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.