FEDERAL COURT OF AUSTRALIA Frauenstein v Farinha [2009] FCA 469 COSTS – Calderbank offer – whether unreasonable to reject offer COSTS – conduct of proceeding – whether unnecessarily burdensome – whether distinction should be drawn between costs of pleadings and costs the hearing Corporations Act 2001 (Cth) Federal Court Rules CARL FRAUENSTEIN and ANOR v TOBIAS FARINHA and ORS NSD2135 of 2006 EMMETT J 23 MARCH 2009 SYDNEY IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY NSD 2135 of 2006 BETWEEN: CARL FRAUENSTEIN First Plaintiff CARPE DIEM INITIATIVES PTY LTD ACN 091 071 359 Second Plaintiff AND: TOBIAS FARINHA First Defendant MIGUEL FARINHA Second Defendant MARCO AZGATO Third Defendant SAN MARCO BONDI JUNCTION PTY LTD Fourth Defendant SAN MARCO PICOLLO PTY LTD Fifth Defendant SAN MARCO WORLD SQUARE PTY LTD Sixth Defendant COCKLE BAY SAN MARCO PTY LTD Seventh Defendant EQUAL 54 LTD Eighth Defendant JAMES PANAGOPOULOS Ninth Defendant TOBY BONDI JUNCTION PTY LTD Tenth Defendant MARCO BONDI JUNCTION PTY LTD Eleventh Defendant MIGUEL BONDI JUNCTION PTY LTD Twelfth Defendant CINE SAN MARCO PTY LTD Thirteenth Defendant ANDREW ALAN JOHNSON Fourteenth Defendant CHIEF COMMISSIONER OF STATE REVENUE DEPUTY COMMISSIONER OF TAXATION Supporting Creditor JUDGE: EMMETT J DATE OF ORDER: 23 MARCH 2009 WHERE MADE: SYDNEY THE COURT ORDERS THAT: 1. The Defendants pay the Plaintiffs costs up to and including 10 December 2007. 2. The Plaintiffs pay any costs of the Defendants thrown away by any amendments of the originating process or statement of claim. 3. The Plaintiffs pay 50% of the Defendants' costs of the proceeding after 10 December 2007. Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules. The text of entered orders can be located using eSearch on the Court's website. IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY NSD 2135 of 2006 BETWEEN: CARL FRAUENSTEIN First Plaintiff CARPE DIEM INITIATIVES PTY LTD ACN 091 071 359 Second Plaintiff AND: TOBIAS FARINHA First Defendant MIGUEL FARINHA Second Defendant MARCO AZGATO Third Defendant SAN MARCO BONDI JUNCTION PTY LTD Fourth Defendant SAN MARCO PICOLLO PTY LTD Fifth Defendant SAN MARCO WORLD SQUARE PTY LTD Sixth Defendant COCKLE BAY SAN MARCO PTY LTD Seventh Defendant EQUAL 54 LTD Eighth Defendant JAMES PANAGOPOULOS Ninth Defendant TOBY BONDI JUNCTION PTY LTD Tenth Defendant MARCO BONDI JUNCTION PTY LTD Eleventh Defendant MIGUEL BONDI JUNCTION PTY LTD Twelfth Defendant CINE SAN MARCO PTY LTD Thirteenth Defendant ANDREW ALAN JOHNSON Fourteenth Defendant CHIEF COMMISSIONER OF STATE REVENUE DEPUTY COMMISSIONER OF TAXATION Supporting Creditor JUDGE: EMMETT J DATE: 23 MARCH 2009 PLACE: SYDNEY REASONS FOR JUDGMENT 1 I have already expressed my concern that this litigation has caused considerable expense in order to resolve issues that should sensibly have been resolved by mediation or other means. The litigation results from the souring of a relationship of trust and cooperation that existed between the individuals involved in the litigation. The background is set out in my reasons of 10 December 2007. Some further issues concerning the litigation are outlined in my reasons of 6 February 2009. The proceeding has now been resolved among the parties apart from the question of costs. For matters of convenience in these reasons I shall use the terms that were defined for the purposes of the reasons of 10 December 2007, which are summarised in my reasons of 6 February 2009. 2 The issue which remains concerns the question of whether the Farinhas should be ordered to pay any part of the costs of the proceeding and whether Carl and Carpe Diem should be required to bear any of the costs of the proceeding. The Farinhas emphasised the fact that there has been no relief granted against them personally. On the other hand, it cannot be doubted that Carl has achieved a considerable measure of success in the proceeding, albeit that he has not recovered, in the events that have occurred, any relief against the Farinhas. 3 The proceeding continued by way of pleadings after directions were given by the Court. The proceeding was finally determined on the basis of a fifth further amended originating process, which contained approximately 140 separate prayers for relief. Many of those were in the alternative and prayers were sought in respect of three different companies, namely, Bondi Junction, Piccolo and World Square. The third further amended statement of claim ran to 117 pages with some 366 allegations leading up to the claim for relief in the fifth further amended originating process. 4 It is desirable to say something about the structure of the final version of the statement of claim. Section A contains in excess of 16 paragraphs and describes the parties to the proceeding. Section B runs from paragraph 17 to paragraph 193 and is headed "Material Facts". It describes in considerable detail and with considerable particularity much of the factual background in respect of which I made findings in my reasons of 10 December 2007. 5 Section C consists of paragraphs 194 to 289 and is headed "Oppressive Conduct". It makes a series of allegations under various subheadings as follows: (1) Agreement, common understanding and fiduciary duties. (2) Breach of common understanding. (3) Breach of fiduciary duty. (4) Misleading conduct by the Farinhas. (5) Under-reporting of revenue or failure to account. (6) Dilution of Carl's shares in World Square. (7) Breach of section 286 of the Corporations Act [relating to the keeping of financial records]. (8) Excessive expenses and payments to associated entities. (9) Reclassification of the $550,000 loan. (10) Failure to provide financial information. (11) The Letter Agreement. (12) Failure to pay Carl the value of his shares in World Square. Section D is headed "Contrary to the interest of the members and oppressive, unfairly prejudicial and/or unfairly discriminatory conduct of affairs". That section really asserts no more than the consequences of the detailed conduct alleged in Section C. Section E is entitled "Misleading or deceptive conduct" and relies upon the facts alleged in section C. 6 Section F is concerned with the Letter Agreement, to which reference is made in my reasons of 10 December 2007. Section G is concerned with the $550,000 loan made by Carpe Diem and consists of paragraphs 336 to 342. Section H and the second Section G, incorrectly labelled, both inserted late in the piece, are concerned respectively with monies lent and monies had and received and consist of paragraphs 343 to 366. 7 As I have said, the originating process and the statement of claim have been amended on a number of occasions. Clearly, any costs thrown away by those amendments, if they have not already been ordered, should be paid by the plaintiffs. 8 The Farinhas describe the originating process and the statement of claim as adopting a scatter-gun approach, which may not be an unfair description. However, it does not necessarily follow that that approach was inappropriate. In par [24] of my reasons of 10 December 2007, I indicated that, in his written submissions to the Court following many days of the taking of evidence, Carl formulated a number of factual issues. The Farinhas did not quarrel with that formulation. In the way in which I summarised the issues there were seven for resolution. My reasons then were structured around those issues. 9 It is common ground that a very considerable part of the hearing time was taken up with Issues 1 and 2; namely, whether the Moda, Momo and Equilibrium businesses were owned by Bondi Junction, Piccolo and World Square beneficially, or whether those three companies were nominees of partnerships. Interrelated to those issues was whether payments made by Carl in connection with the businesses should be characterised as contributions to equity or as advances on loan account and, if the latter, to whom. While ultimately the detail of the second question, namely the characterisation of the payments, did not take as much time as the question of the nature of the business relationship those matters were all put in issue by the pleadings. 10 As directors of the companies, the Farinhas were properly joined as defendants, since there were allegations of breaches of fiduciary duty against them. That, together with other alleged circumstances, constituted conduct that would attract the exercise of jurisdiction under s 461 of the Corporations Act 2001 (Cth) (the Act), namely, jurisdiction to order the winding up of the companies in question, the appointment of receivers or to order one or other of the parties to buy shares of other parties at a price to be determined by the Court. The prayers for relief in the fifth further amended originating process included prayers that Cockle Bay or, alternatively, the Farinhas, purchase Carl's shares in Bondi Junction, Piccolo and World Square. That question was the subject of my further reasons of 6 February 2009. 11 In my substantive reasons I concluded as follows in relation to the seven issues that I formulated: (1) No partnership had come into existence and the Moda, Momo and Equilibrium ventures were carried on by Bondi Junction, Piccolo and World Square respectively in their own rights. (2) The payments made by Carl should be characterised as advances or loan accounts to one or other of World Square, Bondi Junction or Piccolo either jointly or severally. (3) There was no entitlement for the Farinhas under the Letter Agreement to acquire Carl's shares in World Square. (4) The purported allotment of shares in the capital of World Square was made in contravention of its Constitution and would be liable to be set aside. (5) The accounts of the Moda and Momo businesses underestimate the revenues earned by them and management fees, consultancy fees, administration expenses and training costs charged to the businesses had not been properly charged. (6) The Farinhas or entities associated with them should be required to purchase Carl's shares in Bondi Junction, Piccolo and World Square for a consideration to be determined. (7) Carpe Diem is entitled to recover the sum of $550,000 from Cockle Bay. Following the publication of my reasons of 10 December 2007, the question of who should be required to purchase Carl's shares and for what consideration was still outstanding. 12 On 14 December 2007, the Farinhas were ordered to file and serve an affidavit that disclosed relevant financial information with respect to Bondi Junction, Piccolo and World Square for the years ended 30 June 2004 to 30 June 2007. Carl was ordered to file and serve no later than 1 February 2008 submissions as to the basis upon which the valuation of the shares in Bondi Junction, Piccolo and World Square should be made and as to which of the defendants should be ordered to purchase Carl's shares in those companies. The defendants were ordered to respond no later than 8 February 2008. On 26 February 2008 the Court ordered a regime for the carrying out of a valuation of the shares in Bondi Junction, Piccolo and World Square. Successive hearing dates to deal with those questions were vacated; some 10 or 15 different hearings occurred. Ultimately the orders for the valuation of shares were discharged by consent. 13 As I said in my reasons of 6 February 2009, circumstances have changed considerably since the hearing in 2007 and my reasons of 10 December 2007. The changes included the fact that Bondi Junction is now the subject of a deed of company arrangement, Piccolo is the subject of a creditors' voluntary winding up and World Square is being wound up by the Court. In my reasons of 6 February 2009, I indicated that, while I would not be prepared to make any order against the Farinhas personally at that stage, I would not rule that out as a possibility. I considered that the precise nature and terms of any order would depend upon detailed examination of such further evidence as the parties wished to adduce. I therefore directed the parties to bring in short minutes of directions for the further conduct of the proceedings. However, on 23 February 2009, I made an order, at the request of the parties, that the proceeding be otherwise dismissed and listed the question of costs for hearing today. 14 In the course of the conduct of the proceeding, various proposals were put forward by the parties that are now relied upon by them on the question of costs. I would draw the inference that there were probably other discussions beyond those that have been put in evidence before me. I make no criticism of anybody for any failure to adduce evidence as to other discussions that have taken place without prejudice. It is desirable however for me to say something about the proposals that are in evidence before me. 15 On 21 March 2007, Carl's solicitors wrote to the solicitors then appearing for the Farinhas and the other defendants. In that letter Carl's solicitors stated that they expected that their clients will be successful in obtaining the relief they seek, including orders for the appointment of receivers and managers of the companies or, alternatively, orders for the winding up of the companies. Further, they said that they expected that their clients would obtain orders that one or more of the defendants would pay compensation, equitable compensation, damages, interest and costs to the plaintiffs. They therefore were instructed to make what they characterised as a "once only" offer to settle the proceedings on the following basis: (1) Payment to Carpe Diem within 28 days of the loan of $550,000 plus interest from 1 April 2006 to the date of payment. (2) Repayment to Carl within 28 days of the sum of $666,045 invested by him in the World Square project plus interest at 15% per annum from 13 October 2005 to the date of payment. (3) The defendants provide acceptable security for the amounts of the payments referred to in (1) and (2). (4) The defendants arrange for all guarantees given by Carl to any financiers or landlords in respect of the ventures be released and replaced with substitute guarantees that are acceptable to the relevant parties. 16 The letter indicated that the proceedings would be discontinued by consent and that the plaintiffs would be prepared to consider reasonable terms for the payment in the amounts referred to in (1) and (2). The letter also required the defendants to pay the plaintiffs' costs of the proceeding. That offer was apparently not accepted. 17 On 25 May 2007, the Farinhas' then solicitors wrote to Carl's solicitors setting out in some detail the approach that the defendants proposed to take to the claims for relief that were then made in the originating process. Specifically, the letter said that the defendants were prepared to consent to an order that they pay to Carl the amount lent to World Square by him, being the sum of $665,045 contended for by the plaintiffs, on the basis that the plaintiffs withdraw from the position that the option in the Letter Agreement had not been validly exercised. The letter indicated that, in the alternative, if Carl persisted in his position in relation to the Letter Agreement, the defendants would agree to an order that they pay Carl the value of his 30% share in World Square as at the date of the issuing of the further shares as determined by the Court. 18 The letter also indicated that the defendants would be prepared to arrange for the transfer of the outstanding shares in Bondi Junction and Piccolo to Carl if they were released from their guarantees in respect of the obligations of the Moda and Momo businesses. The letter further contained an admission that the loan of $550,000 had been made to Cockle Bay and that that loan remained unpaid. The letter did not dispute that the plaintiffs would be entitled to a reasonable amount in respect of the costs they had incurred up to that stage, taking into account the factors that were outlined in the letter. In particular, the letter asserted that the commencement of the proceeding by interlocutory process was unnecessary and could have been avoided and that the costs of the proceeding had been unnecessarily increased by the way in which the plaintiffs were conducting the litigation. The letter ended by saying that the defendants would, if the proceeding were discontinued forthwith, be willing to discuss an appropriate amount of costs and, failing that, to refer the issue to a costs assessor or the Court for adjudication. That offer was not accepted by the plaintiffs. 19 On 12 July 2007, in the course of the hearing, counsel for the defendants proffered three alternative versions of proposed orders intended to shorten the proceeding. By the first proposal there would be a declaration that the partnerships that were the subject of the defendants' cross claims were dissolved on 14 November 2005 and an order that there be an account of profits and losses. The proposal also involved the entry of judgment against Cockle Bay in the amount of $550,000 in respect of the loan. 20 The second proposal involved orders that the Court direct that the question of whether the business structure of Moda, Momo and Equilibrium was as contended for by Carl be determined before the remaining questions in the proceeding. If the Court determined that Carl had established his primary case as to the business structure, there would be appropriate declarations concerning loan accounts in favour of Carl. The defendants would transfer their shares in Bondi Junction and Piccolo to Carl for a nominal sum and the defendants would be ordered to purchase Carl's shares in World Square at their value as at 14 November 2005. The proposal also involved the entry of judgment against Cockle Bay in the amount of $550,000. In the alternative, if the Court determined that Carl had not established his primary case as to the business structure, there would be declarations for the dissolution of the partnerships and an order for the taking of accounts. 21 The third proposal involved a Court appointed qualified accountant to act as a referee and report on whether Bondi Junction, Piccolo and World Square had kept written financial records as required by the Act, what contributions were made by Carl to each of the three businesses, what contributions were made by the defendants to the three businesses and what the financial position of Bondi Junction, Piccolo and World Square were as at the three relevant dates. 22 None of the three proposals had been foreshadowed to the plaintiffs prior to that day. However, some time was given to counsel for the plaintiffs to obtain instructions. None of the proposals was accepted and the hearing proceeded. 23 On 10 December 2007, following 17 hearing days, I published my conclusions on the seven issues that I had identified. In the course of the communications as between the parties during 2008, there was an exchange of correspondence in April 2008 between Carl's solicitors and the solicitors then acting for the defendants. A proposal was outlined in a letter from Carl's solicitors of 8 April 2008 that was rejected by a letter of 14 April 2008 which outlined alternative proposals. The alternatives were rejected by a letter of 15 April 2008 in which further alternatives were put forward. 24 The exchanges of April brought into consideration matters that were not the subject of the proceeding. However, it is clear enough that the exchange was directed to endeavouring to achieve a complete resolution of the outstanding issues in the proceeding. The proposal ultimately put on behalf of the plaintiffs was that the sum of $700,000 be paid to the plaintiff within three months from the date of execution of a deed of settlement or by 22 July 2008, whichever was the earlier. The plaintiffs were to be secured by a second ranking fixed and floating charge over the assets and undertaking of Cockle Bay or any new entity to which the business of that company might be transferred. Payment of that sum was to be jointly and severally guaranteed by the Farinhas and by Cockle Bay and the new entity. Apart from other subsidiary terms, Carl was to transfer his shares in World Square, Bondi Junction and Piccolo to the defendants or their nominees. The proposals led to nought. 25 It is against that background that the parties have now debated at some length the question of the costs of the proceeding. The Farinhas divide the question of costs into three aspects. The first aspect, which they describe as pre-hearing costs, is effectively limited to the question of the pleadings. The second aspect is the costs of the hearing. The third aspect is the costs incurred following the publication of my reasons of 10 December 2007. 26 The principal contention of the Farinhas is that they have been completely successful in their defence of the proceeding, in so far as no relief has been granted against them. However, they say that if they should be required to bear any part of the hearing costs, the pre-hearing costs should be subject to what they describe as a general discretion allowance and an excessive disallowance. 27 The general discretion allowance is said to reflect what should be disapproval of the way in which the proceedings have been conducted. The excessive disallowance is said to be justified on the basis that the litigation was conducted in an unnecessarily burdensome manner for the Farinhas, given the extent of the relief sought in the proceeding, which, they say, was disproportionate to the commercial interests of Carl. The two seem to be connected and it is not entirely clear to me precisely what difference is intended. 28 As I apprehend it, the Farinhas complain about the prolixity and verbosity of the pleading and what they describe as the scatter-gun approach. Putting aside the question of whether or not the pleading is unnecessarily prolix, I am not persuaded that there is any real distinction to be drawn between the costs of the pleadings on the one hand, and the costs incurred up to the date of the hearing and the hearing costs, on the other hand. As I have said, it is accepted on behalf of the Farinhas that the vast bulk of the hearing was related to the question of the business structure that existed among the various parties to the proceeding. The Farinhas, as directors of the companies that were the subject of the suit, were properly joined. Serious allegations were made against them of breach of fiduciary duty and failure to maintain proper business records. 29 Carl made it clear that he was seeking orders against the Farinhas for compensation and that he was seeking orders in the alternative that they purchase his shares in the companies. It is significant that the Farinhas joined together with all of the defendants in putting in issue the substantive matters that were the subject of the hearing. Ultimately, the vast bulk of the costs of the hearing were directed to the question of whether there was a partnership between companies or individuals on the one hand or whether Bondi Junction, Piccolo and World Square conducted the three businesses in their own rights. 30 Had the defendants succeeded in their contention that there were partnerships, the claim of oppression under the Act would have failed. It is no doubt for that reason that the Farinhas denied most of the allegations made in the statement of claim by Carl. Further, the notion that the Farinhas may have made admissions but nevertheless, as directors, caused the companies to continue to litigate the issues that were raised by the statement of claim, is unrealistic. That is to say, they quite clearly joined in with the corporate defendants in disputing the allegations that were made by Carl that, having regard to the various matters described in the statement of claim to which I have referred above, the affairs of the three companies have been conducted contrary to the interests of the members and in a manner that was oppressive, unfairly prejudicial and unfairly discriminatory against the interests of the members. 31 There were allegations of breaches of fiduciary duties. In substance, those allegations have been made out, in the sense that the allegation was that there was a failure to ensure proper accounting. More significantly, income was not brought to account and charges were made in favour of companies associated with the Farinhas without justification. As I said in my earlier reasons, it may well be that some charge could have been justified, but no attempt was ever made to do so. In the events that occurred, I concluded in December 2007 that the matters that had been litigated up to that time had been resolved substantially in favour of the plaintiffs. As I indicated in my reasons of 6 February 2009, there had been significant change in circumstances since those issues were litigated. 32 In all of the circumstances I am not persuaded that any of the offers to which I have referred should interfere with the making of appropriate orders. While the offers that were made may have been reasonable, I am not persuaded that it was unreasonable for the recipient of any of the offers to fail to accept the relevant offer. It may well be that, had one or other of the offers been accepted or pursued, substantial and significant costs would have been avoided. That however is not the criterion. The question is whether it was unreasonable for any of the offers to have been rejected. I consider that it is a great pity that one or other of them was not accepted, but I do not consider that the failure to accept it interferes with the ordinary exercise of discretion for the making of a costs order. 33 I have no information as to the quantum of the costs for any particular stage of the proceeding. However, I consider that it is appropriate that all of the defendants who resisted the proceeding by contesting the hearing should be held liable for the costs of the proceeding up to that time. I have made no order under Order 29 of the Federal Court Rules for the separate determination of questions and the matter remained part heard after 10 December 2007. It may be that significant costs have been incurred after that time, but I have no way of knowing the quantification of the costs. 34 Nevertheless it was open to Carl to pursue, if he wished, the relief that he had originally claimed in the originating process and the statement of claim. That is to say, there was a claim for the recovery of equitable compensation from various parties including the Farinhas. In circumstances that are not before the court in their entirety Carl has, one would conclude, decided to cut his losses and not pursue the matter any further. While he pursued the relief that he originally claimed, in the light of the findings that were made against the defendants, at some stage, the decision appears to have been made to abandon the pursuit of any further relief against the Farinhas personally. In one sense my conclusion of 6 February 2009 resolved no issue between the parties. In another sense, it did so, in that I indicated that I was not able to conclude that no order could be made against the Farinhas personally. Nevertheless, Carl pressed his claim for relief under s 461 of the Act in circumstances where, for reasons unconnected with the litigation, the conduct about which he complained had come to an end. 35 The question is whether there is a basis for making any order as to the costs of the proceeding after 10 December 2007. It is of course inappropriate for the Court to decide a hypothetical case simply to resolve the question of costs. Further, if both parties act reasonably in commencing and defending a proceeding, and the proceeding is ultimately resolved by settlement, it is appropriate that there be no order as to the costs of the proceeding. However, that is not the present case. 36 It is clear enough that Carl has obtained no relief against the Farinhas personally. In all of the circumstances, I consider that it would be appropriate to order the defendants to pay the plaintiffs' costs up to and including 10 December 2007 and to order Carl to bear 50% of the costs that have been incurred since 10 December 2007. The plaintiffs should, as I have said, pay any costs of the defendants thrown away by any of the amendments of the originating process or the statement of claim. I certify that the preceding thirty-six (36) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Emmett. Associate: Dated: 12 May 2009 Counsel for the Plaintiffs: Mr A McInerney Solicitor for the Plaintiffs: Foulsham and Geddes Counsel for the Defendants: Mr D Cook Solicitor for the Defendants: Raj Lawyers Date of Hearing: 23 March 2009 Date of Judgment: 23 March 2009