Supreme Court Grants Leave for Shareholders to Bring Derivative Proceedings

The Court granted leave for shareholders to bring derivative proceedings against a company, finding that the proposed proceedings involved serious questions to be tried.

Supreme Court New South Wales

Medium Neutral Citation: In the matter of [COMPANY] [2018] NSWSC 1802 Hearing dates: 13 November 2018 Decision date: 13 November 2018 Jurisdiction: [NAME]: Black J Decision: [NAME] are granted leave under s 237 of the [NAME] Act 2001 (Cth) to bring the derivative action on behalf of the First Defendant. Catchwords: [NAME] – membership, rights and remedies – derivative action – application for grant of leave by shareholders to bring derivative proceedings on behalf of the company under [NAME] Act 2001 (Cth) s 237 – whether plaintiffs acting in good faith in bringing proceedings – whether in the best interests of company that plaintiffs be granted leave – whether proposed proceedings involve a serious question to be tried. Legislation Cited: - [NAME] Act 2001 (Cth) ss 79, 180, 181, 182, 237, 247A, 1317H, 1317K Cases Cited: - [NAME] v [NAME] and Co Pty Ltd [2008] NSWSC 976; (2008) 68 ACSR 132 - Huang v Wang [2016] NSWCA 164 - [COMPANY] (in liq) v Carter [2018] NSWCA 118; (2018) 355 ALR 703 - Re [NAME] [2011] NSWSC 1235; (2011) 86 ACSR 432 - Re JGS Investment Holdings Pty Ltd [2014] NSWSC 1532 - Re [COMPANY] [2018] NSWSC 527 - Swansson v RA Pratt Properties Pty Ltd [2002] NSWSC 583; (2002) 42 ACSR 313 - Taxa Australia Pty Ltd v Wang [2016] NSWSC 1913 Category: Principal judgment Parties: [NAME] as Executor of the Estate of the [NAME] (First Plaintiff) [NAME] as Executor of the Estate of the [NAME] (Second Plaintiff) [COMPANY] (First Defendant) [NAME] (Second Defendant) [NAME] (Third Defendant) [COMPANY] (Fourth Defendant) Representation: Counsel: [redacted] [NAME] (Second – Fourth Defendants)

Solicitors: [redacted] [NAME] (Second – Fourth Defendants) File Number(s): 2017/383731

Judgment – ex tempore (revised 14 november 2018)

Nature of the application and affidavit evidence 1. By Interlocutory Process filed on 14 September 2018, [NAME] and [NAME], who are the executors of the estate of the [NAME], sought an order that they have leave to amend an Originating Process in the form attached to an affidavit of their solicitor, [NAME], sworn on 14 September 2018. Events have developed since that point, and the matter has twice been adjourned to reach the form which it takes at the hearing today. Ultimately, [NAME] now seek, in orders that have been provided to the Court, leave to file and serve a Statement of Claim in a form sent to the Court on 9 November 2018, and leave to file an Amended Originating Process to claim the relief sought in that Statement of Claim.

2. Part of the relief sought in that Statement of Claim involves personal claims of [NAME], including that sought in paragraphs 1-2 and 15-22 of the relief set out in the Statement of Claim, involving claims for declarations of the validity of particular transactions, which impact on [NAME]' personal rights as shareholders, and claims for winding up and oppression. Other parts of the Statement of Claim, including particularly the relief sought in paragraphs 3-14, and the pleading in paragraphs 25-74, are in the nature of a derivative claim, that is, a claim that [NAME] and [NAME] seek to bring on behalf of the First Defendant, [COMPANY] ("Company"). [NAME] seek leave under s 237 of the [NAME] Act 2001 (Cth) to bring that claim. The [NAME] do not actively contest the grant of leave to bring the derivative claims for which leave is sought, albeit the Court must be satisfied in order to exercise its statutory power of the basis for the exercise of that jurisdiction.

3. I have set out the background to aspects of this application in an earlier judgment, dealing with an application by [NAME] for access to documents under s 247A of the [NAME] Act and I need not repeat that background. In the application today, [NAME] rely on the affidavit dated 14 September 2018 of their solicitor, [NAME]; [NAME]' affidavits dated 19 September 2017 and 31 July 2018; the affidavit dated 14 March 2018 of their solicitor, [NAME]; the affidavit dated 20 July 2018 of one of their siblings, [NAME]; and [NAME]'s affidavit dated 6 August 2018. The [NAME] in turn rely upon the affidavit dated 18 June 2018 of [NAME], and the affidavits dated 17 and 26 September 2018 of a solicitor acting for them, [NAME].

4. There is a degree of common ground in the affidavit evidence as to facts of certain transactions to which reference is made in the proposed Statement of Claim, although the parties plainly take different views as to the legitimacy of those transactions. The [NAME], for the limited purpose of the application today, accepted that the proposed Statement of Claim accurately pleaded the content of the documents referred to, so that it was not necessary for [NAME] to tender, or the Court to review, a significant volume of documents to confirm the accuracy of the summary of those documents in the proposed Statement of Claim. I recognise that [NAME], who appeared for the [NAME], made clear that that approach did not extend further to any concession as to the substance of the particular transactions pleaded.

The structure of [NAME]' claims 1. It will be convenient to refer first to the structure of the matters relied upon in the Statement of Claim, particularly so far as leave is sought to bring the derivative proceedings, and to some of the evidence which addresses those matters, before returning to the relevant principles and the result of applying them in this case.

2. Paragraphs 1 to 6 of the Statement of Claim plead the parties to the proceedings. Relevantly, as I noted above, [NAME] and [NAME] are the executors of the estate of the [NAME], and hold, in that capacity, approximately 47% of shares in the Company. The Company is the First Defendant in the proceedings. The Second Defendant, [NAME], was purportedly appointed a director of the Company on 30 October 2002, although the validity of that appointment is in issue, and the Third Defendant, his daughter, [NAME], was purportedly appointed a director of the Company on 9 November 2017 although the validity of that appointment is also in issue. The Fourth Defendant, [COMPANY] ("[NAME]"), is the holder of the majority of shares in the Company and [NAME] and [NAME] are its directors. [NAME] seek to bring claims against it, to which I will refer below, broadly in the nature of claims for accessorial liability for the transactions alleged against [NAME] in respect of knowing involvement and knowing receipt.

3. As I noted above, certain claims are pleaded that are in the nature of personal claims by [NAME]. It is not necessary to address those claims for the purposes of determining the application for leave to bring derivative proceedings. The result of the transactions that are challenged in those personal claims is that [NAME] and [NAME] together are the two directors of the Company, and have control of it, and that [NAME], which is also under their control, has a controlling interest in the shares in the Company.

4. Turning now to the matters pleaded by way of derivative claim, [NAME] plead that [NAME] owed certain duties to the Company since October 2002, being the duties owed by a director at general law in respect of the no conflict and no profit rules and the statutory duties under ss 180, 181 and 182 of the [NAME] Act. That claim does not depend upon any question whether Mr [NAME] was validly appointed as a director of the Company or is properly characterised as a de facto director of the Company, since it appears to be common ground that he has acted as director of the Company throughout the relevant period. The relevant duties would likely be owed by [NAME] to the Company, whether as a director appointed in a legally valid manner or as de facto director. 5. [NAME] rely upon a Services Agreement entered into in 1997 between the Company and [NAME], pursuant to which remuneration was payable to [NAME] on a monthly basis at a specified rate. [NAME] contend that the Company has paid an amount exceeding that remuneration, by a significant amount, in the period from 2009 until, relevantly, 1 December 2016 when a new Services Agreement appears to have been entered into. It appears, from the affidavit evidence, that it is at least common ground that a Services Agreement existed and that management fees were paid by the Company to [NAME] over that period. I recognise that, as [NAME] and [NAME], who appeared for [NAME], fairly accepted, there may be a question as to the application of a limitation period in respect of the earlier part of that claim, so far as it extends to amounts paid in the financial years from 2009 to 2012. I will return to the relevance of that question in addressing the application for leave to bring derivative proceedings below. 6. [NAME] plead that, in causing the Company to make payments exceeding the amounts said to be payable under the 1997 Services Agreement and in the particular circumstances of the Company, [NAME] breached his directors' duties involving at least a conflict of interest and alleged breaches of the statutory duties. The relief sought is equitable compensation, statutory compensation under s 1317H of the [NAME] Act or alternatively an accounting, which it appears is sought to identify the relevant payments and put [NAME] or [NAME] to justification of them.

7. A claim is also brought in respect of a Services Agreement entered into on 1 December 2016, which it is alleged provided for payment of excessive service fees in the circumstances of the Company at the relevant time and that conduct is also alleged to amount to a breach of the equitable and statutory duties owed by [NAME]. 8. [NAME] also plead the making of loans in substantial amounts by the Company to [NAME] and [NAME] over the relevant period, and an occasion on which an amount of indebtedness was written off, in what they contend amounted to a waiver of part of that loan. That conduct is also alleged to amount to a breach of fiduciary and statutory duties owed by [NAME] to the Company, so far as the transactions benefitted either [NAME] or [NAME]. [NAME] also plead substantial payments made by the Company to [NAME], by way of reimbursement of amounts which [NAME] contends were paid to employees for the benefit of the Company. Again, that conduct is alleged to constitute a breach of directors' fiduciary and statutory duties. 9. [NAME] also seek to advance claims by the Company for accessorial liability, and specifically for knowing involvement or knowing receipt at general law or for knowing involvement for the purposes of s 79 of the [NAME] Act, against [NAME], where [NAME] contend that [NAME]' knowledge would be attributed to [NAME] so far as he was a director of that company.

10. Finally and for completeness, claims are brought in respect of oppression and relief is sought by way of an order to wind up the Company. Those are personal claims for which no leave to bring a derivative action is required.

Applicable legal principles 1. The applicable legal principles are well established and I reviewed them at some length in my judgment in Re [COMPANY] [2018] NSWSC 527. I will not seek to repeat that review in full here. In order to grant leave to bring the relevant derivative proceedings, the Court must be satisfied of five matters specified in s 237(2) of the [NAME] Act and must grant that leave if satisfied of those matters. Those matters are that the Company will not itself bring the proceedings; [NAME] are acting in good faith; it is in the best interests of the Company that [NAME] be granted leave; there is a serious question to be tried; and at least fourteen days before the making of the application, [NAME] gave written notice to the Company of their intention to apply for leave and of the reasons for applying or, alternatively, it is appropriate to grant leave although such notice was not given. [NAME] bear the onus of establishing that each of these matters is satisfied on the balance of probabilities: Swansson v RA Pratt Properties Pty Ltd [2002] NSWSC 583; (2002) 42 ACSR 313 at [26]; Huang v Wang [2016] NSWCA 164.

Whether the Company will bring the proceedings 1. The first question then is whether the Court can be satisfied on the balance of probabilities that the Company will not itself bring the proceedings. [NAME] submits that the Court may be satisfied of that matter, both because the [NAME] have not contested that proposition in submissions, and because it is apparent that [NAME] and [NAME] control the Company, both as its directors and because [NAME] controls the majority of its shares, and it appears from the evidence that they do not accept the validity of the complaints made as to their conduct. It seems to me that, in circumstances that [NAME] and [NAME] do not accept the validity of those criticisms, it is highly unlikely that they would cause the Company to bring proceedings against themselves where the Company is under their control. As I noted above, the [NAME] have not contended to the contrary. In those circumstances, I am satisfied that the first requirement for the grant of leave is satisfied.

[NAME] are acting in good faith 1. The second requirement for the grant of leave is that [NAME] are acting in good faith. Factors relevant to that requirement include whether they have 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 they are seeking to bring the action for a collateral purpose. [NAME] draws attention to the observation in [NAME] v [COMPANY] above at [38] that it will be relatively easy to satisfy this requirement if an application is made by a current shareholder who has more than a token shareholding and the action seeks recovery of property so that the value of the claimant's shares will be increased. That observation has frequently been applied in the case law, including in the authorities to which I referred in Re Legal [COMPANY] above at [54].

2. It seems to me that the Court should be satisfied on the balance of probabilities that [NAME] are acting in good faith for several reasons. First, as [NAME] points out, it is apparent that [NAME] hold a substantial shareholding in the Company, the value of which will be increased by any recovery made by the Company in these proceedings. Where [NAME] also seek relief in oppression or a winding up, then any recoveries would also be relevant to the amounts which are available to meet claims of creditors and for distribution to contributories in the winding up, and [NAME] would benefit from recovery of those funds by the Company, if a proper claim exists, so as to be distributed on a winding up. 3. [ADDRESS] should also have regard to whether [NAME] have an honest belief that a good cause of action exists and has reasonable prospects of success, and I have referred above to the relevance of whether a reasonable person would hold that belief in the circumstances. The affidavit evidence of [NAME] and [NAME] refers to the factual matters which support the belief that such claims exist and those matters reflect, at least in part, the production of documents following their earlier application under s 247A of the [NAME] Act. The efforts which [NAME] have taken, both to obtain access to those documents by that application to bring this application and to plead the relevant claims, are also indicative of their good faith in pursuing their relevant claims. I can also more readily draw the inference of good faith where no contention to the contrary was put by the [NAME].

For these reasons, I am satisfied on the balance of probabilities that [NAME] are acting in good faith, so far as the action is sought to be brought to establish recoveries for the Company which will be to the benefit of each shareholder if the action were successful.

Whether it is in the Company's best interests that leave be granted 1. The next question in the leave application is whether it is in the best interests of the Company that [NAME] be granted leave. In [NAME] v [COMPANY] above at [55]–[56], Palmer J noted that this element required that the Court be satisfied that the proposed action actually is, on the balance of probabilities, in the relevant company's best interests. Relevant matters were identified by Ball J in Re [NAME] [2011] NSWSC 1235; (2011) 86 ACSR 432 as including the prospects of success of the action; its likely costs; the likely recovery if the action is successful; and the likely consequences for the relevant company if the action is unsuccessful.

2. It will ordinarily be necessary to give evidence of the character of the company in order to allow the Court to determine that question and there is such evidence in this case. As [NAME] points out, the Company had previously conducted the business of a nursing home provider but has since sold that business and now holds the funds that were realised from that sale, which would likely be distributed to shareholders in a winding up. In these circumstances, there is no suggestion that the conduct of these proceedings would have any adverse impact on any ongoing business of the Company. To the contrary, it seems to me that the conduct of these proceedings is likely to determine matters which would be relevant to the amount of assets available for distribution on the winding up of the Company. So far as a serious question to be tried exists, and where there is a prospect of recoveries if the proceedings are successful and the amounts involved are substantial, then it is likely to be in the best interests of the company that it had the opportunity to make those recoveries, as long as it is not exposed to an unjustified risk of costs in doing so.

3. It will also be relevant, in determining whether the proceedings are in the Company's best interests to have regard to whether the Company will be protected against the costs of an adverse result. The case law has recognised the desirability of an indemnity to be given to the relevant company to protect it from adverse costs exposure, or at least that the Court may more readily conclude that it is in a company's best interests to bring such proceedings where such an indemnity is available: [NAME] v [NAME] and Co Pty Ltd [2008] NSWSC 976; (2008) 68 ACSR 132 at [73]; and [NAME] my observations in Re [COMPANY] above at [68]. Here, [NAME] offer such an indemnity for the costs of the conduct of the proceedings by the Company, and for any order as to costs against it, and the Court may note that offer in granting such leave. I recognise that the question of costs may be less significant where a derivative application is to be brought at the same time as an oppression claim, and there is likely to be overlap of relevant issues. Here, however, I proceed on the basis that the issues raised in the derivative action are potentially wider than those raised by the oppression claim, although there is some overlap between them, and the indemnity offered therefore has real significance.

4. I must also have regard, in determining whether it is in the Company's best interests that leave be granted, to the possibility that redress might be available by other means, including by the proceedings for oppression that [NAME] propose to bring. [NAME] fairly acknowledged, in submissions, that there is at least some potential that the issues raised in respect of the derivative action could be addressed in aspects of an oppression claim. For example, if it were established that the Company's assets had been dissipated by related party transactions with [NAME] or [NAME], then it is at least possible that the Court in an oppression claim could order a buy out of [NAME]' shares, at a value that is adjusted for the effect of those transactions upon the Company's assets.

5. However, [NAME] point out, correctly, in my view, that there are potential limits to the availability of such relief. First, an adjustment of that kind can only be made if a buy-out order is made. If a winding up order were made, then it will be much more difficult to adjust contributories' interests in that way. Second, [NAME] point out that, so far as a personal claim is brought by them, it cannot extend to a loss in the value of their shares which is reflexive of the Company's loss suffered by reason of a breach of the duties owed to it: Re JGS Investment Holdings Pty Ltd [2014] NSWSC 1532 at [21]; Taxa Australia Pty Ltd v Wang [2016] NSWSC 1913 at [23]. [NAME] point out that in those circumstances, their personal claim properly does not seek to recover loss which is the Company's loss, albeit they contend that it would be reflected in a diminution in the value of their shares. [NAME] also point out that here there will be no issue as to multiplication of proceedings where there is an overlap in the issues raised in the oppression claim and the proposed derivative action.

6. I recognise that, in some circumstances, it may not be necessary to seek leave to bring a derivative action, because all relevant issues can be determined in the context of an oppression claim. However, there are many cases in which the availability of oppression proceedings, as an alternative to or in addition to the derivative proceedings, have not been treated as preventing a grant of leave to bring derivative proceedings, [NAME] for example, those to which I referred in Re [COMPANY] above at [61]. In these circumstances, I am not satisfied that the availability of an oppression claim to [NAME] and the possible availability of an adjustment for the value of their shares for the conduct alleged in such a claim, has the result that it is not in the best interests of the Company that leave be granted to bring the relevant proceedings, where I would otherwise be satisfied that that was the case.

For these reasons, I am also satisfied on the balance of probabilities that it is in the best interests of the Company that [NAME] be granted leave.

Whether a serious question to be tried is established 1. Next, it is necessary to determine whether there is a serious question to be tried. This is to be determined by applying the same tests as is applied by the Court in determining whether to grant an interlocutory injunction: [NAME] v [COMPANY] above at [25]; Re [NAME] above at [56]. Here, it seems to me that that question is relatively straightforward. There is a degree of common ground in the evidence, as I noted above, as to the fact of particular transactions, including at least the payments made of management fees under the Services Agreements and the loans made by the Company to [NAME] and [NAME]. There is, as I noted above, potentially a significant factual dispute as to the legitimacy of those transactions. However, it seems to me that a seriously arguable case for breach of the rule against conflict of interest or for breach of the no profit rule in equity, or for breach of the statutory analogues in ss 181 and 182 of the [NAME] Act, is here established where significant financial transactions have occurred between the Company on the one hand and its director or a related party on the other, given the amounts involved, and the contention that those amounts exceeded the amounts payable on the terms of the relevant agreements or were excessive in the relevant circumstances.

2. It also seems to me at least seriously arguable in the relevant circumstances that one or other form of accessorial liability could be established against [NAME], including liability for knowing involvement under s 79 of the [NAME] Act in the breach of the statutory duties. For that reason, it seems to me that a serious question to be tried is established in respect of the claims both against [NAME] and [NAME] so far as they are sought to be pursued as derivative claims.

3. I should address one other matter, before leaving the question whether a serious question to be tried is established. I have referred above to the possibility that at least some of the claims brought, particularly in respect of the earlier period, may raise limitation issues. The authorities establish that the Court would ordinarily follow the statutory limitation period under s 1317K of the [NAME] Act in respect of analogous claims for breach of equitable fiduciary duties, although that limitation period will not necessarily be applicable in a claim for accessorial liability: [COMPANY] (in liq) v Carter [2018] NSWCA 118; (2018) 355 ALR 703. In Re [COMPANY] above, I noted that limitation issues were ultimately matters of defence, rather than matters relevant to establishing whether a plaintiff had a serious question to be tried, and may well depend on a detailed examination of facts, including the extent of a plaintiff's knowledge of the relevant conduct at the relevant time and any concealment that may exist in respect of that conduct. I do not [NAME] any reason to take a different view in this case.

Accordingly, the limitation issues to which I have referred do not seem to me to deprive [NAME] of the serious question to be tried which I have held would otherwise be established.

Notice of the application 1. The final issue is whether [NAME] have either given fourteen days written notice to the Company of the intention to apply for leave or it is appropriate to grant leave although such notice was not given. Here, it seems at least arguable that notice was given, so far as the possibility of the derivative action was raised in the earlier proceedings seeking access to documents under s 247A of the [NAME] Act. In any event, where I have held above that it is unlikely that the Company would bring the proceedings itself and given the other findings I have reached above in respect of the other elements necessary for leave under s 237(2) of the [NAME] Act, then the Court could readily conclude that it was appropriate to grant leave even though such notice had not been given.

Conclusion 1. In these circumstances, I am satisfied that the statutory requirements for the grant of leave under s 237(2) of the [NAME] Act are satisfied. Where those requirements are satisfied, the Court has no residual discretion, and must grant leave for the relevant action to be brought. Accordingly I will grant such leave.

********** DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated. Decision last updated: 27 November 2018