Bankruptcy of Fava HC Auckland CIV 2006-404-5233
[2007] NZHC 2072
•30 August 2007
IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY
CIV 2006-404-5233
IN THE MATTER OF the Insolvency Act 1967
ANDIN THE MATTER OF the Bankruptcy of PHILIP JOSEPH FAVA
Hearing: 30 July 2007
Appearances: J C LaHatte for the applicant
N S Gedye for opposing creditors
G Neil for the Official Assignee
Judgment: 30 August 2007 at 12.00 noon
JUDGMENT OF POTTER J
On application to approve compromise
In accordance with r 540(4) High Court Rules
I direct the Registrar to endorse this judgment
with a delivery time of 12.00 noon on 30 August 2007.
Solicitors: Hornabrook Macdonald, P.O. Box 91845, Auckland
Murdoch Price, P.O. Box 23620, Hunters Corner, Papatoetoe, Auckland
Copy to: N Gedye, P.O. Box 2097, Shortland Street, Auckland
J C LaHatte, 24 Brentwood Avenue, Mt Eden, Auckland
IN THE BANKRUPTCY OF FAVA HC AK CIV 2006-404-5233 30 August 2007
TABLE OF CONTENTS
Introduction [1] Preliminary matters [4] The composition [6] Creditors [8] Mrs Zaghloul’s debt [12] The Churchill proceedings [17] Insolvency Act 1967 – relevant provisions [21] Applicant’s position [30] Position of opposing creditors [38] Submissions by the Official Assignee [41]
The terms of the composition – reasonable or not reasonable? [48]
Result [58]
Introduction
[1] Philip Joseph Fava was adjudicated bankrupt on 6 December 2006 on the petition of Mrs Ekhlas Zaghloul. Mr Fava withdrew his opposition to the bankruptcy order being made. A consequence of his bankruptcy was that Mr Fava was disqualified from acting as a director. As he was the sole director of the four plaintiff companies in the Churchill proceedings referred to later in this judgment, Williams J gave judgment for the defendants. Mr Fava now seeks to have approved by the Court a compromise with his creditors so his bankruptcy will be annulled, enabling him to resume directorships of the plaintiff companies and pursue the Churchill proceedings.
[2] Mrs Zaghloul, ASB Bank Limited, Bank of New Zealand and Lion Finance
Limited who are creditors of Mr Fava, oppose the application.
[3] Under s 122 of the Insolvency Act 1967 (“the Act”) the Court may refuse to approve a composition with creditors in certain circumstances. The issues for determination in this case are whether the Court is of the opinion that:
a) The terms of the composition are not reasonable or not calculated to benefit the general body of creditors; or
b)Mr Fava has committed any misconduct that would justify the Court in refusing, qualifying or suspending his discharge from bankruptcy; or
c) For any reason it is not expedient that the composition should be approved.
Preliminary matters
[4] Although an application for approval of a composition would normally come before an Associate Judge, this application was heard by me in open Court pursuant to a ruling of Associate Judge Doogue dated 19 June 2007.
[5] A memorandum of counsel for Aral Property Holdings Limited and David Leung, the defendants in the Churchill proceedings, dated 27 July 2007 was filed. Mr LaHatte for Mr Fava queried the status of this memorandum and objected to it. The defendants in the Churchill proceedings are not parties to this application, nor are they creditors of Mr Fava. I advised counsel that I would not refer to or rely on the matters referred to in the memorandum.
The composition
[6] The terms of the composition of which approval is sought essentially provide for:
a) $2,620 costs and disbursements on the order for adjudication to be paid to Mrs Zaghloul;
b)An interim dividend of 2.5 cents in the dollar to be paid to creditors within one day of Court approval of the composition;
c) As to the remaining 97.5 cents in the dollar, payment to be suspended until, in essence, the plaintiffs in the Churchill proceedings make full recovery following a judgment in their favour. Then a first final dividend of 7.5 cents in the dollar to be paid, followed by a second final dividend of up to 90 cents in the dollar, but subject to prior payment of liquidator’s costs and creditors of Matam Investments Limited which exceed $1m.
d)If the plaintiffs are unsuccessful in the Churchill proceedings, the first final dividend of 7.5 cents to be paid one month after judgment is
given for the defendants, or three years after the date of Court approval of the composition, whichever is later;
e) If Mr Fava fails to cause the plaintiffs to prosecute the Churchill proceedings by applying under r 486 of the High Court Rules to set aside the default judgment against them, then the final dividend would be limited to the amount of the first final dividend of 7.5 cents in the dollar payable three years after the date of Court approval of the composition.
f) All property of the bankrupt vested in the Official Assignee to revert immediately to Mr Fava.
[7] An earlier composition confirmed by creditors on 13 April 2007 lapsed for want of Court approval within one month. The earlier composition did not provide for any dividend to creditors and suspended recovery of debts for three years from 25
March 2007. It provided, as does the second composition, for the bankrupt’s property to revert immediately to Mr Fava.
Creditors
[8] The Official Assignee filed a report, an amended report and a supplementary report. The supplementary report dated 27 April 2007 records that creditors who have proved in the bankruptcy for a total of $1,390,539.40 have voted in favour of the compromise and creditors who have proved for $55,645.57 have voted against the compromise. The number voting in favour is nine (96.1%) and against four (3.9%). The creditors fall into two main categories - non-related (landlord, banks, legal accounting, trade) and related (family and friends).
[9] The principal creditor is Mr Fava’s Trust claiming a debt of $729,947.28, i.e. over half the total value of the claimed indebtedness. The second largest creditor is Mrs C Wardrope, Mr Fava’s sister who has claims totalling $283,824.77. The third largest creditor is Mr D Dustin who claims $290,751.06. Mr Dustin says he became
well acquainted with Mr Fava by supporting him in various financially related matters. Mrs Zaghloul describes him as a friend of Mr Fava.
[10] Mr John Vague, an insolvency practitioner, formerly a partner in McDonald
Vague, filed an affidavit referring to McDonald Vague’s proof of debt for
$28,907.43. He was a receiver of Matam Investments Limited, one of the plaintiffs in the Churchill proceedings. Mr Vague says he believes the second composition is in the best interests of all creditors and McDonald Vague supports its approval by the Court. (The compromise makes provision for payment of liquidator’s costs and creditors of Matam Investments Limited in priority to payment of the second final dividend of 90 cents in the dollar to creditors of Mr Fava – refer [6](c)).
[11] Affidavits were filed by Mrs Zaghloul and on behalf of each of the other creditors who oppose the approval of the composition, namely ASB, BNZ and Lion Finance Limited. The debts of the other creditors relate to credit card accounts. These creditors want their debts paid and oppose the compromise because it does not make some arrangement for a substantial payment of their debts. They do not accept that the initial dividend of 2.5% is an adequate amount – in the case of Mrs Zaghloul
$248.03 of a debt of $12,595.28 plus the $2,620 adjudication costs; BNZ $354.13 of a debt of $14,165.25; ASB $374.66 of a debt of $14,986.51; Lion Finance Limited
$347.46 of a debt of $13,898.53. They do not accept that the proposed further payment in three years time of 7.5% is adequate given there is no certainty it will be paid, even in three years time. They note that having gone from offering effectively nothing under the first compromise Mr Fava is offering under the second compromise 10% of the debts, and the opposing creditors are not satisfied there has been proper disclosure of the financial resources available to the bankrupt. They have concerns about Mr Fava borrowing further money to fund the 10%.
Mrs Zaghloul’s debt
[12] The history of Mrs Zaghloul’s debt on the basis of which she petitioned for the bankruptcy of Mr Fava, is part of the background to the application. Mr Fava was a tenant of Mrs Zaghloul of a house in Remuera, Auckland for about a year. Issues arose between landlord and tenant. These gave rise to proceedings before the
Tenancy Tribunal in 2004 which resulted in orders that Mr Fava pay $3,255.04 to Mrs Zaghloul for unpaid rent and water rates with another $250 for repairs. Mr Fava’s cheque in payment of the $3,255.04 was dishonoured. There were further matters heard by the Tenancy Tribunal.
[13] Mr Fava appealed the Tribunal’s decision regarding rent to the District Court and subsequently the High Court. The appeals were dismissed; so was an application for recall of the High Court judgment and an application for leave to appeal to the Court of Appeal.
[14] On 9 June 2006 Mr Fava sent to Mrs Zaghloul’s lawyer an email in which he stated, among other things:
Finally, I might just add further in relation to potential enforcement of the judgment, that in the unlikely event the High Court do not stay your client’s judgment I can always compromise with my creditors. This is an area of the law in which, from a company perspective, I have much experience … I can assure you a creditors compromise has a 100% chance of success but it too is just the sort of distraction I and my Queens Counsel wish to avoid.
[15] Mrs Zaghloul subsequently served a bankruptcy notice on Mr Fava in respect of the debt of $3,505.04 plus costs and disbursements of the various appeals, the outcome of which was the order for adjudication by Associate Judge Doogue on
6 December 2006.
[16] In an affidavit sworn 4 May 2007 Mrs Zaghloul states that Bell Gully, the lawyers for the defendants in the Churchill proceedings, referred her to Mr Gedye for advice in respect of the composition and said that Aral Property Holdings Limited would meet his fees. She agreed to this. She disagrees with Mr Fava’s contention that she is driven by persons connected to Aral Property Holdings Limited to derail Mr Fava’s strategy to reinstate the Churchill proceedings. She says:
Mr Fava is quite wrong about this – my only objectives are to either have my debt paid in full or to keep Mr Fava in bankruptcy. I do not care about the Churchill litigation … I have no knowledge about the Churchill litigation. What happens with that litigation is none of my concern. I made the decision to initiate bankruptcy proceedings last year after conferring with both Baycorp and my barrister at that time. My position has been honestly and fully stated to Mr Fava and the Official Assignee and Mr Vague and it did not include any interest in the Churchill litigation.
The Churchill proceedings
[17] These proceedings are part of the background to the application. They were commenced in October 2001 under CIV 2001-404-2302. By the eighth amended statement of claim dated 14 August 2006 the plaintiffs, Churchill Group Holdings Limited and three other companies owned or controlled by Mr Fava, alleged against the defendants Aral Property Holdings Limited and David Leung in relation to a joint venture involving the ownership and management of a shopping centre, misleading and deceptive conduct in breach of the Fair Trading Act and deceit. The plaintiffs claimed $25m in compensatory damages and $25m in exemplary damages.
[18] Following Mr Fava being adjudicated bankrupt, on 13 December 2006
Williams J gave judgment for both defendants on both causes of action against all four plaintiffs, under r 485 of the High Court Rules. Williams J recorded that the bankruptcy followed service of a bankruptcy notice on Mr Fava on 22 September
2006 and a petition on 24 October 2006 which related to unpaid rent of a little over
$3,500. However, with costs accumulated over three to four years following Mr Fava’s unsuccessful challenge to the Tenancy Tribunal decision against him, the debt amounted to about $7,000 at the time the order of adjudication was made.
[19] The judgment further recorded that as a result of Mr Fava’s adjudication he became disqualified from continuing to hold any directorships of a company and his assets, including shares in two of the plaintiff companies, passed to the Official Assignee. Mr Fava had been the sole director of each of the four plaintiffs, no substitute director or directors had been appointed, and none of the shareholders appeared likely to take any steps to exercise their rights to appoint a director or directors or to re-instruct counsel. Mr Judd QC who had acted for the plaintiffs up to the point of Mr Fava’s adjudication, had sought leave to withdraw. At that stage the plaintiffs’ case had been completed and the defendants’ case was in progress. The
hearing was in its 31st day.
[20] Williams J also observed that were Mr Fava able to alter the position of the plaintiff companies it might be possible for him to obtain an order under r 486
setting aside the r 485 order. The Judge therefore refrained from making any comments on the merits of the case (at [41]):
… if for no other reason that there is, however remote, the possibility the claim might revive.
Insolvency Act 1967 – relevant provisions
[21] Section 121 of the Act provides that where a person has been adjudged bankrupt, his creditors may by special resolution accept a composition in satisfaction of the debts due to them by the bankrupt.
[22] Section 122 provides for the approval of compositions by the Court. Subsection (3) outlines the circumstances in which the Court may exercise its discretion to refuse to approve the composition. Section 122 provides:
Approval of compositions by Court
(1)When the confirming resolution has been passed, either the bankrupt or the Assignee may apply to the Court to approve the composition, and notice of the application shall be given to each creditor.
(2)The Court shall, before approving a composition, hear a report of the Assignee as to the terms of the composition and as to the conduct of the bankrupt, and any objection which may be made by or on behalf of any creditor.
(3)The Court may refuse to approve the composition, if it is of opinion: (a) That the provisions of section 121 of this Act have not been
complied with; or
(b)That the terms of the composition are not reasonable or not calculated to benefit the general body of creditors; or
(c) That the bankrupt has committed any such misconduct as would justify the Court in refusing, qualifying, or suspending his discharge; or
(d)That for any reason it is not expedient that the composition should be approved.
(4)No composition shall be approved by the Court which does not provide for the payment in priority to other debts of all debts directed to be so paid in the distribution of the property of a bankrupt.
(5)A composition so approved by the Court shall be binding on all the creditors, so far as relates to any debts due to them and provable under the bankruptcy.
(6)At the time when a composition is approved, the Court may correct or supply any accidental or formal error or omission therein, but no alteration in the substance of the composition shall be made.
(7)The approval of the Court shall be conclusive as to the validity of the composition.
[23] Section 123 provides for the bankrupt and the Official Assignee to execute a deed of composition for carrying the proposal into effect forthwith after the Court has approved the composition, which is to be produced to the Court for confirmation.
[24] If satisfied that the deed is in conformity with the composition as approved, the Court directs the deed to be entered and filed in the Court, annuls the adjudication of bankruptcy, and “the bankrupt’s property to which the deed relates shall vest and be dealt with thereafter as provided in the deed” (s 123(2)).
[25] Section 123(4) provides:
When any such deed of composition is entered by the Registrar, the Assignee shall forthwith, subject to the provisions of the deed, put the bankrupt (or, as the case may be, the trustee under the composition) into possession of the bankrupt’s property, or such of it as is in possession of the Assignee and as is intended by the composition to revest in the bankrupt or trustee.
[26] Section 124 gives the Court continuing exclusive jurisdiction in relation to the enforcement of any composition approved by the Court.
[27] Section 125 provides that if the confirming resolution is not passed within one month after the preliminary resolution or if the composition is not approved by the Court within one month after the passing of the confirming resolution or if the Deed of Composition is not executed by the bankrupt within seven days after the approval of the composition by the Court or within such further time as the Court may allow, the proceedings in bankruptcy shall go on as if there had been no resolution.
[28] However, s 10 gives the Court power to extend time, either before or after the expiration of the time specified, upon such terms as it thinks fit. In this case it was accepted by all parties at the hearing that the Court should exercise the power to extend time for approval of the composition under s 10, in the Court’s discretion.
[29] It is convenient to refer also to s 143 which provides for approval of a proposal by an insolvent person prior to adjudication. The Court has a discretion to refuse to approve such a proposal on the same grounds as are provided in s 122(3) in relation to compositions, except that sub-paragraph (c) relating to misconduct of the bankrupt, does not apply.
Applicant’s position
[30] As set out in the application to approve composition, the grounds upon which
Mr Fava relies are:
1.The composition has been confirmed by the majority in number and in excess of 75% in value of creditors present and voting on a Special Resolution to confirm or reject the composition; and
2. Section 121 Insolvency Act 1967 has been complied with; and
3.The terms of the composition are reasonable and are calculated to benefit the general body of creditors; and
4.The Applicant has not committed any misconduct as would justify the Court in refusing qualifying or suspending his discharge; and
5. It is expedient the composition be approved; and
6.Under the composition the preferential creditor will be paid in full the costs and disbursements on the sealed Order for Adjudication and the general body of creditors are all treated equally with an immediate first dividend and a future second dividend (which could perhaps see all creditors paid in full).
[31] Mr Fava filed four affidavits dated 13 April 2007, 20 April 2007, 20 July
2007 and 23 July 2007. Mr Fava’s first two affidavits relate to the first composition which lapsed. Mr Fava is critical of an alleged change of stance by Mrs Zaghloul from supporting his proposed composition on 12 March 2007 to advising that she would not support it on 14 March 2007. He infers that Mrs Zaghloul is funded by the defendants in the Churchill proceedings and they are behind her change of
stance. (Mrs Zaghloul freely acknowledges and Aral Holdings Ltd and Mr Leung have confirmed they are paying her costs in relation to the composition. She denies a change of stance).
[32] Mr Fava’s third affidavit contains a number of serious allegations against Mr R G Simpson of Bell Gully Buddle Weir who represented the defendants in the Churchill proceedings. Also of Mrs Zaghloul’s legal representation, including the independence of Mr Gedye from the defendants in the Churchill proceedings and Bell Gully Buddle Weir. These allegations appear to relate to the period up to 20
April 2007 and therefore do not relate to the composition which is before the Court for approval pursuant to the creditors’ resolution on 7 June 2007. In any event Mr Fava’s allegations, inferences, conclusions and expressions of opinion are not relevant to the Court’s consideration of his application for approval of the second composition with creditors. They are inadmissible as evidence and are inappropriate, as are similar allegations in written submissions. I set them to one side.
[33] The third affidavit includes a description of the Churchill proceedings and Mr Fava’s personal involvement in preparation for and during the hearing. He refers to his application on 29 November 2006 for adjournment of the bankruptcy application which was declined, and says that on 6 December 2006:
… in a ground down state, I made a bad judgment call on the bankruptcy matter. That is regretable, but it is real life … I made a mistake. I withdrew opposition to the bankruptcy. I was bankrupted.
He then says he sought from Williams J an adjournment of the Churchill proceedings whilst he “… organised an annulment”. That request was declined and judgment was entered.
[34] Mr Fava says that upon approval of the composition he will be appointed sole director of all the plaintiffs and:
… any eventual fruits of the litigation will come under my effective control.
He states that the interim dividend will be provided:
… by entities/persons favourably inclined towards me.
Further, that he has advised the Deputy Official Assignee he will have to work to earn the money for the first final dividend and he has a safety net in place to make the first final dividend “fail safe”.
[35] The fourth affidavit sworn 23 July 2007 (filed outside the timetable orders), annexes a statement by a Mr Chong Wai Sum of Singapore signed on 13 June 2003 which appears to relate to the Churchill proceedings. I do not consider this has any relevance to the application for approval of compromise. Also annexed is a copy of the second composition which Mr Fava believed was not before the Court. However, that is not correct. The second composition is annexure “D” to the supplementary report of the Official Assignee dated 10 July 2007, filed on that date.
[36] On 13 August 2007, well after the hearing, Mr Fava filed an affidavit by Graham Wardrope, a medical practitioner who is also Mr Fava’s brother in law. I decline to receive this affidavit in support of Mr Fava’s application. It was too late by far, and the deponent cannot be regarded as independent.
[37] Mr LaHatte made a number of submissions in support of the application:
• 96.1% of the creditors in value have approved the compromise. Even without the support of Mr Fava’s Trust those in support would exceed 50% in number and value.
However, I note that the debt to the Fava Trust of $729,947.28 in fact represents just over half of the total value of the creditors being $1,446,184.97.
• “Independent” parties support the compromise. Mr LaHatte included in this submission Mr Dustin whom he described as simply a creditor who wants to get paid. He also included Mr Vague.
However, Mr Vague is a party to an agreement made in June 2005 with Matam Investments Limited referred to in the second composition. It provides for payment of liquidator’s costs and creditors of Matam in priority to the second
final dividend of 90 cents in the dollar. Thus it appears that Mr Vague or his interests stand to benefit under the compromise ahead of other creditors from any proceeds of the Churchill proceedings, if the plaintiffs are successful. The independence of Mr Dustin and Mr Vague, is questionable.
• The Official Assignee is neutral. (Mr LaHatte retreated from an initial submission that the Official Assignee’s position was that the compromise is “a good thing”).
• The provisions of s 121 of the Act have been complied with.
• The terms of the compromise are reasonable and s 122(3)(b) is satisfied. If Mr Fava remains bankrupt none of the creditors receives anything. If the compromise is approved the general body of creditors will receive an initial dividend of 2.5 cents in the dollar, and Mrs Zaghloul will receive her costs and disbursements on the order for adjudication. If the Churchill proceedings are successful the general body of creditors will receive a further dividend of 7.5 cents in the dollar and, subject to payment of the costs and creditors of Matam Investments Limited, stand to make a full recovery. It is better for the creditors to have some recovery under the compromise and there is the potential for a full or at least significant recovery if the Churchill proceedings are successful. That potential will be destroyed if the compromise is not approved.
• There is no evidence of misconduct by Mr Fava within the meaning of s 122(3)(c). Mr LaHatte referred to the authority of Re Trott & Joy HC AK B1471/88 14 April 1989, Tompkins J, where the principal cause of the insolvent’s losses was borrowing heavily on the security of shares, not riotous living or the squandering of substantial assets on gambling. The fact that Mr Joy charged over $8,600 on his American Express card in the three months after the default on a payment was regarded as “not necessarily improper” and not amounting to gross misconduct that would justify the Court refusing approval to an otherwise acceptable compromise.
• In relation to the Churchill proceedings Mr Fava made “an error of judgment” in withdrawing his opposition to the bankruptcy, not a deliberate attempt to sabotage the case. He emphasised that Mr Fava stands to lose everything, i.e. all his assets, if the Churchill proceedings cannot be pursued, which cannot be in the interests of the general body of creditors.
• As to the compromise being “not expedient” within the meaning of s 122(3)(d), Mr Fava is committed to payment of the initial dividend of 2.5% and that once free of the Churchill proceedings he will be able to earn money. He has said “he will work if he needs to” to pay the first final dividend of 7.5 cents in the dollar.
• It is a highly relevant factor that the defendants in the Churchill proceedings are funding the legal costs of Mrs Zaghloul. Those defendants are not directing their consideration to the merits of the compromise but rather are seeking to protect and advance their own interests by keeping Mr Fava and the plaintiff companies in the Churchill proceedings away from the opportunity to pursue that litigation. Thus, Mrs Zaghloul does not come to the Court with “clean hands”, which answers any criticism she may make of any conduct of Mr Fava.
I do not discount that Mrs Zaghloul’s legal fees re the composition are being funded by the defendants in the Churchill proceedings. Mrs Zaghloul has been completely open about this. She says, and I accept, that she has no interest in the outcome of the Churchill proceedings; she just wants to be paid what Mr Fava owes her. This is entirely consistent with her persistent efforts and actions to recover the debt he owes her.
Position of opposing creditors
[38] The grounds of opposition are stated in the notice of opposition to be:
a) The provisions of s 121 of the Insolvency Act 1967 have not been complied with in that s 121(1) requires a composition providing for satisfaction of the debts due to creditors from the bankrupt; the
composition in this case does not provide for satisfaction of the debts due to the creditors.
b)The proposed composition in this case is in conflict with s 123(2) of the Act which prohibits revesting the bankrupt’s property in him.
c) The proposed composition in this case is in conflict with regs 35 to 39 of the Insolvency Regulations 1970 which contemplate that any composition shall provide for payment of an amount to creditors.
d) The terms of the composition are not reasonable.
e) The terms of the composition are not calculated to benefit the general body of creditors.
f) The bankrupt has committed misconduct justifying the Court in refusing his discharge.
g) It is not expedient that the composition should be approved.
h)The grounds set out in the affidavit of E Zaghloul filed herein and also the affidavits filed in respect of the previous application for composition being the affidavit of E Zaghloul sworn 19 April 2007, the affidavit of T Dabb sworn 2 May 2007, the second affidavit of E Zaghloul sworn 4 May 2007, the affidavit of CA Down sworn 11 May
2007 and the affidavit of L Skinner sworn 11 May 2007.
[39] Mr Gedye submitted that the Court has an unusually broad discretion to refuse to approve a composition under s 122 of the Act which reflects the caution to be exercised in the public interest to approaches by bankrupts to avoid bankruptcy whether by annulment, discharge, a proposal or a composition.
[40] Counsel’s submissions focussed on grounds d) to h):
• The composition provides a very limited benefit, 2.5% of the creditors’ claims.
That leaves 97.5% of the debts of the general body of creditors or the sum of
$1,416,013.69 unsecured and with no certainty whatsoever of being paid.
• The prospect of a substantial sum being obtained from the Churchill proceedings and then reaching from the plaintiff companies in the Churchill proceedings through to the creditors, is the whole foundation of the composition. But the speculative and highly uncertain nature of the Churchill proceedings is a key reason why the composition is not reasonable or likely to benefit the general body of creditors. There is not available to the Court or to the opposing creditors any objective and informed assessment of the prospects of the success of the litigation. The Court is not bound to accept uncritically a claim by a bankrupt that he has a claim against another party when that claim involves a high degree of improbability, speculation and is made in the absence of an accurate assessment of the prospects of success: Kroon v Westpac Banking Corporation HC AK CIV 2006-404-4720 15 May 2007, Ronald Young J.
• The Churchill proceedings are brought by four companies which Mr Fava says he owns or controls. Even if the plaintiff companies were to be successful in their claims in the Churchill proceedings and recover the whole or part of the
$50m claimed in general and exemplary damages, it does not follow that this would benefit the creditors. That would require the direction of Mr Fava. Further there is no information about the financial position of the companies except to the extent that it is clear from the terms of the composition that more than $1m is owed by Matam Investments Limited, one of the plaintiffs, in liquidation costs and to creditors.
• If the chances of success of the plaintiff companies in the Churchill proceedings were strong it is reasonable to expect that a director or directors could have been appointed in place of Mr Fava to pursue the litigation. It would not be necessary that Mr Fava be released from bankruptcy for the litigation to continue.
• There can be no assumption that the Court would set aside the judgment in favour of the defendants given by Williams J on 13 December 2006.
• The creditors have not been given adequate information with which to make an assessment of the prospects of success even if the Churchill proceedings were allowed to be reactivated, despite seeking this.
• There is no adequate explanation as to why after the hearing had extended over
31 days, if he was expecting bountiful returns from the litigation, Mr Fava elected to withdraw his opposition to the bankruptcy so that the order of adjudication was made unopposed on 6 December 2006. Mr Fava elected to refuse to pay some $9,000 owing to Mrs Zaghloul despite the foreseeable and inevitable consequences to the Churchill proceedings of his bankruptcy. It is simply not credible that Mr Fava “made a mistake” as he now claims.
• The terms of the composition give Mr Fava three years shelter from the claims of his creditors whether or not he seeks to have the Churchill proceedings reinstated and whether or not the Court grants an application under r 486 for the judgment to be set aside.
• The most substantial creditors and those providing the necessary percentage of votes are either Mr Fava’s family trust or associates. The majority of the votes in favour of the composition come from “friendly” creditors. It is an inescapable inference that the family trust will be acting and voting at the effective direction of Mr Fava and it is a fair inference that the relatives and friends will be doing so as well.
• There is no satisfactory assurance that the whole of the debt claimed by the family trust is genuine. The opposing creditors are critical of the standard of proof required by the Official Assignee in the face of challenge by the creditors.
• The indication from Mr Fava that he may seek employment at some stage in the future is weak and intangible. It is provided only in respect of the first final dividend which in terms of the composition is three years hence. There is no detail or any assurance that Mr Fava will undertake gainful employment which is in marked contrast to the composition considered and approved by the Court in the only case under s 122: Re Hill HC AK B1034-IMO2 16 October 2002,
Master Lang. Accordingly while a further 7.5% of the debts is to be paid in terms of the composition at the end of three years ($109,000.00), there is no indication as to where those funds will come from.
• Mr Fava is unforthcoming and evasive about the source of funds for the initial dividend and for the first final dividend. In relation to the first dividend he refers to “entities/persons favourably inclined towards me” which gives no assurance that the source of funds can be provided without borrowing or can be assured.
• This lack of information contrasts markedly with voluminous material (much of which is inadmissible) about irrelevant matters such as aspects of the Churchill proceedings.
• The creditors have no way of assessing whether the “entities/persons favourably inclined towards” Mr Fava would be prepared to make available to Mr Fava a greater sum than that required to pay the initial contribution. This is a realistic and important issue given the change from the first composition that offered nothing for creditors to the second composition where approximately $140,000 would be paid as dividends. Selective disclosure is inappropriate in the public context of a bankrupt seeking approval of a composition with his creditors. Lack of candour is an important consideration: Kroon v Westpac Banking Corporation.
• The history of the successive compositions proposed by Mr Fava is significant.
The first composition involved no payment to creditors apart from the costs on the adjudication. It simply suspended all creditors’ rights for three years. While Mr Fava downplays the severe criticisms of the creditors in relation to the first composition by stating “It no longer matters”, it is an important indicator in relation to Mr Fava’s credibility, good faith and attitude generally.
Submissions by the Official Assignee
[41] Mr Neil emphasised that the Official Assignee adopts a neutral position and has filed reports pursuant to the Act for the information of the Court.
[42] As to the voting process, the Official Assignee noted that all those who had filed proofs of debt in the bankruptcy were permitted to vote on the composition. The Official Assignee was satisfied the claims of the so-called “friendly voters” are for unsecured debts owed by the bankrupt at the time of his adjudication. He had no reason to believe the claimants are not bona fide creditors. A “creditor” is any creditor entitled to prove pursuant to s 87 of the Act: Re Donovan HC WN B214/97
28 July 1997, Master Thompson.
[43] In relation to the issue of reasonableness of the composition and whether it is for the benefit of the general body of creditors under s 122(3)(b), counsel referred to: Re McGarry HC AK B2320/89, 29 May 1990, Re Trott & Joy, Re Lowndes HC AK B1879/90, in which proposals under s 143 of the Act (made by an insolvent prior to bankruptcy – refer [29]) were approved, although the amount of any ultimate dividend would be a small proportion of the sum of the debts. In these cases it was determined that the recovery under the proposal, minimal though it was, would achieve a greater recovery of assets than was likely to be obtained from a bankruptcy.
[44] The Official Assignee’s written submissions also cited Farmer v Rowley [1992] 2 NZLR 195 (CA) for authority that it is not relevant that rejection of the proposal might lead to a better proposal. On appeal it was determined that the Judge’s opinion that the offer in the proposal was not as good as it could be, put the matter rather more highly than contemplated by s 143(3)(b) (which is in the same terms in respect of a proposal as s 122(3)(b)), and that the judgment must essentially be one for the creditors to make.
[45] In oral submissions Mr Neil addressed concerns of the Official Assignee:
• The Churchill proceedings would be conducted by the plaintiff companies. He referred to paragraph 7.5 of the Official Assignee’s supplementary report dated
10 July 2007, which states:
A further dividend is dependent on a favourable outcome of the Churchill case and the quantum awarded sufficient to clear both legal costs (estimate unknown, but expected to be significant) and prior commitments to the Matam Investment Limited liquidator’s costs ($20,000) and creditors
($1,047,384.55). If there are further funds then creditors of the bankrupt estate are to receive funds from the plaintiffs in the action …
• It would be a “long route” for any proceeds of the litigation to reach Mr Fava and then to reach the creditors.
• There is no provision for reporting to the Official Assignee in relation to the
Churchill proceedings if they are continued.
• No detail is provided as to the source for meeting the first final dividend which would bring dividends paid to 10%. The Official Assignee has made inquiry of the bankrupt which has evoked the reply:
The funds to pay the preferential creditor and the interim dividend are being provided by entities/persons favourably inclined towards me … The funds for the first dividend will need to be earned by me between the bankruptcy annulment day and the satisfaction day and if on the satisfaction day I am short to pay all creditors the first final dividend in full some of the same entities/persons favourably inclined towards me will provide funds again …
Thus the Court cannot assess the surety of the projected payments which at 10% (2.5% initial dividend and 7.5% first final dividend) involve a payment of in excess of $140,000. This goes to the root of Mr Fava’s composition and undermines it.
• Nevertheless there are no known assets of Mr Fava and the composition is the only means of providing funds in the bankrupt estate.
[46] In submissions in reply, Mr LaHatte sought to address the concerns expressed by the Official Assignee concerning the availability for the creditors of funding from the companies who are the plaintiffs in the Churchill proceedings, should the litigation be successful. He referred to Mr Fava’s third affidavit sworn 20 July 2007 in which he states that any eventual fruits of the litigation would come under his effective control, and that once the plaintiffs have directors he would be happy to consider any suggestion the Official Assignee puts forward to sign up to a deed promising to pay his creditors.
[47] Counsel also referred to s 124(3) of the Act which gives the Court continuing exclusive jurisdiction in the enforcement of the deed of composition, and suggested the Court could if necessary, intervene to protect the creditors’ interests. But as Mr Neil correctly pointed out, the Court’s powers of enforcement are in relation to the deed of composition and pursuant to s 123, the deed of composition which must be executed by the bankrupt and the Official Assignee once the Court has approved the composition is:
… a deed of composition for carrying the proposal into effect.
The Court’s power to vary any of the terms of the composition is limited to correcting or supplying any accidental or formal error or omission in the composition at the time of approval:
… but no alteration in the substance of the composition shall be made. (s 122(6))
The terms of the composition – reasonable or not reasonable?
[48] I have referred earlier in this judgment to matters that are by way of background to the issue before the Court, namely whether the Court should approve the second composition. The background includes the history of the tenancy dispute between Mr Fava and Mrs Zaghloul which gave rise to the debt in respect of which Mrs Zaghloul petitioned for Mr Fava’s bankruptcy, and the history of the Churchill proceedings.
[49] While the history of the Churchill proceedings is by way of background, the future direction of the Churchill proceedings is a very important factor in considering the reasonableness or otherwise of the composition. The composition provides for payment of 90 cents in the dollar to be deferred pending, and contingent upon, a successful outcome for the plaintiffs in the Churchill proceedings. Mr Fava has provided in his affidavits a lot of comment about the Churchill proceedings including his own opinions and conclusions in relation to the proceedings, and as to the conduct of the defendants and their legal advisors in the litigation. As I have previously stated, comment of this nature is inadmissible as evidence, and is not relevant to the issue before the Court. Perhaps Mr Fava contemplated that the Court
would embark upon an assessment of the strength or otherwise of the plaintiffs’ claims in the Churchill litigation. For example, reference to the open (but unsworn) statement by Mr Chong on 13 June 2003 filed in a strike out application by the defendants, which Mr Fava states at paragraph 79 of his third affidavit sworn 20 July
2007:
… leant considerable support to Churchill’s claim -
and which was annexed to his fourth affidavit sworn 23 July 2007, can presumably only have been intended for this purpose. But it is not the function of the Court to assess the merits of the plaintiffs’ claims in the litigation, nor would the Court be in any position to do so on the basis only of the assertions and opinions of Mr Fava coupled with such information as he chose to provide.
[50] Mrs Zaghloul in her second affidavit sworn 4 May 2007 refers to a creditors’ meeting on 12 March 2007 which she and her husband attended, when only Mr Dustin and Mr Vague were present. She says at that meeting it was arranged that Mr Judd QC, the lawyer acting for the plaintiff companies in the Churchill litigation, was to be contacted to provide an opinion on what prospects of success those companies had. She said the contact was to be made through a Mr Chris Taylor, another creditor with whom Mr Vague was to communicate. Mr Vague does not agree with Mrs Zaghloul’s account of what was arranged at that meeting, but that aside, no opinion or assessment has been made available to creditors from anyone with the requisite independence, knowledge and expertise to give an objective and informed assessment of the prospects of success of the plaintiffs in the Churchill proceedings, and of the Court reinstating them under r 486.
[51] Secondly, no information has been provided as to how the Churchill proceedings, if allowed by the Court to be reinstated, would be funded. No information is given about the financial situations of the plaintiffs’ companies. Mr Fava says he has no funds. He, of course, is not a party to the litigation but on his evidence he owns or controls the plaintiff companies. Mr Fava says that Mr Judd QC represented the plaintiffs on a contingency fee basis until the hearing was discontinued and judgment was given for the defendants, when he sought leave to withdraw. There can be no assurance that Mr Judd would continue to provide his
services on that basis were the proceedings to be reinstated. And quite apart from professional fees, there would inevitably be not insignificant costs and disbursements associated with the litigation. There is no information provided as to how these might be met. If Mr Fava were intending to provide funding, the creditors are entitled to know, for those are funds which are not being made available to them.
[52] Thirdly, Mr Fava’s own actions in relation to the Churchill proceedings are very difficult to explain. Mr LaHatte submitted that Mr Fava stands to lose everything if the Churchill proceedings cannot be secured, i.e. all his assets. Mr Fava obviously regards the Churchill proceedings as highly important. Yet on
6 December 2006 he withdrew his opposition to the petition for bankruptcy and adjudication promptly followed. At this point the hearing had continued during
31 days. The plaintiffs’ case was completed and two of the defendants’ witnesses had given evidence. Mr Fava was at pains to explain in his affidavits how closely he had been involved in the litigation. He had the benefit of legal advice – Mr Judd QC was acting for the plaintiff companies in the litigation. Mr LaHatte accepted this in submissions but could not say whether Mr Fava took legal advice in relation to withdrawing his opposition to the petition for bankruptcy. If Mr Fava, having been closely associated with the litigation since 2001 throughout interlocutory applications, preparation for trial and the hearing, assessed the plaintiffs’ case to be strong, as he asserts, it is inexplicable that he did not continue vigorously to oppose bankruptcy, at least to the extent of placing before the Court full details as to the state and stage of the Churchill proceedings and seeking an adjournment of the hearing of the petition until the case concluded. That is, unless the explanation lies in Mr Fava’s assumption expressed to Mrs Zaghloul by email dated 9 June 2006 (refer [18], that a composition of creditors would readily follow his bankruptcy (“ … a 100% chance of success”), thus enabling the bankruptcy to be annulled and the Churchill proceedings to be reinstated. On that reasoning Mr Fava could “have his cake and eat it too”, i.e. both avoid paying his creditors and pursue the Churchill litigation.
[53] Fourthly, there is the concern addressed by the Official Assignee that there is no assurance that any proceeds of the Churchill litigation would reach the creditors. The plaintiff companies in the Churchill proceedings are not debtors of the creditors.
No information has been provided about the liabilities or potential liabilities of the plaintiffs at the present time or at the time any litigation proceeds might be available. Future liabilities would presumably include costs of the litigation which could be significant and the composition provides priority for over $1m to creditors of Matam Investments Limited. No information or assurance has been made available to the creditors that addresses this concern. Mr Fava’s statement that he will have effective control of “any eventual fruits of the litigation”, certainly does not bridge this gap for the creditors.
[54] There are other respects in which the composition is lacking in detail and certainty, including:
• The source of funding for both initial dividend and first final dividend. This is particularly relevant in respect of the first final dividend which is to be deferred three years.
• Mr Fava’s commitment and ability to obtain employment to earn funds to pay the first final dividend. This is in marked contrast to the situation in Re Hill. In that case the composition following bankruptcy included a proposal to repay unsecured creditors an amount equivalent to approximately 60 percent of the total claims provable in the estate. Mr Hill proposed to do this by paying weekly instalments of $400 over a period of five years, producing a total sum of approximately $90,000 for distribution to his creditors.
Lang J (then Master Lang) noted that the composition was estimated to provide creditors with a return of 60 cents in the dollar, whereas the bankrupt had been bankrupt for nearly two years and there had been no return to creditors to date. There were no issues in relation to misconduct that would justify the Court refusing, qualifying or suspending the bankrupt’s discharge. There was no suggestion that the public interest required that the affairs or conduct of the bankrupt be investigated further, and the scheme was sufficiently particular and precise to enable the Court to judge its chances of success. The bankrupt proposed to go back to his former occupation as an insurance broker and was confident that it would provide him with a steady stream of income. The Court
could safely conclude that the proposed composition was reasonable and calculated to benefit the general body of creditors.
• Mr Fava’s credibility is a further concerning factor. I cannot accept that in withdrawing his opposition to bankruptcy Mr Fava simply made a bad judgment, a mistake. He was far to well acquainted with the Churchill proceedings and the inevitable impact on those proceedings of his bankruptcy, to make such a “mistake”. Notwithstanding Mr Fava’s apparent co-operation with the Official Assignee, I am drawn to the conclusion that he has not been fully up-front with his creditors.
• Mr Fava’s Trust and persons associated with him comprise a significant majority in number and value of the creditors. I make no comment about the debts which have been admitted to proof. If Mrs Zaghloul or any other creditor considers any item should be challenged, procedures are available under the Act. But the fact remains that about $1.3m of the total of $1.44m, or 90% of creditors claims, are attributable to Mr Fava’s Trust, Mrs Wardrope and Mr Dustin. They may more readily adopt Mr Fava’s perspective or have access through him to information not available to the general body of creditors. They can provide the necessary majority to approve a compromise which while viewed as reasonable by Mr Fava and his interests, is not reasonable for the remaining creditors.
[55] In summary, in return for a minimal initial dividend (2.5%) the creditors are being required to wait three years before any further payment is made. The source of the first final dividend (7.5%) is unsure. Whether and when any further dividend will be paid depends entirely on the outcome of the Churchill proceedings, which on the basis of the information available, is speculative. Their viability simply cannot be assessed.
[56] In all those circumstances I am of the opinion that the terms of the composition are not reasonable and are not calculated to benefit the general body of creditors.
[57] Given that conclusion it is unnecessary for me to addresses issues b) and c)
in [3].
Result
[58] I extend time for the composition to be approved pursuant to s 10 of the Act, but Mr Fava’s application dated 3 July 2007 for approval of the composition with creditors, is declined.
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