Australian Credit Law Bulletin - Vol 7, No 8, November 2006
A free, plain English review of recent law and items of interest for creditors, produced by Hattaway & Associates Ltd, Credit Consultants. To subscribe send a blank email to: aus-bulletin-join@mailman.hattaways.com
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:
- "You said the guarantee only applied while I was a director!"
Who will the judge believe - the credit manager or the guarantor? - If you bank a cheque sent in full and final settlement, does that mean you can't chase the rest?
Judge: "odd that the law relating to this rather common debtor's stratagem is not yet quite clear" - Does a business farming aquarium fish fall under the Farm Debt Mediation Act?
Or, to put it another way, is a fish farm a farm? - Finance company directors sued for making bad loans
The courts consider the issue of "accepted lending practice"
1. "You said the guarantee only applied while I was a director!"
Australian Postal Corporation v Oliver & Ors [2006] VSC 318 (6 September 2006)
World Class Pty Ltd was a mail house with 2 staff and 2 directors. It used the services of Australia Post on credit terms. World Class had to pay Australia Post 14 days after the date of statement.
Mr Freeman and Mr Oliver were the directors of World Class. Freeman's assets were the security for the business's overdraft with the Commonwealth Bank. Freeman dealt with Paul Michael Davidson, a credit manager at Australia Post. In September 1999, because World Class wasn't paying on time, Davidson required the directors, Freeman and Oliver, sign a guarantee of World Class's debts. The alternative was for World Class to pay cash in advance, which it simply couldn't do. In 2001, Davidson required World Class to give Australia Post a charge over the debtors of World Class. (Australia Post subsequently recovered $54,427.24 as a result of this security.)
Freeman extricated himself from the business. It was agreed with Oliver that he would resign on 30 June 2002 as an employee and director but would continue to provide security for the bank. He would be paid out for his shares over time, and would then transfer them to Oliver.
World Class's financial situation worsened. In October 2004 Australia Post determined to deal with World Class on a cash-on-delivery basis. World Class simply could not do this so the directors put the company into administration.
In December 2004 Australia Post, sent World Class's guarantors, including Freeman, a demand for payment. The next day Freeman telephoned Mr Macdonald, Australia Post's legal counsel, very upset. Freeman said that he had resigned as a director about three years before. Macdonald said to Freeman that his obligations under the guarantee would continue beyond his resignation unless he had been released, and asked Freeman if he had been released. Significantly, Freeman said that he did not know.
Australia Post sued under the guarantees. Judgment was entered by default against the other guarantors. Freeman, however, defended the claim on the grounds that Davidson, the credit manager, told him that the guarantee would only continue in force so long as he remained a director of World Class. Davidson denied having made this statement.
Freeman also said that he advised Davidson by telephone that he was about to leave World Class and resign as a director. Davidson, on the other hand, said that until Oliver's advice on 4 August 2003 (over a year later) he had no idea that Freeman had resigned as a director of World Class. He said that it never became apparent that Freeman was not involved in the business until then.
The judge found that both Davidson and Freeman had difficulty in recalling what had been said 7 years earlier. Davidson said that in September 1999 he met with Freeman and gave him the guarantee for signing and discussed the World Class account. He said that he never provides advice to customers when obtaining a guarantee nor does he explain the effect of a guarantee. That was his personal policy from which he did not deviate. He always suggests customers obtain their own legal and/or accounting advice on the operation of guarantees. He said that his evidence really was that he would have followed standard practice.
Davidson did not make a file note of various other meetings relating to the guarantee, nor of any telephone conversation with Freeman between March 1998 and June 2002.
Freeman said that because Davidson had told him that the guarantee only applied while he was a director he "did not consider it necessary to give Australia Post written notification under clause 9" of the guarantee. He denied that Davidson said that he needed to seek independent legal advice. He said that when he told Davidson he was resigning Davidson did not say that he had to give written notice of resignation.
The Judge considered Davidson "an honest witness and … overall the substance of his evidence fitted the probabilities of the case. I did not reach the same conclusion with Freeman."
The Judge said that it was "overwhelmingly improbable" that Davidson had said that the guarantee only applied while Freeman was a director because Davidson knew that this wasn't correct. The judge concluded that Freeman's version was a "hopeful reconstruction but it is not what Davidson said."
Davidson said that he recalled Oliver telling him at a meeting 'sometime in late 2002' that Oliver was taking over the administrative aspects of World Class including payment of the account and that Freeman was becoming involved on the sales side because that was more of a strength of his than the administrative side. If this was said, it was obviously untrue because Freeman was no longer working in the business.
The Judge pointed out that if Freeman [or Oliver] had told Davidson that he was resigning, "Davidson would have reacted with concern if not alarm." The judge concluded that Freeman chose not to tell Australia Post that he was resigning so that Australia Post continued to allow World Class to trade on credit terms.
Judgment was entered for Australia Post for $560,927.52 plus interest and costs.
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2. If you bank a cheque sent in full and final settlement, does that mean you can't chase the rest?
Ebbage and Madden v McMahon's (Transport) P/L [1996] QCA 332 (6 September 1996)
Someone who was about to attend one of our seminars contacted us last month with a query about what to do with a cheque marked "full and final settlement". Could she bank it and chase the debtor for the balance? The law on this is clear in New Zealand. The law in Australia doesn't seem to be clear. We're not in the business of offering legal advice but I suggested they talk to their lawyer quickly and I promised to summarise the most useful Australian case I could find on it - from the Queensland Court of Appeal - even though it's ten years old.
Ebbage and Madden were appointed receivers and managers of Just Juice (Queensland) Pty Ltd in 1990. McMahon's (Transport) Pty Ltd was the landlord of the building Just Juice occupied. Under the law which applied at the time, the receivers were not personally liable for the rent on the premises, so a landlord needed to get them to agree to pay, or take possession and re-let. The major issue in the case was whether they had agreed to pay the rent.
On 4 September 1990 the solicitors for the receivers wrote to the landlord's solicitor, Mr O'Donoghue enclosing a cheque for $11,611.73 for rental up to 17 August 1990. The cheque was sent "in full and final satisfaction of all claims" the landlord might have against the receivers with respect to the premises in question. The letter said the cheque might only be accepted on that basis and if it was not accepted on that basis the landlord must return it. O'Donoghue said in response that the landlord would bank it in a week and did not accept that it was in full and final satisfaction. The cheque was duly banked.
The receivers claimed the landlord couldn't bank the cheque and still sue for the balance. It could only keep and negotiate the cheque on the basis that it gave up all its claims.
The unanimous judgment was presented by Pincus JA. He said, "It is odd that the law relating to this rather common debtor's stratagem is not yet quite clear. The only point which differentiates the present from what might be called the ordinary case in which a cheque is tendered in full satisfaction of all claims is that here the [landlord] warned the [receivers] that it intended to ignore the condition and gave [them] an opportunity to stop payment."
The judge noted that there was inconsistency in the outcomes in previous reported cases. The cases on this subject, "although numerous, give no clear guidance. I… prefer to follow those in which the Court has rejected the … assertion that there has been an accord." In essence, he said that you can't generally bind someone to a contract by saying, "if you do something you are taken to have agreed with our terms."
Just to repeat - if you find yourself in this sort of situation, seek legal advice immediately.
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3. Does a business farming aquarium fish fall under the Farm Debt Mediation Act?
Charles Craigie and Michael Craigie are father and son. In late 1972, they bought a property to live on and to breed fish for pet shops and aquariums. They had 50 concrete fishponds, 60 fishpond earth-bottom dams and various temperature and humidity controlled sheds for tropical fish.
The fish breeding business was run under a company, Wyong Creek Fish Hatchery Pty Limited. In 2003 they took out a mortgage with Champion Mortgage. They fell behind and Champion subsequently sued, seeking possession.
In October 2005, the court made a number of orders by consent. In essence, Champion agreed to hold off issuing the writ of possession if the Craigies paid a total of $135,000.00 by the end of March 2006. There were further payments missed, so Champion applied for the writ. However, the Craigies were seeking to refinance and paid $150,000 in February. A stay of execution was granted.
In February 2006, a Court order was made to wind up the company and to appoint a liquidator. Charles Craigie, now 80, had retired. Michael was running the fish farming business in his own name.
Under the Farm Debt Mediation Act, mediation is required before a creditor can take possession of property or other enforcement action under a farm mortgage. In fact, all enforcement action by a creditor to whom the Act applies is void unless the Act has been complied with. Sometime in 2006 it occurred to the parties involved, and the judge dealing with the matter, that the Act might apply.
The debtors referred to The Macquarie Dictionary which defined farm, among other things, as, "A tract of land or water devoted to some other industry, especially the raising of livestock, fish, etc" and the Oxford English Dictionary which said, "Extended to tracts of water devoted to the breeding or rearing of some animals, gen. with qualification, as fish-farm, oyster-farm, terrapin-farm, etc." The debtors claimed that a fish farm was obviously a farm.
The lender claimed that a pet fish hatchery, even as part of a commercial operation, is not an activity which the Act intended to constitute farming. A conclusive and exhaustive definition of "farming operation" in the Act refers to "farming (extended to include dairy farming, poultry farming and bee farming), pastoral, horticultural or grazing operations". The conclusive and exhaustive definition of "farm machinery" refers to a "harvester, binder, tractor, plough or other agricultural implement."
There is no reference to fish farming. The judge said that this gave powerful support to the Plaintiff's submission that the 'farming operations" covered by the Farm Debt Mediation Act ought be confined to traditional agricultural pursuits extended only so far as the Act provides.
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4. Finance company directors sued for making bad loans
Gold Ribbon (Accountants) Pty Ltd (in liq) v. Sheers & Ors [2006] QCA 335 (5 September 2006)
Gold Ribbon (Accountants) Pty Ltd was set up in December 1997 and provided unsecured loans to accountants. The interest rate charged was almost twice the bank interest rate for comparable secured loans. Gold Ribbon was described as a "last resort lender". It lent up to 80% of the value of the accounting practice's aged receivables. Borrowers did not have to provide any security other than the personal guarantees of directors if the borrower was a company.
Terence Michael Dunn was a non-executive director of Gold Ribbon. In the early stages it was expected that the Dunn's company, Commercial Recovery Management Pty Ltd, would be responsible for administering the scheme and carrying out the due diligence. However, this role instead went to Austide Holdings Pty Ltd which was run by the de facto partner of Richard Sheers, one of the other directors.
Sheers, Stephen Romp, Garry Howes and Robert Taylor were also directors of Gold Ribbon for most or all of the time during which the scheme was set up and implemented. There was dissention on the board of directors over a number of matters. The judge in the subsequent case said, "[n]either [Sheers nor Howes] was inclined to compromise or conciliation and Howes exhibited a degree of aggression in his dealings with other directors which inhibited any calm exchange of views and dispassionate decision-making". These two apparently tried to exclude Dunn from the affairs of the business.
In 1999 and 2000, Gold Ribbon made a number of bad loans. Borrowers did not, it seems have to produce lists of debtors (even though the basis of the loan was their accounts receivable), or financial statements or tax returns for the previous years, or provide a charge over their debts.
On 8 August 2001, the Gold Ribbon went into liquidation. The directors were sued for breach of their duties of care as directors. Judgment by default was obtained against Howes in May 2003. The other directors are bankrupt and did not defend the claim. The case proceeded against Dunn, who denied liability.
It was not claimed that Dunn should have been checking the loans himself. Instead, it was argued that, as a director, he should have "ensured that the respondent's loan program was administered according to standards of prudence so basic as to be obvious to any lender."
Specifically, the claim said that the lender should have confirmed that:
"A. the applicant was in fact a registered practising accountant;
B. the certified accounts receivable existed...and did not include work in progress;
C. ... the applicant was not currently experiencing and/or had not in the immediate past or repeatedly in the past experienced financial difficulty;
D. the applicant had the ... capacity to service the loan (in terms of making the required payments on the loan) plus repay the loan capital in terms of the loan arrangements, preferably from demonstrated ongoing cash flow, but, at the very least, from available assets of the applicant and/or the guarantors;
E. the terms and conditions of the loan application were otherwise satisfied by the applicant."
The liquidators of Gold Ribbon relied on evidence relating to the five loans in order to establish a case against Dunn. Any "borderline" applications for funding were to be discussed with a director prior to approval or rejection of the application, and this was done for the five loans concerned.
For example, a total of $842,000 was lent to Jumarsh Pty Ltd. The directors of Jumarsh at the time of these advances were Julian Norton-Smith and Sheers (who was a director of Gold Ribbon!) Michael Norton-Smith was a certified practising accountant and it was his professional membership which was relied on to obtain the loan. He was a bankrupt at the material time. It would seem that no credit check was done on him, or, if it was, it was not acted upon. The trial judge said that "Sheers was aware that Julian Norton-Smith's certification of receivables bore little, if any, relation to reality." The loan was guaranteed by Julian Norton-Smith and Michael Norton-Smith. Ultimately there was a loss of $692,000.
A total of $800,000 was lent to John McCouat, approved by Sheers. Austide carried out a search which showed that McCouat had become a member of the National Institute of Accountants and taken out professional assurance only days before his application, but the application listed outstanding practice debtors of $1,707,023. There was no investigation of how McCouat could have generated receivables of this order when it was evident that he had only recently joined the profession. In fact, McCouat did not have the receivables certified in his loan application. He repaid nothing on demand.
For one loan, the judge found that another director, Howes, participated in the fraudulent application and both Sheers and Howes stood to gain from the loan through their companies.
After a trial, the judge awarded judgment against Dunn for $3,629,000. He agreed that the losses on these loans were suffered because of Dunn's failure as a director to ensure that adequate loan application assessment procedures were established and maintained. Dunn appealed.
The judges of the Queensland Court of Appeal concluded that there had been a breach of duty by Dunn. However, this breach did not necessarily cause the losses. In essence, if the directors were approving bad loans to their friends, the judges were not convinced that better credit assessment procedures would have made any difference. Therefore, the fact that Dunn did not put those procedures in place did not make him liable for the losses relating to the five loans.
