Melbourne Property Group Investments (Mpgi) Pty Ltd as trustee for the Mpgi Trust v Knight 43 Martin Street Pty Ltd

IN THE SUPREME COURT OF VICTORIA

Not Restricted

AT MELBOURNE

COMMERCIAL COURT

COMMERCIAL LIST – GARDE J

S ECI 2020 01360

MELBOURNE PROPERTY GROUP INVESTMENTS (MPGI) PTY LTD (ACN 612 456 818) as trustee for the MPGI TRUST	Plaintiff/ Defendant by counterclaim
v
KNIGHT 43 MARTIN STREET PTY LTD (ACN 612 790 351) (and others according to the Schedule attached)	Defendants/ Plaintiffs by counterclaim

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JUDGE:	GARDE J
WHERE HELD:	Melbourne
DATES OF HEARING:	16–19, 23–24 August 2021, 25 January 2022
DATE OF JUDGMENT:	16 February 2022
CASE MAY BE CITED AS:	Melbourne Property Group Investments (MPGI) Pty Ltd as trustee for the MPGI Trust v Knight 43 Martin Street Pty Ltd
MEDIUM NEUTRAL CITATION:	[2022] VSC 41

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CONTRACT – Where moneys lent for the purpose of property development – Breach of contract – Construction of commercial contracts – Implication of terms – Whether implied term not to unreasonably withhold consent to sale – Whether implied term to co-operate and do all things reasonably necessary to facilitate sale of apartments – Whether implied term to act in good faith – Whether implied term not to unreasonably withhold consent to encumbrance – Certainty of contractual terms – Unreasonable restraint on alienation of property – Frustration – Construction of guarantee – Rectification.

PARTNERSHIP – Existence and indicia of partnership – Partnership Act 1958 (Vic) ss 5, 6(3)(d) considered.

EQUITY – Duties of trustee – ‘No conflict’ rule – ‘No profit’ rule – Breach of trust – Knowing receipt – Knowing involvement in breach of trust.

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APPEARANCES:	Counsel	Solicitors
For the Plaintiff/ Defendant by counterclaim	Mr C Brown with Ms A Tresise	Colin Biggers & Paisley
For the Defendants/ Plaintiffs by counterclaim	Mr M Peckham with Mr V Murano	Mills Oakley

TABLE OF CONTENTS

Introduction........................................................................................................................................ 1

The parties........................................................................................................................................... 2

Factual background........................................................................................................................... 2

The project...................................................................................................................................... 2
The loan agreement....................................................................................................................... 4
Cost increases and delays............................................................................................................ 6
Auction authorities....................................................................................................................... 8
The variation deed........................................................................................................................ 8
January 2019................................................................................................................................... 9
March to May 2019........................................................................................................................ 9
June to October 2019................................................................................................................... 15
November 2019 to March 2020.................................................................................................. 18
April 2020 to June 2021............................................................................................................... 19
July 2021 to the present.............................................................................................................. 24

The main issues................................................................................................................................ 25

Evidence............................................................................................................................................. 27

Construction of commercial contracts.......................................................................................... 28

Was there a partnership agreement or partnership agreement variation made between Mr Pelchen and Mr Kavallero?...................................................................................................................... 31

Relevant authority....................................................................................................................... 32
Evidence....................................................................................................................................... 34
Conclusion.................................................................................................................................... 38

Terms of the loan agreement......................................................................................................... 38

Terms of the variation deed........................................................................................................... 41

Brief review of the relevant terms and conditions and underlying issues........................... 47

Was there an implied term in cl 4.5(c) of the variation deed that MPGI’s consent would not be unreasonably withheld to an apartment sale under $4.5 million?................................... 54

Was there an implied term of the variation deed that the parties would cooperate and do all things reasonably necessary to facilitate a sale of the apartments?.............................................. 58

Was there an implied term in the variation deed that the parties would act in good faith in their mutual dealings?........................................................................................................................ 60

Was there an implied term that MPGI’s consent to Knight 43’s encumbering of property under cl 4.8(a) of the variation deed was not to be unreasonably withheld?............................ 65

Existence of a side agreement subsequent to the variation deed........................................... 67

Is cl 4.5(c) of the variation deed an unreasonable restraint on the alienation of property? 70

Relevant authority....................................................................................................................... 71
Conclusion.................................................................................................................................... 76

Defendants’ claims for breach of express or implied terms of the loan agreement or variation deed........................................................................................................................................................ 78

Offers made.................................................................................................................................. 79
Tenancies...................................................................................................................................... 82
Valuations.................................................................................................................................... 82
Sale of the Foote Street apartment................................................................................... 83
Sale of the Martin Street apartment................................................................................ 84

Was MPGI in breach of an express or implied term of the loan agreement, variation deed or the partnership agreement or variation?.............................................................................. 84
Matters raised with Mr Pelchen in evidence................................................................. 85
Relevant authority............................................................................................................. 90
Discussion........................................................................................................................... 92
Conclusion.......................................................................................................................... 94

Have the loan agreement and variation deed been frustrated?.............................................. 96

Claim for holding costs................................................................................................................... 98

Breaches of the variation deed alleged by MPGI.................................................................... 102

Sale of the Foote Street apartment.......................................................................................... 103
Sale of the Martin Street apartment........................................................................................ 105
Findings of breach of cl 4.5(c).................................................................................................. 105
Apartment leases....................................................................................................................... 105
Relevant authority........................................................................................................... 107
Discussion......................................................................................................................... 109
Conclusion........................................................................................................................ 111

Allegations relating to the Equity-One facility..................................................................... 112
Provisions of the variation deed governing the conduct of the Equity-One loan. 112
Knight 43’s repayment obligations to Equity-One..................................................... 112
Conduct of the Equity-One loan by Knight 43............................................................ 113
Acquiescence and estoppel............................................................................................ 115
Conclusion........................................................................................................................ 116

The benefit of the variation deed............................................................................................ 117

Rectification of cl 8.1 of the variation deed.............................................................................. 118

Relevant authority..................................................................................................................... 120
Text of the guarantee................................................................................................................ 123
Context of the guarantee.......................................................................................................... 124
Underlying common intention................................................................................................ 124
Prior correspondence................................................................................................................ 124
Evidence..................................................................................................................................... 129
Conclusion.................................................................................................................................. 133

Liability for breach of the variation deed................................................................................. 133

Breach of trust................................................................................................................................. 134

Variation of building contract, delays and building expenses........................................... 136
Granting leases and accounting for rental payments.......................................................... 137
Invoices to MPGI for costs....................................................................................................... 137
Knowing benefit and receipt of funds................................................................................... 138

Conclusion....................................................................................................................................... 138

HIS HONOUR:

Introduction

Melbourne Property Group Investments (MPGI) Pty Ltd (ACN 612 456 818) as trustee for the MPGI Trust (‘MPGI’) claims the amount of $2,118,822 from Knight 43 Martin Street Pty Ltd (ACN 612 790 351) (‘Knight 43’) and Mr Ronen Kavallero as monies due and payable under a loan agreement dated 21 April 2017 (‘loan agreement’) and a deed of variation dated 15 October 2018 (‘variation deed’). MPGI seeks rectification of cl 8.1 of the variation deed so that a guarantee given by Mr Kavallero is given to MPGI as lender rather than to Knight 43 as borrower under the variation deed. MPGI also seeks damages and other relief for various breaches of contract by Knight 43 and Mr Kavallero. It alleges that Mr Kavallero and Knight Homes Pty Ltd (ACN 121 402 480) (‘Knight Homes’) were knowingly involved in breaches of trust by Knight 43 and knowing recipients of trust funds.

Knight 43 and Mr Kavallero counterclaim against MPGI. They claim that MPGI was in breach of various implied terms of the variation deed, and that MPGI unreasonably failed to agree to accept offers from prospective purchasers to buy apartments at 13 Foote Street, Brighton (‘Foote Street apartment’) and 43 Martin Street, Brighton (‘Martin Street apartment’) (collectively the ‘apartments’). They claim damages and interest, and seek various declarations, including as to implied terms which they contend are imported into the variation deed, and that a provision of the variation deed is an unreasonable restraint on the alienation of property.

The dispute concerns the purchase of a corner block at 43 Martin Street, Brighton (‘property’), and the construction of two luxury apartments on that land (‘project’). One apartment faces onto Foote Street, while the other faces onto Martin Street. The property is described in Certificate of Title Volume 04808 Folio 565.

The parties

MPGI is an investment vehicle established by Mr Christopher Pelchen for the purposes of various property investments, including buying, renovating and selling properties.

Knight 43 was established for the purpose of buying and developing the property. Mr Kavallero is the sole director and secretary of Knight 43, and owns 70% of the shares in Knight 43. The remaining 30% of the shares in Knight 43 are owned by MPGI. Knight 43 is the trustee of the Knight 43 Martin Street Trust (‘Martin Street Trust’), and is the developer of the property. Mr Kavallero’s company, R & SK Pty Ltd (ACN 612 923 467) (‘RSK’) as trustee for the R & SK Family Trust, holds 70% of the units of the Martin Street Trust. MPGI holds the remaining 30% of the units. Mr Kavallero was at all material times the sole director, secretary and shareholder of RSK.

Knight Homes is a building and construction company. Mr Kavallero is the sole director, secretary and shareholder of Knight Homes. Knight 43, Knight Homes and RSK form part of a group of entities operated by Mr Kavallero known as the Knight Building Group (‘Knight Group’).

Between around March 2016 and June 2017, Mr Martin Galea was the general manager of the Knight Group. Mr Grant Harris is a chartered accountant, and since March 2017 has been the financial controller of the Knight Group.

Factual background
The project

In about late February 2016, Mr Pelchen was introduced to Mr Kavallero. On 1 March 2016, Mr Kavallero and Mr Galea met with Mr Pelchen and discussed whether he was interested in lending funds to assist in Knight Group’s building projects. In March 2016, Mr Kavallero and Mr Galea proposed to Mr Pelchen that he contribute funding for a fixed return of around 20% interest per annum, where funding was needed for Knight Group developments over and above the amounts that could be borrowed from a bank.

Mr Pelchen, Mr Kavallero and Mr Galea subsequently discussed a possible joint venture, and in mid-March 2016, a form of joint venture agreement was drawn up by Danaher Legal for the development of a property at 47 Martin Street, Brighton. The agreement was not executed.

On 19 March 2016, Mr Pelchen and Mr Kavallero attended the auction of 47 Martin Street. Mr Pelchen’s bids for that property were unsuccessful.

From about April 2016, Mr Pelchen commenced working from the Knight Group offices, and his company, Melbourne Property Group (MPG) Pty Ltd (ACN 612 456 210) (‘MPG’), became a sales agent for Knight Group.

On Saturday 9 April 2016, Mr Pelchen and a friend, with Mr Kavallero, inspected the property which is the subject of this dispute, which was then essentially an empty block of land for sale. They considered that the property was a worthwhile opportunity for development into two separate apartments.

The following evening, Mr Pelchen and Mr Galea met with Mr Kavallero at his home. They discussed the potential purchase and development of the property. They envisaged that:

(a)Mr Kavallero would buy the property;
(b)a company and unit trust would hold the property and undertake the development;
(c)Mr Kavallero would obtain a bank loan and contribute about 70% of the costs of the development, while Mr Pelchen would provide about 30%;
(d)the total development cost would be $7.2 to $7.3 million;
(e)the construction cost would be about $3.2 million;
(f)Knight Group would build the apartments;
(g)construction would take 12 to 14 months; and
(h)once the apartments were sold, contributions would be repaid, and the remaining proceeds split in accordance with the respective contributions.

On 10 April 2016, Mr Kavallero made an offer for the property. The following day, he signed the contract for the purchase of the property for $3.575 million with a 10% deposit and settlement on 1 August 2016. Mr Pelchen arranged for the deposit to be paid.

Shortly after the purchase, Mr Pelchen informed Mr Galea that the limit of his investment in the property would be about $2.9 million. In late April 2016, Mr Galea advised Mr Pelchen that the total development costs for the property would be greater than $7.3 million because of consultants and contingency costs which may add another $200,000 to $300,000.

On 17 May 2016, MPGI was incorporated by Mr Pelchen. On 3 June 2016, Knight 43 was incorporated by Mr Kavallero. The Martin Street Trust was created on 26 July 2016. Two days later, Knight 43 entered into a building contract with Knight Homes (‘building contract’). Mr Pelchen did not receive a copy of the building contract at this time. On 28 July 2016, Mr Kavallero nominated Knight 43 to be the purchaser of the property. It became the registered proprietor of the property following settlement on 1 September 2016. Mr Kavallero arranged for the National Australia Bank (‘NAB’) to provide a loan to Knight 43 to assist with the purchase and development of the property.

Construction of the property commenced on 11 October 2016. By this time, Mr Pelchen and his entities had contributed about $2.9 million for various loans and developments with the Knight Group.

The loan agreement

In April 2017, Knight Group’s solicitors prepared the loan agreement. The parties to the loan agreement were MPGI, Knight 43 and other Knight Group development entities. Mr Pelchen and Mr Kavallero were not personally parties to the loan agreement. It was executed on 21 April 2017.

The loan agreement recited that MPGI had made advances amounting to $2,900,010. Total borrowing was divided between what was termed the ‘Lender Martin Street Advance’ of $2,151,342 and the ‘Lender Non-Martin Street Advance’ of $748,668. The interest rate was 20% per annum. An information table attached to the loan agreement detailed the advances made by MPGI and the costs incurred or expected. The loan agreement defined the termination date to be the earlier of the application of the net project proceeds or three years after the date of the loan agreement.

Under cl 3.1 of the loan agreement, the Lender Non-Martin Street Advance was to be repaid on a date no later than 60 days after the later of the date of issue of an occupancy permit for the new apartments, or the date of registration of the plan of subdivision, provided that Knight 43 had refinanced the debt facilities secured against the property so that surplus funds were available to Knight 43 to make the payments.

Clause 5.1 of the loan agreement provided for the net project proceeds (if any) to be applied in the following order of priority:

(a)first, in repayment of all amounts owed to the senior lender;
(b)second, in repayment the Lender Non-Martin Street Advance and any accrued interest;
(c)third, in repayment of the Lender Martin Street Advance and interest on certain other advances; and
(d)finally, the balance to be paid to MPGI as to 30% and to Knight 43 as to 70%.

It was common ground between the parties at the trial that cl 5.1 did not entitle MPGI to double dip by receiving a 30% share of the net project proceeds, and then to obtain a second 30% of the same money by reason of its 30% holding of units in the Martin Street Trust.

Cost increases and delays

Mr Pelchen said that when he saw the proposed loan agreement in April 2017, he was concerned because the land cost was shown at $3,771,625 while development costs had escalated to $3,972,425. This totalled $7,744,050, representing a cost to MPGI of $2,323,216. He was not aware of the exact increase in development costs until he saw the finalised loan agreement in April 2017. He also identified from the proposed loan agreement that MPGI was to pay 30% of the NAB loan interest costs, even though the purpose of the NAB loan was to fund Mr Kavallero’s 70% share of the project costs through Knight 43, not Mr Pelchen’s 30% share.

Mr Pelchen and Mr Galea both recall a conversation around this time in which Mr Pelchen said that he would not take responsibility for any interest or costs associated with the NAB loan because the NAB loan related to Mr Kavallero’s 70% contribution to the joint venture and was solely his responsibility.

In an email dated 31 May 2017 to Mr Pelchen, Mr Galea advised of Mr Kavallero’s desire to retain the Martin Street apartment for $4.5 million. Mr Pelchen refused this offer, as he considered the apartment was worth significantly more.

On 5 June 2017, MPGI lodged a caveat over the property claiming an estate or interest under the Martin Street Trust. Mr Pelchen moved out of the Knight Group offices at about this time following a decision by Knight Group that MPG would no longer be the authorised agent for Knight Group. Mr Galea also left Knight Group in June 2017.

From July 2017, Mr Pelchen was increasingly concerned about delays in the project. He spoke to Mr Kavallero in mid-July 2017, and was told that the project was unlikely to be finished before November 2017. Mr Kavallero blamed a contractor for the delay. Mr Galea believed that Mr Kavallero was focussing on other jobs that gave him cash flow.

In an email on 25 September 2017, Mr Pelchen notified Mr Harris that he required the repayment of the Lender Non-Martin Street Advance by 25 December 2017, observing that at a meeting on 12 April 2017, Mr Kavallero had indicated that these loan monies would be returned in September 2017. He referred to Knight Group’s cash flow problems, and requested that his loans to the Knight Group be returned or refinanced at the same time.

Mr Harris responded by email the following day. He said that Mr Kavallero did not believe that he was contractually obliged to return any of the loan until the property was settled. He undertook to provide Mr Pelchen with an update of accrued interest.

The NAB loan obtained by Knight 43 was due to expire on 31 October 2017. Knight Group arranged for it to be extended until 28 October 2018.

On 15 November 2017, Mr Kavallero provided Mr Pelchen with a letter to a bank concerning the project. The letter advised that the two dwellings under construction had been listed with Marshall White, Brighton for sale in the price range of approximately $5 million each. The construction of the development was on schedule for completion by 1 April 2018.

On 14 December 2017, Mr Harris provided Mr Pelchen with an update of his loan status and accrued interest as at 31 October 2017.

On 6 April 2018, Mr Pelchen requested a copy of the building contract, the loan contract with NAB, and the quantity surveyor’s approval for project progress payments. On 19 April 2018, Mr Harris provided spreadsheets of loan expenses and costs to Mr Kavallero. Updated information and a copy of the building contract were provided to Mr Pelchen on 7 and 8 May 2018.

As time passed, both Mr Pelchen and Mr Galea became increasingly concerned about the delays in construction. Mr Pelchen sought certainty as to the date of completion of the project.

At a meeting at the Knight Group offices on 9 May 2018 between Messrs Pelchen, Harris, Galea and Kavallero, the need for a new agreement between the project participants was identified. This would give certainty to project completion and the repayment of MPGI’s advances to Knight 43.

Auction authorities

On 29 May 2018, Mr Kavallero signed an exclusive auction authority giving Marshall White authority to sell the Martin Street apartment at an estimated selling price of between $4.4 and $4.8 million, with an auction intended for 28 June 2018.

By mid-2018, the property market had deteriorated badly. Whereas in late 2017 Marshall White had discussed a possible price range of $5 to 5.5 million for the apartment, by mid-2018, they advised Mr Kavallero that those prices would be difficult to achieve. The proposed auction was cancelled.

By mid-2018, it was clear to Mr Kavallero that he would need to refinance the NAB loan. He chose a financier, Equity-One, for the refinance. On 30 July 2018, Mr Kavallero received valuations from Opteon Valuations (‘Opteon’), who were nominated by Equity-One to value the property. Opteon valued the Foote Street apartment at $5.2 million and the Martin Street apartment at $5 million.

On 17 August 2018, Mr Kavallero signed another authority for Marshall White, to sell the Foote Street apartment. Construction of the apartments was completed in September 2018, and occupancy certificates were issued on 3 October 2018. The plan of subdivision was registered on 16 November 2018. Marshall White advised against an auction on 25 September 2018 because of a lack of interested buyers. The auction was cancelled.

The variation deed

Following negotiations between the parties, the variation deed was executed on 15 October 2018. It was drawn by Knight Group’s legal advisers and made significant changes to the loan agreement. It facilitated the refinancing by Equity-One of the expired NAB loan. MPG, Mr Pelchen and Mr Kavallero were parties to the variation deed, as well as MPGI and Knight 43.

A forecast attached to the variation deed showed that after the Equity-One and MPGI loans and interest were repaid, the project would have a shortfall of $672,495 if gross apartment sale prices averaged $4.5 million.

Knight 43 refinanced the senior loan with Equity-One the day after the variation deed was executed. Mr Kavallero was a guarantor of the Equity-One loan.

After subdivision of the property, MPGI lodged a caveat on the titles of the apartments on 4 December 2018.

January 2019

In a telephone conversation between Mr Kavallero and Mr Pelchen on 24 January 2019, Mr Kavallero advised Mr Pelchen that an offer had been received to purchase both apartments for $7.5 million. Mr Kavallero requested authority to negotiate a sale with the potential purchaser below $4.5 million for each apartment.

Mr Pelchen responded to the request that evening via email. He asked that prior to the acceptance of any offer, Mr Kavallero provide a written guarantee that the net amount to be returned to him would be the minimum return of the Lender Martin Street Advance as shown in the variation deed of $2,368,822. Should the final sale prices for both apartments result in an entitlement above the amount of $2,368,822, MPGI would receive its 30% share.

On 29 January 2019, Mr Kavallero emailed Mr Pelchen advising that negotiations for a higher offer price had been unsuccessful. He said that the offer was way below the estimated sale prices and was unreasonable. It would need to be rejected.

March to May 2019

On 10 March 2019, at 5.09pm, Mr Kavallero emailed Mr Pelchen advising that there was no news concerning the Foote Street apartment. There were a few interested parties but no offers. He was exploring options to rent out the Martin Street apartment. Mr Pelchen responded at 5.22pm that they would need to discuss any proposal around renting the Martin Street apartment. The development was not undertaken for that purpose, and he did not want to lease either property. He said that renting the apartments would cause wear to the properties and possibly prevent a sale with vacant possession. He did not want Mr Kavallero to enter into any agreement to lease either apartment without his written approval. In a later email at 7.33pm, he noted that if either apartment were rented, it would lose its qualification for foreign buyers as a new dwelling never previously occupied. Combined with wear on the apartments, the possible need to sell subject to a lease rather than with vacant possession would impact negatively on marketing and on potential purchasers.

Mr Kavallero responded at 7.54pm noting that no foreign or local buyer had come through with a written offer since June 2018. He would not leave the property vacant as he was the one who was continuously bearing the expenses. He could not continue to pay the $50,000 monthly interest payment while the property stood empty.

Mr Pelchen responded at 9.01pm. He appreciated that Mr Kavallero was keen to sell the apartments but his interest payments were for finance and borrowings of his own choosing. He noted that he had previously offered to accept no profit return on his investment despite incurring more than 2.5 years of interest payments on finance secured over his own properties. He noted that foreign buyers had previously shown interest in the apartments, describing renting as very short-sighted as it limited the potential purchaser market, and only attracted a relatively small rental return per month.

On 18 March 2019, MPGI’s solicitors wrote to Mr Kavallero’s solicitors putting them on notice that MPGI did not consent to the renting of either apartment in any circumstances.

On 26 March 2019, Mr Pelchen became aware from Mr Galea that Mr Kavallero had received an offer of $3.9 million for the Martin Street apartment. The deposit was payable as to 5% on the signing of the contract with the balance of the 10% deposit payable by the end of June. Settlement was due 18 to 24 months from the date of contract. The purchaser also required a licence agreement for the purchaser to occupy the apartment for a monthly fee of $10,000.

Mr Pelchen and Mr Kavallero discussed the offer on the phone that evening. At 10.35pm, Mr Pelchen emailed Mr Kavallero stating that the offer was too low and the settlement period extremely excessive. He advised that to further consider the offer, he would require the following conditions to be accepted by the purchaser and by Knight Group:

(a)a price of $3,900,000 or higher;
(b)10% deposit payable by 30 June 2019 with 5% payable on signing;
(c)12 months maximum settlement term;
(d)a monthly licence fee of $10,833.30 with the purchaser responsible for utilities, maintenance costs and insurance; and
(e)release of the deposit after 30 June 2019.

Mr Pelchen advised that Knight Group would have to enter into a written agreement for the sale of the Martin Street apartment to the effect that MPGI would be paid:

(a) 30% of the deposit monies;

(b) 30% of the settlement monies with a minimum of $1,170,000;

(c) 30% of the monthly licence fee for the Martin Street apartment; and

(d) 30% of all deposit and settlement monies received when the Foote Street apartment was sold.

Mr Pelchen also required agreement that the Foote Street apartment would be sold for $4 million or above on settlement terms of six months or less with a minimum of $1,200,000 to be paid to MPGI. He advised that these figures would return a minimum of $2,370,000 net to MPGI on the sale of both apartments. This was an amount similar to the amount of the Lender Martin Street Advance as defined in the variation deed.

On 3 April 2019, at 9.56pm, Mr Kavallero responded to Mr Pelchen’s email. The purchaser’s offer remained at $3.9 million and the proposed settlement term at 24 months. He believed that Equity-One would require the deposit and settlement monies to be paid to it. The licence fee would cover most of his likely interest costs. He could not afford the interest cost any longer. Likewise, when the Foote Street apartment was sold Equity-One would need to be paid first. His advice from selling agents Kay & Burton was that there was no current market interest in the apartments above $4 million, and that the price range should be adjusted to $3.6 to $3.9 million.

Mr Pelchen responded at 11.48pm. The proposed offer for the Martin Street apartment was completely unsatisfactory. He had no interest in accepting a loss on his $2.37 million investment, and was willing to wait until a more attractive offer came along.

At a meeting on 17 April 2019, Mr Kavallero said to Mr Pelchen that he was paying $50,000 interest every month and that he could not continue to bear this cost. He wanted to sell the Foote Street apartment at auction in May 2019. Mr Pelchen expressed his reservations about selling at auction, and that they were better off waiting until they got an acceptable offer.

On 24 April 2019, and after consulting with his solicitor and accountant, Mr Pelchen advised Mr Kavallero of the terms on which the Foote Street apartment and the Martin Street apartment could be sold. He would not agree to a sale without ensuring a minimum net return of his $2.37 million investment. He said that he was willing to wait until the market recovered and a profit was returned on his initial investment.

The terms offered by Mr Pelchen to Kavallero were:

(a) a guaranteed $2,370,000 net return by 1 May 2021;

(b) $120,000 of the net return to be paid by 15 July 2019;

(c) payment of a guaranteed minimum of $3,000 net per month from the Martin Street apartment licence fees;

(d) he would lend up to $2,250,000 to Mr Kavallero from 1 May 2020 to 1 May 2021 at 8.59% interest plus a 1% establishment fee;

(e) monthly repayments of the loan balance;

(f) the Foote Street apartment could be sold by Mr Kavallero at a price and date of his own choosing;

(g) a registered loan security would be provided by Mr Kavallero by the date of settlement of the sale of the Foote Street apartment in respect of the loan;

(h) caveats were to be maintained on each apartment until sold and settled;

(i) overdue monies were to attract 20% interest on the remaining balance and monies owing;

(j) overdue monies may be legally pursued;

(k) the loan balance was to be repayable prior to 1 May 2021 together with interest due;

(l) legal costs associated with the preparation of the loan agreement were to be paid by Mr Kavallero;

(m) the parties were to bear their own costs associated with a revised variation deed;

(n) Mr Kavallero was to have full and total responsibility for the sale and costs of the apartments; and

(o) the offer could be withdrawn at any time prior to the signature of a revised variation deed.

On 26 April 2019, at 10.45am, Mr Kavallero advised Mr Pelchen that the buyer for the Martin Street apartment was looking at another property. He proposed to proceed to auction the Foote Street apartment on 11 May 2019.

Mr Pelchen responded on the same day at 11.41am. He stated that he would not be agreeable to a sale of either property for less than $4.5 million, which was unlikely at the May auction. He would not be changing his position and did not want an unauthorised sale.

On 30 April 2019, at 9.26pm, Mr Kavallero confirmed that he would be proceeding with the auction of the Foote Street apartment. He did not consider that the current market would suddenly change, and was unwilling to hold the properties indefinitely until the market recovered. He offered to guarantee the full return of Mr Pelchen’s $2.368 million investment. He said that, for there to be any profit, each unit would need to be sold for more than $4.1 million. He requested Mr Pelchen’s consent to sell the Foote Street apartment should the highest offer be less than $4.5 million. He considered that there was no need to change the terms of their current agreement.

Mr Pelchen responded at 2.20pm on 3 May 2019. He was not willing to change the variation deed without satisfactory security being provided for the guaranteed repayment of the Lender Martin Street Advance of $2,368,822 regardless of the sale amount achieved for each apartment. Any revision of the variation deed would need to be to the satisfaction of his accountant and legal representative.

Mr Kavallero replied at 3.00pm on 6 May 2019. He was not proposing to change the variation deed. $4.5 million was not a realistic price in the current market. He was unwilling to bear the interest any longer.

By a letter sent on 7 May 2019 by MPGI’s solicitors to Mr Kavallero and others, MPGI demanded that the lower limit of the indicative selling price be lifted to $4.5 million, or the Foote Street apartment withdrawn from sale.

Mr Kavallero responded to the letter by email on 7 May 2019 at 2.10pm. He considered that the indicative selling price recommended by Kay & Burton of $3.6 to $3.9 million was the reasonable price of the apartment in the current market. He accused Mr Pelchen of acting in an uncompromising manner and of abusing his power under cl 4.5(c) of the variation deed. He said that Mr Pelchen should act fairly and in the interests of both partners and not capriciously or arbitrarily. He also advised that an unconditional written offer of $3.6 million for the Foote Street apartment on a 120 day settlement had been received.

Mr Pelchen’s solicitors responded to Mr Kavallero by email on 7 May 2019 at 4.55pm. They denied that there was any obligation of the nature alleged by Mr Kavallero imported into the variation deed. The sum of $4.5 million per apartment was carefully chosen providing sufficient return to enable Equity-One to be paid out its $6.63 million and MPGI to be paid the amount owed to it. They repeated the offer previously made by Mr Pelchen to Mr Kavallero.

Mr Kavallero replied on 8 May 2019 at 12.32pm. He proposed that MPGI consent to sell the Foote Street apartment below $4.5 million on the basis of a guarantee by Knight 43 that MPGI would incur no loss on the sale of that unit only. He requested written consent to the proposal by 2pm. At 5.27pm, he sent another email requiring consent by 6.00pm. At 10.02pm, he advised that the buyer had withdrawn his offer, and that the auction of the Foote Street apartment on 11 May 2019 would be cancelled. He considered that Mr Pelchen’s insistence on receiving $4.5 million for the apartment was unrealistic and unreasonable in the current property market.

On 9 May 2019, Knight 43 issued MPGI with an invoice for operating costs in the amount of $41,342.76 plus GST. MPGI’s solicitors responded in detail on 14 June 2019, denying liability. Knight 43 responded with a solicitor’s letter on 24 June 2019. Further solicitors’ letters were sent on 27 and 28 June 2019.

June to October 2019

On 11 June 2019, Knight 43 entered into a residential tenancy agreement in relation to the Foote Street apartment at a monthly rental of $13,036 for 18 months. On 17 June 2019, MPGI’s solicitors responded objecting to the leasing of the apartments. They claimed that Knight 43 was acting in breach of its duties under the Martin Street Trust. They drew attention to the loss of ‘new dwelling’ status for foreign purchasers, and the diminution of the value of the apartments by wear and tear. The apartments could not be sold with vacant possession and would likely require further expenditure if they were to be offered for sale.

On 26 June 2019 and 1 July 2019, Mr Kavallero and Mr Pelchen met and discussed the sale of the apartments. Mr Kavallero sought Mr Pelchen’s consent for the sale of the apartments for less than $4.5 million. Mr Pelchen did not agree to the leasing of the apartments or their sale for less than $4.5 million unless Mr Kavallero would agree to his demands for the repayment of his loan money.

Following the meeting on 26 June 2019, Mr Pelchen emailed Mr Kavallero requesting him to provide his proposed timeline for the repayment of his loan. Mr Pelchen sought confirmation that the apartments would not be leased or occupied nor changes made to finance over the property without his consent.

Following the meeting on 1 July 2019, Mr Pelchen emailed Mr Kavallero a summary of key points from the meeting. Mr Kavallero had proposed renting the apartments for two years to assist him to refinance the Equity-One loan at a lower rate of interest with Westpac. He proposed to pay Mr Pelchen $15,000 per month with a lump sum repayment of $500,000 to $1 million from the apartment sale proceeds in approximately two years’ time. Mr Kavallero said that he was able to meet his financial obligations. Mr Pelchen said that he would contact his solicitor and provide feedback on the proposition. On 4 July 2019, Mr Kavallero replied, requesting Mr Pelchen’s agreement to the proposition.

On 12 July 2019, Mr Pelchen confirmed that he would consent only if Mr Kavallero agreed to provide security in relation to the monies payable to MPGI.

On 12 July 2019, Bertacco Ferrier Property Consultants and valuers provided Knight Group with valuations of the Foote Street apartment of $4.3 million and the Martin Street apartment of $4.1 million inclusive of GST. They described the residential market as having experienced a slowdown in the past 18 months. Sales prices had seen a correction from their peak in 2017/18.

On 22 August 2019, Mr Kavallero advised Mr Pelchen by text message that he had an offer on the Martin Street apartment of $3.6 million with a 20% deposit and six month settlement. Later that day Mr Pelchen advised that he did not accept the proposed offer. His position was unchanged.

On 29 August 2019, Knight 43 entered into a residential tenancy agreement for the lease of the Martin Street apartment at a monthly rental of $11,297.61 for twelve months.

On 20 September 2019, MPGI’s solicitor wrote to Knight Group’s solicitor expressing concerns as to Knight 43’s compliance with cl 4.8(c) of the variation deed, which required that Knight 43 would at all times have sufficient funds available to meet its interest obligations to Equity-One. The Equity-One loan would expire in November 2019 and Knight 43 would require written consent from MPGI before further finance could be obtained over the property.

On 26 September 2019, Knight 43’s solicitors advised MPGI’s solicitors that an offer to purchase the Martin Street apartment for $3.8 million with a twelve month settlement date had been received. Knight 43 sought permission to accept the offer or an alternative offer of $3.7 million with a settlement period of 45 days, on the basis that all proceeds of sale would be used to repay part of the Equity-One loan. Knight 43 then proposed to refinance the Foote Street apartment at a reduced interest rate, and fund any shortfall on the Equity-One loan. Knight 43 proposed to use the rental payments on the Foote Street apartment to make interest only repayments to its new financier and to pay outgoings. MPGI would be required to pay development costs of $40,189.65. Consequent upon refinancing, Knight 43 would pay MPGI monthly instalments of $15,000 for the 20 months from 1 February 2020 to 30 September 2021. Following the sale of the Foote Street apartment, if the Lender Martin Street Advance was not yet repaid in full, any outstanding sum would be treated as a loan and be repaid by monthly instalments of $15,000.

Following emails between the parties, MPGI’s solicitors responded by letter of 1 October 2019 referring to $4.5 million as the base level price for each of the apartments in the variation deed. Knight 43 had agreed not to increase the Equity-One loan beyond $6.63 million, and MPGI’s position would be significantly worse if the proposal were accepted. The proposal was refused.

November 2019 to March 2020

On 20 November 2019, Kay & Burton advised Knight Group that they considered a realistic assessment of the current market value of the apartments was closer to $4 million than $4.5 million.

On 22 November 2019, MPGI served a notice of breach under the loan agreement and variation deed on Knight 43 and Mr Kavallero. It alleged:

(a) a breach by Knight 43 of cl 4.8(a) of the variation deed in that it had granted an encumbrance over each of the apartments by leasing them without the consent of MPGI;

(b) a breach by Knight 43 of the warranty under cls 4.8(c) and (d) of the variation deed that Knight 43 would at all times have sufficient funds available to meet its interest obligations to Equity-One;

(c) a breach by Mr Kavallero of his warranty to MPGI to the same effect; and

(d) a breach by Mr Kavallero of his obligations to guarantee Knight 43’s payment of the Lender Martin Street Advance and ensure that Knight 43 complied with its obligations under the loan agreement and variation deed.

MPGI required Knight 43 and Mr Kavallero to remedy the breaches, in default of which all sums contemplated under cl 9.1 of the variation deed would become due and payable immediately.

On the same date, MPGI also served a notice of breach of fiduciary duties on Knight 43. The alleged breach of fiduciary duties to MPGI involved the leasing of the apartments.

Knight 43 and Mr Kavallero responded to the notices on 6 December 2019. They denied commission of any breaches. MPGI served a notice of dispute on 12 December 2019.

On 6 December 2019, Equity-One advised Knight 43 that its loans over the apartments had expired on 1 November 2019. It offered to extend the loans for twelve months with a variation in interest rates. Knight 43 and Mr Kavallero agreed to extend the Equity-One loan on or about 17 December 2019.

On 28 February 2020, Mr Kavallero advised Mr Pelchen that it was intended to sell the Foote Street apartment by private auction on 9 May 2020. Approval of marketing costs was requested. On 13 March 2020, Mr Kavallero advised that the reserve was $4.5 million.

On 3 March 2020, after an unsuccessful mediation, MPGI served a notice of termination of the dispute resolution process.

On or about 13 March 2020, Knight 43 gave Kay & Burton an exclusive auction authority for the Foote Street apartment.

MPGI commenced this proceeding on 18 March 2020.

April 2020 to June 2021

On 2 April 2020, Equity-One staff advised Mr Harris that the interest payments for both loans over the property had not been received, sending a second email on 6 April 2020. Mr Harris responded on 8 April 2020, attaching remittances for the interest payments made that day.

Knight 43 failed to make interest payments on time in every month from May to December 2020. In each month, Mr Harris advanced an explanation as to why the delay in payment by Knight 43 had occurred. Knight 43 became aware in December 2020 that despite the explanations, Equity-One had charged the higher rate of interest in each month. As only the lower rate of interest was paid, the amount of the loans owed by Knight 43 to Equity-One steadily rose during much of 2020.

On 24 August 2020, Knight 43 entered into a second residential tenancy agreement for the lease of the Foote Street apartment at a monthly rental of $11,950. The agreement was for a twelve month period.

On the same day, Knight 43 entered into a second residential tenancy agreement for the lease of the Martin Street apartment at a monthly rental of $10,212. The agreement was also for a twelve month period.

On 11 September 2020, MPGI’s solicitors wrote to Knight 43’s solicitors alleging that Knight 43 was intending to further encumber the apartments with leases without MPGI’s consent. MPGI demanded that it not do so without MPGI’s consent. MPGI also claimed that it was entitled to 30% of the income of the Martin Street Trust including rental income. It requested an accounting of past income, and payment of MPGI’s share.

Knight 43’s solicitors responded on 29 September 2020, claiming that MPGI’s refusal to consent might cause Knight 43 to default on its interest obligations and MPGI was seeking to generate a windfall for itself. The rental income had been applied to payment of the costs of the Martin Street Trust and had not been distributed to MPGI and RSK as the unit holders.

On 6 November 2020, Knight 43’s solicitors sent a letter to MPGI’s solicitors. Among other things, they advised that Kay & Burton had received an oral offer on 5 November 2020 to purchase the Foote Street apartment for $4 million on a 30 to 60 day settlement. MPGI’s consent to the sale at $4 million or higher was sought, contending that it could not reasonably be refused. Knight 43’s solicitors sent a follow up email to MPGI’s solicitors on 9 November 2020 as no response had been received.

On 9 November 2020, MPGI’s solicitors responded denying that it was unreasonable for MPGI not to consent to the sale under $4.5 million as it was entitled to do so under the variation deed. The letter stated that MPGI had shown a willingness to consent to the sale under $4.5 million if certain conditions were met which protected its investment. They were seeking instructions as to the appropriate conditions if MPGI were willing to provide consent to a lower sale price.

On 10 November 2020, Knight 43’s solicitors replied advising that a further offer had been put forward by the proposed purchaser of $4.25 million on a thirty day settlement period. Consent to the sale was sought.

On 11 November 2020, MPGI’s solicitors responded that MPGI was willing to consent to the sale of the Foote Street apartment at a price of $4.25 million or above, subject to specified conditions.

On 11 November 2020, Mr Kavallero, on behalf of Knight 43, signed a contract for the sale of the Foote Street apartment for $4.25 million, with a 10% deposit and settlement on 9 December 2020. Knight 43’s solicitors informed MPGI’s solicitors of the sale of the Foote Street apartment by a letter dated 18 November 2020. They offered terms specified in the letter and stated that unless the offer was accepted by 4.00pm on 20 November 2020, Knight 43 would apply to the Supreme Court for the removal of MPGI’s caveat.

By a letter dated 20 November 2020, MPGI’s solicitors responded alleging that Knight 43 was in breach of cl 4.5(c) of the variation deed. MPGI again offered conditions on which it was prepared to consent to the sale of the Foote Street apartment at the price of $4.25 million. The conditions included:

(a) the only reduction from the gross proceeds of sale would be the 1% agent’s commission. All other costs would be borne by Mr Kavallero;

(b) the net proceeds of the sale would be paid to Equity-One to reduce its loan to the minimum required. Any amount of the net proceeds not paid to Equity-One were to be paid to MPGI in part reduction of the Lender Martin Street Advance;

(c) MPGI would be paid the amount of $250,000 at settlement in part reduction of the Lender Martin Street Advance;

(d) Knight 43 would not seek to increase the amount of the Equity-One loan beyond the amount to which it was reduced by the settlement;

(e) Knight 43 would provide MPGI with a full breakdown of the intended application of the proceeds of sale at least 14 days prior to settlement, and a breakdown of the actual application of the proceeds of sale within 7 days following settlement; and

(f) MPGI would withdraw its caveat over the Foote Street apartment.

On 23 November 2020, Knight 43’s solicitors advised that they intended to issue proceedings for the removal of MPGI’s caveat over the Foote Street apartment. An originating motion, summons on originating motion and affidavit from Mr Kavallero were filed on 26 November 2020.

Following further negotiations, on 27 November 2020, MPGI’s solicitors proposed in summary:

(a) MPGI would remove the caveat on the Foote Street apartment;

(b) Knight 43 could proceed with the settlement of the sale;

(c) after payment of commission, taxes and outgoings, the net proceeds of sale would be paid as to $250,000 to MPGI and the balance in reduction of the Equity-One loan;

(d) Knight 43 would not seek any increase in the amount of the Equity-One loan beyond the amount to which it was reduced by settlement; and

(e) orders would be made by consent to discontinue the caveat proceeding with costs to be in the cause in the main proceeding.

On 30 November 2020, this proposal was accepted by Knight 43, and the caveat removal application was discontinued by order on 1 December 2020.

On 7 December 2020, Knight 43 applied to Equity-One for the extension of the Equity-One loan over the Martin Street apartment in the amount of $2,718,000. Equity-One responded that it was prepared to extend the term of the loan from 1 January 2021 for a further period of 12 months with a 0.50% decrease in interest rates.

The same day, Equity-One provided the Knight Group with a transaction statement concerning the loan over the Martin Street apartment. This showed that Equity-One had charged Knight 43 the higher rate of interest of $33,718.75 rather than the lower rate of $21,103.83 for every month from May 2020 to December 2020 inclusive because of late payments by Knight 43. As a result, Knight 43 was in substantial arrears.

On the settlement of the Foote Street apartment, $93,526.29 was held in trust pending a post-settlement payment to Equity-One. MPGI received $250,000 from the settlement in reduction of the Lender Martin Street Advance.

On 21 December 2020, Knight 43 sought MPGI’s written consent to refinance the Equity-One loan with a loan offered by Westpac. Knight 43 proposed to refinance the loan not beyond the sum of $3,250,000, which was the sum of the Equity-One loan post settlement payment. In a letter sent the following day, MPGI’s solicitor queried why the Equity-One loan exceeded $3,020,462.93. The Equity-One loan was limited to $6,630,000 by the variation deed and Equity-One had received $3,609,537.07 from the settlement of the Foote Street apartment. As a result, $3,020,462.93 was the maximum amount to be refinanced. Under cls 4.7(b) and (d) of the variation deed, MPGI was not liable for costs, fees and interest incurred in relation to the Equity-One loan, and Knight 43 would make all payments to Equity-One as and when they fell due with none of those costs to be charged to MPGI. Under cl 4.8(b) of the variation deed, Knight 43 had warranted that it would not extend the Equity-One loan beyond $6.63 million.

On 13 January 2021, Knight 43’s solicitors responded advising that Equity-One had treated $130,000 of the Foote Street apartment settlement as penalty interest rather than principal repayment. The funds in trust were to be paid to Equity-One to assist with the shortfall of $260,000 between the $3,250,000 Equity-One loan and the proposed $2,990,000 Westpac loan. By 19 January 2021, Knight 43 had received approval from Westpac for a $2.99 million loan to refinance the Martin Street apartment. In further correspondence between the parties’ solicitors, the parties did not agree.

Equity-One’s transaction statement of 10 March 2021 showed that Knight 43 had made late payments of the loan secured over the Foote Street apartment in every month from May 2020 until December 2020. Knight 43 was late for its January and February 2021 interest payments. On 17 February 2021, Equity-One served a notice of demand on Mr Kavallero as guarantor of Knight 43 in respect of the Equity-One loan seeking payment within 14 days. On 26 April 2021, Equity-One issued a default notice under s 76 of the Transfer of Land Act 1958 (Vic).

July 2021 to the present

On 16 July 2021, Kay & Burton advised that the Martin Street apartment had a realistic selling range of $3.6 million to $3.9 million. On 27 July 2021, Knight 43 gave Kay & Burton an authority for the sale of the Martin Street apartment. An auction was proposed for 31 July 2021, but was postponed on a number of occasions because of COVID-19 lockdowns, ultimately taking place on 2 October 2021. The apartment was passed in with no bids from prospective buyers.

On 4 and 9 August 2021, Knight 43’s solicitor sought consent from MPGI’s solicitor to sell the Martin Street apartment for the highest price available at or after auction. On 13 August 2021, MPGI’s solicitor responded that MPGI was willing to consent to the sale of the Martin Street apartment at auction with a reserve of $3.75 million on the condition that the proceeds of sale were paid in reduction of the Lender Martin Street Advance after payment of $3,020,462.93 to Equity-One. Correspondence between the solicitors as to the sale of the Martin Street apartment at or after auction continued without reaching agreement until Knight 43 sold the apartment without MPGI’s consent on 17 November 2021.

In early October 2021, a possible purchaser made a verbal offer to purchase the Martin Street apartment for $3.6 million subject to a building inspection. However, no inspection took place and no contract was signed.

On 17 November 2021, Kay & Burton advised Knight 43 that they had obtained three offers to buy the Martin Street apartment. Acting on the agent’s recommendation, Knight 43 executed a contract to sell the Martin Street apartment for a price of $3.5 million to Dolores Roussos and/or nominee with a 120 day settlement period. On 29 November 2021, Knight 43 advised MPGI that it had sold the Martin Street apartment.

On 24 December 2021, Knight 43 applied to the Court for an order removing MPGI’s caveat over the Martin Street apartment.[1] The application came on for hearing before me on 25 January 2022. On 27 January 2022, I ordered that the caveat be removed. Settlement of the sale is due to occur on 17 March 2022.
[1]Proceeding S ECI 2021 04919 (‘Martin Street caveat proceeding’).

The main issues

The main issues before the Court are:

(a) whether there was a partnership agreement or partnership agreement variation made between Mr Pelchen and Mr Kavallero;

(b) whether there was an implied term in cl 4.5(c) of the variation deed that MPGI’s consent would not be unreasonably withheld to a sale of either apartment for less than $4.5 million;

(c) whether there was an implied term in the variation deed that the parties would cooperate and do all things reasonably necessary to facilitate a sale of the apartments;

(d) whether there was an implied term in the variation deed that the parties would act in good faith in their mutual dealings;

(e) whether there was an implied term in cl 4.8(a) of the variation deed that MPGI’s consent to encumbering the property would not be unreasonably withheld;

(f) whether MPGI and Knight 43 entered into a side agreement subsequent to the variation deed, and if so, whether Knight 43 breached that side agreement;

(g) if there was a side agreement, whether it was subject to an implied term that MPGI’s consent to the appointment of a selling agent would not be unreasonably withheld;

(h) whether cl 4.5(c) of the variation deed was void as an unreasonable restraint on the alienation of property;

(i) if there was an implied term in the variation deed as alleged in any of subparagraphs (b) to (e) above, whether MPGI was in breach of that term;

(j) whether Knight 43 or Mr Kavallero breached the loan agreement or the variation deed by:

(i) selling the Foote Street apartment or the Martin Street apartment without the consent of MPGI;

(ii) granting leases over the apartments without the consent of MPGI;

(iii) failing to meet interest obligations under the Equity-One loans;

(iv) seeking project costs and sale costs from MPGI;

(v) breaching the warranties given in the variation deed;

(vi) breaching the guarantee given in the variation deed; or

(vii) failing to respond to the notice of dispute;

(k) whether the guarantee given by Mr Kavallero was for the benefit of MPGI or Knight 43;

(l) whether Knight 43 breached its duties as trustee of the Martin Street Trust;

(m) if so, whether Mr Kavallero or Knight Homes were knowingly involved in the breach or breaches of trust; and

(n) whether MPGI is liable for any holding costs incurred by Knight 43.

One claim made by Knight 43 in the counterclaim was not disputed at trial. It was agreed that the loan agreement and the Martin Street Trust deed spoke of the same 70:30 profit split. MPGI was not entitled to double dip by taking a 30% share of the sale proceeds under both the loan agreement and the Martin Street Trust. A claim by Knight 43 against MPGI for project costs was not pursued at trial.

It is convenient to first consider the claims made by the defendants in the counterclaim, and then those made by MPGI.

Evidence

MPGI relied on the witness statements and evidence of Mr Pelchen, who was cross-examined.

The defendants relied on the witness statements and evidence of Mr Kavallero, Mr Galea and Mr Harris. Mr Harris made four witness statements. Mr Kavallero and Mr Galea were cross-examined. The defendants also relied on the expert evidence of Grant Sutherland, a certified practising valuer. Mr Harris and Mr Sutherland were not cross-examined.

The evidence also includes an affidavit of Mr Kavallero filed on 24 December 2021 in the Martin Street caveat proceeding, and an affidavit of Mr Pelchen filed on 21 January 2022 in this proceeding.

In a valuation dated 4 August 2021, Mr Sutherland valued the Foote Street apartment at between $4.1 and $4.3 million as at November 2020 assuming vacant possession. He valued the Martin Street apartment at the valuation date as between $3.8 and $4 million. He observed that the prestige residential market peaked in mid-2017, with a slight decline evident through to mid-2018 and a more pronounced decline through to late 2018 due to a tighter bank lending environment. 2019 resumed a little more solidly, but uncertainty continued until after the federal election in May 2019. The market then began to improve following successive interest rate reductions in June and July, and again in October 2019. This continued until the full implications of COVID-19 lockdowns and restrictions began to be felt in March 2020, after which some softness was experienced with some firming after the easing of the lockdown through to late 2020, and then stronger increases. He noted increasing consumer confidence and ongoing low interest rates and the expectation of them remaining low for some time. Subsequent to 4 August 2021, there were further COVID-19 lockdowns and restrictions, including on the conduct of public auctions.

I prefer the evidence of Mr Pelchen to that of Mr Kavallero. Mr Pelchen had a clear recollection of many of the events and discussions that took place during the project. His evidence as to events and discussions is generally consistent with the contemporaneous emails and documents. He often adopted the practice of verifying discussions and agreements with an email sent shortly after they occurred. Mr Kavallero’s recollection was very limited. He was strongly inclined to reconstruct his evidence in a manner favourable to the defendants’ case. In a number of instances, his evidence is inconsistent with contemporaneous emails or documentary evidence. He conducted the business and affairs of Knight 43 in his own interests. He had no appreciation of the fact that the arrangements which he had put in place gave rise to a conflict between his own interests and those of MPGI, which was a minority shareholder in Knight 43 and a minority unit holder in the Martin Street Trust of which Knight 43 was the trustee.

Construction of commercial contracts

A plurality of the High Court in Mount Bruce Mining Pty Ltd v Wright Prospecting Pty Ltd summarised the principles of construction of commercial contracts in these terms:

The rights and liabilities of parties under a provision of a contract are determined objectively, by reference to its text, context (the entire text of the contract as well as any contract, document or statutory provision referred to in the text of the contract) and purpose.
In determining the meaning of the terms of a commercial contract, it is necessary to ask what a reasonable businessperson would have understood those terms to mean. That inquiry will require consideration of the language used by the parties in the contract, the circumstances addressed by the contract and the commercial purpose or objects to be secured by the contract.
Ordinarily, this process of construction is possible by reference to the contract alone. Indeed, if an expression in a contract is unambiguous or susceptible of only one meaning, evidence of surrounding circumstances (events, circumstances and things external to the contract) cannot be adduced to contradict its plain meaning.
However, sometimes, recourse to events, circumstances and things external to the contract is necessary. It may be necessary in identifying the commercial purpose or objects of the contract where that task is facilitated by an understanding “of the genesis of the transaction, the background, the context [and] the market in which the parties are operating”. It may be necessary in determining the proper construction where there is a constructional choice.
...
Each of the events, circumstances and things external to the contract to which recourse may be had is objective. What may be referred to are events, circumstances and things external to the contract which are known to the parties or which assist in identifying the purpose or object of the transaction, which may include its history, background and context and the market in which the parties were operating. What is inadmissible is evidence of the parties’ statements and actions reflecting their actual intentions and expectations.
Other principles are relevant in the construction of commercial contracts. Unless a contrary intention is indicated in the contract, a court is entitled to approach the task of giving a commercial contract an interpretation on the assumption “that the parties … intended to produce a commercial result”. Put another way, a commercial contract should be construed so as to avoid it “making commercial nonsense or working commercial inconvenience”.[2]

[2](2015) 256 CLR 104, 116–7 [46]–[51] (French CJ, Nettle and Gordon JJ) (citations omitted).

These principles have been consistently applied in Victoria.[3]
[3]See Perpetual Ltd v Myer Pty Ltd[2019] VSCA 98, [75] (Whelan, Niall and Hargrave JJA); PCCEF Pty Ltd v Geelong Football Club Ltd[2019] VSCA 144, [27] (Whelan, McLeish and Emerton JJA); Knights Quest Pty Ltd v Daiwa Can Company (2018) 366 ALR 557, 578–9 [88] (Beach, Kyrou and Hargrave JJA).

Likewise, in Toll (FGCT) Pty Limited v Alphapharm Pty Limited, the High Court said:

References to the common intention of the parties to a contract are to be understood as referring to what a reasonable person would understand by the language in which the parties have expressed their agreement. The meaning of the terms of a contractual document is to be determined by what a reasonable person would have understood them to mean. That, normally, requires consideration not only of the text, but also of the surrounding circumstances known to the parties, and the purpose and object of the transaction. [4]

[4](2004) 219 CLR 165, 179 (citation omitted).

To the same effect, in Maggbury Pty Limited v Hafele Australia Pty Limited, Gleeson CJ and Gummow and Hayne JJ said that a court construing a contract will ascertain:

the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.[5]

[5](2001) 210 CLR 181, 188, quoting Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896, 912 (Hoffmann LJ).

These principles were recently expounded by the Court of Appeal in Adaz Nominees Pty Ltd v Castleway Pty Ltd,[6] where the majority said:
[6][2020] VSCA 201, [70] (Whelan JA and Riordan AJA) (‘Adaz’) (citations omitted).

To construe the terms of a commercial contract, the Court asks ‘what a reasonable businessperson would have understood those terms to mean’. To answer that question, ‘the reasonable businessperson [is] placed in the position of the parties’, and the Court applies the following principles:
(ll)The terms are construed objectively, and the subjective intentions of the parties are irrelevant.
(mm)The objective approach requires reference to the text and its ordinary meaning, together with:
(i)the context, being the entire text of the contract including matters referred to in the text; and

(ii) the purpose.

These matters will ordinarily be identified by reference to the contract alone, but evidence of mutually known objective background circumstances relevant to the purpose is admissible ‘no matter how clear the “ordinary meaning” of the words’. Identification of purpose may allow admission of evidence of the genesis of the transaction, the background, the context and the market in which the parties are operating.
(nn)Unless a contrary intention appears in the contract, the court is entitled to approach the task of interpretation on the assumption that the parties intended to produce a commercial result, and should construe it so as to avoid a commercial nonsense. However, the court does not weigh the commerciality of the agreement, and business common sense is a topic on which reasonable minds may differ.
(oo)If, after completion of this process, the language used in the contract ‘is ambiguous or susceptible of more than one meaning’, then evidence of surrounding circumstances external to the contract is admissible to assist with interpretation of the language in question.
(pp)However, ‘evidence of the parties’ statements and actions reflecting their actual intentions and expectations’ is inadmissible. Although evidence of prior negotiations is admissible to establish objective background facts known to both parties and the subject matter of the contract, evidence of negotiations reflective of actual intentions and expectations is not receivable.
(qq)Post-contractual conduct is inadmissible to construe the terms of the contract. However, the parties’ subsequent communications may be relevant to determine whether the parties intended to enter into a binding contract.

Was there a partnership agreement or partnership agreement variation made between Mr Pelchen and Mr Kavallero?

The defendants allege that Mr Kavallero entered into a partnership agreement with Mr Pelchen on or about 9 or 10 April 2016 following the inspection of 43 Martin Street (‘partnership agreement’). The terms of the partnership agreement are said to arise out of conversations between Mr Galea and Mr Pelchen, and Mr Kavallero and Mr Pelchen. They are also said to be implied from the conduct of the parties and in order to give business efficacy to the matters agreed.

The defendants allege that the terms of the partnership agreement included, in substance, that:

(a) the partnership was for the purpose of jointly constructing and selling the apartments;

(b) Mr Kavallero had a 70% interest while Mr Pelchen had a 30% interest;

(c) Mr Kavallero was to purchase the property in his own name;

(d) Mr Pelchen was to provide the initial deposit and make cash contributions comprising 30% of the project costs;

(e) the remaining 70% would be funded initially by way of a bank loan secured over the property;

(f) the apartment would be constructed by an entity within the Knight Group;

(g) Mr Kavallero would have principal oversight of the project; and

(h) on completion of the project, the proceeds would be distributed by returning the funds contributed by the partners or their associated entities, with the balance to go to the partners in accordance with their interest in the partnership.

It is common ground that the Martin Street Trust was executed on 26 July 2016. To accommodate this, the defendants say that, by their conduct, Mr Pelchen and Mr Kavallero agreed to vary the partnership agreement (‘partnership agreement variation’) to the effect that:

(a) Knight 43, MPGI and RSK became members of the partnership;

(b) Knight 43 was to hold the property of the partnership;

(c) Mr Pelchen’s 30% share of the proceeds of the partnership would now be paid to MPGI which would be jointly and severally liable for Mr Pelchen’s share of project costs;

(d) Mr Kavallero’s 70% share of the proceeds of the partnership would be paid to RSK which would be jointly and severally liable for his share of project costs; and

(e) the proceeds of the project monies would be distributed to MPGI and RSK by Knight 43 by means of the Martin Street Trust.

MPGI denies that there was a partnership agreement or a partnership agreement variation.

Relevant authority

In Jafari v 23 Developments Pty Ltd, a key issue was whether an agreement created or recorded the creation of a partnership. The trial judge held that while a number of the terms of the agreement were consistent with a partnership, no aspect of it definitively indicated that a partnership rather than a profit share agreement was intended.[7]
[7][2019] VSCA 201, [147] (Whelan, Niall JJA and Sifris AJA).

The Court of Appeal held that while receipt of a share of the profits is prima facie evidence that that person is a partner of a business, it is not determinative or conclusive. Regard must be had to the parties’ contractual arrangements as a whole, as well as the admissible surrounding circumstances from which their true intention is to be ascertained. The true characterisation of the parties’ relationship does not boil down to giving primacy to a single factor or to the label that they have adopted.[8]
[8]Ibid [153]–[154], [158].

In Friend v Brooker, the parties ran an engineering and construction business, incorporating a company to do so. The High Court held that following the incorporation of the company, the parties were not in a relationship of partnership. The attempt to establish the existence of a partnership sought to enlist the doctrines and remedies respecting contribution and fiduciary obligations to avoid the consequences of the findings of fact and law by the trial judge.[9]
[9](2009) 239 CLR 129, 161 (French CJ, Gummow, Hayne and Bell JJ).

In Brady Queen Pty Ltd v Austhome Developments Pty Ltd, Sifris JA determined that there was no fiduciary duty where the parties made a deliberate and considered decision to undertake a project though a company and unit trust structure. The existence and extent of any fiduciary duties must be assessed by reference to this structure.[10]
[10][2021] VSC 18, [219].

In Warner Capital Pty Ltd v Shazbot Pty Ltd, the New South Wales Court of Appeal considered whether a partnership had been formed. For a partnership to exist under the Partnership Act 1892 (NSW), a business had to be carried on by persons in common with a view to profit. The Court held that the existence of a partnership must be determined by an examination of the parties’ contract and the course of dealing between them.[11]
[11][2020] NSWCA 121, [50]–[51] (Macfarlan, Meagher and Gleeson JJA).

Section 5 of the Partnership Act 1958 (Vic) (‘Partnership Act’) defines a partnership as the relation which subsists between persons carrying on a business in common with a view of profit. Section 6 of the Partnership Act lists various rules which provide assistance in determining whether a partnership exists. Section 6(3)(d) provides in substance that the advance of money by way of loan to a person engaged or about to engage in any business on a contract with that person that the lender shall receive a share of the profits arising from carrying on the business does not of itself make the lender a partner with the person or persons carrying on the business or liable as such, provided that the contract is in writing and signed by or on behalf of all the parties thereto.

Evidence

Mr Kavallero gave evidence that an agreement was made between him and Mr Pelchen verbally in discussions on 9 and 10 April 2016, but that it was never documented. He said that Mr Pelchen did not ask for an agreement in writing at this point. Mr Galea had little (if any) recollection of the discussions. His evidence did not assist on this issue.

Mr Pelchen said that there was no discussion or agreement at the meeting on 10 April 2016 about setting up a company and a unit trust to do the development or about the terms in an earlier draft of a joint venture agreement prepared by Danaher Legal for 47 Martin Street, Brighton. However, Mr Kavallero did say that if a joint venture proceeded, he would purchase the property for the purposes of the joint venture rather than exclusively for Knight Group. Mr Pelchen said that he had intended to invest by way of loan. He did not know Danaher Legal and had never engaged them to act for him. He said that there was no agreement or discussion concerning the content of a joint venture agreement, and the subsequent loan agreement was drafted approximately 12 months later by a different law firm.

Mr Pelchen said that he was very interested in documenting the arrangement between himself and Mr Kavallero. He was told by Mr Kavallero on numerous occasions that he would make arrangements for the documents to be prepared in the near future. He said he became increasingly insistent in his request when no written documentation was forthcoming. In December 2016, he was told by Mr Galea that draft agreements had been prepared by Knight Group’s solicitor and were awaiting Mr Kavallero’s review.

Where there are differences between the evidence of Mr Pelchen and Mr Kavallero, I accept Mr Pelchen’s account. He had a clear recollection of the events and many of the discussions. His evidence was consistent with the contemporaneous documents. By contrast, Mr Kavallero had considerable difficulty recalling discussions and conversations. His evidence often consisted of reconstruction rather than recollection. His reconstructions were favourable to the defendants’ case.

I accept Mr Pelchen’s evidence that there was no partnership agreement or partnership agreement variation. The documentary evidence is consistent with his evidence:

(a) A review of the emails between Mr Pelchen, Mr Kavallero and Mr Galea before and after 9 and 10 April 2016 shows no suggestion of a partnership or partnership agreement or of conduct from which a partnership might be implied. Likewise, a review of the emails between the parties over the period from July to September 2016 shows no mention of a partnership agreement variation or of conduct from which a variation might be implied.

(b) On 20 May 2016, Mr Galea discussed Mr Pelchen’s investment in three projects including the Martin Street project with Dennis Danaher, a solicitor. In an email on 20 May 2016, Mr Danaher described Mr Pelchen’s investment in the project as that of ‘a straight Unitholder with a fixed entitlement to the assets and liabilities of the Unit Trust that is acquiring the property’. He added in substance that Mr Pelchen’s units would be held in his new corporate trustee (MPGI) on behalf of his investment trust, and not in a bare trust by Mr Kavallero’s entity. In an email of 23 May 2016, Mr Galea confirmed in substance that Martin Street Trust units for Mr Pelchen were to be held by MPGI. There was no mention by Mr Galea or Mr Danaher of any partnership agreement.

On 26 September 2018, Mr Pelchen emailed Mr Harris and Mr Kavallero attaching a copy of the draft variation deed amended by MPGI’s solicitor. The email included the following:

As previously indicated by email last week, [MPGI’s solicitor] is insistent that a guarantee is provided by both Knight & Ronen on my investment in 43 Martin Street as the refinance amount is significant and not for my direct benefit as I do not have any personal finance secured against the development…
[MPGI’s solicitor] believes that I am being generous in allowing increased security to be held by Knight against 43 Martin Street and as such, will not exclude this guarantee being provided on my investment particularly as Knight is seeking such a high refinance amount when there is no certainty that the properties will actually achieve these figures upon sale. As ‘Equity One’ will now become the Senior Lender on the development, the guarantee is required to ensure that Knight & Ronen have sufficient funds to pay my $2.368 + 30% Profit Share to me.[102]

[102]Underlining added.

While the draft variation deed as amended by MPGI’s solicitor showed the draft guarantee to be in favour of the Borrower and not the Lender, it is plain from the covering email that the guarantee was to be given by both Knight 43 and Mr Kavallero to MPGI in relation to its investment in the project and its anticipated profit share.

On 3 October 2018, MPGI’s solicitor emailed Knight 43’s solicitor as follows:

We are instructed to advise that, having considered the proposed draft deed, and our client having spoken with Grant Harris concerning the likely equity available from the property after payment of the relevant expenses (including Equity One’s facility), our client is not prepared to proceed with the refinance unless:
1.The Knight Group (being all of the Knight companies and Ronen – or an entity suitable to our client) provides suitable comfort, upon which our client can rely, that if there is a default in the payment of interest on the Equity One facility it will indemnify our client in respect of any loss sustained as a result of the interest, penalty interest and costs that might be incurred if the Mortgagee steps in and effects a mortgagee sale. Such conduct on the part of the Mortgagee would, of course, diminish the equity in the property available to pay our client the monies due to it.
In other words, our client is not prepared to proceed unless some guarantee is provided that the Knight group will service 100% of loan costs with ‘Equity One’ until both properties are sold/settled (not limited to 6 months). This needs to include an agreement that should there be a default at anytime, then any action taken by the mortgagee will not affect repayment of $2.368 million (Martin Street Advance); and
2.It is agreed that the 30% net profits due to MPGI are calculated solely on the basis of the costs of land, construction & agent fees, and exclude any additional costs occasioned by the refinance, and that the Knight Group (as defined above) guarantee to pay to MPGI that sum (or any shortfall) upon settlement of the 2nd property in addition to the Lender Martin Street Advance.[103]

[103]Underlining added.

The first paragraph of this passage makes it clear that MPGI would not proceed unless a guarantee were provided by the Knight Group in relation to the servicing of the loan costs with Equity-One. The second paragraph refers to a guarantee in favour of MPGI in relation to any shortfall on settlement of the second apartment as well as the Lender Martin Street Advance.

Later that day, the solicitor for Knight 43 and Mr Kavallero sent an email containing the following:

1.My client will agree (via Knight Homes and Ronen) to guarantee the additional cost of the Equity One facility. They’re currently working out the relevant amount …
2.My client will provide a guarantee in relation to the interest payments provided it alone can determine the price at which the first of the 2 properties sells and that any sale of the second property that would achieve an aggregate sale price for both properties of greater than $9.2m must be accepted.[104]

[104]Underlining added.

It is clear from this email that Mr Kavallero was agreeing to provide a guarantee in favour of MPGI to cover the additional costs of the Equity-One loan and interest payments. The solicitor was acting with Mr Kavallero’s agreement and on his instructions.

MPGI’s solicitor responded later that day in these terms:

1.We require the guarantee to be agreed as per the terms of point 2 of our earlier email to you sent at 12.38pm today. To clarify, we are instructed that your client must guarantee payment of the Lender Martin Street Advance and the 30% profit share of our client based upon the project costs model and 30% of NAB costs up to 30/9/18 (excluding my client from all Equity One finance costs/fees/interest) …

On the basis that your client is providing the guarantee of the 30% payment, then there is no need to respond to your most recent email.[105]

[105]Underlining added.

It is clear that the guarantee to be provided was to extend to the Lender Martin Street Advance, the 30% profit share and 30% of the costs of the principal lender (NAB) up to 30 September 2018. Equity-One finance costs, fees and interest were not to be borne by MPGI.

On 4 October 2018, the Knight 43’s solicitor responded to MPGI’s solicitor:

I understand there have been numerous discussions between our clients and that they will both agree to the following:
1. Ronen will guarantee any shortfall between: (a) the amount available to distribute to the Lender after repayment of the Equity One facility, the Martin Street Advance and the Agreed Senior Lender Share Amount, and: (b) the CP Forecast Profit (the Shortfall Amount). An illustration of the Shortfall Amount based on a range of assumed sale prices is set out in the first attached spreadsheet.
…
The Borrower (Knight) alone can elect to sell the properties without the Lender’s approval on the basis that this will have no adverse impact on the Lender as the Shortfall Amount has now been guaranteed.[106]

[106]Underlining added, emphasis in original.

This email refers to what are described as ‘numerous discussions between Mr Pelchen and Mr Kavallero’. It records their agreement that Mr Kavallero will provide a guarantee of the shortfall amount as described in the email. As a result, Knight 43 alone could elect to sell the properties without MPGI’s approval on the basis that this will have no adverse impact on MPGI as the shortfall amount had been guaranteed by Mr Kavallero.

An email sent later than day by the solicitors for Knight 43 and Mr Kavallero stated:

[Mr Pelchen] is entitled to 30% of that amount being $239,421.00 and it is this amount that is being guaranteed.

In response to an email from MPGI’s solicitors, Knight 43 and Mr Kavallero confirmed in an email sent on 5 October 2018 by their solicitors that:

In the event that the Borrower (Knight) defaults on the Equity One mortgage and either of the properties are then sold by the mortgagee, the Borrower (Knight) will guarantee a minimum return to the Lender of the amounts to which it is entitled based on total sales equivalent to $9 million – as indicated on the ‘Equity One Refinance’ statement (this Annexure should be included with the Deed) …

This email refers to a guaranteed minimum return to MPGI of the amounts to which it was entitled based on a total sales price of $9 million for the apartments.

On 8 October 2018, MPGI’s solicitor confirmed acceptance that the guarantee would be provided by Mr Kavallero, and that in the event of default in the payment of the loan by the due date, Mr Kavallero and Knight 43 would consent to judgment being entered against them.

The correspondence between solicitors was sent on the respective instructions of Mr Pelchen and Mr Kavallero. The correspondence is entirely consistent with a common intention by the parties that the guarantee would be given by Mr Kavallero in favour of MPGI and that it would relate to the obligations of Knight 43 to MPGI as specified in the variation deed.

The correspondence between the parties’ solicitors leaves no room for doubt that the guarantee was to be given in favour of MPGI. Nothing in the correspondence suggests that the guarantee would be in favour of Knight 43 as the borrower. Such a notion would have been regarded as absurd by the solicitors handling the transaction.

The defendants submitted that if Knight 43 were sued for debt it could join Mr Kavallero to that proceeding and enforce its guarantee against him. That submission is misconceived. Knight 43 is being sued for the debt, and has not sued and cannot sue Mr Kavallero to recover the debt. It is for the obligee or beneficiary of the guarantee to seek to enforce the obligations in the guarantee against the guarantor. The principal debtor has no right to enforce the guarantee against the guarantor. The position is the reverse. The guarantor has the right to be indemnified by the principal debtor for any money that he is required to pay under the guarantee.

I conclude from the correspondence that if Mr Pelchen and Mr Kavallero had been asked at the time when the variation deed was executed whether the guarantee was to be given in favour of MPGI, they would both have responded ‘of course’. No other response would have been commercially sensible.

Evidence

In determining the question of rectification, the Court has the great benefit of the agreed terms of the variation deed itself, and of the correspondence between the respective solicitors giving a comprehensive step by step account of the negotiations between the parties concerning the guarantee. To a large extent, the solicitors’ correspondence summarises the instructions which were given, and the negotiations which occurred between Messrs Pelchen and Kavallero.

The solicitors’ correspondence was contemporaneous with and embodies the negotiations leading to the adoption of cl 8.1 of the variation deed. The correspondence has the highest probity and reliability, and is the best record of the negotiations which took place three years ago.

In his witness statement, Mr Pelchen said that he had telephone calls and attended meetings with Mr Kavallero and others from August 2018 where the terms of the variation deed were negotiated. He said that due to the new Equity-One facility and the increased liability to the first mortgagee, the minimum sale prices in the variation deed were set at $4.5 million for each apartment, or $9 million in total, to ensure that sufficient funds were available to repay the $6.63 million owed by Knight 43 to Equity-One and the $2,368,822 to be repaid to MPGI. The repayment to MPGI was personally guaranteed by Mr Kavallero.

In his reply witness statement, Mr Pelchen stated that his understanding was that the guarantee was from Mr Kavallero in his personal capacity to and for the benefit of MPGI. He referred to his cover email of 26 September 2018, where he said that the guarantee was required to ensure that Knight 43 and Mr Kavallero had sufficient funds to pay $2.368 million and the 30% profit share. He said that this was a reference to the obligations of Knight 43 to his corporate vehicle MPGI under the loan agreement. He said that he required Mr Kavallero and Knight Group to provide personal and company guarantees respectively to MPGI that the Lender Martin Street Advance of $2,368,822 and the 30% profit share due from the sale proceeds would be guaranteed by them regardless of any shortfall of funds at the time of settlement because of the increased loan to Equity-One. He said he sought guarantees from Mr Kavallero and Knight Group because the loan from Equity-One was specifically for Mr Kavallero’s share of the development and his increased borrowings associated with the refinance.

In cross-examination, Mr Pelchen said that he understood that the guarantee was to him rather than to MPGI. He agreed that the guarantee clause was substantially negotiated between solicitors. He said he had had a conversation with Mr Kavallero about Mr Kavallero and a Knight Group company providing a guarantee to him. When he spoke to Mr Kavallero, he said he wanted a guarantee for himself and the company that any moneys advanced would be returned to him.

Mr Kavallero gave an entirely different account. In his witness statement, he said that when he received a draft deed of variation deed, he read the proposed guarantee clause and understood that it required him and Knight Homes to provide a guarantee to Knight 43. He assumed that this was because it was a development vehicle only and had no assets other than the property under development. He stated that Mr Pelchen was incorrect when he said that he gave a personal guarantee in favour of MPGI.

Under cross-examination, Mr Kavallero said that he understood that he was supposed to provide a guarantee to Knight 43. He said that there was a period of time where Mr Pelchen and his lawyer required Knight Homes and Mr Kavallero to guarantee that there would be sufficient funds. There was a discussion at that time in which Mr Pelchen wanted Knight Homes to guarantee that there would be sufficient funds in Knight 43 to fulfil the agreements.

Mr Kavallero denied that he had told Mr Pelchen in a telephone conversation on the night of 3 October 2018 that he would provide a guarantee to him for the shortfall. He then said that he did not recall the conversation at all.

Counsel for the plaintiffs put to Mr Kavallero the email sent by his solicitor to Mr Pelchen’s solicitor on 4 October 2018 which referred to the numerous discussions between their clients and stated that Mr Kavallero would guarantee any shortfall amount. Mr Kavallero denied that he had offered a guarantee other than to Knight 43 for the shortfall amount. He continued to assert that he was giving a guarantee to Knight 43 rather than to MPGI.

Mr Kavallero asserted that his guarantee was clearly to make sure that Knight 43 would fulfil the commitment of the loan under the variation deed. He said that his lawyer had explained it to him numerous times and that it was as clear as clear can be. When asked whether the guarantee was ultimately for the benefit of MPGI so that it could get its Lender Martin Street Advance, Mr Kavallero said that he was not sure and was not a lawyer.

I reject Mr Kavallero’s evidence concerning the purpose of the guarantee and the identity of the beneficiary. It has all of the hallmarks of reconstruction in a manner intended to advance the defendants’ case. For a very experienced developer and builder who has made and financed numerous developments, Mr Kavallero’s evidence was extraordinary and defied logic and common sense. His evidence that he thought that the guarantee (of Knight 43’s obligations) was to be given by him to Knight 43 is not supported by anything in the variation deed or by any email or communication that passed between him and Mr Pelchen or between their respective solicitors. It is most unpersuasive.

Mr Kavallero’s version of the agreement about the guarantee is inconsistent with the emails passing between the solicitors, many of which were sent on his instructions or copied to him. They provide the best record of the intentions of the parties at the time. As a very experienced businessman who has given guarantees, and whose companies have given guarantees in other circumstances – for example to Equity-One – it is beyond belief that he was not aware that the proposed guarantee was to be in favour of MPGI. I find that he was well aware that the guarantee he was asked to give in the variation deed was in favour of MPGI in order to provide a security and safeguard for the repayment of the Lender Martin Street Advance and the profit share that might be payable if the project were successful.

Mr Kavallero’s evidence is also inherently implausible and improbable for another reason. He was the sole director of Knight 43. He had no need for, and there was no benefit in offering, a guarantee to Knight 43. He could capitalise or finance Knight 43 at any time he chose. He was well aware that Knight 43 had obligations to MPGI under the variation deed, as it had under the loan agreement. He had negotiated and discussed these at great length with his solicitor and Mr Pelchen. He was well aware that the obligations that were to be guaranteed were Knight 43’s obligations to MPGI. He was fully aware of the commercial situation in which he found himself and the realities of what he was doing.

Mr Pelchen stated in his reply witness statement that MPGI was to receive the benefit of the guarantee. He stated in cross-examination that the benefit of the guarantee was to himself rather than MPGI. In giving this answer, he may have misunderstood the question or made a slip. It is notable in the numerous emails between the parties that they often referred to their entities as themselves. I am satisfied that he intended that the guarantee be given in favour of MPGI. The variation deed itself, and the emails passing between the parties and their respective solicitors, make it abundantly clear that the parties agreed and intended that the guarantee in cl 8.1 of the variation deed would be in favour of MPGI and not Knight 43. All of the debt was payable to MPGI. The financial obligations in the variation deed are owed to MPGI. There is nothing in the variation deed about payments to Mr Pelchen personally.

Conclusion

I find that it was the agreement and common intention of the parties to the variation deed before and at the time it was made that the guarantee given in cl 8.1 would be in favour of MPGI. However, as a result of a drafting slip which was not detected by the solicitors despite a number of drafts, clause 8.1 referred incorrectly to the Borrower (Knight 43) and not the Lender (MPGI). Instead of the word ‘Borrower’, the word ‘Lender’ should have been used. This was the result of a common mistake by the parties and their legal advisers. Clause 8.1 of the variation deed does not reflect the true agreement between them when the variation deed was signed. It would be unfair and unjust if rectification of cl 8.1 of the variation deed were not granted by the Court. Accordingly, I will order that cl 8.1 be rectified so that the phrase ‘guarantees to the Borrower’ is replaced by the phrase ‘guarantees to the Lender’.

Liability for breach of the variation deed

I have found Knight 43 to be in breach of:

(a) cl 4.5(c) of the variation deed in relation to the sales of the Foote Street apartment and the Martin Street apartment;

(b) cl 4.7(d)(i) of the variation deed in that it failed to make all payments as and when due to Equity-One; and

(c) cl 4.8(b) of the variation deed in that it extended the Equity-One facility beyond $6,630,000.

I have also found that Mr Kavallero is in breach of the warranty in cl 4.8(c) of the variation deed in that Knight 43 did not at all times have sufficient funds available to meet its interest obligations under the Equity-One facility.

Under cl 9.1 of the variation deed, in the event of an unremedied breach by Knight 43, all sums contemplated by the variation deed as being payable to MPGI immediately become due and payable. The Lender Martin Street Advance in the amount of $2,368,822 is a sum contemplated under cl 4.3(b) of the variation deed to be repaid to MPGI. This was the amount claimed in the notice of dispute dated 12 December 2019. Following the settlement of the Foote Street apartment, the Lender Martin Street Advance was reduced by $250,000 to $2,118,822. This amount is presently due and payable to MPGI.

Under cl 8.1(a) of the variation deed, as rectified, Mr Kavallero guaranteed to MPGI the payment of the Lender Martin Street Advance by Knight 43. Under cl 8.1(b), Mr Kavallero guaranteed among other things the punctual observance and performance of all covenants, obligations, terms, conditions and stipulations given by Knight 43 to be observed under the variation deed. Mr Kavallero is also liable to MPGI in the amount of $2,118,822.

Breach of trust

MPGI also claimed for breach of trust. However, in opening, MPGI stated that if it was successful in obtaining repayment of the Lender Martin Street Advance on its claim for breach of the variation deed, it did not press for additional relief on the claim for breach of trust.

As MPGI is successful on its principal claim for breach of the variation deed, and does not seek additional relief for breach of trust, I will only briefly mention the claim for breach of trust.

As the trustee of the Martin Street Trust, Knight 43 had duties arising under the trust deed and implied by law. MPGI claims that in substance Knight 43 owed MPGI the following duties:

(a) a duty arising under cl 2.3 of the Martin Street Trust deed when exercising any discretion or power vested in or conferred upon the trustee in its absolute discretion to exercise that discretion or power subject to the consent of unitholders by unanimous resolution, special resolution or ordinary resolution. Under cl 13.12 of the Martin Street Trust deed, Knight 43 in its absolute and uncontrolled discretion has power to sell, transfer, convey, let, lease, alienate, mortgage, charge or otherwise deal with any real or personal property;

(b) a duty to adhere to and carry out the terms of the trust;

(c) a duty to act impartially between the beneficiaries;

(d) a duty to keep and render proper accounts and to give full information when required;

(e) a duty to exercise reasonable care;

(f) a duty not to deal with the trust property for personal benefit, or otherwise to profit by the trust; and

(g) a duty not to diminish or deplete the corpus of the trust estate.

Among other things, MPGI alleges that Knight 43 acted in breach of these duties by:

(a) failing to obtain the consent of MPGI before agreeing to any variation of the building contract in favour of Knight Homes;

(b) failing to ensure that Knight Homes complied with the building contract as to time and cost of construction;

(c) granting leases over the properties;

(d) failing to account for rental payments and applying the rental payments for its own benefit and the benefit of Mr Kavallero and his companies and trusts;

(e) preferring its own interests to those of the beneficiaries by invoicing MPGI for costs in breach of the loan agreement (as varied), demanding payment and threatening legal proceedings, and failing to withdraw or correctly amend the invoice or provide further information when sought;

(f) failing to maintain the Equity-One facility and incurring penalty interest; and

(g) selling the Foote Street and Martin Street apartments.

Variation of building contract, delays and building expenses

Knight 43 did not obtain the approval of the beneficiaries under the trust deed for a variation of the building contract with Knight Homes. This was a conflicted decision made by Mr Kavallero. There was no informed consent by MPGI. However, the parties largely resolved the issue of building cost increases in the negotiations leading up to the execution of the variation deed. Annexure A2 to the variation deed details the expenditure to date, and forms part of the Financial Statements of the project as that expression is defined in cl 2.2 of the variation deed.

Clause 4.4(a)(i) of the variation deed relevantly provides that the project costs will not exceed the amount identified in Annexure A2. Clause 4.4(a)(ii) provides that any project costs not identified in Annexure A2 must be agreed by MPGI, and if incurred without MPGI’s agreement will not be considered to be a project cost.

In addition, cl 4.4(a)(iii) provides that any project costs which have not been incurred as at 30 September 2018 must be approved in writing by MPGI. Finally, cl 4.4(a)(iv) provides that MPGI must not unreasonably withhold its approval to the incurring and payment of project costs, subject to MPGI being provided with whatever information is reasonable in the circumstances.

In his third witness statement, Mr Harris gave evidence (which was not disputed by MPGI) that the price paid by Knight 43 for construction of the apartments was approximately $3,683,075 (incl GST). Of this amount, only $3,537,910 (incl GST) was to be included when calculating MPGI’s share of the project’s proceeds, with the remainder to be deducted from RSK’s share. The variations not agreed by MPGI amount to $145,165.20, and are outlined in detail by Mr Harris in his evidence. It is not necessary to repeat his evidence here.

In the variation deed, the parties agreed on a regime as to how additional building costs are to be addressed. Project costs not listed in Annexure A2 will not be allowed unless agreed by MPGI. Project costs after 30 September 2018 must be approved in writing by MPGI, which cannot unreasonably withhold its approval.

MPGI claims for additional costs caused by delay by Knight Homes in the construction of the apartments. Mr Galea said that the reason for the delay was that Mr Kavallero was mainly focussing on projects that were delivering cash flow to the Knight Group. Under cl 3.1 of the loan agreement, Knight 43 was only required to repay the Lender Non-Martin Street Advance within 60 days of the later of the issue of an occupancy permit or a plan of subdivision in respect of the apartments. However, MPGI did not call any expert building evidence as to delay or increased construction costs. There is no satisfactory evidence that delay in completing the construction of the apartments caused additional building costs. Some delay was caused by works which were subsequently agreed by MPGI.

In the circumstances, I am not satisfied that MPGI has established that additional building costs or expenditure were incurred by reason of delays by Knight Homes or Mr Kavallero in the construction of the apartments.

Granting leases and accounting for rental payments

Mr Kavallero did not obtain the consent of MPGI before entering into the leases. The rental payments received by Knight 43 from the lease of the apartments were used by Knight 43 to assist with its monthly interest payments on the Equity-One loan. It is not disputed that 30% of the rental payments were attributable to MPGI in accordance with the provisions of the Martin Street Trust. Knight 43 is also entitled to set off 30% of the costs and outgoings incurred in relation to the leasing of the apartments against MPGI’s share of the rental payments. A reconciliation between Knight 43, RSK and MPGI under the terms of the Martin Street Trust is yet to be completed.

Invoices to MPGI for costs

Knight 43’s claim for project costs from MPGI is not pressed. No claims by Knight 43 against MPGI for costs in breach of the loan agreement, variation deed, or Martin Street Trust have been successful.

Knowing benefit and receipt of funds

Mr Kavallero is, and at all relevant times was, the sole director and directing mind of Knight 43 and Knight Homes. MPGI alleges that as the sole director of Knight 43 and Knight Homes, Mr Kavallero acted in breach of the Martin Street Trust when varying the building contract between Knight Homes and Knight 43. MPGI submits that any variations in the building contract were for the benefit of Knight Homes, and were made without the consent of MPGI and to MPGI’s detriment.

I consider that Mr Kavallero acted in breach of trust when he approved the variation of the building contract without seeking MPGI’s approval. Plainly, he was in a conflicted position in being both the sole director of Knight 43 (the trustee of the Martin Street Trust) and of Knight Homes, and he should have obtained the informed consent of MPGI and RSK as the unitholders of the Martin Street Trust before entering into the building contract or variations of the building contract.

Mr Harris’ evidence is to the effect that MPGI agreed or approved costs in the amount of $3,537,910 (incl GST) for the building works. The variations not agreed by MPGI amount to $145,165.20. He stated that these costs would be attributed to RSK. If this is done, there will be no building costs borne by MPGI to which it has not agreed. I will not grant any additional relief on this claim.

Conclusion

MPGI is successful on the principal claim for breach of the variation deed. It has shown breaches by Knight 43 of cls 4.5(c), 4.7(d)(i), 4.8(b) and 9 of the variation deed. It has also shown breaches by Mr Kavallero of cls 4.8(c) and 8.1 (when rectified) of the variation deed. An order will be made for rectification of the first line of cl 8.1 of the variation deed by substitution of the word ‘Lender’ for ‘Borrower’. Judgment will be entered for MPGI against Knight 43 and Mr Kavallero in the amount of $2,118,822 with statutory interest. The proceeding as against the third defendant, and the counterclaim, will be dismissed.

SCHEDULE OF PARTIES

MELBOURNE PROPERTY GROUP INVESTMENTS (MPGI) PTY LTD (ACN 612 456 818) as trustee for the MPGI TRUST	Plaintiff/ Defendant by counterclaim
- and -
KNIGHT 43 MARTIN STREET PTY LTD (ACN 612 790 351)	First Defendant/ First Plaintiff by counterclaim
KAVALLERO, RONEN	Second Defendant/ Second Plaintiff by counterclaim
KNIGHT HOMES PTY LTD (ACN 121 402 480)	Third Defendant

[2022] VSC 41

16 February 2022