The operation of s 122 of the Bankruptcy Act
11 The parties accepted, for the purposes of argument, the Bankruptcy Trustees recovered the payment from the Commissioner pursuant to s 122 of the Bankruptcy Act. There is no evidence to suggest that proceedings were commenced by the Bankruptcy Trustees against the Commissioner or that the obligation of the Commissioner to repay the money was determined by a court. Indeed, there is no clear evidence that Mr Lee was insolvent at the time of the payment, even though the available material points in that direction. Nevertheless, the parties seemed content to proceed on the basis that the sum paid to the Commissioner by Mr Lee was caught by s 122 and it is not inappropriate to accept that assumption.
12 Section 122 provides for the avoidance of a payment which has the effect of giving a creditor a priority or advantage over other creditors when made in the relevant period. Relevantly, it provides:
122 Avoidance of preferences
(1) A transfer of property by a person who is insolvent (the debtor) in favour of a creditor is void against the trustee in the debtor's bankruptcy if the transfer:
(a) had the effect of giving the creditor a preference, priority or advantage over other creditors; and
(b) was made in the period that relates to the debtor, as indicated in the following table.
… [Table not reproduced]
(1A) Subsection (1) applies in relation to a transfer of property by the debtor in favour of a creditor:
(a) whether or not the liability of the debtor to the creditor is his or her separate liability or is a liability with another person or other persons jointly; and
(b) whether or not the property transferred is the debtor's own property or is the property of the debtor and one or more other persons.
13 It can be accepted that s 122 operates without the intervention of the Bankruptcy Trustee or an order of the Court, such that, if it is applicable in a particular case, the preference payment is avoided on the making of the sequestration order: Westpac Banking Corporation v Bell Group Ltd (in liq) (No 3) (2012) 44 WAR 1 at 480 [2526], at 482 [2535] (Westpac Banking Corporation v Bell (No 3)). This was forcefully advanced in submissions by the Commissioner and it is a correct statement of the operation of the section. However, despite that, it also seems to be accepted that, as a matter of practical reality, the payment is defeasible and remains effectual until the Bankruptcy Trustee determines to avoid it: Westpac Banking Corporation v Bell (No 3) at 482 [2535]; Official Trustee in Bankruptcy v Alvaro (1996) 66 FCR 372 at 426. That does not mean that the transfer is actually only voidable as opposed to void. It is merely an appreciation of what occurs in the administration of an insolvent estate and if a Bankruptcy Trustee determines not to take action the transfer is treated as being valid: Kerr (Trustee), In the matter of Cross v Bechara [2015] FCA 284 at [123].
14 It is also apparent that s 122 does not confer on the Bankruptcy Trustee any cause of action to recover money paid. All it does is confer a right to advance a claim that the payment fell within the scope of the section. If the Bankruptcy Trustee's claim that a payment was avoided by the operation of s 122 was contested, proceedings would need to be commenced for a declaration to that effect: s 30(1)(b) of the Bankruptcy Act. If the Bankruptcy Trustee's action was successful, a declaration would be made that the payment or transfer was avoided, presumably from the date of the transaction, with the consequence that title in the property transferred is to be regarded as not ever having passed: See Westpac Banking Corporation v Bell (No 3) at 487 - 488 [2560] where Drummond J said:
The Bankruptcy Act provisions therefore operate as from which ever of these dates is the relevant one to avoid the relevant transfer of property by the company. The avoidance, so triggered, operates retrospectively to make the subject matter of the transfer once again the property of the bankrupt and thus of the trustee or the liquidator, as if he had never parted with that property.
15 Neither s 122 nor any other section of the Act prescribes where the property transferred is to go once the transaction is avoided. Although the right to recover payment arises on a cause of action by virtue of the avoidance of the payment: Cook v Italiano Family Fruit Company Pty Ltd (in liq) (2010) 190 FCR 474 at 486 [41]; Re Fresjac Pty Ltd (in liq); Campbell v Michael Mount PPB (1995) 65 SASR 334 at 339: the right is governed by the application of general law and such causes of actions as are appropriate can be pursued. Where the property exists in species, or money paid can be identified or traced, equity may provide for recovery of that property or money. Where, however, such identification is not possible, other common law rights are available such as a claim for money had and received, conversion, detinue or, apparently, the Court may simply order the payee pay the Bankruptcy Trustee an equivalent amount: Westpac Banking Corporation v Bell (No 3) at 625 - 626 [3228]; Re Ward; Thomas v LG Abbott & Co Ltd (1950) 16 ABC 214 at 222 (Ward); NA Kratzmann Pty Ltd (in liq) v Tucker, Liquidator of Reid Murray Developments (Qld) Pty Ltd (in liq) (No 2) (1968) 123 CLR 295 at 298 - 299 (NA Kratzmann (No 2)); NA Kratzmann Pty Ltd (in liq) v Tucker, Liquidator of Reid Murray Developments (Qld) Pty Ltd (in liq) (1966) 123 CLR 257 at 285. In the Commissioner's written submissions, it was said that the common law causes of action assist in recovery of the money by the Bankruptcy Trustee. Whilst that would appear to be correct, it carries with it acceptance of the proposition that some right which supports a cause of action must exist on which the Bankruptcy Trustee can rely. As the Act confers no such right or cause of action on the Bankruptcy Trustee, it necessarily follows that its claim must be derivative upon some right acquired from the bankrupt.
16 Here, the Bankruptcy Trustees submitted their entitlement to recover payment from the Commissioner arose, in part, from the payment by Mr Lee of trust funds pursuant to his right of exoneration out of the trust assets. They assert the effect of the avoidance was that the parties are in the same position as if the beneficial interest in those funds never passed to the Commissioner and remained with Mr Lee as trustee and, so, in his stead, now vested in them. In that way it was submitted the funds retained their character as trust assets. They asserted the payment to the Commissioner was ineffective to pass to the Commissioner any beneficial interest in any trust funds used pursuant to the right of exoneration which retained their character as trust funds.
17 The submissions of the Bankruptcy Trustees tended to treat money as property in the nature of a specific asset rather than the res fungible it is. The essence of fungibility is "a choice between legally interchangeable units": Prof Sir R Goode, "Are Intangible Assets Fungible?" (2003) 379 Lloyd's Maritime and Commercial Law Quarterly 379. Because the payment is of money and not the transfer of the specific asset, any declaration of invalidity does not affect the title to the money and all that is required to restore the parties to their correct position is the repayment of a similar amount: NA Kratzmann (No 2) at 298. The Bankruptcy Trustees' submissions also fail to recognise that it is more than likely the money was not paid to the Commissioner by way of legal tender in the form of notes and coins, but by way of a transfer of credit through financial institutions which effected a complete discharge of the taxation liability. Moreover, it is likely the credit, assuming it had an independent existence, was mixed with the general revenue received by the Commissioner.
18 It is, with respect to the Bankruptcy Trustees' submissions, quite inapt to consider the rights of the parties by reference to concepts of whether the payment of the taxation liability passed beneficial title in the "money" used to pay the debt. Here, there is no suggestion the money paid is traceable and it follows that all that need be considered is the right of the Bankruptcy Trustees to be repaid an equivalent amount. That right arises through an entitlement to pursue an action for money had and received or for an order to account in equity.
19 Putting to one side the entitlement of the Bankruptcy Trustees to recover the sum of $171,659 paid from Mr Lee's own funds, attention needs be focused on the entitlement to recover the $150,788.58 paid from trust funds pursuant to Mr Lee's entitlement to exonerate himself in respect of debts incurred in his capacity as trustee. In this respect, Mr Lee's entitlement to use trust funds only arose by reason of his position as trustee and because the debt arose from the administration of the trust. Outside of his office as a trustee, he was not entitled to pay the funds to the Commissioner nor did he have any entitlement to recover them when the payment was found to be void. It necessarily follows that the right to recover the payments from a transaction which was avoided was a right which was held for the benefit of the trust. The position would be no different to the situation where a trustee had entered into a contract in the course of the administration of the trust which was subsequently vitiated and declared void by the Court. The right to recover damages, or a sum paid, would be trust property vested in the trustee in that capacity and not in their personal capacity. Rights which accrue from the performance of trust obligations tend to be trust property.
20 The Commissioner submitted that, although the funds were paid to him by Mr Lee as trustee utilising the right of exoneration, when an equivalent amount was repaid, the money was held free of all trust obligations and could be used to discharge the debts of non-trust creditors. He submitted that the funds recovered were not the same moneys or funds which were paid to discharge the taxation liability. This latter point may be readily accepted.
21 However, it was also submitted that the amounts did not retain their original character as trust assets. The foundation for that submission was the argument that, "[t]itle to those funds does not depend upon any succession of title of the bankrupt, it is money paid because of a cause of action in relation to the payment being void as against the Bankruptcy Trustees". Support for that proposition was sought to be obtained from the decision of the High Court in NA Kratzmann (No 2). Again, so much of the Commissioner's submissions may be accepted. Once the money is paid, title passes to the payee and neither the bankrupt, nor the Bankruptcy Trustee in his stead, is entitled to assert a continuing title to the funds.
22 The observations of the High Court in Kratzmann (No 2) are not unimportant in the determination of this separate question. There, the liquidator of the applicant company obtained a declaration that a preferential payment to the respondent company was void as against him and a further order that the respondent pay an equivalent amount to him. As is the usual course, the Court ordered the respondent not be entitled to prove in the liquidation of the applicant company until it had repaid the preferential payment. However, the respondent company was insolvent and a liquidator had been appointed prior to the preference action commencing. The question on appeal was whether the applicant company was entitled to an order to be paid in full, or whether it could only prove in the respondent's winding up. The High Court held the effect of the declaration that the payment was avoided was not such as to revest property in the money in the applicant company. It did not affect the title to any identifiable or specific property. It simply had the consequence of requiring the creditor to repay an amount equal to the value of the preference and a consequential order to that effect would be made. The applicant company had no right higher than that of an ordinary unsecured creditor and if the creditor was insolvent the right was to prove in that creditor's insolvency. The Court also considered the position where the money paid to the creditor as a preference was paid from money which was the subject of a charge. It had been argued that any money recovered by the liquidator would also be subject to the charge. This was rejected by the High Court which said (at 300 - 301):
But where security has been given by a bankrupt over all of his assets and a payment to a creditor is made by him out of moneys subject to the charge and the payment is, as against the trustee, subsequently declared void as a preference the moneys paid, when recovered, will not be subject to the charge. In such a case it may be said that although the moneys paid as a preference were at the time of payment subject to the charge, the moneys recovered by the trustee are not the same moneys and that they do not, by virtue of payment to the trustee, become moneys of the bankrupt or in any way subject to the charge; when recovered they become the moneys of the trustee and his title to them does not depend, upon his succession to any title which the bankrupt had. … The view which we have formed is, we think, borne out by the observations of Russell LJ concerning the decision in the Yagerphone Case (1935) 1 Ch 392 where, in N W Robbie & Co Ltd v Witney Warehouse Co Ltd (1963) 1 WLR 1324, at p 1338, he said:
. . . that a claim by the liquidator for repayment to him of a fraudulent preference was not subject to the debenture-holder's charge; a statutory right in and only in the liquidator to make such a claim could never have been property of the company subject to the charge.
23 The Commissioner relied upon the above as indicating that where property is recovered as a preference it forms part of the general assets under the administration and control of the liquidator which are available to meet the costs of the liquidation and the claims of the general creditors. He submitted that the same principle applies, mutatis mutandis, in a bankruptcy. He also relied upon the observations in Starkey (as liq of Allan Fitzgerald Pty Ltd (in liq)) v Deputy Commissioner of Taxation [1994] 1 Qd R 142 at 154. However, these decisions, and those referred to in them, all concerned instances where the party making the preferential payment was the sole owner of the beneficial interest in the money paid. None of them concerned the recovery of money paid out as trust money and none were referred to the Court.
24 It should be mentioned that, on one view, there appears to be some tension in the reasons of the Court in NA Kratzmann (No 2) between the concept that the Bankruptcy Trustee may recover the avoided payments on a simple common law cause of action on the one hand, and, on the other, the suggestion that the trustee's title "does not depend, upon his succession to any title which the bankrupt had". If the Bankruptcy Trustee cannot assert the bankrupt's title to the money paid, one might wonder what form of cause of action might be asserted given it is well accepted the Act does not confer a cause of action to recover the preference payment. The entitlement of the Bankruptcy Trustee to recover the payment must stem from s 58 of the Bankruptcy Act which vests the property of the bankrupt in the Official Trustee or registered trustee as the case may be. That would appear to be the source of the title to the property which a Bankruptcy Trustee might assert against the creditor who has received the preferential payment and, on the strength of which, might pursue a claim for money had and received, or an order for payment. It may be that the reference in NA Kratzmann (No 2) to "succession to any title" was a reference to a continuing beneficial or legal interest in the property transferred. On that basis it can be accepted that in this case title to the property did not remain with Mr Lee as trustee. The funds were received by the Commissioner who became fully entitled to them. However, when the transaction was vitiated on the making of the sequestration order, the right to be paid an equivalent amount could only arise in the entity who was entitled to funds which had been paid to the Commissioner. In this case that was Mr Lee. But importantly, Mr Lee's right was one which he held in his capacity as trustee of the family trust and not in his personal capacity; namely his entitlement to use trust funds to exonerate him from debts incurred in the proper administration of the trust. It would appear to be axiomatic that the right to receive repayment from the Commissioner consequent upon the avoidance of the preference payment was a right which vested in Mr Lee qua trustee such that the right is property of the trust, albeit one in which Mr Lee also had a beneficial interest. Support for this can be found in Octavo Investments Pty Ltd v Knight (1979) 144 CLR 360 at 374 where the High Court ordered that the preference payment be returned to the insolvent company and not to the liquidator. That was logical because, although the liquidator had the right to cause the preference payment to be avoided, once that occurred the right to recover an equivalent amount arose in the company which had paid the money and not the liquidator. Although the regime under the Bankruptcy Act vests the bankrupt's assets in the Bankruptcy Trustee, it is still the case that the Bankruptcy Trustee's title to assets is only as good as the bankrupt's.
25 It is also not insignificant that in Octavo at 371, the High Court expressly left open whether, where the bankrupt was a trustee, the repayment of money paid out of a trust which was a preference should be refunded to the Bankruptcy Trustee or the trustee. To date there is no sufficiently authoritative statement on this topic although the learned authors of Jacobs' Law of Trusts in Australia (Heydon JD and Leeming MJ, Jacobs' Law of Trusts in Australia (8th ed, LexisNexis, 2016) at 524, [21-16] advance the view that the money received is to be used to discharge trust debts only. The Bankruptcy Trustees have no independent right to assert an entitlement to the funds.
26 The Commissioner further argued that the right of the Bankruptcy Trustees to "recover the unfair preference is not a right held by the bankrupt in his capacity as trustee of the Family Trust for the benefit of the beneficiaries". But, as the authorities identified above disclose, the Bankruptcy Trustee is not afforded a right to recover the amount paid, but merely to recover, at general law, a payment which has been avoided by reason of the making of the sequestration order. The right to recover is dependent on whatever general rights exist. In this case that right is to recover an amount paid out of the trust funds in discharge of a trust debt. Both the beneficiaries and trustee have a beneficial interest in the right and an interest in seeing that it is applied in discharge of trust debts.
27 The Commissioner further submitted that in order for the proceeds, when received, to have the character of trust assets, the beneficial interest in them must never have been transferred, or that the trust obligations would have to re-enliven, and there is no sound basis for that to occur. Whilst the first can be accepted where the property transferred is not traceable, the second cannot. The second amounts to an assertion that if a trustee, in the course of the administration of a trust, enters into an agreement pursuant to which it pays out trust money but the agreement is vitiated, any funds recovered by the trustee would not be subject of the trust obligations. That, of course, cannot be correct. If a trustee acquires a chose in action as a consequence of the operation of a trust, that chose in action is held pursuant to the trustee's rights and obligations, no less than other trust property. In this case, the taxation liability which was discharged by the payment of trust funds to the Commissioner arose as a result of the operation of the trust and Mr Lee paid the amount of $150,788.58 out of the trust funds to discharge that liability and, pro tanto, it reduced the trustee's equitable lien over the trust assets. He was only entitled to use that money by reason of his position as trustee and the rights and entitlements he acquired as a result. When the transaction was avoided by reason of the making of the sequestration order, the right to recover the payment only existed because of Mr Lee's position as trustee. His right to recover the amount paid is subject to the trust obligation to use the trust funds for the purposes of the trust. It is not possible to hive off from the other rights and obligations of a trustee, the right to recover payments made for the purposes of the trust which have been avoided. The right is necessarily a constituent element of the bundle of rights and obligations of the trustee and no principle was referred to which suggests that a trustee might exercise such rights independently of the other trust obligations. If, as the authorities referred to above seem to indicate, the avoidance of the preferential payment merely negates the existence of the original transfer for all purposes and leaves the right to recover to the general law, the foundation of the general law right cannot be ignored.
28 At the very least, the right to receive the funds would be subject to the fiduciary duty that Mr Lee is not to profit from his position as trustee. The Bankruptcy Trustees must also be subject to that obligation to the extent to which they seek to exercise Mr Lee's rights as the trustee. On the Commissioner's arguments, Mr Lee's personal estate will obtain a benefit from the making of preference payments out of the trust assets because, on their repayment to the Bankruptcy Trustees, they can be used to discharge personal debts. The Commissioner's submissions did not explain how the use of trust power could legitimately circumvent the undoubted trust and fiduciary duties.
29 The Commissioner argued that the money recovered is not the same as the trust money which was used to discharge the debt and no form of tracing is available to render it so. However, on the above analysis there is no such tracing of funds. The analysis merely acknowledges that the right to recover the funds paid by Mr Lee is a right which arose from the administration of the trust and is subject to trust obligations. Nor is the above analysis inconsistent with the situation where money the subject of a security has been used to make the preference payment. There, once paid, the money loses its character as secured funds and here the trust funds lose that character when they are paid. The difference is that, once the transaction is avoided, the right to recover the funds in the present case is a right of the trustee qua their position as trustee and is a chose in action belonging to the trust or is confined by trust obligations. In the case of the recovery of money subsequent to the avoidance of the payment of a debt as a preference, the right to recover arises in the debtor who paid the debt and the mere fact that the monies used to make the initial payment were subject to a charge does not alter that right.
30 The argument advanced by the Commissioner creates a number of potentially difficult issues. For instance, if it were the case that after the payment was made but prior to the sequestration order, a new trustee of the trust is appointed, the position of the creditor who had received the preferential payment is problematic. Given that the avoidance of the debt annihilates the payment with the consequence that the trust debt still remains, is the preferred creditor still entitled to be subrogated to the trustees' right of indemnity and supporting lien in respect of the revived debt? On the Commissioner's argument, the erstwhile trust funds are received by the Bankruptcy Trustees free of any trust obligations such that they can be used to meet the claims of all creditors rather than the claims of trust creditors. The undoubted right of the trust creditors to be subrogated to the trustee's rights and to enforce a supporting lien in respect of those funds: Octavo at 370: is said by the Commissioner to have evaporated. Additionally, the Bankruptcy Trustees would remain able to exercise the erstwhile trustees' right to exoneration out of the trust funds in respect of trust debts including for the payment of the creditor who had previously been preferred and whose debt has revived. In effect, the amount of the preferred creditor's debt will be paid more than once from the trust assets albeit one payment will have been returned to the Bankruptcy Trustees to be distributed amongst all creditors. The result of the Commissioner's argument is that the pool of funds to which the trust creditors are entitled to be subrogated is diminished although it is not apparent why such a result is appropriate. This example shows that the failure to correctly identify the nature of the right of exoneration as being a right vested in the trustee to be used for the benefit of the trust and trustee alike, namely discharging trust debts incurred by the trustee in the course of the administration of the trust, can lead to perverse results.