New South Wales Supreme Court CITATION : Karam v ANZ Banking Group Limited & 1Ors [2003] NSWSC 866 HEARING DATE(S) : 19 June 2003 JUDGMENT DATE : 22 September 2003 JURISDICTION: Equity JUDGMENT OF : Santow J DECISION : Other than $63,549 on the equipment account, the Bank fails on its cross-claim. Bank liable to Plaintiffs for $1,235,575 (plus interest as calculated after 14 January 2003) with respect to the residential properties. Bank to pay 85% of the Plaintiffs' costs of the proceedings. Final orders to be submitted by the parties within 14 days. CATCHWORDS : BANKING - Appropriation of payment - what constituted a "true inference" to appropriate - authority to debit payments on Bank's part - does it preclude earlier appropriation by debtor by deposit into trading account - Can a deposit into a certain account suffice for an appropriation vis a vis the Bank. Farrow Finance Company Ltd (in liquidation) v ANZ Executors and Trustee Company Ltd & Ors (Supreme Court of Victoria, 13 December 1996, unreported) Healey v Commonwealth Bank of Australia [1998] NSWSC 678 CASES CITED : Knysh v Corrales Pty Limited (1989) 15 ACLR 629 Leeson v Leeson (1936) 2 KB 156 Parker v Guinness (1910) 27 TLR 129 Re Walsh: ex parte Deputy Commissioner of Taxation (NSW) (1982) 42 ALR 727 Charles Raymond KARAM (First Plaintiff; First Cross-Defendant) John Raymond KARAM (Second Plaintiff; Second Cross-Defendant) PARTIES : Nada Marie KARAM (Third Plaintiff; Third Cross-Defendant) Diane KARAM (Fourth Plaintiff; Fourth Cross-Defendant) AUSTRALIA & NEW ZEALAND BANKING GROUP LIMITED (First Defendant; Cross-Claimant) William Croker (Second Defendant) FILE NUMBER(S) : SC 2142/97 COUNSEL : M L D Einfeld, QC (Plaintiffs; Cross-Defendants) M Walton, SC/ P J Dowdy (First Defendant; Cross-Claimant) SOLICITORS : Webster O'Halloran Associates (Plaintiffs; Cross-Defendants) Coudert Brothers (First Defendant; Cross-Claimant) IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION SC 2142/97 SANTOW J 22 SEPTEMBER 2003 Charles Raymond KARAM First Plaintiff John Raymond KARAM Second Plaintiff Nada Marie KARAM Third Plaintiff Diane KARAM Fourth Plaintiff AUSTRALIA & NEW ZEALAND BANKING GROUP LIMITED First Defendant William Croker Second Defendant AUSTRALIA & NEW ZEALAND BANKING GROUP LIMITED Cross-Claimant Charles Raymond KARAM First Cross-Defendant John Raymond KARAM Second Cross-Defendant Nada Marie KARAM Third Cross-Defendant Diane KARAM Fourth Cross-Defendant Judgment INTRODUCTION 1 In my judgment ("the judgment") of 21 August 2001 at [506] to [512] I set out my overall conclusions and summing up. Subsequently on 16 May 2002 I made additional observations following the parties' attempt to settle orders giving effect to that judgment ("the Observations"). What follows represents a further question addressed by the parties, in order now to finalise orders giving effect to the judgment. 2 The effect of that judgment and the additional observations is that the Karam interests (the first to fourth plaintiffs) remain liable under their personal guarantees for what is described as "non-Ingleburn indebtedness of the company". This essentially represents trading indebtedness for ordinary trading debts as distinct from what is described as "Ingleburn-related indebtedness", for which the Karam interests are not liable. The latter consists of non-trading indebtedness which in general terms can be described as property and construction costs in relation to the Ingleburn factory and property (see judgment, paras [506-8] and especially [506(n)]). 3 It was confirmed in the Observations (Para 5(a) and 6) that the Ingleburn Property Account and the Construction Account should be treated as Ingleburn-related indebtedness and that the Equipment Loan should not. It is undisputed that there are five relevant KBF accounts (previously described in the affidavit of R A Green sworn 29 October 2001, and the plaintiffs' submissions re the orders of 16 May 2002, para 7) as follows: (a) Account No. 8332 50418, constituted by a Fully Drawn Advance for the purchase of the Ingleburn Property ("Ingleburn Property Account"), in debit in the sum of $233,839.07 as at 1.08.01; (b) Account No. 8332 69215, constituted by a Fully Drawn Advance utilised for construction of the factory on the Ingleburn Property "the Construction Account"), in debit in the sum of $968,686.04 as at 1.08.01; (c) Account No. 8333 53097, constituted by a Fully Drawn Advance utilised to purchase equipment installed in the Ingleburn Factory ("the Equipment Account"), in debit in the sum of $66,003.17 as at 1.08.01; (d) Account No. 2282 61231, a current account operated in overdraft ("the Overdraft Account") from which business expenses and interest on the Ingleburn Property Account, Construction Account and Equipment Account were paid, in debit in the sum of $1,165,709.60 as at 1.08.01; (e) Account No. 8333 33547, constituted by a Fully Drawn Advance used to convert $1 million of the Overdraft Account into a fixed loan account in December 1993 (called, somewhat inaccurately, the "Working Capital FDA"), in debit in the sum of $543,246.18 as at 1.08.01. 4 It is agreed that (i) the accounts listed under 3(a) and (b) are Ingleburn-related indebtedness in the sense used in the judgment and were established in the early 1990's; (ii) the account under 3(c) above is non-Ingleburn-related indebtedness in terms of the judgment, and was established in the early 1980's; (iii) the accounts in 3(d) and (e) above are likewise non-Ingleburn-related indebtedness and were established in the early 1980's. 5 It is not disputed that first, money being all its trading income was paid by way of deposit by the Karam owned company, Karam Bros Footwear Pty Limited (KBF) into the trading account in 3(d) above, being as I have said, a trading account for non-Ingleburn-related indebtedness. Nor is it disputed that the Bank then debited that overdraft or trading account with the interest on the Ingleburn land and construction debt, so that the money thereby went into accounts 3(a) and (b) above; that is to say it was towards interest on the Ingleburn-related indebtedness. 6 It is not disputed that there was authority on the Bank's part so to debit account No. 2282 61231 being an overdraft or trading account, pursuant to the documents signed by the Karams on 19 October 1992 and subsequently on 4 November 1993. 7 The wording of the authorisation is identical in each case and I set it out below: "Nominated Account The Nominated Account to which the Bank is authorised to debit amounts due and payable by the Customer to the Bank under the Agreement, and any costs, legal expenses and other amounts in respect of which the Customer indemnifies the Bank under the Agreement is: Account No. 2282 61231 Held at the Ingleburn Branch of the Bank (BSB 012-318)." 8 This language does not in its terms preclude the debtor's prior appropriation of a deposit in reduction of the overdraft or trading account to which paid. The facility Agreement of 19 October 1992 and also 4 November 1983 sets out the various facilities and includes both the overdraft facility and the facilities in relation to the Ingleburn property as well as other facilities. 9 The issues remaining to be determined in order to give effect to my judgment are as follows: (a) What proportion of the overdraft account in 3(d) above and the Working Capital FDA is attributable to "non-Ingleburn-related indebtedness" and thus recoverable by the Bank under the guarantee, and what proportion is attributable to "Ingleburn-related indebtedness" and thus not recoverable under the guarantee; and (b) Costs. 10 It is common ground that the issue under 9(a) above involves the determination of what amount of the total interest applicable to the Ingleburn-related indebtedness, if any, must be taken to have been paid in reduction by Karam company, KBF; a question which depends in turn on whether there has been a prior appropriation by KBF as the debtor in reduction of the overdraft, being non-Ingleburn related indebtedness; see Observations para 7. 11 The basis upon which that determination is to be made (Observations para 7) is that: "Subject to ascertaining whether there has been a specific appropriation of monies paid in the relevant account in terms of the principles set out by Giles JA in Healey v Commonwealth Bank of Australia (NSWCA, 8 December 1998, unreported) the applicable rules for running accounts including the rule in Clayton's case should be applied in correctly making the calculation." 12 For the purposes of the argument, the Karams accept the calculations of Mr Carter, who is the defendant's expert, in his report of 10 September 2002, but only on the assumption that a "Clayton's case" approach is applicable, a matter which the plaintiffs dispute. 13 The plaintiffs contend that the Clayton's case approach has no application. The starting point is the principles set out by Giles JA in Healey v Commonwealth Bank of Australia [1998] NSWSC 678 at p3 (to which reference was made in my Observations at para 7): "When a debtor who owes distinct debts to a creditor makes a payment to the creditor he may appropriate the money as he pleases, and the creditor must apply it accordingly; if the debtor does not direct an appropriation at the time he makes the payment , the right of application devolves on the creditor." [emphasis added] 14 It will be noted that the appropriation must be made by the debtor at the time of payment to the creditor and, I would add, or "by" the time of payment. If then made that precludes any contrary appropriation by the creditor. Clearly an appropriation cannot be made after that payment by the debtor unilaterally. 15 The plaintiffs' submissions then proceed as follows: "10. Here, the relevant trading accounts (leaving aside the Equipment Account) were the Overdraft Account and the Working Capital FDA (the latter established by debiting $1 million to a new account to reduce the Overdraft Account by an equivalent amount); the Ingleburn related accounts were the Ingleburn Property Account and the Construction Account. The present task is to ascertain how much of the Company's indebtedness on the Overdraft Account and working Capital FDA (totalling $1,725,590.83) was derived from [or is represented by] monies paid or applied to interest on the Ingleburn Property Account and Construction Account. 11. On each occasion on which KBF relevantly paid money to the Bank, it did so by depositing funds into its Overdraft Account. At each such point, there was an appropriation by KBF to the trading account of the Company (i.e. a reduction of the trading indebtedness). 12. These appropriations of monies paid into the overdraft Account have had the consequence of reducing continuously the trading indebtedness. Payments from the Overdraft Account in satisfaction of interest (totalling $2,277,092.17) were for Ingleburn-related indebtedness. They exceed the indebtedness on the Overdraft Account and Working Capital FDA (totalling $1,725,590.83). There is thus no resulting liability by the Karams on their guarantee. 13. Incidentally, the debits against the Overdraft Account in reduction of Ingleburn debts (though made with KBF's authority) were not "appropriations" for present purposes – they did not purport to constitute "appropriations" of any particular payment(s) made by KBF to its Overdraft Account. 14. The proposition of Mr Carter [Carter Report, 23.4.03, para 10], that the debiting to the Overdraft Account of interest relating to Ingleburn represents payment by KBF of its normal trading expenses (having regard to (allegedly) usual business practice, and the debit authorities given by KBF), is not in point. The Court has already determined that interest applicable to either the Ingleburn Property Account or the Construction Account "should be treated as Ingleburn related indebtedness" [Observations paras 5(a), 6]; it must therefore be indebtedness of KBF not covered by the Karams' guarantee. 15. In the result, the Bank fails on its cross-claim against the Karams personally (other than for $63,549.00 on the Equipment Account); but the Bank is liable to the Karams for $1,235,575.00 (as at 14.1.03) with respect to the residential properties." 16 The defendant puts its case in these terms: "1. Claytons Case establishes that where there is an account into which receipts and payments are carried in order of date there is a prima facie presumption that the first item on the debit side of the account is intended to be discharged or reduced by the first item on the credit side, and that the various items are appropriated in the order in which the receipts and payments are set against each other in the account. 2. Whilst Claytons Case accepts that a customer can direct the Bank as to the manner of appropriation of payments within a current account it establishes that in so far as the customer does not so appropriate the silence of the customer after receipt of his banking account is regarded as an admission of its being correct. 3. In the present case the rule in Claytons Case applies to each of KBF's accounts with the Bank referred to above. Each time that a payment is effected by the company by it authorising the transfer of funds between its respective accounts the rule is triggered in respect of that account into which the transfer is made. ……… 7. The deposit by the company of funds into its overdraft account from time to time is insufficient by itself to constitute an appropriation of those funds exclusively to the debt attributable to that account. If however it is considered to be sufficient for this purpose then so too must each transfer of funds by KBF (that is pursuant to its authority and direction) from that account to the FDA account or accounts be an appropriation by the company of part of its available working capital towards reducing the debt in that account or those accounts. As explained by Mr Carter in his 2nd report, the periodical debiting of an operating account pursuant to the customer's authority or direction so as to satisfy the repayment or interest servicing regime of a fully drawn advance account is the form such payments most commonly, indeed almost universally, take. There is no distinction in principle between this method of payment and any other, such as the drawing and payment of a cheque, the withdrawal and deposit of cash, or a transfer by the internet or by other electronic means. 8. Mr Carter at paragraph 10(b) of his report in reply, which is dated 23rd April 2003, refers to KBF's nomination dated 1st December 1992 and a further nomination enclosed with the Letter of Offer dated 14th November 1993. there can be no argument that these nominations constituted an authority and direction to the Bank by KBF in express terms to effect payments from the company's operating account in order to reduce and eventually discharge KBF liabilities in respect of its loan accounts. In so doing KBF was adopting the usual method of making such payments, just as it might have done in respect of any of its operating costs. None of this appears to have been considered by Mr Bell [the Plaintiffs' expert] in his report, and this indicates the flaw in the approach he has adopted. As previously noted, apart from this matter, Mr Bell agrees in the methodology and result of Mr Carter's calculations." RESOLUTION OF LEGAL QUESTION 17 Essentially, the dispute between the parties comes down to this. Where there was no written communication from the plaintiff debtor by way of an express request or direction to appropriate a payment or payments to particular indebtedness, "is the true inference to be drawn from all of the circumstances of the case that the debtor paid the monies generally on account, leaving the creditor to apply them as he saw fit, or is the true inference to be that he paid them on account of specific portions of the debt for the purposes and with a view to wipe these out of the debt" such inference to be drawn from the circumstances "at the time of payment"; Parker v Guinness (1910) 27 TLR 129 at 130-1 per Lush J. In putting the question in these terms, one must of course take into account the circumstance of the authority to debit, to which I have earlier made reference. 18 Before dealing with the application of the principle to which I have earlier made reference, I need to say a little more of Healey v Commonwealth Bank of Australia (supra). Giles JA (at p3) continued as follows: Rolfe J held [at trial] referring to Colonial Bank of Australasia v Kerr (1889) 15 VLR 314, that a customer's direction to his bank as to appropriation of a payment must be in clear terms, that there was not in this case a sufficient statement as to how the sum should be appropriated , and that the funds were furnished with no instruction to apply them in reduction of the mortgage account. There was no appeal from his Honour's decision in this respect." [emphasis added] 19 I do not understand Giles JA to controvert what Lush J said in Parker v Guinness (supra) at 130, namely: "It is clear, I think, that the debtor need not state in express terms that he appropriates the payment he makes in any particular way". Then follows the reference to what is "the true inference" to be drawn from all of the circumstances of the case. The case before Giles JA did not involve an appeal from that part of Rolfe J's holding to which I have earlier made reference. Moreover to require that the appropriation be exclusively in writing, with heavy emphasis on clear terms as distinct from what is sufficient in the circumstances to ground that inference, would not comport with the trend of other decisions such as Knysh v Corrales Pty Limited (1989) 15 ACLR 629 at 633 where the full court of the Federal Court approved the earlier statement of Lush J. Similarly Lockhart J in Re Walsh: ex parte Deputy Commissioner of Taxation (NSW) (1982) 42 ALR 727. Lockhart J quoted with approval the following passage of Leeson v Leeson (1936) 2 KB 156 at 162-3 which accepts that appropriation may be inferred and need not be express, though it must still involve more than an intention in the mind of the debtor not sufficiently communicated to the creditor: "When, however, he does not notify the creditor of his intention, and when the circumstances are such that the creditor receives the payment merely in satisfaction of the debts and the payment is not more appropriate to the payment of the one debt than to that of the other the creditor is entitled to make the appropriation. When it is said that there need not be an express appropriation of a payment, but that the appropriation can be inferred, that does not mean that appropriation of a payment can be inferred from some undisclosed intention in the mind of the debtor. It is to be inferred from the circumstances of the case as known to both parties. Any other view might lead to injustice, as the creditor's right to appropriate a payment would be defeated. When the matter is examined upon principle it will be found that an undisclosed intention in the mind of the debtor is not sufficient to support an appropriation. If authority is needed for that proposition it can be found in the judgment of Lush J in Parker v Guinness 27 Times LR 129 at 130 where he said: 'What is to be considered is this. Is the true inference to be drawn from all the circumstances of the case that the debtor paid the moneys generally on account, leaving the creditor to apply them as he thought fit, or is the true inference that he paid them on account of special portions of the debt for the purpose and with a view to wipe these out of the account? His undisclosed intention so to do would, of course, not benefit him. It is what he did in fact, and not what he meant to do that is to be regarded.' A debtor's undisclosed intention to appropriate a payment to one of two debts owed by him to a creditor cannot benefit him." 20 As to what suffices to make an appropriation where no express appropriation has been made, Lockhart J in Re Walsh (supra) at 773 makes the following comments in concluding that the relevant monies had been appropriated to the 1981 debt rather than the earlier 1979 debt: "Judgment was entered in the Supreme Court against the debtor on 19 August 1981 in respect of his liability for tax for the years 1975 to 1978. It is true that it was not until 26 October 1981 that the Supreme Court dismissed the debtor's application to appeal out of time from the Board's decision. It is true also that tax became due and payable by the debtor on the date specified in the notice of assessment for the 1979 year (namely 22 September 1980) and that the pendency of the reference to the Board of Review in respect of such tax did not operate to prevent the creditor recovering it (s 201). But a fair reading of the correspondence between the parties and their advisers establishes clearly to my mind that they were all talking about the debtor's liability to the creditor under the judgment entered on 19 August 1981 and the debtor's proposals to satisfy that liability. Their attention was not directed to the debt due by the debtor in respect of the 1979 year. The debtor never admitted the correctness of the 1979 assessment and therefore was not likely to make a payment on that account, especially when judgment had been recently entered against him in respect of the earlier years of income and a bankruptcy notice could be issued against him in respect of that judgment debt. Notwithstanding that the letters from the debtor to the creditor accompanying the four payments in question did not specifically appropriate the payments to the judgment debt, when considered together with all the other documents and the probabilities, the debtor must be regarded as having appropriated all four payments to the judgment debt." 21 In Healey itself, there was, as I have explained, no need to consider the particular issue of what kind of circumstances suffice for an appropriation in a case where the appropriation was said to be based on an authority and letter which it was uncontested on appeal, did not constitute a sufficient statement by way of appropriation. 22 In Knysh & Anor v Corrales Pty Ltd (supra), the full court of the Federal Court accepted that a communication to appropriate could be inferred from the circumstances. At 633 the conclusion as to that inference being properly able to be drawn from the correspondence, accompanied by payments is set out: "In our opinion, the proper inference from the evidence is that the receiver intended to appropriate the payments made by him to the debt for which he was responsible and that his intention was known to Corrales at the time the payments were made. The correspondence which passed between the parties prior to the payments being made, made it clear that the payments the receiver would be making would be in reduction of his indebtedness. It was said, in terms, in the letter of 9 September 1987 that the payments to be made would be made in reduction of the indebtedness in respect of the post-receivership trading." 23 Finally, I should refer to Farrow Finance Company Ltd (in liquidation) v ANZ Executors and Trustee Company Ltd & Ors (Supreme Court of Victoria, 13 December 1996, unreported), a case regarding the payment of settlement accounts. Hansen J quoted Knysh at 36: "The critical question was whether [the debtor] appreciated at the time it received the payments that they were intended to be made by the [creditor] in satisfaction of his liability." 24 The objective circumstances of that case were not such that one could infer an intention to appropriate the settlement payment. The defendants had calculated their offer by reference to the principal outstanding amount of the notes (the debt that they argued was the debt on account of which they had appropriated an amount) but this was considered insufficient for the purpose of proving the requisite intention: "[I]n the circumstances of this case the fact that the defendants to the ASC proceeding calculated their offer by reference only to one particular debt - that is, by calculating the value of 85% of the principal amount of the notes held by the plaintiffs - was not a sufficient circumstance from which one could infer an appropriation. Taking all the circumstances into account, I am of the firm view that there was no appropriation of the settlement payment." 25 I turn now to the circumstances before me. Accepting that there was no written appropriation, and bearing in mind the principle that an appropriation is made by the debtor at, meaning by no later than, the time of the payment, I consider that the true inference to be drawn is that an appropriation was made by the debtor (via KBF) when the monies were deposited into the overdraft account. One may take it that this was done by some deposit slip or electronic means, or some other pre-arrangement, by which the account for the deposit was in each case sufficiently identified. The deposit was thereby deliberately made by KBF as debtor to that account, all this being clearly with the knowledge of the Bank. That action amounts to an appropriation by the debtor, unless there were an overriding agreement to the contrary – but there was not. True it is that the Bank was authorised thereafter to debit amounts due and payable by the Customer to the Bank under the relevant facility Agreement. But that authorisation was not expressed as overriding or precluding any prior appropriation that might be made. The debiting, without more, was simply a mechanism of payment, but was not such as to preclude or cancel out the debtor's prior appropriation. There is nothing in either facility Agreement which precludes a prior appropriation of that sort. Nor did the authorisation in those Agreements operate by its terms so as to deem there to be an immediate appropriation by the Bank from the time any money was paid into the overdraft account. The authorisation clearly permitted the Bank thereafter and at any time to take monies from the overdraft account, augmented or reduced as it might be by deposits and payments, as and when the Bank so chose. It was perfectly understandable that the Bank would want to have some control over the build up of liquidity in the trading account, by sweeping money across from time to time, by way of direct debit, to the other accounts. The authorisation which permitted this is properly to be understood as simply a payment mechanism and not an appropriation mechanism, by enabling the Bank by direct debit to take money from a trading account and apply it from time to time as the bank so chose. But importantly the Bank inherits the state of the account after the deposit and any other intermediate transactions and with whatever appropriation has previously been made. There is nothing to suggest that these unsophisticated borrowers would have understood otherwise. 26 Any bank statement issued at any particular point of time following a deposit would show the amount in the overdraft account increased at that time by the amount of the deposit, albeit subject to decrease subsequently should the Bank choose to make debits as indeed it did. Clearly the Bank appreciated that appropriation had taken place, from the simple fact that it knew the overdraft has been augmented by the deposits, before the Bank's direct debit to the overdraft account. Ordinarily, of course, this would not matter. The Bank held its security, including personal guarantees. It was only the differential effect of later setting aside part of the Bank's security on the ground of unconscionability that appropriation does come to matter. That said, it is true that if there were no appropriation by the debtor, payment into a general trading or overdraft account would be a normal precursor to appropriation thereafter by the creditor Bank. 27 In short, the appropriation had occurred at the time of the deposit. It is too late for the Bank thereafter to contend that it has, by way of the prior authorisation and subsequent debit, made after the deposit, "appropriated" in circumstances where there was that prior appropriation by the debtor. The argument to the contrary, that the debtor must have understood that any deposit it made was subject to the overriding ability of the bank to allocate by debit amounts under the various indebtedness categories represented by particular facilities, is not reflected in the documentation. Nor would I expect the authorisation to convey this. Nor do I accept that because it would be conventional and normal as the Bank's expert Mr Carter says, for monies to be paid into a trading account before appropriation to other categories of indebtedness represented by particular facilities, that therefore payment into the account could not have evinced any intention, understood by the Bank, to appropriate these monies to the trading account. It was open to the Bank by appropriate wording to make clear that no appropriation would so result from a deposit. It did not do so. The fact of a deposit clearly does point in the circumstances to an appropriation of the funds to the reduction of the overdraft account even though the funds in the account from time to time could be taken out and used ostensibly to reduce other accounts by debit on the Bank's part. CONCLUSION 28 I consider that the Bank fails on its cross-claim against the Karams personally (other than for $63,549 on the equipment account). I further conclude that the Bank is liable to the Karams for $1,235,575 (as at 14 January 2003) with respect to the residential properties, with interest to be calculated for the period thereafter. 29 As to costs, while the Bank has had some success, on the majority of issues the Karams have succeeded. In all the circumstances, I consider that the Bank should pay 85% of the Karam's costs of the proceedings. 30 I direct the parties to submit final orders within 14 days giving effect to this and the previous judgment and observations. ********** Last Modified: 09/30/2003 DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. 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