What happens when trustees fail to protect their interests?

By Mark Flint, Partner

A recent Federal Court decision emphasised the importance of trustees in bankruptcy expressly asserting in a timely manner their rights to property which are considered by the trustees to be voidable transactions.

In Lo Pilato (Trustee) v Kami Saeedi Lawyers Pty Ltd in the matter of ADZIC (Bankrupt) [2017] FCA 34 the debtor had incurred significant debt through certain business ventures resulting in a sequestration order issued on 11 October 2012. In late 2011 the debtor’s de facto partner, who was a solicitor, negotiated with the principal of the law firm the principal’s trust (“Trust”) to enter into a contract for the purchase of the debtor’s home in Nicholls in the ACT for $905,000. The contract noted that a deposit of $100,000 had already been paid by the buyer to the seller. The transaction settled in May of 2012.

The circumstances surrounding the $100,000 deposit were obscure. At the same time as the sale of the property the solicitor, with the consent of the principal, transferred $100,000 from the principal’s personal joint bank account into the principle’s sole bank account as it was denoted as a loan to the solicitor. The underlying agreement was that the loan of $100,000 was not paid it would be treated as payment of the deposit, thereby reducing the amounts payable upon completion of the sale of the house.

It was held that the $100,000 had not been paid by the Trust and accordingly the purchase price was treated as $805,000. It was further held that this was less than market value, although no clear conclusion could be drawn as to what the market value should have been.

The court had little difficulty in concluding that the transfer was void against the trustee pursuant to section 121(1)(b) of the Act because the true consideration of $805,000 paid by the Trust was below market value and the debtor was or was likely to become insolvent at the date of the transfer. The court incidentally clarified that for the purposes of the section the relevant date is the date of completion of the transaction rather than the date of the exchange of contracts. That detail made little difference because the debtor was or was likely to become insolvent at either date.

The difficulty for the trustee was that of the consequential orders. By the time proceedings had been commenced the Trust had sold the property and the question this raised was what orders could be made against the Trust. To recover the profits made the right of the trustee in bankruptcy to recover either the profit made or the difference between sale and market value. The court followed Official Trustee in Bankruptcy v Alvaro (1996) 66 FCR 372 to the effect that until title is defeased by the trustee in bankruptcy calling for delivery up or revesting of the property to the trustee or by instituting proceedings to establish the trustee’s entitlement to the property, the donee may deal with the property as owner and is not required to account for any profits made. If the property is sold and the proceeds of sale dissipated by the donee prior to the defeasance the donee is not personally liable for the value of the property. The court noted a number of decisions arguably to the contrary effect in particular Westpac Banking Corporation v The Bell Group Limited (in liquidation) (3) (2012) 44 WAR 1 in which it was held (at [2535]) that the Act does not in its terms require as a further condition operation that the trustee in bankruptcy take action by electing to challenge the transaction in question before the transaction will be voided. Whilst the court noted that the views expressed in Westpac v Bell had force, Alvaro was binding, whether it be right or wrong.

In this case the trustee had not issued any statement making an election to void the disposition prior to the on sale. It was held that whatever else the communications contained, they stopped short of asserting that the transfer of the property from the debtor to the trust was void. In consequence the trustee had no personal claim against the Trust.

Orders were sought to “identify, locate and pay the proceeds of the sale” of the property to the Trust. In this instance such orders were not made. The proceeds went to discharge of the mortgage and the payment of commissions and fees leaving an amount of $175,490 unaccounted for. Because the trustee would be obliged to pay the amount equivalent to the consideration it gave for the void transfer ($805,000) there was no utility in making a “tracing” order. The court noted that had the trustee brought proceedings before the sale of the property or had it applied for orders preventing the trust from disposing of it in anticipation of the proceedings, the result might have been different.

A second aspect of the case relate to the disposal of proceeds of the first transaction. Upon settlement of the sale of the Nicholls property the debtor paid to respondent law firm by bank cheque a sum of $229,879.14 for the settlement of legal fees for the work the law firm had undertaken in relation to one of the debtor’s companies, Redevelopments Pty Ltd. It was held that the payment made to the law firm’s trust account was made by the debtor on behalf of Redevelopments Pty Ltd, as opposed to being made by the debtor directly. It was conceded that if payment was made for Redevelopments Pty Ltd.’s benefit there was no claim against the respondent legal firm.

The court went on to address the question whether the situation would have been different had the payment to the law firm been made on the debtor’s own account.

The payment of $229,879.14 was to settle fees for legal services in various proceedings undertaken by Redevelopments Pty Ltd. The retainer agreements included a clause that said the debtor was the guarantor and agreed to charge the Nicholls property to meet the obligations of both the debtor as guarantor and Redevelopments Pty Ltd.

The debtor either was or was about to become insolvent in July 2009, the costs agreement were entered into after this point in time, and thus each was a transaction which was deemed to defeat creditors and each of the four guarantees and charges would have been void against the trustee under section 121(1) of the Bankruptcy Act. In the alternative the payment of $229,879.14 was a transfer for which there was no valuable consideration.

The decision is significant for liquidators in that it underscores that, where a bankrupt’s property has been transferred to a third party, and has or may be on sold to a bona fide purchaser, it is important to send a notice unequivocally electing to treat the transaction as voidable and calling for delivery up or revesting of the property.

For law firms the case is significant because it highlights that a costs agreement containing a guarantee by the putative bankrupt and/or a charging clause over the property of the bankrupt for payment of legal fees may be construed as a transaction to defeat creditors if the facts established at the time the costs agreement was executed, the client and or the guarantor was or would likely become insolvent.

 

For further information, please do not hesitate to contact us.

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Commercial Disputes

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