Plaintiff v First Defendant

Supreme Court of Victoria|2008-12-19|Before: Kyrou J

Set-off of a party's entitlement to costs against another party's entitlement to the proceeds of sale of a property in which the parties have been held to have equitable interests pursuant to a constructive trust.

For the First and Second Defendants (and Plaintiffs by Counterclaim)

2 On 10 October 2008, I ordered that the first and second defendants pay two-thirds of the plaintiff's costs of the proceeding. On 27 November 2008, I ordered that the Land be sold by auction pursuant to Part IV of the Property Law Act 1958 (Vic) and that, subject to further order, the net proceeds of sale be distributed to the plaintiff and the first and second defendants in accordance with their equitable interests in the Land. The auction is scheduled to take place no later than 28 February 2009.

3 The plaintiff has applied for an order that his costs of the proceeding be set off against any funds flowing to the first and second defendants from the sale of the Land. The solicitor for the first and second defendants, Buller McLeod Pty, applied to be added as a defendant in order to oppose the plaintiff's application. It did so because it took a charge from the first and second defendants on 24 October 2006 and registered a caveat on the Land to support that charge. On 27 November 2008, I made an order adding Buller McLeod Pty as the third defendant.

4 It is common ground between the parties that the first and second defendants' share of the net proceeds of sale of the Land will be insufficient to pay the fees of Buller McLeod Pty and two-thirds of the plaintiff's costs. Buller McLeod Pty has estimated that its costs are approximately $120,000-$140,000. The plaintiff's total solicitor and client costs are likely to exceed $140,000 because, unlike the first and second defendants, he was represented by senior counsel as well as junior counsel. The first and second defendants' share of the net proceeds of sale will depend on the sale price and the costs of sale. If, for example, a sale price of $550,000 is obtained, that share will be approximately $140,000.

5 In support of its application to be added as a defendant, Buller McLeod Pty relied on an affidavit sworn by Peter McLeod in which he stated that the first and second defendants are aged pensioners who do not have any savings. This evidence was not contradicted.

6 The plaintiff has relied on findings I made in Sivritas v Sivritas[2] that the first and second defendants regularly travelled to Turkey and stayed there for extended periods. He has sought the set-off order because he is concerned that once the first and second defendants' share of the net proceeds of sale is paid to them, they will leave the jurisdiction and he will not be able to recover his costs from them. He has sworn an affidavit stating that, to his knowledge, the first and second defendants do not own any assets in Australia other than their interest in the Land. This evidence was not objected to or contradicted.

7 The plaintiff and Buller McLeod Pty reached an agreement under which, from the first and second defendants' share of the net proceeds of sale, $80,000 will be paid to Buller McLeod Pty, in return for Buller McLeod Pty withdrawing its caveat. The issue of set-off, therefore, relates to the first and second defendants' share of the net proceeds of sale over and above the $80,000 that will be paid to Buller McLeod Pty. That amount will be approximately $60,000.

8 For the reasons that follow, I have decided to grant the plaintiff's application for a set-off.

9 Based on the affidavits of Mr McLeod and the plaintiff and the evidence in the proceeding, I find that the first and second defendants have limited income and do not have any savings or other assets in Australia. It follows that the only source of funds that would enable them to pay two-thirds of the plaintiff's costs of the proceeding is their share of the net proceeds of sale of the Land.

10 It was obvious during the hearing of the proceeding that there is deep seated animosity between the plaintiff and the first and second defendants. Even after I had made the declaration referred to in paragraph 1 of this judgment and the parties came before me to seek consequential orders, there was, sadly, a lack of co-operation between them even on matters where they had a common interest.

11 Based on the evidence given by the parties in the proceeding, my observation of them during the main hearing and what has transpired since that time at several mentions before me, I find that in the absence of a set-off order, there is a serious risk that the first and second defendants will not pay two-thirds of the plaintiff's costs when taxed, pursuant to my order of 10 October 2008.

12 The plaintiff has undertaken to the Court to prosecute a taxation of his costs with diligence if a set-off order is made.

13 The plaintiff has sought an equitable set-off. Rule 13.14 of the Supreme Court (General Civil Procedure) Rules 2005 (Vic) is not applicable to such a set-off.

14 Set-off in the context of judgments and orders for costs is described by Derham,[3] as follows:

It has been the practice of the common law courts since the eighteenth century to allow one judgment or order for the payment of a sum of money to be set off against another. This practice extends to a judgment for damages, as well as to an order for the costs, including costs in bankruptcy proceedings. Furthermore, it is not an objection that one of the judgments had existed at the commencement of the other action, and might have been pleaded as a defence in that action. The set-off in these cases is not pursuant to the Statutes of Set-off, but rather it is allowed in the discretion of the court as part of its inherent jurisdiction. It has been described as a form of 'equitable' jurisdiction possessed by the common law courts for the purpose of preventing absurdity or injustice. In allowing a set-off the court is at liberty to impose such terms as it considers reasonable and just.

15 An award of costs may be set off against an award of costs to the opposite party and an award of damages may be set off against an award of costs to the opposite party. In Lockley v National Blood Transfusion Service, Scott LJ, with whom Sir John Megaw and Farquharson LJ agreed, said: [4]

The broad criterion for the application of set-off is that the plaintiff's claim and the defendant's claim are so closely connected that it would be inequitable to allow the plaintiff's claim without taking into account the defendant's claim. As it has sometimes been put, the defendant's claim must, in equity, impeach the plaintiff's claim.

...

A set off of costs against costs, when all are incurred in the prosecution or defence of the same action, seems so natural and equitable as not to need any special justification. I would expect a party objecting to the set off to give some special reason for the objection. It is, in my opinion, less obvious that a set off of costs against damages would always be justified.

16 In Elphick v Elliott,[5] Dutney J held that the Court has a discretionary equitable jurisdiction to order that a judgment debt for damages be set off against unascertained costs awarded in the proceeding to the opposing party. His Honour stated that Lockley "identifies the right of set-off as being an equitable set-off arising from the close connection between the claims".[6] He added that if the source of the power to order set-off is equity, the opportunity to exercise it has been limited by the adoption in Hill v Ziymack[7] of the "impeachment test" propounded in Rawson v Samuel[8] where Lord Cottenham LC said:

We speak familiarly of equitable set-off, as distinguished from the set-off at law; but it will be found that this equitable set-off exists in cases where the party seeking the benefit of it can shew some equitable ground for being protected against his adversary's demand. The mere existence of cross-demands is not sufficient ...

Several cases were cited in support of the injunction; but in every one of them, except Williams v Davies, it will be found that the equity of the bill impeached the title to the legal demand.

17 Dutney J concluded that if the impeachment test applied to the case before him (which involved an application that costs payable by one party be set off against damages for personal injuries payable to that party), he was satisfied that it was met. His Honour said that while the right to damages arises separately from the trial in which the orders both for damages and costs are made, the obligation to pay the damages is conditional on the order of the court and it is thus possible for equity to require that the cost of ascertaining the amount payable by way of damages be met from the damages themselves by way of set-off.[9] Ultimately, his Honour did not make a set-off order because of the applicant's delay in having its costs assessed. Such a consideration is not relevant here, given the undertaking that the plaintiff has given.

18 The impeachment test set out in Rawson has been applied in Victoria in several cases, including Tadgell J's decision in Eagle Star Nominees Ltd v Merril[10] and the Full Court's decision in Indrisie v General Credits Ltd.[11] It is therefore binding on me in relation to equitable set-off. However, as Gummow J (who was then a judge of the Federal Court) demonstrates after an extensive review of the authorities in James v Commonwealth Bank of Australia, "the requirement of 'impeachment' and the phrase 'title to the legal demand' have not been narrowly construed".[12] His Honour said that the applicable principle is that "equitable set-off is available where the party seeking it can show a recognised equitable ground for being, to the relevant extent, protected from his adversary's demand and the mere existence of cross-demands is not sufficient".[13] His Honour added that the authorities suggest that it is sufficient that the existence of the legal demand would not have come about or was at least contributed to by the conduct of the party making the legal demand.[14]

19 Meagher, Gummow and Lehane's Equity: Doctrines and Remedies summarises the position as follows: [15]

One ingredient was necessary in equity but not required at law, that is, that the set-off actually go to the root of, be essentially bound up with, "impeach", the title of the plaintiff. ... It was not sufficient that there be countervailing claims, nor that those claims were mutual, nor even that they arose out of the same transaction. The defendant, in order to make out an equitable set-off, had to establish that he possessed some equitable right to be protected from the plaintiff's claim.

20 It should be noted that neither Eagle nor Indrisie dealt with set-off in the context of an order for costs. In Team Dynamik Racing Pty Ltd v Longhurst Racing Pty Ltd,[16] Fryberg J criticised Dutney J's statement in Elphick[17] that the source of the Court's power to order a set-off is equitable rather than the Court's inherent power to make orders in respect of costs. Fryberg J said that the Court's inherent power in relation to costs is general and discretionary and that the discretion "ought not to be limited by a search through the categories of equity which ... does not seem ... likely to be a process of greater clarity or certainty than the exercise of an undefined inherent jurisdiction".[18]

21 With respect, there is much to commend Fryberg J's approach. In the ordinary course, the Court adjudicates on the parties' substantive conflicting claims (whether they arise in contract, tort, equity or otherwise), before it makes a decision on costs. While it makes sense to apply the impeachment principle as between the parties' substantive claims, in the sense that one claim may go to the root of, be bound up with or impeach the other claim, it will usually be artificial to describe an order for costs, which is made after the Court has already assessed the parties' claims, as going to the root of, being bound up with or impeaching a claim that the Court has already upheld.

22 Accordingly, the preferable view is that the source of the Court's power to make set-off orders in relation to costs is the Court's inherent jurisdiction. This approach is supported by Flinn v Flinn[19] where the Victorian Court of Appeal ordered that a non-party pay the plaintiffs' costs and then made an order enabling the non-party's liability for costs (the amount of which had not yet been ascertained) to be set off against an amount of $150,000 that the Court held was payable to the non-party by the plaintiffs, without referring to any equitable principles of set-off.

23 However, as the case before me was argued by the parties on the basis of equitable principles, I will apply those principles. I will also consider briefly whether the outcome would be different if the case were decided on the basis of the Court's inherent jurisdiction.

24 Mr Barton, who appeared for the first and second defendants, submitted that it is not appropriate for the Court to make an order for set-off in the circumstances of this case because those circumstances do not fall within the applicable equitable principles. He submitted the following:

(a) The claim of the first and second defendants is their interest in the Land. From 1984 to now, they have held the legal estate under ss 40 to 42 of the Transfer of Land Act 1958 (Vic). On 10 October 2008, it was declared that they held their legal estate on trust for the plaintiff and themselves in the proportions 73.61 to 26.39. The equitable interests were created in 1984.

(b) Under Part IV of the Property Law Act all interests in the Land are being sold with resultant sale proceeds being distributed in the same proportions as the equitable interests.

(c) These proceeds are not damages or costs payable by the plaintiff, nor, in terms of the quotation from Derham in paragraph 14 of this judgment, a judgment or order for the payment of a sum of money. The plaintiff is not being ordered to pay anything, particularly not the value of the first and second defendants' interest in the Land, and accordingly there is nothing for him to "withhold" for the purposes of a set-off. The first and second defendants' share of the net proceeds of sale will be paid to them directly rather than by or through the plaintiff.

(d) The plaintiff's claim is an order for costs which arose for the first time on 10 October 2008 and which has not yet been quantified by taxation. Foots v Southern Cross Mine Management Pty Ltd[20] makes clear, in the context of discussing whether exposure to a future costs order was an obligation incurred prior to bankruptcy, that exposure to an adverse costs order is not "incidental" to liability for the underlying judgment debt because the making of an adverse costs order turns upon discretionary considerations that arise independently of the entry of judgment against the debtor. The plaintiff seeks to set off the proceeds of sale of the first and second defendants' interest in the Land dating from 1984 against their liability to pay costs of an unascertained amount created on 10 October 2008. Irrespective of how the impeachment principle is described, this case does not fall within it.

25 Mr Cawthorn, who appeared with Mr Sedal for the plaintiff, submitted that the test for equitable set-off is not that the plaintiff's claim must impeach the first and second defendants' title but rather that there must be a close connection between the parties' claims. I do not accept Mr Cawthorn's submission. The cases he relies on are from jurisdictions other than Victoria where, in the words of Gummow J, "there appears to have been some loosening in the requirement of impeachment".[21]

26 Mr Cawthorn relied on the following statement in Derham:[22]

it is nevertheless the case that the courts in the past have been prepared to order a set-off of costs against a judgment for damages and costs, or of costs against a judgment for debt and costs, or, more recently, of costs against any future sums which may be ordered to be paid on the taking of a partnership account between the parties.

27 He submitted that as a matter of general principle, a judgment for debt or damages can be set off against costs owing to the other party and vice versa. He submitted that in this case, the fact that the money that is to flow to the first and second defendants is not by way of debt or damages is not fatal. He referred to Klein v Jeffcoat[23] which concerned a claim for declarations as to the assets of a partnership, the taking of accounts and inquiries in relation to the partnership assets and consequential orders for the winding-up of the partnership. One of the issues in the appeal was whether the primary judge had erred in ordering that the costs payable by the defendants to the plaintiffs be set off against any future sums which the plaintiffs might be ordered to pay to the defendants on the taking of accounts and inquiries. Mr Martin, counsel for the defendants, submitted that such a sum could not be the subject of set-off because it was neither damages nor costs. The English Court of Appeal upheld the set-off order. Hirst LJ, with whom Peter Gibson and Pill LJJ agreed, said:[24]

There is so far as I can see, no logical reason why when a sum of money is due, or may become due, under an order of the court, it should only qualify if its character is damages in the strict or narrow sense of the word...

Mr Martin then submitted that an order for set-off is not appropriate on the footing, as he put it, that the claim for the declarations and the claim for accounts and enquiries were different causes of action and that therefore they failed to meet Scott's LJ third criterion [in Lockley] as to a close connection between the two.

This argument I find unsustainable seeing that the claim to an account arose naturally as part and parcel of this conventional partnership action.

28 Mr Cawthorn also relied upon R (on the Application of Bateman) v Legal Services Commission.[25] In that case, the applicants had succeeded in obtaining an order quashing a decision by the Legal Services Commission to revoke various legal aid certificates and were awarded costs. Other proceedings were still on foot between the parties in relation to the revocation of other legal aid certificates. The Commission sought an order that the costs payable by it to the applicants be set off against any amount the Court might order that the applicants pay to the Commission in the pending proceedings. Munby J held that he had "power under the court's inherent jurisdiction to make the order" sought by the Commission. It was common ground that, in the absence of an order for set-off, any amount paid by the Commission to the applicants in respect of their costs would be dissipated and would not be available to meet any liability the applicants would have to the Commission arising from any order that might be made in the pending proceedings. It was acknowledged by the Commission that the order it sought was a form of security for its claims against the applicants, in the event that the revocation of their other legal aid certificates was upheld by the Court. Munby J held that, in the circumstances of that case, justice and fairness required that the Commission be granted the set-off it sought.

29 In relation to the discretionary nature of equitable set-off, Mr Barton submitted that it would not be fair to order a set-off in this case, for the following reasons. The defendants are liable to the plaintiff for an unascertained amount of costs pursuant to an order. They are also liable to their solicitor for an unascertained amount of costs pursuant to a contract. They may have other liabilities, unknown to the Court. As and when any creditor makes demand on them they will then either satisfy that demand or not. There is no reason to prefer the plaintiff now by tying up the proceeds of the first and second defendants' proprietary interest. In relation to any alleged unfairness to the plaintiff, he is in no different position to any other creditor.

30 Mr Barton also submitted that the effect of the order sought by the plaintiff would be to deny or deprive the first and second defendants of any remaining financial interest in the Land and to give the plaintiff a 100 percent financial interest in the Land, contrary to the result reached at trial.

31 Mr Cawthorn submitted that if a set-off order is not made, an unfairness will be visited on the plaintiff, for the following reasons. The plaintiff has been required (at great cost) to sue the first and second defendants to obtain a declaration as to his interest in the Land. At all times they resisted any entitlement he may have had, contending the monies he paid were in the nature of a gift. That was rejected. He had to expend the costs he did in order to achieve the result that he did. It would be unfair if the first and second defendants were to receive monies leaving him very substantially out of pocket.

32 I am satisfied that the very special circumstances of this case satisfy the impeachment test and that I should make an order for set-off in the exercise of my discretion.

33 Although the first and second defendants' joint legal and equitable interests in the Land arose at the time the Land was purchased in 1984 and the plaintiff's entitlement to costs arose on 10 October 2008 by virtue of my order of that date, the plaintiff would not have incurred the costs had the first and second defendants acknowledged his equitable interest in the Land which I have found has existed since 1984. Instead of acknowledging the plaintiff's interest based on the fact that he contributed the bulk of the purchase price of the Land in 1984, the first and second defendants maintained the position, which I readily rejected on the evidence before me, that the plaintiff's contribution had been a gift. They sought to rely on their legal title to deny the plaintiff's equitable interest and thereby left the plaintiff with no choice other than to incur substantial costs in order to have his equitable interest recognised by way of a declaration of this Court. The declaration had the effect of qualifying the first and second defendants' apparent absolute legal title to the Land by pronouncing that it is subject to a constructive trust that is overwhelmingly in favour of the plaintiff.

34 The existence of the plaintiff's claim for costs would not have come about had it not been for the first and second defendants' conduct in denying the plaintiff's equitable interest. The first and second defendants' entitlement to a share of the net proceeds of sale of the Land and the plaintiff's entitlement to costs arise out of their respective equitable interests in the Land. Their respective claims have a common root and are closely connected. It would be inequitable to allow the first and second defendants to have the full benefit of their share of the net proceeds of sale of the Land without taking into account the plaintiff's entitlement to costs. The first and second defendants' liability to pay two-thirds of the plaintiff's costs impeaches, and is essentially bound up in, their entitlement to be paid a share of the net proceeds of sale.

35 The fact that the first and second defendants' entitlement to a share of the net proceeds of sale of the Land does not involve a payment to them by the plaintiff does not preclude a set-off in respect of the liability the first and second defendants have to pay two-thirds of the plaintiff's costs. This view is consistent with Klein and Bateman. The fact that those cases concerned the scope of a provision of the English legal aid legislation does not affect their application to this case. As the Land is the only substantial asset that the plaintiff and the first and second defendants own, the sale of the Land pursuant to an order of this Court will create a pool of funds that will be used to satisfy the parties' entitlements, including costs. A set-off of entitlements from a common pool of funds is appropriate in a case such as this.

36 I agree with Mr Cawthorn's submission that if an order for set-off is not made, the plaintiff will suffer an injustice. This is because, for the reasons set out in paragraph 33 of this judgment, the first and second defendants placed the plaintiff in a position where he had to incur the legal costs if he wanted to preserve his majority interest in the Land. If an order for set-off is not made and the risk I have referred to in paragraph 11 of this judgment materialises, the plaintiff's 73.61 percent interest in the net proceeds of sale of the Land will be significantly diluted by the costs of the proceeding he has incurred, due to the first and second defendants' conduct, which he will be unable to recover from them.

37 In essence, the injustice to the plaintiff will arise out of the first and second defendants' failure to comply with an order of this Court that they pay two-thirds of the plaintiff's costs. To allow them to benefit from such non-compliance in circumstances where it was their conduct that forced the plaintiff to incur those costs would be inequitable and would enable the first and second defendants to benefit from their flouting of the plaintiff's rights, not once, but twice.

38 While there is some merit in Mr Barton's submission that the practical result of an order for set-off will be that the first and second defendants will not receive any part of the net proceeds of sale of the Land and that such an order would provide security for the plaintiff's costs to the extent of the first and second defendants' share in the net proceeds of sale of the Land, these considerations are outweighed by the injustice that the plaintiff will suffer if such an order is not made. The order for set-off will place the first and second defendants in the position they would be in if they complied with the costs order made by this Court. There is nothing unfair about that.

39 Had this matter been left to be determined in accordance with the Court's inherent jurisdiction in relation to costs, rather than equitable principles, I would have concluded that the circumstances of this case overwhelmingly support the making of a set-off order in favour of the plaintiff. This conclusion is consistent with Bateman which involved similar considerations.

40 I will amend my order dated 27 November 2008 by replacing paragraph 13 with the following paragraph:

13 The proceeds of sale be applied as follows:

(a) first, to secure a discharge of the mortgage;

(b) secondly, in payment of the costs and expenses of the sale, including the costs referred to in paragraph 12 of this order;

(c) thirdly, in payment of outstanding rates;

(d) fourthly, in repayment to the Plaintiff of the sum spent pursuant to paragraph 11 of this order;

(e) fifthly, 73.61% of the balance to be paid to the Plaintiff;

(f) sixthly, $80,000 be paid to Buller McLeod Pty, from the remaining 26.39% of the balance (or, if such balance is less than $80,000, such lesser amount);

(g) seventhly, the Plaintiff's costs of this proceeding as ordered by Justice Kyrou on 10 October 2008 in the amount taxed or agreed (or part thereof) be paid to the Plaintiff from any balance and set-off against the monies that would otherwise be payable to the First and Secondnamed Defendants from the proceeds of sale; and then

(h) eighthly, any balance to be paid to the First and Secondnamed Defendants in equal shares.

41 I also propose to order that the solicitors for the plaintiff and the first and second defendants take such steps in conducting the sale of the Land as are necessary to give effect to the order referred to in paragraph 40 of this judgment.

42 I also propose to order that in the event that the parties cannot agree upon the plaintiff's costs of this proceeding, as ordered by me on 10 October 2008, payment to the first and second defendants of the sum referred to in sub-paragraph (h) of the order referred to in paragraph 40 of this judgment not be made to them until taxation of the costs due to the plaintiff, and the payment to the plaintiff of the sum referred to in sub-paragraph (g) of the order referred to in paragraph 40 of this judgment.

44 The order I make will reflect the fact that the amounts referred to in sub-paragraphs (a), (b) and (c) of the order referred to in paragraph 40 of this judgment will be borne by the plaintiff as to 73.61 percent and the first and second defendants as to 26.39 percent.