Elkhoury v Farrow Mortgage Services Pty Ltd (in liq)
[1993] FCA 361
•03 JUNE 1993
LOUIS JOSEPH ELKHOURY and BRENDAN PHILLIP TORPEY v. FARROW MORTGAGE SERVICES
PTY LIMITED (IN LIQUIDATION)
No. NG947 of 1992
FED No. 361
Number of pages - 7
Bankruptcy - Contract - Guarantees
(1993) 114 ALR 541
COURT
IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY
GENERAL DIVISION
Lockhart(1), Gummow(1) and Lee(1) JJ
CATCHWORDS
Bankruptcy - bankruptcy notice based upon final judgment entered in an action brought upon guarantees given by the debtors - whether the appellants had a good defence to the action on the guarantees.
Contract - effect of acceptance of repudiation of contract partly performed at time of discharge - effect upon rights already unconditionally acquired.
Guarantees - whether in the absence of the principal debtor as a party the guarantor may plead in answer to an action on the guarantee an equitable set-off which the debtor would have in an action on the principal obligation.
Bankruptcy Act 1966
McDonald v Dennys Lascelles Ltd (1933) 48 CLR 457.
Westralian Farmers Ltd v Commonwealth Agricultural Service Engineers Ltd (In Liq.) (1936) 54 CLR 361.
HEARING
SYDNEY, 11 February 1993
#DATE 3:6:1993
Counsel and solicitors for the appellants: Mr C.R.C. Newlinds instructed
by Kemp Strang and Chippindall.
Counsel and solicitorsfor the respondent: Mr J.D. Heydon QC and Mr
R.R.I. Harper instructed by Abbott Tout Russell Kennedy.
ORDER
THE COURT ORDERS THAT:
(1) The appeal be dismissed.
(2) The appellants pay the costs of the respondent.
Note: Settlement and entry of orders is dealt with by Order 36 of the Federal Court Rules.
JUDGE1
LOCKHART, GUMMOW, LEE JJ This is an appeal from a sequestration order made by a Judge of this Court (Ryan J) against the estate of each of the appellants. The respondent was the petitioning creditor.
The acts of bankruptcy relied upon were failure to comply with the requirements of a bankruptcy notice or to satisfy the Court of a counter-claim set-off or cross-demand equal to or exceeding the sum specified in para. (a) of that notice: Bankruptcy Act 1966, para. 40 (1) (g). The appellants relied upon Wren v Mahony (1972) 126 CLR 212.
The bankruptcy notice was based upon a final judgment for $2,568,397.16, plus costs, entered against the appellants in the Supreme Court of New South Wales, with effect from 27 November 1991. The action was brought upon a guarantee given by the appellants.
Only two of the grounds of opposition which were before Ryan J were pressed upon the appeal. The first is that the judgment was entered without a trial of the proceeding and did not evidence a true indebtedness, the appellants having as a good defence to the claim therein: "the repudiation by (the respondent) of the Mortgage/Guarantee in respect of which the said guarantee was given and the acceptance of this repudiation".
The second ground of opposition is the illegality of the transaction evidenced by the mortgage and guarantee, such that the provisions of the Building Societies Act 1986 (Vic.) (the "Building Societies Act") render the guarantee void. The respondent ("Farrow") is a member of a group of over 40 corporations which includes Pyramid Building Society ("Pyramid"). Pyramid was incorporated under the Building Societies Act.
Both grounds invited this Court to "look behind" the Supreme Court judgment.
On the appeal, the argument centred principally upon the first of these two grounds. In order to understand the submissions, it is necessary to recount some of the facts and to refer to the conduct of litigation in the Supreme Court. The relevant primary facts are not seriously in dispute, though there is some dispute as to the conclusions of law which are to be drawn from them.
In 1989, two companies, Donmint Pty Limited ("Donmint") and Vamugi Pty Limited ("Vamugi") carried on business, trading together under the name "Citron Developments". Mr Torpey was a director and shareholder of Donmint, and Mr Elkhoury a shareholder and director of Vamugi. Citron Developments wished to acquire and develop two properties in New South Wales, one at Leichhardt and the other at Parramatta. A building on the Leichhardt property was to be refurbished and a building containing 20 home units was to be built upon the Parramatta property.
By letter dated 7 July 1989, Farrow offered to lend Donmint and Vamugi $295,000 to assist in the purchase of the Leichhardt property for $410,000, the term of the loan to be 3 years, secured by a first mortgage over the property.
By a further letter, dated 17 July 1989, Farrow offered to lend a further $3.876m. (including a provision for $400,000 for capitalised interest) for the purchase of the site at Parramatta and the construction thereon of the home units, for sale on completion. The latter loan was to be advanced by a series of progress payments, with an initial progress payment of $1,255,273 to provide funds to effect settlement of the purchase. Further progress payments were to be advanced during the course of construction "at the discretion of the mortgagee" and to be based upon "the cost of the construction of $l,940,000 or the lessor (sic) of valuation of such cost". The term of the loan was to be 1 year. A first mortgage was to be provided over the Parramatta property, and a second mortgage over the Leichhardt property.
The loans as so offered were accepted by Donmint and Vamugi on 1 December 1989, and the loan moneys were disbursed, as to $295,000 in respect of the Leichhardt property, and as to $1.1m. in respect of the Parramatta property. The Parramatta property had been purchased for $900,000. Three mortgages were taken, two over the Leichhardt property and one over the Parramatta property. Each was expressed to be collateral with the other two. Further, guarantees were taken from various persons, including Mr Elkhoury and Mr Torpey.
On 22 June 1990, an administrator to Pyramid was appointed under the provisions of the Building Societies Act; Pyramid was placed in liquidation on 18 December 1990. (Later, on 17 April 1991, Farrow was wound up by the Supreme Court of Victoria.) On 2 July 1990, Citron Developments acknowledged to Farrow a balance of unpaid interest in the sum of $5,316.51 as owing at 1 May 1990. By letter dated 12 July 1990, Farrow claimed that the arrears of interest exceeded $90,000. Thereafter the arrears continued to increase.
Clause 42 (j) of the mortgages, so far as material, provided:
"42 The principal sum together with interest and all other moneys owing and secured hereunder shall, at the option of
(Farrow) (and notwithstanding any delay or previous omission, neglect or waiver of the right to exercise such option), become immediately due and payable without any demand or notice and this security shall become immediately enforceable, upon the happening of (inter alia) any of the following events:-
. . .
(j) if the Mortgagor defaults in respect of any payment of principal or interest or other moneys whatsoever or commits any breach of any agreement or covenant on his part herein contained or implied or contained or implied in any collateral security . . ."
By notices dated 31 January 1991 and 28 February 1991, Farrow demanded repayment by Donmint and Vamugi of the principal sum secured by the mortgages. Further, by letter dated 18 July 1991, addressed to each of the borrowers, Farrow demanded payment of the then amount of principal and interest owing under the securities.
Against this factual background there was some debate before us as to the proper construction of cl. 42. It was conceded for the appellants that the principal sum and interest and all other moneys secured would become immediately due and payable without any demand or notice, upon the happening of events including default in payment of interest. (No point was taken as to the possible effect of s. 111 of the Conveyancing Act 1919 (N.S.W.); see Isherwood v Butler Pollnow Pty Ltd (1986) 6 NSWLR 363 at 383-6.) But it was said that this would only come about "at the option" of Farrow and there was nothing to show that Farrow had exercised its option.
In our view, this misstates the effect of the opening passage in cl. 42; this is plainly designed to assist the position of the mortgagee when one of the events listed in paras. (a) - (n) has occurred. Clause 42 does not say that no demand or notice may be given; it says that it need not be given. If demand or notice is given then, in our view, that may readily be construed as an indication that Farrow has exercised the option given it by cl. 42 to render the whole of the moneys immediately due and payable. Accordingly, at the very latest, by 18 July 1991, the whole of the moneys secured by the mortgages had become immediately due and payable to Farrow. Further, at any time from at least 1 May 1990 the default in interest payments had meant that it had been open to Farrow to act in this way. This is important because, as will later appear, of events which took place subsequently, on 22 August 1990.
The obligation of the guarantors was spelled out in cl. 3 of the guarantees as follows:
"3. In the event of any default by (Donmint and Vamugi) in the repayment of the principal sum or any instalment or part thereof or the payment of interest or other moneys payable under or secured by the Mortgage, or in the event that any such moneys for any other reason are not duly paid, the Guarantor shall pay the same to (Farrow) immediately upon demand."
Further, cl. 7 stated that as between the sureties and Farrow, the instrument "shall constitute a principal obligation and shall not be treated as ancillary or accessory" to the mortgages held by Farrow from the principal debtors. It will be necessary to refer further to clauses 3 and 7 later in these reasons.
We have referred to the demands by Farrow upon Donmint and Vamugi on 31 January 1991 and 28 February 1991 for repayment of the principal sum. Those demands had not been met, nor the arrears of interest paid, when on 18 July 1991 Farrow made demand upon the appellants for the entire debt. Action was then instituted in the Commercial Division of the Supreme Court of New South Wales on 16 August 1991, and, as we have indicated, judgment was recovered with effect from 27 November 1991. An application to set aside the judgment was, after a contested hearing, refused in a reasoned judgment delivered 29 October 1992. Applications to the Court of Appeal for leave to appeal were dismissed on 2 December 1992.
It is now appropriate to return to the first of the grounds urged on the appeal in this Court. It is contended that Ryan J ought to have found that there was no accrued liability at the relevant time which was the subject of the guarantee. This was said to be because of what was alleged to be the unequivocal assertion on behalf of Farrow on 22 August 1990 that it would not make any future progress payments for the Parramatta site to which Donmint and Vamugi might otherwise become entitled under their loan contract. It was submitted that this breach amounted to a repudiation which was accepted by Donmint and Vamugi, and that the consequent termination of this contract thereby in some way extinguished what otherwise would be Farrow's rights to repayment of the principal already advanced and interest accruing thereon. There may be, as counsel for Farrow stressed, good answers to the claim of repudiation by Farrow and acceptance thereof by Donmint and Vamugi.
But even if that not be accepted, there remain substantial reasons why there was no such extinction of Farrow's rights and the obligations of Donmint and Vamugi in relation to the principal moneys already advanced and the interest accruing thereon.
As we have indicated, the date of the alleged repudiation by Farrow was 22 August 1990. By 12 July 1990, Donmint and Vamugi were in default in the payment of interest. The result of this was that before 22 August the whole of the principal sum had become immediately due and payable at the option of Farrow. The right of Farrow to elect to have that sum paid to it had accrued under the contract and the right would continue until either the default was remedied or the right waived.
The submissions for the appellants on this branch of the case rely upon, but misconstrue, what was held in two High Court decisions to be the law concerning the effect of the acceptance of a repudiation of a contract partly performed at the time of the discharge. The two decisions in question are McDonald v Dennys Lascelles Ltd (1933) 48 CLR 457 at 476-7 and Westralian Farmers Ltd v Commonwealth Agricultural Service Engineers Ltd (In liq.) (1936) 54 CLR 361 at 380, 386. These and other authorities are collected and analysed by Professors Carter and Phillips in their recent article "The Liability of Debtors and Guarantors Under Contracts Discharged for Breach" (1992) 22 UWAL Rev. 338.
The well-known passage from the judgment of Dixon J in Dennys Lascelles at 476-7 has recently been approved by the House of Lords in Bank of Boston Connecticut v European Grain and Shipping Ltd (1989) AC 1056 at 1098-9. The passage is as follows:
"When a party to a simple contract, upon a breach by the other contracting party of a condition of the contract, elects to treat the contract as no longer binding upon him, the contract is not rescinded as from the beginning. Both parties are discharged from the further performance of the contract, but rights are not divested or discharged which have already been unconditionally acquired. Rights and obligations which arise from the partial execution of the contract and causes of action which have accrued from its breach alike continue unaffected. When a contract is rescinded because of matters which affect its formation, as in the case of fraud, the parties are to be rehabili-tated and restored, so far as may be, to the position they occupied before the contract was made. But when a contract, which is not void or voidable at law, or liable to be set aside in equity, is dissolved at the election of one party because the other has not observed an essential condition or has committed a breach going to its root, the contract is determined so far as it is executory only and the party in default is liable for damages for its breach."
As Professors Carter and Phillips point out (supra p 340), this passage contains three basic propositions concerning discharge by acceptance of repudiation, (i) termination discharges both parties from further performance, (ii) discharge does not affect rights and obligations which have already been unconditionally acquired, and (iii) causes of action which have accrued from the breach continue. Proposition (iii) applies mainly to claims for damages, whilst (ii) applies particularly to claims for sums fixed by the contract.
Payments which have been "earned" even by the party in breach are still recoverable after discharge: Ettridge v Vermin Board of the District of Murat Bay (1928) SASR 124 at 128-9; Bank of Boston Connecticut v European Grain and Shipping Ltd supra at 1098-99. (It is unnecessary for the present case to consider the status of payments "earned" before termination, but which under the now discharged contract are only due and payable at a later date; it has been said that the creditor must wait until the due date and semble cannot elect to sue forthwith for a discounted sum; see Carter and Phillips supra 348-9.)
In Westralian Farmers at 380, Dixon and Evatt JJ said:
"In the present case the thirty-two tractors had been delivered before the termination of the contract. On behalf of the respondent company, which under the agreement occupies the position of a vendor, the price payable to the vendor's supplier had been paid by the appellant company and the property had under the agreement passed to it. In point of law the percentage formed part of the price payable to the respondent company as vendor. Its payment, however, was by the terms of the contract deferred until the arrival of the goods at Fremantle. This contingency depended upon external events constituting no part of the performance of the contract. The right to payment, no doubt, was at the time of the termination of the agreement contingent but it was a debt otherwise completely vested in the respondent company as creditor. The termination of the agreement did not prevent it becoming absolute on the occurrence of the contingency." (emphasis supplied)
In the same case, at 386, McTiernan J perhaps put the position even more widely by saying:
"The arrival of the goods at Fremantle was not dependent on the subsistence of the contract after the goods were consigned to that port. Payment of the 'percentages' could not be demanded before that time, but all conditions necessary to create the plaintiff's right to payment were fulfilled in accordance with the contract while it was still in existence". (emphasis supplied)
The fourth member of the majority (Latham CJ dissented) was Starke J who, at 375, said that the clause in question merely delayed or postponed payment until the arrival of the goods at Fremantle and did not affect the liability to pay the percentage "arising out of an obligation which had arisen before the termination of the contract".
In the present case, the conditions necessary to create Farrow's right to elect to receive immediate payment of the principal sum together with interest under cl. 42 had been fulfilled before the date of the alleged discharge on 22 August 1990. All that remained was the exercise by Farrow of the right given it by the clause or the waiver of that right.
Farrow cannot be said to have waived its right to receive immediate repayment. The decision in Commonwealth of Australia v Verwayen (1990) 170 CLR 394 now determines this area of law. Setting to one side waiver of rights conferred by statute and steps taken whilst litigation is on foot, a majority of the High Court held that rights may only be lost by contract, election or estoppel: id at 406-7 (Mason CJ), 431 (Deane J), 451-2 (Dawson J) and 497 (McHugh J). Here, there was no agreement with Donmint and Vamugi, supported by consideration, not to demand repayment. Nor was there an election, because Farrow was not entitled to alternative, inconsistent rights.
Nor, finally, did an estoppel arise. The conduct said to found an estoppel must be clear and unambiguous: Legione v Hateley (1983) 152 CLR 406 at 435. On 22 August 1990, Mr Acreman of Farrow said to the appellants:
"Construction funds should have been forthcoming but we are unable to now proceed with the financing and you should make an offer of settlement to Farrow and refinance the project."
This statement is not conduct amounting to a representation that Farrow would not exercise its option to demand immediate repayment arising from past breaches. Still less could it operate to estop Farrow from relying on any future breaches.
In the circumstances, the exercise of its option on 31 January and 28 February by Farrow was effective.
Ryan J examined various authorities, in particular Wren v Mahony supra. His Honour concluded that this Court should only exercise its discretion to go behind the Supreme Court judgment if persuaded that the judgment was infected "by an identifiable error of substantive law", so that its continued existence represented a miscarriage of justice. As to the arguments based upon the alleged repudiation, his Honour, perhaps for slightly different reasons, concluded that they did not disclose such an identifiable error of substantive law.
It follows from what we have said that in our respectful view his Honour was correct in so concluding. Were this the only issue on the appeal it must follow that the appeal should be dismissed.
It may be suggested that in an action by Farrow to recover the principal and interest from Donmint and Vamugi they would have had a cross-claim (as described in s. 78 of the Supreme Court Act 1970 (N.S.W.)), in the nature of an equitable set-off for the unliquidated damages for repudiation by Farrow of its executory obligations under the loan contracts. An examination of the history of this litigation shows that no such claim has been propounded.
In a suit in the Equity Division of the Supreme Court of New South Wales filed 18 April 1991 (that is to say before Farrow commenced the action on the guarantees in the Commercial Division, but on the day after Farrow had been wound up), Donmint and Vamugi claimed unliquidated damages by reason of alleged wrongful repudiation by Farrow of its contractual obligations. In particular, they claimed that in the events that had happened by 7 June 1990, the eighth covenant in the mortgage over the Parramatta site obliged Farrow, if so requested, to capitalise interest and that Farrow had wrongly refused to do so. It was said in the Statement of Claim that the particulars of the loss and damage were "extensive" (para. 14).
In the Commercial Division proceeding on the guarantees, Mr Elkhoury and Mr Torpey pleaded the complaints against Farrow in the Equity suit and alleged that in the circumstances the guarantees were "at an end" or alternatively did not secure any existing obligation of Farrow. No set-off was asserted, and in neither of the Supreme Court proceedings were the principal debtors, guarantors and creditor all joined. Because Farrow had been wound up, leave of the Court was required for the Equity Division proceeding against it. On 1 October 1991, leave was refused by a Master, who gave detailed reasons. He held, on the evidence before him, that there was no prima facie case of breach by Farrow of the eighth covenant. Then on 4 October 1991, a Judge in the Commercial Division gave leave to Farrow to enter judgment in the action on the guarantees against the present appellants. There was no evidence on the hearing of the creditor's petition before Ryan J which supplied real and detailed substance to what might have been a set-off available to the principal debtors against Farrow.
Further, and in any event, a real question would then have arisen as to whether upon this hypothesis the obligation of the guarantors under the guarantees was diminished or discharged. As we have indicated, the obligation thereunder was, in the event of any default of the principal debtors in their repayment of the principal or any instalment of interest, "to pay the same" to Farrow immediately upon demand; cf the differently drawn guarantee discussed in Ashley Guarantee plc v Zacaria (1993) 1 All ER 254 at 259, and see also Ankar Pty Ltd v National Westminster Finance (Australia) Limited (1987) 162 CLR 549; Sunbird Plaza Pty Ltd v Maloney (1988) 166 CLR 245 at 255-7.
There is a substantial body of Australian authority that in the absence of the principal debtor as a party to the proceeding, the guarantor cannot assert in answer to an action on the guarantee an equitable set-off which the debtor might have in an action on the principal obligation: Cellulose Products Pty Ltd v Truda (1970) 92 WN (N.S.W.) 561 at 588; Covino v Bandag Manufacturing Pty Ltd (1983) 1 NSWLR 237 at 240-1; Indrisie v General Creditors Ltd (1985) VR 251 at 253. The position may be otherwise in England: National Westminster Bank plc v Skelton (1993) 1 All ER 242 at 250-1. See, generally, Phillips and O'Donovan "The Modern Contract of Guarantee", 2nd ed., 1992, pp 468-470.
In addition, in the present case, the terms of the guarantee (cl. 3 and 7) appear to be drawn so as to oust what otherwise might be entitlement of the sureties to rely upon a set-off available to the principal debtors. We have set out the text of cl. 3 earlier in these reasons. Clause 7 of the guarantee was in the following terms:
"Although, as between (Donmint and Vamugi) of the one part and the Guarantor of the other, the Guarantor is a surety, it is agreed that, as between the Guarantor and (Farrow), the within guarantee shall constitute a principal obligation and shall not be treated as ancillary or accessory to the Mortgage or any other obligation howsoever created, and may be enforced against the Guarantor notwithstanding any laches, compounding or compromise or any forbearance, extension of time or indulgence granted to (Donmint and Vamugi) or any other acts or omissions whatsoever on the part of
(Farrow) AND the liability of the Guarantor hereunder shall not be affected by reason of the Mortgage, or any other security or agreement held, taken or entered into by (Farrow) at any time being or becoming, in whole or in part, invalid, illegal, unenforceable, void, voidable, defective or informal by reason of any act, omission, rule of law or equity or otherwise."
There remains the issue of illegality.
The present appeal was heard shortly after the appeal in Farrow Mortgage Services Pty Limited (In Liquidation) v Edgar and Ors (No. NG667 of 1992) and by the same bench. Judgment in that appeal is also delivered on 3 June 1993.
In the appellants' written submissions in reply, on the present appeal, counsel stated that his clients were content to abide the outcome of the appeal in the other matter, with the result that if the Full Court upheld that appeal, it was conceded by the present appellants that Ryan J correctly decided the illegality issue.
The other appeal being allowed, it follows that it is unnecessary to deal further here with the issue of illegality.
The appeal should be dismissed with costs.
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