Pesec v Consolidated Builders Ltd (No 3)
[2021] ACTSC 105
•13 April 2021
SUPREME COURT OF THE AUSTRALIAN CAPITAL TERRITORY
Case Title: | Pesec v Consolidated Builders Ltd (No 3) |
Citation: | [2021] ACTSC 105 |
Hearing Dates: | 21-22 October 2020, 9-10 February 2021 |
DecisionDate: | 13 April 2021 |
Reasons Date: | 28 May 2021 |
Before: | McWilliam AsJ |
Decision: | See [141], [146] |
Catchwords: | CORPORATIONS – Application for leave to bring statutory derivative action under ss 236 and 237 Corporations Act2001 (Cth) – whether serious question to be tried – whether proposed proceedings in the best interests of the company – whether plaintiff acting in good faith |
Legislation Cited: | Corporations Act 2001 (Cth) ss 180, 181, 182, 208, 209, 211, 217-228, 236, 237, 239, 241, 1317H Court Procedures Rules 2006 (ACT) r 1203 Uniform Civil Procedure Rules 2005 (NSW) r 31.23 |
Cases Cited: | Aitkenhead v Kaufline and Insurance Australia Ltd [2014] ACTSC 82 American Cyanamid Co v Ethicon Ltd [1975] AC 396; 2 WLR 316 |
Parties: | Anthony Pesec (Plaintiff) Consolidated Builders Limited (Defendant) |
Representation: | Counsel T Lynch SC with A Carr (Plaintiff) M O’Meara SC (Defendant) |
| Solicitors Adero Law (Plaintiff) Clayton Utz (Defendant) | |
File Number: | SC 179 of 2020 |
McWilliam AsJ:
Mr Anthony Pesec, the plaintiff, is a shareholder in the defendant, Consolidated Builders Ltd (CBL), a public company formed by a group of Canberra-based builders and property developers. CBL’s business is purchasing, subdividing, developing and managing land assets.
By Originating Process filed on 14 May 2020 and amended on 24 July 2020, the plaintiff sought leave to bring a derivative action on behalf of CBL, pursuant to ss 236 and 237 of the Corporations Act2001 (Cth) (the Corporations Act). The defendant opposed the grant of leave sought.
The proposed defendants to the derivative action are the Board of Directors of the company: Mr Josip Zivko (CBL’s Managing Director), Mr Frank Crnkovic, Mr Mirko Skrnjug, Mr Rein Heins and Mr Noel McCann (the Directors). A further proposed defendant is the company that was a nominated purchaser of shares in CBL on behalf of CBL’s Managing Director, XO 1 Pty Ltd (XO 1). They were not parties to the present application.
Due to a limitation period set to expire on 14 April 2021 with respect to part of the proposed proceedings, I determined the application on an urgent basis on 13 April 2021. This approach was foreshadowed only on the last day of the hearing, and it arose because the parties wanted time to file detailed closing submissions.
I ordered that the application be dismissed. At the time judgment was delivered, I indicated to the parties that I would subsequently provide written reasons for judgment on the plaintiff’s application. These are the reasons.
The Court’s power to grant leave
Under s 236 of the Corporations Act, and relevant to the present application, a person may bring proceedings on behalf of a company if the person is a member of the company and is acting with leave granted under s 237 of the Corporations Act. The plaintiff, as a shareholder, is a member of CBL.
Section 237 of the Corporations Act sets out five criteria for a grant of leave to bring proceedings on behalf of a company. Under s 237(2), the Court must be satisfied that:
(a)It is probable the company will not bring the proceedings itself, or properly take responsibility for them;
(b)The applicant is acting in good faith;
(c)The grant of leave is in the best interests of the company;
(d)There is a serious question to be tried (if the application is for leave to commence proceedings); and
(e)The company has been given 14 days’ written notice of the application for leave, or alternatively, that it is appropriate to grant leave notwithstanding the notice requirement not being satisfied.
On the express words of the statute, if all five criteria are satisfied, the court “must grant the application”. There is no overriding discretion. Conversely, if any one of the criteria is not established, the application must be refused: Huang v Wang [2016] NSWCA 164; 114 ASCR 586 (Huang) at [57] and the cases there-cited.
The onus is on the applicant to establish each of the five criteria to the Court’s satisfaction, with that level of satisfaction being on the balance of probabilities: Swansson v RA Pratt Properties Pty Ltd [2002] NSWSC 583; 42 ACSR 313 (Swansson) at [24]; Huang at [58].
The granting of leave is serious in nature, as it amounts to the Court requiring a company to bring proceedings which it is unwilling to take itself. Consequently, leave is not given lightly: Huang at [58].
The issues
Two of the five criteria are not in dispute. There is no issue that without a court order granting leave to commence proceedings, CBL will not itself bring the proceedings proposed by the plaintiff. There is also no contest that the requisite notice to CBL was given by the plaintiff.
Accordingly, the controversy surrounds the following issues:
(a)Whether the plaintiff is acting in good faith;
(b)Whether it is in the best interests of the company that leave be granted; and
(c)Whether there is a serious question to be tried.
These matters form the three issues for resolution.
I have found it convenient to deal with whether there is a serious question to be tried first, as that is the issue that most directly exposes the substance of the proposed claim. The existence of a reasonably arguable cause of action is then also relevant in determining whether the application is brought in good faith, and whether a grant of leave is in CBL’s best interests.
The three issues were addressed by the parties primarily in comprehensive written submissions. Those submissions collectively amounted to 140 pages, setting out the applicable authorities, the legal and factual controversies, and the evidence relevant to each, including transcript references. Due to the length of the submissions and the voluminous evidence, I have attempted to incorporate much of what was submitted in writing throughout these reasons without expressly summarising the arguments of each party.
The evidence
The application originally commenced before Elkaim J in October 2020. However, an issue arose which resulted in his Honour recusing himself by consent. By consent, the parties agreed to continue the hearing before the Court differently constituted. The parties tendered the transcript of the hearing before Elkaim J up to the point of recusal and the evidence of the witnesses for CBL was then further heard over 9–10 February 2021. I have read and had regard to the transcript of the October tranche of the proceedings.
The plaintiff relies on the following affidavits:
(a)Mr Rory Markham, sworn on 13 May 2020.
(b)Mr Rory Markham, sworn on 17 September 2020.
(c)Mr Paul Green, sworn on 24 September 2020.
(d)Mr Phillip Miller, sworn on 1 October 2020.
Mr Markham is the plaintiff’s solicitor. Mr Green and Mr Miller are chartered accountants who each provided expert reports on this application.
The defendant relies on the following affidavits:
(a)Ms Barbara Hambley, sworn on 13 August 2020.
(b)Mr John Harris, affirmed on 13 August 2020.
(c)Mr Mark Waller, sworn on 17 August 2020.
(d)Mr Mark Whittaker, sworn on 17 August 2020.
(e)Mr Chris Leck, sworn on 20 August 2020.
(f)Mr Robert Johnson, sworn on 1 October 2020.
(g)Mr Mark Whittaker, sworn on 12 October 2020.
Ms Hambley is a director employed by Hardwickes Partners Pty Ltd, an accounting firm in the ACT. She is the external accountant of CBL and had responsibility for managing CBL’s share registry and share transfer journal. Mr Johnson is a partner of Hardwickes Accountants and is the independent auditor of CBL.
Mr Harris is a solicitor, and a shareholder and director of a company who is itself a shareholder in CBL. He was part of a three-member committee formed on 28 January 2019 (the Committee), following a resolution of the Board of CBL dated 11 January 2019. The plaintiff had raised with CBL the concerns that have given rise to the derivative action proposed. The purpose of the Committee was to conduct an inquiry and report to the shareholders of CBL. The other two members of the Committee were Mr Ross Barrett OAM and Mr Noel McCann.
Mr Waller is the solicitor with carriage of the matter for CBL. He is a Partner at Clayton Utz and gave evidence about the history of the matter and in particular the legal costs incurred to date. His evidence was then directed to the future legal costs likely to be incurred if CBL were to defend the proceedings contemplated.
Mr Whittaker is a Partner of BDO (Qld) Pty Ltd (BDO), who provided an expert valuation opinion as to the fair market value of certain shares issued to CBL’s Managing Director, or his nominee. He has prepared two reports; the first is dated 25 November 2019 titled ‘Consolidated Builders – Valuation Report’ (the BDO Report), and the second is dated 12 October 2020 and is a response to the expert evidence of Mr Green and Mr Miller (the BDO Response).
Mr Leck is the Principal of Argent Group Pty Ltd, a sub-contractor engaged by BDO to prepare an opinion in respect of the total remuneration package amount payable for the Managing Director at CBL. His report is dated 20 August 2020 and is titled ‘Remuneration Review Report’ (the Remuneration Review).
Rulings on evidence
During the hearing I made a number of evidentiary rulings. At the request of the parties, one evidentiary ruling was deferred until after the hearing, when written submissions had been provided on the point. The outstanding evidentiary ruling concerns the BDO Report. On 18 December 2019, an extraordinary general meeting (the EGM) was convened to consider the conduct of CBL and the Directors that is the subject of the plaintiff’s present complaint. Prior to the EGM, the BDO Report was provided to the membership of CBL. It expressed an opinion about the fair market value of certain shares issued to CBL’s Managing Director, or his nominee. The BDO Report is critical to the present application.
The BDO Report was admitted at the hearing, but the outstanding aspect is the plaintiff’s application for a ruling pursuant to s 136 of the Evidence Act 2011 (ACT) (the Evidence Act) that the use of the report be limited to the fact that the document was put before the EGM, and not that it be admitted as expert evidence of the facts contained within it.
Section 136 permits the court to limit the use to be made of evidence if there is a danger that a particular use of the evidence might be unfairly prejudicial to a party or that it might be misleading or confusing. The plaintiff’s objection was based on unfair prejudice, because the BDO Report does not state that Mr Whittaker agreed to be bound by the Expert Witness Code of Conduct (the Code): see r 1203 of the Court Procedures Rules 2006 (ACT) (the Rules). That it does not do so is understandable, as the purpose of the BDO Report was for the assistance of CBL’s membership. It was not to further this litigation, which had not yet commenced. However, the plaintiff submitted such a report cannot then be used in the litigation to support CBL’s position on valuation of the shares and of Mr Zivko’s remuneration.
CBL submitted there was no basis for any limitation under s 136 of the Evidence Act, relying principally on Wood v R [2012] NSWCCA 21; 84 NSWLR 581 (Wood v R) at [728]-[729]. Further, CBL submitted that if there was non-compliance with r 1203, then to the extent that such rule applied (given that it is directed to the point of service, not admissibility at hearing) the Court should nevertheless exercise its discretion to permit reliance on the BDO Report. One of the authorities on which CBL relied was the reasoning in Aitkenhead v Kaufline and Insurance Australia Ltd [2014] ACTSC 82 per Mossop M (as his Honour then was) at [7], [12].
In Wood v R, McClellan CJ (Latham and Rothman JJ agreeing) stated at [729]:
While there is no rule that precludes the admissibility of expert evidence that fails to comply with [the Code, it] is relevant when considering the exclusionary rules in ss 135-137 of the Evidence Act. The expert’s ‘failure to understand his responsibilities as an expert’…may result in the probative value of the evidence being substantially outweighed by the danger that it might mislead or confuse or be unfairly prejudicial to a party.
In the case of the BDO Report, CBL drew attention to that fact that Mr Whittaker had expressly confirmed in his letter of engagement dated 2 September 2019 that the report would be prepared based on a particular accounting standard, namely professional standard APES 225 ‘Valuation Services’, and that Mr Whittaker’s letter expressly states: “including the independence requirements set out in that standard”. That standard includes a requirement that the accountant governed by the standard “shall not act as an advocate in respect of a Valuation Service which requires Independence or purports to be Independent.”
Independence is then defined in the standard APES 225. It is unnecessary to go into the full detail of the definition. It suffices to record that the definition includes independence of mind to ensure the individual acts objectively and is not affected by influences that compromise professional judgment. It also includes independence in appearance.
In each affidavit, Mr Whittaker has confirmed that he has read and agrees to be bound by the Code. Mr Whittaker further states in his affidavit that the BDO Report was prepared in accordance with APES 225. CBL submitted that as a result, when preparing the BDO Report, there was no danger that Mr Whittaker failed to understand his responsibilities of independence as an expert.
CBL’s submissions should be accepted. There are many cases that have dealt with whether a report that fails to state that it has been prepared in accordance with the requirements of the Code should be admitted at all. A relatively recent discussion of the authorities may be found in First Class Securities Pty Ltd v R Neuhaus [2019] NSWSC 1261. This was a decision of Black J in the NSW Supreme Court – a jurisdiction in which, as CBL pointed out, the rules regarding admissibility are more severe. Rule 31.23 of the Uniform Civil Procedure Rules NSW (2005) renders a report inadmissible unless the court otherwise orders.
That line of authority remains relevant here, where the issue is whether unfair prejudice arises under s 136 of the Evidence Act. As I understood the submission, the perceived prejudice arises because of the failure of the BDO Report to state compliance with the Code.
The underlying problem with expert reports that fail to expressly state an adherence to the Code, as explained in Wood v R, does not exist here, because Mr Whittaker expressly accepted a duty of independence in the BDO Report at the time it was prepared. This is not a case where (for example) Mr Whittaker or BDO was the regular accountant for CBL. BDO was retained to provide a separate valuation service. The contents of the letter of engagement indicates that in substance, the spirit of the Code was adhered to, even if the form of the obligation of independence was not that stipulated in the Rules. I consider that in all the circumstances of this case, the objectives of the Code and the Rules have not been affected by the non-compliance: c.f. First Class Securities at [11], discussing the reasoning of Welker v Rinehart (No 6) [2012] NSWSC 160 per Ball J at [35]. I have therefore admitted the BDO Report without limitation.
Is there a serious question to be tried?
There is a dispute between the parties as to the appropriate test for determining this question.
The Court must determine whether the plaintiff has demonstrated that there is a real question to be tried; that is, whether the plaintiff is able to identify the legal or equitable rights to be determined at trial in respect of which the final relief is sought: Ragless v IPA Holdings Pty Ltd (in liq) [2008] SASC 90; 65 ACSR 700 at [40].
The plaintiff must put before the Court sufficient material to enable it to determine that there is a serious question to be tried. The application must be supported by evidence – “a mere ‘indication of the evidence’ without actual evidence is insufficient”: Vinciguerra v MG Corrosion Consultants Pty Ltd [2010] FCA 763; 79 ACSR 293 (Vinciguerra) at [141]; and Gaertner v Dharah Gibinj Aboriginal Medical Service Aboriginal Corporation [2013] FCA 1330 at [47].
However, the plaintiff is not required to bring forward all evidence that might be presented at trial, or to seek to address all questions that might conceivably be raised: Zhu v Orico Australia Pty Ltd [2019] VSC 313 at [31].
This is in part because the Court will “not normally enter into the merits of the proposed derivative action to any great degree, the plaintiff bearing the same relatively low standard as applies in an application for an interlocutory injunction”: Re Karinya Haulage Pty Limited [2017] NSWSC 888 at [12] per Brereton J, citing Swansson at 314. The Court is addressing merit at a threshold level. It does not delve into the detail of the evidence and draw inferences to make findings.
In the present case, CBL contended that whether there is a serious issue to be tried is influenced by the practical consequences of granting leave to bring the proposed action. It argued that the Court’s assessment must reach a level that would justify the imposition of a substantial burden on CBL, the burden being highly disruptive Court proceedings against CBL’s entire Board.
In support of that submission, CBL relied upon Australian Broadcasting Corporation v O’Neill [2006] HCA 46; 227 CLR 57 at [65]–[72]. That was a decision concerning an interlocutory injunction. At [65], Gummow and Hayne JJ referred to the two main inquiries explained in Beecham Group Ltd v Bristol Laboratories Pty Ltd (1968) 118 CLR 618. First, the Court considers whether the plaintiff has made out a prima facie case; and second, the Court considers where the balance of convenience lies (as the principle has subsequently been described). Gummow and Hayne JJ went on to state at [65]:
By using the phrase “prima facie case”, their Honours did not mean that the plaintiff must show that it is more probable than not that at trial the plaintiff will succeed; it is sufficient that the plaintiff show a sufficient likelihood of success to justify in the circumstances the preservation of the status quo pending the trial.
In the ensuing discussion, their Honours considered the authority of American Cyanamid Co v Ethicon Ltd [1975] AC 396; 2 WLR 316, where Lord Diplock described the test (at 407) as being whether there was a “serious question to be tried”. Gummow and Hayne JJ stated at [70]–[71]:
There is then no objection to the use of the phrase “serious question” if it is understood as conveying the notion that the seriousness of the question, like the strength of the probability referred to in Beecham, depends upon the considerations emphasised in Beecham.
…
… the governing consideration [is] that the requisite strength of the probability of ultimate success depends upon the nature of the rights asserted and the practical consequences likely to flow from the interlocutory order sought.
CBL attempted to draw from that statement, by analogy, that the test for whether there is a ‘serious question to be tried’ under s 237 requires consideration of whether the proposed action is strong enough to justify the detriment to and risks to CBL if leave is granted.
I accept that the use of the word ‘serious’ in s 237 imports a degree of gravity that means the Court must find the proposed proceedings involve a matter of genuine substance, excluding claims that are barely arguable or have a bare possibility of success. I also accept that the test has flexibility about it, depending on the nature of the rights asserted.
However, I do not accept CBL’s submission that, before a finding that there is a serious issue to be tried can be made, the Court must effectively undertake a balancing exercise which includes consideration of the consequences to CBL in determining whether the proposed claim is ‘strong enough’ that it ‘justifies’ the potential detriment to the company. The words of s 237(2)(d) do not require such an approach as a relevant consideration in determining whether there is a serious question to be tried. Rather, such a submission is more aptly considered as part of whether it is in the best interests of CBL to commence proceedings against the current Directors and XO 1 when considering s 237(2)(c).
For the following reasons, I am satisfied that there is a serious question to be tried in the present case.
The proposed claim
The plaintiff’s complaint is identified in the proposed claim, which was included in the evidence of the solicitor on the record for the plaintiff. The causes of action relate to statutory contraventions of the Corporations Act and breaches of fiduciary duty on the part of the Directors.
The complaint arises from a deed entered into on 14 April 2015 between CBL and Mr Zivko as Managing Director. The deed was described as a “Deed of Option to Acquire Shares” (the Option Deed). The Option Deed allowed Mr Zivko or his nominee to purchase up to 150,000 shares in CBL, with the price of the shares fixed at various intervals up to 31 December 2019. That fixed price was $21 per share, relevantly, if the option was exercised before 31 December 2015.
Mr Zivko has exercised the option, with XO 1 as the nominated purchaser. Three of the resulting allotments of shares, which I will describe collectively as the Share Issue, are the subject of the proposed proceedings. They are:
(a)39,000 shares issued in April 2015;
(b)46,000 shares issued in October 2015; and
(c)65,000 shares issued in November 2019.
In total, CBL has issued 150,000 shares to XO 1 at an issue price of $21 per share. As a result, CBL has received $3,150,000 in subscribed capital. The plaintiff alleges that those shares were issued at below market value and without the requisite consent or approval of the shareholders (as set out in the CBL’s articles of association and constitution).
The plaintiff says that the Directors either caused CBL to enter into the Option Deed, or otherwise acquiesced in, or adopted, the conduct in subsequently resolving to allot the shares referred to above.
The resolution of the Directors occurred on the same day the Option Deed was executed. The terms of the resolution were set out in evidence led by CBL, as follows:
The Option Deed and Resolution, as follows, was approved by the Board:
“It was resolved that approval of the members of the Company under Chapter 2E of the Corporations Act 2001 (Cth) is not required for the giving of the benefits to Mr Zivko which would arise from the entry into the Deed of option to acquire Shares because the giving of those benefits would be reasonable in the circumstances of the Company for the following reasons:
1.shares were proposed to be issued at market value (with provision for escalation in price over time)
2.managing director would not be given financial assistance in relation to the acquisition of the shares
3.it was part of an overall remuneration package recognising the significant contribution made by the managing director to the company.”
At the heart of the plaintiff’s complaint is that Mr Zivko is a related party to CBL, that he has received a benefit from CBL, and that such benefit was obtained in preference to other shareholders and without the Directors of CBL following the proper statutory procedures. Breaking that down, I have grouped the contents of the proposed claim loosely into six allegations.
First, the plaintiff alleges that under s 208 of the Corporations Act, before Mr Zivko received the benefit of the option to purchase shares combined with the remuneration package, the approval of CBL’s members was required (in the manner specified in ss 217-227 of the Corporations Act). There was no approval.
Accordingly, the plaintiff submitted that s 208 was contravened.
Second, the plaintiff alleges the Directors were each ‘involved’ in the contravention: s 209.
Third, the plaintiff alleges that the failure to obtain shareholder approval was also in breach of cl 5 of the constitution of CBL which was applicable at the time.
The plaintiff recognises that there are statutory exceptions to the requirement for member approval, and relevantly here, that a statutory exception exists where the benefit is part of reasonable remuneration: s 211(1). However, the plaintiff’s fourth allegation is that, to the extent the shares were intended to form part of Mr Zivko’s remuneration as Managing Director, the terms of the Option Deed amounted to a total remuneration over the years that was unreasonable having regard to CBL’s assets and revenue.
Fifth, the plaintiff alleges that the Directors’ conduct further contravened the following sections of the Corporations Act:
(a)The Directors did not act with care and diligence in approving the options and remuneration package: s 180.
(b)The Directors did not act in good faith: s 181.
(c)The Directors, or at least Mr Zivko, improperly used their position to gain an advantage for Mr Zivko: s 182.
Sixth, and to similar effect, the plaintiff contends that the Directors breached the following fiduciary duties:
(a)to avoid conflicts of interest between personal interests and their duties to CBL;
(b)not to use their positions for the benefit or advantage of a third-party;
(c)not to treat any shareholder preferentially to the remaining shareholders; and
(d)not to act capriciously or unreasonably.
The plaintiff alleges CBL has suffered loss because of the conduct of the Directors. The plaintiff desires CBL to commence proceedings to seek the following relief:
(a)Declarations that s 208 of the Corporations Act has been contravened and that the Directors each contravened ss 180(1), 181(1) and 182(1) of the Corporations Act.
(b)An order rescinding the 150,000 shares issued to XO 1 pursuant to the Option Deed.
(c)An order that an independent person be appointed to investigate and report to the Court, at the expense of CBL, the net realisable value of CBL’s inventories and the fair value of CBL’s buildings as at 30 June 2015.
(d)Compensation, pursuant to s 1317H of the Corporations Act, for the loss of value caused by the Share Issue at $21 per share.
The only reason XO 1 is a proposed defendant is because the claim seeks rescission of the shares issued to that company.
In written submissions, the plaintiff further indicated that if leave were granted, the plaintiff would amend the claim in two respects. First, the plaintiff would include a reference to s 209(2) of the Corporations Act, which founds a claim for relief by way of a civil penalty against the Directors for their ‘involvement’ in the contravention of s 208. Second, in addition to the relief set out above, the plaintiff would add a further remedy, seeking equitable compensation against the Directors for the pleaded breach of their fiduciary duties. Rather than require the plaintiff to file a further draft proposed claim, and given the submission was made by senior counsel, I have accepted those matters as part of the case for which leave is sought. That is largely because an applicant for leave only needs to “identify and describe the proposed proceedings with sufficient precision that the court can properly assess the application having regard to the criteria that it is required to consider under s 237(2)”: Ehsman v Nutectime International Pty Ltd [2006] NSWSC 887; 58 ACSR 705 at [43]–[44].
Does the evidence establish the claim is reasonably arguable?
There was an abundance of evidence as to what led to the Option Deed, what its terms were, what happened as a consequence, and the financial statements relevant to establishing the market value of the shares and the financial position of CBL. To determine whether this limb of s 237(2) is satisfied, I have divided the detailed arguments about various aspects of the claim into what I consider to be the key areas of dispute between the parties. These are:
(a)Whether the Option Deed was reasonable remuneration
(b)Market Value of the Share Issue
(c)Subsequent ratification of Option Deed
(d)The involvement of the Directors
(a) Whether the Option Deed was reasonable remuneration
CBL’s defence of the conduct that is the subject of complaint involves a contention that the Share Issue was part of Mr Zivko’s remuneration, which the Directors believed was reasonable (according to the resolution at the time). Section 211 of the Corporations Act provides an exemption from member approval where the benefit constitutes remuneration to an officer of a public company but qualifies that exemption by requiring that the remuneration be reasonable.
There was evidence on the application that at the time the Option Deed was executed in 2015, Mr Zivko had just signed a contract with CBL further employing him as Managing Director until 31 December 2019 (the Employment Contract) from which the inference may conceivably be drawn that the Option Deed was part of an overall remuneration package. The terms of the Directors’ resolution, set out above at [52], were to that effect.
The potential application of s 211 may be separated into two further issues. The first is a dispute about what constitutes remuneration, which might be described as a question of law. The second is more of a factual issue, namely whether the Share Issue was properly to be regarded as remuneration in circumstances where the terms of the Share Issue were not tied to Mr Zivko’s ongoing employment with CBL.
The parties each drew attention to the definition of remuneration in s 9, which picks up the definition in the accounting standard AASB 1046 (in particular, cl 5.1 and cl 5.1.1 of that standard) and subsequently the accounting standards AASB 124 and AASB 2. It is unnecessary to set out the detail of those definitions here or the different constructions for which the parties contend. Broadly, the plaintiff argues that, properly construed, remuneration means benefits that are paid for the performance of service to the entity. CBL argues that what constitutes remuneration is broader than that. It includes compensation, which may include a share option granted as part of a bonus or incentive arrangement rather than as part of basic remuneration. This would mean that the fact that the Option Deed was not expressly conditional upon Mr Zivko’s performance – or even his continued employment with CBL – would not necessarily exclude the benefit from being classified as part of his remuneration.
The Court had the benefit of comprehensive discussion in CBL’s submissions as to why its interpretation of remuneration is, or should ultimately be found to be, correct. However, in my view, merely setting out the competing arguments, each of which has arguable merit, suffices to establish that whether the Share Issue was ‘remuneration’ is an arguable question at two levels, law and fact.
Even if I accepted that it was unarguably the case that the Share Issue was part of Mr Zivko’s remuneration, a second issue arises, namely a dispute about whether such remuneration was ‘reasonable’. Whether remuneration was reasonable is an objective test. Relevant considerations may include the financial position of CBL, the role carried out by Mr Zivko and the market value of the shares.
The plaintiff contends the benefit under the Option Deed did not constitute reasonable remuneration to Mr Zivko in all the circumstances because it was too high or excessive. As part of that submission, the plaintiff drew attention to the financial position of the company. Expert business valuation evidence was led to suggest that the process for how certain assets were classified and then valued was at best inconsistent and at worst wrong. I emphasise that this was what I took to be the import of the plaintiff’s position on the evidence following the cross-examination of the particular accountant, rather than my concluded view. There were also criticisms of the Remuneration Review performed by Mr Leck, an important one being his assumption that BDO’s assessment of the value of the disputed options was correct.
CBL, on the other hand, contended that assessing the market value of shares in a company by reference to the net asset value of the company was a flawed approach. CBL contended that valuation of the shares under the Option Deed required consideration of factors such as the rate of volatility, the appropriate discount rate and dividend yield.
Again, the above discussion of the competing arguments reveals complex valuation questions relevant to an objective standard of reasonableness. They raise arguable questions about a matter of substance which in turn means that whether the exemption from members’ approval provided by s 211 of the Corporations Act applies is also a serious question to be tried.
(b) Market value of the Share Issue
Whether as part of an argument about reasonable remuneration or as a separate argument relevant to breach of fiduciary duty or loss, the market value of the shares at various points in time will be a live issue. This is likely to require the assistance of expert accountants in its resolution.
The evidence established that there was an Option Deed executed between CBL and Mr Zivko, that it was executed in the circumstances pleaded (namely without the approval of members in April 2015), and that Mr Zivko is a related party and shareholder. Through the Option Deed, Mr Zivko was arguably able to purchase the shares in the company at a price not available to other shareholders who were not Directors of CBL, such as the plaintiff.
The parties cross-examined expert accountants who had prepared detailed reports which raised questions about the methodology for valuing the shares. The plaintiff’s concern is that the $21 per share was arrived at by reference to historical transactions which were themselves not sales at arm’s length. Further, the share price did not take into account financial circumstances of CBL, and in particular, the value of its assets. These matters are disputed by CBL, including the method of valuing the shares by having regard (in part) to the value of assets held by a company. There is no contest that CBL did not publicise the availability of shares for sale to shareholders, although CBL contends that does not matter given the circumstances in which the Share Issue took place.
CBL contended that for the plaintiff to succeed, there needed to be actual evidence of the value of the shares under the Option Deed as at April 2015, and that the shares so valued were, in all the circumstances, outside the range of reasonable remuneration for a person holding the position of the Managing Director. CBL is critical of the evidence led by the plaintiff about market value, arguing that it was limited and unsatisfactory and that there is no actual evidence of the kind described.
In my view, to accept that submission would be to require the plaintiff to effectively run the full case on market value before leave were granted to commence the proceedings. The concern is that the valuation methodology was unsound. The actual evidence was that the valuation methodology relied upon by CBL was based on previous share sales, that those sales were few in number, that the sales were some years old and were to persons who are alleged to have been related parties of CBL (as to which see s 228 of the Corporations Act). In light of that evidence, the concern is fairly arguable.
(c) Subsequent ratification of Option Deed
The plaintiff also led evidence to address s 239 of the Corporations Act. That section deals with the circumstance where the members of a company have ratified the disputed conduct. The section provides that such ratification may be taken into account, but the ratification is not determinative of an application for leave. Material to the present case is s 239(2), which provides that when taking the ratification by members into account, the Court must have regard to:
(a)How well-informed about the conduct the members were when deciding whether to ratify or approve the conduct; and
(b)Whether the members who ratified or approved the conduct were acting for proper purposes.
In the present case, it is not in dispute that the shareholders have subsequently ratified the Option Deed at the EGM. 50 shareholders voted for the resolution to approve the decisions of the relevant Directors (Mr Frank Crnkovic, Mr Mirko Skrnjug, Mr Rein Heins and Mr Noel McCann) to enter into the 2015 Employment Contract and the Option Deed. Nine shareholders voted against the resolution, with 1 shareholder abstaining. Of the 50 that voted for the resolution, 20 votes were described as related to the Directors or their associated entities, or alternatively as being related to the members of the Committee or associated entities.
The plaintiff led some evidence to indicate that the members were not “well-informed” about the Option Deed. This included cross examination of Mr Harris, the solicitor who was part of the Committee. The cross-examination was directed to the adequacy of the investigation conducted and the view formed by the Committee on 1 November 2019, based on a draft of the BDO Report it had earlier obtained, that the ‘remuneration package’ for Mr Zivko (including share options) was proper given the broad discretion of a company board to make decisions in the best interests of the company.
It also included evidence concerning the BDO Report provided to the members to help them assess whether to approve the conduct of the above four Directors. The BDO Report was said to be so flawed that it was not reliable. In part that was because of the assumptions BDO was requested to make by CBL. Mr Whittaker would have liked information about fair market value of the property assets. He was told that was not available and in the absence of that information, was instructed to assume the book value in the financial statements. That is one example of an assumption leading to the plaintiff’s criticism of the BDO Report. I have recorded this in part to demonstrate that the criticisms were more directed to the limits and assumptions.
As a consequence, the plaintiff submitted that the purported ratification of the granting of shares under the Option Deed and the ‘remuneration package’ was ineffective to overcome CBL and the Directors’ previous breach.
It is not necessary to make a finding either way as to how well-informed the shareholders were when they subsequently ratified the Option Deed. This would require the Court to assess the quality of the BDO Report and the quality of the legal advice received by the shareholders which relied on the BDO Report. It would also possibly require the Court to assess the conduct of the Committee. What the evidence relied upon by the plaintiff demonstrates is that there is some foundation for the plaintiff’s concerns about what was disclosed to the members before ratification at the EGM. That in turn means that the disputed fact is a reasonably arguable one.
(d) The involvement of the Directors
The plaintiff’s complaint here is that the Directors were involved in the contravention of s 208. CBL argues that the pleading does not refer to s 209 and does not plead the material facts necessary to establish such involvement, such as an articulation of how the Directors were intentional participants in the contravention, including their possession of knowledge of the essential elements of the contravention. In that regard, CBL drew the Court’s attention to cases such as Re HIH Insurance Ltd [2016] NSWSC 482; 335 ALR 320 at [19]–[25] and Rafferty v Madgwicks [2012] FCAFC 37; 203 FCR 1 at [253]. It is unnecessary to set out the principles applicable to ‘involvement’ as this is a matter which the plaintiff accepts requires amendment if leave is granted.
However, the pleading as it stands does plead actual knowledge by the Directors of the fact that the Option Deed and the Share Issue made pursuant to it were ‘effected otherwise than in accordance with s 208 of the Corporation Act and cl 5 of [CBL’s constitution]’. There was also sufficient actual evidence to establish that:
(a)the proposed defendants (apart from XO 1) were active Directors of CBL (whether or not they were non-executive);
(b)the Directors were at least ‘involved’ in causing CBL to enter into the Option Deed insofar as they passed a resolution to that effect; and
(c)by the express terms of the resolution and the minute recording it, the Directors had turned their minds to whether membership approval was required, deciding that it was not, and had also considered whether the Option Deed was ‘remuneration’.
There are other matters stated in the April 2015 resolution, which are relevant both to the Directors’ knowledge and beliefs at the time and to any consequent finding in relation to their knowledge of the material facts constituting the elements of the contravention. Given the plaintiff has not yet reached the point of propounding a pleading that addresses this aspect of the claim, I am concerned not to explain or examine further how the argument either is, or may be, put. I will simply record that in my view, contrary to CBL’s submissions, there is sufficient evidence before the Court to establish that the case for the Directors’ ‘involvement’ in accordance with the established legal principles is one that has substance.
In any event, the pleading raises direct breaches of fiduciary duty and statutory duties under ss 180-182 of the Corporations Act against the Directors. CBL has again provided detailed submissions as to what it asserts are fatal evidential deficiencies in the case alleging breach of directors’ duties. However, CBL’s submissions about the gaps in the evidence place the bar too high on what is a threshold application before proceedings are commenced. The factual matters discussed above are supported by some evidence of the breaches or contraventions alleged against the Directors, and again that establishes that such allegations are arguable.
In making that finding, it should be made clear that merely establishing an arguable case of a breach of ss 208 and 209 does not also establish that there is an arguable case in respect of the alleged breaches of statutory directors’ duties. CBL made that point in submissions, relying on ASIC v Warrenmang Ltd [2007] FCA 973, 63 ACSE 623 (Warrenmang) at [22], where Gordon J pointed out that not every breach by a company of the Corporations Act gives rise to a breach of directors’ duties provisions. Her Honour went on to state at [23]:
That last proposition or principle (that not every breach by a company of the Corporations Act necessarily gives rise to a breach of the directors’ duties provisions) is self evident. It is reinforced by the fact that, under s 180(1) of the Corporations Act, the circumstances of the particular company are relevant to the content of the duty of a director to exercise reasonable care and diligence. The circumstances may include, but are not limited to, the type of company, the size and nature of the company’s business, the director’s position and responsibilities within the company, the particular functions the director is performing, the manner in which responsibility for the business of the company is distributed and, of course, the circumstances of the case: [Australian Securities and Investments Commission v Maxwell [2006] NSWSC 1052; (2006) 59 ACSR 373] at [100] and the authorities referred to.
Similar observations as to regard being had to a corporation’s circumstances and what that entails were made in ASIC v Rich [2009] NSWSC 1229; 236 FLR 1 at [720]. I have also had regard to ASIC v Adler [2002] NSWSC 171; 168 FLR 253 (Adler), where Santow J collected (at [372]) principles applicable to the duty of care and diligence. Later in the reasons for judgment, his Honour also set out the principles applicable to the duty to act in good faith and acting for a proper purpose (s 181), and the principles concerning the duty on directors to avoid using their position improperly to gain advantage (s 182) at [458] and [735]. They provide a useful guide to assess whether there is a serious question to be tried in respect of breach of directors’ duties and fiduciary duties.
At [372(14)] of Adler, Santow J stated (emphasis added):
(14) Where there is a transaction involving the potential for conflict between interest and duty, as here arose, the duty of care and diligence falls to be exercised in a context requiring special vigilance, calling for scrupulous concern on the part of those officers who become aware of that transaction to ensure that any necessary corporate approvals are obtained and safeguards put in place. While the primary responsibility will fall on the director or officer proposing to enter into the transaction, this does not excuse other directors or officers who become aware of the transaction.
The plaintiff’s point is that there is a genuine question of whether the Directors did exercise that level of diligence in approving the Option Deed. Directors are required to act with a bona fide concern for the benefit of the company as a whole or for fairness as between members: Mills v Mills (1938) 60 CLR 150 per Latham CJ (at 164–165).
There is some evidence before the Court as to what steps were taken by the Directors before resolving to approve CBL entering into the Option Deed, what information they had and what was taken into account (see, for example, the minute of the April 2015 resolution). If the evidence is incomplete, that is a feature of the stage at which the proceedings are at (namely, a preliminary stage before commencement).
However, it is the absence of evidence on which the plaintiff primarily relies as supporting his claim and this application. The plaintiff submitted that the duty of care and diligence required of the Directors included giving consideration to matters such as those set out in s 219 of the Corporations Act. That provision lists what an explanatory statement to shareholders must contain when a matter is put to the membership for approval. Among other things, a written statement must set out the details of the related parties to whom the proposed resolution would permit financial benefits to be given and the nature of the financial benefit. There is a requirement to state, for each director, any recommendation made by that director and the reasons for the recommendation. If no recommendation is made, the reasons for that decision are required. The statement must include other information that is reasonably required by members in order to decide whether or not it is in the company’s interests to pass the proposed resolution. The plaintiff submitted there is no evidence the Directors gave consideration to matters of the type listed in s 219.
In combination, I consider that these matters further support a finding that there is a serious question to be tried in respect of the causes of action based on statutory directors’ duties or similar fiduciary duties. CBL raised a number of pleading points in the written submissions, but none of them are so overwhelming as to make the substance of the plaintiff’s complaint unarguable. There may be matters in respect of the role the Directors played that ultimately provide a complete defence to the alleged breaches, but none are matters to be resolved on this application for leave.
Conclusion on s 237(2)(d)
Drawing these various contests together, one can well understand why the plaintiff has made this application for leave. He is a non-director shareholder watching another shareholder take advantage of an opportunity to increase his shares in a profitable company, in a manner not available to him and as a result of a decision by directors of CBL of which he was not initially a part because the directors chose not to involve the membership in approving the Option Deed. I am satisfied that the plaintiff has sufficiently identified a case that involves matters of substance with a reasonable probability of success. It may be put in the following way:
(a)CBL and the Directors conducted themselves so as to bring about and carry out the Option Deed without member approval.
(b)The Option Deed was a benefit to a related party under the Corporations Act. It was also a benefit to a shareholder in preference to other shareholders.
(c)Whether that conduct was in compliance with the Corporations Act or equitable fiduciary duties will depend upon one or more of the following:
(i)How the Option Deed is characterised (as remuneration or as a separate benefit);
(ii)Whether the benefit was at market value notwithstanding it was to a related party;
(iii)If the Option Deed was remuneration, whether it was reasonable, with reasonableness importing an objective test, requiring consideration of matters such as the financial position of CBL, the role carried out by Mr Zivko and the market value of the shares;
(iv)What steps the Directors took leading up to the execution of the Option Deed; and
(v)What significance attaches to the subsequent ratification of the conduct by the members of CBL, which itself depends upon factual questions of what was disclosed to the members and how adequate that information was to equip them with the information necessary to ratify the conduct.
Each of the claims alleged by the plaintiff is fairly arguable and has substance in terms of evidentiary foundation. I am satisfied that there is a serious question to be tried.
Is the applicant acting in good faith?
The onus lies on the plaintiff to satisfy the Court that he (in this case) is acting in good faith: Chahwan v Euphoric Pty Ltd t/as Clay & Michael [2008] NSWCA 52; 227 FLR 43 (Chahwan) at [83]. There is of course no definitive test for whether a person is acting in good faith.
In Swansson, Palmer J made some helpful observations at [35]-[38] (emphasis added):
35 At this early stage in the development of the law on the statutory derivative action created by Pt 2F.1A it would be unwise to endeavour to state compendiously the considerations to which the Courts will have regard in determining whether applicants in all categories defined by s.236(1) are acting in good faith. The law will develop incrementally as different factual circumstances come before the Courts.
36 Nevertheless, in my opinion, there are at least two interrelated factors to which the Courts will always have regard in determining whether the good faith requirement of s.237(2)(b) is satisfied. The first is whether the applicant honestly believes that a good cause of action exists and has a reasonable prospect of success. Clearly, whether the applicant honestly holds such a belief would not simply be a matter of bald assertion: the applicant may be disbelieved if no reasonable person in the circumstances could hold that belief. The second factor is whether the applicant is seeking to bring the derivative suit for such a collateral purpose as would amount to an abuse of process.
37 These two factors will, in most but not all, cases entirely overlap: if the Court is not satisfied that the applicant actually holds the requisite belief, that fact alone would be sufficient to lead to the conclusion that the application must be made for a collateral purpose, so as to be an abuse of process. The applicant may, however, believe that the company has a good cause of action with a reasonable prospect of success but nevertheless may be intent on bringing the derivative action, not to prosecute it to a conclusion, but to use it as a means for obtaining some advantage for which the action is not designed or for some collateral advantage beyond what the law offers. If that is shown, the application and the derivative suit itself would be an abuse of the Court’s process: Williams v Spautz (1992) 174 CLR 509, at 526. The applicant would fail the requirement of s.237(2)(b).
38 Where the application is made by a current shareholder of a company who has more than a token shareholding and the derivative action seeks recovery of property so that the value of the applicant’s shares would be increased, good faith will be relatively easy for the applicant to demonstrate to the Court’s satisfaction. So also where the applicant is a current director or officer: it will generally be easy to show that such an applicant has a legitimate interest in the welfare and good management of the company itself, warranting action to recover property or to ensure that the majority of the shareholders or of the board do not act unlawfully to the detriment of the company as a whole.
Palmer J went on to give examples of what might constitute good faith, or when a litigant may be acting otherwise than in good faith. Relevant to the present circumstances, his Honour stated at [41]–[43] (emphasis added):
41 To take another example: a derivative action sought to be instituted by a current shareholder for the purpose of restoring value to his or her shares in the company would not be an abuse of process even if the applicant is spurred on by intense personal animosity, even malice, against the defendant: it is not the law that only a plaintiff who feels goodwill towards a defendant is entitled to sue: see e.g. Dowling v Colonial Mutual Life Assurance Society (1915) 20 CLR 509, at 521-522; IOC Australia Pty Ltd v Mobil Oil Australia Ltd (1975) 11 ALR 417, at 426-427. On the other hand, an action sought to be instituted by a former shareholder with a history of grievances against the current majority of shareholders or the current board may be easier to characterise as brought for the purpose of satisfying nothing more than the applicant’s private vendetta. An applicant with such a purpose would not be acting in good faith.
42 If a wrong appears to have been done to a company and those in control refuse to take proceedings to redress it, the Court should permit a derivative action to be instituted only by those within the categories allowed by s.236(1) who would suffer a real and substantive injury if the action were not permitted. The injury must be necessarily dependent upon or connected with the applicant’s status as a current or former shareholder or director and the remedy afforded by the derivative action must be reasonably capable of redressing the injury.
43 Further, if an applicant for leave under s.237 seeks by the derivative action to receive a benefit which, in good conscience, he or she should not receive, then the application will not be made in good faith even though the company itself stands to benefit if the derivative action is successful. Such a benefit would include, for example, a double recovery by the applicant for a wrong suffered or recompense for a wrongful act inflicted upon the company in which the applicant was a direct and knowing participant with the proposed defendant in the derivative action. In such a case the law would not permit the applicant to derive a benefit from his or her own wrongdoing.
The plaintiff contended that:
(a)He is an active shareholder;
(b)He is concerned about the apparent favouring of Mr Zivko by the Share Issue; and
(c)He is concerned about the incorrect or inadequate disclosure to shareholders in the financial statements (which led to the Share Issue).
CBL submitted that the plaintiff is not acting in good faith. CBL was critical of the lack of an affidavit from the plaintiff, contending that the plaintiff has not led any evidence that he has an honest belief that CBL has a cause of action with reasonable prospects of success, and further, that there is no evidence as to the plaintiff’s purpose for bringing the proposed proceedings on behalf of CBL. Nor is there evidence from any other shareholder indicating support for his position. These matters, CBL submits, weighed against a finding that the plaintiff was acting in good faith.
I do not accept CBL’s submission. The plaintiff is not obliged to depose to the fact that he honestly believes that a good cause of action exists and has a reasonable prospect of success: Re Dynamic Industries Pty Ltd [2014] VSC 101 (Re Dynamic) at [95].
Good faith may be established by other evidence, such as undertaking to indemnify the company and meet the costs of the proceedings: Re Dynamic at [95]. The Court may also draw inferences as to the plaintiff’s good faith by assessing the nature of the allegations and the circumstances out of which they arose: Vinciguerra at [56]; Fiduciary v Morningstar Research [2005] NSWSC 442 (Fiduciary v Morningstar) at [22].
In Li & Anor v Wu [2019] ACTCA 14, in the context of considering an argument about a lack of good faith where a company was already in liquidation, the Court of Appeal stated at [75]:
An applicant’s assertion of his or her purpose in bringing the proceedings is admissible but not conclusive: Williams v Spautz at 532. Such an assertion must carry limited weight. An obvious way of testing the applicant’s assertion of a proper purpose against the respondent’s assertion of an improper one is to compare the assertions with the undisputed or accepted evidence. Consideration of how a reasonable person would act in the circumstances will usually illuminate the subjective purpose of the applicant in seeking to bring a derivative proceeding.
CBL suggests that the plaintiff has a collateral purpose in the application. In Chahwan, Tobias JA stated at [83] that:
If … an applicant is in reality seeking to further his or her own personal interests other than as a current or former shareholder of the company, rather than the interests of the company as a whole, then in my view [the] onus [to satisfy the court he or she is acting in good faith] will not have been discharged.
CBL submitted that the plaintiff here has an agenda: effectively that the proceedings would cause the members of the Board of CBL to bring cross claims-against each other, that the Board of CBL will then be rendered unable to continue in its current form, and that this will result in the Board being replaced.
CBL draws attention to a number of statements made by the plaintiff at the EGM. These, CBL submits, support the inference of the plaintiff’s alleged agenda. They include:
(a)A concern about the way CBL had been managed for some time;
(b)A perceived inadequacy of CBL’s average profit, when compared with other property developer companies in Canberra;
(c)A concern that the Board as presently constituted may continue to issue options to the Managing Director with the ultimate result that Mr Zivko will control CBL; and
(d)A view that if the derivative proceedings contemplated were brought, there would be an incompatibility with the Board of CBL continuing in its current form.
CBL’s submission continued that the available inference was that:
… [the plaintiff] holds the view that the performance of CBL under the Managing Director has been inadequate and he is concerned that the Board will continue to issue options to the Managing Director such that he will eventually be able to control CBL.
First, I do not accept that the statements made by the plaintiff at the EGM give rise to an inference that there is a collateral purpose behind the present application. Statements about the future of the Board of CBL in its current form were in direct response to a question from a shareholder about whether the Board would continue if the litigation foreshadowed at the EGM were successful, or whether the expectation was that the whole Board would resign.
Second, even if there is a collateral purpose, I am not satisfied it is one that would amount to an abuse of process, although I note the observation of Tobias JA in Chawan at [81] that a lack of good faith under s 237of the Corporations Act extends beyond conduct that would constitute an abuse of process.
I have already found that there is a serious question to be tried, which is relevant to an assessment of the nature of the allegations and the circumstances in which they arose. That favours a finding that the plaintiff is acting in good faith, insofar as the proposed claim may be contrasted with a cause of action that no reasonable person in the circumstances could honestly believe had reasonable prospects of success.
Further, in the application filed 24 July 2020, the plaintiff has proffered an undertaking to indemnify CBL for the costs of the proposed proceedings. Following the hearing, the plaintiff proffered the further undertaking to maintain his substantial shareholdings in CBL and not to deal with or encumber those shareholdings without either CBL’s consent or the leave of the Court.
The plaintiff perceives that the shares were issued to Mr Zivko under market value and in preference to other shareholders. The plaintiff is seeking to ensure that CBL’s interests are managed in compliance with the requirements of the Corporations Act and that its Directors act in accordance with their statutory and fiduciary duties, including by not preferring the interests of a particular shareholder Director over another. This is not a purpose that might be categorised as furthering the plaintiff’s own personal interests. Rather, it is a purpose sufficiently connected with the plaintiff’s status as shareholder to satisfy the requirement of good faith.
I am prepared to accept that the evidence establishes that the plaintiff takes issue with how CBL is being managed and may prefer a different Board of Directors at the helm. In my view, the plaintiff has a belief that the company is underperforming because of his perceptions of the conduct of Mr Zivko and the Board, and his purpose is to further the interests of the company.
The difficulty with CBL’s submission is that even if the plaintiff does have the intent suggested above, that is not necessarily an indication of a lack of good faith. In Maher v Honeysett & Maher Electrical Contractors Pty Ltd [2005] NSWSC 859, Brereton J observed at [45]:
…the existence in an applicant of a personal interest in the outcome of a proposed derivative action, or even of a personal animus against the company, or other members of it, cannot be significant, let alone decisive; they are usual concomitants of the types of disputes which lead to derivative actions, and few if any such actions would be brought but for personal interest on the part of the relevant applicant and in the absence of animus against the company or other shareholders...
I do not think that is enough to find that the plaintiff in the present case is solely acting to further his own interests. Personal animosity towards other shareholders (in this case, members of the Board) does not necessarily involve a lack of good faith: Vicad Pty Ltd, Re; Pottie v Dunkley [2011] NSWSC 166; 82 ACSR 561 at [58].
The plaintiff in this case may well desire to oust the present Board for a number of reasons, including CBL’s underperformance. But the statements referred to by CBL are equally consistent with the plaintiff addressing the consequences of a derivative action being brought. In my view, giving consideration to the consequences of contemplated litigation at an EGM supports a finding that the plaintiff’s conduct was more in the nature of a prudent shareholder, rather than one acting for an improper purpose.
Moreover, if the plaintiff’s purpose is formulated upon an honest belief that CBL is underperforming because of the actions of its Directors – in particular, Mr Zivko – then an attempt to displace the Board is more an indication of an endeavour to further the interests of the company than a demonstration of a collateral purpose.
In combination, these considerations weigh in the balance in favour of a finding that the plaintiff is acting in good faith. Section 237(2)(b) of the Corporations Act is satisfied.
Would the granting of leave be in the best interests of the company?
The starting point is to emphasise that where a company does not itself wish to bring proceedings, it should be not be lightly forced to do so: Huang at [57]. The relevant principles for determining whether it would be in the best interests of CBL that the plaintiff be granted leave to pursue the proposed proceedings have been recently set out by Gleeson J (then sitting in the Federal Court of Australia) in McGuiness v Workplace Eye Protection Pty Ltd [2020] FCA 626 (McGuiness) at [79] as follows:
(1)The applicant must establish the balance of probabilities that the action is in the best interests of the company, a fact which can only be determined by taking into account all relevant circumstances: Huang … at [57].
(2)The best interests of the company means best interests in the sense of its separate and independent welfare. Best interests, at least assuming the company concerned is solvent, will predominantly reflect the interests of shareholders in that capacity: Huang at [59].
(3)A company might have sound business reasons for not pursuing a cause of action open to it and that its management might legitimately have decided that the best interests of the company would be served by not taking action. For example, where it is clear that there has been a breach of duty by a director but the loss to the company may only be nominal, the costs of taking proceedings may outweigh any benefit to the company: [Fiduciary v Morningstar] at [44], citing para 6.38 of the Explanatory Memorandum to the Corporate Law Economic Reform Program Bill 1998 (Cth).
(4)It is necessary to consider both whether it is in the best interests of the company that:
a) the action be brought; and
b) the action be brought by the applicant: Re Gladstone [Pacific Nickel Ltd [2011] NSWSC 1235; (2011) 86 ACSR 432] at [57].
(5)Relevant considerations are the prospects of success of the action, the likely costs and likely recovery if the action is successful and likely consequences if it is not. One relevant matter in considering these issues is the nature of any indemnity the applicant has offered to the company if the action is brought and the likelihood that the company will recover under that indemnity. It is also necessary to consider the resources the company will be required to devote to the action and the resources it has available, together with the effect that the action may have on other aspects of its business. It is also necessary to consider whether some other remedy is available to the applicant so as to make the proposed action unnecessary from its point of view: Gladstone at [57].
The express words of s 237(2)(c) should also be emphasised; namely, that the Court must be satisfied that it is in the best interests of CBL that the plaintiff be granted leave, not that it may be in the company’s best interests: see Keenan v Bundaberg Port Authority [2016] FCA 134 at [37] and the cases there-cited.
The parties’ arguments
CBL submitted that if leave is granted, the risks and detriments to CBL are clear, serious and substantial. They include the following:
(a)CBL will be thrust into pursuing litigation which will be highly uncertain.
(b)The litigation will be against effectively the whole management and Board of CBL and, as a result, will be highly disruptive of, and damaging to, the conduct of CBL’s business and its core purpose which is to produce returns for its shareholders.
(c)The cost of the proceedings for CBL is likely to exceed $1 million. Even if the costs are assumed as being between $600,000 and $1 million, that is a matter that weighs significantly against the benefits discussed below.
(d)As to the likelihood that CBL will be able to recover those costs, the undertaking offered by the plaintiff is inadequate to address the sizeable potential adverse costs order.
(e)The shareholders of CBL, who are the people best able to assess its best interests, have been specifically consulted and the clear and unequivocal view of CBL’s shareholders by resolution at the EGM is that the litigation the plaintiff wishes to bring should not be brought.
(f)The plaintiff has not given any evidence to the Court as to why he considers it in the best interests of CBL to bring the proposed derivative action and it is not obvious that the plaintiff has separately considered that question (relying on McGuiness at [80]).
CBL separately submitted that, insofar as the proposed proceedings concern a contravention of s 208 of the Corporations Act, CBL will effectively be pursuing proceedings to establish its own contravention, in order to then proceed to demonstrate that the Directors were involved in such a contravention.
Weighing the detriments against the benefit of the proceedings, CBL submitted that whatever benefits are proposed to be gained by the litigation, they are either non-existent, illusory or highly uncertain. CBL submitted the following considerations are relevant to the remedies CBL would seek if leave were granted:
(a)The primary relief sought is rescission, which would be brought about by an order rescinding the resolution by CBL to enter into the Option Deed: see Corbett v Corbett Court [2015] FCA 1176; 109 ACSR 296 at [207].
(b)It is unlikely that such relief would be granted because the Option Deed has been fully performed: see Pilmer v Duke Group Limited (in liq) [2001] HCA 31; 207 CLR 165 (Pilmer v Duke) at [44].
(c)Even if the primary relief were granted, the effect would be simply to reduce the share capital of CBL by (at least) $3.15 million and raise a debt to XO 1. The interests of XO 1 would need to be considered.
(d)The alternative relief sought is for compensation. The basis for that remedy is loss of value in CBL by reason of CBL allegedly issuing shares to XO 1 at below market value. CBL submitted that the entire basis for seeking such relief was misconceived. If a share sale at undervalue is established, that may affect the existing shareholders because the value may be diluted by the share issue: Pilmer v Duke at [48]. However, that is not to be confused with the effect on a company as a separate and independent entity: Pilmer v Duke at [18], [20], [47]-[48]. In the absence of any lost opportunity to issue the shares for an amount greater than their issue price (and CBL submitted there is no allegation to that effect in this case) a company gives up nothing or loses nothing by the issue of shares: Pilmer v Duke at [52]-[56].
(e)In relation to the declaratory relief proposed, with an interest in ensuring Directors comply with their statutory obligations and be made accountable if they do not, no rational commercial entity would bring costly proceedings against itself and its Board of Directors seeking only declaratory relief.
(f)Further, the primary accountability of the Directors and the management of a company is to the general body of shareholders, not to individual shareholders, who may have a different notion of accountability. The derivative action process is not an ersatz means of enforcing ‘accountability’ to individual shareholders.
The plaintiff’s position was that CBL has suffered a loss and that, contrary to CBL’s submission, there was a lost opportunity to issue shares at a price greater than their actual issue price, or alternatively, to issue fewer shares for the same total amount. CBL did not attempt to realise the value of the shares.
Further, Mr Zivko has received a benefit (i.e. profited) in breach of statutory or fiduciary duties by the Directors. Alternatively, he has been unreasonably remunerated. Recoverable compensation under ss 1317H(1) and (2) of the Corporations Act extends to recovery from the Directors themselves and includes the profits made by any person resulting from a contravention.
In relation to the consequences of rescission (raising a substantial debt to XO 1), the plaintiff argues that the proposed relief is broader than an order for rescission. It includes an order for the appointment of an ‘independent person’ to investigate and report to the Court about the value of the real estate assets of CBL. This is a matter of significance to CBL’s continuing responsibility for reporting asset values.
Consideration
It might be said that, in this case, CBL does not wish to bring proceedings because such proceedings are, in effect, directed against its own ‘leaders’ who are unlikely to wish to have their actions scrutinised. The interests of the shareholders, expressed by their ratification of CBL’s and the Directors’ conduct at the EGM, similarly indicate a reluctance to bring proceedings.
I am mindful of the criticisms made by the plaintiff about what inference may be drawn from the shareholders’ ratification, or whether the ratification by shareholders should equate to the shareholders determining what is in the interests of BCL. The plaintiff’s submission was that the information provided to the EGM was inadequate to equip the shareholders with the knowledge necessary to make an informed vote.
The import of the plaintiff’s evidence, including the cross-examination of Mr Harris, was that the reluctance of the membership to support his complaints was a product of a number of matters. There was an inadequate investigation by the Committee, and the BDO Report adopted certain assumptions and a methodology that the plaintiff contends was flawed. This not only left the shareholders ill-informed, it misled them about the true value of both CBL and the shares.
However, the absence of the support of other shareholders is a matter which I think is relevant to whether the derivative action is in the best interests of the company. The alternative inference to be drawn from the ratification at the EGM is that in fact, the shareholders understood the perceived shortcomings of the BDO Report and the alleged failures of the Committee but did not agree with the plaintiff’s perspective. Alternatively, they may have taken the view that, for whatever reason, they did not want CBL to conduct expensive litigation over a benefit paid to its Managing Director – that being remuneration or otherwise. Having read the complete transcript of what occurred at the EGM, there were a number of shareholders who spoke and asked questions and explained their perspective on the resolution and what they wanted CBL to do. The concerns of the plaintiff were ventilated at that meeting. It is not a case of the membership voting without the issues identified by the plaintiff in the present application being at least identified for consideration.
Weighing all the above matters in the balance, what CBL will gain by the proposed proceedings, if they are successful, is uncertain.
It is of course important that corporate entities comply with the requirements of the Corporations Act. However, a finding that CBL contravened s 208 of the Corporations Act will only be capable of being made after significant costs as to what constitutes reasonable remuneration (the expense is separately considered below). In any event, it is far from certain that it is in CBL’s interests to litigate with a view to establishing its own contravention.
The focus then turns to relief that may follow if such a contravention is established. Section 209(1) of the Corporations Act provides that “the contravention does not affect the validity of any contract or transaction connected with the giving of the benefit”.
If the Option Deed remains valid despite the contravention, there seem to be two available outcomes. The first is rescission of the resolution that approved the Option Deed. However, it remains a contract between CBL and Mr Zivko. In circumstances where the transactions by which the shares were purchased under the Option Deed have been completed and years have now passed, it is difficult to see what basis would exist for ordering rescission.
Assuming in favour of the plaintiff that both a contravention of s 208 was established (or any other equitable breach established such as to found relief by way of rescission) and that the Court considered it appropriate to bring about the rescission of the Option Deed, the consequence would indeed be an immediate reduction in share capital by (at least) $3.15 million, and the raising of a debt to XO 1 in the same amount. The plaintiff gave no satisfactory explanation for why such relief would be in CBL’s interest.
The second potential outcome is that CBL might seek compensation from the Directors for the ‘profit’ made by Mr Zivko in buying the shares at undervalue (if that is established). That would again be a costly exercise, as it would be necessary to prove not only that the decision was not in CBL’s interests, but that the process engaged in by the Directors fell short of the standard of care and diligence expected or was not taken in good faith or for a proper purpose. Recalling the variety of considerations that will be involved in establishing that aspect of the proposed cause of action (discussed in cases such as Warrenmang and Adler, see [89]–[91] above), that factual conclusion cannot be comfortably predicted.
I also accept the likely cost of the proceedings is a significant factor weighing against a grant of leave. Essentially, the proceedings would be brought to bring the Directors to account if they are found to have acted in breach of their statutory or common law duties, and to attempt to recover money from them by way of compensation for a contested share value over and above that paid by XO 1. Spending significant sums of money with a view to revisiting what may turn out to be reasonable historical remuneration for CBL’s Managing Director puts the proposed proceedings into a category where it may be in CBL’s interests, but I was unable to be satisfied that on balance, the proposed proceedings are in CBL’s best interests. Accordingly, I formed the view, following the principles set out at [8] and [122] above, that I was required to refuse the application.
I did have concerns about an indemnification for CBL’s costs that required CBL to pay money into Court first, as well as the lack of evidence that the plaintiff had the financial means to satisfy an adverse costs order brought by numerous defendants in the event that the proposed action on behalf of CBL did not succeed. However, given the finding that it was not in the best interests of CBL to grant the application, it was unnecessary to address the form of the proposed undertaking.
Conclusion
For the above reasons, the orders of the Court on 13 April 2021 were as follows:
1.The application is dismissed.
2.Grant immediate liberty to apply.
The second order was made because I anticipated there would be a requirement for the parties to approach the Court following the delivery of judgment on an urgent basis. Late in the day on 13 April 2021, I made a further interim order, pursuant to s 241(1)(a) of the Corporations Act, giving leave to the plaintiff to file the proposed claim. This order was made notwithstanding that I had earlier that day ordered that the application for leave to commence proceedings be dismissed. A condition of the grant of leave was that the plaintiff also first filed an application for leave to appeal, because I took the view (accepting CBL’s submissions) that there needed to be extant proceedings in this Court before an order in the ‘interim’ under s 241(1)(a) could be made.
The order was necessary to preserve the status quo until the parties received reasons and had the opportunity to appeal the judgment. The interim filing of the proceedings ensured that any appeal by the plaintiff, if successful, was not then rendered futile by the passing of a limitation period in the meantime.
The plaintiff made the application late in the day and with the Court sitting out of hours in order to hear the application and to make the orders sought the day before the limitation period expired. This was unnecessary and could have been avoided if the plaintiff had taken more timely action. When I raised this with the plaintiff’s legal representative, it was submitted that the plaintiff had commenced proceedings well before the limitation period expired and that he was then faced with a recusal and the intervening end of Court term, followed by a regime for the filing of substantive closing submissions following the hearing. All of this brought the proceedings very close to the limitation period expiring.
The plaintiff did raise the issue of the approaching expiry of the limitation period during the hearing on 10 February 2021. However, no application for expedition was made and no other order was sought. Where there is an approaching expiry of a limitation period, the appropriate course for litigants to follow is to seek to deal with the issue well in advance. It is not to wait until the day before it expires to approach the Court for relief. As submitted by senior counsel for CBL, the plaintiff knew of the date when the limitation period would expire and could have filed an application for an interim order pursuant to s 241(1)(a) at any stage during the proceeding. An example where such a course was taken is: In the matter of Legal Practice Management Group Pty Ltd; nSynergy Pty Ltd and nSynergy International Pty Ltd [2017] NSWSC 1500. Attention is drawn to this more proactive approach in order to encourage litigants to try to avoid last minute dashes to Court, placing the parties, their legal representatives, the Court and the Court staff under pressure unnecessarily.
In relation to costs, I considered it was preferable for the parties to have the benefit of these reasons dealing with each of the issues before addressing the appropriate order as to costs. If no party notifies my associate within seven days of these reasons being published that they seek to be heard on the question of costs, I will order that the plaintiff pay CBL’s costs of the proceedings, on the basis that the ultimate outcome was in CBL’s favour and costs would usually follow the outcome of the proceedings. The further orders are therefore as follows:
1.If either party seeks to be heard on the question of costs, the parties are directed to notify the Court of such intention within 7 days of publication of these reasons.
2.If no party contacts the Court pursuant to Order 1, the plaintiff is to pay the defendant’s costs.
| I certify that the preceding one hundred and forty-six [146] numbered paragraphs are a true copy of the Reasons for Judgment of her Honour Associate Justice McWilliam. Associate: Sebastian King Date: 28 May 2021 |
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