SMSF investors awarded damages in recent litigation case

The plaintiffs in this case included trustees for two SMSFs, trustees for a family trust and three other investors. The plaintiffs invested $950,000 in Mediation & Online Dispute Resolution Operating Network, a start-up company founded by website designer Nathan Polito.

The company was commercialising an online dispute resolution system, referred to as “Modron”.

The investors sought damages from Mr Polito by reason of his contravention of sections 1041H and 1041E, Corporations Act 2001 (Cth), and section 12DA, Australian Securities and Investments Commission Act 2001 (Cth). They also sought damages from his company, Intergalactic Federation, as being involved in the contravention within the meaning of section 79 of the Corporations Act 2001 (Cth).

Mr Polito was asked to assist in developing an online platform for mediations by a barrister. A company was incorporated called Modron. Mr Polito fell out with the barristers and mediators with whom he was working to develop Modron. Modron no longer traded.

He wanted to protect the intellectual property in Modron, but there was an issue as to the intellectual property rights where he had begun working on the Modron project for others. 

In February 2015, Intergalactic Federation was incorporated, with Nathan Polito as sole director and shareholder. It was intended that this company would hold the intellectual property rights. 

In April 2015, Mediation & Online Dispute Resolution Operating Network was incorporated with, again, Nathan Polito as sole director and shareholder. It was intended that this would be the operating company. Mr Polito set up the company by buying a “shelf company” and was provided with a number of documents, including a template constitution.

In May 2015, the barrister provided Mr Polito with a draft IP Deed of Assignment for review, which proposed that Mr Polito, as creator of the intellectual property relating to Modron, would assign his intellectual property rights in the technology to Intergalactic Federation as trustee for the Modron Alpha Trust. The barrister advised Mr Polito that he would need to register the deed and pay duty.

In June 2015, the barrister provided Mr Polito with a draft IP Licence Agreement between Intergalactic Federation as trustee for Modron Alpha Trust (as licensor) and the start-up company (as licensee). The agreement noted that Intergalactic Federation owned the intellectual property in Modron and wished to grant an exclusive licence of the intellectual property to the start-up company, with the intent that it would commercialise the intellectual property. The agreement could be terminated by either party without cause by serving three months’ notice of termination in writing.

In addition to these two documents, the barrister advised that he would start to prepare his own consultancy agreement “with both the operating company and the trustee of the Modron Alpha Trust”.

The barrister explained that this was because the trust could “pull the plug at any time on the operating company and the operating company will not hold any assets other than operating revenue. All real wealth will be in the trust”.

Justice Rees stated that it was plain from the barrister’s explanation that the purpose of the IP structure was for the real wealth, being the intellectual property rights, to be held in the trust, whilst the business of commercialising the product would be conducted by the operating company. Should the business operations prove unsuccessful, then the intellectual property rights were safe.

Whether Mr Polito signed these documents at the time or much later on 19 July 2017 or both was a contested factual issue in the case.

The barrister was then contemplating taking an equity stake in the business. Mr Polito wanted to ensure that his control as sole director and shareholder would not be diluted. On 15 August 2015, Mr Polito amended the original constitution to ensure that he did not lose control of the intellectual property or the company if a dispute occurred with its shareholders.

The effect of the amendments was to permit a director who held at least 75 per cent of the operating company’s votes as a member, as Mr Polito did, to take unilateral action, without notice to other directors or members, in relation to the removal of fellow directors, the removal of the managing director, the holding of meetings of directors, the passing of directors’ resolutions and the execution of company documents, and to increase the voting power of any director who held at least 75 per cent of the shares.

Mr Polito did not share the document with the barrister but left it with his father for safekeeping. The plaintiffs contended that Mr Polito continued to secret the amended constitution when they came to invest in the company two years later.

Ms Nicols and Mr Polito went to high school together. In July 2016, they met by chance. Over time, they began to discuss Ms Nicols joining the company. In December 2016, Mr Polito offered Ms Nicols the role of managing director. Ms Nicols said she would need to do some due diligence before proceeding. On 12 December 2016, Ms Nicols sent an email to Mr Polito asking a series of questions about her salary, the current financial position of the company and its current shareholders.

Ms Nicols also made inquiries about whether Mr Polito had protected his idea or creation from those that originally asked you to create this platform several years ago.

Based on her evidence, Mr Polito was dismissive in his response and assured her that he had changed the original idea that was presented to him.

She also asked him to provide a copy of the company’s constitution. According to Ms Nicols, Mr Polito provided her with a hard copy of the original constitution, which Ms Nicols took home and reviewed, considered to be generic in nature and returned to Mr Polito. According to Mr Polito, he provided her with a copy of the amended constitution. Ms Nicols denied this.

On 31 January 2017, Ms Nicols entered into a consultancy agreement with the company, becoming managing director. Shortly after this in June 2017, the company looked to raise capital in order to be able to apply for a government grant.

Mr Nicols, Ms Nicol’s husband, suggested that he may be able to raise capital through family and friends.

One of the plaintiffs, Mr McCartney, was provided with the original constitution by Mr Nicols, which he reviewed; the constitution appeared to be generic and unexceptional, providing no barrier to making an investment in the company. Mr McCartney said the amended constitution would have been “an absolute deal breaker” for him as it gave almost complete control of the company to any individual investor controlling over 70 per cent of the shares.

Based on an information memorandum from Mr Nicols, Mr McCartney was also under the assumption that the intellectual property was held by the operating company.

Mr McCartney invested $250,000 in the company via his superannuation fund. Had Mr McCartney been aware, prior to investing, that the company did not have the intellectual property in the software and digital platform that it was to commercialise, he would not have invested in the company on any basis.

Mr Nicols and his wife invested $400,000 in the operating company via their superannuation funds. Similarly, had Mr Nicols been aware of the amended constitution, he would not have invested in the company, as the constitution provided that an individual shareholder controlling more than 75 per cent of the shares, as Mr Polito did, could unilaterally terminate the managing director, Ms Nicols, who was Mr Nicols’ only connection with the company. Further, had Mr Nicols understood at the time that the company did not hold the intellectual property in the Modron system and software, he would not have invested in the company at all.

This was also the case for the other plaintiffs involved in the proceeding.

In early 2018, there appears to have been a disagreement between Ms Nicols and Mr Polito, in particular, in respect of the number of shares which had been agreed would be issued to Mr Nicols for his assistance in the capital raise. 

On 28 March 2018, Mr Polito lodged a Form 484 Change to Company Details with ASIC, advising that Ms Nicols had ceased to be a director and secretary of the company effective 27 February 2018. Ms Nicols said that this form was lodged without her knowledge or consent.

In about April 2018, Ms Nicols became aware that she had been removed as director and secretary of the company. In May 2018, the existence of the amended constitution also came to light when one of the investors wished to sell their shares in the company and Mr Polito offered the shares to other investors.

The plaintiffs alleged that Mr Polito engaged in misleading and deceptive conduct by making two misrepresentations:

One was that the company was governed by a constitution that was generic and standard in form when, in fact, he had radically amended the constitution to give himself unilateral control over the company, including removing other directors without notice (the constitution representation);

The other was that he had assigned the intellectual property rights in Modron to the company when, in fact, Mr Polito had assigned the intellectual property rights to Intergalactic Federation (the IP representation).

The court found that the representations that were made contributed to the plaintiffs’ loss. 

“They would not have invested substantial funds in the company absent their understanding – engendered by the representations – that the company owned the intellectual property in Modron and was governed by a constitution in unexceptional terms,” stated Justice Rees.

Justice Rees made an order declaring that Nathan Polito has engaged in conduct that was misleading or deceptive, or likely to mislead or deceive, in contravention of section 1041H of the Corporations Act 2001 (Cth) and section 12DA of the Australian Securities and Investments Commission Act 2001 (Cth).

The court also awarded damages to the plaintiffs against the defendant, with the defendant ordered to pay $950,000 in total.