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Redefining applications for preliminary discovery

Applications for preliminary discovery are usually made by a party in order to obtain documents from another person (or prospective defendant) to assist them to deciding whether or not they should commence proceedings.  

On 28 September 2018, the NSW Court of Appeal handed down a key decision in the case of O’Connor v O’Connor [2018] NSWCA 214, which clarified the requirements for obtaining an order for preliminary discovery under Part 5 Rule 3 of the Uniform Civil Procedure Rules 2005 (NSW) (“UCPR 5.3”).  Coleman Greig Lawyers are the solicitors for the appellants in this particular matter.

The Facts of the Case

By way of background:

  • The company Diona was incorporated in 1980 and carried on business in the construction industry.  John O’Connor held three of the four issued shares in Diona, with his wife Margaret O’Connor holding one share.  
  • In 2005 Morgan O’Connor and Michael Stack each contributed $150,000 to Diona on the understanding that they would be entitled to a 1/12th shareholding of Diona.  No shares were in fact issued to them, although in 2006 both Morgan and Michael were appointed directors of Diona and were treated as shareholders.  
  • A dispute arose with regard to the issuing of shares to Morgan and Michael, which resulted in protracted negotiations between the parties from 2009 – 2013.
  • By mid-2013 the parties were unable to resolve the dispute and both Morgan and Michael were removed as directors by a meeting of shareholders (that is, John and Margaret O’Connor) without prior notice.
  • On 6 November 2014, Michael commenced proceedings against both Diona and John O’Connor in the Supreme Court, where he sought declaratory relief, and orders to the effect that he was a shareholder and had an interest in Diona.  He claimed a contractual entitlement to the issuing of shares representing 1/12th of the ordinary share capital of Diona.  Morgan did not commence proceedings, but asserted his entitlement was identical Michael’s.
  • The disputes between the parties were resolved by a Deed of Mutual Settlement and Release (‘the Deed’) which was executed on 29 July 2015.  The Deed provided that Morgan and Michael would settle their claims against John and Diona, by Diona paying them, respectively, the sums of $1,380,000 and $1,680,000 “in full and final settlement of the Diona Proceedings”.
  • On or about 16 November 2015, Calibre Ltd purchased all shares in Diona from John and Margaret for a purchase price of $45 million, with a potential further $45 million to be paid to them subject to Diona’s successful performance.  

First Instance Hearing

Following Calibre’s purchase of all sales in Diona a few months later, Morgan and Michael believed that the negotiations with Calibre had already begun at the time that the Deed was executed, and that both Diona and John were aware of the potential for the sale.  They claimed that John and Diona owed each of them a fiduciary duty, had in turn breached that duty, and that John held a 1/12th shareholding in Diona on trust for both Morgan and Michael, which meant that both had an equitable interest in Diona because of their shareholding.

Morgan and Michael contemplated that proceedings may be commenced against John and Diona for their breach of fiduciary duty arising out of an asserted trust relationship (per Brunninghausen v Glavanics [1999] NSWCA 199), and Calibre for their knowing receipt of trust property, or knowing participation in a dishonest breach of fiduciary duty.

If this claim could be substantiated, then they could seek an account of profits for the difference between the amount they received under the Deed and a 1/12th share of the purchase price under the sale to Calibre (approx.  $11.9 million).

Consequently, Morgan and Michael sought orders in the Supreme Court for preliminary discovery under UCPR 5.3 to determine whether such claims were maintainable.  In their application, they sought five classes of documents from John, Diona and Calibre (the prospective defendants), including documentation evidencing the negotiations that resulted in that transaction, documentation specifically relating to the value of the claim being put forward by the pair, plus any defences available to any prospective defendants.

In the first instance, the Primary Judge dismissed the application based on the following:

  • Morgan and Michael had not met the threshold required under UCPR rule 5.3, namely that they had failed to establish that there was “reasonable cause to believe” that John  was obliged to disclose a potential deal with Calibre, or that there were any “special facts” resulting in a director of a company owning shareholders fiduciary duties; 
  • The categories of discovery were too broad, thus the judge would not order discovery in relation to documents linked to the overall value of Morgan and Michael’s claim; and that
  • Morgan and Michael should have alternatively tried to set the Deed aside, that the releases contained in the Deed had prevented them from bringing a future claim and that the Deed represented a surrender of any rights they previously had.  

The Appeal

The decision of the Primary Judge as it related to John and Diona was subsequently appealed on the following grounds:

  1. An error in the failure of the Primary Judge to find that John O’Connor and Diona owed them a fiduciary duty;
  2. An error in the conclusion that the Deed was a complete answer to any claims that the appellants might have contemplated; 
  3. That it was inappropriate and premature for the primary judge to decide the merits of the potential claims that Morgan and Michael had contemplated in an application for preliminary discovery; and
  4. The Primary Judge was incorrect to have decided that in the event that he ordered discovery of the documents, he would have excluded documents that solely related to the value of Morgan and Michael’s potential claim.  

The Court of Appeal considered a number of recent decisions made by the Full Court of the Federal Court of Australia relating to the counter part of UCPR 5.3.  Those decisions criticised the developing practice of treating applications for preliminary discovery as “mini trials”, as this is well beyond the scope of the pertinent rules.

Relevant to this, the court noted that the test to be applied under UCPR 5.3 is wider than the test to be applied under the corresponding Federal Court rule.
The court found that the Primary Judge appeared to have decided that at that stage, John owed no fiduciary duties to Morgan and Michael, rather than allowing the merits of that cause of action to be determined as a fully argued claim for relief.

Similarly, the Primary Judge had prematurely determined the merits of Morgan and Michael’s potential claim in deciding that the Deed prevented them from bringing any future claim.  The Court of Appeal commented that such a conclusion could only be made after a close examination of the release clauses in the Deed, and that this type of examination cannot occur at the hearing of an application for preliminary discovery (i.e.  an interlocutory stage).

As such, the court found that the wrong test had been applied in the first instance.  It was not necessary for Morgan and Michael to establish that there was “reasonable cause to believe” that John was obliged to disclose any approaches from Calibre.  UCPR 5.3 imposes no “reasonable cause to believe” test, nor does it require the applicant to establish that the prospective defendant “was obliged” to do anything.   Rather, the correct test is whether it “appears to the court” that a cause of action “may” exist – which is a lower threshold that the one considered by the Primary Judge.

With regard to the scope of documents that may be sought under UCPR 5.3, the court found that documents sought under this rule must relate to the practical decision over whether or not to commence proceedings.  These documents can include those that answer questions such as whether there are any defences that might defeat the claim, and whether a claim would potentially be worthwhile (i.e.  whether the value of the claim would justify the cost of any proceedings).

Accordingly, the court allowed the appeal and ordered that the respondents pay Morgan and Michael’s costs of both the initial proceedings and the appeal.

Points to Take Away

The court made a number of other relevant observations in relation to this matter:

a) The determination of an application for preliminary discovery under UCPR 5.3 does not involve the determination of the merits of any claim for relief that an applicant might put forward;

b) The test to be applied under UCPR 5.3 is whether it appears to the court that a cause of action may exist; and

c) Documents of which discovery may be ordered under UCPR 5.3 are not limited to those relating to the entitlement to make a claim, but extend to documents going only to the overall value of a potential claim, as well as any defences that may be available to prospective defendants.

If you have a query relating to any of the information in this piece, or you would like to speak with one of Coleman Greig’s Accredited Specialists with regard to the potential use of preliminary discovery in your own matter, please don’t hesitate to get in touch with our Litigation and Dispute Resolution team.


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