Plaintiff v First Defendant

Perpetual Trustee Co. Ltd v Barnett (1969) 90 WN (Pt. 1) (NSW) 637

Fletcher v Federal Commissioner of Taxation [1991] HCA 42; (1991) 173 CLR 1

Sharrment Pty Ltd v Official Trustee in Bankruptcy [1988] FCA 179; (1988) 18 FCR 449

Australian Horticultural Finance Pty Ltd v Jekos Holdings Pty Ltd [1997] QCA 440

Borg v Northern Rivers Finance (2004) QSC 029

Introduction

1 The plaintiff ("NPV WA") is a financier. In this proceeding it seeks to recover unpaid interest and enforcement costs alleged to be owing by the first defendant ("INS") under an agreement in writing dated 27 February 2001. The second defendant, Mr Atherton, is alleged to be liable as a guarantor.

2 NPV WA alleges that it made a loan pursuant to the written agreement of 27 February 2001 by applying the sum provided for in that written agreement as the loan, being $2,500,000, in discharge of an earlier obligation owed by INS to a related company of NPV WA, named NPV Finance Pty Ltd ("NPV Finance"). The obligation owed to NPV Finance is alleged to arise pursuant to a loan agreement dated 30 June 2000.

3 Throughout the trial, the loan agreement dated 27 February 2001 was referred to as the second loan agreement, and the loan agreement dated 30 June 2000 was referred to as the first loan agreement. I will also refer to them from time to time in that way.

4 The first loan agreement was part of a series of transactions which were principally, if not exclusively, directed towards generating for INS allowable tax deductions and generating for other participants in the transactions commissions, fees and other profits. The second loan agreement was alleged to constitute a re-financing of the loan made under the first loan agreement.

5 The defences raised in the proceeding reflect defences which have been raised in other recent proceedings arising out of similar circumstances, and which were most recently the subject of the High Court decision in Equuscorp Pty Ltd and Anor v Glengallan Investments Pty Ltd & Ors.[1] The defences, as summarised in the defendants' final submissions, were as follows:

(a) There was no loan made pursuant to the first loan agreement and accordingly nothing was refinanced in the second loan agreement.

(b) In any event, the second loan agreement did not give rise to any enforceable obligations as its prescribed purpose was a purpose which at the time could not possibly have been fulfilled and because NPV WA did not lend money as it was required to do pursuant to the terms of that agreement.

(c) The various interrelated transactions of which the first loan agreement and the second loan agreement form a part are all a sham masking the true transaction (if it is necessary to establish a hidden underlying transaction), which was to generate "real money" for the purpose of payment to those promoting, financing and operating the scheme.

The relevant sequence of events

The scheme

6 The principal participants in the relevant transactions were four individuals, Mr Michael Jarrouge, a director of NPV Finance and NPV WA; Mr Terrence Brain, a director of two related companies named Strategic Project Marketing Pty Ltd and Strategic Distribution Management Pty Ltd ("SDM"); Mr Charbel Nader, an officer of companies in a group of which the publicly listed company Village Roadshow Limited is the parent ("the Village group"); and Mr John Atherton, the second defendant and a director of INS. Mr Jarrouge, Mr Brain and Mr Nader gave evidence. Mr Atherton did not.

7 In referring to the scheme in question here, in the course of his oral evidence, Mr Brain described the Village group as the "manufacturer", his companies as the "distributor", and NPV Finance and NPV WA as the "financier". That seems to me to be an apt description. What occurred, according to Mr Brain, was that the Village group sought to take advantage of its position in the film industry by offering "film investment products" to investors. These "products" were attractive to investors because of what were perceived to be their taxation advantages. The particular advantages sought to be exploited here were deductions available for expenditure on intellectual property pursuant to s.373-15 of the Income Tax Assessment Act 1997 and in accordance with s.373-10 of that Act. In substance, the scheme involved the acquisition of film rights by the investor from a company in the Village group and the licensing of those rights to another company in the Village group. As will be seen, the arrangements were such that the investor could be confident that it would eventually recover from the Village group the capital cost initially paid. If the investor used its own funds, the "cost" of the tax deduction which it was hoped would be obtained would be the time value of the capital expenditure. If the investor used finance available as part of the scheme, the "cost" of the deduction would be the interest payable, which it was expected would itself be deductible. The arrangements were such that the principal of the loan would be met by the eventual recovery of the initial capital outlay to which I have referred.

8 The taxation advantages which were expected were set out in some detail in an advice prepared by a partner of the Melbourne solicitors' firm, Deacons Graham and James, dated 6 June 2000, a copy of which was forwarded to Mr Atherton on behalf of INS by Mr Brain under cover of a letter of 7 June 2000. The advantages were set out in that memoranda of advice as nine "propositions", each of which was separately analysed. The propositions were as follows:

(1) "That the expenditure incurred by investors on purchasing a percentage of the Film Rights will qualify as expenditure on an item of intellectual property namely an interest in the Film copyright pursuant to section 373-15 of ITAA 97 in accordance with section 373-10 of ITAA 97."

(2) "The capital expenditure on the item of intellectual property will be taken under section 373-2, item 3 of the ITAA 97 to be the purchase price paid by the investor for the acquisition of the Film Rights."

(3) "That the licensing of the distributor by the investors under the Distribution Agreement will constitute "use" of the item of intellectual property for the purpose of producing accessible income within the meaning of section 373-10 of ITAA 97."

(4) "That the investor will be entitled to amortisation deductions pursuant to s.373-20 of ITAA 97 in respect of the purchase cost of the intellectual property (as set out in the relevant schedule to the Offer to Acquire document) over its effective life as defined by section 373-35 of ITAA 97. That is, the investor will be entitled to amortise the cost of the Film Rights on a straight line basis over the income years ending 30 June 2000 and 30 June 2001."

(5) "That the income received by the investor from the licensing of the Film Rights to the distributor will be assessable to the investor pursuant to section 15-20 of the ITAA 97."

(6) "That any interest expenses incurred by an investor upon loan funds used to acquire the Film Rights will be deductible to the investor under section 8-1 of the ITAA 97 in the year in which those expenses are incurred, commencing in the year ended 30 June 2000. However, no prepayments of interest will be able to be deducted in a single income year if part of the prepayment relates to interest incurred in the next income year."

(7) "That, on the basis of documentation and information provided to Deacons Graham and James, the provisions of Part IVA of the Act should not apply to the transactions."

(8) "That on the basis of the documentation and information provided to Deacons Graham and James, the provisions of sections 82KH, 82KJ, 82KK and 82KL of ITAA 36 should not apply to the transactions."

(9) "That GST will be chargeable on the supplies made by the investors to the distributor under the Distribution Agreement for supplies made post 1 July 2000, by the Representative to the investors under the Representation Agreement for supplies made post 1 July 2000 but not on the supplies made by the Vendor to the Purchasers under the Offer to Acquire agreement."

9 The propositions set out refer to a number of agreements to which I will shortly turn.

10 The deductions which it was expected, or hoped, would be realised resulted from amortisation of the initial capital expenditure over two years. Thus, the deduction for 30 June 2000 would be 50% of the initial capital expenditure with the other 50% available as a deduction in the year ended 30 June 2001.

11 Mr Atherton on behalf of INS, after discussions and dealings with Mr Brain both personally and through his then accountant Mr Michael Santimauro, determined to participate in the scheme. The initial capital investment which he wished to make was the sum of $5m.

The agreements

12 Mr Atherton on behalf of INS signed a representation agreement ("the Representation Agreement") appointing SDM as its representative and attorney for the purposes of negotiating, executing and acting under two other agreements, being an "Offer to Acquire Film Rights" and a "Distribution Agreement". Pursuant to the Representation Agreement INS agreed to pay to SDM a representation fee of .75% of the purchase price. The purchase price provided for was the sum of $5m.

13 Mr Atherton also signed on behalf of INS a document entitled "Offer to Borrow" which was directed to NPV Finance. It is this document which is referred to as the first loan agreement. There are two versions of the first loan agreement in evidence. One version bears the date 30 June 2000 in the handwriting of NPV Finance's director, Mr Michael Jarrouge, in Item 1 of the Schedule on the document's front page. The other does not. One of the terms of the document, clause 25, reads as follows:

"This contract takes legal effect from the date we accept your Offer to Borrow. We will insert that date in Item 1."

14 The first loan agreement provided, in clause 2, that NPV Finance would lend INS "the amount set out in Item 3 of the schedule". The amount so set out is $5m. This sum is inserted in handwriting. The handwriting is Mr Brain's. Mr Jarrouge's evidence was that when he dated the document this figure was wrong and he knew it was wrong. His evidence was that NPV Finance never agreed to, and never intended to lend INS any more than $2.5m, and that he advised "Village" and "Strategic" accordingly. The evidence of Mr Nader and Mr Brain was consistent with this evidence. According to the evidence of Mr Nader, the $5m investment was financed as to $2.5m by NPV Finance and as to the balance by some form of vendor finance by the Village group.

15 Clause 2 of the first loan agreement required that the loan be used for the purpose stated in Item 4 of the Schedule. Item 4 stated that purpose to be "The acquisition of the Film Rights".

16 The repayments required were purportedly set out in item 6. Item 6 read as follows:

"55 monthly payments and a further balloon payment in the 55th month to coincide with the payment of revenue to investors."

17 Mr Jarrouge's evidence was that this description of payment dates and amounts was "incomplete".

18 It is necessary to set out in full certain of the provisions concerning security, set-off, and application of the loan funds, in the first loan agreement. The terms relevantly provide as follows:

"29. DIRECTION

You authorise us to pay the amount lent to you directly to Vendor pursuant to the Offer to Acquire Film Rights.

30. MORTGAGE OF RIGHTS AS SECURITY

30.1 If we make the Loan to you, as security for your obligation to us under this Offer to Borrow, you:

•

mortgage and charge to us all of your interest, rights and entitlements, now and in the future in the Film and the Film Rights; and

•

mortgage and charge to us all legal and other rights you have in connection with the Distribution Agreement, including your share of the Distribution Guarantee and Net Proceeds and any and all Securities (or any proceeds therefrom).

...

31. DIRECT ALL REVENUE PAYMENTS TO US

You agree to direct to us all payments that may be payable now or in the future to us including the Distribution Guarantee and Net Proceeds such amounts if paid before the dates for the repayment of the Loan as specified in item 6 are to be deposited in an account in your name (but controlled by us) and cannot be withdrawn by you until the repayments specified in Item 6 are made. We will be able to draw amounts from these accounts to make the payments specified in Item 6 and to meet any other fees or costs which we are entitled in accordance with this Offer to Borrow. The account will accrue Interest at a rate which we will nominate from time to time.

...

34. RIGHT OF SET-OFF

34.1 We can apply and/or set off (at our option and without notice) any credit balance in any account that you or the guarantor has with us, and/or any amount we may owe to you, towards any amount payable or owing to us under this contract, if there is an amount of money due to us under this contract, and/or if you have failed to pay an amount of money when it was due for payment under this contract.

...

36. POWER TO DEAL WITH SECURITY

36.1 In relation to any Security provided by the Distributor to secure the payment of the Distribution Guarantee there is no restriction on our ability to exercise any of our rights under this contract and you hereby irrevocably:

(a) appoint us as your attorney with full power to do and refrain from doing all things which in our unfettered discretion we deem necessary or desirable in connection with the Security including, without limitation:

•

nominating the type and nature of any Security as we in our unfettered discretion decide (including without limitation security issued by us) to be issued by the Distributor pursuant to the Distribution Agreement ('Nominated Security'); and

•

exercising any and all of your rights (in our unfettered discretion) pursuant to the Distribution Agreement including the nomination of the type and nature of Security to be provided by of [sic] the Distributor.

36.2 If the Nominated Security is something other than an unconditional and irrevocable promise to pay issued by a bank holding a banking licence under the Banking Act (Commonwealth) ('Bank'), then, subject to Clause 36.3

•

we may not exercise any rights to recover money owing under the contract until the latest date specified in Item 6;

•

we must satisfy our remedies for recovery of the money owing under the contract out of the proceeds of the Nominated Security before seeking to recover same from you and, where applicable, the guarantor;

•

we hereby indemnify you and where applicable the guarantor against any liability or loss arising from and any cost charges and expenses incurred by you and, where applicable, the guarantor, in connection with a default in payment under any Nominated Security

36.3 Notwithstanding anything else in this Clause 36, we are always entitled to exercise all of our rights and powers in relation to recovery of all Interest Charges, break costs and all other Establishment Fees, costs and expenses payable by you to us under this contract at any time.

You agree and acknowledge that we may in our unfettered discretion accept this Offer to Borrow subject to a further requirement that you re-finance the Loan Amount in whole or in part and repaying to us that part of the Loan Amount refinanced. We will notify you in writing of this requirement. You agree to co-operate in good faith and do all things necessary to assist us to ensure that the refinancing is completed, including without limitation executing such further documentation as we may reasonably require."

19 Annexed to the first loan agreement is a document headed "Irrevocable Direction and Notice" which is signed by Mr Atherton on behalf of INS and by one Janine Atherton as a witness. The direction and notice authorises the payment of all money due to INS in relation to the licensing of the film rights to NPV Finance. The document as signed by Mr Atherton and Janine Atherton referred to a loan of $500,000. Mr Jarrouge altered that figure, without reference to the Athertons, by crossing out $500,000 and writing in $2,500,000.

20 The first loan agreement provided for payment of an establishment fee. The establishment fee payable was 1.5% of the loan amount. According to an exhibit tendered by consent setting out the payments made by INS (Exhibit D2) an amount of $37,500 was paid on 1 July 2000. The evidence was that this was the establishment fee. $37,500 is 1.5% of $2,500,000.

21 Pursuant to the Representation Agreement, Mr Brain, on behalf of SDM which was in turn acting on behalf of INS, executed a document entitled "Offer to Acquire Film Rights". The "vendor" named in that document was a company in the Village group, incorporated in the British Virgin Islands, named TAJ Walker Pty Ltd ("TAJ Walker"). Relevantly, the Offer to Acquire Film Rights provided:

(a) for the acquisition of 17% of the exhibition rights of a film named "Red Planet" throughout the world excluding North America, Australia and New Zealand for a purchase price of $5,000,000 (clauses 2 and 3).

(b) that TAJ Walker warranted that it had the right to transfer the film rights (clause 4.1(a)).

(c) that INS as purchaser agreed to co-operate in the commercial exploitation of the film and acknowledged that the "most expedient way" to do this was to enter into a "Distribution Agreement" (clause 6.1).

(d) that TAJ Walker had the option to reacquire the film rights upon the expiry of 12 months for the sum of $1 (clause 7).

22 Mr Brain, on behalf of SDM which was acting in turn on behalf of INS, licensed the film rights to another company in the Village group, also incorporated in the British Virgin Islands, named Nu-Pay View Entertainment Pty Ltd ("Nu-Pay View"), pursuant to an agreement entitled "Distribution Agreement". This agreement relevantly provided for:

(a) the licensing of the film rights to Nu-Pay View (clause 2).

(b) the payment by Nu-Pay View to INS, as licensor, of a licence fee (clause 3 and 4).

23 The licence fee was payable, subject to a provision of no present relevance, on or before the last day of the 55th month succeeding the date of execution of the Distribution Agreement. Thus the licence fee was payable on 31 January 2005. The amount of the licence fee was the subject of a number of provisions suggesting the possibility of recovery of an amount referrable to the earnings of the film but, more significantly, the agreement provided for a "Distribution Guarantee" which could not be less than "an amount equal to 1.01 times the Effective Nominated Cost". The "Effective Nominated Cost" was defined to mean "the purchase price of the film rights as defined in the Offer to Acquire Film Rights". I indicated earlier that the scheme was such that the investor could be confident of recovering the initial capital outlay. The basis for this confidence was the obligation to pay (at least) 1.01 times the purchase price of the film rights on 31 January 2005.

24 The Distribution Agreement contained the following term in clause 5.3:

"(a) Subject to Clause 5.3(b) the Distributor hereby warrants and undertakes to maintain net tangible assets equal to 1.5 times its minimum payment obligations under this Agreements [sic] and other like Agreements and will provide audited accounts on a six monthly basis to the Representative showing the satisfaction of this requirement.

(b) As an alternative to compliance with Clause 5.3(a) the Distributor may elect in its sole and unfettered discretion to provide security to the Licensor for its minimum payment obligations under Clause 3 of this Agreement. The security may be by way of any unconditional and irrevocable instrument issued by any Bank holding a banking licence under the Banking Act (Commonwealth) or such other security that may be nominated by the Licensor and agreed to by the Distributor exercising its sole and unfettered discretion."

The settlement

25 As is the hallmark of transactions of this kind, there was considerable pressure to finalise the transactions before 1 July 2000. Mr Jarrouge agreed to proceed with what was described as a "blind settlement" whereby he would accept loan applications from all of the proposed investors without completing credit checks and without arranging in advance the re-financing of the proposed borrowers with more traditional lenders, as was his ordinary practice. He was prepared to take this course because of arrangements he made with the Village group to secure his position.

26 The transactions were settled in the following way:

(a) NPV Finance drew a counter cheque bearing the date 30 June 2000 in favour of TAJ Walker for the sum of $6,260,000. Mr Jarrouge's evidence was that Mr Nader suggested using a counter cheque. Neither Mr Nader nor Mr Jarrouge proffered an explanation for the use of a counter cheque. NPV Finance did not have funds in its account sufficient to meet this cheque if it had been presented. The credit balance in its account at that time was approximately $10,000.

(b) Mr Nader on behalf of TAJ Walker wrote a note on the cheque acknowledging its receipt. He dated this note 30 June 2000.

(c) Mr Nader then endorsed the back of the cheque with an instruction to pay NPV Finance and signed that endorsement on behalf of TAJ Walker. He returned the cheque to Mr Jarrouge.

27 The cheque has never been presented.

28 There is in evidence a covering letter for the cheque signed by Mr Jarrouge and addressed to Mr Nader. The letter refers to the total of the cheque, being $6,260,000, and says that this amount is referrable to a specified list of investors, one of whom is INS for the sum of $2,500,000.

29 The evidence of the parties involved in the settlement, Mr Jarrouge and Mr Nader, was that the handing over of the cheque by Mr Jarrouge to Mr Nader constituted payment of the amount due for film rights, including $2,500,000 referrable to the acquisition of film rights by INS.

30 Mr Jarrouge explained the transaction whereby the cheque was endorsed and handed back as follows. He considered the payment by endorsement and return of the cheque to be a payment in two parts. The first was the net present value of the Distribution Guarantee. His evidence was that the ordinary way in which transactions of this kind were settled involved the Village group paying this sum to him. The second part of the payment was referrable to the specific circumstances of this transaction and the "blind settlement". His understanding was that an amount in addition to the net present value of the Distribution Guarantee was advanced to him by the Village group to be held by him whilst he completed the usual credit checks and refinancing arrangements.

31 Mr Nader's explanation was more complex than that of Mr Jarrouge. According to Mr Nader the endorsement and handing back of the cheque was the provision of security by Nu-Pay View as provided for in the Distribution Agreement, which security was itself in turn subject to the provisions of the first loan agreement. In this particular case he said the agreed amount of the security was $6.26M but that that amount was only the amount "agreed for that day" and was "subject to them working out what we would regard as acceptable security going forward".

32 Mr Nader's explanation, as adopted by counsel for NPV WA, was that this agreed security deposit was nominated security under clause 5.3(b) of the Distribution Agreement, which NPV Finance was entitled to agree upon and deal with under clause 36.1(a) of the first loan agreement, and which resulted in restriction upon NPV Finance's capacity to recover the money owing, pursuant to clause 36.2 of the first loan agreement, other than recovery of interest and other costs as provided for in clause 36.3.

33 A further explanation was proffered by a letter written in July 2004 by the chief tax counsel of Village Roadshow Limited, Mr Tony Pane. That letter relevantly read as follows:

"The purpose of this letter is to confirm our mutual understanding that Nu-Pay View Entertainment Pty Ltd paid the relevant NPV Finance company amounts at or about the time of settlement of the transactions in consideration of the relevant NPV Finance company agreeing to make the distribution guarantee payments to the third party investors. In practical terms this means that the relevant NPV Finance Company is required to discharge the obligation to pay the distribution guarantee to the respective investors.

I confirm your advice that the funding arrangements with the investors entitle the NPV Finance company concerned to apply the distribution guarantee in repayment of the amounts borrowed from that company to invest in the Films."

34 Parts of Mr Jarrouge's evidence also suggested this explanation, although he said that the basis for this was that it "was all in the documents". There does not appear to be any basis in the documentation for the suggested assumption by NPV Finance of the obligation to make the "distribution guarantee payments" to the investors, but, if Mr Nader's explanation is accepted, NPV Finance in effect held the Distribution Guarantee (as the security deposit) and was bound to apply it against the loan amount when due, which in commercial terms might be said to amount to something similar.

35 The documents signed by and on behalf of INS provide for an acquisition of film rights for a total sum of $5,000,000. It is clear that whatever NPV Finance's obligations at that time may have been, the sum which NPV Finance in fact advanced (assuming for present purposes that there was an advance ) was the sum of $2,500,000. This is clear from the manner in which the total sum of $6,260,000 was calculated, from the establishment fee paid by INS, and from the subsequent interest payments which were made by INS.

36 According to the evidence of Mr Nader, $5,000,000 of film rights were acquired by INS, and the additional $2.5m not financed by NPV Finance was financed by way of short term finance by the Village group. In late 2001, after the Australian Tax Office had indicated that it intended to audit these transactions, Mr Nader's superior, a Mr Zeigler, signed a letter on behalf of TAJ Walker which bears no date and which reads as follows:

"In accordance with the offer to acquire film rights of 30 June 2000 Mr Atherton acquired a 17% interest in the "Red Planet" project for $5,000,000. Of this amount, $2.5 million was received, with an agreement to fund the balance of $2.5 million for an interim period.

As at 31 July 2000, a minimum guarantee amount of $2.5 million was paid, which was applied against the interim funding previously provided. This minimum guarantee extinguishes all of Mr Atherton's entitlements in respect of 50% of his 17% interest in the "Red Planet" project.

As a result Mr Atherton has a net interest of 8.5% in "Red Planet" on a continuing basis in accordance with the agreement."

37 The transaction referred to in the first paragraph of the letter is consistent with the documents which are in evidence. Mr Nader maintained in evidence before me that the transaction referred to in the second paragraph of the letter did happen. It is referred to in correspondence but is not otherwise reflected in the documents in evidence before me.

Problems with interest payments and the "additional" $1m loan

38 According to the evidence of Mr Brain, in July 2000 Mr Atherton sought to increase INS's film rights acquisition to $7m and sought an addition loan of $1m from NPV Finance in order to do so. By a letter which bears no date, but which according to Mr Brain was sent to Mr Atherton on about 12 July 2000, Mr Brain sent Mr Atherton a fresh representation agreement, bearing the date 23 June 2000, which provided for the acquisition of 23.8% of the film rights in "Red Planet" for a purchase price of $7m. The letter requested payments to "First Plus Finance Pty Ltd" (a reference to Mr Jarrouge's companies) of $15,000 (being 1.5% of $1m) and a payment to SDM of $7,500 (being .75% of $1m). INS paid a sum of $15,000 to NPV Finance on 18 August 2000.

39 Meetings were held and correspondence passed between the parties in relation to this request by Mr Atherton to increase his investment and to borrow an additional $1m. No explanation was proffered in the evidence before me as to how this could have been done, given that the transaction had supposedly settled on 30 June 2000. There is in evidence a memoranda from Mr Brain to Mr Jarrouge referring to the fact that Mr Nader perceived a "document management problem". The witnesses before me professed to be unable to remember what this problem was.

40 Mr Jarrouge would not agree to the proposal to increase the loan because he was not happy with the creditworthiness of INS.

41 Throughout the period of the discussions concerning the proposed increase, INS was not paying interest payments which Mr Jarrouge maintained were due. Mr Jarrouge began making demands for payment. He did so not in the name of NPV Finance, but rather in the name of NPV WA, the plaintiff in these proceedings. Mr Jarrouge's evidence was that he treated the obligation as being one owed to NPV WA from 1 July 2000.

42 By a facsimile transmission of 10 October 2000 Mr Jarrouge advised Mr Atherton that he was applying the $15,000 establishment fee paid against outstanding interest due and that the amount of interest then payable was $80,833.33. In due course this amount was paid (together with penalty interest of $66) by INS on 6 November 2000. Thereafter INS made payments of interest, and penalty interest, until 10 July 2003. The total amount paid by INS was $935,783.63. All of the interest payments made were calculated on the basis of an advance of $2.5m.

Withdrawal of investors and dealings between NPV WA and the Village group

43 The settlement cheque for $6,260,000 was referrable to a number of investors. According to the evidence before me investors for a total sum of $1,600,000 decided after 30 June 2000 to "withdraw". The evidence does not permit me to determine how that was accomplished. Village group's financial records, which are in evidence, address the matter by simply writing back $1.6m as at 30 June 2000, thus leaving $4,660,000 as the amount paid for the film rights on that day.

44 Between November 2000, when INS commenced making interest payments, and June 2001, Mr Jarrouge, Mr Brain and Mr Nader corresponded with each other in relation to "release" of the amount purportedly paid back to NPV Finance at the settlement which was in excess of the usual security deposit being the net present value of the Distribution Guarantee. The amount the subject of these dealings was the portion Mr Jarrouge characterised as the second part of the payment made by the return of the cheque with the endorsement. These dealings were the "working out" of the acceptable security "going forward" as the transactions were described by Mr Nader.

45 By June 2001 the parties were agreed upon the manner in which the accounts between NPV Finance and TAJ Walker would be finally settled, and the payment constituting final settlement was made under cover of a letter dated 21 May 2002. Consequent upon that payment, Mr Jarrouge's companies then held a security deposit in relation to INS at an agreed amount which represented the net present value of the Distribution Guarantee together with an additional amount of $150,000 referrable to the particular circumstances of INS.

46 Considerable attention was given during the trial to explaining, tracking and reconciling the various payments made. In the end, no point was made by the defendants about the detail of the particular payments made by NPV Finance or NPV WA to, or at the direction of, TAJ Walker. Once the security deposit as eventually agreed is deducted, the evidence establishes that the balance of the $2.5m was "released" by payments made to, or at the direction of, TAJ Walker.

The second loan

47 On 19 January 2001 Mr Jarrouge wrote on the letterhead of NPV WA to Mr Atherton. The letter relevantly read as follows:

"We are pleased to inform you that your application to borrow has been finalised and refunding for your participation in the Red Planet has been internally arranged. Pursuant to clause 48 of our Offer to Borrow, we request that you execute the enclosed loan documentation."

48 What was enclosed was an "Offer to Borrow" in exactly the same terms as the first loan agreement save for the following:

(a) The lender was NPV WA.

(b) The loan amount was $2,500,000.

(c) Item 6, payment dates and payment amounts, read as follows:

"48 monthly payments of $23,958.33 commencing 15 February 2001 and a repayment of $2,500,000 on 31 January 2005."

49 The date which was eventually inserted on this document (presumably again pursuant to clause 25) was 27 February 2001. This document is the second loan agreement.

50 According to the evidence of Mr Jarrouge, the second loan agreement addressed three matters which he wished to address in relation to the first loan agreement. The first was the identity of the lender. The second was the loan amount. The third was the payment dates and amounts.

51 The second loan agreement was executed by Mr Atherton on behalf of INS and was separately executed by him as the guarantor. An irrevocable direction and notice, referring to a loan of $2,500,000, was also executed by Mr Atherton. It is on this second loan agreement that NPV WA now sues.

Involvement of the Australian Taxation Office

52 I indicated previously that in late 2001 the Australian Taxation Office advised that the transactions the subject of this proceeding were to be the subject of an audit. The taxation aspects of the transactions to which I have referred were the subject of a separate proceeding in the Federal Court of Australia Queensland District Registry, being No. Q152 of 2003.

53 Mr Atherton swore an affidavit in that proceeding which was tendered in the proceeding before me. In that affidavit he gave an account of the circumstances in which he came to make the investment. His affidavit also reveals that when he submitted his 2000 tax return, upon the advice of his then accountants, Arthur Andersen, he did not claim any deduction in relation to the Red Planet investment "pending the ATO publishing a more formal decision regarding the deductability of the Red Planet investment". Once an assessment was issued, according to Mr Atherton's affidavit, a notice of objection was then prepared in which a deduction was claimed. In relation to the deduction claimed Mr Atherton deposed as follows:

"I am aware that objection claims a deduction based upon a total investment of $2.5m over two years in the Red Planet film project despite the initial documents indicating an investment of $5m at the time. I received advice from Ernst & Young that the true value of the applicant's investment in the project following amendments to documents in July 2000 was $2.5m and that should form the basis of any deduction."

54 There was tendered in evidence before me a deed of settlement between INS and the First Assistant Commissioner of Taxation. Amongst other things, under that settlement the Commissioner agrees to allow "deductions for interest" in relation to the 30 June 2000 year in a total sum of $935,817.13.

Interest payments made

55 According to an agreed schedule of payments made, the total sum paid by INS to NPV Finance and NPV WA is $935,783.63. Of that sum $52,500 was paid to NPV Finance and $883,283.63 was paid to NPV WA. Mr Jarrouge sought payment to NPV WA during the period when the transaction was governed by the first loan agreement. $206,202.69 was paid prior to the date of the second loan agreement and $729,580.94 was paid after that date.

56 Whilst it might be observed that the amount of interest deductions which the Commissioner has agreed to allow closely approximates the total payments made according to the agreed document tendered before me, the Commissioner has agreed to allow a deduction for all of the payments in the 30 June 2000 year, which does not reflect what occurred according to the evidence before me. As was submitted by counsel for INS, the settlement with the Commissioner no doubt involves compromises and concessions on both sides.

Applicable legal principles

57 Tax arrangements of the kind in question typically involve elements of artificiality and elements of façade. This is because whilst the commercial objective is to generate tax deductions, the furtherance of that objective is seen to be assisted by the creation of documents suggesting some other commercial objective. Such transactions also often involve "flexibility" in relation to documentation, including backdating or other purportedly retrospective alterations. In this context, the separate issues of:

• whether the transactions were a "sham",

• whether the obligations were indeed performed, and

• whether the transactions were what they purported to be, in the sense that they were of the character which gives rise to the tax benefits sought,

can become confused.

Round robin payments

58 Absent a finding that the underlying transaction is a sham, an exchange of cheques which are intended to cancel each other out, and which could not be met if presented because neither party has the funds available to meet them, is not, by virtue of those circumstances, a pretended payment or a payment which is not in the relevant sense "real": Perpetual Trustee Co. Ltd v Barnett;[2] and Fletcher v Federal Commissioner of Taxation.[3]

Sham

59 In Equuscorp the High Court, citing the decision of the Full Court of the Federal Court in Sharrment Pty Ltd v Official Trustee in Bankruptcy,[4] described a sham as a transaction "which takes the form of a legally effective transaction but which the parties intend should not have the apparent, or any, legal consequences".[5]

60 The critical question in determining whether a transaction is a sham is the question of whether the parties to it commonly intended that it should merely be a disguise or a façade. In Sharrment the Full Court of the Federal Court made some particular comments in relation to the issue which are relevant here. The Court observed:

(a) A round robin of cheques does not establish that the transaction is a sham even if no party has funds to meet the cheques.

(b) Artificiality does not give rise to characterisation as a sham, nor does complexity.

(c) A purported disposal of property, or creation of a debt, may be a sham where the parties intend and agree that there will be in fact no change in ownership, or no sum owing. The conduct of the parties may give rise to this inference.

(d) The existence of an "inacceptable purpose" or of an "ulterior purpose", such as an intention to shield assets from creditors or to avoid tax, does not result in a transaction being characterised as a sham, although it may be liable to be set aside or avoided pursuant to provisions directed to that end in the Bankruptcy Act or the Income Tax Assessment Act.[6]

61 The issue of whether the transactions are in fact of the character which they purport to be, in the sense of falling within applicable provisions of the Income Tax Assessment Act, is a different issue to the issue of whether the transactions are a "sham". As illustrated by decisions such as Fletcher[7], transactions designed to attract the operation of provisions of the Income Tax Assessment Act may be found not to be properly so characterised, but they are not thereby a "sham".

No loan

62 In this proceeding the defendants take the defence that no loan was in fact advanced by the lender. Their position is similar to that taken by defendants in other proceedings where, in the course of tax minimisation schemes, round robin transactions were undertaken by virtue of which sums purportedly advanced by lenders return at the end of the round robin to those same lenders. Defences based upon the proposition that in those circumstances there was no loan made at all succeeded before the Supreme Court of Queensland at first instance and on appeal in Australian Horticultural Finance Pty Ltd v Jekos Holdings Pty Ltd,[8] and in Equuscorp.[9] The principles set out in those Court of Appeal decisions were accepted, but distinguished, by McKenzie J in the Trial Division of the Supreme Court of Queensland in Borg v Northern Rivers Finance.[10]

63 The Queensland Court of Appeal decision in Equuscorp went to the High Court.

64 Equuscorp concerned a tax minimisation scheme in relation to an aqua-culture project. Investors in that case borrowed money for the purpose of paying management fees, acquiring stock, and paying lease and licence fees, which it was expected, or hoped, would entitle the investors to tax deductions. Several transactions were effected on 30 June 1989 at the offices of the Westpac Bank. The account of the lender, Rural Finance (who later assigned the debt to Equuscorp), was debited with two amounts and the account of the trustee of the scheme, Eagle Star Trustees Limited, was credited with those same amounts. Cheques were then drawn whereby those amounts were paid to companies (referred to as "JFM" and "FJA") to whom the fees and other payments were owing, and those companies in turn placed the funds on deposit with Rural Finance.

65 In a single unanimous judgment the Court, constituted by Gleeson CJ, McHugh, Kirby, Hayne and Callinan JJ, rejected the suggestion that the transactions were a sham and held that each of them was legally effective. The Court then went on to deal with the argument there had been no loan made, in these terms:

"In this case, debts were created and satisfied at all points in the chain until, at its end, Rural Finance owed JFM and FJA certain sums, and the respondents owed Rural Finance certain sums. And of most particular relevance to the present matters, in accordance with its obligations under the written loan agreements, Rural Finance had applied the money it lent in payment of the application moneys due from the respondents for the units being bought.

The contrary view reached in the Court of Appeal was much influenced by that Court's earlier decision in Australian Horticultural Finance Pty Ltd v Jekos Holdings Pty Ltd. Perhaps that decision may be understood as turning upon its particular facts. If, as the respondents contended in these matters in the Court of Appeal, it stands for some more general principle - that there is no 'loan' unless there is 'real' money leant - it is wrong and should be overruled.

As the expression 'real money' might suggest, the point which the respondents sought to make in these matters appeared to be one about the economic rather than the legal effect of the transactions in question."

The defences raised here - application of legal principles

The "no loan" defence

66 It seems to me that the decision in Equuscorp is on point and must be followed. It is true that the settlement transactions undertaken were cash neutral for NPV Finance. But just as in Equuscorp, NPV Finance applied the money lent as required by INS in payment of the purchase price to the extent of $2,500,000. The fact that TAJ Walker or other companies in the Village group determined to return that sum to NPV Finance the same day, pursuant to arrangements between them and NPV Finance, however they are characterised, does not alter that position. The transactions might result in the conclusion that the tax consequences desired were not achieved, but they do not result in the conclusion that no loan at all was made, unless the transactions were indeed a sham, which is a separate issue.

67 The transactions at settlement, although perhaps accurately described as "artificial", were consistent with the agreements made, as explained by Mr Nader and adopted by counsel for NPV WA, and, whilst the transactions were cash neutral for NPV Finance on the settlement day, NPV Finance or NPV WA did subsequently pay substantial sums to TAJ Walker or at its direction. The sums so paid were agreed and calculated in a manner not inconsistent with the formal written agreements.

The second loan agreement was ineffective

68 I reject the defences based upon the proposition that the second loan agreement was ineffective. What was put in that respect was that the purpose was misdescribed in that it was said to be for the acquisition of film rights when, assuming NPV Finance had made a loan, it was a refinancing.

69 In my view nothing can turn on any such error, even if it is properly described as an error. Mr Atherton was advised in writing that the transaction was a refinancing. On behalf of INS and on his own behalf as guarantor he agreed to it.

70 It was also suggested that NPV Finance had no right to require the refinancing pursuant to clause 48 of the first loan agreement. This is irrelevant. Whether it had the right to require it or not, INS and Mr Atherton agreed to it.

Sham

71 In its amended defence and counterclaim INS and Mr Atherton set out 24 factors which, it is alleged, indicate that the scheme, including the first loan agreement and the second loan agreement, was a sham.

72 The defendants rely on these factors individually, but also rely upon their cumulative effect.

73 Without ignoring the cumulative effect of the various factors relied upon, a number of the factors enumerated are not of individual significance in my view. The factors which fall into this category are the following (references in brackets are references to the particulars under paragraph 2AB of the amended defence and counterclaim):

• The fact that the transactions settled in a round robin, using a counter cheque, which was never presented, and which could not have been met at the time because of insufficient funds (i - iv): The transactions were intended to offset each other. There was no point in presenting the cheque. The transactions were cash neutral on the day but subsequently NPV Finance or NPV WA did make payments in the manner to which I have referred.

• The fact that Mr Jarrouge in his own mind, and in his own records, treated the loan as one owed to NPV WA (x and xii): Mr Jarrouge did not thereby betray an intention not to create a contract between NPV Finance and INS.

• The Village journal entries (xiii): These journal entries whilst in some respects inaccurate as to the sequence of events are not inconsistent with the explanation of the transactions given by Mr Nader, and they are inconsistent with the suggestion that no relevant obligations were intended to be created or that the obligations intended to be created were different to those documented.

• The existence of the second loan agreement, which (it is said) "served no apparent purpose" (xvi): The second loan agreement served the purpose of addressing the three deficiencies which Mr Jarrouge saw in the first loan agreement and to which I have referred.

• The lack of documentation concerning, and evidence of, the payment of the 101% minimum distribution guarantee (xviii): INS may be entitled to a $25,000 credit on this account but I do not see anything in this factor indicating that the parties did not intend to create the legal obligations provided for.

• Mr Jarrouge's unilateral alteration to the direction annexed to the first loan agreement (xxix): This does not suggest he did not intend that the obligations should be as provided for.

• The lack of "traceable linear" of the film rights (xx): There is no evidence INS did not acquire what it contracted for. TAJ Walker warranted its capacity to transfer the rights the subject of the Offer to Acquire Film Rights.

• The absence of enquiry by the financier as to the security it was to hold (xxi): Mr Jarrouge was most concerned with his security. He was not concerned with the security represented by the mortgage of the film rights themselves, which is not surprising given the $1 option to re-acquire them after 12 months. He was most concerned with the arrangements concerning the security deposit.

• The fact that the only "real" money in the transaction was directed to the various advisers and consultants (xxii) and (xxiv): "Real" money was also directed to TAJ Walker, the company which was the vendor of the film rights. The purported distinction between money which is "real" and money which is not is misconceived.

74 Amongst the 24 factors relied upon, there are factors which relate to three issues which are of potential significance in my view. There is also one further factor which concerns me in this context and which is not listed in the factors relied upon by the defendants.

75 The three issues which relate to factors which the defendants do rely upon are the following:

• The circumstances concerning the component of the purported $5m investment which was not financed by NPV Finance (xi): These arrangements appear to be very close to a mere façade.

• The circumstances whereby investors for a total sum of $1.6m "withdrew" after 30 June 2000 (xiv), (xv), (xvii): It was not explained how this "withdrawal" was consistent with the documents they had signed. The evidence was they had signed documentation relevantly the same as that executed by INS and Mr Atherton, and by SDM on INS' behalf.

• The explanations given for the basis upon which the cheque was endorsed back to NPV Finance (v), (vi), (vii), (viii), (ix), (xxii): Mr Nader's explanation is not inconsistent with the documentation. Mr Jarrouge's explanation was confused, and Mr Pane's appears to be wrong although it is perhaps understandable if viewed as an explanation of the commercial effect of what occurred.

76 The further factor, apparently not relied upon, is the circumstances whereby the parties conducted themselves as if INS's investment could be increased by $2m, involving an additional $1m loan, after 30 June 2000.

77 The issue is whether these circumstances (and the other matters relied upon by the defendants which are not individually significant) result in a conclusion that NPV Finance, NPV WA, INS, and Mr Atherton did not intend to create relationships of lender and borrower/guarantor, but instead intended that there should be no obligations between them, or different obligations of some kind, as to which the first loan agreement and the second loan agreement were no more than a disguise or a façade.

78 I cannot accept that that was their intention.

79 I have reached this conclusion for the following reasons:

(a) Mr Jarrouge was involved in the four aspects of the matter to which I have referred and which are of significance in this context, but he was not the architect of those aspects of the transactions. The architects of those aspects of the transactions were Mr Brain and Mr Nader. On the evidence I am satisfied that Mr Jarrouge did intend that the first loan agreement and the second loan agreement should have legal effect. Mr Jarrouge did not intend that NPV Finance would undertake an obligation to lend $5m under the first loan agreement, but he did intend it to lend $2.5m, and it did do so. The second loan agreement accurately reflected the loan made.

(b) The conduct of the parties to the two loan agreements is only consistent with a conclusion that they did intend that the loan agreements would have legal effect. Mr Jarrouge pursued the recovery of interest on the $2.5m advanced and INS paid substantial sums for interest on that basis. The settlement with the Australian Taxation Office is not inconsistent with this position.

(c) Mr Atherton has chosen not to give evidence of his intention. An affidavit which he swore in the Federal Court proceeding was tendered before me. That affidavit is not consistent with a conclusion that he and his company did not intend to create relationships of borrower/guarantor and lender with NPV Finance and NPV WA.

80 Notwithstanding the disturbing features of a number of aspects of these transactions, I am unable to conclude that the relevant parties for these purposes, being Mr Jarrouge on behalf of NPV WA, and Mr Atherton on behalf of himself and INS, intended that the second loan agreement should not have the legal consequences which it provided for.

Conclusions

81 Accordingly, the defendants' defences fail and the plaintiff is entitled to judgment for the amount owing, which was agreed to be $614,910.18 as at 15 July 2006, subject to an issue referred to late in the trial concerning the possibility of the need for an additional credit of $25,000.

82 I will hear the parties further on the issue of the amount for which judgment should be entered, on the question of costs, and on any further matters related to the orders necessary to give effect to these reasons.

[1] [2004] HCA 55; (2005) 218 CLR 471 ("Equuscorp").

[2] (1969) 90 WN (Pt1) (NSW) 637 at 649-652.

[3] [1991] HCA 42; (1991) 173 CLR 1 at 14 ("Fletcher") and see also Joseph v Campbell [1933] HCA 34; (1933) 50 CLR 317.

[4] [1988] FCA 179; (1988) 18 FCR 449 ("Sharrment").

[5] [2004] HCA 55; (2005) 218 CLR 471 at 486.

[6] [1988] FCA 179; (1988) 18 FCR 449 at 453-458.

[7] [1991] HCA 42; (1991) 173 CLR 1.

[8] [1997] QCA 440.

[9] [2004] HCA 55; (2005) 218 CLR 471.

[10] (2004) QSC 029.