Supreme Court New South Wales

• Medium Neutral Citation: In the matter of Pioneer Energy Holdings Pty Ltd [2013] NSWSC 1134
• Hearing dates: 18 July 2013
• Decision date: 19 August 2013
• Jurisdiction: Equity Division - Corporations List
• Before: Bergin CJ in Eq

Decision

The total price payable for a transfer of shares under clause 7.6(b)(i) of the Shareholders Agreement is $1.

Clause 7.6(b)(i) is a penalty.

• Catchwords: [CONTRACTS] - where parties in a commercial joint venture project for development of maritime fuel facility - where Shareholders Agreement governs funding of project - where one of the joint venturers in funding default - construction of Shareholders Agreement - whether non-defaulting party entitled to compulsory transfer of all the shares of the defaulting party for $1 - or for $1 per share; [PENALTY] - whether compulsory transfer for $1 constitutes a penalty
• Cases Cited: AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170; Andrews v Australia and New Zealand Banking Group Limited (2012) 86 ALJR 1002; Commissioner of Public Works v Hills [1906] AC 368; CRA Limited v NZ Goldfields Investments [1989] VR 873; Dimech v Corlett (1858) 12 Moo PC 199; 14 ER 887; Dunlop Pneumatic Tyre Co Limited v New Garage and Motor Co Limited [1915] AC 79; Forestry Commission of New South Wales v Stefanetto (1976) 133 CLR 507; Jobson v Johnson [1989] 1 All ER 621; Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] AC 749; McCann v Switzerland Insurance Australia Limited (2000) 203 CLR 579; Miwa Pty Limited v Siantan Properties Pte Limited (2011) 15 BPR 29,545; Mosaic Oil NL v Angari Pty Ltd (1990) 20 NSWLR 280; Ringrow Pty Ltd v BP Australia Ltd (2003) 203 ALR 281; Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 224 CLR 656; Swartz v Hadid [2013] NSWCA 89
• Texts Cited: JW Carter, The Construction of Commercial Contracts (2013 Hart Publishing); JW Carter, Wayne Courtney, Elisabeth Peden, Andrew Stewart and GJ Tolhurst "Contractual Penalties: Resurrecting the Equitable Jurisdiction" (2013) 30 Journal of Contract Law 99
• Category: Separate question
• Parties: Charlie di Francesco (First Plaintiff); Prakesh Seth (Second Plaintiff); Blue Oil Energy Pty Ltd (Third Plaintiff); Blue Diamond (Australia) Pty Ltd (Fourth Plaintiff); Pioneer Energy Holdings Pty Ltd (First Defendant); Chark Hoe Tan (Second Defendant); Peter Ng (Third Defendant); Jeremy Tan (Fourth Defendant); Harjeet (Harry) Singh Ubhi (Fifth Defendant); Morgan Stanley Capital Group Inc (Sixth Defendant); Pioneer Energy Pty Ltd (Seventh Defendant)
• Representation: Counsel: FM Douglas QC/JC Conde (3rd Plaintiff); IM Jackman SC/D Klineberg (2nd to 6th Defendants); Solicitors: Spinks Eagle Lawyers (3rd Plaintiff); King & Wood Mallesons (2nd to 6th Defendants)
• File Number(s): 2013/102212

Judgment

1 These proceedings arise out of a dispute in relation to a joint venture project for the construction, operation and maintenance of an automated diesel loading and storage facility to service the shipping industry in Mackay, Queensland (the Facility).

2 Although the main proceedings involve multi-million dollar claims for unpaid tax invoices in respect of the construction of the Facility and competing claims in respect of alleged contractual breaches, this aspect of the litigation involves the determination of separate questions.

3 There are two main contracts that govern the joint venture.

4 This aspect of the proceedings requires the analysis and construction of a Shareholders Agreement dated 9 February 2011, the parties to which are the third plaintiff, Blue Oil Energy Pty Ltd (Blue Oil), the sixth defendant, Morgan Stanley Capital Group Inc (Morgan Stanley) (referred to in the Agreement as MSCG), and the first defendant Pioneer Energy Holdings Pty Ltd (Pioneer) (referred to in the Agreement as the Project Company).

5 Although it will not be necessary to refer to it in any detail, there was also a Head Contract for the construction of the Facility (the Construction Contract), the parties to which are the fourth plaintiff, Blue Diamond (Australia) Pty Ltd (Blue Diamond), and the seventh defendant, Pioneer Energy Pty Ltd (Pioneer Energy) (a wholly owned subsidiary of Pioneer).

6 Blue Oil and Morgan Stanley are the shareholders in Pioneer. Blue Diamond is undertaking the construction of the Facility pursuant to the Contract with Pioneer Energy. The construction is incomplete.

Shareholders Agreement

7 Blue Oil and Morgan Stanley agreed to participate in "an incorporated joint venture to undertake the Business" (Recital A) being "the construction, operation and maintenance of diesel fuel storage terminals and distribution facilities". It included "the storage or lease of storage facilities for diesel and the "distribution of wholesale diesel" in Australia (cl 1.1). Pioneer was established as the Project Company for the purpose of carrying on the Business.

8 Blue Oil and Morgan Stanley agreed to subscribe for shares in Pioneer and decided to "regulate the management and business activities" of Pioneer upon and subject to the provisions of the Shareholders Agreement (Recital C). Pioneer was to be "ultimately responsible" for the construction, operation and maintenance of the diesel terminals through its subsidiaries, the first of which was Pioneer Energy (cl 2.1).

9 Pioneer was to carry on and grow the Business in Australia and to ensure it was managed to maximise its value. It was also required to ensure that its processes and those of Pioneer Energy for making decisions were regulated in accordance with the Shareholders Agreement. Pioneer Energy was responsible for holding the Lease, the Pipeline Licence and the Wharf Licence of the Facility. It was also obliged to own, construct and supply equipment for and to commission the Works at the Facility (cl 2).

10 In accordance with their agreement to subscribe for Subscription Shares in Pioneer, Morgan Stanley subscribed for 75% of the issued Project Company Shares and Blue Oil subscribed for 15% of the issued Project Company Shares (cl 1.1). The Subscription Price for Morgan Stanley was $75, "calculated as $1.00 per share". The Subscription Price for Blue Oil was $15, "calculated as $1.00 per share" (cl 1.1).

11 The parties agreed that the Shareholders Agreement was subject to Conditions Subsequent being: (1) the provision of a Bank Guarantee (complying with a Deed of Priority and the Construction Contract) by Blue Diamond to Morgan Stanley within 15 days of the signing of the Shareholders Agreement; and (2) the execution of Transaction Documents (as defined) within 10 days of the signing of the Agreement (cl 4.1). In the event that either of the Conditions Subsequent were not fulfilled, Morgan Stanley could terminate the Agreement on the condition that it transfer all its Project Company Shares to Blue Oil in accordance with clause 30 (cll 4.3, 5.1). If Blue Oil were to terminate the Agreement on this basis then it and Pioneer were required to reimburse Morgan Stanley for the Subscription Price and any Initial Funding Amount paid by Morgan Stanley (cl 5.2).

12 The parties agreed that the Initial Funding, for the sole purpose of funding Pioneer Energy in the construction of the Facility, was to occur by the issuing of 51,777,948 million partly paid shares in Pioneer. Blue Oil and Morgan Stanley agreed to pay the balance of the amount for the shares in accordance with the Initial Funding Budget until the shares were fully paid. The Initial Funding Budget of $51,777,948 was to be paid in full by the end of 45 weeks. Morgan Stanley was to pay $38,833,461 (75% of the total). Blue Oil was to pay $12,944,487 (25% of the total) (cll 7.1-7.3; Schedule 1).

13 Amendment to the Initial Funding Budget could occur by simple majority consent of the Board of Pioneer if the increase were less than $5 million. An amendment of $5 million or more required the unanimous consent of the Board (cl 7.4). In the event of an amendment to the Initial Funding Amount, each shareholder was required to subscribe for the additional shares in their requisite percentages (75% and 25%) (cl 7.4(d)).

14 If there were any default in providing the Initial Funding (an Initial Funding Default) then a mechanism was agreed whereby each of Morgan Stanley and Blue Oil could require the other (defaulting party) to transfer to it the defaulting party's Project Company Shares (cll 7.6 and 7.7). It is this mechanism that is the subject of the separate questions and to which I will return in more detail later.

15 The parties also provided for a Working Capital Loan of $2.785 million to Pioneer. Morgan Stanley was required to lend no more than $2,088,750 (75%) and Blue Oil was required to lend no more than $696,250 (25%) (cl 8.1). The purpose of the Working Capital Loan was to fund incidental expenses related to the development and operation of the Facility that were not covered by the Initial Funding Amount (cl 8.4).

16 It is apparent that Blue Diamond had contributed $5.65 million to the project prior to the execution of the Shareholders Agreement. Pioneer was required to reimburse $5.65 million to Blue Diamond within 5 business days of the date on which the last Condition Subsequent was satisfied or waived in accordance with clause 4.2 of the Agreement (cl 9).

17 The parties also considered the possibility of the future funding of the project. If that proved necessary the parties were required to subscribe for additional shares in their requisite percentages (cl 10).

18 The parties also considered what would occur after the date of Practical Completion. It was agreed that Pioneer would procure Pioneer Energy to procure agreements with a customer for a term of two years or more for diesel to be supplied from the Facility with gross revenue totalling not less than $10 million per annum. If that did not occur then the parties agreed that Morgan Stanley could issue a written notice to Blue Oil and Pioneer notifying them that it would sell all its Project Company shares and those of Blue Oil (acting as the appointed attorney in accordance with clause 30.6) to an External Transferee (cl 11(c)). The proceeds of such sale would go to Morgan Stanley in an amount equal to its Subscription Price, its Initial Shareholding Funding Amount inclusive of the Working Capital Loan and any other amounts invested by Morgan Stanley in the project. The balance would then be paid to Blue Oil (cl 11(e)).

19 The parties also agreed that if Blue Diamond achieved practical completion on time and within budget, then Blue Oil would have the option to require Morgan Stanley to transfer to it 5% of its total number of Project Company Shares "for $1" (cl 22.2).

20 The parties also agreed on restrictions on competition (cl 23), the way in which future opportunities could be exploited (cl 24), and restrictions on the transfer of their shares to external parties (cl 25).

21 Blue Oil agreed that a change in its control without Morgan Stanley's consent would amount to a breach of the Shareholders Agreement. If this occurred Morgan Stanley had the option to require Blue Oil to transfer to it "for $1" 4 million Project Company Shares (cl 25.6(a)). It was also agreed that if Blue Diamond committed a Blue Diamond Change of Control Default under the Construction Contract or the Side Deed then Morgan Stanley had the option to require Blue Oil to transfer 4 million Project Company Shares to it for "$1 consideration" (cl 25.6(b)). Morgan Stanley and Blue Oil agreed that the option to require these transfers was "a genuine estimate of the damages" Morgan Stanley "will suffer as a consequence" of such Change of Control Default (cl 25.6(c)).

22 The parties defined various Default Events in respect of which the non-defaulting party could issue a notice to remedy the default within 14 days. If the default were not remedied, the non-defaulting party had the option to purchase the defaulting party's "interest in the Project Company at a Fair Market Value minus 10%" (cl 29).

23 The parties also agreed that if a dispute arose and continued for a period not less than 12 months, Morgan Stanley could elect to purchase Blue Oil's "interest" in Pioneer for Fair Market Value in accordance with clause 31 of the Agreement or to sell its Project Company Shares to Blue Oil or a third party for not less than the Fair Market Value (cl 33.4).

Background facts

24 The "Initial Funding Budget" amounts, $38,833,461 for Morgan Stanley and $12,944,487 for Blue Oil, were paid.

25 At a Pioneer Board meeting on 11 April 2013, the Board resolved, by majority, to increase the Initial Funding Budget by $4.99 million pursuant to clause 7.4(a) of the Shareholders Agreement and to issue new shares in Pioneer corresponding to the amount raised (the Resolution). Morgan Stanley was to fund 75% ($3,742,500) and Blue Oil 25% ($1,247,500) of the total amount, with the contributions to be received by 26 April 2013. Morgan Stanley paid its amount due under the Resolution.

26 Blue Oil did not pay the amount it was required to pay by 26 April 2013. On 30 April 2013 Morgan Stanley issued a notice in accordance with clause 7.6(a) of the Agreement requiring Blue Oil to pay the sum of $1,247,500 pursuant to the Resolution within 20 business days, by 28 May 2013. Blue Oil did not pay the amount by that date or at all.

27 Morgan Stanley has not purported to exercise its option pursuant to clause 7.6(b)(i) and the relevant defendants have given undertakings to the Court preventing Morgan Stanley from exercising the option for the time being.

Separate Questions

28 On 27 May 2013 orders were made for the determination of separate questions, which can be stated as follows:

1. On a proper construction of clause 7.6(b)(i) of the Shareholders Agreement, if Morgan Stanley requires Blue Oil to transfer to Morgan Stanley all its "Project Company Shares" as defined in the Shareholders Agreement, pursuant to clause 7.6(b)(i), is the amount payable by Morgan Stanley $1 per share or $1 for all of Blue Oil's shares? (Question 1)

2. If on the proper construction of clause 7.6(b)(i) of the Shareholders Agreement the amount payable by Morgan Stanley is $1 for all of Blue Oil's shares, is clause 7.6(b)(i) a penalty? (Question 2)

The hearing

29 At the hearing on the separate questions on 18 July 2013, Mr FM Douglas QC, leading Mr JC Conde, of counsel, appeared for the 3rd plaintiff (the plaintiff) and Mr IM Jackman SC, leading Mr D Klineberg, of counsel, appeared for the 2nd to 6th defendants.

The clause in question

30 Clause 7.6 of the Shareholders Agreement is in the following terms:

7.6 Blue Oil Initial Funding Default

(a) If Blue Oil fails to pay to the Project Company its Subscription Price or any Initial Shareholding Funding Amount (Blue Oil Initial Funding Default) then MSCG must issue a notice to Blue Oil demanding payment of the sum due within 20 Business Days of the date of that notice.

(b) Should Blue Oil fail to make such a payment to the Project Company in accordance with clause 7.6(a) then:

(i) MSCG has the option to require Blue Oil (Transferring Shareholder) to transfer to MSCG all its Project Company Shares for $1 to MSCG and the provisions in clause 30 will apply; and

(ii) Blue Oil must pay MSCG $2 million (this payment is the same as and not in addition to the ability of MSCG to call on the Blue Diamond Bank Guarantee referred to in clause 28).

(c) The Shareholders agree and acknowledge that the option to require the Share Transfer under clause 7.6(b)(i) and the $2 million payment under clause 7.6(b)(ii) is a genuine estimate of the loss and expense MSCG will incur as a consequence of a Blue Oil Initial Funding Default.

31 If Morgan Stanley committed an Initial Funding Default, Blue Oil was given a similar option pursuant to clause 7.7 as follows:

7.7 MSCG Initial Funding Default

(a) If during the Initial Funding Period, MSCG fails to pay its Subscription Price or any Initial Shareholding Funding Amount by the due date (MSCG Initial Funding Default), then Blue Oil must issue a notice to MSCG demanding payment of the Initial Shareholding Funding Amount within 20 Business Days of the date of that notice, and should MSCG fail to make such a payment to the Project Company within that time, then Blue Oil has the option to require MSCG to transfer all its Project Company Shares to Blue Oil for $1 and clause 30 applies. The Shareholders agree and acknowledge that the option to require the Share Transfer under this clause is a genuine estimate of the loss and expense Blue Oil will incur as a consequence of a MSCG Initial Funding Default.

(b) Blue Oil's rights against MSCG for an MSCG Initial Funding Default are limited to its rights under clause 7.7(a).

Other relevant provisions

32 Relevant expressions in the Shareholders Agreement are defined as follows (cl 1.1):

Compulsory Transfer Event in relation to any Shareholder, means each of those events specified in clause 30.1.

Project Company Share means any ordinary share in the Project Company, issued at any present or future time.

Share Transfer means any actual, proposed or compulsory transfer of any Project Company Share by any Transferring Shareholder under any transfer Provision.

Transfer Price means the price payable by any Transferee Shareholder for any Transfer Share as stipulated by the Transferring Shareholder or as specified in clause 30.5.

Transfer Provision means any provision of this agreement which provides for a Share Transfer.

Transfer Share means any Project Company Share comprised in any Share Transfer.

Transferring Shareholder means any Shareholder who at any time transfers, or proposes or is compelled to transfer, any Project Company Shares under any Transfer Provision.

33 Clause 30, referred to in clause 7.6(b)(i) and clause 7.7(a), provides relevantly:

30. Compulsory transfer

30.1 Compulsory Transfer Event

This clause 30 applies where a Shareholder exercises its right to require a Share Transfer following the occurrence of:

(a) termination of this agreement by MSCG (Transferring Shareholder) under clause 4.3 (Walk away);

(b) the application of clause 7.6(b)(i) where there has been an Initial Funding Default by Blue Oil (Transferring Shareholder);

(c) the application of clause 7.7(a) where there has been an Initial Funding Default by MSCG (Transferring Shareholder);

(d) the circumstances set out in clause 22.2;

(e) the application of clause 25.6(a)(ii) and 25.6(a)(iv) where there has been a Blue Oil Change of Control Default (Transferring Shareholder);

(f) the application of clause 25.6(b) where there has been a Blue Diamond Change of Control Default (Blue Oil is the Transferring Shareholder);

(g) the application of clause 29.5(a) where there has been a Default Event by a Shareholder (Transferring Shareholder); and

(h) the application of clause 33.4(a) where MSCG purchases Blue Oil's Project Company Shares as a consequence of a continuing Dispute,

(each a Compulsory Transfer Event).

...

30.3 Share valuation

If the Compulsory Transfer Event is a circumstance under clause 25.6(a)(iv), 29.5(a) or 33.4(a) then the Project Company must procure a Fair Market Value Assessment in relation to the Transfer Shares held by the Transferring Shareholder as soon as practicable and in any event within 45 days following receipt of actual notice of the Compulsory Transfer Event by the Project Company.

30.4 Continuing shareholder notification

The Project Company must within 5 Business Days of receipt of their Fair Market Value Assessment of the Transfer Shares notify each Continuing Shareholder of any Fair Market Value Assessment and the total number of Transfer Shares.

30.5 Transfer Price

The Transfer Price in each circumstance is:

(a) $1 if the transfer occurs as a consequence of clauses 5.1, 7.6(b), 7.7(a), 22.2, 25.6(a)(ii)or (sic) 25.6(b);

(b) the Fair Market Value of each Transfer Share minus 10% under the Fair Value Assessment if the transfer occurs as a consequence of clauses 25.6(a)(iv) and 29.5(a); and

(c) the Fair Market Value of each Transfer Share under the Fair Market Value Assessment if the transfer occurs as a consequence of clause 33.4(a).

Transfer Price of $1

34 The Transfer Price of $1 is payable "if the transfer occurs as a consequence of clauses" identified in clause 30.5(a) of the Agreement. That includes clause 7.6(b) and clause 7.7(a) referred to above.

35 It also includes clause 5.1 which provides that, in the event of termination of the Shareholders Agreement as a result of non-fulfilment of Conditions Subsequent, Morgan Stanley "must transfer all its Project Company Shares to Blue Oil in accordance with clause 30".

36 The next clause to which clause 30.5(a) applies is clause 22.2 which provides relevantly as follows:

22.2 Transfer

(a) In relation to Blue Diamond's obligations under the Head Construction Agreement, and in consideration of Blue Oil's influence and contribution to Blue Diamond achieving the desired outcome in constructing the Mackay Project in accordance with the approved budget, if:

(i) Blue Diamond achieves practical completion by the Date for Practical Completion (as extended in accordance with the Head Construction Agreement); and

(ii) the amount paid by Pioneer Energy to Blue Diamond under the Head Construction Agreement is no more than the original contract sum under the Head Construction Agreement (plus or minus any adjustments to the contract sum permitted by the Head Construction Agreement),

then, Blue Oil has the option to require MSCG to transfer that number of the Project Company Shares that MSCG holds which is equal to 5% of the total number of Project Company Shares to Blue Oil for $1.

(b) The Board will consent to the Share Transfer proposed under clause 22.2(a)(ii).

(c) No dividends shall be paid prior to the due date for the 5% Share Transfer referred to in clause 22.2(a).

37 The next clause to which clause 30.5(a) applies is clause 25.6(a)(ii) which provides as follows:

25.6 Consequences of a Blue Oil Change of Control and a Blue Diamond Change of Control

(a) Should Blue Oil be subject to a Blue Oil Change of Control without the consent of MSCG then:

...

(ii) MSCG has the option to require Blue Oil to transfer for $1 to MSCG 4 million Project Company Shares (or if Blue Oil's total shareholding in the Project Company is less than 4 million Project Company Shares, such lesser amount) and the provisions of clause 30 will apply;

38 The next clause to which clause 30.5(a) applies is clause 25.6(b) which provides as follows:

Should Blue Diamond commit a Blue Diamond Change of Control Default under the Head Construction Agreement or the Side Deed then in consideration of the influence and contribution Blue Oil makes to Blue Diamond, Blue Oil acknowledges and agrees that at MSCG's option it must transfer 4 million Project Company Shares (or if Blue Oil's total shareholding in the Project Company is less than 4 million Project Company Shares, such lesser amount) to MSCG for $1 consideration and that the provisions of clause 30 will apply to that Share Transfer.

Fair Market Value

39 The transfer price of Fair Market Value is applicable to Compulsory Transfer Events where Blue Oil commits a Change of Control default (cl 25.6(a)(iv)) and where one party commits a Default Event entitling the other to a Default Transfer (cl 29.5). In the former event Morgan Stanley has the option to purchase Blue Oil's remaining Project Company shares (beyond the 4 million referred to in cl 25.6(a)(ii)) at a Fair Market Value minus 10%. In the latter event the non-defaulting party is granted the option to purchase the defaulting shareholder's "interest" in the Project Company at Fair Market Value minus 10%.

40 Finally if there is a dispute that continues for not less than 12 months then Morgan Stanley can elect to purchase Blue Oil's "interest" in the Project Company for Fair Market Value (cl 33.4(a)).

Question 1

41 The plaintiffs contend that the expression "all its Project Company Shares for $1" in clause 7.6(b)(ii) means $1 per share. The defendants contend that the expression means $1 in total for all the shares.

42 The Shareholders Agreement is a commercial agreement and should be given a businesslike interpretation: McCann v Switzerland Insurance Australia Limited (2003) 203 CLR 579 at 589 [22] per Gleeson CJ; or a "commercially sensible construction": Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] AC 749 at 771 per Lord Steyne. However notions of businesslike interpretation and commercially sensible construction do not justify or permit "judicial rewriting" of an agreement in disregard of the language adopted by the parties: Schwartz v Hadid [2013] NSWCA 89 at [86] per Meagher JA; Miwa Pty Limited v Siantan Properties Pte Limited (2011) 15 BPR 29,545 at 29,549 [18] per Basten JA.

43 The Shareholders Agreement is between sophisticated parties who decided to regulate their business arrangements in accordance with what might be described as cascading obligations and entitlements. It is clear that the "Business" was wider than simply the project for the construction of the Facility. Clearly it was intended that Pioneer and its subsidiary Pioneer Energy, and any other later established subsidiaries, would develop the Business at least Australia-wide, for the exploitation of future opportunities in Western Australia, South Australia and New South Wales (cl 24.1). It is clear that the Initial Funding of $56.6 million ($51.7 million plus $4.9 million) was to be governed by a regime that provided an incentive to each of Morgan Stanley and Blue Oil to fund the project in a timely fashion. There were also incentives for Pioneer Energy to complete the construction of the Facility on time and on budget.

44 Immediately after the Shareholders Agreement was executed, Morgan Stanley and Blue Oil were to subscribe for the shares, as defined. Morgan Stanley was to receive 75 shares at $1 per share and Blue Oil was to receive 15 shares at $1 per share. The Conditions Subsequent were then to be satisfied and, if satisfied, then the phase of Initial Funding was to commence, with the payments totalling $51.7 million to be made over 45 weeks.

45 Clause 7.6(b)(i) allowed Morgan Stanley to require Blue Oil to transfer to it "all its Project Company Shares for $1" and the provisions in clause 30 were to apply to such transfer. Clause 30.5(a) refers to the "Transfer Price" of $1 if the transfer "occurs as a consequence of" 7.6(b). Although the concept of a transfer occurring as a consequence of a particular clause is peculiar, it is clear that the parties intended that if a transfer were to occur as a consequence of Morgan Stanley exercising its option pursuant to the provisions of clause 7.6(b), Blue Oil was required to transfer to it "all its Project Company Shares" for $1.

46 There are other provisions within the Shareholders Agreement that confirm that the parties intended that there would be circumstances in which the amount of only $1 would be paid for a large number of shares. For instance, if there were a change in control of Blue Oil without Morgan Stanley's consent, the parties agreed that Blue Oil, at Morgan Stanley's election, had to transfer "for $1" to Morgan Stanley "4 million Project Company Shares" (cl 25.6(a)(ii)). The expression "$1 consideration" in clause 25.6(b) emphasises that it is $1 in total and not $1 for "each" share.

47 The provisions of clause 5.1 are quite different from those in clause 7.6(b)(i) and clause 7.7. There is no reference to the transfer of shares at a particular price. Rather clause 5.1(b) provides that Morgan Stanley must transfer all its Project Company Shares "in accordance with clause 30". The Transfer Price in clause 30.5(a) for a Compulsory Transfer Event under clause 4.3 is $1.

48 Each of the clauses referred to in clause 30.5(a) (except clause 22.2) stipulates that the provisions of clause 30 "will apply" or "applies". The plaintiff submitted that it is important to read clause 30.5(a) with the definition of Transfer Price (cl 1.1) which provides that the price payable is in respect of "any" Transfer Share "as specified in clause 30.5". The plaintiff submitted that the word "any" means that the Transfer Price of $1 referred to in clause 30.5(1) is the price payable for each share.

49 The Walk Away provisions in clause 5.1 relate only to the early phase of the project before the Initial Funding phase. If the Conditions Subsequent are fulfilled the next phase of the relationship is the Initial Funding of the project. The first payment in the Initial Funding phase was to be made after the Conditions Subsequent were satisfied. The parties clearly contemplated that there would be expenditure of a large amount of money in the early construction phase of the Facility. This is evidenced by the large upfront payments in Week 1 of the Initial Funding Budget (totalling $12,616,287) and the requirement to reimburse Blue Diamond $5.65 million early in the Joint Venture relationship.

50 The defendants submitted that it is reasonable for the parties to have approached questions of value of this project in the Initial Funding phase as being on "an all or nothing basis". It was contended that it was open for the parties to conclude that should the Initial Funding not be paid to enable the completion of the construction of the Facility, one party would be left with a partly completed, worthless project. It was submitted that if the entire burden of the completion of the project were thrown upon the remaining party then the entire benefit would "follow suit".

51 The defendants also relied on the provisions of clause 22.2 which can reasonably be described as a commercial incentive to Blue Oil and Blue Diamond. Blue Oil was to receive 5% of Morgan Stanley's shares in return for payment of $1, if Blue Diamond completed the project on time and within budget. It was submitted that the provisions of clause 22.2 make it quite clear that whatever the value of the shares, whether more or less than $1 each, at the time of practical completion Blue Oil was guaranteed 5% of Morgan Stanley's shares for nominal consideration if the project was completed on time and on budget. It was submitted that this financial incentive would obviously be greatly diluted, if not undermined, if one were to read that provision as $1 for "each" share, because it depends on speculation as to whether the shares will ultimately be worth more or less than that amount. It was contended that the whole point of this clause is an incentive, "money in the bag", if the project is completed on time.

52 The plaintiff contrasted the consequences of a Financial Default Event under clause 29.1(c), a failure to pay any money (other than Initial Funding) within 10 business days of it becoming due with the consequences of an Initial Funding Default. It was submitted that if the defendants are correct, the party liable for a Financial Default Event, (say of failing to pay $200 within 10 days of the due date) is entitled to receive Fair Market Value for its "interest" in the Project Company minus 10%, whereas a party who may have paid $12 million in Initial Funding but defaults in the last $1.2 million is only entitled to receive $1 for all its shares in the Project Company. It was submitted that this could not have been the parties' intention. Notwithstanding this analysis (that is also relevant to the second question) I am of the view that the language that the parties employed in respect of the price to be paid for the compulsory transfer of shares for an Initial Funding Default makes clear the intention that it was to be for a total of $1.

53 The provisions in clause 30.5(b) and 30.5(c) dealing with Fair Market Value for Compulsory Transfer Events pursuant to cll 25.6(d), 29.5(a) and 33.4(a) refer expressly to "each" Transfer Share. The absence of such expression in clause 30.5(a) supports the construction that it is not $1 for "each" Transfer Share. The particular clauses referred to in clause 30.5(a) need to be construed in their individual contexts. They are quite different to the circumstances dealt with in the clauses pursuant to which the Fair Market Value is to be paid for "each" Transfer Share.

54 The plain meaning of the language used by the parties in clause 7.6 (and clause 7.7) that the transfer was for "all its Project Company Shares for $1" is that it was a transfer for the total amount of $1. This meaning is supported by the comparison with the other clauses in the Shareholders Agreement and the commercial imperatives of the project. The parties clearly intended that if in the important Initial Funding phase one or other party defaulted in its payments, at any stage, the other party could require transfer of all the defaulting party's Project Company Shares for the total price of $1.

55 The answer to Question 1 is that the amount payable by Morgan Stanley is $1 in total.

Question 2

56 The plaintiffs contend that clause 7.6(b)(i) is unenforceable as a penalty to the extent that it prevents the outgoing shareholder from receiving the subscription amount ($1 per share) or some other amount assessed by the Court as the proper value of the shares.

57 The defendants submitted that clause 7.6(b)(i) is not a penalty. It was submitted that, together with the mechanism in clause 30, it represents one of the ways in which the parties to the joint venture may end their relationship in the event of an Initial Funding Default. Clause 30 lists in detail the various events that result in the ending of the joint venture and provides for the Transfer Price for these various events.

58 The key features of the law of penalties are derived from the speech of Lord Dunedin in Dunlop Pneumatic Tyre Co Limited v New Garage and Motor Co Limited [1915] AC 79, adopted by the High Court in Ringrow Pty Limited v BP Australia Pty Limited [2005] HCA 71; (2005) 224 CLR 656 at 662-663 [11]-[12], and also as stated in Andrews v Australia and New Zealand Banking Group Limited (2012) 86 ALJR 1002 (described recently as "controversial" because it "broadens the reach of the penalty concept": JW Carter, Wayne Courtney, Elisabeth Peden, Andrew Stewart and GJ Tolhurst, "Contractual Penalties: Resurrecting the Equitable Jurisdiction" (2013) 30 Journal of Contract Law 99 at 101).

59 An attribute of a penalty as identified by Lord Dunedin in Dunlop Pneumatic Tyre Co Limited v New Garage and Motor Co Limited at 87 is "if the sum stipulated for is extravagant and unconscionable in amount by comparison with the greatest loss that could conceivably be proved to have followed from the breach". An agreed sum or other benefit can be characterised as a penalty if it provides "advantages significantly greater than the advantages which would flow from a genuine pre-estimate of damage" or "if it is out of all proportion to damage likely to be suffered as a result of breach": Ringrow Pty Limited v BP Australia Pty Limited at 667 (where in respect of the latter description Gleeson CJ, Gummow, Kirby, Hayne, Callinan and Heydon JJ were approving the statement by Mason and Wilson JJ in AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170 at 190).

60 In Andrews v Australia and New Zealand Banking Group Limited (2012) 86 ALJR 1002 at 1005 [10] French CJ, Gummow, Crennan, Kiefel and Bell JJ said (footnotes omitted):

In general terms, a stipulation prima facie imposes a penalty on a party (the first party) if, as a matter of substance, it is collateral (or accessory) to a primary stipulation in favour of a second party and this collateral stipulation, upon the failure of the primary stipulation, imposes upon the first party an additional detriment, the penalty, to the benefit of the second party. In that sense, the collateral or accessory stipulation is described as being in the nature of a security for and in terrorem of the satisfaction of the primary stipulation. If compensation can be made to the second party for the prejudice suffered by failure of the primary stipulation, the collateral stipulation and the penalty are enforced only to the extent of that compensation. The first party is relieved to that degree from liability to satisfy the collateral stipulation.

61 The plaintiff' submitted that (1) the acquisition of shares (the subscription price of which was approximately $13 million) for just $1, is "extravagant and unconscionable in amount by comparison with the greatest loss that could conceivably be proved to have followed from the breach"; (2) $1 is a sum less than the sum which ought to have been paid; and (3) is a sum "payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage": Dunlop Pneumatic Tyre Co Limited v New Garage and Motor Co Limited at 87 per Lord Dunedin; Ringrow Pty Limited v BP Australia Pty Limited at 662 [11] per Gleeson CJ, Gummow, Kirby, Hayne, Callinan and Heydon JJ.

62 The defendants submitted that clause 7.6(b)(i) is not a "collateral stipulation" which imposes an "additional detriment" upon Blue Oil to the benefit of Morgan Stanley due to the failure of Blue Oil to comply with clause 7.6(a).

63 The defendants also submitted that clause 7.6(b)(i), construed in conjunction with clause 30, provides the mechanism for the ending of the joint venture in the event of an "Initial Funding Default". In this regard the defendants relied upon the decision in CRA Limited v NZ Goldfields Investments [1989] VR 873. That was a case involving a joint venture relating to a goldmining project in which the joint venture agreement provided that if a party were in default for more than 60 days after receipt of a notice to remedy the default, the non-defaulting party was entitled to require the defaulting party to sell its interest to it at fair market value less 5 per cent. Tadgell J said at 875-876:

The essential purpose of cl 14(b) appears to me to be neither to compensate the non-defaulting party nor to punish the defaulting party. That is not to say that it is unconcerned to provide a measure of inducement not to default. It is primarily directed, in my view, to dealing with and accommodating a default in a fashion most conveniently suited to overcoming it in the interest of the progress of the joint venture project.

...

The context of cl 14(b) suggests that it is not concerned so much with the imposition of a liability as with the resolution of an impasse. The heads of agreement plainly contemplated that, by the time cl 14(b) was designed to attach or apply, a very considerable expenditure indeed would have been outlaid upon the project. Following a default of a kind that the provision contemplates, a period of at least 60 days must elapse before the non-defaulting party can exercise an option to require the defaulting party to sell its participating interest or to dilute it. By that stage the project could be expected to have run into at least serious commercial bother, and especially so if an amount of money in excess of approved budgets had been spent in advance and in accordance with the manager's entitlement to do so conferred by cl 12. The non-defaulting party, if prepared to ride out the problem, could be expected to encounter disruption, delay and expense of a disturbing order.

64 In Ringrow Pty Ltd v BP Australia Ltd (2003) 203 ALR 281 at 305, Hely J observed that CRA Limited v NZ Goldfields Investments was a case in which the entitlement of an innocent party to acquire the defaulting party's interest for no consideration, or less than market value, was not a penalty "because there was a sensible commercial reason why the provision was included unrelated to any issue of punishment of the defaulting party".

65 The defendants submitted that the same analysis applies equally to cl 7.6(b)(i) of the Shareholders Agreement in this case following a notice issued in accordance with cl 7.6(a).

66 The plaintiff submitted that there are similarities between this case and Jobson v Johnson [1989] 1 All ER 621. In that case the defendant entered into an agreement with the vendors for the purchase of shares in a football club by an initial payment of £40,000 with a provision for six instalments of £51,948, payable half-yearly. The agreement provided that if the defendant defaulted on the payment of any of the instalments, he was required to transfer the shares back to the vendors for the sum of £40,000. At the time of the default, the defendant had paid £140,000. At first instance the clause was ruled to be a penalty and this ruling was not challenged on appeal.

67 Dillon LJ said that the ruling was "plainly right" for two reasons. The first was that it would make no difference if the default were in the payment of the second, the last, or an intermediate instalment, because the price was fixed at £40,000 without regard to how much the defendant had already paid. The second reason was that there was also a side-letter providing for re-purchase at an even lower price in the event of default in payment of the first instalment, when the defendant had only paid £40,000. Dillon LJ concluded that on a plain reading of the relevant provision, the defendant was to be "punished for any default" by being bound to retransfer the shares at a fixed price which was bound to be less than the price the defendant had paid. His Lordship also concluded that the retransfer price "could not have been based on a genuine pre-estimate" of any loss or the value of the shares (at 625). In that same case Kerr LJ described the relevant provision as subjecting the defendant to the same liability "irrespective of the gravity and consequences of the breach" (at 638).

68 The plaintiff also relied upon Mosaic Oil NL v Angari Pty Ltd (1990) 20 NSWLR 280 where Young J (as his Honour then was) was dealing with a clause in a Deed that provided for the transfer of an insolvent party's participating interest in a business to a non-defaulting party free of all liens, charges and encumbrances. The questions before his Honour included whether the clause was a penalty. After referring to the circumstances in Forestry Commission of New South Wales v Stefanetto (1976) 133 CLR 507, his Honour observed that there may be a necessity for the health of a joint venture as a whole that an insolvent party should have no interest in it. His Honour then said, at 283-284:

However, this case goes far beyond the situation where a person permits the use of his tools of trade and equipment after bankruptcy in order to complete the joint venture. It goes far beyond the case of merely excluding the person from further participation in the joint venture: it goes to the extent of completely forfeiting all of his interest in the joint venture. The effect of this may be that the share of the bankrupt co-venturer which, immediately before bankruptcy, was worth millions of dollars, may become absolutely worthless and the shares of the other co-venturers proportionately increased in value. If the provision were not otherwise invalid, it seems to me it would be invalid as a penalty.

69 The fact that the parties expressly agreed that the option to require the share transfer under clause 7.6(b)(i) and the $2 million payment under clause 7.6(b)(ii) was a "genuine estimate of the loss and expense" that Morgan Stanley would incur as a consequence of Blue Oil's Initial Funding Default is not determinative or conclusive: Dimech v Corlett (1858) 12 Moo PC 199 at 229; 14 ER 887 at 898; Commissioner of Public Works v Hills [1906] AC 368 at 375.

70 In determining this question, the construction of the clause is approached from a different perspective to the construction of the clause in respect of the determination of the first question. In determining the first question it was necessary to have regard to the language used, the surrounding circumstances, the expressed intention of the parties and notions of businesslike interpretation and commercial commonsense. In deciding this question it is important to have regard to substance and legal operation: JW Carter, The Construction of Commercial Contracts (2013 Hart Publishing) [2-28]. In determining the answer to the first question, it was necessary to construe the meaning of the clause. In determining the answer to the second question it is necessary to determine the character or nature of the clause, whether it is a penalty.

71 In CRA Ltd v NZ Goldfields Investments the provision on breach was for transfer of the defaulting party's interest in the joint venture at fair market value minus 5%. The "good commercial reason" for the 5% discount on the fair market value was because there was a 60-day notice period during which the joint venture could get into "serious commercial bother" to the burden of the remaining joint venturer. The notice period in the present case was only 20 business days and the degree of commercial bother that could befall the venture would very much depend upon when the default might occur. A discount of 5% on fair market value is quite different from the present case in which there is a requirement on the defaulting party to transfer all of its interest in the joint venture for effectively no value.

72 The payment of $1 was applicable irrespective of how much the defendant had already paid. As in Jobson v Johnson, it would make no difference if the default occurred in the payment of the second, the last or an intermediate instalment.

73 It may be that as the defendants submitted (see [63] above) clause 7.6(b)(i) provides a mechanism for ending the joint venture. However it is not necessary to require Blue Oil to forfeit its interest in the joint venture to effect the termination of the joint venture.

74 Although the defendants submitted that the figure of $1 was appropriate because Morgan Stanley would be left with a worthless, partially completed Facility in the event of an Initial Funding Default that would depend very much on the date of the Default. If the Default occurred at an early stage of the Initial Funding phase that claim may have more force. However the later the breach the greater the likelihood that the Facility would be worth a great deal more. Blue Oil's loss of the whole of the value invested in the joint venture is out of all proportion to the breach. This is a punishment for the default.

75 Notwithstanding that the parties' intentions may have been to utilise this clause as an incentive for prompt payment, I am satisfied that it is a penalty.

76 The answer to Question 2 is "Yes".

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Decision last updated: 19 August 2013