FEDERAL COURT OF AUSTRALIA

Nysan Asia Pacific Pty Ltd trading as Horiso v R & D Automation Technology Corp [2012] FCA 193

THE COURT ORDERS THAT:

1.    The applicant provide, within 28 days of the making of this order, security for the second and third respondents’ costs of and incidental to this proceeding, up to the time of service of their affidavits in answer, in the amount of $126,000 by way of bank guarantee in the terms set out in the schedule to the interlocutory application filed on 20 February 2012.

2.    Subject to further order, the proceeding be stayed until the security is given.

3.    Liberty is reserved for the second and third respondents to apply for further security.

4.    The applicant pay the second and third respondents’ costs of and incidental to the interlocutory application.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

REASONS FOR JUDGMENT

1    By interlocutory application filed on 20 February 2012 the second and third respondents seek an order that the applicant provide security for their costs, up to the time of service of their affidavits in answer, in the amount of $126,000, by way of bank guarantee in the terms set out in the schedule to the application.

2    The respondents rely on s 56 of the Federal Court of Australia Act 1976 (Cth) (the Federal Court Act) or, alternatively, s 1335(1) of the Corporations Act 2001 (Cth) (the Corporations Act).

3    Section 56 of the Federal Court Act provides that:

(1)    The Court or a Judge may order an applicant in a proceeding in the Court, or an appellant in an appeal under Division 2 of Part III, to give security for the payment of costs that may be awarded against him or her.

(2)    The security shall be of such amount, and given at such time and in such manner and form, as the Court or Judge directs.

(3)    The Court or a Judge may reduce or increase the amount of security ordered to be given and may vary the time at which, or manner or form in which, the security is to be given.

(4)    If security, or further security, is not given in accordance with an order under this section, the Court or a Judge may order that the proceeding or appeal be dismissed.

(5)    This section does not affect the operation of any provision made by or under any other Act or by the Rules of Court for or in relation to the furnishing of security.

4    Section 1335(1) of the Corporations Act provides that:

Where a corporation is plaintiff in any action or other legal proceeding, the court having jurisdiction in the matter may, if it appears by credible testimony that there is reason to believe that the corporation will be unable to pay the costs of the defendant if successful in his, her or its defence, require sufficient security to be given for those costs and stay all proceedings until the security is given.

5    Although s 56 of the Federal Court Act provides a broader basis on which to seek security for costs, the second and third respondents advanced their case for security on the basis that there is reason to believe that the applicant will be unable to pay their costs if they are successful in their defence. I have therefore treated the application as one arising essentially under s 1335(1) of the Corporations Act: see Soul Pattinson Telecommunications Pty Ltd v Subex Americas Inc [2009] FCA 651 at [6].

6    In Livingspring Pty Ltd v Kliger Partners (2008) 20 VR 377 the Court of Appeal in Victoria (at [15]) said the following in relation to s 1335(1):

The phrase “reason to believe” is the touchstone of jurisdiction. It requires a rational basis for the belief — and no more. The wording adopted may be contrasted with other familiar formulations such as “if the court is satisfied that” or “if in the view of the court it is likely that”. The section requires the making of a judgment, a risk assessment: is there a risk that the corporation will be unable to pay? (It adds nothing, in our view, to say that it must be a “real risk”.) A risk assessment is, of necessity, imprecise. The section calls for a practical, commonsense approach to the examination of the corporation’s financial affairs.

7    This approach was favoured in Smart Co Pty Ltd v Clipsal Australia Pty Ltd [2009] FCA 1253 at [43] and Power Infrastructure Pty Ltd v Downer EDI Engineering Power Pty Ltd [2010] FCA 1222 at [7]-[8]; see also the discussion in Health Information Pharmacy Franchising Pty Ltd v Khoo [2010] FCA 438 at [5]-[11], in relation to the possibly conflicting observations in Beach Petroleum NL v Johnson (1992) 7 ACSR 203 at 205. This is the approach that I will follow in determining the present application.

The applicant’s pleaded case

8    The applicant’s claim is for damages under s 82 of the Competition & Consumer Act 2010 (Cth) (alternatively, under s 68 of the Fair Trading Act 1987 (NSW)), for breach of contract and for negligence.

9    The claim arises out of the supply of a machine that was specifically built to roll, form and fabricate heavy duty aluminium blades for commercial, industrial and heavy duty residential blinds.

10    In summary, the applicant’s pleaded case is that the first respondent was the person who actually built and supplied the machine. It says that the second and third respondents were directors of the first respondent and made various representations during the course of either their or the first respondent’s engagement to make and supply the machine, which were misleading or deceptive and which were later affirmed by the first respondent. The applicant says that it relied on those representations, to its financial detriment.

11    It also says that the respondents were under a duty to use reasonable care, skill and diligence in making the representations. It says that the respondents breached that duty.

12    The applicant also says that the machine, as ultimately supplied, was seriously defective and not fit for the purposes to which I have referred. The applicant says that it was unable to use the machine at all. It says that it was necessary for it to acquire a substitute machine from another manufacturer to satisfy commitments it had entered into on the faith of one or more of the various representations that were made. It says that the supply of the defective machine was a breach of contract by the first respondent, or alternatively, the second and third respondents.

13    The loss or damage the applicant says it has suffered includes borrowings it has made and interest it has incurred on those borrowings, to fund the acquisition of the machine.

14    There is evidence before me that supports these allegations, including evidence that the machine, as supplied, was seriously defective.

15    The second and third respondents’ application for security for costs has been made, quite properly, at an early stage of the proceeding. They have not filed a defence to the applicant’s pleaded allegations. There is, however, some material before me from which it can be said that the second and third respondents dispute a number of the allegations made by the applicant in the statement of claim. Nevertheless, I am satisfied that the applicant’s claim is made bona fide and raises triable issues.

The applicant’s financial position

16    The focus of the present application was the applicant’s financial position as revealed through its financial report for the year ended 30 June 2011 and its bank statements covering the period 25 June 2011 to 27 January 2012.

17    The second and third respondents submitted that this evidence shows that, for the year ended 30 June 2011, the applicant had made a net operating loss of $2,014 and had incurred a current liability of $895,055 to a related entity, Turner Bros Furnishings Pty Limited (TBF). They also pointed to the fact that, as at 21 January 2012, the applicant held only $6,021.73 in its bank account. I observe that a lesser amount was held as at 25 January 2012.

18    My own perusal of the applicant’s bank statements shows that in the period 1 July 2011 to 25 January 2012 the applicant was regularly and substantially funded by deposits made by TBF. These deposits were in addition to the sum of $895,055 to which I have referred. The applicant also seems to have been funded, to a lesser extent, by another entity which appears to be called Turner Bros Commercial.

19    The applicant’s shareholders are S B Turner Pty Limited and M B Turner Pty Limited. The evidence shows that these companies do not hold their shares in the applicant beneficially. The beneficial ownership of the shares is not disclosed.

20    Scott Branson Turner is the sole director and secretary of the applicant. Mr Turner is also a director and secretary of TBF.

21    The applicant relies on an affidavit made by Mark Tinworth. Mr Tinworth is the applicant’s external accountant. Mr Tinworth made a number of observations in his affidavit about the applicant’s financial position as disclosed by the financial report to which I have referred. Mr Tinworth prepared this report using books and records of the applicant, including the cash book, ledgers and reports prepared by the applicant’s employees.

22    Mr Tinworth said that a component of interest ($14,210.42) incurred by the applicant for the year ended 30 June 2011 was interest payable under a loan agreement into which the applicant had entered with Ford Capital Ltd (Ford Capital) to purchase the machine. He also said that a component of the borrowings ($125,655.31) made by the applicant in that year, which were shown as current liabilities, was an amount drawn down by the applicant under that agreement. Further, a component of the borrowings ($30,406.68) made by the applicant in that year, which were shown as non-current liabilities, was an amount also drawn down by the applicant under the agreement.

23    Mr Tinworth also pointed to an item in the financial report shown as a loss on non-current assets ($299,750). Mr Tinworth said that this represented the write-off costs incurred by the applicant in relation to the machine. He said that, but for the write-off, the applicant would have recorded a further profit of $299,750. A loss of $299,750 had to be recorded because of the inability of the applicant to use the machine.

24    In submissions, the second and third respondents criticised some aspects of the financial report, as well as some aspects of Mr Tinworth’s affidavit evidence.

25    In this connection the second and third respondents submitted that the financial report did not appear to record the reduction in non-current assets reflected by the write-off in relation to the machine. The second and third respondents submitted that the financial report should have recorded that, for the year ended 30 June 2011, the applicant’s total liabilities exceeded its total assets by $156,861.

26    They also pointed to the fact that the applicant’s agreement with Ford Capital to provide funding for the acquisition of the machine was apparently entered into in about August 2010, but that other evidence showed that the machine was paid for prior to that date. They also pointed to discrepancies between the loan amortisation schedule in the agreement, as annexed to Mr Tinworth’s affidavit, and another copy of what appears to be the same agreement, as annexed to an affidavit made by Mr Turner, which was also read on the hearing of the application.

27    The difficulty that confronts the second and third respondents in relation to these submissions (which deal substantially with issues of accounting) is that they were only advanced after the completion of the evidence tendered on the application, in circumstances where the second and third respondents did not adduce any accounting evidence themselves. Moreover, the second and third respondents did not seek to cross-examine either Mr Tinworth or Mr Turner, who may have been able to provide a ready answer to these questions. Accordingly, I would not lightly infer that Mr Tinworth’s treatment of the applicant’s financial position is erroneous or otherwise not soundly based.

28    Nevertheless, taking the financial report at face value, it is clear that, leaving aside amounts said to have been borrowed from Ford Capital in respect of the acquisition of the machine, the applicant still had current borrowings as at 30 June 2011 of approximately $144,000 and non-current borrowings of approximately $138,000, in addition to the amount of $895,055 owing to TBF. No details of these other borrowings have been provided other than that they are, substantially, hire purchase liabilities. No details have been provided about the arrangements under which the applicant is indebted to TBF. However, the financial report does show that the entire sum of $895,055 was provided in the 2011 financial year.

29    The applicant pointed to the fact that the financial report showed that it was conducting a substantial business with sales for the year ended 30 June 2011 in excess of $5 million and a net income in excess of $187,000. However, the fact remains that the applicant’s business appears to be dependent at the present time on funding provided by TBF, which is continuing. In the absence of evidence to the contrary, I would infer that these sums are repayable on demand. I am satisfied that, if that support were to be withdrawn at any time, by TBF seeking to act in its own interests, there is reason to believe that the applicant would not be able to pay the costs of the second and third respondents should they be successful in their defence of the applicant’s claim. That is not a risk to which the second and third respondents should be exposed. I am satisfied, therefore, that the applicant should provide security for the second and third respondents’ costs.

30    I should also record that no evidence has been adduced by the applicant that the making of an order for security for costs would stultify the ability of the applicant to pursue its claims against the second and third respondents in this proceeding, although in submissions the applicant suggested that I should take account of how the requirement to give security for the amount sought might impact on the applicant’s ability to carry on business. That submission seems to me to invert the question posed by s 1335(1) of the Corporations Act. I should add that there is no evidence that the applicant’s shareholders would make funds available to satisfy any order for costs, nor has any undertaking been forthcoming from those who stand behind the applicant to meet any order for costs that may be made against it.

31    I have already noted that the second and third respondents seek security by way of bank guarantee in the terms set out in the schedule to the application. Apart from disputing the second and third respondents’ entitlement to security, and the quantum of security that should be ordered (a matter to which I shall return), no submission was directed by the applicant to contest the suitability of that form of security or the terms as set out in the schedule.

Quantum of the security sought

32     The second and third respondents adduced evidence from Mr Houghton, by way of affidavit, estimating the costs that are likely to be incurred by the second and third respondents up to the conclusion of the preparation of evidence on their behalf. Mr Houghton is the lawyer on the record for the second and third respondents. I am satisfied on the evidence before me that he is qualified to express the opinions he has made in his affidavit in this regard.

33    I allowed some limited cross-examination of Mr Houghton in relation to a schedule he had prepared detailing the general nature of the work he saw as necessary to be undertaken on behalf of the second and third respondents and in relation to his estimate of the costs to be incurred in that regard. No corresponding evidence was adduced by the applicant.

34    Mr Houghton’s schedule gave a break-down of the work by reference to three hourly rates, being $550 per hour for work to be performed by him and Mrs McDermott, a Senior Associate in Mr Houghton’s firm, and $200 per hour for a graduate lawyer. The cross-examination showed that the actual rates of the fees to be charged to the second and third respondents for the work described in the schedule are well in excess of the rates used in Mr Houghton’s calculation. The applicant submitted that it did not follow from this fact that the rates used in Mr Houghton’s schedule were reasonable rates for the work to be performed. As a matter of reasoning, that proposition can be accepted. I am satisfied, however, that, having regard to the nature of the case, and the likely complexity involved, the rates used by Mr Houghton for the purposes of his calculation are reasonable.

35    Although Mr Houghton accepted that, at this early stage of the proceeding, it was necessary for him to make a number of assumptions in arriving at his estimate, I am satisfied that the description of the work contained in the schedule is a reasonable reflection of the work likely to be required in preparing the second and third respondents’ defence to the stage of filing their affidavit evidence. Accordingly, I am satisfied that the sum of $168,463 arrived at by Mr Houghton is a reasonable and likely estimate of costs to be incurred in that regard. Mr Houghton gave evidence that, in his experience, costs on a party/party basis which are considered to be fair and reasonable are usually in the order of 60% to 75% of the costs actually incurred. Applying that discount, he arrived at a likely range of costs on a party/party basis of approximately $101,000 to $126,000.

36    In my view the sum of $126,000 is a proper reflection of the amount of the security that should be ordered.

Disposition

37    The second and third respondents have succeeded in establishing an entitlement to security for costs in the amount that they have sought. I will make orders substantially as sought in paragraphs 1, 2 and 3 of the interlocutory application. The applicant should pay the second and third respondents’ costs of and incidental to the application.

Associate:

Dated:    9 March 2012