Australian Securities and Investment Commission v Adler

The draft Statement of Claim

1. Mr Karam in turn relies on a draft Statement of Claim, to be brought in the name of the Company, which seeks, relevantly, a declaration of breach of fiduciary, equitable or statutory duties by Mr Fox, judgment in the amount of $2,783,565 less any dividend which Mr Fox is entitled to retain, or orders by way of a constructive trust, damages or equitable compensation. The draft Statement of Claim recites events surrounding the development project, and pleads the existence of a loan agreement formed on 6 June 2022, from a telephone conversation between Mr Karam and Mr Fox by which the Company agreed to lend Mr Fox the amount of $3,824,615; Mr Fox was to repay that amount, less his contribution to the Company and any declared dividend; and the repayment of the amount would be within "a few weeks." I recognise that the pleaded loan agreement is, on one view, more favourable to Mr Fox than Mr Karam's evidence, which was that the loan agreement was for the lesser amount and that Mr Fox in fact caused himself to be paid more than was agreed. Mr Karam also seeks to plead a claim for monies received on behalf of the Company. He pleads a claim under Part 2D.2 of the Act, which Mr Rizk, who appears for Mr Karam, indicates is not likely to be pursued, and which I need not further address. Mr Karam also pleads breach of director's duties by Mr Fox, on the basis that the relevant transaction was not in the best interest of the Company in several respects. I will return to that proposition below.
2. The parties tendered voluminous documents in respect of the application for leave, but I was ultimately not taken to those documents in the course of submissions, and it is not apparent from the submissions that it will be necessary to have regard to them to reach a determination as to whether leave should be granted. Neither Mr Karam nor Mr Fox was cross-examined, and that approach was sensible where, in an application of this kind, the Court would ultimately not seek to resolve the dispute between them as to the terms of the agreement alleged to have been reached on or about 6 June 2022. It is also not necessary for the Court to do so where, on one view, either version of the agreement would involve a potential breach of director's duties.

Applicable principles

1. The circumstances in which the Court will grant leave to bring a derivative action are well established, and I will first address those principles, and the parties' submissions in that respect. Section 237(2) of the Act relevantly provides that: "(2) The Court must grant the application if it is satisfied that: (a) it is probable that the company will not itself bring the proceedings, or properly take responsibility for them, or for the steps in them; and (b) the applicant is acting in good faith; and (c) it is in the best interests of the company that the applicant be granted leave; and (d) if the applicant is applying for leave to bring proceedings--there is a serious question to be tried; and (e) either: (i) at least 14 days before making the application, the applicant gave written notice to the company of the intention to apply for leave and of the reasons for applying; or (ii) it is appropriate to grant leave even though subparagraph (i) is not satisfied."
2. The principles which are applicable to determining whether such leave should be granted have been set out in numerous judgments, including my recent judgments in Mount Gilead Pty Ltd Hobhouse v Macarthur-Onslow [2021] 398 ALR 629; [2021] NSWSC 948 ("Mount Gilead"), a decision which was affirmed in the Court of Appeal; Re Carbon Copies Composites Pty Ltd [2022] NSWSC 1638 ("Carbon Copies"), to which Mr Rizk refers; and Re Wonga Pastoral Development Co Pty Ltd [2023] NSWSC 133 ("Wonga Pastoral").
3. It is plain enough that Mr Karam has standing to bring the application under s 236 of the Act, where he is a shareholder in the Company. In order to obtain leave under that section, he must establish the five matters specified in s 237(2) of the Act on the balance of probabilities. If the Court is satisfied that he has done so, the Court must grant that leave and, if those matters are not satisfied, leave must be refused, and leave to bring a derivative action should not be given lightly: Swansson v R Pratt Properties Pty Ltd [2002] 42 ACSR 313; [2002] NSWSC 583, ("Swansson") at [24], [26]; Huang v Wang [2016] 114 ACSR 586; [2016] NSWCA 164 ("Huang v Wang"), [57], [65], and [78]; Mount Gilead at [50].

Whether the Company will bring the proceedings

1. The first matter specified in s 237(2) of the Act is that it is probable that the Company will not bring the proceedings, absent the grant of leave. That matter does not appear to be contested here, and it is likely that the Company will not bring the proceedings, where it would be deadlocked in respect of the commencement of the proceedings. It is plain enough that Mr Fox opposes the commencement of proceedings against him, as he has also opposed the grant of leave to bring the proceedings in this application.

Whether the claim is brought in good faith

1. The second matter specified in s 237(2) of the Act is whether Mr Karam is acting in good faith in bringing the proposed claim. In Swansson at [36], Palmer J observed that there are at least two interrelated factors to which the Court will have regard in determining whether that requirement is satisfied, namely whether the applicant believes that a good cause of action exists and has a reasonable prospect of success, and whether the applicant is seeking to bring the derivative claim for a collateral purpose that would amount to an abuse of process. The case law indicates that it is relatively easy to satisfy this requirement if an application is made by a current shareholder who has more than a token shareholding and the derivative action seeks recovery of property so that the value of the applicant's shares would be increased: Swansson at [38], Re Gladstone Pacific Nickel Ltd (2011) 86 ACSR 432; [2011] NSWSC 1235 ("Gladstone Pacific").
2. Here, Mr Rizk points to a suggested similarity of the claim Mr Karam seeks to bring with that which I addressed in Carbon Copies, in finding that an applicant was acting in good faith although he might also be a creditor of the company. Mr Fernandez, who appears for Mr Fox, submits that the claim cannot be made in good faith where a reasonable person would not consider there is a serious question to be tried on the current facts, and that Mr Karam's own conduct, namely the withdrawal of funds from the Company without apparent authority would lead the Court to consider that the good faith requirement is not met here.
3. It is plain that Mr Karam has more than a token shareholding in the Company, being a 50% shareholder, and it is plain that the recovery of the amount of approximately $2.783 million claimed against Mr Fox, even deducting any dividend to which he may ultimately be entitled, would significantly increase the Company's assets, to the benefit of its creditors and to the benefit of Mr Karam. I will address the question of a serious question to be tried below. I do not accept that the fact that Mr Karam's conduct may itself involve a breach of director's duties is such that the good faith requirement is not met in respect of the claim against Mr Fox, where the Company's claim against Mr Fox has a solid basis and could not be brought unless Mr Karam brings it as a derivative claim or a statutory regulator does so.
4. In particular, it seems to me that the fact that both directors may have breached their duties to the Company has the consequence, not that neither may be held accountable in a derivative action brought by the Company, but instead that leave may potentially be granted to each to pursue a claim in the Company's name against the other. I will return, below, in dealing with the question of the Company's best interests with alternative approaches which may have been better directed to resolving the claims against the directors, but it seems to me that the fact that Mr Karam's conduct itself amounts to a potential breach of duty does not deprive him of good faith in pursuing, in the Company's name, a claim in respect of Mr Fox's conduct, which may equally constitute a breach of duty.

Whether the proposed proceedings are in the Company's best interests

1. The third question in an application under s 237 of the Act relates to whether the proposed proceedings are in the Company's best interests. In Swansson at [55]-[60], Palmer J noted that this requires that the Court be satisfied that the proposed action actually is, on the balance of probabilities, in the company's best interests and that, in order to prove that leave is in a company's best interests, an applicant should generally give evidence of the character of the company in the sense of the nature of its operations and its business so that the effects of the proposed litigation on the conduct of the company's business may be appreciated, and whether there are other means of obtaining the same redress, and the proposed defendant's ability to meet at least a substantial part of any judgment in favour of the company so that the Court may ascertain whether the action is of practical benefit to the company; see also Wonga Pastoral at [40].
2. Here, Mr Karam has largely addressed those questions in his affidavit evidence. The Company has completed the relevant development, so that the commencement of the proceedings will not interfere with the completion of that project, although it has not completed dealing with its creditors, including payment of tax due on its profit in respect of the development, and has also not completed dealing with any claim by Auswide against it. It is not apparent that the commencement of the proceedings would have any adverse effect on the conduct of the Company's business, and it seems to me likely that a recovery would have a positive effect, so far as it may at least prompt the Company to pay any tax due and make any distribution properly payable to its shareholders.
3. I recognise that there may have been other means of achieving the same result, and, on the face of it, it would likely have been preferable that a receiver be appointed to the Company's assets, so as to allow an independent third party to bring the Company's affairs into order, rather than Mr Karam bringing proceedings against Mr Fox in the name of the Company, and Mr Fox potentially bringing proceedings against Mr Karam also in the name of the Company, where he may well seek and obtain leave to bring a cross-claim against Mr Karam on the same basis that Mr Karam has obtained leave to bring a primary claim against Mr Fox in the Company's name. However, neither party sought and both parties opposed the appointment of a receiver.
4. The case law has also recognised the significance of the adequacy of an indemnity in respect of the costs to which the Company would be exposed by the conduct of the proceedings in determining whether they are in its best interests. I noted above that there is no suggestion that Mr Karam does not have sufficient assets, at least at present, to meet such an indemnity, and there was also no suggestion that Mr Fox did not have the capacity to meet a judgment against him so as to deprive the proceedings against him of practical utility.
5. It seems to me that, here, the amounts involved, and the risk to the Company and its creditors (or at least the Australian Taxation Office) if they are not recovered, are such that it is plainly in the Company's interests to bring the relevant proceedings, where they will potentially retrieve its assets paid out to the directors and may, to that extent, assist with creditors being paid, and assist the Company with ultimately making a distribution to its shareholders, if its affairs can be regularised to allow that to occur.

Whether there is a serious question to be tried

1. The fourth requirement for the grant of leave is that there is a serious question to be tried. Whether that is the case requires the application of the same test as applied by the Court in determining whether to grant an interlocutory injunction: Swansson at [25]; Wonga Pastoral at [57]. The relevant test was in turn summarised by Ball J in Gladstone Pacific at [56], where his Honour noted that a relatively low threshold would apply, as in the case of an interlocutory injunction, and that a Court would ordinarily not resolve disputed questions of fact in determining whether a serious question to be tried is established. In particular, it does not seem to me to be necessary to determine the dispute of fact as to the circumstances of the agreement formed on 6 June 2022 where, on either the account given by Mr Karam or the account given by Mr Fox of that agreement, it would be seriously arguable that it involved a breach of director's duties by both directors. I will return to that matter below.
2. In submissions, Mr Rizk refers to the relevant principles in determining whether there is a serious question to be tried, and contends that there is a serious question to be tried on the basis that Mr Fox has caused a substantial amount to be transferred to himself, has only repaid a small part of that amount, and no dividends have since been declared by the directors or shareholders of the Company. Mr Rizk submits that, even on Mr Fox's evidence, he does not have any present entitlement to retain the amount of approximately $2.783 million which he has not repaid.
3. Mr Fernandes in turn submits that there is no serious question to be tried, because the relief claimed by Mr Karam turns on the loan agreement and falls away if there is no serious question to be tried as to breach of the loan agreement. I do not accept that submission which, with respect, seems to me to be perverse. As put by Mr Fernandes in oral submissions, that submission is that the loan agreement, at least on Mr Fox's version of it, and possibly also on Mr Karam's version of it, had no provision for repayment and is unenforceable, because the Company's affairs have not yet been regularised to determine the amount which would be repaid by Mr Fox, less any dividend that was paid to him. The difficulty with that proposition, as Mr Rizk points out, is that, if that is the way in which the loan agreement operates, then the loan will never be repaid, if Mr Fox does not cooperate in regularising the Company's affairs and the Company, by its two directors, has dispersed funds in a manner that will disable it from meeting its creditors' claims, now or ever.
4. That, of course, highlights the difficulty with Mr Fernandes' reliance on the loan agreement in order to submit that there is no serious question to be tried as to the claim against Mr Fox. The proposed Statement of Claim, to which I referred above, also involves a claim for breach of director's duties which, contrary to Mr Fernandes' submission, does not depend on the loan agreement being enforceable or requiring that it be breached. The relevant pleading is, in paragraph 33, that the transaction involved in the loan to Mr Fox was not in the Company's best interests as it constituted, inter alia, a reduction of the Company's assets, was made for no consideration, did not create any benefit for the Company, and the amount payable exceeded the amount which Mr Fox would legitimately be entitled to receive from the Company and, significantly, at all relevant times, the Company had liabilities or debts that were or would be owing.
5. It seems to me that, in those circumstances, a serious question to be tried is established, at least to the interlocutory standard required by the case law. It is sufficient to note, for present purposes, the decision of Chen J in OLI 1 Pty Ltd (in liq) v OLG 1 Pty Ltd (No 2) [2022] NSWSC 1199, to which I referred in Wonga Pastoral at [69]. His Honour there noted that a determination of breach of the duty of care and diligence, which is here alleged (inter alia) against Mr Fox, requires an objective and evaluative assessment of the foreseeable risks of harm to a company's interests against potential benefits that could reasonably result from a transaction, and requires special vigilance where that transaction has the potential for conflict between a director's interest and duty. His Honour there referred to the decision of Santow J in Australian Securities and Investment Commission v Adler (2002) 41 ACSR 72; [2002] NSWSC 171, where his Honour dealt with the position in respect of an undocumented loan agreement that was not on arm's length terms, and to my decisions in Re FAL Healthy Beverages Pty Ltd [2017] NSWSC 476 at [55] and again in regards to Re Sirrah Pty Ltd (in prov liq) [2021] NSWSC 413 at [77]. Chen J noted that a loan agreement which was, as it appears is arguably the case here, made without a term, made no provision for repayment, was interest-free and unsecured, amounted to a transaction which no reasonable director would have caused or permitted a company to have entered into.
6. For these reasons, a serious question to be tried, at least as to a breach of the director's duties owed by Mr Fox in respect of the transaction, although the same may arguably be said in respect of Mr Karam's approval of the transaction. That is sufficient to support a finding that there is a serious question to be tried in respect of the claims brought in the draft Statement of Claim, where success in respect of the director's duties claim would arguably be sufficient to allow the Company to recover the amount paid out.

Notice of the claim

1. The final question in an application of this kind is whether notice has been given to Mr Fox of the potential claim, and it is apparent that it has.

Determination and notice to Australian Securities and Investments Commission and Australian Taxation Office

1. In these circumstances, I am satisfied that leave to bring the derivative claim should be granted, on the basis that I will note the undertaking of Mr Karam as to the Company's costs of the derivative proceedings. In the course of submissions, I had raised with the parties whether the preferable course, here, would have been the appointment of a receiver to the Company, who could have sought to bring its affairs into order, without the need for each director to bring a derivative action against the other, and by lodging the Company's outstanding tax return and attending to any issues which arise from its failure to retain funds to meet any tax liabilities which it owes in respect of the profit derived from the development.
2. Neither party sought to pursue the appointment of a receiver under s 67 of the Supreme Court Act 1970 (NSW), whether on a consensual basis or by one party bringing that application. I would have likely made that order, had either party sought that appointment, where it may have allowed these issues to be resolved at lesser cost and in a more effective way than the commencement of one or possibly two derivative proceedings against the Company's directors. I also raised, in the course of submissions, whether the matters that had arisen in this application were such that I should order that this judgment, and the evidence put before the Court in this application, be drawn to the attention of the Enforcement Division of the Australian Securities and Investments Commission and the Australian Taxation Office.
3. Perhaps not surprisingly, neither party supported that course, and Mr Rizk, who appears for Mr Karam, opposed it on the basis that that matter would be better left to the conclusion of any derivative action, if issues had not resolved between the parties, and a judge in that action may then refer the matter to the Australian Taxation Office. I am not persuaded that it is preferable to defer making such an order, and I am satisfied that it should be made now. On the face of it, the evidence raises a serious question as to whether both directors of the Company may have breached their duties, in respect of the relevant transactions, consistent with the case law to which I have referred above.
4. The pursuit of one or two derivative actions, Mr Karam against Mr Fox in the Company's name, or both directors against the other in the Company's name, will potentially advance their interests and the Company's interest in recovery of the funds, but will not advance any public interest in respect of a breach of directors' duties or any ultimate failure to meet the Company's tax liabilities. I have borne in mind that the Court does not, in a hearing of this kind, reach final conclusions, and I have not done so. However, it seems to me that this application raises issues of a sufficiently serious character that I should make an order that the parties provide this judgment and the evidence led in the application to both the Australian Securities and Investments Commission and the Australian Taxation Office. I would not have considered it necessary to make that order had an independent receiver been appointed to the Company so that the Court could have been satisfied that an adequate investigation of these issues would be undertaken by that receiver, but that has not occurred.

Orders

1. For these reasons, I make the following orders:
2. Order, pursuant to s 237 of the Corporations Act 2001 (Cth), that the Plaintiff have leave to commence proceedings in the name of Winifred Avenue Pty Ltd against Mr Patrick Fox, in respect of the causes of action pleaded (other than in paras 30 and 31) of the draft Statement of Claim exhibited to Mr Karam's affidavit sworn 27 April 2023 in these proceedings.
3. Note the undertaking of Mr Karam to the Court in the form set out in paragraphs 52(a)-(d) of his affidavit sworn 27 April 2023.
4. Direct the parties, by their legal representatives, jointly or severally, to refer a copy of the judgment in these proceedings, and the affidavits and documents read and tendered in these proceedings to the Enforcement section of the Australian Securities and Investments Commission and the Australian Taxation Office.
5. The costs of the application for derivative leave be the Plaintiff's costs in the cause in the proceedings that are ultimately brought by Winifred Avenue Pty Ltd against Mr Fox pursuant to that leave.

DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated. Decision last updated: 24 October 2023