Reconstruction & Insolvency Newsletter, December 2014

Welcome to our December Reconstruction & Insolvency newsletter.

 

In this edition we have included news on:

• the Insolvency Law Reform Bill 2014, which comprises proposals aimed at amending and streamlining the Bankruptcy Act 1966, Corporations Act 2001 (Act) and Australian Securities and Investments Commission Act 2001
• the recent decision of Vasudevan v Becon Constructions (Australia) Pty Ltd [2014] VSCA 14, where the court considered unreasonable director-related transactions under section 588FDA of the Act
• Saker, in the matter of Great Southern Limited [2014] FCA 771, in which the Federal Court found that liquidators do not hold company property on trust for priority creditors such as employees, by reason of section 561 of the Act
• Howard v Commissioner of Taxation [2014] HCA 21, which considered fiduciaries in tax law.

 

Please do not hesitate to contact us if you would like more information on any topic, whether covered in this newsletter or not.  We hope you find the newsletter informative and useful.

INSOLVENCY UPDATE

Insolvency Law Reform Bill 2014

On 7 November 2014, the government released the Insolvency Law Reform Bill 2014 (Bill) that comprises proposals aimed at amending and streamlining the Bankruptcy Act 1966, Corporations Act 2001 and Australian Securities and Investments Commission Act 2001.

 

The government has indicated that the proposed amendments will:

• remove unnecessary costs and increase efficiency in insolvency administrations;
• align and modernise the registration and disciplinary frameworks that apply to registered liquidators and registered trustees;
• align and modernise a range of specific rules relating to the handling of personal bankruptcies and corporate external administrations;
• enhance communication and transparency between stakeholders;
• promote market competition on price and quality;
• improve the powers available to the corporate regulator to regulate the corporate insolvency market and the ability for both regulators to communicate about insolvency practitioners operating in both the personal and corporate insolvency markets; and
• improve overall confidence in the professionalism and competence of insolvency practitioners.

 

Liquidators

The Bill contains proposals to reform how liquidators are registered and regulated. According to the proposals, new liquidators will need to satisfy minimum education requirements, being formal tertiary studies that are specific to insolvency administration.

 

Following completion of the minimum education requirements, an individual will need to apply to ASIC to be registered as a liquidator. ASIC will refer the application to a committee that will consider the applicant's qualifications, conduct and fitness, and whether the applicant will take out appropriate insurance.

 

The registration will have effect for 3 years and may be renewed.

 

Once registered, a liquidator must lodge an annual return with ASIC with proof of appropriate insurance and give ASIC notice if the liquidator's circumstances change.

 

ASIC also has powers to suspend or cancel a liquidator's registration or take disciplinary action against a registered liquidator in appropriate circumstances.

 

Trustees

Among the proposals regarding the registration of registered trustees, a committee considering applications for registration must be satisfied that an applicant:

• has not had his or her registration as a liquidator under the Corporations Act cancelled within 10 years before making the application;
• is not disqualified from managing corporations under Part 2D.6 of the Corporations Act or under a law of an external territory or a law of a foreign country; and
• is a fit and proper person.

 

The proposals regarding the discipline of registered trustees include the following:

• a person who makes a false representation that they are a trustee will have committed an offence;
• a registered trustee who fails to comply with his or her insurance requirements may have committed an offence; and
• the Inspector-General will be able to cancel a trustee's registration without first referring it to a committee under various prescribed circumstances.

 

Changes to corporate administration

The Bill also contains proposals for corporate administrations that will:

• align and enhance the creditors' rights to request information, including information regarding meetings during an external administration;
• align, consolidate and simplify rights of practitioners to claim remuneration;
• enable creditors to require an insolvency practitioner to convene a meeting of the creditors whether by resolution or requested by the creditors, or a committee of inspection in certain circumstances;
• allow for ASIC and the court to appoint a registered liquidator to undertake a review and report on all or part of an external administration on a case-by-case basis;
• provide creditors, ASIC and the court with the power to appoint a cost assessor to assess and report on the reasonableness of the remuneration, and costs incurred during part of or all of an administration; and
• align the rights of creditors to resolve on the removal of an insolvency practitioner and appoint a replacement without recourse to the court.

 

Interested parties have been invited to comment on the draft Bill and the Insolvency Practice Rules Proposals Paper, with submissions closing on Friday, 19 December 2014.

 

Authors: Bianca Quan and Evelyn Ooi

Contact: Jarrod Munro

Case Note: Vasudevan v Becon Constructions (Australia) Pty Ltd [2014] VSCA 14

In the recent decision of Vasudevan v Becon Constructions (Australia) Pty Ltd [2014] VSCA 14, the Victorian Court of Appeal considered the circumstances in which a transaction constitutes an unreasonable director-related transaction under section 588FDA of the Corporations Act 2001 (Cth) (Act).

 

The decision is particularly relevant because it departs from earlier authority in Ziade Investments Pty Ltd v Welcome Homes Real Estate (2006) 57 ACSR 693 (Ziade Investments) that there must be a direct benefit (rather than an indirect or derivative benefit) to a director for a transaction to constitute an unreasonable director-related transaction.

 

Background

Section 588FDA of the Act became effective in April 2003. Subsections 588FDA(1)(b)(ii) and (iii) provide that a transaction is an unreasonable director-related transaction if a payment, conveyance or disposition of company property is made by the company to a close associate of the director of a company or to another person on behalf of or for the benefit of a director. Section 9 of the Act provides that 'on behalf of' includes 'on the instructions of' and that 'benefit' includes 'any benefit whether by way of payment of cash or otherwise'.

 

The section is similar to section 588FB, which deals with uncommercial transactions because both sections involve an examination of the benefits of a transaction to the parties involved. However, section 588FB may be more difficult to prove because it is necessary to show that the company was insolvent at the time of the transaction. Insolvency at the time of the transaction is not a requirement of section 588FDA.

 

Facts in Vasudevan v Becon Constructions (Australia) Pty Ltd

Mr Thompson was the sole director and shareholder of two companies that were in debt to a creditor, Becon Constructions (Australia) Pty Ltd (Becon). Thompson and a third company owned by him, Wulguru Pty Ltd (Wulguru), entered into a Deed with Becon under which Wulguru assumed joint and several liability for the debts and Thompson guaranteed the debts.

 

The debtor companies went into default and Becon instituted proceedings against Thompson personally in order to recover the amounts owing. In consideration for Becon discontinuing proceedings against Thompson, Wulguru executed a mortgage over real property (Mortgage) in favour of Becon in order to secure repayment of the debts.

 

When Wulguru went into liquidation, its real property was sold and Becon sought a portion of the proceeds pursuant to the Deed and Mortgage. The liquidators said the Deed and Mortgage constituted unreasonable director-related transactions that were voidable under the Act.

 

Legal issue

The issue to be determined was whether the Deed and Mortgage were made on behalf of Thompson within the meaning of section 588FDA, either because they were executed on his instructions or because they were of benefit to him.

 

Decision at first instance

The Associate Judge adopted the approach of the prior decision in Ziade Investments in finding that the transactions were enforceable because Thompson had only received an indirect benefit.

 

In Ziade Investments, Ziade Investments Pty Ltd granted mortgages over its real estate to secure loans owed by it to three other companies. The directors of Ziade Investments Pty Ltd were also shareholders of the companies benefitting from the mortgages. The liquidator sought orders that the mortgages were unenforceable on the ground that they were unreasonable director-related transactions.

 

Gzell J considered the second reading speech to the Corporations Amendments (Repayment of Directors' Bonuses) Bill 2002, which introduced section 588FDA into the Corporations Act, and determined that parliament did not intend the section to extend to 'derivative' or 'indirect' benefits to directors.

 

His Honour held that the benefit to the director must be direct and not a derivative benefit. In that case, the benefit to a company of which the director was a shareholder was a derivative benefit only and the company was the party that received the direct benefit. Gzell J considered that a direct benefit may be shown if the payment actually causes an increase in the value of shares in a company.

 

Following Ziade Investments, it was doubtful whether, for example, a payment to a company of which the director was a shareholder, or to a trust of which the director was a beneficiary, could be recovered pursuant to section 588FDA. In those circumstances, a liquidator seeking to void such payments would have had to succeed under sections 588FB and 588FC by claiming that the transaction was uncommercial and, relevantly, by showing that the transaction occurred at a time when the company was insolvent, or that the company became insolvent as a result of the transaction.

 

Court of Appeal decision

The Court of Appeal in Becon overturned the decision of the Associate Judge on the basis that Thompson had obtained a direct benefit from the Deed and Mortgage, being the covenant of Becon to discontinue proceedings against him.

 

The court also considered that a benefit for the purposes of an unreasonable director-related transaction could be a direct or indirect benefit. In the view of Nettle JA (with whom Beach JA and McMillan AJA agreed), the relevant section is an anti-avoidance provision aimed at preventing directors from using companies to their own advantage. Consistent with this objective, the word 'benefit' was construed to include direct and indirect benefits.

 

Implications

As a result of the decision, section 588FDA may now apply to a broader range of transactions including those transactions from which a director obtains only an indirect or derivative benefit. The decision may useful for liquidators seeking to challenge such transactions, without having to prove insolvency.

 

Author: Katherine Wangmann

Contact:  Jarrod Munro

Case Note: Saker, in the matter of Great Southern Limited [2014] FCA 771

A recent decision of the Federal Court has found that liquidators do not hold company property on trust for priority creditors such as employees, by reason of section 561 of the Corporations Act 2001 (Cth) (Act). Although that section imposes an obligation on controllers of company property to pay certain employee entitlements from charged circulating assets if there is a deficiency in uncharged company assets, the obligation is a statutory one and does not create a trust relationship.

 

The decision also indicates that there may be repercussions for receivers who pay out their appointor and their own fees before assessing the company property to determine whether there is sufficient property for employee creditors.

 

Background

Section 561 of the Act states that where the property of a company available for payment of creditors other than secured creditors is insufficient to meet payment of the company's employee entitlements, the property must be used to pay those priority debts before paying out a party who is secured by a circulating security interest.

 

According to the recent decision in Cook Italiano Family Fruit Company Pty Ltd (in liq) [2010] FCA 1355, the effect of section 561 is that a receiver or liquidator holds the property on trust for the secured creditor and the priority creditors until an assessment can be made of the company's property.

 

Facts

The plaintiffs were the liquidators of Great Southern Limited (Company). The Company had granted floating charges to a group of banks. When the Company began experiencing financial difficulty in 2009, the banks appointed receivers pursuant to those charges, who assumed control over all the assets of the Company.

 

Over several years, the receivers recovered the debts due to the banks as well as over $6 million that was spent on their own fees and disbursements. The receivers and the banks were fully paid out with some surplus moneys remaining.

 

The receivers then applied to the court for directions on how to deal with the surplus moneys. In particular, the receivers questioned whether section 561 required them to pay out the employee creditors.

 

In the decision of Re Great Southern Ltd (in liq); Ex Parte Thackray [2012] WASC 59, Sanderson M applied the principles in Cook Italiano Family Fruit Company Pty Ltd (in liq) and found that the receivers held the surplus funds on trust until an assessment of the company property was made. Sanderson M considered that the receivers were entitled to retire and allow the liquidators to become substitute trustees of the surplus moneys.

 

The receivers considered that they were not in a position to make an assessment for the purposes of section 561 and so they transferred the surplus moneys to the liquidators.

 

Issue

The key question was whether the liquidators (just like the receivers) were holding the surplus moneys on trust for the employee creditors. If the moneys were held on trust, then it followed that the employee creditors were entitled to the surplus moneys.

 

On the other hand, if the moneys were not held on trust, then the liquidators were entitled to apply the funds in accordance with section 556 by first expending the moneys on their own fees and disbursements.

 

Decision

His Honour Justice McKerracher found that neither the receivers nor the liquidators held the surplus moneys on trust. Rather, the receivers and the liquidators had a statutory obligation to apply the surplus funds for the benefit of the employee creditors. His Honour also relied on High Court authority that a statutory obligation to apply moneys for the benefit of a particular person does not necessarily create a trust relationship.

 

Having concluded that there was no trust relationship, his Honour found that the liquidators should apply the surplus funds in accordance with section 556. As a result, the liquidators were entitled to pay their own expenses and disbursements in priority to payment of the employee creditors.

 

His Honour noted, however, that the receivers may have breached section 561 by paying out the secured creditors before making an appropriate assessment of whether sufficient property was available to pay the employee creditors. However, his Honour did not have enough evidence from the receivers to come to a conclusion on that point. He suggested that the liquidators should examine this issue and take appropriate steps if it appeared there had been non-compliance by the receivers with section 561.

 

Comment

The decision is useful for liquidators because it releases them from obligations under section 561 and allows them to prioritise their own fees and disbursements ahead of debts owed to employee creditors. The decision also undermines the finding of Finkelstein J in Cook Italiano Family Fruit Company Pty Ltd (in liq) insofar as his Honour found that secured creditors have a right of subrogation, and will stand in the shoes of priority creditors, and thus be able to share in 'free assets' such as unfair preference recoveries. His Honour found that the right of subrogation arose due to a breach of trust by the liquidator. If no trust arises, it is doubtful that a right of subrogation can follow. However, the issue will not arise if a liquidator complies with his or her statutory duties under section 561.

 

Author: Katherine Wangmann

Contact: Jarrod Munro

Howard v Commissioner of Taxation [2014] HCA 21 - Fiduciaries in tax law

It is not uncommon to encounter cases where a defendant, facing allegations of obtaining unauthorised financial benefits from circumstances where a personal conflict of interest exists, denies that the receipt was wrongly received by them. However, few would envisage a circumstance where a defendant would willingly incur the costs associated with a High Court proceeding in order to implore the bench to decide that they did indeed receive a financial benefit in breach of their fiduciary obligations.

 

The recent High Court decision of Howard is, however, just such a case. Notwithstanding the apparently odd submissions made by the taxpayer in that matter, it is perhaps unsurprising that his underlying incentive for litigation was not one of selfless desire, but rather due to the tax bill he would receive.

 

Facts

Mr Howard and two associates were the directors of an investment company called 'Disctronics'. Disctronics had $1.5 million of investible funds. In 1999, the directors and another associate explored the option of a potentially lucrative property development opportunity concerning a golf course. The course would be acquired and a key tenant would be contracted to occupy the premises. After the tenant was signed on, the course would be on-sold for a healthy margin represented by the future rent paid by the tenant.

 

The opportunity was discussed with two new entrants who were consultants on the project. Howard, his fellow directors and the new entrants formed a joint venture. However, prior to the joint venture being formed, Howard and his fellow directors of Disctronics had agreed that, if the equity required to be contributed to the project was less than $1.5 million, then Disctronics should become the purchaser of the golf course (presumably because Disctronics would be taxed on any profits at a lower income tax rate compared to the joint venturers individually).

 

Discord arose among the joint venturers about how best to realise the value of the golf course, and the project was eventually dissolved. Unknown to Mr Howard and his associates, the two new entrants to the joint venture purchased the golf course for themselves. Mr Howard and his associates sued the two new entrants for breach of their fiduciary duties, and they were individually awarded equitable compensation.

 

The equitable compensation amounts were declared as the income of Disctronics and not as personal income of Mr Howard and his associates. This is because, prior to commencement of the Supreme Court proceedings, Mr Howard and his associates entered into a litigation funding agreement with Disctronics under which they individually agreed to assign to Disctronics any proceeds arising from the litigation in consideration for the company funding the litigation costs. The Commissioner of Taxation did not agree with this treatment and amended the income tax assessment of the individuals. The matter subsequently ended up in the High Court, where three issues were considered:

 

• the extent of Mr Howard's fiduciary duties owed to Disctronics, such that the equitable compensation was received by him as constructive trustee;
• whether the assignment of Mr Howard's right to receive that equitable compensation was effective such that it was not income derived by him beneficially; and
• whether Mr Howard incurred liability for the costs of the proceedings in the Supreme Court, which should properly have been taken into account in determining his taxable income; and whether those costs were an outgoing of a revenue nature incurred in gaining the award of equitable compensation granted by the Supreme Court.

 

Submissions

Mr Howard's arguments were that:

• he had placed himself in a position where his duties as director of Disctronics conflicted with his individual interest in the joint venture;
• any gain he received individually would have been made in breach of his fiduciary obligations to Disctronics; and
• he did not receive the equitable compensation beneficially but instead as constructive trustee for Disctronics because the money actually belonged to Disctronics and not to him, and he was therefore not liable to income tax upon it; and
• his right to the amount of equitable compensation received in 2005 was assigned under the litigation funding agreement, rather than merely his entitlement to retain the sum.

 

Decision

The High Court found that:

• Mr Howard had not made an unauthorised profit in his capacity as a director of Disctronics, nor was there a real possibility of conflict between his individual interest in the joint venture and his duties to Disctronics;
• on the basis that Mr Howard was not under a broadly formulated fiduciary obligation to Disctronics, there was no constructive trust of the equitable compensation he received;
• the purported assignment of the equitable compensation under the litigation funding agreement was an assignment of the future judgment debt and not of Mr Howard's rights to the equitable compensation; and
• though there was evidence that Disctronics spent more than $1.2 million in legal fees and disbursements in the Supreme Court proceedings, there was no evidence to demonstrate that Mr Howard incurred any expenses by way of reimbursement of Disctronics or otherwise under the litigation funding agreement.

 

Implications

• Just because certain positions are 'presumptively fiduciary', does not mean that all conduct engaged in by the fiduciary is subject to fiduciary obligations and therefore that the fiduciary must account for a gain.
• Defining the scope of a fiduciary duty broadly does not necessarily result in specific duties arising for the beneficiary - a right cannot be breached unless a correlative duty exists.
• Be careful when drafting litigation funding agreements - taxpayers could be left with a large tax bill and no corresponding deduction to reduce the taxable amount of compensation to which they are no longer entitled.

 

Author:  Meng Lee

Contacts: Stephen Sawer or Michael Kohn

Team member profile

Bianca Quan, Senior Associate

Bianca has experience in insolvency and banking litigation, having acted in a range of matters - predominantly in the areas of personal and corporate insolvency, and the enforcement of mortgages and other securities.

 

She acts for insolvency practitioners, directors, and secured and unsecured creditors regarding the administration of insolvent estates, including providing advice and conducting litigation. Her experience includes acting for major banks and financial institutions in asset and debt recoveries.

 

Bianca also has expertise in advising on and conducting litigation in property and leasing disputes in the Supreme Court and VCAT.