Supreme Court of NSW|1995-09-27|Before: Young J, As Young J, Kirby ACJ, Priestley JA, Handley JA

Kokotovich Constructions Pty Limited and Ors v Wallington Nos. Ca 40723/93; Ed 6321/92 Companies - Trusts [1995] NSWSC 54 (27 September 1995)

COURT IN THE SUPREME COURT OF NEW SOUTH WALES COURT OF APPEAL KIRBY ACJ(1), PRIESTLEY JA(2) AND HANDLEY JA(3) HRNG SYDNEY, 12 April 1995 #DATE 14:7:1995 #ADD 27:9:1995

Counsel for the Appellant: P R Graham QC and D B McGovern

Counsel for the Respondent: C J Birch and J P Berwick

Solicitors for the Respondent: D Mosca and Co ORDER Appeal dismissed with costs. JUDGE1 KIRBY ACJ This appeal comes from a judgment entered by Young J in the Equity Division of the Supreme Court. It raises issues concerning the application of the Corporations Law (the Law). The ultimate question is whether the appellant company should be wound up.

A business and personal relationship over twenty years 2. The personal relationship between the second appellant (Mr Nikola Kokotovich) and the respondent (Mrs Elaine Wallington), which lies at the heart of this case, extends over 20 years to 1962. The relationship was, at times in the past, an intimate one. Also, for most of the past twenty years Mrs Wallington worked for Mr Kokotovich. However these close ties have now been broken. They have been replaced by the bitter dispute between the parties which has resulted in these proceedings. It is necessary, in attempting to understand the dispute, to examine the history of the relationship between Mr Kokotovich and Mrs Wallington.

As Young J noted, the nature of the relationship from the time they met until 1973 is not completely clear. However, it is clear that it was "both an emotional and a business association". Mrs Wallington testified that there was a de facto married relationship between herself and Mr Kokotovich until he was married in
Although Mr Kokotovich tried to minimise the extent of this relationship in his evidence, it is clear that there was, at least, a sexual relationship between the two of them. Mrs Wallington assisted Mr Kokotovich with his formworking business during this period. Eventually, she left work which she had with the railway authority and began to work in Mr Kokotovich's business full-time. Mrs Wallington testified that she prepared quotations, wrote up the books and performed other administrative tasks. There was some evidence that Mrs Wallington supplied money to the business. However, Mr Kokotovich claimed that this money was treated strictly as a loan, and was repaid as such.

In 1972 Mr Kokotovich decided that he would incorporate the business. To this end, two companies were set up: Kokotovich Constructions Pty Limited, which is the first appellant; and N. K. Plant Hire Pty Limited, which has since been placed in liquidation.

The events surrounding the incorporation of Kokotovich Constructions Pty Limited are central to the issues in this case. In his evidence, Mr Kokotovich emphasised that in forming the company, he always intended to keep the business under his sole direction and control. He testified as to the existence of conversations to that end with Mr Robert Bullivant, the accountant employed for the purpose of the incorporation procedures.

Kokotovich Constructions Pty Limited was incorporated with Mr Kokotovich holding one governing director's share as well as one each of the "A and "B" ordinary shares, and with Mrs Wallington holding one "A" and one "C" ordinary share. Mr Bullivant testified that he had told the second appellant that he would need a second person to be a shareholder. He was advised that Mrs Wallington would be that person. Mr Kokotovich claimed that he stressed to Mr Bullivant that the business was his and his alone, and that Mrs Wallington only held shares so as to satisfy the legal requirements. Both Mr Bullivant and Mrs Wallington denied that these words were ever said.

After the companies were formed Mrs Wallington continued working for the business in a largely administrative capacity. It appears that, at first, she also maintained close personal contact with Mr Kokotovich and members of his family. However, these friendly relations began to break down in the early 1990s. On 12 May 1992 Mr Kokotovich asked Mrs Wallington to go to the office of a firm of solicitors with the first appellant's company seal. She refused to do so. On 13 May 1992 Mrs Wallington received notice of an extraordinary general meeting of Kokotovich Constructions Pty Limited which was to be held on 9 June 1992 to consider a special resolution to remove her as director and secretary of the company. She was, in fact, removed from office at that meeting. Then, on 10 December 1992, Mr Kokotovich convened a meeting at which he purported to issue a further 9,795 one dollar shares in the first appellant company. The validity of that share issue is in question in these proceedings.

On 21 December 1992 Mrs Wallington filed a summons in Equity Division of the Supreme Court of New South Wales seeking an order for the winding up of Kokotovich Constructions Pty Limited. By a further amended summons Mrs Wallington sought, in substance: (1) A declaration that the allotment of shares made on 10 December 1992 was invalid; (2) An order pursuant to s 194 of the Corporations Law validating the allotment of shares purportedly made on 30 October 1972; and (3) An order that the first appellant company be wound up.

The decision of the primary judge 9. Young J decided that there were essentially four issues. He phrased those issues in the form of questions as follows: (1) Who beneficially owns the shares in the first defendant? (2) Should any order be made rectifying the initial allotments? (3) Is the allotment of December 1992 valid? (4) Should the company be wound up?

Examining the first issue, Young J categorised the argument put forward by Mrs Wallington as being based on the notion of a "moral partnership". That is, his Honour stated that, although she did not claim to have any say in the actual running of the business, Mrs Wallington felt that her contribution to its formation and operation entitled her to a stake in the operation. She argued that, on incorporation, her moral claims were recognised by the issuing of shares to her. On the other hand, Mr Kokotovich claimed that Mrs Wallington was only given shares so as to comply with the legal formalities laid down by Mr Bullivant.

Faced with this conflict of evidence, Young J felt it necessary to examine the parties' relationship in some detail. He concluded that, although the evidence of both parties was affected by credibility problems, where they conflicted, he preferred the evidence 'Mrs Wallington to that of Mr Kokotovich. In important respects he found that Mr Kokotovich's evidence was "demonstrably more unreliable". His Honour stated that: "My view on the whole of the evidence is that the second defendant (Mr Kokotovich) thought that he had control so that it was not a mailer of great moment that the plaintiff (Mrs Wallington) had an interest in the business. Further, he knew that the plaintiff expected to be beneficially involved in the company. Thus when the company was formed it was intended that the plaintiff have a beneficial interest in the business."

Having reached this conclusion, Young J dealt with a number of points which had been raised in argument. He stated that, although it had been described as "a very valuable business", the business might not have been worth the valuation of $55,000 given to it when it was incorporated. Secondly, Young J noted that Mr Bullivant would not have structured the company in the way that he did if the situation was as described by Mr Kokotovich. Next his Honour explained the overwhelming de facto control of the business exercised by Mr Kokotovich on the ground that this was on account of the powers invested in him as the governing director. Finally, Young J agreed that Mr Kokotovich was entitled to the benefit of the presumption of a resulting trust by reason of his provision of the funds and assets of the company. However, his Honour felt that the presumption was rebutted in this case.

Young J concluded his examination of the first issue by saying that:

"... in all the circumstances it was intended at the time of the formation of the company that Mrs Wallington should have a beneficial interest in the company not because she had made any or any great financial contribution, but in recognition of her emotional relationship with the second defendant and the lime that she had spent in the affairs of the company."

The second issue examined by Young J related to problems with the initial share allotment. At the first meeting of shareholders, Mr Kokotovich and Mrs Wallington had passed a resolution deeming the five shares to have been allotted pursuant to the Companies Act 1961, s 54. However, as Young J pointed out, the deeming procedure of s 54 of that Act only applied when there had been a subscription for the shares in question. Although the allotment of the "A" class shares did fall within the terms of this section, since they were subscriber's shares and could thus be validated, the three remaining shares were not allotted following a subscription and were thus not within the section. Young J noted that where such shares were to be allotted, that is other than following a subscription, an application by the shareholder and a resolution of the directors to allot the shares was required. Such a procedure was not followed in this case. Nonetheless, his Honour noted that a return of the allotment was sent, and from 1972 to 1993 the company's records contained a statement that the five shares were allotted on the relevant date, two to Mrs Wallington and three to Mr Kokotovich.

Mrs Wallington had asked Young J to make an order under s 194 of the Law validating any improper issue of shares in 1972, That section provides: "194 (1) Where a company has purported to issue or allot shares and: (a) the creation, issue or allotment of those shares is invalid by reason of any provision of this or any other Act or of the memorandum or articles of the company or for any other reason; or (b) the terms of the purported issue or allotment are inconsistent with or are not authorised by any such provision;

the Court may, on application by the company, by a holder or mortgagee of any of those shares or by a creditor of the company and on being satisfied that in all the circumstances it is just and equitable so to do, make an order. (c) validating the purported issue or allotment of those shares; or (d) confirming the terms of the purported issue or allotment of the shares; or both

In reply to Mrs Wallington's claim, Mr Kokotovich argued that such an order would not be fair and equitable to him. Moreover, it was suggested that the Court should only make such an order when the validation of the issue was non-contentious, subject to public policy grounds.

Young J expressed surprise at Mr Kokotovich's opposition to the validation order, given that the shares issued to Mr Kokotovich, including the governing director's share, were as much in need of validation as those issued to Mrs Wallington. His Honour rejected the purported limitation as to when the Court should make an order under s 194. He concluded: "the Court has power whenever it is just and equitable to validate the issue of shares not only where the validation is non-contentious. Indeed the main thrust of s 194 is to validate defective titles where there has been a bona fide transaction involving the issue of shares which is flawed for some technical reason: Millheim v Barewa Oil and Mining NL (1971) WAR 64."

In this way, his Honour came to his conclusion that: "In the instant case, where everyone has proceeded for 20 years on the basis that the shares were properly allotted, it seems to me an appropriate case for making the position completely clear by making a validating order. However, the terms on which the Court would make an order validating the issue of the "C" class share to the plaintiff is that the issue of the governing director's share and the "B" class share to Mr Kokotovich would also be validated"

Young J concluded his discussion of this issue by noting that the "A" class shares, which were the only validly issued shares, conferred voting rights, but no rights to participate in, or receive, any dividends, profits, receipts and distribution of surplus assets. Therefore, if the issue of the other shares were not validated, and the holders of the "A" class shares did not alter the Articles of Association, the property of the company on winding up would pass to the Crown as bona vacantia. That fact provided a further reason for validating the shares as asked.

The third issue dealt with by Young J was the validity of the 1992 share allotment. His Honour felt that this question turned largely on the extent of the power of the governing director. Young J therefore reviewed the relevant Articles of Association of the company. He examined the decision of the High Court in Whitehouse and Anor v Carlton Hotel Pty Limited [1987] HCA 11; (1985) 162 CLR 285 and particularly the judgment of Brennan J, at 313. Young J summarised that passage as follows: "Brennan J considered that the Articles in the case before him led to the result that whilst the governing director might summon a meeting and have a decision made at a meeting, there was nothing to suggest that the valid exercise of his powers was conditioned upon the summoning of directors to a meeting."

Although he did not consider that the relevant Article in the present case was as strong as that in Whitehouse, Young J concluded that it should be given the same construction as the Article before the High Court in Whitehouse. Thus he assumed that there was no technical defect in the way Mr Kokotovich exercised his power as governing director.

Young J then proceeded to examine the purpose behind the issue of the shares. His conclusion on this was that: "Although there was an expression in the resolution that it was made for the purpose of raising money and although there is a little bit of evidence that tended in that direction, it seems to me abundantly clear that the whole purpose of the exercise was to make sure any proprietary right the plaintiff personally held in any share was made virtually valueless. If any fiduciary duty was owed towards Mrs Wallington, then as devaluing the plaintiff's shares was not for any demonstrable benefit to the company as a whole, the dominant purpose of the allotment was impermissible and the allotment would be set aside by the Court; see Whitehouse at 294."

Young J rejected the claim by Mr Kokotovich that there was no fiduciary duty owed in the circumstances. Therefore, his Honour considered that the allotment made in 1992 had been made for an impermissible purpose. He declared it to be invalid.

Young J noted that it would be futile to give the shareholders an opportunity to ratify the allotment in a general meeting. At such a meeting the "A" class shareholders, Mr Kokotovich and Mrs Wallington, would have one vote each. Young J considered that there was no provision in the Articles for the chairman to have a casting vote. He thus concluded that such a meeting would be deadlocked, and therefore would be "a waste of time".

In this way, the ultimate issue before Young J became whether he should order the winding up of Kokotovich Constructions Pty Limited. After acknowledging that both sides had reasonable arguments on this point his Honour proceeded to examine the various statutory bases for making a winding up order. First, he discussed s 260 of the Law which authorises winding up on the grounds of oppression. His Honour noted that the section provided that a Court should not make a winding up order where such a course would unfairly prejudice the oppressed member or members. Since, in this case, the allegedly oppressed member was bringing the action, that qualification was not relevant. Young J also acknowledged that it is an extreme step to wind up a successful and solvent company.

Young J then examined the power to wind up on the "just and equitable" ground under s 461 of the Law. The appellants had argued that, because the company was essentially controlled by, and incorporated for the interests of, Mr Kokotovich, his management could not be oppressive. Young J rejected this argument on the basis that he had already found that the company's Articles did not override the fiduciary duties which Mr Kokotovich owed to the company. He also dismissed the claim that a winding up order would be useless given that the governing director, Mr Kokotovich, could redirect the whole of the surplus assets to his own shares. Young J concluded that this argument was a "red herring" because, at the time of the distribution of surplus assets, control of the company will be vested in a liquidator, and not in the directors.

Having noted that the company did not itself conduct a business, and simply owned a piece of land, Young J came to the conclusion that "a winding up is as good a way as (sic) resolving the present conflict as any other". His Honour therefore ordered that the company be wound up and that an official liquidator be appointed to conduct the winding up. However, Young J stayed these orders to give the parties the opportunity to settle the dispute by negotiation. Alas, they failed to do so.

The issues before this Court 28. The appeal against the decision of Young J has, in substance, been directed at each of the four issues decided by his Honour. It is therefore appropriate to deal with each of these issues in turn.

The beneficial ownership of the shares 29. As the preceding discussion shows, Young J concluded that both parties intended Mrs Wallington to have a beneficial interest in the company on account both of the time which she had invested in the business, and the close emotional ties between the two parties. His Honour used the expression "moral partnership" to describe the business relationship between Mr Kokotovich and Mrs Wallington.

The appellants argued that, since the payment for the shares in Kokotovich Constructions Pty Limited had come exclusively from the assets of Mr Kokotovich's business, he was entitled to the presumption of a resulting trust over the shares. Furthermore, they argued that Young J was incorrect in concluding that this presumption was rebutted by the existence of an intention to give Mrs Wallington a beneficial interest in the business.

The appellants correctly pointed out that the question of whether the respondent had acquired a beneficial interest in the shares depends on the intention of Mr Kokotovich, as the party who had paid the purchase price. This principle is confirmed by the decisions of the High Court in Calverly v Green [1984] HCA 81; (1984) 155 CLR 242 at 246, 258; and Muschinski v Dodds [1985] HCA 78; (1986) 160 CLR 583 at 589 - 590. Those cases also make it clear that the evidentiary material from which this Court might draw an inference as to Mr Kokotovich's intention, include acts or declarations before or at the time of the acquisition of the shares, or so immediately after their acquisition as to constitute part of the transaction. See Calverly at 262; and Muschinski at 590; see also Charles Marshall Pty Limited Ors v Grimsley and Anor [1956] HCA 28; (1956) 95 CLR 353 at 365.

Given these principles, the appellants argued, in substance, that there was insufficient evidence of any intention on his part to give Mrs Wallington beneficial ownership of the shares, so as to rebut the presumption of a resulting trust. He argued that the alleged existence of a de facto relationship was not sufficient to rebut the presumption. Indeed, the High Court held in Calverly, admittedly in 1984, that the existence of a de facto relationship would not, alone, give rise to a presumption of advancement.

Although the appellants have correctly stated the legal principles on resulting trusts, they must fail on this point. Young J clearly appreciated the legal principles to be applied. He agreed that the second appellant was entitled to the presumption of a resulting trust. He accepted that there could be no presumption of advancement in the case of a de facto relationship. However, Young J concluded that, on the better view of the facts before him, it was the intention of both parties (and most importantly the intention of Mr Kokotovich) that Mrs Wallington should have a beneficial interest in the shares issued to her.

The role of the appellate court in reviewing a primary judge's findings of fact where those findings are dependent on the judge's views on the credibility of witnesses is clear: see e.g. Galea v Galea (1990) 19 NSWLR 263 (CA). In Devries and Anor v Australian National Railways Commission and Anor [1993] HCA 78; (1993) 177 CLR 472, and Abalos v Australian Postal Commission [1990] HCA 47; (1990) 171 CLR 167, the High Court has affirmed that appellate courts should approach the review of such findings and the conclusions resting on them with caution. This Court is only entitled to overturn a primary judge's conclusion where the judge "has failed to use or has palpably misused his advantage" or has acted on evidence which was "inconsistent with facts incontrovertibly established by the evidence" or which was "glaringly improbable": see e.g. Devries, at 479.

In a case such as the present where the trial judge was faced with differing accounts of events over twenty years in the past an appellate court must be even more cautious in reconsidering the conclusions reached by that judge, where those conclusions are based on the judge's conclusions about the credibility of the witnesses. Young J was faced by two inconsistent accounts of the parties' relationship and intentions at the time Kokotovich Constructions Pty Limited was formed. He preferred the evidence of Mrs Wallington. Indeed, her account of the relevant events was supported, at least in part, by the evidence of Mr Bullivant. The conclusions reached by Young J on this issue were more than open to him. This Court may not disturb them. Given those findings of fact Young J was entitled to conclude that the presumption of a resulting trust in favour of Mr Kokotovich was rebutted by an established intention that Mrs Wallington should have a beneficial interest in the shares. The objective evidence of the documentation and issue of the shares supports this conclusion. It must stand.

In addition to arguing that Mr Kokotovich was entitled to a resulting trust over the shares in Mrs Wallington's name, the appellants also argued that any shares held by the respondent were held on a constructive trust for him. They claimed that Young J had failed to deal with this submission.

The appellants did not make any oral submissions on this issue. They dealt with it only in two paragraphs in their written submissions. It appears that the suggested basis for the constructive trust was the fact that Mr Kokotovich 'established his own formwork business and built it up through his own endeavours". The appellants argued that Young J should have found a constructive trust in light of this alleged disparity in the contribution made by Mrs Wallington and Mr Kokotovich to the business. They maintained that a constructive trust would be justified where, as in this case, "justice and good conscience required it". The case of Morris v Morris (1982) 1 NSWLR 61 (CA) at 64 was cited in support.

This argument has no substance. It is well established that a constructive trust will not be imposed on the ground of mere fairness: see Muschinski v Dodds at 594595, 608, 615-616. In that case, Deane J said at 616:

"The mere fact that it would be unjust or unfair in a situation of discord for the owner of a legal estate to assert his ownership against another provides, of itself, no mandate for a judicial declaration that the ownership in whole or in part lies, in equity, in that other: cf Hepworth v Hepworth ((1963) 110 CLR 309, at pp. 317-318). Such equitable relief by way of a constructive trust will only properly be available if applicable principles of the law of equity require that the person in whom the ownership of property is vested should hold it to the use or for the benefit of another."

But even if fairness were the test it would not in the case of the "moral partnership" here secure the constructive trust asked for. The appellants have not satisfied me that this is a case where the appropriate legal grounds for the grant of a constructive trust have been established. That claim must also be dismissed. The validation of the share issue under the Corporations Law s 194

As preliminary to the question of whether Young J should have ordered the validation of the share issue, the appellants argued that Mr Kokotovich had governing director's powers by means of the validly issued "A" class share. That is, they argued that either governing director's powers attached to the "A" class share which had been issued to him, or that, the share issued to him was, in fact, a governing directors share, and not an "A" class share. The appellants were forced to mount this argument. Otherwise, if this Court chose to quash the validation order, the only validly issued shares in the company would be., the two "A" class shares. There would then have been a deadlock in the company since neither shareholder could exercise any more power than the other. If, however, Mr Kokotovich enjoyed governing director's rights, then he would maintain control over the company in the event that this Court upheld the challenge to the validation order.

Since, for reasons which I will explain below, I am not inclined to disturb the validation order made by Young J, it is not necessary for me to examine this preliminary issue in any great detail. In substance, the appellants attempted to show that the terms of the Articles of Association of Kokotovich Constructions Pty Limited required that the share for which Mr Kokotovich initially subscribed was a governing directors share. There may be some force in this submission. However, because I would uphold the validation order made, it is not necessary for me to investigate this issue further.

Turning to the issue of the validation order itself, the appellants submitted two arguments in resistance to its making. The first was that on the true construction of its facts, this case did not in fact fall within the terms of s 194 of the Law. That section applies "where a company has purported to issue or allot shares". Although this point was not stated specifically in the notice of appeal, the appellants submitted that, in fact, there was no such "purported allotment" in this case. They argued that the resolution of the first meeting of shareholders on 30 October 1972, by which Mrs Wallington and Mr Kokotovich had deemed the five shares to have been allotted, did not constitute a purported issue or allotment of shares within the terms of s 194. Rather, it was submitted, the resolution merely amounted to a declaration that there had been a deemed allotment. All the company was doing was recording what it understood to be the operation of the law.

I am unwilling to read s 194 of the Law in such a restricted manner. The relief provided by s 194 applies in situations such as the present. There was a clear intention on behalf of the incorporators to bring the company into existence with a particular share structure. This involved, in the true sense of the term, the "purported" allotment of the shares. The terms of s 194 refer to the entirety of the events surrounding the disputed allotment. They should not be interpreted so as to focus on one word in a particular resolution. When the conduct of the company is examined as a whole, it is clear that there was a "purported" allotment of the shares. The contrary argument should be rejected.

The second aspect of the appellants' argument on the validation issue related to the exercise of Young J's discretion to order the validation of the shares. It was submitted that Young J, in the proper exercise of his discretion, should have declined to make the order validating the share issue. The appellants argued in this Court, as they had before Young J, that the power to order a validation of a share issue under s 194 of the Law should only be exercised where the validation is non contentious, subject to public policy grounds. They cited the decisions of Re Swan Brewery Company Limited (No 2) (1977-78) CLC 40-450; and Re Hatfield Enterprises Pty Limited (1982) 1 ACLC 208 in support of this proposition. Furthermore, the appellants submitted that the exercise of the power in this case would be inappropriate since the shares held by Mrs Wallington were "forgotten shares". No dividends have been paid on them. No shares have been transferred. The shares subject to possible validation had no voting rights attached. No funds were provided by Mrs Wallington in respect of the acquisition of the shares. The appellants claimed that no rights were ever relevantly afforded to, or exercised in relation to, Mrs Wallington's shares. There was never any reliance on the assumed legitimacy of the share allotment. The appellants attempted to contrast the present case with the decision of Gillard J in Swan Brewery where, so it was argued, his Honour had favoured the exercise of the discretion where parties had relied on the assumed legitimacy of the share issue

Mrs Wallington claimed that the arguments presented by the appellants relied, to a large extent, on the evidence of Mr Kokotovich as to the nature of the business and the company. But Young J had rejected this evidence and preferred that of Mrs Wallington. That is, his Honour found that Mrs Wallington had a real and substantial interest in the company. She was not merely a nominating shareholder. The shares had been issued to her in recognition of her "substantial involvement" in the setting up, and continuing operation of the company for a very long time.

It is clear enough that Young J adopted this view of the evidence. His Honour found that Mrs Wallington was not merely a paid employee who was given shares to "make up the numbers". She was issued with these shares in recognition of what his Honour termed the "moral partnership" between Mr Kokotovich and herself. Given the advantages which Young J enjoyed as trial judge, and to the extent that these findings relied on his Honour's findings as to the credibility of the witnesses, I am not at liberty to overturn his Honour's conclusions. The repeated authority of the High Court upholding the effective finality of such decisions requires that this challenge be rejected.

Nor do I think that the appellants' argument that there had been no "reliance" on the shares can be upheld. It is true that there were no dividends paid on the shares and no transfers of the shares. However, this does not mean that the share structure was not relied upon in the sense that it governed the ownership of the company. Young J found that both parties had a substantial interest in the company. Mrs Wallington relied on her shares, in a passive sense, as entitling her to an interest in the company. This passive reliance is no less important than the active reliance which might be evidenced by, for example, the receiving of dividends. Thus I see no error in the statement by Young J that "everyone has proceeded for 20 years on the basis that the shares were properly allotted". That would be my own conclusion in the facts.

I do not consider that the authorities cited by the appellants exclude a case such as the present from the operation of s 194 of the Law. In Millheim v Barewa Oil and Mining NL (1971) WAR 65, Burt J declined to make an order validating a supposed issue of shares under a predecessor section. His Honour did so because, in the circumstances of that case, there had never been a valid attempt to allot the shares, since the persons acting as directors had not been validly appointed. Accordingly they were not authorised to allot shares. Burt J analysed the Companies Act 1961, s 63, the Parallel section to s 194 of the Law, in the following terms, (at 67.4): "It is directed to cases where the shares have been issued, which represents a bundle of rights proprietary in character and valuable in terms of money, and where it appears for some reason or other there has been an irregularity in the issue or the allotment which in strict law would result in the issue of the shares being, as the section says, "invalid"."

The present factual situation appears to fit well within this stated principle.

Nor does the decision of Gillard J in Re Swan Brewery (No 2) support the appellants' case. Certainly, the decision does not support their contention that the discretion under s 194 of the Law should only be exercised where it is noncontentious, subject to public policy grounds. Gillard J exercised his discretion to order the validation of the shares largely because of the legal and business difficulties which would result if he did not do so, and because of the potential harm to innocent people who had a significant stake in the validity of the share issue. Many of the same considerations apply here.

In Alpha Resources Limited v Corporate Affairs Commission (1987) 5 ACLC 844, Waddell CJ in Eq noted that the fact that there was no likelihood of prejudice to any party if the allotments were validated was a factor in favour of making the validation order. However, his Honour approved of the decision of Gillard J in Swan, and stated, at 846, that: "in the present case ... (t)he legitimate expectations of innocent parties who have been allotted shares in the company are, I think, a dominant consideration"

This statement of the law favours the case of Mrs Wallington, who, as an innocent party, passively relied on the assumed validity of the share allotment for some twenty years.

The only relevance of the decision of Rogers J in Re Hatfield Enterprises Pty Limited (1982) 1 ACLC 208 is that it confirms that a court may take into account public policy in determining whether to exercise its discretion in this regard. I do not doubt that this is so. But it does not control what should be done here.

The final authority which, it was claimed, has some bearing on this issue, was the decision of Bryson J in Swiss Screens (Australia) Pty Ltd and Anor v Burgess and Anor (1986-87) 11 ACLR 756. Bryson J largely focused on issues not relevant to the present proceedings. However, at 765, his Honour decided that a validation order, although not necessary in the circumstances of that case, was justified because of: "... the many events in the conduct of the affairs of the company and of the members and purported members which have proceeded on the basis that the shareholding is in accordance with the register."

I would therefore not disturb the discretionary decision of Young J to order the validation of the 1972 share issue under s 194 of the Law. In light of the factual conclusions reached by his Honour, this case fell within the terms of the section. Moreover, there is nothing in the authorities which I have examined which would lead me to a different or contrary conclusion.

The validity of the 1992 share allotment 54. The appellants made a number of submissions on the issue of the validity of the 1992 allotment. First they argued that the Memorandum and Articles of Kokotovich Constructions Pty Limited were drafted in such a manner so as to relieve the governing director of any fiduciary duty which he might otherwise have. Secondly, they submitted that Young J should have held that the allotment of shares was not shown by the evidence to have been affected by any vitiating purpose. Alternatively, they argued that, even if there was an impermissible purpose on the part of Mr Kokotovich, it could not be said that the allotment was "merely" or "purely" or "solely" for this improper purpose, as required by High Court authority. Nor could it be said, in the view of the appellants, that the attainment of a supposedly impermissible purpose was "the substantial object" of the exercise of the power to allot shares, in the sense in which that expression was used by the High Court in Ngurli Limited and Anor v McCann and Anor [1953] HCA 39; (1954) 90 CLR 425 at 445. Finally, the appellants submitted that even if the allotment constituted a breach of fiduciary duty, this breach, contary to the finding of Young J, could have been cured by the company in a general meeting.

In Darvall v North Sydney Brick and Tile Co Ltd and Ors (1989) 16 NSWLR 260 (CA) at 263, 1 stated that: "It is a fundamental principle of company law that the directors of a company owe a fiduciary duty to the company ... Where issues properly brought before them show a breach by a director of this duty, courts should be vigilant to insist upon the thorough going performance of fiduciary obligations by the directors.

One aspect of the fiduciary duty is that, where the company has vested a power to act in the directors, they can only exercise such power in a manner consistent with purpose for which it was conferred upon them. That is, the power must be exercised for a proper purpose. In Ford's Principles of Corporations Law, 6th ed., (Butterworths: Sydney, 1992), at 473, the authors note that there are two distinct elements involved in the determination of whether this duty has been complied with. The first step involves a question of law. The court must examine the nature of the power in question, and determine the proper limits within which it may be exercised. See Howard Smith Limmted v Ampol Petroleum Limited and Ors [1974] UKPC 3; 1974) AC 821 (PC). The second step involves a question of fact. It involves the determination of the actual purpose for which the power was exercised in the case before the court. When this issue comes before an appellate court, it is important to remember the limitations placed on the review of a trial judge's factual findings where they depend to some extent upon his or her findings as to the credibility of witnesses. The determination of the purposes for which a board of directors acted can, on occasion, be an extremely complex question. It will generally require a very detailed examination of the facts. See Advance Bank Australia Limited and Ors v FAI Insurances Ltd and Anor (1987) 9 NSWLR 464 (CA) at 485. Nonetheless, an appellate court must exercise its true function. It must intervene where the findings of the trial judge are shown to be wrong and in a way that may be corrected consistently with the principles stated in Devries and Anor v Australian National Railways Commission and Anor [1993] HCA 78; (1993) 177 CLR 472 (HQ at 479.

Although, generally speaking, a director is bound by to act only for a proper purpose, the High Court recognised in Whitehouse v Carlton Hotel Pty Limited (I985) [1987] HCA 11; 162 CLR 285, that the Memorandum and Articles of a company may be so worded so as to exclude, or modify, this fiduciary duty in certain defined circumstances. The majority in that case (Mason J, Deane and Dawson JJ) said, at 292: "It may be assumed that the Articles of a company could be so framed that they conferred upon a governing director authority to exercise a power to allot shares for the purpose of diluting the voting power or other rights of existing shareholders. They have not been so framed in the present case. All that the relevant provision of Art 127 does is confer upon Mr Whitehouse the 'powers and authorities and discretion vested in the Board of Directors by the Companies Acts or these Articles'. It does not change the nature of those 'powers and authorities and discretion' It does not convert what is a fiduciary power in the hands of the directors into a non-fiduciary power in the hands of Mr Whitehouse. It does not authorise the exercise by Mr Whitehouse of that fiduciary power for what would be an impermissible and vitiating purpose if it were exercised by the directors.

In the present case, Young J found that the Article which detailed the governing director's powers was "not quite (as) strong)" as the Article before the High Court in Whitehouse. The appellants argued before this Court that, in deciding whether the governing director had a fiduciary duty to the company, it was necessary to consider the whole of the Articles of the company. I will do so. Nevertheless, even upon examining the entirety of the company's Articles, I am not satisfied that the fiduciary duty was excluded in this case. Even Article 7 which appears to authorise the discriminatory distribution of dividends, is expressed to be "subject to Article 6 hereof and without prejudice to any rights previously conferred on the holders of existing shares".

Given that Mr Kokotovich did owe a fiduciary duty to the company, the next question is, did he breach this duty by the way in which he exercised the power to issue shares? The first part of the inquiry initiated by that question requires an examination of the limits of the particular power. In this regard, the appellants submitted that the allotment of shares in this case was not shown to have been vitiated by any improper purpose. The primary purpose, although not the sole purpose, for which the power to issue shares is conferred, is to raise capital. Mrs Wallington alleged that Mr Kokotovich had really issued the shares so as to dilute her shareholding and reduce the value of her interest in the company. It is well established that this is not a proper purpose for the issuing of shares. In Darvall, at 336, Clarke JA stated that "In cases in which directors have resolved that additional shares be issuedfor the purpose of preserving their own control of the management of a company or for the purpose of diluting the shareholdings of particular members the courts have universally held that the resolutions have been vitiated by an underlying improper purpose: Fraser v Whalley (1864) 2 Hem. and M. 10; [1864] EngR 278; 71 ER 361; Punt v Symons and Co Ltd (1903) 2 Ch. 506; Ngurli v McCann [1953] HCA 39; (1953) 90 CLR 425; Howard Smith Ltd v Ampol Petroleum Ltd (1974) 1 NSWLR 68 at 76; (1974) AC 821 at 834 and Whitehouse (at 294)." (emphasis added)

The findings of Young J accord with this approach. His Honour considered that the issuing of shares so as to dilute and devalue Mrs Wallington's shareholding was not a proper exercise of the power to issue shares since it "was not for any demonstrable benefit to the company as a whole". I agree.

The next question which the Court must ask itself is, what, in fact, was the purpose for which the power was actually exercised in this case? This issue becomes more complicated where a power is exercised for a multitude of purposes. When such circumstances arise, it is necessary to discover what was the "substantial purpose" behind the exercise of the power. I endeavoured to state the task facing the court in this regard in Darvall, at 281: "The court must determine whether the complainant has shown that the substantial purpose of the directors for the conduct impugned was improper or collateral to their duties as directors of the company: Mills v Mills [1938] HCA 4; (1938) 60 CLR 150 at 185. This task of characterisation has been assisted by the provision of a rule of thumb, suggested by the High Court, for classification of the facts as they emerge in evidence. By that rule, it is necessary for the court to determine whether but for the allegedly improper or collateral purpose, the directors would have performed the act which is impugned: Ngurli Ltd v McCann [1953] HCA 39; (1953) 90 CLR 425 at 445 and Whitehouse v Carlton Hotel Pty Ltd [1987] HCA 11; (1987) 162 CLR 285 at 292."

The appellants argued that the attainment of any improper purpose in this case could not be said to be "the substantial object" of the exercise of the power. Nor, so they argued, could it be found that the allotment could not have been made "but for" the purpose of manipulating voting power. But Young J found that it was "abundantly clear that the whole purpose" of the share issue was to make Mrs Wallington's shares "virtually valueless". He also found that this was the "dominant purpose".

The appellants have not convinced me, in this regard, that Young J was wrong. Still less have they shown that his Honour "palpably misused his advantage" or that his findings were "inconsistent with facts incontrovertibly established by the evidence" or "glaringly improbable". Indeed, the circumstances surrounding the share issue overwhelmingly support the conclusion reached by his Honour. The issue was made only a short time before the summons commencing these proceedings was filed. The shares were issued to Mr Kokotovich's children, purportedly for the purpose of raising funds. However, no cash was ever exchanged. Rather, it appears that the shares were issued to another company (in which Mr Kokotovich had an interest) in the name of the children, in reduction of a debt owed to that company. Finally, even though it was claimed that the shares were issued to repay a $25,000 tax and rates bill, their issue only raised (nominally) $ 10,000.

Matters of management are within the responsibility of the directors. Courts should hesitate before interfering with management decisions which have been reached bona fide. In Howard Smith, at 832, Lord Wilberforce, delivering the judgment of the Privy Council, said: "Their Lordships accept that such a matter as the raising of finance is one of management, within the responsibility of the directors: they accept that it would be wrong for the court to substitute its opinion for that of the management, or indeed to question the correctness of the management's decision, on such a question, if bona fide arrived at.

However this principle is of no application where, as in this case, the management decision was not bona fide arrived at. Indeed, it would be absurd to suggest that a court should forsake its responsibility to uphold the law in such a situation. If a director breaches his or her fiduciary duty in exercising a power for an improper purpose, not only is it desirable that the courts should intervene. They have a duty to do so.

The final submission put by the appellants was that even if the actions of Mr Kokotovich did constitute a breach of his fiduciary duty to the company, this breach could have been cured by the company in a general meeting. That is, the appellants argued that the allotment was voidable only and not void. Thus, any power to confirm or avoid the transaction remained with the shareholders in general meeting. See Winthrop Investments Limited and Anor v Winns Limited and Ors (1975) 2 NSWLR 666 (CA), at 699-700. Although the legal principle behind this argument is not in doubt, I do not think that it is available to the appellants in the present case. Young J found that, even if such a meeting were called, there would be a deadlock, since the "A" class shareholders, Mrs Wallington and Mr Kokotovich, would have one vote each. His Honour found that even if Mr Kokotovich appointed himself chairman, there was no provision in the Articles for the chairman to have a casting vote. There would therefore be a complete deadlock.

Before this Court the appellants argued that, on the true construction of the Articles of Association of the company, the governing director was entitled to vote at general meetings. Article 6 (3) confers on the holders of "A" class shares "the sole and only right of voting at all meetings . . .". The appellants argued that this provision meant, not that only "A" class shareholders can vote at meetings, but that the only right "A" class shareholders have is to vote at meetings. Article 6 (1) deals with the rights and privileges which attach to the governing director's share. However, this Article does not specifically discuss the right to vote at meetings. Conversely, Article 6 (4) explicitly states that the "B" to "F" class shares "have no voting rights whatsoever". In light of this allocation of voting rights, the appellants submitted that the governing director enjoyed a general right to vote by virtue of Article 76. That Article provides, relevantly, that "on a show of hands every member entitled to vote shall have one vote. (emphasis added)". The appellants argued that this Article would disentite "B" to F" class shareholders, and would allow the remaining shareholders, "A" class shareholders and the governing director, to vote.

I do not accept that the Articles of the company should be interpreted in this manner. The Articles specifically give "A" class shareholders voting rights, and specifically disentitle "B" to "F" class shareholders from enjoying such rights. However, I do not accept that it is to be inferred from this that, in the absence of a specific provision, the governing director must necessarily have voting rights. Even if Article 6 (3) were to be read in the manner submitted by the appellants, and I think this is highly doubtful, no provision in Article 6 either expressly, or impliedly grants the governing director a right to vote as such. Moreover, Article 76 relates to members who are "entitled to vote". If the governing director is not so entitled by operation of any other Article, I do not accept that this provision confers such a right.

It was submitted by the appellants that it would be "illogical and absurd" for the governing director to have the wide array of powers that he has, but not to have the power to vote on a resolution at an ordinary meeting. I do not agree. These provisions, in fact, reflect the view of the nature of the company for which the respondent argued, and which Young J accepted. Mr Kokotovich was to have the control of the day-today operations of the company. He was to manage the company. This was never disputed by the respondent. However, when it came to specific issues about the constitution of the company, issues that the general meeting of shareholders would address, Mrs Wallington and Mr Kokotovich were to have equal voices. This reflects the significant role which both incorporators intended Mrs Wallington to have in the company. It also reflects, and confirms, the "moral partnership- which Young J found to exist.

I would therefore reject the appeal as it challenges the validity of the 1992 share allotment. The allotment was made for the improper purpose of devaluing Mrs Wallington's shares in the company. In allotting the shares Mr Kokotovich was in breach of his fiduciary duty to the company. The allotment was therefore rightly set aside

The company should be wound up 71. The final issue before this Court is whether, in light of the findings made by Young J, his Honour should have ordered that Kokotovich Constructions be wound up pursuant to the Law.

The appellants submitted that the winding-up of a successful and prosperous company is an extreme step, and one which must require a strong case. Authority for this uncontroversial proposition can be found in Cumberland Holdings Limited v Washington H. Soul Pattinson and Company Limited (1977-78) ACLC 29,370 at 29,374; and Hannes and Ors v MJH Pty Limited and Ors (1992) 10 ACLC 400 at 419. It was recently applied and illustrated in Constantinidis and Ors v JGL Trading Pty Ltd and Anor, Court of Appeal, unreported, 19 May 1995; (1995) NSWJB 52. Young J clearly recognised this important principle in his judgment. His Honour acknowledged that Mr Kokotovich had a legitimate commercial interest in maintaining control over the company assets. In fact, it appears that the company's assets are limited to one piece of land. It's business is now limited to renting out this land.

The appellants argued that a winding-up order was not justified in that the present conflict was limited to the 1992 share allotment. They argued that once Young J had resolved this problem, there was no dispute which would warrant winding-up. Moreover the appellants submitted that Young J should have set aside the allotment, if he were so minded, and warned them that any further oppressive conduct would result in a winding-up order.

I can see no reason why this Court should disturb the decision of Young J to wind up the company. In exercising his discretion in this matter, his Honour took into account all of the relevant considerations and gave the clearest possible attention to the gravity of the step which he was taking but also impasse reached between the parties. True, winding up the company was an extreme step. However, Young J realised and stated this. Given the continuing animosity which exists between the two shareholders, the real risk, as I would judge, of further oppression, and the very limited nature of the company's present activities, the order would seem to be soundly based. I am not therefore inclined to disturb what I consider to be the proper exercise of the trial judge's discretion in this regard. The case is entirely different from Constantinidis where a complex business arrangement involved a company which was vigorously trading, which was arguably viable and in whose continued operation many creditors, employees and others had a stake.

Conclusion and orders 75. The appeal should be dismissed with costs. JUDGE2 PRIESTLEY JA I agree with Kirby ACJ. JUDGE3 HANDLEY JA I agree with Kirby ACJ.

Kokotovich Constructions Pty Limited and Ors v Wallington Nos. Ca 40723/93; Ed 6321/92 Companies - Trusts [1995] NSWSC 54

At a glance

Court

Decision date

Before

Source

Judgment (85 paragraphs)

Kokotovich Constructions Pty Limited and Ors v Wallington Nos. Ca 40723/93; Ed 6321/92 Companies - Trusts [1995] NSWSC 54 (27 September 1995)

Parties

Cases Cited (16)