ASIC v Somerville & Ors

CATCHWORDS : CORPORATIONS - breaches of civil penalty provisions - whether exoneration appropriate - whether prohibition orders should be made - degree of responsibility of particular defendants

LEGISLATION CITED : Corporations Act 2001 (Cth), ss 1317S and 1318

ASIC v Edwards [2006] NSWSC 376 ASIC v Macdonald (No 12) [2009] NSWSC 714 CASES CITED : ASIC v Somerville & Ors [2009] NSWSC 934 Commissioner of Corporate Affairs (WA) v Ekamper (1987) 12 ACLR 519 Re HIH Insurance Ltd: ASIC v Adler (2002) 42 ACSR 80 Rich v ASIC (2004) 220 CLR 129

Australian Securities and Investments Commission (P) Timothy Donald Somerville (D1) Somerville & Co Pty Limited (D2) Nicholas Eugene Jones (D3) Simon Durant (D4) PARTIES : Calvin Bert Rowley (D5) John Lancelot Bradnam (D6) Christopher Paul Martin Jones (D7) Adam Leslie Troost (D8) John William Monsell (D9) Arthur James Wells (D10)

J W J Stevenson SC & A J McInerney (P) B A J Coles QC & P M Barham (D1&2) In person (D3) In person (D4) COUNSEL : D L Cook (D5) In person (D6) In person (D7) P Reynolds (D8) No appearance (D9 & 10)

Conrad Gray, Solicitor (P) SOLICITORS : Boyd House & Partners (D1&2) Slater & Gordon (D5) David Frederick Carr, Lawyer (D8)

• 17 - IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION

2154/08 AUSTRALIAN SECURITIES AND INVESTMENTS COMMISSION v TIMOTHY DONALD SOMERVILLE & ORS (No 2) JUDGMENT 1 HIS HONOUR: In my earlier judgment in this action, ASIC v Somerville & Ors [2009] NSWSC 934 ("my earlier judgment"), I found that each of the third to tenth defendants had contravened ss 181(1), 182(1) and 183(1) of the Corporations Act 2001 (Cth) ("the Act") and that the first defendant had been involved in each of the contraventions found and that the second defendant had been involved in one of them. 2 This judgment deals with claims for exoneration under ss 1317S and 1318 of the Act and if exoneration is not obtained then the claim for ASIC seeking orders that the various defendants be disqualified from being involved in the management of a company for a period of years to be determined by the Court. For the purpose of this decision, I will refer only to s 1318, as there seems no real difference between the sections. 3 I refer to some procedural matters. The only defendants who have filed defences are Mr Somerville, Somerville & Co Pty Limited, Mr Rowley and Mr Bradnam. These four defendants seek to be excused for the breaches found in accordance with the two sections of the Act to which I have referred. The ninth and tenth defendants have not appeared at the hearing but, as I said in my earlier judgment, they and the third and seventh defendants had consented to declarations as to contravention being made against them. They did not appear at the second part of the hearing. Mr Nicholas Jones the third defendant, Mr Durant the fourth defendant, and Mr Christopher Jones the seventh defendant, appeared in person on this second part of the hearing, gave evidence and made submissions. Mr Troost, the eighth defendant, has been represented throughout. He filed an affidavit relating to the penalty which was read on this hearing. He always accepted that the contravening conduct took place although he indicated that had the Somerville defendants successfully challenged the claims of contravention made in connection with the transaction involving his company, then he would wish to take the benefit of that success. Mr Rowley, the fifth defendant, has been represented throughout by Mr Cook. As I have said, he did file a defence and he filed an affidavit which was read on the penalty hearing. I have decided to proceed on the basis that all defendants have sought exoneration. I do that because those representing themselves could not be expected to understand any pleading requirement and if they are given this indulgence, Mr Troost should be also. 4 I should indicate that I stated during the hearing and it was accepted by all parties that the exoneration claims should be heard together with the disqualification applications. This seemed to be an appropriate course having regard to the relatively simple nature of the facts in each case. That course was followed by Barrett J in ASIC v Edwards [2006] NSWSC 376. 5 Exoneration under s 1318, in the case of the breach of a civil penalty, requires the Court to be satisfied that:

(a) the person committing the breach has acted honestly; and (b) having regard to all the circumstances of the case, the person ought fairly to be excused for the breach.

If those conditions are met, the Court may relieve the person either wholly or partly from liability on such terms as the Court thinks fit. 6 As would be made clear from the reasons in my earlier judgment, relief could not be given to the Somerville defendants under the sections and it was not really seriously argued that it could be. 7 So far as the other defendants are concerned whether raised by defence or not, they would all say that as regards s 1318, that they acted on the advice of Mr Somerville having gone to him for advice, and that they had no intention of acting dishonestly. 8 It has been held in a number of cases, that the question of honesty or dishonesty here is not one of subjective intention; some of the cases are collected and discussed in ASIC v Edwards at [8] to [10]. 9 I will not restate the facts set out in my earlier judgment which are of course relevant to this part of the action and are to be considered as part of this judgment for that purpose. I will, however, have to deal with additional evidence given on this part of the hearing taking the defendants in turn. Nicholas Eugene Jones 10 Mr Jones gave some short evidence, the gist of which was that he had made no money from the transactions under investigation and that he and his wife had lost money. He did accept there would be some disqualification but referring to what he called the James Hardie Ltd case submitted that there should be some proportionality. He said he was saddened by what had happened. In answer to a question from me, he said he was still moving furniture but through which corporate vehicle, if any, I do not know. I say that because up-to-date searches in Ex D indicate that Jones Removals Pty Ltd was wound up by Court order on 23 April 2009 when Mr D A Hurst was appointed liquidator, the creditor seeking the winding up was Workers Compensation Nominal Insurer. No questions were asked about this but it would seem that however he is moving furniture, Mr Jones cannot be doing it through Jones Removals Pty Ltd. As there was nothing in the statement of claim directed to this and no submissions were made about it, I disregard it other than to record that whether as a sole trader or through some other company, Mr Jones says that he is still in the business of moving furniture. He said that he did not understand the law, though he accepted there was no excuse for this. He said, "All I ever attempted to do was to stay in business and keep employed the guys that worked for me." 11 There could, I think, be no question of exoneration. Mr Jones did know what he was doing. On the first transaction the settlement date had to be altered to bring it before the winding up hearing; on the second transaction the winding up action had to be adjourned to enable the new corporation structure to be put in place. He said in answer to a question from me about his comment to Mr Somerville, "It sounds a bit rich" when discussing a second transaction, that he was taking advice from a lawyer and that you should not have to check that advice - a statement with which I agree. However, he went on to say, "So I said that, I obviously said it, that we had been through the 1980s with Alan Bond walking away with truck loads of money and I thought probably I could keep a few blokes employed without leading to any dire effects." In terms of s 1318, that is not honest behaviour. Simon Durant 12 Mr Durant read an affidavit and gave some oral evidence. The effect of this was that he acted on the advice of his accountant, a Mr Hurley, and of Mr Somerville and that Mr Somerville told him the current creditors would get more from a restructure than from administration. He said that the new Stimulus company paid the majority of the creditors of the old company. While I accept that evidence, it must be remembered that the creditors paid up were employees and providers of services which the new company needed. It was the actions of the Deputy Commissioner of Taxation which triggered the timing of the restructure, the effect of which was to put the old Stimulus assets out of reach of the Commissioner unless the liquidator took action on the basis of an uncommercial transaction which would require funding. There was never any suggestion payment would be made by dividends declared on the "V" class shares. Mr Durant was declared bankrupt as a result of proceedings by the Australian Taxation Office. The new Stimulus company itself went into administration in February 2005 and a deed of company arrangement followed. There is no evidence about that administration. Mr Durant is sole shareholder and director of two IT companies. In an exchange with me, albeit during submissions, but in view of the way the hearing with the unrepresented litigants took place, which probably can be regarded as evidence, the following passage appears: "HIS HONOUR: What is going to happen to you if you can't be a director of the company - sorry, involved in the management of a company?

FOURTH DEFENDANT: I only started having discussion with someone about that this morning. One of the businesses in particular with which I operate will probably have to be sold. I don't know of any other way to run it. But, you know, I haven't had proper advice on how that may transpire, I don't know. The consultancy services, that may just result in my being becoming a sole trader and it will have a significant impact

HIS HONOUR: It might. But the ultimate result might be that you might become personally responsible for the liabilities of any business which you conducted.

HIS HONOUR: The ultimate result might be that you will become personally liable for the debts of any business you conduct. What would be wrong with that?

FOURTH DEFENDANT: Apart from - look, running a business there is always unforeseen events. It may be that software product we develop has some major flaw and has an impact on businesses we sell it to and we have suits filed against us. And that means I'm once again left holding the bag with everything. That would have impact on not just myself but my children. And the way I understand the structure of companies and the law is it that being a director and having a company structure you afford yourself some protection against personal liability" 13 Finally, it is important to take into account the conduct here complained of took place about seven years ago. I do not think Mr Durant acted honestly, but if I were wrong I would not find he should be excused. Calvin Bert Rowley 14 Mr Rowley gave evidence on affidavit and short oral evidence as to contrition. He said that he thought he was doing the right thing. He is 45 years of age. He has a daughter aged 15 who lives part time with him and for whose upkeep and education he is responsible. He lives with a partner who is quite seriously ill. His is a one person company. Mr Cook who appeared for Mr Rowley made some very competent submissions that his client could not be blamed for choosing Mr Somerville as his solicitor and for acting on his advice and that his actions in purchasing the "V" class shares from the liquidator should be seen as a demonstration that he wished to act properly. There is force in that argument which in some ways applies to most of the other defendants except that they did not purchase the shares. There is also to be taken into account the fact that after the first restructure the new company traded for some 16 months. Nevertheless, the winding up of VMT was brought about by a penalty notice issued by the Deputy Commissioner of Taxation. This was also the reason for the second restructure. When failure to meet tax obligations, particularly for superannuation, GST and PAYG deductions are concerned in a company's move to insolvency there must be reason to doubt whether a person responsible for this default is a person proper to be involved in the management of a company. In the VMT case payments which were really wages were shown in the books as loans to directors so as to avoid group tax and superannuation consequences. It is proper when considering the question of disqualification to take into account not only the breaches found but circumstances giving rise to the breaches. Mr Somerville was not responsible for those circumstances. It is, I think, quite clear that it was never thought or intended the purchase moneys would be paid via dividends to the vendor companies, although it may well have been intended to pay employee entitlements or creditors providing services as the new company needed the employees and the services. Mr Rowley does not satisfy the s 1318 requirements. John Lancelot Bradnam 15 Mr Bradnam has expressed his sorrow for what has happened; his present work of developing software makes it convenient to be a director but he does not suggest he could not earn an income unless he were a director. His level of responsibility is a little less than that of Mr Rowley. Christopher Paul Mark Jones 16 This is a sad case. Mr Jones gave oral evidence. I do not think he ever had any concept of what he was doing. The dividend figure for the "V" class shares of $150,000 makes this clear. In oral evidence he said he had no understanding that this amount would be owing to the vendor company although the tax debt was only $40,000. Mr Jones has little work. He does not need a company to exist. His conduct resulted from advice from Mr Thorpe and Mr Somerville. It is, however, a matter of concern that a director of a company has no real understanding of the effect of arrangements being made in that company and a new company as a result of restructure. I do not consider his conduct honest but if it was he cannot be excused. Adam Leslie Troost 17 Mr Troost has filed two affidavits relevant to the second hearing. His evidence is that the claims of the drivers commenced before he was a director of B&R Storage Australia Pty Ltd; and that he realised if the drivers' claims succeeded there would not be sufficient resources to pay the expected judgment debt. He said that Mr Somerville told him that the dividends were discretionary. He was given the impression none would be declared and he would not have to pay the vendor company anything. He understood that the transfer of assets would defeat the employee claims of Collier and Riley but thought that it was in the interests of the company to protect the interests of other employees of whose there were about 40. Mr Troost has made some effort to pay creditors of the vendor company and has paid $150,000 to the liquidator of that vendor company to settle any claims against him. 18 While as with the other defendants, one might feel some sympathy for Mr Troost, any such feeling goes away on reading paragraphs 45 - 47 of his affidavit of 10 July 2009, which are as follows: "45. I say that whilst I acknowledge that my actions were a breach of the Act in the manner alleged by ASIC, I did not breach any standards of conduct that are expected of a person in my position and I did not commit any act which I did not have authority to commit. Or put another way, I only did things which I was authorised to do. 46. At no time did I use my position improperly to cause detriment to B & R. I was advised that B & R could not and would not be able to pay its debts as and when they fell due particularly as a result of the litigation brought by the 2 former employees. I was advised to liquidate B & R. 47. I took the advice and acted upon it." 19 His actions were not honest. He is not entitled to exoneration. However, disqualification will be more serious for him than for most of the other defendants. John William Monsell and Arthur James Wells 20 No evidence was adduced by these defendants. They did, however, consent to the declarations of breach and injunctive order. The evidence shows that the second company, Star Chrome Plating Pty Ltd, was wound up by Court order on 1 May 2008 on the application of the Workers Compensation Nominal Insurer. Nothing further is known about this. Of all the defendants, the impression I gained from the transcript of the ASIC examination was that they, like Mr Chris Jones, really had no concept of the transaction at all but they made some effort to pay the creditors of the original company. I do not consider their actions honest but I think they acted on advice without giving any thought to it. Disqualification 21 The Corporations Act 2001, s 206C provides that the Court may disqualify a person from managing corporations if a declaration of contravention of a civil penalty has been made. Section 206C(2) provides: "In determining whether the disqualification is justified, the Court may have regard to: (a) the person's conduct in relation to the management, business or property of any corporation; and (b) any other matters that the Court considers appropriate." 22 The fact that no order is made under s 1318 does not itself mean that there must be an order for disqualification or in a case where a pecuniary penalty is sought such a penalty. 23 As I have said, it has been put by a number of defendants or their counsel, and particularly strongly by Mr Cook, counsel for Mr Rowley, that it was the advice and actions of Mr Somerville which caused the breaches found; and had it not been for the involvement of Mr Somerville it is quite unlikely proceedings would have been commenced against the other defendants; and that at least in cases where s 206F applied, ASIC would have exercised powers under that section. It is said this is also relevant to costs. 24 This is no doubt correct and it might be considered unfortunate for the defendants here, that they were selected from the directors of the "dozens" of other companies involved in such restructures. However, the Court is dealing with contraventions established. It can of course, take into account the part played by Mr Somerville in the contraventions but ought not to consider some idea of bad luck. 25 The principles to be applied in disqualification cases are established in Re HIH Insurance Ltd: ASIC v Adler (2002) 42 ACSR 80 and discussed in Rich v ASIC (2004) 220 CLR 129 and most recently by Gzell J in ASIC v Macdonald (No 12) [2009] NSWSC 714. I have carefully considered the submissions of the defendants other than Mr Somerville as to their "just following advice". It is, however, necessary to remember that limitation of liability is justified on the basis that it encourages business development and risk taking and use of capital while not exposing directors and shareholders to personal liability. In other words, creditors' claims are, in general, limited to the assets of corporate vehicle. But the assets of the corporate vehicle are those which ought to be available to satisfy proper claims of creditors, and those claims should not be limited to being satisfied after all assets of substance have been removed being replaced by, at best, an asset of little value and probably of no value at all. 26 It is probably the fact that none of the defendants is likely to offend again so that the public needs no protection against the risk of further wrong-doing. Leaving aside Mr Somerville and dealing with the defendants other than Mr Rowley, then apart from Mr Nick Jones and Mr Troost, the relevant wrong-doing has not been of a particularly serious nature and has not involved very large financial losses. Mr Rowley's conduct falls between the two. However, small companies usually have small creditors to whom a relatively small loss can be of major concern. And failure to meet taxation obligations is a matter which in some way affects most Australians. 27 When taking into account the Adler principles it is necessary to consider principle (xii) which was an acknowledgement that the decision in Commissioner of Corporate Affairs (WA) v Ekamper (1987) 12 ACLR 519 sets out some matters to be considered in the exercise of the disqualification power, these being:

(1) Character of the offenders; (2) Natures of the breaches; (3) Structure of the companies and the nature of their business; (4) Interests of shareholders, creditors and employees; (5) Risks to others from the continuation of offenders as company directors; (6) Honesty and competence of offenders; (7) Hardship of offenders and their personal and commercial interests and (8) Offenders' appreciation that future breaches could result in further proceedings. 28 I have considered these matters in connection with the relevant facts for each offender, which I have set out in this and my earlier judgment. I have come to the conclusion that a period of disqualification is justified and that two years is appropriate for each of Mr Durant, Mr Rowley, Mr Bradnam, Mr Christopher Jones, Mr Monsell and Mr Wells. I consider the same period is appropriate for Mr Nicholas Jones, Mr Troost and Mr Rowley because while their conduct was more serious, disqualification is more harmful to them. Timothy Donald Somerville 29 There was read for Mr Somerville an affidavit sworn 9 September 2009. The incorporated legal practice of which he is a director employs 49 people. He had never been charged with or convicted of any offence. He is a member of the Law Society Specialist Accreditation Committee. He has been a director of a number of companies. Paragraphs 14 to 17 of his affidavit together with the heading are as follows: "Explanation of My Involvement 14 Over the years I have advised a great number of directors of insolvent companies, certainly too many for me to put a specific number on it. Depending on the circumstances, I have given different types of advice. I have often advised that the company should cease to trade, and the business should be shut. On other occasions, I have advised that the company be placed into administration with a view to entering into a deed of company arrangement. On other occasions, I have given the advice which is the subject of these proceedings. 15 I have only given the advice referred to in these proceedings where I have obtained instructions that the company has a business which would be profitable and viable if not for the debt or debts currently facing it, where the assets of the company would be minimal if the business ceased to trade, and where the stigma of administration would probably destroy the goodwill of the business. In such cases, I honestly believed that the creditors would be better off if the company could continue to trade and pay off its creditors over time. 16 In all such cases, I believed that it was likely that at least some of the creditors would be paid, who would not be paid otherwise, and that the continuing employees, who would otherwise be unsecured creditors of the old company would be likely to be paid their entitlements. I believed that, if the business were closed down, no such creditors would be paid anything like what they would be paid pursuant to the sale of the business as advised by me. That view was based on years of advising in relation to insolvent companies and being familiar with the methodology and costs involved in administering insolvent companies and them being wound up. 17 In the circumstances of my experience in the area I did not see the need to obtain the advice of experienced Counsel, rather than relying on my own opinions. In forming my own opinions I also relied upon the opinions of accountants with whom I conferred. Had I realised that my conduct was such as to be involved in breaches of the Corporations Act by those to whom I was providing advice as has been found by this Honourable Court, I would not have given that advice." 30 In cross examination, Mr Somerville said that he had given similar advice to that complained of on dozens of occasions, commencing about 10 years ago. He continued to give that advice even after he knew that ASIC was conducting the investigations which brought about these proceedings. He agreed that he had been told by Mr Krejci, one of the accountants involved in liquidating some of the companies, that Mr Krejci considered the transactions to be uncommercial but he thought that was incorrect. He said to Mr Krejci that no one had challenged the transactions and "until the Court proves otherwise I will continue to promote them". 31 In fairness I should say that where the last sentence of paragraph 15 of Mr Somerville's affidavit reads, "In such cases, I honestly believed that the creditors would be better off if the company could continue to trade and pay off its creditors over time", what was explained in cross examination was that what was meant was if the business could continue to trade rather than the company. I regret to have to come to the conclusion that I do not accept that statement. The advice given to Mr Troost in the letter and verbally, makes it perfectly clear that the view of Mr Somerville was that the creditors were unlikely to be paid and that it was really in the hands of the same director of the new company whether any payment was received or not, and by whom. Although he had every chance to do so, Mr Somerville gave no evidence that he considered that the creation of the "V" class shares was anything other than a subterfuge and there was an opportunity for him to do so after he had read and considered para [50] of my earlier judgment. 32 The purpose of the law creating an offence if directors allow a company to continue to trade when it is insolvent, is to prevent further debts being incurred and to allow for an orderly winding up and distribution of assets among the creditors. The effect of the transactions of which Mr Somerville was the architect, was to ensure that this could not happen. I have the greatest difficulty in accepting that Mr Somerville considered that his actions in these cases was proper and in accordance with the law. This is because he must have known the consideration for the sale of assets was not full consideration and was really a fiction and he must have know the transactions were uncommercial. If, however, he did consider that to be the position, then having regard to his position as a legal adviser it shows, I consider, that he ought not be a director, so that so far as these proceedings are concerned, he should be prohibited from taking part in the management of a company for a considerable time. 33 I should say that while there is evidence that Mr Somerville has been involved in what he said were "dozens of cases" apart from the specific ones under consideration here, there is no evidence about those other transactions except that they existed. It would, however, have been open to Mr Somerville to show that some of the other transactions did bring about a real benefit to creditors of the original company but he has not done so. I do not think that this evidence of other transactions should play any part in determining the question of penalty apart from enabling the inference to be drawn that there was a scheme as originally determined by me. 34 So far as hardship to Mr Somerville is concerned, it has not been put that he is unable to continue to practice as a solicitor either as a sole practitioner or in partnership. His corporate structure is one of choice but not an essential choice. 35 In my opinion, the conduct of Mr Somerville was far more serious than that of the other directors and a longer period of disqualification is called for. However, this is not a case which calls for disqualification for a very long period. It is not a case where substantial loss in HIH terms has been incurred as a result of the conduct. Nor is it a case where Mr Somerville has made a great amount of money from his involvement in the breaches. Nevertheless, I do regard the conduct as serious. I accept that the considerations of punishment and general deterrence should be considered together, yet it is important to send a message to the public and those closely engaged in corporate activity that conduct resulting in obvious breaches of the law which is likely to cause disadvantage to creditors of insolvent companies and which deprives them of their statutory rights will not be countenanced and this conduct is in general made worse by dressing it in misleading garments. 36 ASIC has asked for disqualification for 12 years. I consider that excessive and unnecessarily punitive. To some extent, deterrence and punishment are achieved by the publicity resulting from this case and the eventual costs order. Result 37 Each of the defendants other than the first and second defendants will be disqualified for two years from managing corporations. The first defendant, Mr Somerville, will be disqualified from managing corporations for a period of six years. Costs 38 I indicated I would give my tentative views on costs and invite submissions. No orders for costs were sought against the third, seventh, ninth and tenth defendants because they consented to the findings of contravention. Mr Troost did not oppose such a finding, even though represented. Mr Bradnam did not appear at the first hearing and the arguments on behalf of Mr Rowley were really directed to phase two. It might seem unfair that no costs orders are sought against four defendants, all of whom made submissions in phase two, whereas costs orders are sought against Messrs Rowley, Bradnam, Durant and Troost, the second and third of whom did not appear at the first hearing. So far as the second defendant is concerned, it was involved in only one contravention with which Mr Somerville was associated and there seems no point in making a separate order against it. The position of ASIC as to costs is not clear and I will wait for further submissions. 39 Mr Somerville is really responsible for the whole of these proceedings. That does not mean, however, that he should bear all the costs, but he should bear a substantial part of them. I indicate that my initial feeling is that a proper proportion would be 60 per cent of the costs, but I am prepared to hear further submissions on that. I should add that the transcript indicates that ASIC does not seek costs against any defendants, but that is a mistake. The costs of ASIC are not to include costs of copying authorities. Whilst it is helpful to the Court and particularly for a judge sitting in Hospital Road, it is not a cost the defendants should bear. Proposed orders

1. Order that the first defendant be disqualified from managing companies for a period of six years.

2. Order that each of the third, fourth, fifth, sixth, seventh, eighth, ninth and tenth defendants be disqualified from managing companies for a period of two years.

3. The disqualification period for the above orders shall begin on 24 October 2009. **********

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