As a follow-up to our previous article on the issues and risks associated with the same person wearing multiple ‘hats’ within a business, we summarise the recent High Court judgment in the case of Mediaflow Limited v Lucas Marin [2024] NZHC 5369. 

This case serves as a cautionary tale in action, and illustrates that the costs and consequences of having ill-defined and overlapping employee-shareholder-director roles are not merely theoretical. The issues are real, many, and varied, but can be mitigated with quality legal guidance and input at the front end - a point well made by the Judge himself in his concluding observations.

Overview

A dispute arose between two director/shareholders of Mediaflow Limited (Company), David Akal (Akal) and Nahuel Lukomski (Lukomski), and the Company’s third shareholder/director, Lucas Marin (Marin).

The dispute concerned two issues:

1. money paid by the Company to Marin; and
2. control of software, source code, and other services and tools paid for and used by the Company.

Akal and Lukomski used their majority control of the Company to bring proceedings against Marin, which sought summary judgment and an interim injunction.

Background to disputes

Marin had relevant experience as a software engineer in automated media production. Akal and Lukomski sought Marin out in June 2020 to assist them with their new startup which intended to provide digital photo and video recording equipment and services to various tourism operators in Queenstown. 

The three men incorporated the Company on 7 July 2020, with each of them holding 33% of the shares and being directors of the Company. 

Difficulties soon arose and the relationship between Marin and the other two shareholders soured for various reasons. Akal said Marin restricted his access to software and source code, thereby preventing Akal from being able to deal with clients and maintain hardware. While Marin said Akal and Lukomski began to withdraw from the business in late 2021 and early 2022. In September 2022, Akal and Lukomski withdrew $12,000 from the Company’s bank account without Marin’s permission, before resigning as directors of the Company. They considered selling their shares in the Company and advised the Company’s commercial partners of their departure.

Employment Agreement 

Marin was left to run the business on his own. To assist, Marin engaged a contractor, Hyperfocal Limited, from June 2023. On 12 December 2022 after Akal and Lukomski had stepped aside, Marin formalised an employment agreement between himself and the Company which provided for a gross annual salary of $500,000, payment of 12 months’ salary in the event of redundancy, and no restraint of trade restrictions upon termination of his employment (Employment Agreement).

On 6 June 2023, Akal and Lukomski reappointed themselves as directors of the Company, and discovered that the Company had paid Marin more than $183,000 between December 2022 and May 2023 under the Employment Agreement, without their knowledge or approval. The Company promptly reduced Marin’s annual salary to $180,000, and then again to $130,000 from August 2023. As at 31 August 2023, the total amount received by Marin under the Employment Agreement was close to $270,000. 

The Company avoided the Employment Agreement under section 141 of the Companies Act 1993 (Companies Act) on 20 September 2023 and resolved to negotiate a new contract with Marin with a salary of $700 per week, which was later increased to $908 per week.

On 30 July 2024, Marin resigned as an employee of the Company with immediate effect, and alleged that the Company had constructively dismissed him.

Access to Company software and source code

Marin and Lukomski alleged that Marin:

1. continued to withhold access to Company-owned software and source code; and
2. claimed that he, rather than the Company, was the legal owner of the software and source code. 

Whereas, Marin said:

1. he restricted Akal’s access to the software and source code before he resigned as a director, to avoid the risk of Akal damaging it; 
2. Akal’s lack of programming experience had previously caused problems;
3. Akal did not require access to the source code to perform his role; and
4. Akal and Lukomski now have access to everything they need to resume the roles they had before they resigned as directors.

Orders sought

The Company sought the following orders, each of which were opposed by Marin:

1. Summary judgment application: This was for upwards of $205,000, being the salary authorised by Marin to be paid by Mediaflow to himself which was not approved by the other shareholders nor validly authorised under section 161 of the Companies Act as being fair to the Company; and
2. Interim injunction application: This required Marin to deliver to the Company all source code and related software, services and tools used for the purposes of its business, which he had refused to deliver and had asserted ownership of.

For the summary judgment application, the issue to be determined by the Court was whether Marin had an arguable defence under section 161 of the Companies Act to the claim for repayment of circa $205,000. 

In respect of the interim injunction application, the issue was whether there was a genuine question to be tried in respect of the ownership of the source code, software, and other services and tools paid for and used and used by Mediaflow, and whether the balance of convenience and overall justice of the case favoured the making of orders requiring Marin to deliver to Mediaflow the intellectual property resources paid for and used by it.

Summary judgment application - dismissed

On the first order sought to obtain summary judgment, Mediaflow had to demonstrate that there was no real question to be tried, and without any real doubt or uncertainty, Marin had no defence to the claim.

Mediaflow pleaded that the payments to Marin were plainly unfair to the Company for the purposes of s 161 of the Companies Act and should be repaid for reasons including:

1. the payments under the Employment Agreement were much higher than the payments all three shareholders had previously received, despite the services and financial performance of the Company not materially changing;
2. the payments were  not justified by reference to the market value of the work carried out by Marin;
3. the payments were disproportionate to the Company’s total turnover and exceeded its gross profit for the period, causing the business to run at a loss;
4. the payments significantly reduced Mediaflow’s net assets;
5. the payments were not approved by any valid Board resolution or contract, and were made without consultation with the other shareholders, where those shareholders were actively seeking financial information about the Company and where such payments constituted a major transaction;
6. the payments were not supported by a forecast increase in sales or performance due to work carried out by Marin;
7. Marin was not doing more work than all shareholders were doing prior to Akal and Lukomski resigning as directors, and he had also engaged a third party contractor for $15,000 per month without justification.

By way of counterargument, Marin sought to show a tenable basis on which the payments he received from the Company were fair at the time they were made and therefore in accordance with s 161 of the Companies Act. The leading case on the issue, Madsen-Ries v Petera [2016] NZCZ 103, [2018 2 NZLR 500, found that the test under s 161 was an assessment of fairness in a general sense based on the particular facts of the case, by reference to factors such as whether the company derived full value from the work.

In the Judge’s view, it was reasonably arguable that Mediaflow had gained full value from the work carried out by Marin, notwithstanding the large amount of money paid to him in proportion to the Company’s turnover. Rather, the Company had progressed relatively steadily and successfully without an increased risk of failure resulting from the payments. Further, Marin’s peak remuneration was predominantly at a time when he was the only shareholder who was working in the business.

Therefore, the Court adduced that there was an insufficient basis upon which it could definitively conclude that Mediaflow did or did not gain full value from the work carried out by Marin during the period he was sole director and had sole responsibility for the operation of the Company. Also, that it seemed likely that Mediaflow was able to derive a profit and successfully continue in business because of Marin’s work.

The Court was satisfied that Marin had established an arguable defence to Mediaflow’s claim that the payments were not fair to the Company and a tenable basis for saying that the payments he authorised and received were fair to the Company at the times they were made. The Court was not left without any real doubt or uncertainty that Marin had no defence. Accordingly, Mediaflow’s summary judgment application was dismissed.

Interim injunction application – granted

In the second order, Mediaflow pleaded a breach of intellectual property rights and sought to obtain access to, and restrain Marin from using, certain source code and software in relation to the business.  The allegations in this regard were that:

1. the computer software, source code, and all other services, resources, and tools used by the business were the intellectual property of Mediaflow;
2. the source code, web services, and tools were created collaboratively by the shareholders for the use and benefit of Mediaflow;
3. to the extent Marin developed any intellectual property, he either:
   1. was commissioned or employed to do so by Mediaflow, or did so in his capacity as a director of Mediaflow, in which case, Mediaflow owns it; or
   2. did so in his capacity as a director of Mediaflow, in which case, he owns it on trust for Mediaflow and must assign it to Mediaflow when called upon to do so.

Marin denied all of the above scenarios and added a counterclaim against Mediaflow that it had converted his client delivery software and all copyright in it by issuing these allegations against him and asserting ownership of it. Marin sought a declaration from the Court that the software and all copyright therein was owned by him.

Suffice to say, the parties could not have been further at odds in this matter, and both produced arguments in support of their polar positions. Ultimately though, the Court considered that Mediaflow had adduced sufficient evidence to satisfy the Court that there was a real prospect it may succeed in its claim for a permanent injunction in relation to the software and source code. 

As to the well-settled elements of the test for obtaining an interim injunction:

1. The Court accepted that there was a serious question to be tried for the purposes of its injunction application as to whether Marin’s work in developing the software was done for Mediaflow’s benefit. 
2. The Court was of the view that the balance of convenience favoured relief for Mediaflow and concluded that Mediaflow would likely suffer unjustifiable detriment if the status quo continued. That is, unless access to the source code and software was provided, the Company would be impeded from operating as it needed to.
3. In terms of where the overall justice of the case lay, the Court ruled in Mediaflow’s favour. This was on the basis that, whatever the merits of intense disagreement between the parties, it was in the interests of the Company, and the continued operation of its business, that must ultimately prevail at the interim stage.

The outcome of the interim injunction against Marin, was that he was required to relinquish to Mediaflow full administrative access to certain services used in its business, and was prohibited from using any source code, software, or other applications used by Mediaflow in its business, for any purpose other than for Mediaflow’s business, as specifically authorised by its directors.

Judge’s concluding observations

The Judge’s parting comments in his judgment were an invitation to the parties to reflect on the fact that the best solution may lie in commercial negotiations rather than in a decision of the Court. He acknowledged that the people involved are clearly experts in their field who have produced a product which appears to be in demand from tourist operators, and the business had been largely successful to date with a positive future.

However, and hitting the nail on the head, the Judge noted that:

“it was apparent that when the Company was formed it lacked sufficient commercial and legal input to ensure that ownership of its assets, including intellectual property, was carefully thought through and properly assigned to its rightful owner. In short, the parties did not apply legal and commercial foresight to plan for what might happen if their business relationship fell apart.”

He rightly observed that the positive initial working relationship between the three directors had disintegrated, probably beyond restoration. Indeed, he noted that the only way forward may be for one faction to buy out the other, and to that end, adopt a more pragmatic consideration ownership of the intellectual property to overcome the factual and legal complexities (and cost) in resolving the issues though the Court.

Touché and well said, Judge.

Conclusion

As you can see, this case illustrates just one of the many ways that corporate relationships can crumble and erode the value and feasibility of an otherwise prosperous company with a bright future. As the Judge points out, unravelling the issues can be incredibly complex and costly, and are best avoided by upfront foresight, planning, and advice at a fraction of the financial and emotional cost. We would be delighted to help you with this.

If you would like assistance with a shareholders’ agreement, establishing or structuring your business at any stage, please get in touch with the contacts listed with this article or your usual Dentons relationship manager.

This article was written by Sarah Gibbs, Senior Associate in our Corporate and Commercial team.