Paton, S. v Campbell Capital Ltd
[1993] FCA 782
•01 NOVEMBER 1993
STEVE PATON v. CAMPBELL CAPITAL LIMITED
No. NG332 of 1993
FED No 782
Number of pages - 9
Bankruptcy
(1993) 46 FCR 30
COURT
IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY
GENERAL DIVISION
OLNEY, HILL AND COOPER JJ
CATCHWORDS
Bankruptcy - deed of arrangement - exercise of discretion in terminating deed - relevance of minimal distribution to creditors - need for examination of debtor's affairs - consent of some creditors obtained by promise of extraneous benefits - discretion not interfered with.
Bankruptcy Act 1966: s.236(1)(c)
Lancaster v NZI Capital Corporation Ltd (Full Federal Court, unreported, 11 October 1991); applied.
Re Emmett; Ex parte Beneficial Finance Corporation Ltd (O'Loughlin J, unreported, 16 December 1991); applied.
Dauglish v Tennent (1867) 2 LR QB 49; applied.
Ex parte Milner (1885) 15 QBD 605; applied.
HEARING
SYDNEY, 16 September 1993
#DATE 1:11:1993
Counsel and Solicitors Ms R Sofroniou instructed by
for Appellant: Andrew Thorpe Solicitors
Counsel and Solicitors Mr M Aldridge and Ms J Keyes
for Respondent: instructed by Baskin and Lewis
ORDER
THE COURT ORDERS THAT:
1. Appeal dismissed.
Appellant to pay respondent's costs.
Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
JUDGE1
OLNEY, HILL AND COOPER JJ The appellant, Mr Paton, appeals against orders made by a judge of this Court (Davies J) pursuant to s.236(1)(c) of the Bankruptcy Act 1966 ("the Act"), terminating a deed of arrangement entered into between Mr Paton and Maxwell Christopher Donnelly ("the Trustee") on 23 November 1992 and making a sequestration order against the estate of Mr Paton.
A considerable part of the judgment below is taken up with a discussion of whether there had been, in the circumstances of the present case, a deed of arrangement or a deed of composition entered into between Mr Paton and his creditors. However, ultimately it seems that his Honour took the view that Mr Paton entered into an arrangement rather than a composition with his creditors and that is reflected in the order made by his Honour under s.236(1)(c) of the Act, which section is concerned with arrangements rather than compositions. As both parties were in agreement that a deed of arrangement had been executed by Mr Paton and approved by his creditors, that matter ceased to be of any controversy before us.
At issue in the appeal was whether his Honour erred in exercising his discretion to terminate the deed. It was properly accepted by counsel for Mr Paton that it was incumbent upon her to show that the discretion had been vitiated by some error: House v R (1936) 55 CLR 499 at 505.
His Honour's decision to terminate the arrangement rested upon three factors. First, his Honour took into account the fact that if the arrangement proceeded, creditors would receive only one cent in the dollar over a period of some three years, a return scarcely of interest to any of the creditors other than perhaps one, Goodacre Developments Pty Ltd ("Goodacre") whose debt was admitted in proof for an amount in excess of $9,000,000. Weighed up against this factor was the fact that if Mr Paton were made bankrupt, unsecured creditors would most likely receive nothing.
The second factor taken into account in favour of terminating the arrangement was that there were certain matters which called out for inquiries to be made, inquiries which could only properly be made in an administration in bankruptcy. These matters arose because, as his Honour put it (at 16):
"The debtors both appear to have represented themselves as men of substance; yet they arranged their affairs so as to leave themselves without personal assets to which unsecured creditors might look for the recovery of debts."
The third factor taken into account concerned arrangements said to have been entered into between Mr Paton and Goodacre, and between Mr Paton and Permanent Custodians Pty Limited ("Permanent"). His Honour found that each of these arrangements gave to the party, other than Mr Paton, an extraneous benefit so that the resolution in favour of the arrangement did not reflect an agreement between the creditors fairly arrived at. Rather, the votes of Goodacre and Permanent, which were critical to the passing of the resolutions:
"...reflected the benefits which Goodacre and Permanent could see they would achieve extraneous to the scheme if they voted in favour of a release of Messrs Paton and Pidcock." (at 20)
In favour of Mr Paton, his Honour took into account the fact that Mr Paton was a real estate agent and that bankruptcy could adversely affect his licence and his livelihood.
Having taken each of these matters into account, his Honour formed the view that it was in the interest of creditors generally that the arrangement be terminated and that the estate of both Mr Pidcock (Mr Paton's former partner) and Mr Paton be administered in bankruptcy so as to ensure fair treatment for the creditors according to law. His Honour noted that he was unable to find that the creditors would be likely to obtain a better financial result from an administration in bankruptcy, but regarded it as being in the interest of the creditors as a whole that the deeds be set aside or terminated.
Each of the three matters taken into account by his Honour adverse to Mr Paton were the subject of challenge before us.
First, it was submitted that his Honour should not have regarded the recovery by the creditors of one cent in the dollar as being negligible and should have held that the recovery of such amount was preferable to the nil recovery facing the creditors if the estate of Mr Paton was to be administered in bankruptcy.
In support of this submission it was argued that nothing had appeared in the evidence to suggest that there were circumstances warranting an investigation in bankruptcy or to show that Mr Paton had deliberately divested himself of large amounts of personal assets.
His Honour's discretion has not been shown to have miscarried in this respect. In deciding whether an arrangement should be terminated, the fact that the creditors, or the majority of them, will receive but a minimal sum is a relevant matter to take into account. His Honour did not treat the fact that the return to creditors was relatively small as determinative of the exercise of discretion. His Honour referred to a number of cases including Re Richards; Ex parte Beneficial Finance Corporation Ltd (Jackson J, Federal Court, unreported, 17 March 1986); NZI Capital Corporation Ltd v Lancaster (1991) 30 FCR 441; Re Emmett; Ex parte Beneficial Finance Corporation Ltd (O'Loughlin J, Federal Court, unreported, 16 December 1991); and cases referred to in this last case. His Honour said of the size of the potential dividend to creditors that it was but one factor to be taken into account. That is a correct statement of the law.
While it is true that in the absence of features which suggest that it is in the public interest that an arrangement be set aside or other special features the Court will be slow to interfere with the commercial judgment of the creditors in approving an arrangement, the fact that the dividend to creditors will be relatively insignificant will nevertheless be a factor taken into account in the exercise of discretion. It was open to his Honour to find that the present case differed but in a matter of degree from the facts of Lancaster v NZI Capital Corporation Ltd (Full Federal Court, unreported, 11 October 1991) where at first instance, Sheppard J, (unreported, 3 September 1991) making the sequestration order after Foster J had set aside the composition (reported at 30 FCR 441), in a passage cited by the Full Court (at 9) said:
"...in the absence of complete agreement by creditors, and the petitioning creditor which is owed a substantial sum does not agree, there is something which, if not shocking, is at least something which takes one aback about a suggestion that somebody who owes almost 5.5 million dollars can offer $15,000 and walk away without there being any appropriate investigation of his affairs. An examination of the relevant provisions of Part X show that if a deed of composition is entered into neither the provisions of s.69 of the Act which provides for the public examination of bankrupts, nor the provisions of s.81 thereof, which gives trustees in bankruptcy wide powers to examine other persons and to compel the production of documents, will apply."
Counsel for Mr Paton referred us to cases such as Chiragakis v Deputy Commissioner of Taxation (1986) 68 ALR 527; Re Agushi; Ex parte Farrow Mortgage Services Pty Ltd (In Liq) v Cole (1992) 8 ACSR 549; Re Cufari; Ex parte Commissioner of Taxation v Huppatz (1992) 34 FCR 544 at 552-554; Re Williamson; Ex parte Wearne (1980) 31 ALR 598 at 606; and Re Beames; Ex parte Beneficial Finance Corporation Ltd (1985) 7 FCR 216, as examples of the way the courts have exercised their discretion to terminate or not, as the case may be, arrangements. In Chiragakis the deed of arrangement was terminated in circumstances where a full investigation was called for of re-arrangements by the debtor of his affairs which had led to a large tax liability. Relevant also was the possibility of a contribution being made for the benefit of the estate in bankruptcy out of the income of the debtor who was a doctor. By contrast the Court refused to set aside a deed or terminate it in Re Agushi where the return to creditors was only 0.019 of a cent in the dollar, but where there was nothing to suggest that the debtor had any particular income earning capacity and there was nothing before the Court to suggest that further investigation of the affairs of the debtors was called for or might ultimately lead to a more substantial dividend for creditors.
Each of the cases referred to depends upon its own facts. None of them, however, suggest other than that the size of the dividend is a matter that may be taken into account in the exercise of the discretion.
The second challenge to the exercise of discretion related to his Honour's findings that Mr Paton, inter alia, had represented himself as a man of substance and arranged his affairs so as to leave himself without assets available for unsecured creditors.
Counsel for Mr Paton conceded that Mr Paton had represented himself as having in June 1990 a net worth of $450,000. However, his statement of affairs circulated to creditors disclosed no assets other than furniture valued at $5,500 albeit that debts were disclosed of $9,934,706. A person having net assets of $450,000 can appropriately be described as "of substance" and this was conceded.
Counsel's attack, however, focussed on the finding by his Honour that Mr Paton had arranged his affairs to the detriment of unsecured creditors.
What was meant by this passage in his Honour's judgment appears from his Honour's statement of facts earlier. Mr Paton had for some time been financially interested in a real estate agency having a franchise from Richardson and Wrench. The real estate agency was owned as to 90% by Denuka Management Pty Ltd ("Denuka"), the trustee of a unit trust, and Mr Paton and Mr Pidcock personally. Half of the units in that unit trust were held for the benefit of interests associated with Mr Paton, although not by him personally. Mr Paton and Mr Pidcock each retained a 5% interest in the business until June 1992. In that month and after a creditor's petition had been filed in the Court and had been made returnable, Mr Paton assigned to Denuka his interest for $50. A similar transaction was entered into by Mr Pidcock. Thereafter Mr Paton continued with Mr Pidcock to be the principal persons involved in the business until early 1993 when Mr Paton severed his connection with the business and became employed by another real estate agent. In the course of cross-examination Mr Paton was asked for the reason for the assignment of his share of the partnership. He said:
"My reason for getting rid of the 5% in the partnership was that the agency was the only source of income certainly that I had and I took advice as to how to protect that and I was advised that in fact I should sell that share. Well, you were trying to protect it from your creditors, were you not?- - Well, I was trying to protect it from attack, yes. From creditors?- - I was trying to protect it from attack. There was nothing there in terms of asset, because the property had been sold for $50 as I'd explained to you, on valuation, there was nothing there of value, my job was there. Who else would attack your 5% share in the partnership other than creditors? - - Well nobody, I guess. I suppose that's - creditors."
Later in re-examination Mr Paton was shown a copy of an agreement and asked whether it assisted him in explaining why he disposed of his 5% share. That leading question precipitated an affirmative answer. The document to which Mr Paton's attention was drawn was the draft of an unexecuted deed bearing upon its face a date of September 1992 between Mr Pidcock and Mr Paton on the one hand, and various creditors on the other, which referred to the assignments of the respective 5% interests as having been effective. On the face of it is somewhat difficult to see how that draft agreement entered into some months later explained the June assignment. But even if it may have, it was open to his Honour to accept the clear admission which Mr Paton himself had made. In so doing his Honour did not err and his exercise of discretion did not for this reason miscarry.
The third matter concerned the arrangements with Goodacre and Permanent. The Goodacre arrangement, which was known to all creditors, took the form of a deed dated 9 November 1992 to which, inter alia, Mr Paton and Goodacre were parties. Goodacre, which was a wholly owned subsidiary of Australian Gaslight Company Ltd, had been involved in a joint venture with interests associated with Mr Paton and Mr Pidcock. The vehicle for that joint venture was a company called Thorstone Pty Ltd ("Thorstone"). The debts of the joint venture company were guaranteed, inter alia, by Mr Paton and Mr Pidcock. Thorstone was in liquidation. Thorstone had substantial tax losses which Goodacre believed it could use to offset profits, presumably arising from the sale of the joint venture land. Under the deed Messrs Paton and Pidcock agreed that the shareholding in Thorstone Pty Ltd, which they controlled although did not own, would be transferred as to 60% to Goodacre and as to 40% to the Australian Gaslight Company. In consideration Goodacre agreed to vote in favour of the arrangement at the meeting of creditors. In addition Mr Paton agreed to do what was necessary to assist Goodacre in applying for a stay of the winding up of Thorstone and to attend such meetings and do all such things as were necessary. In addition Mr Paton released Goodacre and Thorstone from claims.
Clearly enough the deed gave Goodacre a commercial benefit. Whether that benefit would ultimately be converted into money depended upon whether Goodacre was able to stay the winding up of Thorstone. But that is not to the point. The arrangement was one whereby Mr Paton secured the critical vote of Goodacre by giving that company a commercial benefit, being the benefit of the covenants contained in the deed.
The connection between the vote of Permanent and any benefit to that company is somewhat less direct. It will be recalled that the real estate business was, at the time of the meeting of creditors, carried on by Denuka. The goodwill of that business consisted, at least in part, of a valuable rent roll. As at 23 November 1992, the date of the adjourned meeting at which the resolution requiring Mr Paton to execute the deed of arrangement was passed, Mr Paton and Mr Pidcock were negotiating with Permanent to give to Permanent a charge over the assets of Denuka including that rent roll as additional security for moneys owing to Permanent. At the meeting the representative of Permanent announced that the arrangement was to be formalised later that day. Relevantly to the present proceedings Permanent had security over Mr and Mrs Paton's home.
In fact, it seems that the arrangement did not proceed. The evidence is silent as to why. It does seem, however, that Mr Paton, at his own cost, assisted with the sub-division of the home property to increase the value of the security which was, it would seem, ultimately sold by Permanent as mortgagee under power of sale.
It was open to be inferred by his Honour that the arrangement with the rent roll and perhaps the sub-division was in consideration of Permanent voting in favour of the arrangement. Although Permanent proved in the arrangement only as a creditor in respect of $4,141 out of a total of $13,027,963, that company counted in the number of creditors voting to approve the arrangement (8) and as 6 creditors voted against the arrangement, the vote of Permanent was significant.
The judgment appealed against does not make clear whether his Honour inferred that Permanent's vote was given in exchange for the benefits which were to accrue to it. His Honour indicated that Permanent was looking to the receipt of benefits extraneous to the arrangement and that its position so to do was improved by tying the other creditors into a release. The release, so his Honour said, would leave Permanent free to arrange with Messrs Paton and Pidcock for the payment of the moneys due to it.
The starting point of a discussion on the effect of the provision to a creditor of an extraneous benefit is the decision of Dauglish v Tennent (1867) 2 LR QB 49. That was a case where the debtor proposing a deed of composition agreed with some only of his creditors to make payments to them to provide certain pecuniary and valuable benefits and preferences, thereby inducing those creditors to execute the deed of composition. Cockburn CJ, with whom Mellor and Lush JJ agreed, said (at 53-54):
"In order that such a deed should be binding on the creditors, it is essential that there should be the most perfect good faith between the debtor and all his creditors. It is very true that it does not appear that the preference is to be obtained from the assets, or that all the creditors will not receive an equal distribution of the assets; but it is a wrong ground to rest the validity of a composition deed upon, to say that the creditor looks only to the equal distribution of assets. There may be cases in which a man might not be capable of deciding for himself whether he would accept the composition and would rather trust to the judgment of a body creditors than to his own, whether it was advisable for him to execute the deed; and he is entitled by the agreement into which he enters to insist that the concurrence of the other creditors shall have been obtained by fair means; and if it were obtained by a promise from the debtor to give something more to some creditors than to others, the deed would be fraudulent and void, as between the debtor and the other creditors who were no parties to the arrangement. I think, therefore, that the present deed is void."
In a separate judgment Mellor J spoke of a secret bargain giving some creditors an advantage over others when the deed was to be signed upon the understanding that all creditors were to be placed on the same footing. Lush J, also in a separate judgment, referred to the execution of some of the creditors being obtained by bribery.
The inducement in Ex parte Milner (1885) 15 QBD 605 was an agreement on the part of the debtor's brother to make additional payments on account of the debts of certain creditors in order to induce them to execute the deed. The arrangement was kept secret from the other creditors. It was held not to matter that the inducement came from a person other than the debtor, at least if the debtor knew about it. It was held that equality among creditors was a condition of the validity of the deed of assignment with which the case was concerned. Brett MR set out what was said by Mellor and Lush JJ in Dauglish and continued (at 613):
"This seems to shew that one of the grounds upon which the principle rests is, that the other creditors would not enter into such an agreement if they were not to take it for granted that all the creditors who enter into it are to stand on a footing of absolute equality. If this is not so, they are deceived."
The Master of the Rolls referred to Knight v Hunt ((1829) 5 Bing 432; 130 ER 1127) as carrying the principle further. That case decided, his Lordship said (at 613-614):
"...that it is immaterial whether the bribery is to be carried out at the expense of the debtor or not; if one of the creditors derives an advantage from some other person than the debtor, still he has broken faith with the other creditors, and they are entitled to say that they are not bound by the deed."
In the same case Bowen LJ expressed (at 616) the view that it was of the essence of a composition that the creditors act upon the faith and understanding that they are coming in upon terms of equality and so execute the deed on the faith that there is no private bargain with any of the other creditors which will destroy this equality. Such a private bargain operates as a breach of faith striking at the root of the deed.
It will be noted that there are a number of different thoughts which interact in these two cases. First is the need for creditors to be treated equally. Second there is a reference to the execution by a creditor being obtained by bribery, by which we would understand a reference to the execution being obtained by some inducement or reward special to the person who is to receive it. Third there is in these cases a reference to the secrecy of the bargain between the debtor and the creditors who obtain a special advantage.
Subsequent cases have tended to focus on the inequalities among creditors or the secrecy of the arrangement. In Re Jacobs; Ex parte O'Connor (1984) 1 FCR 1, the discussion focussed on the question of equal treatment of creditors and the absence of private bargain. In that case Fisher J pointed out that it was not improper for the creditors to agree among themselves for something other than equality of treatment, so long as they acted in good faith towards each other and made no secret bargains with any other creditor. His Honour concluded that there was no objection to such a bargain or agreement as long as it was not private or secret but was fully disclosed to and agreed to by other creditors. As his Honour said (at 8):
"There is no express embargo on the creditors openly agreeing amongst themselves, doubtless as a means of obtaining acceptance of the debtor's proposal, that one or more of them should receive priority in the time or amount of payment. Such an arrangement is not contrary to any express provision of the Act, and I see no justification for implying such an embargo."
It is not quite clear from his Honour's discussion (particularly at 10) whether his Honour was of the view that all creditors in such a case would have to agree. Similarly, NZI Capital Corporation Limited v Lancaster (supra) concerned a secret arrangement whereby one creditor received substantially more than the other creditors in exchange for an agreement to support a composition.
In our view, secrecy of itself is not an essential ingredient in treating an arrangement or composition as being void where an inducement is given to a particular creditor to secure his vote, that inducement being over and above the other benefits which accrue to all creditors under the arrangement or composition. No doubt if all creditors agreed there would be no difficulty about an arrangement openly disclosed which provided benefits to some creditors greater than others and in circumstances where the greater benefits acted as an inducement to the creditors preferred to vote for the arrangement. But where there is not such unanimity, the giving of an inducement to a creditor, or in the more colourful language of Lush J in Dauglish "a bribe" operates to render void a deed entered into on that basis. In such a case the necessary good faith between the debtor and the whole of the creditors would be missing.
It is unnecessary therefore to consider whether the facts relating to Permanent sufficed to treat the deed void. For the arrangement entered into between Goodacre and Mr Paton, whereby an inducement was given to Goodacre to secure that company's vote in favour of the arrangement, operated to preclude the arrangement or composition from having been fairly reached and as being in the interests of creditors generally.
It follows therefore that each of the matters considered by his Honour in the exercise of his discretion adverse to Mr Paton cumulatively and the arrangement with Goodacre treated on its own, operated to compel the conclusion that the arrangement should be terminated.
The appeal should accordingly be dismissed with costs.
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