Reported Decision : (2000) 18 ACLC 285 New South Wales Supreme Court CITATION : TSAPRAZIS & ORS. V. GOLDCREST PROPERTIES PTY. LTD. & ORS. [2000] NSWSC 206 CURRENT JURISDICTION: Equity Division FILE NUMBER(S) : SC 3353/99 HEARING DATE(S) : 09/03/00 JUDGMENT DATE : 23 March 2000 Mr. Greg Tsaprazis - 1st Plaintiff Mr. Liam Tsaprazis - 2nd Plaintiff PARTIES : Ms. Sophia Tasovac - 3rd Plaintiff Goldcrest Properties Pty. Ltd. - 1st Defendant Dernu Pty. Ltd.- 2nd Defendant Mr. Robert Micola - 3rd Defendant JUDGMENT OF : Hodgson CJinEq at 1 Mr. Jacobs QC / Mr Jacobs for Plaintiffs COUNSEL : Mr. I.Sanderson for 1st Defendant Mr. Lancaster for 2nd & 3rd Defendants Gibara & Soubris, Marrickville for the Plaintiffs SOLICITORS : Sullivan Solicitors, Sydney for 1st Defendant Woodward, Wickes & Co., Cronulla for 2nd & 3rd Defendants CATCHWORDS : CORPORATIONS - Directors - Lease by company - Whether directors may have duty to tenant to take reasonable care to ensure that company does not breach lessor's covenants. TORTS - Negligence - Whether director of company may have duty to persons contracting with it to take reasonable care to ensure that company does not breach the covenant. Said v Butt (1920) 3 KB 497. O'Brien v Dawson (1942) 66 CLR 18. CASES CITED : Wah Tat Bank Ltd. v Chan (1975) AC 507. Kinsella v Russell Kinsella (1986) 4 NSWLR 722. Perre v Apand Pty. Ltd. (1999) 73 ALJR 1190. DECISION : See pars. 18 to 19 of the judgment. IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION CORAM: HODGSON, CJ in Eq. Thursday, 23 March 2000 NO. 3353 OF 1999 TSAPRAZIS & ORS. V. GOLDCREST PROPERTIES PTY. LTD. & ORS. JUDGMENT INTRODUCTION 1 In this judgment, I am dealing with an application by the third defendant Mr. Micola to strike out paragraphs 23.1, 23.2, and 23.3 of the Amended Statement of Claim, which allege against him a duty of care and breach of that duty. To understand the nature of this application, it is necessary to outline the plaintiffs' claims in the proceedings generally. 2 On 23rd March 1997, the plaintiffs leased from the second defendant Dernu premises in Cronulla for a term of three years, plus an option of a further three years. The plaintiffs conduct a restaurant business in the premises, and they claim to have spent substantial sums in re-furbishing the premises for that purpose. 3 The lease contains in cls.7.1.1 and 7.1.2 covenants by the landlord to maintain the roof, ceilings, external walls and floor of the premises in good condition, and to maintain the premises in a structurally sound condition. There was also a covenant to the effect that, if the premises or the building of which they are part are damaged, the landlord can notify the tenant that it considers the damage such as to make repair impracticable or undesirable, and then terminate the lease on seven days' notice. 4 The plaintiffs claim that, from the time of commencement of the lease, there has been water ingress into the premises because of defects in the roof and/or other structural defects; and this has never been rectified. 5 On 29th May 1998, the first defendant Goldcrest purchased the premises from Dernu, subject to the lease, and thereby became the landlord. On 19th July 1998, Goldcrest purported to terminate the lease, on the ground that the premises had been damaged by water ingress and Goldcrest considered it impracticable or undesirable to repair that damage. 6 In these proceedings, the plaintiffs seek damages against Dernu and Goldcrest for breaches of the covenants in cls.7.1.1 and 7.1.2, and also a declaration that Goldcrest is not entitled to terminate, and consequential relief. There are also claims under the Trade Practices Act. THE CHALLENGED PLEADING 7 The challenged pleading against Mr. Micola is a claim for damages made against him as a director and shareholder of Dernu, on the basis of the following allegations of paragraphs 23.1, 23.2 and 23.3: 23.1 The Third Defendant owed the Plaintiffs a duty of care to ensure that the Second Defendant complied with Clauses 7.1.1 and 7.2.2, so as to avoid the Plaintiffs' suffering economic loss. 23.2 The said duty of care arose out of the following facts: (a) For at least one year prior to the purchase of "the Premises" by the First Defendant, the Third Defendant knew that the First Defendant intended to purchase "the Premises" for the purpose of developing them into 17 residential units, and for this purpose would seek to obtain vacant possession of "the Premises"; and in fact encouraged the proposed Development, by consenting to a Development Application; (b) For some time prior to the purchase of "the Premises", the Second and Third Defendants knew that the First Defendant had spent a substantial amount of money in legal costs in regard to its proposed development above, by litigating in the Land and Environment Court to obtain the relevant Development Consent; (c) At all relevant times, the Third Defendant knew that the Plaintiffs had made a substantial investment in refurbishing "the Premises" and in fact encouraged the Plaintiffs to make that investment; (d) The Third Defendant knew that if "the Premises" were not properly and adequately maintained, that would present an opportunity to the First Defendant to con duct itself as it has now done, as more fully set out above; (e) The Third Defendant knew that if the First Defendant were to terminate the lease under Clause 8.2.3, by relying on Second Defendant's breaches of Clauses 7.1.1 and/or 7.1.2, then the Plaintiffs' substantial investment would or might be sterilised, and in addition they would or might lose the benefits of "the Lease", and would or might be exposed to heavy litigation; (f) The Third Defendant, by virtue of the fact that he controlled the Second Defendant, assumed the responsibility to the Plaintiffs to ensure that the Second Defendant carried out all of its obligations to the Plaintiffs under Clauses 7.1.1 and/or 7.1.2 of the Lease; (g) In the circumstances set out in sub-paragraphs (a)-(f) above, the Plaintiffs were reliant of the Second Defendant maintaining "the Premises" in accordance with Clause 7; and were reliant on the Third Defendant ensuring that the Second Defendant honoured Clause 7; (h) In the circumstances in sub-paragraphs (a)-(g) above, the Plaintiffs were vulnerable in the event the Second and Third Defendants did not conduct themselves so that Clause 7 was complied with. 23.3 The Third Defendant negligently breached his duty of care by failing to ensure that the Second Defendant complied with its obligations under Clause 7, as more fully set out above. SUBMISSIONS 8 Mr. Lancaster for Mr. Micola submitted that there are good reasons of principle and policy that there be no duty of care in this situation. The commercial relationship between Dernu and the plaintiffs carried the rights and obligations set out in the lease: it would be surprising if there were a duty of care owed by the lessor to the lessee not to breach the lease so as to cause economic loss, and it would be more surprising if such a duty were owed by a director of the lessor. The director had not guaranteed the landlord's obligations, and the law of negligence should not be used in substance to give rise to such a guarantee. The law already imposes a wide range of obligations on the director of a corporation and the alleged duty of care could cut across those obligations. Mr. Lancaster also relied on the analogy of the tort of procuring a breach of contract, for which a director is not liable: see Said v. Butt (1920) 3 KB 497 at 506; O'Brien v. Dawson (1942) 66 CLR 18 at 34. 9 In any event, Mr. Lancaster submitted, the particulars were not capable of establishing the necessary relationship between Mr. Micola and the plaintiffs. They could not amount to an allegation of assumption of responsibility, and the economic loss asserted was not reasonably foreseeable. In any event, the alleged economic loss was too remote, because of the intervening conduct of Dernu and Goldcrest. Mr. Lancaster referred to Perre v. Apand Pty. Limited (1999) 73 ALJR 1190; and Esanda Finance Corporation Ltd. v. Peat Marwick Hungerfords (1997) 188 CLR 241. 10 Mr. Jacobs QC for the plaintiffs referred me to Perre v. Apand , and submitted that that case indicated that a duty of care could be found where there was sufficient foreseeability of possible damage, proximity, and vulnerability. He referred me particularly to paragraphs 10 and 11, 27, 31-32, 75, 95, 118-9, 120-24, 133, 196-200, 203-221, 259 and 333. He submitted that all the factors pointing to liability were present in this case and that there were no policy considerations against finding a duty of care. He submitted that the cases showed that directors could be liable in tort in relation to their activities on behalf of a company: Performing Right Society Limited v. Ciryl Theatrical Syndicate Limited (1924)1 KB 1 at 15, Wah Tat Bank Limited v. Chan (1975) AC 507. Mr. Jacobs submitted that the duty of care contended for in no way impacted on any legitimate interest of Dernu or the director's fiduciary duty to Dernu. There was no suggestion of insolvency, so that the duty of care could not conflict with the duty discussed in Nicholson v. Permakraft (1985) 1 NZLT 242 and Kinsella v. Russell Kinsella (1986) 4 NSWLR 722. DECISION 11 In my opinion, this question must be decided in the context of general principles concerning contracts made by companies. In general, only the company is liable under such a contract, not its shareholders or directors, unless they guarantee the company's performance. Directors may become indirectly liable to other contracting parties through breach of their director's duties to the company, or through breach of the Corporations Law relating to such matters as insolvent trading. Consistently with this general approach, directors are not liable for the tort of inducing breach of contract, where, in exercising their functions as directors, they have caused the company to breach its contract: see Said v. Butt and O'Brien v. Dawson . 12 This is not a claim for inducing breach of contract, but has some similarity to it. The relevant elements of the tort of inducing breach of contract would be that the defendant knows of the contract, and with intent to cause a breach procures the party to breach the contract. Here, the alleged elements are that the defendant knows of the contract, knows of circumstances which mean that the plaintiff would be severely damaged by a breach of contract, and contributes to the creation of those circumstances; and then, having the power to ensure that the party did not breach the contract, fails to do so. 13 In my opinion, the Court should be very hesitant to find a duty of care in this situation. The position of directors in relation to contracts by companies is one where there are very extensive general law rules and statutory provisions as to the responsibilities and liabilities of directors. In my opinion, the following remarks by Gleeson, CJ in Perre v. Apand , at par.5, are pertinent: There are at least three considerations which have been, and will remain, influential in restraining acceptance of such a duty of care in particular cases, or categories of case. First, bearing in mind the expansive application which has been given to the concept of reasonable foreseeability in relation to physical injury to person or property, a duty to avoid any reasonably foreseeable financial harm needs to be constrained by "some intelligible limits to keep the law of negligence within the bounds of common sense and practicality". Secondly, to permit recovery of foreseeable economic loss, which may or may not occur in a commercial setting, for any negligent conduct, may interfere with freedoms, controls and limitations established both by common law and statute in many legal contexts. Thirdly, in those cases where the loss occurs in a commercial setting, a third party, C, may suffer financial harm as a result of conduct which is regulated by a contract between A and B. It may be that the consequences of such conduct, as between A and B, are governed and limited by the contract. This is a problem which commonly occurs in relation to maritime claims, and may help to explain the strictness with which an exclusionary rule has been applied in shipping cases. 14 As shown by cases such as Performing Rights and Wah Tat Bank , this does not exclude liability of directors in recognised areas of tort, such as trespass, fraud and conversion, for actions done by them on behalf of the company; but does tend against the existence of a liability based purely on the failure of a director to cause the company to comply with its contract. 15 It is pertinent to note that there would generally be a problem with a director contracting with a third party that he or she would cause the company to perform the obligations of the company under a contract with that third party. Certainly, if a director received consideration in return for such a promise, this would be a secret commission, unless the consideration was received with the informed consent of the company, and in situations of insolvency, possibly the informed consent of creditors. Even if there were such informed consent, it seems to me that a direct promise to act as a director in a particular way, where the director's obligation is to act bona fide in the interests of the company in all situations, may itself be a breach of fiduciary duty. It would be a breach of fiduciary duty to perform that promise if that performance was not itself in accordance with the fiduciary duty of the director. 16 In my opinion, if all that is alleged is that the director knows of a contract by the company, knows of circumstances such that the other party would be severely damaged by breach of that contract, and has the power to ensure that the company does not breach its contract, then this is plainly insufficient to give rise to a duty to exercise reasonable care to ensure that the company fulfils its contract. However, could it perhaps be otherwise if the director by some positive act substantially contributes to the circumstances which make the other party so vulnerable? 17 It is possible that a director of a company who takes some positive action, knowing that it will bring about a situation where a person who has a contract with the company will suffer substantially greater loss if the company breaks its contract, could come under a duty to exercise reasonable care to ensure that the company fulfils its contract. The important elements here, I believe, would be the positive action, substantially increasing the vulnerability of the other party, taken in actual knowledge of this effect. In the present pleading, there is an allegation that Mr Micola encouraged Goldcrest's proposed development by consenting to its development application and encouraged the plaintiffs' expenditure in refurbishing its premises. It is not alleged that these actions substantially increased the vulnerability of the plaintiffs, or that they were taken in actual knowledge of this effect. Of course, an amendment could be sought to make those allegations; but in the circumstances of this case I would not permit such amendment unless the application to amend was supported by evidence showing that the plaintiffs had reasonable grounds for alleging that Mr Micola's actions substantially increased the plaintiffs' vulnerability to damage from Dernu's breach of its covenant, and were taken in actual knowledge of this effect. In my opinion, the mere existence of a clause in the lease permitting the landlord to terminate the lease, on the basis of damage which the landlord considers such as to make repair impracticable or undesirable, would not be a sufficient basis to allege such knowledge. 18 For those reasons, I order that paragraphs 23.1, 23.2 and 23.3 of the Amended Statement of Claim be struck out. 19 Having regard to the relative success of the parties, I order that costs of Mr Micola's application be Mr Micola's costs in the proceedings. ********** Last Modified: 09/25/2000 DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. 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