INDEMNITY COSTS AS THE PRICE OF RELIEF AGAINST FORFEITURE – Reasonableness on the weighing scales

Icechest Corp Pty Ltd v Quan [2017] WASC 345 is probably the latest Australian iteration of the question of who should bear the legal costs of a successful application for relief against forfeiture of a commercial lease.

The decision turned on whether the lessor had acted unreasonably in its initial refusal to allow the lessee re-entry, and in its approach to the ensuing ligation, such as to deny it a right to be indemnified for its costs.

The decision serves as a warning to lessors that a churlish or absolute refusal to accommodate a lessee in re-entering the lease can lead to adverse costs orders, and a reminder to lessees that despite the indulgences the law allows them in re-entering premises after breach and termination, they should expect to pay for it.

Background

The lessor had terminated the lease for the lessee’s failure to pay rent and outgoings and to provide a security deposit.  At or around the time proceedings for relief against forfeiture were commenced, the outstanding rent and outgoings had been paid.  The lessee promised to pay the security deposit within weeks, but was unable to provide the lessor certainty this would occur.

The lessor required payment of the security deposit immediately, the lessee’s commitment to honour future lease obligations on time, and payment of the lessor’s costs associated with the lessee’s defaults.

The lessee in its desperation to obtain re-entry also alleged the lease had been wrongfully terminated; a position it ultimately had to resile from.

Immediately prior to and during the litigation the lessor made an effort to confer with the lessee, to offer re-entry on terms tied to future compliance with the lease, and to minimise argument and cost to the parties.

Following the usual interim injunction proceedings, and once the lessee remedied its defaults; the lessor consented to relief against forfeiture.  At that juncture, given the state of the law reflected by Twinside Pty Ltd v Venetian Nominees Pty Ltd [2008] WASC 110, the lessee was likely to ultimately succeed in obtaining relief against forfeiture (in any event).

Lessons

By consenting to relief and avoiding the tactical power-play of trying to ‘drive the lessee into the ground’, the lessor secured an order for indemnity costs in its favour; namely for the lessee to pay all of the lessor’s costs, save those costs unreasonably incurred, with a view to the lessor otherwise being completely indemnified.

The lessee is left in the invidious position of having to promptly remedy its breaches to secure its relief, pay its own legal costs, and indemnify the lessor for its legal costs – all the while ensuring it continues to meet its future obligations under the lease.

By contrast, the lessor now has a tenant who will either be compliant – terrified of the potential financial burden of any future non-compliance and termination of the lease – or if non-compliant, liable to termination by the lessor in the knowledge a second-time application for relief against forfeiture is less likely to be granted.

Williams + Hughes acted for the lessor in this case.

This article is general information only, at the date it is posted.  It is not, and should not be relied upon as, legal advice.  This article might not be updated over time and therefore may not reflect changes to the law.  Please feel free to contact us for legal advice that is specific to your situation.

Developers and landlords can release their breath – performance bonds and guarantees remain enforceable

In a decision that would otherwise have had serious ramifications, not only in the construction industry but across other industry sectors such as commercial leasing, developers successfully enforced performance and maintenance bonds where the paying financier tried to dodge payment on the basis of an underlying dispute between the developers and contractor.

In Swanhill Enterprises Pty Ltd v QBE Insurance (Australia) Ltd [2017] WASC 279*, various performance and maintenance bonds had been issued by a financier (QBE) in favour of developers Swanhill and Adelaide, to guarantee the obligations of the contractor, Diploma Construction.  Swanhill and Adelaide were related to Diploma Construction.

Swanhill and Adelaide called on the bonds in September and December 2016 respectively.  The Diploma Group collapsed in December 2016.  The financier refused to pay out the bonds.  The financier argued Diploma was not actually in breach contract and thus Swanhill and Adelaide were not entitled to call on the bonds; that Swanhill and Adelaide knew there was a dispute with Diploma and therefore calling on the bonds was unconscionable conduct.

A similar issue arises with a landlord’s call on a lease bank guarantee, when the tenant disputes a breach or asserts a set-off or counter-claim.  Is the bank entitled to ‘look behind’ the call on the guarantee and refuse to pay if there is a dispute between landlord and tenant?

In this case the Court held the bonds were contractual promises between the developers and the financier independent or autonomous of the underlying contracts between the developers and contractor and, if the developers called on the bonds in accordance with their terms, the financier was contractually obliged to honour them notwithstanding its knowledge of any dispute between the developers and contractor.

Further, the Court decided there could not be unconscionable conduct (between developers and financier) in calling on the bonds when the financier would have been aware, when offering to provide the bonds in the first place, of the risk Diploma may dispute the developers’ right to call on them.

Put another way, the financiers could not use the excuse of a dispute between the developers and Diploma to avoid paying on the calls.

A secondary issue arose as to actual compliance with the requirements of the bonds.  Although ‘strict compliance’ was required, the Court was willing to ignore matters it deemed inconsequential or minor.  Given the ‘main requirements’ of the bonds were met – for the developers to certify a breach and specify the amount of the loss – the Court was satisfied there was strict compliance with the requirements of the bonds.

Take away lessons for beneficiaries

• Ensure the contractual right to call on a guarantee or bond is expressed in unconditional terms, and is not reliant on an independent finding of ‘who is right’. At second best, the guarantee or bond should be enforceable if the beneficiary (the developer/landlord) believes, in their discretion, there is a breach entitling them to call on it.
• Check the bond or guarantee when received, to make sure it accords with the beneficiary’s rights in the contract/lease.
• Make an effort to ensure the call on the bond or guarantee is made in accordance with the conditions on that document. This is simply a process of jumping through the hoops.

* Williams + Hughes acted for the successful developers.

This article is general information only, at the date it is posted.  It is not, and should not be relied upon as, legal advice.  This article might not be updated over time and therefore may not reflect changes to the law.  Please feel free to contact us for legal advice that is specific to your situation.

Buying a power boat for the wife – not necessarily an unreasonable director related transaction, but only in the right circumstances

In 2013 a WA Supreme Court decision may have caught the attention of small company directors; it seemed using the company’s funds to buy that shiny new boat for the wife might not be a voidable transaction or breach of directors’ duties after all…

Unfortunately for some, that decision was quickly overturned by the Court of Appeal the subsequent year.  The appeal decision does not necessarily mean an extravagant private purchase by a company will always fall foul of the law in a subsequent liquidation,  but the occasions under which that may happen are confined to quite limited circumstances.

The background facts in the case of Weaver & Jones v Harburn [2013] WASC 441 were that:

• Peter Harburn was the sole director of Harburn Group Australia Pty Ltd;
• The sole shareholder of Harburn Group was a company associated with Mr Harburn, who held the shares as trustee for a family trust;
• Harburn Group provided financial services.   In effect Mr Harburn provided his personal financial planning services through the company;
• In  2007 Mr Harburn decided to reduce his workload,which he effected by selling his client base.  The sale agreement was entered on about 25 June 2007 and settled in July 2007 for $765,000.
• In about July 2007 Mr Harburn bought a $385,000 boat for his wife using Harburn Group’s funds.
• Harburn Group was subsequently wound up in April 2011.

The liquidators of Harburn Group sought recovery of the funds used to buy the boat.  The claim was put on two fronts; as a voidable unreasonable director related transaction under section 588FE(6A) Corporations Act 2001 (Cth), alternatively as a claim for damages for breach of the director duty provisions in sections 181 and 182 Corporations Act 2001 (Cth).

The Court at first instance

Unreasonable director related transaction

The Court first dealt with the voidable transaction claim.  Section 588FE of the Act provides that a transaction is voidable if (amongst other things) it is an unreasonable director related transaction of the company entered into in the 4 years prior to liquidation.  Section 588FDA of the Act provides that a transaction is an unreasonable director related transaction if (amongst other things):

• the transaction is a payment made by or disposition of the company’s property by the company,
• to the director or a close associate of the director,
• where it may be expected a reasonable person in the company’s circumstances would not have entered the transaction having regard to the benefits and detriments to the company of the transaction, the respective benefits to to other parties, and any other relevant matter.

The Court considered there was no doubt (i) the money transferred from Harburn Group to purchase the boat was a payment or disposition of the company’s property; and (ii) Mr Harburn’s wife was a close associate of the company’s director.  The remaining issue was whether ‘a reasonable person in the company’s circumstance would not have entered into the transaction’, considering the company’s circumstances at the time of the transaction (July 2007).

Notwithstanding there was no benefit to Harburn Group in purchasing the boat, and the purchase  caused detriment to Harburn Group (in that it had less money), what was considered highly relevant is that the company was not only solvent but comfortably solvent at the time of the transaction.  It had net assets of between $445,000 and $535,000 of which a significant portion was cash.  It was able to meet its rent through the balance of the 2007 calendar year, and was only wound up in 2011.   At the time of the transaction the future of Harburn Group was uncertain – it may have continued to trade indefinitely.  Mr Harburn was in complete control of the company; not needing to consult with anyone else about how the company’s funds were to be applied.

For these reasons the liquidators failed to establish that the transaction was unreasonable.

Directors duties

The Court then dealt with the claims of breach of sections 181 and 182 Corporations Act 2001(Cth).   Adopting views expressed by the High Court in Angas Law Services Pty Ltd (in liq) v Carabelas (2005) 226 CLR 507, the Court noted that the appropriation of a company’s assets by a director will not necessarily lead to a breach of the director’s duties.  The actions must be considered within their context and no inflexible rule should be imposed.

In then considering the commercial context the Court noted that Mr Harburn was the only director of the company and (importantly) ultimately the only person who could benefit from the company.  At the time of the transaction Harburn Group was solvent and there was no reason to believe it would become insolvent in future.  Just as the liquidators failed to establish that Harburn Group’s payment was an unreasonable transaction; so to they could not establish a breach of the directors duty provisions of the Act.

On appeal

The heart of the appeal in Weaver v Harburn (2014) 103 ACSR 416 was the relevance or weight to be given to the financial health of the company at the time of the boat transaction.

McClure P (Buss and Murphy JJA concurring) rejected the Master’s finding the director reasonably believed  the company was in a comfortable financial position at the time of the transaction.  For example:

• much of the company’s income in the relevant year was a once-off capital gain from the sale of the company’s business (financial planning client base);
• future income would be significantly reduced because of sale of the client base; and
• the company had a significant contingent CGT liability arising from the business sale which was yet to be quantified.

Accordingly, at best the company’s financial health was ‘uncertain’ at the time of the transaction and the director knew this.

Secondly, the Court considered whether the transaction could be reasonable even if the director believed the company was in good financial health.  Approving the decision in Slaven v Menegazzo [2009] ACTSC 94, the Court accepted the appellant’s argument the boat transaction was unreasonable regardless of the financial health of the company.  In essence, a transaction may be so objectively unreasonable that the financial position of the company at the time of entry into the transaction is not relevant.

Lessons

There are at least two lessons from this case at first instance and on appeal.

• On the one hand, the mere fact  the company’s assets were appropriated by the director for personal gain; and that the company suffered a detriment for the personal benefit of someone associated with the director, may not of itself be enough to sustain a claim against a director under section 588FE or sections 181 and 182 of the Act.

• On the other hand, to defend a claim the director may need not only to positively establish the good financial standing of the company into the short to medium future, but also provide a substantive and ‘reasonable’ reason for the ‘gift’ by the company.

An example of a transaction that might satisfy the test, is a ‘gift’ to fend off the risk of an equitable claim based on otherwise unrewarded contributions by a spouse or other third-party to the building up of the company’s income or assets.  Or a payment made by the company said to discharge some liability the recipient claims the company has.  It may be quite difficult to justify the transaction without the company having some form of liability (present or future, certain or contingent) that is discharged by the transaction. Presumably the size and nature of the gift/payment/transaction will play a part in objectively assessing its reasonableness from the company’s perspective.

Future cases will be left to decide what is and is not reasonable, on the particular facts of those cases.   These are already coming through, with liquidators successful in clawing back transactions in some cases, such as Smith v Starke, In The Matter of Action Paintball Games Pty Ltd (In Liq) (No 2) (2015) 109 ACSR 145 (paying loans for a third party), Golden Heritage Golf Pty Ltd (in liq) (recs and mgrs apptd) v Sun (2016) 113 ACSR 550 (offering loans with better security terms), and failing in other cases, such as Crowe-Maxwell v Frost (2016) 91 NSWLR 414 (personal expenses and other payments to directors).

Particularly when winding down a business and considering distributing the remaining assets personally, we recommend legal advice on the appropriate manner to do so (and whether it is appropriate to do so in the first place).

This article is general information only, at the date it is posted.  It is not, and should not be relied upon as, legal advice.  This article might not be updated over time and therefore may not reflect changes to the law.  Please feel free to contact us for legal advice that is specific to your situation.