Commonwealth Bank of Australia v Duggan

11 In the meantime, by Deed entered into on 3 November 1993 between the bankrupt, Raffindale, PPM, PPMW, and TSC on the one hand and the bank on the other (the Deed), it was agreed (inter alia) that collectively the bankrupt and his group of companies would pay to the bank $1.250 million on or before 1 March 1994 together with interest, and that the bank would accept that sum in full and final satisfaction of all its claims against the bankrupt and against his group of companies. The Deed then contemplated that the freehold property would be offered for sale by public tender under the control of the bankrupt, but if not sold so that the bank was not paid the agreed sum of $1.250 million by 1 March 1994, the bank itself would proceed to sell the freehold property to meet the agreed liabilities. 12 The Sale Agreement related to the securities held by the bank, including Raffindale's grant of a first registered mortgage over the freehold property to the bank, and its grant of a first registered mortgage of the MSB lease to AGC. 13 Under the Sale Agreement, the bank agreed to appoint a nominated accountant Mr P Hedge (Mr Hedge) as its agent under the first registered mortgage over the freehold property and as receiver of PPM. AGC had already appointed Mr Hedge as its agent under its second mortgage over the freehold property, and as receiver under its first registered mortgage over the MSB lease. Mr Hedge was to continue to operate the marina business conducted by PPM for the time being. The Sale Agreement included the following: "… I. The Bank and AGC: (i) acknowledge that Mr Hedge will offer the Property and the Business for sale by tender ('the tender'); (ii) agree that neither will request or instruct Mr Hedge to stop or discontinue the Tender without the prior written consent of the other. J. The net proceeds of sale of the Property and the Business (including any amount for Goodwill and/or Licence relating to the Business) and any transfer of the Lease shall be shared in the ratio of 60:40 (The Bank:AGC) provided only that the Bank shall not receive more than $1.3 million. K. The net proceeds of sale shall be determined by deducting from the total proceeds of sale (including any interest accrued on the deposit payable to the Vendor) the following:

(i) Agent's Commission. (ii) Any adjustments at settlement for Council Rates, Water Rates, Land Tax, Lease Payments or items of a similar nature. (iii) Legal Costs on the sale of the Property and the Business. (iv) Costs and expenses of the Receiver/Agent for the Mortgagee (not met under H above) including any legal fees incurred by the Receiver/Agent of the Mortgagee." The Sale Agreement then contained terms requiring Mr Hedge to provide reports both to the bank and to AGC, and an agreement by each of them that, apart from monies received under the Sale Agreement, neither the bank nor AGC would demand any payment from Raffindale or from PPM without the prior written consent of the other. 14 The freehold property, and the marina business including the MSB lease, were then offered for sale together and together sold for $2,150,000. Settlement took place on 6 December 1995. Following settlement, the net proceeds of the sale of $1,980,025.75 were distributed in accordance with the Sale Agreement so that the bank received $1,188,015.45. The bank duly accounted to the bankrupt for the amount so received. Having regard to the accumulation of interest, there was a balance outstanding of about $700,000 by the time the proof of debt was lodged. 15 The bankrupt's claim at first instance was a quite straightforward one. It was that, in the sale of the freehold property, the bank owed a duty to the bankrupt and to Raffindale not to act recklessly in selling the freehold property, to exercise reasonable care in the sale of the freehold property, and to sell it in good faith at the best price reasonably available. The bankrupt claimed that the bank breached those duties by entering into the Sale Agreement of 18 May 1994, by failing to obtain valuations of the freehold property and by failing to sell the freehold property on its own for a sum in the order of $2 million, a sum which would have been sufficient at the time to meet any outstanding indebtedness under the Deed. The claims related only to the sale of the freehold property. He made no complaint concerning the sale of the MSB lease. Overall, his claim was that, because of the way in which the "one-line sale transaction" had occurred and had been accounted for, the bank had wrongly failed to realise a sum sufficient to meet his obligations to the bank under the Deed. 16 The learned judge at first instance addressed at some length the respective evidence of valuers as to the value of the freehold property, and of the MSB lease. Her Honour, after

carefully considering that evidence, expressed a preference for the valuation evidence of two valuers called by the bank. Her Honour said by way of conclusion: "In comparison Mr Ten Kate's report contains more careful and methodical analysis with detailed explanation of the methodology adopted. The approach in the report of Mr Dundas, of giving a value for the sale of the combined property as a marina, as a waterfront dwelling and as a lifestyle property is initially confusing. The difficulty lessens, however if the first two valuations are seen as elements in the process of determining the value of the combined property in its highest and best use. In that light the ultimate valuation of $1.7 million can be seen as resulting from a careful analysis of the relevant information. It should be noted that both Mr Ten Kate and Mr Rowan have calculated a premium over land value attributable to the marina as $500,000 and $300,00 respectively. Given the difference between their total valuations, the value attributable to the marina appears to be approximately between 17.5% and 25% of the total value of the combined property. As indicated earlier Mr Ten Kate and Mr Dundas adopted a similar approach in their reports. In giving evidence they were both straight forward and not defensive. Given that Mr Dundas's valuation was prepared closer to the actual time of sale I would be inclined to give more weight to his estimate. In giving evidence he struck me as a thoughtful and careful person. I accept 17.5% as the appropriate proportion. If this is correct then AGC, in receiving 40% of the net proceeds of sale, received an amount substantially in excess of the amount attributable to their security, that is the MSB lease." 17 Her Honour then referred to the respective contentions of the parties. She rejected the submission on behalf of the bank that it did not owe any duty to the bankrupt, as guarantor of the debts of Raffindale. On this appeal, the bank has not contended that her Honour's conclusion in that respect was erroneous. It has proceeded on the assumption that the bankrupt was owed the same duty as that owed by the bank to Raffindale as mortgagor of the freehold property. Her Honour referred to Tooth & Co Ltd v Lapin (1936) 53 WN (NSW) 224 at 225; Yorkshire Bank Plc v Hall [1999] 1 WLR 1713 at 1728; Medforth v Blake [2000] Ch D 86 at 98 for the proposition that a mortgagee exercising a power of sale owes the same equitable duty to a surety as to a mortgagor. In view of the approach adopted by the bank, it is not necessary to revisit her Honour's conclusion in that regard. For the same reasons, it is not necessary to revisit her Honour's conclusion that, where a mortgagee breaches such a duty, the surety may rely on that breach as a defence to a claim by the mortgagee with the result that the surety's liability is reduced to the extent that the value of the security has been diminished: see Taylor v Bank of NSW (1886) 11 App Case 596 at 601, and generally Phillips & O'Donovan The Modern Contract of Guarantee 3rd Ed 1996 at pp 405-410. Her

Honour in reaching that view also had regard to s 420A of the Corporations Law (the Corporations legislation in force in 1995). It provided: "In exercising a power of sale in respect of property of a corporation, a controller must take all reasonable care to sell the property for: (a) if, when it is sold, it has a market value - not less than the market value; or (b) otherwise - the best price that is reasonably obtainable, having regard to the circumstances existing when the property was sold." Her Honour referred to s 423(1)(b) of the Corporations Law to the effect that, if a person complains to the Court that the controller of the corporation is not observing the obligation imposed by s 420A, the Court can inquire into the matter and "take such action as it thinks fit". Under that provision, her Honour said the Court may, where appropriate, impose a remedy including that the mortgagee pay to the complainant the amount of the loss sustained by reason of the mortgagee's is breach of its statutory duties under s 420A: Artistic Builders Pty Ltd v Elliott & Tuthill (Mortgages) Pty Ltd [2002] NSWSC 16, and Jeogla Pty Ltd v Australia and New Zealand Banking Group (1999) 150 FLR 359. It is unnecessary for us to express any view on the application of s 420A in the present circumstances. 18 Her Honour then turned to whether the bank had breached any duty to Raffindale or to the bankrupt by entering into the Sale Agreement with AGC on 18 May 1994, or by giving effect to it by the distribution of the sale of proceeds of the combined property in December 1995. Her Honour did not consider that the entry into the Sale Agreement itself involved any breach of duty owed to Raffindale or to the bankrupt. It was consistent with its duty that the freehold property was sold in "one-line" with the MSB lease and the marina business. Entry into the Sale Agreement itself did not involve any breach of any duty owed to Raffindale or to the bankrupt: "… because the agreement had no power to affect the interests of the [bankrupt]. It is a principle of contract law so fundamental as to need no authority, that parties to a contract can create rights and duties as between themselves but they cannot, as a matter of contract law, bind or benefit persons who are not party to the contract." 19 The learned trial judge then continued: "It is possible, however, to vary property rights by way of contract or otherwise and such a transaction might well affect third parties. For instance when an owner grants a lease of land, the lessee thereby acquires the right to exclude third parties from the leased land even though they are not privy to the contract creating the lease. A person borrowing a car may have a right to possession of that car to the exclusions of persons other than the owner. On the other hand it is important to realise that one can have a contract where the subject matter of the contract is property without creating or varying any property interests; for instance a contract to paint a house. The fact that the contract between the Bank and AGC was concerned with property does not mean that it had the ability to alter the rights of the [bankrupt] whether or not they were proprietary." 20 Upon the view which her Honour took as to the nature and legal consequences of the Sale Agreement, it was not necessary to consider in detail the course of negotiations leading to the Sale Agreement or the bank's reasons for entering into it. Her Honour did add that she had no reason to doubt the bank entered into the Sale Agreement honestly and thinking its terms were in the best interests of all parties and that the concessions it made to AGC were "just the price of the deal". In the absence of the bankrupt's consent to the Sale Agreement, however, she said the Sale Agreement could not operate at the expense of the bankrupt. 21 A further contention of the bankrupt at the trial that the sale of the combined property was at an under value "was not seriously pressed". The trial judge regarded that as an appropriate position to take as the evidence supported the view that the one-line sale meant that a better price was realised than if the freehold property and the MSB lease had been sold separately. 22 The next step in the trial judge's reasoning was to address the issue whether the disposition of the proceeds of sale of the freehold property was properly effected. Her Honour regarded s 58(3) of the Real Property Act 1900 (NSW) as dictating how the proceeds of the sale were to be applied, at least in the absence of some different agreement of all interested parties. By virtue of the operation of the Sale Agreement, her Honour found the bank applied the proceeds of sale in a manner inconsistent with those provisions. 23 As we understand her Honour's reasons, the arithmetic consequential upon her findings, to that point, is that the fair value of the freehold property sold as part of the one-line sale, on the evidence which her Honour accepted, was 82.5% of the net proceeds of sale, namely $1,633,521 rather than the sum of $1,188,015 (60%) of the net proceeds of sale. Consequently, whatever its private arrangements with AGC under the Sale Agreement, the

bank was obliged to account for the amount of $1,633,521 as the proceeds of sale of the freehold property to reduce Raffindale's indebtedness guaranteed by the bankrupt and as fixed in accordance with the Deed. It did not do so. Had it done so, by reason of the Deed, the liability of the bankrupt and his group of companies to the bank in respect of the total indebtedness would have been discharged, and there would have been no ongoing liability of the bankrupt or of Raffindale under the Deed. The bank would then have been unable to prove in the bankruptcy of the bankrupt, as it sought to do. 24 The proof of debt indicates that at 6 December 1995, when the bank received the net proceeds of the sale of the combined property, the indebtedness under the Deed including interest was $1,505,397. Hence, a payment of $1,633,521 would have extinguished the indebtedness, subject to any recoverable costs being added. The credit given of $1,188,015 reduced that indebtedness to $317,381. It has since increased by the accumulation of interest. The proof of debt submitted on 10 April 2000 was for $717,961 comprising the indebtedness at 6 December 1995 as reduced by the bank's proportion of the net proceeds of sale plus interest to the date of bankruptcy ($184,640) plus costs of proceedings ($215,940). It is unclear how much of the costs relate to the current action. If there is any outstanding small indebtedness, even if the sum of $1,633,521 is credited, the bank may be entitled to lodge a further proof of debt. 25 Finally, her Honour dealt with a discrete issue raised by the bank based upon the terms of the guarantee given by the bankrupt. The bank had claimed that the effect of cl 10 of the guarantee was that none of the claims made by the bankrupt, even if accepted by the Court, could reduce or otherwise extinguish his liability to the bank under the guarantee. Her Honour did not accept the contention that cl 9 and cl 10 of the guarantee served to preclude the extinguishment of the full indebtedness of the bankrupt as guarantor where the bank, as a result of its breach of duty towards him, had not been paid in full. She did not regard either clause as intended to protect the bank from the consequences of its own or its agent's breach. The proper construction of cl 9 and cl 10 of the guarantee is not an issue raised in the appeal. 26 There were four general submissions presented on behalf of the bank. 27 The first was that the bank was not paid, and did not at any time become entitled to be paid, 82.5% of the net proceeds of sale of the combined property but only 60%. It is then

contended that s 58(3) of the Real Property Act did not require the bank to pay or apply towards the indebtedness of Raffindale and the bankrupt (as fixed under the Deed) 82.5% or $1,633,521 of the net proceeds of sale of the combined property. That is because, it is contended, the Sale Agreement between AGC and the bank did not relate to the division of the proceeds of sale of the combined property, but related to the allocation between AGC as first mortgagee of the MSB lease and the bank as first mortgagee of the freehold property of one composite sum to be received from the proceeds of the joint sale of those properties. In other words, it is contended, the bank agreed to sell the freehold property for an amount equal to 60% of the "one-line" sale price, and did not breach its duty to the bankrupt or to Raffindale in doing so. 28 We do not accept that characterisation of her Honour's findings. In our view, it is clear that her Honour found that, whatever the terms of the Sale Agreement between the bank and AGC, the proportion of the net proceeds of sale attributable to the freehold property from the net proceeds of the one-line sale was 82.5% of the net proceeds of sale. The Sale Agreement between AGC and the bank dealt with the distribution of "the net proceeds of sale" of the combined property, but with a limit upon the amount the bank could receive of not more than $1.3 million. As between itself and AGC, for whatever commercial reasons, the bank was entitled to enter into that arrangement. But it could not do so at the expense of the bankrupt or at the expense of Raffindale. Accepting that the bank entered into the Sale Agreement in good faith, in an endeavour to arrive at a realistic commercial outcome, its action does not lead to a recharacterisation of the nature or effect of the Sale Agreement. The relevant provisions of the Sale Agreement are set out in [13] above. It does not express itself as an agreement about the relative values of the freehold property and the MSB lease, or the extent to which they will contribute to the net proceeds of the one-line sale. It deals with the application of the net proceeds of sale. Moreover, the amount the bank may recover from the net proceeds of sale is capped. If the one-line sale were to result in net proceeds of sale in excess of $2,166,670, the bank would not be entitled to participate in any further sum. For example, the bank's share of the net proceeds of sale would be capped at $1,300,000 even if the one-line sale resulted in net proceeds of sale of $2,500,000 or $3,000,000. Such an agreement on its face is not one which therefore represents a recognition of the respective proportions in which the values of the freehold property and the MSB lease would contribute to the amount to be realised in a one-line sale. 29 Once her Honour characterised the Sale Agreement in the way she did, and in our view without error on her part, it follows that the Sale Agreement does not dictate as between the bank on the one hand and the bankrupt and his group of companies on the other how the proceeds of sale of the freehold property with the MSB lease are to be allocated and distributed. Her Honour found, on the evidence which she preferred, that in fact the value of freehold property relative to the value of the MSB lease was 82.5% of the total net proceeds of the one-line sale. In our judgment, she then properly applied that finding in the way described in her reasons for judgment. 30 That is not to accept that, in circumstances such as the present, the bank and AGC might not have entered into an agreement, and any necessary associated conveyances to give effect to an agreement, as to the extent to which the value of the freehold property and the MSB lease may be represented by certain proportions of the net proceeds of sale. It is not apparent at present why security holders might not agree in good faith in advance of the sale of separate properties separately secured to sell them together with the objective of achieving in totality a better net outcome, and might not agree about the proportion of the net outcome which would reflect the respective values of the separate properties. An example may be where different mortgagees of adjoining properties sell the properties together to make the collective properties eligible for some different use than selling them singly, and where the different use might attract a premium on the value of the properties if sold separately. If the learned trial judge were to be taken as indicating that such an arrangement could not be made, so as to affect the interests of the individual mortgagors, as presently advised we would incline respectfully to disagree. In principle, such an arrangement might properly be entered into in accordance with the duties of a mortgagee to the mortgagor (or a surety) when realising the secured property. It would be in accord with the duties of a mortgagee discussed for example in Forsyth v Blundell (1973) 129 CLR 477. Such an arrangement may conceivably be able to be effected in contract alone, or it may require associated conveyancing. 31 It is not necessary on this appeal finally to determine that issue as, in light of our view as to the operation of the Sale Agreement, the question does not arise. On her Honour's findings as to the nature of the Sale Agreement which we have upheld, her application of s 58(3) of the Real Property Act was correct. 32 The remaining matters argued by the bank on the appeal were, in a sense, subsidiary to the point which has been dealt with. It was next argued that the bank, in the circumstances, had not breached any duty it owed to the bankrupt and that the trial judge had failed to address whether it had done so, and if it had the consequences of such breach. As noted above, the bank's point was not to distinguish between any duties it owed to Raffindale as mortgagor from those which it owed to the bankrupt as surety. 33 We do not regard her Honour's decision as turning upon the existence of any common law duty of care owed by a mortgagee to a mortgagor (or a surety), or the breach of such a duty. It is not therefore necessary to consider the significance of Pendlebury v Colonial Mutual Life Assurance Society (1912) 13 CLR 676 at 679-681, 694-695 and 699-701. That case indicates no such common law duty is owed by a mortgagee to a mortgagor when realising a security. See also the discussion of that decision in Jeogla Pty Ltd v ANZ Building Group (1999) 150 FLR 359 at 442-444; and in O'Donovan & Phillips The Modern Contract of Guarantee 3ed, p 407. The reason why her Honour made the orders appealed from is that the bank, by entering into the Sale Agreement, did not do anything which related to or compromised its acknowledged duties to Raffindale and to the bankrupt. The acceptance that the bank entered into the Sale Agreement honestly and thinking the Sale Agreement was in the best interests of all the parties must be seen in the context of her Honour's finding that it was not an agreement which, as between the bank and the bankrupt, affected how the net proceeds of sale of the one-line property were to be accounted for. She considered that, as between the bank and the bankrupt, nothing had been done which amounted to an allocation between the bank and AGC of the real respective values of the freehold property and the MSB lease. Under s 58(3) of the Real Property Act, in light of that finding, the real value of the freehold property as part of the net proceeds of sale of the one-line property (which her Honour found to be 82.5% of the net proceeds of sale) was to be applied to the indebtedness of the bankrupt and his group of companies under the Deed. The breach of duty of the bank was simply, at that point, failing to account to the bankrupt for 82.5% of the net proceeds of sale. 34 The third contention of the bank was that the bankrupt had suffered no loss in any event. In essence, the point was that, to the extent to which the bank may have failed to reduce the indebtedness of the bankrupt under the Deed by applying in reduction of the indebtedness only its share of the net proceeds of sale under the Sale Agreement, the bankrupt's indebtedness to AGC was reduced in an equal amount by AGC applying in reduction of his indebtedness to AGC 40% of the net proceeds of sale. 35 For the sake of considering the contention, we accept the proposition that the bankrupt was indebted to AGC by reason of guarantees given to AGC to support advances to PPMW. We also accept the indebtedness to AGC was in the order of the $792,010 which it received from the net proceeds of sale of the one-line sale pursuant to the Sale Agreement. It does not follow that the bank should be allowed to prove in the bankrupt's estate for an amount to which it is not entitled. It might be that AGC, if it had received a significantly lesser sum from the net proceeds of sale than the amount it received in fact may have sought to prove the outstanding indebtedness in the estate of the bankrupt. The judge at first instance made no finding on the topic. She was not required to do so. The issue in the case was whether the bankrupt was indebted to the bank for the amount which it sought to prove. Her Honour found it was not. For the reasons already given, we do not consider her Honour's conclusion in that regard was erroneous. What AGC might have done, had the circumstances been different, does not entitle the bank to prove in the bankrupt's estate for a sum to which it was not entitled. 36 It is not correct to say, as is implicit in that contention, that AGC in the circumstances received its 40% of the net proceeds of sale and applied 22.5% of the net proceeds of sale towards reduction of the debts of the bank. Nor is it correct to say that the bank's agreement under the Sale Agreement to receive only 60% of the net proceeds of sale involved an allowance made by it to AGC for which, in equity, the bankrupt should now make allowance to the bank so as to entitle the bank to maintain its present claim. In our view, the sort of equitable adjustment discussed, for example, by Scrutton LJ in A L Underwood Ltd v Bank of Liverpool [1924] 1 KB 775 at 795, and by Mahoney J in Associated Midland Corporation Ltd v Bank of New South Wales [1983] 1 NSWLR 533 at 552 does not arise in the present circumstances. Here, the arrangement between the bank and AGC was commercially negotiated at arms length. Outside that arrangement, in the particular circumstances, the bank owed duties to Raffindale and to the bankrupt in relation to the sale of the freehold property. It was obliged to account to the bankrupt for the proceeds of sale of the freehold property. As the Sale Agreement did not constitute an agreement as to what were the respective values of the freehold property and the MSB lease in a one-line sale, or otherwise a dealing with the mortgaged property in question, the bank was obliged to account for the true proceeds of sale of the freehold property, notwithstanding the Sale Agreement. Her Honour found those proceeds were 82.5% of the net proceeds of the one-line sale of the combined properties. 37 The fourth matter argued on the appeal was that the loss suffered by the bankrupt, if the breach of duty alleged by the bankrupt were established, should have been set off against the bank's claim in its proof of debt to the date of bankruptcy on 6 January 1998 of $717,961.97, pursuant to s 86 of the Bankruptcy Act. The proof of debt asserts the composition of the debt to be as follows: Judgment 28 April 1995 $1,505,396 Less credit given 6 December 1995 (1,188,015) Interest to 6 January 1998 184,640 Legal fees "in obtaining judgment and bankruptcy" 215,940 _______ $717,961

The contention of the bank is that in any event there would be an outstanding indebtedness of $101,385. It is premised upon the freehold property realising only $1,400,000 and the costs of the sale of the freehold property being 7.9% (the percentage of the total sale price of the combined properties which represented the costs of sale of the combined properties). As a matter of arithmetic, the calculation is correct. But the bank and AGC in fact sold the freehold property and the MSB lease together. The assumption that the freehold property, if sold alone, would have realised $1,400,000 is beside the point. Moreover, it is a little over 65% of the actual gross sale price of the combined properties. The argument does not give effect to the finding of the trial judge that the one-line sale of the combined properties was appropriate, and that the value of the freehold property as part of the combined property is in fact 82.5% of the net proceeds of sale. The contention must therefore fail.

CONCLUSION 38 In view of the conclusion reached as to the effect of the Sale Agreement, it is not necessary to consider the alternative contention of the bankrupt. It arises only if the Court were to take the view that the Sale Agreement had the effect of allocating between the bank and AGC the respective extent to which the freehold property and the MSB lease would contribute to the net proceeds of sale by the sale of the freehold and the MSB lease together. 39 In the event, we would dismiss the appeal. The bank should pay the costs of the bankrupt of the appeal. The trustee entered a submitting appearance except as to costs, and did not participate in the hearing. I certify that the preceding thirty-nine (39) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Court.

Counsel for the Appellant: Mr RG Forster SC and Mr N Manousaridis

Counsel for the First Respondent: Mr M Aldridge SC

Solicitor for the First Respondent: Horrowitz & Bilinsky

Date of Hearing: 20 November 2002