PHOENIX EAGLE COMPANY PTY LTD -v- TOM McARTHUR PTY LTD [No 2] [2019] WASC 378 (22 October 2019)

1. Under s 1335 of the Corporations Act 2001 (Cth), where a corporation is plaintiff in any action, if it appears by credible testimony that there is reason to believe that the corporation will be unable to pay the costs of the defendant if successful in its defence, the court may require sufficient security to be given for those costs and stay all proceedings until the security is given.
2. Costs are awarded to indemnify the successful party, at least in part, against the expense to which they have been put by reason of the legal proceedings. The purpose of an order for security for costs against a corporate plaintiff is to protect the defendant against the risk of being deprived of the benefit of that compensation, should the defendant be successful.
3. Security can be given in various ways, including by those standing behind an impecunious plaintiff undertaking to meet the costs. This matter has proceeded, however, on the basis that costs would be by payment into court.
4. The defendants have put forward evidence of the plaintiff's financial position, and the plaintiff does not dispute that it would be unable to meet a costs order should the defendants succeed.
5. Once the conditions for the exercise of the power under s 1335 have been met, the court has an unlimited discretion whether to require security. The discretion is to be exercised considering all of the circumstances of the case. Essentially, the section requires a balance to be struck between protecting the defendant from the possible consequences of being sued by an impecunious corporation with limited liability, and avoiding injustice to the corporation by unnecessarily prejudicing it in the conduct of litigation: see Buckley v Bennell Design & Construction Pty Ltd (1974) 1 ACLR 301.
6. The issues raised in this application go to the proper exercise of discretion to make an order. There are several cases which have identified the factors commonly considered in such applications: see KP Cable Investments Pty Ltd v Meltglow Pty Ltd [1995] FCA 76; (1995) 56 FCR 189, 196 - 198; Westonia Earthmoving Pty Ltd v Cliffs Asia Pacific Iron Ore Pty Ltd [2013] WASC 57 [6]. The plaintiff opposes the defendants' application on three grounds relating to the exercise of the court's discretion:

(a) The plaintiff does not have financial capacity to provide the security sought by the defendants, and the directors and shareholders of the plaintiff who have funded the action so far are unable or unwilling to provide further funding. Therefore it is likely that a further order for security for costs will stultify the plaintiff's action ‑ that is, bring it to a premature end.

(b) The plaintiff's lack of financial substance has been brought about by conduct of the defendants, which is the subject of the plaintiff's claim in this action.

(c) The plaintiff's action is bona fide and has strong prospects of success.

1. Before considering the particular grounds, there are some general principles which guide the consideration of this application.
2. The defendants do not have an entitlement to security; nor is there a predisposition towards an order for security: see the extensive review of the authorities in Bryan E Fencott and Associates Pty Ltd v Eretta Pty Ltd [1987] FCA 102; (1987) 16 FCR 497. In the circumstances of a particular case, however, the fact that the plaintiff is impecunious may be an important factor in determining the application: Spiel v Commodity Brokers Australia Pty Ltd (in liq) (1983) 35 SASR 294, 300 ‑ 302; Pearson v Naydler (1977) 1 WLR 899, 906; BPM Pty Ltd v HPM Pty Ltd (1996) 131 FLR 339; (1996) 14 ACLC 857, 860; Harpur v Ariadne Australia Ltd (No 2) (1984) 2 ACLC 356, 361.
3. On the matters raised in the present application, the court should have regard to:

(i) the accepted position that the plaintiff will be unable to pay the defendants' costs;

(ii) whether the plaintiff's impecuniosity was caused or materially contributed to by the defendants' conduct which is the subject of the claim;

(iii) whether the application for security is oppressive, and in particular, whether the award of security would deny the plaintiff a right to litigate, and stultify its claim;

(iv) whether there are persons standing behind the plaintiff who are likely to benefit from the litigation, and whether those persons have offered any security or personal undertaking to be liable for the costs, and if so, the form of such an undertaking.

1. The plaintiff submits that it has strong prospects of success.
2. The bona fides of the claim and its merits may be considered in the exercise of the discretion, at least where there is material from which an assessment may be made: see, for example, Bryan E Fencott & Associates Pty Ltd v Eretta Pty Ltd (513 - 514). Generally, however, the court should not embark on a detailed consideration of the merits: Equity Access Ltd v Westpac Banking Corporation (1989) ATPR 40‑972, 50-636; Interwest Ltd v Tricontinental Corporation Ltd (1991) 5 ACSR 621, 624; Jazabas Pty Ltd v Haddad [2007] NSWCA 291; (2007) 65 ACSR 276 [83] ‑ [84].
3. The action is advanced, with both sides having filed their witness statements. The statements, with attached documents, run to well over 2,000 pages. It is not practical to go into a detailed consideration of the evidence filed.
4. In Jazabas Pty Ltd v Haddad, McClellan CJ at CL said, with the concurrence of Mason P:

The question which must be asked is whether the claimants' case is bona fide and raises real issues to be tried. Unless obviously hopeless the prospect of success or failure is of little relevance. This must especially be the case where, as in the present matter, the issues to be litigated are complex and where it may be thought the law is developing [83].

1. I am satisfied that the plaintiff's case is brought in good faith and raises real issues to be tried.

1. The plaintiff relies on the affidavit of Mark Richardson (sworn 6 September 2019). It also relies on the affidavits of George Baumanis (sworn 6 September 2019); Mervyn Albert Dudley (sworn 6 September 2019); Oliver Morrice Williams (sworn 5 September 2019); and Paul Stanley Wright (sworn 6 September 2019) who are all directors of, or shareholders in, the plaintiff.
2. Mr Richardson deposed that, from the commencement of preparation of the statement of claim in the action until the completion of mediation in 2018, the plaintiff incurred $653,497 in legal costs, although that amount includes $70,000 as security for costs. Some of those costs may have been incurred before the writ was filed.
3. Mr Richardson deposed that the initial costs of the proceedings were funded by the directors and shareholders, and that he also 'made efforts to raise additional funding to meet the Company's expenses, both for the litigation and for continuing protection and development of its intellectual property'. His attempts to secure funding, including through a commercial litigation funder, were unsuccessful.
4. Mr Richardson further deposed that the plaintiff has liability for deferred salaries and directors' fees, including superannuation, which at 30 June 2019 was for more than $4,600,000. The plaintiff has been able to maintain solvency by borrowing from Mr Baumanis. It has outstanding borrowings, including accrued interest, of nearly $3 million.
5. The financial statements for the plaintiff for the 2016, 2017 and 2018 financial years record a contingent liability, pursuant to a Litigation Funding Agreement, to Messrs Dudley, Richardson and Wright, Keith Brown (now deceased), and the Williams Family Trust. In an affidavit filed on the morning of the hearing, the defendants put in evidence the agreements. In short, the parties to the agreement have contributed fixed amounts for, on a successful outcome, the return of their funds and a comparatively modest return.
6. Mr Richardson stated that he is unable to lend any further funds to the plaintiff for the purpose of conducting the action and does not have the financial capacity to provide security for costs.
7. Mr Baumanis deposed that he has already provided significant financial assistance to the plaintiff for its earlier litigation against William Ardrey, a former director of the plaintiff; the legal costs of this action; and expenses required to maintain the plaintiff's solvency. He is prepared to pay essential operating expenses to keep the plaintiff afloat but not to draw on his 'limited remaining personal financial resources' to make further loans to meet legal fees or orders for security for costs.
8. Mr Williams deposed that he is retired. His family trust has already provided litigation funding to the plaintiff in the amount of $200,000. He wants to ensure that adequate provision is made for his children from his family trust and is unwilling to provide further funding to the plaintiff for the purposes of the litigation.
9. Mr Dudley deposed that he has also contributed $200,000 to the litigation fund but said he is unable to lend further funds to the plaintiff for the purpose of conducting the action.
10. Mr Wright described himself as a self-funded retiree. He said that he has provided $100,000 to the litigation fund, but has exhausted his personal financial capacity to support the litigation and is not prepared to make further loans to the plaintiff.
11. Finally, the plaintiff seeks to rely on the affidavit of Joseph Patrick Finnegan (sworn 5 September 2019). Mr Finnegan deposed to his long career and experience in finance and investment strategies in the United States of America. He expressed the opinion that the current litigation creates doubt over the invention and ownership of the OPAL A process, and so long as that doubt continues the investors he would like to introduce to the plaintiff would be unlikely to invest.
12. In his first affidavit in support of the application for security for costs, sworn 23 August 2019, Trevor Howard Brickhill attached two shareholder updates issued by the plaintiff on 22 December 2018 and 2 June 2019. The plaintiff advised shareholders, in effect, that it had recently filed a new patent application, and a new subsidiary company (Newco) would be formed and have joint ownership of all existing patents and would hold new patents. In June 2019, the company advised shareholders that a new Australian subsidiary Proteolytics Pty Ltd had been incorporated in January 2019, and was about to embark on capital raising.
13. In a responsive affidavit, sworn 8 October 2019, Mr Richardson deposed that the proposed capital raising was not successful and no property of the plaintiff was transferred to Proteolytics. Although the issue has largely fallen away, I accept the plaintiff's explanation that the proposed incorporation of Proteolytics was an attempt to commercialise its intellectual property, and not to put property out of the reach of potential creditors.

Was the plaintiff's impecuniosity caused by conduct of defendants

1. The plaintiff carries the onus of establishing both the adequacy of its financial position before its dealings with the defendants, and that the defendants' actions have caused or at least materially contributed to the plaintiff's inability to meet an order for security for costs: Jazabas Pty Ltd v Haddad [94]. The court will not assume that, because a successful claim will result in an award of damages, it was the defendants' wrongful conduct that led to the plaintiff's financial position: Jazabas Pty Ltd v Haddad [33].
2. The plaintiff's claim, set out in par 98 of the Amended Substituted Statement of Claim, is that, by their conduct in and from October 2010, Thomas McArthur (not a party) and Mr Brickhill diverted commercial opportunities for their own benefit and:

(a) deprived the plaintiff of the opportunity to earn additional royalties;

(b) deprived the plaintiff of the opportunity to use the commercial success of the HFPA Products in exploiting its products in other markets; and

(c) compromised the plaintiff's ability to exploit its products in other markets.

1. It has been said that where the plaintiff's claim is based upon a loss of profit, the court will take a more cautious approach in its consideration of the cause of impecuniosity than where the claim is based on the infliction of damage: Fat-sel Pty Ltd v Brambles Holdings Ltd [1985] FCA 89; (1985) 3 ACLC 312; ATPR 40‑544 at 46, 428; Jazabas Pty Ltd v Haddad [33].
2. In the present case, the evidence regarding the financial position of the plaintiff is inadequate.
3. In his affidavit sworn 6 September 2019, Mr Richardson said that in June 2008 the plaintiff entered into an exclusive licensing agreement with HFPA, under which he received a $1.2 million licensing fee upfront, with HFPA paying a low royalty rate. The $1.2 million gave the plaintiff sufficient funding to undertake scientific investigations and clinical investigations. Mr Richardson said the intended business model for the plaintiff was to use the expected success of HFPA's marketing and sale of products to create licensing opportunities in other countries, with better ongoing royalty rates.
4. Mr Richardson said the sales revenue received by HFPA in October 2010 exceeded $300,000 but decreased to an average of less than $30,000 a month for the period July 2011 to March 2012.
5. Mr Richardson also attached, at MR1, the financial statements for the years 2016, 2017, and 2018. The income in each year was largely derived from R&D tax incentives.
6. The plaintiff did not put on any other evidence of its financial position between 2010 and 2015 (the 2015 figures being part of the P&L for 2016).
7. In the earlier application for security, the defendants relied on the affidavit of Ms Brickhill, dated 19 July 2016. Ms Brickhill attached the financial statements for the plaintiff for the financial year ended 30 June 2010, the period after the licencing agreement with HFPA and shortly before the defendants' alleged wrongful conduct: see LCB 15.
8. The plaintiff's income in 2010 was almost all from R&D tax offsets ‑ royalty payments for the year were only $955. In 2009, an amount of $100,000 was received from expiry of options, but no royalty payments. R&D tax offsets were over 75% of the plaintiff's income. In each of the years 2009 and 2010, the plaintiff achieved a loss from ordinary activities before income tax, and its liabilities exceeded its assets by approximately $1 million in each year.
9. The plaintiff's case is that the defendants' dishonesty prevented it from potentially earning a substantial income from licensing opportunities. But on the evidence now before me, I am not satisfied that the plaintiff has shown that its present impecuniosity was caused or materially contributed to by the defendants' conduct.
10. First, the plaintiff put forward incomplete evidence. While it referred to the sales evidence of HFPA in the second quarter of the 2010/2011 financial year, it adduced no evidence of other quarters, either before or after those three months. Second, on the royalty rate of 1% of net sales, even in October 2011 the royalty payment was only $2,094.99. It is a modest return for the company. And there is no basis for the court to infer how that level of sales would have translated into profit on the plaintiff's business model: that is, there is no evidence in this application of potential licensing opportunities in other countries that the plaintiff could have pursued. Third, the plaintiff has not accounted for other matters that may have affected its financial position. For example, the parties referred in the hearing to criminal proceedings against Mr Ardrey. In those proceedings it was alleged that, in 2006, Mr Ardrey defrauded the company of $394,759.38.

1. In Epping Plaza Fresh Fruit & Vegetables Pty Ltd v Bevendale Pty Ltd [1999] VSCA 43; [1999] 2 VR 191 [13] ‑ [14], Winneke P and Phillips JA said

The evident purpose behind statutory provisions such as s 1335 is to draw a distinction between corporate plaintiffs and individual plaintiffs. Thus, whilst it may be said that '[t]the basic rule that a natural person who sues will not be ordered to give security for costs, however poor he is, is ancient and well established' ...it is also true that 'the whole concept of the general practice with regard to companies is just the opposite. It is the poverty of the company that attracts the power'...

...the justification for the statutory rule is that the defendant, not being a voluntary litigant, deserves to be protected from the consequences of limited liability. Those who seek to conduct their businesses through limited liability companies expect to receive the benefits which such liability attracts. It seems to us a necessary corollary that they should be prepared to accept the strictures imposed by the section if the company embarks upon litigation. (citations omitted)

(See also Pearson v Naydler [1977] 1 WLR 899, 904-905).

1. Their Honours emphasised that the section does not compel the court to order security against an impecunious corporate plaintiff, but the court has unfettered discretion to do what is just in the circumstances of each case.
2. Whether an order for security will stifle the proceedings is a powerful factor to which the court will have regard, but one factor only. There are cases in which security is ordered even though the consequence is, or may be, to stultify the claim. See Live Board Holdings Ltd v Cody Live Pty Ltd [2017] NSWCA 302 [92] ‑ [93].
3. One of the other factors to which the court will have regard is whether those who stand behind the plaintiff and would gain from the litigation are financially able to provide adequate security. The plaintiff submitted that not only is it impecunious, but that each of Messrs Richardson, Baumanis, Dudley and Wright, as directors and substantial creditors of Phoenix Eagle, 'have already met and exceeded reasonable expectations in terms of their financial commitment to Phoenix Eagle'. Further, the plaintiff submitted that it has canvassed and exhausted other potential sources of litigation funding, and there are no resources that may reasonably be expected to be available to the company from shareholders, directors or any other outside source. As a result, the plaintiff submitted, it is likely that if a further order for security for costs is made, the action will be brought to a premature end.
4. The plaintiff accepted that the onus was on it to show that the proposed security was likely to stultify the proceedings. The plaintiff submitted that it did not need to establish that its directors and shareholders (some of whom were also creditors) were unable to put up the security sought. It referred, in particular, to the reasons of Barrett JA (with whom McColl and Macfarlan JJA agreed) in LRSM Enterprise Pty Ltd v Zurich Australian Insurance Ltd [2014] NSWCA 88 [36] ‑ [38] where his Honour said:

... the question of lack of means is, in such cases, merely an aspect of a more broadly based inquiry whether, if an order for security is made, the order cannot be met with the result that the litigation will be brought to a premature end. It is the ability of the plaintiff to meet an order for security that is in issue; and, just as the inability of persons standing behind it to give it financial support will be relevant to the inquiry, so too may be unwillingness of those persons (despite ability) and all other reasons for the unavailability of their support. A finding of stultifaction becomes available only to the extent that the reasons of relevant persons other than the plaintiff itself for not giving financial support truly reflect an inability, rather than unwillingness, of the plaintiff to marshall the relevant financial resources. It is for this reason that unwillingness of other persons is viewed differently from their inability.

1. The plaintiff referred also to the decision of the Full Court in BPM Pty Ltd v HPM Pty Ltd, where Anderson J described the correct question as whether in practical commonsense terms it was reasonable to expect the creditors of the plaintiff company to put up a very substantial sum as security for costs.
2. When the question is whether it is possible for the plaintiff to obtain financial support from arms-length creditors, proof by the plaintiff of 'rationally and practically reasonable unwillingness of creditors to give financial support' may be taken into account in the exercise of the undoubtedly wide discretion with respect to security for costs.
3. Counsel did not refer me to any cases where, as here, a litigation funding agreement was in place so that the relevant creditors had a direct interest in any potential return from judgment in the case. There are cases, however, where the court has considered relevant the position of solicitors with an interest in the litigation by reason of an arrangement for the deferment of fees: see Tyneside Property Management Pty Ltd v Hammersmith Management Pty Ltd [2013] NSWCA 404 (referred to in LRSM Enterprise Pty Ltd v Zurich); Ballard v Brookfield Australia Investments Ltd [2012] NSWCA 434; Longjing Pty Ltd v Perpetual Nominees Ltd [2017] NSWSC 1690.
4. The shareholders' interest in the outcome, as litigation funders, is a relevant factor in the decision.
5. Further, on the authorities, different expectations of financial commitment may be applied to officers and shareholders who are involved in the company's internal decision-making and are interested in its ultimate economic success or failure. In Australian Equity Investors v Colliers International (NSW) Pty Ltd [2012] FCAFC 57 [30], Jacobson, Besanko and Perram JJ said, 'The principle at play is a simple one: those who stand to share the benefits of litigation cannot shirk its burdens'. I do not see that statement as excluding the need to consider reasonableness. But the position of the directors, shareholders and creditors of the plaintiff, as persons who will share in the benefits of a successful action, should be taken into account in considering the question of reasonableness, and in assessing the weight to be given to the risk of stultification in the exercise of discretion.
6. There are other factors which require consideration. The weight to be given to each of them depends not only upon its own intrinsic persuasiveness but upon the impact of the other circumstances which have to be weighed: PS Chellaram & Co Ltd v China Ocean Shipping Co [1991] HCA 36; (1991) 65 ALJR 642, 643.
7. First, the court may give weight to the amount of the defendant's loss if the risk materialises: Sent v Jet Corporation of Australia Pty Ltd [1984] FCA 185; (1984) 2 FCR 201, 217. The defendants (from the first application for security) have estimated their costs through to completion as exceeding $500,000. The trial is anticipated to take 10 days and the estimate is reasonable.
8. Second, the plaintiff asks the court to find that it is not reasonable to expect its shareholders and creditors to offer further support. As a result, the plaintiff submits, it is not reasonably able to marshal the necessary financial resources to give security. The plaintiff has not, however, put before the court a full and frank statement of the assets and liabilities of its shareholders and those creditors who are party to the litigation funding agreements: see Newtrend Pty Ltd v Oceanic Life Ltd [1990] WAR 1, 3; Tirops Safety Technology Pty Ltd v Lazer Safe Pty Ltd [2005] WASC 164 [47].
9. Third, the plaintiff has estimated the compensation to which it is entitled as more than $7.5 million, before interest. The litigation is complex and the trial is likely to be long. This factor is essentially neutral between the parties.
10. Fourth, the defendants include two individuals. Some corporations, such as insurers, are capable of absorbing the costs of litigation as part of their business activities. Although it is not the subject of evidence, even if the defendants are wealthy there is a significant potential cost.
11. Fifth, the plaintiff alleges that the individual defendants engaged in a fraudulent and dishonest design. Unless further security is given, they will each be forced to defend serious allegations as to their honesty without any real prospect of recovering more than a small portion of their costs, from the security already given, should they succeed.
12. Sixth, I am not satisfied that the plaintiff has shown its impecuniosity was caused by the defendants' conduct.
13. Seventh, although the plaintiff did not rely on delay, I have taken into account that the application has been brought after the plaintiff filed its witness statements and has already incurred significant costs of its own. On the other hand, the first application for security was for payment in tranches, and was brought on the basis that costs could exceed $500,000. The more recent delay in this matter was the result of the plaintiff's efforts to secure its own funding.
14. Finally, I have considered whether the application for security is oppressive, whether it is being used merely to deny an impecunious plaintiff its right to litigate a just claim. The fact that an order for security may frustrate the plaintiff's claim is a strong factor to take into consideration, but is not decisive. The plaintiff has been able to make arrangements for payment of its own legal fees, should it succeed, but that offers no comfort to the defendants. I do not regard their attempt to protect their own positon as oppressive.
15. Taking those matters into account, I am satisfied that it is just that there should be an order for further security. The risk of stultifying the proceedings does not outweigh the factors favouring an order for further security.
16. The defendants seek security in the amount of $200,000, taking the total security to $270,000, for costs already incurred as well as future costs. They had originally estimated the costs to trial at about $500,000. In an affidavit of Christopher James Terren, affirmed 23 August 2019, the defendants put forward an estimate of costs from these applications through to trial. The amount estimated is between approximately $270,000 and $340,000.
17. I am satisfied that the amount sought is reasonable.
18. There should be an order that the plaintiff give further security for costs in the sum of $200,000. I will hear the parties as to consequential orders.

I certify that the preceding paragraph(s) comprise the reasons for decision of the Supreme Court of Western Australia.