Merkon Constructions Pty Ltd v Residence Company Pty Ltd

IN THE SUPREME COURT OF VICTORIA

Not Restricted

AT MELBOURNE

COMMERCIAL COURT
COMMERCIAL LIST

S ECI 2023 03762

BETWEEN:

MERKON CONSTRUCTIONS PTY LTD (ACN 006 587 319)	Plaintiff
and
RESIDENCE COMPANY PTY LTD (ACN 056 096 121)	First Defendant
MONLAND PTY LTD (ACN 615 257 308)	Second Defendant

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JUDGE:	M Osborne J
WHERE HELD:	Melbourne
DATE OF HEARING:	7 June 2024
DATE OF JUDGMENT:	10 July 2024
CASE MAY BE CITED AS:	Merkon Constructions Pty Ltd v Residence Company Pty Ltd
MEDIUM NEUTRAL CITATION:	[2024] VSC 402

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COSTS – Application for costs of discontinuance – Whether the Court should award costs or otherwise order – Indemnity costs – Whether the granting of a mortgage in breach of a deed warrants a different approach to costs – Judicial sale of mortgaged property – Where a party is a necessary party to a proceeding – Appointment of receivers – Costs of compliance with discovery orders – Supreme Court (General Civil Procedure) Rules 2015 (Vic), r 63.15 – Supreme Court Act 1986 (Vic), s 24 – Soteriadis v Nillumbik Shire Council [2015] VSC 363.

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APPEARANCES:	Counsel	Solicitors
For the Plaintiff	M Galvin KC with O Wolahan	Walpole Menzies
For the First Defendant	I Hone, solicitor	Hone Legal
For the Second Defendant	S Maiden KC	Hall & Wilcox

HIS HONOUR:

On 7 June 2024, I made orders giving the plaintiff, Merkon Constructions Pty Ltd (‘Merkon’), leave to discontinue its proceeding against the second defendant, Monland Pty Ltd (‘Monland’). Merkon’s proceeding remains on foot against the first defendant, Residence Company Pty Ltd (‘Residence’). I heard argument on the question of costs of the discontinuance and reserved my decision. These reasons concern that question.
Rule 63.15 of the Supreme Court (General Civil Procedure) Rules 2015 (Vic) (‘Rules’) provides that unless the Court otherwise orders, a party who discontinues or withdraws part of a proceeding, is liable to pay the costs of the party to whom the discontinuance relates. The rule imposes an onus on the discontinuing party to satisfy the Court why it should not pay costs.[1] Here, Merkon submits that the Court should otherwise order. Monland in contrast submits that the Court should order that Merkon pay its costs and further that the costs should be payable on an indemnity basis.
[1]Soteriadis v Nillumbik Shire Council [2015] VSC 363, [12] (‘Soteriadis’).
In order to understand the parties’ competing submissions, it is necessary to delve into the detail of the proceeding.

Background

Merkon is a builder who completed the design and construction of an apartment development in Hawthorn East in October 2021. It claims to be owed $2,448,869.55 by the owner of the property, Residence. Monland is Residence’s financier. Monland holds a first registered mortgage over the property amongst other securities.
On 31 October 2019, Monland, Merkon and Residence entered into a ‘builders side deed’. Recital B to the deed records that Monland has agreed to provide certain financial accommodation to Residence to fund payments to Merkon to construct the works and recital C records that Residence had agreed to give security to Monland. Clause 3.1(a) of the deed included a consent by Merkon to the grant of security by Residence of its rights under the construction contract whilst clause 3.3 sets out a series of undertakings by Merkon including an undertaking to Monland that Merkon will observe and perform all of its obligations under the construction contract and that it will promptly notify Monland of any breach by Residence of the construction contract or dispute under the works contract. Another one of the undertakings given was that Merkon would not take or maintain any security interest over the site or Residence’s other assets or lodge a caveat against the site or any part of the site without Monland’s consent.
On 1 November 2019, Monland entered into a loan facility agreement with Residence, the terms of which included the provision of security in the form of a registered first mortgage over the property. The maturity date of facility agreement was the earlier of 31 December 2020; the date of repayment of the facility or its termination, although this was later extended by a deed of amendment entered into in around September 2021 to 1 March 2023.
On 29 July 2021, Merkon entered into the ‘first deed of variation’ with Residence under which Residence executed and delivered to Merkon a mortgage over the site.
On 8 October 2021, Merkon and Residence entered the ‘second deed of variation’ under which Residence executed and delivered a further mortgage to Merkon (the ‘Merkon mortgage’).
Monland denies that it consented to or was aware of the Merkon mortgage at the time Residence executed and delivered it to Merkon and says it first became aware of it on 28 February 2023. There is no evidence to the contrary and therefore I accept that Monland was unaware of the grant of the Merkon mortgage until 28 February 2023.
On 28 February 2023, Merkon’s solicitors wrote to Monland, inter alia, informing Monland of the debt owing by Residence to Merkon and of the existence of a mortgage in its favour. Merkon appeared to be under the impression that Monland had taken possession of the site and in any event requested that Monland provide it with information as to the anticipated selling price of the units that comprise the property and the amount presently owing by Residence to Monland amongst other things. Merkon’s solicitor also advised that Merkon had lodged caveats over the titles to the units comprising the property in order to protect its position. In fact and notwithstanding the expiry of the loan facility agreement, Monland did not exercise its security rights; instead it seems that there was some form of agreement between Monland and Residence to the effect that Residence would sell the completed units in an orderly fashion and that the proceeds of sale in the first instance, net of the sale costs, would be used to pay down Monland’s secured debt.
Merkon’s operations manager, Brett Charmers, deposed in an affidavit sworn 17 August 2023, that Monland’s director told him on 3 March 2023 that there was approximately $7 million of equity in the property (after allowing for the repayment of Monland’s secured debt) and that Monland was happy to cooperate with Merkon.
By letter dated 8 March 2023, Monland’s solicitors responded to the letter from Merkon’s solicitors, inter alia, advising that it had not in fact taken possession of the site and otherwise advised that the amount owing to Monland was $40,716,671.20 together with costs with interest and costs continuing to accrue, and otherwise noting that Monland did not have control of the sale process.
In the letter, Monland’s solicitors asserted, among other things, that the grant of the Merkon mortgage constituted a breach by Residence of the loan facility agreement and a breach of the builders side deed by Merkon. Monland requested that the caveats be withdrawn in order to allow settlement of the sale of the units at the site to take place.
By letter dated 5 June 2023, Monland’s solicitors reiterated that the grant of security to Merkon occurred in breach of the loan facility agreement, the mortgage deed and the builders side deed, but otherwise advised that Monland did not object to Merkon maintaining its caveats on the title subject to Monland’s debt, which was secured by a first ranking mortgage, being paid in priority to Merkon and Merkon not interfering with or in any way delaying or preventing settlement occurring on any units and to that end withdrawing the existing caveats promptly at settlement.
In July 2023, Merkon sought documents and information from Residence’s lawyers to verify or alleviate its concern that some of the proceeds of sale and the leasing of units were being applied otherwise than in payment of Monland’s debt.
Dissatisfied with the response, on 21 August 2023, it commenced this proceeding by originating motion seeking a declaration as to its second registered mortgage over the property, judgment for the amount of debt and an order for judicial sale of the remaining units in the development. Merkon never disputed that Monland’s interest in the property had priority over Merkon’s interest.
As Merkon’s interest in the property was only by way of an equitable mortgage, it did not have a right to immediate possession of the secured land. Its rights over the land could only be enforced by an order for judicial sale or the appointment of a receiver. Aside from its debt claim, the essence of the proceeding brought by Merkon was an application for an order for judicial sale. In Hycenko v VHY Enterprises Pty Ltd & Ors,[2] Derham AsJ identified authorities and principles relevant to the Court’s power to order a judicial sale of mortgaged property. The principles may be summarised as follows:[3]
[2][2020] VSC 834.
[3]Ibid [35]-[48].
(a)the Court has an inherent power and a power under s 91 of the Property Law Act 1958 (Vic) (‘PLA’) as well as powers under ord 55 of the Rules, to grant judicial sale to enforce an equitable charge over land, including a charge under an unregistered second mortgage (see the inclusive definition of ‘mortgage’ in s 18 of the PLA);
(b)all persons whose rights might be affected by the proposed order should be joined to the proceeding, including registered mortgagees of the land and other unregistered mortgagees and chargees;
(c)an order for judicial sale is to be made with considerable caution;
(d)if a prior mortgagee or encumbrancer does not consent to the judicial sale, then ordinarily the sale will be subject to payment out of its mortgage or encumbrance;
(e)an order for judicial sale obtained by a second mortgagee or chargee does not prevent a sale by the first mortgagee who is not a party to the action;
(f)usually the Court will require evidence of:
(i)the amount of the secured debt;
(ii)the value of the property (to enable an assessment of an appropriate reserve price);
(g)the Court exercises control over the terms and manner of conduct of the sale imposing such conditions as it sees fit regarding:
(i)the fixing of a reserve price;
(ii)the timing of the sale;
(iii)who is to have the conduct of the sale;
(iv)whether the mortgagor should be afforded some time to redeem the mortgage, which may be informed by:
(1)whether all the parties interested in the equity of redemption are represented;
(2) the property is wholly unproductive;
(3)the rents from the property are not enough to keep the interest down;
(4) market conditions;
(v)any conditions which may be appropriate to protect the interests of the first mortgagee;
(h)the reserve price should be sufficient to cover the principal, interest and costs of the first mortgagee; and
(i)the discretion as to who should conduct the sale is to be exercised with regard to who has the greatest interest in maximising the sale price (in preference to persons who might only have an interest in recovering their debt).
Thus, it was necessary for Merkon to join Monland as a defendant to the proceeding because of Monland’s interest as first registered mortgagee and the potential for it to be adversely affected by the proposed orders for judicial sale. However, no relief was sought against Monland.
On 31 August 2023, Stynes J made orders upon an application by Merkon for Residence to apply the net proceeds of the sale of units that were taking place in payment of Monland’s debt. Orders were also made requiring Residence to produce documents explaining Monland’s debt which included provision by Residence of all written loan agreements evidencing any loan or loans, repayment of which was secured by Monland’s mortgage and/or loan statements for such loan or loans to September 2023. Residence produced various documents purporting to comply with that order which relevantly included an affidavit affirmed 2 October 2023 by Residence’s director, Mark Oman, which asserted that as at 30 August 2024 the total debt to Monland was $38,505,824. Mr Oman also deposed to having received conditional approval for refinance in the amount of $41 million which would be sufficient to pay out Monland’s debt and Merkon’s debt.
On 19 October 2023, Stynes J ordered that the trial of the proceeding be fixed for hearing on a date not before 9 February 2024 on an estimate of one day. At that directions hearing, counsel for Merkon sought clarification as to Monland’s attitude towards the proposed application.
The answer provided by counsel on that day was equivocal, presumably having regard to the fact that counsel had only just been briefed.
By email sent from her Honour’s chambers in advance of a directions hearing scheduled for 8 November 2023, her Honour directed that the parties file short submissions outlining their respective position in the litigation. Monland served an outline of position dated 3 November 2023 stating that it had no view or position with respect to recent exchanges between Merkon and Residence regarding the interlocutory regime with respect to the proceeds of sale. Whilst it referred to its allegation that Merkon’s security was taken in breach of the builders side deed, it voiced no objection to the declarations sought as to Merkon’s security and the proposed order for judicial sale.
At the directions hearing on 8 November 2023, paragraph 2 of her Honour’s orders required both Residence and Monland to give discovery of documents in substantially the same terms as that ordered on 31 August 2023 against Residence alone.
Monland filed an affidavit of documents pursuant to that order.
The trial of the proceeding for judicial sale was scheduled for 15 February 2024.
On 6 February 2024, Monland appointed receivers to the property. The appointment effectively rendered Merkon’s application for judicial sale moot. As a result of this appointment, the judicial sale application did not proceed and instead, orders were made that the proceeding continue as if it was commenced by writ and for pleadings. When Merkon subsequently filed its statement of claim, it did not include any cause of action against Monland.

Costs on discontinuance

Section 24 of the Supreme Court Act 1986 (Vic) gives the Court discretion in relation to the question of costs.
In Soteriadis v Nillumbik Shire Council,[4] Derham AsJ summarised the relevant principles in respect of the Court’s power to otherwise order under r 63.15 of the Rules as follows:[5]
[4]Soteriadis (n 1).
[5]Ibid [12]-[13] (citations omitted).
(a)The rule does not give rise to a presumption that costs will be ordered against the discontinuing party;
(b)However, the rule does create a starting position for the plaintiff or discontinuing party to pay the defendant’s costs, subject to a contrary order;
(c)The contrary order itself involves a discretionary decision to be exercised judicially. If there is to be a departure from the starting position, it should be done in a particularised, and principled way. The Court is required to make such order as it thinks just in the particular circumstances of the case;
(d)The burden is on the party who seeks to persuade the Court that a contrary order should be made. If facts are to be relied upon to found the Court making a different order, the plaintiff will bear the onus of proving the relevant facts;
(e)All the relevant circumstances, and not just the fact of discontinuance, should be considered. This may include a consideration of the whole of the proceedings. Generally the discretion will be exercised on the basis of the objective circumstances established on the evidence and not involve the subjective considerations of one party;
(f)A relevant consideration is whether the plaintiff acted reasonably in commencing the proceedings and whether the defendant acted reasonably in defending them. It might also be appropriate for the Court to consider the conduct of the defendant prior to the commencement of the proceedings where such conduct may have precipitated the litigation;
(g)Generally there must be some proper justification, sound positive ground, or a good reason, for departing from the starting position. The reasons for the discontinuance can bear heavily on the exercise of the discretion as to costs, so for example, it may be appropriate to make a contrary order:
(i)Where the proceedings have been rendered unnecessary by circumstances beyond the plaintiff’s control;
(ii)Where the plaintiff achieved practical success in the proceedings;
(iii)Where costs have been significantly increased by the unreasonable conduct of the defendant;
(h)Where the proceedings are discontinued prior to any hearing on the merits, usually it will be impracticable to assess the eventual prospects of success in the action and the Court cannot try a hypothetical action between the parties to determine the question of costs;
(i)There is a distinction between cases in which one party, after litigating for some time, effectively surrenders to the other, and cases where some supervening event, or settlement, so removes, or modifies, the subject of the dispute that, although it could not be said that one side has simply won, no issue remains between the parties except that of costs. In the former type of case, there will commonly be lacking any basis for an exercise of the court’s discretion otherwise than by an award of costs to the successful party. It is the latter type of case that usually creates problems, since there may be difficulty in discerning a clear reason why one party, rather than the other, should bear the costs; and
(j)Where the proceedings are discontinued after interlocutory relief has been granted, the Court may take into account the fact that that interlocutory relief has been granted;
…
If it appears that both parties have acted reasonably in commencing and defending the proceedings and the conduct of the parties continue to be reasonable until the litigation was settled or its further prosecution became futile, the proper exercise of the costs discretion will usually mean that the Court will make no order as to the cost of the proceeding.
The conduct of the parties in the course of the litigation including their observation of their overarching obligations under the Civil Procedure Act 2010 (Vic) is also a relevant factor.[6]
[6]Brooke & Mackenzie Pty Ltd v El-Gra Engineering Pty Ltd (2015) 331 ALR 535, 536 [7], 540 [22].
In respect of its submission that the Court should not ‘otherwise order’ as submitted by Merkon and further that the order for costs arising on discontinuance should be on an indemnity basis, Monland relies principally on the fact that the proceeding was brought by Merkon to enforce the Merkon mortgage which had been granted by Residence contrary to the builders side deed.
Monland also relies on clause 14.1 of the builders side deed which provides that:
14.1 General indemnities
The Developer [Residence] and Builder [Merkon] each indemnify the Enforcing Party [Monland] against, and must pay to the relevant Enforcing Party on demand, amounts equal to, all Loss arising out of or in connection with breach of this deed or the Construction Contract, and if and to the extent such Loss results from their respective breach of those documents.
The builders side deed defines ‘Loss’ as meaning ‘a loss, claim, action, damage, liability, cost, charge, expense, penalty, compensation, final outgoing suffered, paid or incurred’.
Accordingly, Monland submits that Merkon has agreed to pay those costs and they should be taxed on an indemnity basis because that is what clause 14.1 provides. Secondly, and relatedly, Monland contends that by commencing and continuing the proceeding, Merkon has acted in deliberate, open and continuous breach of its obligations under the builders side deed and has used the Court’s processes in aid of such a breach knowing that Monland was a necessary party to the proceeding and as such knew that Monland would incur costs by reason of that breach.

Monland submits that in those circumstances, Merkon’s submission that its bringing of a claim was reasonable lacks merit and satisfies the description of ‘unmeritorious or deliberate improper conduct such as would warrant the court showing its disapproval and at the same time preventing the respondents being left out of pocket’.[7]
[7]Giles v Jeffrey [2016] VSCA 314, [195], quoting Yara Australia Pty Ltd v Oswal (2013) 41 VR 302, 317 [57].
Merkon’s commencement of this proceeding had its origin in two factors; Monland was content for Residence to oversee the sale of units for the purposes of repaying Monland’s secured debt notwithstanding that Residence was in default of its mortgage with Monland and secondly, Merkon’s belief that there was sufficient equity in the property to enable its unpaid debt to be satisfied.
Monland was of course completely entitled to proceed in whatever way it sought fit to recover the moneys owed to it. Merkon did not submit to the contrary. Monland’s approach however meant that Merkon had to sit back and wait before its debt could be satisfied.
Putting aside for now the relevance of the breach of the builders side deed, the two factors made it understandable that Merkon commenced the proceeding as it did. Further, as Merkon submitted, in those circumstances Monland was a necessary party to the proceeding and was joined for that purpose. The proceeding was rendered otiose because of an event entirely beyond Merkon’s control, namely Monland’s appointment of receivers to the property. Up to that point in time, Merkon’s prosecution of its claim for judicial sale was understandable. Once the receivers were appointed, Merkon confined its statement of claim to a claim for in personam relief against Residence. Further, although Monland was a necessary party to the action, it was not necessary for it to actively participate in the proceeding unless it intended to oppose the application for judicial sale. Monland never took that position and instead expressly took no position on the application.
The second aspect of Monland’s submission that Merkon must have known that Monland would incur costs in defending the proceeding overstates things; particularly in circumstances where it had told Merkon in the 5 June 2023 letter that it did not object to Monland’s caveats and necessarily Merkon’s subordinate security, provided the caveats were withdrawn so as to allow settlements to occur and Monland’s priority debt to be repaid. Further, Monland as the mortgagee also had the capacity to ensure that the costs of the judicial sale proceeding were avoided by appointing receivers earlier or itself entering into possession of the units. Monland has not explained why it did not take any action to that effect until a week before the trial date.
In those circumstances, there is a strong basis for the Court to exercise its discretion to otherwise order.
The critical question is whether the fact that the Merkon mortgage was granted in breach of the builders side deed warrants a different approach.
I do not consider that it does. Monland accepted that clauses such as clause 14.1 of the builders side deed are only a factor to be taken into account in the exercise of the Court’s discretion.[8] The Merkon mortgage was avowedly subordinate to the Monland mortgage, it is difficult to see what prejudice at all Monland suffered as a result of the grant of the Merkon mortgage and the associated breach of the builders side deed, aside from that which followed from any refusal to lift a caveat to allow a settlement to occur. Monland recognised this; so much is apparent from its letter of 5 June 2023. Secondly, I do not accept that it follows that in those circumstances Merkon must have known that the proceeding could have been rendered otiose by Monland exercising its power to appoint receivers and must have known that Monland would incur costs as a defendant in the proceeding.
[8]Chen v Kevin McNamara & Son Pty Ltd [2012] VSCA 229, [7]-[8].
Whilst I accept that there was a risk that Monland may have exercised its power to appoint receivers, I do not accept that Merkon should have anticipated that Monland would actively participate in the proceeding and that it should bear the consequences that follow from its assumption of that risk. Monland did not have to participate; it could have abided the outcome of the proceeding provided that any order for judicial sale was on terms which adequately protected its interests.
It is true that Monland was ordered to provide discovery. If Monland had not been an active participant it still could have been ordered to provide discovery but in that case its position would have been more akin to that of a non-party ordered to provide discovery or produce documents on subpoena. In any of those events, its costs and expenses would be paid and on an indemnity basis. I accept that Monland’s costs of complying with the discovery order of 8 November 2023 should be paid by Merkon on an indemnity basis but I shall also reserve the question of whether Merkon can recover the costs it has been ordered to pay from Residence. Otherwise, there should be no order as to Monland’s costs of the proceeding. Orders shall be made accordingly.

SCHEDULE OF PARTIES

S ECI 2023 03762
BETWEEN:
MERKON CONSTRUCTIONS PTY LTD (ACN 006 587 319)	Plaintiff
- v -
RESIDENCE COMPANY PTY LTD (ACN 056 096 121)	First Defendant
MONLAND PTY LTD (ACN 615 257 308)	Second Defendant

[2024] VSC 402

10 July 2024