Federal Court Annuls Claimant’s Bankruptcy Due to Offsetting Claim

OUTCOME: Allowed

FEDERAL COURT OF AUSTRALIA

[APPELLANT] v [RESPONDENT] [2005] FCA 1760

BANKRUPTCY – Application for annulment of sequestration order – Principles relevant to determination of whether the sequestration order should not have been made – Relevance of fact that [NAME] had a claim against the [NAME] exceeding in value the debt upon which the petition was based. Bankruptcy Act 1966 (Cth) ss 60, 153B [APPELLANT] v [NAME] [RESPONDENT] 2385 of 2005 WILCOX J 1 DECEMBER 2005 [APPELLANT]

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY NSD 2385 of 2005

IN THE MATTER OF: [APPELLANT]: [APPELLANT]

APPLICANT

[RESPONDENT]

RESPONDENT

[APPELLANT] OF ORDER: 1 DECEMBER 2005

[APPELLANT]

THE COURT ORDERS THAT: 1. The bankruptcy of the applicant be annulled. 2. The sequestration order made on 5 September 2005 in the Federal Magistrates Court be set aside. 3. The respondent, [NAME] [RESPONDENT], pay the applicant's costs of the annulment application. Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY NSD 2385 of 2005

IN THE MATTER OF: [APPELLANT]

APPLICANT

[RESPONDENT]

RESPONDENT

JUDGE: WILCOX J

DATE: 1 DECEMBER 2005

PLACE: [APPELLANT] FOR

JUDGMENT WILCOX J: 1 Application has been made to the Court for orders annulling the bankruptcy of the applicant, [APPELLANT], and setting aside the sequestration order made on 5 September 2005. The circumstances behind the application are unusual. 2 Mrs [APPELLANT] was the sole beneficiary of the estate of her husband, [APPELLANT], who died on 25 April 1996 leaving assets, whose gross value was sworn for probate at $959,680.83. The net value of the estate was said to be $731,794.17. Among the assets was a house ('the homestead') in which the deceased and Mrs [APPELLANT] had resided for some 30 years. 3 At the time of his death, Mr [APPELLANT] was a sleeping partner with the respondent, [NAME] [RESPONDENT], in a business known as [NAME]. Mr [RESPONDENT] is a nephew of Mrs [APPELLANT]. The deceased's half-share of partnership debts to the [COMPANY] ('the [COMPANY]') ($77,905) and to a man named [NAME] ($50,000) was included as a liability of the estate. 4 Between the date of Mr [APPELLANT]'s death and 25 November 1996, Mrs [APPELLANT] conferred on several occasions with [COUNSEL], a solicitor who had acted on behalf of her husband and was retained to act on behalf of the estate. Mr [RESPONDENT] attended most of those conferences. 5 Mr [RESPONDENT] prepared two deeds, which were executed on 25 November 1996. There were the same three parties to each deed, Mrs [APPELLANT], Mr [RESPONDENT] and [APPELLANT], Mrs [APPELLANT]'s son. The first deed contained promises by Mrs [APPELLANT] to transfer to Mr [RESPONDENT] and/or Mr [APPELLANT] title to various parcels of real estate and items of plant and equipment and livestock. The property the subject of the promises comprised the entire estate. 6 One of the parcels of land to be transferred to Mr [RESPONDENT] was land containing the homestead ('the homestead block'). At the date of the deed, Mrs [APPELLANT] resided in the homestead with her daughter, [APPELLANT], and Ms [NAME] daughter. 7 The second deed contained the following operative clauses: '1. THE Transferor and [NAME] and [NAME]-daughter shall continue to reside in the said house property rent free and without being liable for costs such as rates, insurance and maintenance at any time.

2. THE consideration for the terms of this Agreement is that consideration as is more fully particularised in the Deed of even date between the parties.

3. THE Transferees shall allow the Transferor and [NAME] and said [NAME]-daughter full free and unfettered access to the said house property at all reasonable times.

4. THE said Transferees will at their own expense continue to maintain the subject house property and ensure that it is at all times habitable to the said Transferor, [NAME] and [NAME].

5. THE said Transferees will in addition to maintaining the property pay all Council rates, Water rates, Land tax and insurance and other charges associated with the said building.' 8 In due course, title to the assets was transferred in accordance with the promises in the first deed. Mr [RESPONDENT] became sole owner of the homestead block. Apparently, he then reorganised his dealings with the [COMPANY] in such a way as to increase his indebtedness to the [COMPANY], which indebtedness was secured inter alia by a mortgage over the homestead block. 9 For some time, Mr [RESPONDENT] performed his obligations towards the [COMPANY]. Mrs [APPELLANT] continued to reside in the homestead with her daughter and [NAME]-daughter. However, in about 2000 or 2001, Mr [RESPONDENT] defaulted in his payments to the [COMPANY]. The [COMPANY] brought proceedings in the Supreme Court of New South Wales ('the Supreme Court') seeking to obtain possession of the homestead block in order to exercise its power of sale as mortgagee. 10 At about this time, Mrs [APPELLANT] initiated proceeding 20124/01 in the Supreme Court against Mr [NAME] and his two legal partners, seeking damages for negligence, and against Mr [RESPONDENT] and Mr [APPELLANT], based on claims of undue influence and unconscionable conduct. 11 On 2 January 2001, Mrs [APPELLANT], through [NAME], lodged a caveat against the title to the homestead block. She followed this with a separate proceeding (91226/03) seeking to uphold the caveat. However, it was apparently realised that the caveat was defective and, on 14 February 2003, Mrs [APPELLANT] consented to an order for removal of the caveat. She also agreed that proceeding 91226/03 be dismissed with costs. The costs were subsequently assessed at $4452.17. The costs were not paid and Mr [RESPONDENT] obtained a judgment in the [ADDRESS] of New South Wales in the sum of $5991.17. That sum included the assessor's fee and legal costs. 12 Matter 20124/01 was heard by [NAME] of the Supreme Court over many days in 2004. On 24 February 2005, his Honour delivered a judgment in which he dismissed Mrs [APPELLANT]'s claim as against all defendants. Mrs [APPELLANT] filed a notice of appeal, as against all defendants. The appeal is currently listed for hearing by the Court of Appeal of New South Wales on 31 January and 1 February next. 13 It was a corollary of the findings made by [APPELLANT] that the deed entitling Mrs [APPELLANT] to continue to occupy the homestead was valid. It is conceded by Mr [RESPONDENT], who appears today for Mr [RESPONDENT], that this means Mr [RESPONDENT] has breached his obligations under the deed and is liable to pay damages for that breach to Mrs [APPELLANT]. No formal claim has yet been made for damages. Nor has their amount been quantified. 14 In relation to that matter, it is relevant to note that, in order to stave off eviction from the homestead, Mrs [APPELLANT] agreed in 2001 to pay to the [COMPANY] the interest that would accrue in the future on the balance of Mr [RESPONDENT]'s debt to the [COMPANY]. On 19 May 2005, the [COMPANY] recovered judgment against Mrs [APPELLANT] in relation to that obligation in the sum of $46,918.36, including legal costs. The [COMPANY] subsequently assigned this judgment to Mr [RESPONDENT]. 15 On 26 May 2005, Mrs [APPELLANT] vacated the homestead at the [COMPANY]'s insistence. Since that time, Mrs [APPELLANT] has been living elsewhere in the Kempsey district. The homestead was sold by the [COMPANY], in exercise of its power of sale. 16 On 1 July 2005, a bankruptcy notice was served on Mrs [APPELLANT]. It demanded payment of $5,995.60 to Mr [RESPONDENT], this being the amount of the [ADDRESS] judgment plus a small amount of interest. The notice was in the usual form and required payment within 21 days. Mrs [APPELLANT] did not comply with the requirements of the bankruptcy notice. In an affidavit read in this Court, Mrs [APPELLANT] explained her inaction by saying: 'I had no assets and I didn't believe I could avoid the bankruptcy'. Mrs [APPELLANT] was not required to attend for cross-examination. 17 On 9 August 2005, Mr [RESPONDENT] filed a bankruptcy petition in the Federal Magistrates Court. The petition was founded on Mrs [APPELLANT]'s failure to comply with the requirements of the bankruptcy notice. It claimed a debt of $5995.60, that is, the judgment debt in respect of the costs order in the caveat proceeding. 18 The bankruptcy petition was made returnable on 5 September 2005. On that day, Mrs [APPELLANT] did not appear. Registrar McIllhatton made a sequestration order. 19 In her affidavit in this application, Mrs [APPELLANT] said her only debts were debts that 'arose out of my endeavours to save myself from having to move out of the Homestead'. Otherwise she was solvent, she said. 20 Notwithstanding her bankruptcy, Mrs [APPELLANT] is anxious to press on with her appeal to the Court of Appeal. The Official Receiver elected, pursuant to s 60 of the Bankruptcy Act 1966 (Cth), not to discontinue the appeal. Instead, the Official Receiver has assigned the bankrupt's chose in action in the appeal to [NAME]. 21 Various motions came before Mason P in the Court of Appeal. In a judgment delivered on 23 November 2005, his Honour upheld [NAME]'s entitlement to prosecute the appeal; but he intimated he would be minded to order her to provide security for the respondent's costs. This she is unable to do.

Accordingly, Mrs [APPELLANT] made this application for annulment. If it is successful, it is proposed Ms [APPELLANT] will assign the chose in action back to Mrs [APPELLANT]. She presumably will be able to prosecute it without being required to provide security for costs. As the matter is to go back to Mason P tomorrow, I have been asked to hear and determine this application as a matter of urgency. 22 Section 153B of the Bankruptcy Act provides that 'if the Court is satisfied that a sequestration order ought not to have been made', the Court may make an order annulling the bankruptcy. 23 Three principles must be noted. First, the relevant facts are those in existence at the date of the sequestration order. However, in considering that situation, the Court is not confined to the evidence that was before the judge or registrar who made the sequestration order. Fresh evidence may be placed before the Court in the annulment application. Second, the Court should not hold that a sequestration order ought not to have been made unless the person who made the order was bound, on the facts now known to the Court, not to have made the order. Third, even if that was the situation, the Court retains a discretion whether or not to annul a sequestration order. 24 Having regard to these principles, it is necessary to focus on the situation that existed on 5 September 2005. 25 First, at that time, Mrs [APPELLANT] was indebted to Mr [RESPONDENT] in the sum of $5,595.60 being a judgment debt in relation to the caveat proceedings, as to which there was no appeal. This indebtedness was the sole basis of the bankruptcy petition. Second, Mrs [APPELLANT] also owed Mr [RESPONDENT], $46,918.36, being the value of the judgment that had been recovered by the [COMPANY] against Mrs [APPELLANT] and assigned by the [COMPANY] to Mr [RESPONDENT]. However, the amount of this judgment would be included in the damages payment that Mrs [APPELLANT] was entitled to recover against Mr [RESPONDENT] arising out of his breach of covenant in the second deed. Third, Mrs [APPELLANT] was entitled to recover other damages arising out of Mr [RESPONDENT]'s breach of the covenants contained in the second deed, being damages consequential upon her dispossession of the homestead. Fourth, costs orders had been made by [NAME] J against Mrs [APPELLANT], in favour of both the solicitors and Mr [RESPONDENT]. However, the ultimate fate of those orders was directly linked to the fate of the appeal, not yet determined. Finally, Mrs [APPELLANT] wished to pursue her appeal, it being an appeal that [NAME] has described as 'arguable'. I respectfully agree with that description. Indeed, in relation to the solicitors, I think the appeal has substantial prospects of success. It was obviously of vital importance to Mrs [APPELLANT] that she be able to continue to reside in the homestead with her daughter and [NAME]-daughter as long as she wished. In 1996 Mrs [APPELLANT] was only 61 years of age. It was foreseeable that she would wish to stay in the house for many years, yet Mr [NAME] took no steps to protect her against alienation or mortgage of the property by the transferee. Neither, it seems, did he take steps to drive home to Mrs [APPELLANT] the risk of this occurring and ensure she had independent advice as to whether she wished to take that risk. 26 In [NAME] v [NAME] of Taxation (1987) 76 ALR 137 at 148 the [ADDRESS] of this Court said: 'It is also well established that in general a court exercising jurisdiction in bankruptcy should not proceed to sequestrate the estate of a [NAME] where an appeal is pending against the judgment relied on as the foundation of the bankruptcy proceedings provided that the appeal is based on genuine and arguable grounds: [NAME]; Ex parte [NAME] (1884) 14 QBD 49; Bayne v Baillieu (1907) 5 CLR 64 and Re Verma; Ex parte [NAME] of Taxation (1985) 4 FCR 181. These cases rest on the broad principle that before a person can be made bankrupt the court must be satisfied that the debt on which the [NAME] relies is due by the [NAME] and that if any genuine dispute exists as to the liability of the [NAME] to the [NAME] it ought to be investigated before he is made bankrupt. Bankruptcy is not mere inter partes litigation. It involves change of status and has quasi-penal consequences.' 27 This case is not the same as [NAME]. The order that founded the bankruptcy petition in this case (the costs order in the caveat proceeding) was not subject to any appeal. Nonetheless, that order was closely related to the subject matter of the appeal. Absent the conduct complained of in the proceeding under appeal, that order would not have been made. Further, and perhaps more importantly, it is clear that, at the date of the sequestration order (and assuming [NAME] was correct in regarding the second deed as valid), Mr [RESPONDENT] was liable to pay damages to Mrs [APPELLANT] in an amount that would undoubtedly exceed the amounts which she owed to him at the date of sequestration. 28 As I have mentioned, her damages must include the amount for which she became liable to the [COMPANY], as the price of mitigating her loss and staying in her home, together with damages for loss of her home during the period 26 May to 5 September 2005 and ongoing. Although the latter sum has not been quantified, it must exceed the judgment debt of $5,995.60. 29 It seems to me that, on these facts, a sequestration order ought not to have been made. If the Registrar had known the full facts, she would have realised it was not clear that Mrs [APPELLANT] was a net [NAME] to Mr [RESPONDENT]. The proper order would have been to adjourn the hearing of the bankruptcy petition until determination of the appeal to the Court of Appeal. 30 Although in the time available I have not been able to find a case that is on all fours with the present case, I note the decision of Emmett J in [COMPANY] v [NAME] (1998) 84 FCR 454. That case arose under the Corporations Law and involved the question whether a statutory demand should be set aside. The legislative provisions are different, but it is relevant to note the following observation by his Honour, at 453: 'It is, in my opinion, appropriate for a Court to exercise the discretion conferred by section 459J(1)(b) where the Court is satisfied that there is an appeal based on reasonable and arguable grounds which, if successful, would result in the existence of an offsetting claim. The expression "reasonable and arguable grounds" is suggested by the decision of the [ADDRESS] in [NAME] v [NAME] of Taxation.' The situation must be a fortiori where the offsetting claim does not depend on success in a forthcoming appeal. [NAME] v [COMPANY] (1997) 74 FCR 19 at 25-26. 31 There is no discretionary factor pointing against annulment. Accepting for present purposes [RESPONDENT] conclusion that Mr [RESPONDENT] did not exert undue influence or engage in unconscionable conduct, it is nevertheless the case that the whole problem arose out of his failure to honour his obligations under the second deed. It was the [COMPANY] who took the action to evict Mrs [APPELLANT]. However, the [COMPANY]'s action was only possible because Mr [RESPONDENT] had encumbered the homestead property with a mortgage obligation he was unable to satisfy. 32 I propose to order that the applicant's bankruptcy be annulled, the sequestration order made against her estate on 5 September 2005 be set aside and that the respondent pay the applicant's costs of this application.

I certify that the preceding thirty-two (32) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Wilcox.

Associate: Dated: 13 December 2005 Counsel for the Applicant: [redacted]

Solicitor for the Applicant: [redacted]

Counsel for the Respondent: [redacted]

Solicitor for the Respondent: [redacted]

Date of Judgment: 1 December 2005