Fraud and more than Barnes v Addy – VSCA on accessorial liability for breach of fiduciary duty or trust

In the wake of a fraud the missing money has sometimes vanished for good – spirited overseas perhaps or lost to the fraudster’s gambling habit. There may be a lack of other assets held by the fraudster against which any judgment could be executed. This is why claims that can be made against third parties who were not the fraudsters themselves but were sufficiently involved in what happened, can be so important. In some circumstances, even where they did not receive the stolen or misappropriated money, the third party’s involvement as an accessory is such as to make them liable, and losses can be recovered from them.

On Tuesday the Victorian Court of Appeal handed down its decision in Harstedt Pty Ltd v Tomanek [2018] VSCA 84. It is a significant judgment for their Honours’ remarks as to the different forms of accessorial liability for breach of fiduciary duty – it is not confined only to the second limb of Barnes v Addy (knowing assistance). Further, the judgment is significant for the principles it identifies as to what will constitute “assistance” for the purposes of the second limb (knowing assistance). There is also useful guidance in relation to the five Baden catetogories of knowledge relevant to knowing assistance.

The judgment was unanimous. The bench comprised their Honours Santamaria, McLeish and Niall JJA. I will briefly summarise the facts and decision in this case, before laying out the learnings to be gained from this judgment.

The facts

The appellant Harstedt Pty Ltd had invested $250,000 in one of those investment schemes which in hindsight was probably too good to be true. Investors were promised sizeable profits to be generated by the investment of capital by a humanitarian organisation. Investors deposited money into a CBA account in the name of the corporate vehicle Apollo Development Enterprises Pty Ltd, which they were told was a ‘non-depleting amount’; the funds were to be held inviolate and were not to leave the account.  They were told CBA had agreed to lend three times the amount held in the account, which presumably was to be used to generate profits via the investment platform. In the event, however, the funds (over $4m) were transferred to an account in Spain where they vanished without a trace.

Harstedt sued the company Apollo and others associated with Apollo, including the company secretary Mr Tomanek. Harstedt made various claims, including fraudulent breach of trust by Apollo and a claim against Mr Tomanek for knowing assistance under the second limb of Barnes v Addy. Harstedt was successful at trial against Apollo, but dismissed the claim against Mr Tomanek. Harstedt appealed.

On appeal the Court of Appeal held that Mr Tomanek knew of the essential facts which constituted the dishonest and fraudulent breach of trust by Apollo (see [105]-[108]). However the appeal failed, primarily on the basis that Harstedt had not established “assistance” on the part of Mr Tomanek. Their Honours held that on the evidence, and on the case as advanced (see below), Harstedt had not established anything beyond knowledge on the part of Mr Tomanek of Apollo’s dishonest and fraudulent design. That knowledge, in and of itself, did not facilitate Apollo’s breach of trust and cause the loss arising therefrom. On the evidence, it was insufficient to constitute “assistance” in the relevant sense (see [119]-[121]).

1.Fraud may give rise to different claims against third party accessories 

Note that on the facts of this case, the claim of knowing receipt (first limb of Barnes v Addy) was not considered, nor was there any question of tracing or following the money. This appeal decision only considered the case where a third party may be liable as an accessory to another’s breach of trust or fiduciary duty.

As their Honours acknowledged, the state of the law on accessorial liability in this context has been riddled with uncertainty and disunity; they set out the relevant authorities and case law in footnotes which I have not reproduced here.

Their Honours observed at [68] that there are different forms of accessorial liability for breach of fiduciary duty, which must be kept distinct. Their Honours identified two forms of liability and went on to describe two other situations in which accessorial liability for breach of fiduciary duty may arise. The two forms of accessorial liability their Honours set out were –

  1. Knowing assistance in the breach – the second limb of Barnes v Addy. This was the claim brought in this case. To be liable under this form, the breach of duty or trust must amount to a ‘dishonest and fraudulent design’ (see [68] and the elements set out at [70]). Note, however, that the dishonesty required is on the part of the fraudster, not the third party (see [97] and see also Farah Constructions Pty Ltd v Say-Dee Pty Ltd [2007] HCA 22; (2007) 230 CLR 89 at [160], [163] and [179]).
  2. Knowing inducement or immediate procurement of the breach. The High Court in Farah drew attention to a line of cases preceding Barnes v Addy in which it was accepted that a third party might be liable as an accessory to a breach of trust (or, their Honours noted, fiduciary duty) on this basis. Procuring or inducing a breach of fiduciary duty is distinct from participating in it (see [68]). The Full Federal Court in Grimaldi v Chameleon Mining NL (No 2) [2012] FCAFC 6; (2012) 200 FCR 296 observed that for this head, as with corporate alter ego cases (see next) it is not necessary to show any dishonest or fraudulent design here, or improper purpose on the part of the trustee or fiduciary (see [245] of Grimaldi; see [161] of Farah). Their Honours in Harstedt sets out the cases under this head at footnote 28 and 29, but see also Marriner v Australian Super Developments Pty Ltd [2016] VSCA 141 and the decision of Sloss J at first instance in Australian Super Developments Pty Ltd v Marriner [2014] VSC 464 from [274].

The two “other situations” their Honours discussed at [69] in which accessorial liability for another’s breach of fiduciary duty may arise were –

  1. Alter ego of the wrongdoer. Their Honours described this as where a company is the corporate creature, vehicle, or alter ego of a wrongdoing fiduciary or trustee, and the wrongdoer uses the company to secure the profits or inflict the losses of their breach (see [69], citing Grimaldi at [243]). In these cases the corporate vehicle is fully liable for the profits made from, and the losses inflicted by, the fiduciary’s wrong. I note that as the Full Federal Court observed in Grimaldi, the basis for third party liability in these cases is said to be that the company had full (imputed) knowledge of all of the facts, and either has a “transmitted fiduciary obligation” or “jointly participated” in the breach. Liability does not turn on the need to show dishonesty, although it often provides the reason for the interposition of the company. (See [243] of Grimaldi.)
  2. Trustee de son tortThis is where the third party is not a trustee but nevertheless presumes to act as a trustee and then commits a breach or profits from the position. In those circumstances the third party can be liable as a trustee de son tort (see [69], citing Mara v Browne [1896] 1 Ch 199, Nolan v Nolan [2004] VSCA 109 at [25]-[29]).

I will not launch into a doctrinal debate about these forms of liability here, although I note that pleadings in these cases need to be carefully considered and framed. However it is worth pausing to comment further on the basis of liability  for number 1 immediately above – where the third party is the corporate alter ego of the wrongdoer. Regarding that type of case, it has been noted it is ‘rather artificial’ to use Barnes v Addy to explain this liability (see [243] of Grimaldi.) Having said that, in Grimaldi, Mr Grimaldi’s company Murchison Pty Ltd was found liable for Mr Grimaldi and Mr Barnes’ diversions of money away from Chameleon Pty Ltd…under both limbs of Barnes v Addy (knowing assistance and knowing receipt). Murchison Pty Ltd was also found liable for aiding and abetting the contraventions of ss181 and 182 of the Corporations Act committed by Mr Barnes as was Mr Grimaldi. (See [312]-[321] where the trial judge’s findings are set out, and the Full Court’s agreement with those findings at [322]-[345] of Grimaldi). As an aside, I note that the defendants had claimed the diverted funds were payments properly posted to their loan accounts – see what the Full Federal Court had to say about that at [336] – the funds were not stolen but they were misappropriated.

I note too that in 2012 in Grimaldi, the Full Federal Court outlined four “quite different manifestations of [third party] participation” in another’s breach of fiduciary duty or breach of trust, rendering them liable in equity. These were framed somewhat differently to those identified here by the Victorian Court of Appeal; for those interested, see Grimaldi at [243]-[248]. My 2012 article discussing the Full Federal Court’s decision in Grimaldi may be read here, and my 2012 discussion of the issue of de facto directors and officers as dealt with in the judgment may be read here. Mr Grimaldi was unsuccessful in obtaining special leave to appeal to the High Court – see here.

2.Assistance  

As noted above, this week’s judgment in Harstedt is also significant for the principles it identifies as to what will constitute “assistance” in the breach of trust or fiduciary duty for the purposes of the second limb (knowing assistance).

Their Honours acknowledged that the authorities offer little guidance, and that plainly whether a third party has assisted relevantly is a question of fact for each case. However their Honours distilled two principles as having emerged from the authorities and commentary on this point (at [116]-[118]) –

  1. There will be assistance where, but for the action or inaction of the third party, the breach of fiduciary duty would not have occurred. Their Honours observed that a common example is the role of a bank or other financial intermediary the function of which is essential to effect a transaction that amounts to a breach of trust.
  2. There may also be assistance where the third party has facilitated a breach of fiduciary duty that would have occurred in any event. (emphasis added)

Before any bankers reading this sit up in alarm at their Honours’ comment under principle 1 immediately above, it should be noted that a finding of assistance alone will not be enough to found liability as an accessory. Indeed there are four necessary elements of liability under the second (knowing assistance) limb of Barnes v Addy. These were set out by their Honours at [70], citing Farah and Grimaldi, and are –

  1. The existence of a fiduciary duty owed by the fiduciary (trustee or otherwise),
  2. A ‘dishonest and fraudulent design’ on the part of the fiduciary,
  3. Assistance by the third party in that design, and
  4. Knowledge on the part of the third party of the circumstances constituting that design.

Turning briefly then to the last of these – knowledge.

3.The Baden categories of knowledge

Their Honours’ judgment in Harstedt also provides useful guidance in relation to the five Baden categories of knowledge relevant to ‘knowing assistance’ at [85]-[87].

The Baden categories are –

  1. Actual knowledge
  2. Wilfully shutting one’s eyes to the obvious
  3. Wilfully and recklessly failing to make such inquiries as an honest and reasonable person would make,
  4. Knowledge of circumstances which would indicate the facts to an honest and reasonable person, and
  5. Knowledge of circumstances which would put an honest and reasonable person on inquiry.

Their Honours noted that the first two speak for themselves. In Harstedt, their Honours’ findings as to Mr Tomanek’s knowledge of the three essential facts which constituted the dishonest and fraudulent breach of trust by the company Apollo fell into the first and second categories (see [105]-[108]).

As to the third category – wilfully and recklessly failing to make inquiries as an honest and reasonable person would make – their Honours observed that this ‘involves such a calculated abstention from inquiry as would disentitle the third party to rely upon lack of actual knowledge of the trustee’s or fiduciary’s wrongdoing’ (see [86]).

I pause to note that last year in Sino Iron Pty Ltd v Worldwide Wagering Pty Ltd [2017] VSC 101, Hargrave J found the third category of knowledge on the part of the director and general manager of the betting company which had unknowingly received over $2m in stolen funds, as at the date they then credited it to the fraudster’s betting account. His Honour took the view that based on what (little) they did know, the inquiries they made were manifestly inadequate. He held that they ought to have made the ‘simple inquiry’ of identifying and contacting the depositors of the stolen funds, and asking if they intended to pay the money to the sports betting company for the benefit of the customer claiming it. My article reviewing and analysing that case can be read here.

As to the fourth category – knowledge of circumstances which would indicate the facts to an honest and reasonable person- their Honours observed that this category ‘is designed to prevent a third party setting up his or her own “moral obtuseness” as the reason for not recognising an impropriety that would have been apparent to an ordinary person’ (see [86]).

The fifth category derives from the doctrine of bona fide purchaser for value without notice (see [86]).

The Court of Appeal noted that the High Court in Farah endorsed the Baden scale and indicated that knowledge falling within any of the first four categories, but not the fifth, represents the law in Australia (see [87]).

Conclusion…and a window left open – omission/acquiescence

The Victorian Court of Appeal’s judgment in Harstedt is worthwhile for practitioners to be across. Their Honours’ remarks as to the different forms of third party liability as an accessory to breaches of fiduciary duty or trust are instructive. Further, the judgment contains useful guidance as to what will constitute “assistance” for the purposes of the second limb (knowing assistance), and as to the five Baden catetogories of knowledge.

One final aspect: Their Honours noted that Harstedt advanced its case as to “assistance” as one of active involvement by Mr Tomanek. Their Honours remarked that Harstedt did not contend that Mr Tomanek’s “assistance” comprised his acquiescence with the breach, which acquiescence caused the loss. Therefore, so their Honours noted, it was unnecessary to decide whether an omission or acquiescence may amount to “assistance” under the second limb (see [119]). Their Honours observed that the authorities on this point appear to be in disharmony. They set out a list of such cases at footnote 84.

Clearly their Honours have left this matter open. It raises interesting questions as to whether a failure to stop a fraud could constitute “assistance”; whether sitting on one’s hands could be held to be enough to facilitate a fraud, sufficiently to amount to “assistance” and satisfy that element of a claim for liability in respect of the fraud against a third party. I would speculate that may depend upon the knowledge of the third party. If the third party’s level of knowledge of the fraud reaches a high enough Baden category, then a failure to take any action to stop the fraud may be more likely to be found to constitute sufficient “assistance” in the fraud. It will be interesting to see what happens in the cases to come.

Newsflash – Amerind is headed for the High Court

Papers have reportedly been filed with the High Court by creditor Carter Holt Harvey Wood Products Pty Ltd. Watch this space.

In the meantime, for my review and analysis of the Victorian Court of Appeal decision in Amerind see here, and for my article considering the recent Full Federal Court decision in Killarnee and the landscape for liquidating corporate trustees of trading trusts in light of both decisions see here.

New article on Killarnee – trading trusts, statutory priorities on the liquidation of trustee companies, lack of power to sell trust assets

I have added a new article to my website reviewing the recent, important decision of Jones (liquidator) v Matrix Partners Pty Ltd, re Killarnee Civil & Concrete Contractors Pty Ltd (in liq) [2018] FCAFC 40 (Killarnee). The full article can be accessed here.

As noted in my alert, last week the Full Court of the Federal Court handed down its much anticipated decision in Killarnee. The issue for the Full Court broadly was how a liquidator is to deal with trust assets in the liquidation of a company which had been trustee of a trading trust.

The three member bench comprised Allsop CJ, and Siopis and Farrell JJ. Unlike in the decision last month in Amerind where the Victorian Court of Appeal spoke with a single unanimous voice, their Honours of the Full Court wrote three separate judgments, with the Chief Justice writing the lead. Overall, while there is sound reasoning and analysis and useful clarity on some points, the Full Court’s decision may be likely to create some other concerns for insolvency practitioners dealing with trustees of trading trusts.

There was unanimity on some issues but not others, and there was a sting or two in the tail. The issue now appears to be resolved that a trustee company’s right of exoneration over the trust assets is property of the trustee company. The Full Court was clear in their view in obiter that trust assets may only be applied in payment of trust debts in exercise of a trustee’s right of exoneration (not non-trust debts). Their Honours also addressed and made clear their position as to the lack of liquidators’ power to sell trust assets, and the need for court order.

On the scheme of priority issue: the majority of the Full Court ostensibly joined with Amerind and resolved some of the uncertainty of the past few years as to whether liquidators should apply the statutory scheme of priorities under the Corporations Act when liquidating companies which have conducted their business through trading trusts and exercising the trustee’s right of exoneration over trust assts to pay creditors. The majority held that the scheme of priorities applies…mostly. This was one of the stings. Whilst the priority afforded employee entitlements was endorsed, as was that for liquidators’ costs, their Honours in the majority queried whether every element of the priority scheme in s 556 should apply in every case (indeed whether some such debts would even qualify as trust debts in every case) – see the discussion below. Their Honours’ comments and the doubt created in this area suggest that court directions are likely to be advisable for a liquidator dealing with trading trust assets on the question of distribution. Resolution of this uncertainty either by the High Court or by legislation – the latter of which was strongly encouraged by Farrell J – would be welcome, although it may need to be carefully done. This also is discussed in the article.

The specific questions considered by the Full Court on the particular case before them, and their Honours’ answers to those questions, are already set out in my alert of last week and can be read here.

To get straight to it, on my analysis, the propositions to be distilled from the Full Court’s decision in Killarnee are these –

  1. The right of exoneration and the lien over trust assets in its support are property of the trustee company. The Full Court agreed with the Victorian Court of Appeal in Amerind on this.
  2. Power to sell assets lacking under s 477 as liquidator. The assets of a trust are not themselves assets in the winding up of the trustee company, though they are subject to the right of indemnity and lien. It follows that the liquidator generally lacks power under s 477 to sell the trust assets.
  3. Power to sell assets lacking where company no longer trustee. Where the company ceases to be trustee of the trust upon its liquidation under the terms of the trust, it will then generally hold the trust assets as bare trustee (and as former trustee liable for unpaid trust debts, retaining its right of indemnity against those assets). As bare trustee, with a duty and power only to hold and preserve trust assets, the company will generally lack a trustee’s power to sell the trust assets.
  4. Power to sell trust assets can be acquired by court order for judicial sale, usually with appointment as receiver of the trust assets to carry out the sale and for the distribution of the proceeds. The liquidator of a trustee company ought approach the courts for authority to sell the trust assets.
  5. Scheme of priorities applies (mostly). The majority of the Full Court held 2:1 that the statutory scheme of priorities laid down in the Corporations Act applies to the distribution of trust assets where subject to a right of exoneration. Note however that the majority judgments raise some doubt as to whether this is achieved by the legislation applying or by Equity echoing the scheme. Siopis J dissented on this, but conceded that a similar result could be produced by way of the court, in its equitable jurisdiction, giving directions to a receiver appointed over the trust assets as to the distributions to be made to trust creditors, subject to the circumstances of the particular case.
  6. However some elements of the priority scheme may not apply in every case.
    The sting: While the majority of Allsop CJ and Farrell J accepted that the priority scheme generally applies, both queried whether all elements of the scheme applies in every case. Their Honours took the view that each paragraph of s 556 must be interrogated for its meaning and endorsed some – but not all – of the priority debts listed in the scheme. Farrell J specifically questioned whether the costs of the winding up application could even be seen as a trust debt. The Court’s position on the various types of priority debt are identified and discussed in my article (here).
  7. Trust assets are not generally available for distribution to non-trust creditors. They may only be used to pay trust creditors. Trust assets may only be applied in payment of Trust debts, where this is done in exercise of the trustee’s right of exoneration (as opposed to the right of recoupment). In re Suco Gold is correct. Re Enhill is not.

The full article can be accessed here.

Newsflash – judgment in Killarnee is in

Late this afternoon the Full Court of the Federal Court of Australia delivered judgment in Jones (liquidator) v Matrix Partners Pty Ltd, re Killarnee Civil & Concrete Contractors Pty Ltd (in liq) [2018] FCAFC 40. The bench comprised Allsop CJ, Siopis and Farrell JJ. The judgment can now be read on Austlii here.

Their Honours delivered three separate judgments. There was unanimity of decision and reasoning on some of the questions answered, but not others. The Court answered the questions posed for decision as follows –

  1. The assets of the Trust are not assets in the winding up of the trustee company Killarnee, such that the liquidator did not have power under s 477 to sell the Trust assets (unanimous).
  2. Two parts –
    1. The proceeds of realisation of Trust assets are to be applied by the Liquidator in accordance with the priority regime under ss 555, 556, 560 and 561 of the Corporations Act (2:1 – Allsop CJ answered yes, Farrell J answered yes but for different reasons, Siopis answered no).
    2. The unfair preference proceeds are to be applied in accordance with the priority regime (unanimous, although with the qualification that this was common ground, which their Honours noted they accepted without undertaking any legal analysis).
  3. Two parts –
    1. The Liquidator should be directed to deal with the proceeds of realisation of Trust assets as assets in the winding up of the Company (2:1 – Allsop CJ answered yes, Farrell J answered yes in substance, Siopis J answered no).
    2. The Liquidator should be directed to deal with the unfair preference proceeds as assets in the winding up of the Company (unanimous).
  4. Neither the proceeds of realisation of Trust assets or the unfair preference proceeds should be distributed by the Liquidator to unsecured creditors of the Trust pari passu after providing for the costs of the administration (unanimous, although Siopis J’s reasons differed to those of Allsop CJ and Farrell J).

More to follow.

 

Heads up – Judgment in Killarnee to be delivered this afternoon

The Full Federal Court matter of Killarnee is listed for handing down of judgment at 5.15 this afternoon. Watch this space.

For more as to the issues arising at the point where trust law intersects with insolvency law, see my review of the recent Victorian Court of Appeal decision in Re Amerind – here.

 

The Amerind appeal – trading trusts, statutory regime of priority applies on receivership of the trustee, employee entitlements protected

As noted in my alert yesterday morning, the Victorian Court of Appeal has handed down it’s decision on appeal from Re Amerind (receivers and managers apptd)(in liq) [2017] VSC 127; (2017) 320 FLR 118. The appeal judgment is now up on Austlii and can be read here: Commonwealth of Australia v Byrnes and Hewitt as receivers and managers of Amerind Pty Ltd (receivers and managers apptd)(in liq) [2018] VSCA 41.

The five member bench comprised their Honours Ferguson CJ, Whelan JA, Kyrou JA, McLeish JA and Dodds-Streeton JA. The judgment was unanimous. At least for Victoria, it resolves the uncertainty  of the past few years following Independent Contractors and Re Amerind as to whether receivers and liquidators should apply the statutory priorities under sections 433, 556 and 560 of the Corporations Act when distributing the assets of corporations who have conducted their businesses through trading trusts. They should; the statutory scheme of priority applies. The fact that the funds are the proceeds of trust assets does not displace the priority regime.

The judgment was divided into two parts. The first part, commanding the bulk of the judgment, dealt with the issue of how a corporate trustee’s right of indemnity from trust assets is to be dealt with in insolvency, whether the receivership surplus in that case was properly characterised as trust property or property of the trustee, and whether the statutory scheme of priority applied. It is this first part I propose to address below.

The second part of the judgment dealt with the second ground on which Robson J had held that s 433 did not apply, namely that the right of indemnity was not subject to a ‘circulating security interest’.

Summary snapshot

To get straight to it, their Honours on the Amerind appeal held that –

  • A corporate trustee’s right of indemnity from trust assets is property of the trustee company within the meaning of s 433 of the Corporations Act. Not property of the trust, as Robson J had held at first instance.
  • The statutory scheme of priority applies to distribution of the relevant property, being the receivership surplus subject to the right of indemnity. This had the result 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 was vindicated.
  • (In the second part of the judgment – certain assets in dispute fell within the ambit of property secured by a ‘circulating security interest’. Their Honours held that the relevant assets in this context was not the right of indemnity but the trust assets. The correct date for assessing whether property is subject to a circulating security interest under s 433 is the date the receiver is appointed and takes possession. The Court also held that on the proper construction of s 340(1) of the PPSA the two limbs (a) and (b) are alternatives. Either may be satisfied to bring property within the definition of a ‘circulating asset’.)

Their Honours took the opportunity to state clearly that Re Enhill remains authoritative in Victoria and must be followed by trial judges here.

However, the Court left open the question of how non-trust creditors (if any) are to be treated on the insolvency of a trustee company. That is, whether on an insolvency a trustee’s right of indemnity must be used in payment of trust debts only, or of non-trust debts of the company also, ranking pari passu. I discuss this below.

Similar issues were also considered by the Full Court of the Federal Court in August last year in a hearing before their Honours Allsop CJ, Siopis and Farrell JJ in In the matter of Killarnee Civil & Concrete Contractors Pty Ltd (in liq) (WAD181/2016). Their judgment must surely be imminent, and it will be interesting to see how their Honours treat the issues. Given the prevalence of the use of trading trusts in Australia, it would be preferable to have both certainty and a national approach on the receivership or liquidation of corporate trustees.

**This concludes the summary. There now follows a more detailed treatment of the judgment, for those interested in reading on.

**********

The facts

The relevant facts and events are summarised at [3]-[8] and [14] of the appeal judgment and [50] at first instance. The key facts were these –

  • The company Amerind carried on business acting solely in its capacity as trustee of a trading trust
  • It had no assets of its own (save for a nominal sum settled to establish the trust)
  • The liabilities were incurred by Amerind acting as trustee
  • The creditors it had were therefore trust creditors
  • Amerind did not have its own money to meet trust liabilities and then seek to be reimbursed from the trust (by a trustee’s right of recoupment)
  • Rather, Amerind sought to be indemnified from the trust assets for liabilities it incurred in carrying out the trust (also called a trustee’s right of exoneration)
  • As all trust liabilities exceeded the trust assets, the beneficiaries’ interest had been entirely supplanted by Amerind’s right of indemnity
  • The Commonwealth had advanced accrued wages and entitlements totalling $3.8million to Amerind’s former employees pursuant to FEGS (the Fair Entitlements Guarantee Scheme)
  • Following repayment to the Bank through the receivers’ realisation of the Bank’s securities, and after providing for their own estimated remuneration, the receivers held a net surplus of $1,619,018.

Issues then arose as to how that surplus was to be applied. The Commonwealth’s position was that the priority regime provided for in the Corporations Act applied. It followed that by operation of s 560 of the Corporations Act, the Commonwealth had the same rights of priority in respect of the money advanced as do employee claims in a winding up under s 556 of the Act.

The receivers sought directions from the Court.

Submissions and authorities

The receivership surplus was subject to a right of indemnity (supported by a lien) held by the insolvent corporate trustee Amerind. The Commonwealth argued the receivership surplus was therefore the trustee company’s property, not trust property, and it should be applied in accordance with the priority regime provided for under the Corporations Act. The receivers agreed at first instance, and did not take a position on appeal. A creditor Carter Holt Harvey Woodproducts Australia Pty Ltd (CHH) opposed the Commonwealth’s position, contending that the Commonwealth was not entitled to priority because s 433 did not apply. At first instance, Robson J agreed with the creditor CHH. He held that s 433 did not apply to the receivership surplus.

Before addressing the issue the Court went on a journey from [19], giving detailed consideration to key principles and tracing through the authorities on the difficult questions that arise in resolving this issue. As it may be useful for practitioners to be aware of what was said, I will summarise those remarks here.

Nature of trust liabilities. Ordinarily a trustee is entitled to be indemnified from the trust assets against liabilities properly incurred. The trustee has a charge or lien over the trust assets for the purpose of enforcing that indemnity. In some circumstances creditors of the trustee whose debts were incurred in discharge of the trust may be subrogated to the trustee’s rights (at [22])

Nature of the trustee’s right of indemnity and creditors subrogation. A trustee’s right of indemnity may take the form of recoupment / reimbursement for trust debts already paid from the trustee’s own money, or of exoneration for trust debts not yet paid (at [23]-[27]).

I pause here to note that unlike the Court in the Re Amerind appeal, in Lane v Deputy Commissioner of Taxation [2017] FCA 953 (discussed below) Derrington J saw this distinction between the two distinct forms of a trustee’s right of indemnity as critical. At [36] of Lane Derrington J observed –

“[T]he right of a trustee to be indemnified from the assets of the trust falls into two distinct parts. First where a trustee has discharged a trust debt out of their own funds, the trustee is entitled to reimbursement out of the trust funds in an equivalent amount. That occurs by money being transferred by trust funds to the trustee who receives an absolute, beneficial interest in that money. That right in relation to satisfied trust liabilities is often referred to as the right of “recoupment”. Second, the trustee is entitled to meet unsatisfied trust debts directly from the trust assets by utilising the right of “exoneration”. Pursuant to this right, the trustee directly applies trust assets to discharge the indebtedness by paying trust funds directly to the trust creditor…This process of “exoneration” does not involve the trustee obtaining any beneficial interest in the assets which are used to discharge the trust debts.”

At [38] of Lane, Derrington J goes on –

“The important distinction between these two aspects of the trustee’s right of indemnity is usefully essayed in…[two texts on subrogation]. In the former work the learned author identifies that a trustee is restricted in the use of the right of exoneration to use it for the purpose of discharging his liability to the trust creditors and no other.”

Finally at [40] Derrington J concludes –

“[S]ome of the authorities concerning the trustee’s right of indemnity from the trust assets do not always maintain this critical distinction between the right of “recoupment” or “reimbursement” on the one hand, and the right of “exoneration” on the other. However the distinction is fundamental. If what comes into the hands of a bankruptcy trustee is a trustee’s right of recoupment, it is a right to take money from the trust funds for the benefit of the insolvent trustee’s estate. It is, in effect, the payment of an amount owing to the trustee for the purposes of reimbursing the trustee’s personal estate. Such a payment is received by the bankruptcy trustee as part of the bankrupt’s personal estate and is available to meet the claims of both trust and non-trust creditors. However, the position is markedly different when what the bankruptcy trustee receives is merely a right or entitlement to have trust assets applied to discharge trust debts. That is a considerably more limited right.”

As will be seen below, this view was not shared by the Court of Appeal.

Returning to the Amerind appeal judgment, from [28]-[56] the Court reviewed English and Australian authorities on this issue handed down between 1802 and 2012. At [57] their Honours distilled these conclusions from those authorities –

  1. There has been long standing, if not uniform, acceptance of the proposition that upon insolvency the trustee’s right of indemnity passes to the insolvent trustee’s insolvency administrator.
  2. Trust creditors deal with the trustee on the footing of the trustee’s personal liability. They may be subrogated to the trustee’s right of indemnity, but any such subrogation cannot yield greater rights than the trustee itself has.
  3. The right of subrogation is better characterised as a remedy. It is based upon the unconscionability of liabilities incurred to augment trust assets not being met out of those assets. Its goal, as revealed by the early cases, was not the protection of trust creditors, but rather the prevention of the unjust enrichment of beneficiaries.
  4. In re Richardson [1911] 2 KB 705 suggests that the right of indemnity cannot be exercised so as to meet the claims of non-trust creditors. Liverpool and the NZ decision in Jarvis would confine In re Richardson to circumstances where the indemnifying party (the beneficiaries, in effect) is ‘concerned’ as to the application of the money. (Note this may rarely be the case on insolvency.)

The statutory insolvency regime. The pari passu principle for the equal treatment of creditors’ claims applying what remains of the insolvent’s property is embodied in s 555 of the Corporations Act. Section 556 then provides for certain debts to be paid in priority to all other unsecured debts. Property held by the insolvent on trust is not property of the company and is excluded from distribution to the company’s creditors.

Employee claims have long been accorded priority over the claims of the holder of a floating charge or circulating security. Section 433 provides that a receiver who takes possession or assumes control of property of the company secured by a ‘circulating security interest’ must pay, out of property coming into his her or its hands, specified debts in priority to any claim for principal and interest under the debentures. Those specified debts include those afforded priority under s 556(1)(e),(g) or (h) or s 560 of the Act. These are the provisions which give priority to employee claims, and to those who advance funds to meet them.

The High Court in Octavo, Buckle and Bruton. The High Court’s decision in Octavo Investments Pty Ltd v Knight [1979] HCA 61; (1979) 144 CLR 360 establishes that an insolvent trustee’s right of indemnity against trust property for trust debts, gives the trustee a proprietary interest in the trust property (at [96]). On liquidation, the trustee company’s liquidator has access to that proprietary interest for the benefit of the trustee’s creditors.

The Court of Appeal expressed the view that Octavo establishes not only that the right of exoneration is property which passes to the trustee in bankruptcy (vests) or the liquidator (control), but also that the respective statutory regimes must apply to the disposition of that property. The Honours’ view was that Octavo does not, however, provide clear guidance on whether distribution is confined to trust creditors (at [100]). Indeed the Court noted that Octavo gives conflicting guidance on this question. The plurality in Octavo made conflicting remarks as to whether the proceeds of a trustee’s right of indemnity would, on insolvency, be confined to trust creditors, or whether the trustee’s non-trust creditors (if any) could share in the distribution (see [98]).

Twenty years later in Chief Commissioner of Stamp Duties (NSW) v Buckle [1998] HCA 4; (1998) 192 CLR 226, the High Court recognised the traditional distinction between rights of exoneration (for trust debts not yet paid) and recoupment (for trust debts already paid by the trustee). However the Court affirmed that the trustee’s right of indemnity, in either manifestation, conferred on the trustee a beneficial proprietary right in the trust assets (at [106]). The High Court affirmed this in Bruton Holdings Pty Ltd (in liq) v Federal Commissioner of Taxation [2009] HCA 32; (2009) 239 CLR 346. The High Court there characterised the trustee’s right of indemnity as a proprietary interest in the trust assets, irrespective of whether it took the form of recoupment or exoneration, by virtue of the lien which survived the loss of office as trustee (at [114]).

The Court of Appeal concluded that the High Court has made it clear that the trustee’s right of indemnity, both as to recoupment and exoneration, constitutes a proprietary interest in the trust assets which, in the corporate insolvency context, is ‘property of the company’. The statutory provisions governing corporate insolvency have changed over time, but none of those changes have altered or affected this position (at [124]).

I pause here to note that it is interesting how different courts in Australia can review the same High Court authorities and draw different conclusions from them as to what they establish as authoritative. In contrast with the Re Amerind appeal decision, see Lane at [96]-[99].

Re Enhill, Re Suco Gold, Independent Contractors. From [125] their Honours reviewed cases applying the English and High Court authorities on the trustee’s right of indemnity and insolvency, prior to the Amerind decision. The main cases considered were these –

Re Enhill Pty Ltd [1983] VicRp 52; [1983] 1 VR 561 is discussed from [136]. There Young CJ observed that the Victorian Full Court had to treat Octavo  as authority for the proposition that the right of a trustee to be indemnified out of the assets of the trust, or the proceeds of the exercise of that right, are assets of the trustee in a winding up.

Young CJ took the view that the proceeds of the trustee’s lien on a bankruptcy or liquidation are available for division amongst the company’s creditors generally, not only among trust creditors (at [144]). Lush J agreed, taking the view that although the case before him in Re Enhill did not concern a competition between trust and non-trust creditors, they should stand on the same footing (at [154]-[155]). He acknowledged however that there can never be exacted from the trust property, by the trustee or by the trust creditors, an amount which is greater than the trust debts (at [158]).

Shortly after Re Enhill in Victoria, the Full Court of the South Australian Supreme Court handed down Re Suco Gold Pty Ltd (in liq) (1983) 33 SASR 99. As in Re Enhill, the practical problem exposed in Re Suco was that the winding up could not proceed unless the liquidator could have recourse to trust funds to meet the costs and expenses of liquidation. King CJ rejected the liquidator’s submission, based on Re Enhill, that the right of exoneration entitled the trustee to transfer trust property to himself to meet unpaid trust debts, which property then ceased to be trust property and was, on insolvency, divisible amongst the general body of creditors. King CJ noted this to be ‘in conflict with fundamental principles of the law of trusts’ (at [171]).

Unlike Young CJ’s application of Octavo in Re Enhill, King CJ in Re Suco stated that in his view Octavo did not lead to the conclusion that the trust assts (to the extent of the trust liabilities) pass to the trustee in bankruptcy or the liquidator for the benefit of the general body of creditors (at [175]).

King CJ acknowledged that the trustee’s indemnity passes to the trustee in bankruptcy or liquidator, and that the proceeds of that indemnity were therefore part of the estate divisible amongst creditors. However King CJ drew a crucial distinction between the right of recoupment and the right of exoneration. In cases of recoupment, the right of indemnity can produce proceeds for division among the creditors generally. However not so in cases of exoneration. If a trustee takes trust property into his possession to satisfy his right to be indemnified for unpaid trust liabilities, that property retains its character as trust property and may be used only for the purpose of discharging the liabilities incurred in the performance of the trust (at [176]).

On the case before him, King CJ concluded that the liquidator was bound by s 292 of the Companies Act to pay the debts (which were all trust debts) in the specified order of priority, having recourse to the property of each trust to pay the debts incurred in performing it, and if there was any surplus after the priority payments, paying other trust debts pari passu (at [180]).

The turning point came in 2016 in Re Independent Contractor Services (Aust) Pty Ltd (in liq)[No 2] [2016] NSWSC 106; (2016) 305 FLR 222, when Brereton J held that the statutory priority scheme in s 556 did not apply to trust assets, and the creditors share pari passu in the trust assets after providing for the costs of administration. His Honour’s view was that s 556 was concerned only with the distribution of assets beneficially owned by a company and available for division between its general creditors, and trust principles provided that trust creditors’ claims rank pari passu (from [186]).

First instance judgment in Re Amerind.  In Re Amerind (receivers and managers apptd)(in liq)[2017] VSC 127; (2017) 320 FLR 118 Robson J controversially held that the trustee’s right of indemnity was not ‘property of the company’ within the meaning of s 433(3) of the Corporations Act and was not available to meet other liabilities of the company. Rather, the right of indemnity and lien could only be used to satisfy liabilities incurred on behalf of the trust (at [194]). His Honour concluded that the corporate trustee’s right of indemnity and lien, of which the receiver’s surplus was the proceeds, was ‘property held in trust’, rather than ‘the corporate trustees own beneficial personal property’. In his view the indemnity was not a personal asset of the trustee; rather it was trust property (at [197]). Hence he found that the receivers were justified in proceeding on the basis that the receivership surplus was properly characterised as property of the trust (at [201]).

Robson J acknowledged that Re Enhill and Re Suco Gold had both held that the statutory regime did apply where the assets of a company are held on trust. However his Honour preferred Brereton J’s reasoning in Re Independent that the statutory provisions applied only to ‘property of the company’ and that the trustee’s right of indemnity was not ‘property of the company’ (at [203]). His Honour took the considered view that the Victorian Full Court’s decision in Re Enhill, which had not been followed in the Federal Court or any other state of Australia, was not binding on him (at [208]).

Before the Court of Appeal, the Commonwealth submitted that Robson J erred in denying employees their rightful status as priority creditors. His Honour’s reasoning was contrary to the High Court’s recognition in Octavo, Buckle and Bruton that the trustee’s right of indemnity (including for exoneration) was a beneficial interest in trust property amounting to a proprietary interest. That analysis was applied by the Full Courts in Re Enhill and Re Suco Gold so as to conclude that the statutory order of priorities applied to the distribution of the property (at [212]).

Lane v Deputy Commissioner of Taxation [2017] FCA 953. Five months after Re Amerind,  Derrington J held in Lane that contrary to Re Independent and Re Amerind, the trustee’s right of indemnity for exoneration was a proprietary right which vested in an insolvent trustee’s trustee in bankruptcy and, by analogy, would also be ‘property of the company’ in the corporate context. But it was a limited right with a sole purpose to pay trust debts, which did not alter on insolvency (at [239]).

In Lane the question was whether trust funds were distributable to all creditors, or only to trust creditors. His Honour held that the right to be indemnified out of trust property (right of exoneration) was personal property of the trustee, “being a right to exercise power with respect to property within the meaning of s 116(1)(b) [of the Bankruptcy Act]…” (at [244]).

As touched on above, in Lane Derrington J analysed the nature of the indemnity, emphasising the distinction between rights of exoneration and recoupment, and concluded that the trustee is restricted in the use of the right of exoneration to using it for the purpose of discharging his liability to the trust creditors and no other (at [246]). The entitlement of trust creditors to be subrogated to the trustee’s right of indemnity was an important factor in Derrington J’s analysis. It gave them in his view a favoured position, and while it did not make them secured creditors, in Derrington J’s view they were akin to secured creditors in some respects (at [256]). His Honour also doubted whether, in the corporate context, ss 555 and 556 could apply to property comprising a trustee’s right of exoneration (at [258]).

Both Re Enhill and Re Suco Gold had characterised the trustee’s right of indemnity as property of the company divisible among creditors according to the statutory order of priorities (at [260]).

From [263] the Court of Appeal compared the reasoning in Re Enhill with that in Re Suco Gold, on the question of whether the trustees’ right of indemnity for exoneration in insolvency could only be used for the satisfaction of trust creditors’ claims, to the exclusion of general creditors. They noted that this question had less practical significance than perhaps anticipated. Many of the decided cases concerned trustee companies with trust liabilities only. Typically the only claims arguably not trust-related were the liquidator’s claims for costs, fees and expenses. It has been held that where it is established the liquidator’s work and costs were essential or beneficial to the trust, the related claims may be satisfied on the basis of Re Suco Gold, alternatively under the principles of Universal Distributing (at [260]).

Their Honours noted that prior to Lane, it seemed that no court had found it necessary to determine the controversy generated by the different holdings in Re Enhill and Re Suco Gold over whether the proceeds of the right of indemnity for exoneration are divisible amongst all creditors or trust creditors only. That was also the position in the instant case, as Amerind had only trust creditors. (at [261]).

At [266] the Court of Appeal noted that Young CJ in Re Enhill took the view that when insolvency intervened, the antecedent obligation to exercise the right of indemnity to meet the claims of trust creditors only was overriden by the prescribed statutory order of priorities. They noted that this approach had the advantage of consistency, but also drawbacks. It renders the trust creditors’ right of subrogation of little or no substance in the very circumstance which would trigger it. It creates a position where, on one view, there is an unauthorised application of trust assets.

However their Honours did not attempt to resolve the issue of whether the right of exoneration can be applied to pay trust creditors only, or trust and general creditors of the trustee, and seemed to doubt that it could be resolved at all:

“It seems to us to be unlikely that any analysis can comprehensively reconcile the competing considerations at play, all of which are supported to some degree in the diverse relevant authorities.” (at [267])

1. Is the right of indemnity property of the trustee company?

The answer given was yes, the right of indemnity by way of exoneration is property of the insolvent trustee company. They categorically overturned Robson J’s holding on this, stating that:

“The primary judge’s conclusion that the corporate trustee’s right of indemnity by way of exoneration was not ‘property of the company’ cannot be sustained in the light of relevant High Court authority.” (at [269])

They discussed and disagreed with his Honour’s reasoning, and observed that as Derrington J had cogently explained, in the light of the High Court decisions in Savage, Octavo, Bruton, Buckle and CPT, it cannot be seriously doubted that the right of indemnity by way of exoneration is property of the insolvent trustee company (at [273]).

2. Is the distribution of the relevant property governed by the Corporations Act?

The answer given was yes.

In Lane, Derrington J held that the right of exoneration was property of the insolvent trustee, but that the provisions of the Bankruptcy Act governing distribution of the insolvent’s property did not apply. He declined to follow Re Suco Gold and Re Enhill on this point (at [274]).

However the Court of Appeal held that in their view Re Suco Gold and Re Enhill are correct on this issue, repeating twice that:

“Once it is accepted that the right of indemnity is property of the insolvent, the insolvency legislation must apply.” (at [276] and [281])

Their Honours conceded that whilst it might be accepted that, at least where beneficiaries have an interest in the discharge of trust debts, the right of exoneration must only be used for that purpose, the imposition of a requirement of ‘directness’ was not, in their view, a requirement found in the existing authorities (at [279]). In any event, the existence of an inherent limitation on what use the right of indemnity could be put (ie to pay only trust creditors), given that it is ‘property’ in the relevant sense, would not justify a conclusion that the statutory regime did not apply (at [280]).

3.  Is the distribution confined to trust creditors? 

The Court of Appeal returned to this issue, but concluded it was unnecessary to decide this question on the application before them. The right of indemnity is property of the company, and the statutory regime applies to its distribution.

“Whether that property has an inherent characteristic which confines its distribution to trust creditors is not one that we need to decide, as all of Amerind’s creditors are trust creditors.” (at [282])

Their Honours recognised that principles of trust law favoured the approach in Re Suco Gold trust giving cogency to the view confining the use of the right of exoneration to the payment of trust debts only (at [283]). However at [284] their Honours then listed four considerations in favour of the Re Enhill approach that trust creditors and general creditors rank equally on a distribution of property constituted by the right of exoneration.

The Court of Appeal concluded that the receivership surplus was not trust property but was trustee property, and that the priority regime in ss 433(3), 556 and 560 applied to that surplus insofar as those assets were circulating assets at the relevant time (at [285]). They then clearly laid down the following guidance –

“[W]hilst the discussion above discloses that there must be some doubt about which of Re Enhill or Re Suco Gold is correct, it suffices to say that unless and until a subsequent appellate decision decides otherwise, the law as it stands in Victoria as articulated in Re Enhill should continue to be followed by trial judges in this State.” (at [286])

Conclusion

As noted above, their Honours concluded that the receivership surplus subject to the trustee’s right of indemnity was not trust property (but rather property of the trustee company), and the priority regime in ss 433(3), 556 and 560 of the Corporations Act applied to that surplus insofar as those assets were circulating assets at the relevant time.

Two final points. First, I would suggest that in bankruptcy cases (as opposed to corporate insolvency) Derrington J’s judgment in Lane is likely to trump the Court of Appeal’s decision on the Amerind appeal as authoritative in the bankruptcy context.

Secondly, Re Amerind had been having a disturbing ripple effect in other insolvent trading trust cases handed down in the intervening months before the appeal decision, which should now ease. For instance, in a case I appeared in for which judgment was delivered by Robson J last week, Re Mamounia Pty Ltd (in liq) (No 2) [2018] VSC 65, a question arose as to whether the liquidators of a trustee company had power to direct payment of a sum held by a firm of solicitors under a solicitors’ general possessory common law lien to be applied in payment of the solicitors’ fees. (Due to the nature of the common law lien, the solicitors’ right was only a passive right to retain the sum, without a power to pay themselves the fees owing by the insolvent client on multiple files.) The doubt arose in light of the then principle in Re Amerind  that a trustee’s right of exoneration itself was a trust asset and not an asset of the trustee, from which it followed that the power the liquidators would otherwise have under s 477 of the Corporations Act in dealing with property of the trustee company may be lacking. The liquidators of Mamounia, a bare trustee, sought power to be conferred upon them or the company under s 63 of the Trustee Act, if otherwise justified in directing the payment to be made. His Honour agreed to make orders conferring the requisite power under s 63 of the Trustee Act, also noting that Universal Distributing may assist the liquidators, at least for the portion of fees owing that related to work performed in producing the sum held.

At least in Victoria, then, calm has largely been restored and life as it was for insolvency practitioners administering insolvent trustees of trading trusts pre-Amerind may resume. However it remains to be seen what the future holds.

No doubt much virtual ink will be spilt in discussing the Court of Appeal’s judgment in the coming days and weeks. We wait with interest to see how the Full Court of the Federal Court treats these issues in its decision which is surely imminent in In the matter of Killarnee Civil & Concrete Contractors Pty Ltd (in liq) (WAD181/2016). Given the prevalence of the use of trading trusts in Australia, it would be preferable to have both certainty and a national approach on the receivership or liquidation of corporate trustees.

*Postscript #1 – the Full Court of the Federal Court handed down its decision in Killarnee on 21 March 2018. My post giving a snapshot analysis of the decision may be read here, and my article reviewing the decision in Killarnee more closely may be read here.

*Postscript #2 – special leave to appeal to the High Court from the Victorian Court of Appeal’s decision in Amerind has been sought – per my update here. The hearing of the special leave application is yet to be heard. 

Newsflash – judgment in the Amerind appeal handed down this morning

This morning a 5-member bench of the Victorian Court of Appeal handed down judgment in the appeal from the decision of Robson J in Re Amerind (receivers and managers apptd) (in liq) [2017] VSC 127; (2017) 320 FLR 118. The bench comprised Ferguson CJ, Whelan JA, Kyrou JA, McLeish JA and Dodds-Streeton JA.

In a unanimous judgment overturning the decision of Robson J, the plurality held that Amerind’s right of indemnity as trustee over trust assets for liabilities it incurred on behalf of the trust was property of the company (not, as his Honour had held at first instance, property of the trust) and that the priority regime in the Corporations Act therefore applied.

The Court held that the Commonwealth (following its advance under FEGS) was entitled to be paid by the Receivers before other creditors from particular assets.

Their Honours did however uphold Robson J’s decision that certain property in issue was subject to a circulating security interest, including cash in Amerind’s trade account, funds advanced to Amerind under a factoring arrangement, and miscellaneous receipts.

I note that there is also a judgment which addresses similar issues pending since it was heard on 10-11 August 2017 by the Full Court of the Federal Court in In the matter of Killarnee Civil & Concrete Contractors Pty Ltd (in liq) (WAD181/2016). I will keep an eye on that also.

More to follow re Amerind, with links to the judgment, once it is up on Austlii.

If anyone cannot wait that long, I recommend that you read the bankruptcy judgment from August last year of Derrington J in Lane v Deputy Commissioner of Taxation [2017] FCA 953. In it, Derrington J took a different view to some of the conclusions of Robson J in Re Amerind. On the question of whether the trustee’s right of indemnity and lien was property of the trust or of the trustee, Derrington J queried whether a conclusion that the right of exoneration was property of the trustee necessarily meant that it was available to the trustee’s general creditors. His Honour took the view that whether the right of exoneration was a trust asset or a trustee asset, there was only one method by which the right could be exercised and that was by the application of trust funds to paying the claims of trust creditors (whether by the trustee or by the trust creditors exercising their right of subrogation to the right of exoneration and lien). Even if the right of exoneration is an asset of the trustee, any property received by a bankruptcy trustee is subject to all of the liabilities and equitable interests existing prior to the bankruptcy. Accordingly the trustee, and subsequently its bankruptcy trustee or its liquidator, could only ever apply trust funds in discharge of trust debts (at [94]-[117]). Derrington J concluded in that case that a trustee’s right of exoneration from trust property was an asset of the trustee.

Watch this space.

New article on Sino Iron v Worldwide Wagering – Fraud and liability in restitution for online sports betting companies and their operators

I have added a new article to my website – Fraud and liability in restitution for online sports betting companies and their operators. The article can be accessed here.

Abstract: With the proliferation of online sports betting enterprises, the decision in Sino Iron Pty Ltd v Worldwide Wagering Pty Ltd [2017] VSC 101 provides a salient warning to those who stand behind them. The case usefully illustrates the legal ramifications where the sports betting company receives a questionable payment and not enough is done by those involved to verify its legitimacy.

Issues of law raised by the fraud and addressed in the judgment include claims for money had and received, Black v Freedman trusts of stolen money, and Barnes v Addy knowing assistance and knowing receipt claims against third parties. It is useful for practitioners to be across the five Baden categories of knowledge, to assess when on a particular set of facts a claim may be established or a defence to such a claim made out.

*** Note that the article was written at the request of and was first published by LexisNexis in the September 2017 issue of the LexisNexis Internet Law Bulletin, volume 20, issue 6, pp 107-110. 

 

Contract law update – Repudiation and how restraint of trade benefits may be lost post termination

Last month the Victorian Court of Appeal handed down judgment in a case which serves as a salient warning for companies or firms when acquiring a business. The case is Crowe Horwath (Aust) Pty Ltd v Loone [2017] VSCA 181.

It  can be common in such circumstances for the new owner to set about reviewing the business practices of the acquired business in its various aspects. They may consider making changes to synergise with the new owner’s own business models. However in doing so, this case demonstrates that the new owner ought take care not to repudiate employment agreements. They may lose the benefit of terms intended to operate to protect the employer post-termination.

More broadly this case also demonstrates that even where a contract provides for certain obligations or restraints to continue to operate post-termination, repudiating the contract may lose the repudiating party those benefits, in certain circumstances.

Repudiation – Key Principles

Before turning to the decision itself, I first set out my distillation of the key principles relating to repudiation and termination of contracts –

  1.  Repudiation is –
    1. Conduct which evinces an unwillingness or an inability to render substantial performance of the contract; evinces an intention no longer to be bound by the contract, or to fulfil it only in a manner substantially inconsistent with the party’s obligations:   Koompahtoo Local Aboriginal Land Council v Sanguine Pty Ltd (2007) 233 CLR 155 at [44]
    2. Any breach of contract which justifies termination by the other party. May include breach of an essential condition, or a sufficiently serious breach [Comment: often multiple breaches] of a non-essential term:  Koompahtoo at [47]-[49]
  2. It is a serious matter, not to be lightly found; it requires a clear indication of the absence of readiness and willingness to perform the contract. Not all breaches will amount to repudiation:  Shevill v Builders Licensing Board (1982) 149 CLR 620, 633
  3. Objective test:  Whether the party’s conduct would convey to a reasonable person, in the position of the other contracting party, renunciation of the contract as a whole or of a fundamental obligation under it:  Koompahtoo at [44]
  4. Response to repudiation can be –
    1. Accept it, and elect to terminate, or
    2. Elect to continue performance of the contract.
  5. To accept and terminate, one must communicate this by words or conduct; the latter must be enough to make the election manifest to the other party:  Karacominakis v Big Country Developments Pty Ltd [2000] NSWCA 313 at [155]
  6. If a party chooses to accept and terminate, the parties are discharged from further obligations to perform, though accrued rights and obligations remain.
  7. Obligations required to be performed in future can survive termination if, on the proper construction of the contract, such obligations are intended to, ie performance is not contingent on the contract’s subsistence. Examples typically can include dispute resolution procedures, choice of law, exclusion of liability, agreed damages, return of property, sometimes restraint of trade. However it is always a question of the proper construction of the relevant contractual term: Richmond v Moore Stephens Adelaide Pty Ltd [2015] SASCFC 147 at [195]-[199].

Facts of the case – as found by the Court

Crowe Horwath (Aust) Pty Ltd (CHA ) acquired an accounting business which included a Launceston office, run by Mr Loone. At all relevant times Mr Loone was the most senior executive and accountant in the Launceston office, and up until 2015 Mr Loone exercised full autonomy in the running of the Launceston office.

In January 2015 CHA was acquired by Findex Group Limited. Through 2015 Findex sought to rationalise and streamline CHA operations across all the CHA offices. These changes were said to be the brainchild of the new owner of CHA. Their nature and implementation were identified by the catchy phrases ‘one best way (to build the business)’, the ‘family office model’, the ‘family office structure’, and the ‘family office initiative’. (See [31] and [124]-[125])

A dispute arose over changes to Mr Loone’s duties under the restructure, and the payment of bonuses to him. As to the former, under the employment contract Mr Loone’s position was that of ‘Managing Principal’. Clause 1.4 provided that the company could require him to occupy a different position, but only if it had consulted with him in relation to the change, and if the other position had at least equivalent status to, and a level of remuneration equivalent to, the position he held. The trial judge found that CHA had breached that clause, and that such breach was so serious as to constitute repudiatory conduct by it.

As to the dispute as to bonuses, CHA proposed to institute an ‘incentive model’ under which, 20% of bonus entitlements would be deferred for a 3-year period. There was a dispute as to the proper construction of clause 7.5 of the employment agreement, which governed annual entitlement’s to bonuses. In the end, the trial judge concluded that the effect of CHA’s decision to implement the new model constituted repudiatory conduct by CHA. There was further repudiatory conduct found, relating to a proposed exclusion from the calculation of the Launceston bonus pool.

In the end Mr Loone left CHA and started his own accounting firm.

CHA argued that restraint of trade clauses in Mr Loone’s employment contract prevented him for 12 months from engaging in competition within 5kms of the prior location, and soliciting work from CHA clients that he had dealt with directly.

Mr Loone argued that the employer CHA had repudiated his contract, he had relied on that repudiation and terminated the contract, and the restraint of trade clause cased to apply and was not enforceable in those circumstances.

The Judgment

At first instance the trial judge agreed with Mr Loone, holding that CHA had repudiated Mr Loone’s employment contract, Mr Loone’s acceptance of the repudiatory conduct terminated the contract, and the restraint of trade clause was unenforceable in those circumstances. [155]

The Court of Appeal agreed, in a unanimous judgment. Their Honours acknowledged that the restraint of trade clause was designed to protect the interests of CHA, and was intended to operate after the contract terminated. [193(1)]. However there is clear authority that language such as that used in the restraint of trade clause will not save the restraint clause where an employer’s repudiatory conduct is accepted by an employee. [193(12)] Their Honours took the view that it was not necessary to conclude there was a ‘rule of law’ which dictates this result in every factual situation involving an employee’s acceptance of an employer’s repudiation of the contract between them. But having said that – all cases considered to date have produced the same outcome. [193(6)]

Indeed the Court noted that for over 100 years a series of decisions in the High Court, and in courts of higher authority in England and Canada have stated that a restraint clause is not enforceable against an employee whose employment ends by the employer’s wrongful conduct. That conduct might be wrongful dismissal, or the employee’s acceptance of the employer’s repudiatory conduct. But researches of all counsel involved, the trial judge, and the Court of Appeal had revealed no reported case in a court of superior jurisdiction in Australia or England which had decided otherwise. [193(3)-(4)]. From paragraph [196] onwards the Court then reviewed many of those decisions, concluding at [271] that the authorities show a consistent trend – though with different juridical explanations – denying an employer who has repudiated a contract of employment, which repudiation has been accepted by the employee, from relying upon a restraint clause against the employee.

In this case, the Court of Appeal took the view that termination of a contract by an employee’s acceptance of an employer’s repudiatory conduct could be said to stand outside the contractual provisions relating to termination. On the proper construction of this contract, the intention of the parties, objectively ascertained, was that the clause would not operate in those circumstances. Acknowledging that the contract provided that: “The obligations in this Schedule 2 [including the restraint of trade clause] survive the termination of the Employment in all circumstances and for any reason“, the Court held that the words in bold should be understood to embrace any and all of the circumstances of termination set out in the contract, together with repudiatory conduct of the employee accepted by the employer – but not the converse. Their Honours reasoned that:

Such a construction is compatible with the fact that the restraint clause was designed to benefit the employer but recognising that there is good reason to differentiate, on objective consideration of the contract, between the consequences of gross default by the party claiming the benefit of such a clause and gross default by a person bound by the burden thereof.” (See [193(11)])

Takeaways

Care ought be taken after a business is acquired when the new owner may move to implement changes to business practices to increase synergies and improve efficiencies. Whilst those changes may be worthwhile from a business perspective, care ought be taken to avoid repudiating employment agreements. This could lead to key staff leaving and setting up business in competition, unfettered by the restraint of trade clauses that ought to have endured to protect the business they have left.

More broadly this case also demonstrates that even where a contract provides for certain obligations or restraints to continue to operate post-termination, repudiating the contract may lose the repudiating party those benefits, in certain circumstances.

* This case review was one part of a presentation I was asked to give on 15 August 2017 to the Leo Cussen Centre for Law’s 2017 Corporate Counsel Conference, on recent cases and developments in contract law. I thank Leo Cussen for their agreement to my publishing this case review here.

Sino Iron v Worldwide Wagering – a case of fraud and restitution “with the lot”

It has not been a good week in Australian courts for sports betting enterprises. On Thursday Tabcorp was fined $45million for breaching anti-money laundering and counter-terrorism financing laws. To less publicity, the day prior, the Victorian Supreme Court found another sports betting company and individuals and companies associated with it were liable for the consequences of receipt of stolen funds of over $2million. The case is Sino Iron Pty Ltd v Worldwide Wagering Pty Ltd [2017] VSC 101.

This was a case of fraud and restitution “with the lot” – the issues raised by the fraud and addressed in the judgment include money had and received (the stolen funds), Black v Freedman trusts and when they arise, Barnes v Addy claims against third parties for knowing receipt of trust funds and knowing assistance in breaches of trust, the Baden categories of knowledge, when knowledge of an agent will be imputed to the principal, the change of position defence, indefeasibility of title and the fraud and in personam exceptions, tracing issues, and more.

The facts as found by the Court

The two plaintiff companies were involved in the development of Australia’s largest magnetite mining and processing project, the Sino Iron Project, conducted at Cape Preston in the Pilbara, Western Australia. They incurred large debts to a company called Monadelphous Engineering Associates Pty Ltd.

The fraudster, pretending to be an authorised representative of Monadelphous, contacted the plaintiffs and directed payment of Monadelphous’ invoices to be paid into a new bank account. The bank account details given were those of the fourth defendant, a company incorporated in Norfolk Island called Worldwide Wagering Pty Ltd. Worldwide carried on an international sports betting business under the name “Pinnaclebet”.

The plaintiffs paid a total of $2,147,689 into Worldwide’s ANZ bank account on 30 May 2016. Worldwide’s sole director Mr H (the fifth defendant), and its general manager Mr O (the sixth defendant), initially suspected fraud when the funds were paid into their company’s account, as there had been a similar theft from La Trobe University about two weeks earlier. They reported it to the police. However they then spoke with a Worldwide customer known to them, a Mr S, who claimed an entitlement to bet with the funds, and on 1 June 2016 they arranged for Worldwide to credit the stolen funds to Mr S’s betting account. Mr O and Mr H gave evidence this was after checking by email with the police (see [140]-[142]), although the judge found on the evidence that the emails to the police excluded important information including Mr S’s surname, to protect Mr S from further enquiries by the detective (see [193]-[200]).

The stolen funds were then gambled on international sporting events. Most bets were lost. Worldwide paid out $550,000 to Mr S on winning bets. The Court found that most of the approximately $2million was used by Worldwide, Mr H, or related companies. The defendants admitted they had actual knowledge of the fraud at 1.13pm on 7 June 2016, six days after crediting the funds to Mr S’s betting account, and after Mr S had placed his last bet. However after that time, the stolen funds continued to be used by the defendants or related companies (see [8]). This included a sum of nearly $796,000 which passed through a related company The Odds Broker and was used by Mr H to purchase a bank cheque, which was then used to settle the purchase by Mr H and Mr O as tenants in common in equal shares of a property at Bondi Junction. See [6] – [12] of the judgment for summary details of the application of the funds. After Mr S’s last bet, the remaining credit in Mr S’s betting account was $70,479.40, which was later repaid to the plaintiffs.

The plaintiffs claimed the balance of the stolen funds ($2,077,210) or their specific traceable proceeds, on multiple grounds. See the list of claims held to have been successfully made out, in the next section below .

The defendants’ arguments included that prior to the time they had actual knowledge of the fraud, they were entitled to rely on Mr S’s statements that the stolen funds belonged to him or those for whom he acted as agent and were legally obtained. Hence, so they contended, the stolen funds were received by Worldwide, and thereafter dealt with by it and the other defendants, as a bona fide purchasers for value without notice of the fraud. They argued the change of position defence (see below). They also argued that Worldwide did not receive the stolen funds on trust as alleged, because at the time of receipt it had no knowledge of the fraud. (See [23]) They succeeded in this last contention, although it only delayed the arising of the trust for 48 hours after receipt of the funds. The question of when the Black v Freedman trust arose is discussed below.

THE SHORT VERSION 

For those wanting a short summary of the outcome of the decision, here it is: The Court held the plaintiffs had established an entitlement to relief on the following (co-existing and overlapping) grounds –

First, for $2,077,210 against Worldwide on the basis of:

  1. the common law claim for money had and received;
  2. the proprietary claim under Foskett v McKeown principles; and
  3. breach of its Black v Freedman trust obligations.

Second, against Mr H and Mr O for $2,077,210 for knowingly assisting Worldwide to breach its Black v Freedman trust obligations.

Third, against Mr O for knowingly assisting Worldwide, The Odds Broker and Mr H to breach their respective Black v Freedman trusts by disposing of the traceable proceeds of the stolen funds comprised in the $800,000 transferred from Worldwide’s ANZ account to a bank account of The Odds Broker, from whence it was transferred to personal bank accounts of Mr H.

Fourth, against Mr H for the traceable proceeds of the stolen funds comprised in the $800,000 on the basis of:

  1. money had and received; and
  2. knowing receipt of trust property.

Fifth, against Mr H and Mr O for the traceable proceeds of the stolen funds comprised in the $345,000, for knowingly assisting Worldwide to breach its Black v Freedman trust obligations.

Sixth, against Worldwide for proprietary relief in the form of an equitable charge over the Worldwide ANZ account to secure the traceable proceeds of the stolen funds remaining in that account.

Seventh, against Mr H and Mr O for proprietary relief in the form of an equitable charge over the Bondi Junction property to secure the traceable proceeds of the stolen funds used to purchase that property.

Eighth, against Worldwide for $8,500 as an account of profits made from its breach of trust.

Each of these findings involved rejection of the change of position and bona fide purchaser for value without notice defences, on the ground that the defendants did not act in good faith at relevant times because of their knowledge of the fraud to the level of the third Baden category (wilfully and recklessly failing to make such inquiries as an honest and reasonable person would make). The indefeasibility defence also failed.See [452]-[462] for these conclusions. The proceeding was adjourned to allow further evidence and submissions before determining tracing issues.

For those interested in reading more about the claims and defences argued in this case, and a discussion of the legal principles involved, read on.

THE LONG VERSION

1. Knowledge of the fraud

In making his findings as to knowledge, Hargrave J first set out the 5 so-called “Baden categories of knowledge” at [27], derived from the well-known 1993 UK decision. The level of knowledge required to be proven to succeed in a relevant claim or defence varies according to the particular claim or defence. The Baden categories of knowledge are –

(1) actual knowledge;

(2) wilfully shutting one’s eyes to the obvious;

(3) wilfully and recklessly failing to make such inquiries as an honest and reasonable person would make;

(4) knowledge of circumstances which would indicate the facts to an honest and reasonable person; and

(5) knowledge of circumstances which would put an honest and reasonable person on inquiry.

(For a further discussion of these categories, see my 2012 article on Grimaldi v Chameleon Mining here.)

None of the parties alleged that Mr S was a party to the fraud. His Honour remarked that that remained an open question (see [63]), and applied the rule in Jones v Dunkel to drew an adverse inference from the defendants’ failure to call Mr S to give evidence (see [201]-[203]).

The defendants admitted they had actual knowledge of ‘a suspicion of’ the fraud at approximately 1.13pm on 7 June 2016, several hours after an ANZ officer initially told Mr H of it. By 1.13pm Mr H believed the stolen funds were ‘likely’ to have been fraudulent deposits and instructed a staff member to freeze Mr S’s betting account. The Court found that Mr H had actual knowledge of the fraud in the first Baden category from the time he gave that instruction on 7 June. (See [98]-[99])

Worldwide, Mr H and Mr O contended that at the time the stolen funds were credited to Mr S’s betting account 6 days prior, on 1 June 2016, they had made all reasonable inquiries to satisfy themselves that Mr S was entitled to bet with the funds (see [157]). Hargrove J did not accept these submissions.

His Honour took the view  that the knowledge that they had admitted to having at that time constituted circumstances which would have led an honest and reasonable person in their position to have made further inquiries before crediting Mr S’s account with the stolen funds. Thus they should have made those inquiries, including the ‘simple inquiry‘ of ascertaining the identities of the depositors of the stolen funds (the plaintiffs) from the internet bank statements, and contacting them to ask if the deposits had been made by the plaintiffs for the purpose of the international sports betting customer claiming the funds. His Honour found that had they done so, the fraud would have been revealed and Mr S’s betting account would not have been credited (see [158]-[159]).

That finding is suggestive of Baden category 5, possibly 4. However the Court went further, and held that Mr H and Mr H acted wilfully and recklessly in failing to make the ‘simple inquiry’ – see Baden category 3 above. His Honour observed that they also had a commercial motive to want to believe Mr S’s claims, being their plan to expand the business’s turnover and customer base to ready it for sale from which they each stood to profit. As a result, his Honour found, they accepted as true flimsy information from a man with, at best, a mixed reputation, and made only superficial inquiries (see [168]-[179]).

His Honour made his findings to the Briginshaw standard (see [180]-[182]). He found that the defendants had knowledge of the fraud in the third Baden category at the time Mr H and Mr O issued the instructions for Mr S’s betting account to be credited with the stolen funds, and thus before any bets were placed. If that were wrong, his Honour held that the defendants had that level of knowledge after the account was credited but before any bets were placed, or alternatively, prior to the final $1.3m in bets were placed on the morning of 7 June (see [272]).

2. Claims in restitution based on mistaken payments, money had and received

The principles his Honour identified from the authorities were these (see [275]-[279], [286]- [288]) –

  1. When money is paid under a mistake of fact, the person paying the money may recover it from the recipient in a common law action for money had and received. Recovery depends upon whether it would be inequitable for the recipient to retain the benefit. Retention may not be inequitable if the recipient has changed its position on the faith of the receipt and thereby suffered a detriment:  Australian Financial Services Leasing Pty Ltd v Hills Industries Ltd [2014] HCA 14; (2014) 253 CLR 250, 568 per French CJ;
  2. Direct receipt is unnecessary; indirect receipt by a volunteer of traceable proceeds of the money paid by mistake is enough: Fistar v Riverwood Legion & Community Club Ltd [2016] NSWCA 81; (2016) 91 NSWLR 732, 746 [62]-[64];
  3. In a common law action based on money paid by mistake, it is not necessary for the plaintiff to allege or prove that the retention of the money received by the defendant would be inequitable. That is a matter for defence, on which the defendant bears the onus: ASFL v Hills Industries at 593 [66]-[67]; David Securities Pty Ltd v CBA [1992] HCA 48; (1992) 175 CLR 353, 379;
  4. One such defence is change of position. Gageler J in AFSL v Hills Industries proposed two conditions for proof of this defence –
    1. That the defendant has acted or refrained from acting in good faith on the assumption that he/she/it was entitled to deal with the payment received. The defendant need not have relied on knowledge derived from the payer.
    2. That by reason of having so acted or retained from acting, the defendant would be placed in a worse position if ordered to make restitution of the payment than if the defendant had not received the payment at all. The detriment need not always be financial. If it is, it need not be established with precision. It can be an opportunity forgone. However it must, in every case, be shown by the defendant to be substantial: ASFL v Hills Industries at 625-626 [157];
  5. This formulation has been accepted by the Victorian Court of Appeal as consistent with the defence and the principles on which it is based as set out by the majority in AFSL v HillsSouthage PL v Vescovi [2015] VSCA 117; (2015) 321 ALR 383, 399 [65].
  6. A defendant relying on a change of position defence who, prior to the change of position, wilfully and recklessly fails to make such inquiries as an honest and reasonable person would make in all the circumstances (i.e. once they have knowledge to the 3rd Baden category), does not act in good faith on the assumption that he, she or it is entitled to deal with the mistaken payment (which is the 1st of Gageler J’s two conditions for this defence): Macquarie Bank Ltd v Sixty Fourth Throne PL [1998] 3 VR 133, 143-144.

The plaintiffs’ claim under this head was against Worldwide for all of the $2.14 million stolen funds (less the approx $70,000 balance at the end, already repaid), and against related company The Odds Broker for $800,000, and against Mr H for $800,000.

The Court held that the defendants could not avail themselves of the defence here because they had sufficient (Baden category 3) knowledge of the fraud at the time each bet was accepted (see [282]). Worldwide was held liable to the plaintiffs for money had and received for the approx $2million.

The Odds Broker and Mr H argued they were not direct recipients of the stolen funds from the plaintiffs. As regards The Odds Broker, $800,000 was paid to it from the Worldwide ANZ account which was substantially comprised of traceable proceeds of the stolen funds (see [290]). There was no evidence The Odds Broker provided any consideration for the payment or changed its position on the faith of the receipt. On the evidence, it did not act in good faith. It was held liable to the plaintiffs for the traceable proceeds of the $800,000 as money had and received.

As regards Mr H and the $800,000 on-paid by The Odds Broker to Mr H’s personal accounts and applied towards the purchase of the Bondi Junction property, the tracing exercise was not straightforward. However even on the defendants’ case, $731,349.45 of the $800,000 was traceable to the Bondi Junction property. The Court found Mr H did not act in good faith because he had the requisite degree of knowledge. Mr H was held liable to the plaintiffs for $800,000 (or its traceable proceeds) as money had and received. ( See [286]-[294])

3. The Black v Freedman trust on which Worldwide held the funds for the plaintiffs – and when it arose

Hargrove J considered the nature of the trust created by receipt of stolen moneys under the Black v S Freedman & Co [1910] HCA 58; (1910) 12 CLR 105 line of authorities from [306]. His Honour discusses these principles –

  1. Black v Freedman has been treated in Australia as a settled law that a thief holds stolen property on trust for the victim: Levy v Watt [2014] VSCA 60; (2014) 308 ALR 748, 766 [65] (see [313]);
  2. For volunteer recipients of stolen money from the fraudster:  a person entirely innocent of a fraud who comes to know that he or she has received and still retains the proceeds of, or taken advantage of, a fraud to which he or she was not party, cannot knowingly seek to retain those proceeds or that advantage without, in effect, becoming a party to that fraud and liable accordingly: Heperu Pty Ltd v Belle [2009] NSWCA 252; (2009) 76 NSWLR 230, 253 [92] (see [314]);
  3. The innocent recipient’s liability is limited to the amount of the stolen funds (or their traceable proceeds) remaining in the hands of the innocent recipient at the time sufficient knowledge of the theft is obtained: Heperu at 264-268 (145]-[163] (see [315]);
  4. In summary, a third party who receives stolen money as a volunteer is only obliged to account to the beneficial owner of the stolen property on Black v Freedman principles to the extent the recipient holds the stolen property or its traceable proceeds at the time the recipient obtains sufficient knowledge of the theft (see [316]).

(In relation to the first principle above, I note in passing that whilst that proposition is settled law, there has been much controversy about whether this is indeed the correct proposition for which Black v Freedman stands. In Fistar v Riverwood Legion and Community Club Ltd [2016] NSWCA 81; (2016) 91 NSWLR 732 at [37] Leeming JA noted this and discussed the cases and academic writings . Leeming JA noted the principal perceived difficulty is that it is said that a thief can have no title to stolen property and so cannot become a trustee for the true owner. His Honour preferred the view on this of Dr Fox expressed in his 2008 book Property Rights in Money, that what the thief is treated as having is legal possession, and therefore a possessory legal title which is capable of being held on trust. A mere finder of a chattel who has nothing more than possession, has a right against other putative possessors who lack better title. This extends even to thieves. But the thief’s right to possess is exigible only against others, not against the true owner: see Bride v Shire of Katanning [2013] WASCA 154 at [72] per Edelman J (with whom Newnes JA agreed). I note that there are other points of controversy concerning Black v Freedman, including whether the reasons there were confined to property disposed of by those in a fiduciary position.)

His Honour concluded that a trust did not arise upon Worldwide’s receipt of the stolen funds. It had not been proven it had sufficient knowledge of the fraud when it received them on 30 May 2016 (see [316]). However, when the defendants did acquire sufficient knowledge of the fraud on 1 June 2016, Worldwide became liable in equity to account to the plaintiffs for the stolen funds, all of which were still in its hands. The Court held that from that time, Worldwide was a trustee of those funds for the plaintiffs under either a constructive or resulting trust (see [325] and the citations of Heperu at [154]-[155] and Sze Tu v Lowe [2014] NSWCA 462 at [141]-[162]).

4. Knowing receipt – Barnes v Addy first limb

On the findings of knowledge already made, it was held The Odds Broker knowingly received the $800,000 with sufficient knowledge of the fraud. The Odds Broker thus became liable to account to the plaintiffs for that amount as a constructive trustee. It breached that trust by paying the $800,000 or its traceable proceeds to Mr H (see [326]).

Similarly, Mr H received the on-payment from The Odds Broker with knowledge of the fraud. Mr H gave evidence he did not know the money was sourced from the stolen funds when he received it into his bank account. However it was held this made no difference, because Mr O knew all the relevant facts and acted as Mr H’s agent in arranging the transfer of the $800,000 to Mr H’s account to enable the purchase of the property. Mr O’s knowledge was attributable to Mr H, so Mr H knowingly received the traceable proceeds of the $800,000 and thus became liable to account to the plaintiffs as a constructive trustee for that amount. He beached that trust when Mr O, as Mr H’s agent, used the traceable proceeds to purchase the Bondi Junction property (see [327]).

5. Knowing assistance – Barnes v Addy second limb

To be liable under the second limb of Barnes v Addy for knowing assistance, his Honour pointed out at [331] that it must be established that –

  1. The defendant assisted a trustee or fiduciary in a breach of trust or fiduciary obligation;
  2. That breach of trust or fiduciary obligation is characterised by the Court as a ‘dishonest and fraudulent design’, and
  3. The assistance was given with the requisite degree of knowledge of that dishonest and fraudulent design.

As to the third element – the requisite degree of knowledge by the recipient – it was accepted that Baden categories 1 to 4, but not category 5, are sufficient for both the first and second limbs of Barnes v Addy. This is consistent with authority: Farah Constructions (2007) 230 CLR 89, 163-4 [177]; Grimaldi v Chameleon Mining NL (No 2) [2012] FCAFC 6; (2012) 200 FCR 296, 362 [262]; Mathieson Nominees v Aero Developments [2016] VSC 131 [166]. Category 5 is a form of constructive notice, rather than knowledge, and is considered insufficient. (See [332])

The Court concluded at [359] that –

  1. Mr H and Mr O knowingly assisted Worldwide to breach its trust obligations in respect of the whole of the stolen funds and hence each was liable to the plaintiffs for equitable compensation for the unpaid balance of that amount (just over $2million),
  2. Mr H and Mr O were also liable for knowing assistance in respect of the traceable proceeds of the stolen funds comprised in payments totalling $345,000,
  3. Mr O was liable for knowingly assisting Worldwide and The Odds Broker to breach their respective trust obligations regarding the traceable proceeds of the stolen funds comprised in the $800,000,
  4. Mr O was also liable for the traceable proceeds of the stolen funds comprised in the $800,000 for knowingly assisting Mr H to breach his Black v Freedman trust obligations, by using those proceeds to purchase the Bondi Junction property.

These liabilities overlapped with each other and other grounds of liability.

The plaintiffs also made proprietary claims over assets which remained to hand, including the Bondi Junction property.

6. Traceable into the Bondi Junction property?

The plaintiffs claimed entitlement to a proprietary remedy against the property in the form of a charge or equitable lien. This was on the basis that the Bondi Junction property was purchased with a bank cheque sourced from the traceable proceeds of the stolen funds comprised in the $800,000. (Hargrove J noted here that the plaintiffs’ claims against the Bondi Junction property were also established on the basis that Mr H funded the purchase of it in breach of his Black v Freedman obligations, with Mr O’s knowing assistance. See [364])

His Honour noted the following tracing principles –

  1. The beneficial owner of misappropriated property can recover it or its traceable proceeds from the person holding the asset, subject only to the defence that the holder is a bona fide purchaser for value without notice: Foskett v McKeown [2000] 1 AC 102, 129, 108-9, 115;
  2. Where a trustee wrongfully uses trust money to provide part of the cost of acquiring an asset, the beneficiary is entitled at his option either to claim a proportionate share of the asset or to enforce a lien upon it to secure his personal claim against the trustee for the amount of the misapplied money. It does not matter whether the trustee mixed the trust money with his own in a single fund before using it to acquire the asset, or made separate payments (whether simultaneously or sequentially) out of the differently owned funds to acquire a single asset: Foskett v McKeown, the ‘basic rule’ stated by Lord Millett at 131.

Here, the plaintiffs’ property was constituted by their choses in action against their bank representing funds held to their account, including the stolen funds. When their bank mistakenly paid the amount of the stolen funds to Worldwide, the plaintiffs’ property was extinguished and Worldwide obtained a chose in action against its bank ANZ, which became the traceable substitute for the plaintiffs’ former property. In turn, further traceable substitutes for lesser amounts were created by the subsequent movement of the $800,000 (or its traceable proceeds) to the bank accounts of The Odds Broker and Mr H and, subsequently, the relevant bank cheque and the Bondi Junction property (see [365]).

In accordance with Lord Millett’s ‘basic rule’, the plaintiffs had elected to claim a charge on the Bondi Junction property to secure their personal claims against Mr H and Mr O for the traceable proceeds of the stolen funds comprised in the $800,000. Subject to the defendants’ defence based on indefeasibility of title, the Court held those claims should succeed (see [367]).

7. Is this claim against the property defeated by indefeasibility of title?

The defendants argued that Mr H and Mr O’s title to the Bondi Junction property was indefeasible by operation of s 42 of the Real Property Act 1900 (NSW). The merits of this argument turned on whether the events in this case brought it within the fraud exception to indefeasibility of title, as provided in s 42(1).

Hargrove J noted it has been held that –

  1. ‘Fraud’ in s 42(1) means ‘actual fraud, moral turpitude’ or ‘dishonesty of some sort’: Farah Constructions (2007) 230 CLR 89, 169 [192]; Bahr v Nicolay (No 2) (1988) 164 CLR 604, 614 (see [373]);
  2. The 3rd Baden category of knowledge is a species of actual knowledge (as opposed to constructive knowledge): Farah Constructions (2007) CLR 89, 163 [174] (see [375]);
  3. Causing registration on title in circumstances of wilful blindness (failing to make such enquiries as an honest and reasonable person would make) may be dishonest, and was categorised by Tadgell JA as fraudulent in Macquarie Bank Ltd v Sixty Fourth Throne Pty Ltd [1998] 3 VR 133, 143-4 (see [375]).

The Court found that Mr O’s actions in causing his registration as an equal proprietor of the Bondi Junction property were dishonest (at [375]). It found he wilfully and recklessly failed to make such enquiries as an honest and reasonable person would make before instructing a staff member to credit the stolen funds to Mr S’s betting account on 1 June 2016, thus allowing the stolen funds to be used to place bets on that account. This fell within the 3rd Baden category of knowledge. Other evidence of Mr O’s showed that the $800,000 transferred from Worldwide to The Odds Broker  was directly referable to the stolen funds (see [376]). Moreover, on the defendants’ admissions of when they acquired actual knowledge of the fraud at 1.13pm on 7 June 2016, Mr O completed the purchase after obtaining this actual knowledge. He nevertheless proceeded to do so.

Notably, his Honour observed at [378]: “Although Mr O… may not have appreciated that his actions were dishonest, they were.” His Honour so found based on the evidence, and on the High Court’s observation in Farah Constructions at [173] that: “As a matter of ordinary understanding, and as reflected in the criminal law in Australia, a person may have acted dishonestly, judged by the standards or ordinary, decent people, without appreciating that the act in question was dishonest by those standards.

The Court also found that Mr H’s registration as an equal proprietor of the Bondi Junction property was procured by fraud for which he was responsible (from [379]). The plaintiffs contended that even if Mr H did not know the money in his personal bank account used to purchase the bank cheque to buy the property was sourced from the stolen funds, he had authorised Mr O to act as his agent in obtaining the moneys required for settlement of the purchase and that Mr O’s knowing use of the stolen funds should be imputed or “brought home” to Mr H as principal.

On this question of attributing the knowledge of an agent to the principal, at [389] Hargrave J noted the reasoning of the High Court in Cassegrain v Gerard Cassegrain & Co Pty Ltd [2015] HCA 2; (2015) 254 CLR 425 as follows –

  1. The title of a registered proprietary may be invalidated on the ground of fraud ‘brought home’ to the registered proprietary or to his agents: Cassegrain 436-7 [32], citing Assets Co Ltd v Mere Roihi [1905] AC 176, 210;
  2. Whether fraud by an agent will be brought home to the registered proprietor depends upon the ‘scope of authority and whether the agent’s knowledge of the fraud is to be imputed to the principal [registered proprietor]’: Cassegrain 439 [40]. This involves consideration of why the fraudster’s knowledge should be imputed to the registered proprietor: Cassegrain 439 [41];
  3. It is not sufficient to impute the agent’s fraud to the registered proprietor whether the registered proprietor is ‘no more than the passive recipient of an interest in land’: Cassegrain 439 [41];
  4. In order to bring fraud home to the registered proprietor, it is necessary to show that the agent’s fraud was within the scope of the agent’s authority given by the registered proprietor: Cassegrain 439 [42].

In the present case, the Court found Mr H gave a broad general authority to Mr O to move funds between the relevant accounts and he expected that the money required to complete the purchase of the property would be moved into his personal account from one of the accounts Mr O was authorised to operate. Hargrave J found that Mr O’s authority was sufficiently broad to encompass using the stolen funds if that was the only available source at the time to enable completion of the purchase. The Court found that given that Mr H had the same knowledge of the fraud as Mr O at relevant times, and thus acted dishonestly in instructing Mr O to arrange for Mr S’s betting account to be credited with the stolen funds, the Court was satisfied on the evidence that Mr O’s broad authority encompassed him acting fraudulently by using the stolen funds to complete the purchase if that was necessary. (See [391]-[392])

8. The in personam exception to indefeasibility of title

In addition to the statutory fraud exception to indefeasibility of title under s 42 of the Act, Hargrave J went on to find that indefeasibility also did not accrue as the in personam exception to indefeasibility of title was also made out. His Honour noted that in personam exception was generally described as existing ‘in relation to certain legal or equitable causes of action against the registered proprietor’ in Farah Constructions (2007) 230 CLR 89, 169 [193]. This language echoes the requirement that the in personam exception depends on the establishment of a known legal or equitable cause of action: Macquarie Bank Ltd v Sixty Fourth Throne Pty Ltd [1998] 3 VR 133, 146-7. (See [394]) Hargrave J also noted the statements of Brennan J in Bahr v Nicolay (No 2) (1988) 164 CLR 604, 653 to the effect that the in personam exception does ‘not infringe the indefeasibility provisions of the Act. Those provisions are designed to protect a transferee from defects in the title of the transferor, not to free him from interests with which he has burdened his own title‘.

On the findings in this case, the plaintiffs’ claim for an equitable lien or charge over the Bondi Junction property arises from their establishing the known legal causes of action based on (1) Foskett v McKeown tracing principles, (2) Mr H’s breach of his Black v Freedman trust obligations, and (3) knowing assistance in that breach by Mr O. The Court held that the conduct of Mr H and Mr O, before registration of their interests as proprietors of the Bondi Junction property, had burdened their interests. (See [394]-[397])

(Sidenote: Hargrave J’s seemingly unexamined acceptance here that a knowing assistance Barnes v Addy claim is a personal equity which may defeat indefeasibility of title under the in personam exception appears to be directly inconsistent with obiter in the judgment last year of Vickery J in Mathieson Nominees Pty Ltd v Aero Developments Pty Ltd [2016] VSC 131. In that decision his Honour noted the debate on this point between various courts and confirmed the effect of ratio in Farah Constructions v Say-Dee [2007] HCA 22; 230 CLR 89, 140 [193]-[196] to the effect that a claim under Barnes v Addy is not a personal equity which defeats statutory indefeasibility of title. See my review of the Mathieson Nominees decision and discussion of this issue here.)

9. Traceable into the Worldwide ANZ account? Mixed funds

His Honour discussed the tracing issues that arose here at [398]-[435]. There were complications. He sets out a useful review of the competing tracing rules and principles that may be applied in cases of tracing into (and out of) mixed funds – see in particular at [408]-[422].

In the end Hargrave J concluded more evidence was needed to finally determine the tracing issues, much of which he noted was in the hands of the defendants. His Honour adjourned the proceeding to allow further evidence and submissions as to the remaining tracing issues – see [423]-[430] and [434].

For completion, I should note that an additional claim was made for recovery of the stolen funds under s 2.6.3 of the Gambling Regulation Act 2003, but was unsuccessful (see [440]-[450]).

Conclusion

The judgment is only two days old, so we cannot yet know whether an appeal will be pursued. In the meantime, on a practical level, the case stands as a salient warning to betting companies and those associated with them, and potentially similar entities which may receive questionable deposits into accounts held with them. Each case will turn on its own facts, and certainly here there was, amongst other things, an unusually timely warning of another fraud just 2 weeks prior. However in circumstances where a recipient is put on enquiry in some way, before on-paying or releasing the funds, it may be prudent to make the so-called ‘simple inquiry’ as described by Hargrave J at [158]-[159]: to seek to ascertain the identity of the depositor of the funds, contact them, and inquire as to whether they intended to make the deposit or payment to the benefit and for the purposes of the person or entity claiming to be entitled to access or control the funds. It is worth bearing in mind that whatever the circumstances are, the Baden categories of knowledge (see above) direct attention to what would an honest and reasonable person consider or do in those circumstances and with that awareness. As this case illustrates, a failure to meet that standard may have significant consequences for recipients of suspicious payments