ASIC v Nelson

IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION

4319/01 AUSTRALIAN SECURITIES & INVESTMENTS COMMISSION V LESLEY REGINALD NELSON & ORS JUDGMENT (Revised for typographical errors 7 March 2003) 1 HIS HONOUR: This is an interlocutory application by Mr Love as liquidator of the following six companies: Barroin Pty Ltd; Provest (NSW) Pty Ltd; Australasian Quality Testing Pty Ltd; Transline Pty Ltd; Rural Orchard Management Services Pty Ltd; and Mudgee Property Management Services Pty Ltd ("the Companies"). The primary relief sought by Mr Love is as follows: "A direction, in the circumstances outlined in [his affidavit] and any other evidence presented to the Court in support of this interlocutory application, that notwithstanding the terms and conditions of a trust deed or other instrument governing the administration, management or winding up of the trusts ( Trusts ) of which the defendant companies are trustees [as detailed in a schedule to the application] the applicant ( Liquidator ) is justified in proceeding and making a first and final distribution of the funds ( Funds ) comprising the remaining property of the Trusts: (a) as if and on the basis that the Funds comprise a single fund; and (b) in the following order of priority: (i) first in payment of the Liquidator's remuneration, costs, charges and expenses of and in connection with the winding up of the Companies (including his costs of this interlocutory application); and (ii) second pari passu among all of the persons who are adjudged by the Liquidator to be beneficiaries of the Trusts, in proportion to the amount adjudged by the Liquidator to be the amount of their claim(s) against the property of the Trust(s) of which they are a beneficiary." 2 If the Court makes a direction in the terms sought, Mr Love intends to give notice of his intention to distribute the property in accordance with Part 70 rule 16 of the Supreme Court Rules. 3 A schedule to the interlocutory application lists 14 trusts of which Barroin is Trustee, and two trusts of which Provest is Trustee. The Trusts bear comfortable names like "The Banksia Unit Trust" and "The Greendale Unit Trust". 4 The motive force behind this dry and technical application is a very sorry tale of funds mismanagement causing substantial losses to inexperienced "retail" investors. Mr Love became receiver and manager of the Companies, and subsequently liquidator, following an investigation by ASIC into the affairs of an accountant named Leslie Nelson. ASIC's investigation followed complaints after Mr Nelson induced some of his clients to acquire units in unit trusts for investment purposes. Barroin and Provest were the trustees. Many of the clients (whom I shall call "the Unitholders") were elderly, and some have passed away, so that their interests are being represented by executors and beneficiaries. None of them were sophisticated investors. 5 Mr Love's investigations as receiver and liquidator have confirmed the worst fears of the investors. All but a small amount of the money they paid to Nelson has been lost. The total amount of the investments exceeded $4 million - his current estimate is $4,537,368. Mr Love now holds $105,439.44 in cash and intends to seek recovery of an additional $44,242 held in the trust account of Nelson's solicitor. History of the Trusts 6 It appears that the 14 trusts of which Barroin is the Trustee ("the Barroin Trusts") were established in the late 1980s by Peter Bennett, an investment adviser, for his clients. Nelson and Bennett had a business relationship in which Nelson prepared tax returns for Bennett's clients. Subsequently Nelson became a director of the trustee company, Barroin. 7 According to information supplied to Mr Love by Nelson, Bennett orally represented to Unitholders of the Barroin Trusts that their funds would be invested in bank-backed securities, yielding a fixed quarterly interest payment. In fact a total of approximately $3.6 million from the trust funds was lent to Bennett and/or entities connected to him. The loans were secured by mortgages on properties owned by or linked to Bennett. In the period between the late 1980s and 1993, funds were intermingled between the Trusts to satisfy interest payments, loan payments and redemptions. 8 The money taken by Bennett was repaid in three instalments, two on 14 June 1995 and one on 6 February 1997, by interests associated with Bennett. However, Mr Love says that he cannot be certain that the particular Barroin Trusts were repaid these funds in their entirety. Mr Love has provided me with a schedule that shows that $3,563,333 was paid out by seven lender Trusts of which Barroin was Trustee. The repayments on 14 June 1995 were, in total, $1,333,333 less than the total amount that Bennett had taken from the Trusts. The June 1995 repayments were applied at Nelson's direction to meet interest payments, redemptions and loan repayments, as well as to fund losses of Australasian Quality Testing, at that stage one of Bennett's companies. The repayment in February 1997 was by a company owned and controlled by Bennett named Galelad Pty Ltd, which paid $1,299,505 to the Banksia Unit Trust. Some of these funds were applied by Nelson to meet interest and redemption payments, and to make loan repayments, but the balance was applied towards the purchase price of three rural properties in the Mudgee district, two acquired in the name of Australasian Quality Testing and one in the name of Nelson. 9 Mr Love has prepared another schedule which summarises in more detail the application of the Bennett repayments. His evidence is that while he can identify how the money was used to purchase the three properties which I have mentioned, he has been unable to determine whether the balance of the money paid in was correctly distributed to or among the various Trusts from which the money was taken. 10 In 1992 Bennett was the subject of an investigation conducted by ASIC, which resulted in his being banned from acting as a securities representative for 10 years. Consequently Nelson took over complete management of the affairs of the Barroin Trusts as an investment adviser. 11 Another phase in the misuse of trust funds began in 1993. Nelson acquired Bennett's interest in Australasian Quality Testing, and primarily using funds from the Barroin Trusts, he bought out the company's only other shareholder to become its sole owner. During the period 1993 to 1995 Nelson diverted funds from the Barroin Trusts to support the operations of Australasian Quality Testing, which at that stage carried on a soil testing business in New South Wales and Queensland. The business incurred losses and was terminated in 1996. 12 Nelson has informed Mr Love that the loss on the soil testing business was in the vicinity of $800,000 to $900,000, and that the loss was funded by money advanced from the Trusts. Mr Love has not been able independently to verify the amount of the loss, but he has identified various payments and advances from the Trusts to the company prior to 1996. 13 During the period 1993 to 1996, and subsequently, Nelson also directed the application of trust money between the Barroin Trusts, as necessary to pay Unitholders' interest entitlements and to make redemptions. This resulted in a very substantial co-mingling of the funds of the various Trusts. As not all of the bank records are available, Mr Love has not been able to ascertain the full extent and nature of these funds transfers. 14 In 1996, in an attempt to recoup money that had been diverted from the Barroin Trusts, Nelson initiated the development of an olive grove and processing project in Mudgee. The project involved the purchase of two properties at Mudgee by Australasian Quality Testing, the purchase of a property called "Nobby's Block" in Nelson's name, and the sale by Nelson of interests in the project to "partners" who each purchased a share in the Mudgee properties from Australasian Quality Testing, which would provide vendor finance and take a mortgage over the partner's interest. The company would on-sell the mortgages to a third party for cash, and then reimburse the Barroin Trusts. Rural Orchard Management Services and Mudgee Property Management Services were formed to manage the olive grove project. The purchase money of $67,384.48 for Nobby's Block came partly from Australasian Quality Testing and partly from the Banksia Unit Trust, although the source of $2,228.50 is unknown. Mr Love has proceeded on the basis that the proceeds of any sale of the Mudgee properties are held on constructive trust for the Unitholders of the 14 Barroin Trusts. 15 In 1996 Nelson established two new unit trusts, the Illawarra Unit Trust and the Botany Unit Trust, the trustee being Provest. The money invested in those trusts was used to meet interest payments and redemption obligations of Barroin, and also to meet loan repayments paid to Australasian Quality Testing and to Rural Orchard Management Services to fund improvements to the olive grove properties. Mr Love has been able to prepare a schedule summarising proceeds and payments in respect of these two trusts. 16 Nelson sought to entice existing Unitholders of the Barroin Trusts to transfer their investments into the two Provest Trusts by offering high interest rates. He required existing unitholders of the two Provest Trusts to give 12 months notice of intention to redeem their investments. He attracted new investors to the Provest Trusts and used their monies to meet redemption requests from the Barroin Trusts. 17 The cash held by Mr Love, $105,439.44, comprises credit balances in three Barroin Trust bank accounts and one Provest Trust bank account, the proceeds from the sale of Nobby's Block and the sale of properties held by Australasian Quality Testing. As I have said, there is $44,242 held in the trust account of Nelson's solicitor. Mr Love says this sum represents some of the funds used for the purchase of Nobby's Block which derived from the Banksia Unit Trust, and that it is held on constructive trust for the benefit of Unitholders. Mr Love's investigations 18 Mr Love became receiver and manager on 2 October 2001. Since that time he and his staff have inspected and, as far as possible, reconstructed the financial and other records of the Companies and the Trusts. In many cases the records were incomplete. They have inspected properties and other assets, interviewed Nelson and various others associated with the Companies and the Trusts, conducted a public examination of Ms Linda Roels (who worked in Nelson's accounting practice), and obtained the production of documents from Ms Roels and various banks and others. I have not identified any further investigations that (having regard to reasonable cost constraints) Mr Love should undertake beyond what he has done. 19 There is a separate trust deed for each of the 16 Trusts. Mr Love has not been able to locate the trust deed for five of the Trusts. He has identified 131 individual Unitholders, who had invested in the Trusts since the late 1980s. He has prepared a table showing the number of Unitholders in each Trust, the number of units on issue in each Trust, and the value of the units issued. He has expressed the view, based on his investigations, that Nelson directed the funds of the Trusts to · himself and other related parties for private purposes; · Australasian Quality Testing to acquire properties; · Rural Orchard Management Services to develop the property; and · other Trusts to meet redemption demands and interest payments. Communication with Unitholders and ASIC 20 Mr Love has issued six reports, four to Unitholders and two to the Court, outlining his investigations. In his reports to Unitholders he foreshadowed that it may be necessary for him to seek the Court's direction as to the distribution of the funds. He held a meeting of Unitholders on 17 December 2002, when he informed Unitholders who attended that he would proceed with the present application. No-one spoke in opposition to the application and his sense of the mood of the meeting was that those present supported his approach. Through his solicitors, Mr Love has informed ASIC of the present application. Upon receiving confirmation that the issue had been discussed with and understood by Unitholders, ASIC has confirmed in writing that it supports the application. Mixing of trust moneys 21 This is a case where funds deriving from the 14 Barroin Trusts and the two Provest Trusts have been mixed, in the sense that, repeatedly, funds in one trust have been applied to meet obligations of other trusts. There has also been a physical mixing in bank accounts, and additionally mixed funds have been applied to acquire assets, the proceeds of sale of which remain. The mixing has not led to a single asset such as a bank account, but instead there are several bank accounts and the proceeds of several asset sales. 22 The precise ascertainment of the beneficial interest of each Unitholder in the remaining bank accounts and proceeds of sale would require an identification of funds in which the Unitholder had an equitable interest, and the tracing of those funds to their destination. But the principles upon which the tracing would be carried out are unclear. There is some support in the case law for applying the rule in Clayton's Case; Devaynes v Noble (1816) 1 Mer 572 [35 ER 781], according to which the first payment out of the mixed fund would be allocated to the first payment in. An alternative approach has received some support in case law and academic literature. According to this approach, the credit balance in the mixed fund is distributed amongst the beneficiaries of the funds that have been mixed, proportionately to their beneficial interests. 23 The case law and academic literature were recently reviewed by Campbell J in Re French Caledonia Travel Service Pty Ltd (in liq); application of Sutherland [2002] NSWSC 641. I respectfully agree with his Honour's analysis. He referred, in particular, to the observations of Priestley JA in Keefe v Law Society of New South Wales (1998) 44 NSWLR 451, with which Sheller and Powell JJA agreed. Priestley JA referred to Hagan v Waterhouse (1991) 34 NSWLR 308, in which Kearney J (at 358-9) supported academic literature which had advocated the "rateable solution" over the "first in, first out" approach. Priestley JA expressed the opinion that Kearney J's decision should be approved by the Court of Appeal. 24 It seems to me that Australian authority has reached the point that the rateable solution is to be preferred to the first in, first out approach where trust funds are mixed, without qualification. However, Campbell J noted that some of the decisions (but not Priestley JA's dictum in Keefe) preferring the rateable solution rely, as a ground for their decision, on the impossibility of carrying out a tracing exercise under the first in, first out rule. Campbell J then summarised the position as follows (at paragraphs [26] and [27]): "[26] If the dictum in Keefe is applied as the law in New South Wales, the effect is that, where money held on several different trusts has been mixed in the one bank account Clayton's case cannot be used to identify for which of the beneficiaries the money in the account is held. …" "[27] If the Keefe line is followed it has the advantage that the way in which the law decides the beneficial entitlement of beneficiaries whose assets have been mixed with those of other beneficiaries is the same, whether the mixing occurs in the bank account, or in some other form of assets…." 25 Campbell J then considered how it could be established, on a procedural and evidentiary basis, that it had become impossible to trace under the first in, first out rule. He suggested that if a single depositor could be identified who would, in accordance with that rule, be entitled in specie to some of the money remaining in the trust account, then impossibility would not have been established. In that event, he suggested, that person should be designated as a party to an application to establish, against a representative of the beneficiaries whose interests would be defeated by the application of Clayton's case, whether the dictum in Keefe ought to be applied in that situation. 26 As I have said, the better view appears to be that in Australian law the dictum in Keefe should be applied regardless of whether it is impossible on the facts to apply the first in, first out approach. If, however, the rateable solution were limited to cases where it was impossible on the facts to apply Clayton's case, then the rateable solution would apply in the present case, in my view. This is because the evidence shows that the defalcations by Bennett exhausted the Barroin Trusts after the beneficiaries had made their contributions. Consequently it appears from the evidence in this case that there is no beneficiary of the Barroin Trusts who could succeed under the first in, first out rule. As regards the Provest trusts, the evidence is less clear but again, it appears to me that the evidence as a whole, especially exhibits AJL 19 and 20 and the evidence concerning loss of records, implies that impossibility is also established in respect of all of the beneficiaries of these trusts. Therefore this is a case where the application of the rateable solution is required. Conclusion 27 The rateable solution is reflected in the directions sought by Mr Love. As a practical matter, it is far and away the best solution in the circumstances. The fact that some of the trust funds have finished up as proceeds of sale of property acquired with the mixed funds does not prevent the application of this approach, as Campbell J pointed out in French Caledonia at paragraph [27], in the passage quoted above. I have therefore decided it is appropriate to give the direction sought by Mr Love, in the exercise of the Court's powers under both s 479(3) of the Corporations Act 2001 (Cth) and s 63 of the Trustee Act 1995 (NSW). 28 I shall make the order sought by Mr Love with respect to costs, on the ground set out by Campbell J in the French Caledonia case at paragraphs [32] to [35]. I do so on the basis that Mr Love will, as he indicates, advertise under s 60 of the Trustee Act and Part 70 rule 16 of the Supreme Court Rules. **********

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