FEDERAL COURT OF AUSTRALIA Health Information Pharmacy Franchising Pty Ltd v Khoo [2010] FCA 438 Citation: Health Information Pharmacy Franchising Pty Ltd v Khoo [2010] FCA 438 Parties: HEALTH INFORMATION PHARMACY FRANCHISING PTY LTD v WILLIAM KHOO, RONALD KHOO, WILLIAM LEE-LING KHOO, HUI LIONG ANG AND KEN WONG and WILLIAM LEE-LING KHOO, HUI LIONG ANG File number: NSD 1386 of 2009 Judge: YATES J Date of judgment: 10 MAY 2010 Catchwords: PRACTICE AND PROCEDURE – security for costs Held: Security ordered Legislation: Corporations Act 2001 (Cth), s 1335(1) Federal Court of Australia Act 1976 (Cth), s 56 Cases cited: Allstate Life Insurance Co v Australia & New Zealand Banking Group Ltd (No 19) (1995) 134 ALR 187 Beach Petroleum NL v Johnson (1992) 7 ACSR 203 Bell Wholesale Co Pty Ltd v Gates Export Corporation (No 2) (1984) 2 FCR 1 Brundza v Robbie & Co [No. 2] (1952) 88 CLR 171 Bryan E Fencott and Associates Pty Ltd v Eretta Pty Ltd (1987) 16 FCR 497 Central Bayside General Practice Association Ltd v Commissioner of State Revenue (2006) 228 CLR 168 Concrete Constructions Pty Ltd v Dalma Formwork Pty Ltd (Administrator Appointed) [1999] NSWCA 16 Estates Property Investment Corporation Ltd v Pooley (1975) 3 ACLR 256 Epping Plaza Fresh Fruit & Vegetables Pty Ltd v Bevendale Pty Ltd [1999] 2 VR 191 Equity Access v Westpac Banking Corporation (1989) ATPR ¶40-972 Gentry Bros Pty Ltd v Wilson Brown & Associates Pty Ltd (1992) 8 ACSR 405 Harpur v Ariadne Australia Limited [1984] 2 Qd R 523 Instyle Contract Textiles Pty Ltd v Good Environmental Choice Services Pty Ltd (2009) 181 FCR 360 Jazabas Pty Ltd v Haddad (2007) 65 ACSR 276 KP Cable Investments Pty Ltd v Meltglow Pty Ltd (1995) 56 FCR 189 Livingspring Pty Ltd v Kliger Partners (2008) 20 VR 377 MA Productions Pty Ltd v Austarama Television Pty Ltd (1982) 7 ACLR 97 MHG Plastic Industries Pty Ltd v Quality Assurance Services Pty Limited [2002] FCA 821 PS Chellaram & Co Ltd v China Ocean Shipping Co (1991) 102 ALR 321 Reinsurance Australia Corporation Limited v HIH Casualty and General Insurance Ltd (in liquidation) [2003] FCA 803 Smart Co Pty Ltd v Clipsal Australia Pty Ltd [2009] FCA 1253 Soul Pattinson Telecommunications Pty Ltd v Subex Americas Inc [2009] FCA 651 Southern Cross Exploration NL v Fire & All Risks Insurance Co Ltd (1985) 1 NSWLR 114 Sydmar Pty Ltd v Statewise Developments Pty Ltd (1987) 73 ALR 289 Total Development Supplies Pty Ltd v GRD Building Pty Ltd [2008] FCA 844 Tran v The Commonwealth (2009) 111 ALD 111; [2009] FCA 921. Date of hearing: 9 March 2010, 14 April 2010 Place: Sydney Division: GENERAL DIVISION Category: Catchwords Number of paragraphs: 84 Solicitor for the Applicant: Mr J Hassett of Hassett Dixon Solicitors and Attorneys Solicitor for the Respondents: Bell Partners Legal Pty Limited Counsel for the Respondents: Mr P Knowles IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY GENERAL DIVISION NSD 1386 of 2009 BETWEEN: HEALTH INFORMATION PHARMACY FRANCHISING PTY LTD Applicant AND: WILLIAM KHOO First Respondent RONALD KHOO Second Respondent WILLIAM LEE-LING KHOO, HUI LIONG ANG AND KEN WONG Third Respondent WILLIAM LEE-LING KHOO, HUI LIONG ANG Fourth Respondent JUDGE: YATES J DATE OF ORDER: 10 MAY 2010 WHERE MADE: SYDNEY THE COURT ORDERS THAT: 1. Within seven days the parties are to endeavour to agree on the form of orders giving effect to these reasons. If agreement cannot be reached in that time, the parties are to re-list the proceeding at the earliest possible time by arrangement with my Associate. 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 Federal Law Search on the Court's website. IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY GENERAL DIVISION NSD 1386 of 2009 BETWEEN: HEALTH INFORMATION PHARMACY FRANCHISING PTY LTD Applicant AND: WILLIAM KHOO First Respondent RONALD KHOO Second Respondent WILLIAM LEE-LING KHOO, HUI LIONG ANG AND KEN WONG Third Respondent WILLIAM LEE-LING KHOO, HUI LIONG ANG Fourth Respondent JUDGE: YATES J DATE: 10 MAY 2010 PLACE: SYDNEY REASONS FOR JUDGMENT introduction 1 By notice of motion filed on 18 February 2010, the respondents seek orders that the applicant provide security for the respondents' costs in the sum of $154,780 or such other amount as the Court sees fit, and that such security be in the form of a payment into Court to be held in an interest bearing account. 2 The respondents rely on s 1335(1) of the Corporations Act 2001 (Cth) (the Corporations Act)or, alternatively, s 56 of the Federal Court of Australia Act 1976 (Cth) (the Federal Court Act). 3 Section 1335(1) of the Corporations Actprovides that: Where a corporation is plaintiff in any action or other legal proceeding, the court having jurisdiction in the matter may, if it appears by credible testimony that there is reason to believe that the corporation will be unable to pay the costs of the defendant if successful in his, her or its defence, require sufficient security to be given for those costs and stay all proceedings until the security is given. 4 Section 56 of the Federal Court Act provides that: (1) The Court or a Judge may order an applicant in a proceeding in the Court, or an appellant in an appeal under Division 2 of Part III, to give security for the payment of costs that may be awarded against him or her. (2) The security shall be of such amount, and given at such time and in such manner and form, as the Court or Judge directs. (3) The Court or a Judge may reduce or increase the amount of security ordered to be given and may vary the time at which, or manner or form in which, the security is to be given. (4) If security, or further security, is not given in accordance with an order under this section, the Court or a Judge may order that the proceeding or appeal be dismissed. (5) This section does not affect the operation of any provision made by or under any other Act or by the Rules of Court for or in relation to the furnishing of security. 5 Unlike s 1335(1) of the Corporations Act, s 56 of the Federal Court Act does not require "credible testimony that there is reason to believe that the corporation will be unable to pay the costs of [the respondents]". The differences between the two provisions have been considered by decisions of this Court: see, for example, Instyle Contract Textiles Pty Ltd v Good Environmental Choice Services Pty Ltd (2009) 181 FCR 360 at [6]-[8]; MHG Plastic Industries Pty Ltd v Quality Assurance Services Pty Limited [2002] FCA 821 at [8]-[9]. However, given that the applicant's impecuniosity was the cornerstone of their motion, the respondents submitted that the Court's jurisdiction under both provisions was, in this case, relevantly identical. They proceeded on the basis that they were required to satisfy the threshold requirement of s 1335(1) in order to succeed on the motion. This approach is understandable. Where the only asserted basis for an order for security relates to the alleged inability of the applicant to meet a future costs order, it is difficult to see in practice a difference between the operation of the two provisions: see the observations of Perram J in Soul Pattinson Telecommunications Pty Ltd v Subex Americas Inc [2009] FCA 651 at [6]. 6 In light of the way in which the respondents have put their motion, it is appropriate to say something further about the threshold requirement of s 1335(1) of the Corporations Act. 7 The nature of the requirement was described by von Doussa J in Beach Petroleum NL v Johnson (1992) 7 ACSR 203 at 205 as follows: In my opinion the power of the court under s 1335 arises if credible evidence establishes that there is reason to believe there is a real chance that in events which can be fairly described as reasonably possible the plaintiff corporation will be unable to pay the costs of the defendant on service of the allocatur, if judgment goes against it. This will be so even if in other events which can also be fairly described as reasonably possible the plaintiff corporation would be able to pay the costs. The degree of likelihood of the plaintiff corporation being unable to pay the costs along with all the circumstances, actual and possible, about its financial position, would be then taken into account in the exercise of discretion, and in framing the orders of the court if the decision is to order security. 8 This approach has been applied many times but has been criticised. In Livingspring Pty Ltd v Kliger Partners (2008) 20 VR 377 at [13]-[14] the Court of Appeal in Victoria said that it was wrong to substitute a judicial exposition for the words of the statute itself: see Central Bayside General Practice Association Ltd v Commissioner of State Revenue (2006) 228 CLR 168 at [84]. The Court of Appeal said that the statutory test was clear: Is there reason to believe that the corporation will be unable to pay the costs of the defendant if successful? 9 The Court of Appeal at [15] continued as follows: The phrase "reason to believe" is the touchstone of jurisdiction. It requires a rational basis for the belief – and no more. The wording adopted may be contrasted with other familiar formulations such as "if the court is satisfied that" or "if in the view of the court it is likely that". The section requires the making of a judgment, a risk assessment: is there a risk that the corporation will be unable to pay? (It adds nothing, in our view, to say that it must be a "real risk".) A risk assessment is, of necessity, imprecise. The section calls for a practical, commonsense approach to the examination of the corporation's financial affairs. 10 This approach was favoured in Smart Co Pty Ltd v Clipsal Australia Pty Ltd [2009] FCA 1253 at [43]. 11 It may be a matter of debate whether in Beach Petroleum von Doussa J did place an impermissible gloss of the words of s 1335(1): Reinsurance Australia Corporation Limited v HIH Casualty and General Insurance Ltd (in liquidation) [2003] FCA 803 at [12]-[21]. Be that as it may, I propose to follow the approach in Livingspring and Smart, by focussing on the words of the statutory provision itself. background The applicant's pleaded case 12 In summary, the case pleaded by the applicant is as follows. The applicant is the franchisor and owner of the Health Information Pharmacy franchise. It has entered into written franchise agreements with, and provides various services to, Health Information Pharmacy franchisees operating pharmacies in New South Wales, Queensland and Victoria. The franchise agreements are in standard form, having relevantly identical terms and conditions. The applicant has entered into various individual franchise agreements with each of the respondents and has carried out its obligations under each of those agreements. 13 On 5 November 2009 the respondents purported to terminate their respective franchise agreements by giving notices in writing. By giving the notices the respondents breached the franchise agreement because, in each case, they failed to follow the procedure of clause 23.2. Clause 23.2 provides as follows: 23.2 Termination after notice of breach Either party may terminate this Agreement, effective immediately, by written notice to the other party where: (1) the other party breached a provision of this Agreement; (2) the first party gave written notice (Notice of Breach) to the other party which specified: (a) the breach; (b) the fact that the first party proposed to terminate this Agreement as a result of the breach unless the other party remedied the breach within a reasonable period (being not more than 30 days); and (c) the action required by the first party to remedy the breach; and (3) the other party failed to remedy the breach in accordance with the Notice of Breach. 14 The applicant contends that it is a precondition to giving notice of termination of the franchise agreement that the party to whom the notice is given be afforded the opportunity to remedy the breach, as provided by the clause. It alleges that no such opportunity was given by any of the respondents and that, for that reason, the notices were invalid and of no legal effect. 15 The applicant claims declarations and orders for specific performance as well as damages for breach of contract. On the hearing of the motion I was informed that the applicant itself had given notices of termination, with the consequence that the only relief that might be pursued was damages. 16 The respondents, by their defence, contend that, on its proper construction, clause 23.2 does not require the giving of notice as stipulated by that clause (a) where the respondents had already put the applicant on notice of its breaches, the actions required to remedy the breaches and their intention to terminate the franchise agreements if the breaches were not remedied; or (b) where the breaches were incapable of remedy; or (c) where the applicant had repudiated the relevant franchise agreement. The unpleaded assumption in (b) and (c) is that the applicant breached the franchise agreements in a way or in ways that were incapable of being remedied and that the applicant had thereby repudiated the franchise agreements. The respondents also contend that clause 23.2 did not operate, in any event, to prevent the respondents from exercising a right to terminate their respective franchise agreements at general law. The respondents' cross-claim 17 By their cross-claim the respondents plead a number of causes of action against the applicant (as cross-respondent). They allege that prior to entering into their respective franchise agreements the applicant made certain representations. The respondents allege that they relied on these representations and were induced to enter into the franchise agreements as a consequence. They allege that some of the representations were with respect to future matters. They allege that the representations were false with the consequence that the applicant engaged in misleading or deceptive conduct that contravened s 52 of the Trade Practices Act 1974 (Cth) (the Trade Practices Act) and/or s 12DA of the Australian Securities and Investments Commission Act 2001 (Cth). 18 The respondents also allege various breaches of contract. First they allege that each of the representations they have pleaded was a contractual warranty that was incorporated into the respective franchise agreements, and was breached by the applicant. Secondly they allege that they had entered into other contracts with the applicant (identified as the "June 2008 Agreement" and the "September 2008 Agreement") under which the applicant agreed to make certain payments, give certain rebates, and provide other financial benefits to the respondents. The respondents allege that the applicant breached those agreements by not making certain payments to them under those agreements. 19 They also rely on clause 23.3 of the franchise agreement which provides: 23.3 Breach of a Collateral Agreement The parties acknowledge and agree that any breach of a Collateral Agreement will constitute a breach of this Agreement. 20 They allege that, by dint of clause 23.3, the breach of these other contracts also constituted a breach of the respective franchise agreements. 21 In addition, the first respondent alleges that he entered into an agreement with the applicant with respect to the sale of pharmaceutical and other goods which were to be transferred from one of the first respondent's franchised pharmacies to a pharmacy operated by the applicant. The first respondent alleges that the applicant failed to pay the agreed price for the goods, which the first respondent alleges were transferred in pursuance of the agreement. The first respondent alleges that this contract was a collateral agreement within the meaning of clause 23.3 of his franchise agreement and thus, by breaching this agreement, the applicant breached the franchise agreement with the first respondent. 22 Thirdly the respondents allege that the applicant engaged in unconscionable conduct within the meaning of s 51AC of the Trade Practices Act in the course of making the franchise agreements with the respondents. 23 The respondents claim damages or, alternatively, orders under s 87 of the Trade Practices Act declaring the franchise agreements between the respondents and the applicant to be void ab initio or from some other date determined by the Court, and orders directing the applicant to refund any fees the respondents paid under the franchise agreements after they became void. Alternatively, the respondents claim orders under s 87 of the Trade Practices Act refusing to enforce the provisions of the franchise agreements to the extent that those provisions would require the respondents to pay fees under the franchise agreements after 5 November 2009. is there reason to believe that the applicant will be unable to pay the respondents' costs? The applicant is a wholly-owned subsidiary company 24 The applicant is a proprietary company and a wholly-owned subsidiary of Health Corporation Limited (HCL). It has a paid up capital of $1.00 represented by one issued ordinary share held by HCL. Ken Beng Chye Lee is the sole director and company secretary of the applicant. He is also the majority shareholder, Managing Director and Chief Executive Officer of HCL. As at 30 June 2009, Mr Lee, or companies related to him, held 34,642,175 of the 46,326,827 shares issued in HCL (ie. approximately 75% of the issued capital of HCL). 25 Mr Lee has proffered an undertaking to the court on behalf of HCL to pay any adverse costs order made against the applicant. Accordingly, the applicant submits that it should be treated as one with HCL for the purposes of this proceeding. The financial position of the applicant 26 The evidence of the financial position of the applicant is scant. Shortly after this proceeding was commenced, the then solicitors for the respondents wrote to the applicant's then solicitors on 14 December 2009 seeking documents in relation to the applicant's assets and liabilities to satisfy the respondents that the applicant could pay any costs awarded in the respondents' favour. In response, by letter dated 15 December 2009, the applicant's then solicitors queried the basis on which the respondents claimed to be entitled to security for costs and said that the applicant "did not acknowledge" any liability to give security. This prompted a further letter, dated 16 December 2009, from the respondents' then solicitors. The letter set out the basis for the respondents' claimed entitlement, namely that the applicant had a paid up capital of only $1.00 and that the respondents believed that it had unpaid creditors who were owed more than $100,000. The letter repeated the request for information about the applicant's financial position. The request was not answered. 27 In an affidavit affirmed on 22 February 2010 Mr Lee stated that, as an operating subsidiary of HCL, the applicant has no need of capital. He said that, on average, the applicant has about $50,000 in its bank account on an everyday basis. A bank statement and a transaction list printed from an internet banking site are in evidence. They show that the available balance in an account in the applicant's name fluctuated between $11,113.90 and $56,709.96 over a range of dates between 1 December 2009 and 22 February 2010. There is no evidence of the applicant's assets beyond these matters. There is no evidence of its liabilities. The applicant was capable of calling evidence on these matters. I infer from Mr Lee's evidence that the applicant is really an instrument of and substantially financially dependent on HCL and that its only real asset is the funds that it might have from time to time in its bank account. 28 The respondents submitted that, no matter where the average balance of the applicant's bank account sat within the range indicated by the evidence, that sum would not be sufficient to meet an adverse costs order in the proceeding. The respondents submitted that there was a prospect that some (if not all) of the applicant's available cash will be spent on its own legal fees. They further submitted that the amount of cash held by the applicant is irrelevant in any event to determining whether it can meet an adverse costs order, when it has put forward no evidence of its assets and liabilities, or its trading position. 29 In making these submissions, the respondents relied on the following observations of von Doussa J in Beach Petroleum at 205: An application for security of costs under s 1335 is likely to be made many months, perhaps a year or more, before the trial and judgment is given in the litigation. The court is required to form an opinion about what the financial position of the plaintiff will be at the time of judgment and immediately thereafter. The financial position of the plaintiff at the time when the application is made will be an important guide, but is not the sole consideration. Not infrequently a plaintiff corporation will be carrying on business. Its financial position at the end of the anticipated trial will depend not only on the outcome of the trial, and the costs likely to be associated with it, but on the success or otherwise of its business and investments in the meantime. Many uncertain factors may influence the corporation's financial position. In many of these cases the uncertainties will mean that the court will be faced with a range of possibilities, which, depending on whether fortunes run with or against the plaintiff in the meantime, extend from insolvency at one extreme and at the other extreme to more than sufficient immediate cash resources to meet the costs and other debts as they fall due. Between the extremes a variety of quite possible, but not necessarily probable, contingencies could render the plaintiff company, in the event of the proceedings being lost, unable to pay the costs in full and without delay in the ordinary course of business upon service of an allocatur. The financial position of HCL and the HCL Group 30 HCL was listed on the Australian Securities Exchange (the ASX) on 21 December 2006. At that time, its share price was approximately $0.60. As at 18 February 2010, its share price was $0.04. 31 HCL and the entities controlled by it (collectively, the HCL Group) are consolidated for tax and accounting purposes. 32 HCL Group's Financial Report for the year ended 30 June 2009 (the 2009 Financial Report), states that the HCL Group incurred a net loss before income tax of $1,945,590. A slightly smaller net loss before income tax of $1,634,239 was recorded for the previous financial year. The balance sheet for the HCL Group as at 30 June 2009 shows that, during the year, the group had been involved in substantial borrowing and had a deficiency of net assets of $8,790. 33 Despite the financial performance described above, the 2009 Financial Report states: The Directors [of HCL] nevertheless believe that its [sic] is appropriate to prepare the financial report on a going concern basis because: - a) Following a recent restructure, the company is transitioning towards profitability and positive cash flows. b) The company has recently introduced new income streams and exploring [sic] other avenues to increase revenue. c) The ability to meet operating expenditure is also dependant upon future fundraising and/or the company's business opportunities generating positive cash flows. 34 An independent auditor's report to the members of HCL prepared by Drew Townsend of Hall Chadwick Chartered Accountants, which was attached to the 2009 Financial Report, stated that the net loss and deficiency of net assets indicated "the existence of a material uncertainty which may cast doubt about the group's ability to continue as a going concern." 35 On 30 October 2009, HCL released its Quarterly Report for the period ended 30 September 2009 (the September Quarterly Report). The report showed that the HCL Group had total operating and investing cash flows of (negative) $371,000 for the quarter. The HCL Group incurred a net decrease in cash held of $271,000. The HCL Group's cash at the end of the quarter was $619,000, with borrowings for the quarter of $100,000. 36 Following the release of the September Quarterly Report, the ASX wrote to HCL requesting responses to a number of questions relating to that report. The request was sent by letter dated 9 November 2009. Relevantly, the letter stated: 1. It is possible to conclude on the basis of the information provided that if [HCL] were to continue to expend cash at the rate for the quarter indicated by [the September Quarterly Report], [HCL] may only have sufficient cash to fund its activities for less than 2 quarters. Is this the case, or are there other factors that should be taken into account in assessing [HCL's] position? 37 HCL responded in a letter dated 13 November 2009 that was signed by Mr Lee. In response to the question set out above, Mr Lee stated: 1. While assessing [HCL's] Quarterly Report… submitted to the ASX on 30 October 2009, there are additional factors that the reader should take into consideration while assessing [HCL's] position. Firstly, [HCL] has developed additional revenue streams from the pharmacy management model and Chemconsult which have broadened the revenue base of [HCL] and are now starting to provide [HCL] with additional revenue over what has been achieve [sic] in previous quarters. [HCL] also continues to hold discussions with a number of major industry players about the rapid expansion of Chemconsult. Secondly, [HCL] has implemented an organisation restructure and cost cutting program designed to ensure that the cost base of the business is substantially below the anticipated revenue streams that are developing. Thirdly, [HCL] continues it [sic] efforts to raise additional funding by way of Convertible Notes and is in discussions with a number of potential investors. These three measures are designed to provide [HCL] with additional working capital and revenue which will see [HCL] expand in the future. 38 On 29 January 2010, HCL released its Quarterly Report for the period ended 31 December 2009 (the December Quarterly Report). The report showed that the HCL Group had total operating and investing cash flows of (negative) $323,000 for the quarter. The HCL Group incurred a net decrease in cash held of $118,000. The HCL Group's cash at the end of the quarter was $500,000 with borrowings for the quarter of $205,000. 39 The Chairman's Report 2009 addressed to "shareholders and members" states: Health Corporation's losses being no exception over the past year were not entirely anticipated. Primarily, this result is attributable to final provisioning outlays for the subsidiary financing arm of the Company, Leverage Finance. 40 On 1 February 2010 the ASX wrote to HCL requesting responses to a number of questions arising from the December Quarterly Report. Once again the letter asked: 1. It is possible to conclude on the basis of the information provided that if [HCL] were to continue to expend cash at the rate for the quarter indicated by [the December Quarterly Report], [HCL] may only have sufficient cash to fund its activities for less than 2 quarters. Is this the case, or are there other factors that should be taken into account in assessing [HCL's] position? 41 HCL responded by letter dated 2 February 2009. In the letter Mr Lee addressed that question in similar terms to those set out in paragraph 37above. 42 HCL's Interim Financial Report for the half-year period ending 31 December 2009 (the Interim Financial Report) was lodged with the ASX on 1 March 2010. The report shows that as at 31 December 2009, the HCL Group had incurred a net loss of $1,070,287 for the period, and that its current liabilities exceeded its current assets by $2,304,842. The report included the following statement: As at 31 December 2009, [HCL] incurred a loss of $1,070,287. The Financial Report has been prepared on a going concern basis as the Directors believe it is appropriate. This opinion is based upon the projected future profits and negotiations with various parties who are prepared to invest in [HCL]. In the event that [HCL] will not be able to earn future profits as stated in its current projections, and negotiations with various parties fail to materialise, the Directors will consider a further capital raising. 43 An Independent Auditor's Review Report to Members dated 26 February 2010, based on the Interim Financial Report, was prepared by Mr Townsend (the Review Report). The Review Report noted that the Interim Financial Report had been prepared on a "going concern" basis. It also noted the Directors' opinion quoted above. Mr Townsend said: In Note 1 to the half year financial report, the directors state their opinion that the going concern basis used in the preparation of the half year financial report is appropriate. This opinion is based on projected profits and negotiations with various parties who are prepared to invest in the company. In our opinion these circumstances are unlikely to eventuate and indicate the existence of a material uncertainty which may cast significant doubt on the company's ability to continue as a going concern and therefore it may be unable to realise its assets and discharge its liabilities in the normal course of business and at the amounts stated in the financial report. 44 The Review Report concluded: …[T]he half year financial report of Health Corporation Limited and Controlled Entities is not in accordance with the Corporations Act 2001 and does not: a. give a true and fair view of the company's financial position as at 31 December 2009 and of its performance for the half year ended on that date; and b. comply with Accounting Standard AASB 134 Interim Financial Reporting and the Corporations Regulations 2001. 45 In his affidavit affirmed on 22 February 2010 Mr Lee said that the losses incurred for the financial year ended 30 June 2009, as set out in the 2009 Financial Report, would not have the effect of rendering the applicant incapable of performing its obligations under its franchise agreements. He said that, on the float, HCL had a market capitalisation of some $28 million and that, even with the decline in share price to $0.04, it still had a market capitalisation of some $2 million. 46 The respondents submitted, correctly in my view, that the market capitalisation of HCL is irrelevant to the present question of the applicant's ability to meet an adverse costs order in this proceeding. 47 Mr Lee also said that the losses incurred by HCL as recorded in the September Quarterly Report and the December Quarterly Report were primarily related to bad debt provisions, staff redundancies and other cost cutting measures, and will not be ongoing. He said that the redundancies and cost cutting measures have had the effect of reducing HCL's monthly operating costs by approximately $70,000 per month. He said that he expected "the third quarter of this financial year to break-even, or near break-even." 48 Mr Lee also said that he expected HCL to continue to have around $500,000 cash at the end of the third quarter of the present financial year, and that this would be more than adequate provision to meet any adverse costs order made against the applicant. 49 The respondents submitted that the fact that the HCL Group had cash assets of approximately $500,000 as at 31 December 2009 did not remove the risk that the applicant will be unable to meet an adverse costs order (on the assumption that HCL and the applicant are treated as one). They submitted that any cash held by the HCL Group must be considered in light of the group's overall negative equity. Therefore, it is likely that some or all of the cash assets will be required to meet existing liabilities. Moreover, given the losses sustained by the HCL Group in the six months to 31 December 2009, it could not be assumed that any cash currently held by the HCL Group would be available in the future to meet an adverse costs order. In this regard the respondents submitted that it was notable that the HCL Group's independent auditor had expressed the view that the profits projected and negotiations with various parties who were prepared to invest in HCL, as mentioned in the Interim Financial Report, were circumstances that were "unlikely to eventuate". I accept these submissions. Conclusion 50 I am satisfied on the evidence that there is reason to believe that the applicant will be unable to pay the costs of the respondents if they are successful in their defence of this proceeding. I have reached this conclusion by considering the applicant's financial position alone and also by treating the applicant and the HCL Group as one and the same financial entity. It follows that the threshold requirement of s 1335(1) of the Corporations Act has been met. 51 I now turn to consider those matters that have been brought forward by the parties for consideration as factors relevant to the exercise of the discretion whether or not to order the giving of security. discretionary considerations Merit 52 The strength and bona fides of the applicant's claim are relevant considerations: KP Cable Investments Pty Ltd v Meltglow Pty Ltd (1995) 56 FCR 189 at 197; Equity Access v Westpac Banking Corporation (1989) ATPR ¶40-972 at 50,636. However, at this stage of the proceeding, it is not possible for me to form any sure view as to the likelihood of success of the applicant's claim. 53 The respondents accepted, correctly in my view, that the applicant's claim is bona fide and raises triable issues. However, they submitted that the respondents have raised a bona fide defence to the applicant's claim, including a claim by way of set-off that the respondents are owed money by the applicant under the relevant franchise agreements: Bryan E Fencott and Associates Pty Ltd v Eretta Pty Ltd (1987) 16 FCR 497 at 514. They submitted that, in these circumstances, the strength of the applicant's claim is a neutral factor in the exercise of the Court's discretion and that the Court ought not to inquire further into the merits of the claim: Jazabas Pty Ltd v Haddad (2007) 65 ACSR 276 at 296. 54 The applicant on the other hand submitted that the defence propounded by the respondents was "obviously hopeless" when confronted by the plain language of clause 23.2 of the franchise agreement. 55 I do not accept the applicant's submission in this regard. On its face the respondents' defence and cross-claim raises a number of issues which strike at the enforceability of the franchise agreements or speak as to their termination by the respondents, notwithstanding the terms of clause 23.2 thereof. The defence and cross-claim also raise claims by way of set-off for the damages claimed by the applicant. I am satisfied that those matters are raised bona fide by the respondents. I am not satisfied that they are "obviously hopeless". 56 In all the circumstances, based on my present understanding of the competing claims, the merits of the applicant's claim stands as a neutral factor in the exercise of the discretion. Cause of impecuniosity 57 The respondents submitted that the applicant might more easily resist an order for security if it could show that the respondents were the cause of its impecuniosity: MA Productions Pty Ltd v Austarama Television Pty Ltd (1982) 7 ACLR 97 at 100; KP Cable Investments at 197; Equity Access at 50,635. In this context the word "impecuniosity" must be given a relative meaning. It must be taken to refer to the financial position in which the applicant finds itself, which is the reason why an order for security should be made. 58 In Jazabas at [95] the following passage from Law of Costs, G E Dal Pont was quoted with approval: [T]he plaintiff must be able to support the allegation with relatively straightforward and unambiguous evidence of a fairly compelling nature, because otherwise the hearing of the issue of security might become a trial within a trial. For this reason, it is not enough that the defendant's conduct is merely a contributing factor — it must be the material contributor to or cause of the plaintiff's impecuniosity. 59 The respondents submitted that there is no evidence to support a finding that the respondents caused the applicant's impecuniosity. 60 On the other hand the applicant submitted that, if it was regarded as impecunious, that would be attributable to the respondents not paying franchise fees totalling $158,619.51. The applicant conceded that the respondents are owed money by the applicant for "Chemconsult claims" and "Alphapharm Rebates". However, the applicant submitted that, once these sums are taken into account, it is still owed some $128,000 by the respondents. 61 As I have stated, the evidence on the applicant's financial position is scant. It has chosen to align its financial position with the HCL Group, such that its financial position is no better than the financial position of the HCL Group. Seen in this context, it is difficult to see how the non-payment of franchise fees by the respondents since 5 November 2009 has caused the apparently poor financial position of the HCL Group. Indeed, the Chairman's Report 2009 makes plain that the losses suffered by the HCL Group result primarily from outlays for a subsidiary financing arm of HCL. Mr Lee attributed the losses to bad debt provisions, staff redundancies and cost-cutting measures. The amount of $128,000 claimed to be owed by the respondents is to be compared with the fact that, as at 31 December 2009, the total current liabilities of the HCL Group exceeded total current assets by $2,304,842 and that it had a deficiency of net assets of $1,079,078. There is no doubt that, if the applicant is correct in the claims it makes, the failure of the respondents to pay franchise fees from 5 November 2009 will have contributed in some measure, and will continue to contribute, to the losses suffered by the HCL Group. It is clear on the evidence however that, overwhelmingly, the apparently poor financial position of the HCL Group arises from causes that are extraneous to the matters in dispute in this proceeding. Persons standing behind the company 62 The respondents submitted that, generally speaking, where the persons standing behind a company are able to provide adequate security then it is inappropriate to refuse an order for security: Bryan E Fencott at 511. They submitted that, in the present case, the relevant person for this purpose was Mr Lee who holds approximately 75% of the issued capital of HCL: MHG Plastics at [22]. 63 This consideration is typically raised in the context of considering whether the ordering of security will shut out an applicant for relief from making a genuine claim. In such a case it is not for the party seeking security to raise the matter but for the party resisting the giving of security to raise it and to show that the granting of security will frustrate the litigation: Bell Wholesale Co Pty Ltd v Gates Export Corporation (No 2) (1984) 2 FCR 1 at 4; PS Chellaram & Co Ltd v China Ocean Shipping Co (1991) 102 ALR 321 at 323; MHG Plastics at [21]. Here the applicant does not advance any submission that the ordering of security will stultify its claim. Undertakings 64 As I have noted, Mr Lee has proffered an undertaking on behalf of HCL to pay any adverse costs orders made against the applicant. In Gentry Bros Pty Ltd v Wilson Brown & Associates Pty Ltd (1992) 8 ACSR 405 Cooper J at 415 observed that, where the shareholders of a corporate applicant have agreed to accept personal liability for any judgment for costs against the applicant, the statutory purpose behind s 1335 has been satisfied, because the making of an order which secures the personal liability of shareholders is itself the provision of security. However, it does not necessarily follow from the fact of the acceptance of personal liability by shareholders that an order for security will not be made. The relevant cases are discussed in KP Cable Investments at 202-204 and in Instyle at [51]-[67]. It is not necessary to explore this line of authority in any detail. It is sufficient to note that there are two problems facing the applicant in this case. 65 The first problem is that the undertaking that has been proffered does not squarely address the mischief at which s 1335 and similar provisions are aimed. Connolly J in Harpur v Ariadne Australia Limited [1984] 2 Qd R 523 at 532 explained the rationale for the relevant principle when considering the application of s 533(1) of the Companies (Queensland) Code (a predecessor of s 1335(1) of the Corporations Act). His Honour said: The mischief at which the provision is aimed is obvious. An individual who conducts his business affairs by medium of a corporation without assets would otherwise be in a position to expose his opponent to a massive bill of costs without hazarding his own assets. The purpose of an order for security is to require him, if not to come out from behind the skirts of the company, at least to bring his own assets into play. If however he is already available for whatever he is worth, the object of the legislation is seen to be satisfied. 66 As Lindgren J explained in Instyle at [53]: It seems to follow from the dictum of Connolly J that if the present respondents can be placed in a position in which they will enjoy the same remedies against Mr Fitzsimons in respect of costs as they would if he were the applicant instead of Instyle, the object of s 1335(1) of the Corporations Act would be achieved and Mr Fitzsimons's own worth would be "not really relevant". The basis of this approach is the proposition that the impecuniosity of an individual is not a ground on which to order him or her to give security for costs: see Cowell v Taylor (1885) 31 Ch D 34 at 38; Pearson v Naydler [1977] 1 WLR 899 at 902; Barton v Minister for Foreign Affairs (1984) 2 FCR 463 at 469. 67 Here the undertaking that has been proffered is one by a corporate shareholder, not by the individual or individuals who may be seen as standing behind the applicant. No individual standing behind the applicant is putting at risk his or her own assets. The only assets at risk are HCL's assets. This leads to the second problem. The acceptance of an undertaking by HCL to pay the applicant's costs is worth no more than HCL's prospective ability to pay those costs. As I have already found, the HCL Group's apparently poor financial position is one of the reasons why the threshold requirement of s 1335(1) has been met in the present case. Thus the undertaking proffered by HCL provides no effective security at all: Epping Plaza Fresh Fruit & Vegetables Pty Ltd v Bevendale Pty Ltd [1999] 2 VR 191 at [24]. Quantum of risk 68 The applicant submitted that the risk that it cannot satisfy an adverse costs order is low. In making this submission it relied, once again, on the market capitalisation of HCL and on the fact that, as at 31 December 2009, the HCL Group had cash reserves of $500,000. As I have already held, the market capitalisation of HCL is irrelevant. The cash reserves of the HCL Group must be viewed in the context of the Group's overall financial position as I have found it to be. I do not accept that the risk of either the applicant or HCL being unable to meet an adverse costs order of the quantum likely to be awarded in this case is low. Public interest 69 The applicant submitted that there was a public interest element in the present case that militated against the ordering of security for costs. The public interest was said to lie in the enforcement of contracts, particularly where those contracts form a substantial component of a public company's business model. In my view there is no public interest element that has any bearing on the exercise of discretion in this case. Other discretionary matters 70 In its written submissions the applicant advanced a number of additional matters as being relevant to the exercise of discretion, namely (a) the length of time that had elapsed between execution of the franchise agreements and the matters the subject of complaint by the respondents; (b) the nature of the respondents' complaints and the difficulty of making out a case for termination; and (c) the fact that the applicant has continued to provide services to the respondents under the franchise agreements after service of the respondents' notices of termination. Properly considered, the first two matters address the merits of the applicant's claim and the defence of that claim by the respondents. I have already dealt with that question. As to the third matter, the applicant's election to continue to provide services to the respondents after service of the contentious notices of termination is a matter entirely for its own commercial and legal judgment. It is not a matter which, in my view, bears upon the exercise of the discretion whether to order the giving of security for costs. The prosecution of the respondents' cross-claim 71 The respondents have submitted that their cross-claim is defensive in nature. Importantly, the respondents have stated that they are prepared to give an undertaking to the Court not to prosecute their cross-claim against the applicant should the principal proceeding be stayed for failure to provide security, and to withdraw their cross-claim should the principal proceeding be dismissed for failure to provide security. 72 The importance of this lies in the fact that, where the claim and cross-claim arise out of the same or essentially the same factual matrix, an order for security will not generally be made as a matter of discretion. This is because it would be unjust to allow the situation to arise where a principal proceeding is stayed because of an inability to provide security but a cross-claim proceeds covering substantially the same factual area: Sydmar Pty Ltd v Statewise Developments Pty Ltd (1987) 73 ALR 289 at 300; Concrete Constructions Pty Ltd v Dalma Formwork Pty Ltd (Administrator Appointed) [1999] NSWCA 16 at [24]; Reinsurance Australia at [84]-[92]; Total Development Supplies Pty Ltd v GRD Building Pty Ltd [2008] FCA 844 at [30]-[35]. This situation is avoided by the giving of an undertaking of the kind foreshadowed by the respondents. Conclusion 73 The purpose of the discretion to order security is protective, to ensure a respondent is not unreasonably exposed to a risk that, if successful in defending the claim, the respondent will nevertheless be deprived of the benefit of a costs order in its favour by reason of the applicant being impecunious: Tran v The Commonwealth (2009) 111 ALD 111; [2009] FCA 921. 74 In light of the financial position of the applicant and of the HCL Group, and having regard to the discretionary considerations advanced by the parties, I am of the view that the applicant should be ordered to provide security for the respondents' costs, on condition that the respondents give to the Court an appropriate undertaking not to prosecute their cross-claim in the circumstances they have indicated. quantum of security 75 The respondents have adduced evidence of the respondents' likely costs and disbursements should the application proceed to a final hearing. This evidence was given in an affidavit by Andrew Mark Williams, the solicitor on the record for the respondents, sworn on 18 February 2010. Mr Williams gave evidence that he has been continuously practising as a solicitor in private practice for 27 years and that for the last 15 years he has acted predominantly as a commercial litigator with experience acting for applicants and respondents in this Court and in other commercial courts. He gave evidence that he attends to the preparation of his own bills of costs when acting for clients in those courts and that he is well-acquainted with the method and rate of billing in those courts. He provided an estimate of costs and disbursements based on a four day hearing. He estimated the respondents' party/party costs (exclusive of the costs of the respondents' motion) to be $131,100. 76 Mr Williams' experience was not challenged and he was not cross-examined on his affidavit, although his estimate of costs was challenged in some respects by the applicant. This challenge was made by an affidavit sworn on 24 February 2010 by Jonathon Francis Hassett, the solicitor for the applicant, and by the applicant's written submissions. The challenge was primarily directed to the allowance for costs for and in relation to the respondents' cross-claim which had been foreshadowed but not filed at the time that Mr Hassett's affidavit was sworn and the applicant's written submissions were prepared. I adjourned the respondents' motion during the course of the hearing to enable the respondents to file their defence and cross-claim. At the resumed hearing Mr Hassett accepted the correctness of the estimate provided by Mr Williams. 77 In ordering security for costs the Court does not set out to give a complete and certain indemnity to a respondent: Brundza v Robbie & Co [No. 2] (1952) 88 CLR 171 at 175. The discretion as to the amount of security to be ordered is unfettered: Allstate Life Insurance Co v Australia & New Zealand Banking Group Ltd (No 19) (1995) 134 ALR 187 at 197-201. I have reviewed Mr Williams' estimate and consider it to be an appropriate indication of the proper amount of security that should be ordered for the respondents' costs (exclusive of the costs of the respondents' motion). 78 What remained in dispute after the filing of the respondents' defence and cross-claim was whether any order for security should cover the costs of the respondents' motion and, if so, the quantum of security to be ordered in that regard. 79 I can see no reason why an order for security should not extend to the costs of the respondents' motion: see Estates Property Investment Corporation Ltd v Pooley (1975) 3 ACLR 256; Southern Cross Exploration NL v Fire & All Risks Insurance Co Ltd (1985) 1 NSWLR 114. The respondents' solicitors raised the question of the apparent impecuniosity of the applicant with the applicant's solicitors shortly after the proceeding was commenced. The applicant contested the respondents' entitlement to security for costs at the outset. The respondents evinced determination to be protected on the question of costs. In those circumstances it was inevitable that, subject to the respondents' concerns being appropriately accommodated, an application for security for costs would be made and costs would be incurred in the proceeding in making that application. So far as the question of security for costs is concerned, those costs are not to be treated any differently from the respondents' other costs in the proceeding. 80 As to quantum, Mr Williams estimated the costs of the respondents' motion to be $23,680. The applicant submitted that this figure was excessive and directed attention to four items for which allowances had been made, namely (a) the time for attendance to take initial instructions in relation to making an application for security of costs; (b) the time taken to prepare the eight page affidavit of Liong Ang sworn 18 February 2010 in support of the respondents' motion; (c) the time for hearing the motion; and (d) the allowance for preparing any affidavit in reply. As to the last of these matters, an eleven page affidavit in reply was in fact prepared and sworn by Liong Ang on 3 March 2010, and read on the hearing of the respondents' motion. 81 In my view the only matter for adjustment in relation to Mr Williams' estimate in this regard is the allowance for the preparation of Liong Ang's affidavit sworn 18 February 2010. Although Mr Williams was not cross-examined on the matter, it does seem to me that the full allowance which the respondents' seek should not be made for the purposes of providing security for costs. In saying this I leave open the possibility, should it arise, that the respondents might satisfy a taxing officer that the amount claimed by Mr Williams in this regard is an appropriate amount to be allowed on a taxation of costs. However, for present purposes, the amount of security to be ordered in relation to this aspect of the matter should be reduced by the sum of $4,000. disposition 82 The applicant should be ordered to provide security for costs in the total amount of $150,780 on condition that the respondents give, in appropriate form, an undertaking to the Court not to prosecute their cross-claim in the circumstances I have mentioned. The applicant's application should be stayed until security is provided. The form of the security that is sought has not been challenged by the applicant, and is appropriate. 83 The respondents have substantially succeeded on their motion. I can see no reason why costs should not follow the event. 84 The parties should endeavour to agree on the form of orders giving effect to these reasons. If they are unable to agree within seven days, the proceeding should be re-listed by arrangement with my Associate as soon as possible. I certify that the preceding eighty-four (84) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Yates. Associate: Dated: 10 May 2010