Worldwide freezing orders – recent developments in Australia

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?

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

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)

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

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

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

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

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

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.

Vic Court of Appeal denies liquidators approval of proposed settlement agreement

Recently the Victorian Court of Appeal upheld a decision to deny liquidators approval of a proposed settlement in McDermott and Potts as liquidators of Lonnex Pty Ltd (in liquidation) [2019] VSCA 23. The creditors had been opposed to the settlement.

Background

The liquidators of Lonnex (Ross McDermott and John Potts) had commenced proceedings pursuing claims which arose from a striking series of transactions. Lonnex and a related company Millennium Management Pty Ltd each operated two medical practices at different locations in Melbourne. The day after establishing a tax consolidated group with related entities, Lonnex and Millennium both sold their assets – their 4 clinics – to Lonnex & Millennium Management Holdings Pty Ltd (LMMH) for $22m and $18m respectively. These amounts were payable at LMMH’s option by way of intercompany loans.

On the same day, Lonnex and Millennium forgave those loans.

Under the transactions LMMH acquired some of their liabilities. However others, principally those owing to the Commissioners of Taxation and State Revenue, were left with Lonnex and Millennium. The owner of the shares in LMMH, Dr Geoffrey Edelsten, subsequently onsold them.  (See [4]-[6])

The liquidators of Lonnex claimed inter alia that the release of the debts given by Lonnex to LMMH was an uncommercial transaction under s 588FB of the Corporations Act 2001 (Cth), and an unreasonable director-related transaction under s 588FDA, and sought judgment in the sum of $22m. The liquidator of Millennium (Andrew Yeo) subsequently issued a corresponding proceeding.   LMMH’s defence included arguments that the forgiveness of the loans was part of a larger composite transaction under which benefits flowed to Lonnex and Millennium, such that the impugned transactions were neither uncommercial nor unreasonable. (See [8])

Lonnex’s creditors were recorded in the judgment as including the Commissioner ($7.7m), the State Revenue Office ($264K), “perhaps” Dr Edelston ($3.6m) and minor creditors including Medicare. (See [10])

The Commissioner had funded Lonnex’s liquidators to conduct the Lonnex proceedings up to mediation. Agreement had not been reached on funding beyond that. (See [11])

Following mediation, Lonnex’s liquidators made applications under s 477(2B) and the then s 511 of the Corporations Act for orders directing that they were justified in compromising the proceeding and approving their entry into terms of settlement accordingly. An associate judge refused that application. The liquidators sought leave to appeal. The Commissioner of Taxation, being the largest creditor, appeared in opposition to the liquidators’ application. (See [2]) Indeed the proposed settlement was opposed by the Commissioner, the State Revenue Office, and the trustee in bankruptcy. (See [10])

Broadly, the liquidators argued that the proposed settlement was a reasonable commercial outcome and that they had not been put in funds to contest the proceeding further. The Commissioner disputed the wisdom of accepting the settlement and wanted a different liquidator appointed to pursue Lonnex’s litigation. (See [2]) Senior Counsel for the Commissioner informed the Court of Appeal that if Millennium’s liquidator Mr Yeo were to take over as liquidator of Lonnex, the Commissioner would be prepared to enter into a funding arrangement with him, and that Mr Yeo had consented to act as liquidator of Lonnex.

On the appeal, the liquidators submitted that the associate judge’s discretion had miscarried on several grounds. There was argument on the following issues –

  1. the significance of the fact that funding of the liquidation and the liquidators’ past and future expenses and liabilities had not been secured,
  2. the significance of the creditors’ opposition to the proposed settlement,
  3. the relevance and content of the legal opinion, and
  4. whether the proposed settlement was in the interests of creditors. (See [41])

Another proposed ground of appeal was the liquidators’ contention that the associate judge erred, or his discretion miscarried, in failing to give reasons or adequate reasons, for refusing leave under s 477(2B). (See [40]) The associate judge had stated that the s 477(2B) application was refused for the same reasons as the s 511 application. (See [62])

The Provisions

After the filing of the application, s 511 of the Corporations Act was repealed and replaced by the Insolvency Law Reform Act 2016 (Cth). The liquidators submitted that the principles which formerly covered s 511 applications applied equally to the replacement provisions contained in the Insolvency Practice Schedule (Corporations), namely ss 90-15 and 90-20. The case therefore proceeded as an application under s 511.

To pause here – for any practitioners looking to bring an application now under s 90-15 – I note that on an application for directions in Walley, In the matter of Poles & Underground Pty Ltd (Admin Apptd) [2017] FCA 486 at [41], Gleeson J observed that the question of whether to exercise the power in s 90-15 was “to be answered by reference to the principles applied to the exercise of the discretions previously contained in s 479(3) and s 511 of the Act”. This has since been approved in El-Saafin v Franek (No 2) [2018] VSC 683 at [110] (application by administrators for directions), in Re Hawden Property Group Pty Ltd (in liq) [2018] NSWSC 481; (2018) 125 ACSR 355 at [8] (application for directions), in Krejci (liquidator), re Community Work Pty Ltd (in liq) [2018] FCA 425 at [46] (application for directions and for s 477(2B) approval), in GDK Projects Pty Ltd re Umberto Pty Ltd (in liq) [2018] FCA 541 at [33] (application for the appointment of special purpose liquidators), and in an unreported decision in which I appeared last year for the liquidator Re Cameron Lane Pty Ltd (in liquidation); Playaround Pty Ltd v Peter Robert Vince, Supreme Court of Victoria, 14 August 2018 (appeal from the rejection of a proof of debt).  

Returning to the present case, section 511 of the Corporations Act relevantly provided –

(1) The liquidator, or any contributory or creditor, may apply to the Court:

(a) to determine any question arising in the winding up of a company; or

(b) to exercise all or any of the powers that the Court might exercise if the company were being wound up by the Court.

(2) The Court, if satisfied that the determination of the question or the exercise of power will be just and beneficial, may accede wholly or partially to any such application on such terms and conditions as it thinks fit or may make such other order on the application as it thinks just.

Section 477(2B) of the Corporations Act provides –

Except with the approval of the Court, of the committee of inspection or of a resolution of the creditors, a liquidator of a company must not enter into an agreement on the company’s behalf (for example, but without limitation, a lease or an agreement under which a security interest arises or is created) if:

(a) without limiting paragraph (b), the term of the agreement may end; or

(b) the obligations of a party to the agreement may, according to the terms of the agreement, be discharged by performance;

more than 3 months after the agreement is entered into, even if the term may end, or the obligations may be discharged, within those 3 months.

I pause here to draw attention to the fact – sometimes overlooked – that s 477(2B) is framed as a prohibition. However, if a liquidator has entered into such an agreement without prior creditor or court approval, it can in some cases be possible to obtain retrospective approval from the court (nunc pro tunc). Such an application is often made together with an application under s 1322(4)(a) and (d). By way of example, two cases in which I appeared for the liquidators in obtaining such approval are –

Principles

The Court of Appeal reviewed the key authorities at [63]-[91]. The passages cited by their Honours  focussed upon several issues, including notably the importance of the views of the creditors. For instance at [66] their Honours cited this passage from the judgment of Lindley LJ in Re English, Scottish & Australian Chartered Bank [1893] 3 Ch 385, 409 –

If the creditors are acting on sufficient information and with time to consider what they are about, and are acting honestly, they are, I apprehend, much better judges of what is to their commercial advantage than the Court can be

At [72] the Court repeated the oft-cited observation of Giles J considering an earlier provision (s 377 of the NSW Companies Code prior to 1992 – authorisation to compromise) in Re Spedley Securities Ltd (in liq) (1992) 9 ACSR 83, 85-6 –

In any application pursuant to s 377(1) the court pays regard to the commercial judgment of the liquidator… That is not to say that it rubber stamps whatever is put forward by the liquidator but … the court is necessarily confined in attempting to second guess the liquidator in the exercise of his power, and generally will not interfere unless there can be seen to be some lack of good faith, some error in law or principle, or real and substantial grounds for doubting the prudence of the liquidator’s conduct. The same restraint must apply when the question is whether the liquidator should be authorised to enter into a particular transaction the benefits and burdens of which require assessment on a commercial basis. Of course, the compromise of claims will involve assessment on a legal basis, and a liquidator will be expected…to obtain advice and, as a prudent person would in the conduct of his own affairs, advice from practitioners appropriate to the nature and value of the claims. But in all but the simplest case, and demonstrably in the present case, commercial considerations play a significant part in whether a compromise will be for the benefit of creditors.

The Court observed that, significantly, Giles J went on to say that it is for these reasons that the attitudes of creditors are ‘important’ in these applications. (See [73])

Following their review of the authorities, their Honours then distilled the following principles at [92]

  1. The nature of the inquiry undertaken by the court when approval is sought under s 477(2B) in relation to a proposed compromise of litigation is different from the nature of inquiry the court undertakes under s 511 when a liquidator seeks directions in relation to such a compromise.
  2. On a directions application the court must be positively persuaded that the liquidator’s decision to enter into the compromise is, in all the circumstances, a proper one. This necessarily involves a broad consideration of all the relevant circumstances. A direction will exonerate the liquidator.
  3. In contrast, the discrete consideration of an application under s 477(2B) involves a more circumscribed inquiry. The court reviews the liquidator’s proposal, satisfying itself that there is no error of law or ground for suspecting bad faith or impropriety, and weighing up whether there is any good reason to intervene. An order under s 477(2B) does not constitute an endorsement of the proposed compromise. An approval will not exonerate the liquidator.
  4. Given that the nature of the inquiry undertaken in relation to the directions application is broader than that under s 477(2B), it would usually be convenient to deal with with directions application first, and often that consideration would substantially overtake any discrete consideration of the application under s 477(2B).
  5. The court always pays due regard to the commercial judgment of the liquidator, and, on both applications, the attitudes of creditors are also important.
  6. On both applications, but particularly the application for directions, it would ordinarily be expected that a liquidator would have obtained appropriate legal advice in relation to the proposed compromise, and the nature and content of that advice is a relevant consideration.
  7. While the focus of s 477(2B) is delay, the inquiry under s 477(2B) still requires consideration of the substance of the proposed compromise. If a related application for directions reveals either that the directions should, or should not, be given, discrete consideration of the application under s 477(2B) may be superfluous.

Their Honours then added this at [93]

It can be seen that the authorities present a tension in the circumstances of the applications the subject of the present case. The liquidator is ordinarily best placed to determine what course the liquidation should take, in the interests of creditors, any contributors and the proper recovery of the costs and expenses of the liquidation. the court will generally not enter into the merits of that determination, confining itself to the question whether the proposed course is a proper one for the liquidator to take. At the same time, the interests and wishes of creditors are highly influential and the creditors are, if properly informed, in the best position to evaluate what is in their own interests. As such, the views of the creditors as to the merits of the present proposal are a highly material consideration.

Principles from Newtronics – s 477(2B)

I pause here to note that the principles here distilled by the Court of Appeal are somewhat informed by the circumstances of this case, and partly focussed upon the different functions served by each of s 477(2B) and s 511. On s 477(2B) applications, the Courts often cite and apply the principles as distilled by her Honour Justice Gordon in Stewart, in the matter of Newtronics Pty Ltd [2007] FCA 1375. It may be useful to repeat them here –

  1. The Court does not simply “rubber stamp” whatever is put forward by a liquidator. (The passage by Giles J in Re Spedley Securities, reproduced above, is often quoted in full together with this principle. Note that its final sentence makes clear that the key consideration is whether the proposal is for the benefit of creditors.)
  2. A Court will not approve an agreement if its terms are unclear.
  3. The role of the Court is to grant or deny approval to the liquidator’s proposal. Its role is not to develop some alternative proposal which might seem preferable.
  4. In reviewing the liquidator’s proposal, the task of the Court is – “[not] to reconsider all of the issues which have been weighed up by the liquidator in developing the proposal, and to substitute its determination for his in…a hearing de novo [but]…simply to review the liquidator’s proposal, paying due regard to his or her commercial judgment and knowledge of all of the circumstances of the liquidator, satisfying itself that there is no error of law or ground for suspecting bad faith or impropriety, and weighing up whether there is any good reason to intervene in terms of the ‘expeditious and beneficial administration’ of the winding up.
  5. Further, in judging whether or not a liquidator should be given permission to enter into a funding agreement (whether retrospective or not), it is important to ensure, inter alia, that the entity or person providing the funding is not given a benefit disproportionate to the risk undertaken in light of the funding that is promised or a “grossly excessive profit”,
  6. Generally, the Court grants approval under s 477(2B) only where the transaction is the proper realisation of the assets of the company or otherwise assists in the winding up of the company.

(See Newtronics at [26] and the authorities there cited.)

Application 

The Court of Appeal – in the unanimous judgment of Whelan AP and McLeish and Hargrave JJA – held that the associate judge had not erred.

Their Honours found that the associate judge was correct to regard the wishes of creditors as a “very important consideration”. Indeed they noted that “he would have erred not to have done so” (see [98]). It was clear, however, that the associate judge did not consider himself bound to act in accordance with the creditors’ wishes, taking account of other matters including the funding position, the legal opinion tendered, the relevance of the Millennium proceeding and the possibility that Mr Yeo might be placed in funds to conduct the Lonnex proceeding. Their Honours noted that the fact that the source of those funds would be the principal creditor served to highlight the importance, in this case, of the attitude of creditors to the proposed compromise of the Lonnex proceeding. (See [95] & [98])

The Commissioner had also submitted that there would be adverse consequences for the Millennium proceeding if the Lonnex proceeding were to be settled, which the Court accepted had considerable force. (See [99])

The Court found the absence of funding for the Lonnex liquidators to continue the liquidation was not an “overriding factor” in this particular case. Here there were alternative options, including that the liquidators could resign so that Mr Yeo could be appointed. (See [95]-[96]) Notably, however, the Court observed that in a different case where no compromise has been achieved, it might be proper for a liquidator to discontinue litigation if funds to continue to conduct it are unavailable. (See [97])

Takeaway

This case serves as a warning to liquidators to take heed of the attitude of creditors to a proposed settlement of a claim, particularly majority, unrelated creditors. Certainly it is a reminder that the Courts will treat the creditors’ judgment of what is in their own commercial interests as of importance, in considering an application for approval to enter into a settlement deed and for directions.

Having said that, this was a somewhat unusual case. Each case will turn on its own facts. It will not always be the case when it comes to settling a proceeding that there is another proceeding arising out of the same transaction/s running in parallel, which may be adversely impacted by the settlement. Moreover, where liquidators are without the funds or a creditor willing to fund litigation, there will not always be an alternative convenient option waiting in the wings, of another liquidator who has consented to act with a creditor willing to fund him (and the majority creditor at that).