McBain (Trustee) in the matter of Turner (Bankrupt) v Palffy - [2009] FCA 260 - FCA 2009 case summary — Zoe

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McBain (Trustee) in the matter of Turner (Bankrupt) v Palffy

[2009] FCA 260

Federal Court of Australia|2009-03-24|Before: Marshall J

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Court

Federal Court of Australia

Decision date

2009-03-24

Before

Marshall J

Source

Original judgment source is linked above.

Judgment (18 paragraphs)

[1]

REASONS FOR JUDGMENT 1 On 10 April 2002, Mr John Turner ("the bankrupt") entered into a contract of sale with the respondents for the sale of approximately 164 acres of land in Sandford, Tasmania known as "The Oakes". The respondents are, respectively, the daughter and son of the bankrupt. The contract provided for a purchase price of $500,000. 2 The applicant, Mr McBain, is the trustee in bankruptcy of the estate of the bankrupt. Mr McBain applied to the Court for orders, including the following: · a declaration that the transfer of the property, by the bankrupt, to the respondents is void pursuant to s 120 of the Bankruptcy Act 1966 (Cth) ("the Act"); · a declaration that the transfer is void pursuant to s 121 of the Act. 3 This proceeding raises the following two issues for determination: · was the transfer effected for less than the April 2002 market value of the property? · was the bankrupt solvent at the time of the transfer?

[2]

Valuation 4 The respondents relied on the evidence of Mr McNamara. Mr McNamara is a certified valuer. He provided a report in which he valued the property, as at 10 April 2002, at $490,000. Mr McBain relied on the evidence of Mr Cripps and Mr Edwards. Mr Cripps is a certified valuer. He provided a report in which he valued the property, as at 10 April 2002, at $1,000,000. Mr Edwards is also a certified valuer. He provided a report in which he valued the property, as at 10 April 2002, at between $690,000 to $790,000. 5 The government valuation for the property, as at 10 April 2002, was $500,000. This fact is of little weight as Mr Cripps gave uncontradicted evidence that, until recently, government valuations had no capacity to keep pace with market movements. Mr McNamara agreed with a proposition put to him, in cross-examination, that the most appropriate method of performing a valuation involves consideration of comparable sales. 6 According to the evidence of Mr Edwards, which I accept, the most comparable sale disclosed in the evidence was the sale of a neighbouring property situated at 765 Rifle Range Road, Sandford ("765"). 765 was sold in July 2001 for $575,000. It consists of 103.3 hectares. Mr Cripps gave evidence, which I accept, that 765 is a much inferior property to the property sold by the bankrupt. As Mr McNamara conceded, 765 has inferior foreshore, beach access and views to that of the bankrupt's neighbouring property. 765 was capable of being sub-divided, but I accept the evidence of Mr Cripps that no-one would have paid more for that property for the potential of sub-division, as distinct from its use as a single parcel. As at April 2002, the bankrupt's property was a "lifestyle property", with no sub-divisional potential. Mr McNamara believed that the potential for sub-division enhanced the value of 765. I do not accept that evidence. I prefer the evidence of Mr Cripps that sub-dividing 765 would not have added to its value. This is based on Mr Cripps' unchallenged evidence that the highest and best use of 765 was without sub-division at the relevant time. He gave the same unchallenged evidence concerning the subject property. 7 Mr McNamara's view about the value of 765 was influenced by his understanding that approval had been given to sub-divide the property. When pressed, Mr McNamara conceded that the information that led him to come to that view was gained from an optimistic surveyor. 8 On a balance of probabilities, taking into account all of the valuation evidence, I consider that the market value of the bankrupt's former property exceeded $500,000 as at 10 April 2002. I consider that the valuation provided by Mr Edwards after a mature consideration of the competing valuers provided by the two experts to be the most reliable valuation. Accordingly, in the context of s 120(1)(b) of the Act, the respondents gave consideration of less than the market value of the property.

[4]

Relevant authorities 13 The approach to assessing insolvency set out by Palmer J in Lewis v Doran (2004) 184 FLR 454 at [106]-[108] is particularly instructive. Those paragraphs are set out below. They relate to the Corporations Act 2001 (Cth) ("the Corporations Act"), but are applicable to like considerations which arise under the bankruptcy legislation. I think that I must approach the application of s 95A [of the Corporations Act] with two considerations in mind. First, the words of s 95A must be construed as they stand, without addition or subtraction. Second, the law both before and after the enactment of s 95A is unequivocally and emphatically clear that insolvency is, first and last, a question of fact: …to be ascertained from a consideration of the company's financial position taken as a whole. In considering the company's financial position as a whole, the Court must have regard to commercial realities. Commercial realities will be relevant in considering what resources are available to the company to meet its liabilities as they fall due, whether resources other than cash are realisable by sale or borrowing upon security, and when such realisations are achievable… Southern Cross Interiors Pty Ltd (in liq) v Deputy Commissioner of Taxation (2001) 53 NSWLR 213 at 224; 164 FLR 430 (citations of authority omitted)… The question of a company's solvency may arise retrospectively or prospectively. The question arises retrospectively where, for example, a liquidator is seeking to recover an unfair preference or to set aside an insolvent transaction so that the issue is solvency as at a date prior to the winding up. The question may arise prospectively where a company is sought to be wound up in insolvency and the company's ability to pay its debts must be determined not only by reference to debts payable as at the date of trial but also by reference to its ability to pay debts which will fall for payment some time in the near future. Where the question is retrospective insolvency, the Court has the inestimable benefit of the wisdom of hindsight. One can see the whole picture, both before, as at and after the alleged date of insolvency. The Court will be able to see whether as at the alleged date of insolvency the company was, or was not, actually paying all of its debts as they fell due and whether it did, or did not, actually pay all those debts which, although not due as at the alleged date of insolvency, nevertheless became due at a time which, as a matter of commercial reality and common sense, had to be considered as at the date of insolvency. By reference to what actually happened, rather than to conflicting experts' opinions as to the implications of balance sheets, the court's task in assessing insolvency as at the alleged date should not be very difficult. 14 Transferring the matters referred to by Palmer J to their current context, the following propositions may be stated: 1. The bankrupt's financial position must be considered as a whole, having regard to commercial realities. 2. Resources available to the bankrupt, whether by cash or realisation of assets or by borrowing upon security, are to be taken into account. 3. With hindsight, the bankrupt's ability to pay his debts as and when they fall due is to be assessed. 15 The cash flow test is not simply an assessment of the bankrupt's debts due and cash available to pay them on one day fixed in time, but involves a forward looking assessment of the bankrupt's ability to pay his debts as and when they fall due in the not distant future. Debts are not simply "debts 'then' payable, but…debts 'as they become due' - a phrase which looks to the future" (Griffiths CJ in Bank of Australasia v Hall (1907) 4 CLR 1514 at 1527). 16 The identification of the bankrupt's contingent and prospective liabilities as at 10 April 2002 and the extent to which they may be considered as part of his debts, at that time, is a crucial matter for determination. The weight of authority suggests that contingent or prospective liabilities may be included as part of a person's debts provided that there is a real likelihood of them being established. 17 In Re Saebar; Official Receiver v Saebar (1971) 18 FLR 317, Hoare J was concerned with the predecessor version of s 120. In that form, the exception currently found in s 120(3)(b) was found in s 120(2)(a). The exception provided that the transfer would not be void if the party claiming under the transfer could prove "that the settlor was, at the time of making the settlement, able to pay all his debts without the aid of the property comprised in the settlement". As in the current Act, "debt" was defined to include a liability. 18 In that case, the prospective liability at issue was a liability to pay damages for a personal injury, where judgment had not yet been entered. The question before Hoare J was whether a liability extended to contingent and prospective liabilities. His Honour held that a prospective liability should be taken into account in determining "all of the debts" of the settlor if, considering the whole of the circumstances, there is a real likelihood of the prospective liability becoming, in due course, an actual liability. According to Hoare J, prospective liabilities may be ignored if they are "purely speculative and without any real likelihood of being established" (at 322). 19 It should be noted that the test for insolvency at that time was a cash flow test which is the same test required by the current Act and the Corporations Act. 20 In Re Hyams; Official Reciever v Hyams (1971) 19 FLR 232, Gibbs J similarly held that when determining the debts of a settlor for the purposes of s 94(1) of the Bankruptcy Act 1924 (Cth), contingent liabilities should be considered if there was a reasonable possibility that the settlor would have had to meet them at the time. That case dealt with a contingent liability arising from a guarantee and as such it was a liability that could be easily quantified. In any event, Gibbs J did not limit his relevant observations to cases so quantifiable. 21 Justice Davies' judgment in Re Cao, ex parte Dixon v Cao [1994] FCA 536 provides an interesting analysis of the case law dealing with the inclusion of contingent liabilities in the assessment of insolvency for the purposes of s 120 of the Act. His Honour relied on this extract by Cotton LJ in Re Ridler; Ridler v Ridler (1882) 22 Ch.D. 74 at 82: Then as to the point that the settler was not indebted, but only subject to a liability which might never become a debt. A man is not at liberty to take a sanguine view, but is bound to act upon a reasonable view of what is likely to happen. After discussing what his Honour called a "clear line of authorities", his Honour concluded that, "[i]n a determination of the issue whether the settler can pay 'all his debts', it is necessary to take account of contingent liabilities and, if necessary, to make a valuation" (at 6-7). 22 Justice Einfeld in Re Finney; Official Trustee in Bankruptcy v Finney (1996) 35 ATR 259 endorsed the decision in Re Cao and also relied on the decisions in Re Saebar and Re Hyams in holding that contingent and prospective liabilities are relevant debts for the exercise of determining solvency pursuant to s 120 of the Act. At 270, Einfeld J said, "[i]t is clear law that a prospective liability for a debt should only be disregarded if it is purely speculative and without any real likelihood of being imposed". 23 In White Constructions (ACT) Pty Ltd (In Liq) v White (2004) 49 ACSR 220, McDougall J distinguished the circumstances of the case before him from those of both Re Saebar and Re Hyams. White Constructions concerned the solvency of a company for the purposes of the Corporations Actand relying on the definition of solvency in s 95A of that Act. At [317], McDougall J said: The decisions in Saebar and Hyams, and the decisions discussed in those cases, recognise that an unestablished (and unquantified) liability may be required to be taken into account for the purposes of the particular exercise propounded by the legislation. They do not show that a claim for unliquidated damages is a debt, let alone a debt that is due and payable. I therefore do not think that the decisions are of direct relevance to the issue of insolvency as it has been framed. 24 Justice McDougall distinguished those authorities in part because "debt" in the Corporations Act is not defined to include a liability as it is in theAct. 25 The respondents rely on Box Valley Pty Ltd v Kidd [2006] NSWCA 26 as an answer to the authorities reviewed above. That judgment dealt with whether a contingent liability arising from a default clause in a forward sales contract before a default notice has been given constitutes a debt for the purposes of s 95A of the Corporations Act. The New South Wales Court of Appeal determined that it did not because it was an unliquidated claim for damages that was not yet quantified. At [14], Bryson JA said: "The word 'debt' is used in s 95A of the Corporations Act without any supporting definition. An entitlement to claim damages for breach of a contractual obligation to sell and deliver goods is not a debt within the ordinary meaning of that word." Section 95A of the Corporations Act defines solvency and insolvency in the same terms as ss 5(2) and (3) of the Act. In contrast to the Act, the Corporations Act does not define debt to include liability. 26 I am persuaded, having regard to the above analysis, that the proper view of the authorities on this question is that the principles enunciated in the early 1970s in Re Saebar and Re Hyams are still good law and should be applied, as they were in Re Finney.

[6]

Breach of contract 29 From approximately 1967, the firm of solicitors Piggott Wood and Baker ("PWB") ran a mortgage lending fund known as the PWB Mortgage Run Out Fund ("the Fund"), whereby investors would deposit monies in the Fund and those monies would be lent to borrowers on mortgage security. While the fund had operated for many years before, it was registered with the Law Society of Tasmania as a controlled fund and operated as such from 4 January 1995. The bankrupt was one of two partners of PWB who were responsible for the running of the Fund, on behalf of the firm as a whole. 30 On 2 November 1998, PWB first reported to the Law Society that the Fund was in trouble. The Fund ceased accepting deposits and lending monies in November 1998 as a result of significant borrower defaults. In a notice to investors dated 6 November 1998, PWB advised investors with monies invested in defaulting loans of that fact and that "investors will be unable to withdraw their money until either we are satisfied that the borrower has and will continue to meet its obligations under the loan or until the mortgaged property or properties which secure the loan have been sold" (original emphasis). 31 When the shortfall in the Fund became well known, there was a run on the Fund with many investors demanding that PWB return their invested monies. PWB was not in a financial position to meet those demands. 32 It is contended by the applicant that PWB was contractually obliged to refund investors' monies within one month of the investor giving notice of its demand. Justice Crawford, as his Honour then was, made factual findings to this effect in Law Society of Tasmania v Turner (2001) 11 Tas R 1 at [7]. Investors were provided by PWB with a "PWB Mortgage Register Information Sheet" and with a "Mortgage Investment Form" to sign. Though these forms appear to have changed slightly over time, they are, in all relevant respects, the same. The Information Sheet states that the terms of the investment are contained in the Investment Form and the Information Sheet. The Information Sheet contains a term, under the heading "Withdrawals" that "[o]ne month's notice is required for both partial and total withdrawal of funds". 33 The respondents contend for an interpretation of this term that is both contrary to the finding of Crawford J and contrary to the plain meaning of the document. They submit that, read in conjunction with another section of the Information Sheet which is headed 'Loan Advances' and states "[l]oan advances are interest only and repayable on demand. Capital repayments are accepted subject to notice", one should understand the 'Withdrawals' term to refer to the loans made by PWB to borrowers on behalf of the investors, not to funds invested with PWB and repayable by PWB. 34 I do not accept this submission. PWB was liable to investors for the repayment of their monies on one month's notice. Investors had a cause of action for breach of contract against PWB as at April 2002. 35 There is no evidence as to how many investors made demands for the return of their money and what amounts were demanded and were unpaid, although it may be inferred that investors with a right to seek a repayment of their funds would have pursued their return in the absence of any other method of recovery. It does not stand to reason, as a matter of commercial reality, that they would not have pursued PWB for a return of their funds. 36 I am satisfied that the shortfall in funds owed by PWB to investors was significant. Even on the basis of the most conservative estimate, they were in the realm of $6.4 million. That figure is reached by calculating the defaults in the problem loan reports prepared by PWB's external accountant, Mr Robinson, for the Law Society of Tasmania. PWB itself provided the figure of a $6.87 million shortfall in its report to the Australian Securities and Investments Commission of 14 September 2001. Mr Hamilton, appointed by the Court as liquidator of the Fund pursuant to s 601EE of the Corporations Act, came to a balance of unpaid investor funds of $9.8 million. It is not necessary to make an exact determination of what the claims might have been worth. I am satisfied on this evidence that there was a shortfall of at least $6.4 million and that actions by the investors to recover their monies was not, as at 10 April 2002, merely speculative but was an event that was reasonably foreseeable.

[7]

Breach of trust 37 As at 10 April 2002, causes of action in breach of trust had accrued in investors. PWB was in a trust relationship with investors in the Fund. PWB was more than an agent, it was a trustee. Investors invested their funds with the Fund, not with a specific borrower. They were, amongst other things, entitled to be informed and kept up to date about the loans in which their money had been invested. PWB engaged in conduct that breached the trust arrangement constituted by the Fund between PWB and the investors. Judgment has not been entered in relation to these claims, but, in accordance with the authorities referred to above, I am satisfied that these claims as at 10 April 2002 were likely to become debts of the bankrupt. I base this finding on the following: · PWB regularly substituted investor funds in defaulting loans without advising clients and without client consent. The bankrupt has conceded as much. Justice Crawford found at [37] of Law Society of Tasmania v Turner: [i]n my opinion a competent legal practitioner, paying proper regard to a practitioner's duty to investor clients, would have realised long before November 1998 that the firm's practice of substituting clients' funds into defaulting loans, without the authority of the clients, amounted to a breach of that duty. · PWB failed to inform clients that had money invested in defaulting loans that the loans were in arrears. Instead, PWB forwarded interest due to clients from its own pocket. The bankrupt conceded in cross examination that this was "a stupid thing to do". It gave investors the impression that their money was invested in performing loans when this was not in fact the case. Justice Crawford found in Law Society of Tasmania v Turner that "[e]xtended periods of default in paying interest amounted to relatively serious breaches of mortgage conditions and ought to have raised concerns for the safety of investments about which the clients were entitled to be informed" (at [36]). · In Fouche v Superannuation Fund Board (1952) 88 CLR 609, the High Court found that it was a breach of trust to advance monies on a speculative investment and that the investment itself was a breach of trust ab initio. As at 10 April 2002, there was a strong case to be made that PWB invested their clients' funds in hazardous ventures that were a breach of trust in and of themselves. The defaulting loan reports prepared by PWB, or its accountants, state (in relation to many loans) that they may have been speculative ventures of the kind discussed in the Fouche case. PWB was alive to the real liability this conduct posed. 38 It is unnecessary to quantify the equitable debts that these breaches of trust gave rise to in light of my finding in relation to the contractual right of investors to their funds. Quantifying the debts of the bankrupt resulting from the breaches of trust is not straightforward. On the evidence, it is in the realm of millions of dollars. Absent the debts of the bankrupt as a result of the breach of contract, I am satisfied the bankrupt would not have had the ability to meet the debts arising from claims in breach of trust.

[8]

Law Society proceedings 39 On 19 December 2001, the Law Society of Tasmania applied to the Supreme Court of Tasmania for a declaration that PWB, the firm, was in fiduciary default (proceeding TASC M 377 of 2001). Mr Turner was not named as a respondent to this action because he was not a partner of the firm at that date. An order was made on 1 October 2002 that PWB was "in default". The Solicitors Trust paid $80,216.04 into the Court fund subsequent to that order. That amount increased to $195,601.74 by August 2004. 40 Prior to amendments that came into force on 28 June 2002 to s 111 of the Legal Profession Act 1993 (Tas) ("LPA"), the Solicitors' Trust only had a cause of action against the firm, not former members of the firm, for the amount the Solicitors' Trust paid into the Court fund pursuant to the orders of 1 October 2002. 41 The amendments gave rise to a statutory cause of action in favour of the Solicitors Trust against Mr Turner as a "a former member" of the firm PWB because of an amendment to s 111(8) of the LPA that allowed the Solicitors' Trust to apply to the Supreme Court for an order that the amount be paid to the Trust by a firm, a member or former member of a firm or a legal practitioner corporation. 42 Pursuant to s 111(8) of the LPA, on 6 November 2003 the Solicitors' Trust commenced proceeding TASC M319 of 2003 in the Supreme Court. As a result of the amendment to s 111 of the LPA, Mr Turner was able to be named as the second respondent. The Solicitors' Trust originally claimed for the repayment of $80,216.04. Judgment was entered in favour of the Solicitors' Trust in the amount of $195,601.74 plus costs, which was the actual amount paid into the Court fund by the Solicitors' Trust. Pursuant to that order, Mr Turner became liable for that judgment debt. 43 On 23 January 2003, the Solicitors' Trust filed an application pursuant to s 108(2C) of the LPA for the recovery of $1,114,231.61 paid by the Solicitors' Trust to cover the costs of Mr Hamilton as liquidator of the Fund pursuant to s 108(2)(a)(iii). Mr Turner was named as second respondent in the proceeding. The provision pursuant to which that application was made only came into force on 28 June 2002. Judgment was entered in that proceeding, TASC M13 of 2003, on 6 August 2004 for the amount of $2,085,636.48 against the respondents. 44 The respondents submit that those statutory liabilities did not exist at 10 April 2002 because the amendments to the legislation allowing the Solicitors' Trust to claim against the bankrupt were not in force at that time. While that may be true, it does not change the existence of investors' claims against the bankrupt as at April 2002 either as a result of breach of contract or breach of trust. 45 The potential claims of investors were not far flung or illusory. The bankrupt was found guilty of unprofessional conduct in November 2001 in respect of his conduct in running the Fund, in particular, the substitution of clients' funds and further advances of clients' funds into defaulting loans. Justice Crawford made findings of fact in relation to the practice and also about the incompetence and negligence involved. There is no question that investors' claims were real as at April 2002. The manner of pursuing those liabilities is of minimal relevance. The fact that at some later date the investors' interests were assigned to the Solicitors' Trust by virtue of a legislative provision does not change the bankrupt's liability to the investors as at April 2002. 46 The submission that the bankrupt only became bankrupt in fact as a result of the amendments to the LPA may well be true. The Court is not presently concerned with the cause of the bankrupt's actual bankruptcy, but with whether the bankrupt was insolvent, at a time, some 3 years before he became bankrupt.

[9]

Assets and indicators of possible solvency 47 The bankrupt asserts that between 10 April 2002 and 13 June 2002, he had total assets of $1,595,364.32. This was comprised of the following: · Property at 31 Beddome Street, Sandy Bay, Tasmania - $275,000 · Motor vehicle - $8,000 · Subject property at the "The Oakes", Sandford, Tasmania - $500,000 · Livestock on "The Oakes" - $4,800 · Share portfolio - $450 · Tools and equipment - $1,000 · Superannuation - $806,114.32 48 Mr Turner also had an interest in the firm PWB, but that interest had lost any material value by April 2002. 49 The above is uncontested by the parties, except for two points. Firstly, the value of the subject property is at issue and, consistent with my finding above, the property was worth $690,000-$790,000. The applicant contests that the bankrupt's superannuation should be included in the assessment of the bankrupt's solvency. I turn to that question now. 50 The bankrupt's superannuation was a protected asset. It may be taken into account if the Court is convinced that the bankrupt would have made it available. I do not accept that Mr Turner would have used it to pay his debts at the time. The bankrupt has given hypothetical evidence that he would have drawn on his superannuation entitlements in 2002 to pay his debts. When he later had the opportunity to try to avoid bankruptcy, he did not offer to access his superannuation to settle or compromise with creditors. The bankrupt was not able to offer the Court an explanation why the circumstances would have been different in 2002. It defies reality to suggest that in 2002, the bankrupt would have made protected funds available to creditors which would have then been lost to him. 51 The respondents submit that it is not open to look at the subjective intentions of the bankrupt when assessing solvency. They submit that the assessment is an objective test of looking at what assets a bankrupt has, not at whether the bankrupt would have provided them. I do not agree with the respondents' submission concerning protected assets. In respect of non-protected assets, the bankrupt would have no choice but to make them available and therefore the existence of the asset can be looked at objectively. However in the case of a protected asset, it only becomes available by the bankrupt making it so. This must involve an assessment whether, in reality, the bankrupt would or would not access the protected asset. The assessment made in the foregoing paragraph is one the Court is entitled to make.