Dunphy v Watson - [2008] FMCA 527

FEDERAL MAGISTRATES COURT OF AUSTRALIA

DUNPHY & ANOR v WATSON

[2008] FMCA 527

BANKRUPTCY – Creditor’s application for review of trustee’s refusal of proof of debt – liquidator’s claim against bankrupt director for insolvent trading – trustee admitted claim after seeing evidence – costs of application – whether either party acted unreasonably – no order made as to costs.

Bankruptcy Act 1966 (Cth), ss.32, 82(2), 100, 102, 102(1), 102(4), 104, 105(2)
Corporations Act 2001 (Cth), ss.95A, 286(2), 588E(3), 588E(4)(b), 588M
Federal Magistrates Act 1999 (Cth), s.79

Official Trustee in Bankruptcy v CS & GJ Handby Pty Ltd (1989) 21 FCR 19, (1989) 87 ALR 734
Re Minister for Immigration & Ethnic Affairs; Ex parte Lai Qin (1997) 186 CLR 622
Taylor v Rudaks [2007] FCA 1962

First Applicant:

BRIAN PATRICK DUNPHY

Second Applicant:

COMWISE PTY LTD (IN LIQUIDATION)

Respondent:

DAVID WATSON

File Number:

SYG 3746 of 2007

Judgment of:

Smith FM

Hearing date:

16 April 2008

Delivered at:

Sydney

Delivered on:

16 April 2008

REPRESENTATION

Counsel for the Applicants:

Mr B Skinner

Solicitors for the Applicants:

McLean & Associates

Counsel for the Respondent:

Mr E W Young

Solicitors for the Respondent:

B A Chora & Company

ORDERS

Note that the respondent on 26 February 2008 admitted the applicant’s proof of debt dated 4 October 2007 in the sum of $37,638.80.
The application is dismissed.
There be no order as to costs.

FEDERAL MAGISTRATES
COURT OF AUSTRALIA AT
SYDNEY

SYG 3746 of 2007

BRIAN PATRICK DUNPHY

First Applicant

COMWISE PTY LTD (IN LIQUIDATION)

Second Applicant

And

DAVID WATSON

Respondent

REASONS FOR JUDGMENT

(revised from transcript)

This matter has become an unfortunate argument about costs, in which both parties are seeking indemnity costs against the other. The parties are Mr Dunphy, a liquidator of a company, and Mr Watson, a trustee in bankruptcy, and the effect of an indemnity costs order may be that personal liability would be incurred. For the following reasons, I am not persuaded that either of them should be ordered to pay costs.
The dispute in relation to costs turns upon whether Mr Watson, as trustee in bankruptcy of Sylvana Ploner, ought to have admitted prior to the commencement of the present litigation, a proof of debt lodged by Mr Dunphy as liquidator of Ms Ploner’s former company, Comwise Pty Ltd. In form, the application is made under s.104 of the Bankruptcy Act 1966 (Cth), seeking review by Mr Dunphy of a decision of Mr Watson under s.102 in respect of a proof of debt. As I shall recount below, a number of proofs of debt were lodged, and a number of decisions were made in relation to those requests adverse to the admission of the proof, prior to the commencement of the litigation.
Under s.104, the Court has power itself to form an opinion about the admission of the debt, and it has general power to award costs under s.32 of the Bankruptcy Act in relation to that litigation and also, if necessary, under s.79 of the Federal Magistrates Act 1999 (Cth).
The Bankruptcy Act also has in s.105(2), a specific provision in relation to the costs of a registered trustee. This provides that such a person “is not personally liable for such costs unless the Court is of opinion that there are special circumstances that justify an order that the trustee be personally liable”. This seems to imply that the registered trustee would lose his right of indemnification from the bankrupt estate if the Court makes such an order, but counsel for the applicants submits that there may be some doubt about that, and that a special particular order excluding indemnification should also be made.
The Bankruptcy Act in s.100 addresses a creditor’s costs generally in relation to proving a debt. It provides that a creditor shall “unless the Court in the particular case otherwise orders, bear his or her own costs of proving a debt”, or in relation to “the amendment of a proof of debt”.
The substantive issue in the present application was whether Ms Ploner was personally liable under s.588M of the Corporations Act 2001 (Cth) as a director of her company for the company’s trading while it was insolvent. Very extensive material has been presented to the Court by the applicants to make out such a claim. However, before the application could be set down for a hearing, Mr Watson looked at the material which was filed, and made a decision reversing his previous refusal to admit the debt. He then made a decision admitting the proof of debt in the amount claimed, apparently exercising his reconsideration power under s.102(4). In those circumstances, it is in my view unnecessary for the Court itself to make any substantive order. I consider that the preferable order is to dismiss the application on the ground that it has become unnecessary to be determined.
Mr Watson made his decision reasonably promptly after receiving and considering the evidence filed in the Court by Mr Dunphy. This material had not previously been delivered to Mr Watson by or on behalf of Mr Dunphy. If it was reasonable for Mr Watson to await the receipt of the material before making a favourable decision on the proof of debt, then it would not be appropriate to order him to pay indemnity costs. Conversely, the reasonableness of Mr Dunphy in not presenting any corroborative company documents to Mr Watson in support of the proof of debt, goes to the crux of the application for indemnity costs against Mr Dunphy.
A brief chronology of the dispute between the parties is as follows. Ms Ploner was made bankrupt, and Mr Watson was appointed her trustee, on 21 October 2005. It appears he then became aware of her involvement in her company Comwise Pty Ltd, and the need for the company to be liquidated. He referred the bankrupt to Mr Dunphy, who became the company’s liquidator.
In Mr Watson’s report to creditors in December 2006, he reported that Ms Ploner had attributed her bankruptcy to “gambling, speculation & extravagance in living”, and that she herself had few assets, but had recently inherited significant property which would become available to her bankrupt estate. The situation of her company is less clear on the evidence before me, but it appears to have been trading with minimal assets and income, and to have incurred ongoing liability to the taxation commissioner which it had difficulty meeting.
Mr Dunphy first lodged a proof of debt on 30 March 2007. This was not accompanied by any documents or particulars, but merely claimed $48,812.33 as “liabilities arising from insolvent trading by the company and breach of directors duties”. The proof was rejected by Mr Watson on 25 July 2007, on the ground that its demands were excluded from being provable debts by s.82(2) of the Bankruptcy Act, which excludes debts “in the nature of unliquidated damages arising otherwise than by reason of a contract, promise or breach of trust”.
Mr Dunphy then instructed solicitors, who wrote to Mr Watson drawing his attention to authority in relation to previous sections of corporations law concerning claims against directors for insolvent trading, which had held that they were not excluded by s.82(2) (see Official Trustee in Bankruptcy v CS & GJ Handby Pty Ltd (1989) 21 FCR 19, (1989) 87 ALR 734).
Mr Watson then employed solicitors to advise him, and in a letter dated 9 August 2007 his solicitors accepted that authority, thereby anticipating a recent judgment on the point given by Mansfield J in Taylor v Rudaks [2007] FCA 1962. However, the solicitors also said that Mr Watson was not satisfied that a claim for insolvent trading in the amount claimed could be made out, because the time at which the company became insolvent was unknown to him, and the quantum of the debt could not reasonably be determined. In relation to breaches of director’s duties, their letter said that Mr Watson did not have “sufficient information to make a decision in this regard. Basically, statements of allegations have been made that breaches occurred but no evidence or details have been provided which would enable the Trustee to properly consider any such claims”. A similar statement was made in relation to a claim for breach of trust.
These points appear to have been accepted by Mr Dunphy, who withdrew his proof, and proceeded to lodge a second proof of debt which was forwarded on 4 October 2007. It was not accompanied by any records from the company, but attached a schedule setting out the taxation office account, and indicating a continual state of indebtedness to that creditor between 2001 and 2005.
A rejection of this proof was sent by Mr Watson dated 8 October 2007. His covering letter gave the ground that “no further documentation or information provided to support either the bases of the claims for insolvent trading or breach of director’s duties, or the separate amount for each of those claims”. Mr Watson’s covering letter noted that the proof had been reduced to the amount of $37,048.80, and that “none of the matters raised in our solicitor’s correspondence have been dealt with in the Proof of Debt dated 30/3/07 and no further supporting documentation has been provided by you with Proof of Debt dated 4/2007”.
Mr Dunphy’s solicitors responded on 26 October 2007, attaching a third proof of debt “together with further information/particulars of the insolvent trading claim and calculation of the amount claimed”. That letter concluded: “should your client require anything further we would also ask that your client make a request for the further information rather than simply reject the proof of debt once again”.
The enclosed third proof did not attach any company records. It repeated the taxation office account, and also contained a two page schedule making assertions that the company was insolvent within the meaning of s.95A of the Corporations Act 2001 (Cth) on 27 August 2001 and on 6 April 2005, and that the company must therefore be presumed by sub-s.588E(3) to have been insolvent since 27 August 2001. The schedule also asserted an alternative basis for concluding insolvency, referring to the company’s paid up capital, its profit and loss statements and other accounts, copies of which were not enclosed. It was also asserted:
The Company failed to keep financial records in accordance with section 286(2) of the Corporations Act 2001 for the period of seven years prior to my appointment. Pursuant to section 588E(4)(b) the Company is presumed to have been insolvent throughout the entire period between 1 February 1999 and 1 February 2006.
Reference was also made to debt recovery action taken by the Australian Taxation Office against the company.
In effect, the schedule accompanying the third proof of debt set out, for the first time, alternative arguments to establish a liability for insolvent trading, and gave some particulars of evidence which were claimed to support that claim. It also contained the assertion of a company liquidator that he was of the opinion that insolvent trading had occurred. The question which is posed by Mr Dunphy’s present application for indemnity costs personally against Mr Watson, is whether Mr Watson unreasonably failed to accept this submission as sufficient to admit the debt. I shall return to this issue after recounting the further history of the matter.
The lodgement of the third proof of debt was followed closely by letters from Mr Dunphy’s solicitors urging a swift decision, and also an email from Mr Dunphy to an employee of Mr Watson in somewhat peremptory terms. This demanded an immediate response on when a dividend would be declared and “why the trustee appears to be incurring the unnecessary expense of having [the trustee’s solicitors] deal with routine matters between your office and creditors”.
This appears to have caused Mr Watson to make a decision immediately, as requested. By a letter dated 16 November 2007, Mr Watson informed Mr Dunphy that he had again rejected the proof of debt on the ground of “insufficient documentation or information provided to support the basis of the claim for insolvent trading”. His covering letter rejected the suggestion that a solicitor had been unnecessarily employed, pointing out that this arose out of Mr Dunphy’s own employment of a solicitor. He also rejected the claim that unnecessary costs were being incurred.
It was as a result of that determination by Mr Watson, that Mr Dunphy gave instructions to commence the present proceeding. This was preceded by a letter dated 23 November 2007 from Mr Dunphy’s solicitors who again maintained that “our client has provided more than sufficient information upon which your client can make his determination”, but also enclosed some documents showing the demands of the Australian Taxation Office.
No further documents were provided before the commencement of the proceeding on 5 December 2007. The application was supported by two affidavits by Mr Dunphy. The first affidavit with its attachments occupies 105 pages. The second affidavit and attachment occupies 155 pages. The documents attached to the second affidavit include a number of director’s reports, company accounts, and copies of its banking records. The affidavits also contain sworn statements by Mr Dunphy deposing to his opinions about insolvent trading, and setting out his reasons for forming those opinions by reference to the attached banking records.
As I have indicated, Mr Watson upon receipt of that material, and within a reasonable period, formed the opinion that the proof of debt should now be admitted in the claimed amount of $37,638.80. His decision was communicated to the solicitors for Mr Dunphy on 6 February 2008, and a formal determination by Mr Watson to accept the claim in full was made by him on 26 February 2008.
The usual position of a Court in relation to the award of costs, in circumstances where the Court has not had occasion to determine the substantive matter after a hearing on the merits was described by McHugh J in Re Minister for Immigration & Ethnic Affairs; Ex parte Lai Qin (1997) 186 CLR 622 at 624‑625:
In most jurisdictions today, the power to order costs is a discretionary power. Ordinarily, the power is exercised after a hearing on the merits and as a general rule the successful party is entitled to his or her costs. Success in the action or on particular issues is the fact that usually controls the exercise of the discretion. A successful party is prima facie entitled to a costs order. When there has been no hearing on the merits, however, a court is necessarily deprived of the factor that usually determines whether or how it will make a costs order.
In an appropriate case, a court will make an order for costs even when there has been no hearing on the merits and the moving party no longer wishes to proceed with the action. The court cannot try a hypothetical action between the parties. To do so would burden the parties with the costs of a litigated action which by settlement or extra‑curial action they had avoided. In some cases, however, the court may be able to conclude that one of the parties has acted so unreasonably that the other party should obtain the costs of the action. In administrative law matters, for example, it may appear that the defendant has acted unreasonably in exercising or refusing to exercise a power and that the plaintiff had no reasonable alternative but to commence a litigation. Thus, for example, in R v Gold Coast City Council; Ex parte Raysun Pty Ltd [1971] QWN 13, the Full Court of the Supreme Court of Queensland gave a prosecutor seeking mandamus the costs of the proceedings up to the date when the respondent Council notified the prosecutor that it would give the prosecutor the relief that it sought. The Full Court said that the prosecutor had reasonable ground for complaint in respect of the attitude taken by the respondent in failing to consider the application by the prosecutor for approval of road and drainage plans.
Moreover, in some cases a judge may feel confident that, although both parties have acted reasonably, one party was almost certain to have succeeded if the matter had been fully tried. This is perhaps the best explanation of the unreported decision of Pincus J in South East Queensland Electricity Board v Australian Telecommunications Commission, Unreported; Federal Court of Australia; 10 February 1989, where his Honour ordered the respondent to pay 80 per cent of the applicant’s taxed costs even though his Honour found that both parties had acted reasonably in respect of the litigation. But such cases are likely to be rare.
If it appears that both parties have acted reasonably in commencing and defending the proceedings and the conduct of the parties continued to be reasonable until the litigation was settled or its further prosecution became futile, the proper exercise of the cost discretion will usually mean that the court will make no order as to the cost of the proceedings. This approach has been adopted in a large number of cases.
(other citations omitted)
In my opinion, it would be appropriate to apply his Honour’s approach in the present context unless, as is submitted by each of the present parties, I am persuaded that the expenses of the litigation have been unreasonably incurred by the conduct of one of them. Mr Dunphy’s submission in this respect is that he was forced to commence the proceeding as a result of Mr Watson’s unreasonableness in not accepting the third proof of debt in the form that I have described above. On Mr Watson’s part, it is submitted that Mr Dunphy acted unreasonably by not presenting to Mr Watson before bringing his application, all the material which he subsequently presented to the Court and which led Mr Watson to admit the proof of debt.
I have given both of these submissions serious consideration. In my opinion, no general proposition can be stated as to when a trustee in bankruptcy should or should not accept a proof of debt supported only by an assertion of a creditor, and in particular when such a creditor is an official liquidator. There may be many circumstances where it would be very reasonable to accept such assertions without calling for evidence. However, in the present case I am not persuaded that Mr Watson’s insistence upon being presented with evidence reveals “special circumstances that justify an order” that he should be made personally liable for the litigation which resulted from his taking that position, within s.105(2) of the Bankruptcy Act. Indeed, I would not characterise his insistence on the receipt of evidence as revealing conduct which was ‘unreasonable’ within the term used by McHugh J in Lai Qin.
Under s.102(1) of the Bankruptcy Act, a trustee is given a general discretion as to his procedures in relation to the admission of a proof of debt, which expressly includes the power to “require further evidence in support of it”. I am not persuaded that there was unreasonableness on Mr Watson’s part in his exercise of this power.
Mr Watson’s correspondence was criticised by counsel for Mr Dunphy because it did not specify which particular evidence was being called for. There is some substance to that submission. However the claim made by Mr Dunphy was based both on a claim of trading during actual insolvency of the company, and also a claim based on deemed insolvency from the inadequacy of the company records. In this situation, it was in my opinion not unreasonable for Mr Watson generally to require the person making the proof of debt to present all the supporting evidence available to that creditor, in this case in his capacity as the official liquidator with possession of the company records.
I therefore do not accept Mr Dunphy’s application for costs to be ordered against Mr Watson based on the argued unreasonable conduct on his part.

In relation to Mr Dunphy’s conduct in failing to present more evidence before commencing the proceeding, I am similarly unable to arrive at a conclusion that his conduct was so unreasonable as to require him to be ordered to pay indemnity costs in relation to the litigation. The position he took was a rational position, and in the circumstances and amount of the company’s claim not one which I would characterise as unreasonable. It was understandable on his part that he should believe that the proof of debt might be admitted purely upon the basis of his assertions, made in his capacity as an official liquidator.
In my opinion, we have a situation where the two positions taken by the liquidator and the trustee respectively prior to the commencement of the litigation were positions which each of them took for understandable and rational reasons. It has unfortunately led to the need for the dispute to be resolved by way of application to the Court. However, this is the position in much litigation that comes to the court, and I do not consider that in the present case any special orders as to costs should be made.
I therefore am not persuaded that the general situation in relation to the resolution of a case in the present circumstances such as were also before McHugh J in Lai Qin should not be followed. I consider in all the circumstances that the proper exercise of the Court’s discretions makes it appropriate to make no order as to the costs in the proceeding.
In relation to the costs of the two cost applications that were before me this morning, I have also decided that no order for costs should be made. My above reasons explain why I have rejected both of those applications. In those circumstances, it is appropriate that no order should be made.
I am asked to depart from that obvious outcome by reason of a letter sent by the solicitors for Mr Watson dated 4 March 2008, which appears to have been sent to Mr Dunphy’s solicitors by facsimile at 11.13 am on that date. In that letter it was contended that the applicants had “very poor prospects of obtaining an order for costs going back to July 2007” as had previously been foreshadowed on behalf of the applicants. It was pointed out that there would need to be a two to three hour hearing on the question of costs, and the letter concluded:
Even though the Trustee considers he has strong prospects on costs, he still wishes to stop further costs accruing. Therefore the Trustee offers to pay the Applicant’s filing fee plus $1,000 for costs. This offer will remain open until 5 pm on Friday 7 March 2008.
The offer was therefore one which was presented with very limited currency. The offer was maintained in a second letter dated 6 March 2008, which contained no suggestion that it would be extended beyond the following day.
In the event, the offer was not accepted, and the matter was then on 11 March 2008 referred to me by the Registrar, with consent orders in which both parties had agreed that there would be a need to list the costs applications for a hearing. I proceeded to list the matter for today.
It may be regrettable that the offer from Mr Watson was not accepted. However, given the complexity of the matter, I do not consider that a decision to accept Mr Watson’s offer should obviously have been made within the very short period allowed. In the event, the positions taken by the parties in their exchange of submissions were diametrically opposed. Mr Watson’s claim for indemnity costs was presented by way of counsel’s submissions to the Court, which was served on Mr Dunphy, and it was reasonable for him to maintain an argument at today’s hearing in opposition to that application.
In all the circumstances, I consider that since Mr Watson’s argument for costs failed, and also since Mr Dunphy’s own costs application failed, the appropriate order is that no order for costs should be made in relation to the costs applications.

I certify that the preceding thirty‑six (36) paragraphs are a true copy of the reasons for judgment of Smith FM

Associate: Lilian Khaw

Date: 13 May 2008