Re Magarey Farlam Lawyers Trust Accounts (No 3)
[2007] SASC 9
•18 January 2007
SUPREME COURT OF SOUTH AUSTRALIA
(Civil: Application)
RE MAGAREY FARLAM LAWYERS TRUST ACCOUNTS (No 3)
[2007] SASC 9
Judgment of The Honourable Justice Debelle
18 January 2007
PROFESSIONS AND TRADES - LAWYERS - ACCOUNTS AND TRUST MONEY - STATUTORY PROVISIONS - TRUST ACCOUNTS
Misappropriation of trust moneys - application under s 47(1) of the Legal Practitioners Act 1981 seeking directions as to disbursements of moneys remaining in trust accounts - trust account ledgers manipulated to conceal misappropriation - whether moneys remaining in trust accounts are to be distributed according to the trust account ledgers - whether moneys remaining are to be pooled and distributed on pro rata basis.
RESTITUTION - MISTAKE: RESTITUTION ARISING FROM A PLAINTIFF'S MISTAKEN ACTIONS - RECOVERY OF MONEY PAID UNDER MISTAKE
Solicitors' trust account - misappropriation therefrom of trust money - partners of firm pay into the trust account an amount equal to the defalcations - partners mistakenly believe that there will be no further defalcation - whether payment by partners was made under a mistake of fact - whether partners are entitled to be repaid.
An Act to amend the law of property and for other purposes 1860 s 25; Administration and Probate Act 1919 s 69; Administration and Probate Act 1891 s 99; Corporations Act 2001 (Cth) s 479; Financial Transactions Reports Act 1988 (Cth) s 20A(1)(b)(i); Law of Property Amendment Act 1859 (UK) (22 and 23 Vict. c 35) s 30; Legal Practitioners Act 1981 s 5, s 31, s 33, s 44, s 45, s 47; Legal Practitioners Regulations 1994 reg 12, reg 14, reg 15; Legal Practitioners Act 1898 (NSW) s 61; Public Trustee Act 1880 s 28; Public Trustee Act 1995 s 37; Trustee Act 1893 s 78; Trustee Act 1936 s 90, s 91, referred to.
Barclays Bank Ltd v W J Simms Son & Cooke (Southern) Ltd [1980] QB 677; David Securities Pty Ltd v Commonwealth Bank of Australia (1992) 175 CLR 353; Farmer v Arundel (1722) 2 Wm B1 824; 96 ER 485; Foskett v McKeown [2001] 1 AC 102; Kelly v Solari (1841) 9 M & W 54; 152 ER 24; Lloyd v Grace, Smith & Co [1912] AC 716; Morris v C W Martin & Sons Ltd [1966] 1 QB 716; New South Wales v Lepore (2003) 212 CLR 511; Re Registered Securities Ltd [1991] 1 NZLR 545; Re Stillman and Wilson (1956) 15 ABC 68; Sinclair v Brougham [1914] AC 398, applied.
Barclays Bank Ltd v Quistclose Investments Ltd [1970] AC 567; Cheshire v Bailey [1905] 1 KB 237; Clayton's Case; Devaynes v Noble (1816) 1 Mer 572; 35 ER 781; Jobson v Palmer [1893] 1 Ch 71; Toovey v Milne (1819) 2 B & A1d 683; 106 ER 514, not followed.
Anmi Pty Ltd v Williams [1981] 2 NSWLR 138; Australian & New Zealand Banking Group Ltd v Westpac Banking Corporation (1987) 164 CLR 662; Australian Securities and Investment Commission v Enterprise Solutions 2000 Pty Ltd [2001] QSC 82; Australian Securities Commission v Melbourne Asset Management Nominees Pty Ltd (1994) 49 FCR 334; Australian Securities and Investment Commission v Nelson (2003) 44 ACSR 719; Australian Securities Commission v Buckley (1996) 7 BPR 15,024; Barlow Clowes International Ltd (in liq) v Vaughan [1992] 4 All ER 22; Commerzbank Aktiengesellschaft v IMB Morgan Plc [2004] All ER 450; Cory Brothers & Co Ltd v Owners of the Turkish Steamship "Mecca" [1897] AC 286; Fibrosa Spolka Akcyjna v Fairbairn Lawson Combe Barbour Ltd [1943] AC 32; General Medical Council v Spackman [1943] AC 627; Harrison v Mills [1976] 1 NSWLR 42; Hodges & Hurley v Kovacs Estate Agency Pty Ltd [1961] WAR 19; In the Estate of Hunter, deceased [1957] SASR 194; James Roscoe (Bolton) Ltd v Winder [1915] 1 Ch 62; Johns v Law Society of New South Wales [1982] 2 NSWLR 1; Keefe v Law Society of New South Wales (1998) 44 NSWLR 451; Lady Hood of Avalon v Mackinnon [1909] 1 Ch 476; Law Society of Upper Canada v Toronto-Dominion Bank (1998) 169 DLR (4th) 353; Morgan v Ashcroft [1938] 1 KB 49; Murdoch v Crawford [1986] VR 97; Pavey & Matthews Pty Ltd v Paul (1987) 162 CLR 221; Re Cleadon Trust Ltd [1939] Ch 286; re G B Nathan & Co Pty Ltd (in liq) (1991) 24 NSWLR 674; Re Global Finance Group Pty Ltd (in liq) (2002) 26 WAR 385; Re Magarey Farlam Lawyers Trust Accounts (No 2) [2006] SASC 382; re Mallen [1929] SASR 154; re Ontario Securities Commission and Greymac Credit Corporation (1986) 55 OR (2d) 673; 30 DLR (4th) 1; re Staff Benefits Pty Ltd (in liq) and the Companies Act [1979] 1 NSWLR 207; re Standard Insurance Co Pty Ltd (in liq) (1963) 5 FLR 292; Re Sutherland; French Caldeonia Travel Service Pty Ltd (in liq) (2003) 59 NSWLR; Re Sutherland; French Caledonia Travel Service Pty Ltd (in liq) (2003) 59 NSWLR 361; Re Walter J Schmidt & Co (1923) 298 F 314; Russell-Cooke Trust Co v Prentis [2003] 2 All ER 478; South Australia Cold Stores Ltd v Electricity Trust of South Australia (1957) 98 CLR 65; United Bank of Kuwait Ltd v Hammoud [1988] 3 All ER 418; Windsor Mortgage Nominees Pty Ltd v Cardwell (1979) ACLC 40-540, considered.
RE MAGAREY FARLAM LAWYERS TRUST ACCOUNTS (No 3)
[2007] SASC 9Civil
DEBELLE J: On 1 August 2005, the Council of the Law Society of South Australia, acting pursuant to s 44 of the Legal Practitioners Act 1981, resolved to appoint a supervisor of the trust accounts of Magarey Farlam Lawyers. Ms S R Bishop is the supervisor.
The Law Society had appointed Ms Bishop as supervisor after it had been informed by the partners of Magarey Farlam Lawyers that an employee of the firm, Mr W B Willoughby, had made misappropriations from the trust accounts of the firm. It is common ground that the partners of the firm were not knowingly implicated in the wrongdoing. They were unwitting instruments of Willoughby’s fraudulent dealings. The supervisor has ascertained that the misappropriations are very substantial. They total approximately $4.5 million. The precise amount of the defalcation depends on the orders made on this application. The money in the trust accounts is not adequate to pay all that is due to the present clients of the firm.
The supervisor has power to ascertain and verify entitlements to trust money: s 44(2)(a) of the Legal Practitioners Act. Section 47 of that Act authorises the supervisor to apply to this Court for directions in relation to any matter affecting her duties or functions. The supervisor has applied for directions as to how she should distribute the balance remaining in the trust accounts to those clients of the firm who had money in the trust accounts at the date of her appointment.
Willoughby has been charged with a number of criminal offences. The issues involved in the supervisor’s application are different from those in the criminal proceedings and nothing said in these reasons can have any relevance in those proceedings.
I set out the facts which have led to this application.
Magarey Farlam Lawyers
Magarey Farlam Lawyers (“Magarey Farlam”) was a firm of solicitors practising in Adelaide. It had commenced business on 1 July 2001. It was a successor to the firm of Magarey & Magarey. The partners of Magarey Farlam have continued the practice after the appointment of the supervisor. That continued until 1 February 2006 when the Council of the Law Society, acting pursuant to s 45 of the Legal Practitioners Act, resolved to appoint a manager to the practice of Magarey Farlam. Ms K N Thomas is the manager. The appointment of Ms Thomas as manager is noted as a matter of history. It has no consequence for the issues the subject of this application. The partnership dissolved shortly after the appointment of the manager.
Magarey Farlam was a relatively small firm. It has three partners, Messrs Farlam, Mudri and Adams. Until he retired on 18 February 2005, Mr B A Magarey had been a consultant to the firm. For many years before, Mr Magarey had been the senior partner of the firm, Magarey & Magarey. The firm provided legal advice in a number of fields including, but not limited to, administering and advising in respect of estates and trusts, taxation, property, personal injury, as well as financial management.
A Client Affairs Practice
That part of the practice conducted by Mr Magarey and, more recently, by Mr Farlam predominantly involved the management of estates and the financial affairs of clients, acting as attorneys or trustees, acting as directors or secretaries of corporations on behalf of clients, bookkeeping and the preparation of financial statements and taxation returns on behalf of clients. In a statement provided to the supervisor on 25 January 2006, the partners described that part of the practice in terms used by Lord Donaldson MR in United Bank of Kuwait Ltd v Hammoud [1988] 3 All ER 418 at 430, namely, the old-fashioned expression “men of affairs”. It is convenient to call it “a client affairs practice”. In the course of that practice, a significant amount of cash was either held in or transacted through the trust accounts of the firm. Some of that cash was used to purchase shares, unit trusts, debentures or other investments, or was placed on deposit at banks.
In 2003 and 2004, the management of substantial holdings of cash held in the firm’s trust accounts and other investments made on behalf of clients was transferred to an outside organisation, MLC Masterkey Custom Investment Platform. Notwithstanding that change in management, significant holdings of cash, shares and other investments remained under the management of the partners of Magarey Farlam.
Two Trust Accounts
Magarey Farlam and its predecessor Magarey & Magarey operated two trust accounts, each with the ANZ Bank. The first was the principal trust account of the firm and was used for most of the moneys received on trust by the firm. The second trust account was used for the electronic receipt of dividends and interest on shares, unit trusts and other investments held by clients. Both trust accounts were kept pursuant to the Legal Practitioners Act and the Legal Practitioners Regulations 1994 (“the Regulations”) and were audited as required by s 33 of the Act.
Second Trust Account Not Affected
Save for some dealings with Gimalo investment accounts to be mentioned in a moment, all of the misappropriations were of moneys held in the first trust account. The defalcations were not debited to the ledgers of all clients. As at 1 August 2005, Magarey Farlam had about 250 clients. The ledgers of 42 of those clients were debited with money which had been misappropriated.
There was no misappropriation from moneys held in the second trust account. The fact that they were separate trust accounts has the consequence that the money in the second trust account must be treated quite separately from the money in the first trust account. That is because the moneys are not mixed in the one trust account. It is as if two clients each had a separate trust account with the firm. If there were a defalcation from one, it would not affect the other. The clients with moneys in the second trust account are each entitled to be paid the balance shown in the trust ledgers as being due. It is unnecessary, therefore, to consider further the issues concerning the second trust account. Thus, when examining the basis for distribution, I will be referring only to the moneys in the first trust account.
A Third Trust Account
Upon her appointment on 1 August 2005, the supervisor opened an additional trust account with the ANZ Bank. All trust moneys received by Magarey Farlam after 1 August 2005 were deposited into that account. The moneys in this trust account must also be considered separately from those in the first trust account.
Trust Records
Magarey Farlam used an accounting software package called Perfect Balance for recording trust account dealings in both the first and second trust account. The Perfect Balance software package is capable of keeping all records required by the Legal Practitioners Act and the Regulations. Magarey Farlam had established the Perfect Balance system on 31 August 1999. Before then it had used another system. There is no evidence of that other system.
Trust Ledgers
Magarey Farlam kept trust ledgers as required by the Regulations on the Perfect Balance system. There was a separate ledger in respect of each client. The ledger recorded the name of the client, the client’s address, the client’s code, and the nature of the matter. The ledger chronologically recorded the date of each transaction, as well as the nature or particulars of the transactions, with a reference either to the relevant receipt number, the number of the cheque by which a payment was made, or the number of the journal entry if funds were transferred from one account to another in that way. The ledger recorded a running balance of the amount held on trust on behalf of each client.
Gimalo
In 1972, an unlimited liability company, Gimalo Administrators Pty (“Gimalo”), was incorporated as a nominee company to hold assets on behalf of clients of the firm. The three partners of Magarey Farlam are the present directors of Gimalo. Mr Magarey had been a director of Gimalo from its incorporation in 1972 until he retired on 18 February 2005, and one of its secretaries from 17 December 1981 to 18 February 2005. Until his resignation on 30 June 2005, Mr Willoughby was one of the secretaries of the company. At all times the company had at least two secretaries.
Both Magarey & Magarey and Magarey Farlam deposited clients’ moneys in investment accounts held by Gimalo with three banks, Bank SA, the Commonwealth Bank of Australia and Adelaide Bank. The advantage to clients was that the amount on deposit in a Gimalo investment account earned interest. Interest was not payable to the client on money held in the trust account. When it was intended to deposit moneys with these financial institutions, Gimalo created a new account on behalf of Magarey & Magarey or its successor, Magarey Farlam. In this way, a new account could be opened with any of the three banks without having to satisfy the one hundred point check required by s 20A(1)(b)(i) of the Financial Transactions Reports Act 1988 (Cth). On a few occasions, investments were made in the name of the client and not through Gimalo.
Shares Not Affected
Magarey & Magarey and Magarey Farlam also administered share portfolios on behalf of clients or purchased shares on behalf of clients. It seems that all of Willoughby’s fraudulent activities were confined to money. No fraudulent dealings in respect of the shares of clients have been identified. Some of the shares were purchased on behalf of clients using moneys in the trust account held on behalf of that client. While the shares might be held on trust, the shares are not trust money as defined by s 5 of the Legal Practitioners Act. No client of Magarey Farlam has made a claim in respect of shares. The shares can, therefore, be excluded from consideration.
Willoughby and His Bank Accounts
Willoughby had been employed by the firm for more than 25 years. He had been employed in various capacities as a tax agent, a probate clerk, an accountant and trust account officer. In his later years, he was responsible for a wide range of duties within the firm and was entrusted with the management of the trust accounts. He supervised the trust accounts on a daily basis. His duties required him to ensure that the trust account records were properly kept and maintained. He attended to most of the banking on behalf of the firm. Willoughby’s duties enabled him to have access to all primary records relating to the trust accounts of the firm. In addition to these functions, Willoughby was one of the secretaries of Gimalo.
Willoughby had three accounts at Bank SA. One account was in his own name, the account being entitled “W B Willoughby”. The second account was in the name of Jackwill Pty Ltd (“Jackwill”). Jackwill was the trustee company for a discretionary family trust controlled by Willoughby. Jackwill has changed its name to Tonryn Pty Ltd. It is, however, convenient to call it “Jackwill”. The third account was in the name of Zama Bloodstock Pty Ltd, a company controlled by Willoughby. The company has been de-registered. Willoughby used these accounts to effect his misappropriations from the trust accounts of Magarey Farlam.
A Defalcation is Discovered
In mid-June 2005, an article concerning Willoughby was published in the Sunday Mail. It referred to his involvement in the racing industry. Among other things, it described him as “the king of fines”. That was a reference to the fact that he owed some $100,000 in traffic and parking fines. Following the publication of the article, Mr Willoughby had a meeting with the partners. He admitted that the content of the article was substantially true. He offered to resign his position with the firm. It was agreed that he should resign on Thursday, 30 June 2005 and that, for a week thereafter, he would come to the office to assist in handing over his duties.
On 1 July 2005, the partners of the firm instructed Mr Owens, the firm’s auditor, to expedite the annual audit of the trust accounts of the firm. I find that the partners did not then believe or suspect that Willoughby had misappropriated any trust moneys. I find also that they asked for an expedited audit as a precautionary measure so that they would be in a position to assure the firm’s clients that Mr Willoughby’s activities as reported in the Sunday Mail had not affected the firm’s trust accounts.
On Tuesday, 5 July 2005, an employee of Magarey Farlam drew the attention of the partners to an apparent discrepancy between the trust accounts and the investment accounts in the name of Gimalo at Bank SA. The employee had made an enquiry of Willoughby, who was at the office of the firm that day. The firm’s employee then made further enquiries of Bank SA. Later that day, Bank SA informed the firm of a defalcation totalling $108,000. Willoughby did not return to the office thereafter. I set out the circumstances in which the defalcation was made.
The practice of Magarey Farlam in relation to withdrawals from the trust account was as follows. A trust requisition form would be prepared. That form stated the name of the client and the client code, the purpose of the withdrawal, the destination of the moneys withdrawn, and, if a trust account cheque was to be drawn, the number of the cheque. The requisition form had to be initialled by a partner before the moneys could be withdrawn from the trust account.
On 30 May 2005, Willoughby had presented one of the partners with a requisition form to withdraw a total of $108,000 from the trust account. Attached to the requisition was a list of nine ledger accounts for nine separate persons and the amount to be withdrawn on behalf of each. Eight of those ledger accounts concerned clients. The ninth was the ledger account of the B A Squared Trust, a trust operated by Mr B A Magarey. I find that a trust account cheque for $108,000 was presented for signature with the requisition and that that cheque, when presented for signature, stated that the payee was Bank SA. The intention was to transfer amounts of moneys on behalf of the nine persons listed in the schedule attached to the requisition from the trust account to investments accounts at Bank SA.
At some time after the trust account requisition and the trust account cheque had each been signed by a partner of the firm, Willoughby altered the payee on the cheque by adding a dash followed by the words “Acc W B Willoughby”, so that the payee became “Bank SA – Acc W B Willoughby”. The words “Bank SA” had been typed on the cheque when drawn so that it was relatively easy to type further words on to the cheque. In that way, Willoughby was able to transfer $108,000 into his own account.
The Trust Account is Replenished
On discovering the misappropriations, the partners decided that they should replenish the ledger accounts of eight clients. The only ledger account not replenished was that of the B A Squared Trust, Mr Magarey’s trust. Mr Magarey had informed the partners that he did not wish to have his ledger account replenished at that stage and told them they should leave the matter until some later time. The sum of $15,000 had been misappropriated from the B A Squared Trust.
The partners borrowed $93,000 from a company called Augustus Pty Ltd, the trustee of the Joseph Trust which was the firm’s service trust. They paid that $93,000 into the trust account, crediting the trust account ledgers of each of the eight clients with the amount that had been misappropriated from each. They then transferred to Bank SA the sum initially intended to be placed on deposit in a Gimalo investment account at that bank on behalf of each of the eight clients. This was all effected on 8 July 2005. Later, on 22 July 2005, the partners paid into the trust account an amount equal to the amount of the interest for the period 30 May 2005 to 8 July 2005 which each client had lost by reason of the misappropriation. It must also be noted that Mr Owens began the audit of the trust accounts on 8 July 2005.
Each of the partners was cross-examined as to his intention when making good the misappropriation. I find that on 8 July 2005 none of the partners then believed that there was any further defalcation. Each believed that $108,000 was the full extent of the defalcation. That is the evidence of each. That evidence is consistent with objective facts. It is consistent with the fact that recent audits of the firm had not disclosed any defalcation. It is consistent also with the fact that the sum of $108,000 was an amount approximately equal to the amount of fines unpaid by Willoughby. I find also that, had they known or suspected that there were further defalcations, the partners would not have replenished each of the eight accounts for to do so would have placed the partners in the invidious position of preferring some clients over others. Finally, notwithstanding the partners’ request to expedite the next audit of the trust accounts, Mr Owens had not started that audit until 8 July 2005. The conclusion that the partners believed that the defalcations were limited to $108,000 is reinforced by the fact that on 13 July 2005 they commenced an action in this Court against Willoughby to recover the sum of $108,000. Two of the partners gave evidence that they replaced the misappropriated money because they believed that the partners had a moral responsibility to replace it. For the reasons just given, I accept that evidence.
On 8 July, the partners immediately informed the eight clients and the Law Society of what had occurred.
Further Defalcations Discovered
Mr Owens reported to the firm by letter dated 24 July 2005. He had identified misappropriations totalling sum $674,000. On 28 July 2005, Magarey Farlam informed the Law Society of that fact.
On 1 August 2005, the Council of the Law Society appointed Ms Bishop as supervisor of the trust accounts of Magarey Farlam.
On 5 August 2005, the supervisor appointed a chartered accountant, Mr M McLaren, to assist her by conducting an investigation of the trust accounts of Magarey Farlam for the purpose of detecting irregularities in those accounts, to ascertain the true balance in the ledger of each client, and to identify who was entitled to the moneys in the trust accounts. That examination has disclosed that the defalcations are considerably larger than had been ascertained by Mr Owens. The defalcations have affected some of the clients of Magarey Farlam who had moneys deposited in trust accounts of the firm and some who had moneys invested in Gimalo.
The investigations made by the supervisor have ascertained that there are essentially two classes of claimants to the balance of the trust moneys. For convenience, they have been called “the tracing claimants” and “the pooling claimants”. Although these labels do not describe the nature of their respective claims with complete accuracy, it is convenient to use them. There are several whose interests might be said to be variations of the claims made by the tracing claimants. Their interests will be noted later. Those variations do not mean that it is incorrect to proceed on the footing that there are two classes of claimants to the balance of the trust money remaining.
On 6 September 2005, after it had been ascertained that the defalcations were substantially larger than $108,000, the partners of Magarey Farlam wrote to the supervisor asking for repayment of the sum of $93,000, which they had paid to the eight clients to replenish moneys which had been misappropriated from each. The supervisor seeks directions as to how she should respond to that request.
Three Sets of Claimants
There are, therefore, three sets of claimants to the balance of the trust moneys remaining. They are the tracing claimants, the pooling claimants and the partners of Magarey Farlam who seek repayment of the sum of $93,000 paid into the trust account on 8 July 2005.
The Supervisor Seeks Directions
From time to time the supervisor has applied for directions as to how she should discharge her duties. Included in the directions which she has sought are directions as to how she should call for claims on the trust accounts, administer those claims, determine the number and type of claimants, and make a distribution among the claimants. Thus, on 5 December 2005, Ms Bishop applied:
·for directions so that she might give notice by letter and advertisement to obtain details from claimants of their claims to moneys held in the trust accounts of Magarey Farlam and to make a determination as to the nature and extent of such claims;
·for directions as to press advertisements for claims;
·directions regarding the process to be adopted by the Court for hearing submissions from the supervisor, claimants and other interested parties as to the nature of claims on the trust accounts, including directions as to how to deal with legal representation for claimants;
·a direction that upon hearing submissions from the supervisor, claimants and other interested parties, the Court determine the number and type of categories of competing claimants; and
·a direction that the supervisor make a determination about how the claimants are to be allocated to the various categories.
The Court has made orders with directions from time to time. They include orders:
·that the supervisor give notice in writing to all persons who have a claim against the trust account;
·that before 23 December 2005, the supervisor publish in the Public Notices of the Advertiser and the Australian newspapers a notice calling for claims;
·requiring the supervisor to publish before 16 February 2006 a more detailed notice in the general section of the Advertiser newspaper calling for claims;
·requiring the supervisor on 17 February 2006 to circulate a letter to all known claimants informing them that investigations were being undertaken, that the defalcations amounted to some $5.5 million, of the potential classes of claimants, of the desirability of obtaining legal advice and representation, and of the holding of a meeting to provide information to claimants (the meeting was held on 27 February 2006 and about 100 claimants attended);
·as to the management and administration of investments made through Gimalo;
·for the provision of information to all claimants and, in particular, the provision of the opinion of senior counsel dated 27 July 2006, which was obtained by the supervisor, and a memorandum of facts prepared by the supervisor’s solicitor which was provided in August 2006.
In short, orders and directions which the Court has made have to a large extent been concerned to ensure that all claimants are identified, that all classes of claimants and all other interested parties are before the Court, that the opinion of counsel obtained by Ms Bishop was made available to all claimants, and that all claimants were provided with a memorandum of the relevant facts. The supervisor has complied with those orders and directions.
Ms Bishop has obtained the opinion of senior counsel as to how to distribute the balance remaining in the trust account. She has made the opinion available to all claimants to assist them. Almost all of the claimants have obtained a copy of the opinion. Having considered that opinion, Ms Bishop believed at one time that the most fair, expeditious, and least costly means of distributing the moneys still held in the trust accounts (including the investment accounts of Gimalo) is to aggregate all moneys under her control and distribute the fund in proportion to the balance as set out in the trust account ledger of each client or, in the case of those 42 clients whose ledger accounts were debited with the misappropriations, as set out in a reconstructed ledger as recommended by Mr McLaren.
On 31 August 2006, the supervisor sought directions to enable her to distribute the remaining trust moneys in accordance with that belief. She later decided not to express a view as to distribution and amended her application so that she sought directions only. She also sought directions to enable all competing interests to be heard.
A Well-established Procedure
In Re Magarey Farlam Lawyers Trust Accounts (No 2) [2006] SASC 382, I examined the history and the limitations of the procedure by which a person administering the affairs of others may apply for directions. It is convenient to repeat it.
The ability to apply for directions is a well-established procedure available to those administering the affairs of others. Two well-known instances of the procedure are the ability of the liquidator of a company to apply for directions pursuant to s 479 of the Corporations Act 2001 (Cth) and the ability of a trustee, executor or administrator of the estate of a deceased person to apply for advice and directions: s 69 of the Administration and Probate Act 1919 and s 91 of the Trustee Act 1936.
The application for directions has a relatively long pedigree. In re G B Nathan & Co Pty Ltd (in liq) (1991) 24 NSWLR 674 McLelland J examined the historical development of the various statutory provisions for directions in England and in New South Wales. I gratefully adopt his analysis and add a note on the development of the procedure in South Australia.
A statutory procedure for application for directions by a trustee, executor or administrator was introduced in England by s 30 of the Law Property Amendment Act 1859 (UK) (22 and 23 Vict. c 35). Those provisions had developed from the practice of the Court of Chancery under the general law in giving directions to those entrusted with the administration of property under the control of the Court. The two main classes of such persons were, firstly, trustees of trust property, or executors or administrators of a deceased estate, under administration by the Court pursuant to a decree for general administration and, secondly, receivers (and managers) appointed by the Court in respect of property the subject of litigation. McLelland J said (at 677):
These various statutory provisions for directions were a development from the practice of the Court of Chancery under the general law in giving directions to those entrusted with the administration of property under the control of the court. Two main classes of such persons were (1) trustees of trust property, or executors or administrators of a deceased estate, under administration by the court pursuant to a decree for general administration, and (2) receivers (and managers) appointed by the court in respect of property the subject of litigation. In such cases the exercise by those persons (to whom I will collectively refer as official administrators) of administrative or managerial functions was subject to close control by the court and in many instances they could safely exercise their powers only with the approval, and in accordance with the directions, of the court see, eg, as to trustees, Re Furness [1943] Ch 415, and as to receivers and managers, Gardner v London Chatham and Dover Railway Co (No 1) (1867) LR 2 Ch App 201 at 211 and Rosanove v O’Rourke [1988] 1 Qd R 171 at 173.
Generally speaking, if the court gave a direction to an official administrator who had made a full and fair disclosure to the court of the material facts, the official administrator might act in accordance with the direction without thereby incurring personal liability to any of the persons in whose interests the administration was being conducted, for example, creditors or beneficiaries of a deceased estate: see Waller v Barrett (1857) 24 Beav 413; 53 ER 417; Dean v Allen (1855) 20 Beav 1; 52 ER 502; Williams v Headland (1864) 4 Giff 505, 66 ER 806, Pinnock v Hull (1876) 2 VLR (Eq) 18 at 24-25 and Chisholm v Gilchrist (1902) 2 SR (NSW) (Eq) 84 at 86; (1902) 19 WN (NSW) 140.
Section 30 of the 1859 Act in the United Kingdom was soon adopted and enacted in South Australia by s 25 of the Act No. 6 of 1860 entitled An Act to amend the Law of Property and for other purposes, a provision in almost identical terms of s 30 of the 1859 Act. It provided:
25. Any trustee, executor, or administrator shall be at liberty, without the institution of a suit, to apply by petition to the Court for the opinion, advice, or direction of the Court, on any question respecting the management or administration of the trust, property, or the assets of any testator or intestate, such application to be served upon, or the hearing thereof to be attended by all persons interested in such application, or such of them as the Court shall think expedient, and the trustee, executor, or administrator, acting upon the opinion, advice, or direction given by the Court, shall be deemed, so far as regards his own responsibility, to have discharged his duty as such trustee, executor, or administrator, in the subject matter of the said application: Provided, nevertheless, that such application shall not extend to indemnify any trustee, executor, or administrator in respect of any act done in accordance with such opinion, advice, or direction as aforesaid, if such trustee, executor, or administrator shall have been guilty of any fraud, or wilful concealment, or misrepresentation, in obtaining such opinion, advice, or direction; and the costs of such application shall be in the discretion of the Court.
Section 25 (and s 30 of the 1859 Act) made the protection of the official administrator explicit in terms which broadly reflected the position under the general law following a decree for general administration. The proviso to s 25 was particularly relevant. The official administrator was protected only if full disclosure had been made.
In South Australia in 1880 the ability to obtain the advice and direction of this Court was extended to Public Trustee by s 28 of the Public Trustee Act 1880. The terms of s 28 were, however, similar to what is now s 69 of the Administration and Probate Act 1919. The predecessor of s 69 was s 99 of the Administration and Probate Act 1891. It was in identical terms to what is now s 69 save that s 69 is now set out in six subsections which contain the provisions of the four subsections in s 99 of the 1891 Act.
In 1893 the Trustee Act 1893 repealed, among other statutory instruments, s 25 of the Act No. 6 of 1860. Section 78 of the Trustee Act 1893 provided a power for a trustee to obtain the advice and direction of the Court in terms which are very similar to what is now s 91 of the Trustee Act 1936.
These are the legislative antecedents of what is now s 69 of the Administration of Probate Act 1919 and s 90 of the Trustee Act 1936 and of s 37 of the Public Trustee Act 1995 which preserves the ability of Public Trustee to apply to the Court for directions. It is unnecessary for present purposes to examine the later history of what is now s 479 of the Corporations Act. It is sufficient to refer to Nathan at 677.
Section 47 of the Legal Practitioners Act is but another instance of a statutory procedure for application for directions based on s 30 of the 1859 Act of the United Kingdom and the other provisions in this State which have since been enacted.
Limits on the Procedure
While the procedure provides protection for those who apply for directions, it does not as a general rule enable the determination of rights as between parties. So, where a trustee of the estate of a deceased person applies pursuant to s 69 of the Administration of Probate Act 1919 for the advice or the directions of the Court, those directions protect and indemnify the trustee against any claim for breach of trust, provided always that the facts have been fully and fairly disclosed, but it leaves the question open as between beneficiaries who have not been cited in the proceedings: re Mallen [1929] SASR 154 at 157; In the Estate of Hunter, deceased [1957] SASR 194 at 196. Where it is desirable or necessary to obtain a final determination of the rights of parties, it is necessary to proceed inter partes: Estate of Hunter (ibid).
Where the procedures of the Court are sufficiently flexible to enable proceedings commenced as an application for directions to be changed to proceedings for determining substantive rights, the Court will on occasions make orders binding on the parties to those proceedings. The Court will do so where the parties consent and the Court has, where necessary, made representative orders for the purpose: Nathan at 679; Harrison v Mills [1976] 1 NSWLR 42 at 45 to 46; re Staff Benefits Pty Ltd (in liq) and the Companies Act [1979] 1 NSWLR 207. It is a convenient course which avoids the need to commence further proceedings which will result in additional cost and delay: Anmi Pty Ltd v Williams [1981] 2 NSWLR 138 at 156 to 157. Nevertheless, it is important that the distinction is recognised between on the one hand an application for directions and, on the other, proceedings where it is intended to obtain orders which bind the parties to the proceedings: Nathan at 680; re Standard Insurance Co Pty Ltd (in liq) (1963) 5 FLR 292 and Murdoch v Crawford [1986] VR 97 at 100 to 101; Estate of Hunter at 196. Thus, generally speaking, the Court will not permit proceedings commenced as an application for directions to be changed into proceedings for determining substantive rights unless it is satisfied that those affected have consented to that course or will not suffer injustice in consequence of the change in the nature of the proceedings: Nathan at 680.
The initial application by the supervisor has caused each of the three sets of claimants to seek orders determining their substantive rights. The applications are a direct consequence of the fact that the supervisor has applied for directions as to how she should distribute the trust moneys remaining after the defalcations.
A number of clients of Magarey Farlam who are either tracing claimants or pooling claimants had instructed solicitors. Those solicitors had retained counsel to represent each class of claimants. As those two competing classes were seeking a final determination of their respective rights, it was necessary to recognise the limitations of the procedure of an application for directions and to proceed inter partes. In addition, the partners of Magarey Farlam sought a final determination of their claim to recover the sum of $93,000. Thus, on 7 November 2006, I made orders with directions to enable a determination of rights as between those parties. No one opposed those orders. The supervisor consented to this course. The respective claimants were ordered to file points of claim, any affidavit on which they sought to rely, and submissions in support of the points of claim. In this way, the issues between all claimants were identified, if they were not already apparent. In addition, because a large number of clients of the firm were not before the Court, orders were made on 11 December 2006 appointing persons to represent any claimant who fell into the class of tracing claimants and any claimant who fell into the class of pooling claimants who was not before the Court. These representation orders have been made to bind parties who are not before the Court.
It was convenient to proceed in this way. It will avoid additional delay to all claimants who have already had to wait a long time for the resolution of their affairs and will avoid additional costs to those who have already incurred substantial costs in seeking the resolution of the issues. In addition, a number of clients of Magarey Farlam have expressed in open court their concern at the cost and delay of resolving the issues flowing from the defalcations made by Willoughby. Nothing would be gained by requiring separate proceedings inter partes but added cost and further delays. It is for these reasons that the supervisor’s application has been used as the means by which to determine the issues as between the three classes of claimants.
The supervisor had sought directions authorising what for convenience has been called “the pooling method”, that is to say, directions that the balance remaining in the trust account should be distributed rateably in proportion to the balance as set out in the trust account ledger of each client or, in the case of those 42 clients to whom misappropriations had been debited, as set out in the reconstructed trust ledgers. The effect of the pooling method is that the defalcations should not affect individual clients but should be spread rateably among all clients who had money in the trust account on 1 August 2005. The supervisor made the application in those terms on the basis of the advice of counsel. At the hearing, counsel for the supervisor did not press that contention. Instead, the supervisor’s application was effectively amended to be an application simply for directions as to how the supervisor should distribute the moneys remaining in the trust account after the defalcations.
The contentions of the parties essentially boiled down to two alternative methods of distribution. The pooling claimants contended for the pro rata distribution method just described. The tracing claimants contended that the distribution should be according to the amount actually shown in the trust account ledger of each client at 1 August 2005. The effect of this contention was that the loss should lie where it falls so that the losses incurred by the 42 clients whose trust account ledgers were debited with the moneys fraudulently withdrawn by Willoughby from them should each bear that loss. Those clients whose ledgers were not affected should be entitled to withdraw the balance of the account. The label “tracing claimants” is not an entirely accurate description. It is not a tracing exercise in the ordinary way. It is simply a payment according to the amount stated in the ledger. If a label is to be attached to this class of claimants, it might have been better to call them “the ledger claimants”. However, it is convenient to continue to call them the tracing claimants.
No basis of distribution between the clients, other than the pooling method or the tracing method, was put forward.
I will deal first with the competing claims of the pooling claimants and the tracing claimants. That will require an examination of the means by which Willoughby effected the misappropriations, the number of clients whose ledgers were debited with the misappropriation, and other facts. After determining how the balance remaining in the trust account should be distributed, I will examine the claim of Magarey Farlam to recover the sum of $93,000 paid into the trust account on 8 July 2005.
The supervisor’s application was heard on 19, 20 and 21 December 2006. All interested parties were heard. The hearing proceeded on affidavit evidence. Three deponents of affidavits were cross-examined on their affidavits. They were the three partners of Magarey Farlam, Messrs Farlam, Mudri and Adams. The evidence also included the opinion of counsel, as well as the brief to counsel. Those documents were admitted for no other purpose than to prove the opinion on which the supervisor has sought directions and the facts on which counsel had based that opinion. At the hearing, Mr Livesey QC and Mr Keith represented two groups of tracing claimants. Mr N Swan appeared for two claimants who were essentially tracing claimants. Dr B Saunders and his wife had an interest which was a variation of the tracing claimants. Dr Saunders appeared on behalf of himself and his wife. Mr David Howard appeared on behalf of the pooling claimants. In the appendix to these reasons, I set out the individual parties for whom counsel respectively appeared.
The Fraudulent Dealings
Willoughby used four methods to effect the misappropriations. They were described by Mr McLaren as
·the bank cheque method,
·the replenished funds method,
·the altered cheque method, and
·the replaced funds method.
I briefly describe each. There were variations of these four methods. They are identified by Mr McLaren in paras 14.5, 14.6 and 15 of his affidavit sworn on 17 September 2005. However, it is not necessary for present purposes to examine the details of each variation.
Bank Cheque Method
The bank cheque method began by Willoughby or someone on his behalf presenting to a partner of the firm a requisition for payment out of the moneys held on trust for a particular client and a trust account cheque. The partner was requested to authorise the payment and sign the cheque. The trust account cheque was made payable to the ANZ Bank. After the partner had signed the requisition and the trust account cheque for the approved amount, the trust account ledger for that client was debited with the amount withdrawn. Willoughby then took the trust account cheque to the ANZ Bank and purchased an ANZ Bank cheque in the name of Jackwill. The bank cheque was then deposited into the bank account of Jackwill.
Replenished Funds Method
The replenished funds method is a variation of the bank cheque method. Moneys which had been placed on deposit through Gimalo were withdrawn and deposited into the trust account. A requisition for a payment out of the trust account was presented with the trust account cheque to a partner who authorised the requisition and signed the cheque. The trust account cheque payable to the ANZ Bank had been drawn for the approved payment and the trust account ledger was debited with that withdrawal. Willoughby then proceeded as with the bank cheque method, that is to say, the trust account cheque was taken to the ANZ Bank and used to purchase an ANZ Bank cheque in favour of Jackwill. It was then deposited into the bank account of Jackwill.
Altered Cheque Method
The altered cheque method was effected by adding to the name of the payee on the cheque, as drawn and authorised, the words “Acc W B Willoughby”. In these cases, the payee was always Bank SA. Willoughby arranged for a requisition for payment out of a client’s moneys held on trust and the cheque to be placed before a partner for authorisation. The partner signed the requisition and the cheque. The requisition stated that moneys were to be transferred to Bank SA for deposit on behalf of the client. The trust account cheque was payable to Bank SA. The ledger for that client was debited with the withdrawal. After the cheque had been authorised and signed, the cheque was altered by adding “Acc W B Willoughby”. Thus, the payee as shown on the cheque was “Bank SA – Acc W B Willoughby”. One example of the altered cheque method is the misappropriation of $108,000 from nine persons on 31 May 2005, which has already been mentioned and was the first defalcation to be discovered. It appears to have been the last defalcation.
Replaced Funds Method
The replaced funds method was used to conceal a misappropriation made by the bank cheque method. It was usually confined to those matters where Magarey Farlam was administering an estate or trust. It was used when it became necessary to make a payment to beneficiaries. In order to replace moneys which had been misappropriated earlier by the bank cheque method, moneys were transferred from another client to the ledger account of the matter in which the misappropriations had occurred, usually by a journal entry which was not authorised by a partner. A cheque would then be drawn in favour of the ANZ Bank and that cheque would be used to purchase an ANZ Bank cheque drawn in favour of the beneficiary. The withdrawal was authorised in the usual way on a trust requisition and the cheque was signed by a partner. An example of this kind of misappropriation occurred in the Lillian Todd Estate. It was one of a number of misappropriations from that estate. A beneficiary of that estate was Mrs J Lloyd. Various defalcations had been made from the estate from time to time by using the bank cheque method. It became necessary to make a payment to Mrs Lloyd of $100,000. In order to replace funds which had been misappropriated from the estate of Lillian Todd, withdrawals were made from three other unrelated estates of three separate sums of $25,000, $21,000 and $54,000. A requisition for a withdrawal from each of the three estates was authorised and a trust account cheque in favour of the ANZ Bank was drawn for each of those three sums. The cheques were then used to purchase an ANZ Bank cheque for $100,000 in favour of Mrs Lloyd and her husband. This last method plainly affected the trust account ledgers for a number of clients. Mr McLaren’s investigations have identified that defalcations were made in this way affected nine trust account ledgers of only six clients.
The Withdrawals Were Authorised
It will have been noticed that in each of the four methods a requisition for the withdrawal of moneys from the trust account on behalf of a particular client was authorised by a partner of the firm. The trust account cheque was also signed by a partner. That was also the case with the variations of those four methods. The appropriate entry was then made in the trust account ledger for that client. The bookkeeping was meticulously carried out in the sense that the details of the withdrawal were correctly entered in the ledger consistently with what had been stated on the requisition. No doubt, that was one means by which Willoughby hoped to conceal his fraudulent dealings. It certainly assisted in concealing them for some thirteen years. It is a curious paradox that Willoughby’s compliance with the Legal Practitioners Act and the Regulations assisted him to conceal his fraudulent activities. Even in the case of the nine ledgers where withdrawals from the trust account for one client were supplemented by moneys transferred by journal entry from the ledger of another client, the final withdrawal was authorised and the appropriate entries were made in the relevant trust account ledgers.
It is apparent from this recitation of the facts that this was not a case where there has been a substantial defalcation from the trust account which has been effected without debiting the ledgers of individual clients. Such a defalcation could be effected by a fraudster drawing one cheque for a substantial sum, or a series of cheques totalling that sum, and presenting them for payment. Instead, in this case, all the bookkeeping required by the Legal Practitioners Act and the Regulations and, in particular, the entry of withdrawals in the trust ledger was undertaken. Importantly, the withdrawals were debited to the ledgers of 42 clients only. At 1 August 2005, there were some 250 clients who had moneys held on trust. A central question in these proceedings, which is later addressed, is whether the fact that the misappropriations were effected by debiting the trust account ledgers of those 42 individual clients means that those clients bear the loss.
Misappropriation from Gimalo
Gimalo does not have detailed accounting records. It did not keep ledgers. The firm manually kept a record book called the “Money Book” which recorded moneys being placed on deposit or withdrawn in the name of Gimalo. The Money Book is liable to error because it is not reconciled with either the deposit or the trust account ledgers. This absence of accounting records and ledgers means that it is not possible to reconcile investments in the name of Gimalo.
According to the Money Book, a total sum of $4,062,000 should have been on deposit in the separate Gimalo accounts. However, the bank statements of those accounts disclose that only the sum of $2,902,078 was on deposit, a discrepancy of $1,159,922. The moneys were misappropriated by withdrawing the moneys from separate investment accounts and returning them to the trust account. However, the money was not returned to the client but credited to the ledger of another client. Willoughby would then misappropriate the funds by one of the methods already discussed.
The method used to conceal these misappropriations was to use a ledger created by Willoughby, called the “Wychwood/Kallinta ledger”. When opened, it had a nil balance. On funds being withdrawn from a Gimalo investment account, the funds would be credited to the Wychwood/Kallinta ledger. The funds would be withdrawn almost immediately and misappropriated to one of Willoughby’s accounts and the ledger debited with that withdrawal. The ledger would return to a nil balance. When reports were generated at the end of each month, the nil balance would be suppressed, thus limiting the likelihood of detection of the fraudulent dealings.
Moneys were misappropriated in this way through the Wychwood/Kallinta ledger in two periods, 27 August 1997 to 28 May 1999, and between 9 February 2002 and 24 February 2002. The total amount misappropriated in this way was $507,000. In those periods, there was a clear pattern of moneys being withdrawn from individual accounts and paid directly into the Jackwill account.
Bank statements before 1997 for Jackwill are not available. Mr McLaren has identified transactions in the period 10 February 1995 to 14 May 1997 which follow the same pattern and which total $250,000. Mr McLaren believes that those moneys have been misappropriated. However, in the absence of bank statements of Jackwill before 1997, Mr McLaren is unable to confirm that belief.
As the moneys deposited in the Gimalo investment account was misappropriated by being transferred to the trust account, it is unnecessary to examine those misappropriations any further. They will be considered when dealing with the misappropriations of money from the trust account. I deal later with the question of how the moneys which remained on deposit should be treated.
Other Features of Gimalo Investment Accounts
The moneys standing to the credit of the individual investment accounts of Gimalo stand on a different footing from moneys in the first trust account.
Each of the investment accounts represent moneys withdrawn out of the money held on trust on behalf of a client which was then placed on deposit at Bank SA, the Commonwealth Bank of Australia, or Adelaide Bank through Gimalo. In each instance, a separate investment account was opened for each client with the account having both its own name and its own number. In some cases, the account would bear a title which used part of the name of the client. In a number of instances, the investment was made with moneys which were not tainted in any way by Willoughby’s defalcations in the sense that the money was paid into and withdrawn from the trust account in a period between defalcations. In each case, the withdrawal was authorised by a trust requisition and the clear intention was to use the trust money withdrawn to place it on deposit in a Gimalo investment account on behalf of the client. As the partner authorising the withdrawal from the trust account intended that the money should be placed on deposit in the investment account, these were all legitimate transactions by which moneys of a client were transferred with the express or implied authority of the client. It is as if the money in each trust ledger can be traced to the individual Gimalo account. Interest from each individual client’s investment account was credited to the trust account in the name of the client, the credit being recorded in the trust account ledger for that client, a fact which confirms the conclusion that it was intended to establish an investment for that client. In each case, effect was given to that intention. There is no equity in requiring a client to pool the money invested through Gimalo to offset any defalcations. The money applied to that investment is not subject to any equity in favour of any other person.
In other cases, it might be said that the money withdrawn might have been tainted only in the sense that a defalcation occurred at or about the time when the money was withdrawn. There is no evidence as to the proportion of Gimalo investment accounts which might be said to be tainted in that way. In the absence of any evidence to the contrary and in the absence of any claim by any person to trace into any of the Gimalo investment accounts, there is no sound reason why all of the moneys deposited in the separate Gimalo investment accounts should not be treated in the same way as untainted money deposited in that way.
The Gimalo investment accounts are quite unlike the trust account in that there is no mixed fund. Instead, a separate investment account is held at the relevant bank for each client’s separate investment. The money belonging to each individual client can be recovered from the relevant bank in the same way as any other depositor with that bank. They are to be distributed, therefore, according to the name of each client.
There is no evidence to suggest that the Gimalo investment accounts do not provide a proper basis for distribution. No person has challenged the entitlement of any client in whose name an investment was made to hold that investment. As each investment account bears a name and number which identifies it with a particular client of Magarey Farlam, the separate investment accounts provide a basis for payment to each client of the funds standing to the credit of that account.
The money placed on deposit on the Gimalo investment account was trust money as defined by s 5 of the Legal Practitioners Act. Section 5 defines “trust money” in these terms:
“Trust money” means money received by a legal practitioner to which the practitioner is not wholly entitled both at law and in equity, but does not include money received by a practitioner in the course of mortgage financing.
The money on deposit in each of the Gimalo investment accounts represents money withdrawn from the trust account of each client in whose name the investment was made. Expressed another way, the moneys withdrawn from the trust account can be traced to the Gimalo investment account. The moneys on deposit are, therefore, trust moneys. The client of Magarey Farlam has a beneficial interest in those moneys. They are trust moneys, albeit they are not moneys held in the trust account. Nevertheless, for the reasons just given, they can be treated separately from the trust account.
Some Dealings in Gimalo
A number of clients who had money on deposit on a Gimalo investment account were investing money which was not affected by Willoughby’s defalcations. They illustrate how the money came from a clearly identifiable source which could not be affected by the misappropriation. I list some instances.
On 17 January 2005, Mr Peter Wells and Mrs Jennifer Wells instructed Magarey Farlam to assist them with the sale of their house property at Greenwith. As Mr and Mrs Wells had not decided how to apply the proceeds of sale, they instructed Magarey Farlam to invest the proceeds in an interest bearing account. The funds were invested through Gimalo at Bank SA. The proceeds were handled in the following way:
(1)On 18 February 2005, the sum of $221,043.42 was paid into the trust account. Part of that sum was applied to pay rates and other outgoings.
(2) On 3 March 2005, the sum of $210,000 was transferred from the trust account to an account at Bank SA in the name of Gimalo and named GIMALOWELLSP.
(3) On 4 March 2005, a further sum of $7,463.92 was received into the trust account in relation to the sale of the house property.
(4)On 21 March 2005, the sum of $10,000 was transferred from the trust account to the GIMALOWELLSP account so that a total of $220,000 was invested in that account.
(5)Interest earned on funds on the deposit at Bank SA was paid into the trust account. The balance of the trust account, as at 22 July 2005, was $4,637.68.
The proceeds of sale of the house property were paid into the trust account between 18 February 2005 and 21 March 2005. In that same period, a total of $220,000 was transferred to the GIMALOWELLSP account at Bank SA. In that time, no misappropriations occurred in the trust account. Mr and Mrs Wells seek payment of the sum of $220,000 held on the investment account.
As the two deposits in the Gimalo investment account were made at a time when there were no defalcations, there is no ground on which to deny Mr and Mrs Wells the ability to recover the amount on deposit. The position is the same as if the transactions had been made through a trust account which was entirely intact. There are other instances illustrating why those who had moneys on deposit in the Gimalo investment account should be entitled to recover that deposit.
In 2001, Mr Ivan May instructed Magarey Farlam in relation to the receipt of a substantial sum of money in settlement of litigation. On 5 March 2001, Mr May paid the sum of $400,000 into the trust account. On 9 March 2001, $375,000 of that sum was placed on deposit at Bank SA, through Gimalo, in an account named GIMALOMAY. The balance of that account as at 7 October 2005 was $8,107.08. No misappropriation occurred in the trust account in the period 5 March 2001 to 9 March 2001. Mr May seeks payment of the sum of $8,107.08. From time to time, Mr May made withdrawals from the investment account.
Mr Brenton Robinson is the executor and trustee of the estate of Mr B H Robinson, who died on 24 July 2004. He instructed Magarey Farlam to act for him in relation to the administration of the estate. The following amounts were received into and paid out of the trust account.
(1)On 23 September 2004, the sum of $102,990.57 was paid into the trust account. Of that sum, $68,000 was paid to a beneficiary and $15,000 paid to Magarey Farlam Lawyers. A balance of $19,990.57 remained in the trust account.
(2)On 6 October 2004, the sum of $93,128.23 was paid into the trust account, making a total of $113,118.80.
(3)On 11 October 2004, the sum of $110,000 was deposited with Bank SA through Gimalo into an investment account entitled GIMALOROBEST.
(4)In the months following rental income and other amounts were paid into the trust account so that by 8 February 2005 the balance of the account was $5,035.18.
(5)On 28 February 2005, the sum of $3,000 was deposited into the GIMALOROBEST account at Bank SA.
(6)Thereafter, rental income increased the balance of the account to $4,647.76, as at 4 May 2005.
(7) On 4 May 2005, the sum of $4,000 was deposited into the GIMALOROBEST account at Bank SA.
Mr Robinson seeks an order that the supervisor pay him the sum of $110,000 standing to the credit of the GIMALOROBEST account. There was no defalcation in the period 17 September 2004 to 8 October 2004.
On 8 October 2004, $80,000 was misappropriated from the estate of D B Pettitt, deceased. At that time, there was considerably more than $80,000 in the trust account. There is no evidence as to when the defalcation occurred or when the cheques involved in that defalcation were cleared. If that defalcation was not completed on 8 October 2004 or the cheque was not cleared before 11 October 2004, the deposit into the GIMALOROBEST account would plainly be of funds paid into the trust account on behalf of the estate.
The affairs of Mr W T Wright provide another instance of the inequity of a pro rata distribution, which was called the pooling method. Since at least October 1999, Mr Wright has had the sum of $23,000 on deposit with the Commonwealth Bank of Australia in an investment account in the name of Gimalo. Interest from that investment was paid into the trust account every quarter. He also had an investment at the Adelaide Bank and interest was also paid quarterly into the trust account. Each quarter, the total of those interest payments was paid to Mr Wright leaving a nil balance in the trust account. In other words, the amounts paid to Mr Wright each quarter represented the whole of the amount paid into the trust account as interest earned by his deposits. On 2 May 2001, the sum of $59,941.30 was paid into the trust account, being part of the proceeds of the sale of a house property. Mr Wright’s ledger then had a credit balance of $311.12. On 3 May 2001, the sum of $60,000 was transferred to a Gimalo investment account at Bank SA entitled GIMALOWRIGHT. There were no misappropriations from the trust account in the period 29 March 2001 to 4 May 2001.
On 22 April 2005, the sum of $29,079.25 on deposit at Adelaide Bank, plus interest, was transferred to the trust account. The trust account ledgers showed a credit of $279.78, which was interest which had been received from the Commonwealth Bank of Australia on 1 April 2005. On 3 May 2005, the sum of $30,000 was transferred to the GIMALOWRIGHT account at Bank SA. There were no misappropriations of trust moneys in the period between 25 March 2005 and 8 April 2005 and in the period 14 April 2005 and 5 May 2005. Thus, the total sum of $30,000 was unaffected by any defalcation. Mr Wright is also an example of those clients who happen to have substantial sums in the trust account in the last ten months of Willoughby’s defalcations.
Mr D K Norris and Mrs J P Norris have been clients of Magarey Farlam since at least 4 July 2003 and have paid moneys into the trust account from time to time. On 15 March 2005, the sum of $270,786.48 was paid into the trust account on their behalf. It was a payment under a policy of insurance following the destruction of their farm by a bushfire in January 2005. On 21 March 2005, the sum of $200,000 was transferred to an investment account through Gimalo at Bank SA entitled GIMALONORR. There were no defalcations in the period 31 December 2004 to 24 March 2005 so that the moneys paid into and out of the trust account could not be affected by any defalcation. Mr and Mrs Norris have made a number of withdrawals from the GIMALONORR account at Bank SA between 2 May and 22 July 2005. The balance of the account, as at 9 January 2006, was $30,000. Interest is paid from the GIMALONORR account into the trust account and credit to the ledger account of the Norrises.
The Amount Misappropriated
Mr McLaren’s investigations have identified payments into the three accounts used by Willoughby for his fraudulent purposes. The sum of $3,662,017 has been banked into the account of Jackwill, representing moneys taken from clients of Magarey Farlam in the trust account of Magarey Farlam. This was determined by tracing deposits from the bank statements of Jackwill to the trust ledgers and bank statements of the trust account. Not all of those moneys were misappropriated directly from a client. On a number of occasions, moneys were transferred by journal entry from one client to another, as shown in the ledgers for each client.
The moneys in the W B Willoughby account include $872,200, which had been withdrawn from the Jackwill account and deposited in this account. In addition, $586,000 can be traced back to the firm’s trust account and individual ledger accounts of clients.
Most of the deposits into the Zama Bloodstock account represent moneys withdrawn from the W B Willoughby account. Mr McLaren has identified $9,500 which can be traced back to the firm’s trust account and into individual ledger accounts of clients.
The investigations so far made by Mr McLaren show that the amount of trust money misappropriated by Willoughby totalled approximately $4.5 million: see Exhibit SRB60 of the affidavit of the supervisor sworn on 4 October 2006. That is a higher amount than the sum of the moneys mentioned in the previous three paragraphs. The evidence did not explain the difference.
Other Relevant Facts
The following findings of fact are based on the facts as discovered by the supervisor and Mr McLaren in the course of their inquiries and investigations.
1.As already noted, the total amount of the defalcations was approximately $4.5 million: see Exhibit SRB60 to the affidavit of the supervisor sworn on 4 October 2006.
2.The defalcations were all made from the first trust account. There were no defalcations from the second trust account.
3.At no time was either of the trust accounts overdrawn.
4.As at June 2006, there was $1,086,021 in the first trust account and $27,457 in the second trust account.
5.As at 1 August 2005, the date of the appointment of the supervisor, there were some 250 clients of Magarey Farlam who had moneys in the firm’s trust account. There was a separate trust account ledger for each client.
6.The defalcations are confined to the ledger accounts of 42 clients of Magarey Farlam.
7.The defalcations began at least in 1992 and continued until 31 May 2005, a period of some thirteen years.
8.Some defalcations occurred as long ago as 1991. It is not possible to conclude that no defalcations occurred before 1991.
9.The trust account ledgers of the firm are available for at least 25 years. The dealings with trust moneys were extensive so that the trust account ledgers record a multitude of transactions. It is reasonable to infer, as I do, that in the period of thirteen years over which the defalcations occurred many clients have had dealings with either Magarey Farlam or Magarey & Magarey and there has been a multitude of transactions in which money has been paid into and withdrawn from the firm’s trust account. In the period from August 1999 to July 2005, 860 trust account ledgers were closed. There is no evidence of the number of trust account ledgers closed in the years 1992 to 1999. It is probable that it was a similar number. In the period August 1999 to 1 August 2005 when the supervisor was appointed, 2076 ledgers were credited with money paid into the trust account. At 1 August 2005, 1861 of those ledgers had zero balances. This is another indication of the large number of transactions which had occurred over the thirteen year in which the defalcations occurred.
10.A number of clients paid moneys into the trust account after 31 May 2005, a period when no further defalcation occurred.
11.As already mentioned, the misappropriations were confined to 42 of the 250 or so clients who had moneys held in the trust account ledgers on 1 August 2005, that is to say, the misappropriations were effected by debiting the ledgers of those 42 clients. The ledgers of the rest of the 250 or so clients of Magarey Farlam are unaffected. Their ledgers record in the required way all transactions of that client through the trust account.
12.Willoughby made 204 separate defalcations. All of those defalcations were confined to the trust ledgers of the 42 separate clients. Thus, most of those 42 clients suffered more than one defalcation. Forty five separate defalcations were made from the Laughton estate alone. The estate of Lillian Todd suffered eighteen defalcations. The ledger of Moonaree Partners was debited with fifteen defalcations, and the ledger of the estates of D B and D R Pettit were debited with seventeen defalcations. These are but four examples. Together they represent 95 of the 204 defalcations, some 46 per cent of those defalcations.
13.The 42 clients whose ledgers were affected by misappropriations had substantial, or relatively substantial, moneys in the trust account. Most of those clients were trustees of estates or trusts being administered by Magarey Farlam. Of those 42 clients, seventeen relate to the administration of estates, eleven relate to the administration of affairs of clients, and eleven relate to the administration of trusts. They were all clients who formed part of Magarey Farlam’s client affairs practice. Plainly, Willoughby recognised that substantial estates or trusts were a convenient target. I have already mentioned the substantial number of misappropriations from the Laughton estate. This was a very substantial estate. It was a very convenient target. The evidence suggests that the misappropriations from this estate totalled $1,309,000. The defalcations from that estate constitute about one‑quarter of all defalcations. I find there was no point in Willoughby seeking to misappropriate moneys from those clients who had relatively small sums in the trust account or from those clients who had moneys moving relatively quickly into and out of the trust account. More importantly, it is reasonable to infer, as I do, that Willoughby’s knowledge of the statutory and other obligations of running a trust account was such that he realised that it was necessary to ensure that there was a sufficient amount credited to a trust ledger to enable the intended withdrawal to be made. That conclusion is confirmed by the fact that Willoughby arranged to transfer money from one ledger to another when the balance of the ledger was insufficient to cover the intended withdrawal. This is but one example of Willoughby’s compliance with the obligations of operating a trust account which enabled him to conceal his defalcations for as long a time as thirteen years.
14.In the case of all of the misappropriations, save those very few where moneys were transferred by journal entry from a trust account ledger of one client to another, a trust account requisition was presented to a partner of Magarey Farlam to authorise the withdrawal from the trust account. In each instance, the trust account ledger of the client was contemporaneously debited with the withdrawal. Before the purpose of the withdrawal could be effected, Willoughby misappropriated the moneys to his own use by one of the methods already described. Notwithstanding the misappropriation, the trust account ledger was debited with the withdrawal.
The Bookkeeping
Some features of the recording of all of the trust account transactions, including the misappropriations, must be noted. The records of the trust account were kept in compliance with the Legal Practitioners Act and the Regulations. The trust account records, including the trust ledgers, were subject to annual audit, as required by s 33 of the Legal Practitioners Act. All transactions with trust moneys were contemporaneously recorded in the trust account ledgers. This was not a case where ledgers were written up after the events attributing the moneys fraudulently withdrawn to a particular client or clients. Instead, the entries in the ledger correctly recorded withdrawals as authorised by a partner. The trust ledgers, therefore, accurately record the flow of moneys into and out of each ledger, that is to say, the movement of the trust moneys of each client can be accurately traced.
It must be especially noticed that every withdrawal of moneys from the trust account was accurately recorded in the ledger with a statement of the intended purpose, that statement being consistent with a trust account requisition authorising the withdrawal. Each withdrawal was a real, not a fictitious, transaction. Each withdrawal was authorised by a partner believing that it was to be applied for the purpose of the client. Once the cheque was drawn, Willoughby then acted fraudulently in one of the methods already described and applied the money for his own purposes. It was as if a partner authorised a withdrawal of cash from the trust account to be applied for the purpose of a client and Willoughby stole the cash by depositing it in his bank account. In short, the bookkeeping relating to trust moneys was meticulous in the sense that every dealing with trust money for each client was recorded in the trust account ledger.
A number of clients of Magarey Farlam Lawyers were persons who had invested funds and were being advised as to the investment of those funds by either Mr B A Magarey or Mr Farlam or had their funds managed by them. Dividends or interest on investments was paid into the trust account and the ledger for each client recorded the date, the amount, the nature and source of the payment. Thus, an entry concerning the payment of a dividend into the trust account would record the date of the payment and the company paying the dividend and, in many cases, the amount of the imputed credit if the dividend was franked. If the payment was of interest, the financial institution paying it would be stated. If a refund was received from the Australian Taxation Office and paid into the trust account, that would be stated in the entry in the ledger. The source of all payments into the trust account was held in the ledger of the client receiving the payment. Similarly, the reason for any payment out of the trust account would be stated in the ledger of the client. Trust accounts were provided to clients enabling them to understand the source of their income and how it was being applied. When funds accumulated in the trust account, they were either paid to the client or applied to the purchase of another investment.
I find that many dealings in the trust account and in the Gimalo investment accounts were not in any way affected by Willoughby’s defalcations in the sense that the source of the money and its ultimate destination were meticulously recorded in the ledgers. In addition, as has already been demonstrated, on a number of occasions, trust money was transferred from the trust account to a Gimalo investment account on behalf of a client at a time when Willoughby was not making any misappropriations so that, given that the source of the money can be identified, it is in no way tainted by Willoughby’s fraudulent dealings.
No person has challenged the reliability of the Gimalo investment accounts, that is to say, no person challenges the entitlement of any client to the moneys held in a Gimalo investment account.
Are the Trust Records Reliable?
An important question is whether the trust account records and, in particular, the trust account ledgers can be relied on for the purposes of determining the issues in this application.
Mr McLaren has expressed the opinion that the only appropriate method by which to determine the amount held by each client in the trust account is to re-write the trust account ledgers. However, one weakness of that approach is that, in the case of the ledgers of long-standing clients of the firm, it will not be possible to verify the opening balance. The other alternative would be to re-write the books of the trust account. However, in Mr McLaren’s opinion, that would be an expensive and unreliable undertaking because of the extensive dealings in the trust account and the fact that defalcation has occurred as long ago as 1991, if not before. An accurate set of trust account records could be prepared only if there is a starting point constituted by properly reconciled figures. The inability to identify the full extent of the defalcations means that such a starting point is not available. In addition, some ledger accounts include inaccurate postings. Apart from the factors which will affect the accuracy of the reconstructed accounts, Mr McLaren estimates that the task would occupy five people for some four years. The task would, therefore, be extremely expensive and, even after that time, it could not be said that the reconstructed accounts would be entirely reliable.
I accept Mr McLaren’s opinion. The consequence is that there is no sensible or feasible alternative other than to proceed on the basis of the trust accounts as verified by Mr McLaren and, with one exception, on the trust account ledgers as re-worked by him. I will refer to that single exception in a moment. I set out the reasons for that conclusion.
First, a very substantial cost will be incurred if the trust accounts and the trust account ledgers are reconstructed. Secondly, it will take a long time to reconstruct these records. The task will result in at least a further four years’ delay which will prevent the clients of Magarey Farlam from gaining access to the funds in the trust account due to them. A number of clients of Magarey Farlam have already expressed their concern at the time and cost so far incurred in resolving how the balance in the trust account should be distributed. Many of the claimants are elderly. They will have suffered great anxiety as a result of the wrongful conduct. The sooner some certainty is reached in connection with their financial position, the better. Thirdly, the cost and delay involved in reconstructing the trust account records must be weighed against the likely benefits of the exercise. Mr McLaren’s evidence shows that the benefits will be minimal. He cannot assert that the reconstructed records will be entirely reliable. Thus, the very substantial cost of engaging five persons over four years to reconstruct the accounts will not necessarily produce accounts which are so much more reliable as to justify that cost. Other factors weighing against the utility of the exercise are that it appears that the preponderance of the trust account ledgers were not directly affected by the defalcation. Of the 250 to 260 ledger accounts investigated, only 42 have been identified as being affected, that is to say, about 17 per cent of the clients were directly affected by the misappropriations and there seems to be no basis to question their accuracy. In the case of many of those who were not directly affected, the cost of undertaking a reconstruction would be substantially higher than the balance shown in the ledgers. Finally, the ledgers have already been subjected to an extensive review by Mr McLaren. There must, therefore, be a real question whether any new information of significance will come to light. Rather than wait a further four years, it is better for all to have a determination of the extent of their respective losses as soon as possible so that each may assess his or her own individual loss and take steps to recover that loss. These are all compelling reasons for making a determination at this stage.
I accept that, when the partners paid the sum of $93,000 into the trust account, they were mistaken as to the true extent of the defalcations. When they made the payment, the partners assumed they were compensating all those who had suffered loss. In truth, they were not. I accept also that, had they known the true position, they would not have made the payment for that would place them in the position of preferring some clients over others.
Mr Roder, who appeared for the partners of Magarey Farlam, contended that the partners had made two mistakes. The first was that the amount of $108,000 was the full amount of the defalcation. The second was that the partners were ignorant of the true extent of the defalcation. There was, in truth, only one mistake, namely, that the misappropriations were limited to a total of $108,000. The two mistakes identified by Mr Roder are but two means of referring to what was but one mistake. They might be said to be two sides of the one coin. Mr Roder contended that, as the partners would not have made the payment of $93,000 into the trust account had they known the true position, they were entitled to recover the sum of $93,000 Mr Roder advanced his submission on two grounds, one based on the law of trust and the other on the common law. I deal with each in turn.
A Quistclose Trust?
Mr Roder’s first proposition was that there was a resulting trust in favour of the partners, a so-called Quistclose trust. Mr Roder relied on the decision in Barclay’s Bank Ltd v Quistclose Investments Ltd [1970] AC 567. In that case, a company, Rolls Razor Ltd, which was in serious financial difficulties, had declared a dividend. It borrowed money from Quistclose to pay the dividend. It was a condition of the loan that it be applied only for the purpose of paying the dividend. The amount of the loan was paid into an account at Barclays Bank especially opened for the purpose. Before the dividend was paid, Rolls Razor went into voluntary liquidation. Quistclose brought an action against Rolls Razor and Barclay’s Bank, claiming that the money was held by Rolls Razor on trust to pay the dividend so that, when that trust failed, it was held on a resulting trust for Quistclose. The case against Barclay’s Bank was that the bank had notice of the trust and was, therefore, a constructive trustee of the money for Quistclose. The claim of Quistclose was upheld. Lord Wilberforce delivered the decision of the House of Lords. Lord Wilberforce demonstrated that it had been recognised for at least 150 years that an arrangement by which a third person paid a person’s creditors gave rise to a trust in favour of the creditors and, if that trust should fail, a resulting trust would arise in favour of the third person.
The principle is grounded on the decision in Toovey v Milne (1819) 2 B & A1d 683; 106 ER 514, described by Lord Wilberforce in these terms at 580:
In Toovey v. Milne (1819) 2 B. & A. 683 part of the money advanced was, on the failure of the purpose for which it was lent (viz, to pay certain debts), repaid by the bankrupt to the person who had advanced it. On action being brought by the assignee of the bankrupt to recover it, the plaintiff was nonsuited and the nonsuit was upheld on a motion for a retrial. In his judgment Abbott C.J. said, at p. 684:
“I thought at the trial, and still think, that the fair inference from the facts proved was that this money was advanced for a special purpose, and that being so clothed with a specific trust, no property in it passed to the assignee of the bankrupt. Then the purpose having failed, there is an implied stipulation that the money shall be repaid. That has been done in the present case; and I am of the opinion that that repayment was lawful, and that the nonsuit was right.”
The basis for the decision was thus clearly stated, viz., that the money advanced for the specific purpose did not become part of the bankrupt’s estate. …
On that footing, Rolls Razor held the money lent by Quistclose on trust to pay its creditors (that is to say its shareholders) and the trust, having failed, there was a resulting trust to Quistclose. Lord Wilberforce said at 581 to 582:
… There is surely no difficulty in recognising the co-existence in one transaction of legal and equitable rights and remedies: when the money is advanced, the lender acquires an equitable right to see that it is applied for the primary designated purpose (see In re Rogers, 8 Morr. 243 where both Lindley L.J. and Kay L.J. recognised this): when the purpose has been carried out (i.e., the debt paid) the lender has his remedy against the borrower in debt: if the primary purpose cannot be carried out, the question arises if a secondary purpose (i.e., repayment to the lender) has been agreed, expressly or by implication: if it has, the remedies of equity may be invoked to give effect to it, if it has not (and the money is intended to fall within the general fund of the debtor’s assets) then there is the appropriate remedy for recovery of a loan. I can appreciate no reason why the flexible interplay of law and equity cannot let in these practical arrangements, and other variations if desired: it would be to the discredit of both systems if they could not. In the present case the intention to create a secondary trust for the benefit of the lender, to arise if the primary trust, to pay the dividend, could not be carried out, is clear and I can find no reason why the law should not give effect to it.
Lord Wilberforce then held that the bank had notice of the arrangement.
The principle has no application to this payment of $93,000 into the trust account simply because the purpose of the payment has not failed. The purpose of the payment was to reimburse the eight clients who had suffered loss as a result of the defalcations by Willoughby. That purpose has entirely succeeded. Those clients have been reimbursed for the loss each sustained. As a result of the payment, the balance in the ledger accounts of the eights clients has been restored to what it was before the defalcations. There might have been a number of reasons why the partners made the payment, for example, because they believed they had a moral obligation to do so. I accept also that the partners then believed that they were reimbursing all who had suffered loss and that they were entirely mistaken in that belief. However, their belief at the time of the payment must not be confused with the purpose of the payment. The partners succeeded in their purpose. There is, therefore, no Quistclose trust. There is no resulting trust in favour of the partners.
Money Paid by Mistake
Mr Roder’s alternative contention was that the partners could recover the sum of $93,000 as money paid under a mistake of fact. Where money has been paid either under a mistake of fact or under a mistake of law, there is a prima facie entitlement to recover that money: David Securities Pty Ltd v Commonwealth Bank of Australia (1992) 175 CLR 353 at 378. It is sufficient if the mistake has caused the payment to be made; it is not necessary to demonstrate that the mistake was fundamental: David Securities at 376 to 378. However, not every mistaken payment may be recovered. The nature of the payment and the circumstances in which it was made may bar recovery. In addition, the payee might be able to rely on one of the defences which displace or reduce the prima facie right to recover.
Those basic principles were expressed more than 200 years in Farmer v Arundel (1722) 2 Wm B1 824 at 825-826; 96 ER 485 at 486 where De Grey CJ said:
When money is paid by one man to another on a mistake either of fact or of law, or by deceit, this action will certainly lie. But the proposition is not universal, that whenever a man pays money which he is not bound to pay, he may by this action recover it back. Money due in point of honour or conscience, though a man is not compellable to pay it, yet if paid, shall not be recovered back … (Footnotes omitted)
As is apparent from that passage, at that time no distinction was drawn between a payment under a mistake of fact and a payment under a mistake of law. The claim by the partners of Magarey Farlam concerns money due in point of honour and conscience. It was money paid when there was no compulsion to do so. The remarks of De Grey CJ are sufficient to dispose of the partners’ claim. But, as the principles as to restitution have been refined since, it is necessary to have regard to them. Those principles confirm the conclusion that the claim by the partners for repayment must be dismissed.
The rationale for the law of restitution is unjust enrichment: Pavey & Matthews Pty Ltd v Paul (1987) 162 CLR 221 at 227, 254-257, 267; Australian & New Zealand Banking Group Ltd v Westpac Banking Corporation (1987) 164 CLR 662 at 673; David Securities Pty Ltd at 379. In that last case, at 379, the majority of the High Court said:
…The fact that the payment has been caused by a mistake is sufficient to give rise to a prima facie obligation on the part of the respondent to make restitution. Before that prima facie liability is displaced, the respondent must point to circumstances which the law recognizes would make an order for restitution unjust. There can be no restitution in such circumstances because the lase will not provide for recovery except when the enrichment is unjust. It follows that the recipient of a payment, which is sought to be recovered on the ground of unjust enrichment, is entitled to raise by way of answer any matter or circumstance which shows that his or her receipt (or retention) of the payment is not unjust. (Emphasis added. Citations omitted)
As that passage indicates, the burden of proof that there is no unjust enrichment lies on the payee, in this case the eight clients. Enrichment is unjust because the payee has no right to receive it or, as the case may be, to retain the money or property which the payer has paid or transferred to him: per Brennan J in David Securities at 393 citing Fibrosa Spolka Akcyjna v Fairbairn Lawson Combe Barbour Ltd [1943] AC 32 at 65. The question whether the enrichment is unjust is not to be determined by some subjective evaluation of what is fair or unconscionable: David Securities at 379. It depends on proving one of the established defences.
There is no criterion by which it can be said that the eight clients were not entitled to be reimbursed for the loss each had suffered. The payment was not unjust. Each of the eight clients was reimbursed for a loss each had incurred. It was just as if the partners had replaced money which had been stolen from the eight clients. The partners were in no sense mistaken as to the extent of the defalcations. In no sense were those eight clients unjustly enriched. They may have secured an advantage over other clients of the firm as a result of the fact that the money stolen from them has been replaced and the other clients have not yet been reimbursed for their loss. However, that does not make the payment unjust. As this is a case where money due in point of honour or conscience was paid, it would be a surprising injustice if it had to be repaid. There are a number of grounds on which the eight clients are able to resist the claim to recover the $93,000.
This was a voluntary payment. On one view, it was a gift. The partners believed that they had a moral obligation to reimburse their clients for the loss each had suffered. They therefore gave to each the amount which each had lost. However, I do not think that it was an unalloyed gift. It is reasonable to infer, as I do, that the partners were conscious of the risk of legal proceedings. On any view of the facts of this matter, there was a serious question whether the partners were vicariously liable for the fraudulent conduct of their employee Willoughby: Lloyd v Grace, Smith & Co [1912] AC 716; Morris v C.W. Martin & Sons Ltd [1966] 1 QB 716; New South Wales v Lepore (2003) 212 CLR 511 at [44]-[52] per Gleeson CJ, at [228] per Gummow and Hayne JJ, at [307]-[314] per Kirby J. I therefore find that one matter which was exercising their minds was whether any of the clients would make a claim to recover the amount which had been lost. It was very likely that they would. The partners would have been aware that those eight clients would, in all likelihood, make claims, either jointly or severally, to recover what each had lost. Thus, when the partners made the payment of $93,000, their purpose was mixed. They intended to discharge a moral obligation and, as well, to forestall any claim by a client. Their intention was also to ensure that they maintained a good relationship with those eight clients by making the payment before even a demand for payment or a threat of litigation. All of these factors were operating upon the minds of the partners. It is unnecessary to find whether the payment was a gift. It is sufficient to find that it was a voluntary payment.
A mistaken payment of a gift may in certain circumstances be recovered. A gift may be recovered where the donor has forgotten that the donee has already been paid: Lady Hood of Avalon v Mackinnon [1909] 1 Ch 476; Barclays Bank Ltd v WJ Simms Son & Cooke (Southern) Ltd [1980] QB 677 at 697 (“Barclays Bank v Simms”). A gift may be recovered where it was made under the mistaken belief that the donee is someone else: Morgan v Ashcroft [1938] 1 KB 49 at 66.
However, a gift or other voluntary payment cannot be recovered, if at the time the payment was made, the payee had an expectation as to some future event and that expectation is not fulfilled. As Professor Birks said in his Introduction to the Law of Restitution (Oxford, 1985) at 147, “A claim for restitution cannot be founded on a misprediction”. He continued at 147:
The reason is that restitution for mistake rests on the fact that the plaintiff’s judgement was vitiated in the matter of the transfer of wealth to the defendant. A mistake as to the future, a misprediction, does not show that the plaintiff’s judgement was vitiated, only that as things turned out it was incorrectly exercised. A prediction is an exercise of judgement. To act on the basis of a prediction is to accept the risk of disappointment. If you then complain of having been mistaken you are merely asking to be relieved of a risk knowingly run.
Professor Birks also examines the same issue at 277 to 279 when examining the doctrine of free acceptance which is a ground of restitution concerning unjust enrichment recovered in the form of goods and services. It is a topic which has no direct relevance for present purposes and can, therefore, be put to one side. Thus, a distinction must be drawn between mistakes and mispredictions. A claim for restitution cannot be founded on a misprediction: Re Cleadon Trust Ltd [1939] Ch 286. The principle is expressed in these terms in Halsbury’s Laws of Australia Vol 23 at para. 370-685:
[A] mistake which is a mere misprediction as to the future will not, in the absence of conduct by the defendant to create or encourage the expectation, enable the plaintiff to recover money paid, or the value of services rendered. (Citations omitted)
The difference between a mistake and a misprediction is readily apparent in this case. The partners were not mistaken in believing that the eight clients had each suffered loss as a result of Willoughby misappropriating trust money belonging to them. Notwithstanding that knowledge, they assumed that there would be no further defalcations. They were wrong in that assumption. Although theirs was a mistake about a present state of affairs, that is to say, that at 8 July 2005 there were no further defalcations, it was an assumption or a prediction as to what future inquiries would disclose. The partners took a risk as to what those inquiries would disclose and in that sense they made a misprediction. The partners assumed the results of the audit and so, to use Professor Birks’ words, they accepted the risk of disappointment. They therefore cannot complain that they were mistaken. Expressed another way, at the time they made the payment of $93,000 the partners had an expectation that the audit of the trust account would disclose that there were no further defalcations. That expectation was not fulfilled.
The conclusion that the partners cannot recover can be reached by another route. If the payer has assumed the risk of his mistake, he will not be permitted to recover the money paid under that mistake. In Kelly v Solari (1841) 9 M & W 54; 152 ER 24, an insurance company had paid money on a claim on an insurance policy, overlooking the fact that the policy had lapsed. The action was brought to recover the mistaken payment. The trial judge had directed a non-suit expressing the opinion (at 55) that, “if the directors had had knowledge or the means of knowledge of the policy having lapsed, the plaintiff could not recover and that thereafterwards forgetting it would make no difference”. The plaintiff obtained a rule nisi for a new trial. The rule was made absolute. In his reasons, Parke B said at 58-59:
I think that where money is paid to another under the influence of a mistake, that is, upon the supposition that a specific fact is true, which would entitle the other to the money, but which fact is untrue, and the money would not have been paid if it had been known to the payer that the fact was untrue, an action will lie to recover it back, and it is against conscience to retain it …
If, indeed, the money is intentionally paid, without reference to the truth or falsehood of the fact, the plaintiff meaning to waive all inquiry into it, and that the person receiving shall have the money at all events, whether the fact be true or false, the latter is certainly entitled to retain it; but if it is paid under the impression of the truth of a fact which is untrue, it may, generally speaking, be recovered back, however careless the party paying may have been, in omitting to use due diligence to inquire into the fact. In such a case the receiver was not entitled to it, nor intended to have it.
Lord Abinger CB said at 58:
There may also be cases in which, although he might by investigation learn the state of facts more accurately, he declines to do so, and chooses to pay the money notwithstanding; in that case there can be no doubt that he is equally bound.
The principle expressed in Kelly v Solari is the basis for category 2(a) identified by Goff J in Barclays Bank v Simms at 695. In that passage, Goff J identifies some principles which can be extracted from the cases. He lists the circumstances in which a person who has paid money under a mistake of fact is not able to recover the mistaken payment. Category 2(a) is the case where the payer intends that the payee shall have the money at all events, whether the fact be true or false, or is deemed in law so to intend.
Plainly, it is necessary to make a careful examination of the facts and determine whether the payer has waived any or any further investigation of the facts: Goff and Jones, The Law of Restitution (6th edition) at 4-032. If the payer takes the chance that his view of the facts may be mistaken, or if he could not be bothered to investigate further whether he was mistaken, a claim for restitution of the mistaken payment will fail: see Arrowsmith in Burrowes (ed), Essays on The Laws of Restitution, pp.25-27, cited in Goff and Jones at 4-032. That is precisely what has occurred here. The partners paid $93,000 into the trust account notwithstanding the fact that they had asked Mr Owens to make an urgent audit of the trust account, notwithstanding that they had learned on 5 July that there had been a defalcation, and notwithstanding that Mr Owens had on 8 July begun his audit. Despite the fact that they had put in train an investigation of the trust account to ascertain whether there were any further defalcations, they made the payment of $93,000. On any view, they took a risk knowing that the investigation was on foot. They denied themselves the opportunity to ascertain the true position and are, therefore, not entitled to recover. They fall within the first arm of the remarks made by Parke B. They do not come within the second arm of those remarks because they could not have had any impression of the true position, one way or the other. They plainly fall within the example provided by Lord Abinger CB.
There is yet another route to the same conclusion. As I have already found, one purpose of the payment was to forestall any claim for reimbursement of the loss which each of the eight clients had suffered. Another class of payments where recovery is not permitted is where the payment is made in response to an honest claim by the payee. This is another means of expressing the principle in para. 2(a) in Barclays Bank v Simms. The decision in South Australian Cold Stores Ltd v Electricity Trust of South Australia (1957) 98 CLR 65, as explained in David Securities at 373 to 374 is an example. In South Australian Cold Stores the plaintiff sought to recover overpayment for electricity charges which had been made at an increased rate after it had successfully challenged the validity of the prices order by which the charges had been increased. Before making the payment, the plaintiff had objected to the increased charge and had even declined to pay the extra amount pursuant to the first monthly account after the prices order. The court held that the plaintiff could not recover because it had assumed that the increased charge might have lawfully been made and was ready to comply with the demand without further inquiry. The Court said at 74 to 75:
The present case may also be regarded as of the description which Lord Abinger C.B. had in mind when in Kelly v. Solari he said: “There may also be cases in which, although he” (the payer) “might by investigation learn the state of facts more accurately, he declines to do so, and chooses to pay the money notwithstanding; in that case there can be no doubt that he is equally bound”. In the present case the only reason why the higher rates were not chargeable was because the formal requirements of the law were not observed by a third party for expressing or giving effect to the decision at which he had actually arrived. Neither he nor the trust were aware of his failure lawfully to exercise his authority. They were unaware because they did not perceive what was required or the true effect of what the document contained. On the side of the company it was simply taken for granted that somehow or another the charges might be lawfully made. This seems to fall outside the reason of the rule under which an action of money had received lies in cases of payment by mistake. Under that rule the action is available when the payee cannot justly retain the money paid to him because it would not have come to his hands if it had not been for a false supposition of fact on the part of the payer causing the latter to believe that he was compellable to make the payment or at all events that he ought to make it. It is to be noticed that Parke B. in Kelly v. Solari defines the requisite mistake as “the supposition that a specific fact is true, which would entitle the other to the money, but which fact is untrue”. According to the decision of Pilcher J. in Turvey v. Dentons 1923 Ltd. it is too restrictive to say that the fact would if true have entitled the payee to the money; and perhaps the word “specific” may also be too definite. But here there was nothing but an assumption that in some way or other the increased charge might lawfully be made and a readiness to comply with the payee’s demand without more, a demand which but for formal defects in the authorisation would have been enforceable. (Footnotes omitted)
In David Securities at 373-374, the High Court explained South Australian Cold Stores and earlier decisions in these terms:
An important feature of the relevant judgments in these three cases is the emphasis placed on voluntariness or election by the plaintiff. The payment is voluntary or there is an election if the plaintiff chooses to make the payment even though he or she believes a particular law or contractual provision requiring the payment is, or may be, invalid, or is not concerned to query whether payment is legally required; he or she is prepared to assume the validity of the obligation, or is prepared to make the payment irrespective of the validity or invalidity of the obligation, rather than contest the claim for payment. We use the term “voluntary” therefore to refer to a payment made in satisfaction of an honest claim, rather than a payment not made under any form of compulsion or undue influence. If such qualifying, factual circumstances are considered relevant, the sweeping principle that money paid under a mistake of law is irrecoverable or even the Federal Court’s modification of that principle to the effect that mistake of law does not on its own found an action for the recovery of money paid is broader and more preclusive than is necessary. As the authorities cited earlier in explanation of the term “mistake of law” make clear, the concept includes cases of sheer ignorance as well as cases of positive but incorrect belief. To define “mistake” as the supposition that a specific fact is true, as Parke B. did in Kelly v. Solari, which was a mistake of fact case, leaves out of account many fact situations. A narrow principle, founded firmly on the policy that the law wishes to uphold bargains and enforce compromises freely entered into, would be more accurate and equitable. (Emphasis added. Citations omitted)
It is well established that a payment in response to an honest claim cannot be recovered. The payment in this case was not made in response to a claim but to forestall it. The fact that the payment was made to forestall a claim is so closely analogous to a payment in response to an honest claim that recovery should be denied on this ground also.
Mason and Carter in Restitution Law in Australia (Butterworths, 1995) at [415] identify another kind of payment which cannot be recovered, one of the kind of voluntary payments identified by the majority in David Securities. It is a payment made by a payer who knows the money is not due or has no belief one way or the other on the matter but is willing to pay because of the relationship with the payee or some anticipated benefit. This is but another instance of the kind of case falling within para.2(a) in Barclays Bank v Simms. The payment of $93,000 in this case has all the hallmarks of this kind of payment. It was voluntary in the sense that the partners made the payment believing they had a moral obligation to make it. They intended that each of the eight clients should have the money for that and other reasons. The money might not have been immediately due and, at the time of the payment, the partners might not have had any belief whether the money was or was not due. For the reasons already given, a moment’s reflection would have caused them to realise that the clients who had suffered loss might seek to be compensated for that loss. The payment was clearly made because of the relationship of solicitor and client and to preserve goodwill with the clients who had suffered in consequence of the defalcation. At the time of the payment, the partners would have hoped that it would preserve goodwill for other clients who might come to learn of the defalcations.
It might be said that the four sets of circumstances I have identified as defences to the partners’ claim are not more than different applications of the rule in Kelly v Solari. That may well be so. Nevertheless, they underline the fact that there is no basis on which the partners are entitled to recover. There are several grounds which defeat their claim.
Finally, a payment cannot be recovered if, in fact, the payer is liable to the payee. As Brennan J observed in David Securities at 392:
In essence, to say that a defendant has been unjustly enriched by the receipt of a payment is to say that the defendant has no right to receive it. Palmer translates the judgment in an ancient case as holding “if I pay money in satisfaction of a duty, and he to whom it is paid has no title to receive it, and so the duty is not satisfied, he to whom the money is paid is thereby indebted to me”. If a defendant has a right to receive a payment, whether under a statute, in discharge of a liability owing to him or pursuant to a contract, a mistake by the plaintiff in making the payment does not convert the receipt into an unjust enrichment. To the extent that a payment satisfies a defendant’s right to receive it, the defendant gives good consideration and is not unjustly enriched. If the defendant receives more than his due, he may be unjustly enriched to the extent of the excess and restitution may be ordered pro tanto. (Citations omitted)
Mr Howard submitted that the partners of Magarey Farlam were vicariously liable to the eight clients who had together lost $93,000. He relied on Lloyd v Grace, Smith & Co. Mr Roder submitted that I should not in these proceedings determine whether the partners are liable for the fraudulent dealings of Willoughby. He submitted that all the relevant facts had not been adduced. The submission is surprising for at least two reasons. The first is that the question whether the partners are vicariously liable is a central question affecting the ability of the partners to recover the $93,000. The second reason is that there is a wealth of evidence on the topic to which I will refer in a moment. The partners have a prima facie entitlement to recover a mistaken payment. It is for the eight clients to establish the defence on which they seek to rely: David Securities at 379. However, there is a very substantial body of evidence pointing to the conclusion that the firm is vicariously liable. If the partners had wished to controvert that evidence, it was necessary for them to adduce their own evidence on the question. That was especially so given that the parties were directed to file affidavit evidence of the facts which they intended to prove in support of the points of claim. Each partner filed an affidavit proving only the circumstance in which the payment of $93,000 was made and his belief at the time of payment. The partners have not disputed any of the other evidence. There is, therefore, no proper reason why I should not determine the question. I add that the other grounds discussed above which bar the claim to recover the payment of $93,000 are a sufficient answer. If I err in considering the issue of liability, the partners’ claim will be defeated by those other grounds.
The facts adduced on this application establish that Willoughby was a long-standing and trusted employee of the firm. I have already referred to his duties. For some years those duties had included the day‑to-day management of the trust account of the firm. He was authorised to handle trust moneys, subject only to the requirement to obtain authority from a partner for the withdrawal of money held on trust. He supervised the trust accounts on a daily basis. His duties enabled him to have access to all primary records relating to the trust accounts of the firm. These duties and responsibilities clearly indicate the level of trust and confidence reposed in him. Importantly, Willoughby attended to the bank transactions relating to trust money. The firm held him out as having authority to transact business relating to the trust account. These are all uncontroverted facts.
It is also not disputed that Willoughby misappropriated an extraordinarily large of trust money. Mr McLaren’s evidence explains how Willoughby effected those fraudulent misappropriations. Mr McLaren’s evidence was not disputed or questioned by the partners. In addition, there is evidence of the trust account ledgers of the 42 clients whose ledgers were manipulated by Willoughby to effect his fraudulent activities. The evidence includes two very large volumes of the trust account ledgers of those clients.
In Lloyd v Grace, Smith & Co, it was held that a firm of solicitors was vicariously liable for an employee who had acted fraudulently for his own ends. The firm was liable because the employee’s fraudulent acts were sufficiently similar to the acts which he was authorised to perform so that it was immaterial if he had chosen to perform them in a fraudulent manner. The decision is explained by Professor Atiyah in Vicarious Liability in the Law of Torts (Butterworths, 1967) at p.198 in these terms:
One it has been found that the servant’s tort is sufficiently similar to acts which he was authorised to perform, it is immaterial that he has chosen to perform them in a fraudulent or a malicious manner. All this is really inherent in the decision in Lloyd v. Grace Smith & Co. and what has continuously hampered the development of this branch of the law has been the failure to recognise that this important case necessarily settles two points, both of which concern the question of the servant’s intention, viz., (1) that in cases of ostensible authority the fact that the servant has a secret fraudulent intention does not prevent his having authority quoad the plaintiff to do properly what he has done fraudulently, and (2) that once it is established that the servant did have authority to do the act properly, it is immaterial that he chose to perform it in a manner which could only benefit himself. While the first part of the decision has been repeatedly accepted and acted on by the court it has not always been appreciated that the second proposition stated above is also necessarily implicit in the decision. Perhaps part of the explanation for this is that the courts have sometimes assumed that the second proposition means that the question of the servant’s intention to benefit the master would become completely irrelevant in the law of vicarious liability, and this conclusion they have rightly found suspect.
That analysis of the decision is consistent with the decision in Morris v C W Martin & Sons Ltd. In that case, an employee of a firm of furriers stole a mink stole which had been delivered to the furriers for cleaning. The defendant furrier was liable because the employee who stole the fur was himself entrusted with the cleaning of the fur. The theft was an improper mode of performing the acts he had been authorised to perform. As Professor Atiyah said (at 200), the decision is explicit authority in favour of the second of the two propositions which is inherent in Lloyd v Grace, Smith & Co, namely, that once it is established that the servant was engaged in performing an act which he was authorised to perform properly, it is immaterial that he chose to perform it in a way which could only benefit himself. That reasoning is affirmed in New South Wales v Lapore at [44]-[52], [228], and [307]-[314].
Willoughby’s fraudulent misappropriations were, of course, conducted for his own personal gains. It is equally clear that he was performing an act which he was authorised to perform properly. He was dealing with trust money which had been withdrawn for a purpose authorised by a partner but, instead of applying the money withdrawn for the intended purpose, he had applied it to his own purposes. It is, therefore, immaterial that he chose to perform his duties in a way to benefit himself. The firm is, therefore, vicariously liable for the fraudulent activities of Willoughby.
Mr Roder’s list of cases included Jobson v Palmer [1893] 1 Ch 71. He did not, however, expressly rely on it. In that case, it was held that a trustee who was remunerated for his services is not liable for a loss occasioned to the trust estate by the felonious acts of his employee, provided that the employee is properly entrusted with the custody of the trust property and is employed without negligence. The decision predates Lloyd v Grace, Smith & Co and is inconsistent with it. The reasoning is similar to that in Cheshire v Bailey [1905] 1 KB 237 which was expressly overruled in Morris v CW Martin & Sons Ltd. In addition, as Gleeson CJ pointed out in New South Wales v Lapore at [52], the defendants in Lloyd v Grace, Smith & Co were fiduciaries. Jobson v Palmer must be considered as not representing current law.
For these reasons, the partners are vicariously liable for the fraudulent activities of Willoughby. That liability is a further bar to the claim by the partners to recover the sum of $93,000. The partners of Magarey Farlam are not entitled to recover the sum of $93,000 which they paid into the trust account of the firm on 8 July 2005. More accurately, none of the eight clients is liable to repay to the partners of Magarey Farlam that client’s portion of the sum of $93,000 paid into the trust account, credited to that client’s ledger and ultimately placed on deposit in a Gimalo investment account.
Conclusion
I will hear the parties on the terms of the orders to be made to give effect to these reasons. For convenience, I repeat the conclusions I have made.
1.With the exception of those clients whose ledgers or investment accounts are affected by the transactions identified by footnotes 1 to 12 inclusive in Exhibit SRB60 to the affidavit of Ms Bishop sworn on 4 October 2006, the moneys remaining in the first trust account shall be distributed to each of the clients of Magarey Farlam according to the balances shown in the trust account ledgers as at 1 August 2005.
2.The moneys in the second trust account shall be distributed to clients according to the balances shown in the trust account ledger as at 1 August 2005.
3.The moneys in the third trust account opened by the supervisor shall be distributed to clients according to the balances shown in that ledger.
4.The beneficial interest in trust money which has been deposited in a Gimalo investment account belongs to each of the clients in whose name the trust money was deposited.
5.The partners of Magarey Farlam are not entitled to repayment of the sum of $93,000. The supervisor should inform the partners of Magarey Farlam that she has been directed by this Court not to comply with the request made by the partners in the letter from their solicitors dated 6 September 2005.
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