Karl Suleman Enterprizes Pty Ltd (in liq) v Babanour

[2004] NSWCA 214

Reported Decision: 49 ACSR 612
(2004) 22 ACLC 931

Court of Appeal

CITATION:	KARL SULEMAN ENTERPRIZES PTY. LIMITED (In Liquidation) ACN 090 895 364 (Appellant)BABANOUR (Respondent) [2004] NSWCA 214
HEARING DATE(S):	19/04/2004
JUDGMENT DATE:	28 June 2004
JUDGMENT OF:	Spigelman CJ at 1; Beazley JA at 2; Santow JA at 75
DECISION:	1. Appeal allowed; 2. Direct the appellant to file any amended pleading within 28 days; 3. The respondent is to pay the appellant's costs of the Notice of Motion dated 7 March 2003 before Windeyer J and is to pay 50% of the appellant's costs of the appeal
CATCHWORDS:	PLEADING - Strike-out - Dismissal - Leave to replead. - DEFENCE - Illegality - Unclean Hands. - ILLEGALITY - Whether statute intended that contracts entered into as part of an unregistered scheme are illegal - Unlawful conduct no bar to bringing proceedings. - EQUITY - Equitable defence - Doctrine of unclean hands - Party who offends principle may wash hands of the impropriety.
LEGISLATION CITED:	Banking Act 1959 (Cth) Bankruptcy Act 1966 (Cth) Corporations Act 2001 (Cth) Crimes Act (1914) (Cth) Supreme Court Act 1970 (Cth)
CASES CITED:	Abignano & Anor. v. Wenkart (unreported FC of FCA 13 November 1998) Barnes v. Addy (1874) 43 LJ Ch 513 Beresford's case [1938] AC 586 Cleaver's case (1892) 1 QB 147 Fitzgerald v. Leonhardt (1997) 189 CLR 215 Harry Parker Ltd. v. Mason [1940] 2 KB 590 Khoury v. Government Insurance Office (NSW) (1984) 165 CLR 622 Marshall Futures Limited v. Marshall [1992] 1 NZLR 316 Nelson v. Nelson (1995) 184 CLR 538 Sargent v. ASL Developments Ltd. 131 CLR 634 Yango Pastoral Co. Pty. Limited v. First Chicago Australia Ltd. (1978) 139 CLR 410
PARTIES :	KARL SULEMAN ENTERPRIZES PTY. LIMITED (In Liquidation) ACN 090 895 364 (Appellant) SAM BABANOUR (Respondent)
FILE NUMBER(S):	CA 40567/03
COUNSEL:	J. Thomson/C. Wood (Appellant) R. Angyal/N. Obrart (Respondent)
SOLICITORS:	Coudert Brothers (Appellant) Keith Hurst & Associates (Respondent)

LOWER COURTJURISDICTION:	Supreme Court - Equity Division
LOWER COURT FILE NUMBER(S):	1446/02
LOWER COURT JUDICIAL OFFICER :	Windeyer J

1

CA 40567/2003
SC 1446/2002

SPIGELMAN CJ
BEAZLEY JA
SANTOW JA

28 June 2004

KARL SULEMAN ENTERPRIZES PTY. LIMITED (IN LIQUIDATION)

ACN 090 895 364 v. BABANOUR

Headnote

The appellant conducted a Managed Investment Scheme which, was unregistered in breach of the Corporations Act 2001 (Cth). The appellant brought a claim against the respondent alleging that the latter did not fulfil his duty as an agent to, inter alia, promote the Scheme, to act with good faith, loyalty and fidelity and not to use moneys received from investors for his own purposes. It was also alleged that the respondent was at all times, in the course of being an agent for the Managed Investment Scheme, on notice of its fraudulent nature.

The respondent successfully applied to have the claim brought against him by the appellant struck out on the basis that the appellant was required to rely upon its own illegal and fraudulent conduct in order to establish its claim and, to the extent that the claim was equitable, it was tainted in accordance with the doctrine of unclean hands. The trial judge struck out the pleadings but granted liberty to replead on a limited basis.

The appellant appealed against the trial judge’s decision to strike out the claim brought by him against the respondent.

(i) Courts should not refuse to enforce legal or equitable rights simply because they arose out of an unlawful purpose unless the statute discloses an intention that those rights should be unenforceable in all circumstances or the sanction of refusing to enforce those rights is not disproportionate to the seriousness of the unlawful conduct, the imposition of the sanctions is necessary to protect the objects or policies of the statute and the statute does not disclose an intention that the sanctions and remedies contained in the statute are to be the only legal consequences of a breach of the statute or the frustration of its policies; Nelson v Nelson (1995) 184 CLR 583; Yango Pastoral Co. Pty. Limited v. First Chicago Australia Ltd. (1978) 139 CLR 410; Fitzgerald v. Leonhardt (1997) 189 CLR 215.

(ii) The illegality alleged arose out of the appellant’s failure to register the scheme as required by ss.601EB and 601ED of the Corporations Act . However, the Act does not expressly make an unregistered scheme unlawful. Rather, it impugns the conduct of the entity responsible for registration by imposing a penal sanction for a contravention of the registration provisions: s.1311(1)(c). It also protects the members of an unregistered scheme through its provisions permitting such a scheme to be compulsorily wound up.

(iii) To preclude the appellant from bringing its claim would potentially lead to the unsatisfactory position whereby a party, regardless of its previous conduct, but now acting in good faith would be prevented from bringing proceedings for the purposes of recovering moneys in order to pay wronged investors.

(iv) A party who offends the principle of unclean hands may wash his/her hands of the impropriety where, for example, the misconduct has ceased before suit or where a company takes steps to reimburse the investors of sums of moneys of which they have been defrauded.

(v) The appeal was not an abuse of process. The appellant had not elected between inconsistent rights in appealing against the trial judge’s order and in making an application to amend the Statement of Claim.

(vi) The Court has the power to direct that the appellant file any amended pleading within a specified time: s.76(6) Supreme Court Act 1970 (Cth).

(vii) Where much of the time on the appeal is taken up with understanding the nature of the claims made against the appellant and the state of the pleadings is less than satisfactory, despite its success, the appellant may not recover 100% of the costs of the appeal from the respondent.

1. Appeal allowed.

2. Direct the appellant to file any amended pleading within 28 days.

3. The respondent is to pay the appellant’s costs of the Notice of Motion dated 7 March 2003 before Windeyer J and is to pay 50% of the appellant’s costs of the appeal.

CA 40567/2003
SC 1446/2002

SPIGELMAN CJ
BEAZLEY JA
SANTOW JA

28 June 2004

KARL SULEMAN ENTERPRIZES PTY. LIMITED (IN LIQUIDATION)

ACN 090 895 364 v. BABANOUR

Judgment

1 SPIGELMAN CJ: I agree with Beazley JA.

2 BEAZLEY JA: The principal question on this appeal is whether the appellant’s pleading against the respondent should have been struck out on the basis that the claims made against the respondent were affected by illegality and the doctrine of unclean hands.

3 The respondent, who was the fifth defendant in proceedings brought by the appellant in the Equity Division of the Supreme Court, successfully applied to have the claim against him struck out on the basis that the appellant was required to rely upon its own illegal and fraudulent conduct in order to establish its claim and, to the extent that the claim was equitable, it was tainted in accordance with the doctrine of unclean hands. The application was brought alternatively under Pt 13 r 5 (the dismissal provision) and Pt 15 r 26 (the strike out provision) of the Supreme Court Rules. The trial judge struck out the pleadings but granted liberty to replead as he considered there might be a basis upon which the appellant could plead that there had been a breach of trust. I return in more detail later to the orders made by his Honour.

The parties

4 The first plaintiff, Karl Suleman Enterprizes Pty. Limited (in liquidation) (KSE) was incorporated on 17 December 1999 and placed into liquidation by a creditors’ resolution on 7 December 2001. During this period the appellant conducted a Managed Investment Scheme as defined, which, as was acknowledged by all parties, was at all times unregistered in breach of the Corporations Law, (later replaced by the Corporations Act).

5 The second and third plaintiffs, Paul Weston and Neil Cussen were appointed by the Court as receivers for the purposes of winding-up the unregistered fund: see s.601EE of the Corporations Act 2001 (Cth). Messrs. Weston and Cussen were subsequently appointed liquidators of the company. Windeyer J held that there was no proper basis upon which Messrs. Weston and Cussen, as receivers of the managed investment fund could bring proceedings against the respondent. His Honour accordingly struck out their claims against the respondent and removed them as plaintiffs from the proceedings. There is no appeal in respect of that order.

6 The directors and shareholders of KSE were Karl Suleman and his wife. Karl Suleman was the only effective controller of the company. Neither has been made a party to these proceedings.

7 The respondent was, according to the pleadings, an agent appointed by the appellant to promote and introduce investors to the Scheme. Eight of the other defendants were likewise alleged to have been appointed as agents by the appellant.

The Scheme

8 Under the Scheme, investors were invited to invest in a shopping trolley collection service business in consideration for the payment of a significant monetary amount, paid on a regular basis for a predetermined period. There were some variations in the way the Scheme operated. For example, some investments were made by way of specific loan to KSE. Overall, however, the Scheme, properly characterised, was a Ponzi or pyramid scheme under which funds received from new investors were used to pay out existing investors or to pay interest on money advanced by existing investors.

9 The appellant operated the Scheme through agents who were used to promote the Scheme and to introduce investors. The agency was alleged to have arisen “expressly, impliedly and by way of conduct” of certain of the defendants, including the respondent, who were said to be the agents used by the appellant for the purposes of the Scheme: Statement of Claim para. 5.

10 The details of the contracts offered to investors were particularised in para. 26 of the Statement of Claim. According to those particulars, contracts entered into with investors were of two types. The first type of contract stated that there was a sale of a trolley collection service owned by KSE to the investor in consideration for the investor paying a specified amount of money. The purchaser was to receive a fixed sum of money on a regular fortnightly basis for a predetermined period and KSE was to conduct the day to day management of the business. The pleadings acknowledged that no business was in fact sold: Statement of Claim para. 26(i). Contracts of that type were issued until about August 2000.

11 The second type of contract commenced to be issued from about July 2000. Under those contracts, KSE represented that it was a manager carrying on a trolley collection service and the investor agreed to invest in that business. Again, the investor was to receive a fixed sum of money on a regular fortnightly basis for a predetermined period in consideration for making the investment: Statement of Claim para. 26(v). Subsequently, there were two variations to the second type of contract. In the first of those variations, KSE represented that it carried on business including, but not limited to, trolley collection services and the payment by the investor to KSE was structured as “a loan”. In the second variation, which occurred in about September 2001, the investors were allocated to purported partnerships with other investors for the purposes of investing in the Scheme: Statement of Claim para. 26(vii).

12 In para. 34, the Statement of Claim pleads that from the date of incorporation onwards, the income and profits of the contracts were insufficient to enable KSE to fulfil its obligations to the investors. To overcome the insufficiency “KSE utilised the funds from latter investors to fund the payments to investors earlier in time”. In para. 35, the Statement of Claim pleads that as from the date of incorporation the nature of the Scheme “was contrary to the Managed Investment provisions of the Corporations Act 2001 and fraudulent”.

The claims against the respondent

13 The pleadings constituted the only material before the trial judge so that the success or otherwise of the respondent’s strike out claim has to be assessed solely by reference to the Statement of Claim. It is necessary to look at that document in some detail.

14 The appellant’s Statement of Claim is structured in the following manner.

15 By way of introductory pleadings at paras. 1-23 the Statement of Claim introduces the parties and other relevant persons and entities; the details of the Scheme; and the various steps taken to appoint administrators of the fund and to wind-up the appellant. The only paragraphs of these pleadings presently relevant are paras 5 and 6. Para 5 , to which I have already referred, alleges that agents were appointed to introduce investors and to promote the Scheme.

16 In para 6, it is alleged that the respondent was appointed as one of those agents.

17 In the next part of the Statement of Claim there is a pleading as to the “nature of the unregistered scheme” (para. 24-35). I have already outlined in broad detail what is alleged as to the manner of operation of the Scheme. Of particular relevance to the issues under appeal are paras. 30 and 31. In para. 30 it is alleged that KSE and Karl Suleman authorised, inter alia, the agents, to receive, and the agents did receive, out of the proceeds of the Scheme various payments including: lump sum payments; percentage payments out of the investments of particular investors; and commissions. Such payments were made without appropriate accounting records being kept. In para. 31, it is alleged that KSE and Karl Suleman authorised, inter alia, the agents to pay cash to Karl Suleman, or to refrain from banking cash to KSE’s bank account. Reference should also be made to para. 32(i) in which it is alleged that the funds paid by investors to KSE under the Scheme were dissipated in a variety of ways, including payments to agents in the manner referred to in para. 30.

18 I have already referred to the pleading in para. 35 in which it is alleged that the Scheme was operated contrary to the Managed Investment provisions of the Corporations Act and was fraudulent. Particulars of the fraudulent nature of the Scheme are then given. Again, the detail is not important for present purposes and it is sufficient to make reference to particular (i) in which it is alleged that:

“The Scheme was inherently fraudulent in that it relied on KSE incurring liabilities to new investors to fund liabilities incurred to existing investors, both of which were unserviceable.”

19 The next section of the Statement of Claim pleads details of “the Conduct of Karl Suleman” (paras. 36-43). Para. 42 pleads that Karl Suleman breached his fiduciary duty and duty of good faith owed to KSE. There is then a generalised pleading in para. 43 that Karl Suleman “used KSE to defraud investors and then defrauded KSE by misappropriating its funds”.

20 There then follows specific pleadings against each defendant. The specific claim against the respondent is contained in paras. 172-188. The following allegations are made in those paragraphs. First there is an allegation of agency (para. 172); an allegation that as agent the respondent had a duty to KSE to act “with all good faith, loyalty and fidelity”. That duty is said to arise by implication of the law of agency and as part of the respondent’s fiduciary obligation as an agent (para. 173). It is next alleged that, arising out of the same two matters, the respondent had a duty not to use moneys received from investors for his own purposes (para. 174).

21 In para. 175 it is alleged that the respondent had “knowledge of and participated in the Scheme”. Particulars of that knowledge are set out in para. 177. Para 176 is in the following terms:

“176. In the premises, [the respondent] at all times owed a duty to act honestly and to exercise a reasonable degree of care and diligence in carrying out his duties and the discharge of his functions and further he owed the following fiduciary obligations to KSE:
(i) a duty to act bona fide in the best interests of KSE as a whole;
(ii) a duty to avoid placing himself in a position where his duties as an agent conflicted with his personal interests or the interests of other persons or companies of which he was a director or in which he was a substantial shareholder or otherwise associated; and
(iii) a duty not to use his position in KSE to gain an advantage for himself or for any other person.”

22 Para. 179 is one of two paragraphs which appear under a heading “Knowingly Assisted”. In that paragraph, it is alleged that the respondent, in the course of being an agent of KSE was on notice of the fraudulent nature of the Scheme. The particulars of the knowledge include that he was in receipt of funds to which he had no entitlement (sub-para. (i)); there was no clear directive as to who was entitled to the funds (sub-para. (ii)); he did not keep appropriate records (sub-para. (iii)); and that he did not remit the funds made to him (sub-para. (iv)). It was also alleged that he failed to make appropriate enquiries as to who was entitled to funds (sub-para. (vi)) and that he was aware that the returns were in excess of a realistic commercial return (sub-para. (vii)).

23 Para. 181 is another paragraph which appears under a heading “Knowingly Assisted”. By a series of particulars of specific conduct or omissions by the respondent it is alleged that the respondent “knowingly assisted Karl Suleman to misappropriate funds from KSE and by reason thereby perpetrated a fraud upon KSE”.

24 It is convenient to next refer to paras. 183 and 186. Para. 183 is introduced with the heading: “Alleged Receipt of KSE Funds”. There follows an allegation that the respondent received various moneys as set forth in the Schedule of Particulars. In the Schedule, details are given of the receipt of cheques between 14 May 2001 and 2 October 2001 endorsed to cash, totalling $162,800.00, together with details of total deposits to the respondent’s bank accounts from 17 December 1999 in a total amount of $393,761.84. Para. 186 is a general allegation of loss and damage suffered as a consequence of the “breaches of duty aforesaid”. The particulars of that loss are specified as being the moneys belonging to KSE received by the respondent as set forth in the Schedule of Particulars. A statement is made that further particulars of loss were to be provided in due course.

25 Para. 184 alleges that by reason of retaining the significant amounts of money paid to him the respondent “was unjustly enriched at the expense of and to the detriment of KSE, in circumstances where he is obliged to return the funds and compensate KSE for funds he is unable to return”. This claim is characterised by the pleader as a claim in unjust enrichment, or alternatively, moneys had and received.

26 In para. 185 it is pleaded that “the significant amounts received and retained by [the respondent] was money had and received to the use of KSE”.

27 In para. 187, it is alleged that by virtue of the respondent’s knowing participation in the breaches of fiduciary duty, good faith and fraudulent behaviour, he is liable to account to KSE in respect of the said losses.

28 Then, in its general claim for relief, the plaintiff seeks five specific remedies: damages, damages pursuant to s.1317H of the Corporations Act 2001, equitable compensation, taking of accounts, and tracing into accounts.

The strike out motion

29 As I have already indicated, the respondent moved the Court to strike out the claims against him on the basis that they required the appellant to rely upon its own illegality and fraud or, to the extent that the claims were equitable in nature, that the appellant’s conduct was tainted by unclean hands, such that the claims ought not to be able to be maintained.

30 As I have indicated the respondent brought its motion under Pt 13 r 5 and Pt 15 r 26. There was no issue in the proceedings as to the principles to be applied under either Rule. The facts pleaded in the Statement of Claim were treated as true for the purposes of the application.

The trial judge’s reasons

31 The primary judge at [13] summarised KSE’s claim in these terms:

“13. The claim of the company, put simply, is that having conducted an illegal and fraudulent operation under which investors, - whom I should say would not necessarily all be innocent people – paid money to it, and having passed on some of those moneys to agents engaged to assist in the fraudulent and illegal operation or having allowed those agents to keep some of the moneys collected by them as recompense for their efforts, it should now recover from those agents the amounts which they received through their agency efforts. In other words the agents having performed in accordance with their contract of agency are to be required to disgorge to the company which instituted the fraudulent operation because that company has now had an unpleaded change of heart and instead of denuding investors, innocent or not, of their funds, now intends to restore them so far as possible to the victims of the fraudulent operation.”

32 His Honour continued at [15]:

“15. … Without going into the matter in any detail it is difficult to understand why any equitable claim of the plaintiff would not be defeated by a defence of lack of clean hands and illegality and why any claim for breach of contract would not be defeated by a defence of illegality. Insofar as the claim which appears to be based on unjust enrichment might be thought to fall within the two, it is clearly unsustainable.”

33 His Honour then considered an argument advanced on behalf of the appellant in an attempt to maintain the claim, that, the principles in Marshall Futures Limited v. Marshall [1992] 1 NZLR 316 applied. In that case the plaintiff company had breached the trust upon which client funds were held by paying the moneys to an associated company. The company, then in liquidation, brought an action against the associated company and its directors based upon their knowing assistance in the breach of trust. Tipping J, who refused to strike out the Statement of Claim said:

“… Although in strictly analytical terms it is the same legal entity as it was when the allegedly fraudulent breaches of trust occurred, the hands controlling it are now those of the liquidator and not those of the directors. There cannot be any suggestion that the liquidator’s hands are unclean. …
It seems to me … that in these particular and unusual circumstances the corporate veil can reasonably be lifted to reflect the reality of what is going on. …”

Tipping J continued:

“The plaintiff must prove that the hands of those who were controlling it at the material times were unclean in such a way as to make it, the plaintiff, fraudulent. It must also be proved that the hands of all those who are alleged to have assisted were also unclean. I am not to be taken in this approach to be saying that a company in liquidation is in law a different person from the company before its liquidation. What I am saying is that in substance in the present case the company now in liquidation raises the first cause of action in essence as the agent of its creditors.”

His Honour added that dirty hands are not an absolute bar and that all the circumstances have to be taken into account.

34 Windeyer J did not agree with the reasoning in Marshall. He said at [17]:

“It does not seem to me to be possible that there can be a difference in rights where a company is subject to a members (sic) voluntary winding up in the case where it is solvent and a case where there is a winding up on insolvency which may or may not ultimately result in some funds being available to the contributories. If a company guilty of fraud under one set of directors comes under the control of an honest set of directors that cannot make a claim which, if made by the company in the control of dishonest directors, would fail, into a claim that could succeed if brought when honest directors were in control. … the moneys which the plaintiff company seeks to recover are moneys to which the plaintiff company has no right, those moneys having been obtained through its fraud. The persons having a right to recover such moneys are those persons from whom they were originally received.”

35 It should be noted that there was no specific Barnes v. Addy pleading in the appellant’s Statement of Claim. In particular, there was no allegation that moneys were held on trust and no allegation that KSE breached any fiduciary duty to the investors. His Honour adverted to this towards the end of his reasons when he referred to one of the appellant’s submissions on the application in which it claimed that it was alleging, inter alia, a cause of action of “knowing receipt or knowing assistance of a breach … of trust under the principles set out in Barnes v. Addy”. His Honour observed that not only was there no pleading that KSE was a trustee of the invested funds or in any way a fiduciary but that in any event the relationship between KSE and the investors was probably one of debtor and creditor. Indeed, there is no allegation at all in the pleading as to how the funds received from the investors were or should have been held. His Honour also observed that the fiduciary relationship alleged to arise between KSE and the respondent was based on a contract of agency. His Honour considered therefore that the principles in Barnes v. Addy were irrelevant as he said: “There is no claim of trust fund; there is no allegation of fiduciary duty to investor.” His Honour added: “Thus although a trustee in breach of trust can pursue a claim against a co-trustee for the purpose of reinstating the trust fund: see Young v. Murphy [1996] 1 VR 279 at 282-283 per Brooking J … that is not the claim made by the plaintiff here”. His Honour added that Marshall Futures might be explained on the basis that the funds sought to be recovered were trust funds although he noted that was not the basis of the reasoning.

36 His Honour next considered the provisions of s.601 FC(2) of the Corporations Act 2001 on the basis that the appellant, as the responsible entity as defined under the Corporations Act, held the Scheme property on trust for the members. His Honour considered that because of the possible availability of that cause of action, the appropriate order in the present case was to strike out the Statement of Claim rather than to dismiss.

37 His Honour next, at [21] considered the claims for money had and received and unjust enrichment and breach of contract (if that could be found in the Statement of Claim). He held that these claims “must be defeated by the defence of illegality”. His Honour also considered that, to the extent that the claims were equitable the defence of lack of clean hands must succeed.

38 His Honour concluded at [23] that the plaintiffs could not succeed on the present pleadings against the respondent. He noted that he was not dealing with the pleadings as against all defendants although the same would apply to them. However, because of the potential availability of a claim on the basis that the investors’ moneys were held on trust, his Honour considered that the appellant should have the opportunity to replead. He thus ordered that the claim against the respondent be struck out with leave to replead within 28 days. His Honour made that order self-executing by ordering that in default of such amendment the proceedings against the respondent were to stand dismissed.

Matters occurring subsequent to his Honour’s Judgment

39 Subsequent to the making of the orders on 20 June 2003, the appellant made an application to the primary judge to seek a variation thereof and also sought leave to amend in terms more extensive than that granted by his Honour. His Honour acceded to the application and on 17 July revoked the self-executing order and extended the time in which to replead to 8 August 2003. Had those orders not been made, the self-executing order would have had effect on 18 July 2003. The respondent now alleges that having taken an alternate route to pursue its claim it should not now be allowed to pursue the appeal. I will return to this later in these reasons.

Errors by the trial judge

40 With respect to his Honour, I consider that he erred in holding that the appellant’s claims could not be maintained because they were tainted by illegality and a lack of clean hands.

41 In Yango Pastoral Co. Pty. Limited v. First Chicago Australia Ltd. (1978) 139 CLR 410 the Court was concerned with the question whether the Court would enforce a mortgage if the mortgage was found to be illegal. The ground of illegality alleged was that the mortgagee was carrying on a banking business but was not authorised to do so by s.9 of the Banking Act 1959 (Cth) and had granted the mortgage in the course of carrying on that business. In considering that question Mason J said at p.426:

“Where, as here, a statute imposes a penalty for contravention of an express prohibition against carrying on a business without a licence or an authority and the business is carried on by entry into contracts, the question is whether the statute intends merely to penalize the person who contravenes the prohibition or whether it intends to go further and prohibit contracts the making of which constitute the carrying on of the business. In deciding this question the court will take into account the scope and purpose of the statute and the consequences of the suggested implication with a view to ascertaining whether it would conduce to, or frustrate, the object of the statute.”

42 His Honour concluded that the statute did not prohibit contracts made by unauthorised banks. His Honour said at p.427:

“To do so would be to prejudice depositors, not to protect them. The implication of such a prohibition would deny to innocent depositors the right to recover moneys deposited unlawfully with persons carrying on banking business because ex hypothesi the prohibited contract would be illegal and void.”

43 However, a further question arose because in Yango, it was the unauthorised bank that was seeking to enforce the illegal transaction. The defendants relied upon the principle ex turpi causa non oritur actio or upon the more specific rule that the court will not enforce a contract at the suit of a party who has entered into a contract with the object of committing an illegal act. In dealing with that issue, Mason J observed that it gave rise to a conflict with another policy consideration, namely that contracts, otherwise properly formed, ought to be enforced: see Beresford’s case [1938] AC 586 at 603. Such a conflict is to be resolved, according to Beresford’s case, by giving weight to the former only to the extent that “the protection of the public requires”: Cleaver’s case (1892) 1 QB 147 per Lord Esher MR at 181.

44 Mason J considered that the resolution of the conflict between the competing public policy considerations was influenced by the form of the legislation that created the illegality. In particular, as his Honour observed at p.429:

“There is much to be said for the view that once a statutory penalty has been provided for an offence the rule of the common law in determining the legal consequences of commission of the offence is thereby diminished – see … Jackson v. Harrison. See also the suggestions that the principle cannot apply to all statutory offences ( Beresford v. Royal Insurance Co. Ltd. in the Court of Appeal, per Lord Wright; Marles v. Philip Trant & Sons Ltd. per Denning L.J., and that it would be a curious thing if the offender is to be punished twice, civilly as well as criminally ( St. John Shipping Corporation v. Joseph Rank Ltd . per Devlin J.). The main consideration from which the principle ex turpi causa arose can be seen in the reluctance of the courts to be instrumental in offering an inducement to crime or removing a restraint to crime: Beresford’s Case ; Amicable Society v. Bolland ( Fauntleroy’s Case ).”

45 His Honour concluded that under the Banking Act the Parliament had provided for a penalty which was “a measure of the deterrent” it intended for non-compliance with the Act. To impose a further penalty by refusing to enforce the contract was a consequence that “could well far exceed the prescribed penalty and could even … lead the [appellant] to insolvency with resultant loss to innocent lenders or investors”. Gibbs ACJ held at 417 that neither the making nor the performance of the contract was unlawful. The fact that the contract was made and performed in the course of conduct of an unlawful enterprise did not provide a ground for denying relief. In such a case, the illegality was “merely casual or adventitious”. Jacobs J and Murphy J each in separate judgments adopted a similar approach. Aickins J agreed with Mason J.

46 The High Court’s approach in Yango has not been doubted although there has, perhaps been some development, or at least greater exposition, of the principles (not presently relevant) in the later decisions of Nelson v. Nelson (1995) 184 CLR 538 and Fitzgerald v. Leonhardt (1997) 189 CLR 215. So far as is relevant in this case, both cases reinforce the approach taken in Yango. In Nelson v. Nelson McHugh said at 604:

“[C]ourt that finds that an agreement is unlawful or has an unlawful purpose has merely set the stage for a further inquiry: are the circumstances surrounding the agreement such that the court should deny a relevant remedy to the party seeking the assistance of the court?”

His Honour said further:

“… courts should not refuse to enforce legal or equitable rights simply because they arose out of or were associated with an unlawful purpose unless: (a) the statute discloses an intention that those rights should be unenforceable in all circumstances; or (b)(i) the sanction of refusing to enforce those rights is not disproportionate to the seriousness of the unlawful conduct; (ii) the imposition of the sanctions is necessary, having regard to the terms of the statute, to protect its objects or policies, and (iii) the statute does not disclose an intention that the sanctions and remedies contained in the statute are to be the only legal consequences of a breach of the statute or the frustration of its policies.”

47 In Fitzgerald v. Leonhardt McHugh and Gummow JJ said at 576-579:

“[T]he question then becomes whether, as a matter of public policy, the court should decline to enforce the contract because of its association with the illegal activity of the owner … The refusal of the courts in such a case to regard the contract as enforceable stems not from express or implied legislative prohibition but from the policy of the law, commonly called public policy [( Yango Pastoral Co. Pty. Ltd. v. First Chicago Australia Ltd (1978) 139 CLR 410 at 429-30, 432-3; 21 ALR 585; Nelson v. Nelson (1995) 184 CLR 538 at 551-2, 593, 611; 132 ALR 133)]. Regard is to be had primarily to the scope and purpose of the statute to consider whether the legislative purpose will be fulfilled without regarding the contract as void and unenforceable ( Yango Pastoral Co. Pty.Ltd. v. First Chicago Australia Ltd (1978) 139 CLR 410 at 434; 21 ALR 585).

Their Honours continued:

“… the courts should not refuse to enforce contractual rights arising under a contract, merely because the contract is associated with or in furtherance of an illegal purpose, where the contract was not made in breach of a statutory prohibition upon its formation or upon the doing of a particular act essential to the performance of the contract or otherwise making unlawful the manner in which the contract is performed.”

Their Honours then cited with approval McHugh J’s statement in Nelson referred to above.

48 In the present case, the illegality alleged arose out of the appellant’s failure to register the scheme as required by ss.601EB and 601ED of the Corporations Act 2001. Section 601ED(5) provides:

“A person must not operate in this jurisdiction a managed investment scheme that this section requires to be registered under s.601EB unless the scheme is so registered.”

49 Section 1311 provides that a person who contravenes a provision of the Act is guilty of an offence: s.1311(1)(c). Sub-section 1A provides that sub-section (1)(c) only applies if, relevantly, a penalty, pecuniary or otherwise, is set out in Schedule 3 for that provision. Schedule 3 specifies the penalties applicable to various offences under the Act. Item 163 of the Penalties List specifies a penalty for s.601ED(5) of 200 penalty units or imprisonment for five years or both. A penalty unit in a law of the Commonwealth means $110.00 (see s.4AA Crimes Act 1914 (Cth).

50 In addition, pursuant to s.601EE, the Court may wind up a scheme that is being operated in contravention of s.601ED(5).

51 The registration requirement for the operation of a Managed Investment scheme is for the protection of investors. The legislation does not expressly make an unregistered scheme unlawful. Rather it impugns the conduct of the entity responsible for registration by imposing a penal sanction for a contravention of the registration provisions. The members of an unregistered scheme are protected by the provisions whereby the scheme may be compulsorily wound up. There is nothing, therefore, in the scheme of the legislation whereby an implication of an illegality would arise, nor is there anything that points to a legislative intention that contracts entered into as part of an unregistered scheme are illegal.

52 However, that still leaves the question which was considered in Yango as to whether the appellant ought to be able to bring proceedings when to do so it is necessary to rely upon its own wrongful conduct, namely, the operation of an unregistered managed investment scheme, which was conducted fraudulently. The legislative framework requiring registration and the penalty provisions imposed upon a person who fails to register a scheme as required by the Act all lead to a conclusion that the appellant ought not be precluded from bringing the claim. Indeed, to preclude the appellant would, at least potentially, lead to the unsatisfactory position whereby a party, regardless of its previous conduct, but now acting in good faith and from proper motives would be prevented from bringing proceedings for the purposes of recovering moneys in order to repay wronged investors. In my opinion, this case falls within the category of case discussed in Yango whereby the appellant ought not be precluded from bringing the proceedings.

53 Having regard to my conclusion in relation to illegality, it is not necessary to consider the further matters argued by the respondent and, in particular, its argument that it is now too late to restore funds to the defrauded investors: see Harry Parker Ltd. v. Mason [1940] 2 KB 590. For the reasons that I have given, this principle has no application.

54 That leaves the question whether, to the extent the claims are brought in equity, they should be defeated by the doctrine of unclean hands. A number of observations about the application of this principle should be made. First, the doctrine of unclean hands is an equitable defence to an equitable claim. Secondly, where it applies the party suing may still assert such rights as are available at law. Thirdly, the defence is distinct from the defence of illegality so where that defence is available, it is not necessary to rely on the equitable principle. Fourthly, the conduct relied on must relate directly to the equity relied on. Finally, a party who offends the principle may “wash [her/his] hands” of the impropriety.

55 An application of this last principle is where the misconduct has ceased before suit (see Meagher Gummow & Lehane’s Equity Doctrines and Remedies [3-135]). That example does not precisely fit the present case because, although the appellant’s wrongful behaviour has ceased, that is only because it has gone into liquidation. That fact in itself may, however, provide a reason why the defence of unclean hands should not prevail. That was the approach taken in Marshall Futures Ltd. v. Marshall [1992] 1 NZLR 316 where Tipping J, noting that unclean hands was not an absolute defence said at pp. 330-331:

“Although in strictly analytical terms it is the same legal entity as it was when the allegedly fraudulent breaches of trust occurred, the hands controlling it are now those of the liquidator and not those of the directors. There cannot be any suggestion that the liquidator’s hands are unclean. …
It seems to me … in these particular and unusual circumstances the corporate veil can reasonably be lifted to reflect the reality of what is going on. …
… What I am saying is that in substance in the present case the company now in liquidation raises the first cause of action in essence as the agent of its creditors.”

56 Windeyer J rejected such an approach in the present case. He said at [17]:

“If a company guilty of fraud under one set of directors comes under the control of an honest set of directors that cannot make a claim which, if made by the company in the control of dishonest directors, would fail, into a claim that could succeed if brought when honest directors were in control. … the moneys which the plaintiff company seeks to recover are moneys to which the plaintiff company has no right, those moneys having been obtained through its fraud. The persons having a right to recover such moneys are those persons from whom they were originally received.”

57 I do not agree with his Honour’s reasoning. Although his Honour is correct when he says that a change in directorship does not alter the legal identity of a company, I consider that his approach fails to pay sufficient regard to the principle to which I have just referred. The liquidators cannot make legal or non-fraudulent that which was illegal or fraudulent. However, they can take steps to reimburse the investors of sums of moneys of which they have been defrauded. These proceedings are, we have been informed, an attempt to do that. It seems that that conduct is or is at least of a similar cleansing nature as has been held sufficient to defeat the defence of unclean hands. The question whether a Court would impose any conditions on the grant of relief is not a matter in issue on the appeal.

Abuse of process

58 The respondent also contended that the appellant should not be entitled to pursue this appeal as to do so would be an abuse of process. Two bases were advanced in support of this submission. First, it was submitted that the respondent had made an election between inconsistent rights and secondly, and this flowed from the first, it had propounded an inconsistent pleading because it no longer sought to plead illegality or fraud. In order to understand the argument it is necessary to revisit the orders made by the trial judge and the steps taken by the appellant subsequent thereto.

59 The trial judge, on 20 June 2003, made an order giving leave to the appellant to replead within twenty-eight days. His Honour made an order that in default of filing such an amended pleading the proceedings against the respondent would stand dismissed. His Honour gave leave to apply within the same period of time for a continuance of the existing Mareva injunctions against the respondent in the event that an application for leave to appeal had been made. The appellant’s application for a stay for the purpose of considering and prosecuting an appeal was refused.

60 Prior to the expiration of the twenty-eight day period, the appellant sought an extension of time in which to file an amended pleading. In dealing with that application, the trial judge, on 17 July 2003, revoked the self-executing order and extended the time for filing an Amended Statement of Claim to 8 August 2003. His Honour also directed that any proposed amended pleading be served on the respondent by 1 August 2003 and stood the matter over to 8 August 2003. The appellant utilised the extension of time granted by his Honour and filed a proposed Amended Statement of Claim. Prior to filing the proposed Amended Statement of Claim, the appellant filed a Holding Summons for Leave to Appeal. Subsequently, on 8 October 2003 it filed its Summons for Leave to Appeal. Leave to appeal was granted.

61 The appellant’s application to amend was heard by his Honour on 8 August 2003. Following argument of the matter and apparently due to some confusion as to what amendment the appellant was proposing, the appellant’s solicitor wrote to the trial judge advising his Honour of the precise amendments which were sought. The proposed amendments were opposed by the respondent in a letter from his counsel, Mr. Angyal, to his Honour, dated 15 August 2003.

62 On 2 September 2003 his Honour delivered judgment on the appellant’s application to amend. In his judgment his Honour pointed out that the repleading which he had envisaged in the making of his initial orders was so as to allow the appellant an opportunity to plead that the moneys paid by the investors were held by KSE on trust and that the respondent was in knowing receipt of those trust funds, or alternatively, had knowingly assisted KSE in breach of trust. He considered that such claims had not been made in the proposed new pleading. He observed however, that the important change that had been made was an attempt to separate KSE from the activities of Suleman and to associate the agents with the activities of Suleman as if those were separate from KSE. His Honour also observed that the facts alleging the fraudulent and illegal transactions which had been pleaded in the original Statement of Claim had been omitted from the new document. I pause to observe that this was undoubtedly done to overcome his Honour’s finding in his original judgment that the appellant was not entitled to pursue its claims against the respondent because of illegality and unclean hands.

63 Because his Honour was doubtful that the new pleading complied with the leave that he had given on 20 June, he formally refused the amendment sought in the proposed Statement of Claim “at this stage”. He deferred making any determination on the appellant’s application to replead in accordance with the proposed Amended Statement of Claim because, as he understood the new pleading, it had been recast against all fifteen defendants. He considered that all defendants should be notified of the proposed amendments sought and the matter should be brought before the Court by Notice of Motion with all defendants as respondents to that Motion.

64 The respondent contends that by making the application to amend and simultaneously filing a Summons for Leave to Appeal, the appellant made an election between inconsistent rights: Sargent v. ASL Developments Ltd. 131 CLR 634; Khoury v. Government Insurance Office(NSW) (1984) 165 CLR 622. The respondent identified the inconsistent rights as being the right to utilise the leave to replead which was granted by the trial judge in his orders of 20 June and the right to appeal against those orders. He submitted that those rights were inconsistent because if the respondent had not chosen a third route, that is an application to amend beyond the leave granted by his Honour and had not made the successful application to have the self-executing order revoked, then by operation of that order, the proceedings would have been dismissed on 18 July, should the appellant not have repleaded by that date.

65 It followed, on this argument, that there would have then been no statement of claim left to amend and the only course available to the appellant would have been the application for leave to appeal. It was only the revocation of the self-executing order that enabled the appellant to “pursue its application before the trial judge to amend the pleading”. Put another way, once the orders of 17 July 2003 were made revoking the self-executing order, the appellant had elected to pursue its application to amend the Statement of Claim rather than to appeal against the trial judge’s decision to strike out the Statement of Claim. It was submitted therefore that this Court should not entertain this appeal because it is an abuse of process.

66 The respondent sought to rely upon Abignano & Anor. v. Wenkart (unreported FC of FCA 13 November 1998). In that case, the Court was dealing with an appeal from an order of a single judge setting aside a bankruptcy notice. On the same day that the bankruptcy notice had been set aside, the appellants issued a fresh bankruptcy notice based on the same judgment debt. An application was brought by the recipient of the notice to set aside that order. That application was unsuccessful. On the hearing of the appeal in relation to the first bankruptcy notice, the Court held that the prosecution of the appeal in relation to the first bankruptcy notice was “tantamount to an abuse of process”. Their Honours accordingly declined to entertain the appeal.

67 However, Abignano has no application to the circumstances before this Court. There is a well established line of authority that a creditor may issue a fresh bankruptcy notice to overcome or circumvent a challenge to an earlier notice. When that happens however, the party is put to an election between the bankruptcy notices. There are a numbers of reasons why a creditor is put to such an election, not the least of which is that a failure to comply with a bankruptcy notice constitutes an act of bankruptcy so as to ground the making of a sequestration order and the relation back period is dependant on the date of the act of bankruptcy: Bankruptcy Act 1966 (Cth) s 115. Other provisions of the bankruptcy legislation are also dependant upon the date that the act of bankruptcy was committed for example, see s.122. In Abignano, the Court had refused to set aside the second bankruptcy notice. In those circumstances, the Full Court was of the view that the appellants, having sought to maintain the validity of the second bankruptcy notice could not, in parallel, seek to maintain the validity of the first. Their Honours were clearly correct in this but that is because of the nature and operation of a bankruptcy notice. In my opinion, it does not assist in the determination of the matter before this Court which involves the determination of a number of procedural issues.

68 In my opinion, the circumstances here do not involve a case of election at all. The present appeal involves a determination as to whether the appellant is entitled to maintain its claim against the respondent or whether that claim is barred by illegality and lack of clean hands. In dealing with that application, the Court is entitled to make such order as it thinks fit, including requiring the appellant to replead. If the Court takes that course, it can grant the appellant liberty to replead with or without restriction. Also, in considering whether it should require the appellant to replead, it would not be inappropriate and indeed may well be necessary in order to attempt to bring these proceedings into proper order, to consider the position of the other defendants to the Statement of Claim. That is the very matter which was of concern to the trial judge and which was the essence of his reasoning in his judgment of 2 September. It follows therefore, that despite the ungainly way in which this matter has proceeded to date, both applications currently before the Court, namely this appeal, and the application which remains alive before the trial judge, are directed to the one end, namely the amendment of the Statement of Claim. It follows that I would reject the respondent’s resistance to the appeal on the ground of abuse of process.

Conclusion

69 It follows from these conclusions that his Honour erred in finding that the appellant’s claim was barred by illegality and unclean hands. Accordingly, the Statement of Claim should not have been struck out on that basis. That is not to say however, that the appellant’s pleading is a model of perfection, as was readily conceded by senior counsel. During the course of oral argument, senior counsel was requested by the Court to state what causes of action were alleged against the respondent. In response, the appellant provided a document to the Court specifying the causes of action and the paragraphs of the existing pleading that were said to raise, or at least relate, to those causes of action.

70 The causes of action so specified were:

“1. Liability to account arising out of the relationship of agency (paragraphs 172, 173 and 174, and the general claim for relief);
2. Breach of duty, including fiduciary duty (paragraphs 172, 173, 174, 176, 183, 186).
3. Barnes v Addy claim based on both knowing participation in and receipt of funds with knowledge of a breach of Mr.Suleman’s fiduciary duty (paragraphs 181 179, 183, 186 and 187).
4. Unjust enrichment, or alternatively, money had and received (paragraphs 184 and 185 and the references in 3 above).”

71 Although hints of some at least of these causes of action emerge from the Statement of Claim, the fact is none is clearly pleaded and the proper basis for others is not apparent. For example, the first, “liability to account” is a reference to a remedy. The second “breach of duty” is too broad to be meaningful and the appellant’s later attempts to restrict it, e.g. to a breach of duty arising out of contract reveals the uncertain understanding it has of this claim, and in any event there is no pleading of a breach of fiduciary duty by KSE to the investors. As to the third, there is no pleading that moneys were held on trust so as to properly ground a Barnes v. Addy claim. Finally unjust enrichment is not a cause of action. These criticisms are made at a level of generality only. As was pointed out to the appellant, the Court was hearing an appeal from a specific decision of a judge of the Court. It was not sitting to settle a pleading. However, the pleading requires amendment and that should be attended to.

72 A nice question arises as to whether the appellant requires leave to amend. Pt 20 r 2 of the Supreme Court Rules provides that a party may, without leave, amend once at any time before pleadings are closed. The amended Statement of Claim that was the subject of the second motion before Windeyer J has not, as I understand it, been formally filed. It would seem therefore that leave is not required. It is apparent however from that proposed amended pleading that the appellant has sought to recast its claim against all defendants. The questions raised in this Court as to the nature of the claims made against the respondent presumably are questions relevant to all defendants and indicate that the pleadings need a thorough overhaul. Although the matter remains in the directions list in the Equity Division, I am of the opinion that it is appropriate for this Court to direct the appellant to file any amended pleading within a specified time. The Court has the power to make that direction: see s.76(6) Supreme Court Act 1970 (Cth). The effect of making such a direction will render otiose the motion currently in the Registrar’s list. It will also make unnecessary the filing of a motion joining all defendants as required by his Honour.

73 That leaves the question of costs. The appellant has succeeded on the appeal and should have succeeded on the respondent’s motion before Windeyer J on the basis on which that motion was brought. The result of the respondent’s success on that motion was to restrict, wrongfully, the claims that could be brought against the respondent. However, the appellant’s pleading cannot stand in its present form. This makes the making of an order for costs in its favour problematic. Much of the time on the appeal was taken up with understanding the nature of the claims alleged against the appellant and the state of the pleadings is such as to necessitate judicial intervention of some kind at this stage. I have concluded that the best way forward is to make the direction I have proposed. In those circumstances, I consider that the appropriate order for costs is for the respondent to pay the costs of the Notice of Motion and to pay 50% of the appellant’s costs of the appeal.

74 Accordingly, the orders I propose are:

1. Appeal allowed.

2. Direct the appellant to file any amended pleading within 28 days.

3. The respondent is to pay the appellant’s costs of the Notice of Motion dated 7 March 2003 before Windeyer J and is to pay 50% of the appellant’s costs of the appeal.

75 SANTOW JA: I agree with Beazley JA.

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Last Modified: 07/02/2004