Shield Lifestone Holdings Pty Limited v LSKF Holdings Pty Limited

The dispute between the plaintiff and the first defendant relates to the meaning and operation of certain provisions in a shareholders agreement. The agreement regulates their rights as equal shareholders in a company that carries on the business of developing, designing, manufacturing and marketing kitchen bench tops. In broad terms, the first defendant provided the intellectual property and expertise for the business and the plaintiff provided its funding. The shareholders have now fallen out over the company’s trading and financial position and the plaintiff is unwilling to provide further funding.

Among their respective arguments is the first defendant’s contention that the shareholders’ agreement is void and ineffective because the provisions relating to the plaintiff’s funding obligation either impose an illusory obligation or they are uncertain. These questions raise issues of general application in the law of contract.

The principal provision of the agreement relating to funding is Clause 5.2:

The Board of the company consists of two directors, one of whom must be appointed by the plaintiff and the other of whom must be appointed by the first defendant. A quorum for a meeting of directors is two directors. The Board is responsible for the management of the company. Certain matters require the unanimous resolution of its directors. They include ‘(loans) request for further loans from either the shareholders or any financial institution’.

In making decisions in relation to the management of the company, the directors are subject to an express contractual obligation to act in good faith. Clause 7.6 provides:

It is obvious that, for sound commercial reasons, there may be circumstances where the directors fail to agree – while nonetheless acting in good faith, in the best interests of the company and having regard to the interests of their appointing shareholder. Such an outcome is the inevitable result of the contractual regime embodied in a shareholders’ agreement in these terms. It is no different to the situation that might pertain in any two person partnership.

In this case, there has been a disagreement between the directors. But for the purpose of the argument, there is no suggestion of any breach of good faith, in particular by Mr Ye who is the director appointed by the plaintiff. Nor is there any suggestion that he has failed to act reasonably or other than in accordance with the object, purpose or terms of the shareholders’ agreement. The argument is simply that, by their terms, the contractual provisions relating to funding render the shareholders’ agreement void and ineffective. The plaintiff’s obligation is said to be illusory because it amounts to an unfettered discretion which would enable one director to thwart the contemplated funding process.

The legal principle relating to discretionary promises is well-known. In general terms, a contract that reserves to a party a true discretion or option whether to carry out what appears to be a promise is void: Thorby v Goldberg (1964) 112 CLR 597 at 605. The following formulation of the principle by Vaughan Williams LJ in Loftus v Roberts (1902) 18 TLR 532 at 534 was authoritatively adopted by Kitto J in Placer Development Ltd v Commonwealth (1969) 121 CLR 353 at 356:

However, little is needed to show that it is inappropriate to characterise a discretion as unfettered – in the sense that it leaves the promisor with an unqualified option whether to perform the promise or not. It has been said that all that is required is ‘some vestige of an objectively ascertainable obligation’: Giasoumi v Ribbera [2017] VSC 631 at [82] and Cheshire & Fifoot Law of Contract, 11th Australian Edition p195; or that the discretion be contained within confined parameters: Anglican Development Fund Diocese of Bathurst [2015] NSWSC 1856 at [349]. In the latter case, Hammerschlag J said:

In Meehan v Jones (1982) 149 CLR 571, one of the issues was whether a contract for the sale of land was void because the purchaser’s performance was allegedly voluntary and depended on an unfettered discretion. The contract was subject to the purchaser ‘receiving approval for finance on satisfactory terms and conditions’. It was held that the purchaser did not have an unfettered discretion and that his decision as to whether the finance was satisfactory was circumscribed by defined parameters. Mason J said at 590-1.

Ultimately, in this case, the argument that the plaintiff’s obligation in relation to funding amounted to an unfettered discretion and was therefore illusory, rested on a narrow foundation. It depended on the effect of the words ‘may request’ in Clauses 5.2(a) and (b), read in isolation, without giving weight to the textual context and the overriding good faith obligation of each director stipulated in clause 7.6(a).

Counsel for the first defendant placed reliance on the decision of Sholl J in Bailes v Modern Amusements Pty Ltd [1964] VR 436, which concerned an agreement by a company to repay a shareholder loan ‘when the company considers that it is in a position to repay’. That obligation was held to be void for uncertainty. However, among many obscurities, it was not even clear whether the phrase ‘when the company considers …’ should be taken to mean a decision of the board or of the shareholders, or whether the decision should be unanimous or by majority. There is no such obscurity in this case.

The discretion to request a shareholder loan in both Clauses 5.2(a) and (b) is controlled by objectively ascertainable criteria. The ground for a request in Clause 5.2(a) depends on the express factors stipulated in that clause, namely the existence of a requirement that funds are needed by the company ‘for the purpose of performing the Assets Management Functions’ or ‘any other activities as determined by the Board of Directors in accordance with this Agreement’. The ground for a request in Clause 5.2(b) depends on the existence of a ‘reasonable request’ by KLK ‘to provide funds for the Business’.

In both cases, the operation of the discretion whether to request a shareholder loan is further controlled by each director’s express obligation to ‘act in good faith and in the best interests of the Company and the Group as a whole’ subject to his entitlement to have regard to and act in the interests of his appointing shareholder. These are defined, ascertainable and justiciable criteria whose performance can be tested by time-honoured court processes.

As Mason J said in Meehan v Jones at 589: ‘There is in this formulation no element of uncertainty – the courts are quite capable of deciding whether the purchaser is acting honestly and reasonably’. To apply those remarks to this case, one only need substitute for ‘honestly and reasonably’ the words ‘in good faith in accordance with Clause 7.6(a) of the shareholders’ agreement’. For those reasons, I have concluded that there is nothing illusory in the obligation to request a shareholder loan. It is neither optional nor unfettered.

For similar reasons, there is no available separate argument that the contractual provisions relating to a request for a shareholder loan are void for uncertainty.

The general principle is that a contractual obligation expressed in language ‘so obscure and so incapable of any definite or precise meaning that the court is unable to` attribute to the parties any particular contractual intention’ is void for uncertainty. Scammell & Nephew Ltd v Ouston [1941] AC 251 at 268; Meehan v Jones (1981-2) 149 CLR 571 at 587. However, an important qualification is that, where possible, courts are ‘astute to adopt a construction which will preserve the validity of the contract’: Meehan v Jones Mason J at 589. As Barwick CJ said in Upper Hunter County District Council v Australian Chilling & Freezing Co Ltd (1967-8) 118 CLR 429 at 437:

More recently, in Mount Bruce Mining Pty Ltd v Wright Prospecting Pty Ltd [2015] HCA 37 at [51], the High Court reaffirmed that, unless a contrary intention is indicated in the contract, a court should approach the task of giving a commercial contract an interpretation based on the assumption that the parties intended to produce a commercial result. Further, a commercial contract should be construed so as to avoid it ‘making commercial nonsense or working commercial inconvenience’; see also Electricity Generation Corporation v Woodside Energy Ltd [2014] HCA 7; (2014) 251 CLR 640 at 657 [35], citing Zhu v Treasurer of New South Wales [2004] HCA 56; (2004) 218 CLR 530 at 559 [82]; [2004] HCA 56.

For those reasons, I have concluded that there is no ground for holding that the shareholders’ agreement is void for uncertainty. The parties should deliver agreed short minutes to my Associate disposing of the proceedings.