Australian Credit Law Bulletin - Vol 5, No 7, July 2004
A free, plain English review of recent law and items of interest for creditors, produced by Hattaway & Associates Ltd, Credit Consultants. To subscribe, visit the Australian bulletin index and enter your details on the right
Plain language disclaimer:
This bulletin is not legal advice. Do not make decisions on legal matters based on a brief commentary. Instead, get professional legal advice.
In this issue:
- Director of a corporate trustee found personally liable for the trust’s debt
s this the end of the use of trading trusts as a form of business structure in Australia? - Appeal on decision that paying restitution for theft is ‘in the ordinary course of business’
Thief pays ex-employer then goes bankrupt - trustee tries to claw the money back - Engineering firm tries to use statutory demand to recover fees
Unfortunately they hadn't delivered the plans - was there a genuine dispute? - Application to set aside default judgment - was there an arguable defence to negligence claim?
Hold-ups due to HIH failure not a good enough reason - Trustee in bankruptcy disclaims bankrupt’s interest in a mortgaged property
Can the mortgagee bank claim his half share in the house? - Rules for appointing a substitute administrator fall through the cracks
…so the court waves its magic wand
1. Director of a corporate trustee found personally liable for the trust’s debt
John O'Neill owned the shopping centre on the Belair Road in Kingswood. Daroko Pty Ltd was a tenant and Mr Kerry Hanel was the sole director of Daroko. Daroko was the trustee of the Daroko Unit Trust and held its interest in the lease. A clause in the trust deed of the Daroko Unit Trust provided a comprehensive indemnity to Daroko.
The lease was for a term of five years from October 1998 and was due to expire on 30 September 2003. However, Hanel lost his Wendy’s franchise, so Daroko gave notice that it intended to vacate the premises on 30 June 2001. Before then the Daroko Unit Trust (which had made a profit of $512,617) paid out all its funds to Hanel’s personal trust which left both Daroko and the Daroko Unit Trust without assets.
<>In July 2002, O'Neill obtained judgment in the Adelaide Magistrates Court for $23,132.62, which he said were the costs associated with obtaining a tenant to replace Daroko. O'Neill sought to enforce his judgment but in September Hanel informed the court that without any assets, Daroko was unable to pay the judgment. O’Neill then applied for an order under s.197 of the Corporations Act. This section says in part:
(1) A person who is a director of a corporation when it incurs a liability while acting, or purporting to act, as trustee, is liable to discharge the whole or a part of the liability if the corporation:
(a) has not, and cannot, discharge the liability or that part of it; and
(b) is not entitled to be fully indemnified against the liability out of trust assets.
This is so even if the trust does not have enough assets to indemnify the trustee.
O'Neill argued that as Hanel was the sole director of Daroko, Hanel was personally liable for the debt. O’Neill claimed the judgment debt of $23,132.62 plus a further $15,928.51 for a shortfall of rent. In December O’Neill was awarded summary judgment against Hanel for the $23,132.62. Hanel appealed.
Hanel argued that s.197 is to be taken as saying that the director of a corporate trustee has a personal liability in circumstances where a debt is incurred and there are insufficient trust assets to meet the debt. Unless this case is overturned in the courts it means that s.197 represents an extension to the liability of the director of a trustee company. It means for example, that if a newly established trading trust does not have sufficient assets to guarantee the full payment of its rent over the 10 year period of its new lease, then that might make the directors of the corporate trustee personally responsible for any subsequent loss. Liquidators will be noting this with interest and anticipation.
However, this was only a partial win for O'Neill. Hanel successfully argued that O'Neill had not complied with his duty under the lease to mitigate. Clause 4.3(e) of the lease said that when a tenant vacated the property before the lease expired the landlord had a duty to mitigate and to try to lease the property at a reasonable rent on reasonable terms. Before it vacated the premises, it was claimed that Daroko had arranged to assign the remainder of its lease on identical terms to Hood and Stevens Accountants, who were leasing another part of the Belair Road shopping centre. However, O’Neill did not sign up Hood and Stevens and did not sign up another tenant for the space until December. If O’Neill had taken up the assignment to Hood and Stevens, Daroko would not have owed any rent or its liability would have been substantially reduced, and so Hanel's would also be reduced. All three of the judges in the Supreme Court of SA agreed and the appeal was allowed. The judgment was set aside and the matter was sent back for trial (essentially to see if a judge believed the claims about Hood and Stevens).
The case may effectively mean the end of the use of trading trusts as a form of business structure in Australia (at least if the directors of the corporate trustee don’t want to be personally liable).
Back to top
Information on our current seminars
2. Appeal on decision that paying restitution for theft is ‘in the ordinary course of business’
This case concerns an appeal about a decision we reported on in our March 2004 Bulletin. The Federal Magistrate’s Court originally decided that Southall & Bourke Pty Ltd (Ballarat Books) had priority over other creditors in recouping the money that their employee, Heather MacNeil-Brown, had stolen from them. In general, a creditor is not allowed to get old debts paid or secured just before the debtor goes bankrupt, ahead of other creditors who get little or nothing. The trustee generally has the right to claw back such payments and have such securities declared void.
<>MacNeil-Brown was convicted of stealing nearly $138,511.12 from Ballarat Books. She had given a security over her house to Ballarat Books, sold the house, and paid them $67,500. MacNeil-Brown’s trustee in bankruptcy, Norman Jones, had tried to recover the restitution payment as a voidable preference. The court however, said that the charge Ballarat Books had taken over MacNeil-Brown’s house had been arranged in the ordinary course of business and in good faith (that is, without any knowledge of MacNeil-Brown’s financial difficulties). It was also determined that a constructive trust existed which meant that MacNeil-Brown was deemed to be holding the money she had stolen on Ballarat Books’ account. Jones appealed against all of these findings.
The Federal Court endorsed most of the original decision. It explained that the act of restitution was not extraordinary because the system of criminal justice encouraged such conduct. This meant that the restitutionary payment and the charge given by MacNeil-Brown over her house, which secured the payment, had to be characterised as ‘fair’, ‘usual’ or ‘unremarkable’ occurrences, despite not being actions which were ‘common’ or ‘everyday’ actions. The court also verified that Ballarat Books was not aware that MacNeil-Brown was insolvent even at the time of the hearing. It had no reason to suspect her insolvency considering the significant amount of money she had stolen from it over an eight year period and also based on its decade-long knowledge of the circumstances in which she had lived in the country town of Ballarat. It was confirmed that “a payment, which is encouraged by the law, is capable of being a payment accepted in good faith by a creditor”.
The court then went on to consider whether there was in fact, a constructive trust. The court’s investigations centred on the issue of whether MacNeil-Brown had used the stolen money to finance the house that was the subject of the charge, or not. This was important because there was no doubt that any money stolen which could be traced remained the money of the person from whom it was taken.
It was clear that MacNeil-Brown had mixed the stolen funds with her salary to fund an extravagant lifestyle, but the evidence demonstrated that MacNeil-Brown had made all her mortgage repayments legally from her bank account. Nor was there any other property which had clearly been purchased with the stolen money. The court said the fact that MacNeil-Brown had a ‘pool of resources’ including the fraudulently stolen money which enabled her to pay her living expenses including her mortgage payments, did not give rise, as a matter of law, to a constructive trust in respect of the proceeds of sale of the house.
The court explained that MacNeil-Brown actually held the proceeds subject to personal equitable remedies, including an equitable lien or charge or a liability to account as a defaulting fiduciary. The court said, however, that because Ballarat Books’ other arguments had been accepted, Jones’ appealed failed and Ballarat Books got to keep the money from the sale of MacNeil-Brown’s house.
Back to top
Information on our current seminars
3. Engineering firm tries to use statutory demand to recover fees
Tinbyr Investments Pty Ltd v K L Special Projects Pty Ltd [2003] NSWSC 63
Tinbyr Investments Pty Ltd was a building developer. It engaged KL Special Projects Pty Ltd to draw engineering plans for a building development for a total price of $99,429. The contract permitted payments on account during the period of the work and it appeared that the work was to be completed within at least 12 weeks. This meant that the due date for the completed plans was about the middle of February 2002.
KL Special Projects provided a number of preliminary plans but not all the plans necessary for the development to proceed were handed over. Tinbyr needed the plans to get the appropriate certificates from the Water Board and a Construction Certificate, particularly as the building contract, which amounted to some millions of dollars, had been accepted by TQM Design and Construct in March 2002.
Tinbyr was anxious to obtain the rest of the plans but by the end of May it was plain that the balance of the plans would not available. Tinbyr informed KL Special Projects that this amounted to KL invalidating the contract and Tinbyr considered the contract was now at an end. Tinbyr proceeded to have the plans completed by TQM. The cost of TQM completing the plans was $35,200.
KL Special Projects later said that the final plans had actually been completed in the last week of May but Tinbyr was never told that they were ready. After Tinbyr had cancelled the contract KL Special Projects refused to release the completed plans until $39,657.40 still owing under the contract was paid. KL Special Projects then issued a statutory demand against Tinbyr for that amount on 24 September 2002. Tinbyr applied to have the demand set aside.
Tinbyr argued that under s.459H of the Corporations Act 2001, it had an offsetting claim and that there was a genuine dispute about the amount demanded by KL Special Projects. The court decided that it had to determine whether there was an offsetting claim that was neither frivolous nor vexatious. In fact, the offsetting claim was really a claim for damages, to try and recoup the $35,200 paid to TQM. The court found that offsetting claim was legitimate and the statutory demand procedure was not the appropriate way to decide the outstanding questions.
That left $4,457.40 (the difference between the offsetting claim and the amount in the demand), and the court had also to decide whether there was a genuine dispute over this remaining amount. The judge said that it was not clear whether this amount was owing “because of the terms of the written contract”. The fact that Tinbyr had indicated that it considered that the contract was at an end also pointed to there being a genuine dispute – a dispute which could also not be resolved in statutory demand proceedings. The statutory demand was set aside and Tinbyr and KL Special Projects had to go to court to argue the merits of their cases.
Back to top
Information on our current seminars
4. Application to set aside default judgment - was there an arguable defence to negligence claim?
Autorent Pty Ltd v Millar Seymour & Co; Alpha Pty Ltd v Millar Seymour & Co [2004] TASSC 2
Autorent Pty Ltd and its associated companies, was involved in the hire car business. Millar Seymour acted as the accountants, auditors and tax agents for the group. In 1996 Autorent was audited by the ATO for the financial years ended 1993, 1994 and 1995. Following the audit Autorent changed to new accountants who discovered problems in the tax work done by Millar Seymour. Autorent sued Millar Seymour for damages for negligence and breach of contract. None of the partners of Millar Seymour appeared at the hearing and on 22 March 2001 a default judgment was entered. It was not until April 2002 that Millar Seymour applied to get the judgment set aside.
Autorent claimed that Millar Seymour had made four errors. First, Autorent had become exempt from some fringe benefits tax obligations concerning the car parking provided to its employees. Millar Seymour did not allow for the exemption and Autorent paid fringe benefits tax of $13,613.24 which was not due. It did not recover the money from the ATO until after it had changed accountants. Secondly, Millar Seymour did not tell Autorent about "the significant cash flow tax disadvantages" of financing the hire fleet by lease rather than by hire purchase and after the audit, Autorent received an amended tax assessment for tax which could have been deferred. Thirdly, Autorent’s depreciation schedules were not checked properly. This resulted in a significant underpayment of tax. The ATO audit picked up the errors and the ATO reconstructed the schedules, with Autorent receiving an amended assessment for back tax and interest. Millar Seymour advised Autorent to accept the amended assessments and it paid the tax and interest. Autorent's new accountants however, discovered that the ATO's reconstruction of the depreciation schedules also contained errors and Autorent got a refund of $138,551.69. Fourthly, Millar Seymour overstated Autorent's taxable income for the 1996 financial year. Autorent's new accountants discovered this error and made further tax savings that allowed the ATO to refund $1,248,300 to Autorent.
Millar Seymour conceded that there was no arguable defence over the completion of the Fringe Benefits Tax return or for the overstatement of income in the 1996 tax return. The partners argued however, that the reason why their lawyers hadn’t turned up to the hearing was because everything had been delayed during the liquidation of Millar Seymour’s insurers, HIH. The court decided that it wasn’t appropriate to set aside the judgments merely because the partners had not followed up with HIH. What was important however, was whether or not there was a defence to Autorent’s charges.
Millar Seymour claimed that it had given Autorent advice about the cash flow tax disadvantages over leasing over hire purchase on several occasions between 1992 and 1996 but Autorent had not acted upon it. Millar Seymour also said that they had suggested that the software used by Autorent to create the depreciation schedules should be reviewed and this suggestion was also not acted upon by Autorent. After the ATO had issued the amended assessment following its reconstruction of the schedules, Autorent instructed Millar Seymour not to spend time, money and accounting costs reviewing the amended assessment. Instead Autorent told Millar Seymour to pursue the alternative that the amended assessment "should be accepted as a commercial settlement to end the risk of the imposition of penalties and further amended assessments ...". There was also evidence the tax returns for group companies had been signed by the directors of the companies submitting them and verified to be correct. In any case, Millar Seymour pointed out, they had not been engaged as tax planners.
The court determined that even if Millar Seymour had been at fault for not appearing it would not have been sufficient to conclude that their claims about arguable defences should be rejected. Autorent would not be prejudiced by a belated trial and the default judgments were set aside to allow Millar Seymour a proper opportunity to put their case at a later hearing.
Back to top
Information on our current seminars
5. Trustee in bankruptcy disclaims bankrupt’s interest in a mortgaged property
National Australia Bank Ltd v Leroy & ors; in the matter of Woo & ors [2003] FCA 862
Dion Woo and Millie Soo owned an inner-city Sydney property in Regent Street, Chippendale in as joint tenants. The National Australia Bank made large loans to both of them which were secured by a mortgage over the property. Woo and Soo defaulted on their mortgage repayments and then on 27 June 2001 Woo was made bankrupt.
In October, Paul Leroy, the trustee in Woo’s bankruptcy, disclaimed Woo’s interest in the property under s.133 of the Bankruptcy Act 1966. Such a disclaimer operates to put an end to the rights, interests and liabilities of the bankrupt in relation to the disclaimed property. Leroy did this because the property was "burdened with onerous covenants" although what they were was not explained. The NAB then applied to the court to have the property vested in it as a tenant in common in equal shares with Soo.
Disclaiming a property in this way however, automatically involves the State of NSW because after a property is disclaimed, it is forfeited to the Crown subject to any charges outstanding on it. Apart from governmental bodies that might for example, have a charge for unpaid rates, another body that had an interest in the property was an institutional lender holding an equitable mortgage over the property. The mortgage was protected by way of a caveat but it ranked after the mortgage held by the NAB. The person who placed the caveat on the property, as well as the relevant government bodies were notified of the NAB’s application but all of them decided not to go ahead with their claims. That left the way clear for the court to decide whether or not to award a half share of the property to the NAB.
Section 133(9) of the Bankruptcy Act says that the court may make a vesting order on the application of someone "claiming an interest in" the disclaimed property. It was quickly decided that a registered mortgagee's interest in mortgaged land under Torrens title legislation was an interest that would qualify. Given that a significant amount of money remained outstanding to the NAB, the court said that it was right and proper that the bank should have the opportunity to take reasonable steps to recover the loan which it had advanced to Woo. The court also explained that normally, changing a joint tenancy into a tenancy in common required an application to the Supreme Court of NSW. It decided however, that it also had the power to “tidy up” this difficulty and vested a half share in the Chippendale property in both the NAB and Soo as tenants in common.
The court pointed out that the trustee, Leroy, could not be personally held accountable for the court costs. The NAB was, however, given 48 hours to calculate their application costs as it was considered appropriate to burden Woo’s bankrupt estate with a court order for costs if at all possible.
Back to top
Information on our current seminars
6. Rules for appointing a substitute administrator fall through the cracks
The National Express group of companies ran the railway and tram services in Victoria following their privatisation. The railway and tram operations proved unsuccessful and the companies failed. The Director of Public Transport, who held security for a debt of a mere $1.126 billion, appointed receivers and managers to the companies. Soon after that the directors of the companies appointed Mr Wallace-Smith and Mr Whitton to be joint administrators of each company.
In due course the administrators proposed that the creditors of each company accept deeds of company arrangement and the required resolutions were passed at each company's respective statutory meeting. The deeds were still being prepared and it was expected would soon be executed. Around this time however, Whitton resigned as an administrator. The creditors were informed of this and also that a Mr Yates would be appointed instead. No objection to this was raised at any of the statutory meetings. The problem was, however, that a gap in the legislation meant that it was not clear how Yates’ appointment could be made. Wallace-Smith and the companies applied to the court to have their choice of substitute administrator appointed.
The dilemma arose due to the overlap in the provisions of s.449C and s.449D of the Corporations Act 2001. Section 449C(1) says that when the administrator of a company resigns, his appointer may appoint a replacement. When the appointer is the company (as in this case) the appointment has to be made by a resolution of the board (s.449C(3)) but the respective boards of the companies had not met to pass the necessary resolution. The court has the power to appoint an administrator under s.449C(6) but that power is confined to circumstances where “for some reason no administrator is acting”. As the joint administrator (Wallace-Smith) was still acting, that sub-section was not appropriate either.
Section 449D(1) allows the court to appoint someone else as administrator of a deed of company management if the original administrator resigns. The court can also appoint a person as administrator of a deed if "for some reason no administrator of the deed is acting" (s.449D(2)). Appointments under this section however, must be made on the application of the Australian Securities and Investments Commission or an officer, member or creditor of the company (s.449D(3)). In this case, no application could be made because the deeds of company arrangement had not yet been signed.
In order to help get Yates appointed immediately the court resorted to the magic wand-like provision, s.447A(1), to aid them. Section 447A confers a broad power that allows the court to “make such order as it thinks appropriate about how [Part 5.3A of the Corporations Act] is to operate in relation to a particular company”. The court explained that the scope of orders that could be made under s 447A(1) included ones which filled in gaps in the legislative scheme as well as permitting alterations to the way in which Part 5.3A operated. The court said that “the order sought by [Wallace-Smith and the companies] fills a gap in the legislative regime in the very way that s.447A was designed to operate. The legislature could not have prescribed a method of appointment for every conceivable situation that may arise during the course of an administration. The section is designed to allow the parties to have orders made that suit the particular circumstances at hand”. The court ordered Yates’ appointment as administrator.
