KDL Building v Mount

LEGISLATION CITED : Corporations Act 2001 (Cth), s 1335(1) Uniform Civil Procedure Rules 2005 (NSW), r 42.21(1)(d)

Beech Petroleum NL v Johnson (1992) 10 ACLR 525 CASES CITED : Pacific Acceptance Corporation Limited v Forsyth (No 2) (1967) 85 WN Pt 1 (NSW) 715 Equity Access Ltd v Westpac Banking Corporation [1989] 18 BR 14-972

KDL Building Pty Ltd (P) PARTIES : Duncan Mount (D1) Sally Mount (D2)

COUNSEL : Mr J A D de Greenlaw (P) Mr D R Meltz (D)

SOLICITORS : Lucas v Staggs (P) MBP Legal (D1 & D2)

IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION TECHNOLOGY AND CONSTRUCTION LIST

55086/05 KDL BUILDING PTY LIMITED v DUNCAN MOUNT & 1 OR

JUDGMENT 1 HIS HONOUR: The plaintiff KDL Building Pty Limited sues the defendants Duncan and Sally Mount, for moneys said to be due to the plaintiff under a home building contract dated 4 June 2001, by which KDL or its principal Kevin Lucas was engaged by Mr and Mrs Mount to perform home building works at their property at 54 Lane Cove Road, Ingleside. Initially, KDL commenced proceedings in the Consumer Trader and Tenancy Tribunal (CTTT) claiming a sum of $264,428.37. Subsequently, KDL obtained the leave of that Tribunal to amend its claim to an amount in excess of $700,000, with the consequence that, on KDL's application, the proceedings were transferred to this Court. By Motion filed on 17 March 2006, Mr and Mrs Mount seek security for their costs of the proceedings.

2 The application is made under Uniform Civil Procedure Rules 2005 (NSW), r 42.21(1)(d) and/or Corporations Act 2001 (Cth), s 1335(1). UCPR, r 42.21(1) provides as follows: If in any proceedings, it appears to the Court on the application of a defendant:

… (d) that there is reason to believe that a plaintiff, being a corporation, will be unable to pay the costs of the defendant if ordered to do so, ...

the Court may order the plaintiff to give such security as the Court thinks fit, in such manner as the Court directs, for the defendant's costs of the proceedings and that the proceedings be stayed until the security is given.

3 Corporations Act, s 1335(1), provides as follows: Where a corporation is the plaintiff in any action or other legal proceeding, the Court having jurisdiction in the matter may, if it appears by credible testimony that there is reason to believe that the corporation will be unable to pay the costs of the defendant if successful in his, her or its defence, require sufficient security to be given for those costs and stay all proceedings until the security is given.

4 In the context of this case, nothing turns on such fine distinctions as there may be between the two provisions.

5 In Beech Petroleum NL v Johnson (1992) 7 ACSR 203, Von Doussa J said (at 205): In my opinion the power of the Court under s 1335 arises if credible evidence establishes that there is reason to believe there is a real chance that in events which can fairly be described as reasonably possible the plaintiff corporation will be unable to pay the costs of the defendant on service of the allocatur if judgment goes against it. This will be so even if in other events which can also be fairly described as reasonably possible the plaintiff corporation would be able to pay the costs. The degree of likelihood of the plaintiff corporation being unable to pay the costs along with all the circumstances, actual and possible, about its financial position, would be then taken into account in the exercise of discretion, and in framing the orders of the Court if the decision is to order security.

6 On an application for security for costs, whether under s 1335 or under r 42.21(1)(d), three issues generally arise. The first is whether the ground referred to in the section or the rule is established. The second is whether, if the ground has been established, as a matter of discretion an order should be made. The third is the quantum of any order to be made and, perhaps, the terms on which it might be made.

7 I turn then to consider whether the ground - which may, for the sake of convenience, be shortly, if somewhat inaccurately, described as impecuniosity - has been established.

8 The applicants have read affidavits of an insolvency practitioner, Anthony Warner, who has considered various financial records and taxation documents of KDL for the period 2002 to date, with a view to expressing an opinion as to its ability to meet any order for costs should it be unsuccessful in its proceedings against the Mounts. He has opined that, based on the information provided to him, which is now nine months out of date, it is highly probable that KDL would not be able to pay a costs order of $125,000 from its own resources if it were unsuccessful in these proceedings. He points out that KDL appears to have been highly dependent on the support of its shareholders during the period 1 July 2004 and 30 June 2005, during which it received loan funds from its shareholders amounting to $262,353. Mr Warner concludes that it is likely KDL's continuing solvency is dependent upon the ability of its shareholders to continue supporting it, and that if the shareholders' loans were called up, it is likely that the company would become immediately insolvent.

9 But ultimately, it is for the Court, not for an accountant, to conclude whether it is likely that KDL would not be able to pay a costs order. In his report, Mr Warner sets out KDL's balance sheets for the financial years ending 2002 to 2005 inclusive. They reveal that, as at 30 June 2005, KDL's total shareholders' equity was $98,141, after total liabilities of $501,085 were deducted from total assets of $599,226. It is noteworthy that, of the total assets, trade debtors account for $214,000 and work in progress accounts for $334,000, so that the conclusion that there were net assets of $98,000 implies that trade debtors and work in progress would be recovered to the extent of 100 percent, which might be thought optimistic. Moreover, the non-current assets, included in the total assets of $599,000, comprised property, plant and equipment of $10,246, motor vehicles of $37,735, and formation expenses of $1,200. Those figures are presumably, although the evidence does not disclose with any clarity, at cost, perhaps less depreciation; and it is unknown whether in reality they would be realised for the amounts reflected in the 2005 balance sheet.

10 Thus even Mr Warner's conclusion that KDL would have funds of $98,141 available in the event that it were unsuccessful in the proceedings seems highly doubtful, and that material would be practically enough to conclude that is unlikely to be able to pay an adverse costs order. More so is that the case when it is appreciated that there is already a costs order against KDL in the CTTT, which remains unpaid. More so still is it the case when it is realised there is no provision made in the balance sheet figures for KDL's own legal costs of these proceedings, and even more so is it the case when it is appreciated, from the material analysed in Mr Warner's second affidavit, that since 30 June 2005 KDL has incurred trading losses of some $320,000, and its sales appear to have declined markedly, to the point that in the second quarter of the 2005/06 financial year it had no sales income at all . The impact of trading losses of $320,000 on net assets of $98,000 is self-evident. Although Mr De Greenlaw, for the plaintiff, has submitted that Mr Warner did not draw such an inference, I think Mr Warner's statement in paragraph 17 of his second report - that his opinion does not change from his first report - is clear confirmation of his opinion in paragraph 20 of his first report to the effect that it remains highly probable that KDL would not be able to pay a costs order of $125,000 from its own resources. In my opinion, the evidence goes significantly further than that, and it is unlikely that KDL, if it fails in these proceedings, would be able to pay from its own resources any significant adverse costs order.

11 I am, accordingly, satisfied that the ground referred to in s 1335 and/or r 42.21(1)(d) is made out.

12 I turn then to the question of discretion. The parties have conveniently addressed the discretionary considerations by reference to the criteria identified by Hill J in Equity Access Ltd v Westpac Banking Corporation [1989] ATPR 40-972, 50,635, which I address in turn below.

13 First, the plaintiff's prospects of success. This does not involve any detailed review or assessment of the plaintiff's prospects, but only the formation of a view whether the claim is bona fide or a sham. While a finding that a claim is a sham would normally lead to an order for security, once it is established that the claim is bona fide, then it is appropriate to consider the other discretionary factors without too detailed a review of the strengths and weaknesses of the plaintiff's case. Although it did not receive much attention in argument, the defendants' prospects are also of some significance. If the defence appears to be, at first sight, plainly without merit, then that will be a strong indicator against making an order for security. But again, once it is established that the defence is bona fide, not too detailed a review of its merits is warranted.

14 Secondly, the magnitude of the risk that the plaintiff cannot satisfy an adverse costs order in the event that it fails. This is the point that was referred to in the judgment of Von Dousa J in Beech Petroleum, to which I have referred. In other words, if it is thought that there is some, but only a slight risk that the plaintiff will be unable to satisfy an adverse costs order, then that tends against making an order for security, whereas if there is a very substantial risk that it will be unable to do so, that tends in favour of making an order for security.

15 Thirdly, whether the use of the power would be oppressive or would stultify the plaintiff's claim by preventing it from prosecuting a genuine claim. On this factor, an important subsidiary consideration is whether those who beneficially stand behind the impecunious corporation and stand to benefit if the claim succeeds are prepared to make their own assets available, if they have any of significance, to satisfy an adverse costs order.

16 Fourthly, whether the impecuniosity arises out of the conduct of the defendant in respect of which relief is sought in the proceedings. If the defendant has caused the plaintiff's impecuniosity, that may tend against the making of a costs order. But if all that has happened is that the defendant's conduct has exacerbated the condition of an already financially strapped plaintiff, then this ground will not be made out.

17 Fifthly, whether there are public interest aspects which affect whether or not an order for security should be made.

18 Sixthly, whether there are discretionary matters peculiar to the particular case which weigh one way or the other.

19 A further consideration is whether the application for security has been brought sufficiently promptly.

20 Of those considerations, the first relevant to the present case is the respective prospects of success of the parties. Although the Mounts have argued that KDL's claim is not bona fide or is apparently hopeless - because the contract, on its face, is between the Mounts as owner and Mr Lucas as contractor, and does not refer to KDL company at all - KDL has tendered some material which suggests that it was involved in the negotiation of the contract, and that it was KDL which provided a quote, and to which progress payments were certified and made. I am not prepared to find that the claim is other than bona fide on that basis.

21 The Mounts have also referred to the circumstance that what commenced in the CTTT as a claim for $200,000 or thereabouts has increased to one in excess of a million dollars, without any further work whatsoever having been performed. Whatever the rights and wrongs of this, KDL's response - that, at least as to the original claim for $200,000 or so, this circumstance would not establish any absence of good faith - is a good one.

22 I would not find that KDL's claim is other than bona fide. But at the same time it cannot be said that this is a case in which the defence is hopeless; far from it. To the contrary, the defence seems to make strong, if not telling points. In those circumstances, I do not think that the respective prospects of success of either party weighs significantly in the decision as to whether or not an order for security should be made. I proceed on the basis that both the claim and the defence are bona fide and arguable.

23 As to the magnitude of risk that KDL will not be able to satisfy an adverse costs order, it will be apparent from the conclusions I have reached on the question of impecuniosity that in my judgment the risk is a very great one. This weighs significantly in favour of making an order for security.

24 As to whether it would be oppressive to order security in this case, it is significant that Mr Lucas, the person named on the contract as the contracting party, is the sole director, secretary, and shareholder in KDL. It is he, apparently alone, who stands to benefit from any success which KDL might have in these proceedings. KDL is a sole director and sole shareholder company. In those circumstances, the practice of the courts in considering applications for security for costs is to inquire whether the person who stands to benefit from the plaintiff's success is prepared to make his or her own assets available to satisfy an adverse costs order or, alternatively, to show that he or she too is impecunious, so as to make out the so-called "defence" of "stultification".

25 In this case, there is practically no evidence of Mr Lucas' personal financial position. He says that he has had to raise money on the security of his home, which he says is his only major personal asset, and lend it to KDL, and that that has left him with insufficient leverage to secure further loans. Even if I were to accept that, notwithstanding that Mr Lucas was unavailable for cross-examination, that does not answer the point. KDL has repeatedly been asked by the Mounts' solicitors whether it is prepared to proffer an undertaking from Mr Lucas to meet any costs order, and Mr Lucas has declined to give that undertaking. Indeed, from the course of correspondence, I would infer that he, knowing of the consequences of not giving such an undertaking, has deliberately refrained from doing so. The number of requests which have been made in that respect provides a powerful basis for that inference. For that reason, I cannot be satisfied that an order for security would be oppressive, or would stultify KDL's case.

26 As to whether KDL's impecuniosity has been caused by the Mounts' conduct, it seems that originally the contract value was $1,212,000, that that has been to some extent at least varied - and that there have, to some extent, been approved variations, although the extent at which they have been approved is in dispute - but that, in any event, there has been paid, by way of progress payments numbers 1 to 25 inclusive, a total of $734,680. Progress claim number 26, which was the precursor to the present motion, was certified by the architect in the amount of the $5,591.51, against a claim by the plaintiff for $264,752.32. Taking a broader view of the initial amount of the contract, the amount which has actually been paid, the net asset position of the plaintiff, and its ongoing trading losses in 2005 and 2006, I am not satisfied that there is any sufficient connection between the defendants' refusal to pay the 26th progress claim and the plaintiff's impecuniosity to justify declining to make an order for security if otherwise appropriate.

27 Other discretionary considerations do not loom large, but I should mention them, at least in passing. The history of the proceedings does not assist KDL. It commenced the proceedings in the CTTT, as I have said, for a much smaller sum than $1,000,000 plus now claimed. Its pleadings do not fully or clearly articulate the material facts which support its claims. It has defaulted in compliance with directions of the Court, and it did not respond to repeated requests for the provision of financial documentation, which might have made the present application a far more simple proposition. But those matters, while not favourable to KDL, are not of significant moment in my decision.

28 KDL submitted that the application was made too late, and that the Mounts should be debarred from claiming security by their delay. I must say I found this a surprising submission. KDL's claim was filed in the CTTT, for $264,000, on 8 March 2005. Following an informal settlement conference on 14 March 2005, the Mounts first requested the provision of financial documentation in order to ascertain whether they should make an application for security on 14 April 2005. On 17 April 2005, KDL's solicitors responded, to the effect that any application for security would be vexatious and that the Mounts were adopting a position that was no more than speculation as to KDL's financial position. On 21 April, the Mounts renewed their request for relevant financial documentation of KDL. In the absence of a response, they repeated this request on 6 May 2005, and then, on 10 May 2005 indicated that, as a result of KDL's failure to produce any of the documents requested, a formal application for security for costs would be made to the CTTT. Before that application was formally made, KDL, on 24 June 2005, served a Scott Schedule claiming $914,000, and applied for leave to amend its claim and to have the proceedings transferred to this Court. The CTTT adjourned the proceedings before it for that purpose on 27 June 2005, and ultimately transferred the file to this Court on 31 August 2005. KDL not having filed any summons in this Court, it was listed in the Administrative Law List on 14 October 2005, and ultimately transferred to the Construction List on 21 October 2005. No summons was filed and served until 20 December 2005. A further request was made by the Mounts for financial information on 22 February 2006. When that was not answered, notice was given on 2 March 2006 that application would be made for security for costs. A Notice to Produce for the relevant financial documentation and some other material was served on 3 March 2006, and another on 8 March 2006, and documents were produced, at least in partial compliance with those notices, on 17 March 2006, on which day the Mounts filed this Motion. 29 I cannot see any relevant delay on the part of the defendants in making an application for security for costs in circumstances where the only step KDL has taken in the proceedings in this Court is to file a summons.

30 For these reasons, I am satisfied that, having regard to the relevant discretionary considerations to which I have referred, it is appropriate to make an order for security, and I turn to the quantum of the order which should be made.

31 The Mounts have tendered a report of a solicitor, an experienced costs consultant, Mr Kerry Hardman, who has opined that the total defence costs, including costs already incurred, are likely to be in the range of $132,000 to $184,000. Mr Hardman's report is prepared on a party/party basis, but on the assumption that the proceedings will include a cross-claim for defective building works. Such a cross-claim had previously been foreshadowed, and it was suggested that it might be in the order of $150,000 in quantum. Nonetheless, it is clear that the Mounts should not have security for the costs of their proposed cross-claim, as distinct from their defence to KDL's claim.

32 In evaluating the appropriate amount, I have used as a starting point Mr Hardman's lower estimate - that is, what he called his estimate of recoverable costs "minimum", as distinct from "maximum". I think that is, in the absence of other evidence, the appropriate basis, since it can be said that the evidence shows that the Mounts will probably incur at least the amount of the minimum estimate, whereas it cannot be said to show that they will probably incur the maximum. 33 So far as the costs to date are concerned, Mr Hardman assesses the amount which would be allowable on a party/party assessment as at least $16,600, and I will include that amount in the sum for which security should be given.

34 So far as future costs are concerned, I have proceeded on the following basis. First, although Mr Hardman has assumed a final hearing of ten days, I have allowed for a final hearing of six days on the claim, without making any allowance for the cross-claim. Secondly, I have disallowed those items which are specific to the cross-claim, such as preparation of the cross-claim and the Scott Schedule in relation to it. Thirdly, I have conversely allowed in full those items which are specific to the claim, as distinct from the cross-claim, such as preparation of the Construction List response. So far as concerns the other matters, which are not specific either to the claim or the cross-claim, I have generally taken the view that they will fall approximately 50 percent to the claim and approximately 50 percent to the cross-claim. This is because, while the cross-claim is of significantly less value than the claim, it is on the cross-claim that technical questions may arise and on which expert evidence more likely will be required.

35 On that basis, for the costs directly related to a six day trial on the claim, being counsels' fees for preparation for trial, hearing fees, and the solicitors' costs of instructing at trial, I would allow $31,000; and the costs until trial I would allow at $32,500. I stress that this is not a precise exercise in assessment or taxation of costs, but a broad assessment of what is, in the circumstances of the case, a reasonable and just allowance having regard to the position of both parties.

36 It is, of course, always possible that the case will settle before any trial, and I propose to follow the course adopted by Moffitt J in Pacific Acceptance Corporation Limited v Forsyth (No 2) (1967) 85 WN Pt 1 (NSW) 715, by requiring security to be given for the pre-trial component now, but for the trial component only when the matter is set down for final hearing.

37 Accordingly, I make the following orders: 1. Order that the plaintiff give security for the defendants' costs of the proceedings in a form acceptable to the Registrar as follows: 1.1 Within 28 days, a sum of $49,100; and 1.2 Not less than 28 days prior to the date fixed for the hearing, or if an order for reference is made for the commencement of the reference, whichever is the earlier, a further $31,000. 2. Order that if security is not given in accordance with order 1.1 or 1.2, the proceedings be stayed. 3. Order that the plaintiff pay the defendants' costs of the motion. **********

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