New Cap Reinsurance Corporation Ltd v General Cologne Re Australia Ltd

IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION CORPORATIONS LIST

2371/02 - NEW CAP REINSURANCE CORPORATION LTD v GENERAL COLOGNE RE AUSTRALIA LTD & ORS JUDGMENT 1 HIS HONOUR: The plaintiffs filed originating process on 19 April 2002 seeking orders that certain transactions which are referred to in the originating process as Leg One and Leg Two were voidable or void under s 588FF of the Corporations Act together with ancillary orders. A statement of claim was filed on 23 April 2003. 2 The claim originally was against General Cologne Re Australia Ltd (GCRA) a reinsurer and Guy Carpenter & Company Pty Ltd (Guy Carpenter Australia) an Australian company which is a subsidiary of the third defendant Guy Carpenter & Company Ltd of the United Kingdom, the principal business of both companies being to act as brokers in the insurance industry. 3 On 22 May 2003, I heard a motion by the Guy Carpenter Australia that the proceedings against it be struck out. At the end of the hearing on that day I struck out the statement of claim as against that defendant and gave leave to replead within a certain time. 4 The time limit for repleading was not observed, but extensions were granted. In September 2003, the plaintiffs sought to add a host of new parties as defendants. The second defendant objected to the revised form of statement of claim. Eventually, all the various interlocutory applications were set down for hearing by me on 21 and 22 June 2004. 5 On 21 June, the plaintiffs wished to make a further attempt to put the claim in proper order. The matter was then fixed to be argued before me on 22 July 2004 on the basis that the amendment to be presented to me on that day would be the plaintiffs' last chance to file an appropriate pleading. 6 On 22 July 2004, I had before me two interlocutory applications: an interlocutory application filed by the plaintiffs on 2 July 2004 to amend the statement of claim with ancillary orders, and the second by the second defendant of 9 July 2004 that the proceedings be dismissed against it. The second of these was dismissed without argument. 7 At the hearing on 22 July 2004, Mr S G Finch SC and Mr N Perram appeared for the plaintiffs, Mr M A Pembroke SC and Mr L P Menzies appeared for the second defendant. 8 I must note that there are other proceedings in the Commercial List of this Division raising identical issues. As I understand what the parties wish me to do, it is to decide the present question as to the adequacy of the pleadings, to publish my reasons for that decision and then relist the matter later. On the later occasion it may well be that an order is made either staying these proceedings pending the hearing of the Commercial List proceedings, or else having the two matters heard together or some variation of one or other of those orders. 9 Some background is necessary. The first plaintiff is a company in liquidation (often referred to in the pleadings as NCRA), the second plaintiff is its liquidator. 10 The plaintiffs say that on 17 September 1998 the company in liquidation and GCRA entered into a contract called in the pleading "Leg One" whereby GCRA purported to reinsure the company for up to $US10 million against all losses wheresoever arising in respect of all business underwritten by the company. In the circumstances, it was certain as at 3 and 17 September 1998 that GCRA would become liable to pay the company an amount of $US7.5 million under Leg One and this was recorded in the half yearly accounts of the first plaintiff's holding company New Cap Reinsurance Corporation Holdings Ltd (NCRH) a company incorporated under the laws of Bermuda. The half yearly accounts for 30 June 1998 of NCRH were released on 4 September 1998. 11 The plaintiffs say that on or about 4 September 1998 NCRA and GCRA entered into a contract called in the pleading "Leg Two" whereby NCRA purported to reinsure GCRA against the loss of up to $US11 million over and above a loss of $A90 million. The plaintiffs say that at all material times all concerned knew under Leg Two NCRA would have to pay GCRA a substantial sum and that Leg 2 was a payback of Leg One. The reason for the two transactions, the plaintiffs say was to enable NCRA to produce accounts as at 30 June 1998 showing its financial state to be in a better position than it actually was by taking the profits from Leg One into account, but with no reference to Leg Two. It is said that if the true position had been known, it would have been inevitable that the first plaintiff would have had to have gone into "run off". 12 The plaintiffs say that Guy Carpenter UK (now named as the third defendant) and Guy Carpenter Australia knew exactly what was going on in July 1998, assisted the directors in putting together their plan and knew how the two Legs were linked. They also knew that the directors of the company were fraudulently seeking to inflate NCRH's balance sheet for the year ended 30 June 1998 by including in that balance sheet as an asset the monies that would flow through to the company under Leg One whilst knowing that there were repayment offsets which were certain to arise which would eliminate it. 13 It is useful to provide a summary of the statement of claim so far as it affects the second defendant. After defining the parties and what is meant by "Leg One" and "Leg Two", paragraph 10 names the four directors of the company, Messrs Daya, Ghose, Williams and Peck. Paragraph 12 notes that Messrs Ghose, Daya and Peck were directors of the holding company together with three others. Paragraph 29 pleads that in causing the company to enter into Leg One and Leg Two, its directors were acting pursuant to a dishonest and fraudulent design. Paragraph 30 alleges how that dishonest and fraudulent design was carried out. Paragraph 33 pleads that the second defendant knew circumstances that would have indicated to an honest and reasonable person that a fraud was being committed or attempted, and para 54 that it assisted the directors in the dishonest and fraudulent design. 14 The pleading shows that the case against the second defendant is based on its alleged knowing assistance to the directors of NCRA creating an equitable obligation to pay equitable compensation under what is known as the second limb in Barnes v Addy (1874) LR 9 Ch App 244 at 251-252. In that case Lord Selborne LC made his now famous statement that: "Strangers are not to be made constructive trustees merely because they act as the agents of trustees in transactions within their legal powers, transactions perhaps of which a Court of Equity may disapprove, unless those agents receive and become chargeable with some part of the trust property, or unless they assist with knowledge in a dishonest and fraudulent design on the part of the trustees."

15 It is essential to plead the elements of the second limb in Barnes v Addy which Jacobs, Law of Trusts 6th ed [1339] sets out as:

(2) A dishonest and fraudulent design by the fiduciary;

(3) The assistance by the third party in that design;

(4) With knowledge. 16 The principles to be considered in a case under the second limb of Barnes v Addy have diverged between Australia and England over the last decade. There was no attempt during the argument to introduce any of the modern English additional principles that have attached to Barnes v Addy into the argument. 17 I agree with this approach. As Santow J said in Turner v TR Nominees Pty Ltd (3.11.1995, unreported), in Royal Brunei Airlines Sdn Bhd v Tan Kok Ming [1995] 2 AC 378, Lord Nicholls formulated a new accessory liability principle (see p 22). As Foster AJ said in Gertsch v Atsas (1999) 10 BPR 18431 at 18440, Australian judges need to realise the difference between what was decided in Consul Development Pty Ltd v DPC Estates Pty Ltd (1975) 132 CLR 373 and the different views expressed by English judges in recent cases. See, however, Compaq Computer Australia Pty Ltd v Merry (1998) 157 ALR 1, 21 where Finkelstein J followed the Royal Brunei case in the knowing assistance situation. 18 However, before considering the law as laid down in the Consul Development case, I must mention one English decision, Baden v Societe Generale [1983] BCLC 325, 407; [1992] 4 All ER 161, 235 ; [1993] 1 WLR 509, 575. In that case at [250], Peter Gibson J in the English Chancery Division appears to have adopted the five different mental states categorised by counsel as: (i) actual knowledge;

(ii) wilfully shutting the eyes to the obvious; (iii) wilfully and recklessly failing to make such enquiries as an honest and reasonable man would make; (iv) knowledge of circumstances which would indicate the facts to an honest and reasonable man; (v) knowledge of circumstances which would put an honest and reasonable man on enquiry. 19 Modern English authority has abandoned these distinctions; however, on my reading of the Australian authorities, the distinctions are still considered valuable. If the 'knowledge' of the propositus falls within categories (i)-(iv) the propositus may be liable under the second limb of Barnes v Addy, but it is otherwise if his or her knowledge comes within category (v). 20 Mr Pembroke put that the applicable law was that laid down by the High Court of Australia in Consul Development Pty Ltd v DPC Estates Pty Ltd (1975) 132 CLR 373 at 399-400. The basal facts of that case were that Grey was manager of a company, DPC, controlled by Walton, a solicitor, which carried on the business of acquiring dilapidated properties which could be renovated and sold for a profit. Walton employed one Robert Clowes as his clerk. Grey told Clowes about a number of properties which he had recommended for purchase saying that the company had been interested in them, but could not afford them. Clowes' company, Consul Development purchased the properties having reached an agreement with Grey that they would share equally any profits or losses. The solicitor's company claimed that those properties were held on trust for it. At 399 Gibbs J said Clowes was aware that Grey stood in a fiduciary position; he knew that Walton did not have full knowledge of the transactions and had not assented to them. His Honour then continued: "If it has been proved that Clowes knew, or that an honest and reasonable man with knowledge of the facts known to Clowes would have thought, that Grey was acting in breach of his fiduciary duty in arranging for Consul to buy the properties to share in the profits, enough will have been established (on the assumption made above) to render Consul accountable to DPC." 21 However, his Honour later said that as on the facts which Clowes believed to exist Grey was not acting in breach of fiduciary duty, Clowes did not knowingly participate in Grey's breach "he neither actually knew, nor had reason to believe, that Grey was violating his duty, and in the circumstances an honest and reasonable man would not have thought it necessary to enquire further." 22 Stephen J, with whom Barwick CJ agreed, said at 407-408 that the plaintiff had not only failed to establish actual knowledge against Clowes but the evidence established that Clowes did not wilfully shut his eyes to the truth. He considered that knowledge does not include constructive notice. 23 Accordingly, when the second limb of Barnes v Addy is relied upon the pleading must allege that there is a fiduciary, the fiduciary has breached his or her fiduciary duty and that the defendant has assisted with knowledge in a dishonest and fraudulent design on the part of the fiduciary. 24 Of course, equity is flexible and does give relief in cases analogous to Barnes v Addy as Lord Selborne's statement is not to be construed as if it was a statute or as exhaustively stating the reach of equity over fraudsters. Thus if a wife makes a profit from a trade in a commodity which she knows her husband has stolen, she will be accountable in equity, see Franklin v Giddens [1978] Qd R 72, 81. However, it is not suggested that the instant case falls into this extended category. 25 Before turning to the pleadings, I should make a few further observations about this second limb of Barnes v Addy. 26 In Robb Evans v European Bank Ltd [2004] NSWCA 82 at [160], Spigelman CJ, with whom Handley and Santow JJA agreed, said: " … it is an essential aspect of accessorial liability for 'knowing receipt' that the act of transfer of the property … must be in breach of a fiduciary obligation. The claim arises in equity's exclusive jurisdiction …". 27 Whilst those words were spoken in connection with the first limb of Barnes v Addy, and although, generally speaking it is wise to put the two limbs of Barnes v Addy in two separate watertight compartments, it would seem to me that they apply equally to the second. 28 There are many situations where directors will be liable under what is called the second limb of the Barnes v Addy principle for assisting a breach of trust committed by the company. Many of the cases in this area are noted in Ford and Lee on Trusts [22680] at p 96 of Chapter 22 of the booklet issued in December 2000. 29 It is clear when one reads the cases referred to in Ford & Lee that they fall into two categories. Category 1 is where the director owes a fiduciary duty to the company and breaches it and causes the company loss by breach of that fiduciary duty. An example is Young v Murphy (1994) 13 ACSR 722. The other case, which is more common, is where the company owes a fiduciary duty to a third party and the director assists in the company diverting property from the third party to some other purpose. The simplest case is where the company holds money on trust for a third party and the director makes sure that it is used for some other purpose such as paying the company's bills: the Royal Brunei case and Educational Resources Pty Ltd v Poteri (1996) 20 ACSR 628 are examples. 30 However, the cases attach liability in a wider situation; see eg Biala Pty Ltd v Mollina Holdings Ltd (1993) 11 ACSR 785, 833 per Ipp J, affirmed by the Western Australian Full Court sub nom Dempster v Mollina Holdings Ltd (1994) 15 ACSR 1 and Turner v TR Nominees Pty Ltd (supra). In these cases, the directors of a trustee type of company carried on its activities for their own or the company's best interests and not for the benefit of the beneficiary. 31 It should be noted that there is no case of accessory liability where the directors of a company do something "naughty" in order to further what they perceive to be the benefit of the company at the time they acted. It is trite law that the directors are the mind of the company and their actions in making a corporate decision are seen as the corporation making a decision and not as the directors acting in conspiracy or individually inducing a breach of contract: O'Brien v Dawson (1941) 41 SR (NSW) 295, 308. Such directors may perhaps be attacked for failing to act honestly or some other way but they do not breach any fiduciary duties owed to the company. 32 Finally it must be observed that whilst the second limb of Barnes v Addy is often indexed as "accessory liability", it must be made clear that this in no sense connotes some liability which will only attach if some other person makes default. As Professor Michael Bryan says in his learned article "Cleaning Up After Breaches of Fiduciary Duty" (1995) 7 Bond Law Review 67 at 70: "A fiduciary does not escape liability simply because the victim of the breach elects to sue a secondary party. The secondary party may seek contribution from the fiduciary, compelling the latter to pay a proper share of the compensation payable upon breach and thereby defeating the victim's election of the defendant." 33 Professor Bryan says this in noting that there is a very strong tendency of families not to sue the principal perpetrator of a breach of fiduciary duty who might be a relation or companies not to sue their directors because other directors have a personal or business reason of their own for not suing them. 34 Ford and Lee point out in [22700], that the accessory is jointly and severally liable with the principal malefactor to pay the amount of equitable compensation required to restore the trust fund; see eg Rolfe v Gregory (1865) 4 De G J & S 576; 46 ER 1042. 35 I now turn to the proposed amended statement of claim. 36 The second defendant makes four principal attacks on the latest version of the pleading. 37 Paragraph 29 of the statement of claim alleges that the directors of NCRA were acting pursuant to a dishonest and fraudulent design to cause NCRA to enter into Leg One and Leg Two. It alleges that the directors were acting pursuant to a dishonest and fraudulent design under which the company facilitated its holding company falsely to claim that its financial state was in a much better situation than was really the case.

38 However, there is no allegation that entering into Legs One and Two was a breach of duty. Nor is there any pleading as to how it came about that the directors of the holding company came to their decision as to the structure of their accounts, nor is it pleaded that the directors of the company participated in that decision. The pleading states that at all material times the board of NCRH consisted of Messrs Ghose, Daya and Peck (who were three of the four directors of NCRA) plus Messrs Beach, Deery and Morrissey who were not directors of the company.

39 The kernel of the plaintiffs' complaint is that the board of the holding company resolved in September 1998 to adopt the accounting treatment. However, there is no pleading that the three directors of the company voted in favour of it. 40 Assuming it was alleged by implication that there was a fiduciary duty and that the fiduciary duty was to the company, it would still be necessary to look at each director's position separately: Re Southern Resources Ltd (1989) 15 ACLR 770, 781. The case went on appeal where it is reported as Southern Resources Ltd v Residues Treatment & Trading Co Ltd (1990) 56 SASR 455; 3 ACSR 207, where at SASR 466 and ACSR 217, the same flavour comes through. 41 Mr Pembroke says that it is important in a Barnes v Addy case for there to be precise identification of the persons who are alleged to have breached the fiduciary duty and statements of what it is was they did to breach that duty.

42 I have set out the elements of the equitable cause of action in the preceding analysis. Because of the limitations noted in that analysis, it is important that a pleading not leave it open to inference but to state what is the breach of fiduciary duty, to whom the duty was owed and by whom and by what act the duty was breached. 43 The present pleading does not to my mind state the fiduciary duty alleged to be breached or, indeed, to whom it is said to be owed. There is, as Mr Pembroke has submitted, no allegation of a fiduciary obligation which was breached. 44 The present pleading does not look at each of the three directors and state how that person breached his duty. A look at the facts reinforces the need for this to be done as the case of Mr Peck would, at least seem to be different from the case concerning the others. 45 Even if one reads into the pleading an implication that the relevant directors owed a fiduciary duty to the company, what they did was to further the company's interest, at least in the thinking of the time, and the case does not fall into either of the categories considered earlier. 46 The next attack is on the pleading against the second defendant in paragraphs 33 and 34. 47 So far as the second defendant is concerned, paragraph 33 of the statement of claim says: "Circumstances were known to Guy Carpenter Australia that would have indicated to an honest and reasonable person that a fraud was being committed or attempted". 48 There are then a series of particulars (a) to (l) which detail various communications between Guy Carpenter UK and others to the second defendant. It is then alleged in paragraph 34 that the second defendant "knowing of the circumstances referred to in the preceding paragraph, assisted the directors in the dishonest and fraudulent design". There are then set out nine overt acts which are alleged to have constituted the assistance. 49 Similar allegations are made with respect to other defendants. No other defendant has filed a motion to strike out, but I was given to understand that the result of this motion may well lead to similar results flowing through to other defendants. 50 First, the statement in 33 "circumstances were known to Guy Carpenter Australia that would have indicated to an honest and reasonable person that a fraud was being committed or attempted" seems to fall between the fourth and fifth class of Peter Gibson J's classification in Baden v Societe Generale. Further, the words "committed or attempted" are quite nebulous. None of the overt acts alleged against Guy Carpenter Australia occurred after 9 July 1998. 51 In my view the paragraphs insufficiently set out the material facts as to the vital element of knowledge said to be possessed by the second defendant. 52 The third main attack was on paras 43-45, the claim for damage to the company. The allegation is that as a result of the false claim that the company had reinsurance recoveries of just under $US7 million under Leg One, it was able to continue negotiation with its bankers and show in the consolidated accounts of NCRH that those funds existed and if it had not been able to do that the company would not or could not have attempted the capital raising and would have gone into run off on or about 3 September 1998. But for the entry into Legs One and Two, the company would not have paid out the deposit premium and in consequence of the entry into Legs One and Two the company has incurred a loss of $US1 million by virtue of making that payment. In consequence of not having gone on to run off on 3 September 1998, it incurred substantial further losses and would not have become a party to the proceedings Ingot Capital Investments Pty Ltd v Macquarie Equity Capital Markets Ltd, No 50169/01 in the Commercial List of this Division. 53 I was referred to Alexander v Cambridge Credit Corporation Ltd (1987) 9 NSWLR 310. That was a case of damages for breach of contract whereas the present is a case of equitable compensation for breach of fiduciary duty or assisting a breach of fiduciary duty. The main complaint here was insufficient particularity. 54 Equitable compensation is, of course, assessed on quite a different basis to common law damages. Furthermore, the rules of causation differ. The applicable principles are set out by the High Court in Youyang Pty Ltd v Minter Ellison Morris Fletcher (2003) 212 CLR 484. 55 I do not consider that this pleading is helpful. Equitable compensation differs from legal and equitable damages and looks not so much to the loss suffered as to what is required to restore the trust fund. It would be difficult to make that assessment from the facts pleaded. 56 I would not consider that I should strike out these paragraphs as it was probably sufficient merely to plead that equitable compensation is required to atone for the fiduciary breach with particulars. 57 There was a fourth attack and that was based upon a series of emails and other correspondence passing between the parties during 1998. 58 Although a fair bit of the hearing time was spent on these, I do not consider that they are vital on a strike out application. 59 Mr Pembroke endeavoured to show through reference to the actual correspondence and emailed particularized, that when one looked at the text in an impartial way, there were ongoing discussion between interested parties between February and the end of September 1998 as to what to do about the financial problems of NCRA. That material shows that the possible solution changed from time to time. It shows that at least Mr Peck was uncomfortable about some of the suggestions and wished further consideration and to take further advice. 60 Furthermore, the material shows that it is debateable whether the directors of NCRA even had some sort of constructive notice as to how the Leg One or Leg Two transaction might appear in the final consolidated accounts for NCRH. 61 Mr Pembroke makes the further point that one would not assume that directors of a subsidiary would have an appreciation that something they were doing in September might affect the consolidated accounts for the year ended 30 June then last past. 62 I appreciate these arguments, but in my view they are not strong enough to lead to striking out. 63 Mr Finch SC said that virtually all of the second defendant's attacks were as to particulars. He put that the plaintiffs have pleaded the material facts which they are bound to do and although particularity is desirable, lack of particulars are not fatal. 64 He puts that the plaintiffs do not complain at all about what the board of NCRH did. He further says that everyone knew about Leg One. It was Leg Two which caused the problem. 65 There is a lot in what Mr Finch says about defects of particularity, but it seems to me for the reasons that I have already expounded, that the defects in the pleadings go deeper than that. It is essential to plead the elements of the second limb in Barnes v Addy and this the pleading has not done. 66 The last version of the pleading does not to my mind set out the material facts as to the duty and breach of duty: the failing goes further than a mere matter of particulars. 67 The case has now reached the point where there have been about half a dozen versions of the statement of claim over the last two years. I gave fair warning that this was the last chance and I did not intend to keep striking out attempts and allowing repleading. Accordingly, it seems to me that I should decline to give leave to amend the first statement of claim further, and I should strike out the claim as against the second defendant. 68 In accordance with my understanding set out earlier, I will have the matter listed at 9:30 am on Thursday 16 September 2004 for mention to plot the next step in the case. However, if counsel indicate to my Associate by 4:00 pm on 10 September that this time is inconvenient or that they expect the mention to take more than ten minutes, some other time can be arranged.

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