FEDERAL COURT OF AUSTRALIA Forty Two International Pty Limited v Barnes (No 2) [2011] FCA 210 Citation: Forty Two International Pty Limited v Barnes (No 2) [2011] FCA 210 Parties: FORTY TWO INTERNATIONAL PTY LIMITED ACN 095 622 889, BLUEFREEWAY LIMITED ACN 122 262 819 and THE GANG OF 4 PTY LIMITED ACN 095 624 678 v KIM BARNES and LEE HAWKSLEY File number(s): NSD 2018 of 2008 Judge: YATES J Date of judgment: 11 March 2011 Catchwords: PRACTICE AND PROCEDURE – application for discovery of documents – discovery required to inform the making of an election between remedies – whether contemplation of the possibility of joining additional parties following discovery constitutes a collateral or improper purpose PRACTICE AND PROCEDURE – application for discovery of documents – whether proper basis established for discovery – whether the discovery sought is based on issues raised by the pleadings or on matters that are speculative or hypothetical Legislation: Corporations Act 2001 (Cth) Fair Trading Act 1987 (NSW) Cases cited: Bailey v Beagle Management Pty Ltd (2001) 105 FCR 136 Campaign Master (UK) Ltd v Forty Two International Pty Ltd (No 4) (2010) 269 ALR 76 Colbeam Palmer Ltd v Stock Affiliates Pty Ltd (1968) 122 CLR 25 Dorajay Pty Ltd v Aristocrat Leisure Limited [2005] FCA 588 Dr Martens Australia Pty Ltd v Bata Shoe Co of Australia Ltd (1997) 75 FCR 230 Fexuto Pty Ltd v Bosnjak Holdings Pty Ltd (No 2) (1998) 29 ACSR 290 F Hoffmann-La Roche AG v Chiron Corporation (2000) 171 ALR 295 LED Builders Pty Ltd v Eagle Homes Pty Ltd (No 3) (1996) 70 FCR 436 McIlwain v Ramsey Food Packaging Pty Ltd (2005) 221 ALR 785 Minnesota Mining & Manufacturing Co v C Jeffries Pty Limited (1992) 37 FCR 294 Date of hearing: 7 March 2011 Place: Sydney Division: GENERAL DIVISION Category: Catchwords Number of paragraphs: 44 Counsel for the Applicants: Mr J Ireland QC with Mr J Cooke Solicitor for the Applicants: Argyle Lawyers Pty Ltd Counsel for the Respondents: Mr R Dubler SC with Mr J Emmett Solicitor for the Respondents: Herbert Geer Lawyers IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY GENERAL DIVISION NSD 2018 of 2008 BETWEEN: FORTY TWO INTERNATIONAL PTY LIMITED ACN 095 622 889 First Applicant BLUEFREEWAY LIMITED ACN 122 262 819 Second Applicant THE GANG OF 4 PTY LIMITED ACN 095 624 678 Third Applicant AND: KIM BARNES First Respondent LEE HAWKSLEY Second Respondent JUDGE: YATES J DATE OF ORDER: 11 MARCH 2011 WHERE MADE: SYDNEY THE COURT ORDERS THAT: 1. By no later than 4.00 pm on 14 March 2011 the parties are to submit to my Associate a draft of the orders they propose to give effect to these reasons. 2. The parties have leave to make submissions in writing on the question of costs, provided those submissions are no more than two pages in length and are delivered to my Associate by no later than 4.00 pm on 14 March 2011. 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 2018 of 2008 BETWEEN: FORTY TWO INTERNATIONAL PTY LIMITED ACN 095 622 889 First Applicant BLUEFREEWAY LIMITED ACN 122 262 819 Second Applicant THE GANG OF 4 PTY LIMITED ACN 095 624 678 Third Applicant AND: KIM BARNES First Respondent LEE HAWKSLEY Second Respondent JUDGE: YATES J DATE: 11 MARCH 2011 PLACE: SYDNEY REASONS FOR JUDGMENT 1 There are two motions before the Court relating to the discovery of documents. The first is a notice of motion filed by the applicants in the proceeding on 11 February 2011. The second is a notice of motion filed by the respondents in the proceeding on 16 February 2011. 2 The issue in each motion is whether the respondents on the motion should give discovery of documents in relation to certain categories of documents nominated by the applicants on the motion. At the time of hearing each motion the issues between the parties in this regard had narrowed somewhat. These issues were even further narrowed during the course of argument. The applicants' pleaded case 3 The principal proceeding concerns alleged breaches of directors' duties arising under the Corporations Act 2001 (Cth) and under general law, breaches of contract and conduct in contravention of s 42 of the Fair Trading Act 1987 (NSW) (FTA) arising out of the purchase of shares in the first and third applicants by the second applicant from the first respondent, second respondent and others (the sellers). The relief claimed includes damages (on various bases), equitable compensation and an account (pleaded as an account of profits). 4 The proceeding also concerns alleged infringement of copyright and related breaches of duties. These claims can be put to one side for present purposes because no issue relating to discovery arises in respect of them. 5 The various causes of action on which the applicants rely are pleaded in an amended statement of claim filed on 30 August 2010 (the statement of claim). The essence of the matter concerning the share purchase relates to the purchase price ultimately paid by the second applicant for the shares in the first and third applicants. The following is a summary of the substance of the principal allegations in the statement of claim that are of present relevance. 6 Under a Share Purchase Agreement entered into on 24 October 2006 (the Share Purchase Agreement) the purchase price for the shares was to be paid by reference to amounts identified as the "Initial Payment", the "Additional Payment" and the "Earn Out Price". The Initial Payment can be left to one side for present purposes. 7 The Additional Payment was an amount to be paid to the sellers by the delivery of shares in the second applicant as soon as reasonably practicable after 31 October 2007. The number of shares was to be determined by reference to a formula which embodied various elements defined in the Share Purchase Agreement, including "Forty Two EBIT 07" and "Forty Two Forecast EBIT 07". 8 I would add that the Share Purchase Agreement, which is in evidence, reveals that the Earn Out Price was an amount to be paid to the sellers in either cash or, at their election, by the delivery of shares in the second applicant as soon as reasonably practicable after 30 October 2008 (the Earn Out Price 2008) and an amount to be paid to the sellers by the delivery of shares in the second applicant on 30 October 2009 (the Earn Out Price 2009), provided certain conditions were met. The conditions related to first applicant's EBIT defined in the Share Purchase Agreement as the "Forty Two EBIT 08" and the "Forty Two EBIT 09". 9 The Share Purchase Agreement also provided for a "Clawback Amount". This was an amount to be paid by the respondents to the second applicant on or before 30 December 2009 in the event that the Forty Two EBIT 07, the Forty Two EBIT 08 or the Forty Two EBIT 09 did not exceed a certain sum. 10 At the time of the Share Purchase Agreement the respondents were directors of the first applicant. 11 On 24 October 2006 the applicants and the respondents also entered into a Management Deed (the Management Deed). The Management Deed was for a term which was expressed to commence on the completion of the Share Purchase Agreement (19 December 2006) and to end at the end of the "Earn Out Period" (30 October 2009). Under the Management Deed the respondents were entitled to nominate two directors of the first applicant and the third applicant. They nominated themselves. The effect of this was that, after completion of the Share Purchase Agreement, the respondents remained as directors of the first and third applicants. 12 The respondents also entered into Service Agreements with the first applicant. 13 The first applicant is the owner and developer of a software product called "Campaign Master Software" (the software). 14 In about February 2007 (that is, after completion of the Share Purchase Agreement) the respondents, on behalf of the first applicant, entered into negotiations to grant a licence of the software to Campaign Master (UK) Limited (CMUK). 15 On 22 May 2007 the first applicant and CMUK entered into an agreement (the Licence Agreement) by which the first applicant granted to CMUK a perpetual exclusive non-transferable licence to use and market the software in the United Kingdom and the Republic of Ireland. Under this agreement CMUK was obliged to pay a stipulated licence fee (the licence fee) to the first applicant on or before 30 June 2007. The first applicant in fact received an amount representing the licence fee on 29 June 2007. The applicants plead that the receipt of the licence fee significantly increased the Forty Two EBIT 07 from what it otherwise would have been. 16 It is the applicants' case that, unbeknown to them, the licence fee was paid through the intervention of the respondents and their involvement in financial arrangements with National Australia Bank Limited and a company called CMUK (Aust) Pty Limited, which actually paid the licence fee. The applicants allege that this conduct had particular consequences in respect of another agreement that was entered into in about October 2007 by a number of parties, including the applicants and the first and second respondents (the Exit Agreement). 17 The Exit Agreement was entered into to bring about an early finalisation of the arrangements between the applicants and the respondents that had been put in place by the Share Purchase Agreement and the Management Deed. Its effect was to adjust the financial arrangements that had been agreed upon. In effect, the Exit Agreement was the means by which the respondents' final entitlements in respect of the sale of the shares were negotiated and paid. Of particular significance was the fact that the Additional Payment was to be calculated by reference to the Forty Two EBIT 07. For this purpose, the parties to the Exit Agreement had agreed that the Forty Two EBIT 07 was a sum which, as it turns out, included the amount of the licence fee that had been paid in respect of the Licence Agreement. Under the Exit Agreement the Additional Payment was to be made to the sellers in cash on or before 1 November 2007. Also of significance is the fact that the provisions of the Share Purchase Agreement relating to the Earn Out Price and the Clawback Amount were deleted. 18 The applicants' case is that the respondents' intervention and involvement in the financing of the licence fee, and their failure to disclose their intervention and involvement to the applicants, constituted a breach of the statutory and general law duties that each of them owed to the first applicant and a breach of the Share Purchase Agreement, the Management Deed and the Exit Agreement. The applicants also allege that the respondents' conduct was misleading or deceptive, in contravention of s 42 of the FTA. 19 On about 1 November 2007 the second applicant paid $16,436,488 to the sellers pursuant to the Exit Agreement. This amount represented the Additional Payment as agreed under the Exit Agreement ($16,463,538), less certain agreed deductions. 20 The respondents thereafter resigned as directors of the first applicant. 21 The applicants say they acted in the belief that CMUK had paid the licence fees to the first applicant on 29 June 2007 from its own resources and that, in that belief, they negotiated and entered into the Exit Agreement and made the Additional Payment as therein provided. The applicants say that, but for the respondents' intervention and involvement in relation to the payment of the licence fee and but for their failure to disclose that fact: (a) the applicants would not have entered into the Exit Agreement; (b) the Share Purchase Agreement would have remained enforceable according to its terms; and (c) the entitlements of the respondents under the Share Purchase Agreement would not have included the Additional Payment and hence the sum of $16,436,488 would not have been paid. 22 As a consequence the second applicant says that it suffered loss or damage represented by the payment of the $16,436,488 and the loss of the use of this sum as well as the costs incurred to fund that payment. 23 Alternatively, the applicants say that the respondents have made and received profits for which they are accountable to the applicants, namely those parts of the sum of $16,436,488 received by the first and second respondents, together with interest thereon. The Discovery Sought by the Applicants 24 In relation to the discovery sought by the applicants, the only matter remaining in dispute between the parties is discovery in respect of the following category of documents (identified as category 36): For the period 1 October 2006 to 31 January 2008 all bank statements or other documents recording: (a) receipt of moneys by either of the respondents from the second applicant pursuant to: (i) the SPA; (ii) the Exit Agreement; and (b) disbursements of those moneys from the account into which they were received by either respondent to any other account or payee. 25 The focus of the dispute is subparagraph (b) of this category. 26 The applicants submit that they are entitled to "trace" these funds as part of the present claim for an account of profits. They submit that the measure of their recovery on this basis will require examination of any payments that have been made so that they can ascertain the quantum of recoverable profits. They submit that, ultimately, it will be necessary for them to make an election between damages or an account of profits and that, in accordance with general principles, they are entitled to discovery which will inform the election that has to be made. 27 The respondents submit that the documents falling within subparagraph (b) do not relate to any matter in issue in the proceeding. In this connection they submit that, by paragraph 16D of the statement of claim, the applicants have identified the profits which it is said the respondents have made and for which they are liable to account (assuming that an account of profits is available as a remedy), namely those parts of the $16,436,488 received respectively by the first and second respondents. They say that they will give discovery showing the receipt of the amounts in question, but that any information beyond this does not relate to any issue in the proceeding. 28 They also point to an observation in the applicants' written submissions to the effect that, depending upon the destination of the relevant funds, there may be a requirement to join additional parties in order to secure effectively the relief that is sought. The respondents submit that this observation bespeaks a collateral purpose for seeking discovery of these documents. 29 I am not persuaded that this lastmentioned submission is correct. At the present time the applicants' claims for relief include a claim for damages (or for equitable compensation) and a claim for an account of profits. No order has been made which would see the question of relief determined as a separate question. It is clear that, if otherwise entitled to such relief, the applicants will need to elect between these remedies. They cannot have all of them. 30 The distinction between an account of profits and damages is well-known. Under an account of profits the party liable to account is "required to give up his ill-gotten gains" to the party who has been wronged whereas, by an award of damages, the party against whom damages are awarded is required to compensate the party wronged for the loss that has been suffered: Colbeam Palmer Limited v Stock Affiliates Pty Limited (1968) 122 CLR 25 at 32. One party's loss is not necessarily commensurate with the other party's gain. But equity's concern is that profits unconscientiously received should not be retained but given over to the party to whom the equitable obligation is owed. 31 It seems to me that, when faced with making an election between remedies, information, by way of discovery, that funds representing profits for which a defendant might be liable to account to a plaintiff have been disbursed to another, might well serve to inform the plaintiff of the utility of the remedy in all the circumstances and, to that extent, whether an election for an account of profits should be made in preference to an election for damages. In circumstances where the conscience of a subsequent recipient of those funds is equally or sufficiently affected by the defendant's wrongdoing, the obligation to account may well extend to that person. This possibility may well be influential in a plaintiff deciding to pursue the remedy for an account rather than the remedy in damages. As a general principle, a plaintiff can insist on being fully informed before making such an election: Meagher R, Heydon D, Leeming M, Meagher Gummow & Lehane's Equity: Doctrines and Remedies (4th ed, Butterworths LexisNexis, 2002) p 873; see also LED Builders Pty Ltd v Eagle Homes Pty Ltd (No 3) (1996) 70 FCR 436 at 449; Dr Martens Australia Pty Ltd v Bata Shoe Co of Australia Ltd (1997) 75 FCR 230 at 237; Fexuto Pty Ltd v Bosnjak Holdings Pty Ltd (No 2) (1998) 29 ACSR 290 at 299; Minnesota Mining & Manufacturing Co v C Jeffries Pty Limited (1992) 37 FCR 294 at 296. It may be that, in such circumstances, a plaintiff might seek to join that recipient as a party to the proceeding in an endeavour to perfect the remedy to account. The fact that this possibility is in contemplation at the time that discovery is sought does not, in my view, reveal the existence of a purpose that is improper or collateral to the purpose for which discovery might properly be ordered in the circumstances. 32 For these reasons I propose to order that the respondents give discovery by reference to this category of documents. The discovery Sought by the Respondents 33 In relation to the discovery sought by the respondents, the respondents' motion, as argued, was more confined than foreshadowed by their notice of motion. The respondents' submissions were directed to documents falling within two broad groups of documents referred to in a schedule headed "Proposed narrowed categories for discovery", forming part of Annexure MTL-5 to the affidavit of Michele Tomoko Langtry sworn 15 February 2011. 34 The first broad group of documents was comprised in categories 4(n) and 7(n) of the schedule. The documents sought in those categories were essentially "high level" documents in the sense that they were limited to certain kinds of documents placed before meetings of the board of directors of the first applicant within a defined period (category 4(n)) and certain kinds of documents placed before meetings of the board of directors of the second applicant within a defined period (category 7(n)). During the course of submissions the applicants accepted the significance of this limitation and, on that basis, maintained no substantial opposition to discovery being given according to these categories. I am satisfied that it is appropriate to order that discovery be given in relation to categories 4(n) and 7(n) of the schedule. 35 The second broad group of documents was comprised in categories 4(v) and (w), 7(v) and (w), 23 and 27 to 30 of the schedule. Discovery of documents in these categories remained in contention. These categories were directed to the discovery of documents which might show a change in business of the first applicant. They ranged from so-called "high level" documents (namely documents placed before the board of directors of the first applicant or the board of directors of the second applicant) to business plans, competitor analysis reports and documents relating to the development, features and new releases of the software. 36 The applicants' principal objection to giving discovery in respect of these categories was on the basis of relevance. The respondents supported the necessity for discovery on the basis that the documents related to the question of damages. Specifically, on the question of damages, the respondents contended that an issue would arise as to what the Forty Two EBIT would have been for the 2008 and 2009 financial years had the arrangements originally agreed under the Share Purchase Agreement run their course and not been cut short by the Exit Agreement. The respondents argued that the question of damages could not be considered properly without regard to this counterfactual, which would or might have a flow-on effect to the issues of: (a) whether the second applicant would have been entitled to a Clawback Amount (which the respondents disputed), and (b) whether, correspondingly, the respondents would have been entitled to an Earn Out Price for 2008 and 2009 (which the respondents raised as a possibility). 37 In this connection the respondents indicated that they proposed to adduce evidence at trial that prior to the Exit Agreement being entered into, the forecast EBIT for the first applicant for the 2008 and 2009 years was significantly higher than the actual results that were achieved. The respondents submit that it will be their case that this "shortfall" was because the second applicant effected a change in the nature of the first applicant's business. They submit that their case will be that the second applicant did not take steps to develop or promote the software, but rather promoted other software products "owned" by other entities within the second applicant's group of companies. The respondents drew attention to a number of covenants in the Share Purchase Agreement limiting the entitlement of the second applicant to claim a Clawback Amount where the second applicant has acted in a way that has materially prejudiced the first applicant's EBIT, and requiring the second applicant to ensure that the first applicant's business would be conducted during the Earn Out Period in a certain manner, including in a way that would not adversely affect the ability of the first applicant to achieve the highest level of EBIT. I should add that the proper construction and effect of these provisions is not currently a matter for me to decide. The existence of provisions of this kind does, however, assist the respondents in laying a foundation for the discovery they seek. 38 The difficulty which faces the respondents, however, is the fact that, beyond their bare denial of damage having been suffered as alleged, their joint amended defence does not articulate any such case. 39 The respondents did place particular reliance on paragraph 6ZJ of their defence in which they assert that the applicants bear an onus of pleading and proving certain matters (namely, that the respondents themselves would not have taken certain steps or done certain things with respect to the operation of the first applicant's business absent the Licence Agreement with CMUK). I do not think that this paragraph of their defence assists their application for discovery. Whether the applicants bear any such onus is not a matter which I need decide on the present motion because it seems to me that, for present purposes, paragraph 6ZJ of the defence raises a false issue (what the respondents would not have done) that distracts attention from the fact that what the respondents seek by way of discovery are documents showing what the applicants (and, more specifically, the first and second applicants) did, in fact, do. 40 In the absence of an appropriate articulation of the respondents' proposed case in their defence, the issue they raise in submissions is essentially speculative or hypothetical. Apparent or adjectival relevance is addressed by considering, primarily, the issues raised by the pleadings: F Hoffmann-La Roche AG v Chiron Corporation (2000) 171 ALR 295 at [2]-[3]; Bailey v Beagle Management Pty Ltd (2001) 105 FCR 136 at [28]; McIlwain v Ramsey Food Packaging Pty Ltd (2005) 221 ALR 785 at [35]; Dorajay Pty Ltd v Aristocrat Leisure Limited [2005] FCA 588 at [34]; Campaign Master (UK) Ltd v Forty Two International Pty Ltd (No 4) (2010) 269 ALR 76 at [40]. The fact that the respondents have traversed the applicants' allegations by simple denial that the second applicant has suffered loss or damage does not of itself justify the ordering of the particular discovery they now seek in that regard. 41 I would add that, had such a case been articulated in their defence, I would have been disposed to grant, at least in the first instance, some of the discovery the respondents seek by reference to categories 4(v) and (w), 7(v) and (w), 23 and 30 of the schedule. 42 The respondents sought this discovery on the additional basis that the applicants proposed to adduce evidence at trial from Mr Puckrin, the Financial Controller of the second applicant, of what the first applicant's EBIT would have been in the absence of the Exit Agreement and in the absence of the Licence Agreement with CMUK. They submit that this evidence proceeds on the counterfactual that, if the Exit Agreement and the Licence Agreement were taken out of the picture, the other financial results of the first applicant would remain unchanged. They submit that this is unlikely to be a sound reflection of what would have happened and are entitled to discovery to test whether Mr Puckrin's evidence should be accepted. However, I do not know whether Mr Puckrin's evidence is unlikely to be a sound reflection of what would have happened. All that has been put before me to justify that conclusion is, once again, the speculative possibility advanced in submissions by the respondents that the second applicant knowingly effected a particular material change to the first applicant's business. To merely raise this possibility, by way of argument, without more, and without that issue having been otherwise articulated in the pleadings, does not, in my view, provide a sufficient basis to order the particular discovery that is sought by the respondents in this regard. 43 For these reasons, I will not make orders providing for the giving of discovery in relation to the second broad category of documents. Disposition 44 I will order the giving of discovery as indicated in these reasons. The parties are to submit to my Associate by no later than 4.00 pm on 14 March 2011 a draft of the orders they propose to give effect to these reasons. If the parties are unable to agree on appropriate orders for costs then they have liberty to make submissions in writing on that question, provided those submissions are delivered to my Associate by 4.00 pm on 14 March 2011 and do not exceed two pages in length. I will then determine the question of costs on the papers. I certify that the preceding forty-four (44) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Yates. Associate: Dated: 11 March 2011