Allatech v Construction Management Group

IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION

1053/02 ALLATECH PTY LTD V CONSTRUCTION MANAGEMENT GROUP PTY LTD & ANOR JUDGMENT 1 HIS HONOUR: This judgment relates to the admissibility of an expert's report. In the proceeding the plaintiff, Allatech, seeks an order under s 445D of the Corporations Act 2001 (Cth) terminating a deed of company arrangement relating to the first defendant, CMG, dated 28 July 2000 ("the DCA"). Under the DCA the directors of CMG, Mr Attard and Mr Henry, have agreed to pursue various litigation claims, including proceedings against Allatech and its related entities. The second defendant, Mr Hillig, is the administrator under the deed, having previously been the voluntary administrator of CMG. 2 The Court may make an order terminating a deed of company arrangement if it is satisfied that there was an omission from the administrator's report that accompanied the notice of meeting at which the creditors passed a resolution that the company execute the deed, and the omission can reasonably be expected to have been material to the creditors in so deciding: s 445D (1) (c). One of the grounds advanced by Allatech for termination of the DCA is that in his report to creditors dated 4 July 2000, Mr Hillig as voluntary administrator failed to disclose a material cause of action arising out of a breach of fiduciary duty by the directors of CMG, Mr Attard and Mr Henry. Allatech alleged that in about 18 June 1998 Mr Attard and Mr Henry entered into a joint venture agreement with Robert and Daniel Josef, under which a new company called CMG Civil Division Pty Ltd ("Civil") was formed, owned and controlled by them, and the new company successfully tendered for a contract which CMG might otherwise have had, thereby diverting a corporate opportunity from CMG in breach of duty. 3 In its Points of Defence CMG pleaded that there was no breach of fiduciary duty because the activities of Mr Attard and Mr Henry with Robert and Daniel Josef were unanimously consented to by all of the shareholders of CMG. In its Reply to the Points of Defence, Allatech pleaded that the unanimous consent of the shareholders did not prevent Mr Attard and Mr Henry from breaching their fiduciary duty to CMG because of CMG's financial position at all material times. The Reply alleged that CMG was insolvent, or nearing insolvency, or of doubtful insolvency, or in a position whereby the conduct complained of would jeopardise solvency. 4 In other interlocutory judgments I have referred to the contention in the Reply that one of these four conditions was present as the contention that CMG was "Kinsela insolvent". This label, adopted for convenience, reflects the fact that Kinsela v Russell Kinsela Pty Ltd (in liq) (1986) 4 NSWLR 722 is one of several well-known cases commonly cited for the proposition that the shareholders cannot, by resolution or even unanimously, cure what would otherwise be a breach of the directors' fiduciary duty if at the relevant time the company is insolvent, or nearing insolvency, or of doubtful insolvency, or in a position whereby the conduct complained of would jeopardise solvency. 5 When the present proceeding was launched, Mr Attard and Mr Henry were vigorously prosecuting proceedings as envisaged by the DCA, including proceedings against Allatech and Franks Centre Lofts Pty Ltd ("FCL", a related entity of Allatech). Those proceedings had been sent to referees under Part 72 of the Supreme Court Rules. The hearing before the referee in the FCL proceedings has now been completed, and the parties believe that the referee's report is imminent. 6 When the present proceeding began, Allatech applied to me successfully, notwithstanding trenchant opposition by CMG, for an order staying the hearing by the referee of the Allatech proceeding. I decided that the most just, fair and cheap way of advancing the overall dispute between the parties towards resolution was to give priority to deciding whether the DCA should be set aside, because that question seemed to involve relatively contained issues about the adequacy and accuracy of Mr Hillig's disclosure to creditors (indeed, counsel for Allatech estimated a three-day hearing including submissions); and if Allatech were to succeed, the other proceedings would not go ahead unless the liquidator of CMG decided to continue them and had funding to do so. At that time it seemed that the hearing of the Allatech proceeding before the referee would be long and factually complicated, and comparatively expensive. To borrow the analogy put to me by counsel for CMG yesterday, Allatech enticed me with the prospect of consuming a crisp young lettuce in a light meal, in preference to a full and heavy dinner. 7 Unfortunately the crisp young lettuce has wilted. After ten hearing days and a very large number of interlocutory applications, we are still a long way from completing the hearing. One of the main problems has been how to handle the question of CMG's solvency. The issue for determination is whether Mr Hillig omitted to disclose to the creditors, as a matter material to their decision, that there was a prospect of recovery from Mr Attard, Mr Henry and Civil for breach of, and knowing participation in a breach of, a fiduciary duty owed to CMG. That seems to raise issues about Mr Hillig's state of knowledge of matters relevant to the alleged breach of duty during the period of voluntary administration, his duty to make inquiries about such matters, and the duty of Mr Attard and Mr Henry as directors of CMG to inform him about such matters. One of the matters relevant to the alleged breach of duty is whether CMG was Kinsela insolvent at times relevant to the breach. The defendants contend that on the facts CMG was not insolvent in fact, or otherwise Kinsela insolvent, at any relevant time, and therefore there cannot have been any breach of duty because of the unanimous assent of the shareholders, and consequently there cannot have been any material omission from Mr Hillig's report to creditors in this respect. 8 In this way, evidence going to the solvency of CMG in June 1998, and perhaps subsequently, is relevant to one of the main issues in this proceeding. The trouble is that proving the solvency or insolvency of CMG in June 1998 or at any other relevant time is a complicated matter. CMG was a builder with several concurrent projects, and its debts to subcontractors were subject to the retention and dispute provisions of the relevant subcontracts, and may have been subject to other special arrangements alleged by CMG. Its cash flow position depended upon a number of specific transactions, which (according to CMG) would need to be understood before one could determine the company's ability to pay its debts as and when they fell due. Its financial records were difficult to understand because the company used a financial software system called Lodex for the year to 30 June 1998, and the system was unsatisfactory in various ways. 9 During the course of the hearing I made rulings about the admissibility of various documentary records, generally having the effect of keeping the documentary evidence within reasonable bounds. Problems have arisen, however, through the attempts of the parties to read expert opinion evidence on the question of solvency. 10 CMG sought to read an affidavit annexing a report by Robin Humphreys, a practising chartered accountant who is a director of a company providing expert witness services in the accounting field. Mr Humphreys was instructed to form an opinion as to the solvency or otherwise of CMG during the period from 1 June 1998 to 30 June 1999. He considered solvency by reference to the cash flow and balance sheet tests. 11 He expressed the opinion that in order to apply the cash flow test, it would be necessary to have access to a large number of documents including bank statements, payment records, receipts, contract documents and creditor invoices, and to review those documents. He said that this assessment could not be performed within six weeks and would involve the use of substantial manpower resources. In his opinion the mere fact, if it were so, that there were unfunded variation claims in the order of $340,000 would not justify an inference of insolvency unless there was an extensive review of all the projects in which CMG was involved during the relevant period, analysing the timing of cash flows and profit margins relating to each project. He observed that according to records he had examined, there was always cash in the company's bank account, and he expressed the opinion, based on his experience, that where an entity consistently maintains cash surpluses this is an indication that the entity is meeting its obligations. 12 As to the balance sheet test of solvency, he examined the financial statements of CMG for June 1998 and June 1999. He compared the figure for trade creditors in the 1998 balance sheet with the Lodex Creditors Trial Balance Report and found that the company had overstated its liabilities, and that the list of creditors in the Lodex records included an amount that was subsequently reversed by journal entry or credit note from the supplier. He made adjustments to reflect these matters and concluded that the company had substantial positive net assets. He examined the balance sheet as at 30 June 1999 and compared the amount recorded as cash with the company's bank statements. He concluded that the balance sheet understated the amount of cash at bank by a significant amount, and therefore that the net assets were significantly higher than stated. 13 His overall conclusion was that CMG passed the cash flow and balance sheet tests as at 30 June 1998 and 30 June 1999, and was not insolvent or nearing insolvency during the period from 1 June 1998 to 30 June 1999. 14 I decided that, with minor exclusions, I should admit Mr Humphreys' report into evidence. It seemed to me that his expertise and experience qualified him to give evidence of these matters. His evidence went well beyond the mere reading and interpretation of the financial statements: cf Quick v Stoland (1998) 87 FCR 371. I rejected a submission by counsel for Allatech that the report did not sufficiently disclose the chain of reasoning that led Mr Humphreys to his conclusions: cf Pownall v Conlan Management Pty Ltd (1995) 16 ACSR 227; Makita (Australia) Pty Ltd v Sprowles (2001) 52 NSWLR 705. 15 Allatech then sought to read an affidavit made on 8 August 2002 by Claude Jugmans, annexing his report. Mr Jugmans is also a chartered accountant, in charge of the Corporate and Forensic Accounting Division of Horwath (NSW) Pty Ltd and a partner of the firm, Horwath Sydney Partnership. He was instructed to prepare a report setting out his comments on the report of Mr Humphreys and an affidavit by Mr Attard on financial matters dated 18 July 2002, and to give his opinion as to the solvency or otherwise of CMG at 30 June 1998, 31 March 1999 and 30 June 1999. The documents given to him for the purposes of preparation of the report are, for the most part, already in evidence, and I was informed by counsel for Allatech that the documents not in evidence will be tendered. 16 The briefest perusal of Mr Jugmans' report shows that it is quite a different document from Mr Humphreys' report. Mr Humphreys' report is a letter of three pages, with an annexure (Annexure B) prepared by him from the financial records of CMG, and other annexures which are extracts from those sources. Mr Jugmans' report is a letter of 22 pages, with another 12 pages of annexures prepared by him from the financial records of CMG. It makes inferences at a much more detailed factual level than Mr Humphreys' report, and draws conclusions upon detailed assumptions which it articulates. In some respects it is a model of expert opinion evidence in the financial area, especially when compared with the summary views expressed by Mr Humphreys. However, it raises the difficulty that by making inferences and assumptions at such a level of detail, it invites factual rebuttal from CMG. CMG has strongly resisted the tender of the report. 17 The main principles regarding the admissibility of such a report are not in dispute. During the course of submissions, senior counsel for Allatech stated some legal principles with which senior counsel for CMG agreed (Transcript, 22 August 2002, p 513-4). The principles formulated by counsel were as follows: (1) An expert must give evidence on the basis of assumptions of fact, which must be clearly and expressly stated and identified, and the expert's opinion evidence must be confined to opinions expressed upon the basis of those assumed facts: Makita v Sprowles , paragraphs 64, 70-82 and 85. (2) If an expert makes and sets out an assumption, there is no objection to the expert arguing what the consequences of the assumption should be: Arnotts Ltd v Trade Practices Commission (1990) 24 FCR 313 at 352. (3) An expert cannot tell the judge what facts the judge should accept, but instead the expert should make assumptions with respect to facts and set them out in his or her report: Arnotts case, p 352. (4) The assumptions upon which an expert witness bases his or her opinion evidence must ultimately be proved by admissible evidence: Paric v John Holland Constructions Pty Ltd (1985) 59 ALJR 844, 846; Makita v Sprowles , paragraphs 64, 80, 81 and 85. (5) If ultimately an assumption upon which the expert's opinion is based, and which is essential to the integrity of the opinion, is not found to be a fact, then the Court should not accept the expert opinion to the extent that it is based on the assumption: Paric , p 846; Makita v Sprowles , paragraph 64. (6) An expert's report may be admitted into evidence before the Court makes factual findings as to the assumptions upon which the opinions in the report are based: Paric , p 846 (and in the Court of Appeal [1984] 2 NSWLR 505, 507; Makita v Sprowles paragraph 64. (7) The Court is only entitled (relevantly) to reject expert opinion evidence if there are other facts and circumstances which it accepts, which are sufficient to reject the expert evidence: Taylor v R (1978) 22 ALR 599, 618. 18 In my view, just as Mr Humphreys' report was admissible upon the application of these principles, Mr Jugmans' report complies with the principles and is admissible. As I understood him, senior counsel for CMG reached the position during submissions that he did not challenge the strict admissibility of the report. 19 Rather than attacking the tender on grounds relating to strict admissibility, counsel for CMG invited me to exercise my discretion against allowing the report into evidence under s 135 of the Evidence Act 1995 (NSW), essentially on six grounds. 20 The first ground relied on by CMG was that the report by Mr Jugmans was served later than the time limit provided for in my directions, and after senior counsel for CMG had left on vacation (his intention to do so having been made well known to the parties in advance). I sympathise with the frustration that the late filing of the report must have caused to CMG and its legal team, but I do not regard Allatech's delay by a few days as sufficiently serious to justify my excluding the report from evidence. The report is detailed and obviously reflects a great deal of work, the execution of which may well have absorbed more than the time allowed in my directions. Although it is regrettable that it was filed out of time, any prejudice caused to CMG by the delay could be addressed in other ways, if necessary. 21 Senior counsel for CMG also submitted that there was ample time for Allatech to produce a report by Horwaths, well in advance of the commencement of the final hearing. He noted that Horwaths were instructed on behalf of Allatech in April this year, and that Allatech was invited to file a report from Horwaths in May. He offered to tender a bundle of correspondence on the subject. I decided not to embark on an inquiry into that correspondence. I was aware, having heard many other interlocutory applications, that there was a dispute for some time as to whether Allatech and Horwaths had been given access to all of the financial information going to the solvency of CMG at the relevant times. Further, Mr Humphreys' report was completed and filed only on 18 July 2002, and clearly the task of responding to it has been a substantial one. In my view it cannot be said that fairness required Allatech to produce a report by Horwaths substantially sooner than the report was in fact produced. 22 Secondly, CMG submits that Mr Jugmans' report does not merely reply to Mr Humphreys' report, but contains substantial new material not canvassed in the evidence to date. In his written submissions, senior counsel for CMG lists 21 examples of new material. Much of the oral argument on the admissibility of Mr Jugmans' report was directed to these examples. 23 It is not necessary for me separately to set out my views with respect to each of the 21 examples identified in CMG's written submissions. Having considered the argument and the evidence adduced so far in the proceeding, I have concluded that, by and large, the additional factual material introduced by Mr Jugmans is in the nature of inferences from identified documentary evidence tendered or to be tendered, made in reasonable response to Mr Humphreys' report. Essentially CMG's contention is that the inferences should not be drawn by Mr Jugmans because, regardless of whether they may be plausible on the basis of the material before him, they do not accord with the whole of the facts. 24 At one stage during argument I was attracted by the submission that Mr Jugmans' report is categorically different from the report of Mr Humphreys, because of the way that Mr Jugmans has drilled down into matters of specific fact in the inferences he has made. On reflection, however, it does not seem to me that there is any categorical difference between the two reports. Mr Jugmans has given much more detail in his opinion and his inferences than Mr Humphreys, but his report is nevertheless a response upon the subjects that were raised by Mr Humphreys and differs in degree rather than in kind. 25 I am not able to conclude that any of the discretionary criteria of s 135 is attracted. I accept the submission by counsel for CMG that he may find it necessary (subject to any leave that may be required) to adduce a substantial volume of additional evidence to respond to the matters raised by Mr Jugmans' report, but I do not, for that reason, conclude that to admit the report into evidence would lead to or involve a waste of time. It has become evident that, unless Mr Jugmans' report is rejected, it will not be possible to complete the hearing in the time presently allocated for it in any event, and so CMG will have time, if it wants it, to prepare additional evidence prior to the resumed hearing. 26 Thirdly, CMG complains that Mr Jugmans' report is based on "a vast number of assumptions", detailed in the further report by Mr Humphreys dated 20 August 2002. The submission is not that the report makes and articulates assumptions (indeed, it is conceded that this is the proper approach for an expert to take), but that there is no evidence making good the assumptions and that to canvass the appropriateness of the assumptions would involve many more days of evidence. During submissions senior counsel for CMG seemed to imply that in his view, any assumptions made by an expert in his or her report must be made good by the party tendering and relying on the report, but in the end he conceded that the correct principles are stated above. He put his submission on the basis that the assumptions made by Mr Jugmans were either unreasonable or would lead to substantial new factual inquiries upon which the Court should not embark at this stage. The written submission lists seven areas in which substantial additional evidence would be required. 27 Once again, I do not believe it is necessary separately to set out my views with respect to each of the seven areas identified in the written submission. Having considered each of them, I have formed the view that the assumptions made by Mr Jugmans are pertinent to the issues he has been asked to address, they are clearly set out, and they are reasonable to be made in response to Mr Humphreys' report. I accept CMG's submission that will be necessary to adduce substantial further evidence in order to show, if it wishes to do so, that each of these assumptions is so out of line with the facts that Mr Jugmans' resulting opinions should be given no weight. But I have decided that this does not provide sufficient ground for me to exclude the evidence under s 135. 28 Fourthly, CMG submits that Mr Jugmans has overlooked material facts which could detract from his concluded opinion (citing National Justice Compania Naviera SA v Prudential Assurance Co Ltd (The Ikarian Reefer) [1993] 2 Lloyd's R 68 at 81-2). Seven examples are given. Once again, I have considered each of these matters but I do not regard it as necessary to set out my reasoning separately on each point. In my opinion, CMG's submissions on the subject go to the weight to be given to Mr Jugmans' evidence rather than to its admissibility. I accept that failure by an expert to consider material facts may be a sufficient ground for rejecting that expert's evidence. Here, however, it is not clear to me that the matters identified in the written submission were not considered by Mr Jugmans, although that issue may become clearer when he is cross-examined. Moreover, the facts allegedly not considered are not so clear-cut, nor so fundamental to Mr Jugmans' conclusion as to the financial position of CMG at the relevant times, that his evidence should be rejected in limine. 29 Fifthly, CMG submitted that, if Mr Jugmans' report is admitted into evidence, Mr Henry's cross-examination (currently underway) should not be allowed to continue on any of the issues raised in Mr Jugmans' report, until he has had ample time to consider the report. Further, CMG contended that Mr Mann should have been cross-examined first on the issues raised in Mr Jugmans' report and that to recall him for further cross-examination now, after he has spent time giving instructions to Mr Jugmans of these issues, would not be conducive to fairness and the search for truth. 30 As to Mr Henry's evidence, given that it will not be possible to finish the case in the allotted time if Mr Jugmans' report is allowed into evidence, the appropriate course is to defer further cross-examination until the resumption of the hearing. That will give Mr Henry ample time to consider Mr Jugmans' report. As to Mr Mann's evidence, the submission really is that CMG has missed the opportunity for forensic advantage. I am not sure that this is so, but if it is, nothing can be done about the matter now and I do not regard CMG as having suffered any significant prejudice. If an application is made to recall Mr Mann for further cross-examination in light of the further evidence constituted by the Jugmans report and foreshadowed further evidence by CMG, I shall consider it on its merits. 31 Sixthly, in his oral submissions senior counsel for CMG invited me to exercise my discretion under s 135 to reject Mr Jugmans' report in light of the overall impact of the report on the progress of the hearing. During the course of argument senior counsel for Allatech had foreshadowed an application for a reference out under Part 72 of issues relating to solvency, after Mr Humphreys and Mr Jugmans had been directed to produce a joint report identifying their differences and CMG had been given the opportunity to put on the further evidence that it said would be needed if Mr Jugmans' report were in evidence. Senior counsel for CMG said (Transcript, 22 August 2002, p 535-6: "My basic submission is, that applying the provisions of section 135 and having regard to the plethora of issues that are going to arise and the fact that the answers to any of these things may not be decisive one way or the other, the probative value of all of this evidence and the costs to the parties of yet another reference and very substantial affidavits and preparations doesn't justify the end result and doesn't assist your Honour, ultimately, in the section 445D task which your Honour is compelled, or required, to decide." 32 I have much sympathy with this submission. I am not sure that further evidentiary inquiry into the financial position of CMG at relevant times will put me in a materially stronger position to decide the issue under s 445D than I was in before the tender of any experts' reports. 33 However, both parties have pressed the tender of experts' reports which are, in each case, strictly admissible. I do not think it would be proper for me to intervene by preventing the parties from doing so, when both of them are determined to extract such advantage (limited though it may be) as may be gained through reliance upon expert opinion. There is no basis for me to exclude Allatech's expert's report, having admitted CMG's expert's report into evidence. 34 I invited senior counsel for CMG to reconsider whether his client would withdraw the tender of Mr Humphreys' report if Mr Jugmans' report was not put into evidence. My suggestion arose out of the submission by senior counsel for CMG that, if Mr Jugmans' report was put into evidence, it would be necessary for CMG to respond with substantial additional evidence, and therefore the length and cost of the hearing would be greatly increased. CMG was not prepared to do so. In the circumstances, I do not see any real alternative but to allow Allatech to put on its expert evidence, which is clearly admissible subject to discretionary considerations, in reply to CMG's evidence and for everyone to face up to the consequences of doing so, as regards the length and cost of the hearing. 35 I shall make directions for a joint report of the experts and for the parties to put on additional evidence concerning solvency, and I shall then consider Allatech's foreshadowed application for a reference out under Part 72. CMG has also foreshadowed an application for vacation of the stay of the reference out to the Honourable Morton Rolfe QC of the Allatech proceeding. I shall give directions for the hearing of that application. It may be that the other proceedings can be resolved more quickly and cheaply than the present case, given the difficulties that have arisen here. 36 In my view the whole of Mr Jugmans' report should be admitted into evidence. **********

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