Corporations - Companies - Constitution and legal capacity - External litigation - Security for costs - Discretion of court - Threshold question - Whether order should be made against trustee of discretionary trust with no independent assets. Corporations Law s1335(1) Goliath Portland Cement Company Pty Ltd v McNalley Australia Pty Ltd (No 6) A62/1993; Beach Petroleum NL v Johnson [1992] FCA 110; (1992) 7 ACSR 203, applied.

Solicitors for Applicant/First Defendant: Dobson Mitchell and Allport

Order that the plaintiff's action against the first defendant be stayed.

CRAWFORD J The plaintiff has sued the first defendant, Tabe and Lees Pty Ltd, and five other defendants. The first defendant acted as agent for the second to sixth defendants in the sale of their business to the plaintiff for $180,000. By its statement of claim the plaintiff has alleged against the first defendant inter alia that at various times in the course of negotiations the first defendant represented to the plaintiff that: 1 The Shell Company was a major secured sponsor of the business, and the sponsorship was worth $10,000 per annum. 2 There were guaranteed incomes from sponsors other than the Shell Company. 3 The gross takings of the business were between $7,000 and $10,000 per week. 4 The business was "a real winner" for a price of $260,000. 5 The business was fast expanding.

2. The plaintiff alleged that the representations were each made in the course of trade or commerce and acting in reliance on them it entered into an agreement for the purchase of the business in May 1993 for $180,000. It complained that in fact the representations were false, misleading and deceptive in that: 1 The business did not have secured sponsorship in the sum of $10,000 per annum from the Shell Company. 2 There were no other guaranteed sponsors. 3 The business did not have gross takings of between $7,000 and $10,000 per week. 4 The business was not worth even $180,000. 5 The business was not fast expanding.

3. The plaintiff claimed that upon discovering that the representations were misleading it resold the business in August 1993 for $100,000 in an attempt to mitigate its loss. It sued the first defendant for the capital loss of $80,000 together with consequential damages and interest, claiming that the representations were misleading or deceptive or likely to mislead or deceive contrary to the Trades Practices Act 1974 (Cth), s52 and the Fair Trading Act 1990, s14. It also sued the second to sixth defendants on a similar basis upon the same and other representations.

4. By its defence the first defendant denied or did not admit most of the essential allegations made against it. It raised no other basis for its defence other than to plead that any loss suffered by the plaintiff was caused or contributed to by the plaintiff's failure to properly manage and operate the business.

5. The statement of claim was issued in January 1994 and a defence was delivered in May 1994. It was amended in March 1996. The first defendant has filed and served a list of documents, requested further and better particulars of the statement of claim, served a notice of contribution on the fifth defendant, delivered interrogatories for the examination of the plaintiff and provided further and better particulars of its defence. By an interlocutory application filed on 7 August 1996 the first defendant applied pursuant to the Corporations Law, s1335(1), and the Rules of Court, O80, r18, for an order that the plaintiff give security for the first defendant's costs of the action in such amount, at such time and in such manner and form as the court directs and for an order that until such security be given the plaintiff's action be stayed.

6. Affidavits read were of the first defendant's solicitor (Miss A M Quinn), a director of the plaintiff (Mr D K Allen) and an accountant to the plaintiff and to the family trust of which the plaintiff is the trustee (Mr R V Millar). Mr Millar was cross-examined. There was little dispute, if any, concerning the evidence.

7. The plaintiff has a share capital of two $1 shares. One share is held by each of its directors, Mr D K Allen and Mrs J A Allen. It operates solely as the trustee of a discretionary trust, the Allen Family Trust. According to its most recent annual return, as at 30 June 1995, its liabilities totalled $210,712 and in respect of all that sum it has a right to be indemnified out of the assets of the trust. It has no other assets.

8. According to the most recent financial statements of the Allen Family Trust, as at 30 June 1995, the only assets of the trust are units in the Meadow Mews Unit Trust stated to be worth $140,052, Its liabilities were shown to consist of $110,473 owing on loans from Mr and Mrs Allen, and $100,000 due to Tasmanian Trustees on a loan. Thus the liabilities totalled $210,473, a sum which was $70,421 in excess of the assets. On the basis of the figures to which I have referred it is not surprising that the first defendant made this application, for it must have appeared that the plaintiff might have considerable difficulty satisfying an order for costs in the event of one being made against it in favour of the first defendant. However, according to Mr Millar, the value of the units in the Meadow Mews Unit Trust was stated at cost and a recent arms length sale of other units in that trust, at 83 cents each, suggest a current market value of the units owned by the Allen Family Trust of $249,000, with a resulting excess of assets over liabilities in the sum of $38,527. Incidentally, the evidence of Mr Millar revealed that the debt of $100,000 due to Tasmanian Trustees has been repaid with however a corresponding increase by that amount in the sum owing by the trust to Mr and Mrs Allen.

9. It was also the evidence of Mr Millar that the capital loss of $70,421, to which reference is made above, essentially came about because of a recorded loss of $78,037 consequent upon the resale of the business purchased by the plaintiff from the first defendant's principals. That loss is part of what is being claimed in this action by the plaintiff from the first defendant, and from the other defendants.

10. The profit and loss statement of the Allen Family Trust for the year to 30 June 1995 reveals a net operating profit of $11,080. It seems reasonable to assume that a profit of that magnitude is likely to continue for the foreseeable future. The income of the trust is earned from its units in the Meadow Mews Unit Trust which is trading profitably. By the terms of the deed of settlement establishing the Allen Family Trust the plaintiff has a discretion whether or not to distribute the net income of the trust each year among the beneficiaries in such proportions as the plaintiff thinks fit. The beneficiaries include Mr and Mrs Allen and members of their extended family. The plaintiff also has a discretion exercisable at any time to distribute the whole or any part of the capital of the trust fund among the beneficiaries in such proportions as the plaintiff thinks fit.

11. The evidence of the solicitor for the first defendant was that she estimates the first defendant's legal costs of preparing for trial will be in the vicinity of $10,000 and its costs of the trial will be about $2,000 per day for seven days. Her estimate of all of the first defendant's costs of the action was therefore $24,000.

12. The Corporations Law, s1335(1) provides: "1335 (1) Where a corporation is plaintiff in any action or other legal proceeding, the court having jurisdiction in the matter may, if it appears by credible testimony that there is reason to believe that the corporation will be unable to pay the costs of the defendant if successful in his, her or its defence, require sufficient security to be given for those costs and stay all proceedings until the security is given."

13. On the hearing of an application under the section there is required by its terms satisfaction of a threshold test before any discretion falls to be exercised namely, establishment by credible testimony that there is reason to believe that the plaintiff will be unable to pay the costs of the first defendant if successful in its defence. E and I Steigman Holdings Pty Ltd v Simons (1985) 4 ACLC 64; Goliath Portland Cement Company Pty Ltd v McNalley Australia Pty Ltd (No 6) A62/1993. The task of the court requires the formation of an opinion about the financial position of the plaintiff at and immediately after judgment, an event which may well not occur until long after the determination of the application.

14. Although s1335 requires there to be reason to believe that the plaintiff "will be unable to pay the costs of the defendant if successful in ... its defence", the section does not require that the court be satisfied, as a matter of probability, that every eventuality which could lead to eventual payment of the costs be excluded. The section will be satisfied if it appears by credible testimony that there is reason to believe that if the defendant is successful circumstances may then exist in which the plaintiff will be unable to pay the costs. Beach Petroleum NL v Johnson [1992] FCA 110; (1992) 7 ACSR 203 at 204 - 5. I respectfully adopt other statements made by von Doussa J in that case at 205 which I will summarise. The financial position of the plaintiff at the time when the application is made will be an important guide, but it is not the sole consideration. The financial position of the plaintiff at the end of the anticipated trial will depend not only on the outcome of the trial, and the costs likely to be associated with it, but on the success or otherwise of its business and investments in the meantime. Many uncertain factors may influence a corporation's financial position. The court may be faced with a range of possibilities, which, depending on whether fortunes run with or against the plaintiff in the meantime, extend from insolvency at one extreme and at the other extreme to more than sufficient immediate cash resources to meet the costs and other debts as they fall due. Between the extremes there are a variety of quite possible, but not necessarily probable, contingencies which could render a plaintiff company, in the event of the proceedings being lost, unable to pay the costs in full and without delay in the ordinary course of business upon service of an allocatur.

15. In this case there are a number of possibilities which ought to be taken into account. I cannot assess the chances of the plaintiff's action being successful against the first defendant or against the other defendants. I have no information either way which enables me to make an assessment of that nature. It is possible that the plaintiff will entirely lose the action. If that eventuality occurs and orders for costs are made in favour of the first defendant against the plaintiff and in favour of the second to sixth defendants against the plaintiff then it appears quite likely that the plaintiff will be unable to pay those costs, certainly not in full. It is obvious that the plaintiff will also incur costs in the action. Even on Mr Millar's figures the excess of assets over liabilities in the Allen Family Trust are likely to be insufficient to satisfy all of those costs. Regard should also be had to the possibility that prior to judgment the plaintiff may distribute income and capital from the Allen Family Trust to its beneficiaries thereby reducing the prospect of the first defendant being able to recover its costs.

16. It is apparent that the plaintiff has no cash or other resources which are readily available to pay debts. To satisfy an order for costs it would need to have recourse to the assets of the Allen Family Trust and in such event it would appear necessary for there to be a sale of all or almost all the units owned by the trust in the Meadow Mews Unit Trust to meet the claims of all its creditors. It is possible that such a sale, at a price sufficient to generate enough proceeds to meet the costs of this action, might take some considerable time to achieve. As was said in Beach Petroleum NL v Johnson [1992] FCA 110; (1992) 7 ACSR 203 by von Doussa J at 205 a corporation "will be unable to pay" the costs within the meaning of s1335 if it can only do so if given extended time to realise assets which might be difficult to realise, at least at a price sufficient to provide a surplus of other liabilities, sufficient to pay the costs. Von Doussa J went on to say: "In my opinion the power of the court under s1335 arises if credible evidence establishes that there is reason to believe there is a real chance that in events which can fairly be described as reasonably possible the plaintiff corporation will be unable to pay the costs of the defendant on service of the allocatur, if judgment goes against it. This will be so even if in other events which can also be fairly described as reasonably possible the plaintiff corporation would be able to pay the costs. The degree of likelihood of the plaintiff corporation being unable to pay the costs along with all the circumstances, actual and possible, about its financial position, would be then taken into account in the exercise of discretion, and in framing the orders of the court if the decision is to order security." The first two sentences of that passage were cited with obvious approval by Underwood J in Goliath Portland Cement Company Pty Ltd v McNalley (Australia) Pty Ltd (No 6) A62/1993 at 3.

17. I am satisfied, on the basis of credible testimony, that there is reason to believe that the plaintiff will be unable to pay the costs of the first defendant in the event of it obtaining an order for costs against the plaintiff following a trial. According to the most recent information, the plaintiff's assets amount to $2 together with a right to be indemnified out of the assets of the Allen Family Trust. At best, on the evidence before me, the trust has an excess of assets over liabilities in the sum of $38,527. It seems likely that in the event of the plaintiff losing its action against the first defendant and against the second to sixth defendants and orders for cost being made against it in favour of those parties, that sum may well be insufficient to meet its liability for those costs together with its liability to meet its own costs of the action. As I have already said, to realise cash to pay the first defendant's costs it appears likely that the plaintiff will first have to sell the only assets of the Allen Family Trust, being its units in the Meadow Mews Unit Trust. Such a sale may well take some time to arrange. The recent sale price of 83 cents per unit, about which Mr Millar gave evidence, may not be easily achievable.

18. Further to these matters, it is possible that between now and the conclusion of the trial the plaintiff will distribute all the net income of the trust, as it is received, to the beneficiaries of the trust and it may also distribute the whole or any part of the capital of the trust to those beneficiaries in accordance with its power to do so which is contained in the deed of settlement establishing the trust. If the plaintiff does so it will significantly reduce its ability to pay the first defendant's costs upon its liability to do so arising. In this connection it is material that the plaintiff's only directors are Mr D K Allen and Mrs J A Allen who are presently the only creditors of the Allen Family Trust and, together with their children, are the primary beneficiaries of the trust. It is easy to understand that the first defendant may feel very uneasy about its prospects of recovering from the plaintiff the full amount of any costs to which it might eventually be entitled.

19. It is therefore my determination "that there is reason to believe there is a real chance that in events which can fairly be described as reasonably possible the plaintiff corporation will be unable to pay the costs of the (first) defendant on service of the allocatur, if judgment goes against it." Beach Petroleum NL v Johnson [1992] FCA 110; (1992) 7 ACSR 203 at 205. Within the terms of the Corporations Law s1335(1) I am satisfied "that there is reason to believe that the (plaintiff) corporation will be unable to pay the costs of the (first) defendant if successful in ... its defence". The threshold test has therefore been satisfied and I deal next with the question whether I should exercise my discretion to order security for costs.

20. Upon the hearing of an application for security for costs which is made under the Rules of Court, O80, r18 delay on the part of an applicant in making the application may well be determinative in causing the application to be refused. This is particularly so because of the provisions of r22 which state that the application should, "in ordinary cases, be made before issue joined, but the Court or a judge may under special circumstances allow the application to be made at any later time". The Corporations Law s1335 does not fetter the exercise of the discretion in that way. It is an unfettered discretion. Goliath Portland Cement Company Pty Ltd v McNalley Australia Pty Ltd (No 6) A62/1993 at 3. Nevertheless delay in making an application is a relevant consideration to be taken into account along with other relevant matters, because it may operate to the prejudice of the plaintiff. Smail v Burton [1975] VicRp 76; (1975) VR 776; PG Gabel Pty Ltd v Katherine Enterprises Pty Ltd (1977) 2 ACLR 400. In this case the apparent delay in making the application ought attract little regard however, for it was not relied upon by the plaintiff as a cause of prejudice or even mentioned by its counsel. No other basis for prejudice was raised either. Indeed submissions by counsel for the plaintiff were directed almost entirely at the threshold test apart from a final sweeping submission that the discretion ought not be exercised in favour of the first defendant. Significantly no claim was made by the plaintiff that the making of an order for security for costs will unduly stultify its ability to pursue the action. MA Productions Pty Ltd v Austarama Television Pty Ltd (1982) 7 ACLR 97; Spiel v Commodity Brokers Australia Pty Ltd (1983) 8 ACLR 410.

21. Counsel for the plaintiff pointed to the fact that if the plaintiff's cause of action against the first defendant is established then the relatively precarious financial position of the Allen Family Trust will have been shown to have been brought about by the first defendant's representations. That is of course correct but it is impossible for me to assess the likelihood of success of the plaintiff's action. Such a factor would be particularly material if the making of an order for security for costs would be likely to obstruct the plaintiff in proceeding with its action, but there is no suggestion of that.

22. The plaintiff operates only as a trustee. Whatever financial benefit it gains from the action will be held by it on trust for the Allen Family Trust of which its two directors and shareholders, and their immediate family, are the primary beneficiaries. One of those directors, Mr D K Allen, swore an affidavit for the purpose of opposing the application. It is reasonable in all the circumstances to expect that those who stand to benefit from the action should accept liability for its costs in the event of it being unsuccessful, and particularly in a case such as this where the plaintiff is merely a trustee with no independent assets. The words of Connolly J in Harpur v Ariadne Australia Ltd (1984) 2 Qd R 523 at 532 have particular application: "The mischief at which the provision is aimed is obvious. An individual who conducts his business affairs by medium of a corporation without assets would otherwise be in a position to expose his opponent to a massive bill of costs without hazarding his own assets. The purpose of an order for security is to require him, if not to come out from behind the skirts of the company, at least to bring his own assets into play. If however he is already available for whatever he is worth, the object of the legislation is seen to be satisfied."

23. I do not overlook that there is a reasonable chance that by the time an order for costs is made (if it is made) in favour of the first defendant against the plaintiff there will be sufficient assets in the Allen Family Trust upon which the plaintiff will be able to call. It is the absence of evidence of any prejudice to the plaintiff if an order for security is made which is the material factor in persuading me that this is an appropriate case for the making of such an order.

24. There will be an order that the plaintiff's action against the first defendant be stayed until such time as the plaintiff pays into court, or otherwise provides security for, the sum of $24,000 by way of security for the first defendant's costs of the action. It may be that the plaintiff can provide security in accordance with this order pursuant to the provisions of the Rules of Court O70. As the only creditors of the Allen Family Trust are Mr and Mrs Allen, and they are substantial creditors in a sum exceeding $200,000, and they and members of their family stand to benefit from the plaintiff's action, they may well be appropriate persons to act as sureties under O70, r4. However it is unnecessary for me to determine that.