FEDERAL COURT OF AUSTRALIA Stedman v Deputy Commissioner of Taxation [2000] FCA 336 BANKRUPTCY – appeal from a decision to sequestrate the debtors' estates in spite of the debtors' compositions having been accepted by creditors' meetings – whether the trial judge had regard to relevant considerations in deciding to set aside the debtors' compositions - unreasonableness of compositions - not calculated to benefit creditors - real prospect of sham transactions - issues of credibility EVIDENCE – admissibility of the transcript of proceedings in the Administrative Appeals Tribunal to review the merits of tax assessments in an application to the Federal Court to set aside compositions accepted by creditors' meetings Bankruptcy Act 1966 (Cth), ss 189A, 222, 239, 242 House v The King (1936) 55 CLR 449, applied Sharrment Pty Ltd v Official Trustee in Bankruptcy (1988) 18 FCR 449, considered Khera v National Australia Bank Ltd (1996) 71 FCR 133, applied Re Mills ex parte Lloyds v Prentice & Mills (1997) 73 FCR 551, applied Re Segal ex parte Lensworth Finance Pty Ltd v Segal & Ward (1975) 9 ALR 154, referred to ACT v Badcock [2000] FCA 142, referred to JACQUELINE ANNE STEDMAN v DEPUTY COMMISSIONER OF TAXATION N 320 OF 1999 FREDERIK ANTONIUS MARE v DEPUTY COMMISSIONER OF TAXATION N 321 OF 1999 EINFELD, WHITLAM & WEINBERG JJ 23 MARCH 2000 SYDNEY IN THE FEDERAL COURT OF AUSTRALIA N 320 OF 1999 NEW SOUTH WALES DISTRICT REGISTRY On appeal from a Judge of the Federal Court of Australia BETWEEN: JACQUELINE ANNE STEDMAN First Appellant AND: DEPUTY COMMISSIONER OF TAXATION Respondent JUDGE: EINFELD, WHITLAM & WEINBERG JJ DATE OF ORDER: 23 MARCH 2000 WHERE MADE: SYDNEY THE COURT ORDERS THAT: 1. the appeal be dismissed with costs. Note: Settlement and entry of order is dealt with in Order 36 of the Federal Court Rules. IN THE FEDERAL COURT OF AUSTRALIA N 321 OF 1999 NEW SOUTH WALES DISTRICT REGISTRY On appeal from a Judge of the Federal Court of Australia BETWEEN: FREDERIK ANTONIUS MARE Second Appellant AND: DEPUTY COMMISSIONER OF TAXATION Respondent JUDGE: EINFELD, WHITLAM & WEINBERG JJ DATE OF ORDER: 23 MARCH 2000 WHERE MADE: SYDNEY THE COURT ORDERS THAT: 1. the appeal be dismissed with costs. Note: Settlement and entry of order is dealt with in Order 36 of the Federal Court Rules. IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY On appeal from a Judge of the Federal Court of Australia BETWEEN: JACQUELINE ANNE STEDMAN N 320 OF 1999 Appellant AND: DEPUTY COMMISSIONER OF TAXATION BETWEEN: Respondent AND: FREDERIK ANTONIUS MARE N 321 OF 1999 Appellant DEPUTY COMMISSIONER OF TAXATION Respondent JUDGE: EINFELD, WHITLAM & WEINBERG JJ DATE: 23 MARCH 2000 PLACE: SYDNEY REASONS FOR JUDGMENT OF JUSTICE EINFELD INTRODUCTION 1 On 17 November 1997 the appellants Jacqueline Anne Stedman (Stedman) and Frederik (Frits) Antonius Mare (Mare) signed authorities under section 188 of the Bankruptcy Act 1966 (Cth) (the Act) appointing Andrew Hugh Jenner Wily (Wily) as controlling trustee and thereafter filed statements of affairs. At meetings of their creditors on 22 December 1997, they presented compositions under Part X of the Act. The meetings purported to accept the compositions by special resolutions but by amended applications dated 10 February 1998, one of their creditors, the Deputy Commissioner of Taxation, who voted against the compositions, applied to have them set aside and declared void. He sought sequestration orders against both appellants. On 26 March 1999 Justice O'Connor granted the Deputy Commissioner's application and sequestrated the debtors' estates but stayed the orders on undertakings to permit the present appeal. There were 23 identical grounds in the appellants' separate notices of appeal. The appellants have for many years been de facto partners: they have dependent children and joint financial affairs. The appeals were heard, and may be determined, together. 2 The relevant provisions of the Act were set out in the first instance judgment and need only be summarised here. After a report by the controlling trustee under section 189A is presented to a creditors' meeting considering a composition, the Court may be approached under section 222, 239 or 242 seeking respectively a declaration that the composition is void or an order setting aside or terminating the composition. The relevant circumstances for the present case are: 1. Void composition (s. 222) – when it has not been accepted by a special resolution of creditors (majority in number and 75% in value) 2. Setting aside composition (s. 239) – if its terms are unreasonable or not calculated to benefit creditors generally or for any other reason it ought to be set aside 3. Terminate composition (s. 242) – where there will be injustice or undue delay to creditors or for any other reason that it ought to be terminated THE FACTS 3 On 13 July and 10 August 1994, the appellants were assessed for income tax for the fiscal years 1989, 1990 and 1991. Objections were disallowed and the appellants sought merits review by the Administrative Appeals Tribunal. The Tribunal's hearings took place on a number of days between 1 April and 18 November 1997 when the appellants discontinued the proceedings thus leaving the assessments untouched. The discontinuance was filed a day after their appointment of Wily as the trustee of their compositions. The transcript of the Tribunal proceedings was admitted in evidence by Justice O'Connor and has been before this Full Court. 4 Admitted to vote by Wily as chairman of the creditors' meetings was a company called South Island Investments NV incorporated in the Netherlands Antilles, without whose votes the special resolutions approving the compositions would not have obtained the requisite majorities. The Deputy Commissioner argued before the Tribunal and her Honour, and again on appeal, that this company was a sham and, together with a number of related entities, was a front for the appellants to allow them to avoid income tax. As such, it was said, the company should not have been admitted to vote. 5 The particular issue affecting the appellants' tax liability involved a debt resulting from an unpaid loan on 20 June 1986 from South Island to a company called Stadaco Limited. By a novation agreement dated 31 December 1990, Mare purported to assume liability for this debt which was said in the evidence before the Tribunal to have originally been $914,056. At the creditors' meetings, South Island purported to prove this debt against Mare by reason of the novation agreement and a handwritten promissory note dated 31 December 1990, and against Stedman pursuant to an undated handwritten guarantee of Mare's promissory note which was expressed to be operative from 24 January 1991, an undated handwritten acknowledgment or acceptance of Mare's debt to South Island, and a mortgage of 12 November 1991 which names Stedman as mortgagor and South Island as mortgagee in respect of a property she owned at Collaroy in which the appellants lived. By the time of the creditors' meeting, the debt had, by reason of interest charged at 21% per annum, become $3,475,476.02 but for some reason Mare's creditors were admitted to vote in the sum of $3,348,147 and Stedman's in the sum of $2,600,487. Nothing now turns on the correctness of these amounts or to what extent they overlap. The composition offered by Mare was $80,000 and by Stedman was $20,000 or about 3 cents in the dollar. No payments have been made under the compositions. THE FIRST INSTANCE PROCEEDINGS 6 Wily was a party to the proceedings before Justice O'Connor where there was extensive criticism of his s.189A reports. Although she found that the report was deficient in a number of respects especially as to the behaviour of the appellants and the status of the South Island debt, her Honour made no particular finding on these arguments except to point out that Wily had recommended bankruptcy instead of the compositions if funding was available as he believed that further investigation of the appellants' affairs was warranted. The notices of appeal call for a decision that her Honour should have expressly upheld Wily's reports as in full compliance with section 189A of the Act but as the Deputy Commissioner has taken no point in this respect on these appeals, there is no need for us to say anything about the matter at all. 7 The loan and novation agreements involving South Island were in evidence and oral evidence about them was given by the appellants and Mr Kourtland a Dutch lawyer, called as an expert on the laws of the Netherlands Antilles. Her Honour found that this written and oral evidence "belied commercial or arms-length arrangements". The evidence, she said, was vague and inconsistent not least because there was no attempt to call up the loans after they fell into substantial arrears and no mention of the mortgage in Stedman's later dealings with the National Australia and ANZ Banks where mention of the debt and the mortgage might have been expected. Her Honour found Mr Kourtland to be a quite unsatisfactory and unpersuasive witness. She found that Mare was inconsistent and aggressive and Stedman unco-operative and disingenuous in response to questions. 8 Noting that funding of bankruptcy is now available from the Deputy Commissioner, Justice O'Connor found that there was "cause for a suspicion" that there may be assets available to benefit genuine creditors: Re Mills ex parte Lloyds v Prentice & Mills (1997) 73 FCR 551. In her Honour's view that finding was enough to warrant setting aside the compositions without the need to find that South Island and its debt were shams. Although she did not expressly find that the terms of the composition were unreasonable or not calculated to benefit creditors, so much may be implied. She also relied on the "any other reason" provision of section 239(2), and it is that conclusion that the appellants particularly focussed on in argument in this appeal. THE APPEAL 9 The notices of appeal essentially raise only questions of fact. It was said in a number of different ways that the compositions were reasonable, that there was no cause for suspicion about South Island and the status of its debt, and that the evidence of Kourtland and the appellants should have been accepted. The only legal matters touched on were that the transcript before the Tribunal should not have been admitted into evidence, and that her Honour's exercise of discretion in making a sequestration order miscarried. Some of these matters were raised for the first time on the appeal and were not put to her Honour. Unreasonableness etc 10 In Khera v National Australia Bank Ltd (1996) 71 FCR 133 at 146, Justices Lockhart and Hill said that setting aside compositions for unreasonableness or because they are not calculated to benefit creditors "plainly centres attention on the terms of the composition itself" based on "facts which were in existence (whether known or not) at the time of the passing of the special resolution of creditors to accept the composition …". As to the third ground provided under section 239(2), their Honours said: Then follows the third ground "for any other reason the composition ought to be set aside". In our opinion this ground, despite the width of its language, is confined to circumstances which relate to the terms of the composition itself or the circumstances in which the composition came to be accepted by special resolution of the creditors. To an extent these grounds may overlap with the grounds on which the court may declare a composition void under s 222. That does not militate against the construction of s 239(2) which appeals to us. 11 The appellants submitted that there was nothing in the evidence to show that the terms of the composition so understood were unreasonable or unfair. In my opinion, if the South Island agreements were shams, this argument must be rejected for the reason that the sham can only have been to protect the appellants from their due tax liabilities. In this event, offering to pay 3 cents in the dollar was manifestly unreasonable and derisory. 12 It is true that the Court will not impose its views on informed creditors who express a contrary view: Re Segal ex parte Lensworth Finance Pty Ltd v Segal & Ward (1975) 9 ALR 154 at 163. But if South Island should not have been admitted to vote at all, a decision favourable to the compositions cannot be assumed especially as most of the other creditors have apparently subsequently withdrawn their claims. 13 The same may be said of the appellants' contention that there was no evidence that the Deputy Commissioner will gain a financial benefit if the compositions are set aside. I agree with her Honour's view that it was sufficient that the evidence amply disclosed such a possibility, and with her belief that investigation of South Island may well reveal it as Mare's alter ego. Bankruptcy would permit a full examination of South Island so that if the company itself, and the loan agreements and associated documentation, were in fact shams, the Deputy Commissioner would be substantially advantaged as the Collaroy property and other valuable personal assets of the appellants identified in the evidence would become available for distribution, as against the compositions which offered such a minimal return. Sham transaction 14 The features of sham transactions identified by Lockhart J in Sharrment Pty Ltd v Official Trustee in Bankruptcy (1988) 18 FCR 449 at 454–5 are well known. Naturally to find that a series of transactions was artificially manufactured so as to provide an appearance which was not the substantive reality is a major conclusion which cannot be reached easily or on suspicion alone. And her Honour did not do so. What she said was that the evidence raised serious doubts about the documentation and evidence on the transactions such as to provide sufficient cause to set aside the composition. In my view, it would have prejudged, and would prejudge now, the conclusions to be reached by the trustee in bankruptcy to find as a fact that South Island was a front for Mare and that the assignment of the debts to him was a sham. It is not necessary on an application to set aside a composition to go so far. It is only necessary to conclude, on the basis of evidence, that there is a real prospect that further investigation will so demonstrate: Re Mills at 560. I reject the appellants' submission that Re Mills is wrong or relevantly distinguishable on the facts. There was ample evidence in this case to support her Honour's conclusions about the prospects in this regard. Credibility of appellants and Kourtland 15 Her Honour had the benefit of seeing and hearing these persons give evidence. As I wrote recently in ACT v Badcock [2000] FCA 142 at [15], this advantage … is considerable and is not always able to be precisely defined or enunciated. It is not necessary to describe the advantage by reference to now widely discredited notions of "demeanour" or to what is sometimes called "the whites of the eyes" test. It is often nothing more, but nothing less, than an impression or feeling about the accuracy of a particular witness' description of the events in question. Sometimes it is more even though it might not be reflected in the printed transcript. 16 Even though her Honour was no doubt partly influenced by her reading of the Tribunal transcript which I have also undertaken, it will be a rare case that an appellate court which has not seen the witnesses will "on the papers" substitute its views for the impression of the trial Judge who has. In any event, for myself, and for what it is worth, I do not regard "the papers" as throwing any doubt on her Honour's findings in this regard. Admission of the Tribunal transcript 17 The appellants argued that the transcript should have been rejected as the Tribunal determined no issue, the evidence was given on different issues, and the Tribunal was not bound by the rules of evidence. Much of the evidence was not even relevant to the matters relied on by the Deputy Commissioner, they said, but her Honour admitted it all over objection. In particular admissions of persons other than the appellants, they contended, should have been rejected as hearsay. 18 Had her Honour placed any reliance on inadmissible parts of the transcript, there might have been force in this argument. But she was obviously careful not to do so for that very reason. As far as I can see, the only evidence on which she placed specific substantive reliance was the testimony of the appellants. This evidence was both relevant and admissible. Discretionary matters 19 The appellants relied on the failures on the part of the Deputy Commissioner to: (a) offer at the time of the meetings the funding he now offers to investigate the appellants' affairs (b) seek an adjournment of the meetings (c) question the appellants at the meetings on the issues in dispute (d) seek particulars of the appellants' claims in relation to the South Island debt (e) challenge the decision of the trustee to admit South Island to vote, whether at the amount claimed or some lesser sum (f) put forward any material resulting from its years of investigations into the appellants to demonstrate that the South Island debt was a sham (g) reveal any assets available or likely to be available to the appellants to satisfy creditors if the South Island transaction is not a sham 20 In addition, it was submitted that Justice O'Connor failed to consider the effect of bankruptcy on Mare's income and ability to manage and direct corporations and on his standing in the Dutch community. 21 To the extent that all these matters were assertions of fact, it must be said that all except (f) and (g) are correct. But discretion was, in this case as in many others, a matter of balancing what are sometimes competing public interests, sometimes competing private interests, and sometimes a mixture of each. Since House v The King (1936) 55 CLR 499, it has been well settled that an appellate court will only interfere with an exercise or failure to exercise a relevant discretion where an error of legal principle has been demonstrated. Obviously a failure to take account of relevant considerations will point to error of this kind. 22 Here the balance her Honour was required to undertake was between the considerations referred to by the appellants and the real prospect that the appellants may be able to provide significant sums towards a sizeable taxation liability. It can always be said of a company director and manager that s/he will suffer considerable hardship from bankruptcy. Hence that argument will rarely persuade a court to withhold a sequestration order in an otherwise appropriate case. But this case had many very suspicious, disturbing and unsatisfactory features including evidence from the appellants and Kourtland which her Honour was clearly, and in my view understandably, unable to accept as true. The choice was between compositions which showed every sign of having been manufactured to avoid a likely adverse outcome in the Tribunal and the type of detailed investigation which bankruptcy permits. Some of the appropriate considerations are: 1. A trustee in bankruptcy has more time and much greater powers to investigate bankrupts' affairs than a controlling trustee. 2. There was significant evidence of a lack of co-operation and frankness by the bankrupts with Wily. 3. A number of other corporate entities with which the appellants had association have not yet been investigated. There was sufficient evidence to suggest that further inquiries in this connection may provide fruitful results. 4. Further investigation of the whole South Island saga, including its structure, corporate government, the supposed loan and the mortgage, is clearly called for. 5. There is a serious likelihood that section 81 examinations of persons other than the appellants who had association with some of the dealings in which the appellants were involved and with the companies and commercial entities with which the appellants were associated would reveal matters of significance in relation to the appellants' assets. Like Wily had done in his s.189A report to creditors, her Honour believed that, for these and similar reasons, further investigation served the greater public interest, and will be for the much greater potential benefit of creditors than the compositions. There was no error of law or principle in this discretionary exercise. CONCLUSION 23 The appeals must fail and be dismissed with costs. I certify that the preceding twenty-three (23) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Marcus Einfeld. Associate: Dated: 23 March 2000 IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY On appeal from a Judge of the Federal Court of Australia BETWEEN: JACQUELINE ANNE STEDMAN N 320 OF 1999 Appellant AND: DEPUTY COMMISSIONER OF TAXATION BETWEEN: Respondent AND: FREDERIK ANTONIUS MARE N 321 OF 1999 Appellant DEPUTY COMMISSIONER OF TAXATION Respondent JUDGES: EINFELD, WHITLAM & WEINBERG JJ DATE: 23 MARCH 2000 PLACE: SYDNEY REASONS FOR JUDGMENT WHITLAM J: 24 I have had the advantage of reading in advance the reasons for judgment of Einfeld J. The background to these appeals and the issues they raise are contained in those reasons. 25 In the court below the primary judge referred to factors relevant to the exercise of the discretion under s 239 of the Bankruptcy Act 1966 ("the Act"), which were identified by Merkel J in Re Mills; Ex parte Lloyd's (1997) 73 FCR 551 at 559-560. In that case Merkel J cited authority for each of the factors he listed. In the present case what Lindgren J said in Mendelson v Lelleton (unreported, Federal Court of Australia, 6 November 1996) about circumstances which "give cause for suspicion" is particularly apposite. Whether or not the controlling trustee complied with s 189A of the Act is quite beside the point. 26 As Einfeld J's narrative shows, the circumstances in which the compositions came to be accepted were carefully considered by the primary judge. It was not necessary for her Honour to make a finding that any particular transaction was a "sham", and she did not do so. Characterizing the circumstances as "suspicious" was, however, a matter in which the primary judge had the great advantage of having seen the debtors give their evidence. This was not a case in which it can be seriously suggested that her Honour's unfavourable impression of those witnesses can be regarded as a fragile base to support her conclusion in the light of other incontrovertible documentary evidence. On the contrary, here evidence of the mortgages over Ms Stedman's property plainly reinforced the primary judges' finding of suspicious circumstances. 27 I agree that the appeals should be dismissed with costs. I certify that the preceding four (4) numbered paragraphs are a true copy of the Reasons for Judgment herein of Whitlam J. Associate: Dated: 23 March 2000 IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY On appeal from a Judge of the Federal Court of Australia BETWEEN: JACQUELINE ANNE STEDMAN N 320 OF 1999 Appellant AND: DEPUTY COMMISSIONER OF TAXATION BETWEEN: Respondent AND: FREDERIK ANTONIUS MARE N 321 OF 1999 Appellant DEPUTY COMMISSIONER OF TAXATION Respondent JUDGE: EINFELD, WHITLAM & WEINBERG JJ DATE: 23 MARCH 2000 PLACE: SYDNEY REASONS FOR JUDGMENT WEINBERG J: 28 I have had the benefit of reading the reasons for judgment of Justice Einfeld. I agree with his Honour's analysis of these appeals and the orders he proposes. I certify that the preceding one (1) numbered paragraph is a true copy of the Reasons for Judgment herein of The Honourable Justice Weinberg. Associate: Dated: 23 March 2000 Counsel for the Appellants: Mr B. A. Coles QC Mr J. K. Chippindall Solicitor for the Appellants: M. D. Nikolaidis & Co Counsel for the Respondent: Mr D. B. McGovern Solicitor for the Respondent: Australian Government Solicitor Date of Hearing: 30 August 1999 Written Submissions completed: 10 September 1999 Date of Judgment: 23 March 2000