Michell as trustee of the Property of Holbrook, a Bankrupt v Holbrook
[2019] FCCA 2649
•20 September 2019
FEDERAL CIRCUIT COURT OF AUSTRALIA
| MICHELL AS TRUSTEE OF THE PROPERTY OF HOLBROOK, A BANKRUPT v HOLBROOK | [2019] FCCA 2649 |
| Catchwords: BANKRUPTCY – After a member of an accounting partnership became bankrupt he directed the partnership to pay into a bank account held in the name of his father an amount that under a deed he entered into with the partnership before he became bankrupt became payable to the bankrupt after he became a bankrupt – whether the payment the partnership made in response to the bankrupt’s request bore the character of income, and therefore did not vest in the bankrupt’s trustee in bankruptcy, or whether the payment bore the character of capital in which case the payment vested in the trustee in bankruptcy – payment was income – discussion of remedies available if payment bore the character of capital and for that reason vested in the trustee in bankruptcy. |
| Legislation: Bankruptcy Act 1966 (Cth), ss.5(1), 58, 116, 120, 121, 121A, 139J(a), 139L, 139P |
| Cases cited: Cummins v Claremont Petroleum NL (1996) 185 CLR 124 Dickenson v Federal Commissioner of Taxation (1958) 98 CLR 460 National Trustees Executors and Agency Co. of Australasia Ltd v FederalCommissioner of Taxation (1954) 91 CLR 540 Re Gillies; Ex parte Official Trustee v Gillies (1993) 42 FCR 571 Sent v Commissioner of Taxation [2012] FCA 382 The Comptroller of Stamps (Victoria) v Howard-Smith (1936) 54 CLR 614 Tinker v Federal Commissioner for Taxation [1979] FCA 88 |
| Applicant: | STEPHEN JOHN MICHELL AS TRUSTEE OF THE PROPERTY OF GARY BRUCE HOLBROOK, A BANKRUPT |
| Respondent: | ROBERT WALTER HOLBROOK |
| File Number: | SYG 1476 of 2017 |
| Judgment of: | Judge Manousaridis |
| Hearing date: | 13 February 2019 |
| Date of Last Submission: | 13 February 2019 |
| Delivered at: | Sydney |
| Delivered on: | 20 September 2019 |
REPRESENTATION
| Counsel for the Applicant: | Mr D Eardley |
| Solicitors for the Applicant: | CLH Lawyers |
| Counsel for the Respondent: | Mr T Yeh |
| Solicitors for the Respondent: | Moisson Lawyers Pty Ltd |
ORDERS
The application is dismissed.
Subject to order 3 the applicant pay the respondent’s costs as agreed, taxed, or assessed.
The parties have liberty to apply within 14 days of these orders for an order varying or discharging order 2.
| FEDERAL CIRCUIT COURT OF AUSTRALIA AT SYDNEY |
SYG 1476 of 2017
| STEPHEN JOHN MICHELL AS TRUSTEE OF THE PROPERTY OF GARY BRUCE HOLBROOK, A BANKRUPT |
Applicant
And
| ROBERT WALTER HOLBROOK |
Respondent
REASONS FOR JUDGMENT
Introduction
On 25 November 2013 Gary Holbrook requested BDO East Coast Partnership (Partnership) pay $48,840 into a bank account his father, Robert Holbrook, held with Bendigo Bank (RH Account). Gary Holbrook was then a bankrupt, having on 29 August 2013 presented a debtor’s petition to the Official Receiver.[1] Until 23 November 2012 Gary Holbrook was a partner of the Partnership; and the $48,840 represents an amount to which, in the circumstances I describe later, Gary Holbrook became entitled under a deed he entered into with the Partnership when he retired from the Partnership (Partner Retirement Deed).
[1] The Official Receiver accepted the debtor’s petition on 2 September 2013.
The principal question that arises in this proceeding, which is brought by the trustee of the bankrupt estate of Gary Holbrook (Trustee) against Robert Holbrook, is whether the $48,840 the Partnership paid to Robert Holbrook represents money that ought to have been paid to the Trustee. The Trustee and Robert Holbrook agree that the determination of that question turns on the character of the payment. Was it of a capital character, as the Trustee contends? Or did the payment represent income that was payable to Gary Holbrook, as Robert Holbrook contends?
Before I consider the parties’ submissions, it will be necessary to set out some background, including the relevant terms of the Partner Retirement Deed, the payments the Partnership made under that deed, and the Partnership’s characterisation, after the event, of the payments it made. It will also be necessary to explain why the parties agree that the determination of the question whether the $48,840 was payable to the order of the Trustee, rather than to the order of Gary Holbrook, turns on the character of the payment to Robert Holbrook as capital or income.[2]
[2] The parties relied on a Court Book which was divided into Part A and Part B. Both parts contained affidavits which I read, but none of the parties otherwise formally tendered documents that formed part of the Court Book that were not annexed or otherwise exhibited to the affidavits. Counsel for the Trustee and Robert Holbrook, however, referred to documents in Part B that were not tendered. In those circumstances, I take it that counsel for the Trustee and Robert Holbrook proceeded on the assumption that all documents in the Court Book were to be treated as having been admitted into evidence. I too will proceed on that assumption.
Background
Gary Holbrook commenced practice as an accountant in 1983. He became a partner of a firm known as Pannell Kerr Forster on 1 July 1998 (PFK Partnership). In about 2012 the PKF Partnership became part of the Partnership on the terms set out in an agreement (Partnership Agreement).
According to Gary Holbrook, the Partnership was a “no goodwill” partnership. That meant that a person was not required to make a capital payment to be admitted into the Partnership, and a partner was not entitled to a capital payment on retirement from the Partnership. Again according to Gary Holbrook, the Partnership Agreement provided for a work in progress loan from partners of $400,000, and the Partnership arranged for a bank to make back-to-back loans to each partner who then lent that money to the Partnership.
In October 2012, for reasons it is unnecessary to set out here, Gary Holbrook agreed with the Partnership that he would retire from it; and he and the Partnership entered into negotiations about the terms on which he would retire. That resulted in the making of the Partner Retirement Deed.
The first provision of the Partner Retirement Deed to which it is relevant to refer is cl.2. It provides that the Gary Holbrook (who is referred to as the “Retiring Partner”) and the remaining partners of the Partnership (who are referred to as the “Continuing Partners”) agree that clauses 20 and 22 of the Partnership Agreement will continue to bind Gary Holbrook for twelve months after 23 November 2012.
Clause 20 of the Partnership Agreement is headed “Restrictive Covenant”. Subject to irrelevant exceptions, cl.20.2 provides that if a partner departs the Partnership, the partner must not, among other things:
(a)solicit work as an Accountant from, or act as an Accountant for, any Existing Client of the Partnership; nor
(b)sell to Existing Clients Competing Software Products, [sic] nor
(c)carry on, operate or be engaged, interested or employed in a business which carries on an activity the same as, similar to, or competitive with, any activity engaged in by the Partnership as a significant part of its Business, in which the Partner has been involved during the Relation Back Period; nor
(d)induce, encourage or solicit any of the Firm’s employees, contractors or agents, with whom the Partner has worked or has had a business relationship at any time during the Relation Back Period, to leave the Firm’s employment or agency or to cease providing services to the Firm.[3]
[3] The word “Firm” is defined in cl.1.1 of the Partnership Agreement as “the Partnership and Related Entities”
in any capacity for the Restraint Period in the Restraint Area.
The expressions “Restraint Area”, “Restraint Period”, and “in any capacity” are defined in cl.20.1 of the Partnership Agreement. Clause 2 of the Partner Retirement Deed provides that a maximum 12 month restraint period will apply, and that this will apply from midnight on 23 November 2012 (which, in recital D, is referred to as the “Retirement Date”).
Next, it is necessary to refer to cl.3(a) of the Partner Retirement Deed. It provides that the Continuing Partners agree to pay to Gary Holbrook the amounts set out in Item A(A) of Schedule 2 by the dates there set out. Subclause 3(a) further provides:
The Retiring Partner agrees that the Payments constitute the Retiring Partner’s entire entitlements under the BDO East Coast Partnership Agreement and the Partner Remuneration Framework and any other claims or interest the Retiring Partner may have against or in the Partnership including any claim for goodwill or any other payment relating to the sale of any assets of the Partnership or security interests in Related Entities or the underlying assets in those Related Entities.
The expression “Partner Remuneration Framework” is to be found in the Partnership Agreement. It is defined in cl.1.1 to mean “the document titled “Partner Remuneration Framework” relating to the structure for rewarding Partners approved and/or amended by Resolution of the Board from time to time”.[4]
[4] There is included in the Court Book a document titled “BDO East Coast Practice Partner Remuneration Framework”. No party, however, has referred to this document.
Item A of the Partner Retirement Deed contains four numbered paragraphs, and a concluding, unnumbered, paragraph. Numbered paragraphs 1, 3, and 4 are as follows:
The Continuing Partners will pay to the Retiring Partner:
1.$250,000 representing a payment to the Retiring Partner on account of their entire entitlements under the BDO East Coast Partnership Agreement and the Partner Remuneration Framework and any other claims or interest they may have against or in the Partnership including any claim for goodwill.
It is noted that this amount will be paid in 3 instalments, being:
· $150,000 payable to the Retiring Partner upon retirement within seven (7) days of the Retirement Date;
· $50,000 payable to the Retiring Partner 6 months from the date of retirement, on the basis that the Retiring Partner adheres to the Restrictive Covenants as detailed in the Partnership Agreement within this 6 month period;
· $50,000 payable to the Retiring Partner 12 months from the date of retirement, on the basis that the Retiring Partner adheres to the Restrictive Covenants as detailed in the Partnership Agreement within the second 6 month period;
. . . .
Less:
3.The remaining equalisation amount owed to the Firm for the year 30 June 2012 is $17,591.
4.$11,844 relating to personal expenses charged to the Firms [sic] credit card.
The concluding unnumbered paragraph is as follows:
Total payment to be made to Gary Holbrook is $226,888. The payment to be made to the Retiring Partner within seven (7) days of the Retirement Date will be $126,888 with the balance to be paid in accordance with Clause A as follows:
· $50,000 payable to the Retiring Partner 6 months from the date of retirement;
· $50,000 payable to the Retiring Partner 12 months from the date of retirement;
According to Gary Holbrook, he was paid the “first tranche” of $150,000 on execution of the Partner Retirement Deed;[5] and he was paid the second tranche of $50,000 in around late May 2013.[6] According to a letter dated 23 March 2015 from the Partnership to the Trustee, the Partnership paid $150,000 to Gary Holbrook on 1 December 2012, and $50,000 on 23 May 2013.[7]
[5] Affidavit of G B Holbrook 03.11.2018, [21]
[6] Affidavit of G B Holbrook 03.11.2018, [25]
[7] Affidavit of S J Michell, exhibit SJM-1, page 15
In the meantime, in about March 2013 Gary Holbrook borrowed $20,000 from Robert Holbrook.[8] In around July 2013 Robert Holbrook opened the RH Account. He did so at the suggestion of Gary Holbrook who informed Robert Holbrook that he intended to repay into that account the money Robert Holbrook lent to Gary Holbrook.[9]
[8] Affidavit of G B Holbrook 03.11.2018, [24]
[9] Affidavit of G B Holbrook 03.11.2018, [26]
By email sent on 25 November 2013 Gary Holbrook requested the Partnership “deposit the final payment into my Dad’s account as I borrowed from him to keep me going”, and provided the relevant details of the RH Account.[10] On that day the Partnership transferred $48,840 to the RH Account.[11]
[10] Affidavit of S J Michell, exhibit SJM-1, page 36
[11] Affidavit of S J Michell, exhibit SJM-1, page 34
According to Gary Holbrook, in around late November 2013 he informed Robert Holbrook that he was about to receive a payment from the Partnership, and that he had asked the Partnership to pay the amount into the RH Account. Gary Holbrook said he did not know the exact amount the Partnership would be paying, but if it were more than $20,000 “the rest is mine”.[12] On 3 December 2013 Gary and Robert Holbrook attended a branch of the Bendigo Bank, and Robert Holbrook withdrew $8,000 in cash from the RH Account.[13] On 9 December 2013 Gary and Robert Holbrook attended the same or another branch of the Bendigo Bank, Robert Holbrook withdrew $14,000 from the RH Account, and gave $2,000 of that amount to Gary Holbrook.
[12] Affidavit of G B Holbrook 03.11.2018, [32]
[13] Affidavit of G B Holbrook 03.11.2018, [34]
By letter dated 16 December 2013 the Partnership provided to Gary Holbrook his “Individual Taxation Schedule for the 2013 financial year”. The schedule discloses a “Distribution from Partnership” of $519,141. This appears to reflect the calculation contained in an extract from a document titled “BDO Profit Splits and Taxable Incomes for the Financial Year ending 30 June 2013”. The extract shows in relation to Gary Holbrook an “Accounting profit per Net Assets” of $389,167, and a taxable income of $519,141. Gary Holbrook lodged an income tax return for the year ended 30 June 2013 in which he disclosed having earned a partnership income of $515,994.[14]
[14] Affidavit of G B Holbrook 03.11.2018, [38]
By letter dated 29 January 2015 the Trustee served on the Partnership a notice to produce document.[15] The Partnership responded with a letter dated 11 February 2015.[16] The letter explains that each year an “Income and Equalisation schedule” is prepared for each partner, and that an “equalisation amount” is determined each year. That amount represents the difference between cash distributions that are made to a partner, and the partner’s income. The letter attaches as “Appendix 1” a “summary of Partnership distributions paid in the 3 years from 2011 to 2013 to” Gary Holbrook. The appendix includes the following information:
The below summarises the Partnership distributions to the Bankrupt for the 2013 financial year:
[15] Affidavit of S J Michell, exhibit SJM-1, page 5-11
[16] Affidavit of S J Michell, exhibit SJM-1, pages 12-13
Income $
Distributions $
Notional salary
104,167
Notional salary
104,167
Profit share
35,000
First quarterly draw
35,000
PCCL interest
15,909
PCCL interest
15,909
Ex Gratia (including Annual Leave
250,000
Ex Gratia
200,00
405,076
355,076
Positive equalisation (“payable distribution”) of $50,000. This was paid in accordance with the Bankrupt’s Retirement Deed in November 2013.
The Bankrupt’s income of $405,076 in 2013 was derived from the following sources:
Income $
Partnership
389,167
Interest – working capital
15,909
405,076
By letter dated 4 March 2015 Mr Michell requested the Partnership inform him of the dates on which a number of the payments referred to in the schedule were made.[17] The Partnership responded by letter dated 23 March 2015 and provided the following information.[18]
[17] Affidavit of S J Michell, exhibit SJM-1, page 14
[18] Affidavit of S J Michell, exhibit SJM-1, page 15
Item
Net Amount
Date Paid
First quarterly draw $35,000 ($6K was deducted from this amount to pay for PY equalisation)
$29,000
12/10/12
PCCL Interest (Total of $15,909 was paid in 5 instalments)
$3,333.33
30/07/12
$3,333.33
30/08/12
$3,333.33
28/09/12
$3,333.33
29/10/12
$2,575.75
29/11/12
Ex Gratia (Total of $200,000 paid in two instalments)
$150,000
01/12/12
$50,000
23/05/13
Positive Equalisation (“payable distribution”)
$50,000
23/11/13
Why parties agree that entitlement turns on character of payment
As I noted at the beginning of these reasons, the parties agree that whether the Partnership ought to have paid the $48,840 to Robert Holbrook or to the Trustee turns on whether the payment to the RH Account had the character of capital or income. It is necessary to consider why the parties so agree, and whether they are correct in so agreeing.
The starting point is s.58(1) of the Bankruptcy Act 1966 (Cth) (Act), which provides:
Subject to this Act, where a debtor becomes a bankrupt:
(a)the property of the bankrupt, not being after‑acquired property, vests forthwith in the Official Trustee or, if, at the time when the debtor becomes a bankrupt, a registered trustee becomes the trustee of the estate of the bankrupt by virtue of section 156A, in that registered trustee; and
(b)after‑acquired property of the bankrupt vests, as soon as it is acquired by, or devolves on, the bankrupt, in the Official Trustee or, if a registered trustee is the trustee of the estate of the bankrupt, in that registered trustee.
The expression “the property of the bankrupt” is defined in s.5(1) of the Act as “property divisible among the bankrupt’s creditors”, and “any rights and powers in relation to that property that would have been exercisable by the bankrupt if he or she had not become a bankrupt”. “Property divisible among the bankrupt’s creditors” is the property identified in s.116(1) of the Act. That includes the property described in s.116(1)(a) of the Act:
[A]ll property that belonged to, or was vested in, a bankrupt at the commencement of the bankruptcy, or has been acquired or is acquired by him or her, or has devolved or devolves on him or her, after the commencement of the bankruptcy and before his or her discharge . . .
“Property”, as used in s.58(1) and s.116(1) of the Act, includes “choses in action”.[19] That expression denotes a “heterogeneous group of rights which . . . have only one common characteristic, viz. that they do not confer the present possession of a tangible object”.[20] It includes “the right to receive money”.[21] “Property”, as used in these two provisions, therefore, is broad enough to include the rights Gary Holbrook had under the Partner Retirement Deed; and, if considered alone, s.58 of the Act would have operated at the time Gary Holbrook became bankrupt to vest in the Trustee his rights under the Partner Retirement Deed.
[19] Cummins v Claremont Petroleum NL (1996) 185 CLR 124, at page 133: “A chose in action may be the property of the person entitled to enforce it . . . .” (Brennan CJ, and Gaudron and McHugh JJ)
[20] National Trustees Executors and Agency Co. of Australasia Ltd v Federal Commissioner of Taxation (1954) 91 CLR 540, at page 584 (Kitto J). For an extensive treatment of the types of rights denoted by the expression “chose in action” see Smith QC and N Lesi The Law of Assignments, second edition, Oxford University Press 2013, at [2.68] – [2.86]
[21] Cummins v Claremont Petroleum NL (1996) 185 CLR 124, at page 133
Whether that was the effect of Gary Holbrook’s becoming bankrupt cannot, however, be assessed only by reference to the operation of s.58 and s.116 of the Act. Also relevant are the provisions of Div. 4B of Part VI of the Act. One of the objects of Div. 4B is to “require a bankrupt who derives income during the bankruptcy to pay contribution towards the bankrupt’s estate”.[22] A central provision is s.139P of the Act which provides:
(1)Subject to section 139Q, if the income that a bankrupt is likely to derive during a contribution assessment period as assessed by the trustee under an original assessment exceeds the actual income threshold amount applicable in relation to the bankrupt when that assessment is made, the bankrupt is liable to pay to the trustee a contribution in respect of that period.
(2)Subject to section 139Q, if the income that a bankrupt is likely to derive during a contribution assessment period as assessed by the trustee under an original assessment does not exceed the actual income threshold amount applicable in relation to the bankrupt when that assessment is made, the bankrupt is not liable to, but may if he or she so wishes, pay to the trustee a contribution in respect of that period.
[22] Act, s.139J(a)
Subsection s.139L(1) of the Act provides that “income”, “in relation to a bankrupt, has its ordinary meaning”. That is subject to the qualifications stated in the subsection. These include particular matters that are stipulated to be income, and matters that are stipulated not to be income.
In Re Gillies; Ex parte Official Trustee v Gillies, [23] French J (as his Honour then was) held that any after acquired property that is “income” within the meaning of s.139L of the Act is excluded from the operation of s.58 and s.116 of the Act, and is instead subject to the provisions Div.4B of Part VI of the Act. His Honour said:[24]
It is true that the after-acquired property to which ss.58 and 116 apply is defined widely enough to encompass income. However, in my opinion, the legislative scheme now in place is quite inconsistent with the application of those provisions to after-acquired income. This follows from the comprehensive scheme embodied in Division 4B which approaches a code for dealing with after-acquired income of the bankrupt. There is nothing in the extrinsic material to support a change in the approach to after-acquired income which would bring it within after-acquired property vesting in the trustee. In my opinion such income does not vest in the trustee.
[23] (1993) 42 FCR 571
[24] (1993) 42 FCR 571, at page 577
Lockhart J arrived at the same conclusion in Re Sharpe; Ex parte Donnelly:[25]
In my opinion the scheme of Div 4B of the Bankruptcy Act proceeds on the assumption that after acquired income of a bankrupt does not vest in the trustee of the bankrupt’s estate. Although the after acquired property to which ss 58 and 116 of the Bankruptcy Act apply are sufficiently widely defined to include income of the bankrupt, Div 4B establishes a comprehensive scheme of dealing with after acquired income of the bankrupt. Where it is inconsistent with sections such as ss 58 and 116, provisions of the division must be taken to apply . . .
[25] (1998) 80 FCR 536, at page 540
It can now be seen why the parties agree that the question whether the Partnership ought to have paid the $48,840 to Robert Holbrook turns on whether the payment is to be characterised as income or as capital. If the amount of $48,840 paid to Robert Holbrook represented income that Gary Holbrook derived, the right to be paid that money did not vest in the Trustee when Gary Holbrook became entitled to be paid that amount. If, on the other hand, the $48,840 the Partnership paid to Robert Holbrook did not represent income that Gary Holbrook had derived, the right to be paid that money had vested in the Trustee, and Gary Holbrook had no right to direct that it be paid to Robert Holbrook.
Parties’ pleaded cases and submissions
In the amended statement of claim the Trustee alleges that, when Gary Holbrook became bankrupt, his property initially vested in the Official receiver and, when appointed, on the Trustee; the property included “an entitlement from the bankrupt’s former employers, being a chose in action”, that entitlement being the $48,840 to which Gary Holbrook became entitled in about November 2012; on 23 November 2013 Gary Holbrook directed the Partnership to pay the $48,840 to Robert Holbrook; on about 25 November 2013 the Partnership deposited $48,840 into the RH Account; that transfer is void under s.120 or s.121, or s.121A of the Act; and Robert Holbrook held the $48,840 paid into the RH Account as constructive trustee for the Trustee.
In his defence Robert Holbrook says that until about November 2012 Gary Holbrook was a partner of the Partnership; under the terms of the partnership partners were entitled to receive distributions of income; the effect of the Partner Retirement Deed was that Gary Holbrook would receive a final distribution of $50,000, the payment of which was subject to the satisfaction of various conditions that could only have been met by November 2013; the final distribution, when paid, was treated as distribution of income of Gay Holbrook, and Gary Holbrook lodged an income tax return in which he treated the $48,840 as income.
The Trustee filed written submissions; but these go no further than setting out some background, the effect of s.58(1)(a) and s.116(1) of the Act, passages from cases that discuss principles relating to constructive trusts, and passages from cases that concern the awarding of costs. In oral address, however, counsel for the Trustee submitted that the $48,840 was not income because it was paid to secure Gary Holbrook’s agreement that he would abide by the restrictive covenant continued in cl.20 of the Partnership Agreement for twelve months; and there is authority to the effect that, at least where a lump sum is paid, as opposed to the making of periodic payments, as consideration for a person’s agreeing to restrict his or her activities, the payment has the character of capital, not income. Counsel for the Trustee particularly relied on the following passage from the judgment of Williams J in Dickenson v Federal Commissioner of Taxation:[26]
Where a person agrees to restrict his personal activities and the use of his capital, the consideration he receives for doing so may be income or capital. If the consideration takes the form of recurring payments, these payments may well be considered to be a quid pro quo for the profits the covenantee would have made if he had not withdrawn from such activities and be income . . . . But where the consideration takes the form of a lump sum, so that it appears to represent a quid pro quo for giving up a substantial sphere of activity which would otherwise be open to the covenantee, it would prima facie be capital
[26] (1958) 98 CLR 460, at page 483
In his written submissions, counsel for Robert Holbrook submits that the $48,840 was income in the hands of Gary Holbrook because the Partnership characterised the payment as an ex gratia payment and partnership income that was earned during the financial year ending 30 June 2013; that the payment arose from Gary Holbrook’s personal exertion; and the $48,840 was one of three payments, thus exhibiting regularity. Counsel for Robert Holbrook referred to Re Sharpe; Ex parte Donnelly,[27] and Michell (Trustee), in the matter of Lee (deceased),[28] noting that in those cases the fees received by the barristers after they became bankrupt were treated as income that did not vest in their trustees in bankruptcy even though the barristers’ entitlement to be paid had accrued before they became bankrupt. Finally, in oral address, counsel for Robert Holbrook submitted that the $48,840 payment cannot reasonably be characterised as a payment the Partnership made as consideration for Gary Holbrook’s agreeing to be bound by the restrictive covenant because he was already bound by that covenant.
[27] (1998) 80 FCR 53
[28] [2012] FCA 1046
Was the $48,840 payment income?
I do not accept the Partnership agreed to pay $48,840 to Gary Holbrook as consideration for his agreeing to comply with the restrictive covenant. First, the $48,840 forms part of the amount which under cl.3 of the Partner Retirement Deed the Partnership agreed to pay Gary Holbrook; and that clause stated the purpose of the payment, namely, that it was “on account of” Gary Holbrook’s “entitlements under the” Partnership Agreement “and the Partner Remuneration Framework and any other claims or interest” Gary Holbrook “may have against or in the Partnership”. Clause 3 does not state, and there is no other provision of the Partner Retirement Deed that states, that any part of the amount payable under the Partnership Deed is made as consideration for Gary Holbrook’s agreeing to be bound by the restrictive covenant. Stated more simply, the payment is expressed to be made on account of Gary Holbrook’s entitlements, not as consideration to restrict rights he otherwise had.
Second, as counsel for Robert Holbrook submitted, Gary Holbrook was already bound by the restrictive covenant. Clause 2 of the Partner Retirement Deed recognises that fact by providing that the Partners and Gary Holbrook agree that the restrictive covenant will continue to bind them for twelve months in circumstances where cl.20 of the Partnership Agreement provided for a two year, one year, and a six month “restraint period”.[29]
[29] The Partnership’s agreeing to a 12 month “restraint period” when cl.20 of the Partnership Agreement provided three restraint periods, one of which was for two years, might be viewed as the Partnership’s relinquishing whatever rights it had to a two year restraint period.
It is true that the Partnership’s agreement to pay the second and third instalments of the $250,000 was conditional on Gary Holbrook adhering to the restrictive covenant; but that is not the same thing as saying that the Partnership agreed to pay these amounts as consideration for Gary Holbrook agreeing to adhere to the restrictive covenant. As I have already noted, the Partnership’s agreement to pay the second and third instalments was part of the Partnership’s agreement to pay Gary Holbrook $250,000 “on account of” Gary Holbrook’s “entitlements under the” Partnership Agreement “and the Partner Remuneration Framework and any other claims or interest” Gary Holbrook “may have against or in the Partnership”. In other words, the Partnership’s agreement to pay the $250,000 was given in consideration of Gary Holbrook’s entitlements under the Partnership Agreement. The purpose of making the Partnership’s payments of the second and third instalments conditional on Gary Holbrook adhering to the restrictive covenants was to afford the Partnership security for Gary Holbrook’s obligations under the restrictive covenant.
Counsel for the Trustee did not submit that the payment of the $48,840 bore the character of capital for a reason other than one on which he relied; and it appears that counsel for the parties assumed that if, contrary to the Trustee’s contention, the Partnership did not agree to pay to Gary Holbrook the $48,840 as consideration for his agreeing to be bound by the restrictive covenant, the payment was income.[30] My conclusion that the Partnership did not agree to pay to Gary Holbrook the $48,840 as consideration for his agreeing to be bound by the restrictive covenant, however, does not necessarily mean the payment is income; and it would be useful if I consider the correct character of the payment, notwithstanding what appears to have been the common assumption of counsel for the parties.
[30] This may reflect the acknowledgment counsel for the Trustee made during address that the Trustee bears the onus of proving that the payment was capital.
Whether the payment was income derived by Gary Holbrook depends on whether it comes within the ordinary meaning of income or some other paragraph of s.139L of the Act. It is unnecessary to consider in any broad terms what the ordinary meaning of income is. It is sufficient if I identify the basic facts by reference to which, in my opinion, the character of the $48,840 payment is capable of being determined; and these are as follows:
a)First, and as I have already noted, the Partner Retirement Deed provides that the Partnership agreed to pay to Gary Holbrook $250,000 on account of Gary Holbrook’s entitlements under the Partnership Agreement.
b)Second, Gary Holbrook retired from the Partnership on 23 November 2012. That necessarily means Gary Holbrook did not undertake any work as a partner after that date.
c)Third, cl.14.3 of the Partnership Agreement provided that a Partner may resign from the Partnership “in accordance with clause (f) of Schedule 5”. That clause provides that “any Partner with the consent of the Board (such consent not to be unreasonably withheld) may retire on giving at least six (6) months [sic] notice in writing or such lesser period and on such terms and conditions as are agreed between the Partner and the Chief Executive Officer”.
On these facts, it is reasonable to infer that the $250,000 the Partnership agreed to pay to Gary Holbrook represented an amount the parties agreed to pay to him instead of Gary Holbrook having to give at least six months’ notice of his intention to resign from the Partnership and continue to work in the Partnership during that time. The $250,000, therefore, may reasonably be viewed as the agreed amount of compensation for income the parties expected Gary Holbrook would have earned had he remained in the Partnership for at least the six months for which he was required to give notice. So viewed, the payments of each of the three instalments, including the last instalment of $48,840, had the character of income.
Support for this conclusion is to be found in authorities that have held or have otherwise proceeded on the view that a payment made to compensate loss of income, or otherwise to provide a quid pro quo for income, is itself income. In Tinker v Federal Commissioner for Taxation, for example, Brennan J (as his Honour then was) said that where “a taxpayer gives up his income in exchange for other payments, the other payments take on the character of the income for which they are exchanged”;[31] and in Sent v Commissioner of Taxation Murphy J said:[32]
[I]t is established that an amount that is substituted for another amount has the same tax character as the amount substituted or compensated for. . . . [T]he substituting payment acquires “the character of that for which it is substituted...”
[31] [1979] FCA 88, at [8]
[32] [2012] FCA 382 at [45]
Position if payment not income
Although I have found that the payment of the $48,840 into the RH Account bore the character of income, it would be useful to offer a number of observations about what the consequences would have been had I found that the payment was not income.
In his amended statement of claim the Trustee alleges that the partnership’s payment of $48,840 was void because of one or more of s.120, s.121, s.121A of the Act; and it appears that the amended statement of claim alleges Robert Holbrook became a constructive trustee of the $48,840 that was paid into the RH Account because the payment was void. None of the provisions on which the Trustee relies, however, applies to the payment of the $48,840. That is so because each of s.120, s.121, and s.121A of the Act applies to transfers by “a person who later becomes a bankrupt”. That is, each provision applies to transfers a bankrupt has made before he or she becomes bankrupt. The Partnership’s payment, however, was made after Gary Holbrook became a bankrupt.
Further, it is doubtful that the Partnership’s payment could be characterised as a transfer. The Partnership paid the $48,840 to the RH Account after Gary Holbrook requested that it do so. It is certainly possible to assign a claim to a fund by making an irrevocable request to the holder of the fund to pay it to a particular person; but to operate as an assignment the request “must be a direction, and not a mere authority revocable until acted upon”, in which case “such an authority is not in itself an assignment”.[33] It is doubtful, at least to my mind, that Gary Holbrook’s request to the Partnership constituted a direction, rather than a revocable authority, that the $48,840 be paid to Robert Holbrook.
[33] The Comptroller of Stamps (Victoria) v Howard-Smith (1936) 54 CLR 614, at page 622 (Dixon J)
Assuming the payment of the $48,840 was not income, perhaps a constructive trust over the $48,840 paid into the RH Account could be said to have arisen from the circumstances that, on Gary Holbrook’s becoming bankrupt, the chose in action that constituted his entitlement to be paid under the Partner Retirement Deed had vested in the Trustee; and that the fruits of that chose in action, the $48,840 the Partnership paid in performance or purported performance of its obligations under the Partner Retirement Deed, vested in the Trustee and, for that reason, was trust property of which the Trustee was the beneficiary. Whether that analysis would have been available depends on whether the Partnership had notice of Gary Holbrook’s bankruptcy. If the Partnership paid the $48,840 into the RH Account without notice of Gary Holbrook’s bankruptcy, the Partnership would have been discharged of its obligations to pay that amount, and the money paid into the RH Account would have had the character of trust property under a trust of which the Trustee was beneficiary. If, on the other hand, the Partnership paid the $48,840 after it received notice of Gary Holbrook’s bankruptcy, the Partnership would not have discharged its obligations to pay the $48,840, and it would be difficult find that the amount it did pay constituted trust property of any trust of which the Trustee is the beneficiary.
It is unnecessary to arrive at any final view about these matters, first, because I have concluded that the payment of the $48,840 did not vest in the Trustee; and, second, because the parties made no submissions about these matters.
Conclusion and disposition
The $48,840 the Partnership paid into the RH Account constituted income Gary Holbrook derived after he became bankrupt and, for that reason, did not constitute property that vested in his trustee in bankruptcy under s.58 of the Act. I propose, therefore, to order that the application be dismissed.
There appears to be no reason why costs should not follow the event, and I propose to order that the Trustee pay the costs of Robert Holbrook. I also propose, however, to make that order conditional on reserving to the parties liberty to apply within fourteen days for an order to set aside or vary the order for costs I propose to make.
I certify that the preceding forty-seven (47) paragraphs are a true copy of the reasons for judgment of Judge Manousaridis
Associate:
Date: 20 September 2019
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