Veremu Pty Ltd & Ors v Ezishop.Net Ltd & Ors [2003] NSWCA 317 | Case summary

10 November 2003 VEREMU PTY LTD & ORS v EZISHOP.NET LTD (In Liquidation) & ORS Judgment 1 HANDLEY JA: I agree with Giles JA. 2 GILES JA: Some of the appellants agreed to subscribe for shares in Ezishop.Net Ltd ("Ezishop"), and the others of them agreed to guarantee payment for the shares. The principal question in this appeal was whether the agreement was frustrated upon Ezishop becoming insolvent and going into liquidation. 3 It was common ground that frustration occurs when the law recognises that a contractual obligation has become incapable of being performed because the circumstances in which the performance is called for would render it a thing radically different from that which was undertaken by the contract: Davis Contractors Ltd v Fareham Urban District Council (1956) AC 696 at 729 per Lord Radcliffe; adopted in Codelfa Construction Pty Ltd v State Rail Authority of New South Wales (1982) 149 CLR 337. In Davis Contractors Ltd v Fareham Urban District Council at 720-1 Lord Reid said that the task of the court is to determine on the true construction of the terms of the contract, read in the light of its nature and the relevant surrounding circumstances, whether the contract is wide enough to apply to the new situation. In Codelfa Construction Pty Ltd v State Rail Authority of New South Wales at 357 Mason J referred to frustration when the parties entered into the contract on the common assumption that some particular thing or state of affairs essential to its performance will continue to exist and that common assumption proves to be mistaken, and at 360 his Honour stated the critical issue as whether the situation which had come about was fundamentally different from that contemplated by the contract on its true construction in the light of the surrounding circumstances. The question should be determined by regard to all these statements. 4 Ezishop was incorporated in September 1998 and commenced trading in February 1999. The judge described its business - "It sought to target opportunities through the convergence of television and the internet to develop cross-promotional strategies for electronic retailing in Australia. Its core business activities included producing television and radio ('infotainment' and 'infomercial') programs offering merchandise and services to consumers. It also operated what was described in the Administrator's Report to Creditors as a 'linked interactive internet portal offering traditional department store retailing for branded goods and services'." 5 Ezishop was a venture capital company, requiring ongoing capital subscriptions to fund its business until, hopefully, it became profitable. A number of persons, including the subscribing appellants, were issued with shares from time to time during 1998, 1999 and 2000, and as well debt capital was obtained, whereby the company's trading losses were met and its ongoing operations were funded. In May 2000 Ezishop's status was changed to a public company, and it was proposed to make an initial public offering and list the company in order to raise further capital. 6 However, by August 2000 Ezishop was in difficulties. There had been a severe downturn in the market for technology stocks, and for that reason or otherwise the proposed initial public offering was delayed and was thought unlikely to occur for several months. Trading losses of about $180,000 per month were being incurred. Unless further capital was obtained the company would fall into insolvency. In order that it continue to trade, it was necessary that further capital be raised from existing shareholders. 7 The appellants were made aware of this situation. At a meeting of the board and shareholders on 16 August 2000, the shareholders participating including some of the appellants, it was agreed to raise $2 million from the shareholders. Two of the subscribing appellants made immediate payments of $125,000 and $50,000. 8 A draft agreement was prepared and distributed providing for payment to Ezishop of equity and debt capital. Before it was signed a blight fell upon the company's future. An unfavourable credit report and difficulty in meeting payments to its advertising agency caused the cancellation on 24 August 2000 of its infomercial booking with the Ten Network, depriving it of most of its revenue. The appellants were told of this. Nonetheless the agreement was signed by the appellants and other existing shareholders. It was dated 29 August 2000. 9 By cl 2 of the agreement the subscriber appellants agreed to apply for shares and pay the subscription moneys by or on various future dates and Ezishop agreed to allot and issue the relevant shares. The payments already made were noted. The dates began with 31 August 2000 and continued with month ends until 30 April 2001, so that there was an ongoing funding programme. By cl 2.7 - "Subject to clause 3, each Subscriber and Lender agrees that they are legally bound to subscribe for the Shares and make Loans as set out in Annexure 2, and that if they fail to comply with these obligations, the amount that they should have subscribed or lent will be a debt due to the Company and immediately recoverable as such, notwithstanding that an Application has not been lodged and/or that Shares and/or Options have not been issued in respect of the amounts that should have been subscribed or lent as set out in Annexure 2." 10 By cl 4 of the agreement it was acknowledged that the funding obligations would remain even if the proposed initial public offering and listing of the company was delayed or did not occur. Clause 9.1 was an entire agreement clause, and included that all other understandings were superseded and the appellants had "carried out their own due diligence on the Company". 11 By cl 8 the guarantor appellants, all natural persons, guaranteed the performance of the obligations of the respective subscriber appellants, all corporations, with which each was associated. 12 Subscription moneys were payable by one of the subscriber appellants on 31 August 2000, and payment was made. At a meeting on 31 August 2000 and at various times during September it was proposed that $300,000 payable under the agreement in 2001 be accelerated to meet Ezishop's working capital deficiency, but the parties responsible for the payments did not agree. The subscription moneys payable by some of the subscriber appellants on 30 September 2000 were not paid. On 5 October 2000 the board resolved that Ezishop be placed in voluntary administration. At a meeting of creditors on 1 November 2000 it was resolved that it be wound up. 13 The respondents obtained judgment against the appellants for the subscription moneys payable by the subscriber appellants on 30 September 2000 and the later dates. It was held that Ezishop was able and willing to issue the shares notwithstanding its administration and liquidation, and questions of implied terms and repudiation were decided adversely to the appellants. There was no appeal in these respects. That left the question of frustration, also decided adversely to the appellants. 14 In their written submissions the appellants submitted that there was frustration because payments for the shares in Ezishop which would be issued following its insolvency and liquidation would be radically different from the payments the subscriber appellants agreed to make. There would be the difference, it was said, because shares issued following insolvency and liquidation had no value or potential value whereas the shares to be issued pursuant to the agreement had potential value; because at least following administration and liquidation the shares effectively carried no control of Ezishop's affairs through voting rights; because there was effectively no prospect of receiving a dividend; and because the transfer of the shares was inhibited. It was said that other particular rights attaching to the shares were altered upon liquidation, for example, the books of the company could be inspected only by order of the Court. 15 It may be accepted that matters of these kinds marked differences between the position of a shareholder in Ezishop as at 29 August 2000 and the position of a shareholder in Ezishop after it had gone into liquidation. It is unnecessary to analyse them in more detail or distinguish between the significance of insolvency and the significance of liquidation, because I do not think they establish frustration of the agreement. 16 The judge said - "62 The circumstances which led to the making of the Agreement have been referred to. It should also be mentioned that each of the Guarantors, namely Messrs Marheine, Efkarpidis, Hand and Coleman, gave evidence which demonstrated that he was a person of extensive commercial experience and acumen. Evidence given in cross examination left me in no doubt that in the period prior to signing the Agreement (sometimes described as the "Survival Proposal") each knew of, and accepted, the uncertainty of the Company's future trading prospects, the risk that the Company might fail, and that failure might result in the loss of the investment in it. It is to be remembered that it was to save the Company from inevitable solvency that each agreed to provide funds in the expectation that to do so would enable the Company to continue trading. I am satisfied that, as for example advised by Mr Scutt in his e-mails of 15 August 2001, they well knew that even with such funding the Company's trading future could be neither predicted nor guaranteed." 17 The judge later referred to his "finding that insolvency and liquidation was within the contemplation of the parties". 18 In oral submissions the appellants submitted that the risk they accepted, in the circumstances in which the agreement was entered into, did not extend to insolvency and liquidation. They submitted that the capital subscriptions were to ensure continuation of trading, and that while risk was accepted it was what they called the entrepreneurial risk of venturing capital in trading. Continuation of trading was the common assumption. The entrepreneurial risk was distinguished from the risk of insolvency and liquidation by saying that the contributors intended to put money into a trading company but not into a non-trading company 19 We were taken to the evidence underlying the judge's findings. I do not think the judge's findings were in error, or that the distinction drawn by the appellants is warranted. If capital is ventured conscious of the risk that trading will not be successful, the risk extends to the risk of cessation of trading and the insolvency and liquidation which might follow, notwithstanding that those accepting the risk hope or believe that these dismal outcomes will not occur. Indeed, the distinction drawn by the appellants has an unfortunate implication. The debts incurred while trading in reliance on the promise to provide funds have to be paid after trading ceases. A promise to fund the trading would hardly be qualified so that the funds do not have to be provided although the debts have been incurred, and that qualification on the acceptance of risk would not readily be found. 20 Such a qualification is not found in the agreement. The subscriber appellants' return for their subscription moneys was shares in Ezishop. What they agreed to receive was not shares in a solvent Ezishop, shares in an Ezishop which would remain solvent, or shares in an Ezishop which would remain trading or in corporate existence. On the contrary, in the circumstances in which the agreement was entered into insolvency and liquidation were obvious possibilities if Ezishop did not prosper, however much the parties may have hoped, even expected, that in time its business would become profitable. In the circumstances in which the agreement was entered into, it amply accommodated the possibility of supervening insolvency and liquidation. Clause 9's exclusion of other understandings and acknowledgement of due diligence and cl 4's reference to the initial public offering are not conclusive, but underline that the appellants bore the risk of Ezishop remaining solvent and continuing to trade. 21 A share is often described as a bundle of rights and obligations. What the subscriber appellants were to obtain was bundles of rights and obligations which meant that, if things went well, voting rights would enable them to participate in the control of Ezishop's affairs, they might receive dividends, and they would have property of value which they could deal with more or less at will; but if things did not go well, they would be left as shareholders in an insolvent company or even a company in liquidation. The latter is the situation which they now argue brings frustration. Ezishop's performance of the agreement by issuing the shares would provide to the subscriber appellants their bundles of rights, and their performance of the agreement by payment would bring to them their bundles of rights. The fact that insolvency and liquidation afflicted Ezishop prior to the issue of the shares rather than afterwards did not affect the rights conferred by the shares agreed to be issued, or mean that the payment for the shares was something radically changed in its nature. It meant only that the hope or expectation of the parties was disappointed at a time earlier than it might in any event have been disappointed. 22 A subsidiary question in the appeal was whether the appellants were relieved of their obligations to pay or see to payment of the subscription moneys because there had been a total failure of consideration. Reliance was placed on the references by McHugh J in Baltic Shipping Co v Dillon (1993) 176 CLR 344 at 389 and Gummow J in Roxborough v Rothmans of Pall Mall (2001) 208 CLR 516 at [104] to failure of a state of affairs contemplated as a basis for payment of money to sustain itself. It is sufficient that in the present case the relevant state of affairs was the issue of the shares, and for the reasons I have given that state of affairs was sustained. 23 In my opinion, the appeal should be dismissed with costs. 24 SANTOW JA: I agree with Giles JA. **********

Veremu Pty Ltd & Ors v Ezishop.Net Ltd & Ors

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