Foez Dewan
Principal
Insolvency
Can a bankruptcy trustee acquire then sue on causes of action held by a third party?
18 September, 2018
The recent case of Vanguard 2017 Pty Limited, in the matter of Modena Properties Pty Limited v Modena Properties Pty Limited (No 2) [2018] FCA 1461 serves as a reminder to directors and other non-parties whose conduct materially influences the conduct of a company which is involved in court proceedings, that the Court may order non-parties to reach into their pockets and personally pay costs.
Background facts
On 13 January 2017, Modena Pty Ltd (Modena) and Vanguard 2017 Pty Ltd (Vanguard) entered into two separate agreements in relation to proposed property developments, which included payment of a “commitment fee” from Vanguard to Modena under each agreement, totalling $138,000. Each agreement stated: “We underwrite the agreement for the refund of the upfront fee if this facility does not go unconditional”.
After the agreements were terminated on 14 August 2017, the sole director of Modena, Mr Carr, provided assurances that Modena “will refund the fee as soon as possible but in any instance no later than 29 March 2018”.
Vanguard did not accept this situation. On 27 September 2017, it served on Modena a statutory demand for repayment of the commitment fees. Modena was unsuccessful in its application to set aside the statutory demand and was therefore deemed insolvent. On 17 January 2018, Vanguard commenced proceedings in the Federal Court of Australia to wind up Modena in insolvency.
Modena indicated its intention to oppose the winding up on the basis that it was, contrary to the statutory presumption, in fact solvent. It served on Vanguard an affidavit sworn by a Mr Schimana. He deposed, amongst other matters, that he was a Certified Practising Accountant; that his employer performed accounting services for Mr Carr and entities associated with him; and “Modena is now, and has, at all times since its incorporation been able to pay its debts as and when they fall due”. However, the affidavit failed to annex or exhibit any financial records to evidence Modena’s solvency.
In a second affidavit, Mr Schimana deposed that he had been engaged by Modena to prepare current annual financial statements, and that “[t]hese Financials indicate Modena’s solvency”. The affidavit did not annex or exhibit a single financial record, but indicated that copies of the Financials would be “available for submission at hearing should the honourable court require”.
On 1 June 2018, Vanguard issued a subpoena to Westpac to ascertain the balance of the Modena’s only bank account. Modena unsuccessfully sought to set aside the subpoena on the basis that it was too broad and irrelevant.
At the hearing on 4 July 2018, Modena neither consented to nor opposed the orders which had been sought in the originating process.
Relevant principles
The Federal Court’s power to award costs in all proceedings before it is contained in section 43 of the Federal Court of Australia Act 1976 (Cth). The presiding judge in this case, the Honourable Thawley J, noted although section 43, does not expressly state that the Court has power to make an order for costs against a non-party, it has been accepted that it does provide such power.
Thawley J also observed that the exercise of the discretion to make an order for a non-party to pay the successful party’s costs has been described as “rare and exceptional”. His Honour continued as follows (at [46]):
“[I]t is obviously not sufficient of itself that the director, being actively involved in the proceedings, caused the company to defend proceedings. … However, there may be situations where the director’s conduct is such that a non-party costs order is appropriate. The question might arise, for example, where the director’s management of the litigation was in breach of a duty to the company or was in some material way improper, or where the director caused the litigation to be conducted in a manner intended to increase irrecoverable costs of the opposing party.”
Non-party costs orders against Mr Carr
In considering whether to make a non-party costs order against Mr Carr personally, Thawley J examined Mr Schimana’s two affidavits and identified the numerous deficiencies and/or discrepancies in them. For example, in his first affidavit, Mr Schimana stated that he was aware that Modena had approximately $300,000 in “cleared funds” available in its Westpac account. However, in fact, as was demonstrated by the bank statements obtained from Westpac under subpoena, there was only $1,203.54 in the account on the date the affidavit was sworn. His Honour also noted that if the evidence of Mr Schimana had been read in the principal proceedings, it could not rationally have been accepted as establishing solvency, absent tender of appropriate financial records.
Thawley J noted that Mr Carr was the sole director of (and shareholder in) Modena, and thus inferred that Mr Schimana’s affidavits were filed on his instructions and that he was aware of the contents of them.
Mr Carr argued that insolvency is one matter which it is always incumbent upon a moving party to establish at a final hearing, with the result that “it cannot be said that there was anything unreasonable or improper in the respondent company agitating solvency or ultimately conceding that matter shortly before hearing”. Thawley J rejected this submission, observing (inter alia) that Vanguard did not need to establish insolvency; Modena was presumed insolvent.
Ultimately, the Court concluded that this was an exceptional case in which it was appropriate to make a non-party costs order. It ordered that Mr Carr pay Modena’s costs on the party and party basis until and including 14 February 2018 and on the indemnity basis from and including 15 February 2018 (the day Mr Schimana’s first affidavit was sworn and filed).
In relation to the exercise of its discretion to make a non-party costs order, the Court was satisfied that:
- Modena was in fact insolvent from at least the time the proceedings to have it wound up in insolvency were commenced on 17 January 2018;
- Mr Carr as the sole director of Modena played an active role in the conduct of the litigation;
- he procured Modena to conduct its defence of the proceedings maintaining solvency as an issue until shortly prior to the hearing, in reliance on evidence which he knew to be inadequate to prove solvency and/or knew to be misleading; and
- the conduct of the litigation in this way had the consequence of increasing Vanguard’s (probably irrecoverable) costs in engaging with the issue of solvency.
In relation to the exercise of its discretion to order costs on the indemnity basis, the Court found that this was justified because “the proceedings were continued in wilful disregard of known facts and the proceedings were unduly prolonged by making groundless contentions”.
Take home points
- Although directors may not actually be a party to court proceedings, the Court does have a broad power to make non-party costs orders against those who actively and unreasonably manage litigation on behalf of the company.
- Although it is understandable that a company may wish to vigorously defend winding-up proceedings, there are limits to this and a clear line that cannot be crossed. Directors need to be careful to never cause the company to mislead the opposing party and/or the Court as to the company’s solvency or make groundless contentions, including in affidavits deposed to by other persons.
- Non-party costs orders are not necessarily limited to insolvency cases in the Federal Court of Australia, as similar powers are vested in State Courts and may in theory be made in any case to which a company is a party.
