The Court applied the plain language and the commercial imperatives of the parties to interpret the terms of a shareholders agreement to require a party who failed to contribute further board approved funding to transfer its shares for only nominal consideration of $1 in total (despite the fact that it had already contributed a significant sum). However in this case, the Court went on to find that such a clause was out of proportion to the shareholder’s breach and therefore a penalty. Contracting parties should ensure clear and tight drafting of default clauses to avoid adverse interpretation by a Court, which may not be minded in the circumstances to ‘save’ a defaulting party with a penalty construction.

Blue Oil Energy Pty Ltd (Blue Oil), Morgan Stanley Capital Group Inc (Morgan Stanley) and Pioneer Energy Pty Ltd (Project Company) (owned partly by each of Morgan Stanley and Blue Oil) entered into a shareholders agreement for the construction and operation of an oil shipping terminal in Queensland by the Project Company (Project) (Shareholders Agreement). Under the Shareholders Agreement:

  • the Project Company board could increase the Initial Funding Budget for the Project by up to $5,000,000 by simple majority (and by unanimous board consent for increases of $5,000,000 or more), in which case Blue Oil and Morgan Stanley were to contribute such further funding in proportion to their shareholdings;
  • if a shareholder failed to contribute further funding, the other shareholder could require that defaulting shareholder to transfer all of its Project Company Shares “for $1”, which was acknowledged to be ‘a genuine estimate of the loss and expense’ the non-defaulting shareholder ‘will incur as a consequence’;
  • a failure to contribute further funding also triggered the compulsory transfer regime in the Shareholders Agreement (which also referred to a “Transfer Price” of $1 for a transfer occurring as a result of a failure to contribute further funding); and
  • there were other provisions which also operated such that only $1 would be paid for a large proportion of shares.

The Project Company board voted to increase the Initial Funding Budget by $4,990,000. Blue Oil failed to contribute its proportion of funding and Morgan Stanley sought to exercise its right to acquire Blue Oil’s shares in the Project Company.

In finding that the total consideration payable by Morgan Stanley to Blue Oil was $1 in total (as opposed to $1 per share as argued by Blue Oil), Bergin CJ found that:

  • the Shareholders Agreement should be given a ‘businesslike’ interpretation without “judicial rewriting” of the language adopted;
  • it was intended to put in place incentives for the parties to fulfil their obligations such that the venture could eventually expand to Australia-wide operations;
  • the plain meaning of the clauses required that the shares be transferrable for $1 in total, and this was supported by the language used in other similar clauses of the agreement, as well as the commercial imperatives of the Project.

However, Bergin J found that the clause dealing with Blue Oil’s failure to contribute further funding was a penalty. The fundamental issue was that it took no account of the stage of the Project at which the default occurred. If the default had occurred at an earlier stage, Morgan Stanley’s argument that it would be left with a worthless, partially completed facility would have had more force. Here however, Blue Oil was set to lose the entire value of its investment despite having already made a substantial contribution to the funding of the Project, which was all out of proportion to the breach and therefore a ‘punishment’ for the breach.

See the case.