Octavo Investments Pty Ltd v Knight

It does not appear directly whether Coastline had power under its memorandum of association to act as a trustee but unless the powers in the Third Schedule of the Companies Act, 1961 Q., as amended, were excluded it would have had clear power to do so under cl. 25 of that Schedule, so long as the kind of business being carried on as trustee fell within either pars. 1 or 2 thereof.

By deed dated 16th April 1975, the settlor settled the sum of $10 upon Coastline to hold the same and any further additions thereto and any investments representing the same upon the trusts set out in the trust deed. The trust fund was to be held for five named companies upon trust to pay the income to them in equal shares and to distribute the capital equally between them upon the "vesting day" which was defined as being on the expiration of eighty years or such earlier date as the trustee might appoint. By cl. 15 of the deed the trustee was authorized to carry on any business as it thought fit and to employ the whole or part of the trust fund in managing and carrying on such business and it was also authorized to borrow moneys on bank overdraft or otherwise and to secure the payment of such moneys as it thought fit. It was given many other powers which are not now relevant.

Coastline commenced trading with the trust fund in its capacity as trustee in April 1975 as a distributor of frozen foods. Its operations were financed by borrowings from its bankers, advances from Octavo, and a loan of $25,000 from each of the five beneficiary companies. These companies were described by Connolly J. as being the "family trust" companies of Coastline's five directors, an expression no doubt sufficiently accurate for present purposes.

Unfortunately the enterprise was not successful. By 30th June 1975 it had lost some $12,000 on trading account, and thereafter its trading losses and liabilities grew steadily. A petition for the winding up of Coastline was presented on 26th July 1977. A winding up order was made on 25th August 1977, and in accordance with s. 223 (2) of the Companies Act the winding up therefore commenced on 26th July.

Between 28th January 1977 and the commencement of the winding up Coastline made a number of payments to Octavo. These payments totalled $49,750.

The liquidators of Coastline instituted proceedings in the Supreme Court of Queensland seeking to have the payments to Octavo declared void as preferences pursuant to s. 293 of the Companies Act and s. 122 of the Bankruptcy Act 1966 Cth.. The primary judge (Connolly J.) made the order sought by the liquidators, and that decision was confirmed on appeal by the Full Court of the Supreme Court of Queensland (Hoare, W.B. Campbell and Andrews JJ.). Octavo now appeals to this Court.

The primary judge had little difficulty in coming to the conclusion that the payments in question gave Octavo a preference or an advantage over other creditors of Coastline and that, throughout the period in which the payments were made, Coastline was unable to meet its debts as they became due from its own money. He also concluded that the directors of Octavo had, at the very least, reason to suspect that Coastline was unable to pay its debts as they became due from its own money and that the effect of the payments to Octavo was to give that company an advantage over other creditors.

It followed from these findings that, provided s. 122 of the Bankruptcy Act applied, Octavo was to be deemed not to be a payee in good faith within the meaning of s. 122 (4) and the payments in question were void against the liquidator (s. 122 (1) and (2)). Both the trial judge and the Full Court were of the opinion that s. 122 did apply to the facts of this case.

Subject to a reservation concerning the significance of the phrase "from its own money" in s. 122 (1) of the Bankruptcy Act, which we will deal with later, the appellant did not challenge the findings of the trial judge. The grounds of the appeal in essence question the relevance of the statutory framework within which those findings were made. Section 293 (1) of the Companies Act provides as follows:

(1) Any transfer, mortgage, delivery of goods, payment, execution or other act relating to property made or done by or against a company which, had it been made or done by or against an individual, would in his bankruptcy be void or voidable shall in the event of the company being wound up be void or voidable in like manner.

It was argued that if Coastline had been an individual trustee the payments in question would not have been void in his bankruptcy. The reasoning advanced in support of this conclusion was as follows:

All the property in the hands of Coastline was trust property.

Trust property does not come within the description of "property divisible amongst the creditors of the bankrupt" within the meaning of s. 116 of the Bankruptcy Act.

Consequently the legal estate in trust property does not vest in the trustee in bankruptcy upon the bankruptcy of an individual trustee.

It follows that if payments of the present kind were declared void in the case of an individual trustee, the money would have to be repaid to the bankrupt trustee, but s. 122 does not render preferences void as against a bankrupt but only as against the trustee in the bankruptcy.

Consequently s. 122 of the Bankruptcy Act has no application to the payments under challenge.

Alternatively, two further submissions were advanced for the appellant in support of the proposition that s. 122 has no application to the facts of this case. The first was that because the payments to Octavo were made from Coastline's trust funds - it having no money of its own - it cannot be said that the payments were made "from its own money". The second is that what the liquidators are in truth complaining of is the loss of Coastline's right to an indemnity against that part of the trust assets comprised in the payments to Octavo, and that such a right is not "property" within the meaning of s. 122. It is said that the section does not touch the release or surrender of the lien or charge by which that right was secured.

The relevant provisions of the Bankruptcy Act are as follows:

(1) In this Act, unless the contrary intention appears -

"property" means real or personal property of every description, whether situate in Australia or elsewhere, and includes any estate, interest or profit, whether present or future, vested or contingent, arising out of or incident to any such real or personal property;

"the property of the bankrupt", in relation to a bankrupt, means the property divisible amongst the creditors of the bankrupt and includes any rights and powers in relation to that property that would have been exercisable by the bankrupt if he had not become a bankrupt.

(a) all property that belonged to, or was vested in, a bankrupt at the commencement of the bankruptcy, or has been acquired or is acquired by him, or has devolved or devolves on him, after the commencement of the bankruptcy and before his discharge; and

(b) the capacity to exercise, and to take proceedings for exercising, all such powers in, over or in respect of property as might have been exercised by the bankrupt for his own benefit at the commencement of the bankruptcy or at any time after the commencement of the bankruptcy and before his discharge,

is property divisible amongst the creditors of the bankrupt.

(2) The last preceding sub-section does not extend to the following property: -

(a) property held by the bankrupt in trust for another person;

(1) A conveyance or transfer of property, a charge on property, a payment made or an obligation incurred by a person who is unable to pay his debts as they become due from his own money (in this section referred to as "the debtor"), in favour of a creditor, having the effect of giving that creditor a preference, priority or advantage over other creditors, being a conveyance, transfer, charge, payment or obligation executed, made or incurred -

(a) within six months before the presentation of a petition on which, or by virtue of the presentation of which, the debtor becomes a bankrupt; or

(b) after the presentation of a petition on which the debtor becomes a bankrupt and before the debtor becomes a bankrupt,

There follow other provisions in s. 122 which it is not necessary to set out in view of the uncontested findings of the primary judge.

We do not understand the general principles concerning the bankruptcy of a trading trustee to be in dispute. It is common ground that a trustee who in discharge of his trust enters into business transactions is personally liable for any debts that are incurred in the course of those transactions: Vacuum Oil Co. Pty. Ltd. v. Wiltshire [22] . However, he is entitled to be indemnified against those liabilities from the trust assets held by him and for the purpose of enforcing the indemnity the trustee possesses a charge or right of lien over those assets: Vacuum Oil Co. Pty. Ltd. v. Wiltshire. The charge is not capable of differential application to certain only of such assets. It applies to the whole range of trust assets in the trustee's possession except for those assets, if any, which under the terms of the trust deed the trustee is not authorized to use for the purposes of carrying on the business: Dowse v. Gorton [23] .

In such a case there are then two classes of persons having a beneficial interest in the trust assets: first, the cestuis que trust, those for whose benefit the business was being carried on; and secondly, the trustee in respect of his right to be indemnified out of the trust assets against personal liabilities incurred in the performance of the trust. The latter interest will be preferred to the former, so that the cestuis que trust are not entitled to call for a distribution of trust assets which are subject to a charge in favour of the trustee until the charge has been satisfied: Vacuum Oil Co. Pty. Ltd. v. Wiltshire.

The creditors of the trustee have limited rights with respect to the trust assets. The assets may not be taken in execution (Savage v. Union Bank of Australia Ltd. [24] ; In re Morgan; Pillgrem v. Pillgrem [1] ) but in the event of the trustee's bankruptcy the creditors will be subrogated to the beneficial interest enjoyed by the trustee: Vacuum Oil Co. Pty. Ltd. v. Wiltshire; Ex parte Garland [3] .

1. (1906) 3 C.L.R. 1170, at p. 1186. 2. (1881) 18 Ch. D. 93. 3. (1804) 10 Ves. Jun 110, at p. 120; [32 E.R. 786, at p. 789].

These principles lead naturally to the conclusion that the beneficial interests which, by subrogation, the creditors whose claims arise from the carrying on of the business have in the assets held by a bankrupt trustee form part of the property of the bankrupt divisible amongst his creditors:Savage v. Union Bank of Australia [4] ; Jennings v. Mather [5] ; Governors of St Thomas's Hospital v. Richardson [6] . The definitions of both property and property of the bankrupt in s. 5 of the Bankruptcy Act are apt to include such a beneficial interest.

1. (1906) 3 C.L.R., at p. 1188. 2. [1901] 1 Q.B. 108, at p. 116. 3. [1910] 1 K.B. 271.

It is within this framework of principle that s. 293 of the Companies Act and s. 122 of the Bankruptcy Act fall to be construed.

Section 293 (1) of the Companies Act speaks of any "transfer, mortgage, delivery of goods, payment, execution or other act relating to property made or done by or against a company". Having identified the subject-matter, one is then required to see whether, if the transaction had been made or done by or against an individual, it would have been void or voidable in the event of the bankruptcy of that individual. If the answer is in the affirmative then, in the event of the company being wound up, the transaction shall be void or voidable in like manner.

Section 122 (1) of the Bankruptcy Act renders void as against the trustee in bankruptcy a "conveyance or transfer of property, a charge on property, a payment made or an obligation incurred by a person who is unable to pay his debts as they become due from his own money in favour of a creditor, having the effect of giving that creditor a preference, priority or advantage over other creditors".

Both sections include a "payment" in their subject-matter. If they are to have any application to the facts of this case this would seem to be the only relevant subject-matter: it is the payments of money that Coastline made to Octavo that have been declared void against the liquidators.

Section 122 only applies to a transaction engaged in by the debtor himself. In the present case, the relevant payments will attract s. 122 only if they were made by Coastline. The question that follows is whether, as the appellant contended, the payments must also have been made "from his (the debtor's) own money" to attract s. 122.

Such a conclusion does not follow from a literal reading of the words of the provision. The phrase "from his own money" forms part of the description of the person who makes the payment or engages in the transaction in question and who subsequently becomes bankrupt. The reference is to a person "who is unable to pay his debts as they become due from his own money". We are unable to see any merit in the submission that the phrase "from his own money" qualifies the classes of transaction covered by s. 122 (1).

Even if we are mistaken in this conclusion, the words "from his own money" may well be satisfied if a trustee makes payments to a creditor out of trust assets in respect of which he has not only the legal estate but also a beneficial interest to secure his right to an indemnity.

The appellant further submitted that the transaction that the liquidators are seeking to have declared void in the present case is, in fact, the surrender of Coastline's charge over the trust moneys paid to Octavo, and that such a transaction is not covered by s. 122 (or, for that matter, by s. 293 of the Companies Act) and that therefore the relief cannot be granted.

In reality the truth is otherwise. Section 122 applies, amongst other transactions, to a payment made by a prospective bankrupt to a creditor which has the effect of giving that creditor a preference, priority or advantage over other creditors. If the present payments had not been made by Coastline to Octavo then the liquidator of Coastline would have had access to the charge over those moneys for the benefit of all its creditors. The payments therefore were to the prejudice of the creditors generally and it is those payments which attract s. 122. In our opinion this argument fails.

We turn now to the central argument of the appellant.

This argument was that the money paid to Octavo by Coastline was trust property and that therefore that property would not under any circumstances have been property divisible among the creditors of Coastline had Coastline been an individual trustee.

The appellant referred the Court to s. 116 (2) (a) of the Bankrupty Act. This section, which has appeared in the bankruptcy legislation of both the United Kingdom and Australia from the inception of the legislation, provides that the property which is divisible amongst the creditors of a bankruptcy does not include "property held by the bankrupt in trust for another person".

Property which is an asset of a trading estate carried on by a trustee is properly described as trust property: Dowse v. Gorton [7] ; Jennings v. Mather [8] . However, as we have already indicated, that does not mean that the cestuis que trust are necessarily entitled to call for the delivery of the property. If the trustee has incurred liabilities in the performance of the trust then he is entitled to be indemnified against those liabilities out of the trust property and for that purpose he is entitled to retain possession of the property as against the beneficiaries. The trustee's interest in the trust property amounts to a proprietary interest, and is sufficient to render the bald description of the property as "trust property" inadequate. It is no longer property held solely in the interests of the beneficiaries of the trust and the trustee's interest in that property will pass to the trustee in bankruptcy for the benefit of the creditors of the trust trading operation should the trustee become bankrupt.

1. [1891] A.C. 190. 2. [1901] 1 Q.B., at p. 111.

The fact that the trust property itself cannot be taken in execution by the creditors of the trustee is not to the point. Those creditors are nevertheless subrogated to the rights of the trustee in relation to that property, and in the event of the trustee becoming bankrupt, it is those rights which are to be realized in their favour.

Counsel for the appellant pressed the argument a step further, however. He submitted that in the case of an individual trustee becoming bankrupt the legal estate in the trust property does not pass to the trustee in bankruptcy, but remains vested in the bankrupt trustee. Consequently, the result of declaring void payments such as those in the present case would be that the money paid by way of preference would have to be repaid to the bankrupt trustee. It was argued that this would mean that s. 122 would have the effect of avoiding such payments not as against the trustee in bankruptcy but as against the bankrupt trustee. This result, it was submitted, is inconsistent with the proper operation of s. 122 and demonstrates that the section has no application to the facts of this case.

Conflicting views have been expressed on the question of whether the legal title to trust property over which a bankrupt trustee has a charge vests in the trustee in bankruptcy. In several cases it has been held that it does: Carvalho v. Burn [9] ; Morgan v. Swansea Urban Sanitary Authority [10] ; Jennings v. Mather [11] ; Governors of St Thomas's Hospital v. Richardson [12] ; Savage v. Union Bank of Australia Ltd. [13] . It is noted in Halsbury's Laws of England, 4th ed., vol. 3, par. 636, that it is doubtful "whether, in cases where the bankrupt has a beneficial interest and is also a trustee the legal estate does not pass". The learned author of Lewin on Trusts 16th ed. (1964), p. 400, is more emphatic and declares himself for the proposition that the legal estate does not pass. He submits that Sir George Jessel M.R. was wrong when he said in Morgan v. Swansea Urban Sanitary Authority: "under the Bankruptcy Act, where a trustee has no beneficial interest, the legal estate does not pass; but where he has it does pass." However, that same passage was cited with approval by the Court of Appeal in Governors of St Thomas's Hospital v. Richardson [14] .

1. (1833) 4 B. & Ad. 382 [110 E.R. 499]; affd. (1834) 1 Ad. & E. 883 [110 E.R. 1445]. 2. (1878) 9 Ch. D. 582, at p. 585. 3. [1901] 1 Q.B. 108; affd. [1902] 1 K.B. 1. 4. [1910] 1 K.B. 271. 5. (1906) 3 C.L.R. 1170. 6. [1910] 1 K.B. 271, at p. 284.

The appellant placed great significance on the outcome of this issue. It conceded that the trustee in bankruptcy is entitled to the benefit of a trustee's charge over the trust assets, at least in relation to assets held by the trustee at the date of the bankruptcy order, but denied that the legal estate in the trust property vests in the trustee in bankruptcy. It relied strongly on Jennings v. Mather [15] and Savage v. Union Bank of Australia Ltd. [16] and argued that Governors of St Thomas's Hospital v. Richardson [17] should be distinguished on the ground that the Court of Appeal was there concerned with property of a special kind, namely leaseholds with onerous covenants.

1. [1901] 1 Q.B. 108; [1902] 1 K.B. 1. 2. (1906) 3 C.L.R. 1170. 3. [1910] 1 K.B. 271.

In our respectful opinion the controversy to which we have alluded is of little moment in the present case and we find it unnecessary to decide the particular question.

We take the view that the passing to the trustee in bankruptcy of the trustee's beneficial interest in the trust estate, even if that is all that passes, is sufficient to attract the operation of s. 122 of the Bankruptcy Act. Once it is recognized that a trustee may enjoy a right of indemnity over trust property in respect of liabilities incurred by him in the administration of the trust, it follows that the creditors of a trust business may have resort to the assets of the trust to the extent of the liabilities incurred by the trustee. Section 122 is apt in the case of an individual trading trustee to render void as against the trustee in bankruptcy a payment out of the trust property in circumstances which have the effect of giving the payee a preference, priority or advantage over other creditors.

It is not necessary for us to decide in the present case whether money paid by way of preference would normally have to be repaid to the trustee in bankruptcy or to the bankrupt trustee.

In the case of the winding up of a company the legal title to all company property, including trust property, remains in the company. The liquidator of a company takes the position of the directors and, in the absence of a court order under s. 233 (2) of the Companies Act, acquires no title to company property:In re H. J. Webb & Co. (Smithfield, London) Ltd. [18] ; affd sub nom. Food Controller v. Cork [19] . No order has been made under s. 233 (2) in the present case and there is no question of company property vesting in the liquidator. It is not necessary to decide where legal title to the money paid to Octavo would lie in the present case if Coastline had been an individual trustee.

1. [1922] 2 Ch. 369, at p. 385. 2. [1923] A.C. 647.

The appellant strongly criticised certain of the reasoning advanced by the Full Court in support of the conclusions of the primary judge but it is unnecessary to deal with that criticism. We have written sufficient to show that in our opinion this appeal should fail. The significant feature of s. 293 of the Companies Act is that payments which, in the case of bankruptcy, would constitute a preference and thereby be rendered void or voidable are, in the case of a winding up, likewise void or voidable. The payments to Octavo fit this description.

However, a question remains as to the propriety of the relief granted by Connolly J. and affirmed by the Full Court. The applicants, being the liquidators, sought and obtained inter alia an order that Octavo pay to them the amount of the preference. As we have already said there is no question in this case of the property of Coastline vesting in the liquidators. To order the moneys to be paid to the liquidators tends to confuse their position with that of a trustee in bankruptcy. Payment should therefore be made to Coastline, notwithstanding that the practical result may be regarded as substantially the same because the liquidators are in control of the assets of the company, having vested in them all the powers of the board of directors.

We would therefore vary the order of the Full Court by requiring the $49,750 to be paid to Coastline but would otherwise dismiss this appeal. The orders for costs should not be disturbed, and of course the respondents are entitled to the costs of this appeal.

It would be a curious perversion of the doctrines of trust evolved by Equity Courts if they can be used to implement a scheme in which a straw company is used as a trading trustee, and assets can be transferred preferentially to defeat ordinary creditors. A device to defeat creditors is not improved by using a straw company instead of a straw man. Trusts, including trading trusts, should not be allowed to become instruments to undermine the protection which the law otherwise confers on creditors, as was attempted in this case.