JUDGMENT No. 2°. 7.523 onus CATCHWORDS BANKRUPTCY —- Sub-s.109(10) Bankruptcy Act 1966 - Application by trustee for order conferring advantage on indemnifying creditors with respect to distribution of recovered asset - Asset recovered without resorting to litigation - Bankruptcy Amendment Act 1985 - What is meant by "recovered under an indemnity for costs of litigation" - Principles applicable to determination of degree of advantage which should be conferred. Bankruptcy Act 1966 sub-ss.109(10), 116(1), 152(1), 153(1), 154(1), iets, para.58(1)(b) Bankruptcy Amendment Act 1985 RE: DAVID HAROLD SERRA~SANFELIN EX PARTE: THE OFFICIAL TRUSTEE IN BANKRUPTCY the Trustee of the property of David Harold Serra-Santelin NO. 171 OF 1980 LEE J. PERTH 30 JUNE 1988 IN THE FEDERAL COURT OF AUSTRALIA GENERAL DIVISION OF THE STATE OF ) BANKRUPTCY DISTRICT ) ) ) WESTERN AUSTRALIA NO. 171 OF 1980 RE: DAVID HAROLD SERRA-SANFELIN EX PARTE: THE OFFICIAL TRUSTEE IN BANKRUPTCY the Trustee of the property of David Harold Serra-Sanfelin Applicant MINUTE OF ORDER JUDGE MAKING ORDER: LEE J. DATE OF ORDER: WHERE MADE: 30 JUNE 1988 PERTH THE COURT ORDERS THAT: 1. The sum of $45,000 recovered by the trustee indemnities for costs of litigation, under less deductions for relevant fees, costs and expenses, be distributed in the following manner: (a) (b) The sum of $12,000 be distributed to the indemnifying creditors pro rata; and the balance, after payment of costs and expenses of administration, be distributed to creditors of the separate estate and the remaining surplus to creditors of the joint estate of the bankrupt and Graeme John Jones. action to include the joint estate of the bankrupt Graeme John Jones. The applicant be granted leave to amend the title of the and So much of the trustee's costs as do not exceed $1,000 be paid as part of the expenses of recovery of the property the subject of this application. Note: Settlement and entry of orders is dealt with in Rule 124 of the Bankruptcy Rules. IN THE FEDERAL COURT OF AUSTRALIA GENERAL DIVISION BANKRUPTCY DISTRICT OF THE STATE OF WESTERN AUSTRALIA were rr NO. 171 OF 1980 RE: DAVID HAROLD SERRA-SANFELIN EX PARTE: THE OFFICIAL TRUSTEE IN BANKRUPTCY the Trustee of the property of David Harold Serra-Sanfelin Applicant CORAM: LEE J. 30 June 1988 REASONS FOR JUDGMENT This is an application by the trustee of the property of the bankrupt seeking orders pursuant to sub-s.109(10) of the Bankruptcy Act 1966 ("the Act") which will have the effect of giving creditors who gave the trustee an indemnity for costs of litigation an advantage over other creditors with respect to the distribution of property of the bankrupt recovered by the trustee consequent upon such indemnities having been provided by those creditors. The trustee of the bankrupt's estate 1s the Official Trustee 1n Bankruptcy ("the trustee"). The bankrupt had carried on business in partnership as a building contractor. The bankrupt and his partner presented a joint debtor's petition on 15 April 1980. The debts owing to unsecured creditors of the joant estate were approximately $190,000. The debts due to the unsecured creditors of the separate estate of the bankrupt amounted to approximately $8,800. The respective estates were duly administered by the realization of assets and the distribution of dividends. The joint estate of the bankrupt and his partner made a distribution to unsecured creditors of 2.082 cents in the dollar after payment of priority creditors. In the separate estate of the bankrupt a dividend of 42.22 cents in the dollar was distributed. The bankrupt was discharged from his bankruptcy on 12 July 1983. In November 1985 the trustee became aware that the bankrupt had made application to become registered as the proprietor of land of which he claimed to be entitled either as a beneficiary of his late father's estate or through rights of adverse possession. The trustee lodged caveats against the property after making enquiries and forming the view that the land in which the bankrupt claimed an interest was an asset of the estate of the bankrupt which had vested in the trustee upon the commencement of the bankrupt's bankruptcy. In March 1986 a meeting of the creditors of the joint estate of the bankrupt and his partner and of the separate estate of the bankrupt was held to decide what action should be taken in respect of the newly discovered item of property in the bankrupt's estate. The meeting resolved that an opinion be obtained from the trustee's solicitors and that the costs thereof be borne by the creditors present in proportion to their proofs of debt. The trustee's solicitors provided advice and recommended that the opinion of counsel be obtained. The trustee instructed solicitors to obtain the advice of counsel. In July 1986 counsel advised that the bankrupt had succeeded to the property upon his father's death which had occurred after the commencement of the bankruptcy but before the discharge of the bankrupt. Counsel concluded that the property was, therefore, property divisible amongst the creditors of the bankrupt's estate pursuant to sub-s.116(1) of the Act. Counsel advised the trustee that pursuant to para.58(1)(b) of the Act, the property vested in the trustee upon being vested in or devolved upon the bankrupt. Counsel did not discuss the effect of discharge of the bankrupt but it is clear that pursuant to sub-s.152(1) and in the absence of any order of annulment under sub-s.154(1) with consequent reversion of the property to the bankrupt under 4. sub-s.154(2), the property remained vested in the trustee for the purpose of realization and distribution to the creditors of the bankrupt's separate and joint estates. The creditors retained rights to receive distributions from those estates in respect of the unsatisfied debts notwithstanding that the bankrupt personally had been released from those debts upon discharge from his bankruptcy pursuant to sub~-s.153(1) of the Act. Another meeting of joint creditors of the bankrupt and his partner and the separate creditors of the bankrupt was held on 19 December 1986 to consider the opinion the trustee had received. The meeting was advised that 1t appeared to be necessary for the trustee to commence legal proceedings to obtain orders allowing him to deal with the bankrupt's property. The creditors were advised that if such litigation were successful the creditors of the bankrupt's separate estate would be paid in full and creditors of the joint estate would receive a further dividend of approximately 16 cents in the dollar. The meeting resolved that the trustee be authorized to institute legal proceedings to establish the interest of the trustee in the bankrupt's properties and to realize that property. At that meeting creditors were informed that the trustee would require the creditors to provide indemnities in respect of his legal costs before proceedings could be commenced. The creditors were informed of the provisions of sub-s.109(10) of the Act which allowed creditors who had provided such indemnities to receive an advantage over other creditors. In the notice of meeting forwarded to creditors, the trustee advised creditors that he had received legal opinions expressing the view that he had a good claim to the bankrupt's half anterest in the property in question, He further advised creditors that the bankrupt had offered to compromise the trustee's claim by payment of a sumof $5,000. The trustee informed creditors that a valuation of the property as at September 1980 indicated that the bankrupt's half share was worth approximately $37,000. Notice of the meeting of 19 December 1986 was forwarded to all creditors of each estate at the last addresses notified to the trustee. In some cases notices were returned unclaimed and the trustee made further efforts to trace those creditors and obtain an alternative address to which another copy of the notice could be forwarded. After the meeting of creditors held on 19 December 1986 had resolved that the trustee be authorized to commence legal proceedings, the trustee, 1n January 1987, forwarded a notice to creditors that the trustee required to be indemnified for the costs of that action. The notice specified that the costs were anticipated to be approximately $9,000 and the notice also set out the text of sub-s.109(10) in full. Creditors were advised that should insufficient or unsatisfactory indemnities be received the matter would not proceed. 6. As a result of that notice eleven creditors of the joint estate provided indemnities for the trustee's costs. One of those creditors limited his liability under that indemnity to the sum of $1,000. There were only two creditors of the separate estate and neither creditor provided an indemnity. According to the trustee's affidavit there were erghty-four creditors who lodged proofs of debt in the joint estate and another ten creditors who had been identified as creditors of that estate but had not proved. The eleven creditors providing indemnities represented approximately 27% of the value of the total debts of the joint estate and approximately 31% of the value of the proved claims lodged in that estate. The indemnity provided by the eleven creditors was in the following form: "IN CONSIDERATION of your undertaking such steps, actions, proceedings or suits aS you may be advised to obtain an Order from the Court claiming the Official Receiver's half anterest in the properties at T7 Stone Street, Bayswater, presently registered in the name of David Harold Serra-Sanfelin and for the realisation of that interest. TWO. ccc cece cece eee teen ee ence a creditor...in the abovenamed estate hereby agree that I will pay to you on demand all costs, charges, expenses and sums of damages for which you may become liable, pay, incur or sustain in respect of or arising out of or in connection with such steps, actions, proceedings or suits (including appeals)." Upon receipt of the indemnities the trustee authorized solicitors to take such steps as were necessary to establish the trustee's interest in the bankrupt's property. The trustee's solicitors made formal demand upon the bankrupt on behalf of the trustee as a result of which negotiations to compromise the matter were commenced. The bankrupt offered to pay to the trustee a sum of $45,000 in full settlement of the rights of the trustee. This proposal was placed before a duly convened meeting of the creditors of the joint and separate estates of the bankrupt on 10 July 1987. Creditors attending that meeting resolved unanimously to authorize the trustee to accept the offer of settlement proposed by the bankrupt. The trustee did compromise the matter by receiving the sum of $45,000. It is said that after payment of various fees and disbursements the amount available for distribution to creditors will be approximately $37,000. In bringing this application for consideration of an order to advantage the creditors who have provided an indemnity, the trustee has given notice of the application to all creditors and that notice has provided a summary of relevant facts. On the hearing of the application no creditor sought to oppose an order being made to advantage the creditors who had provided indemnities. Although the creditors of the separate estate did not provide indemnities, it may not have been reasonable to expect them to have done so. At the time indemnities were sought' the amount still owing to creditors of the separate estate was only approximately $5,000 and the bankrupt was offering to pay that sum to the trustee without the trustee taking any further step in the matter, The terms of sub-s.109(10) are as follows: "Where in any bankruptcy -— (a) property has been recovered, realized or preserved under an andemnity for costs of litigation given by a creditor or creditors; or (b) expenses in relation to which a creditor has, or creditors have, indemnified a trustee have been recovered, the Court may, upon the application of the trustee or a creditor, make such orders as 1t thinks just and equitable with respect to the distribution of that property and the amount of those expenses so recovered with a view to giving the indemnifying creditor or creditors, as the case may be, an advantage over others in consideration of the £15k assumed by creditor or creditors." 9. The indemnity provided by creditors to the trustee was for such costs, charges and expenses which the trustee may have incurred or sustained in respect of steps, actions, proceedings or suits undertaken to obtain an order from the Court in respect of the bankrupt's property. The question that arises is whether the property recovered in the estate, the sum of $45,000, was so recovered under an indemnity for costs of litigation. Prior to the Bankruptcy Amendment Act 1985 it was necessary to show that property had been recovered by means of an indemnity for costs of litigation (at that time sub-s.109(6)). After the Bankruptcy Amendment Act 1985 it became necessary to show that the property had been recovered under an indemnity for costs of litigation. The phrase "by means of" may have required some causal relationship, not necessarily direct, to be demonstrated. (See discussion of meaning of phrase "by reason of" in Vickers v. Minister for Business and Consumer Affairs (1982) 43 A.L.R. 389, 407 per Morling J.) Before the amendment it had been suggested that the meaning of the word "recovered" was limited by the context provided by the words "by means of an indemnity for costs of litigation", In Re Passmore; Ex parte Official Receiver in Bankruptcy (1984) 56 A.L.R. 181 Northrop J. said at p.184: 10. "The court is required to construe the words 'recovered or preserved' appearing in the opening part of s.109(6) of the Act. It is apparent that they are to be construed in the context of litigation. In that context the word 'recover' signifies to recover by legal action, normally by the judgment of a court. It is quite correct to refer, for example, to the recovery of damages for personal injuries even though the legal proceedings in which damages are sought result in a settlement being reached." and at p.186, for the purposes of the Act, the meaning of the words "recovered or preserved" meant: ",..recovered or preserved in some action, matter or proceeding in a court of law." However, in several earlier cases where the trustee had relied upon an indemnity for the costs of litigation in taking any step to assert his right to a bankrupt's property, it had been held that assets recovered by those steps without resort to litigation were assets recovered by means of the indemnity. In Re A. and M. Myerson (1908) 25 W.N. (N.S.W.) 136 Street J. stated at p.137: "I am not going to attempt to put an exhaustive interpretation upon the words 'by means of'. Each case must depend upon its own circumstances, but I think that in every case the Court must see, not merely that the assets in question were recovered after the giving of the indemnity, but that were it not for the indemnity they would probably not have been recovered at all, or at least that the protection and assurance afforded to the official assignee by the indemnity have been material factors in rendering possible and helping towards and facilitating the recovery of the assets claimed to have been recovered by means of such indemnity." 11. and at p.138: "Nearly the whole of this amount was recovered without hostile litigation being resorted to, but if the indemnity comes within the terms of the section I do not think that it is necessary that in every case hostile litigation should have been embarked upon before the provisions of the section can be brought into operation." In that case the Official Assignee had recovered monies from various sources by letters of request and demand without resort to litigation but had made demand only after receiving the indemnities in respect of his costs of litigation. In Re Farrow (1956) 18 A.B.C. 225 the Official Receiver demanded repayment of monies the Official Receiver claimed to have been preferential payments. The demand was refused. The Official Receiver obtained counsel's opinion and thereafter an indemnity from creditors for the costs of litigation. The Court then granted leave to the Official Receiver to institute proceedings and to recover the disputed payments. However, the creditor paid the amounts previously demanded upon becoming aware that leave to institute proceedings had been granted without any formal litigous step having been taken. In that case Jeffriess J. said at p.229: "By the indemnity, it appears to me that the creditors who signed have subjected themselves' to the risk of having to pay the costs of adverse litigation. According to the affidavit of the official receiver, he would not have taken any further action or made any further demand against 12. Burns Philp and Co. Limited had those creditors not given the indemnity...Therefore I conclude that the protection and assurance afforded to the official receiver by the indemnities have been the material factor in bringing about the recovery of these moneys and that the official receiver would not have incurred the expense and risk which he did and take the action which he did, unless he had been secured against personal loss by the indemnity, especially as Burns Philp and Co. Ltd had made it clear from the outset that the claim would be resisted. For these reasons I hold that the assets have been recovered by means of an indemnity for the costs of litigation within the meaning of s.84(2) of the Bankruptcy Act." The effect of the 1985 amendments to s.109 have been considered by Pincus J. in Re Webb; Ex parte Taylor (1987) 75 A.L.R. 139. At pp.141-142 his Honour said: "The expression 'recovered under an indemnity for costs of litigation' is a little elliptical. It seems to mean ''recovered by reason of steps taken under an indemnity for costs of litigation'; an indemnity cannot itself directly bring about recovery. Counsel argued that there is no intention in the section to give a creditor an advantage by reason of having given an indemnity for the costs of any investigation with a view to possible litigation and referred to in Re A Shadler Ltd (1905) 5 SR(NSW) 33. In that case Walker J. held that s.77 of the Bankruptcy Act 1899 (NSW) applied in a winding up under the Companies Act but that, giving that section (which was similar in terms so far as_ relevant to s109(10)) a strict interpretation, the costs of inquiry into whether or not litigation should be instituted were not covered by the section. It follows from Shadler's case that here, if there had been an indemnity only for the costs of investigation, the section would not have applied; but the indemnity in the end covered both investigation and litigation, as it did not in Shadler''s case. The question whether the property was recovered 'under' the indemnity is one of some difficulty. Giving the provision the construction mentioned in 13. the preceding paragraph, however, I find that the property was so recovered. It seems a reasonable inference that it was the threat of immediate litigation which induced Mr. Webb to offer to transfer the properties, and that threat was made in the course of the solicitors pursuing their retainer covered by the indemnity for the costs of litigation. In my view, that indemnity covered the preliminary steps such as preparing the court papers and writing a letter of demand." In the present case the indemnity is not an indemnity limited to the costs of litigation. It extends to costs or charges incurred in respect of such steps as the trustee may be advised to take to obtain an order from the Court. Furthermore, the trustee made it plain that he would take no steps to proceed to obtain a court order in respect of the property unless' such indemnities were received. Whatever the meaning of the expression "recovered under an indemnity" may be, it is apparent that replacement of the phrase "by means of" with the word "under" does not display any intention to contract the scope of operation of the section, and, to the contrary, may show an intention to loosen the nexus of a causal relationship. Ifa trustee or creditor is able to show that an indemnity for costs of litigation has been provided and that the trustee relied upon that indemnity in taking steps preparatory to litigation as a result of which property was recovered for the estate, such circumstances will come within the meaning of the words ""property...recovered...under an indemnity for costs of litigation." 14. I am satisfied that the provisions of sub-s.109(10) apply to the facts of the present case. Accordingly the Court 18 empowered to make such order as it considers to be just and equitable with regard to the distribution of the property recovered with a view to giving indemnifying creditors an advantage over others in consideration of the risk assumed. The risk assumed by the indemnifying creditors must therefore be assessed. Before the indemnity was requested and given, the trustee had already obtained advice from solicitors and counsel's opinion which expressed the view that the trustee had a good claim to the bankrupt's property. Furthermore, before the trustee sought an indemnity in respect of his costs of litigation estimated to be approximately $9,000, the bankrupt had already offered, without prejudice, to settle the trustee's claim by payment of a sum of $5,000. It would not be appropriate to conclude that the indemnifying creditors had exposed themselves to a_ substantial risk. The costs of litigation would have been shared by eleven creditors and an individual creditor's liability may have been comparatively modest. (See Re M.L. Ried (1946) 13 A.B.C. 287.) 15. At worst no indemnifying creditor would have been likely to have been called upon to pay more than the $1,000 to which one of their number limited his exposure under the indemnity. As is stated in Re Manson; Ex Parte the Official Assignee [1897] 18 L.R.(N.S.W.) B & P 45, each case must stand on its own facts and it is for the Court to weigh up all the circumstances including the amount of risk run by the indemnifying creditors, the amount recovered, the proportion between the debts of indemnifying creditors and non-indemnifying creditors and any other matters considered to be relevant. In assessing the degree of risk, of course, the Court must be careful not to rely too strongly on the benefit of hindsight. I am of the opinion that the indemnifying creditors did undertake a risk, although not major, and they are entitled to some advantage. It would not be proper to disturb the anticipated distribution in full to the creditors of the separate estate and it must be remembered that the indemnifying creditors represent less than one-third of the total proved debts of the joint estate. The proceeds of the property recovered in respect of which an order may be made under sub-s.109(10) are the net proceeds after deduction of relevant remuneration, legal costs and expenses which deductions will not include the cost of work done prior to the receipt of indemnity. Some of the outstanding fees and disbursements recited by the trustee in his affidavit appear 16. to relate to costs incurred prior to the receipt of indemnity and if so they should be charged against the general administration and not deducted from the proceeds received. (See Re Ehrat and Danglmaier (1976) 12 A.L.R. 566.) Accordingly, the appropriate order would be that the sum of $45,000 recovered by the trustee under indemnities for costs of litigation, less deductions for relevant fees, costs and expenses, be distributed in the following manner: (a) The sum of $12,000 be distributed to the indemnifying creditors pro rata; and (b) the balance, after payment of costs and expenses of administration, be distributed to creditors of the separate estate and the remaining surplus to creditors of the joint estate of the bankrupt and Graeme John Jones. Leave will be granted to amend the title of the application to include the joint estate of the bankrupt and Graeme John Jones, the trustee having given appropriate notice of the application to all creditors of the joint estate. I will receive submissions from counsel on the question of costs of the application. 17. I certify that the preceding sixteen (16) pages are a true copy of the Reasons for Judgment of his Honour Justice Lee. Associate: fetnaa Calull Date: 4ot Gere, (98s. Counsel for the Applicant: Mr. R. Harrison Solicitors for the Applicant: Messrs. Warren Harrison The following indemnifying creditors appeared on their own behalf: Mr. D. Campbell Allied Glass Pty. Ltd. through its representative Miss F. Grey Date of Hearing: 22 February, 8 March 1988 Date of Judgment: 30 June 1988