Costs - security for costs - relevant principles for order for costs against defendant who defends and counter-claims - necessity to identify who is the aggressor in a commercial sense

Supreme Court Act 1933, s.92 Corporations Law, s.1335 Supreme Court Rules, O.75B, 4.7, Schedule 13, O.33B, O.61A, r.1(1)

Delany, Security for Costs (Law Book Co., 1989) p.17 Halsbury, 4th ed., Vol. 37, para 303 Visco v Minter [1969] P 82 Fat-sel Pty Ltd v Brambles Holdings Ltd (1985) ATPR 40-544 Do Carmo v Ford Excavations Pty Ltd [1981] 1 NSWLR 409 House v The King (1936) 55 clr 499 In Re Milosevic (unreported, Hogan AJ, 13 September 1996) Aquatown Pty Ltd v Holder Stroud Pty Ltd (1995) 18 ACSR 622 Interwest Ltd v Tricontinental Corporation Ltd (1991) 5 ACSR 621 Weily's Quarries v Divine Shipping Pty Ltd [1994] TASSC 76; (1994) 14 ACSR 186

Counsel for the Plaintiff: Mr G. Richardson SC and Mr R. Clynes

Counsel for the Defendant: Mr J.S. Hilton SC and Mr R. Refshauge

1. The order for security for costs made by the Master on 2 August 1996 be set aside. 2. The plaintiff pay the defendant's costs of the application before the Master and of this appeal.

1. This is an appeal against a decision of the Master delivered on 2 August 1996 whereby the defendant was ordered to provide security for costs in the sum of $160,000 and, pending compliance with this order, all further proceedings by the defendant be stayed. The defendant was also ordered to pay the plaintiff's costs of the application.

2. Proceedings were instituted in this Court by Writ of Summons issued on 9 June 1992 by the plaintiff for payment of a contractual debt of $309,250.96 plus interest and costs. The dispute arose out of an agreement between the parties dated 8 September 1989, wherein the plaintiff was to grant a licence to the defendant "to manufacture, use, market, sell and otherwise commercialise" certain technology. This technology related to "phase change materials". These materials are substances which will preserve a low temperature environment without refrigeration or cooling. As the learned Master recognised, "the successful development of such a substance has enormous commercial potential". In addition, the plaintiff was to undertake research in consideration of payments to be made by the defendant, as particularised in the agreement.

3. It is claimed by the plaintiff that the terms of the agreement giving rise to the dispute, provided for the following: (1) The defendant was to pay $125,000 to the plaintiff on a date nominated by the parties (clause 6.5). That date was nominated to be 22 November 1991. (2) The defendant was to pay the royalties at 21 November 1991 and each year following. A requirement of a minimum annual royalty of $50,000 was imposed (clause 6.15). (3) The defendant was to contribute not less than $30,000 in the first and second year of the agreement in respect of building and production of, and alterations to, prototype equipment (clause 6.9). (4) The defendant was to fund the reasonable costs of applying, maintaining and renewing any patent (clause 9.3). (5) The defendant was to pay $7,700 per month to the plaintiff for 6 months from 23 November 1990 for the purpose of further research and development (clause 7.10.

4. A second written agreement between the plaintiff and the defendant, made on or about 9 August 1990, provided that the defendant pay to the plaintiff a contribution to the cost of production of prototype equipment and that the plaintiff would undertake patent applications in Australia and elsewhere (clause 9.1).

5. The plaintiff alleges that the defendant is in breach of both the first and second agreements, and claims $309.250.96 for non-payment.

6. By its Amended Defence (wrongly called Further Amended Notice of Grounds of Defence to Writ of Summons and Notice of Counter-Claim) the defendant denies any liability to the plaintiff on certain grounds set out therein. Briefly stated, those grounds were that payment of the moneys claimed by the plaintiff was conditional upon performance by the plaintiff of its obligation under the agreement which it had not done.

7. By its Cross-Claim, the defendant seeks damages for alleged breach of contract and misrepresentation. The basis of this claim is that: (1) the plaintiff failed to make accurate representations concerning the nature and quality of the materials it had developed and the defendant's reliance upon these representations resulted in substantial costs being incurred by the defendant and non-receipt of anticipated royalties; (2) the representations were made negligently and in breach of duty; (3) the plaintiff failed to do certain things pursuant to the agreements, including providing information promptly to allow the defendant to undertake negotiations for the sale and further development of the materials; and (4) the plaintiff failed to comply with other obligations under the agreement.

8. It is not necessary to set out all the failures of the plaintiff relied upon by the defendant.

9. In particulars of the Cross-Claim the defendant claims damages totalling $5.6 million (incorrectly referred to in proceedings before this Court as $5.4 million), plus costs and interest.

10. By Notice of Motion returnable on 26 April 1996, the plaintiff sought the orders granted by the Master on 2 August 1996. The appeal to this Court is brought pursuant to s.92 of the Supreme Court Act 1933 (ACT).

11. It was common ground on the hearing of the appeal that an application for security for costs was within the jurisdiction of the Master either in respect of an application brought under s.1335 of the Corporations Law, pursuant to O.75B, r.7 and Schedule 13 of the Supreme Court Rules, or in respect of the general power to seek security contained in O.33B pursuant to O.61A, r.1(1).

The Master's decision 12. In ordering security for costs, the Master identified that a court's discretion is exercisable: "where a party is forced into court to defend an action in circumstances where, even if that party is eventually successful, the party bringing the unsuccessful action would be unable to meet the costs orders that would flow. This acknowledges the reality of litigation - that the plaintiff has the choice of continuing the process or not, whereas the defendant must incur the costs of the defence, or risk a form of default judgment, whatever the real merits of the case."

13. The Master then referred to Delany, Security for Costs (Law Book Co., 1989) at 17: "Traditionally, security would only be ordered against a person in substance the plaintiff. The rationale was that security should not be ordered against persons compelled to litigate."

14. The Master concluded that the question of who is a defendant and who is a plaintiff for the purposes of a security for costs order is a question of substance and not of form.

15. In analysing the substance of the matter brought before the Court, the Master referred to the principles espoused in Visco v Minter [1969] P 82 at 85: "The principle seems to be that where a defendant counter attacks on the same front on which it is being attacked by the plaintiff, it will be regarded as a defensive manoeuvre. But if he opens a counter attack on a different front, even to relieve pressure on the front attacked by the plaintiff, he is in danger of an order for security or costs depending on the Court's assessment of the position in each case."

16. The Master then quoted Young J in that same case where his Honour stated that: "... one should focus on the question as to whether in a commercial sense the defendant to litigation is the aggressor."

17. In the Master's opinion, the requirement of identifying the aggressor represented the correct approach to be taken by this Court in the present case.

18. The Master went on to quote the relevant law as stated in Halsbury (Vol. 37, 4th Ed., para 303): "Where the defendant makes a counterclaim, he does not necessarily place himself in the position of a plaintiff so as to be liable to give security for costs. The crucial question is whether, on analysis, the counterclaim operates as a defence, in which case the defendant is merely defending himself, or it amounts to a crossclaim, in which case he is in a position of a plaintiff prosecuting his own claim."

19. I turn to the primary facts as found by the Master, when he considered who the aggressor was in this matter. The Master found that the respondent's counterclaim was "quite apart from and additional to" the defence it also filed. The Master's reason for coming to this conclusion, it would seem, was that if the plaintiff abandoned its claim for unpaid moneys under the contract, the defendant's counter- claim for $5.6 million would still stand. The Master then deduced from this that the defendant was the aggressor because the counter-claim went beyond the function of a "mere defence" and involved a "substantial claim".

20. The Master made certain findings of fact when deciding that the grounds for making an order for security for costs had been made out. First, the demand made by the plaintiff was "an appropriate demand for security" and that the amount had been estimated by "an appropriately experienced practitioner".

21. Secondly, the defendant had "no discernible assets against which ANUTECH might execute upon any future costs orders", and that the defendant was "without its own funds" and was compelled to utilise directors' funds to meet costs orders made to date.

22. Thirdly, in light of the evidence the defendant had always been impecunious and he rejected the argument that the defendant's impecuniosity was attributable to the plaintiff.

23. Fourthly, the defendant had a substantial claim for the loss of profits it could have expected to earn in the future, which was to be contrasted for present purposes with a claim for damages to recoup funds lost in reliance upon the plaintiff's representations. The Master referred to Fat-sel Pty Ltd v Brambles Holdings Ltd (1985) ATPR 40-544 at 46,428 where it was acknowledged that there is a difference between refusing security in each of these instances, the former case giving rise to such a refusal.

24. Fifthly, the Master acknowledged that it could be successfully argued that to make an order for security for costs would stultify the litigation, however to do so it must be shown that it is not only the company who is without funds, but also those standing behind the company. In the present case, the Master was of the opinion that the defendant had failed to illustrate this.

Appeals from the exercise of discretion by the Master - relevant principles 25. In Do Carmo v Ford Excavations Pty Ltd [1981] 1 NSWLR 409, Cross J set out the relevant principles which govern the power of an appellate court to examine the discretion exercised by a Master. Cross J expressed the view that in relation to the exercise of a discretion by a Master, the Judge on appeal is bound to approach the matter in the same way as the Court of Appeal (in New South Wales) would examine the exercise of a discretion by a Judge (or by a Master), ie in the manner referred to in the well-known passage from House v The King [1936] HCA 40; (1936) 55 CLR 499, at pp.504, 505, where Dixon, Evatt and McTiernan JJ said: "The manner in which an appeal against an exercise of discretion should be determined is governed by established principles. It is not enough that the judges composing the appellate court consider that, if they had been in the position of the primary judge, they would have taken a different course. It must appear that some error has been made in exercising the discretion. If the judge acts upon a wrong principle, if he allows extraneous or irrelevant matters to guide or affect him, if he mistakes the facts, if he does not take into account some material consideration, then his determination should be reviewed and the appellate court may exercise its own discretion in substitution for his if it has the materials for doing so. It may not appear how the primary judge has reached the result embodied in his order, but if upon the facts it is unreasonable or plainly unjust, the appellate court may infer that in some way there has been a failure properly to exercise the discretion which the law reposes in the court of first instance. In such a case, although the nature of the error may not be discoverable, the exercise of the discretion is reviewed on the ground that a substantial wrong has in fact occurred."

26. See also In Re Milosevic (unreported decision of Hogan AJ delivered 13 September 1996).

The defendant's submissions on appeal 28. The defendant submitted that the Master erred in the exercise of his discretion to order security for costs because he failed to analyse the piece of litigation before the Court and consequently to identify that the claim and the counter-claim arose out of the same matter or transaction.

29. It was further submitted that the Master did not in fact base his conclusion on the "substance of the litigation", rather he viewed the defendant as the aggressor "solely upon the grounds that its claim for damages was some $5.4 million, whereas the plaintiff's claim was for "some $300,000 for moneys allegedly unpaid under the contract".

30. It was further submitted by the defendant that the Master failed to take into account the following material considerations: "(i) that the counterclaim raised issues which were pleaded in the defence; (ii) that the counterclaim raised issues which could be relied upon as an equitable set off - ie a defence- to the plaintiff's claim; and (iii) that those issues of fact raised in the counterclaim overlapped with, or were co-extensive with issues of fact pleaded in the defence."

31. In these circumstances, it is the defendant's contention that the Master erred in his conclusion that the counter-claim was "on the pleadings quite apart from and additional to the defence".

32. It is clear law that the crucial question is whether on analysis the counter-claim operates as a defence, in which case the defendant is really defending himself, or it amounts to a cross action, in which case he is in the position of a plaintiff prosecuting his own claim (Halsbury, 4th ed., Vol. 37, para.303). That passage was quoted by the Master in his reasons for judgment, but he did not go on to quote the very next sentence in Halsbury in the same paragraph, as follows: "Thus, where the claim and the counterclaim arise out of the same matter or transaction, and the counterclaim is in fact the defence to the action, security will not ordinarily be ordered from the defendant who is resident abroad or a limited liability company (Accidental and Marine Insurance Co v Mercati (1866) LR 3 Eq 200; Mapleson v Masini (1879) 5 QBD 144, DC, where the counterclaim was in respect of breaches of the contract sued on by the plaintiff; Neck v Taylor [1893] 1 QB 650, CA)."

33. In addition, the defendant submitted that because its claim was substantially in excess of the plaintiff's in terms of quantum, this was the predominant if not sole consideration of the Master when deciding the substance of the litigation and who was the aggressor in a commercial sense.

34. It was submitted that the Master failed to have regard to the impecunious state caused or brought about by the conduct of the plaintiff. It was the defendant's submission that the Master misapprehended the defendant's case because in his judgment he held that the defendant had "always been impecunious" and that the defendant's claim for damages was only or mainly for loss of expected profits.

35. In coming to his conclusions, the Master seems to have had no regard to the contents of the affidavit of Henry Norman Freedman, the solicitor for the defendant, sworn 31 May 1996, wherein Freedman said: (1) in addition to the capital contributions from its directors and some commercial borrowings, the principal source of income available to the defendant for its operations was to be obtained from the fees secured under the sub-licence agreements with other companies throughout the world for the exploitation of the technology. To this end the defendant undertook a world-wide marketing campaign and commenced negotiations with various interested parties. (2) An agreement with a Korean company was entered into but operations were unable to proceed since the technology could not in fact be exploited commercially for the alleged reason that the representations of the plaintiff as to the existence and properties of the technology were false. (3) The defendant supplied products to Telecom under an agreement but the products manufactured in accordance with specifications pursuant to the agreement were unsatisfactory for the purpose for which Telecom required them, despite the representations made by the plaintiff to the contrary, and that agreement also ended. (4) In the circumstances, no further marketing by the defendant was commercially possible. (5) The directors of the defendant provided capital and effected borrowings to provide funds from which the defendant expended the moneys, more particularly described in para 6 of the counter-claim in and about the commercial exploitation of the technology. (6) As a result of the failure of the arrangements with the Korean company and Telecom, the defendant was unable to generate sufficient income to continue trading in the technology which was the business for which it had been established. Accordingly, the only source the defendant has from which to fund the current proceedings in this Court and the Federal Court proceedings, are capital contributions or loans made by its directors; and (7) the defendant claims that the alleged falsity of the representations made by the plaintiff has caused its present lack of income and that any order for security for costs would prevent it from prosecuting these proceedings.

Submissions on behalf of the plaintiff on appeal 36. It was submitted on behalf of the plaintiff that if the defendant had commenced the action based upon its counter-claim, it would clearly be ordered (other things being equal) to provide security for costs. Similarly, the plaintiff in those circumstances would not be required to give security because the defendant's counter-claim is for a far greater sum and involving much greater complexity.

37. All the other facts were properly considered by the Master, so the plaintiff's submission went, including the amounts involved, the ability of the defendant to pay, the nexus between impecuniosity and the alleged misconduct stultifying the action and the resources behind the defendant, the prospects of success of the defendant on its counter-claim, and the delay by the defendant in getting its claim in order.

38. Having considered all those submissions, I am satisfied that the Master's analysis of the pleadings and his reasoning, fail to take into account the following material considerations, namely: (1) that the counter-claim raised issues which were pleaded in the defence; (2) that the counter-claim raised issues which could be relied upon as an equitable set-off - ie a defence to the plaintiff's claim; and (3) those issues of fact raised in the counter-claim overlap with or were co-extensive with, issues of fact raised in the defence.

39. In the circumstances, the Master erred in his conclusion that the counter-claim was "on the pleadings, quite apart from and additional to the defence".

40. It appears to me that the Master overlooked that the issues arising under the defendant's counter-claim are substantially defensive in character and the bulk of the time and resources required to litigate those issues would be devoted to establishing that in truth the defendant had a defence to the plaintiff's claim even if, in the end result, success for the defendant in this result could eventuate in a substantial verdict for the defendant against the plaintiff. In that respect I agree with the assessment by Freedman, as stated in paragraph 10 of his affidavit sworn 31 May 1996.

41. The relevant principles were summarised by Sundberg J in Aquatown Pty Ltd v Holder Stroud Pty Ltd (1995) 18 ACSR 622. Sundberg J cited the following passage in Interwest Ltd v Tricontinental Corporation Ltd (1991) 5 ACSR 621 where Ormiston J said: "Perhaps it may be said that the authorities support the proposition that security will only ordinarily be ordered against a party who is in substance the plaintiff, and that an order ought not to be made against parties who are defending themselves and thus forced to litigate: cf. Accidental & Marine Insurance Co v Mercati (1866) LR 3 Eq 200. That would appear to be an overstatement, but the fact that a plaintiff ... has instituted essentially defensive proceedings, must be a significant factor in the exercise of the court's discretion."

42. After noting Sydmar Pty Ltd v Statewise Developments Pty Ltd (1987) 73 ALR 289 where, at 300, Smart J said that the factors relevant to the exercise of the discretion to order security include "whether the plaintiff's proceedings are merely a defence against "self-help" measures taken by the defendant", Ormiston J said: "Principally it would appear necessary to characterise the proceedings in respect of which security is sought. If they are 'defensive' proceedings, either directly resisting proceedings already brought or seeking to 'halt self-help procedures', it would seem that to require security would be oppressive, or at least would provide serious grounds for refusing to make an order. At the least, it is a factor to be considered in the exercise of the discretion."

43. In my opinion, the order for security for costs made by the Master was oppressive or manifestly unfair because he failed to recognise that the defendant was genuinely trying to resist the plaintiff's claim and his order would operate as a fetter upon the defendant's ability to do so (Interwest Ltd v Tricontinental Corporation Ltd (1991) 5 ACSR 621 at 626-7; Weily's Quarries v Divine Shipping Pty Ltd [1994] TASSC 76; (1994) 14 ACSR 186, 189-90).

44. It is unnecessary to deal at any length with the submission on behalf of the defendant that the making of an order for security for costs may stultify the litigation. For the purposes of the appeal, the defendant accepted the onus of establishing that persons standing behind the defendant in the litigation could not provide a requisite security for the benefit of the defendant. Accordingly, an order for security for costs would affect the defendant's ability to pursue these proceedings and the Federal Court proceedings. That consequence illustrates the harshness and unfairness of the order for security for costs against the defendant. There was ample evidence to that effect in the affidavit of Freedman. That was a factor which the Master should have taken into account. It was evidence that was not contradicted, not cross-examined upon, and was inherently probable.

45. In all the circumstances, I am of the firm opinion that the exercise of the Master's discretion was wrong and the order for security for costs should be set aside. I order accordingly.

46. I further order that the plaintiff pay the defendant's costs of the application before the Master and of this appeal.