FEDERAL COURT OF AUSTRALIA
Smith v Starke, in the matter of Action Paintball Games Pty Ltd (in liq) (No 2) [2015] FCA 1119
Citation: Smith v Starke, in the matter of Action Paintball Games Pty Ltd (in liq) (No 2) [2015] FCA 1119 Parties: MICHAEL JOHN MORRIS SMITH IN HIS CAPACITY AS LIQUIDATOR OF ACTION PAINTBALL GAMES PTY LTD (IN LIQUIDATION) ACN 085 205 536 and ACTION PAINTBALL GAMES PTY LIMITED (IN LIQUIDATION) ACN 085 205 536 v BILL ROY STARKE, BERYL JEANETTE STARKE, JOHN SALVINU CARUANA, MICHAEL WILLIAM WHYBREW and ELIZABETH SUSAN WHYBREW File number: NSD 2451 of 2013 Judge: GLEESON J Date of judgment: 22 October 2015 Catchwords: CORPORATIONS – whether certain payments unreasonable director-related transactions – whether reasonable person in company’s circumstances would not have made payments – where payments made by company to director defendants’ creditor – where defendants borrowed money, in part to purchase property to be developed for company’s use – where company unable to purchase property itself – where difficulties experienced with development – whether payments conferred benefits on company – detriment to company of making payments – obligation to consider interests of members – some impugned payments found to be unreasonable director-related transactions – Corporations Act 2001 (Cth), s 588FF Legislation: Corporations Act 2001 (Cth), ss 588FB, 588FDA, 588FE, 588FF Cases cited: Cashflow Finance Pty Ltd v Westpac Banking Corporation [1999] NSWSC 671
Cussen v Sultan [2009] NSWSC 1114
Equiticorp Finance Ltd (in liq) v Bank of New Zealand (1993) 32 NSWLR 50
Fielding as liquidator of Lyngray Developments Pty Ltd v Dushas [2013] QCA 55
Kazar, in the matter of Frontier Architects Pty Limited [2010] FCA 1381; (2010) 81 ACSR 158
Kijurina (as liquidator of ET Family Pty Ltd) v Taouk [2015] FCA 424; (2015) 105 ACSR 686
Lewis v Doran [2005] NSWCA 243; (2005) 219 ALR 555
Linton v Telnet Pty Ltd [1999] NSWCA 33; (1999) 30 ACSR 465
Re Lesvos Pty Ltd [2012] NSWSC 1288
Slaven v Menegazzo [2009] ACTSC 94
Tosich Constructions Pty Ltd (in liq) v Tosich (1997) 78 FCR 363
Vasudevan v Becon Constructions (Australia) Pty Ltd [2014] VSCA 14; (2014) 41 VR 445
Weaver v Harburn [2014] WASCA 227; (2014) ACSR 416
Welcome Homes Real Estate Pty Ltd v Ziade Investments Pty Ltd (in liq) [2007] NSWCA 167Date of hearing: 7, 8, 9, 10 April 2015 Place: Sydney Division: GENERAL DIVISION Category: Catchwords Number of paragraphs: 159 Counsel for the Plaintiffs: Mr J Rose Solicitor for the Plaintiffs: Watson Mangioni Counsel for the Defendants: Mr H Somerville Solicitor for the Defendants: Nelson McKinnon Lawyers
IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY
GENERAL DIVISION
NSD 2451 of 2013
IN THE MATTER OF ACTION PAINTBALL GAMES PTY LTD (IN LIQUIDATION) ACN 085 205 536
BETWEEN: MICHAEL JOHN MORRIS SMITH IN HIS CAPACITY AS LIQUIDATOR OF ACTION PAINTBALL GAMES PTY LTD (IN LIQ) ACN 085 205 536
First PlaintiffACTION PAINTBALL GAMES PTY LIMITED (IN LIQ) ACN…
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- AGLC
- Smith v Starke (No 2) [2015] FCA 1119
- Case
- [2015] FCA 1119
- Decision Date
CaseChat Overview and Summary
The case of Smith v Starke (No 2) involved a dispute between the liquidators of Action Paintball Games Pty Ltd and the directors of the company regarding certain payments made by the company to the defendants' creditors. The liquidators alleged that these payments constituted unreasonable director-related transactions under the Corporations Act 2001 (Cth). The legal issues before the court were whether the payments were unreasonable and whether a reasonable person in the company's circumstances would not have made them. The court was also required to consider the detriment to the company of making the payments and the obligation to consider the interests of the members.
The court found that the defendants had acted reasonably in making the disputed payments. The company had no legal obligation to make the payments, and they did not provide any benefit to the company. However, the payments were made to secure an alternative site for the company's business, which was of significant importance given the unsatisfactory relationship with the landlord of the existing site. The court held that a reasonable person in the company's circumstances would have considered the interests of the members as a whole before deciding to cease making the payments. The directors wished to maintain the availability of the alternative site for the long-term benefit of the company, having spent a considerable amount towards developing it. The court found that the payments would benefit all shareholders and that there was a significant risk of serious detriment to the shareholders if the payments ceased. Therefore, the court held that the payments were not unreasonable.
The court also considered the ratio of previous cases in which certain transactions had been found to be unreasonable director-related transactions. These included the purchase of a boat using company funds for a close associate, an agreement to assume joint liability for obligations owed by a director to a third party, a contract to dispose of real property of a company for no consideration, a payment made into a home loan account of a company's directors, the incurring of costs and liabilities by a company to construct a house on property owned by a close associate, and rental payments made by the company for premises owned by the director's daughter. The court found that the transactions in the present case did not fall within the same category as those in the previous cases.
In conclusion, the court found that the disputed payments were not unreasonable director-related transactions and that a reasonable person in the company's circumstances would not have made them. The court ordered the parties to file and serve a joint proposed minute of order giving effect to these reasons and listed the matter for directions. The parties were also given liberty to apply.
The court found that the defendants had acted reasonably in making the disputed payments. The company had no legal obligation to make the payments, and they did not provide any benefit to the company. However, the payments were made to secure an alternative site for the company's business, which was of significant importance given the unsatisfactory relationship with the landlord of the existing site. The court held that a reasonable person in the company's circumstances would have considered the interests of the members as a whole before deciding to cease making the payments. The directors wished to maintain the availability of the alternative site for the long-term benefit of the company, having spent a considerable amount towards developing it. The court found that the payments would benefit all shareholders and that there was a significant risk of serious detriment to the shareholders if the payments ceased. Therefore, the court held that the payments were not unreasonable.
The court also considered the ratio of previous cases in which certain transactions had been found to be unreasonable director-related transactions. These included the purchase of a boat using company funds for a close associate, an agreement to assume joint liability for obligations owed by a director to a third party, a contract to dispose of real property of a company for no consideration, a payment made into a home loan account of a company's directors, the incurring of costs and liabilities by a company to construct a house on property owned by a close associate, and rental payments made by the company for premises owned by the director's daughter. The court found that the transactions in the present case did not fall within the same category as those in the previous cases.
In conclusion, the court found that the disputed payments were not unreasonable director-related transactions and that a reasonable person in the company's circumstances would not have made them. The court ordered the parties to file and serve a joint proposed minute of order giving effect to these reasons and listed the matter for directions. The parties were also given liberty to apply.
Orders
Orders of the court
1. Within 14 days of the date of this judgment, the parties file and serve a joint proposed minute of order giving effect to these reasons.
2. The matter be listed for directions at 9.30 am on 12 November 2015.
3. The parties have liberty to apply.
Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.
Background
Background to the litigation
The evidence did not include minutes of meetings. The witnesses gave evidence to the effect that formal meetings of directors were not held and that decisions were made by consensus. FACTS Action Paintball was registered as a corporation on or about 17 November 1998. Prior to its incorporation, Mr and Mrs Whybrew operated a business trading as “Action Paintball Games” from the Rouse Hill property.Lease of Rouse Hill property The Rouse Hill property is owned by Graham Trilby Pty Ltd (“landlord”). A substantial portion of the defendants’ evidence was directed to establishing the unsatisfactory nature of the relationship between Action Paintball and the landlord. It is unnecessary to go into great detail. The evidence reveals that the directors of Action Paintball were dissatisfied with the terms on which they leased the Rouse Hill property from at least around 2003, particularly because they wanted a longer term of lease which the landlord was not willing to give. They were also dissatisfied with the rate at which rent for the property was increasing. In March 2002, the landlord offered a two-year lease commencing 8 March 2002 for an annual rent of $77,000. In about July 2003, the landlord offered a two year lease commencing 8 August 2003 for an annual rent of $100,000. In September 2003, the landlord wrote to Mr Whybrew complaining about the importation of fill onto the Rouse Hill property and stating that “until satisfactory amendment…has been carried out, … we are only prepared to allow a month by month tenancy of the land at the rate of $10,000 per month, i.e. $120,000 per annum”. By letter dated 19 November 2003, the landlord made two proposals for Action Paintball’s occupation of the Rouse Hill property, being a three-year lease of 40 acres for a rent of $150,000 per annum (excluding outgoings) or continued occupation on a month-to-month basis with rent to be adjusted to $125,000 per annum (excluding outgoings) from 1 December 2003. By letter dated 24 November 2003, Action Paintball accepted the first proposal, saying:…if you could look into any further extension in regard to the lease of the property for a further five to eight years at some time in the near future then that would be greatly appreciated. There is an unsigned “commercial lease” between the landlord and Mr and Mrs Whybrew trading as Action Paintball for three years commencing 1 December 2003 at an annual rent of $150,000. However, the landlord refused to sign a three-year lease until fill dumped on the site was removed. By letter dated 15 December 2003, the landlord requested a cheque for $13,750 “which represents the new monthly amount of rental which was due on 8 December 2003”. At this rate, the annual rental for the Rouse Hill premises was now set at $165,000 per annum. A letter dated 1 June 2004 from the landlord confirms that the rental was $165,000 from 1 December 2003. By letter dated 24 June 2004, the landlord informed Action Paintball that it was on a monthly tenancy “and unless all matters are rectified immediately, your use of the land will be terminated….Please respond and bring the current rent up to date within seven (7) days otherwise we will no longer allow the tenancy to continue”.
Evidence
Evidence Before The Court
The liquidator gave evidence on behalf of the plaintiffs. Based on his examination of the financial records of the company, the liquidator’s opinions were:(1)The company had no legal obligation to make any of the relevant payments;(2)The company did not guarantee or provide any form of security interest in favour of Perpetual to secure any payments or obligations arising from the loans;(3)The company did not have any interest (legal or equitable) in either the Starke family home or Lot 22;(4)The company did not have any legally binding option or right to acquire, lease or otherwise use either the Starke family home or Lot 22;(5)The payments deprived the company of the use of those payments, which could otherwise have been used for the purpose of its business, such as the payment of its creditors; and(6)The payments reduced the debt owing by the defendants to Perpetual and thereby benefited both the defendants and Perpetual.Defendants’ evidence Each of the defendants except Mrs Starke (who was ill at the time of the hearing) gave evidence. An affidavit made by the company’s accountant, Mr Holman, was also relied upon as part of the defendants’ case. Mr Holman was not required for cross-examination and, consequently, was not available to explain some of the financial reports and tax returns which he apparently prepared. After hearing cross-examination of the defendants (except Mrs Starke), I was satisfied that each of them was an honest witness, doing his or her best to give accurate evidence to the best of their recollection. I generally accept their evidence. In some respects, the oral evidence was contradicted by contemporaneous records and, in those cases, I prefer the evidence of the contemporaneous records. For example, Mr Whybrew gave oral evidence that seemed to suggest that at all relevant times there were written leases between Action Paintball and Graham Trilby, but contemporaneous correspondence strongly suggests that this was not the case. Even so, disparities of that kind did not affect my positive assessment of the credibility of each of Mr Starke, Mr Caruana and Mr and Mrs Whybrew. The evidence did not include minutes of meetings. The witnesses gave evidence to the effect that formal meetings of directors were not held and that decisions were made by consensus. FACTS Action Paintball was registered as a corporation on or about 17 November 1998. Prior to its incorporation, Mr and Mrs Whybrew operated a business trading as “Action Paintball Games” from the Rouse Hill property.Lease of Rouse Hill property The Rouse Hill property is owned by Graham Trilby Pty Ltd (“landlord”). A substantial portion of the defendants’ evidence was directed to establishing the unsatisfactory nature of the relationship between Action Paintball and the landlord. It is unnecessary to go into great detail. The evidence reveals that the directors of Action Paintball were dissatisfied with the terms on which they leased the Rouse Hill property from at least around 2003, particularly because they wanted a longer term of lease which the landlord was not willing to give. They were also dissatisfied with the rate at which rent for the property was increasing.
Decision
Reasons for decision
The defendants identified the particular nature of the company’s business as another relevant matter. The defendants submitted:It is clear from the evidence that the operation of a paintball business has complex and unique requirements. Of particular importance is the site from which such a business operates. With no site or no site with the appropriate infrastructure and government approvals, a paintball company such as that in the present case would be unable to operate. The evidence of the defendants speaks to the importance of this issue and when viewed in the context of the continued difficulties with the landlord at the Rouse Hill site, taking steps to secure an alternative site albeit at some cost to the company was a responsible and reasonable thing to do.Conclusion Taking all these matters into account, I am not satisfied that it may be expected that a reasonable person in the company’s circumstances would not have made any of the disputed payments. The payments were plainly made pursuant to an arrangement by which the defendants took on obligations to Perpetual primarily to secure Lot 22 for the long term benefit of Action Paintball. Accepting that the defendants and Action Paintball were entitled to make that arrangement, by which the defendants (being the company’s shareholders) were exposed to significant liabilities, it would not be expected that a reasonable person in the company’s circumstances would have simply ceased making the payments on and from February 2008. Such an action could have resulted in significant losses for the shareholders of the company arising from the likely consequent defaults on the loan agreements and consequent need to sell Lot 22. The evidence does not explain what the impact of ceasing to make the payments at any particular time would have been on the company’s shareholders. In my view, a reasonable person in the company’s position was required to consider the interests of its members as a whole before making a decision to cease making the payments: see Austin RP and Ramsay IM, Ford, Austin and Ramsay’s PrinciplesofCorporationsLaw (16th ed, LexisNexis Butterworths, 2015) at [8.095]. That reasoning applies to all of the disputed payments made during the financial year ended 30 June 2008, in which the company’s net profit after income tax was $385,830. The company was in an apparently healthy financial situation (albeit the business had commenced to be affected by the GFC) and the directors of the company wished to maintain the availability of Lot 22 for the long-term benefit of Action Paintball, having spent a considerable amount towards developing Lot 22 and the payments would benefit all shareholders. These were reasons why a reasonable person in the company’s circumstances could have decided to make the payments. I am not satisfied that I should reach a different conclusion concerning disputed payments made during the financial years ended 30 June 2009 and 30 June 2010. The financial position of the company deteriorated over those two years. However, in each year, the company made significant net profits after income tax. Even if the company’s inventories are assumed to have no significant value (a conservative assumption), then the company’s financial reports show positive net assets when non-current liabilities (shareholder loans) are excluded. The prospect of developing Lot 22 was more remote, having regard to the company’s less favourable trading since the GFC. However, the directors of the company wished to maintain the availability of Lot 22 for the long-term benefit of Action Paintball, having spent a considerable amount towards developing Lot 22, the payments would benefit all shareholders and there was a significant risk of serious detriment to the shareholders if the payments ceased. In all of those circumstances, I am not satisfied that it may be expected that a reasonable person in the company’s circumstances would not have made the disputed payments during those two financial years.
Ratio Decidendi
Legal Principle Established
The following transactions have been found to be unreasonable director-related transactions within s 588FDA:·The purchase of a boat using company funds for a close associate: Weaver. McLure P (at [98]), Buss and Murphy JJA agreeing, concluded that, prima facie, a reasonable person in the company’s circumstances would not have made the payments, regardless of the financial health of the company. They would not have done so because it involved the director using corporate property as if it was his own (at [103]). That conclusion was fortified by the conclusion that at the time of the payments the company was in uncertain financial and commercial circumstances.·An agreement by a company to assume joint liability for obligations owed by a director to a third party and to grant a mortgage to secure performance of the assumed liability: Vasudevan at [31];·A contract to dispose of real property of a company for no consideration, which was found to amount “to giving away a valuable asset of the company to the son of one of the directors, because it was anticipated that in due course the company would realise its assets and have a sufficient surplus (in excess of the value of the property) available for distribution to the unitholders of the trust of which it was the trustee, and that those unit holders would somehow be able to procure a distribution in kind of the property to [the son]”: Slaven v Menegazzo [2009] ACTSC 94 at [45] (Mansfield J);·A payment made into a home loan account of a company’s directors. The Court found that the payment was probably used to finance a home loan with which a property was purchased. The Court was “unable to find any reasonable basis for a hypothesis that there was any benefit to [the company] as distinct from the defendants personally, from that payment, or any basis for thinking that it discharged any liability of [the company] to them”: Re Lesvos Pty Ltd [2012] NSWSC 1288 at [30].·The incurring of costs and liabilities by a company to construct a house on property owned by a close associate, in the absence of any commensurate benefit accruing to the company at the outset when the close associate thought that the house was to be built for “free”: Kazar at [152-[153];·22 rental payments made by the company for premises owned by the director’s daughter, and occupied by the director and her domestic partner: Fielding as liquidator of Lyngray Developments Pty Ltd v Dushas [2013] QCA 55 at [5], [18], [63].CONSIDERATION I accept the defendants’ evidence that the purpose of their acquisition of Lot 22 was to make the property available to Action Paintball as the site at which the company could conduct its business, subject to obtaining Council approval. The main reason for a substantial portion of the defendants’ loans from Perpetual was to acquire Lot 22 for use by Action Paintball, and the purpose of an equivalent portion of each of the disputed payments was to enable the defendants to discharge their obligations arising from the acquisition of Lot 22 for the benefit of Action Paintball.