In the matter of The Corporations Law and Re: Wintulichs Pty Ltd
[1996] FCA 866
•26 Nov 1996
CATCHWORDS
CORPORATIONS - application to confirm proposed issue of shares at discount - application opposed by certain members - relevant considerations - resolution passed only on casting vote of Chairman of meeting - commercial interests of company - whether Court's role to assess best commercial interests - potential prejudice to guarantor of secured creditor in event of further trading - adequacy of financial information provided - application refused.
Corporations Law 1990 s 190(2) & (3)
The Ooregum Gold Mining Company of India, Ltd v Roper [1892] AC 125
Welton v Saffery [1897] AC 299
Re Jarass Pty Ltd (1988) 13 ACLR 728
Re Melacare Industries of Australia Pty Ltd (1993) 12 ACSR 236
Re "Air North West" Pty Ltd (1988) 6 ACLC 1143
Re Mallina Holdings Ltd (1989) 15 ACLR 493
Carruth v Imperial Chemical Industries, Ltd [1937] AC 707
Bulfin v Bebarfald's Ltd (1938) 38 SR (NSW) 423
Re Esmeralda Exploration Ltd (1991) 33 FCR 192
No SG 3119 of 1996
In the matter of THE CORPORATIONS LAW
RE:
WINTULICH PTY LTD (ACN 007 765 924)
Mansfield J
Adelaide
26 November 1996
IN THE FEDERAL COURT OF AUSTRALIA )
)
SOUTH AUSTRALIA DISTRICT REGISTRY ) No SG 3119 of 1996
)
GENERAL DIVISION )
In the matter of
THE CORPORATIONS LAW
RE:
WINTULICHS PTY LTD
(ACN 007 765 924)
Applicant
MINUTES OF ORDER
CORAM: Mansfield J
PLACE: Adelaide
DATE: 26 November 1996
THE COURT ORDERS THAT:
The application be refused.
Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
IN THE FEDERAL COURT OF AUSTRALIA )
)
SOUTH AUSTRALIA DISTRICT REGISTRY ) No SG 3119 of 1996
)
GENERAL DIVISION )
In the matter of
THE CORPORATIONS LAW
RE:
WINTULICHS PTY LTD
(ACN 007 765 924)
Applicant
REASONS FOR JUDGMENT
CORAM: Mansfield J
PLACE: Adelaide
DATE: 26 November 1996
By application dated 19 August 1996 the applicant sought the Court's confirmation of a resolution empowering the applicant to issue up to 2.64 million ordinary $1.00 shares at a discount of 95¢ per share, and that such issue may be effected within two calendar months from the day of any approval given by the Court: s190(2) Corporations Law 1990 ("the Law"). Notice of the application has been given to each of the applicant's members and creditors, although there is an issue as to whether all creditors have been notified. The application is opposed by two members: John Wintulich Pty Ltd and Huxley Pty Ltd.
Sections 190(2) and (3) provide:
"(2)Subject to this section, a company other than a no liability company may issue at a discount shares in
a class of shares already issued if:
(a)the issue of the shares at a discount:
(i)is authorised by resolution passed in general meeting of the company; and
(ii)is confirmed by order of the Court;
(b)the resolution specifies the maximum rate of discount at which the shares are to be issued;
(c)the shares are issued within the period of one month after the day on which the issue is confirmed by order of the Court or within that period as extended by the Court; and
(d)the shares are first offered to every holder of shares in that class in proportion to the number of shares in that class already held.
(3)The Court may, if having regard to all the circumstances of the case it thinks proper to do so, make an order confirming the issue on such terms and conditions as it thinks fit."
It is only if existing shareholders do not take up the shares offered to them proportionately under subs(2)(d) that those shares may then be issued to other persons, but on terms that are not more favourable than those offered to the shareholders: s190(6).
The applicant was incorporated on 18 September 1974. It is a smallgoods manufacturer. It has always had a small number of shareholders only. It has an authorised capital of $10,000,000 divided into 10,000,000 ordinary shares of one dollar each. There are no special classes of shares. It presently has 1,980,000 issued shares, but it is necessary to review how that has come about.
On 4 July 1995 the applicant was placed into administration under Part 5.3A of the Law by resolution of its directors pursuant to s436A of the Law. On 19 September 1995, it entered into a deed of company arrangement between it, and others including its members and creditors, pursuant to s439C(a) of the Law. The purpose of that deed was to provide for all employee entitlements to be paid in full, for a composition of the unpreferred unsecured creditors of the applicant using funds proposed to be contributed by a consortium of proposed investors, and for the transfer of certain shares held by its existing shareholders to that consortium of investors, all of which then was to enable the applicant to continue trading.
Prior to the deed of company arrangement, entities associated with the Wintulich family, including the two present objectors, held the 1,680,000 issued shares in the applicant. Those shares had all been issued at par, but were worth considerably less by 1995. As a result of the implementation of the deed, a further 300,000 shares were issued at par and there were six equal shareholders (treating the two present objectors as one shareholder). Five of those shareholders were new, and were not associated with the Wintulich family. Each shareholder held 330,000 shares. In the case of the new shareholders, 280,000 of those shares were acquired by transfers from existing shareholders for the nominal value of $1 and 50,000 of those shares were new shares issued at par. In the case of the remaining shareholding, 280,000 shares were retained by John Wintulich Pty Ltd of its pre-existing shareholding, and 50,000 shares were new shares issued at par to Huxley Pty Ltd, both entities controlled by John Huxley Wintulich ("Wintulich"), the former managing director of the applicant. The two entities together have been treated by the parties as the sixth equal shareholder. That process resulted in $300,000 capital being injected into the applicant. The shareholding was then:
John Wintulich Pty Ltd 280,000 shares
Huxley Pty Ltd 50,000 shares
Soxami Pty Ltd 330,000 shares
Ahrens Engineering Pty Ltd 330,000 shares
Corinbar Pty Ltd 330,000 shares
AJE Haigh, SME Haigh, JD Haigh 330,000 shares
Simco Nominees Pty Ltd 330,000 shares
Issued shares 1,980,000
It remains that way, save for Simco Nominees Pty Ltd having transferred its shares to Palseem Pty Ltd on 26 July 1996. Both those companies have the same controlling interests.
Although the shares have all been issued at par, the effect of the transactions effected under the deed was for each new shareholder to acquire 330,000 shares for $50,001, and as a matter of arithmetic that equates to approximately 15¢ per share.
Following the deed of company arrangement, the directors of the applicant were Michael Howard Lawson ("Lawson"), (who became Chairman on 5 February 1996), Harold Bonney, and Wintulich. Wintulich resigned as a director on 22 May 1996, as he then believed the applicant was insolvent and should not further trade.
The working capital so provided did not have the desired effect. The applicant continued to struggle financially, and in May 1996 it entered into an informal arrangement with its creditors to provide a three month moratorium on payment of outstanding debts, and thereafter progressive reduction of those debts pursuant to an agreed timetable.
As the applicant's financial status was very unsatisfactory, steps were taken both to inform its shareholders and to try and secure further working capital. On 24 May 1996 Lawson wrote to shareholders to inform them of the parlous position of the applicant. The prospect of further financing from bankers had been unsuccessfully explored. The applicant, as Lawson confirmed in oral evidence, was incurring no further debt. Additional equity funding of $60,000 was being pursued "urgently" and the cash situation was then "critical". One shareholder, with support from others, suggested an independent accounting assessment of the financial position of the applicant; that did not happen. Progressively cutbacks to reduce expenditure, and changes in the focus of activities to improve revenue were taking place. On 21 June 1996 the directors asked each shareholder to contribute a further $15,000 equity, but they were not as a group prepared to do so. On 27 June 1996, Lawson sent to the shareholders a letter from the applicant's accountants reporting on its May 1996 "financial reports"; it provided limited information and it urged the injection of further capital either from shareholders or externally.
On 5 July 1996, in the context of a "desperate need of funds", Lawson again reported to shareholders, on that occasion of a proposal that certain sources had agreed to advance funds of $45,000 to the applicant but with the prospect of further funds, initially as loan funds, on the basis that the articles of association of the applicant would be altered to create a new class of shares with a par value of one cent, and which would rank equally in all respects with the existing shares. It was proposed also that existing shareholders would each convert $5,000 of their current loan account to such shares. It became clear that the necessary majority for a special resolution would not be procured, and the proposal was not pursued.
On 12 July 1996, with the prospect of a further $55,000 capital investment, the applicant gave notice to its shareholders of an extraordinary general meeting to be held on 30 July 1996 for the following purposes:
"Issue of Shares at a discount
To consider the audit report from Price Waterhouse with respect to the affairs of the Company;
To consider, and if thought fit, pass the following resolution;
That subject to the obtaining of the necessary consent from a Court of competent
jurisdiction, the Directors be empowered to issue ordinary $1.00 shares at a price of 5¢ (being approximatelya discount not exceeding 95% of the par value of those shares.)
And to transact any other business that may be legally brought forward."
The letter accompanying that notice explained that the current shares issued acquired pursuant to the deed were at about 85% discount, and that the proposed new shares would be at 95% discount, arrived at roughly on the basis - so Lawson said in oral evidence - that the net asset backing of the shares was about one third of its value at the time of the deed. That letter also enclosed projected profit and loss and cashflow budgets for 1996/97 to which I shall refer shortly.
The meeting took place on 30 July 1996. All shareholders were represented in person or by proxy. The first item of business could not be effected as the report from the accountants had not been acquired. It was a topic of some vigorous comment. The meeting then considered, and passed a resolution in the following terms:
"That subject to the obtaining of the necessary consent from a Court of competent jurisdiction, the Directors be empowered to issue ordinary $1.00 shares at a price of 5¢ (being approximatelya discount not exceeding 95% of the par value of those shares) and that a maximum of 2.64 million shares be available to be issued by the Directors."
The shareholders' vote on that resolution was 990,000 votes for and 990,000 votes against. As the shareholders were tied, the Chairman of the meeting had a casting vote under the Articles, and on the casting vote of Lawson as Chairman of the meeting, the resolution was passed. The resolution was altered at the meeting from that in the notice apparently as a consequence of notice from the objectors that the proposed motion was invalid.
Some of the proposed investors of the further $55,000 were existing shareholders or persons associated with existing shareholders. Those persons have since advanced that sum to the applicant by way of loan, secured by a third ranking registered debenture pending the outcome of this application. Lawson's evidence is that if the application is granted, and subject to existing shareholders not taking up the full amount of their entitlement to be offered, those persons will convert that debt to equity, but if the application is not granted, they may well call up those funds. At a 95¢ discount, that investment would be reflected in a further 1,100,000 issued shares. The number of shares specified in the resolution is much in excess of that because, according to Lawson, existing shareholders may take up the offer of 1,100,000 shares and the balance could then be offered to the potential further investors. That is somewhat fallacious as any offer must first be made to the shareholders equally for any shares proposed to be so offered, but practically it is apparently unlikely that all existing shareholders would take up such an offer. If 1,100,000 shares were taken up other than by current shareholders, the six existing shareholders' interest in the applicant would each be diluted from 16_ to about 10%.
It is in that context that this application is made. I am satisfied that, although the notice of meeting did not set out the full terms of the resolution as adopted, the purpose of the meeting was properly understood by all shareholders and that, although no formal amending motion was put to the motion notice of which had been given, the shareholders at the meeting decided that the motion as passed should be the one put to the meeting. I do not think any shareholder was in fact disadvantaged by any lack of formality, both because the shareholders understood the motion and because any formal amendment would have been passed. I am also satisfied that the creditors of the applicant including the financiers who are secured creditors have been given notice of this application; none have sought to be heard on the application. There was some dispute as to whether one entity was a creditor, and had received notice, but the evidence satisfies me that any failure to formally notify that entity was not indicative of a more generalised failure but the result of an honest judgment formed by the general manager of the applicant that it was not necessary to do so as the alleged debt was disputed, and in any event that entity has been made aware of the proceedings by Wintulich.
The objectors have raised a number of grounds in opposition to the application, which can be dealt with in the following broad heads:
(1)matters relating to the meeting: inadequacy of information; balance of vote; method of formulation of motion; absence of consent of debenture holders or other creditors;
(2)matters relating to the proposal: absence of financial commitment; inadequacy or inutility of proposed capital raising; risk of further trading diminishing assets (of particular concern to Wintulich and his wife as they have guaranteed the indebtedness of both the Commonwealth Bank of Australia and of the Commonwealth Development Bank of Australia together in excess of $900,000, and supported those guarantees by mortgages over their house); dilution of existing shareholders' interest to their detriment in the event of winding up; and
(3)matters relating to the public: misleading picture of true capital.
There is relatively little authority on s190(2) of the Law. The preconditions for the Court's exercise of its power to confirm the issue of the shares at a discount are that such issue at a discount is authorised by resolution passed in general meeting of the Company: s190(2)(a)(i), and that the resolution specifies the maximum rate of discount at which the shares are to be issued: s190(2)(b). The Court's power is discretionary: s190(3).
Section 190 provides an exception to the general rule that a company may not apply any of its shares or capital in making a payment to a person in consideration of that person subscribing or agreeing to subscribe for shares in the company, including specifically by issuing shares at a discount: s203(1) and (2). That is directed to preserving the capital of a company, and in circumstances where a company is wound up, to ensuring unpaid capital is recoverable for the benefit of creditors: The Ooregum Gold Mining Company of India, Ltd v Roper [1892] AC 125, and for the protection of existing shareholders: Welton v Saffery [1897] AC 299.
Clearly the Court will not, and should not, simply rubber stamp a proposal presented for its confirmation: Re Jarass Pty Ltd (1988) 13 ACLR 728 at 731. As Young J then commented in relation to the legislative predecessor to s190:
"There is little guidance as to how the court should exercise its power to confirm an issue of shares at a discount under s 118. Indeed, the only decided case that I have been able to find of even passing value is Re Edinburgh & Dundee Investment Co 1930 SC 601 which held that the court must weigh the pros and cons of the proposal and not merely rubber stamp what the company had done. It seems to me that the approach of the court under s 118 should be similar to its approach to reduction of capital matters. In the twentieth century the doctrine of maintenance of capital has not the same sanctity as it had in the nineteenth, and if all persons who might be affected by the proposal have had the appropriate information put before them and have been given the chance to object, then the court should be confident that it is proper in the spirit of the Code to confirm the resolution. At least this is the situation where there is nothing in the proposal which makes it appear other than one which is submitted bona fide and in the best commercial interests of the company."
That case was one where no creditor objected, all members were in favour of the proposal, and the Court was satisfied that the proposal made commercial sense. It was confirmed. The scheme involved certain "internal" creditors of the company being allotted redeemable preference shares in substitution for debt, that in the circumstances being found (for reasons to which it is unnecessary to refer) as involving a proposed issue of shares at a discount. A similar approach was adopted by Young J in Re Melacare Industries of Australia Pty Ltd (1993) 12 ACSR 236, again in the absence of opposition, because the issue of shares at a discount was necessary as the only way to procure the funds required to save the company and the public was not misled by a nominal capital figure that exceeded the true capital of the company.
McLelland J may have adopted a slightly different emphasis in Re "Air North West" Pty Ltd (1988) 6 ACLC 1143. In that case, with the support of existing shareholders, it was proposed to issue shares at a 50% discount to investors to finance an application for an airline licence, obviously a speculative investment unless the licence was granted. His Honour commented at 1143:
"In my opinion the Court should ordinarily confirm a proposed issue of shares at a discount if it is satisfied that the issue has a legitimate commercial justification and that it is not likely to operate to the prejudice of any interested person."
He confirmed the issue, subject to the condition that for five years any future subscribers for shares in the company
should be informed of the details of shares issued at a discount so they were not misled. No objection was taken to the application, except that the Corporate Affairs Commission was anxious to ensure that the offer of the shares be otherwise in accordance with the Companies (New South Wales) Code. His Honour's approach involved determining whether the proposal had a legitimate commercial justification, whereas Young J posed the question whether the proposal was in the best commercial interests of the company. Both recognised that any prejudice or potential prejudice to any person was relevant.
Seaman J in Re Mallina Holdings Ltd (1989) 15 ACLR 493 was confronted with a contested application, the challenge being from two shareholders who complained that the proposal was for the ulterior motive of placing control of the company in the hands of one other shareholder as it had no commercial reality, and that insufficient information had been provided to shareholders for the purposes of the meeting. His Honour found that the directors of the company were acting in good faith, that the issue of shares at a discount had a legitimate commercial justification, and that it was not likely to operate to the prejudice of either the shareholders or the creditors. The legitimate commercial purpose as found was the reduction of debt and the provision of working capital to be used for specific identified projects, and no other means than a capital raising was available to achieve those purposes.
Having reached those views, Seaman J relied on the passage from Jarass above as a guide to the exercise of his discretion. In those terms he was satisfied that the proposal was submitted bona fide, and in the best commercial interests of the company. His Honour thus took the extra step, which Young J appears also to have taken, of forming the view as to whether the proposal was in the best commercial interests of the company, and not merely that it had a proper commercial justification.
The information provided to shareholders was assessed as clearly and fairly stating the salient and most important of the facts necessary for them to form a judgment on the proposed issue: Carruth v Imperial Chemical Industries, Ltd [1937] AC 707 at 768; Bulfin v Bebarfald's Ltd (1938) 38 SR (NSW) 423 at 440. That information may not have been sufficient for the later stage of offering to shareholders the opportunity to take up shares pursuant to the resolution.
In Re Esmeralda Exploration Ltd (1991) 33 FCR 192, French J sought to draw those threads together. It was an ex parte application for confirmation of a resolution to issue, at a discount of 8 cents per share on shares of 20 cents par value, 5,952,119 shares in a company which, after an earlier capital reduction, had 4,302,114 issued ordinary 20 cent shares. Only one shareholder, holding 500 shares, had voted against the motion. The proposed capital injection was to pay existing creditors, for the exploration and development of existing mining tenements, and for the acquisition of additional tenements.
French J traced the decisions expressing the public policy considerations against discount issues as background to s190, including in particular its "statutory ancestor" in s47 of the Companies Act 1929 (UK) and noted that the issue of shares at a discount is now prohibited: s21(1) Companies Act 1980 (UK). His Honour concluded at 199 that the Court in a matter such as the present should have regard to the following factors:
"1.The public interest in ensuring that prospective shareholders and creditors are not misled by a nominal capital figure that exceeds the true capital of the company. The significance of this factor may be mitigated by the contemporary recognition that issued capital may, by reason of trading losses and the like, not reflect the asset backing of the company.
2.The effect of the proposal upon the interests of actual or prospective shareholders and creditors.
3.The extent to which shareholders have been informed of the reasons for the issue prior to voting on it.
4.The extent to which creditors may find the proposal objectionable and the notice both formal and substantive that they have been given to enable them to object if they so wish.
5.The objectives of the proposed issue and the extent to which it serves the interests of the shareholders and creditors of the company."
Of course he did not suggest that those factors were exhaustive. He concluded in favour of the application in the particular circumstances. His fifth proposition also reflects that it is appropriate for the Court to consider for itself how the proposal may serve the interests of shareholders and
creditors, whilst not requiring that it be satisfied that it is the best course available.
That approach is the one which I adopt. It is incumbent on the Court to be satisfied that the proposal is a commercially appropriate one to follow, as the test otherwise on this aspect would fall, not much if at all, above a test of bona fides. It is not necessarily appropriate for the Court to assess the best commercial course for a company, and sometimes the Court will simply not be in a position to do so. Indeed, it is for those controlling the company to form such judgments: s232ff. On the other hand, the check which s190 creates on the issue of shares at a discount does oblige the Court to have regard to how the proposal will serve the interests of shareholders and creditors of the company, in the process of weighing its pros and cons. In many cases the answer will be clear, and certainly in the absence of opposition or of asserted prejudice the balance in favour of a proposal being confirmed will be tilted by evidence of its commercial justification. Where there is opposition, or evidence of actual or potential prejudice, the weight to be given to the commercial justification for the proposal may be enhanced by evidence as to its particular merits or as to the particular disadvantages of other commercial options.
I turn to the grounds of objection referred to above.
I can conveniently deal with those numbered (1) and (3) together. Whilst not of course discounting the desirability of those dealing with the applicant not being misled by a misleading nominal capital figure, it is a matter of relatively little weight where it is known generally that trading losses may reduce the asset backing of the company, and more so in a company such as the applicant where its existing creditors and shareholders are well aware of its financial plight. It is very unlikely that future investors or substantial suppliers would involve themselves in its affairs without being aware of those matters. The information provided to the shareholders was, in my view, adequate to comprehend the proposal and to assess its dilution consequences to them. That is demonstrated not just by the material provided to the shareholders over a period prior to and for the purposes of the meeting, but by the nature of the discussion at the meeting itself. It is however necessary to separately review the adequacy of the detailed commercial information provided, as relevant to the commercial wisdom of the proposal and as relevant to the weight to be given to the vote. I do regard it as relevant that the shareholders were equally divided on the proposal, and that it was only on the Chairman's casting vote that the proposal was passed. For reasons I have given, it is also desirable to have a picture of the potential economic consequences of the proposal to weigh against any actual or potential prejudice to actual or prospective shareholders or creditors of the applicant, including that to the guarantors of the secured indebtedness Wintulich and his wife. I should make it plain that any vulnerability of a guarantor of the indebtedness of the applicant by reason of such guarantee, and where there may be a right then of that guarantor to seek reimbursement from the applicant, is a matter I regard as relevant. It was submitted that this was such a case, and no contrary submission was put. If Wintulich and his wife are called upon in relation to their guarantees, it is appropriate in my view to consider whether the order sought will or might adversely affect their prospects of reimbursement from the applicant. Every case will be different, in content and degree, but here that is clearly a not insignificant prospect to consider. In the light of the events at the meeting, I do not think that the method of formulation of the motion weighs against the Court's confirmation if it is otherwise appropriate to be given. Nor, in my view, does the absence of any formal consent to the proposal from the creditors at the meeting or before the Court, whether secured or unsecured, weigh against any confirmation in circumstances where they are aware of the application and have chosen not to express any opposition to it.
The financial picture of the applicant, as presented to the Court and to the shareholders, is important, mainly but not solely in relation to the grounds of objection numbered (2) above.
The applicant's financial position has been addressed in evidence but is not clear. As a result of the paucity of
material before me, the applicant was given leave to adduce further evidence. The unaudited set of accounts to 24 August 1996 provided by accountants John S Lawson & Associates Pty Ltd contains the express disclaimer that no opinion is expressed on whether they present a true and fair view of the position or of the one month's trading upon which they report and they offer no warranty of accuracy or reliability. The earlier evidence included the April 1996 profit and loss account. From the material provided, therefore, the picture is scanty only, but it provides:
1996
April
May
June
July
August
Profit and Loss
Sales
Manufacturing profit (loss)*
Net profit (loss)
167,828
(4,252)(73,550)
(32,000)#
151,546
57,411(17,150)
Balance sheet
Current assets
Non-current assets
Total assets
Current liabilitiesNon-current liabilities+
Total liabilities
Net assets (deficiency)
N/A
139,000#
74,000#
214,885
$ 1,266,429**
1,481,314
414,446
1,068,8131,483,259
($1,945)
*It is difficult to make a direct comparison as presentation is not standard.
**Non-current assets include factory plant and equipment of $650,000 at directors' valuation 15 May 1996 less accumulated depreciation of $4,472, and not independently verified.
+Non-current liabilities include monies owing under a third registered debenture of $55,000 which it is intended will be converted into equity if the application is granted.
# Reported in correspondence only.
That limited information does illustrate that the monthly loss reduced when comparing April and August, and it is also plain that the August figure included the non-cash item of $2,714 for depreciation (motor vehicle depreciation may be included twice). The applicant has since August 1996 also reduced its staff: its marketing manager and one of its two merchandisers have left, and are not being replaced. The conversion of $55,000 debt to equity would also reduce the monthly interest liability slightly, assuming the interest liability in respect of that debenture has been brought to account.
There are factors which, given the disclaimer accompanying those August accounts, cause me concern as to the weight I should attach to them. There is no obvious reason why depreciation, which was $11,284 in April 1996, should reduce so much; that may somehow be a consequence of the directors' revaluation of factory plant and equipment or as a result of the sale of some equipment but I am left to speculate. Indeed, I do not have any information as to whether that revaluation increased or decreased the previous value in the accounts, or as to the material (if any) upon which it was based.
The secured creditors include the Commonwealth Bank which has issued bills to the value of $650,000 and made available on further loan of $100,000 as well as an overdraft which at 24 August 1996 stood at $35,261.95 and the Commonwealth Development Bank which has made a loan which at 24 August 1996 was $148,987.45, a total of $934,249.40. The non-current assets include land and buildings valued at $550,000 and factory plant and equipment valued at $645,528 in the balance sheet. The auction realisable value of those two items according to certificates provided to the Commonwealth Bank of Australia both in June 1995 is $550,000 at fair market value but $470,000 on "current forced sale", and $441,730 auction realisable value respectively. Those auction realisable values, assuming they remain the same at August 1996 and the present, would not produce enough to meet the secured and guaranteed indebtedness. The guarantors of that indebtedness are, at the least, vulnerable. Even on the balance sheet presented, the net assets are negative and if the auction realisable values are substituted for the values referred to, that position worsens to a deficiency of in excess of $300,000. Of course, on the basis of the application $55,000 of debt would be converted to equity, and the picture changed to that extent. If the confirmation sought were likely to remove, or substantially diminish, the prospect of the applicant ceasing to trade then the risk of it having to realise its assets piecemeal in liquidation would not loom as large as a factor to be put into the scales. If, on the other hand, the confirmation would only marginally improve that prospect, the risk to which weight should be given is a greater one. It is still, then, some distance to assessing from that risk the potential prejudice to the guarantors: the applicant might well be sold as a going concern, at a value sufficient to pay off its secured creditors, or even if it ceased trading its assets sold at values sufficient to do so. The further trading of the applicant might enhance both its net asset position, and its value. It might enable debt to be reduced. It might lead to further capital investment. The range of possibilities about which one might speculate is broad. But it is for the Court to make some assessment of those matters upon the basis of the material put before it.
The limited information of actual financial performance does not lead to any confidence of a significant turn around in the applicant's trading performance. Certainly its monthly trading losses have reduced but in the context of its capital they are still substantial. Its net assets have been reduced to a negative figure. The projections for increased sales revenue made in communications to shareholders have not come to pass, for reasons which I do not find reflect in any way adversely on its directors or management but reflect changing market circumstances and probably also the consequence of limited working capital.
The profit and loss and cashflow budgets dated 8 July 1996 to cover the period July 1996 - June 1997, which projected net profit (loss) results for July, August and September of ($17,194), $27,073 and $65,679 have not been shown to be reliable; from the table above the net assets position worsened by nearly $59,800 during June and July (months about which I have not been given financial information) and the August performance was some $44,000 worse than that budget. That budget included projected sales revenue for exports to the middle East and to the European Union for the financial year of $849,900, but neither of those projects is now to proceed. Other sales avenues are being explored, but cannot be assured. The net sales for August 1996 were considerably below those budgeted. The rate of repayment of the moratorium creditors has not been in accordance with the agreement with those creditors. I note that there are several items of expense included in the August 1996 trading account which are substantially different from those budgeted for that month and from comparable figures for April 1996, but I am unable to make any finding as to whether those differences are significant; they may simply be timing differences. The absence of figures for adjacent months, together with the accountant's comments as to the status of the August accounts, does however lead to the consequence that I am not satisfied that the August trading figures are necessarily reflective of a trend towards profitability. For reasons mentioned above, I am unable to treat the rosy picture presented in the budgeted profit and loss and cashflow figures as indicating with any accuracy the future prospects for the applicant.
I have referred above to a number of matters relevant to the order I am asked to make. I have no doubt that the applicant, through its directors, regards the proposal as a proper one and one which it is in the best commercial interests of the applicant and its members and creditors. It is seen as the means whereby the applicant may continue trading with the real prospect of that trading becoming profitable, and over time of progressively reducing deferred and secured debt so as to restore value to the shareholders. In a practical sense, it involves converting $55,000 debt to equity and possibly procuring further limited equity, although the applicant has the use of the funds already. At the very least, it is a proposal acquiesced in by the applicant's creditors.
If the proposal were also supported by the existing shareholders, despite the limited financial information available, and if there were no evidence of prejudice or potential prejudice, I would be inclined to confirm it although, for reasons I have given, I am unable to find that the proposal is in the best commercial interests of the applicant. However, the shareholders are equally divided on the proposal, although the reasons for that are not clear. As things presently stand, they would not recover any sum upon the winding-up of the applicant so the dilution of their interest in the applicant is unlikely to have direct economic consequences. If the applicant continues trading, with or without the $55,000 presently advanced by way of loan, and becomes profitable then some value may be restored to their shares. Their opposition may signal a concern that the conversion of that debt to equity (which is the object underlying the proposal) will make little difference to the prospects of the applicant turning around its trading position.
That is certainly the view presented by the shareholders which appeared to oppose the application. The conversion of that debt to equity will clearly make some difference to the net asset position of the applicant in the short term, and may reduce outgoings for interest to some extent if indeed interest is being brought to account on that debt, but as the applicant already has the use of those funds it is unlikely to make any real difference to its trading prospects to date. In my view, those matters are not shown overall to have more than marginal significance to the future prospects of the applicant. Of course, the removal of those funds (assuming the lenders are entitled to withdraw them) will very adversely affect the cash position of the applicant, and although none of those lenders has given evidence as to their intentions in that regard I accept the very real prospect of that occurring. I am not however satisfied what such action would do other than bring forward the occasion for the applicant to confront that problem, as I am unable to find that even with the use of those funds, if they remain available to the applicant either as loan funds or capital, the applicant's prospects of trading profitably in the future with its present operations are really much enhanced.
It follows from the above that the further trading of the applicant in the present manner carries with it the prospect of further trading losses, and potential reduction of its realisable assets available to meet its liabilities to secured and unsecured creditors. That in turn may lead to the increase in the potential exposure of Wintulich and his wife under their guarantees to the major secured creditors, and if so called upon, to claims for repayment of such amounts from the applicant in circumstances where they cannot be met. That risk, which I regard as a real one, is a matter which weighs in the scales against the Court confirming the proposed issue of shares at a discount.
The balancing of the pros and cons is a difficult exercise. It involves assessing a range of factors, based upon the evidence, which are necessarily predictive. The evidence in this instance has not enabled me to form the view that the confirmation, if granted, would ultimately lead to any substantial change in the applicant's trading prospects although I accept that its pursuance is in its legitimate commercial interests. The factors which the Court should take into account extend beyond that point. The view I have reached, weighing the factors mentioned, is that I should not confirm the proposed share issue. Given my findings, it would almost amount to the Court rubber stamping the proposal once it is accepted, as I do, that the applicant, through its directors and by a bare majority achieved by a casting vote at a meeting of members, itself regards the proposal as in its best commercial interests.
I accordingly refuse the application.
I note that, as with any such decision, it is made on the evidence before the Court. If the proposed investors maintain the availability to the applicant of the present loan funds of $55,000 secured by the third ranking debenture, and if trading performance over the period from September 1996 illustrates that the permanent availability of that sum as capital invested in the applicant was likely to significantly improve its future prospects, or indeed if further evidence disclosed its current performance and future prospects were such that the potential prejudice I have identified was no longer a realistic prospect, obviously the applicant could then - provided the members so resolved - seek confirmation from the Court of a proposal the same as or similar to that now presented or indeed any other proposal for the issue of shares at a discount. It would then be for the Court to assess that application on the evidence then before it.
I certify that this and the preceding pages are a true copy of the Reasons for Judgment of the Honourable Justice Mansfield.
Associate:
Dated:
Counsel for the Applicant : Mr S Mathwin
Solicitors for the Applicant : Kelly & Co
Objector : Mr Wintulich, Director,
appearing by leave
Hearing Dates : 10 & 11 October 1996
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