FEDERAL COURT OF AUSTRALIA Kell & Rigby Building Pty Limited v Shephard [2011] FCA 324 Citation: Kell & Rigby Building Pty Limited v Shephard [2011] FCA 324 Parties: KELL & RIGBY BUILDING PTY LIMITED v ADAM SHEPARD, BLUE MOUNTAINS MEGACINEMA PTY LIMITED, MASAAKI WAKABAYSHI File number: NSD 1770 of 2010 Judge: EMMETT J Date of judgment: 4 March 2011 Legislation: Corporations Act 2001 (Cth) s 447A Date of hearing: 4 March 2011 Place: Sydney Division: GENERAL DIVISION Category: No catchwords Number of paragraphs: 24 Counsel for the Plaintiff: M. R. Aldridge SC Solicitors for the Plaintiff: Sally Nash & Co Counsel for the Defendants: M. Rosenblatt Solicitors for the Defendants: Somerset Ryckmans IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY GENERAL DIVISION NSD 1770 of 2010 BETWEEN: KELL & RIGBY BUILDING PTY LIMITED Plaintiff AND: ADAM SHEPHARD First Defendant BLUE MOUNTAINS MEGACINEMA PTY LIMITED Second Defendant MASAAKI WAKABAYSHI Third Defendant JUDGE: EMMETT J DATE OF ORDER: 4 March 2011 WHERE MADE: SYDNEY THE COURT ORDERS THAT: 1. The plaintiff pay the defendants' costs on an indemnity basis. 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 1770 of 2010 BETWEEN: KELL & RIGBY BUILDING PTY LIMITED Plaintiff AND: ADAM SHEPHARD First Defendant BLUE MOUNTAINS MEGACINEMA PTY LIMITED Second Defendant MASAAKI WAKABAYSHI Third Defendant JUDGE: EMMETT J DATE: 4 March 2011 PLACE: SYDNEY REASONS FOR JUDGMENT 1 This proceeding was commenced on 17 December 2010. By its initiating process the plaintiff claimed an order that the appointment of the first defendant as voluntary administrator of the second defendant was invalid, void and of no effect. The plaintiff also claimed a declaration that the second defendant was not insolvent at the time that a resolution was passed to that effect. On 4 February, the Court ordered by consent that the proceeding be dismissed subject to the question of costs. I have now heard argument on that question. In order to explain the dispute between the parties, it is necessary to say something more about the background that led to the commencement of the proceeding. 2 The plaintiff, Kell & Rigby Building Pty Limited (Kell & Rigby) commenced a proceeding in the Supreme Court of New South Wales against the second defendant in this proceeding, Blue Mountains Megacinema Pty Limited (the Company). On 3 August 2010, an order was made by consent in the Supreme Court that there be judgment for Kell & Rigby against the Company in the sum of $700,000. The Company was also ordered to pay Kell & Rigby's costs of the proceeding in the sum of $93,500. On 31 August 2010, an examination notice was issued by the Supreme Court to the Company requiring the Company to complete a financial statement about its current income, assets and liabilities and to provide other information to Kell & Rigby by 9 September 2010. 3 By letter of 10 September 2010, a response was made to the examination notice. The form attached to the examination notice called for a financial statement of sorts including the estimated gross annual income of the business, the total value of assets of the business, the average annual expenses of the business, and other liabilities. The form was completed in handwriting to disclose that the nature of the business was 'cinema and restaurant' and that its estimated gross annual income was $2,300,000. The financial statement disclosed real estate with a value of some $10.7 million, and current assets consisting of cash at bank and debtors in the vicinity of $37,000. The financial statement also referred to tools and equipment consisting of a motor vehicle having a value of $15,000, and cinema projection equipment having a value of $600,000. 4 The form also disclosed average annual expenses somewhat below the estimated gross annual income. It also showed liabilities consisting of loans of $7.9 million and other liabilities described as "preference share" of $6,201,400. The other material enclosed with the letter of 10 September 2010 included the annual financial report of the Company for the year ended 30 June 2009. That showed comparative figures for the year ended 30 June 2008 as well as the figures for the year ended 30 June 2009. 5 The accounts are curious in at least one respect: the income statement shows a net profit for 2009 of $4,021,769 as against a loss for the 2008 year of $1,490,959. However, included in the revenue for 2009 were two items that had no corresponding item in 2008. They were donations from related parties of $5,612,867 and forgiveness of accrued interest of $673,499. That was, in effect, treated as revenue in the note to the accounts. It was stated that as 30 June 2009, the Company had an excess of liabilities over assets of $1,342,440, which is the amount shown on the balance sheet, compared with an excess of liabilities over assets as at 2008 of $5,364,209. The note stated that the Company had made a profit for the 2009 year predominantly due to a donation of $5,612,867. 6 The note reported that the accounts had been prepared on a basis which contemplated the continuity of normal operating activities and the realisation of assets and settlement of liabilities in the ordinary course of business. It stated that the directors had implemented a cost reduction program for the Company and that the directors were of the opinion that the cost savings from that program, coupled with forecast increased patronage of the cinema complex, would increase the ability of the Company to generate and maintain profitable operations in the future. Another note stated, somewhat baldly, that donations were recognised in profit or loss as other income as at the date the donation was received. There does not appear to be any other explanation for the donation. An inference is certainly to be drawn that the shareholders of the Company were providing some measure of support to it. 7 The accounts show issued capital of $1,900,000. The note in relation to that item shows that the capital consisted of 1,900,000 ordinary shares of $1 each. That is to say, there is no reference of preference shares as at 30 June 2009 or 30 June 2008. There is nothing to indicate what was happening with the affairs of the Company between 10 September and 24 November 2010. However, on the latter date, a resolution was passed by the directors that the Company was insolvent and that the first defendant, Mr Adam Shephard, be appointed as voluntary administrator. It appears that the administrator wrote to creditors by letter of 25 November 2010, although that letter does not appear to be in evidence. However, it prompted a letter of 2 December 2010 from Kell & Rigby's solicitors foreshadowing a letter setting out a number of concerns that Kell & Rigby had in respect of the administrator's letter. The administrator was asked in the interim to provide a list of creditors of the Company, together with their relevant contact details. 8 On 8 December 2010, Kell & Rigby's solicitors responded to a letter of 7 December 2010, which is not in evidence. The letter was written to Somerset Ryckman solicitors. After dealing with a number of assertions made in the letter of 7 December 2010, the letter went on to say as follows: Finally, having regard to the timing of the directors of the Company putting it into administration (i.e. less than 24 hours prior to the examination hearing, in circumstances where it was in contempt of Court by failing to comply with the order made by consent on 3 August 2010 that it pay our client the judgment debt), together with the financial position of the Company set out in the documents produced pursuant to the examination notice, in our view there is a real basis for the proposition that the provisions of Part 5.3A are being abused and our client reserves its rights generally, including in relation to an application pursuant to s 447A. 9 Section 447A(1) of the Corporations Act 2001 (Cth) relevantly provides that the court may make such orders as it thinks appropriate about how Part 5.3A of the Corporations Act is to operate in relation to a particular company. 10 Section 447A(2) specifically says that, if the court is satisfied that the administration of a company should end because the company is solvent, the court may order that the administration is to end. 11 By letter of 10 December 2010, a response was provided to the letter of 8 September 2010. In relation to the paragraph that I have just quoted, the response was: Finally, our client sees no basis for an argument for the proposition that there has been an abuse of process in respect of the provisions of part 5.3A of the Corporations Act. 12 On 13 December 2010, Kell & Rigby's solicitors wrote again to the administrator confirming request for a List of Creditors and for the Report as to the Affairs of the Company. The letter said that the administrator had advised that he was still considering creditors' claims and anticipated being in a position to finalise those documents within the next two days. The letter went on to say that once they were finalised, electronic copies were requested and in the interim an electronic copy of the current draft List of Creditors was requested. The letter ended by asking for an electronic copy of the Second Report to Creditors as soon as it was finalised, and that it was expected that the Second Report would be circulated on 21 December 2010 and that the second meeting of creditors would be convened on 31 December 2010 at 10 am. 13 On 14 December 2010, Kell & Rigby's solicitors wrote again to the administrator, complaining that there was no response to the letter of 13 December 2010. It is in that context that this proceeding was commenced by an application for abridgement of time for service. On 17 December 2010, after the proceeding had been commenced, the solicitors for Kell & Rigby wrote to the solicitors who had responded on 10 December 2010, Brown, Wright and Stein, asking that they be provided with copies of all documents that the Company relies upon in support of the assertion that the Company is insolvent, including copies of books and records and financial reports, reports after 30 June 2009, any draft Report to Creditors and any advice or evidentiary material relied upon by the Company in support of that position. 14 The defendants joined in the proceeding were the administrator of the Company and Mr Masaaki Wakabayashi, who is one of three directors of the Company. Brown, Wright and Stein responded to the letter from Kell & Rigby's solicitors on 30 December 2010, saying that their client made no "assertion" as to solvency, bears no onus with respect to solvency and is subject to no obligation to produce any documents. The letter also went on to say that in the light of the absence of any evidence adduced in substantiation of the application made in the proceeding and their client's knowledge of the circumstances of the Company, their client has cause to wonder as to the basis for the commencement of the proceeding. 15 The letter said that their client remained prepared to be co-operative in the voluntary provision of information that may be of reasonable assistance in Kell & Rigby's consideration of the further prosecution of the application. A specific offer was made of information concerning the affairs of the Company. In response to the request for 'any advice or other evidentiary material', the solicitors responded that they had considerable difficulty because their client neither had made nor was required to make any assertion as to solvency. That letter was followed by a further letter of 11 January 2011 addressed to the solicitors for Kell & Rigby, noting that Kell & Rigby's solicitors had not yet indicated whether their client intended to press its application. 16 Against that background, the matter came before Flick J during vacation on 13 January 2011. Orders were made by consent, relevantly, as follows: 1. Pursuant to section 447A of the Corporations Act, that Part 5.3A of that Act was to have effect in relation to the Company as though the convening period referred to in s 439A were the period ending 31 January 2010. 5. Kell & Rigby, by 21 January 2011, was to notify the defendants whether Kell & Rigby intended to proceed with its application. 6. The defendants were to file and serve any affidavit material upon which they sought to rely by 25 January 2011. 17 The Court also noted an undertaking by the administrator not to seek to call a meeting of creditors to be held before 11 February 2010, and to give written notice of a meeting of creditors before 3 pm 3 February 2011. On 18 January 2011, Brown, Wright and Stein wrote to Kell & Rigby's solicitors enclosing documents produced in accordance with the agreement recorded by Flick J. Notwithstanding the terms of order 5, Kell & Rigby did not inform the defendants whether it intended to proceed with the application. Rather, on 27 January 2011, Kell & Rigby's solicitors wrote to Brown, Wright, Stein saying that, having reviewed the financial material provided, Kell & Rigby had indicated that it did not wish to proceed with the current application. 18 On 28 January 2011, the administrator provided his report to creditors under s 439A of the Corporations Act. Some light, but not very much, is thrown on the question of the status of preference shareholders in that report. The report suggests that related party preference shareholders were treated as unsecured creditors to the extent of $4,916,402 and that third party preference shareholders were treated as unsecured creditors to the extent of $1,597,370. Later on, the report suggests that there may have been an issue of redeemable preference shares after 30 June 2009 and that those shares had been redeemed, although the moneys payable on redemption do not appear to have been paid to the holders of the shares, hence their treatment as unsecured creditors. 19 It was against that background that the Court ordered by consent on 4 February 2011 that the proceeding be dismissed. The Company, as well as the administrator and Mr Wakabayshi, asked for an order for costs. They ask that that order be on an indemnity basis, because they say there was no justification for commencing the proceeding calling in question the solvency of the Company. In any event, it is said on behalf of Mr Wakabayshi that, even if there were some justification for commencement of the proceeding to challenge solvency, there was no justification for the joinder of him as a defendant without at least joining the other defendants. 20 The material that was provided to Kell & Rigby by the letter of 10 September 2010 is curious in some respects insofar as it describes other liabilities by reference to "preference share". However, the material disclosed in the material enclosed with the letter of 10 September 2010 does not, in my view, on any basis cast doubt on the proposition that the Company might be insolvent as at 24 November 2010. The accounts as at 30 June 2009 showed that the Company had been trading unprofitably for at least two years and that the only way in which the Company was being maintained was by donations from a source not specified. As I said, an inference might be drawn that the shareholders were prepared to support the Company. 21 The financial statement did suggest that revised expenses were not exceeding gross annual income. However, the statement of average annual expenses would need to be reconciled with the income statement in order to determine whether the information contained in the financial statement, in response to the examination matters, disclosed a change in the profitability of the Company. In any event, even if it might not be possible to suggest that income exceeded expenses on an annual basis, it is quite clear from the document that the Company's current assets were totally insufficient to meet its liabilities. There is, of course, nothing to indicate whether the other loans of in excess of $7.9 million were current liabilities. 22 However, the balance sheet as at 30 June 2009 showed current liabilities of in excess of $4 million, so that there is every reason to think that the current liabilities as at the date of the preparation of the financial statement attached to the examination notice were far in excess of current assets. While the slight curiosity to which I have referred may prompt an inquiry, there was in fact no real inquiry made by Kell & Rigby prior to the commencement of the proceeding. As I have said, the only possible inquiry was that made in the letter of 8 December 2010, which I have quoted already. However, the context of that inquiry is unclear in the absence of the letter to which the 8 December 2010 letter is a response. In any event, merely referring to the financial position set out in the documents is hardly an inquiry designed to prompt a response explaining the Company's insolvency. 23 In all of the circumstances, I do not consider that there was any basis for suspicion that the Company was not insolvent when the administrator was appointed. In those circumstances, I consider that the proceeding was commenced precipitately. It is clear, therefore, that Kell & Rigby must bear the Defendant's costs. 24 In all of the circumstances, in the absence of any explanation from Kell & Rigby as to why the proceedings commenced, other than argument based on the correspondence, I consider that it is appropriate to order that the costs be paid on an indemnity basis. I order the Plaintiff to pay the Defendant's costs on an indemnity basis. I certify that the preceding twenty-four (24) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Emmett. Associate: Dated: 5 April 2011