Arnaout v Arnaout

By summons (originally filed on 27 February 2018, successively amended on 24 April 2018, 24 May 2018 and 27 September 2018), the plaintiff applies for orders for “preliminary (cause of action) discovery“, under rule 5.3 of the Uniform Civil Procedure Rules 2005 NSW (“UCPR”), against three parties, each a prospective defendant in substantive proceedings.

The central dispute is between the plaintiff and the first defendant. The prospective defendants other than the first defendant provided professional (legal and accounting) services to the plaintiff and the first defendant at and about the time that the plaintiff and the first defendant ended their commercial relationship.

The plaintiff and the first defendant are brothers. Between 1999 and October 2013 or thereabouts they worked together in commercial operations which grew from small to big. Through a variety of corporations which came to be called “the Iris Group“, they together bought, operated, developed and sold businesses (including hotels) and real estate.

On 9 October 2013 the brothers executed a written contract (bearing that date and entitled “Implementation Agreement-Restructure of the Iris Group“) which provided, on terms, for the first defendant to buy out the plaintiff. The object of the contract was for the plaintiff to withdraw from the Iris Group so that its ownership and control would pass to the first defendant alone.

As events transpired, the Implementation Agreement provided for the first defendant to procure payment to the plaintiff of $19,499,970 by three instalments.

The first instalment was payable on or before 30 August 2014; the second, on or before 30 August 2015; and the third, on or before 30 August 2016.

Payments having been made to the plaintiff, more or less as contemplated by the Implementation Agreement, on 26 August 2016 the brothers executed a “Deed of Release“, bearing that date, in which the plaintiff: (a) acknowledged that the first defendant had complied with his obligations under the Implementation Agreement; and (b) gave, in favour of the first defendant and “related persons“, a release from any claims, and a covenant not to sue on any claim, in respect of the Implementation Agreement.

The plaintiff executed the Implementation Agreement at a time when he was suffering from a medical condition diagnosed as severe depression. He has adduced evidence of conversations which supports a finding that, in the lead up to execution of the Implementation Agreement, the first and third defendants knew of his ill health.

He suspects that the price at which he was bought out of the Iris Group, on the terms for which the Implementation Agreement provided, was significantly less than the true value of his interest in the Group.

He contends that, on account of his ill health, he had no choice but to submit to a sale of his interest in the Group on the terms proposed, and insisted upon, by the first defendant.

He suspects that, at the time of execution of the Implementation Agreement, the defendants may have had in their possession documentation – not disclosed to him – which, if brought to light, would show that, objectively, the true value of his interest in the Iris Group was significantly greater than the buy-out figure he felt compelled, in the vulnerability caused by his ill-health, to accept.

He commenced the present proceedings because he suspects that he may have claims for relief against one or more of: (a) his brother, the first defendant, his former business partner; (b) the firm of solicitors (Henry Davis York) who acted for both parties in connection with the Implementation Agreement and the Deed of Release, in these reasons for judgment nominally identified as the second defendant; and (c) the accountants for the Iris Group (Pitcher Partners, by their corporate identity), the third defendant.

By his “second further amended summons“ filed on 27 September 2018, the plaintiff sought orders for preliminary discovery against each of those parties.

It is not necessary to consider the claim for preliminary discovery against the solicitors, nominally the second defendant. They and the plaintiff settled that claim.

The focus for attention is primarily upon the plaintiff’s claim for preliminary discovery against the first defendant, in terms elaborated in Schedule A to the second further amended summons. The independent but associated claim for preliminary discovery against the accountants (the third defendant) is elaborated in Schedule C to the second further amended summons.

There is overlap in the categories of documents sought against the first and third defendants respectively. This is, in part, because the plaintiff seeks to ascertain whether any (and, if so, what) nominated classes of documents were in the possession of each defendant at the time the Implementation Agreement was executed.

In written submissions (marked for identification as “P2“and “P13“) the plaintiff articulated prospective claims for relief against each of the first and third defendants.

Against the first defendant, the plaintiff points to potential claims for relief (under the general law and legislation) based upon allegations of unconscionable conduct, breach of fiduciary duty, and misleading or deceptive conduct.

In response to the first defendant’s reliance upon the Deed of Release, the plaintiff contends that the deed does not operate as a bar to any proceedings against the first defendant because: (a) on its proper construction, the Deed does not bar a claim that the Implementation Agreement was procured by unconscionable conduct, a breach of fiduciary duty or misleading and deceptive conduct; (b) the Deed was affected by a course of conduct that was unconscionable, in breach of fiduciary duty and misleading or deceptive vitiating the Implementation Agreement; (c) if the Implementation Agreement is found to have been procured by unconscionable conduct, the Deed may be declared void under sections 237 and 243(a) of the Australian Consumer Law; (d) the Deed may be void to the extent that it is an attempt to contract out of the Australian Consumer Law (ACL section 276); and (e) the Deed may not be enforceable for a want of formality and a lack of consideration.

Against the third defendant, the plaintiff asserts potential claims for relief based upon allegations of negligent misstatement, misleading or deceptive conduct, and accessorial liability for misleading and deceptive conduct of the first defendant.

In evidence in support of his applications for preliminary discovery, the plaintiff deposes, inter alia, that he has no recollection of ever having been advised of any potential conflict of interest involved in the second and third defendants respectively acting for both the first defendant and himself, and related persons, on the Implementation Agreement.

Although the two affidavits sworn by the plaintiff in support of his applications for preliminary discovery depose to a substantial amount of detail about the nature and terms of particular commercial transactions going back to the early days of the commercial partnership between the plaintiff and the first defendant, the plaintiff expresses concern that he lacks documentation perceived to be necessary for there to be a valuation of the Iris Group at the date of execution of the Implementation Agreement, a material element in determining whether he suffered any, or any significant, loss from conduct the subject of complaint against the prospective defendants.

His summons is supported by a report, and supplementary correspondence, prepared by forensic accountants (RSM Bird) who state that, without access to particular classes of documentation, they cannot, with any confidence, attribute a value to the Iris Group.

In paragraphs 325-328 and 331 of his first affidavit, the plaintiff explains in the following terms (with editorial adaptation) his “need to further documents“ by way of orders for preliminary discovery:

The reference in paragraph [325] to the year 2011 needs explanation. As emerged in cross examination of the plaintiff by senior counsel for the first defendant, that paragraph refers not only to a lack of physical access to books and records since October 2013, but to the plaintiff’s self perception of an inability, arising from his medical condition over the preceding two years or so, to analyse accounts with the acumen he formerly displayed in active management of the affairs of the Iris Group.

UCPR rule 5.3 is in the following terms (with emphasis added):

UCPR rule 5.3 appears in Part 5 of the UCPR, entitled “Preliminary Discovery and Inspection”. That Part makes provision for three different types of “preliminary discovery”, sufficiently described in their respective titles. UCPR rule 5.2 is entitled “Discovery to Ascertain Prospective Defendant’s identity or whereabouts”. UCPR rule 5.3, as extracted, is entitled “Discovery of Documents from Prospective Defendant”. UCPR rule 5.3 is entitled “Discovery of Documents from Other Persons”.

Ancillary provisions of UCPR Part 5 relate to the formalities of the discovery and inspection process (UCPR rule 5.5, incorporating by reference provisions of UCPR Part 21); provision for security for the costs of the person against whom a preliminary discovery order is made (UCPR rule 5.6); claims of privilege (UCPR rule 5.7); and orders for the payment of costs and expenses associated with an application for preliminary discovery and the process of preliminary discovery (UCPR rule 5.8).

UCPR rule 5.6 provides that an order for preliminary discovery may be made subject to a condition requiring an applicant to give security for the costs of the person against whom the order is made. More generally, section 86 of the Civil Procedure Act 2005 NSW empowers the Court to make orders on such terms and conditions as the Court thinks fit. Accordingly, an order for preliminary discovery can be made conditionally.

The parties agree that the outcome of the plaintiff’s applications for preliminary discovery is governed by the judgment of the Court of Appeal in O’Connor v O’Connor [2018] NSWCA 214, published during the course of argument.

Relevantly, the law governing the proper operation of UCPR rule 5.3 can be found in paragraphs [21]-[30], [70], [76], [79] and [86]-[90] of the Court of Appeal’s judgment.

From that judgment I draw, for the purpose of the current proceedings, the following particular points:

An applicant for a preliminary discovery order must disclose what information he, she or it already has relevant to making a decision whether or not to commence proceedings against a prospective defendant. Preliminary discovery cannot be used to build up a case which an applicant has already decided, or could decide, to bring: Morton v Nylex Ltd [2007] NSWSC 562 at [33].

An exercise of the discretion for which UCPR rule 5.3 provides is governed by the case management provisions for which Part 6 Division 1 (sections 56-60) of the Civil Procedure Act 2005 NSW provides.

In that context, without detracting from any entitlement for which UCPR rule 5.3 provides, the Court may take into account the availability of “discovery“ procedures (including subpoenas for the production of documents, notices to produce, discovery and interrogatories) available against a defendant after the commencement of substantive proceedings, and restrictions (such as apply in the Equity Division of the court by reference to Practice Note SC Eq 11) on the availability of interlocutory “discovery“ procedures.

A determination that an application for preliminary discovery is an abuse of the processes of the court is not a necessary foundation for a decision, upon an exercise of discretion, to dismiss, or limit a grant of relief upon, an application for preliminary discovery.

It is not necessary, in the current proceedings, to examine the potential claims for relief propounded by the plaintiff with the precision that would attend critical analysis of a pleading. Sufficient elaboration of them can be found in the plaintiff’s written submissions, earlier identified, and in this judgment’s general characterisation of them.

Principal factors which point to a potentially arguable claim for relief against the first defendant, on the evidence adduced in support of the plaintiff’s application for preliminary discovery, are the facts that:

Principal factors which point to a potentially arguable claim for relief against the third defendant, on the evidence adduced in support of the plaintiff’s application for preliminary discovery, are the facts that:

There are two particular deficiencies in the documentation presently available to the plaintiff for the purpose of determining whether or not to commence proceedings against the first and third defendants respectively:

The detailed narrative of the plaintiff’s affidavits in support of his application for preliminary discovery, and the nature of the advice he has received from RSM Bird, evidence the fact that the plaintiff has made reasonable inquiries in aid of decision-making about whether or not to commence proceedings against the first and third defendants respectively. He has applied his own knowledge and business experience (including experience in management and control of the Iris Group) to a narrative of material facts about the nature and course of the business the subject of the Implementation Agreement, and he has sought expert advice about the critical question of valuation of the Iris Group as a preliminary to assessment of the value of his interest in the Group.

The nature of the business operations of the Iris Group, the active involvement of the first defendant in management and control of the Group, the professional involvement in the business of the third defendant as the Group’s accountants, and the nature and purpose of the Implementation Agreement all point to a probability that:

Although the nature of the claims for relief propounded by the plaintiff against the defendants is such that documents in the possession of one defendant might be relevant to a potential claim for relief against another defendant, the availability of preliminary discovery under UCPR rule 5.3 requires that the exposure of each defendant to an order for preliminary discovery be assessed independently of the exposure of the other defendant.

The rule does not, however, quarantine the use that can be made by a party in favour of whom a preliminary discovery order is made in the sense of precluding use of information provided by one prospective defendant in deciding whether or not proceedings should be commenced against another prospective defendant.

Cross examination of the plaintiff by senior counsel for the first defendant can be taken to have established that:

That evidence does not stand in the way of a finding that the plaintiff has satisfied the pre-conditions set out in UCPR rule 5.3 for the making of orders for preliminary discovery. The deficiencies in documentation available to the plaintiff are not offset by facts established by cross examination of him.

What cross examination of the plaintiff did do is: (a) to identify as an issue of fact to be determined in any prospective substantive proceedings whether the plaintiff relied upon representations made to him by the first and third defendants, jointly or severally, about the value of his interest in the Iris Group when he executed the Implementation Agreement; (b) to invite the Court to view with a critical eye whether the plaintiff’s decision whether or not to commence proceedings is really contingent on documentation that may be available to it on preliminary discovery; and (c) to invite consideration whether case management principles ought to be applied by dismissal of the plaintiff’s preliminary discovery application, in whole or part, leaving him to invoke “discovery” procedures in substantive proceedings should he decide to bring them.

A case management perspective of the plaintiff’s application naturally presents itself for consideration because the application is driven, in large part, by what his expert (RSM Bird) identifies as required for the preparation of a valuation report which, if prepared, would likely have all the characteristics of evidence available to be adduced at a final hearing.

The defendants submit, correctly, that the purpose of UCPR rule 5.3 is not to give a plaintiff a head-start advantage in prospective proceedings by arming an applicant (a prospective plaintiff) for preliminary discovery with trial standard evidence before any originating process is filed or served in substantive proceedings.

Care also needs to be taken to minimise the risk of substantive proceedings being driven, not by claims for relief pleaded and particularised in advance of resort to interlocutory “discovery” procedures, but by preliminary discovery in advance of pleadings. The administration of justice in this court is predicated upon an assumption that, in the ordinary course, the interests of justice are best served by a plaintiff being required, in substantive proceedings, to formulate claims for relief and to plead and particularise all facts material to such claims before resort to “discovery” procedures.

Nevertheless, for the reasons here published, I am satisfied that the pre-conditions for the making of an order for preliminary discovery under UCPR rule 5.3 have been satisfied and that, subject to conditions, orders for preliminary discovery should be made as sought against the first and third defendants in the plaintiff’s second further amended summons.

Having regard to case management principles in the current proceedings, and anticipating their operation in the substantive proceedings against the first and third defendants which are presently under consideration by the plaintiff, in my opinion the interests of justice dictate that the plaintiff be granted the orders for preliminary discovery he seeks, but on conditions designed to maintain a balance of fairness between the competing forensic interests of the parties – in particular, to address potential unfairness to the defendants in the plaintiff being allowed extensive discovery before pleading in complex commercial litigation.

The preliminary discovery sought by the plaintiff is designed, inter alia, to provide him with a soundly-based expert evaluation of whether he was, or was not, bought out of the Iris Group at an undervalue. An incident of such an evaluation is that he is likely to have available to him at the time of commencement of substantive proceedings, or very soon thereafter, an expert’s report suitable for tender at a final hearing. This is a forensic advantage which a plaintiff does not routinely enjoy over a defendant in complex commercial litigation. It is potentially unfair to the defendants in that they are required to make disclosures of primary material without the benefit of customary, particularised pleadings of claims for relief against which interlocutory discovery obligations are ordinarily measured.

In my opinion, the interests of justice require this source of potential unfairness to be addressed by a procedure designed: (a) to require the plaintiff to disclose to the defendants at the time of commencement of any substantive proceedings, or soon thereafter, the fruits of his engagement with the preliminary discovery process; and (b) to allow the defendants an opportunity for reciprocal discovery before they plead to any case pleaded against them.

The plaintiff should not be permitted to monopolise the benefits of a preliminary discovery procedure intended to expose, for objective assessment, a valuation of property in which both sides of the record have a forensic interest.

The plaintiff contends that he should be granted preliminary discovery to enable an expert report to be prepared by RMS Bird as to the valuation of the Iris Group. Taking the benefit of preliminary discovery, he should be held, as far as may be practicable, to his intended course of action by imposition of a requirement that he serve the foreshadowed report on the defendants at an early stage of substantive proceedings, if substantive proceedings are to be pursued.

With this objective in mind, I propose to require from the plaintiff, as a condition of orders for preliminary discovery, an undertaking to the effect that, if he commences substantive proceedings against one or more of the defendants then, unless the Court otherwise orders:

Prima facie, the interests of justice also require that the plaintiff be ordered: (a) pursuant to UCPR rule 5.8, to pay the first and third defendants’ costs of the second further amended summons, on the ordinary basis; and (b) pursuant to UCPR rule 5.6, to give security for those defendants’ costs of making and serving any list of documents, their costs of producing any documents for inspection, and their costs of otherwise complying with the Court’s orders for preliminary discovery.

Having sought forensic advantage in orders for preliminary discovery, prima facie the plaintiff should be required to pay the costs of the defendants in having to provide it.

Subject to allowing the plaintiff, and the first and third defendants an opportunity to make submissions about the form of orders to be made by way of preliminary discovery, and in relation to costs, I propose to make orders to the following effect:

Having proposed a general scheme of orders by publication of these reasons for judgment, I will adjourn the proceedings for a short time to allow the parties to consider, inter alia, whether an agreement can be reached as to the amounts and form of security to be given by the plaintiff and any other matters of detail that might be appropriate to accommodate administrative tasks.

Unless the parties otherwise agree in writing, any expert report prepared pursuant to these orders will be a report prepared on behalf of the plaintiff alone. A joint report is not intended. Nevertheless, the Expert Witness Code of Conduct must apply: UCPR rule 31.23 and Schedule 7.

Questions about the deployment and admissibility of any expert report proposed, in due course, to be relied upon by any party to substantive proceedings the plaintiff may commence will be for the judicial officer, or officers, managing those proceedings to determine.

If the plaintiff declines to submit to the conditions here proposed to be imposed upon the making of preliminary discovery orders against the first and third defendants (as he is entitled to do), an exercise of that right of election will carry with it a consequential dismissal of the plaintiff’s application for preliminary discovery orders against those defendants. In my opinion, the interests of justice would not be served by the making of unconditional orders for preliminary discovery.

On 17 May 2019 I published reasons for judgment, as Arnaout v Arnaout [2019] NSWSC 565, in disposition of an application for preliminary discovery made by the plaintiff under rule 5.3 of the Uniform Civil Procedure Rules 2005 NSW.

I have today made orders substantially in accordance with draft orders 1 to 7 inclusive set out in paragraph 60 of those reasons for judgment.

I have today heard argument advanced on behalf of the plaintiff and on behalf of all the defendants (including the Henry Davis York defendants, nominally described as the "second defendant") about what order, or orders, should be made about the costs of the plaintiff's application for preliminary discovery.

It is not necessary to deal with any questions that might arise about the costs of preliminary discovery being provided. There is no dispute between the parties about that; those costs are, uncontroversially, to be paid by the plaintiff. The focus for decision is on the costs of the application for preliminary discovery which, as a matter of form, was made ultimately by reference to the second further amended summons.

The starting point for considering this question of costs is section 98 of the Civil Procedure Act 2005 NSW, which confirms that costs are in the discretion of the Court.

The next point of reference must be rule 42.1 of the Uniform Civil Procedure Rules 2005 NSW, which provides that, unless the Court otherwise orders, costs are to follow the event.

The jurisdiction to make an order for preliminary discovery under UCPR rule 5.3, although perhaps not correctly described as exceptional, is unique in the sense that it does not fit neatly in the mould of ordinary adversary civil litigation.

It may be that, preliminary discovery having been given, the plaintiff decides not to institute any proceedings against the defendants notwithstanding his present contemplation that proceedings might be commenced. It might also be that these preliminary discovery proceedings, when viewed in retrospect, appear as stage one of further litigation between the parties.

It is, in my opinion, desirable that there be an order for costs in these preliminary discovery proceedings which has immediate, not a contingent, effect.

Although the parties have debated whether it is appropriate to characterise these preliminary discovery proceedings as “adversarial” to the extent that they have been opposed by the defendants, I am not comfortable with such a characterisation as a determinant of costs orders.

It is not entirely correct to say that the plaintiff has obtained in orders for preliminary discovery “an indulgence”. That it is because UCPR rule 5.3 provides, subject to an exercise of discretion, an entitlement if certain elements are made out. Nevertheless, there is something in the nature of an "indulgence" that is sought by a plaintiff who seeks to obtain preliminary discovery against parties against whom he may or may not bring subsequent proceedings.

In deciding whether or not to make an order departing from the scheme of UCPR rule 42.1, relevant factors are whether it was reasonable for the defendants to oppose the plaintiff's application for preliminary discovery, and whether they acted reasonably in the conduct of their opposition.

In my assessment the defendants in these proceedings did act reasonably in their opposition to the plaintiff's application for preliminary discovery; reasonably in their decision to oppose it and reasonably in their conduct of their opposition.

In my opinion, the proper order in these proceedings, subject to one qualification, is that the plaintiff pay the costs of the defendants on the ordinary basis.

The qualification is this. If the plaintiff does, in the fullness of time, commence substantive proceedings against the defendants, or either of them, it should be open to the plaintiff in those proceedings to apply to the Court, to the extent that any application may be necessary, for orders recognising that costs payable in these preliminary discovery proceedings should be dealt with as an expense necessarily incurred by the plaintiff in pursuit of what, by that stage, will have become the substantive proceedings.

It is for that reason that, in making an order that the plaintiff pay the defendant's costs of the second further amended summons I have formally reserved such, if any, entitlements the plaintiff may have to claim the costs payable by him pursuant to the current orders as an expense recoverable as costs in any future proceedings.