This is an application for preliminary discovery under rule 5.3(1) of the Uniform Civil Procedure Rules 2005 (NSW), which provides:
If it appears to the court that--
(a) the applicant may be entitled to make a claim for relief from the court against a person ("the prospective defendant") but, having made reasonable inquiries, is unable to obtain sufficient information to decide whether or not to commence proceedings against the prospective defendant, and
(b) the prospective defendant may have or have had possession of a document or thing that can assist in determining whether or not the applicant is entitled to make such a claim for relief, and
(c) inspection of such a document would assist the applicant to make the decision concerned,
the court may order that the prospective defendant must give discovery to the applicant of all documents that are or have been in the person's possession and that relate to the question of whether or not the applicant is entitled to make a claim for relief.
The three plaintiffs are shareholders in the defendant company, Lakeba Group Limited. They became shareholders in December 2019, after having been provided with information as to the financial performance and expected financial performance of the company. Specifically, the plaintiffs were given an Annual Investor Update for 2019 in respect of the Lakeba Group, which stated that the revenue for the 2019 financial year was $17.4 million and the forecast revenue for the 2020 financial year was $19.8 million. The forecast revenue was subject to a notation that the figure excluded revenue attributed to "venture exits" in the 2020 financial year, which were then described.
In addition, the plaintiffs were also provided with a profit and loss statement for "Lakeba Consolidated" for the 2019 financial year. Total income was some $16.5 million, largely comprising income derived for "Technology Solutions" of some $2.3 million, "Profit on Sale of Venture Shares" of some $6 million and management fees of $905,000.
Finally, the plaintiffs were also provided with a profit and loss statement for the five months to November 2019 and a balance sheet as at November 2019.
Some emails passed between the plaintiffs and the defendant's representative, Mr Bennett, regarding the valuation of the company in which the plaintiffs were interested in investing. On 16 December 2019, Mr Bennett advised:
This valuation was based on 2.8 x revenue at the time - which for a technology company, was seen as quite low, however, based upon the blend of services revenue vs. recurring, this multiple was agreed as being fair value at that stage
On the basis of this material, the plaintiffs say that they were persuaded to acquire shares in the defendant company for a total outlay of some $800,000. Each of the plaintiffs then entered into subscription agreements with the plaintiff (the Subscription Agreement).
Clause 6 of the Subscription Agreement provided:
6 Representations and warranties
6.1 Representations and warranties by the Issuer
The Issuer represents and warrants to the Subscriber that (except as expressly disclosed in this Agreement or consented to by the Subscriber) each of the statements contained in Schedule 1 is true, accurate and not misleading as at each of the Signing Date and the Settlement Date.
…
6.4 Time limitation
Each warrantor in clause 6.1 and 6.2 has no liability to the other party relating to or arising out of a breach of a Warranty unless the other party has given written notice of the Claim relating to or arising out of the breach to each Warrantor within 24 months after the Settlement Date.
The Settlement Date was defined as 20 December 2019.
Schedule 1 of the Subscription Agreement included the following items:
3 Accuracy of information
(a) All information relating to the Issuer and the Issuer's operations provided to the Subscriber or its advisers in connection with the proposed investment by the Subscriber in the Issuer as contemplated by this Agreement is true in all material respects and is not by omission or otherwise misleading in any material respect.
4 Financial position and conduct of Business
(a) To the best of the Issuer's knowledge, the Accounts:
(i) have been prepared in accordance with applicable Accounting Standards and the Corporations Act applied on a consistent basis;
(ii) fully reflect the assets and liabilities of the Company and Group;
(iii) show a true and accurate view of the financial position of the Company and Group as at the Accounts Date and the financial performance of the Company and Group for the financial period ending on the Accounts Date; and
(iv) are not affected by any unusual or non-recurring items.
By September 2021, the plaintiffs had expressed concerns about a lack of financial transparency, in particular, that the accounts for the 2020 financial year were not produced on a consolidated group basis. As such, it was said that the revenue and expenses for the ventures in which the plaintiffs had invested were not visible. Accounts were requested on a consolidated group basis, but not provided.
In November 2021, the defendant's audited financial reports for the 2020 and 2021 financial years were published, albeit not on a consolidated basis. The financial reports included comparable figures for previous years. As published, the defendant declared income of $790,000 in 2019, $766,000 in 2020 and $680,077 for 2021. As these accounts were not prepared on a consolidated basis, there was little information to assist the plaintiffs to understand the performance of their investment as anticipated by the Annual Investor Update for 2019; they could not compare 'apples with apples'.
On 14 December 2021, the plaintiffs' solicitors wrote to the defendant, requesting the production of documents to assist them to decide whether to bring legal proceedings. The defendant rightly pointed out that the timeframe in which the documents were sought was unreasonable and further suggested that there was no proper basis for any proceedings. The defendant requested particulars of the suggested claim.
On 17 December 2021, the plaintiffs each served a notice of claim for breach of warranty on the defendant, although I note that the validity of service of the notice may be in issue in any future proceedings. Each of the notices contended that the information which had been provided to the plaintiffs was misleading. While the Investor Update contained a statement that the actual revenue for "Lakeba Consolidated" in the 2019 financial year was $17.4 million and the Profit and Loss Statement to June 2019 put actual revenue at some $16.5 million, it was said that these representations "did not reflect the true position of the Issuer or its operations", contrary to representations and warranties contained in the Subscription Agreement and in contravention of clause 6.1. The plaintiffs gave notice of a claim for breach of warranty under clause 6.4 of the Subscription Agreement, noting that the amount of the claim was still to be quantified, but may be equal to or exceed the amount paid for the shares together with the plaintiffs' legal fees on a reasonable basis.
The defendant points to these notices as evidence that the plaintiffs have already made a decision to commence legal proceedings against the defendant and, therefore, preliminary discovery is not necessary and should not be ordered under the Rules. The plaintiffs say that these documents were served in accordance with the limitation period contained in the Subscription Agreement and necessarily reflected the terms of that agreement, requiring any claim relating to breach of warranty to be notified by 20 December 2019. The plaintiffs' counsel, however, said that further information was in fact needed before the plaintiffs could take a responsible decision as to whether or not to bring legal proceedings. I am inclined to accept the plaintiffs' explanation of the import which should be attached to the notices of claim given the provisions of the Subscription Agreement.
In February 2022, the plaintiffs' solicitor provided further detail of the plaintiffs' concerns, as requested by the defendant's solicitors, noting that since the plaintiffs had become shareholders, none of the plaintiffs had seen any evidence consistent with "Lakeba Consolidated" having a revenue or income of either $17.4 million or $16.5 million in the 2019 financial year. All that the plaintiffs had received were financial reports for the defendant company on an unconsolidated basis, "In the absence of any alternative explanation, this suggests that the revenue or income figures … for the year ended 30 June 2019 … may have been substantially overstated." Further correspondence ensued.
In March 2022 a further investor update was published on the defendant's website, which provided a "Financial Snapshot" reporting that revenue for the 2019 financial year was $9 million. This, of course, is obviously less than $17.4 million. A notation to the $9 million figure stated: "Revenue excludes proceeds from sale of ventures and other income … FY19 revenue including proceeds from sale of ventures and other income was $17.4 million." The plaintiffs note that the Financial Snapshot did not report the results for the 2020 financial year at all but proceeded to report the figures for 2021 and the first half of the 2022 financial year. The defendant suggested there was nothing sinister about this, but alluded to the fact that COVID-19 may have resulted in worse than expected financial results in the 2020 financial year.
Having no doubt closely reviewed the March 2022 shareholder update, this application was filed in April 2022. In support of the application, the plaintiffs' solicitor, Nicola Nygh, deposed that her clients had serious concerns about the accuracy of the investment information provided to them in December 2019 and believed that they may have a right to obtain relief from the Court for misleading or deceptive conduct in breach of the Australian Consumer Law, breach of warranty under the Subscription Agreement or equitable relief based on misrepresentations. However, the plaintiffs had not yet decided whether to commence proceedings and believed that the prospective defendant had in its possession consolidated financial reports for "Lakeba Consolidated", financial reports for each of Lakeba Group's subsidiaries, and other accounting information which would allow the plaintiffs to assess the statements regarding actual and forecast income and revenue contained in the investment information provided to them. It is this information which is now sought. The application is firmly opposed by the defendant.
[3]
PRINCIPLES
The legal principles are not in dispute. Both parties accepted the approach of the Court of Appeal in O'Connor v O'Connor [2018] NSWCA 214 at [31], which outlined four conditions of which the Court must be satisfied before rule 5.3(1) can be engaged:
1. the plaintiffs may be entitled to make a claim for relief against the defendant;
2. the plaintiffs have made reasonable inquiries to obtain sufficient information to decide whether or not to commence proceedings;
3. having made those inquiries, the plaintiffs are unable to decide whether or not to commence proceedings; and
4. the defendant may have documents that could assist in determining whether the plaintiffs are entitled to make a claim for relief and inspecting those documents would assist them to make their decision.
The rule is to be beneficially construed in the plaintiffs' favour: Hatfield v TCN Channel Nine Pty Ltd [2010] NSWCA 69; (2010) 77 NSWLR 506 at [52]. That said, even if the plaintiffs satisfy each of these conditions, the Court retains a discretion to make or refuse the application: Western Bulk Carriers (Australia) Pty Ltd v Cosco Bulk Carrier Co Ltd [2002] FCA 1520 at [25]. Courts regularly exercise such discretion in cases where the giving of discovery would be oppressive, for instance because the effort and cost required to give discovery would be disproportionate to the relevance of the documents and the benefit obtained by the plaintiffs: Hatfield at [137].
It is only necessary to say something about the first and third conditions. As to the first condition, it is not necessary for an application for preliminary discovery to identify with precision any claim that may be brought, nor is it "necessary for the applicant to show a prima facie or pleadable case": O'Connor at [30]; Morton v Nylex Ltd [2007] NSWSC 562 at [25]. Rather, all that is required is for the plaintiff to demonstrate that they may be entitled to make a claim for relief. While the threshold for proving such an entitlement may be "low", the requisite level of belief requires "more than mere assertion and more than suspicion or conjecture": O'Connor at [23]; Hatfield at [49].
The bulk of argument focussed on the third condition, being whether the plaintiffs presently lack sufficient information to commence proceedings against the defendant. The nature of the requirement was described in Morton at [33]: (citations omitted)
The third requirement of r 5.3(1)(a) requires an objective assessment of the information already possessed by the plaintiffs to determine whether that information is sufficient for such a decision to be made. The question is whether the applicant has insufficient information to be able to decide whether to institute proceedings; not merely to establish a cause of action. Hence, an applicant may be entitled to preliminary discovery of documents relevant to available defences, or the extent of apprehended breaches, or the likely quantum of damages, as well as of documents which may establish whether there is a cause of action. However, unless the applicant is lacking something reasonably necessary to make a decision whether to institute proceedings, he or she is not entitled to preliminary discovery. An applicant must disclose what information he or she already has relevant to making such a decision, and identify what information is lacking. Preliminary discovery cannot be used to build up a case which an applicant has already decided, or could decide, to bring.
The purpose of preliminary discovery is to obtain information for the purpose of enabling a decision to be made as to whether there is a cause of action: Howell v Kelly [2021] NSWSC 1422. Preliminary discovery is distinct from discovery in substantive proceedings and serves an entirely different purpose: it is not to be used for the purposes of conducting a wide-ranging fishing expedition: Pfizer Ireland Pharmaceuticals v Samsung Bioepis AU Pty Ltd (No 3) [2021] FCA 1428 at [50], citing Arisocrat Technologies Australia Pty Ltd v Ainsworth Game Technology Ltd [2018] FCA 1511 (noting that "[t]he purpose of preliminary discovery is not to require the production of material that strengthens or enhances a decision to commence a proceeding, where that decision can already be made on already existing material").
This condition involves an objective inquiry: The New South Wales Solicitors Mutual Indemnity Fund v The Hancock Family Memorial Foundation Ltd (No 2) [2009] WASCA 146 at [60]; Morton at [33]. Meeting the test "does not rest merely in the assertion of the plaintiffs or the plaintiffs' legal adviser": Western Bulk Carriers at [18]. The plaintiffs were required to adduce evidence to demonstrate the particular respects in which their current information is deficient: Morton at [34]. Such a requirement may be fulfilled by the giving of "clear evidence as to what the [plaintiffs] have learned over time and… the ways the information they have gleaned is insufficient to enable them to decide whether or not to commence proceedings": Rinehart v Rinehart [2015] NSWSC 1201 at [94]. Pre-action correspondence and notices of claim are significant for the purposes of such an inquiry: Glezer v Deals.com.au [2014] VSC 202 at [44]-[46]; Kevin Young v The Neil Jenman Group Pty Limited [2015] NSWSC 1908 at [33].
[4]
CONSIDERATION
Turning to the first element, the question is whether the plaintiffs have satisfied the Court that they may be entitled to make a claim for relief against the prospective defendant. I am satisfied that that element has been established. Whilst the defendant has given an explanation in its March 2022 investor update of how it is said that the $17.4 million disclosed to the plaintiffs when they were considering investing in the defendant company should be read as $9 million, that explanation was given after the plaintiffs had made various accusations as to the reliability of the figure initially provided.
It is certainly open to the plaintiffs to either accept or reject that explanation without further information. However, on the face of the material which was initially provided to the plaintiffs, it can reasonably be put forward that that material was less than clear and may be considered to have been misleading and deceptive. That is not to say that such a claim would be bound to succeed or would be weak or strong; it is not necessary for the plaintiffs to even establish that they have a prima facie claim, but simply that they may be entitled to make such a claim, and I am so satisfied.
As to the second condition, the defendant accepts that the plaintiffs have made reasonable inquiries. No argument was raised in relation to this condition and it is not necessary to consider it further.
The more difficult element is the third condition, namely whether the plaintiffs have been unable to obtain sufficient information to decide whether to commence proceedings. As matters presently stand, the decision which the plaintiffs will need to make as to whether or not to commence proceedings will have to turn upon whether they are prepared to accept the defendant's explanation in the March 2022 investor update or not. What the plaintiffs are seeking is further financial information from the defendant to enable them to assess whether, in fact, the information which was given to them at the outset can be reasonably explained as the defendant has now sought to do or not.
There is limited information presently at the plaintiffs' disposal and I am satisfied that they do need further information to have sufficient information to make a decision as to whether to commence proceedings.
As to the fourth condition, the defendant did not contest that it was likely to have the documents sought within their possession, custody or control. However, most of the documents sought were said to be irrelevant to whether or not the revenue figure of $17.4 million was correct. The defendant did agree, however, that the FY2018/2019 documents sought, and some of the documents recording the calculation of revenue, satisfied the fourth condition. I agree, and will endeavour to confine the categories to only relevant documents.
The question remains as to whether the Court should exercise its discretion to decline to make an order for preliminary discovery on the basis that giving preliminary discovery would place a disproportionately onerous burden on the defendant or that the categories of discovery sought include material which goes beyond that which is necessary to make the decision whether or not to commence proceedings.
There is some force in the defendant's submissions in this regard. The defendant's solicitor, Claire van der List, had described the task involved in giving the discovery sought by the plaintiffs. One of the categories of discovery, being prayer 1(d), (which seeks documents recording the calculation of certain revenue, valuation, OPEX, EBIT and net profit figures presented to the plaintiffs at the time of their investment) was said to be particularly oppressive and likely to take the plaintiff 16 weeks to complete the necessary searches. The costs of the associated review for relevance, confidentiality and privilege of such material were estimated to exceed $25,000, including GST. For their part, the plaintiffs submitted that giving discovery in respect of that specific category, and generally, would not be nearly as onerous as suggested.
Having regard to the purposes of preliminary discovery, I accept that the cost and effort required by the defendant to give discovery of all material falling within the proposed categories would be onerous. Further, I consider that some of the categories of discovery sought by the plaintiffs are in excess of what is required for preliminary discovery. Accordingly, I grant the plaintiff's application, but exercise the Court's discretion to limit the categories of documents sought to reduce the burden on the defendant and ensure that such categories include only those documents necessary for the plaintiffs to determine whether to commence proceedings.
By prayer 1(a), the plaintiffs seek consolidated financial reports for financial years 2017/18, 2018/19 and 2019/20 for the consolidated group of companies of which the defendant is the holding company, whether audited or not. I consider it appropriate that the defendant should only be required to give discovery for those financial reports in the financial year when it is thought that misleading or deceptive conduct may have occurred. What has happened since is of limited utility.
By prayer 1(b), the plaintiffs seek financial reports for each of the entities in the Group, whether audited or not, for those same financial years. I propose to limit that category to just the 2018/19 financial year for the same reason given in respect of prayer 1(a).
By prayer 1(c), the plaintiffs seek a detailed general ledger for each of the entities in the Group for those same financial years. I propose to limit the discovery of detailed general ledgers not only to the financial year 2018/2019, but also for the company called NTICK8 Pty Ltd, formerly known as Lakeba Future Hub Pty Ltd, as it is one of the subsidiary companies said to have contributed towards a change in accounting treatment in respect of the "Technology Solutions" income. It may be, however, that once preliminary discovery has been provided, it is necessary for a general ledger to be sought in respect of some of the other entities in the group. It is, however, too onerous to require such material be provided for all entities at the outset.
Last, with respect to prayer 1(d), which I describe above at [31], I propose to limit the discovery sought to only those documents recording the calculation of the revenue figures contained on page 10 of the document entitled "Lakeba Annual Investor Update 2019" and the net profit set out in the document entitled "Profit and Loss Statement - Lakeba Consolidated Jul 2018 - Jun 2019". The calculations sought by prayer 1(d) with respect to other documents do not appear to me to be necessary for the purposes of preliminary discovery.
[5]
COSTS
The plaintiffs submitted that they should be granted the relief sought in their summons with costs. During the course of oral argument, counsel for the plaintiff conceded that there is no clear line of precedent as to costs for preliminary discovery; such determinations are fact-based and discretionary. For its part, the defendant submitted that if the Court were to grant the application for preliminary discovery, whether in whole or in part, an order should be made pursuant to rule 5.8 of the Rules requiring the plaintiffs to pay the defendant's costs of production and preparation of their affidavit of discovery. Such an order was said to be principled as proceedings for preliminary discovery are discreet proceedings separate from discovery in the substantive proceedings and should be dealt with on that basis: Andrews Advertising Pty Ltd v David Andrews [2011] NSWSC 244 at [57] (per Ball J), citing C7 Pty Ltd v FOXTEL Management Pty Ltd [2001] FCA 1864 at [50] (per Gyles J).
The defendant's solicitor has given an estimate of costs based on a much more expansive scope of preliminary discovery than I am proposing to order. The cost roughly adds up to $25,000 including GST. I would propose that, first, the plaintiffs place $20,000 into their solicitor's trust fund and that the plaintiffs' solicitor confirm to the defendant's solicitor when that amount has been received. Second, on receipt of that confirmation, that the defendant would then provide preliminary discovery and the relevant list of documents verified confirming that that has happened. Third, on completion of the preliminary discovery, the plaintiffs would pay the defendant's costs of having provided that preliminary discovery. In the event that proceedings are commenced within three months of the completion of provision of preliminary discovery, then the costs of this motion will be the parties' respective costs in the cause in the main proceedings. So too will be the plaintiffs' costs incurred in obtaining preliminary discovery. If proceedings are not commenced within that timeframe, then the plaintiffs will pay the defendant's costs of these proceedings.
[6]
ORDERS
At the conclusion of the hearing of this motion, counsel were directed to confer on short minutes of order to put into effect my reasons. Those short minutes were provided to my Chambers on 23 June 2022. In accordance with those short minutes and for the above reasons, I make the following orders and directions:
1. Order that the Defendant give discovery to the Plaintiffs pursuant to Uniform Civil Procedure Rules 2005 (NSW) rule 5.3 of the following documents:
1. final consolidated Financial Reports (as defined in Schedule A) for FY 2018/2019 and FY 2019/2020 for the consolidated group of companies of which the Defendant is the holding company (Lakeba Consolidated) (whether audited or not);
2. final Financial Reports for each of the entities in the Group (as defined in Schedule A) for FY 2018/2019 (whether audited or not);
3. detailed general ledger for Ntick8 Pty Ltd (formerly known as Lakeba Future Hub Pty Ltd) for FY 2018/2019; and
4. documents recording the calculation of:
1. the revenue figures contained on page 10 of the document entitled "Lakeba Annual Investor Updated 2019"; and
2. the net profit set out in the document entitled "Profit and Loss Statement - Lakeba Consolidated Jul 2018 - Jun 2019".
1. Order that the Plaintiffs place $20,000 into their solicitor's trust account and direct that the Plaintiffs' solicitors notify the Defendant's solicitors when this has occurred.
2. Order that the Defendant serve on the Plaintiffs a verified list of the documents identified in order 1 in accordance with Uniform Civil Procedure Rules 2005 (NSW) rule 21.3, within 6 weeks of receiving the notice referred to in order 2.
3. Order that the Defendant provide electronic copies of the documents in the verified list referred to in order 3 at the same time as the verified list is served.
4. Order that within 2 weeks of service of the verified list, the Plaintiffs are to notify the Defendant of any company in the Group (as defined in Schedule A) in respect of which it seeks production of the detailed general ledger, such notification to identify the reason why the Plaintiffs seek production of the detailed general ledger for that company.
5. If the Defendant agrees to produce detailed general ledger(s) in accordance with a request as referred to in order 5, order that such detailed general ledger(s) be produced to the Plaintiffs within 1 week of the request being made.
6. If the Defendant does not agree to produce detailed general ledger(s) in accordance with a request as referred to in order 5, order that the Plaintiff has liberty to restore the proceedings for the purpose of seeking an order for the production of such detailed general ledger(s).
7. Following service of the verified list, and any subsequent production pursuant to order 6 or on an application made pursuant to order 7, the Plaintiffs to pay the Defendant's costs of complying with order 1 and 3 above as notified or agreed within 7 days of receiving written notice from the Defendant as to those costs, unless before that time the Plaintiffs re-list the matter for argument in relation to the quantum of the Defendant's costs.
8. If a proceeding in this Court is commenced by the Plaintiffs against the Defendant for claims arising out of the subscription agreements between each Plaintiff and the Defendant, or the circumstances of entry into the subscription agreements, within 3 months after the date on which the Defendant serves the verified list, or such later date as any subsequent production is made pursuant to order 6 or on an application made pursuant to order 7:
1. the costs of the application for preliminary discovery are to be costs in those proceedings; and
2. the Defendant's costs of complying with orders 1 and 3 as paid by the Plaintiffs pursuant to order 8 are the Plaintiffs' costs in those proceedings.
1. If a proceeding in this Court is commenced by the Plaintiffs against the Defendant for claims arising out of the subscription agreements between each Plaintiff and the Defendant, or the circumstances of entry into the subscription agreements, is not brought within 3 months after the date on which the Defendant serves the verified list, or such later date as any subsequent production is made pursuant to order 6 or on an application made pursuant to order 7, the Plaintiffs to pay the Defendant's costs of the application for preliminary discovery as agreed or assessed.
[7]
Schedule A
Financial Report includes:
a. Statement of Profit or Loss;
b. Statement of Comprehensive Income;
c. Statement of Financial Position;
d. Statement of Changes in Equity; and
e. Statement of Cash Flows; and
f. Notes to the Financial Statements.
Group means each of the related bodies corporate of Lakeba Group Ltd including without limitation all entities whose financial results were incorporated in any of:
a. the calculation of the revenue, opex, EBIT or valuation figures contained on page 10 of the document entitled "Lakeba Annual Investor Updated 2019";
b. the calculation of the assets and liabilities set out on the document entitled "Balance Sheet - Lakeba Consolidated - Nov 2019";
c. the calculation of net profit set out in the document entitled "Profit and Loss Statement - Lakeba Consolidated Jul 2018 - Jun 2019"
d. the calculation of net profit set out in the document entitled "Profit and Loss Statement - Lakeba Consolidated Jul 2019 - Nov 2019"
e. the calculation of the revenue or valuation figures contained on page 10 of the document entitled "Lakeba Shareholder Update March 2022.
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: 29 July 2022
Parties
Applicant/Plaintiff:
B & J Hudghton Investments Pty Ltd as trustee for the B & J Hudghton Family Trust