Kay v Australian Securities and Investments Commission & Ors

[2003] HCATrans 430

[2003] HCATrans 430

IN THE HIGH COURT OF AUSTRALIA

Office of the Registry
  Perth  No P125 of 2002

B e t w e e n -

ROMANA MIKA KAY

Applicant

and

AUSTRALIAN SECURITIES & INVESTMENT COMMISSION

First Respondent

KNIGHTSBRIDGE MANAGED FUNDS LTD

Second Respondent

KNIGHTSBRIDGE FINANCE PTY LTD

Third Respondent

Application for special leave to appeal

GLEESON CJ
CALLINAN J

TRANSCRIPT OF PROCEEDINGS

AT PERTH ON FRIDAY, 24 OCTOBER 2003, AT 9.39 AM

Copyright in the High Court of Australia

__________________

MR D.H. SOLOMON:   May it please your Honours, I appear for the applicant.  (instructed by Solomon Brothers)

MR N.W. McKERRACHER, QC:   May it please the Court, with my learned friend, MS W.F. BUCKLEY, I appear for the first respondent.  (instructed by Mr Michael Gething)

GLEESON CJ:   Just before you commence, Mr Solomon, there is a certificate from the Deputy Registrar that he has been informed by the solicitors for the second and third respondents that they will abide by the decision of the Court and do not intend to appear at the hearing of the application for special leave to appeal.  Yes, Mr Solomon.

MR SOLOMON:   Your Honours, the point of the importance with respect to this application is the proper identification of what constitutes a managed investment scheme under the current Corporations Act.  The subsidiary point is the proper place of the observations of this Court in Australian Softwood Forests in 1981 with respect to the construction of the term “interest” as it then appeared in the 1961 Companies Act.  That analysis, with respect, requires review in light of the vastly different terms in which the statutory provisions are cast.

The issue arises in this matter in this way.  The second and third respondents in different ways operated what is called in this State a finance broking operation.  Through that operation, investors invested in contributory mortgages, acquiring an interest in the mortgage.  Generally, each investor got a registered interest in a mortgage as a tenant in common for a part of the mortgage.

It was not the type of scheme which has been held to be a scheme where the investors do not go on the title but they simply get a share of a pool produced from a large number of mortgages, which are in the name of some manager or trustee, and they share in a whole range of mortgages.  This did not have that quality.  The investors went into a separate loan to a separate borrower and generally they got a separate tenant in common share as a registered mortgagee.

We say that there was plainly a scheme with respect to each such pooled mortgage, but that there was not a scheme with respect to the overall operation of the broker.  The reason it is important as to which of those is correct is particularly manifest by section 601FC(2) in the law now, which is, as with a lot of modern legislation, strikingly brief but of strikingly wide impact.  It provides that:

The responsible entity holds scheme property on trust for scheme members.

When one goes back to “scheme property” in the definitions in section 9 that means “a registered scheme”.  So if there is a scheme for the entire range of mortgages that are arranged by this particular broker, then all of those mortgages are held on trust for all of the members.  That just cannot be right. 

Now, the way in which the Full Court here, applying a decision of his Honour Justice Owen in the State Supreme Court, got around this is at paragraph 48 in the judgment. 

GLEESON CJ:   Page?

MR SOLOMON:   Page 81 of the application book, your Honours.  In the first sentence it is said:

In my opinion, each separate investment was part of an overall scheme in the sense explained by Owen J in the Chase Capital decision.

The quote of that is at paragraph 15, which is back on page 74.  Chase Capital was a scheme of organising betting syndicates.  The relevant parts of his Honour Justice Owen’s judgment there – in the second and third lines, his Honour says:

I acknowledge that each is comprised of different participants or groups of participants.

But then, lower down, about 12 lines from the bottom at the end of the quote, his Honour says, at line 40:

But that does not mean that the individuality of a particular investment is ignored.  It would be unrealistic to ignore the subtle differences between the individual components that go, in combination, to make up the scheme.  In the end. on the finalisation of the scheme (whether that be by a simple realisation of the assets or a formal winding up and, in the latter event, subject to the costs of the winding up generally) each individual investment will have to be accounted for separately.

Then coming back to what their Honours say at paragraph 48 in the Full Court here, page 81 of the application book, their Honours say:

There were different participants and the target or object of the various investments was usually different.  However, there was the same overall supervisory structure using the same method of operation and designed towards the same end.  Before stating this conclusion, it is unnecessary to analyse in detail the decision of Holmes J in Lawloan Mortgage Pty Ltd [2002] QSC 302, since Holmes J expressly held (at par 79) that the matter before [her] was distinguishable from the present case at first instance.

Justice Holmes’ decision is on a virtually identical arrangement except that, as is common in the eastern States, it involved solicitors and not finance brokers organising the mortgages. There is a copy of her Honour’s decision at No 5 in the materials that I have provided. Her Honour declined to follow the first instance decision in this matter. In the Lawloan Case, there was a ‑ ‑ ‑

GLEESON CJ:   What paragraph is it that she deals with this case?

MR SOLOMON:   Paragraphs 78 and 79.  The judgment goes through a number of different mortgages which were arranged by these arrangers, all separate mortgages, although they arranged them all with the same system.  Her Honour then says at paragraph 78:

It is significant that –

in looking at the definition of what a managed investment scheme is –

the definite article precedes in each case the nouns “people” and “members”.  The subparagraph specifies the people, the members holding interests; in other words, the benefits produced by the pooling of funds in a given scheme must be capable of flowing to all, not a sub‑set, of the members in the scheme.  In the present case, the absence of the pooling of contributions, or their use “in a common enterprise” –

because they each go into separate mortgages –

to produce financial benefits for the members holding interests in the applicant’s general mortgage lending scheme at large, as opposed to the pooling of contributions in each individual loan for the benefit of the members of that particular loan arrangement, prevents the mortgage lending scheme as a whole from meeting the terms of subpara(ii) of the definition.  It has not, therefore, all of the features necessary to render it a “managed investment scheme” –

because it is a cumulative definition requiring three elements to be satisfied ‑ 

The individual loan arrangements, on the other hand, do in each case amount to a scheme possessing the three prescribed features.

Her Honour goes on to then distinguish Chase Investments, Justice Owen’s decision.  She says:

My conclusion differs from that reached in Australian Securities & Investments Commission v Chase Capital Management Pty Ltd, in which Owen J considered that there were two schemes, notwithstanding that each involved a number of investments, each with a distinct group of investors.  It is to be noted that, in that case, the issue was not whether the individual investment should be characterised as schemes, as opposed to the overall arrangement, but rather whether the arrangements amounted to managed investment schemes at all.  And the circumstances of the present case can be distinguished from those in Australian Security & Investments Commission v Knightsbridge Managed Funds Ltd –

that is a reference to the first instance decision, because the Full Court decision here was not yet available –

in which a number of mortgaged lending arrangements were characterised a single scheme.  There the monies to be advanced in all loans were placed into a single cash management account which attracted interest on the total funds, subsequently shared among investors pro rata.  As Pullin J observed, “Pooled monies therefore produced ‘financial benefits’ in a direct sense”.  In the present case there was no such feature; no interest accrued on the funds for the short period they were held in the Elliot & Harvey trust account.

As I have said in the outline, your Honours, it appears that the Full Court did not base their decision upon the reasoning of Justice Pullin.  What Justice Pullin’s reasoning was was this, that before the moneys were lent out to the individual lenders and secured by separate mortgages, investors paid the money to the broker, who put it into a trust account and invested it with a bank, and then there was interest divided amongst all investors at that time.  His Honour said, well, that was therefore a “pooling” at that point.

The point, of course, is that if that constituted a scheme that was only a scheme at that time with respect to those funds as a preliminary to the actual advances.  It was not the scheme with respect to the mortgage lending at all.  It was just a preliminary investment of money to earn interest, pending advancing to separate borrowers.  So even if that was a scheme, the winding‑up of that scheme would have been merely to wind up the actual account in which moneys may have remained at the time the fund was wound up for future investors, but it could not possibly constitute the entire scheme.  It was a mere preliminary.

The Full Court mentioned, at paragraph 19 of its judgment, page 75, that Justice Pullin had dealt with the matter that way and then notes the extent to which the reasoning of Justice Mason in Australian Softwood had influenced Justice Pullin, which was, as I say, on legislation which did not have this trust situation where all of the property is by statute held on trust for all of the members, which makes it quite impossible to have this sub‑scheme type arrangement that Justice Owen and now the Full Court in this decision is talking about.  Because how can there be a statutory trust over the whole pool, which is all of the mortgages, and yet one is accounting for it separately for individual members? 

That is why, with respect, Justice Holmes is right.  The only scheme can be the scheme for the particular mortgage.  What have the other investors got in common?  They are one group.  Their money has gone to a particular borrower, on security of a particular property, with a particular mortgage.  If it turns out to be a bad investment and they suffer a loss, they wear the loss.  They do not share profits with those who are in a different mortgage.  They do not wear losses, equally, with those in a different mortgage.

The only thing that could be said to be in common is the aspect Justice Pullin focused on, the pre‑scheme part where the money goes to the broker and it is in a trust account – but that is not part of the actual scheme, anyway, it is a preliminary or a separate sub‑scheme of its own – or there is common management.  Now, if common management of a broker is enough to give rise to a scheme and to make all property that is within the scheme trust property for all members, there is all manner of arrangements that are actually managed investment schemes now.

Common management of apartments that are bought under some investing plan promoted by a particular real estate agent for investment ‑ they all have the expertise and management of that particular agent, and yet each person would not say, “But I’m in a scheme, because this agent says, well, you buy on these criteria and this and that.  I am in a scheme with other people who have bought another home unit because they are all managed by the same manager”.  And yet, it is indistinguishable.

Whilst the wording in section 76 was extremely broad in the 1960s, there was none of this pooling requirement and there was certainly no requirement of a statutory trust.  Justice Barrett, in the case of Investa Properties (2001) 187 ALR 462 – that is No 4 on my list – dealt with this issue in New South Wales, in dealing with the impact of the provision that requires that all of the property be held in trust. In paragraph [12], his Honour, in the second sentence, refers to section 601FC(2):

That section declares in unequivocal terms that the responsible entity of a registered management investment scheme “holds scheme property on trust for scheme members”.  The term “scheme property”, as it relates to a registered scheme, is defined by s 9.  It means contributions in money or money’s worth to the scheme, certain other money, “property acquired, directly or indirectly, with, or with the proceeds of” such contributions –

which means, here, all of the mortgages –

and money and income and property derived directly or indirectly from any of the foregoing.

GLEESON CJ:   But what are the terms of the trust?  In particular, are the terms of the trust such that they preclude separate accounting in relation to each group of investments?

MR SOLOMON:   The terms of the trust are particularly briefly stated in section 601FC(2), but what is clear is that all scheme property is held in trust for all members.

GLEESON CJ:   Yes, but it is the terms of the trust that would then have to be worked out, is it not?

MR SOLOMON:   We would simply say that it is impossible that one scheme member, that is, an investor in mortgage B, can have an interest in mortgage A at all. 

GLEESON CJ:   But your argument is that the statute, if it creates a trust applicable to all investments, precludes separate accounting in respect of separate investments.

MR SOLOMON:   That is right.

GLEESON CJ:   You may be right, you may be wrong, but can you say why?  You just seem to be assuming that.

MR SOLOMON:   The reason why, your Honour is that – the point I am making is that because all scheme members are to have a beneficial interest in all scheme property, it is quite impossible that the scheme can be such that it requires completely separate accounting for separate members, because what it means is the separate members ‑ ‑ ‑

GLEESON CJ:   You inserted the word “completely” there into that sentence.

MR SOLOMON:   Yes.

GLEESON CJ:   Delete the word “completely”.  Do you still appear to have the same proposition?

MR SOLOMON:   The proposition is that one has to determine what is a scheme by reference to the trust that the statute creates.  The trust contemplates that what the scheme is is such that all members have a beneficial interest in it.  It is held in trust for all of them.  To identify the scheme, one must therefore find the property of the scheme which could be held in trust for all of them.  Where they simply cannot have an interest in part of what might otherwise be scheme property, that proves that that is not the scheme.

The scheme must be such that all members can be beneficially entitled to the property.  That works with respect to each individual mortgage.  It does not work with respect to the entire proceeds of lending of a particular mortgage broker.  In paragraph [13], in analysing the effect of section 601FC(2), Justice Barrett says it is:

a provision which establishes and maintains the connection between all property within the definition of “scheme property” and the responsible entity.  This seems to follow from the definition of “managed investment scheme” (which contemplates a relationship between participants and a “scheme”) –

Then he goes on, in paragraph [14], to say:

The section could have said that if scheme property is held by the responsible entity, that entity holds it on trust for scheme members; or that such scheme property as is held by the responsible entity is held on trust for scheme members.  It says neither of these things.  It expresses itself to apply indiscriminately to property having such a

connection with the scheme of which the entity is responsible entity as to make the property scheme property of that scheme.

We say that this issue is an appropriate one to be resolved at this level, particularly because the words in Australian Softwood simply were not applicable to the legislation as it now is. 

I just need to make one more point before I sit down. What my learned friends say is that this administration by the liquidator appointed is virtually at an end and this is academic.  My client is an investor who, like a lot of investors in finance broking schemes in this State, has lost money.  The administration of the secured property is but the first step for her and for all other investors in this scheme.  Thereafter, her rights need to be ascertained as against promoters and others involved in the investment by reference to whether she was part of this overall scheme, or part of an unregistered separate scheme for a separate mortgage.  The basis upon which those matters are to be determined remains very live.

Although the liquidator appointed by the Securities and Investments Commission has virtually finished realising the properties, that has not finished the issue for my client or the other investors.  In fact, it is the first step in now pursuing rights for recovery against various persons, the basis upon which depends very importantly on the outcome of this application.  So although it might be academic to the Investments Commission and the liquidator, their work is essentially finished.  It is but a first step for us and it remains live and important, not only for my client, but for all other investors through this broker.  May it please your Honours, they are my submissions.

GLEESON CJ:   Thank you.  Mr McKerracher, could I just ask you a question in relation to one point that was discussed with Mr Solomon.  He argues that if the conclusion of the Full Court and the primary judge are correct, that prevents separate accounting in relating to particular investments.  What is your submission in relation to that?

MR McKERRACHER:   Your Honour, our submission is that the learned primary judge carefully analysed the contractual relationship between the borrowers and Knightsbridge and devoted a substantial portion of his reasons to that, to look at the actual terms of the prospectus documentation, the constitution and the custodial agreements.  Those agreements and all that documentation make it clear that the individual lenders will be the lenders under the mortgages themselves.  So what happens is that it is more like an introduction agency, really.  What Knightsbridge does is introduce the borrower to the lender ‑ ‑ ‑

GLEESON CJ:   But when they come to account for the overall results of the transaction, do they account separately?

MR McKERRACHER:   Yes.

GLEESON CJ:   So that, if one investment is successful and another investment fails, the investors in the successful investment get the benefit of the successful investment and the investors in the failed investment take the burden of that.

MR McKERRACHER:   Yes, because that is the nature of this particular scheme.  For my learned friend’s argument to suggest that that is inappropriate would require a reading of the documentation which cannot withstand scrutiny.  Secondly, it would require a conclusion that mortgages are part of the scheme property, and we submit that they are not.  Additionally, it would require a construction of the section on which my learned friend relies to indicate that every bit of scheme property is held for every participant in the overall scheme.

GLEESON CJ:   Equally.

MR McKERRACHER:   Equally.  And that simply is not so, on the contractual documentation.

CALLINAN J:   That appears, does it not, from that passage in the prospectus set out at page 8 of the record?

MR McKERRACHER:   Precisely, your Honour, and it is repeated in the constitution, throughout the documentation.

CALLINAN J:   The mortgages are held “on trust for individual investors”.

MR McKERRACHER:   May it please your Honour.

GLEESON CJ:   Yes, thank you, Mr McKerracher.  Mr Solomon, is there anything you want to say in reply to that?

MR SOLOMON:   Only this, your Honour.  That is my point as well, that the rights of the individual mortgagees are plainly, under this scheme, for the individual mortgagees in each scheme, and it is because of that that there is no pooling within the second element of the definition to mean that there is a scheme at all.  There simply was never a scheme, in an overall sense, for pooling to produce income for all scheme members.  It is quite inappropriate to say there is such a scheme, it is quite inappropriate to

register such a scheme, and it is quite inappropriate to create rights when there is no scheme.  The only scheme was the separate mortgages.

We are ad idem – myself, my learned friend and, I think, your Honours – that this could only be accounted for under the separate mortgages, but, that being the case, and the Act requiring a pooling by all scheme members to earn money from the property, it was quite impossible that there was ever a scheme.  The scheme is really a very ephemeral overall management arrangement and that is just not a scheme at all.  Yet rights are now created based upon there being a scheme, where plainly there was none.  That is the point we are making as well, your Honours.  If it please the Court.

GLEESON CJ:   Thank you.

The unanimous decision of the Full Court which upheld the decision of the primary judge turned on the application of the relevant statutory language to the particular facts and circumstances of the operations of the second and third respondents.  The reasoning of the Full Court raises no issue of law suitable to a grant of special leave to appeal to this Court.  In particular, the Full Court’s application of the observations of Justice Mason in the case of Australian Softwood Forests Pty Ltd was appropriate in the light of the facts of the case and does not raise an issue that requires further consideration by this Court.  The application is refused with costs.

AT 10.04 AM THE MATTER WAS CONCLUDED