New South Wales Supreme Court CITATION : Brand -v- Digi-Tech [2001] NSWSC 425 CURRENT JURISDICTION: Equity Division Commercial List FILE NUMBER(S) : SC 50169/99 HEARING DATE(S) : 11.5.01 JUDGMENT DATE : 24 May 2001 PARTIES : Brand v Digi-Tech (Australia) Ltd & Ors JUDGMENT OF : Hunter J COUNSEL : Applicant/Plaintiff: P. Silver Respondent/Defendant: M. Christie SOLICITORS : Applicant/Plaintiff: Atanaskovic Hartnell Respondent/Defendant: Blake Dawson Waldron CATCHWORDS : Practice & procedure - setting aside subpoena for abuse of process - ground of manifest irrelevance - status of applicant party other than person subpoenaed - sufficient interest of applicant. Compsyd Pty Ltd -v Streamline Travel Service Pty Ltd (unreported, NSW Supreme Court, 12 August 1987) Joye v Rehuxo (1999) NSWSC 785 (3 August 1999) National Employers' Mutual General Association Ltd v Waind & Hill (1978) 1 NSWLR 372 CASES CITED : Botany Bay Instrumentation & Control Pty Ltd v Steward (1984) 3 NSWLR 98 Re ACI International (1986) 11 ACLR 240 Trade Practices Commission v Kimberley Homes Pty Ltd (unreported, Federal Court, 19 July 1989) Fried -v- National Australia Bank (2000) FCA 991 (unreported) DECISION : Subpoena to BDO Nelson Parkhill be set aside. Subpoena to Smith Greenwood Bennet be set aside in part. Costs be costs in the proceedings. IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION COMMERCIAL LIST HUNTER J THURSDAY 24 MAY 2001 50169/99 BRAND -v- DIGI- TECH (AUSTRALIA) LTD & ORS REASONS FOR JUDGMENT 1 There are two applications before me by notice of motion filed on behalf of the plaintiffs seeking an order setting aside subpoenas issued on the application of the defendants against two firms of accountants, namely, Smith Greenwood Bennet (SGB) and BDO Nelson Parkhill (BDO). In each case the defendants seek production of similar documents, namely : To SGB - "1. All documents, including auditing records, correspondence, engagement letters, file notes, work papers and time sheets, in the period June 1997 to date relating to any audit, review or preparation of financial statements by Smith Greenwood Bennet ("SGB") of: (a) Digi-Tech Software Pty Limited ("DTSPL"); (b) The Terminal Adapter Investor Partnership ("TAIP"); (c) The Freerider Partnership ("FP"); 2. All documents, including file notes, relating to the engagement of SGB to perform any audit, review or preparation of financial statements relating to DTSPL, TAIP and/or FP including communications: (a) with BDO Nelson Parkhill, or any other previous auditor; (b) with the person instructing; (c) relating to the scope of the engagement and any disclaimers; (d) concerning fees; (e) relating to the users or distribution of the financial statements and/or auditors report. 3. All documents, including file notes, recording or evidencing any instructions, reasons and/or circumstances relating to the second set of financial statements for the years ended 30 June 1997 and 30 June 1998 for TAIP and FP which were issued in or about March 1999. 4. All documents, including file notes, evidencing communications with KPMG or concerning KPMG's review (as Digi-Tech) (Australia) Limited's independent party) of the work referred to in 1 above including: (a) Communications or requests from KPMG; (b) responses to KPMG"s communications or requests; (c) instructions or advice received and/or given in relation to KPMG's communications or requests." To BDO - "1. All documents, including file notes, work papers and time sheets, in the period June 1997 to date evidencing or recording any audit, review or preparation of financial statements, draft or otherwise, by BDO Nelson Parkhill ("BDO") of: (a) Digi-Tech Software Pty Limited ("DTSPL") (b) The Terminal Adapter Investor Partnership ("TAIP") (c) The Freerider Partnership ("FP") 2. All documents, including file notes, in the period June 1997 to date evidencing or recording any communications in relation to BDO's involvement in performing any audit; review or preparation of financial statements, whether completed or not, relating to DTSPL, TAIP and/or FP 3. All documents, including file notes, relating to the engagement of BDO to perform any audit, review or preparation of financial statements relating to DTSPL, TAIP and/or FP including communications: (a) with any previous auditor; (b) with the person instructing; (c) relating to the scope of the engagement and any disclaimers; (d) concerning fees; (e) relating to the users or distribution of the financial statements; (f) with Smith Greenwood Bennett (sic); (g) with any other firm who sought to become auditor." 2 In each case the plaintiffs seek to set aside the subpoenas as an abuse of process on the principal ground that the documents, the subject of the subpoenas, are manifestly irrelevant to the issues in these proceedings. Those issues are not free of complexity and I think it is sufficient for the purposes of these applications to identify the nature of these issues to which the defendants claim the subpoenas have been directed. 3 The proceedings are for declarations of enforceability of option agreements under which the second defendant Digi-Tech Equities Limited (DTEL) could be called upon to acquire equity in certain corporations, and a declaration that notices of demand and of termination by the first defendant, Digi-Tech (Australia) Ltd (DTAL), purporting to terminate a certain sale agreement, was invalid and of no effect. Those notices had been given in relation to purported breaches of the sale agreement which included an alleged default in failing to comply with cl 8.10 of the subject agreement, requiring TAIP to provide DTAL within 90 days of the end of the financial year, a copy of the audited financial statements of TAIP and DTSPL. 4 In support of that claim for declaratory relief the plaintiffs asserted that there had been no breaches as relied upon by DTAL and, in particular, that audited financial statements and accounts of TAIP and DTSPL had been furnished to DTAL in accordance with the subject agreement (par 82 of the plaintiffs' contentions). 5 By their defences the defendants deny that the accounts were audited in the following terms: "34. As to paragraph 82, the Defendants… (g) admit that accounts purporting to be audited accounts of DTSPL for the years ending 30 June 1997 and 30 June 1998 were provided to DTAL on 26 February 1999, but: (i) say that the accounts were not audited; (ii) say that the accounts were not prepared in accordance with accounting standards or generally accepted accounting principles; and (iii) say that the accounts were not signed. … (i) admit that accounts purporting to be audited accounts of the Partnership and DTSPL for the two financial years ending 30 June 1997 and 30 June 1998 were provided to DTAL on 26 February 1999, but: (i) deny that the accounts were audited; (ii) repeat paragraph 16 above and say that the accounts were not prepared in accordance with generally accepted accounting principles; (iii) say that the Partnership accounts were not signed by any of the Partners; (iv) say that DTSPL accounts were not signed by any of its directors." 6 No particulars other than those contained in the quoted passages of the defence were provided to support the allegation that the subject accounts were not audited or were not prepared in accordance with accepted accounting services. 7 When the matter came before me on 2 February 2001 I indicated to the parties that it was unlikely that I would require the subpoenaed parties to produce documents in terms of the subject subpoenas without more particularity of the issues surrounding the performance of the obligation to provide audited accounts. By consent, on that date, the defendants were ordered to provide particulars of para 34(g) of their defence and the matters were stood over to 16 February 2001. On that occasion the motions were again stood over to enable the defendants to file and serve their expert statements of evidence on, inter alia, the issue of audited accounts. 8 On 23 March 2001 consent orders were made extending the time for the filing of statements of evidence and providing for a particular order in the following terms: "The defendants file and serve any expert report in support of the subpoenas addressed to Smith Greenwood Bennett (sic) and BDO Nelson Parkhill by 4 May 2001." 9 On the same day the hearing of the proceedings was fixed for 13 August 2001 and the motion adjourned to 11 May 2001. 10 Pursuant to directions of the Court particulars of par 34(g) of the defence were provided in the following terms: "1. Neither Digi-Tech Software Pty Limited (DTSPL) nor the Terminal Adapter Partnership (the Partnership) appointed auditors. 2. The work, if any, carried out by Smith Greenwood Bennett (sic) ("SGB") was limited to revising the four sets of accounts (1997 and 1998 accounts of DTSPL and the 1997 and 1998 accounts of the Partnership) prepared by Horwath (NSW) Pty Limited (ACN 001 263 332). SGB did not have sufficient time to conduct an audit and had no basis to form the opinion allegedly held. 3. SGB did not examine, on a text (sic) basis, evidence supporting the amounts and other disclosures in the accounts. Thus (1) DTSPL's Profit and Loss Account for the year ended 30 June 1997 shows an Operating Loss Before Income Tax of $60,000. The Profit and Loss Statement attached to the 1997 accounts shows the loss is the result of expenditure on Consulting Fees of $60,000. DTSPL's financial year ended on 30 June 1997. It entered into the Licence Agreement about then. As this was the only expense of DTSPL for, at most, one day of business in the 1997 financial year, SGB should have, but did not: (a) consider whether the Consultancy Fee related to DTSPL's business as Licensee and was properly its expense, (b) verify that the Consultancy Fee was properly authorised. (c) consider if the Consultancy Fee related to the year ended 30 June 1997, (d) ascertain to whom the Consultancy Fee was paid, (e) ascertain if the recipient of the Consulting Fee was a "related party" of DTSPL such that separate disclosure was required. (f) ascertain if paying the Consultancy Fees was a breach of the covenant DTSPL gave in clause 7.21 the Licence Agreement which states : The Licensee may not return to any shareholder any amount contributed by way of Call Contribution or make any advance to any shareholder while this agreement remains in effect. (2) DTSPL's Balance Sheet as at 30 June 1998 has under the heading Current Assets an item Receivables of $207,206. Note 3 to the accounts breaks down the Receivables into 3 items including: Loans - Probe Pharmaceuticals Pty Ltd 92,213 The name of the company is wrong. The company that received the loan is Probe Pharmaceuticals Australia Pty Ltd ("Probe"). C. G. Kelliher is the sole director of Probe. All the shares in Probe were owned by Kelcom Pty Limited and C.G. Kelliher owned all of the shares in Kelecom Pty Limited. SGB should have, but did not: (a) ascertain whether the loan was properly authorised, (b) ascertain if making the loan was a breach of the covenant DTSPL gave in clause 7.21 the Licence Agreement which states: 9. The licensee may not return to any shareholder any amount contributed by way of Call Contribution or make any advance to any shareholder while this agreement remains in effect. (c) consider if the loan was recoverable and worth $92,213. (d) ascertain if Probe was a "related party" of DTSPL such that separate disclosure was required. 4. On 23 March 1999 Gary Urwin faxed "amended audited Financial Statements" for the Partnership for 1997 and 1998. These were significantly different to the accounts supplied on 26 February 1999. (For instance the approximately $50 million liability to DTAL was now missing from the amended accounts.) In this respect: (a) SGC did not approach DTAL to withdraw its opinion of 26 February 1999 nor did it explain the reasons, if any, for the amended accounts. (b) The Partnership did not approach DTAL to withdraw its accounts faxed on 26 February 1999 nor did it explained (sic) the reasons, if any, for the amended accounts. 5. (a) Bestaway Investments Pty Limited, Ophir Developments Pty Limited and S & K Developments Pty Ltd ("the Defaulters") signed to become partners in the Partnership on or about 1 July 1997. The Defaulters were to be 34.87% of the Partnership. None of the Defaulters paid any of the monies they had contracted to pay under the Partnership Agreement or Sale Agreement. (b) The Amended Profit & Loss Account for the year ended 30th June 1997 of the Partnership shows the distribution of the loss of $9,263,083 to the Partners including: BESTAWAY INVESMENTS PTY LIMITED (729,755) OPHIR DEVELOPMENTS PTY LIMITED (1,249,997) S & K DEVELOPMENTS PTY LIMITED (1,249,997) (c) Note 3 to the Amended accounts includes: Bestaway Investments Pty Limited Capital Introduced 4,378,500 Profit/(Loss) (729,755) 3,648,745 Ophir Developments Pty Limited Capital Introduced 7,500,000 Profit/(Loss) ( 1,249,997 ) 6,250,003 S & K Developments Pty Limited Capital Introduced 7,500,000 Profit/(Loss) (1,249,997) 6,250,003 (d) SGB should have, but did not: (i) verify if the Defaulters had introduced capital totalling $19,378.500 (sic) which is 34.87% of the Partnership capital, (ii) ascertain if the Defaulters shared in the 1997 loss. 6. (a) In about May 1998, McLean Technic Pty Limited became a partner for 34.87% of the Partnership in place of the Defaulters. It never paid the Defaulters any money to acquire their interest in the Partnership. (b) The Amended Profit & Loss Account for the year ended 30th June 1998 shows the distribution of the loss of $9,263,083 to the Partners including: BESTAWAY INVESTMENTS PTY LIMITED - OPHIR DEVELOPMENTS PTY LIMITED - S & K DEVELOPMENTS PTY LIMITED - MCCLEAN TECHNIC PTY LIMITED (3,229,747) (c) Note 3 to the Amended accounts includes: McLean Technic Pty Ltd Purchase from other Partners 16,148,751 Profit/(Loss) (3,229,747 ) 12,919,004 (d) SGB should have, but did not: (i) ascertain if the Defaulters shared in the 1998 loss, (ii) ascertain if McLean Technic Pty Limited shared in 34.87% of the loss when it was a partner for about 2 months, (iii) questioned whether the Defaulters were paid $16.148,751 (sic) by McLean Technic Pty Limited as Note 3 shows." 11 In response to those particulars, the solicitors for the plaintiffs sought clarification in the following terms: "Would you please advise whether the effect of the Particulars is that your clients are alleging that: (a) no audit work was performed by Smith Greenwood Bennett (sic) for the 1997 and 1998 financial years; or (b) audit work was performed by Smith Greenwood Bennett (sic) for the 1997 and 1998 financial years but that the work was insufficient to comply with the relevant accounting standards. We also note that no particulars have been provided in relation to BDO Nelson Parkhill". 12 The expert report "in support of the subpoenas" pursuant to the direction of 23 March 2001 was that of Geoffrey Sinclair Kirk of 7 May 2001. That report is extremely useful from a number of viewpoints. I have not found it necessary to satisfy myself that the factual assumptions made by Mr Kirk faithfully mirror the issues raised in the pleadings in these proceedings. However they do provide a convenient summary of the substance of the defendants' case as seen by the defendants. They also furnish an insight into the objectives of the defendants in causing the subject subpoenas to be issued. 13 The following extracts from that summary I think are sufficient for the purposes of considering the issues raised on these applications " The parties a) DTCL [Digi-Tech Communications Ltd] is a New Zealand incorporated company and has a number of New Zealand incorporated subsidiaries. b) One of DTCL subsidiaries, DTAL has the right to exploit in Australia the intellectual property rights for various Digi-Tech products ("the Rights"). c) DTAL entered into two Sale Agreements dated 30 June 1997. One Sale Agreement was with a number of Investors who became partners in TAIP under a Partnership Agreement dated 30 June 1997. The other Sale Agreement was with a number of Investors who became partners in another partnership known as the Freerider Investor Partnership… ["FP"] under a Partnership Agreement also dated 30 June 1997. d) Under the TAIP Sale Agreements, DTAL assigned for a period of 5 years the Rights in return for an agreed purchase consideration ("the Purchase Price"). e) Payment of the Purchase Price was agreed as being $1,230,728 (fixed at A$) on 30 June 1997 and quarterly instalments of $188,672 (again fixed at A$) with the final substantial instalment of $57,341,955 (fixed in NZ$), due on 30 September 2000. f) Each investor contracted to pay his or her proportionate share of the Purchase Price and became severally liable for this proportionate share. g) DTSPL was incorporated on 11 June 1997 to act as the operating company for the two Investor partnerships and entered into two Licence Agreements dated 30 June 1997 with each of TAIP and …[FP]. Investors also became liable to contribute capital to DTSPL in proportion to their share in the respective partnerships. h) At or about 30 June 1997 another of DTCL's subsidiaries, DTEL entered into an Option Agreement with the Investors (or their shareholders in the case of corporate Investors). Under this Option Agreement, for a quarterly option fee. DTEL granted an option to the Investors which could be exercised at any time between 15 April 1999 and 31 July 2000. The option enabled the Investor to require DTEL to subscribe for shares in corporate vehicles established by each Investor. The amount that DTEL became liable to subscribe was equal to the proportionate share of the Investor exercising the option of the balance of the debt outstanding under the relevant Sale Agreement. Background to the establishment of TAIP and DTSPL i) Mr Gary K Urwin ("Urwin") the then managing director of Horwath Corporate Pty Ltd, financial consultants, introduced a number of his organisation's clients as investors in TAIP. Urwin himself also became a partner in TAIP and a shareholder in DTSPL. He was also (and still is) a director in DTSPL and at all relevant times was responsible for it's accounting and management. j) Mr Christopher G Kelliher ("Kelliher") is a former Managing Director of Microsoft in Australia. He also became an investor in TAIP and …[FP] as well as a shareholder in DTSPL. Kelliher, who held out to be a director of DTSPL, was represented by Urwin as providing the technical input into DTSPL and acted as temporary CEO when the CEO position was vacant. k) Three of the original partners in TAIP and …[FP] failed to honour their commitments to make the required payments under the various Agreements. These partners are Bestaway Investments Pty Ltd, Ophir Developments Pty Ltd and S&K Developments Pty Ltd ("the Defaulting Investors"). l) In May 1998 the Defaulting Investors assigned their interests to a company, McLean Tecnic (sic)Pty Ltd (McLean Tecnic)(sic), a company associated with a Mr Ian McLean. m) McLean Tecnic (sic) paid up the outstanding share capital of DTSPL on or about 4 May 1998 or $144,332 (fixed in A$) and the outstanding instalments under the Sale Agreement on or about 4 May 1998 of $197,352 (fixed in A$) except for the instalment due on 30 June 1997 of $429,117 (fixed in A$). The purported audit retainer of Smith Greenwood Bennet n) In a fax dated 12 February 1999 from Mr Jilnaught Wong ("Wong"), a director of DTCL, to Mr Reid Wong indicated that Urwin had appointed Smith Greenwood Bennet as auditors of DTSPL and the two Partnerships on and before that date. However, I am instructed that there is no evidence independent of Urwin available to DTAL evidencing that Urwin had in fact appointed Smith Greenwood Bennet on or before 12 February 1999. o) The 12 February 1999 fax indicated that Urwin would forward "the audited accounts" to Wong as soon as they were available and in the meantime was to fax "the audited accounts" of DTSPL and the two partnerships to DTCL on Monday 15 February 1999 but I am instructed that the later did not occur. p) On 25 February 1999, Mr John Robins ("Robins"), General Manager of DTCL, was informed by Mr Rob Bridger ("Bridger"), the then CEO of DTSPL, that the auditors had just arrived to commence the audit. [See file note of 25 February 1999 and letter of 5 March 1999]. q) On 26 February 1999, Urwin faxed to DTAL documents that purported to be the financial statements of DTSPL and TAIP (as well as …[FP]) for the financial years ended 30 June 1997 and 1998. r) All the aforementioned purported financial statements, relevant extracts of which I have set out further below, had attached to them audited reports signed by Smith Greenwood Bennet partners Smith or Greenwood, dated 26 February 1999. s) Whilst the Plaintiffs were instructed to discover copies of all relevant documents created by Smith Greenwood Bennet, I am instructed that the only documents that have been discovered are the purportedly audited financial statements referred to above and in sub-paragraph u) below. t) The 26 February 1999 audit report on the TAIP financial statements was qualified on the basis that there had been insufficient time to verify a debt of around $50M recorded in those financial statements as owing by the partnership to DTAL. u) On 23 March 1999 DTAL were provided with documents that purported to be amended audited financial statements for …TAIP (and …[FP]) for the 1997 and 1998 ("the amended TAIP financial statements") which had attached to them unqualified audit reports dated 18 March 1999, signed by Smith Greenwood Bennet partner, Mr Greenwood. v) The amended TAIP financial statements differed substantially from the financial statements provided on 26 February 1999 ("the original TAIP financial statements") as the liability to DTAL of around $50m had been removed from the balance sheet. Instead the Partners were treated as having provided equity equal to the cost of the Rights, presumably on the basis that they were personally severely liable for the amounts owing to DTAL. w) On the day prior to the date of the auditors reports on the amended TAIP financial statements (ie 17 March 1999), Urwin wrote to DTAL asserting that TAIP was not in breach of clause 8.10 of the Sale Agreement as "the partnership has provided audited accounts" (presumably a reference to the original TAIP financial statements) but made no mention of the amended TAIP financial statements." 14 In the succeeding statement of assumptions of fact Mr Kirk identified the "form and content of the purported audited statement" referred to in the earlier assumptions. The questions addressed in the report of Mr Kirk were identified by him as follows: "a) Whether or not, in my opinion, the furnishing of the special purpose financial report referred to in paragraphs 11q) (and paragraph 11u)) below to DTAL on 26 February 1999 (or 23 March 1999) discharged TAIP's and DTSPL's obligations under the respective Sale Agreement and Licensing Agreement to provide to DTAL "a copy of the audited financial statements of the Investor Partnership and DTSPL". b) Whether or not, in my opinion, having regard to the timing of the events referred to in paragraph 11n) to 11w) below and the content of relevant information contained in (or absent from) the documents provided to me, all or any of the said financial reports had been "audited", as that term is generally understood by members of the auditing profession and, as is stated in the respective audit reports, whether or not the alleged audit of those financial statements had been conducted in accordance with Australian Auditing Standards." 15 As to question one he expressed the following opinion: "54. In my opinion, therefore, the furnishing of the special purpose financial report referred to in paragraphs 11q) (and paragraph 11u)) above to DTAL on 16 February 1999 (or 23 March 1999) did not discharge TAIP's and DTSPL's obligations under the respective Sale Agreement and Licensing Agreement to provide to DTAL "a copy of the audited financial statements of the Investor Partnership and DTSPL." 16 In considering the second question he expressed the following conclusion: "60. Based on the relevant assumptions of fact detailed in paragraph 11 above, the audit of the four financial reports provided to DTAL on 26 February 1999 were completed in the course of a single day." 17 It is not particularly surprisingly that he expressed the following opinion in relation to question 2: "67. In my opinion it is unlikely that an auditor with no prior involvement with the audit client or knowledge of the audit client's business could complete in one day the 1998 audit of DTSPL as well as, on the same day, the 1997 the DTSPL audit and both the 1997 and 1998 audits of TAIP (and … [FP]). It is therefore in my opinion unlikely that all the financial reports the subject of Question 2 were "audited". However, to express a conclusive opinion in this respect I would need to have access to the Smith Greenwood Bennet audit files." 18 Counsel for the defendants places particular significance on the last sentence in that quoted passage as justification for the breadth of the subpoena addressed to SGB. 19 Without objection the plaintiff adduced evidence of the documents referred to in subparagraph (e), namely the "file note of 25 February 1999 and letter of 5 March 1999". 20 The terms of the file note were as follows: "J Robbins reported that Rob Bridger said, today, Thursday 25-2-1999, two auditors turned up at the offices of DTSPL in Sydney." 21 The letter of 5 March 1999 was that of DTCL to KPMG. Its purpose was expressed as follows: " Introduction Russell Florence of your Auckland office has referred your to our company. We would like to appoint your firm to assist us in relation to the audit and confirmation of selected items and transactions in the financial records of the Terminal Adapter Partnership, the Freerider Partnership, and Digi-Tech Software Proprietary Limited. Your appointment is made under an agreement which allows Digi-Tech (Australia) Limited to appoint an "independent party" to audit the records of these entities. Before specifying the services that we require from your firm, I shall provide some background information and the concerns that we have." 22 In that letter the writer set out the "CONCERNS" of DTCL which provides a further insight into the rationale for the defendants' objectives in seeking production of subpeonaed documents. The relevant portion of the letter is as follows: "To our knowledge, the directors of DTSPL are Messrs Gary Urwin, Chris Kelliher and Andrew Hamish Cleland. All three are Investors in the Partnerships. Mr Urwin also manages the two partnerships. Until the end of last year, Mr Urwin was Managing Director of Horwath Corporate Pty Limited. He currently practices out of North Sydney. On 27 July 1998, Mr Urwin informed us in writing that "BDO Nelson-Parkhill have been appointed auditors for the Partnerships and Digi-Tech Software Pty Limited and they would expect to commence and complete their audit in the month of August". On 11 August 1998, Mr Urwin met with Mr Dennis Rowe (Chairman of DTCL). Mr Urwin informed Mr Rowe that the audited accounts for the Partnerships and DTSPL would be with DTAL by 30 September 1998, and that he had draft accounts at that time. Those financial statements were not forthcoming. On 29 January 1999, DTAL sent a notice to the Investor Partnership (Attention of Mr Gary Urwin) to remedy breaches in the Sale and Purchase Agreement of Intellectual Property Rights. A copy of that notice is enclosed. One of the breaches is the failure to provide DTAL with audited financial statements with 90 days of year end. On 12 February 1999, I called Mr Urwin to ask him for the audited accounts. Mr Urwin told me that he was going to get Arthur Andersen to do the audit, "but that they wanted too much money". He said he had appointed Smith Greenwood Bennet to do the audit which should be completed on 18 February 2001. I faxed Mr Urwin on 23 February 1999 to ask for the audited financial statements, which were promised to us by 18 February 1999. On 25 February 1999, Mr Robins (General Manager of DTCL) was informed by Mr Rob Bridger (CEO of DTSPL) that the auditors had just arrived to commence the audit. On 26 February 1999, Mr Urwin faxed to DTAL the enclosed audited financial statements for the two partnerships and DTSPL for the June 1997 and 1998 years. The history of events has raised a number of concerns. Some are: 1. The audited financial statements were provided long after the 90 day period required under that clause 8.10 of the Sale & Purchase Agreement of Intellectual Property Rights. 2. If BDO Nelson-Parkhill were appointed auditors in July 1998 and conducted an audit in August 1998, why wasn't the outcome of that audit made available to DTAL ? Did BDO Nelson-Parkhill come up with something or were there disagreements that could not be satisfactorily resolved? Were BDO Nelson-Parkhill fired because they would not bow to the demands of the auditee/Mr Urwin? 3. Were Arthur Anderson appointed auditors and then subsequently fired ( in the same vein as BDO Nelson-Parkhill)? 4. Did Smith Greenwood Bennet follow the relevant professional rules when they accepted appointment (e.g., communication with previous auditor(s), etc)? Were Smith Greenwood Bennet advised that previous auditors were engaged in the audit of the Partnerships and DTSPL? 5. If Smith Greenwood Bennet commenced their audit on 25 February 1999, how reliable is their work if they signed off the financial statements in time for them to be faxed to DTAL on 26 February 1999? The typos in the audit report ("Out" instead of "Our" and "text" instead of "test") and the non verification of the Partnerships' very large liabilities to DTAL are signs of an extremely broad-brush approach to the audit. 6. The audit reports for the Investor Partnerships and DTSPL are for special purpose financial reports, which have been prepared using the tax basis for the Investor Partnerships and using certain selected accounting policies for DTSPL. My interpretation of clause 8.10 of the Sale and Purchase Agreement of Intellectual Property Rights is that DTAL requires an audit of general purpose financial reports. The rationale for this is that, as indicated under the Background section, DTEL may be called upon to subscribe for capital in the Investors' corporate vehicles, and it is therefore crucial that DTEL and DTAL (sister companies) are satisfied that the financial statements of the Partnerships and DTSPL have been audited under generally accepted auditing standards and comply with generally accepted accounting principles and Corporations Law. 7. Notwithstanding paragraph 6 above, (a) the Investor Partnership's financial statements recognise unrealised exchange differences, and this contradicts the tax basis, and (b) the scope limitation and qualification (insufficient time to confirm the balance outstanding to DTAL) in the audit report are inappropriate. Smith Greenwood Bennet did not attempt to confirm the largest liability on the balance sheet - the amount owing to DTAL, who could have provided a response within a very short time. 8. The 30 June 1998 financial statements for the Terminal Adapter Partnership "Sundry Debtors" of $188,973. It is intriguing that there would be sundry debtors, and who are concerned with who the debtors are and whether they are legitimate and collectible. 9. The 30 June 1998 financial statements for the FreeriderPartnership show "Sundry Debtors" of $31,137. Same comment as in paragraph 8. 10. The 30 June 1997 financial statements for DTSPL show: (a) "Sundry Debtors" of $74,998. Same comment as in paragraph 8. (b) Consulting free of $60,000. We are concerned whether this is it a genuine expense of the company? 11. The 30 June 1998 financial statements for DTSPL show: (a) "Receivables" of $207,206, comprising Sundry Debtors $107,403. Loans - Probe Pharmaceuticals Pty Ltd of $92,213 and Other debtors of $7,590. Same comment as in paragraph 8. (b) The bank account was in overdraft of $34,583, but DTSPL had $107,513 in Horwath's Trust Account. This needs explaining. (c) General concern whether the expenses are legitimate. In summary, the protracted history of trying to obtain audited financial statements and the switching of auditors are of concern to us. Further, the audit report is for special purpose financial reports where the auditor does not: (a) report that audit procedures have been undertaken to form an opinion on whether the financial statements are presently fairly in accordance with Accounting Standards, other mandatory professional reporting requirements (Urgent Issues Group Consensus Views) and statutory requirements, and (b) give an opinion on whether the financial statements have been drawn up so as to give a true and fair view of the financial position, profit and cash flows, and are in compliance with Corporations Law, applicable Accounting Standards and other mandatory professional reporting requirements. Such an audit report is tantamount to a no-audit, which raises even more concerns." 23 The services that were requested of KPMG were described in the letter as follows: "The services we would like KPMG to perform are set out as two assignments. Assignment 1 comprises the urgent work that needs to be done as soon as possible, and we would like a draft report from you on Friday, 12 March and the final report on Wednesday, 17 March. Assignment 2 details the work that is to be done after completion of Assignment 1; we would like a draft report of Assignment 2 on Friday, 19 March and the final report on Wednesday, 24 March." 24 Nothing has been said in these applications of any report by KPMG on those assignments. 25 The 'Concerns' of DTCL as expressed in its letter to KPMG of 5 March 1999 explained the defendants' justification for seeking production of the records the subject of the BDO subpoena. The reference in those "Concerns" to Mr Irwin's written statement of 27 July 1998 relating to the appointment of BDO as auditor, is a letter of that date from Horwath Corporate to DTAL which was put into evidence in the applications by the defendants. The statement referred to was in the following context: "* I concur that the function of the Management Committee should be formalised and would advise that the company holds monthly Board Meetings. Those scheduled for the remainder of the current year are attached and I would suggest that it might well be that the format for the Board Meeting be expanded to incorporate the Committee. * BDO Nelson-Parkhill have been appointed auditors for the Partnerships and Digi-Tech Software Pty Limited and they would expect to commence and complete their audit in the month of August." 26 There was also admitted into evidence, the facsimile of SGB to the plaintiffs' solicitors of 10 May 2001 enclosing a cost sheet of work carried out by SGB "in connection with the audit … for the years ended 30 June 1997 and 1998" for TAIP, FP and DTSPL. It disclosed audit work being carried out under the heading "Audit of Financial Statements" and related work between 16 February 1999 and 18 March 1999, amounting to a total of seven hundred and eight 'units'. 27 The defendants raise a threshold objection to the applications on the basis that the plaintiffs do not have any standing to make applications for the setting aside of the subpoenas. Given the provisions of Pt 37 r 8 of the Supreme Court Rules which empower the Court of its own motion to set aside a subpoena, that is a particularly arid ground of objection. 28 Pt 37 r8 of the Supreme Court Rules provides: "the Court may, of its own motion or on the motion of any person having a sufficient interest, set aside the subpoena wholly or in part". 29 I think it would be both unproductive and an exercise in futility to attempt any definition of 'sufficient interest', however broadly that definition might be expressed. It is easier to identify what it isn't, namely, the interest of a curious bystander. Clearly, the subpoenaed party has an interest in having a subpoena set aside for abuse of process, or where the production required of the subpoenaed party is oppressive. 30 I think it is beyond argument that the party entitled to the protection of client legal privilege or the preservation of confidentiality attaching to subpoenaed documents would have sufficient interest to move to set aside a subpoena that was oppressive or an abuse of process. 31 In this case, the interests of the plaintiffs who have interests in the businesses whose records are the subject of the subpoenaed audit records, are 'sufficient', in my view, to entitle them to move for the setting aside of the subpoenas as an abuse of process. I think, as parties, the plaintiffs also have a 'sufficient' interest in applying to set aside subpoenas issued in the exercise of an abuse of process, on the basis that, as parties, they have an interest in due process being observed in the preparation for hearing and in the conduct of the proceedings on hearing. 32 I think similar considerations which I have expressed were caught in the observations of McLelland J in Compsyd Pty Ltd v Streamline Travel Service Pty Ltd (unreported, NSW Supreme Court, 12 August 1987) as follows: "That rule [Pt 37 r8], by its terms, does not confine standing to make such an application to the person to whom the subpoena is directed; all that is required is that the moving party have a sufficient interest. On the other hand, I do not think that the mere fact that the moving party is a party to the proceedings necessarily establishes a sufficient interest in having the subpoena set aside. It would all depend on what interest existed, in fact, in the moving party in relation to the documents which the subpoena required to be produced. If, for instance, the documents were documents in which the moving party had a proprietary interest or if the documents contained information which the moving party claimed to be confidential to it, then, in my view, either of those situations would provide a sufficient interest to justify an application to set aside the subpoena. Another example is the very situation illustrated by the case R v Lewes Justices where the Crown, obviously, had a sufficient interest in seeking to set aside a subpoena addressed to someone else on the basis of public interest privilege in the contents of the documents sought to be produced. So I do not think that this application can be disposed of on the ground of standing without an examination of the connection, if any, between the documents sought to be required to be produced by the subpoenas in question on the one hand, and the defendants on the other. I would also add this: that the rule provides that the Court may, of its own motion, set aside subpoena, and one can readily contemplate situations where the Court, having had its attention drawn to the terms of the particular subpoena by a party might decide to act on its own motion, and the Court would well take such a course where the circumstances indicated that to require a formal application by the person to whom the subpoena was addressed would simply waste money and time." 33 It was also submitted that an application to set aside a subpoena, on the ground that the subpoenaed documents are irrelevant to the issues in the subject proceedings, is unfounded. It was submitted that the proper course was to require the production of documents leaving it to the trial judge to address questions of relevance should they arise in relation to any of the subpoenaed documents. 34 In support of that submission reliance was placed upon Joye v Rehuxo & Ors [1999] NSWSC 785 (3 August 1999), a decision of Foster AJ. That was an application relating to a notice to produce which was treated as attracting the same principles as if production of the subject documents was required under subpoena. Foster AJ addressed the question of relevance of the subject documents in the following context : " Is it appropriate, however, that standing be accorded to Joye simply on the basis that it is asserted, by way of submission, that the notice to produce and subpoena relate to, in part, documents which he asserts can have no relevance to the issues in the proceedings? It is to be noted that Joye has not provided any evidence as to the nature of the documents asserted to be irrelevant nor as to his "interest" in their not being produced to the Court. Although the question of proprietary interest or confidentiality referred to by McLelland J are, no doubt, not exhaustive as heads of "interest", they would be bases upon which Joye could assert a sufficient interest to have the process set aside. He has provided no evidence to this effect. Moreover, the assertion of irrelevance appears to me to be one that can only be satisfactorily determined by a consideration of particular documents in respect of which the claim is made. This appears to be a matter which falls for determination at a later stage. Nor has any attempt been made by Joye to separate out documents, the production of which would affect some "interest" of his, which would militate against their production to the Court. In my view, Joye has not demonstrated standing to seek to set aside the notice to produce or the subpoena". 35 The defendants submitted that further support for that position is found in National Employers' Mutual General Association Ltd v Waind & Hill (1978) 1 NSWLR 372 at 385 in the following passage from Moffitt P: "…in my experience it has long been the practice in this State for the judge, even against opposition, to exercise a discretion to allow one party or the other to inspect documents which appear to be relevant to the issues, whether or not in admissible form. As I understand past practices, where, however, objection is raised by the owner of the documents, the judge examines the documents with some care to ensure there is no abuse of the subpoena, and to determine whether the documents appear relevant in the sense that they relate to the subject matter of the proceedings, in which event he will permit inspection by one or both parties at an appropriate time. The question of their admissibility without more, in accordance with the rules of evidence, does not then arise because, if relevant, they may be admitted in a variety of ways, as by first establishing facts or adopting procedures which make them admissible or by their being admitted by consent. If apparently relevant, I do not see how the objections of the stranger could prevent their admission in evidence, by consent or otherwise, or the inspection which may lead to this occurring. The ultimate question of whether they are ruled to be relevant and/or admissible is left to the third stage of receiving evidence. In my view, this practice is within the wide judicial discretion already referred to, to permit inspection of documents in the control of the court pursuant to a valid subpoena. The crucial question in relation to the exercise of the discretion to permit inspection in the second step is whether the documents have apparent relevance to the issues. It is at the third step that questions between the parties of relevance in fact and admissibility are ruled upon. The judge is in some difficulty in determining whether documents are relevant prior to the presentation of the evidence or at the commencement of the case." 36 I think it is indisputable that, if the subpoenaed documents are by their description arguably relevant or capable of providing a legitimate basis for cross examination on credit matters, then an application to set aside a subpoena on the grounds of irrelevance of the documents to the proceedings is misconceived. It is equally clear, in my view, that, if the description of the documents is such as to admit of a finding that the documents are manifestly irrelevant and incapable of touching matters of credit, then the issuing of such a subpoena represents an abuse of process. 37 I have not found it necessary to comment on Botany Bay Instrumentation & Control Pty Ltd v Stewart [1984] 3 NSWLR 98 and Re ACI International (1986) 11 ACLR 240, where contrary views were expressed as to the right of the party to proceedings, as a matter of right, to move for the setting aside of subpoenas. 38 In Trade Practices Commission v Kimberly Homes Pty Ltd (No.1) (unreported, Federal Court, 19 July 1989) Hill J expressed the relationship between the inherent jurisdiction of the Court to prevent abuse of process and the interest of a party in setting aside a subpoena on the ground of it constituting an abuse of process in the following way: "In my view, once it is accepted that the court has inherent jurisdiction to prevent an abuse of its process it must follow that a party to proceedings before the court is entitled to move the court in respect of some action that has been taken by another party where it is alleged that that action constitutes an abuse of the process of the court. In my view, a party to proceedings in this Court has standing to move to set aside a subpoena where it is alleged that the subpoena, in some way, constitutes an abuse of the Court's process and it is accordingly appropriate that the Court be moved by way of a motion, notice of which is to be given to those affected by it." 39 In expressing some approval of that passage Weinberg J, in Fried v National Australia Bank Ltd (2000) FCA 991 (unreported), added that: "If a subpoena is issued, which ought to be set aside, it matters little, at the end of the day, whether it is set aside at the instigation of a party to the proceeding, or because the Court itself has come to the conclusion that this should occur." 40 It was observed by Hill J in Kimberly Homes that : "It is a well-accepted rule that a subpoena may be set aside as oppressive and as an abuse of process of the court if it requires the production of documents which are manifestly irrelevant to the issues between the parties". 41 The passage in which that quotation appears was cited with apparent approval by Weinberg J in Fried. 42 I think that cases will be rare in which, prior to production of documents, a subpoena will be set aside as an abuse of process, on the ground that the documents by description are manifestly irrelevant to the subject proceedings, or are incapable of bearing upon matters of credit pertinent to those proceedings. 43 The affidavit of Emma Kate Christie sworn 15 February 2001 evidenced two copies of the audited "Financial Statements for the Terminal Adapter Investor Partnership for the financial years ended 30 June 1998 (and) for Digi-Tech Software for the financial years ended 30 June 1997 and 30 June 1998." 44 Given that the partnership was entered into on 30 June 1997 and that DTSPL was incorporated on 11 June 1997, the financials for the year ended 30 June 1997 were particularly simple financial statements. In the case of TAIP, the profit and loss account consisted of amortisation of the fee paid for the intellectual property rights acquired by the plaintiffs - presumably amortised over the five year period of the subject agreement. The profit and loss account for the year ended 30 June 1998 was almost identical. The balance sheet for the years ended 30 June 1998 and 30 June 1999 simply showed the amortised fee as intangibles and as the only asset of TAIP. 45 The profit and loss account for DTSPL for the year ended 30 June 1997 consisted of a single entry, namely a loss of $60,00, which is noted as a consultancy fee. The balance sheet showed this loss and share capital in the sum of $134,998 leaving shareholders equity in the sum of $74,998, recorded as current assets. 46 The profit and loss account for the year ended 30 June 1998 recorded an operating loss of $479,303. The profit and loss statement for that year particularised that sum. Consultancy fees of $241,260 were the most significant cost. There were some twenty seven items of expenditure, most of them quite minor, apart from tender costs of $100,629, recruitment costs of $59,775 and marketing costs of $20,507. On the face of the accounts an audit of TAIP and of DTSPL would not be regarded as a challenging one. The financials appear to accord with the assumptions made by Mr Kirk for the purpose of his report. 47 Although the evidence to which I have referred was admitted without objection, I do not regard it as part of the function of resolving the issues raised on these applications to make determinations as to the time during which the purported audit of the subject financials took place. On the face of it, the assumed fact that the audit was performed over the space of one day is erroneous. However, that presumably will be a matter put to rest at the hearing of these proceedings. Moreover, the issues raised by par 34(g)(ii) of the defence may also fall within a very narrow ambit. 48 The view I have formed is that the 'audit' issues raised in par 34(g) of the defence, as particularised in the facsimile of the defendants' solicitors of 14 February 2001 and further particularised in the report of Mr Kirk of 7 May 2001, are such that preclude a finding that the documents required to be produced on subpoena by SGB are manifestly irrelevant to the issues raised in the proceedings, 49 In the case of the subpoena addressed to BDO, so far as the subject documents could have any possible relevance to the issues in the proceedings, they will fall within the ambit of the subpoena to SGB. 50 In the case of the SGB subpoena there is no justification for the inclusion of the production of records in relation to FP nor for the production of records for the period stipulated in par 1 of the schedule to that subpoena. As to the documents the subject of pars 2, 3, and 4 of the schedule, to the extent that they have any possible relevance to the issues in the proceedings, they will fall within the ambit of par 1 of that schedule. 51 Accordingly, I order that the subpoena to the partners BDO Nelson Parkhill be set aside. The subpoena to the partners Smith Greenwood Bennet, so far as it requires production of records in pars 1(c) to 4 inclusive of the schedule, be set aside and the production of documents referred to in par 1 of that schedule be limited to the period June 1997 to April 1999. 52 The costs of the applications will be costs in the proceedings. ************ Last Modified: 05/28/2001 DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. 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