As I have said, it has been accepted on both sides that this will result in a substantial balance in favour of the defendant, probably exceeding the total of the plaintiff's judgment and the plaintiff's entitlement to costs.

At this stage, that part of the defendant's application in which he seeks an award of a lump sum, namely $400,000, in lieu of taxed costs has been put on one side and has yet to be argued. Rather, argument so far has concentrated on paragraph 3 of the defendant's application, in which he seeks an order that the balance of costs which he asserts will become payable to him be off-set against the plaintiff's judgment.

This gives rise to several discrete questions, which may be summarised as follows:

(2) Does the defendant's entitlement to costs merge in the plaintiff's bankruptcy?

(3) Should the defendant's entitlement to costs be set-off against the judgment moneys?

I will address each of those questions in turn.

vested in the plaintiff's trustee in bankruptcy?

The answer to these questions represents the only common ground between the parties. Both the plaintiff and the defendant submit that the judgment moneys did not vest in the plaintiff's trustee in bankruptcy and are not divisible amongst his creditors.

Furthermore, as will have been seen from the letter to which I have referred from the Official Receiver to the defendant's solicitors, the plaintiff's trustee in bankruptcy does not claim that the judgment moneys form part of the plaintiff's sequestrated estate.

While neither that concession nor the agreement of the parties can be determinative of the question, in my view, that conclusion follows from a proper application of the relevant provisions of the Bankruptcy Act 1996 (Cth) ("the Act").

Section 58(1) of the Act relevantly provides that "where a debtor becomes a bankrupt ... the property of the bankrupt, not being after-acquired property, vests forthwith in the Official Trustee", or the registered trustee in cases where s 156A of the Act applies.

The phrase "the property of the bankrupt" is defined in s 5 of the Act as follows:

"the property of the bankrupt, in relation to a bankrupt, means:

(i) the property divisible among the bankrupt's creditors;

(ii) any rights and powers in relation to that property that would have been exercisable by the bankrupt if he or she had not become a bankrupt; and

(i) the property, rights and powers referred to in paragraph (a) of this definition; and

(ii) any other property of the bankrupt." (emphasis added)

Section 116 of the Act defines the property divisible amongst the bankrupt's creditors.

Section 116(1) provides, inter alia, that subject to the Act, all property that belonged to the bankrupt at the commencement of the bankruptcy is property divisible amongst the creditors of the bankrupt.

But s 116(2) provides that s 116(1) does not extend to property answering the description of a number of specified categories, one of which is the following:

(g) any right of the bankrupt to recover damages or compensation:

(i) for personal injury or wrong done to the bankrupt .....;

and any damages or compensation recovered by the bankrupt (whether before or after he or she became a bankrupt) in respect of such an injury or wrong ........"

In this case, the right of the plaintiff to recover damages on the cause of action which was the subject of the proceedings brought to trial, which was a cause of action to recover damages for personal injury, merged in the judgment pronounced by me on 23 August 2001, five months before the plaintiff was declared bankrupt.

Because of the stay of execution of the judgment which I ordered on the same date, which is still in place, none of the damages has been "recovered by the bankrupt". But if at any time the plaintiff recovers the damages, they would, by force of s 116(2)(g)(i), which expressly applies to such damages whether recovered before or after bankruptcy, be excluded from the property divisible amongst his creditors.

As for the costs to which the plaintiff is entitled, no suggestion has been made by either party, or for that matter the plaintiff's trustee in bankruptcy, that the plaintiff's entitlement to costs should form part of his bankrupt estate.

Although an entitlement to costs relating to the successful enforcement of a right of recovery of damages or compensation for personal injury is not expressly referred to in s 116(2)(g) of the Act, for the purposes of that subsection, I would regard any entitlement for costs arising in such circumstances as falling within the meaning of the words "damages or compensation".

It would be a strange result indeed if the plaintiff was entitled to keep the fruits of a successful action for damages for personal injury, but was obliged to hand over as part of the property divisible amongst his creditors his entitlement to costs arising in the course of the proceedings in which the damages were recovered.

Such a result would effectively diminish the entitlement to damages by the amount of the costs. I cannot accept that such a result could have been intended. I would regard the entitlement to costs as an appendage to the right to recover damages, and the destination of the costs should be the same as the destination of the damages.

In any event, in this case on 28 August 2001, five months before the date of bankruptcy I ordered that the lesser of the amounts payable under the costs orders which I made be off-set against the larger amount of costs payable pursuant to the costs orders. As I have already indicated, there seems to be no doubt that in the working out of the off-set of the costs orders, a substantial balance will be payable to the defendant.

Effectively, the plaintiff's entitlement to costs merged in the order I made for the setting-off of the costs entitlement as between the parties. It follows that in practical terms, the plaintiff had no entitlement to recover costs as at the date of the sequestration order.

So that however the matter is approached, in my view, there can be no question of the plaintiff's entitlement to costs, whether it should properly be viewed as subsisting as at the date of the sequestration order, or not, forming part of his sequestrated estate.

It follows that I would answer both parts of the first question "No".

It is convenient to deal with the next two questions together, as, for reasons which will appear, they are interrelated.

(2) Does the defendant's entitlement to costs merge in the plaintiff's bankruptcy?

(3) Should the defendant's entitlement to costs be set-off against the judgment moneys?

Mr McNamara QC for the defendant contended that the debt due by the plaintiff with respect to the balance of costs payable to the defendant is not a debt provable in bankruptcy, but his argument is that even if it should be so regarded, the defendant's right to a set-off is unaffected by the bankruptcy.

I will deal first with the question whether it is a provable debt.

The definition of "provable debt" is contained in s 82 of the Act, which is to the following effect:

(1) Subject to this Division, all debts and liabilities, present or future, certain or contingent, to which a bankrupt was subject at the date of the bankruptcy, or to which he or she may become subject before his or her discharge by reason of an obligation incurred before the date of the bankruptcy, are provable in his or her bankruptcy.

Note: The operation of this section in relation to accumulated HEC debts and semester debts under the Higher Education Funding Act 1988 is affected by section 106YA of that Act.

(2) Demands in the nature of unliquidated damages arising otherwise than by reason of a contract, promise or breach of trust are not provable in bankruptcy.

Mr McNamara QC argued that given that the defendant's entitlement to costs:

"arose in an action for recovery of property which is not divisible among the creditors, by virtue of s 116(2)(g)(i), the costs due to the defendant should be treated as an addition or appurtenance to the damages (which are outside the bankrupt estate) and as also being outside the bankrupt estate, that is to say, as not being a provable debt."[4]

In support of that contention, he cited In re Newman.[5]

In In re Newman the appellant obtained a verdict of £50 for damages for personal injuries against a bus proprietor. However, she did not sign judgment against the defendant until the defendant became bankrupt on his own petition.

Section 31 of the Bankruptcy Act 1869 (UK) provided, inter alia, that:

"Demands in the nature of unliquidated damages arising otherwise than by reason of a contract or promise shall not be provable in bankruptcy ....."

After judgment was signed, the Registrar of the Court of Queen's Bench, which was the court in which the appellant had obtained her judgment, made an order restraining the appellant from further proceeding on the judgment, apparently on the basis that the debt represented by the judgment was provable in the bankruptcy.

The decision of the Registrar was reversed on appeal to the Court of Appeal, the court holding that where judgment for damages for a tort is signed after bankruptcy, the amount of the judgment is not a "debt or liability to which the bankrupt is subject at the date of the" bankruptcy.[6]

There was a separate question as to the taxed costs of the action, judgment for which was also signed after the bankruptcy. As to that aspect of the matter, in the course of his judgment, Mellish LJ said:[7]

"It was clear law before the present Bankruptcy Act that there could be no proof for damages in an action of tort until judgment had been signed, and I am of the opinion that [the relevant clause] ... of section 31 was intended to preserve the law in this respect as it was. And the costs, being a mere addition or appurtenance to the damages, must follow the same rule as that to which they are attached."

Baggallay JA concurred with the judgment of Mellish LJ.

In my view, the decision in In re Newman does not assist the defendant in this case. Newman is authority for the proposition that a liability for damages in tort which has merged in a judgment signed after bankruptcy, and in that sense which became liquidated after bankruptcy, is not provable in the bankruptcy, and a costs order against the bankrupt made in the proceedings leading to the judgment likewise does not give rise to a provable debt.

Here, we are dealing with an item of property (the fruits of the judgment) which does not form part of the estate of the bankrupt, and a separate liability of the bankrupt to pay costs arising from the proceedings in which the bankrupt's entitlement to the item of property was established, the liability for costs arising before bankruptcy. I am unable to accept that the reasoning in In re Newman is applicable to the situation in this case.

Insofar as Mr McNamara QC relies upon the fact that by virtue of the operation of s 116(2)(g)(i) of the Act the entitlement of the plaintiff to damages lies outside of the bankruptcy, and does not represent an item of property divisible amongst the creditors, I am unable to accept that it should follow that the plaintiff's liability for costs to the defendant in the action in which his entitlement to damages for personal injury was adjudged should not properly be regarded as a provable debt.

Section 116 does not deal with provable debts; it deals with property divisible amongst the creditors. If a debt is otherwise a provable debt within the meaning of s 82 of the Act, I am unable to see that there is anything in s 116 which would operate to take the debt out of that category.

Mr McNamara QC's alternative argument was that even if the plaintiff's liability for costs, being the balance of the costs after applying the set-off which I ordered on 28 August 2001, is a provable debt, nonetheless his client should be entitled to set-off that liability against the plaintiff's judgment.

In order to deal with that argument it is necessary first to determine whether or not the defendant's rights to a set-off in such circumstances are exclusively determined by the relevant provisions of the Bankruptcy Act.

As to that question, the plaintiff contended that once bankruptcy has supervened, rights to a set-off may only be dealt with pursuant to s 86 of the Bankruptcy Act. The plaintiff further contended that to permit the defendant to pursue its application for an order that the balance of costs be set-off against the judgment, would be to enforce a remedy or commence proceedings in respect of a provable debt contrary to s 58(3) of the Bankruptcy Act.

It is convenient first to deal with the question whether or not s 86 of the Bankruptcy Act stands in the path of acceding to the defendant's application. Section 86 is in the following terms:

(1) Subject to this section, where there have been mutual credits, mutual debts or other mutual dealings between a person who has become a bankrupt and a person claiming to prove a debt in the bankruptcy:

(a) an account shall be taken of what is due from the one party to the other in respect of those mutual dealings;

(b) the sum due from the one party shall be set off against any sum due from the other party; and

(c) only the balance of the account may be claimed in the bankruptcy, or is payable to the trustee in bankruptcy, as the case may be.

(2) A person is not entitled under this section to claim the benefit of a set-off if, at the time of giving credit to the person who has become a bankrupt or at the time of receiving the credit from that person, he or she had notice of an available act of bankruptcy committed by that person."

It might be thought that the defendant is not, within the meaning of the section, "... a person claiming to prove a debt in the bankruptcy", given that even if it is a provable debt, he eschews any obligation to claim for it, pursuing instead his alleged right to a set-off.

But in Guye v McIntyre[8] the High Court held that the words "... a person claiming to prove a debt" in s 86 are to be:

"... understood as including a person who, but for the set-off under s 86, would be entitled to prove a debt in the bankruptcy. That construction can be partly, but not wholly, rationalized by the consideration that a person who asserts a set-off against a trustee in bankruptcy may be loosely said to be indirectly claiming to prove in the bankruptcy, albeit by retaining the full amount as distinct from seeking a dividend. It is supported by considerations of 'substantial justice' in that it enables the section to operate regardless of whether set-off produces a positive or negative (or nil) balance from the point of view of either party."

That passage might be thought to support the view that, even though the defendant is not a person "claiming to prove a debt" in the plaintiff's bankruptcy, s 86 is nonetheless of potential application.

However, it seems to me that a passage which follows immediately upon the passage which I have just cited from Guye v McIntyre, identifies considerations which make it clear that for other reasons, s 86 is not of application in this case in the manner contended for by the plaintiff.

The further passage is in these terms:[9]

"Section 86 is a statutory directive ('shall be set off') which operates as at the time the bankruptcy takes effect. It produces a balance upon the basis of which the bankruptcy administration can proceed. Only that balance can be claimed in the bankruptcy or recovered by the trustee. If its operation is to produce a nil balance, its effect will be that there is nothing at all which can be claimed in the bankruptcy or recovered in proceedings by the trustee. The section is self-executing in the sense that its operation is automatic and not dependent upon 'the option of either party': ....."

The reference in that passage to the operation of s 86 producing a "balance upon the basis of which the bankruptcy administration can proceed" and references to the fact that a nil balance, or even a credit in favour of the trustee may be created by the application of the section, make it plain that the section only has application in a case where the fund or entitlement against which the set-off is claimed, vests in the trustee in bankruptcy.

The operation of s 86 in those circumstances prevents what would otherwise be the somewhat anomalous and unfair result which would follow if a trustee in bankruptcy could claim in full a debt owed by a person with whom a bankrupt has had dealings, but oblige that person, who might otherwise have a set-off as to a debt due by the bankrupt, to prove in bankruptcy for the amount sought to be set-off, and perhaps recover a small dividend only for the amount of the set-off.

However, in this case, for the reasons already given, and having regard to the operation of s 116 of the Act, the plaintiff's judgment moneys are not moneys to which his trustee in bankruptcy is entitled. That being so, s 86 cannot be of application in this case, as the set-off is sought against moneys to which the trustee is not entitled.

Once it is accepted that s 86 is not of application to the case, it then becomes necessary to address the question whether or not other rights of set-off may be availed of by the defendant.

(1) Notwithstanding the following provisions of this Rule and of the provisions of Rule 101A.01, the costs of any party, the amount thereof, the person by whom, or the fund or estate, or portion of an estate, out of which they are to be paid are in the discretion of the Court, and the Court may:

(c) direct whether or not the costs are to be set-off;

This Court has held that the discretion conferred by that rule to direct a set-off of costs extends to permit a direction that costs awarded to a defendant may be set-off against damages payable to a plaintiff in the same action.

That course was taken by Legoe J in McGregor-Dey v SACAE and Anor.[10] In his decision in that case, Legoe J made reference to Burke v Lunn[11] and Watkins Ltd v Ranger Uranium Mines Pty Ltd and Ors.[12]

Burke v Lunn concerned the arbitration of a building dispute. The Supreme Court of Victoria adopted the report of the special referee appointed under the Arbitration Act 1958 (Vic) and enforced it as a judgment of the court. The judgment was in favour of the builder to whom it was found that the building owner owed a sum of money.

As it turned out, the amount awarded was greater than an amount which had been paid into court.

Pursuant to the relevant rules of the Victorian Supreme Court, the builder was ordered to pay the costs of the building owner subsequent to the date of payment into court, the building owner being liable for the costs incurred prior to that date. The court further held not only that the costs should be set-off against each other, but that any surplus of costs payable by the plaintiff builder to the defendant building owner, should be set-off against the amount of the judgment in favour of the plaintiff.

In so holding, Menhennitt J in that case followed a practice of the court which had been the subject of an earlier decision to which he made reference, namely that of Newton J in Pryor v Hennessy and Anor.[13]

In Pryor v Hennessy and Anor, Newton J was dealing with a claim brought by an infant plaintiff who sued by his next friend. In the course of his judgment, he said:[14]

"In cases where an adult plaintiff recovers less than a sum paid into court and where the defendant's costs since the date of payment into court will exceed the plaintiff's costs prior to that date, the usual practice is to order that costs be set off and that the balance of costs owing by the plaintiff to the defendant be set off or charged against the plaintiff's damages; see, for example, Lyons v Winter,[15] Spencer v Commonwealth,[16] Crapp v Crocker,[17] Abrahams v Catip[18] and Baird v Baird;[19] cf O'Sullivan v Morton.[20] This practice appears to me to be based on considerations of fairness and good sense. A payment into court by a defendant is an offer to the plaintiff to settle the action for the amount of the payment, and is subject to the sanction that if the plaintiff rejects the offer but recovers less than the payment into court, then the plaintiff will have to pay the defendant's costs since the date of the payment into court. The proper implementation of this sanction, in cases where it takes effect will ordinarily justify an order that the costs owing by the plaintiff to the defendant be set off against the damages recovered by the plaintiff as well as against costs owing by the defendant to the plaintiff; the costs which the plaintiff is ordered to pay to the defendant represent in effect a price payable by the plaintiff for his judgment for the damages, and he should not be allowed to take the damages without paying that price; the money in court is under the control of the court, which can properly order that the money shall be the sole source for the payment of the plaintiff's damages, subject to all necessary set offs or charges in respect of the defendant's costs."

It is clear from the reports of the decisions of Menhennitt and Newton JJ to which I have referred, that neither took the course they did by reference to any express power conferred by rule of court. Rather, as Newton J explained in the passage just cited, the course taken was a reflection of the "usual practice of the court" as supported by the authorities to which he referred. The rule of practice had its origin in the fact that where an otherwise successful plaintiff is ordered to pay a balance of costs to the defendant as the "price payable by the plaintiff for his judgment for the damages", the costs should be set-off against the judgment.

The decision in Burke v Lunn was referred to by approval and applied by Nader J in Watkins Ltd v Ranger Uranium Mines Pty Ltd and Ors.[21] In the course of his judgment in that case, Nader J observed:[22]

"One cannot but notice that in the long line of cases going well back into the last century concerning set-off, the distinction between costs and damages has not been the important matter of debate. I think that the reason for this is clear enough, and depends on an understanding of the idea of 'judgment'. In the common case a judgment is made up of the verdict of damages and costs. Unless costs are specified by the court they remain indeterminate until the taxing master's allocatur when the amount of judgment, damages and costs, becomes a sum certain. The set-off is better regarded as a set-off between judgments. The question whether set-off should be allowed can be determined upon application to the court. The judge will be free to make such order as will best do justice to the parties."

In McGregor-Dey v SACAE and Anor (supra), Legoe J specifically adopted and applied as a correct statement of the law the observations of Nader J which I have just quoted. He did so in the context of consideration of the question of the ambit of the power to award a set-off of damages against an award of costs, pursuant to SCR r 101.01.

In Settlement Wine Co Pty Ltd v National & General Insurance (No 2),[23] I ordered that the defendant's entitlement to costs be off-set against the judgment pronounced against it for damages, specifically referring to SCR r 101.01(1)(c). I took that course notwithstanding that given the parlous financial position of the plaintiff company, if it should ultimately go into liquidation, there was the possibility that the order might be regarded as creating a preference.

Having regard to the authorities to which I have so far referred, I have no doubt that, putting aside the question of the effect of the supervening bankruptcy, it would be proper in this case to accede to the application to set-off the balance of costs due, against the plaintiff's judgment.

The remaining question is whether, having regard to the supervening bankruptcy of the plaintiff, s 58(3) of the Act stands in the path of taking that course.

Section 58 is headed "Vesting of property upon bankruptcy". Subsections (1) and (2) set out the manner in which the property of the bankrupt, including after acquired property, vests in the trustee in bankruptcy. Subsection (3) is as follows:

"(3) Except as provided by this Act, after a debtor has become a bankrupt, it is not competent for a creditor:

(a) to enforce any remedy against the person or the property of the bankrupt in respect of a provable debt; or

(b) except with the leave of the Court and on such terms as the Court thinks fit, to commence any legal proceeding in respect of a provable debt or take any fresh step in such a proceeding."

Put shortly, Mr McNamara QC's argument is that the allowance of the defendant's claim for a set-off against the judgment does not amount to the enforcement of a remedy within the meaning of s 58(3)(a), or the commencement of legal proceedings or taking of any fresh step in legal proceedings within the meaning of s 58(3)(b).

In support of his contention that to allow a set-off in the present circumstances would not be to enforce a remedy, Mr McNamara QC referred to what he submitted was the essential nature of the set-off.

To understand Mr McNamara QC's point, it is necessary to refer briefly to the history of the legal principles relating to a set-off.

No right of set-off was recognised in an action at law prior to the first statute of set-off in 1729. That statute provided:[24]

"And be it further enacted .... that where there are mutual debts between the plaintiff and defendant, or if either party sue or be sued as executor or administrator, where there are mutual debts between the testator or intestate and either party, one debt may be set against the other, and such matter may be given in evidence upon the general issue, or pleaded in bar, as the nature of the case shall require, ..."

That provision was re-enacted with a somewhat more expanded wording but to the same effect in the second of the statutes of set-off:[25]

"And be it further enacted ...... that by virtue of the said clause in the said first recited Act contained [the first statute of set-off 1729], and hereby made perpetual, mutual debts may be set against each other, either by being pleaded in bar or given in evidence on the general issue, in the manner therein mentioned, notwithstanding that such debts are deemed in law to be of a different nature, unless in cases where either of the said debts shall accrew by reason of a penalty contained in any bond or specialty; and in all cases where either the debt for which the action hath been or shall be brought, or the debt intended to be set against the same hath accrewed or shall accrew by reason of any such penalty, the debt intended to be set off shall be pleaded in bar, in which plea shall be shewn how much is truly and justly due on either side; and in case the plaintiff shall recover in any such action or suit, judgment shall be entred for no more than shall appear to be truly and justly due to the plaintiff after one debt being set against the other as aforesaid."

It will be seen from both enactments that the right of set-off may be "pleaded in bar", and from the second of those statutes, the judgment to be entered for the plaintiff will be for the amount due after one debt has been set off against the other.

Mr McNamara QC submitted that since the early statutes of set-off, the nature of a set-off has remained essentially the same in the relevant respect, namely that a set-off operates as a plea in bar, and where applicable, reduces pro tanto (or extinguishes) the judgment to which the plaintiff might otherwise be entitled. Subsequent authority supports that view as to the nature and operation of a set-off.

In Mersey Steel & Iron Co v Naylor and Ors[26] the defendants agreed to purchase a large quantity of steel from a company, to be delivered in instalments. After the company had delivered about half of the first instalment, but before payment became due, the company was wound up. The plaintiff, who was the liquidator of the company, sued for the price of the steel delivered.

It was held by the Court of Appeal (reversing the decision of Lord Coleridge CJ at first instance) that the defendant was entitled to set-off against the liquidator's claim for the price of the steel which had been delivered, the amount due to it by way of damages for non-delivery of the balance of the steel.

In the course of his reasons for judgment Jessel MR observed:[27]

"Now, in reason there cannot be any question whatever that the right to set-off unliquidated damages against a debt is one which ought to be supported. Irrespective of winding-up, the present defendants would have had a right to say: 'You owe us a large sum of money for damages; you sold us iron at a price which, if delivered, would have left us a very handsome profit; we have lost that by your non-delivery of part, set that off against what we owe you for the portion you have delivered'. In reason there is nothing to be said against this. In law there is nothing to be said against it, independently of winding-up, because, as the law now stands, whatever the law was formerly, they could have pleaded as they did plead, by way of set-off, the amount of unliquidated damages against the claim for the goods delivered. Then does the winding-up prevent that? In other words, has the liquidator the right by reason of the winding-up of a company to claim payment in full for the goods sold and delivered, leaving the purchasers to prove for their damages, and get perhaps a small dividend in the winding-up proceedings."

"... justice can be done by giving the defendant what they ask, viz, the right to a defence to the extent of the amount of the damages."[28]

In Peat v Jones & Co,[29] one Hill sued to recover £150, being the unpaid balance of the price of a certain quantity of iron which Hill had contracted to deliver to the defendants by monthly deliveries. On his subsequent bankruptcy, his trustee continued the action.

The defendants admitted their liability but set up a counterclaim for damages arising from non-delivery and a rise in the price of iron.

The question arose as to whether or not a counterclaim could be allowed against a trustee under the Bankruptcy Act 1969, more particularly s 39 of that Act which allowed a set-off of "mutual dealings".

During the course of his judgment in the case, Cotton LJ observed:[30]

"As a trustee in bankruptcy cannot be sued, a counter-claim is not maintainable against him, except so far as it is reduced to a set-off. But a succession of cases shews that a set-off was long treated as a good defence at common law, and I think that the principle of those cases applies to the mutual credit section of the present Bankruptcy Act ..." (emphasis added)

The importance of the case is that it demonstrates that although a trustee in bankruptcy cannot be sued (the creditor being obliged to prove in the bankruptcy), the claim which a trustee in bankruptcy might be entitled to pursue against a third party stands to be reduced insofar as there is a counterclaim arising out of a mutual course of dealing giving rise to the claim.

In In re Collison: Smith v Sinnathamby,[31] before bankruptcy, the bankrupt contracted to sell a property to the respondent, but subsequently refused to perform it. The respondent then obtained a decree for specific performance, upon which an order for taxed costs to be paid by the bankrupt was ordered.

Following his bankruptcy, the trustee of his estate agreed to comply with the decree for specific performance.

The respondent sought to deduct from the purchase moneys and retain the taxed costs awarded on the application for specific performance. His claim to be entitled to do so was upheld by Smith J sitting in the Supreme Court of Western Australia.

During the course of his judgment, Smith J observed:[32]

"At the commencement of the bankrupt's bankruptcy, the trustee was entitled to receive payment from the respondent of the balance of the purchase price and there was in existence a judgment of the court that the bankrupt pay to the respondent, the respondent's costs of the action for specific performance. The amount which was ultimately to be payable by the bankrupt could not be ascertained until some time later than the date of the sequestration of the bankrupt's estate, .... In my view, it matters not that the precise amount due to the respondent was not known at that time and could be ascertained only by resort to taxation of the respondent's solicitor's bill of costs."

By analogy with that case, Mr McNamara QC argued that as of 28 August 2001, when I made the costs orders, the state of affairs which existed between the plaintiff and the defendant in this case resembled that which Smith J held to be the position which existed between the trustee in bankruptcy and the respondent in In re Collison. The plaintiff in this case had a judgment, but the defendant became entitled to taxed costs which, upon taxation or other ascertainment of the costs, on Mr McNamara QC's argument, he is entitled to set-off.

There are a number of difficulties in the path of accepting that argument.

In In re Collison at the date of the commencement of the bankruptcy, the trustee was entitled to the balance of the purchase price, and the judgment ordering the bankrupt to pay the respondent's costs was also in existence.

It followed that s 86 of the Act was able to be invoked so as to enable a set-off within the bankruptcy.

Likewise, in Peat v Jones (supra) the unpaid balance of the price due for the steel delivered before bankruptcy was payable to the trustee for the benefit of the bankrupt's creditors, so that the set-off with respect to damages operated within the bankruptcy.

The situation is different in this case. The plaintiff's entitlement to the fruits of the judgment which he has obtained lies outside the bankruptcy. It follows for the reasons which I have explained that s 86 does not enable a set-off to be made.

Looking at the position as at the date of the sequestration order, that is, as at 23 January 2002, the plaintiff was entitled in his own right to payment of the amount of the judgment (subject to the stay which I had ordered), and the defendant was entitled to payment of the balance of the costs awarded in his favour (subject to taxation).

As I have already explained, the defendant's entitlement to costs was a debt provable in the bankruptcy. Although he had sought an order off-setting the costs against the judgment, no such order had been made, and indeed, has still not been made.

"On bankruptcy all provable debts owing by the debtor are converted from rights of action against the debtor to a right to share in the distribution of the debtor's estate vested in the trustee ....".[33]

While it is true that a set-off operates to reduce the claim pro tanto, in a case such as this it does not operate until it is ordered.

The practice of the common law courts to allow a set-off of judgments is not founded upon the statutes of set-off; rather, it is an exercise of the inherent jurisdiction of the court. That would seem clearly to have been recognised in Burke v Lunn and Pryor v Hennessy and Anor (supra). See also the following passage in Derham on Set-Off:[34]

"It has been the practice of the common law courts since the eighteenth century to allow one judgment or order for the payment of a sum of money to be set off against another. This practice extends to a judgment for damages as well as to an order for the costs, including costs in bankruptcy proceedings and costs when one of the parties is legally aided. It applies to judgments in the same action or in different actions, or in the same or different courts. Nor is it an objection that one of the judgments had existed at the commencement of the other action, and might have been pleaded as a defence in that action. The set-off in these cases is not pursuant to the Statutes of Set-off, but rather it is allowed in the discretion of the court as part of its inherent jurisdiction. It has been described as a form of 'equitable' jurisdiction possessed by the common law courts for the purpose of preventing absurdity or injustice. In allowing a set-off the court is at liberty to impose such terms as it considers reasonable and just." (Emphasis added. I have not paused to cite the authorities referred to in various footnotes to that passage.)

As the learned author of that work goes on to explain, although it has been suggested that the jurisdiction exercised by the courts in setting-off judgments is a species of equitable set-off, this is not so, and this kind of set-off:

"... in truth has a common law origin. It is part of the court's inherent jurisdiction."[35]

In this case, the set-off sought by the defendant is not a set-off of the kind provided for in the statutes of set-off. Neither, as was suggested in an alternative argument put by Mr McNamara QC, could it be regarded as a set-off of the kind of sanctions ordered by a court of equity. Rather, it is in the category of set-off of judgments, which may be effected in the inherent jurisdiction of the court. SCR r 101.01(1)(c), which empowers the court to direct whether or not costs are to be set-off, creates a procedural regime within which the inherent jurisdiction in that respect may be exercised.

I accept that the use of the words "set-off" in the rule means that in general terms a set-off, once ordered, will take effect to reduce pro tanto the judgment against which the set-off operates. Two judgments will become one, representing the balance struck between the two judgments after the set-off has operated. In that sense, Mr McNamara QC's analogy with the juristic nature of a set-off under the statutes of set-off is correct.

However, where his argument breaks down, is that there cannot be a set-off under SCR r 101.01(1)(c) until the court orders it. There is a discretion. Upon an application being made, the court may or may not order that the judgment (or order) as to costs be set-off against the judgment or fund against which the set-off is claimed. The set-off, if ordered, will take effect upon the making of the order, and not before.

It follows that if one analyses the situation as at the date of bankruptcy in this case, because the entitlement to costs ordered in favour of the defendant was a debt provable in bankruptcy, it merged in the bankruptcy and was converted into a right on the part of the defendant to prove in the plaintiff's bankruptcy. Once that situation has arisen, s 58(3) of the Act comes into operation.

I accept that s 58(3)(b) would not stand in the path of the defendant, in the sense that the interlocutory application issued on 19 December 2001, and indeed the oral application made by Mr Trim QC on 28 August 2001 seeking a set-off of the costs, both antedate the plaintiff's bankruptcy. In those circumstances, in pursuing the application for a set-off, the defendant is not to be taken to be commencing a legal proceeding after bankruptcy. Neither do I think that merely listing the matter for hearing is properly to be regarded as taking a "fresh step" in the proceeding.[36]

But s 58(3)(a) is, in my view, an insurmountable hurdle against the success of the defendant's pursuit of the application for a set-off.

Mr McNamara QC put an interesting argument as to the application of s 58(3)(a) to the effect that to obtain a set-off "in respect of a provable debt" is not to "enforce" a "remedy" against the person or the property of the bankrupt within the meaning of s 58(3)(a). This argument was predicated upon his submission, soundly based in the authorities to which I have referred, that a true set-off, that is, a set-off of the kind provided for in the statutes of set-off, is not a "remedy" which may be enforced, but operates by way of a defence or plea in bar which, if successful, reduces the claim against which it operates.

However, I think that to approach s 58(3)(a) on a footing that the words "to enforce any remedy" are not apt to include an order for a set-off made pursuant to SCR r 101.01(1)(c), would be to construe the phrase too narrowly.

Section 58(1)(3) of the Act is clearly an expression of the legislative intention to confine a bankrupt's creditors, whose debts are provable in bankruptcy, to their right to so prove. Against that background, to allow a set-off in the circumstances of this case, in practical terms, would be to circumvent that intention. In the broad sense, a set-off of the kind which may be ordered under SCR r 101.01(1)(c) affords to the party obtaining it a "remedy", namely payment of the costs by way of a reduction, pro tanto, of the judgment.

I realise that the words "the property of the bankrupt" in s 58(3)(a) might not be thought to include the rights of the bankrupt to the fruits of the judgment in question, having regard to the definition of the words "the property of the bankrupt" in s 5. But subparagraph (b) of that definition operates so that with respect to s 58(3) the phrase "the property of the bankrupt" has a more extended meaning beyond the property available for division amongst the creditors, and includes "any other property of the bankrupt".[37]

To summarise, it seems to me that there are at least two reasons why the defendant is unable to succeed in his application to set-off the balance of costs. They are:

(a) As at the date of bankruptcy, the defendant's entitlement to costs merged in the bankruptcy, and the defendant was left with his right to prove for the balance of costs in the plaintiff's bankruptcy.

(b) In such circumstances, to allow the defendant to pursue an application, albeit one which was instituted before bankruptcy, in an endeavour to secure an order for a set-off pursuant to SCR r 101.01(1)(c), would be a breach of s 58(3)(a).[38]

In those circumstances, it is unnecessary to consider the question whether or not leave might otherwise have been granted under s 58(3)(b). But I should mention, in case it might be thought that I had acceded to Mr McNamara QC's argument that this Court had jurisdiction to grant leave should the occasion for its exercise arise, that in my view, this is not so.

In support of his contention Mr McNamara QC referred to the judgment of Mansfield J in In re Killington: ex parte Chisholm.[39]

But that decision was doubted by Barrett J in Green v Schneller and Anor.[40] In that case, Barrett J held that the Supreme Court of New South Wales did not have jurisdiction to grant leave to proceed under s 58(3). I am inclined to accept the reasoning adopted by Barrett J, which would apply equally to exclude the jurisdiction of this Court in such matters.

I am well aware of the fact that the result which I have reached, namely that the plaintiff is entitled to keep his judgment moneys and that the defendant is obliged to prove in the plaintiff's bankruptcy for the balance of costs due to him, might be thought to be unsatisfactory and anomalous. This is particularly so, as if a set-off was to be allowed, the situation of the unsecured creditors proving in the bankruptcy would be improved rather than impaired.

Furthermore, it may well be that the plaintiff has deliberately sought and obtained the sequestration order, with the intention of preserving his entitlement to the judgment moneys. I stress, however, that I have no evidence of any such intention, although the opportunity to manipulate the system, in this and in other similar cases, is obvious.

The fact that in the case of the insolvency of the debtor such an anomaly may arise is recognised in the introduction to Set-off (Derham) (supra), more particularly in the following passage in the introduction to that work:[41]

"If there are cross-demands between a creditor and a debtor who has become insolvent, the creditor, in the absence of a set-off, may be obliged to pay the full amount of his own indebtedness, and yet be confined to receiving a dividend along with the other creditors for the amount for which the insolvent debtor is indebted to him."

I would dismiss the defendant's application for a set-off of the balance of costs.

(a) as to whether the defendant still wishes to proceed with his application to award an interim lump sum in lieu of taxed costs;

(b) as to the disposal of the application by Tindall Gask Bentley for a declaration that they are entitled to a lien over the judgment moneys to secure payment of their outstanding legal fees and expenses; and

(c) as to the costs of the defendant's application for a set-off.

1. Davies v Gertig (2001) 215 LSJS 298.

3. See Bankruptcy Act 1966 (Cth) s 55 and s 115.

5. [1876] 3 Ch D 494.

8. [1991] HCA 60; (1990-1991) 171 CLR 609 per Mason CJ, Brennan, Deane, Dawson, Toohey, Gaudron, McHugh JJ at 621-622.

10. (1993) 171 LSJS 290.

11. [1976] VicRp 22; [1976] VR 268.

12. (1985) 35 NTR 27.

13. [1973] VicRp 20; [1973] VR 221.

15. [1900] ArgusLawRp 30; (1899) 25 VLR 464 at 468; [1899] ArgusLawRp 166; 6 ALR 122.

16. [1907] HCA 82; (1907) 5 CLR 418 at 439-40; [1977] VicRp 29; 14 ALR 253.

17. (1941) 58 WN (NSW) 146.

18. [1942] QWN 19.

19. [1946] QWN 37.

20. [1911] ArgusLawRp 38; [1911] VLR 249 at 260; [1911] ArgusLawRp 38; 17 ALR 201.

21. (1985) 35 NTR 27 at 39.

23. (1994) 175 LSJS 282.

24. Insolvent Debtors Relief Act 1729 2 Geo II c 22 (Imp) s 1 and s 13.

25. Insolvent Debtors Relief Amendment Act 1735 8 Geo II c 24 (Imp) s 4 and s 5. It was conceded by counsel on both sides that both Acts are in force in South Australia by force of the Australian Courts Act 1828 9 Geo IV c 83 (Imp) s 24.

26. [1882] 9 QBD 648.

29. (1881) 8 QBD 147.

31. (1978) 33 FLR 39.

33. McDonald Henry & Meek Australian Bankruptcy Law and Practice 5th ed, vol 1, page 3140, para 58.3.15, citing Clyne v Deputy Commissioner of Taxation (No 3) [1984] HCA 44; (1984) 154 CLR 589, 594-595; Re Cole: ex p Richards (1966) 9 FLR 190, 191.

36. The relevant "proceeding" in this case is a "legal proceeding in respect of a provable debt", which must be the defendant's application for a set-off rather than the principal proceedings brought by the plaintiff.

37. See s 5 definition of "the property of the bankrupt" (b)(ii).

38. Having regard to the manner in which I have reasoned to these conclusions, it has not been necessary to refer to the decision of the Full Court in Rex v Ray; Ex parte Chapman [1936] SAStRp 27; [1936] SASR 241, but I note that none of my findings are inconsistent with my understanding of that case. That case, however, does turns on its special facts, notably the existence of moratorium legislation in force during the Great Depression.

39. (1998) FCA 1474.

40. [2001] NSWSC 897; (2001) 164 FLR 82.

[1] Davies v Gertig (2001) 215 LSJS 298.

[3] See Bankruptcy Act 1966 (Cth) s 55 and s 115.

[4] Written outline of submissions, para 19.

[5] [1876] 3 Ch D 494.

[8] [1991] HCA 60; (1990-1991) 171 CLR 609 per Mason CJ, Brennan, Deane, Dawson, Toohey, Gaudron, McHugh JJ at 621-622.

[10] (1993) 171 LSJS 290.

[11] [1976] VicRp 22; [1976] VR 268.

[12] (1985) 35 NTR 27.

[13] [1973] VicRp 20; [1973] VR 221.

[15] [1900] ArgusLawRp 30; (1899) 25 VLR 464 at 468; [1899] ArgusLawRp 166; 6 ALR 122.

[16] [1907] HCA 82; (1907) 5 CLR 418 at 439-40; [1977] VicRp 29; 14 ALR 253.

[17] (1941) 58 WN (NSW) 146.

[18] [1942] QWN 19.

[19] [1946] QWN 37.

[20] [1911] ArgusLawRp 38; [1911] VLR 249 at 260; [1911] ArgusLawRp 38; 17 ALR 201.

[21] (1985) 35 NTR 27 at 39.

[23] (1994) 175 LSJS 282.

[24] Insolvent Debtors Relief Act 1729 2 Geo II c 22 (Imp) s 1 and s 13.

[25] Insolvent Debtors Relief Amendment Act 1735 8 Geo II c 24 (Imp) s 4 and s 5. It was conceded by counsel on both sides that both Acts are in force in South Australia by force of the Australian Courts Act 1828 9 Geo IV c 83 (Imp) s 24.

[26] [1882] 9 QBD 648.

[29] (1881) 8 QBD 147.

[31] (1978) 33 FLR 39.

[33] McDonald Henry & Meek Australian Bankruptcy Law and Practice 5th ed, vol 1, page 3140, para 58.3.15, citing Clyne v Deputy Commissioner of Taxation (No 3) [1984] HCA 44; (1984) 154 CLR 589, 594-595; Re Cole: ex p Richards (1966) 9 FLR 190, 191.

[34] 2nd ed, 1996, Clarendon Press - Oxford p 34.

[36] The relevant "proceeding" in this case is a "legal proceeding in respect of a provable debt", which must be the defendant's application for a set-off rather than the principal proceedings brought by the plaintiff.

[37] See s 5 definition of "the property of the bankrupt" (b)(ii).

[38] Having regard to the manner in which I have reasoned to these conclusions, it has not been necessary to refer to the decision of the Full Court in Rex v Ray; Ex parte Chapman [1936] SAStRp 27; [1936] SASR 241, but I note that none of my findings are inconsistent with my understanding of that case. That case, however, does turns on its special facts, notably the existence of moratorium legislation in force during the Great Depression.

[39] (1998) FCA 1474.

[40] [2001] NSWSC 897; (2001) 164 FLR 82.