Jeffcott Holdings Ltd v Swiss Partners & Ors No. Scgrg-95-535 Judgment No. S6461

[1997] SASC 6461

JEFFCOTT HOLDINGS LIMITED (IN LIQUIDATION)
v
SWISS PARTNERS PTY LTD AND ORS

Civil
Duggan J

This is an appeal from a series of orders made by Judge Burley.

The litigation arises out of the purchase by the plaintiff company, formerly called Magnacrete Ltd, of shares in another company, Jeffcott Investments Ltd (JIL).   Shares were paid for by an allotment of shares in the plaintiff company. The plaintiff claims that the defendants, who are the appellants before me, owed a duty of care to the plaintiff company in connection with the preparation of a report to its shareholders relating to the purchase of shares in JIL as part of a takeover of JIL.  According to the statement of claim the defendants were negligent in the preparation of the report in that they attached a value to the shares when they were, in fact, worthless.

The loss and damage allegedly suffered by the plaintiff is pleaded in paragraph 95 of the statement of claim which states:

“95.   In consequence of the matters referred to in paragraph 94 above, Magnacrete has suffered the following loss and damage which was within the contemplation of Swiss Partners at all material times:

PARTICULARS

95.1.......... The difference between the amount paid by Magnacrete constituted by the issue of fully paid shares and options in Magnacrete pursuant to the takeover for the issued capital in JIL and the true value of JIL.  The true value of JIL at the time of the takeover was nil.  Magnacrete will provide details of such loss before the trial of its action.

95.2          Loss of use of assets including available money.

95.3.......... Consequential loss flowing from the making of payment for or on behalf of JIL which Magnacrete would not have otherwise made, details of which Magnacrete will provide prior to trial.”

The application before Judge Burley sought a number of orders, the following being of relevance to the present appeal:

“5..... That any claim based on or relying on the allegation set out in paragraph 95 of the statement of claim (and the particulars subjoined thereto) be dismissed and that as a result of that dismissal there be judgment (sic) for the defendants on the claims based on or which rely on paragraph 95.

6...... That in the alternative to paragraph 5, paragraph 95 of the statement of claim (and the particulars subjoined thereto) be struck out on the grounds (sic) that it does not disclose a reasonable course of action.”

The main issue argued before Judge Burley and on appeal was whether the plaintiff could establish a loss if the consideration for the shares which it purchased came from the issue of its own unallotted share capital.  His Honour took the view that it was at least arguable that the plaintiff was entitled to recover on the basis pleaded in paragraph 95 and he dismissed this part of the defendants’ application.

Mr Lucarelli, for the defendants, based his argument on what he described as a fundamental principle of law, mainly, that an issue of unallotted shares by a company and the transferring of them in order to acquire the shares of another company does not involve a company in transferring any of its assets or otherwise losing its capital.

Mr Lucarelli relied on cases in which the High Court had considered the concepts involved in the allotment and issue of company shares in a taxation or revenue context.   In Ord Forrest Pty Ltd v Federal Commissioner of Taxation (1974) 130 CLR 125 Gibbs J said (p148):

“The question then is, was the allotment a disposition of property?  An allotment of shares cannot be described as a disposition of property in the ordinary meaning of that expression.  When a share is allotted, nothing is transferred or conveyed from the company to the shareholder.  The person who becomes a shareholder by the allotment and issue of the share does not acquire any property in the assets of the company: Macaura v Northern Assurance Co. Ltd [1925] A.C. 619, at p.633; Archibald Howie Pty Ltd v Commissioner of Stamp Duties (N.S.W.) (1948) 77 C.L.R. 143, at p.152. What he acquires is the share, which is separate right of property: Bradbury v English Sewing Cotton Co. Ltd. [1923] A.C. 744, at p.767. Moreover, the share does not pass from the company; before allotment the share does not exist as a piece of property; it is only when it is allotted and issued that the rights which it confers are created: In re V.G.M. Holdings Ltd. [1942] Ch. 235, at pp.240-241.”

Reference was also made to Federal Commissioner of Taxation v St. Helens Farm (ACT) Pty Ltd (1981) 146 CLR 336. Barwick CJ observed (at 349):

“Until allotment and issue, which includes the entry of the allottee’s name on the share register in respect of the allotted share or shares, there is no property in the unissued shares; and, in  particular, there is not then, or for that matter at any other time, any property or proprietorial right in or of the company in the unissued shares in its capital.  The company has the capacity to allot and issue shares in the capital up to the amount of that capital, its nominal capital.  But that capital is not property of the company.  Indeed, when allotted and issued, the nominal amount of the issued share or shares constitutes in accounting terms a liability of the company.  But, upon allotment and issue, the allottee has property in the shares allotted, the extent of that property being determined by the constitutional instruments of the company.  But it is not property which comes to the allottee from, or by transfer from, the company.  It is property which comes into existence by the allotment and issue or, more precisely, which is the consequence of such allotment and issue.  The property consists of rights which may thereafter be exercised by virtue of the membership of the company thus gained and in accordance with its memorandum and Articles of Association.”

Mr Strawbridge, for the plaintiff, acknowledged that these pronouncements represented the law, but he stressed that they were made in a revenue context and he argued that in an assessment of damages in a matter such as the present the court was entitled to look at the commercial reality of the situation involving as it does if the plaintiff’s allegations are proved, the receipt of valueless shares.  It was pointed out that a realistic view of this nature was taken by Lord Greene MR in Osborne v SteeleBarrel Co. Ltd (1942) 1 All ER 634 at 637 where his Lordship said:

“It was strenuously argued on behalf of the Crown that, if a company acquires stock in consideration of the issue of fully-paid shares to the vendor, that stock must, for the purpose of ascertaining the company’s profits, be treated as having been acquired for nothing, with the result that, when it comes to be sold, the Revenue is entitled to treat the whole of the purchase price obtained on the sale as a profit.  This is a remarkable contention, and it would require conclusive authority before we could accept it.  The cases relied on in its support were Inland Revenue Comrs. v Blott, Inland Revenue Comrs. v Greenwood, [1921] 2 AC 171; 28 Digest 107, 663; 90 LJKB 1028; 125 LT 497; 8 Tax Cas. 101 and Lowry v Consolidated African Selection Trust, Ltd., [1940] AC 648; [1940] 2 All ER 545; Digest Supp.; 109 LJKB 539; 23 Tax Cas. 259, neither of which, in our view, has any bearing on the point. The argument really rests on a misconception as to what happens when a company issues shares credited as fully paid for a consideration other than cash. The primary liability of an allottee of shares is to pay for them in cash; but, when shares are allotted credited as fully paid, this primary liability is satisfied by a consideration other than cash passing from the allottee. A company, therefore, when, in pursuance of such a transaction, it agrees to credit the shares as fully paid, is giving up what it would otherwise have had - namely, the right to call on the allottee for payment of the par value in cash. A company cannot issue £1,000 nominal worth of shares for stock of the market value of £500, since shares cannot be issued at a discount. Accordingly, when fully-paid shares are properly issued for a consideration other than cash, the consideration moving from the company must be at the least equal in value to the par value of the shares and must be based on an honest estimate by the directors of the value of the assets acquired.”

(See also ADT Limited v BDO Binder Hamlyn (QBD 16 December 1995, unreported), a claim against auditors who had given a false view of the financial standing of a company which was a takeover target.  The takeover company issued shares in return for shares of the target company and May J assessed damages by reference to the market value of the shares in the respective companies.)

Mr Lucarelli also relied for support on the cases of Poseidon Ltd v Adelaide Petroleum (1991) 105 ALR 25 and Strategic Minerals Corporation v Hendry, Rae and Court (1996) 14 ACLC 485. In the first of these cases Adelaide Petroleum (Adelaide) negotiated separately with two companies, Posiedon Ltd (Poseidon) and Pagini Resources NL (Pagini) in order to acquire additional capital.   In the course of negotiations Poseidon’s representative made several misrepresentations to Adelaide.   Heads of agreement were signed between Adelaide and Poseidon, but the agreement did not come to fruition when Poseidon refused to meet a condition precedent.  Adelaide recommenced negotiations with Pagini and came to an agreement with that company on terms which were far less favourable to it than the agreement with Poseidon.   The delay caused by Poseidon resulted in the less favourable conditions.    The trial judge refused to compensate Adelaide for loss of capital.  There was no loss arising from the failure to raise capital; instead the loss was a loss of revenue which might have been earned by the use of the capital.  Burchett J commented on this aspect in his judgment in the Federal Court of Appeal.  He said (p42):

“The respondents brought a cross-appeal in relation to the assessment of damages.  The principal point raised in the argument on the cross-appeal was the proposition that Adelaide was deprived of some $4 million of capital which would have been raised pursuant to the proposed Pagini agreement, had it proceeded.  His Honour declined to allow this capital sum, taking the view that the loss was a loss of revenue which might have been obtained by the use of the money, and not a loss of the capital.  In my opinion, his Honour’s approach was right.  There was no evidence that the capital sum was irrevocably lost.  It remained open to the company to make a share issue.  I do not accept that the share price, at some arbitrary date in the future, can be selected in order to enable a calculation to be made of how much less capital could be raised at that date, by an issue of the same number of shares as would have been issued pursuant to the Pagini agreement had it been concluded.  The fact is that share prices fluctuate, and companies take the current and expected prices into account in fixing upon the date of a share issue and the number of shares to be issued.”

This statement was relied upon by Scott J in the Strategic Minerals case (supra).  Strategic Minerals Corporation NL (Strategic) purchased another company and paid for it by issuing unallotted shares and transferring them to the owner of the target company.   Strategic later claimed that its purchase of the company was neither fair nor reasonable and took action against an auditor who had prepared a report on the target company.   Strategic claimed that its loss was the value of the shares it had issued for the purpose of the takeover.  Scott J decided against Strategic on the issue of liability so that it was unnecessary for him to assess damages.   However he did comment on the damages issue.  After referring to the passage which I have quoted from the Poseidon case his Honour said (at 501):

“As I understand their Honours’ reasoning in this case, the issue of unallotted share capital by way of acquisition of assets does not represent a loss to the company.  The plaintiff in the present case released for issue 8,900,000 unallotted shares in consideration for what the plaintiff pleads to be worthless assets.  The effect of that was, of course, to dilute the asset backing of the shareholders as existing prior to the transaction so that in theory the value of the shares was diminished to that extent.  However, I agree with their Honours in Poseidon that the issue of such unallotted shares does not of itself represent a loss to the company.”

Mr Strawbridge criticised this analysis of Poseidon’s case on the basis that it overlooked the important distinction between a transaction in which the unallotted shares were issued and transferred as part of a takeover transaction and the situation which existed in Poseidon where shares were not issued because the transaction did not reach fruition.  After the hearing of the present appeal the Strategic case went on appeal to the Full Court of the Supreme Court of Western Australia. The appeal on liability was dismissed, but White J said ((1997) 15 ACLC 1158 at 1189):

“The appellant submits:

‘90.      The decision in Poseidon Ltd v Adelaide Petroleum NL & Ors (1991) 105 ALR 25 does not stand for the proposition that the issue of unallotted share capital by way of acquisition of assets does not represent a loss to the company. Rather, that case stands for the proposition that where the breach of contract, duty of care or statutory duty by the Defendant causes a failure to make an allotment, the loss suffered is not the amount of the allotment but rather the lost use of the money that would have been realised by the allotment.  That is because the allotment of capital is neutral, in a balance sheet sense, in that the funds realised by the allotment are matched by an equivalent obligation to subscribing shareholders.  The present case is fundamentally different, because shares were allotted, giving rise to an obligation by the company towards the holders of the shares, conferring value upon those shareholders, in return for scrip in AMF of no value at all.’

With respect, I am of the opinion that Poseidon Ltd v Adelaide Petroleum NL & Ors (1994) ATPR ¶41-164; (1991) 105 ALR 25 is not authority for the proposition that the issue of unallotted share capital by way of acquisition of assets does not represent a loss to the company. Rather, it is authority for the proposition that where a company has agreed to allot shares for a consideration pursuant to a transaction which does not proceed, the resultant loss to the company by reason of the failure of that transaction is not the capital sum represented by the shares to be allotted but, rather, the loss of the use of the consideration, in other words, the loss of the revenue which might have been derived by the investment of the agreed price. That case is distinguishable on its facts from the one under consideration in this Appeal, where the plaintiff did allot shares for a consideration which, it says, was, in effect, valueless.

Accordingly, I would find in favour of the appellant in relation to the limited contention set out in this ground of appeal.”

Since the hearing of the appeal in the present matter the point in issue has also been raised in Health and Life Care v Price Waterhouse and Others (unreported JN S6240).  In that case Olsson J refused leave to amend a statement of claim so as to add a pleading on the issue of damages of the type under consideration in this case.   Part of the consideration in that case was a large number of shares in the capital of the plaintiff.   His Honour allowed a separate pleading based on “loss of opportunity to invest in other entities at a profit at the relevant time or, alternatively, loss of use of money which might otherwise have been raised on an allotment for cash”.

In the present matter I take the view that it is not my function on an application of this nature to resolve this complex issue.   Summary procedures of the type which I am asked to invoke are “not apt for the resolution of difficult questions of law”.  Esanda v Peat Marwick Hungerfords (1994) 61 SASR 424 at 433. I cannot say that the point is unarguable. There are some statements in the authorities which might be advanced in support of it. The issue has not been finally decided at an appellate level.

I have concentrated on the argument in relation to paragraph 95.1 of the statement of claim, but if the plaintiff’s case on this point is arguable, I think it follows that the same can be said for paragraphs 95.2 and 95.3.

In my view Judge Burley acted correctly in refusing the defendant’s application in relation to the pleadings on the issue of damages and the appeal will be dismissed.