Recovering “your” money when entities collapse – when can you successfully claim a Quistlose Trust?

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When a company collapses, those who had paid money to it for a particular purpose are, unsurprisingly, often keen to retrieve “their” funds. This is especially so for those who paid over money shortly prior to the collapse, or in any case where the money had not been applied for the intended purpose by the time of the collapse.

This article is about a way recovery may be achieved in equity, in some circumstances. These issues can of course arise in external administrations, hence it is also useful for administrators, receivers and liquidators to be across the principles governing Quistclose trusts.

Some of the introductory remarks below are of historical interest, as physical money has less relevance in commercial life in Australia in 2023. However as the law developed in part in that context, these remarks are instructive as to the current state of play as to property rights, the electronic recording of bank accounts and transfers of funds, and when a Quistclose trust may arise.

The first point to make is that physical money itself is capable of being the object of property rights, but is fungible. That is, one unit is identical to and interchangeable with any other unit. Once it is mixed with other money it cannot be separately identified in the same way, it has been said, that a raindrop cannot be separately identified once it has fallen into the ocean. At that point property in money is lost at common law.1

If physical money is paid into a bank account, it “passes into currency”2 and ownership of the money itself passes to the bank, which may use the money for its own lending and other purposes. The item in which any property rights may be held becomes the chose in action constituted by the debt owed by the bank to the account holder.

A bank account is nothing more or less than a chose in action, consisting “in the contractual right against the bank, ie in a debt, but a debt fluctuating in amount as moneys might be deposited and withdrawn”.3 “[T]hough in a popular sense it may be said that a depositor with a bank has “money in the bank”, in law he has but a chose in action, a right to recover from the bank the balance standing to his credit in account with the bank at the date of his demand, or the commencement of action. That recovery will be effected by an action for debt. But the money deposited becomes an asset of the bank which may use it as it pleases…”.4

Thus it is common, but a fallacy, to point to a bank account – yours or someone else’s to whom you had paid money – and say that it holds “your money”. In truth what is held is a chose in action – a debt owing by the bank to the account holder. (The reason bank accounts are so secure, particularly in Australia, is the Australian Government scheme guaranteeing deposits in banks, building societies and credit unions.)

For an entity or person who has paid money to a company for a particular purpose, the question becomes: when will equity respond to the circumstances of the payment by impressing the funds / chose in action with a trust?5

It can be an important question.

Principles – Quistclose Trusts

A Quistclose trust may arise where A pays money to B to be used for a particular purpose, and the circumstances of this transaction are such that equity regards B as holding that money – or rather, its value – on trust for A. That is, in equity, A retains a proprietary interest – not in the money itself of course, but rather in its traceable product (generally the chose in action which is the recipient’s bank account). Making a payment or a transfer for a purpose is not enough to give rise to a trust, even if that purpose is not effected and the money is subsequently misdirected or the company fails. Equity requires more before it will respond.

The prevailing view in Australia is that the Quistclose trust is explained on express trust principles, although this is not settled. Some judges continue to discuss a resulting trust analysis upon the failure of the purpose of the payment in line with the English position stemming from the early cases, including Lord Millett’s judgment in Twinsectra Ltd v Yardley6 (see below). It may be that when the position is settled here, both are embraced as the correct analysis, arising in different circumstances.

The principles governing when a Quistclose trust will be held to have been created may be distilled as follows7 –

  1. The question whether a Quistclose trust has been created will be answered by reference to the intention of the parties and the ‘essence’ of their bargain.8 The intention not to part with the beneficial ownership of the funds must be sufficiently indicated.9.
  2. The relevant intention is to be inferred from the language used by the parties in question, having regard to the nature of the transaction and the relevant circumstances of the relationship between them. It is ascertained by reference to the objective intention of the parties,10 outwardly manifested.11
  3. In determining the intention of the parties at the time, the Court can take into account events and documents which postdate the date on which the trust is said to have been created, although little weight may be given to what the parties say was the nature of the transaction at a subsequent point in time.12
  4. In a commercial setting there must be clear evidence that the parties intended a trust to arise in circumstances where a trust would not normally exist.13
  5. A Quistclose trust does not arise simply because money is paid for a particular purpose. The mere provision of money or property for a purpose is not enough.14 ‘An expectation or general understanding falls short of the necessary mutual intention that funds have been provided on the express condition that they will be earmarked for use exclusively in accordance with an agreed purpose’.15
  6. The parties must intend that the money not be used at the free disposal of the recipient.16 The transferee must be subject to restrictions on the use of the money for any other purpose.17
  7. Payment of the money into a separate account may be indicative, but not determinative, of the existence of a Quistclose trust.18 However a lack of evidence of an express requirement to keep money separate is a powerful indicator of an absence of an intention that the money was to be held on trust,19
  8. The onus of proof lies on those who assert that a trust was created.20
  9. If there was a trust, but it was created for an illegal purpose (such as the purpose of avoiding tax obligations), then the trust must fail as a matter of public policy.21
  10. Trust obligations arise where equity operates on the conscience of the holder of the legal interest. A person cannot be a trustee of property if that person is ignorant of the facts alleged to affect their conscience. That is, unless a putative trustee is aware that they are intended to hold the property for the benefit of others, their conscience will not be affected in a relevant way.22

It is clear from the authorities that the two key requirements are those at principles (5) and (6) above. As the New South Wales Supreme Court observed last year, in order for a transfer of funds or assets to be characterised as held on a Quistclose trust, the Court will look to whether the parties outwardly manifested a mutual intention that – 

  1. The money was provided for a specific purpose, and
  2. The recipient was to be subject to restrictions on the use of the money for any other purpose.23

Precedents – When the Courts will and will not uphold a Quistclose Trust claim

The most useful way to gain an understanding of how the principles are applied and where the Courts tend to draw the line as to when a Quistclose trust has and has not been created is to read cases. It is worth making sure to have regard to the most recent iterations of the Courts’ application of the principles, to see the current approach. You can then consider the facts of the case before you, and the picture will generally become clearer as to on which side of the line it likely falls.

Here, then, is a selection of 11 Quistclose trust cases, falling variously either side of the line. These are in chronological order and are mostly Australian, though I have included several English decisions. The frequency with which the issue continues to arise recently is eloquent as to how important a potential claim the Quistclose trust continues to be.

(1) Barclays Bank Ltd v Quistclose Investments Ltd [1970] AC 567

In the original Quistclose decision, Rolls Razor was seeking financing, and turned to the company of a significant shareholder. Quistclose Investments agreed to provide finance but as a precondition, Rolls Razor was required to pay all pre-declared dividends. The evidence was that the mutual intention of Quistclose and Rolls Razor, and indeed the essence of their bargain, was that the sum advanced by cheque should not become part of the assets of Rolls Razor but should be used exclusively for the payment of the particular class of creditors. The cheque drawn by Quistclose in favour of Rolls Razor, which represented the moneys borrowed by Rolls Razor, had been paid into a special account with Barclays who, importantly, had been informed that the account was to be used only to pay the dividend to those creditors. Rolls Razor subsequently went into liquidation. The findings as to the parties’ mutual intention was held to give rise to a primary trust in favour of those entitled to a dividend, and that if the purpose could not be carried out, the money was then held on a secondary trust to be returned to Quistclose. Quistclose trust found.

(2) Twinsectra Ltd v Yardley [2002] UKHL 12; [2002] 2 AC 164

In this case, Yardley obtained a loan from Twinsectra to buy a property. Twinsectra asked for a solicitor’s undertaking to secure the loan; the undertaking was to ensure that the moneys lent were not disbursed pending the acquisition of property and would only be used to acquire property. The solicitor S gave the undertaking. The moneys lent were applied in breach of the undertaking. It was argued that given Twinsectra was a commercial lender, it was difficult to conclude that it intended to retain beneficial title or create a trust over the money advanced, but failed to make this explicit in the loan agreement; that instead, all indicia pointed to an unsecured loan protected by a high interest rate and a solicitor’s personal undertaking. However, the Appellate Committee held that the solicitor’s undertaking, which was given as a condition of payment, gave rise to a Quistclose trust. Clauses 1 and 2 of the undertaking made it clear that the money was not to be at the free disposal of Mr Yardley.24 Lord Millet observed at [73] that it was not enough that the money was lent for a particular purpose because money so lent without more is at the free disposition of the borrower. Quistclose trust found.

(3) David Alan Thomson v Golden Destiny Investments Pty Ltd (No 2) [2015] NSWSC 1929

This case in 2015 involved a property development that had failed. NGI had contributed $6 million on behalf of investors. NGI argued that the $6 million was at all times impressed with a Quistclose trust. The Court however held that it was not. There was no evidence of such a mutual intention nor did the plaintiffs ever constitute themselves as trustees, nor did GDI. Once the monies were paid away to the plaintiffs, without it being impressed with a trust, it became the plaintiffs’. It was no longer NGI’s money or the investors’. Upon rescission of the original contracts, the plaintiffs were obliged to repay the $6 million to GDI. There existed a chose in action. GDI was indebted to NGI. But there was no trust. No Quistclose trust.

(4) First City Monument Bank PLC v Zumax Nigeria Ltd Ltd [2019] EWCA Civ 294

The issue in this case was whether a financial institution (IMB) held on trust for Zumax moneys credited to IMB’s bank account with Commerzbank by a nominee for Zumax from its account with a different bank, and transmitted with instructions that the credits were for onward transmission to Zumax. The Court of Appeal of England and Wales held that a trust was not established because, per Newey LJ (Lewison and Males LLJ agreeing) –

  1. In so far as it was said that the trust was an express trust, there had to be certainty of intention, objects and subject matter (which was not shown), and
  2. In so far as a resulting trust was relied upon, it was not enough to show that the moneys were paid for a purpose. More had to be shown. This could be demonstrated by showing that the money was not at the free disposition of the recipient. However that could not be shown here because there was no segregated bank account for these credits and the parties would expect the moneys held by a bank to be used by the bank for its own purposes. No Quistclose trust.

(5) Nikitins (Liquidator) v EncoreFX (Australia) Pty Ltd (in liq) No 2) [2021] FCA 27

In this case in 2021, the company EncoreFX operated a business providing foreign exchange services to businesses. On a particular day two customers deposited about $800,000 to be exchanged into USD. However before the funds could be exchanged, EncoreFX was placed into external administration. The Court found that the moneys were held under a statutory trust established by Australian financial services legislation (s 981H of the Corporations Act 2001 (Cth), although the alternative claim to a statutory trust under s 1017E failed). In obiter, it went on to find that the funds were not held on a Quistclose trust. Colvin J observed –

  1. The fact that before the payment of one of the customers, its CEO expressed the need to feel his company’s money would be safe. An employee of the recipient company said his company’s funds would be held in a trust bank account pending completion of the transactions. The Court attributed no weight to this oral conversation, as there was no evidence as to what authority (if any) that employee had to make representations on behalf of EncoreFX. Instead the correct approach was to focus upon the nature of the transaction and the objective intention.
  2. The Court examined the PDS and found the language was equivocal as to whether funds paid would be held separately. This was not enough to establish a trust. No Quistclose trust.

(6) Krejci, in the matter of Union Standard International Group Pty Ltd (in liq) [2021] FCA 1483

In this case in 2021, Union Standard had provided financial services to various customers, including a class known as “investing clients”. When it went into liquidation, there were insufficient funds to pay all creditors. The investing clients claimed a priority over funds in a particular account, on the basis those funds were held on trust for the investing clients. The Court held that a statutory trust was established by Australian financial services legislation. It went on to consider, in obiter, whether a Quistclose trust was established. It found that it was, on the basis that –

  1. everything the investing clients were told indicated to them that their funds were held and used by Union Standard as a trustee, on trust for those clients. They were told this directly by Union Standard’s agents. They were told this throughout the documentation.
  2. a Quistclose trust arose as moneys were paid by investing clients to Union Standard not to become part of Union Standard’s general assets but only to be used for the purpose of Union Standard using the moneys to generate leverage in trading transactions on behalf of the investing clients. Quistclose trust found.

(7) Re BBY Limited (Receivers and Managers Appointed)(in liq) [2022] NSWSC 29

This was a case last year where money was transferred for a purpose (payment of a margin call). The payer imposed no restrictions or conditions on BBY as to its treatment of the funds, other than its repayment within a short-time frame. Relevantly, no request was made for BBY to segregate the $3m from its general assets. The payer was not told that the funds would be deposited into a trust account of BBY, nor was an undertaking given by anyone on behalf of BBY that the $3 million advance would be used solely for paying margin calls in relation to the Aquila trade and for no other purpose, and was to be retained by BBY until so applied. The payer could have, but did not, place any conditions or restrictions on the use of the funds by BBY, or the ability of BBY to mix the funds with other monies. The payer’s submissions “conflated an expectation or general understanding that funds would be used for a specific purpose with the mutual intentions of the parties. The question [was] whether the objective intention of the parties was that the funds advanced would remain the beneficial property of the lender (even if not an exclusive beneficial interest) until the borrower applied those funds in the manner required by the stipulated purpose.” The Court held that the payment was not of moneys impressed with a trust, the payer became a creditor of BBY, and the payment was an unfair preference. No Quistclose trust.

(8) Prickly BayWaterside Ltd v British American Insurance Company Ltd (Grenada) [2022] UKPC 8 

In this Privy Council decision last year, a Mrs Lee had paid the respondent Baico a sum of money which the appellant Prickly Bay asserted was intended to be used for the purpose of payment in two years’ time of an amount which would then have become due and payable to a Mr Steele. Baico had given a guarantee that this sum would be duly paid. Prickly Bay contended that in this context Mrs Lee retained the beneficial right and title to the moneys and that Baico, having failed to pay under the guarantee, was liable to return the moneys to her. Prickly Bay failed both at first instance in Grenada, on appeal to the Eastern Carribean Court of Appeal, and in the Privy Council. In dismissing the appeal, the Board of the Privy Council observed, inter alia – 

  1. It was critical that there was no requirement that the funds be segregated, so long as money to the same amount was then paid as intended pursuant to the contractual obligations assumed. (at [42])
  2. There was nothing to indicate that Prickly Bay (or Mrs Lee on its behalf) retained any beneficial interest in the money or that it did not form part of the general assets of Baico once paid over to it. What was created was a contractual arrangement, not a trust. (at [44])
  3. Mrs Lee had remedies in contract against Baico, but did not require Baico to act as a fiduciary or to keep her subscription moneys separate from any of its own moneys. Those aspects of the parties’ arrangements were inconsistent with the retention by Prickly Bay (or Mrs Lee) of any partial beneficial interest under a Quistclose trust to enforce the performance of the purpose of the trust or alternatively the return of the moneys. (at [46]) No Quistclose trust.

(9) Goo v Sim [2022] NSWSC 420

In this case last year, the plaintiffs and Mr Sim had entered into a business venture to create an online remittance portal for the real-time transfer of money between individuals in Australia and South Korea. Mr Sim set up a South Koren company global HR for the new business. A sum of $110,000 ($109,000 cash and $1,000 transfer) was given to Mr Sim by one of the plaintiff companies, just before Global HR was incorporated, and a second cash amount of $50,000 was given to Mr Sim two months later by another plaintiff. It was alleged Mr Sim had then used the money for his own benefit rather than for the business venture, although Mr Sim said it was used for his salary and business expenses. A range of claims were brought, including a contention that the $110,000 was held on a Quistclose trust. The plaintiffs claimed the $110,000 did not become Global HR’s property or part of its assets because of the specific purpose for which the money was paid, which Global HR knew. The Court accepted that objectively, it must have been the purpose of the parties that the $110,000 was to be transferred to Global HR and to be used only for its establishment and ordinary business operations in connection with the establishment of the online remittance business in Korea. However it was not sufficient to show the money was advanced for such a purpose. There had to be other objective indicators of an intention to create a trust, and an intention that the money not become part of the general assets of Global HR. There was no evidence that Mr Goo and Mr Sim discussed a requirement to keep the money in an account separate from any other money Global HR might receive, a powerful indicator of an absence of intention that the money was intended to be held on trust. The plaintiffs did not point to any language used by the parties that was suggestive of the $110,000 being held on trust. No Quistclose trust.

(10) Eumeralla Estate Pty Ltd v Chen [2022] VSCA 78

I regard this case as probably the low water mark of Quistclose trust cases, in that at first blush it looks like a case where money was paid into a company’s bank account for a purpose, as is always the case, but with no explicit restrictions. However there was more to it than that. This was a joint venture case, with a JV agreement governing the parties’ dealings. The defendants had paid $430,000 into the JV vehicle Eumeralla’s bank account for the future development of a particular property. Ultimately the sale did not proceed. One of the plaintiffs moved the money out of the account inconsistently with the intended purpose. The Court of Appeal held that Eumeralla held the money on trust for the defendants, on the basis that the money was paid into Eumeralla’s account for a particular purpose known to all parties. It was significant that: Eumerella was incorporated to further the mutually agreed purpose of the parties, being the corporate vehicle for the property purchase and development, it conducted no other business and had that single purpose, the payment occurred pursuant to a joint venture agreement, it was not open to the plaintiffs to withdraw the money from the account as they did. Quistclose trust found.

(11) Jieyun International Investments Pty Ltd v Toorak Development Group Pty Ltd [2022] VSC 387

In this case last year, loan money was advanced by Jieyun under a loan deed pursuant to which the moneys advanced “must only be used for the Approved Purpose”, which was the purchase by Toorak Development of certain Toorak properties, and the payment of development and construction expenses. The deed repeated that the parties acknowledged and agreed that the loan must only be used for the Approved Purpose. The Court held that the moneys were held on a Quistclose trust, inferring the intention to create a trust from –

  1. Both Jieyun and Toorak Development expressly acknowledged and agreed that the advances must only be used for the Approved Purposes. This was intended to make clear that the advances were not intended to become the beneficial property of Toorak Development 
  2. There was an express restriction on the manner in which the trustee Toorak Development could deal with trust assets
  3. The fact that Toorak Development was an SPV to be trustee of the TDG Unit Trust, established for the purpose of carrying on the business of real estate, in developing the particular properties.  Quistclose trust found.

Conclusion

Quistclose trusts can be a useful tool for recovery in equity, if the circumstances of the relevant transaction/s support them. They become more acutely important when the recipient subsequently collapses. If a trust arose and the payor retains a proprietary interest in the funds paid, it may be traceable into the recipient’s bank account / chose in action and potentially – subject to matters like the tracing rules – recovered. So – when will that be the case?

The principles distilled above should be read in full. However it is clear from the authorities that the two key requirements are those at principles (5) and (6) above. As the New South Wales Supreme Court concluded last year in Re BBY Ltd, in order for a transfer of funds or assets to be characterised as held on a Quistclose trust, the Court will look to whether the parties outwardly manifested a mutual intention that –

  1. The money was provided for a specific purpose, and
  2. The recipient was to be subject to restrictions on the use of the money for any other purpose

If equity would so respond, this can be a valuable claim.

Footnotes

  1. As to the last point, see Lipkin Gorman v Karpnale Ltd [1991] 2 AC 548 (Lipkin Gorman), 572 per Lord Goff of Chieveley.
  2. There is no property in currency: Lipkin Gorman at 563 per Lord Templeman. It is said that when money passes into currency property goes with possession: Ilich v The Queen (1987) 162 CLR 110, 128 per Wilson and Dawson JJ, 138-139 per Brennan J.
  3. Russell v Scott (1936) 55 CLR 440, 450-451 per Dixon and Evatt JJ.
  4. Croton v The Queen [1967] HCA 48; (1967) 117 CLR 326, 330 per Barwick CJ.
  5. Note that in some cases, a statutory trust may arise under Australian financial services legislation, such as s 981H or s 1017E of the Corporations Act 2001 (Cth). That is a topic for another paper.
  6. See eg Salvo v New Tel Limited [2005] NSWCA 281 (Salvo) at [32]-[53] per Spigelman CJ; Legal Services Board v Gillespie-Jones (2013) 249 CLR 493 at [112]-[127] per Bell, Gageler and Keane JJ; Raulfs v Fishy Bite [2012] NSWCA 135, [44]-[55] per Campbell JA; See also Abandoning the Quistclose Trust in Insolvency, Balani R, (2021) 42(1) Adelaide Law Review 259, 263. Cf Salvo at [76]-[78] per Handley JA, McManus RE Pty Ltd v Ward (2009) 74 NSWLR 662 at [25] per Palmer J, Adam v Hasabo [2019] NSWSC 1167 at [252] per Robb J; Eumeralla Estate Pty Ltd v Chen [2022] VSCA 78.
  7. The original decision is Barclays Bank Ltd v Quistclose Investments Ltd [1970] AC 567.
  8. Nikitins (Liquidator) v EncoreFX (Australia) Pty Ltd (in liq)(No 2) [2021] FCA 27 (Nikitins v EncoreFX) at [100], citing Re Australian Elizabethan Theatre Trust; Lord v Commonwealth Bank of Australia (1991) 30 FCR 491 (Re Australian Elizabethan Theatre Trust), 502-503 per Gummow J.
  9. Prickly Bay Waterside Ltd v British American Insurance Company Ltd [2022] UKPC 8; [2022] 1 WLR 2087 (Prickly Bay) at [32] per Lady Arden, delivering the judgment of the Privy Council.
  10. Nikitins v EncoreFX at [100], citing Re Australian Elizabethan Theatre Trust at 503, Byrnes v Kendle [2011] HCA 26; (2011) 243 CLR 253 at [53]-[59] per Gummow and Hayne JJ.
  11. Re BBY Limited (Receivers and Managers Appointed)(in liq) [2022] NSWSC 29 (Re BBY Limited).
  12. Prickly Bay at [37].
  13. Prickly Bay at [47].
  14. Prickly Bay at [34]; Twinsectra Ltd v Yardley [2002] 2 AC 164 (Twinsectra v Yardley) at [73].
  15. Nikitins v EncoreFX at [101], citing Legal Services Commissioner v Brereton [2011] VSCA 241; (2011) 33 VR 126 at [96] per Tate JA, Nettle and Ashley JJA agreeing.
  16. Nikitins v EncoreFX at [101], citing George v Webb [2011] NSWSC 1608 at [211] per Ward J, and Twinsectra Ltd v Yardley at 185.
  17. See Re BBY Limited.
  18. Nikitins v EncoreFX at [102], citing Walker v Corboy (1990) 19 NSWLR 382, 397-398 per Meagher JA.
  19. Raulfs v Fishy Bite [2012] NSWCA 135 at [61] per Campbell JA, Meagher and Barrett JJA agreeing.
  20. Nikitins v EncoreFX at [103], citing Peter Cox Investments Pty Ltd (in liq) v International Air Transport Association [1999] FCA 27; 161 ALR 105 at [49] O’Loughlin J.
  21. Earth Civil Australia Pty Ltd, RCG CBD Pty Ltd, Bluemine Pty Ltd, Diamondwish Pty Ltd and Rackforce Pty Ltd (all in liq) [2021] NSWSC 966 at [2686] per Ward CJ in Eq. Note this principle applies to all express trusts, not only Quistclose trusts.
  22. Eumeralla Estate Pty Ltd v Chen [2022] VSCA 78 at [83(g)] per the plurality. This trust law principle is not exclusive to Quistclose trusts, however this was a Quistclose trust case.
  23. See Re BBY Limited.
  24. See Prickly Bay at [23].

Worldwide freezing orders – recent developments in Australia

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Three recent Australian judgments on freezing and ancillary disclosure orders, and their application to ‘worldwide’ (outside Australia) assets, are worth noting. The first is a High Court decision as to the courts’ discretion to compel disclosure of worldwide assets pursuant to freezing and ancillary orders, despite accepting a claim to the privilege against self-incrimination. The second is a decision of the Full Federal Court on the issue of a jurisdictional precondition for worldwide freezing orders to be made by the Federal Court. The High Court has granted special leave in this case and will be hearing the appeal tomorrow, 13 October 2021. The third is an illustrative Federal Court decision handed down last week, in which worldwide freezing orders were made.

Deputy Commissioner of Taxation v Shi [2021] HCA 22

In August the High Court (4:1 majority) upheld the Deputy Commissioner’s appeal over the proper construction and application of s 128A of the Evidence Act 1995 (Cth) and whether the taxpayer in that case could – and should be permitted to – decline to comply with an order to disclose his worldwide assets relying upon the s 128A privilege against self-incrimination

The Deputy Commissioner had obtained ex parte orders in the Federal Court freezing the worldwide assets of a Mr Zu Neng (Scott) Shi, up to the unencumbered value of $41,092,549.03. Mr Shi had been the head of a large labour hire business that supplied workers through various companies, to a number of abattoirs in Victoria and NSW. The Deputy Commissioner’s evidence in support of his application dealt with investigations relating to Mr Shi, his wife and his son by the ATO and the AFP, and allegations of asset stripping, phoenix activity and systematic non-payment of taxation liabilities as well as fraud and evasion (see [56]). The sum for which the freezing orders were sought and made was the total income tax, penalty and interest for which Mr Shi had been assessed. The freezing orders were made on the acceptance by the Court that that there was a risk that assets might be removed from Australia to the detriment of the Commonwealth (see [3]-[8] and [20] of the freezing order judgment). Ancillary orders required Mr Shi to disclose all of his worldwide assets including their value, location and details, and the extent of his interest in the assets (disclosure order) (see [14]). Five months after the freezing and disclosure orders were made, judgment for the debt alleged was entered for the Commissioner by consent against Mr Shi and other respondents with costs – see [1] of the first instance judgment.)

To pause here for a moment, in practical terms, a party against whom a freezing order with a disclosure order is made, who seeks to claim the privilege against self-incrimination, generally responds to the disclosure order by filing up to three affidavits: (1) an affidavit disclosing so much of the information ordered to be disclosed to which no objection is taken (disclosure affidavit), (2) an affidavit disclosing the information required to be disclosed to which objection is taken (privilege affidavit), and (3) a separate affidavit setting out the basis of the objection (objection affidavit). As to the latter two, pursuant to s 128A(2), the privilege affidavit is delivered to the Court in a sealed envelope, and the objection affidavit is filed and served on each other party.

At first instance in the Federal Court Steward J, as his Honour then was, was satisfied that there were reasonable grounds for Mr Shi’s objection to disclosure of his worldwide assets. In other words, Mr Shi had established his claim to privilege on the grounds that disclosure of his worldwide assets may tend to incriminate him. Under s 128A(5), subject to one matter, it would follow that the Court must not require the sealed privilege affidavit to be disclosed and must return it. However a discretion lies in the space between the Court concluding the objection has reasonable grounds, and it being wholly upheld, by virtue of s 128A(6). Once it concludes under s 128A(4) that the objection has reasonable grounds, the Court then turns to consider whether to exercise its discretion under s 128A(6) to require the disclosure of the whole or part of the privilege affidavit to the other parties in the interests of justice, despite the soundness of the objection taken.

The Court may require disclosure of the information under s 128A(6) if it is satisfied of three things. In this case, the Court had to be satisfied (a) that the information disclosed in the Privilege Affidavit may tend to prove that Mr Shi had committed an offence against or arising under an Australian law (it was), (b) that the information does not tend to prove that the person has commented an offence or is liable to civil penalty under a law of a foreign country (it was), and (c) that the interests of justice so required. If it was satisfied as to all three, the Court could exercise a discretion to order all or part of the information to be disclosed.

Steward J’s decision turned upon the third of these. His Honour held that, subject to one matter, the interests of justice did favour disclosure. However his Honour considered that he was entitled to have regard to the consequences of the issue of a s 128A(7) certificate. This would mean that much of the information disclosed would not be able to be used against Mr Shi in any Australian court under s 128A(8), which would impact any future criminal proceedings as well as any future tax appeal. Steward J considered it was open to the Commissioner to exercise the powers under s 353-10 of Sch 1 to the Taxation Administration Act to obtain the same information without the ability of Mr Shi to refuse production on the grounds of self-incrimination. (see [61]) His Honour declined to order disclosure, essentially because in his view the public interest would be better served by the Commissioner obtaining the information via different means. The High Court majority held that this was an irrelevant consideration to take into account in failing to be satisfied for the purpose of s 128A(6)(c). (see [11] and [68]) The Full Federal Court had also so held. (see [62])

On appeal, the Full Court held that the interests of justice did not require disclosure of the privilege affidavit to the Commissioner, but for a different reason than at first instance. Their Honours so held on the basis that because judgment had already been entered for the Commissioner for the sum sought to be recovered, disclosure of the information was sought solely for the purpose of assisting methods of execution. This meant it was relevant to consider whether there were other available ways that execution could be assisted, including the Commissioner’s ability to examine Mr Shi as a judgment debtor under s 108 of the Civil Procedure Act 2005 (NSW). (see [62]) Lee J had also identified a risk of derivative use of the information disclosed despite ss 128A(7) and (8). Like the primary judge, but for different reasons, their Honours also declined to exercise their discretion to order disclosure.

The High Court upheld the Deputy Commissioner’s appeal, holding that these matters too were irrelevant considerations (see [11] and [68]-[69]). As to the risk of derivative use raised by Lee J, Gordon J observed that this was contrary to the proper construction of s 128A, and was addressed by a number of measures: the certificate procedure in s 128A(7), the non-derivative use prescribed in s 129A(8), the Harman undertaking; the ability of the Court to craft the form of orders made under s 128A(6) including requiring only part of the information to be disclosed, suppression or non-publication orders could be made under s 37AF of the Federal Court of Australia Act 1976 (Cth) requiring the information not be provided or disclosed to anyone other than identified persons. (see [69])

The negative proposition in s 128A(6)(b)

I pause here to address an aspect of this case worth noting, which highlights the significance for a respondent to a disclosure order in taking and establishing the claim to privilege under s 128A(2)(e) in the objection affidavit; in particular, making it clear that the respondent is objecting on the basis of a risk of incrimination as to an Australian criminal or civil penalty law, a foreign criminal or civil penalty law, or both (and providing adequate evidence as to the legal and factual foundation for that objection).

The issue arises from the negative proposition of which the Court must be satisfied under s 128A(6)(b) before it is able to exercise the discretion, a matter raised by Mr Shi in his notice of contention. That proposition is, essentially, that the information in the privilege affidavit does not tend to expose Mr Shi to criminal or civil penalty liability in a foreign country. Mr Shi submitted to the High Court that once the Full Court majority had found that the onus was on the Commissioner to satisfy the Court of that matter, it should have found that it was not open to the primary judge to be satisfied of this negative proposition. (see [64])

However Gordon J noted that under s 128A(2), it had been open to Mr Shi to object to disclosure on the grounds of the risk of incrimination as to either Australian laws or foreign laws. Mr Shi did not object with reference to his exposure to incrimination for criminal or civil liability under a foreign law. His objection had been only based upon potential incrimination under Australian law. At best, her Honour noted, Mr Shi’s solicitor and counsel had made a bare general assertion that disclosure may tend to prove the commission of an offence against a law of a foreign country. However the objection was not taken on that ground, and bare assertion by counsel was not sufficient for s 128A(2). (see [65]) Her Honour concluded that a failure to object on the grounds of foreign law meant that the question raised by s 128A(6)(b) does not arise. (see [67])

The plurality also found that Mr Shi did not take the objection based upon a tendency of the information to incriminate him for a crime or civil penalty under any Chinese law, nor did he lead any evidence capable of establishing such a tendency. However rather than concluding that the question raised by s 128A(6)(b) did not arise, their Honours concluded that the omission of such a basis for objection pursuant to s 128A(2)(e) is a sufficient evidentiary foundation for the Court, in the absence of evidence to the contrary, to be satisfied of the negative proposition in s 128A(6)(b). (see [9]-[10])

Hence the plurality and Gordon J took different paths, but arrived at the same destination. Whether or not the requirement for the Court to be satisfied of the negative proposition in s 128A(6)(b) arose here, this was no impediment in this case. The discretion to compel disclosure could properly be exercised pursuant to s 128A(6) if the interests of justice so required (and, it was held, they did). Edelman J, in dissent, disagreed, taking the view that s 128A(6)(b) placed an onus upon the Deputy Commissioner to negate Mr Shi’s prima facie entitlement to the privilege, which was not done. (see [77]-[78] and surrounding passages)

On the question of onus as to the matters set out in s 128A(6)(a) and (b), Gordon J held that it is for the party claiming the objection to set out the basis for the objection pursuant to s 128A(2) and (4). Sections 128A(6)(a) and (b) do not impose a standard or burden on that party additional to or higher than that imposed by s 128A(2) and (4). The premise that the onus is on the party seeking disclosure to satisfy the court of the matters in s 128A(6)(a) and (b) is contrary to the proper construction of s 128A. (see [70]) Edelman J in dissent disagreed, taking the view that it was for the party seeking to abrogate the privilege to satisfy the Court to exercise its discretion under s 128A(6) to strip the person of that privilege. (see [102]) Whilst generally agreeing with the views of Gordon J, the plurality did not address the issue of onus specifically.

The plurality make the point in obiter at [8] that if the person claiming the privilege based their objection to disclosure on the ground that it might incriminate them as to a criminal offence or penalty under a foreign law and if the Court was satisfied that there were reasonable grounds for the objection pursuant to s 128A(4), this would necessarily mean that the Could could not at the same time be satisfied of the negative proposition in s 128A(6)(b). This is an important point. It means that if the objection is taken based upon self-incrimination as to a foreign law, and the Court is satisfied on the material that there are reasonable grounds for the objection, then the Court cannot compel disclosure in the interests of justice. The discretion does not arise.

The interests of justice – s 128A(6)(c)

On the issue of the proper application of s 128A(6((c), and the matters properly to be considered by the Courts, the plurality Kiefel CJ, Gageler and Gleeson JJ observed –

“Evaluation of the interests of justice for the purpose of s 128A(6)(c) is informed primarily by balancing the public interest in the person to whom the extant disclosure order is directed complying with that disclosure order by disclosing information to the party to the civil proceeding in whose favour the order has been made, against the potential detriment to the person that arises from the tendency of the information to prove that the person has committed an offence against or arising under, or is liable to a civil penalty under, an Australian law. A court assessing that potential detriment must obviously take into account the prohibition in s 128A(8) on derivative use of the information disclosed. As recognised by the primary judge, and as explained by Gordon J, a court assessing that potential detriment must also take account of constraints on the use and dissemination of the disclosed information that arise within the context of the civil proceeding in which the disclosure order has been made. Those constraints include the obligation of the party to whom disclosure is made, and of any other person to whom the disclosed information might be given, not to make any use of the information other than for the purpose of the civil proceeding without leave of the court. they include too the availability of orders restricting the dissemination of the disclosed information, relevantly under s 37AF of the Federal Court of Australia Act 1976 (Cth).”

Huang v Deputy Commissioner of Taxation [2020] FCAFC 141; 280 FCR 160

In this case, the taxpayer Mr Changran Huang successfully appealed the making of worldwide freezing orders against him and an ancillary order as to the disclose of information (asset disclosure order) only insofar as it applied to assets outside Australia. Mr Huang had substantial assets in China and Hong Kong.

The freezing orders had applied to assets held by Mr Huang in Australia to the unencumbered value of over $140million as well as to assets outside Australia. Mr Huang challenged the extension of the freezing and ancillary (disclosure) orders to assets outside Australia, submitting that foreign revenue laws would not be enforced either directly or indirectly in China or Hong Kong. The Deputy Commissioner’s own case was that enforcement of a judgment against Mr Huang in Hong Kong or China “is not likely” (see [23]-[24] and [34]) although she submitted that the evidence did not establish that enforcement in China or Hong Kong or elsewhere in the world was impossible. (see [25])

The plurality, Besanko, Thawley and Stewart JJ, observed that the purpose of a freezing order as identified in r 7.32 of the Federal Court Rules 2011 (Cth) is the prevention of the frustration or inhibition of the Court’s process by seeking to meet a danger that a judgment or prospective judgment of the Court will be wholly or partly unsatisfied. A freezing order is no doubt an important weapon in the Court’s arsenal, but it must not be used for a purpose beyond that identified in r 7.32. (see [41]) If assets are beyond the reach of the Court’s enforcement processes, then a freezing order with respect to those assets is not for the purpose identified in r 7.32 because there is no longer a realistic possibility that the removal or disposition of the assets will frustrate or inhibit the Court’s process such that a judgment or prospective judgment will be wholly or partly unsatisfied. (see [42])

Their Honours accepted that the primary judge had applied an incorrect test, as to whether it was “not impossible” that the Deputy Commissioner may be able to take enforcement action against Mr Huang in China or Hong Kong. Their Honours held that a realistic possibility of enforcement in a foreign State is necessary. That is, there must be a realistic possibility that any judgment obtained by the plaintiff can be enforced against assets of the defendant in the place to which the proposed order relates. A test of a ‘realistic possibility’ is consistent with the approach taken by the courts in determining what must be shown in terms of the risk of the removal of assets or the disposal of assets, matters to which a freezing order is directed. (see [43] and [47]) Their Honours sought to make clear at [47] –

“At the same time, and at the risk of stating the obvious, we wish to make it clear that we are not laying down any general principle as to the evidence which will be necessary to satisfy that test. Each case is likely to turn on all its circumstances and the cogency of the evidence and the inferences which can be drawn from it.”

Their Honours then applied the test and concluded that none of the matters relied on by the primary judge, either individually or collectively, provided a basis for a conclusion that enforcement of a judgment in China or Hong Kong was a realistic possibility. (see [49] et seq) Those matters were –

  1. That there were exceptions to the presumption in Damberg v Damberg, the presumption that foreign law is the same as Australian law where a party with the onus fails to prove the content of foreign law. No particular exceptions were identified as possibly applicable. The law applied by the courts in this country will not countenance a claim by a foreign government, directly or indirectly, for the enforcement of a foreign revenue debt. (see [51]-[56])
  2. The potential use of bankruptcy procedures, the recognition of which in Hong Kong may be unaffected by the foreign revenue rule. The latter part of that proposition was doubted by the Court, where this would constitute indirect enforcement of a foreign revenue debt. (see [57]-[58])
  3. The potential willingness of the courts of Hong Kong and China to enforce Australian insolvency laws. Same point. (see [59])
  4. The possibility of Mr Huang moving assets to other jurisdictions where enforcement is readily available. There was no evidence of a threat to do this, and it was a theoretical possibility. Their Honours did not consider this could be a basis for an order restraining the disposition or diminution of assets in jurisdictions where enforcement was not a realistic possibility. (see [60])
  5. The potential willingness of the courts of China and Hong Kong to enforce Australian laws relating to the payments of penalties and interest. However these follow from the tax which is owed by reason of Australian revenue laws and arise by reason of those laws. Their Honours’ view was that it was not open to the Deputy Commissioner to argue that penalties and interest may not fall within China and Hong Kong’s reservations in the Convention on Mutual Administrative Assistance in Tax Matters in light of her failure to adduce evidence of the Convention in accordance with s 174 of the Evidence Act 1995 (Cth). In any event, in their Honours’ view penalties and interest are within the rule against the enforcement of the revenue laws of a foreign State. (see [61])

Their Honours concluded there was no realistic possibility that the Deputy Commissioners’ judgment debt would be enforceable in China or Hong Kong. (see [62]) The appeal was allowed.

On 11 February 2021, the High Court granted special leave to the Deputy Commissioner to appeal this decision. The Deputy Commissioner has submitted that the appeal is on the issue of whether the power of the Federal Court to grant a freezing order is subject to a mandatory jurisdictional precondition that there be proof of a realistic possibility of enforcement of a judgment debt against assets of the respondent in each foreign jurisdiction to which the proposed freezing order relates. The Deputy Commissioner submits that the Full Court was wrong to construe r 7.32 of the Federal Court Rules 2011 (Cth) as being subject to an unexpressed mandatory jurisdictional precondition to this effect. Difficulties of enforcement may be a permissible discretionary consideration in an application to discharge a freezing order previously made, weighed with other relevant discretionary considerations. However it ought not be a mandatory evidentiary requirement operating as a precondition to the power to grant or continue any freezing order, noting that worldwide freezing orders are frequently sought ex parte in urgent circumstances. (The DCOT’s submissions may be read here. Those for Mr Huang may be read here.) The appeal is due to be heard tomorrow 13 October 2021.

Rambaldi (Trustee) v Sumpton, in the matter of the Bankrupt Estate of Sumpton [2021] FCA 1199

In this case the Trustees in Bankruptcy of Mr Robert Sumpton had sought orders for the transfer of shares in Conecc Concrete Solutions Private Ltd, a foreign company located in India. The Bankrupt had failed to disclose his interest in these shares to the Trustees, which is an offence under s 265 of the Bankruptcy Act which may result in a maximum penalty of one year’s imprisonment.

The Trustees brought an ex parte application for freezing and ancillary (asset disclosure) orders, to reduce the risk of dissipation of those assets and preserve the Trustees’ interest in those shares for the benefit of the creditors of Mr Sumpton’s bankrupt estate. Anderson J agreed that the CCS shares fell within the description of property which vests in the Trustees following Mr Sumpton’s bankruptcy, having regard to ss 5, 58(1) and 116(1) of the Bankruptcy Act.

Applying the key principles governing freezing order applications (summarised briefly at [9]-[15]), one of the matters the Trustees needed to show was that unless the freezing order were granted, there was a reasonable apprehension that assets would be dissipated so as to frustrate the action or execution. They did not need to demonstrate a positive intention on Mr Sumpton’s part to frustrate a judgment, nor did they need to demonstrate that the risk of dissipation was more probable than not. It was enough for the Trustees to establish that, in the absence of relief, there was a danger or real risk that the assets would be dealt with in a way that would prevent them from recovering judgment.

Where allegations made against a respondent contain allegations of serious dishonesty, evidence of that nature is capable of satisfying the Court of the existence of the requisite danger to dispose of, deal with or dissipate assets: Spotlight Pty Ltd v Mehta [2019] FCA 1796 at [23]. In this regard the Trustees pointed to Mr Sumpton’s failure to disclose the shares, and that this was an offence punishable by imprisonment.

The Trustees submitted that their concern that if a freezing order is not made that their attempts to realise their interest in the CCS shares may be prevented by Mr Sumpton seeking to transfer them away without recourse to the Trustees, was based on the following matters –

  1. Mr Sumpton had failed to lodge his tax returns for the past 3 years.
  2. There had been no disclosure by Mr Sumpton of his shareholding in CCS.
  3. Mr Sumpton’s failure to provide further information in relation to his examinable affairs and answer questions in relation to his property interests.
  4. The difficulties for the Trustees in realising their interest in, and taking transmission of, the CCS shares.

The Trustees submitted that it was necessary for them to obtain a court order in the form of a ‘freezing order’, before engaging with CCS, so that they were able to engage with CCS in respect of realising the shares issued to Mr Sumpton which had vested in them as trustees of his bankrupt estate. (see [24])

His Honour noted that the Trustees sought a worldwide freezing order out of an abundance of caution in circumstances where the CCS shares relate to an Indian company. As Mr Sumpton is located in Australia and is an undischarged bankrupt, all of his assets whether local or intentional vested in the Trustees. The Trustees did not foresee any issue in effecting the transfer of the CCS shares once Mr Sumpton executed the necessary documentation.(see [27])

Anderson J referred to the pending High Court appeal from the decision in Huang v Deputy Commissioner of Taxation [2020] FCAFC 141; 280 FCR 160, and noted that there is an issue as to whether it is a jurisdictional precondition to the granting of a freezing order with respect to overseas assets, that there be a realistic possibility that any judgment obtained by the applicant can be enforced against assets of the defendant in the place to which the proposed order relates. However his Honour concluded that to the extent that the jurisdictional precondition applies, the Trustees anticipate that they will be able to obtain the transfer of the CCS shares once Mr Sumpton executes the necessary documents, or alternatively, they will be able to obtain a transfer based on the provisions of the Articles of Association and the Indian Companies Act. (see [28]-[29])

His Honour was satisfied that it was appropriate to make the freezing order in the terms sought.

Conclusion – Takeaways

On the issues dealt with in these decisions, the takeaways are these –

  1. What informs the courts’ discretion to compel disclosure of worldwide assets in the interests of justice, despite accepting the soundness of a claim to privilege against self-incrimination – The High Court in DCOT v Shi has clarified what is and is not relevant to the “interests of justice” assessment to be made by the courts under s 128A(6)(c). Evaluation of the interests of justice in each case will primarily involve weighing the balance between the public interest in the disclosure sought on the one hand, against the potential detriment of the tendency of the disclosure to incriminate a person under an Australian law on the other. It is irrelevant to consider other means the plaintiff may have for obtaining the information sought. If the courts are inclined to order disclosure notwithstanding the reasonable grounds for the claim to privilege, they will give consideration to whether to order disclosure to the whole or only part of the privilege affidavit, and what other orders ought be made to minimise the detrimental impact of the disclosure on the respondent.
  2. Who bears the onus relevant to the exercise of the discretion – The question of onus as to the matters to be established for the discretion to arise – those at ss 128A(6(a) and (b) – is not clearly settled. It may be likely that Gordon J’s view on this will be treated as authoritative, given the alignment of her Honour’s judgment with that of the plurality. That is: that the onus is not on the party seeking the disclosure, which would be contrary to the proper construction of s 128A. It is for the party claiming the objection to set out the basis for the objection pursuant to s 128A(2) and (4). Sections 128A(6)(a) and (b) do not impose a standard or burden on that party additional to or higher than that imposed by s 128A(2) and (4). (see DCOT v Shi [70])
  3. The discretion to compel disclosure despite the privilege is only available where the tendency to incriminate relates to Australian law – Where the party claiming the objection bases their objection on the risk of incrimination as to a foreign criminal or civil penalty law – and if that objection is accepted by the Court as based on reasonable grounds – the discretion to compel disclosure under s 128A(6) in the interests of justice is not available. This follows from the conclusion of the plurality in obiter that in those circumstances, the Court will be unable to be satisfied as to the negative proposition in s 128A(6)(b): the plurality in DCOT v Shi at [8].
  4. Is there a mandatory jurisdictional precondition to the making of worldwide freezing orders under the Federal Court Rules – High Court decision pending – The Full Federal Court has held in Huang v Deputy Commissioner of Taxation that there must be a ‘realistic possibility’ that any judgment obtained by the plaintiff can be enforced against assets of the defendant in the place to which the proposed order relates, for a worldwide freezing order to be made in Australia pursuant to r 7.32 of the Federal Court Rules. The High Court will hear the Deputy Commissioner’s appeal on this tomorrow, 13 October 2021. We await the High Court’s judgment with interest.

Statutory demands – setting aside under s 459G – what is a ‘genuine’ dispute or offsetting claim?

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When a company is served with a statutory demand it may apply to Court to set it aside under s 459G Corporations Act 2001 (Cth) (see also s 459J). Where the ground for the application is that the company disputes that it owes the debt, or has an offsetting claim, s 459H requires that this be genuine (see s 459H(1) and the definition of ‘off-setting’ claim in s 459H(5)). So – when will an alleged dispute or off-setting claim be accepted as genuine? Or what should be pointed to as demonstrating that it is not?

Practitioners will in some cases quickly form a preliminary view on this based upon the old ‘smacks of recent invention’ hallmark. Certainly that preliminary view may be borne out on closer examination, as was the case in a Court of Appeal decision in which I appeared some years ago – Rescom Asia Pacific v Reapfield Property Consultants Pty Ltd [2014] VSCA 92. However there is of course more to it than that. Often a fair amount of evidence is filed, which must be addressed by the parties and considered by the Courts in making a determination. Hence it is worth having regard to the principles that govern this issue.

Principles – ‘genuine’

The principles to be applied in applications to set aside statutory demands are well settled, though they are sometimes restated or collected together in different ways or with different emphases in the authorities. On this particular issue / element, my distillation of the key principles are as follows:

To be accepted as ‘genuine’[1] a dispute or offsetting claim must be shown to be both real, have some merit, and be plausible,[2] as well as authentic, not spurious or artificial or have been ‘manufactured or got up’.[3] In summary – 

  1. “The threshold is not high or demanding; a genuine dispute means there must be a plausible contention requiring investigation; and it is only if the applicant’s contentions are so devoid of substance that no further investigation is warranted that the applicant will fail. The court is not called on to determine the merits of, or to resolve, the dispute.”[4] The essential task is relatively simple – to identify the genuine level of a claim (not the likely result of it) and to identify the genuine level of an offsetting claim (not the likely result of it).[5]
  2. “This does not mean that the court must accept uncritically as giving rise to a genuine dispute, every statement in an affidavit ‘however equivocal, lacking in precision, inconsistent with undisputed contemporary documents or other statements by the same deponent, or inherently improbable in itself, it may be’ not having ‘sufficient prima facie plausibility to merit further investigation as to [its] truth’.”[6]
  3. The questions for the Court have been identified as: “whether there is such a dispute and, if there is, whether it is genuine.” [7]
  4. “The claim must not be spurious or artificial, or have been ‘manufactured or got up simply for the purpose of defeating the demand made against the company’.”[8] “If the dispute is of that quality and is accordingly not advanced in good faith, it is not ‘genuine’.”[9]
  5. “[T]he court must decide whether the grounds of dispute delineated by the affidavit are grounds which, when viewed in the whole of the circumstances emerging from the evidence, indicate a plausible defence propounded in good faith and not one merely constructed in response to the pressure represented by the statutory demand.”[10]
  6. “Where an applicant to set aside a statutory demand contends for the existence of an offsetting claim it bears the onus of establishing that it is genuine in the sense of being authentic or bona fide, and real, not spurious, and not frivolous or vexatious.”[11]

In terms of the evidential burden and onus on the applicant – 

  1. “In order for [an alleged claim] to be genuine, there must be sufficient factual material to support the essential elements that go to make up that claim.”[12]
  2. “…the onus rest[s] on the [applicant] to provide a sufficient account of its dealings…to raise a genuine dispute and take the matter beyond mere assertion.”[13] 

Case Study

In Alpine Valley Flour Mill Pty Ltd v Grainlink (NSW) Pty Ltd [2020] VSC 85, Alpine Valley applied under s 459G (engaging s 459H and 459J) to set aside a statutory demand for just under $160,000 served on it by Grainlink in 2019 for unpaid invoices for grain supplied in 2018. The two companies had been trading since 2013.

Alpine Valley alleged an offsetting claim due to the alleged presence of weevils its customers had found in grain Alpine Valley had supplied to them, which it had acquired from Grainlink. Alpine Valley contended the grain was contaminated with weevil larvae at the time it was supplied by Grainlink, which had made the grain adulterated and unfit for purpose, causing Alpine Valley loss and damage. Alpine Valley estimated the value of that offsetting claim as almost $228,000, exceeding the amount of the statutory demand. (see [6]-[7],[23], [30])

Grainlink gave evidence as to is rigorous treatment and testing procedures for eliminating weevil and larvae from all grain (see [65]). Grainlink argued that Alpine Valley’s alleged offsetting claim was unsupported by probative evidence and was spurious (see [9] and [133]). Whilst Alpine Valley alleged that weevils had been a ‘constant issue’ (see [29]), Grainlink pointed out that the first time any issue was raised with them was when Alpine Valley filed its application to set aside the statutory demand in 2019 (see [132]).

Gardiner AsJ held that the offsetting claim was not genuine, based on the fact that the claim was only made after service of the demand, and was preceded by numerous promises to pay, with the reasons proffered for non-payment being cashflow problems and the internal turmoil within the company (the directors were in dispute). His Honour found that the alleged offsetting claim was not genuine, rather, it was spurious and had been ‘got up’ as an attempted means to defeat Grainlink’s demand. The application was dismissed. (see [148])

In particular, Gardiner AsJ found that the following features of the dealings between the parties in this case were ‘particularly powerful’ in convincing him that Alpine Valley’s alleged offsetting claim was not genuine (see [146]) –

  1. There was no notification of any kind by Alpine Valley of its alleged offsetting claim to Grainlink until it first served its material to set aside the statutory demand.
  2. There was evidence that Alpine Valley’s customers had received contaminated product from Alpine Valley. There were no contemporaneous documents generated by Alpine Valley connecting any of those complaints with Grainlink.
  3. Even if Alpine Valley had demonstrated that it had a genuine and arguable claim that Grainlink was responsible for the contaminated product, which his Honour found it had not, there was insufficient evidence to support the quantification of loss Alpine Valley claimed to have suffered as a result.
  4. Alpine Valley now claimed that throughout the trading period there was an endemic problem with weevil infestation in the grain. However Alpine Valley had paid all of Grainlink’s invoices between July 2013 and July 2018 without complaint.
  5. In December 2018, when Grainlink was pressing for payment of its invoices and any alleged claim would have been known to Alpine Valley, it simply conceded the amounts were overdue and a payment plan would be implemented.
  6. In January 2019 when Grainlink followed up, Alpine Valley responded that they hoped to pay $10,000 or $20,000 by the end of the month and hopefully a larger amount the following month.
  7. Grainlink then passed the matter to is collection agency. If Alpine Valley genuinely considered it had an offsetting claim, it would have raised it in its communications with the agency, and would not have been making promises to pay the debt in full.
  8. On 16 May 2019 shortly before the issue of the statutory demand, Alpine Valley made a payment of $10,000. Alpine Valley never explained why it would do so if it had a belief it had a genuine offsetting claim for a greater amount than it owed Grainlink.
  9. The age of the alleged offsetting claims, now said to have arisen throughout the trading period, was implausible.

While it is often said that the bar is not high or demanding in applications to set aside statutory demands, it still must be cleared. That an alleged dispute or off-setting claim is ‘genuine’ must be shown. In assessing the evidence, what the contemporaneous documents do – and do not – show will always be significant. For another recent example of a case involving promises to pay made without mentioning offsetting claims later raised to support an application to set aside a statutory demand, see Re CMG Automotive Pty Ltd [2020] VSC 779 – see [161], [164], [174].

[1] Within the meaning of s 459H(1) and (5).

[2] See quotes from authorities drawn together in Viva Olives Pty Ltd v Origin Olives Australasia Pty Ltd [2012] FCA 545 at [7] per Perram J; See also Abadeen Group Pty Ltd v Bluestone Property Services Pty Ltd [2011] NSWSC 137 at [33] per Ball J and the authorities there cited.

[3] See below.

[4] SGR Pastoral Pty Ltd v Christensen [2019] QSC 229 per Bowskill J, citing Citation Resources Ltd v IBT Holdings Pty Ltd [2016] FCA 1265; (2016) 116 ACSR 274 at [17] per McKerracher J.

[5] Re Morris Catering (Australia) Pty Ltd (1993) 11 ACSR 601, 605 per Thomas J; cited with approval in In the matter of Essential Media and Entertainment Pty Ltd [2020] NSWSC 990 at [81] per Rees J.

[6] Eyota Pty Ltd v Hanave Pty Ltd (1994) 12 ACSR 785, 787 per McLelland CJ in Eq, oft-cited and applied, as for example in Grandview Ausbuilder Pty Ltd v Budget Demolitions Pty Ltd [2019] NSWCA 60 at [63] per Bell P.

[7] Viva Olives Pty Ltd v Origin Olives Australasia Pty Ltd [2012] FCA 545 at [8] per Perram J.

[8] SGR Pastoral at [52], quoting from JJMR Pty Ltd v LG International Corp [2003] QCA 519 at [18]; See also the citing of the ‘must not have been manufactured or got up’ principle from JJMR Pty Ltd in: Brandon Industries (Vic) Pty Ltd v Locker Pty Ltd [2016] VSC 373 at [150] and Alpine Valley Flour Mill Pty Ltd v Grainlink (NSW) Pty Ltd [2020] VSC 85 at [17].

[9] Grandview Ausbuilder Pty Ltd v Budget Demolitions Pty Ltd [2019] NSWCA 60 at [95] per White JA, quoting from Creata (Aust) Pty Ltd v Faull [2017] NSWCA 300; 125 ACSR 212 at [47] per Barrett AJA.

[10] Ligon 158 Pty Ltd v Huber [2016] NSWCA 330 at [10] per Barrett AJA, McColl and Meagher JJA agreeing.

[11] Alpine Valley Flour Mill Pty Ltd v Grainlink (NSW) Pty Ltd [2020] VSC 85 at [15] per Gardiner AsJ.

[12] Abadeen Group Pty Ltd v Bluestone Property Services Pty Ltd [2011] NSWSC 137 at [40] per Ball J.

[13] Bendigo and Adelaide Bank Ltd v Pekell Delaire Holdings Pty Ltd [2017] VSCA 51 at [78], citing Eyota Pty Ltd v Hanave Pty Ltd (1994) 12 ACSR 785 at 787 (McLellan CJ in Eq), TR Administration Pty Ltd v Frank Marchetti & Sons Pty Ltd [2008] VSCA 70; (2008) 66 ACSR 67 at [71] (Dodds-Streeton JA,Neave and Kellam JJA agreeing).

New article – Full Federal Court in COT v Lane – bankrupt trading trustees and statutory priorities, the principle of ‘hotchpot’, and the treatment of preference recoveries of payments of trust money

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I have added a new article to my website reviewing an important decision of the Full Federal Court handed down in November 2020, addressing 3 key questions that arose at the intersection of trust law and bankruptcy law – Commissioner of Taxation v Lane [2020] FCAFC 184 (COT v Lane). Some were similar to those which arise in the context of corporate insolvency law, and were addressed in recent years by the High Court in Carter Holt/Amerind and the Full Federal Court in Jones/Killarnee. The full article can be accessed here.

Breaking news – Treasury unveils new SME insolvency reforms (overnight – twice)

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In an extraordinarily unheralded development, it has been reported that overnight Treasury issued a press release to major publications – then retracted it until midnight. It has announced significant planned reforms, primarily a new SME restructuring mechanism to catch the wave of insolvencies projected to hit in 2021 when the current pandemic-linked protections end. It is a debtor-in-possession model which adopts aspects of the US Chapter 11 bankruptcy process. The laws are intended to be passed in the coming months so that they take effect from 1 January 2021.

Key elements include –

  • To be eligible, companies must have liabilities of less than $1million
  • They will be able to keep trading while they develop a debt restructuring plan
  • They will engage a specialist “small business restructuring practitioner” (SBRP) to help them prepare the plan, certify the plan to creditors, and oversee disbursements once the plan is in place
  • They will have 20 business days to develop the plan, during which there is a moratorium on unsecured and some secured creditors taking action against the company
  • As noted above, the SBRP “certifies” whether she/he considers the business can meet the proposed repayments and has properly disclosed its affairs (Note: this element could be significantly problematic. It will only be an opinion, and one that relies upon the information provided to the SBRP by those running the business. But it may be understood by creditors to be akin to a guarantee)
  • Creditors will then have 15 business days to vote on the plan, including the remuneration of the insolvency practitioner to deliver on the plan
  • Employee entitlements that are due and payable will be required to be paid in full before the plan is voted on by creditors (Note: this may exclude many failing SME’s from using this model)
  • It will require a vote of more than 50% of creditors by value to approve the plan
  • Related party creditors will be prohibited from voting on the plan
  • There will be a streamlined liquidation process for companies that cannot be revived

The announcement was made without consultation with industry (what could possibly go wrong?) It is hoped this will take place now. Whilst the aspirations are understandable, commentators are already pointing out the problems and risks with the proposed new model.

The Treasurer is expected to announce more detail later today.

In the meantime, Treasury has released a fact sheet with Q&A and case study – see here.

Bankrupt trustees – High Court pronounces on what “property of the bankrupt” vests in the trustee in bankruptcy where property had been held on trust

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In a last Amerind-tinged gift before Christmas, the High Court has today handed down another judgment on an issue which lies at the intersection between insolvency law and trust law, although this time in the bankruptcy context. It is the latest in a string of unfolding legal developments at this intersection, including the High Court’s decision in June in Amerind and the Full Federal Court’s decision last year in Killarnee. (For more in relation to those decisions see here (Amerind) and here (Killarnee).)

In this case the High Court unanimously dismissed an appeal from the Full  Federal Court concerning whether property held by a bankrupt on trust for another vests in the bankrupt’s trustee in bankruptcy under s 58 of the Bankruptcy Act 1966 (Cth). The decision – which stems from a bankruptcy which has been before the Courts more than once – is Boensch v Pascoe [2019] HCA 49.

The case arose from a claim by the bankrupt Mr Boensch for compensation under s 74P(1) of the Real Property Act 1900 (NSW) on the basis that his trustee in bankruptcy Mr Scott Pascoe had lodged, and later refused or failed to withdraw, a caveat without reasonable cause. Mr Boensch’s claim for compensation was unsuccessful at each stage.

To give you a snapshot of the principles and reasoning on the key issue –

  1. Upon a person becoming bankrupt, section 58 of the Bankruptcy Act vests “property of the bankrupt” in the trustee of the estate of the bankrupt.
  2. The “property of the bankrupt” includes real or personal property and any estate or interest in real or personal property belonging to the person at the time of bankruptcy and divisible among the bankrupt’s creditors:  s 5(1) of the Bankruptcy Act (definitions of “property” and “the property of the bankrupt”).
  3. Excluded from the “property of the bankrupt” which vests in the trustee in bankruptcy is property held in trust by the bankrupt for another person: s 116(2)(a) of the Bankruptcy Act.
  4. It was settled in Octavo that where a person who is a trustee becomes bankrupt, and he/she has incurred liabilities in the performance of the trust, that person’s right to be indemnified out of trust property gives rise to an equitable interest in the property held on trust. This takes that property outside the exclusion in s 116(2)(a), on the basis that the exclusion is limited to property held by the bankrupt solely in trust for another person:  [2] per Kiefel CJ, Gageler and Keane JJ.
  5. The bankrupt’s entitlement in equity to be indemnified out of the trust property, giving rise to the equitable interest in the property, is property belonging to the bankrupt that is divisible among the bankrupt’s creditors. The right of indemnity is therefore property that vests in the trustee in bankruptcy:  [2] per Kiefel CJ, Gageler and Keane JJ.
  6. Octavo left open the question of whether the legal estate in the property held on trust by the bankrupt also vests in the bankruptcy trustee, where the bankrupt as trustee held a right of indemnity. This is part of the more general question of whether the legal estate in property held on trust by a bankrupt in which the bankrupt has an equitable interest vests in the bankruptcy trustee: [3] per Kiefel CJ, Gageler and Keane JJ.
  7. The more general question was substantially answered in Carter Holt Harvey Woodproducts Australia Pty Ltd v The Commonwealth (Amerind):  [3] per Kiefel CJ, Gageler and Keane JJ.
  8. The short answer is yes it does. Under the Bankruptcy Act, where a trustee has no beneficial interest, the legal estate does not pass; but where he has, it does pass: [4] per Kiefel CJ, Gageler and Keane JJ, quoting with approval from Sir George Jessel MR in Morgan v Swansea Urban Sanitary Authority (1878) 9 Ch D 582 at 585. (However note that where, as here, the trust property is real estate, then pending registration on title, what is vested in the bankruptcy trustee by s 58(2) is the equitable estate: [5] per Kiefel CJ, Gageler and Keane JJ; [94] per Bell, Nettle, Gordon and Edelman JJ.)
  9. This answer is informed by a recognition of two things: (1) the fundamental nature of an equitable interest as something that “is not carved out of a legal estate but impressed upon it“; and (2) consistency with the objects of the Bankruptcy Act that the bankruptcy trustee automatically obtains the legal estate in property held by the bankrupt in which the bankrupt has an equitable interest in order better to secure the realisation of that equitable interest for the benefit of creditors: [4] per Kiefel CJ, Gageler and Keane JJ.

Their Honours held here that by reason of his having an entitlement to indemnification out of the trust property, the bankrupt Mr Boensch had an equitable interest in the Rydalmere property which subsisted at the time of his bankruptcy. It followed that that equitable interest, and with it the equitable estate in the Rydalmere property, vested in Mr Pascoe as the trustee in bankruptcy of the estate of Mr Boensch. The equitable estate so vested in Mr Boensch was a caveatable interest:  [10]-[11] per Kiefel CJ, Gageler and Keane JJ.

Interestingly, the High Court decided this issue in the absence of a determination by the primary judge and the Full Court on the question of whether the bankrupt held a right of indemnity against the trust property, although the question was raised by the pleadings of the trustee in bankruptcy Mr Pascoe. Both judgments discuss this matter.

Takeaways

Broadly, where a bankrupt held property as a trustee and had a right of indemnity in the trust assets, the property will vest in the bankruptcy trustee, subject to the trust: [93] per Bell, Nettle, Gordon and Edelman JJ.

However where a bankrupt held property on trust for another but held no interest in the property at all, whether vested or contingent, and no matter how remote, that property will not vest in the bankruptcy’s trustee upon bankruptcy: [87] per Bell, Nettle, Gordon and Edelman JJ.

To put it this way, at [92] their Honours Bell, Nettle, Gordon and Edelman JJ quoted with approval from Farwell LJ in Governors of St Thomas’s Hospital v Richardson [1910] 1 KB 271 at 284 –

The property of the bankrupt does not include property held by the bankrupt on trust for any other person. But it does include property held by the bankrupt on any trust for his own benefit, and when … he holds property to secure his own right of indemnity in priority to all claims of any cestui que trust, and the retention of such property is necessary to give full effect to such right, it follows that the property, ie the legal estate, and right to possession vest in the trustee in bankruptcy to the extent to which they were vested in the bankrupt…

Latest decision of interest in this post-Amerind world dropped today

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Just a note to alert readers that the latest decision of interest in this post-Amerind world dropped today in the Federal Court in Queensland. The liquidators of an insolvent corporate trustee successfully obtained orders appointing them receivers of the assets of two trusts to enforce the rights of exoneration and liens of the former trustee. The application was contested by the new trustee of the property trust, who sought to sell the key asset itself (a hotel – freehold title to the land). Note the orders made (order 6) as to recourse to the assets of the trusts for the receivers’ remuneration, costs and expenses regarding each trust and the winding up of the company generally.

The case was the decision of Derrington J in Connelly, in the matter of Gregorski Investments Pty Ltd (in liq) v 320 Nominees Pty Ltd as trustee of the Gregorski Property Trust [2019] FCA 1400. 

 

New article on the High Court in Amerind – statutory priorities apply on insolvency of trustee companies, employee entitlements protected, Re Enhill is no more

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I have added a new article to my website reviewing last week’s important High Court decision in the Amerind appeal – Carter Holt Harvey Woodproducts Australia Pty Ltd v The Commonwealth [2019] HCA 20; 368 ALR 390 (Amerind). The full article can be accessed here.

 

Newsflash – the High Court’s judgment in Amerind is in

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This morning the High Court has handed down judgment dismissing the appeal from the decision of the Victorian Court of Appeal in Commonwealth of Australia v Byrnes and Hewitt as receivers and managers of Amerind Pty Ltd (receivers and managers apptd)(in liq) [2018] VSCA 41; (2018) 54 VR 230, which itself was the appeal of the decision of Robson J in Re Amerind (receivers and managers apptd)(in liq) [2017] VSC 127; (2017) 320 FLR 118.

The bench comprised Kiefel CJ, Bell, Gageler, Keane, Nettle, Gordon and Edelman JJ. Whilst the decision to dismiss the appeal was unanimous, three separate judgments were written: one by Kiefel CJ and Keane and Edelman JJ, another by Bell, Gageler and Nettle JJ and the third by Gordon J. The decision is: Carter Holt Harvey Woodproducts Australia Pty Ltd v The Commonwealth [2019] HCA 20.

My fuller review of the decision will follow. For now, some highlights –

  • The High Court unanimously held that s 433 of the Corporations Act applies in the exercise of the power of exoneration in the receivership of a trustee company. Slight points of difference in reasoning between the judgments, but the same result. Kiefel CJ, Keane and Edelman JJ expressly pointed out that the same reasoning applies to s 561, which is the provision cognate to s 433 but relevant to liquidators rather than receivers.
  • The High Court unanimously held that accordingly the statutory scheme of priority applies to distribution of the relevant trust property, being here the receivership surplus subject to the trustee’s right of indemnity. It follows from this that the Commonwealth’s claim to priority in the distribution of the receivership surplus by virtue of the payments it had made of employee entitlements under FEGS is vindicated.
  • The High Court went on unanimously to hold that trust assets may only be used to pay trust creditors on exercise of the power of exoneration in a receivership or in the liquidation of a trustee company, not also non-trust creditors. Re Enhill was wrongly decided.

More to follow.

Newsflash – High Court to hand down judgment in Amerind this Wednesday

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The High Court of Australia will be handing down judgment in the Amerind appeal this Wednesday 19 June 2019. Watch this space.

In the meantime, for my review and analysis of the Victorian Court of Appeal decision in Amerind which is the subject of this appeal see here.

For my article considering the Full Federal Court decision in Killarnee and the landscape for liquidating corporate trustees of trading trusts in light of both Amerind and Killarnee see here.

For those who want more, the submissions that have been filed for each of the appellant (creditor Carter Holt Harvey Woodproducts Australia Pty Ltd), the first respondent (the Commonwealth of Australia, which advanced $3.8m for former employees of the company under FEGS) and the second respondent (the Receivers of Amerind Pty Ltd (Receivers & Managers appointed)(in liquidation)) may be read on the High Court website here.

For now, I note that the submissions for the appellant creditor identified the following three issues for consideration in the appeal –

  1. Whether the “property of the company” of a corporate trustee under s 433(3) of the Corporations Act 2001 (Cth) includes not only the trustee’s right of indemnity but also the underlying assets to which the trustee company can have recourse.
  2. The precise nature of, and the limitations upon, a trustee’s right of indemnity where the trustee seeks exoneration in respect of unmet trust liabilities, in particular in the context of the insolvency of the trustee.
  3. Whether a corporate trustee’s right of indemnity from trust assets is “property comprised in or subject to a circulating security interest” for the purposes of s 433(2) of the Corporations Act.

The appellant submitted, inter alia, that –

  • Properly understood, a trustee’s right of indemnity, especially the ‘exoneration arm’ of the right of indemnity, is no more than a right to have trust assets applied to meet trust debts. It confers upon the trustee no interest in the trust assets themselves, or the proceeds thereof.
  • A trustee’s right of indemnity is not subject to s 433(2) of the Corporations Act because it is not a “circulating asset” and hence is not property which is “comprised in or subject to a circulating security interest”.

The appellant submitted that if either of these challenges be upheld, the Court of Appeal’s decision cannot stand.

The Commonwealth identified two issues for consideration in the appeal –

  1. On the basis that the trustee’s right of indemnity gave it a beneficial interest in the assets of the trust – was that interest “property of the company” within the meaning of s 433(3)?
  2. On the basis that s 433(3) applies to property coming into the hands of a receiver who is appointed by a debenture holder ‘secured by a circulating security interest’ – was it necessary that the trustee’s right of indemnity itself be ‘property comprised in or subject to a circulating security interest’? If so, was the trustee’s right of indemnity such property?

The Commonwealth submitted inter alia that –

  • Sections 433, 556 and 561 of the Corporations Act give statutory priority to employees’ claims in insolvency. Insolvency law is statutory and primacy must be given to the relevant statutory text. That statutory priority has been recognised since 1883 in the case of corporate insolvency. The compelling reasons for the statutory priority of employees claims is well known. It is a strong thing to deprive employee creditors of their statutory priority merely because their employer had acted as a trustee.
  • There are no non-trust creditors. There is only one trust. This case does not give rise to the question of whether creditors of the company who are not ‘trust creditors’ may be paid from the proceeds of realisation of trust assets.
  • A trustee’s right of indemnity (whether by way of reimbursement or exoneration) confers on the trustee an interest in the trust assets which is a proprietary, beneficial interest, and takes priority to the interests of the beneficiaries of the trust. This submission relies on several previous High Court decisions, including Octavo Investments Pty Ltd v Knight (1979) 144 CLR 360 and Chief Commissioner of Stamp Duties (NSW) v Buckle (1998) 192 CLR 226.
  • What matters in the Personal Property Securities Act‘s interaction with the Corporations Act is the nature of the security held by the secured party, not the nature of the interest in the personal property held by the grantor. Even if it was necessary to characterise the trustee’s right of indemnity as an asset subject to a circulating security interest, it was such an asset.
  • It follows that, as the Court of Appeal held, s 433(3) was engaged. The Court of Appeal’s decision should be upheld.

We await Wednesday’s judgment with interest.