Rocking Horse Constructions Pty Ltd v Equa Building Services Pty Ltd

1. [1]

   By Notice of Motion filed on 29 September 2022 the plaintiffs/cross-defendants, Rocking Horse Construction Pty Ltd (Rocking Horse) and Alexander Scionti, seek security for their costs of defending the cross-claim brought against them by the defendant/cross-claimant, Equa Building Services Pty Ltd (Equa), in the amount of $235,168.

Background

1. [2]

   These proceedings concern a residential development at Baulkham Hills, Sydney known as “Elora” involving the construction of a 5 storey residential building, containing 45 units. In December 2017, Equa entered into a contract with Arden SL Pty Ltd (as trustee for the Arden SL Trust) for the design and construction of the Elora development (D & C Contract). Equa was the principal under that contract and the contract price was $13.5 million (excluding GST). Both Equa and Arden SL Pty Ltd (Arden SL) form part of a group of companies engaged in residential developments across New South Wales and Queensland (Arden Group). Mr Derek McCartney is the sole director of Equa and, it would appear, the person who controls the Arden Group.

2. [3]

   Equa acts as the trustee of a discretionary trust known as the Equa Trust and operates as a building company, performing management services to the special purpose vehicles within the Arden Group which own land used for development purposes. The trust deed appears to be a fairly standard form of discretionary trust with the discretionary beneficiaries including Mr McCartney and his wife, and their relatives as well as any company or trust in which any discretionary beneficiary holds an interest. Mr McCartney, as appointor, effectively controls the Trust through his power to remove and/or appoint a trustee. Under cl 15 of the trust deed, the trustee has a right of indemnity against all liabilities that it incurs as trustee.

3. [4]

   On 1 March 2018, Equa entered into a contract with Mr Scionti for the provision, by a company to be nominated by Mr Scionti, of construction management and supervision services in relation to the Elora development (CM Contract). Subsequently, Mr Scionti nominated Rocking Horse as the party to perform those services and it became the contracting party with Equa under the CM Contract. The CM Contract provided for the payment of a management fee to Rocking Horse of $1.35 million (plus GST).

4. [5]

   The CM Contract required Rocking Horse, under the supervision of Mr Scionti as a licensed builder, to perform construction management services in relation to the development, including obtaining the construction certificate for the development to proceed (and any other necessary certificates required to be obtained by Equa under the D & C Contract), engaging sub-contractors to design and build the development, completing the development within 12 months from commencing construction and ensuring that any defects were completed in accordance with the D & C contract and any applicable law. The CM Contract required Equa to be responsible for the payment of all sub-contractors and expenses relating to the design and construction of the development. Rocking Horse was required to obtain the approval of Equa before incurring expenses above $1,000. It appears that Rocking Horse was entitled to reimbursement from Equa for all expenses which it incurred with Equa’s approval.

5. [6]

   Construction of the development commenced but was not completed within 12 months leading to a dispute between the parties and on 26 February 2020 Equa terminated the CM Contract.

6. [7]

   Rocking Horse claimed to be entitled to an amount of $486,489 in respect of costs and expenses it had incurred in respect of the development. In May 2020 the parties entered into a Deed of Settlement and Release (Deed) to settle the dispute. Under the Deed:

7. [8]

   Equa having paid only one of the instalments of the settlement sum, Rocking Horse commenced proceedings in the District Court for recovery of $409,489. After exchange of evidence in chief, Equa foreshadowed seeking leave to file a cross-claim, and in doing so joined Mr Scionti and claimed damages in a sum that exceeded the jurisdiction of the District Court. The proceedings where then transferred to this Court by consent.

8. [9]

   After the transfer to this Court, Equa amended its defence which led to further evidence being filed by the parties. There was also a dispute about the pleading of the cross-claim and ultimately an amended cross-claim was filed on 11 April 2022. No procedural steps have been taken in relation to the cross-claim save for the filing of list responses by the cross-defendants on 3 June 2022. Under the cross-claim, Equa seeks damages from Rocking Horse and Mr Scionti of $5.6 million.

9. [10]

   As a result, the proceedings involve two overlapping claims. The first is the main claim, in which Rocking Horse seeks to recover the sum of $409,489 as a debt owing under the Deed, following default by Equa in payment of the second and subsequent instalments of the settlement sum. Equa denies liability on essentially two grounds: (a) that the condition precedent in cl 3 of the Deed was not satisfied, and (b) that it entered into the Deed in reliance on representations made to it by Rocking Horse and Mr Scionti that the works performed at the property under the CM Contract while under the supervision of Rocking Horse and Mr Scionti had been carried out in accordance with the Building Code of Australia and Australian Standards (and other relevant requirements) and also that Rocking Horse and Mr Scionti held originals of the warranties, certifications, and other compliance documents referred to in cl 3 of the Deed. Equa contends that each of the representations referred to in (b) were misleading and deceptive contrary to s 18 of the Australian Consumer Law (ACL) and that had it not been misled it would not have entered into the Deed.

10. [11]

    The second is the cross-claim in which Equa claims:

Applicable principles

1. [12]

   The application is brought under r 42.21(1)(d) of the Uniform Civil Procedure Rules 2005 (NSW) or in the alternative, under s 1335(1) of the Corporations Act 2001 (Cth), although it is not in dispute that there is no relevant difference in the applicable principles. I will focus on r 42.21(1)(d) as the parties did.

2. [13]

   Rule 42.21(1)(d) provides:

3. [14]

   The application made under r 42.21(1)(d) raises three questions. First, whether there is reason to believe that a plaintiff, being a corporation, will be unable to pay the costs of the defendant if ordered to do so. This is commonly referred to as the threshold question. Second, if the Court is satisfied as to the threshold question, whether as a matter of discretion, having regard to the matters listed in r 42.21(1A), the order should be made. Third, if that question is answered in the affirmative, the third question which arises is the quantum and form which the security should take.

4. [15]

   While r 42.21(1)(d) only permits security for costs against a plaintiff, “plaintiff” is defined to include a person by whom a cross-claim is made (Civil Procedure Act 2005 (NSW), s 3(1)). However, where security is sought against a defendant who has filed a cross-claim, it is necessary for the applicant to show that having regard to the overall nature of the claim and the cross-claim, the cross-claim is not in reality a defence to the claim and the cross-claimant has become in substance the plaintiff or attacker: Bevwizz Group Pty Ltd v Transport Solutions Pty Ltd [2008] NSWSC 1399 at [18]; Interwest Ltd v Tricontinental Corporation Ltd (1991) 5 ACSR 621 at 626-627.

5. [16]

   The threshold question requires the consideration of two matters. First, the likely quantum of costs of Rocking Horse which it says that Equa will be ordered to pay if Rocking Horse is successful. Second, whether there is a rational basis for the belief that Equa will be unable in the future to pay a costs order in that amount: Cornelius v Global Medical Solutions Australia Pty Ltd [2014] NSWCA 65 at [16] and [59]. The Court must be satisfied that there is a probability, amounting to more than a mere risk, that there will be an inability to pay Rocking Horse’s costs if required to do so: Cornelius at [16] and [59]; Di Francesco v Pioneer Energy Pty Ltd (No 2) [2014] NSWSC 1923 at [7]. It is an inherently predictive assessment and must relate to the cross-claimant’s likely financial position at the time of judgment and immediately after: Idoport Pty Ltd v National Australia Bank [2001] NSWSC 744 at [58].

Evidence

1. [17]

   The evidence relied upon by Rocking Horse on the threshold question can be summarised as follows.

2. [18]

   Mr Michael Wirth, the solicitor for Rocking Horse, provided an estimate of the costs he expects Rocking Horse and Mr Scionti to incur in defending the cross-claim. His affidavit states that in forming that estimate he did not include costs of responding to Equa’s contention that in entering the Deed it relied on conduct of Rocking Horse and/or Mr Scionti that was misleading or deceptive or likely to mislead or deceive because those costs arise on both the cross-claim and the main claim, with the exception that “I do include the costs of responding to the cl 3 MDC Claim in so far as it depends on [Equa] establishing the defects which are also the subject of the Defects Claim”. The “cl 3 MDC Claim” is the claim referred to at [10(b)] above and the “Defects Claim” is the claim referred to in [11(a)] above. This was said to be on the basis that while Rocking Horse has already served its evidence on the main claim, it has not gone into evidence on its response to the alleged defects forming part of the cl 3 MDC claim and the Defects Claim.

3. [19]

   Equa did not dispute the calculations in Mr Wirth’s estimate, but rather contended that it does not provide an estimate of the likely costs that would be ordered only in respect of the cross-claim because the defects that are the subject of the defence are the same defects the subject of the cross-claim.

4. [20]

   In relation to the financial position of Equa, Rocking Horse tendered corporate searches and real property searches which establish that Equa has a total paid up share capital of $1 and does not own any real property in New South Wales or Queensland and that Arden Group Services Pty Ltd (of which Mr McCartney is the managing director) has a total paid up share capital of $2 and does not own any real property in New South Wales or Queensland apart from two leasehold interests in New South Wales which appear to have recently expired. I do not regard any of these matters as significant in the present context for the reasons stated in Di Francesco at [8].

5. [21]

   Equa also relied on the financial statements (balance sheets and profit and loss accounts) for the Equa Trust (which in the case of the 2022 financial year comprises unaudited management accounts). The relevant aspects of this evidence can be summarised as follows:

6. [22]

   Rocking Horse drew attention to the following aspects of the balance sheet of the Equa Trust as at 30 June 2022:

Consideration

1. [23]

   Rocking Horse submitted that the “reason to believe” requirement in UCPR r 42.21(1)(d) is “undemanding” and a “low threshold” and that what is required is a practical, common sense approach to the examination of the corporation’s financial affairs: Treloar Constructions Pty Ltd v McMillan [2016] NSWCA 302 at [11]-[13]; Cornelius at [15]-[17], [56] and [60]. Rocking Horse submitted that when this practical common sense approach is applied to the financial affairs of Equa disclosed by the financial statements referred to above, there is a rational basis for an actual prospective inability of Equa to pay costs of the cross-claim at the conclusion of the proceedings. While the profit and loss statement for the 2022 financial year shows a profit, this is solely due to clawing back payments to sub-contractors for the Elora development and that while the balance sheet for 30 June 2022 records a net asset balance, there is negligible cash at bank. The only significant assets are book entries for accounts receivable from a related company, Arden SL, undocumented loans to related parties in relation to which there was no evidence to suggest that they were recoverable, and a retention that is still being withheld in relation to a development (Elora) which, on Equa’s case, is riddled with defects. It was submitted that there was no evidence to suggest that Equa would be able to claw back any further payments from its sub-contractors for the Elora development and accordingly it may not have further profit between now and the conclusion of the proceedings when its assets would have continued to be expended on its own costs.

2. [24]

   Equa submitted that the matter should not be approached on the basis that the “reason to believe” requirement in UCPR r 42.21(1)(d) is undemanding, relying on observations of Kunc J in Ken Tugrul v Tarrants Financial Consultants Pty Ltd ACN 086 674 179 [No 4] [2014] NSWSC 291 at [26]-[27]. There is force in that submission in that it is necessary to focus on the statutory language rather than what might be regarded as a characterisation of the nature of the test it contains. Further, the threshold question requires consideration of two matters, first the likely quantum of costs of the party seeking security and secondly the ability of the plaintiff corporation to pay costs in that amount. This is because in circumstances where the plaintiff corporation has some capacity to meet a costs order, the precise amount of costs may be relevant to whether the “reason to believe” requirement is met: see Ken Tugrul at [30]; Brecher v Barrack Investments Pty Ltd [2018] FCA 472 at [18].

3. [25]

   Equa submitted that the threshold requirement is not satisfied in the present case for two reasons. First, Rocking Horse has not identified what are the costs that are only referable to the cross-claim so that the first matter identified in the previous paragraph is not known. Second, Equa submitted that the financial statements of Equa disclose net assets of approximately $830,000 which is more than sufficient to meet an adverse costs order and hence Equa has not discharged its onus in establishing that there is a real risk that an adverse costs order would not be met.

4. [26]

   In my view, Rocking Horse has discharged its onus on the threshold question. The financial statements in evidence do provide a rational basis for the belief that Equa will be unable to pay a potential adverse costs order. I agree with the submission of Rocking Horse that when the integers of the net assets of the Equa Trust as at 30 June 2022 are analysed, the Court can have no confidence that if, ultimately, an adverse costs order is made, Equa will have assets to which Equa could have recourse by reason of the indemnity contained in cl 15 of the Trust Deed, given the nature of the assets and the other liabilities of the Trust.

5. [27]

   In particular, where as here the company against which security is sought is a trustee it is necessary for the Court to have regard to the practical difficulties which the applicant would face in enforcing an order for costs against the trustee given that its assets are held on trust: Laundry Coin-Wash Nominees Pty Ltd v Dunlop Olympic Ltd [1985] 7 ATPR 40-584; Lagarna Pty Ltd v Bridge Wholesale Acceptance Corporation (Australia) Ltd [1995] 1 VR 150 at 153-154; Transocean Capital Pty Ltd v AFSIG Pty Ltd [2006] NSWSC 806 at [34]-[40]; ACN 105 921 962 Pty Ltd v Dominic Wiggett [2012] NSWSC 1526 at [10]; Brecher at [24]. In Laundry Coin-Wash at 46,729 Smithers J said:

6. [28]

   These difficulties can, in an appropriate case, be overcome by the controller of the trustee giving appropriate undertakings. In the present case no undertaking was given by Mr McCartney to ensure that there are sufficient trust assets against which Equa could obtain indemnity to meet any adverse costs order.

7. [29]

   Where the court’s jurisdiction to order security for costs under UCPR r 42.21 is established, the court has a discretion whether to make such an order. The relevant discretionary matters are set out in r 42.21(1A).

8. [30]

   The essential debate between the parties on the question whether the discretion should be exercised was whether Equa is effectively in the position of a defendant: r 42.21(1A)(e). Equa submitted that the cross-claim is essentially defensive in nature and arises out of the identical matters to be raised in defending the main claim brought by Rocking Horse. Equa submitted that Rocking Horse will need to incur the costs associated with those matters because of the main claim: see Interslice Pty Ltd v CCA Investments Bass Hill Pty Ltd [2021] NSWSC 1578 at [60].

9. [31]

   Rocking Horse submitted that this contention should be rejected on the basis that Equa is the aggressor, bringing a large and expensive building defects case claiming damages of approximately $5.7 million in relation to 45 listed categories of defects. By contrast, Rocking Horse’s claim is a simple one in debt, for less than a tenth of the quantum of the defects claim and, if found to be enforceable, will rely on the releases in the Deed as to the claims made against it.

10. [32]

    In my view, this is not an appropriate case in which to order security for costs against Equa for two reasons. First, where both the claim and the cross-claim arise out of the same factual matrix and are not wholly distinct, it is necessary for the applicant for security for costs to show that having regard to the overall nature of the claim and the cross-claim, the cross-claimant has become in substance the plaintiff or attacker: see [15] above. In the present case, Rocking Horse brings a claim in debt but does so in reliance on the Deed which contains in cl 5.2 a release of all claims, present and future, brought against it by Equa. In propounding the Deed to recover the debt, an essential element of its claim is that the release in cl 5.2 of the Deed is enforceable. The defence to that claim challenges that premise on the basis of an allegation of misleading and deceptive conduct that the construction work done at the property under the supervision of Rocking Horse and Mr Scionti complied with the Building Code of Australia and Australian Standards. At the heart of this defence is an allegation that the construction work done under the supervision of Rocking Horse and Mr Scionti was defective which is also at the heart of the allegations of misleading and deceptive conduct which form the basis of the cross-claim. In substance, Rocking Horse is seeking its own costs arising in the main claim: cf The Owners - Strata Plan No. 94267 v DEC Engineering & Construction Pty Ltd [2020] NSWSC 1647 at [33]-[36].

11. [33]

    Second, in so far as it might be said that there are some matters in the cross-claim which cannot be regarded as defensive, for example quantification of the damages sought in the cross-claim, it is a matter for Rocking Horse to establish the costs in relation to those matters. In the present case the evidence of Mr Wirth makes no attempt to isolate the costs in relation to the matters which are truly independent of Equa’s defence to the main claim, as he has not excluded costs in relation to whether the construction work done was defective: see [18] above. The Court is not in a position to estimate those costs and should not speculate as to what they may be, as that is a matter to be addressed by evidence for the applicant for security: see Ken Tugrul at [51].

12. [34]

    For the above reasons, the Notice of Motion should be dismissed with costs.