FIDUCIARY v MORNINGSTAR [2001] NSWSC 1087 | Case summary

HIS HONOUR: 1 The first plaintiff, Fiduciary Ltd, a company owned and controlled by the second plaintiff, Mr Rich, is a minority shareholder in the first defendant, Morningstar Research Pty Ltd, which I shall call "the Company". The other shareholder is the second defendant, Morningstar Inc, a United States corporation which holds more than 50 per cent of the shares. 2 There are six members of the board of directors of the Company. Four (being the third to sixth defendants) are nominated by Morningstar Inc and two, including Mr Rich, by Fiduciary. The board composition and other matters concerning the structure and operations of the Company are the subject of agreements between the shareholders. These operate as a supplement to the Company's constitution. 3 In these proceedings, Fiduciary seeks substantive relief by reason of conduct of Morningstar Inc in relation to the Company alleged to be oppressive or otherwise within s.232 of the Corporations Act 2001 (Cth). There are also allegations of actual or potential breaches of the duties of directors, both under the Act and at general law, although, as was pointed out by Mr Hutley SC who appeared for the defendants, the proceedings are not constituted in a way which allows such complaints to be pursued by the Company against the directors. That matter is now governed by s.236 which has abolished the rule in Foss v Harbottle (1843) 2 Hare 461 (67 ER 189). 4 That, however, is not something that need concern me now. It is sufficient to say that conduct involving breach of directors' duties might quite readily be made the subject of a claim for relief under s.232. The "oppression" concept, as explained by Brennan J in Wayde v NSW Rugby League Ltd (1985) 180 CLR 459, may be measured by reference to the conduct of "reasonable directors, possessing any special skill, knowledge or acumen possessed by the directors and having in mind the importance of furthering the corporate object on the one hand and the disadvantage, disability or burden which their decision will impose on a member on the other". Oppression is thus, in one broad sense, a departure from norms of behaviour adopted by reasonable directors acting reasonably. There is also the point that, according to its own terms, s.232 may be invoked in relation to matters "contrary to the interests of the members as a whole". That is a criterion cast in terms strongly reminiscent of those which define aspects of directors' duties. 5 The further amended interlocutory process which I have heard today seeks principally injunctions restraining the Company from issuing shares to Morningstar Inc in consideration of funds paid to the Company by Morningstar Inc in September 2001; an injunction restraining any other issue of shares in the Company; and injunctions restraining the various defendants from being party to actions culminating in the dismissal of Mr Rich as managing director of the Company and the appointment of Mr Reynolds as an employee of the Company. The orders are sought until hearing of the action or further order. 6 This being an application for an interlocutory injunction, the matters to be considered are those which were confirmed as relevant by the High Court in its decision earlier this month in Australian Broadcasting Corporation v Lenah Game Meats Pty Ltd [2001] HCA 63. Gleeson CJ there noted the continuing applicability of the following statement of Mason ACJ in Castlemaine Tooheys Ltd v South Australia (1986) 161 CLR 148: "In order to secure such an injunction the plaintiff must show (1) that there is a serious question to be tried or that the plaintiff has made out a prima facie case, in the sense that if the evidence remains as it is there is a probability that at the trial of the action the plaintiff will be held entitled to relief; (2) that he will suffer irreparable injury for which damages will not be an adequate compensation unless an injunction is granted; and (3) that the balance of convenience favours the granting of an injunction." 7 In the Lenah case, Callinan J preferred, for item (1), a test of "whether the applicant can demonstrate either a reasonably arguable case on both the facts and the law, or that there is a serious question to be tried". 8 The first step is accordingly to consider whether the plaintiffs have made out a prima facie or reasonably arguable case or shown that there is a serious question to be tried as to an invasion of some legal or equitable right of the plaintiffs. 9 In relation to the claim for an interlocutory injunction to restrain the issue of shares, the legal or equitable right to which the plaintiffs would point is the implied right of every shareholder to see share capital of the company issued in a financially responsible and economical way so that, in general, the minimum practicable number of shares is issued to obtain the quantity of capital required. Such a principle would no doubt be asserted by reference to the English case of Shearer (Inspector of Taxes) v Bercain Ltd [1980] 3 All ER 295, which was among the cases to which the High Court referred in Pilmer v Duke Group Ltd (2001) 75 ALJR 1067. In Shearer, Walton J said: "It is, in normal circumstances, the duty of the company to issue its shares at the highest premium it can command for them, but for good reason it may issue them for any less amount, obviously not less than par."

10 In saying this, Walton J approved the following extract from the speech of Lord Wright in Lowry (Inspector of Taxes) v Consolidated African Selection Trust Ltd [1940] AC 648: "If the share stands at a premium, the directors prima facie owe a duty to the company to obtain for it the full value that they are able to get. It is true that it is within their powers under the Companies Acts to issue it for par, even in such a case, but their duty to the company is not to do so unless for good reason." 11 The references to "par" in these extracts are, of course, no longer meaningful in Australia following the abolition of par value shares by the Company Law Review Act 1998 (Cth) with effect from 1 July 1998. But that in no way alters the basic principles and their applicability. 12 The plaintiffs rely on evidence that an outside party has expressed itself willing to take up shares priced on the basis that the Company has a value of $25 million. There is evidence that the party concerned has repeated that willingness in recent days, although the indicated willingness of the outside party is qualified by conditions about due diligence and the like. 13 One thing the outside party would now find when it conducted due diligence is a report received yesterday from Ferrier Hodgson, the firm of insolvency practitioners. That report states an opinion that, on assumptions detailed in the report, the Company is now insolvent and is likely to remain so in the absence of appropriate financial support from some external source. No doubt the financial support would need to be of an equity nature. With the outside party, so far as the evidence shows, not aware of the Ferrier Hodgson opinion, I doubt that much reliability can be placed upon that party's view of the value of the Company. That being so, it is difficult to see how the plaintiffs can today show a prima facie case or serious question to be tried on the point that the shares to be issued for the consideration of $550,000 are being issued at an effective undervalue. 14 As to the second subject matter, being the possible removal of Mr Rich as managing director, one question is whether a management agreement was entered into, being an agreement a term of which would entitle him to certain notice before termination could be effected. The indications on this in the evidence are that such an agreement was probably not signed, although a draft or form of agreement was prepared. There is also evidence to suggest that the parties may have proceeded informally on the basis that the agreement (or a large part of it) existed or, at least, that equivalent terms were by some means or other adopted into their relationship. 15 On that basis, there may be an arguable case that removal of Mr Rich without the notice in question would amount to a breach of contract, but that does not change the ability of the board of directors to dismiss him just the same, thereby committing the company to the consequences of breach of contract. I bear in mind that this is in the nature of a contract for personal services which the court would not normally seek to enforce in such a way as to make parties stay together as employer and employee, which is effectively what the relationship is. Damages would normally be foreseen as the appropriate outcome in case of breach of such a contract. There is an arguable case on the issue of dismissal of Mr Rich but it is not a strong one and, in any event, the situation will be adequately dealt with by damages. 16 Overall, then, my conclusion on the issue of serious question to be tried is that there is what I would describe as a weak case on the share issue point and a slightly more sustainable, but not at all strong, case on the dismissal point. 17 Against this background, I turn to the balance of convenience and the question of the respective degrees of hardship that the grant of the injunctions would entail. The first and most important consideration is obviously the fact that the firm of Ferrier Hodgson, after conducting a review of the Company's situation, has in the last 24 hours expressed the opinion that the Company is insolvent. It is thus in urgent need of attention. 18 The material before me indicates that Fiduciary is not prepared to introduce further equity. Morningstar Inc is, however, prepared to do so. There is evidence from the President of the International Division of Morningstar Inc, Ms Desmond, that Morningstar Inc will provide the funding required to finance the business of the Company for the next six months, but only if there is no order of the court preventing the removal of Mr Rich. Ms Desmond gave this evidence by affidavit and elaborated upon it in supplementary oral evidence. 19 The plaintiffs have raised other issues relevant to the balance of convenience, particularly evidence of opinions in the market places in which the Company operates that the absence of Mr Rich would deal the Company's reputation a severe blow. The criticism made of that evidence was that the affidavits have been sworn by prominent business figures without the court having had any means of knowing the nature or quality of the information about the Company on which they based their judgments. But given that it is a judgment, in each case, about the reputation of the Company and its standing in the market, perhaps not much information about internal affairs was needed by the deponents. 20 Also in relation to the balance of convenience, there arises a question about the sufficiency of the undertaking as to damages that would necessarily be given by the plaintiffs. Although it is not I think a major point, there must be some question mark over that as Fiduciary has said that it is not prepared to fund the Company. That no doubt also reflects the position of Mr Rich as well, he being the controller of Fiduciary. The relevance of the worth of an undertaking as to damages to the balance of convenience is demonstrated by the decisions of Hodgson J in French v Chapple [2000] NSWSC 1240 and Wentworth v Wentworth (NSWSC, unreported, 12 June 1997). A relevant passage from the latter judgment was quoted by me in EPP National Buying Group Pty Ltd v Levy [2001] NSWSC 482 and need not be repeated here. 21 As I have said, the factor at the forefront of the balance of convenience assessment in this case and the consideration of overwhelming significance is what has now been established to be, to the standard needed for present purposes, the insolvency of the Company in the absence of immediate financial support. The only source of such support which presents itself as being immediately and clearly available is the source deposed to by Ms Desmond of Morningstar Inc, both in her affidavit and in supplementary oral evidence. But the clearly stated position of Morningstar Inc is that it is not prepared to introduce into the Company the equity support it so urgently needs if there is any order in place which has the effect of preventing action under the Company's constitution to remove Mr Rich as managing director. 22 In these circumstances, the court is bound to see the balance of convenience as favouring refusal of the injunctive relief sought. The interests of the Company and the other defendants in seeing the Company retrieved forthwith from insolvency clearly outweigh the interests of the plaintiffs in maintaining the status quo pending the hearing of the action. If it is shown in due course that the plaintiffs have satisfactorily made out their case of oppression, an array of remedies will be at the court's disposal under s.233 to vindicate their rights. 23 I have not so far mentioned the fact that, in the course of the hearing this morning, Mr Ellicott QC sought for the plaintiffs and was granted leave to amend further the amended interlocutory process so as to add, as an additional head of relief sought, an order that the company be wound up and that a liquidator be appointed provisionally. 24 I do not intend to deal with that application at this point. As it is inappropriate for the injunctive relief to be granted, there is, on the evidence, a clear probability and expectation that the Company's position of insolvency will now be addressed by Morningstar Inc in a way which will have a significant bearing on the appropriate outcome in relation to the application for the appointment of a provisional liquidator. I am also mindful of the fact that such an appointment at this stage would in a sense pre-empt the hearing of the proceedings for final relief, an order for winding up (and no doubt an order for the appointment of a liquidator provisionally, in the first instance) being conceivably one of the outcomes in oppression proceedings. 25 The decision of the court is that orders 1, 2, 3 and 4 in the further amended interlocutory process are refused. As to order 5, the further amended interlocutory process is stood over to 9.30am on Friday 30 November 2001 before me. I direct that the defendants serve by 2pm on Thursday 29 November 2001 an affidavit deposing to actions taken to that point to address the issue of the Company's solvency. 26 The plaintiffs will pay the defendants' costs of these interlocutory proceedings.

FIDUCIARY v MORNINGSTAR

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