FEDERAL COURT OF AUSTRALIA Corvest 6 (Pty) Ltd v PKF (Gold Coast) Pty Ltd [2016] FCA 1458 File number: NSD 898 of 2016 Judge: GLEESON J Date of judgment: 8 December 2016 Catchwords: PRACTICE AND PROCEDURE – interlocutory application to strike out portions of the statement of claim – alleged failure to disclose a reasonable cause of action – requirement for particulars related to condition of mind Legislation: Competition and Consumer Act 2010 (Cth) Corporations Act 2001 (Cth) Federal Court Rules 2011 Cases cited: Young Investments Group Pty Ltd v Mann [2012] FCAFC 107; (2012) 293 ALR 538 Date of hearing: 21 October 2016 Registry: New South Wales Division: General Division National Practice Area: Commercial and Corporations Sub-area: Corporations and Corporate Insolvency Category: Catchwords Number of paragraphs: 40 Counsel for the Applicants: Mr MW Young SC Solicitor for the Applicants: Bransgroves Lawyers Counsel for the Respondents: Ms PA Horvath Solicitor for the Respondents: Moray & Agnew Lawyers ORDERS NSD 898 of 2016 BETWEEN: CORVEST 6 (PTY) LIMITED First Applicant NCF FINANCIAL SERVICES PTY LTD ACN 128 593 975 Second Applicant AND: PKF (GOLD COAST) PTY LTD ACN 137 531 250 First Respondent GRANT CHATHAM Second Respondent JUDGE: GLEESON J DATE OF ORDER: 8 DECEMBER 2016 THE COURT ORDERS THAT: 1. Leave be granted to the applicants to file an amended statement of claim in terms consistent with these reasons on or before 22 December 2016, such amended statement of claim to include the best particulars the applicants are presently able to give of paras 82A to 82C of the amended statement of claim. 2. The applicants pay the respondents' costs thrown away by reason of the amendment including the costs of the application, made by amended interlocutory application dated 8 September 2016, to strike out paras 83 and 84 of the statement of claim. Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011. REASONS FOR JUDGMENT GLEESON J: 1 By amended interlocutory application dated 8 September 2016, the respondents sought an order, pursuant to r 16.21 of the Federal Court Rules 2011 ("the Rules"), that paras 83 and 84 of the statement of claim be struck out with no leave to re-plead. Paragraphs 83 and 84 plead facts and matters relevant to a claim that the second respondent ("Mr Chatham") bears secondary liability to pay damages, pursuant to s 236 of the Australian Consumer Law, for his alleged involvement in the alleged primary contraventions of that Law by the first respondent ("PKF"). The Australian Consumer Law is Schedule 2 to the Competition and Consumer Act 2010 (Cth). 2 Rule 16.21 of the Rules provides, relevantly: (1) A party may apply to the Court for an order that all or part of a pleading be struck out on the ground that the pleading: … (d) is likely to cause prejudice, embarrassment or delay in the proceeding; or (e) fails to disclose a reasonable cause of action or defence or other case appropriate to the nature of the pleading; or (f) is otherwise an abuse of the process of the Court. 3 After hearing argument, the application was adjourned to enable the applicants to serve a proposed amended statement of claim. 4 The respondents now contend that the proposed amendments, contained in paras 82A to 84 of the proposed amended statement of claim, do not rectify the deficiencies in the original statement of claim. Background to the disputed claims 5 The facts set out below are based on the statement of claim. On an application to strike out a pleading (and, by parity of reasoning, an application for leave to file an amended statement of claim), all of the facts alleged in the relevant pleading are to be accepted as true: cf Young Investments Group Pty Ltd v Mann [2012] FCAFC 107; (2012) 293 ALR 538 ("Young Investments v Mann") at [6]. 6 The first applicant ("Corvest") is a corporation registered in the Republic of South Africa and is the majority shareholder in the second applicant ("New Capital Finance"). 7 PKF is a firm of auditors. Mr Chatham was an agent of PKF and an auditor registered with the Australian Securities and Investments Commission. 8 The applicants seek damages for losses allegedly suffered by reason of PKF's conduct pursuant to an appointment as the independent auditor for New Capital Finance. 9 In particular, the applicants complain about PKF's provision of audited financial reports for New Capital Finance for the financial years ended 30 June 2009, 2010 and 2011. They allege that Mr Chatham prepared the financial reports on behalf of PKF. Breach of contract and negligence concerning 2009 financial report 10 In connection with the 2009 financial report, the applicants allege that PKF breached its implied contractual obligation to exercise all due care and skill in performing its auditing work for New Capital Finance, and that PKF and Mr Chatham breached their respective common law duties of care to Corvest and New Capital Finance, in relation to the following two matters: (1) the provision for bad and doubtful debts, which Corvest and New Capital Finance say was inadequate by a large margin; (2) the misreporting, as income received, of interest that had accrued but had not been paid under loans made by New Capital Finance. 11 The applicants allege that, but for the respondents' breaches, New Capital Finance would not have made certain payments and Corvest would have acted differently in certain specified respects. Breach of contract and negligence concerning 2010 financial report 12 Similar allegations are made in relation to the 2010 financial report. 13 In addition, there are allegations concerning certain payments, described as "unauthorised commissions" paid to persons associated with the then directors of New Capital Finance. In para 46 the applicants allege that the 2010 financial report was deficient in that it did not reveal that the directors were not entitled to the payments and that they were contrary to the terms of a loan agreement between Corvest and New Capital Finance. The statement of claim pleads that the respondents breached their respective duties of care, and PKF breached its implied contractual obligation, "by failing to obtain evidence of the Former Directors' entitlement to the Payments, and/or to verify their entitlement to the Payments". This allegation suggests that there could have been an entitlement to the payments, contrary to the allegation in para 46. 14 As with the 2009 financial report, the applicants allege that, but for the respondents' breaches, New Capital Finance would not have made certain payments and Corvest would have acted differently in certain specified respects. Breach of contract and negligence concerning 2011 financial report 15 Allegations similar to those made in relation to the 2010 financial report are also made in relation to the 2011 financial report. 16 In addition, the applicants allege that the respondents breached their respective duties of care, and PKF breached its implied contractual obligation, by misreporting a deferred tax asset of $1,059,094. 17 Again, the applicants allege that, but for the respondents' breaches, New Capital Finance would not have made certain payments and Corvest would have acted differently in certain specified respects. Alternative claim of misleading or deceptive conduct 18 For each of the financial reports, the applicants allege that "[b]y way of the unqualified auditor statement attached to" the relevant report, PKF made representations that: (1) the report presented the financial position of New Capital Finance fairly and truthfully; (2) the report presented the results of New Capital Finance's operations fairly and truthfully; (3) PKF did not have concerns about matters affecting the financial statements; (4) New Capital Finance had only the amount specified in the relevant report in bad or doubtful debts; (5) New Capital Finance had sufficient profit to declare the dividend that was declared. 19 For each of the financial reports, it is then alleged that the representations were misleading and deceptive within the meaning of the Australian Consumer Law in that they were untrue and PKF had no reasonable basis for making them. For the 2009 financial report, the particulars of this allegation are: PKF (Gold Coast) had no reasonable basis for making the Representations in that: a. The bad and doubtful debts were substantially higher than disclosed in the Financial Reports; b. The Dooney Loan went into default in July 2008, and remained in default as at 30 June 2009 with the amount of $2,331,224.02 outstanding; c. The Southern Loan went into default in December 2008 and remained in default as at 30 June 2009 with the amount of $2,099,603.46 outstanding; d. There were additional loans outstanding as at 30 June 2009 as set out in Schedule "B" [to the statement of claim]; e. Unpaid but accrued interest was reported as income in the 2009 Financial Report. 20 Since the respondents do not presently seek further particulars of this aspect of the applicants' claims, the sufficiency of this aspect of the pleading was not agitated before me. However, it is not self-evident that the five particularised matters support either a conclusion that the representations were false or a conclusion that PKF did not have a reasonable basis for the alleged misrepresentations. 21 The applicants allege that PKF breached s 18 of the Australian Consumer Law by making the alleged representations. Section 18 provides that a person must not, in trade or commerce engage in conduct that is misleading or deceptive or likely to mislead or deceive. It is alleged that each of the applicants suffered loss and damage by reason of PKF's conduct in contravention of s 18. Paragraphs 82A to 84 of the proposed amended statement of claim 22 Paragraphs 82A, 82B and 82C plead that Mr Chatham knew that the alleged representations were made without any proper basis. 23 Paragraph 82A sets out 12 matters from which, it is alleged, Mr Chatham's state of knowledge is to be concluded concerning the 2009 financial report. Paragraphs 82B and 82C are relevantly similar. 24 Paragraphs 82A(a) and (b) are matters which, when combined with other matters, could support the alleged knowledge. 25 Paragraphs 82A(c) and (d) concern the "Dooney Loan". As appears above, the facts that the Dooney Loan went into default in July 2008, and remained in default as at 30 June 2009 with the amount of $2,331,224.02 outstanding are identified as matters supporting a conclusion that PKF did not have a reasonable basis for making the alleged representations in connection with the 2009 financial report. 26 Paragraph 82A(c) and (d) are as follows: Chatham knew that the Dooney Loan had gone into default in July 2008 and remained in default as at 30 June 2009 with the amount of $2,331,224.02 outstanding. He knew that because any competent auditor auditing NCF's accounts would have made inquiries of the Dooney Loan and thereby learned those facts; In the alternative, if Chatham did not know the default status of the Dooney Loan and/or the amount outstanding, he knew he had failed to make proper enquiries concerning the Dooney Loan and knew that as a result there was no reasonable basis for any conclusion PKF (Gold Coast) had reached about the proper provision for NCF's bad and doubtful debts. 27 Taken as a whole, I do not understand para 82A(c) to involve an allegation that Mr Chathan knew the relevant facts, to be evidenced by an admission or some other evidence consistent with that state of mind. Rather, the allegation is that knowledge is to be inferred from what a competent auditor in Mr Chatham's position would have done and thereby learned, namely "make inquiries of the Dooney Loan". 28 There is no separate allegation that Mr Chatham knew of the existence of the "Dooney Loan". Assuming that this alleged knowledge is implicit in the second sentence of para 82A(c), para 82A(c) appears to be an allegation of knowledge based on presumed inquiries made by Mr Chatham in the course of the audit. That interpretation of para 82A(c) is reinforced by the alternative allegation in para 82A(d). To put it another way, the applicants' basis for making the allegation of knowledge does not appear to be founded upon factual material about the actual conduct of the audit, but rather upon a belief as to inquiries that would have been made by Mr Chatham in the course of the audit. The pleading that a "competent auditor" would have made inquiries does not advance the allegation of knowledge because Mr Chatham's state of mind could never be inferred from the evidence about the conduct of a competent auditor, unless there is evidence (or an admission) that, on the relevant occasion or occasions, Mr Chatham acted in the manner of a competent auditor. 29 Paragraph 82A(d) pleads, in the alternative, that if Mr Chatham did not know the alleged facts concerning the "Dooney Loan", then he knew that he had failed to make proper enquiries about the loan. 30 Paragraphs 82A(e) to (l) are relevantly similar to paras 82A(c) and (d). That is, they allege knowledge of certain facts, to be inferred from what a competent auditor in Mr Chatham's position would have done and thereby learned (paras 82A(e), (g) and (j)). Alternatively, if those facts were not learned, it is alleged that Mr Chatham knew that he had failed to make proper enquiries about the loan. In addition, at para 82A(i) and (l), it is alleged that Mr Chatham knew that there was no proper basis for the statement of bad or doubtful debts, or for the figure provided as income in the 2009 financial report. 31 Paragraph 83 pleads: Chatham, by preparing and auditing the Financial reports for PKF (Gold Coast) is a person who has aided, abetted, counselled and procured a contravention of the Australian Consumer Law and has been directly and knowingly concerned with the said breach of s 18; and who has conspired with PKF (Gold Coast) to effect that breach. This is so because Chatham: (a) Was the person who, on behalf of PKF (Gold Coast) conducted the work involved in preparing (in their final form) and auditing the Financial reports; (b) Made each of the 2009, 2010 and 2011 Representations on behalf of PKF (Gold Coast); (c) Knew that each of the 2009, 2010 and 2011 Representations had been made by PKF (Gold Coast); and (d) Knew that each of the 2009, 2010 and 2011 Representations were misleading and deceptive in that they had been made without any proper basis, for the reasons set out in paragraphs 82A, 82B and 82C above. Particulars As the person performing the relevant tasks of preparing and auditing the Financial Reports, Chatham had the same relevant knowledge and access to records as PKF (Gold Coast) in relation to those task. 32 Paragraph 84 pleads: By reason of the circumstances pleading in paragraphs 82A, 82B, 82C and 83, Chatham is a person involved in the contravention pursuant to s236 Australian Consumer Law, and hence is also liable to pay damages to NCF and Corvest by reason of the said breach of s 18 of the Australia Consumer Law. Relevant law 33 Rule 16.43 of the Rules provides: (1) A party who pleads a condition of mind must state in the pleading particulars of the facts on which the party relies. (2) If a party pleads that another party ought to have known something, the party must give particulars of the facts and circumstances from which the other party ought to have acquired the knowledge. (3) In this rule: "condition of mind", for a party, means: (a) knowledge; and (b) any disorder or disability of the party's mind; and (c) any fraudulent intention of the party. 34 The following relevant principles are derived from Young Investments v Mann, a case which concerned an attempt to plead a case of involvement in companies' contraventions of the Corporations Act 2001 (Cth) by the directors of the relevant companies: (1) Provided that a pleading fulfils its basic function of identifying the issues, disclosing an arguable cause of action and apprising the other party of the case that it has to meet at trial, the pleading should be allowed to stand and the proceeding should be allowed to go to trial (at [6]). (2) A statement of claim must allege a cause of action with sufficient particularity and not simply make allegations in general terms. The adequacy of a statement of claim is to be assessed by reference to whether the cause of action is pleaded at a level of particularity that is sufficient to define the issues and inform the other party of the case that it has to meet, in the context of the particular allegations. A respondent or defendant is entitled to know the factual foundation for the case that is being alleged, so that the respondent or defendant can prepare to meet that case at trial. In order to disclose a reasonable cause of action, a statement of claim must contain an allegation of all of the relevant facts necessary to support any allegation made in it. A pleading that simply pleads a conclusion is embarrassing and should not be permitted to stand (at [7]). (3) There are sound reasons for requiring knowledge to be particularised in a case of this kind. Proving a director's actual knowledge of the essential ingredients of a contractual or tortious breach, or statutory contravention, is a prerequisite to the director's personal liability. For statutory breaches, it is well established that, in order to be an accessory or to be knowingly involved in a contravention, a person must have intentionally participated, having knowledge of the essential matters constituting the contravention (at [11]). Consideration 35 I accept Mr Young SC's submission that the proposed pleading does not plead constructive knowledge, that degree of knowledge being insufficient to make out the pleaded contravention of s 236 of the Australian Consumer Law, which is for involvement in PKF's contravention of s 18 of that Law: cf Young Investments v Mann at [11]. 36 I am satisfied that the applicants have pleaded the knowledge required to disclose a cause of action based on secondary liability under s 236 of the Australian Consumer Law. 37 However, there is a further question, namely whether the applicants have a sufficient basis for their allegations of knowledge. As currently pleaded, para 82A raises the following questions: (1) What is the true basis for the allegations that Mr Chatham made the pleaded enquiries? Are they based on Mr Chatham's knowledge of other facts, or some professional standard or statutory duty, or some other matter? In particular, is it alleged that Mr Chatham knew of the existence of the "Dooney Loan", the "Southern Loan" and the various other transactions referred to in the particulars underpinning PKF's alleged lack of a reasonable basis for the alleged representations? (2) What is the basis for the alternative allegations that Mr Chatham knew that he had failed to make proper enquiries? Are they based on Mr Chatham's knowledge of facts that put him on enquiry, or some professional standard or statutory duty, or some other matter? Is it to be alleged that Mr Chatham's knowledge is demonstrated from his enquiries about some other, relevantly analogous matter? 38 I do not accept that the alleged conduct of "any competent auditor" provides a sound basis for a conclusion about Mr Chatham's state of knowledge. The applicants must decide whether they have a proper basis for alleging that Mr Chatham learned facts which, they allege, any competent auditor would have learned. If so, the relevant allegation will be that Mr Chatham learned those facts from enquiries that he made. Accordingly, I would not grant leave to file the proposed amended statement of claim to the extent that it includes the second sentence of paras 82A(c), (e), (g) and (j) and the comparable sentences in paras 82B and 82C. 39 Otherwise, I will grant leave to the applicants to file the proposed amended statement of claim (if they continue to be satisfied that they have a proper basis for the pleadings as to Mr Chatham's knowledge) and order them, within 14 days, to provide the best particulars they are presently able to provide of the facts, matters and circumstances from which it may be inferred that Mr Chatham made enquiries from which he acquired the pleaded knowledge, and from which it may be inferred (in the alternative) that Mr Chatham knew that he had failed to make proper inquiries. 40 The applicants should pay the respondents' costs thrown away by reason of the amendment including the costs of the application, made by amended interlocutory application dated 8 September 2016, to strike out paras 83 and 84 of the statement of claim. I certify that the preceding forty (40) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Gleeson. Associate: Dated: 8 December 2016