Galati v Deans

Supreme Court of NSW|2019-04-15|Before: Rees J, Brereton J, Gleeson JA

These proceedings

The proceedings were commenced on 25 October 2018. On 5 November 2018, the defendants foreshadowed an application for security for costs and, on 16 November 2018, the plaintiffs' solicitors advised that such an application would be opposed on the basis that the financial difficulties of Commercial Indemnity were caused by the deliberate actions of Mr Gardiner but, if the Court made such an order, Mr Hancock would comply with it. Further correspondence ensued as to the appropriate amount of any security.
On 12 December 2018, consent orders were made for the progress of the matter, including that the defendants serve any evidence by 15 February 2019. In agreeing to the proposed orders, the defendants' solicitors made clear: Please note that we hold instructions to make an application for security for costs and it is to be filed as soon as possible. The absence of a direction to that effect is not a waiver by our clients of such application.
On 15 February 2019, the defendants filed no evidence, in breach of the consent orders which had been made. Consequently, the plaintiffs' evidence has been served but the defendants' evidence has not.
On 22 February 2019, the defendants filed an interlocutory process seeking security for costs of $151,000, to be provided in two tranches of $75,500 each. The application was supported by an affidavit by the defendants' solicitor setting out how these figures had been arrived at.
On 11 March 2019, the defendants' solicitor sought confirmation that Mr Hancock accepts that he is personally liable for any adverse costs orders made in the proceedings. The defendants' solicitor sought a statement of assets and liabilities of Mr Hancock, a copy of any funding or indemnity agreement between Mr Hancock and Mr Newling and, if Mr Hancock has any insurance beyond the funding agreement, a copy of the insurance policy. The plaintiffs' solicitor responded that the orders appointing Mr Hancock as special purpose liquidator did not, at this stage, entitle him to have recourse to the assets of Commercial Indemnity for the payment of any costs order made against him and that, in the absence of such an order, he would be personally liable for those costs. The defendants otherwise declined to provide the information and documents sought.

Power to order security for costs

There is no doubt that Commercial Indemnity is insolvent, and there is reason to believe that it would be unable to pay the defendants' costs if ordered to do so, thereby satisfying the requirements of rule 42.21(1)(d) of the Uniform Civil Procedure Rules 2005 (NSW) and section 1335 of the Corporations Act 2001 (Cth). As such, the question for determination is whether the Court should exercise its discretion to order security, in respect of which rule 42.21(1A) of the Uniform Civil Procedure Rules provides: In determining whether it is appropriate to make an order that a plaintiff … give security for costs, the court may have regards to the following matters and such other matters as it considers relevant: (a) the prospects of success or merits of the proceedings, (b) the genuineness of the proceedings, (c) the impecuniosity of the plaintiff, (d) whether the plaintiff's impecuniosity is attributable to the defendant's conduct, … (f) whether an order for security for costs would stifle the proceedings, (g) whether the proceedings involves a matter of public importance; … (j) the costs of the proceedings, (k) whether the security sought is proportionate to the importance and complexity of the subject matter in dispute, (l) the timing of the application for security for costs, …
The defendants accepted that, in practical terms, there is no substantial difference between the operation of the Uniform Civil Procedure Rules and section 1335 of the Corporations Act in this case. Five factors are most pertinent in this case.

Impecuniosity caused by defendants

The plaintiffs oppose security on the basis that Commercial Indemnity's impecuniosity is attributable to the conduct of the defendants. What is needed to establish this proposition was explained in Jazabas Pty Ltd v Haddad (2007) 65 ACSR 276; [2007] NSWCA 291 at [94]-[95] per McClellan CJ at CL (with whom Mason P agreed): 94 The claimants carried the onus of establishing both the adequacy of their financial position before their dealings with the opponents and that the opponents' actions have caused or at least materially contributed to the claimants' inability to meet an order for security for costs (see Fiduciary Ltd v Morningstar Research Pty Ltd [2004] NSWSC 664; (2004) 208 ALR 564 at [100]). 95 In "Law of Costs", G E Dal Pont says: "[T]he plaintiff must be able to support the allegation with relatively straightforward and unambiguous evidence of a fairly compelling nature, because otherwise the hearing of the issue of security might become a trial within a trial. For this reason, it is not enough that the defendant's conduct is merely a contributing factor - it must be the material contributor to or cause of the plaintiff's impecuniosity." (at [29.96] emphasis added)…
The defendants submitted that the evidence did not indicate that, but for the withdrawals made by Mr Gardiner, Commercial Indemnity would be financially sound. The most recent balance sheet for Commercial Indemnity, being for the financial year ended 30 June 2014, indicates the company had a substantial working capital deficiency as at 30 June 2013 and 30 June 2014, and its most substantial assets were "Property, plant and equipment", that is, non-cash assets. The defendants submitted that the company was in a borderline financial position from 30 June 2013 on. This was before the bulk of the transactions complained of occurred.
The audited financial statements indicate the following: 30 June 2013 30 June 2014 Income $1,176,449 $990,358 Expenses (including director's fees and management fees to Corporate Indemnity and Mr Newling) $1,086,972 $955,580 Profit $89,476 $34,778 Current assets $119,490 $96,763 Non-current assets (at cost) $187,521 $177,329 Current liabilities $155,280 $168,989 Net assets $125,248 $94,636

I do not accept the defendants' submission that Commercial Indemnity was financially unsound in any event. The transactions about which complaint is made began mid-way through the financial year ended 30 June 2014. The financial state of Commercial Indemnity worsened in that year, both in terms of lower profit, lower current assets, increased current liabilities and less net assets. The financial statements tend to support the plaintiffs' submission.

Merits

The plaintiffs submitted that the present case is one where Mr Gardiner did not merely cause Commercial Indemnity's impecuniosity, but that the company was effectively "put out of business" by him. This was, effectively, a submission that the plaintiffs' claim was strong and the defendants' conduct was to be strongly condemned.
The defendants submitted that the allegations of the plaintiffs as to breaches of the Corporations Act are all denied and an application for security is an inappropriate forum for a mini-trial of the substantive issues raised in the case. The court should not draw any preliminary view of the strength or weakness of the plaintiffs' case or of the defences. There is no reason to conclude that the defence is weak and no application for summary dismissal has been brought.
The defendants' submission was perhaps undermined somewhat by the fact that the defendants haven't put their evidence on, in breach of an order to which they consented. Further, it does not reflect Live Board Holdings Ltd v Cody Live Pty Ltd [2017] NSWCA 302, where the Court (constituted by Bathurst CJ, Leeming JA and Barrett AJA), at [97]-[102], stated that, on an application for security, the court was entitled to have regard to the prospects of success or merits of the proceedings; and earlier authorities - which stood for the proposition that the "merits" factor was neutral if a claim was not frivolous - placed a gloss on rule 42.21(1A)(a). At [98]-[99]: 98 That constrained approach does not reflect the broad discretion conferred by the rules. UCPR r 42.21(1A)(a) entitles the court in terms to have regard to "the prospects of success or merits of the proceedings". It is true that in many cases it will not be possible to form a meaningful view as to the strength or weakness of a plaintiff's claim for the purposes of an application for security for costs. Such applications are ordinarily brought before pleadings are closed and evidence filed. But that does not mean that, for example, there may never be a case in which a court can be satisfied that an impecunious corporate plaintiff has prima facie a very strong case, such as to inform the exercise of discretion on an application for security for costs. The starting point in the exercise of discretion is the legislation conferring the power, not some gloss upon it. 99 The authorities on which the primary judge relied for the narrower proposition that the strength of a claim was neutral so long as it was advanced bona fide and gave rise to real issues should not be understood as denying an ability on the part of the Court, in an appropriate case, of relying on its assessment of the strength or weakness of the case, in accordance with UCPR r 42.21(1A)(a). In Fiduciary v Morningstar Research [2004] NSWSC 664 at [37] Austin J was speaking of the particular facts of the claim before him, and accepted what appears to have been an uncontroversial submission in the particular application before him that the merits of the underlying claims should be regarded as neutral. That is particularly plain from the closing sentence in [39]. ("In the present case, the merits of the Rich interests' case against the Morningstar interests are a neutral factor".)
As I said in Trojan Marketing & Consultants Pty Limited v Kirela Pty Limited [2018] NSWSC 1786 at [64], Live Board Holdings was doing no more than pointing to the express terms of rule 42.21(1A)(a), which entitles the Court to have regard to the merits of the claim in respect of which security for costs is sought and, if able to form a meaningful view on the merits of the claim, to take the merits into account. The rule does not mandate that the Court do so, and in many cases the parties will not agitate the matter but simply proceed on the basis that the claim is bona fide. As much can be seen from how Live Board Holdings has been applied. In Galati v Deans [2018] NSWSC 1600 (Ward CJ in Eq) and In the matter of Australian Style Holdings Pty Ltd [2018] NSWSC 1368 (Black J), their Honours considered that the evidence was insufficient for the prospects of success to be anything other than a neutral factor. In In the matter of Australia Wattle Fund Pty Ltd [2017] NSWSC 1664, Black J considered that the matter was too complex and involved issues about which there would be significant factual contest at the hearing and no further assessment of its merits could reasonably be undertaken at such an early stage of the proceedings (at [23]).
In Luo v Windy Hills Australian Game Meats Pty Ltd (No 2) [2018] NSWSC 1139, Stevenson J noted Live Board Holdings at [19]: The Court of Appeal has recently emphasised that when looking at the merits of the proceedings it may be necessary to go further than concluding that the proceedings are not frivolous and that there are real issues to be tried. His Honour was able to, and did, assess the strength of the plaintiff's claims on a security for costs application. His Honour concluded that the plaintiff had prima facie a very strong case against the defendants and this was a factor that militated against providing security: at [45]. It should be noted that the plaintiff's claim in Luo v Windy Hills was based on fraud but this did not preclude an examination of the merits of that claim. Likewise, in Trojan Marketing v Kirela, there was sufficient evidence to conclude that the plaintiffs' claims had merit, which militated against ordering security.
In this case, having reviewed the plaintiffs' evidence and the judgments of Brereton J and Gleeson JA, there is sufficient evidence to conclude that the plaintiffs' claims have merit, which militates against ordering security.

Public importance

The defendants say this case does not involve a matter of public importance but is another incarnation of an ongoing dispute between Mr Newling and Mr Gardiner. I do not agree. Where directors undertake transactions in breach of their duties, it is a matter of public importance that directors be held to account for the consequences of their breach, in particular, where the company is in liquidation and creditors have been deprived of payment for goods and services extended to the company.

Delay

The plaintiffs submit that the application is too late. The proceedings commenced in October 2018 by originating process and the defendants sought to have the matter proceed on pleadings. The plaintiffs agreed and pleadings were filed. Directions were then made by consent for the defendants to file evidence. They did not do so, and it was only after the deadline for doing so had passed that they filed an application for security for costs.
The defendants submitted that there has been no relevant delay. In any event delay per se does not disqualify a defendant from bringing an application for security. A long delayed application may fail because a defendant with a valid claim for security should not sit back and allow a plaintiff to incur substantial costs before bringing the application. In this case, which was started with an originating process and a lengthy affidavit, the bulk of the plaintiffs' costs were incurred in the very act of commencing proceedings. There has been no "sitting back".
Overall, I regard the delay in this case as minor and this factor as of little weight. If I were otherwise minded to order security, the amount of security could be fixed to ensure that security was not ordered for costs incurred by the defendants before seeking security.

Funding

The defendants pointed to the fact that there is funding agreement in place to enable Mr Hancock to bring these proceedings. It was submitted that Mr Newling could have sought leave to bring proceedings in the name of the company, but this would have exposed him to personal liability for any costs order made against the company. Although in some cases liquidators conduct litigation which serves an obvious public interest and, generally, are not required to provide security, this is not such a case. Rather, this is a dispute between Mr Newling and Mr Gardiner, and some 85% of the debts of Commercial Indemnity are owed to Mr Newling.
I was informed by the plaintiffs' senior counsel that the funding agreement approved by Gleeson JA has been replaced by a new funder. The plaintiffs submitted that the existence of a funding agreement was not relevant where the reason why the company has no funds with which to provide security or to pay costs is the actions of the person against whom the proceedings have been initiated.
In Green (as liquidator of Arimco Mining Pty Ltd) v CGU Insurance Ltd (2008) 67 ACSR 105; [2008] NSWCA 148, Hodgson JA reviewed the competing lines of authority in respect of making security for costs orders against a liquidator and set out guidelines in such cases: at [45]. His Honour noted that a court should be readier to order security for costs where litigation funding is in place. At [51]: Courts should be particularly concerned that persons whose involvement in litigation is purely for commercial profit should not avoid responsibility for costs if the litigation fails.
His Honour considered that the existence of the funder and the funding agreement was a matter that favoured an order for security and, where the court knows the extent of the funder's interest in the outcome of the case, this can also be a factor which might lead the court to order security for less than the totality of the costs: at [53]. Campbell JA agreed, noting that much will depend on the facts of each case: at [86]. In dissent, Basten JA was not persuaded that there was any distinction between a liquidator pursuing a claim with litigation funding and the maintenance of such proceedings by a creditor whose interest was not in the subject matter of the proceedings save to the extent that success in the litigation would expand the resources of the corporation from which the creditor may receive payment of an enhanced dividend: at [76]-[77].
As such, the existence of litigation funding is a relevant factor. The funding agreement was not in evidence, and the plaintiffs have not provided it to the defendants despite having been asked to do. I will infer, in the absence of production of the document, that the funder stands to benefit from the proceedings if the plaintiffs succeed, by making a commercial profit on the funding extended to bring the proceedings at all.

Other factors

The defendants submitted that there is no compelling evidence that would satisfy the court that an order for security would stultify the litigation or that those standing behind Commercial Indemnity could not provide security were it to be ordered. This is true and is a relevant factor.
The defendants submitted that Mr Hancock had refused to give an undertaking. That is not correct. Mr Hancock made the acknowledgement sought, but simply declined to provide the documents also sought.

Conclusion

It appears that the plaintiffs have a strong case. The defendants are in breach of an order, made by consent, to file their evidence. The special purpose liquidator is seeking to unravel transactions entered into by Mr Gardiner which, it would appear, have had the effect of depriving creditors of Commercial Indemnity of a distribution in the winding up, and this is a matter of public importance. There is a funder, but it appears to me that obtaining funding was effectively necessitated by Mr Gardiner's actions taken before placing Commercial Indemnity into liquidation. Mr Hancock has acknowledged that he may be personally liable to pay a costs order in these proceedings. As a liquidator, I do not doubt that he would comply with an order made by the Court in this regard. Whilst ordering security would not stultify these proceedings, ultimately, I do not want to make it harder for the plaintiffs to retrieve the assets of Commercial Indemnity than Mr Gardiner already appears, on the evidence before me on this interlocutory application, to have made it. I am not prepared to order security.

orders

For these reasons, I make the following orders: 1. Dismiss the interlocutory process filed by the defendants on 22 February 2019. 2. Order the defendants to pay to the plaintiffs' costs of the interlocutory process.

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: 31 May 2019

Underlying facts

I have set out these facts on the basis of the plaintiffs' evidence and by reference to the judgments of Brereton J in In the matter of Commercial Indemnity Pty Ltd [2016] NSWSC 1125 and Gleeson JA in In the matter of 77738930144 Pty Ltd (in liq) (formerly Commercial Indemnity Pty Ltd) [2017] NSWSC 452. The defendants' evidence has yet to be filed and may reveal further material which results in a different conclusion at a final hearing in these proceedings.
In 1996, Mr Gardiner incorporated a company, Corporate Indemnity Pty Limited (ACN 072 366 968), not to be confused with Commercial Indemnity. Mr and Mrs Gardiner were shareholders. Mr Gardiner was the sole officeholder.
In 2003, Commercial Indemnity was incorporated. Mr Gardiner was the sole shareholder and officeholder. Commercial Indemnity carried on business as an agent for commercial and industrial rental and petroleum bonds.
In 2008, Mr Newling purchased a half interest in Commercial Indemnity. Mr Newling paid the agreed consideration but Mr Gardiner did not transfer the shares. They both worked full time in the business. In 2011, Commercial Indemnity expanded its business to New Zealand.
In 2012, Mr Gardiner incorporated 4142 Clarence Street Pty Ltd, of which he was sole shareholder and sole officeholder. Commercial Indemnity assisted in the purchase and fitout of commercial office premises at Level 4, 142 Clarence Street, Sydney by 4142 Clarence Street. A deed of loan was executed between Commercial Indemnity and 4142 Clarence Street in respect of an advance of $93,000 towards the purchase and a further $99,000 for fitout. On 1 July 2013, Commercial Indemnity leased the premises from 4142 Clarence Street Pty Ltd for three years.
Towards the end of 2013, there was a serious dispute between Mr Newling and Mr Gardiner. Mr Newling ceased to work for Commercial Indemnity.
In January 2014, Mr Gardiner caused Commercial Indemnity to pay $150,000 to his wife as "director's fees", although she had never been a director of the company. I note that, in 2017, Mr Gardiner's solicitor advised Mr Hancock that these monies were provided as a contribution to the purchase of a property by Mrs Gardiner rather than as director's fees. In 2018, Mr Gardiner's current solicitor advised that the monies were a payment from Commercial Indemnity to Corporate Indemnity in respect of management fees owing.
In mid-2014, Mr Gardiner began to divert income of Commercial Indemnity to Corporate Indemnity, which retained 35% of the income before paying the balance to Commercial Indemnity. On 8 September 2014, Mr Gardiner sent an email to his solicitors as follows: I have considered your comments … We will incorporate a new business offshore and "move" the renewals into a local subsidiary of the offshore business. The existing business will settle all debts with all creditors, with the exception of myself who will be owed outstanding director's and management fees. The existing business will be owed money from the trust (which owns level 4) under an existing loan agreement. In essence, Geoff has had the opportunity to take up my previous offer. Given the business no longer has "underwriting paper" my previous offers have expired and I have no interest in making any further offers. I am happy to consider any offer from Geoff for my shares in the business but I will not agree to any non-compete arrangements.
In October 2014, Mr Gardiner caused Commercial Indemnity to: 1. pay $50,000 to Corporate Indemnity, unsupported by an invoice or any apparent entitlement; and 2. write-off a personal debt of $31,584 which he owed to Commercial Indemnity, for no apparent reason.
In January 2015, Mr Gardiner: 1. changed the name of Corporate Indemnity to CorpIndem Pty Ltd; 2. incorporated a new company called Corporate Indemnity Pty Limited (ACN 603 453 498) of which he was sole shareholder and sole officeholder (I will refer to this company as Corporate Indemnity II); 3. operated a competing business using Corporate Indemnity II from the Clarence Street premises which, as I have already noted, were leased to Commercial Indemnity and had been financed, at least in part, by Commercial Indemnity.
In February 2015, Commercial Indemnity paid $30,000 to Viva Energy for no apparent reason. In March 2015, Mr Gardiner caused Commercial Indemnity to make payments of $31,107 and $22,530 to Corporate Indemnity II for no apparent reason. All of these payments were in addition to $11,000 per fortnight which Commercial Indemnity paid Mr Gardiner for the work that he did.
In May 2015, Mr Newling commenced proceedings in this Court against Mr Gardiner and Commercial Indemnity seeking a declaration that Mr Newling owned 50% of the shares of Commercial Indemnity: In the matter of 77738930144 Pty Ltd (in liq) (formerly Commercial Indemnity Pty Ltd) [2017] NSWSC 452.
In June 2015, the following events occurred, leading to the appointment of liquidators by Mr Gardiner to Commercial Indemnity: 1. On 10 June 2015, Mr Gardiner caused Commercial Indemnity to pay $80,000 to Corporate Indemnity II, for no apparent reason. 2. On 11 June 2015, Mr Gardiner changed the name of Commercial Indemnity to 77738930144 Pty Ltd. 3. On 12 June 2015, Mr Gardiner caused Commercial Indemnity to pay another $49,500 to Corporate Indemnity II for no apparent reason. Mr Gardiner then sold Commercial Indemnity's business to Corporate Indemnity II for $21,000 and an agreement by Corporate Indemnity II to assume certain liabilities of Commercial Indemnity, including whatever interest it had in the lease of Clarence Street. Mr Gardiner then put Commercial Indemnity into voluntary liquidation. As a result of these actions, Commercial Indemnity's only assets when it went into liquidation were the proceeds of sale of its business of $21,000 and about $2,500, which was not enough to pay the costs of the liquidator or make any distribution to creditors.
On 9 June 2016, Brereton J declared that Mr Gardiner held half of the shares of Commercial Indemnity on trust for Mr Newling and ordered Mr Gardiner to execute a share transfer and pay 75% of Mr Newling's costs of the proceedings: In the matter of Commercial Indemnity Pty Ltd [2016] NSWSC 1125. The transfer was signed and provided to the liquidator.
On 30 September 2016, Corporate Indemnity II onsold Commercial Indemnity's business, which it had bought for $21,000 the day that Commercial Indemnity went into voluntary liquidation, to Assetinsure for over $500,000 plus commission and a profit share arrangement.
Mr Gardiner took no action to recover the debt of $143,584 owed by 4142 Clarence Street to Commercial Indemnity or to otherwise account for it as a debt owed by 4142 Clarence Street so that it was never pursued by the liquidator of Commercial Indemnity.
On 24 February 2017, Mr Newling applied for the appointment of a special purpose liquidator. In April 2017, Gleeson JA appointed Mr Hancock as a special purpose liquidator and approved a funding deed under which G & L Newling Pty Ltd would provide funding to Commercial Indemnity and Mr Hancock to carry out the investigation of various transactions and financial dealings between Commercial Indemnity and Mr Gardiner: In the matter of 77738930144 Pty Ltd (in liquidation) [2017] NSWSC 452. His Honour found that it was in the interests of the creditors, other than Corporate Indemnity II, that Mr Hancock investigate the matters the subject of his appointment as these had a potential to deliver a recovery and increase the funds available to discharge debts owed to all creditors. The existing liquidator had no funds and was not minded to pursue any investigation.
Lengthy correspondence ensued between Mr Hancock and Mr Gardiner's solicitors in respect of the allegations which are the subject of these proceedings.

At a glance

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