FEDERAL COURT OF AUSTRALIA Deputy Commissioner of Taxation v Zappia [2019] FCA 2152 File number: NSD 2117 of 2018 Judge: JAGOT J Date of judgment: 19 December 2019 Catchwords: BANKRUPTCY – application to set aside a composition - terms of agreement unreasonable – terms not calculated to benefit creditors generally – possibility of greater return to creditors –private arrangements made with creditors – more extensive investigation into the bankruptcy required – application allowed Legislation: Bankruptcy Act 1966 (Cth) ss 73, 76B, 222, 222(1), 222A, 222B, 222C, 222D, 224 and 224A Cases cited: Augustyn v Putnin (1988) 83 ALR 514 Deputy Commissioner of Taxation v Alternative Business Solutions (Aust) Pty Ltd (Administrators Appointed) [2006] FCA 400 ET Fisher & Co Pty Ltd v English, Scottish and Australian Bank Ltd [1940] HCA 42; [1941] ALR 1 Grocon Constructors Pty Ltd v Kimberley Securities Ltd [2009] NSWSC 541 Moran v Robertson [2012] FCA 371 Re Mills; Ex parte Lloyd's (1997) 73 FCR 551 Date of hearing: 10 December 2019 Registry: New South Wales Division: General National Practice Area: Commercial and Corporations Sub-area: General and Personal Insolvency Category: Catchwords Number of paragraphs: 16 Solicitor for the Applicant: Mr K Metlej of Craddock Murray Neumann Lawyers Solicitor for the First Respondent: Mr T Hall of Hall Partners Table of Corrections 8 January 2020 In paragraph 9 "on a liquidation" has been replaced with "if the bankruptcy were to proceed". ORDERS NSD 2117 of 2018 BETWEEN: DEPUTY COMMISSIONER OF TAXATION Applicant AND: JOHN ZAPPIA First Respondent SARANDOS SPYRAKIS IN HIS CAPACITY AS TRUSTEE OF THE COMPOSITION OF JOHN ZAPPIA PURSUANT TO SECTION 73 OF THE BANKRUPT ACT 1966 Second Respondent JUDGE: JAGOT J DATE OF ORDER: 19 December 2019 THE COURT ORDERS THAT: 1. The parties confer and within 28 days of the publication of these reasons for judgment file agreed or competing orders in accordance with these reasons for judgment. 2. If the orders are not agreed, the parties notify the Associate to Jagot J by an agreed email, at the same time as the filing of the competing orders, whether any further hearing is required or if the parties wish to file short written submissions in support of the orders they propose. 3. Pending further orders, the second respondent be restrained from effecting any transactions under the composition under s 73 of the Bankruptcy Act 1966 (Cth) entered into by the first respondent pursuant to the resolution of the first respondent's creditors passed on 19 September 2018, including payments by way of dividends to the creditors of the first respondent. Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011. REASONS FOR JUDGMENT JAGOT J: 1 The Deputy Commissioner of Taxation applies to set aside a composition entered into by the first respondent, Mr Zappia, under s 73 of the Bankruptcy Act 1966 (Cth) (the Bankruptcy Act) pursuant to a resolution of Mr Zappia's creditors on 19 September 2018. 2 By s 76B of the Bankruptcy Act, ss 222 to 222D, 224 and 224A apply in relation to a composition as if the composition were a personal insolvency agreement executed by the debtor and the trustee of the composition were the trustee of the personal insolvency agreement. By s 222(1) of the Bankruptcy Act, the Court may make an order setting aside the composition if it is satisfied that the terms of the agreement are unreasonable or are not calculated to benefit the creditors generally or for any other reason. 3 I have decided that the composition should be set aside as sought by the Deputy Commissioner for the following reasons. 4 Mr Zappia lodged a debtor's petition on 16 September 2016, which was accepted and Mr Zappia thereby became bankrupt, with Mr Sarandos Spyrakis becoming the trustee of Mr Zappia's estate. At that time, Mr Zappia was indebted to the Commonwealth in the amount of $496,056.74. 5 A composition proposed by Mr Zappia was accepted by a majority of creditors at a meeting convened on 19 September 2018. The composition provided for Mr Zappia to pay a total of $140,000, being $40,000 within 14 days of acceptance of the composition and $100,000 in two $50,000 payments within 9 and 18 months respectively of the date of acceptance of the composition. The Deputy Commissioner voted against acceptance of the composition. 6 The principles which apply to an application to set aside a composition were identified by Merkel J in Re Mills; Ex parte Lloyd's (1997) 73 FCR 551 at 559 to 561, with the relevant factors (as cited in Moran v Robertson [2012] FCA 371 at [16]) including: (1) 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 is called for; (2) 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; (3) 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, but 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": Augustyn v Putnin (1988) 83 ALR 514 at 515; (4) 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; and (5) a Court may be more disposed to set aside a composition if no payments to creditors have been made pursuant to the composition. 7 A number of factors in the present case weigh in favour of the setting aside of the composition. 8 First, it is apparent from the evidence that the trustee considered Mr Zappia's financial affairs to be complex. If the creditors had not voted in favour of the composition the trustee recommended that, having regard to the complexity of Mr Zappia's financial affairs, there be a public examination of Mr Zappia to allow a collection of information and evidence that would support future recovery action in the bankrupt estate. 9 Second, according to the trustee's calculations, the composition would offer creditors a return of 1.98 cents in the dollar compared to a range of between 0.23 cents in the dollar and 1.29 cents in the dollar if the bankruptcy were to proceed. It would be fair to characterise the return under the composition as little or trivial with the consequence that the potential harm to creditors from the setting aside of the composition will be minimal. 10 Third, some creditors provided affidavits which disclosed that they voted in favour of the composition with the view to achieve objectives distinct from their interest as a creditor in recovering what is owed to them: Deputy Commissioner of Taxation v Alternative Business Solutions (Aust) Pty Ltd (Administrators Appointed) [2006] FCA 400 at [9]. Accordingly, those creditors said that they had voted for the composition for the purpose of assisting Mr Zappia to re-establish his commercial affairs. From this it must be inferred that those creditors did not exercise their vote informed only by their interest as creditors and it is this interest, rather than their desire to rehabilitate Mr Zappia, which is of fundamental importance under the legislative scheme. 11 Fourth, it emerged in evidence that Mr Zappia had made representations to a number of creditors that if and when he rehabilitated himself he would be aiming to repay the money he owed to them irrespective of the composition. Contrary to the submissions for Mr Zappia, this raises the very real issue that the composition is affected by a kind of equitable fraud. As the Deputy Commissioner pointed out, a composition is a contract between all creditors. In ET Fisher & Co Pty Ltd v English, Scottish and Australian Bank Ltd [1940] HCA 42; [1941] ALR 1 Starke J described the essence of a composition as an arrangement in which all of the creditors are dealt with equally without the intrusion of any private bargain destroying that equality. In Grocon Constructors Pty Ltd v Kimberley Securities Ltd [2009] NSWSC 541 at [69] Barrett J said: It is pertinent, at this point, to refer to a species of equitable fraud identified by Lord Hardwicke in a passage in Earl of Chesterfield v Janssen (1750) 2 Ves Sen 125; 28 ER 82 quoted with approval by Owen J in Bell Group Ltd v Westpac Banking Corporation (No 9) [2008] WASC 239; (2008) 70 ACSR 1 at [4860]. His Lordship said at 100: "Where a debtor enters into a deed of composition with his creditors for 10s in the pound, or any other rate, attended with a proviso that all creditors executed this within a certain period, if the debtor privately agrees with one creditor to induce him to sign this deed, that he will pay or secure a greater sum in respect of his particular debt: in this there can be no particular deceit on the debtor, who is party thereto: but it tends to deceit of the other creditors, who relied on an equal composition, and did it out of compassion to the debtor. This court therefore relieves against all such underhand bargains." 12 In the present case the evidence does not establish the existence of any binding contract between Mr Zappia and some of his creditors, but it does establish that Mr Zappia represented to some of his creditors that he would repay their debts in full if and when he was able to do so. From this it must be inferred that those creditors may well have voted in favour of the composition on the basis of an expectation that they would or could receive more than the composition enabled them to receive. In my view, this is a factor which weighs heavily in favour of the setting aside of the composition. 13 Fifth, I accept the contentions of the Deputy Commissioner that there are matters in the bankruptcy which warrant further investigation by the trustee and which have the capacity to yield greater return to creditors. Contrary to the approach for Mr Zappia, it was not a matter for the Deputy Commissioner to have carried out investigations for the purpose of proving that the trustee's conclusions were in error. The issues are the prospect or possibility of a greater return and whether a more extensive investigation is called for in all of the circumstances. The fact the trustee was of the view Mr Zappia's financial affairs are complex and that he would have recommended a public examination of Mr Zappia if the creditors had not voted in favour of accepting the composition supports the setting aside of the composition. As the Deputy Commissioner's submissions pointed out, there are matters which would appear to call for a more extensive investigation including: (1) the value of Mr Zappia's interest in 8 Rutar Place, Abbotsbury depends on the value of a series of other properties which also secure the indebtedness of JRZ Harley Pty Ltd to the National Australia Bank. Those other properties have not been valued, their value being estimated only. The capacity of JZR Harley Pty Ltd to meet its obligations itself is unknown. Accordingly, there is at least a prospect of a greater recovery from 8 Rutar Place than proposed by the trustee, which further examination of Mr Zappia's affairs may well disclose; (2) it is not apparent why there would be a contest in relation to the sale of Mr Zappia's one sixth share of a property at 19 Walker Place, Wetherill Park. Mr Zappia's evidence was that his co-owners were his family and he did not wish to cause a family issue but the fact is he has a one sixth share in that property and if the other co-owners do not wish to buy him out the trustee could have pursued a sale of the property; (3) Mr Zappia's wife is the owner of a property at 5 Unsworth Street, Abbotsbury. Although Mrs Zappia owned the property before her marriage to Mr Zappia there have been no investigations of Mr Zappia's contributions to the property either in the form of mortgage repayments or potential improvements, which might result in Mr Zappia having an interest in the property; (4) there have been various share transfers and changes in the status of shares held by Mr Zappia which have not been investigated. For example, Mr Zappia held shares beneficially in JRZ Harley Pty Ltd until 22 November 2010 when he thereafter held the shares on trust for the Zappia Investment Trust. The change in the holding has not been investigated. Mr Zappia was a shareholder in One Whitsunday Development Pty Ltd but said that he was registered as a shareholder in error. The explanation for this error is not currently apparent; and (5) Mr Zappia owns a number of motor vehicles which are the subject of encumbrances in favour of Mr Zappia's solicitor. How those encumbrances came about has not been investigated although the trustee did not accept the validity of the solicitor's interest in one of the vehicles. 14 Contrary to the submissions for Mr Zappia, it is not to the point that the Deputy Commissioner has neither carried out investigations nor is in a position to assert that any conclusion reached by the trustee as to the value or lack of value of any asset is wrong. The trustee has acknowledged in a Circular to creditors dated 22 January 2018 that "there are multiple issues with assets and creditor claims in this administration…" and opined that a public examination of Mr Zappia would be of assistance in examining his examinable affairs. In other words, the point is that there are a number of matters arising in the bankruptcy, which are of some complexity and suggest that there may be the potential for greater return to creditors than the trivial return of 1.98 cents in the dollar offered under the composition. When these circumstances are taken with the fact that it should be inferred that some creditors voted in favour of the composition not solely on the basis of their interest as creditors and may have been influenced to do so by representations from Mr Zappia that if he "got back on his feet" he would repay them their debts in full, I consider that there is a compelling case to set aside the composition. There are circumstances which call for a greater inquiry into Mr Zappia's affairs than has occurred to date. 15 To the extent that other submissions were made for Mr Zappia, I do not find them material to the matters in issue. For example, the fact that the Deputy Commissioner refused a settlement offer from Mr Zappia is not a reason to refuse to set aside the composition in the circumstances which otherwise call for it to be set aside. The Deputy Commissioner was right to contend that the settlement offer itself was potentially problematic as it would have involved the Deputy Commissioner receiving a payment greater than that available under the composition and the assignment of its debt to a third party. As the Commissioner recognised, this would have tended to undermine the good faith as between creditors who are to be treated equally by the composition. The fact that Mr Zappia has issues about his indebtedness to the Deputy Commissioner is also immaterial. Whatever concerns Mr Zappia may have about his dealings with the Deputy Commissioner do not weigh as material factors in the resolution of this matter. 16 In summary, on the evidence, I accept the Deputy Commissioner's submission that: The Composition should be set aside because there is a real possibility that further investigation into the affairs of Mr Zappia in bankruptcy may yield a better return to creditors. Mr Zappia's financial affairs are complex, and his debts are significant: the return offered under the Compromise is not sufficiently high as to deny creditors the opportunities of those investigations. I certify that the preceding sixteen (16) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Jagot. Associate: Dated: 19 December 2019