Wife's equity - enforceability of guarantee against wife of borrower

The Queensland Court of Appeal in Agripay Pty Ltd v Byrne [2011] QCA 85 considered enforcement of a guarantee against the wife of a borrower and held that it would be unconscionable to allow the guarantee to be enforced in circumstances in which the wife was a 'volunteer' and the effect of the guarantee was not fully understood by her.

The court held that it was not necessary that a guarantor positively misapprehend some matter material to the guarantee, it is enough that she did not know its details. The transaction need merely be one in which the creditor has not properly explained or ensured that the guarantor understands the effect of the transaction where the transaction is substantially for the benefit of the husband. In addition, the existence of a life insurance policy or similar arrangements calculated to cover the debts guaranteed by the wife did not prevent equity's intervention. Any benefit derived by a guarantor must be direct or immediate, not indirect and prospective. The benefit to the wife here was contingent so she was held to be a 'volunteer'.

This case reinforces the absolute necessity of providing the wife of a borrower a full and proper explanation of the nature and effect of the transaction before allowing her to sign a guarantee. This important case appears to be the first one in which an appellate court has found it would be unconscionable to enforce a guarantee where the wife was not labouring under any material misapprehension. It would not be surprising to see this case go to the High Court.

Controller's liability under s419A - Rapid Metal appeal

The New South Wales Court of Appeal has recently handed down an important decision relating to a controller's liability to pay amounts in respect of property in the possession of the company to which the controller is appointed. The decision also provides guidance for controllers appointed to companies which possess large quantities of stock where the ownership of that stock is contested.

De Vries & Anor v Rapid Metal Developments (Australia) Pty Ltd [2011] NSWCA 100 dealt with the issue of whether the appellants, as agents of a mortgagee in possession of a company in the business of hiring scaffolding, were liable to the respondent for using or disposing of the respondent's scaffolding after their appointment as the mortgagee's agents.

The respondent (RMD) claimed that all of the scaffolding hired by it to the company (Rildean) was still in Rildean's possession at the date of the appellants' appointment.

The court held that RMD did not prove on the balance of probabilities that all of the scaffolding hired by it to Rildean was still in Rildean's possession at the date of the appellants' appointment. Rildean hired scaffolding from multiple suppliers and it was often impossible to identify which equipment belonged to which supplier. As possession of all of RMD's scaffolding could not be established, the controllers' appeal had to be allowed.

In the decision at first instance, the court held that the controllers were liable under s419A of the Corporations Act for certain amounts including the value of unreturned scaffolding. Although the Court of Appeal did not have to decide the point, Sackville JA commented that the language of s419A was 'not apt' to extend to a liability to make payments at the end of the period of hire. Accordingly, had RMD succeeded on the possession issue, his Honour would not have awarded judgment pursuant to s419A(2) for the value of the unreturned scaffolding (thus limiting the controllers' liability under s419A(2) to the outstanding hire charges plus interest).

However, his Honour did demonstrate support in obiter for the primary judge's finding that the controllers had committed an act of conversion by selling the scaffolding. As such, controllers still need to proceed with caution when dealing with stock where the ownership of that stock is contested.

Unfair preferences and retention of title

A South Australian Supreme Court decision has considered whether certain payments made by a company were unfair preferences or whether the defendant could rely on a retention of title clause to say that the payments did not result in the decrease in the net value of the company's assets.

Dwyer and Davis v Chicago Boot Co Pty Ltd [2011] SASC 27 highlights that in invoking the 'good faith' defence in relation to voidable transactions, the court is required to look at the position of the directors in question through the eyes of the reasonable person. Evidence of the director's knowledge may be used in a limited way in applying the test and is relevant only insofar as their subjective appreciation of the circumstances are those to be expected of a reasonable person.

This case also shows that where a retention of title clause is relied upon, the court will have regard to all the circumstances which exist between the parties. The court found that despite the retention of title clause which appeared on the back of the invoice for delivery of goods, the lack of steps taken by the defendant to ensure that its goods were identifiable and that the company in liquidation could account for goods on-sold to third parties, together with the fact that money from the proceeds of sale was not kept in a separate account, deprived the clause of its purported effect. Further, the agreed terms of trade showed the relationship between the parties to be a debtor/creditor relationship. The court therefore did not consider whether there was preferential treatment because of the retention of title clause.

Test for removal of caveat when mortgagee exercises its power of sale

The NSW Court of Appeal has stated that in determining whether to order the withdrawal of a caveat lodged by a mortgagor, the courts must examine whether the caveator would have been granted an interlocutory injunction to protect the interest claimed by the caveator (ie that there is a serious question to be tried and that the balance of convenience favours the granting of the injunction).

Bayblu Holdings Pty Ltd v Capital Finance Australia [2011] NSWCA 39 showed that the courts will order caveats lodged by a mortgagor to be removed in circumstances where the mortgagor seeks to delay the mortgagee exercising the power of sale because the mortgagee could obtain a better price at a later date. The fact that there will be a significant shortfall between the proceeds of sale and the debt owed will mean that the balance of convenience favours the mortgagee and it will be rare for the courts to conclude that the balance of convenience favours the mortgagor and that the caveats should remain. The fact that the mortgagor cannot give an adequate undertaking as to damages or cannot pay into court the amount sworn by the mortgagee as due and payable will also favour the mortgagee.

Winding up of insolvent insurance company upon application of judicial manager

A recent decision of the Federal Court has resolved a conflict in the provisions of the Corporations Act and the Insurance Act concerning the winding up of insurance companies on the application of a judicial manager appointed under the Insurance Act. Australian Prudential Regulation Authority v ACN 000 007 491 Pty Ltd (in liq) [2011] FCA 353 confirms that the winding up provisions of the Corporations Act apply, including those provisions concerning voidable transactions.

This case dealt with the winding up of an insolvent insurance company following the recommendation of a judicial manager appointed to the company under the Insurance Act 1973 (Cth). The court held that the where the court makes a winding up order in relation to an insurance company following receipt of a report from a judicial manager recommending that course, the winding up occurs under the Corporations Act 2001 (Cth) rather than the Insurance Act. Thus, the provisions of Part 5 of the Corporations Act will apply in the winding up.

Applicant for leave to appeal against winding up order must be 'sufficiently interested'

The Federal Court of Australia has recently considered the circumstances in which leave to appeal against orders for winding up by a non-party will be granted.

Binetter v Deputy Commissioner of Taxation [2011] FCA 184 dealt with an application by a former director of the two companies being wound up for leave to appeal against orders for the winding-up of those companies. The court held that the applicant did not have standing to seek leave to appeal and dismissed the application with costs.

This case demonstrates that the standing requirement for such an application is that the applicant be 'aggrieved' or 'sufficiently interested'. The fact that the applicant was a former director of the company, or that the applicant may become involved in a liquidator's investigation and the associated consequences, was not a sufficient interest.

Proceeds from preference actions

Cook v Italiano Family Fruit Co Pty Ltd (in liq) [2010] FCA 1355 provided the following guidance in relation to preference actions: 

• Causes of action accruing to the company (eg action for breach of contract or breach of duty) and the proceeds of those actions are property of the company and caught by a charge over the company's present and future property.
• Preference actions, which can only be brought by a liquidator, are not property of the company and not caught by a charge over the company's present and future property. (The judge in this case expressed reservations about the different treatment of the recovery of proceeds in preference and other actions, but was bound to follow High Court precedent in NA Kratzmann Pty Ltd (in liq) v Tucker (No 2) (1968) 123 CLR 295.)
• A creditor is entitled to a right of subrogation if money to which it was entitled to is paid out by a liquidator in breach of trust.

In this case, upon winding up of the company, the liquidators realised assets subject to National Australia Bank's (NAB) floating charge. They used those proceeds to pay the claims of priority creditors and the costs of the liquidation. The liquidators then recovered funds from two unfair preference claims. After taking out their costs, the liquidators were left with a sum of money and applied for directions on whether they could pay the remaining funds to NAB rather than unsecured creditors.

The court stated that the right of liquidators to have recourse to charged assets to meet priority claims is conditional on there being insufficient property of the company available to meet those claims. Such an assessment must be made once and take into account actual and potential realisations. Here, the liquidators had made an interim assessment that did not consider potential recoveries from unfair preference actions. The liquidators had therefore paid priority creditors with money NAB was entitled to, thereby committing a breach of trust. In these circumstances, NAB was entitled to be subrogated to the company's free assets, which meant that NAB was entitled to the remaining money.

Alinta restructure ALB Insolvency and Restructuring Deal of the Year

The Alinta Energy restructure has won the prestigious 2011 ALB Australasian Law Award for the insolvency and restructing deal of the year. Allens acted for the agent and security trustee on behalf of Alinta's syndicate of lenders.

The $2.8 billion restructure was effected by way of schemes of arrangement and has been described as one of the most complex restructures in Australian corporate history. Allens' insolvency team included Michael Quinlan, John Warde, Ian Wallace, Diccon Loxton, Vijay Cugati, Mark Kidston, Chris Prestwich and Przemek Kucharski.

For more information on the Alinta restructure, see our media release and our Focus.

One-Tel - the danger of 'hastening slowly'

The NSW Supreme Court has handed down a decision setting aside service of the statement of claim brought by the special purpose liquidator of One.Tel Limited (in liq) and dismissing the proceedings in their entirety. The reasoning of the court is particularly relevant to liquidators who may delay the service of proceedings while they attempt to obtain litigation funding. More broadly, the decision highlights the dangers for plaintiffs who delay serving proceedings.

Allens' Malcolm Stephens, Andrea Martignoni and Chris Prestwich acted for the News Group defendants in this matter. For more information, see our Focus on this case.

Costs do not always follow the event for liquidators

In Chand v Azurra Pty Ltd (in liq) [2011] NSWCA 58, the Court of Appeal confirmed that even if a party seeking leave to bring proceedings against a company in liquidation is successful in obtaining that leave, it is within the Court's discretion to order that the successful party pay the liquidator's costs of the application.

This case highlights that the exercise of the Equity Division's administrative jurisdiction, including overseeing the conduct of liquidations, involves different factors relevant to who should bear the cost of court proceedigns to those that are involved in contentious litigation. Generally, in contentious litigation, 'costs follow the event', which means that the successful party's costs are paid by the unsuccessful party.

The Court noted that it is proper that a person who needs to ask a privilege or dispensation from the court pay the costs of the other parties who need to be notified of that claim. Further, a liquidator who has limited funds, is a necessary party, and acts reasonably, is usually entititled to its costs. If a liquidator were to be ordered to pay the costs of the application for leave to proceed or to bear his own costs it would, in effect, be the other creditors of the company who would be required to pay.

Alinta Gas restructure

Allens Arthur Robinson and Mallesons Stephen Jaques co-hosted a seminar on 5 May 2011 in relation to the Alinta Energy group's $2.9 billion deleveraging transaction.

The deleveraging was effected by way of schemes of arrangement in March 2011. This was one of the most complex restructures in Australian corporate history.

Throughout the process Allens acted for the agent and security trustee representing Alinta's syndicate of lenders, which ultimately acquired the operating entities in the Alinta group.

The panel of speakers included:

• Ross Rolfe AO - formerly CEO, Alinta Energy
• Sylvia Wiggins - former commercial adviser to Alinta Energy
• Tim Bednall - Partner & Chairman of the Board, Mallesons Stephen Jaques (panel chair)
• Scott Gardiner - Partner, Mallesons Stephen Jaques
• Vijay Cugati - Partner, Allens Arthur Robinson
• Ian Wallace- Partner, Allens Arthur Robinson
• John Williamson-Noble - Partner, Gilbert + Tobin
• Robert Nicholson - Partner, Freehills
• David Holland - Partner, Baker & McKenzie

The slides from the presentation are now available.

For more information on the Alinta transaction, see our deal release.

Insolvency Law Bulletin April 2011

The Insolvency Law Bulletin (April 2011) featured the following articles by Allens lawyers:

1. In 'Restructuring in Australia: making the most of the legal framework', Michael Quinlan and Przemek Kucharski discuss aspects of Australian insolvency law that can work as useful tools in restructuring troubled business if deployed in the right circumstances. These include:

• the ability of directors to act early in appointing administrators;
• the circumstances in which receivers may be able to effect a quick receivership sale;
• the ability of administrators to restructure troubled businesses;
• the return of creditors' schemes of arrangement as a restructuring tool; and
• the use of the long-term administration.

2. In 'Back in fashion: schemes of arrangement as a restructuring tool', John Warde and Chris Prestwich discuss the recent Alinta transaction and the benefits of using creditors' schemes of arrangement as a means of restructuring companies in financial distress.

No lender liability for loss suffered by borrowers in relation to failed investments

In Banksia Mortgages Limited v Croker and Ors [2010] NSWSC 1447, the NSW Supreme Court held that a lender, Banksia Mortgages, could not be held responsible for loss suffered by a borrower in relation to failed investments.

Banksia had commenced proceedings against Mr and Mrs Croker after they had defaulted on interest payments due in respect of moneys outstanding under loans secured by a mortgage over the Crokers' property. Banksia sought judgment in respect of the debt owed and an order for possession of the secured land.

The Crokers sought to have the loans set aside or reduced, contending that the loan agreements were 'unjust'. The Crokers alleged that the loan agreements contained terms which were unreasonably difficult to comply with, had not been accurately explained by anyone to the Crokers, that unfair influence and pressure was exerted by Banksia and that Banksia had acted unconscionably in the circumstances.

The NSW Supreme Court held that none of the Crokers' arguments were made out. The court took note of the fact that Banksia had not engaged in asset lending, that the Crokers did not fully disclose their plans for the borrowed funds, and that the Crokers chose not to obtain independent financial advice in relation to investments which they knew were high-risk ventures. Further, the court considered that Banksia had not acted unconscionably as it had complied with its internal lending procedures and was entitled to rely upon the information the Crokers provided about their investments in assessing the Crokers' ability to repay their loans.

This case illustrates the importance of lenders:  

• complying with their lending manuals;
• encouraging prospective borrowers to obtain independent financial advice;
• assessing the capacity of a prospective borrower to repay; and
• not engaging in the practice of asset lending.

Good news for lenders - Buzzle approved: NSW Court of Appeal clarifies shadow directorship risks

On 9 May 2011, the NSW Court of Appeal handed down its decision in Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd [2011] NSWCA 109. The court has confirmed Justice White's decision and dismissed the appeal. Among other things, the case is significant for providing appellate-level guidance on the hotly debated topic of the requisite elements of shadow directorship.

Shadow directorship can be a highly relevant concern for lenders particularly in workout situations where they attempt to protect their interests by placing stringent conditions on new loans and/or standstills.

In the course of delivering its judgement, the Court of Appeal provided the following guidance:

• Where a secured lender acting in its own interests exercises influence on the directors of a debtor company, it will not generally become a shadow director.
• This is particularly so if the mortgagee's exercise of influence is supported by contractual rights in its mortgage documents and/or the directors of the company exercise independent judgement regarding whether to accede to the mortgagee's influence.

Although this guidance was provided in obiter, it provides some comfort to secured lenders wishing to exercise a degree of control or oversight over the activities of debtors in financial strife.

The Allens insolvency team is currently working on a more comprehensive analysis of the implications of the decision and we will issue a Focus soon. For more information, keep an eye on our publications or contact us direct.

Mutual claims and set-off in insolvency

A recent decision from the Isle of Man High Court, Simpson and Spratt and Kaupthing Singer & Friedlander (Isle of Man) Limited v Light House Living Limited and Elle Macpherson (High Court of Justice of the Isle of Man, unreported 2 December 2010, Civil, Chancery Procedure) found that the insolvency set-off provisions in section 22 of the Bankruptcy Code will apply where:

• a trustee/nominee has assumed liability for a debt wholly for the benefit of his/its beneficiary/principal;
• the beneficiary/principal is really, in truth and substance, the party benefiting from the transfer of funds which gives rise to the debt; and
• it is the beneficiary/principal who, under the mutual dealings on which the parties have agreed and engaged, is intended ultimately to return the benefit received from the legal creditor, by way of repayment through his trustee/nominee, the legal debtor. 

In this case, the bank provided funds to a company to purchase property as nominee and trustee for Ms Macpherson. The bank required as security, a charge over a cash deposit in Ms Macpherson's name with the bank. The parties envisaged that Ms Macpherson would, through the company, repay the bank loan. The bank became insolvent and the court held that set-off was available between the bank loan which Ms Macpherson was beneficially entitled to and Ms Macpherson's cash deposit with the insolvent bank.

The court found that s22 was available where the beneficial entitlement and beneficial liability in respect of the countervailing credits and debits correspond. The court noted the purpose of s22 as enabling and requiring a court exercising bankruptcy jurisdiction to do substantial justice between the parties to mutual dealings upon insolvency. The court said that substantial justice would not have been achieved if Ms Macpherson was forced to pay 100 cents in the dollar through her nominee but only receive a dividend of some few cents in the dollar on the debt owed to her by the bank.

One would expect this case to be applied in Australia because it builds on the position of mutuality outlined in the Australian High Court case of Gye v McIntyre (1991) 171 CLR 609, which was relied on in the present case. Although the term 'beneficial liability' is new, the claims must still be between the same parties (ie the 'real' and 'substantial' parties) and made by parties in the same capacity (ie where the 'beneficial interests' and 'beneficial liabilities' correspond).

Beneficial ownership of securities and a trust relationship

In Pearson & Ors v Lehman Brothers Finance SA & Ors [2010] EWHC 2914 (Ch), the High Court of England and Wales examined where the beneficial ownership of securities acquired by a company for the account of its affiliates lies. The court held that the affiliates had no proprietary interest in the securities held in the affiliates' accounts. The court stated that the greater the extent to which trustee duties are consensually departed from, the more likely it is that the court will not recognise the arrangement as a trust.

Administrators for Lehman Brothers International (Europe) (LBIE) sought the court's direction as to the principles governing beneficial ownership between LBIE and a number of affiliates within the Lehman Brothers Group (the Affiliates), of securities acquired by LBIE for the account of the Affiliates. LBIE acquired the securities pursuant to a 'Global Settlement Practice' for securities bought and sold in Europe, and also used them for the raising of finance by lending them to third parties. However, the concentration of the acquisition, sale and lending of securities within LBIE created problems in relation to regulatory charges, segregation of securities and the effective transfer of absolute title to third parties (for the raising of finance). In response, the Lehman Brothers Group established internal processes which allowed LBIE to remain the owner of the securities.

The court held that the Affiliates did not have a proprietary interest in the securities after they went through the internal processes. The court noted that:

• The terms on which LBIE acquired securities did not give rise to a proprietary interest in favour of the Affiliates through a trustee-beneficiary relationship. LBIE had none of the characteristic obligations of a trustee, there was no mutual intention to share the securities and the court will not impose a trust where purely personal rights between the two parties sufficiently achieve their commercial objective.
• The internal processes were effective in transferring the proprietary interest held by the Affiliates to LBIE, so that LBIE held absolute title to the relevant securities.

This case also considers the application of internal accounting mechanisms including daily repo transactions and stock loans. It demonstrates that such processes depend on the on-leg seller or stock lender having some form of proprietary interest in the underlying security, and establishes the circumstances in which they are effective in transferring absolute title of the security.

Directors' wilful blindness: breach of duty and insolvent trading

A recent UK case, Roberts v Frohlich [2011] EWHC 257 (Ch), makes it clear that 'wilful blindness' to a company's financial situation will not be sufficient to excuse directors from liability for breach of directors' duties and insolvent trading. Directors should be wary of continuing to trade on an overly optimistic view of a company's future prospects in the hope that 'something might turn up'.

The facts concern a failed property development by Onslow Ditching Ltd (ODL). The directors of ODL were experienced professionals (an accountant and an engineer) with experience in property development. To fund the development, ODL arranged, relevantly, a facility with the Bank of Scotland (HBoS). ODL engaged a main contractor but did not resolve with them whether the contract would be on a 'fixed price' or 'cost plus' basis.

The directors failed to disclose to HBoS that there was no fixed price contract in existence with the main contractor. HBoS later required evidence of the fixed price contract before any further funding was to be provided to ODL. ODL did not communicate these difficulties in funding to the contractor. There was subsequently a dispute between ODL and the contractor regarding the costs basis of the contract. The contractor subsequently suspended further work as ODL had not paid it in full. The contractor was later awarded, by an adjudicator, monies in respect of work done but not paid for.

A short time later, the directors appointed administrators to ODL. The development site was sold and HBoS was repaid. Liquidators were then appointed and after the sale of assets, there was still a shortfall owing to unsecured creditors. The liquidators sought relief against the directors for breach of directors' duties and wrongful trading in breach of the UK Insolvency Act 1986.

The court held that from a particular date, the directors were in breach of their fiduciary duties which they owed ODL in failing: to seek to suspend performance of the unperformed parts of existing contracts; to refuse to authorise the placement of any further orders; to disclose to the contractor the funding status of the project; and to disclose to HBoS the contractual status of the project. The court also held that the directors were in breach of their common law duty to exercise reasonable care and skill in continuing with the development after a particular date. Further, it was held that the directors were liable for wrongful trading in breach of the UK Insolvency Act as they should have concluded at a particular date that there was no realistic prospect of avoiding an insolvent liquidation. The judge said that the directors were driven by 'wilfully blind optimism' and the 'reckless belief' that in continuing with the project 'something might turn up'. Such a belief was groundless in circumstances where liquidation was inevitable.

Review of compensation arrangements for consumers of financial services

The Federal Government has launched a consultation paper - Review of compensation arrangements for consumers of financial services - to review the need for a compensation scheme for investors who lose their money through the misconduct of a financial services provider.

Although there are some arrangements in place to protect consumers of financial services, consumers may face problems where a financial services provider does not have professional indemnity insurance cover or does not have the financial capacity to pay compensation; for example, where the provider has ceased to trade or become insolvent. The consultation paper discusses a number of ways that existing compensation arrangements may be strengthened.

Submissions on the consultation paper are due by 1 June 2011.