hepburn would remain the managing director, Dr Teplitzky would resign as executive chairman and Mr Clarke would replace Mr Bourke as a director of Hydrocool. Mr Hepburn advised Mr Clarke that the plan would have an “explosive effect” on the Hydrocool board and asked Mr Clarke to keep the plan confidential. Mr Hepburn did not tell the Hydrocool board about his plan.
In September 2004, Water Master advised Hydrocool that it would require the proposed heads of agreement to be amended to provide for a term that Hydrocool would employ Mr Hepburn, Mr Clarke and the engineers for a period of two years.
In October 2004, Dr Teplitzky wrote to Mr Richardson advising that Hydrocool would not agree to the term proposed by Water Master calling for the two year employment commitment from Hydrocool. Mr Richardson referred Dr Teplitzky’s email to Mr Hepburn. After then conferring by telephone with Mr Hepburn, Mr Clarke and the engineers as to the response he should make to Dr Teplitzsky’s email, Mr Richardson, using wording which had been provided to him by Mr Hepburn, advised Dr Teplitzky that Water Master would not enter into the proposed licence agreement with Hydrocool, in the absence of the employment commitment term.
On 19 October 2004, Dr Teplitzky dismissed Mr Hepburn during the course of a meeting in Perth. Mr Hepburn had anticipated that he may be dismissed at that meeting and, before going to the meeting, he had been provided with letters of resignation from each of Mr Clarke and the four engineers. During the course of the meeting, and immediately after he was advised by Dr Teplitzky that he had been dismissed, Mr Hepburn handed Dr Teplitzky the letters of resignation signed by each of Mr Clarke and the four engineers.
On 19 October 2004, a firm of accountants, Grant Thornton, took control of the Hydrocool premises in Fremantle and commenced the process of closing down Hydrocool’s operations in Fremantle and vacating the Fremantle premises.
In or about December 2004, Mr Hepburn, Mr Richardson and each of the engineers became shareholders in a company, Thermoelectric Applications Pty Ltd (TEA). Mr Clarke’s wife, Mrs Rita Clarke, also became a shareholder of TEA. Water Master became the owner of 300 shares of the 600 shares in the company. Mr Hepburn became the managing director, and Mr Clarke and Mr Richardson became directors, of TEA.
In October 2005, TEA announced that it had produced a prototype of a device for harvesting water from air using thermoelectric technology.
In 2006, Hydrocool commenced this proceeding against ten respondents. However, by the time of closing submissions, the proceeding comprised only claims by Hydrocool for compensation against each of Mr Hepburn and Mr Clarke, alleging breaches of fiduciary and statutory duties; and a claim against Mr Hepburn for the breach of a confidentiality agreement.
BACKGROUND
In August 2000, Mr Hepburn was appointed managing director of Hydrocool and employed by Hydrocool. At that time, ATG was the sole shareholder of Hydrocool.
In 2001, Dr Teplitzky told Mr Stephen Murphy, an accountant, that he was looking for investors to raise AUD2.5 million for Hydrocool to complete a refrigerator freezer project with MARCO. In June 2001, Mr Murphy incorporated two companies, Coolhydro (1) and Coolhydro (2). These companies then acquired shares in Hydrocool. Mr Murphy’s clients held shares in the two Coolhydro companies. Mr Murphy became a director of Hydrocool on 1 July 2001.
There were also employee options which had been issued. Each of Mr Hepburn, Mr Clarke and the engineers held options in Hydrocool. Although the evidence is not clear on the precise number of options held by each employee, it appears that in 2003, Mr Hepburn held over 100,000 options, Mr Clarke held over 50,000 options, each of Mr Banney, Mr Manners and Mr Davis held over 27,000 options, and Mr Weymouth held 50,000 options in Hydrocool.
By the middle of 2003, Hydrocool’s technology included a thermoelectric heat exchanger which Hydrocool had developed and patented. As mentioned, the heat exchanger and related patented Hydrocool systems were used, pursuant to a licence granted to MARCO, in a bar fridge. Hydrocool was in receipt, annually, of a small amount of monies by way of royalties paid by MARCO pursuant to this licence agreement.
Hydrocool had also developed a prototype fridge freezer, which was the world’s first refrigerator with freezer using thermoelectric technology.
At this time, Hydrocool was also working on the development of a unit for cooling the central processing unit of a computer. This technology was referred to as “the CPU cooling unit”. In 2004, Hydrocool submitted a prototype of this unit for review by Overclockers.com and had received a favourable review.
Further, in 2003, as mentioned, Hydrocool was also working in conjunction with Symetrix, on a research project. The research activities were undertaken in Colorado Springs under the direction of Dr Carlos Araujo of Symetrix – a close friend of Dr Teplitzky. Hydrocool contributed funds to this project and supplied the services of two of its engineers on secondment from Fremantle. During the term of their secondment, the two engineers resided in Colorado Springs and worked with Dr Araujo on the research activities. In 2002, Mr Davis and Mr Manners of Hydrocool were seconded to the Symetrix project in Colorado Springs. In 2003, Mr Banney replaced Mr Davis, and Mr Banney and Mr Manners continued working there until they returned to Fremantle in around August 2004. The purpose of the research was to develop a highly efficient peltier. A conventional peltier had a ZT (a measure of efficiency) of 1; the aim was to develop a peltier with a ZT of 2 or more. In short, the research was directed towards trying to decouple two variables which would allow the ZT to increase independently of the traditional theory that there was a coupling relationship between the variables. This was the breakthrough which the research was trying to achieve.
In the middle of 2003, the board of directors of Hydrocool comprised Dr Teplitzky, Mr Hepburn, Mr Murphy and Mr Bourke, who was also the chairman of ATG, and Mr Sashi Paul.
At a meeting of the board of directors of Hydrocool on 7 July 2003, Dr Teplitzky briefed the members of the board on the proposed “exit strategy” which would allow ATG to sell its investment in Hydrocool, following the Australian government’s decision to dispose of any research and development investments. Dr Teplitzky explained that he had identified some organisations (including some private individuals and merchant banks) which may be interested in arranging the acquisition by third parties of ATG shares in Hydrocool. The board minutes record that it was agreed that Hydrocool’s management did not have the discretion to represent ATG on the sale of its shares to possible interested parties.
At the meeting of the board of directors of Hydrocool held on 17 September 2003, Mr Hepburn advised that the worst case scenario was that Hydrocool would be able to fund itself until the end of March 2004, assuming that there was no research and development grant or further funds from a third party company.
At Hydrocool’s board meeting held on 31 March 2004, Mr Hepburn reported that Hydrocool’s management had revised the cash forecast and this had shown that Hydrocool would be in a position to fund its operations until around July 2004. Dr Teplitzky was still attempting to identify possible sources of further investment in Hydrocool. One of the possible sources of investment was a company, Emerson Electric Corporation, a United States company.
On 8 May 2004, Mr Richardson on behalf of Water Master, a company with which Hydrocool had not had previous dealings, sent an email advising that it was interested in exploring the prospect of using Hydrocool’s technology in a device to extract water from air, which Water Master wanted to develop.
Water Master is, and was, a company incorporated under the laws of New Zealand. At that time, its major shareholder was a company associated with Windsor, which was based in Hong Kong. Water Master was described as a joint venture company. Mr Richardson was at that time, a director and chief operating officer of Water Master and was engaged in the day-to-day management and operations of that company. The other members of the Water Master board were Mr Gordon Tse, Mr Michael Chung, Mr William Campbell, Ms Linda Chen and Mr Peter Hawkins.
By this time, Water Master had developed a device that made potable water by extracting water from air. The intended market for this device was the replacement of office water coolers that used refillable bottles. That device was compressor driven. Water Master wanted to consider making a small device for domestic use which used thermoelectric technology to extract the water from air.
Following Mr Richardson’s initial email to Hydrocool on 8 May 2004, further emails were exchanged between Mr Richardson and Mr Clarke, on behalf of Hydrocool.
Mr Hepburn sent an email on 31 May 2004 to Mr Clarke, stating that there was a question within the board as to the work which was to be done in Perth “given the extended time in CS”. The reference to “CS” was to Colorado Springs, the location of the Symetrix project. Mr Hepburn asked Mr Clarke to prepare a technical report pointing out all the work that had been done in Fremantle and was still needed to be done. Mr Hepburn concluded the email by saying: “We do not need renewed pressure for personnel reductions at this time”.
In early June 2004, Mr Hepburn prepared a letter for the Fremantle based staff to sign. This letter was referred to in the case as the “engineers’ letter”. The draft letter was addressed to the board of Hydrocool. The draft letter stated:
We have written this letter and have advised Iain Hepburn that he may or may not provide it to the Board at his discretion and judgement.
The purpose of this letter is to explain the attitude of the employees with respect to the past and future of the company.
All of us have been with the company for approximately four years, with some having been here in excess of that time.
During this period, we feel that, not only have we worked extremely well together as a team, but also that this team has remained intact in spite of the on-going financial uncertainty within the company.
It could be said that there have been occasions where common sense should have persuaded us to look elsewhere. We have not done so since we have remained motivated to see Hydrocool achieve both research success and commercial success on behalf of the shareholders who have supported the company.
We would also make that point that, notwithstanding this uncertainty, none of us have requested any securement of employment tenure, via an employment contract, which in the present day is now quite common.
We are unanimously hopeful in the work being carried out with Symetrix, but do however remain cautious in our opinion, until proof of theory, via the decoupling of Seebeck Coefficient and Electrical Conductivity is demonstrated via sample measurement.
This has always been our collective opinion. It is not negative it is just careful and cognisant of the facts.
We are also unanimous in our opinion that even when this breakthrough is achieved there is a long way to go to complete the optimisation process based on the proven theory and that this optimisation process, together with the integration of the convector, will require the full participation of all existing personnel.
We would go further by saying that, without the considerable expertise and knowledge within Hydrocool on module design, heat exchange modelling and convector integration, this work could not be carried out and hence value would not accrue for the company and hence ourselves as option holders.
The strength of our convictions in this regard is such that we intend to work for Hydrocool as a team or not at all.
Furthermore, we would like to take this opportunity of advising the Board that in the latter event, we think it is only reasonable that an appropriate redundancy payment of at least one month for each year of service be provided.
We would not intend to pursue this request if the company is unable to make payment due to lack of cash so long as our current team of employees remains in place for the reason stated above in italics. (Original emphasis.)
As stated in the body of the letter, Mr Hepburn intended to have this letter available to produce to the other directors, at the board meeting on 24 June 2004.
On 8 June 2004, Mr Richardson visited Hydrocool’s Fremantle operations, to further pursue Water Master’s interest in Hydrocool’s technology. On that occasion, Mr Richardson met with Mr Clarke, Mr Hepburn, Mr Weymouth and Mr Davis. Mr Richardson did not meet with Mr Manners and Mr Banney, because they were in Colorado Springs working on the Symetrix project. Mr Richardson spent most of his time speaking to Mr Clarke. The prospect of future meetings between Water Master and Hydrocool was discussed.
By an email dated 8 June 2004, Mr Hepburn, who had met with Mr Richardson, reported to Dr Teplitzky that Water Master was seeking “to convert their water cooler device from being compressor driven to being thermoelectric driven. The main reason being noise and unless they can reduce the noise they cannot sell into the residential home market”. The email also stated that:
They have done extensive investigations and are of the opinion that the expertise and technology of Hydrocool is required by them to achieve this conversion.
They have also expressed an initial interest concerning the possibility of making an equity investment in Hydrocool, which would secure them some rights to the enhanced ZT material IP, for the application of their water cooler.
On 9 June 2004, Mr Hepburn sent Mr Richardson an email to which was attached a copy of the Information Memorandum relating to the disposal of the ATG shareholding in Hydrocool. Mr Hepburn stated in his email to Mr Richardson that:
In summary, I believe that Hydrocool needs to be able to simultaneously carry out the following three activities:
1.Progress the important research program with Symetrix in order to achieve the fundamental breakthrough in TE material ZT values and subsequently the integration of our second-generation heat transfer technology with this new thermoelectric material.
2.Progress the commercialisation, via manufacture-under-license in China, of our CPU cooler devices.
3.Progress the prototyping and development of your thermoelectric-driven water cooler device.
Hydrocool currently retains all the necessary manpower and expertise to carry out the above activities.
As we discussed, our only difficulty is one of time and hence of funding.
We are therefore seeking, by way of an equity investment, additional working capital of US$1.5M, which will allow the company to conduct all three of these activities through to December 2005.
By that time, I would suggest that there will be significant progress with number one, number two will be cash flow positive and number three will be complete.
In general terms, I would see the possible investment by Water Master Hong Kong Ltd in Hydrocool Pty Ltd, perhaps being as follows:
*Between US$1.5 and 2M being a placement in Hydrocool for new shares. I believe (without any assurances) that I can persuade the Board to accept up to the level of $2M, at a price equal to the last issued price (A$1 per share).
*The granting to Water Masters of the exclusive and worldwide right to acquire a license for both the new thermoelectric material and the second‑generation heat transfer technology (which will achieve freezing) for the application of your water cooler/dispenser product.
On 13 June 2004, Dr Teplitzky sent Mr Hepburn an email complaining of the “constant negative attitudes” of Mr Manners and Mr Banney (referred to in the email as “B&B”), about the Symetrix research project. The email stated:
I object to constant negative attitudes and it will matter little that you consider B&B participation as crucial. If the negative attitude does not cease, their participation will. What is crucial is Carlos positive participation. If B&B were terminated tomorrow it would be a very disappointing and serious setback. But they could be replaced. Carlos can not be. Good management certainly calls for full participation. But it does not allow constant negative comment and unsubtle criticism.
This time I am very serious – they either stop, or their employment will.
Mr Hepburn sent an email to Mr Richardson on 16 June 2004. In that email, Mr Hepburn stated that all ATG investments had been sold by the Australian government, except Hydrocool; and that the Australian government intended to remain a shareholder in Hydrocool for the time being. Mr Hepburn went on to say:
Confidentially between you and me, I feel that they would probably be just as inclined to sell in order to bring “political closure” to this whole matter…
Mr Hepburn also said that if the Australian government shareholding went below 51%, Hydrocool would lose its AUD1.9 million Start Grant.
On 16 June 2004, Mr Hepburn stated, in response to an email from Mr Richardson, that Hydrocool only had enough funding to carry on until December 2004 and that it was the company’s intention to issue new capital for at least USD1.5 million to allow the Symetrix research to continue beyond December 2004. Mr Hepburn suggested that the time to put in funding was now, because positive developments may cause an increase in Hydrocool’s share price.
On that day, Mr Hepburn also sent an email to Mr Paul and Dr Teplitzky stating that Water Master understood that Hydrocool would need a major injection of capital. He went on to state that the Water Master work would require “all our personnel and possibly some additional personnel” since it would be equal in scope to the work done to produce the fridge freezer prototype for MARCO.
On 17 June 2004, Dr Teplitzky sent an email to Mr Hepburn in which Dr Teplitzky expressed strong concern at the idea of Water Master seeking equity. Dr Teplitzky advised that he wished to be directly involved in the negotiations.
On 18 June 2004, Mr Richardson sent an email to Mr Hepburn advising of his intended visit to Fremantle for further discussions. Mr Richardson said he would be accompanied by Mr Michael Chung, Mr Gordon Tse and Mr Chi Kong Luk. Mr Richardson referred to the following topics for discussion at the forthcoming meetings:
(a)the licensing of Hydrocool technology for use in the domestic market water maker;
(b)the manufacturing of new products in China for Hydrocool;
(c)investing in Hydrocool; and
(d)acquiring rights for the use of Symetrix/Hydrocool peltier technology improvements for all water from air applications and possibly the use of the same for power generation.
On 19 June 2004, Mr Hepburn responded to Mr Richardson‘s email. In his email, Mr Hepburn stated:
Some of my fellow directors may have thought that we supplied too much information too soon, but you needed all of it to make an initial decision.
My priority will be to play a “middle” role in our negotiations to make sure that any agreement we reach is good not only for Hydrocool but also for WaterMaster.
On 22 June 2004, Mr Clarke prepared a staffing plan for the Water Master project. It provided for, on a “best case” scenario, one engineer and one technician over a 12 month period. Mr Clarke estimated the labour costs of the engineer and the technician to be AUD60,000 and AUD45,000 respectively.
On 24 June 2004, there was a meeting of the board of directors of Hydrocool. Mr Hepburn went to the meeting armed with the engineers’ letter. However, he did not have to use the letter because at the board meeting, Dr Teplitzky said that he would issue an official letter of appreciation for the work done by the engineers on the CPU cooler project.
On the night of 24 June 2004, after the board meeting, Mr Hepburn prepared a document in relation to a strategy meeting which he intended to hold with Mr Clarke and the engineers, on the following day. The document stated:
1.Did not have to use the “collective” all of us or none of us letter.
2.However the Board remains apparently unwilling to understand the work being done here
3.I requested the Board to issue a letter of appreciation via David for the CPU cooler work
4.David has continually criticized the CPU project and an official letter of appreciation will come from him to the engineers with a separate one to me with many criticisms. Peter and myself will answer this second letter. The reason I wanted the official letter from the Board was to help to secure all of your positions. This was achieved.
5.Also not fully appreciative of the work done to get WaterMasters to the table nor the work to be done to develop a TE version of their cooler.
6.Instead the Board continues to support Carlos in the face of mounting evidence to suggest we should have serious doubts.
7.In the case of David, this is caused by his unexplainable confidence in Carlos notwithstanding his previous resignation from Ramtron. In the case of Steve, he has told his shareholders that Carlos will make them all rich and cannot rescind from this. In the case of Don he has similarly told the Government and also cannot retract.
8.We have fortunately got Carlos on record as saying the Dec 31st is bale out time if no proof of theory. This has been said in front of Emerson and David and submitted in writing by me to the Board.
9.My prediction is that we will have no proof by Dec 31st although I hope I am proved to be wrong.
10.In this event, I will be submitting to the Board and failing a positive reaction, then to the Government, that we pull out of the Symetrix project and also attempt to recover some of the fees paid. We have various written statements from Carlos which would support such an attempt.
11.Between now and then we will continue to do everything possible to make this project with Symetrix succeed
12.Ressult from conversation with Randall?
13.Result from ATG Board meeting regarding DON?
14.However, looking beyond December 31st and assuming that we will [be] out of funds by then if we cannot raise more money before then, we need to have a very clear plan of what needs to be done here in Australia:
1.Progress the CPU cooler, present a very good paper at ITC and use this position to secure a license agreement.
2.Progress the JV with WaterMasters and develop their TE Version so that we can earn license fees from that
3.At December 31st we may need to use another “collective” position to maintain the future of Hydrocool and this collective position would probably need to be adopted in order to:
To Pull out for Symetrix.
To perhaps purchase the company from the Government who by that time will be very truly tired of listening to the Hydrocool situation and will want to simply walk away with no liabilities.On 25 June 2004, Mr Clarke forwarded by email to Dr Teplitzky and Mr Hepburn a draft detailed project plan for the Water Master project. The draft plan prepared by Mr Clarke, projected that the Water Master project would take 18 months with two engineers and two technicians/draftsmen working full-time during that period and one project manager contributing 25% of his time during that period. On the basis of this plan, Mr Clarke recommended a USD500,000 licence fee and a 5% royalty. Mr Clarke also recommended that as a negotiating strategy, Hydrocool should offer to bear the costs should the costs of the project exceed USD500,000.
On 28 and 29 June 2004, Dr Teplitzky and Mr Hepburn met with Mr Richardson and the other Water Master representatives. During the course of the meetings, Dr Teplitzky advised the representatives of Water Master that Hydrocool would require that Water Master pay a fee of USD1 million for the development work, with half payable on the signing of the agreement, with the balance payable in two tranches over 12 months. Dr Teplitzky said that the cost of the development work would be payable out of that fee.
During the meetings, Mr Richardson also raised the question of whether Water Master could invest in Hydrocool. Dr Teplitzky prepared a report on the meeting with Water Master to the board of Hydrocool dated 4 July 2004, based on the notes he had taken of the meeting. In his report of the meeting, Dr Teplitzky stated that he responded “very direct and strongly” to the suggestion that Hydrocool was interested in offering equity for the injection of funds. Dr Teplitzky said that he also stated that he was not authorised by the Hydrocool board to discuss equity, and no one else was either. Dr Teplitzky said that he told those present that Hydrocool worked only on licence fees and royalty fees and was not a manufacturing company.
The representatives of Hydrocool and Water Master agreed at the meeting that Hydrocool would draw up a heads of agreement. Mr Hepburn carried the responsibility for doing so.
On 1 July 2004, Mr Hepburn sent Mr Richardson a draft heads of agreement between Hydrocool and Water Master. In outline, the draft heads of agreement contained the following provisions:
(a)The parties would cooperate in relation to the design and development of the domestic water making device.
(b)Hydrocool would grant Water Master an exclusive worldwide licence for the HS5 technology for the application of water making devices.
(c)Water Master would pay a licence fee of USD1 million in three tranches; and Water Master would also pay a royalty fee of 5% for ex-factory total cost of the commercial domestic water making device, based on the number of devices manufactured.
On 5 July 2004, Mr Hepburn sent Mr Richardson, the draft heads of agreement between Hydrocool and Windsor Group Company Limited, incorporating the proposed terms of agreement. In outline, the proposed terms were:
(a)Windsor would be licensed to manufacture HS5 convector modules.
(b)Windsor would be licensed to supply these HS5 convector modules to Water Master to use only in the domestic water making device.
(c)Windsor would be licensed to manufacture the CPU cooler unit and to market and distribute the units.
(d)Windsor would pay a licence fee of USD500,000 on the execution of the final agreement, and also a royalty fee of 5% of the ex-factory total cost of the CPU cooler units.
Both draft heads of agreement provided for final agreements to be signed by 31 August 2004 and that future improvements to the HS5 convector modules or CPU cooler units by Hydrocool, including, improvements in peltier performance, as a result of the Symetrix research, would flow to Water Master and Windsor within the licences to be issued.
On 1 July 2004, Mr Richardson sent an email to Dr Teplitzky and Mr Hepburn. Mr Richardson expressed concern in relation to the CPU cooler unit licence fees. Mr Richardson also stated:
We really liked your team – you have very good people and we very much look forward to working with them closely in the future.
On 5 July 2004, Dr Teplitzky sent Mr Hepburn an email. This email relevantly reads:
1.I had a private letter from Carlos yesterday.
Amongst a number of issues, he asked me for details of the offer from Emerson for 7% of HPL equity in return for cash.
I do not appreciate being asked by Carlos or anyone else on confidential matters to HPL Board.
Cleary there has been some loose talk from Fremantle to Brett/Ben.
It is none of their business and they have no right to discuss such matters in Coloardo Springs.
In fact it is nobody’s business other than Directors, including the staff at Fremantle, and they should not be party to this information.
If I can not rely on confidentiality on matters I share with you, I will not pass these on.
By 5 July 2004, an invitation had been issued by Water Master for Mr Hepburn, Dr Teplitzky and Mr Clarke to visit Windsor’s factory in China. In the visa application letter of that date, signed by the Mr Chung of Windsor, he stated that Windsor had formed a joint venture with Water Master and that they had “decided to acquire the rights to new technology from a company based in Australia called Hydrocool Pty Ltd”.
On 5 July 2004, Mr Hepburn sent Mr Banney and Mr Manners an email in relation to the Symetrix project. It read as follows:
Further to our strategy discussions this morning, I would appreciate if you would prepare a confidential report over the next few months (aim to have complete by say October)
This report should be a chronological description of the work program with Carlos since the very beginning, which is when Brett first went to CS.
In addition to the general chronological history I am also looking for the details of how Hydrocool has done everything possible to help Carlos, even when we have sometimes disagreed and of how we have frequently had our suggestions rejected only to find that months later, they were valid and applicable.
I also need included the situations in which Carlos’s behaviour, attitude etc made the project difficult to progress.
I also need included details of where we have received incorrect advice from Carlos – for example the confirmation of active Ferro inclusions, which if more thought had been given, were never capable of being proven.
I want to be in a position at the end of this year of being able to report our factual and comprehensive side of the Colorado Springs story.
You may run drafts past both Peter and myself but nobody else.
Please be careful therefore when you transmit any drafts by email !
In an email to Mr Clarke dated 6 July 2004, Mr Hepburn stated:
I do not want Carlos or David to have any excuse between now and Dec 31st.
My draft wording for the condition which the employees might attach to any employment contract which Water Masters in their wisdom might request, given that we are asking them to pay a license fee 18 months ahead of when the licensed technology would actually be proven in practice, is as follows:
That the Board give due consideration to our collective request that, if there is no progress before November 30th on the proof of theory (ie Milestone One of the Start Grant) via sample measurements which repeat, then a comprehensive review of the entire Symetrix project be undertaken jointly by Hydrocool and Symetrix during December 04 with a view to:
•evaluating what has been achieved to date and the cost to do so
•determining if there is adequate justification to continue the project past the deadline previously set by Carlos of December 31st.
The only downside for HPL, which I can see to Water Masters requesting two year contracts for all employees, is the effect this would have on our balance sheet.
I will have to work out the numbers, but it will make us insolvent much earlier, how early I will determine. This in turn could force the GOV to get out before March.
We could ask for a major shareholder guarantee (from the GOV) as part of the employment contract but I do not think this would have any chance of flying and may bring unpredictable consequences immediately.
Let’s discuss more tomorrow. (Original emphasis.)
In an email dated 7 July 2004 to Mr Hepburn, Mr Clarke stated:
A detailed task and resources plan for water master project is attached. I will need 2 engineers and 2 technicians/draftsmen on the project for 18 months, plus about ¼ of my time for project management.
If we reserve Monty and Rob for other duties, eg cpu cooler, automobile cooler box etc (essential as we can’t commit 100% of our resources to the water master project) then that means preferably applying Brett, Ben, Norm and one additional hire for Water Master. If Brett and Ben remain in the US then we will need 3 additional engineers (an extra body to make up for lack of experience), one additional technician/draftsman, more like 50% of my time for project management and allocation of Monty to the project, reducing capacity to service other applications.
I can’t budget for materials costs yet until I have a better idea of the actual program.
Mr Hepburn advised Mr Clarke that he agreed with his assessment and requirements.
Mr Clarke then forwarded the detailed task and resources plan to Dr Teplitzky.
On 8 July 2004, Mr Hepburn sent an email to Dr Teplitzky about Mr Clarke’s plan. He said that it was too early to define clearly what would be needed to be done. Mr Hepburn went on to say:
I have looked at Peter’s proposal closely and I think it is a reasonable maximum guesstimate at this time but the fact of the matter if we do not know enough details at this time to make this analysis.
On 10 July 2004, Mr Richardson advised Mr Hepburn that he intended to send Mr John Christian, a technical expert, to Fremantle to carry out an independent technical review of Hydrocool’s technology, with Mr Clarke.
Mr Christian visited the Fremantle premises on 15 July 2004. Mr Christian met with Mr Weymouth and Mr Davis. Mr Manners and Mr Banney were still in Colorado Springs working on the Symetrix research. Mr Clarke was in Croatia. Mr Christian also met with Mr Hepburn.
Mr Hepburn prepared a report of Mr Christian’s visit which he sent to the other directors. The report included the following statements:
He [Mr Christian] made the point that Water Master was being asked to make full payment of an up-front license fee of US$1M now and hence in advance of Hydrocool being able to demonstrate that our technology could do what Water Master needed to be done and at an acceptable cost.
He sees the main risk of this situation for Water Master being the personnel in Hydrocool and the need to retain all of this expertise to make sure that the development program was on time and successful.
He sees this as important for both of us since the product will not sell and generate royalty, unless the development is done well in the first place.
Mr Hepburn also emailed to Mr Clarke a copy of this report to the board. However, in forwarding the report to Mr Clarke, Mr Hepburn had applied bold font to the last two sentences referred to in the previous paragraph. Mr Hepburn’s email to Mr Clarke read:
FYI
On the section Bolded, I have primed Jon to discuss with Garth.On 16 July 2004, Mr Hepburn sent the following email to Mr Clarke:
Please keep this confidential…The main downside of this plan, is the explosive effect it would have on the Board and on particular David.
We would certainly create permanent destruction of any relationship with Symetrix and probably with David.
I am far from thinking that we should put this plan into action and I will not do so without all of us in agreement…
Plan:
I think it is understandable for Water Masters to require some assurance that the project to develop the TE Domestic Water Maker can be successfully completed on schedule.
In this regard, it is very clear that we would need to retain all our engineering expertise to do so. Jon Christian, their independent expert will advise Garth of this.
Therefore, given that WM are paying the license fee up-front, they need assurance that Hydrocool will retain this personnel expertise.
Therefore WM need Hydrocool to have two-year employment contracts with their employees. This has no downside for Water Masters.
This would have significant effect on the HPL balance sheet and would make the Government much more eager to get out…
I would predict that David Teplitzky and Don Bourke would resist such a requirement for employee contracts since they know this would concern their Gov masters. They would also reject simply to disagree.
However, if WM insist they would then be forced to ask the Gov and the answer would almost certainly be try to avoid at all costs.
In the event that they did agree (very unlikely) then perhaps the employees would be willing to sign two year contracts, knowing the general attitude of the Hydrocool Board to various matters.
WM could then offer the following alternative proposal to the Gov via ATG
WM offers to by the 77% of HPL from ATG at 10 cents per share (A$770,000)
Also to pay out the ATG loan of $350,000
Hence for just over A$1M WM gets ATG out and hence the Gov out.
All employee options are cancelled and instead WM provides 5% equity to the following personnel – (DT – subject to the Symetrix situation), IH, PC, MD. RW, BM, BB.
This WOULD allow me to secure two year contracts with all employees.
This would change our shareholding as follows: 47% to 42% with WM, 30 to 35% with HPL employees and 23% with CH
We would keep our Start Grant since less than 50% is owned by overseas entities.
…
David resigns as executive Chairman, may stay on as a director…
Garth or some other nominee is appointed non-executive chairman.
Don Bourke resigns.
Peter Clarke replaces him on the Board.
I firmly believe that the Gov remaining as a shareholder with ATG as their board nominee, is presently not beneficial in any way for Hydrocool.
They have only an objective to get out as soon as possible, without regard to the long term prospects of the company.
Equally I believe that the above outcome would be beneficial for the future of the company and hence in the future for remaining shareholders.
My concern is the unpredictable element of this plan and do we want Water Masters as a major shareholder so soon.
On 18 July 2004, Mr Manners, one of the engineers located in Colorado Springs working on the Symetrix project, prepared a report to Mr Hepburn in relation to the Symetrix research. Mr Manners complained about the “very poor methodology” used in the project. He also stated that the nature of the research had changed from “increasing ZT via thin films to increasing ZT by any method we can find”. He went on to say that he was not confident the project would produce a breakthrough, and was unwilling to be associated with such poor research practises any longer. He said that it was not his place to decide if Hydrocool should continue with the project.
On 23 July 2004, Mr Banney wrote to Mr Hepburn to similar effect.
On 1 August 2004, Mr Larry McMillan wrote to Hydrocool notifying it that it was necessary to suspend the Symetrix research for up to six months due to the illness of Dr Araujo.
In August 2004, after the suspension of the Symetrix project, Mr Manners and Mr Banney ceased working on the Symetrix research and departed from Colorado Springs to return to Fremantle. Mr Manners travelled back to Australia via Europe.
On 16 August 2004, Mr Clarke issued a report which was critical of the Symetrix project.
On 17 August 2004, Dr Teplitzky sent Mr Hepburn an email headed: “Discussion with Carlos CONFIDENTIAL”, complaining of the negative attitudes to the Symetrix project from Fremantle over the previous few months. Dr Teplitzky also asked Mr Hepburn to produce a business plan and budget for the work to be undertaken at Fremantle.
On or about 20 August 2004, at an annual general meeting of Water Master, the shareholders of Water Master expressed support for the Water Master project. Mr Richardson emailed Dr Teplitzky in the following terms:
Our AGM concluded with good shareholder support for the Hydrocool proposal.
We can now proceed to discuss the Heads of Agreement with the comfort of this support…
I hope to expedite this matter but I cannot be sure how long it may take.
We are excited about the prospect and our shareholders now share that same excitement.
Further, on 20 August 2004, Mr Richardson sent Mr Hepburn an email attaching Water Master’s invitation letter to Dr Teplitzky, Mr Hepburn and Mr Clarke to visit Windsor’s factory in China. Mr Richardson suggested in the email, that Mr Hepburn forward the invitation to Dr Teplitzky.
Following the receipt of Mr Richardson’s email, however, Mr Hepburn sent to Mr Richardson an email in which Mr Hepburn suggested to Mr Richardson that the visit to China be limited to a technical visit only, and, therefore, that only Mr Clarke and himself should come.
Mr Hepburn’s email stated:
Peter and I will proceed to obtain our visas.
Given that we will have a signed Heads of Agreement prior to this visit (that condition has been imposed upon me by the Hydrocool Board) I view the main objective of this visit as being technical. Peter and I need to gather all required technical information from yourself and your engineers to commence work in Perth.
Final terms of the license agreement can be handled by myself in China, in consultation with the Hydrocool Board.
I remain concerned about anything, which might jeopardise the creation of a good relationship between Hydrocool and your Chinese partners.
Given all of the above I think it is best for both Hydrocool and Water Masters that this visit be seen as a technical visit and hence that only Peter and myself come.
I suggest that to achieve this, that you send me an email along the following lines, after we have concluded the Heads of Agreement.
now that the Heads of Agreement is finalised the main purpose of your visit to China will be to discuss the prototype design and development project in detail and gather all the required technical information. This may take several days and hence we suggest that there is only a need for Peter Clarke and yourself to visit.
Let me know what you think
Later that day, Mr Richardson responded by email to Mr Hepburn’s email in the following terms:
Understand Iain,
Looks good.
I will comply as you suggest.
This email will self-destruct in 5 minutes time.
On 21 August 2004, Mr Richardson sent an email back to Mr Hepburn which adopted Mr Hepburn’s suggestion that the invitation to visit China exclude Dr Teplitzky. The email also included the following statements:
As you know, I was quite taken aback during our meetings in Perth, when at one point in my conversation with David, he was particularly insistent to the point where he lost his temper over a relatively minor matter.
We have always viewed the engineering staff at Hydrocool as critical to the development of our domestic device and equally the management of this resource by Peter Clarke and yourself. As such we will be seeking some assurances that you and your staff will be available to work on our project through its entirety.
With regard to the visit by Hydrocool personnel to China…(w)e would recommend that both Peter and yourself make this visit and I do not see the need for anyone else at this time.
Due to the above issues I would be most appreciative if all communications with Hydrocool could be conducted directly with yourself, since I believe that you understand our way of doing business and we already see eye to eye on most aspects of this project.
Shortly after receiving a copy of Mr Richardson’s email, Mr Hepburn forwarded it to Mr Clarke. The email stated:
See email from Garth pursuant to my conversations with him. This should solve our problem.
On 25 August 2004, Mr Hepburn replied to Dr Teplitzky’s confidential email of 17 August 2004, that complained about Fremantle’s negative attitude to the Symetrix project and that requested a business plan from Mr Hepburn, by inserting highlighted responses into the text of Dr Teplitzky’s email. In response to the request for a business plan and budget, Mr Hepburn said that a “detailed work schedule and resources plan for the Water Master project has already been supplied”.
Mr Hepburn sent a copy of Dr Teplitzky’s confidential email of 17 August 2004 and his responsive email of 25 August 2004 to Mr Clarke and each of the engineers, other than Mr Manners, saying: “Hold your breaths for the reply to this one!”
On 25 August and 26 August 2004, Dr Teplitzky attended a meeting in Colorado Springs with Dr Araujo and Mr McMillan about the Symetrix project.
On 25 August 2004, Mr Bourke sent a memorandum to Mr Hepburn (with copies to Dr Teplitzky and Mr Murphy) asking Mr Hepburn to prepare a comprehensive report for the next board meeting. Mr Bourke said that the report should include a report on the current status of the negotiations in relation to the Water Master project. The memorandum went on to state:
6.The Board obviously need detail projected P&L and cash flow arising from the proposed programs, which will need Board approval.
Part of this financial planning should include a comprehensive status of the START Grant.
Obviously the company has only limited financial resources. Part of the review is to examine each cost and person’s contribution and determine:
a.whether we can afford them; and
b.do they have the right skill set to do the job at hand?
7.It is obvious that there has been a break down and dysfunctionality in the relationship between you and the CEO/Chairman.
The Board needs to understand how the company is going to operate in a functional manner.
You and David should meet and put all the issues on the table. As grown men I would expect that the majority of the issues are resolved between yourselves, but unsolved issues are brought to the Board for final decision.
8.The Board will need to consider recommendations from you and Dr Teplitzky as to how any additional financial resources required can be funded.
Mr Hepburn forwarded a copy of this memorandum to Mr Clarke under cover of an email, in which Mr Hepburn stated:
No surprises here but you can see that he is still raising the aspect of reducing or changing or our personnel.
The end of Aug progress report will need to cover all the information he asks for in this letter plus we will need to emphasise yet again that the Water Masters project will essentially need all the personnel whom we currently have.
On 26 August 2004, Mr Clarke sent by email to each of the engineers, as a pro forma draft letter, a letter addressed to Mr Hepburn, as managing director, advising that the writer, Mr Clarke’s wife, wished to exercise the options she held in Hydrocool. The letter stated that the writer wished to exercise her options in part as per section 4 of Appendix A, Option Conditions; and subscribe for 10 ordinary shares, and attached a cheque. Mr Clarke’s covering email said:
A form of words that you might like to use.
It is to be inferred that each of the engineers and Mr Hepburn gave a notice to similar effect to exercise a small number of his options. This is because on 2 September 2004, Mr Hepburn signed a document which was headed: “Resolution of Directors of Hydrocool Pty Ltd”. The document stated that it was resolved to approve the allotment of 100 shares to Mr Hepburn, each of the engineers and Mr Clarke’s wife, Mrs Rita Clarke. In fact, there had been no meeting of the board of directors on 2 September 2004, or at all, approving any such allotment of shares, nor had any such resolution been passed by the board of directors of Hydrocool.
On 5 September 2004, Dr Teplitzky prepared a memorandum addressed to the shareholder representatives of Hydrocool. Dr Teplitzky complained of the defiant attitude of Mr Hepburn and sought confirmation of his own authority by the shareholders to manage the company. Dr Teplitzky described a number of possible actions that the company could take in response to Mr Hepburn’s conduct. One of the possible actions was headed: “Dismiss the Managing Director/Relocation in Sydney”. The memorandum contemplated that such an action may lead to the resignation of “one or two of engineering staff and R&D Manager”. Dr Teplitzky said that the staff could be replaced in time, but not at that time. Dr Teplitzky recommended not taking that step at that time.
On 6 September 2004, there was a meeting of the shareholders of Hydrocool. They were represented by Mr Bourke and Mr Stone on behalf of ATG, and Mr Murphy on behalf of the two Coolhydro companies. The shareholders considered Dr Teplitzky’s memorandum and confirmed support for Dr Teplitzky in his dealings with Mr Hepburn. The meeting agreed that every effort should be made to reactivate a working relationship between Dr Teplitzky and Mr Hepburn, and to this end, Dr Teplitzky was authorised to set an action plan for Mr Hepburn. Further, it was agreed that Mr Bourke would also write to Mr Hepburn expressing the concern of the shareholders that Mr Hepburn had not addressed the matters raised in Mr Bourke’s memorandum of 25 August 2004. The representatives of the shareholders agreed that Mr Hepburn needed to produce a detailed business plan to the next meeting of the board of directors which, among other things, would outline the costs of completing the development of the CPU cooler project and the Water Master prototype.
In accordance with the agreement reached at the shareholders’ meeting, Mr Bourke sent a letter to Mr Hepburn dated 7 September 2004. The letter stated that shareholders were very concerned about the direction and focus of the company. The letter stated that the relationship between Dr Teplitzky and Mr Hepburn was “totally dysfunctional and is unacceptable”. It also said that the research and development being conducted by Symetrix was vital to Hydrocool and must continue. One technician from Fremantle was to be located in Colorado Springs to assist in the measurement of the results of the research. The letter went on to state that Dr Teplitzky, solely, was to manage the relationship between Symetrix and Hydrocool, and Mr Hepburn’s contact with Symetrix and related companies, was to cease forthwith. The letter also stated that Mr Hepburn’s July/August monthly report had not adequately addressed the issues that were essential to the company’s future. The letter asked Mr Hepburn to provide cost estimates and time frames for the marketing of the company’s technology and a comprehensive cash flow statement for achieving a break even position. Mr Bourke’s letter also stated that the shareholders regarded Dr Teplitzky as the senior executive.
On 7 September 2004, Mr Clarke sent Mr Hepburn an email attaching a draft letter. The email was titled “Water Master guarantee” and said “Suggested draft attached”. The draft letter attached stated:
Water Master intends to enter into an agreement with Hydrocool Pty Ltd for the development of a domestic water drinking unit which freezes water from air. The cooling power required will be provided by a thermoelectric system which Hydrocool will design and develop using Hydrocool’s proprietary technology.
This development project is to be carried out over an 18 month period with funds being provided by Water Master as part of a licence agreement with Hydrocool. The success of the development project, both in performance and in timeliness, depends to a large degree on the application of Hydrocool’s existing technology and experience and on the development expertise of Hydrocool’s research and development team based in Fremantle.
Upon execution of the agreement between Water Master and Hydrocool, Water Master will be liable for payments to Hydrocool for the life of the project. This puts Water Master at risk and there needs to be some level of guarantee to ensure that the development project will be carried out with the application of expert and experienced personnel. As with most R&D companies we believe the technical value that Hydrocool brings to the project is partly in its proprietary technology but more so in the capability of its personnel. This project will be extending Hydrocool’s technology into new areas and we need assurances that not only will Hydrocool’s best managers and engineers be placed on the project but that there is some assurance that they will remain with the project until it is completed.
Thermoelectrics is a field that few engineers are experienced in and we do not have the time frames available to suffer lengthy delays while new engineers or managers are trained.
We also seek assurances that the funds provided by Water Master will be used exclusively for the development of the drinking water technology during the life of the project. We do not wish to see them being used to support other activities the company may undertake during the life of the project. At the conclusion of the project any excess funds of course may be used for whatever purpose Hydrocool sees fit.
By a letter to the board of directors of Hydrocool dated 7 September 2004, Water Master advised that it was prepared to sign the heads of agreement sent on 1 July 2004, with various changes. One change proposed was that a licence fee of USD750,000 was to be paid in three tranches and a royalty fee of initially 3%, but reducing to 2.5%, was to be paid, once the production exceeded 10,000 units per month.
Another change was a requirement for an employee commitment. The letter relevantly read:
3.Safeguard the required Expertise
The development of our domestic water-making device depends on the ability of your team of engineers to successfully apply their knowledge and expertise in the design and development process. From the analysis so far done, we may or may not need to use your patented convector heat exchange technology and instead may use the more simple single fluid circuit or both. In either case, we view continued engineer involvement as a very crucial factor for us.
Consequently we would need the following clause added to the agreement.
Hydrocool provides a written undertaking from all of the current Fremantle‑based employees that they will remain employed with Hydrocool until the Water Master design and development project is completed.
This letter was sent as an attachment to an email from Mr Richardson to Mr Hepburn.
On 8 September 2004, Mr Hepburn sent an email to Dr Teplitzky and Mr Murphy, which recommended acceptance of the proposed amendments to the heads of agreement put forward by Water Master.
On 9 September 2004, Dr Teplitzky sent an email to Mr Hepburn. Dr Teplitzky said that Mr Hepburn would have received Mr Bourke’s note on management responsibilities. Dr Teplitzky went on to state that Mr Manners was to be seconded to Symetrix and was to return to Colorado Springs. Dr Teplitzky also said that he would review the proposed amendments to the heads of agreement from Water Master and get back to Mr Hepburn. Dr Teplitzky also sought a “credible development plan” from Mr Hepburn costing the Water Master project. Dr Teplitzky asked how it was possible to decide if the proposed amendments were “OK” if they had no idea of the cost of undertaking the development.
Dr Teplitzky also expressed his dissatisfaction at the fact that Water Master had come to the 28 and 29 June meeting seeking equity and stated:
It took me some time to get the message through that there was no one authorised to negotiate such a basis and that we are a work for fee/licence for fee company only.
In the email, Dr Teplitzky went on to express his concern that Mr Hepburn had previously suggested that the whole of the proposed licence fee be earmarked for the Water Master project. He said that the fee was a licence fee and would be spent as the board and management of Hydrocool saw fit.
Dr Teplitzky also said that Water Master appeared to have ignored the proposed licence agreement with Windsor relating to the manufacture of the HS5 convector modules; and that it was no use selling a licence to Water Master, if there was no one to make the convector modules that would be used in the water making devices.
Mr Hepburn forwarded Dr Teplitzky’s email of 9 September 2004, to Mr Clarke and the engineers with the comment: “Received today – we need to discuss”.
Later on 9 September 2004, Mr Hepburn replied by email to Dr Teplitzky’s email to him. Mr Hepburn stated that Hydrocool needed to grab the Water Master deal with both hands before Water Master withdrew the deal. Mr Hepburn also copied his responsive email to Mr Clarke and the engineers.
On 10 September 2004, Mr Hepburn made a detailed response to Dr Teplitzky’s email. The response also included comments from Mr Clarke. This email was also copied to Mr Clarke and the engineers.
Shortly before 14 September 2004, Mr Hepburn forwarded to Dr Teplitzky, the reports, referred to previously, of Mr Banney, Mr Manners and Mr Clarke, criticising the Symetrix research project. Mr Hepburn asked Dr Teplitzky to distribute the reports to other members of the board of directors.
By an email dated 14 September 2009 to Dr Teplitzky, Mr Hepburn asked for his confirmation that he had distributed the reports to Mr Bourke and Mr Murphy. Mr Hepburn went on to state that the engineers were seeking his assurance that the board of directors would vote on the future of the Symetrix project, after the reports had been carefully reviewed. Mr Hepburn copied this email to Mr Clarke and the engineers.
By an email dated 15 September 2004, Dr Teplitzky responded to Mr Hepburn by saying that the reports would be distributed at his discretion, and it was none of the engineers’ business what the board of directors did, or voted on. Mr Hepburn underlined those sentences in Dr Teplitzky’s email, and copied Dr Teplitzky’s email to Mr Clarke and to each of the engineers with the following comment:
I have to say that his comments which I have underlined are for me the most infuriating and the most unacceptable I have seen in business in thirty years.
Arrogance, ignorance and insensitivity to the extreme.
We need to discuss what action should be taken if he does refuse to distribute.
On 17 September 2004, Mr Clarke sent Mr Hepburn a document containing “redrafted and expanded manning descriptions” for the Water Master and CPU cooler projects. Mr Clarke envisaged two new staff members being hired as engineers. There were now to be four engineers on the Water Master project including two new engineers, and two existing engineers and one new engineer for the CPU cooler project.
On Saturday, 18 September 2004, Dr Teplitzky sent Mr Hepburn an email about the amendments to the heads of agreement proposed by Water Master. The email said:
Amendment – it will not guarantee current staff as stated. Will consider “appropriate staff to complete development at HPL discretion”
The email also stated that Dr Teplitzky required Mr Manners to visit Symetrix in Colorado Springs for a couple of weeks to carry out measurements and transfer his knowledge of measurement procedures to Symetrix employees.
On Sunday, 19 September 2004, Mr Hepburn forwarded Dr Teplitzky’s email to Mr Clarke and the engineers, stating:
We will need to discuss on Monday.
On 19 September 2004, Mr Hepburn sent an email to Mr Richardson which stated that Dr Teplitzky had advised that he was not prepared to accept the required commitment from all current employees and instead wanted to replace the wording by “appropriate staff to complete development at HPL discretion”.
Mr Hepburn’s email went on to state:
I need to talk to you about this since firstly I can tell you with absolute certainty that unless we do retain all of the current employees we would not have the expertise to successfully complete the project. This expertise cannot be replaced even if we wanted to These guys have been working on our technology and the application of it for the last five years. They are the same team which produced the prototype for Marco and whether we go with the convector or the SFC we need every single one of them.
David simply does not like the employees to have any say in any matter.
Secondly, I am not sure if Peter would accept the responsibility of the project unless he knows that he has the required engineers available.
I will discuss with Peter on Monday morning.
Mr Hepburn copied this email to Mr Clarke, inviting him to discuss the email on Monday – which was the next day. On that day, Mr Hepburn sent Mr Clarke an email stating that it would help if Mr Clarke drafted an email to Mr Richardson expressing his view on the necessity of retaining all the current employees for the Water Master project. Mr Hepburn asked Mr Clarke to let him see the email before he sent it to Mr Richardson.
On 20 September 2004, Mr Clarke drafted the email requested by Mr Hepburn. The email read as follows:
I understand there has been some communication between yourself and Hydrocool regarding the staffing required to successfully carry out the development of the thermoelectric “water from ice from air” prototype.
The current Hydrocool staffing is:
Monty Davis Applications/Design engineer
Rob Weymouth Applications/Test engineerboth of whom you met in Fremantle
As well as:
Brett Manners Research/Development engineer
Ben Banney Research/Development engineerBrett and Ben have recently returned from the US and have expertise particularly in modelling and analysis.
Brett has been involved intensively in developing the single fluid circuit concept over the last couple of years and assisted Monty in modelling for the demonstration prototypes recently tested.
I can assure you that all of the engineers are highly motivated to bring your project to a successful conclusion. They were all involved in the MARCO prototype project and it was a disappointment for all of us when that did not proceed commercially. We see your project as an excellent opportunity to get the technology we have all worked so hard on finally out into the market place as a commercial product.
I believe that all of these engineers are going to be required by Hydrocool to carry out your project successfully. Monty and Rob will also have responsibilities in finalizing development of the CPU cooler heat exchanger devices as they will most likely be used as essential componentry on your project. I expect to hire additional new engineers as well to enable timely completion of all of our projected work for the rest of 2004 and through 2005.
I can assure you of my 100% commitment to the project as well, provided I get the support I need from the Board to apply the resources necessary to carry it to completion.
After Mr Hepburn had seen and approved Mr Clarke’s draft letter, Mr Clarke emailed that letter to Mr Richardson on 20 September 2004.
On 20 September 2004, Mr Hepburn responded to Mr Clarke as follows:
Peter, I have just read this again at home and it was a very good email. Also wanted to make mention of my appreciation for your support and advice through this difficult period.
On 20 September 2004, Mr Clarke prepared further budgets for the Water Master and CPU projects. The Water Master project was costed at AUD585,500. The Gantt chart showed that four engineers were required to May 2005, with two engineers required from July 2005 onwards. The CPU project was costed at AUD548,000.
On 21 September 2004, Dr Teplitzky sent an email to the other directors of the Hydrocool board, which attached two papers. The first paper stated that it was a summary of what Dr Teplitzky discussed at his August 2004 meeting in Colorado Springs with Dr Araujo. The second paper was a paper requested by Mr Bourke, which set out alternative strategies regarding Hydrocool’s future. Dr Teplitzky’s covering email stated:
My position is that I support completing a deal with Water Master as long as we can get a few mentioned amendments, solely as a means of staying financial longer to enable us to pursue the Symetrix R&D and hope we do achieve the elusive milestone of proof of concept. Unless we also complete a license for CPU system, and perhaps at least one other license, we won’t even complete the Watermaster development before running out of money. As you will read, I have been unable to get any interest in purchase of ATG shares and associated injection of funds into HPL (without dilution to other shareholders) until we can demonstrate the ZT milestone, and show that the establishment at Fremantle can be sustained on a break even basis from licenses of current technology.
Our only upside is the Symetrix project (if successful) and so I want to give this the maximum time to succeed.
Two alternative strategies were identified by Dr Teplitzky in the second paper. The first alternative was maintaining the Fremantle operation and engaging in the Water Master project. The alternative strategy referred to in the paper, was to close down the Fremantle operation, terminate all staff at Fremantle, and retain Dr Teplitzky as the sole employee. In this case, Hydrocool would not continue with the Water Master project.
Dr Teplitzky stated that Hydrocool would, on current projections, and in the absence of a further source of revenue or funding, run out of money in the first scenario by August 2005, not completing the Water Master project; and in the second scenario, by April 2005. Dr Teplitzky recognised that there were a number of obstacles facing the successful licencing of the CPU cooler unit.
One of the desired amendments to the Water Master heads of agreement referred to by Dr Teplitzky in his email of 21 September 2004, was the rejection of Water Master’s requirement to guarantee that existing employees would be available full-time for the duration of the project, and the acceptance by Water Master, of Hydrocool’s proposal that it would allocate appropriate experienced personnel to the project.
On 21 September 2004, Mr Hepburn wrote to Mr Richardson commenting:
Further to this email I have discussed the situation with Peter and he is rather firm in his belief that without the confirmed commitment from all the current engineers, he would not be able to do a good job on the prototype. In fact, he is reluctant to accept the project unless he is sure he can succeed.
I am sure that David will be trying to persuade the Board that Hydrocool needs to be able to take people off the Water Master project at its discretion whenever and for whatever reason.
Am I correct in assuming that Water Master will not proceed without the employee commitment as stated in the draft HOG?
On 21 September 2004, Mr Richardson emailed Mr Hepburn stating:
You are correct in your assessment. Without Hydrocool’s employee commitment our very large investment in this project would be at risk. We believe that the real value of Hydrocool’s technology is resident in its employees. Without them we do not believe Hydrocool would have the ability to complete this project. Hence our request for this simple assurance to be embodied in the HOA.
Later on 22 September 2004, Mr Hepburn sent Dr Teplitzky, Mr Murphy and Mr Stone an email, which reported, inter alia:
The employee commitment is a deal-breaker for Water Master…
Mr Hepburn’s email went on to say of the employee commitment that this was “something [Water Master] have said from the very beginning”. Mr Hepburn also included in that email, an extract from Mr Richardson’s email of 21 September 2004. Mr Hepburn forwarded his email to Mr Clarke and the engineers.
On 24 September 2004, there was a meeting of Hydrocool’s board of directors in Sydney. Present at the meeting were Dr Teplitzky, Mr Hepburn, Mr Bourke, Mr Murphy and Mr Stone. At the meeting, Mr Hepburn described the proposed activity of the company. He presented a cash flow forecast for the period ending December 2005. This reflected Hydrocool deriving income from the licence fee payable under the proposed Water Master licence agreement, a licence fee and royalties under the proposed Windsor licence agreement, and from a licence fee payable in respect of a second licence agreement which Mr Hepburn predicted would be entered into in relation to the CPU cooler project in 2005. Mr Hepburn did not include any proposed payments being made to Symetrix in connection with Hydrocool’s participation in the Symetrix project.
At the meeting, Mr Hepburn voted against the continuation of payments for the Symetrix research project until there had been a review of the project.
Mr Hepburn secretly taped the proceedings at the board meeting. A transcript of the board meeting was in evidence. Notwithstanding, the existence of a transcript, there was controversy as to what instructions were given to Mr Hepburn at that board meeting, in relation to the employee commitment amendments sought by Water Master. I will deal with the controversy later in these reasons.
It is uncontroversial that after the board meeting, Mr Hepburn obtained a draft from the law firm, Abbott Tout, which relevantly included three new clauses for the Water Master heads of agreement relating to the employee commitment, and a draft of the proposed undertaking to be given by the employees affected (the Key Employee Undertaking). The proposed new clauses provided as follows:
3.5Pending execution of the Final Agreement, the Key Employees will give Water Master the Key Employee Undertaking.
3.6Subject to the provisions of clause 3.7, HPL undertakes to Water Master that HPL will not undercut the benefit of the Key Employee Undertaking by terminating the services of the Key Employees prior to 31 December 2005 on the grounds of redundancy.
3.7Nothing in clause 3.6 precludes HPL from terminating the services of the Key Employees prior to 31 December 2005 for cause eg unsatisfactory performance or misconduct.
Further, Mr Richardson also said in his witness statement of 9 September 2009, that Water Master had not been able to raise the funds to commercialise the domestic water from air device.
The amount claimed of AUD1,674,000 is based on the loss of royalties founded on the manufacture in one year of 10,000 water from air units per month, at an ex-factory cost of AUD399 per unit.
The licence granted by Hydrocool under the proposed Water Master licence agreement was to manufacture and commercially exploit the HS5 and/or the single fluid circuit technologies, for the single application of domestic water from air devices. The prospect of Hydrocool earning royalties under the Water Master licence agreement, was, therefore, to an extent, subject to the contingencies relating to the unsolved problems with the HS5 convector, to which I have already referred. Because of the prospect of the single fluid circuit technology being used in the water maker, I place less weight on this contingency, in relation to the Water Master agreement, than in respect of the CPU cooler units.
In addition to the other contingencies to which I have already referred, there are further contingencies which are to be taken into account in assessing the prospect of Hydrocool receiving the royalties contemplated under the Water Master licence agreement.
The first contingency is that, even if a domestic water from air prototype had been successfully developed by Hydrocool and been capable of commercial production, the product would not have been a market success. Plainly, in the absence of a domestic water from air device being a success in the market, the prospect of receiving substantial royalties under the Water Master licence agreement is substantially diminished. In this regard, there was no evidence that Water Master’s compressor driven office water maker was a market success. In fact, to the contrary, the evidence of Mr Skillecorn was to the opposite effect.
The next contingency is the risk of Water Master being unable to manufacture or procure the manufacture of the water from air devices, in respect of which the licence had been granted. As mentioned, in 2004, the parties had proceeded on the assumption that there would be a manufacturer for the CPU cooler units and the domestic water from air devices. However, it was apparent that by the time of the trial, Windsor had closed down the factory in China where the units were to have been manufactured, for financial reasons. The WMEL business plan stated that WMEL, with which Mr Richardson was associated, had located an alternative factory. However, WMEL was looking for further monies to progress the venture.
Also, there was no evidence that TEA had earned any royalties in respect of the licensing of its technology for use in relation to the domestic water maker prototype which it had produced.
Although it may be that Windsor’s actions in closing down the factory in China, and the absence of TEA earning royalties, are to be explained by the existence of this litigation, as hinted by Hydrocool, this was not a matter which was explored in the evidence. I, accordingly, proceed on the basis that Water Master’s inability to manufacture, or to procure a manufacturer for the water from air device, is a contingency to be taken into account in assessing the prospect of Hydrocool earning the royalties contemplated under the proposed Water Master licence agreement.
Taking all the contingencies into account, I find that there was about a 15% prospect of Hydrocool earning royalties under the contemplated Water Master licence agreement.
In assessing the compensation to be awarded in respect of this lost opportunity, I prefer to use the larger of the sums claimed by Hydrocool as the base upon which to assess the quantum of compensation payable. This is because Hydrocool has clamed its loss by reference only to one year’s potential lost royalty, whereas had the project been successful, the royalties would have continued for longer than one year. Further, Mr Hepburn and Mr Clarke did not adduce their own expert evidence directed to establishing a projected loss, against which a discount should be applied for contingencies.
I observe that Mr Hepburn and Mr Clarke contended that Hydrocool had not established an ex-factory cost for the water from air device. The figure of AUD399 was based on projected figures for manufacturing costs used in the WMEL business plan. Mr Richardson said in evidence that the manufacturing costs referred to in the business plan were hypothetical and bore no relation to fact. In my view, this is not a sufficient basis to find that Hydrocool’s figure is not supported by the evidence. Notwithstanding that the manufacturing costs may have been hypothetical, WMEL a company with which Mr Richardson was associated, was content to publish those figures in a business plan to be used for the purposes of seeking investors, in respect of the commercialisation of a domestic water maker.
Accordingly, I award compensation in the sum of AUD270,000 in respect of the loss of opportunity to earn royalties under the contemplated Water Master licence agreement.
I observe that in the closing submissions of Hydrocool, Hydrocool also referred to the market projection in respect of office water from air machines. However, the office water from air machine on which Water Master based its sales projections, was a compressor based machine. Further, such evidence as there was about the office based water from air machine, was that it had not been a success in the market. In my view, the submission was unhelpful.
The loss of opportunity to earn royalties from the Windsor agreement
As I have already mentioned, Hydrocool claimed the sum of AUD600,000 or alternatively, AUD72,926.18 as compensation for the loss of the opportunity to earn royalties under the proposed Windsor licence agreement. Although the proposed Windsor licence agreement provided for a royalty of 5%, Mr Hepburn advised the board at the 24 September 2004 meeting, that a royalty of 3% of ex-factory cost was more appropriate. Hydrocool has used this rate in the calculation of its loss.
It was contemplated that Windsor would have had an exclusive licence to manufacture and distribute Hydrocool’s CPU cooler units for South-East Asia and Australasia and a non-exclusive licence for the rest of the world.
There were a number of obstacles in respect of Hydrocool’s claim under this head of claim compensation.
First, the sum of AUD72,928.18 which Hydrocool claims, is founded on an addressable market which is derived by the application of two filters, namely 20% and 0.3%, referred to by Mr McGrath in his evidence. However, in his cross-examination Mr McGrath said that the application of those filters showed only those persons with computers with specifications (“highly spec’d machines”) who would benefit from a CPU cooler. The market for persons who are likely to actually buy CPU coolers requires the application of a third filter, namely, a smaller group than in the total addressable market. The application of this third filter would reduce further the potential sales of Hydrocool CPU cooler units relied upon by Hydrocool in assessing its loss of opportunity to earn royalties in respect of its CPU cooler units.
Further, in assessing potential royalties based on a formula of 3% of the ex-factory cost of a CPU cooler unit, Hydrocool relied upon the evidence of Mr McGrath for the ex-factory cost of a CPU cooler unit. Mr McGrath used AUD297.50 as the ex-factory cost. During cross-examination, however, Mr McGrath accepted that the cost to build each unit was AUD264. Mr McGrath conceded during cross-examination that on a sale price of AUD297.50 the manufacturer’s overheads would not be covered, with the consequence that there would be no net profit on sales. Mr McGrath went on to concede that as a matter of commercial reality no such sales would ever occur.
However, notwithstanding the concessions made by Mr McGrath in cross‑examination, it must be possible to derive an ex-factory cost of a CPU cooler unit which will generate a profit for the manufacturer. I will, in the absence of Mr Hepburn and Mr Clarke having in final submissions relied upon evidence of an alternative figure for the ex-factory cost of a CPU cooler unit, assume that the cost of manufacture, namely AUD260 referred to by Mr McGrath, was higher than was in truth the case, and proceed on the assumption that the figure of AUD297.50 as the ex-factory cost of a CPU cooler unit was within the range of reasonable estimates.
In addition to the substantial contingency risks to which I have already referred, namely, the unsolved problems associated with the HS5 convector and the substantial risk that Windsor would be unable to manufacture the HS5 convectors and CPU cooler units, by reason of having been forced for financial reasons, to close down the factory in China, there was also a further risk that Hydrocool was too late in entering the market for the supply of CPU cooler units.
This risk was recognised by Mr Stone at the board meeting on 24 September 2004, when he raised with Mr Hepburn the fact that there were pages of hits on Google which indicated that there were several manufacturers of CPU coolers already in the market. Mr Stone queried whether Hydrocool may have missed the boat. At the same meeting, Dr Teplitzky asked whether computer manufacturers themselves would be integrating water cooling into their manufacturing and, if so, who was going to buy an ancillary unit. Mr Hepburn said that, even if the manufacturers were integrating water cooling into their computers, if Hydrocool was the best performer, that was something the computer manufacturer had to look at.
However, there was no evidence that Hydrokinetics had achieved any success in commercialising a CPU cooler using the HS5 technology. Indeed, Mr Skillecorn said that he had abandoned attempts to commercialise the HS5 convector.
Nevertheless, the fact that a prototype Hydrocool Hydro-Stream CPU cooler unit had received a favourable review in Overclockers.com in June 2004, is a factor to which weight should be accorded. Further, as Dr Bellstedt deposed, the period during which Hydrocool was able to take advantage of the favourable review was limited.
In my view, seeking to quantify the prospect of Hydrocool subsequently earning royalties by reference to the application of a percentage to either of the sums claimed by Hydrocool would not fairly represent the loss of opportunity. The figure of AUD600,000 is based purely on optimistic speculation by Mr Hepburn at the board meeting on 24 September 2004, whereas the figure of AUD72,926.18 is affected by obvious anomalies in the evidence of Mr McGrath.
In my view, taking into account the contingencies referred to above, I award compensation of AUD30,000 in respect of Hydrocool’s loss of the opportunity to earn royalties under the Windsor agreement.
LOSSES ARISING FROM THE EN MASSE RESIGNATION OF THE ENGINEERS
There are two elements to Hydrocool’s claim for losses arising from the en masse resignation of the engineers.
The first element relates to the time costs and expenses claimed by Mr Skillecorn and Mr Murphy in re-establishing the Hydrocool technology. The second element of the claim comprises a claim by Hydrocool for the loss of opportunity to earn royalties under the Hydrokinetics license agreement.
I have found that the conduct by Mr Hepburn in breach of his fiduciary duty, and the conduct of Mr Hepburn and Mr Clarke in contravention of s 182(1) of the Corporations Act, caused the en masse resignation of the engineers.
The next question is whether the en masse resignation of the engineers caused the losses claimed by Hydrocool.
Mr Hepburn and Mr Clarke contended that the causal chain between the losses claimed by Hydrocool, and any breach of duty by them, had been broken because Hydrocool had, before Mr Hepburn was dismissed, and, therefore, before the en masse resignation of the engineers, already decided to close the Fremantle premises, terminate the contracts of employment of Mr Clarke and the engineers, and move the operations to Sydney. Accordingly, said Mr Hepburn and Mr Clarke, Hydrocool was in no different a position after the en masse resignation of the engineers and Mr Clarke, than it would otherwise have been.
In my view, on the operation of the more stringent test in equity, it is not open to Mr Hepburn to raise this contention in response to the finding that his breach of fiduciary duty caused the en masse resignation of the engineers.
However, in my view, a contention to that effect is available to Mr Hepburn and Mr Clarke in relation to Hydrocool’s contention that losses were caused by their respective contraventions of s 182(1) of the Corporations Act. I now consider this contention.
I find that prior to the dismissal of Mr Hepburn on 19 October 2004, Dr Teplitzky had already decided to close the Fremantle operations. It is apparent from his communication with Grant Thornton, on 18 October 2001, that he intended to close the Fremantle operations, whether any one or more of the engineers agreed to relocate to Sydney or not. As previously mentioned, I reject Dr Teplitzky’s evidence at para 35 of his affidavit, that he intended to keep the Fremantle operations going under a new managing director if the engineers did not want to relocate to Sydney, as being contrary to the contemporaneous documentation.
It follows that in relation to Hydrocool’s claim for compensation against Mr Hepburn and Mr Clarke under s 1317H of the Corporations Act, Hydrocool has failed to establish the necessary causal link between Mr Hepburn’s and Mr Clarke’s contraventions of s 182(1) and the damage that Hydrocool claims that it has suffered.
I now deal with the claim against Mr Hepburn arising from his breach of his fiduciary duty.
In Youyang, the High Court at [44], said that there was “no equitable by-pass to the need to establish causation”. It is necessary, therefore, to apply the principles referred to at [469]-[473] above.
Mr Skillecorn and Mr Murphy’s time and expenses
The claim in relation to the time spent and expenses incurred by Mr Skillecorn in re‑establishing the Hydrocool technology, comprises the following components:
(a)time cost for Mr Skillecorn of AUD167,115;
(b)telephone costs of AUD1,400;
(c)motor vehicle expenses of AUD1,400;
(d)stationery costs of AUD500;
(e)other consultants costs of AUD3,500.
The claim for AUD82,929.27 in relation to Mr Murphy, represents a charge in respect of the time which he said that he spent on Hydrocool matters in the course of seeking to re‑establish the Hydrocool operations.
Mr Skillecorn deposed that since July 2005, he kept Mr Murphy advised of the costs and expenses incurred, and Mr Murphy advised Mr Skillecorn that if Hydrocool had funds in the future, the costs and expenses would be reimbursed.
In his affidavit of 28 November 2008, Mr Murphy said he was the sole director of Hydrocool and he made all decisions relating to the payment of money by Hydrocool to third parties. He said that it was his intention as soon as there were funds available to Hydrocool from trading activities, including the receipt of royalties from Hydrokinetics, to authorise the payment to both Mr Skillecorn and himself of an amount of money to reimburse each of them for the costs they had incurred in re-establishing Hydrocool’s technology. He said that neither he, nor Mr Skillecorn, had rendered invoices in respect of the charges Hydrocool claimed.
Mr Murphy annexed to the affidavit a print out of the spreadsheet setting out the activities in which he engaged in trying to re-establish Hydrocool’s technology. Those activities include dealing with Mr Skillecorn.
In my view, Hydrocool has not proved that it has suffered a loss in respect of these charges. The evidence does not reveal that either Mr Skillecorn or Mr Murphy has a presently enforceable right in respect of these monies against Hydrocool, which Hydrocool would be liable to meet. At best, the evidence of Mr Murphy discloses a statement of future intent to make payments, should circumstances change.
It is significant that neither he nor Mr Skillecorn had issued invoices relating to the costs they incurred.
Accordingly, I dismiss this claim.
Further, and in any event, I am not satisfied that all of the time spent by Mr Skillecorn is causally connected to Mr Hepburn’s breach.
First, after his appointment, Mr Skillecorn, who is not an engineer, contrary to the advice of Mr Murphy and Dr Teplitzky, declined for some time, to engage engineering assistance to help him in his task of re-establishing the Hydrocool technology.
During cross-examination, Mr Skillecorn was taken to an email from Mr Murphy dated 5 October 2005. The email contained the following statement:
From day one it was understood that you would need to employ a competent engineer and I have lost count of the number of times David has brought this up. As this has not occurred to date the slow progress sorting out the technology is therefore not unexpected.
Secondly, Mr Clarke during his evidence, showed that a full set of records and reports were left on Hydrocool’s server.
Mr Skillecorn said in cross-examination, however, that Grant Thornton delayed providing him the portable hard drive and ghost copies of the Hydrocool computers until 1 November 2005 – about one year after Grant Thornton took control of the Fremantle premises.
Mr Skillecorn also admitted that he was unable to access the CAD drawings stored on the hard drive because he did not know how to do so. It took nine months after the delivery of the disk by Grant Thornton before he sought advice from an information technology expert.
Further, Dr Bellstedt gave evidence that he would advise the company against hiring a person with no qualifications or experience in engineering, thermodynamics or in thermoelectrics to develop a new heat pump.
Accordingly, if contrary to my view, Hydrocool was liable to meet Mr Skillecorn’s costs, it would have been my view that Hydrocool has not proved that all the costs and expenses incurred by Mr Skillecorn were related to Mr Hepburn’s breach of duty.
I would have been prepared to award only AUD25,000 in respect of this claim.
In relation to the claim in respect of Mr Murphy’s time, had I been of the view, that Hydrocool had suffered a loss in respect of this claim, I would only have awarded Hydrocool AUD25,000 in respect of those costs. This is because Hydrocool chose to enter into a licence agreement with Hydrokinetics knowing full well that Mr Skillecorn was not an engineer, and the predictable consequences occurred. This meant that Mr Murphy’s involvement was greater than it would otherwise have been, had Hydrocool acted reasonably, and appointed a person with the necessary professional expertise to re-establish Hydrocool’s technology.
Thetford
Hydrocool claimed the sum of AUD300,000 in respect of the lost opportunity to earn royalties under the Hydrokinetics licence agreement from a licence that Hydrokinetics would have entered into with a company, Thetford.
In May 2006, Mr Paul Chandler who agreed to assist Mr Skillecorn in licensing Hydrocool technology, met a friend who worked for Thetford, which was a large supplier of refrigeration equipment for recreational vehicles, boats and trucks in the United States and around the world. They discussed Hydrocool technology. Hydrokinetics entered into a non-disclosure agreement with Thetford on 12 May 2006. During negotiations, an executive of Thetford said that Thetford produced about 40,000 refrigerators a year and it was interested in Hydrocool’s technology.
Negotiations proceeded to the point where an executive from Thetford asked Hydrokinetics to send a complete thermoelectrical refrigeration system to its plant in Ohio so that it could be tested. Thetford said that they would need to see the complete refrigeration system before proceeding further. Mr Skillecorn was unable to comply with Thetford’s request because the one sample he had, comprised the Hydrocool 126 litre refrigerator freezer prototype built as part of the MARCO project. However, the fridge freezer did not work because the system had largely corroded. Also, Mr Skillecorn had no further heat exchangers. Mr Skillecorn also said that it would have cost several thousand dollars to replicate the refrigerator freezer. Hydrokinetics did not have sufficient funds at the time to obtain the required heat exchangers and replicate the refrigerator freezer. Negotiations with Thetford, therefore, ceased.
Mr Skillecorn said that Hydrokinetics would have sold heat exchangers to Thetford and entered into a licence agreement with Thetford in respect of which it would have charged a licence fee of 4%. Mr Skillecorn went on to say that an ex-factory cost of the Thetford refrigerator could be assumed to be AUD300 to AUD400.
Hydrocool contended that pursuant to its licence agreement with Hydrocool, Hydrokinetics would be required to pay Hydrocool a royalty/licence fee of 5% of the ex‑factory cost of the fridge freezer. On that basis, a licence fee payable in respect of 40,000 refrigerators for one year would be AUD600,000. Hydrocool contended that a deduction of 50% was acceptable, reducing the claim to AUD300,000.
In my view, this claim is entirely speculative and demonstrates no causal link to the en masse resignation of the engineers. There is no prospect that Thetford would have entered into an agreement with Hydrokinetics. This is because Hydrokinetics was in such a parlous financial position that it was not able even to supply a sample of the complete refrigeration system. The fact that it could not supply that system was not related to the en masse resignation of the engineers, but to the fact that the fridge freezer had corroded and Hydrokinetics was not in a financial position to repair or replicate the system. The fact that Hydrokinetics was in a parlous financial position was also unrelated to the en masse resignation of the engineers.
Marlow
Hydrocool claimed the sum of AUD16,500 by way of a lost opportunity to earn royalties under the Hydrokinetics licence agreement in relation to an opportunity which Hydrokinetics had to enter into a contract with a company, Marlow, in 2006.
In June 2006, Mr Skillecorn had a conversation with Mr Dwight Johnson, an executive of Marlow. During that conversation Mr Johnson asked Mr Skillecorn to give Marlow a quote to supply up to 60,000 heat exchangers.
Mr Skillecorn deposed that Hydrokinetics did not have the funding to build the heat exchangers and so sought a quote from Matsushita in Japan. Matsushita quoted USD60 to supply a complete heat exchanger unit. Mr Chandler then on behalf of Hydrokinetics quoted the price of USD60 per heat exchanger. Marlow rejected the quote on the grounds that it was too expensive.
Mr Skillecorn deposed that if Hydrokinetics had been in a position to build the heat exchangers it would have quoted Marlow AUD22.50 per heat exchanger to supply 60,000 heat exchangers.
Hydrocool contended that on that basis it would have been entitled under the Hydrokinetics licence agreement to a royalty payment of AUD33,000. However, Hydrocool contended that a 50% reduction was applicable for contingencies.
This claim, too, is speculative and does not demonstrate a causal link with the en masse resignation of the engineers. There was no prospect of Hydrocool earning any royalty by reason of Hydrokinetics entering into a transaction for the supply of 60,000 heat exchangers to Marlow. The evidence shows that Hydrokinetics was not in a financial position to build the heat exchangers. As mentioned above, Hydrokinetics’ parlous financial position, was unrelated to the en masse resignation of the engineers.
The claim for the repayment by Mr Hepburn of the monies he claimed as a bonus
The next question is whether Mr Hepburn is required to pay Hydrocool the sum of AUD33,280 and interest.
On 19 October 2004, Mr Hepburn procured Mr Clarke to pay the sum of AUD33,280 to a bank account under his control. Mr Hepburn says in his defence, that he was entitled to be paid that sum as his annual bonus for the 2003/2004 financial year.
Mr Hepburn’s terms of employment are recorded in a letter of engagement dated 20 July 2000. The letter contains the following term relating to the payment of a bonus:
Annual Bonus. The Board of Directors reserves the right to pay a bonus upon the achievement of approved objectives. Any such bonus shall be up to 20% of base salary.
At the meeting of the board of Hydrocool on 23 June 2004, the payment of a bonus to Mr Hepburn was discussed by the board members. However, no minutes of the meeting were prepared.
On 14 July 2004, Mr Hepburn sent an email to Dr Teplitzky in which Mr Hepburn stated that his intention was “to seek payment” of the bonus before December 2004. A copy of that email was sent to Mr Bourke.
Dr Teplitzky responded to Mr Hepburn’s email noting that Mr Hepburn stated that “he will wait for further funds to come into [Hydrocool] before seeking payment. We anticipate licence fees to be paid this year”.
On 26 July 2004, Dr Teplitzky sent an email to Mr Bourke in which Dr Teplitzky stated “that the accounts for 03/04 should contain a provision for the full bonus payment to Iain for the year 03/04 none of which has been paid”.
On 27 July 2004, Mr Bourke sent a facsimile to “Dorothy” which stated that a decision had been made to make a provision for the payment of the bonus to Mr Hepburn in the accounts. The facsimile also contained an undated and unsourced handwritten note, stating that a binding commitment had been received from Water Master on 8 September and the bonus was now payable. I place no weight on this note. Its author is unknown. Further, its contents are inconsistent with the views expressed by the members of the board, including the views of Mr Hepburn set out in his email of 27 September 2004, that the bonus would be paid once the Water Master heads of agreement was signed.
On 27 September 2004, Mr Hepburn, in response to a request to provide his notes of the Board meeting of 23 June 2004, sent an email to Dr Teplitzky. The email relevantly stated:
Don asked that I provide a list of the action points from our Board Meeting of 23 June 2004. These are listed below and have been taken from my notes of the meeting.
...
6.Bonus for IH for 2003/2004 to be accrued in the 2003/2004 accounts and paid once HOG with Water Master signed.
On the same day, Dr Teplitzky responded to Mr Hepburn in relation to the bonus as follows:
I do not recall this as a condition, but more to do with funds available. I may be wrong.
Mr Hepburn then respond to Dr Teplitzky as follows:
My notes recorded what I have advised.
In his witness statement, however, Mr Hepburn said that he may not have referred at the June 2004 directors meeting to the signing of the Water Master heads of agreement being the basis on which the bonus would be paid to him. I prefer the evidence comprised by Mr Hepburn’s email of 27 September 2004.
Mr Murphy gave the following oral evidence as to Hydrocool’s practice, in respect of the accrual of a bonus payment in the accounts:
The procedures with Hydrocool was that every year the accrual would be recognised and when the criteria had been met to make the payment, the payment would be made so that the accrual would be cleared out. It would be paid in subsequent year, basically, if everything that needed to be done had been done to receive that bonus.
There was no dispute between the parties that Mr Hepburn had met the annual bonus objectives which Dr Teplitzky had set Mr Hepburn for the financial year 2003/2004.
In cross-examination, Mr Hepburn said that he believed that he was entitled to the bonus payment because “the Water Master heads of agreement in my view should have been signed” by the date he was dismissed.
In his closing submissions, Mr Hepburn submitted that he was entitled to receive the payment of the bonus because he had met the objectives which Dr Teplitzky had set for him for the 2003/2004 year. Accordingly, his right to be paid the bonus sum had accrued several months before he sent his email of 27 September 2004 to Dr Teplitzky. There was, said Mr Hepburn, no need for any further decision to be made by the board, whether by board resolution or otherwise.
For the following reasons, I find that at the date of his dismissal, Mr Hepburn was not entitled to be paid the sum of AUD33,280 which was paid by Mr Clarke.
First, on a proper construction of the term of his contract relating to the annual bonus, whether Mr Hepburn received a payment by way of a bonus was a matter which lay within the discretion of the board. There was, contrary to Mr Hepburn’s contention, no accrued right to the payment of a bonus by reason only of having achieved the objectives set by Dr Teplitzky for the financial year in question. The achievement of the objectives was a condition of the receipt of the bonus payment, but did not in itself, vest in Mr Hepburn a right to receive the bonus. The payment of a bonus even when the qualifying condition had been fulfilled, was a matter for the exercise of the board’s discretion. After all, the contract provided for the payment of an amount “up to 20% of base salary”.
In my view, by 19 October 2004, the board had not decided that Mr Hepburn should have an immediate right to be paid a bonus for the 2003/2004 financial year.
In my view, the evidence when taken as a whole, shows that there was no final decision by the board made in June 2004, to approve the payment of a bonus to Mr Hepburn. Rather, the evidence shows that the decision made was to make a provision in the accounts for the payment of the bonus, but the final approval of the bonus was to be a matter for the board to consider at a future time, once the financial circumstances of the company had changed. The evidence also shows that, in June 2004, the directors anticipated that the most likely source of revenue to the company in the near future was the payment of a licence fee under the Water Master agreement, which all concerned anticipated would be signed before the end of 2004.
However, even if the evidence was to be construed as the board having decided finally to pay Mr Hepburn the annual bonus, subject only to the fulfilment of a further condition, namely, on Dr Teplitzky’s version, the receipt of funds, or on Mr Hepburn’s version, the signing of the Water Master heads of agreement, Mr Hepburn would still not have been entitled to the bonus payment of AUD33,280 on 19 October 2004. This is because, by that date, Hydrocool had neither signed the Water Master heads of agreement, nor was it in receipt of further funds.
I do not accept Mr Hepburn’s argument that he was entitled to the payment of the bonus because it was by reason of Hydrocool’s actions, that the Water Master heads of agreement was not signed by the date of his dismissal. As I have found above, it was by reason of Mr Hepburn’s own conduct, namely, his breaches of duty that the Water Master heads of agreement was not signed.
I find that by the date of his dismissal on 19 October 2004, Mr Hepburn had no accrued right to receive the payment of AUD33,280, by way of a bonus for the 2003/2004 financial year.
Hydrocool contended that in procuring Mr Clarke to pay the bonus payments to his nominated bank account, Mr Hepburn acted in breach of his fiduciary duty. Counsel for Mr Hepburn and Mr Clarke did not put in issue whether, in relation to an entitlement to his own remuneration, Mr Hepburn owed Hydrocool a fiduciary duty. In my view, however, in relation to the question of the payment of his own remuneration, Mr Hepburn did not owe Hydrocool a fiduciary duty. He was entitled to act in his own interest in relation to securing payment of his own remuneration from Hydrocool. However, in my view, in procuring Mr Clarke on 19 October 2004, to make the bonus payment, Mr Hepburn improperly used his position as a director for his own advantage. This is because he sought to justify his actions on the basis that the condition for the payment of the bonus, namely, the entry into the Water Master licence agreement, had, by reason of Hydrocool’s actions not been fulfilled. I have found, however, that the loss of the Water Master licence agreement arose by reason of Mr Hepburn’s conduct which was in breach of fiduciary duty and improper. In those circumstances, and with knowledge of the true reason why the heads of agreement had not been signed, Mr Hepburn acted improperly, by procuring Mr Clarke to make the payment.
It follows that Mr Hepburn is liable to pay Hydrocool the sum of AUD33,280 and interest.
SHOULD HYDROCOOL PAY TEA’S COSTS ON AN INDEMNITY BASIS?
On 24 March 2010, following discussion between counsel, counsel for the second respondent, TEA, moved for orders that the claim against the second respondent, TEA, be dismissed with costs. Senior counsel for Hydrocool agreed with the orders. I, accordingly, made an order in Court that the application against TEA be dismissed and that Hydrocool pay TEA’s costs.
However, on 28 May 2010, TEA filed a notice of motion and an affidavit of Mr Hepburn sworn 27 May 2010 in support of an application that its costs be payable on an indemnity basis.
In the originating application filed by Hydrocool on 12 September 2006, it was alleged that TEA made use of Hydrocool’s confidential information in building the TEA prototype. However, following a meeting of the experts on 1 February 2010, the experts issued a joint report in which they agreed that the TEA technology did not incorporate any of Hydrocool’s technology.
Following the production of the joint report, Hydrocool amended its statement of claim to withdraw the allegations that TEA had used Hydrocool’s confidential information, in relation to the production of the TEA prototype. During the trial, the rest of Hydrocool’s claim against TEA was dismissed by consent.
On the last day of closing submissions, I heard submissions on the question of whether Hydrocool should pay TEA’s costs on an indemnity basis.
In support of its claim for indemnity costs, TEA contended that, even prior to the commencement of the proceeding, TEA had maintained that the technology it used in the TEA prototype did not make use of any of Hydrocool’s technology.
Mr Hepburn’s affidavit annexes correspondence between TEA and Hydrocool, which goes back to February 2005, which asserts that TEA had not made use of the Hydrocool technology.
Further, there is a letter from TEA’s solicitors dated 30 May 2008, to Hydrocool’s solicitors, which states:
As previously advised, the single prototype is available for inspection in Perth, by arrangement with this office.
We expect that any independent assessment of the technology arranged by your client will require a detailed inspection of the prototype. We look forward to receiving your advices as to when this is to occur.
Hydrocool did not inspect the prototype.
On 26 June 2008, Corser & Corser again wrote to Hydrocool’s solicitors stating:
Inspection of Prototype
Our clients interpret your client’s failure to take any action to inspect the prototype held by our clients as strong evidence that your client accepts that its action is without merit. Our clients reserve their rights in respect of this inference.
Despite the regular invitations issued by TEA to Hydrocool to inspect the prototype, Hydrocool declined to do so.
Hydrocool’s refusal to accept TEA’s invitation to inspect the prototype typified Hydrocool’s more general attitude opposing a cooperative approach by the respective experts to the assessment of whether TEA had made use of Hydrocool’s technology in the development of its prototype. Hydrocool opposed TEA’s application to the Court that there be a meeting of experts for the purpose of producing, if possible, a joint report on this issue. On 12 December 2009, the Court made orders over the opposition of Hydrocool that such a meeting of experts take place before 31 January 2010. As mentioned, as a consequence of the meeting of experts, a joint minute was signed by the experts to the effect that they were satisfied that Hydrocool’s technology had not been used by TEA.
The refusal of Hydrocool to join with TEA in a cooperative approach by their respective experts, to the question of whether Hydrocool’s technology had been used by TEA until 12 December 2009, when Hydrocool was ordered by Court order to do so, was unreasonable and contrary to the modern approach to the conduct of litigation.
One of the recognised bases on which a Court may award indemnity costs is where a party by its unreasonable conduct unduly prolongs the litigation. Hydrocool was on notice from 26 June 2008, that an application for indemnity costs may be made arising from the refusal to inspect the prototype.
It is no answer to TEA’s claim, as Hydrocool contended, that TEA engaged the same lawyers as did Mr Hepburn and Mr Clarke, and had, therefore, not incurred costs independently of Mr Hepburn and Mr Clarke. The extent of any overlap in costs between TEA and Mr Hepburn and Mr Clarke is a matter to be determined at taxation.
A court will exercise caution in making supplemental orders, and in ordering indemnity costs. However, in my view, the circumstances of this case, warrant the making of such orders.
I will, accordingly, order that all costs incurred by TEA from 26 June 2008, be paid by Hydrocool on an indemnity basis.
I certify that the preceding six hundred and fifty-four (654) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Siopis. Associate:
Dated: 16 May 2011
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