CATCHWORODS Bankruptcy - Avoidance of preference - mortgage securing antecedent andebtedness - good faith - whether person in position of mortgagees would have suspected insolvency - matter for objective determination in laght of carcumstances known to mortgagees. BANKRUPTCY ACT 1966 s.122(1) (2) (3) (4) Sandell v Porter (1966) 115 C.L.R. 660 Queensland Bacon Proprietary Limited v Rees (1966) 115 C.L.R. 266 Re Weiss Ex parte White v John Vicars & Co. Ltd. [1970] A.L.R. 654 Re: DOMENICO CASTELLUCCI Ex Parte: KEVIN MICHAEL PIPKIN and MICHELE GAMMA and ROSA GAMMA Fisher J. Adelaide 11 March 1983. ~ - IN THE FEDERAL COURT OF AUSTRALIA) ) SOUTH AUSTRALIA DISTRICT REGISTRY) No. 648 of 1981 GENERAL DIVISION BANKRUPTCY DISTRICT OF THE eed STATE OF SOUTH AUSTRALIA Re: DOMENICO CASTELLUCCI A bankrupt Ex parte: KEVIN MICHAEL PIPKIN Applicant and MICHELE GAMMA and ROSA GAMMA Respondents ORDER JUDGE MAKING ORDER : Fisher J. WHERE MADE : Adelaide DATE , : 11 March 1983 THE COURT ORDERS THAT: 1. The mortgage is not void against the applicant. 2. The applicant pay the respondents their costs to be taxed if not agreed. IN THE FEDERAL COURT OF AUSTRALIA SOUTH AUSTRALIA DISTRICT REGISTRY No. 648 of 1981 GENERAL DIVISION BANKRUPTCY DISTRICT OF THE ee eee ee STATE OF SOUTH AUSTRALIA Re: DOMENICO CASTELLUCCI A bankrupt Ex Partc: KEVIN MICHAEL PIPKIN Applicant and MICHELE GAMMA and ROSA GAMMA Respondents CORAM: Fisher J. 11 March 1983 REASONS FOR JUDGMENT This application is made pursuant to s.122 of the Bankruptcy Act 1966 ("the Act") by Michael Kevin Pipkin ("the applicant") a registered trustee as trustee of the bankrupt estate of Domenico Castellucci ("the bankrupt"). The proceedings were commenced in the Court of Insolvency of the State of South Australia exercising, as it did at the time, Federal jurisdiction in bankruptcy. Eventually it came on for hearing in this Court which on 1 February 1982 assumed jurisdiction in bankruptcy in the State of South Australia in place of the State Court of Insolvency, Transitional provisions enacted in the Statute Law (Miscellaneous Amendments) Act 1981 ensured that it was proper for the Federal Court to exercise jurisdiction in the Matter: notwithstanding the fact :that.the_action had commenced in another Court. By this application orders are sought pursuant to s.122(1) declaring that a certain mortgage executed by the bankrupt in favour of the respondents on 25 May 1981 is void as against the applicant and requiring the respondents to execute a discharge thereof. Section 122(1) to the extent material to this application is as follows: "122(1) ...A conveyance or transfer of property, a charge on . property, or a payment made, or an obligation incurred y by a person who is unable to pay his debts as they become due from his own money... in favour of a creditor, having the effect of giving that creditor a preference, priority or advantage over other creditors, being on a conveyance, transfer, charge, payment or obligation executed, made or incurred - (a) within 6 months before the presentation of a petition on which, or by virtue of the presentation of which, the debtor becomes a bankrupt; or (b) on or after the day on which the petition on which, or by virtue of presentation of which, the debtor becomes a bankrupt is presented and before the day on which the debtor becomes a bankrupt, is void as against the trustee in the bankruptcy." The petition on which ultimately on 4 September 1981 the bankrupt became bankrupt was presented on 12 December 1980. In the circumstances that the mortgage in question was executed on 25 May 1981 the applicant was entitled to bring these proceedings. As ultimately it was conceded that the applicant had discharged the onus on him to establish the elements of that subsection most of the argument turned on what I would call the "protective provisions" of s.122(2) and thereafter. They are in these terms: "(2) Nothing in this section affects (a) the rights of a purchaser, payee or encumbrancer in. . good faith and.in the ordinary course of business, Ab) ... (c) ... (3) The burden of proving the matters referred to in sub- section (2) lies upon the person claiming to have the benefit of that sub-section. (4) For the purposes of this section - (a) ... {b) ... (c) a creditor shall be deemed not to be a purchaser, payee or encumbrancer in good faith if the conveyance transfer, charge, payment or obligation was executed, made or incurred under such circumstances as to lead to the inference that the creditor knew, or had reason to suspect - (1) that the debtor was unable to pay his debts as they became due from his own money; and (ii) that the effect of the conveyance, transfer, charge payment or obligation would be to give hima preference, priority or advantage over other creditors." The execution of the Mortgage on 25 May 1981 clearly brought the transaction within the terms of s.122, and it was common ground that its effect was in the circumstances to give to the respondents a preference, priority or advantage over other creditors as it purported to secure antecedent debts. Much evidence was directed in the first instance to the question whether the bankrupt was at the time unable to pay his debts, but ultimately counsel for the respondents did not press me to find to the contrary. Likewise counsel for the applicant did not contend that the transaction was outside of the ordinary course of business. "It is theref6re not' necéssary to spend much time on these two issues and the evidence relevant thereto. The principal issue is whether the respondents have established that they are entitled to the benefit of the above protective provisions, mene The relevant facts are as follows; At all material times the bankrupt conducted three butcher's shops in the subyrbs. He leased premises at Findon Road, Findon and in Payneham Road, Royston Park and was the registered proprietor of the land in Payneham Road, Glynde upon which he conducted the third business. His dwellinghouse, recently built, was situated upon this land, which was the security for the mortgage under consideration in these proceedings. The male respondent ("Mr. Gamma") said that he had been friendly with the bankrupt for about 15 years though the bankrupt stated it as a shorter period of about 5 years. It would appear that they became acquainted at the stock markets in that Mr. Gamma was a dealer in stock and the bankrupt a purchaser for the purposes of his business, Both the bankrupt and Mr. Gamma gave evidence in the proceedings and it is apparent that they are of the same ethnic background and neither is thoroughly fluent in the English language, Late in 1979 the bankrupt approached Mr. Gamma seeking a loan of $20,000 for the purpose, he said,of paying his liability to the Commissioner of Taxation. He said that the advance would be repaid as soon as he sold his Findon business in respect of which he had a contract to sell for $30,000. He told Mr. Gamma that he was short of funds as he had too much money owing by his debtors who were slow in paying. Mr. Gamma accepted, as he appears at all times to have done, the bankrupt's statements and obtained the funds to lend from his sister and sisters-in-law. On the making of this loan there was no document evidencing the same and no arrangement concerning time for repayment or interest. Shortly thereafter the bankrupt told Mr.. Gamma that the sate .of uthe- Findom-business had fallen through because. the prospective 'purchaser had been unable to obtain finance. However he said the business was stiil on the market as was the Royston Park business. He asked for the loan of a further $10,000. In respect of this evidence the parties were slightly more business like in that a document was prepared by Mr. Gamma's solicitors setting out the terms of the loan. It appears that Mr. Gamma again obtained funds from his sister and sisters-in-law and had himself no interest in the moneys advanced except he anticipated participating in some portion of the interest, or as he called 1t "the profit". This agreement was in the following terms: " ACKNOWLEDGMENT OF DEBT I, DOMENICO CASTELLUCCI of 484 Payneham Road, Glynde, 5070 in the State of South Australia, Butcher, HEREBY ACKNOWLEDGE that I am indebted to MICHELE GAMMA C/- Post Office, Carey Gully, 5144 in the said State, Farmer, in the sum of THIRTY THOUSAND DOLLARS ($30,000.00) being moneys lent to me, which sum is repayable by amounts of not less than FIVE THOUSAND DOLLARS ($5,000.00) from time to time but in any event on or before the expiration of two (2) years from the date hereof. I do further agree to pay the said MICHELE GAMMA interest on the said sum for on so much thereof as may be owing) adjustable as at the time of making payments at the rate of 10 per centum per annum calculated from the date hereof and I further acknowledge and agree to pay interest in any event at the end of each twelve calendar monthly period and that in the event of default being made in paying any of the interest due herein the full amount of principal owing shall thereupon become immediately due and payable. DATED the 22nd day of November 1979 SIGNED by the said ) ; . DOMENICO CASTELLUCCI ) Signed .Domenico.Castellucci in the presence of ; ) Signed Laurie Carbone SIGNED by the said ) . MICHELE GAMMA in the) Signed.Michele Gampa presence of : ) Signed. Laurié Garbone w At about this time the bankrupt informed Mr. Gamma that an agent had placed the figure of $235,000 on the Glynde dwellinghouse - shopping complex, though it was Mr. Gamma's view that the value was close to $170 7000-$180,000. He also said in evidence that he considered that at this time the Royston Park business was worth $15,000 - $18,000 and the larger business at Findon $25,000 - $30,000. "In early 1980 the bankrupt requested Mr. Gamma to purchase stock on his behalf at the public auctions. He said that he had had an argument wath one of the agents, in consequence of which he was required to pay cash on the spot for his purchases. This Mr. Gamma agreed to do, purchasing the stock for the bankrupt, as the agents, he said, were aware, On an account styled "Gamma a/c Napoli". These purchases were relatively substantial in amount, totalling $101,612.81 or thereabouts over a period of some 17 weeks and until the end of the period the bankrupt honoured his promise to pay Mr. Gamma weekly for these purchases. In July 1980 Mr. Gamma told the bankrupt that thereafter he would have to purchase stock on his own account. He said that he was too busy to attend the stock sales frequently, as he was contemplat- ing purchasing a shop and business in Summertown. There was at the tume a balance of $5,770.75 owing by the bankrupt to Mr. Gamma, who, when requested by the bankrupt-to allow the same to remain outstanding until he sold his shops, agreed to do so. "Mr. Gamma sard-that in thestedtter-part of the calendar year -1980 -checwas,.still waiting onthe sale'of -one-ior 'more -of the bankrupt's-shops before he could expect repayment of the $30,000 loaned. He had not received at the time any payment on account of interest or principal as contemplated by the agreement. He did commence to press the bankrupt for payment in November or thereabouts in 1980 as he had contracted to buy the business in Summertown. Mr. Gamma said that when he pressed the bankrupt for payment, the latter said "Do not force me to sell the shops, I cannot get the price for it. If you give me a bit of time, I can try and get a price and I give you a mortgage." Mr. Gamma said he said "That is up to you. I am not worrying about a mortgage, I prefer to have the money." The bankrupt 1s alleged to have said "Please do not force me to sell the shops for cheaper(sic), I give you a mortgage and I will give you interest on it anda couple of years time, give me a bit of time to sell the shops." Mr. Gamma said he was informed bythe bankrupt that he was at the time trying to sell the Findon shop from which he was expecting to receive $25,000 and the Royston Park shop, for $12,000 or $13,000. He said that he trusted the bankrupt and was prepared to allow him a further two years within which to pay and that his sister and sisters-in-law were prepared to accept the position. However the sum to be secured by the mortgage was agreed to cover not only the $30,000 but the outstanding interest thereon and the sum of $5,770,75 being the amount owing by the bankrupt for stock. This mortgage was secured on the premises of the dwellinghouse and business at Payneham Road, Glynde, upon 'which -the~barikrupt.said he-owed $%0,000 to $80,000-to his Bank. Mr. Gamma said'he- had -his wife -search the title to the property to confirm the information given by the bankrupt as to the mortgages thereon. The general tenor of his evidence was that he was prepared to give the bankrupt further time in which to sell his shops and that he believed he had no creditors, apart from himself, other than periodic trade creditors. This aspect of his evidence will require careful consideration when I come to consider the protective provisions First I will deal with the two questions of insolvency and preference on which in the end there was little dispute. ' 1. Insolvency In his statement of affairs prepared some six months after the date of execution of the mortgage, the bankrupt considerably over- stated his assets and understated his liabilities. The applicant prepared a statement of assets and liabilities as at the earlier date which was initially challenged, at least in respect of liabilities, by the respondents. However 1t was ultimately common ground that the bankrupt's liabilities totalled at least $202,000 at the time. The test of insolvency was enunciated by Barwick C.J. in Sandell v Porter (1966) 115 C.L.R. 660 at page 670 and requires consideration of what the debtors may be able to procure in addition to their immediate cash resources by realization or mortgage of their assets within a relatively short period of time. In this matter there is no . doubt that in May 1981 the bankrupt had very substantial creditors, On both trade and -.- personal loan accounts. The only assets which he had for realization were the assets of his businesses and his reason _- £oxsrequesting further time was his inability to sell_ the Findon_and _ ry Royston Park-shops.. 'There -is no doubt the bankrupt was.-insolvent at . the relevant time. 2. Preference There is also no doubt that by obtaining security to cover the bankrupt's indebtedness Mr. Gamma obtained a preference,priority or advantage over other creditors of the bankrupt. There was no contest to the contrary. ° Thus the applicant has made out his case that the mortgage is void against him unless the respondents establish that they are entitled to take advantage' of the protective provisions. These are contained in s.122({2) (3) and (4) of the Act and are as set out above. The evidence must be scrutinised for the purpose of determining whether I am satisfied of the bonafides of Mr. Gamma, and,notwithstand- ing that I may so find, whether there are circumstances from which the inference can be drawn that the respondents either knew or had reason to suspect both the insolvency of the debtor and the preferential effect of the mortgage. Counsel for the applicant did not dispute that the mortgage was given for valuable consideration and in the ordinary course of business. If the respondents fail to satisfy me that they acted in good faith, that 1s the end of the matter and I must set aside the mortgage. It is only if they do so satisfy me that a further objective question remains to be determined. This question will fall for consideration - 2n the light of circumstances surrounding the giving of the mortgage, as they were or should have been known to the respondents. Itws so a Kl Sind . stated by Kitto Jin Queensland=Bacen Proprietory Limited v Rees 2p: Y wee tev vor -mmen 17966) ° 715 C.L.R.-266 at'-p.303 as an ebjective questiort-im- 'the following terms: 10. "What the payee or anyone else inferred at the time is not to be treated as decisive, though the Court may be assisted in reaching its own conclusion by seeing how business men in fact reacted to the circumstances. The character of the circumstances is what has to be decided: were they such as to lead to the specified inference? The inference 1s that the payee had cause to suspect the existence of two states of fact." The provisions of s.122(4) of the Act do not impose any onus on the respondents. The effect of the subsection is, as stated by Gibbs J. in re Weiss, Ex parte White v John Vicars & Co. Ltd. [1970] A.L.R. 654 at 665 "...that, 1£ the Court is positively satisfied that the circumstances of the payment justify the inference by it that the creditors knew or had reason to suspect the insolvency and the preference, the Court is precluded from finding good faith (Queensland Bacon Pty. Ltd. v Rees at p.287).' Gibbs J. went on to indicate, by reference to extracts from the reasoning in that case, certain other matters which are required to be established. He said on the same page of re Weiss "To satisfy the subsection, 'it is not enough that the circumstances are such as to lead to the inference that the creditor had reason to suspect that the debtor might be insolvent. The words of the subsection, to my mind, are quite clear that it 1s the fact of actual insolvency which must be known or suspected. To be insolvent, the debtor must be unable, as distinct from being merely unwilling, to pay his debts as they fall due. It is one thing to suspect a man's solvency in the sense that one doubts whether he is solvent or insolvent. It is another thing to suspect that he is in fact insolvent. It as of the latter suspicion that s.95(4), in my opinion speaks' (Queensland Bacon Pty. Ltd. v Rees, supra at pp.291-2, per Barwick, C.J.). 'The notion which "reason to suspect" ex- presses in subsection (4), is, I think, of something which in all the circumstances would create in the mind of a reasonable person in the position of the payee an actual apprehension or fear tnat the situation of the payer is in actual fact that which the subsection describes - a mistrust of the payer's ability to pay his debts as they become due and of the effect - wWwhich-acceptance of the.payment would have as hetween the - payee-.and the-other creditors' (p.303, per Kitto, J)." ll. The words which I have emphasised in the last mentioned extract from the reasons of Kitto J, namely "a reasonable person in the position of the payee", support my view that I am required to take into account the knowledge and circumstances of the respondents in, deciding whether I should draw the inference that they had reason to suspect. I also draw attention to the distinction made between doubting whether a person is solvent and suspecting that he is in fact insolvent. Mr. Gamma was the only respondent to give evidence and it was not suggested that the respondents' case was defective by reason of the absence of Mrs. Gamma, who, her husband said, had only been included as a mortgagee to cover the eventuality of his death. However, I must first turn to the question of the onus on Mr. Gamma to satisfy me that he acted in good faith. This is a matter for subjective determination and can not be found if Mr, Gamma knew or suspected that the bankrupt was insolvent. To my mind Mr. Gamma has satisfied me on this aspect, and he supported his alleged knowledge to the contrary by pointing to the fact that all the businesses were well patronised and appeared busy and profitable. He did not know of the private borrowings of the bankrupt and there was no reason why he should suspect that the reason why the bankrupt required further time was other than to enable him to sell the businesses at what he considered a- fair-price. He said he trusted the bankrupt, and - when there had been a firm obligation on the bankrupt to make regular payments of day to day outgoings in respect of the purchase of stock, these payments had been made. 12. Mr. Gamma having satisfied me, on the balance of probabilities that he acted in good faith, I turn to consider whether I am prepared to draw the inference that a reasonable man in his position would have known or suspected the insolvency ard the preference. In this regard I look to the circumstances as known to Mr. Gamma and his position as a person of another ethnic group accustomed to dealing with relations and friends on a basis of trust rather than in accord with businesslike practices, " In this case, as I see it, the most crucial circumstance, both in respect of solvency and preference, is, as it was in re Weiss (cf. p.665), whether Mr. Gamma knew in May 1981 that the bankrupt had other creditors. As I have said he must have known that he had trade creditors arising out of his day to day conduct of the three businesses, but from his experience he was entitled to assume that they were paid reasonably promptly. He was himself paid promptly when he was purchasing on the bankrupt's behalf with the exception of the last $5,770, and he was aware that thereafter the bankrupt was likely to have been required to pay cash for his stock. He said that he was not aware that there were other creditors, and in particular that the bankrupt had made a number of other personal borrowings. These assertions were not shaken in cross-examination. An instinctive reaction that a-reasonable man would have suspected -- that he was not the only creditor who had made personal advances is understandable. Likewise a reasonable man would have enquired whether the bankrupt was in arrears with payments of interest or instalments of capital. -However I am.not satisfied "that -such an inference 'should be drawn when. considering a person in the circumstances 'of Mr..Gamma. ~o rt aoe 13. My disinclination to draw this inference receives support from the evidence of the other creditors called by the applicant. Each was unaware that the bankrupt had borrowed from any other person or had other creditoys. Each appeared, to a greater or lesser degree, to have lent money on trust, and to have accepted at face value the representations of the bankrupt. Each confirmed the impression that Mr. Gamma had, that the bankrupt was conducting flourisninyg and profitable businesses. The attitude of each of these persons aids a finding that I should be prepared to accept the evidence of Mr. Gamma that he was not aware of other creditors, This becomes a crucial if not conclusive circumstance in considering whether I can draw the inference that a reasonable man would have suspected insolvenc and preference. If the reasonable man was not aware of other creditors he is hardly likely to suspect insolvency and could not suspect prefe.ence. In my opinion the other circumstances surrounding the execution of the mortgage do not necessary require the drawing of the relevant inference. Mr. Gamma reasonably held the view that the bankrupt had substantial assets encumbered only to a limited extent, and that his difficulties which prompted an extension of time to repay outstanding monies (even though the whole of the $30,000 was not at the time payable) arose out of a desire to sell the bankrupt!'s-business. He—— accepted his statements that he was having trouble in collecting promptly amounts owing to him and this was preventing-the making of repayments. He accepted. and his accep.ance was not unreasonable, the > vtexplanations;which' the bankrupt made as.earlier set out at the time he 'requested 'repayment..toszassist in his purchases at Summertown,. 14. Gibbs J. in re Weiss at page 667 sets out the manner in which it is proper to reach a conclusion from the circumstances on the question of solvency. He had earlier stated the essential question for the Court as follows on page 665. "The question remains whether it can be inferred that the respondent had reason to suspect that the bankrupt was unable to pay his debts as they became due. It 1s the circumstances under which the bill of sale was executed that must support this inference, although those circumstances would include the respondent's knowledge of anterior events (see Queensland Bacon Pty. Ltd. v Rees supra at p.292)." After discussing the relevant circumstances, including the fact thé certain of the bankrupt's cheques in favour of the respondent had been dishonoured, His Honour concluded as follows on page 667. "Whether the circumstances were such that there was reason to suspect insolvency is a question of degree, but in the present case, although it is clear that a reasonable man in the position of the respondent might have doubted whether the bankrupt was insolvent or not, I am not satisfied that the circumstances in which the bill of sale was executed justify the inference that the respondent had reason to suspect that the bankrupt was in fact insolvent." I have emphasized significant words. In the matter before me, because of circumstances peculiar to a person in the position of Mr. Gamma, I am not prepared, on the balance of probabilities, to make the finding made by Gibbs J. that a person in the position of this respondent might have doubted whether the bankrupt was insolvent or not. It must follow that I can not draw the inference that the respondent had reason to suspect that the bankrupt was in fact insolvent. - My finding is that the respondents took security by way of mortgage "for the-bankrupt's antecedent indebtedness in good faith. "There -being, 15. as I have said, no contest on the questions of valuable consideration and ordinary course of business, I hold that the mortgage is not void against the applicant. The application must be dismissed with costs. | certify that this and the 1% preceding pages are a true copy of the Reasons for Judgment of Mr Justice WA a pated. //7¢L Mock L733