Labraga v Pomfret [2005] NSWSC 490

New South Wales Supreme Court

CITATION : Labraga v Pomfret [2005] NSWSC 490

HEARING DATE(S) : 16/05/05

JUDGMENT DATE : 19 May 2005

Equity Division JURISDICTION : Corporations List

JUDGMENT OF : Barrett J

DECISION : Provisional liquidator appointed

CATCHWORDS : CORPORATIONS - winding up - application for appointment of provisional liquidator - strongly arguable case of insolvency - breakdown in relationship of directors and shareholders

Commonwealth v Henden Industrial Park Pty Ltd (1998) 17 ACSR 358 Constantinidis v J G R Trading Pty Ltd 17 ACSR 625 Morgan v Macrae [2001] NSWSC 1017 CASES CITED : Natural Extracts Pty Ltd v Stotter, (unreported FCA, 18 December 1998) Re Club Mediterranean Pty Ltd (1975) 11 SASR 481 Triulcio v Chase Property Investments Pty Ltd [2003] NSWSC 861 Zempilas v J N Taylor Holdings Ltd (No. 2) (1990) 55 SASR 103

Julio Cesar Labraga - Plaintiff Philip Edward Pomfret - First Defendant PARTIES : Exception Holdings Pty Limited - Second Defendant Exception Finance Pty Limited - Third Defendant

FILE NUMBER(S) : SC 2063/05

Mr M.A. Ashhurst - Plaintiff COUNSEL : Mr G.K. Burton SC - Defendants

Cordato Partners - Plaintiff SOLICITORS : Dibbs Barker Gosling - Defendants

LOWER COURT JURISDICTION :

IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION CORPORATIONS LIST

BARRETT

THURSDAY 19 MAY 2005

2063/05 - JULIO CESAR LABRAGA v PHILIP EDWARD POMFRET & ORS

JUDGMENT

1 On Monday last, 16 May, I heard an application by the plaintiff, Mr Labraga, for an interlocutory order for the appointment of a provisional liquidator of the second defendant, Exception Holdings Pty Ltd. The application was made in proceedings in which Mr Labraga seeks winding up of Exception Holdings on the ground of insolvency and the just and equitable ground, as well as declaratory relief against the other director, Mr Pomfret, who is the first defendant. 2 The interlocutory application first came before me on 22 April 2005. I stood it over at that time in the expectation that it might prove possible to restore the original pattern of ownership within Exception Holdings and thereby to address, at least to some extent, the matters that have led to the application. 3 Exception Holdings was established in 2001 with three proprietors and directors: Mr Labraga (the plaintiff), Mr Pomfret (the first defendant) and Mr Highland. Each of them brought to the venture a business of finance broking or loan origination and expertise relevant to that form of enterprise. The three (or their vehicle companies) became equal one-third shareholders. 4 Exception Holdings has four subsidiaries, including Exception Finance (the third defendant) and Exception Advertising. The latter, on 21 April 2005, entered into a Part 5.3A administration. 5 Mr Highland died in March 2003. Mr Labraga and Mr Pomfret were named as executors in his will. Probate was in due course granted to them. I have been told that the sole beneficiary under the will is a company which is the trustee of a discretionary trust under which Mr Highland's widow and other members of his family are the discretionary beneficiaries, but with the shares in the trustee company being held as to half by Mrs Highland and half by Mr Labraga and Mr Pomfret under the provisions of Mr Highland's will and in consequence of their appointment thereunder. 6 There has been a serious falling out, for want of a better description, between Mr Labraga and Mr Pomfret. The third force there once was in the administration of the affairs of Exception Holdings is now lacking and cannot be brought to bear in relation to that falling out. When the matter was before me on 22 April, there was an expectation that this might be addressed by the appointment of substitute executors of Mr Highland's will. A consensual outcome has not eventuated, but there is on foot an application by Mr Highland's widow, in other proceedings, for an order that Mr Labraga be replaced by her as one of the two executors. 7 Mr Ashhurst, who appears for Mr Labraga, pointed to difficulties in the way of such an outcome. On the basis of the decision of the Chief Judge in Equity in Morgan v Macrae [2001] NSWSC 1017, he says that Mrs Highland cannot succeed in replacing Mr Labraga unless she seeks revocation of the grant of probate to both Mr Labraga and Mr Pomfret, which she currently does not do – also, that grounds beyond conflicting interests are needed to support an application for removal of executors and have not been put forward in connection with Mrs Highland's application. There is also Mrs Highland's lack of status as beneficiary under the will, plus the point that the sole beneficiary, in the person of the trustee company of the discretionary trust, is controlled in the way I have described, so that is unlikely that it will progress matters in the absence of some broadening of proceedings to include replacement of that trustee. 8 Before I commenced giving judgment this morning, Mr Burton outlined, in more detailed terms, the way in which Mrs Highland might go about her attempt to have matters reconfigured at the estate level. Nothing he said altered the view I had reached on 16 May 2005 that there is unlikely to be early resolution of matters through the separate proceedings concerning the estate. I therefore proceeded to hear, on 16 May, the application for the appointment of a provisional liquidator and declined this morning to defer giving judgment on that application. 9 The circumstances requiring consideration may be approached from a starting point shortly after Mr Highland's death. During the month in which Mr Highland died (March 2003), Exception Holdings' indebtedness to Westpac Banking Corporation on overdraft account reached $1.45 million. In September 2004, Westpac sued Mr Labraga and Mr Pomfret, both personally and as executors of the estate of Mr Highland, as well as Mrs Highland, upon alleged guarantees of the indebtedness of Exception Holdings. Mr Labraga says that he and Mr Pomfret developed a plan for paying Westpac by resort to the funds available in the estate of Mr Highland or capable of being borrowed at the estate level and funds available to Mr Labraga from a line of credit. The estate made available some $890,000 in this way, while Mr Labraga made available $400,000 which he borrowed at interest from the external source. These funds were lent to Exception Holdings. It appears to have been agreed that the company would pay Mr Labraga interest equivalent to that he had to pay to the external lender. Mr Labraga says that he left it to Mr Pomfret to arrange security for these advances to Exception Holdings. Mr Pomfret held a general power of attorney from Mr Labraga. Indeed, Mr Labraga also held a general power of attorney from Mr Pomfret. Mr McCabe, a solicitor, received instructions in relation to a grant of security by Exception Holdings to the estate for moneys advanced by it. He says he received no instructions to prepare a security in favour of Mr Labraga. 10 At, or soon after, the time of leaving the loan and security matters in the hands of Mr Pomfret, Mr Labraga went on extended leave. This was in early December 2004. When, in mid February 2005, Mr Labraga told Mr Pomfret that he expected to return in mid March, Mr Pomfret replied that he, Mr Labraga, had resigned and that his monthly drawings and expense account payments had been stopped. At that stage Mr Labraga was drawing $9,000 a month and Mr Pomfret $12,000 a month, plus $6,000 additional payments. The parties engaged in long correspondence during February and March. Mr Pomfret eventually said, in effect, that he was willing to overlook the supposed resignation of Mr Labraga and was happy to have him back in the business. 11 In response to a complaint from Mr Labraga that Mr Pomfret had arranged for security to be given by Exception Holdings to the estate in respect of the loan by the estate but had not done likewise in relation to Mr Labraga's advance of $400,000, Mr Pomfret said that his agreement that Mr Labraga was to have security was conditional on two things: first, Mr Labraga's "signing documentation confirming that you will fulfil your obligation to pay one-third of the company's liability on departure so that the amount advanced would be washed up against one-third of your share of the company's liability on leaving the company"; and, second, mortgage security being provided also to Mrs Highland and Mr Pomfret for moneys they had previously advanced to the business. 12 On his return, Mr Labraga could not access the business premises as the entry code had been changed. Mr Pomfret said this had been done when another employee had left while Mr Labraga was away. 13 During February and March 2005, Mr Labraga's monthly payments and automatic debit to the company account for expenses were not made, nor were payments of interest on Mr Labraga's loan at $400,000. Mr Labraga called on Mr Pomfret to remedy what he regarded as defaults in these respects, also for the charge in his favour to be granted. Mr Labraga also became aware of a clause in the estate's mortgage allowing creation of a prior ranking security of up to $1 million and says that as an executor he never agreed to this. 14 Mr Labraga gave notice calling a meeting of directors for 17 March 2005 for Exception Holdings and all subsidiaries to discuss a number of matters, including bank account signatories, provision of security to Mr Labraga, payment of directors' remuneration and expenses, valuation of assets and, significantly, the possibility of appointing a voluntary administrator if any of the companies was insolvent. At the same time, Mr Labraga sent a memo to the financial controller, Mr Walmsley, asking him to have up to date financial information available for the proposed directors' meeting. Mr Pomfret said that he was not available for a meeting at the time nominated by Mr Labraga or at any of several alternative times Mr Labraga had suggested. He proposed other times for Mr Labraga's consideration. Mr Labraga then went into Mr Pomfret's electronic diary and challenged Mr Pomfret's statement that he was not available at the times nominated by Mr Labraga. A meeting eventually took place on 4 April 2005. I shall refer to it presently. 15 In the meantime, there were various happenings concerning signing authorities on the ANZ bank account of Exception Holdings. Mr Labraga, on 17 March 2005, sent an e-mail to Mr Walmsley saying that he, Mr Labraga, was to be the sole bank signatory and that this had been agreed to by Mr Pomfret, to whom the e-mail was copied, along with a copy to Mr Encina, a senior manager. Mr Pomfret, on the same day, sent an e-mail to Mr Walmsley, copy to Mr Labraga and Mr Encina, saying that Mr Pomfret, Mr Labraga and Mr Encina were the authorised signatories (with any two to sign) and that this would remain the position until Mr Labraga and Mr Pomfret decided to change it. Mr Encina, in reply to both of them, expressed concern about the conflicting instructions he was receiving from the two directors and said he would hold off signing any cheques until he received clarification. 16 On 1 April 2005, Mr Pomfret asked Mr Labraga to sign a cheque for $13,000 for the Australian Taxation Office. This apparently followed a refusal of Mr Encina to sign it. Mr Labraga also refused because he says he was given no supporting documentation and was merely told, "It's for an agreement with the ATO"; and he was not aware of any such agreement. Mr Pomfret then sent a cheque to the ATO bearing his signature alone and the ANZ, contrary to its mandate, it is said, paid it. This resulted in a letter from Mr Labraga's solicitors to the ANZ demanding that no cheques be paid unless carrying two signatures in accordance with the mandate. 17 These proceedings were commenced by Mr Labraga on 23 March 2005. On the following day, Mr Pomfret gave to the court an undertaking that he would will not deal with or dispose of (or cause to be sold, charged, mortgaged or otherwise dealt with) the mortgage book owned by the wholly owned subsidiary, Exception Finance. The Court noted an undertaking given by Mr Pomfret to Mr Labraga that he provide Mr Labraga with certain financial information and documents and that he would make necessary arrangement with the financial controller and would attend a directors' meeting on 4 April. 18 The meeting of directors eventually took place on that day. The minutes are in evidence. They show that there was disagreement at the outset between Mr Pomfret and Mr Labraga as to who should be the chairman. It appears that this went on for some time. They decided eventually to proceed without a chairman. There was next a dispute as to who should have arranged financial information to be available for the meeting. Eventually, it seems, some material as at 24 March 2005, by way of profit and loss account and balance sheet printed from the internal computer system, was obtained together with some form of financial snapshot as at 20 March 2005. An account of accusations and counter accusations about who should have done what on the accounting front contains the information that the financial controller had resigned four weeks earlier, that is, before Mr Pomfret gave the undertaking noted by the Court on 24 March involving actions by the financial controller. Mr Labraga proposed that an administrator be appointed to the subsidiary, Exception Advertising because it was insolvent. Mr Pomfret said, in effect, that he needed time to digest the financial information. This was agreed to. 19 It is relevant to note that Exception Advertising was later placed in voluntary administration following non-compliance with a creditor's statutory demand. The appointment of the administrators occurred 21 April 2005. 20 On 6 April 2005, financial information was extracted. It showed, ostensibly for Exception Holdings, a quite parlous position which I shall mention presently. It seems fairly clear that this summary information did not properly differentiate between the several companies in the group. 21 On 12 April 2005, there was another directors' meeting. This concentrated on matters to do with the bank account. It apparently ended up in impasse and in the following days there was correspondence back and forth about payment of employees. Not surprisingly, employees had become sick of the wrangling, and on 18 April 2005, three of them resigned, including Mr Encina, the senior manager to whom I have referred. Mr Encina in fact wrote a letter of resignation to Mr Labraga, copied to Mr Pomfret, which I should quote in part. He said: "I appreciate that each of you have genuine motivations for your actions. However, the reality is that regardless of how the dispute now unfolds, it is almost certain that the companies will not emerge intact and the futures of all the companies' employees is anything but certain. Over the past weeks I have been approached by a number of employees who have detailed their concerns. As with all of the employees, I have entered into arrangements with the companies in good faith and provided loyal and diligent service for the term of my employment. The non-payment of superannuation for more than two quarters is but one issue whereby the company has acted in breach of its employment contract and also, to my understanding, in breach of its statutory requirements. As a consequence of the dispute between the directors, the company has failed to pay my wages in accordance with the terms and conditions of my contract. By this and other actions the company has repudiated my contract of employment. I accept that repudiation. I am also concerned as to the financial status of the holding company and, in particular, the solvency of that entity. From our conversations it appears to me that the holding company is, prima facie, insolvent." 22 Mr Encina, as I have said, was a senior manager. Ms Sye, in her resignation letter, referred to non-payment of superannuation for three quarters. 23 In late April and early May 2005, there was e-mail correspondence between Mr Labraga and Mr Pomfret about payment of creditors. On 27 April, Mr Pomfret proposed a series of creditor payments which omitted any payments to Mr Labraga and himself. Mr Labraga replied at length. The essential message was that payment arrangements should be arranged through the parties' respective solicitors and that he had left on Mr Pomfret's desk a list of proposed payments he wanted progressed in that way. As to any other creditors, he said that written instructions and supporting documents should be provided. A subsequent e-mail shows that supporting material was furnished and that a number of payments were processed. In the meantime, however, a great volume of e-mail correspondence containing personal insult, expressions of distrust and minute dissecting of the supposed rights and wrongs of past events had been generated. 24 On 9 May 2005, the Australian Taxation Office served a statutory demand on Exception Holdings in respect of the debt of $336,501.84 for unpaid PAYG instalments. On 12 May 2005, Mr Pomfret proposed a regime of payment by instalments to the ATO which, on 13 May 2005, sent him a letter confirming that it was in negotiation with him. 25 On 11 May 2005, Exception Holdings received a request for payment from Fuji Xerox. The sum was $141,534.27 and related to hire of equipment. On 13 May 2005, Fuji Xerox notified Mr Pomfret of acceptance of a payment schedule extending to September 2005, although this appears to have accounted for only $71,000. 26 I return now to the financial position and the financial statements as at 6 April 2005 to which reference has already been made. Those statements showed that amounts due to trade creditors were $1,430,228 of which $1,308,622 was 90 days plus. It also showed amounts due from trade creditors of only $804,262 of which $673,859 was 90 days plus and therefore, on the face of things, unlikely to be collected in full. The balance sheet showed current assets of $62,742 and current liabilities of $1,638,822. There was only $48,388 cash and there was a net equity position of negative $986,734. The profit and loss account shows a loss for the year to date of $427,606. The balance sheet does not appear, on my examination of it, to reflect either the loan from the Highland estate of some $890,000 or the Labraga loan of $400,000, although there is a reference to a Westpac loan of $325,000 as a non-current liability. 27 Some further insight into the financial position may be obtained from a report dated 10 May 2005 by the administrators of Exception Advertising to the creditors of that company. That report is, of course, a report about the subsidiary but, as I say, provides some insight into the position of the holding company. The administrators said: "As a result of Holdings acting as treasury for the group, the company [that is to say Advertising] was unable to make payments to suppliers and employees and thus was unable to trade. Due to the manner of the operations of Holdings, the financial affairs of the group are so intertwined, it is difficult to differentiate their financial position without a full reconciliation of the accounts." 28 The administrators also said: "It is clear that the directors have focussed their attentions on the ongoing dispute rather than the day to day management of the group. This is has had a significant impact on the financial affairs of the company [again, of course, a reference to Advertising]. I note that the company has entered into repayment plans with a number of creditors and thus it is apparent it had been experiencing financial difficulties for a considerable period, possibly as far back as the death of Mr Highland." 29 At page 17 of the report, the administrators, speaking of Exception Advertising, expressed an opinion that it may have been trading while insolvent for a period before their appointment. They then referred to six indicia of likely insolvency, indicia which, on the evidence before me, apply equally to Exception Holdings. 30 The final piece of evidence as to the financial position is a brief report commissioned by Mr Pomfret on 11 May 2005 and delivered on 13 May 2005 by an external accountant, Mr Kelly, of WHK Greenwoods Pty Ltd. The report is based on unaudited information obtained by Mr Kelly from Mr Pomfret. Mr Kelly refers to outstanding demands from three creditors, in addition to those I have mentioned. He refers also to loans from related parties, including the Highland estate, totalling $2,320,000. Mr Kelly makes two comments about these items. First, he says that he understands, no doubt from Mr Pomfret, that these related party loans are not expected to be called to the detriment of outside creditors of the company. Second, he says that he cannot reconcile the items with the balance sheet he was given. As to the first comment, no basis for the stated expectation is given. Speaking of the group as a whole, Mr Kelly says that the major asset is the loan book producing trailer commissions of $720,000 per annum from the one source and $180,000 per annum from another source. On the information Mr Kelly had, he was unable to express an opinion on solvency although he pointed to a possibility that the liabilities, although substantial, may prove to be covered by "the potential income flow and related assets". 31 It was submitted, on behalf of Mr Pomfret, that despite the differences between him and Mr Labraga, the company continues to function, albeit with some "argy-bargy" in decision making. Mr Labraga's contention is, however, that there is a deadlock and that the assets are at risk. He also says that the company is insolvent, pointing to the matters I have mentioned. Attention is also drawn to the fact that the accounting records are in substantial disarray with both Mr Kelly and the administrators of Exception Advertising unable to give a view as to the separate assets and liabilities of the separate companies, each of which, of course, has a separate group of creditors to whom responsibilities are owed. 32 Mr Pomfret says that the appointment of a provisional liquidator to Exception Holdings would cause serious harm by way of threat to the ongoing flow of trailer commissions from Australian Mortgage Securities Limited. His counsel, Mr Burton SC, introduced into evidence the agreement with that company and pointed to a provision under which it may terminate the agreement if there is, in respect of the party designated the "correspondent", an "event of insolvency". Although appointment of a provisional liquidator is not included specifically in the definition of "event of insolvency", the definition has aspects, such as ceasing to carry on business, that might arguably be satisfied by such an appointment. But, as was pointed out by Mr Ashhurst, on behalf of Mr Labraga, Exception Holdings is not a party to this agreement. The "correspondent" is the subsidiary, Exception Finance. There will, accordingly, be no direct impact under the terms of the agreement if a provisional liquidator is appointed in respect of Exception Holdings. 33 The court will generally decline to appoint a provisional liquidator pending final determination of a winding up application where some suitably stabilising interim regime is in place. Mr Burton referred to Triulcio v Chase Property Investments Pty Ltd [2003] NSWSC 861 as an example of such a case. Mr Burton also suggested that the undertaking given by Mr Pomfret to the court on 24 March 2005, together with the inter-partes undertakings noted on that day and the evidence that, except for payments to themselves, the two directors have generally been able to see creditors paid, means that there is no need for interlocutory relief. Mr Ashhurst accepted that when Mr Pomfret has made a request for a cheque to be signed and has provided proper back-up material, the creditor has been paid. But Mr Ashhurst points to other serious matters of deadlock and says that the maintenance of the status quo pending trial will not be achieved under the current management, which is not in the best interests of creditors. This is because, he says, the company is almost certainly insolvent, that it was founded on the basis of the talents of three individuals, of whom one has now died and the other two are so hostile to one another that they cannot work together, with the result that there is negative profitability which is likely to continue. 34 The approach of the court to this kind of application must be in accordance with established principle. All three judgments in Constantinidis v J G R Trading Pty Ltd 17 ACSR 625 emphasise the care that must be taken upon an application of the appointment of a provisional liquidator. Meagher JA saw such an order as a judicial remedy of a "wholly extraordinary nature". Both Kirby P, in whose judgment Meagher JA concurred and Powell JA, who dissented, quoted with approval the observation of King CJ in Zempilas v J N Taylor Holdings Ltd (No. 2) (1990) 55 SASR 103: "The appointment of a provisional liquidator pending adjudication upon the petition of a winding up is a drastic intrusion into the affairs of the company and is not to be contemplated if other measures would be adequate to preserve the status quo." 35 In Commonwealth v Henden Industrial Park Pty Ltd (1998) 17 ACSR 358, O'Loughlin J referred to such an appointment as "a serious step". 36 There is a statement of Bright J in Re Club Mediterranean Pty Ltd (1975) 11 SASR 481, that it is not possible to state an exhaustive catalogue of the circumstances in which a provisional liquidator should be appointed since "commercial affairs are infinitely serious". Bright J also said: "Where the petitioning creditor makes the application and the company opposes it the Court must come to a conclusion as to the degree of urgency and of the need established, by the petitioning creditor and the balance of convenience." 37 In Natural Extracts Pty Ltd v Stotter , (unreported FCA, 18 December 1998), Hely J said that the Constantinidis case: "… is a reminder that whilst there is a wide discretion as to the circumstances in which an appointment of a provisional liquidator will be made the appointment of a provisional liquidator involves the taking of a serious step which requires the exercise of very great care. It is usually at least necessary to establish that the assets of the company are in some degree of jeopardy and that there are good prospects that a winding up order will ultimately be made."