Re Hudson, T.R. v Ex parte Australia & New Zealand Banking Group Ltd

RE: TOM RUTHERFORD HUDSON
EX PARTE: AUSTRALIA AND NEW ZEALAND BANKING GROUP LIMITED AND ESANDA FINANCE
CORPORATION LIMITED v. ALEX NEVILLE BIRD
No. VB894 of 1988
FED No. 254/94
Number of pages - 17
Bankruptcy

COURT

IN THE FEDERAL COURT OF AUSTRALIA
EXERCISING FEDERAL JURISDICTION IN BANKRUPTCY
BANKRUPTCY DISTRICT OF THE STATE OF VICTORIA
NORTHROP J

CATCHWORDS

Bankruptcy - Scheme of arrangement or composition entered into after sequestration order made - litigation between trustee and bankrupt compromised as a result - whether creditor funding litigation can obtain priority under Bankruptcy Act 1966 s109(10) - no assets of bankrupt - scheme of arrangement - money provided by relative - control by creditors - power of Court to order priority

HEARING

MELBOURNE, 4 and 5 November 1993
#DATE 6:5:1994

Counsel for Australia and New
Zealand Banking Group Limited
and Esanda Finance Corporation
Limited: Mr K. Baker

Solicitors for Australia and New
Zealand Banking Group Limited
and Esanda Finance Corporation
Limited: Dunhill Madden Butler

Counsel for Mr Ernest James Moore: Mr G.T. Bigmore

Solicitors for Mr Ernest James Moore: J.M. Smith and Emmerton

JUDGE1

NORTHROP J This application raises an issue between creditors of Tom Rutherford Hudson ("the bankrupt") over the distribution of the bankrupt's property. Under s108 of the Bankruptcy Act 1966, the general rule is all debts proved in the bankruptcy rank equally and if the proceeds of the property of the bankrupt are insufficient to meet them in full, the debts are to be paid proportionately. Section 109 provides for exceptions to this general rule in that it makes provision whereby some creditors are entitled to priority of payment of debts over other creditors. The provision relevant for this application is contained in subsection 109(10) which provides:

"Where in any bankruptcy:

(a) property has been recovered, realized or preserved under an indemnity for costs of litigation given by a creditor or creditors; or

(b) expenses in relation to which a creditor has, or creditors have, indemnified a trustee have been recovered; the Court may, upon the application of the trustee or a creditor, make such orders as it thinks just and equitable with respect to the distribution of that property and the amount of those expenses so recovered with a view to giving the indemnifying creditor or creditors, as the case may be, an advantage over others in consideration of the risk assumed by creditor or creditors.

By application dated 8 April 1993, Australia and New Zealand Banking Group Ltd ("ANZ Bank") and Esanda Finance Corporation Ltd ("Esanda"), as creditors of the bankrupt, are seeking an order for such priority pursuant to subsection 109(10) of the Bankruptcy Act as the Court determines. Another creditor, Ernest James Moore, appeared at the hearing to oppose the orders sought by ANZ Bank and Esanda. The grounds of the opposition were stated to be:

"1. The Applicants did not provide an indemnity within the meaning of section 109(10) of the Bankruptcy Act 1966 (the Act) to the Respondent for costs of litigation or the expenses of the Respondent.

2. Alternatively, if the Applicants did provide an indemnity to the Respondent (which is denied) the Applicants in their capacity as purported indemnifying creditors ran little or no risk in giving any purported indemnity or indemnities to the Respondent.

3. Further or alternatively, Ernest James Moore did not have the opportunity of joining the Applicants in their capacity as indemnifying creditors and so himself qualify for the advantage given by section 109(10) of the Act.

4. Further or alternatively, no property has been recovered, realised or preserved under an indemnity for (a) costs of litigation or (b) the expenses of the Respondent.

5. Alternatively, if any property has been recovered, realised or preserved under an indemnity for (a) costs of litigation or (b) the expenses of the Respondent (which is denied) the value of that property does not exceed $200,000.00 leaving a balance of $400,000.00 to be distributed pari passu to, among others, Ernest James Moore.

6. Alternatively, in the exercise of this Honourable Courts'

(sic) discretion, the orders sought should not be made."

In these reasons ANZ Bank and Esanda are described as the applicants and the bankrupt's trustee in bankruptcy, Alex Neville Bird, is described as the respondent. Mr Bird did not appear at the hearing of the application. The grounds of opposition appear deceptively simple but they hide a complex series of facts and involve very difficult questions of law. Before turning to the facts, it will be helpful to set out in brief form the chronology within which the facts arise.
The bankrupt became a bankrupt on 15 July 1988 when his debtor's petition was accepted by the Registrar in Bankruptcy. John Richard Morrow was the trustee in bankruptcy. The statement of affairs filed with the petition is not helpful, since, on its face, it suggests that the bankrupt was not insolvent but it does describe contingent liabilities in the nature of guarantees given by the bankrupt to persons including ANZ Bank and Esanda. The statement gives particulars of a contingent asset as "Interest in Estate E.G. Hudson (Deceased)". E.G. Hudson was the grandmother of the bankrupt and will be described in these reasons as "the grandmother".
A meeting of creditors was held on 5 August 1988. ANZ Bank, Esanda and Mr Moore were represented or present at this meeting. At the meeting it became apparent that the only asset of any substance of the bankrupt was the contingent interest which was described as "the Bankrupt's interest as a remainderman" in his grandmother's estate. It was apparent also that great difficulties would arise getting in that asset. The position was made more difficult by the fact that there were insufficient funds in the estate of the bankrupt to pursue the matter.
On 30 November 1988, a further creditors' meeting was held at which the bankrupt proposed a composition under s73 of the Bankruptcy Act for the payment of $400,000.00 and an annulment of the bankruptcy. The meeting was adjourned on two occasions. At the final adjournment of the meeting the offer of composition was rejected. Three creditors voted against the approval, ANZ Bank ($1,120,443.00), Esanda ($180,672.00) and a third ($40,230.00). Four creditors voted in favour, Mr Moore ($261,942.00) and three others to a total value of $35,939.00; see definition of "special resolution" in subsection 5(1). The battle lines were drawn.
Thereafter, nothing much happened until just before 15 July 1991 being the time when the bankrupt would have been discharged from bankruptcy by operation of law, see s149 of the Bankruptcy Act as then in operation. A further meeting of creditors was held on 28 June 1991 at the instigation of ANZ Bank to consider whether the trustee should file, pursuant to subsection 149(7), an objection to discharge which would have the effect of preventing the automatic discharge of bankruptcy on 15 July 1991. That meeting resolved to direct the trustee to lodge an objection to discharge, to continue a policy of insurance by which $1,000,000.00 was to be paid to the trustee if the bankrupt predeceased his father, who had a life interest in the estate of the grandmother, to make provision for payment of the premium, if necessary, and finally, to replace Mr Morrow as trustee and to appoint Mr Bird as trustee. ANZ Bank, by far the major creditor, forced the day. Mr Moore abstained from voting on all motions except the one to replace the trustee. He voted in favour of that motion.
On 11 July 1991, Mr Bird filed an objection to the discharge of bankruptcy.
On 5 May 1992, the bankrupt made application to the Court under s178 of the Bankruptcy Act for an order that the trustee withdraw the objection to discharge and alternatively for an order under s150 that he be discharged from bankruptcy forthwith.
On 28 May 1992, the trustee made application to the Court for a declaration that the interest of the bankrupt in the estate of his grandmother "vests in" the trustee. The bankrupt's father, who had a life interest in the estate, was still alive.
The two applications were heard together on 31 August 1992. Judgment was reserved but, because of subsequent events, was never published.
At this stage, it is necessary to make reference to some of the particular facts relevant to this application. Arising out of the resolutions passed at the creditor's meeting on 28 June 1991, a deed of indemnity was entered into between ANZ Bank and the trustee. This deed will be referred to as the first deed of indemnity. It recites the consent of Mr Bird to act as trustee, his appointment as trustee and the desire of ANZ Bank to facilitate the conduct of the trustee by agreeing "to indemnify the trustee in respect of costs, charges and expenses to the limit of $5,000.00" on the terms contained in the deed. The operative clause, for present purposes, is as follows:

"1. The ANZ Bank hereby covenants with the trustee that subject to clause 2 hereof that in the event the trustee considers that the assets of the administration are insufficient for the payment of his remuneration costs charges disbursements and expenses ANZ Bank will indemnity and forever keep indemnified the trustee, his legal personal representatives, partners, employees and agents for remuneration costs charges disbursements and expenses arising out of or in connection with the administration."

Clause 2 limits the indemnity to the sum of $5,000.00.

Shortly after the bankrupt made his applications on 5 May 1992, the trustee by letter dated 14 May 1992 wrote to ANZ Bank as follows:

"I refer to my letter dated 3 March 1992 and subsequent telephone conversations between Mr Paul Belcher of your office and Mr Peter Rennie of my office.

Enclosed is a copy of the following:

(i) Letter dated 6 May 1992 from Messrs Madgwicks, Mr Hudson's solicitors.

(ii) Application to the Federal Court.

(iii) Affidavit in Support.

(iv) My letter dated 14 May 1992 to Dunhill Madden Butler. Please confirm my understanding that you will pay the necessary costs, including my fees on a time basis at the hourly rates recommended by the Insolvency Practitioners' Association of Australia, of this matter.

I shall keep you informed of developments.

In the meantime, should you have any queries in respect of this matter, please contact Mr Peter Rennie."

The application by the trustee commenced on 28 May 1992 was made apparently without reference to creditors. However, ANZ Bank, by letter dated 2 June 1992 wrote to the trustee as follows:

"Further to your letter dated May 14th 1992 and our telephone discussion on 29th May we confirm our acceptance of necessary costs and fees as per the scale recommended by the Insolvency Practitioners Association of Australia, (IPAA). Please provide us with an update on the position with regards to the two properties left under the will of Edith Hudson to the bankrupt and one other.

We also believe that the bankrupt's income is presently $41,000 pa approx; plus motor vehicle benefit. Bankrupt is married with two dependant children.

We have advised Mr Victor Bennets (sic) of Dunhill Madden Butler to proceed in obtaining a declaration from the executors of the deceased estate of Edith Hudson that the bankrupt's interest therein vests with yourself as the Trustee in bankruptcy of T R Hudson.

Also Mr Bennets (sic) is to lodge an objection to the bankrupt's discharge application.

Notwithstanding scale IPAA rates are to apply we expect costs to be kept at a minimum particularly in view of Mr Bennetts (sic) assistance."

ANZ Bank contends that these two letters constitute an indemnity for costs under paragraph 109(10)(a) of the Bankruptcy Act.
On 1 July 1992 the Bankruptcy Amendment Act 1991 came into operation. That Act dramatically amended the provisions relating to automatic discharge of bankruptcy under s149 of the Bankruptcy Act as well as subsequent provisions. As a result of these amendments, the automatic discharge from bankruptcy of the bankrupt was extended to a period of 3 years after 1 July 1992 and the application for discharge made by the applicant under s150 of the Bankruptcy Act lapsed, see s55 of the Amendment Act. Further, the latter Act introduced provisions relating to the payment of income by a bankrupt to the trustee. The trustee, in the present case, exercised that power with respect to the bankrupt.
By circular dated 20 August 1992, the trustee notified all creditors of the bankrupt, apart from those related to the bankrupt, of the existing position relating to the estate of the bankrupt. It is a long and detailed circular which need not be reproduced in full but the opening paragraphs are important. They are as follows:

"I refer to the meeting of creditors held on 28 June 1991. At that meeting the creditors passed a resolution directing me to lodge an objection to the bankrupt's discharge. I subsequently lodged a notice of objection to discharge which is dated 11 July 1991. The effect of the notice of objection was to extend the bankruptcy for a further two years to 15 July 1993. You will recall that the objection was lodged because of the following facts:

1. The bankrupt has a contingent interest under the will of his deceased grandmother, E.G Hudson;

2. The interest will vest in the bankrupt and therefore in me as his trustee only upon the death of his father, provided the bankrupt has not pre-deceased his father;

3. Legal advice obtained by the previous trustee cast some doubt on whether the interest in the deceased estate would vest in me as trustee in bankruptcy if the bankrupt's father died after the bankrupt's discharge;

4. The assets of the deceased estate were known to be substantial, exceeding $2 million and the bankrupt would be entitled to a one half share of that residuary. At the meeting on 28 June 1991 the creditors were also invited to indemnify me for the premiums of an insurance policy with respect to the bankrupt's life.

The only creditor which expressed an interest in granting an indemnity for the costs of the insurance policy was the Australia and New Zealand Banking Group Limited.

I understand that the bank has an arrangement with Esanda Finance Corporation Limited whereby Esanda reimburses the bank for part of the monies it advances to me by way of indemnity. There have recently been a number of significant developments in my administration which have required me to take immediate action to protect the interests of creditors. Because of the urgency of the various matters I contacted the only creditor who had previously expressed an interest in indemnifying me for costs, the Australia and New Zealand Banking Group Limited and sought an informal assurance that the bank would put me in funds with which to meet the matters which have recently arisen. The bank has indicated on an informal basis that such an indemnity would probably be forthcoming. In light of further developments and expenditure which is required I am now seeking to formalise that arrangement with the bank.

The purpose of this circular is threefold, namely:-

1. To inform you of the recent developments which have required urgent action on my part;

2. To inform you of the funding arrangement which I will shortly seek to put in place with the Australia and New Zealand Banking Group Limited; and

3. To give you an opportunity as a creditor to offer me an indemnity."

The circular referred to s109 of the Bankruptcy Act, the details of the applications before the Court, the result of property searches of property owned by the trustees of the bankrupt's grandmother, the effect of the terms of the will (which may not have been entirely correct), the exercise of the power to compel payment of income, and correspondence with the bankrupt and related interests. The trustee referred also to the desirability of conducting examinations under s81 of the Bankruptcy Act of the bankrupt and related persons and that he had informally discussed with ANZ Bank the giving of an indemnity with respect to the proposed examinations. He sought the response of the creditors.
Mr Moore did not receive this circular until the afternoon of Friday 28 August. The hearing of the applications was due to commence on 31 August. Mr Moore says, quite correctly, that this did not give him time to consider properly whether to offer an indemnity. He did not do so.
On 11 September 1992, ANZ Bank and the trustee entered into another deed of indemnity. This deed will be described as the second deed of indemnity. The recitals referred to the bankruptcy, the first deed of indemnity and the desire to increase the amount of that indemnity to $10,000.00 and to grant "a further indemnity .... for an additional sum of $18,000.00 for legal costs and expenses." Clause 1 of the second deed of indemnity increases the amount mentioned in the first deed of indemnity from $5,000.00 to $10,000.00. It is obvious that the parties intended that deed as amended to continue to operate. Clause 2 is as follows:

"2. ANZ Bank agrees to grant the trustee in addition to the indemnity given in the first deed a further indemnity to the extent of $18,000 in respect of the trustee's legal costs, charges and expenses arising from and relating to:

(a) an investigation of the financial position and past financial position of the deceased estate of E.G Hudson including an application under 381 (sic) Bankruptcy Act;

(b) seeking declaratory relief from the Federal Court of Australia as to the vesting in the trustee of the bankrupt's interest in the deceased estate of E.G Hudson; and

(c) resisting the bankrupt's application dated 5 May 1992 or any other application, proceeding or action taken by the bankrupt seeking early discharge from bankruptcy or a review of the trustee's decision to lodge any objection against such discharge."

The reference in clause 2(a) to "an application under 381 Bankruptcy Act" obviously is an error and the reference should be to "an application under s81 Bankruptcy Act".
By letter dated 17 September 1992, Esanda wrote to the trustee as follows:

"In reply to your letter of 20 August 1992. I wish to advise that Esanda Finance Corporation Limited agrees to indemnify you as trustee of the Bankrupt estate of T.R. Hodson

(sic) as requested, in the actions you will and need to take as outlined in your letter of 20 August 1992.

I expect costs to be shared amongst indemnifying creditors on a pro-rata basis.

If you have any queries please do not hesitate to contact me."

On 16 October 1992 Esanda and the trustee entered into a deed of indemnity. For present purposes it is sufficient to say that this deed, hereafter called "the Esanda indemnity", is in similar form to the second deed of indemnity and identifies the trustee with respect to the same three matters as contained in clause 2 of the second deed of assignment but limited to the sum of $4,500.

After the completion of the hearing of the applications before the Court, but before judgment was given, the trustee and the bankrupt commenced discussions regarding a possible compromise. The parties requested the Court not to announce its judgment while the negotiations continued. Eventually, by a proposal dated 25 January 1993, the bankrupt made a proposal for a scheme of arrangement of his affairs under s73 of the Bankruptcy Act. The proposal is lengthy but for present purposes it is sufficient to say that the bankrupt proposed the payment of $600,000.00 upon the terms contained in the proposal. Some of those terms will need to be considered in some detail later in these reasons. At present, it is sufficient to say that the proposal was accepted unanimously at a meeting of creditors held on 23 February 1993. As a result, by force of subsection 74(5), the bankruptcy of the bankrupt was annulled on 23 February 1993. The trustee received the $600,000.00 referred to in the proposal. This sum was provided by the brother of the bankrupt.
Before turning to consider the issues raised by the application, several other matters should be mentioned. The trustee did not appear at the hearing of the application. As a result, the Court has not had the benefit of information relating to the administration of the estate of the bankrupt during the period of the bankruptcy up to the time of the automatic annulment. Further, all creditors have not been given notice of the application. From all the material before it, the Court is prepared to infer that no other creditor, apart from the three appearing on the application, has shown a sufficient interest in what has happened and what might happen. Accordingly the Court is prepared to hear and determine this application without directing service of the application on other creditors, compare Bankruptcy Rule 105.
The Court is prepared to accept as fact the acceptance made by the parties appearing before it that, apart from the $600,000.00 paid pursuant to the proposal, the property received by the trustee was minimal. As a result, the trustee had no funds from which to pay his costs, charges and expenses of the administration of the bankruptcy. Hence the importance in this case of indemnities and of payment by creditors of the expenses which otherwise could not be satisfied from the funds received by the trustee. An illustration of this is the payment of the premium for the insurance referred to earlier in these reasons. The question of the policy loomed large and the question of payment of premiums was raised at the first meeting of creditors held on 5 August 1988. It is necessary to explain why this is important.
In simple terms, the bankrupt had a future contingent interest in remainder of the residual estate of the grandmother. The bankrupt, his father and his brother were the executors and trustees of the estate of the grandmother who died on 10 August 1970. She left her residual estate to her trustees, with a power of sale, upon expressed trusts. During the lifetime of the father, one quarter of the income was to be paid to the bankrupt, but on his death before the father that one quarter share was to be paid to his children. Upon the death of the father, the bankrupt and his brother, if both then living, were each to receive one half of the residual estate. If either was then deceased leaving issue, then that share would go to the issue. Thus, the interest of the bankrupt in the residual of the estate of his grandmother was contingent upon him surviving his father. His father was alive on 23 February 1993.
Under s58 of the Bankruptcy Act, all the property of the bankrupt, except after acquired property, vested in the trustee on 15 July 1988. By definition, the word "property" in the Bankruptcy Act has a very wide meaning and includes any estate or interest in real or personal property whether present or future, vested or contingent.
"After acquired property" means property that is acquired by or devolves on the bankrupt on or after the date of the bankruptcy, being property that is divisible amongst the creditors of the bankrupt, see subsection 58(6).
The application heard by the Court on 31 August 1992 involved the question whether the future contingent interest "vests in" the trustee. That issue has not been decided. What is clear, even though a present value could be placed upon the future contingent interest of the bankrupt, is that if the bankrupt predeceased his father, there was no property arising under the will of the grandmother that could vest in the trustee. Hence the concern of the trustee and the creditors to have insurance for the payment of a lump sum to the trustee if the bankrupt predeceased his father.
A preliminary question arose as to the jurisdiction of the Court to hear and determine the application. It was said that this issue arose from a combination of grounds 4 and 1 of the grounds of opposition. There is some doubt about this but any question of jurisdiction, if raised, must be considered.
To a large extent, the problem arises from amendments made to Division 6 of Part IV of the Bankruptcy Act by the Bankruptcy Amendment Act 1991 already mentioned. That Division, which now comprises sections 73 to 76A, is headed "Composition or Arrangement with Creditors". The provisions of that Division enable a bankrupt to make a proposal to his creditors for a composition in satisfaction of his debts or a scheme of arrangement of his affairs, see s73. The procedure to be followed is set out in that section. The word and phrase "composition" and "scheme of arrangement" are not defined for the purposes of Part IV of the Act, but there can be no doubt, when used in s73, that they refer to a composition or deed of arrangement under Part X of the Bankruptcy Act. That Part is headed "ARRANGEMENTS WITH CREDITORS WITHOUT SEQUESTRATION". For the purposes of that Part, "composition" and "deed of arrangement" are defined. It is not surprising that s73 makes no mention of a deed of arrangement, since, of necessity, all the property of a bankrupt by then has vested in the trustee. It follows, therefore, that any composition or scheme of arrangement proposed by a bankrupt under s73 should comply with the requirements of a composition or deed of arrangement under Part X of the Act.
Under those provisions, the debtor does not become a bankrupt, but the signing of an authority under s188 does constitute an act of bankruptcy. To be consistent, on the acceptance of the proposal under s73, the bankruptcy of the bankrupt is annulled, now by force of subsection 74(5) but before the amendments made by the Bankruptcy Amendment Act, by order of the Court where the Court approved a composition or a scheme, see subsections 74(1) to (5) as in operation before the amendments. It follows that under the law as it now stands, the Court does not consider whether an order for annulment should be made, but there is a power under s75 for the Court to annul a composition or scheme, see s75.
The effect of an annulment of bankruptcy is to put the bankrupt back in the position he would have been in as if the bankruptcy had never occurred. In Re Lawson (1939) 11 ABC 137 Clyne J, at p138, said that the effect of an annulment is, subject to the matters to be mentioned later in these reasons, "to remit the party whose bankruptcy is set aside to his original situation". An annulment is to be contrasted with a discharge of bankruptcy which confirms the existence of the bankruptcy prior to discharge. The legal consequence of an annulment is discussed at length in Theissbacher v MacGregor Garrick and Co (a firm) (1993) 2 Qd R 223 by Pincus J A and White J at pp228-230. At p226 Fitzgerald P referred to the effect of an annulment order involving "the retrospective annihilation of the sequestration order". In the later case of Coyle v Cassimatis, Court of Appeal, Qld 1 November 1993, unreported, Fitzgerald P in speaking of annulment under s74(5) said:

" ... although only annulled "on" the day of the creditors' special resolution, the annulment was retrospectively effective to annihilate the (bankrupts') bankruptcy and its consequences except as otherwise provided by the Act, notably subs 74(6). Prima facie, therefore, the (bankrupts) were, in law, never bankrupt ..."

Subsection 74(6) of the Bankruptcy Act contains special provisions protecting action taken by a trustee before annulment. That subsection is set out in full:

"(6) Where a bankruptcy is annulled under this section, all sales and dispositions of property and payments duly made, and all acts done, by the trustee or any person acting under the authority of the trustee or the Court before the annulment shall be deemed to have been validly made or done but, subject to subsection (7), the property of the bankrupt still vested in the trustee vests in such person as the Court appoints or, in default of such an appointment, reverts to the bankrupt for all his estate or interest in it, on such terms and subject to such conditions (if any) as the Court orders."

Subsection 74(6) is not relevant to this case. Subsection 74(6) is in the same form as it was before the amendments made by the Bankruptcy Amendment Act. The reference to "the Court" in the subsection was appropriate under the former provisions of s74, but it is difficult to see its present relevance having regard to the automatic annulment under the existing subsection 74(5).
There is no mention in s74(6) of a power enabling the trustee to apply the property of the trustee to pay "the costs, charges and expenses of the administration of the bankruptcy" out of property of the former bankrupt still vested in the trustee. This position is contrasted with the provisions of s154 of the Bankruptcy Act. That section is in Division 5 of Part VII of the Bankruptcy Act. That Division is headed "Annulment of Bankruptcy". Section 154 provides for the effect of an annulment. It is similar to s74(6) but paragraph 154(1)(b) empowers:

"(b) the trustee may apply the property of the former bankrupt still vested in the trustee in payment of the costs, charges and expenses of the administration of the bankruptcy, including the remuneration and expenses of the trustee;"

On this analysis, counsel for Mr Moore suggested that the Court had neither jurisdiction nor power to make the orders sought by ANZ Bank and Esanda. Subsection 109(10) empowers the Court to make orders "where in any bankruptcy" certain conditions are established. It was suggested that after 23 February 1993, there was no bankruptcy in existence; it had been annihilated retrospectively from its commencement on 15 July 1988.
Under s27 of the Bankruptcy Act, this Court has jurisdiction in bankruptcy. Having regard to the definition of "bankruptcy" in s5, that word means, in relation to jurisdiction or proceedings, any jurisdiction or proceedings under or by virtue of the Bankruptcy Act. It follows that the Court has jurisdiction to hear and determine a proceeding brought under subsection 109(10). Likewise, it has jurisdiction to hear and determine matters arising under Part X of the Bankruptcy Act even though that Part deals with matters where no bankruptcy exists.
The Court finds it has jurisdiction to hear and determine the application before it. Whether it has the power to make the orders sought is another matter. Normally it would be expected that any orders made could be satisfied only with respect to the administration of the estate of a bankrupt. The subsection is in a division of the Act providing for the payment of debts "proved in a bankruptcy", s108. Section 109 contains provisions for priority payments. Subsection 109(1) lists payments to be made in priority of other payments. Thus, for present purposes, the first payment is payment of "the costs, charges and expenses of the administration of the bankruptcy, excluding the remuneration and expenses of the trustee". These are all to be paid out of the property of the bankrupt which has vested in the trustee. Under subsection 109(10), an advantage may be given to some creditors over other creditors despite the provisions of s108. Nevertheless the provisions of s109, including subsection 109(10), all relate to payments by a trustee in bankruptcy from moneys of the bankrupt vested in the trustee under the provisions of s58.
Before considering whether the Court has power to make the orders sought under subsection 109(10), it is necessary to consider in some detail the provisions of the scheme of arrangement proposed to and accepted by the creditors. This is necessary because, apart from the $600,000.00 paid under the scheme, there are no funds or property held by the trustee as trustee in bankruptcy of the bankrupt from which the expenses of the administration of the bankruptcy can be met nor payment to creditors, whether as an advantage over other creditors or not, can be made. In the absence of any specific provisions, any orders made, if there is power to make them, would be futile. In considering this appeal, it must be remembered that the trustee, in his capacity as trustee in bankruptcy of the estate of the bankrupt, has no assets in the estate to meet his legal expenses, or his costs, charges and expenses properly incurred during the period of the bankruptcy. It must be remembered that ANZ Bank and Esanda have a common interest and between them can control any decision at a meeting of creditors. There are a number of creditors related to the bankrupt who are not seeking to enforce their claims. There are a number of other creditors who, apparently, have not taken an active interest in the affairs of the bankrupt. Mr Moore has been an active creditor, but he alone carries no legal weight. Further, it appears that the trustee had not, by 23 February 1993, admitted any of the claims of the creditors, the amount of the claims had not been determined and, apparently, no advertisement had been given calling for proofs of debts. Further, if the debtor predeceased his father, the trustee would not receive any capital assets from the estate of the grandmother.
In the circumstances, the trustees, one can infer at the instance of ANZ Bank, commenced negotiations with the bankrupt to resolve the whole issue, including the issues arising in the proceedings before the Court which had been heard but not then determined. As a result, by a document headed "Proposal" under subsection 73(1) of the Bankruptcy Act, and dated 25 January 1993, the bankrupt made a proposal to the trustee. The opening paragraph of the proposal is:

"The bankrupt hereby makes this proposal for a scheme of arrangement of his affairs (the scheme of arrangement) pursuant to Section 73(1) of the Bankruptcy Act 1966 (the Act) on the following terms:"

Having regard to the definitions of "composition" and "deed of arrangement" contained in subsection 187(1) of the Bankruptcy Act, it is a nice question whether the proposal was in truth a "composition" or "a scheme of arrangement". When used in Part X of the Bankruptcy Act, "composition", for relevant purposes, is defined to mean "an arrangement ... by which the creditors of a debtor ... agree to accept, in full satisfaction of the debts due to them, less than the full amount of those debts, whether in the form of money or other property and whether by instalments or otherwise". Similarly, "deed of arrangement" means "a deed (not being ... a deed in respect of a composition ... ) providing for the arrangement of the affairs of the debtor with a view to the payment, in whole or in part, of his debts". This matter was not raised during the hearing of the application but the nature of the proposal may be important having regard to the slightly different provisions of Part X with respect to the application of the general provisions of the Bankruptcy Act to deeds of arrangement and compositions, see sections 237 and 243 respectively. Specifically, section 109 applies to deeds of arrangements but not to compositions. In the present case, the proposal does not require the bankrupt to enter into a deed of arrangement. The proposal has all the hallmarks of a composition.
The crucial clause of the proposal is clause 1. It is headed "Settlement Sum" and is as follows:

"1. The bankrupt shall pay to the trustee the sum of $600,000 (the settlement sum) upon the bankrupt's creditors accepting this proposal by a special resolution pursuant to section 73(4) of the Act."

The sum of $600,000.00 was to be provided by the brother of the bankrupt. The proposal contained specific clauses, being 13, 14 and 15, relating to the payment. At or before the commencement of the meeting, the bankrupt had to produce and show a bank cheque in the sum of $600,000.00 payable to the trustee's trust account. If the proposal were accepted by a special resolution of the creditors, then the bankrupt was to "immediately deliver the cheque" to the trustee but the acceptance of the proposal could be conditional on the cheque being received.
There were other clauses by which the creditors related to the bankrupt agreed not to prove in the scheme of arrangement together with written notice from each of them assenting to the proposal, see subsection 73(5). If other creditors were discovered, under Clause 11, the bankrupt would ensure that their claims would be settled without recourse to the $600,000.00. Further, the other proceedings in the Federal Court were to be discontinued.
Clauses 2 to 6 remain to be mentioned. Their presence in the proposal is somewhat unusual. Essentially they relate to the affairs between the creditors themselves and the creditors and the trustee. Normally these clauses would be of no concern to the bankrupt. The contents of the clause relate to matters which should be determined by the creditors. They relate to how the $600,000.00 is to be expended. They are set out in full:

"TRUSTEE

2. If this proposal is accepted the scheme of arrangement shall be administered by the trustee pursuant to the Act.

3. The trustee shall be entitled to remuneration for administration of the scheme of arrangement in accordance with the Act to be satisfied from the settlement sum and if this proposal is accepted the remuneration shall be fixed on a time basis pursuant to the scale of charged (sic) published from time to time by the Insolvency Practitioner's

(sic) Association of Australia.

APPLICABILITY OF THE ACT

4. In addition to Part IV divisions 5 and 6 and Part VIII of the Act which pursuant to the Act are applicable to the scheme of arrangement the following provisions of the Act, with all necessary modifications (as if the debtor remained a bankrupt and the trustee was his trustee in bankruptcy) so far as permissible, shall be applicable to the scheme of arrangement together with any rules which relate to the said provisions:

(a) sections 82-114 including specifically (without limiting the generality of the foregoing Section 109(10));

(b) sections 134 and 135;

(c) section 140-147;

(d) section 309.

PRIORITY

5. The trustees in bankruptcy of the bankrupt, namely Alex Neville Bird and John Richard Morrow, shall be entitled to such priority of payment in the scheme of arrangement as they would have been entitled to in the bankruptcy of the bankrupt.

6. The costs, charges an (sic) expenses of the scheme of arrangement and of the trustee, Alex Neville Bird, (including remuneration and expenses) in administering the scheme of arrangement shall be included in those debts entitled to a first priority pursuant to Section 109(1)(a) of the Act."

Clause 2 does not make clear the capacity in which the trustee is to administer the scheme of arrangement. Upon the passing of the specified resolution, the bankruptcy was annulled. The trustee no longer has power over the property vested in him at the time of the annulment. Reference has been made already to the apparent anomaly between subsection 74(b) and subsection 154(1) of the Bankruptcy Act. It follows that, on the acceptance of the proposal, the trustee held the $600,000.00 as trustee to administer it under the scheme of arrangement or composition.
Clause 3 refers to the future remuneration of the trustee. Clauses 5 and 6 give rise to some confusion. They appear to refer to future costs, charges and expenses relating to the scheme of arrangement, but under clause 5, Mr Morrow, who on any view was not a trustee of the bankrupt at the relevant time, is said to get priority.
Clause 4 seems to be directed to make certain provisions of the Bankruptcy Act applicable to the scheme of arrangement. The position can be contrasted with sections 237 and 243 of the Bankruptcy Act. What is important is that this clause draws particular attention to the application of subsection 109(10). This suggests that the trustee was having special regard to the position of ANZ Bank and Esanda.
Upon receipt of the proposal, the trustee called a meeting of creditors of the bankrupt, see subsection 73(2). Reference is made to s76A which provides that Division 5 of Part IV of the Bankruptcy Act applies to meetings of creditors under Division 6. This appears to have been complied with here.
In conformity with those provisions, the trustee gave notice to the creditors of the meeting to be held on 25 January 1993 and distributed a circular to them explaining why the meeting was being called, the proposal, the source of the $600,000.00 and the effect of an acceptance. Reference was made to the insurance policy on the life of the bankrupt, the effect of the will of the grandmother, the fact that the father, although aged 87, appeared to be in good health, that there are no other assets in the bankrupt's estate and that only small amounts of income had been paid by the executors of the estate of the grandmother. Reference was also made to the value of the estate of the grandmother, the legal proceedings then before the Court and the settlement negotiations between the trustee and the bankrupt and his brother. Paragraph 12 of the circular was headed "Indemnifying Creditors". Reference was made to the indemnities given by ANZ Bank and Esanda and the provisions of subsection 109(10) but it was stated that whether they obtained priority depends upon the discretion of the Court. It suggested that, as an alternative, ANZ Bank and Esanda might be given priority by agreement of the creditors under paragraph 109(1)(j). The circular stated that ANZ Bank intended to apply for priority but that, to avoid legal and other costs, the ANZ Bank proposed to compromise its claim to priority on the basis that:

"(a) the sum of $400,000 be distributed pari passu between all unsecured creditors, and,

(b) the remaining $200,000 less the costs charges and expenses of the bankruptcy be distributed solely to their (sic) indemnifying creditors in proportion to their respective debts.

Whether creditors wish to support such a resolution is a matter for discussion at the meeting.

If the proposed compromise is accepted by creditors they will on present information, receive a dividend of approximately 25 cents in the dollar. This rate could vary should creditors lodge claims for amounts greater than which are known at present or creditors not known to me lodge claims on the advertising of a dividend."

The trustee expressed the opinion that the proposal should be accepted.
The trustee was unable to attend the meeting held on 23 February 1993. In conformity with the requirements of Division 5 of Part IV of the Bankruptcy Act, the meeting elected his assistant Ms Erskine as Chairwoman. She explained to the meeting that one of the main purposes of the meeting was to consider the proposal of the bankrupt. The bankrupt was not present but was represented by his brother who said he had the cheque for $600,000.00. The meeting resolved unanimously that the proposal by the bankrupt be accepted but acceptance being conditional upon the trustee receiving the bank cheque for $600,000.00 before the close of the meeting.
The question of priority to indemnifying creditors was raised. Mrs Erskine advised that ANZ Bank did not wish to proceed with the proposed priority resolution, but reserved its rights.
The question of the legal costs incurred by the trustee in relation to the Court proceedings was raised as were other costs and expenses. During discussion, reference was made to legal costs as well as other costs, charges and remuneration of the trustee, and the former trustee Mr Morrow. Some of these had been paid by ANZ Bank and by Esanda. Included among these were the premiums paid on the insurance policy. In all, some $80,740.00 had been paid or incurred. This figure was given during the course of the hearing. There might be more expenses. It was suggested that they be approved for payment by resolution of the creditors at the meeting. After further discussion, the meeting resolved that the trustee be authorized to pay his legal costs and disbursements to date. The bankrupt's brother then handed over the cheque to the trustee. Mrs Erskine informed the meeting that proof of debts would now be called for and, subject to any further action that ANZ Bank and Esanda might take in respect of receiving priority, a first and final dividend should be paid to creditors in about two months time. The application before the Court was issued on 8 April 1993.
This narrative illustrates difficulties in applying the provisions of Division 6 of Part IV of the Bankruptcy Act as it now stands. Any nullity of bankruptcy occurs by force of subsection 74(5) operating upon the passing of the special resolution under s73. No longer does the Court have to approve the composition or scheme of arrangement. No longer does the Court have the power to consider the conduct of the bankrupt and to determine whether to annul the bankruptcy or not, see subsections 74(1) to (5) before the amendments made by the Bankruptcy Amendment Act 1991.
Further, unless great care is taken, confusion can arise between the position of the trustee in bankruptcy and the trustee of the composition or deed of arrangement. This occurred here. When the Court had the discretion whether to grant or refuse an annulment of a bankruptcy, it could, by order made under subsection 74(6), ensure that the trustee in bankruptcy received payment of costs, charges and expenses of the administration in bankruptcy from the property of the bankrupt vested in the trustee. There is no statutory provision for this under Division 6 of Part IV. This is a matter that should be corrected.
Further, upon annulment, any property of the bankrupt vested in the trustee normally reverts to the bankrupt. Any property acquired by a trustee under a composition or scheme of arrangement is not property of the bankrupt vested in the trustee in bankruptcy by reason of s58 or by reason of any action taken by the trustee in bankruptcy to recover property properly belonging to the estate. It is easy to visualize a case where a trustee under a compromise or scheme of arrangement should take legal proceedings to recover property under the terms of the composition or scheme. This has not arisen in the present case. The Court has power to make orders under s109(10) in respect to indemnities given by creditors with respect to actions arising out of schemes of arrangement, but that has not arisen here. That power is express, and reliance need not be had to s30 or subsection 75(3). There is no such express power in relation to compositions.
In the present case, the trustee, albeit almost as the alter ego of ANZ Bank and Esanda, appears to have been conscious of the problems posed. Clause 4 of the proposal, which has been set out earlier in these reasons, appears to be directed to resolve the problem. Despite the explicit provisions of subsection 74(5) of the Bankruptcy Act, Clause 4 purports to deem that the bankruptcy has not been annulled and that subsection 109(10) will be applicable to the scheme of arrangement "as if the debtor remained a bankrupt and the trustee was his trustee in bankruptcy". This is in circumstances where it is impossible in law for the trustee in bankruptcy to take action to recover property owing to the bankrupt under a bankruptcy which has been annihilated from its beginning. This is in circumstances where the trustee in bankruptcy has no lawful powers conferred upon him by the Bankruptcy Act. The contentions on behalf of ANZ Bank and Esanda are rejected. In all the circumstances of this case, the Court does not have power to make orders under subs 109(10) of the Bankruptcy Act in relation to actions commenced before the scheme of arrangement was accepted by the creditors.
In coming to this conclusion, the Court does not decide whether Clause 4 of the proposal is proper to be included in a proposal for a scheme of arrangement. It deals with a matter which it is proper for the creditors to consider and deal with. This was raised by the trustee by the reference to the suggested motion to be put by ANZ Bank to the meeting. ANZ Bank did not pursue it.
In coming to this conclusion, the Court does not decide whether, in any event, subsection 109(10) has any application. One thing is clear: no property of the bankrupt has been recovered, realized or preserved in the bankruptcy of the bankrupt under an indemnity for costs of litigation given by a creditor. Further, in the bankruptcy of the bankrupt, no expenses in relation to which a creditor has indemnified the trustee in bankruptcy been recovered. It may well be that the brother of the bankrupt may have been persuaded to make the payment of $600,000.00 by reason of the legal proceedings in the Court, but this sum was not recovered by the trustee in bankruptcy so that it formed part of the property of the bankrupt divisible amongst the creditors of the bankrupt under s116 of the Bankruptcy Act.
Many submissions were made at the hearing which have not been discussed in these reasons since, in my opinion, they do not call for consideration.
Many of the matters discussed in these reasons were not the subject of submissions at the hearing of this application. Consideration was given to relisting the matter for further hearing but this idea was discarded. I propose to publish these reasons and to adjourn the further hearing of the application to 13 May 1994. Unless on or before that date, either party requests the opportunity to make further submissions I propose to order on 13 May 1994 that the application be dismissed with costs including reserved costs of the creditor Mr Moore, to be taxed and paid by ANZ Bank and Esanda. If the matter is to be relisted for further submissions, this is a case where it is appropriate for the trustee to be present to assist the Court. This may involve the filing of further affidavit evidence. Accordingly the further hearing of this matter is adjourned to 13 May 1994.

[1994] FCA 254

06 MAY 1994