FEDERAL COURT OF AUSTRALIA

Mhanna v Sovereign Capital Limited [2004] FCA 1300

CORPORATIONS – leave sought to institute proceedings in the name of the company pursuant to s 237 of the Corporations Act 2001 (Cth) – whether serious issue to be tried – whether company in default of loan agreement

INTERLOCUTORY PROCEEDINGS – injunctions – balance of convenience – company seeks to prevent the sale, by its administrator, of property it has partially developed – no prospect of paying the amount owed – creditor likely to suffer loss if sale prevented

Corporations Act 2001 (Cth) ss 236, 237

Real Property Act 1900 (NSW)

JOHN MHANNA & ORS v SOVEREIGN CAPITAL LIMITED & ANOR

NSD 908 of 2004

SACKVILLE J

SYDNEY

8 OCTOBER 2004

THE COURT ORDERS THAT:

1. The plaintiffs’ application for leave pursuant to s 237 of the Corporations Act 2001 (Cth) be dismissed.
2. The application for interlocutory relief be dismissed.
3. The first and second plaintiffs pay the costs of the application for leave and the application for interlocutory relief.

Note:    Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

REASONS FOR JUDGMENT

THE PROCEEDINGS

1                     The first plaintiff (‘Mr Mhanna’) is a former director and the second plaintiff (‘Ms Shonoda’) is a director of the third plaintiff (‘Highwatch’), a company under administration.  By an amended application, the plaintiffs seek:

(1)               leave, pursuant to s 237 of the Corporations Act 2001 (Cth) (‘Corporations Act’), for the first and second plaintiffs to bring these proceedings on behalf of the third plaintiff (‘Highwatch’); and

(2)               an order restraining the defendants from selling a property known as 5A Blackwall Point Road, Chiswick (‘the Property’) pending the determination of the plaintiffs’ claim for final relief. 

2                     This is the plaintiffs’ second attempt to obtain interlocutory relief.  On 23 September 2004, Stone J rejected an application by the plaintiffs to restrain the second defendants, the administrators of Highwatch under a deed of company arrangement, from proceeding with a meeting of creditors scheduled for the following day: [2004] FCA 1252.  Her Honour held that the plaintiffs had not established that there was a serious issue to be tried as to whether the appointment of the administrators was a nullity, as the plaintiffs had claimed. 

3                     At the conclusion of the hearing before me on 5 October 2004, I announced that I did not propose to grant the relief sought by the plaintiffs.  I indicated that I was not satisfied that the plaintiffs had established that there was a serious issue to be tried on the question of whether Highwatch had a cause of action against the first defendant (‘Sovereign’) for breach of the Master Loan Deed (the ‘Construction Facility’) entered into between Highwatch and Sovereign on 13 August 2003.  I also indicated that, in any event, I was not satisfied that the balance of convenience favoured the grant of interlocutory relief to the plaintiffs.  I stated that I would provide brief written submissions explaining my conclusions.  These are my reasons.

THE CONTENTIONS

4                     The plaintiffs’ case is essentially that Highwatch’s financial difficulties were caused by Sovereign’s failure to comply with its obligations under the Construction Facility.  In particular, the plaintiffs allege that Sovereign was obliged to lend Highwatch an initial sum of $6,270,000 and further sums of $550,000 on the first day of each month until Sovereign advanced a total amount of $12,535,000.  The purpose of the loan was to enable Highwatch to acquire the Property and to construct 54 residential home units on the land.

5                     The plaintiffs say that Sovereign, in breach of its obligations under the Construction Facility, failed to make any of the monthly advances to Highwatch.  This failure, so it is said, caused Highwatch to default on its obligations under the Construction Facility and prevented it from completing the development project.  The plaintiffs contend that Sovereign’s breach has rendered invalid the purported appointment by it of receivers to Highwatch and has also rendered invalid its purported appointment of the second defendants as administrators of the company.

6                     The defendants say that any obligation on Sovereign to advance funds to Highwatch after making the initial advance of $6,270,000 was subject to a variety of conditions, none of which Highwatch satisfied.  Accordingly, so the defendants argue, the plaintiffs have not established that there is a serious issue to be tried as to whether Sovereign breached the Construction Facility.  The defendants also say that the balance of convenience clearly favours refusing the grant of interlocutory relief.  They also rely on a number of other arguments, but in view of the conclusions I have reached it is unnecessary to address them.

LEGISLATION

7                     Section 236(1)(a) of the Corporations Act provides that an officer or former officer of a company may bring proceedings on behalf of the company if that person obtains the leave of the Court pursuant to s 237.  Section 237(2) requires the Court to grant the application for leave if it is satisfied that:

‘(a)    it is probable that the company will not itself bring the proceedings, or properly take responsibility for them, or for the steps in them; and

(b)     the applicant is acting in good faith; and

(c)     it is in the best interests of the company that the applicant be granted leave; and

(d)     if the applicant is applying for leave to bring proceedings – there is a serious question to be tried; and

(e)     either:

(i)            at least 14 days before making the application, the applicant gave written notice to the company of the intention to apply for leave and of the reasons for applying; or

(ii)          it is appropriate to grant leave even though subparagraph (i) is not satisfied.’

FACTS

8                     On 7 February 2003, Sovereign advanced $5,000,000 to Highwatch to finance the acquisition by the latter of the Property.  The purchase price was $6,000,000 and the loan was secured by a first mortgage over the Property. 

9                     On 12 June 2003, Sovereign advanced a further $800,000 to Highwatch. 

10                  On 30 June 2003, Sovereign wrote to Highwatch stating that it had approved Highwatch’s application for finance on the terms and conditions stated in the letter (‘the Letter of Offer’).  The total sum to be advanced was $12,535,000 and the term of the loan was to be twelve months.  The initial advance was to be a sum equivalent to 66 per cent of the ‘As Is’ value of the Property or $6,270,000, whichever was the lesser sum.

11                  The special conditions in the Letter of Offer included the following:

‘(a)      Quantity Surveyors and Project Managers will be instructed in accordance with our compliance plan and are to confirm the “cost to complete” and inspect and confirm the works completed.  These reports are to be addressed to us and meet our approval.  You will only receive 95% of each claim, which is certified by the Quantity Surveyor.  You will be responsible for the cost of these reports.

(b)       We will provide you with principal instalments on the first day of each month in the sum of $550,000 per month.  You will only receive progress payments to the maximum amount of $550,000 per month with interest payable on these instalments on the first day of each month irrespective of whether you have or have not “drawn down” the funds.  You will not receive the benefits of any interest whilst these funds are deposited with us …

(c)       We will provide you with progress payments subject to our approval and the contents of the Quantity Surveyor … Further all progress payments are to be paid directly to the builder and in the event there is a surplus of funds available the balance is to be paid to you.  The builder must provide written confirmation that they approve of the $550,000 principal instalment amounts.’

12                  On 5 and 6 August 2003, Sovereign and Highwatch entered into a series of ‘Undertakings and Acknowledgements’.  One of these documents is in the following terms:

‘In consideration of Sovereign … proceeding to settlement in this matter and providing the initial advance, [Highwatch]:

1.         Undertakes:

(a)       not to permit the Builder … or any other person … to carry out any demolition, building or other construction work of any kind on the subject land prior to [Highwatch] supplying to [Sovereign]:

(i)        a Contract Works Policy issued by a respectable insurer for the amount stipulated by [Sovereign] …;

(ii)       Workers Compensation Insurance Policy in relation to any person carrying out construction or other works on the subject land, with a respectable insurer and such Policy found to be satisfactory to [Sovereign];

2.      undertakes to supply the policies … to [Sovereign] within 21 days of the initial advance having been made to [Highwatch] in connection with the Construction Facility;

3.      acknowledges that the failure by [Highwatch] to comply to the undertakings contained in either paragraph 1 or 2 of this Undertaking and Acknowledgement will constitute breach of the Master Loan Deed … and each of the Collateral Securities referred to in the Master Loan Deed;

4       acknowledges and agrees that pending compliance by [Highwatch] with the undertakings contained in this Undertaking and Acknowledgement [Sovereign] will not be obliged to nor will it advance any further moneys to [Highwatch] in connection with the Construction Facility (including any progress payment claims due to the Builder in connection with the development to be constructed on the subject land);

5.      acknowledges that this Undertaking and Acknowledgement is given for valuable consideration received by [Highwatch].’

13                  The other Undertakings and Acknowledgements required Highwatch to provide specified survey documentation, a site audit and the consent of a bank to the registration of a charge over the assets of Uptight Pty Ltd, presumably a company related to Highwatch.

14                  On 13 August 2003, Sovereign and Highwatch entered into the Construction Facility.  The key provisions are as follows:

‘BACKGROUND

A.      The Borrower has requested the Lender to make advances and/or provide facilities and/or accommodation from time to time to or at the direction of the Borrower.

B.      The Lender has agreed to do so upon the terms and conditions agreed from time to time.

…

3.      ADVANCES

3.1        The Lender will from time to time make advances to the Borrower and/or provide facilities and accommodation in the manner at the times and on the terms, conditions and securities the Lender nominates in its absolute and unfettered discretion.  The initial advance contemplated by the Lender is the amount specified in Item 1 (Construction Facility) buy [sic] may be less as specified in the Letter of Offer.

3.2        The parties acknowledge that the Construction Facility will be advanced to the Borrower as follows:-

(a)   As to the sum of $6,270,000.00 (First Tranche Advance) on execution of the Collateral Security referred to in the Letter of Offer of Loan dated 12 June 2003 from the Lender to the Borrower (Letter of Offer) a copy of which is annexed to this Deed and marked “A”;

(b)   As to the balance of the Construction Facility on and subject to the terms and conditions contained in the Letter of Offer.

3.3  The Borrower hereby acknowledges receipt of the First Tranche Advance.’

On or about the same date, Highwatch executed the security documentation.

15                  On 11 September 2003, Sovereign’s solicitors wrote to the solicitors for Highwatch.  The letter noted that Highwatch had provided three separate Undertakings and Acknowledgements prior to settlement.  The letter also noted that Highwatch was obliged to supply certain insurance policies within 21 days of the initial advance having been drawn down.  The letter pointed out that more than 21 days had elapsed since the initial draw down and the requisite policies had not been supplied.  Accordingly, so the letter continued, Highwatch was in default under the Construction Facility.  The letter concluded as follows:

‘We would also point out that in relation to the other 2 Undertakings and Acknowledgements your client has a time constraint of 42 days from the date of the initial advance having been drawn down, to do those things specified in such documentation … Accordingly, please ensure [Highwatch] complies with the undertakings contained in those Undertakings and Acknowledgements, failing which [Highwatch] will fall into further default’.

16                  Mr Benson (a director of Sovereign) gave evidence, which was not seriously disputed, that Highwatch did not supply Sovereign with any of the documentation required by the Undertakings and Acknowledgements.

17                  In January 2004, Mr Mhanna told Mr Benson that some of the documentation previously provided to Sovereign was not genuine.  This documentation included purported pre-sale contracts, insurance policies and deposit bonds.  In his evidence, Mr Mhanna acknowledged the substance of these conversations, but denied that he knew of the bogus documentation prior to January 2004.  He claimed that the preparation and presentation of those documents were the handiwork of a broker. 

18                  On 3 February 2004, Sovereign served notices on Highwatch under s 57(2)(b) of the Real Property Act 1900 (NSW), alleging that Highwatch had defaulted under the terms of the Construction Facility.

19                  On 2 March 2004, Sovereign appointed Mr D J F Lombe and Mr P G Yates receivers and managers of Highwatch.  On 5 March 2004, Sovereign appointed the second defendants to be the administrators of Highwatch. 

20                  The present proceedings were commenced on 4 June 2004.  However, the claims now made by the plaintiffs were not introduced into the proceedings until the filing of an amended application and an amended statement of claim on 20 September 2004. 

21                  Between the date of appointment of the administrators and the filing of the amended pleadings, a number of events occurred which it is unnecessary to recount in detail.  The events included, however, the execution of a deed of company arrangement by Highwatch, the performance of which was guaranteed by Mr Mhanna and Ms Shonoda.  Neither Highwatch nor the guarantor made the payments contemplated by the deed of company arrangement. 

SERIOUS ISSUE TO BE TRIED

22                  The question of whether the plaintiffs’ allegations against Sovereign give rise to a serious issue to be tried is relevant for two reasons.  First, the Court is only required to grant leave to a person to bring proceedings on behalf of a company if, among other requirements, there is a serious question to be tried in the proceedings: Corporations Act, s 237(2)(d).  Secondly, if leave is granted to the first and second plaintiffs to bring proceedings on behalf of Highwatch, the company can obtain interlocutory relief against Sovereign only if it can establish that its claims give rise to a serious issue to be tried.

23                  The plaintiffs’ written submissions argue that the Construction Facility, read in conjunction with the Letter of Offer, imposed an obligation on Sovereign to advance monthly sums of $550,000 to Highwatch until the limit of the loan was reached.  According to Mr Grey, who appeared for the plaintiffs, the only condition precedent to Sovereign’s obligation to advance the funds to Highwatch was that stated in special condition (c) of the Letter of Offer, namely the provision of a quantity surveyor’s report.  Mr Grey acknowledged that there was no evidence that any such report had been prepared or provided, but he contended that the responsibility for obtaining the report was Sovereign’s. 

24                  The difficulty with this argument is that it overlooks the terms of the Undertakings and Acknowledgements executed by Highwatch.  By these documents, Highwatch agreed to supply certain critical documentation to Sovereign within a short time of the initial draw down.  Failing compliance, Highwatch acknowledged expressly that it would be in breach of the Construction Facility and of each of the collateral securities.  Moreover, the Letter of Offer expressly stated that Sovereign would not be obliged to make the advances referred to in the Construction Facility until Highwatch provided the necessary documentation.  As I have found, Highwatch failed to provide the documentation required by the Undertakings and Acknowledgements. 

25                  Mr Grey sought to avoid the obvious conclusion that Highwatch was in default of the Construction Facility and that Sovereign was thereby relieved from the obligation to advance funds over and above the initial advance.  He put two arguments, as follows:

• first, the Undertakings and Acknowledgements were unenforceable because Sovereign had provided no consideration to Highwatch for the latter’s undertakings;
• secondly, the Undertakings and Acknowledgements had been superseded by the Construction Facility, which was intended (together with the security documentation) to constitute the entire agreement between Sovereign and Highwatch so far as the construction loan was concerned. 

26                  The first argument is, in my opinion, without merit.  The Undertakings and Acknowledgements expressly identify the consideration provided by Sovereign for Highwatch’s undertakings.  The consideration is said to be Sovereign’s agreement to proceed to settlement and to provide the initial advance.  At the time the Undertakings and Acknowledgements were executed, Sovereign was not obliged to enter into the Construction Facility.  Clearly enough, Highwatch was in need of funds to enable construction of the development to progress.  The evident intent was that Sovereign, in return for Highwatch’s agreement to provide the documentation, agreed to enter into the Construction Facility within a reasonable time.  In fact, Sovereign did so a week later.  In my view, Sovereign provided consideration for Highwatch’s agreement to provide the documentation specified in the Undertakings and Acknowledgements.

27                  Highwatch’s second argument is, in my view, equally without merit.  The Undertakings and Acknowledgements were not intended to take effect independently of the Construction Facility.  On the contrary, they were expressed to be entered into in contemplation of Sovereign and Highwatch executing the Construction Facility and associated security documentation, which they did within a week.

28                  The language of the Construction Facility, although not explicitly referring to the Undertakings and Acknowledgements, is quite appropriate to incorporate the relevant terms and conditions previously agreed to by the parties.  The recitals to the Construction Facility, for example, record that Sovereign has agreed to make advances and provide accommodation to Highwatch ‘upon the terms and conditions agreed from time to time’.  Similarly, cl 3.1 of the Construction Facility requires Sovereign to make advances from time to time:

‘in the manner at the times and on the terms, conditions and securities [Sovereign] nominates in its absolute and unfettered discretion’.

29                  The Letter of Offer, which is expressly incorporated into the Construction Facility
(cl 3.2(d)) provides that Sovereign will make progress payments to Highwatch ‘subject to our approval and the contents of the Quantity Surveyor report’.  The reference to approval anticipates that Sovereign may require Highwatch to comply with additional terms and conditions, as indeed it did in the Undertakings and Acknowledgements.

30                  In my opinion, the three sets of documents – the Letter of Offer, the Undertakings and Acknowledgements and the Construction Facility (together with the security documentation) – sit perfectly well together.  Judging the matter objectively, it is inconceivable that the parties could have intended the Construction Facility to operate independently of the agreements made only a week beforehand specifically in anticipation of the Construction Facility being executed.  It is true that the Construction Facility does not explicitly refer to the Undertakings and Acknowledgements.  However, as I have observed, the language of the Construction Facility is consistent with the parties intending to give effect to the terms and conditions agreed in those documents.

31                  For these reasons, there is no serious issue to be tried on the question of whether Sovereign’s failure to make advances other than the initial advance of $6,270,000 was in breach of the Construction Facility.  It follows that the plaintiffs have not established an arguable case that Sovereign’s breach of the Construction Facility invalidated the appointment of both the receivers and managers and the administrators to Highwatch.  Accordingly, it is not appropriate to grant leave to the first and second plaintiffs pursuant to s 237 of the Corporations Act to bring proceedings on behalf of Highwatch against Sovereign.  Even if such leave were granted, I would not grant the interlocutory relief sought against the defendants.

Balance of convenience

32                  Mr Grey submitted that the balance of convenience is in the plaintiffs’ favour because if no injunction is granted the Property will be sold and Highwatch will lose its last chance to complete the project and retrieve its financial position.  Although not necessary to do so, I shall express my view on this question.

33                  The plaintiffs adduced no evidence that it was feasible for Highwatch either to refinance the loan or to complete the development project on the Property.  Such evidence as there is suggests that Highwatch has virtually no chance of raising the substantial funds it apparently needs to complete the project.  There is no evidence as to the amount of work still to be done on the site.  Nor is there evidence of the current value of the Property, or of its likely value if and when the project is complete. 

34                  By contrast, Highwatch owes Sovereign a very large amount of money, on which interest is rapidly accumulating.  Highwatch appears to have no prospect of paying the amounts due by it to Sovereign.  If the sale of the Property is delayed, Sovereign is likely to suffer further irremediable losses.

35                  I should add that if no injunction is granted, Highwatch (subject to the first and second plaintiffs obtaining leave pursuant to s 237 of the Corporations Act) conceivably may still be able to pursue a damages claim against Sovereign.  There is nothing to suggest that Sovereign will be unable to meet any awarded damages against it. 

36                  Thus, even if the plaintiffs had shown that there is a serious issue to be tried, I would have concluded that the balance of convenience is against the grant of interlocutory relief.

CONCLUSION

37                  The plaintiffs’ application for leave pursuant to s 237 of Corporations Act must be dismissed.  I also dismiss the plaintiffs’ claim for interlocutory relief against the defendants. 

38                  The first and second plaintiffs must pay the defendants’ costs of the applications for leave under s 237 of the Corporation Act and for interlocutory relief.  The defendants were separately represented but it was appropriate that they should be. 

Associate:

Dated:              8 October 2004