Breach of Director's Duties in Connection with the Finmore Mortgage
110 By granting a second mortgage over its interest in the Dee Why property as security for the advance of $400,000, Finmore's proportion of the proceeds of sale of the units after ING's mortgage had been discharged was not available to meet its liability to contribute to the expenses of the development until the debt owed to Super 1000 was discharged. Although Finmore was a joint borrower with PED, the advance was not made to allow Finmore to pay its share of the development expenses. By taking a second mortgage over Finmore's interest in the Dee Why properties to secure the obligation of Finmore and PED to pay $500,000, Super 1000 was advancing its interests at the expense of PacGen's interest. That was so because all of the joint venture expenses, to the extent they were not met from moneys borrowed from ING, were paid by PacGen. Finmore was liable to reimburse PacGen for 35 percent of those expenses.
111 Mr McLay beneficially holds 100 of the 101 shares in Super 1000. Under the agreements of 28 March 2002 and 30 May 2003 he was to receive any profits made by PacGen. But PacGen had obligations to the debenture holders and the investors in the Fund. Mr McLay had a conflict between his interest as a shareholder in Super 1000 in having Super 1000 recoup its advance to PED (for which both Finmore and PED were liable), from Finmore's interest in the Dee Why property, and his duty as a director of PacGen. PacGen was prejudiced by Finmore's encumbering its interest in the Dee Why properties to secure the debt of $500,000 owed to Super 1000, where the advance of $400,000 (net $391,991) (being the consideration for the debt of $500,000), was not applied towards the joint venture expenses.
112 Mr McLay was conscious of that conflict. He was asked in cross-examination whether it occurred to him that he had a conflict and said that "It did occur to me that there was a problem but I took advice and signed it." He agreed that the problem was that "if Finmore was giving up effectively its interest in the development to support a loan that you made to them [Finmore and PED], there would be less available if the project wasn't otherwise successful to pay the development expenses". When asked where he thought the funds to pay the $500,000 debt to Super 1000 would come from, Mr McLay said that he expected the funds to come from the later sale of the apartments. He said in cross-examination that he had advice at the time that he did not have a conflict of interest, but he acknowledged that if Finmore gave a mortgage over its interest in the Dee Why development, there would be less funds from which PacGen could be reimbursed for the expenses it incurred in the development. Mr McLay said that he did not know what happened to the advance made to PED. I consider that evidence to be implausible and do not accept it. Finmore did not pay any part of its 35 percent proportion of expenses for the Dee Why development.
113 By causing Super 1000 to take a mortgage from Finmore over Finmore's interest in the Dee Why properties to secure repayment of the debt of $500,000, Mr McLay stood to profit personally from the transaction when he owed a duty to protect the interests of the creditors of PacGen and the beneficiaries of the trust who were liable to suffer from the transaction. This was a breach of his duty as a director.
114 It was submitted for Mr McLay that there was no breach of duty, because the only respect in which Mr McLay might be said to have improperly used his position as a director of PacGen was in causing PacGen to enter into the deed of 25 August 2003 consenting to Finmore's mortgage to Super 1000. It was submitted that PacGen did not plead a claim that Mr McLay breached his duty as a director of PacGen by procuring PacGen to enter into the priority deed of 25 August 2003. However, that is not to the point. PacGen did plead that in obtaining the Finmore mortgage, Mr McLay breached his fiduciary duty to PacGen and preferred his personal interests to those of PacGen which were prejudiced by the granting of the mortgage. The fact that in causing Super 1000 to take a mortgage from Finmore Mr McLay was not acting as a director of PacGen, does not mean that he did not breach his duty as a director of PacGen in that transaction. He would equally have been in breach had there been no priority deed. There are many cases in which directors will breach their duties as directors by carrying out transactions in which they do not purport to act in that capacity. For example, directors improperly establishing a rival business will not act in their capacity as directors of their principal in doing so.
115 In any event, the pleading point is without merit. PacGen pleaded that "In obtaining the Finmore mortgage Mr McLay breached his fiduciary duty ...". The pleading encompassed all the steps by which the Finmore mortgage was obtained. Mr McLay and Super 1000 themselves pleaded that the priority deed was an answer to the claim for breach of fiduciary duty as it operated as an informed consent to the alleged breach. Although the validity of the priority deed was not challenged, the question whether Mr McLay breached his fiduciary duty in connection with the deed was ventilated at the hearing without objection.
116 Counsel for Super 1000 and Mr McLay submitted that whilst entering into the priority deed involved the potential reduction of assets available to meet joint venture expenses and thus a potential detriment to PacGen, that potential detriment could readily have been seen as a price worth paying to avoid the possibility of Mr Dixon's and Mr Kelly's causing the delay or even the collapse of the development. The difficulty with this submission is that for the reasons above, I infer that no part of the advance was used towards meeting joint venture expenses, and there was a mere scintilla of evidence that the advance was made to prevent the potential collapse of the development. I do not accept Mr McLay's evidence that there was a threat to appoint a receiver to Finmore. I do not accept his evidence that he was unaware how the advance was applied.
117 In any event, even if there were a potential benefit, as well as detriment, to PacGen in the transaction, the fact remains that Mr McLay had a conflict between his interests and his duty. No inquiry as to the fairness or unfairness of the transaction is to be entered into (Aberdeen Railway Co v Blaikie Bros (1854) 2 Eq Rep 1281; [1843-60] All ER Rep 249 at 252-253).
Informed Consent - The Priority Deed
118 The priority deed was not considered by the directors of PacGen. The only basis for contending that PacGen gave its informed consent to what would otherwise in Mr McLay's breach of fiduciary duty is if such consent were given by the shareholders unanimously. The only shareholders were Mr Scott Heathwood and Mr McLay. I have concluded above that Mr Scott Heathwood was aware that Finmore was to mortgage its interest in the Dee Why properties to Super 1000.
119 I will assume without deciding that the consent of PacGen could be conveyed by the assent of its two shareholders notwithstanding that the self-interested "consent" of Super 1000 was to the furtherance of Mr McLay's breach of duty as a director, and he controlled Super 1000 (but cf McLeod v The Queen [2003] HCA 24; (2003) 214 CLR 230 at 240 [28]-[30]). Nonetheless, the shareholders were required to have regard to the interests of third parties. If there is a real and not a remote risk that creditors will be prejudiced by the dealing in question, their interests must be considered (Kalls Enterprises Pty Ltd (in liq) v Baloglow & Anor [2007] NSWCA 191; (2007) 63 ACSR 557; 25 ACLC 1094 at [161]-[162]). A fortiori, where the company is a trustee, the interests of the beneficiaries must be considered.
120 Whilst Mr Scott Heathwood was aware that Finmore was to mortgage its interest in the Dee Why properties to Super 1000, he did not give his "fully informed" consent to the transaction. He did not consider the interests of beneficiaries or debenture holders. Nor, for that matter, did Mr McLay. Moreover, Mr McLay has not shown that Mr Scott Heathwood was fully informed as to other aspects of the transaction. Thus, the priority deed did not disclose that the debt to be repaid was not $400,000 plus interest, but $500,000. There was no disclosure of the purpose for which the advance was to be made.
Conclusion as to Breach of Fiduciary Duty
121 I conclude that Mr McLay breached his fiduciary duty as a director of PacGen by causing Super 1000 to take a second mortgage over Finmore's interest in the Dee Why properties and that PacGen did not give its informed consent to the breach.
Remedy Against Mr McLay
122 Mr McLay is liable to pay equitable compensation to PacGen to make good the loss suffered by it which would not have been suffered but for the breach (Target Holdings Ltd v Redferns [1996] AC 421 at 439; Beach Petroleum NL v Kennedy [1999] NSWCA 408; (1999) 48 NSWLR 1 at 90 [432]; O'Halloran v RT Thomas & Family Pty Ltd (1988) 45 NSWLR 262 at 276-277). Mr Halley for PacGen submitted that if the present position were compared with the position PacGen would have been in had Finmore not given the mortgage to Super 1000, then the whole of its 35 percent share of the moneys paid into court, namely $386,173.55, would be available to meet its share of the shortfall in the joint venture expenses which were not covered by the loan from ING and which have been met by PacGen. Likewise Finmore's 35 percent share of rent and of the proceeds of sale when received of the remaining units in the development would be available to meet its shortfall of the joint venture expenses. (This assumes that the moneys were not secured by the April 2004 mortgage given by Finmore.) I accept that submission. It has not been shown that Finmore had other liabilities other than costs of the receivership which arose from the giving of the mortgage. As Finmore was a special purpose vehicle for the development it can be inferred it had not other liabilities to be discharged from its share of the proceeds from the development.
123 The measure of equitable compensation is thus 35 percent of the net proceeds of sale of the units after discharge of the ING mortgage plus 35 percent of the net rents received from the letting of unsold units, up to one-third of the joint venture expenses not paid from the ING loans, after deducting any sums recoverable from Finmore's share of the proceeds of sale or letting of the units under the April 2004 mortgage.
124 Mr Parker SC and Ms Gerace for Mr McLay submitted that this approach was wrong because it assumed that the development would have proceeded in the same way had Super 1000 not made the advance to Finmore and PED. They submitted that PacGen presented no evidence which would allow the hypothetical financial outcome if the 2003 mortgage had not been granted to be calculated.
125 Whilst the onus of establishing the measure of equitable compensation rests with PacGen, because Mr McLay contends that the joint venture development would have proceeded differently had the 2003 loan to Finmore and PED not been made and the mortgage not been taken, there is an evidentiary onus on him to establish that that is so. As none of the funds advanced was used in the development, and as I do not accept that there was a threat to appoint a receiver to Finmore, that evidentiary onus has not been discharged. It is true that Mr McLay gave some unspecific evidence of a threat to appoint a receiver to PED and that PED was named as the project manager. However, according to Mr McLay, Finmore performed the role of project manager and provided architectural and engineering services. Mr McLay arranged for Super 1000 to make advances in 2003 and 2004 to pay for building works for the project which were not covered by funding from ING. He gave no evidence that he would not have been prepared to make those funds available if he had not made the separate loan to PED and Finmore.
126 In short, I am not satisfied that the development would have proceeded any differently had the mortgage not been given, even though the loan to PED and Finmore would not have been made.
127 The appropriate remedy is equitable compensation. Mr McLay, as distinct from Super 1000, will not derive a profit if the debt of $500,000 is repaid.
Claim against Super 1000 Arising from Mr McLay's Breach of Fiduciary Duty in Connection with the Finmore Mortgage
128 PacGen does not seek to set aside the mortgage to Super 1000. It is not a party to the mortgage and such relief would not be available to it. PacGen pleaded that Super 1000 was knowingly concerned in and benefited from Mr McLay's breach of fiduciary duty. It sought "equitable damages" against both Mr McLay and Super 1000, which has been treated as a claim for equitable compensation.
129 So far as the personal remedy is concerned, a third party will be personally liable as a constructive trustee to pay equitable compensation if either the first or second limb of Barnes v Addy (1874) LR 9 Ch App 244 at 251-252 is satisfied (Greater Pacific Investments Pty Ltd (in liq) v Australian National Industries Ltd (1996) 39 NSWLR 143 at 153). No claim was pleaded on this basis. Super 1000 did not receive trust property or property transferred in breach of fiduciary duty. Nor would it be liable under the second limb of Barnes v Addy because although Mr McLay breached his fiduciary duty, and Super 1000 assisted with knowledge in the breach, the breach was not dishonest and fraudulent (Farah Constructions Pty Ltd v Say-Dee Pty Ltd [2007] HCA 89; (2007) 230 CLR 89 at 164-166 [179]-[186]).
130 PacGen also sought a declaration that Super 1000 held the Finmore mortgage and any moneys received from enforcement of the mortgage on trust for it. I do not accept that Super 1000 holds its mortgage on trust for PacGen. For reasons discussed in more detail below at paras [200]-[234], unless there were personal dealings between Super 1000 and PacGen to create the "personal equity" exception to indefeasibility, such a claim is inconsistent with s 42 of the Real Property Act. Super 1000 did not obtain registration of the Finmore mortgage by fraud. The fraud exception to indefeasibility does not apply.
131 Whilst it is arguable that Super 1000 is liable to account for profits derived by it as a result of Mr McLay's breach of his fiduciary duty, I see no basis for either the recognition or imposition of a constructive trust. I did not understand PacGen to contend for the existence of an institutional constructive trust. Counsel submitted that a constructive trust should be imposed as a remedy on the basis that profit could be traced into identifiable property in the hands of an agent of the defaulting fiduciary citing Robins v Incentive Dynamics Pty Ltd (in liq) [2003] NSWCA 71; (2003) 175 FLR 286; 45 ACSR 244 at [74]-[78]).
132 Super 1000 was not a defaulting fiduciary. Nor was it alleged or proved to have been an agent of Mr McLay. Nor is this a case such as Robins v Incentive Dynamics Pty Ltd (in liq) where the profit is represented by property which can be traced.
133 It is arguable that PacGen is entitled to a personal remedy by way of account of profits from Super 1000. It is arguable that a third party who participates with knowledge in a fiduciary's breach of duty and derives profits therefrom is liable to account for the profits derived even if the fiduciary's breach was not dishonest and fraudulent (Cook v Deeks [1916] AC 554 at 565; Consul Development Pty Ltd v DPC Estates Pty Ltd (1975) 132 CLR 373 at 397-398; Warman International Ltd v Dwyer (1995) 182 CLR 544 at 564-565, 569-570). No such remedy was specifically sought in its cross-claim, but the facts giving rise to the claim for relief were sufficiently alleged and the fact that this relief was not sought in the alternative to the proprietary claim is not a bar to the relief. No submissions were made in relation to such a remedy. I will invite further submissions on whether PacGen is entitled to this remedy against Super 1000.
134 PacGen is not entitled to recover both full equitable compensation from Mr McLay and an account of profits from Super 1000. That would be a double satisfaction.
Conclusion in Relation to Finmore Mortgage
135 For these reasons, I conclude that PacGen is not entitled to a proprietary remedy, but is entitled to equitable compensation from Mr McLay assessed in accordance with para [123] above. I will hear further submissions on whether it is entitled to an account of profits from Super 1000, provided there is no double satisfaction of judgments.
PacGen Mortgage dated 6 April 2004
136 From April 2003, Super 1000 provided loans to PacGen to provide it with funds to pay for the building works and other expenses associated with the Dee Why development. Between 1 April 2003 and 11 December 2003 it advanced $250,000. This was in addition to the $500,000 advance secured by the debenture of 3 March 2002. In January and February 2004 it advanced a further $60,000. Building works had commenced in about October 2002. There were serious problems with the builders which ultimately led to litigation during 2005. Mr McLay deposed that by December 2003, it was apparent to him that there had been and would continue to be ongoing funding difficulties with the joint venture. The project was running well behind program. Financing costs were eating into the funds available to pay for the construction costs. Drawdowns under the ING facility were dependent upon the achievement of certain milestone events and these were delayed. The builder was demanding payments notwithstanding that the milestone events had not been achieved. Building costs were escalating and were above budget. As at April 2004, further money was required to enable the building works to continue. Mr McLay was only prepared to make further advances if PacGen and Finmore executed a mortgage in registrable form over their interests in the Dee Why property which secured both past and future advances.
137 Although the mortgage is dated 6 April 2004, it was not executed by PacGen until some weeks after that date. The minutes of a meeting of directors of PacGen held on 20 April 2004 attended only by Mr McLay and Mr Scott Heathwood records that at the meeting, Mr McLay advised that Super 1000 was prepared to advance a further sum of $200,000 to Prime Property Plus (the Fund) upon the same terms and conditions as the advances totalling $810,000 had been made. The minutes record that Mr McLay tendered a deed of charge and a mortgage to secure all the advances. It was resolved that the documents be executed by the company. The minutes contain an inherent contradiction. Because all advances were to be secured by mortgage, future advances would not be made on the same terms as the earlier advances of $810,000 had been made.
138 It is curious that the meeting was attended only by Mr McLay and Mr Scott Heathwood and not by any of the other directors. Apart from Mr Scott Heathwood and Mr McLay, the other directors at that time were Mr Paul Heathwood, Mr Melki and Mr Dixon. Mr Melki did not give evidence. Mr Paul Heathwood deposed that he was unaware of the existence of a mortgage until 2005 or 2006 when he was told by his son that PacGen had given a mortgage to Mr McLay over PacGen's share of the Dee Why property. On the other hand, Mr Dixon was aware of the mortgage. The mortgage was given by both PacGen and Finmore and he signed the document in his capacity as a director of Finmore. Mr Dixon gave contradictory evidence as to whether he understood that Mr McLay's company, Super 1000, was to receive security for both the loans to be made and the loans previously made. Initially he agreed that he understood that Super 1000 was to receive security for the money to be lent for the purposes of the Dee Why development and for the loans that had already been made. Later, he said he was confused and that he did not understand that the effect of the mortgage was to secure advances which had already been made. Later again in his cross-examination he said that he thought the mortgage would secure Mr McLay's total interests including the loans he had made in the past. Mr Dixon did not discuss Mr McLay's request for a mortgage to secure all of his loans with either Mr Paul Heathwood or Mr Scott Heathwood.
139 Mr Scott Heathwood deposed that he was unaware that the mortgage Mr McLay required would secure past advances so as to give Super 1000 priority over other lenders. I do not accept that evidence.
140 Mr Scott Heathwood signed the annexure to the mortgage which provided that it secured the sum of $810,000 plus other moneys which may become owing by the Mortgagor to the Mortgagee. He said that he did not appreciate that the mortgage secured the existing advances of $810,000. Cross-examination did not shake him from that position. Mr Scott Heathwood said that he gave the page a cursory glance which did not include reading the first paragraph that said that the mortgage secured the sum of $810,000. He said he would not have agreed to such a position. I do not accept that evidence. I infer that Mr Scott Heathwood was well aware, as was Mr Dixon, that the mortgage was expressed to secure Super 1000's prior advances to PacGen.
141 The mortgage of 6 April 2004 was given by both PacGen and Finmore. Although the mortgage provided that it secured the sum of $810,000 plus other moneys owing or which may become owing by "the mortgagor" to the mortgagee, it was common ground that the mortgage secured the sum of $810,000 lent to PacGen, even though that amount was lent to PacGen alone.
142 The mortgage also further secured the earlier advance of $400,000 by Super 1000 to PED and Finmore which was also secured by the earlier Finmore mortgage. Counsel for Super 1000 and Mr McLay did not submit that if the taking of the earlier mortgage was a breach of fiduciary duty, the taking of the later mortgage, insofar as it secured the same debt, was not.
The April 2004 Mortgage was a Breach of the Debentures
143 Mr Paul Heathwood and Mr Bonic pleaded that the issue of the 2003 debentures and the grant of the April 2004 mortgage was a breach of their debentures. Mr McLay and Super 1000 concede that the 2002 debentures have priority over the 2003 debentures. They disputed that Mr Bonic was given a debenture in 2002 but I have decided that he did. Mr McLay had notice of Mr Bonic's 2002 debenture and it has priority over Super 1000's 2003 debenture. The claim in tort for inducing breach of contract therefore turns on the April 2004 mortgage which I will assume has priority over the 2002 debentures, its now having been registered.
144 As explained above, Super 1000 and Mr McLay denied that the grant of the April 2004 mortgage was a breach of the debentures because they contended that the property charged by the debentures was property of the Fund, and so far as the Dee Why development is concerned, the only asset which that trust held was a right to share in the profits of the development. I have rejected that submission. It follows that if the April 2004 mortgage has priority to Mr Paul Heathwood's debenture and Mr Bonic's debenture, as Super 1000 contends, PacGen breached the debenture by giving the mortgage.
No Intentional Inducement of Breach of the Debentures
145 Mr Paul Heathwood and Mr Bonic claim damages from Super 1000 and Mr McLay for knowingly inducing PacGen's breach of the 2002 debentures. Mr McLay and Super 1000 submit that they did not intend to induce a breach of contract and that no damages have been proved.
146 In Allstate Life Insurance Co v Australia & New Zealand Banking Group Ltd (1995) 58 FCR 26, Lindgren J, with whom Lockhart and Tamberlin JJ agreed, said (at 43):
" In my opinion, the authorities establish conclusively that the gravamen of the tort is intention. Although the requirement of knowledge of the contract is sometimes discussed as if it was a separate ingredient of the tort, it is in fact an aspect of intention. The requirement that the alleged tortfeasor have 'sufficient knowledge of the contract' is a requirement he have sufficient knowledge to ground an intention to interfere with contractual rights.