Plaintiff v Defendant

2 The plaintiff's claim herein is for damages arising out of allegedly defective flexible polypropylene resins supplied to it by the defendant for the purpose of manufacturing geomembranes (or liners) for the containment of water and other substances.

3 The action is set down for a trial commencing on Wednesday 15 April 2009 and is estimated to take about 35 days.

4 The plaintiff is a subsidiary of Nylex Ltd, a company whose shares are quoted on the ASX but which are currently suspended. Events in February of this year have given rise to this application for security for costs, although there were indications last year that the Nylex group was experiencing some problems in relation to the extension of its banking or other loan facilities.

5 On 9 February 2009, the parent company announced that a default had arisen under its borrowing arrangements with its lenders and that this event had given rise to a further default under a trust deed governing unsecured convertible notes that had been issued in 2006. On 11 February 2009, a trading halt was requested in respect of the listed shares.

6 Later on 11 February 2009, the company appointed voluntary administrators (who were also appointed to the parent company), and, at or about the same time, certain banks as secured creditors appointed receivers and managers of the assets of the group (including the plaintiff).

7 Although the solicitors for the defendant had first foreshadowed an application for security for costs in December 2008, it was the appointment of the administrators, and also the receivers and managers, that not unreasonably precipitated the present application.

8 The solicitors for the defendant wrote to the solicitors for the plaintiff by letter dated 13 February 2009 asking them whether the plaintiff intended to proceed with the litigation, in the light of the recent events affecting the group and went on to say:**

"In the event that it does our client holds grave concerns that the plaintiff will be unable to pay the defendant's costs in this proceeding, if the defence succeeds. These costs could easily exceed $1 million given the likely duration of the trial and the costs incurred to date...Accordingly we would ask that you furnish us with documentation that will satisfy our client that the plaintiff will be able to meet any order for costs that might be made in our client's favour."

9 By letter dated 16 February 2009, the plaintiff's solicitors replied stating that, pending completion of an investigation by the administrators, they were not in a position to advance knowledge of the plaintiff's financial affairs beyond that available in the public domain. They went on to say that:

"As you will also know from the discovery, this is in large part a subrogated claim arising in consequence of payments made by recall insurers in respect of liabilities of Nylex arising on account of the defective nature of the products supplied by your client and incorporated into the liners sold...In order to avoid argument, our instructions are that recall underwriters will agree to enter an undertaking in favour of your client to indemnify it in respect of any recoverable costs incurred as from 12 February 2009 awarded by a Court but not otherwise paid by Nylex..."

**10 I note that the plaintiff has since widened the proffered undertaking to cover all of the defendant's costs, both past and future, that the plaintiff might be ordered to pay.

11 In reply, by letter dated 18 February 2009, the defendant's solicitors asked in substance to what extent the claim was not a subrogated one and, as I understand the position, that enquiry has never been answered.

12 The defendant's solicitors nevertheless proffered a form of undertaking but shortly thereafter contended and still contend that any such undertaking would be inadequate.

13 The defendant bases its application upon s.1335 of the Corporations Act 2001 (Cth) and contends that "it appears by credible testimony that there is reason to believe that the [plaintiff] will be unable to pay the costs of the defendant if successful in...its defence." The defendant further relies on O 62.02(1)(b) of the Supreme Court Rules which applies where the plaintiff is a corporation that sues, not for its own benefit, but for the benefit of some other person, and "there is reason to believe that the plaintiff has insufficient assets in Victoria to pay the costs of the defendant if ordered to do so."

14 The plaintiff submitted that the defendant had failed to establish the fundamental pre-condition (often referred to as "jurisdictional") to an order for security for costs. Senior counsel for the plaintiff said that the mere fact that a company was in administration and receivership did not of itself establish the pre-condition and in addition he pointed to the financial statements of the Nylex group for the year ended 30 June 2008 which showed substantial assets and to the recent statement made by the receivers that it was intended that the group continue in business. The plaintiff submitted, in the alternative, that as it was entitled to an indemnity for all costs from the insurers who were bringing the proceeding in its name, the defendant had not established the pre-condition and that, in any event, that the existence of that indemnity meant that the defendant had no need to obtain security for costs.

15 For reasons that follow, I do not accept the plaintiff's submissions in that regard.

16 The onus is and remains on the defendant to establish the necessary requirements for an order for security for costs under s.1335 and the language of the statutory test is clear.[1] As the Court of Appeal said in Livingspring Pty Ltd v Kliger Partners:[2]**

"The phrase "reason to believe" is the touchstone of jurisdiction. It requires a rational basis for the belief - and no more. The wording adopted may be contrasted with other familiar formulations such as "if the court is satisfied that ..." or "If in the view of the court it is likely that...". The section requires the making of a judgment, a risk assessment: is there a risk that the corporation will be unable to pay? (it adds nothing, in our view, to say that it must be a "real risk".) A risk assessment is, of necessity, imprecise. The section calls for a practical, commonsense approach to the examination of the corporation's financial affairs.

It may be said, with justification, that this is a low threshold. But the test simply reflects the policy of the provision, which is to protect a defendant against the risk of the plaintiff corporation's impecuniosity. The provision equips the court with the means to require that the defendant be secured against that risk.

The power being enlivened, the court must consider whether it should be exercised. Foremost among discretionary considerations will be any contention on behalf of the plaintiff that an order for security would work an injustice..."

**17 The object of Part 5.3A of the Corporations Act is stated to be, by s.435A thereof, to provide for the business, property and affairs of an insolvent company to be administered in a way that maximises the chances of the company, or as much as possible of its business, continuing in existence, or, if it is not possible for the company or its business to continue in existence, to be administered in a way that results in a better return for the company's creditors and members than would result from a winding up.

18 The object of Part 5.3A is thus predicated upon the existence of an insolvent company. For the company to appoint administrators, by s.436A(1), the directors must be of the opinion that "the company is insolvent, or is likely to become insolvent at some future time." The text of the directors' resolution is not in evidence but it can be presumed to have been a regular resolution and that, even if it did not state that the plaintiff was insolvent, it must at least have stated that the company was likely to become insolvent. For this purpose, it is insufficient for the directors to consider that there is a "question" about the company's insolvency or likely insolvency - they must be of the opinion that it is or is likely to become insolvent.[3]

19 In my view, where directors have put a company into administration on this statutory basis, and in the absence of any other evidence, there is very likely to be "reason to believe" that the corporation will be unable to pay the costs of the defendant if required to do so. In the present case, I do not think that there is any satisfactory countervailing evidence. The plaintiff pointed to its 30 June 2008 Annual Report as demonstrating balance sheet solvency but, as the defendant pointed out, there are significant qualifying statements in that document including a statement that the directors acknowledged that uncertainty remained over the ability of the group to meet its funding requirements and that, if for any reason the group was unable to operate as a going concern, there would be an associated impact on its ability to realise assets at their recognised values. Of course, since then, the plaintiff and the group as a whole have defaulted not only in relation to its banking facilities but also in relation to its convertible notes, administrators and receivers have been appointed and there is no satisfactory evidence of the plaintiff's present financial position.

20 Putting aside the matter of the insurers' indemnity, I am therefore satisfied that there is reason to believe that the plaintiff will be unable to pay the costs of the defendant if required to do so.

21 The plaintiff said that security should not be ordered because the action was brought "largely" as a subrogated action at the instance of the insurers of the plaintiff who would be liable to indemnify it for the costs incurred in doing so, including any adverse costs order. In this regard, the plaintiff further relied upon the fact that the insurers of the plaintiff had offered and continued to offer an enforceable undertaking to pay the defendant's costs.

22 It was common ground that, as a general rule, to the extent that any action was a subrogated action, the insurers would be obliged to indemnify a plaintiff against any orders as to costs. However, I note that the plaintiff did not provide evidence of the relevant insurance policy or policies and did not provide evidence as to the extent to which the action was a subrogated action. The plaintiff baldly submitted, without reference to any authority, that, having regard to the existence of an indemnity, "there is no risk...of the defendant not recovering costs." Even if the action was a wholly subrogated action, I cannot discern the basis upon which it could be said that there was no risk of the defendant not recovering costs by reason of an indemnity from the insurers. As this argument has to proceed on the basis that the plaintiff would be, without the indemnity, unable to pay any such costs (i.e. insolvent), the proceeds of such indemnity would have to be paid into the pool available to all creditors and would not be directly available to the defendant.[4]

23 Of course, to the extent that the action is a subrogated action, the defendant might in due course seek an order for costs against the non-party insurers but that, of itself, was not, and it seems to me could not, be relied upon as a sufficient answer to the present application.

24 It was no doubt in light of the foregoing considerations that the plaintiff placed principal reliance upon its offer to provide a written undertaking on behalf of the insurers to meet any order for costs in favour of the defendant.

25 The undertaking was put forward either on the basis that it rendered security for costs unnecessary or on the basis that the undertaking itself constituted a more than satisfactory form of security that was "least disadvantageous to the party giving that security."[5]

26 The final version of the written undertaking was an undertaking by "QBE Casualty Syndicate 386 at Lloyds" for and on behalf of the insurers set out in the schedule for what was said to be their respective proportionate liability under the insurance policy.[6] The undertaking provided that QBE Casualty Syndicate 386 warranted that it was duly authorised to execute the same on behalf of each of the insurers. The substantive undertaking was that each insurer for its respective proportion would pay to the defendant (within sixty days of non-payment by the plaintiff) all costs the subject of a Court order in favour of the defendant. The undertaking was to be signed by "David Lloyd who is authorised to and signs on behalf of Syndicate 386 and on behalf of the insurers set out in the Schedule to this Agreement by QBE Casualty Syndicate 386."

27 The solicitor for the plaintiff swore a number of affidavits to which was exhibited substantial documentation relating to the financial position of the various Lloyds' syndicates comprising the insurers. On the face of it, this material, as one would expect, depicted a number of insurers with substantial premium income and considerable financial resources. On the other hand, the material was not verified by anyone with personal knowledge of the financial statements contained in it. The solicitor simply produced the material and in effect said that he believed the contents thereof. In the current global financial climate, even if I assume that there is no publicly known reason to doubt this information, I would have some hesitation in accepting what is simply hearsay material.

28 More importantly, the proposed written undertaking relies for its efficacy upon two warranties of authority (one by the QBE Casualty Syndicate 386 and one by David Lloyd) and offers only proportional liability by the various insurers.

29 I am satisfied that an order for security for costs should be made and the uncertainties and complexities presented by the proffered undertaking are such that I am not satisfied that the undertaking constitutes an appropriate mode of providing such security.

30 There was no evidence that the insurers would have any difficulty in obtaining a guarantee from an Australian bank and the only apparent prejudice to the insurers by ordering this form of security would be the bank charges incurred in obtaining the same. In that regard, the defendant in substance offered to abide any order of the Court as to those bank charges should the plaintiff subsequently succeed in the proceeding (or it was otherwise appropriate to reimburse the plaintiff or the insurers for those bank charges).

31 The defendant sought an order for security for both past and future costs of the proceeding. The Court has power to make an order in relation to past costs as well as future costs[7] and I think it is appropriate to do so in this case.

32 Although the solicitors for the defendant in their letter dated 13 February 2009 said that the defendant's costs "could easily exceed $1 million given the likely duration of the trial and the costs incurred to date,"[8] when it came to his affidavit the relevant partner of the solicitors for the defendant said that the defendant had already incurred legal costs and disbursements in the amount of approximately $1.7M and estimated further costs, of the trial, of some $800,000. He estimated that 65% of that total of $2.5M would be recoverable on a party-party taxation. However, no details were provided and there was no evidence from an independent costing expert, as is often the case.

33 Doing the best I can, and recognising that security for costs need not necessarily provide a full indemnity, and taking into account the apparent substance of the insurers standing behind the plaintiff, I consider that it is appropriate in the discretion of the Court to order that the plaintiff provide as security for the past and future costs of the defendant, a guarantee from one of the four major Australian banks (such guarantee to be in a form acceptable to the Prothonotary) in the sum of $500,000.**

[1] Livingspring Pty Ltd v Kliger Partners (2008) 55 ACSR 455, 459.

[2] (2008) 55 ACSR 455, 459 at [15]-[17].

[3] See Wagner v IHP (1994) 15 ACSR 419, 421 per Santow J.

[4] That position may be contrasted with that which arises when a company in liquidation is liable to a third party and is covered by a relevant insurance policy - the third party can look to the liquidator for direct payment of the insurance monies: s.562 of the Corporations Act 2001.

[5] See Rosengrens Ltd v Safe Deposit Centres Ltd [1984] 3 All ER 198, 200.

[6] The percentages are set out in the schedule.

[7] See Brocklebank & Co v The King's Lynn Steamship Co (1878) 3 CPD 365; Massey v Allen (1879) 12 Ch D 807; JWH Turner & Co Ltd v O'Riordan (1923) 40 WN 64; Southern Cross Exploration NL v Fire & All Risks Insurance Co Ltd (1985) 1 NSWLR 114, 122.