Law Society of Tasmania v McCulloch and McCulloch (A Firm)
[2006] TASSC 23
•11 April 2006
[2006] TASSC 23
CITATION: Law Society of Tasmania v McCulloch & McCulloch (A Firm) [2006] TASSC 23
PARTIES: LAW SOCIETY OF TASMANIA (THE)
WOODS, John William
As Liquidator of the McCulloch & McCulloch Unregistered Managed Investment Scheme
v
McCULLOCH & McCULLOCH (A Firm)
TITLE OF COURT: SUPREME COURT OF TASMANIA
JURISDICTION: ORIGINAL
FILE NO/S: M273/1997
DELIVERED ON: 11 April 2006
DELIVERED AT: Hobart
HEARING DATE: 21 – 22, 30 – 31 March 2006
JUDGMENT OF: Tennent J
CATCHWORDS:
Professions and Trades - Lawyers - Legal practitioners' guarantee funds - Other States or Territories - Tasmania - Default order - Fiduciary default - Advancing trust monies on mortgage without appropriate enquiry as to capacity to repay - Advancing trust monies on mortgage without appropriate valuation – Payment into Court fund.
In the Matter of the Legal Profession Act 1993 and In the Matter of McCulloch & McCulloch (a firm); ex parte the Law Society Of Tasmania, 130/1997; In re Olive; Olive v Westerman (1886) 34 Ch D 70; In re Somerset; Somerset v Earl Poulett (1894) 1 Ch D 231; Best v Housing Commission of New South Wales (1949) 17 LGR 129; Canberra Freeholds Ltd v Queanbeyan Municipal Council (1973) 27 LGRA 134, applied.
In the Matter of Section 111 of the Legal Profession Act 1993 and In the Matter between Lewis Driscoll & Bull and Thomas Baron; Robert Allen Glover and Barbara Anne Glover, 1 February 2002, referred to.
Legal Profession Act 1993 (Tas), s111.
Supreme Court Rules2000 (Tas), r184.
Trustee Act 1898 (Tas), s10(1) (s12B).
Rules of Practice1994 (Tas), rr62, 66.
Aust Dig Professions and Trades [103]
REPRESENTATION:
Counsel:
First Named Applicant: No appearance
Second Named Applicant: D J Porter QC
Quentin John McCulloch: A J Munro
David Alistair McCulloch: No appearance
Solicitors:
First Named Applicant: No appearance
Second Named Applicant: Toomey Manning & Co
Quentin John McCulloch: McCulloch & Associates
David Alistair McCulloch: No appearance
Judgment Number: [2006] TASSC 23
Number of paragraphs: 45
Serial No 23/2006
File No M273/1997
LAW SOCIETY OF TASMANIA and JOHN WILLIAM WOODS
AS LIQUIDATOR OF THE McCULLOCH & McCULLOCH
UNREGISTERED MANAGED INVESTMENT SCHEME v
McCULLOCH & McCULLOCH (A FIRM)
REASONS FOR JUDGMENT TENNENT J
11 April 2006
The applicant is the liquidator of the McCulloch & McCulloch Unregistered Managed Investment Scheme ("the Scheme"). That Scheme was operated by the legal firm of McCulloch & McCulloch ("the firm") constituted at all relevant times by David Alistair James McCulloch and Quentin John McCulloch.
On 7 November 1997 on the application of the Law Society of Tasmania ("the Society") pursuant to the Legal Profession Act 1993 ("the Act"), s111, the firm was declared to be in default in respect of a number of loans made by it pursuant to the Scheme. As a consequence, a Court fund was established in this Court.
On 1 November 2005, pursuant to the Supreme Court Rules 2000, r184(1)(b), the applicant was added as an applicant in the proceedings. He then applied, pursuant to the Act, s111, for orders that the firm be declared in default in respect of a number of loans made by it pursuant to the Scheme. Those loans were identified by number in an interlocutory application filed with the Court on 19 October 2005. He also applied for consequential orders pursuant to the Act, s111(5), in the following terms, namely that:
-any money standing to the credit of any trust bank account or trust deposit account of the firm relating to the loans, be paid into the Court fund, and
-the Solicitors' Trust take whatever action may be necessary to ascertain any prospective claimants against the Court fund and notify such claimants that they may make claims against the Court fund.
The firm was declared to be in default in respect of all except one of the loans listed and the consequential orders sought were made. It is that remaining loan to which these reasons relate.
Appearances
Mr Alistair McCulloch did not appear or seek to be heard on the application. Mr Quentin McCulloch appeared by counsel and gave evidence. He opposed the application.
The remaining loan - loan number 960333
Between 28 August 1996 and 2 September 1996, the firm advanced a total amount of $55,000 ("the Loan") to a company R & B Developments Pty Ltd ("the Company"). The Loan was obtained to purchase three vacant lots within a subdivision at Youngtown. The lots were not side by side. The purchase price was $64,500. The Loan was secured by way of first mortgage over the titles to the vacant lots. The transfer of title and following first mortgage were dated 6 September 1996. Contemporaneously, the Company gave a second mortgage, also dated 6 September 1996, to another mortgagee over the same titles to secure an advance of $24,500. Each of the mortgages was personally guaranteed by Barry Charles Padgett and Raymond Leigh Cross, the directors of the Company. Each mortgage included a number of pages of additional clauses. Save for some detail on the first page and an extra clause on the last page of the second mortgage, the terms of the two mortgages were identical. The signatures on both documents were witnessed by the same person who, at the time, was a secretary within the firm.
In all, the Company borrowed $79,500 using the vacant lots purchased for $64,500 as security. It is apparent that the Company itself contributed nothing to the purchase. In fact, they gained in cash terms approximately $11,300 from the transaction. The firm's ledgers show that the Loan amount of $55,000 was paid out by the firm in the following way:
- $40,000 to settle the purchase;
- $11,370.87 to the Company; and
- $3,629.13 by way of miscellaneous payments of expenses to complete the purchase.
The balance of the $64,500 purchase price was then funded by the amount advanced under the second mortgage.
The firm's files contained valuations by Mantach Whitmore Valuations of Launceston in respect of each of the three vacant lots at $28,000 each, $84,000 in total. Who commissioned the valuations was not apparent. They were described as residential mortgage valuations, with the lender shown as the firm. They were all in the same standard form but noted the address, the title reference, size, and government valuation of each lot, and that that was as a result of a revaluation in July 1991. The valuer noted in respect of each lot that:
"Blocks within this subdivision have proved popular on the real estate market and many modern brick homes have now been developed in this area. Sales also include many developed properties with good prices being achieved."
The valuer included a heading "Sales Evidence" and in each valuation the same information appeared. That showed the sale prices of three nearby lots in April and July 1995 and May 1996. The maximum price was $28,000 in July 1995. In each valuation what was said to be a "market value" was provided, and at the end of the valuation the following words appeared:
"… I assess the Market Value of the property as above and recommend it for an appropriate mortgage advance. The valuation is for the use only of the party to which it is addressed and its mortgage insurers for mortgage purposes … ."
Other relevant facts
There was evidence about other transactions between the firm and Mr Padgett and Mr Cross.
On 20 March 1996, Cross Family Pty Ltd purchased a property at Sheffield for $75,000. Mr Cross was at the time a director of both that company and the Company. The firm advanced $49,000 to Cross Family Pty Ltd on the security of a first mortgage over the purchased property, which loan was guaranteed by Mr Cross and, I infer, his wife. On the same date, Cross Family Pty Ltd granted a second mortgage to the vendor of the property to it to secure an advance of $25,000. Cross Family Pty Ltd therefore borrowed all except $1,000 of the purchase price. The security documents were registered with the Land Titles Office at the same time. The firm, I accept, had knowledge of the second mortgage arrangement at the time of its own advance.
On 8 August 1996, the Company purchased a property at Canning Street, Launceston for $160,000. The firm advanced $120,000 on the security of a first mortgage over the property. Mr Cross and Mr Padgett were shown as borrowers on the mortgage. On the same date, the Company granted a second mortgage to the vendor of the property to secure an advance of $50,000. The mortgage documents were almost identical, the witness to the signatures was Mrs Jarvis, a secretary in the firm and sister of the members of it, and the handwriting of the person dating the documents appears to be the same. The documents were registered in the Land Titles Office together. The firm, I accept, had knowledge of the second mortgage arrangement at the time of its own advance. The clear inference is that the Company borrowed $170,000 to buy a property for $160,000, thereby putting no equity into the property.
Hearing of this application
On this application, the applicant filed and relied on three further affidavits over and above that sworn by the applicant on 17 October 2005. There was one by the applicant, one by valuer Mr Westwood, and one by a solicitor. Notice to cross-examine both the applicant and Mr Westwood was given and both gave oral evidence. An affidavit was also sworn by Mr Quentin McCulloch on 27 March 2006 and he was cross-examined.
The evidence of the applicant established that he did not interview either Quentin or Alistair McCulloch about their lending practices, that the papers he had, and which he relied on as the source of his information relating to the firm's lending, had come mostly from Mr Joyce, who was the manager of the firm, that he called on Mr Alistair McCulloch and asked him if he had any documents, and that McCulloch did not provide any to him. He did not speak to Mr McCulloch after he examined the documents he had and there was nothing in the papers he had which indicated there had been any enquiry about the capacity of the Company or Mr Padgett and Mr Cross to pay.
The applicant was cross-examined particularly about an annexure to his affidavit sworn 17 October 2005, which was a search conducted by his office of the National Personal Insolvency Index maintained by the Insolvency Trustee Service Australia. This questioning appeared to be an attempt to discredit the applicant in some way. The applicant had, in his affidavit, recorded what the search showed. The search, insofar as it related to Mr Padgett, showed a bankruptcy start date of 8 July 1958, with a court-ordered discharge of 27 November 1983. Given Mr Padgett's date of birth as elsewhere appearing and that at the relevant time bankruptcies were normally for 5 years, it is likely the reference to 1958 was a typing error and that the correct date was 1978. This questioning did not discredit the applicant in any way.
The same annexure showed that Mr Cross became a bankrupt on his own petition on 3 July 1990 and was discharged 3 years later.
As to Mr Westwood, he was a valuer and the former Valuer-General for Tasmania. Counsel for Mr Quentin McCulloch conceded he was an expert. He gave evidence not about the figures in the Mantach valuations, but about what was appropriate valuation methodology when valuing a group of lots in a subdivision for an investor proposing to buy that group. He described such a valuation as being an "in one line" valuation. In substance, what he said was that such a valuation was not a case of valuing each of the lots separately and adding the values up to reach a total. That total needed to be discounted in respect of an investor purchaser by reference to expenses and profit and risk, taking into account the time which might be needed to sell the lots.
Mr Westwood detailed the types of expenses he considered were relevant, agreeing many would be incurred whether there was one lot or several. As to profit and risk, he said risk was an element of profit. In essence, no investor would incur those expenses without a profit motive. Hence an investor would pay less for a sale in one line. He differentiated this from a purchaser who bought multiple lots in a subdivision for personal use, that is, to build a house and have extra land around it (a not for profit exercise), although he agreed such a purchaser would want a discount for buying in bulk.
He said that for security purposes it had been accepted practice for many years that valuations be in one line valuations when multiple lots were acquired because if a default occurred, a mortgagee may be forced to sell the lots as a bulk lot rather than individually.
In the present case, he said the valuer should have provided an in one line valuation and he did not.
Mr Quentin McCulloch was cross-examined by counsel for the applicant. His evidence did not assist the Court. What was disclosed by it was that he had taken the position with the Society that in relation to the operation by the firm of the Scheme, his brother Alistair was the person who dealt with the Scheme and that he, that is Quentin McCulloch, had no active role in its management or real knowledge of its operations. His affidavit sworn 27 March 2006 and his oral evidence, on the other hand, disclosed he had in fact had some dealings with the firm's mortgage lending. When questioned about specifics, however, he could not recall any discussions about it which might have flowed from those dealings. He was also obliged to acknowledge that the statements made in the second sentence of par7 and in par8 of his affidavit were speculation by him about what might have been in his brother's mind and that he could really not make those statements on behalf of the firm. Other statements in his affidavit were simply statements from knowledge he had gleaned from the firm's records having reviewed them for this hearing.
The default
Counsel for the applicant submitted there was fiduciary default by the firm as at the date the Loan was made. There were two bases for this submission. The first was that the firm made no enquiry as to the capacity of the Company or Mr Cross and Mr Padgett to pay. This was, however, put in the context that it was not so much that they made no enquiry, but that they advanced with express knowledge of other transactions involving one or more of these parties where no, or minimal, equity was provided, apart from borrowings, and yet still no enquiry was made as to the other financial commitments of the Company or Mr Cross and Mr Padgett.
It was submitted that the state of the firm's knowledge about these other transactions was such they were on notice about what appeared to be a pattern of borrowing to purchase real estate without providing equity and that the firm should, in those circumstances, have made further enquiry. This being in the context of no obvious enquiry at all as to the capacity of the Company or Mr Padgett's or Mr Cross's capacity to pay not only capital but interest.
The second basis was that the firm made no enquiry, having received the Mantach valuations, as to what the in one line value of the vacant lots together was. Once the valuations were received from Mantach which were obviously not such a valuation and in the context of a purchase price of $64,500, it was not prudent to lend without further enquiry.
Counsel for Mr Quentin McCulloch submitted that the essence of his client's position was that the firm made the Loan on the basis of a valuation, that valuation was a security valuation, the security was first mortgage security, the Loan represented less than two-thirds of the valuation, the Company was known to the firm, the Loan was guaranteed by its directors, and there was at the time no default under any other loan. In those circumstances the members of the firm discharged their duty as trustees and there was no fiduciary default.
Counsel submitted in relation to the submission about capacity to pay that despite the applicant's statement in his affidavit sworn 17 October 2005 to the effect that the documents inspected disclosed no evidence of any enquiry as to capacity to pay, in his oral evidence the applicant acknowledged that he had made no enquiry of either partner in the firm as to their enquiries or lack thereof about capacity to pay. Three points should be made about this submission. The applicant was not cross-examined about the statement in his affidavit. Secondly, Mr Quentin McCulloch swore an affidavit and gave evidence, but said nothing to the effect he made any enquiry about capacity to pay when he had the opportunity to do so. Thirdly, Mr Alistair McCulloch has chosen not to take part in these proceedings. He is the person who, on all the evidence, could have said he did make enquiries and what they were. He chose not to. I am entitled to draw an inference he did not because there were no such enquiries.
Counsel for Mr McCulloch made a number of other more detailed submissions. These were:
-The firm was the first mortgagee and as such it was entitled to invest trust monies because irrespective of the existence of the second mortgage, they would always recover the debt.
- There were a number of prior loans and no default.
- The repayments on the Loan were modest.
- Mr Padgett's bankruptcy was not relevant because he was discharged in 1983.
-The firm had complied with the terms of the Trustee Act 1898, s10(1), as it then relevantly provided.
-Mantach was a competent valuer and the firm was entitled to rely on its valuation. There was no obligation to enquire further.
-The provision of monies to a trustee to invest was not a guarantee and simply because there is loss does not mean there is fiduciary default.
The law
The Act, s111(1)(d), provides:
"111 (1) The following persons may apply to the Supreme Court for an order declaring a firm or legal practitioner corporation to be in default:
…
(d) a liquidator appointed in the circumstances referred to in section 108(2)(a)(iii)."
There was no dispute the applicant was entitled to apply for an order pursuant to the above section.
The term "default" is not defined in the Act. However, the term "fiduciary default" is defined in the Act, s3, as meaning:
"'fiduciary default' means –
(a) a defalcation, misappropriation or misapplication of money or other property held on trust by a legal firm or legal practitioner corporation; or
(b) the failure of a firm or legal practitioner corporation to account for that money or property held on trust by that firm or legal practitioner corporation; or
(c) a breach of any duty by a firm or legal practitioner corporation as trustee in relation to money or property held on trust by that firm or legal practitioner corporation;"
As Wright J said at 4 of his reasons in support of orders made in these proceedings on 7 November 1997 (In the Matter of the Legal Profession Act 1993 and In the Matter of McCulloch & McCulloch (a firm); ex parte the Law Society Of Tasmania, 130/1997):
"It will be noted that on the face of it, it appears that, for the purposes of an application by the Society, a 'default' is sufficient to justify an order, whereas in the cases of a person claiming loss and a legal firm which has paid money to such a person, a 'fiduciary default' must be established."
This matter has proceeded on the basis that the Rules of Practice 1994, Pt 5, made pursuant to the Act insofar as they could relate to the lending by the firm, applied to the firm. Counsel for Mr Quentin McCulloch relied on rr62 and 66 which provide as follows:
"62 First Mortgage
(1) A first mortgage is a mortgage that has priority over any other encumbrance or over any charge, other than a statutory charge, in respect of the land to which it relates and under which the amount advanced does not at the time of any advance under the mortgage exceed –
(a)two-thirds of the security valuation if the mortgage is not insured; or
(b)90% of the security valuation if the mortgage is insured in respect of so much of the amount advanced as exceeds two-thirds of the security valuation; or
(c)50% of the government valuation in force at the date of the mortgage if there is no security valuation.
(2) If the amount secured under a first mortgage does not exceed the limits specified in subrule (1), a mortgage includes a further mortgage or further charge between the same parties in relation to the same estate if no other creditor of the mortgagor has priority over the claims under the further mortgage or charge by reason of any other encumbrance or any charge that is not a statutory charge."
"66Security valuation
A security valuation is to be made in writing by a registered valuer not earlier than 3 months before the date of the first mortgage or second mortgage on the security of which money is advanced to the borrower."
Counsel for Mr McCulloch also relied on the Trustee Act, s10(1) (now s12B), as it stood at the time of the Loan. It provided:
"Loans and investments by trustees not chargeable as breaches of trust
10 (1) A trustee lending money on the security of any property on which he can lawfully lend shall not be chargeable with breach of trust by reason only of the proportion borne by the amount of the loan to the value of the property at the time when the loan was made, provided that it appears to the Court that in making the loan the trustee was acting upon a report as to the value of the property made by a person whom he reasonably believed to be a competent valuer instructed and employed independently of any owner of the property, whether that valuer resided in the locality where the property is situate or elsewhere, and that the amount of the loan does not exceed two equal third parts of the value of the property as stated in the report, and that the loan was made under the advice of that valuer expressed in the report."
Counsel for the applicant referred to a number of authorities to support his submissions. These related to the use of in one line valuations and the existence and nature of the fiduciary default in this case.
I will briefly refer to those authorities. As to a general proposition about a trustees' obligations when obtaining a valuation, counsel referred to a statement by Kay J in In re Olive; Olive v Westerman (1886) 34 Ch D 70 where, at 73, he said:
"They should ask for a valuation which would enable them to judge whether they are justified in lending the amount they propose to lend."
He relied further on the statements by Kekewich J in In re Somerset; Somerset v Earl Poulett (1894) 1 Ch D 231 at 247 - 248 where he said:
"The object of trustees must ever be to make a permanent investment, that is, one which will be maintained for a considerable period, and which will not only during that period yield the stipulated income, but will ultimately and whenever required, realize the full sum advanced. In Learoyd v Whiteley (12 App Cas 732) the Lord Chancellor dwells on the importance of securing the capital sum, but did not, I am convinced, intend to place in the background the importance of also securing the income, which may be and often is as essential to the welfare of the remainderman as it is to that of the tenant for life. Trustees, therefore, must regard any advice given to them respecting value from this double point of view, and cannot be absolved from liability for loss arising on a particular transaction by shewing that their advance was within the allowed limits as regards capital, if they were exceeded as regards income, and the income was insufficient to pay the stipulated interest. I express myself thus, because the limits stated with reference to capital have not been specifically applied to income, and I am not sure that as regards income some larger latitude might not safely be permitted. On the question how far, if at all, trustees may properly rely on the position of the borrower, there is, so far as I am aware, no authority. Men of ordinary care and prudence managing their own affairs would, no doubt, take this into consideration, and, in the mercantile world, it is frequently treated as equally important with the value of the security. It is impossible, I think, to exclude it from the consideration of trustees, who are bound to have regard to all the circumstances connected with any proposed advance on security, and it would not be difficult to put cases in which the solvency or insolvency of the borrower would properly influence them in making an advance somewhat in excess of the limits generally allowed, or declining the transaction altogether; but where the object is to make a permanent investment of trust money on mortgage of real estate, it seems to me wrong to advance a sum largely in excess of what is otherwise right, because it is believed that the borrower is now, and it is anticipated that he will remain, capable of paying the principal and interest, or such part thereof as cannot be realized from the security."
As to the nature of the valuation and the profit and risk factor to which Mr Westwood referred, counsel referred to Best v Housing Commission of New South Wales (1949) 17 LGR 129 where Sugerman J said at 131:
"It has been held that the mere fact that land has already been subdivided does not necessarily have the result that no allowance is to be made for risk of realisation when considering what price the land might be expected to realise upon an in globo sale (Closer Settlement Ltd v The Minister [1942] 17 LGR 62)."
In this regard, in Canberra Freeholds Ltd v Queanbeyan Municipal Council (1973) 27 LGRA 134, Else-Mitchell J said at 136:
"The approach made by the defendant's valuers was in conformity with the accepted authority of judges of this Court over many years that a profit and risk factor should not be excluded simply because the resumed land had been previously subdivided."
The obligations of a trustee as identified by Evans J in In the Matter of Section 111 of the Legal Profession Act 1993 and In the Matter between Lewis Driscoll & Bull and Thomas Baron; Robert Allen Glover and Barbara Anne Glover, 1 February 2002 in par3 are clearly also relevant.
Was there default?
At the time the advance was made, the firm had direct knowledge of two recent transactions where one or more of the Company or its directors entered into real estate purchases where borrowings accounted for, in one case, all bar $1,000 of the cost and in the other some $10,000 more than the cost. In those circumstances no enquiry was made by the firm as to the financial commitments of the Company or its directors and as to their capacity to pay the repayments which would result from the Loan.
Counsel for the respondent suggested the repayments were modest. That is, with respect, irrelevant. It is the failure to even enquire prior to the repayments even commencing, which is the matter of concern.
If that were not sufficient, the question of the valuations would support the finding of default. I accept the appropriate valuation methodology in this case was as outlined by Mr Westwood. The Mantach valuations did not accord with that. In those circumstances and where the purchase price was some $20,000 less than the valuation total, the firm should have made further enquiry. It was not sufficient for them to simply say, as counsel for Mr Quentin McCulloch submitted, we had a valuation, we were entitled to rely on it, we lent under two-thirds of that valuation on first mortgage, there was no breach of duty. That argument, with respect, misconceives entirely the duty of care imposed on trustees.
I am satisfied the firm was in default in relation to the Loan from the date it was made.
Orders
1 That any money standing to the credit of any trust bank account or trust deposit account of McCulloch & McCulloch (a firm) relating to loan number 960333 be paid to the Court fund established by virtue of the order of this Court on 7 November 1997.
2That the Solicitors Trust take whatever action may be necessary to ascertain any prospective claimants against the Court fund in respect of the Loan referred to in order 1 and to notify those prospective claimants that claims may be made against the Court fund.
0
0
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