N M Tobin Orthodontics Ltd v Tobin

[2013] NZHC 463

IN THE HIGH COURT OF NEW ZEALAND PALMERSTON NORTH REGISTRY

CIV2012-454-000440 [2013] NZHC 463

UNDER  the Companies Act 1993

IN THE MATTER OF     an interlocutory application for leave to bring a derivative action

BETWEEN  N M TOBIN ORTHODONTICS LIMITED First Plaintiff

ANDTHE ORTHODONTIC CENTRE LIMITED

Second Plaintiff

ANDSADIE TOBIN First Defendant

ANDJOHN CAWOOD AND LYNN CAWOOD Second Defendants

Hearing:         9 August 2012

Appearances: P J Drummond for applicant

D G Dewar for respondents

Judgment:      28 February 2013

Reasons:        11 March 2013   

REASONS FOR JUDGMENT OF ASSOCIATE JUDGE ABBOTT

This judgment was delivered by me on 11 March 2013 at 5pm, pursuant to Rule 11.5 of the High Court Rules.

Registrar/Deputy Registrar

Date……………

Solicitors:

M Woods, Winter Woods, PO Box 12067, Palmerston North
Thomas Dewar Sziranyi Letts, PO Box 31240, Lower Hutt 5040

Counsel:

P J Drummond, Barrister, PO Box 12164, Palmerston North

N M TOBIN ORTHODONTICS LIMITED V SADIE TOBIN HC PMN CIV 2012-454-000440 [28 February

2013]

[1]      On 28 February 2013 I issued a judgment granting leave to Mr N M Tobin to bring a derivative action on behalf of two family companies against his estranged wife, Mrs S Tobin and her parents, J and L Cawood, seeking to recover a total sum of

$223,393 removed from the company’s account and paid into the account of Mr and

Mrs Cawood.

[2]      This judgment records the reasons for that decision.

Background

[3]      Mr Tobin is an orthodontist by profession.   He is a director and minority shareholder of both of the intended plaintiffs.  He is also a trustee of a family trust that holds the majority of the shares in the intended plaintiffs.

[4]      Mr Tobin is married to, but separated from, the first respondent, Mrs S Tobin, who is the intended first defendant.  Mrs Tobin has continuing responsibilities for the children of the marriage.  Mrs Tobin is also a director and minority shareholder of the intended plaintiffs.  The second respondents are the intended second defendants, Mrs Tobin’s step-father and mother, L & J Cawood (for simplicity I will refer to them as her parents).

[5]      Mr Tobin provided his services to the intended first plaintiff, N M Tobin Orthodontics Ltd, which operated an orthodontic practice.   The intended second plaintiff, The Orthodontic Centre Ltd, is a property holding company which owns the premises in which the practice was conducted.   Mrs Tobin worked on the administration side of the practice.  A family trust, the Neil & Sadie Family Trust, holds 2,850 of the 3,000 shares in N M Tobin Orthodontics Ltd (the operating company) with Mr Tobin holding 145 shares and Mrs Tobin 5 shares.  The family trust holds 900 of the 1000 shares in The Orthodontic Centre Ltd (the property company).  Mr and Mrs Tobin each hold 50 shares in that company.

[6]      Mr and Mrs Tobin have separated (the actual date of separation has not been determined, but it seems to be accepted that they were separated by 27 February

2012).

[7]      In transactions on 17 February 2012, 20 February 2012, and 21 March 2012, Mrs Tobin transferred $220,000 from the bank account of the operating company, to the   bank   account   of   Mrs   Tobin’s   parents   ($75,000,   $75,000   and   $70,000 respectively).    On  21  March  2012  Mrs Tobin  also  transferred  $3,393  from  the property company’s account to her parents’ account.  All the transfers were affected via internet banking, and without the prior knowledge or agreement of Mr Tobin. The effect of the transfers was that the account of the operating company was overdrawn by the sum  of $163,217.24  (the transfers  were possible because  the operating company had an overdraft facility).

[8]      Subsequent to these transfers, the operating company has ceased business. Mr Tobin has incorporated a new company to which he provides his services.  The new company runs an orthodontic practice out of the same premises (owned by the property company), using the assets of the former operating company.

The application and opposition

[9]      Mr Tobin has applied for leave to bring a proceeding in the joint names of the operating company and the property company to recover the sums transferred out of their accounts by Mrs Tobin.   He says  that  Mrs Tobin  had access to the bank accounts as a director of the companies, and that the transfers were prima facie in breach of statutory duties1 because they were without his consent (as co-director) or the agreement of the majority shareholders (the trustees of the family trust), and were for her personal benefit.   He says that the transfers prevented the operating company from paying a GST obligation of $32,533.53 as well as the overdraft

obligation  to  its  bank,  and  says  that  it  is  appropriate  that  the  companies  bring

1 The duties to act in good faith and in the best interests of the company, to exercise powers for a proper purpose, not to allow the business to be carried on in a way that can cause substantial risk or serious loss to the companies’ creditors, and to exercise the care, diligence and skill of a reasonable director: ss 131, 133, 135 and 137 of the Companies Act 1993.

proceedings to recover property that rightly belongs to the company, for the benefit of all of their shareholders.  Mr Tobin says that the companies have an even clearer claim against Mr and Mrs Cawood as they have no lawful entitlement to the money (they have not asserted any such entitlement either in their notice of opposition or by evidence) and have been given opportunity to repay it but have failed to do so.

[10]     Mr Tobin has agreed to meet the costs of bringing the proceeding, subject to seeking reimbursement from the companies when they are in a position to meet those costs.

[11]     Mrs  Tobin  and  her  parents  oppose  the  application  on  the  basis  that  the transfers have to be seen in the context of the relationship between Mr and Mrs Tobin and the underlying purpose of the company to provide financial benefits for them, both directly and through their family trust.  She says that she and Mr Tobin had a mutually-accepted practice of drawing from the companies as funds were needed, and says that she transferred the money in accordance with that practice.

[12]     She says further that the shares in the company are relationship property, and that she has a relationship property entitlement significantly in excess of the amount she transferred, and that the money should be regarded as part of her relationship property entitlement.   She makes the point that Mr Tobin has previously made an offer to resolve their relationship property which includes her keeping the money now in dispute.  She contends that this is no different from Mr Tobin having the use of the companies’ assets to conduct his new orthodontic practice.

Legal principles

[13]     Section 165 of the Companies Act 1993 gives the Court a discretion to allow a shareholder or director to  bring proceedings  in  the name and  on  behalf  of a company:

165 Derivative actions

(1)       Subject to subsection (3), the court may, on the application of a shareholder or director of a company, grant leave to that shareholder or director to—

(a)       bring proceedings in the name and on behalf of the company or any related company; or

(b)       intervene  in  proceedings  to  which  the  company  or  any related company is a party for the purpose of continuing, defending, or discontinuing the proceedings on behalf of the company or related company, as the case may be.

(2)       Without limiting subsection (1), in determining whether to grant leave under that subsection, the court shall have regard to—

(a)      the likelihood of the proceedings succeeding:

(b)       the costs of the proceedings in relation to the relief likely to be obtained:

(c)       any action already taken by the company or related company to obtain relief:

(d)      the interests of the company or related company in the proceedings being commenced, continued, defended, or discontinued, as the case may be.

(3)       Leave  to  bring  proceedings  or  intervene  in  proceedings  may  be granted  under  subsection  (1),  only  if  the  court  is  satisfied  that either—

(a)       the company or related company does not intend to bring, diligently  continue  or  defend,  or  discontinue  the proceedings, as the case may be; or

(b)       it is in the interests of the company or related company that the conduct of the  proceedings  should not be left to  the directors or to the determination of the shareholders as a whole.

(4)       Notice of the application must be served on the company or related company.

(5)      The company or related company—

(a)      may appear and be heard; and

(b)       must inform the court, whether or not it intends to bring, continue, defend, or discontinue the proceedings, as the case may be.

(6)       Except  as  provided  in  this  section,  a  shareholder  is  not entitled to bring or intervene in any proceedings in the name of, or on behalf of, a company or a related company.

[14]     As may be seen from this section, the Court is required2  to have regard to several identified factors, but they do not limit the broad discretion under s 165(1). Leave is to be given only if the Court is satisfied that the company does not intend to bring the proceedings or it is in the interests of the company that the conduct of the proceedings not be left to the directions or determination of the shareholders as a whole.3

[15]     It is common ground that the Court exercises its discretion by assessing whether a prudent business person, acting in the conduct of his or her own affairs, would  decide  to  bring  the  proceedings  after  taking  into  account  the  mandatory factors and any other material matters.

[16]     This test was stated by this Court in Vrij v Boyle4 by reference to the first of the mandatory factors (the likelihood of the proceeding succeeding):5

...the first requirement is that the Court have regard to “the likelihood of the proceedings succeeding.” I adopt in that regard the useful test suggested in a slightly different context in Smith & Ors v Croft & Ors. It is not for me to conduct an interim trial on the merits. The appropriate test is that which would be exercised by a prudent business person in the conduct of his or her own affairs when deciding whether to bring a claim. Such a decision requires one to consider such matters as the amount at stake, the apparent strength of the claim, likely costs and the prospect of executing any judgment.

[17]     This test has been extended in recent cases6  to all aspects of the discretion. The fact that it has been so extended was confirmed in Needham v EBT Worldwide Ltd:7

[23] On one view the test adopted by Fisher J encompasses not only consideration of the likelihood of the proceedings succeeding but also other relevant considerations such as the costs in relation to the relief likely to be obtained and the overall interests of the company. As such the test is also

2 S 165(2).

3 S 165(3).
4 Vrij v Boyle [1995] 3 NZLR 763 (HC).
5 At 765.

6 For example, Presley v Callplus Ltd (2008) NZCCLR 37; Bendall v Marshall (2005) 5 NZCLC 263

772; Re Mega-Merger Housing Ltd HC Auckland CIV 2004-404-364, 16 November 2004; Frykberg v

Heaven (2002) 9 NZCLC 262 966.

7 Needham v EBT Worldwide Ltd (2006) 3 NZCCLR 57(HC) at [23]. Similar statements have been made in Martin v Martinborough Brewing Co Ltd (2007) 10 NZCLC 264,269 at [20] and in Peters v Birnie [2010] NZAR 494 at [28].

applicable to other aspects of s 165(2) and to the exercise of the overall discretion.

Discussion

[18]     If the relationship between Mr and Mrs Tobin is put to one side, there can be no question that the factors in s 165(2) would cause a prudent business person to bring this action.  The companies’ claims would be likely to succeed because, in the absence of an agreed distribution to Mrs Tobin as a shareholder, the money belongs to the company and no other basis has been advanced for her parents to be entitled to retain the money.  The costs of bringing the proceeding would not be significant, and would be well justified by the return to the operating company.  The position for the holding company might be different if its claim stood alone (because of the cost involved), but it can be brought simply and efficiently in conjunction with the claim by the operating company.

[19]     Efforts have been made to have the money repaid, but both Mrs Tobin and her parents have declined to comply with those requests.   It is prima facie in the interests of the companies to bring the proceeding so as to recover the money for the benefit of all its shareholders.

[20]     Counsel for Mrs Tobin and her parents submitted, however, that such an approach ignored the family context and the reasonable expectations of Mrs Tobin (as a shareholder)8  to derive financial support from the companies both for herself and for the children of the marriage.   Counsel argued that when viewed in that context the dispute was more appropriately resolved as part of a division of relationship property (including trust property).   He submitted that it was a very relevant factor in the exercise of the Court’s discretion that any proceedings on behalf of the companies would have little ultimate effect if Mrs Tobin was bought out of the companies, or the companies were wound up and assets distributed, in the

course of the relationship property division.

8 Relying on the proposition that the reasonable expectations of the shareholders guide the practice of companies even in a commercial context: Re Waitikiri Links Ltd, HC Christchurch M567/87, 2

February 1989, Hardie Boyes J at 5, 23 and 26.

[21]     He also argued that it was by no means certain that Mrs Tobin was in breach of her duties to the companies, contending that in light of the underlying purpose of the properties to provide maintenance and support for the family, her recourse to the companies’ capital could be performance of her fiduciary role.  Even if that was not accepted, he submitted that it should not be presumed that the funds were automatically recoverable given that a director’s primary duty to a company is to look after the interests of its shareholders (and in the context of this case, that was the purpose of the transfer of funds).

[22]     Lastly, counsel for Mrs Tobin and her parents said that the Court could take into account, in the exercise of its discretion, Mr Tobin’s own unilateral action (in relation to the companies) in taking control of the companies’ assets and denying Mrs Tobin and the trust (the other shareholders) any ability to derive income from those assets.

[23]     Similar background circumstances  came before  this Court  in  Stichbury v One4All Ltd.9    That case also involved a family owned and operated company.  A family trust held the other 50% of the shares. Mr and Mrs Stichbury were both directors.  Following a breakdown of their personal and working relationships, Mr Stichbury  applied  for  leave  to  bring  a  derivative  action  against  Mrs  Stichbury, making  a number of  allegations  including  that  she had  taken  the  whole of the company’s  business  into  a  new  company.    In  determining  the  interests  of  the company as required by s 165(2) the Court commented that:10

The interests of the company and all its shareholders including the Trust here should not be ignored.

and further:11

...the company’s position as a separate entity with its own legal identity (and

given that half its shares are owned by the Trust) must be viewed separately.

[24]     After noting that the company was a separate legal entity, and that there was need for an investigation into the assets and operation of the company, the Court

9 Stichbury v One4All Ltd HC Palmerston North, CIV 2004-454-889, 18 April 2005.

10 At [51].

referred to a distinction between issues as to the control and management of the company and giving effect to a division of shares and dismissed, as a relevant factor in that case, the possibility of duplication between the proposed derivative action and relationship property and other Court proceedings, taking the view that the proceedings could be run separately:12

[58] And on the question of duplication between the proposed derivative action and the relationship property and other Court proceedings between the parties, Fisher J in Vrij v Boyle held that it was possible in principle to have a situation where a plaintiff could be claiming for independent wrongs done to the plaintiff directly, while a company was at the same time recovering its own compensation for losses due to a breach of fiduciary duty.

[25]     Counsel for Mrs Tobin and her parents sought to distinguish Stichbury on the basis that in that case derivative proceedings were needed to protect shareholders’ interests from the acts of the proposed defendant (who had moved the company’s assets into a separate company).  He contrasted that with Mrs Tobin’s acts which he submitted  were  to  protect  her  interests  and  the  interests  of  the  children  as beneficiaries of a shareholder – and argued that Stichbury was more applicable to Mr Tobin’s actions.

[26]     I am not persuaded that that is an appropriate distinction.  I do not consider it appropriate to conflate Mrs Tobin’s obligations as a director with her possible entitlements as a shareholder.  Nor do I accept that she can rely on the interest of her children as beneficiaries of the major shareholder, to justify breach of obligations to the company.   Although the shareholders may have a legitimate interest in maintaining the financial benefits to be gained from their shareholding, that does not justify stripping the company of its cash flow, causing it to default on a tax payment, and leaving it with a substantial overdraft obligation.   Mrs Tobin’s interests as a director are to protect the assets of the companies for all of its shareholders, thereby allowing  it  to  meet  obligations  so  as  to  continue  trading  and  thereby  produce financial benefits for the shareholders. Adopting the analysis in Stichbury, there may be some overlap between the matters in effect, but not the level of duplication that I would consider necessary to require exercise of the discretion against leave.

[27]     I do not overlook her criticism of Mr Tobin’s actions, which similarly could be said to have affected the financial benefits flowing through to the shareholders. However, there is a difference in that Mr Tobin has acknowledged that he has an obligation to account to the company, whereas Mrs Tobin (and her parents) appear to be conflating the companies’ interests with Mrs Tobin’s personal interest in relationship property.   Mr Tobin’s actions have not removed assets from the companies, nor prevented the companies from earning income on those assets given

that Mr Tobin acknowledges that he must account for their use.13    In that respect I

take into account (but without making a finding on this) Mr Tobin’s evidence that he acted as he did because Mrs Tobin’s self-help action had prejudiced the companies’ ability to continue the previous business (more applicable to the operating company) and that there is no evidence to suggest that there was any other realistic use of the assets.    On  the  other  hand,  Mrs Tobin’s  actions  have  removed  assets  from  the company, and there is no suggestion of an accounting to the company either in respect of the capital or any income to be derived from it.  In this regard (the failure to acknowledge any obligation to account) I note that Mrs Tobin appears to have made a deliberate decision to place all of the money out of reach even of any relationship property accountability by placing it into her parents account.  She has given no explanation for this action.

[28]     I take a similar view of the argument that the family context and reasonable expectations of the shareholders means that a derivative action is not a suitable vehicle to address this dispute.  Whilst I accept that there is an argument that Mrs Tobin may have had a reasonable expectation that she could draw funds from the company (pursuant to either an express or an implied agreement between shareholders), any such expectation could only apply to funds that were available for distribution to shareholders.  As a director she had an obligation to ensure the funds were kept to meet tax obligations, and not to put the company into debt (in terms of an overdrawn bank facility) where there was at least potential uncertainty as to how that debt would be met.  Further, even assuming an argument that Mrs Tobin could

have a reasonable expectation of some continuing drawings, she has not justified the

13 Although the shareholders may have a legitimate complaint that that accounting should be now

rather than at Mr Tobin’s convenience.

sum taken in terms of living expenses in existence or in contemplation at time of the transfers, nor explained why she could not have explored other avenues for obtaining financial support before the relationship property was resolved.

[29]     Lastly, the fact that Mrs Tobin may be entitled to receive the same amount, or even substantially more, in a relationship property division does not justify her self- help action to the assets of the companies, even if she may ultimately be entitled to the value of her shareholding, let alone on the basis of the shareholding of the trust.

[30]     Standing back and judging the matter from the point of view of a prudent business person, I am satisfied that leave should be granted under s 165:

(a)      The claims  are likely to  succeed.  It  is  at  least  arguable  that  Mrs Tobin’s actions have prejudiced the companies (causing the operating company to default in payment of a GST obligation, and putting it into overdraft, and by removing assets from both companies).

(b)The  costs  of  the  action  are  likely to  be  modest  compared  to  the recovery, having regard to the relatively straight forward fact situation and the companies’ clear ownership of the funds.

(c)      The companies have has not brought, and practically cannot bring, action itself, given Mrs Tobin’s role and conflicting interests.

(d)The companies’ interest in the money should be treated separately from Mrs Tobin’s claim in a division of relationship property.

(e)       Mrs  Tobin’s  relationship  property  entitlements  can  be  addressed

independently.

[31]     I confirm the order made on 28 February 2012 granting leave to Mr Tobin to commence his proceeding in the name of and on behalf of the companies, subject to Mr Tobin meeting the companies’ costs pending any claim for reimbursement.  His entitlement to reimbursement for the cost of the proceeding is to be determined at the conclusion of the proceedings.

[32]     I  record  that  the  applicant  is  willing  to  have  the  balance  of  the  money ($223,393 less the $32,533.53 payable to the IRD)   paid into Court pending determination of any relationship property claim in respect of it, in the absence of any agreement between the parties.

Costs

[33]     As the successful party, Mr Tobin is entitled to costs against Mrs Tobin and her parents jointly on a scale 2B basis, together with disbursements as fixed by the

Registrar.

Associate Judge Abbott