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Cases Update - December 2017
This case highlights the importance of ensuring that an agreement executed by only one director of a company (even where it is the managing director) is validly executed (whether by authorisation under the constitution or in accordance with the Corporations Act 2001 (Cth)).
After ASIC became concerned that WealthSure Pty Ltd (WealthSure) may not have adequately monitored and supervised its representatives, WealthSure and ASIC entered into an enforceable undertaking dated 29 August 2013. The terms of the enforceable undertaking included that companies in the WealthSure group were not to have sole director boards and must have a majority of independent non-executive directors. Following the resignation of Mr Pawski as sole director and secretary of WealthSure, 2 independent directors, Mr Newman and Ms Humphries, were appointed.
The key question for the Court was whether a General Security and Loan Facility Agreement purportedly entered into between WealthSure and the first defendants (which included Mr Pawski) on 15 April 2015 (Loan Facility Agreement), which had been signed for WealthSure by Mr Newman alone, was validly executed.
Mr Pawski argued that he believed that Mr Newman had the authority to sign the Loan Facility Agreement alone, while Mr Newman gave evidence that he had indicated to Mr Pawski when he signed the Loan Facility Agreement that it still required the signature of Ms Humphries.
In finding that the Loan Facility Agreement was not validly executed, Master Sanderson in the Supreme Court of Western Australia found that:
- Mr Newman’s version of events was more internally consistent (although it was not necessary to prefer one version over the other to decide the outcome of the case);
- the WealthSure board had not, under its constitution, conferred on Mr Newman the power to unilaterally enter into the Loan Facility Agreement;
- Mr Newman, as managing director of WealthSure, did not have implied authority under the ‘indoor management rule’ in section 126(1) of the Corporations Act 2001(Cth) (Corporations Act). Entry into the Loan Facility Agreement was of great significance to WealthSure (it was pledging all of its assets) and was therefore not something that fell within the ‘usual scope’ of the office of managing director and was ‘far from the normal trading activity’ for WealthSure;
- the first defendants were not entitled to rely on the assumption under section 129(2) of the Corporations Act that Mr Newman had authority to enter into the Loan Facility Agreement because it was not customary for a managing director to pledge all of the company’s assets; and
- in any case, the first defendants were precluded under section 128(4) from relying on section 129(2) because Mr Pawski ‘knew or suspected that the assumption was incorrect’.
Master Sanderson also found that:
- WealthSure’s acceptance of funds did not, without further evidence, constitute ratification of the Loan Security Agreement; and
- WealthSure was not estopped by representation from asserting that it was not bound. The first defendants were on notice at all times, via their agent Mr Pawski, of the need for Ms Humphries’ signature, and there was no unconscionable conduct by WealthSure.
Drafting to avoid a negative earn-out amount: Lynam & Ors v Arthur J Gallagher Australasia Holdings Pty Ltd  QSC 240
This case is a good reminder to sellers to pay close attention to the drafting of earn-out clauses to minimise the risk of the calculation producing what may be an unintended negative amount. Where the language of the contract is clear that an earn-out amount may be negative, a Court will not allow evidence of the parties’ pre-contractual negotiations to support claims to have the contract rectified or construed to require an earn-out amount of not less than zero.
Under a share sale agreement (Agreement), Arthur J Gallagher Holdings Australasia Pty Ltd (AJG Holdings) was required to pay an initial purchase price, as well as an ‘Earn-Out Amount (if any)’ to be paid after 3 years. The Earn-Out Amount comprised the following (subject to a maximum cap):
the Earn-Out EBITDA Amount; plus
the Earn-Out Profit Commissions Amount.
When the Earn-Out Amount became due, the Earn-Out EBITDA Amount was a negative amount of over $17 million, with the result that the overall Earn Out Amount was also negative.
The sellers sought declarations that, on the proper construction of the Agreement:
the Earn-Out EBITDA Amount and the Earn-Out Profit Commissions Amount could not be less than zero; and/or
the Earn-Out EBIDTA Amount and the Earn-Out Profit Commissions Amount were separate payments which could not be set off against each other (and therefore produce a negative figure).
Factors which weighed in the decision of Dalton J in the Supreme Court of Queensland not to make the declarations included:
the parties chose not to define Earn-Out EBITDA Amount in a way which would prevent it from being a negative amount and by way of contrast, the definition of Profit Commission Amount (which was the more predictable amount) did include a minimum floor;
in the circumstances, the use of the word “plus” had a mathematical meaning, namely a single amount comprising the 2 amounts (as opposed to the ordinary English meaning of “by the addition of”, “increased by”);
in other sections of the Agreement, the words “each of” were used to give rights over 2 distinct sums of money. As such, it appeared that a deliberate choice was made in the definition of Earn-Out Amount to use algebraic language;
the pro forma Earn Out Statement attached to the Agreement, albeit labelled “for information purposes only” showed the calculation as an algebraic exercise which strongly supported the interpretation of a mathematical calculation; and
the omission of the words “if any” after the reference to the Earn Out EBITDA Amount supported the construction that it could be a negative amount.
In construing the Agreement, Dalton J refused to have regard to evidence of the parties’ pre-contractual negotiations on the basis that there was no ambiguity in the language used, and also because the evidence referred to was irrelevant.
Dalton J also refused to rectify the Agreement to insert the words “if greater than zero” after the reference to Earn-Out EBITDA Amount because the sellers failed to establish a “common intention” of the parties.