Household Financial Services Pty Ltd v Chase Medical Centre Pty Ltd

• 9 - IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION CORPORATIONS LIST

4699/01 - HOME CORP PROJECTS PTY LTD v HOME CORP PROJECTS (NO 100) PTY LTD JUDGMENT 1 By its interlocutory process filed on 30 August 2002, Australian Home Mortgage Corporation Pty Ltd (in liquidation) seeks an order under s.564 of the Corporations Act 2001 (Cth) in the liquidation of Home Corp Projects Pty Ltd. I shall refer to these companies as, respectively, "Mortgage Corp" and "Projects". A third relevant company, Home Corp Projects (No 100) Pty Ltd, will be referred to as "No 100". All three companies have some commonality of ownership and directorate. Their financial affairs are said to be intermingled. 2 In September 2001, Projects sought in this court an order for the winding up of No 100 or, at least, for the appointment of a provisional liquidator in the first instance. This followed an earlier move by Mortgage Corp to obtain an order for the winding up of No 100, apparently on the basis of an alleged debt which became the subject of a statutory demand which was afterwards set aside. The subsequent winding up proceedings initiated by Projects were later compromised on the basis that a sum of $90,000 would be paid by No 100 to Projects. Mortgage Corp paid $4,850 towards the legal costs incurred by Projects in connection with the litigation against No 100 which was thus settled. This contribution was made at the behest of Mortgage Corp's liquidator and in the context of the following resolution passed at a meeting of the committee of inspection on 14 September 2001: "The Liquidator of Australian Home Mortgage Corp. Pty. Limited (In Liquidation) be authorised to offer funding to the Liquidator of Home Corp Projects Pty. Limited (In Liquidation) to support an application for the appointment of a Provisional Liquidator/Liquidator to Home Corp Projects (No 100) Pty. Limited. Alternatively, if the offer is not accepted by the Liquidator of Home Corp Projects Pty. Limited (In Liquidation) or for any reason the Liquidator of Home Corp Projects Pty. Limited (In Liquidation) does not wish to proceed, then the Liquidator of Australian Home Mortgage Corp. Pty. Limited (In Liquidation) is authorised to commence proceedings in the District Court for recovery of monies owed by Home Corp Projects (No. 100) Pty. Limited." 3 It will be seen that the resolution of the committee was not particularly specific. It authorised an offer of "funding". No amount was mentioned. Nor was there any reference to indemnity. The evidence discloses, in addition to this resolution, that $4,850 was provided by Mortgage Corp (which sum Mortgage Corp recovered, or will recover, as a result of the favourable outcome) and that other creditors - or, at least, Mr Mann as trustee of the bankrupt estate of Mr Leishman (a creditor) - did not receive an opportunity to contribute to or underwrite the Mortgage Company's legal costs. Total costs of the proceedings were somewhat more than $50,000. There is no evidence as to the extent to which these have been paid or to the source or sources to which the liquidator will resort in obtaining funds. In particular, there is no evidence that Mortgage Corp has become bound to provide anything beyond the $4,850 already provided. No such commitment can be inferred from the resolution of 14 September 2001. 4 It is in these circumstances that Mortgage Corp seeks an order under s.564(a) that the debt due to it by Projects be paid, in whole or in part, in priority to those of other creditors out of property recovered by the liquidator of Projects. Mortgage Corp's preferred position is, needless to say, that it should be granted priority as to the whole of its debt. Mr Mann, in the capacity to which I have referred, opposes the making of any order, saying that he and other creditors had no opportunity to be part of the support that Mortgage Corp now says is deserving of preferential treatment and that, in any event, a contribution by way of loan to the extent of $4,850, if deserving any such treatment, does not deserve it to the extent of priority for the total debt. 5 I should record, at this point, the liquidator's expectations as set out in his report to creditors dated 21 August 2002. His summary of receipts and payments for the 13 months to that date (actual and expected) shows receipts of $100,045.18, of which $90,000 represents the settlement sum, $10,000 represents cash at bank at appointment and $45.18 represents interest. The proceeds of the settlement thus represent almost 90% of available funds. Total payments are $76,470.45 of which $46,873.53 is for legal fees and $4,850 is reimbursement of Mortgage Corp. I infer from this (and it was, I think, accepted in argument) that total legal fees were $51,723.53 and that the whole of this related to the proceedings which produced the settlement of $90,000. 6 The cash surplus in the hands of the liquidator is (or will be) $23,574.73. If the Mortgage Company is afforded full priority for its debt of $65,081.39, there will be no return to other creditors. If the Mortgage Company is given no priority, there will be a dividend of some 5.92 cents in the dollar for all creditors. 7 Neither Mr Johnson of counsel who appeared for the Mortgage Company nor Mr Pringle who appeared for Mr Mann offered submissions as to the construction and effect of s. 564, beyond Mr Johnson's observation that a case involving Tosich Constructions (no doubt Power Demolitions Pty Ltd v Tosich Constructions Pty Ltd (1998) 26 ACSR 22) was one in which priority had been afforded to a creditor, although not for the full amount of the debt. I therefore proceed to make my own analysis. 8 Looking at s.564(a), the first task is to decide whether this case is one in which either "property has been recovered under an indemnity for costs of litigation" given by Mortgage Corp, or "property … has been protected or preserved by the payment of money or the giving of indemnity by" Mortgage Corp. There may be some residual doubt as to whether a creditor who provides funds to a liquidator to enable the liquidator to continue litigation can be said to have indemnified the liquidator for costs of the litigation. The view of Franklyn J in Re Kyra Nominees Pty Ltd (1987) 11 ACLR 767 that there is no "indemnity" in that case was questioned by Branson J in Power Demolitions Pty Ltd v Tosich Constructions Pty Ltd (above). I note that the view to which Branson J inclined was preferred by Santow J in Re Parkston Ltd (2000) 35 ACSR 114. His Honour said that: "the actual provision of funds by unsecured creditors to the liquidator would meet that description in providing the liquidator with a measure of protection in respect of the costs of the litigation instituted by him." 9 I agree with the approach taken by Santow J which seems to me to accord also with the decision of Campbell J in Re Pinnacle Construction Pty Ltd [2001] NSWSC 1210. The matter may, in any event, be of limited importance given that both Franklyn J and Branson J accepted that a creditor outlaying money as distinct from undertaking to hold harmless falls within the second limb of s.564(a), the property preserved or protected by the payment of money by the creditor being the right of action the liquidator is enabled to pursue. 10 I therefore conclude that, in the present case, Mortgage Corp is, in the context of the compromise by which the liquidator of Projects came to receive $90,000 from No 100, properly regarded as a creditor to which s.564(a) applies. 11 It then becomes necessary to consider the factors by reference to which the court's decision under s.564(a) is to be made. These are identified in the judgment of Brownie J in Household Financial Services Pty Ltd v Chase Medical Centre Pty Ltd (1995) 18 ACSR 294 as including the sum recovered, the failure by other creditors to provide indemnity, the proportion between the debts of the indemnifiers and others, the public interest in encouraging creditors to assist in the recovery of assets and the overall circumstances. 12 Brownie J added that "it will be an extremely rare case" in which contributing creditors receive 100% of the proceeds of the funded litigation. Cases decided in the six years or so since Brownie J made that observation make it necessary to reconsider the "extremely rare" description. In both Parkston and Pinnacle the supporting creditors were awarded the whole of the proceeds. The decision to that effect in Parkston was upheld on appeal: see State Bank of NSW v Brown (2001) 38 ACSR 715. In the Court of Appeal, judgments were delivered by Spigelman CJ and Hodgson JA, with whom Handley JA agreed. The purpose and effect of s.564 (or, more precisely, s.450 of the Companies (New South Wales) Code which was in the same terms) were described in the following passage in the judgment of the Chief Justice: "There is a public interest dimension in proceedings by a liquidator. As the Full Court of the Federal Court said in Grosvenor Hill (Qld) Pty Ltd v Barber (1994) 48 FCR 301; at 306; 120 ALR 262: 'A liquidator, when engaged in litigation on behalf of a company which is being wound up, or when contemplating instituting such litigation, is not in the same position as an ordinary litigant. The liquidator comes to the company as an officer of the court under a duty and responsibility to get in and maximise the assets of the company for distribution for the benefit of creditors.' With respect to s450 of the Companies Code, Hayne J said in Re Ken Godfrey Pty Ltd (in liq) (1994) 14 ACSR 610; at 612: '… the discretion covered by s 450 is a broad and general discretion and one that is to be exercised having regard to the desirability in the public interest of encouraging creditors to indemnify liquidators who desire to pursue claims in the winding up of companies.' It is in the public interest that all of the assets of a company are available for creditors. This extends to assets which can only be collected by litigation. Encouragement of liquidators to realise all of the assets of a company, if necessary by litigation, is intended to redound to the advantage of all creditors. The primary rule, is found in s 440 of the Companies Code: '440 Except as otherwise provided by this Code, all debts proved in a winding up rank equally and, if the property of the company is insufficient to meet them in full, they shall be paid proportionately.' Section 450, relevantly, 'otherwise provides'. The respondents submitted that a further public interest was served by s 450, over and above the interests of the body of creditors. They submitted that litigation by liquidators enforces the law and there is a public interest in such enforcement, relevantly, in the present case, to ensure that directors perform their duties. In my opinion, a power to make an order which is "just", for a purpose expressed in terms of giving creditors "an advantage over others in consideration of the risk assumed by them" is not designed to serve a public interest of that character. The litigation which may have resulted in the recovery, protection or preservation of property, within s 450, could be of any character and will not necessarily involve any kind of public interest. The thrust of the appellant's primary submission was the fact of incongruity in the exercise of a power which was intended to encourage conduct to serve the interests of all creditors, in such a way that some creditors receive no benefit in fact. There is an element of incongruity in such a result. That is why the exercise of the power in such a way as to give 100% of the proceeds to funding creditors should be rare.

However, the incongruity is not a contradiction. There is a difference in the information available at the different points of time that the two considerations arise. When the discretion comes to be exercised, the court knows the outcome of the proceedings. At the time the incentive to support such proceedings must be assessed, that outcome is, by definition, uncertain. The hazards of litigation are well illustrated by what actually happened in the present case, as summarised by Hodgson JA. The submissions to this court were put in terms of the exercise of a discretion. This is, in my opinion, a misnomer. Section 450 confers power to make a judgment as to what is "just". Judgment and discretion are distinct: see Bennion, "Distinguishing Judgment and Discretion" 2000 PL 368. A wide range of considerations are relevant in making the judgment for which s 450 provides: see the summary by Brownie J in Household Financial Services Pty Ltd v Chase Medical Centre Pty Ltd (1995) 18 ACSR 294 ; at 296-7 ."

13 Hodgson JA's description of the section's purposes was as follows: "I accept that it is not the object of the section to encourage litigation for the sake of litigation, or for the private benefit of creditors who provide the indemnity or the funds. In my opinion, there are two public purposes involved in the encouragement of pursuit of claims by liquidators, namely to benefit creditors and shareholders generally, and to recover property from wrong-doers and thus discourage misconduct in relation to corporations." 14 On the question whether 100% of recovered funds should be paid to the creditor furnishing financial supports, Spigelman CJ said: "Santow J said that the exercise of the statutory power to give funding creditors 100% of recovery will be rare. I agree. (Little is added by adding an adjective, for example "extremely rare": cf Household Financial Services , above, at 297 per Brownie J.) The cases in which 100% has been awarded have had particular features. In Cartco the amounts were very small. Creditors had advanced $4000 and were permitted to retain the net recovery of $7000. In Glenisia Investments the amounts were also small: $36,000 expended for a net return of $114,000. Furthermore, no unsecured creditor opposed the distribution of costs to the funding creditors. That was also the position in Household Financial Services but, in view of the absence of explicit disclosure in the liquidator's letter to shareholders about the proposal to seek a 100% order under s 450, Brownie J gave leave to any creditor to apply to vary the order. In that case some $65,000 had been advanced for a net return of $215,000. The amounts involved in the present case are of a different order of magnitude. Furthermore, other creditors, who were not asked to contribute, object to the allocation of 100%. Tricontinental and Gibraltar are entitled to a substantial advantage in view of the risks they assumed. I do not, however, believe that this is the rare case in which a 100% award is just. The funding creditors have received back the amount they advanced. Tricontinental has received a small amount from its arrangement in relation to Roxbury. A substantial preferential amount should be awarded as a reward for the risks assumed. By reason of the size of the recovery, the funding creditors can be given a large reward without allocating the whole amount. In my opinion, Tricontinental and Gibraltar should share, on their agreed 60%-40% basis, the first $1m of the total amount available for distribution from the settlement. The balance should be distributed rateably to all creditors, including the appellants and the second and third respondents. On the basis of figures accepted by Santow J, Tricontinental and Gibraltar are jointly entitled to 55.54% of that balance on a pro-rata basis. The distribution between them should be in accordance with their arrangements, if applicable." 15 Hodgson JA dealt with the matter thus, having first stated the section's purposes in the way set out above: "In my opinion, both purposes may be advanced by the grant of an advantage of 100% of the recovered funds to supporting creditors in appropriate cases. Plainly, such a benefit can support the objective of recovering property from wrong-doers. In my opinion also, the grant of a 100% advantage in cases where recovery turns out to be relatively small can also support the objective of benefiting creditors generally, by encouraging the support of litigation in cases where there is a prospect of a large recovery which would inure for the benefit of all creditors, but which may in certain eventualities result only in a small recovery. Of course, if a 100% advantage is too readily granted in such cases, this could unduly encourage the settling of claims for less than their reasonable value; but this risk can be taken into account when settlements are approved, as well as in applications by supporting creditors to be given an advantage." 16 Against that background, I turn to the relevant considerations as they emerge from the evidence in this case. The first is that, out of legal expenses apparently totalling some $51,000, Mortgage Corp contributed $4,850 for which it has been (or will be) reimbursed. The section makes it clear that the priority awarded is to be "consideration for" the funding creditor's risk. The risk, in the present case, was the risk of the loss of $4,850. The evidence does not disclose or suggest that Mortgage Corp was bound by any commitment to make on-going contributions or to provide, in the long run, any more than it did provide. There is no evidence of anything beyond the provision of the $4,850 in pursuance of the authority given by the committee of inspection on 14 September 2001. The support provided by Mortgage Corp thus covered much less than the total requirement of the liquidator - in fact, only some 10%. 17 It is also to be noted that, on Mr Mann's evidence, he (as trustee of the bankrupt estate of Mr Leishman), was never asked to contribute to the funding of the litigation by the liquidator. Nor, he says, were other creditors, so far as he knows. Against that, however, it is by no means clear that the bankrupt estate of Mr Leishman could have made any contribution, even if asked. 18 This case is not, in my judgment, one in which priority could be given as to 100% of Mortgage Corp's debt. It provided roughly 10% of the funds needed by the liquidator. It was at risk to that extent, but will recover the sum outlaid. Mortgage Corp's encouragement of the liquidator to pursue recovery was minor compared with whatever other factor encouraged him to incur the remaining 90% of the legal costs. I consider that some recognition should be afforded to Mortgage Corp by way of priority. That should, however, be limited to payment of 100 cents in the dollar in respect of 10% of Mortgage Corp's debt, with the remaining 90% ranking for dividend pari passu with the debts of other unsecured creditors. 19 I direct that the parties agree and forward to my Associate within ten days short minutes of orders giving effect to this judgment. **********

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