Kieren Leslie Welzel v Stephen Paul Francis

Supreme Court of NSW|2011-05-20|Before: Ball J, Hammerschlag J

Background 1By a notice of motion dated 3 March 2011, the defendant, Mr Francis, seeks an order that the first plaintiff, Mr Welzel, provide further security for his costs in these proceedings. 2The proceedings arise out of an agreement reached between Mr Welzel and Mr Francis some time in the second half of 2001 to establish a company called OpenIN Pty Ltd, the second plaintiff, to carry on the business of developing and marketing certain specialised telecommunications software. Previously, Mr Francis and Mr Welzel had worked for Dimension Data Australia Pty Ltd, and it was while working there that they decided to establish a business together. OpenIN Pty Ltd was incorporated on 23 October 2001. Mr Francis and Mr Welzel were equal shareholders and both became directors of that company. Both left Dimension Data to work for the new company. 3In 2004, Mr Francis and Mr Welzel also established the third and fourth defendants, OpenIN Holdings Pty Limited and OpenIN Assets Pty Limited, and OpenIN Holdings became the holding company for the companies in the group. In the same year, Mr Francis moved to the United Kingdom and incorporated a company there called OpenIN Limited. Since then, Mr Francis has dissolved OpenIN Limited but has established a number of other companies in the United Kingdom and has carried on a successful business independently of Mr Welzel through them. Mr Welzel says that in doing so, and in undertaking other work other than through the corporate plaintiffs, Mr Francis has breached the agreement reached between him and Mr Welzel in the second half of 2001. Originally, Mr Welzel commenced these proceedings in his own name claiming an account of profits or damages in relation to those alleged breaches. Subsequently, Mr Welzel obtained leave from Hammerschlag J on 28 August 2009 under s 237 of the Corporations Act 2001 (Cth) to bring proceedings in the name of the three corporate plaintiffs alleging that Mr Francis had breached fiduciary duties he owed to them and the statutory duties imposed on him as a director of those companies by ss 180-183 and 286 of the Corporations Act by conducting a similar business independently of the business carried on by those companies. That leave was given on condition that Mr Welzel "pay and bear (and indemnify [OpenIN, OpenIN Holdings and OpenIN Assets] against) all costs, charges and expenses of and incidental to the bringing and continuation of these proceedings except to such extent, if any, as the court may in the future or otherwise direct or allow". At the heart of the case is the scope of the business Mr Francis and Mr Welzel agreed to carry on together. 4On 30 October 2009, Mr Francis filed a notice of motion seeking, among other things, an order that Mr Welzel provide security for Mr Francis's costs. That motion was heard by Bergin CJ in Eq on 27 November 2009, at which time her Honour ordered that Mr Welzel provide security in the sum of $25,000. It is clear from the transcript of the hearing on that day that, in making that order, her Honour was influenced by the fact that Mr Welzel had agreed to indemnify the corporate plaintiffs (making an order for security appropriate) and evidence and statements made to the court by Mr Welzel's counsel that Mr Welzel's net assets were limited to an amount of approximately $100,000 to $110,000 (making it appropriate to limit the security to $25,000). In particular, in an affidavit sworn by Mr Welzel on 23 November 2009, Mr Welzel deposed to the following matters:

Relevant legal principles 7Before dealing with the application, it is necessary to say something about the relevant legal principles. The notice of motion seeks an order that Mr Welzel provide additional security. That order is sought pursuant to UCPR r 42.21 or alternatively s 1335(1) of the Corporations Act or alternatively the court's inherent jurisdiction. Section 1335(1) of the Corporations Act can be put to one side. It only gives power to the court to order security against a corporation. Here, however, security is sought from Mr Welzel. 8UCPR r 42.21(1) provides: If, in any proceedings, it appears to the court on the application of a defendant: (a) that a plaintiff is ordinarily resident outside New South Wales, or (b) that the address of a plaintiff is not stated or is mis-stated in his or her originating process, and there is reason to believe that the failure to state an address or the mis-statement of the address was made with intention to deceive, or (c) that, after the commencement of the proceedings, a plaintiff has changed his or her address, and there is reason to believe that the change was made by the plaintiff with a view to avoiding the consequences of the proceedings, or (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, or (e) that a plaintiff is suing, not for his or her own benefit, but for the benefit of some other person and there is reason to believe that the plaintiff 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. None of (a) to (e) applies in this case. Consequently, security for costs cannot be awarded under UCPR r 42.21. 9However, in Rajski v Computer Manufacture & Design Pty Ltd [1982] 2 NSWLR 443, Holland J held that the court retained its inherent jurisdiction to order security for costs against a plaintiff notwithstanding legislative provisions which permitted a defendant to obtain security for costs in certain circumstances. In particular, the inherent jurisdiction to order security against a plaintiff was not affected by Pt 53 r 2(1) of the Supreme Court Rules, which has now been superseded by, but which was in substantially the same terms as, UCPR r 42.21. That jurisdiction was an aspect of the court's inherent power to regulate its own practice and procedure "to procure proper and effective administration of justice and prevent abuse of process" (at 447). In Rajski , proceedings had been brought by Dr Rajski and Raybos Pty Ltd, a company controlled by him, against the defendant. The defendant sought security for its costs. That application was contested on the basis that the court had no power to order security against Dr Rajski, or against Raybos in circumstances where its co-plaintiff was a natural person. Holland J rejected that submission. There was evidence that Dr Rajski had denuded Raybos of approximately $275,000 before the proceedings were commenced and that most of that money had gone to Dr Rajski's mother, with whom Dr Rajski resided. In those circumstances, his Honour thought that it was appropriate to order security against both Raybos and Dr Rajski. 10The decision of Holland J was affirmed on appeal (see Rajski v Computer Manufacture & Design Pty Ltd [1983] 2 NSWLR 122) and has been applied in a number of subsequent cases: see, for example, Bhagat v Murphy [2000] NSWSC 892; Byrnes v John Fairfax Publications Pty Ltd [2006] NSWSC 251. In the former case, there had been a large number of interlocutory applications and, although Young J thought that Mr Bhagat had a glimmer of a good case, that glimmer was "very much obscured by the vast amount of irrelevancies thrown up around it" (at [19]). The defendant made an application for security for costs. Mr Bhagat originally refused to give any evidence concerning his personal assets in opposition to that application. When he was informed by Young J that, in those circumstances, his Honour would award security against him, Mr Bhagat gave evidence that he had no assets. However, under cross-examination he conceded that he lived with his wife in an apartment in the Connaught, although he gave evidence that he had no idea who owned the apartment or how his occupation of it was funded. He also conceded that he had been the beneficial owner of 760,000 units in Estate Mortgage Depositors Trust No 4, although he had disposed of most of those units to his wife, and that he owned some property in Poona, India. Taking those matters into account Young J ordered that Mr Bhagat provide security in the sum of $300,000. In the latter case, Simpson J (at [17]) observed that the adoption of the Uniform Civil Procedure Rules did not affect the conclusions reached by Holland J in Rajski in relation to the existence of the inherent power to order a plaintiff to provide security or the principles that should be applied by the court in determining whether to exercise that power. Clearly, one type of case where it may be appropriate for the court to order security in exercise of its inherent power is where the plaintiff has taken steps to divest himself or herself of assets to avoid the consequences of an adverse costs order. 11There is one other possible source of power to order security. Section 242 of the Corporations Act provides: The Court may at any time make any orders it considers appropriate about the costs of the following persons in relation to proceedings brought or intervened in with leave under section 237 or an application for leave under that section: (a) the person who applied for or was granted leave; (b) the company; (c) any other party to the proceedings or application. An order under this section may require indemnification for costs. In my opinion, this section is sufficiently broad to permit the court to order the person who was granted leave under s 237 to provide security for the company's costs. In this case, that would involve a variation of the orders made by Hammerschlag J. No application of that type, however, has been made. Consequently, s 242 can also be put to one side. 12Several other principles are relevant in this case. 13First, one matter that is very relevant to the exercise of the court's power to order security is whether the effect of the order would be to stultify the proceedings. Generally, a court should not make an order for security that would have that consequence: Hession v Century 21 South Pacific Ltd (in liq) (1992) 28 NSWLR 120. However, it is for the party resisting an order for security to establish that the order is likely to have that effect, and in doing so that party must establish that those who stand behind the party in the proceedings are not in a position to contribute to any order for security. As the Full Federal Court said in Bell Wholesale Co Ltd v Gates Export Corporation (1984) 52 ALR 176 at 179-80: In our opinion a court is not justified in declining to order security on the ground that to do so will frustrate the litigation unless a company in the position of the appellant here establishes that those who stand behind it and who will benefit from the litigation if it is successful (whether they be shareholders or creditors or, as in this case, beneficiaries under a trust) are also without means. It is not for the party seeking security to raise the matter; it is an essential part of the case of a company seeking to resist an order for security on the ground that the granting of security will frustrate the litigation to raise the issue of the impecuniosity of those whom the litigation will benefit and to prove the necessary facts. As Austin J pointed out in Fiduciary Ltd v Morningstar Research [2004] NSWSC 664; (2004) 208 ALR 564 at [77], that statement of principle was approved by McHugh J in PS Chellaram & Co Ltd v China Ocean Shipping Co [1991] HCA 36; (1991) 102 ALR 321 at 3 23 and by the New South Wales Court of Appeal in Hession v Century 21 South Pacific Ltd (in liq) (1992) 28 NSWLR 120. There is no reason why it should not apply equally to an application for security against a natural person. 14Second, a court will not generally order a plaintiff to provide security where the plaintiff's impecuniosity has been brought about by the defendant's conduct: Lynnebry Pty Ltd v Farquhar Enterprises Pty Ltd (1977) 3 ACLR 133. There must, however, be "a real causal connection between the conduct and the impecuniosity which, in the exercise of the Court's discretion, would make it unjust to require security": Dalma Formwork Pty Limited (Administrator Appointed) v Concrete Constructions Group Limited [1998] NSWSC 472 per Rolfe J. 15Third, it is relevant to take into account whether the plaintiff's claim has reasonable prospects of success. Generally, however, it is the absence of reasonable prospects of success that provides a reason for ordering security. The existence of reasonable prospects does not of itself provide a reason for refusing security; and the court will not embark on a detailed consideration of the merits of the case in determining whether an order for security is appropriate: see Fiduciary Ltd v Morningstar Research [2004] NSWSC 664; (2004) 208 ALR 564 at [37]-[38] per Austin J. Other matters may also be relevant, such as delay in making the application and the conduct of the parties in connection with the proceedings: see Bhagat v Murphy [2000] NSWSC 892. 16Fourth, different principles apply depending on whether the application is a fresh application for additional security or an application to vary an existing order granting security: Ingot Capital Investments Pty Ltd v Macquarie Equity Capital Markets Ltd (No 5) [2006] NSWSC 255 at [9]ff per McDougall J. Where the application is an application to vary an existing order, the applicant must satisfy the requirements identified by McLelland J in Brimaud v Honeysett Instant Print Pty Ltd (1988) 217 ALR 44. An obvious example is where an application is made to set aside the original order for security. Another example is where it is clear that the original order was in respect of the total costs of the case. However, I do not think that it follows from that that the respondent to the application for additional security is limited to raising arguments in opposition to the application that were raised at the time security was sought originally. For example, there is no reason why a respondent should be prevented from submitting that further security will stultify the proceedings or that the respondent's impecuniosity was brought about by the applicant, even if those grounds were not raised in opposition to the original application.

Should additional security be ordered? 17Mr Welzel resists an application for further security on three main bases. First, he says that security should not be awarded against him as a personal plaintiff. Second, he says that any award of security will stultify the proceedings. Third, he says that Mr Francis's conduct has caused the impecuniosity of the corporate plaintiffs. During the course of the hearing, Mr Gration, who appeared for the plaintiffs, also placed considerable emphasis on the allegations against Mr Francis and, in particular, what was said to be a strong case that Mr Francis had appropriated what was meant to be a joint business to himself and had gone to considerable lengths to put that business out of the reach of the plaintiffs. He also submitted that Mr Francis had been guilty of extraordinary delay in the proceedings - in particular, in giving discovery, and that that should affect the court's attitude to security. 18In my opinion, the critical question in this case is whether Mr Welzel has taken steps to put his assets out of Mr Francis's reach in the event that Mr Francis is successful in the case and obtains a costs order in his favour. If Mr Welzel has done that, then I do not think that the other factors provide a reason for refusing an order for further security, although they may be very relevant to the amount of security that should be ordered. I say that for several reasons. 19First, there is obviously a connection between the stultification argument and the question whether a plaintiff has disposed of assets to avoid the consequences of a costs order. In principle, the amount of any security should reflect the assets that it might have been expected the plaintiff would have had available to meet a costs order but for the disposition of those assets to avoid having to meet the costs order from them. The purpose of an order for security for costs is not to punish the plaintiff for disposing of the assets to avoid the consequences of a costs order. It is to put the defendant in the position it could have expected to be in if the assets had not been disposed of. The assumption underlying this approach is that, if the assets were disposed of to avoid the consequences of a costs order, then those to whom they were disposed ought to be willing to make them available to enable the action to continue. Two other points should be made in this context. The first is that difficulties may arise in determining the amount of security that is appropriate where the plaintiff has not given a full account of the assets that he or she owns. However, those difficulties cannot prevent the court from fixing an appropriate sum. If they were permitted to do so, the plaintiff would have achieved the very object that the order for security was intended to prevent. The second is that, in fixing the amount of security, it is necessary to make allowance for the fact that some of the assets in question may be needed to pay the plaintiff's own legal costs. 20Second, so far as the impecuniosity argument is concerned, the relevant question is whether Mr Francis's alleged conduct caused Mr Welzel's impecuniosity, since it is from him that security is sought. Once that is accepted, impecuniosity becomes an irrelevant factor. If Mr Welzel is impecunious because he disposed of his assets, then he should provide security; and the amount of that security should fairly reflect the position the parties would have been in if Mr Welzel had not disposed of those assets. Mr Welzel should not be required to supply more security than that. Consequently, whether Mr Welzel would have been better off but for Mr Francis's alleged breaches, even assuming that could be described as a form of impecuniosity for the purpose of the principle, is irrelevant. 21Third, it cannot be disputed that Mr Welzel has a reasonably arguable case. Moreover, there is evidence to suggest that Mr Francis has engaged in the very activities that he accuses Mr Welzel of engaging in. In particular, it seems at least arguable that Mr Francis dissolved OpenIN Limited and set up alternative companies through which to conduct his business as a means of defeating Mr Welzel's claim. However, the fact that Mr Welzel has a reasonably arguable case is, as I have said, not a reason for refusing security if it should otherwise be ordered and I do not think Mr Francis's conduct is a ground on which Mr Welzel can justify his own. If Mr Francis has sought to avoid the consequences of a judgment against him, then that may justify other orders, but it does not provide a reason for not making an order for security if one otherwise should be made. On the other hand, in my opinion, Mr Francis's conduct in the litigation is relevant to the amount of any security that should be ordered. There is evidence that Mr Francis has delayed excessively in complying with the court's orders -in particular, the order in relation to discovery. That is likely to have increased the costs of the proceedings. That is one matter that the court should take into account in determining the amount of any security. 22The principal evidence that Mr Francis relies on in support of the allegations concerning the disposal and concealment of assets is evidence that:

On 24 October 2008, three days before these proceedings were commenced, a company known as FIAP Pty Ltd was incorporated with Mrs Welzel as its sole director;
On 29 October 2008, FIAP became the trustee of the 3B Property Trust 2, a new discretionary trust which has as its primary beneficiaries Mr and Mrs Welzel;
On 15 December 2008, FIAP acquired a waterfront property with a jetty, a pontoon and a swimming pool in Buddina for $1,000,000;
The property is the subject of a mortgage to ANZ Bank and the amount outstanding to the bank as at 30 March 2011 was approximately $411,000;
Mr Welzel says that he is currently staying in a room at the residence of Mrs Welzel's parents. However, there is evidence that he also stays at the house in Buddina;
On 29 February 2008, Macquarie Bank Limited took a charge over Welzel Systems to secure a margin lending account to be operated by Welzel Systems. There has been no disclosure of any shares owned by that company;
On 17 August 2008, Mr and Mrs Welzel both signed a document described as a "Separation Agreement". The agreement is unusual. It is a single handwritten page that purports to deal with the 3 properties owned by Mr and Mrs Welzel at that time that were disclosed to Bergin CJ in Eq together with 2 motor vehicles that they owned. It also provides that Mr Welzel would resign as a director of Welzel Systems, but it says nothing about maintenance payments to Mrs Welzel;
In 2007 Welzel Systems trading as "OpenIN ASIAPAC" rendered 5 invoices totalling $119,790.50 to Genesys. Genesys paid that money to Welzel Systems. A substantial proportion of that money was then paid to Mrs Welzel as salary, directors fees and superannuation. $20,000 was also paid to the "3B trading account". In his affidavit sworn on 13 September 2010, Mr Welzel said in relation to the money received from Genesys "[a]s Mr Francis has refused to provide any accounting details from the OpenIN UK operation to date, I have retained the balance of funds from this work in trust and will reconcile this at the completion of this court case". In fact, however, no amount is held in trust. 23Mr Welzel gave evidence in relation to these matters in an affidavit sworn on 11 May 2011. Mrs Welzel did not give evidence. However, Mr McGregor, Mr Welzel's solicitor, gave evidence of a conversation that he had had with her concerning the house at Buddina and her separation from her husband. By agreement between the parties, no witnesses were cross-examined. 24Both Mr Welzel and his wife, through Mr McGregor, assert that they have separated. Mrs Welzel explains Mr Welzel's presence at the house at Buddina over the weekends as enabling Mr Welzel to spend time with their children. She says that he stays in a spare room during those visits. Both Mr and Mrs Welzel give evidence concerning the ownership of the Buddina property. Mr Welzel's position is that he made no reference to it in his earlier affidavits because it was not a property in which he ever had an interest. However, neither Mr nor Mrs Welzel offer any explanation of how FIAP or the 3B Property Trust No 2 acquired the funds to buy the property in the first place. Neither refers to the margin lending account with Macquarie Bank. 25In my opinion, there is sufficient evidence to conclude that Mr Welzel has disposed of assets in order to avoid the consequences of a costs judgment. It is unclear whether Mr and Mrs Welzel have separated or not. However, even if they have, it is clear that their financial affairs are closely connected and that they have co-operated closely in relation to them. Mr Welzel has disposed of all of the significant assets that he concedes he once had an interest in - in the case of the house at Dural, to a discretionary trust of which he is a beneficiary. He has also effectively disposed of his income to a company controlled by his wife. He did so shortly before the proceedings were commenced. Even assuming that he and his wife separated at that time, the timing of the transactions and the extent to which Mr Welzel alienated his assets and income strongly suggest that an important reason for doing so was to insulate them from a costs order against him. Moreover, neither Mr Welzel nor his wife have given any explanation of how FIAP, as trustee of the 3B Property Trust 2, had funds to acquire the property at Buddina. In circumstances where Mr Welzel is a discretionary beneficiary of that trust, it would have been necessary to disclose that fact to Bergin CJ in Eq in order to give a full picture of his financial position. The fact that he did not do so together with the fact that neither he nor his wife have offered any explanation of the source of the funds strongly suggest that, directly or indirectly, the source of some or all of the funds was Mr Welzel. That inference is reinforced by the fact that Mrs Welzel earns no income of her own. It is also reinforced by the fact that amounts that Mr Welzel admits are due to the corporate plaintiffs appear to have been paid to Welzel Systems and then disbursed to Mrs Welzel and the fact that neither Mr nor Mrs Welzel have offered any explanation for the margin lending account with Macquarie Bank. Taking these matters together, in my opinion, the only conclusion is that Mr Welzel contributed a substantial proportion of the funds used to buy the Buddina property. 26It follows, in my opinion, that Mr Welzel ought to provide further security in respect of Mr Francis's costs. I will hear the parties in relation to the amount of that security and the costs of the motion.

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