Re Ayoub; Ex parte Silvia

[1983] FCA 159

Re: ELIAS AYOUB
Ex parte: BRIAN RAYMOND SILVIA (1983) 67 FLR 144
No. 614 of 1981
Bankruptcy

COURT

IN THE FEDERAL COURT OF AUSTRALIA

GENERAL DIVISION
BANKRUPTCY DISTRICT OF THE STATE OF NEW SOUTH WALES AND THE AUSTRALIAN CAPITAL TERRITORY
Morling J.(1)

CATCHWORDS

Bankruptcy - sequestration order - bankrupt trading after sequestration - goods supplied to bankrupt - goods used in bankrupt's business - trustee unaware of bankrupt's trading - business sold by trustee to advantage - whether suppliers of goods entitled to be paid in priority to other creditors - rule in Ex parte James: In re Condon - application of rule

Bankruptcy Act 1966, ss. 58, 59, 82(1), 134(4)

Bankruptcy - Sequestration order - Bankrupt trading after sequestration - Goods supplied to bankrupt - Goods used in bankrupt's business - Trustee unaware of bankrupt's trading - Business sold by trustee to advantage - Whether supplier of goods entitled to be paid in priority to other creditors - Rule in Ex parte James; Re Condon - Bankruptcy Act 1966 (Cth), ss 58, 59, 82(1), 134(4).

HEADNOTE

In early July 1981 Ayoub (the bankrupt) had obtained a spirit merchant's licence. On 14 July 1981 a sequestration order was made against his estate. On 22 July 1981, unaware of the sequestration order, he began trading as a liquor merchant. On 30 July 1981 the official receiver first made contact with the bankrupt but received no information as to the business being operated by him. Between 14 July and 23 October 1981 the bankrupt purchased liquor stock from three creditors and office equipment from one creditor (the subsequent creditors) to a value in excess of $15,000. The subsequent creditors were unaware of the bankruptcy when they afforded credit to the bankrupt. The majority of the stock supplied by the subsequent creditors was delivered in the three weeks prior to 23 October 1981. On that date, the official receiver became aware of the trade being conducted by the bankrupt and took over the business on a C.O.D. basis. The stock taken over amounted to some $14,000 worth. On 10 June 1982 the official receiver sold the business as a going concern for $80,000 and stock valued at $6,500.

After payment of priority claims and the trustee's remuneration and expenses, the sum of $48,000 remained available for distribution. Proofs of debt submitted by unsecured creditors totalled nearly $350,000 not including the claims from the subsequent creditors.

The trustee applied for directions pursuant to s. 134 of the Bankruptcy Act 1966 (the Act) as to whether he would be justified in paying out the claims of the subsequent creditors of the assets of the estate in priority to unsecured creditors.

Held: (1) The trustee would not be directed to pay the subsequent creditors out of the assets of the estate in priority to the unsecured creditors because:

(a) the debts of the subsequent creditors were not provable in the

bankruptcy as

they were not in existence at the date thereof;

(b) the debts of the subsequent creditors were not debts incurred by or with the

authority of the trustee and therefore neither s. 109(1)(a) of the Act nor

r. 40(a) of the Bankruptcy Rules could justify payment thereof;

(c) payment would not be justified within the principle originally laid down in Ex

parte James; Re Condon (1874) 9 Ch App 609, for the reasons that:

(i) the inference from the evidence was that the subsequent creditors had each failed to take any or any adequate steps to check the financial

position of the bankrupt before supplying goods in credit;

(ii) the carrying on of the business by the trustee after 23 October 1981 was

not done pursuant to any guarantee or other undertaking by the trustee to

the subsequent creditors that their debts would be paid;

(iii)it is not unconscionable of the trustee to require the subsequent creditors to pursue their statutory rights and, if they so desire, take fresh

bankruptcy proceedings against the bankrupt. The fact that such proceedings

might prove fruitless does make the conduct by the trustee inequitable.

(2) It was entirely proper for the trustee to seek directions in such circumstances. The court therefore directed that his costs should be paid out of the assets of the estate.

HEARING

1983, May 26; June 8. #DATE 8:6:1983

APPLICATION.

Application pursuant to s. 135 of the Act for directions. The circumstances are set out in the judgment below.

R. Parsons, for the applicant trustee.

Cur. adv. vult.

Solicitors for the applicant trustees: Barraket, Kemp & Strang.

D.L.

ORDER

1. The trustee would not be justified in paying out of the assets of the estate in priority to unsecured creditors debts incurred between 15 July, 1981 and 22 October, 1981 by the bankrupt to the following:

(a) A.G. Campbell Pty. Limited $6,341.12

(b) Tooheys Limited $2,493.85

(c) Tooth & Co. Limited $5,759.41

(d) Prestige Office Equipment $700.00

in respect of goods supplied to the bankrupt between the dates hereinbefore referred to.

2. The trustee's costs to be paid out of the assets of the estate. Order accordingly.

JUDGE1

This is an application by Brian Raymond Silvia, the trustee of the bankrupt estate of Elias Ayoub ("the bankrupt"). The application is brought pursuant to s.134(4) of the Bankruptcy Act 1966 ("the Act") for directions in respect of a matter which has arisen in connection with the administration of the estate of the bankrupt. The trustee seeks a direction from the court as to whether he would be justified in paying out of the assets of the estate in priority to unsecured creditors certain debts incurred by the bankrupt between 15 July 1981 and 22 October 1981. All the debts are in respect of goods supplied to the bankrupt and are as follows:

(a) A.G. Campbell Pty. Limited $6,341.12

(b) Tooheys Limited $2,493.85

(c) Tooth & Co. Limited $5,759.41

(d) Prestige Office Equipment $700.00

It will be convenient to refer to these creditors as "the four creditors".

On 14 July 1981 a sequestration order was made against the estate of the bankrupt and the Official Receiver in Bankruptcy was appointed trustee of his estate. On 22 July 1981 the bankrupt began trading in a business known as "Lexington Cellars" from premises at Maroubra. He had been granted a spirit merchant's license on 10 July 1981. Between 14 July 1981 and 23 October 1981 the bankrupt, or persons upon his behalf, purchased liquor stock from the first three of the four creditors. The bankrupt also purchased office equipment from Prestige Office Equipment. The debts incurred to these creditors remain unpaid.

It appears that although the sequestration order was made on 14 July 1981 the Official Receiver did not make contact with the bankrupt until 30 July 1981. The bankrupt did not tell the Official Receiver about his interest in Lexington Cellars.

On 23 October 1981 the Official Receiver was advised that the bankrupt was conducting the business. On that date his representative visited the business and made arrangements to conduct a stock-take and to carry on the business. On 26 October suppliers of liquor to the business were contacted as regards future supplies. It then became known to the suppliers for the first time that the proprietor of the business with whom they had been dealing was a bankrupt. The Official Receiver made arrangements with the suppliers to continue to supply goods to him on a C.O.D. basis. He informed the suppliers that he would consider payment of the post-sequestration debts when the business was sold. However, he did not give any guarantee or indemnity to the suppliers as regards actual payment of their outstanding accounts.

It is plain that the bankrupt may have committed one or more of the offences referred to in s.269 of the Act but for present purposes nothing turns upon this.

Most of the stock in respect of which the four creditors' debts was incurred were supplied to the bankrupt in the two or three weeks prior to the Official Receiver first becoming aware that the bankrupt was carrying on business. There was about $14,000 worth of stock on the business premises when the Official Receiver took possession of it. It is the Official Receiver's belief that most of the stock on hand when the stock-take was made comprised stock obtained from the four creditors during the period 30 September 1981 to 22 October 1981. He carried on the business for some time and thereafter the present trustee continued to conduct the business. On 10 June 1982 the trustee entered into a contract to sell the business as a going concern for the sum of $80,000. In addition, he sold the stock to the purchaser for about $6,500. The trustee presently holds funds in the order of $55,000 and after payment of priority creditors and trustee's remuneration and expenses he anticipates that approximately $48,000 will remain available for distribution to unsecured creditors. Proofs of debt have been received from unsecured creditors totalling $348,311.23 and there are in addition to those unsecured creditors there are the debts of the four creditors.

In these circumstances the trustee seeks directions from the court as to whether he would be entitled to pay the four creditors in priority to the unsecured creditors of the estate. If the four creditors are excluded from distribution, the unsecured creditors could expect to receive a dividend from the estate of approximately 13.7c. in the $. If, however, the four creditors are paid in priority, there will be available for distribution to unsecured creditors money sufficient to realise a dividend of about 9.4c. in the $.

I am satisfied that the four creditors were unaware that a sequestration order had been made against the estate of the bankrupt at the time they gave credit to him. However, there is no evidence as to what steps, if any, they took to ascertain the credit worthiness of the bankrupt before they supplied him with goods.

Before turning to consider what directions should be given to the trustee it will be helpful to refer to some of the provisions of the Act. By s.82(1) it is provided that:

" . . . all debts and liabilities, . . . to which a bankrupt was subject at the date of the bankruptcy, or to which he may become subject before his discharge by reason of an obligation incurred before the date of the bankruptcy, are provable in his bankruptcy."

It is clear that the four creditors' debts are not provable in the bankruptcy as they were not in existence at the date of the bankruptcy. Of course there would be nothing to stop any of the four creditors from taking fresh bankruptcy proceedings against the bankrupt. If this were to occur, the provisions of ss. 58 and 59 of the Act would become of importance. By s.58(1)(b) it is provided that, subject to the Act, where a debtor becomes a bankrupt:

"(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."

But s.59(1) provides, in part, as follows:

"59(1) Where a person who is a bankrupt again becomes a bankrupt -

(a) the property of the bankrupt -

(i) that was acquired by, or devolved on, the bankrupt on or after the date of the earlier bankruptcy; and

(ii) that had not been distributed amongst the creditors in the earlier bankruptcy before the date on which the person became a bankrupt on the later occasion,
shall (subject to any disposition of that property made by the trustee in the earlier bankruptcy without knowledge of the presentation of the petition on, or by virtue of the presentation of which, the person became bankrupt on the later occasion and subject also to section 126) vest forthwith in the trustee in the later bankruptcy;"

Thus, insofar as the goods supplied by the four creditors could still be identified in specie they would vest in the trustee in the later bankruptcy and be available to pay the debts admitted to proof in the second bankruptcy.

The trustee's power to carry on the business of the bankrupt is found in s.134(1)(b) of the Act. By s.109(1)(a) it is provided that, subject to certain provisions which are not relevant for present purposes, the trustee shall, before applying the proceeds of the property of the bankrupt in making any other payments, apply those proceeds first in payment of the taxed costs of the petitioning creditor and the costs, charges and expenses of the administration of the bankruptcy. Paragraph (a) of rule 40 of the Bankruptcy Rules provides as follows:

"40. For the purposes of paragraph 109(1)(a) of the Act, the trustee shall apply the proceeds of the property of the bankrupt in the following order: -

(a) first, in payment of the expenses incurred by the trustee in protecting the assets, or any part of the assets, of the bankrupt, and the expenses (if any) incurred by him or by his authority in connexion with the carrying on, in accordance with the Act, of a business of the bankrupt;"

Since it is plain that the debts of the four creditors were not incurred by the trustee or with his authority, neither s.109(1)(a) nor rule 40(a) would provide any justification for the payment of the debts by the trustee either in priority to other debts, or at all.

There being no other provision of the Act authorising the trustee to pay the four creditors' debts, he has sought the court's direction as to whether he should pay those debts in accordance with the principle originally laid down in Ex parte James; In re Condon (1874) L.R. 9 Ch. App. 609 and subsequently followed and applied in many other cases both in England and Australia. In James' Case money had been voluntarily paid to a trustee in bankruptcy under a mistake of law. It was thus irrecoverable under ordinary principles. But the Court of Appeal in Chancery held that, in such a case, the trustee is not bound strictly by the law. At p.614 James L.J. said:

"I am of opinion that a trustee in bankruptcy is an officer of the Court. He has inquisitorial powers given him by the Court, and the Court regards him as its officer, and he is to hold money in his hands upon trust for its equitable distribution among the creditors. The Court, then, finding that he has in his hands money which in equity belongs to some one else, ought to set an example to the world by paying it to the person really entitled to it. In my opinion the Court of Bankruptcy ought to be as honest as other people."

A statement of the conditions which must exist before the rule operates appears in the judgment of Walton J. in In re Clarke (1975) 1 W.L.R. 559 at 563-4. First, there must be some form of enrichment of the assets of the bankrupt by the person seeking to have the rule applied. See Government of India v. Taylor (1955) A.C. 491 per Lord Keith at 512-513. Next, except in the most unusual circumstances the claimant must not be in the position to submit an ordinary proof of debt. See Ex parte Whittaker, In re Shackelton (1875) 10 Ch. App. 446 and In re Gozzett, Ex parte Messenger & Co. Limited v. The Trustee (1936) 1 All E.R. 79. The purpose of the rule is not to confer a preference on an otherwise unsecured creditor, but to provide relief to a creditor who would otherwise be without a remedy. Thidly, and most importantly, it must be shown that it would be unfair for the trustee to rely upon his strict legal rights.

Cases in which the rule has been applied include Ex parte Simmonds, In re Carnac 16 Q.B.D. 308 (where a trustee was directed to refund money paid under a mistake of law); In re Tyler Ex parte The Official Receiver (1907) 1 K.B. 865 (where a trustee was directed to pay to the wife of a bankrupt premiums which she had paid upon a policy of life insurance on the bankrupt's life in the erroneous belief that she was entitled to the proceeds of the policy) and In re Thellusson Ex parte Abdy (1919) 2 K.B. 735 (where Warrington L.J., at p. 743, described the Court's jurisdiction as being a ". . . jurisdiction it has often asserted of directing its officer - in this case a trustee in bankruptcy - to pursue a line of conduct which an honest man actuated by motives of morality and justice would pursue, although not compellable thereto by legal process.").

The Australian cases in which the rule has either been referred to or applied include Re Henderson; Ex parte Tonkin (1934) 7 A.B.C. 273; Re Docker; Ex parte Official Receiver (1938) 10 A.B.C. 97; Re M. & J. De Wit; Ex parte Custom Credit Corporation Limited (1961) 19 A.B.C. 63; Re Roberts; Official Receiver v. Lincoln Investments Limited (1976) 26 F.L.R. 330 and Re Arcadiau; Ex parte Guardian Investments Pty Limited (C.A. Sweeney J., 22 May 1979, unreported).

The rule in Ex parte James was referred to in Downs Distributing Co. Pty. Limited v. Associated Blue Star Stores Pty. Limited (In liquidation) (1948) 76 C.L.R. 463. Latham C.J. referred at p. 476 to "the difficulties involved in applying a criterion of honest and high minded conduct." Williams J. reviewed the cases in which the rule has been invoked and said, at p. 482:

"-but the cases as a whole appear to show that it is only in exceptional cases that the rule would be applied where the officer or his predecessor in office has not been personally concerned in the transaction".

I turn now to consider the facts of the present case. It is regrettable that the bankrupt continued to trade after his estate had been sequestrated and that the four creditors gave him credit. But that is not, in itself, a particularly exceptional circumstance. The provisions of the Act dealing with second bankruptcies contemplate that conduct of this kind may occur and make provision for it. I have already said that I accept that the four creditors were unaware when they dealt with the bankrupt that his estate had been sequestrated. But there is no evidence as to what steps, if any, they took to check the bankrupt's credit worthiness before supplying and continuing to supply him with goods. I would have thought that they would have had officers whose duty it was to make some assessment of the ability of their customers to meet their debts. Why they failed to become aware of the sequestration of the bankrupt's estate has not been explained. It is, I think, notorious that information as to the making of sequestration orders is readily available through services provided by mercantile agencies.

It is not as if the goods supplied to the bankrupt were of little value. Moreover, since the bankrupt did not commence business until July 1981 (and there is no evidence that he had been in any other business before then) it is surprising that positive steps were not taken at that time to check his financial position. In the absence of evidence to the contrary I think I should infer that either no, or inadequate, steps were taken to do this.

The four creditors were not represented at the hearing of the application, although they knew of it and were aware of their right to be heard. But counsel for the trustee very fairly and competently put all that could be said in favour of the four creditors. In particular, he pointed out that although the stock supplied by the four creditors would be after-acquired property of the bankrupt, it would be virtually impossible to trace it so as to make it available to the creditors in any subsequent bankruptcy. He also pointed out that by continuing to supply the Official Receiver and the trustee with goods, the liquor suppliers had enabled the business to be carried on and subsequently sold to advantage. But the liquor which was subsequently supplied was on a C.O.D. basis and it cannot be said that favourable terms of trading were given to the Official Receiver to assist him in running the business. It is not as if an agreement was reached between the Official Receiver and the liquor suppliers that they would only continue to supply goods if their debts were met. Had this been the case, the position would have been quite different because payment of the suppliers' debts would have been akin to an expenditure necessarily made by the Official Receiver in carrying on the business. But as I have already observed, no guarantee was given to the four creditors that their debts would be paid.

In these circumstances, I do not think this is a case for the application of the principle laid down in James' Case. It would not be unconscionable for the trustee to require the four creditors to pursue their rights under the Act. It is not to the point that the exercise of those rights may prove fruitless. They ran the risk of doing business with the bankrupt, as did the creditors who have proved in the bankruptcy. The Act proceeds upon the basis that debts proved against an estate are to rank equally except in special circumstances for which provision is made for priority payment. See ss. 108 and 109. For the trustee to require the four creditors in this case to pursue the rights given to them under the Act does not amount to inequitable conduct of the kind that has hitherto been regarded as sufficient to invoke the rule in James' Case.

For these reasons I am of the opinion that the court would not be justified in directing the trustee to pay out of the assets of the estate in priority to unsecured creditors the debts incurred to the four creditors. However, it was entirely proper for the trustee to seek directions from the court and I direct that his costs should be paid out of the assets of the estate.