Relevant principles
15 The principles in relation to the setting aside of compositions or declaring them void are well settled. In relation to s 222 and 239 they are summarised in Re Mills: Ex parte Lloyd's (1997) 73 FCR 551 at 559-561. Those considerations which are relevant to the present case can be summarised as follows:
(a) Whether there should be further inquiry into the debtor's affairs and greater details provided by the debtor. In these circumstances the interests of unsecured creditors, and the public interest, would be served by the investigation being conducted by a trustee in bankruptcy armed with the coercive power provided by the Act.
(b) Whether there is cause for a suspicion or an arguable cause of action which may benefit creditors which has not been taken into account or properly considered. In this respect it is not necessary to establish that the creditors are more likely to be advantaged by bankruptcy but it is sufficient if bankruptcy will afford a "prospect or possibility of economic advantage to creditors sufficient to justify the conclusion that it is in their interest to make the declaration": Augustyn v Putnin (1988) 83 ALR 514 at 515
(c) Whether the amount offered under the composition is trivial.
(d) Whether payments to creditors have been made pursuant to the composition.
(e) Whether material placed before creditors in the form of reports, or conduct at the meeting, was misleading.
(f) Whether there is any reasonable basis for a conclusion that the controlling trustee may not have acted with diligence or impartiality.
16 These principles were recently applied by the Full Court in Stedman v Deputy Commissioner of Taxation [2000] FCA 336. That case concerned the setting aside of a Composition in light of alleged sham transactions. Einfeld J, with whom Whitlam and Weinberg JJ agreed, said at par 14:
"Naturally to find that a series of transactions was artificially manufactured so as to provide an appearance which was not the substantive reality is a major conclusion which cannot be reached easily or on suspicion alone. And her Honour did not do so. What she said was that the evidence raised serious doubts about the documentation and evidence on the transactions such as to provide sufficient cause to set aside the composition. In my view, it would have prejudged, and would prejudge now, the conclusions to be reached by the trustee in bankruptcy to find as a fact that [the series of transactions] was a sham. It is not necessary on an application to set aside a composition to go so far. It is only necessary to conclude, on the basis of evidence, that there is a real prospect that further investigation will so demonstrate: Re Mills at 560. I reject the appellants' submission that Re Mills is wrong or relevantly distinguishable on the facts."
17 The first important circumstance raised concerns the position and conduct of Knaggs as Controlling Trustee. Knaggs, in addition to his role as trustee, was French's solicitor and had been closely involved in many transactions referred to in the evidence, acting both for French and for companies in which French and his wife held an interest or were directors. Knaggs was also a claimant in his own right for a substantial amount, namely $124,000 in respect of legal fees, which represented about 11% of the debts accepted as proved.
18 The Minutes indicate that Knaggs did not see his position as legal adviser to French and as a creditor of French giving rise to a conflict of interest. He said that his Proof of Debt was available for inspection, and that he had earlier stated in his Supplementary Report of 30 December 1999 that he would leave acceptance of his Statement of Debt to the President of the meeting, Wily. It is not suggested that Wily was in any sense partial to either side. In my view these circumstances do not justify an assertion that there was no conflict of interest.
19 There are further matters in relation to Knaggs' behaviour which call for explanation. To be valid, Knaggs' claim for $124,000 must relate to debts owed by French. However the annexures to his Proof of Debt includes an account for $44,542.00 addressed: "Attn. Mr French, Kiama Developments Pty Limited". The costs claimed are stated to be Knagg's costs of acting "on the company's behalf in claim (sic) against sub-tenants for damages and possession" (emphasis added). This wording indicates that this claim may be the responsibility of the company and not of French personally. Moreover, there is no breakdown as to the way in which any of the costs claimed by Knaggs are constituted apart from the assertion of an hourly rate of a number of hours in the accounts. These matters are significant enough to warrant impartial investigation in the interest of creditors.
20 Surprisingly, Knaggs was not called on behalf of French to give evidence to meet the claims made as to the performance of his office as Controlling Trustee. I say "surprisingly" in view of the fact that Kemp Strang's letter of 11 April 2000 made it clear that the essential basis of the application squarely raised serious allegations as to shortcomings in Knaggs' performance as Trustee. There is no suggestion that Knaggs was unavailable. French says that he could not be expected to call Knaggs. I disagree. French appointed him and he was the legal adviser to French. He appeared on directions hearings in this Court in these matters. French further says that no determination should be made as to the conduct of Knaggs because he is not a party and has not been called as a witness. Again, I disagree. The conduct of Knaggs as Controlling Trustee is central to the case although no relief is sought personally against him. No satisfactory explanation was given for French's failure to call Knaggs. This omission in my view serves to reinforce the conclusion that there are grounds for carrying out further investigations.
21 Further, I am not satisfied that Knaggs drew to the attention of Credit Corp, prior to the Creditors' Meeting, the fact that there was to be an adjourned meeting on 4 January 2000. No document or letter from Knaggs has been put in evidence to support the assertion, in his Supplementary Report, that notification had been given to Credit Corp before the meeting. Further, the letter of 14 January 2000 from Credit Corp refers to Knaggs' letter of 7 January 1999. I am prepared on the present state of the evidence to infer that the letter to Custom Credit was dated 7 January and not 4 January. It seems that Credit Corp was not given an opportunity to participate at the meeting. Mr French asserts that there was a defence to Credit Corp's claim, and so any omission is immaterial. However in my view, that is not sufficient reason for Knaggs not to notify Credit Corp of the scheduled meeting.
22 In addition to the irregularities regarding Knagg's claim there are other questions raised on the evidence. In evidence there are Terms of Settlement dated 19 April 2000 in respect of proceeding No 27374/99 before the Local Court. Those proceedings involved a liquidated claim by Coca Cola Amatil (NSW) Pty Ltd ("Coca Cola") against French and Knappman. In the terms of settlement Knappman consented to a verdict and Judgment for Coca Cola against her without admission of liability, in the sum of $8,000, but with a provision that Coca Cola would accept $5,500 by way of full and final settlement if payment was made before 22 May 2000. It is clear that at 4 January 2000 Coca Cola was claiming that French was indebted to it. French argued that he had a defence to Coca Cola's original claim. Be that as it may this claim should have been disclosed to the Creditors' Meeting. Non-disclosure of it was significant.
23 The evidence before the Court does not warrant a conclusion that Knaggs carried out any satisfactory investigation in relation to the large claim by French's wife referred to in his Report of 26 November 1999. Knappman is recorded there as having a claim for $58,250 which was said to be an unsecured loan. In the Statement of Affairs of 18 December that claim is recorded as $158,250. It may be that the reference to $58,250 was a typographical error. However, there is no evidence that there were any satisfactory steps taken to verify the terms of the Knappman loan to French; the interest rate on the loan; or to obtain supporting documentation. The assertions were accepted at face value. There is a Statutory Declaration given by Knappman dated 16 December 1999 which sets out the amount of three loans and interest accrued but there is little in the way of independent documentary backup.
24 It is also significant that there does not appear to have been any investigation as to the large debts claimed by Mr Day ("Day") and his company Daylin Pty Ltd ("Daylin"). A company search dated 19 January 2000 indicated that with Day, Knappman was a director of Daylin. Day had for some time been French's accountant. Failure to investigate debts allegedly owing to parties connected to French is another significant omission.
25 A further matter relied on by the applicants was the statement in the documents placed before the Creditors on 4 January 2000 that French's interest in KDC was worthless. Seven days before the appointment of Knaggs by French an elaborate, documented arrangement was put in place which appears to have been designed to ensure that a Head Lease previously held by KDC, but mortgaged to St George Bank ("the Bank"), was dealt with in such a way that it remained under the control of Knappman and Day. KDC's debt to the Bank was paid by Terralong Estates Pty Ltd ("Terralong"), a company controlled by French and parties related to him. Terralong then received a transfer of the mortgage from the Bank before again transferring the mortgage to Daylin. This tends to indicate that the shares in KDC may not have been "worthless" as claimed.
26 Another important consideration is that Knaggs must have been well aware of these transactions in relation to the lease because he is named as Solicitor for three of the parties in some of the documentation, yet the transactions were not disclosed to the general body of creditors. I express no concluded view on these matters, but in my opinion the circumstances clearly give rise to the need for further investigation of this series of transactions to determine whether there may be additional funds available to creditors.