Hydrocool Pty Limited v Hepburn

background 16 In August 2000, Mr Hepburn was appointed managing director of Hydrocool and employed by Hydrocool. At that time, ATG was the sole shareholder of Hydrocool. 17 In 2001, Dr Teplitzky told Mr Stephen Murphy, an accountant, that he was looking for investors to raise AUD2.5 million for Hydrocool to complete a refrigerator freezer project with MARCO. In June 2001, Mr Murphy incorporated two companies, Coolhydro (1) and Coolhydro (2). These companies then acquired shares in Hydrocool. Mr Murphy's clients held shares in the two Coolhydro companies. Mr Murphy became a director of Hydrocool on 1 July 2001. 18 There were also employee options which had been issued. Each of Mr Hepburn, Mr Clarke and the engineers held options in Hydrocool. Although the evidence is not clear on the precise number of options held by each employee, it appears that in 2003, Mr Hepburn held over 100,000 options, Mr Clarke held over 50,000 options, each of Mr Banney, Mr Manners and Mr Davis held over 27,000 options, and Mr Weymouth held 50,000 options in Hydrocool. 19 By the middle of 2003, Hydrocool's technology included a thermoelectric heat exchanger which Hydrocool had developed and patented. As mentioned, the heat exchanger and related patented Hydrocool systems were used, pursuant to a licence granted to MARCO, in a bar fridge. Hydrocool was in receipt, annually, of a small amount of monies by way of royalties paid by MARCO pursuant to this licence agreement. 20 Hydrocool had also developed a prototype fridge freezer, which was the world's first refrigerator with freezer using thermoelectric technology. 21 At this time, Hydrocool was also working on the development of a unit for cooling the central processing unit of a computer. This technology was referred to as "the CPU cooling unit". In 2004, Hydrocool submitted a prototype of this unit for review by Overclockers.com and had received a favourable review. 22 Further, in 2003, as mentioned, Hydrocool was also working in conjunction with Symetrix, on a research project. The research activities were undertaken in Colorado Springs under the direction of Dr Carlos Araujo of Symetrix - a close friend of Dr Teplitzky. Hydrocool contributed funds to this project and supplied the services of two of its engineers on secondment from Fremantle. During the term of their secondment, the two engineers resided in Colorado Springs and worked with Dr Araujo on the research activities. In 2002, Mr Davis and Mr Manners of Hydrocool were seconded to the Symetrix project in Colorado Springs. In 2003, Mr Banney replaced Mr Davis, and Mr Banney and Mr Manners continued working there until they returned to Fremantle in around August 2004. The purpose of the research was to develop a highly efficient peltier. A conventional peltier had a ZT (a measure of efficiency) of 1; the aim was to develop a peltier with a ZT of 2 or more. In short, the research was directed towards trying to decouple two variables which would allow the ZT to increase independently of the traditional theory that there was a coupling relationship between the variables. This was the breakthrough which the research was trying to achieve. 23 In the middle of 2003, the board of directors of Hydrocool comprised Dr Teplitzky, Mr Hepburn, Mr Murphy and Mr Bourke, who was also the chairman of ATG, and Mr Sashi Paul. 24 At a meeting of the board of directors of Hydrocool on 7 July 2003, Dr Teplitzky briefed the members of the board on the proposed "exit strategy" which would allow ATG to sell its investment in Hydrocool, following the Australian government's decision to dispose of any research and development investments. Dr Teplitzky explained that he had identified some organisations (including some private individuals and merchant banks) which may be interested in arranging the acquisition by third parties of ATG shares in Hydrocool. The board minutes record that it was agreed that Hydrocool's management did not have the discretion to represent ATG on the sale of its shares to possible interested parties. 25 At the meeting of the board of directors of Hydrocool held on 17 September 2003, Mr Hepburn advised that the worst case scenario was that Hydrocool would be able to fund itself until the end of March 2004, assuming that there was no research and development grant or further funds from a third party company. 26 At Hydrocool's board meeting held on 31 March 2004, Mr Hepburn reported that Hydrocool's management had revised the cash forecast and this had shown that Hydrocool would be in a position to fund its operations until around July 2004. Dr Teplitzky was still attempting to identify possible sources of further investment in Hydrocool. One of the possible sources of investment was a company, Emerson Electric Corporation, a United States company. 27 On 8 May 2004, Mr Richardson on behalf of Water Master, a company with which Hydrocool had not had previous dealings, sent an email advising that it was interested in exploring the prospect of using Hydrocool's technology in a device to extract water from air, which Water Master wanted to develop. 28 Water Master is, and was, a company incorporated under the laws of New Zealand. At that time, its major shareholder was a company associated with Windsor, which was based in Hong Kong. Water Master was described as a joint venture company. Mr Richardson was at that time, a director and chief operating officer of Water Master and was engaged in the day-to-day management and operations of that company. The other members of the Water Master board were Mr Gordon Tse, Mr Michael Chung, Mr William Campbell, Ms Linda Chen and Mr Peter Hawkins. 29 By this time, Water Master had developed a device that made potable water by extracting water from air. The intended market for this device was the replacement of office water coolers that used refillable bottles. That device was compressor driven. Water Master wanted to consider making a small device for domestic use which used thermoelectric technology to extract the water from air. 30 Following Mr Richardson's initial email to Hydrocool on 8 May 2004, further emails were exchanged between Mr Richardson and Mr Clarke, on behalf of Hydrocool. 31 Mr Hepburn sent an email on 31 May 2004 to Mr Clarke, stating that there was a question within the board as to the work which was to be done in Perth "given the extended time in CS". The reference to "CS" was to Colorado Springs, the location of the Symetrix project. Mr Hepburn asked Mr Clarke to prepare a technical report pointing out all the work that had been done in Fremantle and was still needed to be done. Mr Hepburn concluded the email by saying: "We do not need renewed pressure for personnel reductions at this time". 32 In early June 2004, Mr Hepburn prepared a letter for the Fremantle based staff to sign. This letter was referred to in the case as the "engineers' letter". The draft letter was addressed to the board of Hydrocool. The draft letter stated: We have written this letter and have advised Iain Hepburn that he may or may not provide it to the Board at his discretion and judgement. The purpose of this letter is to explain the attitude of the employees with respect to the past and future of the company. All of us have been with the company for approximately four years, with some having been here in excess of that time. During this period, we feel that, not only have we worked extremely well together as a team, but also that this team has remained intact in spite of the on-going financial uncertainty within the company. It could be said that there have been occasions where common sense should have persuaded us to look elsewhere. We have not done so since we have remained motivated to see Hydrocool achieve both research success and commercial success on behalf of the shareholders who have supported the company. We would also make that point that, notwithstanding this uncertainty, none of us have requested any securement of employment tenure, via an employment contract, which in the present day is now quite common. We are unanimously hopeful in the work being carried out with Symetrix, but do however remain cautious in our opinion, until proof of theory, via the decoupling of Seebeck Coefficient and Electrical Conductivity is demonstrated via sample measurement. This has always been our collective opinion. It is not negative it is just careful and cognisant of the facts. We are also unanimous in our opinion that even when this breakthrough is achieved there is a long way to go to complete the optimisation process based on the proven theory and that this optimisation process, together with the integration of the convector, will require the full participation of all existing personnel. We would go further by saying that, without the considerable expertise and knowledge within Hydrocool on module design, heat exchange modelling and convector integration, this work could not be carried out and hence value would not accrue for the company and hence ourselves as option holders. The strength of our convictions in this regard is such that we intend to work for Hydrocool as a team or not at all. Furthermore, we would like to take this opportunity of advising the Board that in the latter event, we think it is only reasonable that an appropriate redundancy payment of at least one month for each year of service be provided. We would not intend to pursue this request if the company is unable to make payment due to lack of cash so long as our current team of employees remains in place for the reason stated above in italics. (Original emphasis.) 33 As stated in the body of the letter, Mr Hepburn intended to have this letter available to produce to the other directors, at the board meeting on 24 June 2004. 34 On 8 June 2004, Mr Richardson visited Hydrocool's Fremantle operations, to further pursue Water Master's interest in Hydrocool's technology. On that occasion, Mr Richardson met with Mr Clarke, Mr Hepburn, Mr Weymouth and Mr Davis. Mr Richardson did not meet with Mr Manners and Mr Banney, because they were in Colorado Springs working on the Symetrix project. Mr Richardson spent most of his time speaking to Mr Clarke. The prospect of future meetings between Water Master and Hydrocool was discussed. 35 By an email dated 8 June 2004, Mr Hepburn, who had met with Mr Richardson, reported to Dr Teplitzky that Water Master was seeking "to convert their water cooler device from being compressor driven to being thermoelectric driven. The main reason being noise and unless they can reduce the noise they cannot sell into the residential home market". The email also stated that: They have done extensive investigations and are of the opinion that the expertise and technology of Hydrocool is required by them to achieve this conversion. They have also expressed an initial interest concerning the possibility of making an equity investment in Hydrocool, which would secure them some rights to the enhanced ZT material IP, for the application of their water cooler. 36 On 9 June 2004, Mr Hepburn sent Mr Richardson an email to which was attached a copy of the Information Memorandum relating to the disposal of the ATG shareholding in Hydrocool. Mr Hepburn stated in his email to Mr Richardson that: In summary, I believe that Hydrocool needs to be able to simultaneously carry out the following three activities: 1. Progress the important research program with Symetrix in order to achieve the fundamental breakthrough in TE material ZT values and subsequently the integration of our second-generation heat transfer technology with this new thermoelectric material. 2. Progress the commercialisation, via manufacture-under-license in China, of our CPU cooler devices. 3. Progress the prototyping and development of your thermoelectric-driven water cooler device. Hydrocool currently retains all the necessary manpower and expertise to carry out the above activities. As we discussed, our only difficulty is one of time and hence of funding. We are therefore seeking, by way of an equity investment, additional working capital of US$1.5M, which will allow the company to conduct all three of these activities through to December 2005. By that time, I would suggest that there will be significant progress with number one, number two will be cash flow positive and number three will be complete. In general terms, I would see the possible investment by Water Master Hong Kong Ltd in Hydrocool Pty Ltd, perhaps being as follows: * Between US$1.5 and 2M being a placement in Hydrocool for new shares. I believe (without any assurances) that I can persuade the Board to accept up to the level of $2M, at a price equal to the last issued price (A$1 per share). * The granting to Water Masters of the exclusive and worldwide right to acquire a license for both the new thermoelectric material and the second-generation heat transfer technology (which will achieve freezing) for the application of your water cooler/dispenser product. 37 On 13 June 2004, Dr Teplitzky sent Mr Hepburn an email complaining of the "constant negative attitudes" of Mr Manners and Mr Banney (referred to in the email as "B&B"), about the Symetrix research project. The email stated: I object to constant negative attitudes and it will matter little that you consider B&B participation as crucial. If the negative attitude does not cease, their participation will. What is crucial is Carlos positive participation. If B&B were terminated tomorrow it would be a very disappointing and serious setback. But they could be replaced. Carlos can not be. Good management certainly calls for full participation. But it does not allow constant negative comment and unsubtle criticism. This time I am very serious - they either stop, or their employment will. 38 Mr Hepburn sent an email to Mr Richardson on 16 June 2004. In that email, Mr Hepburn stated that all ATG investments had been sold by the Australian government, except Hydrocool; and that the Australian government intended to remain a shareholder in Hydrocool for the time being. Mr Hepburn went on to say: Confidentially between you and me, I feel that they would probably be just as inclined to sell in order to bring "political closure" to this whole matter… 39 Mr Hepburn also said that if the Australian government shareholding went below 51%, Hydrocool would lose its AUD1.9 million Start Grant. 40 On 16 June 2004, Mr Hepburn stated, in response to an email from Mr Richardson, that Hydrocool only had enough funding to carry on until December 2004 and that it was the company's intention to issue new capital for at least USD1.5 million to allow the Symetrix research to continue beyond December 2004. Mr Hepburn suggested that the time to put in funding was now, because positive developments may cause an increase in Hydrocool's share price. 41 On that day, Mr Hepburn also sent an email to Mr Paul and Dr Teplitzky stating that Water Master understood that Hydrocool would need a major injection of capital. He went on to state that the Water Master work would require "all our personnel and possibly some additional personnel" since it would be equal in scope to the work done to produce the fridge freezer prototype for MARCO. 42 On 17 June 2004, Dr Teplitzky sent an email to Mr Hepburn in which Dr Teplitzky expressed strong concern at the idea of Water Master seeking equity. Dr Teplitzky advised that he wished to be directly involved in the negotiations. 43 On 18 June 2004, Mr Richardson sent an email to Mr Hepburn advising of his intended visit to Fremantle for further discussions. Mr Richardson said he would be accompanied by Mr Michael Chung, Mr Gordon Tse and Mr Chi Kong Luk. Mr Richardson referred to the following topics for discussion at the forthcoming meetings: (a) the licensing of Hydrocool technology for use in the domestic market water maker; (b) the manufacturing of new products in China for Hydrocool; (c) investing in Hydrocool; and (d) acquiring rights for the use of Symetrix/Hydrocool peltier technology improvements for all water from air applications and possibly the use of the same for power generation. 44 On 19 June 2004, Mr Hepburn responded to Mr Richardson's email. In his email, Mr Hepburn stated: Some of my fellow directors may have thought that we supplied too much information too soon, but you needed all of it to make an initial decision. My priority will be to play a "middle" role in our negotiations to make sure that any agreement we reach is good not only for Hydrocool but also for WaterMaster. 45 On 22 June 2004, Mr Clarke prepared a staffing plan for the Water Master project. It provided for, on a "best case" scenario, one engineer and one technician over a 12 month period. Mr Clarke estimated the labour costs of the engineer and the technician to be AUD60,000 and AUD45,000 respectively. 46 On 24 June 2004, there was a meeting of the board of directors of Hydrocool. Mr Hepburn went to the meeting armed with the engineers' letter. However, he did not have to use the letter because at the board meeting, Dr Teplitzky said that he would issue an official letter of appreciation for the work done by the engineers on the CPU cooler project. 47 On the night of 24 June 2004, after the board meeting, Mr Hepburn prepared a document in relation to a strategy meeting which he intended to hold with Mr Clarke and the engineers, on the following day. The document stated: 1. Did not have to use the "collective" all of us or none of us letter. 2. However the Board remains apparently unwilling to understand the work being done here 3. I requested the Board to issue a letter of appreciation via David for the CPU cooler work 4. David has continually criticized the CPU project and an official letter of appreciation will come from him to the engineers with a separate one to me with many criticisms. Peter and myself will answer this second letter. The reason I wanted the official letter from the Board was to help to secure all of your positions. This was achieved. 5. Also not fully appreciative of the work done to get WaterMasters to the table nor the work to be done to develop a TE version of their cooler. 6. Instead the Board continues to support Carlos in the face of mounting evidence to suggest we should have serious doubts. 7. In the case of David, this is caused by his unexplainable confidence in Carlos notwithstanding his previous resignation from Ramtron. In the case of Steve, he has told his shareholders that Carlos will make them all rich and cannot rescind from this. In the case of Don he has similarly told the Government and also cannot retract. 8. We have fortunately got Carlos on record as saying the Dec 31st is bale out time if no proof of theory. This has been said in front of Emerson and David and submitted in writing by me to the Board. 9. My prediction is that we will have no proof by Dec 31st although I hope I am proved to be wrong. 10. In this event, I will be submitting to the Board and failing a positive reaction, then to the Government, that we pull out of the Symetrix project and also attempt to recover some of the fees paid. We have various written statements from Carlos which would support such an attempt. 11. Between now and then we will continue to do everything possible to make this project with Symetrix succeed 12. Ressult from conversation with Randall? 13. Result from ATG Board meeting regarding DON? 14. However, looking beyond December 31st and assuming that we will [be] out of funds by then if we cannot raise more money before then, we need to have a very clear plan of what needs to be done here in Australia: 1. Progress the CPU cooler, present a very good paper at ITC and use this position to secure a license agreement. 2. Progress the JV with WaterMasters and develop their TE Version so that we can earn license fees from that 3. At December 31st we may need to use another "collective" position to maintain the future of Hydrocool and this collective position would probably need to be adopted in order to: To Pull out for Symetrix. To perhaps purchase the company from the Government who by that time will be very truly tired of listening to the Hydrocool situation and will want to simply walk away with no liabilities. 48 On 25 June 2004, Mr Clarke forwarded by email to Dr Teplitzky and Mr Hepburn a draft detailed project plan for the Water Master project. The draft plan prepared by Mr Clarke, projected that the Water Master project would take 18 months with two engineers and two technicians/draftsmen working full-time during that period and one project manager contributing 25% of his time during that period. On the basis of this plan, Mr Clarke recommended a USD500,000 licence fee and a 5% royalty. Mr Clarke also recommended that as a negotiating strategy, Hydrocool should offer to bear the costs should the costs of the project exceed USD500,000. 49 On 28 and 29 June 2004, Dr Teplitzky and Mr Hepburn met with Mr Richardson and the other Water Master representatives. During the course of the meetings, Dr Teplitzky advised the representatives of Water Master that Hydrocool would require that Water Master pay a fee of USD1 million for the development work, with half payable on the signing of the agreement, with the balance payable in two tranches over 12 months. Dr Teplitzky said that the cost of the development work would be payable out of that fee. 50 During the meetings, Mr Richardson also raised the question of whether Water Master could invest in Hydrocool. Dr Teplitzky prepared a report on the meeting with Water Master to the board of Hydrocool dated 4 July 2004, based on the notes he had taken of the meeting. In his report of the meeting, Dr Teplitzky stated that he responded "very direct and strongly" to the suggestion that Hydrocool was interested in offering equity for the injection of funds. Dr Teplitzky said that he also stated that he was not authorised by the Hydrocool board to discuss equity, and no one else was either. Dr Teplitzky said that he told those present that Hydrocool worked only on licence fees and royalty fees and was not a manufacturing company. 51 The representatives of Hydrocool and Water Master agreed at the meeting that Hydrocool would draw up a heads of agreement. Mr Hepburn carried the responsibility for doing so. 52 On 1 July 2004, Mr Hepburn sent Mr Richardson a draft heads of agreement between Hydrocool and Water Master. In outline, the draft heads of agreement contained the following provisions: (a) The parties would cooperate in relation to the design and development of the domestic water making device. (b) Hydrocool would grant Water Master an exclusive worldwide licence for the HS5 technology for the application of water making devices. (c) Water Master would pay a licence fee of USD1 million in three tranches; and Water Master would also pay a royalty fee of 5% for ex-factory total cost of the commercial domestic water making device, based on the number of devices manufactured. 53 On 5 July 2004, Mr Hepburn sent Mr Richardson, the draft heads of agreement between Hydrocool and Windsor Group Company Limited, incorporating the proposed terms of agreement. In outline, the proposed terms were: (a) Windsor would be licensed to manufacture HS5 convector modules. (b) Windsor would be licensed to supply these HS5 convector modules to Water Master to use only in the domestic water making device. (c) Windsor would be licensed to manufacture the CPU cooler unit and to market and distribute the units. (d) Windsor would pay a licence fee of USD500,000 on the execution of the final agreement, and also a royalty fee of 5% of the ex-factory total cost of the CPU cooler units. 54 Both draft heads of agreement provided for final agreements to be signed by 31 August 2004 and that future improvements to the HS5 convector modules or CPU cooler units by Hydrocool, including, improvements in peltier performance, as a result of the Symetrix research, would flow to Water Master and Windsor within the licences to be issued. 55 On 1 July 2004, Mr Richardson sent an email to Dr Teplitzky and Mr Hepburn. Mr Richardson expressed concern in relation to the CPU cooler unit licence fees. Mr Richardson also stated: We really liked your team - you have very good people and we very much look forward to working with them closely in the future. 56 On 5 July 2004, Dr Teplitzky sent Mr Hepburn an email. This email relevantly reads: 1. I had a private letter from Carlos yesterday. Amongst a number of issues, he asked me for details of the offer from Emerson for 7% of HPL equity in return for cash. I do not appreciate being asked by Carlos or anyone else on confidential matters to HPL Board. Cleary there has been some loose talk from Fremantle to Brett/Ben. It is none of their business and they have no right to discuss such matters in Coloardo Springs. In fact it is nobody's business other than Directors, including the staff at Fremantle, and they should not be party to this information. If I can not rely on confidentiality on matters I share with you, I will not pass these on. 57 By 5 July 2004, an invitation had been issued by Water Master for Mr Hepburn, Dr Teplitzky and Mr Clarke to visit Windsor's factory in China. In the visa application letter of that date, signed by the Mr Chung of Windsor, he stated that Windsor had formed a joint venture with Water Master and that they had "decided to acquire the rights to new technology from a company based in Australia called Hydrocool Pty Ltd". 58 On 5 July 2004, Mr Hepburn sent Mr Banney and Mr Manners an email in relation to the Symetrix project. It read as follows: Further to our strategy discussions this morning, I would appreciate if you would prepare a confidential report over the next few months (aim to have complete by say October) This report should be a chronological description of the work program with Carlos since the very beginning, which is when Brett first went to CS. In addition to the general chronological history I am also looking for the details of how Hydrocool has done everything possible to help Carlos, even when we have sometimes disagreed and of how we have frequently had our suggestions rejected only to find that months later, they were valid and applicable. I also need included the situations in which Carlos's behaviour, attitude etc made the project difficult to progress. I also need included details of where we have received incorrect advice from Carlos - for example the confirmation of active Ferro inclusions, which if more thought had been given, were never capable of being proven. I want to be in a position at the end of this year of being able to report our factual and comprehensive side of the Colorado Springs story. You may run drafts past both Peter and myself but nobody else. Please be careful therefore when you transmit any drafts by email ! 59 In an email to Mr Clarke dated 6 July 2004, Mr Hepburn stated: I do not want Carlos or David to have any excuse between now and Dec 31st. My draft wording for the condition which the employees might attach to any employment contract which Water Masters in their wisdom might request, given that we are asking them to pay a license fee 18 months ahead of when the licensed technology would actually be proven in practice, is as follows: That the Board give due consideration to our collective request that, if there is no progress before November 30th on the proof of theory (ie Milestone One of the Start Grant) via sample measurements which repeat, then a comprehensive review of the entire Symetrix project be undertaken jointly by Hydrocool and Symetrix during December 04 with a view to: • evaluating what has been achieved to date and the cost to do so • determining if there is adequate justification to continue the project past the deadline previously set by Carlos of December 31st. The only downside for HPL, which I can see to Water Masters requesting two year contracts for all employees, is the effect this would have on our balance sheet. I will have to work out the numbers, but it will make us insolvent much earlier, how early I will determine. This in turn could force the GOV to get out before March. We could ask for a major shareholder guarantee (from the GOV) as part of the employment contract but I do not think this would have any chance of flying and may bring unpredictable consequences immediately. Let's discuss more tomorrow. (Original emphasis.) 60 In an email dated 7 July 2004 to Mr Hepburn, Mr Clarke stated: A detailed task and resources plan for water master project is attached. I will need 2 engineers and 2 technicians/draftsmen on the project for 18 months, plus about ¼ of my time for project management. If we reserve Monty and Rob for other duties, eg cpu cooler, automobile cooler box etc (essential as we can't commit 100% of our resources to the water master project) then that means preferably applying Brett, Ben, Norm and one additional hire for Water Master. If Brett and Ben remain in the US then we will need 3 additional engineers (an extra body to make up for lack of experience), one additional technician/draftsman, more like 50% of my time for project management and allocation of Monty to the project, reducing capacity to service other applications. I can't budget for materials costs yet until I have a better idea of the actual program. 61 Mr Hepburn advised Mr Clarke that he agreed with his assessment and requirements. 62 Mr Clarke then forwarded the detailed task and resources plan to Dr Teplitzky. 63 On 8 July 2004, Mr Hepburn sent an email to Dr Teplitzky about Mr Clarke's plan. He said that it was too early to define clearly what would be needed to be done. Mr Hepburn went on to say: I have looked at Peter's proposal closely and I think it is a reasonable maximum guesstimate at this time but the fact of the matter if we do not know enough details at this time to make this analysis. 64 On 10 July 2004, Mr Richardson advised Mr Hepburn that he intended to send Mr John Christian, a technical expert, to Fremantle to carry out an independent technical review of Hydrocool's technology, with Mr Clarke. 65 Mr Christian visited the Fremantle premises on 15 July 2004. Mr Christian met with Mr Weymouth and Mr Davis. Mr Manners and Mr Banney were still in Colorado Springs working on the Symetrix research. Mr Clarke was in Croatia. Mr Christian also met with Mr Hepburn. 66 Mr Hepburn prepared a report of Mr Christian's visit which he sent to the other directors. The report included the following statements: He [Mr Christian] made the point that Water Master was being asked to make full payment of an up-front license fee of US$1M now and hence in advance of Hydrocool being able to demonstrate that our technology could do what Water Master needed to be done and at an acceptable cost. He sees the main risk of this situation for Water Master being the personnel in Hydrocool and the need to retain all of this expertise to make sure that the development program was on time and successful. He sees this as important for both of us since the product will not sell and generate royalty, unless the development is done well in the first place. 67 Mr Hepburn also emailed to Mr Clarke a copy of this report to the board. However, in forwarding the report to Mr Clarke, Mr Hepburn had applied bold font to the last two sentences referred to in the previous paragraph. Mr Hepburn's email to Mr Clarke read: FYI On the section Bolded, I have primed Jon to discuss with Garth. 68 On 16 July 2004, Mr Hepburn sent the following email to Mr Clarke: Please keep this confidential…The main downside of this plan, is the explosive effect it would have on the Board and on particular David. We would certainly create permanent destruction of any relationship with Symetrix and probably with David. I am far from thinking that we should put this plan into action and I will not do so without all of us in agreement… Plan: I think it is understandable for Water Masters to require some assurance that the project to develop the TE Domestic Water Maker can be successfully completed on schedule. In this regard, it is very clear that we would need to retain all our engineering expertise to do so. Jon Christian, their independent expert will advise Garth of this. Therefore, given that WM are paying the license fee up-front, they need assurance that Hydrocool will retain this personnel expertise. Therefore WM need Hydrocool to have two-year employment contracts with their employees. This has no downside for Water Masters. This would have significant effect on the HPL balance sheet and would make the Government much more eager to get out… I would predict that David Teplitzky and Don Bourke would resist such a requirement for employee contracts since they know this would concern their Gov masters. They would also reject simply to disagree. However, if WM insist they would then be forced to ask the Gov and the answer would almost certainly be try to avoid at all costs. In the event that they did agree (very unlikely) then perhaps the employees would be willing to sign two year contracts, knowing the general attitude of the Hydrocool Board to various matters. WM could then offer the following alternative proposal to the Gov via ATG WM offers to by the 77% of HPL from ATG at 10 cents per share (A$770,000) Also to pay out the ATG loan of $350,000 Hence for just over A$1M WM gets ATG out and hence the Gov out. All employee options are cancelled and instead WM provides 5% equity to the following personnel - (DT - subject to the Symetrix situation), IH, PC, MD. RW, BM, BB. This WOULD allow me to secure two year contracts with all employees. This would change our shareholding as follows: 47% to 42% with WM, 30 to 35% with HPL employees and 23% with CH We would keep our Start Grant since less than 50% is owned by overseas entities. … David resigns as executive Chairman, may stay on as a director… Garth or some other nominee is appointed non-executive chairman. Don Bourke resigns. Peter Clarke replaces him on the Board. I firmly believe that the Gov remaining as a shareholder with ATG as their board nominee, is presently not beneficial in any way for Hydrocool. They have only an objective to get out as soon as possible, without regard to the long term prospects of the company. Equally I believe that the above outcome would be beneficial for the future of the company and hence in the future for remaining shareholders. My concern is the unpredictable element of this plan and do we want Water Masters as a major shareholder so soon. 69 On 18 July 2004, Mr Manners, one of the engineers located in Colorado Springs working on the Symetrix project, prepared a report to Mr Hepburn in relation to the Symetrix research. Mr Manners complained about the "very poor methodology" used in the project. He also stated that the nature of the research had changed from "increasing ZT via thin films to increasing ZT by any method we can find". He went on to say that he was not confident the project would produce a breakthrough, and was unwilling to be associated with such poor research practises any longer. He said that it was not his place to decide if Hydrocool should continue with the project. 70 On 23 July 2004, Mr Banney wrote to Mr Hepburn to similar effect. 71 On 1 August 2004, Mr Larry McMillan wrote to Hydrocool notifying it that it was necessary to suspend the Symetrix research for up to six months due to the illness of Dr Araujo. 72 In August 2004, after the suspension of the Symetrix project, Mr Manners and Mr Banney ceased working on the Symetrix research and departed from Colorado Springs to return to Fremantle. Mr Manners travelled back to Australia via Europe. 73 On 16 August 2004, Mr Clarke issued a report which was critical of the Symetrix project. 74 On 17 August 2004, Dr Teplitzky sent Mr Hepburn an email headed: "Discussion with Carlos CONFIDENTIAL", complaining of the negative attitudes to the Symetrix project from Fremantle over the previous few months. Dr Teplitzky also asked Mr Hepburn to produce a business plan and budget for the work to be undertaken at Fremantle. 75 On or about 20 August 2004, at an annual general meeting of Water Master, the shareholders of Water Master expressed support for the Water Master project. Mr Richardson emailed Dr Teplitzky in the following terms: Our AGM concluded with good shareholder support for the Hydrocool proposal. We can now proceed to discuss the Heads of Agreement with the comfort of this support… I hope to expedite this matter but I cannot be sure how long it may take. We are excited about the prospect and our shareholders now share that same excitement. 76 Further, on 20 August 2004, Mr Richardson sent Mr Hepburn an email attaching Water Master's invitation letter to Dr Teplitzky, Mr Hepburn and Mr Clarke to visit Windsor's factory in China. Mr Richardson suggested in the email, that Mr Hepburn forward the invitation to Dr Teplitzky. 77 Following the receipt of Mr Richardson's email, however, Mr Hepburn sent to Mr Richardson an email in which Mr Hepburn suggested to Mr Richardson that the visit to China be limited to a technical visit only, and, therefore, that only Mr Clarke and himself should come. 78 Mr Hepburn's email stated: Peter and I will proceed to obtain our visas. Given that we will have a signed Heads of Agreement prior to this visit (that condition has been imposed upon me by the Hydrocool Board) I view the main objective of this visit as being technical. Peter and I need to gather all required technical information from yourself and your engineers to commence work in Perth. Final terms of the license agreement can be handled by myself in China, in consultation with the Hydrocool Board. I remain concerned about anything, which might jeopardise the creation of a good relationship between Hydrocool and your Chinese partners. Given all of the above I think it is best for both Hydrocool and Water Masters that this visit be seen as a technical visit and hence that only Peter and myself come. I suggest that to achieve this, that you send me an email along the following lines, after we have concluded the Heads of Agreement. now that the Heads of Agreement is finalised the main purpose of your visit to China will be to discuss the prototype design and development project in detail and gather all the required technical information. This may take several days and hence we suggest that there is only a need for Peter Clarke and yourself to visit. Let me know what you think 79 Later that day, Mr Richardson responded by email to Mr Hepburn's email in the following terms: Understand Iain, Looks good. I will comply as you suggest. This email will self-destruct in 5 minutes time. 80 On 21 August 2004, Mr Richardson sent an email back to Mr Hepburn which adopted Mr Hepburn's suggestion that the invitation to visit China exclude Dr Teplitzky. The email also included the following statements: As you know, I was quite taken aback during our meetings in Perth, when at one point in my conversation with David, he was particularly insistent to the point where he lost his temper over a relatively minor matter. We have always viewed the engineering staff at Hydrocool as critical to the development of our domestic device and equally the management of this resource by Peter Clarke and yourself. As such we will be seeking some assurances that you and your staff will be available to work on our project through its entirety. With regard to the visit by Hydrocool personnel to China…(w)e would recommend that both Peter and yourself make this visit and I do not see the need for anyone else at this time. Due to the above issues I would be most appreciative if all communications with Hydrocool could be conducted directly with yourself, since I believe that you understand our way of doing business and we already see eye to eye on most aspects of this project. 81 Shortly after receiving a copy of Mr Richardson's email, Mr Hepburn forwarded it to Mr Clarke. The email stated: See email from Garth pursuant to my conversations with him. This should solve our problem. 82 On 25 August 2004, Mr Hepburn replied to Dr Teplitzky's confidential email of 17 August 2004, that complained about Fremantle's negative attitude to the Symetrix project and that requested a business plan from Mr Hepburn, by inserting highlighted responses into the text of Dr Teplitzky's email. In response to the request for a business plan and budget, Mr Hepburn said that a "detailed work schedule and resources plan for the Water Master project has already been supplied". 83 Mr Hepburn sent a copy of Dr Teplitzky's confidential email of 17 August 2004 and his responsive email of 25 August 2004 to Mr Clarke and each of the engineers, other than Mr Manners, saying: "Hold your breaths for the reply to this one!" 84 On 25 August and 26 August 2004, Dr Teplitzky attended a meeting in Colorado Springs with Dr Araujo and Mr McMillan about the Symetrix project. 85 On 25 August 2004, Mr Bourke sent a memorandum to Mr Hepburn (with copies to Dr Teplitzky and Mr Murphy) asking Mr Hepburn to prepare a comprehensive report for the next board meeting. Mr Bourke said that the report should include a report on the current status of the negotiations in relation to the Water Master project. The memorandum went on to state: 6. The Board obviously need detail projected P&L and cash flow arising from the proposed programs, which will need Board approval. Part of this financial planning should include a comprehensive status of the START Grant. Obviously the company has only limited financial resources. Part of the review is to examine each cost and person's contribution and determine: a. whether we can afford them; and b. do they have the right skill set to do the job at hand? 7. It is obvious that there has been a break down and dysfunctionality in the relationship between you and the CEO/Chairman. The Board needs to understand how the company is going to operate in a functional manner. You and David should meet and put all the issues on the table. As grown men I would expect that the majority of the issues are resolved between yourselves, but unsolved issues are brought to the Board for final decision. 8. The Board will need to consider recommendations from you and Dr Teplitzky as to how any additional financial resources required can be funded. 86 Mr Hepburn forwarded a copy of this memorandum to Mr Clarke under cover of an email, in which Mr Hepburn stated: No surprises here but you can see that he is still raising the aspect of reducing or changing or our personnel. The end of Aug progress report will need to cover all the information he asks for in this letter plus we will need to emphasise yet again that the Water Masters project will essentially need all the personnel whom we currently have. 87 On 26 August 2004, Mr Clarke sent by email to each of the engineers, as a pro forma draft letter, a letter addressed to Mr Hepburn, as managing director, advising that the writer, Mr Clarke's wife, wished to exercise the options she held in Hydrocool. The letter stated that the writer wished to exercise her options in part as per section 4 of Appendix A, Option Conditions; and subscribe for 10 ordinary shares, and attached a cheque. Mr Clarke's covering email said: A form of words that you might like to use. 88 It is to be inferred that each of the engineers and Mr Hepburn gave a notice to similar effect to exercise a small number of his options. This is because on 2 September 2004, Mr Hepburn signed a document which was headed: "Resolution of Directors of Hydrocool Pty Ltd". The document stated that it was resolved to approve the allotment of 100 shares to Mr Hepburn, each of the engineers and Mr Clarke's wife, Mrs Rita Clarke. In fact, there had been no meeting of the board of directors on 2 September 2004, or at all, approving any such allotment of shares, nor had any such resolution been passed by the board of directors of Hydrocool. 89 On 5 September 2004, Dr Teplitzky prepared a memorandum addressed to the shareholder representatives of Hydrocool. Dr Teplitzky complained of the defiant attitude of Mr Hepburn and sought confirmation of his own authority by the shareholders to manage the company. Dr Teplitzky described a number of possible actions that the company could take in response to Mr Hepburn's conduct. One of the possible actions was headed: "Dismiss the Managing Director/Relocation in Sydney". The memorandum contemplated that such an action may lead to the resignation of "one or two of engineering staff and R&D Manager". Dr Teplitzky said that the staff could be replaced in time, but not at that time. Dr Teplitzky recommended not taking that step at that time. 90 On 6 September 2004, there was a meeting of the shareholders of Hydrocool. They were represented by Mr Bourke and Mr Stone on behalf of ATG, and Mr Murphy on behalf of the two Coolhydro companies. The shareholders considered Dr Teplitzky's memorandum and confirmed support for Dr Teplitzky in his dealings with Mr Hepburn. The meeting agreed that every effort should be made to reactivate a working relationship between Dr Teplitzky and Mr Hepburn, and to this end, Dr Teplitzky was authorised to set an action plan for Mr Hepburn. Further, it was agreed that Mr Bourke would also write to Mr Hepburn expressing the concern of the shareholders that Mr Hepburn had not addressed the matters raised in Mr Bourke's memorandum of 25 August 2004. The representatives of the shareholders agreed that Mr Hepburn needed to produce a detailed business plan to the next meeting of the board of directors which, among other things, would outline the costs of completing the development of the CPU cooler project and the Water Master prototype. 91 In accordance with the agreement reached at the shareholders' meeting, Mr Bourke sent a letter to Mr Hepburn dated 7 September 2004. The letter stated that shareholders were very concerned about the direction and focus of the company. The letter stated that the relationship between Dr Teplitzky and Mr Hepburn was "totally dysfunctional and is unacceptable". It also said that the research and development being conducted by Symetrix was vital to Hydrocool and must continue. One technician from Fremantle was to be located in Colorado Springs to assist in the measurement of the results of the research. The letter went on to state that Dr Teplitzky, solely, was to manage the relationship between Symetrix and Hydrocool, and Mr Hepburn's contact with Symetrix and related companies, was to cease forthwith. The letter also stated that Mr Hepburn's July/August monthly report had not adequately addressed the issues that were essential to the company's future. The letter asked Mr Hepburn to provide cost estimates and time frames for the marketing of the company's technology and a comprehensive cash flow statement for achieving a break even position. Mr Bourke's letter also stated that the shareholders regarded Dr Teplitzky as the senior executive. 92 On 7 September 2004, Mr Clarke sent Mr Hepburn an email attaching a draft letter. The email was titled "Water Master guarantee" and said "Suggested draft attached". The draft letter attached stated: Water Master intends to enter into an agreement with Hydrocool Pty Ltd for the development of a domestic water drinking unit which freezes water from air. The cooling power required will be provided by a thermoelectric system which Hydrocool will design and develop using Hydrocool's proprietary technology. This development project is to be carried out over an 18 month period with funds being provided by Water Master as part of a licence agreement with Hydrocool. The success of the development project, both in performance and in timeliness, depends to a large degree on the application of Hydrocool's existing technology and experience and on the development expertise of Hydrocool's research and development team based in Fremantle. Upon execution of the agreement between Water Master and Hydrocool, Water Master will be liable for payments to Hydrocool for the life of the project. This puts Water Master at risk and there needs to be some level of guarantee to ensure that the development project will be carried out with the application of expert and experienced personnel. As with most R&D companies we believe the technical value that Hydrocool brings to the project is partly in its proprietary technology but more so in the capability of its personnel. This project will be extending Hydrocool's technology into new areas and we need assurances that not only will Hydrocool's best managers and engineers be placed on the project but that there is some assurance that they will remain with the project until it is completed. Thermoelectrics is a field that few engineers are experienced in and we do not have the time frames available to suffer lengthy delays while new engineers or managers are trained. We also seek assurances that the funds provided by Water Master will be used exclusively for the development of the drinking water technology during the life of the project. We do not wish to see them being used to support other activities the company may undertake during the life of the project. At the conclusion of the project any excess funds of course may be used for whatever purpose Hydrocool sees fit. 93 By a letter to the board of directors of Hydrocool dated 7 September 2004, Water Master advised that it was prepared to sign the heads of agreement sent on 1 July 2004, with various changes. One change proposed was that a licence fee of USD750,000 was to be paid in three tranches and a royalty fee of initially 3%, but reducing to 2.5%, was to be paid, once the production exceeded 10,000 units per month. 94 Another change was a requirement for an employee commitment. The letter relevantly read: 3. Safeguard the required Expertise The development of our domestic water-making device depends on the ability of your team of engineers to successfully apply their knowledge and expertise in the design and development process. From the analysis so far done, we may or may not need to use your patented convector heat exchange technology and instead may use the more simple single fluid circuit or both. In either case, we view continued engineer involvement as a very crucial factor for us. Consequently we would need the following clause added to the agreement. Hydrocool provides a written undertaking from all of the current Fremantle-based employees that they will remain employed with Hydrocool until the Water Master design and development project is completed. 95 This letter was sent as an attachment to an email from Mr Richardson to Mr Hepburn. 96 On 8 September 2004, Mr Hepburn sent an email to Dr Teplitzky and Mr Murphy, which recommended acceptance of the proposed amendments to the heads of agreement put forward by Water Master. 97 On 9 September 2004, Dr Teplitzky sent an email to Mr Hepburn. Dr Teplitzky said that Mr Hepburn would have received Mr Bourke's note on management responsibilities. Dr Teplitzky went on to state that Mr Manners was to be seconded to Symetrix and was to return to Colorado Springs. Dr Teplitzky also said that he would review the proposed amendments to the heads of agreement from Water Master and get back to Mr Hepburn. Dr Teplitzky also sought a "credible development plan" from Mr Hepburn costing the Water Master project. Dr Teplitzky asked how it was possible to decide if the proposed amendments were "OK" if they had no idea of the cost of undertaking the development. 98 Dr Teplitzky also expressed his dissatisfaction at the fact that Water Master had come to the 28 and 29 June meeting seeking equity and stated: It took me some time to get the message through that there was no one authorised to negotiate such a basis and that we are a work for fee/licence for fee company only. 99 In the email, Dr Teplitzky went on to express his concern that Mr Hepburn had previously suggested that the whole of the proposed licence fee be earmarked for the Water Master project. He said that the fee was a licence fee and would be spent as the board and management of Hydrocool saw fit. 100 Dr Teplitzky also said that Water Master appeared to have ignored the proposed licence agreement with Windsor relating to the manufacture of the HS5 convector modules; and that it was no use selling a licence to Water Master, if there was no one to make the convector modules that would be used in the water making devices. 101 Mr Hepburn forwarded Dr Teplitzky's email of 9 September 2004, to Mr Clarke and the engineers with the comment: "Received today - we need to discuss". 102 Later on 9 September 2004, Mr Hepburn replied by email to Dr Teplitzky's email to him. Mr Hepburn stated that Hydrocool needed to grab the Water Master deal with both hands before Water Master withdrew the deal. Mr Hepburn also copied his responsive email to Mr Clarke and the engineers. 103 On 10 September 2004, Mr Hepburn made a detailed response to Dr Teplitzky's email. The response also included comments from Mr Clarke. This email was also copied to Mr Clarke and the engineers. 104 Shortly before 14 September 2004, Mr Hepburn forwarded to Dr Teplitzky, the reports, referred to previously, of Mr Banney, Mr Manners and Mr Clarke, criticising the Symetrix research project. Mr Hepburn asked Dr Teplitzky to distribute the reports to other members of the board of directors. 105 By an email dated 14 September 2009 to Dr Teplitzky, Mr Hepburn asked for his confirmation that he had distributed the reports to Mr Bourke and Mr Murphy. Mr Hepburn went on to state that the engineers were seeking his assurance that the board of directors would vote on the future of the Symetrix project, after the reports had been carefully reviewed. Mr Hepburn copied this email to Mr Clarke and the engineers. 106 By an email dated 15 September 2004, Dr Teplitzky responded to Mr Hepburn by saying that the reports would be distributed at his discretion, and it was none of the engineers' business what the board of directors did, or voted on. Mr Hepburn underlined those sentences in Dr Teplitzky's email, and copied Dr Teplitzky's email to Mr Clarke and to each of the engineers with the following comment: I have to say that his comments which I have underlined are for me the most infuriating and the most unacceptable I have seen in business in thirty years. Arrogance, ignorance and insensitivity to the extreme. We need to discuss what action should be taken if he does refuse to distribute. 107 On 17 September 2004, Mr Clarke sent Mr Hepburn a document containing "redrafted and expanded manning descriptions" for the Water Master and CPU cooler projects. Mr Clarke envisaged two new staff members being hired as engineers. There were now to be four engineers on the Water Master project including two new engineers, and two existing engineers and one new engineer for the CPU cooler project. 108 On Saturday, 18 September 2004, Dr Teplitzky sent Mr Hepburn an email about the amendments to the heads of agreement proposed by Water Master. The email said: Amendment - it will not guarantee current staff as stated. Will consider "appropriate staff to complete development at HPL discretion" 109 The email also stated that Dr Teplitzky required Mr Manners to visit Symetrix in Colorado Springs for a couple of weeks to carry out measurements and transfer his knowledge of measurement procedures to Symetrix employees. 110 On Sunday, 19 September 2004, Mr Hepburn forwarded Dr Teplitzky's email to Mr Clarke and the engineers, stating: We will need to discuss on Monday. 111 On 19 September 2004, Mr Hepburn sent an email to Mr Richardson which stated that Dr Teplitzky had advised that he was not prepared to accept the required commitment from all current employees and instead wanted to replace the wording by "appropriate staff to complete development at HPL discretion". 112 Mr Hepburn's email went on to state: I need to talk to you about this since firstly I can tell you with absolute certainty that unless we do retain all of the current employees we would not have the expertise to successfully complete the project. This expertise cannot be replaced even if we wanted to These guys have been working on our technology and the application of it for the last five years. They are the same team which produced the prototype for Marco and whether we go with the convector or the SFC we need every single one of them. David simply does not like the employees to have any say in any matter. Secondly, I am not sure if Peter would accept the responsibility of the project unless he knows that he has the required engineers available. I will discuss with Peter on Monday morning. 113 Mr Hepburn copied this email to Mr Clarke, inviting him to discuss the email on Monday - which was the next day. On that day, Mr Hepburn sent Mr Clarke an email stating that it would help if Mr Clarke drafted an email to Mr Richardson expressing his view on the necessity of retaining all the current employees for the Water Master project. Mr Hepburn asked Mr Clarke to let him see the email before he sent it to Mr Richardson. 114 On 20 September 2004, Mr Clarke drafted the email requested by Mr Hepburn. The email read as follows: I understand there has been some communication between yourself and Hydrocool regarding the staffing required to successfully carry out the development of the thermoelectric "water from ice from air" prototype. The current Hydrocool staffing is: Monty Davis Applications/Design engineer Rob Weymouth Applications/Test engineer both of whom you met in Fremantle As well as: Brett Manners Research/Development engineer Ben Banney Research/Development engineer Brett and Ben have recently returned from the US and have expertise particularly in modelling and analysis. Brett has been involved intensively in developing the single fluid circuit concept over the last couple of years and assisted Monty in modelling for the demonstration prototypes recently tested. I can assure you that all of the engineers are highly motivated to bring your project to a successful conclusion. They were all involved in the MARCO prototype project and it was a disappointment for all of us when that did not proceed commercially. We see your project as an excellent opportunity to get the technology we have all worked so hard on finally out into the market place as a commercial product. I believe that all of these engineers are going to be required by Hydrocool to carry out your project successfully. Monty and Rob will also have responsibilities in finalizing development of the CPU cooler heat exchanger devices as they will most likely be used as essential componentry on your project. I expect to hire additional new engineers as well to enable timely completion of all of our projected work for the rest of 2004 and through 2005. I can assure you of my 100% commitment to the project as well, provided I get the support I need from the Board to apply the resources necessary to carry it to completion. 115 After Mr Hepburn had seen and approved Mr Clarke's draft letter, Mr Clarke emailed that letter to Mr Richardson on 20 September 2004. 116 On 20 September 2004, Mr Hepburn responded to Mr Clarke as follows: Peter, I have just read this again at home and it was a very good email. Also wanted to make mention of my appreciation for your support and advice through this difficult period. 117 On 20 September 2004, Mr Clarke prepared further budgets for the Water Master and CPU projects. The Water Master project was costed at AUD585,500. The Gantt chart showed that four engineers were required to May 2005, with two engineers required from July 2005 onwards. The CPU project was costed at AUD548,000. 118 On 21 September 2004, Dr Teplitzky sent an email to the other directors of the Hydrocool board, which attached two papers. The first paper stated that it was a summary of what Dr Teplitzky discussed at his August 2004 meeting in Colorado Springs with Dr Araujo. The second paper was a paper requested by Mr Bourke, which set out alternative strategies regarding Hydrocool's future. Dr Teplitzky's covering email stated: My position is that I support completing a deal with Water Master as long as we can get a few mentioned amendments, solely as a means of staying financial longer to enable us to pursue the Symetrix R&D and hope we do achieve the elusive milestone of proof of concept. Unless we also complete a license for CPU system, and perhaps at least one other license, we won't even complete the Watermaster development before running out of money. As you will read, I have been unable to get any interest in purchase of ATG shares and associated injection of funds into HPL (without dilution to other shareholders) until we can demonstrate the ZT milestone, and show that the establishment at Fremantle can be sustained on a break even basis from licenses of current technology. Our only upside is the Symetrix project (if successful) and so I want to give this the maximum time to succeed. 119 Two alternative strategies were identified by Dr Teplitzky in the second paper. The first alternative was maintaining the Fremantle operation and engaging in the Water Master project. The alternative strategy referred to in the paper, was to close down the Fremantle operation, terminate all staff at Fremantle, and retain Dr Teplitzky as the sole employee. In this case, Hydrocool would not continue with the Water Master project. 120 Dr Teplitzky stated that Hydrocool would, on current projections, and in the absence of a further source of revenue or funding, run out of money in the first scenario by August 2005, not completing the Water Master project; and in the second scenario, by April 2005. Dr Teplitzky recognised that there were a number of obstacles facing the successful licencing of the CPU cooler unit. 121 One of the desired amendments to the Water Master heads of agreement referred to by Dr Teplitzky in his email of 21 September 2004, was the rejection of Water Master's requirement to guarantee that existing employees would be available full-time for the duration of the project, and the acceptance by Water Master, of Hydrocool's proposal that it would allocate appropriate experienced personnel to the project. 122 On 21 September 2004, Mr Hepburn wrote to Mr Richardson commenting: Further to this email I have discussed the situation with Peter and he is rather firm in his belief that without the confirmed commitment from all the current engineers, he would not be able to do a good job on the prototype. In fact, he is reluctant to accept the project unless he is sure he can succeed. I am sure that David will be trying to persuade the Board that Hydrocool needs to be able to take people off the Water Master project at its discretion whenever and for whatever reason. Am I correct in assuming that Water Master will not proceed without the employee commitment as stated in the draft HOG? 123 On 21 September 2004, Mr Richardson emailed Mr Hepburn stating: You are correct in your assessment. Without Hydrocool's employee commitment our very large investment in this project would be at risk. We believe that the real value of Hydrocool's technology is resident in its employees. Without them we do not believe Hydrocool would have the ability to complete this project. Hence our request for this simple assurance to be embodied in the HOA. 124 Later on 22 September 2004, Mr Hepburn sent Dr Teplitzky, Mr Murphy and Mr Stone an email, which reported, inter alia: The employee commitment is a deal-breaker for Water Master… 125 Mr Hepburn's email went on to say of the employee commitment that this was "something [Water Master] have said from the very beginning". Mr Hepburn also included in that email, an extract from Mr Richardson's email of 21 September 2004. Mr Hepburn forwarded his email to Mr Clarke and the engineers. 126 On 24 September 2004, there was a meeting of Hydrocool's board of directors in Sydney. Present at the meeting were Dr Teplitzky, Mr Hepburn, Mr Bourke, Mr Murphy and Mr Stone. At the meeting, Mr Hepburn described the proposed activity of the company. He presented a cash flow forecast for the period ending December 2005. This reflected Hydrocool deriving income from the licence fee payable under the proposed Water Master licence agreement, a licence fee and royalties under the proposed Windsor licence agreement, and from a licence fee payable in respect of a second licence agreement which Mr Hepburn predicted would be entered into in relation to the CPU cooler project in 2005. Mr Hepburn did not include any proposed payments being made to Symetrix in connection with Hydrocool's participation in the Symetrix project. 127 At the meeting, Mr Hepburn voted against the continuation of payments for the Symetrix research project until there had been a review of the project. 128 Mr Hepburn secretly taped the proceedings at the board meeting. A transcript of the board meeting was in evidence. Notwithstanding, the existence of a transcript, there was controversy as to what instructions were given to Mr Hepburn at that board meeting, in relation to the employee commitment amendments sought by Water Master. I will deal with the controversy later in these reasons. 129 It is uncontroversial that after the board meeting, Mr Hepburn obtained a draft from the law firm, Abbott Tout, which relevantly included three new clauses for the Water Master heads of agreement relating to the employee commitment, and a draft of the proposed undertaking to be given by the employees affected (the Key Employee Undertaking). The proposed new clauses provided as follows: 3.5 Pending execution of the Final Agreement, the Key Employees will give Water Master the Key Employee Undertaking. 3.6 Subject to the provisions of clause 3.7, HPL undertakes to Water Master that HPL will not undercut the benefit of the Key Employee Undertaking by terminating the services of the Key Employees prior to 31 December 2005 on the grounds of redundancy. 3.7 Nothing in clause 3.6 precludes HPL from terminating the services of the Key Employees prior to 31 December 2005 for cause eg unsatisfactory performance or misconduct. 130 The Key Employee Undertaking provided: We, the undersigned, all being employees of HPL: (a) undertake in favour of Water Master that we will continue in the employment of HPL until at least 31 December 2005, but subject to the terms of our respective service contracts with HPL and to the right of HPL to terminate those services contracts on the grounds of unsatisfactory performance or misconduct; (b) acknowledge that Water Master has entered into the Heads of Agreement on the basis (amongst other things) of our assurance that we will remain in the service of HPL until 31 December 2005. 131 At the 24 September board meeting, the directors also discussed the exercise of options by the employees and the issue of shares consequent thereon. Mr Bourke, unaware of the resolution signed by Mr Hepburn dated 2 September 2004, stated that shares were not to be issued to the employees until they signed a document acknowledging that they understood Hydrocool's precarious financial position. After Mr Hepburn stated that he understood that the company secretary had already issued the shares, Mr Bourke and Mr Murphy stated that the shares should not have been issued by the company secretary because there had been no resolution of the board of directors giving authority to issue the shares. Mr Hepburn did not disclose that he had signed the resolution bearing the date 2 September 2004, authorising the issue of the shares. 132 On 27 September 2004, Mr Hepburn emailed Mr Richardson stating: Garth, Just to confirm my telephone conversation with you. At our Board Meeting, the following was decided: I have been advised to progress the agreements (HOG and License Agreement) with Water Master and in this regard to take the following action. Have our lawyers review the draft HOG and suggest some wording for the employee commitment matter, which will satisfy all three parties, Water Master, Hydrocool Board and Hydrocool employees. I expect to have this back from our lawyers by tomorrow night and then I will seek final director approval so that I may execute the HOG on behalf of Hydrocool and send to yourself. I am to get this all done before the end of this week. 133 On 27 September 2004, Mr Richardson sent an email to Mr Hepburn which stated: …Our board is keen to move to a shareholding position in Hydrocool in the near future if the Aus Government is prepared to sell. I advised our board that you will be preparing a position whereby a management buy out by the staff of Hydrocool might be included with a Water Master purchase of shares thereby ensuring that Water Master became at least a 50% plus shareholder. We all favor this as employees who are also shareholders work better as partners. Our board asked me to ensure that in this eventuality you would remain as the CEO of Hydrocool. They (all of us actually) feel very comfortable and happy with yourself. I trust this would not be a problem for you. 134 Later on 27 September 2004, Mr Hepburn forwarded Mr Richardson's email to Mr Clarke and the engineers, under cover of an email which said: See email from Garth below. This is progressing from an idea in my head, to an idea put in Garth's head, to an option, to a likely outcome. I would like to have a meeting this morning to discuss the issues which I see need to be solved/considered. In this way we can all collectively think of the best strategy to employ during the visit to China and beyond. I feel strongly that whatever strategy we employ we all need to think it is the best one. This is going to be an interesting situation and we will need to tread carefully. 135 On 28 September 2004, Mr Hepburn responded by email to Mr Richardson in the following terms: …all of the Hydrocool employees are not keen to see ATG/Fed Government simply replaced by another shareholder who can bring no value to the company. It is unarguable that ATG have not been able to provide any value or help with our technology or its commercialisation. We have had many years of that and I am convinced that it has held us back. In contrast to this, we feel very strongly that both Water Master and Windsor can bring significant opportunities and hence future value to Hydrocool by way of helping us to progress and to commercialise our technology. This is why we are so keen for such a shareholder outcome to be achieved. It will benefit all parties, Water Master, Windsor and Hydrocool. Our lawyer called me tonight and said he will have a draft to me tomorrow which satisfies all of the Water Master concerns and requirements (expressed in your letter of offer) and at the same time is reasonable for Hydrocool to accept or more accurately will be unreasonable for Hydrocool not to accept. I will send this to the other directors tomorrow with my strong advice that we should now execute. I will copy this communication to you. Regards Iain. 136 On 29 September 2004, Mr Richardson emailed Mr Hepburn: This is all good news and I agree we are a very good fit and in particular yourself. It is rare these days to find someone in business you feel totally comfortable with as a future partner. 137 On 29 September 2004, Mr Hepburn forwarded the Abbott Tout draft amended heads of agreement and Abbott Tout's covering letter of advice to the other directors. In his covering email, Mr Hepburn reported on his dealing with Abbott Tout and that Abbott Tout had advised that the employee commitment clauses were reasonable for all parties. Mr Hepburn went on to say that he did not believe that in the absence of the employee commitment provisions binding Hydrocool, Water Master would execute the heads of agreement, nor would the employees provide the commitment sought by Water Master. Mr Hepburn asked the directors to review the document and confirm that Hydrocool would execute the document. 138 Mr Hepburn's email went on to say: Water Master has been awaiting our decision for a period of three weeks and they are becoming concerned at this delay. This draft will satisfy all their requirements and I am confident that they would immediately finalise the attached document and the license agreement to follow. 139 Mr Hepburn also forwarded a copy of his email and attachments, to Mr Clarke and the engineers and Mr Richardson. 140 In his covering email to Mr Richardson, Mr Hepburn included the reference to Abbott Tout's advice and that he had recommended that the directors accept the clauses. Mr Hepburn stated that he hoped his co-directors were sufficiently reasonable to accept his advice. 141 On 1 October 2004, in response to Mr Hepburn's email of 29 September 2004, Mr Murphy emailed Mr Hepburn and the other board members in the following terms: I have reviewed the revised HOA for Water Master and believe that the new clauses, and Schedule of Undertaking concerning the Key Employees, satisfies all our respective requirements and I am happy for the HOA to be signed in this form. 142 Later that day, Mr Hepburn forwarded Mr Murphy's email to Mr Richardson and suggested that Mr Richardson attend to having Water Master execute the heads of agreement. Mr Hepburn went on to say: I will then present the Agreement to David and Don as "take it or leave it but this is the final offer" This is assuming that they do not confirm their agreement beforehand. I will then have the Agreement signed by Hydrocool and all of the Hydrocool engineers and send one fully signed copy back to you. 143 Also on 1 October 2004, Dr Teplitzky sent an email to Mr Hepburn in the following terms: I believe the HPL Board made it very clear that any issue you wanted to bring to the Directors, should be directed through me as Executive Chairman. In recent days you have chosen to communicate on matters you were perfectly aware were contentious without first raising with me. In particular the Heads of Agreement for Watermaster in regard to the staff employment. I am currently taking legal advice as to whether the proposed wording is consistent with the clearly stated policy of the Board. I would have wished to have resolved this with you before requesting approval from the Board. I advise you that I will not accept this flouting of a Board directive any longer, and you should take this as a warning as unacceptable behaviour of the Managing Director of this company. 144 Mr Hepburn responded to Dr Teplitzky by saying that at the board meeting, Mr Bourke had specifically asked him to send the draft heads of agreement to members of the board as soon as he had taken advice from Abbott Tout, and that is what he did. Mr Hepburn said that he rejected Dr Teplitzky's allegation as a proper basis for the issue of a warning. 145 On 2 October 2004, Dr Teplitzky sent an email asking Mr Hepburn to supply him with each of the employee's terms and conditions of employment so that he could obtain legal advice. Mr Hepburn complied with that request. Mr Hepburn forwarded Dr Teplitzky's email to Mr Clarke and the engineers and said that he feared that they were heading towards a stand-off on the Water Master agreement. 146 Mr Richardson responded to Mr Hepburn's email of 1 October 2004, by seeking further amendment to the Water Master heads of agreement. Mr Richardson stated that Water Master would like the word "domestic" replaced wherever it appeared in the heads of agreement, because Water Master did not want Hydrocool to be at liberty to licence the technology for other water from air machines which were not related to domestic use. Mr Richardson said that: It would be appreciated if Water Master would be the only company that develops water for air products using Hydrocool's technologies. 147 Mr Richardson made some specific proposals to change the wording of the heads of agreement. 148 On 2 October 2004, Mr Hepburn advised Mr Richardson that he agreed to the changes and asked Mr Richardson to print out two copies of the heads of agreement with the changes incorporated, sign the heads of agreement and courier the copies to him. Mr Hepburn told Mr Richardson that Dr Teplitzky and Mr Bourke were "still going back and forward with each other on various clauses", but that he was comfortable that they had an agreement which was fair to both companies. 149 On 4 October 2004, Dr Teplitzky sent Mr Hepburn an email. The email referred to cl 3.6 of the proposed terms of the heads of agreement drafted by Abbott Tout in the following terms: All the directors I have spoken to have a problem with this clause, and I have as yet not had complete legal advice and sign off as to whether this condition contradicts the Board policy as stated in the minutes, or any issue covered in their letters/contracts of appointment. I am hoping to finalise all this with the Solicitor on Tuesday, so your advice would be appreciated. 150 Dr Teplitzky also referred, in the email, to the importance of Mr Hepburn preparing a business plan for the Water Master and the CPU cooler projects. Dr Teplitzky emphasised the need to have an assurance as to the developmental costs for the Water Master project before any heads of agreement could be signed. 151 Mr Hepburn copied that email to Mr Clarke saying that he was close to not being able to work with Dr Teplitzky anymore. Mr Hepburn went on to say that calling a meeting of shareholders to consider their draft resolution was looking inevitable. The reference to the meeting of shareholders was a reference to Mr Hepburn, Mr Clarke and the engineers' intention to call a meeting of the shareholders of Hydrocool, at which it was proposed to move resolutions which criticised the board's policy in relation to the Symetrix project, and which supported their views of the direction Hydrocool should take. 152 On 4 October 2004, Dr Teplitzky had a telephone conversation with Mr Richardson. He later sent an email to Mr Richardson stating: It was good to chat to you and hear your progress. I understood you to say that you would be comfortable with the proposed agreement containing the undertaking to Water Master of only those current HPL employees who are to work on the Water Master project, remaining until at least December 2005. Employees not involved in the project can not also give an undertaking as it does not refer to them. I believe this is also totally acceptable to the HPL Board, although HPL is not a party to that undertaking. For its part HPL can only agree terms for its employees that are consistent with their current employment terms, and that allow HPL to determine those conditions. Would you be comfortable if we deleted clause 3.6 as we are unable to determine whether redundancy is relevant to this contract with you. We have a problem with this, and it would help to get final approval if this clause was removed. We would be happy to add a clause in which we undertake in a contractual sense that HPL will at all times during this Water Master development at Fremantle, ensure that the highest qualified, most relevant, and experienced personnel will be provided by HPL. 153 Mr Richardson did not reply immediately to Dr Teplitzky's email but sent a copy of Dr Teplitzky's email to Mr Hepburn and said: I am not going to respond to it tonight. I will do so tomorrow but only after you have had a chance to give any further advice. 154 On 4 October 2004, Mr Hepburn responded to Mr Richardson's email, which he copied to Mr Clarke and the engineers, in the following terms: Garth, Thanks for this. Please standby on your reply to David until I have a meeting with our engineers in the morning. I suspect that there will be some developments from this meeting, which will influence what should be done. I shall advise you further, via telephone, after the meeting. regards Iain. 155 On 4 October 2004, at 10:13 pm, Mr Hepburn sent an email to Mr Clarke and the engineers, which stated, relevantly: …During a Water Master Management meeting on Monday in China which was to approve execution of the HOA as revised by Abbott Tout, David again called Garth to discuss the suggestion that Hydrocool only needs to provide the commitment from two to six employees. See separate email from Garth. I no longer think we can depend on any good faith from David on this employee commitment issue. He is clearly trying to get around it instead of appreciating that it is something which the company absolutely needs and hence should be grateful for. If we are to stand on this issue I think the time is now or never. We should meet on Tuesday morning and call Garth and advise him what to do. Presently my feeling is that we should issue the notice of General Meeting and unanimously withdraw all offers for the one year commitment. As I said if we do not do that now, I think that we will lose this leverage for good. At the same time we advise Garth, that he should reply to David as follows - ["We confirm that our previous offers to finalise the Heads of Agreement was made subject to the commitment from all six of the Fremantle based employees, comprising of four engineers and Peter Clarke and Iain Hepburn. This position remains unchanged for reasons already explained in our previous correspondence. We understand that the commitment from your employees, while previously thought to be sorted out, is now quite unclear and your telephone call has served to confirm that. Consequently we feel obliged to withdraw our offer until this matter is both clarified and certain."] 156 Mr Hepburn then stated: "Let's review where we are on Tuesday and then decide what to do". 157 There was a meeting between Mr Hepburn, Mr Clarke and the engineers at the Fremantle premises on 5 October 2004, and during the meeting they participated in a telephone conference with Mr Richardson, who was on a speaker telephone. 158 On 5 October 2004, Mr Richardson sent an email to Dr Teplitzky which adopted the text proposed by Mr Hepburn. The email stated: Dear David, On further consideration after our phone conversation yesterday we confirm that our previous offer to finalise the Heads of Agreement was made subject to the commitment from all of the six Fremantle based employees, comprising of four engineers and Peter Clarke and Iain Hepburn. This position remains unchanged for reasons already explained in our previous correspondence. We understand that the commitment from your employees, while previously thought to be resolved, is now quite unclear and your telephone call has served to confirm that. In addition we have today discussed the employee commitments directly with the Hydrocool Engineers in Perth and we regret to advise you that all of them have decided not to provide any commitment to Water Master due to the current situation within Hydrocool. Consequently we now feel obliged to withdraw our offer until this matter is both clarified and certain. We would ask that the Board of Hydrocool be advised as such and we would also mention again that our preference is to continue communicating with Hydrocool via Iain Hepburn as confusion sets in when more than one person is involved. 159 On 5 October 2004, Mr Hepburn sent an email to Mr Murphy and Mr Bourke advising that Water Master had withdrawn its offer to licence Hydrocool's technology and making complaints about Dr Teplitzky. Mr Hepburn copied this letter to Mr Clarke and the engineers. 160 Also, on that day, Dr Teplitzky, unaware of Mr Richardson's email withdrawing the Water Master offer, sent Mr Hepburn an email saying that he and Mr Stone would be visiting the Fremantle premises to completely resolve all issues outstanding in relation to the heads of agreement. Dr Teplitzky also said that he wanted to discuss the development plan and costs with Mr Clarke and spend time with the engineers who were to work on the project. 161 Further, on 5 October 2004, Mr Hepburn prepared two documents. One document was a notice calling a general meeting of shareholders of Hydrocool to consider four resolutions. Two of the resolutions were critical of the Symetrix research and sought to restrict further funding of the research. The other two resolutions were critical of Dr Teplitzky and called for an expression of no confidence in Dr Teplitzky for among other things, his attitude to the employment commitment in the heads of agreement called for by Water Master. The notice shows that it was intended that it would be signed by Mr Clarke, Mr Manners, Mr Davis, Mr Banney, Mr Weymouth and Mr Hepburn. The second document was a memorandum addressed to the shareholders of Hydrocool criticising Symetrix research and blaming the withdrawal of the Water Master offer on Dr Teplitzky. 162 On 6 October 2004, Dr Teplitzky and Mr Stone visited Hydrocool's premises in Fremantle, to meet with the staff. Before that meeting, however, Mr Clarke sent Mr Davis, one of the engineers, an email saying that at the meeting with Dr Teplitzky he would be "playing down" the progress made on the CPU cooler project to extend the time frame and hence the costs past December 2004. Mr Clarke asked Mr Davis not to disagree with Mr Clarke about this in front of Dr Teplitzky. 163 On 6 October 2004, Dr Teplitzky met with the engineers at the Fremantle premises. During the meeting, the engineers told Dr Teplitzky that their refusal to give an undertaking to work for the company until December 2005, was not permanent and the withdrawal could be reversed if Hydrocool allowed the Water Master project to proceed properly resourced. During these discussions, Dr Teplitzky referred to the Symetrix research and suggested that a breakthrough was imminent. Dr Teplitzky also raised the possibility of moving the Hydrocool operations conducted in Fremantle to Sydney and retaining a partial staff. Dr Teplitzky and Mr Stone also met with Mr Clarke. 164 On 13 October 2004, Dr Teplitzky sent a memorandum to Mr Burke and Mr Murphy. That memorandum set out a detailed timetable which contemplated the termination of Mr Hepburn's employment and the closure of the Fremantle premises. 165 Dr Teplitzky, Mr Bourke and Mr Murphy conferred on 15 October 2004. They decided that Mr Hepburn's employment should be terminated and the Fremantle premises and operations should be shut down. Further, on that day, Dr Teplitzky invited Mr Hepburn to attend a meeting with Dr Teplitzky at the Rydges Hotel in Perth on the following Tuesday, 19 October 2004. 166 Following the receipt of Dr Teplitzky's invitation, Mr Hepburn informed Mr Clarke and the engineers that he had been invited to the meeting, and that he might be dismissed at this meeting. Each of the engineers and Mr Clarke then gave Mr Hepburn a letter of resignation dated 19 October 2004, to be given to Dr Teplitzky, if Dr Teplitzky dismissed Mr Hepburn. Each letter gave notice of one month, and offered to accept payment in lieu of serving one month's notice. Each letter, other than that signed by Mr Clarke, criticised the board of directors and/or Dr Teplitzky. 167 Further, on 18 October 2004, Mr Hepburn also amended the draft resolutions which he had previously drafted, to be considered at a proposed meeting of shareholders, to include a resolution calling on the Auditor-General to investigate the circumstances surrounding the resignation of all the Hydrocool engineering staff. Mr Hepburn sent Mr Clarke an email asking him to have the notice calling for the shareholders meeting signed by the intended signatories. The notice was subsequently signed by Mr Hepburn, Mr Clarke and all of the engineers. 168 On 18 October 2004, Dr Teplitzky attended a meeting with representatives of Grant Thornton, an accounting firm, and Jackson MacDonald, a law firm. He instructed the representatives to take steps to close down the Fremantle operations, including cancelling the lease, paying out entitlements to staff, demolishing the cool room and store and cancelling all phones. Mr Dermott McVeigh, who gave evidence, was one of the consultants employed by Grant Thornton, who attended the meeting with Dr Teplitzky. 169 On 19 October 2004, Mr Hepburn met with Dr Teplitzky at the Rydges hotel. At the meeting, Dr Teplitzky advised Mr Hepburn that his employment was terminated with immediate effect. Mr Hepburn then handed to Dr Teplitzky the letters of resignation from Mr Clarke, Mr Banney, Mr Davis, Mr Manners and Mr Weymouth. 170 Mr Hepburn then left the meeting with Dr Teplitzky and telephoned Mr Clarke from the Rydges hotel, and asked Mr Clarke to pay the sum of AUD33,280 to a nominated bank account, as his annual bonus payment. Mr Clarke paid the sum to the bank account nominated by Mr Hepburn. Mr Hepburn also asked Mr Clarke to send a notice calling a meeting of the shareholders of Hydrocool, at the instance of the "minority shareholders" in Hydrocool, namely, Mr Clarke, the engineers and himself. The notice proposed the consideration of five resolutions which had been drafted by Mr Hepburn. 171 On 19 October 2004, representatives of Grant Thornton entered Hydrocool's Fremantle premises and in accordance with Dr Teplitzky's instructions, took control of the office. 172 Mr Clarke and the engineers continued to work until 12 November 2004 and assisted in the closure of the Fremantle operations, and premises. Grant Thornton supervised the closure of the Fremantle premises. 173 In November 2004, at the invitation of Mr Richardson, Mr Hepburn, Mr Clarke and the engineers, visited the Windsor factory in China. 174 On 15 December 2004, TEA was incorporated in Western Australia. Water Master was allotted 300 shares. Each of Mr Banney, Mr Hepburn, Mr Manners, Mr Weymouth, Mr Davis, Mr Tse and Mrs Clarke (for the benefit of Mr Clarke) was allotted 49 shares. The directors of TEA included Mr Hepburn, Mr Richardson and Mr Clarke. 175 On 14 March 2005, pursuant to a share sale deed, ATG sold all of its shares in Hydrocool to the companies under the control of Mr Murphy, selling 424,730 shares to Coolhydro (1), 373,270 shares to Coolhydro (2), and 7,000,000 shares to Coolhydro (3) Pty Ltd, also a company under the control of Mr Murphy. Mr Bourke and Dr Teplitzky ceased to be directors of Hydrocool in March 2005. Since March 2005, Mr Murphy has been the sole director of Hydrocool. 176 In July 2005, Hydrocool entered into a licence agreement with Hydrokinetics Pty Ltd for the purpose of commercialising Hydrocool's technology. Hydrokinetics is a company controlled by Mr John Skillecorn, and in respect of which, Mr Skillecorn is a director. The licence agreement granted Hydrokinetics an exclusive licence to use Hydrocool's technology. The agreement provided for the payment to Hydrocool of a licence fee of AUD62,000 and royalties of 5% on the ex-factory price of any units that were manufactured using Hydrocool technology. 177 In October 2005, Mr Hepburn announced that TEA had developed a water harvester. 178 I make findings in terms of the matters of fact set out in [16]-[177] above.