Assessable Income
2 In relation to the 2005 income year, the issue is whether the sum of $861,853.35, received by Mr Stephen Howard in that year as his share of an award of equitable damages made by the Supreme Court of Victoria (Warren J) in consequence of the determination in Disctronics Ltd v Edmonds [2002] VSC 454 and [2002] VSC 534, and confirmed on appeal in Edmonds v Donovan (2005) 12 VR 513, was assessable income in his hands. Mr Howard accepted that the award had the character of income and was made in his favour. However, Mr Howard contended that he received the money awarded to him as trustee primarily arising from his fiduciary relationship as a director of Disctronics Ltd ('Disctronics'). The primary judge found in favour of Mr Howard on this issue.
3 The principles of law, and the factual context in which they are to be applied, are not in dispute. During the course of hearing, the dispute between the parties became considerably refined and primarily concerned whether Mr Howard had been in breach of his fiduciary duty owed to Disctronics.
4 Mr Howard and the Commissioner accepted certain principles of law to be applied:
(a) a person holding a fiduciary position is entitled to engage in profit-making activities outside his fiduciary office;
(b) a director who brings a business opportunity to a company of which he or she is a director cannot, if the company adopts it, subsequently withdraw it and exploit it for his on her own benefit, except with the company's informed assent;
(c) a director is prohibited from placing his or her personal interests in conflict or potential conflict with the company of which he or she is a director, and must not take an unauthorised profit or benefit; and
(d) there is no inconsistency in both being a principal in a transaction and being bound by fiduciary duties arising from the office of director.
5 We accept that each of these principles of law are well established by authority: see eg Breen v Williams (1996) 186 CLR 71 at 137-8; Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134; Warman International Ltd & Anor v Dwyer & Ors (1995) 182 CLR 544; Grimaldi v Chameleon Mining NL (No 2) [2012] FCAFC 6; Furs Ltd v Tomkies (1936) 54 CLR 583 at 592; Chan v Zacharia (1984) 154 CLR 178 at 198; and Noranda Australia Ltd v Lachlan Resources NL (1988) 14 NSWLR 1 at 15.
6 The primary judge carefully analysed the facts and made a number of findings. It is convenient to set out some salient facts as found by the primary judge:
(a) In early 1999, Mr Howard and three others, Messrs Donovan, Quinert and Bucknall (all four collectively called 'the plaintiffs') investigated a proposal for funding the acquisition of a golf course by leasing it to a substantial tenant. Two other parties, Messrs Edmonds and Cahill ('the defendants') were invited to provide services in relation to the proposal, initially for a fee. The proposal evolved into a joint venture project to acquire and lease Kingston Links golf course, such that the tenanted course could be held or resold as a package, so realising a "day-1" profit. To succeed, the revised project would require a lessee of the course at a sufficient rent and an "equity participant", which "equity participant" would purchase the course (using borrowed funds secured on the land, and its own "equity" funds) at a price based on the capitalised value of the rent.
(b) Messrs Howard, Donovan and Quinert were directors of Disctronics, a delisted public company with investable funds. In early July 1999, the director plaintiffs proposed among themselves that if the equity required was less than $1.5 million, Disctronics should be the purchaser. The driving force behind the proposal was Mr Donovan, who was ultimately in control of Disctronics.
(c) The proposal was put to and adopted "as a possible investment opportunity" by an informal meeting of directors of Disctronics on 13 or 14 July 1999. The directors agreed that if Disctronics took up the investment any joint venture profit share accruing to them would be accounted for or rebated to Disctronics.
(d) The introduction of Disctronics as purchaser was objected to by the defendants. Variations to the terms of the joint venture, still involving Disctronics as equity participant, were discussed between the plaintiffs and defendants but not adopted.
(e) On 20 July 1999, joint venture terms were agreed. While the terms contemplated that an equity participant might "form part of our team", only the plaintiffs and defendants, not Disctronics, were named as joint venturers.
(f) By the beginning of August 1999, a purchase price and a rent had been agreed in principle with the vendor and a prospective lessee, although no agreement had been executed by either. The vendor was represented by Mr Kevin Wood.
(g) In the first week of August 1999, the plaintiffs and Disctronics asserted Disctronics' intention and "right" to become equity participant and purchaser. Disctronics acquired a subsidiary, Corwen Grange Pty Ltd, to play that role. The defendants disputed any such right. Negotiations ensued as to sharing of profits if Disctronics became purchaser, but no final agreement was reached.
(h) Meanwhile, the defendants negotiated a purchase and lease of the golf course by a syndicate comprising themselves and a third party, Mr Buxton. In December 1999 a company called Kingston Links Country Club Pty Ltd ('KLCC'), which had the defendants and Mr Buxton as its directors, became the owner and lessor of the golf course.
(i) In December 2000, Disctronics lodged a caveat on the title to the golf course land, claiming a constructive trust in its favour. In June 2001, proceedings for removal of the caveat, and for remedies consequent on the defendants' breach of fiduciary duties to the plaintiffs, were commenced in the Supreme Court of Victoria.
(j) On 15 June 2001, Messrs Donovan, Quinert and Howard, of the one part, and Disctronics, of the other part, executed what was referred to as the 'litigation agreement' (in which the parties of the first part were referred to as "the directors" and Disctronics was referred to as "DL") in the following relevant terms:
Whereas
A. The directors were formerly members of a joint venture to acquire the Kingston Links Golf Course (KLGC) with others namely Christopher Edmonds (CT) [sic], Peter Cahill (PC) and Richard Bucknall (RB) to package an approved tenant and KLGC to an investor (the joint venture). The joint venturers agreed that the investor would be either a third party or DL;
B. On or about 14.07.'99 in London meetings of DL, the directors agreed that if the equity requirement to require KLGC was less than AUD$1.5m then the directors would seek to have DL become the equity participant and purchaser of KLGC (the "option"). The directors further agreed that if DL exercised its Option then the directors would rebate to DL any entitlement (whether on revenue or capital account) they may have as a consequence of their participation in the joint venture;
…
H. The directors have concerns about their ability to fund from their own resources the anticipated costs of the proceedings. The directors are advised that the case to be put is compelling and the prospects of a favourable outcome are strong. The directors desire to prosecute the proceedings, as contemplated, which requires the directors to accept the litigation risk of being individual [sic] named plaintiffs with DL, in order to ensure that DL is afforded the opportunity of exercising its right to seek damages and compensation for the loss of its corporate opportunity and the wrongful appropriation of KLGC by CE, PC and others.
Now, for good and valuable consideration, this agreement witnesses:
1. DL shall pay all legal fees and disbursements associated with the prosecution of the proceedings, or either of them, to Mallesons, counsel, Oakley Thompson & Co including reasonable travel and accommodation costs;
2. The directors have agreed with RB that he will not be liable for either any legal fees or disbursements associated with the prosecution of the proceeding or in relation to any damages or costs orders of any description in favour of CE, PC (or others);
3. DL shall indemnify the directors (and for their obligation to RB) against payment of any order/s for costs, howsoever arising, in favour of CE, PC (or others) arising out of the prosecution of the proceedings or any damages they are found liable to pay to CE, PC (or others);
4. In consideration of DL's promises set out in paras 1 and 3 hereof the directors, and each of them, assign absolutely into (sic) and to the sole use of DL, any award of damages (whether our revenue or capital account), costs or interest made in their favour as a consequence of their participation in the joint venture or arising out of the proceedings and the ultimate outcome thereof;
…
(k) In the Supreme Court of Victoria, judgment was given in favour of the plaintiffs at first instance and upheld on appeal.
(l) Each of the directors of Disctronics, including Mr Howard, accounted to Disctronics for his share of the award.
7 Before going to the primary issue, we should say something briefly about the litigation agreement. The primary judge did not accept that the terms of the litigation agreement involved a recognition by Mr Howard of his own liability for taxation, or that the entering into of the litigation agreement involved conduct on his part which should be seen as inconsistent with his claim to have received the award of equitable damages as a fiduciary or trustee. Whether that conclusion is correct or not does not foreclose enquiry as to whether Mr Howard received the award beneficially or as trustee for Disctronics. That enquiry will involve an analysis of the facts to determine whether Mr Howard breached his fiduciary obligations to Disctronics.
8 Further, some reliance was placed upon by the Commissioner on recital B of the litigation agreement, seeking to characterise the 'agreed' position between the directors in terms of a contract. We doubt whether it is appropriate to characterise the 'agreed' position in terms of contract, but whether or not this is so is of no moment. The agreed position can be seen, at the very least, as reflecting an arrangement as to a course of action and of the contingencies upon which action would be taken - both as to investment by Disctronics and as to the consequential actions of the participants. We will return later to this aspect of the arrangement and its significance.
9 Finally, it was put by Mr Howard that whether the litigation agreement records an existing constructive trust arising from the fiduciary relationship between the directors and Disctronics, or evidences its absence by effecting an assignment of the rights to the fruits of the litigation (so constituting an express trust of those rights and of the award when and if made by the court), it nevertheless did vest the beneficial entitlement to the award in Disctronics. This was an argument not raised before the primary judge. In any event, it has no substance. The effect of the litigation agreement cannot be to prevent the award of equitable damages from being derived by Mr Howard in his hands beneficially: see Booth v Commissioner of Taxation (1987) 164 CLR 159 at 167 (per Mason CJ).
10 The true enquiry must then be to analyse the factual findings of the primary judge to determine whether Mr Howard received the award of equitable damages beneficially or as trustee.
11 As to the involvement of the parties to the joint venture, the primary judge made the following findings at [74] to [77]:
74. … In its origins, the concept of investing in a golf course, engaging a stable, long-term, tenant, and then on-selling the course for a day-one profit was Donovan's, or perhaps Solette's. It was not Disctronics'. Neither was it in Disctronics' normal line of business. At the outset at least, Donovan was not under any obligation to involve Disctronics in that concept, or to offer the investment opportunity to Disctronics.
75. Had Donovan implemented his concept, as originally devised with the assistance of Bucknall, then, Disctronics could have claimed no interest in the resulting investment. When, as Warren J found, Quinert and the applicant (and possibly also Solette) were included in what her Honour found to be a joint venture in May or June 1999, the position was no different. The investment then envisaged had nothing to do with Disctronics.
76. On the applicant's case, the position was different from at least when the directors of Disctronics met in London over the period 12-14 July 1999. Had they procured the Board to resolve to make the investment contemplated, then, at least as between the three individuals involved and Disctronics, the proposed investment would have belonged in equity to the latter. … The applicant contends that the directors did enough then, and later, to preclude themselves from later asserting, as against Disctronics, that the investment opportunity belonged to them rather than to it. Although not made by the Board as such, the decision provisionally (ie subject to the equity requirement falling within a certain limit) to involve Disctronics in the proposed investment was made by all directors in a context in which they had come together for the purposes of a Board meeting. The decision was made by them in their capacities as Board members. The decision was communicated contemporaneously to Edmonds (and, inferentially, by him to Cahill). That Disctronics would be the purchaser if the equity requirement was within the specified limit was known to all six venturers when the joint venture was formed on 20 July 1999. Once it became known that the equity requirement was within that limit, Quinert, on behalf of himself, Donovan and the applicant, notified Edmonds on 4 August 1999 that Disctronics would take up the opportunity to be the purchaser. According to the applicant, by that stage at least, it was no longer open to him to assert, as against Disctronics, the right to insert some other purchaser into the proposed transaction with Kingston Links for the purpose of securing, for himself, the originally-intended day-one profit.
77. To the extent that it is significant, I would find that there is no doubt about the reality of the intention of Donovan, Quinert and the applicant to make the opportunity to purchase the golf course available to Disctronics. They made their decision so to proceed in what were plainly the interests of Disctronics rather than of themselves, they identified the source of funds which would be used, they informed their co-venturers of the condition under which the opportunity would be taken up by Disctronics, and they caused Disctronics to be issued a share in the company which was to be the nominee under the contract of sale, Corwen Grange. Indeed, it was the reality of their insistence upon Disctronics being the purchaser, and the refusal of Edmonds and Cahill to accept that, that ultimately led to the disintegration of the joint venture of 20 July 1999.
12 It is apparent from the above findings that:
the original proposal was in reality that of Mr Donovan, not Disctronics;
Disctronics was a vehicle for the implementation of an agreement entered into by the six joint venturers;
the involvement of an opportunity to be given to Disctronics would arise once it became known that the equity requirement was within the agreed limit;
Mr Howard did all he could to proceed in the interests of Disctronics; and
the failure of Disctronics to become involved was because of the actions of Messrs Edmonds and Cahill, and ultimately of the vendor in not accepting the offer put on behalf of Mr Howard (which was to involve the subsidiary of Disctronics, Corwen Grange Pty Ltd).
13 Whatever the source of the fiduciary duty said to arise, it seems to us that the current issue can be determined by focussing on the content of that duty and the position of Mr Howard. Unlike the position in the Supreme Court proceedings, we are not concerned with Disctronics' rights as against Messrs Edmonds and Cahill, nor the rights and obligations of the joint venturers. The focus before us is upon the obligation of Mr Howard to Disctronics, which was not a question requiring determination in the Supreme Court proceedings.
14 It was submitted by Mr Howard that once Disctronics had adopted the project as a potential investment, it was incumbent on the directors to do what was in their power to preserve that company's opportunity to invest. It was said to be inconsistent with their fiduciary duties to Disctronics to conduct themselves, in their personal capacity as participants on their own account in the joint venture, in a manner which conflicted with the interests of Disctronics.
15 Mr Howard argued that there was no simple contingency according to which Disctronics would, or would not, make the investment. It was argued that the factual context was that Disctronics had available to it $1.5 million in non-operational investment funds. The price at which the "investor" would acquire the golf course was not an independent, objective fact dependent on external events: it was a matter for negotiation among the joint venturers.
16 It was then submitted that this circumstance put the directors of the joint venture in a position of immediate and unresolvable conflict of duty and interest. The interest of the joint venturers was, to secure the highest possible purchase price from an investor: the higher the price, the larger their individual share of profit. The interest of Disctronics was diametrically opposed: it sought to secure the lowest (and to it, the most advantageous) price. It was the duty of the directors to do all in their power to advance Disctronics' interest, and to do so at the expense of their own interest (and that of their joint venturers).
17 It was contended by Mr Howard that the directors could not simply stand by and wait to see whether the price to a potential investor would fall below $1.5 million (so that Disctronics would invest and they would "rebate" their profit shares), or would exceed that sum so that they could take their share of the consequently enlarged project profit free of obligation to Disctronics. It was their duty to Disctronics to use their best endeavours to negotiate the lowest price, and one within Disctronics' reach.
18 We do not accept this is a correct analysis, nor one that accords with the conclusion reached by the primary judge as to Mr Howard's role or fulfilment of his obligation to Disctronics. The evidence, as accepted by the primary judge, was that Mr Howard was responsible to have Disctronics accepted as equity participant by the other joint venturers. In that case, and only in that case, did Mr Howard agree to rebate his share of the "day-1" profit to Disctronics. Otherwise, as the primary judge found at [77], Mr Howard proceeded in the interests of Disctronics rather than his own. Mr Howard's obligation to Disctronics only involved Mr Howard using his reasonable endeavours to have it become purchaser, which obligation he discharged.
19 Therefore, the only expectation of Disctronics was to be a potential purchaser, if and when there was a secured sale price and a tenant's agreement for a long-term lease. There was no expectation that Disctronics was to have any other role. Disctronics was only a vehicle to be used in the event of certain contingencies occurring. This is not to suggest that each director did not owe obligations to Disctronics imposed by legislation and the general law. However, those obligations must be seen in the context of what was the true and only interest that Disctronics had in the implementation of the joint venture, should certain contingencies eventuate. Putting it another way, Disctronics could have had no expectation that Mr Howard would work towards a certain price being accepted. Disctronics' only interest arose when and if the equity required was less than $1.5 million. In the end, the defendants (Messrs Edmonds and Cahill), despite all of the endeavours of Mr Howard, were not prepared to accept Disctronics as equity participant and purchaser.
20 In these circumstances, there could be no conflict of interest in the way contended for by Mr Howard, and no breach of Mr Howard's fiduciary duty to Disctronics. Accordingly, the award of damages in question had the character of assessable income in Mr Howard's hands, and was not received by him as trustee.
21 Therefore, we would uphold the appeal of the Commissioner in respect of the income year 2005.