Fencott & Associates Pty Ltd v Eretta Pty Ltd

REASONS FOR INTERLOCUTORY DECISION This is an application for security for costs. On 28 December 1995, the applicant brought a claim against the respondent alleging a breach of section 46 the Trade Practices Act 1974 andseeking an injunction and damages. An application for an interlocutory injunction was dismissed on 29 December 1995. The pleadings closed in mid-1996. On 25 July 1997 the matter was set down for trial before a Judge of this Court over nine days commencing on 9 February 1998. The respondent filed a Notice of Motion on 16 December 1997 seeking an order that the applicant provide security for the respondent's costs. The interlocutory application has been referred to me for hearing and determination. It was first before me on 19 December 1997 but, due to the speed with which the matter was listed, doubts were raised as to the comprehensiveness of the affidavit evidence filed by the applicant in response to the interlocutory application. It was therefore agreed between the parties that the application be adjourned for further hearing on 9 January 1998.

Statutory Framework The Court has power to order security for costs in these circumstances by reference to both section 56 of the Federal Court of Australia Act and Section 1335 of the Corporations Law. The rules governing such applications are set out in Order 28 of the Federal Court Rules. Section 56 of the Federal Court of Australia Act provides that the Court may order an applicant in a proceeding in the Court to give security for the payment of costs that may be awarded against him. The section specifically provides that it does not affect the operation of any provision made under any other Act or by the Rules of Court in relation to the furnishing of security. Section 1335 (1) of the Corporations Law provides: "(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 security is given". The Nature of the Discretion. The discretion to make an order for security for costs is a wide and unfettered discretion to be exercised judicially according to how justice would best be served on the merits of each case without any particular predisposition: eg Fencott & Associates Pty Ltd v Eretta Pty Ltd (1987) 16 FCR 497 at 511; Hunt Contracting Co Pty Ltd v Roebuck Resources NL (unreported, Federal Court No. 521 of 1995, R.D. Nicholson J, 26 July 1995. However, as French J noted in Fencott & Associates Pty Ltd v Eretta Pty Ltd at 504-5, in most cases the general power conferred by Section 56 of the Federal Court of Australia Act will be exercised the same way as would the special power conferred by Section 1335(1) of the Corporations Law where, as here, the facts are within the range of application of the special power. The respondent acknowledges that the threshold issue is therefore whether it appears by credible testimony that there is reason to believe that the applicant will be unable to pay the respondent's costs if the respondent is successful in its defence. Under the terms of Corporations Law, the discretion arises only in those circumstances. The respondent bears the burden of showing, by credible testimony, that those circumstances exist. When considering the operation of Section 1335 of the Corporations Law, Lee J observed in Warren Mitchell Pty Ltd v Aust Maritime Officers Union 12 ACSR 1 that: "...an evidentiary burden is undertaken by the party seeking the order. It amounts to an obligation on an applicant for an order to show that the material before the Court is sufficiently persuasive to permit a rational belief to be formed that, if ordered to do so, the corporation would be unable to pay the costs of that party upon disposal of the proceedings. To what extent the satisfaction of that standard may fall short of the demonstration of a likelihood that the corporation will be insolvent at the relevant time is unnecessary to decide. It is enough to say that speculation as to insolvency or financial difficulties likely to confront the corporation will be insufficient to ground the exercise of the discretion." If the respondent succeeds in crossing the threshold on this issue, then the Court can proceed to weigh in the balance the other relevant factors. The quantum of the risk that the applicant will be unable to pay the respondent's costs if it is successful is one of those factors. Whether there is Reason to Believe that the Applicant will be unable to Pay the Respondent's Costs The respondent contends that there is credible testimony that there is reason to believe that the applicant will be unable to pay the respondent's costs if the respondent is successful in its defence. The testimony advanced by the respondent consisted of two affidavits sworn by a law clerk in the employ of the Western Australian agents of the respondent's solicitors. She has exhibited to the first affidavit: · a bundle of correspondence concerning the question of security for costs between the respondent's solicitors and the applicant's solicitors in the period from 26 September 1996 to 1 April 1997, and between the respondent's Western Australian agents and the applicant's solicitors in the period from 27 November 1997 to 16 December 1997; attachments to the correspondence include a Legal Cost Insurance Policy, correspondence from the insurer's claims broker advising of confirmation that indemnity had been granted under the policy and a balance sheet for the applicant as at 30 June 1996; · financial statements for the applicant for the year ending 30 June 1997; and · a draft bill of the respondent's costs showing costs incurred together with anticipated costs. The second affidavit deposes to costs incurred to date by the respondent's solicitors and their Western Australian agent, and to the manner in which the solicitors and agents have allocated between them the various tasks involved in the respondent's defence to the claim. When considering whether there is reason to believe that the applicant will be unable to pay the respondent's costs, I must assess what the costs are likely to be if the respondent is successful in its defence. The applicant disputes the adequacy of the draft bill of costs, which estimates total costs of $436,169. The applicant also challenges some of the items claimed, including Senior Counsel fees of $7,500 per day and a claim for $175,000 for "General Care and Conduct". The matter was not argued exhaustively, but I have concluded from my consideration of the draft bill and other relevant evidence that a fair estimate of the respondent's eventual recoverable costs for the purposes of this threshold test would be about $300,000. The respondent, while acknowledging that the material exhibited to its affidavit disclosed the existence of: · an insurance policy for legal costs up to $500,000; and · financial statements showing that the applicant had net assets of $569,485 as at 30 June 1997 nevertheless contends that there is reason to believe that the applicant will be unable to pay the respondent's costs if the respondent is successful. The respondent points out that, because it is not in privity with the insurer, it cannot directly enforce the policy. However, from its examination of the terms of the policy and the circumstances of this litigation, it has raised several potential concerns in connection with the insurance policy and the applicant's capacity to enforce it. The first concern is the extent of disclosure by the applicant to its legal insurer. The respondent submits that the weakness of the applicant's case is such that it calls into question the willingness of a legal costs insurer, if properly informed, to fund the case. In support of its submission that the applicant's case is weak, the respondent points to the result of the application for an interlocutory injunction. In his reasons for decision when refusing that application, Nicholson J, while acknowledging that there was "an arguable legal case to be made and a serious legal question to be tried", went on to observe that the evidence before him at that time did not disclose a strong case to be argued that the respondent acted for the purpose of deterring or preventing the applicant from engaging in competitive conduct either in the wholesale or any other market (my emphasis). He ultimately concluded that the applicant's case did not show that there was a serious question to be tried: Regent's Pty Ltd v Subaru (Aust) Pty Ltd (1996) ATPR 41-463 @ 41,630 The respondent questioned whether the insurer has been informed of the Court's interlocutory finding that the application did not to raise a serious question to be tried. The applicant filed an affidavit of Steven Michael Standing, one of the applicant's solicitors. It did not address the issue of disclosure. However, there was other evidence before the Court as to the extent of disclosure. A letter from the insurer's claims broker dated 22 February 1996, which was forwarded by a director of the applicant to the applicant's solicitors, requests that the solicitors be instructed to keep the insurer informed of progress in the matter, and to send copies of their fees; the evidence is that the insurer has since been paying the applicant's legal fees, from which it may be inferred that the insurer is satisfied with the extent to which the solicitors are keeping it informed. In a facsimile dated 18 December 1996, annexed to the respondent's affidavit, Mr Standing advised the respondent's solicitors that: "The insurer has been kept fully informed as to the progress of court proceedings, and has been paying our costs in this matter. There can therefore be no question that the insurer is aware of the proceedings (we provide the insurer with reports on the proceedings from time to time) and the liability of the insurer for your client's costs (if successful) is explicitly provided for in... the policy." No further evidence on the issue was presented by the applicant after the adjournment. The respondent submits that, given that it expressly challenged the bona fides of the applicant's claims under the insurance policy before the adjournment, Mr Standing should have deposed to the extent of disclosure to the insurer in a second affidavit. The respondent sought, on this issue among others, to rely upon the proposition that, because the extent of disclosure to the insurer is a matter peculiarly within the knowledge of the applicant, the applicant's failure to present evidence in relation to the matter, and inferences arising from that failure, may be taken into account in determining whether the respondent has satisfied its burden of proof. I will consider this proposition in more detail later in these reasons. For now it will suffice to say that I do not draw any inference in these circumstances from the fact that no additional evidence was led concerning disclosure to the insurer. Notwithstanding the interlocutory decision and the other authorities cited by the respondent as to the state of the law in this area, I do not consider the insurer's decision to fund the case so inexplicable as to give rise to an inference that the applicant has not met its obligations concerning disclosure. Such other evidence as was before me supported the proposition that the applicant was meeting its obligations to the insurer in that regard. Given the state of the evidence, I draw no inference from the applicant's decision not to add to the evidence on this issue. In any event, the respondent could have addressed the issue by cross-examining Mr Standing on his affidavit if it wished: Order 14 rule 9 Federal Court Rules. The respondent's second concern is that the litigation does not fall within the ambit of the policy, because the applicant's claim really relates to the respondent's conduct after the termination of the franchise agreement, rather than during it. The applicant disputes this analysis of its claim, and in any event points to the fact that the insurer has accepted liability for the applicant's costs in these proceedings. The respondent's third concern relates to the insurer's right under the policy to withdraw from the litigation if it decides that it is not economically viable to continue, subject to the applicant's right to submit the matter to final and binding independent legal advice. In Keriswey Pty Ltd v Granny May's Management Pty Ltd (unreported, Federal Court No. 295 of 1995, Olney J, 24 April 1995), security of costs was ordered where the applicant had the benefit of a legal insurance policy, in part because the policy contained a similar clause. In these proceedings the applicant has undertaken to immediately advise the respondent if the insurer seeks to invoke this clause. It submits, I think correctly, that it would be effectively entitled to an indemnity for all costs incurred both by itself and the respondent up to the date of withdrawal, which withdrawal would have to be by leave of the court. The respondent could, if necessary, immediately seek security for any future costs. No such undertaking was given in Keriswey Pty Ltd v Granny May's Management Pty Ltd. Dealing with the matters canvassed to this point, I do not find there to be credible testimony that there is reason to believe that the applicant will not be able to have recourse to the benefit of the insurance policy to pay the respondent's costs, if it is successful. The respondent's final concern is that the insurance cover will be inadequate to meet both parties' costs. According to Mr Standing's affidavit, accounts rendered to the applicant by its solicitors as at 1 November 1997 amounted to $96,433, of which the insurer had already paid at least $75,935. In correspondence dated 1 December 1997 to the Western Australian agents of the respondent's solicitors, he advised that costs to date were $107,000, of which $86,600 had been paid. He estimated that future costs would be up to $130,000. I will assume therefore that the applicant's total costs will be $240,000. Given my estimate that the respondent's recoverable costs would be about $300,000, the policy, being limited to $500,000, is therefore likely to be insufficient to meet all of the legal costs if the respondent is successful. The applicant would need to be able to meet the shortfall. The respondent went on to make submissions concerning the applicant's financial position. Before the adjournment, the evidence before the Court on this issue was comprised of the respondent's first affidavit, described above, and an affidavit from Mr John Miller. Mr Miller is an accountant employed by the Regent Motors Pty Ltd Group ("the Group") of which the applicant forms part. His affidavit annexed the applicant's financial statements as at 30 June 1997. The financial statements were prepared by Mr Miller in accordance with Schedule 5 of the Corporations Law and specified accounting standards. Those standards included AASB 1017 requiring provision for any doubtful receivables from related third parties. The financial statements show the applicant to have net assets of $569,485. However, the respondent noted that: · two entries listed as assets of the applicant effectively depended upon the financial position of other companies within the Group. They were a $274,092 loan to Scarboro Motors Pty Ltd ("Scarboro Motors") and a $225,000 investment in shares in Regents Finance Pty Ltd ("Regents Finance"). The total exposure of the applicant to these Group companies was $499,092; · The applicant has a further contingent liability of $525,000, being the balance of uncalled capital on its shares in Regent Finance, so that its exposure could potentially total $1,024,092; and · The applicant's assets secure the liabilities of Group companies (which liabilities are, however, also secured by land with a total value of over $5,000,000). Before the adjournment, the evidence on the financial position of the other companies within the Group was limited to statements in Mr Miller's affidavit that: · Scarboro Motors had total net shareholders equity of $1,914,121 as at 30 June 1997; · Regents Finance had net assets of $1,150,356, of which $3,038,501 were inter-company loans, and that there was no reason of which Mr Miller was aware to treat the applicant's investment in Regents Finance as worth anything less than the $225,000 shown in the applicant's balance sheet; and · the net assets of the Group as a whole was $2,776,000. The respondent indicated before the adjournment that it again intended to rely upon the proposition that, because the financial position of the Group companies is a matter peculiarly within the knowledge of the applicant, the applicant's failure to present evidence in relation to the matter, and inferences arising from that failure, should be taken into account in determining whether the respondent has satisfied its burden of proof. An adjournment was granted when the parties agreed that they have further time to present additional evidence as to the financial position of the other companies within the Group. During the adjournment, a further affidavit of Mr Miller was filed, annexing financial statements for the year ending 30 June 1997 for each of the other companies within the Group, together with correspondence answering questions from the respondent's solicitors pertaining to those accounts. Those accounts were prepared by Mr Miller on the same basis as the applicant's accounts. The respondent raised two matters after the adjournment. First, the respondent notes that part of the Group's assets is comprised of "goodwill" of $1,100,000, listed on the balance sheet of Galleria Motors Pty Ltd ("Galleria Motors"). Galleria Motors is a Group company to whom Regent Finance has a loan of $1,603,098 and Scarboro Motors has a loan of $447,990. The amount shown as goodwill reflects the price paid for the purchase of Galleria Motors in March 1997. Galleria Motors made an operating loss of $327,772 after tax in the year ending 30 June 1997. As at 30 June 1997, Galleria Motors' liabilities exceeded its assets (including goodwill) by $317,772. The respondent therefore casts doubt to that extent on the weight the Court should place on Mr Miller's statement that the net assets of the Group were $2,766,000. Secondly and more importantly, it was apparent from Mr Miller's second affidavit that the financial position of each of the companies within the Group, including the applicant, ultimately depends upon whether loans totalling $3,575,240 made by Scarboro Motors to entities outside the Group are readily recoverable. The loans by Scarboro Motors are detailed by Mr Miller as follows: Debtor Amount Barrabadeen Stud $84,848 Van Helvoort Family Trust $31,057 Van Helvoort (1978)Trust $1,628,532 Ryder Investments $541 Wollondilly Unit Trust $7,347 Wirrimbirra Unit Trust $1,822,915 $3,575,240