CATCHWORODS COSTS - security - applicant a shell company (trustee) - relevance of financial position of beneficiaries - strong prima facie case for applicant - security refused. Rabvila Pty. Limited v. Reymor Investments Pty. Limited & Ors. Qld G106 of 1985 PINCUS J. BRISBANE 16.6.86 IN THE FEDERAL COURT OF AUSTRALIA ) QUEENSLAND DISTRICT REGISTRY ) QLD G106 of 1985 GENERAL DIVISION BETWEEN : AND: AND: AND: JUDGE MAKING ORDER: DATE OF ORDER: WHERE MADE: RABVILA PTY. LIMITED Applicant REYMOR INVESTMENTS PTY. LIMITED First Respondent JOHN CHARLES REYNOLDS. Second Respondent IAN MOIR Third Respondent HUNGERFORD, HANCOCK & OFFNER (a firm) Fourth Respondent MINUTES OF ORDER PINCUS J. 16 JUNE 1986 BRISBANE THE COURT ORDERS THAT: 1. The application for security for costs be dismissed. NOTE: Settlement and entry of orders 1s dealt with in Order 36 of the Federal Court Rules. IN THE FEDERAL COURT OF AUSTRALIA ) QUEENSLAND DISTRICT REGISTRY ) QLD Gi06 of 1985 GENERAL DIVISION ) BETWEEN: RABVILA PIY. LIMITED Applicant AND: REYMOR INVESTMENTS PTY. LIMITED First Respondent AND: JOHN CHARLES REYNOLDS Second Respondent AND: IAN MOIR Third Respondent AND: HUNGERFORD, HANCOCK & OFFNER (a firm) Fourth Respondent PINCUS J. 16 June 1986 REASONS FOR JUDGMENT This is an application for security for costs in a case in which the applicant alleges breaches of s.52 of the Trade Practices Act 1974. The application is made by the respondents, but, for clarity, I shall give the parties the designations they have in the principal proceedings. The applicant purchased a restaurant business in 1982 from the first respondent, of whom the second and third respondents are directors; the fourth respondent is a well-known firm of accountants, one of whose members acted as accountant for the first respondent during the periods of time discussed below. The applicant is a company of no financial substance and plainly could not meet an order for costs if one were made against it in these proceedings. It was established as a trustee, no doubt for tax reasons, and it has been suggested by counsel for the fourth respondent that those who might expect to benefit from distributions made by the applicant, if 1t recovers damages in the principal proceedings, should be at some risk as to costs. There are no fixed equitable interests; the trust is purely discretionary. Counsel drew my attention to the fact that the Full Court had to consider what was apparently a discretionary trust case (see the report at first instance in 8 A.C.L.R. 483 at 484) in Bell Wholesale Co. Pty. Ltd. v. Gates Export Corporation 52 A.L.R. 176. The Court expressed itself in terms which may he argued to suggest that here security should be ordered unless 1t is shown that all the possible beneficiaries are without means. Whether that is the proper view of the Court''s reasons is further discussed below. I mention the case at this point in explanation of the fact that the parties adduced before me evidence as to the financial position of some of the rather numerous "beneficiaries" under the trust in question. From the sketchy account given of their financial position, it seemed to me probable that at least some of the beneficiaries might have residual borrowing power such as to enable them to provide some security. The beneficiaries to whom I refer are children of Mr. and Mrs. McLean who are, or at least were at material times, the directors of the applicant. It does not seem likely, however, that any of those children would be prepared to try to raise money to enable the proceedings to go on. Mr. and Mrs. McLean have, on the evidence, little or nothing. For their current financial position they blame the respondents, alleging in the principal application that they were ruined by the purchase of the first respondent's restaurant business which, I am satisfied, was indeed financially disastrous for them. It is another question, however, whether their losses were due to 1ts being impossible to extract any reasonable return from the business purchased, or due, rather, to the fashion in which they ran the business. Questions of that sort are sometimes expressed by speaking of the purchasers having behaved "reasonably", or otherwise, in their conduct of the business purchased. As to a business of this sort, such language is hardly appropriate. Common experience suggests that a restaurant may do well under one management and fail under another apparently competent management into whose hands it passes; it may be difficult to discern why the former patrons have transferred their custom elsewhere. For the reason just given, it 1s impossible to hold that the case is one in which the applicant (or more accurately, those who control it) have been rendered incapable of giving security by the misdeeds of the respondent. Even if it is shown that there is a strong prima facie case that the purchase was induced by misleading statements, it does not follow that the financial catastrophe which has ensued was the inevitable result of those statements. The most which the applicant can hope to show is that misleading statements may have contributed to the financial difficulties of the McLeans. The application for security was heard on two days with a gap of a week intervening. When the matter first came on, the applicant had placed before me a considerable amount of material relevant to the merits of its claim under the Trade Practices Act. Mrs. McLean made an affidavit on this subject and was cross-examined with respect to it. During the course of addresses, counsel for the respondents, who had adduced only slight evidence as to the merits, asked for an adjournment, and when the matter came on again, they were armed with material to rebut the applicant's case. Thus, although the strength of that case was determined only ina preliminary way, it is important to note that the applicant distinctly based its resistance to an order for security on the strength of its case, and that the respondents had a clear opportunity to rebut the material the applicant filed. The case is principally about representations as to profitability. The third respondent (a director of the first) does not dispute that the applicant was told that the business was very profitable. The fourth respondent firm admits that Mr. Fellowes, a member of the firm, said he believed the business would be profitable. Although the latter statement was an opinion only and one as to the future, it falls to be considered in light of the fact that the fourth respondent had been acting as the accountant for the first respondent, and had prepared its annual financial statements. They have been tendered and show a_ series of losses as follows:- 1979/80 $13,931 1980/81 $6,691 1981/82 $16,290 1982/83 $46,068 It will be seen that, in the last three years, the losses rose from year to year, and quite substantially. ° I do not think anything of significance can, at this stage, be taken from the 1982/83 result because in part of that year the business was being run by the applicant; it took possession on 22 November 1982 and ran the restaurant unsuccessfully until, in March 1983, it was sold back to the first respondent (the vendor) at a greatly reduced price. Mr. McMurdo, for the applicant, placed at the forefront of his argument the contention that security should not be ordered because the business, said to be very profitable, was not, on the admitted financial statements. It is common ground that those financial statements were not produced to the applicant before the purchase. I accept Mr. McMurdo's principal submission. The practical effect of making any realistic order for security in this case would be to stifle the litigation. That does not seem just when it is clear that, if the financial statements produced by the respondents are right, the business not only was not very profitable, but not profitable at all. The possibility exists, of course, that the figures presented on behalf of the respondents are not correct and show a worse result than would be shown by a proper analysis of the outcome of trading, but no one has seen f16 to swear to that; part of the evidence advanced on behalf of the respondents is concerned to rebut any suggestion that the full income received did not find its way into the financial statements. On examination of these statements, some items can be seen which may have artificially depressed the years' results. In the 1981/82 year, an expense 1s shown of $31,200 described as service fees", suggestive of the possibility ot a tax Minimisation arrangement. It would seem to be unorthodox, however, merely to assume, without any evidence, that the sum in question does not represent a proper expense. Aqain, 1t was said, that the sum shown for wages in the same year ($88,961) should be considered tn the light of the fact that substantial sums were paid to directors, but even if it 1s right, for the purposes of the present preliminary examination, to deduct those fees, the result for the year 1s still very poor. There are other aspects of the evidence placed before me which support the view that 1t would not be just to make an order having the effect of putting an end to the claim. It is common ground that two versions of a "statement of operations" were prepared and presented on behalf of the first respondent. One of them purported to set out results for the years ended 30 June 1980, 1981 and 1982. There seems no doubt that 1t was presented to induce the McLeans to buy. It showed a figure of "net profit" for the 1982 year of $112,969, nearly $130,000 better than the actual result for that year. Various explanations were given for the discrepancy, but the most important one 1s that the document contained a note: "The above figures are extracted from records maintained by Hungerford, Hancock and Offner, Chartered Accountant, Gladstone. Items such as telephone, postage, insurance, leasing are not included, as this is dependent on the individual Purchaser." Mr. McMurdo contended that the document was misleading on the basis that a reciplent of it would hardly have suspected that taking the items said to be "dependent on tne undividual purchaser" into account would turn the handsome profit shown into a loss. It 1s not clear on what basis the items in the document being discussed (showing the 1982 profit of $112, 969) were chasen, but the suggestion that they were deleted because dependent upon individual choice seems, prima facie, to be false. An example 1s amortization or leasehold improvements, a sum of $18,454 in each of the 19381 and 1982 years. Insurance, a sum not particularly dependent on modes of management, 1s deleted, whereas sums paid to restaurant entertainers are included. There 15 at least a prima facie inference that the real function of the document was to delude the McLeans into thinking that although the adjustments referred to in the note would worsen the results shown, they would not substantially or entirely eliminate the profit. A second version of a "statement of operations" presented on behalf of the first respondent was placed in evidence. It is dated 29 October 1982. The function of that document was to assist the applicant to obtain finance. Its date Talls after the applicant had executed a cantract to purchase the business; that contract was not completed because the purchaser could not obtain finance, and a second contract was entered into towards the end of November. It was arqued that the document of 29 October 1982 could not have misled the applicant because of its date - i.e. falling between the first and second contracts. Whether or not that is so, 1& would certainly not increase one's confidence in the veracity of auts author, for it deleted the qualitying note abcut items dependent upon the individual purchaser. On 1ts face 1t guve a blatantly false picture. A further point relied on by the applicant was simply chat the "statement of operations" showed sales of $478,873 wnereas the actual saies were $446,859 - a difference of over £30,990; that, of course, made a substantial contribution to the disappearance of the $112,959 profit shown in the "statement of operations" presented to the applicant. By way of explanation, evidence was adduced that the accounts had not been finalised when the statement was drawn up. Nevertheless, the financial year's end was comfortably past, and it is difficult to believe that an accurate statement of the takings could not have been given. There are other aspects relied on, such as the various figures given for expenses in the 1983 year in the "statement of operations". In the result, I hold that there is a strong prima facie case for the applicant that the figures admittedly presented an behalf of the fir¢t respondent were misleading. The position 1s mot quite so clear wtth respect to the tourth respondent, although 1 2s common ground, as I have mentioned. that Mr. Fellowes expressed the view that the business would be profitable. There 1s a dispute as to whether Mr. Fellowes also told the McLeans that the farst "statement of operations", mentioned above, was correct, There was undoubtedly centact between the McLeans and Mr. Fellowes, the latter acting in his profecsinnal capacity ar an accountant, befare erection of the firck contract. Tt would seem unlinels thar In the course ar a aiteusyi1cn with recpeer fa toe then proemered rurchice, ne ane would have mace referance re the "tharoment ef aperarion." which, on .t. face, purported to be derived from figures prepared by the rourth recpondent. It would have been mirleading tor Mr. Fellowes fa youch for fimires cer our in the "statement oar snerafions" wirhantr warning the MecLeans that these figures showed a rosulr fac different from the accounts prepared by the tourth roependenk. Th seems ta me unfertunate that the application for security has involved a preliminary hearing of the issues likely to be finally tought cut at the trial]. Presenting an apptiication for security on such a basis as this must involve the parties in considerable expense, and there will be duplication of effort, since much of the ground gone over will have to be considered again at the trial. However, it seems to me clear that' the 10. discretion given to the Court is wide enough to entitle the applicant (particularly in acase of this sort, depending in considerable part upon admitted documents) to have the Court examine in some detail the strength of the applicant's case. To revert to the decision of the Full Court in the Bell Wholesale case, counsel relied upon the passage 1n 52 A.L.R. at p.179: "In our opinion a Court is not justified in declining to order security on the ground that to do so will frustrate the litigation unless a company in the position of the appellant here establishes that those who stand behind it and who will benefit from the litigation if it 1s successful (whether they be shareholders or creditors or, as in this case, beneficiaries under a trust) are also without means," Since that was apparently a discretionary trust case, the contention may be put forward that because some of the McLeans' children had some means, security must be ordered. Ido not regard that proposition as following from the statement quoted. Some of the discretionary beneficiaries are adult children (all, apparently in modest circumstances) leading independent lives, wha could hardly be expected to be interested in utterly 1mpoverishing themselves to provide security. Further, there was not in the Bell Wholesale case the circumstance which has shown to exist here, namely a strong prima facie case that misleading statements were made. I should mention that counsel for the fourth respondent told me, without objection, that his solicitor estimated "party ll. and party" costs of their client at $20,000, if the hearing lasted a week. conclusion that [ff In the result, I have come to the should not make any order for security, and the application for such an order will be dismissed. t certify that this and the /O preceding pages are a true copy of the reasons for judgment herein of His Honour Mr Justice Pincus ptt Lagorno Associate Dated "6 chore 1986 o