MV’s top 5 insolvency cases for October 2014

Each month numerous insolvency-related cases are decided by various courts around the country.

For October 2014, we have picked five of the most thought-provoking decisions dealing with issues like when a liquidator is required to retain funds to pay a tax debt, whether a document can be electronically attached to a bankruptcy notice, the obligations of administrators to scrutinise their legal bills and the latest woes in Geoffrey Edelsten’s business life.

Case No. 1: Commissioner of Taxation v Australian Building Systems Pty Ltd (In Liquidation) [2014] FCAFC 133 – 8 October 2014

During the year ended 30 June 2012 the liquidators of Australian Building Systems sold real property in Queensland, which gave rise to a capital gain in the order of $1.2M. The liquidators sought a private binding ruling from the Commissioner of Taxation about, among other things, whether section 254 of the Income Tax Assessment Act 1936 (Cth) required the liquidators to account to the Commissioner before issue of a notice of assessment for the capital gain out of the proceeds of sale for an asset that belonged to ABS pre-liquidation.

The key issue before the trial judge was whether section 254(1)(d) of the ITAA 1936 would operate with the effect that the Commissioner was to be paid the whole of any tax liability due by ABS (namely CGT) in priority to other creditors. Relevantly, section 254(1)(d) provides that a “trustee”, which is defined to include a liquidator, is required ‘to retain from time to time out of any money which comes to him or her in his or her representative capacity so much as is sufficient to pay tax which is or will become due in respect of the income, profits or gains’.

The Commissioner argued that tax became due as soon as the sale proceeds were received by the liquidators, and a notice of assessment was unnecessary. The liquidators argued that in the absence of a notice of assessment, there could be no obligation to retain and pay tax. The trial judge, Justice Logan, agreed with the liquidators, as did the Full Court of the Federal Court in dismissing the Commissioner’s appeal of Justice Logan’s decision.

This decision confirms that liquidators are not required to retain money to meet tax liabilities until those liabilities have been assessed. Having said that, there are three postscripts:

  1. Justice Logan, at paragraph 31 of his decision, issued a cautionary note against immediate distribution of the sale proceeds to creditors, namely that a prudent liquidator would be entitled to retain the sale proceeds to meet other expenses in the liquidation, to wait until the final tax position was certain upon receipt of a notice of assessment and to resolve the amount of debt provable by the Commissioner in the winding up.
  2. This decision contradicts two current draft taxation determinations issued by the Commissioner, namely TD 2012 / D6 and TD 2012 / D7, which apply to liquidators and receivers respectively, and say that no assessment is necessary for obligations to arise under section 254. Presumably the draft determinations will be reviewed or withdrawn in due course.
  3. The Commissioner has applied to the High Court for special leave to appeal the Full Court’s decision.

Case No. 2: Curtis v Singtel Optus Pty Ltd & Anor [2014] FCAFC 144 – 30 October 2014

In February 2014, at the request of Optus, the Official Receiver issued a bankruptcy notice in respect of a judgment debt owed by Mr Curtis to Optus. Mr Curtis applied to the Federal Circuit Court to have the bankruptcy notice set aside. Mr Curtis challenged the validity of the notice on the basis that the court judgment was not attached to it at the time of issue.

The issues before the trial judge, and subsequently the Full Court of the Federal Court, were:

  1. whether the Bankruptcy Act 1966 (Cth) and Bankruptcy Regulations 1966 (Cth) require the court judgment to be attached to the bankruptcy notice at the time of its issue;
  2. whether the judgment was actually attached in circumstances where the notice was issued by the Official Receiver via email to Optus’ solicitors, and that email attached three separate pdf documents being a copy of the bankruptcy notice, the relevant court judgment and a covering letter to Mr Curtis; and
  3. if the judgment was not attached to the notice upon issue via that email arrangement, whether that defect was a formal defect or irregularity that could be cured by section 306(1) of the Bankruptcy Act (noting there was no dispute between the parties that the bankruptcy notice had been served with a copy of the judgment attached).

In upholding the trial judge’s decision that the bankruptcy notice was valid, the Full Federal Court confirmed that the judgment must have been attached to the bankruptcy notice at the time of its issue as per section 41(2) and regulation 4.02(2). The Court also confirmed that any failure to attach the judgment at the time of issue of the bankruptcy notice would have been fatal and incurable by section 306(1).

On the question of “issue”, the Court said that the email from the Official Receiver to Optus’ solicitors was the act that ‘culminated in the issue of the bankruptcy notice’. The Court went on to say that two of the three pdf documents, namely the notice and the judgment, could be considered as being attached to each other because both of those documents ‘were attached to the same email and electronically proximate to each other…in one sense they were electronically “glued” together…they were electronically “fastened” to each other’. Accordingly, the judgment was attached to the notice at the time of issue.

This decision gives comfort to creditors that the email mode of issue of a bankruptcy notice by the Official Receiver is valid (all other things being in order), and the finding about documents being attached to each other when attached to the same email is useful for wider application than bankruptcy notices.

Case No. 3: Endrez & Ors v Australian Securities and Investments Commission [2014] FCA 1139 – 27 October 2014

This case may be considered a casualty of the arguably infamous ACT Supreme Court case of Commonwealth v Davis Samuel Pty Ltd & Ors (No. 7) [2013] ACTSC 146 where it took the trial judge five years to deliver his findings of fact and law in August 2013, but to this day has still not made final orders giving effect to his findings.

The plaintiffs in Endrez v ASIC were also defendants in the ACT Supreme Court case. In July 2014 a sequestration order was made against each of the Endrez parties and those parties subsequently filed a notice of appeal against the sequestration orders. Before the appeals were heard, the Endrez parties filed an interlocutory application asking that the sequestration orders be stayed until the hearing and determination of each appeal.

Among other things, the Endrez parties sought a stay of any sequestration order until final orders are made in the ACT Supreme Court case and they know whether they have any appeal rights there.

The question before the Federal Court was whether a sequestration order could be stayed.

At the outset, Justice Beach said it was ‘inapposite to talk of a stay of a sequestration order as such’ because when it is made, ‘it takes immediate and automatic effect by force of’ the Bankruptcy Act, with the bankrupt’s property vesting in the trustee. His Honour continued that it is ‘conceptually incoherent to contemplate a judicial stay order as being available to countermand automatic legislative operation where no question of invalidity is involved’. Finally, his Honour noted that section 37(2)(a) of the Bankruptcy Act does not permit a court to suspend the operation of a sequestration order.

However, at the request of the Endrez parties’ counsel, Justice Beach agreed to consider whether a stay of any “proceedings” under the sequestration orders should be ordered in light of a possible appeal of the ACT Supreme Court decision. In doing this, his Honour confirmed the two relevant questions to be answered when dealing with a stay application – namely whether there is some rational prospect of success of the appeal and whether the balance of convenience favours the granting of a stay. His Honour was unconvinced that the Endrez parties’ circumstances warranted the application being granted.

This case confirms that a sequestration order cannot be stayed, which is unlike a winding up order which can be stayed by specific provision of the Corporations Act 2001 (Cth).

Case No. 4: Kapila, in the matter of Edelsten [2014] FCA 112 – 10 October 2014

In an effort to get hold of local assets, this case involved the US bankruptcy trustee of Geoffrey Edelsten applying for recognition in Australia of the foreign bankruptcy under the Cross Border Insolvency Act 2008 (Cth) (1) .

Mr Edelsten’s major US creditor is his estranged business partner Rafael Mawardi, and together they owned a casino in the Dominican Republic, fashion label ‘House of Nurielle’ and hundreds of apartments in Tennessee and Ohio. In tabloid fashion, the US case has involved allegations of Mr Edelsten conspiring with another person to have Mr Mawardi stabbed, and admissions Mr Edelsten has squandering something in the order of $63M in two years.

Other parties who took a keen interest in this Federal Court proceeding were the Australian Taxation Office (said to be owed anywhere up to around $14M), the National Australia Bank (keen to protect its interests as secured creditor) and Mr Edelsten’s ex-wife, Brynne Gordon (keen to protect her interests in pending Family Court proceedings).

The key issue before the Court was whether the US bankruptcy should be recognised here as a “foreign main proceeding” or a “foreign non-main proceeding”, the difference impacting on the interests and authority of the US bankruptcy trustee. To determine this question, Justice Beach examined the evidence of where Mr Edelsten’s “centre of main interests” is, focusing on where Mr Edelsten habitually resides.

Justice Beach noted that it is possible ‘a transnational insolvent’, such as Mr Edelsten, ‘may lead such a nomadic life so as not to have a habitual residence’. The applicant US trustee argued that Mr Edelsten’s centre of main interests were in the US, but his Honour was not convinced.

His Honour found that Mr Edelsten’s habitual residence is in Victoria, and in reaching that decision placed considerable weight on Ms Gordon’s detailed evidence of Mr Edelsten’s recent whereabouts. Ultimately, the US bankruptcy was ordered to be recognised as a foreign non-main proceeding and a Sydney-based insolvency practitioner appointed to deal with administration and realisation of the local assets.

This decision provides a useful discussion of the provisions of UNCITRAL’s Model Law, and the necessary level of detail of evidence to establish the insolvent’s centre of main interests.

Case No. 5: In the matter of Joe & Joe Developments Pty Ltd (Subject to Deed of Company Arrangement) [2014] NSWSC 1444 – 22 October 2014

The lead up to this decision featured heavily in insolvency-related press, the focus being on what some commentators considered a scandalous cost of the administration.

At its heart, the case concerned a complaint by director and shareholder Mr Elias that the deed administrators had managed and were continuing to manage the affairs of Joe & Joe in a manner that was prejudicial to creditors and shareholders. The plaintiffs claimed that:

  • Joe & Joe was solvent at the time of the administrators’ appointment at the beginning of 2009;
  • the administrators had merely been appointed because the directors and shareholders could not agree on how to deal with certain real property;
  • the administrators had represented that the administration would be a matter of months and cost no more than $50,000 to resolve the dispute between directors about the real property;
  • the administrators’ legal fees of around $800,000 were excessive in the circumstances, particularly where there was now an expected net loss to creditors; and
  • the administrators had acted in their own interests by pursuing a deed of release from the directors and shareholders of the company.

The plaintiffs asked the court to declare that the deed administrators be replaced, the DOCA terminated, Joe & Joe’s creditors be paid out and the deed administrators pay Joe & Joe damages and costs.

In a lengthy decision, Justice Black of the NSW Supreme Court analysed the evidence before him and rejected most of the complaints levied against the deed administrators, pointing instead to shareholder dysfunction and the conduct of those parties and their advisors as a key cause for the delay, costs and general difficulties of the administration.

His Honour, however, ultimately agreed that the deed administrators had acted in a manner prejudicial to Joe & Joe’s creditors and shareholders by failing to undertake appropriate review of the invoices received from the deed administrators’ solicitors and thereby to supervise the work undertaken by them. His Honour drew attention to the fact that the vast majority of time entries for the solicitors were for no less than two units (12 minutes) and that many time entries for the solicitors said to relate to conferences and communications with the deed administrators were not reflected in the time entries for the deed administrators.

This decision confirms there is no change to the Stockford (3) principle that an insolvency practitioner must act like any prudent businessperson and obtain the best solicitor at the best possible rate, and closely monitor the solicitor’s fees as they are incurred.

The decision is also one that, in our opinion, highlights the impact of opening communications between an insolvency practitioner and a director / shareholder, and managing expectations about what external administration entails. We have often seen this situation described by Justice Black (3):

Mr Elias gave evidence of his understanding as to the circumstances in which [the deed administrators] were initially appointed as administrators, which made clear that he did not then or now have an adequate understanding of the role of administrators or their statutory responsibilities under the Corporations Act. It is clear…that shortly after the appointment of the administrators, [Mr Elias] came to regret the appointment and was frustrated by the fact that the administrators did not see their role in the narrow way in which he understood it. Mr Elias also appears to have believed that the administrators’ services could be dispensed with, if the shareholders were able to resolve or narrow their differences, but that belief also gave too little weight to the statutory structure of an administration under the Corporations Act.

For more information contact:

Greg Brackenreg — Partner — Dispute Resolution Team
(02) 6279 4409
greg.brackenreg@meyervandenberg.com.au

Bernice Ellis — Senior Associate — Dispute Resolution Team
(02) 6279 4385
bernice.ellis@meyervandenberg.com.au