HBSY Pty Ltd v Lewis

Supreme Court of NSW|2021-08-02|Before: Kunc J

Solicitors: Roberts & Partners Lawyers (Plaintiff/Cross Defendant) Shields Lawyers (Defendant/Cross Claimant) File Number(s): 2019/263639 Publication restriction: Nil

Summary

These proceedings concern the estate of the late Marjorie Lewis (the Estate), who died on 15 August 2008 leaving a will dated 10 October 2006 (the Will). Without disrespect, I will refer to Marjorie and others in these reasons by their first names.
Other than a legacy of $5,000, the Estate fell into residue. There were five residuary beneficiaries under the Will: Marjorie's brother (Allan) and his four sons (including Anthony and Geoffrey). The Will named Allan and Anthony as executors. However, they renounced their executorship before obtaining probate. Letters of administration have been granted to Geoffrey. These proceedings have their origin in Anthony's alleged misconduct in relation to Estate funds during the months it is said he was purporting to act as executor, and his subsequent bankruptcy.
Geoffrey is the defendant and cross claimant in these proceedings. The plaintiff and cross defendant, HBSY Pty Ltd (HBSY), is the assignee of Anthony's residuary share of the Estate. By his amended cross-claim filed on 14 December 2020, Geoffrey seeks declarations that HBSY is not entitled to be paid Anthony's share of the Estate: "1. If the Court determines that the Cross-Defendant received a valid and enforceable assignment of an interest of Anthony Richard Lewis in the estate of the late Marjorie Lewis who died on 15 August 2008 ("the Estate") (which is denied), the Cross-Claimant seeks: (a) a declaration that the Cross-Defendant is deemed to have received a distribution from the Estate in the sum of $502,554.74 ("the Net Sum") and interest thereon (or such other amount as the Court may determine); Or further or in the alternative: (b) a declaration that the Cross-Defendant cannot participate in or receive a distribution from the Estate without having first paid the Net Sum and interest thereon to the Estate (or such other amount as the Court may determine). 2. A declaration that the Estate is not liable to pay any legacy to the Cross-Defendant. …"
Geoffrey also seeks a declaration that HBSY does not have standing to bring the primary proceedings. The primary proceedings were commenced by statement of claim on 23 August 2019. By that statement of claim, HBSY sought to have Geoffrey removed and replaced as administrator of the Estate.
Geoffrey filed a notice of motion in the primary proceedings on 22 November 2019 seeking security for costs from HBSY in the sum of $75,000. That motion was successful before Lindsay J on 20 March 2020. HBSY failed to provide security for costs and on 24 April 2020, the primary proceedings were stayed until further order of the Court. As a result, this judgment concerns only the cross claim.
The issues before the Court can be summarised as: 1. Was Anthony an intermeddler or executor de son tort? 2. If the answer to the previous question is yes, did he breach his obligations? 3. Is any debt arising out of a breach able to be set-off against Anthony's beneficial entitlement in the Estate under s 86 of the Bankruptcy Act 1966 (Cth) (the BA)? 4. If the answer to the previous question is no, is HBSY nevertheless prevented from receiving any funds pursuant to the equitable principles in: 1. Re Dacre; 2. Morris v Livie; or 3. Cherry v Boultbee. 1. If the answer to the previous question is yes, was the right to rely on the principles waived by the Estate proving in Anthony's bankruptcy? 2. If the answer to the previous question is no, has Anthony's debt been extinguished by virtue of his discharge from bankruptcy?
The Court's conclusions on those issues can be summarised as: 1. Anthony acted as an intermeddler when he obtained the funds of the Estate and transferred them to Lewis Securities because he took considerable steps of his own volition to manage the Estate and intended to act as executor. 2. Anthony breached his obligations as trustee for the Estate by unilaterally transferring funds to Lewis Securities. Anthony was, at all relevant times, a director and majority shareholder of that company who stood to personally benefit from doing so. 3. Anthony's debt is not subject to set-off under s 86 because a gift under a Will is not a 'dealing' for the purpose of that provision. 4. Each of the equitable principles would operate to prevent HBSY from obtaining any funds from the Estate without the debt being satisfied. The principles as they apply to defaulting trustees (being the principles in Re Dacre and Morris v Livie) have wide scope in their applicability to assignees, such that HBSY cannot claim the interest unencumbered. 5. The Estate did not waive its right to pursue the equitable principles by proving in Anthony's bankruptcy because the Estate withheld Anthony's entitlement from the amount it sought to prove. Any waiver only applies to the extent of the debt that was sought to be recovered. 6. Anthony's debt was not extinguished because he engaged in a fraud or fraudulent breach of trust within the meaning of s 153(2)(b) of the BA by unilaterally investing almost the entirety of the Estate's funds in his own company.
Mr D K Smith of Counsel appeared for HBSY. Mr P Menadue of Counsel appeared for Geoffrey.

Facts

The Court finds the facts to be as follows.
Marjorie died on 15 August 2008. At the time of her death, Marjorie was a resident of the Sir Moses Montefiore Jewish Home (Montefiore).
The value of the Estate identified in the Letters of Administration was $786,453.31. The Estate's assets included a deposit of $551,084.93 held by Montefiore (the Montefiore Sum).
On the day of Marjorie's death, Anthony rang Marjorie's lawyers. His evidence was that he rang to ask whether they had any instructions about whether Marjorie wished to be buried or cremated. Following that conversation, Marjorie's lawyers emailed a copy of the Will to Anthony.
On 25 August 2008, Anthony emailed Montefiore. His email attached the Deceased's death certificate and included: "I am the executor of [the Will]. How do we commence action to get [the] Montefiore deposit back?"
Anthony was taken to that email in cross-examination (Tcpt, 2 August 2021, p 22(1-4)): "Q. You believed when you sent that email that you were acting as an executor, didn't you? A. Well, someone has to do the - yes, because someone has to do the work until probate is granted."
Montefiore responded to Anthony on the same day saying: "The bond will be sent back to [the Estate] and mailed to the person responsible for her accounts within two weeks of her passing."
The next morning, on 26 August 2008, Anthony forwarded that email exchange to Geoffrey.
Anthony subsequently received a cheque for the Montefiore Sum payable to the "Estate of the Late Marjorie Lewis". The cheque was dated 21 August 2008.
Anthony controlled and operated Lewis Securities Ltd (Lewis Securities) until 29 October 2008, when an administrator was appointed. He was the majority shareholder and a director at all relevant times.
Marjorie had invested with Lewis Securities since 1992. At the time of her death, the value of her portfolio with Lewis Securities was $305,606.
On or shortly before 2 September 2008, Anthony caused Lewis Securities to open an account in the name of "Anthony Lewis - Estate of Marjorie Lewis a/c" (the Estate Account).
On 2 September 2008, the Montefiore Sum was deposited into the Estate Account. On 9 September 2008, the Montefiore Sum was transferred into Lewis Securities' general trading account (the Lewis Securities Account). On the same day, Lewis Securities transferred $20,000 (the Additional Sum) from Marjorie's pre-existing account with Lewis Securities to the Lewis Securities Account.
On 29 October 2008, Lewis Securities went into voluntary administration.
On 14 December 2008, Allan renounced his executorship of the Estate. On 17 December 2008, Anthony also renounced his executorship of the Estate. Neither had ever been granted probate of the Will. On 13 January 2009, Geoffrey was granted letters of administration with the Will annexed.
On 27 January 2009, Geoffrey wrote to the administrators of Lewis Securities seeking repayment of the Montefiore Sum and the Additional Sum, which together totalled $571,084.93 (the Net Sum).
On 6 February 2009, Lewis Securities went into liquidation. It remains in liquidation.
On 24 March 2009, the liquidators' solicitor responded to Geoffrey's letter on 27 January 2009, stating: "... our clients do not accept the position set out in your letter. In our clients' opinion, the Estate is an unsecured creditor of Lewis Securities and its claim ranks equally with the other unsecured creditors of the company."
On 2 April 2009, Anthony was declared bankrupt. Andrew Aravanis was appointed his trustee in bankruptcy.
On 18 August 2010, the Estate received a dividend from the liquidator of Lewis Securities of $57,108.49, being 10 per cent of the Net Sum.
On 5 November 2010, Geoffrey wrote to Mr Aravanis enclosing: 1. A proof of debt in the amount of $300,000 to $330,000; and 2. Calculations dated 4 November for the "wastage" of $300,842 said to have been caused to the Estate by Anthony's conduct. The calculations explicitly omit Anthony's residual share of the Estate from the amount claimed to be owing.
As at 31 May 2011, Avaranis Insolvency formally recorded a proof of debt for $300,000 by the Estate.
On 21 July 2011, Mr Aravanis entered into an asset sale agreement with HBSY. The "Purchase Price" was $275,000. The assets sold by that agreement included the "Estate Interest", defined as "the Bankrupt's interest (if any) in the estate of the late Marjorie Elizabeth Lewis."
On 11 August 2011, Mr Aravanis notified Geoffrey of the assignment. On 17 August 2011, HBSY notified Geoffrey of the assignment.
On 3 April 2012, Anthony was discharged from bankruptcy.
On 1 May 2013, the Estate received a further dividend from Lewis Securities' liquidator of $11,421.70.
On 9 November 2015, Anthony became the registered owner of all of HBSY's share capital.
On 7 October 2020, the Estate received a further dividend from Lewis Securities' liquidator of $17,132.55.
The three dividends paid to the Estate by the liquidator of Lewis Securities total $85,662.74. Mr Aravanis as Anthony's trustee in bankruptcy declared a nil dividend and the Estate has not recovered any funds from Anthony.

Intermeddlers and executors de son tort

The authors of S Janes, D Liebhold and P Studdert, Wills, Probate and Administration Law in NSW (Lawbook Co, 2nd ed, 2020) state at [PAA.40-170] (citations omitted): "If the person named as executor in the will intermeddles in the estate, not having taken out probate, he or she becomes an "intermeddler"; if the person who intermeddles is not the appointed executor, he or she becomes an executor de son tort. The intermeddler and the executor de son tort incur the same liabilities, except that the intermeddling executor has an additional liability: he or she may be compelled to take out probate and cannot renounce without the consent of the court. The executor de son tort is "subject to the liabilities that an ordinary executor is subject to in respect of the assets with which he has intermeddled". The same is true of an intermeddling executor."
In Re Abat [2020] VSC 560, McMillan J said (at [31]): "Intermeddling in an estate is ordinarily considered to be an indication of an intention to accept an executorship and constitute acceptance of that office by the named executor."
In Mulray v Ogilvie (1987) 9 NSWLR 1, Needham J observed (at 3): "The questions of what acts will make a person an executor de son tort and of what acts make it impossible for a person named as executor to renounce probate cannot be said to have instant and convincing answers. There are many decisions on each of these points, most of them comparatively ancient, but it is not possible, I think, to reconcile them."
Needham J did however conclude (at 6) that "…the trend of more modern cases is to take a more lenient view of acts of nominated executors".
In Holder v Holder [1968] Ch 353 (Holder), three executors were nominated by a will. Before probate, they signed documents for the opening of an executor's bank account, signed cheques and endorsed insurance policies. One executor sought to renounce and purchased property from the estate. At the hearing, it was conceded that his renunciation was ineffective because he was an executor de son tort. Each member of the Court of Appeal considered that concession to have been wrongly made (Harman LJ at 391 and 392, Danckwerts LJ at 397, Sachs LJ at 401).

Breach of duty

In Gray v Hart [2012] NSWSC 1435 (Gray v Hart), White J (as his Honour then was) said: "321 Mr Swindells [who had been appointed as Mrs Harris' financial manager] was a partner of HLB Mann Judd and entitled to share in the firm's profits. He was not entitled to retain his own firm to provide accountancy services for reward, let alone to retain that firm to charge professional rates for the non-professional work of financial manager. In doing so, he placed himself in a position of conflict between his duty to Mrs Harris and his personal interest (e.g. Broughton v Broughton (1855) 5 De GM & G 160; (1855) 43 ER 831; In re Doody; Fisher v Doody [1893] 1 Ch 129 at 134-135; In re Gates; Arnold v Gates [1939] 1 Ch 913 at 918; In the Estate of Instone (Supreme Court of New South Wales, Powell J, 23 August 1993, unreported, BC9303622 at 30-35). Although the Protective Commissioner apparently passed Mr Swindells' accounts, that is not the same as Mr Swindells being authorised to charge personal remuneration. 322 Mr Swindells saw no conflict. He said that it was in the best interests of Mrs Harris that the work be done by his firm, as the charges were less than they would otherwise have been because he charged very little for his time. 323 It is no answer for a fiduciary faced with a conflict between his duty to his principal and his personal interest to say that what was done was for the benefit of his principal as well as his own benefit. In Aberdeen Railway Co v Blaikie Bros (1854) 2 Eq Rep 1281; [1843-60] All ER Rep 249 at 252-253, Lord Cranworth LC said (speaking of directors of a company): "Such an agent has duties to discharge of a fiduciary character towards his principal, and it is a rule of universal application that no one having such duties to discharge shall be allowed to enter into engagements in which he has or can have a personal interest conflicting or which possibly may conflict with the interests of those whom he is bound to protect. So strictly is this principle adhered to that no question is allowed to be raised as to the fairness or unfairness of a contract so entered into. ... It may sometimes happen that the terms on which a trustee has dealt or attempted to deal with the estate or interests of those for whom he is a trustee have been as good as could have been obtained from any other person; they may even at the time have been better. But still so inflexible is the rule that no inquiry on that subject is permitted."" Quantification of loss
All losses that flow from a trustee's breach are recoverable. The Court of Appeal in O'Halloran v R T Thomas and Family Pty Ltd (1998) 45 NSWLR 262 said (at 275): "There is an oft-cited formulation of the appropriate test for a trustee to be found in the judgment of Street J, as the former Chief Justice of NSW then was, in Re Dawson (deceased); Union Fidelity Trustee Co Limited v Perpetual Trustee Co Limited (1966) 2 NSWR 211. His Honour referred to a number of cases, including Caffrey v Darby [1801] EngR 484; (1801) 6 VES 488; 31 ER 1159, and said: "Caffrey v Darby is consistent with the proposition that if a breach has been committed then the trustee is liable to place the trust estate in the same position as it would have been in if no breach had been committed. Considerations of causation, foreseeability and remoteness do not readily enter into the matter."
It is observed in J D Heydon, Meagher, Gummow and Lehane's Equity Doctrines and Remedies (LexisNexis, 5th ed, 2015 at 23-175) that: "For a complaint as to loss to succeed, that loss must be shown by the plaintiff to have been suffered as a result of the defendant's default. Sometimes the facts will speak for themselves, in that proof of the breach will also be proof, at least prima facie, of the plaintiff's loss. For example, if a trust beneficiary shows that the trustee committed a breach of trust by disposing of trust property without power to do so, the beneficiary will also have discharged the onus of proving that the trust fund thereby suffered a loss: prima facie, the trust fund has suffered a loss to the value of the property of which the trustee disposed, assessed as at the date of judgment."
See also Youyang Pty Ltd v Minter Ellison Morris Fletcher (2003) 212 CLR 484; [2003] HCA 15 at [69].

The principle in Re Dacre

In Re Dacre; Whitaker v Dacre [1916] 1 Ch 344 (Re Dacre), Henry Dacre was appointed executor under the will of JG Womack. The will bequeathed a legacy of £2,000 to Henry's wife, Alice. She died without having received that legacy. Henry was both the sole executor and beneficiary of her estate. Henry died insolvent, never having proved in Alice's estate. It was discovered after his death that Henry had misappropriated £1,500 in his role as executor of JG Womack's estate. Lord Cozens-Hardy MR said at 347: "… the true principle, I think, is that which is laid down by Sir George Jessel in Jacubs v Rylance (L.R. 17 eq. 341) and which is again affirmed by Stirling J in the case of Doering v Doering (42 Ch. D. 203) and lastly emphatically affirmed by Parker J in re Towndrow ([1911] 1 Ch 662, 666, 668) where during the course of the argument he said this: "The real principle is that where there is an aggregate fund in which the trustee is beneficially interested and to which he owes something, he must be taken to have paid himself that amount on account of his share." That principle he lays down again in the same judgment where, quoting the words of Stirling J, he says: "The theory on which that rule is based is that the Court treats the trustee as having received his share by anticipation and the answer to any claim made by the trustee is this: "You have already received your share; you have it in your own hands." That doctrine has been applied not merely as against the defaulting trustee, but against his assignees for value."
This approach was endorsed by the Full Bench of the Victorian Supreme Court in Cumming v Austin (1903) 28 VLR 622 (at 628-9) per Holroyd J (Williams and Hodges JJ agreeing): "The rule, as stated by Stirling J in Doering v Doering, is that a defaulting trustee who has a beneficial interest in the trust estate cannot claim anything against it without making good his defalcations; and his assignee is in no better position, even when the default is committed after the assignment. … The trustee when he misappropriated the trust money is considered as paying himself, by anticipation, what would come to him as beneficiary, and the excess, if any, of the value of his share over the amount misappropriated is all that is left of it …"
In Re Sewell; White v Sewell [1909] 1 Ch 806 (Re Sewell), trustees appointed under a will misappropriated funds from the estate. A composition was agreed with the defaulting trustees' creditors which had the effect of extinguishing their liabilities. It was held that no sum could be impounded by the new trustees when monies became payable to the defaulting trustees under the will. Parker J said (at 808-9): "In my opinion the equity which has been asserted … depends upon the existence of a liability on the part of the person against whom it is asserted to pay money to an estate in the distribution of which he is interested. This liability may be legal or equitable only, and it may or may not be a liability which is enforceable by action. But in my opinion the liability must exist when the equity is asserted. It is not enough that it previously existed and has been released prior to the time when the equity is asserted … I do not think it makes any difference whether the liability be to executors for a debt or to trustees for a breach of trust."
Re Sewell was applied by the Full Court of the Supreme Court of Tasmania in Re Hurburgh [1959] Tas SR 25 at 48 (Crawford and Green JJ agreeing).

The principle in Morris v Livie

In Morris v Livie (1842) 62 ER 934 (Morris v Livie), the elder Robert Livie bequeathed £4,000 under his will to his brother-in-law, Alexander Champion and his partner, Robert Livie the younger, to be held on trust by them for the sole benefit of his sister, Catherine Primrose (or, in the event of her death, her son). The funds were to be invested in stocks and the dividends paid to Catherine. Alexander Champion died and Robert Livie the younger sold the stocks for his own benefit. Approximately £2,200 of dividends owed to Catherine was unpaid. Robert Livie the younger had been bequeathed a £5,000 legacy under the will which, prior to selling the stock, he had assigned to another for valuable consideration. Catherine's executors sought to reclaim what was owed out of Robert's legacy.
It was held that a legacy given to a trustee was subject to a condition that the trustee would properly perform their duties. That condition "if existing, accompanied his legacy until its discharge, and applied to it as much after as before its assignment" (at [389]). If the trustee acted in breach of trust, the right to participate could not be exercised until the breach was remedied.
The principle was also stated by Isaacs J in Cock v Aitken (No 2) (1912) 15 CLR 373 (at 384); [1912] HCA 70: "The case of Morris v Livie … shows that where a legacy is given to a trustee, there is a condition implied by law and attaching to the legacy until due that he shall fulfill his fiduciary obligations. That condition, as Bruce, VC says, accompanies the legacy until its discharge, and applies as much to it after as before assignment. That is the risk the assignee runs."
The author of R Derham, The Law of Set-Off (Oxford University Press, 4th ed, 2010) interprets the principle in Morris v Livie in this way: "[14.81] … the trustee's breach impugns his or her very entitlement to participate in the trust to the extent of the breach. Strictly, this is not a case of the trustee's interest being impounded. Rather, it is said that, in the event of a breach, the trustee does not have an interest. Since an assignee can only claim what the trustee could claim, the assignee should also take subject to the obligation to remedy the breach, regardless of when the breach may have occurred. … [14.85] One consequence of both [the Re Dacre and Morris v Livie] formulations is that, unlike under Cherry v Boultbee, it should not make any difference that the liability to contribute otherwise ceased to exist before the right to participate became due and payable, for example because of a discharge from bankruptcy, or as a result of a composition or scheme of arrangement. The discharge should not be relevant, because the breach would mean that the right to participate has already been impugned (under Morris v Livie), or it has already been satisfied by a notional payment in advance to the defaulting trustee. Similarly, in the case of Morris v Livie, the fact of proving the debt and receiving a dividend in the defaulting trustee's bankruptcy should not constitute a waiver of the right to invoke the principle either before or after discharge, since the trustee's right should still be impugned until such time as the default is remedied in toto. While Re Sewell is authority to the contrary, the point may be made that Parker J did not analyze the case in terms of the defaulting trustee formulations."

The rule in Cherry v Boultbee

In Cherry v Boultbee (1839) 4 Myl & Cr 442; 41 ER 171 (Cherry v Boultbee), Thomas Boultbee became bankrupt. His sister, Catherine, was a creditor but she did not prove in his bankruptcy. Catherine died and bequeathed a legacy to Thomas which exceeded the sum he owed to her. Mr Cherry, the assignee of Thomas' bankrupt estate, claimed the legacy. Catherine's executors claimed a right to set off the amount owing by Thomas against the legacy. Lord Cottenham said (at 447): "The right of an executor of a creditor to retain a sufficient part of a legacy given by the creditor to the debtor, to pay a debt due from him to the creditor's estate, is rather a right to pay out of the fund in hand, than a right of set off. Such a right of payment, therefore, can only arise where there is a right to receive the debt so to be paid; and the legacy or fund, so to be applied in payment of the debt, must be payable by the person entitled to receive the debt."
In Re Akerman; Akerman v Akerman [1891] 3 Ch 212, the testator died leaving part of his residue to his sons. At the time of his death, three of his five sons were financially indebted to him. Kekewich J held at (219-20): "The Lord Chancellor, Lord Cottenham, in the case of Cherry v Boultbee, took occasion to remark that the expression "set-off" is very inaccurately used in cases of this kind, and he might have added, no doubt, that inaccuracy implies confusion. I will venture to add to that remark that the term "retainer" also is inaccurately used in cases of this kind. I have heard more of "retainer" in this case than I have heard of "set-off," but neither the one term nor the other can really be used with propriety, and either, I think, equally introduces confusion. The principle is to be found laid down in Cherry v Boultbee in the passage to which I have just referred, and also in Courtenay v Williams, and no doubt, if search were made, it would be found to have been laid down in many other cases. It is this. A person who owes an estate money, that is to say, who is bound to increase the general mass of the estate by a contribution of his own, cannot claim an aliquot share given to him out of that mass without first making the contribution which completes it. Nothing is in truth retained by the representative of the estate; nothing is in strict language set off; but the contributor is paid by holding in his own hand a part of the mass, which, if the mass were completed, he would receive back. That is expanding what the Lord Chancellor calls in Cherry v Boultbee "a right to pay out of the fund in hand," rather than a set-off, and is in conformity with what the Lord Chancellor, Lord Lyndhurst, in Courtenay v Williams, says, "The defendant's, the legatee's, demand (the Court says) is in respect of the testator's assets, without which the executor is not liable; and it is very just and equitable for the executor to say, that the defendant, the legatee, has so much of the assets already in his own hands, and consequently is satisfied pro tanto.""
The rule was put in the following terms by Sargant J in Re Peruvian Railway Construction Co Ltd [1915] 2 Ch 144 at 150: "…where a person entitled to participate in a fund is also bound to make a contribution in aid of that fund, he cannot be allowed so to participate unless and until he has fulfilled his duty to contribute."
In Gray v Guardian Trust Australia [2002] NSWSC 1218, Austin J summarised at [108]: "… (1) where a person is entitled to participate in a fund, but is also bound to make a contribution into that fund, he cannot be allowed so to participate unless he has fulfilled his duty to contribute: Cherry v Boultbee; Re Peruvian Railway Construction Co Ltd [1915] 2 Ch 144 at 150; Herskope v Perpetual Trustees (WA) Ltd [2002] NSWSC 153; (2) this principle applies in respect of a beneficiary of the estate of a deceased person who has an obligation to contribute to the estate (for example, where the beneficiary is indebted to the estate); (3) the principle applies to a beneficiary who is indebted to an estate even where the debt is statute barred: Re Akerman [1891] 3 Ch 212; Re Abrahams; Abrahams v Abrahams [1908] 2 Ch 69; Re Wheeler; Hankinson v Hayter [1904] 2 Ch 66 at 71; (4) the same principle applies whether the obligation be to pay the principal alone, or to pay principal and interest: Re Akerman; Re Abrahams; Re Bickerdike [1919] VR 62."
A fund administrator may lose the right to apply the rule in Cherry v Boultbee if they elect to pursue a different remedy. Palmer J in Otis Elevator Co Pty Ltd v Guide Rails Pty Ltd (in liq) (2004) 49 ACSR 531; [2004] NSWSC 383 (Otis) said at [48]: "It is now established that a fund administrator such as a liquidator, a bankruptcy trustee or an executor of a deceased estate may lose the right to apply the rule in Cherry v Boultbee against an insolvent debtor/claimant of the fund if the fund administrator elects to pursue another remedy for payment of the debtor/claimant's debt to the fund. The most common instance is where the fund administrator proves in the insolvent estate of the debtor/claimant rather than applying the rule in Cherry v Boultbee: see Stammers v Elliott (1868) LR 3 Ch App 195; In re Sewell; White v Sewell [1909] 1 Ch 806; Wood English and International Set-off (1989) para. 8-131."

Effect of the Bankruptcy Act 1966 (Cth)

Section 86 of the BA provides: "86 Mutual credit and set‑off (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 the 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 credit from that person, he or she had notice of an available act of bankruptcy committed by that person."
In Gye v Mclntyre (1991) 171 CLR 609 at 618-9; [1991] HCA 60 (Gye v McIntyre), the High Court observed: "It has often been pointed out that the object of a set-off in bankruptcy is, in the words of Parke B in Forster v Wilson, "to do substantial justice between the parties, where a debt is really due from the bankrupt to the debtor to his estate". … To the extent necessary to achieve that legislative purpose of "substantial justice" to the parties, it is established by authority that a provision such as s 86 of the Act should be given "the widest possible scope" …"
The High Court also said at 624 that: "The requirement that the credits, the debts or the claims arising from other dealings be commensurable does not mean they must be vested, liquidated or enforceable at the decisive date, that is to say, at the time of the sequestration order or special resolution accepting the composition. Provided they exist as contingent at that date and are of a kind which will ultimately mature into pecuniary demands susceptible of set-off, the requirement of the section may be satisfied in relation to them."
The mutuality of parties' debts or credits requires consideration of their equitable or beneficial interests in those debts or credits, rather than the "dry legal right" alone: Hiley v People's Prudential Assurance Company Ltd (in liq) (1938) 60 CLR 468 at 497 per Dixon J.
As to whether a liquidated debt may arise, Bryson AJ held in Auto Group Ltd v England [2008] NSWSC 402 at [4] that: "... Equity has its own approach where there are fraudulent misappropriations of money in breach of trust. The trustee's obligation to make good the breach of trust is treated as "a species of equitable debt".
The effect of discharge on a bankrupt's debts is set out in s 153 of the BA, which provides: "153 Effect of discharge (1) Subject to this section, where a bankrupt is discharged from a bankruptcy, the discharge operates to release him or her from all debts (including secured debts) provable in the bankruptcy, whether or not, in the case of a secured debt, the secured creditor has surrendered his or her security for the benefit of creditors generally. (2) The discharge of a bankrupt from a bankruptcy does not: … (b) release the bankrupt from a debt incurred by means of fraud or a fraudulent breach of trust to which he or she was a party or a debt of which he or she has obtained forbearance by fraud …"
The proper construction of s 153(2)(b) is a significant issue in the proceedings, including whether establishing fraud or a fraudulent breach of trust under s 153(2)(b) requires proof of the debtor's state of mind. To consider this question it is necessary to consider the history and cases concerning this provision in some detail.
Prior to the 18th Century, discharge from bankruptcy could only be obtained by full satisfaction of any debts. That changed under Section VII of An Act to prevent frauds frequently committed by creditors (4 Anne I, c. 17) which allowed debtors to discharge their debts in circumstances where they fully co-operated with any inquiry. This was quickly amended in 1706 to require the consent of four-fifths of a bankrupt's creditors before discharge could be obtained.
The purpose of discharge was primarily to protect creditors' interests by persuading bankrupts to co-operate and to encourage risk-taking in commercial matters. To a lesser extent, it also recognised a distinction in circumstances where bankrupts had become so due to external events (such as war or shipwreck) as opposed to their own conduct (or misconduct).
The term fraud, as it was understood at that time, was both foreign and familiar to the present day: "As used in the seventeenth and early eighteenth centuries, the word [fraud] had two very different meanings. The first meant, as it does today, criminal deception. An excellent example of this is Kadens's description of the Pitkin Affairs, in which the parties were found to have acted fraudulently and the creditors took them to court for recourse. The second meaning of fraud, as used then but much less often today, is "a quality or disposition of being deceitful; faithlessness, insincerity". Here, the use conveys individuals who were not legally or criminally fraudulent but rather did not make the interest of others' resources paramount in their actions. … [T]he Anne statute sought to differentiate between those who were misfortunate, those who were perhaps somewhat deceitful, and those who were legally fraudulent." (Ann M Carlos, Edward Kosack and Luis Castro Penarietta, 'Bankruptcy, Discharge, and the Emergence of Debtor Rights in Eighteenth-Century England' (2019) 20(2) Enterprise & Society 475, 486-7.)
Despite this development, the eighteenth century was a time in which bankrupts who did not co-operate with inquiries could face imprisonment or even, in a handful of cases, execution. Bankruptcy also remained involuntary for the debtor.
At the time Cherry v Boultbee was decided, the Bankruptcy Act 1825 (UK) ensured that bankruptcy was no longer wholly involuntary. It was, however, limited to persons who operated in some form of trade. Discharge from bankruptcy did not extend to circumstances in which a person engaged in making "false or fraudulent entries in any book of account or other document, with intent to defraud his creditors" (s CXXX, 6 George c. 16).
Creditor veto over discharge was limited under the Bankruptcy Act 1842 (UK) which is, coincidentally, the same year that Morris v Livie was decided. That statute maintained the exception to discharge where the debtor had acted with "intent to defraud his creditors" and, if found to have done so, was liable to imprisonment and hard labour (s XXXVI, 5 & 6 Victoria c. 122).
The first near equivalent to s 153(2)(b) made its appearance in the Bankruptcy Law Consolidation Act 1849 (UK) which stipulated that a discharge did not operate against "any debt which shall have been contracted wholly or in part by reason of any Manner of Fraud or Breach of Trust" (s CCXXI, 12 & 13 Victoria c. 106). That provision was overtaken by s 49 of the Bankruptcy Act 1869 (UK) (the 1869 Act) which was enacted with the related Debtors Act 1869 (UK). Section 49 relevantly provided that "an order of discharge shall not release the bankrupt from any debt or liability incurred by means of any fraud or breach of trust, nor from any debt or liability whereof he has obtained forbearance by any fraud".
The Debtors Act 1869 (UK) abolished imprisonment for debtors except in a small number of circumstances. At the same time, the 1869 Act provided some comfort for debtors by removing both creditors' power of veto over discharge and the restriction that discharge was only available to those operating in trade.
In the 1880 decision of Emma Silver Mining Company v Grant 17 Ch.D. 122 (Emma Silver Mining), Jessel MR was called upon to consider the expression "debt incurred by means of fraud or breach of trust" in s 49 of the 1869 Act. The defendant, Mr Grant, was the promoter of the plaintiff company. He took a secret commission from the vendor of an asset that was sold to the company. The company sued Mr Grant and recovered a judgment in respect of the secret profit he had made. Mr Grant presented what was known as a petition for liquidation and ultimately had the benefit of a scheme of arrangement approved by his creditors. The relevant question before the Court was whether the amount for which Mr Grant was subsequently sued by the company in respect of its judgment was a "debt or liability incurred by means of any fraud or breach of trust" so that his discharge did not provide a defence to the proceedings.
Jessel MR had no difficulty (at 127-128) in finding that what Mr Grant and another had done was "fraud": "Messrs Albert and Morris Grant, as the agents of the Emma Mining Company (that was their position; they were what are called "promoters". They formed the company and were fiduciary agents) agreed with Messrs Parke and Stewart for the purchase of the mine. They nominally purchased for a million, and they agreed to divide something over £200,000 between themselves and the vendors, by which they, the Grants, pocketed upwards of £100,000 … It appears to me there is no other word to characterise the transaction except fraud."
His Lordship went on (at 128) to find Mr Grant's alleged state of mind to be irrelevant: "A man may commit a fraud without believing it to be a fraud, that is, without believing it to be a fraud for which he can be held responsible in law; though I am by no means convinced that even Mr Albert Grant could have treated this originally as an equitable or moral transaction".
Finally, while (at 128) his Lordship describes the point as "much more arguable, as one upon which there is much more difficulty it is not absolutely necessary for me now to decide the point", he goes on to consider whether Mr Grant's conduct was in breach of trust. He concluded (at 129) that it was: "There does not appear to me any reason in the world for not giving the words "breach of trust" in the Bankruptcy Act their proper legal meaning. If an agent, either buying or selling, misuses or abuses the confidence reposed in him with a view to retaining the profits for himself, he commits a breach of trust".
On 19 March 1883, the Bankruptcy Bill 1883 (UK) was read for a second time in the House of Commons and was the first bill referred to the new Standing Committee on Trade. A contemporary bankruptcy text records that "The Grand Committee held nineteen sittings to consider the Bill and reported it to the House with numerous amendments. The House accepted the measure as it came from the hands of the Committee…It was introduced in the Lords on the 17th of August, and various amendments in matters of detail were there inserted. The Bill received the Royal Assent on the 25th of August." (Chalmers, MD and Hough, E, The Bankruptcy Act 1883 (London, Waterlow and Sons Ltd, 1883) at vii) (Chalmers).
The timing is important because on 28 May 1883 - while the Bankruptcy Bill would have been in committee - the Court of Appeal (Brett MR, Lindley and Fry LJJ) delivered its decision in Cooper v Prichard 11 QBD 351 (Cooper) concerning s 49 of the 1869 Act.
Because the facts bear some similarity to the present case, I set them out from the report (at 351): "In 1879, the plaintiffs, who were two maiden ladies, employed [Mr Prichard's and Mr Turner's firm] with reference to the sale of a house of theirs to the Metropolitan Board of Works and Mr Turner, as a member of the firm, at the completion of the sale, on 10 October, 1879, received the purchase money from the Board with the authority of the plaintiffs. This money Mr Turner undertook to invest for the plaintiffs on mortgage, and he afterwards informed the plaintiffs that he had done so; but instead of investing he misappropriated it to his own use, and on the 15th February, 1881, he absconded. The firm had carried on business at Lincoln's-Inn-Fields, and in the City, and the defendant, who attended to the City branch, was ignorant and innocent of fraud which had been so committed by his partner Turner."
The firm went into liquidation, which was resolved by a scheme of arrangement that included granting the innocent Mr Prichard a discharge. He was then sued by the plaintiffs to recover the money that been received and misappropriated by Mr Turner, and for which he was alleged to be liable as partner. Mr Prichard contended that s 49 of the 1869 Act released him from all liability to the plaintiffs upon his discharge in the liquidation of the firm. Mr Prichard appealed the decision of Baron Pollock, who gave judgment against him for the plaintiffs notwithstanding his discharge.
The Court of Appeal held that the language of s 49 meant that where a debt had been incurred by one of several partners for which the partnership was liable and then went into liquidation under the 1869 Act, a partner who had been discharged was not released from that debt if it was incurred by fraud, even though he was himself innocent of that fraud. Brett MR described Mr Turner's conduct in this way (at 353-354): "In this case Turner, acting for the firm and under the authority which he had as partner to bind the firm, received money for the purpose of it being invested on security, and having so received it he was bound as an agent of the partnership to invest it accordingly. … He did not however do so, but committed a fraud by misappropriating the money to his own use instead of investing it. He committed another fraud when he misrepresented what he had done, and told one of the plaintiffs that he had invested the money. He was authorized as a partner to make statements as to whether he had invested the money or not, therefore Mr Prichard was liable before his bankruptcy for both of these frauds, they having been committed by Turner in the course of doing that which was authorized as a partner to do".
His Lordship also made this observation (at 354) (emphasis added): "We have no right to speculate as to whether the legislature intended that a bankrupt should not be discharged where the debt or liability was incurred by any fraud or breach of trust other than his own, but if I were to speculate I should say that it was the foundation of the bankrupt laws that the bankruptcies to be allowed and protected were only bankruptcies which had been incurred honestly, and here the bankruptcy was actually brought about by the dishonesty of one of the partners."
For his part, Lindley LJ (at 355) was of the view that "looking at Turner's conduct it would be very difficult to say that liability of the firm was not incurred both by fraud and some form of breach of trust" (emphasis added). Fry LJ (at 356) said that "the debt in this case was one clearly incurred by means of fraud", but did not find it necessary to decide whether it was also incurred by breach of trust".
It is in s 30(1) of the Bankruptcy Act 1883 (UK) that the term "fraudulent breach of trust" first appears in the concluding sentence of that sub-section: "An order of discharge shall not release the bankrupt from any debt or liability incurred by means of any fraud or fraudulent breach of trust to which he was a party, nor from any debt or liability whereof he has obtained forbearance by any fraud to which he was a party."
Chalmers records (at 28) that the words "to which he was a party" were inserted to "override" the decision in Cooper. However, the learned authors offer no explanation as to why "fraudulent" was inserted before "breach of trust". My research, and that of those assisting me, has been unable to find any contemporary source which offers an explanation. However, to my mind, the fact that Cooper undoubtedly drew the attention of the House of Commons Grand Committee to the discharge provision suggests that "fraudulent" is likely to have been inserted before "breach of trust" under the influence of Lord Lindley's conclusion that Mr Turner's conduct was both fraud "and some form of breach of trust".
Returning to Brett MR's observation set out in [84] above, this would suggest that a "fraudulent breach of trust" was any breach of trust that was not an honest one because "it was the foundation of the bankrupt laws that the bankruptcy is to be allowed and protected for only bankruptcies which had been incurred honestly". As I will develop further below, approaching the matter in this way is both consistent with equity's understanding of "fraud" being a wider concept than common law fraud requiring an actual dishonest intent and disposes of any debate about the need for dishonesty to be proven. A breach of trust will be fraudulent for the purposes of the expression "fraudulent breach of trust" if it is not honest or innocent but does not have to meet the high bar of actual dishonesty in the common law sense.
After his decision in Cooper, Lord Lindley would be given an opportunity to express his reaction to the expression "fraudulent breach of trust" a decade later in In Re Smith; Hands v Andrews [1893] 2 Ch 1 (Smith). Thomas Andrews and Peter Hooton were defaulting trustees under a will. While s 4(3) of the Debtor's Act 1869 (UK) had abolished imprisonment for debt, it made certain exceptions, including cases of "default by a trustee or person acting in a fiduciary capacity and ordered to pay by a Court of Equity any sum in his possession or under his control".
Upon accounts being taken, Mr Andrews and Mr Hooton were ordered to repay certain amounts to the estate. Neither of them obeyed the orders and leave was sought to issue writs of attachment against them for their contempt. In opposing the leave, Mr Andrews made an affidavit that he had left everything to Mr Hooton and that he believed that money received by Mr Hooton was duly applied by the latter for the purposes of a business being run for the benefit of the estate. Mr Hooton's evidence is recorded in the judgment (at 13) as "unsatisfactory" and that "his position was worse than that of" Mr Andrews.
In his judgment at first instance (at 10-11) Kekewich J said (emphases added): "I accept what is said by Mr. Justice North in the case of Earl of Aylesford v. Earl Poulett, adopting the decision of Mr. Justice Kay in In re Knowles, that "the exception contained in sect. 4, sub-sect. 3, of the Debtors Act, 1869, was intended for the punishment of fraudulent trustees, not merely in order to inflict personal inconvenience on the defaulters, but to deter other trustees from committing fraudulent breaches of trust"; and I accept what Mr. Justice North himself said respecting a trustee who is not fraudulent, and has committed a comparatively venial offence. But it seems to me that if, on a fair consideration of all the facts, I come to the conclusion, in this or any other case, that I have before me a fraudulent trustee, then I am bound to exercise the discretion vested in me by the Debtors Act, 1878, by doing what Mr. Justice Kay refers to in In re Knowles, attempting not so much to inflict personal inconvenience as to deter other trustees from committing fraudulent breaches of trust. What is the meaning of the word "fraud"? Of course, if a trustee puts into his own pocket, or applies to his own purposes, speculates with, or makes away with money belonging to his cestui que trust-i.e., money that is not his, he is only in language distinguishable from a thief; and about his fraudulent character there can be no doubt whatever. On the other hand, when a trustee yields to the influence of charity or sympathy and pays to widows or infants in distress money which he knows ought not to go to them, but which he ought to hoard up and keep according to the mandate of the trust instrument, though, perhaps, he is guilty of a breach of trust, he cannot, in my opinion, be said to be a fraudulent trustee. He may be very wrong; his good nature may, and often does, amount to folly; but he is after all doing that which I have heard one of the most eminent of Equity Judges, the late Sir George Jessel, describe as committing an "honest breach of trust." The Court is always unwilling to visit a breach of trust of that kind with serious results. But it seems, to me that there may be dishonesty amounting to fraud well within these two extreme cases, and I am bound to say that, in my opinion, a trustee, whoever he is, whether of a deed or will, who, having accepted the trusts, and knowing that he has to provide, it may be, for children or for a wife entitled for her separate use at the present time, or for legatees or creditors, simply does nothing at all, but walks away and leaves others to see to his duty, is dishonest. He is a man of no moral character, or not shewing any morality in the performance of his duty."
His Lordship concluded in relation to Mr Andrews (at 12): "Without going on to say that he put any money into his own pocket, I think that, having accepted the office of trustee, he simply neglected it, and thereby wronged these whom it was his paramount duty to protect. In my opinion, that is dishonest; and by such conduct he makes himself a fraudulent trustee, and punishable as such."
His Lordship ordered writs to issue against both defendants. They appealed to the Court of Appeal (Lord Esher MR, Lindley and Lopes LJJ) with the judgment read by Lord Lindley. The Court of Appeal compared the 1869 Act and its 1883 successor (at 16) (emphasis added): "Under both Acts, money due from a trustee in respect of a breach of trust, whether fraudulent or not, is a debt provable against his estate in the event of his bankruptcy. But there is a very remarkable difference between the two Acts as regards the effect of an order of discharge. For whilst under sect.49 of the Bankruptcy Act, 1869, an order of discharge did not release a bankrupt from any breach of trust, under sect.30 of the Bankruptcy Act, 1883, an order of discharge does release a bankrupt from all breaches of trust except fraudulent breaches of trust to which he was a party."
The Court of Appeal dismissed Mr Hooton's appeal. However, while not expressly disapproving Kekewich J's general analysis of a fraudulent breach of trust, it disagreed with his Lordship's conclusion in relation to Mr Andrews, concluding (at 18): "Andrews trusted his co-trustee Hooton, and handed money to him, and this money was misapplied. Andrews is liable for it; but he was not himself guilty of any dishonesty or fraudulent breach of trust. Mr Justice Kekewich ordered an attachment to issue against him on the broad ground that every trustee who trusts his co-trustee, and remits trust money to him, and does not look sharply after him, is dishonest and fraudulent. We cannot agree in this view, and consistently with the principles upon which this Court acts in reviewing discretionary orders, we have come to the conclusion that Andrews' appeal ought to be allowed."
While little of the wording of the relevant provisions has changed over time since the late 19th century bankruptcy legislation, the constraints upon bankrupts seeking discharge have lessened, especially with the introduction of automatic discharge in both the UK and Australia. As Michael Quilter writes: "[B]y the middle of the 20th Century, consumer bankruptcy and "fresh start" thinking heralded a liberalisation of discharge philosophy with an emphasis (at least in theory) on the bankrupt's rehabilitation." (Quilter, M, "Bankruptcy Discharge: Origins and Liberalisation" (2017) 25 Insolvency Law Journal 107, 126.)
Turning to the Australian cases, Emma Silver Mining was followed by Brinsden J in Barewa Oil and Mining NL (In liq) v Isim Mineral Development Pty Ltd (1981) 38 ALR 288 (Barewa Oil). The plaintiff company alleged that the third defendant had breached his duties as a director, or breached his fiduciary duties, to the plaintiff by using moneys from applicants for shares in the plaintiff company to purchase various mineral and petroleum assets. Mr Cornelius entered into a composition with his creditors and the question was whether s 240 of the BA discharged him from the debts or liabilities for which he was now being sued by the plaintiff.
One submission put on his behalf was that s 153(2)(b) of the BA only released a bankrupt from a debt incurred by means of common law fraud or "pure fraud". It was submitted that no part of the claim brought against by Mr Cornelius, including for money received or breach of fiduciary duty, had as an essential ingredient an allegation of fraud.
Brinsden J referred to both Cooper (noting Fry LJ's observation that the words used in s 49 were very general) and the decision in Emma Silver Mining. Of the latter, his Honour said (at 296) that it "appears to be clearly against the proposition submitted on behalf of Cornelius. A consideration of the facts pleaded in this statement of claim show that, however the claim is put, there is clearly within the claim an allegation of fraud, and that, within the intendment of s 153 of the Act, the debt or liability has been incurred by means of fraud."
Mr Cornelius appealed: Cornelius v Barewa Oil & Mining (NL) (in liq) [1982] WAR 311; (1982) 42 ALR 83 (Cornelius v Barewa Oil). One of the grounds of contention was whether Brinsden J had erred in finding that constructive fraud fell within s 153(2)(b) as opposed to actual fraud. In dismissing the appeal, Burt CJ stated (at 313): "The second limb of the ground now under consideration, and it involves the same argument as arises under para (b) of the particulars within the ground of appeal, is that "the words 'fraud' and 'fraudulent' appearing in s 153(2)(b) mean fraud in the common law sense or in the sense of 'pure fraud'". I can for present purposes, but without deciding the question, accept that to be the case, but having done so I can only say that accepting the truth of the facts pleaded the debts claimed appear to me to have been incurred by means of fraud or fraudulent breach of trust of uncontaminated purity. In my opinion, and assuming as we must that the facts pleaded are true, the liability created by them is one "incurred by means of fraud or fraudulent breach of trust" whatever epithet is attached to the word "fraud" or to the expression "fraudulent breach of trust"."
Wickham J, also dismissing the appeal, held that the issue of whether actual or constructive fraud was required to establish fraudulent breach of trust under s 153(2)(b) need not be decided because the facts demonstrated the defendant had been dishonest, which "coupled with the other facts pleaded is sufficient to propound a case of actual fraud" (at 317).
Kennedy J (agreeing with Burt CJ and Wickham J) added (at 319-320): "The next contention is that the words "fraud" and "fraudulent" appearing in s 153(2)(b) mean fraud in the common law sense or in the sense of "pure fraud". There appear to me to be some risks involved in glossing over the words of the statute [citations omitted]. I am, however, prepared to accept, for the purposes of this case, that "fraud" and "fraudulent" in this section mean "actual fraud" and "actually fraudulent". Such an interpretation has been placed upon these words where used in earlier Acts, although not in relation to this particular provision - see, for example, Federal Grocery Co v Noble (1896) 22 VLR 318 at 320 and Re Barnes (1961) 19 ABC 126 at 131. I am, however, for the reasons expressed by the Chief Justice, unable to accept that the facts alleged as to each and every cause of action pleaded in the statement of claim do not establish actual fraud."
For a New South Wales judge the dispositive Australian case is Maxwell v Chittick [1994] NSWCA 196 (Maxwell). As I will explain below, in my respectful opinion I am bound by that decision to the effect that fraud in the extended or equitable sense will be a "fraud or fraudulent breach of trust" for the purposes of s 152(2)(b). However, before turning to the decision of the Court of Appeal, it is necessary to begin with the decision of Young J (as his Honour then was) at first instance in Chittick v Maxwell (1993) 118 ALR 728.
In 1979, the Chitticks and the Maxwells agreed that the Chitticks could build a home on the Maxwells' land. It was agreed that the Chitticks could stay on the land as long as they liked and, if they moved, then the Maxwells would purchase their improvements. In 1982, the Chitticks and the Maxwells entered into a deed prepared by Mr Maxwell, who was a solicitor, in relation to the Chitticks' occupation of the land for at least 15 years from the date of the deed. No caveat was lodged to protect the Chitticks' interests.
Other than once being told by Mr Maxwell that there was a "temporary loan" about which they need not worry, the Chitticks were unaware of any mortgages over the property. However, Mr Maxwell repeatedly mortgaged the land without disclosing the Chitticks' interest to the various mortgagees or to the Chitticks. As Young J recorded (at 732), "the amount borrowed against the property was increased from time to time by Mr Maxwell to support his own business dealings".
A mortgagee eventually sold the land and the Chitticks had to leave. Mr Maxwell ultimately entered into a composition with his creditors. The Chitticks sued Mr Maxwell and his then law partners. They alleged, among other things, breach of fiduciary duty. One of the questions before the Court was whether Mr Maxwell's debt owed to the Chitticks survived his composition with creditors as a debt incurred by "means of fraud or a fraudulent breach of trust".
While Young J dismissed the Chitticks' case insofar as it alleged that certain representations Mr Maxwell had made were fraudulent, his Honour concluded (at 736) that Mr Maxwell was liable to the Chitticks for breach of fiduciary duty. Section 240 of the BA provided that a composition with creditors released the debtor from all provable debts other than those (if any) that would not be released by the debtor's discharge from bankruptcy. His Honour concluded (at 740) that were it not for s 153(2)(b) of the BA, he would have been of the view that s 240 would have released Mr Maxwell from the Chitticks' claim. Having earlier noted the decision in Emma Silver Mining that receiving a secret commission is a fraud from which a bankrupt is not released under s 153(2)(b), his Honour's conclusions on the effect of a discharge in this case were briefly stated (at 740): "I turn now to that provision. I have already mentioned that taking a secret commission is a matter of fraud which comes within the exception from release on discharge from bankruptcy. There was no fraud associated with the count in tortious negligence. Thus that claim must be considered to have been released by the Act. So far as the claim for equitable compensation is concerned, one must see whether there is a debt incurred by means of fraud or a fraudulent breach of trust to which Mr Maxwell was a party. In Jenkins v Fereday (1872) LR 7 CP 358 , it was held in the Common Pleas Division that where a solicitor had brought an action without the knowledge and consent of the plaintiff and had been ordered to pay costs, the debt for costs was incurred by fraud within the meaning of the corresponding section in the English Act. Unfortunately the three judges do not really give any reasons for that view. Misfeasance by a company director was held to be a liability incurred by means of a breach of trust: Ramskill v Edwards (1885) 31 Ch D 100 . It seems to me that the conduct of Mr Maxwell in being involved in mortgaging the land and making misrepresentations to the lenders that the plaintiffs had no interest in the land when he knew the contrary was the case shows that his liability to the plaintiffs is a debt which was incurred by fraud within the meaning of s 153. Accordingly in my view the Pt X composition does not release Mr Maxwell from the liability to pay equitable compensation for breach of fiduciary duty in this case."
Young J's view of Mr Maxwell's conduct is further illuminated by his Honour's treatment of another aspect of the case. Mr Maxwell's professional insurer, LawCover, sought to rely on an exclusion for damages "brought about the dishonest or fraudulent act or omission of the assured …". His Honour felt himself bound by authorities which gave "dishonest" a wide interpretation. In any event, his Honour concluded (at 749): "I feel, however, that I should follow the previous cases and I point out that in this particular case it would not matter if I took a stronger view as to what the word "dishonesty'' meant, because it would seem to me that under any definition of dishonesty a person who knows that his parents-in-law have for value built a house on the land and think they are protected, who for his own purposes mortgages that land, misleads the mortgagee as to the state of the title and who mortgages the land for his own gain without telling his parents-in-law is dishonest. As it is a combination of these activities rather than mere failure to draft a proper deed in July 1982 that brings about the loss, the insurer is entitled to rely on the exception."
The judgment of the Court of Appeal was delivered by Mahoney JA, with whom Priestley and Powell JJA agreed. In upholding the decision of Young J, his Honour analysed what Mr Maxwell had done with a precision which is important for the present case (emphases added): "In my opinion, what Mr Maxwell did in his relationships with Mr and Mrs Chittick involved fraud of various kinds. When, in 1979-1980, he induced them to spend money in the erection of a home upon the land owned by him and his wife, he was involved in fraud in the sense of conscious deceit. At the time of the discussion the land was subject to a mortgage. During the course of the discussion of and the erection of the home, the then existing mortgage was discharged and another mortgage given over the land. These facts were not revealed to Mr and Mrs Chittick. It was obviously in their interest that they be told of the existence of such mortgages. Not to tell them of the mortgages involved, in my opinion, a deceit of them. There was, in the extended or equitable sense, a fraud committed upon them. It is not necessary for present purposes to determine whether, at that stage, Mr Maxwell had the intention of defrauding them in the sense of defeating the interest which he held out to them in respect of their continued residence upon the land and in the house. It may be that it was then his intention to carry out the terms of the mortgage so that they would remain undisturbed in their occupation of the land. But, in my opinion, however that be, the mortgage transaction entered into by him in the context of what occurred involved deceit of them and, in the sense to which I have referred, fraud. … I do not mean by this that there was then no obligation upon Mr Maxwell to inform Mr and Mrs Chittick frankly of the encumbrances upon the land. The deed was plainly intended to create legal relationships. In that context, it was necessary that they be informed of the existence of the mortgage upon the land. It was deceit of them by Mr Maxwell not to tell them of it. Again, in the sense to which I have referred, there was at that time a further fraud committed."
His Honour also found Mr Maxwell acted in breach of fiduciary duties which existed, among other things, in the context of a trust relationship (at 10-11): "… I would conclude that, once the home had been erected, Mr and Mrs Maxwell held the land as trustees subject to obligations of the nature of a trust to deal with the land so as to procure for Mr and Mrs Chittick the right of occupation and otherwise specified in the agreement made between them. … By what he did in creating and discharging the successive mortgages over the land, Mr Maxwell acted in breach of the duties which, in this way, he had created in their favour in respect of the land. Those duties were of an equitable nature and, insofar as it may be relevant, included obligations arising from the trust created in respect of the land and from the fiduciary obligations which he undertook by virtue of the position which he assumed in relation to their affairs. As the learned trial judge said, it is clear that Mr Maxwell knew that the plaintiffs were not people who had any legal training or were sophisticated in the ways of business and that they looked to him to preserve their position. Instead of preserving their position, he dealt with the land in a way which was contrary to their interests and favourable to his."
Finally, his Honour expressed the Court's conclusion in relation to s 153(2)(b) (at 13) (emphasis added): "It was submitted for Mr Maxwell that the result of the composition with creditors which was effected in 1991 was that he was released from the claims made by the plaintiffs. S153(2)(b) of the Bankruptcy Act 1966 provided that no discharge should be effected so as to "release the bankrupt from a debt incurred by means of fraud or a fraudulent breach of trust to which he was a party or a debt of which he has obtained forbearance by fraud". The learned judge concluded, and I agree, that the "debt" owed to the plaintiffs was incurred by means of fraud or a fraudulent breach of trust. As the learned judge has pointed out, the term "fraud" in the bankruptcy provisions in this regard has been given a broad interpretation. It is not necessary to pursue the authorities which were referred to by the judge and in argument before this Court. So much is accepted. The obligations incurred by Mr Maxwell, however they arose and whatever point in time they arose, involved fraud of the relevant kind. The obligations which arose under and by virtue of the original proposal to build were of an equitable nature and, as I have indicated, there was deceit in the nature of fraud at that time. That deceit was repeated at the time the deed was executed. There were, when the various mortgages were entered into, breaches of equitable obligations arising from deceit in the nature of fraud. In my opinion, on each of the relevant occasions, there was fraud within the meaning of the statute. I agree with the judge's conclusions in this regard."
For completeness, I will set out the current law in the United Kingdom, where the legislative equivalent to s 153(2)(b) is provided for by s 281(3) of the Insolvency Act 1986 (UK): "281 Effect of discharge (3) Discharge does not release the bankrupt from any bankruptcy debt which he incurred in respect of, or forbearance in respect of which was secured by means of, any fraud or fraudulent breach of trust to which he was a party."
In Mander v Evans [2001] 1 WLR 2378 (Mander v Evans), Ms Mander sought to recover loans of £140,000 that she had made to Mr Evans, who had been made bankrupt and subsequently discharged. Ms Mander asserted that the discharge was not applicable to the debts because they had been accrued by undue influence exerted by Mr Evans. Ferris J rejected Ms Mander's claim on the basis that s 281(3) concerned actual fraud and did not extend to constructive fraud. No allegation of fraudulent breach of trust was raised. Ferris J stated: "[25] … [S]ection 281(3) must be construed in accordance with ordinary principles without assistance from authority concerning the construction of other statutes. Approaching it on that basis, I think that the natural meaning of the word 'fraud' is actual fraud in the Derry v Peek sense. I find it readily comprehensible that the legislature should consider that a bankrupt who has obtained his discharge should not be relieved of liability for his actual fraud committed before the bankruptcy. I find it much less comprehensible that he should remain liable for constructive fraud, which covers a wide range of conduct regarded by equity as unconscionable but not necessarily involving actual dishonesty. If the legislature had intended to preserve liability for such conduct I think that wider language than the one word 'fraud' would have been used. Somewhat wider language has indeed been used, because the full reference is to 'fraud or fraudulent breach of trust', but I think that this militates against Mr Marten's argument rather than in favour of it. 'Fraudulent breach of trust' does, of course, indicate an area which is the concern of equity. But the fact that it is referred to in conjunction with 'fraud' indicates that 'fraud' by itself is not enough to take one into such an area. It was not suggested that the acts of the defendant complained of in this case amount to fraudulent breach of trust."
Fraudulent breach of trust under s 281(3) was dealt with in Woodland-Ferrari v UCL Group Retirement Benefits Scheme [2003] Ch. 115 (Woodland-Ferrari). That case involved an application to set aside a statutory demand for the sum of £877,883.03 for maladministration of a pension scheme by Mr Woodland. After the breaches of trust were committed, Mr Woodland had been made bankrupt and subsequently discharged from bankruptcy. He claimed that the discharge included his liability to make good his breaches of trust.
Ferris J specifically considered whether dishonesty was required for the purpose of a fraudulent breach of trust under s 281(3). In doing so, Ferris J set out much of the legislative history of s 281, tracing its origins to the bankruptcy statutes of 1883 and 1914. His Honour held that, as it appeared in those statutes, fraudulent breach of trust required "deliberate conduct involving an element of dishonesty" (at [32]). Ferris J concluded at [50] that fraudulent breach of trust in s 281(3) required dishonesty as "an essential ingredient".
The wider availability of discharge referred to by Michael Quilter at [95] above was taken into account by Ferris J in Woodland-Ferrari and formed part of the basis for his Honour's overall conclusion that dishonesty was a required element of fraudulent breach of trust.
The analysis in Mander and Woodland-Ferrari was expanded by HHJ Barker QC in Templeton Insurance Ltd v Brunswick & Ors [2012] EWCH 1522 (Ch), finding: "48. Where a trustee consciously acts beyond his powers (e.g. by making an investment known to be unauthorised), there is a deliberate breach of trust. However, if done in good faith and in the honest belief that the investment is made in the interests of the beneficiaries, the breach of trust is not fraudulent. 49. S.281(3) does not recognise or preserve beyond discharge from bankruptcy a debt or liability unless it is founded in fraud or fraudulent breach of trust to which the bankrupt was a party. The touchstone in each case is that actual dishonesty on the part of the bankrupt is a necessary ingredient … 55. … [F]raud as the gateway to the application of s.281(3) and a route through the barrier imposed by s.281(1) is not satisfied by establishing 'fraud' in the equity sense ('against conscience' or 'unconscionable'). To pass through the gateway and remain on the road to recourse against the discharged bankrupt, a creditor must prove 'fraud' in the common law sense; this is not to be understood as restricting access only to bankruptcy debts founded in the tort of deceit, but rather as a reference to debts tainted by actual dishonesty."
HHJ Barker QC also set out the law on whether dishonesty for fraudulent breaches of trust was subjective or objective in nature: "38. In Barlow Clowes International Ltd (in liquidation) v Eurotrust International Ltd [2006] 1 WLR 1476, Lord Hoffmann, giving the advice of the Board of the Privy Council, explained that "[a]lthough a dishonest state of mind is a subjective mental state, the standard by which the law determines whether it is dishonest is objective. If by ordinary standards a defendant's mental state would be characterised as dishonest, it is irrelevant that the defendant judges by different standards". Acknowledging an element of ambiguity in his and Lord Hutton's speeches in Twinsectra, Lord Hoffmann explained that the test as formulated in Twinsectra "meant only that [the defendant's] knowledge of the transaction had to be such as to render his participation contrary to normally accepted standards of honest conduct. It did not require that he should have had reflections about what those normally accepted standards were. 39. In Abu-Rahman v Abacha [2007] 1 Lloyd's Rep 115, the Court of Appeal approached the issue of dishonesty by applying Twinsectra as explained or clarified in Barlowe Clowes. In doing so, Arden LJ observed that the Court of Appeal should follow Barlowe Clowes. Accordingly, in her judgment, Arden LJ held that a claimant is not required to prove subjective dishonesty, in the sense of consciousness on the part of the defendant that the transaction is dishonest; that dishonesty is established if the claimant proves that the defendant knows of the elements of the transaction which make it dishonest according to normally acceptable standards of behaviour; and, that the test of dishonesty is predominantly objective: did the conduct of the defendant fall below the normally acceptable double standard? Arden LJ acknowledged that there are also subjective aspects to dishonesty whereby the conduct in issue is to be assessed the light of what the defendant actually knew at the time, as distinct from what a reasonable person would have known or appreciated; and, concluded that the law as laid down in Twinsectra as interpreted in Barlowe Clowes represents the law of England and Wales. 40. More recently, in Starglade Properties Ltd v Nash [2010] EWCA Civ 1314, the Court of Appeal had to consider whether a sole director and shareholder's (N) disregard of a side letter he had signed on behalf of his company promising to hold certain monies he received on trust for the claimant (S) and application of the monies in paying (and, because the company was insolvent, preferring) creditors of the company was dishonest. After referring to Royal Brunei Airlines, Barlowe Clowes and Abu-Rahman, the trial judge expressed the test for dishonesty as follows: "the defendant must be guilty of conduct which transgresses normally accepted standards of conduct, i.e. conduct which all normal people would regard as dishonest". The trial judge found that most people would not know whether, as a matter of law, a company director may prefer some creditors over others and that in the absence of advice or actual knowledge as to the law, the preference did not transgress generally accepted standards of commercial behaviour. 41. The Court of Appeal held that the test was incorrectly expressed as "conduct which all normal people would regard as dishonest"; the correct test was the ordinary and not the unanimous standard of behaviour."

Geoffrey's submissions in chief

It was submitted for Geoffrey that: 1. Anthony was an intermeddler or an executor of the Estate when he dealt with the Net Sum because: 1. Anthony was one of the executors named in the Will; 2. Anthony rang Marjorie's solicitor to ask about funeral arrangements. The solicitor then provided Anthony with a copy of the Will; 3. Anthony described himself as the executor in the email to Montefiore set out at [13]; and 4. Anthony accepted in cross-examination that he was acting as executor in sending that email: see [14] above. 1. In that capacity, Anthony was subject to the same duties as an ordinary executor: he could not misappropriate the Net Sum, nor create a conflict of interest between himself and the Estate. He was also required to act jointly with the other executor (Allan). 2. Anthony breached those duties on 9 September 2009 when he paid the Net Sum into the Lewis Securities Account: Gray v Hart at [321]-[323]. 3. Further, Anthony breached his fiduciary duties because his handling of the Estate's Net Sum was imprudent, lacking in reasonable care, and not conducted jointly with the other executor (Allan). 4. As a result of Anthony's breach, the Estate has lost $485,422.19, being the Net Sum less the total dividends paid to the Estate by Lewis Securities' liquidator.
Counsel for Geoffrey submitted that as a consequence of Anthony's default, Anthony (and HBSY as his assignee), are barred from claiming Anthony's share under the Will. Four grounds were relied on: 1. A trustee-beneficiary who misappropriates trust funds is deemed to have received their beneficial entitlement in the amount of the misappropriated funds: Re Dacre. 2. A defaulting trustee-beneficiary cannot claim their beneficial entitlement until they have made good their default: Morris v Livie. 3. Where a person is entitled to participate in a fund, but also bound to make a contribution into the fund, they cannot participate unless they have fulfilled their duty to contribute: Cherry v Boultbee. 4. Section 86 of the BA provides that if a creditor and trustee in bankruptcy have mutual claims, those claims shall be set off against each other at the time the bankruptcy takes effect.

HBSY's submissions

Counsel for HBSY submitted: 1. Anthony was not a trustee or an executor de son tort of the Estate. The bare act of depositing the Montefiore Sum into the Lewis Securities Account was insufficient to amount to intermeddling: citing Holder (Harman LJ at 391 and 392, Danckwerts LJ at 397, Sachs LJ at 401). Anthony was simply a debtor of the Estate. 2. The rule in Cherry v Boultbee did not apply because a debtor's discharge from bankruptcy extinguishes their liabilities: Re Watson; Turner v Watson [1896] 1 Ch 925; Re Baird; Hall v Macky [1935] NZLR 847; Re Hurburgh at 50. The same analysis applies to the principles in Re Dacre and Morris v Livie. For instance: 1. Re Dacre provides that if a defaulting trustee is required to contribute to a fund, they are to be treated as having paid themself the amount they are liable to contribute. 2. The claim for contribution to the fund is provable in the defaulting trustee's bankruptcy. 3. Upon the defaulting trustee's discharge from bankruptcy, every provable claim is extinguished. From that point on, the defaulting trustee cannot be treated as having paid themself anything because that treatment was based on a claim which has been extinguished. 1. Geoffrey lost the right to apply the rule in Cherry v Boultbee by electing to prove in Anthony's bankruptcy: Otis at [48] per Palmer J. As Geoffrey proved for $300,000 of the Net Sum in Anthony's bankruptcy and received dividends totalling $85,662.74 from the liquidator of Lewis Securities, Anthony is entitled to payment to the extent his one fifth residuary share exceeds the leftover amount. 2. Section 86 of the BA does not apply because: 1. Beneficial entitlement under the Will is not a relevant "dealing" as it lacks any mercantile aspect: Gye v McIntyre at 625. 2. Section 86 takes effect automatically at the date of bankruptcy: Gye v McIntyre at 622. But while the Estate remains in administration, it is not possible to determine the amount representing the residuary shares for the purposes of a set-off: Phillips v Howell (1901) 2 Ch 773. 3. Section 86 requires mutuality. There is no mutuality between a creditor of the Estate and a person who is entitled to participate as one of the residuary beneficiaries: Ex parte Morier; In re Willis, Percival & Co (1879) 12 Ch D 491.

Geoffrey's submissions in reply

It was submitted for Geoffrey in reply that the four grounds set out [X] above also defeat any defences based on proving in Anthony's bankruptcy or Anthony's discharge from bankruptcy: 1. At the moment at which Anthony misapplied the Net Sum, he either received his legacy by anticipation (applying Re Dacre) or was prevented by a condition attached to his legacy from obtaining it without remedying his breach (applying Morris v Livie). Subsequent discharge from bankruptcy is not relevant. Proving in bankruptcy does not waive the right to invoke Morris v Livie either before or after discharge, because the defaulting trustee's right is impugned until the default is remedied in total: S R Derham, The Law of Set-Off (Oxford University Press, 4th ed, 2010) at [14.85] (set out at [54] above). 2. The Estate reserved its Cherry v Boutlbee rights by excluding the notional amount of Anthony's residuary share from the debt it sought to prove in bankruptcy: see [29] to [30] above. 3. There is no sound juridical reason why an executor would be entitled to apply the rule in Cherry v Boultbee against a bankrupt up to the moment of discharge, but would lose that right if the executor did not finalise the administration of the estate before the bankrupt's discharge. 4. Anthony's discharge from bankruptcy did not extinguish the Estate's claim because by reason of s 153(2)(b) of the BA he was not released on discharge: Maxwell.

The parties' further submissions on s 153(2)(b)

HBSY pleaded reliance on s 153 of the BA. Geoffrey's reliance in reply on s 153(2)(b) was not pleaded. At the hearing before me, counsel for HBSY contended that Geoffrey was not entitled to rely on s 153(2)(b) because it entails an allegation of fraud which must be properly pleaded. Counsel for Geoffrey contended that his reliance on s 153(2)(b) was confined to equitable fraud and did not require proof of state of mind. On that limited basis, I invited the parties to provide further written submissions addressing s 153(2)(b).
It was submitted for Geoffrey that: 1. Fraud and fraudulent breach of trust in s 153(2)(b) must be given a broad interpretation which includes equitable fraud by a trustee or person owing fiduciary duties: Maxwell. 2. Maxwell is analogous to the present case. In that case, the Court of Appeal held that Mr Maxwell had committed an equitable fraud in acting for his own benefit when a conflict of interest existed. 3. Proof of state of mind is not required to establish a debt incurred by fraud for the purposes of s 153(2)(b): Emma Silver Mining. In Maxwell, the Court did not need to make findings about Mr Maxwell's state of mind. 4. That bad faith or dishonesty do not need to be proved does not make such breaches of trust trivial. Equity is anxious to protect those in a vulnerable position and apply preventative justice: J D Heydon, Meagher, Gummow and Lehane's Equity Doctrines and Remedies (LexisNexis, 5th ed, 2015) at 12-005. 5. It would be contrary to the purpose of the legislation to allow Anthony to be released from liability for putting most of the assets of the Estate into a company of which he was the majority shareholder.
It was submitted for HBSY in reply that there is no support in principle or authority for a construction of "fraud or fraudulent breach of trust" which encompasses all equitable fraud: 1. If "fraud or fraudulent breach of trust" encompassed all equitable fraud, the word "fraudulent" in the provision would have little or no work to do. 2. The purpose of the statute is to ensure that bankrupts are not freed from liability for reprehensible conduct. Section 153(2)(b) can be traced to provisions of the Debtors Act 1869 (UK). In Barewa Oil, Brinsden J observed at 295: "In Middleton v Chichester, Lord Hatherley LJ (at 156) referred to the policy of the legislature as expressed in the Debtors Act in relation to certain types of debts, not being simple debts contracted in the ordinary intercourse between man and man, but debts the incurring of which in some degree was worthy of being visited with punishment, as being punitive in character." 1. In the context of a now-repealed limitation provision in the Trustee Act 1925 (NSW), the High Court held that "fraud or fraudulent" breach of trust requires "dishonesty or at least some knowledge of the impropriety of the conduct involved" and that negligent or innocent conduct is insufficient: Banque Commercial SA (In liq) v Akhil Holdings Ltd (1990) 169 CLR 279 at 286; [1990] HCA 11 (Mason CJ and Gaudron J) (Banque Commercial SA v Akhil Holdings). When the same words are used in an analogous context, they should be given the same meaning. 2. The authorities relied on by Geoffrey do not support his argument. For example, in Maxwell at first instance (at 740), Young J found that Mr Maxwell's conduct fell within s 153(2)(b) because he made misrepresentations "that the plaintiffs had no interest in the land when he knew the contrary was the case" (emphasis added).
Geoffrey submitted in reply: 1. If HBSY's construction of s 153(2)(b) was correct, the inclusion of "fraudulent breach of trust" would serve no purpose. 2. Brinsden J in Barewa Oil was referring to provisions of the Debtors Act 1869 (UK) which allowed debtors to be imprisoned. That legislation has no relevance in the present context. 3. Young J at first instance and Mahoney JA in Maxwell did not interpret s 153(2)(b) as requiring conscious dishonesty.

Was Anthony acting as an intermeddler or executor de son tort?

The Court concludes that Anthony acted as an intermeddler in his conduct with the Estate when he obtained the Montefiore Sum. This is because he took actions while named as an executor but without obtaining probate for the management of the Estate.
There will be occasions, as was submitted by Mr Smith for HBSY, where the actions of an individual are too trivial to constitute intermeddling. Holder is an example of this. However, the acts of Anthony went beyond those of the executor in that case. In Holder, the executor's actions were confined to opening an account and signing off on nine small liabilities and a few insurances, all of which occurred in concert with the other executors. Importantly, the executor in Holder was found to have acted under the instructions of another executor (Danckwerts LJ at 397). Anthony acted of his own volition when he dealt with the Montefiore Sum (an amount which was by no means trivial as it represented more than two thirds of the Estate's overall value) and with the Additional Sum. The extent to which anyone else was involved in the matter was limited.
This conclusion is fortified by the fact that Anthony knew he was named as executor in the Will, explicitly represented himself to Montefiore and the bank as an executor and, by his own admission, understood himself to be acting in that capacity. He gave evidence in his affidavit sworn 30 July 2020 that the only reason he sought to revoke that position was because he believed he was about to become bankrupt, which would have prevented him from being the executor. Anthony had every intention to act in that capacity and cannot now resile from it.
The effect of this is that, at the time he transferred the Montefiore Sum and the Additional Sum to the Lewis Securities Account, Anthony had all of the obligations of an executor, including the obligation to avoid any conflict of interest, not to misappropriate the assets of the Estate, and to act in concert with the other trustee (his father, Allan). He failed in those obligations.
The Court is also satisfied that Anthony's conduct in transferring the Net Sum to the Lewis Securities Account was in breach of his duties as trustee. His explanation for having done so was twofold. First, the money constituted a loan to Lewis Securities. No loan agreement was provided as evidence though he claimed to have a written agreement to this effect. Second, the interest rate offered by Lewis Securities was higher than the Estate Account.
Anthony was a director and majority shareholder of Lewis Securities, which created an obvious conflict of interest. As the authorities set out in [43] above make clear, any purported intention by Anthony to benefit the Estate by transferring the funds is irrelevant. What matters is that Anthony held a personal interest which stood in conflict with the interests of the Estate.
Anthony also claimed that he opened the bank account without Allan because "my father said he was very ill, was not interested and said to me to look after it all, so I did" (Tcpt, 2 August 2021, p 23(8-9)). Anthony gave evidence that his understanding was that Allan "had really effectively resigned in practice" and "he was not interested in looking after any of the affairs of the estate" (Tcpt, 2 August 2021, p 24(16-19)). This may be an understandable explanation for his opening the bank account without Allan's input, but it fails to explain adequately why he then proceeded to transfer the Net Sum unilaterally. If, as claimed by Anthony, there was loan documentation between the Estate and Lewis Securities that had been provided to the liquidators, that documentation should have borne Allan's signature. Instead, from the most benign perspective Anthony effectively gave himself a loan or, from the less indulgent perspective which should be applied to trustees, he misappropriated the Net Sum for his own benefit through his company Lewis Securities.
As an intermeddler, Anthony's renunciation of his position as executor was ineffective and, if called upon, he would be liable to resume his duties. This is relevant to the question dealt with below at [142] of whether Anthony (or HBSY as his assignee) may participate in the Estate. However, it is of no relevance to the question of any breach of trust because the renunciation occurred after Anthony transferred the Net Sum to the Lewis Securities Account.
Having breached his obligations as trustee, Anthony is liable to account for the breach.

Does s 86 of the Bankruptcy Act 1966 apply?

The Court has determined that mutual set-off under s 86 does not because a beneficial entitlement under a will is not a 'dealing' for the purposes of that provision.
Mr Smith on behalf of HBSY directed the Court's attention to the joint judgment of the High Court in Gye v McIntyre where their Honours stated at 625: "The word "dealings" is used in a non-technical sense in s 86. It has been construed as referring to matters having a commercial or business flavour: if "one man assaults another or injures him through negligence, that gives rise to a claim, but is not a dealing" (per Lord Esher MR, Eberle's Hotels, at 465). The word is, none the less, one of very wide scope which embraces far more than a legally binding contract or "deal". Even if it be correct to construe "dealings" in s 86 as confined to a commercial or business setting, it covers the communings, the negotiations, verbal and by correspondence, and other relations which occur or exist in that setting. Whatever may be the outer limits of the word "dealings" in s 86, it encompasses, as a matter of ordinary language, commercial transactions and the negotiations leading up to them."
While the provision refers to 'mutual credits' and 'mutual debts' these are to be properly understood as having arisen from dealings: Hamersley Iron Pty Ltd v Forge Group Power Pty Ltd (In liq) (Recrs and Mgrs Apptd) (2018) 53 WAR 325; [2018] WASCA 163 at [88] (Hammersley Iron v Forge Group Power). Where the dealings are themselves not of a business or commercial nature, it follows that the debts and credits they give rise to do not fall within the ambit of s 86. An entitlement to residue under a will is not, in any ordinary sense, of a business or commercial nature. It is a unilateral act - a gift - by one party to the benefit of another and cannot be considered a dealing. The equitable principles must be considered in this case in lieu of statutory set-off.

The equitable principles

Each of the equitable principles relied on in this case by Geoffrey may be neatly summarised by the equitable maxim: those who seek equity must do equity.
To the extent the principles differ, Re Dacre and Morris v Livie deal with matters involving defaulting trustees. As a general observation, the rule in Cherry v Boultbee applies to ordinary debtors and not defaulting trustees. In Re Dacre, Lord Cozens-Hardy MR (Phillimore and Warrington LJJ agreeing) took the view that it was unnecessary to rely on Cherry v Boultbee in cases involving a defaulting trustee (at 347).
Equity may look upon a defaulting trustee who seeks to claim a beneficial entitlement more severely than a mere debtor. So much was accepted by HBSY in its written submissions. Regarding the equitable principles relating to defaulting trustees, Professor HG Hanbury QC in Modern Equity (Steven & Sons Limited, 8th ed, 1962 - the last edition under his editorship) stated (at 302-303): "The most interesting cases are those in which is involved that equitable centaur, the trustee who is also a beneficiary. We have seen, in discussing Chillingworth v Chambers, that the tendency of equity is to write in imperishable ink his character of trustee and scribble in pencil his character of beneficiary … The severity of equity towards a defaulting trustee-beneficiary is just."
Putting that difference aside for now, the effect of these principles on Anthony's interest in the Estate is: 1. Under Re Dacre, Anthony is taken to have been paid his entitlement at the time he breached his obligation as trustee. When HBSY purchased Anthony's interest, there was nothing left in Anthony's entitlement for HBSY to claim because he had already received it in the misappropriated funds. 2. Under Morris v Livie, Anthony's interest in the Estate was extinguished at the time he breached his obligation. When HBSY purchased Anthony's interest, it had already ceased to exist. The interest can only be reinvigorated by curing the default by repayment. 3. Under Cherry v Boultbee, Anthony is taken to already be in receipt of his share. HBSY is unable to claim the interest until it is released by repayment of the default in full.
The principles dealing with defaulting trustees have wider application in respect of assignees than Cherry v Boultbee. They do not necessarily require notice but do require that the assignor was a trustee at the time of assignment (R Derham at [14.80]). As an intermeddler, Anthony's revocation of his status as executor was ineffective. He has never truly ceased to be an executor and HBSY took the interest subject to the equitable principles. For the sake of completeness, the validity of the assignment was not contested in this case.
There are two critical bases on which HBSY claims that the equitable principles do not apply in this case: 1. The Estate waived its right to rely on the equitable principles (or Cherry v Boultbee at the very least) by electing to prove in Anthony's bankruptcy; and 2. Alternatively, Anthony's debt was discharged under s 153(2)(b).
Each of these objections is dealt with next.

Did the Estate waive its right to rely on the equitable principles?

It is clear that the rule in Cherry v Boultbee cannot be relied on where the creditor elects to obtain the debt through other means, most commonly where the creditor proves in the debtor's bankruptcy (Otis at [120(3)] above). It is less apparent whether these restrictions apply to the principles affecting defaulting trustees (R Derham at [14.85] referred to above at [54]).
There is good reason why waiver should not be too strictly applied where the equitable principles operate, particularly with respect to defaulting trustees. The concern of the equitable principles is not so much to compel the debtor to repay but to prevent them from unconscionably obtaining a benefit. Professor Hanbury stated in relation to the rule in Cherry v Boultbee at 46: "Equity regards the question, not what A can be compelled to do, but what he ought in conscience to do, and will withhold from him the advantages which it is in its power to give him, unless he will purge his conscience by paying what he is morally bound to pay."
This statement was referred to with approval by the NSW Court of Appeal in Gray v Gray [2004] NSWCA 408 at [98] (Young CJ in Eq; Sheller and Bryson JJA agreeing).
Palmer J in Otis (at [58]) adopted the following statement of Young CJ in Eq in Borda v Burgess [2003] NSWSC 1171 at [70]: "… fairness dictates that people should not too easily lose important rights by unwitting conduct unless that conduct has been acted upon by another to his or her detriment. Losing a right by conduct which is undertaken in ignorance of its legal consequences should be confined to estoppel. The law should preserve the distinction between election, where no detriment to the other side is required, and estoppel where detriment is required."
The necessary elements of an election were set out by Palmer J in Otis: "[51] … The electing party must: - have two alternative and inconsistent legal rights; - have knowledge of the facts which give rise to the alternative and inconsistent rights; - by words or conduct unequivocally communicate to the other party a decision to exercise one of the rights to the exclusion of the other: Sargent v ASL Developments Ltd (1974) 131 CLR 634, at 642 per Stephen J and at 655 per Mason J."
The rights as described by Palmer J were those arising out of a contract but are nevertheless of broad application.
Geoffrey sought to prove in Anthony's bankruptcy but withheld the amount to which Anthony was beneficially entitled under the Will. Anthony's bankrupt Estate declared a nil dividend and nothing was recovered. In the Court's view, this is not an unequivocal communication that Geoffrey sought to prove in bankruptcy to the exclusion of the equitable principles. Rather, it seems to be a lay attempt at preserving it, but is nonetheless effective for that. On that basis, Geoffrey has not relinquished his right to rely upon the equitable principles.
However, the right to recover the debt from Anthony was waived to the extent the Estate sought to prove in Anthony's bankruptcy (being $300,000.00) and the dividends already received from Lewis Securities (being $85,662.74). The remainder is still owing and is subject to the equitable principles.

Does discharge under the Bankruptcy Act extinguish the claims?

Discharge by a bankrupt clearly extinguishes liability with respect to the rule in Cherry v Boultbee: Re Sewell at 808 (Parker J); Re Hurburgh at 47-9 (Crawford J). As with waiver discussed directly above, it is less certain whether discharge assists a defaulting trustee under Re Dacre and Morris v Livie. The rationale for this is stated by R Derham at [54] above. If that is so, then s 153(2)(b) is of no assistance to HBSY. However, the authorities above at [60] to [110] (and especially at [78]) make plain that the words "breach of trust" should be applied broadly and given their ordinary meaning. Equitable debts incurred by defaulting trustees would fall within the provision.
Because the Court is satisfied that s 153 operates against debts incurred by breach of trust, it falls to consider the meaning of "fraudulent breaches of trust" under s 153(2)(b).
Before turning to a wider discussion of the question of the construction of s 153(2)(b), it is convenient to set out what I understand to be the ratio of Maxwell which is binding upon me in this case and why I am satisfied that, applying Maxwell, Mr Lewis' conduct in this case gives rise to a debt incurred "by means of fraud or a fraudulent breach of trust" to which Mr Lewis was a party. In doing so, I accept Geoffrey's submission that Maxwell is the authority which I should follow.
In my respectful view, the passages which I have emphasised in [108] and [110] above demonstrate that Maxwell is authority for the proposition that fraud in the equitable sense, i.e. not requiring the defendant to have an actual intention to defraud the plaintiff, will meet the description "fraud or a fraudulent breach of trust" for the purposes of s 153(2)(b). The fact Mahoney JA did not seek to draw a distinction between "fraud" and "fraudulent breach of trust" in terms does not detract from that conclusion and I consider myself bound by the reasoning and that result.
In the present case, there can be no doubt that Mr Lewis, as an executor de son tort, held both the Montefiore Sum and the Additional Sum as a trustee who owed duties to the Estate. As such, he was precluded from making his position a means of obtaining a personal profit or benefit or conferring such a benefit on a third party, including not to engage in transactions in relation to which there was a conflict between his personal interest and his duty to the Estate.
By his dealing with both the Montefiore Sum and the Additional Sum in depositing them into the Lewis Securities Account, being the account of a company which was in effect his, Mr Lewis breached those duties. As far as equity is concerned, it is irrelevant that he was unaware he was breaching his duties or that he hoped that there would be a benefit to the Estate. His subjective beliefs are irrelevant: Emma Silver Mining. If his state of mind were relevant, it would be determined by objective standards. He committed a further breach, in the nature of a deceit, by not informing his fellow executor of what he was doing, as I discuss further below. Nor is this conclusion affected by the fact that the funds were paid to Lewis Securities, which as a matter of law was a third party. What Mr Lewis did falls precisely within Kekewich J's description of "fraud" in a proposition which was not overturned by the Court of Appeal (Smith at 11): "Of course, the trustee puts into his own pocket, or applies to his own purposes, speculates with, or makes away with money belonging to his cestui qui trust - i.e. money that is not his, he is only in language distinguishable from a thief, and about his fraudulent character there can be no doubt whatever."
In short, the Court has no difficulty in concluding that Mr Lewis, at the very least, speculated with money that was not his. As I have already observed, the fact that he may have subjectively seen nothing wrong with it or hoped that it would be to the benefit of the Estate is irrelevant. Mr Lewis thereby engaged in conduct which was fraudulent in the equitable sense, and applying Maxwell, the Court finds therefore gave rise to a debt to the Estate which was "incurred by means of fraud or a fraudulent breach of trust to which [Mr Lewis] was a party" for the purposes of s 153(2)(b).
Against the possibility this matter may go further, I should also record that I would have reached the same conclusion even if I were not bound by Maxwell. The Australian authorities set out at [96] to [110] above do not provide a neat answer. Kennedy J in Cornelius v Barewa Oil took the view that only actual fraud would enliven s 153(2)(b). In the same case, Burt CJ noted but did not decide the point and Wickham J did not consider it at all. In contrast, the joint judgment of the NSW Court of Appeal in Maxwell found an equitable fraud that satisfied s 153(2)(b) in the form of both deceit (not telling the mortagees of the Chitticks' interest and vice versa) and by taking actions which privileged the trustee's interests over those of the beneficiaries (by Mr Maxwell mortgaging the land for his own benefit).
The modern United Kingdom authorities are unequivocal that what is necessary for fraudulent breaches of trust is actual fraud by way of deliberate conduct involving dishonesty (at [115]-[116] above). This aligns with the rehabilitative purposes of that statute. The standard by which dishonesty is to be ascertained is largely based on the objective circumstances rather than the subjective belief of the defendant.
The discharge provisions of the Australian and United Kingdom bankruptcy laws are of common origin. The development of those provisions has, at least to some extent, been indicative of a more merciful approach to debtors over time (see Michael Quilter at [95] above). However, the Court is mindful that the words 'fraud' and 'fraudulent' as they appear in s 153(2)(b) have been given broad interpretation: Maxwell at [162] above. Fraudulent breaches of trust will include deceit which can be ascertained from the objective circumstances. It will not include breaches of trust that the Court is satisfied are totally innocent.
The Court accepts Mr Smith's submission that some guidance can be found in the interpretation of similar provisions. Although s 69(1) of the Trustee Act 1925 (NSW) was repealed, I do not overlook the High Court's obiter consideration of the term "fraud or fraudulent breach of trust" as it then appeared in that statute. In Banque Commercial SA v Akhil Holdings, Mason CJ and Gaudron J stated (at 286) (emphasis added): "Counsel for the respondent did not maintain that the amended statement of claim contained an allegation of "fraud or fraudulent breach of trust" by the appellant within the meaning of s.69(1) of the Act. The section itself does not disclose what is meant by those expressions. But it would be surprising if the legislature had meant to exclude from the operation of s 69(1) breaches of trust which were not fraudulent in the ordinary sense of the word, that is, committed with dishonesty or at least the knowledge of the impropriety of the conduct involved: Joliffe v Baker (1883) 11 QBD 255. In any event, the protection of the section is directed at "the relief of trustees from what may be called innocent or negligent breaches of trust" …"
However, with great respect, their Honours' observation does not assist in determining on which side of the line a breach of trust should fall that was more than innocent and less than fraudulent (knowingly dishonest). That was not a matter they had to consider.
It is uncontroversial that a trustee who, believing they are acting for the benefit of the trust, may engage in an honest breach by making an unauthorised or improvident investment. The case is different where the investment was made in circumstances in which there was a clear conflict of interest. Anthony was the controlling mind of Lewis Securities. He appropriated the Net Sum by depositing it into the company's account some six weeks before the company entered voluntary administration. He now says this was done pursuant to a written loan agreement between Lewis Securities and the Estate, but no documentary evidence was provided to the Court. Even if such a loan agreement existed, it would have been executed by Anthony or Allan.
Anthony attested to his state of mind at the time he made the transfer, claiming "I did not think [Lewis Securities] was at risk of insolvency". He claimed that Marjorie had invested in Lewis Securities previously and the Will allowed for the funds of the Estate to be invested. However, Marjorie's largest deposit was for an amount less than half the Net Sum which was made in 2004. Irrespective, Anthony had an obvious conflict of interest by investing the monies - an amount that constituted almost the whole of the Estate - in his own company.
It is the extent of that conflict and the element of personal benefit - like Mr Maxwell mortgaging the property in Maxwell - which convinces the Court that Anthony conducted himself in a manner that was a fraudulent breach of trust within the meaning of s 153(2)(b). The impropriety of his actions goes beyond mere innocent error or negligence. As I have already observed, on any ordinary view of what occurred, when Anthony transferred the money to his company this was tantamount to putting the money in his own pocket. His conduct (his state of mind or subjective beliefs being irrelevant) was plainly unconscionable so as to be fraudulent in equity.
This conclusion is fortified by the fact that Anthony failed to advise or include Allan, as his co-trustee, in the transaction. Geoffrey said that Allan (who is deceased) never knew about the deposit of the Net Sum into Lewis Securities' account. He claimed Allan said words to him to the effect of: "I didn't know that any of Marjorie's money was put into Lewis Securities. I can't understand why an investor would put substantial amounts of money into an unsecured account."
Anthony stated that he did not "believe" such a conversation ever occurred between Geoffrey and Allan because Allan was not a savvy investor, implying that Allan's understanding of investing was insufficient to make such a comment. He did not deny that he never included Allan in the transfer of the Net Sum nor sought his consent. The Court finds that Anthony never told Allan what he (Anthony) had done with the Net Sum.
The Court notes that Anthony claimed to have formed the impression that Allan did not want to be involved in the administration of the Estate (see: [132] above). However, his impression forms part of the broader picture in which Anthony unilaterally took the Estate funds for his own benefit. Had any written loan agreement existed (as was suggested by Anthony under cross-examination) that document should, at the very least, have borne Allan's signature. In lieu of that, Anthony has taken advantage of his position as trustee and his father's purported disinterest to misappropriate the funds for himself.
As I have observed, with the exception of the unequivocal requirement in the United Kingdom that dishonest intent must be proven because of the word "fraudulent", consideration of the history of the section, the older English authorities and the Australian cases including Maxwell when taken together do not yield a completely clear or consistent answer on what "fraudulent" means in the expression "fraudulent breach of trust". All of the authorities that have dealt with the issue are consistent about one thing only, namely that it does not include conduct which is innocent or inadvertent.
One of the difficulties in this field of discourse is that in ordinary usage "dishonest" and its cognates are used as synonyms for "fraudulent' and its cognates. So much will become apparent from comparing the definitions of those words in any dictionary.
However, in engaging in the exercise of statutory construction to construe the words "fraud" or "fraudulent breach of trust" in s 153(2)(b), in my respectful view the starting point must be to recognise that fraud at common law and in equity can mean different things in different legal contexts. I respectfully adopt this convenient summary by Leeming JA (Beazley P agreeing) in Nadinic v Drinkwater (2017) 94 NSWLR 518; [2017] NSWCA 114: "22. First, as Gleeson CJ said in Magill v Magill (2006) 226 CLR 551; [2006] HCA 51 at [17], "the concept of 'fraud' is wider in some legal contexts than in others". For present purposes, it will suffice to distinguish the two senses in which "fraud" is used in civil litigation which correspond to different meanings at law and in equity. The difference turns on the state of mind of the person said to have committed fraud. At common law, "fraud is proved when it is shewn that a false representation has been made (1) knowingly, or (2) without belief in its truth, or (3) recklessly, careless whether it be true or false": Derry v Peek (1889) 14 App Cas 337 at 374. The contrast with equity was explained by Viscount Haldane LC in Nocton v Lord Ashburton [1914] AC 932 at 953-954: "[i]n Chancery the term 'fraud' thus came to be used to describe what fell short of deceit, but imported breach of a duty to which equity had attached its sanction". His Lordship emphasised that a person who misconceived the extent of the obligation which a court of equity imposed upon him or her, "however innocently because of his ignorance", was taken to have violated an obligation which he was taken by the Court to have known, and with the result that the conduct was labelled fraudulent. He said of fraud in this sense at 954 that: "What it really means in this connection is, not moral fraud in the ordinary sense, but breach of the sort of obligation which is enforced by a Court that from the beginning regarded itself as a Court of conscience".
The distinction must be taken to be settled law. For example, a unanimous High Court said (albeit in a statutory context) that establishing equitable fraud "does not require that an actual intention to cheat must always be proved": Polyaire Pty Ltd v K-Aire Pty Ltd (2005) 221 CLR 287; [2005] HCA 32 at [35]."
Furthermore, what may constitute fraud in equity and its consequences in terms of relief may be different depending upon the equitable doctrine that is invoked. This issue is touched upon in Phang, A, "Equitable Fraud - some personal reminisces and reflections", (2019) 13 J Eq 114.
With the greatest of respect, the position adopted in the United Kingdom leaves "fraudulent breach of trust" with no work to do. I accept Mr Menadue's submission to that effect if the Court were to construe "fraudulent" as finding its meaning by reference to the earlier reference to "fraud". As I next explain, it is to be understood by reference to "breach of trust".
At the time of the 1849, 1869 and 1883 Bankruptcy Acts in the United Kingdom, and as is demonstrated by the 19th century decisions to which I have referred above, the distinction between common law and equity was well understood. In my respectful view, given its antecedents and as a matter of ordinary construction, s 153(2)(b) must be construed by giving effect to both the disjunctive "or" and the fact that "fraudulent" is part of the collocation "fraudulent breach of trust" where breach of trust is a creature of equity. As such, the fraud in "fraudulent breach of trust" must at least include fraud as understood in equity, otherwise it would add nothing to "fraud" (in the common law sense). As the cases demonstrate, there may be factual situations where the trustee's conduct will constitute both fraud in its common law sense and in equity. However, in my opinion the proper construction of s 153(2)(b) compels the conclusion that the section comprehends breaches of trust that are "fraudulent" in the equitable sense but may not satisfy the common law definition of fraud.
In such cases, proof of the defendant's state of mind is irrelevant. This is such a case because Mr Menadue confined his case to equitable fraud that did not require proof of Anthony's state of mind. Anthony was in a position of trust. He breached that trust. The Court is satisfied that his breach was not innocent or inadvertent. For example, Anthony did not make an impermissible investment with a reputable and substantial financial organisation unrelated to him acting on legal advice that he was entitled to do so. The element of conflict of interest and using money that was not his for potential personal benefit by being deposited with his own company are enough to constitute breach of trust that is fraudulent in the equitable sense. That conclusion is only fortified by his deceitful failure to inform his co-executor of what he was doing. On this analysis (which assumes that I am not bound by Maxwell) the Court also concludes that the debt owed by Anthony to the Estate survives his discharge from bankruptcy.

Conclusion

Anthony was not released from his debt to the Estate upon his discharge from bankruptcy. The cross-claim is upheld so that Anthony's beneficial interest in the Estate is unable to be claimed by HBSY as assignee until repayment of the remainder of the debt.
That debt, still owing, attracts the intervention of the equitable principles. HBSY as assignee of Anthony's interest is unable to receive any funds from the Estate until the breach is made good. That can be achieved either by the Estate receiving the Net Sum less Anthony's entitlement or by repaying the entire Net Sum, at which time HBSY may acquire Anthony's interest.
The parties will be given an opportunity to bring in orders to give effect to these reasons. Costs should follow the event, subject to any further application by either party. Furthermore, unless some reason is advanced against this, the stayed statement of claim should now be dismissed with costs.

I certify that this and the 54 preceding pages are a true copy of the reasons for judgment herein of the Honourable Justice Francois Kunc 24 June 2022 Mary Boneham DATED Associate

Amendments 01 July 2022 - Para [24] $584,661.74 changed to $571,084.93 Para [177] First line "of both the" changed to "of the" , last sentence commencing "However," s 162(2)(b) changed to "s 153(2)(b) DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated. Decision last updated: 01 July 2022

(UK) Bankruptcy Act 1966(Cth)

(UK) Trustee Act 1925(NSW)

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