Commonwealth of Australia, in the matter of Leahy Petroleum - Retail Pty Ltd (Subject to Deed of Company Arrangement) v Leahy Petroleum - Retail Pty Ltd

REASONS FOR JUDGMENT 1 The plaintiff, the Commonwealth of Australia, holds a debt of record against the first defendant, Leahy Petroleum - Retail Pty Ltd (subject to deed of company arrangement), being a judgment entered in the Federal Court of Australia. The judgment is for a pecuniary penalty in the amount of $2.5 million, for breach of s 45 of the Trade Practices Act 1974 (Cth), and for costs which exceed $60,000. Within weeks of the imposition of the penalty the directors acknowledged that the company was insolvent. They appointed the second and third defendants, Mr Yeo and Mr Rambaldi, chartered accountants, to be the company's administrators. 2 The creditors subsequently resolved that the company execute a deed of company arrangement. The deed provides that all of the company's creditors (other than the Commonwealth) are to be paid in full out of the company's assets. Any surplus is then to be divided equally between the Commonwealth, in composition of its debt, and the fourth defendant, Leahy Family Holdings Pty Ltd, which owns all the issued shares in the company. The effect of the deed is that following the payment of the debts due to creditors there will be a surplus of approximately $916,700, one half of which will go to the Commonwealth (after payment of costs and expenses). 3 The Commonwealth is dissatisfied with the deed because it believes that in a winding up it would be entitled to the whole of the surplus. It therefore seeks to have the deed terminated under s 445D of the Corporations Act 2001 (Cth) on any of the following grounds: that effect cannot be given to the deed without injustice (s 445D(1)(e)); that it unfairly discriminates against the Commonwealth (s 445D(1)(f)); or that it should be terminated for some other reason (s 445D(1)(g)). 4 A point has been taken that the Commonwealth has no standing to bring this application. It seems to be accepted (at least the case was argued on this assumption) that a pecuniary penalty imposed under the Trade Practices Act is a debt provable in the winding up of a solvent company. In the case of an insolvent company, however, s 553B provides that subject to certain immaterial exceptions "penalties or fines imposed by a court in respect of an offence against a law are not admissible to proof against an insolvent company." The suggestion is that this provision applies to an administration with the result, according to the argument, that the Commonwealth is not a creditor of the company and for this reason lacks standing. Reference was made to Mathers v Commonwealth (2004) 134 FCR 135 and Australian Winch and Haulage Co Pty Ltd v State Debt Recovery Office [2005] NSWSC 423. 5 It is, I think, clear that s 553B, which is found in a group of provisions concerned with the proof and ranking of claims in a winding up, cannot be imported into Pt 5.3A, being the Part that deals with administrations. Nothing said by Palmer J in Australian Winch and Haulage Co Pty Ltd is to the contrary. Properly understood his comments regarding the operation of s 553B in an administration were made on the basis that the section had been incorporated into a deed of company arrangement. He was explaining the effect of s 553B as an incorporated term. The same is probably true as regards the order made by Heerey J in Mathers, although the background to the case is not fully explained. If Heerey J meant to say that s 553B applies of its own force to an administration, he is in error. 6 Returning now to the Commonwealth's case, I have mentioned that it is based on the proposition that in a winding up the company's assets would be applied, first, in payment of the debts due to creditors other than the Commonwealth, then in discharge of the debts due to the Commonwealth and, finally, if there are still funds available, in payment to the contributories. The defendants disagree. It is their contention that s 553B excludes for all time the right of the Commonwealth to be admitted to proof, at least as regards the pecuniary penalty. Indeed, the administrators had received legal advice before the creditors' meeting to the effect that in a winding up the Commonwealth could not be admitted to proof. The resolution that the company execute the deed was carried on the chairman's casting vote. The chairman was one of the administrators. Normally a casting vote should be exercised to preserve the status quo. Here, the chairman was of the opinion that in a winding up the Commonwealth would get nothing and so the deed was to its benefit. 7 Clearly, then, it is necessary to determine what would be the Commonwealth's entitlement to proof in a winding up of the company. The resolution of that issue depends, in turn, upon the manner in which s 553B will operate when a company is wound up as an "insolvent company" but it later turns out that the company is solvent. 8 There are several English cases which, while not directly on point, provide the solution. The cases were concerned with ss 316 and 317 of the Companies Act 1948 (UK). Section 316 provided that: "In every winding up (subject, in the case of insolvent companies, to the application in accordance with the provisions of this Act of the law of bankruptcy) all debts payable on a contingency, and all claims against the company … shall be admissible to proof against the company". Section 317 provided that: "In the winding up of an insolvent company … the same rules shall prevail and be observed with regard to the respective rights of secured and unsecured creditors and to debts provable … as are in force for the time being under the law of bankruptcy in England with respect to the estates of persons adjudged bankrupt". 9 The relevant bankruptcy rules that were picked up by s 317 included s 30(1) of the Bankruptcy Act 1914 (UK), which provided that "[d]emands in the nature of unliquidated damages … shall not be provable", and s 33(8) which was that: "If there is any surplus after payment of the foregoing debts, it shall be applied in payment of interest from the date of the receiving order at the rate of four pounds per centum per annum on all debts proved in the bankruptcy." 10 The Australian companies legislation followed a similar pattern. There has always been a provision which mirrors s 316 of the 1948 UK Companies Act. Currently, that provision is s 553(1) of the CorporationsAct. Until the Corporate Law Reform Act 1992 (Cth), there was also a provision that picked up the bankruptcy rules for proofs of debt in terms similar to s 317 of the 1948 UK Act. With the passage of the 1992 Act the cross-referencing to the bankruptcy law was discontinued and the relevant provisions incorporated into the Corporations Act itself. They are now found in Part 5.6. 11 Turning to the cases, the first is In re Fine Industrial Commodities Ltd [1956] Ch 256, which was concerned with the payment of interest to simple contract creditors. The company had been wound up on the ground of insolvency. In the course of the winding up the liquidators brought an action to set aside a debenture. The action was successful and the liquidator recovered sufficient funds to enable him to pay out the contract creditors in full and leave a surplus. The liquidator sought directions from the court as to whether he could pay interest to creditors on the amount of their respective proofs from the commencement of the winding up to the date of payment. 12 It was only if s 33(8) of the Bankruptcy Act was picked up by s 317 of the Companies Act that the simple contract creditors (whose contracts did not entitle them to interest) would be entitled to interest on their respective debts. The judge, Vaisey J, held that s 317 had ceased to have application to the company as soon as it was discovered that there was a surplus. He said (at 262): "Although for some purposes during the winding-up proceedings this company must have been deemed to have been insolvent, it seems to me that when the time comes for dealing with the surplus it must no longer be deemed to be an insolvent company, but has to be treated as a company which is, and was, and always has been, solvent." 13 The second case is In re Rolls-Royce Co Ltd [1974] 1 WLR 1584. This involved a creditors' voluntary winding up. Over time the liquidators were able to pay all admitted debts in full and hold surplus funds, due to their disposal of the company's undertaking on favourable terms. One of the creditors applied to the Court for an order that out of the surplus it be paid interest on its debt. The application was heard by Pennycuick VC. He refused to apply s 33(8) of the Bankruptcy Act. He said (at 1591): "[S]ection 317 of the Companies Act 1948 has no application once the liquidation throws up a surplus, whatever may have been the position at the commencement of the winding up." Put another way, if the admitted debts are paid in full and there is a surplus the company is no longer "an insolvent company" for the purposes of s 317. 14 The approach in these cases gives rise to a conundrum. What would be the situation if the surplus available after payment of debts that are admissible to proof in an insolvent winding up is insufficient to discharge the balance of the company's debts? If there is still a deficiency does the company remain "an insolvent company" under s 317? 15 The answer was provided by In re Islington Metal & Plating Works Ltd [1984] 1 WLR 14. Here again the company was wound up in insolvency. At that point there were several persons who had claims in tort against the company. They could not be admitted to proof because s 317 incorporated the bankruptcy rule that unliquidated damages were not provable. It turned out, however, that the liquidators were able to recover in misfeasance proceedings against the former directors sufficient to pay all provable claims and still hold a surplus. According to In re Fine Industrial Commodities Ltd and In re Rolls-Royce Co Ltd the company was no longer insolvent and the surplus should go to the tort claimants. But their claims exceeded the surplus. In these circumstances the liquidator sought directions as to whether he should still admit the tort claimants to proof. The judge, Harman J, held that he should. First, he noted that the liquidation of a company and the distribution of its assets were to be treated notionally as simultaneous, relying on In re Humber Ironwork and Shipbuilding Co (1869) LR 4 Ch App 643. It followed that all debts were to be computed as at the date of liquidation. Then Harman J said that admission to proof was also to be determined at the commencement of the winding up. At that point the company was insolvent. Accordingly, the effect of s 30 of the Bankruptcy Act was to exclude the tort claimants from proof. Next Harman J considered the position where creditors who had been admitted to proof had been paid in full but there was a surplus which was insufficient to pay the torts claimants. As to this he said (at 23): "The real difficulty arises when a liquidator, having paid a company's undoubted creditors and provided for the costs of winding up, is left with moneys in his hand but on turning to 'all claims' under section 316 finds that there are now claimants - such as the tort claimants here - whose claims exceed the apparent surplus. The company is thus again 'insolvent.' Does section 317 again apply? If so, there being no undoubted creditors left, an eternal state of oscillation between the sections would be created. This might be the secret of perpetual motion, but I cannot believe it is the law. In my judgment, once a company has passed from section 317 to section 316 all claims have to be admitted. I appreciate that this may result in some claims in an apparently solvent liquidation not being paid in full. But any other result seems to me a view that is impossible and, in my judgment, there is no legislative or authoritative compulsion enforcing such a result upon me." 16 Following the reasoning of these cases, s 553B will operate in the following way. If the company being would up is insolvent when it is placed into liquidation it is "an insolvent company" and fines and penalties cannot be admitted to proof. If, however, all provable claims are paid in full and, for one reason or another, there is still a surplus, the company is no longer "an insolvent company" and the surplus is to be applied in discharge of the fines and penalties. 17 This approach accords with Parliament's intention. In the first place, the section does not extinguish the obligation to pay the penalty or fine imposed against an insolvent company. The purpose of the section is to prevent the burden of the penalty falling upon creditors. The Explanatory Memorandum for the Corporate Law Reform Bill 1992 (Cth), which introduced s 553B, said this (at [854]): "[A]lthough the fine may be a claim by the community, fines are by their nature generally intended to be a deterrent. In the case of a corporate insolvency, it is difficult to justify 'penalising' creditors for a wrong committed by the company. Proposed s 553B provides that penalties or fines imposed by a court are not admissible to proof against an insolvent company." 18 Second, the objective of s 553B is not defeated if during the winding up of a company the body to whom a penalty or fine is payable (most often a government or government agency) is preferred over contributories. In any event, if a penalty or fine were not paid out of any surplus the contributories will receive a windfall and for this result there is no justification. 19 Finally, the approach is consistent with the Australian cases which, for many years, have allowed for a second round of proofs: see, for example, Mackenzie v Rees (1941) 65 CLR 1; Page v Commonwealth Life Assurance Society Ltd (1935) 36 SR (NSW) 85; Gerah Imports Pty Ltd v Duke Group Ltd (in liq) (2004) 88 SASR 419; Re Kershaw (as liq of Equitycorp Tasman Ltd) (2005) 54 ACSR 214, to mention a few. 20 What effect does this construction of s 553B have on the Commonwealth's application to terminate the deed? In my opinion it means that the application should succeed. There are two reasons. First, the chairman exercised his casting vote on a mistaken view of the law. Mr Randall, who appeared for the administrators, told me that it would be incorrect to assume that the chairman would have used his casting vote to approve the deed had he known the true position. I assume that he would have voted the deed down. 21 The second, and more important, reason is that the Commonwealth is indeed unfairly prejudiced by the deed. It will receive a dividend of about $458,350 if the deed is given effect, whereas in a winding up it would receive around double this amount. 22 There will therefore be an order that the deed be terminated. The effect of such an order is the winding up of the company pursuant to s 446B of the Corporations Act and reg 5.3A.07 of the Corporations Regulations 2001. 23 This brings me to the question of costs. The Commonwealth contends that the costs should be borne by the fourth defendant because it is in effect an unsuccessful party. I think that the better principle is this. Where an action is brought for the purposes of determining how a fund should be distributed, it is the fund that should bear the costs, so long as none of the parties to the litigation is guilty of misconduct. That is the practice the Chancery courts have followed for many years and which, to my knowledge, has been adopted by company judges in cases similar to the present. It is the practice I will adopt here. I certify that the preceding twenty-three (23) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Finkelstein.