French & Ors v Smith & Ors [2004] VSCA 207

French & Ors v Smith & Ors [2004] VSCA 207 - VSCA 2004 case summary — Zoe

[5]

As will become apparent later, one of the main areas of dispute between the parties concerned the operation of a quarry business, first by Quarry Quip and then by Skye Quarries, on land owned by the French interests. It is, therefore, desirable to describe briefly at this point the land in question ("the Ballarto land") and some of the early quarry operations on it. Since approximately 1974, Ballarto has been the registered proprietor of land on the Mornington Peninsula at Skye, being Crown allotment 31A described in the Certificate of Title Volume 9580 Folio 194 ("Lot 31A"). The land immediately to the north of it is Crown allotment 33A ("Lot 33A") and adjoining that land, on its northern side, is Crown allotment 33C ("Lot 33C"). Between 1974 and 1981 sand was extracted from Lot 31A pursuant to an extractive industry licence that was issued under the relevant legislation to the lessees from Ballarto; first, Southern Sand and Gravel Pty Ltd and then, William Edgar Sims and William Eric Sims ("the Sims"). As part of the mining operations, a number of slime dams were created on the property. When, however, the Sims in 1980 ceased to operate the quarry, the reclamation of this portion of the land was neglected. On 29 March 1982, the relevant Minister issued a notice requiring the dams to be drained and the sludge to be dried and disposed. The notice was not complied with. As a result, the licence was on 15 November 1983 revoked. On 13 May 1985, however, the Minister issued to Ballarto a fresh extractive industry licence to mine sand on the Ballarto land on the basis, inter alia, that the previously neglected work on the dams and sludge would be carried out. At that point, Lots 33A and 33C were not owned by the French interests, but in late 1993 Quarry View purchased Lot 33C, although it was not able to exploit it for quarrying purposes until 1996 due to planning restrictions. In May 1994 it also acquired Lot 33A and the bulk of the quarrying operations with which the appeal is concerned were carried out on that land, first by a division of Quarry Quip known as Skye Sand Stone and Soil ("Skye Sand"), even before Lot 33A was owned by Quarry View, then by Skye Quarries between late 1993 and September 1995, and thereafter, so far as is relevant, by Skye Sales.

[16]

Throughout its operation, French treated Skye Quarries as if it was his own and, from time to time, drew out large amounts from its bank account for his own purposes or those of Ballarto. In the main, such drawings were made by cheques that were countersigned by Smith who, on nearly all such occasions, was aware that the payments were not being made for the benefit of Skye Quarries. In order to account for such transfers in the financial records of Skye Quarries, French often raised fictitious invoices which, on their face, showed that Ballarto had sold sand to Skye Quarries. It is common ground that on two occasions in December 1994 French, without notifying Smith or McCallum, caused to be withdrawn from the bank account of Skye Quarries and paid to Ballarto, by way of bank transfer, two sums each for $200,000 which, French said, were used to pay for the purchase of two expensive machines by Ballarto, namely, an excavator and a dump truck, the purchase price of which was approximately $400,000. Both items were delivered to the quarry before December 1994. It should be noted for completeness, however, that, in cross-examination, French accepted that the vehicles were purchased pursuant to hire purchase agreements, but said that the money was needed by Ballarto as operating capital, essentially to fund its acquisition, through Quarry View, of Lots 33A and 33C and to enable it to continue its facilities with the bank. He said that he did not consider it necessary to consult Smith about the transfer of the $400,000 "because Skye Quarries was my company". In order to provide a justification for the transfer of the $400,000 in the financial records, French created two invoices, dated 30 November 1994 and 16 December 1994, each for $200,000, which showed that Ballarto supplied to Skye Quarries 40,000 tons of mineral sand at $5.00 per ton. In fact, there was no such sale and the invoices reflected no more than fictitious transactions in order to give the appearance of a legitimate commercial basis for the transfer of the funds. His Honour considered that this was an example of the preparedness of French "to use the funds and moneys of Skye Quarries [and] appropriate such moneys for his own use and that of Ballarto and to [create] fictitious documents which, on their face, purported to record the sale of sand, for `accounting purposes' when the moneys appropriated from Skye Quarries to Ballarto were direct transfers of moneys held in the account of Skye Quarries." His Honour recognised that French took large sums of money from Skye Quarries and transferred them to Ballarto against fictitious invoices and that, on his own admission, since 1993, he caused to be prepared, for the Ballarto accounts, false depreciation schedules totalling hundreds of thousands of dollars in order to inflate artificially the apparent cost of Ballarto's operation, thereby minimising the profit of the company.

[26]

The resolution of this claim depended almost entirely on whether the quarry business that was operated by Skye Quarries belonged to it, or whether it was beneficially owned by the French and Ballarto interests. It has already been noted that his Honour rejected the appellants' claim that Smith and McCallum held their shares in Skye Quarries for the benefit of French. His Honour also rejected French's claim that Skye Quarries, like Skye Sand, was a mere "marketing" entity. It was claimed by French that Smith had acknowledged to him that Skye Quarries was set up "as a marketing company as a result of your [aeroplane] accident", but this was denied by Smith. His Honour was not prepared to accept that Smith made such an acknowledgment and, as we have said, he rejected the notion that the role and function of Skye Sand and Skye Quarries were limited to that of marketing. He considered that each of Skye Sand and Skye Quarries was actively involved in the working of the quarry, the mining of the sand and also of its sale. But this is as close as his Honour came to saying, in terms, that the quarry business belonged to Skye Quarries. Nevertheless, that must have been his Honour's conclusion given that he accepted, as we have said, that the Skye Quarries money that French appropriated belonged to that company and given that he held that the French interests must pay Skye Quarries essentially the whole of the Schedule 2 claims. In his reasons for judgment the learned trial judge closely analysed the Schedule 2 claims and effectively concluded that $1,749,149.38 had been misappropriated from the Skye Quarries bank account at the behest of French. Accordingly, he ordered that French and some of his companies pay this amount to Skye Quarries. As will be seen, the appellants challenge this aspect of his Honour's decision on the basis that the quarry business belonged beneficially to the French and Ballarto interests and that, therefore, there was no basis for his Honour making the above order in respect of the Schedule 2 claims.

[31]

The respondents, however, contended that the decision that the French and Ballarto interests pay the Schedule 1 claims was not determinative of the capacity in which Skye Sand carried on the quarry business. According to them, the reason his Honour found that the French and Ballarto interests were required to pay the Schedule 1 claims was that his Honour was satisfied that they had agreed to reimburse Quarry Quip for the costs and expenses incurred by it in relation to the setting-up of the quarry, and not because Skye Sand operated the quarry for their benefit. The respondents also claimed that the nature of the work performed by Skye Quarries was materially different from that which was performed by Skye Sand. It was said that Skye Sand merely carried out work that was preparatory to the mining operation that was ultimately undertaken by Skye Quarries. In particular, the respondents pointed to the fact that Skye Quarries was established shortly after the completion of the sand washing plant, which enabled it to sell washed sand at a significantly higher price than that charged by Skye Sand for the dried (unwashed) sand in addition to the overburden that it already excavated and sold. Such excavation of overburden by Skye Sand, said the respondents, was necessarily preparatory work undertaken to expose the sand for excavation and processing (by Skye Quarries). It was further argued for the respondents that the decision by French and Smith to establish Skye Quarries and to issue the shares in it to the three parties reflected the recognition by French and Ballarto of the material contribution made by Smith and McCallum through Quarry Quip to the setting up of the quarry and preparing it for large scale operations, including the building, at cost, of critical plants, such as the rock crushing and sand washing plants as well as roads and the reclamation of slime dams. Moreover, said the respondents, it was wrong to claim, as the appellants did, that his Honour's finding that Skye Quarries beneficially owned the quarrying business necessarily involved the conclusion that French and Ballarto effectively made a gift of two-thirds of their quarrying business to Smith and McCallum. Such a contention, it was said, overlooked the fact that Smith and McCallum, through their interest in Quarry Quip, contributed towards the quarry business their notional interest in the notional profit component of the engineering and civil works that were provided by Quarry Quip (at cost) for the benefit of the quarry operation and the several years that Smith spent working seven days per week at the quarry to re-establish it as a going concern. The respondents argued that these circumstances explain and justify his Honour's decision that, in the circumstances, it was intended by the parties that Smith and McCallum would own their shares in Skye Quarries in their own right and that, consistently with that position, Skye Quarries would operate the quarry business for its own benefit. In the circumstances, it was said, no error attaches to his Honour's ultimate conclusion that the money in question belonged to Skye Quarries and that the French and Ballarto interests must repay it.

[32]

In analysing the competing arguments of the parties for the purpose of determining whether his Honour erred as is contended for by the appellants in ground 5, we consider it useful first to establish the capacity in which Skye Sand carried out the work at the quarry, particularly given that the learned primary judge made no specific finding on this issue. Needless to say, if the work was done for the benefit of French and Ballarto and not for itself, that would go a considerable way towards supporting the appellants' claim that Skye Quarries conducted the business on behalf of French and Ballarto given that, as was accepted by the parties and as his Honour found, Skye Quarries took over the quarrying operations from Skye Sand on the basis that it would conduct them in the same capacity as Skye Sand had done. We consider that the following evidence points to the conclusion that Skye Sand carried out the quarry work for the benefit of the French and Ballarto interests and not for the benefit of Quarry Quip. First, according to its own accounting records, Quarry Quip did not regard itself as the beneficiary of its contribution, through Skye Sand, to the development of the quarry. Rather, consistently with its relationship with French and Ballarto during the "M&K period", Quarry Quip viewed itself as a creditor in relation to the cost of its work. Its debtors' card, to which we have referred earlier, treated Skye Sand and, through it, French and Ballarto, as a debtor in respect of its quarry related expenses. Moreover, in accordance with its arrangement with French, Quarry Quip claimed payment for such work, first out of the proceeds of sale of the quarry product and, when those proceeds proved to be insufficient, it claimed the costs from French and Ballarto. In the proceeding this claim was, as we have already noted, particularised in Schedule 1. Secondly, the provision in May 1993 by Ballarto, at the behest of French, of a debenture for $600,000 to secure the amount due to Quarry Quip in relation to the work carried out by Skye Sand, points almost unequivocally to the conclusion that the parties regarded the French and Ballarto interests as the beneficial owner of the quarry business during the period when Skye Sand conducted its operations.

[125]

"The words are a recognition of the fact that a limited company is more than a mere legal entity, with a personality in law of its own: that there is room in company law for recognition of the fact that behind it, or amongst it, there are individuals, with rights, expectations and obligations inter se which are not necessarily submerged in the company structure. That structure is defined by the Companies Act and by the articles of association by which shareholders agree to be bound. In most companies and in most contexts, this definition is sufficient and exhaustive, equally so whether the company is large or small. The `just and equitable' provision does not, as the respondents suggest, entitle one party to disregard the obligation he assumes by entering a company, nor the court to dispense him from it. It does, as equity always does, enable the court to subject the exercise of legal rights to equitable considerations; considerations, that is, of a personal character arising between one individual and another, which may make it unjust, or inequitable, to insist on legal rights, or to exercise them in a particular way. It would be impossible, and wholly undesirable, to define the circumstances in which these considerations may arise. Certainly the fact that a company is a small one, or a private company, is not enough. There are very many of these where the association is a purely commercial one, of which it can safely be said that the basis of association is adequately and exhaustively laid down in the articles. The superimposition of equitable considerations requires something more, which typically may include one, or probably more, of the following elements: (i) an association formed or continued on the basis of a personal relationship, involving mutual confidence - this element will often be found where a pre-existing partnership has been converted into a limited company; (ii) an agreement, or understanding, that all, or some (for there may be `sleeping' members), of the shareholders shall participate in the conduct of the business; (iii) restriction upon the transfer of the members' interest in the company - so that if confidence is lost, or one member is removed from management, he cannot take out his stake and go elsewhere."

[133]

"2.2.3 Except as provided in Article 2.2.3 (ix), no transfer of shares shall be registered unless all members of the Company agree, or unless the following procedure is followed:- (i) The person proposing to transfer any shares called `the proposing transferor' shall give notice in writing to the Company that he desires to transfer the shares. (ii) The notice shall specify the sum he fixes as the fair value, and shall constitute the Company his agent for the sale of the shares at the price so fixed, or, at the option of the purchaser, at the fair value to be fixed by arbitration under the Arbitration Act 1958 and shall constitute an offer: (a) in the first instance to the existing shareholders in the proportion of their shareholding which offer shall remain open for acceptance in writing for a period of seven days from the date of offer; (b) in the event of any shareholder not accepting the purchase of his proportion of shares, the number of shares not taken up shall then be offered to those shareholders of the Company who are willing to purchase the same and if more than one in equal shares and such offer shall remain open for acceptance in writing for a further period of seven days; (c) any shares not taken up may then be offered by the Directors to any person selected by the Directors as being one whom it is desirable to admit to membership. (iii) A transfer notice may include several parcels of shares, and in such case shall operate as if it were a separate notice in respect of each parcel. (iv) A transfer notice shall not be revocable except with the sanction of the Directors. (v) If the Company, within twenty-eight days after being served with a transfer notice, finds a member or person called `the purchaser' as aforesaid willing to purchase the shares and gives notice to the proposing transferor, he shall be bound, upon payment of the fair value, to transfer the shares to the purchaser. (vi) In case any difference arises between the proposing transferor and the purchaser as to the fair value of the shares, the fair value shall be fixed by arbitration under the Arbitration Act 1958. (vii) If in any case the proposing transferor, after having become bound under paragraph (v) of this Article makes default in transferring the shares, the Company may receive the purchase money, and shall thereupon execute a transfer of the shares and cause the name of the purchaser to be entered in the register as the holder of the shares, and shall hold the purchase money in trust for the proposing transferor. The receipt of the Company for the purchase money shall be a good discharge to the purchaser, and after his name has been entered in the Register in purported exercise of the power given by this paragraph, the validity of the proceedings shall not be questioned by any person. (viii) If the Company, within twenty-eight days after being served with a transfer notice, fails to find a member or person selected as aforesaid willing to purchase the shares, or fails to give notice as provided in paragraph (v) above of this Article, the proposing transferor at any time within three calendar months after the transfer notice is served on the Company shall be at liberty to sell and transfer the shares (or those not placed ) to any person and at any price. (ix) Any share may be transferred by a member to any child or other issue, son-in-law, daughter-in-law, father, mother, brother, sister, nephew, niece, wife, or husband of the member; and any share of a deceased member may be transferred by the legal personal representative to any child or to other issue, son-in-law, daughter-in-law, father, mother, brother, sister, nephew, niece, widow or widower of such deceased member to whom the deceased member may have specifically bequeathed the same; the shares standing in the name of the trustees of the will of any deceased member may be transferred upon any change of trustees to the trustee for the time being of the will."

[137]

"[222] In the circumstances of this case Quarry Quip was formed and it commenced to carry out and still carries out its business as an engineering company. The breakdown in the relationship that has occurred between Smith, McCallum and French initially had its roots in the discovery by Smith, that without his knowledge, French had withdrawn by bank transfers sums totalling $400,000 from the account of Skye Quarries. It was following this discovery that Smith withdrew from the affairs of Skye Quarries and returned to and thereafter continued working in the engineering business of Quarry Quip. It was subsequent to that that McCallum withdrew from the day to day business of Quarry Quip and concentrated on the affairs of M. Steel. From the evidence of Smith it is to be concluded that after McCallum withdrew from Quarry Quip and after he appointed a manager of the company and notwithstanding that M. Steel was in competition to the company that Quarry Quip has prospered. It has continued to carry on its business as an engineering company. There has been no breakdown in the relationship between Smith, McCallum and French brought about by the manner in which, initially, McCallum and Smith and thereafter Smith has conducted the affairs of Quarry Quip. [His Honour then quoted the passage from Lord Shaw's opinion in Loch v. John Blackwood Limited quoted above.] [223] In relying on this ground French relied on the fact that the relationship between the three directors of Quarry Quip had broken down. On the evidence the breakdown in the relationship between the directors of Quarry Quip related to matters outside the conduct of the affairs of Quarry Quip and had as its root cause the actions and conduct of French in relation to the affairs of Skye Quarries. In such circumstances it cannot be concluded that it is `just and equitable that the company be wound up'. For the same reasons I conclude that it would not be appropriate for the court to order that Smith purchase the shares of French in Quarry Quip. These matters can be attended to pursuant to the provisions of the articles of association of Quarry Quip."

[138]

The judge, from the passages just quoted, appears to have accepted that the relationship of the three parties as shareholders and directors of Quarry Quip had broken down. Mr Bick submitted that this finding was clearly correct and well supported by the evidence. His next submission related to the judge's statement that the breakdown of the relationship between the directors of Quarry Quip "related to matters outside the conduct of the affairs of Quarry Quip and had as its root cause the actions of French in relation to the affairs of Skye Quarries". He accepted that the judge was adverting to a discretionary matter against the making of a winding up order on the just and equitable ground to the effect that French did not come to court with clean hands, putting it that this finding was in turn substantially based on his Honour's view that French was misappropriating funds of Skye Quarries. Mr Bick challenged the judge's conclusion that there had been any such misappropriation by French, and we have already stated our view that French was not misappropriating funds of Skye Quarries when he took $400,000 from the account of that company. Mr Bick built on this submission saying that the judge had not made a finding that French was the sole cause of the breakdown of the relationship which had occurred, submitting that no such finding could properly have been made on the evidence. He submitted that the facts demonstrated that the breakdown of the relationship between Smith and McCallum was not caused by any act or omission of French. He argued that Smith and McCallum were content to have a commercial relationship with French in Quarry Quip throughout 1995 and into 1996. He argued that the dispute between Smith and McCallum in December 1994 was not caused by any act or omission of French; the proper inference was that Smith and McCallum became tired of the arrangement by which Smith would devote his time to the quarry business, which led to Smith withdrawing his services from the quarry at the end of 1994 at McCallum's insistence, before Smith was aware of the transfers made by French to Ballarto from the Skye Quarries account. He argued that the proper inference to draw was that the transfers made by French from the Skye Quarries account to Ballarto were of no real significance to Smith. However by mid 1996 the relationship between Smith and McCallum had deteriorated to such an extent that McCallum told Smith he would leave Quarry Quip if things did not improve. He submitted accordingly that the judge erred in not making an order winding up Quarry Quip since the personal relationship involving mutual confidence upon the basis of which Quarry Quip was formed or continued had broken down.

At a glance

Court

Decision date

Before

Source

Judgment (197 paragraphs)

Parties