FEDERAL COURT OF AUSTRALIA National Bank of Australia Limited, in the matter of Nemeth v Nemeth [2003] FCA 866 BANKRUPTCY - composition - application for composition to be declared void or set aside - whether greater opportunity to inquire into the debtor's affairs and a more comprehensive explanation by the debtor is called for - consideration of matters relevant to the exercise of the power to set aside the composition under s 239 of the Bankruptcy Act 1966 (Cth) - whether it is in the interests of creditors and in the public interest to set aside the composition Bankruptcy Act 1966 (Cth), Pt X, ss 222(1), s 222(4), 239, 242 Khera v National Australia Bank Limited (1996) 71 FCR 133 cited Re Mills; Ex parte Lloyd's (1997) 73 FCR 551 followed Calverley v Green (1984) 155 CLR 242 cited Richards, Re Peter Leigh Ex Parte Beneficial Finance Corporation Limited [1986] FCA 79 cited NATIONAL AUSTRALIA BANK LIMITED v DR KATHERINE EVA NEMETH AND ORS N 7146 OF 2003 STONE J 20 AUGUST 2003 SYDNEY IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY N 7146 OF 2003 BETWEEN: NATIONAL AUSTRALIA BANK LIMITED APPLICANT AND: DR KATHERINE EVA NEMETH FIRST RESPONDENT PAUL ANDREW LEROY IN HIS CAPACITY AS CONTROLLING TRUSTEE OF THE ESTATE OF KATHERINE EVA NEMETH SECOND RESPONDENT THE OFFICIAL RECEIVER THIRD RESPONDENT JUDGE: STONE J DATE OF ORDER: 20 AUGUST 2003 WHERE MADE: SYDNEY THE COURT ORDERS THAT: 1. The composition accepted by creditors on 24 April 2003 in respect of Katherine Eva Nemeth be set aside. 2. The estate of Katherine Eva Nemeth be sequestrated. 3. The applicant's costs of and incidental to this proceeding be taxed and paid in accordance with the Bankruptcy Act 1966 (Cth). THE COURT NOTES THAT: 1. The date of the bankruptcy is 10 March 2003. 2. A consent to act as trustee has been signed by Maxwell William Prentice and must be lodged with the Official Receiver in Sydney no later than two working days after the making of the sequestration order. 3. A copy of these orders is to be provided to the trustee and to the Official Receiver in Sydney within two working days after the orders are entered. Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules. IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY N 7146 OF 2003 BETWEEN: NATIONAL AUSTRALIA BANK LIMITED APPLICANT AND: DR KATHERINE EVA NEMETH FIRST RESPONDENT PAUL ANDREW LEROY IN HIS CAPACITY AS CONTROLLING TRUSTEE OF THE ESTATE OF KATHERINE EVA NEMETH SECOND RESPONDENT THE OFFICIAL RECEIVER THIRD RESPONDENT JUDGE: STONE J DATE: 20 AUGUST 2003 PLACE: SYDNEY REASONS FOR JUDGMENT Introduction 1 The applicant, National Australia Bank Limited ('NAB'), pursuant to s 222(1) or s 222(4) of the Bankruptcy Act 1966 (Cth) ('Act'), seeks an order declaring that a composition in respect of the first respondent's affairs, accepted under Part X of the Act at a creditors' meeting on 24 April 2003 ('composition'), is void. In the alternative NAB seeks an order, under s 239 of the Act, that the composition be set aside or that it be terminated pursuant to s 242(1). In addition NAB seeks a sequestration order against the estate of the first respondent ('Dr Nemeth') and costs. Outline of facts 2 Dr Nemeth engaged in property development for which purpose NAB provided her with various loan facilities secured by mortgages over the properties she planned to develop. Dr Nemeth defaulted under the loan facilities and the mortgaged properties were sold, leaving a shortfall of $983,378 as at 11 April 2003. 3 On 4 January 1999 Dr Nemeth provided NAB with a statement of her financial position in which she disclosed total liabilities of $3,140,000 and total assets of $4,513,000. On 29 June 2001 she signed an authority under s 188 of the Act authorising a trustee to call a meeting of her creditors and to take control of her property. In her signed statement of affairs, dated 22 June 2001 ('2001 statement'), Dr Nemeth listed 51 unsecured creditors to whom she admitted owing a total of $2,654,354.61. A creditors' meeting was convened pursuant to this authority however no Deed of Arrangement was passed. 4 On 10 March 2003, Dr Nemeth signed a further authority under s 188 naming the second respondent as trustee ('Trustee'). On the same date she signed a second statement of affairs including a certification that the particulars contained in it were correct ('2003 statement'). According to the Trustee's report under s 189A of the Act, dated 28 March 2003, the 2003 statement reveals that Dr Nemeth had total assets of $5,005 and total liabilities of $13,034,765.35 including unsecured debts of $12,794,765.35. 5 At the creditors' meeting, convened by the Trustee on 11 April 2003, Ms Johnson, solicitor for NAB, attended as proxy for NAB. Ms Johnson objected to a number of proxies, including those of J & M Nemeth and Versatile Retirement Living Services Pty Limited ('Versatile Living'). The meeting was adjourned to 24 April 2003. On the morning of 24 AprilMs Johnson inspected the proxies and proofs of debt at the Trustee's offices. At the reconvened meeting later that morning she objected to 27 of the proxies, including those of J & M Nemeth and Versatile Living. Eight of the proxies were rejected, the others were accepted. Ms Johnson also expressed concern about discrepancies between the 2001 and 2003 statements of affairs and the apparent failure of the Trustee to investigate potentially voidable transactions. It is apparent from the minutes that the Trustee refused to entertain challenges to the validity of certain debts and advised the creditors that if they were aggrieved they could apply to the courts for relief. 6 Despite NAB's opposition, the creditors accepted the composition under Part X of the Act by passing a special resolution to that effect. On 14 May 2003 NAB commenced this proceeding, seeking to have the composition declared void or set aside. Section 239 – setting aside a composition under Part X of the Act 7 There is substantial overlap between the matters relevant to the exercise of the Court's power to set aside a composition under s 239 and those that might prompt the Court to declare a composition void under s 222; Khera v National Australia Bank Limited (1996) 71 FCR 133 at 146 ('Khera'). NAB presented evidence and made submissions in respect of both those sections as well as s 242. Mr Stoljar, counsel for NAB, accepted however, that as no action has been taken to implement the composition and, in particular, as no payments have been made, there would be no practical difference in this case between declaring the composition void and ordering that it be set aside. As I have decided, for reasons explained below, that the circumstances warrant my setting aside the composition under s 239 it is not necessary for me to determine whether ss 222 or 242 are applicable. 8 Section 239 of the Act relevantly provides that: '(1) A creditor may, within 21 days from the date on which the special resolution accepting a composition under this Part was passed, apply to the Court for an order setting aside the composition and may also apply for the making of a sequestration order against the estate of the debtor. (2) If the Court, on such application, considers that the terms of the composition are unreasonable or are not calculated to benefit the creditors generally or that for any other reason the composition ought to be set aside, it may make an order setting it aside and, if it thinks fit, may forthwith make the sequestration order sought.' 9 The extent of the discretion in s 239(2) was considered by the Full Court in Khera where Lockhart and Hill JJ commented at 146: 'Although at first sight the grounds on which the Court may set aside a composition under s 239(2) are wide, upon closer examination they relate… to matters that concern the terms of the composition itself, that is to say 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 under Pt X. The Court may set aside the composition if it considers "that the terms of the composition are unreasonable". This plainly centres attention upon the terms of the composition itself. The Court may set aside a composition if the terms of the composition "are not calculated to benefit creditors generally". Again attention is centred upon the terms of the composition. 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.' (emphasis added) 10 The grounds on which circumstances surrounding creditors' acceptance of a composition might lead to it being set aside were explored in more detail in Re Mills; Ex parte Lloyd's (1997) 73 FCR 551 ('Re Mills'). There Merkel J thoroughly traversed the matters relevant to the exercise of the Court's power to set aside a composition under s 239. At 559-561 Merkel J said: 'The factors are: (a) Whether, after considering all the circumstances of the case, a greater opportunity to inquire into the debtor's affairs and a more comprehensive explanation by the debtor were called for: see Re Doukidis Ex parte Consolidated Constructions Pty Ltd (unreported Toohey J, 26 June 1985) at p 15. In Mendelson v Lelleton (unreported, Federal Court, Lindgren J, 6 November 1996), Lindgren J observed at p 38 that where there is cause for investigation of the debtor's dealings the interests of unsecured creditors and the public interest would be served by the investigation being conducted by a trustee in bankruptcy armed with the coercive power provided by the Act. Further, in Re Bendel Ex parte Lowe Lippman (A Firm) (unreported, Federal Court, Merkel J, 19 April 1996) I concluded that where serious issues are raised about preferences to some creditors, dissipation of assets, the validity or enforceability of "loans" from associated parties and, in particular, whether any "friendly" debts were intended to create legal relations, a sequestration order rather than a composition is the more appropriate vehicle for resolving such issues. (b) If circumstances arise which "give cause for a suspicion" or to "arguable" causes of action which may benefit creditors then that can suffice to set aside the composition: see Mendelson at p 33. It is not necessary to establish that the creditors will be, or even are more likely to be, advantaged by bankruptcy rather than the composition. It is sufficient if bankruptcy will afford: "a prospect or possibility of economic advantage to creditors sufficient to justify the conclusion that it is in their interests to make the declaration." per Jenkinson J in Augustyn v. Putnin (1988) 83 ALR 514 at 515. In Augustyn, French J (with whom Spender J agreed), in explaining why "a real possibility of a financial benefit" to creditors was sufficient, said at (521-522): "And although in Re Doukidis; Ex parte Consolidated Constructions (unreported, Federal Court, 26 June 1985), Toohey J said that "it is enough if the evidence justifies an inference that there are likely to have been assets and that the creditors may be better off if the composition is set aside" (a dictum repeated in Re Brown; Ex parte Humes Ltd (1987) 74 ALR 611 at 619 per Pincus J), it does not follow that the court must be satisfied on the balance of probabilities that there will be a financial benefit to creditors from an order avoiding or setting aside a deed. .......... In my opinion, his Honour the trial judge in the present case was entitled to form the view that the orders sought would provide the creditors with an opportunity to further investigate the appellant's position and that it was in their interests to do so." See also Re Cufari at 551-552. (c) If the amount offered under the composition is little or trivial there may be no harm of any consequence to creditors for the composition to be set aside if other factors warrant that course: see Re Richards; Ex parte Beneficial Finance Corporation Limited (unreported, Jackson J, 17 March 1986 at pp 3 and 6 and Mendelson at p 32. (d) A Court may be more disposed to set aside a composition if no payments to creditors have been made pursuant to the composition: see Raschilla v Gullini (1987) 14 FCR 57 at 70. (e) A composition passed, inter alia, on the basis of a report to creditors as to the debtor's financial affairs which is misleading will also be a relevant factor: see Re Cufari at 549.' 11 I respectfully adopt Merkel J's analysis which is relevant to the circumstances under consideration here. The need for further investigation into Dr Nemeth's financial affairs 12 There is considerable uncertainty as to the true state of Dr Nemeth's affairs suggesting that the interests of creditors would be served if they were subject to more stringent examination than has been the case to date. NAB submits that the following matters are of particular relevance to the exercise of the Court's discretion in the present case: 'a. The amount offered pursuant to the Composition is $40,000, yielding a return to the creditors of one cent in the dollar. This amount is trivial compared to the total amount of the debts. The first respondent has gross assets of $5005, but has been prepared to incur debts amounting to over 2000 times that amount. In these circumstances the case should be dealt with by way of bankruptcy (thereby giving rise to such matters as public examination of the bankrupt and other persons under section 81 of the Act). b. In all the circumstances of the case a greater opportunity to enquire into the first respondent's affairs and a more comprehensive explanation by the first respondent may be called for. In particular, in all the circumstances an investigation by the trustee armed with the coercive powers provided by the Act will serve the interests of the unsecured creditors and the public interest. … c. Given the size of the amount offered under the Composition no harm of any consequence will be occasioned to creditors by setting aside the Composition.' 13 The debtor's proposal, signed by Dr Nemeth on 17 March 2003, and approved at the creditors' meeting on 24 April 2003 states: 'The following related party creditors will not participate in any dividend made in my Estate: (i) Magda Nemeth (ii) The Estate of the Late John Nemeth (iii) Adalong Holdings Pty Ltd (iv) Versatile Retirement Living Services Pty Ltd (v) Brinjolla Pty Ltd (vi) Mirramba Holdings Pty Ltd (vii) Stoneway Holdings (viii) Renaissance Holdings (NSW) Pty Ltd'. Of these creditors, only the debt of $140,000 to Magda Nemeth and the debts to Adalong Holdings Pty Ltd, Brinjolla Pty Ltd and Renaissance Holdings (NSW) Pty Ltd were disclosed in the 2001 statement. The debt to Stoneway Holdings was disclosed in neither statement of affairs. 14 A comparison of the 2001 and 2003 statements of affairs reveals other significant discrepancies. The 2003 statement discloses nine debts that were said to have been incurred prior to 2001 but which were not disclosed in the 2001 statement. The most significant of these are a debt of $8,500,000 to J & M Nemeth, apparently Dr Nemeth's parents, incurred in 1989 and a $906,500 debt to Versatile Living incurred between 1988 and 1995. There also appear to be discrepancies in the quantum of some debts that were specified in both the 2001 and 2003 statements. It is alleged that these discrepancies cannot be accounted for by either payment of principal or accrual of interest. In addition there are a number of debts subsequently accepted by the Trustee that were not acknowledged in Dr Nemeth's statement of position (see [3] above) or in either statement of affairs. 15 This uncertainty extends beyond the question of the accurate disclosure of debts to the validity and amount of some disclosed debts. A good example is the debt of $8,500,000 referred to in [14] above. This debt is said to have been incurred pursuant to a deed dated 2 December 1989 between Dr Nemeth and her parents. That deed refers to Dr Nemeth having purchased a property in Killara, a suburb of Sydney, in 1979 for $300,000 which was provided as to $30,000 by Dr Nemeth, as to $60,000 by her parents and as to the balance of $210,000 by mortgage funds. It states that from 1979 to the date of the deed Dr Nemeth held the property on trust for her parents as to a two-thirds interest. There is no indication in the deed as to how the trust arose; whether it was in writing or whether the parties relied on the presumption of a resulting trust. There is no explanation as to how a contribution of five per cent of the purchase price resulted in Mr and Mrs Nemeth acquiring a two-thirds interest in the property. This is not to say an explanation is not possible. There may be an agreement not reflected in the deed. It may be, for example, that Mr and Mrs Nemeth contributed to the mortgage payments; cf Calverley v Green (1984) 155 CLR 242. There is, however, no evidence before the Court that might resolve the issue. 16 There are other difficulties in relation to the deed of 1989. At the date of the deed the value of the two-thirds interest in the property attributed to Mr and Mrs Nemeth was stated to be $493,333. This amount was said to be calculated, at the time of the deed, on the property having a value of $1,150,000, $410,000 owing under the mortgage and a 'total equity of the parties' of $790,000. Obviously there is an error in that calculation. The deed then states that the trust is 'discharged' and Dr Nemeth owes Mr and Mrs Nemeth the amount of $493,333 which is said to be a loan payable upon written call with interest at 24 per cent per annum. 17 Mr Nemeth died in 2001. On 1 February 2003, Mrs Nemeth signed a written call for payment of the amount owing under the deed which she expressed to be $8.2 million being 'the original sum of $493,333 with capitalised interest calculated at 24% per annum for the last 13 years and 2 months.' It should be noted that there is no reference to the capitalisation of interest in the deed and, moreover, the document does not appear to be stamped. As noted earlier, no evidence or explanation has been proffered by Dr Nemeth that might resolve these issues. 18 As indicated in [13] above, the terms of the composition accepted by Dr Nemeth's creditors include that certain related creditors, including Mrs Nemeth, would not participate in any return from Dr Nemeth's estate. Nevertheless, the uncertainties surrounding the debt said to have been created by the deed of 1989 are relevant to an understanding of Dr Nemeth's affairs and the voting rights of creditors in relation to the special resolution. 19 Section 5 of the Act provides that a 'special resolution', 'means a resolution passed by a majority in number and at least three-fourths in value of the creditors present personally, by telephone, by attorney or by proxy at a meeting of creditors and voting on the resolution'. Irrespective of the quantum of the debt owed to it the number of creditors is such that NAB would not have been in a position to ensure the passage of any special resolution. However, if the related party debts are excluded, NAB's proportion of the value of the residual debts may well have been sufficient for it to veto the passing of any special resolution. 20 Another issue concerns the sale of several properties in the five years immediately preceding the composition. These sales were admitted in the 2003 statement of affairs. It appears that there has been no investigation of whether any of these sales could be set aside for the benefit of creditors. Given the size of Dr Nemeth's debts and the complexity of her affairs, including the large number of related creditors, a full investigation of these transactions might be warranted. 21 Applying the analysis of Merkel J, quoted in the passage at [10] above, I am satisfied that it is in the interests of Dr Nemeth's creditors for the composition approved on 24 April 2003 to be set aside and for there to be a greater opportunity to inquire into Dr Nemeth's affairs. In summary I am particularly persuaded by the evidence, (a) that Dr Nemeth has, in the past, made misleading statements in respect of her financial affairs; (b) that she has disposed of significant assets within the last five years and that those disposals have not been the subject of any investigation; (c) that there is considerable confusion as to the details of her financial affairs, and (d) that the amount offered under the composition, namely $40,000 yielding a return to creditors of around one cent in the dollar, is trivial and that no harm or serious consequence to Dr Nemeth's creditors will result from setting aside the composition; see Richards, Re Peter Leigh Ex Parte Beneficial Finance Corporation Limited [1986] FCA 79, per Jackson J, at [7]. 22 This evidence is particularly compelling in the absence of any evidence from Dr Nemeth that might clarify these issues. Apart from tendering a bundle of documents that was apparently available to the Trustee before the creditors' meeting of 11 and 24 April, Dr Nemeth provided no evidence whatsoever. No explanation was offered as to why Dr Nemeth did not give evidence on her own behalf. There are a number of significant gaps in the material before the Court, and apparently in the material which was before the Trustee. Many questions in respect of Dr Nemeth's financial affairs have been raised before the Court. These questions are almost impossible to resolve without additional evidence, and almost certainly require evidence from, and possibly examination of, Dr Nemeth and others. This fortifies my reasoning and indicates that an investigation by a trustee in bankruptcy is appropriate. Sequestration order 23 Section 239(1) provides that a creditor applying to the Court for an order to set aside a composition 'may also apply for the making of a sequestration order against the estate of the debtor'. Section 239(4) states that: 'The making of an application for a sequestration order against the estate of the debtor under this section shall, for the purposes of this Act, be deemed to be equivalent to the presentation of a creditor's petition against the debtor, but the provisions of subsection 43(1), sections 44 and 47, subsections 52(1) and (2) and Part XIA do not apply in relation to such an application.' 24 On her own admission Dr Nemeth is insolvent. Moreover my reasons for making an order under s 239 also lead to the conclusion that the proper course is for a sequestration order to be made so that there can be further investigation into Dr Nemeth's affairs. Section 115(1) of the Act states that where a sequestration order is made under Part X (which includes s 239) the bankruptcy of the person against whom the order is made, 'shall be deemed to have relation back to, and to have commenced at, the time of the commission of the earliest act of bankruptcy committed by that person within the period of 6 months immediately preceding the date on which the creditor's petition was presented or the application for the making of the sequestration order was made, as the case may be.' 25 The application for the sequestration order against Dr Nemeth was made on 14 May 2003. The relevant act of bankruptcy must therefore be the earliest such act committed in the period commencing 14 November 2002. Under s 40(1)(i) it is an act of bankruptcy to sign an authority under s 188. Dr Nemeth signed such an authority on 10 March 2003. It has not been suggested to the Court that there is any other relevant act of bankruptcy and therefore I conclude that, once the sequestration order has been made, Dr Nemeth's bankruptcy will, under s 115, be deemed to have commenced on 10 March 2003. 26 Section 156A of the Act provides that a registered trustee may consent to act as trustee of the estate of the debtor, in this case Dr Nemeth, in the event of bankruptcy. There is on the Court file a consent to act as trustee signed by Maxwell William Prentice of Prentice Parbery Barilla as a registered trustee within the meaning of s 5 of the Act. I note that Regulation 8.06(1) provides that a trustee who signs such an instrument must file it with the Official Receiver not later than two working days after the day on which the sequestration order is made. 27 The orders of the Court will be that: 1. The composition accepted by creditors on 24 April 2003 in respect of Katherine Eva Nemeth be set aside. 2. The estate of Katherine Eva Nemeth be sequestrated. 3. The applicant's costs of and incidental to this proceeding be taxed and paid in accordance with the Bankruptcy Act 1966 (Cth). 4. The applicant shall notify the trustee of the estate of the debtor of these orders within two working days after these orders are entered. I certify that the preceding twenty-seven (27) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Stone. Associate: Dated: 20 August 2003 Counsel for the Applicant: Mr J Stoljar Solicitor for the Applicant: Mallesons Stephen Jaques Counsel for the First Respondent: Mr D Ash Solicitor for the First Respondent: Morgan Ardino & Co Date of Hearing: 12 August 2003 Date of Judgment: 20 August 2003