FEDERAL COURT OF AUSTRALIA Zhongcheng Holdings Pty Ltd v Grand Orchid 21 Pty Ltd, in the matter of Grand Orchid 21 Pty Ltd [2020] FCA 35 File number: NSD 1691 of 2019 Judge: STEWART J Date of judgment: 30 January 2020 Date of publication of reasons: 5 February 2020 Catchwords: CORPORATIONS – application for direction under s 424 of the Corporations Act 2001 (Cth) – whether Court should give direction that it is not unlawful for controller to enter into contract for sale solely by reason of relationship between purchaser and controller – mortgagee principle not contravened – direction made Legislation: Corporations Act 2001 (Cth) ss 9, 420A, 424 Cases cited: Preston, in the matter of Sandalwood Properties Ltd [2018] FCA 547 Re Actwane Pty Limited [2002] NSWSC 527; 42 ACSR 307 Re Copperco Ltd; Ex Parte Doran [2009] WASC 170 Re One.Tel Networks Holdings Pty Ltd [2001] NSWSC 1065; 40 ACSR 83 White v Huxtable, in the matter of Lake Federation Pty Ltd (ACN 099 611 453) (receivers and managers appointed) [2006] FCA 559; 232 ALR 388 Date of hearing: 30 January 2020 Registry: New South Wales Division: General Division National Practice Area: Commercial and Corporations Sub-area: Commercial Contracts, Banking, Finance and Insurance Category: Catchwords Number of paragraphs: 27 Counsel for the Plaintiffs: C D Freeman Solicitor for the Plaintiffs: Goodwin & Co Lawyers Counsel for the Defendants: The defendants did not appear ORDERS NSD 1691 of 2019 IN THE MATTER OF GRAND ORCHID 21 PTY LTD BETWEEN: ZHONGCHENG HOLDINGS PTY LTD ACN 625 048 599 First Plaintiff VICTORY INVESTMENT DEVELOPMENT PTY LTD ACN 632 959 472 Second Plaintiff AND: GRAND ORCHID 21 PTY LTD ACN 609 492 284 First Defendant WAYNE ANTHONY RODDENBY Second Defendant GREGORY WILLIAM DE COURCY BELL Third Defendant JUDGE: STEWART J DATE OF ORDER: 30 JANUARY 2020 THE COURT DIRECTS THAT: 1. Entry into and completion of the contract for sale of land between the first plaintiff and the second plaintiff, a copy of which is at tab 1 of exhibit "ZZ1" to the affidavit of Zhonglai Zhao affirmed on 2 October 2019, is not unlawful solely by reason of the relationship between the first plaintiff and the second plaintiff. Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011. REASONS FOR JUDGMENT (Revised from the transcript) STEWART J: 1 The plaintiffs seek an order under s 424 of the Corporations Act 2001 (Cth) that entry into and completion of the contract for sale of land between the first plaintiff and the second plaintiff, a copy of which is at tab 1 of exhibit "ZZ1" to the affidavit of Zhonglai Zhao affirmed on 2 October 2019, is not unlawful solely by reason of the relationship between the first plaintiff and the second plaintiff. 2 Each of the defendants has been served with the originating process and then with orders made on 14 November 2019 listing the matter for hearing today. No defendant has filed an appearance or otherwise opposes the order. No defendant has appeared today, despite their names being called outside the court. 3 Zhonglai Zhao is a director of the first plaintiff, Zhongcheng Holdings Pty Ltd, and the second plaintiff, Victory Investment Pty Ltd. The other director of Zhongcheng Holdings and Victory Investment is Hong Luo. With common directors, Victory Investments is a related entity of Zhongcheng Holdings as defined in s 9 of the Act. There is also a substantial overlap in shareholding between Zhongcheng Holdings and Victory Investments. Zhongcheng Holdings is the trustee of the Zhongcheng Investment Trust. 4 Zhongcheng Holdings's shareholders are either former investors or a related entity of a former investor in a trust known as the Royal JC Fund. The trustee of the Fund was Royal National Capital Alliance Ltd (RNCA). The Fund marketed an investment in respect of a development at a property at 21 Orchid Avenue, Surfers Paradise, Queensland. 5 RNCA entered into an agreement with Grand Orchid 21 Pty Ltd to advance up to $39,000,000 for the development of the property. The directors of Orchid 21 were the second and third defendants, and they also guaranteed the facility that RNCA advanced to Orchid 21. 6 Section 424 of the Act provides that a controller of property of a corporation may apply to the court for directions in relation to any matter arising in connection with the performance or exercise of any of the controller's functions and powers as controller. Section 9 defines a controller in relation to property of a corporation to include a receiver or receiver and manager of the property, or anyone else who is in possession or has control of the property for the purpose of enforcing a security interest. Section 420A provides that: (1) In exercising a power of sale in respect of property of a corporation, a controller must take all reasonable care to sell the property for: (a) if, when it is sold, it has a market value--not less than that market value; or (b) otherwise--the best price that is reasonably obtainable, having regard to the circumstances existing when the property is sold. (2) … 7 In White v Huxtable, in the matter of Lake Federation Pty Ltd (receivers & managers appointed) [2006] FCA 559; 232 ALR 388, Young J (at [38]) held that it was appropriate to make a direction under s 424 to the effect that a particular transaction was not unlawful solely because the purchaser was a company associated with the entity which appointed the receivers and managers. That is because such a sale does not contravene the mortgagee principle, being the principle of mortgage law that a mortgagee cannot exercise a power of sale in favour of itself (see [36]-[37]). See also Re One.Tel Networks Holdings Pty Ltd [2001] NSWSC 1065; 40 ACSR 83 at [52]-[54] and Re Actwane Pty Ltd [2002] NSWSC 572; 42 ACSR 307 at [13]-[15]. 8 The cases nevertheless emphasise that in making such a direction all that is intended to be established is that the contract is not unlawful by reason of the relationship between seller and purchaser. The direction does not deal with the position of the plaintiffs under the law concerning the proper exercise of powers of sale by a controller, which depends upon considerations relating to good faith, proper procedure and fair price. In making the direction, no view is expressed on those matters; nor is it appropriate to do so in a summary procedure where only a limited direction is sought. See White v Huxtable at [21] and [39], Re One.Tel at [64]-[65], Re Actwane at [18]-[19] and Re Copperco Ltd; Ex parte Doran [2009] WASC 170, at [41]. 9 The directions that may be made under s 424 are a form of personal guidance or advice to the controller. They do not involve an adjudication of the claims, rights or entitlements of third parties. Rather, they articulate the approach or steps that the controller is justified in taking having regard to the facts and circumstances as known, including the nature and extent of any disputed or contentious aspects, and relevant legal principles. See Preston, in the matter of Sandalwood Properties Ltd [2018] FCA 547 at [47] per Colvin J. The making of the direction that is sought in this case would not amount to the Court giving advice as to how the controller should act, but rather that there is legal justification in proceeding on the basis of a particular view as to the nature and extent of legal obligations in the particular circumstances: Preston at [52]. 10 The investors in the Fund invested $14,813,000 into the Orchid 21 project, mainly during 2016. RNCA published an information memorandum and an information proposal in February 2016, inviting investments. Mr Zhao has deposed to receiving those documents and ultimately investing $4,343,000 with the Fund for the Orchid 21 project. Orchid 21 contracted to purchase the property for $8,000,000 plus GST on 18 December 2015, and settled the acquisition on 29 April 2016, with the finance advanced by RNCA under the facility. On 11 March 2016, RNCA and Orchid 21 entered into a deed of loan, pursuant to which RNCA would provide a total facility of $39,000,000 to Orchid 21. The total drawdown as at 8 March 2018 was $15,191,116.43. The loan was secured by a mortgage over the property. 11 As I have indicated, the second and third defendants were also guarantors to RNCA of the facility. 12 On 31 July 2017, RNCA served a default notice on Orchid 21. RNCA entered into possession of the property on 9 August 2017. RNCA thereafter through its director, Min Li, entered into settlement negotiations with the investors, which resulted in a settlement whereby the security was transferred to the investors' nominee, namely Zhongcheng Holdings, the first plaintiff. The settlement was documented in a deed of assignment of loan documents, debt and security, dated 23 May 2018. Notice of the assignment was provided to Orchid 21 and to the guarantors. A transfer of the mortgage was effected. 13 The result was that Zhongcheng Holdings became the mortgagee and each of the defendants became indebted to Zhongcheng Holdings for the debt owing on the facility – Orchid 21 as borrower and the second and third defendants as guarantors. Zhongcheng Holdings, as mortgagee in possession, became the controller of the property. It is in that capacity that it wishes to sell the property and to apply the proceeds against the debt. 14 As indicated, as at March 2018, a total of $15,191,116.43 was owing on the facility. That comprised $13,314,873.07 in principal, and $1,876,243.36 in interest and fees. There is evidence to suggest that interest calculated in accordance with the loan would increase the total amount now owing to $45,615,412.02. On the current state of the evidence, which involves Ms Yang, a solicitor for the plaintiffs, reviewing documents produced by RNCA on subpoena, there is no indication of any payments having been made by Orchid 21 to reduce the amount owing. Thus, on the current state of the evidence, the amount of the debt, as will be seen, well subsumes the value of the property. 15 A valuation of the property was obtained from National Property Valuers, dated 11 July 2018, at $5,200,000 exclusive of GST. A second valuation was obtained from JJL, dated 4 September 2019, at $4,500,000 exclusive of GST. Mr Berrick Wilson, as an expert witness, has reviewed the valuations and other evidence and has concluded that the proposed sale price of $5,000,000 is at or above market value. Mr Wilson is a partner of KordaMentha. He is also a licensed real estate agent and director of a real estate agency on the Gold Coast, and a fellow of the Australian Property Institute. He has firsthand knowledge of the property. 16 There have been three relevant attempts at sale of the property. First, an auction was conducted by Sotheby's on 19 November 2018. There were no bids at the auction. Second, there was a negotiation and then a contract for sale dated 21 December 2018 for $12,250,000 plus GST to Hotel Orchid Pty Ltd. The buyer had as its director Mr Bell, who was also a director of Orchid 21 and is the third defendant. The contract was subject to due diligence by 28 February 2019. Zhongcheng Holdings granted an extension to the buyer for due diligence to 27 March 2019. The buyer raised issues as to encroachments. The buyer ultimately did not proceed and Zhongcheng Holdings terminated the contract. 17 Third, an auction was fixed for 11 September 2019, but there was no interest shown and the auction did not proceed. No contracts were requested by any potential bidder. 18 Shortly prior to Christmas 2019, an offer subject to due diligence was then made by Helixian Group Pty Ltd. The material terms of the offer were as follows: (a) purchase price of $7,500,000; (b) $10,000 deposit, but 100 percent refundable if due diligence was not satisfactory; (c) due diligence period of 120 days from signing the contract; (d) during the due diligence period, the purchaser has access to the site for investigation purposes; (e) after the due diligence is satisfied, the contract will become unconditional; (f) settlement 10 months after due diligence period, and; (g) once the due diligence period is satisfied and confirmed in writing, i.e. the contract is unconditional, the deposit would be increased to $500,000. 19 This was rejected by Zhongcheng Holdings principally because if due diligence was not satisfactory, the property would have been tied up for four months without any moneys being paid. 20 On 8 January 2020, a second offer was made by Helixian. The only change was that the due diligence period was shortened from 120 days to 90 days. That offer was also not accepted. On 17 January 2020 a third offer was made by Helixian. This increased the purchase price by $500,000 to $8,000,000. It provided for a deposit of $50,000, but maintained that it would be 100 percent refundable if due diligence was not satisfactory, and it increased the proposed deposit once the due diligence period had passed and the contract had been confirmed in writing to $800,000. This was again rejected for the same reason as the first offer. 21 On 27 January 2020, there was a final Helixian offer. The essential difference is that it provided for $10,000 as part of the initial deposit being non-refundable. It was also rejected by Zongcheng Holdings. 22 Mr Wilson has reviewed the Helixian offers and does not consider that they change his opinion on the reasonable market value of the property at $4,500,000, because the offers from Helixian were not firm offers with a non-refundable deposit. The final Helixian offer was, in reality, an option to purchase, with an option fee of $10,000. To those reasons can be added the consideration that the offers provided for a long due diligence period and no certainty to Zhongcheng Holdings that a sale would eventuate. In the meanwhile, it has holding costs. 23 Insofar as the proposed sale to Victory Investments is concerned, the draft contract for sale is at a price of $5,000,000. Mr Wilson reviewed the valuations, as I have indicated, and he is of the view that $4,500,000 is an appropriate and reasonable valuation. 24 I am satisfied that the parties that might be prejudiced in the event that this sale is at less than market value have been identified and joined. The first defendant has an interest because the sale proceeds will serve to diminish the first defendant's indebtedness to Zhongcheng Holdings under the assigned debt. The second and third defendants have interest as guarantors of that debt. As indicated, none of the defendants has opposed the relief sought. 25 On the current state of the evidence, untested as it is, the proposed sale appears to be at or more than market value. What appear to be reasonable efforts to sell the property by public auction have failed. The offers made by Helixian are too speculative to displace the conclusion with regard to market value. 26 As indicated, the authorities (see above at [7]-[10]) make it clear that I am not required to form a view on the commercial wisdom of the sale, and I accordingly form no such view. I also make no final or binding findings of fact in relation to the matters discussed; they merely inform my conclusion that the proposed sale is not unlawful by reason only of the relationship between seller and purchaser. 27 In the circumstances, I will make the order that is sought and which I identified at the outset – that is that under s 424 of the Act, I direct that entry into and completion of the contract for sale of land between the first plaintiff and the second plaintiff, a copy of which is at tab 1 of exhibit "ZZ1" to the affidavit of Zhonglai Zhao, affirmed 2 October 2019, is not unlawful solely by reason of the relationship between the first plaintiff and the second plaintiff. I certify that the preceding twenty-seven (27) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Stewart. Associate: Dated: 5 February 2020