Grant of Leave for Derivative Proceedings Under Corporations Act

The Court granted leave to bring derivative proceedings on behalf of a company against a director, finding that the criteria under s 237 of the Corporations Act were met, including the best interests of the company and the presence of a serious question to be tried.

Supreme Court New South Wales

Medium Neutral Citation: In the matter of [COMPANY] [2020] NSWSC 1436 Hearing dates: 10 September 2020 Date of orders: 10 September 2020 Decision date: 10 September 2020 Jurisdiction: Equity - Corporations List Before: Black J Decision: Leave granted to bring proceedings on behalf of [COMPANY] under s 237 of the Corporations Act 2001 (Cth) Catchwords: CORPORATIONS – statutory derivative action – application to bring proceedings on behalf of company – where applicant is one of company's two statutory directors – where applicant undertakes to indemnify company in respect of costs of conducting the proceedings – where defendant does not oppose grant of leave – whether the proposed proceedings are in the company's best interests – whether leave should be granted to the applicant to commence proceedings in company's name. Legislation Cited: - Corporations Act 2001 (Cth) ss 9, 237, 237(2), 237(2)(a), 237(2)(c), 237(2)(d) Cases Cited: - Huang v Wang [2016] NSWCA 164 - Power v Ekstein [2010] NSWSC 137; (2010) 77 ACSR 302 - Re Yinsanity Pty Limited [2019] NSWSC 1290 - Swansson v RA Pratt Properties Pty Ltd [2002] NSWSC 583; (2002) 42 ACSR 313 - The App Shop Pty Ltd v Jalal Brothers Pty Ltd [2019] NSWSC 490 Category: Principal judgment Parties: [NAME] (First Plaintiff) [COMPANY] (Second Plaintiff) [NAME] (First Defendant) [COMPANY] (Second Defendant) [COMPANY] (Third Defendant) Representation: Counsel: [redacted] [NAME] (First and Second Defendants)

Solicitors: [redacted] [COMPANY] (First and Second Defendants) File Number(s): 2019/392777

Judgment – EX TEMPORE

Nature of the application and background 1. By paragraph 4 of an Originating Process filed on 13 December 2019, the Plaintiffs, [NAME] and [COMPANY], seek leave to bring proceedings on behalf of the Third Defendant, [COMPANY] ("the company") against the First Defendant, [NAME], seeking recovery of compensation under s 1317H of the Corporations Act 2001 (Cth) or equitable compensation arising from allegations that [NAME] had caused [NAME] to incur expenses unrelated to [NAME]'s business or for her personal benefit, in breach of her duties as a director.

2. The application is supported by three affidavits of [NAME] dated 6 August 2020, [NAME] dated 13 August 2020 and [NAME] dated 13 August 2020. The position of [NAME], and [COMPANY], which I infer is a company associated with her, for which [NAME] appears, is that they consent, without admissions, to the grant of leave, although [NAME] made submissions as to matters which are relevant to the grant of leave. [ADDRESS] nonetheless needed to address the application on its merits, because the grant of leave under s 237 of the Corporations Act involves the exercise of a statutory discretion conferred on the Court.

3. I should add, before turning to the applicable principles, that there has already been some investigation of the relevant transactions, by an expert appointed by the Court, at the invitation of the parties, and that expert had concluded that, of 454 transactions, 113 were "proper expenses", within the definition adopted by the expert; 338 were "not proper expenses", within that definition; and one transaction was of a mixed character. The expert had in turn observed that, within some categories, a significant number of the relevant expenses were not "proper expenses", in the particular sense. It appears that [NAME] had acknowledged that a number of expenses were of a personal character, and offered to reimburse those amounts to [NAME], although it is not clear whether that reimbursement has since occurred. [NAME] rightly points out that the expert had understood the question of whether an expense was a "proper expense" as involving not only the nature of the transaction, but also whether that transaction was properly documented, and that a significant number of transactions were found not to be "proper expenses" in the particular sense because they were not documented or not sufficiently documented to allow the expert to determine their purpose.

4. I bear that in mind in this judgment, and I recognise that the fact that a transaction is not documented, or not adequately documented, does not necessarily indicate that it is not for a proper corporate purpose, although it may involve a potential contravention of the obligations to maintain true and fair accounts, and the documents necessary to prepare true and fair accounts, under Chapter 2M of the Corporations Act. I, of course, express no final view in that respect. I also express no view as to the extent to which the Court may be able to draw inferences, in a proper case, as to the nature of a transaction if documents are not available in respect of it. It is not necessary to address those questions at this stage, and plainly not appropriate to do so in an interlocutory application, where [NAME] will not have had either the need or the opportunity to address the particular transactions which are in issue in any detail. I note that expert's findings because they indicate that at least there will be a question, in respect to a large number of transactions, as to whether they were adequately documented, and (possibly ultimately as to a smaller number of transactions) whether they were proper in their ultimate character.

The relevant factors to a grant of leave 1. I turn now to the matters that are relevant to an application for leave under s 237 of the Act. In order to obtain the leave which she seeks, [NAME] needs to satisfy the criteria specified in s 237(2) of the Act. In order to grant leave under that section, the Court must be satisfied of five matters, and it must grant that leave if it is satisfied of those matters, and must not grant that leave if it is not satisfied of those matters.

2. Those matters are, first, that it is probable that [NAME] will not bring the proceedings, absent the grant of leave. I am satisfied of that matter, where [NAME] and [NAME] are the two directors of [NAME], and they will almost inevitably be in deadlock as to that question. The second question, to which I will return, is whether [NAME] is acting in good faith. The third is whether it is in the best interests of [NAME] that [NAME] be granted leave to bring the proceedings in its name. The fourth is that there is a serious question to be tried and the fifth is that [NAME] had given notice of her intention to apply for leave and the reasons for applying, or that the Court should dispense with that requirement. [NAME] bears the onus of establishing each of those matters on the balance of probabilities: Swansson v RA Pratt Properties Pty Ltd (2002) 42 ACSR 313; [2002] NSWSC 583 at [26]; Huang v Wang [2016] NSWCA 164; Re Yinsanity Pty Limited [2019] NSWSC 1290 at [5]ff. I have drawn on my summary of the relevant principles in the third of those judgments for a number of aspects of the observations which follow.

3. As I noted above, the first contention, is whether [NAME] would bring the relevant proceedings, and it seems to me unlikely that it would do so for the reasons that I have noted.

4. The second contention is whether [NAME] is acting in good faith. The case law establishes that relevant factors include whether she has an honest belief that a good cause of action exists and has reasonable prospects of success, although that belief will be tested against whether a reasonable person in the circumstances would hold that belief, and whether she is seeking to bring the action for a collateral purpose. The case law recognises that it is relatively easy to satisfy that requirement if an application is made by a current shareholder who has more than a token shareholding, as [NAME] plainly does, and the derivative action seeks recovery of property so that the value of her shares would be increased. I am satisfied that the Court can reasonably infer that [NAME] is acting in good faith, where there appears to be at least a basis in the expert's report for considering that some expenses, and possibly a significant number of expenses, are open to challenge on the basis that they have a personal character. To the extent that such a challenge succeeds, [NAME] would benefit, so far as it recovered compensation, and [NAME] would indirectly benefit so far as the value of her shares reflects that recovery.

5. The next question is whether the proceedings are in [NAME]'s best interests. In Swansson v [COMPANY] above, Palmer J noted that this required that the Court be satisfied that the proposed action actually is, on the balance of probabilities, in the relevant company's best interests. The evidence should ordinarily address a number of matters in that regard, and [NAME]'s evidence generally addresses those matters. [NAME] in particular addresses her view that, given the nature of [NAME]'s operations, the proposed claim ought not to affect its continued operations.

6. I was concerned, when the application was first brought, that the number of transactions in issue, including a very large number of transactions of small value, could have the consequence that [NAME] would expend costs in bringing those smaller claims which would exceed the amount likely to be recoverable under them. That question has been addressed, when the matter was adjourned, by a proposal now put by [NAME], in the form of an Amended Schedule which I have marked MFI 1, which reduces the number of transactions that will be challenged to 809 from the previously suggested 3,644 transactions, by imposing a limit of a minimum value of $500 on transactions which have not already been reviewed by the Court-appointed expert. The consequence is to marginally reduce the amount that would potentially be recoverable, but significantly reduce the number of transactions which would be in issue in seeking to establish that recovery. It seems to me that that is a first, and significant, step in addressing the risk that the cost of the proceedings would have the result that they were not in [NAME]'s best interests. 7. [NAME], who appears for [NAME], also proposes that the Court would make orders which require [NAME] to indicate, at an early stage, whether she accepts that particular expenses are of a personal nature, or contends that they are proper expenses of [NAME], and to provide information as to the transactions. It may be that the Court could make that order, at least by consent, if both parties considered that it would likely reduce the costs that would be incurred by approaching the issue in a more formal way. There may be a real question whether the Court could make that order, otherwise than by consent, which will turn upon the extent of its power to make directions, which are intended to promote the just, quick and cheap resolution of the real issues in the proceedings, for the purposes of s 56 of the Civil Procedure Act. It is, however, not necessary to address that question, because it seems to me that, even without the Court's involvement, [NAME] could achieve much of the objective sought from such a direction by a notice to admit facts, which would tend to shift the cost risks of the defence of any indefensible transactions from [NAME] to [NAME] without, of course, expressing any view on the merits as to how many transactions may fall in that category.

8. This may also be one of the relatively rare cases, in modern times, where it may be appropriate for the parties to consider, and the Court to make, orders for interrogatories, if that would allow a significant number of transactions to be dealt with in a more efficient way than other mechanisms. Again, I express no final view as to those matters, which are only relevant at this point because they are other means of addressing the risk that the costs of recovery of amounts claimed would exceed the amounts in issue.

9. It seems to me that, so far as that question has been addressed, and there is a potential for a significant recovery if the claim is successful, the claim is in [NAME]'s best interests.

10. I also bear in mind that the case law, at least in New South Wales, has recognized the importance of an adequate indemnity to be given by [NAME] in favour of [NAME] in respect of the costs to which it would be exposed if the proceedings were unsuccessful, as a relevant factor to whether proceedings are in [NAME]'s best interests: Power v Ekstein (2010) 77 ACSR 302; [2010] NSWSC 137 and see the other cases to which I referred in The App Shop Pty Ltd v Jalal Brothers Pty Ltd [2019] NSWSC 490 at [19]. [NAME] offers such an undertaking to the Court by her counsel.

11. The next question is whether there is a serious question to be tried, and that requires the application of the same test as applied by the Court in determining whether to grant an interlocutory injunction. It is not necessary for me to address this question at any length, and it is preferable that I do not do so for all the reasons that such questions are normally dealt with briefly in interlocutory applications. The matters to which I have referred raise serious questions to be tried as to whether expenses have been charged by [NAME] against [NAME] which are of a personal character, and whether that involved a breach of director's duty on [NAME]'s part, which may give rise to a claim for relief by way of compensation or an account of profits so far as the transactions were, in fact, improper transactions. I put that matter in that way because, as [NAME] points out, it is not immediately apparent that a claim for a failure to maintain financial records would, without more, give rise to loss to [NAME] which would be recoverable.

12. I am satisfied that the Court should dispense with the notice requirement under s 237 of the Act to the extent necessary, where the intent to bring this application was foreshadowed in the Originating Process, and the application for leave has been deferred while the parties have obtained the expert report to which I have referred above.

13. In these circumstances, I am satisfied, for the purposes of s 237 of the Corporations Act, of the matters required to grant leave under that section, and I will grant that leave. The parties have agreed the form of orders which should be made if the Court reached that result. I make orders in accordance with the short minutes of order initialled by me and placed in the file.

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