Re Nicholson, J.C. v Ex parte Totterdell, G.F

[1989] FCA 261

Re: JOHN CAMPBELL NICHOLSON
Ex Parte: GEOFFREY FRANK TOTTERDELL
No. 854 of 1988
FED No. 261
Bankruptcy

COURT

IN THE FEDERAL COURT OF AUSTRALIA

GENERAL DIVISION
BANKRUPTCY DISTRICT OF THE STATE OF WESTERN AUSTRALIA
French J.(1)

CATCHWORDS

Bankruptcy - composition - approval - massive discrepancy between assets and liabilities - no issue of fraud or recklessness - debts arising from guarantees - no steps taken to revoke for future advances - question of right of subrogation - double proofing - principles - approval of composition and annulment of bankruptcy.

Bankruptcy Act 1966 s.73(4), s.74, s.116(2)(b)

O'Donovan and Phillips - The Modern Law of Guarantee

Re Fryda (1964) 6 FLR 144

Re Aylmer; Ex parte Bischoffscheim (1887) 19 QBD 33

Re Lewis (1987) 77 ALR 165

Re Clyne (1978) 44 Australian Bankruptcy Bulletin 3901

HEARING

PERTH

#DATE 23:5:1989

Counsel for the Bankrupt: Mr K. Dundo

Solicitors for the Bankrupt: Robinson Cox

The Trustee appeared in person.

ORDER

The composition approved by special resolution of the general meeting of the bankrupt's creditors held on 13 March 1989 be approved.

The bankruptcy be annulled.

NOTE: Settlement and entry of orders is dealt with in Rule 124 of the Bankruptcy Rules.

JUDGE1

John Campbell Nicholson became a bankrupt on 19 December 1988 by filing a debtors petition. Proofs of debt lodged with his Trustee amounted to $17,231,194.80. Realisation of his assets yielded $2,000. The Trustee now seeks the Court's approval of a composition under which the estate would receive a sum of $150,000. Nicholson in turn seeks an annulment of the bankruptcy.

1. Nicholson was employed as an accountant with various firms from 1962 to 1973. In 1973 he went into partnership with Mr D. Kennerly under the firm name Kennerly Nicholson. While a member of that firm he acted as director on the boards of a number of Western Australian companies, the majority of which were his clients and to whom he provided financial management advice. In 1982 Kennerly and Nicholson together acquired a 25% interest in the Potter Group of companies, well known for their operation of a chain of health studios. The interest was acquired through two investment trusts, the trustees of which were Forfeit Pty Ltd (as trustee for the J.C.N. Family Trust) and Sequin Pty Ltd (as trustee for the D.K.Family Trust). The majority interest in the group was held by Mr Laurie Potter and his associated companies. Kennerly retired from the partnership in 1983, upon being bought out by Nicholson and two other partners. The practice was thereafter incorporated as Kennerly Nicholson Pty Ltd. At the same time, Nicholson acquired Kennerly's interest in the Potter Group and Kennerly resigned as a director of its various companies. It is apparent also that Nicholson either directly or through Forfeit Pty Ltd acquired control of Sequin's holding. Nicholson's involvement with the Potter Group was secondary to the secretarial and tax accounting work provided to it by his firm. From 1983 to 1985 he used to meet Potter regularly to discuss business matters. In 1984 he formed the view that the Group needed additional capital to fund health clubs at Melville and Midland. He negotiated the acquisition of a 25% interest in the Group by B.L.E. Capital Ltd, a subsidiary of Westpac Banking Corporation. Potter himself saw other opportunities for expansion in property and health club related activities. In 1985 and 1986 he began borrowing from the Teachers Credit Society and was provided with overdraft facilities to fund various developments, including one known as The Tradewinds Hotel. In 1985 Nicholson, Forfeit and Sequin guaranteed all advances made by the Teachers Credit Society and it appears that the guarantees extended not only to existing, but to future loans. Nicholson had also given guarantees to finance companies principally for purchases of health club equipment. In June 1985 the business of Kennerly Nicholson Pty Ltd was sold to Ernst & Whinney, Accountants and Nicholson took up an appointment as managing director of Sealcorp Holdings Limited, a company concerned with research into and marketing of software for computer based financial management advice, and in which Ernst & Whinney held shares. His day to day involvement with Potter decreased. He did, however, express concern in late 1985 and early 1986 that the Group was expanding without adequate capital support. Potter did not take his advice "and proceeded to control the operation of the Potter Group as if he was the only principal". Their meetings became informal briefing sessions. According to Nicholson:
   

"It was simply impossible to get a fix on what was really happening with the Potter Group and Potter appeared to tell me what he wanted me to know."

1. In 1986 Nicholson's concern about the affairs of the Potter Group deepened and he told Potter that he wanted to withdraw from participation in it. Late in 1986 Potter Nominees Pty Ltd acquired the Forfeit and Sequin interests for $400,000 under a contract of sale, pursuant to which Potter and Potter Nominees Pty Ltd executed a Deed of Indemnity in relation to the personal guarantees. Nicholson resigned his directorships with the Potter Group companies in January 1987 and urged Potter to seek a substantial partner to adequately capitalise the Group and to ensure that the Indemnity would be of substance. In the event, he or interests associated with him were only paid $100,000 under the contract of sale and the bulk of that went to pay his income tax liabilities. Although he says he approached the Group's creditors and in particular, Teachers Credit Society, to release him from his guarantees they were unwilling to do so. In oral evidence Nicholson told the Court that it had not occurred to him to consider whether he could revoke the guarantee in respect of future advances.

2. Between January and October 1987 Nicholson said the Potter Group increased its borrowings with the Teachers Credit Society by about $10 million. Although he did not participate in these loans, his personal guarantees and those given by Forfeit and Sequin were still operative. In late October 1987 the Potter companies went into receivership. In October 1988 Nicholson resigned as a director of Sealcorp Holdings Pty Ltd, although he has been employed by that company as a consultant ever since. The Teachers Credit Society loans and its operations generally were taken over by the Rural and Industries Bank of Western Australia. Nicholson tried unsuccessfully to negotiate a Part X arrangement with the Bank. The Bank however would not consider a composition until he had become a bankrupt. On this basis he had no choice but to file his debtor's petition, which he did on 19 December 1988.

3. The Trustee has to this date admitted proofs of debt to a total value of $16,961,986. Outstanding proofs yet to be admitted amount to $255,323. Assets realised in the estate totalled $2,000 from the sale of a yacht. The only other assets of any value were household furniture and effects, worth $5,000 which are protected by s.116(2)(b) of the Bankruptcy Act 1966.

4. Nicholson is evidently a beneficiary of the J.C.N. Family Trust and possibly the D.K. Family Trust, but the corporate trustees Forfeit and Sequin, having also provided guarantees of borrowings by the Potter Group, are in liquidation and the trust assets will be realised, the surplus to be paid to their creditors. The debts owed to the Teachers Credit Society by the Potter Group will be reduced by the sale of its assets to a level of about $4 million, according to Nicholson.

5. As to property that he has owned and disposed of, Nicholson says that a former family home in Shenton Park owned jointly with his previous wife was transferred to her as part of a divorce settlement in 1977. His only other assets in the past 15 years have been his interest in the practice of Kennerly Nicholson, which was sold in 1985, a house which was sold in 1982 and the proceeds of which sale cleared two mortgages, and personal effects which have already been mentioned. He is paid about $85,000 per annum by Sealcorp Holdings Pty Ltd and of that pays some $25,000 annually to his ex-wife for the support of their two children who are currently at university and college.

6. In 1987 he married Rosemary Goode, a senior executive with Sealcorp. She is a director and shareholder of Woneaton Pty Ltd, a shareholder in Sealcorp and trustee of the Campbell Family Trust.

7. The proposed composition was approved at a general meeting of creditors called for the purpose on 13 March 1989. At that meeting four creditors representing $16,578,740.57 voted by proxy in favour of the proposal. Two creditors dissented. Those in favour of the proposal represented a majority in number and exceeded three quarters in value of all creditors voting, thus satisfying the requirements for a special resolution under s.73(4) of the Bankruptcy Act.

8. The terms of the composition were as follows:
   

"1. That payment of all proper costs, charges and expenses of and incidental to the proceedings of all fees payable to the Trustee in Bankruptcy shall constitute a first charge on the moneys referred to in paragraph 3 hereof.

2. That payment of all priority debts directed to be so paid under the Act in the distribution of the property of a bankrupt shall constitute a second charge on the moneys referred to in paragraph 3 hereof.

3. That the Composition shall be paid on all proved debts from the following funds:

(a) From all moneys in my estate held by the Trustee.

(b) From the sum of $150,000 to be provided as set out in paragraph 4 hereof.

4. That the payment of the Composition to be secured in the following manner: Loan provided by Woneaton Pty Ltd which in turn is provided by Esanda Finance Corporation Ltd."

1. The Trustee estimates that there will be $141,000 available to be distributed to ordinary unsecured creditors representing about 0.87 cents in the dollar on claims lodged to date.

2. The application for approval of the composition was not opposed before the Court, nor was the bankrupt's application for annulment. I am satisfied on the evidence before me that there is no reasonable prospect that the creditors would, in the foreseeable future, fare any better out of the continuance of the bankruptcy than under this composition. There is no indication that Nicholson has access to any other property or would be in a position to make any greater contribution from income than that proposed.

3. The Trustee reports that he is unaware of any conduct on the part of Nicholson either prior to or since he became a bankrupt which was other than satisfactory. Nicholson has been a registered auditor and registered liquidator and is presently registered as a trustee in bankruptcy. He has resigned from the offices of auditor and liquidator and informs the Court that he has filed papers to effect his removal from the Register as a trustee. At present he is employed as a marketing consultant with Sealcorp, but has not taken part in its management. He has taken steps to avoid spending any prolonged period of time in its head office so there may be no suggestion that he may have become involved in the management of that company. He has found increasing difficulty in carrying out his marketing role as, he claims, his credibility is undermined by competitors who refer to his bankruptcy. If the bankruptcy is not annulled he believes he will have to sever any connection with Sealcorp. If the bankruptcy is annulled he intends to assume a general management role in the company.

4. A number of affidavits were filed sworn by persons who had had associations with Nicholson over a number of years and testifying as to his general competence and care, both as an advisor and as a company director.
   Relevant Legal Principles

5. The relevant provisions of the Bankruptcy Act are to be found in s.74 which provides:
   

"74(1) If a bankrupt's proposal for a compostion or a scheme of arrangement is accepted by his creditors in accordance with section 73, the bankrupt or the trustee may apply to the Court for approval of the composition or scheme of arrangement.

(2) The trustee shall give notice of the time appointed for hearing the application to each creditor who did not assent to the proposal.

(3) The Court shall, upon the hearing of the application, hear -

(a) a report by the trustee about:

(i) the terms of the composition or scheme of arrangement; and

(ii) such (if any) of the bankrupt's conduct and examinable affairs as the trustee has investigated; and

(b) any objections to the composition or scheme of arrangement made by or on behalf of a creditor.

(4) The Court may approve, or refuse to approve, the composition or scheme of arrangement.

(5) Where the Court approves a composition or scheme of arrangement under this section, it may make an order annulling the bankruptcy."

(6) and (7) are not relevant for present purposes.

1. It is necessary in approving a composition that the Court be satisfied that the proposal is reasonable, is in accordance with the provisions of the Act and will benefit the creditors generally and to a greater extent than under the continuing administration of the bankruptcy: Re Fryda (1964) 6 FLR 144, 152 (Paine J.); Re Aylmer; Ex parte Bischoffscheim (1887) 19 QBD 33. I adopt as I did in Re Lewis (1987) 77 ALR 165, the observations of Deane J. in Re Clyne (1978) 44 Australian Bankruptcy Bulletin 3901 at 3902:
   

"Generally speaking, this Court should be slow to refuse to approve a proposed composition or scheme of arrangement which has been duly approved by special resolution (i.e. by a majority in number and at least three-quarters in value of those present, either personally or by attorney or proxy) at a properly convened meeting of creditors, in the absence of considerations which indicate the presence of one or more of the following factors:

(i) That material was concealed from some or all of the creditors.

(ii) That some or all of the creditors were unaware of material considerations which could conceivably have led them to take a different view to the view expressed in their voting on the proposed scheme.

(iii) That some or all of the creditors were not given a proper opportunity of considering or voting upon the proposed composition or scheme.

(iv) That the provisions of the proposed composition or scheme are unreasonable or clearly not in the interests of the creditors.

(v) That the provisions of the proposed composition or scheme unfairly favour some class or classes of creditors over another class or classes or some creditor or creditors over another creditor or other creditors.

(vi) That some or all of the creditors voted in support of the proposed composition or scheme of arrangement by reason of dishonest or collateral purposes or objects.

(vii) That the bankrupt has been guilty of such misconduct either leading to or in relation to the bankruptcy that, in all the circumstances including the period since the making of the sequestration order, it is necessary in the public interest to refuse to lend the sanction of the Court to the arrangement which he has reached with the creditors, or that the circumstances of the matter are such as to make it necessary for the Court to refuse its approval to the scheme for the reason that to give such approval would not be consistent with the general purposes of the Bankruptcy Act."

1. In relation to the application for annulment it does not automatically follow from the approval of the composition:
   

"...as with an application for discharge, I have to consider not only the interests of the creditors and of the bankrupt but also the interests of the public and of commercial morality...and take into account such conduct and affairs as have relation to the bankruptcy." Re Groom; Ex parte The Bankrupt

(1977) 16 ALR 278, 283-4 (Riley J.).

Approval and Annulment

1. The magnitude of the disparity between the bankrupt's assets and his total liabilities raise the spectres of fraud and recklessness on his part. In this case, however, I am satisfied on the evidence that these spectres can be banished. That satisfaction is reinforced by the absence of any pressure from his creditors for a public examination and the absence of any objection to this Court's approval of the composition or to the application for annulment.

2. Nicholson may be criticised for having failed to take some steps to revoke his continuing guarantee in respect of the TCS advances. Generally speaking, a guarantee in respect of advances made from time to time by creditor to principal may be regarded as a standing offer which matures into a contract of guarantee as each new advance is made. It can therefore be revoked at any time in respect of future advances - O'Donovan and Phillips - The Modern Law of Guarantee pp 343-344. In the absence of evidence of the precise terms of the guarantees which gave rise to the liabilities in this case, it is not possible to arrive at a concluded view on whether Nicholson could have effected a revocation. Given the magnitude of the additional borrowings in 1987 and his concern about the way Potter was conducting the business, it is surprising that he did not take some steps to at least obtain advice about his position. That is not a factor however which stands in the way of approval of the composition or annulment of the bankruptcy. The only real victim of Nicholson's omission in this regard, was himself. An organisation which was prepared to advance $10 million to the Potter Group in 1987 was hardly likely to be influenced by the guarantee on offer from Nicholson. In any event, it is his evidence that he did seek a release from the guarantee and tried to protect his position with an indemnity from Potter and Potter Nominees Pty Ltd.

3. The other question that arises in this case and which was not raised by either party is as to whether the bankrupt has an asset in the form of a right of subrogation against the members of the Potter Group whose debts he guaranteed. In this case it appears that the rule against double proof applies to prevent the guarantor recovering where the creditor proves in the debtor's bankruptcy or insolvency - see O'Donovan and Phillips (supra) at pp 435-436.

4. In the event, I am satisfied that the proposed composition is in the interests of the creditors and that they could not look forward to any better outcome deriving from the continuance of the bankruptcy. I am also satisfied that there is no issue of public interest or commercial morality which would have to be taken into account adverse to Nicholson. In my opinion the composition should be approved and the bankruptcy should be annulled.